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RAYTHEON CO/ - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Edgar Glimpses Via Acquire Media NewsEdge)
Management's Discussion and Analysis (MD&A) of Financial Condition and Results
of Operations are outlined below:
MD&A Topic Page
Overview 29
Financial Summary 33
Critical Accounting Estimates 34
Consolidated Results of Operations 41
Segment Results 48
Financial Condition and Liquidity 66
Capital Resources 70
Contractual Obligations 71
Off-Balance Sheet Arrangements 72
Commitments and Contingencies 72
Accounting Standards 75
OVERVIEW
Introduction
Raytheon Company develops technologically advanced, integrated products,
services and solutions in four core defense markets: sensing; effects; command,
control, communications and intelligence (C3I); and mission support, as well as
other important markets, such as cybersecurity. We serve both domestic and
international customers, as both a prime contractor and subcontractor on a broad
portfolio of defense and related programs for primarily government customers.
We operate in six business segments: Integrated Defense Systems (IDS);
Intelligence and Information Systems (IIS); Missile Systems (MS); Network
Centric Systems (NCS); Space and Airborne Systems (SAS); and Technical Services
(TS). For a more detailed description of our segments, see "Business Segments"
within Item 1 of this Form 10-K.
In this section, we discuss our industry and how certain factors may affect our
business, key elements of our strategy, and how our financial performance is
assessed and measured by management. Next, we discuss our critical accounting
estimates, which are those estimates that are most important to both the
reporting of our financial condition and results of operations and require
management's subjective judgment. We then review our results of operations for
2012, 2011 and 2010, beginning with an overview of our total company results,
followed by a more detailed review of those results by business segment. We also
review our financial condition and liquidity including our capital structure and
resources, off-balance sheet arrangements, commitments and contingencies, as
well as changes in accounting standards, and conclude with a discussion of our
exposure to various market risks.
Industry Considerations
Domestic Considerations
The U.S. Government continues to focus on efforts to both stimulate the economy
and reduce federal budget deficits in order to address the growing amount of
national debt. The Budget Control Act of 2011 (BCA) was enacted as part of the
Administration's and Congress' effort to reduce the deficit. The BCA reduces the
U.S. Department of Defense's (DoD) base budget (excluding funding for operations
in Afghanistan) by $487 billion over the ten-year period from fiscal year
(FY)2012 - FY 2021 relative to the long-range defense plans that accompanied the
FY 2012 budget request.
The BCA also required Congress to enact legislation by January 15, 2012 that
would result in deficit reduction of at least $1.2 trillion, which Congress has
not done. Pursuant to the terms of the BCA, as amended by the American Taxpayer
Relief Act of 2012, a sequestration is scheduled to commence on March 1, 2013
that would result in a total of nearly $1.2 trillion in reduced funding over the
FY 2013 - FY 2021 period. Unless Congress and the Administration agree to amend,
delay, or revoke the BCA, the DoD will bear approximately 50% of the cuts,
excluding reduced interest payments, under
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sequestration. DoD officials estimate that such sequestration would reduce
funding for the DoD by approximately $45 billion in FY 2013 and nearly $500
billion over the FY 2013 - FY 2021 period, relative to long-term plans provided
as part of the DoD's FY 2013 budget request.
Both Administration officials and senior congressional leaders have indicated
their desire to avoid sequestration, and agreed to delay the commencement of
sequestration from the originally scheduled date of January 2, 2013 until the
current date of March 1, 2013. However, it remains uncertain whether
sequestration will be averted fully or in part, or delayed further, due to the
overall fiscal constraints of the U.S. Government and the difficulty of enacting
relevant legislation. As a result, a broad range of potential outcomes for the
DoD budget in FY 2013 and future years remains possible at this time, with the
specific outcome depending upon decisions and legislation that will need to be
agreed upon by the Administration and Congress. In addition, there are potential
changes in how sequestration could be implemented that will determine the
impacts that may result, and officials in both the Administration and Congress
have indicated that the DoD may be given more flexibility than the BCA currently
provides. As a result, the specific impact of sequestration, if any, as well as
any other potential actions on U.S. Government spending and future DoD budgets
and our programs are unknown at this time and we are unable to predict the
effect any of the foregoing would have on our future financial performance and
outlook. Nonetheless, in the event that sequestration does go into effect, or if
other actions are taken to significantly reduce the DoD budget, it is possible
that such reductions and related cancellations or delays affecting our existing
contracts or programs could have a significant impact on the operating results
of our business.
With respect to U.S. defense priorities, the DoD issued strategic guidance in
January 2012 regarding its priorities for the next ten years. The DoD guidance
identified the primary missions of the U.S. armed forces and the capabilities
expected to be critical to future success, including intelligence, surveillance
and reconnaissance (ISR), missile defense, electronic warfare, unmanned systems,
special operations forces, interoperability with allied forces and
cybersecurity. Although the actual impact of implementation of the strategic
guidance on the DoD budget and our programs is uncertain, we believe that we
continue to be well positioned to support and provide many of these critical and
enduring missions and capabilities.
U.S. Government sales, excluding foreign military sales, accounted for 73% of
our total net sales in 2012. Our principal U.S. Government customer is the DoD.
Although DoD funding has grown substantially since FY 2001, when it was
approximately $300 billion, given the current budget environment, future
domestic defense spending levels are difficult to predict and may decline over
the next several years. A number of additional factors potentially impacting the
DoD budget include the following:
- External threats to our national security, including potential security
threats posed by terrorists, emerging nuclear states and other countries;
- Support for on-going operations overseas, including Afghanistan, which will
require funding above and beyond the DoD base budget for their duration;
- Reductions as a result of sequestration, or lesser reductions as an
alternative to sequestration;
- Disruptions to federal appropriations from default, a government shutdown, or
a year-long continuing resolution (CR);
- Cost-cutting measures implemented by the DoD, such as the "Better Buying
Power" initiative, to ensure more efficient use of its resources in order to
sufficiently fund its highest priorities;
- Priorities of the Administration and the Congress, including but not limited
to deficit reduction, which could result in changes in the overall DoD budget
and various allocations within the DoD budget; and
- The overall health of the U.S. and world economies and the state of
governmental finances.
Congress has not yet made a final appropriation for the DoD for FY 2013. The DoD
is scheduled to operate until March 27, 2013 under the terms of a CR. The CR
caps funding, on an annualized basis, for the DoD base budget at 0.6% over the
FY 2012 approved base budget of $531 billion. However, since the FY 2012 base
budget is greater than the Administration's request of $525 billion for FY 2013,
we do not expect funding for the CR to exceed the requested amount for FY 2013.
The Administration's request for the DoD FY 2013 base budget represents a
reduction of 1% from the prior year's approved amount and reflects the
constrained budget environment. Although the Administration's long-term plan,
published in February 2011, contemplates a modest increase in DoD funding for
future years, the results of deficit reduction actions or changes in priorities
by the Administration and/or Congress could reduce these projections.
Overseas Contingency Operations (OCO) in Afghanistan (and before they were
concluded, in Iraq), have largely been funded apart from the DoD base budget to
better maintain visibility and oversight of war costs. Under the CR, OCO funding
for FY 2013 is $88 billion. This is lower than the $115 billion enacted for FY
2012 OCO activities, due to reduced
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operations in Afghanistan and conclusion of operations in Iraq. Looking forward,
OCO funding is expected to continue to decline as troops redeploy out of
Afghanistan. The request for future OCO funding will be determined on an
as-needed basis and will likely be closely correlated to the amount of troops
required for each operation. OCO funding has not been a significant source of
new orders for Raytheon in the last three years, and is not expected to be so in
future years.
Although the uncertainty of funding changes that may result from the BCA, among
other factors, makes predicting the DoD budget beyond FY 2013 difficult, we
expect the DoD to continue to prioritize and protect the key capabilities
required to execute its strategy, including ISR, cybersecurity, missile defense,
electronic warfare, unmanned systems, special operations forces and
interoperability with allied forces. We believe those priorities are well
aligned with our product offerings, technologies, services and capabilities.
With respect to other domestic customers beyond the DoD, we have contracts with
a wide range of U.S. Government agencies, including the Department of Justice
(DoJ), the Department of State, the Department of Energy, the Intelligence
Community, the National Aeronautics and Space Administration (NASA), the Federal
Aviation Administration (FAA), the Department of Homeland Security (DHS) and the
National Science Foundation (NSF). Similar to the budget environment for the
DoD, we expect the Administration will have to take the spending limits imposed
by the BCA into account when determining spending priorities for these agencies.
Our relationship with these agencies generally is determined more by specific
program requirements than by a direct correlation to the overall funding levels
for these agencies; however, further changes in government spending priorities
may adversely impact these specific programs. We also have contracts with
various state and local government agencies that also are subject to budget
constraints and conflicts in spending priorities.
We currently are involved in over 15,000 contracts, with no single contract
accounting for more than 5% of our total net sales in 2012. Although we believe
our diverse portfolio of programs and capabilities is well suited to a changing
defense environment, we face numerous challenges and risks, as discussed above.
For more information on the risks and uncertainties that could impact the U.S.
Government's demand for our products and services, see Item 1A "Risk Factors" of
this Form 10-K.
International Considerations
In 2012, our sales to customers outside of the U.S. accounted for 26% of our
total net sales (including foreign military sales through the U.S. Government).
Internationally, the growing threat of additional terrorist activity, cyber
threats, emerging nuclear states, long-range missiles and conventional military
threats have led to an increase in demand for defense products and services and
homeland security solutions. In North Asia, both short- and long-term security
concerns are increasing demand for air and missile defense, air/naval
modernization, maritime security, homeland security and air traffic management.
In the Middle East, threats from state and non-state actors are increasing
demand for air and missile defense, air/land/naval force modernization,
precision engagement, maritime security, border security, and cybersecurity
solutions. In South America, the economic growth in some developing countries is
being accompanied by an increase in defense spending. While this region has
traditionally been a smaller market for U.S.-based suppliers, it is likely to
see above average growth rates in the future. In Europe, nations continue to
manage downward pressure on defense spending as their governments grapple with
regional economic challenges and reprioritize accordingly. Although these global
economic challenges may continue to restrain and even shrink the defense budgets
of certain European nations, requirements for advanced air and missile defense
capabilities continue to exist in the European market. Overall, we believe many
international defense budgets have the potential to grow and to do so at a
faster rate than the U.S. defense budget.
International customers have and are expected to continue to adopt defense
modernization initiatives similar to the DoD. We believe this trend will
continue as many international customers are facing a threat environment that is
similar to the U.S. and they are looking for advanced weapons and sensor
systems. Alliance members also wish to assure their forces and systems will be
interoperable with U.S. and North Atlantic Treaty Organization (NATO) forces.
However, international demand is sensitive to changes in the priorities and
budgets of international customers and geo-political uncertainties, which may be
driven by changes in threat environments and potentially volatile worldwide
economic conditions, various regional and local economic and political factors,
risks and uncertainties, as well as U.S. foreign policy. For more information on
the risks and uncertainties that could impact international demand for our
products and services, see Item 1A "Risk Factors" of this Form 10-K.
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Our Strategy and Opportunities
The following are the broad elements of our strategy:
- Focus on key strategic pursuits, Technology and Mission Assurance, to sustain
and grow our position in four core defense markets: Sensing, Effects, C3I and
Mission Support;
- Leverage our domain knowledge in air, land, sea, space and cyber for all
markets;
- Expand international business by building on our relationships and deep
market expertise;
- Continue to be a customer-focused company based on performance, relationships
and solutions; and
- Deliver innovative supply chain solutions to accelerate growth, create competitive advantage and bring valued, global solutions to our customers.
Our Markets
We believe that our broad mix of technologies, domain expertise and key
capabilities and our cost-effective, best-value solutions and their alignment
with customer needs in our core markets, position us favorably to continue to
grow and increase our market share. Our core markets also serve as a solid base
from which to expand into growth areas, such as Cybersecurity and key mission
areas. We continually explore opportunities to leverage our existing
capabilities, or develop or acquire additional ones, to expand into growth
markets.
Sensing-Sensing encompasses technologies that acquire precise situational data
across air, space, ground and underwater domains and then generate the
information needed for effective battlespace decisions. Our Sensing technologies
span the full electromagnetic spectrum, from traditional radio frequency (RF)
and electro-optical (EO) to wideband, hyperspectral and acoustic sensors. We are
focused on leveraging our sensing technologies to provide a broad range of
capabilities as well as expanding into growth markets such as sensors to detect
weapons of mass destruction.
Effects-Effects achieve specific military actions or outcomes, from small-unit
force protection to theater/national missile defense. The missions may be
achieved by kinetic means, directed energy or information operations. Our
Effects capabilities include advanced airframes, guidance and navigation
systems, multiple sensor seekers, targeting, net-enabled systems,
multi-dimensional effects, directed energy and cyber systems.
Command, Control, Communication and Intelligence (C3I)-C3I systems provide
integrated real-time support to decision-makers on and off the battlefield,
transforming raw data into actionable intelligence. Our C3I capabilities include
situational awareness, persistent surveillance, communications, mission
planning, battle management command and control, intelligence and analysis, and
integrated ground solutions. We are also continuing to grow our market presence
in C3I and expand our knowledge management and discovery capabilities.
Mission Support-We are focused on enabling customer success through total
life-cycle support that predicts customer needs, senses potential problems and
proactively responds with the most appropriate solutions. Our Mission Support
capabilities include technical services, system engineering, product support,
logistics, training, operations and maintenance. Our training business continues
to expand and we now train military, civil and commercial customers in over 80
countries and in 40 different languages.
Cybersecurity-We continue to enhance our capabilities in the cybersecurity
market as well as leverage the capabilities of the twelve cyber acquisitions
made since 2007. We are focused on providing cyber capabilities to the
Intelligence, DoD and DHS markets as well as embedding information assurance
capabilities in our products and our IT infrastructure. In 2012, we acquired
Teligy, Inc., which specializes in wireless communications, vulnerability
analysis, reverse engineering and custom kernel software/device driver
development. Also in 2012, we acquired the Government Solutions business of
SafeNet, Inc., which provides encryption products for integration at all levels,
and targets high-speed, satellite, networking, data link, voice, key management,
and wireless communication markets.
Key Mission Areas-Within our market focus areas, we emphasize our capabilities
in key mission areas of enduring importance to our customers. These key mission
areas include missile defense, ISR and electronic warfare. In a
budget-constrained environment, customers are increasingly seeking
cost-effective mission solutions. These solutions can take the form of new
electronics or electronic upgrades, but draw on our market focus area
capabilities, deep domain expertise and system architecture skills.
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International Growth
Because of the breadth of our offerings, our systems integration capability, the
value of our solutions and our strong legacy in the international marketplace,
we believe that we are well positioned to continue to grow our international
business. As discussed under "International Considerations," we believe demand
continues to grow for solutions in air and missile defense, air traffic
management, precision engagement, homeland security, naval systems integration
and ISR. In addition, as coalition forces increasingly integrate military
operations worldwide, we believe that our capabilities in network-enabled
operations will continue to be a key discriminator in these markets.
Our international sales, including foreign military sales through the U.S.
Government, were $6.2 billion in 2012 and $6.1 billion in 2011, and our
international bookings were $6.0 billion in 2012 and $7.7 billion in 2011.
Focus on the Customer and Execution
Our customer focus continues to be a critical part of our strategy-underpinned
by a focus on performance, relationships and solutions. Performance means being
able to meet customer commitments which is ensured through strong processes,
metrics and oversight. We maintain a "process architecture" that spans our six
businesses and our broad programs and pursuits. It consists of processes such as
Integrated Product Development System (IPDS), which assures consistency of
evaluation and execution at each step in a program's life-cycle. It also
includes our Achieving Process Excellence (APEX), which is our SAP business
system software for accounting, finance and program management; Process
Re-Invention Integrating Systems for Manufacturing (PRISM), which is our SAP
software for manufacturing operations; Advanced Company Estimating System (ACES)
which is our cost proposal system; and Raytheon Enterprise Supplier Assessment
(RESA) tool for Supply Chain Management. These processes and systems are linked
to an array of front-end and back-end metrics. With this structure, we are able
to track results and be alerted to potential issues through numerous oversight
mechanisms, including operating reviews and annual operating plan reviews.
We are also continuing to build strong customer relationships by working with
them as partners and including them on Raytheon Six SigmaTM teams to jointly
improve their programs and processes. We are increasingly focused on responding
to our customers' changing requirements with rapid and effective solutions to
real-world problems. In recognition of our customers' constraints and
priorities, we also continue to drive various cost reductions across the Company
by continuing to focus on improving productivity and strong execution throughout
our programs. We have worked to reduce costs across the Company, improve
efficiencies in our production facilities, and continue to increase value
through Raytheon Six SigmaTM, the implementation of lean processes, reduced
cycle times and strategic supply chain initiatives in addition to other
initiatives.
FINANCIAL SUMMARY
We use the following key financial performance measures to manage our business
on a consolidated basis and by business segment, and to monitor and assess our
results of operations:
- Bookings-a forward-looking metric that measures the value of new contracts
awarded to us during the year;
- Net Sales-a growth metric that measures our revenue for the current year;
- Operating Income-a measure of our profit from continuing operations for the
year, before non-operating expenses, net and taxes; and
- Operating Margin-a measure of our operating income as a percentage of total
net sales.
We also focus on earnings per share (EPS), including Adjusted EPS, and measures
to assess our cash generation and the efficiency and effectiveness of our use of
capital, such as free cash flow (FCF) and return on invested capital (ROIC).
Considered together, we believe these metrics are strong indicators of our
overall performance and our ability to create shareholder value. We feel these
measures are balanced among long-term and short-term performance, efficiency and
growth. We also use these and other performance metrics for executive
compensation purposes.
In addition, we maintain a strong focus on program execution and the prudent
management of capital and investments in order to maximize operating income and
cash. We pursue a capital deployment strategy that balances funding for growing
our business, including capital expenditures, acquisitions, and research and
development; prudently managing our balance sheet, including debt repayments and
pension contributions; and returning cash to our stockholders, including
dividend payments and share repurchases.
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Bookings were $26.5 billion, $26.6 billion and $24.4 billion in 2012, 2011 and
2010, respectively, resulting in backlog of $36.2 billion, $35.3 billion and
$34.6 billion at December 31, 2012, 2011 and 2010, respectively. Backlog
represents the dollar value of contracts awarded for which work has not been
performed. Backlog generally increases with bookings and generally converts into
sales as we incur costs under the related contractual commitments. We therefore
discuss changes in backlog, including any significant cancellations, for each of
our segments, as we believe such discussion provides an understanding of the
awarded but not executed portion of our contracts. As described in Commitments
and Contingencies, beginning on page 72, in the second quarter of 2010, Raytheon
Systems Limited (RSL) was notified of its termination on the U.K. Border Agency
(UKBA) program, which resulted in a net backlog adjustment of $556 million at
IIS.
Total net sales were $24.4 billion, $24.8 billion and $25.2 billion in 2012,
2011 and 2010, respectively.
Operating income was $3.0 billion, $2.8 billion and $2.6 billion in 2012, 2011
and 2010, respectively. Operating margin was 12.2%, 11.4% and 10.4% in 2012,
2011 and 2010, respectively. Included in operating income was the FAS/CAS
Adjustment, described below in Critical Accounting Estimates, of $255 million,
$337 million and $187 million of expense in 2012, 2011 and 2010, respectively.
Operating cash flow from continuing operations was $2.0 billion, $2.1 billion
and $1.9 billion in 2012, 2011 and 2010, respectively.
A discussion of our results of operations and financial condition follows below
in Consolidated Results of Operations; Segment Results; Financial Condition and
Liquidity; and Capital Resources.
CRITICAL ACCOUNTING ESTIMATES
Our consolidated financial statements are based on the application of U.S.
Generally Accepted Accounting Principles (GAAP), which require us to make
estimates and assumptions about future events that affect the amounts reported
in our consolidated financial statements and the accompanying notes. Future
events and their effects cannot be determined with certainty. Therefore, the
determination of estimates requires the exercise of judgment. Actual results
could differ from those estimates, and any such differences may be material to
our consolidated financial statements. We believe the estimates set forth below
may involve a higher degree of judgment and complexity in their application than
our other accounting estimates and represent the critical accounting estimates
used in the preparation of our consolidated financial statements. We believe our
judgments related to these accounting estimates are appropriate. However, if
different assumptions or conditions were to prevail, the results could be
materially different from the amounts recorded.
