Overview

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. We serve all branches of the U.S. Military and numerous other U.S. Government agencies, as well as the North Atlantic Treaty Organization (NATO) and many allied governments.

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 our 2007 Annual Report on Form 10-K.

The following discussion should be read along with our 2007 Annual Report on Form 10-K and our Financial Statements included in this Form 10-Q.

Consolidated Results of Operations

As described in our Cautionary Note Regarding Forward-Looking Statements on page 3 of this Form 10-Q, our interim period results of operations and period-to-period comparisons of such results, particularly at a segment level, may not be indicative of our future operating results. Additionally, we use a fiscal calendar, which may cause the number of workdays in the current and comparable prior interim period to differ and could affect period-to-period comparisons. There were 64 workdays in the second quarters of 2008 and 2007 and 127 workdays in the first six months of 2008 compared to 123 workdays in the first six months of 2007. The following discussions of comparative results among periods should be viewed in this context. We also generally express changes in sales in terms of volume in our discussions of comparative period results. Volume generally refers to increases or decreases in revenues related to varying production activity levels or service levels on individual contracts. Volume changes will typically drive a corresponding margin change based on the profit rate for a particular contract. We generally express changes in segment operating income in terms of volume or changes in program performance. Segment operating margin reflects the performance on programs and changes in contract
mix. Changes in program performance typically relate to profit recognition associated with revisions to total estimated costs at completion that reflect improved or deteriorated operating performance or award fee rates. We record changes in estimates of contract sales, costs and profits using a cumulative catch-up, which recognizes in the current period the cumulative effect of the changes in estimates on current and prior periods.

                                                            Three Months Ended                         % of Net Sales
(In millions, except percentages)                    June 29, 2008       June 24, 2007        June 29, 2008       June 24, 2007
Net sales                                           $         5,870     $         5,278
Gross margin                                                  1,200               1,084               20.4  %             20.5  %
Administrative and selling expenses                             396                 357                 6.7                 6.8
Research and development expenses                               142                 138                 2.4                 2.6
Operating income                                                662                 589                11.3                11.2
Interest expense (income), net                                   17                  (3 )               0.3                (0.1 )
Income from continuing operations                               426                 355                 7.3                 6.7
Income from discontinued operations, net of tax                  -                  980                  -                 18.6
Net income                                                      426               1,335                 7.3                25.3




                                                       Six Months Ended                         % of Net Sales
(In millions, except percentages)             June 29, 2008         June 24, 2007      June 29, 2008       June 24, 2007
Net sales                                    $        11,224       $        10,082
Gross margin                                           2,295                 2,032             20.4  %             20.2  %
Administrative and selling expenses                      776                   687               6.9                 6.8
Research and development expenses                        249                   235               2.2                 2.3
Operating income                                       1,270                 1,110              11.3                11.0
Interest expense, net                                     28                    29               0.2                 0.3
Income from continuing operations                        826                   679               7.4                 6.7
(Loss) income from discontinued
operations, net of tax                                    (2 )               1,002               0.0                 9.9
Net income                                               824                 1,681               7.3                16.7

The overall increase in sales in the second quarter of 2008 was spread across all segments as discussed below in Segment Results. Sales to the U.S. Department of Defense (DoD) were 84.5% of sales compared to 78.8% of sales in the second quarter of 2008 and 2007, respectively and total sales to the U.S. Government were 88.1% of sales compared to 85.6% of sales in the second quarter of 2008 and 2007, respectively. Included in U.S. Government sales were foreign military sales of $449 million and $362 million in the second quarter of 2008 and 2007, respectively. Total international sales, including foreign military sales, were $1,122 million or 19.1% of sales in the second quarter of 2008 compared to $1,082 million or 20.5% of sales in the second quarter of 2007.

The overall increase in sales in the first six months of 2008 was spread across all segments as discussed below in Segment Results. Sales to the U.S. DoD were 83.3% of sales compared to 80.8% of sales in the first six months of 2008 and 2007, respectively and total sales to the U.S. Government were 87.4% of sales compared to 86.3% of sales in the first six months of 2008 and 2007, respectively. Included in U.S. Government sales were foreign military sales of $847 million and $702 million in the first six months of 2008 and 2007, respectively. Total international sales, including foreign military sales, were $2,166 million or 19.3% of sales in the first six months of 2008 compared to $2,001 million or 19.8% of sales in the first six months of 2007.

