Raytheon 2012 Annual Report Download - page 57

49
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
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.