Revenue Recognition
We determine the appropriate method by which we recognize revenue by analyzing
the type, terms and conditions of each contract or arrangement entered into with
our customers. The significant estimates we make in recognizing revenue for the
types of revenue-generating activities in which we are involved are described
below. We classify contract revenues as product or service according to the
predominant attributes of the relevant underlying contracts unless the contract
can clearly be split between product and service. We define service revenue as
revenue from activities that are not associated with the design, development or
production of tangible assets, the delivery of software code or a specific
capability. Our services sales are primarily related to our TS business segment.
Percentage-of-Completion Accounting-We use the percentage-of-completion
accounting method to account for our long-term contracts associated with the
design, development, manufacture, or modification of complex aerospace or
electronic equipment and related services, such as certain cost-plus service
contracts. Under this method, revenue is recognized based on the extent of
progress towards completion of the long-term contract. Our analysis of these
contracts also contemplates whether contracts should be combined or segmented in
accordance with the applicable criteria under GAAP. We combine closely related
contracts when all the applicable criteria under GAAP are met. The combination
of two or more contracts requires judgment in determining whether the intent of
entering into the contracts was effectively to enter into a single project,
which should be combined to reflect an overall profit rate. Similarly, we may
segment a project, which may consist of a single contract or group of contracts,
with varying rates of profitability, only if the applicable criteria under GAAP
are met. Judgment also is involved in determining whether a single contract or
group of contracts may be segmented based on how the arrangement was negotiated
and the performance criteria. The decision to combine a group of contracts or
segment a contract could change the amount of revenue and gross profit recorded
in a given period.
The selection of the method by which to measure progress towards completion of a
contract requires judgment and is based on the nature of the products or
services to be provided. We generally use the cost-to-cost measure of progress
for our long-
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term contracts unless we believe another method more clearly measures progress
towards completion of the contract. Under the cost-to-cost measure of progress,
the extent of progress towards completion is measured based on the ratio of
costs incurred to date to the total estimated costs at completion of the
contract. Contract costs include labor, material and subcontracting costs, as
well as an allocation of indirect costs. Revenues, including estimated fees or
profits, are recorded as costs are incurred. Due to the nature of the work
required to be performed on many of our contracts, the estimation of total
revenue and cost at completion (the process for which we describe below in more
detail) is complex and subject to many variables. Incentive and award fees
generally are awarded at the discretion of the customer or upon achievement of
certain program milestones or cost targets. Incentive and award fees, as well as
penalties related to contract performance, are considered in estimating profit
rates. Estimates of award fees are based on actual awards and anticipated
performance, which may include the performance of subcontractors or partners
depending on the individual contract requirements. Incentive provisions that
increase or decrease earnings based solely on a single significant event
generally are not recognized until the event occurs. Such incentives and
penalties are recorded when there is sufficient information for us to assess
anticipated performance. Our claims on contracts are recorded only if it is
probable that the claim will result in additional contract revenue and the
amounts can be reliably estimated.
We have a Company-wide standard and disciplined quarterly Estimate at Completion
(EAC) process in which management reviews the progress and performance of our
contracts. As part of this process, management reviews information including,
but not limited to, any outstanding key contract matters, progress towards
completion and the related program schedule, identified risks and opportunities,
and the related changes in estimates of revenues and costs. The risks and
opportunities include management's judgment about the ability and cost to
achieve the schedule (e.g., the number and type of milestone events), technical
requirements (e.g., a newly-developed product versus a mature product), and
other contract requirements. Management must make assumptions and estimates
regarding labor productivity and availability, the complexity of the work to be
performed, the availability of materials, the length of time to complete the
contract (to estimate increases in wages and prices for materials and related
support cost allocations), performance by our subcontractors, the availability
and timing of funding from our customer, and overhead cost rates, among other
variables. These estimates also include the estimated cost of satisfying our
industrial cooperation agreements, sometimes referred to as offset obligations
required under certain contracts. Based on this analysis, any quarterly
adjustments to net sales, cost of sales, and the related impact to operating
income are recorded as necessary in the period they become known. These
adjustments may result from positive program performance, and may result in an
increase in operating income during the performance of individual contracts, if
we determine we will be successful in mitigating risks surrounding the
technical, schedule, and cost aspects of those contracts or realizing related
opportunities. Likewise, these adjustments may result in a decrease in operating
income if we determine we will not be successful in mitigating these risks or
realizing related opportunities. Changes in estimates of net sales, cost of
sales, and the related impact to operating income are recognized quarterly on a
cumulative catch-up basis, which recognizes in the current period the cumulative
effect of the changes on current and prior periods based on a contract's
percentage of completion. A significant change in one or more of these estimates
could affect the profitability of one or more of our contracts. When estimates
of total costs to be incurred on a contract exceed total estimates of revenue to
be earned, a provision for the entire loss on the contract is recorded in the
period the loss is determined.
Our operating income included net EAC adjustments resulting from changes in
estimates of approximately $613 million, $548 million and $158 million for the
years ended December 31, 2012, 2011 and 2010, respectively. These adjustments
increased our income from continuing operations attributable to Raytheon Company
common stockholders by approximately $398 million ($1.19 per diluted share),
$348 million ($0.98 per diluted share), and $75 million ($0.20 per diluted
share) for the years ended December 31, 2012, 2011 and 2010, respectively.
Other Revenue Methods-To a much lesser extent, we enter into other types of
contracts such as service, commercial, or software and licensing arrangements.
Revenue under fixed-price service contracts not associated with the design,
development, manufacture, or modification of complex aerospace or electronic
equipment and commercial contracts generally is recognized upon delivery or as
services are rendered once persuasive evidence of an arrangement exists, our
price is fixed or determinable, and collectability is reasonably assured. Costs
on fixed-price service contracts are expensed as incurred, unless they otherwise
qualify for deferral. There were no costs deferred on fixed price service
contracts at December 31, 2012 and December 31, 2011. We recognize revenue on
contracts to sell software when evidence of an arrangement exists, the software
has been delivered and accepted by the customer, the fee is fixed or
determinable, and collection is probable. For software arrangements that include
multiple elements, including perpetual software licenses and undelivered items
(e.g., maintenance and/or services; subscriptions/term licenses), we allocate
and defer revenue for the undelivered items based on vendor specific objective
evidence (VSOE) of the fair value of the undelivered elements, and
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recognize revenue on the perpetual license using the residual method. We base
VSOE of each element on the price for which the undelivered element is sold
separately. We determine fair value of the undelivered elements based on
historical evidence of our stand-alone sales of these elements to third parties
or from the stated renewal rate for the undelivered elements. When VSOE does not
exist for undelivered items, we recognize the entire arrangement fee ratably
over the applicable performance period. Revenue from non-software license fees
is recognized over the expected life of the continued involvement with the
customer. Royalty revenue is recognized when earned.
We apply the separation guidance under GAAP for contracts with multiple
deliverables. We analyze revenue arrangements with multiple deliverables to
determine if the deliverables should be divided into more than one unit of
accounting. For contracts with more than one unit of accounting, we allocate the
consideration we receive among the separate units of accounting based on their
relative selling prices, which we determine based on prices of the deliverables
as sold on a stand-alone basis, or if not sold on a stand-alone basis, the
prices we would charge if sold on a stand-alone basis, and we recognize revenue
for each deliverable based on the revenue recognition policies described above.
Other Considerations-The majority of our sales are driven by pricing based on
costs incurred to produce products or perform services under contracts with the
U.S. Government. Cost-based pricing is determined under the Federal Acquisition
Regulations (FAR). The FAR provide guidance on the types of costs that are
allowable in establishing prices for goods and services under U.S. Government
contracts. For example, costs such as those related to charitable contributions,
certain merger and acquisition costs, lobbying costs, interest expense and
certain litigation defense costs are unallowable. In addition, we may enter into
agreements with the U.S. Government that address the allowability and allocation
of costs to contracts for specific matters. Certain costs incurred in the
performance of our U.S. Government contracts are required to be recorded under
GAAP but are not currently allocable to contracts. Such costs are deferred and
primarily include a portion of our environmental expenses, asset retirement
obligations, certain restructuring costs, deferred state income tax, workers'
compensation and certain other accruals. These costs are allocated to contracts
when they are paid or otherwise agreed. We regularly assess the probability of
recovery of these costs. This assessment requires us to make assumptions about
the extent of cost recovery under our contracts and the amount of future
contract activity. If the level of backlog in the future does not support the
continued deferral of these costs, the profitability of our remaining contracts
could be adversely affected.
Pension and other postretirement benefits costs are allocated to our contracts
as allowed costs based upon the U.S. Government Cost Accounting Standards (CAS).
The CAS requirements for pension and other postretirement benefit costs differ
from the Financial Accounting Standards (FAS) requirements under GAAP. Given the
inability to match with reasonable certainty individual expense and income items
between the CAS and FAS requirements to determine specific recoverability, we
have not estimated the incremental FAS income or expense to be recoverable under
our expected future contract activity, and therefore did not defer any FAS
expense for pension and other postretirement benefit plans. This resulted in
$255 million, $337 million and $187 million of expense in 2012, 2011 and 2010,
respectively, reflected in our results of operations for the difference between
CAS and FAS requirements for our pension and other postretirement plans in those
years.
Pension and Other Postretirement Benefits Costs
We have pension plans covering the majority of our employees, including certain
employees in foreign countries. We must calculate our pension costs under both
CAS and FAS requirements under GAAP, and both calculations require judgment. CAS
prescribes the allocation to and recovery of pension costs on U.S. Government
contracts through the pricing of products and services and the methodology to
determine such costs. GAAP outlines the methodology used to determine pension
expense or income for financial reporting purposes. The CAS requirements for
pension costs and its calculation methodology differ from the FAS requirements
and calculation methodology. As a result, while both CAS and FAS use long-term
assumptions in their calculation methodologies, each method results in different
calculated amounts of pension cost. In addition, the cash funding requirements
for our pension plans are determined under the Employee Retirement Income
Security Act of 1974 (ERISA). ERISA funding requirements use a third and
different method to determine funding requirements, which is primarily based on
the year's expected service cost and amortization of other previously unfunded
liabilities.
Effective January 1, 2011, we are subject to the funding requirements under the
Pension Protection Act of 2006 (PPA), which amended ERISA. Under the PPA, we are
required to fully fund our pension plans over a rolling seven-year period as
determined annually based upon the funded status at the beginning of each
year. Due to the foregoing differences in requirements and calculation
methodologies, our FAS pension expense or income is not indicative of the
funding
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requirements or amount of government recovery.
On December 27, 2011, the CAS Pension Harmonization Rule (CAS Harmonization) was
published in the Federal Register. The rule will impact pension costs on
contracts beginning in 2013 and is effective for forward pricing purposes for
contracts negotiated on or after February 27, 2012. The rule is intended to
improve the alignment of the pension cost recovered through contract pricing
under CAS and the pension funding requirements under the PPA. The rule shortens
the CAS amortization period for gains and losses from 15 to 10 years and
requires the use of a discount rate based on high quality corporate bonds to
measure liabilities in determining the CAS pension expense. While the change in
amortization period is applicable in 2013, there is a transition period for the
impact of the change in liability measurement method of 0% in 2013, 25% in 2014,
50% in 2015, 75% in 2016 and 100% in 2017. CAS Harmonization is currently
expected to increase pension costs under CAS and is also expected to decrease
our FAS/CAS expense primarily in 2014 and beyond due to the liability
measurement transition period included in the rule. Since the pension cost
increases occur primarily in 2014 and beyond, the impact to our contracts in
existence prior to February 27, 2012 was not material. Furthermore, since CAS
Harmonization is a mandatory change in cost accounting for government
contractors, we may be entitled to an equitable adjustment for some portion of
the increase in costs on contracts.
We record CAS expense in the results of our business segments. Due to the
differences between FAS and CAS amounts, we also present the difference between
FAS and CAS expense, referred to as our FAS/CAS Pension Adjustment, which is a
component of our total FAS/CAS Adjustment disclosed as a separate line item in
our segment results. This effectively increases or decreases the amount of total
pension expense in our results of operations so such amount is equal to the FAS
expense amount under GAAP. Due to the foregoing differences in requirements and
calculation methodologies, our FAS pension expense or income is not indicative
of the funding requirements or amount of government recovery.
The assumptions in the calculations of our pension FAS expense and CAS expense,
which involve significant judgment, are described below.
FAS Expense-Our long-term return on plan assets (ROA) and discount rate
assumptions are the key variables in determining pension expense or income and
the funded status of our pension plans under GAAP.
The long-term ROA represents the average rate of earnings expected over the long
term on the assets invested to provide for anticipated future benefit payment
obligations. We employ a "building block" approach in determining the long-term
ROA assumption. Historical markets are studied and long-term relationships
between equities and fixed income are assessed. Current market factors such as
inflation and interest rates are evaluated before long-term capital market
assumptions are determined. The long-term ROA assumption is also established
giving consideration to investment diversification, rebalancing and active
management of the investment portfolio. Also, historical returns are reviewed to
assess reasonableness and appropriateness.
The investment policy asset allocation ranges for our domestic pension plans, as
set by the Company's Investment Committee, for the year ended December 31, 2012
were as follows:
Asset Category
U.S. equities 25% - 35%
International equities 15% - 25%
Fixed-income securities 25% - 40%
Cash and cash equivalents 1% - 10%Private equity and private real estate 3% - 10%
Other (including absolute return funds) 5% - 20%
In validating the 2012 long-term ROA assumption, we reviewed our pension plan
asset performance since 1986. Our average actual annual rate of return since
1986 has exceeded our estimated 8.75% assumed return. Based upon these analyses
and our internal investing targets, we determined our long-term ROA assumption
for our domestic pension plans in 2012 was 8.75%, consistent with our 2011
assumption. Our domestic pension plans' actual rates of return were
approximately 12%, (1)% and 11% for 2012, 2011 and 2010, respectively. The
difference between the actual rate of return and our long-term ROA assumption is
included in deferred losses. If we significantly change our long-term investment
allocation or strategy, then our long-term ROA assumption could change.
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The long-term ROA assumptions for foreign Pension Benefits plans are based on
the asset allocations and the economic environment prevailing in the locations
where the Pension Benefits plans reside. Foreign pension assets do not make up a
significant portion of the total assets for all of our Pension Benefits plans.
The discount rate represents the interest rate that should be used to determine
the present value of future cash flows currently expected to be required to
settle the pension and postretirement benefit obligations. The discount rate
assumption is determined by using a theoretical bond portfolio model consisting
of bonds AA rated or better by Moody's for which the timing and amount of cash
flows approximate the estimated benefit payments for each of our pension plans.
The discount rate assumption for our domestic pension plans at December 31, 2012
is 4.15%, which represents a weighted-average discount rate across our plans,
compared to the December 31, 2011 discount rate of 5.00% as a result of the bond
environment at December 31, 2012.
An increase or decrease of 25 basis points in the long-term ROA and the discount
rate assumptions would have had the following approximate impacts on 2012
pension results:
(In millions)
Change in assumption used to determine net periodic benefit cost for the
year ended December 31, 2012
Discount rate $ 60
Long-term ROA 40Change in assumption used to determine benefit obligations for the year
ended December 31, 2012
Discount rate
$ 645
CAS Expense-In addition to providing the methodology for calculating pension
costs, CAS also prescribes the method for assigning those costs to specific
periods. While the ultimate liability for pension costs under FAS and CAS is
similar, the pattern of cost recognition is different. The key drivers of CAS
pension expense include the funded status and the method used to calculate CAS
reimbursement for each of our plans. Under the existing CAS rules, which
continue to apply through 2012, the discount rate used to measure liabilities is
required to be consistent with the long-term ROA assumption, which changes
infrequently given its long-term nature. In addition to certain other changes,
CAS Harmonization will require contractors to compare the liability under the
current CAS methodology and assumptions to a liability using a discount rate
based on high quality corporate bonds and use the greater of the two liability
calculations in developing CAS expense. In addition, unlike FAS, we can only
allocate pension costs for a plan under CAS until such plan is fully funded as
determined under CAS requirements. When the estimated future CAS pension costs
increase, the estimated CAS cost to be allocated to our contracts in the future
increases.
Other FAS and CAS Considerations-On an annual basis, at December 31, we update
our estimate of future FAS and CAS pension expense based upon actual discount
rates, asset returns and other actuarial factors. Other variables that can
impact the pension plans' funded status and FAS and CAS expense include
demographic experience such as the expected rates of salary increase, retirement
age, turnover and mortality. In addition, certain pension plans provide a lump
sum benefit that varies based on externally determined interest rates.
Assumptions for these variables are set at the beginning of the year, and are
based on actual and projected plan experience. In addition, on a periodic basis,
generally planned annually in the third quarter, we update our actuarial
estimate of the unfunded projected benefit obligation for both FAS and CAS with
final census data from the end of the prior year.
The components of the FAS/CAS Pension Adjustment were as follows:
(In millions)
2012 2011 2010
FAS expense $ (1,093 ) $ (1,073 ) $ (896 )
CAS expense 838 733 666
FAS/CAS Pension Adjustment $ (255 ) $ (340 ) $ (230 )
In accordance with both FAS and CAS, a "market-related value" of our plan assets
is used to calculate the amount of deferred asset gains or losses to be
amortized. The market-related value of assets is determined using actual asset
gains or losses over a certain prior period (three years for FAS and five years
for CAS, subject to certain limitations under CAS on the difference between the
market-related value and actual market value of assets). Because of this
difference in the number of years over which actual asset gains or losses are
recognized and subsequently amortized, FAS expense generally
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tends to reflect recent asset gains or losses faster than CAS. Another driver of
CAS expense (but not FAS expense) is the funded status of our pension plans
under CAS. As noted above, CAS expense is only recognized for plans that are not
fully funded; consequently, if plans become or cease to be fully funded under
CAS due to our asset or liability experience, our CAS expense will change
accordingly.
The change in the FAS/CAS Pension Adjustment of $85 million in 2012 compared to
2011 was driven by a $105 million increase in our CAS expense, primarily due to
the continued recognition of the 2008 negative asset returns.
The change in the FAS/CAS Pension Adjustment of $110 million in 2011 compared to
2010 was primarily driven by a $177 million increase in our FAS expense. The
$177 million increase in our FAS expense was driven primarily by the continued
recognition of the 2008 losses in the market related value of assets, which had
an impact of approximately $200 million. Our CAS expense increased $67 million
as a result of actual versus expected asset and liability experience.
For 2013 compared to 2012, we currently expect our FAS expense will increase
more than our CAS expense, which will increase the FAS/CAS Pension Adjustment.
We expect the FAS/CAS Pension Adjustment to be approximately $289 million of
expense driven by the lower discount rate environment and the difference in the
recognition period for actual asset gains and losses under FAS and CAS,
described above. This expected increase in FAS expense in excess of CAS expense
is subject to our annual update, generally planned in the third quarter, of our
actuarial estimate of the unfunded benefit obligation for both FAS and CAS for
final 2012 census data. After 2013, the FAS/CAS Pension Adjustment is more
difficult to predict because future FAS and CAS expense is based on a number of
key assumptions for future periods. Differences between those assumptions and
future actual results could significantly change both FAS and CAS expense in
future periods. However, based solely on our current assumptions at December 31,
2012 and taking into account CAS Harmonization, which increases CAS expense in
2013 and beyond, we would expect after 2013 our FAS/CAS Pension Adjustment
expense to decline and ultimately result in FAS/CAS Pension Adjustment income in
2015.
The pension and other postretirement benefit plans' investments are stated at
fair value. Investments in equity securities (common and preferred) are valued
at the last reported sales price when an active market exists. Investments in
fixed-income securities are generally valued using methods based upon market
transactions for comparable securities and various relationships between
securities which are generally recognized by institutional traders. Investments
in private equity and private real estate funds are estimated at fair market
value which primarily utilizes net asset values reported by the investment
manager or fund administrator. We review independently appraised values, audited
financial statements and additional pricing information to evaluate the net
asset values. For the very limited group of securities and other assets for
which market quotations are not readily available or for which the above
valuation procedures are deemed not to reflect fair value, additional
information is obtained from the investment manager and evaluated internally to
determine whether any adjustments are required to reflect fair value. The change
in accumulated other comprehensive loss (AOCL) related to pension and other
postretirement benefit plans is as follows:
(In millions) 2012 2011 2010
Beginning balance $ (10,776 ) $ (7,931 ) $ (7,526 )
Amortization of net losses included in net income 950 800 573
Loss arising during the period (2,225 ) (3,645 ) (978 )
Ending balance $ (12,051 ) $ (10,776 ) $ (7,931 )
The balance in AOCL related to our pension and other postretirement benefit
plans is composed primarily of differences between changes in discount rates,
differences between actual and expected asset returns, differences between
actual and assumed demographic experience and changes in plan provisions.
