Boeing Company 10-K 2010
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the fiscal year ended December 31, 2009
For the transition period from to
Commission file number 1-442
THE BOEING COMPANY
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code (312) 544-2000
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 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 registrants 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, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. Large accelerated filer x Accelerated filer ¨
Non-accelerated filer ¨ (Do not check if a smaller reporting company) Smaller reporting company ¨
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, 2009, there were 697,288,343 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 $29.6 billion.
The number of shares of the registrants common stock outstanding as of February 1, 2010 was 756,976,242.
(This number includes 30 million outstanding shares held by the ShareValue Trust which are not eligible to vote.)
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates information by reference to the registrants definitive proxy statement, to be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year ended December 31, 2009.
Index to the Form 10-K
For the Fiscal Year Ended December 31, 2009
Item 1. Business
The Boeing Company, together with its subsidiaries (herein referred to as Boeing, the Company, we, us, our), is one of the worlds major aerospace firms.
We are organized based on the products and services we offer. We operate in five principal segments:
Our Other segment classification principally includes the activities of Engineering, Operations & Technology (EO&T) and certain intercompany items. EO&T is an advanced research and development organization focused on innovative technologies, improved processes and the creation of new products.
Commercial Airplanes Segment
The Commercial Airplanes segment develops, produces and markets commercial jet aircraft and provides 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 narrow-body model and the 747, 767, 777 and 787 wide-body models. The Commercial Airplanes segment also offers aviation services support, aircraft modifications, spares, training, maintenance documents and technical advice to commercial and government customers worldwide.
Boeing Defense, Space & Security
On January 7, 2010, we announced that Integrated Defense Systems will begin operating under the name Boeing Defense, Space & Security (BDS). Our BDS operations principally involve research, development, production, modification and support of the following products and related systems: global strike systems, including fighters, bombers, weapons and unmanned systems; global mobility systems, including transport and tanker aircraft; rotorcraft systems, including transport, combat and tilt-rotor aircraft; airborne surveillance and reconnaissance aircraft, including command and control, battle management and airborne anti-submarine aircraft; network and tactical systems, including information and battle management systems; intelligence and security systems; missile defense systems; space and intelligence systems, including satellites and commercial satellite launching vehicles; and space exploration. BDS is committed to providing affordable, best-of-industry solutions and brings value to customers through its ability to solve the most complex problems utilizing expertise in large-scale systems integration, knowledge of legacy platforms and development of common network-enabled solutions across all customers domains. BDS primary customer is the United States Department of Defense (U.S. DoD) with approximately 80% of BDS 2009 revenues being derived from this customer. Other significant revenues were derived from the National Aeronautics and Space Administration (NASA) and international defense markets, civil markets and commercial satellite markets.
Boeing Military Aircraft Segment
This segment is engaged in the research, development, production and modification of military aircraft and precision engagement and mobility products and services. Included in this segment are the AH-64 Apache, Airborne Early Warning and Control (AEW&C), CH-47 Chinook, C-17 Globemaster, EA-18G Growler Airborne Attack Electronic Aircraft, F/A-18E/F Super Hornet, F-15 Strike Eagle, F-22 Raptor, Harpoon, International KC-767 Tanker, Joint Direct Attack Munition, P-8A Poseidon, Small Diameter Bomb, T-45 TS Goshawk and V-22 Osprey.
Network & Space Systems 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 the Airborne Laser, Family of Advanced Beyond Line-of-Sight Terminals (FAB-T), Brigade Combat Team Modernization (BCTM) (formerly Future Combat Systems (FCS)), Future Rapid Effects System, Global Positioning System, Ground-based Midcourse Defense (GMD), International Space Station, Joint Tactical Radio System (JTRS), Satellite Systems, SBInet, Space Payloads and Space Shuttle.
Global Services & Support 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 the following activities: Integrated Logistics on platforms including AH-64, AV-8B, C-17, CH-47, F-15, F/A-18, F-22, GMD, International 767 Tanker and V-22; Maintenance, Modifications and Upgrades on platforms including A-10, B-1, B-52, C-32, C-40, C-130, E-4B, E-6, KC-10, KC-135, T-38 and VC-25; Training Systems and Services on platforms including AH-64, C-17, F-15, F-16, F/A-18 and T-45; and International Support and Advanced Global Services and Support.
Boeing Capital Corporation Segment
In the commercial aircraft market, BCC facilitates, arranges, structures and provides selective financing solutions for our Commercial Airplanes customers. In the space and defense markets, BCC primarily arranges and structures financing solutions for our BDS government customers. BCCs portfolio consists of equipment under operating leases, finance leases, notes and other receivables, assets held for sale or re-lease and investments.
Financial and Other Business Information
See the Summary of Business Segment Data and Note 21 to the Consolidated Financial Statements for financial information, including revenues and earnings from operations, for each of the major business segments.
We own numerous patents and have licenses for the use of patents owned by others, which relate to our products and their manufacture. In addition to owning a large portfolio of intellectual property, we also license intellectual property to and from third parties. For example, the U.S. government has licenses in our patents that are developed in performance of government contracts, and it may use or authorize others to use the inventions covered by such patents for government purposes. Unpatented research, development and engineering skills, as well as certain trademarks and other intellectual property rights, also make an important contribution to our business. While our intellectual property
rights in the aggregate are important to the operation of each of our businesses, we do not believe that our business would be materially affected by the expiration of any particular intellectual property rights or termination of any particular intellectual property patent license agreements.
See Note 21 to the Consolidated Financial Statements for information regarding non-U.S. sales.
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 are expensed as incurred including amounts allocable as reimbursable overhead costs on U.S. government contracts.
Our total research and development expense amounted to $6.5 billion, $3.8 billion and $3.9 billion in 2009, 2008 and 2007, respectively. These amounts are net of 787-related research and development cost sharing payments from suppliers of $0, $50 million and $130 million in 2009, 2008 and 2007, respectively. Research and development expense in 2009 includes $2.7 billion of production costs related to the first three flight test 787 aircraft that cannot be sold due to the inordinate amount of rework and unique and extensive modifications made to the aircraft.
Research and development costs also include bid and proposal efforts related to government products and services, as well as costs incurred in excess of amounts estimated to be recoverable under cost-sharing research and development agreements. Bid and proposal costs were $343 million, $330 million and $306 million in 2009, 2008 and 2007, respectively.
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 38.
Total workforce level at December 31, 2009 was 157,100.
As of December 31, 2009, our principal collective bargaining agreements were with the following unions:
The commercial jet aircraft market and the airline industry remain extremely competitive. We face aggressive international competitors, including Airbus, who are intent on increasing their 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 to provide a higher level of customer satisfaction and productivity.
BDS faces strong competition in all market segments, primarily from Lockheed Martin Corporation, Northrop Grumman Corporation, Raytheon Company and General Dynamics Corporation. Non-U.S. companies such as BAE Systems and European Aeronautic Defence and Space Company (EADS), the parent of Airbus, continue to pursue a strategic presence in the U.S. market by strengthening their North American operations and partnering with U.S. defense companies. In addition, certain of our competitors have occasionally formed teams with other competitors to address specific customer requirements. BDS expects the trend of strong competition to continue into 2010 with many international firms pursuing announced intentions of increasing their U.S. presence.
Our businesses are heavily regulated in most of our markets. We deal with numerous U.S. government agencies and entities, including but not limited to all of the branches of the U.S. military, NASA and the Department of Homeland Security. Similar government authorities exist in our international markets.
U.S. Government Contracts. 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 to ensure our operations are in substantial compliance with all applicable environmental laws and regulations.
Operating and maintenance costs associated with environmental compliance and management of sites are a normal, recurring part of our operations. These costs often are allowable costs under our contracts with the U.S. government. It is reasonably possible that continued environmental compliance could have a material impact on our results of operations, financial condition or cash flows if more stringent clean-up standards are imposed, additional contamination is discovered and/or clean-up costs are higher than estimated.
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 11 to the Consolidated Financial Statements.
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.
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 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 companies.
We are dependent upon the ability of a large number 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 program/contract profitability, thereby 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. A number of our suppliers have made assertions for higher prices or other contractual compensation relief which could affect program/contract profitability.
No material portion of our business is considered to be seasonal.
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 SECs public reference room at 100 F Street, N.E., 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.
This report, as well as our Annual Report to Shareholders, quarterly reports, press releases and other written and oral communications, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as may, will, should, expects, intends, projects, believes, estimates, targets, anticipates and similar expressions are used to identify these forward-looking statements. Forward-looking statements include any statement that does not directly relate to any historical or current fact.
Forward-looking statements are based on our current expectations and assumptions, which may not prove to be accurate. These statements are not guarantees and are subject to risks, uncertainties and changes in circumstances that are difficult to predict. Many factors, including those set forth in the Risk Factors section below, could cause actual results to differ materially and adversely from these forward-looking statements. Any forward-looking statement herein speaks only as of the date on which it is made, and we assume no obligation to publicly update any forward-looking statement, except as required by law.
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 airline 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 can make no assurance that any customer will purchase additional products or services from us after our contract with the customer ends. In addition, financial difficulties, including bankruptcy, of any of the major commercial airlines could significantly reduce our revenues, even under existing contracts, and limit our opportunity to generate profits from those customers. Several commercial airlines, including certain of our customers, have filed for or emerged from bankruptcy protection.
Our ability to deliver aircraft on time depends on a variety of factors, 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) and internally and supplier produced parts and structures, 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 adversely affect production schedules and program/contract profitability, the latter through increased costs as well as possible customer and/or supplier claims or assertions. In addition, the introduction of new commercial aircraft programs and major derivative aircraft involves increased risk associated with meeting development, production and certification schedules. For example, recent modifications required on the side-of-body section of our 787 aircraft have resulted in testing and delivery delays.
Market conditions have a significant impact on our ability to sell aircraft into the future. The worldwide market for commercial jet aircraft is predominantly driven by long-term trends in airline passenger and cargo 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 aircraft purchase agreements that may, for a variety of reasons, become the subject of cancellation, modification or rescheduling. Changes in the economic environment and the financial condition of the airline industry and our customers could result in customer requests to reschedule or cancel contractual orders. Our contracts have specific provisions relating to schedule and performance and failure to deliver airplanes in accordance with such provisions could result in cancellations and/or claims for compensation. Any such cancellations, modification, rescheduling or claims could significantly reduce our backlog, revenues, profitability and cash flows.
