Raytheon 2003 Annual Report Download - page 24

Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued) 3333333333333
RAYTHEON COMPANY 333
other asset classes in which the Company has invested pension
plan assets, and the expectations for future returns of each asset
class. Since the Company’s investment policy is to employ active
management strategies in all asset classes, the potential exists to
outperform the broader markets, therefore, the expected returns
were adjusted upward. The expected return for each asset class
was then weighted based on the target asset allocation to develop
the long-term ROA assumption. The long-term ROA assumption is
based on target asset allocations of between 65 and 70 percent
equities with a 9.75% expected return, between 20 and 25 per-
cent fixed income with a 5.25% expected return, up to 5 percent
real estate with an 8.25% expected return, and between 5 and
10 percent other (including private equity and cash) with a 10.5%
expected return. The long-term ROA assumption for the Company’s
domestic pension plans in 2004 is 8.75%. The discount rate
assumption was determined by using a model consisting of a theo-
retical bond portfolio that matches the Company’s pension liability
duration. The discount rate assumption for the Company’s domes-
tic pension plans in 2004 is 6.25%. The Company’s pension
expense is expected to be approximately $700 million in 2004 and
$750 million in 2005. For every 2.5 percent that the actual
domestic pension plan asset return exceeds or is less than the
long-term ROA assumption for 2004, the Company’s pension
expense for 2004 will change by approximately $15 million. If the
Company adjusts the discount rate assumption for 2005 up or
down by 25 basis points, the Company’s pension expense would
change by approximately $40 million.
Effective January 1, 2004, the Company changed the measure-
ment date for its pension and other postretirement benefit plans
from October 31 to December 31. This change in measurement
date will be accounted for as a change in accounting principle. The
cumulative effect of this change in accounting principle is antici-
pated to be a gain of $34 million after-tax for pension benefits and
a gain of $7 million after-tax for other postretirement benefits and
will be recognized in 2004. Using the Company’s year end as the
measurement date for pension and other postretirement benefit
plans more appropriately reflects the plans’ financial status for the
years then ended.
333 CONSOLIDATED RESULTS OF OPERATIONS
Net sales were $18.1 billion in 2003, $16.8 billion in 2002, and
$16.0 billion in 2001. The increase in sales was due primarily to
higher U.S. Department of Defense expenditures in the Company’s
defense businesses, primarily Integrated Defense Systems, Missile
Systems, and Space and Airborne Systems. Sales to the U.S.
Department of Defense were 65 percent of sales in 2003, 62 per-
cent in 2002, and 59 percent in 2001. Total sales to the U.S. gov-
ernment, including foreign military sales, were 74 percent of sales
in 2003, 73 percent in 2002, and 70 percent in 2001. International
sales, including foreign military sales, were 19 percent of sales
in 2003, 21 percent in 2002, and 22 percent in 2001. While
international sales have remained flat, the amount as a percent of
sales has declined as a result of increased sales to the U.S.
Department of Defense.
Gross margin (net sales less cost of sales) was $3.1 billion in
2003, $3.4 billion in 2002, and $2.4 billion in 2001, or 17.2 per-
cent of sales in 2003, 20.3 percent in 2002, and 14.7 percent in
2001. Included in gross margin was a FAS/CAS Pension
Adjustment, described below, of $109 million of expense,
$210 million of income, and $386 million of income in 2003, 2002,
and 2001, respectively. The change in the FAS/CAS Pension
Adjustment was due primarily to the reduction in the Company’s
long-term return on asset assumption and the actual rate of return
on pension plan assets over the last several years. The decrease in
gross margin as a percent of sales in 2003 was due, in part, to
charges of $237 million at Network Centric Systems and $39 mil-
lion at Technical Services, described below in Segment Results.
Included in gross margin in 2001 was goodwill amortization of
$334 million, which was discontinued January 1, 2002 as
described below. Excluding goodwill amortization, gross margin
was $2.7 billion or 16.8 percent of sales in 2001. Included in gross
margin in 2001 were charges of $745 million at Raytheon Aviation
Airline Services,™ described below in Segment Results.
Statement of Financial Accounting Standards No. 87,
Employers’ Accounting for Pensions (SFAS No. 87), outlines the
methodology used to determine pension expense or income for
financial reporting purposes, which is not necessarily indicative of
the funding requirements of pension plans, which are determined
by other factors. A major factor for determining pension funding
requirements are Cost Accounting Standards (CAS) that pro-
scribe the allocation to and recovery of pension costs on U.S. gov-
ernment contracts. The Company now reports the difference
between SFAS No. 87 (FAS) pension expense or income and CAS
pension expense as a separate line item in the Company’s segment
results called FAS/CAS Pension Adjustment. The results for each
segment only include pension expense as determined under CAS,
which can generally be recovered through the pricing of products
and services to the U.S. government.
Administrative and selling expenses were $1,306 million or
7.2 percent of sales in 2003, $1,170 million or 7.0 percent of sales
in 2002, and $1,131 million or 7.1 percent of sales in 2001. Included
in administrative and selling expenses in 2002 was a $29 million gain
on the sale of the Company’s corporate headquarters.
Research and development expenses were $487 million or
2.7 percent of sales in 2003, $449 million or 2.7 percent of sales
in 2003, and $456 million or 2.8 percent of sales in 2001.
Operating income was $1,316 million or 7.3 percent of sales in
2003, $1,783 million or 10.6 percent of sales in 2002, and