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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

 

x

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

 

For the fiscal year ended December 31, 2007

 

OR

 

¨

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

 

For the transition period from                      to                     

 

Commission file number 1-442

 

THE BOEING COMPANY

 

(Exact name of registrant as specified in its charter)

 

Delaware				91-0425694
(State or other jurisdiction of incorporation or organization)				(I.R.S. Employer Identification No.)
100 N. Riverside, Chicago, IL				60606-1596
(Address of principal executive offices)				(Zip Code)

 

Registrant’s telephone number, including area code (312) 544-2000

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

 

Title of each class				Name of each exchange on which registered
Common Stock, $5 par value				New York Stock Exchange

 

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

 

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

 

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

 

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

 

As of June 30, 2007, there were 754,025,903 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 $72.5 billion.

 

The number of shares of the registrant’s common stock outstanding as of February 8, 2008 was 764,833,186.

 

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

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Part I and Part II incorporate information by reference to certain portions of the Company’s 2007 Annual Report to Shareholders. Part III incorporates information by reference to the registrant’s definitive proxy statement, to be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year.

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THE BOEING COMPANY

 

FORM 10-K

 

For the Fiscal Year Ended December 31, 2007

 

INDEX

 

						Page
Part I
		Item 1.		Business		1
		Item 1A.		Risk Factors		5
		Item 1B.		Unresolved Staff Comments		12
		Item 2.		Properties		12
		Item 3.		Legal Proceedings		12
		Item 4.		Submission of Matters to a Vote of Security Holders and Executive Officers of the Registrant		13
Part II
		Item 5.		Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		17
		Item 6.		Selected Financial Data		18
		Item 7.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		19
		Item 7A.		Quantitative and Qualitative Disclosures About Market Risk		47
		Item 8.		Financial Statements and Supplementary Data		48
		Item 9.		Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		110
		Item 9A.		Controls and Procedures		110
		Item 9B.		Other Information		110
Part III
		Item 10.		Directors, Executive Officers and Corporate Governance		112
		Item 11.		Executive Compensation		112
		Item 12.		Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		112
		Item 13.		Certain Relationships and Related Transactions, and Director Independence		113
		Item 14.		Principal Accounting Fees and Services		113
Part IV
		Item 15.		Exhibits and Financial Statement Schedules		114
		Signatures Schedule II – Valuation and Qualifying Accounts				119 120
		Exhibit (12) – Computation of Ratio of Earnings to Fixed Charges				120
		Exhibit (21) – List of Company Subsidiaries				121
		Exhibit (23) – Consent of Independent Registered Public Accounting Firm				128
		Exhibit (31)(i) – CEO Section 302 Certification				129
		Exhibit (31)(ii) – CFO Section 302 Certification				130
		Exhibit (32)(i) – CEO Section 906 Certification				131
		Exhibit (32)(ii) – CFO Section 906 Certification				132

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FORWARD-LOOKING INFORMATION IS SUBJECT TO RISK AND UNCERTAINTY

 

 

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Item 1. Business

 

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

 

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

 

·

Commercial Airplanes;

 

·

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

 

·

Precision Engagement and Mobility Systems (PE&MS),

 

·

Network and Space Systems (N&SS) and

 

·

Support Systems

 

·

Boeing Capital Corporation (BCC).

 

Our Other segment classification principally includes the activities of Engineering, Operations and Technology, 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 is involved in developing, producing and marketing commercial jet aircraft and providing related support services, principally to the commercial airline industry worldwide. We are a leading producer of commercial aircraft and offer a family of commercial jetliners designed to meet a broad spectrum of passenger and cargo requirements of domestic and non-U.S. airlines. This family of commercial jet aircraft currently includes the 737 Next-Generation narrow-body model and the 747, 767, 777 and 787 wide-body models. The Commercial Airplanes segment also offers aviation services support, aircraft modifications, spares, training, maintenance documents and technical advice to commercial and government customers worldwide.

 

Integrated Defense Systems

 

IDS is principally involved in the research, development, production, modification and support of the following products and related systems and services: military aircraft, including fighters, transports, tankers, intelligence surveillance and reconnaissance aircraft, and helicopters; missiles; space systems; missile defense systems; satellites and satellite launch vehicles; and communications, information and battle management systems. IDS 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. IDS’s primary customer is the United States Department of Defense (U.S. DoD) with additional revenues being derived from the National Aeronautics and Space Administration (NASA) and international defense markets, civil markets, and commercial satellite markets. Approximately 84% of IDS 2007 revenues were from our U.S. DoD customer.

 

PE&MS Segment:

 

This segment is engaged in the research, development, production, and modification of precision engagement and mobility products and services. Included in this segment are programs such as AH-64 Apache, 737 Airborne Early Warning & Control (AEW&C), C-17 Globemaster, C-40A Clipper, CH-47 Chinook, E-10A Multi-sensor Command and Control Aircraft (MC2A), EA-18G Growler, F/A-18E/F Super Hornet, F-15 Strike Eagle, F-22 Raptor, Harpoon, Joint Direct Attack Munition, International KC-767 Advanced Tanker, P-8A Poseidon, Stand-off Land Attack Missile-Expanded Response (SLAM-ER), Small Diameter Bomb, T-45 Training System, and V-22 Osprey.

 

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N&SS Segment:

 

This segment is engaged in the research, development, production, and modification of products and services to assist our customers in transforming their operations through network integration, intelligence and surveillance systems, communications, architectures, and space exploration. Included in this segment are programs such as Airborne Laser, Family of Advanced Beyond Line-of-Sight (FAB-T) Terminals, Future Combat Systems (FCS), SBInet, Future Rapid Effects System, Global Positioning System, Ground-based Midcourse Defense (GMD), International Space Station, Joint Tactical Radio System (JTRS) and Airborne, Maritime/Fixed station, Satellite Systems, Space Payloads, and Space Shuttle.

 

Support Systems Segment:

 

This segment is engaged in the operations, maintenance, training, upgrades, and logistics support functions for military platforms and operations. Included in this segment are program areas such as Integrated Logistics on platforms including C-17, F/A-18, and AH-64; Maintenance, Modifications and Upgrades on platforms including A-10, AC-130, KC-135, and KC-10; Training Systems and Services on platforms including F-16, C-17, AH-64, and F-15; and International Support.

 

Boeing Capital Corporation Segment

 

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

 

Financial and Other Business Information

 

See the Summary of Business Segment Data and Note 22 for financial information, including revenues, net earnings and our backlog of firm contractual orders, for each of the major business segments.

 

Intellectual Property

 

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

 

Non-U.S. Sales

 

See Note 22 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 expenditures are expensed as incurred including amounts allocable as reimbursable overhead costs on U.S. government contracts.

 

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Our total research and development expense amounted to $3.9 billion, $3.3 billion and $2.2 billion in 2007, 2006, and 2005, respectively. This is net of research and development cost sharing payments from suppliers of $130 million, $160 million and $611 million in 2007, 2006, and 2005, respectively. These cost sharing payments are related to our 787 program.

 

Research and development costs also include bid and proposal efforts related to government products and services and costs incurred in excess of amounts estimated to be recoverable under cost-sharing research and development agreements. Bid and proposal costs were $306 million, $227 million and $210 million in 2007, 2006, and 2005, 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 19-36.

 

Employees

 

Our workforce level at December 31, 2007 was approximately 159,300, including approximately 3,846 in Australia and 1,720 in Canada.

 

As of December 31, 2007, our principal collective bargaining agreements were with the following unions:

 

Union		Percent of our Employees Represented		Status of the Agreements with the Union
The International Association of Machinists and Aerospace Workers (IAM)		19%		We have two major agreements; one expiring in September and one in October of 2008.
The Society of Professional Engineering Employees in Aerospace (SPEEA)		14%		We have three major agreements expiring in December of 2008.
The United Automobile, Aerospace and Agricultural Implement Workers of America (UAW)		3%		We have one major agreement expiring in October of 2009.

 

Competition

 

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.

 

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

 

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Regulatory Matters

 

U.S. Government Contracts. Our businesses are heavily regulated in most of our markets. We deal with numerous U.S. government agencies and entities, including 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.

 

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 13.

 

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.

 

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Raw Materials

 

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 domestic and non-U.S. companies.

 

Suppliers

 

We are dependent upon the ability of large numbers of suppliers and subcontractors to meet performance specifications, quality standards and delivery schedules at anticipated costs. While we maintain an extensive qualification and performance surveillance system to control risk associated with such reliance on third parties, failure of suppliers or subcontractors to meet commitments could adversely affect production schedules and 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.

 

Other Information

 

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

 

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

 

Item 1A. Risk Factors

 

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

 

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

 

We derive a significant portion of our revenues from a limited number of major commercial airlines, some of which have encountered financial difficulties. We depend on a limited number of customers, including the major commercial airlines. We can make no assurance that any customer will purchase additional products or services from us after our contract with the customer ends. Financial difficulties, including bankruptcy, of any of the major commercial airlines could significantly reduce our revenues and our opportunity to generate a profit. Several commercial airlines have filed for or recently emerged from bankruptcy.

 

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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), internal 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 that result in significant inefficiencies and that adversely affect production schedules and program/contract profitability, the latter through possible customer and/or supplier claims or assertions. In addition, the introduction of new commercial aircraft programs and major derivatives involves increased risks associated with meeting development, production and certification schedules.

 

We rely on market conditions to sell aircraft into the future. The worldwide market for commercial jet aircraft is predominantly driven by long-term trends in airline passenger traffic. The principal factors underlying long-term traffic growth are sustained economic growth and political stability, both in developed and emerging countries. Demand for our commercial aircraft is further influenced by airline industry profitability, world trade policies, government-to-government relations, terrorism, disease outbreaks, environmental constraints imposed upon aircraft operations, technological changes, price and other competitive factors.

 

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

 

Our commercial aircraft production rates could change. As a result of worldwide demand for new aircraft, we have received more than one thousand net orders per year during 2007, 2006 and 2005. There may be production rate changes in order to meet the delivery schedules for existing and new airplane programs. This may lead to adding extra production lines, implementing infrastructure changes, seeking additional qualified and skilled employees, and obtaining other resources. Failure to successfully implement any production rate changes could lead to missed delivery commitments, and depending on the length of delay in meeting delivery commitments, additional costs and customers rescheduling their deliveries or terminating their aircraft on contract with us.

 

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

 

In 2007, 42% of our revenues were derived from U.S. government contracts. In addition to normal business risks, our contracts with the U.S. government are subject to unique risks some of which are beyond our control.

 

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

 

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

 

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

 

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

 

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technical quality issues requiring further delays in schedule or revisions to our cost estimates. Examples of other significant fixed-price development contracts include KC-767 Tankers, commercial and military satellites, Vigilare and High Frequency Modernisation.

 

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

 

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

 

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

 

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

 

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

 

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

 

Under program accounting, inventoriable production costs (including overhead), program tooling costs and routine warranty costs are accumulated and charged as cost of sales by program instead of by individual units or contracts. A program consists of the estimated number of units (accounting quantity) of a product to be produced in a continuing, long-term production effort for delivery under existing and anticipated contracts limited by the ability to make reasonable 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, circumstances or estimates concerning the selection of the initial accounting quantity or changes in market conditions, along with a failure to realize predicted costs, may adversely affect future financial performance.

 

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Because of the significance of the judgments and estimation processes described above, it is likely that materially different sales and profit amounts could be recorded if we used different assumptions or if the underlying circumstances were to change. Changes in underlying assumptions, circumstances or estimates may adversely affect future period financial performance. For additional information on our accounting policies for recognizing sales and profits, see our discussion under “Management’s Discussion and Analysis—Critical Accounting Policies—Contract Accounting/Program Accounting” on pages 43-44 and Note 1 to the Consolidated Financial Statements on pages 53-54 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 “Management’s Discussion and Analysis—Critical Accounting Policies—Postretirement 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 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 workforce is represented by labor unions, which may lead to work stoppages.

 

Approximately 58,197 of our employees are unionized, which represented approximately 38% of our employees at December 31, 2007. We experienced work stoppages in 2005 when labor strikes halted commercial aircraft and IDS production and we may experience additional work stoppages in the future, which could adversely affect our business. We cannot predict how stable our relationships, currently with 17 different U.S. labor organizations and 7 different non-U.S. labor organizations, will be or whether we will be able to meet the unions’ requirements without impacting our financial condition. The unions may also limit our flexibility in dealing with our workforce. Work stoppages and instability in our union relationships could negatively impact the timely production of our products, which could strain relationships with customers and cause a loss of revenues that would adversely affect our results of operations.

 

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

 

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

 

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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 2007, sales to non-U.S. customers accounted for approximately 40% of our revenues. We expect that non-U.S. sales will continue to account for a significant portion of our revenues for the foreseeable future. As a result, we are subject to risks of doing business internationally, including:

 

·

changes in regulatory requirements

 

·

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

 

·

fluctuations in international currency exchange rates

 

·

delays in placing orders

 

·

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

 

·

the uncertainty of adequate and available transportation

 

·

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

 

·

uncertainties and restrictions concerning the availability of funding credit or guarantees

 

·

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

 

·

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

 

·

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

 

·

economic and geopolitical developments and conditions

 

While 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 is unpredictable and an adverse decision in any such matter could have a material adverse affect on our financial position and results of operations.

 

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

 

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

 

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

 

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We may not realize the anticipated benefits of acquisitions, joint ventures/strategic alliances or divestitures.

 

As part of our business strategy, we acquire businesses and form joint ventures/strategic alliances. Whether we realize the anticipated benefits from these transactions will depend in part upon the integration of the acquired business, the performance of the acquired products, capabilities or technologies and the management of strategic investments. Accordingly, our results of operations could be adversely affected from transaction-related charges, amortization of expenses related to intangibles, charges for impairment of long-term assets, credit guarantees 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.

 

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

 

The statements in this Risk Factors section describe material risks to our business and should be considered carefully. In addition, these statements constitute our cautionary statements under the Private Securities Litigation Reform Act of 1995. Our disclosure and analysis in this report and in our Annual Report to Shareholders contain some forward-looking statements that set forth anticipated results based on management’s plans and assumptions. From time to time, we also provide forward-looking statements in other materials we release as well as oral forward-looking statements. Such statements give our current expectations or forecasts of future events; they do not relate strictly to historical or current facts.

 

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

 

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

 

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

 

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Item 1B. Unresolved Staff Comments

 

Not Applicable.

 

Item 2. Properties

 

We occupied approximately 88 million square feet of floor space on December 31, 2007 for manufacturing, warehousing, engineering, administration and other productive uses, of which approximately 96% was located in the United States.

 

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

 

(thousands of square feet)		Owned		Leased
Commercial Airplanes		35,930		4,751
Integrated Defense Systems		30,831		10,527
Other*		5,223		871
Total		71,984		16,149

 

—

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

—

Rent-free space furnished by U.S. government landlord: 1,121 square feet (Excluded)

*

Other includes Boeing Capital Corporation, Engineering, Operations and Technology, Corporate Headquarters, and Boeing Shared Services Group.

 

Our businesses had major operations at the following locations:

 

·

Commercial Airplanes – Greater Seattle, WA

 

·

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

 

·

Other – Chicago, IL; Greater Seattle, WA

 

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

 

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

 

Item 3. Legal Proceedings

 

Currently, we are involved in a number of legal proceedings. For a discussion of contingencies related to legal proceedings, see Note 21 to our Consolidated Financial Statements, which is hereby incorporated by reference.