Changes to our pension and other postretirement benefit obligation as a result
of these variables are initially reflected in other comprehensive income. The
deferred gains and losses are amortized and included in future pension expense
over the average employee service period of approximately 10 years at
December 31, 2012. The $2,225 million in 2012 losses arising during the period
were driven primarily by the decrease in the discount rate from 5.00% at
December 31, 2011 to 4.15% at December 31, 2012, which had an impact of
approximately $2.0 billion. The $3,645 million in 2011 losses arising during the
period were driven primarily by the decrease in the discount rate from 5.75% at
December 31, 2010 to 5.00% at December 31, 2011, which had an impact of
approximately $1.7 billion, as well as actual asset returns which were lower
than our expected return, which had an impact of approximately $1.5 billion. The
$978 million in 2010 losses arising during the period were driven primarily by
the decrease in the discount rate from 6.25% at December 31, 2009 to 5.75% at
December 31, 2010, which had an impact of
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approximately $1.0 billion. The historical 25-year average high quality
corporate bond rate is approximately 7%. If our pension benefit obligations were
valued at the historical average rate, we would expect our pension funded
status, on a projected benefit obligation basis, to approximate 100% and the
corresponding AOCL to be substantially reduced.
Impairment of Goodwill
We evaluate our goodwill for impairment annually as of the first day of the
fourth quarter and in any interim period in which circumstances arise that
indicate our goodwill may be impaired. Indicators of impairment include, but are
not limited to, the loss of significant business, significant decreases in
federal government appropriations or funding for our contracts, or other
significant adverse changes in industry or market conditions. No events occurred
during the periods presented that indicated the existence of an impairment with
respect to our goodwill. We estimate the fair value of our reporting units using
a discounted cash flow (DCF) model based on our most recent long-range plan in
place at the time of our impairment testing, and compare the estimated fair
value of each reporting unit to its net book value, including goodwill. We
discount the cash flow forecasts using the weighted-average cost of capital
method at the date of evaluation. The weighted-average cost of capital is
comprised of the estimated required rate of return on equity, based on publicly
available data for peer companies, plus an equity risk premium related to
specific company risk factors, and the after-tax rate of return on debt,
weighted at the relative values of the estimated debt and equity for the
industry. Preparation of forecasts for use in the long-range plan and the
selection of the discount rate involve significant judgments that we base
primarily on existing firm orders, expected future orders, contracts with
suppliers, labor agreements and general market conditions. Significant changes
in these forecasts or the discount rate selected could affect the estimated fair
value of one or more of our reporting units and could result in a goodwill
impairment charge in a future period. The combined estimated fair value of all
of our reporting units from our DCF model resulted in a premium over our market
capitalization, commonly referred to as a control premium. We believe our
control premium is reasonable based upon historic data of premiums paid on
actual transactions within our industry. When available and as appropriate, we
also use comparative market multiples to corroborate our DCF model results.
There was no indication of goodwill impairment as a result of our 2012
impairment analysis. The fair values of each of our reporting units exceeded
their respective net book values, including goodwill. Based on our 2012
impairment analysis, the reporting unit that was closest to impairment had a
fair value in excess of net book value, including goodwill, of more than 47%.
All other factors being equal, a 10% decrease in expected future cash flows for
that reporting unit would result in an excess of fair value over net book value
of approximately 30%. Alternatively, all other factors being equal, a 100 basis
points increase in the discount rate used in the calculation of the fair value
of that reporting unit would result in an excess of fair value over net book
value of approximately 25%. If we are required to record an impairment charge in
the future, it could materially affect our results of operations.
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CONSOLIDATED RESULTS OF OPERATIONS
Selected consolidated results were as follows:
% of Total Net Sales
(In millions, except percentages and
per share data) 2012 2011 2010 2012 2011 2010
Net sales
Products $ 20,380 $ 20,725 $ 21,363 83.5 % 83.6 % 84.9 %
Services 4,034 4,066 3,787 16.5 % 16.4 % 15.1 %
Total net sales 24,414 24,791 25,150 100.0 % 100.0 % 100.0 %
Operating expenses
Cost of sales
Products 15,712 16,245 17,000 64.4 % 65.5 % 67.6 %
Services 3,380 3,419 3,273 13.8 % 13.8 % 13.0 %
Total cost of sales 19,092 19,664 20,273 78.2 % 79.3 % 80.6 %
Administrative and selling expenses 1,629 1,672 1,639 6.7 % 6.7 % 6.5 %
Research and development expenses 704 625 625 2.9 % 2.5 % 2.5 %
Total operating expenses 21,425 21,961 22,537 87.8 % 88.6 % 89.6 %
Operating income 2,989 2,830 2,613 12.2 % 11.4 % 10.4 %
Non-operating (income) expense, net
Interest expense 201 172 126
Interest income (9 ) (14 ) (12 )
Other expense (income), net 18 12 65
Total non-operating (income) expense,
net 210 170 179
Federal and foreign income taxes 878 782 590
Income from continuing operations 1,901 1,878 1,844
Income (loss) from discontinued
operations, net of
tax (1 ) 18 35
Net income 1,900 1,896 1,879
Less: Net income attributable to
noncontrolling
interests in subsidiaries 12 30 39
Net income attributable to Raytheon
Company $ 1,888 $ 1,866 $ 1,840
Diluted earnings per share from
continuing
operations attributable to Raytheon
Company
common stockholders $ 5.65 $ 5.22 $ 4.79
Diluted earnings (loss) per share
from discontinued
operations attributable to Raytheon
Company
common stockholders - 0.05 0.09
Diluted earnings per share
attributable to Raytheon
Company common stockholders 5.65 5.28 4.88
Total Net Sales
The composition of external net sales by products and services for each segment
in 2012 was approximately the following:
External Net Sales by Products and Services (% of segment total external net sales)
IDS IIS MS NCS SAS TS
Products 95% 75% 100% 90% 90% 15%
Services 5% 25% -% 10% 10% 85%
Total Net Sales - 2012 vs. 2011-The decrease in total net sales of $377 million
in 2012 compared to 2011 was primarily due to lower external net sales of $405
million at NCS. The decrease in external net sales at NCS was primarily due to
lower net sales on U.S. Army sensor programs driven principally by planned
declines in production, on certain radio and
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communications programs driven principally by reduced customer program
requirements, on acoustic sensor systems due to higher 2011 deliveries based on
customer demand, on various air traffic control programs due to planned declines
in production and on an international command, control, communications,
computers and intelligence (C4I) program driven principally by program schedule
requirements. The lower net sales at NCS were partially offset by higher net
sales on a close combat tactical radar program and an air traffic control
program due to planned increases in production.
Products and Services Net Sales - 2012 vs. 2011-The decrease in product net
sales of $345 million in 2012 compared to 2011 was primarily due to lower
external product net sales of $355 million at NCS. The decrease in external
product net sales at NCS was primarily due to the activity on the programs
described above. Service net sales in 2012 were relatively consistent with 2011.
Included in service net sales in 2012 was higher external service net sales of
$115 million at IIS, partially offset by lower external service net sales of
$103 million at TS. The increase in external service net sales at IIS was
primarily due to higher service net sales on classified programs and on
cybersecurity solutions driven by recent acquisitions and increased customer
orders. The decrease in external service net sales at TS was primarily due to
lower external service net sales on the NSF Polar contract, which was completed
in the first quarter of 2012.
Total Net Sales - 2011 vs. 2010-The decrease in total net sales of $359 million
in 2011 compared to 2010 was primarily due to lower external net sales of $492
million at IDS, $380 million at NCS and $143 million at TS, partially offset by
higher external net sales of $501 million at SAS and $259 million at IIS. The
decrease in external net sales at IDS was primarily due to lower net sales from
the scheduled completion of certain design and production phases on a U.S. Navy
combat systems program and the deferment of certain work due to the U.S. Navy's
extension of the program schedule and lower net sales, as planned, on an
international Patriot program driven by the completion of scheduled design and
certain production efforts. The decrease in external net sales at NCS was
primarily due to lower net sales on U.S. Army sensor programs due to a planned
decline in production, lower net sales on a combat vehicle sensor program, due
to a program restructuring and related termination for convenience, and lower
net sales on a U.S. Army radar support program, principally due to the
completion of significant upgrade efforts, partially offset by higher net sales
on numerous programs, including acoustic sensor system sales and combat vehicle
sensor program sales for domestic and international customers. The decrease in
external net sales at TS was primarily due to lower net sales on a Defense
Threat Reduction Agency (DTRA) program which completed significant efforts at
the end of 2010 and lower net sales on training programs, principally domestic
training programs supporting the U.S. Army's Warfighter Field Operations
Customer Support (FOCUS) activities due to a decrease in customer determined
activity levels, partially offset by higher net sales on various depot services
operations programs, driven primarily by new contract awards. The increase in
external net sales at SAS was primarily due to higher net sales related to
Raytheon Applied Signal Technology (RAST), which we acquired in the first
quarter of 2011, higher volume on ISR systems programs due to increased bookings
over the last few years driven by customer demand for these capabilities, and
higher volume, as production work increased, as planned, on an international
airborne tactical radar program awarded in the first half of 2010. The increase
in external net sales at IIS was primarily due to the difference in net sales
from the UKBA program on which RSL was notified of its termination in the second
quarter of 2010 (UKBA Program), as described in Commitments and Contingencies,
beginning on page 72. Net sales from the UKBA Program in 2011 were higher than
2010 by $240 million, primarily driven by the adjustment recorded in the second
quarter of 2010 from a change in our estimated revenue and costs (UKBA Program
Adjustment), which negatively impacted sales by $316 million. Also included in
the increase in external net sales at IIS was higher net sales on a GPS command,
control, and mission capabilities program awarded in the first quarter of 2010,
primarily as a result of scheduled design and build efforts.
Products and Services Net Sales - 2011 vs. 2010-The decrease in product net
sales of $638 million in 2011 compared to 2010 was primarily due to lower
external product net sales of $427 million at NCS, $391 million at IDS and $129
million at MS, partially offset by higher external product net sales of $328
million at SAS. The decrease in external product net sales at IDS and NCS and
the increase in external product net sales at SAS were primarily due to the
activity in the programs described above. The decrease in external product net
sales at MS was primarily due to lower net sales on the Standard Missile-2
(SM-2), Evolved Seasparrow Missile (ESSM) and Standard Missile-3 (SM-3)
programs, principally from lower volume driven by scheduled lower production
build rates. The decrease in external product net sales at MS was partially
offset by higher net sales on the Small Diameter Bomb II (SDB II) and Paveway™
programs, principally from higher volume due to scheduled increases in design
and production efforts. The increase in service net sales of $279 million in
2011 compared to 2010 was primarily due to higher external service net sales of
$202 million at IIS and $173 million at SAS, partially offset by lower external
service net sales of $101 million at IDS. The increase in external service net
sales at IIS was primarily due to higher service net sales on classified
programs. The increase in external service net
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sales at SAS was primarily due to increased volume on ISR systems programs and
higher service net sales related to RAST. The decrease in external service net
sales at IDS was spread across numerous programs with no individual or common
significant driver.
Sales to Major Customers-Sales to the DoD were 82%, 82% and 85% of total net
sales in 2012, 2011 and 2010, respectively. Sales to the U.S. Government were
86% of total net sales in 2012 and 2011, and 89% of total net sales in 2010.
Included in both DoD and U.S. Government sales were foreign military sales
through the U.S. Government of $3.2 billion, $3.0 billion and $3.3 billion in
2012, 2011 and 2010, respectively. As described above in Industry
Considerations, U.S. defense spending levels are difficult to predict due to
numerous factors, including U.S. Government budget appropriation decisions and
geo-political events and macroeconomic conditions. Total international sales,
including foreign military sales through the U.S. Government, were $6.2 billion
or 26% of total net sales, $6.1 billion or 25% of total net sales and $5.8
billion or 23% of total net sales in 2012, 2011 and 2010, respectively.
Total Cost of Sales
Cost of sales, for both products and services, consists of labor, material and
subcontract costs, as well as related allocated costs. For each of our
contracts, we manage the nature and amount of direct costs at the contract
level, and manage indirect costs through cost pools as required by government
accounting regulations. The estimate of the actual amount of direct costs and
indirect costs form the basis for estimating our total costs at completion of
the contract.
Total Cost of Sales - 2012 vs. 2011-The decrease in total cost of sales of $572
million in 2012 compared to 2011 was primarily due to decreased external costs
of $196 million at NCS and $132 million at TS, and $82 million of lower expense
in 2012 compared to 2011 related to the FAS/CAS Adjustment described below in
Segment Results. The decrease in external costs at NCS was driven primarily by
the activity on the programs described above in Total Net Sales. The decrease in
external costs at TS was driven primarily by the activity on the NSF Polar
contract described above in Total Net Sales. Included in cost of sales in 2011
was $80 million related to the drawdown by the UKBA on letters of credit
provided by RSL (UKBA LOC Adjustment), as described in Commitments and
Contingencies, beginning on page 72.
Products and Services Cost of Sales - 2012 vs. 2011-The decrease in products
cost of sales of $533 million in 2012 compared to 2011 was primarily due to
lower external product cost of sales of $188 million at IIS, $147 million at
NCS, and $120 million at SAS. The decrease in external product cost of sales at
IIS was driven principally by activity on the UKBA Program, including $80
million related to the UKBA LOC Adjustment in the first quarter of 2011, as
described in Commitments and Contingencies beginning on page 72. The decrease in
external product cost of sales at NCS was driven principally by the activity on
the programs described above in Total Net Sales. The decrease in external
product cost of sales at SAS was primarily due to activity on various classified
programs. Service cost of sales in 2012 was relatively consistent with 2011.
Included in services cost of sales in 2012 was higher external service cost of
sales of $107 million at IIS, driven principally by the activity on the programs
described above in Total Net Sales, partially offset by lower external service
cost of sales of $101 million at TS, driven principally by the activity on the
NSF Polar contract described above in Total Net Sales.
Total Cost of Sales - 2011 vs. 2010-The decrease in total cost of sales of $609
million in 2011 compared to 2010 was primarily due to decreased external costs
of $479 million at IDS, driven primarily by the activity on the U.S. Navy combat
systems program and international Patriot program described above in Total Net
Sales, $340 million at NCS, driven primarily by the activity on the U.S. Army
sensor programs, combat vehicle sensor program and a U.S. Army radar support
program described above in Total Net Sales, partially offset by the activity on
numerous other programs, including acoustic sensor system sales and combat
vehicle sensor program sales for domestic and international customers described
above in Total Net Sales, and $146 million at TS driven primarily by the
activity on the DTRA program and training programs described above in Total Net
Sales, partially offset by the activity on depot services operation programs
described above in Total Net Sales. The decreases in external costs were
partially offset by increased external costs of $395 million at SAS driven
primarily by the activity on RAST programs, the ISR systems programs, and the
international airborne tactical radar program described above in Total Net
Sales, and $150 million of higher expense in 2011 compared to 2010 related to
the FAS/CAS Adjustment described below in Segment Results. Included in cost of
sales in the 2011 was $80 million related to the drawdown by the UKBA on letters
of credit provided by RSL (UKBA LOC Adjustment), as described in Commitments and
Contingencies, beginning on page 72. Included in cost of sales in 2010 was $79
million related to the UKBA Program Adjustment described above in Total Net
Sales.
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Products and Services Cost of Sales - 2011 vs. 2010-The decrease in product cost
of sales of $755 million in 2011 compared to 2010 was primarily due to lower
external product cost of sales of $384 million at IDS and $349 million at NCS,
driven principally by the activity on the programs described above, $188 million
at IIS, driven primarily by activity on the UKBA Program described above in
Total Net Sales and lower external product net sales on various classified
programs, and $152 million at MS, driven principally by the activity on the
programs described above in Total Net Sales. The decrease in product cost of
sales was partially offset by higher external product cost of sales of $266
million at SAS, driven primarily by the activity in the programs described
above. The increase in service cost of sales of $146 million in 2011 compared to
2010 was primarily due to higher external service cost of sales of $129 million
at SAS, driven principally by the activity on ISR systems programs and RAST
described above in Total Net Sales, and $118 million at IIS, driven principally
by the activity on classified programs described above in Total Net Sales. The
increase in service cost of sales was partially offset by lower external service
cost of sales of $95 million at IDS, which was spread across numerous programs
with no individual or common significant driver.
Administrative and Selling Expenses
The decrease in administrative and selling expenses of $43 million in 2012
compared to 2011 was primarily due to decreases in marketing and selling
expenses of $47 million, $27 million lower of acquisition-related costs for
RAST, and a $15 million increase in insurance recovery, net of legal and period
expenses, in connection with the UKBA Program dispute and arbitration at IIS,
partially offset by an increase of $62 million in state taxes allocated to our
contracts.
The increase in administrative and selling expenses of $33 million in 2011
compared to 2010 was primarily due to $62 million of acquisition-related
expenses and $35 million of increased marketing and selling costs, the largest
increase of which was for opportunities on electronic warfare, airborne radar,
NASA and certain classified programs, partially offset by a decrease of $43
million in state taxes allocated to our contracts.
The provision for state income taxes can generally be recovered through the
pricing of products and services to the U.S. Government. Net state income taxes
allocated to our contracts were $78 million, $16 million and $59 million
in 2012, 2011, and 2010, respectively.
Research and Development Expenses
The increase in research and development expenses of $79 million in 2012
compared to 2011 was primarily related to increased bid and proposal expenses
due to the timing of various radar, classified, electronic warfare and
communications programs.
Research and development expenses remained relatively consistent in 2011
compared to 2010.
Total Operating Expenses
The decrease in total operating expenses of $536 million in 2012 compared to
2011 was primarily due to the decrease in total cost of sales of $572 million,
the primary drivers of which are described above in Total Cost of Sales.
The decrease in total operating expenses of $576 million in 2011 compared to
2010 was primarily due to the decrease in total cost of sales of $609 million,
the primary drivers of which are described above in Total Cost of Sales,
partially offset by the increase in administrative and selling expenses of $33
million, the primary drivers of which are described above in Administrative and
Selling Expenses.
Operating Income
The increase in operating income of $159 million in 2012 compared to 2011 was
primarily due to the decrease in total operating expenses of $536 million, the
primary drivers of which are described above in Total Operating Expenses,
partially offset by the decrease in total net sales of $377 million, the primary
drivers of which are described above in Total Net Sales. Included in the change
in operating income were the remaining net EAC adjustments described in Segment
Results beginning on page 48.
The increase in operating income of $217 million in 2011 compared to 2010 was
primarily due to the decrease in total operating expenses of $576 million, the
primary drivers of which are described above in Total Operating Expenses,
partially offset by the decrease in total net sales of $359 million, the primary
drivers of which are described above in Total Net Sales.
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Total Non-Operating (Income) Expense, Net
The increase in total non-operating (income) expense, net of $40 million in 2012
compared to 2011 was primarily due to the $29 million pretax charge associated
with the make-whole provision on the early repurchase of long-term debt in the
fourth quarter of 2012 and $29 million of higher interest expense, principally
due to the issuance of $1.0 billion of fixed rate long-term debt in the fourth
quarter of 2011, partially offset by a $15 million change in the fair value of
investments held in rabbi trusts associated with certain of our non-qualified
deferred compensation plans due to a net gain of $14 million in 2012 compared to
a net loss of $1 million in 2011.
The decrease in total non-operating (income) expense, net of $9 million in 2011
compared to 2010 was primarily due to the $73 million pretax charge associated
with the make-whole provision on the early repurchase of long-term debt in the
fourth quarter of 2010, partially offset by $46 million of higher interest
expense, principally due to the issuance of $2.0 billion of fixed rate long-term
debt in the fourth quarter of 2010, and an $18 million change in the fair value
of investments held in rabbi trusts associated with certain of our non-qualified
deferred compensation plans due to a net loss of $1 million in 2011 compared to
a net gain of $17 million in 2010.
