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TMCNet:  RAYTHEON CO/ - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

[February 13, 2013]

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 29-------------------------------------------------------------------------------- Table of Contents 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 30-------------------------------------------------------------------------------- Table of Contents 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.

31-------------------------------------------------------------------------------- Table of Contents 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.

32-------------------------------------------------------------------------------- Table of Contents 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.

33-------------------------------------------------------------------------------- Table of Contents 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- 34-------------------------------------------------------------------------------- Table of Contents 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 35-------------------------------------------------------------------------------- Table of Contents 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 36-------------------------------------------------------------------------------- Table of Contents 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.

37-------------------------------------------------------------------------------- Table of Contents 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 38-------------------------------------------------------------------------------- Table of Contents 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 39-------------------------------------------------------------------------------- Table of Contents 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.

40-------------------------------------------------------------------------------- Table of Contents 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 41-------------------------------------------------------------------------------- Table of Contents 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 42-------------------------------------------------------------------------------- Table of Contents 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.

43-------------------------------------------------------------------------------- Table of Contents 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.

44-------------------------------------------------------------------------------- Table of Contents 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 45-------------------------------------------------------------------------------- Table of Contents 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 46-------------------------------------------------------------------------------- Table of Contents 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.

47-------------------------------------------------------------------------------- Table of Contents 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 48-------------------------------------------------------------------------------- Table of Contents 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 49-------------------------------------------------------------------------------- Table of Contents 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 50-------------------------------------------------------------------------------- Table of Contents 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.

51-------------------------------------------------------------------------------- Table of Contents 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 52-------------------------------------------------------------------------------- Table of Contents 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.

53-------------------------------------------------------------------------------- Table of Contents 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 54-------------------------------------------------------------------------------- Table of Contents 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.

55-------------------------------------------------------------------------------- Table of Contents 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 56-------------------------------------------------------------------------------- Table of Contents 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 57-------------------------------------------------------------------------------- Table of Contents 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.

58-------------------------------------------------------------------------------- Table of Contents 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).

59-------------------------------------------------------------------------------- Table of Contents 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 60-------------------------------------------------------------------------------- Table of Contents 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.

61-------------------------------------------------------------------------------- Table of Contents 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.

62-------------------------------------------------------------------------------- Table of Contents 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 ) 63-------------------------------------------------------------------------------- Table of Contents 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.

64-------------------------------------------------------------------------------- Table of Contents 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 65-------------------------------------------------------------------------------- Table of Contents 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- 66-------------------------------------------------------------------------------- Table of Contents 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 67-------------------------------------------------------------------------------- Table of Contents 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.

68-------------------------------------------------------------------------------- Table of Contents 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.

69-------------------------------------------------------------------------------- Table of Contents 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 70-------------------------------------------------------------------------------- Table of Contents 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.

71-------------------------------------------------------------------------------- Table of Contents 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 72-------------------------------------------------------------------------------- Table of Contents 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.

73-------------------------------------------------------------------------------- Table of Contents 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.

74-------------------------------------------------------------------------------- Table of Contents 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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