 

We possess a National Pollutant Discharge Elimination System (NPDES) permit, issued by the California Regional Water Quality Control Board, Los Angeles Region (Regional Board), which sets limits on the permissible level of certain constituents in surface water discharged from various outfalls at our Santa Susana Field Laboratory (SSFL) site in Simi Valley, California. Since June 2004, the Regional Board has amended this permit to impose increasingly stringent numeric limits. In late 2006, the California Water Resources Control Board (State Board) partially granted and partially denied the

 

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Company’s appeal of these amendments, and remanded the permit to the Regional Board to correct certain errors. On January 17, 2007, we filed an action in Los Angeles County Superior Court challenging the State Board’s rulings that are adverse to the Company, including the determination to uphold the more stringent numeric limits in the permit, and that matter remains pending.

 

On November 1, 2007, the Regional Board responded to the remand from the State Board by amending the permit, and issuing a cease and desist order incorporating some (but not all) relief that we had requested. On December 3, 2007, we filed an administrative appeal of certain portions of the Regional Board’s November 1st action, but asked that the State Board hold the appeal in abeyance as we seek to work cooperatively with the Regional Board to address continuing permit compliance issues.

 

During the period from January 2004 to the present, we have received five violation notices from the Regional Board for discharging surface water exceeding certain of the permit limits. On August 27, 2007, we entered into an administrative settlement with the Regional Board under which we paid $235,595 in civil penalties and $235,595 to fund Supplemental Environmental Projects, for a total cost of $0.471 million. This resolution addressed most but not all of the incidents cited in the violation notices, and additional administrative or other action is still possible.

 

In November 2005, we received a grand jury subpoena from the U.S. Attorney’s office in Los Angeles seeking documents from 2001 onward pertaining to our NPDES permit compliance status under the federal Clean Water Act (CWA). We maintain that no criminal violations of the CWA have occurred and that the incidents are being appropriately addressed by civil administrative actions undertaken by the Regional Board. We have produced the documents requested by the subpoena, and made our last submission in February 2007. No further action has been taken by the U.S. Attorney’s Office.

 

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, 2007.

 

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Executive Officers of the Registrant

 

Our executive officers as of February 1, 2008, are as follows:

 

Name		Age		Principal Occupation or Employment/Other Business Affiliations
James F. Albaugh		57		Executive Vice President, President and Chief Executive Officer, IDS since July 2002. Prior thereto, Senior Vice President of Boeing, President, Space and Communications Group from September 1998 (named CEO of Space and Communications Group in March 2001). Prior thereto, President, Boeing Space Transportation from April 1998. Prior thereto, President of Rocketdyne Propulsion and Power from March 1997. Current director of TRW Automotive Holdings, Inc.
James A. Bell		59		Executive Vice President and Chief Financial Officer since January 2004. Prior thereto, Senior Vice President of Finance and Corporate Controller from October 2000 to January 2004. Prior thereto, Vice President of Contracts and Pricing for Boeing Space Communications from January 1997 to October 2000. Current director of The Dow Chemical Company.
Scott E. Carson		61		Executive Vice President and President and Chief Executive Officer of Boeing Commercial Airplanes since September 2006. Prior thereto, Vice President of Sales at Commercial Airplanes. Prior thereto, President of Connexion by Boeing. Prior thereto, Chief Financial Officer of Commercial Airplanes. Prior thereto, Executive Vice President of Business Resources for the former Boeing Information, Space and Defense Systems.
Michael J. Cave		47		Senior Vice President of Business Development and Strategy since November 2007. Prior thereto, Vice President of Business Strategy & Marketing for Boeing Commercial Airplanes, and prior thereto Vice President/General Manager of Airplane Programs for Commercial Airplanes and prior thereto Senior Vice President for Commercial Aviation Services. Prior thereto, Senior Vice President and Chief Financial Officer of Commercial Airplanes from November 2000 through January 2003. Prior thereto, Vice President – Finance for Commercial Aviation Services, Vice President – Controller for Boeing Commercial Airplanes Group, and Vice President – Finance for the twin-aisle programs. Prior to joining Commercial Airplanes, Vice President – Finance for Boeing Information, Space & Defense Systems.
Wanda K. Denson-Low		51		Senior Vice President, Office of Internal Governance since May 2007. Prior thereto, vice president and assistant general counsel of IDS, August 2003 to May 2007. Prior thereto, vice president of human resources for IDS, March 2002 to August 2003, and prior thereto Chief Counsel, S&C Legal, August 2001 to March 2002, and Vice President, General Counsel, Hughes Space and Communications, January 1998 to August 2001. Vice President, Assistant General Counsel, Hughes Electronics, 1992 to January 1998. Wanda Denson-Low joined the Company in 1984.

 

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Name		Age		Principal Occupation or Employment/Other Business Affiliations
Thomas J. Downey		43		Senior Vice President, Communications since January 1, 2007. Prior thereto, Vice President, Corporate Communications, April 2006 to December 2006. Prior thereto, Vice President, Commercial Airplanes Communications, May 2002 to April 2006. Prior thereto, Corporate Vice President, Internal and Executive Communications, 1999 to April 2002. Prior thereto, General Manager of Communications and Community Relations for Military Aircraft and Missile Systems unit and director of Communications for Douglas Aircraft Company. Mr. Downey joined the Company in 1986.
Shepard W. Hill		55		Senior Vice President, President, Boeing International since November 2007. Prior thereto, Senior Vice President, Business Development and Strategy, Vice President, Business Development, at IDS, and prior thereto, he was Vice President, Boeing Space and Communications Government Relations and was vice president, Space Systems, Integrated Space and Defense Systems business unit. Mr. Hill joined Boeing when the Company acquired Rockwell’s Aerospace and Defense business in 1996. At that time, Hill was Rockwell’s Vice President, Aerospace Government Affairs and Marketing.
Tod R. Hullin		64		Senior Vice President, Public Policy since May 2006. Prior thereto, Senior Vice President, Communications since December 2003. Prior thereto, Executive Vice President, Global Public Policy and North American Communications, Vivendi Universal from December 2000 to March 2002. Prior thereto, Senior Global Communications Officer for the Seagram Company Ltd. from October 1998 to December 2000 and Time Warner from February 1991 to March 1997.
James M. Jamieson		59		Senior Vice President, Chief Operating Officer, Boeing Commercial Airplanes since September 2006. Prior thereto, Chief Technology Officer December 2003 and prior thereto, Senior Vice President, Airplane Programs for Boeing Commercial Airplanes from February 2000 to December 2003. Prior thereto, Executive Vice President of Single Aisle Airplane Programs from October 1998 to February 2000.
J. Michael Luttig		53		Senior Vice President and General Counsel of the Company since May 2006. Prior thereto, served on the United States Court of Appeals for the Fourth Circuit from October 1991 to May 2006. Prior thereto, Assistant Attorney General of the United States from October 1990 to October 1991, and Counselor to the Attorney General at the Department of Justice from August 1990 to October 1991. Prior thereto, Principal Deputy Assistant Attorney General at the Department of Justice from March 1989 to October 1990. Prior thereto, Luttig was associated with Davis Polk and Wardwell from September 1985 to March 1989. Prior thereto, special assistant to the Chief Justice of the United States from September 1984 to September 1985. Prior thereto, law clerk to the Honorable Warren E. Burger, Chief Justice of the United States from July 1983 until August 1984 and law clerk to then-Judge Antonin Scalia of the United States Court of Appeals from August 1982 to July 1983. Prior thereto, special assistant to The White House Counsel and then as assistant counsel from March 1981 to August 1982. Prior thereto, Luttig worked at the Supreme Court of the United States in the Office of Administrative Assistant to the Chief Justice from September 1976 to September 1978.

 

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Name		Age		Principal Occupation or Employment/Other Business Affiliations
W. James McNerney, Jr.		58		Chairman, President and Chief Executive Officer, The Boeing Company. Mr. McNerney has served as Chairman and Chief Executive Officer of the Boeing Company since July 1, 2005. Previously, he served four and a half years as Chairman and Chief Executive Officer of 3M Company (diversified technology). Beginning in 1982, he served in management positions at General Electric Company, his most recent being President and Chief Executive Officer of GE Aircraft Engines from 1997 until 2000. Mr. McNerney is on the board of the following public company in addition to The Boeing Company: The Procter & Gamble Company. He is also a member of various business and educational organizations.
Richard D. Stephens		55		Senior Vice President Human Resources and Administration since September 2005. He previously served as Senior Vice President of Internal Services and prior thereto, he was President of Shared Services Group. Prior thereto, he was Vice President and General Manager, Integrated Defense Systems Homeland Security and Services, from July 2002 to December 2003. Mr. Stephens has previously led a number of Boeing businesses, including Space and Communications Services, Reusable Space Systems, Naval Systems and Tactical Systems.
John J. Tracy		53		Chief Technology Officer and Senior Vice President of Engineering, Operations and Technology since October 1, 2006. Prior thereto, Vice President of Engineering and Mission Assurance for IDS, February 2004 to September 2006. Prior thereto, Vice President of Structural Technologies, Prototyping, and Quality for Phantom Works, September 2001 to January 2004. Prior thereto, General Manager of Engineering for Military Aircraft and Missiles September 2000 to August 2001. Dr. Tracy joined the Company in 1981.

 

 

 

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PART II

 

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

 

The principal market for our common stock is the New York Stock Exchange. Our common stock is also listed on the Amsterdam, Brussels, London, Swiss and Tokyo Exchanges as well as various regional stock exchanges in the United States. The number of holders of common stock as of February 8, 2008, was approximately 159,913. Additional information required by this item is incorporated by reference from the table captioned Quarterly Financial Data (Unaudited) on page 108.

 

Issuer Purchases Of Equity Securities

 

The following table provides information about purchases we made during the quarter ended December 31, 2007 of equity securities that are registered by us pursuant to Section 12 of the Exchange Act:

 

(Dollars in millions except per share data)

 

		(a)		(b)			(c)		(d)
Period		Total Number of Shares Purchased(1)		Average Price Paid per Share			Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs(1)		Approximate Dollar Value That May Yet be Purchased Under the Plans or Programs
10/01/07 thru 10/31/07		4,235,525		$	98.57		4,234,772		$	7,069
11/01/07 thru 11/30/07		3,035,600		$	93.04		3,035,600		$	6,787
12/01/07 thru 12/31/07		2,116,807		$	89.74		2,116,796		$	6,597
TOTAL		9,387,932		$	94.79		9,387,168

 

(1)

We repurchased an aggregate of 9,387,168 shares of our common stock in the open market pursuant to our repurchase programs. On August 28, 2006 our Board of Directors approved the repurchase of $3 billion of common stock (the 2006 Program). On October 29, 2007, the Board approved a new repurchase plan (the 2007 Program) for up to $7 billion of common stock that commenced following the completion of the 2006 Program. Unless terminated earlier by a Board resolution, the 2007 Program will expire when we have used all authorized funds for repurchase. Outside of the programs, we purchased an aggregate of 764 shares in swap transactions.

 

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Item 6. Selected Financial Data

 

Five-Year Summary (Unaudited)

 

(Dollars in millions except per share data)		2007				2006				2005				2004				2003
Operations
Revenues
Commercial Airplanes (a)		$	33,386			$	28,465			$	21,365			$	19,925			$	21,380
Integrated Defense Systems: (b)(c)
Precision Engagement and Mobility Systems			13,685				14,107				13,308				12,646				11,605
Network and Space Systems			11,696				11,941				12,221				12,992				11,392
Support Systems			6,699				6,391				5,577				5,101				4,610
Total Integrated Defense Systems			32,080				32,439				31,106				30,739				27,607
Boeing Capital Corporation (d)			815				1,025				966				959				991
Other			280				299				657				275				625
Accounting differences/eliminations			(174	)			(698	)			(473	)			(498	)			(1,292	)
Total revenues		$	66,387			$	61,530			$	53,621			$	51,400			$	49,311
General and administrative expense (d)			3,531				4,171				4,228				3,657				3,200
Research and development expense			3,850				3,257				2,205				1,879				1,651
Other income, net			484				420				301				288				460
Net earnings from continuing operations (d)		$	4,058			$	2,206			$	2,562			$	1,820			$	685
Cumulative effect of accounting change, net of taxes											17
Income from discontinued operations, net of taxes (e)															10				33
Net gain/(loss) on disposal of discontinued operations, net of tax			16				9				(7	)			42
Net earnings		$	4,074			$	2,215			$	2,572			$	1,872			$	718
Basic earnings per share from continuing operations			5.36				2.88				3.26				2.27				0.86
Diluted earnings per share from continuing operations			5.26				2.84				3.19				2.24				0.85
Cash dividends declared		$	1,129			$	991			$	861			$	714			$	573
Per share			1.45				1.25				1.05				0.85				0.68
Additions to plant and equipment			1,731				1,681				1,547				1,246				836
Depreciation of plant and equipment			978				1,058				1,001				1,028				1,005
Employee salaries and wages			14,852				15,871				13,667				12,700				12,067
Year-end workforce			159,300				154,000				153,000				159,000				157,000
Financial position at December 31
Total assets (e)		$	58,986			$	51,794			$	59,996			$	56,224			$	55,171
Working capital			(4,258	)			(6,718	)			(6,220	)			(5,735	)			892
Property, plant and equipment, net			8,265				7,675				8,420				8,443				8,597
Cash and cash equivalents			7,042				6,118				5,412				3,204				4,633
Short-term investments			2,266				268				554				319
Total debt			8,217				9,538				10,727				12,200				14,443
Customer financing assets			7,105				8,890				10,006				11,001				10,914
Shareholders’ equity (e)			9,004				4,739				11,059				11,286				8,139
Per share			12.22				6.25				14.54				14.23				10.17
Common shares outstanding (in millions) (f)			736.7				757.8				760.6				793.2				800.3
Contractual Backlog
Commercial Airplanes (a)		$	255,176			$	174,276			$	124,132			$	65,482			$	63,929
Integrated Defense Systems: (b)(c)
Precision Engagement and Mobility Systems			22,957				24,739				21,630				21,296				22,871
Network and Space Systems			9,167				7,838				6,324				10,923				11,753
Support Systems			9,664				9,714				8,551				7,077				6,302
Total Integrated Defense Systems			41,788				42,291				36,505				39,296				40,926
Total		$	296,964			$	216,567			$	160,637			$	104,778			$	104,855

 

Cash

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

(a)

In the first quarter of 2006, Commercial Airplanes changed its accounting policy for concessions received from vendors. The years 2005 through 2003 were retroactively adjusted for comparative purposes.

(b)

Effective January 1, 2007, the B-1 bomber program (formerly included in PE&MS) and certain Boeing Australia Limited programs (formerly included in N&SS) are included in Support Systems. The years 2006 through 2003 were restated for comparative purposes.

(c)

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

(d)

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

(e)

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

(f)

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

 

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

 

Consolidated Results of Operations and Financial Condition

 

Overview

 

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

 

Our business strategy is centered on successful execution in healthy core businesses – Commercial Airplanes and Integrated Defense Systems (IDS) – supplemented and supported by Boeing Capital Corporation (BCC). Taken together, these core businesses generate substantial earnings and cash flow that permit us to invest in new products and services that open new frontiers in aerospace. We focus on producing the airplanes the market demands and we price our products to provide a fair return for our shareholders while continuing to find new ways to improve efficiency and quality. IDS integrates its resources in defense, intelligence, communications and space to deliver capability-driven solutions to its customers at reduced costs. Our strategy is to leverage our core businesses 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 commercial and defense markets often offset each others’ cyclicality. BCC delivers value through supporting our business units and managing overall financing exposure.