Federal and Foreign Income Taxes
Our effective tax rate, which is used to determine federal and foreign income
tax expense, differs from the U.S. statutory rate due to the following:
2012 2011 2010
Statutory tax rate 35.0 % 35.0 % 35.0 %
Research and development tax credit - % (1.0 )% (1.1 )%
Tax settlements and refund claims (0.8 )% (2.6 )% (8.0 )%
Domestic manufacturing deduction benefit (1.9 )% (1.8 )% (1.7 )%
Foreign income tax rate differential 0.3 % 0.2 % 0.8 %
Other items, net
(1.0 )% (0.4 )% (0.8 )%
Effective tax rate 31.6 % 29.4 % 24.2 %
Our effective tax rate reflects the 35% U.S. statutory rate adjusted for various
permanent differences between book and tax reporting. During 2012, we received
final approval from the Internal Revenue Service (IRS) and U.S. Congressional
Joint Committee on Taxation of IRS Appeals Division settlement for the 2006-2008
IRS examination cycle (2012 Tax Settlement). As a result, all federal income tax
audits prior to 2009 are closed. During 2011, we received final approval from
the IRS and the U.S. Congressional Joint Committee on Taxation of our Minimum
Tax Refund claim for the 2006-2008 IRS examination cycle, which related to items
not included in the 2012 Tax Settlement (2011 Tax Settlement). During 2010, we
received final approval from the IRS and the U.S. Congressional Joint Committee
on Taxation for a settlement of the 1998-2005 IRS examination cycle (2010 Tax
Settlement).
The increase in our effective tax rate of 2.2% in 2012 was primarily due to the
difference between the 2011 and 2012 Tax Settlement amounts, which changed the
rate by approximately 1.8%. Our effective tax rate in 2011 was 5.2% higher than
2010 primarily due to the difference between the 2010 and 2011 Tax Settlement
amounts, which changed the rate by approximately 5.4%.
Our effective tax rate in 2012 was lower than the statutory federal tax rate
primarily due to the domestic manufacturing deduction which decreased the rate
by approximately 1.9%, and the 2012 Tax Settlement, which decreased the rate by
approximately 0.8%. Our effective tax rate in 2011 was lower than the statutory
federal tax rate primarily due to the 2011 Tax Settlement, which decreased the
rate by approximately 2.6%, the domestic manufacturing deduction, which
decreased the rate by approximately 1.8%, and the U.S. research and development
tax credit, which decreased the rate by approximately 1.0%.
Our effective tax rate in 2010 was lower than the U.S. statutory tax rate
primarily due to the 2010 Tax Settlement, which decreased the rate by
approximately 8.0%, and the domestic manufacturing deduction, which decreased
the rate by approximately 1.7%.
The increase in federal and foreign income taxes of $96 million in 2012 compared
to 2011 was primarily due to the difference between the 2011 and 2012 Tax
Settlement amounts described above and higher income from continuing
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operations before taxes. The increase in federal and foreign income taxes of
$192 million in 2011 compared to 2010 was primarily due to the difference
between the 2010 and 2011 Tax Settlement amounts described above and higher
income from continuing operations before taxes.
In January 2013, legislation was enacted that included the extension of the
research and development tax credit. The legislation retroactively reinstated
the research and development tax credit for 2012 and extended it through
December 31, 2013, resulting in a total expected benefit of $50 million,
approximately $25 million of which is for 2012 and will be recognized in the
first quarter of 2013. The remaining benefit relates to 2013 and will be
recognized ratably during 2013.
Income from Continuing Operations
Income from continuing operations was $1,901 million, $1,878 million and $1,844
million in 2012, 2011 and 2010, respectively. The increase in income from
continuing operations of $23 million in 2012 compared to 2011 was primarily due
to the $159 million increase in operating income, described above in Operating
Income, partially offset by the $96 million increase in federal and foreign
income taxes, related primarily to higher levels of income and the change in the
effective tax rate described above in Federal and Foreign Income Taxes and the
$40 million increase in total non-operating expenses, net, the primary drivers
of which are described above in Total Non-Operating (Income) Expense, Net.
The increase in income from continuing operations of $34 million in 2011
compared to 2010 was primarily due to the $217 million increase in operating
income described above in Operating Income and the $9 million decrease in total
non-operating expenses, net, the primary drivers of which are described above in
Total Non-Operating (Income) Expense, Net, partially offset by the $192 million
increase in federal and foreign income taxes, related primarily to higher levels
of income and the change in the effective tax rate described above in Federal
and Foreign Income Taxes.
Income (loss) from Discontinued Operations, Net of Tax
The decrease in income (loss) from discontinued operations, net of tax, of $19
million in 2012 compared to 2011 was primarily due to $19 million less of
income, net of tax, related to our former turbo-prop commuter aircraft
portfolio, Raytheon Airline Aviation Services (RAAS), in 2012 compared to 2011.
The decrease in income (loss) from discontinued operations, net of tax, of $17
million in 2011 compared to 2010 was primarily due to the 2010 Tax Settlement,
described above, which included an $89 million decrease in tax expense from
discontinued operations, primarily related to our previous disposition of
Raytheon Engineers and Constructors (RE&C), partially offset by a $39 million,
net of the federal tax benefit, excise tax assessment in 2010 related to our
previous disposition of Flight Options LLC (Flight Options), described below in
Discontinued Operations, and $20 million more of income, net of tax, related to
RAAS in 2011 compared to 2010.
Net Income
Net income was $1,900 million, $1,896 million and $1,879 million in 2012, 2011
and 2010, respectively. The increase in net income of $4 million in 2012
compared to 2011 was primarily due to the increase in income from continuing
operations of $23 million described above in Income from Continuing Operations,
partially offset by the decrease in income (loss) from discontinued operations,
net of tax, of $19 million, the primary drivers of which are described above in
Income (loss) from Discontinued Operations, Net of Tax.
The increase in net income of $17 million in 2011 compared to 2010 was primarily
due to the increase in income from continuing operations of $34 million
described above in Income from Continuing Operations, partially offset by the
decrease in income (loss) from discontinued operations, net of tax, of $17
million, the primary drivers of which are described above in Income (loss) from
Discontinued Operations, Net of Tax.
Diluted Earnings per Share (EPS) from Continuing Operations Attributable to
Raytheon Company Common Stockholders
Diluted EPS from continuing operations attributable to Raytheon Company common
stockholders for the years ended 2012, 2011, and 2010 was as follows:
(In millions, except per share amounts) 2012 2011 2010
Income from continuing operations attributable to
Raytheon Company $ 1,889 $ 1,848 $ 1,805
Diluted weighted-average shares outstanding 334.2 353.6 377.0
Diluted EPS from continuing operations attributable to
Raytheon Company $ 5.65 $ 5.22 $ 4.79
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The increase in diluted EPS from continuing operations attributable to Raytheon
Company common stockholders of $0.43 in 2012 compared to 2011 and in 2011
compared to 2010 was primarily due to the decrease in diluted weighted average
shares outstanding, which was affected by the common stock share activity shown
in the table below.
Our common stock share activity for the years ended 2012, 2011, and 2010 was as
follows:
(Shares in millions) 2012 2011 2010
Beginning balance 338.9 359.4 377.9
Warrants exercised - 3.3 6.7Stock plans activity 5.8 4.0 4.6
Treasury stock repurchases (16.6 ) (27.8 ) (29.8 )
Ending balance
328.1 338.9 359.4
Warrants to purchase shares of our common stock, with an exercise price of
$37.50 per share, were included in our calculations of diluted EPS at
December 31, 2011 and 2010. These warrants expired in June 2011.
Diluted Earnings (Loss) per Share from Discontinued Operations Attributable to
Raytheon Company Common Stockholders
Diluted earnings (loss) per share from discontinued operations attributable to
Raytheon Company common stockholders was a loss of less than $0.01 in 2012,
earnings of $0.05 in 2011, and earnings of $0.09 in 2010. The decreases in
diluted earnings (loss) per share from discontinued operations attributable to
Raytheon Company common stockholders of $0.05 in 2012 compared to 2011 and $0.04
in 2011 compared to 2010 were primarily due to the activity described above in
Income (loss) from Discontinued Operations, Net of Tax.
Diluted EPS Attributable to Raytheon Company Common Stockholders
Diluted EPS attributable to Raytheon Company common stockholders was $5.65 in
2012, $5.28 in 2011 and $4.88 in 2010. The increases in diluted EPS attributable
to Raytheon Company common stockholders of $0.37 in 2012 compared to 2011 and
$0.40 in 2011 compared to 2010 were primarily due to the decreases in diluted
shares, partially offset by the decreases in Diluted Earnings (Loss) per Share
from Discontinued Operations Attributable to Raytheon Company Common
Stockholders described above.
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Adjusted EPS
Adjusted EPS is diluted EPS from continuing operations attributable to Raytheon
Company common stockholders excluding the EPS impact of the FAS/CAS Adjustment,
tax effected at the federal statutory rate of 35% and, from time to time,
certain other items. In addition to the FAS/CAS Adjustment, our 2012 Adjusted
EPS also excludes the EPS impact of the make-whole provision on the early
retirement of debt. In addition to the FAS/CAS Adjustment, our 2011 Adjusted EPS
also excludes the EPS impact of the 2011 Tax Settlement, and the UKBA LOC
Adjustment tax effected at the 2011 U.K. statutory tax rate of approximately
25%, as described in Commitments and Contingencies, beginning on page 72. In
addition to the FAS/CAS Adjustment, our 2010 Adjusted EPS also excludes the EPS
impact of the 2010 Tax Settlement, the UKBA Program Adjustment tax effected at
the 2010 U.K. statutory rate of approximately 28%, the make-whole provision on
the early retirement of debt, all previously described, and the impact of the
acceleration of deferred gains related to terminated interest rate swaps on the
retired debt. We are providing Adjusted EPS because management uses it for the
purpose of evaluating and forecasting our financial performance and believes
that it provides additional insight into our underlying business performance. We
believe it allows investors to benefit from being able to assess our operating
performance in the context of how our principal customer, the U.S. Government,
allows us to recover pension and other postretirement benefits costs and to
better compare our operating performance to others in the industry on that same
basis. Adjusted EPS is not a measure of financial performance under GAAP and
should be considered supplemental to and not a substitute for financial
performance in accordance with GAAP. Adjusted EPS may not be defined and
calculated by other companies in the same manner and the amounts presented may
not recalculate directly due to rounding. Adjusted EPS was as follows:
2012 2011 2010
Diluted EPS from continuing operations attributable to
Raytheon Company common
stockholders $5.65 $5.22 $4.79
EPS impact of the FAS/CAS Adjustment 0.50 0.62 0.32
EPS impact of the early retirement of debt charges 0.06 - 0.13
EPS impact of UKBA LOC Adjustment - 0.17 -
EPS impact of the 2010 and 2011 Tax Settlements - (0.17 ) (0.45 )
EPS impact of the UKBA Program Adjustment - - 0.75
EPS impact of the acceleration of deferred gains related to
terminated
interest rate swaps on retired debt - - (0.03 )
Adjusted EPS $6.21 $5.85 $5.51
SEGMENT RESULTS
We report our results in the following segments: IDS; IIS; MS; NCS; SAS; and TS.
The following provides some context for viewing our segment performance through
the eyes of management.
Given the nature of our business, bookings, net sales, and operating income (and
the related operating margin percentage), which we disclose and discuss at the
segment level, are most relevant to an understanding of management's view of our
segment performance, and often these measures have significant interrelated
effects, as described below. In addition, we disclose and discuss backlog, which
represents future sales that we expect to recognize over the remaining contract
period, which is generally several years. We also disclose cost of sales and the
components of cost of sales within our segment disclosures.
Bookings-We disclose the amount of bookings and notable contract awards for each
segment. Bookings generally represent the dollar value of new contracts awarded
to us during the reporting period and include firm orders for which funding has
not been appropriated. We believe bookings are an important measure of future
performance and are an indicator of potential future changes in net sales,
because we cannot record revenues under a new contract without first having a
booking in the current or a preceding period (i.e., a contract award).
Total Net Sales-We generally express changes in net sales in terms of volume.
Volume generally refers to increases or decreases in revenues related to varying
amounts of total operating expenses, which are comprised of cost of sales,
administrative and selling expenses, and research and development expenses,
incurred on individual contracts (i.e., from performance against contractual
commitments on our bookings related to engineering, production or service
activity). Therefore, we discuss volume changes attributable principally to
individual programs unless there is a discrete event (e.g., a major contract
termination, natural disaster or major labor strike), or some other unusual item
that has a material effect on
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changes in a segment's volume for a reported period. Due to the nature of our
contracts, the amount of costs incurred and related revenues will naturally
fluctuate over the lives of our contracts. As a result, in any reporting period,
the changes in volume on numerous contracts are likely to be due to normal
fluctuations in our engineering, production or service activities.
Total Operating Expenses-We generally disclose operating expenses for each
segment in terms of the following: 1) cost of sales-labor; 2) cost of
sales-materials and subcontractors; and 3) other costs of sales and other
operating expenses. Included in cost of sales-labor is the incurred direct labor
associated with the performance of contracts in the current period and any
applicable overhead and fringe costs. Included in cost of sales-materials and
subcontractors is the incurred direct materials, subcontractor costs (which
include effort performed by other Raytheon segments), and applicable overhead
allocations in the current period. Included in other cost of sales and other
operating expenses is other direct costs not captured in labor or material and
subcontractor costs, such as precontract costs previously deferred, costs
previously deferred into inventory on contracts using commercial or units of
delivery accounting, applicable overhead allocations, general and administrative
costs, research and development costs (including bid and proposal costs), other
direct costs (such as ancillary services and travel expenses) and adjustments
for loss contracts.
Operating Income (and the related operating margin percentage)-We generally
express changes in segment operating income in terms of volume, net changes in
EAC adjustments or changes in contract mix and other program performance.
The impact of changes in volume on operating income excludes the impact of net
EAC adjustments and the impact of changes in contract mix and other program
performance and is calculated based on changes in costs on individual programs
at an overall margin for the segment.
Changes in net EAC adjustments typically relate to the current period impact of
revisions to total estimated revenues and costs at completion. These changes
reflect improved or deteriorated operating performance or award fee rates. We
have a Company-wide standard and disciplined quarterly EAC process in which
management reviews the progress and performance of our contracts. As part of
this process, management reviews information including, but not limited to, any
outstanding key contract matters, progress towards completion and the related
program schedule, identified risks and opportunities, and the related changes in
estimates of revenues and costs. The risks and opportunities include
management's judgment about the ability and cost to achieve the schedule (e.g.,
the number and type of milestone events), technical requirements (e.g., a
newly-developed product versus a mature product), and other contract
requirements. Management must make assumptions and estimates regarding labor
productivity and availability, the complexity of the work to be performed, the
availability of materials, the length of time to complete the contract (to
estimate increases in wages and prices for materials and related support cost
allocations), performance by our subcontractors, the availability and timing of
funding from our customer, and overhead cost rates, among other variables. These
estimates also include the estimated cost of satisfying our industrial
cooperation agreements, sometimes referred to as offset obligations required
under certain contracts. Based on this analysis, any quarterly adjustments to
net sales, cost of sales, and the related impact to operating income are
recorded as necessary in the period they become known. These adjustments may
result from positive program performance, and may result in an increase in
operating income during the performance of individual contracts, if we determine
we will be successful in mitigating risks surrounding the technical, schedule,
and cost aspects of those contracts or realizing related opportunities.
Likewise, these adjustments may result in a decrease in operating income if we
determine we will not be successful in mitigating these risks or realizing
related opportunities. Changes in estimates of net sales, cost of sales, and the
related impact to operating income are recognized quarterly on a cumulative
catch-up basis, which recognizes in the current period the cumulative effect of
the changes on current and prior periods based on a contract's percentage of
completion. A significant change in one or more of these estimates could affect
the profitability of one or more of our contracts. Given that we have over
15,000 individual contracts and the types and complexity of the assumptions and
estimates we must make on an on-going basis, as discussed above, we have both
favorable and unfavorable EAC adjustments. We had the following aggregate EAC
adjustments for the periods presented:
EAC Adjustments (In millions) 2012 2011 2010
Gross favorable $ 1,026 $ 1,041 $ 968
Gross unfavorable (413 ) (493 ) (810 )
Total net EAC adjustments $ 613 $ 548 $ 158
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There were no significant individual EAC adjustments in 2012. There was one
significant individual EAC adjustment in 2011 for the UKBA LOC Adjustment of $80
million and there were two significant individual EAC adjustments in 2010, the
UKBA Program Adjustment for $395 million and an NCS EAC adjustment for $28
million, as described more fully beginning on page 58.
The $65 million increase in net EAC adjustments in 2012 compared to 2011 was
primarily due to the impact of the UKBA LOC Adjustment described above.
The $390 million increase in net EAC adjustments in 2011 compared to 2010 was
primarily due to the impact of the UKBA Program Adjustment described above.
Changes in contract mix and other program performance refer to changes in
operating margin due to a change in the relative volume of contracts with higher
or lower fee rates such that the overall average margin rate for the segment
changes and other drivers of program performance, including margin rate
increases or decreases due to EAC adjustments in prior periods. A higher or
lower expected fee rate at the initial award of a contract typically correlates
to the contract's risk profile, which is often specifically driven by the type
of customer and related procurement regulations, the type of contract (e.g.,
fixed price vs. cost plus), the maturity of the product or service, and the
scope of work.
Because each segment has thousands of contracts in any reporting period, changes
in operating income and margin are likely to be due to normal changes in volume,
net EAC adjustments, and contract mix and other performance on many contracts
with no single change, or series of related changes, materially driving a
segment's change in operating income or operating margin percentage.
Backlog-We disclose period-ending backlog for each segment. Backlog represents
the dollar value of contracts awarded for which work has not been performed.
Backlog generally increases with bookings and generally converts into sales as
we incur costs under the related contractual commitments. Therefore, we discuss
changes in backlog, including any significant cancellations, for each of our
segments, as we believe such discussion provides an understanding of the awarded
but not executed portions of our contracts.
Segment financial results were as follows:
Total Net Sales (In millions) 2012 2011 2010
Integrated Defense Systems $ 5,037 $ 4,958 $ 5,470
Intelligence and Information Systems 3,012 3,015 2,757
Missile Systems 5,693 5,590 5,732
Network Centric Systems 4,058 4,497 4,918
Space and Airborne Systems 5,333 5,255 4,830
Technical Services 3,239 3,353 3,472
Corporate and Eliminations (1,958 ) (1,877 ) (2,029 )
Total $ 24,414 $ 24,791 $ 25,150
Operating Income (In millions) 2012 2011 2010
Integrated Defense Systems
$ 918 $ 836 $ 870
Intelligence and Information Systems 247 159 (157 )
Missile Systems 719 693 650
Network Centric Systems 495 667 692
Space and Airborne Systems 784 717 676
Technical Services 282 312 297
FAS/CAS Adjustment (255 ) (337 ) (187 )
Corporate and Eliminations (201 ) (217 ) (228 )
Total $ 2,989 $ 2,830 $ 2,613
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Bookings (In millions) 2012 2011 2010
Integrated Defense Systems $ 4,668 $ 6,392 $ 3,269
Intelligence and Information Systems 2,756 3,217 3,709
Missile Systems 7,135 5,948 6,485
Network Centric Systems 4,089 3,632 4,034
Space and Airborne Systems 5,305 4,592 4,321
Technical Services 2,551 2,774 2,631
Total $ 26,504 $ 26,555 $ 24,449
Included in bookings were international bookings of $5,979 million, $7,692
million and $4,371 million in 2012, 2011 and 2010, respectively, which included
foreign military bookings through the U.S. Government. International bookings
amounted to 23%, 29% and 18% of total bookings in 2012, 2011 and 2010,
respectively.
We record bookings for not-to-exceed contract awards based on reasonable
estimates of expected contract definitization, which will generally not be less
than 75% of the award. We subsequently adjust bookings to reflect the actual
amounts definitized, or, when prior to definitization, when facts and
circumstances indicate that our previously estimated amounts are no longer
reasonable. The timing of awards that may cover multiple fiscal years influences
the size of bookings in each year. Bookings exclude unexercised contract options
and potential orders under ordering-type contracts (e.g., indefinite
delivery/indefinite quantity (IDIQ) type contracts), and are reduced for
contract cancellations and terminations of bookings recognized in the current
year. We reflect contract cancellations and terminations from prior year
bookings, as well as the impact of changes in foreign exchange rates, directly
as an adjustment to backlog in the period in which the cancellation or
termination occurs and the impact is determinable.