Our commercial aircraft production rates could change. Production rate reductions could cause us to incur disruption and other costs and result in infrastructure costs being allocated to a smaller quantity of airplanes, all of which could reduce our profitability. The introduction of new aircraft program and/or higher orders for our aircraft could lead to production rate increases in order to meet the delivery schedules. Failure to successfully implement any production rate changes could lead to extended delivery commitments, and depending on the length of delay in meeting delivery commitments, additional costs and customers rescheduling their deliveries or terminating their related contract with us.
We depend heavily on U.S. government contracts, which are subject to unique risks.
In 2009, 43% 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 last several years; however, these programs are normally funded annually. Changes in military strategy and priorities may affect our future procurement opportunities and existing programs. Long-term government contracts and related orders are subject to cancellation, or delay, if appropriations for subsequent performance periods are not made. In addition, the U.S. DoD budget is under pressure due to competing national priorities. The termination or reduction of funding for existing or new U.S. government programs could result in a material adverse effect on our earnings, cash flow and financial position.
The U.S. government may modify, curtail or terminate our contracts. The U.S. government may modify, curtail or terminate its contracts and subcontracts with us, without prior notice and at its convenience upon payment for work done and commitments made at the time of termination. Modification, curtailment or termination of one or more 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 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 BDS and most of our contracts in Commercial Airplanes are on a fixed-price basis. Approximately 50% of BDS revenues are generated from fixed-price contracts. While firm fixed price contracts enable us to benefit from performance improvements, cost reductions and efficiencies, they also subject us to the risk of reduced margins or incurring losses if we are unable to achieve estimated costs and revenues. If our estimated costs exceed our estimated price, we recognize reach-forward losses which can significantly affect our reported results.
The long term nature of many of our contracts and programs makes the process of estimating costs and revenues on fixed price contracts inherently risky. For example commercial jet aircraft are normally sold on a firm fixed-price basis with an indexed price escalation clause. These escalation clauses account for economic fluctuations over the period of time from sale to delivery which can span many years. A price escalation formula based on pre-defined factors is used to determine the final price of the airplane at the time of customer delivery. Changes in future estimates of the underlying price escalation index can significantly impact estimated revenues and margins in any quarter. Fixed price contracts in our BDS business often contain price incentives and penalties tied to performance which can be difficult to estimate and have significant impacts on margins. 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, our sales price could be reduced, which would adversely affect our financial condition.
Fixed-price development work inherently has more uncertainty than work pursuant to production contracts and, therefore, more variability in estimates of the cost to complete the work. Fixed price development contracts inherently have more uncertainty than fixed price production contracts. Examples of significant BDS fixed-price development contracts include AEW&C, International KC-767 Tankers and commercial and military satellites. Examples of significant Commercial Airplanes development programs include the 787 and 747-8. Many of these development programs have very complex designs. As technical or quality issues arise, we may experience schedule delays and higher costs to complete. Additionally, price escalation factors may also impact margins by reducing the estimated price of airplanes delivered in the future. Both of these factors may ultimately result in a material charge if the program has or is determined to have a reach forward loss. Successful performance 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, the price we will eventually be paid and, in the case of commercial programs, the number of units to include in the initial accounting quantity. 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. Changes to estimates of the program accounting quantity, production costs and rates, learning curve, costs of derivative aircraft, customer negotiations/settlements, supplier claims and certification issues could also result in lower margins or reach-forward losses. We may continue to experience technical and quality issues requiring further delays in schedule or revisions to our cost estimates.
On Commercial Airplanes development programs our ability to sell test aircraft or initial units produced can also affect our results. For example in 2009 we determined that three of the 787 flight test aircraft could not be sold. This resulted in $2.7 billion being accounted for as research and development expense as opposed to being capitalized as inventory. Our inability to sell additional test aircraft could increase future research and development expenses.
We enter into cost-type contracts which also carry risks.
Approximately 50% of BDS revenues are generated from cost-type contracting arrangements. Some of these are development programs that 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, BCTM (formerly FCS), P-8A Poseidon, Proprietary programs, Airborne Laser, JTRS, FAB-T and the EA-18G Growler.
We enter into contracts that include in-orbit incentive payments that subject us to risks.
Contracts in the commercial satellite industry and certain government satellite contracts include in-orbit incentive payments. 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 payment 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 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, material 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. Suppliers assertions are also assessed and considered in estimating costs and profit rates. 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 limited by the ability to make reasonably dependable estimates. 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. Such estimates are
reconsidered throughout the life of our programs. Changes in underlying assumptions, supplier performance, circumstances or estimates concerning the selection of the 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 Managements Discussion and AnalysisCritical Accounting PoliciesContract Accounting/Program Accounting on pages 43-45 and Note 1 to the Consolidated Financial Statements on pages 56-57 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 in the United States of America (GAAP) 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 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 Managements Discussion and AnalysisCritical Accounting PoliciesPostretirement Plans on pages 46-47 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 or common stock we 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 and our suppliers workforces are represented by labor unions, which may lead to work stoppages.
Approximately 57,000 employees, which constitute approximately 36% of our total workforce, are union represented as of December 31, 2009. We experienced a work stoppage in 2008 when a labor strike halted commercial aircraft and certain BMA program 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 14 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. Union actions at suppliers can also affect us. Work stoppages and instability in our union relationships could delay the production and/or development of our products, which could strain relationships with customers and cause a loss of revenues which would adversely affect our 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 2009, sales to non-U.S. customers accounted for approximately 42% 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:
While the impact of these factors is 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 and of government inquiries and investigations involving our business is unpredictable and an adverse decision in any such matter could result in significant monetary payments and 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. 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. In addition, we are sometimes subject to government inquiries and investigations of our business due, among other things, to our business relationships with the U.S government, the heavily regulated nature of our industry, and in the case of environmental proceedings, our ownership of certain property. Any such inquiry or investigation could potentially result in an adverse ruling against us, which could result in significant monetary payments (including possible environmental remediation costs) and a material adverse effect on our financial position and operating results.
A substantial deterioration in the financial condition of the commercial airline industry or significant changes to the financial or regulatory landscape could have a significant impact on Boeing Capital Corporation, which could in turn have an adverse effect on our earnings, cash flows and/or financial position.
BCC, our wholly-owned subsidiary, has substantially all of its portfolio concentrated among commercial airline customers. If terrorist attacks, a serious health epidemic, significant regulatory actions in response to environmental concerns, increases in fuel related costs or other exogenous events were to have an adverse impact on the airline industry, increased requests for financing, significant defaults by airline customers, repossessions of aircraft and/or airline bankruptcies and restructurings could negatively impact the strength of BCCs portfolio and our operating results. In addition, a significant deterioration in the aircraft financing environment, or significant regulatory reforms that increase costs to companies like BCC, could impact BCCs financial position and operating results. Any of these events could have a negative effect on our earnings, cash flows and/or financial position.
We may be unable to obtain debt to fund our operations and contractual commitments at competitive rates, on commercially reasonable terms or in sufficient amounts.
We depend, in part, upon the issuance of debt to fund our operations and contractual commitments. If we were called upon to fund all outstanding financing commitments, our market liquidity may not be sufficient. A number of factors could cause us to incur increased borrowing costs and to have greater difficulty accessing public and private markets for debt. These factors include disruptions or declines in the global capital markets and/or a decline in our financial performance or outlook or credit ratings. The occurrence of any or all of these events may adversely affect our ability to fund our operations and contractual or financing commitments.
We may not realize the anticipated benefits of mergers, acquisitions, joint ventures/strategic alliances or divestitures.
As part of our business strategy, we may merge with or acquire businesses, form joint ventures/strategic alliances and divest operations. Whether we realize the anticipated benefits from these transactions depends, in part, upon the integration between the businesses involved, the performance of the underlying products, capabilities or technologies and the management of the transacted operations. Accordingly, our financial results could be adversely affected from unanticipated performance issues, transaction-related charges, amortization of expenses related to intangibles, charges for impairment of long-term assets, credit guarantees, partner performance and indemnifications. Consolidations of joint ventures could also impact our results of operations or financial position. While we believe that we have established appropriate and adequate procedures and processes to mitigate these risks, there is no assurance that these transactions will be successful. Divestitures may result in continued financial involvement in the divested businesses, such as through guarantees or other financial arrangements, following the transaction. Nonperformance by those divested businesses could affect our future financial results.
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 cannot 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.
Business disruptions could seriously affect our future sales and financial condition or increase our costs and expenses.
Our business may be impacted by disruptions including, but not limited to, threats to physical security, information technology attacks or failures, damaging weather or other acts of nature and pandemics or other public health crises. Any of these disruptions could affect our internal operations or services provided to customers, and could impact our sales, increase our expenses or adversely affect our reputation or our stock price.
Item 2. Properties
We occupied approximately 86 million square feet of floor space on December 31, 2009 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:
At December 31, 2009, our segments occupied facilities at the following major locations that occupied in excess of 74 million square feet of floor space:
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 major 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 involved in a number of legal proceedings. For a discussion of contingencies related to legal proceedings, see Note 20 to our Consolidated Financial Statements, which is hereby incorporated by reference.
BSSI/SES New Skies
During 2007, the SES New Skies (New Skies) NSS-8 satellite, a Boeing 702 model spacecraft, was declared a loss when the Sea Launch Zenit-3SL vehicle carrying the satellite experienced an anomaly during the launch that destroyed the rocket and the payload. In the event of such a launch failure, New Skies had an option under the NSS-8 contract to order a replacement satellite. On December 23, 2009, the parties executed a confidential settlement agreement with respect to all claims arising from the matter.
Santa Susana Field Laboratory
We possess a National Pollutant Discharge Elimination System permit, issued by the California Regional Water Quality Control Board, Los Angeles Region (the California Board), which limits the permissible level of certain constituents in storm water discharged from various outfalls at our Santa Susana Field Laboratory site. On June 11, 2008, the California Board issued a Notice of Violation informing us that the California Board has identified 24 discharge violations from our self-monitoring reports covering the period October 1, 2006, through March 31, 2008, and in subsequent communications we have been informed that the California Board believes there may be an additional 11 exceedences for a total of 35 potential discharge violations through February 28, 2009. Each violation, if established, could give rise to assessment of an administrative penalty of up to $10,000, or $25,000 if the matter is ultimately resolved by the California Department of Justice, plus possible additional assessments based upon the volume of water discharged.
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, 2009.
Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The principal market for our common stock is the New York Stock Exchange and trades under the symbol BA. The number of holders of common stock as of February 1, 2010, was approximately 222,498. Additional information required by this item is incorporated by reference from Note 22 to our Consolidated Financial Statements.
