Boeing Company 10-Q 2011
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended June 30, 2011
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)
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 whether the registrant is a large accelerated filer, an 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. (Check one):
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 July 20, 2011, there were 741,091,503 shares of common stock, $5.00 par value, issued and outstanding.
THE BOEING COMPANY
For the Quarter Ended June 30, 2011
Item 1. Financial Statements
Condensed Consolidated Statements of Operations
See Notes to the Condensed Consolidated Financial Statements.
Condensed Consolidated Statements of Financial Position
See Notes to the Condensed Consolidated Financial Statements.
Condensed Consolidated Statements of Cash Flows
See Notes to the Condensed Consolidated Financial Statements.
Condensed Consolidated Statement of Equity
See Notes to the Condensed Consolidated Financial Statements.
Notes to Condensed Consolidated Financial Statements
Summary of Business Segment Data
This information is an integral part of the Notes to the Condensed Consolidated Financial Statements. See Note 15 for further business segment data.
The Boeing Company and Subsidiaries
Notes to the Condensed Consolidated Financial Statements
(Dollars in millions, except per share data)
Note 1 Basis of Presentation
The condensed consolidated interim financial statements included in this report have been prepared by management of The Boeing Company (herein referred to as Boeing, the Company, we, us, or our). In the opinion of management, all adjustments (consisting of normal recurring accruals) necessary for a fair presentation are reflected in the interim financial statements. The results of operations for the period ended June 30, 2011 are not necessarily indicative of the operating results for the full year. The interim financial statements should be read in conjunction with the audited consolidated financial statements, including the notes thereto, included in our 2010 Annual Report on Form 10-K.
Note 2 Earnings Per Share
The weighted average number of shares outstanding used to compute earnings per share were as follows:
Basic earnings per share is calculated by the sum of (1) net earnings less declared dividends and dividend equivalents related to share-based compensation divided by the basic weighted average shares outstanding and (2) declared dividends and dividend equivalents related to share-based compensation divided by the weighted average shares outstanding.
The weighted average number of shares outstanding included in the following table were excluded from the computation of diluted earnings per share because the average market price did not exceed the exercise/threshold price. However, these shares may be dilutive potential common shares in the future.
Note 3 Income Taxes
The effective tax rates were 33.7% and 33.9% for the six and three months ended June 30, 2011 and 42.1% and 34.8% for the same periods in the prior year. The decrease in the effective tax rate for the six months as compared with the prior year was primarily due to an income tax charge of $150
recorded during the first quarter of 2010 as a result of the Patient Protection and Affordable Care Act, as modified by the Health Care and Education Reconciliation Act of 2010. The decrease in the effective tax rate was also due to U.S. research and development tax credit benefits that exist in 2011, but did not exist in the first half of 2010. In December 2010, the research and development tax credit was retroactively renewed for 2010 and extended through December 31, 2011.
The 2007-2008 tax years are currently being examined by the Internal Revenue Service (IRS), and we have filed appeals with the IRS for the 2004-2006 tax years. We are also subject to examination in major state and international jurisdictions for the 2001-2010 tax years. We believe appropriate provisions for all outstanding issues have been made for all jurisdictions and all open years.
Audit outcomes and the timing of audit settlements are subject to significant uncertainty. It is reasonably possible that within the next 12 months we will resolve some or all of the matters presently under consideration for the 2004-2006 tax years with the IRS. Based on current estimates, unrecognized tax benefits for the 2004-2006 tax years could increase earnings by up to $325.
Note 4 Inventories
Inventories consisted of the following:
Long-Term Contracts in Progress
Long-term contracts in progress included Delta launch program inventory that will be sold at cost to United Launch Alliance (ULA) under an inventory supply agreement that terminates on March 31, 2021. At June 30, 2011 and December 31, 2010, the inventory balance was $1,145 and $1,385. At June 30, 2011, $912 of this inventory related to yet unsold launches. ULA is continuing to assess the future of the Delta II program. In the event ULA is unable to sell additional Delta II inventory, our earnings could be reduced by up to $70. See Note 9.
Inventory balances included $236 subject to claims or other uncertainties relating to the A-12 program as of June 30, 2011 and December 31, 2010. See Note 14.
Capitalized precontract costs of $911 and $527 at June 30, 2011 and December 31, 2010, are included in inventories.
Commercial Aircraft Programs
As of June 30, 2011 and December 31, 2010 commercial aircraft programs inventory included the following amounts related to the 787 program: $12,684 and $9,461 of work in process (including deferred production costs), $1,852 and $1,956 of supplier advances, and $1,677 and $1,447 of tooling and other non-recurring costs.
Commercial aircraft programs inventory included $235 and $319 of deferred production costs, and $156 and $170 of unamortized tooling for the 777 program, at June 30, 2011 and December 31, 2010.
Commercial aircraft programs inventory included amounts credited in cash or other consideration (early issue sales consideration) to airline customers totaling $2,522 and $1,970 at June 30, 2011 and December 31, 2010.
Note 5 Customer Financing
Customer financing consisted of the following:
Three primary factors influencing the level of our allowance for losses on customer financing receivables are customer credit ratings, default rates and collateral values. A significant portion of our portfolio is also concentrated among a few individual customers and as such the credit rating of those customers can have a significant influence on the level of the allowance. We assign internal credit ratings for all customers and determine the creditworthiness of each customer based upon public information and information obtained directly from our customers. We utilize these credit ratings as one of the factors in assessing the adequacy of our allowance for losses on receivables. Our rating categories are comparable to those used by the major credit rating agencies.
The following table details our receivable balances by the internal credit rating category which was used as a factor in determining our allowance for losses on receivables.
At June 30, 2011, our allowance primarily related to customers with ratings of B, CCC+ and CCC in the table above, and we applied default rates that averaged 4.7%, 42.2% and 48.7% to receivables from these customers. On May 2, 2011, Southwest Airlines Co. (Southwest) completed its acquisition of AirTran Holdings, Inc. and AirTran Holdings, Inc. became a wholly owned subsidiary of Southwest. At June 30, 2011, the internal rating category of CCC+ is assigned to the receivables with AirTran Holdings LLC (AirTran), the successor to AirTran Holdings Inc., for the purpose of assigning default rates discussed above.