Gross margin reflects a FAS/CAS Pension Adjustment of $34 million and $63 million of expense in the second quarter of 2008 and 2007, respectively, and $67 million and $125 million of expense in the first six months of 2008 and 2007, respectively. The FAS/CAS Pension Adjustment, which we report as a separate line item in our segment results, represents the difference between our pension expense or income under Statement of Financial Accounting Standards (SFAS) No. 87, Employers' Accounting for Pensions (SFAS No. 87), and our pension expense under Cost Accounting Standards (CAS). SFAS No. 87 outlines the methodology used to determine pension expense or income for financial reporting purposes, which is not necessarily indicative of the funding requirements for pension plans that we determine by other factors. CAS prescribe the allocation to and recovery of pension costs on U.S. Government contracts and are a major factor in determining our pension funding requirements. Our segment results only include pension expense as determined under CAS that we generally recover through the pricing of our products and services to the U.S. Government.

In accordance with the requirements of SFAS No. 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans, SFAS No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, and SFAS No. 87, pension and other postretirement benefit assets and liabilities are valued annually at the end of the year for purposes of determining funded status and future year pension expense. Our long-term return on assets and discount rate assumptions are key variables in making such determinations. Refer to "Critical Accounting Estimates" within Item 7 of our 2007 Form 10-K for more information regarding our long-term return on assets and discount rate assumptions. There has been a negative return on pension assets through June 29, 2008 compared to our assumption of a positive annual return of 8.75% at December 31, 2007. If the actual rate of return on our plan assets continues to be below our assumed 8.75% rate of return through December 31, 2008, it would negatively impact our funded status at year end and increase pension expense in future years. In addition, if the current corporate bond yield environment as of June 29, 2008 continues through December 31, 2008, it may result in a higher discount rate than our discount rate assumption of 6.5% at December 31, 2007 and positively impact our funded status at year end. The ultimate impact on our future pension expense and funded status will be determined based upon market conditions in effect when we perform our annual valuation for the December 31, 2008 financial statements.

Administrative and selling expenses and research and development expenses increased in the second quarter of 2008 and the first six months of 2008 primarily due to higher volume and remained consistent as a percent of sales.

Included in operating income is 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, including the net costs associated with our residual commuter aircraft portfolio. We describe below the changes in operating income by segment and from Corporate and Eliminations.

The decrease in interest expense in the second quarter of 2008 and the first six months of 2008 compared to the second quarter of 2007 and the first six months of 2007 was primarily due to lower average outstanding debt.

The decrease in interest income in the second quarter of 2008 compared to the second quarter of 2007 was primarily due to a lower average cash balance and a decrease in interest rates. The decrease in interest income in the first six months of 2008 compared to the first six months of 2007 was primarily due to a decrease in interest rates and a lower average cash balance.

Other (income) expense, net in the second quarter of 2007 and the first six months of 2007 included a $59 million loss on the repurchases of long-term debt.

The effective tax rate from continuing operations was 34.2% and 33.8% in the second quarter of 2008 and 2007, respectively, and 33.3% and 33.6% in the first six months of 2008 and 2007, respectively, reflecting the U.S. statutory rate adjusted for various permanent differences between book and tax reporting. The effective tax rate in the second quarter of 2008 was lower than the statutory rate due to manufacturing tax benefits and certain dividend deductions, and was partially offset by various non-deductible expenses. The effective tax rate in the first six months of 2008 was lower than the statutory rate due to manufacturing tax benefits, certain dividend deductions and tax benefits related to certain refund claims, and was partially offset by various non-deductible expenses. The effective tax rate in the second quarter of 2007 and the first six months of 2007 was lower than the statutory rate due to manufacturing tax benefits, certain dividend deductions and the research and development tax credit, and was partially offset by various non-deductible expenses. The effective rate in the second quarter of 2008 was 0.4% higher than the second quarter of 2007 primarily due to the expiration of the research and development tax credit in 2007. The effective tax rate in the first six months of 2008 was 0.3% lower than the first six months of 2007 primarily due to the tax benefits related to certain refund claims in the first quarter of 2008, partially offset by the effect of the research and development tax credit expiration in 2007.

Income from continuing operations was $426 million or $1.00 per diluted share on 427.7 million average shares outstanding in the second quarter of 2008 compared to $355 million or $0.79 per diluted share on 448.8 million average shares outstanding in the second quarter of 2007. The increase in income from continuing operations of $71 million in the second quarter of 2008 compared to the second quarter of 2007 was primarily due to lower other expense, net of $58 million primarily related to the loss on repurchases of debt in the second quarter of 2007 noted above, $44 million of volume, net of program performance, discussed below in Segment Results, and lower FAS/CAS expense of $29 million, offset by higher taxes of $40 million related primarily to our higher income and higher net interest expense of $20 million.