Issuer Purchases of Equity Securities
The following table provides information about purchases we made during the quarter ended December 31, 2009 of equity securities that are registered by us pursuant to Section 12 of the Exchange Act:
(Dollars in millions, except per share data)
Item 6. Selected Financial Data
Five-Year Summary (Unaudited)
Cash dividends have been paid on common stock every year since 1942.
Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
Consolidated Results of Operations and Financial Condition
We are a global market leader in design, development, manufacture, 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 one of the largest defense contractors 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 around the world.
Our strategy is centered on successful execution in healthy core businesses Commercial Airplanes and Boeing Defense, Space & Security (BDS) supplemented and supported by Boeing Capital Corporation (BCC). Taken together, these core businesses have historically generated 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. BDS integrates its resources in defense, intelligence, communications, security and space to deliver capability-driven solutions to its customers at reduced costs. Our strategy is to leverage our core businesses to capture key next-generation programs while expanding our presence in adjacent and international markets, underscored by an intense focus on growth and productivity. Our strategy also benefits as the cyclicality of commercial and defense markets often offset. BCC delivers value by supporting our business units and managing overall financing exposure.
Consolidated Results of Operations
(Dollars in millions)
Revenues in 2009 increased by $7,372 million due to higher revenues in Commercial Airplanes and BDS. Commercial Airplanes revenues increased by $5,788, primarily due to higher commercial airplane deliveries in 2009. Deliveries in 2008 were lower as a result of a labor strike in the prior year. Increases were partially offset by decreases in commercial aviation services and intercompany revenues. BDS revenues increased by $1,614 million, primarily due to higher revenues in Global Services & Support (GS&S) and Boeing Military Airplanes (BMA), partially offset by decreases in Network & Space Systems (N&SS). BCC revenues decreased by $43 million during the year primarily due to a decrease in the customer financing portfolio. Other segment revenues decreased by $402 million partly due to higher revenues in the prior year from the sale of four C-17 aircraft held under operating lease. Lower Unallocated items and eliminations improved revenues by $415 million primarily due to lower P-8A Poseidon program (P-8A) intercompany revenues recognized by Commercial Airplanes in 2009 compared with 2008.
The decrease in 2008 revenues of $5,478 million compared with 2007, is primarily due to lower revenues at Commercial Airplanes. Commercial Airplanes revenues decreased by $5,123 million, primarily as a result of decreases in new airplane deliveries reflecting the effects of the labor strike, partially offset by higher intercompany revenues and higher pre-strike deliveries and model mix. We delivered 104 fewer airplanes than expected during 2008 due to the strike. This reduced revenue by approximately $6.4 billion for the twelve months ended December 31, 2008. BDS revenues were unchanged as revenue growth in GS&S was offset by decreases in BMA and N&SS. BCC revenues decreased by $112 million primarily due to lower interest income on financing receivables and notes and a decrease in the customer financing portfolio. Other segment revenues increased by $259 million primarily due to the sale of four C-17 aircraft during 2008, that were held under an operating lease. Unallocated items and eliminations changed by $497 million, primarily due to the intercompany elimination of P-8A revenues recognized by Commercial Airplanes.
Earnings From Operations
The following table summarizes our earnings/(loss) from operations:
(Dollars in millions)
Operating earnings in 2009 decreased by $1,854 million compared with 2008. Commercial Airplanes earnings decreased by $1,769 million primarily due to $2,693 million of costs related to the first three 787 flight test aircraft included in research and development expense as a result of our determination in August 2009 that these aircraft could not be sold. The earnings decrease is also attributable to reach-forward losses on the 747 program which grew by $1,352 million in 2009 which is an increase of $667 million over 2008. Lower commercial aviation services and intercompany earnings also contributed to lower 2009 earnings. These decreases were partially offset by higher commercial airplane deliveries in 2009 compared with 2008. BDS earnings increased by $67 million compared with 2008 primarily due to higher earnings in the BMA segment partially offset by lower earnings in the N&SS segment. BCC operating earnings decreased $36 million reflecting lower revenues, higher impairment expense and a provision for losses, partially offset by lower interest expense. Other segment losses decreased by $155 million primarily due to recognition of pre-tax expense of $82 million in the prior year to increase the allowance for losses on customer financing receivables and lower environmental remediation charges compared with the prior year. Unallocated items and eliminations in 2009 reduced earnings by $271 million compared with 2008, which is further explained in the table below.
Operating earnings in 2008 decreased by $1,880 million compared with 2007. Commercial Airplanes earnings decreased by $2,398 million compared with the same period in 2007, primarily due to fewer new airplane deliveries resulting from the strike, increased program infrastructure costs related to the strike and revised schedules on 787 and 747-8, and a charge taken on the 747-8 program. Commercial Airplanes research and development expense decreased by $124 million to $2,838 million compared with the same period in 2007, primarily due to lower spending on 787 partially offset by higher spending on 747-8 and lower supplier development cost sharing payments. BDS earnings decreased by $208 million compared with 2007 primarily due to lower earnings in the BMA segment resulting from charges taken on the Airborne Early Warning and Control (AEW&C). BCC operating
earnings decreased $72 million reflecting lower revenues and a provision for losses partially offset by lower interest expense. Unallocated items and eliminations in 2008 improved by $774 million compared with 2007, which is further explained in the table below.
The most significant items included in Unallocated items and eliminations are shown in the following table:
(Dollars in millions)
The reduction in Share-based plans expense in 2008 is primarily due to the expiration of certain Performance Shares during 2008 and higher expense acceleration during 2007, resulting from six payouts compared with zero payouts in 2008.
Deferred compensation expense increased by $381 million in 2009 and decreased by $274 million in 2008. The year over year changes in deferred compensation expense are primarily driven by changes in our stock price and broad stock market conditions.
Other unallocated items and eliminations expense increased by $154 million in 2009 primarily due to timing of intercompany expense allocations, elimination of profit on intercompany items and a more favorable insurance adjustment in the same periods of the prior year. Other unallocated items and expense in 2008 includes a charge related to satellite litigation of $100 million, offset by lower performance-based compensation in 2008.
Unallocated pension and other postretirement expense represents the difference between costs recognized under Generally Accepted Accounting Principles in the United States of America (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. We recorded net periodic benefit cost related to pensions and other postretirement benefits of $1,816 million, $1,132 million and $1,773 million in 2009, 2008 and 2007, respectively. 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 end of the reporting period. A portion of pension and other postretirement expense is recorded in the business segments and the remainder is included in unallocated pension and other postretirement expense. Earnings from operations included the following amounts allocated to business segments and Other unallocated items and eliminations.
Other Earnings Items
(Dollars in millions)
Other income decreased by $273 million and $237 million in 2009 and 2008. The decreases are primarily driven by a reduction in investment income as a result of lower interest rates and lower investment balances. Interest and debt expense increased by $137 million compared with 2008 due to additional debt issued in 2009.
For a discussion related to Income Taxes, see Note 5.
Our backlog at December 31 was as follows:
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. The decrease in contractual backlog during 2009 was due to deliveries in excess of orders, changes in projected revenue escalation and cancellations of orders. The increase in backlog during 2008 was due to orders in excess of deliveries for our 737, 767, 777 and 787 programs.
Unobligated backlog includes U.S. and non-U.S. government definitive contracts for which funding have not been authorized. The decrease in unobligated backlog during 2009 is primarily due to decreases at BDS of $8,904 million compared with 2008 partly due to a partial termination for convenience by the U.S. Army of the Brigade Combat Team Modernization (BCTM) (formerly the Future Combat Systems (FCS)) System Development and Demonstration contract relating to Manned Ground Vehicles and associated systems and equipment. Approved funding of existing multi-year contracts including the BCTM, V-22, Chinook, Proprietary and Ground-Based Midcourse Defense (GMD) programs also reduced unobligated backlog. The decrease in Unobligated backlog during 2008 is primarily due to decreases at BDS of $2,174 million compared with 2007 primarily due to funding of existing multi-year contracts including the F/A-18, BCTM and F-22 programs. These decreases were partially offset by multi-year procurement contracts awarded on the V-22 and Chinook programs.
Segment Results of Operations and Financial Condition
Business Environment and Trends
Airline Industry Environment 2008 and 2009 were extremely challenging for the worlds airlines as key external business factors (oil prices, economic growth, exchange rates, financing terms) experienced high levels of volatility. In the first half of 2008, airlines focused on adapting to spiking oil prices which peaked close to $150/barrel. In autumn 2008, the airlines focus shifted to the fallout of the global credit crisis and recession as fuel prices fell below $40/barrel for the first time since 2004, and in 2009 passenger and cargo traffic experienced their worst ever declines. This business environment curtailed the airline industry profit recovery that started in 2006. As a result, the global airline industry has now reported losses in seven out of the last ten years, and over 30 airlines have entered bankruptcy since the beginning of 2008.
In this challenging environment, airlines are adapting their operations to meet the realities of the markets in which they operate. Airlines reduced global passenger capacity by 2% in 2009 through a combination of frequency and route cuts in unprofitable markets, lower daily airplane utilization (flight hours per day) and parking/scrapping of older generation airplanes. Airlines are also replacing older less fuel efficient airplanes, reducing non-fuel costs and finding new ways to partner through alliances or via mergers and acquisitions.
These conditions have caused customers to request cancellations, modifications, or rescheduling of their existing orders and advance payment schedules to meet revised fleet plans or address financing and cash flow issues. Whether such requests will result in a material adverse impact on our earnings, cash flow or financial position depends on a number of factors including whether the request is granted, the type of aircraft, how much compensation is paid to us for costs already incurred and our ability to reschedule other orders to replace those canceled, modified, or rescheduled.
Near-term global airline industry indicators are improving although many uncertainties persist. Global economic recovery has begun. Although it is expected to vary significantly by region both in terms of speed and magnitude, world economic growth is forecast to grow moderately in 2010 following contraction in 2009. As a result, airline industry forecasts generally indicate global passenger traffic returning close to 2008 levels in 2010 with many emerging markets posting growth over 2009. Air cargo traffic is forecast to grow above the long-term trend rates in 2010 following two years of contraction which have taken traffic back to 2002 and 2003 levels. Due to these improving demand conditions, airlines are expected to see significantly smaller financial losses globally in 2010.
Beyond the near-term market uncertainties, the long-term outlook for the industry remains positive due to the fundamental drivers of air travel growth: 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. Our 20-year forecast is for a long-term average growth rate of 5% per year for passenger and cargo traffic based on a projected average annual worldwide real economic growth rate of 3%. Based on long-term global economic growth projections, and factoring in increased utilization of the worldwide airplane fleet and requirements to replace older airplanes, we project a $3.2 trillion market for 29,000 new airplanes over the next 20 years.