 

In 2007, our revenues grew by 8%. Earnings from operations increased 93%. We continued to invest in key growth programs as Research and Development expense grew by 18% to $3.9 billion, reflecting increased spending on the 787 and 747-8 programs and lower cost sharing payments from suppliers. We generated operating cash flow of $9.6 billion driven by operating and working capital performance. We reduced debt by $1.3 billion and repurchased 29 million common shares. Our contractual backlog grew 37% to $297 billion, driven by 46% growth at Commercial Airplanes while our total backlog grew 31% to $327 billion.

 

We expect continued growth in Commercial Airplane revenues and deliveries as we execute our record backlog and respond to global demand by ramping up commercial aircraft production. We expect IDS revenue to remain relatively flat in 2008 compared with 2007 and anticipate that the U.S. Department of Defense (U.S. DoD) budget growth will begin to moderate over the next several years. We are focused on improving financial performance through a combination of productivity and customer-focused growth.

 

Consolidated Results of Operations

 

Revenues

 

(Dollars in millions)

 

Years ended December 31,		2007				2006				2005
Commercial Airplanes		$	33,386			$	28,465			$	21,365
Integrated Defense Systems			32,080				32,439				31,106
Boeing Capital Corporation			815				1,025				966
Other			280				299				657
Accounting differences/eliminations			(174	)			(698	)			(473	)
Revenues		$	66,387			$	61,530			$	53,621

 

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Revenues in 2007 grew by $4,857 million, primarily due to the growth at Commercial Airplanes. Commercial Airplanes revenues increased by $4,921 million, primarily due to higher new airplane deliveries and increased commercial aviation support activities. IDS revenues decreased by $359 million, primarily due to lower revenues in Network and Space Systems (N&SS) resulting from the formation of the United Launch Alliance (ULA) joint venture in 2006 and lower revenues in Precision Engagement and Mobility Systems (PE&MS), offset by growth in Support Systems. BCC revenues decreased by $210 million primarily due to a decrease in the customer financing portfolio. Accounting differences/eliminations changed by $524 million primarily due to fewer Commercial Airplanes intercompany deliveries when compared with 2006.

 

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

 

Earnings from Operations

 

The following table summarizes our earnings from operations:

 

(Dollars in millions)

 

Years ended December 31,		2007				2006				2005
Commercial Airplanes		$	3,584			$	2,733			$	1,431
Integrated Defense Systems			3,440				3,032				3,919
Boeing Capital Corporation			234				291				232
Other			(243	)			(738	)			(363	)
Unallocated Expense			(1,185	)			(1,733	)			(2,407	)
Settlement with U.S. Department of Justice, net of accruals							(571	)
Earnings from operations		$	5,830			$	3,014			$	2,812

 

Operating earnings in 2007 improved by $2,816 million compared with 2006. The increase is partly due to the $571 million global settlement with U.S. Department of Justice (U.S. DoJ) that occurred in the second quarter of 2006. Commercial Airplanes earnings increased by $851 million compared with the same period in 2006, primarily due to higher new airplane deliveries, commercial aviation support activities and improved cost performance offset by increased research and development expense. Commercial Airplanes’ research and development expense increased by $572 million to $2,962 million compared with the same period 2006, primarily due to spending on the 787 and 747-8 programs. IDS earnings increased by $408 million compared with 2006. The increase is primarily due to 2006 charges of $770 million in the PE&MS segment related to Airborne Early Warning & Control (AEW&C), partially offset by lower 2007 earnings on several programs in the PE&MS and N&SS segments. BCC operating earnings decreased $57 million reflecting lower revenues partially offset by a recovery of losses and lower expenses. Other segment earnings improved by $495 million primarily due to the absence of losses related to Connexion by Boeing, which included a charge of $320 million to exit this business in 2006. Lower unallocated expense in 2007 contributed $548 million to the 2007 earnings improvement.

 

Operating earnings increased in 2006 compared with 2005 primarily driven by improved earnings at Commercial Airplanes resulting from higher revenue from new aircraft deliveries, increased earnings from commercial aviation support business and improved cost performance. Lower unallocated expense in 2006 also contributed to the 2006 earnings increase. This was partially offset by a $571 million charge for

 

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global settlement with U.S. DoJ, lower IDS earnings reflecting a $569 million net gain on the sale of our Rocketdyne business in 2005 and $770 million of charges on the AEW&C development program in 2006 partially offset by improved margins on other programs and a $320 million charge related to the exit of the Connexion by Boeing business recorded in Other segment.

 

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

 

(Dollars in millions)

 

Years ended December 31,		2007				2006				2005
Pension and other postretirement		$	(686	)		$	(472	)		$	(851	)
Share-based plans			(233	)			(680	)			(999	)
Deferred compensation			(51	)			(211	)			(186	)
Other			(215	)			(370	)			(371	)
Unallocated expense		$	(1,185	)		$	(1,733	)		$	(2,407	)

 

We recorded net periodic benefit cost related to pensions and other postretirement benefits of $1,773 million, $1,663 million and $1,852 million in 2007, 2006 and 2005, 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. Accordingly, earnings from operations included $1,730 million, $1,227 million and $1,893 million in 2007, 2006, and 2005, respectively. 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.

 

Unallocated pension and other postretirement expense represents the difference between costs recognized under GAAP in the consolidated financial statements and federal cost accounting standards required to be utilized by our business segments for U.S. government contracting purposes.

 

Pension and other postretirement expense increased during 2007 when compared with 2006 primarily due to increased overall pension costs recognized in inventory as of December 31, 2006, which are subsequently expensed in cost of sales in 2007. Pension and other postretirement expense decreased in 2006 compared with 2005 mainly due to an absence of net settlement and curtailment charges partially offset by an increase in the amount of actuarial loss that was amortized.

 

The reduction in Share-based plans expense is primarily due to lower Performance Shares outstanding during 2007 and higher expense acceleration during 2006, resulting from 12 payouts compared with six payouts in 2007. The decrease in 2006 Share-based plans expense is primarily due to the increase in our stock price during 2005 which resulted in additional compensation expense due to an increase in the number of performance shares meeting the price growth targets and being converted to common stock. The year over year changes in deferred compensation expense are primarily driven by changes in our stock price. Other expense decreased in 2007 partly due to reduced intercompany profit elimination as a result of fewer intercompany deliveries during 2007 compared with 2006.

 

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Other Earnings Items

 

(Dollars in millions)

 

Years ended December 31,		2007				2006				2005
Earnings from operations		$	5,830			$	3,014			$	2,812
Other income, net			484				420				301
Interest and debt expense			(196	)			(240	)			(294	)
Earnings before income taxes			6,118				3,194				2,819
Income tax expense			(2,060	)			(988	)			(257	)
Net earnings from continuing operations		$	4,058			$	2,206			$	2,562

 

Other income, which primarily consists of interest income, was higher in 2007 compared with 2006 as a result of increases in average principal balances and higher average rates of return on cash and investments. Other income was higher in 2006 compared with 2005 as a result of increases in average principal balances and higher average rates of return, partially offset by lower interest income compared with 2005 related to federal income tax settlements for prior years.

 

Interest and debt expense decreased in 2007 and in 2006, primarily due to debt repayments.

 

The effective income tax rate of 33.7% for 2007 differed from the 2006 effective income tax rate of 30.9% primarily due to Foreign Sales Corporation and Extraterritorial Income exclusion tax benefits that existed in 2006, but did not recur in 2007. This was partially offset by the non-deduction in 2006 of the global settlement with the U.S. DoJ and other income tax provision adjustments. The 2007 tax rate of 33.7% included enhanced Research and Development credits that exceeded the credits in 2006. The effective income tax rate of 30.9% for 2006 differed from the 2005 effective income tax rate of 9.1% primarily due to the favorable 2005 settlement with the Internal Revenue Service and the non-deduction in 2006 of the global settlement with the U.S. DoJ. For additional discussion related to Income Taxes see Note 4.

 

Backlog

 

Contractual backlog of unfilled orders excludes purchase options, announced orders for which definitive contracts have not been executed, and unobligated U.S. and non-U.S. government contract funding. Contractual backlog increased by $80,397 million in 2007 compared to 2006 as a result of increases at Commercial Airplanes of $80,900 million, which were due to new orders in excess of deliveries for all programs offset by decreases at IDS of $503 million.

 

Unobligated backlog includes U.S. and non-U.S. government definitive contracts for which funding has not been authorized. Funding that is subsequently received is moved to contractual backlog. The decrease in IDS unobligated backlog of $3,502 million during 2007 compared with 2006 is primarily due to funding released from existing contracts on Future Combat Systems (FCS), Proprietary, C-17, P8-A and F-18, partially offset by increases in the F-22 program and Support Systems.

 

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Segment Results of Operations and Financial Condition

 

Commercial Airplanes

 

Business Environment and Trends

 

Airline Industry Environment The fundamental drivers of air travel growth are a combination of economic growth and the increasing propensity to travel due to increased trade, globalization and improved airline services driven by liberalization of air traffic rights between countries. Air traffic growth continues to exceed its long-term trend due to strong performance of these key drivers. Global economic growth, the primary driver of air traffic growth, remained above long-term trend for the fourth straight year in 2007. The world economy has grown at an average 3.8% annual rate since 2004 compared to the long-term trend rate of 3.1%. The increasingly diversified world economy is forecast to continue above-trend growth through the end of the decade although there is increased uncertainty in the near-term outlook due to a slowdown in the United States economy.

 

Increasingly liberalized and competitive air travel markets are also supporting strong traffic growth. Many bilateral air service agreements governing air traffic rights between countries are liberalizing air travel around the world particularly in high growth markets such as China and India which have signed multiple new agreements over the last several years. In addition, open skies agreements, in which all traffic rights restrictions are eliminated, continue to emerge with United States – European Union open skies negotiations being the most prominent recent example. Airline ownership is also becoming more commercially driven – governments are reducing ownership and control stakes, moving away from national carriers. All of these facets of liberalization are increasing competition between airlines and further stimulating demand for air travel. In this increasingly liberalized environment, airlines are offering improved service levels increasing flight frequency and airport pairs served by 5% per year since 2004.

 

The combination of these two fundamental drivers has led to a 9% annual average increase in the number of passengers since 2003. In addition, high fuel prices are spurring strong demand to replace older, less fuel efficient airplanes. Together, these two factors have led to strong demand for new aircraft – over 7,000 orders for large commercial jet aircraft over the last four years, increasing industry backlog levels to seven years of deliveries at current production rates.

 

Fuel prices are also playing a key role in increasing the current demand for new aircraft. Strong economic growth has also led to sustained high oil and fuel prices. Between 2003 and 2007, jet fuel expense grew from 15 percent to more than 30 percent of airline operating costs. Airlines are responding by improving the fuel efficiency of their aircraft operations and reducing cost in many other areas. They are implementing more efficient (internet based) distribution systems, reducing commission payments, and drawing on their employees for participation in labor cost reduction. These initiatives, combined with strong demand, are enabling industry-wide profitability despite high fuel prices. Worldwide airlines achieved a $5.6 billion net profit in 2007 and are forecast to earn $5.0 billion in 2008.

 

Looking forward, our 20-year forecast is for a long-term average growth rate of 5% per year for passenger traffic, and 6% per year for cargo traffic based on projected average annual worldwide real economic growth rate of 3%. Based on long-term global economic growth projections, and factoring in increased utilization of the worldwide airplane fleet and requirements to replace older airplanes, we project a $2.8 trillion market for 28,600 new airplanes over the next 20 years.

 

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

 

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Industry Competitiveness The commercial jet aircraft market and the airline industry remain extremely competitive. We expect the existing long-term downward trend in passenger revenue yields worldwide (measured in real terms) to continue into the foreseeable future. Market liberalization in Europe and Asia has continued to enable low-cost airlines to gain market share. These airlines have increased the downward pressure on airfares. This results in continued cost pressures for all airlines and price pressure on our products. Major productivity gains are essential to ensure a favorable market position at acceptable profit margins.

 

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

 

We face aggressive international competitors who are intent on increasing their market share. They offer competitive products and have access to most of the same customers and suppliers. Airbus has historically invested heavily to create a family of products to compete with ours. Regional jet makers Embraer and Bombardier, coming from the less than 100-seat commercial jet market, continue to develop larger and more capable airplanes. Additionally, other competitors from Russia, China, and Japan are likely to enter the 70 to 130 seat aircraft market over the next few years. This market environment has resulted in intense pressures on pricing and other competitive factors.

 

Worldwide, airplane sales are generally conducted in U.S. dollars. Fluctuating exchange rates affect the profit potential of our major competitors, all of whom have significant costs in other currencies. A decline of the U.S. dollar relative to their local currencies as experienced in 2007 puts pressure on competitors’ revenues and profits. Competitors often respond by aggressively reducing costs and increasing productivity, thereby improving their longer-term competitive posture. Airbus has recently announced such initiatives targeting a two-year reduction in its development cycle and a significant increase in overall productivity by 2010. If the U.S. dollar strengthens, Airbus can use the extra efficiency to develop new products and gain market share.

 

We are focused on improving our processes and continuing cost-reduction efforts. We continue to leverage our extensive customer support services network which includes aviation support, spares, training, maintenance documents and technical advice for airlines throughout the world. This enables us to provide a higher level of customer satisfaction and productivity. These efforts enhance our ability to pursue pricing strategies that enable us to price competitively and maintain satisfactory margins.

 

Operating Results

 

(Dollars in millions) Years ended December 31,		2007				2006				2005
Revenues		$	33,386			$	28,465			$	21,365
% of Total company revenues			50	%			46	%			40	%
Earnings from operations		$	3,584			$	2,733			$	1,431
Operating margins			10.7	%			9.6	%			6.7	%
Research and development		$	2,962			$	2,390			$	1,302
Contractual backlog		$	255,176			$	174,276			$	124,132

 

Revenues The increase in revenue of $4,921 million in 2007 from 2006 was primarily attributable to higher new airplane deliveries, including model mix changes, of $3,369 million, increased commercial aviation support business of $1,432 million and $120 million primarily attributable to revenue from aircraft trading.

 

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The increase in revenue of $7,100 million in 2006 from 2005 was primarily attributable to higher new airplane deliveries, including model mix changes, of $6,820 million, increased commercial aviation support business of $873 million offset by $593 million primarily attributable to lower revenue from aircraft trading. In 2005 we delivered 29 fewer than expected airplanes due to the International Association of Machinists and Aerospace Workers (IAM) strike during the month of September 2005. This resulted in approximately $2,000 million lower revenue than anticipated for 2005.

 

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

 

		717			737 NG			747		757		767			777		Total
2007
Cumulative Deliveries		155			2,466			1,396		1,049		959			687
Deliveries					330	*		16				12	*		83		441
2006
Cumulative Deliveries		155			2,136			1,380		1,049		947			604
Deliveries		5	(3)		302	*		14				12	*		65		398
2005
Cumulative Deliveries		150			1,834			1,366		1,049		935			539
Deliveries		13	(5)		212	*		13		2		10	*		40		290

 

*	Intracompany deliveries were one 767 aircraft and one 737 Next Generation aircraft in 2007, two 767 aircraft and eight 737 Next Generation aircraft in 2006 and two 767 aircraft and two 737 Next Generation aircraft in 2005.