Funded Backlog Total Backlog
Backlog at December 31 (In millions) 2012 2011 2010
2012 2011 2010
Integrated Defense Systems $ 7,313 $ 7,100 $ 6,433 $ 9,431 $ 9,766 $ 8,473
Intelligence and Information Systems 1,067 829 725 3,989 4,366 4,319
Missile Systems 6,939 6,205 6,385 10,030 8,570 8,212
Network Centric Systems 3,583 3,267 3,740 4,364 4,160 4,912
Space and Airborne Systems 3,409 3,104 3,266 6,031 5,864 5,981
Technical Services 1,736 1,957 2,083 2,336 2,586 2,654
Total $ 24,047 $ 22,462 $ 22,632 $ 36,181 $ 35,312 $ 34,551
Total backlog includes both funded backlog (unfilled orders for which funding is
authorized, appropriated and contractually obligated by the customer) and
unfunded backlog (firm orders for which funding has not been appropriated and/or
contractually obligated by the customer). Revenue is generally not recognized on
backlog until funded. Backlog excludes unexercised contract options and
potential orders under ordering-type contracts (e.g., IDIQ). Both funded and
unfunded backlog are affected by changes in foreign exchange rates. In 2010, IIS
recorded a net backlog adjustment of $556 million as a result of the UKBA
Program.
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Integrated Defense Systems
% Change
2012 compared 2011 compared
(In millions, except percentages) 2012 2011 2010 to 2011 to 2010
Total Net Sales $ 5,037 $ 4,958 $ 5,470 1.6 % (9.4 )%
Total Operating Expenses
Cost of sales-labor 1,788 1,813 1,910 (1.4 )% (5.1 )%
Cost of sales-materials and
subcontractors 1,676 1,613 2,006 3.9 % (19.6 )%
Other cost of sales and other
operating expenses 655 696 684 (5.9 )% 1.8 %
Total Operating Expenses 4,119 4,122 4,600 (0.1 )% (10.4 )%
Operating Income $ 918 $ 836 $ 870 9.8 % (3.9 )%
Operating Margin 18.2 % 16.9 % 15.9 %
Year
Ended 2012
Versus Year Ended 2011
Change in Operating Income (in Year Ended Versus Year Ended
millions) 2011 2010
Volume $ 1 $ (73 )
Net change in EAC adjustments - 34
Mix and other performance 81 5
Total Change in Operating Income $ 82 $ (34 )
% Change
2012 compared 2011 compared
(In millions, except percentages) 2012 2011 2010 to 2011 to 2010
Bookings $ 4,668 $ 6,392 $ 3,269 (27.0 )% 95.5 %
Total Backlog 9,431 9,766 8,473 (3.4 )% 15.3 %
IDS is a leader in integrated air and missile defense, radar solutions, and
naval combat and ship electronic systems. IDS delivers combat-proven performance
against the complete spectrum of airborne and ballistic missile threats and is a
world leader in the technology, development and production of sensors and
mission systems. IDS provides solutions to the U.S. Department of Defense (DoD),
its services and agencies, and numerous international customers which represent
approximately half of IDS' business.
Total Net Sales-Total net sales in 2012 were relatively consistent with 2011.
Included in total net sales in 2012 was higher net sales of $281 million on an
international Patriot program awarded in the second quarter of 2011 as the
program transitioned into full production, $194 million on a missile defense
radar program for an international customer as the program transitioned into
full production, and $155 million on various Patriot programs for an
international customer, driven principally by scheduled program production
requirements. The increase was partially offset by $210 million of lower net
sales from the scheduled completion of certain design and production phases on
an international Patriot program awarded in the first quarter of 2008, $164
million from the scheduled completion of certain design and production phases on
a U.S. Navy combat systems program, and $144 million of lower net sales on
various global integrated sensors programs. The remaining change in total net
sales was spread across numerous programs with no individual or common
significant driver.
The decrease in total net sales of $512 million in 2011 compared to 2010 was
primarily due to $316 million of lower net sales from the scheduled completion
of certain design and production phases on a U.S. Navy combat systems program
and the deferment of certain work due to the U.S. Navy's extension of the
program schedule, and $175 million of lower net sales, as planned, on an
international Patriot program driven principally by lower volume due to
completion of scheduled
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design and certain production efforts.
Total Operating Expenses-Total operating expenses in 2012 remained relatively
consistent with 2011. The decrease in other cost of sales and other operating
expenses of $41 million was primarily due to lower outside service costs due to
the scheduled completion of an international global integrated sensors program.
The decrease in total operating expenses of $478 million in 2011 compared to
2010 was primarily due to the decreased volume on a U.S. Navy combat systems
program and an international Patriot program for the reasons described above in
Total Net Sales. The decrease in materials and subcontractor costs of $393
million was driven primarily by the decreased volume on these programs and the
types of costs incurred in the respective periods based on the program
requirements and program schedules. The decrease in labor costs of $97 million
in 2011 compared to 2010 was primarily due to lower net sales on numerous
missile defense programs, driven principally by lower volume due to the
completion of scheduled program design, development and production efforts, and
decreased volume on a U.S. Navy combat systems program for the reasons described
above in Total Net Sales.
Operating Income and Margin-The increase in operating income of $82 million in
2012 compared to 2011 was primarily due to a change in mix and other performance
of $81 million, principally driven by increased activity on certain
international Patriot programs. The increase in operating margin in 2012
compared to 2011 was primarily due to the change in mix and other performance.
The decrease in operating income of $34 million in 2011 compared to 2010 was
primarily due to decreased volume of $73 million, principally driven by the
programs described above in Total Net Sales, partially offset by a net change in
EAC adjustments of $34 million, driven primarily by the amount of EAC
adjustments on a U.S. Navy combat systems program. The increase in operating
margin in 2011 compared to 2010 was primarily due to the net change in EAC
adjustments described above.
Backlog and Bookings-Backlog was $9,431 million, $9,766 million and $8,473
million at December 31, 2012, 2011 and 2010, respectively. The decrease in
backlog of $335 million or 3% at December 31, 2012 compared to December 31, 2011
was primarily due to sales in excess of bookings in 2012, principally across our
Integrated Air & Missile Defense product line. The increase in backlog of $1,293
million at December 31, 2011 compared to December 31, 2010 was primarily due to
higher bookings in 2011 described below.
Bookings decreased by $1,724 million in 2012 compared to 2011, primarily due to
the large 2011 Patriot air and missile defense system booking for the Kingdom of
Saudi Arabia described below. In 2012, IDS booked $422 million for production
and sustainment of U.S. Army/U.S. Navy Transportable Radar Surveillance
(AN/TPY-2) radars for the Missile Defense Agency (MDA), $366 million on the
Zumwalt-class destroyer program for the U.S. Navy, $301 million to provide
Patriot engineering services support for U.S. and international customers, $293
million to provide technical and logistics support for a Hawk and Patriot air
and missile defense program for an international customer, $293 million on an
Early Warning Surveillance Radar System (EWSRS) support program for Taiwan, $240
million to provide engineering services, production and support for the Aegis
weapon system for the U.S. Navy, $199 million to provide Consolidated Contractor
Logistics Support (CCLS) for the MDA, $198 million for the production of
Airborne Low Frequency Sonar (ALFS) systems for the U.S. Navy, $184 million to
provide advanced Patriot air and missile defense capability for an international
customer, $172 million for the Upgraded Early Warning Radar (UEWR) system for
the MDA and the U.S. Air Force, and $126 million to provide air and missile
defense capability for the U.S. Army.
Bookings increased by $3,123 million in 2011 compared to 2010. In 2011, IDS
booked $3,147 million for the Patriot Air and Missile Defense System, including
$1,698 million for the Kingdom of Saudi Arabia, $560 million for Taiwan, $340
million for other international customers, and $257 million to provide
engineering services support for U.S. and international customers. IDS booked
$1,027 million for AN/TPY-2 radars, spares and training for the United Arab
Emirates (UAE), MDA and U.S. Army. IDS also booked $345 million on the
Zumwalt-class destroyer program for the U.S. Navy, $268 million for the
production of ALFS systems and spares for the U.S. Navy and the Australian Navy,
$193 million to provide CCLS for the MDA, and $107 million for development on
the competitively awarded Space Fence program for the U.S. Air Force.
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In 2010, IDS booked $400 million to provide advanced Patriot air and missile
defense capability for an international customer, $271 million on the
Zumwalt-class destroyer program for the U.S. Navy, $228 million on the Aegis
weapon system for the U.S. Navy, $222 million to provide engineering services
support for a Patriot air and missile defense program for U.S. and international
customers, $190 million for AN/TPY-2 radar for the MDA, $148 million to provide
CCLS for the MDA, $131 million to provide Patriot Guidance Enhanced
Missile-Tactical (GEM-T) missiles for Kuwait, and $112 million on the Air &
Missile Defense Radar (AMDR) program for the U.S. Navy.
Intelligence and Information Systems
% Change
2012 compared 2011 compared
(In millions, except percentages) 2012 2011 2010 to 2011 to 2010
Total Net Sales $ 3,012 $ 3,015 $ 2,757 (0.1 )% 9.4 %
Total Operating Expenses
Cost of sales-labor 1,264 1,214 1,232 4.1 % (1.5 )%
Cost of sales-materials and
subcontractors 1,078 1,138 1,169 (5.3 )% (2.7 )%
Other cost of sales and other
operating expenses 423 504 513 (16.1 )% (1.8 )%
Total Operating Expenses 2,765 2,856 2,914 (3.2 )% (2.0 )%
Operating Income $ 247 $ 159 $ (157 ) 55.3 % 201.3 %
Operating Margin 8.2 % 5.3 % (5.7 )%
Year
Ended 2012
Versus Year Ended 2011
Change in Operating Income (in Year Ended Versus Year Ended
millions) 2011 2010
Volume $ 5 $ (12 )
Net change in EAC adjustments 75 297
Mix and other performance 8 31
Total Change in Operating Income $ 88 $ 316
% Change
2012 compared 2011 compared
(In millions, except percentages) 2012 2011 2010 to 2011 to 2010
Bookings $ 2,756 $ 3,217 $ 3,709 (14.3 )% (13.3 )%
Total Backlog 3,989 4,366 4,319 (8.6 )% 1.1 %
IIS is a leader in global intelligence, surveillance and reconnaissance (ISR),
advanced cyber solutions, and DoD space, weather and environmental solutions.
Approximately half of its business is for classified customers. Key customers
include the U.S. Intelligence Community, DoD agencies, the National Oceanic and
Atmospheric Administration (NOAA), Department of Homeland Security (DHS), and
the National Aeronautics and Space Administration (NASA).
Total Net Sales- Total net sales in 2012 were relatively consistent with 2011.
Included in total net sales in 2012 was $54 million of lower net sales on the
UKBA Program as a result of the program termination. Also included in total net
sales in 2012 was $75 million of higher net sales of cybersecurity solutions
driven by recent acquisitions and increased customer orders and $72 million of
higher net sales on the Joint Polar Satellite System (JPSS) program primarily
due to scheduled design and production efforts. The remaining change in total
net sales was primarily spread across numerous domestic programs with no
individual or common significant driver.
The increase in total net sales of $258 million in 2011 compared to 2010 was
primarily due to the difference in net sales from the UKBA Program. Net sales
from the UKBA Program in 2010 were lower than 2011 by $240 million, primarily
due
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to the UKBA Program Adjustment, as described in Commitments and Contingencies
beginning on page 72, which negatively impacted 2010 net sales by $316 million.
Also included in the increase in net sales was $85 million of higher net sales
on a GPS command, control, and mission capabilities program awarded in the first
quarter of 2010, primarily as a result of scheduled design and build efforts.
The remaining change in total net sales was primarily spread across numerous
domestic programs.
Total Operating Expenses-The decrease in total operating expenses of $91 million
in 2012 compared to 2011 was primarily due to the UKBA LOC Adjustment in the
first quarter of 2011, as described in Commitments and Contingencies beginning
on page 72, which had an impact of $80 million and primarily drove the change in
other cost of sales and other operating expenses. The decrease in materials and
subcontractor costs of $60 million was driven primarily by the activity on the
UKBA Program as described above.
The decrease in total operating expenses of $58 million in 2011 compared to 2010
was driven primarily by a reduction in operating expenses related to the UKBA
Program. Included in other cost of sales and other operating expenses in 2011
was $80 million related to the UKBA LOC Adjustment, as described in Commitments
and Contingencies beginning on page 72. Included in other cost of sales and
other operating expenses in 2010 was $79 million related to the UKBA Program
Adjustment.
Operating Income and Margin-The increase in operating income of $88 million and
the related increase in operating margin in 2012 compared to 2011 was primarily
due to a net change in EAC adjustments of $75 million, driven principally by the
UKBA LOC Adjustment in the first quarter of 2011, which had an impact of $80
million. Mix and other performance in 2012 included $31 million of legal and
other period expenses in connection with the UKBA Program dispute and
arbitration, compared to $21 million in 2011. Mix and other performance in 2012
also included an insurance recovery for legal expenses of $34 million, compared
to $9 million in 2011. Operating income in 2012 and 2011 was reduced by
approximately $18 million and $14 million, respectively, of certain cyber
security-related acquisition costs and investments.
The increase in operating income of $316 million in 2011 compared to 2010 and
the related increase in operating margin was primarily due to a net change in
EAC adjustments of $297 million, principally driven by the UKBA Program
Adjustment in 2010, which had an impact of $395 million, partially offset by the
UKBA LOC Adjustment in 2011, which had an impact of $80 million. Operating
income in 2011 included $21 million of legal and other period expenses in
connection with the UKBA Program dispute and arbitration compared to $10 million
of legal and other period costs in 2010. Operating income in 2011 included $9
million relating to an insurance recovery. IIS' operating income was also
reduced by approximately $14 million in 2011 and $17 million in 2010 by certain
cyber security related acquisition costs and investments.
Backlog and Bookings-Backlog was $3,989 million, $4,366 million and $4,319
million at December 31, 2012, 2011 and 2010, respectively. The decrease in
backlog of $377 million or 9% at December 31, 2012 compared to December 31, 2011
was primarily due to sales in excess of bookings in 2012, primarily for the
Global Positioning System Advanced Control Segment (GPS-OCX) and JPSS programs.
Backlog at December 31, 2011 was relatively consistent with December 31, 2010.
Bookings decreased by $461 million in 2012 compared to 2011. In 2012, IIS booked
$172 million on a contract to provide ISR support to the U.S. Air Force. IIS
also booked $1,812 million on a number of classified contracts.
Bookings decreased by $492 million in 2011 compared to 2010. In 2011, IIS booked
$520 million on the JPSS program for NASA, $183 million on a contract to provide
ISR support to the U.S. Air Force and $134 million for development on the
GPS-OCX program for the U.S. Air Force. IIS also booked $1,554 million on a
number of classified contracts.
In 2010, IIS booked a $901 million award on a contract to develop the
next-generation GPS-OCX for the U.S. Air Force, a $167 million booking on a
major U.S. Air Force program, $80 million on the Earth Observing System Data and
Information System (EOSDIS) contract for NASA and $1,723 million on a number of
classified contracts, including $371 million on a major classified program.
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Missile Systems
% Change
2012 compared 2011 compared
(In millions, except percentages) 2012 2011 2010 to 2011 to 2010
Total Net Sales $ 5,693 $ 5,590 $ 5,732 1.8 % (2.5 )%
Total Operating Expenses
Cost of sales-labor 1,756 1,662 1,725 5.7 % (3.7 )%
Cost of sales-materials and
subcontractors 2,520 2,579 2,682 (2.3 )% (3.8 )%
Other cost of sales and other
operating expenses 698 656 675 6.4 % (2.8 )%
Total Operating Expenses 4,974 4,897 5,082 1.6 % (3.6 )%
Operating Income $ 719 $ 693 $ 650 3.8 % 6.6 %
Operating Margin 12.6 % 12.4 % 11.3 %
Year Ended 2012 Year Ended 2011
Change in Operating Income (in Versus Year Ended Versus Year Ended
millions) 2011 2010
Volume $ 10 $ (26 )
Net change in EAC adjustments (27 ) 54
Mix and other performance 43 15
Total Change in Operating Income $ 26 $ 43
% Change
2012 compared 2011 compared
(In millions, except percentages) 2012 2011 2010 to 2011 to 2010
Bookings $ 7,135 $ 5,948 $ 6,485 20.0 % (8.3 )%
Total Backlog 10,030 8,570 8,212 17.0 % 4.4 %
MS is a premier developer and producer of missile systems for the armed forces
of the U.S. and other allied nations. Leveraging its capabilities in advanced
airframes, guidance and navigation systems, high-resolution sensors, targeting,
and netted systems, MS develops and supports a broad range of advanced weapon
systems, including missiles, smart munitions, close-in weapon systems,
projectiles, kinetic kill vehicles and directed energy effectors. Key customers
include the U.S. Navy, Army, Air Force and Marine Corps, the MDA and the armed
forces of more than 40 allied nations.
Total Net Sales-Total net sales in 2012 were relatively consistent with 2011.
Included in total net sales was $170 million of higher net sales on the SM-3
program due to higher volume driven by scheduled increases in production and
development efforts, partially offset by $141 million of lower net sales on the
Tomahawk program due to lower volume driven by scheduled lower production rates.
The remaining change in total net sales was spread across numerous programs with
no individual or common significant driver.
The decrease in total net sales of $142 million in 2011 compared to 2010 was
primarily due to lower net sales of $210 million on the SM-2 program, $90
million on the ESSM program, and $70 million on the SM-3 program, principally
from lower volume driven by scheduled lower production build rates. The decrease
in net sales was partially offset by higher net sales of $92 million on the SDB
II program and $86 million on the Paveway™ program, principally from higher
volume due to scheduled increases in design and production efforts.
Total Operating Expenses-Total operating expenses in 2012 were relatively
consistent with 2011. The increase in labor costs of $94 million was primarily
due to labor volume on the SM-3 program as a result of higher scheduled
production rates. The increase in other cost of sales and other operating
expenses of $42 million was driven principally by a change in the amount of
previously deferred precontract costs based on contract awards or funding, which
had an impact of $84
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million, partially offset by lower refurbishment costs due to scheduled lower
production rates on the Phalanx program.
The decrease in total operating expenses of $185 million in 2011 compared to
2010 was primarily due to the activity on the SM-2, ESSM and SM-3 programs for
the reasons described above in Total Net Sales, partially offset by the activity
in the SDB-II and Paveway™ programs for the reasons described above in Total Net
Sales.
Operating Income and Margin-The increase in operating income of $26 million in
2012 compared to 2011 was primarily due to the $43 million change in mix and
other performance principally driven by a $15 million negative adjustment in
2011 related to a contract settlement, and prior period EAC adjustments on
certain classified and close-in weapons systems programs, which had an impact of
$20 million, partially offset by the net decrease in EAC adjustments of $27
million, which included a $21 million favorable contract resolution in 2011.
The increase in operating income of $43 million in 2011 compared to 2010 was
primarily due to a net change in EAC adjustments of $54 million, principally
driven by the amount of EAC adjustments on our air warfare systems programs,
partially offset by lower volume of $26 million, driven principally by the
programs described above in Total Net Sales. Included in EAC adjustments in 2011
was a $21 million favorable contract resolution. Included in contract mix and
other performance in 2011 was a $15 million negative adjustment related to a
contract settlement. The increase in operating margin in 2011 compared to 2010
was primarily due to the net change in EAC adjustments described above.
Backlog and Bookings-Backlog was $10,030 million, $8,570 million and $8,212
million at December 31, 2012, 2011 and 2010, respectively. The increase in
backlog of $1,460 million or 17% at December 31, 2012 compared to December 31,
2011 was primarily due to the higher 2012 bookings described below. Backlog at
December 31, 2011 was relatively consistent with December 31, 2010.
Bookings increased by $1,187 million in 2012 compared to 2011. In 2012, MS
booked $1,421 million for the production and development of SM-3 and $855
million for the production of Exoatmospheric Kill Vehicle (EKV) contract for the
MDA, $710 million for Tomahawk for the U.S. Navy and international customers,
$689 million for the production of Paveway™ for the U.S. Air Force and
international customers, $553 million for the production of Advanced
Medium-Range Air-to-Air Missile (AMRAAM) for the U.S. Air Force and
international customers, $364 million for the production of Rolling Airframe
Missile (RAM) for the U.S. Navy and international customers, $356 million for
the production of tube-launched, optically-tracked, wireless-guided (TOW)
missiles for the U.S. Army, $301 million for production of ESSM for the U.S.
Navy and international customers, $281 million for the production of Standard
Missile-6 (SM-6) for the U.S. Navy, $216 million for AIM-9X Sidewinder short
range Air-To-Air Missiles for the U.S. Navy and international customers, $190
million for Phalanx weapon systems for the U.S. Navy and international
customers, and $105 million for production of Miniature Air-Launch Decoy (MALD®)
for the U.S. Air Force.
Bookings decreased by $537 million in 2011 compared to 2010. In 2011, MS booked
$1,402 million for the development of SM-3 for the MDA, $696 million for the
production of AMRAAM for the U.S. Air Force and international customers, $393
million for production of ESSM for the U.S. Navy and international customers,
$374 million for Phalanx weapon systems for the U.S. Navy and international
customers, $311 million for the production of Excalibur for the U.S. Army, U.S.