Declines in collateral values are a significant driver of our allowance for losses. Generally, out-of-production aircraft have had greater percentages of collateral value declines than in-production aircraft. Our portfolio consists primarily of financing receivables for out-of-production aircraft. The value of the collateral is closely tied to commercial airline performance and may be subject to reduced valuation with market decline. Our customer financing portfolio has a concentration of various model aircraft. Customer financing carrying values related to major aircraft concentrations were as follows:
Note 6 Investments
Our investments, which are recorded in Short-term and other investments or Investments, consisted of the following:
At June 30, 2011 and December 31, 2010, Other assets included $356 of receivables related to our former investment in the Sea Launch venture which became payable by certain Sea Launch partners following Sea Launchs bankruptcy filing in June 2009. The $356 includes $147 related to a payment made by us under a bank guarantee on behalf of Sea Launch and $209 related to loans we made to Sea Launch. The net amounts owed to Boeing by each of the partners are as follows: S.P. Koroley Rocket and Space Corporation Energia of Russia $223, PO Yuzhnoye Mashinostroitelny Zavod of Ukraine $89 and KB Yuzhnoye of Ukraine $44.
Although each partner is contractually obligated to reimburse us for its share of the bank guarantee, the Russian and Ukrainian partners have raised defenses to enforcement and contested our claims. On October 19, 2009, we filed a Notice of Arbitration with the Stockholm Chamber of Commerce seeking reimbursement from the other Sea Launch partners of the $147 bank guarantee payment. On October 7, 2010, the arbitrator ruled that the Stockholm Chamber of Commerce lacked jurisdiction to hear the matter but did not resolve the merits of our claim. We filed a notice appealing the arbitrators
ruling on January 11, 2011. We believe the partners have the financial wherewithal to pay and intend to pursue vigorously all of our rights and remedies. In the event we are unable to secure reimbursement of $147 related to our payment under the bank guarantee and $209 related to loans made to Sea Launch, we could incur pre-tax charges of up to $356.
Financing commitments totaled $14,254 and $9,865 as of July 22, 2011 and December 31, 2010. We anticipate that we will not be required to fund a significant portion of our financing commitments as we continue to work with third party financiers to provide alternative financing to customers. However, there can be no assurances that we will not be required to fund greater amounts than historically required.
Standby Letters of Credit and Surety Bonds
We have entered into standby letters of credit agreements and surety bonds with financial institutions primarily relating to the guarantee of our future performance on certain contracts. Contingent liabilities on outstanding letters of credit agreements and surety bonds aggregated approximately $7,233 and $7,599 as of June 30, 2011 and December 31, 2010.
Commercial Aircraft Commitments
In conjunction with signing definitive agreements for the sale of new aircraft (Sale Aircraft), we have entered into specified-price trade-in commitments with certain customers that give them the right to trade in used aircraft upon the purchase of Sale Aircraft. The total contractual trade-in value was $295 as of June 30, 2011 and December 31, 2010. We anticipate that a significant portion of these commitments will not be exercised by customers.
The probability that trade-in commitments will be exercised is determined by using both quantitative information from valuation sources and qualitative information from other sources. The probability of exercise is continually assessed, taking into consideration the current economic environment. Trade-in commitments, which can be terminated by mutual consent with the customer, may be exercised only during the period specified in the agreement, and require advance notice by the customer. The fair value of trade-in aircraft related to probable contractual trade-in commitments was $27 and $30 as of June 30, 2011 and December 31, 2010. Trade-in commitment agreements have expiration dates from 2011 through 2023.
Commitments to ULA
In connection with the formation of ULA, we and Lockheed Martin Corporation (Lockheed) each committed to provide up to $200 to support ULAs working capital requirements through December 1, 2011. ULA did not request any funds under the commitment as of June 30, 2011. We and Lockheed have also each committed to provide ULA with up to $304 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 4.
The following table summarizes product warranty activity recorded during the six months ended June 30, 2011 and 2010.
The following table summarizes environmental remediation activity recorded during the six months ended June 30, 2011 and 2010:
The liabilities recorded represent our best estimate or the low end of a range of reasonably possible costs expected to be incurred to remediate sites, including operation and maintenance over periods of up to 30 years. It is reasonably possible that we may incur charges that exceed these recorded amounts because of regulatory agency orders and directives, changes in laws and/or regulations, higher than expected costs and the discovery of additional contamination. As part of our estimating process, we develop a range of reasonably possible alternate scenarios which include highest cost estimates for all remediation sites for which we have sufficient information based on our experience and existing laws and regulations. At June 30, 2011 and December 31, 2010, our reasonably possible highest cost estimate for all remediation sites exceeded our recorded liabilities by $997 and $957.
At June 30, 2011, our backlog included 6 C-17 aircraft currently under contract with the U.S. Air Force (USAF) as well as international orders for 5 C-17 aircraft. We believe that 18 additional orders beyond the 11 in backlog are probable. Probable orders include 13 aircraft for international orders and 5 aircraft for the USAF funded in Fiscal Year 2010 Defense Appropriations Act which are not currently under contract. At June 30, 2011, we had approximately $630 of inventory expenditures and potential termination liabilities to suppliers associated with probable orders. The Fiscal Year 2011 Appropriations Budget and the Presidents Fiscal Year 2012 budget request did not include any additional C-17 aircraft. We continued to work towards the planned production rate decrease from 15 per year to 10 per year and we expect the transition to be complete in third quarter 2011. The associated reduction in headcount resulted in pension curtailment charges of $34 in the first quarter of 2011. Should additional orders not materialize, it is reasonably possible that we will decide in 2012 to end production of the C-17 at a future date. We are still evaluating the full financial impact of a potential production shut-down, including additional pension curtailment charges, and any recovery that would be available from the U.S. government. Such recovery from the U.S. government would not include the costs incurred by us resulting from our direction to suppliers to begin working on aircraft beyond those currently under contract with the USAF.
At June 30, 2011, we had approximately $1,335 of inventory expenditures and potential termination liabilities to suppliers related to probable international orders. Should these orders not materialize, we could incur losses to write off inventory and settle termination liabilities.
BDS Fixed-Price Development Contracts
Fixed-price development work is inherently uncertain and subject to significant variability in estimates of the cost and time required to complete the work. Significant BDS fixed-price development contracts include Airborne Early Warning and Control, P-8I, KC-46A Tanker, KC-767 International Tanker and commercial and military satellites. The operational and technical complexities of these contracts create financial risk, which could trigger termination provisions, order cancellations or other financially significant exposure. Changes to cost and revenue estimates could also result in lower margins or a material charge for reach-forward losses during the next 12 months.