Income from continuing operations was $826 million or $1.92 per diluted share on 430.0 million average shares outstanding in the first six months of 2008 compared to $679 million or $1.51 per diluted share on 451.0 million average shares outstanding in the first six months of 2007. The increase in income from continuing operations of $147 million in the first six months of 2008 compared to the first six months of 2007 was primarily due to $102 million of volume, net of program performance discussed below in Segment Results, lower FAS/CAS expense of $58 million and lower other expense, net of $56 million primarily related to the loss on repurchases of debt noted above, offset by higher taxes of $70 million related primarily to our higher income. Included in the $102 million of volume, partially offset by program performance, in the first six months of 2008 is a $13 million decrease in Corporate and Eliminations compared to the first six months of 2007 driven primarily by a decrease in Corporate expenses in the first quarter of 2008.

Included in income from discontinued operations, net of tax, in the second quarter of 2007 and the first six months of 2007 was $986 million related to the gain on sale of Raytheon Aircraft.

Net income decreased in the second quarter of 2008 and the first six months of 2008 primarily due to the gain on the sale of Raytheon Aircraft noted above partially offset by increased income from continuing operations as noted above.

Segment Results

Segment financial results were as follows:



                                                                          Net Sales
                                                 Three Months Ended                         Six Months Ended
(In millions)                            June 29, 2008        June 24, 2007        June 29, 2008        June 24, 2007
Integrated Defense Systems              $         1,257      $         1,166      $         2,449      $         2,258
Intelligence and Information Systems                829                  666                1,521                1,254
Missile Systems                                   1,355                1,244                2,666                2,384
Network Centric Systems                           1,173                1,052                2,240                1,981
Space and Airborne Systems                        1,096                1,065                2,091                2,029
Technical Services                                  647                  514                1,168                  977
Corporate and Eliminations                         (487 )               (429 )               (911 )               (801 )
Total                                   $         5,870      $         5,278      $        11,224      $        10,082

                                                                       Operating Income
                                                 Three Months Ended                         Six Months Ended
(In millions)                            June 29, 2008        June 24, 2007        June 29, 2008        June 24, 2007
Integrated Defense Systems              $           209      $           212      $           420      $           411
Intelligence and Information Systems                 67                   63                  119                  118
Missile Systems                                     156                  134                  293                  254
Network Centric Systems                             145                  139                  268                  256
Space and Airborne Systems                          144                  133                  265                  262
Technical Services                                   45                   32                   80                   55
FAS/CAS Pension Adjustment                          (34 )                (63 )                (67 )               (125 )
Corporate and Eliminations                          (70 )                (61 )               (108 )               (121 )
Total                                   $           662      $           589      $         1,270      $         1,110

                                                 Funded Backlog(1)                           Total Backlog
(In millions)                            June 29, 2008        Dec. 31, 2007        June 29, 2008        Dec. 31, 2007
Integrated Defense Systems              $         5,044      $         4,781      $         8,882      $         9,296
Intelligence and Information Systems              2,554                2,325                5,756                5,636
Missile Systems                                   5,873                5,218               10,250                9,379
Network Centric Systems                           4,244                3,957                5,479                5,102
Space and Airborne Systems                        3,301                3,037                5,102                5,276
Technical Services                                1,210                1,200                2,058                1,925
Total                                   $        22,226      $        20,518      $        37,527      $        36,614

(1) Funded backlog excludes U.S. and foreign government contracts for which funding has not been appropriated.

                                                                         Bookings(1)
                                                 Three Months Ended                        Six Months Ended
(In millions)                             June 29, 2008       June 24, 2007       June 29, 2008        June 24, 2007
Integrated Defense Systems               $           981     $         1,050     $          2,087     $         2,306
Intelligence and Information Systems                 776                 564                1,795               1,099
Missile Systems                                    1,938               1,005                3,573               2,317
Network Centric Systems                              895               1,165                2,487               2,129
Space and Airborne Systems                           812                 790                1,547               1,267
Technical Services                                   595                 218                1,013                 796
Corporate                                             11                  40                   22                  76
Total                                    $         6,008     $         4,832     $         12,524     $         9,990

(1) Bookings in each year are influenced by timing of awards that may cover multiple fiscal years and exclude contract cancellations and terminations.

Integrated Defense Systems



                                                   Three Months Ended                                    Six Months Ended

(In millions, except percentages)    June 29, 2008       June 24, 2007      % Change      June 29, 2008       June 24, 2007      % Change
Net Sales                           $         1,257     $         1,166          7.8 %   $         2,449     $         2,258          8.5 %
Operating Income                                209                 212         -1.4 %               420                 411          2.2 %

Net Sales. The increase in sales in the second quarter of 2008 of $91 million was primarily due to $93 million of higher volume from two joint battlefield sensor programs, our various Patriot programs and a U.S. Navy combat systems program.

The increase in sales in the first six months of 2008 of $191 million was primarily due to $133 million of higher volume from two joint battlefield sensor programs and a U.S. Navy combat systems program.