The industry remains vulnerable to near-term exogenous developments including disease outbreaks (such as avian or H1N1 flus), terrorism and increased global environmental regulations.
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 enabled low-cost airlines to continue gaining market share. These airlines have increased the downward pressure on airfares. This results in continued cost pressures for all airlines and price pressure on our products. Major productivity gains are essential to ensure a favorable market position at acceptable profit margins.
Continued access to global markets remains vital to our ability to fully realize our sales potential and long-term investment returns. Approximately 10% of Commercial Airplanes contractual backlog in dollar terms is with U.S. airlines.
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. Additionally, other competitors from Russia, China and Japan are likely to enter the 70 to 190 seat aircraft market over the next few years. This market environment has resulted in intense pressures on pricing and other competitive factors and we expect these pressures to continue or intensify in the coming years.
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 as experienced in the second half of 2009 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 announced such initiatives targeting overhead cost savings, a reduction in its development cycle and a significant increase in overall productivity through 2012. If the U.S. dollar strengthens again, Airbus can use the improved efficiency to fund product development, gain market share through pricing and/or improve earnings.
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.
(Dollars in millions)
Year-over-year changes in Revenue are shown in the following table:
The increase in revenue of $5,788 million in 2009 from 2008 is primarily attributable to higher new airplane deliveries partially offset by lower intercompany revenues. Prior year revenues were negatively impacted by the 2008 IAM strike. The decrease in revenues from commercial aviation services business was driven by economic conditions.
The decrease in revenue of $5,123 million in 2008 from 2007 is primarily attributable to lower new airplane deliveries. The IAM strike resulted in 104 airplane deliveries moving out of 2008 which reduced 2008 revenues by $6,406 million. The strike impact was partially offset by higher intercompany revenues of $804 million, and higher pre-strike deliveries, net of model mix changes, of $726 million. Aircraft trading activity decreased by $264 million as a result of fewer sales of used aircraft. Revenues in commercial aviation services business increased by $17 million driven by increased spares and services revenue offset by decreased passenger to freighter conversions.
Commercial jet aircraft deliveries as of December 31, were as follows:
Earnings From Operations
Earnings from operations for 2009 decreased by $1,769 million when compared to 2008, primarily due to the reclassification from inventory to research and development expense of $2,481 million related to the three 787 flight test aircraft previously recorded as inventory as of July 31, 2009. Additional production costs incurred between August and December 2009 of $212 million related to those flight-test airplanes were also included in research and development expense. Those amounts were partially offset by a $148 million decrease in other research and development expense. The decrease in earnings is also attributable to reach-forward losses on the 747 program which grew by $1,352 million in 2009 compared with losses of $685 million in 2008. The 2009 reach-forward losses were primarily due to increased production costs, reductions in projected delivery price increases associated with escalation and the difficult market conditions affecting the 747-8. Lower commercial aviation services
revenues and margins reduced earnings by $245 million. Higher infrastructure cost allocations related to the 787 and 747-8 schedule delays announced in 2008 and 2009 and infrastructure costs incurred during the 2008 IAM strike reduced earnings by $199 million. Increased period and other costs reduced earnings by $47 million. These decreases were partially offset by increased earnings of $1,934 million related to new airplane deliveries.
Earnings from operations decreased by $2,398 million in 2008 when compared to 2007, with operating margins decreasing 6.5 percentage points to 4.2%. Lower new airplane deliveries, partially offset by higher intercompany revenues, reduced earnings by $1,400 million. A charge for a reach-forward loss on the 747 program resulting from increases to estimated costs for development and production of 747-8 derivatives reduced 2008 earnings by $685 million. Infrastructure cost allocations related to the 787 and 747-8 schedule delays and infrastructure costs incurred during the IAM strike reduced earnings by $287 million. The 787 and 747-8 schedule delays resulted in production programs receiving larger allocations of current and future infrastructure costs and reduced margins on 2008 deliveries, while the program infrastructure costs incurred during the IAM strike decreased margins on airplanes delivered during the second half of the year. Increased period and other costs reduced earnings by $108 million. A reduction in commercial aviation services volume and mix-related earnings of $42 million was primarily due to a decrease in volume on passenger to freighter conversion programs. Lower research and development costs improved earnings by $124 million.
Backlog Firm backlog represents orders for products and services where no contingencies remain before Boeing and the customer are required to perform. Backlog does not include prospective orders where customer controlled contingencies remain, such as the customers receiving approval from their Board of Directors, shareholders or government and completing financing arrangements. All such contingencies must be satisfied or have expired prior to recording a new firm order even if satisfying such conditions is highly certain. Firm orders exclude options. A number of our customers may have contractual remedies that may be implicated by program delays. We continue to address customer claims and requests for other contractual relief as they arise. However, once orders are included in firm backlog, orders remain in backlog until canceled or fulfilled, although the value of orders is adjusted as changes to price and schedule are agreed to with customers.
The decrease in contractual backlog during 2009 was due to deliveries in excess of orders, changes in projected revenue escalation and cancellations of orders. The increase in backlog during 2008 was due to orders in excess of deliveries for our 737, 767, 777 and 787 programs.
Accounting Quantity The accounting quantity is our estimate of the quantity of airplanes that will be produced for delivery under existing and anticipated contracts and is limited by the ability to make reasonably dependable estimates of the revenue and costs of these contracts. It is a key determinant of the gross margins we recognize on sales of individual airplanes throughout a programs life. Estimation of each programs 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 does not vary with production rates. As the amount of time needed to produce the accounting quantity increases, the average cost of the accounting quantity also increases as these infrastructure costs are included in the total cost estimates. This has the effect of decreasing the gross margin and related earnings provided other factors do not change.
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:
737 Program The accounting quantity for the 737 program increased by 400 units during 2009 due to the programs normal progression of obtaining additional orders and delivering aircraft. Production rates remained unchanged in 2009.
747 Program There was no change in the accounting quantity for the 747 program during 2009.
In 2008, we recorded a charge of $685 million to recognize a reach-forward loss. The charge was primarily related to higher than anticipated costs due to late changes to wing design which drove new load requirements into the fuselage and created other statement of work changes for our suppliers.
During 2009, additional charges of $1,352 million were recorded to recognize reach-forward losses. During the first quarter of 2009, we recorded $347 million of a reach-forward loss due to a reduction in projected delivery price increases associated with escalation and an increase in estimated costs due to our decisions to reduce twin-aisle production rates which impact production rates beginning in 2010. During the third quarter of 2009 we increased the reach-forward loss on the 747 program by $1,005 million. Of this amount, $643 million was caused by higher estimated production costs, including both additional internal production costs and higher supplier expenses, attributable to greater than expected re-work and disruption in manufacturing due to late maturity of engineering designs as well as the limited availability of engineering resources. The remaining $362 million was primarily due to challenging cargo market conditions and our related decision to defer a planned increase in the 747-8 production rate, which drove higher allocations of fixed costs and caused us to incur volume-based penalties to suppliers.
First flight of the 747-8 Freighter is expected to occur during the first quarter of 2010, with the flight test program expected to take place in 2010. First delivery of the 747-8 Freighter is expected in the fourth
quarter of 2010. First delivery of the Intercontinental passenger variant remains scheduled for the fourth quarter of 2011. The gap between the delivery of the last 747-400, which occurred in 2009, and first deliveries of the 747-8 will result in lower 747 program revenues.
767 Program The accounting quantity for the 767 program increased by 12 units during 2009. In April 2009, we announced a delay in previous plans to increase the production rate.
777 Program The accounting quantity for the 777 program increased by 50 units during 2009. Delivery of the first 777 Freighter occurred in February 2009. In April 2009, we announced that we will lower the production rate on our 777 airplane program, affecting deliveries beginning in June 2010. This lower production rate will decrease revenues and earnings in 2010 and 2011.
787 Program We announced on June 23, 2009 the necessity to reinforce an area of structure at the side-of-body section of the airplane. During the fourth quarter, we completed the modifications on the first two flight-test airplanes and the full-scale static test airplane. First flight of the 787 occurred on December 15, 2009. A second 787 completed its first test flight on December 22, 2009. Six aircraft in total will be involved in the flight test program, which is expected to result in certification of the 787-8 in the fourth quarter of 2010. First delivery is also expected to occur in the fourth quarter of 2010. We continue to work toward our planned increases in 787 production rates as well as the timely introduction of the 787-9 derivative.
During 2009, we concluded that the first three flight-test 787 aircraft could not be sold as previously anticipated due to the inordinate amount of rework and unique and extensive modifications made to those aircraft. As a result, costs of $2,481 million previously recorded as program inventory as of July 31, 2009 were reclassified to research and development expense. Additional production costs incurred between August and December 2009 of $212 million related to these flight-test airplanes were also included in research and development expense. We will continue to incur research and development costs on these flight test aircraft in 2010. We believe that the other three additional 787 flight test aircraft are commercially saleable and we continue to include costs related to those aircraft in program inventory at December 31, 2009. If we determine that one or more of the other flight test aircraft cannot be sold we may incur additional charges.
On July 30, 2009, we acquired the business, assets and operations of Vought Aircraft Industries, Inc.s (Vought) 787 business conducted at North Charleston, South Carolina. The facility produces aft fuselage sections, including the fabrication, assembly and systems installation. See Note 2. On December 22, 2009, we acquired Alenia North Americas 50% ownership interest in Global Aeronautica. As a result of the transaction, we are the sole owner of this entity. Located adjacent to Boeing Charleston, Global Aeronautica is an integrator of the 787 mid-fuselage sections.
On October 28, 2009 we announced the North Charleston facility as the location for a second final assembly site for the 787 Dreamliner program. A groundbreaking ceremony was held November 20, 2009 to mark the start of construction. Until the additional 787 assembly line is fully operational, we will establish transitional surge capability at our Everett, Washington, location to facilitate the planned introduction of the 787-9, the first derivative model of the 787 family. When the additional line in North Charleston is fully operational, the surge capability in Everett will be phased out.
Looking beyond first flight, we continue to monitor and address other areas of challenge associated with assembly of initial airplanes including management of our extended global supply chain, completion and integration of traveled work as well as weight and systems integration. Efforts continue to ensure we remain focused on satisfying customer mission and performance needs in light of the anticipated weight of their respective aircraft.