Commercial Airplane Development Programs
Significant risks are inherent throughout the development of new commercial airplanes and new commercial airplane derivatives. Currently the 787-8, 747-8 Freighter and 747-8 Intercontinental are completing the demanding flight test and certification stages of program development. The 787-9 is also in development. These programs require substantial investments and research and development as well as investments in working capital and infrastructure. They also entail significant commitments to customers and suppliers and require substantial internal resources. Performance issues on these programs could have a material adverse impact on our consolidated results and financial position during the next 12 months.
Note 9 Arrangements with Off-Balance Sheet Risk
We enter into arrangements with off-balance sheet risk in the normal course of business, primarily in the form of guarantees. The following table provides quantitative data regarding our third-party guarantees. The maximum potential payments represent a worst-case scenario, and do not necessarily reflect amounts that we expect to pay. Estimated proceeds from collateral and recourse represent the anticipated values of assets we could liquidate or receive from other parties to offset our payments under guarantees. The carrying amount of liabilities represents the amount included in Accrued liabilities.
Contingent Repurchase Commitments We have entered into contingent repurchase commitments with certain customers in conjunction with signing definitive agreements for the sale of new aircraft. Under these commitments, we agreed to repurchase the Sale Aircraft at a specified price, generally 10 to 15 years after delivery of the Sale Aircraft. Our repurchase of the Sale Aircraft is contingent upon a future, mutually acceptable agreement for the sale of additional new aircraft, and the subsequent exercise by the customer of its right to sell the Sale Aircraft to us. The repurchase price specified in contingent repurchase commitments is generally lower than the expected fair value at the specified repurchase date. Estimated Proceeds from Collateral/Recourse in the table above represent the lower of the contracted repurchase price or the expected fair value of each aircraft at the specified repurchase date.
Indemnifications to ULA We agreed to indemnify ULA through December 31, 2020 against potential non-recoverability and non-allowability of $1,360 of Boeing Delta launch program inventory included in contributed assets plus $1,860 of inventory subject to an inventory supply agreement which ends on March 31, 2021. Since inception, ULA has consumed $1,209 of inventory that was contributed by us. ULA has made advance payments of $660 to us and we have recorded revenues and cost of sales of $374 under the inventory supply agreement through June 30, 2011.
In June 2011, the Defense Contract Management Agency (DCMA) notified ULA that it had determined that $271 of costs that are partially indemnified by us are not recoverable under government contracts. ULA and Boeing believe these costs are recoverable and as such intend to challenge DCMAs determination. If, contrary to our belief, it is determined that some or all of these costs are not recoverable, we could be required to record pre-tax losses and make indemnification payments of up to $226.
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 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 satellite missions. In March 2009, the USAF issued a denial of that claim. In June 2009, ULA filed a notice of appeal and in October 2009, ULA filed a complaint before the Armed Services Board of Contract Appeals (ASBCA) for a contract adjustment for the price of the two satellite missions. In September 2009, the USAF exercised its option for a third satellite mission. The USAF did not exercise an option for a fourth mission prior to the expiration. During the third quarter of 2010, ULA submitted a claim to the USAF to re-price the contract value of the third mission. In March 2011, ULA filed a notice of appeal before the ASBCA, seeking to re-price the third mission. If ULA is unsuccessful in obtaining additional pricing, we may be responsible for a portion of the shortfall and may record up to $282 in pre-tax losses associated with the three missions, representing up to $261 for the indemnification payment and up to $21 for our portion of additional contract losses incurred by ULA.
Other Indemnifications As part of the 2004 sale agreement with General Electric Capital Corporation related to the sale of Boeing Capital Corporations (BCC) Commercial Financial Services business, BCC is involved in a loss sharing arrangement for losses on transferred portfolio assets, such as asset sales, provisions for loss or asset impairment charges offset by gains from asset sales.
In conjunction with our sales of the Electron Dynamic Devices, Inc. and Rocketdyne Propulsion and Power businesses and the sale of our Commercial Airplanes facilities in Wichita, Kansas and Tulsa and McAlester, Oklahoma in 2005, we agreed to indemnify, for an indefinite period, the buyers for costs relating to pre-closing environmental contamination and certain other items. As it is impossible to assess whether there will be damages in the future or the amounts thereof (if any), we cannot estimate the maximum potential amount of future payments under these indemnities. Therefore, no liability has been recorded. There have been no claims submitted to date.
Credit Guarantees We have issued credit guarantees, principally to facilitate the sale and/or financing of commercial aircraft. Under these arrangements, we are obligated to make payments to a guaranteed party in the event that lease or loan payments are not made by the original lessee or debtor or certain specified services are not performed. A substantial portion of these guarantees has been extended on behalf of original lessees or debtors with less than investment-grade credit. Our commercial aircraft credit guarantees are collateralized by the underlying commercial aircraft and certain other assets. Current outstanding credit guarantees expire within the next nine years.
Residual Value Guarantees We have issued various residual value guarantees principally to facilitate the sale and financing of certain commercial aircraft. Under these guarantees, we are obligated to make payments to the guaranteed party if the related aircraft or equipment fair values fall below a specified amount at a future time. These obligations are collateralized principally by the underlying commercial aircraft and expire within the next seven years.
Note 10 Postretirement Plans
The components of net periodic benefit cost were as follows:
A portion of net periodic benefit cost is allocated to production as product costs and may remain in inventory at the end of the reporting period.
During the six months ended June 30, 2011 and 2010, we made discretionary pension contributions of $0 and $4. During the six months ended June 30, 2011 and 2010, we made contributions to our other postretirement benefit plans of $8 and $8.
On February 22, 2011, we granted to our executives 5,426,910 options with an exercise price equal to the fair market value of our stock on the date of grant and which expire ten years after the date of grant. The stock options vest over a period of three years, with 34% vesting after the first year, 33% vesting after the second year and the remaining 33% vesting after the third year. The fair value of stock options granted was estimated using the Black-Scholes option-pricing model with the following assumptions:
We determined the expected term of the stock option grants to be six years, calculated using the simplified method in accordance with the SEC Staff Accounting Bulletin 110. We use the simplified method since we have insufficient historical data to estimate expected term.
Restricted Stock Units
On February 22, 2011, we granted to our executives 1,364,440 restricted stock units (RSUs) as part of our long-term incentive program with a grant date fair value of $71.44 per share. The RSUs will vest and settle in common stock (on a one-for-one basis) on the third anniversary of the grant date. In addition to RSUs awarded under our long-term incentive program, we have granted RSUs to certain executives and employees to encourage retention or to reward various achievements.
