10-K 1 d10k.htm FORM 10-K Form 10-K
Table of Contents

LOGO

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

 

x   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2006

 

OR

 

¨   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                      to                     

 

Commission file number 1-442

 

THE BOEING COMPANY


(Exact name of registrant as specified in its charter)

 

Delaware

 

    

91-0425694

 

(State or other jurisdiction of

incorporation or organization)

     (I.R.S. Employer Identification No.)

100 N. Riverside, Chicago, IL

 

    

60606-1596

 

(Address of principal executive offices)      (Zip Code)

 

(312) 544-2000


(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

                Title of each class                

      

Name of each exchange on which registered

Common Stock, $5 par value      New York Stock Exchange

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes      X        No            

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes      No      X        

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      X        No            

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.            

 

Indicate by check mark whether the registrant is a large accelerated filer, accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer    x    Accelerated Filer    ¨    Non-Accelerated Filer    ¨    

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

 

As of June 30, 2006, there were 758,911,265 common shares outstanding held by nonaffiliates of the registrant, and the aggregate market value of the common shares (based upon the closing price of these shares on the New York Stock Exchange) was approximately $62.2 billion.

 

The number of shares of the registrant’s common stock outstanding as of January 31, 2007 was 789,265,357.

 

(This number includes 31 million outstanding shares held by the ShareValue Trust which are not eligible to vote.)

 

Part I and Part II incorporate information by reference to certain portions of the Company’s 2006 Annual Report to Shareholders. Part III incorporates information by reference to the registrant’s definitive proxy statement, to be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year.


Table of Contents

THE BOEING COMPANY

 

FORM 10-K

 

For the Fiscal Year Ended December 31, 2006

 

INDEX

 

             Page

Part I

  
  Item 1.  

Business

   1
  Item 1A.  

Risk Factors

   5
  Item 1B.  

Unresolved Staff Comments

   11
  Item 2.  

Properties

   11
  Item 3.  

Legal Proceedings

   12
  Item 4.  

Submission of Matters to a Vote of Security Holders

  
   

and Executive Officers of the Registrant

   13

Part II

  
  Item 5.  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   16
  Item 6.  

Selected Financial Data

   17
  Item 7.  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   18
  Item 7A.  

Quantitative and Qualitative Disclosures About Market Risk

   44
  Item 8.  

Financial Statements and Supplementary Data

   46
  Item 9.  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   109
  Item 9A.  

Controls and Procedures

   109
  Item 9B.  

Other Information

   109

Part III

  
  Item 10.  

Directors, Executive Officers and Corporate Governance

   111
  Item 11.  

Executive Compensation

   111
  Item 12.  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   111
  Item 13.  

Certain Relationships and Related Transactions, and Director Independence

   112
  Item 14.  

Principal Accounting Fees and Services

   112

Part IV

  
  Item 15.  

Exhibits and Financial Statement Schedules

   113
  Signatures    117
  Schedule II – Valuation and Qualifying Accounts    118
  Exhibit (12) – Computation of Ratio of Earnings to Fixed Charges    119
  Exhibit (21) – List of Company Subsidiaries    120
  Exhibit (23) – Consent of Independent Registered Public Accounting Firm    127
  Exhibit (31)(i) – CEO Section 302 Certification    128
  Exhibit (31)(ii) – CFO Section 302 Certification    129
  Exhibit (32)(i) – CEO Section 906 Certification    130
  Exhibit (32)(ii) – CFO Section 906 Certification    131

 

i


Table of Contents

Forward-Looking Information is Subject to Risk and Uncertainty

 

Certain statements in this report may constitute “forward-looking” statements within the meaning of the Private Litigation Reform Act of 1995. Forward-looking statements are based upon assumptions as to future events that may not prove to be accurate. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Actual outcomes and results may differ materially from what is expressed or forecasted in these forward-looking statements. As a result, these statements speak only as of the date they were made and we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Words such as “expects,” “intends,” “plans,” “projects,” “believes,” “estimates,” and similar expressions are used to identify these forward-looking statements. These include, among others, statements relating to:

 

  ·  

the effect of economic downturns or growth in particular regions;

 

 

  ·  

the adequacy of coverage, by allowance for losses, of risks related to our non-U.S. accounts receivable being payable in U.S. dollars;

 

 

  ·  

the continued operation, viability and growth of Commercial Airplane revenues and successful execution of our backlog in this segment;

 

 

  ·  

the timing and effects of decisions to complete or launch a Commercial Airplane program;

 

 

  ·  

the ability to successfully develop and timely produce the 787 aircraft;

 

 

  ·  

the effect of political and legal processes, changing priorities or reductions in the U.S. Government or international government defense and space budgets on our revenues from our Integrated Defense System business segments;

 

 

  ·  

the effective negotiation of collective bargaining agreements;

 

 

  ·  

the continuation of long-term trends in passenger revenue yields in the airline industry;

 

 

  ·  

the effect of valuation decline of our aircraft;

 

 

  ·  

the impact of airline bankruptcies on our revenues or operating results;

 

 

  ·  

the continuation of historical costs for fleet support services;

 

 

  ·  

the receipt of cost sharing payments for research and development;

 

 

  ·  

the receipt of estimated award and incentive fees on U.S. Government contracts;

 

 

  ·  

the future demand for commercial satellites and projections of future order flow;

 

 

  ·  

the potential for technical or quality issues on development programs, including the Airborne Early Warning & Control program and other fixed price development programs, or in the commercial satellite industry to affect schedule and cost estimates or cause us to incur a material charge or experience a termination for default;

 

 

  ·  

the outcome of any litigation and/or government investigation in which we are a party and other contingencies;

 

 

  ·  

returns on pension fund assets, impacts of future interest rate changes on pension obligations and healthcare cost inflation trends;

 

 

  ·  

the amounts and effects of underinsured operations including satellite launches;

 

 

 

ii


Table of Contents
  ·  

the scope, nature or impact of acquisition or disposition activity, such as Aviall, and investment in any joint ventures including Sea Launch and United Launch Alliance, and indemnifications related thereto; and

 

 

  ·  

the expected cash expenditures and charges associated with the exit of the Connexion by Boeing business.

 

 

This report includes important information as to these factors in the “Business” section under the heading “Other Business Information” and in the “Risk Factors” and “Legal Proceedings” sections and in the Notes to our consolidated financial statements included herein. Additional important information as to these factors is included in this report in the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

 

 

iii


Table of Contents

Item 1. Business

 

The Boeing Company, together with its subsidiaries (herein referred to as “we”, “us”, “our”), is one of the world’s major aerospace firms.

 

We are organized based on the products and services we offer. We operate in five principal segments:

 

·  

Commercial Airplanes;

 

·  

The three segments that comprise our Integrated Defense Systems (IDS) business:

 

  ·  

Precision Engagement and Mobility Systems (PE&MS),

 

  ·  

Network and Space Systems (N&SS) and

 

  ·  

Support Systems

 

·  

Boeing Capital Corporation (BCC).

 

Our Other segment classification principally includes the activities of Connexion by BoeingSM, a high speed broadband communications business; and Engineering, Operations and Technology (formerly, Boeing Technology), an advanced research and development organization focused on innovative technologies, improved processes and the creation of new products. We exited the Connexion by BoeingSM business in 2006.

 

Commercial Airplanes Segment

 

The Commercial Airplanes segment is involved in developing, producing and marketing commercial jet aircraft and providing related support services, principally to the commercial airline industry worldwide. We are a leading producer of commercial aircraft and offer a family of commercial jetliners designed to meet a broad spectrum of passenger and cargo requirements of domestic and non-U.S. airlines. This family of commercial jet aircraft currently includes the 737 Next-Generation narrow-body model and the 747, 767, 777 and 787 wide-body models. Final delivery of the 717 aircraft occurred in the second quarter of 2006. The Commercial Airplanes segment also offers aviation support, aircraft modifications, spares, training, maintenance documents and technical advice to commercial customers worldwide. On September 20, 2006, we acquired Aviall, Inc. (Aviall), an independent provider of new aviation parts and services.

 

Integrated Defense Systems

 

IDS is principally involved in the research, development, production, modification and support of the following products and related systems and services: military aircraft, including fighters, transports, tankers, and helicopters; missiles; space systems; missile defense systems; satellites and satellite launch vehicles; and communications, information and battle management systems. IDS is focused on bringing value to customers through expertise in large-scale systems integration, knowledge of legacy platforms, initiatives to define and utilize common network-centric architectures across the organization, and commitment to providing best-of-industry solutions. IDS’s primary customer is the United States Department of Defense (US DoD) with additional revenues being derived from the National Aeronautics and Space Administration (NASA) and international defense, civil markets, and commercial satellite markets. Approximately 84% of IDS 2006 revenues were from our US DoD customer.

 

PE&MS Segment:

 

This segment is engaged in the research, development, production, and modification of precision engagement and mobility products and services. Included in this segment are programs such as AH-64

 

1


Table of Contents

Apache, 737 Airborne Early Warning & Control (AEW&C), C-17 Globemaster, C-40 Clipper, CH-47 Chinook, E-10A Multi-sensor Command and Control Aircraft (MC2A), EA-18G Growler, F/A-18E/F Super Hornet, F-15 Strike Eagle, F-22A Raptor, Harpoon, Joint Direct Attack Munition, KC-767 Advanced Tanker Transport, P-8A Poseidon, Stand-off Land Attack Missile–Expanded Response (SLAM-ER), Small Diameter Bomb, T-45 Training System, and V-22 Osprey.

 

N&SS Segment:

 

This segment is engaged in the research, development, production, and modification of products and services to assist our customers in transforming their operations through network integration, intelligence and surveillance systems, communications, architectures, and space exploration. Included in this segment are programs such as Airborne Laser, Delta Launch Vehicles, Family of Beyond line-of-sight Terminals, Future Combat Systems (FCS), Global Positioning System, Ground-based Midcourse Defense (GMD), International Space Station, Joint Tactical Radio System Cluster 1 and Airborne, Maritime/Fixed station, Satellite Systems, Space Payloads, and Space Shuttle. On December 1, 2006, we completed the transaction with Lockheed Martin Corporation (Lockheed) to create a 50/50 joint venture named United Launch Alliance L.L.C. (ULA) that combines the production, engineering, test and launch operations associated with U.S. Government launches of Boeing Delta and Lockheed Atlas rockets.

 

Support Systems Segment:

 

This segment is engaged in the operations, maintenance, training, upgrades, and logistics support functions for military platforms and operations. Included in this segment are program areas such as Integrated Logistics on platforms including C-17, F/A-18, AH-64; Maintenance, Modifications and Upgrades on platforms including AC-130, KC-135, and KC-10; Training Systems and Services on platforms including C-17, AH-64, and F-15; and International Support through involvement in Boeing Australia Limited and Alsalam Aircraft Co. (Alsalam).

 

Boeing Capital Corporation Segment

 

In the commercial aircraft market, BCC facilitates, arranges, structures and provides selective financing solutions to our Commercial Airplanes segment customers. In the space and defense markets, BCC arranges and structures financing solutions for our IDS segment government customers. BCC’s portfolio consists of finance leases, notes and other receivables, equipment under operating leases, investments and assets held for sale or re-lease.

 

Financial and Other Business Information

 

See the Summary of Business Segment Data and Note 24 for financial information, including revenues, net earnings and our backlog of firm contractual orders, for each of the major business segments.

 

Intellectual Property

 

While we own numerous patents and have licenses under patents owned by others relating to our products and their manufacture, we do not believe that our business would be materially affected by the expiration of any patents or termination of any patent license agreements. We have no trademarks, franchises or concessions that are considered to be of material importance to the conduct of our business.

 

Non-U.S. Sales

 

See Note 24 for information regarding non-U.S. sales.

 

2


Table of Contents

Research and Development

 

Research and development expenditures involve experimentation, design, development and related test activities for defense systems, new and derivative jet aircraft including both commercial and military, advance space and other company-sponsored product development. These expenditures are expensed as incurred including amounts allocable as reimbursable overhead costs on U.S. Government contracts.

 

Our total research and development expense amounted to $3.3 billion, $2.2 billion, and $1.9 billion in 2006, 2005, and 2004, respectively. This is net of research and development cost sharing payments from suppliers of $160 million in 2006, $611 million in 2005 and $205 million in 2004. These cost sharing payments are related to our 787 program.

 

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 21 - 34.

 

Employees

 

Our workforce level at December 31, 2006 was approximately 154,000, including approximately 1,300 in Canada and 3,700 in Australia.

 

As of December 31, 2006, our principal collective bargaining agreements were with the following unions:

 

Union    Percent of our
Employees
Represented
   Status of the Agreements with the Union
The International Association of Machinists and Aerospace Workers (IAM)    17%    We have one major agreement expiring in May 2007, primarily affecting IDS, and two major agreements expiring in September and October of 2008.
The Society of Professional Engineering Employees in Aerospace (SPEEA)    15%    We have four major agreements expiring in February and December of 2008.
The United Automobile, Aerospace and Agricultural Implement Workers of America (UAW)    3%    There are major agreements expiring in May and October of 2007, primarily affecting IDS, and October of 2009.

 

Competition

 

The commercial jet aircraft market and the airline industry remain extremely competitive. We face aggressive international competitors, including Airbus, that are intent on increasing their market share. To effectively and profitably compete, we focus on new product technology, 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.

 

IDS faces strong competition in all market segments, primarily from Lockheed Martin, Northrop Grumman, Raytheon and General Dynamics. Non-U.S. companies such as BAE Systems and European Aeronautic Defence and Space Company continue to build a strategic presence in the U.S. market by strengthening their North American operations and partnering with U.S. defense companies.

 

3


Table of Contents

Regulatory Matters

 

U.S. Government Contracts. 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 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, 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, 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.

 

Commercial Aircraft. In the United States, our commercial aircraft products are required to comply with Federal Aviation Administration regulations governing production and quality systems, airworthiness, and installation approvals, repair procedures and continuing operational safety. Internationally, similar requirements exist for airworthiness, installation and operational approvals. These requirements are generally administered by the national aviation authorities of each country and, in the case of Europe, coordinated by the European Joint Aviation Authorities.

 

Environmental. Our operations are subject to and affected by a variety of federal, state, local and non-U.S. environmental laws and regulations relating to the discharge, treatment, storage, disposal, investigation and remediation of certain materials, substances and wastes. We continually assess our compliance status and management of environmental matters and believe that our operations are in substantial compliance with all applicable environmental laws and regulations.

 

Operating and maintenance costs associated with environmental compliance and management of contaminated sites are a normal, recurring part of our operations. These costs are not significant relative to total operating costs or cash flows, and often are allowable costs under our contracts with the U.S. government. These costs have not been material in the past. Based on information currently available to us and current U.S. Government policies relating to allowable costs, we do not expect continued compliance to have a material impact on our results of operations, financial condition or cash flows.

 

A Potentially Responsible Party (PRP) has joint and several liability under existing U.S. environmental laws. Where we have been designated a PRP by the Environmental Protection Agency or a state environmental agency, we are potentially liable to the government or third parties for the full cost of remediating contamination at our facilities or former facilities or at third-party sites. If we were required to fully fund the remediation of a site, the statutory framework would allow us to pursue rights to contribution from other PRPs. For additional information relating to environmental contingencies, see Note 23 to the Consolidated Financial Statements contained in Part II, Item 8 of this Annual Report on Form 10-K.

 

International. Our international sales are subject to U.S. and non-U.S. governmental regulations and procurement policies and practices, including regulations relating to import-export control, investment, exchange controls and repatriation of earnings. International sales are also subject to varying currency, political and economic risks.

 

Raw Materials and Suppliers

 

We are highly dependent on the availability of essential materials, parts and subassemblies from our suppliers and subcontractors. The most important raw materials required for our aerospace products

 

4


Table of Contents

are aluminum (sheet, plate, forgings and extrusions), titanium (sheet, plate, forgings and extrusions) and composites (including carbon and boron). 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 non-U.S. companies. We are dependent upon the ability of large numbers of suppliers and subcontractors to meet performance specifications, quality standards and delivery schedules at anticipated costs. While we maintain an extensive qualification and performance surveillance system to control risk associated with such reliance on third parties, failure of suppliers or subcontractors to meet commitments could adversely affect production schedules and contract profitability, while jeopardizing our ability to fulfill commitments to our customers. We are also dependent on the availability of energy sources, such as electricity, at affordable prices.

 

Other Information

 

Boeing was originally incorporated in the State of Washington in 1916 and reincorporated in Delaware in 1934. Our principal executive offices are located at 100 N. Riverside, Chicago, Illinois 60606 and our telephone number is (312) 544-2000.

 

General information about us can be found at www.boeing.com. The information contained on or connected to our web site is not incorporated by reference into this Annual Report on Form 10-K and should not be considered part of this or any other report filed with the Securities and Exchange Commission (SEC). Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, as well as any amendments to those reports, are available free of charge through our web site as soon as reasonably practicable after we file them with, or furnish them to, the SEC. These reports may also be obtained at the SEC’s public reference room at 450 Fifth Street, N.W., Washington, DC 20549. The SEC also maintains a web site at www.sec.gov that contains reports, proxy statements and other information regarding SEC registrants, including Boeing.

 

Item 1A. Risk Factors

 

An investment in our common stock or debt securities involves risks and uncertainties and our actual results and future trends may differ materially from our past performance due to a variety of factors, including, without limitation, the following:

 

We depend heavily upon commercial customers, our suppliers and the worldwide market, which are subject to unique risks.

 

We derive a significant portion of our revenues from a limited number of major commercial airlines, some of which have encountered financial difficulties. We depend on a limited number of customers, including the 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 ends. Financial difficulties, including bankruptcy, of any of the major commercial airlines could significantly reduce our revenues and our opportunity to generate a profit. Several commercial airlines have filed for or recently emerged from bankruptcy.

 

We depend on a variety of factors to deliver aircraft on time, which are subject to unique risks. 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 (such as aluminum, titanium, and composites), internal and supplier produced parts, conversion of raw materials into parts and assemblies, performance of suppliers and subcontractors, and regulatory certification. The failure of any or all of these factors could result in significant out-of-sequence work and disrupted process flows that result in significant inefficiencies. In addition, the introduction of new commercial aircraft programs and major derivatives involves increased risks associated with meeting development, production and certification schedules.

 

5


Table of Contents

We rely on market conditions to sell aircraft into the future. 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 and political stability, both in developed and emerging countries. Demand for our commercial aircraft is further influenced by airline industry profitability, world trade policies, government-to-government relations, terrorism, disease outbreaks, environmental constraints imposed upon aircraft operations, technological changes, and price and other competitive factors.

 

Our commercial aircraft customers may request to cancel, modify or reschedule orders. We generally make sales under purchase orders that are subject to cancellation, modification or rescheduling, changes in the economic environment and the financial condition of the airline industry could result in customer requests for rescheduling or cancellation of contractual orders. If we agree to such cancellations, modification or rescheduling, it could significantly reduce our revenues.

 

Our commercial aircraft production rates could change. As a result of worldwide demand for new aircraft, we have received more than one thousand net orders per year during 2006 and 2005. There will be production rate changes in order to meet the delivery schedules for existing and new airplane programs. This may lead to adding extra production lines, implementing infrastructure changes, seeking additional qualified and skilled employees, and obtaining other resources. Failure to successfully implement any production rate changes could lead to missed delivery commitments, and depending on the length of delay in meeting delivery commitments, additional costs and customers rescheduling their deliveries or terminating their aircraft on contract with us.

 

We depend heavily on U.S. Government contracts, which are subject to unique risks.

 

In 2006, 46% of our revenues were derived from U.S. Government contracts. In addition to normal business risks, our contracts with the U.S. Government are subject to unique risks some of which are beyond our control.

 

The funding of U.S. Government programs is subject to congressional appropriations. Many of the U.S. Government programs in which we participate may extend for several years; however, these programs are normally funded annually. Long-term government contracts and related orders are subject to cancellation if appropriations for subsequent performance periods are not made. The termination of funding for a U.S. Government program would result in a loss of anticipated future revenues attributable to that program, which could have a materially negative impact on our operations.

 

The U.S. Government may modify, curtail or terminate our contracts. The U.S. Government may modify, curtail or terminate its contracts and subcontracts without prior notice at its convenience upon payment for work done and commitments made at the time of termination. Modification, curtailment or termination of our major programs or contracts could have a material adverse effect on our results of operations and financial condition.

 

Our contract costs are subject to audits by U.S. Government agencies. U.S. Government representatives may audit the costs we incur on our U.S. Government contracts, including allocated indirect costs. Such audits could result in adjustments to our contract costs. Any costs found to be improperly allocated to a specific contract will not be reimbursed, and such costs already reimbursed must be refunded. We have recorded contract revenues based upon costs we expect to realize upon final audit. However, we do not know the outcome of any future audits and adjustments and we may be required to reduce our revenues or profits upon completion and final negotiation of audits. If any audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines and suspension or prohibition from doing business with the U.S. Government.

 

Our business is subject to potential U.S. Government inquiries and investigations. We are sometimes subject to certain U.S. Government inquiries and investigations of our business practices

 

6


Table of Contents

due to our participation in government contracts. Any such inquiry or investigation could potentially result in a material adverse effect on our results of operations and financial condition.

 

Our U.S. Government business is also subject to specific procurement regulations and other requirements. These requirements, although customary in U.S. Government contracts, increase our performance and compliance costs. These costs might increase in the future, reducing our margins, which could have a negative effect on our financial condition. Failure to comply with these regulations and requirements could lead to suspension or debarment, for cause, from U.S. Government contracting or subcontracting for a period of time and could have a negative effect on our reputation and ability to secure future U.S. Government contracts.

 

We enter into fixed-price contracts, which could subject us to losses if we have cost overruns.

 

Many of our contracts in IDS and Commercial Airplanes are contracted on a fixed-price basis. Approximately 50% of IDS revenues are generated from fixed-price contracts, and commercial jet aircraft are normally sold on a firm fixed-price basis with an indexed price escalation clause. 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 and the cost to perform the work prove to be incorrect, we could incur losses. In addition, some of our contracts have specific provisions relating to cost, schedule, and performance. If we fail to meet the terms specified in those contracts, then our cost to perform the work could increase or our price could be reduced, which would adversely affect our financial condition. These programs have risk for reach-forward losses if our estimated costs exceed our estimated price.

 

Fixed-price development work inherently has more uncertainty than production contracts and, therefore, more variability in estimates of the cost to complete the work. Many of these development programs have very complex designs. As technical or quality issues arise, we may experience schedule delays and cost impacts, which could increase our estimated cost to perform the work or reduce our estimated price, either of which could result in a material charge. Some fixed-price development contracts include initial production units in their scope of work. Successful performance of these contracts depends on our ability to meet production specifications and delivery rates. If we are unable to perform and deliver to contract requirements, our contract price could be reduced through the incorporation of liquidated damages, termination of the contract for default, or other financially significant exposure. Management uses its best judgment to estimate the cost to perform the work and the price we will eventually be paid on fixed-price development programs. While we believe the cost and price estimates incorporated in the financial statements are appropriate, future events could result in either upward or downward adjustments to those estimates. In 2006 we recorded charges of $770 million on our AEW&C program, delayed delivery of the first two aircraft and revised the delivery schedule for the remaining aircraft under this program. We may continue to experience technical quality issues requiring further delays in schedule or revisions to our cost estimates. Examples of other significant fixed-price development contracts include 767 Tankers, commercial and military satellites, Vigilare and High Frequency Modernisation.