We continue to work with our customers and suppliers to assess the specific impacts of schedule changes including delivery delays and supplier assertions. A number of our customers have contractual remedies for schedule delays and/or performance. We continue to address customer claims and requests for other contractual relief as brought forth.
The cumulative impacts of the flight test delays, production challenges, schedule delays and customer and supplier impacts create significant pressure on program revenue and cost estimates. We continue to assess our mitigation plans and cost reduction efforts to address these pressures.
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.
Research and Development The following chart summarizes the time horizon between go-ahead and certification/initial delivery for major Commercial Airplanes derivatives and programs.
Our Research and development expense increased by $2,545 million in 2009. This was due to reclassification to research and development expense of $2,693 million of production costs related to the three 787 flight test aircraft and $50 million of lower supplier development cost sharing payments, partially offset by a $198 million decrease of other research and development expense.
Our Research and development expense decreased $124 million in 2008. Research and development expense is net of development cost sharing payments received from suppliers. The decrease in research and development spending for 2008 was primarily due to reduced 787 product development activities partially offset by $278 million of increased spending on the 747-8 program and $80 million of lower supplier development cost sharing payments.
The 787 and 747-8 programs highlight the risks that are always inherent in new airplane programs and new derivative airplanes, particularly as both the 747-8 and the 787 begin the demanding flight test and certification phases of program development. Costs related to development of new programs and derivative airplanes are expensed as incurred. Costs to produce new aircraft are included in inventory and accounted for using program accounting. Airplane programs have risk for reach-forward losses if our estimated production costs exceed our estimated program revenues for the accounting quantity. Generally commercial airplanes are sold on a firm fixed-price basis with an indexed price escalation clause and are often sold several years before scheduled delivery. Each customer purchase
agreement contains an escalation clause to account for the effects of economic fluctuations over the period of time from airplane sale to airplane delivery. A price escalation formula based on pre-defined factors is used to determine the final price of the airplane at the time of customer delivery. While firm fixed-price contracts allow us to benefit from cost savings, they also expose us to the risk of cost overruns. Many new airplanes and derivatives have highly complex designs, utilize exotic materials and require extensive coordination and integration with supplier partners. As technical or quality issues arise, such as issues experienced on the 787 and 747-8 programs, we may experience schedule delays and higher costs to complete new programs and derivative aircraft. Additionally, price escalation factors may also impact margins by reducing the estimated price of airplanes delivered in the future. There are other factors that could also result in lower margins or a material charge if a program has or is determined to have reach-forward losses. These include: changes to the program accounting quantity, production costs and rates, capital expenditures and other costs associated with increasing or adding new production capacity, learning curve, anticipated cost reductions, flight test and certification schedules, costs and schedule for derivative airplanes and status of customer claims, supplier assertions and other contractual negotiations. While we believe the cost and revenue 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 extended, which could trigger termination provisions, order cancellations or other financially significant exposure.
Boeing Defense, Space & Security
Business Environment and Trends
On January 7, 2010, we announced that Integrated Defense Systems will begin operating under the name Boeing Defense, Space & Security (BDS).
BDS consists of three capabilities-driven businesses: Boeing Military Aircraft (BMA), Network & Space Systems (N&SS) and Global Services & Support (GS&S). Additionally, BDS Phantom Works supports all three businesses via product development, rapid prototyping and customer engagement through experimentation and enterprise technology investment strategies.
Defense Environment Overview The U.S. continues to balance funding priorities to plan for the broadest possible range of operations that include homeland defense, natural disasters, stabilization efforts, counterinsurgency and counterterrorism operations, or nation state aggressors with growing sophistication and military means. The U.S. Department of Defense (U.S. DoD) faces the simultaneous requirements to recapitalize important capabilities and transform the force to meet the changing national security as articulated in the 2010 Quadrennial Defense Review. All of this must be carried out against a backdrop of significant competing national priorities including the economic crisis and healthcare reform. We anticipate that the national security environment will remain dynamic and challenging well into this decade trending with the threat environment.
Government policies are impacting the defense environment including defense acquisition reform, more insourcing, concerns over industrial base, a shift in emphasis towards more affordable solutions and emphasis on increasing diplomatic efforts to expand and strengthen our alliances.
Although the U.S. DoD budget has grown substantially over the past decade, we expect the total budget growth rate to level off over the next several years due to shifting priorities and budget pressures. The fiscal year 2010 discretionary budget request of $660 billion includes an Overseas Contingency Operations (OCO) budget of $130 billion, with an additional $33 billion requested.
The fiscal year 2011 discretionary budget of $708 billion includes OCO budget of $159 billion. Procurement is expected to increase, while Research and Development accounts decrease, facing increasing budgetary pressures due to growing requirements from Operations and Maintenance (O&M) and personnel costs tied to U.S. commitments overseas. However, this trend is partially offset by
equipment recapitalization efforts and continued demand for systems development. The near-term forecast of the defense budget environment shows limited growth in the 2011 to 2015 period for investment efforts. Though opportunities may exist following U.S. troop draw-downs in Iraq, they are offset by recent increases in Afghanistan. We continue to see pressure to reduce OCO requests that have been used to cover the ongoing costs of the wars.
It is unlikely that the U.S. DoD will be able to fully fund all programs of record already in development as well as new initiatives. This imbalance between future costs of 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 and occasionally by cancellation of programs. We expect the U.S. DoD will respond to future budget constraints by focusing on affordability strategies from acquisition reform and emphasizing utilization of commercial off-the-shelf solutions and network-enabled operations. These strategies will be enabled through persistent intelligence, surveillance, and reconnaissance (ISR), long-range strike, special operations, unmanned systems, cyber security, and precision-guided kinetic and non-kinetic weapons, electronic warfare, as well as selected outsourcing of logistics and support activities to improve overall effectiveness while maintaining control over costs.
Other nations continue to experience growing demands for new equipment to address operational requirements, aging inventories, and changing threat environments. Greater U.S. reliance on allies and coalition partners places additional pressure on nations to emphasize acquisition of material that is deployable, survivable, and interoperable with the international community. European nations are struggling to meet defense investment needs as budget deficits create greater pressure on resources. Though regional financial concerns exist, Middle Eastern military markets remain robust with stable oil prices and persistent regional security concerns sustaining continued defense investment. In Asia, growth is slowing with nations pursuing select acquisitions to address growing regional threats. The international market will continue to be affected by global economic challenges. However, the continuing threat environment should keep demand stable in 2010.
Missile Defense Environment The proliferation of short- and medium-range ballistic missiles is considered the greatest current threat to security and is driving missile defense spending. As a result, the near-term focus for growth is in regional and tactical BMD systems.
Civil Space Transportation and Exploration Environment The National Aeronautics and Space Administration (NASA) budget is focused on technology development and demonstration programs, the International Space Station, and new initiatives associated with space exploration. NASA is developing new approaches to space exploration with added emphasis on commercial spaceflight systems, space technology development and robotic missions. NASA is also enhancing its focus on climate change and aeronautics research.
Homeland Security Environment The continuing threat from terrorism is the key driver for the homeland security market. Key growth areas include aviation security, border security, maritime security and cyber security. Additionally, the U.S. government is focused on increasing cooperation with state and local institutions.
Commercial Satellite Environment The commercial satellite market is experiencing improvement in market demand, partly driven by strong U.S. government demand for commercial satellite systems and services, but the overall sector continues to be characterized by overcapacity creating strong competitive pressures on pricing.
Adjacent Market Environment We see growth opportunities across a number of adjacent markets with both U.S. DoD and other U.S. government customers. These markets, including services, unmanned systems, intelligence, cyber, and energy, represent key development areas which support the current engagements overseas as well as emerging national security issues.
Services Growth in services is anticipated both domestically and internationally, as customers have a wide variety of needs, including information services, platform-related services, facility management, infrastructure services and logistics command and control.
Unmanned Systems The unmanned market continues to see growth in all classes of platforms due to the high demand from the U.S. military in Southwest Asia. We anticipate this growth increasing as unmanned systems continue to provide critical mission functions to the war fighter with affordability, persistence, and accuracy.
Intelligence We see the intelligence market growing based on the demands of data collection, dissemination, and analysis driven by the conflicts in Southwest Asia. Growth in data fusion, data management, and information sharing is expected as the use of ISR assets increase.
Cyber The demand for defensive, offensive, and exploit operations in the emerging cyber market provides unique growth opportunities as explicit needs are further defined by customers. Cyber threats from both state and non-state actors represent a critical national security issue. The U.S. government is taking significant steps to mitigate the cyber threat to the U.S. DoD and to U.S. critical infrastructure.
Energy We anticipate the energy market will emerge with growth potential. As energy volatility becomes more substantial, the need for energy management, infrastructure security, and scenario modeling will increase accordingly. The U.S. DoD, including individual service branches, is also actively engaged in developing energy policy guidance and comprehensive plans from which to execute programs.
Effective January 1, 2009, 2008 and 2007 certain programs were realigned among BDS segments. In addition, effective January 1, 2008, certain environmental remediation contracts (formerly included in N&SS) were transferred to the Other Segment. Business segment data for all periods presented have been adjusted to reflect the realignment. See Note 21.
(Dollars in millions)
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 BDS revenues increased by $1,614 million in 2009 compared to 2008, primarily due to higher revenues in GS&S and BMA, partially offset by decreases in N&SS. BDS revenues were unchanged in 2008 compared to 2007 as revenue growth in GS&S was offset by decreases in BMA and N&SS.
Operating Earnings BDS operating earnings in 2009 increased by $67 million compared with 2008 primarily due to higher earnings in the BMA segment, partially offset by lower earnings in the N&SS segment. BDS earnings decreased by $208 million in 2008 compared with 2007 primarily due to lower earnings in the BMA segment resulting from a $248 million charge taken on the AEW&C program in the second quarter partially offset by higher earnings in the N&SS segment.
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. BDS total backlog decreased 11% in 2009, from $73,004 million to $64,839 million, partly due to a partial termination for convenience from the U.S. Army of the BCTM (formerly FCS) System Development and Demonstration contract relating to Manned Ground Vehicles and associated systems and equipment. Current year deliveries and sales on multi-year contracts awarded in prior years also contributed to the backlog reduction.
For further details on the changes between periods, refer to the discussions of the individual segments below.
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 Airborne Laser, EA-18G, Family of Beyond Line-of-Sight Terminals (FAB-T), BCTM (formerly FCS), GMD, Joint Tactical Radio System (JTRS), P-8A and Proprietary programs.
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 extended, which could trigger termination provisions, the loss of satellite in-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, International KC-767 Tanker, commercial and military satellites, Vigilare and High Frequency Modernisation.
