Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Introduction
We are a global market leader in design, development, manufacturing, sale and
support of commercial jetliners, military aircraft, satellites, missile defense,
human space flight and launch systems and services. We are one of the two major
manufacturers of 100+ seat airplanes for the worldwide commercial airline
industry and the United States' second-largest defense contractor. While our
principal operations are in the United States, we rely extensively on a network
of partners, key suppliers and subcontractors located around the globe.
We operate in six principal segments: Commercial Airplanes; Aircraft and Weapon
Systems (A&WS), Network Systems, Support Systems, and Launch and Orbital Systems
(L&OS) collectively Integrated Defense Systems (IDS); and Boeing Capital
Corporation (BCC). All other activities fall within the Other segment,
principally made up of Boeing Technology and Connexion by BoeingSM. Our
Commercial Airplanes operations primarily involve development, production and
marketing of commercial jet aircraft and providing related support services,
mainly to the commercial airline industry worldwide. IDS operations principally
involve research, development, production, modification and support of the
following products and related systems: military aircraft, helicopters and
missiles, space systems, missile defense systems, satellites and satellite
launching vehicles, rocket engines, and information and battle management
systems. BCC is primarily engaged in supporting our major operating units by
facilitating, arranging, structuring and/or providing selective financing
solutions to our customers and managing overall portfolio risk exposures. Boeing
Technology is an advanced research and development organization focused on
innovative technologies, improved processes and the creation of new products.
Connexion by BoeingSM provides two-way broadband data communications service for
global travelers. Effective April 1, 2004, Air Traffic Management was absorbed
into Phantom Works research division which is included within Boeing Technology.
Financing activities other than those carried out by BCC are also included
within the Other segment classification.
Our business strategy is centered on running healthy core businesses -
Commercial Airplanes and IDS supplemented and supported by BCC. Taken together,
these core businesses generate substantial earnings and cash flow to permit us
to invest into new products and services and to open new frontiers in aerospace.
Our Commercial Airplanes business has been lean and profitable despite severe
recent downturn in commercial aviation. We are focused on producing the
airplanes the market demands and we price our products to provide a fair return
for our shareholders while continuing to find new ways to improve efficiency and
quality. IDS is more than a collection of defense programs that acts as a
counterweight to the cyclical commercial airplane business. It is a dynamic
business with a strategy to establish ourselves as the leading industry partner
to governments in developing an effective defense system against conventional
and non-conventional threats. BCC delivers value through supporting our business
units and reducing our customer financing exposures. Boeing Technology, our
advanced research and development unit, provides new systems, technologies and
processes to position us for future growth. Connexion by BoeingSM makes an
airplane seem more like the office or home with internet connection at anytime
and anywhere.
Risk Factors
We generally make sales under purchase orders that are subject to cancellation,
modification or rescheduling without significant penalties to our customers.
Changes in the economic environment and the financial condition of the airline
industry or continuing availability of the U.S. congressional appropriations
could result in customer requests for rescheduling or cancellation of
contractual orders.
We depend on a limited number of customers, including the U.S. Government and
major commercial airlines. We can make no assurance that any customer will
purchase additional products or services from us after our contract with the
customer has ended. The loss of a U.S. Government major program
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or any of the major commercial airlines as customers could significantly reduce
our revenues. Several of our commercial airline customers have filed for
bankruptcy protection.
We are highly dependent on the availability of essential materials and parts and
subassemblies from our suppliers. The most important raw materials required for
our aerospace products include aluminum and titanium (sheet, plate, forgings and
extrusions). Although alternative sources generally exist for these raw
materials, qualification of the sources could take a year or more. Many major
components and product equipment items are procured or subcontracted on a
sole-source basis with a number of domestic and foreign companies. We are
dependent upon the ability of our large number of suppliers and subcontractors
to meet performance specifications, quality standards, and delivery schedules at
anticipated costs, and their failure to do so could adversely affect production
schedules and contract profitability, while jeopardizing our ability to fulfill
commitments to our customers. We maintain an extensive qualification and
performance surveillance system to control risk associated with such reliance on
third parties.
Sales outside the U.S. (principally export sales from domestic operations) by
geographic area are included on page 118. Approximately 2% of total sales were
derived from non-U.S. operations for each year ended December 31, 2004 and 2003
and 1% for the year ended December 31, 2002. Approximately 47% of our
contractual backlog at December 31, 2004, was with non-U.S. customers compared
to 41% at December 31, 2003 and 40% at December 31, 2002. Sales outside the
United States are influenced by U.S. Government foreign policy, international
relationships, and trade policies of governments worldwide. Relative
profitability is not significantly different from that experienced in the
domestic market.
Consolidated Results of Operations and Financial Condition
Consolidated Results of Operations
The aerospace and defense industry experienced a strong year in 2004. Commercial
jetliner deliveries stabilized after two years of steep declines. The U.S.
Government continued to increase defense spending and proceeded with the
military transformation. On the other hand, we continued to face numerous
challenges. Competition from Airbus and regional jet makers intensified as they
expand airplane model offerings and competitively price their products. Many
airlines, particularly domestic carriers, experienced losses in 2004 negatively
impacting new orders for jetliners. Our launch business remained on Air Force
suspension and we did not conclude a contract for supplying Tankers to the U.S.
Air Force (USAF).
Management responded to the challenges by relentlessly focusing on execution of
our business strategy and introducing new products and services. During 2004, we
successfully launched the 787 with unprecedented customer interest and the 747
Special Freighter and began offering the 777 Freighter. Commercial Airplanes
delivered 285 planes as compared to 281 in 2003 and captured 272 net orders, up
14% from 2003. IDS posted a record year in 2004 by delivering double-digit
revenue growth and excellent profitability. BCC more than doubled its pre-tax
income while Connexion by BoeingSM launched its first commercial services in
2004.
The following table summarizes our key indicators of consolidated results of
operations for the past three years.
(Dollars in millions) 2004 2003 2002
Revenues $ 52,457 $ 50,256 $ 53,831
Operating Earnings $ 2,007 $ 398 $ 3,426
Operating Margins 3.8 % 0.8 % 6.4 %
Net Earnings $ 1,872 $ 718 $ 492
Research and Development $ 1,879 $ 1,651 $ 1,639
Effective Income Tax Rate 7.1 % (37.0 )% 26.9 %
Contractual Backlog $ 109,600 $ 104,812 $ 104,173
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Revenues
The increase in 2004 consolidated revenues was driven by strong growth at IDS as
its defense and intelligence businesses continued to perform in the healthy
markets. IDS revenues grew on increased aircraft deliveries; increased activity
in Future Combat Systems (FCS), missile defense, intelligence, airborne command
and control programs; and significant increases in supply chain services,
life-cycle customer support, and training system and services. Despite increased
new aircraft deliveries, Commercial Airplanes revenues declined in 2004. The
decline is primarily due to the delivery mix as more single-aisle aircraft and
fewer twin-aisle aircraft were delivered in 2004. BCC revenues were down
slightly in 2004 due to lower new business volume. (For additional discussion of
Commercial Airplanes, IDS and BCC revenues, see pages 29,41 and 50.)
Lower consolidated revenues in 2003 compared to 2002 were primarily due to
reduced deliveries of our commercial airplanes. The reduced deliveries were the
result of the airline industry's reduced need for additional new aircraft and
increased market share of Airbus. The 2003 overall decrease in Commercial
Airplane revenues was partially offset by strong performance by IDS and BCC. IDS
posted revenue growth across all segments driven by increased deliveries of
Joint Direct Attack Munitions (JDAM); increased volume in homeland security,
spares and maintenance, and proprietary programs; and the start up of FCS.
Operating Earnings
Our 2004 operating earnings increased sharply primarily due to the solid
performance by IDS. IDS earnings were driven by increased revenue base and
improved profitability across all segments. (For detailed discussion of IDS
operating earnings please refer to IDS Results of Operation and Financial
Condition beginning on page 41.) Commercial Airplanes operating earnings
increased slightly as margin improvements and improved period cost performance
were partially offset by the negative impact of the change in the model mix and
increased research and development costs associated with the 787 program. (See
page 30 for additional discussion of Commercial Airplanes operating earnings.)
Included in 2004 results is a charge of $555 million related to the USAF 767
tanker program and expenses incurred to end production of the 717 aircraft. $475
million of the charge was recorded by our Commercial Airplanes segment, while
$80 million was recorded by IDS (see pages 31 and 38 for additional discussion
of the charge). Other significant factors contributing to the 2004 operating
earnings compared to 2003 include higher share-based plans expenses, increase in
BCC operating earnings, and higher pension expense. The increase in the
share-based plans expense in 2004 was attributable to vested and undistributed
performance shares. (See Note 17.) For information on BCC operating earnings
please refer to page 51. Pension expense is discussed on page 15.
Lower operating earnings in 2003 compared to 2002 reflect lower planned
commercial airplane deliveries, charges related to the decision to end
production of the 757 program, goodwill impairment charges, charges related to
the satellite and launch businesses, lower pension income, and an increase in
other expenses, as described below. We delivered 100 fewer commercial airplanes
in 2003 compared to 2002, and recognized a $184 million charge associated with
the decision to end production of the 757 program. We also recognized $913
million in goodwill charges as a result of a goodwill impairment analysis
triggered by the reorganization of our Military Aircraft and Missile Systems and
Space and Communications segments into IDS; $572 million recorded at IDS and
$341 million recorded at the Commercial Airplanes segment. 2003 operating
earnings were negatively impacted by a $1,030 million charge related to the
satellite and launch businesses (see page 46 for details of the charge). We
experienced lower pension income due to declining interest rates and negative
pension asset returns in 2001 and 2002, the impact of which is amortized into
earnings in future periods. We also incurred higher estimated environmental
cleanup costs, increased workers' compensation claims, and increased legal
expense. These factors were partially offset by continued
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growth and strong operating performance in our portfolio of defense businesses
and by continued improvements in operating efficiencies at Commercial Airplanes.
We incurred net periodic pension benefit cost of $451 million in 2004 compared
to net periodic pension benefit income of $67 million in 2003, and $404 million
in 2002. Not all net periodic pension benefit income or cost is recognized in
net earnings in the year incurred because it is allocated to production as
product costs, and a portion remains in inventory at the end of a reporting
period. Accordingly, the operating earnings for 2004 included $335 million of
pension expense while operating earnings for 2003 and 2002 included $147 million
and $526 million of pension income, respectively.