 

We enter into cost-type contracts which also carry risks.

 

Approximately 50% of IDS revenues are generated from cost-type contracting arrangements. Some of these are development programs which have complex design and technical challenges. These cost-type programs typically have award or incentive fees that are subject to uncertainty and may be earned over extended periods. In these cases the associated financial risks are primarily in lower profit rates or program cancellation if cost, schedule, or technical performance issues arise. Programs whose contracts are primarily cost-type include GMD, FCS, P-8A Poseidon, Proprietary programs, Airborne Laser, JTRS, FAB-T, and the E/A-18 Growler.

 

7


Table of Contents

We enter into contracts that include in-orbit incentive payments that subject us to risks.

 

Contracts in the commercial satellite industry include in-orbit incentive payments, and government satellite contracts also may include in-orbit incentives. These in-orbit payments may be paid over time after final satellite acceptance or paid in full prior to final satellite acceptance. In both cases, the in-orbit incentive is at risk if the satellite does not perform to specifications for up to 15 years after acceptance. The net present value of in-orbit incentive fees we ultimately expect to realize is recognized as revenue in the construction period. If the satellite fails to meet contractual performance criteria, customers will not be obligated to continue making in-orbit payments and/or we may be required to provide refunds to the customer and incur significant charges.

 

We use estimates in accounting for many contracts and programs. Changes in our estimates could adversely affect our future financial results.

 

Contract and program accounting require judgment relative to assessing risks, estimating contract revenues and costs and making assumptions for schedule and technical issues. Due to the size and nature of many of our contracts and programs, the estimation of total revenues and cost at completion is complicated and subject to many variables. Assumptions have to be made regarding the length of time to complete the contract or program because costs also include expected increases in wages, materials prices and allocated fixed costs. Incentives or penalties related to performance on contracts are considered in estimating sales and profit rates, and are recorded when there is sufficient information for us to assess anticipated performance. Estimates of award fees are also used in sales and profit rates based on actual and anticipated awards.

 

Under program accounting, inventoriable production costs (including overhead), program tooling costs and routine warranty costs are accumulated and charged as cost of sales by program instead of by individual units or contracts. A program consists of the estimated number of units (accounting quantity) of a product to be produced in a continuing, long-term production effort for delivery under existing and anticipated contracts. To establish the relationship of sales to cost of sales, program accounting requires estimates of (a) the number of units to be produced and sold in a program, (b) the period over which the units can reasonably be expected to be produced, and (c) the units’ expected sales prices, production costs, program tooling, and routine warranty costs for the total program. Several factors determine accounting quantity, including firm orders, letters of intent from prospective customers, and market studies. Changes in underlying assumptions, circumstances or estimates concerning the selection of the initial accounting quantity or changes in market conditions, along with a failure to realize predicted costs, may adversely affect future financial performance.

 

Because of the significance of the judgments and estimation processes described above, it is likely that materially different sales and profit amounts could be recorded if we used different assumptions or if the underlying circumstances were to change. Changes in underlying assumptions, circumstances or estimates may adversely affect future period financial performance. For additional information on our accounting policies for recognizing sales and profits, see our discussion under “Management’s Discussion and Analysis—Critical Accounting Policies—Contract Accounting/Program Accounting” on pages 40-41 and Note 1 to the consolidated financial statements on pages 51-52 of this Form 10-K.

 

Significant changes in discount rates, actual investment return on pension assets, and other factors could affect our earnings, equity, and pension contributions in future periods.

 

Our earnings may be positively or negatively impacted by the amount of income or expense we record for our pension and other postretirement benefit plans. Generally accepted accounting principles (GAAP) in the United States of America require that we calculate income or expense for the plans using actuarial valuations. These valuations reflect assumptions relating to financial market and other economic conditions. Changes in key economic indicators can change the assumptions. The most

 

8


Table of Contents

significant year-end assumptions used to estimate pension or other postretirement income or expense for the following year are the discount rate, the expected long-term rate of return on plan assets, and expected future medical inflation. In addition, we are required to make an annual measurement of plan assets and liabilities, which may result in a significant change to equity through a reduction or increase to Other comprehensive income. For a discussion regarding how our financial statements can be affected by pension and other postretirement plan accounting policies, see “Management’s Discussion and Analysis—Critical Accounting Policies—Postretirement Plans” on pages 43-44 of this Form 10-K. Although GAAP expense and pension or other postretirement contributions are not directly related, the key economic factors that affect GAAP expense would also likely affect the amount of cash the company would contribute to the pension or other postretirement plans. Potential pension contributions include both mandatory amounts required under federal law Employee Retirement Income Security Act (ERISA) and discretionary contributions to improve the plans’ funded status.

 

Some of our workforce is represented by labor unions, which may lead to work stoppages.

 

Approximately 56,980 of our employees are unionized, which represented approximately 37% of our employees at December 31, 2006. We experienced work stoppages in 2005 when labor strikes halted commercial aircraft and IDS production and we may experience additional work stoppages in the future, which could adversely affect our business. We cannot predict how stable our relationships, currently with 17 different U.S. labor organizations and 7 different non-U.S. labor organizations, will be or whether we will be able to meet the unions’ requirements without impacting our financial condition. The unions may also limit our flexibility in dealing with our workforce. Work stoppages and instability in our union relationships could negatively impact the timely production of our products, which could strain relationships with customers and cause a loss of revenues that would adversely affect our results of operations.

 

Competition within our markets may reduce our procurement of future contracts and sales.

 

The markets in which we operate are highly competitive. Our competitors may have more extensive or more specialized engineering, manufacturing and marketing capabilities than we do in some areas. In addition, some of our largest customers could develop the capability to manufacture products or provide services similar to products that we manufacture or services that we provide. This would result in these customers supplying their own products or services and competing directly with us for sales of these products or services, all of which could significantly reduce our revenues. Furthermore, we are facing increased international competition and cross-border consolidation of competition. There can be no assurance that we will be able to compete successfully against our current or future competitors or that the competitive pressures we face will not result in reduced revenues and market share.

 

We derive a significant portion of our revenues from non-U.S. sales and are subject to the risks of doing business in other countries.

 

In 2006 sales to non-U.S. customers accounted for approximately 37% of our revenues. We expect that non-U.S. sales will continue to account for a significant portion of our revenues for the foreseeable future. As a result, we are subject to risks of doing business internationally, including:

 

·  

changes in regulatory requirements

 

·  

domestic and international government policies, including requirements to expend a portion of program funds locally and governmental industrial cooperation requirements

 

·  

fluctuations in international currency exchange rates

 

·  

delays in placing orders

 

·  

the complexity and necessity of using non-U.S. representatives and consultants

 

9


Table of Contents
·  

the uncertainty of adequate and available transportation

 

·  

the uncertainty of the ability of non-U.S. customers to finance purchases

 

·  

uncertainties and restrictions concerning the availability of funding credit or guarantees

 

·  

imposition of tariffs or embargoes, export controls and other trade restrictions

 

·  

the difficulty of management and operation of an enterprise spread over various countries

 

·  

compliance with a variety of international laws, as well as U.S. laws affecting the activities of U.S. companies abroad

 

·  

economic and geopolitical developments and conditions

 

While these factors or the impact of these factors are difficult to predict, any one or more of these factors could adversely affect our operations in the future.

 

The outcome of litigation in which we have been named as a defendant is unpredictable and an adverse decision in any such matter could have a material adverse affect on our financial position and results of operations.

 

We are defendants in a number of litigation matters. These claims may divert financial and management resources that would otherwise be used to benefit our operations. Although we believe that we have meritorious defenses to the claims, no assurances can be given that the results of these matters will be favorable to us. An adverse resolution of any of these lawsuits could have a material adverse affect on our financial position and results of operations.

 

A substantial deterioration in the financial condition of the commercial airline industry as it relates to Boeing Capital Corporation (BCC) may have an adverse effect on our earnings, cash flows and/or financial position.

 

BCC, our wholly-owned subsidiary, has a substantial portion of its portfolio concentrated among commercial airline customers. A material adverse effect in the airline industry could result in significant defaults by airline customers, repossessions of aircraft, airline bankruptcies, or restructurings. Several of the major commercial airlines, including Delta and Northwest have filed for bankruptcy protection. Additional bankruptcies or restructurings of our current or potential customers could lead to reduced demand for leased aircraft and reduced aircraft lease rates. These events could have a negative effect on our earnings, cash flows and/or financial position.

 

Our insurance coverage may be inadequate to cover all significant risk exposures.

 

We are exposed to liabilities that are unique to the products and services we provide. While we maintain insurance for certain risks and, in some circumstances, we may receive indemnification from the U. S. Government, insurance can’t be obtained to protect against all risks and liabilities. It is therefore possible that the amount of our insurance coverage may not cover all claims or liabilities, and we may be forced to bear substantial costs.

 

Our forward looking statements, projections and business assumptions may prove to be inaccurate, resulting in lower than expected earnings.

 

The statements in this Risk Factors section describe the material risks to our business and should be considered carefully. In addition, these statements constitute our cautionary statements under the Private Securities Litigation Reform Act of 1995. Our disclosure and analysis in this report and in our 2006 Annual Report to Shareholders contain some forward-looking statements that set forth anticipated results based on management’s plans and assumptions. From time to time, we also

 

10


Table of Contents

provide forward-looking statements in other materials we release as well as oral forward-looking statements. Such statements give our current expectations or forecasts of future events; they do not relate strictly to historical or current facts.

 

Statements in the future tense, and all statements accompanied by terms such as “believe,” “project,” “expect,” “estimate,” “assume,” “intend,” “anticipate,” and variations thereof and similar terms are intended to be forward-looking statements as defined by federal securities law. While these forward-looking statements reflect our best estimates when made, the preceding risk factors could cause actual results to differ materially from estimates or projections.

 

We intend that all forward-looking statements we make will be subject to safe harbor protection of the federal securities laws pursuant to Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.

 

You should consider the limitations on, and risks associated with, forward-looking statements and not unduly rely on the accuracy of predictions contained in such forward-looking statements. As noted above, these forward-looking statements speak only as of the date when they are made. We do not undertake any obligation to update forward-looking statements to reflect events, circumstances, changes in expectations, or the occurrence of unanticipated events after the date of those statements. Moreover, in the future, we may make forward-looking statements that involve the risk factors and other matters described in this document as well as other risk factors subsequently identified.

 

Item 1B. Unresolved Staff Comments

 

There are no material unresolved SEC staff comments as of the date of this report.

 

Item 2. Properties

 

We occupied approximately 87 million square feet of floor space on December 31, 2006 for manufacturing, warehousing, engineering, administration and other productive uses, of which approximately 96% was located in the United States.

 

The following table provides a summary of the floor space by business:

 

(thousands of square feet)    Owned    Leased

Commercial Airplanes

   35,978    4,036

IDS

   31,193    10,315

Other*

   4,853    757

Total

   72,024    15,108
 

 

 

Commercial leases from U.S. Government landlord: 158 square feet (Included)

 

Rent-free space furnished by U.S. Government landlord: 1,232 square feet (Excluded)

*

 

Other includes Boeing Capital Corporation, Engineering, Operations and Technology (formerly, Boeing Technology), Corporate Headquarters, and Boeing Shared Services Group. Additionally, Connexion by BoeingSM represents 98 square feet, however the lease ended on January 31, 2007.

 

Our businesses had major operations at the following locations:

 

·  

Commercial Airplanes – Greater Seattle, WA; Long Beach, CA

 

·  

Integrated Defense Systems – Greater Los Angeles, CA; Greater Seattle, WA; Greater St. Louis, MO; Philadelphia, PA; San Antonio, TX; Huntsville, AL; Mesa, AZ; Wichita, KS; Houston, TX; Greater Washington, DC

 

·  

Other – Chicago, IL; Irvine, CA; Greater Seattle, WA

 

11


Table of Contents

Most runways and taxiways that we use are located on airport properties owned by others and are used jointly with others. Our rights to use such facilities are provided for under long-term leases with municipal, county or other government authorities. In addition, the U.S. Government furnishes us certain office space, installations and equipment at U.S. Government bases for use in connection with various contract activities.

 

We believe that our principal properties are adequate for our present needs and, as supplemented by planned improvements and construction, expect them to remain adequate for the foreseeable future.

 

Item 3. Legal Proceedings

 

Currently, we are a defendant in a number of legal proceedings. For a discussion of contingencies related to legal proceedings, see Note 22 to our consolidated financial statements, which is hereby incorporated by reference.

 

In addition, in September 2003, two virtually identical shareholder derivative lawsuits were filed, and later consolidated, in Cook County Circuit Court, Illinois, against 11 of our current and former directors. We were named as a nominal defendant in the litigation. Other shareholders, who had earlier served demands under Section 220 of the Delaware Code to inspect our books and records, intervened in the litigation. Plaintiffs in the consolidated litigation alleged that the directors breached their fiduciary duties by permitting, or failing to remedy, certain alleged ethical and legal violations by employees in our defense businesses over the period 1989 – 2003. The lawsuit sought an unspecified amount of damages against each director and the implementation of remedial measures.

 

All parties in the consolidated litigation have reached a settlement. Under the terms of the settlement, we have agreed to adopt certain corporate governance measures that provide for and support board of director oversight and monitoring of our ethics and compliance program. We also commit to spend over a five-year period $29 million, in excess of 2004 expenditure levels for Boeing’s ethics and compliance program, to implement those measures and to further enhance our compliance, risk management, and internal governance functions and processes.

 

On December 12, 2006, the Court approved the proposed settlement, awarded plaintiffs’ attorneys $6 million in fees and expenses, and entered final judgment dismissing the consolidated action with prejudice.

 

The Company possesses a National Pollutant Discharge Elimination System (NPDES) permit allowing it to discharge industrial waste water and surface storm water from its Santa Susana Field Laboratory (SSFL) site in Simi Valley, California. The permit regulates surface water discharges at various locations on the property and imposes limits on the permissible levels of certain chemical compounds in the discharges. In July 2004 and again in January and March 2006, the California Regional Water Quality Control Board, Los Angeles Region (Regional Board), amended our 1998 NPDES Permit for the SSFL site. The amendments imposed increasingly more stringent numeric surface water discharge limits. Boeing appealed the permit amendments to the California Water Resources Control Board (State Board) in early 2006. In December 2006, the State Board issued its order on Boeing’s appeal of the surface water permit. The order remands the matter to the Regional Board to establish a compliance schedule, but upholds the Regional Board’s inclusion of the limits in the permit. On January 17 2007, the Company filed a petition for a writ challenging the State Board’s adverse rulings in Los Angeles County Superior Court (an earlier court action challenging the Board’s refusal to stay enforcement of the permit limits pending the State Board’s action on the appeal was dismissed as moot on January 5, 2007).

 

In the period 2004 to the present, we have received five violation notices for exceeding permissible limits under our NPDES permit. For each notice of violation, Boeing may be subject to administrative

 

12


Table of Contents

penalties of up to $10,000 per violation and an additional charge based on the volume of water discharged. No such penalties have been assessed. In November 2005, the U.S. Attorney’s office in Los Angeles served us with a grand jury subpoena seeking documents pertaining to Boeing’s compliance with the NPDES permit during the period 2001 to the present and subsequently alleged that we have violated the federal Clean Water Act. We are completing document production pursuant to the subpoena and intend to engage in discussions with the U.S. Attorney’s office regarding the basis for our belief that no criminal violations of the Act occurred, and that, even if violations had occurred, prosecution would be inappropriate.

 

Item 4. Submission of Matters to a Vote of Security Holders

 

There were no matters submitted to a vote of security holders during the quarter ended December 31, 2006.

 

Executive Officers of the Registrant

 

Our executive officers as of February 1, 2007, are as follows:

 

Name    Age    Principal Occupation or Employment/Other Business Affiliations

James F. Albaugh

   56   

Executive Vice President, President and Chief Executive Officer, IDS since July 2002. Prior thereto, Senior Vice President of Boeing, President, Space and Communications Group from September 1998 (named CEO of Space and Communications Group in March 2001). Prior thereto, President, Boeing Space Transportation from April 1998. Prior thereto, President of Rocketdyne Propulsion and Power from March 1997. Current director of TRW Automotive Holdings, Inc.

James A. Bell

   58   

Executive Vice President and Chief Financial Officer since January 2004. Prior thereto, Senior Vice President of Finance and Corporate Controller from October 2000 to January 2004. Prior thereto, Vice President of Contracts and Pricing for Boeing Space Communications from January 1997 to October 2000. Current director of The Dow Chemical Company.

Scott E. Carson

   60   

Executive Vice President and President and Chief Executive Officer of Boeing Commercial Airplanes since September 2006. Prior thereto, Vice President of Sales at Commercial Airplanes. Prior thereto, President of Connexion by Boeing. Prior thereto, Chief Financial Officer of Commercial Airplanes. Prior thereto, Executive Vice President of Business Resources for the former Boeing Information, Space and Defense Systems.

Thomas J. Downey

   42   

Senior Vice President, Communications since January 1, 2007. Prior thereto Vice President, Corporate Communications, April 2006 to December 2006. Prior thereto, Vice President, Commercial Airplanes Communications, May 2002 to April 2006. Prior thereto, Corporate Vice President, Internal and Executive Communications, 1999 to April 2002. Prior thereto, General Manager of Communications and Community Relations for Military Aircraft and Missile Systems unit and director of Communications for Douglas Aircraft Company. Mr. Downey joined the company in 1986.

Shepard W. Hill

   54   

Senior Vice President, Business Development and Strategy. Prior thereto Hill was Vice President, Business Development, at IDS, and prior thereto, he was Vice President, Boeing Space and

 

13


Table of Contents
Name    Age    Principal Occupation or Employment/Other Business Affiliations
     

Communications Government Relations and was vice president, Space Systems, Integrated Space and Defense Systems business unit. Mr. Hill joined Boeing when the company acquired Rockwell’s Aerospace and Defense business in 1996. At that time, Hill was Rockwell’s Vice President, Aerospace Government Affairs and Marketing.

Tod R. Hullin

   63   

Senior Vice President, Public Policy since May 2006. Prior thereto, Senior Vice President, Communications since December 2003. Prior thereto, Executive Vice President, Global Public Policy and North American Communications, Vivendi Universal from December 2000 to March 2002. Prior thereto, Senior Global Communications Officer for the Seagram Company Ltd. from October 1998 to December 2000 and Time Warner from February 1991 to March 1997.

James M. Jamieson

   58   

Senior Vice President, Chief Operating Officer, BCA since September 2006. Prior thereto, Chief Technology Officer December 2003 and prior thereto, Senior Vice President, Airplane Programs for Boeing Commercial Airplanes from February 2000 to December 2003. Prior thereto, Executive Vice President of Single Aisle Airplane Programs from October 1998 to February 2000.

Laurette T. Koellner

   52   

Senior Vice President, President, Boeing International since May 2006. Prior thereto, Executive Vice President and President, Connexion by Boeing since December 2004. Prior thereto, Chief People and Administration Officer, Executive Vice President from August 2002 through December 2004. Member of the Office of the Chairman from March 2002 until December 2003. Prior thereto, Chief People and Administration Officer, Senior Vice President, from March 2002. Prior thereto, Senior Vice President of the Company and President, Shared Services Group from November 2000. Prior thereto, Vice President and Corporate Controller from March 1999. Prior thereto, Vice President and General Auditor from August 1997. Prior thereto, Vice President of Auditing at McDonnell Douglas Corporation from May 1996. Prior thereto, Division Director of Human Resources at McDonnell Douglas Aerospace Company from May 1994. Current director of Sara Lee Corporation.

J. Michael Luttig

   52   

Senior Vice President and General Counsel of the Company since May 2006. Prior thereto, served on the United States Court of Appeals for the Fourth Circuit from October 1991 to May 2006. Prior thereto, Assistant Attorney General of the United States from October 1990 to October 1991, and Counselor to the Attorney General at the Department of Justice from August 1990 to October 1991. Prior thereto, Principal Deputy Assistant Attorney General at the Department of Justice from March 1989 to October 1990. Prior thereto, Luttig was associated with Davis Polk and Wardell from September 1985 to March 1989. Prior thereto, special assistant to the Chief Justice of the United States from September 1984 to September 1985. Prior thereto, law clerk to the Honorable Warren E. Burger, Chief Justice of the United States from July 1983 until August 1984 and law clerk to then-Judge Antonin Scalia of the United States Court of Appeals from August 1982 to July 1983. Prior thereto, special assistant to The White House Counsel and then as assistant counsel from March 1981 to August 1982. Prior thereto, Luttig worked at the Supreme Court of the United States in the Office of Administrative Assistant to the Chief Justice from September 1976 to September 1978.

 

14


Table of Contents
Name    Age    Principal Occupation or Employment/Other Business Affiliations

W. James McNerney, Jr.

   57   

Chairman, President and Chief Executive Officer, The Boeing Company. Mr. McNerney has served as Chairman and Chief Executive Officer of the Boeing Company since July 1, 2005. Previously, he served four and a half years as Chairman and Chief Executive Officer of 3M Company (diversified technology). Beginning in 1982, he served in management positions at General Electric Company, his most recent being President and Chief Executive Officer of GE Aircraft Engines from 1997 until 2000. Mr. McNerney is on the board of the following public company in addition to The Boeing Company: The Procter & Gamble Company. He is also a member of various business and educational organizations.

Bonnie W. Soodik

   56   

Senior Vice President, Office of Internal Governance since November 2003. Prior thereto, President, Shared Services Group since March 2002. Prior thereto, Vice President of Human Resources for Boeing Space and Communications Group. Prior thereto, Vice President and General Manager of Shared Services Group. Prior thereto, Vice President of Product Assurance and Services at Aircraft & Missiles from April 1997. Prior thereto, Vice President of Quality at Douglas Aircraft from 1995.

Richard D. Stephens

   54   

Senior Vice President Human Resources and Administration since September 2005. He previously served as Senior Vice President of Internal Services and prior thereto, he was President of Shared Services Group. Prior thereto, he was Vice President and General Manager, Integrated Defense Systems Homeland Security and Services, from July 2002 to December 2003. Mr. Stephens has previously led a number of Boeing businesses, including Space and Communications Services, Reusable Space Systems, Naval Systems and Tactical Systems. Current director of Exostar.

John J. Tracy

   52   

Senior Vice President of Engineering, Operations and Technology (formerly Boeing Technology). Prior thereto, Vice President of Engineering and Mission Assurance for Integrated Defense Systems. Prior thereto, Vice President of Structural Technologies, Prototyping, and Quality for Phantom Works. Prior thereto, General Manager of Engineering for Military Aircraft and Missiles, the Director of the Space and Communications Advanced Engineering organization, the Director of Operations Management, and Director of Structures Technology for Phantom Works.

 

15


Table of Contents

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

The number of holders of common stock as of February 9, 2007, was approximately 171,079.