Boeing Military Aircraft
(Dollars in millions)
Revenues BMA revenues increased 6% in 2009 and decreased 1% in 2008. The increase of $746 million in 2009 was primarily due to higher deliveries and volume on the Apache, V-22 and Chinook rotorcraft programs and the F-18 and Proprietary programs, partly offset by lower volume on the F-22 and several weapons programs. The decrease of $188 million in 2008 is primarily driven by lower F-22, Apache, F-18 and Chinook revenue partially offset by increased deliveries on F-15 and International KC-767 Tanker and C-17 contract mix.
Deliveries of new-build production aircraft, excluding remanufactures and modifications, were as follows:
Operating Earnings BMA operating earnings increased by $236 million in 2009 partly due to higher deliveries on several programs and volume, partially offset by a change in delivery mix. Operating earnings in both years were negatively impacted by charges on the AEW&C and International KC-767 Tanker programs. BMA earnings decreased by $330 million in 2008 primarily due to charges taken on the AEW&C program. Delivery mix and lower volume also contributed to the decrease in 2008.
Research and Development The BMA segment continues to focus research and development resources to leverage customer knowledge, technical expertise and system integration of manned and unmanned systems that provide innovative solutions to meet the warfighters enduring needs. Research and development expense in 2009 increased by 13% over 2008 primarily due to proprietary programs which was partially offset by lower international tanker development costs. Research and development activities utilize 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 mobility, precision effects, situational awareness and survivability. Investments in prototyping allow us to offer low-risk programs to our customers. The products of our research and development support both new manned and unmanned systems as well as enhanced versions of existing fielded products. Investments support vertical integration of our product line in
areas like autonomous operation of unmanned vehicles, advanced sensors and Electronic Warfare. These efforts focus on increasing mission effectiveness, interoperability, reliability and reducing the cost of ownership.
Backlog BMA total backlog in 2009 was virtually unchanged from 2008. Backlog increases due to 2009 current year orders for C-17, P-8 India and Chinook aircraft were offset by revenues recognized on multi-year contracts received in prior years with the largest decrease in the F/A-18 program. Total backlog increased by 13% in 2008 compared with 2007 primarily due to an increase in the V-22, Chinook and F-15 program backlog. These increases were partially offset by deliveries and sales on multi-year contracts awarded in prior years with the largest decreases in the C-17 and F/A-18 programs.
Items which could have a future impact on BMA operations include the following:
AEW&C During 2009, 2008 and 2007, we recorded charges increasing the reach-forward losses on the AEW&C programs in Australia and Turkey by $133 million, $308 million and $81 million, respectively. The 2009 charge primarily related to delivery schedule delays. The 2008 charge, primarily related to our program in Australia, was due to subsystem development issues on the electronic warfare and ground support systems and the additional time required for integration testing. The AEW&C development program, also known as Wedgetail in Australia, Peace Eagle in Turkey and Peace Eye in the Republic of Korea, consists of 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 and Peace Eye include four aircraft each. During the fourth quarter of 2009, two Wedgetail aircraft were provided to Australia for familiarization and training. Wedgetail final delivery and customer acceptance is scheduled to begin in late 2010 and extend through the second quarter of 2011. These are advanced and complex fixed-price development programs involving technical challenges at the individual subsystem level and in the overall integration of these subsystems into a reliable and effective operational capability. We believe that the cost and revenue estimates incorporated in the financial statements are appropriate; however, the technical complexity of the programs creates financial risk as additional completion costs may be necessary or scheduled delivery dates could be delayed.
International KC-767 Tanker Program During 2009, 2008 and 2007, we recorded charges increasing the reach-forward losses in the International KC-767 Tanker programs by $78 million, $85 million and $152 million, respectively. The 2007 charge was partially offset at the consolidated level. The International KC-767 Tanker program includes four aircraft for the Italian Air Force and four aircraft for the Japanese Air Self Defense Force. The final delivery to Japan was made in December 2009. The Italian International KC-767 program is ongoing, and while we believe the revenue and cost estimates incorporated in the financial statements are appropriate, the technical complexity of the program creates financial risk as additional completion and development costs may be necessary or remaining scheduled delivery dates could be delayed.
C-17 See the discussion of C-17 in Note 11 Liabilities, Commitments and Contingencies.
Network & Space Systems
(Dollars in millions)
Revenues N&SS revenues decreased 4% in 2009 and 1% in 2008. N&SS revenues are expected to decrease in 2010, primarily due to lower revenues on the BCTM and GMD programs. The decrease of $469 million in 2009 is primarily due to lower volume on the GMD, Intelligence and Security Systems, and Proprietary programs, partly offset by higher volume on several satellite programs. The decrease of $135 million in 2008 is primarily due to decreased revenues in BCTM (formerly FCS), Proprietary and satellite programs partially offset by increased revenues in the SBInet program.
Delta launch and new-build satellite deliveries were as follows:
Operating Earnings N&SS operating earnings decreased by $195 million in 2009 primarily due to lower revenues and charges related to the Sea Launch bankruptcy. Earnings in 2009 were also reduced by charges related to the settlement of a satellite contract dispute and indemnification of Delta II inventory. Earnings in 2008 included a favorable settlement on a civil satellite program. N&SS earnings increased by $171 million in 2008 primarily due to increased earnings from our investment in United Launch Alliance (ULA). N&SS operating earnings include equity earnings of $164 million, $178 million and $74 million from the United Space Alliance joint venture and the ULA joint venture in 2009, 2008, and 2007, respectively.
Research and Development The N&SS research and development funding remains focused on the development of communications, command and control, computers, intelligence, surveillance and reconnaissance systems (C4ISR); that support a network-enabled architecture approach for our customers. We are investing in capabilities to enhance connectivity between existing and new air/ground and maritime platforms, to increase communications availability, utility and bandwidth through more robust space systems, and to leverage innovative networking and ISR concepts. Key programs in this area include BCTM, JTRS, Wideband Global Satellite System Ares, FAB-T and SBInet. Investments were also made to develop concepts and capabilities related to cyber and security products, as well as the development of next-generation space and intelligence systems. Along with increased funding to support these network-enabled capabilities, we also maintained our investment levels in missile defense, directed energy and advanced exploration systems.
Backlog N&SS total backlog decreased by 34% in 2009 compared with 2008 partly due to the partial termination for convenience from the U.S. Army of the BCTM (formerly FCS) System Development and Demonstration contract related to Manned Ground Vehicles and associated systems and equipment. Current year deliveries and sales on multi-year contracts awarded in prior years including BCTM,
GMD, and Proprietary programs also contributed to the backlog reduction. Total backlog decreased by 12% in 2008 compared with 2007 primarily due to revenues recognized on multi-year orders received in prior years on BCTM, GMD and C3 programs, partially offset by an increase in the International Space Station program.
Items which could have a future impact on N&SS operations include the following:
United Launch Alliance On December 1, 2006, we and Lockheed Martin Corporation (Lockheed) created a 50/50 joint venture named United Launch Alliance L.L.C. ULA combines the production, engineering, test and launch operations associated with U.S. government launches of Boeing Delta and Lockheed Atlas rockets. We initially contributed net assets of $914 million at December 1, 2006. The book value of our investment exceeded our proportionate share of ULAs net assets. This difference is expensed ratably in future years. Based on the adjusted contributions and the conformed accounting policies established by ULA, this amortization is expected to be approximately $15 million annually for the next 15 years.
In connection with the formation of ULA, we and Lockheed each have agreed to extend a line of credit to ULA of up to $200 million to support its working capital requirements during the 5 year period following December 1, 2006. 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 and Lockheed have also each committed to provide ULA with up to $122 million of additional capital contributions in the event ULA does not have sufficient funds to make a required payment to us under an inventory supply agreement. See Note 7.
We agreed to indemnify ULA through December 31, 2020 against potential non-recoverability and non-allowability of $1,360 million of Boeing Delta inventories included in contributed assets plus $1,860 million of inventory subject to an inventory supply agreement which ends on March 31, 2021. Since inception, ULA has consumed $1,111 million of inventories that were contributed by us and has made payments of $120 million to us under the inventory supply agreement. As part of its integration, ULA is continuing to assess the future of the Delta II program beyond what is currently on contract. In the event ULA is unable to sell additional Delta II inventory, earnings could be reduced by up to $62 million.
We agreed to indemnify ULA against potential losses that ULA may incur in the event ULA is unable to obtain certain additional contract pricing from the U.S. Air Force (USAF) for four satellite missions. We believe ULA is entitled to additional contract pricing. In December 2008, ULA submitted a claim to the USAF to re-price the contract value for two of the four satellite missions covered by the indemnification. In March 2009, the USAF issued a denial of that claim and in June 2009, ULA filed an appeal. During 2009, the USAF exercised its option for a third satellite mission. ULA intends to submit a claim to the USAF in 2010 to re-price the contract value of the third mission. If ULA is unsuccessful obtaining additional pricing we may be responsible for some of the shortfall and may record up to $382 million in pre-tax losses associated with the four missions.
Business Environment and Trends During 2009, we received a partial termination for convenience from the U.S. Army of the BCTM (formerly FCS) System Development and Demonstration contract relating to Manned Ground Vehicles and associated systems and equipment. We believe the final restructured BCTM contract will negatively impact revenue and earnings in the N&SS segment going forward. In addition, we completed the TSAT risk reduction and system definition contract in July 2009 and do not anticipate a future TSAT space segment program competition. As a result of lower than anticipated revenue and earnings, we tested N&SS goodwill for impairment during 2009. No
impairment was indicated by our tests. Future recommended budgetary changes, if approved by Congress, or additional partial terminations, could further impact N&SS programs, including the recoverability of goodwill.
Sea Launch See the discussion of Sea Launch Chapter 11 Filing and outstanding accounts receivable in Note 6 Accounts Receivable.
Satellites See the discussions of Boeing Satellite Systems International, Inc. (BSSI) in Note 20 Legal Proceedings and discussion of Satellite insurance risk in Note 11 Liabilities, Commitments and Contingencies.
Global Services & Support
(Dollars in millions)
Revenues GS&S revenues increased $1,337 million in 2009 and $318 million in 2008, an increase of 18% and 4%. The 2009 increase was due to increased volume in the Integrated Logistics (IL), and the Training Systems and Services (TS&S) divisions. The 2008 increase was due to higher revenues in the TS&S and IL divisions partially offset by decreases in International Support program volume.