 

Earnings from Operations The $851 million increase in earnings from operations in 2007 over the comparable period of 2006 was primarily attributable to earnings of $950 million on increased new aircraft deliveries and $304 million in increased earnings primarily attributable to commercial aviation support business. In addition cost performance improved by $169 million. These were offset by an increase in research and development costs of $572 million.

 

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

 

Backlog The backlog increase in 2007 related to orders in excess of deliveries for all programs, while the increase in 2006 related to orders in excess of deliveries for 737NG, 747 and 787.

 

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

 

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Commercial aircraft production costs include a significant amount of infrastructure costs, a portion of which do not vary with production rates. As the amount of time needed to produce the accounting quantity decreases, the average cost of the accounting quantity also decreases as these infrastructure costs are included in the total cost estimates, thus increasing the gross margin and related earnings provided other factors do not change.

 

The accounting quantity for each program may include units that have been delivered, undelivered units under contract, and units anticipated to be under contract in the reasonable future (anticipated orders). In developing total program estimates all of these items within the accounting quantity must be considered. The table below provides details as of December 31:

 

		Program
		717		737 NG		747		757		767			777		787
2007
Program accounting quantities		156		3,800		1,474		1,050		998			950		*
Undelivered units under firm orders1				2,076		125				52			357		817
Cumulative firm orders (CFO)2		155		4,542		1,521		1,049		1,011			1,044
Anticipated orders		N/A		N/A		N/A		N/A		N/A			N/A
Anticipated orders as a % of CFO		N/A		N/A		N/A		N/A		N/A			N/A
2006
Program accounting quantities		156		3,200		1,449		1,050		985			900		*
Undelivered units under firm orders1				1,560		116				28			299		448
Cumulative firm orders (CFO)2		155		3,696		1,496		1,049		975			903
Anticipated orders		N/A		N/A		N/A		N/A		8			N/A
Anticipated orders as a % of CFO		N/A		N/A		N/A		N/A		1	%		N/A
2005
Program accounting quantities		156		2,800		1,424		1,050		971			800		*
Undelivered units under firm orders1		5		1,123		58				30			288		287
Cumulative firm orders (CFO)2		155		2,957		1,424		1,049		965			827
Anticipated orders		N/A		N/A		N/A		N/A		3			N/A
Anticipated orders as a % of CFO		N/A		N/A		N/A		N/A		0	%		N/A

 

*

The accounting quantity for the 787 program will be determined in the year of first airplane delivery, targeted for 2009.

1

Firm orders represent new aircraft purchase agreements where the customers’ rights to cancel without penalty have expired. Typically customer rights to cancel without penalty include the customer receiving approval from its Board of Directors, shareholders, government and completing financing arrangements. All such cancellation rights must be satisfied or expired prior to recording a firm order even if satisfying such conditions are highly certain. Firm orders exclude option aircraft and aircraft with cancellation rights.

2

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

 

737 Next-Generation The accounting quantity for the 737 Next-Generation program increased by 600 units during 2007 due to the program’s normal progression of obtaining additional orders and delivering aircraft.

 

747 Program The accounting quantity for the 747 program increased by 25 units during 2007. In the fourth quarter of 2007 we completed firm configuration of the 747-8 Intercontinental airplane and during 2006 we completed firm configuration of the 747-8 Freighter. While there are always risks to development, production and certification schedules in the introduction of a new commercial derivative airplane, deliveries of the first 747-8 Freighter and Intercontinental airplane are targeted for late 2009 and late 2010.

 

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767 Program The accounting quantity for the 767 program increased by 13 units during 2007.

 

777 Program The accounting quantity for the 777 program increased by 50 units during 2007 as a result of the program’s normal progression of obtaining additional orders and delivering aircraft. Firm configuration of the 777 Freighter was completed during 2006. Deliveries of the first 777 Freighter are targeted for late 2008.

 

787 Program We are in the very critical stages of final assembly and planning for flight test, and the risks that are always inherent in these latter stages of airplane production still remain. We continue to address challenges associated with assembly of the first airplanes, including start-up issues in our factory, management of our extended global supply chain, completion and integration of traveled work and reconciliation of the airplane’s configuration with supplier and partner engineering. In January 2008 we announced that first flight of the 787 has been moved from the end of the first quarter of 2008 to around the end of the second quarter of 2008 to provide additional time to complete assembly of the first airplane. Deliveries are now expected to begin in early 2009, rather than late 2008. We continue working with our customers and suppliers to assess the specific impacts of the schedule change on the flight test program and entry into service.

 

Fleet support We provide the operators of our commercial airplanes with assistance and services to facilitate efficient and safe aircraft operation. Collectively known as commercial aviation support, 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 $572 million and $1,088 million in 2007 and 2006. Research and development expense is net of development cost sharing payments received from suppliers. The increase in 2007 was due to higher spending of $542 million, primarily on 787 and 747-8, and $30 million of lower supplier development cost sharing payments. We anticipate a decrease in research and development spending for 2008 primarily due to reduced 787 product development activities.

 

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Integrated Defense Systems

 

Business Environment and Trends

 

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

 

Defense Environment Overview The U.S. is faced with continuous force deployments overseas, stability operations in Afghanistan and Iraq, and uncertainties about near-peer adversary states with growing sophistication and military means. At the same time, our defense department faces the simultaneous requirements to recapitalize important defense capabilities and to transform the force to take advantage of available technologies to meet the changing national security environment as outlined in the latest Quadrennial Defense Review (QDR). All of this must be carried out against a backdrop of significant Federal budget deficits and bipartisan objectives to reduce and ultimately eliminate annual deficit spending as well as the upcoming 2008 Presidential elections. We anticipate that the national security environment will remain challenging for at least the next decade.

 

Because U.S. DoD spending was about half of worldwide defense spending and represented approximately 84% of IDS revenue in 2007, the trends and drivers associated with the U.S. DoD budget are critical. The U.S. DoD budget has grown substantially over the past decade, particularly after the terrorist attacks of September 11, 2001. Although the growth rate had moderated in recent years, the 2009 submittal equates to a 7.5% increase over 2008. The President’s request for fiscal year 2009 is $515 billion, excluding the additional initial request of $70 billion to continue the fight in the Global War on Terror (GWOT). The Procurement account continues to see growth with a request of $104 billion, a 5% increase over 2008, while the Research, Development, Test & Evaluation account increased modestly to $80 billion, a 4% increase from the 2008 level. (All projections and percentage increases are made without taking inflation into account and without accounting for Supplemental funding.)

 

Over the past years, emergency supplemental requests have been used to cover the on-going costs of the GWOT. In addition to the fiscal year 2008 discretionary budget request, the President also submitted supplemental requests totaling $189 billion to cover operations in the GWOT. It is anticipated that additional supplemental requests for 2009 will exceed $100 billion, including the $70 billion initially requested, and that the trend to use supplemental requests to fund the GWOT will continue.

 

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

 

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

 

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Civil Space Transportation and Exploration Environment NASA has had stable but very little growth in their funding in this decade. NASA’s fiscal year 2007 appropriation of $16.6 billion was approximately equal to the fiscal year 2006 funding level. NASA’s budget remains focused on needed funds for Space Shuttle Operations, International Space Station, and new initiatives associated with the Vision for Space Exploration. We anticipate funding levels to remain in the $17-$18 billion range in the near future. NASA is continuing to pursue elements of the Vision for Space Exploration, which will provide additional opportunities.

 

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

 

Integrated Defense Systems Operating Results

 

IDS Realignment

 

Effective January 1, 2007, the B-1 bomber program (formerly included in PE&MS) and certain Boeing Australia Limited programs (formerly included in N&SS) are included in Support Systems. Business segment data for all periods presented have been adjusted to reflect the realignment. See Note 22.

 

Operating Results

 

(Dollars in millions) Years ended December 31,		2007				2006				2005
Revenues		$	32,080			$	32,439			$	31,106
% of Total company revenues			48	%			53	%			58	%
Earnings from operations		$	3,440			$	3,032			$	3,919
Operating margins			10.7	%			9.3	%			12.6	%
Research and development		$	851			$	791			$	855
Contractual backlog		$	41,788			$	42,291			$	36,505
Unobligated backlog		$	29,922			$	33,424			$	44,008

 

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

 

Revenues IDS revenues decreased 1% in 2007 primarily due the exclusion of the government Delta volume from N&SS revenues, now a revenue component for our joint venture ULA. Decreased revenue from this exclusion and lower revenues in the PE&MS segment were partially offset by increased volume in other N&SS programs and growth in the Support Systems segment. IDS revenues increased 4% in 2006 as growth in PE&MS and Support Systems was partially offset by lower volume in N&SS.

 

Operating Earnings IDS operating earnings increased by $408 million in 2007 compared with 2006 primarily due to $770 million of charges on the AEW&C development program in 2006. The 2007 increase was partially offset by lower earnings in the PE&MS and N&SS segments. Operating earnings

 

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decreased by $887 million in 2006 compared with 2005 reflecting a $569 million net gain on the sale of Rocketdyne in 2005 and $770 million of charges on the AEW&C development program in 2006 partially offset by improved margins on other programs.

 

Backlog Total backlog is comprised of contractual backlog, which represents work we are on contract to perform for which we have received funding, and unobligated backlog, which represents work we are on contract to perform for which funding has not yet been authorized and appropriated. IDS total backlog decreased 5% in 2007, from $75,715 million to $71,710 million, primarily due to current year deliveries and sales on multi-year contracts awarded in prior years with the largest decreases in FCS, C-17, and P-8A programs.

 

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

 

Additional Considerations

 

Our business includes a variety of development programs which have complex design and technical challenges. Many of these programs have cost-type contracting arrangements. In these cases the associated financial risks are primarily in lower profit rates or program cancellation if milestones and technical progress are not accomplished. Examples of these programs include Airborne Laser, E/A-18G, Family of Beyond Line-of-Sight Terminals (JTRS), FCS, Ground-based Midcourse Defense (GMD), Joint Tactical Radio System, 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 missed, which could trigger termination-for-default 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, SBInet, Vigilare and High Frequency Modernisation.

 

Precision Engagement and Mobility Systems Operating Results

 

(Dollars in millions) Years ended December 31,		2007				2006				2005
Revenues		$	13,685			$	14,107			$	13,308
% of Total company revenues			21	%			23	%			25	%
Earnings from operations		$	1,629			$	1,208			$	1,720
Operating margins			11.9	%			8.6	%			12.9	%
Research and development		$	447			$	392			$	432
Contractual backlog		$	22,957			$	24,739			$	21,630
Unobligated backlog		$	8,564			$	8,962			$	15,054

 

Revenues PE&MS revenues decreased 3% in 2007 compared with an increase of 6% in 2006. The decrease of $422 million in 2007 was due to reduced deliveries of the Apache and T-45 aircraft and Joint Direct Attack Munitions, partially offset by higher deliveries of Chinook and F-18 aircraft and higher volume on the P-8A program. The revenue growth of $799 million in 2006 was driven by higher deliveries of F-15 and Apache aircraft and higher volume on P-8A, F-22, and Chinook, partially offset by reduced revenues on AEW&C.

 

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

 

		2007		2006		2005
F/A-18 Models		44		42		42
T-45TS Goshawk		9		13		10
F-15E Eagle		12		12		6
C-17 Globemaster		16		16		16
CH-47 Chinook		10		2
AH-64 Apache		17		31		12
C-40A Clipper		3		1		2
Total New-Build Production Aircraft		111		117		88

 

Operating Earnings PE&MS operating earnings increased by $421 million in 2007 primarily due to the 2006 charges of $770 million on the AEW&C development program, which were partially offset by lower 2007 earnings due to revised cost estimates on the international KC-767 Tanker program, lower prices on the C-17 program and revised cost and revenue estimates on the AEW&C program. Operating earnings decreased by $512 million in 2006 due to the above mentioned AEW&C charge, which was partially offset by earnings from revenue growth, favorable contract mix, and reduced Company-Sponsored Research & Development expenditures on the 767 Tanker program.

 

Research and Development The PE&MS segment continues to focus its research and development resources where it can use its customer knowledge, technical strength and large-scale integration capabilities to provide innovative solutions to meet the war fighter’s enduring needs. Research and development has remained consistent over the past several years. Research and development activities leverage our capabilities in architectures, system-of-systems integration and weapon systems technologies to develop solutions which are designed to enhance our customers’ capabilities in the areas of mobility, precision effects, situational awareness and survivability. These efforts focus on increasing mission effectiveness and interoperability, and improving affordability, reliability and economic ownership. Continued research and development investments in unmanned technology and systems have enabled the demonstration of multi-vehicle coordinated flight and distributed control of high-performance unmanned combat air vehicles. Research and development in advanced weapons technologies emphasizes, among other things, precision guidance and multi-mode targeting. Research and development investments in the Global Tanker Aircraft program represent a significant opportunity to provide state-of-the-art refueling capabilities to domestic and non-U.S. customers. Investments were also made to support various intelligence, surveillance, and reconnaissance business opportunities including P-8A and AEW&C aircraft. Other research and development efforts include upgrade and technology insertions to network-enable and enhance the capability and competitiveness of current product lines such as the F/A-18E/F Super Hornet, F-15E Eagle, AH-64 Apache, CH-47 Chinook and C-17 Globemaster.

 

Backlog PE&MS total backlog decreased by 6% in 2007 compared with 2006 primarily due to deliveries and sales on C-17, F/A-18, P-8A and F-15. These decreases were partially offset by a multi-year contract for F-22 aircraft and international orders for AEW&C and F/A-18 aircraft. Total backlog decreased by 8% in 2006 compared with 2005 primarily due to deliveries and sales on F/A-18 and F-15 from multi-year contracts awarded in prior years.

 

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Additional Considerations

 

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

 

AEW&C During 2006 we recorded charges of $770 million on our international Airborne Early Warning & Control program. This development program, also known as Wedgetail in Australia and Peace Eagle in Turkey, consists of a 737-700 aircraft outfitted with a variety of command and control and advanced radar systems, some of which have never been installed on an airplane before. Wedgetail includes six aircraft and Peace Eagle includes four aircraft. This is an advanced and complex fixed-price development program involving technical challenges at the individual subsystem level and in the overall integration of these subsystems into a reliable and effective operational capability. We believe that the cost 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 missed.

 

International KC-767 Tanker Program During 2007, the PE&MS segment recorded charges of $152 million which were partially offset at the consolidated level. Currently the international KC-767 Tanker program includes four aircraft for the Italian Air Force and four aircraft for the Japanese Air Self Defense Force. These charges are associated with additional estimated costs for mitigating both the risks on the flight test program and the delivery risk associated with the Italy and Japan contracts. These programs are ongoing, and while we believe the cost estimates incorporated in the financial statements are appropriate, the technical complexity of the programs creates financial risk as additional completion and development costs may be necessary or scheduled delivery dates could be missed.

 

C-17 As of December 31, 2007 we delivered 171 of the 190 C-17 aircraft ordered by the U.S. Air Force, with final deliveries scheduled for 2009. In June 2007, based upon continued bipartisan congressional support, including the House Armed Services Committee addition of $2.4 billion for 10 C-17s in their mark of the 2008 budget, and U.S. Air Force testimony to Congress reflecting interest in additional C-17 aircraft, we directed key suppliers to begin work on 10 aircraft beyond the 190 currently on order. As of December 31, 2007, inventory expenditures and potential termination liabilities to suppliers for work performed related to anticipated orders for 10 C-17 aircraft to the U.S. Air Force and anticipated international orders for 3 additional aircraft totaled approximately $215 million. It is reasonably possible that we will decide in 2008 to complete production of the C-17 if further orders are not received. We are still evaluating the full financial impact of a potential production shut-down, including any recovery that would be available from the government. Such recovery from the government would not include the costs incurred by us resulting from the second-quarter direction to key suppliers to begin working on the additional 10 aircraft.