Marines, and an international customer, $270 million for the production of
Paveway™ for the U.S. Air Force and international customers, $237 million for
the production of SM-2 for the U.S. Navy and international customers, $225
million for a major classified program, $210 million for production of SM-6 for
the U.S. Navy, $191 million for the production of the Joint Stand-off Weapon
(JSOW) for the U.S. Navy and international customers, $152 million for the
production of TOW missiles for the U.S. Army, and $113 million for production of
MALD® for the U.S. Air Force.
In 2010, MS booked $743 million for SM-3 for the MDA and an international
customer, $698 million for the production of AMRAAM for the U.S. Air Force and
international customers, $675 million on a classified program, $668 million for
the production of Paveway™ for the Kingdom of Saudi Arabia and other
international customers, $501 million for the production of Tomahawk missiles
for the U.S. Navy and an international customer, $451 million for engineering
and manufacturing development of SDB II for the joint U.S. Air Force and U.S
Navy program, $425 million for the production of SM-2 for the U.S. Navy and
international customers, $274 million for the production of Rolling Airframe
Missile (RAM) for the U.S. Navy and international customers, $271 million for
the Phalanx Weapons System for the U.S. Navy, Army and international customers,
$262 million for development work on the EKV program for the MDA, $209 million
for the production of AIM-9X Sidewinder short range Air-to-Air missiles for the
U.S. Navy and international customers, $198 million for the Javelin program for
the U.S. Army and international customers, $168 million on the MALD® for the
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U.S. Air Force, Army, and Navy, $147 million for ESSM for the U.S. Navy and
international customers, $122 million for the production of TOW missiles for
U.S. Army and international customers, and $114 million for the production of
the JSOW for the U.S. Navy and international customers.
Network Centric Systems
% Change
2012 compared 2011 compared
(In millions, except percentages) 2012 2011 2010 to 2011 to 2010
Total Net Sales $ 4,058 $ 4,497 $ 4,918 (9.8 )% (8.6 )%
Total Operating Expenses
Cost of sales-labor 1,405 1,482 1,531 (5.2 )% (3.2 )%
Cost of sales-materials and
subcontractors 1,507 1,699 2,055 (11.3 )% (17.3 )%
Other cost of sales and other
operating expenses 651 649 640 0.3 % 1.4 %
Total Operating Expenses 3,563 3,830 4,226 (7.0 )% (9.4 )%
Operating Income $ 495 $ 667 $ 692 (25.8 )% (3.6 )%
Operating Margin 12.2 % 14.8 % 14.1 %
Year Ended 2012 Year Ended 2011
Change in Operating Income (in Versus Year Ended Versus Year Ended
millions) 2011 2010
Volume $ (40 ) $ (59 )
Net change in EAC adjustments (1 ) (22 )
Mix and other performance (131 ) 56
Total Change in Operating Income $ (172 ) $ (25 )
% Change
2012 compared 2011 compared
(In millions, except percentages) 2012 2011 2010 to 2011 to 2010
Bookings $ 4,089 $ 3,632 $ 4,034 12.6 % (10.0 )%
Total Backlog 4,364 4,160 4,912 4.9 % (15.3 )%
NCS leverages the capabilities of the network through communications, sensors,
and command and control systems, to develop and produce customer solutions for
land combat modernization, international and domestic Air Traffic Management
(ATM) and other transportation systems, military and civil communications, and
homeland security. NCS key customers include the DoD, the U.S. Federal Aviation
Administration (FAA) and other U.S. Government customers, as well as numerous
international customers.
Total Net Sales-The decrease in total net sales of $439 million in 2012 compared
to 2011 was primarily due to $188 million of lower net sales on U.S. Army sensor
programs driven principally by planned declines in production, $105 million of
lower net sales on certain radio and communications programs driven principally
by reduced customer program requirements, $85 million of lower net sales of
acoustic sensor systems due to higher 2011 deliveries based on customer demand,
$74 million of lower net sales on various air traffic control programs due to
planned declines in production and $61 million of lower net sales on an
international command, control, communications, computers and intelligence (C4I)
program driven principally by program schedule requirements. The lower net sales
were partially offset by higher net sales of $109 million on a close combat
tactical radar program and higher net sales of $62 million on an air traffic
control program due to planned increases in production. The remaining change in
net sales was spread across numerous programs with no individual or common
significant driver.
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The decrease in total net sales of $421 million in 2011 compared to 2010 was
primarily due to $283 million of lower net sales on U.S. Army sensor programs
due to a planned decline in production, $124 million of lower net sales on a
combat vehicle sensor program, principally from lower volume due to a program
restructuring and related termination for convenience, and $98 million of lower
net sales on a U.S. Army radar support program, principally due to the
completion of significant upgrade efforts, partially offset by higher net sales
on numerous programs, including a combined $106 million on acoustic sensor
system sales and combat vehicle sensor program sales for domestic and
international customers.
Total Operating Expenses-The decrease in total operating expenses of $267
million in 2012 compared to 2011 was driven primarily by the activity on the
programs, and for the reasons described above in Total Net Sales. The decrease
in materials and subcontractor costs of $192 million was driven primarily by the
activity on the programs, and for the reasons described above in Total Net
Sales. The decrease in labor costs of $77 million was spread across numerous
programs driven by the various reduced program requirements.
The decrease in total operating expenses of $396 million in 2011 compared to
2010 was driven primarily by the activity on U.S. Army sensor programs, a combat
vehicle sensor program and a U.S. Army radar support program for the reasons
described above in Total Net Sales, partially offset by the activity on numerous
programs, including acoustic sensor systems and a combat vehicle sensor program
for domestic and international customers as described above in Total Net Sales.
The decrease in materials and subcontractor costs of $356 million was driven
primarily by the net decreased volume on the programs described above due to a
planned decline in production.
Operating Income and Margin-The decrease in operating income of $172 million in
2012 compared to 2011 was primarily due to a change in mix and other performance
of $131 million, driven primarily by reduced deliveries of acoustic sensor
systems, and reduced sales on U.S. Army and other production programs. Included
in the change in mix and other performance are $17 million of costs related to
ending a supplier agreement and $14 million for inventory valuation allowances.
The decrease in operating margin in 2012 compared to 2011 was primarily due to
the change in mix and other performance.
The decrease in operating income of $25 million in 2011 compared to 2010 was
primarily due to decreased volume, which had an impact of $59 million,
principally driven by the programs described above in Total Net Sales, and a net
change in EAC adjustments of $22 million, which was spread across numerous
programs with no individual or common significant driver, partially offset by a
change in contract mix and other performance of $56 million, principally driven
by higher domestic and international acoustic sensor systems sales. Included in
operating income in 2010 was a negative EAC adjustment of $28 million relating
to an infrastructure protection program as a result of a change in our estimated
revenue and costs due to the termination of a subcontractor and the Company's
subsequent direct assumption of that subcontractor's scope of work. The increase
in operating margin in 2011 compared to 2010 was primarily due to the change in
contract mix and other performance and the net change in EAC adjustments
described above.
Backlog and Bookings-Backlog was $4,364 million, $4,160 million and $4,912
million at December 31, 2012, 2011 and 2010, respectively. The increase in
backlog of $204 million or 5% at December 31, 2012 compared to December 31, 2011
was primarily due to bookings in excess of external sales, principally within
our C4I product line, primarily on an international C4I program, partially
offset by our Combat and Sensing Systems (CSS) product line, primarily on U.S.
Army programs. The decrease in backlog of $752 million at December 31, 2011
compared to December 31, 2010 was primarily due to external sales in excess of
bookings in 2011, principally within our Combat and Sensing Systems (CSS) and
C4I product lines, primarily on U.S. Army programs.
Bookings increased by $457 million in 2012 compared to 2011. In 2012, NCS booked
$650 million on an international C4I program, $187 million for the Navy
Multiband Terminal (NMT) program for the U.S. Navy and $173 million on the
Standard Terminal Automation Replacement System (STARS) program for the FAA.
Bookings decreased by $402 million in 2011 compared to 2010. In 2011, NCS booked
$211 million for the production of Sentinel radars, spares and services for the
U.S. Army and international customers, $146 million for the Long Range Advanced
Scout Surveillance Systems (LRAS3) program for the U.S. Army, $71 million for
the Thermal Weapon Sight (TWS) program for the U.S. Army and $64 million for
Enhanced Position Location Reporting System (EPLRS) and MicroLight® radios from
the Australian Defence Materiel Organisation (DMO).
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In 2010, NCS booked $254 million on the STARS program for the FAA and the DoD,
$250 million for the LRAS3 program for the U.S. Army, $146 million on a command
and control program for an international customer, $111 million for Horizontal
Technology Integration (HTI) forward-looking infrared kits for the U.S. Army,
$104 million on the NMT program for the U.S. Navy and $96 million for Improved
Thermal Sight Systems (ITSS) for an international customer.
Space and Airborne Systems
% Change
2012 compared 2011 compared
(In millions, except percentages) 2012 2011 2010 to 2011 to 2010
Total Net Sales $ 5,333 $ 5,255 $ 4,830 1.5 % 8.8 %
Total Operating Expenses
Cost of sales-labor 2,071 2,077 1,968 (0.3 )% 5.5 %
Cost of sales-materials and
subcontractors 1,775 1,820 1,632 (2.5 )% 11.5 %
Other cost of sales and other
operating expenses 703 641 554 9.7 % 15.7 %
Total Operating Expenses 4,549 4,538 4,154 0.2 % 9.2 %
Operating Income $ 784 $ 717 $ 676 9.3 % 6.1 %
Operating Margin 14.7 % 13.6 % 14.0 %
Year
Ended 2012
Versus Year Ended 2011
Change in Operating Income (in Year Ended Versus Year Ended
millions) 2011 2010
Volume $ 5 $ 43
Net change in EAC adjustments 51 16
Mix and other performance 11 (18 )
Total Change in Operating Income $ 67 $ 41
% Change
2012 compared 2011 compared
(In millions, except percentages) 2012 2011 2010 to 2011 to 2010
Bookings $ 5,305 $ 4,592 $ 4,321 15.5 % 6.3 %
Total Backlog 6,031 5,864 5,981 2.8 % (2.0 )%
SAS is a leader in the design and development of integrated systems and
solutions for advanced missions, including traditional and non-traditional ISR,
precision engagement, unmanned aerial operations, and space. Leveraging advanced
concepts, state-of-the-art technologies and mission systems knowledge, SAS
provides electro-optical/infrared sensors, airborne radars for surveillance and
fire control applications, lasers, precision guidance systems, signals
intelligence systems, processors, electronic warfare systems and space-qualified
systems for civil and military applications. Key customers include the U.S.
Navy, Air Force and Army, as well as classified and international customers.
Total Net Sales-Total net sales in 2012 were relatively consistent with 2011.
Included in total net sales was $100 million of higher net sales due to
increased volume on an international tactical airborne radar program primarily
due to program schedule requirements, partially offset by lower net sales of $97
million primarily due to lower volume on certain sensor systems programs due to
program schedule requirements. The remaining change in total net sales was
primarily spread across numerous domestic programs with no individual or common
significant driver.
The increase in total net sales of $425 million in 2011 compared to 2010 was
primarily due to $200 million of higher net sales related to RAST, which we
acquired in the first quarter of 2011, $187 million of higher volume on ISR
systems programs due to increased bookings over the last few years driven by
customer demand for these capabilities, and $102 million from higher volume, as
production work increased, as planned, on an international airborne tactical
radar program
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awarded in the first half of 2010.
Total Operating Expenses-Total operating expenses in 2012 were relatively
consistent with 2011. The increase in other cost of sales and other operating
expenses of $62 million was primarily due to the timing and amount of
adjustments for loss contracts.
The increase in total operating expenses of $384 million in 2011 compared to
2010 was primarily due to the activity described above. The increase in
materials and subcontractor costs of $188 million was driven primarily by the
timing of program requirements, principally on the ISR systems production
programs and on the international airborne tactical radar program for the
reasons described above in Total Net Sales. The increases in labor of $109
million and in other cost of sales and other operating expenses of $87 million
compared to 2010 were primarily related to RAST.
Operating Income and Margin-The increase in operating income of $67 million in
2012 compared to 2011 was primarily due to a net change in EAC adjustments of
$51 million principally as a result of material and support efficiencies and
contract modifications on international tactical airborne radar programs and
certain classified programs. Included in mix and other performance in 2012 and
2011 was $22 million and $41 million, respectively, of acquisition-related costs
for RAST.
The increase in operating income of $41 million in 2011 compared to 2010 was
primarily due to higher volume of $43 million, principally driven by the
activity on the programs described above in Total Net Sales, and net change in
EAC adjustments of $16 million, driven primarily by the amount of EAC
adjustments on an international airborne tactical radar program and on an
advanced targeting program, partially offset by a change in contract mix and
other performance of $18 million. Included in contract mix and other performance
was $41 million of acquisition-related costs for RAST, partially offset by the
2011 impact of the mix of contracts completing and new contract awards.
Operating margin in 2011 remained relatively consistent with 2010.
Backlog and Bookings-Backlog remained relatively consistent and was $6,031
million, $5,864 million and $5,981 million at December 31, 2012, 2011 and 2010,
respectively.
Bookings increased by $713 million in 2012 compared to 2011. In 2012, SAS booked
$617 million on radar contracts for international customers, $205 million to
provide Multi-Spectral Targeting Systems (MTS) for unmanned aerial vehicles to
the U.S. Air Force, $77 million for the production of radar warning receivers
for the U.S. Navy, and $76 million for the production of the Multi-Platform
Radar Technology Insertion Program (MP-RTIP) surveillance system for NATO. In
addition to the bookings noted above, SAS booked $1,858 million on a number of
classified contracts.
Bookings increased by $271 million in 2011 compared to 2010. In 2011, SAS booked
$782 million on an international Active Electronically Scanned Array (AESA)
program for F-15's to the Kingdom of Saudi Arabia, $291 million for the
production of AESA radars for the U.S. Air Force, U.S. Navy and the Air National
Guard, and $78 million on radar contracts for an international customer. SAS
also booked $954 million on a number of classified contracts.
In 2010, SAS booked $1,106 million on a number of classified contracts,
including $332 million on a major classified space program. In 2010, SAS also
booked $618 million for the production of AESA radars for the U.S. Air Force,
U.S. Navy, Air National Guard and international customers and $90 million for
the production of Advanced Countermeasures Electronic System (ACES) for Egypt.
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Technical Services
% Change
2012 compared 2011 compared
(In millions, except percentages) 2012 2011 2010 to 2011 to 2010
Total Net Sales $ 3,239 $ 3,353 $ 3,472 (3.4 )% (3.4 )%
Total Operating Expenses
Cost of sales-labor 1,076 1,100 998 (2.2 )% 10.2 %
Cost of sales-materials and
subcontractors 1,589 1,664 1,903 (4.5 )% (12.6 )%
Other cost of sales and other
operating expenses 292 277 274 5.4 % 1.1 %
Total Operating Expenses 2,957 3,041 3,175 (2.8 )% (4.2 )%
Operating Income $ 282 $ 312 $ 297 (9.6 )% 5.1 %
Operating Margin 8.7 % 9.3 % 8.6 %
Year Ended 2012 Year Ended 2011
Change in Operating Income (in Versus Year Ended Versus Year Ended
millions) 2011 2010
Volume $ (6 ) $ (9 )
Net change in EAC adjustments (33 ) 11
Mix and other performance 9 13
Total Change in Operating Income $ (30 ) $ 15
% Change
2012 compared 2011 compared
(In millions, except percentages) 2012 2011 2010 to 2011 to 2010
Bookings $ 2,551 $ 2,774 $ 2,631 (8.0 )% 5.4 %
Total Backlog 2,336 2,586 2,654 (9.7 )% (2.6 )%
TS provides a full spectrum of technical and professional services to defense,
federal, international and commercial customers worldwide. It specializes in
training, logistics, engineering services and solutions, product and operational
support services for the mission support, homeland security, space, civil
aviation, counter proliferation and counterterrorism markets. Key customers
include all branches of the U.S. Armed Forces, as well as the Department of
Homeland Security (DHS), NASA, FAA, Department of State (DOS), Department of
Energy (DOE), Defense Threat Reduction Agency (DTRA), international governments
and commercial entities.
Total Net Sales-The decrease in total net sales of $114 million in 2012 compared
to 2011 was due to lower net sales of $121 million on the NSF Polar contract,
which was completed in the first quarter of 2012.
The decrease in total net sales of $119 million in 2011 compared to 2010 was
primarily due to $76 million of lower net sales on a DTRA program which
completed significant efforts at the end of 2010 and $60 million of lower net
sales on training programs, principally domestic training programs supporting
the U.S. Army's Warfighter FOCUS activities due to a decrease in customer
determined activity levels, partially offset by $45 million of higher net sales
on various depot services operations programs, driven primarily by new contract
awards.
Total Operating Expenses-The decrease in total operating expenses of $84 million
in 2012 compared to 2011 was primarily due to the activity on the programs and
for the reasons described above in Total Net Sales. The $15 million increase in
other cost of sales and other operating expenses was due primarily to an
increase in administrative and selling, and bid and proposal, expenses.
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The decrease in total operating expenses of $134 million in 2011 compared to
2010 was driven primarily by the activity on the DTRA and training programs for
the reasons described above in Total Net Sales. The decrease in materials and
subcontractor costs of $239 million was driven primarily by the decreased volume
on these programs and the types of costs incurred in the respective periods
based on the program requirements and program schedules. The decrease in
materials and subcontractor costs was partially offset by higher labor of $102
million driven primarily by training programs supporting the U.S. Army's
Warfighter FOCUS activities due to a change in customer determined activities.
Operating Income and Margin-The decrease in operating income of $30 million in
2012 compared to 2011 was primarily due to a net change in EAC adjustments of
$33 million driven primarily by operational efficiencies in 2011 on various
customized engineering and depot support programs. The decrease in operating
margin in 2012 compared to 2011 was primarily due to the net change in EAC
adjustments.
The increase in operating income of $15 million in 2011 compared to 2010 was
primarily due to a change in contract mix and other performance of $13 million,
primarily driven by cost efficiencies and higher award fees associated with
various training programs, which had an impact of $8 million. Operating income
also increased due to a net change in EAC adjustments of $11 million, primarily
driven by cost efficiencies on a weapon production and modification program,
which had a $7 million impact on operating income. The increases in operating
income were partially offset by lower volume, which had a $9 million impact on
operating income. The increase in operating margin in 2011 compared to 2010 was
primarily due to the change in net change in EAC adjustments and the contract
mix and other performance described above.
Backlog and Bookings-Backlog remained relatively consistent and was $2,336
million, $2,586 million and $2,654 million at December 31, 2012, 2011 and 2010,
respectively.
Bookings decreased by $223 million in 2012 compared to 2011. In 2012, TS booked
$900 million on domestic training programs and $394 million on foreign training
programs in support of the Warfighter FOCUS activities and $246 million for work
on the Air Traffic Control Optimum Training Solution (ATCOTS) contract to
maintain and improve air traffic control (ATC) training and support the FAA in
meeting the current and future ATC demands.
Bookings increased by $143 million in 2011 compared to 2010. In 2011, TS booked
$994 million on domestic training programs and $347 million on foreign training
programs in support of the Warfighter FOCUS activities, $150 million to provide
operational and logistics support to the NSF Office of Polar Programs, $120
million to design, develop and deliver technical training to a commercial
customer, and $100 million with Australia for base operations, maintenance and
support services at the Harold E. Holt Naval Communications station.
In 2010, TS booked $952 million on domestic training programs and $328 million
on foreign training programs in support of the Warfighter FOCUS activities, $173
million to provide operational and logistics support to the NSF Office of Polar
Programs and $88 million on the Security Equipment Integration Services (SEIS)
contract for the Transportation Security Administration (TSA).
FAS/CAS Adjustment
The FAS/CAS Adjustment represents the difference between our pension and other
postretirement benefit (PRB) expense or income under Financial Accounting
Standards (FAS) requirements under GAAP and our pension and PRB expense under
U.S. Government cost accounting standards (CAS). The results of each segment
only include pension and PRB expense under CAS that we generally recover through
the pricing of our products and services to the U.S. Government.