The increase in the pension expense was primarily due to higher amortizations of
actuarial losses experienced in the last few years. The actuarial losses were
created by a combination of decreasing discount rates, which increased the
projected benefit obligation, and negative investment earnings in 2001 and 2002,
which reduced the market related value of assets. Our pension plan investment
returns of 13 percent for the plan year ended September 30, 2004, and 17 percent
for the plan year ended September 30, 2003, reflected strong market and plan
asset performance. However, over the past five years, the plan returns were
lower than expected. Because we expect low interest rates to persist, we
anticipate our pension investment returns over the long term to decrease, as
reflected in reduction of the expected long-term asset return rate from 9.00
percent in 2003 to 8.75 percent in 2004 and to 8.50 percent in 2005. We also
lowered the discount rate from 6.00 percent to 5.75 percent as of September 30,
2004.
Net Earnings
Our net earnings increased in 2004 due to higher operating earnings partially
offset by lower other income and higher income taxes. Additionally, included in
2004 earnings is a $42 million net gain on BCC's disposal of a substantial
portion of its Commercial Financial Services business. The increase in 2003 net
earnings over 2002 reflects the federal tax settlement mentioned below,
partially offset by lower operating earnings.
Other income primarily consists of interest income. Other income in 2004
includes $219 million; of this amount $154 million related to interest income
associated with a settlement of federal income tax audits relating to tax years
1983 through 1987 and $65 million related to interest associated with a
subsequent settlement for the 1986 through 1997 years. Other income in 2003
increased over 2002 mainly due to the receipt of $397 million of interest income
associated with a $1.1 billion partial settlement of federal income tax audits
relating to tax years 1992 through 1997. There was no similar interest income in
2002. Also, contributing to lower income in 2002 was $46 million of losses on
long-term equity investments.
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Research and Development
Research and development expenditures involve experimentation, design,
development and related test activities for defense systems, new and derivative
commercial jet aircraft, advance space and other company-sponsored product
development. These expenditures are either charged directly against earnings or
are included in amounts allocable as reimbursable overhead costs on U.S.
Government contracts. In addition, Boeing Technology, our advanced research and
development organization, focuses on improving our competitive position by
investing in certain technologies and processes that apply to multiple business
units. Technology investments currently being pursued within Boeing Technology
include network-centric operations, affordable structures and manufacturing
technology, lean and efficient design processes and tools, lean support and
service initiatives, advanced platform systems and safe and clean products.
[[Image Removed: LOGO]] Research and development expenses were up in 2004
due to increased spending on the 787 program. The
expenses are presented net of payments in accordance
with sharing arrangements with some suppliers as
described on page 34. Research and development
expense increased in 2003, principally reflecting
IDS's continued focus on the 767 Global Tanker
Transport Aircraft (GTTA) program development as
well as the development of communication system
architectures in order to support various business
opportunities including Future Combat Systems, Joint
Tactical Radio System, FAB-T and Global Missile. In
2003, research and development expenses decreased at
Commercial Airplanes due to reduced spending on the
development of the 747-400ER. Research and
development highlights for each of the major
business segments are discussed in more detail in
Segment Results of Operations and Financial
Condition on pages 33-34 and 43-47.
Income Taxes
The 2004 effective income tax rate of 7.1% differed
from the federal statutory tax rate of 35%, due to
Foreign Sales Corporation (FSC) and Extraterritorial
Income (ETI) exclusion tax benefits, tax credits,
state income taxes, tax benefits from a settlement
with the Internal Revenue Service (IRS) of the years
1986-1997, tax benefits associated with state tax
audit settlements, and other provision adjustments.
The effective income tax rates of (37.0)% for 2003
and 26.9% for 2002 also vary from the federal
statutory tax rate due to FSC and ETI benefits, tax
credits, state income taxes, and in 2003, favorable
resolution of IRS audit issues and the
non-deductibility for tax purposes of certain
portions of goodwill impairment charges.
IRS Audit Overview IRS examinations have been completed through 1997 and income
taxes have been settled with the IRS for all years through 1996 and for
McDonnell Douglas Corporation for all years through 1992. We have filed appeals
with the IRS for 1993 through 1997 for McDonnell Douglas Corporation.
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During 2004 we received $896 million relating to federal income tax refunds for
which estimated accruals had primarily been recorded in prior periods. Of this
amount, $681 million related to the 2003 federal tax return. $104 million
related to a settlement of the 1996 tax year and the 1997 partial tax year for
McDonnell Douglas Corporation, $69 million related to a settlement of the 1983
through 1987 tax years, and $1 million related to the 1985 tax year. The balance
of $41 million relates to a partial settlement of the 1986 through 1997 Boeing
Company audit and was recorded in the year ended December 31, 2004. In addition,
$217 million of interest income associated with the tax refunds was received and
recorded in the Consolidated Statements of Operation. Of the $217 million of
interest income received, $40 million was recorded in 2003 and the balance was
recorded during 2004. In addition to the cash received above, we are awaiting
the receipt of an additional $124 million of federal net income tax refund and
$42 million of interest for the settlement of the years 1986 through 1997 which
have already been accrued during the year ended December 31, 2004.
Legislative Update On October 22, 2004, the President signed the American Jobs
Creation Act of 2004 (the Act). The Act provides a deduction for income from
qualified domestic production activities, which will be phased in from 2005
through 2010. In return, the Act also provides for a two-year phase-out (except
for certain pre-exisitng binding contracts) of the existing ETI exclusion tax
benefit for foreign sales which the World Trade Organization (WTO) ruled was an
illegal export subsidy. The European Union (EU) believes that the Act fails to
adequately repeal the illegal export subsidies because of the transitional
provisions and has asked the WTO to review whether these provisions are in
compliance with their prior ruling. It is not possible to predict what impact
this issue will have on future earnings pending the final resolution of this
matter. Additionally, the Act creates a temporary incentive for U.S.
corporations to repatriate accumulated income earned abroad by providing an 85
percent dividend received deduction for certain dividends from controlled
foreign corporations.
On December 21, 2004, the Financial Accounting Standards Board Staff Position
(FSP) No. FAS 109-1, Application of FASB Statement No. 109, Accounting for
Income Taxes, to the Tax Deduction on Qualified Production Activities Provided
by the American Jobs Creation Act of 2004, was issued. FSP No. FAS 109-1
clarifies that this tax deduction should be accounted for as a special deduction
in accordance with Statement of Financial Accounting Standards (SFAS) No. 109,
Accounting for Income Taxes. As such, the special deduction has no effect on
deferred tax assets and liabilities existing at the date of enactment. Rather,
the impact of this deduction will be reported in the period in which the
deduction is claimed on our tax return beginning in 2005. As regulations are
still pending, we have been unable to quantify this impact.
On December 21, 2004, FSP No. FAS 109-2, Accounting and Disclosure Guidance for
the Foreign Earnings Repatriation Provision within the American Jobs Creation
Act of 2004, was issued. FSP No. FAS 109-2 provides companies additional time,
beyond the financial reporting period during which the Act took effect, to
evaluate the Act's impact on a company's plan for reinvestment or repatriation
of certain foreign earnings for purposes of applying SFAS No. 109. FSP No. FAS
109-2 was effective upon issuance. As of December 31, 2004, we have not decided
on whether and to what extent we might repatriate foreign earnings under the
Act, and accordingly, the financial statements do not reflect any provisions for
taxes on unremitted foreign earnings. Based on our analysis of the Act, although
not yet finalized, it is possible that under the repatriation provision of the
Act we may repatriate some amount of earnings between $0 to $350 million with
the respective tax liability ranging from $0 to $26 million. We expect to be in
a position to finalize our assessment by June 30, 2005.
Backlog
Contractual backlog of unfilled orders excludes purchase options, announced
orders for which definitive contracts have not been executed, and unobligated
U.S. and foreign government contract funding. The increase in contractual
backlog from 2003 to 2004 primarily relates to new orders for the
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787. The increase was partially offset by sales on multi-year contracts that
were awarded in prior periods, particulary the C-17 and F/A-18 programs in A&WS,
and strong sales on the Ground-Based Midcourse Defense (GMD) program and
proprietary programs in Network Systems.
The increase in contractual backlog from 2002 to 2003 related to increases in
contractual backlog for A&WS and Network Systems, offset by decreases for
Commercial Airplanes. A&WS obtained orders for the Apache helicopters from
Greece and Kuwait, the F/A-18 E/F Multi Year II contract and the initial funding
for the EA-18G from the U.S. Navy while Network Systems obtained orders for the
GMD program and Turkey 737 Airborne Early Warning and Control (AEW&C) programs
coupled with the initial funding of the FCS program. Commercial Airplanes'
decrease in contractual backlog reflects the impact that the economic downturn
has had on the airline industry.
Unobligated backlog includes U.S. and foreign government definitive contracts
for which funding has not been appropriated. The decrease in unobligated backlog
in 2004 is mainly due to strong sales throughout the IDS segments but was
partially offset by contract awards for the Multi-Mission Maritime Aircraft
(MMA) and FCS program extension and an order from DIRECTV for 3 satellites.
For segment reporting purposes, we report Commercial Airplanes contractual
backlog for airplanes built and sold to other segments. Commercial Airplanes
relieves contractual backlog upon the sale of these airplanes to other segments.
IDS contractual backlog includes the modification performed on intracompany
airplane purchases from Commercial Airplanes. IDS relieves contractual backlog
for the modification performed on airplanes received from Commercial Airplanes
upon delivery to the customer or at the attainment of performance milestones.
Liquidity and Capital Resources
Primary sources of our liquidity and capital resources include cash flow from
operations and substantial borrowing capacity through commercial paper programs
and long-term capital markets, as well as unused borrowing on revolving credit
line agreements. The primary factors that affect our investment requirements and
liquidity position, other than operating results associated with current sales
activity, include the following: timing of new and derivative programs requiring
both high developmental expenditures and initial inventory buildup; growth and
contractions in business cycles, including growth and expansion requirements and
requirements associated with reducing sales levels; customer financing
assistance; the timing of federal income tax payments/refunds as well as
interest and dividend payments; our stock repurchase plan; internal investments;
and potential acquisitions and divestitures.