On February 22, 2011, we granted to our executives Performance Awards with the payout based on the achievement of financial goals for the three-year period ending December 31, 2013. The minimum payout amount is $0 and the maximum amount we could be required to pay out is $267.
Cash Flow Hedges
Our cash flow hedges include foreign currency forward contracts, foreign currency option contracts, commodity swaps, and commodity purchase contracts. We use foreign currency forward and option contracts to manage currency risk associated with certain transactions, specifically forecasted sales and purchases made in foreign currencies. Our foreign currency contracts hedge forecasted transactions principally occurring within five years in the future, with certain contracts hedging transactions up to 2021. We use commodity derivatives, such as swaps and fixed-price purchase commitments, to hedge against potentially unfavorable price changes for items used in production. These include commitments to purchase electricity at fixed prices through 2016.
Fair Value Hedges
Interest rate swaps under which we agree to pay variable rates of interest are designated as fair value hedges of fixed-rate debt. The net change in fair value of the derivatives and the hedged items is reported in Boeing Capital Corporation interest expense.
Derivative Instruments Not Receiving Hedge Accounting Treatment
We also hold certain derivative instruments, primarily foreign currency forward contracts, for risk management purposes but without electing any form of hedge accounting.
Notional Amounts and Fair Values
The notional amounts and fair values of derivative instruments in the Condensed Consolidated Statements of Financial Position were as follows:
Gains/(losses) associated with our cash flow and undesignated hedging transactions and their effect on other comprehensive loss and Net earnings were as follows:
Based on our portfolio of cash flow hedges, we expect to reclassify gains of $49 (pre-tax) during the next 12 months. Ineffectiveness related to our hedges was insignificant for the six and three months ended June 30, 2011 and 2010.
We have derivative instruments with credit-risk-related contingent features. For foreign exchange contracts with original maturities of at least five years, our derivative counterparties could require settlement if we default on our five-year credit facility, expiring November 2012. For commodity contracts, our counterparties could require collateral posted in an amount determined by our credit ratings. The fair value of foreign exchange and commodity contracts that have credit-risk-related contingent features that are in a net liability position at June 30, 2011 was $48. At June 30, 2011, there was no collateral posted related to our derivatives.
Note 13 Fair Value Measurements
The following table presents our assets and liabilities that are measured at fair value on a recurring basis and are categorized using the fair value hierarchy. The fair value hierarchy has three levels based on the reliability of the inputs used to determine fair value. Level 1 refers to fair values determined based on quoted prices in active markets for identical assets. Level 2 refers to fair values estimated using significant other observable inputs and Level 3 includes fair values estimated using significant non-observable inputs.
Money market funds and available-for-sale equity securities are valued using a market approach based on the quoted market prices of identical instruments. Available-for-sale debt investments are primarily valued using a market approach based on benchmark yields, reported trades and broker/dealer quotes.
Derivatives include foreign currency, commodity and interest rate contracts. Our foreign currency forward contracts are valued using an income approach based on the present value of the forward rate less the contract rate multiplied by the notional amount. Commodity derivatives are valued using an income approach based on the present value of the commodity index prices less the contract rate multiplied by the notional amount. The fair value of our interest rate swaps is derived from a discounted cash flow analysis based on the terms of the contract and the interest rate curve.
Certain assets have been measured at fair value on a nonrecurring basis using significant unobservable inputs (Level 3). The following table presents the nonrecurring losses recognized for the six months ended June 30, and the carrying value and asset classification of the related assets still held as of June 30:
The operating lease equipment was valued using a market approach based on the fair value for the related aircraft. The acquired intangible asset was valued using an income approach based on the discounted cash flows associated with the underlying tradename. The property, plant and equipment
was valued using an income approach based on the discounted cash flows associated with the underlying equipment.
Fair Value Disclosures
The following table presents our financial assets and liabilities that are not measured at fair value on a recurring basis. The carrying amounts and estimated fair values consisted of the following:
The fair values of the accounts receivable and accounts payable are based on current market rates for loans of the same risk and maturities. The fair values of our variable rate notes receivable that reprice frequently approximate their carrying amounts. The fair values of fixed rate notes receivable are estimated using discounted cash flow analysis using interest rates currently offered on loans with similar terms to borrowers of similar credit quality. The fair value of our debt is based on current market yields for our debt traded in the secondary market. The fair values of the residual value guarantees and contingent repurchase commitments are determined using a Black Futures Options formula and include such assumptions as the expected value of the aircraft on the settlement date, volatility of aircraft prices, time until settlement and the risk free discount rate. The fair value of the credit guarantees is estimated based on the expected cash flows of those commitments, given the creditors probability of default, and discounted using the risk free rate. With regard to other financial instruments with off-balance sheet risk, it is not practicable to estimate the fair value of our indemnifications because the amount and timing of those arrangements are uncertain.
Note 14 Legal Proceedings
Various legal proceedings, claims and investigations related to products, contracts and other matters are pending against us. Potentially material contingencies are discussed below.
We are subject to various U.S. government investigations, from which civil, criminal or administrative proceedings could result or have resulted. Such proceedings involve or could involve claims by the government for fines, penalties, compensatory and treble damages, restitution and/or forfeitures. Under government regulations, a company, or one or more of its operating divisions or subdivisions, can also be suspended or debarred from government contracts, or lose its export privileges, based on the results of investigations. We believe, based upon current information, that the outcome of any such government disputes and investigations will not have a material adverse effect on our financial position, results of operations, or cash flows, except as set forth below. Unless otherwise indicated below, a range of loss associated with any individual legal proceeding set forth below cannot be estimated.
In 1991, the Department of the Navy (the Navy) notified McDonnell Douglas Corporation (now merged into The Boeing Company) and General Dynamics Corporation (together, the Team) that it was terminating for default the Teams contract for development and initial production of the A-12 aircraft. The Team had full responsibility for performance of the contract and both contractors are jointly and severally liable for any potential liabilities resulting from the termination. The Team filed a legal action to contest the Navys default termination, to assert its rights to convert the termination to one for the convenience of the government, and to obtain payment for work done and costs incurred on the A-12 contract but not paid to date. As of June 30, 2011, inventories included approximately $586 of recorded costs on the A-12 contract, against which we have established a loss provision of $350. The amount of the provision, which was established in 1990, was based on McDonnell Douglas Corporations belief, supported by an opinion of outside counsel, that the termination for default would be converted to a termination for convenience, and that the best estimate of possible loss on termination for convenience was $350.