 

The following table provides information about purchases we made during the quarter ended December 31, 2006 of equity securities that are registered by us pursuant to Section 12 of the Exchange Act:

 

(Dollars in millions)

 

     (a)    (b)    (c)    (d)
Period   

Total Number

of Shares

Purchased(1)

  

Average Price

Paid per Share

  

Total Number of

Shares Purchased

as Part of Publicly

Announced Plans

or Programs(1)

  

Approximate dollar
value that May

Yet Be Purchased

Under the Plans

Or Programs

10/01/06 thru 10/31/06

   1,793,834    $ 81.99    1,790,200    $ 2,672

11/01/06 thru 11/30/06

   1,648,174    $ 85.92    1,641,400    $ 2,530

12/01/06 thru 12/31/06

   1,733,264    $ 90.11    1,730,800    $ 2,374

TOTAL

   5,175,272    $ 85.96    5,162,400   

 

(1)

 

We repurchased an aggregate of 5,162,400 shares of our common stock in the open market pursuant to our repurchase programs. The program approved by the Board of Directors in June 2005 (the “2005 program”) was terminated by our Board of Directors on August 28, 2006 and replaced with a program approving the repurchase of $3 billion of additional common stock (the “Program”). Unless terminated earlier by resolution of our Board of Directors, the Program will expire when we have used all funds authorized for repurchase thereunder. Outside of the program, we purchased an aggregate of 12,872 shares in swap transactions.

 

The principal market for our common stock is the New York Stock Exchange. Our common stock is also listed on the Amsterdam, Brussels, London, Swiss and Tokyo Exchanges as well as various regional stock exchanges in the United States. Additional information required by this item is incorporated by reference from the table captioned Quarterly Financial Data (Unaudited) on page 107.

 

16


Table of Contents

Item 6. Selected Financial Data

 

Five-Year Summary (Unaudited)

 

(Dollars in millions except per share data)   2006     2005     2004     2003     2002  

Operations

         

Revenues

         

Commercial Airplanes(a)

  $ 28,465     $ 21,365     $ 19,925     $ 21,380     $ 27,202  

Integrated Defense Systems: (b)

         

Precision Engagement and Mobility Systems

    14,350       13,510       12,835       11,783       11,635  

Network and Space Systems

    11,980       12,254       13,023       11,416       9,658  

Support Systems

    6,109       5,342       4,881       4,408       3,977  

Total Integrated Defense Systems

    32,439       31,106       30,739       27,607       25,270  

Boeing Capital Corporation (c)

    1,025       966       959       991       764  

Other

    299       657       275       625       223  

Accounting differences/eliminations

    (698 )     (473 )     (498 )     (1,292 )     (739 )

Total revenues

  $ 61,530     $ 53,621     $ 51,400     $ 49,311     $ 52,720  

General and administrative expense (c)

    4,171       4,228       3,657       3,200       2,959  

Research and development expense

    3,257       2,205       1,879       1,651       1,639  

Other income, net

    420       301       288       460       37  

Net earnings from continuing operations (c)

  $ 2,206     $ 2,562     $ 1,820     $ 685     $ 2,296  

Cumulative effect of accounting change, net of taxes

      17           (1,827 )

Income from discontinued operations, net of taxes(c)

        10       33       23  

Net gain/(loss) on disposal of discontinued operations, net of tax

    9       (7 )     42                  

Net earnings

  $ 2,215     $ 2,572     $ 1,872     $ 718     $ 492  

Basic earnings per share from continuing operations

    2.88       3.26       2.27       0.86       2.87  

Diluted earnings per share from continuing operations

    2.84       3.19       2.24       0.85       2.84  

Cash dividends declared

  $ 991     $ 861     $ 714     $ 573     $ 570  

Per share

    1.25       1.05       0.85       0.68       0.68  

Additions to plant and equipment

    1,681       1,547       1,246       836       954  

Depreciation of plant and equipment

    1,058       1,001       1,028       1,005       1,094  

Employee salaries and wages

    15,871       13,667       12,700       12,067       12,566  

Year-end workforce

    154,000       153,000       159,000       157,000       166,000  

Financial position at December 31

         

Total assets(d)

  $ 51,794     $ 59,996     $ 56,224     $ 55,171     $ 54,225  

Working capital

    (6,718 )     (6,220 )     (5,735 )     892       (2,955 )

Property, plant and equipment, net

    7,675       8,420       8,443       8,597       8,765  

Cash

    6,118       5,412       3,204       4,633       2,333  

Short-term investments

    268       554       319                  

Total debt

    9,538       10,727       12,200       14,443       14,403  

Customer financing assets

    8,890       10,006       11,001       10,914       9,878  

Shareholders’ equity(d)

    4,739       11,059       11,286       8,139       7,696  

Per share

    6.25       14.54       14.23       10.17       9.62  

Common shares outstanding (in millions) (e)

    757.8       760.6       793.2       800.3       799.7  

Contractual Backlog

         

Commercial Airplanes (a)

  $ 174,276     $ 124,132     $ 65,482     $ 63,929     $ 68,159  

Integrated Defense Systems: (b)

         

Precision Engagement and Mobility Systems

    24,988       21,815       21,539       23,131       17,862  

Network and Space Systems

    8,001       6,324       10,923       11,753       12,634  

Support Systems

    9,302       8,366       6,834       6,042       5,518  

Total Integrated Defense Systems

    42,291       36,505       39,296       40,926       36,014  

Total

  $ 216,567     $ 160,637     $ 104,778     $ 104,855     $ 104,173  
   

 

Cash dividends have been paid on common stock every year since 1942.

 

(a)  

In the first quarter of 2006, Commercial Airplanes changed its accounting policy for concessions received from vendors. The years 2005 through 2002 were retroactively adjusted for comparative purposes.

 

(b)  

In 2006 we realigned IDS into three capabilities-driven businesses: Precision Engagement and Mobility Systems (PE&MS), Network and Space Systems (N&SS), and Support Systems. As part of the realignment, certain advanced systems and research and development activities previously included in the Other segment transferred to the new IDS segments. The years 2005 through 2002 were restated for comparative purposes.

 

(c)  

During 2004, BCC sold substantially all of the assets related to its Commercial Financial Services business. Thus, the Commercial Financial Services business is reflected as discontinued operations. The years 2003 and 2002 were restated for comparative purposes.

 

(d)  

Statement of Financial Accounting Standard No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans was adopted in 2006 and reduced shareholders’ equity by $8.2 billion. Retrospective application is not permitted.

 

(e)  

Computation represents actual shares outstanding as of December 31, and excludes treasury shares and the outstanding shares held by the ShareValue Trust.

 

17


Table of Contents

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Consolidated Results of Operations and Financial Condition

 

Overview

 

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 second-largest defense contractor in the U.S. While our principal operations are in the U.S., we rely extensively on a network of partners, key suppliers and subcontractors located around the world.

 

Our business strategy is centered on successful execution in healthy core businesses – Commercial Airplanes and Integrated Defense Systems (IDS) – supplemented and supported by Boeing Capital Corporation (BCC). Taken together, these core businesses generate substantial earnings and cash flow that permit us to invest in new products and services that open new frontiers in aerospace. We focus 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 a defense systems business that integrates its resources in defense, intelligence, communications and space to deliver capability-driven solutions to its customers at reduced costs. Our strategy is to leverage our core businesses with a simultaneously intense focus on growth and productivity. Our strategy also benefits as commercial and defense markets often offset each others’ cyclicality. BCC delivers value through supporting our business units and managing overall financial exposures.

 

In 2006, our revenues grew by 15 percent. Earnings from operations increased 7%. We continued to invest in key growth programs as Research and Development expense grew by 48% to $3.3 billion, reflecting increased spending on the 787 and 747-8 programs and lower cost sharing payments from suppliers. We generated operating cash flow of $7.5 billion driven by operating and working capital performance. We reduced debt by $1.2 billion and repurchased 25 million common shares. Our contractual backlog grew 35% to $217 billion, driven by 40% growth at Commercial Airplanes while our total backlog grew 22% to $250 billion. At the end of 2006, we implemented new accounting rules for pensions and other post-retirement benefits, which together with the annual remeasurement of our pension plans reduced our shareholders’ equity by $6.5 billion. This decrease did not affect cash flows or the funded status of our benefit plans.

 

We expect continued growth in Commercial Airplane revenues and deliveries as we execute our record backlog and respond to global demand by ramping up commercial aircraft production. We expect IDS revenue to be slightly lower in 2007 and anticipate that the U.S. Department of Defense (U.S. DoD) budget growth will moderate over the next several years. We are focused on improving financial performance through a combination of productivity and customer-focused growth.

 

Consolidated Results of Operations

 

Revenues

 

(Dollars in millions)

 

Year ended December 31,    2006      2005      2004  

Commercial Airplanes

   $ 28,465      $ 21,365      $ 19,925  

Integrated Defense Systems

     32,439        31,106        30,739  

Boeing Capital Corporation

     1,025        966        959  

Other

     299        657        275  

Accounting differences/eliminations

     (698 )      (473 )      (498 )

Total revenues

   $ 61,530      $ 53,621      $ 51,400  
   

 

18


Table of Contents

Higher consolidated revenues in 2006 were primarily due to higher new commercial aircraft deliveries. IDS revenues were up moderately in 2006 as growth in Precision Engagement and Mobility Systems and Support Systems was partially offset by lower volume in Network and Space Systems. BCC revenues increased in 2006 primarily due to higher investment income and higher net gain on disposal of assets. Other segment revenues decreased in 2006 as a result of the buyout of several operating lease aircraft in the amount of $369 million in 2005. In addition, revenues decreased in Accounting differences/eliminations due to higher Commercial Airplanes intercompany deliveries in 2006.

 

Consolidated revenues also increased in 2005 as compared to 2004. The increase was due to the growth at Commercial Airplanes driven by higher new aircraft deliveries, increased spares and aircraft modifications, and higher used aircraft sales. IDS revenues remained stable in 2005 after strong growth in 2004. BCC revenues for 2005 were essentially unchanged from 2004.

 

Earnings from Operations

 

The following table summarizes our earnings from operations:

 

(Dollars in millions)

 

Year ended December 31,    2006     2005     2004  

Commercial Airplanes

   $ 2,733     $ 1,431     $ 745  

Integrated Defense Systems

     3,032       3,919       2,936  

Boeing Capital Corporation

     291       232       183  

Other

     (738 )     (363 )     (546 )

Unallocated expense

     (1,733 )     (2,407 )     (1,311 )

Global Settlement with U.S. Department of Justice

     (571 )                

Earnings from operations

   $ 3,014     $ 2,812     $ 2,007  
   

 

Our earnings from operations increased in 2006 compared to 2005 primarily driven by improved earnings at Commercial Airplanes and lower unallocated expense. This was partially offset by a $571 million charge for global settlement with U.S. Department of Justice (see Note 22), lower IDS earnings reflecting a $569 million net gain on the sale of our Rocketdyne business in 2005 and $770 million of charges on the Airborne Early Warning & Control (AEW&C) development program in 2006 partially offset by improved margins on other programs and a $320 million charge related to the exit of the Connexion by Boeing business recorded in Other segment (see Note 9).

 

An increase in earnings from operations in 2005 compared to 2004 was primarily due to strong operating performance by our business segments partially offset by higher unallocated expense. Included in 2004 results is a charge of $555 million related to the United States Air Force (USAF) 767 tanker program and expenses incurred to end production of the 717 aircraft.

 

The most significant items included in Unallocated expense are shown in the following table:

 

(Dollars in millions)

 

Year ended December 31,    2006     2005     2004  

Pension and post-retirement expense

   $ (472 )   $ (851 )   $ (258 )

Share-based plans expense

     (680 )     (999 )     (627 )

Deferred compensation expense

     (211 )     (186 )     (54 )

Other

     (370 )     (371 )     (372 )

Unallocated expense

   $ (1,733 )   $ (2,407 )   $ (1,311 )
   

 

We recorded net periodic benefit cost related to pensions of $1,050 million in 2006, $1,303 million in 2005, and $451 million in 2004. Not all net periodic benefit cost is recognized in earnings in the period incurred because it is allocated to production as product costs and a portion remains in inventory at the

 

19


Table of Contents

end of the reporting period. Accordingly, earnings from operations included $746 million, $1,225 million and $335 million of pension expense in 2006, 2005, and 2004, respectively. A portion of pension expense is recorded in the business segments and the remainder is included in unallocated pension expense.

 

Unallocated pension and other post-retirement expense represents the difference between costs recognized under GAAP in the consolidated financial statements and federal cost accounting standards required to be utilized by our business segments for U.S. government contracting purposes. Net periodic benefit cost related to pensions decreased in 2006 compared to 2005 mainly due to an absence of net settlement and curtailment charges partially offset by an increase in the amount of actuarial loss that was amortized. The increase in 2006 and 2005 deferred compensation plans expense is primarily due to the increase in our stock price.

 

Higher pension and post-retirement amounts in 2005 compared to 2004 are primarily related to higher amortization of actuarial losses and net settlement and curtailment charges due to 2005 divestitures. The increase in 2005 share-based plans expense is primarily due to the increase in our stock price which resulted in additional compensation expense due to an increase in the number of performance shares meeting the price growth targets and being converted to common stock.

 

Other Earnings Items

 

(Dollars in millions)

 

Year ended December 31,    2006     2005     2004  

Earnings from operations

   $ 3,014     $ 2,812     $ 2,007  

Other income, net

     420       301       288  

Interest and debt expense

     (240 )     (294 )     (335 )

Earnings before income taxes

     3,194       2,819       1,960  

Income tax expense

     (988 )     (257 )     (140 )

Net earnings from continuing operations

   $ 2,206     $ 2,562     $ 1,820  
   

 

Other income primarily consists of interest income. Interest income was higher in 2006 and 2005 as a result of higher interest rates and higher cash and investment balances partially offset by lower interest income related to federal income tax settlements for prior years.

 

Interest and debt expense decreased in 2006 and 2005 due to debt repayments.

 

The effective income tax rate of 30.9% for 2006 differed from the 2005 effective income tax rate of 9.1% primarily due to the favorable 2005 settlement with the Internal Revenue Service and the non-deduction in 2006 of the global settlement with the U.S. Department of Justice. The effective income tax rate of 9.1% for 2005 was comparable to the 2004 effective income tax rate of 7.1%. Both 2005 and 2004 benefited from audit settlements and export tax benefits. 2006 is the final year for recognizing export tax benefits. For additional discussion related to Income Taxes see Note 6.

 

Backlog

 

Contractual backlog of unfilled orders excludes purchase options, announced orders for which definitive contracts have not been executed, and unobligated U.S. and non-U.S. government contract funding. Contractual backlog increased by $55,930 million in 2006 compared to 2005 as a result of increases at Commercial Airplanes of $50,144 million, which were primarily due to new orders in excess of deliveries for the 737NG, 747 and 787 airplanes, and increases at IDS of $5,786 million which were driven by funding received from new orders and existing contracts for C-17, F/A-18, Integrated Logistics Chinook support, and Proprietary.

 

20


Table of Contents

Unobligated backlog includes U.S. and non-U.S. government definitive contracts for which funding has not been authorized. Funding that is subsequently received is moved to contractual backlog. The decrease in IDS unobligated backlog of $10,584 million during 2006 compared to 2005 is primarily due to funding released from new orders and existing contracts on F/A-18, Future Combat Systems (FCS), C-17, and Proprietary.

 

Segment Results of Operations and Financial Condition

 

Commercial Airplanes

 

Business Environment and Trends

 

Airline Industry Environment Air travel growth is driven by a combination of economic growth and the increasing propensity to travel due to increased trade, globalization and improved airline services driven by liberalization of air traffic rights between countries. Air traffic growth continues to exceed its long-term trend due to strong performance of these key drivers. Global economic growth, the primary driver of air traffic growth, remained above long-term trend for the third straight year in 2006. Evidence of increasing liberalization can be seen in the declining restrictions on flights between countries, increasing private ownership of airlines and reduced regulation of competition within markets.

 

Looking forward, our 20-year forecast is for a long-term average growth rate of 5% per year for passenger traffic, and 6% per year for cargo traffic based on projected average annual worldwide real economic growth rate of 3%. Based on long-term global economic growth projections, and factoring in increasing utilization of the worldwide airplane fleet and requirements to replace older airplanes, we project a $2.6 trillion market for 27,200 new airplanes over the next 20 years.

 

The airline industry is becoming increasingly competitive resulting in airlines focusing on increasing productivity and improving service levels. Airlines are changing many aspects of their operations including simplifying fleets, distribution, and pricing; outsourcing non-essential operations; reducing labor costs and airport costs; increasing asset utilization; and developing new business models through innovations in network structure, fare structures, service levels and distribution networks. Such changes are providing new opportunities for airline industry suppliers.

 

Worldwide, many airlines continue reporting operating profits although performance varies significantly by region and business model. Recent industry financials generally show increasing unit revenues and rising fares. Cost-cutting initiatives and efficiency improvements are helping many airlines remain profitable despite intense competition and high fuel prices. Fuel costs now comprise one quarter of airline operating costs compared to less than 15% three years ago. Overall, the industry is forecast to lose half a billion dollars in 2006, but return to profitability in 2007. Many airlines that are growing to meet increased demand are acquiring new capacity from manufacturers.

 

The industry remains vulnerable to near-term exogenous developments including disease outbreaks (such as avian flu), the threat of terrorism, global economic imbalances, increasing global environmental concerns and fuel prices. Fuel prices are forecast to remain elevated and volatile in the near-term due to strong demand driven by economic growth and minimal surplus capacity to cushion against supply shocks.

 

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.

 

21


Table of Contents

Continued access to global markets remains vital to our ability to fully realize our sales potential and long-term investment returns. Approximately two-thirds of Commercial Airplanes’ sales and contractual backlog are from customers based outside the United States.

 

We face aggressive international competitors who 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. A decline of the U.S. dollar relative to their local currencies puts pressure on competitors’ revenues and profits. Competitors often respond by aggressively reducing costs and increasing productivity, thereby improving their longer-term competitive posture. Airbus has recently announced such initiatives targeting a two-year reduction in its development cycle and a 20% increase in overall productivity by 2010. If the U.S. dollar strengthens, Airbus can use the extra efficiency to develop new products and gain market share.

 

We are focused on improving our processes and continuing cost-reduction efforts. We continue to leverage our extensive customer support services network which includes aviation support, spares, training, maintenance documents and technical advice for airlines throughout the world. This enables us 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.

 

Operating Results

 

(Dollars in millions)    2006     2005     2004  

Revenues*

   $ 28,465     $ 21,365     $ 19,925  

% of Total Company Revenues

     46 %     40 %     39 %

Operating Earnings

   $ 2,733     $ 1,431     $ 745  

Operating Margins

     9.6 %     6.7 %     3.7 %

Research and Development

   $ 2,390     $ 1,302     $ 941  

Contractual Backlog*

   $ 174,276     $ 124,132     $ 65,482  
   

 

*

Note: In the first quarter of 2006, Commercial Airplanes changed its accounting policy for concessions received from vendors. The years 2005 and 2004 were retroactively adjusted for comparative purposes. See Note 1.

 

Revenues The increase in revenue of approximately $7,100 million in 2006 from 2005 was primarily attributable to higher new airplane deliveries, including model mix changes, of $6,820 million, increased aircraft modification and spares business of $873 million offset by $593 million primarily attributable to lower revenue from aircraft trading.

 

The increase in revenue of $1,440 million in 2005 from 2004 was primarily attributable to higher new airplane deliveries, including model mix changes, of $845 million, used airplane sales of $302 million and $293 million primarily attributable to aircraft modification, and spares.

 

Increased deliveries in 2005 were achieved despite delivering 29 fewer than expected airplanes due to the IAM strike during the month of September 2005. This resulted in approximately $2,000 million lower revenue than anticipated for 2005.

 

22


Table of Contents

Commercial jet aircraft deliveries as of December 31, including deliveries under operating lease, which are identified by parentheses, were as follows:

 

      717     737 NG     747    757    767     777    Total

2006

                 

Cumulative Deliveries

   155     2,136     1,380    1,049    947     604   

Deliveries

   5 (3)   302 *   14       12 *   65    398

2005

                 

Cumulative Deliveries

   150     1,834     1,366    1,049    935     539   

Deliveries

   13 (5)   212 *   13    2    10 *   40    290

2004

                 

Cumulative Deliveries

   137     1,622     1,353    1,047    925     499   

Deliveries

   12 (6)   202 *   15    11    9 (1)   36    285
 

 

*

Intracompany deliveries were two 767 aircraft and eight 737 Next Generation aircraft in 2006, two 767 aircraft and two 737 Next Generation aircraft in 2005 and three 737 Next-Generation aircraft in 2004.

 

Earnings from Operations The $1,302 million increase in earnings from operations in 2006 over the comparable period of 2005 was primarily attributable to earnings of $1,781 million on increased revenue from new aircraft deliveries and $315 million in increased earnings primarily attributable to aircraft modifications. In addition cost performance improved by $226 million. Such items were offset by increased research and development costs of $1,088 million. In 2005 we had a loss on the sale of Wichita, Kansas and Tulsa and McAlester, Oklahoma operations of $68 million. The IAM strike resulted in lower operating earnings in 2005 due to 29 fewer than expected airplane deliveries.

 

The $686 million increase in earnings from operations in 2005 over the comparable period of 2004 was primarily attributable to earnings on increased revenue from new aircraft deliveries of $265 million and $135 million of increased revenue primarily attributable to aircraft modification. In addition, margin improved $414 million mainly due to improved cost performance, which was offset by increased research and development costs of $361 million and other period costs of $174 million, and a loss on the sale of Wichita, Tulsa and McAlester operations of $68 million. In 2004, we also had charges of $280 million resulting from the decision to complete production of the 717 program and $195 million of the 767 USAF Tanker program charge.

 

Backlog The backlog increase in 2006 related to orders in excess of deliveries for 737NG, 747 and 787, while the increase in 2005 related to orders in excess of deliveries for 737NG, 777 and 787.

 

Accounting Quantity The accounting quantity is our estimate of the quantity of airplanes that will be produced for delivery under existing and anticipated contracts. It is a key determinant of gross margins we recognize on sales of individual airplanes throughout a program’s life. Estimation of each program’s accounting quantity takes into account several factors that are indicative of the demand for that program, including firm orders, letters of intent from prospective customers, and market studies. We review our program accounting quantities quarterly.

 

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 decreases, the average cost of the accounting quantity also decreases as these infrastructure costs are included in the total cost estimates, thus increasing the gross margin and related earnings provided other factors do not change.