 

Network and Space Systems Operating Results

 

(Dollars in millions) Years ended December 31,		2007				2006				2005
Revenues		$	11,696			$	11,941			$	12,221
% of Total company revenues			18	%			19	%			23	%
Earnings from operations		$	891			$	952			$	1,395
Operating margins			7.6	%			8.0	%			11.4	%
Research and development		$	300			$	301			$	334
Contractual backlog		$	9,167			$	7,838			$	6,324
Unobligated backlog		$	20,210			$	23,723			$	27,634

 

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Revenues N&SS revenues decreased 2% in both 2007 and 2006. The decrease of $245 million in 2007 was primarily due to the exclusion of government Delta volume, now a component of our equity investment in ULA and lower FCS volume, partially offset by increased volume on SBInet and several satellite programs. The decrease of $280 million in 2006 was primarily due to lower volume in Proprietary and GMD as well as the divestiture of our Rocketdyne business, which were partly offset by significant growth in FCS and higher Delta IV volume. Additional impacts resulted from fewer milestone completions in our commercial satellite business in 2006 and the completion of a Homeland Security contract in 2005.

 

Delta launch and new-build satellite deliveries were as follows:

 

		2007		2006		2005
Delta II Commercial		3
Delta II Government				2		2
Delta IV Government				3
Satellites		4		4		3

 

Delta government launches are excluded from our deliveries after December 1, 2006 due to the formation of ULA.

 

Operating Earnings N&SS operating earnings decreased by $61 million in 2007 and decreased by $443 million in 2006. The decrease in 2007 was due to lower earnings on FCS and several satellite programs. These decreases were partially offset by higher award fees on GMD and a $44 million gain on sale of Anaheim property. The decrease in 2006 was primarily due to the $569 million net gain on the Rocketdyne sale and higher contract values for Delta IV launch contracts in 2005, partially offset by increased earnings in the FCS program in 2006. N&SS operating earnings include equity earnings of $85 million, $71 million and $72 million from the United Space Alliance joint venture in 2007, 2006, and 2005, respectively and equity loss of $11 million and equity earnings of $5 million from the ULA joint venture in 2007 and 2006. The ULA equity earnings and loss amounts are net of the basis difference amortization.

 

Divestitures On February 28, 2005, we completed the stock sale of Electronic Dynamic Devices Inc. to L-3 Communications. On August 2, 2005 we completed the sale of our Rocketdyne business to United Technologies Corporation. See Note 7 Exit Activity and Divestitures.

 

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

 

Backlog N&SS total backlog decreased by 7% in 2007 compared with 2006 due to revenues recognized on multi-year orders received in prior years on FCS and Proprietary programs, partially offset by an increase in our Space Exploration programs. Total backlog decreased by 7% in 2006 compared with 2005 primarily due to revenues recognized on multi-year orders received in prior years on the FCS program.

 

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Additional Considerations

 

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

 

United Launch Alliance On December 1, 2006, we completed the transaction with Lockheed Martin Corporation (Lockheed) to create a 50/50 joint venture named United Launch Alliance L.L.C. (ULA). ULA combines the production, engineering, test and launch operations associated with U.S. government launches of Boeing Delta and Lockheed Atlas rockets. In connection with the transaction, we initially contributed net assets of $914 million at December 1, 2006. On July 24, 2007 we and Lockheed reached agreement with respect to resolution of the final working capital and the value of the launch vehicle support contracts that each party contributed to form ULA. Effective August 15, 2007 the parties received all necessary approvals pursuant to the terms of the Consent Order and the terms of the agreement which resulted in additional contributions from both parties with Boeing agreeing to contribute an additional $97 million which did not result in a cash outflow as it will be offset against future payments due to us from ULA associated with an inventory supply agreement. Additionally, conformed accounting adjustments made by ULA resulted in adjustments to ULA’s balance sheet. The book value of our investment exceeds our proportionate share of ULA’s net assets. This difference will be 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 $14 million annually for the next 17 years.

 

In connection with the formation of ULA, we and Lockheed each committed to provide up to $25 million in additional capital contributions and we each have agreed to extend a line of credit to ULA of up to $200 million to support its working capital requirements. 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.

 

In December 2006, we agreed to indemnify ULA through December 31, 2020 against potential non-recoverability of $1,375 million of Boeing Delta inventories included in contributed assets plus $1,860 million of inventory subject to the inventory supply agreement which ends on March 31, 2021. Since inception, ULA sold $443 million of inventories that were contributed by us. During 2007, ULA determined that certain Delta II inventory is not fully recoverable. As a result we recorded charges of $31 million for non-recoverable Delta II inventory and $39 million for our share of the loss recorded by ULA related to Delta II. Future decisions regarding the Delta II program could reduce our earnings by up to $100 million.

 

We also agreed to indemnify ULA in the event ULA is unable to obtain re-pricing of certain contracts which we contributed to ULA and to which we believe ULA is entitled. We will be responsible for any shortfall and may record up to $332 million in pre-tax losses related to these contracts.

 

Sea Launch The Sea Launch venture, in which we are a 40% partner, provides ocean-based launch services to commercial satellite customers.

 

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

 

(Dollars in Millions)		Estimated Maximum Exposure			Established Reserves			Estimated Proceeds from Recourse			Estimated Net Exposure
Credit guarantees		$	457		$	183		$	274
Partner Loans (principal and interest)			479			287			192
Trade receivable from Sea Launch			337			334						3
Performance guarantees			33						20			13
Subcontract termination			8									8
Other receivables and Inventory			47			39						8
		$	1,361		$	843		$	486		$	32

 

We made no additional capital contributions to the Sea Launch venture during the year ended December 31, 2007.

 

The venture conducted zero, five and four successful launches for the years ended December 31, 2007, 2006, and 2005, respectively. A Sea Launch Zenit-3SL vehicle, carrying a Boeing-built NSS-8 satellite, experienced an anomaly during launch on January 30, 2007. The launch platform has been repaired and resumed flight operations on January 15, 2008, successfully launching a Boeing-built satellite. The venture incurred losses in 2007 due to a delay in its 2007 launch manifest that was caused by the launch anomaly and unusually strong ocean currents at the launch site during November and December. The venture incurred losses in 2006 and 2005 due to the relatively low price and volume of launches, driven by a depressed commercial satellite market and oversupply of launch vehicles as well as a high level of debt and debt servicing requirements.

 

We suspended recording equity losses after writing our investment in and direct loans to Sea Launch down to zero in 2001 and accruing our obligation for third-party guarantees on Sea Launch indebtedness. We are not obligated to provide any further financial support to the Sea Launch venture. However, in the event that we do extend additional financial support to Sea Launch in the future, we will recognize suspended losses as appropriate. In addition, we continue to look at alternative capital structures for the venture.

 

Satellites The Boeing-built NSS-8 satellite was declared a total loss due to an anomaly during launch on January 30, 2007. The NSS-8 satellite was insured for $200 million which was collected during the second and third quarter of 2007. New Skies Satellites B.V. (New Skies) declined to exercise its option to purchase a replacement spacecraft due to its assertion that we anticipatorily breached the contract. We believe that had New Skies exercised its option, we would have fulfilled our contractual responsibilities. We do not expect New Skies’ assertion to materially impact our consolidated results of operations, financial position, or cash flows.

 

See the discussions of Boeing Satellite Systems International, Inc. (BSSI) litigation/arbitration with ICO Global Communications (Operations), Ltd., Thuraya Satellite Telecommunications, Telesat Canada, and Space Communications Corporation in Note 21.

 

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Support Systems Operating Results

 

(Dollars in millions) Years ended December 31,		2007				2006				2005
Revenues		$	6,699			$	6,391			$	5,577
% of Total company revenues			10	%			10	%			10	%
Earnings from operations		$	920			$	872			$	804
Operating margins			13.7	%			13.6	%			14.4	%
Research and development		$	104			$	98			$	89
Contractual backlog		$	9,664			$	9,714			$	8,551
Unobligated backlog		$	1,148			$	739			$	1,320

 

Revenues Support Systems revenues increased $308 million in 2007 and $814 million in 2006, an increase of 5% and 15%. The increases were due to higher Integrated Logistics (IL) program volume resulting from the 2006 acquisition of Aviall, Inc. (Aviall) and increased revenue on the C-17 support program. Higher international program volume in 2007 was the result of our increased ownership in Alsalam Aircraft Company (Alsalam) which occurred during the second quarter of 2006. Lower volume on several Maintenance, Modification and Upgrades (MM&U) and Training Systems and Services (TS&S) programs partially offset the 2007 increases. Higher volume on several MM&U programs also contributed to the significant growth in 2006 revenues.

 

In the second quarter of 2006 we increased our ownership interest in Alsalam, which operates as a Maintenance, Repair and Overhaul facility for various military and commercial aircraft. As a result, we began consolidating Alsalam’s financial statements, which generated revenues of $207 million during 2007 and $137 million during the last three quarters of 2006.

 

Operating Earnings Support Systems operating earnings increased by 5% in 2007 and increased by 9% in 2006 driven by the revenue increases mentioned above in addition to a different contract mix.

 

Research and Development Support Systems continues to focus investment strategies on its core businesses including IL, MM&U, TS&S and Advanced Logistics Support Systems, as well as on moving into the innovative Network Centric Logistics areas. Investments have been made to continue the development and implementation of innovative and disciplined tools, processes and systems as market discriminators in the delivery of integrated customer solutions. Examples of successful programs stemming from these investment strategies include the C-17 Globemaster Sustainment Partnership, the F/A-18 Integrated Readiness Support Teaming program, and the F-15 Singapore Performance Based Logistics contract.

 

Backlog Support Systems total backlog increased by 3% in 2007 compared with 2006 due to increases in TS&S programs and International Support programs which were partially offset by decreases in MM&U and IL programs. Total backlog increased by 6% in 2006 compared with 2005 driven by a large IL order for Chinook support.

 

Boeing Capital Corporation Segment

 

Business Environment and Trends

 

BCC’s customer financing and investment portfolio at December 31, 2007 totaled $6,532 million, which was substantially collateralized by Boeing produced commercial aircraft. While worldwide traffic levels are well above those in the past, the effects of higher fuel prices continue to impact the airline industry. At the same time, the credit ratings of some airlines, particularly in the United States, have remained at low levels. A substantial portion of BCC’s portfolio is concentrated among U.S. commercial airline customers.

 

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Certain aircraft models in BCC’s portfolio have recently experienced a lower rate of decline in market value and some models have experienced increases in market value. This market value condition had been due to certain positive factors including passenger load at record high levels, a limited supply of economically viable used aircraft, increasing lease rates, and increased demand from used aircraft buyers.

 

Aircraft values and lease rates are impacted by the number and type of aircraft that are currently out of service. Approximately 1,600 commercial jet aircraft (8.2% of current world fleet) continue to be parked, including both in-production and out-of-production aircraft types, of which over 60% are not expected to return to service. Aircraft valuations could decline if significant numbers of aircraft, particularly types with relatively few operators, are placed out of service.

 

Summary Financial Information

 

(Dollars in millions) Years ended December 31,		2007				2006				2005
Revenues		$	815			$	1,025			$	966
Earnings from operations		$	234			$	291			$	232
Operating margins			29	%			28	%			24	%

 

Revenues

 

BCC segment revenues consist principally of lease income from equipment under operating lease and interest from financing receivables and notes. BCC’s revenues decreased $210 million in 2007, resulting from lower interest income on notes receivable of $75 million, lower investment income of $50 million primarily due to the sale or repayment at maturity of certain investments in 2006 and lower net gain on disposal of assets of $47 million. BCC’s revenues increased $59 million in 2006, primarily due to an increase of investment income and higher gain on the sale of aircraft and certain investments in notes receivable.

 

Operating earnings

 

BCC’s 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 $57 million in 2007 primarily due to lower revenues partially offset by lower interest expense, lower asset impairment expense and lower depreciation expense and a recovery of losses. The increase in operating earnings in 2006 compared with 2005 was primarily due to higher revenues.

 

Financial Position

 

The following table presents selected financial data for BCC:

 

(Dollars in millions)		2007				2006
BCC Customer Financing and Investment Portfolio		$	6,532			$	8,034
Valuation Allowance as a % of Total Receivables			2.5	%			2.4	%
Debt		$	4,327			$	5,590
Debt-to-Equity Ratio			5.0-to-1				5.0-to-1

 

BCC’s customer financing and investment portfolio at December 31, 2007 decreased from December 31, 2006 due to prepayment of certain notes receivable, normal portfolio run-off and sale of certain portfolio assets. At December 31, 2007 and 2006, BCC had $86 million and $259 million of

 

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assets that were held for sale or re-lease of which $86 million and $253 million had firm contracts to be sold or placed on lease. Additionally, aircraft subject to leases with a carrying value of approximately $292 million are scheduled to be returned off lease in the next 12 months. These aircraft are being remarketed or the leases are being extended and $132 million were committed at December 31, 2007.

 

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

 

Finance Restructurings

 

From time to time, certain BCC customers have requested a restructuring of their transactions with BCC. As of December 31, 2007, 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.

 

Other Segment

 

Other segment operating losses were $243 million during 2007 as compared to losses of $738 million in 2006. The reduction of $495 million was primarily due to the absence of losses related to Connexion by Boeing, which we exited in 2006. As part of our exit from this business, we recognized a charge of $320 million in 2006, in addition to losses of $237 million for the year ended December 31, 2006. We have not reached final settlements with all customers or suppliers. We do not believe the final settlements will have a material adverse effect on our earnings, cash flows and/or financial position.

 

Other segment operating losses were $738 million during 2006 as compared to losses of $363 million in 2005. The increase of $375 million was primarily due to the $320 million charge from the exit of the Connexion by Boeing business and the $68 million environmental expense recognized in 2006. The Other segment recorded $74 million of lower valuation allowances for customer financing in 2006 compared to 2005. Additionally, during 2005, the Other segment recognized earnings of $63 million associated with the buyout of several operating lease aircraft by a customer.

 

Liquidity and Capital Resources

 

Cash Flow Summary

 

(Dollars in millions)

 

Years ended December 31,		2007				2006				2005
Net earnings		$	4,074			$	2,215			$	2,572
Non-cash items			2,835				3,097				3,494
Changes in working capital			2,675				2,187				934
Net cash provided by operating activities			9,584				7,499				7,000
Net cash used by investing activities			(3,822	)			(3,186	)			(98	)
Net cash used by financing activities			(4,884	)			(3,645	)			(4,657	)
Effect of exchange rate changes on cash and cash equivalents			46				38				(37	)
Net increase in cash and cash equivalents			924				706				2,208
Cash and cash equivalents at beginning of year			6,118				5,412				3,204
Cash and cash equivalents at end of year		$	7,042			$	6,118			$	5,412

 

Operating activities Net cash provided by operating activities increased by $2,085 million to $9,584 million in 2007, primarily due to an increase in Net earnings. In addition, working capital improved in 2007, reflecting higher advances driven by commercial airplane orders and decreases in customer financing assets due to pre-payment of certain notes receivable and normal portfolio run-off, which were partially offset by an increase in inventories driven by the continued ramp-up of the 787 program.