Cash Flow Summary
(Dollars in millions)
Year ended December 31, 2004 2003 2002
Net earnings $ 1,872 $ 718 $ 492
Non-cash items 3,070 3,137 4,357
Changes in working capital (1,484 ) (1,146 ) (2,513 )
Net cash provided by operating activities 3,458 2,709 2,336
Net cash provided (used) by investing activities (1,369 ) 112 (1,382 )
Net cash provided (used) by financing activities (3,518 ) (521 ) 746
Net increase (decrease) in cash and cash equivalents (1,429 ) 2,300 1,700
Cash and cash equivalents at beginning of year 4,633 2,333 633
Cash and cash equivalents at end of year $ 3,204 $ 4,633 $ 2,333
---------------------------------------------------- - ------ - - ------ - - ------ -
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Non-cash items Non-cash items in earnings primarily include depreciation,
amortization, share-based plans expense, impairments, valuation provisions, and
pension expense/income. Non-cash items and corresponding amounts are listed in
our Consolidated Statements of Cash Flows.
Working capital During 2004, our investment in working capital increased. This
increase is primarily due to $4.4 billion of discretionary and non-discretionary
pension contributions made in 2004 (see discussion following on pensions). Other
items primarily contributing to the net increase in investment in working
capital include:
† an increase in accounts payable, due to normal business operating cycle,
principally in our Other operating segment,
† a change in income taxes payable related to the tax refunds recorded and tax
expense related to current earnings,
† cash used by customer financing additions of $1,380 million, offset by
customer financing collections of $959 million due to normal customer
financing activities,
† an increase in advances in excess of related costs due to the recovery of the
commercial airplane market,
† an increase in cash received from inventories due to lean initiatives.
During the third quarter of 2004, we received a federal income tax refund of
$681 million cash which resulted from net operating and capital loss carry-backs
related to large pension contributions in 2003 and first quarter of 2004.
Working capital includes customer financing transactions primarily in the form
of notes receivable, sales-type/financing leases and operating leases. These
transactions occur as the result of customer related financing activities
associated with items recorded in inventory. The origination and subsequent
principal collections for these transactions were previously presented as
investing activites in our Consolidated Statements of Cash Flows, consistent
with the presentation by BCC in their stand alone financial statements. We
changed the classification of the cash flow effects of customer financing
transactions based on concerns raised by the SEC staff. The amounts for prior
periods have been reclassified to be consistent with current year presentation.
(See Note 26). For the years ended December 31, 2004, 2003, and 2002, the net
impact on operating cash flow was ($421) million, ($1.3) billion, and ($2.0)
billion, respectively, for customer financing transactions.
Pensions 2004 operating cash flow included $4.4 billion of cash funding to the
pension plans. Almost all of the contributions were voluntary to improve the
funded status of our plans. On February 4, 2005, we contributed $450 million to
the pension plans. Required pension contributions under Employee Retirement
Income Security Act (ERISA) regulations are not expected to be material in 2005.
However, we are evaluating discretionary contributions of approximately $550
million (pre-tax) later in the year. We expect to contribute approximately $17
million to our other postretirement benefit plans in 2005.
We measure our pension plans using a September 30 year-end for financial
accounting purposes. Although in 2004 and 2003, actual investment returns were
well in excess of the expected rates of 8.75% and 9.0%, respectively, we reduced
our expected long-term rate of return on plan assets by 25 basis points to 8.5%
beginning in 2005 because of general market conditions and changes in the
pension plan investment portfolio allocation. The expected long-term rate of
return on plan assets is based on long-term target asset allocations of 50%
equity, 31% fixed income, 6% real estate, and 13% other. Current allocations are
within 1 to 10% of each of the long-term targets. Historically low interest
rates (a key factor when estimating plan liabilities) which have persisted in
2003 and 2004, caused us to recognize an additional non-cash charge to equity in
the fourth quarter of 2003. This charge, which
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resulted in a $358 million increase to the accrued pension plan liability and a
$226 million after-tax decrease to the accumulated other comprehensive income
account within shareholders' equity, was reversed in the fourth quarter of 2004.
The reversal, which was due in large part to $4.4 billion in pension
contributions made during 2004, resulted in a $3.5 billion decrease to the
accrued pension liability and a $2.2 billion after-tax increase to the
accumulated other comprehensive income account within shareholders' equity. The
charges in 2003 and reversal in 2004, did not impact earnings or cash flow, and
will change in future periods as interest rates, market performance, and plan
returns vary from expected assumptions. We use a discount rate that is based on
a point-in-time estimate as of each annual September 30 measurement date.
Although future changes to the discount rate are unknown, had the discount rate
increased or decreased by 25 basis points, pension liabilities in total would
have decreased $1.3 billion or increased $1.5 billion, respectively.
Investing activities In 2004, the amount of cash used for investing activities
was approximately $1.5 billion greater than in 2003. A portion of our cash used
by investing activities in 2004 was offset by cash of $2 billion generated by
the sale of a substantial portion of BCC's Commercial Financial Services
business. Also, additions to Property, Plant, and Equipment in 2004 were
approximately $250 million more than 2003 to support the growth of the 787
program and growth of IDS.
During 2004, we invested $3.0 billion of cash in an externally managed portfolio
of investment grade fixed income instruments. The portfolio is diversified and
highly liquid and primarily consists of U.S. dollar debt obligations of the
United States Treasury, other government agencies, corporations, mortgage-backed
and asset-backed securities. The portfolio has an average duration of 1.5 years.
Short-term investments are debt securities with maturities less than one year
and the remaining securities are long term investments (except cash equivalents
with maturities less than 90 days). As of December 31, 2004, amounts invested
with a fair value of $2.7 billion were classified as available-for-sale
Investments on the Consolidated Statements of Financial Position. We do not
intend to hold these investments to maturity, nor do we intend to actively and
frequently buy and sell these securities with the objective of generating
profits on short-term differences in price. In addition, amounts totaling $108
million were classified as Cash and cash equivalents and $173 million were
classified as available-for-sale and recorded in Short-term investments. During
2004, realized gains and losses on these investments were not material.
The majority of BCC's customer financing is funded by debt and cash flow from
its own operation. As of December 31, 2004, we had outstanding irrevocable
commitments of approximately $6.7 billion to arrange or provide financing
related to aircraft on order or under option for deliveries scheduled through
the year 2007. Not all of these commitments are likely to be used; however, a
significant portion of these commitments are with parties with relatively low
credit ratings. (See Notes 15 and 20.)
Financing activities There were no debt issuances during 2004. In 2003, we
received proceeds of $1 billion related to our September 13, 2002 shelf
registration.
Debt maturities, which include BCC amounts, were $1.1 billion in 2004, $1.8
billion in 2003, and $1.3 billion in 2002. Additionally, BCC issued debt in the
amount of $1.0 billion in 2003 and $2.8 billion in 2002. In 2003 and 2002, BCC's
debt issuances were generally used for growth in the customer financing
portfolio.
On July 26, 2004, BCC redeemed $1 billion face value of its outstanding senior
notes, which had a carrying value of $999 million. This redemption included the
entire principal amount, equal to $500 million face value, of its 7.10% senior
debt securities due 2005 at a redemption price equal to 105.30% of the principal
amount of the notes together with interest accrued to the redemption date. BCC
redeemed $500 million face value of its 5.65% senior debt securities due 2006 at
a redemption price
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equal to 104.81% of the principal amount of the notes together with interest
accrued to the redemption date. BCC recognized a net loss of $42 million related
to this early debt redemption. (See Note 15.)
There were 14,708,856 shares repurchased at a price of $752 million in our open
market share repurchase program, and 50,657 shares repurchased in a stock swap
in 2004 and no shares were repurchased in 2003 or 2002.
Credit Ratings
Our credit ratings are summarized below:
Standard &
Fitch Moody's Poor's
Long-term:
Boeing/BCC A+ A3 A
Short-term:
Boeing/BCC F-1 P-2 A-1
Capital Resources
We and BCC each have a commercial paper program that continues to serve as a
significant potential source of short-term liquidity. As of December 31, 2004,
neither we nor BCC had any outstanding commercial paper issuances.
We have substantial borrowing capacity. Currently, $3.4 billion remains
available to BCC from shelf registrations filed with the SEC and $3.5 billion
($2.0 billion exclusively available for BCC) of unused borrowing on revolving
credit line agreements with a group of major banks remains available. (See Note
15). We believe our internally generated liquidity, together with access to
external capital resources, will be sufficient to satisfy existing commitments
and plans, and also to provide adequate financial flexibility to take advantage
of potential strategic business opportunities should they arise within the next
year.
On March 23, 2004, we filed a shelf registration with the SEC for $1 billion for
the issuance of debt securities and underlying common stock.
In November 2004, we rolled over the 364-day revolving credit facility, reducing
it from $2.5 billion to $2.0 billion. Prior to November we had $1.25 billion
assigned to BCC and $1.25 billion assigned to us. Currently, there is $1.25
billion assigned to BCC with only $750 million assigned to us. There was no
change to the 5-year credit facility of $1.5 billion, of which $750 million
remains assigned to BCC, we established in November 2003.
As of December 31, 2004, we are in compliance with the covenants for the 364-day
and the 5-year revolving credit facilities.
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Disclosures about Contractual Obligations and Commitments
The following table summarizes our known obligations to make future payments
pursuant to certain contracts as of December 31, 2004, as well as an estimate of
the timing in which these obligations are expected to be satisfied.
Contractual obligations
Less than 1-3 3-5 After 5
(Dollars in millions) Total 1 year years years years
Long-term debt $ 11,884 $ 1,250 $ 3,181 $ 514 $ 6,939
Capital lease obligations 316 71 152 32 61
Operating lease obligations 2,284 390 665 364 865
Purchase obligations:
Not recorded on statement of financial
position
Production related 44,676 20,981 16,192 6,381 1,122
Pension and other post retirement cash
requirements 2,985 537 1,174 1,274
Recorded on statement of financial
position 6,953 5,718 319 328 588
Total contractual obligations $ 69,098 $ 28,947 $ 21,683 $ 8,893 $ 9,575
--------------------------------------- - ------ -- -------- - ------ - ----- -- -----
|
Purchase obligationsPurchase obligations represent contractual agreements to
purchase goods or services that are legally binding; specify a fixed, minimum or
range of quantities; specify a fixed, minimum, variable, or indexed price
provision; and approximate timing of the transaction. In addition, the
agreements are not cancelable without a substantial penalty. Long-term debt,
capital leases, and operating leases are shown in the above table regardless of
whether they meet the characteristics of purchase obligations. Purchase
obligations include both amounts that are and are not recorded on the statements
of financial position. Approximately 23% of the purchase obligation amounts
disclosed above are reimbursable to us pursuant to cost-type government
contracts.