Operating Earnings GS&S Operating earnings increased 3% in 2009 as additional earnings from increased volume were partially offset by lower margins due to contract adjustments and changes in contract mix. Operating earnings decreased by 5% in 2008 due to changes in the contract mix and disposition of contract matters.
Research and Development GS&S continues to focus investment strategies on its core businesses including IL, Maintenance Modifications and Upgrades (MM&U) and TS&S, as well as on moving into new market areas of Logistics Command and Control (Log C2) and Energy Management in Advanced Global Services and Support. Investments have been made to continue the development and implementation of innovative tools, processes and systems as market discriminators in the delivery of integrated customer solutions. Examples of successful programs stemming from these investment strategies include the C-17 Globemaster Sustainment Partnership, the F/A-18 Integrated Readiness Support Teaming program, the F-15 Singapore Performance-Based Logistics contract, and Smart Grid Projects. Successful development of adaptable systems has allowed GS&S to transition from Boeing platforms and into the broader aviation market. Beyond aerospace, GS&S capabilities have created opportunities in adjacencies and new markets exemplified in 2009 through entrance into the Land Vehicle support, Energy Solutions, and Logistics Information Systems markets.
Backlog GS&S total backlog increased by 8% in 2009 compared with 2008 due to significant growth in International Support and Defense and Government Services programs and partially offset by decreases in the IL and MM&U divisions. Total backlog increased 6% in 2008 compared with 2007 primarily due to increases in IL and International Support programs.
Boeing Capital Corporation
Business Environment and Trends
BCCs customer financing and investment portfolio at December 31, 2009 totaled $5,666 million, which was substantially collateralized by Boeing produced commercial aircraft. A substantial portion of BCCs portfolio is concentrated among U.S. commercial airline customers.
The weak global economic environment and capital market disruptions affected the availability of credit for the airline industry. While sources of financing available for aircraft deliveries improved during 2009, BCC provided limited financing to certain Boeing customers. To the extent capital market conditions continue to improve, we believe the overall aircraft financing market should improve as well and lessen the need for BCC to provide financing.
Aircraft values and lease rates are impacted by the number and type of aircraft that are currently out of service. Approximately 2,400 western-built commercial jet aircraft (11.6% of current world fleet) were parked as of December 2009, including both in-production and out-of-production aircraft types. Over 36% of the parked aircraft are not expected to return to service. In December 2008 and 2007, 11.0% and 8.2% of the western-built commercial jet aircraft were parked. Aircraft valuations could decline if significant numbers of aircraft, particularly types with relatively few operators, are placed out of service.
Summary Financial Information
(Dollars in millions)
BCC segment revenues consist principally of lease income from equipment under operating lease and interest from financing receivables and notes. BCCs revenues decreased $43 million in 2009, resulting from lower operating lease income resulting from a smaller portfolio of equipment under operating leases as a result of aircraft returns and asset dispositions. BCCs revenues decreased $112 million in 2008, primarily due to lower interest income on notes receivable and lower investment income.
Earnings From Operations
BCCs operating earnings are presented net of interest expense, provision for (recovery of) losses, asset impairment expense, depreciation on leased equipment and other operating expenses. Operating earnings decreased by $36 million in 2009 primarily due to lower revenues, higher impairment expense and a provision for losses primarily due to declines in aircraft collateral values and reduced projected cash flows for certain aircraft. The decrease in operating earnings in 2008 compared with 2007 was primarily due to lower revenues.
The following table presents selected financial data for BCC as of December 31,:
BCCs customer financing and investment portfolio at December 31, 2009 decreased from December 31, 2008 due to normal portfolio run-off partially offset by new business volume. At December 31, 2009 and 2008, BCC had $385 million and $685 million of assets that were held for sale or re-lease, of which $345 million and $305 million had either executed term sheets with deposits or firm contracts to be sold or placed on lease. In March 2009, Mexicana Group committed to lease 25 717 aircraft, including 13 that were placed on lease and 12 that were held for sale or re-lease at December 31, 2009. Additionally, aircraft subject to leases with a carrying value of approximately $171 million are scheduled to be returned off lease during 2010. These aircraft are being remarketed or the leases are being extended and approximately $15 million of such aircraft had either executed term sheets with deposits or firm contracts at December 31, 2009.
BCC enters into certain transactions with the Other segment in the form of intercompany guarantees and other subsidies.
Restructurings and Restructuring Requests
From time to time, certain customers have requested a restructuring of their transactions with BCC. As of December 31, 2009, BCC has not reached agreement on any restructuring requests that would have a material adverse effect on its earnings, cash flows and/or financial position.
(Dollars in millions)
Effective January 1, 2008, certain intercompany items were realigned between the Other segment and Unallocated expense. Business segment data for all periods presented have been adjusted to reflect the realignment. Other segment revenues for the year ended December 31, 2009 decreased by $402 million compared with 2008 primarily due to the sale of three C-17 aircraft in 2008 held under operating lease. Other segment operating losses for the year ended December 31, 2009 decreased by $155 million primarily due to recognition of pre-tax expense of $82 million in the prior year to increase the allowance for losses on customer financing receivables related to lower U.S. airline customer credit ratings. During 2009, Other segment recognized $76 million in lower charges relating to environmental remediation than in 2008.
Other segment revenues for the year ended December 31, 2008 increased by $259 million compared with 2007 primarily due to the sale of four C-17 aircraft held under operating lease, three of which were sold in 2008. Other segment operating losses for the year ended December 31, 2008 decreased by $24 million compared with 2007 primarily due to $50 million in lower environmental and certain other charges offset by the recognition of a provision for losses of $82 million related to lower U.S. airline customer credit ratings. The provision for losses amount has been recorded in the Other segment as a result of intercompany guarantees we provide to BCC.
Liquidity and Capital Resources
Cash Flow Summary
Operating Activities Net cash provided by operating activities increased by $6,004 million to $5,603 million during 2009 compared with 2008. The improvement reflects a reduction in working capital due to the inventory that was built up during the 2008 IAM strike which was delivered in 2009, offset by the continued ramp up of the 787 program during 2009. We expect operating cash flows to be lower in 2010 as we continue to build inventories prior to deliveries of the 787 and 747-8 airplanes. We contributed 29,211,295 shares of our common stock with an aggregate value of $1.5 billion to our pension plans in November 2009. Cash contributions to our pension plans totaled $82 million and $531 million in 2009 and 2008.
Investing Activities Cash used by investing activities totaled $3,794 million during 2009 compared with $1,888 million provided during 2008. The $5,682 million year-over-year change is primarily due to changes in investments in time deposits and debt securities. In 2008 we received net proceeds of $4,670 million from liquidating investments. In 2009, we made net contributions of $1,588 million to investments. In 2009, other investing outlays included $639 million for acquisitions and $448 million to satisfy guarantees of Sea Launch indebtedness, which was partially offset by a $40 million reimbursement. These cash outlays were partly offset by $488 million of lower capital spending on property, plant and equipment additions in 2009 compared with 2008. We expect capital spending in 2010 to be higher than 2009 due to the construction of a second 787 final assembly line in North Charleston, South Carolina.
Financing Activities Cash provided by financing activities totaled $4,094 million during 2009 compared with $5,202 million used during 2008, primarily due to proceeds from borrowings of $5,961 million in 2009 and reductions in share repurchases in 2009.
On March 13, 2009, we issued notes totaling $1,850 million, on July 28, 2009, we issued notes totaling $1,950 million, and on November 20, 2009, we issued notes totaling $1,200 million. On October 27, 2009, BCC issued notes totaling $1,000 million.
In 2009, we repaid $551 million of debt, including $528 million of debt held at BCC. In 2008, we repaid $738 million of debt, including $709 million of debt held at BCC. In 2007, we repaid $1,406 million of debt, including $1,309 million of debt held at BCC. There were no material debt issuances during 2008 or 2007. At December 31, 2009 and 2008, the recorded balance of debt was $12,924 million and $7,512 million, of which $707 million and $560 million were classified as short-term. This includes $4,075 million and $3,652 million of debt recorded at BCC, of which $659 million and $528 million was classified as short-term.
During 2009, we repurchased 1,173,152 shares at an average price of $42.94 in our open market share repurchase program and 477,176 shares transferred to us from employees in satisfaction of minimum tax withholding obligations associated with the vesting of restricted stock during the period. During 2008, we repurchased 42,073,885 shares at an average price of $69.79 in our open market share repurchase program, 1,462,776 shares at an average price of $64.95 as part of the ShareValue Trust distribution, and 74,824 shares in stock swaps. During 2007, we repurchased 28,995,599 shares at an average price of $95.68 in our open market share repurchase program and 28,432 shares in stock swaps. Share repurchase activity is expected to remain at a minimal level in 2010.
Credit Ratings Our credit ratings are summarized below:
On April 30, 2009, Fitch Ratings affirmed Boeings and BCCs A+ credit rating but changed its outlook from stable to negative. On July 29, 2009, Standard & Poors lowered Boeings and BCCs long-term ratings from A+ to A. On October 14, 2009, Moodys affirmed Boeings and BCCs A2 and P-1 ratings, but changed its outlook from neutral to negative.
Capital Resources We have substantial borrowing capacity. Any future borrowings may affect our credit ratings and are subject to various debt covenants. We and BCC have commercial paper programs that continue to serve as significant potential sources of short-term liquidity. Throughout 2009 and at December 31, 2009, neither we nor BCC had any commercial paper borrowings outstanding. Currently, we have $3,525 million ($1,500 million exclusively available for BCC) of unused borrowing on revolving credit line agreements, of which $2,000 million is a 5-year credit facility expiring in November 2012 and $1,525 million is a 364-day revolving credit facility expiring in November 2010. Both the 5-year and 364-day credit facilities have a one-year term out option which allows us to extend the maturity of any borrowings one year beyond the aforementioned expiration dates. In 2009, we renewed the 364-day revolving credit facility, of which $500 million is allocated to BCC. We anticipate that these credit lines will primarily serve as backup liquidity to support possible commercial paper borrowings in 2010. On March 9, 2009, we filed a public shelf registration with the U.S. Securities and Exchange Commission for the issuance of an indeterminate amount of debt securities and common stock.
In the event we require additional funding to support strategic business opportunities, our commercial aircraft financing commitments, unfavorable resolution of loss contingencies, or other business requirements, we expect to meet increased funding requirements by issuing commercial paper or term debt. We believe our ability to access external capital resources should be sufficient to satisfy existing short-term and long-term 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. At this point in time, our access to liquidity sources has not been materially impacted by the current credit environment, and we do not expect that it will be materially impacted in the near future. There can be no assurance, however, that the cost or availability of future borrowings, if any, under our commercial paper program, in the debt markets or our credit facilities will not be materially impacted by capital market conditions.