 

23


Table of Contents

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 reasonable future (anticipated orders). In developing total program estimates all of these items within the accounting quantity must be considered. The table below provides details as of December 31:

 

      Program
      717    737 NG     747     757    767     777     787

2006

                

Program accounting quantities

   156    3,200     1,449     1,050    985     900     *

Undelivered units under firm orders1

      1,560     116        28     299     448

Cumulative firm orders (CFO)2

   155    3,696     1,496     1,049    975     903    

Anticipated orders

   N/A    N/A     N/A     N/A    8     N/A    

Anticipated orders as a % of CFO

   N/A    N/A     N/A     N/A    1 %   N/A      

2005

                

Program accounting quantities

   156    2,800     1,424     1,050    971     800     *

Undelivered units under firm orders1

   5    1,123     58        30     288     287

Cumulative firm orders (CFO) 2

   155    2,957     1,424     1,049    965     827    

Anticipated orders

   N/A    N/A     N/A     N/A    3     N/A    

Anticipated orders as a % of CFO

   N/A    N/A     N/A     N/A    0 %   N/A      

2004

                

Program accounting quantities

   156    2,400     1,400     1,050    959     700     *

Undelivered units under firm orders1

   18    771     27     2    25     167     52

Cumulative firm orders (CFO) 2

   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 %  
 

 

*  

The accounting quantity for the 787 program will be determined in the year of first airplane delivery, targeted for 2008.

 

1

 

Firm orders represent new aircraft purchase agreements where the customers’ rights to cancel without penalty have expired. Typically 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 prior to recording a firm order even if satisfying such conditions are highly certain. Firm orders exclude option aircraft and aircraft with cancellation rights.

 

2

 

Cumulative firm orders represent the cumulative number of commercial jet aircraft deliveries plus undelivered firm orders.

 

737 Next-Generation The accounting quantity for the 737 Next-Generation program increased by 400 units during 2006 due to the program’s normal progression of obtaining additional orders and delivering aircraft.

 

747 Program In November 2005, we launched the 747-8 family, which includes the 747-8 Intercontinental passenger airplane and the 747-8 Freighter. This launch and additional firm orders have extended the life of this program and have also solidified product strategy. The accounting quantity for the 747 program increased by 25 units during 2006. During 2006 we completed firm configuration of the 747-8 freighter and the same is expected for the passenger version in 2007. Deliveries of the first 747-8 freighter and intercontinental passenger airplane are targeted for late 2009 and late 2010.

 

767 Program During 2005 and 2006 the 767 program obtained additional orders, including 10 firm orders during 2006. In addition, on February 5, 2007, a customer announced its plans to order 27 767-300 Extended Range Freighters. We continue pursuing market opportunities for additional 767 sales.

 

24


Table of Contents

777 Program The accounting quantity for the 777 program increased by 100 units during 2006 as a result of the program’s normal progression of obtaining additional orders and delivering aircraft.

 

787 Program As we progress toward first flight and entry into service of the 787, we continue to manage pressures with respect to weight, schedule, and supplier implementation as they arise. There are inherent risks associated with the development and production of any new airplane, which can impact expectations. But we still continue to expect delivery of the 787 on schedule and in accordance with our contractual obligations. We are preparing for the first test flight of the 787 in 2007, and for entry into service in 2008.

 

A key milestone of the program was achieved in 2006 with the initial flight of the first 747-400 Large Cargo Freighter (LCF), called the DreamLifter. These specially-modified freighters will transport major composite structures of the 787 airplanes. Other key events during 2006 were the first shipment of a major assembly between supplier partners and the introduction of a digital computer simulation of the entire 787 production and assembly process.

 

Completed programs

 

717 Program On January 12, 2005, we announced our decision to complete production of the 717 aircraft during 2006 due to the lack of overall market demand. The final 717 was delivered in the second quarter of 2006.

 

757 Program Production of the 757 program ended in October 2004. The last aircraft was delivered in the second quarter of 2005.

 

For additional information regarding termination liabilities remaining in Accounts payable and other liabilities for these two programs see Note 23.

 

Deferred production costs Deferred production costs represent commercial aircraft inventory production costs incurred on in-process and delivered units in excess of the estimated average cost of such units using program accounting. As of December 31, 2006 and 2005 deferred production costs relate to the 777 program and there were no significant excess deferred production costs or unamortized tooling costs not recoverable from existing firm orders.

 

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)    2006    2005

Deferred production costs

   $ 871    $ 683

Unamortized tooling

     329      411
 

 

As of December 31, 2006 and 2005, 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 our commercial airplanes with assistance and services to facilitate efficient and safe aircraft operation. Collectively known as fleet support services, these activities and services begin prior to aircraft delivery and continue throughout the operational life of the aircraft. They include flight and maintenance training, field service support costs, engineering services and technical data and documents. 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.

 

25


Table of Contents

Research and development The following chart summarizes the time horizon between go-ahead and certification/initial delivery for major Commercial Airplanes derivatives and programs.

 

LOGO

 

Our Research and development expense increased $1,088 million and $361 million in 2006 and 2005. Research and development expense is net of development cost sharing payments received from suppliers. The increase in 2006 was due to higher spending of $636 million, primarily on 787 and 747-8, and $452 million of lower supplier development cost sharing payments. The increase during 2005 was primarily due to increased spending on the 787 program and was partially offset by supplier development cost sharing payments. During the second and third quarters of 2006, we increased our research and development expense forecasts for 2006 and 2007 to reflect increasing pressures on the 787 program as well as modified and increased scope on the 747-8 program to support customer expectations. We are also continuing to develop derivatives and features for our other programs primarily the 737 and 777 programs.

 

Integrated Defense Systems

 

Business Environment and Trends

 

IDS consists of three capabilities-driven businesses: Precision Engagement and Mobility Systems (PE&MS), Network and Space Systems (N&SS), and Support Systems.

 

Defense Environment Overview The U.S. is faced with continuous force deployments overseas, stability operations in Afghanistan and Iraq, and the requirement both to recapitalize important defense capabilities and to transform the force to take advantage of available technologies to meet the changing national security environment as outlined in the 2006 Quadrennial Defense Review Report (QDR). All of this must be carried out against a backdrop of significant Federal budget deficits and an administration pledge to reduce and ultimately eliminate annual deficit spending. We anticipate that the national security environment will remain challenging for at least the next decade.

 

Because U.S. DoD spending makes up about half of worldwide defense spending and represented approximately 84% of IDS revenue in 2006, the trends and drivers associated with the U.S. DoD budget are critical. The U.S. DoD budget has grown substantially over the past decade, particularly after the terrorist attacks of September 11, 2001. Although the growth rate had moderated in recent years, the 2008 submittal equates to an 11% increase over the projected 2007 enacted level. The President’s request for fiscal year 2008 is $481 billion, excluding the additional $142 billion request to continue the fight in the Global War on Terror (GWOT) in fiscal year 2008. In the past emergency supplementals had been used to cover the on-going costs of the GWOT. In addition to the fiscal year 2008 budget request the President also submitted a fiscal year 2007 Emergency Supplemental requesting $93 billion to cover operations in the GWOT for the remainder of fiscal year 2007. This Supplemental is in addition to the $70 billion previously provided by Congress. The Procurement account continues to see growth with a request of $102 billion, a 25% increase over 2007, while the

 

26


Table of Contents

Research, Development, Test & Evaluation (RDT&E) account remains flat at $75 billion. (All projections and percentage increases are made without taking inflation into account and without accounting for Supplemental funding.)

 

Even though we continue to see some growth in the U.S. DoD budget, it is unlikely that the U.S. DoD will be able to fully fund the hardware programs already in development as well as new initiatives in order to address the capability gaps identified in the 2006 QDR. This imbalance between future costs of hardware programs and expected funding levels is not uncommon in the U.S. DoD and is routinely managed by internally adjusting priorities and schedules, restructuring programs, and lengthening production runs to meet the constraints of available funding. We expect the U.S. DoD will respond to future budget constraints by focusing on affordability strategies that emphasize jointness, network-centric operations, persistent intelligence, surveillance, and reconnaissance, long-range strike, special operations, unmanned systems, precision guided kinetic and non-kinetic weapons, and continued privatization of logistics and support activities to improve overall effectiveness while maintaining control over costs.

 

Consolidation of contractor-provided U.S. Government launch capabilities was completed with the formation of the United Launch Alliance L.L.C. (ULA) joint venture in 2006. This consolidation was driven by the limited schedule of government launches as well as the downturn in the commercial launch market. Launch contractors had built business cases around the government market being supplemented by a robust commercial market, but as the commercial market declined these business cases were re-evaluated. The U.S. Government has an assured access to space policy which requires that two separate vehicles be available for use. The ULA joint venture is intended to provide this assurance.

 

Civil Space Transportation and Exploration Environment NASA has had stable but very little growth in their funding in this decade. NASA’s fiscal year 2006 appropriation of $16.6 billion was approximately equal to the fiscal year 2005 funding level, and presently the agency is operating under a “Continuing Resolution” in 2007. NASA’s budget remains focused on needed funds for Space Shuttle Operations, International Space Station, and new initiatives associated with the Vision for Space Exploration. We anticipate funding levels to remain in the $16 billion range in the near future. NASA is continuing to pursue elements of the Vision for Space Exploration, which will provide additional opportunities.

 

Commercial Satellite Environment The commercial satellite market has strengthened since the downturn earlier in the decade and is expected to stabilize with replacement demand through the end of the decade. The market remains extremely competitive however, with overcapacity across the overall industry and strong pressure on pricing. We will continue to pursue profitable commercial satellite opportunities where the customer values our technical expertise and unique solutions.

 

Integrated Defense Systems Operating Results

 

(Dollars in millions)    2006     2005     2004  

Revenues

   $ 32,439     $ 31,106     $ 30,739  

% of Total Company Revenues

     53 %     58 %     60 %

Operating Earnings

   $ 3,032     $ 3,919     $ 2,936  

Operating Margins

     9.3 %     12.6 %     9.6 %

Research and Development

   $ 791     $ 855     $ 834  

Contractual Backlog

   $ 42,291     $ 36,505     $ 39,296  

Unobligated Backlog

   $ 33,424     $ 44,008     $ 47,472  
   

 

27


Table of Contents

Since our operating cycle is long-term and involves many different types of development and production contracts with varying delivery and milestone schedules, the operating results of a particular year, or year-to-year comparisons of revenues and earnings, may not be indicative of future operating results. In addition, depending on the customer and their funding sources, our orders might be structured as annual follow-on contracts, or as one large multi-year order or long-term award. As a result, period-to-period comparisons of backlog are not necessarily indicative of future workloads. The following discussions of comparative results among periods should be viewed in this context.

 

Revenues IDS revenues increased 4% in 2006 and 1% in 2005 as growth in both PE&MS and Support Systems was partially offset by lower volume in N&SS.

 

Operating Earnings IDS operating earnings decreased by $887 million in 2006 from 2005 reflecting a $569 million net gain on the sale of Rocketdyne in 2005 and $770 million of charges on the AEW&C development program in 2006 partially offset by improved margins on other programs. Operating earnings increased by $983 million in 2005 from 2004 primarily due to the net gain on the Rocketdyne sale in 2005 in addition to stable performance in the commercial satellite business compared to 2004, when losses were recorded resulting from cost growth due to technical and quality issues and write-downs of slow-moving inventory.

 

Backlog Total backlog is comprised of contractual backlog, which represents work we are on contract to perform for which we have received funding, and unobligated backlog, which represents work we are on contract to perform for which funding has not yet been authorized and appropriated. IDS total backlog decreased 6% in 2006, from $80,513 million to $75,715 million, primarily due to decreases in unobligated backlog of $10,584 million which resulted from funding released from new orders and existing contracts on F/A-18, FCS, C-17, and Proprietary, offset by increases in contractual backlog of $5,786 million which were driven by funding received from new orders and existing contracts for C-17, F/A-18, Integrated Logistics Chinook support, and Proprietary.

 

For further details on the changes between periods, refer to the discussions of the individual segments below.

 

Additional Considerations

 

Our business includes a variety of development programs which have complex design and technical challenges. Many of these programs have cost-type contracting arrangements. In these cases the associated financial risks are primarily in lower profit rates or program cancellation if milestones and technical progress are not accomplished. Examples of these programs include Ground-based Midcourse Defense (GMD), FCS, P-8A (P-8A, formerly Multi-mission Maritime Aircraft), Proprietary programs, Airborne Laser, Joint Tactical Radio System (JTRS), Family of Beyond Line-of-Sight Terminals, and the E/A-18G.

 

Some of our development programs are contracted on a fixed-price basis. Many of these programs have highly complex designs. As technical or quality issues arise, we may experience schedule delays and cost impacts, which could increase our estimated cost to perform the work or reduce our estimated price, either of which could result in a material charge. These programs are ongoing, and while we believe the cost and fee estimates incorporated in the financial statements are appropriate, the technical complexity of these programs creates financial risk as additional completion costs may become necessary or scheduled delivery dates could be missed, which could trigger termination-for-default provisions, the loss of satellite on-orbit incentive payments, or other financially significant exposure. These programs have risk for reach-forward losses if our estimated costs exceed our estimated contract revenues. Examples of these programs include AEW&C, 767 Tanker, commercial and military satellites, Vigilare and High Frequency Modernisation.

 

28


Table of Contents

Precision Engagement and Mobility Systems Operating Results

 

(Dollars in millions)    2006     2005     2004  

Revenues

   $ 14,350     $ 13,510     $ 12,835  

% of Total Company Revenues

     23 %     25 %     25 %

Operating Earnings

   $ 1,238     $ 1,755     $ 1,697  

Operating Margins

     8.6 %     13.0 %     13.2 %

Research and Development

   $ 404     $ 440     $ 420  

Contractual Backlog

   $ 24,988     $ 21,815     $ 21,539  

Unobligated Backlog

   $ 9,194     $ 15,189     $ 20,885  
   

 

Revenues PE&MS revenues increased 6% in 2006 and 5% in 2005 primarily due to additional aircraft deliveries and other volume. The revenue growth of $840 million in 2006 was driven by higher deliveries of F-15 and Apache and higher volume of P-8A, F-22, and Chinook, partially offset by reduced revenues of AEW&C. The revenue growth of $675 million in 2005 was driven by higher deliveries on F-15 and Apache and higher volume and milestone completions on P-8A and AEW&C, partially offset by fewer deliveries on F/A-18 and lower volume resulting from the Comanche termination.

 

Deliveries of new-build production aircraft, excluding remanufactures and modifications, were as follows:

 

      2006    2005    2004

C-17 Globemaster III

   16    16    16

F/A-18E/F Super Hornet

   42    42    48

T-45 Training Systems

   13    10    7

F-15 Eagle

   12    6    3

CH-47 Chinook

   2      

C-40 Clipper

   1    2    3

AH-64 Apache

   31    12    3

Total New-Build Production Aircraft

   117    88    80
 

 

Operating Earnings PE&MS operating earnings decreased $517 million in 2006 driven by the $770 million AEW&C charges mentioned above, which were partially offset by earnings from revenue growth, favorable contract mix, and reduced Company Sponsored Research & Development (CSR&D) expenditures on the 767 Tanker program. Operating earnings increased 3% in 2005 driven by earnings from revenue growth and reduced CSR&D expenditures on 767 Tankers in 2005 and charges recorded in 2004 to write off pre-contract development costs on the 767 USAF Tanker program.

 

Research and Development The PE&MS segment continues to focus its research and development resources where it can use its customer knowledge, technical strength and large-scale integration capabilities to provide transformational solutions to meet the war fighter’s enduring needs. Research and Development has remained consistent over the past several years. Research and development activities leverage our capabilities in architectures, system-of-systems integration and weapon systems technologies to develop solutions which are designed to enhance our customers’ capabilities in the areas of situational awareness and survivability. These efforts focus on increasing mission effectiveness and interoperability, and improving affordability, reliability and economic ownership. Continued research and development investments in unmanned technology and systems have enabled the demonstration of multi-vehicle coordinated flight and distributed control of high-performance unmanned combat air vehicles. Research and development in advanced weapons technologies emphasizes, among other things, precision guidance and multi-mode targeting. Research and development investments in the Global Tanker Transport Aircraft program represent a significant

 

29


Table of Contents

opportunity to provide state-of-the-art refueling capabilities to domestic and non-U.S. customers. Investments were also made to support various intelligence, surveillance, and reconnaissance business opportunities including P-8A and AEW&C aircraft. Other research and development efforts include upgrade and technology insertions to network-enable and enhance the capability and competitiveness of current product lines such as the F/A-18E/F Super Hornet, F-15E Eagle, AH-64 Apache, CH-47 Chinook and C-17 Globemaster III.

 

Backlog PE&MS total backlog decreased 8% from 2005 to 2006 primarily due to deliveries and sales on F/A-18 and F-15 from multi-year contracts awarded in prior years. Total backlog decreased 13% from 2004 to 2005 primarily due to deliveries and sales on C-17, F/A-18 and P-8A, and partially offset by additional F-15 and Chinook orders.

 

Additional Considerations

 

Items which could have a future impact on PE&MS operations include the following:

 

AEW&C During 2006 we recorded charges of $770 million on our international Airborne Early Warning and Control program. This development program, also known as Wedgetail in Australia and Peace Eagle in Turkey, consists of a 737-700 aircraft outfitted with a variety of command and control and advanced radar systems, some of which have never been installed on an airplane before. Wedgetail includes six aircraft and Peace Eagle includes four aircraft. This is an advanced and complex fixed-price development program involving technical challenges at the individual subsystem level and in the overall integration of these subsystems into a reliable and effective operational capability. The second-quarter charge of $496 million included estimated additional program costs and reductions in expected pricing caused by technical complexities which resulted in schedule delays and cost growth and increased the risk of late delivery penalties. The financial impact recorded in that quarter resulted from a detailed analysis of flight test data along with a series of additional rigorous technical and cost reviews after flight testing ramped up. The hardware and software development and integration had not progressed as quickly as we planned, resulting in the delivery for the first two aircraft being delayed 15 months. We reorganized the program to improve systems engineering and integration and we strengthened the leadership team in both program management and engineering. In the fourth quarter of 2006, after a revised estimate of technical progress by us and our subcontractors, we determined that program subsystems and software development had not matured as we had anticipated earlier in the year. We recorded a charge of an additional $274 million, reflecting further program delays of up to six months. These programs are ongoing, and while we believe the most recent cost estimates incorporated in the financial statements are appropriate, the technical complexity of the programs creates financial risk as additional completion costs may be necessary or scheduled delivery dates could be missed.

 

C-17 As of December 31, 2006, we have delivered a total of 159 of the 190 C-17s ordered by the U.S. Air Force, with final deliveries scheduled for 2009. Despite pending orders, which would extend deliveries of the C-17 to mid-2009, it is reasonably possible that we will decide in 2007 to suspend work on long-lead items from suppliers and/or to complete production of the C-17 if further orders are not received. We are still evaluating the full financial impact of a production shut-down, including any recovery that would be available from the government.

 

767 Tanker Program The 767 Tanker Program has orders for eight 767 Tankers, four from the Italian Air Force and four from the Japan Self Defense Agency. The USAF is continuing to pursue a replacement for the KC-135 tanker and has identified it as its top acquisition priority for 2007. In addition, the Pentagon requested funding for the development phase of the program in its 2008 budget request in February 2007. We remain firmly committed to the USAF 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.

 

30


Table of Contents

Network and Space Systems Operating Results

 

(Dollars in millions)    2006     2005     2004  

Revenues

   $ 11,980     $ 12,254     $ 13,023  

% of Total Company Revenues

     19 %     23 %     25 %

Operating Earnings

   $ 958     $ 1,399     $ 577  

Operating Margins

     8.0 %     11.4 %     4.4 %

Research and Development

   $ 301     $ 334     $ 357  

Contractual Backlog

   $ 8,001     $ 6,324     $ 10,923  

Unobligated Backlog

   $ 23,723     $ 27,634     $ 25,019  
   

 

Revenues N&SS revenues decreased 2% in 2006 and 6% in 2005 as significant growth in FCS and higher Delta IV volume were offset by lower volume in Proprietary and GMD as well as the divestiture of our Rocketdyne business. Additional impacts resulted from fewer milestone completions in our commercial satellite business in 2006 and the completion of a Homeland Security contract in 2005.

 

Launch and new-build satellite deliveries were as follows:

 

      2006    2005    2004

Delta II

   2    2    4

Delta IV

   3      

Commercial/Civil Satellites

   4    3    2
 

 

Operating Earnings N&SS operating earnings decreased $441 million from 2005 to 2006 and increased $822 million from 2004 to 2005 driven by significant items in all three periods. The decrease from 2005 to 2006 was driven by the $569 million net gain on the Rocketdyne sale and higher contract values for Delta IV launch contracts in 2005, partially offset by increased earnings in the FCS program in 2006. The increase from 2004 to 2005 was driven by the favorable Rocketdyne and Delta IV impacts in 2005 mentioned above, while losses were recorded in our commercial satellite business in 2004 caused by performance issues due to cost growth from technical and quality issues and write-offs of slow-moving inventory. N&SS operating earnings include equity earnings of $71 million, $72 million, and $70 million from the United Space Alliance joint venture in 2006, 2005, and 2004, respectively.

 

Divestitures On February 28, 2005, we completed the stock sale of EDD to L-3 Communications. On August 2, 2005 we completed the sale of our Rocketdyne business to United Technologies Corporation. See Note 9 Exit Activity and Divestitures.

 

Research and Development The N&SS research and development funding remains focused on the development of communications and command and control capabilities that support a network-centric architecture approach for our various government customers. We are investing in the communications market to enable connectivity between existing air/ground platforms, increase communications availability and bandwidth through more robust space systems, and leverage innovative communications concepts. Key programs in this area include JTRS, FCS, GPS, and Transformational Communications System. Investments were also made to support concepts that will lead to the development of next-generation space intelligence systems. Along with increased funding to support these areas of architecture and network-centric capabilities development, we also maintained our investment levels in global missile defense and advanced missile defense concepts and technologies.

 

Backlog N&SS total backlog decreased 7% from 2005 to 2006 driven by sales from a multi-year order received in prior years on FCS. Total backlog decreased 6% from 2004 to 2005 driven by sales from multi-year orders received in prior years on GMD and FCS, partially offset by new orders on Proprietary programs.

 

31


Table of Contents

Additional Considerations

 

Items which could have a future impact on N&SS operations include the following:

 

United Launch Alliance On December 1, 2006, we completed the transaction with Lockheed Martin Corporation (Lockheed) to create a 50/50 joint venture named United Launch Alliance L.L.C. (ULA). ULA combines the production, engineering, test and launch operations associated with U.S. Government launches of Boeing Delta and Lockheed Atlas rockets. In connection with the transaction, we contributed assets and liabilities of $1,609 million and $695 million, respectively, to ULA. These amounts are subject to adjustment pending final review of the respective parties’ contributions. Any difference between the book value of our investment and our proportionate share of ULA’s net assets would be recognized ratably in future years. We also entered into an inventory supply agreement with ULA that provides for the purchase by ULA from us of Boeing Delta inventories totaling $1,860 million by March 31, 2021. We and Lockheed each will provide ULA with initial cash contributions of up to $25 million, and we each have agreed to extend a line of credit to ULA of up to $200 million to support its working capital requirements. In connection with the transaction, we and Lockheed transferred performance responsibility for certain U.S. Government contracts to ULA as of the closing date. We and Lockheed agreed to jointly guarantee the performance of those contracts to the extent required by the U.S. government. We agreed to indemnify ULA through December 31, 2020 against potential non-recoverability of $1,375 million of Boeing Delta inventories included in contributed assets plus $1,860 million of inventory subject to the inventory supply agreement. In addition, in the event ULA is unable to obtain re-pricing of certain contracts which we contributed to ULA and to which we believe ULA is entitled, we will be responsible for any shortfall and may record up to $322 million in pre-tax losses. ULA is accounted for under the equity method of accounting. N&SS 2006 revenues include $727 million related to Delta rockets and formation of ULA will reduce N&SS revenues in 2007. We do not expect ULA to have a material impact to our earnings, cash flows, or financial position for 2007.