Purchase obligations - not recorded on the statement of financial position.
Pension and other postretirement benefits Pension funding is an estimate of our
minimum funding requirements through 2006 to provide pension benefits for
employees based on service provided through 2004 pursuant to the ERISA
regulations, although we may make additional discretionary contributions.
Obligations relating to other postretirement benefits are based on both our
estimated future benefit payments, since the majority of our other
postretirement benefits are not funded through a trust, and the estimated
contribution to the one plan that is funded through a trust through 2009. Our
estimate may change significantly depending on the actual rate of return on plan
assets, discount rates, discretionary pension contributions, regulatory rules,
and medical trends.
Production related Production related purchase obligations include agreements
for production goods, tooling costs, electricity and natural gas contracts,
property, plant and equipment, and other miscellaneous production related
obligations. The most significant obligation relates to inventory procurement
contracts. We have entered into certain significant inventory procurement
contracts that specify determinable prices and quantities, and long-term
delivery timeframes. These agreements require suppliers and vendors to be
prepared to build and deliver items in sufficient time to meet our production
schedules. The need for such arrangements with suppliers and vendors arises due
to the extended production planning horizon for many of our products, including
commercial aircraft, military aircraft and other products where delivery to the
customer occurs over an extended period of time. A significant portion of these
inventory commitments are either supported by firm contracts from
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customers, or have historically resulted in settlement through either
termination payments or contract adjustments should the customer base not
materialize to support delivery from the supplier. Some inventory procurement
contracts may include escalation adjustments. In these limited cases, we have
included our best estimate of the effect of the escalation adjustment in the
amounts disclosed in the table above.
Industrial participation agreements We have entered into various industrial
participation agreements with certain customers in foreign countries to effect
economic flow back and/or technology transfer to their businesses or government
agencies, as the result of their procurement of goods and/or services from us.
These commitments may be satisfied by our placement of direct work, placement of
vendor orders for supplies, opportunities to bid on supply contracts, transfer
of technology, or other forms of assistance to the foreign country. However, in
certain cases, our commitments may be satisfied through other parties (such as
our vendors) who purchase supplies from our foreign customers. We do not commit
to industrial participation agreements unless a contract for sale of our
products or services is signed. In certain cases, penalties could be imposed if
we do not meet our industrial participation commitments. During 2004, we
incurred no such penalties. As of December 31, 2004, we have outstanding
industrial participation agreements totaling $7.4 billion that extend through
2015. In cases where we satisfy our commitments through the purchase of supplies
and the criteria described in "purchase obligations" is met, amounts are
included in the table above. To be eligible for such a purchase order commitment
from us, the foreign country or customer must have sufficient capability and
capacity and must be competitive in cost, quality and schedule.
Purchase obligations recorded on the statement of financial position
Purchase obligations recorded on the statement of financial position primarily
include accounts payable and certain other liabilities including accrued
compensation and dividends payable.
Off-Balance Sheet Arrangements
We are a party to certain off-balance sheet arrangements including certain
guarantees and variable interests in unconsolidated entities.
Guarantees The following tables provide quantitative data regarding our
third-party guarantees. The maximum potential payment amounts represent
"worst-case scenarios" and do not necessarily reflect our expected results.
Estimated proceeds from collateral and recourse represent the anticipated values
of assets we could liquidate or receive from other parties to offset our
payments under guarantees. The carrying amount of liabilities recorded on the
balance sheet reflects our best estimate of future payments we may incur as part
of fulfilling our guarantee obligations.
Estimated
Proceeds
Maximum from Carrying
Potential Collateral/ Amount of
As of December 31, 2004 Payments Recourse Liabilities*
Contingent repurchase commitments $ 3,751 $ 3,743
Trade-in commitments 972 947 $ 25
Asset-related guarantees 408 296 12
Credit guarantees related to the Sea
Launch venture 510 306 204
Other credit guarantees 60 19 10
Equipment trust certificates 28
Performance guarantees 64 21 1
------------------------------------------ -- -------- -- ---------- --- ---------
|
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Estimated
Proceeds
Maximum from Carrying
Potential Collateral/ Amount of
As of December 31, 2003 Payments Recourse Liabilities*
Contingent repurchase commitments $ 5,712 $ 5,712
Trade-in commitments 1,279 1,214 $ 65
Asset-related guarantees 468 364 5
Credit guarantees related to the Sea
Launch venture 519 311 208
Other credit guarantees 106 50 5
Equipment trust certificates 28
Performance guarantees 56 18
------------------------------------------ -- -------- -- ---------- --- ---------
|
* Amounts included in accounts payable and other liabilities
In conjunction with signing a definitive agreement for the sale of new aircraft
(Sale Aircraft), we have entered into specified-price trade-in commitments with
certain customers that give them the right to trade in used aircraft for the
purchase of Sale Aircraft. Additionally, we have entered into contingent
repurchase commitments with certain customers wherein we agree to repurchase the
Sale Aircraft at a specified price at a future point in time, generally ten
years after delivery of the Sale Aircraft. Our repurchase of the Sale Aircraft
is contingent upon a future, mutually acceptable agreement for the sale of
additional new aircraft. If, in the future, we execute an agreement for the sale
of additional new aircraft, and if the customer exercises its right to sell the
Sale Aircraft to us, a contingent repurchase commitment would become a trade-in
commitment. Contingent repurchase commitments and trade-in commitments are now
included in our guarantees discussion based on our current analysis of the
underlying transactions. Based on our historical experience, we believe that
very few, if any, of our outstanding contingent repurchase commitments will
ultimately become trade-in commitments. During 2004, we recorded no expense and
made no net cash payments related to our contingent repurchase commitments.
Exposure related to the trade-in of used aircraft resulting from trade-in
commitments may take the form of: (1) adjustments to revenue related to the sale
of new aircraft determined at the signing of a definitive agreement, and/or (2)
charges to cost of products and services related to adverse changes in the fair
value of trade-in aircraft that occur subsequent to signing of a definitive
agreement for new aircraft but prior to the purchase of the used trade-in
aircraft. The trade-in aircraft exposure included in accounts payable and other
liabilities in the tables above is related to item (2) above.
There is a high degree of uncertainty inherent in the assessment of the
likelihood of trade-in commitments. The probability that trade-in commitments
will be exercised is determined by using both quantitative information from
valuation sources and qualitative information from other sources and is
continually assessed by management. As disclosed in the above table, the maximum
amounts payable under trade-in commitments were $972 million and $1.3 billion as
of December 31, 2004 and 2003. Based on the best market information available at
the time, it was probable that we would be obligated to perform on trade-in
commitments with gross amounts payable to customers totaling $116 million and
$582 million as of December 31, 2004 and 2003. The estimated fair value of
trade-in aircraft related to probable contractual trade-in commitments was $91
million and $517 million as of December 31, 2004 and 2003. Accounts payable and
other liabilities included $25 million and $65 million as of December 31, 2004
and 2003, which represents the exposure related to these trade-in commitments.
We have issued various asset-related guarantees, principally to facilitate the
sale of certain commercial aircraft. Under these arrangements, we are obligated
to make payments to a guaranteed party in the event the related aircraft fair
values fall below a specified amount at a future point in time. No aircraft have
been delivered with these types of guarantees in several years. During 2004, we
recorded no expense and made no net cash payments related to our asset-related
guarantees.
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We have previously issued credit guarantees to creditors of the Sea Launch
venture, of which we are a 40% partner, to assist the venture in obtaining
financing. In the event we are required to perform on these guarantees, we have
the right to recover a portion of the loss from other venture partners and have
collateral rights to certain assets of the venture.
In addition, we have issued other credit guarantees to facilitate the sale of
certain commercial aircraft. Under these arrangements, we are obligated to make
payments to a guaranteed party in the event that lease or loan payments are not
made by the original debtor or lessee. Our commercial aircraft credit-related
guarantees are collateralized by the underlying commercial aircraft. A
substantial portion of these guarantees have been extended on behalf of original
debtors or lessees with less than investment-grade credit. Recent financial
weakness in certain airlines further exposes us to loss under our credit
guarantees. During 2004, we recorded expense of $1 million and made no net cash
payments related to our credit guarantees.
We had certain obligations to investors in the trusts as a liquidity provider
for Equipment Trust Certificates (ETC) pass-through arrangements, which required
funding to the trust to cover interest due to such investors in the event of
default by United Airlines, Inc. (United). In the event of funding, we are
entitled to receive a first priority position in the ETC collateral in the
amount of the funding. On February 7, 2003, we advanced $101 million to the
trust perfecting our collateral position and terminating our liquidity
obligation. On August 9, 2004, The Bank of New York, acting as the collateral
agent, reimbursed us for this advance with a total payment of $107 million. The
payment included the original advanced amount, as well as interest income
related to the advance.
Also relating to an ETC investment, we have potential obligations relating to
shortfall interest payments in the event that the interest rates in the
underlying agreements are reset below a certain level. These obligations would
cease if United were to default on our interest payments to the trust. There
were no significant payments made by us during 2004.
We have outstanding performance guarantees issued in conjunction with joint
venture investments. Pursuant to these guarantees, we would be required to make
payments in the event a third-party fails to perform specified services. We have
made no significant payments in relation to these performance guarantees.
Material variable interests in unconsolidated entities Our investments in ETCs,
Enhanced Equipment Trust Certificates (EETCs) and Special Purpose Entities
(SPEs) are included in the scope of Revised Interpretation No. 46 (FIN 46 (R)),
Consolidation of Variable Interest Entities. All entities that were required to
be consolidated under FIN 46(R) had been previously consolidated, and therefore,
the adoption of FIN 46(R) had no impact on our consolidated financial
statements.
From 1999 through 2004, we invested in ETCs and EETCs, which are trusts that
passively hold debt investments for a large number of aircraft to enhance
liquidity for investors, who in turn pass this liquidity benefit directly to
airlines in the form of lower coupon and/or greater debt capacity. ETCs and
EETCs provide investors with tranched rights to cash flows from a financial
instrument, as well as a collateral position in the related asset. Our
investment in ETCs and EETCs do not require consolidation under FIN 46(R). We
believe that our maximum exposure to economic loss from ETCs and EETCs is $349
million, comprised of our $321 million investment balance and a maximum
potential exposure of $28 million relating to potential shortfall interest
payments. Accounting losses, if any, from period to period could differ. As of
December 31, 2004, the ETC and EETC transactions we participated in had total
assets of $3.9 billion and total debt (which is non-recourse to us) of $3.6
billion. During the year ended December 31, 2004, we recorded revenues of $28
million and cash flows of $70 million.