On November 9, 2009, we made pension contributions in the form of 29,211,295 shares of our common stock. The contributed shares had an aggregate value of $1.5 billion, as of the contribution
date. The share contribution did not affect cash balances. In addition, we made cash contributions of $82 million during 2009. In 2010, we will begin matching employee contributions to the company-sponsored 401(k) plan with common stock instead of cash for nonunion employees.
At December 31, 2009 and 2008 our pension plans were $6,356 million and $8,420 million underfunded as measured under GAAP. In 2010, required contributions to our pension plans are not expected to exceed $100 million.
As of December 31, 2009, we were in compliance with the covenants for our debt and credit facilities. The most restrictive covenants include a limitation on mortgage debt and sale and leaseback transactions as a percentage of consolidated net tangible assets (as defined in the credit agreements), and a limitation on consolidated debt as a percentage of total capital (as defined). When considering debt covenants, we continue to have substantial borrowing capacity.
The following table summarizes our known obligations to make future payments pursuant to certain contracts as of December 31, 2009, and the estimated timing thereof.
Pension and Other Postretirement Benefits Pension cash requirements are based on 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 contributions to plans that are funded through trusts.
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 Consolidated Statements of Financial Position. Approximately 9% 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.
Purchase Obligations Recorded on the Consolidated Statement of Financial Position Purchase obligations recorded on the Consolidated Statement of Financial Position primarily include accounts payable and certain other liabilities including accrued compensation and dividends payable.
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 2009, we incurred no such penalties. As of December 31, 2009, we have outstanding industrial participation agreements totaling $11 billion that extend through 2024. 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 foreign supplier must have sufficient capability to meet our requirements and must be competitive in cost, quality and schedule.
Income Tax Obligations As of December 31, 2009, our total liability for income taxes payable, including uncertain tax positions, was $1,009 million, of which $182 million we expect to pay in the next twelve months. We are not able to reasonably estimate the timing of future cash flows related to the remaining $827 million. Our income tax obligations are excluded from the table above. See Note 5.
The following table summarizes our commercial commitments outstanding as of December 31, 2009.
Commercial aircraft financing commitments include commitments to provide financing related to aircraft on order, under option for deliveries or proposed as part of sales campaigns based on estimated earliest potential funding dates. Based on historical experience, we currently do not anticipate that all of these commitments will be exercised by our customers; however there can be no assurances that we will not be required to fund greater amounts than historically required. See Note 11.
We have significant contingent obligations that arise in the ordinary course of business, which include the following:
Legal Various legal proceedings, claims and investigations are pending against us. Legal contingencies are discussed in Note 20, including our contesting the default termination of the A-12 aircraft, litigation/arbitration involving BSSI programs and employment and benefits litigation brought by several of our employees.
Environmental Remediation We are involved with various environmental remediation activities and have recorded a liability of $706 million at December 31, 2009. For additional information, see Note 11.
Income Taxes We have recorded a net liability of $1,787 million at December 31, 2009 for uncertain tax positions. For further discussion of these contingencies, see Note 5.
Off-Balance Sheet Arrangements
We are a party to certain off-balance sheet arrangements including certain guarantees. For discussion of these arrangements, see Note 12.
Critical Accounting Policies
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. 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 contracts 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 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 BDS for all of 2009 had been estimated to be higher or lower by 1%, it would have increased or decreased pre-tax income for the year by approximately $337 million. A number of our contracts are in a reachforward loss position. Changes to estimated loss in future periods are recorded immediately in earnings.
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. The determination of the accounting quantity is limited by the ability to make reasonably dependable estimates of the revenue and cost of 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 part costs, major component costs, overhead costs, program tooling costs, and routine warranty costs. 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 prices 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, customer and/or supplier claims or assertions, 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 normally recognized on a prospective basis; when estimated costs to complete a program exceed estimated revenues from undelivered units in the accounting quantity, a loss provision is recorded in the current period for the estimated loss on all undelivered units in the accounting quantity.
The program method of accounting allocates tooling and production costs over the accounting quantity for each program. Because of the higher unit production costs experienced at the beginning of a new program and substantial investment required for initial tooling, new commercial aircraft programs, such as the 787 program, typically have lower margins than established programs.
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, supplier performance, or circumstances may adversely or positively affect financial performance in future periods. If combined cost of sales percentages for commercial airplane programs, excluding the 747 program, for all of 2009 had been estimated to be higher or lower by 1%, it would have increased or decreased pre-tax income for the year by approximately $275 million. The 747 program is in a reach-forward loss position. Absent changes in the estimated revenues or costs, subsequent deliveries are
recorded at zero margin. Reductions to the estimated loss in subsequent periods are spread over all undelivered units in the accounting quantity, whereas increases to the estimated loss are recorded immediately.
Allowance for Losses on Customer Financing Receivables The allowance for losses on customer financing receivables (valuation provision) is used to provide for potential impairment of customer financing receivables in the Consolidated Statements of Financial Position. The balance represents an estimate of probable but unconfirmed losses in the customer financing receivables portfolio. The estimate is based on various qualitative and quantitative factors, including historical loss experience, collateral values, and results of individual credit and collectibility reviews. The adequacy of the allowance is assessed quarterly.
Three primary factors influencing the level of our allowance are customer credit ratings, collateral values and default rates. If each customers credit rating were upgraded or downgraded by one major rating category at December 31, 2009, the allowance would have decreased by $142 million or increased by $308 million. If the collateral values were 10% higher or lower at December 31, 2009, the allowance would have decreased by $56 million or increased by $54 million. If the cumulative default rates used for each rating category should increase or decrease 1%, the allowance would have increased by $6 million or decreased by $6 million.
Impairment Review for Assets Under Operating Leases and Held for Re-Lease We evaluate for impairment assets under operating lease or assets held for re-lease when events or changes in circumstances indicate that the expected undiscounted cash flow from the asset may be less than its carrying value. We use various assumptions when determining the expected undiscounted cash flow including the expected future lease rates, lease terms, residual value of the asset, 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 impairment expense recorded is the excess of the carrying value over the fair value of the asset.
Had future lease rates on assets evaluated for impairment been 10% lower, we estimate that we would have incurred additional impairment expense of $8 million for the year ended December 31, 2009.
Lease Residual Values Equipment under operating leases and assets held for re-lease are carried at cost less accumulated depreciation and are depreciated to estimated residual value using the straight-line method over the period that we project we will hold the asset for lease. Estimates used in determining residual values significantly impact the amount and timing of depreciation expense for equipment under operating leases and assets held for re-lease. If the estimated residual values declined 10% at December 31, 2009, this would result in a future cumulative pre-tax earnings impact of approximately $180 million recognized over the remaining depreciable periods, of which approximately $45 million would be recognized in 2010.
Goodwill and Indefinite-Lived Intangible Impairments
Goodwill and other acquired intangible assets with indefinite lives are not amortized but are annually tested for impairment, and when an event occurs or circumstances change such that it is reasonably possible that an impairment may exist. April 1 is our annual testing date. 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, if any.
Changes in our forecasts or decreases in the value of our common stock could cause book values of certain operations to exceed their fair values which may result in goodwill impairment charges in future periods. A 10% decrease in the estimated fair value of any of our operations would have no impact on the carrying value of goodwill.
As of December 31, 2009 and 2008, we had $499 million of indefinite-lived intangible assets related to the Jeppesen and Aviall brand and trade names acquired in business combinations. We test these intangibles for impairment by comparing their carrying value to current projections of discounted cash flows attributable to the brand and trade names. Any excess carrying value over the amount of discounted cash flows represents the amount of the impairment. A 10% decrease in the discounted cash flows would have no impact on the carrying value of these indefinite-lived intangible assets.
Substantially all our employees are covered by defined benefit pension plans. We also have other 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. Significant assumptions include the discount rate, the expected long-term rate of asset return, and medical trend rate (rate of growth for medical costs). Future changes in assumptions or differences between actual and expected outcomes can significantly affect our future annual expense, projected benefit obligations and Shareholders equity.
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 December 31, 2009.
Pension expense is also sensitive to changes in the expected long-term rate of asset return. A decrease or increase of 25 basis points in the expected long-term rate of asset return would have increased or decreased 2009 net periodic pension expense by $117 million.
Differences between actual and expected returns can affect future years pension cost. The asset balance used to calculate the expected return on pension plan assets is a calculated value that recognizes changes in the fair value of assets over a five year period. Despite investment gains during 2009, the significant losses incurred during 2008 will cause net periodic pension cost for 2010 to increase by approximately $100 million due to amortization of actuarial losses. Absent a recovery of asset values or higher interest rates or higher contributions, net periodic pension expense will increase further in future years.
The assumed medical trend rates have a significant effect on the following years 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 December 31, 2009.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
We have financial instruments that are subject to interest rate risk, principally fixed-rate debt obligations, and customer financing assets and liabilities. Additionally, BCC uses interest rate swaps with certain debt obligations to manage exposure to interest rate changes. Exposure to this risk is managed by generally matching the profile of BCCs liabilities with that of BCCs assets in relation to amount and terms such as expected maturities and fixed versus floating interest rates. As of December 31, 2009, the impact to BCCs pre-tax earnings of a 100 basis point immediate and sustained rise in interest rates would be insignificant for the year ended December 31, 2010. Historically, we have not experienced material gains or losses on our investments or customer financing assets and liabilities due to interest rate changes.
Based on the portfolio of other Boeing fixed-rate 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 forward and option contracts are sensitive to changes in foreign currency exchange rates. At December 31, 2009, a 10% increase in the exchange rate in our portfolio of foreign currency contracts would have decreased our unrealized gains by $136 million and a 10% decrease in the exchange rate would have increased our unrealized gains by $150 million. At December 31, 2008, a 10% increase in the exchange rate in our portfolio of foreign currency forward and option contracts would have decreased our unrealized losses by $70 million and a 10% decrease in the exchange rate would have decreased our unrealized losses by $196 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.
Item 8. Financial Statements and Supplementary Data
Index to the Consolidated Financial Statements
Consolidated Statements of Operations
See notes to consolidated financial statements on pages 55 112.
Consolidated Statements of Financial Position
See notes to consolidated financial statements on pages 55 112.
Consolidated Statements of Cash Flows
See notes to consolidated financial statements on pages 55 112.
Consolidated Statements of Shareholders Equity
See notes to consolidated financial statements on pages 55 112.
Notes to Consolidated Financial Statements
Summary of Business Segment Data