On August 31, 2001, the U.S. Court of Federal Claims issued a decision after trial upholding the governments default termination of the A-12 contract. In 2003, the Court of Appeals for the Federal Circuit, finding that the trial court had applied the wrong legal standard, vacated the trial courts 2001 decision and ordered the case sent back to the trial court for further proceedings. On May 3, 2007, the U.S. Court of Federal Claims issued a decision upholding the governments default termination of the A-12 contract. We filed a Notice of Appeal on May 4, 2007 with the Court of Appeals for the Federal Circuit. On June 2, 2009, the Court of Appeals rendered an opinion affirming the trial courts 2007 decision sustaining the governments default termination. On December 29, 2009, the Navy sent letters to the Team requesting payment of $1,352 in unliquidated progress payments, plus applicable interest. On February 19, 2010, the Navy sent a letter confirming that it would not pursue payment from the Team pending the U.S. Supreme Courts review of this matter. On May 23, 2011, the U.S. Supreme Court vacated the decision of the Court of Appeals upholding the default termination, and remanded the case to the Court of Appeals. On July 7, 2011, the Court of Appeals remanded the case to the trial court for additional factual determinations.
We believe that the termination for default is contrary to law and fact and that the loss provision established by McDonnell Douglas Corporation in 1990, continues to provide adequately for the reasonably possible reduction in value of A-12 net contracts in process as of June 30, 2011. Final resolution of the A-12 litigation will depend on the outcome of further proceedings or possible negotiations with the U.S. government. If, upon remand, the Court of Appeals holds, contrary to our belief, that the government was not obligated to share its superior knowledge and determines that a termination for default was appropriate, we could incur an additional loss of up to $275, consisting principally of $236 of remaining inventory costs. If the courts further hold that a money judgment should be entered against the Team, we could be required to pay the U.S. government up to one-half of the unliquidated progress payments of $1,350 plus statutory interest from February 1991 (currently totaling up to $1,545). In that event, our loss would total approximately $1,720 in pre-tax charges. Should, however, the March 31, 1998 judgment of the U.S. Court of Federal Claims in favor of the Team be reinstated, we could be entitled to receive payment of approximately $1,169, including interest from June 26, 1991.
Employment, Labor and Benefits Litigation
We have been named as a defendant in two pending class action lawsuits filed in the U.S. District Court for the District of Kansas, each related to the 2005 sale of our former Wichita facility to Spirit AeroSystems, Inc. (Spirit). The first action involves allegations that Spirits hiring decisions following the sale were tainted by age discrimination, violated the Employee Retirement Income Security Act
(ERISA), violated our collective bargaining agreements, and constituted retaliation. The case was brought in 2006 as a class action on behalf of individuals not hired by Spirit. During the second quarter of 2010, the court granted summary judgment in favor of Boeing and Spirit on all class action claims. The plaintiffs then filed a motion seeking reconsideration of the summary judgment decision and the court denied that motion on March 28, 2011. On April 8, 2011, plaintiffs sought final certification of the class claims to permit an immediate appeal of those claims.
The second action, initiated in 2007, alleges collective bargaining agreement breaches and ERISA violations in connection with alleged failures to provide benefits to certain former employees of the Wichita facility. Discovery in the case is ongoing. Spirit has agreed to indemnify Boeing for any and all losses in the first action, with the exception of claims arising from employment actions prior to January 1, 2005. While Spirit has acknowledged a limited indemnification obligation in the second action, we believe that Spirit is obligated to indemnify Boeing for any and all losses in the second action.
On October 13, 2006, we were named as a defendant in a lawsuit filed in the U.S. District Court for the Southern District of Illinois. Plaintiffs, seeking to represent a class of similarly situated participants and beneficiaries in The Boeing Company Voluntary Investment Plan (the VIP), alleged that fees and expenses incurred by the VIP were and are unreasonable and excessive, not incurred solely for the benefit of the VIP and its participants, and were undisclosed to participants. The plaintiffs further alleged that defendants breached their fiduciary duties in violation of §502(a)(2) of ERISA, and sought injunctive and equitable relief pursuant to §502(a)(3) of ERISA. During the first quarter of 2010, the Seventh Circuit Court of Appeals granted a stay of trial proceedings in the district court pending resolution of an appeal made by Boeing in 2008 to the cases class certification order. On January 21, 2011, the Seventh Circuit reversed the district courts class certification order and decertified the class. The Seventh Circuit remanded the case to the district court for further proceedings. On March 2, 2011, plaintiffs filed an amended motion for class certification.
On April 20, 2011, the National Labor Relations Board (NLRB) issued a complaint claiming that our decision to build an airplane final assembly plant in Charleston, South Carolina was made in retaliation for strikes conducted by the International Association of Machinists in Washington State. The complaint seeks to force Boeing to place the second 787 line in the Puget Sound area instead of South Carolina. We believe that the allegations in the complaint are without merit and that the legal theory advanced is contrary to settled precedent. Boeing intends to vigorously contest the claim. A hearing before an Administrative Law Judge of the NLRB began on June 14, 2011 and is ongoing.
On August 16, 2004, our wholly-owned subsidiary, Boeing Satellite Systems International, Inc. (BSSI) filed a complaint for declaratory relief against ICO Global Communications (Operations), Ltd. (ICO) in Los Angeles County Superior Court seeking a declaration that ICOs prior termination of two contracts for convenience extinguished all claims between the parties. On September 16, 2004, ICO filed a cross-complaint alleging breach of contract, economic duress, fraud, unfair competition, and other claims. ICO added The Boeing Company as a defendant in October 2005 to some of these claims and for interference with contract and misappropriation of trade secrets. On January 13, 2006, BSSI filed a cross-complaint against ICO, ICO Global Communications (Holdings) Limited (ICO Holdings), ICOs parent, and Eagle River Investments, LLC, parent of both ICO and ICO Holdings, alleging fraud and other claims. The trial commenced on June 19, 2008, with ICO seeking to recover approximately $2,000 in damages, including all monies paid to BSSI and Boeing Launch Services, plus punitive damages and other unspecified damages and relief.
On October 21, 2008, the jury returned a verdict awarding ICO compensatory damages of $371 plus interest, based upon findings of contract breach, fraud and interference with contract. On October 31,
2008, the jury awarded ICO punitive damages of $236. On January 2, 2009, the court entered judgment for ICO in the amount of $631 which included $24 in prejudgment interest.
On February 26, 2009 the trial court granted in part and denied in part post-trial motions we filed seeking to set aside the verdict. As a result, on March 3, 2009, the court entered an amended judgment for ICO in the amount of $604, which included $371 in compensatory damages, $207 in punitive damages and $26 in prejudgment interest. Post-judgment interest will accrue on the judgment at the rate of 10% per year (simple interest) from January 2, 2009. As of June 30, 2011, the amount of post-judgment interest totaled $151.