 

Sea Launch The Sea Launch venture, in which we are a 40% partner, provides ocean-based launch services to commercial satellite customers. For the year ended December 31, 2006, the venture conducted five successful launches.

 

We have issued credit guarantees to creditors of the Sea Launch venture to assist it in obtaining financing. In the event we are required to perform on these guarantees, we believe we can recover a portion of the cost (estimated at $486 million) through guarantees from the other venture partners. The components of this exposure are as follows:

 

(Dollars in Millions)    Estimated
Maximum
Exposure
   Established
Reserves
   Estimated
Proceeds
from
Recourse
   Estimated
Net
Exposure

Credit Guarantees

   $ 471    $ 188    $ 283   

Partner Loans (Principal and Interest)

     451      271      180   

Advances to Provide for Future Launches

     76          $ 76

Trade Receivable from Sea Launch

     311      289         22

Performance Guarantees

     33         20      13

Other Receivables from Sea Launch

     45      38      3      4
   $ 1,387    $ 786    $ 486    $ 115
 

 

We made no additional capital contributions to the Sea Launch venture during the year ended December 31, 2006.

 

We suspended recording equity losses after writing our investment in and direct loans to Sea Launch down to zero in 2001 and accruing our obligation for third-party guarantees on Sea Launch indebtedness. We

 

32


Table of Contents

are not obligated to provide any further financial support to the Sea Launch venture. However, in the event that we do extend additional financial support to Sea Launch in the future, we will recognize suspended losses as appropriate.

 

A Sea Launch Zenit-3SL vehicle, carrying a Boeing-built satellite, experienced an anomaly during launch on January 30, 2007. The impact to Sea Launch operations, including the remaining launches scheduled for 2007 is not yet known. Based on our preliminary assessment, we do not believe that this anomaly will have a material adverse impact on our results of operations, financial position, or cash flows.

 

Satellites

 

The Boeing-built NSS-8 satellite was declared a total loss due to an anomaly during launch on January 30, 2007. The NSS-8 satellite was insured for $200 million. We believe the NSS-8 loss was the result of an insured event and have so notified our insurance carriers.

 

See the discussions of Boeing Satellite International, Inc. (BSSI) litigation/arbitration with ICO Global Communications (Operations), Ltd., Thuraya Satellite Telecommunications, Telesat Canada, and Space Communications Corporation in Note 22.

 

Support Systems Operating Results

 

(Dollars in millions)    2006     2005     2004  

Revenues

   $ 6,109     $ 5,342     $ 4,881  

% of Total Company Revenues

     10 %     10 %     10 %

Operating Earnings

   $ 836     $ 765     $ 662  

Operating Margins

     13.7 %     14.3 %     13.6 %

Research and Development

   $ 86     $ 81     $ 57  

Contractual Backlog

   $ 9,302     $ 8,366     $ 6,834  

Unobligated Backlog

   $ 507     $ 1,185     $ 1,568  
   

 

Revenues Support Systems revenues increased 14% in 2006 and 9% in 2005 driven by growth throughout the segment. The increase of $767 million in 2006 was due to higher Integrated Logistics (IL) volume on programs such as C-17 and increased program volume resulting from Aviall, which we acquired in the third quarter; higher International program volume resulting from our increased ownership in Alsalam Aircraft Co. (Alsalam); and volume on Maintenance, Modification, & Upgrade (MM&U) programs such as AC-130. The increase of $461 million in 2005 was due to higher volume on MM&U programs such as F-15 and AC-130 and IL programs such as Chinook and C-17.

 

In the second quarter of 2006 we increased our ownership interest in Alsalam, which operates as a Maintenance, Repair and Overhaul facility for various military and commercial aircraft. As a result, we began consolidating Alsalam’s financial statements, which generated revenues of $137 million during the last three quarters of 2006.

 

Operating Earnings Support Systems operating earnings increased 9% in 2006 and 16% in 2005 driven by the revenue increases mentioned above in addition to a different contract mix.

 

Research and Development Support Systems continues to focus investment strategies on its core businesses including Engineering and Logistic Services, MM&U, Supply Chain Services, Training and Support Systems, and Advanced Logistics Services, as well as on moving into the innovative Network Centric Logistics areas. Investments have been made to continue the development and implementation of innovative and disciplined tools, processes and systems as market discriminators in the delivery of integrated customer solutions. Examples of successful programs stemming from these

 

33


Table of Contents

investment strategies include the C-17 Globemaster Sustainment Partnership, the F/A-18 Integrated Readiness Support Teaming program, and the F-15 Singapore Performance Based Logistics contract.

 

Backlog Support Systems total backlog increased 3% from 2005 to 2006 driven by a large IL order for Chinook support. Total backlog increased 14% from 2004 to 2005 driven by orders for new business offsetting sales on various IL programs.

 

Boeing Capital Corporation Segment

 

Business Environment and Trends

 

BCC’s customer financing and investment portfolio at December 31, 2006 totaled $8,034 million, which was substantially collateralized by our commercial aircraft. While worldwide traffic levels are well above those in the past, the effects of higher fuel prices continue to impact the airline industry. At the same time, the credit ratings of some airlines, particularly in the United States, have remained at low levels. Despite positive factors including passenger load at record high levels, a limited supply of economically viable used aircraft and, increasing lease rates, values as measured by reference to published reports from multiple external appraisers for the various aircraft types that are collateral in BCC’s portfolio generally have not increased.

 

Aircraft values and lease rates are impacted by the number and type of aircraft that are currently out of service. Approximately 1,850 commercial jet aircraft (9.9% of current world fleet) continue to be parked, including both in production and out-of-production aircraft types of which over 50% are not expected to return to service. Aircraft valuations could decline if significant numbers of aircraft, particularly types with relatively few operators, are placed out of service.

 

At December 31, 2006, $2,590 million and $1,171 million of BCC’s portfolio was collateralized by 717 and 757 aircraft. During 2006, BCC recognized an expense of $15 million to increase the valuation allowance resulting from a decrease in the collateral value of the 717 aircraft. See Note 10.

 

Summary Financial Information

 

(Dollars in millions)    2006     2005     2004  

Revenues

   $ 1,025     $ 966     $ 959  

Operating Earnings

   $ 291     $ 232     $ 183  

Operating Margins

     28 %     24 %     19 %
   

 

Revenues

 

BCC segment revenues consist principally of interest from financing receivables and notes, and lease income from equipment under operating lease. BCC’s revenues increased $59 million in 2006, primarily due to an increase in investment income of $40 million from the sale or repayment at maturity of certain investments and a higher gain on the sale of aircraft and certain investments in notes receivable of $23 million. These increases were partially offset by a decline in interest and lease income due to decreases in the weighted average balance of the related portfolio. BCC’s revenues were essentially unchanged in 2005 compared with 2004.

 

Operating earnings

 

BCC’s operating earnings are presented net of interest expense, provision for losses, asset impairment expense, depreciation on leased equipment and other operating expenses. Operating earnings increased by $59 million in 2006 primarily due to increased revenues. The increase in operating earnings in 2005 compared with 2004 was primarily due to a lower asset impairment expense and the absence of debt redemption costs partially offset by increased depreciation expense.

 

34


Table of Contents

Financial Position

 

The following table presents selected financial data for BCC:

 

(Dollars in millions)    2006     2005  

BCC Customer Financing and Investment Portfolio

   $ 8,034     $ 9,206  

Valuation Allowance as a % of Total Receivables

     2.4 %     2.0 %

Debt

   $ 5,590     $ 6,322  

Debt-to-Equity Ratio

     5.0-to-1       5.0-to-1  
   

 

BCC’s customer financing and investment portfolio at December 31, 2006 decreased from December 31, 2005 due to portfolio run-off and sale of certain portfolio assets. At December 31, 2006 and 2005, BCC had $259 million and $47 million of assets that were held for sale or re-lease of which $253 million and $6 million had firm contracts to be sold or placed on lease. Additionally, leases with a carrying value of approximately $144 million are scheduled to terminate in the next 12 months and the related aircraft are being remarketed or the leases are being extended.

 

BCC enters into certain transactions with the Other segment in the form of intercompany guarantees and other subsidies.

 

Finance Restructurings

 

Delta Air Lines, Inc.

 

At December 31, 2006 and 2005, Delta Air Lines, Inc. (Delta) accounted for $135 million and $161 million of BCC’s total assets. At December 31, 2006, the Delta portfolio consisted of an investment in an Enhanced Equipment Trust Certificate (EETC) secured by 12 aircraft. Delta retains certain rights by operating under Chapter 11 bankruptcy protection. As of December 31, 2006, Delta has made the contractually required payments relating to the remaining EETC held by BCC. BCC does not expect that the Delta bankruptcy, including the possible return of some or all of the aircraft financed, will have a material effect on its future earnings, cash flows and/or financial position.

 

Northwest Airlines, Inc.

 

At December 31, 2006 and 2005, Northwest Airlines, Inc. (Northwest) accounted for $349 million and $494 million of BCC’s total assets. At December 31, 2006, the Northwest portfolio consisted of notes receivable on six aircraft and two additional notes receivable. Northwest retains certain rights by operating under Chapter 11 bankruptcy protection. On November 8, 2006, the bankruptcy court approved the restructured terms of certain obligations relating to the notes receivable. At December 31, 2006, Northwest is current on payments relating to the notes receivable held by BCC. We do not expect the Northwest bankruptcy, including the impact of any restructurings, to have a material effect on our future earnings, cash flows and/or financial position.

 

In addition to the customers discussed above, certain other customers have requested a restructuring of their transactions with BCC. BCC has not reached agreement on any restructuring requests that it believes would have a material adverse effect on its earnings, cash flows and/or financial position.

 

Other Segment

 

Other segment operating losses were $738 million during 2006 as compared to losses of $363 million in 2005. Major factors contributing to operating results of the segment are described below.

 

During the third quarter of 2006, we announced that we would exit the Connexion by Boeing high speed broadband communications business having completed a detailed business and market

 

35


Table of Contents

analysis. Our decision resulted in a pre-tax charge of $320 million (See Note 9). We have not reached final settlements with all customers or suppliers. We do not believe the final settlements will have a material adverse effect on our earnings, cash flows and/or financial position.

 

In 2006, the Other segment recorded valuation allowances for customer financing losses of $24 million due to deteriorated airline credit ratings and depressed aircraft values. In 2005, such provisions were $98 million, which consisted of losses of $76 million and $22 million, due to decreases in the collateral values of the 717 and 757, respectively.

 

In 2006, the Other segment recorded an increase in environmental expense of $68 million primarily related to a write-down of previously capitalized environmental costs.

 

In 2005, the Other segment recognized earnings of $63 million associated with the buyout of several operating lease aircraft by a customer.

 

Liquidity and Capital Resources

 

Cash Flow Summary

 

(Dollars in millions)

 

Year ended December 31,    2006     2005     2004  

Net earnings

   $ 2,215     $ 2,572     $ 1,872  

Non-cash items

     3,097       3,494       3,126  

Changes in working capital

     2,187       934       (1,494 )

Net cash provided by operating activities

     7,499       7,000       3,504  

Net cash (used)/provided by investing activities

     (3,186 )     (98 )     (1,446 )

Net cash used by financing activities

     (3,645 )     (4,657 )     (3,487 )

Effect of exchange rate changes on cash and cash equivalents

     38       (37 )        

Net increase/(decrease) in cash and cash equivalents

     706       2,208       (1,429 )

Cash and cash equivalents at beginning of year

     5,412       3,204       4,633  

Cash and cash equivalents at end of year

   $ 6,118     $ 5,412     $ 3,204  
   

 

Operating activities Net cash provided by operating activities increased by $499 million to $7,499 million in 2006. The increase was primarily due to working capital improvements which were partially offset by lower Net earnings. The working capital improvements in 2006 compared with 2005 reflect $1,340 million of lower pension contributions in 2006. Working capital reductions in 2006 also reflect higher advances driven by commercial airplane orders, decreased investment in customer financing, and low income tax payments which were partially offset by a decrease in accounts payable and other liability.

 

Net cash provided by operating activities increased to $7,000 million in 2005 from $3,504 million in 2004 primarily due to lower pension contributions, decreased investment in customer financing, and higher advances and billings in excess of related costs, partially offset by increased investment in inventories.

 

Investing activities Cash used for investing activities increased to $3,186 million in 2006 from $98 million in 2005. The increase is primarily due to our investment of $1,738 million in the 2006 acquisition of Aviall, Inc. (Aviall), net of $42 million of cash acquired, and $458 million of assumed debt, in an all-cash merger. The assumed debt was subsequently repaid on the acquisition closing date. In 2005, we received proceeds of $1,676 million, primarily from the disposition of our Commercial Airplanes

 

36


Table of Contents

operations in Wichita, Kansas and Tulsa and McAlester, Oklahoma, and the sale of Rocketdyne. In 2004, we received proceeds of $2,017 million from the sale of substantially all of the assets related to BCC’s Commercial Financial Services business.

 

During 2004, we invested $3,000 million of cash in an externally managed portfolio of investment grade fixed income instruments. The portfolio is diversified and highly liquid and primarily consists of investment fixed income instruments (U.S. dollar debt obligations of the United States Treasury, other government agencies, corporations, mortgage-backed and asset-backed securities). As of December 31, 2006, our externally managed portfolio of investment grade fixed income instruments had an average duration of 1.6 years. The investments are classified as available for sale.

 

Financing activities Cash used by financing activities decreased to $3,645 million in 2006 from $4,657 million in 2005 primarily due to lower common share repurchases. Cash used by financing activities increased by $1,170 million in 2005 from $3,487 million in 2004 primarily due to a $2,125 million increase in common share repurchases partially offset by lower debt repayments.

 

During 2006, we repurchased 21,184,202 shares at an average price of $80.18 in our open market share repurchase program, 3,749,377 shares at an average price of $80.28 as part of the ShareValue Trust distribution, and 49,288 shares in stock swaps. During 2005 and 2004, 45,217,300 shares and 14,708,856 shares were repurchased at an average price of $63.60 and $51.09 in our open market share repurchase program, and 33,660 shares and 50,657 shares were repurchased in stock swaps.

 

In 2006, we repaid $1,681 million of debt, including $713 million of debt held at BCC and $458 million of debt assumed in the Aviall acquisition. In 2005 and 2004, we repaid $1,378 million and $2,208 million of debt. Repayments in 2004 included BCC’s redemption of $1,000 million face value of its outstanding senior notes, which had a carrying value of $999 million. BCC recognized a net loss of $42 million related to this early debt redemption.

 

Credit Ratings Our credit ratings are summarized below:

 

      Fitch    Moody’s    Standard &
Poor’s

Long-term:

        

Boeing/BCC

   A+    A2    A+

Short-term:

        

Boeing/BCC

   F-1    P-1    A-1
 

 

On March 15, 2006, Moody’s Investors Service upgraded its ratings on debt securities issued by Boeing and BCC. The short term rating was changed to P-1 from P-2 and the long term rating was changed to A2 from A3. On May 11, 2006, Standard & Poor’s revised its outlook on Boeing and BCC to positive from stable. On November 3, 2006, Standard & Poor’s increased the long-term debt ratings for Boeing and BCC to A+ from A, citing substantial cash flow and expectations that a balanced capital allocation will continue to be pursued.

 

Capital Resources We and BCC have commercial paper programs that continue to serve as significant potential sources of short-term liquidity. Throughout 2006 and at December 31, 2006, neither we nor BCC had any commercial paper borrowings outstanding.

 

We believe we have substantial borrowing capacity. Currently, we have $3,000 million ($1,500 million exclusively available for BCC) of unused borrowing on revolving credit line agreements. In 2006, we rolled over the 364-day revolving credit facility, reducing it from $1,500 million to $1,000 million.

 

37


Table of Contents

Currently, there is $500 million allocated to BCC. We also rolled over the 5-year credit facility, increasing it from $1,500 million to $2,000 million, of which $1,000 million is allocated to BCC. We have $1,000 million that remains available from a shelf registration filed with the SEC on March 23, 2004, and BCC has an additional $3,421 million available for issuance, which is due to expire in November 2008. 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.

 

We and Lockheed have agreed to make available to ULA a line of credit in the amount of up to $200 million each as may be necessary from time to time to support ULA’s Expendable Launch Vehicle business during the five year period following December 1, 2006. ULA did not request any funds under the line of credit as of December 31, 2006.

 

In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106 and 132(R) (SFAS No. 158), which required recognition of the funded status of defined benefit pension and other postretirement plans, with a corresponding after-tax adjustment to Accumulated other comprehensive loss. The adoption of SFAS 158, together with the annual remeasurement of our pension plans, resulted in a net $6,509 million decrease in Shareholders’ equity. This decrease does not affect cash flows or the funded status of our benefit plans. The covenants for our debt and credit facilities were amended to exclude the impacts of SFAS No. 158.

 

As of December 31, 2006, we were in compliance with the covenants for our debt and credit facilities.

 

Disclosures about Contractual Obligations and Commercial Commitments

 

The following table summarizes our known obligations to make future payments pursuant to certain contracts as of December 31, 2006, and the estimated timing thereof.

 

Contractual obligations

 

(Dollars in millions)    Total    Less than
1 year
   1–3
years
   3–5
years
   After 5
years

Long-term debt (including current portion)

   $ 9,405    $ 1,322    $ 1,260    $ 1,519    $ 5,304

Interest on debt*

     6,195      557      992      814      3,832

Pension and other post retirement cash requirements

     7,330      675      1,432      1,549      3,674

Capital lease obligations

     153      59      31      20      43

Operating lease obligations

     1,064      239      301      164      360

Purchase obligations not recorded on statement of financial position

     86,254      34,926      35,076      11,940      4,312

Purchase obligations recorded on statement of financial position

     10,632      9,394      518      344      376

Total contractual obligations

   $ 121,033    $ 47,172    $ 39,610    $ 16,350    $ 17,901
 

 

*

Includes interest on variable rate debt calculated based on interest rates at December 31, 2006. Variable rate debt was approximately 3% of our total debt at December 31, 2006.

 

Pension and other postretirement benefits Pension cash requirements is an estimate of our minimum funding requirements, pursuant to ERISA regulations, although we may make additional discretionary contributions. Estimates of other postretirement benefits are based on both our estimated future benefit payments and the estimated contribution to the one plan that is funded through a trust.

 

38


Table of Contents

Purchase obligations Purchase 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 specify approximate timing of the transaction. In addition, the agreements are not cancelable without substantial penalty. Purchase obligations include amounts recorded as well as amounts that are not recorded on the statements of financial position. Approximately 16% of the purchase obligations disclosed above are reimbursable to us pursuant to cost-type government contracts.

 

Purchase obligations not recorded on the Consolidated Statement of Financial Position

 

Production related purchase obligations not recorded on the Consolidated Statement of Financial Position 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. In addition, we purchase raw materials on behalf of our suppliers. 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 from the extended production planning horizon for many of our products. A significant portion of these inventory commitments is supported by firm contracts and/or has historically resulted in settlement through reimbursement from customers for penalty payments to the supplier should the customer not take delivery. These amounts are also included in our forecasts of costs for program and contract accounting. 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 outside of the U.S. to facilitate 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 or vendor orders for supplies, opportunities to bid on supply contracts, transfer of technology or other forms of assistance. However, in certain cases, our commitments may be satisfied through other parties (such as our vendors) who purchase supplies from our non-U.S. 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 2006, we incurred no such penalties. As of December 31, 2006, we have outstanding industrial participation agreements totaling $7.7 billion that extend through 2019. Purchase order commitments associated with industrial participation agreements are included in the table above. To be eligible for such a purchase order commitment from us, a country outside the U.S. or customer must have sufficient capability to meet our requirements and must be competitive in cost, quality and schedule.

 

Purchase obligations recorded on the Consolidated 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. For discussion of these arrangements, see Note 19.

 

39


Table of Contents

Commercial commitments The following table summarizes our commercial commitments outstanding as of December 31, 2006.

 

(Dollars in millions)   Total Amounts
Committed/Maximum
Amount of Loss
  Less than
1 year
 

1-3

years

 

4-5

years

  After 5
years

Standby letters of credit and surety bonds

  $ 4,368   $ 2,849   $ 1,381   $ 3   $ 135

Aircraft financing commercial commitments

    10,164     1,534     5,525     3,025     80

Total commercial commitments

  $ 14,532   $ 4,383   $ 6,906   $ 3,028   $ 215
 

 

Related to the issuance of certain standby letters of credit and surety bonds included in the above table, we received advance payments of $2,869 million as of December 31, 2006.

 

Aircraft financing commercial commitments include commitments to arrange or provide financing related to aircraft on order or under option for deliveries based on estimated earliest funding dates. Based on historical experience, it is not anticipated that all of these commitments will be exercised by our customers (See Note 19).

 

Industrial Revenue Bonds We utilize Industrial Revenue Bonds (IRB) issued by the City of Wichita, Kansas and Fulton County, Georgia to finance the purchase and/or construction of real and personal property (See Note 19).

 

Critical Accounting Policies and Standards Issued and Not Yet Implemented

 

Contract Accounting

 

Contract accounting involves a judgmental process of estimating the total sales and costs for each contract, which results in the development of estimated cost of sales percentages. For each contract, the amount reported as cost of sales is determined by applying the estimated cost of sales percentage to the amount of revenue recognized.

 

Due to the size, length of time and nature of many of our contracts, the estimation of total sales and costs through completion is complicated and subject to many variables. Total contract sales estimates are based on negotiated contract prices and quantities, modified by our assumptions regarding contract options, change orders, incentive and award provisions associated with technical performance, and price adjustment clauses (such as inflation or index-based clauses). The majority of these contracts are with the U.S. Government. Generally the price is based on estimated cost to produce the product or service plus profit. The Federal Acquisition Regulations provide guidance on the types of cost that will be reimbursed in establishing contract price. Total contract cost estimates are largely based on negotiated or estimated purchase contract terms, historical performance trends, business base and other economic projections. Factors that influence these estimates include inflationary trends, technical and schedule risk, internal and subcontractor performance trends, business volume assumptions, asset utilization, and anticipated labor agreements.

 

The development of cost of sales percentages involves procedures and personnel in all areas that provide financial or production information on the status of contracts. Estimates of each significant contract’s sales and costs are reviewed and reassessed quarterly. Any changes in these estimates result in recognition of cumulative adjustments to the contract profit in the period in which changes are made.