From 1998 through 2004, we provided subordinated loans to certain SPEs that are
utilized by the airlines, lenders and loan guarantors, including, for example,
the Export-Import Bank of the United States. All of these SPEs are included in
the scope of FIN 46(R); however, only certain SPEs require
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consolidation. SPE arrangements are utilized to isolate individual transactions
for legal liability or tax purposes, or to perfect security interests from our
perspective, as well as, in some cases, that of a third-party lender in certain
leveraged lease transactions. We believe that our maximum exposure to economic
loss from non-consolidated SPE arrangements that are Variable Interest Entities
(VIE) is $43 million, which represents our investment balance. Accounting
losses, if any, from period to period could differ. As of December 31, 2004,
these SPE arrangements had total assets of $451 million and total debt (which is
non-recourse to us) of $408 million. During the year ended December 31, 2004, we
recorded revenues of $3 million and cash flows of $28 million.
Commercial commitments The following tables summarize our commercial commitments
outstanding as of December 31, 2004, as well as an estimate of the timing in
which these commitments are expected to expire.
Total Amounts
Committed/Maximum Less than 1-3 4-5 After 5
(Dollars in millions) Amount of Loss 1 year years years years
Standby letters of credit
and surety bonds $ 3,183 $ 2,866 $ 152 $ 34 $ 131
Other commercial commitments 6,661 495 3,755 2,321 90
Total commercial commitments $ 9,844 $ 3,361 $ 3,907 $ 2,355 $ 221
Related to the issuance of certain standby letters of credit and surety bonds
included in the above table, we received advance payments of $1.8 billion and
$1.0 billion as of December 31, 2004 and 2003, respectively.
Other commercial commitments include irrevocable financing commitments related
to aircraft on order and commercial equipment financing. (See Note 20.)
Industrial Revenue Bonds We utilize Industrial Revenue Bonds (IRB) issued by the
City of Wichita to finance the purchase and/or construction of real and personal
property at our Wichita site. Tax benefits associated with IRBs include a
provision for a ten-year property tax abatement and a sales tax exemption from
the Kansas Department of Revenue. We record the property on our Consolidated
Statements of Financial Position, along with capital lease obligation to repay
the proceeds of the IRB. We have also purchased the IRBs and therefore we are
the Bondholder as well as the Borrower/ Lessee of the property purchased with
the IRB proceeds.
We also have a similar arrangement in place with the Development Authority of
Fulton County, Georgia where we are both borrower and bondholder. Tax benefits
associated with these IRBs are the provision of a ten-year partial property tax
abatement.
The capital lease obligation and IRB asset are recorded net in the Consolidated
Statements of Financial Position pursuant to FIN 39, Offsetting of Amounts
Related to Certain Contracts. As of December 31, 2004 and 2003, the assets and
liabilities associated with the City of Wichita IRBs were $2.9 billion, and the
amounts associated with the Fulton County IRBs were $19 million.
Segment Results of Operations and Financial Condition
Commercial Airplanes
Business Environment and Trends
Airline Industry Environment World-wide air travel experienced a strong rebound
in 2004. This rebound is notable in that it represents a recovery from the
levels of 2003 which were depressed by the
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Severe Acute Respiratory Syndrome (SARS) outbreak in Asia, and represents a
traffic level that exceeds the previous record which was set in 2000. It has
taken the industry four years to exceed that level, indicating the difficulties
faced by the world's airlines as they have dealt with the effects of recession,
terrorism, and disease. This traffic volume has been driven by strong world-wide
economic growth which stimulates demand, and declining real airline yields which
makes air travel more affordable to more people.
This increase in demand has produced high load factors, but not industry-wide
profitability due to a significant increase in the price of jet fuel. The
world's airlines have made great strides in cost efficiency, only to see those
improvements be more than offset by price increases of jet fuel. The world-wide
increases in the price of crude oil that began in mid 2003 and peaked in late
2004 have contributed to world airline losses that are estimated to be about $5
billion dollars in 2004 and represent the fourth consecutive year of losses for
the world's airlines.
This large industry loss does not mean that all airlines are losing money in the
current environment. We are seeing divergence in the profitability of different
types of airlines as their different business models are proving to be
vulnerable or robust to these environmental changes. The hardest-hit have been
the large U.S. network carriers. These airlines were the most damaged by the
results of the 2001 terrorist attacks on the United States and have been the
most vulnerable to increasing competition and technology changes that are
changing the air travel business. The large network airlines outside the United
States have been more successful in dealing with the challenges of 2004, most
are profitable despite current fuel prices, and they continue to order new
airplanes. The airlines that have fared best are the low-cost, low-fare
airlines. They have been consistently profitable throughout the current
challenges and their continued growth represents a real change in the air travel
market. These airlines also continue to order and to take delivery of new
airplanes.
Further recovery in profitability for the world's airlines is highly dependent
on the future movement in oil and fuel prices; as these prices fall the
prospects of the world's airlines will improve. As profitability improves and
air travel demand continues to increase with increasing economic activity, we
see an improvement in the prospects for future airplane orders and deliveries.
Our 20-year forecast of the average long-term growth rate of passenger traffic
is 5.2% per annum, and 6.2% per annum for cargo traffic based on projected
average annual worldwide real economic growth of 3.0%. Based on global economic
growth projections over the long term, and taking into consideration an
increasingly competitive environment, increasing utilization levels of the
worldwide airplane fleet and requirements to replace older airplanes, we project
a $2.0 trillion market for 25,000 new airplanes over the next 20 years. This is
a long-term forecast; historically, while factors such as the Gulf War and
increased ticket charges for security have had significant impact over the span
of several years, they have not dramatically affected the longer-term trends in
the world economy, and therefore, our market outlook.
Inherent Business Risks Commercial jet aircraft are normally sold on a firm
fixed-price basis with an indexed price escalation clause. Our ability to
deliver jet aircraft on schedule is dependent upon a variety of factors,
including execution of internal performance plans, availability of raw
materials, performance of suppliers and subcontractors, and regulatory
certification. The introduction of new commercial aircraft programs and major
derivatives involves increased risks associated with meeting development,
production and certification schedules.
The worldwide market for commercial jet aircraft is predominately driven by
long-term trends in airline passenger traffic. The principal factors underlying
long-term traffic growth are sustained economic growth, both in developed and
emerging countries and political stability. Demand for our commercial aircraft
is further influenced by airline industry profitability, world trade policies,
government-to-
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government relations, environmental constraints imposed upon aircraft
operations, technological changes, and price and other competitive factors.
Industry Competitiveness The commercial jet aircraft market and the airline
industry remain extremely competitive. We expect the existing long-term downward
trend in passenger revenue yields worldwide (measured in real terms) to continue
into the foreseeable future. Market liberalization in Europe and Asia has
continued to enable low-cost airlines to gain market share. These airlines have
increased the downward pressure on airfares. This results in continued cost
pressures for all airlines and price pressure on our products. Major
productivity gains are essential to ensure a favorable market position at
acceptable profit margins.
Continued access to global markets remains vital to our ability to fully realize
our sales potential and long-term investment returns. Approximately 2/3 of
Commercial Airplanes' third-party sales and contractual backlog are from
customers based outside the United States.
We face aggressive international competitors that are intent on increasing their
market share. They offer competitive products and have access to most of the
same customers and suppliers. Airbus has historically invested heavily to create
a family of products to compete with ours. Regional jet makers Embraer and
Bombardier, coming from the less than 100-seat commercial jet market, continue
to develop larger and more capable airplanes. This market environment has
resulted in intense pressures on pricing and other competitive factors.
Worldwide, airplane sales are generally conducted in U.S. dollars. Fluctuating
exchange rates affect the profit potential of our major competitors, all of whom
have significant costs in other currencies. The recent decline of the U.S.
dollar relative to their local currencies is putting unusual pressure on their
future revenues and profits. While this may seem like an advantage to us, it
contains a potential threat in that competitors may react by aggressively
reducing costs, potentially improving their longer-term competitive posture.
Airbus has indicated that they are adopting this approach, and plan more than
10% reduction in costs by 2006. If the dollar strengthens by then, Airbus could
use the extra efficiency to gain market share and develop new products.
We are focused on improving our processes and continuing cost-reduction efforts.
We continue to leverage our extensive customer support services network for
airlines throughout the world to provide a higher level of customer satisfaction
and productivity. These efforts enhance our ability to pursue pricing strategies
that enable us to price competitively and maintain satisfactory margins. While
we are focused on improving our processes and continuing cost reduction
activities, events may occur that will prevent us from achieving planned
results.
We continue to explore strategic options related to our operations at various
sites to focus on large-scale systems integration, which is where we are most
competitive and can add the most value to our airplanes and services. These
sites include but are not limited to Wichita, Tulsa and McAlester. (See Note
27.)
Summary Air travel continues to be the safest, most cost-effective form of
travel ever invented. Modern air travel is essential to world-wide economic
development, contributing to, and benefiting from increasing global trade.
Recent signs of recovery and the continued expectation for long-term growth in
air travel are encouraging. The airline industry continues to evolve in a
challenging environment. Successful airlines with robust business models are
continuing to grow and will need new airplanes to accommodate that growth as
well as to maintain modern, cost-effective fleets. We will continue to evolve as
well, providing airplanes and services that are recognized as providing the most
capable and productive solutions to the airlines' business requirements.
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Operating Results
(Dollars in millions) 2004 2003 2002
Revenues $ 21,037 $ 22,408 $ 28,387
% of Total Company Revenues 40 % 44 % 53 %
Operating Earnings $ 753 $ 707 $ 2,017
Operating Margins 3.6 % 3.2 % 7.1 %
Research and Development $ 941 $ 676 $ 768
Contractual Backlog $ 70,449 $ 63,929 $ 68,159
Revenues
Commercial Airplanes revenue is derived primarily from commercial jet aircraft
deliveries. New commercial jet aircraft deliveries were higher in 2004 compared
to 2003, but the delivery mix included more single-aisle aircraft and fewer
twin-aisle aircraft. The decline in revenue of $1.4 billion in 2004 from 2003
was primarily attributable to new airplane model mix of $1.2 billion and net
reduction of $132 million in other products.