We filed a notice of appeal and ICO filed a notice of cross-appeal in March 2009. As of November 1, 2010, the appeals were fully briefed. No date has been set by the court for argument. We believe that we have substantial arguments on appeal, which we intend to pursue vigorously.
On November 9, 2006, Telesat Canada (Telesat) and a group of its insurers served BSSI with an arbitration demand alleging breach of contract, gross negligence and willful misconduct in connection with the constructive total loss of Anik F1, a model 702 satellite manufactured by BSSI. Telesat and its insurers initially sought over $385 in damages and $10 in lost profits, but revised their demand to $263. BSSI has asserted a counterclaim against Telesat for $6 in unpaid performance incentive payments plus late charges. BSSI also asserted a $180 contingent counterclaim on the theory that any ultimate award to reimburse the insurers for their payments to Telesat could only result from Telesats breach of its contractual obligation to obtain a full waiver of subrogation rights barring recourse against BSSI. We believe that the claims asserted by Telesat and its insurers lack merit, but we have notified our insurance carriers of the demand. The arbitration was stayed pending an application by Telesat to the Ontario Superior Court on a preliminary issue. On July 16, 2010, the court denied Telesats request to exclude certain evidence, but granted its alternative request to remove the Chairperson from the arbitration panel. A new Chairperson was appointed on August 19, 2010, and the stay has been lifted. The arbitration hearing has been rescheduled for April 16, 2012.
On April 26, 2007, a group of our insurers filed a declaratory judgment action in the Circuit Court of Cook County, Illinois asserting certain defenses to coverage and requesting a declaration of their obligation under our insurance and reinsurance policies relating to the Telesat Anik F1 arbitration. On June 12, 2008, the court granted the insurers motion for summary judgment, concluding that our insurance policy excluded the kinds of losses alleged by Telesat. On January 16, 2009, the court granted Boeings motion for reconsideration, ruling in favor of Boeing to require the insurers to provide insurance coverage to defend the claim. The case has been stayed pending completion of the underlying arbitration.
Civil Securities Litigation
On November 13, 2009, plaintiff shareholders filed a putative securities fraud class action against The Boeing Company and two of our senior executives in federal district court in Chicago. This lawsuit arose from our June 2009 announcement that the first flight of the 787 Dreamliner would be postponed due to a need to reinforce an area within the side-of-body section of the aircraft. Plaintiffs contended that we were aware before June 2009 that the first flight could not take place as scheduled due to issues with the side-of-body section of the aircraft, and that our determination not to announce this delay earlier resulted in an artificial inflation of our stock price for a multi-week period in May and June 2009. On March 7, 2011, the Court dismissed the complaint with prejudice. On April 4, 2011, plaintiffs filed a motion for reconsideration.
In addition, plaintiff shareholders have filed three similar shareholder derivative lawsuits concerning the flight schedule for the 787 Dreamliner that closely track the allegations in the putative class action lawsuit. Two of the suits were filed in Illinois state court and have been consolidated. The remaining derivative suit was filed in federal district court in Chicago. No briefing or discovery has yet taken place in any of these lawsuits. We believe the allegations in all of these cases are without merit, and we intend to contest the cases vigorously.
Note 15 Business Segment Data
Effective January 1, 2011, certain programs and assets were realigned within BDS segments. Business segment data for all periods presented have been adjusted to reflect the realignment.
Our primary profitability measurements to review a segments operating results are earnings from operations and operating margins. See page 5 for a Summary of Business Segment Data, which is an integral part of this note.
Intersegment revenues, eliminated in Unallocated items and eliminations, are shown in the following table.
Unallocated items and eliminations includes costs not attributable to business segments as well as intercompany profit eliminations. This includes unallocated pension and other postretirement expense which represents the difference between costs recognized under Generally Accepted Accounting Principles in the United States of America in the consolidated financial statements and federal cost accounting standards required to be utilized by our business segments for U.S. government contracting purposes. The most significant items not allocated to segments are shown in the following table.
Segment assets and liabilities are summarized in the following tables.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
The Boeing Company
We have reviewed the accompanying condensed consolidated statement of financial position of The Boeing Company and subsidiaries (the Company) as of June 30, 2011, the related condensed consolidated statements of operations for the three-month and six-month periods ended June 30, 2011 and 2010, and the related condensed consolidated statements of cash flows and equity for the six-month periods ended June 30, 2011 and 2010. These interim financial statements are the responsibility of the Companys management.
We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statement of financial position of the Company as of December 31, 2010, and the related consolidated statements of operations, equity and cash flows for the year then ended (not presented herein); and in our report dated February 9, 2011, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated statement of financial position as of December 31, 2010 is fairly stated, in all material respects, in relation to the consolidated statements of financial position from which it has been derived.
/S/ DELOITTE & TOUCHE LLP
July 27, 2011
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Consolidated Operating Results
The following table summarizes key indicators of consolidated results of operations:
The following table summarizes revenues:
Revenues for the six and three months ended June 30, 2011 increased by $664 million and $970 million or 2% and 6% compared with the same periods in 2010. Commercial Airplanes revenues increased by $1,060 million and $1,410 million or 7% and 19% primarily due to new airplane revenues and increases in commercial aviation services sales. Boeing Defense, Space & Security (BDS) revenues decreased by $291 million and $295 million, primarily due to lower revenues in the Network & Space Systems (N&SS) and Global Services & Support (GS&S) segments, partially offset by higher revenues in the Boeing Military Aircraft (BMA) segment.
Earnings From Operations
The following table summarizes earnings from operations:
Operating earnings for the six and three months ended June 30, 2011 increased by $53 million and $227 million compared with the same periods in 2010. Commercial Airplanes earnings increased by $67 million and $237 million primarily due to new airplane deliveries and increases in commercial aviation services sales. BDS earnings increased by $94 million and $87 million compared with the same periods in 2010. The increase for the six months was primarily due to higher earnings in the BMA segment. The increase for the three months was primarily due to higher earnings in all three BDS segments. Unallocated items and eliminations changed by $163 million and $118 million reflecting higher pension and deferred compensation costs which were partially offset by lower share based plan expense.
The most significant expense items not allocated to segments are shown in the following table:
Unallocated pension costs for the six and three months ended June 30, 2011 increased by $201 million and $85 million compared with the same periods in 2010 reflecting higher amortization of prior actuarial losses, lower discount rates and C-17 related pension curtailment charges.