 

Due to the significance of judgment in the estimation process described above, it is likely that materially different cost of sales amounts could be recorded if we used different assumptions, or if the

 

40


Table of Contents

underlying circumstances were to change. Changes in underlying assumptions/estimates, supplier performance, or circumstances may adversely or positively affect financial performance in future periods. If the combined gross margin for all contracts in IDS for all of 2006 had been estimated to be higher or lower by 1.0%, it would have increased or decreased income for the year by approximately $324 million.

 

Program Accounting

 

Program accounting requires the demonstrated ability to reliably estimate the relationship of sales to costs for the defined program accounting quantity. A program consists of the estimated number of units (accounting quantity) of a product to be produced in a continuing, long-term production effort for delivery under existing and anticipated contracts. For each program, the amount reported as cost of sales is determined by applying the estimated cost of sales percentage for the total remaining program to the amount of sales recognized for airplanes delivered and accepted by the customer.

 

Factors that must be estimated include program accounting quantity, sales price, labor and employee benefit costs, material costs, procured parts, major component costs, overhead costs, program tooling costs, and routine warranty costs. Underlying all estimates used for program accounting is the forecasted market and corresponding production rates. 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. Total estimated program sales are determined by estimating the model mix and sales price for all unsold units within the accounting quantity, added together with the sales for all undelivered units under contract. The sales prices for all undelivered units within the accounting quantity include an escalation adjustment that is based on projected escalation rates, consistent with typical sales contract terms. Cost estimates are based largely on negotiated and anticipated contracts with suppliers, historical performance trends, and business base and other economic projections. Factors that influence these estimates include production rates, internal and subcontractor performance trends, asset utilization, anticipated labor agreements, and inflationary trends.

 

To ensure reliability in our estimates, we employ a rigorous estimating process that is reviewed and updated on a quarterly basis. Changes in estimates are recognized on a prospective basis.

 

Due to the significance of judgment in the estimation process described above, it is likely that materially different cost of sales amounts could be recorded if we used different assumptions, or if the underlying circumstances were to change. Changes in underlying assumptions/estimates, or circumstances may adversely or positively affect financial performance in future periods.

 

If combined cost of sales percentages for all commercial airplane programs for all of 2006 had been estimated to be higher or lower by 1%, it would have increased or decreased pre-tax income for 2006 by approximately $243 million.

 

Aircraft Valuation

 

Used aircraft under trade-in commitments The fair value of trade-in aircraft is determined using aircraft specific data such as, model, age and condition, market conditions for specific aircraft and similar models, and multiple valuation sources. Trade-in aircraft valuation varies significantly depending on which market we determine is most likely for each aircraft. This process begins years before the return of the aircraft. On a quarterly basis, we update our valuation analysis based on the actual activities associated with placing each aircraft into a market.

 

41


Table of Contents

Based on the best market information available at the time, it is probable that we would be obligated to perform on trade-in commitments with net amounts payable to customers totaling $19 million and $72 million at December 31, 2006 and 2005. Accounts payable and other liabilities included $22 million at December 31, 2005, which represents the exposure related to these trade-in commitments.

 

Had the estimate of trade-in value used to calculate our obligation related to probable trade-in commitments been 10% lower than our actual assessment, using a measurement date of December 31, 2006, Accounts payable and other liabilities would have increased by approximately $2 million. We continually update our assessment of the likelihood of our trade-in aircraft purchase commitments and continue to monitor all these commitments for adverse developments.

 

Impairment review for assets under operating leases and held for sale or re-lease When events or circumstances indicate, we evaluate assets under operating lease or held for re-lease for impairment utilizing an expected undiscounted cash flow analysis. We use various assumptions when determining the expected undiscounted cash flow including our intention to hold or dispose of an asset before the end of its economic useful life, the expected future lease rates, lease terms, residual value of the aircraft or equipment, periods in which the asset may be held in preparation for a follow-on lease, maintenance costs, remarketing costs and the remaining economic life of the asset.

 

When we determine that impairment is indicated for an asset, the amount of asset impairment expense recorded is the excess of the carrying value over the fair value of the asset.

 

Had future lease rates on these assets we evaluate for impairment been 10% lower, we estimate that no additional impairment expense would have been recognized as of December 31, 2006. We are unable to predict the likelihood of any future impairments.

 

Used aircraft acquired by the Commercial Airplanes segment are included in Inventories at the lower of cost or market as it is our intent to sell these assets. To mitigate costs and enhance marketability, aircraft may be placed on operating lease. While on operating lease, the assets are included in ‘Customer financing’, however, the valuation continues to be based on the lower of cost or market.

 

Allowance for losses on receivables The allowance for losses on receivables (valuation provision) is used to provide for potential impairment of receivables on the Consolidated Statements of Financial Position. The balance represents an estimate of reasonably possible and probable but unconfirmed losses in the receivables portfolio. The estimate is based on various qualitative and quantitative factors, including historical loss experience, collateral values, and results of individual credit reviews. Factors considered in assessing collectibility include, but are not limited to, a customer’s extended delinquency, requests for restructuring and filings for bankruptcy. The adequacy of the allowance is assessed quarterly. There can be no assurance that actual results will not differ from estimates or that the consideration of these factors in the future will not result in an increase or decrease to the allowance for losses on receivables.

 

Had the applicable cumulative default rate been changed by plus or minus 15%, excluding impaired customers for which the default rate is maintained at 100%, we estimate that the allowance would have been higher or lower by approximately $34 million.

 

Lease residual values Equipment under operating leases is carried at cost less accumulated depreciation and is depreciated to estimated residual value using the straight-line method over the lease term or projected economic life of the asset. Estimates used in determining residual values significantly impact the amount and timing of depreciation expense for equipment under operating leases. For example, a change in the estimated residual values of 1% as of December 31, 2006 could result in a cumulative pre-tax earnings impact of $20 million to be recognized over time.

 

42


Table of Contents

Goodwill impairment

 

Goodwill and other acquired intangible assets with indefinite lives are not amortized but are tested for impairment annually, and when an event occurs or circumstances change such that it is reasonably possible that an impairment may exist. Our annual testing date is April 1. We test goodwill for impairment by first comparing the book value of net assets to the fair value of the related operations. If the fair value is determined to be less than book value, a second step is performed to compute the amount of the impairment. In this process, a fair value for goodwill is estimated, based in part on the fair value of the operations, and is compared to its carrying value. The shortfall of the fair value below carrying value represents the amount of goodwill impairment.

 

We estimate the fair values of the related operations using discounted cash flows. Forecasts of future cash flows are based on our best estimate of future sales and operating costs, based primarily on existing firm orders, expected future orders, contracts with suppliers, labor agreements, and general market conditions. Changes in these forecasts could significantly change the amount of impairment recorded, if any.

 

The cash flow forecasts are adjusted by an appropriate discount rate derived from our market capitalization plus a suitable control premium at the date of evaluation. Therefore, changes in the stock price may also affect the amount of impairment recorded. At the date of our previous impairment test, a 10% increase or decrease in the value of our common stock would have had no impact on the financial statements.

 

Postretirement plans

 

We have defined benefit pension plans covering substantially all our employees. We also have postretirement benefits consisting principally of healthcare coverage for eligible retirees and qualifying dependents. Accounting rules require an annual measurement of our projected obligations and plan assets. These measurements require several assumptions, the most significant of which are the discount rate, the expected long-term rate of asset return, and medical trend rate (rate of growth for medical costs). Changes in assumptions can significantly affect our future annual expense. In addition, as result of our adoption of SFAS 158, changes in assumptions could significantly increase or decrease Shareholders’ Equity (net of taxes) at future measurement dates.

 

We use a discount rate that is based on a point-in-time estimate as of our September 30 annual measurement date. Changes in the discount rate will increase or decrease our recorded liabilities with a corresponding adjustment to Shareholders’ Equity as of the measurement date. In future reporting periods, the adjustment for a change in the discount rate will be recognized in Other comprehensive loss in the period in which it occurs. In the following table, we show the sensitivity of our pension and other postretirement benefit plan liabilities and net periodic cost to a 25 basis point change in the discount rate.

 

As of September 30, 2006 (in millions)

 

      Change in discount rate
Increase 25 bps
    Change in discount rate
Decrease 25 bps

Pension plans

   Dollars     Dollars

Projected benefit obligation (pensions)

   (1,271 )   1,555

Net periodic pension cost

   (145 )   165

Other postretirement benefit plans

    

Accumulated postretirement benefit obligation

   (181 )   212

Net periodic postretirement benefit cost

   (14 )   15
 

 

43


Table of Contents

Pension expense is also sensitive to changes in the expected long-term rate of asset return. An increase or decrease of 25 basis points in the expected long-term rate of asset return would have increased or decreased 2006 pension income by approximately $108 million. Differences between the actual return on plan assets and the expected long term rate of return are reflected in Shareholders’ Equity (net of taxes) as of our annual measurement date. In future reporting periods, the difference between the actual return on plan assets and the expected long term rate of return will be recognized in Other comprehensive loss in the period in which it occurs.

 

The assumed medical trend rates have a significant affect on the following year’s expense recorded liabilities and Shareholders’ Equity. In the following table, we show the sensitivity of our other postretirement benefit plan liabilities and net periodic cost to a 100 basis point change.

 

As of September 30, 2006 (in millions)

 

      Change in medical trend rate
Increase 100 bps
   Change in medical trend rate
Decrease 100 bps
 

Other postretirement benefit plans

     

Accumulated postretirement benefit obligation

   683    (652 )

Net periodic postretirement benefit cost

   127    (116 )
   

 

Standards Issued and Not Yet Implemented

 

See Note 2 in the Notes to our consolidated financial statements included herein.

 

Contingent Items

 

Various legal proceedings, claims and investigations are pending against us. Most significant legal proceedings are related to matters covered by our insurance. Major contingencies are discussed in Note 22, including our contesting the default termination of the A-12 aircraft, employment and benefits litigation brought by several of our employees, and litigation/arbitration involving BSSI.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

 

Interest rate risk

 

We have financial instruments that are subject to interest rate risk, principally investments, fixed-rate debt obligations, and customer financing assets and liabilities. Historically, we have not experienced material gains or losses on these instruments due to interest rate changes. Additionally, Boeing Capital Corporation (BCC) uses interest rate swaps with certain debt obligations to manage exposure to interest rate changes.

 

The principal source of BCC’s market risk relates to interest rate changes. This risk is managed by matching the profile of BCC’s liabilities with the profile of assets. Any exposure to mismatch risk is measured and managed with the use of interest rate derivatives. We do not use interest rate derivatives for speculative or trading purposes. Although many of the assets, liabilities and derivatives affected by a change in interest rates are not traded, if we had an immediate, one-time, 100 basis-point increase in market rates at December 31, 2006, we estimated that the tax-adjusted net fair value of these items would have decreased by $9 million compared to a decrease of $15 million at December 31, 2005.

 

44


Table of Contents

Based on the portfolio of other Boeing existing debt, the unhedged exposure to interest rate risk is not material. The investors in the fixed-rate debt obligations that we issue do not generally have the right to demand we pay off these obligations prior to maturity. Therefore, exposure to interest rate risk is not believed to be material for our fixed-rate debt.

 

Foreign currency exchange rate risk

 

We are subject to foreign currency exchange rate risk relating to receipts from customers and payments to suppliers in foreign currencies. We use foreign currency forward and option contracts to hedge the price risk associated with firmly committed and forecasted foreign denominated payments and receipts related to our ongoing business. Foreign currency contracts are sensitive to changes in foreign currency exchange rates. At December 31, 2006, a 10% unfavorable exchange rate movement in our portfolio of foreign currency contracts would have reduced our unrealized gains by $69 million. Consistent with the use of these contracts to neutralize the effect of exchange rate fluctuations, such unrealized losses or gains would be offset by corresponding gains or losses, respectively, in the remeasurement of the underlying transactions being hedged. When taken together, these forward currency contracts and the offsetting underlying commitments do not create material market risk.

 

45


Table of Contents

Item 8. Financial Statements and Supplemental Data

 

Consolidated Statements of Operations

 

(Dollars in millions, except per share data)                   
Year Ended December 31,    2006     2005     2004  

Sales of products

   $ 52,644     $ 44,174     $ 42,922  

Sales of services

     8,886       9,447       8,478  

Total revenues

     61,530       53,621       51,400  

Cost of products

     (42,490 )     (36,858 )     (36,864 )

Cost of services

     (7,594 )     (7,767 )     (6,754 )

Boeing Capital Corporation interest expense

     (353 )     (359 )     (350 )

Total costs and expenses

     (50,437 )     (44,984 )     (43,968 )
     11,093       8,637       7,432  

Income from operating investments, net

     146       88       91  

General and administrative expense

     (4,171 )     (4,228 )     (3,657 )

Research and development expense, net of credits of $160, $611, and $205

     (3,257 )     (2,205 )     (1,879 )

(Loss)\gain on dispositions/business shutdown, net

     (226 )     520       23  

Goodwill impairment

         (3 )

Settlement with U.S. Department of Justice, net of accruals

     (571 )                

Earnings from operations

     3,014       2,812       2,007  

Other income, net

     420       301       288  

Interest and debt expense

     (240 )     (294 )     (335 )

Earnings before income taxes

     3,194       2,819       1,960  

Income tax expense

     (988 )     (257 )     (140 )

Net earnings from continuing operations

     2,206       2,562       1,820  

Income from discontinued operations, net of taxes of $6

         10  

Net gain\(loss) on disposal of discontinued operations, net of taxes of $5, $(5) and $24

     9       (7 )     42  

Cumulative effect of accounting change, net of taxes of $10

             17          

Net earnings

   $ 2,215     $ 2,572     $ 1,872  
   

Basic earnings per share from continuing operations

   $ 2.88     $ 3.26     $ 2.27  

Income from discontinued operations, net of taxes

         0.01  

Net gain\(loss) on disposal of discontinued operations, net of taxes

     0.01       (0.02 )     0.05  

Cumulative effect of accounting change, net of taxes

             0.03          

Basic earnings per share

   $ 2.89     $ 3.27     $ 2.33  
   

Diluted earnings per share from continuing operations

   $ 2.84     $ 3.19     $ 2.24  

Income from discontinued operations, net of taxes

         0.01  

Net gain\(loss) on disposal of discontinued operations, net of taxes

     0.01       (0.01 )     0.05  

Cumulative effect of accounting change, net of taxes

             0.02          

Diluted earnings per share

   $ 2.85     $ 3.20     $ 2.30  
   

 

See notes to consolidated financial statements on pages 51 – 106.

 

46


Table of Contents

Consolidated Statements of Financial Position

 

(Dollars in millions except per share data)                 
December 31,    2006     2005       

Assets

      

Cash and cash equivalents

   $ 6,118     $ 5,412    

Short-term investments

     268       554    

Accounts receivable, net

     5,285       5,246    

Current portion of customer financing, net

     370       367    

Deferred income taxes

     2,837       2,449    

Inventories, net of advances and progress billings

     8,105       7,878      

Total current assets

     22,983       21,906    

Customer financing, net

     8,520       9,639    

Property, plant and equipment, net

     7,675       8,420    

Goodwill

     3,047       1,924    

Prepaid pension expense

       13,251    

Other acquired intangibles, net

     1,698       875    

Deferred income taxes

     1,051       140    

Investments

     4,085       2,852    

Other assets, net of accumulated amortization of $272 and $204

     2,735       989      
   $ 51,794     $ 59,996    
 

Liabilities and Shareholders’ Equity

      

Accounts payable and other liabilities

   $ 16,201     $ 16,513    

Advances and billings in excess of related costs

     11,449       9,868    

Income taxes payable

     670       556    

Short-term debt and current portion of long-term debt

     1,381       1,189      

Total current liabilities

     29,701       28,126    

Deferred income taxes

       2,067    

Accrued retiree health care

     7,671       5,989    

Accrued pension plan liability

     1,135       2,948    

Other long-term liabilities

     391       269    

Long-term debt

     8,157       9,538    

Shareholders’ equity:

      

Common shares issued, par value $5.00 – 1,012,261,159 and 1,012,261,159 shares;

     5,061       5,061    

Additional paid-in capital

     4,655       4,371    

Treasury shares, at cost

     (12,459 )     (11,075 )  

Retained earnings

     18,453       17,276    

Accumulated other comprehensive loss

     (8,217 )     (1,778 )  

ShareValue Trust shares

     (2,754)       (2,796)      

Total shareholders’ equity

     4,739       11,059      
   $ 51,794     $ 59,996    
 

 

See notes to consolidated financial statements on pages 51 – 106.

 

47


Table of Contents

Consolidated Statements of Cash Flows

 

(Dollars in millions)                   
Year ended December 31    2006     2005     2004  

Cash flows – operating activities:

      

Net earnings

   $ 2,215     $ 2,572     $ 1,872  

Adjustments to reconcile net earnings to net cash provided by operating activities:

      

Non-cash items –

      

Goodwill impairment

         3  

Share-based plans expense

     743       1,036       655  

Depreciation

     1,445       1,412       1,412  

Amortization of other acquired intangibles

     100       91       97  

Amortization of debt discount/premium and issuance costs

     14       23       15  

Pension expense

     746       1,225       335  

Investment/asset impairment charges, net

     118       83       122  

Customer financing valuation provision

     32       73       45  

Net loss (gain) on disposal of discontinued operations

     (14 )     12       (66 )

Loss/(gain) on dispositions/business shutdown, net

     226       (520 )     (23 )

Other charges and credits, net

     82       129       539  

Non-cash adjustments relating to discontinued operations

         15  

Excess tax benefits from share-based payment arrangements

     (395 )     (70 )     (23 )

Changes in assets and liabilities –

      

Accounts receivable

     (244 )     (592 )     (241 )

Inventories, net of advances and progress billings

     444       (1,965 )     535  

Accounts payable and other liabilities

     (744 )     963       1,242  

Advances and billings in excess of related costs

     1,739       3,562       735  

Income taxes receivable, payable and deferred

     933       628       1,086  

Other long-term liabilities

     (62 )     (476 )     (30 )

Prepaid pension expense

     (522 )     (1,862 )     (4,355 )

Goodwill

         (3 )

Other acquired intangibles

       11       (1 )

Accrued retiree health care

     114       30       214  

Customer financing

     718       589       (421 )

Other

     (189 )     46       (255 )

Net cash provided by operating activities

     7,499       7,000       3,504  
   

Cash flows – investing activities:

      

Discontinued operations customer financing, reductions

       2       174  

Property, plant and equipment, additions

     (1,681 )     (1,547 )     (1,246 )

Property, plant and equipment, reductions

     225       51       268  

Acquisitions, net of cash acquired

     (1,854 )     (172 )     (34 )

Proceeds from dispositions of discontinued operations

       33       2,017  

Proceeds from dispositions

     123       1,676       194  

Contributions to investments

     (2,815 )     (2,866 )     (4,142 )

Proceeds from investments

     2,850       2,725       1,323  

Other

     (34 )                

Net cash used by investing activities

     (3,186 )     (98 )     (1,446 )
   

Cash flows – financing activities:

      

New borrowings

     1      

Debt repayments

     (1,681 )     (1,378 )     (2,208 )

Stock options exercised

     294       348       98  

Excess tax benefits from share-based payment arrangements

     395       70       23  

Common shares repurchased

     (1,698 )     (2,877 )     (752 )

Dividends paid

     (956 )     (820 )     (648 )

Net cash used by financing activities

     (3,645 )     (4,657 )     (3,487 )
   

Effect of exchange rate changes on cash and cash equivalents

     38       (37 )        

Net increase/(decrease) in cash and cash equivalents

     706       2,208       (1,429 )

Cash and cash equivalents at beginning of year

     5,412       3,204       4,633  

Cash and cash equivalents at end of year

   $ 6,118     $ 5,412     $ 3,204  
   

Non-cash investing and financing activities:

      

Capital lease obligations incurred

   $ 357      
   

 

See notes to consolidated financial statements on pages 51 – 106.

 

48


Table of Contents

Consolidated Statement of Shareholders’ Equity

 

(Dollars in millions)   Additional
Paid-In
Capital
    Treasury
Stock
    ShareValue
Trust
    Accumulated
Other
Comprehensive
Loss
    Retained
Earnings
    Comprehensive
Gain
 

Balance January 1, 2004

  $ 2,880     $ (8,322 )   $ (1,740 )   $ (4,145 )   $ 14,407     $ 618  

Share-based compensation

    576            

Tax benefit related to share-based plans

    13            

Shares paid out, net of fees

        143        

ShareValue Trust market value adjustment

    283         (426 )      

Treasury shares issued for share-based plans, net

    (332 )     264          

Treasury shares repurchased

      (752 )        

Net earnings

            1,872       1,872  

Cash dividends declared ($0.85 per share)

            (714 )  

Minimum pension liability adjustment, net of tax of $(1,257)

          2,188         2,188  

Reclassification adjustment for losses realized in net earnings, net of taxes of $(12)

          21         21  

Gain on derivative instruments, net of tax of $(8)

          14         14  

Unrealized loss on certain investments, net of tax of $18

          (34 )       (34 )

Currency translation adjustment

                            31               31  

Balance December 31, 2004

  $ 3,420     $ (8,810 )   $ (2,023 )   $ (1,925 )   $ 15,565     $ 4,092  

Share-based compensation

    720            

Tax benefit related to share-based plans

    35            

Restricted stock compensation and reclassification of deferred compensation

    3            

Changes in capital stock

    23            

ShareValue Trust market value adjustment

    773         (773 )      

Excess tax pools

    63            

Treasury shares issued for share-based plans, net

    (666 )     612          

Treasury shares repurchased

      (2,877 )        

Net earnings

            2,572       2,572  

Cash dividends declared ($1.05 per share)

            (861 )  

Minimum pension liability adjustment, net of tax of $(45)

          167         167  

Reclassification adjustment for losses realized in net earnings, net of taxes of $(15)

          21         21  

Unrealized loss of certain investments, net of tax of $8

          (12 )       (12 )

Currency translation adjustment

                            (29 )             (29 )

Balance December 31, 2005

  $ 4,371     $ (11,075 )   $ (2,796 )   $ (1,778 )   $ 17,276     $ 2,719  

Share-based compensation

    487            

ShareValue Trust withholding tax

    (265 )          

ShareValue Trust distribution

    (471 )       457        

Tax benefit related to share-based plans

    36            

ShareValue Trust market value adjustment

    716         (716 )      

Excess tax pools

    325            

Treasury shares issued for share-based plans, net

    (544 ) 1     615          

Treasury shares repurchased

      (1,698 )        

Treasury shares transfer

      (301 )     301        

Net earnings

            2,215       2,215  

Cash dividends declared ($1.25 per share)

            (991 )  

Dividends related to Performance Share payout

            (47 )  

Reclassification adjustment for gains realized in net earnings, net of tax of $23

          (39 )       (39 )

Unrealized gain on derivative instruments, net of tax of $(16)

          23         23  

Unrealized gain on certain investments, net of tax of $(7)

          13         13  

Minimum pension liability adjustment, net of tax of $(1,116)

          1,733         1,733  

SFAS 158 transition amount, net of tax of $5,195

          (8,242 )    

Currency translation adjustment

                            73               73  

Balance December 31, 2006

  $ 4,655     $ (12,459 )   $ (2,754 )   $ (8,217 )   $ 18,453     $ 4,018  
   

 

1

 

Includes transfers of Shareholders’ equity of $224, primarily to other liabilities for employee withholding taxes.