The decline in revenue in 2003 compared to 2002 was primarily due to the decline
in the commercial aviation market which resulted in fewer commercial jet
aircraft deliveries.
Commercial jet aircraft deliveries as of December 31, including deliveries under
operating lease, which are identified by parentheses, were as follows:
Model 2004 2003 2002
717 12 (6) 12 (11) 20
737 Next-Generation* 202 173 223 (2)
747 15 19 (1) 27 (1)
757 11 14 29
767 9 (1) 24 (5) 35 (1)
777 36 39 47
Total 285 281 381
* Deliveries in 2004 included intracompany deliveries of three 737
Next-Generation aircraft (two USNR C40A aircraft and one Project Wedgetail
AEW&C System aircraft). Deliveries in 2003 included intra-company deliveries of
three 737 Next-Generation aircraft (two C-40 aircraft and one AEW&C System
aircraft). Deliveries in 2002 included intracompany deliveries of four 737
Next-Generation aircraft (three C-40 aircraft and one AEW&C System aircraft).
The cumulative number of commercial jet aircraft deliveries as of December 31
were as follows:
Model 2004 2003 2002
717 137 125 113
737 Next-Generation 1,622 1,420 1,247
747 1,353 1,338 1,319
757 1,047 1,036 1,022
767 925 916 892
777 499 463 424
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The undelivered units under firm order* as of December 31 were as follows:
Model 2004 2003 2002
717 18 22 26
737 Next-Generation 771 800 765
747 27 32 52
757 2 13 28
767 25 25 39
777 167 159 173
787 52
* Firm orders represent new aircraft purchase agreements where the customers'
rights to cancel without penalty have expired. Typical customer rights to
cancel without penalty include the customer receiving approval from its Board
of Directors, shareholders, government and completing financing arrangements.
All such cancellation rights must be satisfied or expired even if satisfying
such conditions are highly certain. Firm orders exclude option aircraft and
aircraft subject to reconfirmation.
Operating earnings The increase of $46 million in operating earnings in 2004
from 2003 was primarily attributable to $466 million from improved program
margins due to cost reduction initiatives and decreased period costs offset by
lower earnings from the change in model mix of $205 million, 717 program
termination charge of $280 million, 767 USAF Tanker program charge of $195
million and increased research and development expense of $265 million.
Additionally, in 2003 we had a goodwill impairment charge of $341 million and a
charge of $184 million resulting from the decision to end production of the 757
program.
The decline in operating earnings in 2003 compared to 2002 was primarily due to
the reduction in revenue as a result of lower delivery volume, a goodwill
impairment charge of $341 million, a $184 million charge resulting from the
decision to end production of the 757 program, and increased pension expense,
all of which was partially offset by improved operating efficiency and reduced
research and development expense.
Backlog Contractual backlog of unfilled orders excludes purchase options,
announced orders for which definitive contracts have not been executed, and
unobligated U.S. and foreign government contract funding. The increase in
backlog in 2004 compared to 2003 primarily relates to new orders for the 777 and
787. The decline in backlog in 2003 compared to 2002 represents higher delivery
volume on all airplane programs relative to new orders.
Unobligated backlog increased by approximately $0.6 billion for the twelve
months ended December 31, 2004. This increase is attributed to the MMA program
contract award. There was no unobligated backlog as of December 31, 2003. For
each airplane program, we estimate the quantity of airplanes that will be
produced for delivery under existing and anticipated contracts. We refer to this
estimate as the "accounting quantity." The accounting quantity for each program
is a key determinant of gross margins we recognize on sales of individual
airplanes throughout the life of a program. See "Application of Critical
Accounting Policies-Program accounting." Estimation of the accounting quantity
for each program takes into account several factors that are indicative of the
demand for the particular program, such as firm orders, letters of intent from
prospective customers, and market studies. We review and reassess our program
accounting quantities on a quarterly basis in compliance with relevant program
accounting guidance.
Commercial aircraft production costs include a significant amount of
infrastructure costs, a portion of which do not vary with production rates. As
the amount of time needed to produce the accounting quantity increases, the
average cost of the accounting quantity also increases as these infrastructure
costs are included in the total cost estimates, thus reducing the gross margin
and related earnings provided other factors do not change.
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The estimate of total program accounting quantities and changes, if any, as of
December 31 were:
737 Next-
717 Generation 747 757 767 777
2004 156 2,400 1,400 1,050 959 700
Additions/(deletions) 8 200 12 (16 ) 50
2003 148 2,200 1,388 1,050 975 650
Additions/(deletions) 8 200 (13 ) (50 ) (25 ) 50
2002 140 2,000 1,401 1,100 1,000 600
717 Program The accounting quantity for the 717 program has been based on firm
orders since the fourth quarter of 2001. The 717 program accounting quantity was
increased during 2004 due to the program obtaining additional firm orders. As of
December 31, 2004, of the 18 remaining undelivered units, 8 units will be
delivered to a single customer with uncertain financial condition. As a result,
on a consolidated basis, these aircraft are accounted for as long-term operating
leases as they are delivered. The value of the inventory for the undelivered
aircraft as of December 31, 2004, remained realizable.
Program continuity at the end of the third quarter of 2004 was dependent on the
outcome of current sales campaigns. During the nine months ended September 30,
2004 firm orders for six additional units had been received and during November
2004, firm orders for two additional units had been received.
On January 12, 2005, we decided to conclude production of the 717 commercial
airplane in 2006 due to the lack of overall market demand for the airplane. The
decision is expected to result in total pre-tax charges of approximately $385
million, of which $280 million is incorporated in the 2004 fourth quarter and
year end results.
Of the $280 million charge that was incorporated in the 2004 fourth quarter and
year end results, supplier termination charges are estimated to be $171 million;
production disruption and related charges are estimated to be $36 million;
pension/post-retirement curtailment charges are estimated to be $43 million; and
severance charges are estimated to be $30 million. Of the $105 million charge
that is expected to be recorded in periods subsequent to 2004, pension
settlement charges are estimated to be $60 million and plant shutdown charges
are estimated to be $45 million. The termination of the 717 line will result in
$385 million of cash expenditures that are expected to occur during 2005 through
2007. This charge is determined based on current facts and information and we
will revise our estimates accordingly as new facts and information become
available.
737 Next-Generation and 777 Program The accounting quantity for the 737
Next-Generation and 777 programs were increased during 2004 as a result of the
programs' normal progression of obtaining additional orders and delivering
aircraft.
747 Program The 747 program accounting quantity was increased during 2004 as a
result of additional orders received since 2003. We are continuing to monitor
the commercial market for the 747 and potential new derivatives. The future of
the program largely depends on market acceptance of new derivatives. Due to the
uncertainty of the market acceptance, completion of production is reasonably
possible. A forward loss is not expected as a result of a decision to complete
production but program margins would be modestly impacted. Additionally,
completion of production may create excess spares inventory, resulting in a
charge that is not expected to be material. A decision to proceed with a new
derivative or complete production is likely to be made mid-year 2005.
757 Program Due to lack of demand for the 757 program, a decision was made in
the third quarter of 2003 to end production of the program. Production of the
757 program ended in October 2004. There are two remaining aircraft that will be
delivered in the first half of 2005.
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In 2003, the 757 program charge of $184 million included $15 million of spares
inventory writedown and $169 million forward loss. The forward loss was
comprised of $111 million in vendor termination charges and $58 million due to
the requirement to allocate incurred inventory costs over a reduced quantity of
757 airplane deliveries. Other than an estimated $17 million of tooling
disposition and plant clean-up costs, which will be expensed as incurred, no
future charges related to the 757 airplane program are expected. However, we
will continue to monitor the total estimated cost of sales and total estimated
revenues for the remaining program, and will revise our estimates accordingly as
new facts and information become available.
767 Program Based on the regular quarter and year-end reviews, our updated
assessment of securing the specific USAF 767 Tanker contract resulted in the
decision that the pre-contract costs should no longer be deferred, given the
continued delay and now likely recompetition of the contract. Commercial
Airplanes' portion of the charge was $195 million consisting of $125 million of
incurred development and tooling costs, $54 million of spending, net of scrap
value, for production of a partially complete USAF Tanker, and $16 million of
supplier termination liability.
The decrease in the 767 program accounting quantity during 2004 was due to the
removal of anticipated future 767 Tanker deliveries to the USAF. The long term
viability of the 767 program is dependent on receiving a timely USAF Tanker
contract. We will be closely monitoring the future market for the 767. Due to
the uncertainty, production completion is reasonably possible. A forward loss is
not expected as a result of this decision but program margins would be
significantly impacted. Additionally, completion of production may create excess
spares inventory, resulting in a charge that is not expected to be material. A
decision to complete production is likely to be made mid-year 2005. We continue
to actively market the 767 program to commercial customers and position the
program to support a USAF 767 Tanker contract and other military applications.
(See IDS 767 Tanker Program on page 38 for further discussion.)
The accounting quantity for each program may include units that have been
delivered, undelivered units under contract, and units anticipated to be under
contract in the future (anticipated orders). In developing total program
estimates all of these items within the accounting quantity must be addressed.
The percentage of anticipated orders included in the program accounting
estimates as compared to the number of cumulative firm orders* as of December 31
were as follows:
737 Next-
717 Generation 747 757 767 777
2004
Cumulative firm orders (CFO) 155 2,393 1,380 1,049 950 666
Anticipated orders N/A 5 19 N/A 6 34
Anticipated orders as a % of CFO N/A 0 % 1 % N/A 1 % 5 %
2003
Cumulative firm orders 147 2,220 1,370 1,049 941 622
Anticipated orders N/A N/A 17 N/A 32 28
Anticipated orders as a % of CFO N/A N/A 1 % N/A 3 % 5 %
2002
Cumulative firm orders 139 2,012 1,371 1,050 931 597
Anticipated orders 0 N/A 29 49 67 3
Anticipated orders as a % of CFO 0 % N/A 2 % 5 % 7 % 1 %
* Cumulative firm orders represent the cumulative number of commercial jet
aircraft deliveries (see table in Commercial Airplanes Revenues discussion)
plus undelivered units under firm order (see table in Commercial Airplanes
Revenues discussion). Cumulative firm orders include orders that fall within
the current accounting quantities as well as orders that extend beyond the
current accounting quantities. Cumulative firm orders exclude program test
aircraft that will not be refurbished for sale.