Unallocated pension and other postretirement expense represents the difference between costs recognized under Generally Accepted Accounting Principles in the United States of America in the condensed 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 $1,489 million and $726 million for the six and three months ended June 30, 2011 and $967 million and $498 million for the six and three months ended June 30, 2010. Not all net periodic benefit cost is recognized in earnings in the period incurred. A portion of net periodic benefit cost is allocated to production as product cost and a portion remains in inventory at the end of the reporting period. Earnings from operations included the following net periodic benefit cost allocated to business segments and Unallocated items and eliminations:
Other Earnings Items
The effective tax rates were 33.7% and 33.9% for the six and three months ended June 30, 2011 and 42.1% and 34.8% for the same periods in the prior year. The decrease in the effective tax rate for the six months compared with the prior year was primarily due to an income tax charge of $150 recorded during the first quarter of 2010 as a result of the Patient Protection and Affordable Care Act, as modified by the Health Care and Education Reconciliation Act of 2010. The decrease in the effective tax rate was also due to U.S. research and development tax credit benefits that exist in 2011, but did not exist in the first half of 2010. In December 2010, the research and development tax credit was retroactively renewed for 2010 and extended through December 31, 2011.
For additional discussion related to Income Taxes, see Note 3 to our Condensed Consolidated Financial Statements.
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 increase in contractual backlog during the six months ended June 30, 2011 compared with December 31, 2010 was primarily due to Commercial Airplanes.
Unobligated backlog includes U.S. and foreign government definitive contracts for which funding has not been authorized. The decrease in unobligated backlog during the six months ended June 30, 2011 was due to funding of existing multi-year contracts and a partial termination for convenience by the U.S. Army of the Brigade Combat Team Modernization (BCTM) program, partially offset by the U.S. Air Force (USAF) contract for the KC-46A Tanker.
KC-46A Tanker On February 24, 2011, we were awarded a contract from the USAF to design, develop, manufacture and deliver 4 next generation aerial refueling tankers. The KC-46A Tanker will be a derivative of our 767 commercial aircraft. This initial contract is a fixed-price incentive firm contract, valued at $4.4 billion and involves highly complex designs. Changes to our estimated cost to perform the work could result in a material charge. This contract contains production options. If all options under the contract are exercised, we expect to deliver 179 aircraft for a total expected contract value of approximately $30 billion. For segment reporting purposes, backlog, revenues and costs are recorded in the Commercial Airplanes and BMA segments.
Segment Results of Operations
Business Environment and Trends
Airline Industry Environment In 2011, the global airline industry continues to adjust to impacts on traffic and costs caused by political turmoil in the Middle East, the March 2011 natural disasters in Japan, and high fuel prices. Due in large part to these factors, the airline industry 2011 net profit outlook has been reduced to $4 billion compared to an $18 billion profit in 2010, a rebound year when traffic growth was higher and fuel costs were significantly lower. 2011 passenger and cargo traffic growth are forecast to be around the long-term average, supporting near-term airplane and services demand.
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%6% 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 $4.0 trillion market for 33,500 new airplanes over the next 20 years.
Year over year changes in Revenue are shown in the following table:
Revenues for the six and three months ended June 30, 2011 increased by $1,060 million and $1,410 million or 7% and 19% compared with the same periods of 2010. These increases were primarily due to new airplane revenues and increases in commercial aviation services sales.
Commercial jet aircraft deliveries, including intercompany deliveries, were as follows:
Earnings From Operations
Earnings from operations for the six and three months ended June 30, 2011 increased by $67 million and $237 million. These increases were primarily due to earnings from higher revenues on new airplane deliveries and commercial aviation services, partially offset by increases in planned research and development cost.
The increase in contractual backlog during the six months ended June 30, 2011 was due to net orders in excess of revenues and changes in projected revenue escalation. 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 increase in unobligated backlog represents Commercial Airplanes share of the USAF contract for the KC-46A Tanker.
The following table provides details of the accounting quantities and firm orders by program. Cumulative firm orders represent the cumulative number of commercial jet aircraft deliveries plus undelivered firm orders.
737 Program The accounting quantity for the 737 program was unchanged for the three months ended June 30, 2011, and increased by 600 units during the first quarter to reflect the current backlog and
continued demand. On June 15, 2011, to address continued demand for delivery positions, we announced plans to increase production of the 737 to 42 aircraft beginning in 2014. During 2010, we announced plans to increase monthly production from 31.5 to 35 airplanes per month beginning in 2012 and a further increase to 38 airplanes per month beginning in 2013. In July 2011, we entered into an agreement with a customer who committed to order a variant of the 737 featuring new more fuel-efficient engines, pending final airplane configuration and launch approval of the program by the Boeing board of directors.
747 Program The accounting quantity for the 747 program increased by 25 units during the six months ended June 30, 2011. Flight testing of the 747-8 Freighter is nearing completion and we expect certification and first delivery in the third quarter of 2011. We are currently producing 747-8 airplanes and until completion of our flight test program, there is risk that additional items may be identified that require further modifications or other changes to those aircraft we have produced. On March 19, 2010, we announced that we will accelerate, from mid-2013 to mid-2012, a planned production rate increase from 1.5 to 2 airplanes per month. First flight of the 747-8 Intercontinental passenger derivative occurred on March 20, 2011. Certification and first delivery of the Intercontinental is expected in the fourth quarter of 2011. Schedule and other risks inherent in the demanding flight test and certification phases of program development remain.
767 Program The accounting quantity for the 767 program increased by 12 units during the six months ended June 30, 2011 due to the programs normal progress of obtaining additional orders and delivering aircraft.
777 Program The accounting quantity for the 777 program increased by 50 and 100 units during the three and six months ended June 30, 2011 due to the programs normal progress of obtaining additional orders and delivering aircraft. As planned, the 777 programs first delivery at 7 airplanes per month from 5 per month occurred in June 2011.
787 Program Flight testing activities are nearing completion and we continue to expect certification and first delivery in the third quarter of 2011.
A number of engineering and other design changes have been identified in conjunction with the flight test program that are being incorporated into our production system and on aircraft already completed. Though the risk has been reduced with the completion of the majority of flight test conditions, there is risk that additional items could be identified requiring further modifications or other changes to airplanes we have already produced or are near completion.