 

See notes to consolidated financial statements on pages 51 – 106.

 

49


Table of Contents

The Boeing Company and Subsidiaries

Notes to Consolidated Financial Statements

Summary of Business Segment Data

 

(Dollars in millions)                   
Year ended December 31,    2006     2005     2004  

Revenues:

      

Commercial Airplanes*

   $ 28,465     $ 21,365     $ 19,925  

Integrated Defense Systems:

      

Precision Engagement and Mobility Systems

     14,350       13,510       12,835  

Network and Space Systems

     11,980       12,254       13,023  

Support Systems

     6,109       5,342       4,881  

Total Integrated Defense Systems

     32,439       31,106       30,739  

Boeing Capital Corporation

     1,025       966       959  

Other

     299       657       275  

Accounting differences/eliminations

     (698 )     (473 )     (498 )

Total revenues

   $ 61,530     $ 53,621     $ 51,400  
   

Earnings from operations:

      

Commercial Airplanes

   $ 2,733     $ 1,431     $ 745  

Integrated Defense Systems:

      

Precision Engagement and Mobility Systems

     1,238       1,755       1,697  

Network and Space Systems

     958       1,399       577  

Support Systems

     836       765       662  

Total Integrated Defense Systems

     3,032       3,919       2,936  

Boeing Capital Corporation

     291       232       183  

Other

     (738 )     (363 )     (546 )

Unallocated expense

     (1,733 )     (2,407 )     (1,311 )

Settlement with U.S. Department of Justice, net of accruals

     (571 )                

Earnings from operations

     3,014       2,812       2,007  

Other income, net

     420       301       288  

Interest and debt expense

     (240 )     (294 )     (335 )

Earnings before income taxes

     3,194       2,819       1,960  

Income tax expense

     (988 )     (257 )     (140 )

Net earnings from continuing operations

   $ 2,206     $ 2,562     $ 1,820  

Income from discontinued operations, net of taxes of $6

         10  

Net gain/(loss) on disposal of discontinued operations, net of taxes of $5, $(5) and $24

     9       (7 )     42  

Cumulative effect of accounting change, net of taxes of $10

             17          

Net earnings

   $ 2,215     $ 2,572     $ 1,872  
   

 

*

2005 and 2004 amounts have been adjusted due to the retrospective adoption of EITF 02-16. See Note 1.

 

This information is an integral part of the Notes to consolidated financial statements. See Note 24 for further segment results.

 

50


Table of Contents

THE BOEING COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2006, 2005, 2004

(Dollars in millions except per share data)

 

Note 1 – Summary of Significant Accounting Policies

 

Principles of consolidation

 

Our consolidated financial statements include the accounts of all majority-owned subsidiaries and variable interest entities that are required to be consolidated.

 

Use of estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make assumptions and estimates that directly affect the amounts reported in the consolidated financial statements. Significant estimates for which changes in the near term are considered reasonably possible and that may have a material impact on the financial statements are disclosed in these notes to the consolidated financial statements.

 

Operating cycle

 

For classification of certain current assets and liabilities, we use the duration of the related contract or program as our operating cycle, which is generally longer than one year and could exceed 3 years.

 

Revenue and related cost recognition

 

Contract accounting Contract accounting is used for development and production activities predominately by the three segments within Integrated Defense Systems (IDS). These activities include the following products and systems: military aircraft, helicopters, missiles, space systems, missile defense systems, satellites, and information and battle management systems. The majority of business conducted in the IDS segments is performed under contracts with the U.S. Government and non-U.S. governments that extend over a number of years. Contract accounting involves a judgmental process of estimating the total sales and costs for each contract resulting in the development of estimated cost of sales percentages. For each contract, the amount reported as cost of sales is determined by applying the estimated cost of sales percentage to the amount of revenue recognized.

 

We combine contracts for accounting purposes when they are negotiated as a package with an overall profit margin objective; they essentially represent an agreement to do a single project for a single customer; they involve interrelated construction activities with substantial common costs; and they are performed concurrently or sequentially. When a group of contracts is combined, revenue and profit are earned uniformly over the performance of the combined contracts.

 

Sales related to contracts with fixed prices are recognized as deliveries are made, except for certain fixed-price contracts that require substantial performance over an extended period before deliveries begin, for which sales are recorded based on the attainment of performance milestones. Sales related to contracts in which we are reimbursed for costs incurred plus an agreed upon profit are recorded as costs are incurred. The Federal Acquisition Regulations provide guidance on the types of cost that will be reimbursed in establishing contract price. Contracts may contain provisions to earn incentive and award fees if targets are achieved. Incentive and award fees that can be reasonably estimated are recorded over the performance period of the contract. Incentive and award fees that cannot be reasonably estimated are recorded when awarded.

 

Program accounting Our Commercial Airplanes segment predominately uses program accounting to account for sales and cost of sales related to commercial airplane programs. Program accounting is a

 

51


Table of Contents

method of accounting applicable to products manufactured for delivery under production-type contracts where profitability is realized over multiple contracts and years. Under program accounting, inventoriable production costs, program tooling costs and routine warranty costs are accumulated and charged to cost of sales by program instead of by individual units or contracts. A program consists of the estimated number of units (accounting quantity) of a product to be produced in a continuing, long-term production effort for delivery under existing and anticipated contracts. To establish the relationship of sales to cost of sales, program accounting requires estimates of (a) the number of units to be produced and sold in a program, (b) the period over which the units can reasonably be expected to be produced, and (c) the units’ expected sales prices, production costs, program tooling, and routine warranty costs for the total program.

 

We recognize revenue on sales of commercial airplanes based on the gross amount billed to customers. We recognize sales for commercial airplane deliveries as each unit is completed and accepted by the customer. Sales recognized represent the price negotiated with the customer, adjusted by an escalation formula. The amount reported as cost of sales is determined by applying the estimated cost of sales percentage for the total remaining program to the amount of sales recognized for airplanes delivered and accepted by the customer.

 

Concession sharing arrangements We account for sales concessions to our customers in consideration of their purchase of products and services as a reduction to revenue (sales concessions) when the related products and services are delivered. The sales concessions incurred are partially reimbursed by a supplier in accordance with a concession sharing arrangement. Prior to adoption of EITF Issue No. 02-16, Accounting by a Customer (including a reseller) for Certain Consideration Received from a Vendor (EITF 02-16), we recognized concessions received from vendors as revenue. Upon adoption of EITF 02-16 on January 1, 2003, in accordance with the transition provisions of the consensus, we recognized concessions received from vendors for new arrangements, including modifications of existing arrangements, as a reduction in Cost of products. We continued to apply our previous accounting policy to arrangements entered into prior to December 31, 2002 that were not modified; such arrangements were grandfathered under EITF 02-16 and, accordingly, we continued to recognize concessions associated with these arrangements as revenue.

 

Effective January 1, 2006, we changed how we account for concessions received from vendors that were grandfathered under EITF 02-16. For the years ended December 31, 2005 and 2004, this change decreased Consolidated and Commercial Airplanes segment Sales of products and Cost of products by $1,224 and $1,057 as follows:

 

      Year ended December 31, 2005     Year ended December 31, 2004  
      As
Originally
Reported
    Effect of
Change
    As
Adjusted
    As
Originally
Reported
    Effect of
Change
    As
Adjusted
 

Sales of products

   $ 45,398     $ (1,224 )   $ 44,174     $ 43,979     $ (1,057 )   $ 42,922  

Sales of services

     9,447         9,447       8,478         8,478  

Total revenues

   $ 54,845     $ (1,224 )   $ 53,621     $ 52,457     $ (1,057 )   $ 51,400  
   

Cost of products

   $ (38,082 )   $ 1,224     $ (36,858 )   $ (37,921 )   $ 1,057     $ (36,864 )

Cost of services

     (7,767 )       (7,767 )     (6,754 )       (6,754 )

Boeing Capital Corporation interest expense

     (359 )       (359 )     (350 )       (350 )

Total costs and expenses

   $ (46,208 )   $ 1,224     $ (44,984 )   $ (45,025 )   $ 1,057     $ (43,968 )
   

 

52


Table of Contents

We believe the newly adopted accounting method is preferable because it aligns our accounting for all concession arrangements with vendors with guidance provided by EITF 02-16. In accordance with EITF 02-16, reimbursements received by a customer from a vendor are presumed to be a reduction in the price of the vendor’s products or services and should be treated as a reduction of Cost of products when recognized in the customer’s income statement.

 

As of January 1, 2006, we have also adopted Statement of Financial Accounting Standards (SFAS) No. 154, Accounting Changes and Error Corrections (SFAS No. 154), which requires that changes in accounting policies such as the one described above be applied retrospectively to all periods presented to the extent practicable. Consequently, we have retrospectively adjusted 2005 and 2004 to be consistent with the 2006 presentation. The change had no effect on Earnings from continuing operations, Net earnings, Retained earnings or Shareholders’ equity. The change reduced previously reported Sales of products and Cost of products by equal amounts both on a consolidated basis and in our Commercial Airplanes segment.

 

Spare parts revenue We recognize sales of spare parts upon delivery and the amount reported as cost of sales is recorded at average cost.

 

Service revenue Service revenue is recognized when the service is performed with the exception of U.S. Government service agreements, which are accounted for using contract accounting. Service activities primarily include the following: Delta launches, ongoing maintenance of International Space Station and Space Shuttle, support agreements associated with military aircraft and helicopter contracts and technical and flight operation services for commercial aircraft. Lease and financing revenue arrangements are also included in Sales of services on the Consolidated Statements of Operations. Service revenue and associated cost of sales from pay-in-advance subscription fees are deferred and recognized as services are rendered.

 

Financial services revenue We recognize financial services revenue associated with sales-type finance leases, operating leases, and notes receivable.

 

For sales-type finance leases we record an asset at lease inception. This asset is recorded at the aggregate future minimum lease payments, estimated residual value of the leased equipment and deferred incremental direct costs less unearned income. Income is recognized over the life of the lease to approximate a level rate of return on the net investment. Residual values, which are reviewed periodically, represent the estimated amount we expect to receive at lease termination from the disposition of leased equipment. Actual residual values realized could differ from these estimates. Declines in estimated residual value that are deemed other than temporary are recognized as Cost of services in the period in which the declines occur.

 

For operating leases, revenue on leased aircraft and equipment representing rental fees and financing charges are recorded on a straight-line basis over the term of the lease. Operating lease assets, included in Customer financing, are recorded at cost and depreciated over either the term of the lease or the economic useful life of the asset to an estimated residual or salvage value based on our intent to hold or dispose of the equipment before the end of its economic useful life, using the straight-line method. Prepayments received on operating lease contracts are classified as Deferred lease income on the Consolidated Statements of Financial Position. We periodically review our estimates of residual value and recognize forecasted decreases in residual value by prospectively adjusting depreciation expense.

 

For notes receivable, notes are recorded net of any unamortized discounts and deferred incremental direct costs. Interest income and amortization of any discounts are recorded ratably over the related term of the note.

 

53


Table of Contents

Reinsurance revenue Our wholly-owned insurance subsidiary, Astro Ltd., participates in a reinsurance pool for workers’ compensation. The member agreements and practices of the reinsurance pool minimize any participating members’ individual risk. Reinsurance revenues were $84 and $101 during 2006 and 2005 respectively. Reinsurance costs related to premiums and claims paid to the reinsurance pool were $91 and $115 during 2006 and 2005 respectively. Both revenues and costs are presented net in Cost of services in the Consolidated Statements of Operations.

 

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 as Cost of services.

 

Research and development

 

Research and development (R&D) includes costs incurred for experimentation, design and testing and are expensed as incurred unless the costs are related to certain contractual arrangements. Costs that are incurred pursuant to such contractual arrangements are recorded over the period that revenue is recognized, consistent with our contract accounting policy. We have certain research and development arrangements that meet the requirement for best efforts research and development accounting. Accordingly, the amounts funded by the customer are recognized as an offset to our research and development expense rather than as contract revenues.

 

We have established cost sharing arrangements with some suppliers for the 787 program, which have enhanced our internal development capabilities and have offset a substantial portion of the financial risk of developing this aircraft. 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 retain substantial rights to the 787 part or component covered by the arrangement. The amounts received from these cost sharing arrangements are recorded as a reduction to research and development expenses since we have no obligation to refund any amounts received per the arrangements regardless of the outcome of the development efforts. Specifically, under the terms of each agreement, payments received from suppliers for their share of the costs are typically based on milestones and are recognized as earned when we achieve the milestone events and no ongoing obligation on our part exists. In the event we receive a milestone payment prior to the completion of the milestone the amount will be classified in Accounts payable and other liabilities until earned.

 

Share-based compensation

 

Our primary types of share-based compensation consist of Performance Shares, ShareValue Trust distributions, stock options and other stock unit awards.

 

In 2005 we adopted the provisions of SFAS No. 123 (Revised 2004), Share-Based Payment (SFAS No. 123R) using the modified prospective method. Prior to 2005, we used a fair value based method of accounting for share-based compensation provided to our employees in accordance with SFAS No. 123. (See Note 16.)

 

54


Table of Contents

Income taxes

 

Provisions for federal, state and non-U.S. income taxes are calculated on reported Earnings before income taxes based on current tax law and also include, in the current period, the cumulative effect of any changes in tax rates from those used previously in determining deferred tax assets and liabilities. Such provisions differ from the amounts currently receivable or payable because certain items of income and expense are recognized in different time periods for financial reporting purposes than for income tax purposes. Significant judgment is required in determining income tax provisions and evaluating tax positions. We establish reserves for income tax when, despite the belief that our tax positions are fully supportable, we believe that it is probable that our positions will be challenged and possibly disallowed by various authorities. The consolidated tax provision and related accruals include the impact of such reasonably estimable losses and related interest and penalties as deemed appropriate. To the extent that the probable tax outcome of these matters changes, such changes in estimate will impact the income tax provision in the period in which such determination is made.

 

Postretirement plans

 

We sponsor various pension plans covering substantially all employees. We also provide postretirement benefit plans other than pensions, consisting principally of health care coverage to eligible retirees and qualifying dependents. Benefits under the pension and other postretirement benefit plans are generally based on age at retirement and years of service and for some pension plans, benefits are also based on the employee’s annual earnings. The net periodic cost of our pension and other post-retirement plans is determined using the projected unit credit method and several actuarial assumptions, the most significant of which are the discount rate, the long-term rate of asset return, and medical trend (rate of growth for medical costs). A portion of net periodic pension and other post-retirement income or expense is not recognized in net earnings in the year incurred because it is allocated to production as product costs, and reflected in inventory at the end of a reporting period. If gains and losses, which occur when actual experience differs from actuarial assumptions, exceed ten percent of the greater of plan assets or plan liabilities we amortize them over the average future service period of employees.

 

Effective December 31, 2006, we adopted SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106 and 132(R) (SFAS No. 158) which requires that the Consolidated Statements of Financial Position reflect the funded status of the pension and postretirement plans. In future reporting periods, the difference between actual amounts and estimates based on actuarial assumptions will be recognized in Other comprehensive loss in the period in which they occur.

 

Postemployment plans

 

We record a liability for postemployment benefits, such as severance or job training, when payment is probable, the amount is reasonably estimable, and the obligation relates to rights that have vested or accumulated.

 

Environmental remediation

 

We are subject to federal and state requirements for protection of the environment, including those for discharge of hazardous materials and remediation of contaminated sites. We routinely assess, based on in-depth studies, expert analyses and legal reviews, our contingencies, obligations and commitments for remediation of contaminated sites, including assessments of ranges and probabilities of recoveries from other responsible parties who have and have not agreed to a settlement and of recoveries from insurance carriers. Our policy is to immediately accrue and charge to current expense

 

55


Table of Contents

identified exposures related to environmental remediation sites based on our best estimate within a range of potential exposure for investigation, cleanup and monitoring costs to be incurred.

 

Cash and cash equivalents

 

Cash and cash equivalents consist of highly liquid instruments, such as certificates of deposit, time deposits, and other money market instruments, which have original maturities of less than three months. We aggregate our cash balances by bank, and reclassify any negative balances to a liability account presented as a component of Accounts payable and other liabilities.

 

Inventories

 

Inventoried costs on commercial aircraft programs and long-term contracts include direct engineering, production and tooling costs, and applicable overhead, which includes fringe benefits, production related indirect and plant management salaries and plant services, not in excess of estimated net realizable value. To the extent a material amount of such costs are related to an abnormal event or are fixed costs not appropriately attributable to our programs or contracts, they will be expensed in the current period rather than inventoried. In accordance with industry practice, inventoried costs include amounts relating to programs and contracts with long production cycles, a portion of which is not expected to be realized within one year. Included in inventory for federal government contracts is an allocation of allowable costs related to manufacturing process reengineering. We net advances and progress billings on long-term contracts against costs incurred to date for each contract in the Consolidated statements of financial position. Contracts where costs incurred to date exceed advances and progress billings are reported in Inventories, net of advances and progress billings. Contracts where advances and progress billings exceed costs incurred to date are reported in Advances and billings in excess of related costs.

 

Because of the higher unit production costs experienced at the beginning of a new or derivative commercial airplane program (known as the learning curve effect), the actual costs incurred for production of the early units in the program may exceed the amount reported as cost of sales for those units. In addition, the use of a total program gross profit rate to delivered units may result in costs assigned to delivered units in a reporting period being less than the actual cost of those units. The excess actual costs incurred over the amount reported as cost of sales is disclosed as deferred production costs, which are included in inventory along with unamortized tooling costs.

 

The determination of net realizable value of long-term contract costs is based upon quarterly contract reviews that determine an estimate of costs to be incurred to complete all contract requirements. When actual contract costs and the estimate to complete exceed total estimated contract revenues, a loss provision is recorded. The determination of net realizable value of commercial aircraft program costs is based upon quarterly program reviews that determine an estimate of revenue and cost to be incurred to complete the program accounting quantity. When estimated costs to complete exceed estimated program revenues to go, a loss provision is recorded.

 

Used aircraft purchased by the Commercial Airplanes segment and general stock materials are stated at cost not in excess of net realizable value. See ‘Aircraft valuation’ within this Note for our valuation of used aircraft purchased by the Commercial Airplanes segment. Spare parts inventory is stated at lower of average unit cost or market. We review our commercial spare parts and general stock materials each quarter to identify impaired inventory, including excess or obsolete inventory, based on historical sales trends, expected production usage, and the size and age of the aircraft fleet using the part. Impaired inventories are written-off as an expense to Cost of products in the period the impairment occurs.

 

Included in inventory for commercial aircraft programs are amounts paid or credited in cash, or other consideration to certain airline customers, that are referred to as early issue sales consideration. Early

 

56


Table of Contents

issue sales consideration is recognized as a reduction to revenue when the delivery of the aircraft under contract occurs. In the unlikely situation that an airline customer was not able to perform and take delivery of the contracted aircraft, we believe that we would have the ability to recover amounts paid through retaining amounts secured by advances received on aircraft to be delivered. However, to the extent early issue sales consideration exceeds advances and is not considered to be recoverable it would be recognized as a current period expense.

 

Precontract costs

 

We may, from time to time, incur costs to begin fulfilling the statement of work under a specific anticipated contract that we are still negotiating with a customer. If we determine it is probable that we will be awarded the specific anticipated contract, then we capitalize the precontract costs we incur, excluding any start-up costs which are expensed as incurred. Capitalized precontract costs of $40 and $39 at December 31, 2006, and 2005, are included in Inventories, net of advances and progress billings in the accompanying Consolidated Statements of Financial Position.

 

Property, plant and equipment

 

Property, plant and equipment are recorded at cost, including applicable construction-period interest, less accumulated depreciation and are depreciated principally over the following estimated useful lives: new buildings and land improvements, from 10 to 40 years; and new machinery and equipment, from 3 to 20 years. The principal methods of depreciation are as follows: buildings and land improvements, 150% declining balance; and machinery and equipment, sum-of-the-years’ digits. Capitalized internal use software is included in Other assets and amortized using the straight line method over five years. We periodically evaluate the appropriateness of remaining depreciable lives assigned to long-lived assets, including assets that may be subject to a management plan for disposition.

 

We review long-lived assets, which includes property, plant and equipment, for impairment in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS No. 144). Long-lived assets held for sale are stated at the lower of cost or fair value less cost to sell. Long-lived assets held for use are subject to an impairment assessment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If the carrying value is no longer recoverable based upon the undiscounted future cash flows of the asset, the amount of the impairment is the difference between the carrying amount and the fair value of the asset.

 

Asset retirement obligations

 

On December 31, 2005, we adopted Financial Accounting Standards Board (FASB) Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations – an interpretation of FASB Statement No. 143 (FIN 47). In accordance with FIN 47, we record all known asset retirement obligations for which the liability’s fair value can be reasonably estimated, including certain asbestos removal, asset decommissioning and contractual lease restoration obligations. Recorded amounts are not material.

 

We also have known conditional asset retirement obligations, such as certain asbestos remediation and asset decommissioning activities to be performed in the future, that are not reasonably estimable due to insufficient information about the timing and method of settlement of the obligation. Accordingly, these obligations have not been recorded in the consolidated financial statements. A liability for these obligations will be recorded in the period when sufficient information regarding timing and method of settlement becomes available to make a reasonable estimate of the liability’s fair value. In addition, there may be conditional asset retirement obligations that we have not yet discovered (e.g. asbestos may exist in certain buildings but we have not become aware of it through the normal course of business), and therefore, these obligations also have not been included in the consolidated financial statements.

 

57


Table of Contents

Goodwill and other acquired intangibles

 

Goodwill and other acquired intangible assets with indefinite lives are not amortized, but are tested for impairment annually and when an event occurs or circumstances change such that it is reasonably possible that an impairment may exist. Our annual testing date is April 1. In conjunction with our January 1, 2006 IDS segment realignment, we performed a goodwill impairment test in addition to our annual goodwill impairment test. Both tests resulted in no identified impairments.

 

We test goodwill for impairment by first comparing the carrying value of net assets to the fair value of the related operations. If the fair value is determined to be less than carrying value, a second step is performed to compute the amount of the impairment. In this process, a fair value for goodwill is estimated, based in part on the fair value of the operations, and is compared to its carrying value. The shortfall of the fair value below carrying value represents the amount of goodwill impairment.

 

Our finite-lived acquired intangible assets are amortized on a straight-line basis over their estimated useful lives as follows: developed technology, 5 to 12 years; product know-how, 30 years; customer base, 12 to 15 years; and other, 2 to 17 years. In accordance with SFAS No. 144, we evaluate the potential impairment of finite-lived acquired intangible assets when appropriate. If the carrying value is no longer recoverable based upon the undiscounted future cash flows of the asset, the amount of the impairment is the difference between the carrying amount and the fair value of the asset.

 

Investments

 

We classify investments as either operating or non-operating. Operating investments are strategic in nature, which means they are integral components of our operations. Non-operating investments are those we hold for non-strategic purposes. Earnings from operating investments, including our share of income or loss from equity method investments, dividend income from certain cost method investments, and any gain/loss on the disposition of these investments, are recorded in Income from operating investments, net. Other income on our Consolidated Statements of Operations consists primarily of income from non-operating investments, such as interest and dividends on marketable securities, as well as interest income related to income taxes. See Note 6.