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Deferred production costs Commercial aircraft inventory production costs
incurred on in-process and delivered units in excess of the estimated average
cost of such units, determined as described in Note 1 represent deferred
production costs. As of December 31, 2004 and 2003, there were no significant
excess deferred production costs or unamortized tooling costs not recoverable
from existing firm orders for the 777 program.
The deferred production costs and unamortized tooling included in the 777
program's inventory at December 31 are summarized in the following table:
(Dollars in millions) 2004 2003
Deferred production costs $ 703 $ 794
Unamortized tooling 485 582
As of December 31, 2004 and 2003, the balance of deferred production costs and
unamortized tooling related to all other commercial aircraft programs was
insignificant relative to the programs' balance-to-go cost estimates.
Fleet support We provide the operators of all our commercial airplane models
assistance and services to facilitate efficient and safe aircraft operation.
Collectively known as fleet support services, these activities and services
include flight and maintenance training, field service support costs,
engineering services and technical data and documents. Fleet support activity
begins prior to aircraft delivery as the customer receives training, manuals and
technical consulting support, and continues throughout the operational life of
the aircraft. Services provided after delivery include field service support,
consulting on maintenance, repair, and operational issues brought forth by the
customer or regulators, updating manuals and engineering data, and the issuance
of service bulletins that impact the entire model's fleet. Field service support
involves our personnel located at customer facilities providing and coordinating
fleet support activities and requests. The costs for fleet support are expensed
as incurred and have been historically less than 1.5% of total consolidated
costs of products and services. This level of expenditures is anticipated to
continue in the upcoming years. These costs do not vary significantly with
current production rates.
Research and development We continually evaluate opportunities to improve
current aircraft models, and assess the marketplace to ensure that our family of
commercial jet aircraft is well positioned to meet future requirements of the
airline industry. The fundamental strategy is to maintain a broad product line
that is responsive to changing market conditions by maximizing commonality among
our family of commercial aircraft. Additionally, we are determined to continue
to lead the industry in customer satisfaction by offering products with the
highest standards of quality, safety, technical excellence, economic performance
and in-service support.
The increase in 2004 research and development compared to 2003 was primarily due
to increased spending on the 787. The decrease in 2003 research and development
compared to 2002 was primarily due to reduced spending on the development of the
747-400ER. The initial delivery of the 747-400ER and the rollout of the first
777-300ER occurred in the fourth quarter of 2002. The initial delivery of the
777-300ER occurred during the first half of 2004.
We are currently focusing our new airplane product development efforts on the
787 program, which with the three planned versions will seat 223 to 296
passengers in multiple class configurations. In early 2004, we received the
initial launch order for the 787 and Board of Directors (BoD) approval to
proceed with full development and production. Entry into service is targeted for
2008. We project a continued increase in our research and development spending
in 2005, primarily driven by spending on the 787 while we also continue to
develop derivatives and features for our other programs primarily the
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737, 747-400 Special Freighter modification and 777 programs. Commercial
Airplanes' development work to support the MMA contract with the U.S. Navy is
being deferred as part of the contract costs and is not reflected as research
and development.
During 2004, we established cost sharing arrangements with some suppliers for
the 787 that will enhance our internal development capabilities and offset a
substantial portion of the financial risk of developing the 787 product. Amounts
received from these suppliers will reduce our research and development expense
related to the 787, since we will have no obligation to refund any amounts
earned per the arrangements regardless of the outcome of the development
efforts. Our cost sharing arrangements explicitly state that the supplier
contributions are for reimbursements of costs we incur for experimentation,
basic design and testing activities during the development of the 787. In each
arrangement, we will retain the same rights that have been available under
traditional supplier arrangements on past airplane programs. For 2004, 787
supplier development cost sharing payments earned were $205 million.
The following chart summarizes the time horizon between go-ahead and
certification/initial delivery for major Commercial Airplanes derivatives and
programs.
[[Image Removed: LOGO]]
Integrated Defense Systems
Business Environment and Trends
IDS is comprised of four reportable segments, which include A&WS, Network
Systems, Support Systems and L&OS. The IDS business environment extends over
multiple markets, including defense (A&WS, Network Systems and Support Systems
segments), homeland security (Network Systems), civil space transportation and
exploration (L&OS), and launch and satellites (L&OS). IDS derives over 85% of
its revenue from sales to the U.S. Government and we are forecasting this
business mix will remain at this level into the foreseeable future.
Specifically, the primary customers of IDS are the DoD for our products in the
defense market, the U.S. Department of Homeland Security for the homeland
security market, NASA for the civil space transportation and exploration market,
and the U.S. Government and commercial satellite service providers for the
launch and satellite market. Since the trends associated with these markets
impact IDS opportunities and risks in unique ways, the various environmental
factors for each are discussed individually below.
Defense environment overview The U.S. DoD represents nearly 50% of the world's
defense budget. The current defense environment is characterized by
transformation and change in the face of shrinking force structure, aging
platforms, and levels of operations and engagements worldwide that are expected
to remain high for the foreseeable future. The current environment is also
heavily influenced by the continuing war on terrorism and the need to bring new
technologies to assist the war fighter. The United States' leadership in the
global war on terrorism demonstrates the value of
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networked intelligence, surveillance and communications, interoperability across
platforms, services and forces, and the leveraging effects of precise,
persistent, and selective engagement. The significance and advantage of unmanned
systems to perform many of these tasks is growing. These experiences are driving
the DoD, along with militaries worldwide, to transform their forces and the way
they operate. Network-centric operations are at the heart of this
transformation. There will continue to be pressure between this transformation
goal and the support required for the existing forces.
The 2005 DoD authorization was approved in the fourth quarter of 2004 at a total
level of $402 billion, including supplementals. Supplementals are the additional
funds that are requested by the DoD to cover extraordinary events that were not
planned for in the usual budget cycle. Although under pressure, the DoD budget
remains strong and focused on transformation. This will provide opportunities
for IDS products in the future. However, with a struggling global economy and
anticipated federal budget deficits, allocations to DoD procurement decreased
between fiscal year 2004 and 2005, and will remain under pressure in the near
future. This suggests that the DoD will continue to focus on affordability
strategies emphasizing network-centric operations, joint interoperability,
long-range strike, unmanned air combat and reconnaissance vehicles, precision
guided weapons and continued privatization of logistics and support activities
as a means to improve overall effectiveness while maintaining control over
costs. Along with this, we are already seeing the need for the military to make
difficult choices between programs in an effort to support their highest
priority. Programs will be continually evaluated with program performance and
relevancy to the overall DoD vision as the measures for continuation or
cancellation.
Military transformation The defense transformation is evidenced by a trend
toward smaller, more capable, interoperable, and technologically advanced
forces. To achieve these capabilities, a transformation in acquisition is
underway with an increasing trend toward early deployment of initial program
capabilities followed by subsequent incremental improvements (referred to as
spiral development), cooperative international development programs and a
demonstrated willingness to explore new forms of development, acquisition and
support. Along with these trends, new system procurements are being evaluated
for the degree to which they support the concept of jointness and
interoper-ability among the services.
Institutions and events continue to shape the defense industrial environment.
The DoD's implementation of a new Joint Capabilities Integration and Development
Systems organization and process, along with revisions to the Defense
Acquisition System, Program Planning Budgeting and Execution processes and the
establishment of the Office of Force Transformation, has created a durable
institutional foundation for continued transformation. Operations in the
continuing global war on terrorism reaffirm the need for the rapid projection of
decisive combat power around the world and emphasize the need for new
capabilities and solutions for the war fighter. They also highlight the need for
improved logistics and stability operation capabilities at completion of
hostilities. Toward that end, the DoD is fully committed to a transformation
that will achieve and maintain advantages through changes in operational
concepts, organizational structure and technologies that significantly improve
war fighting capabilities.
Missile Defense Funding for the missile defense market is primarily driven by
the U.S. Government Missile Defense Agency (MDA) budget. The primary thrusts in
this market are the continued development and deployment of theater missile
defense systems and the Ground-based Midcourse Defense (GMD) program. The
overall MDA missile defense budget for 2004 was approximately $9 billion and
appropriations for 2005 are about $10 billion. With the Administration trying to
curb the rise in defense spending it appears the MDA's budget will begin to come
under pressure. That said we feel the GMD program has continued to make great
progress over the past year in meeting President Bush's call to deploy a
capability by the end of 2004. We believe this program, which is the cornerstone
of our Missile Defense business, will be supported. Through our leadership
position on the
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Missile Defense National Team and our prime contractor role on the GMD segment
program and on the Airborne Laser program, IDS is positioned to maintain its
role as the MDA's number one contractor.
Defense Competitive Environment The global competitive environment continues to
intensify, with increased focus on the U.S. defense market, the world's largest
and most attractive. IDS faces strong competition in all market segments,
primarily from Lockheed Martin, Northrop Grumman, and Raytheon. Foreign
companies such as BAE Systems and EADS continue to build a strategic presence in
the U.S. market by strengthening their North American operations and partnering
with U.S. defense companies.
We expect industry consolidation, partnering, and market concentration to
continue. Prime contractors will continue to partner or serve as major suppliers
to each other on various programs and will perform targeted acquisitions to fill
technology or customer gaps. At the lower tiers, consolidation persists and
select companies have been positioning for larger roles, especially in the
aerospace support market.
Homeland Security Environment The Department of Homeland Security became
official in 2003, a year characterized by significant U.S. Government
transformational and organizational challenges. Organizational alignment is
ongoing and procurement practices are evolving. It is important to realize that
this department has been formed from existing agencies and their budgets, and
therefore a large portion of the near-term budget is committed to heritage
programs and staffing. Until some of these existing commitments are complete,
funding for new opportunities will represent a small share of the overall
Department of Homeland Security budget. We expect Homeland Security to be a
stable market with minimal growth and emphasis being placed on Information
Analysis and Infrastructure Protection.
Congress and the Administration appropriated $33 billion to The Department of
Homeland Security in fiscal year 2005. This amount is a slight decrease compared
to the fiscal year 2004 appropriations of $29 billion, but still exhibits a
continued commitment to homeland security. Only 50% of the federal spending on
homeland security is within the newly formed Department of Homeland Security.
Other federal agencies such as the DoD still have homeland security and homeland
defense funding under their direction. We will continue to leverage our
experience as the systems integrator on the Explosive Detection Systems program,
our aviation heritage and our Integrated Battlespace and network-centric
operations expertise and capabilities into the homeland security marketplace.