 

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

 

Investing activities Cash used for investing activities increased to $3,822 million in 2007 from $3,186 million in 2006, largely due to increases in short-term investments, primarily time deposits and commercial paper, partially offset by our investment in the acquisition of Aviall in 2006. At December 31, 2007 the recorded balances of time deposits and commercial paper classified as short-term investments were $1,025 million and $799 million.

 

As of December 31, 2007, our externally managed portfolio of investment grade fixed income instruments had an average duration of 1.5 years. The balance, at December 31, 2007 and 2006, was $3,269 million and $3,180 million, of which $306 million and $257 million was classified as short-term. The investments are held as available for sale.

 

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

 

Financing activities Cash used by financing activities increased to $4,884 million in 2007 from $3,645 million in 2006 primarily due to increased common share repurchases. Cash used by financing activities decreased to $3,645 million in 2006 from $4,657 million in 2005 primarily due to lower common share repurchases.

 

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

 

In 2007, we repaid $1,406 million of debt, including $1,309 million of debt held at BCC. In 2006, we repaid $1,681 million of debt, including $713 million of debt held at BCC and $458 million of debt assumed in the Aviall acquisition. In 2005, we repaid $1,378 million of debt. There were no debt issuances during 2007, 2006, or 2005. At December 31, 2007 and 2006, the recorded balance of debt was $8,217 million and $9,538 million, of which $4,327 million and $5,590 million was recorded at BCC.

 

Credit Ratings Our credit ratings are summarized below:

 

		Fitch		Moody’s		Standard & Poor’s
Long-term:
Boeing/BCC		A+		A2		A+
Short-term:
Boeing/BCC		F1		P-1		A-1

 

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On September 12, 2007, Fitch Ratings revised its ratings outlook to positive from stable, citing continuation of strong orders and production ramp up of large commercial aircraft, in addition to an over-funded status of our pension plans, debt reduction and stronger than expected cash flows. The ratings were reaffirmed at A+ for long-term borrowings and F1 for short-term borrowings. On January 16, 2008, Fitch Ratings changed their outlook on the A+ rating to stable from positive, citing the impact of delays in the 787 program.

 

Capital Resources We and BCC have commercial paper programs that continue to serve as significant potential sources of short-term liquidity. Throughout 2007 and at December 31, 2007, neither we nor BCC had any commercial paper borrowings outstanding.

 

We believe we have substantial borrowing capacity. Currently, we have $3,000 million ($1,500 million exclusively available for BCC) of unused borrowing on revolving credit line agreements. In 2007, we renewed the 364-day revolving credit facility and the 5-year credit facility, of which $500 million and $1,000 million is allocated to BCC. BCC has an aggregate of $3,421 million available for issuance from shelf registrations filed with the SEC, which are due to expire in November 2008. We believe our internally generated liquidity, together with access to external capital resources, will be sufficient to satisfy existing commitments and plans, and also to provide adequate financial flexibility to take advantage of potential strategic business opportunities should they arise within the next year.

 

We and Lockheed have agreed to make available to ULA a line of credit in the amount of up to $200 million each as may be necessary from time to time to support ULA’s Expendable Launch Vehicle business during the five year period following December 1, 2006. ULA did not request any funds under the line of credit as of December 31, 2007.

 

In accordance with Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106 and 132(R) (SFAS 158), we recognize the funded status of our defined benefit pension and other postretirement plans, with a corresponding after-tax adjustment to Accumulated other comprehensive loss. The 2007 annual remeasurement of our pension and other postretirement plans resulted in a net $3,441 million increase in Shareholders’ equity.

 

As of December 31, 2007, we were in compliance with the covenants for our debt and credit facilities.

 

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Disclosures about Contractual Obligations and Commercial Commitments

 

The following table summarizes our known obligations to make future payments pursuant to certain contracts as of December 31, 2007, and the estimated timing thereof.

 

Contractual obligations

 

(Dollars in millions)		Total			Less than 1 year			1–3 years			3–5 years			After 5 years
Long-term debt (including current portion)		$	8,114		$	746		$	1,197		$	2,090		$	4,081
Interest on debt*			5,607			507			910			684			3,506
Pension and other post retirement cash requirements			7,403			675			1,441			1,549			3,738
Capital lease obligations			103			19			22			22			40
Operating lease obligations			1,086			221			297			158			410
Purchase obligations not recorded on statement of financial position			104,023			37,922			40,785			18,281			7,035
Purchase obligations recorded on statement of financial position			10,827			9,829			598			396			4
Total contractual obligations		$	137,163		$	49,919		$	45,250		$	23,180		$	18,814

 

*	Includes interest on variable rate debt calculated based on interest rates at December 31, 2007. Variable rate debt was approximately 3% of our total debt at December 31, 2007.

 

Income tax obligations As of December 31, 2007, our total liability for income taxes payable, including uncertain tax positions, was $1,374 million, of which $253 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 $1,121 million. Our income tax obligations are excluded from the table above. See Note 4.

 

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 a single plan that is funded through a trust.

 

Purchase obligations Purchase obligations represent contractual agreements to purchase goods or services that are legally binding; specify a fixed, minimum or range of quantities; specify a fixed, minimum, variable, or indexed price provision; and specify approximate timing of the transaction. In addition, the agreements are not cancelable without substantial penalty. Purchase obligations include amounts recorded as well as amounts that are not recorded on the statements of financial position. Approximately 11% 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

 

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through reimbursement from customers for penalty payments to the supplier should the customer not take delivery. These amounts are also included in our forecasts of costs for program and contract accounting. Some inventory procurement contracts may include escalation adjustments. In these limited cases, we have included our best estimate of the effect of the escalation adjustment in the amounts disclosed in the table above.

 

Industrial participation agreements We have entered into various industrial participation agreements with certain customers outside of the U.S. to facilitate economic flow back and/or technology transfer to their businesses or government agencies as the result of their procurement of goods and/or services from us. These commitments may be satisfied by our placement of direct work or vendor orders for supplies, opportunities to bid on supply contracts, transfer of technology or other forms of assistance. However, in certain cases, our commitments may be satisfied through other parties (such as our vendors) who purchase supplies from our non-U.S. customers. We do not commit to industrial participation agreements unless a contract for sale of our products or services is signed. In certain cases, penalties could be imposed if we do not meet our industrial participation commitments. During 2007, we incurred no such penalties. As of December 31, 2007, we have outstanding industrial participation agreements totaling $8.9 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 country outside the U.S. or customer must have sufficient capability to meet our requirements and must be competitive in cost, quality and schedule.

 

Purchase obligations recorded on the Consolidated Statement of Financial Position Purchase obligations recorded on the Consolidated Statement of Financial Position primarily include accounts payable and certain other liabilities including accrued compensation and dividends payable.

 

Commercial commitments The following table summarizes our commercial commitments outstanding as of December 31, 2007.

 

(Dollars in millions)		Total Amounts Committed/Maximum Amount of Loss			Less than 1 year			1-3 years			4-5 years			After 5 years
Standby letters of credit and surety bonds		$	4,973		$	4,585		$	238		$	1		$	149
Aircraft financing commercial commitments			8,350			879			2,764			3,443			1,264
Total commercial commitments		$	13,323		$	5,464		$	3,002		$	3,444		$	1,413

 

Aircraft financing commercial commitments include commitments to arrange or provide financing related to aircraft on order, under option for deliveries or proposed as part of sales campaigns based on estimated earliest funding dates. Based on historical experience, we currently do not anticipate that all of these commitments will be exercised by our customers, see Note 13.

 

Industrial Revenue Bonds We utilize Industrial Revenue Bonds (IRB) issued by the City of Wichita, Kansas and Fulton County, Georgia to finance the purchase and/or construction of real and personal property, see Note 12.

 

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Contingent Obligations

 

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. Most significant legal proceedings are related to matters covered by our insurance. Legal contingencies are discussed in Note 21, including our contesting the default termination of the A-12 aircraft, employment and benefits litigation brought by several of our employees, and litigation/arbitration involving BSSI programs.

 

Environmental Remediation We are involved with various environmental remediation activities and have recorded a liability of $679 million at December 31, 2007. For additional information, see Note 13.

 

Income Taxes We have recorded a net liability of $1,272 million at December 31, 2007 for uncertain tax positions. For further discussion of these contingencies, see Note 4.

 

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

 

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

 

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

 

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

 

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

 

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periods. If the combined gross margin for all contracts in IDS for all of 2007 had been estimated to be higher or lower by 1.0%, it would have increased or decreased pre-tax income for the year by approximately $321 million.

 

Program Accounting

 

Program accounting requires the demonstrated ability to reliably estimate the relationship of sales to costs for the defined program accounting quantity. A program consists of the estimated number of units (accounting quantity) of a product to be produced in a continuing, long-term production effort for delivery under existing and anticipated contracts. 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 parts, 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 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.

 

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, or circumstances may adversely or positively affect financial performance in future periods. If combined cost of sales percentages for all commercial airplane programs for all of 2007 had been estimated to be higher or lower by 1%, it would have increased or decreased pre-tax income for the year by approximately $278 million.

 

Aircraft Valuation

 

Impairment review for assets under operating leases and held for sale or re-lease We evaluate assets under operating lease or assets held for sale or re-lease for impairment when the expected undiscounted cash flow from the asset is less than its carrying value. We use various assumptions when determining the expected undiscounted cash flow including our intentions for how long we will

 

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hold an asset subject to operating lease before we sell the asset, 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 $6 million for the year ended December 31, 2007.

 

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

 

Allowance for losses on customer financing receivables The allowance for losses on receivables (valuation provision) is used to provide for potential impairment of receivables on the Consolidated Statements of Financial Position. The balance represents an estimate of probable but unconfirmed losses in the receivables portfolio. The estimate is based on various qualitative and quantitative factors, including historical loss experience, collateral values, and results of individual credit and collectibility reviews. The adequacy of the allowance is assessed quarterly.

 

Two of the major factors influencing the level of our allowance are customer credit ratings and collateral values. If each customer’s credit rating were increased or decreased by one major rating category at December 31, 2007, the allowance would have decreased by $22 million or increased by $49 million. If the collateral values were 10% lower at December 31, 2007, the allowance would have increased by $27 million.

 

Lease residual values Equipment under operating leases is carried at cost less accumulated depreciation and is depreciated to estimated residual value using the straight-line method over the 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. If the estimated residual values declined 5% at December 31, 2007, this would result in a future cumulative pre-tax earnings impact of $105 million recognized over the remaining depreciable periods, of which $10 million would be recognized in 2008.

 

Goodwill and indefinite-lived intangible impairments

 

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

 

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

 

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

 

Indefinite-lived intangibles consist of 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 result in an impairment charge of approximately $11 million.

 

Postretirement plans

 

We have defined benefit pension plans covering substantially all our employees. 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, the most significant of which are the discount rate, the expected long-term rate of asset return, and medical trend rate (rate of growth for medical costs). Changes in assumptions can significantly affect our future annual expense. In addition, as result of our adoption of SFAS 158, differences between actual and expected returns on assets, changes in assumptions, and changes in plan provisions could significantly increase or decrease Shareholders’ Equity (net of taxes) at future measurement dates.

 

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

 

As of September 30, 2007 (in millions)

 

		Change in discount rate Increase 25 bps			Change in discount rate Decrease 25 bps
Pension plans		Dollars			Dollars
Projected benefit obligation (pensions)		(1,263	)		1,436
Net periodic pension cost		(145	)		155
Other postretirement benefit plans
Accumulated postretirement benefit obligation		(168	)		185
Net periodic postretirement benefit cost		(14	)		13

 

Pension expense is also sensitive to changes in the expected long-term rate of asset return. An increase or decrease of 25 basis points in the expected long-term rate of asset return would have increased or decreased 2007 pension income by approximately $114 million. Differences between the actual return on plan assets and the expected long term rate of return are reflected in Shareholders’ Equity (net of taxes) as of our annual measurement date.

 

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

 

As of September 30, 2007 (in millions)

 

		Change in medical trend rate Increase 100 bps		Change in medical trend rate Decrease 100 bps
Other postretirement benefit plans
Accumulated postretirement benefit obligation		621		(545	)
Net periodic postretirement benefit cost		121		(109	)

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

 

Interest rate risk

 

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

 

The principal source of BCC’s market risk relates to interest rate changes. This risk is managed by matching the profile of BCC’s liabilities with the profile of BCC’s assets. Exposure to mismatched risk is measured and managed with the use of interest rate derivatives. We do not use interest rate derivatives for speculative or trading purposes. Although many of the assets, liabilities and derivatives affected by a change in interest rates are not traded, if we had an immediate, one-time, 100 basis-point increase in market rates at December 31, 2007, we estimate that the tax-adjusted net fair value of these items would have decreased by $12 million compared to a decrease of $9 million at December 31, 2006.

 

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

 

Foreign currency exchange rate risk

 

We are subject to foreign currency exchange rate risk relating to receipts from customers and payments to suppliers in foreign currencies. We use foreign currency forward and option contracts to hedge the price risk associated with firmly committed and forecasted foreign denominated payments and receipts related to our ongoing business. Foreign currency contracts are sensitive to changes in foreign currency exchange rates. At December 31, 2007, a 10% unfavorable exchange rate movement in our portfolio of foreign currency contracts would have reduced our unrealized gains by $69 million. Consistent with the use of these contracts to neutralize the effect of exchange rate fluctuations, such unrealized losses or gains would be offset by corresponding gains or losses, respectively, in the remeasurement of the underlying transactions being hedged. When taken together, these forward currency contracts and the offsetting underlying commitments do not create material market risk.

 

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Item 8. Financial Statements and Supplemental Data

 

Consolidated Statements of Operations

 

(Dollars in millions except per share data)
Years Ended December 31,		2007				2006				2005
Sales of products		$	57,049			$	52,644			$	44,174
Sales of services			9,338				8,886				9,447
Total revenues			66,387				61,530				53,621
Cost of products			(45,375	)			(42,490	)			(36,858	)
Cost of services			(7,732	)			(7,594	)			(7,767	)
Boeing Capital Corporation interest expense			(295	)			(353	)			(359	)
Total costs and expenses			(53,402	)			(50,437	)			(44,984	)
			12,985				11,093				8,637
Income from operating investments, net			188				146				88
General and administrative expense			(3,531	)			(4,171	)			(4,228	)
Research and development expense, net of credits of $130, $160, and $611			(3,850	)			(3,257	)			(2,205	)
Gain/(loss) on dispositions/business shutdown, net			38				(226	)			520
Settlement with U.S. Department of Justice, net of accruals							(571	)
Earnings from operations			5,830				3,014				2,812
Other income, net			484				420				301
Interest and debt expense			(196	)			(240	)			(294	)
Earnings before income taxes			6,118				3,194				2,819
Income tax expense			(2,060	)			(988	)			(257	)
Net earnings from continuing operations			4,058				2,206				2,562
Net gain/(loss) on disposal of discontinued operations, net of taxes of $9, $5 and $(5)			16				9				(7	)
Cumulative effect of accounting change, net of taxes of $10											17
Net earnings		$	4,074			$	2,215			$	2,572
Basic earnings per share from continuing operations		$	5.36			$	2.88			$	3.26
Net gain/(loss) on disposal of discontinued operations, net of taxes			0.02				0.01				(0.02	)
Cumulative effect of accounting change, net of taxes											0.03
Basic earnings per share		$	5.38			$	2.89			$	3.27
Diluted earnings per share from continuing operations		$	5.26			$	2.84			$	3.19
Net gain/(loss) on disposal of discontinued operations, net of taxes			0.02				0.01				(0.01	)
Cumulative effect of accounting change, net of taxes											0.02
Diluted earnings per share		$	5.28			$	2.85			$	3.20

 

See notes to consolidated financial statements on pages 53 – 107.