The components of the FAS/CAS Adjustment were as follows:
(In millions)
2012 2011 2010
FAS/CAS Pension Adjustment $ (255 ) $ (340 ) $ (230 )
FAS/CAS PRB Adjustment - 3 43
FAS/CAS Adjustment $ (255 ) $ (337 ) $ (187 )
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The components of the FAS/CAS Pension Adjustment were as follows:
(In millions)
2012 2011 2010
FAS expense $ (1,093 ) $ (1,073 ) $ (896 )
CAS expense 838 733 666
FAS/CAS Pension Adjustment $ (255 ) $ (340 ) $ (230 )
As described above in Critical Accounting Estimates, a key driver of the
difference between FAS and CAS expense (and consequently, the FAS/CAS Pension
Adjustment) is the pattern of earnings and expense recognition for gains and
losses that arise when our asset and liability experience differ from our
assumptions under each set of requirements. Generally, such gains or losses are
amortized under FAS over the average future working lifetime of the eligible
employee population of approximately 10 years at December 31, 2012, and are
currently amortized under CAS over a 15-year period. However, the CAS
Harmonization described above will reduce this amortization period from 15 to 10
years beginning in 2013, as well as changing the liability measurement method.
In accordance with both FAS and CAS, a "market-related value" of our plan assets
is used to calculate the amount of deferred asset gains or losses to be
amortized. The market-related value of assets is determined using actual asset
gains or losses over a certain prior period (three years for FAS and five years
for CAS, subject to certain limitations under CAS on the difference between the
market-related value and actual market value of assets). Because of this
difference in the number of years over which actual asset gains or losses are
recognized and subsequently amortized, FAS expense generally tends to reflect
recent gains or losses faster than CAS. Another driver of CAS expense (but not
FAS expense) is the funded status of our pension plans under CAS. As noted
above, CAS expense is only recognized for plans that are not fully funded;
consequently, if plans become or cease to be fully funded under CAS due to our
asset or liability experience, our CAS expense will change accordingly.
The change in the FAS/CAS Pension Adjustment of $85 million in 2012 compared to
2011 was driven by a $105 million increase in our CAS expense, primarily due to
the continued recognition of the 2008 negative asset returns.
The change in the FAS/CAS Pension Adjustment of $110 million in 2011 compared to
2010 was primarily driven by a $177 million increase in our FAS expense. The
$177 million increase in our FAS expense was driven primarily by the continued
recognition of the 2008 losses in the market related value of assets, which had
an impact of approximately $200 million. Our CAS expense increased $67 million
as a result of actual versus expected asset and liability experience.
For 2013 compared to 2012, we currently expect our FAS expense will increase
more than our CAS expense, which will increase the FAS/CAS Pension Adjustment.
We expect the FAS/CAS Pension Adjustment to be approximately $289 million of
expense driven by the lower discount rate environment and the difference in the
recognition period for actual asset gains and losses under FAS and CAS,
described above. This expected increase in FAS expense in excess of CAS expense
is subject to our annual update, generally planned in the third quarter, of our
actuarial estimate of the unfunded benefit obligation for both FAS and CAS for
final 2012 census data. After 2013, the FAS/CAS Pension Adjustment is more
difficult to predict because future FAS and CAS expense is based on a number of
key assumptions for future periods. Differences between those assumptions and
future actual results could significantly change both FAS and CAS expense in
future periods. However, based solely on our current assumptions at December 31,
2012 and taking into account CAS Harmonization, which increases CAS expense in
2013 and beyond, we would expect after 2013 our FAS/CAS Pension Adjustment
expense to decline and ultimately result in FAS/CAS Pension Adjustment income in
2015.
The components of the FAS/CAS PRB Adjustment were as follows:
(In millions)
2012 2011 2010
FAS (expense) income $ (16 ) $ (13 ) $ 11
CAS expense 16 16 32
FAS/CAS PRB Adjustment $ - $ 3 $ 43
The FAS/CAS PRB Adjustment in 2012 was relatively consistent with 2011.
The change in the FAS/CAS PRB Adjustment of $40 million in 2011 compared to 2010
was primarily due to the expiration of historical amortization under FAS of
previous benefit modifications.
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Corporate and Eliminations
Corporate and Eliminations includes corporate expenses and intersegment sales
and profit eliminations. Corporate expenses represent unallocated costs and
certain other corporate costs not considered part of management's evaluation of
reportable segment operating performance.
During the first quarter of 2012, we completed the disposal or abandonment of
the remaining individual assets of our former turbo-prop commuter aircraft
portfolio, RAAS, and all operations have ceased. As a result, we have reported
the results of RAAS, which were formerly included in Corporate and Eliminations,
as a discontinued operation for all periods presented.
The components of total net sales and operating income related to Corporate and
Eliminations were as follows:
Total Net Sales (in millions) 2012 2011 2010
Intersegment sales eliminations $ (1,958 ) $ (1,876 ) $ (2,023 )
Corporate - (1 ) (6 )
Total $ (1,958 ) $ (1,877 ) $ (2,029 )
Total Operating Income (in millions) 2012 2011 2010
Intersegment profit eliminations $ (191 ) $ (177 ) $ (189 )
Corporate
(10 ) (40 ) (39 )
Total $ (201 ) $ (217 ) $ (228 )
Total net sales and operating income related to Corporate in 2012 remained
relatively consistent with 2011 and 2010.
Discontinued Operations
In pursuing our business strategies we have divested certain non-core
businesses, investments and assets when appropriate. All residual activity
relating to our previously-disposed businesses appears in discontinued
operations.
During the first quarter of 2012, we completed the disposal or abandonment of
the remaining individual assets of our former turbo-prop commuter aircraft
portfolio, Raytheon Airline Aviation Services (RAAS), and all operations have
ceased. As a result, we have reported the results of RAAS as a discontinued
operation for all periods presented. The sale of the remaining operating assets
in the year ended December 31, 2012, resulted in a gain of less than $1 million.
Income (loss) from discontinued operations included the following results of
RAAS at December 31:
(In millions) 2012 2011 2010
Pretax $ - $ 30 (2 )
After-tax - 19 (1 )
No interest expense relating to RAAS was allocated to discontinued operations
for the twelve months ended December 31, 2012 and 2011 because there was no debt
specifically attributable to discontinued operations.
We retained certain assets and liabilities of our previously-disposed
businesses. At December 31, 2012 and December 31, 2011, we had $7 million and
$19 million, respectively, of assets primarily related to our retained interest
in general aviation finance receivables previously sold by Raytheon Aircraft
Company (Raytheon Aircraft). At December 31, 2012 and December 31, 2011, we had
$36 million and $44 million, respectively, of liabilities primarily related to
non-income tax obligations, certain environmental and product liabilities,
various contract obligations and aircraft lease obligations. We also retained
certain pension assets and obligations which we include in our pension
disclosures.
In the divestiture of Flight Options LLC (Flight Options), we agreed to
indemnify Flight Options in the event they were assessed and paid excise taxes.
In the fourth quarter of 2010, Internal Revenue Service (IRS) appeals
proceedings failed to resolve the federal excise tax dispute, and as a result,
the IRS assessed Flight Options for excise taxes. As a result, in the fourth
quarter of 2010 we recorded a $39 million charge, net of federal tax benefit, in
discontinued operations. In the first quarter of 2011, Flight Options paid the
assessment. On behalf of Flight Options, we intend to vigorously contest the
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matter through litigation and, if successful, we would be entitled to recover
substantially all of the amounts paid. We also have certain tax obligations
relating to disposed businesses.
As further described in "Note 15: Income Taxes" within Item 8 of this Form 10-K,
during the year ended December 31, 2010, we recorded a $281 million reduction in
our unrecognized tax benefits, which included a decrease of $89 million in tax
expense from discontinued operations, including interest, primarily related to
our previous disposition of Raytheon Engineers and Constructors (RE&C).
FINANCIAL CONDITION AND LIQUIDITY
Overview
We pursue a capital deployment strategy that balances funding for growing our
business, including working capital, capital expenditures, acquisitions and
research and development; prudently managing our balance sheet, including debt
repayments and pension contributions; and returning cash to our stockholders,
including dividend payments and share repurchases, as outlined below. Our need
for, cost of and access to funds are dependent on future operating results, as
well as other external conditions. We currently expect that cash and cash
equivalents, available-for-sale securities, cash flow from operations and other
available financing resources will be sufficient to meet anticipated operating,
capital expenditure, investment, debt service and other financing requirements
during the next twelve months and for the foreseeable future.
In addition, the following table highlights selected measures of our liquidity
and capital resources at December 31, 2012 and 2011:
(In millions)
2012 2011
Cash and cash equivalents $ 3,188 $ 4,000
Short-term investments 856 -
Working capital 3,344 3,179
Amount available under our credit facilities 1,398 1,397
Operating Activities
(In millions) 2012 2011 2010
Net cash provided by (used in) operating activities from
continuing operations
$ 1,951 $ 2,102 $ 1,892
Net cash provided by (used in) operating activities 1,957 2,107 1,942
Net cash provided by (used in) operating activities in 2012 remained relatively
consistent with 2011. Net cash provided by (used in) operating activities in
2011 remained relatively consistent with 2010.
Tax Payments-In 2012, we received federal tax refunds totaling $79 million,
including the refund relating to the 2012 Tax Settlement, and $41 million of
foreign tax refunds, and made $959 million in federal and foreign tax payments
and $77 million in net state tax payments. In 2011, we received federal tax
refunds totaling $128 million, including the refund relating to the 2011 Tax
Settlement, and made $553 million in federal and net foreign tax payments and
$12 million in net state tax payments. In 2010, we received federal tax refunds
totaling $96 million and made $433 million in federal and net foreign tax
payments and $54 million in net state tax payments. Federal and foreign tax
payments for 2013 are expected to approximate $655 million.
Pension Plan Contributions-We may make both required and discretionary
contributions to our pension plans. Required contributions are primarily
determined in accordance with the PPA, which amended the ERISA rules and are
affected by the actual return on plan assets and plan funded status. The funding
requirements under the PPA require us to fully fund our pension plans over a
rolling seven-year period as determined annually based upon the PPA calculated
funded status at the beginning of the year. The PPA funded status is based on
actual asset performance, averaged over three years and PPA discount rates,
which are based on a 24-month average of high quality corporate bond rates, as
published by the IRS. In July 2012, the Surface Transportation Extension act,
which is also referred to as the Moving ahead for Progress in the 21st Century
Act (STE Act), was passed by Congress and signed by the President. The STE Act
includes a provision for temporary pension funding relief from the current
historically low interest rate environment. The provision adjusts the 24-
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month average high quality bond rates used to determine the PPA funded status so
that they are within a floor and cap, or "corridor," based on the 25-year
average of corporate bond rates. Beginning in 2012, interest rates must be
between 90% and 110% of the 25-year rate, with a 5% increase in this corridor
for each year from 2013-2016, resulting in a gradual phase-out of the provision.
As a result of the STE Act, the approximate PPA funding status for most of our
plan increased from 80-90% funded to 90-100% funded. The provision reduced our
cash funding requirements in 2012 by approximately $450 million before an
estimated tax impact of $275 million ($175 million after-tax). Funding
requirements for future periods will be based on actual asset performance and
future interest rates. Pension assets and liabilities are valued annually at
December 31 for purposes of determining funded status and future year for FAS
expense, CAS expense and cash funding requirements.
The STE Act does not change the calculation of our FAS expense. However,
reductions in our required contributions could increase our FAS expense in
future years by the amount of expected return that would have applied to the
contributions. Our $500 million discretionary pension contribution in 2012
generally offsets the impact to our future year FAS expense that would have
resulted from the reduced 2012 funding requirements under the STE Act. In
addition, based upon current interest rate projections, the STE Act could have a
modest impact on our CAS expense in 2014, when CAS Harmonization incorporates
the PPA interest rate into CAS calculations.
The STE Act also increases the insurance premiums that we are required to pay to
the Pension Benefit Guarantee Corporation (PBGC). However, we do not expect
these increases to have a material effect on our financial position, results of
operations or liquidity.
We made the following required and discretionary contributions to our pension
plans during the years ended December 31:
(In millions) 2012 2011 2010
Required contributions $ 721 $ 1,078 $ 1,152
Discretionary contributions 500 750 750
Total
$ 1,221 $ 1,828 $ 1,902
The decrease in required contributions of $357 million in 2012 compared to 2011
was primarily due to the passage of the STE Act as discussed above. Required
contributions in 2011 were relatively consistent with 2010. With the passage of
the STE Act discussed above, we now expect to make required contributions to our
pension and other postretirement benefit plans of approximately $800 million in
2013. The gradual phase out of the STE Act provisions is expected to result in
an increase in our required pension contributions in 2014 and beyond to levels
comparable to 2010 and 2011 unless interest rates significantly increase. We
periodically evaluate whether to make discretionary contributions. Due to the
differences in requirements and calculation methodologies, our FAS pension
expense or income is not indicative of the funding requirement or amount of
government recovery.
Other postretirement benefit payments were $19 million, $18 million and $32
million in 2012, 2011 and 2010, respectively.
Interest Payments-We made interest payments on our outstanding debt of $198
million, $167 million and $134 million in 2012, 2011 and 2010, respectively. The
increase in interest payments in 2012 compared to 2011 was principally due to
the issuance of $1.0 billion of fixed rate long-term debt in the fourth quarter
of 2011. The increase in interest payments in 2011 compared to 2010 was
primarily due to interest payments on the 1.625% notes, 3.125% notes, and 4.875%
notes issued in the fourth quarter of 2010.
Investing Activities
(In millions) 2012 2011 2010
Net cash provided by (used in) investing activities from
continuing operations
$ (1,523 ) $ (1,083 ) $ (535 )
Net cash provided by (used in) investing activities (1,523 ) (1,051 ) (535 )
The change of $472 million in net cash provided by (used in) investing
activities in 2012 compared to 2011 was primarily due to purchases of short-term
investments, as described below, partially offset by lower cash payments for
acquisitions due to the acquisition of Applied Signal Technology, Inc. in 2011,
as described below. The change of $516 million in net cash provided by (used in)
investing activities in 2011 compared to 2010 was primarily due to the
acquisition of Applied
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Signal Technology, Inc., as described below.
Additions to property plant and equipment and capitalized internal use
software-Additions to property, plant and equipment and capitalized internal use
software were as follows:
(In millions) 2012 2011 2010
Additions to property, plant and equipment $ 339 $ 340 $ 319
Additions to capitalized internal use software 76 97 67
We expect our property, plant and equipment and capitalized internal use
software expenditures to be approximately $360 million and $70 million,
respectively, in 2013, consistent with the anticipated needs of our business and
for specific investments including program capital assets and facility
improvements.
Short-term investments activity-We invest in marketable securities in accordance
with our short-term investment policy. These marketable securities are
classified as available-for-sale and are recorded at fair value as short-term
investments in our consolidated balance sheets. During 2012, we made purchases
of short-term investments, comprised of highly rated bank certificates of
deposit, of $1,505 million, while sales of short-term investments amounted to
$150 million and maturities of short-term investments amounted to $505 million.
As of December 31, 2012, our short-term investments had an average maturity of
approximately six months.
Acquisitions and Divestitures-In pursuing our business strategies, we acquire
and invest in certain businesses that meet strategic and financial criteria, and
divest of certain non-core businesses, investments and assets when appropriate.
Payments for purchases of acquired companies, net of cash acquired were as
follows:
(In millions) 2012 2011 2010
Payments for purchases of acquired companies, net of
cash acquired
$ 301 $ 645 $ 152
In December 2012, we acquired the Government Solutions business of SafeNet,
Inc., subsequently renamed Raytheon Secure Information Systems, LLC (RSIS) for
approximately $280 million in cash, net of cash acquired and exclusive of
retention payments. RSIS will be integrated into our Network Centric Systems
(NCS) business, within the Integrated Communication Systems product line as the
Secure Information Systems product area. RSIS provides advanced encryption
capabilities needed by government and industry customers to protect classified
data. In connection with this transaction we have preliminarily recorded $197
million of goodwill related to expected synergies from combining operations and
the value of the existing workforce, and $75 million of intangible assets,
primarily related to technology with an estimated weighted-average life of eight
years. We expect to complete the purchase price allocation process in the first
quarter of 2013 after the purchase price adjustment process and our final
reviews are completed.
Additionally, in 2012 we acquired Teligy, Inc., subsequently renamed Raytheon
Teligy, Inc., and an Australian company, Poseidon Scientific Instruments Pty
Ltd., for an aggregate of $22 million in cash, net of cash acquired. Raytheon
Teligy, Inc. further extends our cybersecurity offerings in wireless
communications at Intelligence and Information Systems (IIS). The Poseidon
Scientific Instruments Pty Ltd. acquisition is part of our strategy to extend
and enhance our Integrated Defense Systems (IDS) offerings. In connection with
these acquisitions we recorded $15 million of goodwill, primarily related to
expected synergies from combining operations, and $5 million of intangible
assets, primarily related to customer relationships and technology with a
weighted-average life of six years.
In 2011, we acquired Applied Signal Technology, Inc., subsequently renamed
Raytheon Applied Signal Technology, Inc. (RAST) for $500 million in cash, net of
$25 million of cash and cash equivalents acquired, and exclusive of retention
and management incentive payments. RAST provides advanced intelligence,
surveillance and reconnaissance (ISR) solutions to enhance global security. The
acquisition is part of our strategy to extend and enhance our Space and Airborne
Systems (SAS) offerings related to certain classified and Department of Defense
markets. Pro forma financial information has not been provided for this
acquisition since it is not material. In connection with this acquisition, we
recorded $387 million of goodwill, all of which was allocated to our SAS
segment, primarily related to expected synergies from combining operations and
the value of RAST's assembled workforce, and $89 million in intangible assets,
primarily related to contractual relationships, license agreements and trade
names with a weighted-average life of seven years.
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Additionally, in 2011 we acquired Henggeler Computer Consultants Inc., Pikewerks
Corporation and substantially all of the assets of Ktech Corporation for an
aggregate of $145 million in cash, net of cash acquired. The Henggeler Computer
Consultants Inc. and Pikewerks Corporation acquisitions enhance our
cybersecurity and information assurance capabilities at Intelligence and
Information Systems (IIS). The Ktech Corporation acquisition is part of our
strategy to extend and enhance our Missile Systems (MS) offerings. In connection
with these acquisitions, we recorded $112 million of goodwill, primarily related
to expected synergies from combining operations and the value of the existing
workforce, and $26 million of intangible assets, primarily related to customer
relationships, trade names and technology with an initial estimated
weighted-average life of seven years.
In 2010, we acquired Trusted Computer Solutions Inc., Technology Associates Inc.
and substantially all of the assets of an Australian company, Compucat Research
Pty. Ltd, for an aggregate of $152 million in cash, net of cash acquired. These
acquisitions enhance our cybersecurity and information assurance capabilities at
IIS. In connection with these acquisitions, we recorded $125 million of
goodwill, primarily related to expected synergies from combining operations and
the value of the existing workforce, and $28 million of intangible assets,
primarily related to technology, trade names and customer relationships with a
weighted-average life of five years.
Financing Activities
(In millions) 2012 2011 2010
Net cash provided by (used in) financing activities $ (1,246 ) $ (694 ) $ (411 )
We have used cash provided by operating activities, and proceeds from the
issuance of new debt in 2012 and 2011 as our primary source for the repayment of
debt, payment of dividends, pension contributions and the repurchase of our
common stock. The change of $552 million in net cash provided by (used in)
financing activities in 2012 compared to 2011 was primarily due to the
repayments of long-term debt in 2012 offset by the change in the amount of stock
repurchased described below. The change of $283 million in net cash provided by
(used in) financing activities in 2011 compared to 2010 was primarily due to
lower net proceeds from debt issuances and repayments in 2011 compared to 2010,
and the lower level of warrants exercised in 2011 compared to 2010.
Debt-In the fourth quarter of 2012, we received proceeds of $1,092 million for
the issuance of $1.1 billion fixed rate long-term debt and exercised our call
rights to repurchase, at prices based on fixed spreads to U.S. Treasuries, $970
million of our long-term debt due in 2014 and 2015 at a loss of $29 million
pretax, $19 million after-tax, which is included in other expense (income), net.
In the fourth quarter of 2011, we received proceeds of $992 million for the
issuance of $1.0 billion fixed rate long-term debt.
In the fourth quarter of 2010, we received proceeds of $1,975 million for the
issuance of $2.0 billion fixed rate long-term debt and exercised our call rights
to repurchase, at prices based on fixed spreads to U.S. Treasuries, $678 million
of our long-term debt due in 2012 and 2013 at a loss of $73 million pretax, $47
million after-tax, which is included in other expense (income), net.
Stock Repurchases-In September 2011, our Board of Directors authorized the
repurchase of up to an additional $2.0 billion of our outstanding common stock.
