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RTN > SEC Filings for RTN > Form 10-K on 11-Feb-2014All Recent SEC Filings

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Form 10-K for RAYTHEON CO/


11-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Topic Page Overview 29 Financial Summary 33 Critical Accounting Estimates 34 Consolidated Results of Operations 42 Segment Results 49 Financial Condition and Liquidity 63 Capital Resources 67 Contractual Obligations 68 Off-Balance Sheet Arrangements 68 Commitments and Contingencies 69 Accounting Standards 72

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 cyber and information security. We serve both domestic and international customers, as both a prime contractor and subcontractor on a broad portfolio of defense and related programs primarily for government customers.

In April 2013 we consolidated our business from six to four business segments. Those operating business segments are: Integrated Defense Systems (IDS); Intelligence, Information and Services (IIS); Missile Systems (MS); and Space and Airborne Systems (SAS). 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 2013, 2012 and 2011, 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.

Industry Considerations

Domestic Considerations
Faced with significant budget pressures, in recent years, the U.S. Government has implemented reductions in government spending, including reductions in appropriations for the U.S. Department of Defense (DoD) and other federal agencies, pursuant to the Budget Control Act of 2011, as amended by the American Taxpayer Relief Act of 2012 (BCA). The BCA reduced the DoD's 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 was not accomplished. Pursuant to the terms of the BCA, a sequestration went into effect on March 1, 2013 resulting in a 7.8% reduction to the DoD budget for FY 2013, excluding funding for military personnel, and a total reduction of approximately $500 billion over the FY 2013-FY 2021 period.


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On December 26, 2013, the President signed into law the Bipartisan Budget Act of 2013, which amended the BCA and reduced the amount of the sequestration by a total of $63 billion for FY 2014 and FY 2015. As a result, funding for national security programs, including the DoD, will be cut by $32.3 billion in FY 2014 rather than by $54.7 billion ($22.4 billion in sequestration relief), and by $45.4 billion in FY 2015 rather than $54.7 billion ($9.3 billion in sequestration relief). The final FY 2014 DoD base budget (excluding funding for operations in Afghanistan) appropriation enacted into law in January 2014 is approximately $497 billion, which is similar to the level of funding for the DoD in FY 2013 after sequestration. FY 2015 is expected to be funded at a similar level. Looking forward, under current law, it appears funding for the DoD will remain flat through FY 2016 and modestly increase thereafter.

While the impacts of the BCA will be partially mitigated in the near term by the Bipartisan Budget Act of 2013, the remaining contemplated reductions under the BCA are still substantial and will impact DoD funding levels through 2021. In addition, the manner in which the DoD funding reductions will be implemented remains uncertain. As a result, the specific impact of future reductions required by the BCA, if any, as well as any other potential actions on U.S. Government spending and future DoD budgets on our programs are unknown at this time, and we are unable to specifically predict the effect any of the foregoing would have on our future financial performance and outlook. The impact of sequestration on our 2013 total net sales was less than the FY 2013 7.8% reduction noted above due to our international business, our position relative to critical DoD priorities and mission areas, and the anticipated length of time that it will take for sequestration reductions to impact future contracts. However, in the event that reduced BCA funding levels continue, 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.

U.S. Government appropriations have and likely will continue to be affected by larger U.S. Government budgetary issues and related legislation. For example, the U.S. Government has not been able to pass any appropriations bills before the end of its fiscal year (September 30) in any of the past five years and has enacted defense appropriations bills prior to the end of its fiscal year only five times since FY 2001. When a formal appropriation bill has not been signed into law before the end of the fiscal year, Congress may pass a Continuing Resolution (CR) that authorizes agencies of the U.S. Government to continue to operate, generally at the same funding levels from the prior year, but typically does not authorize new spending initiatives during this period. If Congress fails to enact a CR, the U.S. Government may shutdown, which likely would result in the closure of government offices and furlough of government workers, as well as impact the availability of funds to pay its contractors for work performed. In addition, if the national debt reaches the statutory debt ceiling, the Congress must enact legislation to increase the statutory debt ceiling. If the Congress fails to do so, then the U.S. Government may default on its debts, which would likely have a material adverse effect on the global financial markets. After operating under a CR at the end of 2013, final FY 2014 appropriations bills were enacted in January 2014. The national debt is expected to reach the statutory debt ceiling in the first half of 2014 unless legislation is enacted by Congress.