 

Available-for-sale securities including marketable debt and equity securities and Enhanced Equipment Trust Certificates (EETCs) are recorded at their fair values and unrealized gains and losses are reported as part of Accumulated other comprehensive loss on the Consolidated Statements of Financial Position. Realized gains and losses on marketable securities are recognized based on the shares whose cost is closest to our average cost of the specific security. Realized gains and losses on all other available-for-sale securities are recognized based on specific identification.

 

The fair value of marketable securities is based on quoted market prices. The fair value of non-publicly traded securities, including certain EETCs, is based on discounted cash flows at market yield. In cases when we determine that it is probable that recovery of our investment will come from recovery of collateral, the fair value is based on the underlying collateral.

 

Available-for-sale securities are assessed for impairment quarterly. To determine if an impairment is other than temporary we consider the duration of the loss position, the strength of the underlying collateral, the term to maturity, and credit ratings. For investments that are deemed other-than-temporarily impaired, losses are recorded in Cost of products or Cost of services and payments received on these investments are recorded using the cost recovery method.

 

Equity Method Investments The equity method of accounting is used to account for investments for which we have the ability to exercise significant influence, but not control, over an investee. Significant influence is generally deemed to exist if we have an ownership interest in the voting stock of an investee of between 20% and 50%.

 

58


Table of Contents

Derivatives

 

All derivative instruments are recognized in the financial statements and measured at fair value regardless of the purpose or intent of holding them. We use derivative instruments to principally manage a variety of market risks. We record our interest rate swaps, non-U.S. currency swaps and commodity contracts at fair value based on discounted cash flow analysis. For derivatives designated as hedges of the exposure to changes in the fair value of a recognized asset or liability or a firm commitment (referred to as fair value hedges), the gain or loss is recognized in earnings in the period of change together with the offsetting loss or gain on the hedged item attributable to the risk being hedged. The effect of that accounting is to reflect in earnings the extent to which the hedge is not effective in achieving offsetting changes in fair value. For our cash flow hedges, the effective portion of the derivative’s gain or loss is initially reported in shareholders’ equity (as a component of Accumulated other comprehensive loss) and is subsequently reclassified into earnings in the same period or periods during which the hedged forecasted transaction affects earnings. The ineffective portion of the gain or loss of a cash flow hedge is reported in earnings immediately. We also hold certain instruments for economic purposes that do not qualify for hedge accounting treatment. For these derivative instruments as well as other derivatives not receiving hedge accounting treatment, the changes in their fair value are also recorded in earnings.

 

Aircraft valuation

 

Used aircraft under trade-in commitments and aircraft under repurchase commitments 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 upon 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, 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 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. Our historical experience is that no contingent repurchase agreements have become trade-in commitments.

 

All trade-in commitments at December 31, 2006 and 2005 are solely attributable to Sale Aircraft and did not originate from contingent repurchase agreements. Exposure related to trade-in commitments may take the form of:

 

  (1)  

Adjustments to revenue for the difference between the contractual trade-in price in the definitive agreement and our best estimate of the fair value of the trade-in aircraft as of the date of such agreement, which are recorded in Inventory and recognized upon delivery of the Sale Aircraft, and/or

 

  (2)  

Charges to cost of products for adverse changes in the fair value of trade-in aircraft that occur subsequent to signing of a definitive agreement for Sale Aircraft but prior to the purchase of the used trade-in aircraft. Estimates based on current aircraft values are included in Accounts payable and other liabilities.

 

The fair value of trade-in aircraft is determined using aircraft specific data such as, model, age and condition, market conditions for specific aircraft and similar models, and multiple valuation sources. This process uses our assessment of the market for each trade-in aircraft, which in most instances begins years before the return of the aircraft. There are several possible markets in which we continually pursue opportunities to place used aircraft. These markets include, but are not limited to, the resale market, which could potentially include the cost of long-term storage; the leasing market,

 

59


Table of Contents

with the potential for refurbishment costs to meet the leasing customer’s requirements; or the scrap market. Trade-in aircraft valuation varies significantly depending on which market we determine is most likely for each aircraft. On a quarterly basis, we update our valuation analysis based on the actual activities associated with placing each aircraft into a market. This quarterly valuation process yields results that are typically lower than residual value estimates by independent sources and tends to more accurately reflect results upon the actual placement of the aircraft.

 

Used aircraft acquired by the Commercial Airplanes segment are included in Inventories at the lower of cost or market as it is our intent to sell these assets. To mitigate costs and enhance marketability, aircraft may be placed on operating lease. While on operating lease, the assets are included in Customer financing, however, the valuation continues to be based on the lower of cost or market. The lower of cost or market assessment is performed quarterly using the process described above.

 

Asset valuation for assets under operating lease, assets held for sale or re-lease and collateral underlying receivables Included in Customer financing are operating lease equipment, notes receivables and sales-type/financing leases. Sales-type/financing leases are treated as receivables, and allowances are established as necessary.

 

We assess the fair value of the assets we own, including equipment under operating leases, assets held for sale or re-lease and collateral underlying receivables, to determine if their fair values are less than the related assets’ carrying values. Differences between carrying values and fair values of finance leases and notes and other receivables, as determined by collateral value, are considered in determining the allowance for losses on receivables.

 

We use a median calculated from published collateral values from multiple third-party aircraft evaluations based on the type and age of the aircraft to determine the fair value of aircraft. Under certain circumstances, we apply judgment based on the attributes of the specific aircraft or equipment, usually when the features or use of the aircraft vary significantly from the more generic aircraft attributes covered by outside publications.

 

Impairment review for assets under operating leases and held for sale or re-lease When events or circumstances indicate, we evaluate assets under operating lease or held for re-lease for impairment utilizing an expected undiscounted cash flow analysis. We use various assumptions when determining the expected undiscounted cash flow including our intention to hold or dispose of an asset before the end of its economic useful life, the expected future lease rates, lease terms, residual value of the aircraft or equipment, periods in which the asset may be held in preparation for a follow-on lease, maintenance costs, remarketing costs and the remaining economic life of the asset. We state assets held for sale at the lower of carrying value or fair value less costs to sell.

 

When we determine that impairment is indicated for an asset, the amount of asset impairment expense recorded is the excess of the carrying value over the fair value of the asset.

 

Allowance for losses on receivables We record the potential impairment of receivables in our portfolio in a valuation account, the balance of which is an accounting estimate of probable but unconfirmed losses in the receivables portfolio. The allowance for losses on receivables relates to two components of receivables: (a) specifically identified receivables that are evaluated individually for impairment and (b) all other receivables.

 

We determine a receivable is impaired when, based on current information and events, it is probable that we will be unable to collect amounts due according to the original contractual terms of the receivable agreement, without regard to any subsequent restructurings. Factors considered in assessing collectibility include, but are not limited to, a customer’s extended delinquency, requests for

 

60


Table of Contents

restructuring and filings for bankruptcy. We determine a specific impairment allowance based on the difference between the carrying value of the receivable and the estimated fair value of the related collateral.

 

We review the adequacy of the allowance attributable to the remaining other receivables (after excluding receivables subject to a specific impairment allowance) by assessing both the collateral exposure and the applicable cumulative default rate. Collateral exposure for a particular receivable is the excess of the carrying value of the receivable over the fair value of the related collateral. A receivable with an estimated fair value in excess of the carrying value is considered to have no collateral exposure. The applicable cumulative default rate is determined using two components: customer credit ratings and weighted average remaining contract term. Credit ratings are determined for each customer in the portfolio. Those ratings are updated based upon public information and information obtained directly from our customers.

 

We have entered into agreements with certain customers that would entitle us to look beyond the specific collateral underlying the receivable for purposes of determining the collateral exposure as described above. Should the proceeds from the sale of the underlying collateral asset resulting from a default condition be insufficient to cover the carrying value of our receivable (creating a shortfall condition), these agreements would, for example, permit us to take the actions necessary to sell or retain certain other assets in which the customer has an equity interest and use the proceeds to cover the shortfall.

 

Each quarter, we review customer credit ratings, published historical credit default rates for different rating categories, and third-party aircraft valuations as a basis to validate the reasonableness of the allowance for losses on receivables. There can be no assurance that actual results will not differ from estimates or that the consideration of these factors in the future will not result in an increase or decrease to the allowance for losses on receivables.

 

Supplier Penalties

 

We record an accrual for supplier penalties when an event occurs that makes it probable that a supplier penalty will be incurred and the amount is reasonably estimable. Until an event occurs, we fully anticipate accepting all products procured under production related contracts.

 

Guarantees

 

We account for guarantees in accordance with FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. We record a liability for the fair value of guarantees in Accounts Payable and other liabilities that are issued or modified after December 31, 2002. For a residual value guarantee where we received a cash premium, the liability is equal to the cash premium received at the guarantee’s inception. For credit and performance guarantees, the liability is equal to the present value of the expected loss. For each future period the credit or performance guarantee will be outstanding, we determine the expected loss by multiplying the creditor’s default rate by the guarantee amount reduced by the expected recovery, if applicable. If at inception of a guarantee we determine there is a probable related contingent loss, we will recognize a liability for the greater of (a) the fair value of the guarantee as described above or (b) the probable contingent loss amount.

 

Note 2 – Standards Issued and Not Yet Implemented

 

In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FIN 48 prescribes a more-likely-than-not

 

61


Table of Contents

threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income taxes in interim periods, and income tax disclosures. This Interpretation is effective as of January 1, 2007 and the cumulative effects of applying this Interpretation will be recorded as an adjustment to retained earnings as of January 1, 2007. Additional guidance from the FASB on FIN 48 is pending. As a result, we are currently unable to finalize our estimate of the impact that adopting this Interpretation will have on our financial statements.

 

Note 3 – Acquisition

 

On September 20, 2006, we acquired all of the outstanding shares of Aviall, Inc. (Aviall) for $1,780, including transaction fees totaling $46. Aviall is an independent provider of new aviation parts and services in the aerospace industry. Its capabilities include global parts distribution and supply chain services for aerospace, defense and marine industries worldwide. The Aviall acquisition is intended to complement existing offerings in our Commercial Airplanes and IDS Support Systems reporting segments. The acquisition of Aviall was accounted for under the purchase method of accounting and the results of operations from the acquisition date are included in Commercial Airplanes’ and IDS’ Support Systems reporting segments.

 

The allocation of the purchase price is as follows:

 

Accounts receivable

   $ 200  

Net inventory

     539  

Other current assets

     64  

Property, plant and equipment

     17  

Goodwill

     1,055  

Finite-lived intangible assets (primarily contractual supplier and customer relationships) 1

     519  

Indefinite-lived intangible assets not subject to amortization (Aviall brand and trade names)

     302  

Other assets

     42  

Accounts payable

     (196 )

Other current liabilities

     (79 )

Debt acquired and repaid

     (458 )

Other long-term liabilities

     (225)  

Total net assets acquired

   $ 1,780  
   

 

1

 

The weighted average amortization period for finite-lived intangible assets is 11 years.

 

62


Table of Contents

Note 4 – Goodwill and Acquired Intangibles

 

Changes in the carrying amount of goodwill by reportable segment for the years ended December 31, 2006, 2005 and 2004 were as follows:

 

      Commercial
Airplanes
    Precision
Engagement
& Mobility
Systems
    Network
& Space
Systems
    Support
Systems
   Other     Total  

Balance at January 1, 2004

   $ 282     $ 588     $ 922     $ 118    $ 3     $ 1,913  

Goodwill Adjustments

       25       2            27  

Acquisitions

       11              11  

Impairment Losses

                                    (3 )     (3 )

Balance at December 31, 2004

   $ 282     $ 624     $ 924     $ 118            $ 1,948  

Goodwill Adjustments

     21       (13 )     (18 )     11        1  

Divestitures

     (23 )             (2 )                    (25 )

Balance at December 31, 2005

   $ 280     $ 611     $ 904     $ 129            $ 1,924  

Aviall acquisition

     1,014           41        1,055  

Other 1

     71               (3 )                    68  

Balance at December 31, 2006

   $ 1,365     $ 611     $ 901     $ 170      $ 3,047  
   

 

1

 

The increase in goodwill is primarily the result of an acquisition in the second quarter 2006. The purchase price allocation for this acquisition was finalized in the fourth quarter of 2006.

 

The gross carrying amounts and accumulated amortization of our other acquired finite-lived intangible assets were as follows at December 31:

 

     2006    2005
      Gross
Carrying
Amount
   Accumulated
Amortization
   Gross
Carrying
Amount
   Accumulated
Amortization

Developed technology

   $ 615    $ 369    $ 576    $ 312

Product know-how

     308      64      308      54

Customer base

     307      51      96      34

Other

     536      83      173      75
   $ 1,766    $ 567    $ 1,153    $ 475
 

 

Amortization expense for acquired finite-lived intangible assets for the years ended December 31, 2006 and 2005 was $100 and $91. Estimated amortization expense for the five succeeding years are as follows: 2007 – $148; 2008 – $148; 2009 – $147; 2010 – $129 and 2011 – $86.

 

As of December 31, 2006 and 2005, we had indefinite-lived intangible assets with carrying amounts of $499 and $197.

 

63


Table of Contents

Note 5 – Earnings Per Share

 

The weighted-average number of shares outstanding (in millions) for the years ended December 31, used to compute earnings per share are as follows:

 

      2006    2005    2004

Weighted-average shares outstanding

   760.5    779.4    800.2

Participating securities

   10.5    9.1    6.8

Basic weighted-average shares outstanding

   771.0    788.5    807.0

Diluted potential common shares

   16.6    14.4    6.0

Diluted weighted-average shares outstanding

   787.6    802.9    813.0
 

 

The numerator used to compute diluted earnings per share is as follows:

 

      2006    2005    2004

Net earnings

   $ 2,215    $ 2,572    $ 1,872

Expense related to diluted shares

     27              

Total numerator

   $ 2,242    $ 2,572    $ 1,872
 

 

Expense related to diluted shares in the amount of $27 in 2006 represented mark-to-market adjustment of performance share payouts to employees terminated as of December 31, 2005.

 

Basic earnings per share is calculated by the sum of (1) net income less declared dividends divided by the basic weighted average shares outstanding and (2) declared dividends divided by the weighted average shares outstanding.

 

The weighted-average number of shares outstanding for the year ended December 31 (in millions), included in the table below, is excluded from the computation of diluted earnings per share because the average market price did not exceed the exercise/threshold price. However, these shares may be dilutive potential common shares in the future.

 

      2006    2005    2004

Stock options

      0.2    10.9

Stock units

   0.1      

Performance Shares

   4.0    24.9    28.6

Performance Awards

   1.4      

ShareValue Trust

   24.6    33.9    38.4
 

 

Note 6 – Income Taxes

 

The components of earnings before income taxes were:

 

Year ended December 31,    2006    2005    2004

U.S.

   $ 3,067    $ 2,605    $ 1,960

Non-U.S.

     127      214       
   $ 3,194    $ 2,819    $ 1,960
 

 

Note: The 2004 non-U.S. earnings before income tax amounts are not significant and as such are reflected in the U.S. numbers shown above.

 

64


Table of Contents

Income tax expense/(benefit) consisted of the following:

 

Year ended December 31,    2006     2005     2004  

Current tax expense

      

U.S. federal

   $ 193     $ (276 )   $ (435 )

Non-U.S.

     35       58    

U.S. state

     (58 )     (86 )     (58 )
       170       (304 )     (493 )

Deferred tax expense

      

U.S. federal

     750       547       787  

Non-U.S.

     (6 )     (120 )  

U.S. state

     74       134       (154 )
       818       561       633  

Total income tax expense

   $ 988     $ 257     $ 140  
   

 

Note: The 2004 non-U.S. income tax expense/(benefit) amounts are not significant and as such are reflected in the U.S. numbers shown above.

 

The following is a reconciliation of the U.S. federal statutory tax rate of 35% to our recorded income tax expense/(benefit):

 

Year ended December 31,    2006     2005     2004  

U.S. federal statutory tax

   35.0 %   35.0 %   35.0 %

Global Settlement with U.S. Department of Justice

   6.7      

Foreign Sales Corporation/Extraterritorial Income tax benefit

   (5.8 )   (5.6 )   (8.6 )

Research benefit

   (0.7 )   (1.2 )   (1.4 )

Federal audit settlement

   (1.5 )   (13.1 )   (7.5 )

State income tax provision, net of effect on U.S. federal tax

   0.4     1.1     (7.0 )

Change in valuation allowances

     (3.2 )  

Other provision adjustments

   (3.2 )   (3.9 )   (3.4 )

Income tax expense

   30.9 %   9.1 %   7.1 %
   

 

Significant components of our deferred tax assets, net of deferred tax liabilities, at December 31 were as follows:

 

      2006     2005  

Retiree health care accruals

   $ 3,257     $ 2,314  

Inventory and long-term contract methods of income recognition

     640       1,368  

Other employee benefits accruals

     1,473       1,363  

In-process research and development related to acquisitions

     124       137  

Net operating loss, credit, and charitable contribution carryovers (net of valuation allowance of $2 and $0)

     319       494  

Pension benefit accruals

     (397 )     (3,688 )

Customer and commercial financing

     (1,517 )     (1,442 )

Unremitted earnings of non-U.S. subsidiaries

     (48 )     (32 )

Other net unrealized losses

     37       8  

Net deferred tax assets1

   $ 3,888     $ 522  
   

 

1

Of the deferred tax asset for net operating loss and credit carryovers, $172 expires in years ending from December 31, 2007 through December 31, 2026 and $147 may be carried over indefinitely.

 

65


Table of Contents

 

Net deferred tax assets at December 31 were as follows:

 

      2006     2005  

Deferred tax assets

   $ 12,174     $ 8,168  

Deferred tax liabilities

     (8,284 )     (7,646 )

Valuation allowance

     (2 )        

Net deferred tax assets

   $ 3,888     $ 522  
   

 

As a result of acquisitions in 2006, primarily related to Aviall, a net deferred tax liability of $171 was recorded.

 

As required under SFAS 123R, a deferred tax liability of $306 was reclassified to Additional paid in capital. This represents the tax effect of the net excess tax pool created during 2006 due to share awards paid with a fair market value in excess of the book accrual for those awards.

 

Net income tax payments/(refunds) were $28, ($344) and ($903) in 2006, 2005 and 2004, respectively.

 

We have provided for U.S. deferred income taxes and foreign withholding tax in the amount of $48 on undistributed earnings not considered permanently reinvested in our non-U.S. subsidiaries. We have not provided for U.S. deferred income taxes or foreign withholding tax on the remainder of undistributed earnings from our non-U.S. subsidiaries because such earnings are considered to be permanently reinvested and it is not practicable to estimate the amount of tax that may be payable upon distribution.

 

Within the Consolidated Statements of Operations, Other income included interest of $16 in 2006, $100 in 2005 and $219 in 2004 related to federal income tax settlements for prior years.

 

Contingencies

 

We are subject to income taxes in the U.S. and numerous non-U.S. jurisdictions.

 

Amounts accrued for potential tax assessments recorded in current tax liabilities total $960 and $900 at December 31, 2006 and 2005. Accruals relate to tax issues for U.S. federal, U.S. state, and taxation of non-U.S. earnings as follows:

 

·  

The accruals associated with U.S. federal tax issues such as the tax benefits from the Foreign Sales Corporation/Extraterritorial Income (FSC/ETI) tax rules, the amount of research and development tax credits claimed, U.S. taxation of non-U.S. earnings, and valuation issues regarding charitable contributions claimed were $841 at December 31, 2006, and $771 at December 31, 2005. IRS examinations have been completed through 2001. We have filed an appeal with the IRS for 1998-2001. During 2006, we settled the McDonnell Douglas Corporation appeal for 1993-1997 which had the effect of decreasing federal income tax expense by $46.

 

·  

The accruals for domestic state tax issues such as the allocation of income among various state tax jurisdictions and the amount of state tax credits claimed were $88 at December 31, 2006 and $98 at December 31, 2005, net of federal benefit.

 

·  

The accruals associated with taxation of non-U.S. earnings were $31 at December 31, 2006 and 2005.

 

We believe adequate provisions for all outstanding issues have been made for all jurisdictions and all open years.

 

66


Table of Contents

Legislative Update

 

On May 17, 2006, the Tax Increase Prevention and Reconciliation Act of 2005 was enacted, which repealed the FSC/ETI exclusion tax benefit binding contract provisions of the American Jobs Creation Act of 2004. Therefore, 2006 will be the final year for recognizing any export tax benefits. The 2006 effective tax rate was reduced by 5.8% due to export tax benefits.

 

Effective December 31, 2005, the U.S. research tax credit expired. On December 20, 2006, President Bush signed into law, the Tax Relief and Health Care Act of 2006 that retroactively renews the research tax credit for 2006 and extends the credit through December 31, 2007.

 

Note 7 – Accounts Receivable

 

Accounts receivable at December 31 consisted of the following:

 

      2006     2005  

U.S. Government contracts

   $ 2,667     $ 2,620  

Commercial and customers

     1,423       1,155  

Other

     1,278       1,561  

Less valuation allowance

     (83 )     (90 )
   $ 5,285     $ 5,246  
   

 

The following table summarizes our accounts receivable under long-term contracts that were not billable or related to outstanding claims as of December 31:

 

      2006    2005

Unbillable

     

Current

   $ 830    $ 687

Expected to be collected after one year

     705      404
   $ 1,535    $ 1,091
 

Claims

     

Current

   $ 10    $ 15

Expected to be collected after one year

     84      90
   $ 94    $ 105
 

 

Unbillable receivables on long-term contracts arise when the sales or revenues based on performance attainment, though appropriately recognized, cannot be billed yet under terms of the contract as of the balance sheet date. Accounts receivable related to claims are items that we believe are earned, but are subject to uncertainty concerning their determination or ultimate realization. Accounts receivable, other than those described above, expected to be collected after one year are not material.

 

As of December 31, 2006 and 2005, other accounts receivable included $538 and $621 of reinsurance receivables held by Astro Ltd., a wholly-owned subsidiary, which operates as a captive insurance company. Other also included $308 and $650 at December 31, 2006 and 2005, related to non-U.S. military contracts.

 

67


Table of Contents

Note 8 – Inventories

 

Inventories at December 31 consisted of the following:

 

      2006     2005  

Long-term contracts in progress

   $ 12,329     $ 14,194  

Commercial aircraft programs

     8,743       7,745  

Commercial spare parts, used aircraft, general stock materials and other

     2,888       2,235  
     23,960       24,174  

Less advances and progress billings

     (15,855 )     (16,296 )
   $ 8,105     $ 7,878  
   

 

Included in long-term contracts in progress inventories at December 31, 2006, are Delta launch program inventories of $1,860 that will be sold at cost to United Launch Alliance L.L.C. (ULA) under an inventory supply agreement that terminates on March 31, 2021. We have agreed to indemnify ULA in the event that these inventories are not recoverable from existing and future orders; however,