 

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Consolidated Statements of Financial Position

 

(Dollars in millions except per share data)
December 31,		2007				2006
Assets
Cash and cash equivalents		$	7,042			$	6,118
Short-term investments			2,266				268
Accounts receivable, net			5,740				5,285
Current portion of customer financing, net			328				370
Deferred income taxes			2,341				2,837
Inventories, net of advances and progress billings			9,563				8,105
Total current assets			27,280				22,983
Customer financing, net			6,777				8,520
Property, plant and equipment, net			8,265				7,675
Goodwill			3,081				3,047
Other acquired intangibles, net			2,093				1,698
Deferred income taxes			197				1,051
Investments			4,111				4,085
Pension plan assets, net			5,924				1,806
Other assets, net of accumulated amortization of $385 and $272			1,258				929
		$	58,986			$	51,794
Liabilities and Shareholders’ Equity
Accounts payable and other liabilities		$	16,676			$	16,201
Advances and billings in excess of related costs			13,847				11,449
Income taxes payable			253				670
Short-term debt and current portion of long-term debt			762				1,381
Total current liabilities			31,538				29,701
Deferred income taxes			1,190
Accrued retiree health care			7,007				7,671
Accrued pension plan liability, net			1,155				1,135
Non-current income taxes payable			1,121
Other long-term liabilities			516				391
Long-term debt			7,455				8,157
Shareholders’ equity:
Common shares issued, par value $5.00 – 1,012,261,159 and 1,012,261,159 shares			5,061				5,061
Additional paid-in capital			4,757				4,655
Treasury shares, at cost			(14,842	)			(12,459	)
Retained earnings			21,376				18,453
Accumulated other comprehensive loss			(4,596	)			(8,217	)
ShareValue Trust shares			(2,752	)			(2,754	)
Total shareholders’ equity			9,004				4,739
		$	58,986			$	51,794

 

See notes to consolidated financial statements on pages 53 – 107.

 

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Consolidated Statements of Cash Flows

 

(Dollars in millions)
Years ended December 31,		2007				2006				2005
Cash flows – operating activities:
Net earnings		$	4,074			$	2,215			$	2,572
Adjustments to reconcile net earnings to net cash provided by operating activities:
Non-cash items –
Share-based plans expense			287				743				1,036
Depreciation			1,334				1,445				1,412
Amortization of other acquired intangibles			152				100				91
Amortization of debt discount/premium and issuance costs			(1	)			14				23
Pension expense			1,082				746				1,225
Investment/asset impairment charges, net			51				118				83
Customer financing valuation (benefit)/provision			(60	)			32				73
(Gain)/loss on disposal of discontinued operations			(25	)			(14	)			12
(Gain)/loss on dispositions/business shutdown, net			(38	)			226				(520	)
Other charges and credits, net			197				82				129
Excess tax benefits from share-based payment arrangements			(144	)			(395	)			(70	)
Changes in assets and liabilities –
Accounts receivable			(392	)			(244	)			(592	)
Inventories, net of advances and progress billings			(1,558	)			444				(1,965	)
Accounts payable and other liabilities			928				(744	)			963
Advances and billings in excess of related costs			2,369				1,739				3,562
Income taxes receivable, payable and deferred			1,290				933				628
Other long-term liabilities			71				(62	)			(476	)
Pension contributions			(580	)			(522	)			(1,862	)
Accrued retiree health care			(664	)			114				30
Customer financing, net			1,458				718				589
Other			(247	)			(189	)			57
Net cash provided by operating activities			9,584				7,499				7,000
Cash flows – investing activities:
Property, plant and equipment additions			(1,731	)			(1,681	)			(1,547	)
Property, plant and equipment reductions			59				225				51
Acquisitions, net of cash acquired			(75	)			(1,854	)			(172	)
Proceeds from dispositions of discontinued operations											33
Proceeds from dispositions							123				1,676
Contributions to investments			(5,710	)			(2,815	)			(2,866	)
Proceeds from investments			3,817				2,850				2,725
Other			(182	)			(34	)			2
Net cash used by investing activities			(3,822	)			(3,186	)			(98	)
Cash flows – financing activities:
New borrowings			40				1
Debt repayments			(1,406	)			(1,681	)			(1,378	)
Stock options exercised, other			209				294				348
Excess tax benefits from share-based payment arrangements			144				395				70
Common shares repurchased			(2,775	)			(1,698	)			(2,877	)
Dividends paid			(1,096	)			(956	)			(820	)
Net cash used by financing activities			(4,884	)			(3,645	)			(4,657	)
Effect of exchange rate changes on cash and cash equivalents			46				38				(37	)
Net increase in cash and cash equivalents			924				706				2,208
Cash and cash equivalents at beginning of year			6,118				5,412				3,204
Cash and cash equivalents at end of year		$	7,042			$	6,118			$	5,412

 

See notes to consolidated financial statements on pages 53 – 107.

 

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Consolidated Statement of Shareholders’ Equity

 

(Dollars in millions except per share data)		Common Stock			Additional Paid-In Capital				Treasury Stock				ShareValue Trust				Retained Earnings				Accumulated Other Comprehensive Loss				Total
Balance January 1, 2005		$	5,059		$	3,420			($	8,810	)		($	2,023	)		$	15,565			($	1,925	)		$	11,286
Net earnings																		2,572								2,572
Unrealized loss of certain investments, net of tax of $8																						(12	)			(12	)
Reclassification adjustment for losses realized in net earnings, net of taxes of $(15)																						21				21
Minimum pension liability adjustment, net of tax of $(45)																						167				167
Currency translation adjustment																						(29	)			(29	)
Comprehensive income																										2,719
Restricted stock compensation and reclassification of deferred compensation						3																				3
Share-based compensation						720																				720
ShareValue Trust market value adjustment						773								(773	)
Tax benefit related to share-based plans						35																				35
Excess tax pools						63																				63
Treasury shares issued for share-based plans, net						(666	)			612																(54	)
Changes in capital stock			2			23																				25
Treasury shares repurchased										(2,877	)															(2,877	)
Cash dividends declared ($1.05 per share)																		(861	)							(861	)
Balance December 31, 2005		$	5,061		$	4,371			($	11,075	)		($	2,796	)		$	17,276			($	1,778	)		$	11,059
Net earnings																		2,215								2,215
Unrealized gain on derivative instruments, net of tax of $(16)																						23				23
Unrealized gain on certain investments, net of tax of $(7)																						13				13
Reclassification adjustment for gains realized in net earnings, net of tax of $23																						(39	)			(39	)
Minimum pension liability adjustment, net of tax of $(1,116)																						1,733				1,733
Currency translation adjustment																						73				73
Comprehensive income																										4,018
SFAS 158 transition amount, net of tax of $5,195																						(8,242	)			(8,242	)
Share-based compensation						487																				487
ShareValue Trust activity						(20	)							(259	)											(279	)
Tax benefit related to share-based plans						36																				36
Excess tax pools						325																				325
Treasury shares issued for stock options exercised, net						(51	)			345																294
Treasury shares issued for other share-based plans, net						(493	)			270																(223	)
Treasury shares repurchased										(1,698	)															(1,698	)
Treasury shares transfer										(301	)			301
Cash dividends declared ($1.25 per share)																		(991	)							(991	)
Dividends related to Performance Share payout																		(47	)							(47	)
Balance December 31, 2006		$	5,061		$	4,655			($	12,459	)		($	2,754	)		$	18,453			($	8,217	)		$	4,739
Net earnings																		4,074								4,074
Unrealized gain on derivative instruments, net of tax of $(58)																						97				97
Unrealized gain on certain investments, net of tax of $(11)																						17				17
Reclassification adjustment for gains realized in net earnings, net of tax of $13																						(21	)			(21	)
Currency translation adjustment																						87				87
Postretirement liability adjustment, net of tax of $(1,948)																						3,441				3,441
Comprehensive income																										7,695
Share-based compensation						287																				287
ShareValue Trust activity						(2	)							2
Tax benefit related to share-based plans						18																				18
Excess tax pools						85																				85
Treasury shares issued for stock options exercised, net						(32	)			241																209
Treasury shares issued for other share-based plans, net						(254	)			151																(103	)
Treasury shares repurchased										(2,775	)															(2,775	)
Cash dividends declared ($1.45 per share)																		(1,129	)							(1,129	)
Dividends related to Performance Share payout																		(11	)							(11	)
FIN 48 transition amount																		(11	)							(11	)
Balance December 31, 2007		$	5,061		$	4,757			($	14,842	)		($	2,752	)		$	21,376			($	4,596	)		$	9,004

 

See notes to consolidated financial statements on pages 53 – 107.

 

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The Boeing Company and Subsidiaries

Notes to Consolidated Financial Statements

Summary of Business Segment Data

 

(Dollars in millions)
Years ended December 31,		2007				2006				2005
Revenues:
Commercial Airplanes		$	33,386			$	28,465			$	21,365
Integrated Defense Systems:
Precision Engagement and Mobility Systems			13,685				14,107				13,308
Network and Space Systems			11,696				11,941				12,221
Support Systems			6,699				6,391				5,577
Total Integrated Defense Systems			32,080				32,439				31,106
Boeing Capital Corporation			815				1,025				966
Other			280				299				657
Accounting differences/eliminations			(174	)			(698	)			(473	)
Total revenues		$	66,387			$	61,530			$	53,621
Earnings from operations:
Commercial Airplanes		$	3,584			$	2,733			$	1,431
Integrated Defense Systems:
Precision Engagement and Mobility Systems			1,629				1,208				1,720
Network and Space Systems			891				952				1,395
Support Systems			920				872				804
Total Integrated Defense Systems			3,440				3,032				3,919
Boeing Capital Corporation			234				291				232
Other			(243	)			(738	)			(363	)
Unallocated expense			(1,185	)			(1,733	)			(2,407	)
Settlement with U.S. Department of Justice, net of accruals							(571	)
Earnings from operations			5,830				3,014				2,812
Other income, net			484				420				301
Interest and debt expense			(196	)			(240	)			(294	)
Earnings before income taxes			6,118				3,194				2,819
Income tax expense			(2,060	)			(988	)			(257	)
Net earnings from continuing operations			4,058				2,206				2,562
Net gain/(loss) on disposal of discontinued operations, net of taxes of $9, $5, and ($5)			16				9				(7	)
Cumulative effect of accounting change, net of taxes of $10											17
Net earnings		$	4,074			$	2,215			$	2,572

 

This information is an integral part of the Notes to consolidated financial statements. See Note 22 for further segment results.

 

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THE BOEING COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2007, 2006, 2005

(Dollars in millions except per share data)

 

Note 1 – Summary of Significant Accounting Policies

 

Principles of consolidation

 

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

 

Use of estimates

 

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

 

Operating cycle

 

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

 

Revenue and related cost recognition

 

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

 

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

 

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

 

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

 

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

 

Concession sharing arrangements We account for sales concessions to our customers in consideration of their purchase of products and services as a reduction to revenue (sales concessions) when the related products and services are delivered. The sales concessions incurred may be partially reimbursed by certain suppliers in accordance with concession sharing arrangements. We record these reimbursements, which are presumed to represent reductions in the price of the vendor’s products or services, as a reduction in Cost of products.

 

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

 

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

 

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

 

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

 

For operating leases, revenue on leased aircraft and equipment is recorded on a straight-line basis over the term of the lease. Operating lease assets, included in Customer financing, are recorded at cost and depreciated over the period that we project we will hold the asset to an estimated residual

 

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value, using the straight-line method. Prepayments received on operating lease contracts are classified as Deferred lease income on the Consolidated Statements of Financial Position. We periodically review our estimates of residual value and recognize forecasted changes by prospectively adjusting depreciation expense.

 

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

 

Reinsurance revenue Our wholly-owned insurance subsidiary, Astro Ltd., participates in a reinsurance pool for workers’ compensation. The member agreements and practices of the reinsurance pool minimize any participating members’ individual risk. Reinsurance revenues were $84, $84, and $101 during 2007, 2006, and 2005 respectively. Reinsurance costs related to premiums and claims paid to the reinsurance pool were $93, $91, and $115 during 2007, 2006, and 2005 respectively. Revenues and costs are presented net in Cost of services in the Consolidated Statements of Operations.

 

Fleet support

 

We provide the operators of all our commercial airplane models assistance and services to facilitate efficient and safe aircraft operation. Collectively known as fleet support services, these activities and services include flight and maintenance training, field service support, engineering services, and technical data and documents. Fleet support activity begins prior to aircraft delivery as the customer receives training, manuals, and technical consulting support, and continues throughout the operational life of the aircraft. Services provided after delivery include field service support, consulting on maintenance, repair, and operational issues brought forth by the customer or regulators, updating manuals and engineering data, and the issuance of service bulletins that impact the entire model’s fleet. Field service support involves our personnel located at customer facilities providing and coordinating fleet support activities and requests. The costs for fleet support are expensed as incurred as Cost of services.

 

Research and development

 

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

 

We have established cost sharing arrangements with some suppliers for the 787 program, which have enhanced our internal development capabilities and have offset a substantial portion of the financial risk of developing this aircraft. Our cost sharing arrangements explicitly state that the supplier contributions are for reimbursements of costs we incur for experimentation, basic design, and testing activities during the development of the 787. In each arrangement, we retain substantial rights to the 787 part or component covered by the arrangement. The amounts received from these cost sharing arrangements are recorded as a reduction to research and development expenses since we have no obligation to refund any amounts received per the arrangements regardless of the outcome of the development efforts. Specifically, under the terms of each agreement, payments received from suppliers for their share of the costs are typically based on milestones and are recognized as earned

 

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when we achieve the milestone events and no ongoing obligation on our part exists. In the event we receive a milestone payment prior to the completion of the milestone, the amount is classified in Accounts payable and other liabilities until earned.

 

Share-based compensation

 

Our primary types of share-based compensation consist of Performance Shares, ShareValue Trust distributions, stock options, and other stock unit awards. In 2005, we adopted the provisions of SFAS No. 123 (Revised 2004), Share-Based Payment (SFAS No. 123R) using the modified prospective method.

 

Income taxes

 

Provisions for federal, state, and non-U.S. income taxes are calculated on reported Earnings before income taxes based on current tax law and also include, in the current period, the cumulative effect of any changes in tax rates from those used previously in determining deferred tax assets and liabilities. Such provisions differ from the amounts currently receivable or payable because certain items of income and expense are recognized in different time periods for financial reporting purposes than for income tax purposes. Significant judgment is required in determining income tax provisions and evaluating tax positions.

 

Effective January 1, 2007, we adopted Financial Accounting Standards Board (FASB) Interpretation No. (FIN) 48, Accounting for Uncertainty in Income Taxes (FIN 48), which requires a more-likely-than-not threshold for financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. We record a liability for the difference between the benefit recognized and measured pursuant to FIN 48 and the tax position taken or expected to be taken on our tax return. To the extent that our assessment of such tax positions changes, the change in estimate is recorded in the period in which the determination is made. Prior to 2007, we established contingencies for income tax when, despite the belief that our tax positions were fully supportable, we believed that it was probable that our positions would be challenged and possibly disallowed by various authorities. The consolidated tax provision and related accruals included the impact of such reasonably estimable losses and related interest and penalties as deemed appropriate.