Operating Income and Margin. The decrease in operating income of $3 million in the second quarter of 2008 was primarily due to favorable performance adjustments recorded on certain programs in the second quarter of 2007, partially offset by increased volume. The decline in operating margin was primarily due to favorable program performance adjustments in the second quarter of 2007 and the completion of certain contracts.

The increase in operating income of $9 million in the first six months of 2008 was primarily due to increased volume, partially offset by favorable performance adjustments recorded on certain programs in the first six months of 2007. The decline in operating margin was primarily due to favorable program performance adjustments in the first six months of 2007 and the completion of certain contracts.

Backlog and Bookings. Backlog was $8,882 million at June 29, 2008 compared to $9,296 million at December 31, 2007. Bookings in the second quarter of 2008 were $69 million lower than the second quarter of 2007. In the second quarter of 2008, IDS booked $140 million for the upgrade and support of the Patriot system for Kuwait. IDS also booked $143 million for the Rapid Aerostat Initial Deployment (RAID) program for the U.S. Army.

Bookings in the first six months of 2008 were $219 million lower than the first six months of 2007, primarily due to the Terminal High Altitude Area Defense (THAAD) radar program and the Zumwalt Class Destroyer program awards in the first quarter of 2007, partially offset by the Patriot awards described below. In the first six months of 2008, IDS booked $510 million on certain contracts for the design, development and support of the Patriot system for international customers, including $285 million for South Korea, $140 million for Kuwait and $85 million for Taiwan. IDS also booked $133 million to provide engineering services support for a Patriot air and missile defense program and $143 million for the RAID program, both for the U.S. Army.

Intelligence and Information Systems



                                                   Three Months Ended                                    Six Months Ended
(In millions, except percentages)    June 29, 2008       June 24, 2007      % Change      June 29, 2008       June 24, 2007      % Change
Net Sales                           $           829     $           666         24.5 %   $         1,521     $         1,254         21.3 %
Operating Income                                 67                  63          6.3 %               119                 118          0.8 %
Operating Margin                                8.1 %               9.5 %                            7.8 %               9.4 %
Gross Bookings                      $           776     $           564         37.6 %   $         1,795     $         1,099         63.3 %

Net Sales. The increase in sales in the second quarter of 2008 of $163 million and in the first six months of 2008 of $267 million were primarily due to $105 million and $161 million, respectively, of higher volume from an advanced border control and security program.

Operating Income and Margin. The increase in operating income of $4 million in the second quarter of 2008 and $1 million in the first six months of 2008 were principally due to increased volume, partially offset by certain acquisition costs and other investments in cyber operations and information security capabilities. The decline in operating margin in the second quarter of 2008 and the first six months of 2008 was due primarily to the acquisition costs and investments noted above.

Backlog and Bookings. Backlog was $5,756 million at June 29, 2008 compared to $5,636 million at December 31, 2007. Bookings in the second quarter of 2008 were $212 million higher than the second quarter of 2007, primarily due to various classified bookings. In the second quarter of 2008, IIS booked $497 million on a number of classified contracts, including $379 million on a major classified program.

Bookings in the first six months of 2008 were $696 million higher than the first six months of 2007, primarily due to various classified bookings and $182 million booked on the U.K. e-Borders contract. In the first six months of 2008, IIS booked $1,053 million on a number of classified contracts, including $379 million and $171 million on two major classified programs.

Missile Systems



                                                   Three Months Ended                                    Six Months Ended
(In millions, except percentages)    June 29, 2008       June 24, 2007      % Change      June 29, 2008       June 24, 2007      % Change
Net Sales                           $         1,355     $         1,244          8.9 %   $         2,666     $         2,384         11.8 %
Operating Income                                156                 134         16.4 %               293                 254         15.4 %
Operating Margin                               11.5 %              10.8 %                           11.0 %              10.7 %
Gross Bookings                      $         1,938     $         1,005         92.8 %   $         3,573     $         2,317         54.2 %

Net Sales. The increase in sales in the second quarter of 2008 of $111 million was primarily due to $60 million of higher volume from the Phalanx, PavewayTM and Advanced Medium-Range Air-to-Air Missile (AMRAAM) programs.

The increase in sales in the first six months of 2008 of $282 million was primarily due to $151 million of higher volume on the Rolling Airframe Missile, Phalanx, PavewayTM, Tube-launched Optically guided Wire controlled (TOW) and Excalibur programs.

Operating Income and Margin. The increase in operating income of $22 million in the second quarter of 2008 was primarily due to a $21 million increase on our Standard Missile programs, primarily resulting from higher award fees, and increased volume. The increase in operating margin in the second quarter of 2008 was primarily due to the higher award fees noted above.

. . .