Civil Space Transportation and Exploration Environment Congress approved very
close to full funding of NASA's fiscal year 2005 budget request, including
needed funds for Space Shuttle Return to Flight, International Space Station,
and new initiatives associated with the Vision for Space Exploration. NASA
fiscal year 2005 appropriations of approximately $16 billion is a slight
increase over the fiscal year 2004 funding level.
The Administration recently released a new Space Transportation Policy. This
document recognizes the critical need for Space Shuttle Return to Flight,
reinforces the nation's commitment to the Vision for Space Exploration -
including the development of a Crew Exploration Vehicle (CEV) - provides for the
evaluation of Shuttle-derived systems, and supports a viable space
transportation industrial and technology base. We believe NASA will remain
focused on supporting this new policy even as they transition to a new
Administrator, who has yet to be named. The New Vision for Space Exploration and
the priorities laid out in the new Space Transportation Policy will provide
great opportunities for industry to develop new technologies and operational
concepts to take human beings beyond low earth orbit. IDS, with our strong
heritage in the development of space systems and our expertise in the area of
human space flight, including the Space Shuttle and the International Space
Station, is well positioned to work with and support our customer in
accomplishing their goals. IDS will continue its work on the Space Shuttle and
International Space Station programs along with development of critical
technologies such as rocket propulsion and life support systems to prepare to
meet the challenge of returning to the Moon and exploring the Solar System.
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Launch and Satellite Environment The commercial space market has softened
significantly since the late 1990s in conjunction with the downturn in the
telecommunications industry. This market is now characterized by overcapacity,
aggressive pricing and limited near-term opportunities. Recent projections
indicate these market conditions will persist until the end of this decade. We
believe there will be lower commercial satellite orders through this decade,
along with lower demand for commercial launch services as compared to the high
points of the early to mid-1990s. However, the replacement market for satellites
will drive some recovery in the second half of this decade. In this extremely
limited market, we see a growing amount of overcapacity, which in turn is
driving the continued deterioration of pricing conditions. We will continue to
pursue profitable commercial satellite opportunities, where the customer values
our technical expertise and unique solutions, like the recently awarded order by
DIRECTV. However, we will not pursue commercial satellite orders or launch
contracts at a loss, and given the current pricing environment, we have decided,
for the near-term, to focus on our Delta IV program on the government launch
market, which we believe is a more stable market.
Inherent business risks Our businesses are heavily regulated in most of our
markets. We deal with numerous U.S. Government agencies and entities, including
all of the branches of the U.S. military, NASA, and the Department of Homeland
Security. Similar government authorities exist in our international markets.
The U.S. Government, and other governments, may terminate any of our government
contracts at their convenience as well as for default based on our failure to
meet specified performance measurements. If any of our government contracts were
to be terminated for convenience (TFC), we generally would be entitled to
receive payment for work completed and allowable termination or cancellation
costs. If any of our government contracts were to be terminated for default
(TFD), generally the U.S. Government would pay only for the work that has been
accepted and can require us to pay the difference between the original contract
price and the cost to re-procure the contract items, net of the work accepted
from the original contract. The U.S. Government can also hold us liable for
damages resulting from the default.
On February 23, 2004, the U.S. Government announced plans to terminate for
convenience, the RAH-66 Comanche EMD contract. The joint venture of Boeing and
Sikorsky Aircraft (a division of United Technologies Corporation) had a 50/50
share in program work share and earnings. On March 19, 2004, the U.S. Government
issued a partial TFC notification. By March 19, 2005, a termination proposal
will be submitted and negotiations will commence with the U.S. Government
shortly thereafter. The program represents less than 1% of our projected
revenues for 2005 and less than 1% of our revenues for 2004.
U.S. Government contracts also are conditioned upon the continuing availability
of Congressional appropriations. Long-term government contracts and related
orders are subject to cancellation if appropriations for subsequent performance
periods become unavailable. On research and development contracts, Congress
usually appropriates funds on a government fiscal year basis (September 30
year-end), even though contract performance may extend over several years.
Many of our contracts are fixed-price contracts (just over 50% of IDS revenues
are generated from fixed-price type contracts). Of the fixed-price contracts,
40% are fixed-price delivery contracts and 10% are fixed-price milestone. While
firm, fixed-price contracts allow us to benefit from cost savings, they also
expose us to the risk of cost overruns. If the initial estimates we use to
calculate the contract price prove to be incorrect, we can incur losses on those
contracts. In addition, some of our contracts have specific provisions relating
to cost controls, schedule, and product performance. If we fail to meet the
terms specified in those contracts, then we may not realize their full benefits.
Our ability to manage costs on these contracts may affect our financial
condition. Cost overruns may result in lower earnings, which would have an
adverse effect on our financial results.
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Just under 50% of IDS revenues are generated from cost type contracts. Revenues
related to cost type contracts are recorded as costs are incurred plus an agreed
upon profit in relation to the costs incurred. Cost type contracts are normally
used for development and study type programs. Cost overruns on these contracts
usually result in a lower profit to cost ratio. Sufficient notification must be
given to the customer for any anticipated cost growth and customer authorization
received to proceed in order to be reimbursed for said costs.
Sales of our products and services internationally are subject not only to local
government regulations and procurement policies and practices but also to the
policies and approval of the U.S. Department of State and DoD. The policies of
some international customers require "industrial participation" agreements,
which are discussed more fully in the "Disclosures about contractual obligations
and commitments" section on page 22.
We are subject to business and cost classification regulations associated with
our U.S. Government defense and space contracts. Violations can result in civil,
criminal or administrative proceedings involving fines, compensatory and treble
damages, restitution, forfeitures, and suspension or debarment from U.S.
Government contracts. We are continuing discussions towards resolution with the
U.S. Government regarding the allocation methodology of pension costs and have
assessed the impact of potential outcomes. Based on our assessment, the most
probable outcome of this matter is expected to be immaterial to our business,
financial condition, results of operations, and liquidity. However, it is not
possible at this time to predict when resolution will be reached nor the final
outcome.
767 Tanker Program Prior to the fourth quarter of 2004 we incurred pre-contract
costs related to development costs and one in-production aircraft. These costs
were being deferred based on our assessment that it was probable that we would
recover these costs from the USAF 767 Tanker contract. The pre-contract costs
were being deferred and recorded in inventory based on AICPA Statement of
Position 81-1, Accounting for Performance of Construction-Type and Certain
Production-Type Contracts, which states that costs may be deferred if the costs
can be associated with a specific anticipated contract and if their
recoverability from that contract is probable. Our assessment of probability was
based on the following:
The Department of Defense Appropriations Act for fiscal year 2005 provides $100
million funding for tanker replacement. The National Defense Authorization Act
for fiscal year 2005 provides authorization for the procurement of 100 tanker
aircraft and associated support contracts. We believed, based on our
understanding of the requirements, that our 767 aircraft was the most cost
effective solution that meets those requirements and it is therefore probable we
would be awarded the USAF 767 Tanker contract. Based on prior DoD contracting
practices we believed it was probable that we would also be awarded the initial
support contracts.
On January 14, 2005 we announced our plan to recognize pre-tax charges totaling
$275 million related to the USAF 767 Tanker program. The charge is related to
the initial production of the aerial refueling tankers for the USAF and includes
expected supplier obligations. The Commercial Airplanes segment share of the
charge is $195 million and the IDS segment share is $80 million. Within IDS, the
A&WS and Support Systems segments were impacted by the charge. We used our own
money and received no government funding in development of the USAF 767 Tanker.
The charge, which is a result of our regular quarter and year-end reviews,
reflects our updated assessment of securing the specific USAF 767 Tanker
contract that was being negotiated, given the continued delay and now likely
recompetition of the contract. This charge covers both incurred cost and
anticipated liabilities associated with the USAF 767 Tanker program.
We remain firmly committed to the USAF 767 Tanker program and are ready to
support our customer in whatever decision is made regarding the recapitalization
of the nation's current aerial refueling fleet.
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Sea Launch The Sea Launch venture, in which we are a 40% partner, provides
ocean-based launch services to commercial satellite customers and is reported in
the L&OS segment. For the year ended December 31, 2004, the venture conducted
two successful launches and a third launch where the satellite reached an orbit
that will meet or exceed its expected life with the aid of its propulsion
system.
We have issued credit guarantees to creditors of the Sea Launch venture to
assist the venture in obtaining financing. In the event we are required to
perform on these guarantees, we have the right to recover a portion of the loss
from other venture partners. We believe our total net maximum exposure to loss
from Sea Launch at December 31, 2004 totals $212 million. The components of this
exposure are as follows:
Established
from
Maximum Estimated Proceeds Net
Exposure Reserves Recourse Exposure
Credit Guarantees $ 510 $ 204 $ 306
Partner Loans (Principal and Interest) 401 241 160
Advances to Provide for Future Launches 209 35 $ 174
Trade Receivable from Sea Launch 202 202
Performance Guarantees 35 1 21 13
Subcontract Termination 25 25
Other Receivables from Sea Launch 35 35
$ 1,417 $ 683 $ 522 $ 212
We made no additional capital contributions to the Sea Launch venture during the
year ended December 31, 2004. (See Notes 12 and 20.)
Delta IV In 1999, two employees were found to have in their possession certain
information pertaining to a competitor, Lockheed Martin Corporation, under the
Evolved Expendable Launch Vehicle (EELV) Program. The employees, one of whom was
a former employee of Lockheed Martin, were terminated and a third employee was
disciplined and resigned. In March 2003, the USAF notified us that it was
reviewing our present responsibility as a government contractor in connection
with the incident. In June 2003, Lockheed Martin filed a lawsuit against us and
the three individual former employees arising from the same facts. It is not
possible at this time to predict the outcome of these matters or whether an
adverse outcome would or could have a material adverse effect on our financial
position. In addition, on July 24, 2003, the USAF suspended certain
organizations in our space launch services business and the three former
employees from receiving government contracts for an indefinite period as a
direct result of alleged wrongdoing relating to possession of the Lockheed
Martin information during the EELV source selection in 1998. The USAF also
terminated 7 out of 21 of our EELV launches previously awarded through a mutual
contract modification and disqualified the launch services business from
competing for three additional launches under a follow-on procurement. The same
incident is under investigation by the U.S. Attorney General in Los Angeles, who
indicted two of the former employees in July 2003.
The cost estimates for the Delta II and Delta IV programs are based, in part,
upon estimated quantities and timing of launch missions for existi