At December 31, 2012, we had approximately $1.3 billion remaining under this
repurchase program. All previous programs have been completed as of December 31,
2012. Share repurchases will take place from time to time at management's
discretion depending on market conditions.
Stock repurchases also include shares surrendered by employees to satisfy tax
withholding obligations in connection with restricted stock awards, restricted
stock units and stock options issued to employees.
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Our stock repurchases were as follows:
(In millions) 2012 2011 2010
$ Shares $ Shares $ Shares
Stock repurchased under our stock
repurchase programs $ 825 15.9 $ 1,250 27.1 $ 1,450 29.0
Stock repurchased to satisfy tax
withholding obligations 37 0.7 36 0.7 46 0.8
Total stock repurchases $ 862 16.6 $ 1,286 27.8 $ 1,496 29.8
In May 2010, our stockholders approved the Raytheon 2010 Stock Plan. Under the
plan, we may grant restricted stock awards, restricted stock units, stock
grants, stock options and stock appreciation rights.
Cash Dividends-Our Board of Directors authorized the following cash dividends:
(In millions, except per share amounts) 2012 2011 2010
Cash dividends per share
$2.00 $1.72 $1.50
Total dividends paid 643 588 536
In March 2012, our Board of Directors authorized a 16% increase to our annual
dividend payout rate from $1.72 to $2.00 per share. In March 2011, our Board of
Directors authorized a 15% increase in our annual dividend payout rate from
$1.50 to $1.72 per share. Dividends are subject to quarterly approval by our
Board of Directors.
CAPITAL RESOURCES
Total debt was $4.7 billion at December 31, 2012, $4.6 billion at December 31,
2011 and $3.6 billion at December 31, 2010. Our outstanding debt bears
contractual interest at fixed interest rates ranging from 2.5% to 7.2% and
matures at various dates from 2018 through 2041.
Cash and Cash Equivalents and Short-term Investments-Cash and cash equivalents
and short-term investments were $4.0 billion at December 31, 2012 and
December 31, 2011. We may invest in U.S. Treasuries; AAA/Aaa rated money market
funds; certificates of deposit, time deposits and commercial paper of banks with
a minimum long-term debt rating of A or A2 and minimum short-term debt rating of
A-1 and P-1, and commercial paper of corporations with a minimum long-term debt
rating of A+ or A1 and minimum short-term debt rating of A-1 and P-1. Cash and
cash equivalents and short-term investments balances held at our foreign
subsidiaries were approximately $725 million and $450 million at December 31,
2012 and December 31, 2011, respectively. Earnings from our foreign subsidiaries
are currently deemed to be indefinitely reinvested. We do not expect such
reinvestment to affect our liquidity and capital resources, and we continuously
evaluate our liquidity needs and ability to meet global cash requirements as a
part of our overall capital deployment strategy. Factors that affect our global
capital deployment strategy include anticipated cash flows, the ability to
repatriate cash in a tax efficient manner, funding requirements for operations
and investment activities, acquisitions and divestitures, and capital market
conditions.
Credit Facilities-In December 2011, we entered into a $1.4 billion revolving
credit facility maturing in 2016, replacing the previous $500 million and $1.0
billion credit facilities, which were both scheduled to mature in November 2012.
Under the $1.4 billion credit facility, we can borrow, issue letters of credit
and backstop commercial paper. Borrowings under this facility bear interest at
various rate options, including LIBOR plus a margin based on our credit ratings.
Based on our credit ratings at December 31, 2012, borrowings would generally
bear interest at LIBOR plus 90 basis points. The credit facility is comprised of
commitments from approximately 25 separate highly rated lenders, each committing
no more than 10% of the facility. As of December 31, 2012 and December 31, 2011,
there were no borrowings outstanding under this credit facility. However, we had
$2 million and $3 million of outstanding letters of credit at December 31, 2012
and December 31, 2011, respectively, which effectively reduced our borrowing
capacity under this credit facility by those same amounts.
Under the $1.4 billion credit facility we must comply with certain covenants,
including a ratio of total debt to total capitalization of no more than 60%. We
were in compliance with the credit facility covenants during 2012 and 2011. Our
ratio of total debt to total capitalization, as those terms are defined in the
credit facility, was 36.6% at December 31, 2012. We are providing this ratio as
this metric is used by our lenders to monitor our leverage and is also a
threshold that limits
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our ability to utilize this facility. We were also required to comply with
certain covenants in connection with our previous credit facilities and were in
compliance with such covenants in 2011.
Credit Ratings-Three major corporate debt rating organizations, Fitch Ratings
(Fitch), Moody's Investors Service (Moody's) and Standard & Poor's (S&P), assign
ratings to our short-term and long-term debt. The following chart reflects the
current ratings assigned by each of these agencies as of December 31, 2012 to
our short and long-term senior unsecured debt:
Short-Term Long-Term Senior
Rating Agency Debt Rating Debt Rating Outlook Date of Last Action
Fitch F2 A- Stable September 2008
Moody's P-2 A3 Stable October 2011
S&P A-2 A- Stable September 2008
Shelf Registrations-We have an effective shelf registration with the SEC, filed
in January 2013, which covers the registration of debt securities, common stock,
preferred stock and warrants.
CONTRACTUAL OBLIGATIONS
The following is a schedule of our contractual obligations outstanding at
December 31, 2012:
Payment due by period
Less than After 5 years
1 year 1-3 years 3-5 years (2018 and
(In millions) Total (2013) (2014-2015) (2016-2017) thereafter)
Debt(1) $ 4,783 $ - $ - $ - $ 4,783
Interest payments 2,932 209 418 418 1,887
Operating leases 962 206 307 184 265
Purchase obligations 7,650 5,985 1,332 244 89
Total $ 16,327 $ 6,400 $ 2,057 $ 846 $ 7,024
(1) Debt includes scheduled principal payments only.
Purchase obligations in the table above represent enforceable and legally
binding agreements with suppliers to purchase goods or services. We enter into
contracts with customers, primarily the U.S. Government, which entitle us to
full recourse for costs incurred, including purchase obligations, in the event
the contract is terminated by the customer for convenience. These purchase
obligations are included above notwithstanding the amount for which we are
entitled to full recourse from our customers. The table above does not include
required pension and other postretirement benefit contributions. We expect to
make required pension and other postretirement benefit contributions of
approximately $800 million in 2013, exclusive of any U.S. Government recovery.
Amounts beyond 2012 for required pension and other postretirement benefit
contributions depend upon actuarial assumptions, actual plan asset performance
and other factors described under pension costs in Critical Accounting Estimates
beginning on page 34. However, based solely on our current assumptions, we
expect our funding requirements to be approximately $1 billion in 2014,
exclusive of any U.S. Government recovery, and slowly decreasing thereafter.
Interest payments include interest on debt that is redeemable at our option.
As of December 31, 2012 and December 31, 2011, the total amount of unrecognized
tax benefits for uncertain tax positions and the accrual for the related
interest, net of the federal benefit, was $141 million and $178 million,
respectively, and was included in accrued retiree benefits and other long-term
liabilities. These amounts were not included in the table above because we are
unable to make a reasonably reliable estimate of when a cash settlement, if any,
will occur with a tax authority as the timing of examinations and ultimate
resolutions of those examinations is uncertain.
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OFF-BALANCE SHEET ARRANGEMENTS
At December 31, 2012, we had no significant off-balance sheet arrangements other
than operating leases and guarantees to third parties on behalf of our
affiliates as described below in Commitments and Contingencies. Such
arrangements are not material to our overall liquidity or capital resources,
market risk support or credit risk support as described below.
COMMITMENTS AND CONTINGENCIES
Environmental Matters-We are involved in various stages of investigation and
cleanup related to remediation of various environmental sites. Our estimate of
the liability of total environmental remediation costs includes the use of a
discount rate and takes into account that a portion of these costs is eligible
for future recovery through the pricing of our products and services to the U.S.
Government. We consider such recovery probable based on government contracting
regulations and our long history of receiving reimbursement for such costs, and
accordingly have recorded the estimated future recovery of these costs from the
U.S. Government within contracts in process. Our estimates regarding remediation
costs to be incurred were as follows at December 31:
(In millions, except percentages) 2012 2011
Total remediation costs-undiscounted $ 202 $ 227
Weighted-average risk-free rate 5.6 % 5.6 %
Total remediation costs-discounted $ 131 $ 152
Recoverable portion 86 105
We also lease certain government-owned properties and are generally not liable
for remediation of preexisting environmental contamination at these sites; as a
result, we generally do not provide for these costs in our consolidated
financial statements.
Due to the complexity of environmental laws and regulations, the varying costs
and effectiveness of alternative cleanup methods and technologies, the
uncertainty of insurance coverage and the unresolved extent of our
responsibility, it is difficult to determine the ultimate outcome of
environmental matters; however, we do not expect any additional liability to
have a material adverse effect on our financial position, results of operations
or liquidity.
Environmental remediation costs expected to be incurred are:
(In millions)
2013 $ 38
2014 18
2015 14
2016 12
2017 11
Thereafter 109
Financing Arrangements and Other-We issue guarantees and banks and surety
companies issue, on our behalf, letters of credit and surety bonds to meet
various bid, performance, warranty, retention and advance payment obligations of
us or our affiliates. These instruments expire on various dates through 2023.
Additional guarantees of project performance for which there is no stated value
also remain outstanding. The stated values outstanding consisted of the
following at December 31:
(In millions) 2012 2011
Guarantees $ 255 $ 256
Letters of Credit 1,474 1,275
Surety Bonds 239 233
Included in guarantees and letters of credit described above were $108 million
and $225 million, respectively, at December 31, 2012, and $109 million and $240
million, respectively, at December 31, 2011, related to our Thales-Raytheon
Systems Co. Ltd. (TRS) joint venture. We provide these guarantees and letters of
credit to TRS and other affiliates to assist these entities in obtaining
financing on more favorable terms, making bids on contracts and performing their
contractual obligations. While we expect these entities to satisfy their loans,
and meet their project performance and
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other contractual obligations, their failure to do so may result in a future
obligation to us. We periodically evaluate the risk of TRS and other affiliates
failing to satisfy their loans, project performance and meet other contractual
obligations described above. At December 31, 2012, we believe the risk that TRS
and other affiliates will not be able to perform or meet their obligations is
minimal for the foreseeable future based on their current financial condition.
All obligations were current at December 31, 2012. At December 31, 2012 and
December 31, 2011, we had an estimated liability of $4 million and $6 million,
respectively, related to these guarantees and letters of credit.
In 1997, we provided a first loss guarantee of $133 million on $1.3 billion of
U.S. Export-Import Bank loans (maturing in 2015) to the Brazilian Government
related to System for the Vigilance of the Amazon (SIVAM) program being
performed by Network Centric Systems. Loan repayments by the Brazilian
Government were current at December 31, 2012.
We have entered into industrial cooperation agreements, sometimes referred to as
offset agreements, as a condition to obtaining orders for our products and
services from certain customers in foreign countries. At December 31, 2012, the
aggregate amount of our offset agreements had an outstanding notional value of
approximately $5 billion. To the extent we have entered into purchase
obligations that satisfy our offset agreements, those amounts are included in
the Contractual Obligations table on page 71. These agreements are designed to
return economic value to the foreign country by requiring the contractor to
engage in activities supporting local defense or commercial industries,
promoting a balance of trade, developing in-country technology capabilities, or
addressing other local development priorities. Offset agreements may be
satisfied through activities that do not require a direct cash payment,
including transferring technology, providing manufacturing, training and other
consulting support to in-country projects, and the purchase by third parties
(e.g., our vendors) of supplies from in-country vendors. These agreements may
also be satisfied through our use of cash for activities such as subcontracting
with local partners, purchasing supplies from in-country vendors, providing
financial support for in-country projects, and making investments in local
ventures. Such activities may also vary country-by-country depending upon
requirements as dictated by their governments. We typically do not commit to
offset agreements until orders for our products or services are definitive. The
amounts ultimately applied against our offset agreements are based on
negotiations with the customers and typically require cash outlays that
represent only a fraction of the notional value in the offset agreements. Offset
programs usually extend over several or more years and may provide for penalties
in the event we fail to perform in accordance with offset requirements. We have
historically not been required to pay any such penalties.
As a government contractor, we are subject to many levels of audit and
investigation by the U.S. Government relating to our contract performance and
compliance with applicable rules and regulations. Agencies that oversee contract
performance include: the Defense Contract Audit Agency, the Defense Contract
Management Agency, the Inspector General of the Department of Defense and other
departments and agencies, the Government Accountability Office, the Department
of Justice and Congressional Committees. From time to time, these and other
agencies investigate or conduct audits to determine whether our operations are
being conducted in accordance with applicable requirements. Such investigations
and audits could result in administrative, civil or criminal liabilities,
including repayments, fines or penalties being imposed upon us, the suspension
of government export licenses or the suspension or debarment from future U.S.
Government contracting. U.S. Government investigations often take years to
complete and many result in no adverse action against us. Our final allowable
incurred costs for each year are also subject to audit and have from time to
time resulted in disputes between us and the U.S. Government with litigation
resulting at the Court of Federal Claims (COFC) or the Armed Services Board of
Contract Appeals (ASBCA) or their related courts of appeals. In addition, the
Department of Justice has, from time to time, convened grand juries to
investigate possible irregularities by us. We also provide products and services
to customers outside of the U.S. and those sales are subject to local government
laws, regulations, and procurement policies and practices. Our compliance with
such local government regulations or any applicable U.S. Government regulations
(e.g., the Foreign Corrupt Practices Act and the International Traffic in Arms
Regulations) may also be investigated or audited. Other than as specifically
disclosed herein, we do not expect these audits, investigations or disputes to
have a material effect on our financial position, results of operations or
liquidity, either individually or in the aggregate.
We have completed a self-initiated internal review of certain of our
international operations, focusing on compliance with the Foreign Corrupt
Practices Act. In the course of the review, we identified possible areas of
concern involving certain practices related to operations in a foreign
jurisdiction where we do business. We voluntarily disclosed and shared the
results of our review with the SEC and the DoJ. The SEC staff and the DoJ have
completed their review of this matter without recommending enforcement action.
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On July 22, 2010, RSL was notified by the UKBA that it had been terminated for
cause on a program. The termination notice included allegations that RSL had
failed to perform on certain key milestones and other matters in addition to
claiming entitlement to recovery of certain losses incurred and previous
payments made to RSL. We believe that RSL performed well and delivered
substantial capabilities to the UKBA under the program, which has been operating
successfully and providing actionable information since live operations began in
May 2009. As a result of the termination notice, we adjusted our estimated
amount of revenue and costs under the program in the second quarter of 2010. The
impact of the UKBA Program Adjustment reduced IIS' total net sales and operating
income by $316 million and $395 million, respectively, for the year ended
December 31, 2010. The UKBA Program Adjustment also reduced total company
diluted earnings per share from continuing operations by $0.75 in the year ended
December 31, 2010. On July 29, 2010, RSL filed a dispute notice on the grounds
that the termination by the UKBA was not valid. On August 18, 2010, the UKBA
initiated arbitration proceedings on this issue. On March 22, 2011, the UKBA
gave notice that it had presented a demand to draw on the approximately $80
million of letters of credit provided by RSL upon the signing of the contract
with the UKBA in 2007. On March 23, 2011, the UKBA submitted a detailed claim in
the arbitration of approximately £350 million (approximately $565 million based
on foreign exchange rates as of December 31, 2012) for damages and clawback of
previous payments, plus interest and arbitration costs, excluding any credit for
capability delivered or draw on the letters of credit. The UKBA also asserted
that additional amounts may be detailed in the claim in the future if estimates
of its damages change, and for continuing post-termination losses and any
re-procurement costs, which have not been quantified. At RSL's request, on
March 29, 2011, the Arbitration Tribunal issued an interim order restraining the
UKBA from drawing down on the letters of credit pending a hearing on the issue.
Following the hearing, the Tribunal lifted the restraint on the basis that, at
this early stage of the proceedings, the Tribunal had not heard the evidence
needed to decide the merits of whether the contractual conditions for a drawdown
had been established. The Tribunal also concluded that any decision on the
UKBA's right to call on the letters of credit is inextricably intertwined with
the ultimate decision on the merits in the arbitration. The Tribunal also
preserved RSL's right to claim damages should RSL later establish that the
drawdown was not valid. As a result, on April 6, 2011, the UKBA drew the $80
million on the letters of credit.
As a result of the Tribunal's decision that the letters of credit are
inextricably intertwined with the ultimate decision on the merits in the
arbitration, we were no longer able to evaluate, independently from the overall
claim, the probability of recovery of any amounts drawn on the letters of
credit. We therefore recorded $80 million of costs related to the UKBA drawdown
(UKBA LOC Adjustment), which is included in the operating expenses of our
Intelligence and Information Systems (IIS) segment in the first quarter of 2011.
In June 2011, RSL submitted in the arbitration its defenses to the UKBA claim as
well as substantial counterclaims in the amount of approximately £500 million
(approximately $808 million based on foreign exchange rates as of December 31,
2012) against the UKBA for the collection of receivables and damages. On October
3, 2011, the UKBA filed its reply to RSL's counterclaims, and increased its
claim amount by approximately £32 million, to include additional civil service
and post-termination costs, and approximately £33 million for interest, raising
the total gross amount of the UKBA claim for damages and clawback of previous
payments to approximately £415 million (approximately $670 million based on
foreign exchange rates as of December 31, 2012). On January 6, 2012, RSL filed
its response to the UKBA's reply. RSL is pursuing vigorously the collection of
all receivables for the program and damages in connection with the wrongful
termination and is mounting a strong defense to the UKBA's alleged claims for
losses and previous payments. RSL has also settled substantially all
subcontractor claims, novated all key subcontracts to the UKBA and agreed with
the UKBA that RSL's exit obligations to operate the previously delivered
capability ended in April 2011. Effective April 15, 2011, the UKBA took over
responsibility for operating the previously delivered capability.
The receivables and other assets remaining under the program for technology and
services delivered were approximately $40 million at December 31, 2012 and 2011.
We believe the remaining receivables and other assets are probable of recovery
in litigation or arbitration. We currently do not believe it is probable that
RSL is liable for losses, previous payments (which includes the $80 million
related to the drawdown on the letters of credit), clawback or other claims
asserted by the UKBA either in its March 2011 arbitration filing or its October
2011 reply. Due to the inherent uncertainties in litigation and arbitration, and
the complexity and technical nature of actual and potential claims and
counterclaims, it is reasonably possible that the ultimate amount of any
resolution of the termination could be less or greater than the amounts we have
recorded. For the same reasons, at this time, we are unable to estimate a range
of the possible loss or recovery, if any, beyond the claim and counterclaim
amounts. If we fail to collect the receivable balances or are required to make
payments against claims or other losses asserted by the UKBA in excess of the
amounts we have recorded, it could have a material adverse effect on our
financial position, results of operations or liquidity. Arbitration hearings
commenced in late 2012 and we expect to have a decision in 2013.
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On June 29, 2012 and July 13, 2012, we received a contracting officer's final
decision (COFD) for 2005 and 2004 incurred costs at our SAS business. The COFDs
demand a total payment of $241 million for costs, interest and penalties
associated with several issues, the largest of which relates to specific
research and development and capital projects undertaken by SAS between 2000 and
2005. To date, no COFDs have been provided for 2000 to 2003 periods at SAS on
these issues. The Government alleges that the costs incurred on the projects
should have been charged directly to U.S. Government contracts rather than
through indirect rates and that these costs should not be recoverable. We
strongly disagree with the Government's position. We have requested a deferment
of the payment and intend to litigate the issues. Due to the inherent
uncertainties of litigation, we cannot estimate a range of potential loss. We
believe that we appropriately charged the disputed costs based on government
accounting standards and applicable precedent and properly disclosed our
approach to the Government. We also believe that in many cases, the statute of
limitations has run on the issues. Based upon the foregoing, we do not expect
the results of the COFDs to have a material impact on our financial position,
results of operations or liquidity.
In addition, various other claims and legal proceedings generally incidental to
the normal course of business are pending or threatened against us. We do not
expect any additional liability from these proceedings to have a material
adverse effect on our financial position, results of operations or liquidity. In
connection with certain of our legal matters, we may be entitled to insurance
recovery for qualified legal costs. We do not expect any insurance recovery to
have a material impact on the financial exposure that could result from these
matters.
ACCOUNTING STANDARDS
New pronouncements issued but not effective until after December 31, 2012, are
not expected to have a material impact on our financial position, results of
operations or liquidity.
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