We continue to monitor and address challenges associated with assembly of airplanes including management of our extended global supply chain, incorporation of design changes into aircraft in various stages of assembly, completion and integration of traveled work as well as weight and systems integration. For example, in 2011 and 2010 we delayed some 787 component deliveries to reduce out-of-sequence work moving into final assembly at our Everett factory and improve supply chain efficiency.
We are working toward planned increases in 787 production rates as well as the timely introduction of the 787-9 derivative. Such efforts include start-up of a second assembly line in North Charleston, South Carolina and establishing transitional surge capacity at our Everett location. On July 1, 2010, we completed firm configuration of the 787-9 airplane and first delivery of that model is scheduled for late 2013.
We continue to work with our customers and suppliers to assess the specific impacts of schedule changes, including delivery delays and supplier assertions. Efforts continue to ensure we remain
focused on satisfying customer mission and performance needs in light of the anticipated weight of their respective aircraft. A number of our customers have contractual remedies for schedule delays and/or performance. We continue to address customer and supplier claims and requests for other contractual relief as brought forth. 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 associated with these airplanes were included in research and development expense. We believe that the other three 787 flight test aircraft are commercially saleable and we continue to include costs related to those airplanes in program inventory at June 30, 2011. If we determine that one or more of the other aircraft cannot be sold, we may incur additional charges.
Our current assessment is that the program is not in a reach-forward loss position, however the cumulative impacts of the production challenges, schedule delays and customer and supplier impacts have created significant pressure on program profitability and we expect to record zero margin on our initial deliveries. We continue to implement mitigation plans and cost-reduction efforts to address this pressure.
The 787 and 747-8 programs highlight the risks inherent in new airplane programs and new derivative airplanes, particularly as the 787-8, 747-8 Freighter and the 747-8 Intercontinental continue the demanding flight test and certification phases of program development. Development also continues on the 787-9. 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, customer and model mix, 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, schedule and demand 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.
BDS revenues for the six and three months ended June 30, 2011 decreased by $291 million and $295 million or 2% and 4% compared with the same periods in 2010. The decreases were primarily due to lower revenues in the N&SS and GS&S segments, partially offset by higher revenues in the BMA segment.
Earnings From Operations
BDS operating earnings for the six and three months ended June 30, 2011 increased by $94 million and $87 million compared with the same periods in 2010. The increase for the six months was primarily due to higher earnings in the BMA segment. The increase for the three months was due to higher earnings in all three BDS segments.
BDS total backlog decreased 6% in 2011, from $65,186 million to $61,260 million, due to current year deliveries, sales on multi-year contracts awarded in prior years and a partial termination for convenience by the U.S. Army of the BCTM program, partially offset by new orders.
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 Family of Beyond Line-of-Sight Terminals, BCTM, Ground-based Midcourse Defense (GMD), P-8A Poseidon 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 our fixed-price development programs include Airborne Early Warning and Control (AEW&C), P-8I, KC-46A Tanker, KC-767 International Tanker and commercial and military satellites.
Boeing Military Aircraft
BMA revenues for the six and three months ended June 30, 2011 increased by $213 million and $62 million, increases of 3% and 2% compared with the same periods in 2010. The six month increase was primarily due to higher C-17 revenues partially offset by lower F-22 and Apache revenues. The three month increase reflects higher C-17 revenues, partially offset by lower revenues on F-22, Apache and AEW&C. C-17 deliveries in 2010 were negatively impacted by a second quarter 2010 labor strike.
Deliveries of units for new-build production aircraft, excluding remanufactures and modifications, were as follows:
Earnings From Operations
BMA operating earnings for the six and three months ended June 30, 2011 increased by $132 million and $33 million, increases of 21% and 9% compared with the same periods in 2010. The increases for both periods were partially due to the one additional C-17 delivery and lower research and development costs, partially offset by lower earnings on the F-22 and Apache programs. In addition, there was a charge which increased the reach-forward losses on the AEW&C program in the second quarter of 2010 with no comparable charge in 2011.
BMA total backlog was $33,544 million at June 30, 2011, compared with $33,391 million at December 31, 2010, as first quarter contracts for the KC-46A Tanker and P-8A were partially offset by current year deliveries and sales on multi-year contracts awarded in prior years.
AEW&C 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. Four Wedgetail aircraft were delivered to Australia with initial customer acceptance in 2010 and the final two Wedgetail aircraft are scheduled for delivery with initial customer acceptance in 2011. Final customer acceptance for all six Wedgetail aircraft is scheduled to be completed during the first quarter of 2012. In January 2011, the Peace Eagle program began the formal test phase. The Peace Eye program entered its formal test phase in April 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, either of which could result in lower margins or additional material charges.
KC-767 International Tanker We delivered the first of four aircraft to the Italian Air Force in December 2010 and the second in March 2011. We believe the revenue and cost estimates incorporated in the financial statements are appropriate; however, 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, either of which could result in additional material changes.
C-17 and F-15 See the discussion of the C-17 and F-15 programs in Note 8 to our Condensed Consolidated Financial Statements.
Network & Space Systems
N&SS revenues for the six and three months ended June 30, 2011 decreased by $247 million and $273 million, decreases of 5% and 12% compared with the same periods in 2010. The decrease for the six months was primarily due to funding reductions on BCTM and lower revenues on satellite programs, partially offset by higher first quarter 2011 sales of Delta inventory to United Launch Alliance (ULA) and revenues of Argon ST, Inc. acquired in August 2010. The decrease for the three months was primarily due to funding reductions on BCTM and lower revenue on SBInet, partially offset by higher satellite and Argon ST, Inc revenues.
Earnings From Operations
N&SS operating earnings were unchanged for the six months and increased by $31 million for the three months ended June 30, 2011, a 19% increase compared with the same period in 2010. For the six months ended June 30, 2011, higher earnings from our investment in ULA and a gain from a property sale were offset by mix and lower earnings on satellite programs. The increase for the three months was primarily due to higher earnings from our investment in ULA and a gain from a property sale.
N&SS total backlog was $14,583 million at June 30, 2011, a decrease of 19% from December 31, 2010 primarily due to revenues recognized on multi-year contracts awarded in prior years including the BCTM and GMD programs and a partial termination for convenience by the U.S. Army BCTM program.
United Launch Alliance See the discussion of Commitments to ULA and Indemnifications to ULA in Notes 8 and 9 to our Condensed Consolidated Financial Statements.
Sea Launch See the discussion of the Sea Launch receivables in Note 7 to our Condensed Consolidated Financial Statements.
Satellites See the discussions of Boeing Satellite Systems International, Inc. in Note 14 to our Condensed Consolidated Financial Statements.
Global Services & Support