With respect to U.S. defense priorities, the DoD conducted a Strategic Choices and Management Review (SCMR) in 2013 to provide its leadership with various options to meet the DoD's strategic objectives in light of sequestration and the budgetary uncertainty the DoD faces. As a result of the SCMR, the DoD reiterated its commitment to the strategic guidance issued in January 2012 regarding its priorities through 2019 and possibly beyond. The 2012 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. The SCMR acknowledged that under decreased spending levels due to sequestration, the DoD would not meet all of its strategic objectives, but did not identify the impacted specific objectives nor the extent to which they would not be met.

U.S. Government sales, excluding foreign military sales, accounted for 72% of our total net sales in 2013. Our principal U.S. Government customer is the DoD. Given the current budget environment, including the elements noted above, future domestic defense spending levels are difficult to predict and may continue to 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;


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- 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.

Although the uncertainty of funding changes that may result from the BCA, among other factors, makes predicting the DoD budget 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 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 2013. 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 2013, our sales to customers outside of the U.S. accounted for 27% 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 systems and services and other security solutions. In North Asia, both short- and long-term regional security concerns are increasing demand for air and missile defense, air/naval modernization, maritime 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 and Central Americas, economic growth in certain 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 threat environments similar to that of 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, volatility in worldwide economic conditions, regional and local economic and political factors, U.S. foreign policy and other risks and uncertainties. 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 Technology, Innovation and Mission Assurance for existing and evolving customer mission needs. Sustain and grow our position in our core markets: sensing, effects, C3I, mission support and cyber;

- Leverage our domain knowledge in air, land, sea, space and cyber for all markets;

- Extend core capabilities to relevant new markets and customers;

- Expand global business by building on our relationships and deep market expertise, particularly cyber;

- Build upon our Customer Focused mindset, further strengthening our company based on performance, relationships and solutions;

- Deliver innovative supply chain solutions to accelerate growth, create competitive advantage and bring value to our global customers; and

- Use our technology and competitive strengths to expand our footprint in radar and electronic warfare solutions.

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, electronic warfare, 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.

Cyber-We continue to enhance our capabilities in the cyber market as well as leverage the capabilities of the thirteen cyber acquisitions made since 2007. We are focused on providing cyber capabilities to the Intelligence, DoD, DHS markets as well as embedding information assurance capabilities in our products and our IT infrastructure. In 2013, we acquired Visual Analytics Incorporated, which provides innovative software solutions for accessing, sharing, analyzing, and reporting on data across any domain in a secure and scalable manner.

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, 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. Although we believe our international business is well positioned to continue to grow, we recognize that we face substantial competition from both U.S. companies and other competitors in international markets.

(In millions)               2013       2012       2011
International sales(1)   $ 6,446    $ 6,232    $ 6,139
International bookings     6,604      5,979      7,692

(1) Includes foreign military sales through the U.S. Government.

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 four businesses and our broad programs and pursuits. It consists of enterprise-wide processes and systems such as our Integrated Product Development System (IPDS), which assures consistency of evaluation and execution at each step in a program's life-cycle; Product Data Management (PDM), which is our business system software for engineering; 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, including through our recent consolidation, 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 firm orders 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.


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(In millions, except for percentages)                2013         2012         2011
Bookings                                         $ 22,132     $ 26,504     $ 26,555
Total backlog                                      33,685       36,181       35,312
Total net sales                                    23,706       24,414       24,791
Total operating income(1)                           2,938        2,989        2,830
Total operating margin                               12.4 %       12.2 %       11.4 %
Operating cash flow from continuing operations   $  2,382     $  1,951     $  2,102

(1) Includes FAS/CAS Adjustment, described below in Critical Accounting Estimates, of $249 million, $255 million and $337 million of expense in 2013, 2012 and 2011, respectively.

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 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.

Backlog represents the dollar value of firm orders 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.

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 service revenue is primarily related to our IIS 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

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