 

With the adoption of FIN 48, we also began reporting tax-related interest and penalties as a component of Income tax expense. Prior to 2007, income tax-related interest income was classified as Other income, net, whereas, tax-related interest expense and penalties were reported as a component of Income tax expense.

 

Postretirement plans

 

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

 

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Effective December 31, 2006, we adopted SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106 and 132(R) (SFAS No. 158) which requires that the Consolidated Statements of Financial Position reflect the funded status of the pension and postretirement plans.

 

Postemployment plans

 

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

 

Environmental remediation

 

We are subject to federal and state requirements for protection of the environment, including those for discharge of hazardous materials and remediation of contaminated sites. We routinely assess, based on in-depth studies, expert analyses and legal reviews, our contingencies, obligations, and commitments for remediation of contaminated sites, including assessments of ranges and probabilities of recoveries from other responsible parties who have and have not agreed to a settlement and of recoveries from insurance carriers. Our policy is to accrue and charge to current expense identified exposures related to environmental remediation sites based on our best estimate within a range of potential exposure for investigation, cleanup, and monitoring costs to be incurred. Estimated remediation costs are not discounted to present value as the timing of payments cannot be reasonably estimated. We may be able to recover a portion of the remediation costs from insurers or other third-parties; such recoveries are recorded when realization of the claim for recovery is deemed probable.

 

Cash and cash equivalents

 

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

 

Inventories

 

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

 

Because of the higher unit production costs experienced at the beginning of a new or derivative commercial airplane program (known as the learning curve effect), the actual costs incurred for production of the early units in the program may exceed the amount reported as cost of sales for those units. In addition, the use of a total program gross profit rate to delivered units may result in costs

 

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assigned to delivered units in a reporting period being less than the actual cost of those units. The excess actual costs incurred over the amount reported as cost of sales is disclosed as deferred production costs, which are included in inventory along with unamortized tooling costs.

 

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

 

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

 

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

 

Precontract costs

 

We may, from time to time, incur costs to begin fulfilling the statement of work under a specific anticipated contract that we are still negotiating with a customer. If we determine it is probable that we will be awarded the specific anticipated contract, then we capitalize the precontract costs we incur, excluding any start-up costs which are expensed as incurred. Capitalized precontract costs of $27 and $40 at December 31, 2007 and 2006, are included in Inventories, net of advances and progress billings, in the accompanying Consolidated Statements of Financial Position.

 

Property, plant and equipment

 

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

 

We review long-lived assets, which includes property, plant and equipment, for impairment in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS No. 144). Long-lived assets held for sale are stated at the lower of cost or fair value less cost to

 

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sell. Long-lived assets held for use are subject to an impairment assessment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If the carrying value is no longer recoverable based upon the undiscounted future cash flows of the asset, the amount of the impairment is the difference between the carrying amount and the fair value of the asset.

 

Asset retirement obligations

 

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

 

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

 

Goodwill and other acquired intangibles

 

Goodwill and other acquired intangible assets with indefinite lives are not amortized, but are tested for impairment annually and when an event occurs or circumstances change such that it is reasonably possible that impairment may exist. Our annual testing date is April 1.

 

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

 

Indefinite-lived intangibles consist of 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.

 

Our finite-lived acquired intangible assets are amortized on a straight-line basis over their estimated useful lives as follows: developed technology, 5 to 12 years; product know-how, 30 years; customer base, 12 to 15 years; distribution rights, 6 to 30 years; and other, 2 to 17 years. In accordance with SFAS No. 144, we evaluate the potential impairment of finite-lived acquired intangible assets when appropriate. If the carrying value is no longer recoverable based upon the undiscounted future cash flows of the asset, the amount of the impairment is the difference between the carrying amount and the fair value of the asset.

 

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Investments

 

We classify investment securities as either held-to-maturity or available-for-sale. Held-to-maturity securities include commercial paper and are carried at amortized cost.

 

Available-for-sale securities include marketable debt and equity securities and Enhanced Equipment Trust Certificates (EETCs) and are recorded at their fair values, with unrealized gains and losses reported as part of Accumulated other comprehensive loss on the Consolidated Statements of Financial Position. Realized gains and losses on marketable securities are recognized based on the cost of securities using the first-in, first-out method. Realized gains and losses on all other available-for-sale securities are recognized based on specific identification.

 

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

 

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

 

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

 

We classify investment income and loss on our Consolidated Statements of Operations based on whether the investment is operating or non-operating in nature. Operating investments align strategically and are integrated with our operations. Earnings from operating investments, including our share of income or loss from equity method investments, dividend income from certain cost method investments, and any gain/loss on the disposition of these investments, are recorded in Income from operating investments, net. Non-operating investments are those we hold for non-strategic purposes. Earnings from non-operating investments, including interest and dividends on marketable securities, are recorded in Other income, net.

 

Derivatives

 

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

 

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Aircraft valuation

 

Used aircraft under trade-in commitments and aircraft under repurchase commitments In conjunction with signing a definitive agreement for the sale of new aircraft (Sale Aircraft), we have entered into specified-price trade-in commitments with certain customers that give them the right to trade in used aircraft upon the purchase of Sale Aircraft. Additionally, we have entered into contingent repurchase commitments with certain customers wherein we agree to repurchase the Sale Aircraft at a specified price, generally ten years after delivery of the Sale Aircraft. Our repurchase of the Sale Aircraft is contingent upon a future, mutually acceptable agreement for the sale of additional new aircraft. If we execute an agreement for the sale of additional new aircraft, and if the customer exercises its right to sell the Sale Aircraft to us, a contingent repurchase commitment would become a trade-in commitment. Our historical experience is that no contingent repurchase agreements have become trade-in commitments.

 

All trade-in commitments at December 31, 2007 and 2006 are solely attributable to Sale Aircraft and did not originate from contingent repurchase agreements. Exposure related to trade-in commitments may take the form of:

 

(1)

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

 

(2)

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

 

The fair value of trade-in aircraft is determined using aircraft specific data such as model, age and condition, market conditions for specific aircraft and similar models, and multiple valuation sources. This process uses our assessment of the market for each trade-in aircraft, which in most instances begins years before the return of the aircraft. There are several possible markets in which we continually pursue opportunities to place used aircraft. These markets include, but are not limited to, the resale market, which could potentially include the cost of long-term storage; the leasing market, with the potential for refurbishment costs to meet the leasing customer’s requirements; or the scrap market. Trade-in aircraft valuation varies significantly depending on which market we determine is most likely for each aircraft. On a quarterly basis, we update our valuation analysis based on the actual activities associated with placing each aircraft into a market. This quarterly valuation process yields results that are typically lower than residual value estimates by independent sources and tends to more accurately reflect results upon the actual placement of the aircraft.

 

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

 

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

 

We assess the fair value of the assets we own, including equipment under operating leases, assets held for sale or re-lease, and collateral underlying receivables, to determine if their fair values are less

 

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than the related assets’ carrying values. Differences between carrying values and fair values of finance leases and notes and other receivables, as determined by collateral value, are considered in determining the allowance for losses on receivables.

 

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

 

Impairment review for assets under operating leases and held for sale or re-lease We evaluate assets under operating lease or assets held for sale or re-lease for impairment when the expected undiscounted cash flow from the asset is less than the carrying value. We use various assumptions when determining the expected undiscounted cash flow including our intentions for how long we will hold an asset subject to operating lease before it is sold, 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. We state assets held for sale at the lower of carrying value or fair value less costs to sell.

 

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

 

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

 

We determine a receivable is impaired when, based on current information and events, it is probable that we will be unable to collect amounts due according to the original contractual terms of the receivable agreement, without regard to any subsequent restructurings. Factors considered in assessing collectibility include, but are not limited to, a customer’s extended delinquency, requests for restructuring and filings for bankruptcy. We determine a specific impairment allowance based on the difference between the carrying value of the receivable and the estimated fair value of the related collateral.

 

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

 

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

 

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

 

Supplier Penalties

 

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

 

Guarantees

 

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

 

Note 2 – Goodwill and Acquired Intangibles

 

Changes in the carrying amount of goodwill by reportable segment for the years ended December 31, 2007, 2006 and 2005 were as follows:

 

		Commercial Airplanes				Precision Engagement and Mobility Systems				Network and Space Systems				Support Systems				Total
Balance at January 1, 2005		$	282			$	616			$	924			$	126			$	1,948
Goodwill Adjustments			21				(13	)			(18	)			11				1
Divestitures			(23	)							(2	)							(25	)
Balance at December 31, 2005		$	280			$	603			$	904			$	137			$	1,924
Aviall acquisition 1			1,014												41				1,055
Other 2			71								(3	)							68
Balance at December 31, 2006		$	1,365			$	603			$	901			$	178			$	3,047
Goodwill Adjustments			(25	)											(1	)			(26	)
Acquisition 3			60																60
Balance at December 31, 2007		$	1,400			$	603			$	901			$	177			$	3,081

 

1

On September 20, 2006, we acquired all of the outstanding shares of Aviall, Inc. (Aviall) for $1,780. The acquisition of Aviall was accounted for under the purchase method of accounting. The purchase price was allocated to the net assets acquired based on their fair values and finalized in the fourth quarter of 2006.

2

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

 

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3

The increase in goodwill is primarily the result of an acquisition in the first quarter 2007. The purchase price allocation for this acquisition was finalized in the fourth quarter of 2007.

 

As of December 31, 2007 and 2006, we had indefinite-lived intangible assets with carrying amounts of $499 relating to tradenames.

 

Amortization expense for acquired finite-lived intangible assets for the years ended December 31, 2007 and 2006 was $152 and $100. Estimated amortization expense for the five succeeding years are as follows: 2008 – $209; 2009 – $207; 2010 – $183; 2011 – $134 and 2012 – $124.

 

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

 

		2007						2006
		Gross Carrying Amount			Accumulated Amortization			Gross Carrying Amount			Accumulated Amortization
Developed technology		$	640		$	432		$	615		$	369
Product know-how			308			74			308			64
Customer base			325			77			307			51
Distribution rights			796			40			295			8
Other			249			101			241			75
		$	2,318		$	724		$	1,766		$	567

 

Acquired finite-lived intangibles of $342 remain unpaid as of December 31, 2007.

 

Note 3 – Earnings Per Share

 

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

 

		2007		2006		2005
Weighted-average shares outstanding		750.5		760.5		779.4
Participating securities		8.8		10.5		9.1
Basic weighted-average shares outstanding		759.3		771.0		788.5
Diluted potential common shares		13.2		16.6		14.4
Diluted weighted-average shares outstanding		772.5		787.6		802.9

 

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

 

		2007			2006			2005
Net earnings		$	4,074		$	2,215		$	2,572
Expense related to diluted shares			2			27
Total numerator		$	4,076		$	2,242		$	2,572

 

Expense related to diluted shares in the amount of $2 and $27 in 2007 and 2006 represented mark-to-market adjustment of vested performance shares to employees terminated as of December 31, 2005.

 

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

 

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

 

		2007		2006		2005
Stock options						0.2
Stock units				0.1
Performance Shares		0.7		4.0		24.9
Performance Awards		3.0		1.4
ShareValue Trust		25.8		24.6		33.9

 

Note 4 – Income Taxes

 

The components of earnings before income taxes were:

 

Years ended December 31,		2007			2006			2005
U.S.		$	5,901		$	3,067		$	2,605
Non-U.S.			217			127			214
		$	6,118		$	3,194		$	2,819

 

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

 

Years ended December 31,		2007				2006				2005
Current tax expense
U.S. federal		$	1,260			$	193			$	(276	)
Non-U.S.			139				35				58
U.S. state			164				(58	)			(86	)
			1,563				170				(304	)
Deferred tax expense
U.S. federal			487				750				547
Non-U.S.			(6	)			(6	)			(120	)
U.S. state			16				74				134
			497				818				561
Total income tax expense		$	2,060			$	988			$	257

 

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

 

Years ended December 31,		2007			2006			2005
U.S. federal statutory tax		35.0	%		35.0	%		35.0	%
Global Settlement with U.S. Department of Justice					6.7
Foreign Sales Corporation/Extraterritorial Income tax benefit					(5.8	)		(5.6	)
Research benefit		(2.4	)		(0.7	)		(1.2	)
Federal audit settlement					(1.5	)		(13.1	)
State income tax provision, net of effect on U.S. federal tax		1.6			0.4			1.1
Change in valuation allowances		0.3						(3.2	)
Other provision adjustments		(0.8	)		(3.2	)		(3.9	)
Income tax expense		33.7	%		30.9	%		9.1	%

 

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

 

		2007				2006
Retiree health care accruals		$	2,581			$	3,257
Inventory and long-term contract methods of income recognition			209				640
Other employee benefits accruals			1,476				1,473
In-process research and development related to acquisitions			108				124
Net operating loss, credit, and charitable contribution carryovers (net of valuation allowance of $20 and $2)			275				319
Pension asset			(1,648	)			(397	)
Customer and commercial financing			(1,587	)			(1,517	)
Unremitted earnings of non-U.S. subsidiaries			(48	)			(48	)
Other net unrealized losses			(18	)			37
Net deferred tax assets1		$	1,348			$	3,888

 

1

Of the deferred tax asset for net operating loss and credit carryovers, $151 expires in years ending from December 31, 2008 through December 31, 2027 and $125 may be carried over indefinitely.

 

Net deferred tax assets at December 31 were as follows:

 

		2007				2006
Deferred tax assets		$	9,640			$	12,174
Deferred tax liabilities			(8,272	)			(8,284	)
Valuation allowance			(20	)			(2	)
Net deferred tax assets		$	1,348			$	3,888

 

We recorded net deferred tax liabilities of $11 and $171 in 2007 and 2006, which were primarily due to acquisitions.

 

As required under SFAS 123R, deferred tax liabilities of $79 and $306 were reclassified to Additional paid in capital in 2007 and 2006. This represents the tax effect of the net excess tax pool created during 2007 and 2006 due to share awards paid with a fair market value in excess of the book accrual for those awards.

 

Included in the net deferred tax assets at December 31, 2007 and 2006 are deferred tax assets in the amounts of $3,169 and $5,240 related to other comprehensive income.

 

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Net income tax payments/(refunds) were $711, $28 and ($344) in 2007, 2006 and 2005, respectively.

 

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

 

FASB Interpretation No. 48

 

Effective January 1, 2007, we adopted FIN 48 which prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on derecognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income taxes in interim periods and income tax disclosures. The cumulative effects of applying this interpretation have been recorded as a decrease of $11 to Retained earnings, an increase of $125 to Deferred income taxes and an increase of $136 to Income taxes payable as of January 1, 2007.

 

In conjunction with adoption of FIN 48, we classified uncertain tax positions as non-current income tax liabilities unless expected to be paid in one year. We also began reporting income tax-related interest income in Income tax expense in our Consolidated Statement of Operations. In prior periods, such interest income was reported in Other income. Within the Consolidated Statements of Operations, Other income included interest of $16 in 2006 and $100 in 2005 related to federal income tax settlements for prior years. Penalties and tax-related interest expense are reported as a component of Income tax expense. As of December 31 and January 1, 2007, the amount of accrued income tax-related interest and penalties included in the Consolidated Statement of Financial Position was as follows: interest of $143 and $63, and penalties of $17 and $1. The amounts of interest and penalties accrued during 2007 are $108 and $17 respectively.

 

We are subject to examination in the U.S. federal tax jurisdiction for the 1998-2007 tax years. We are also subject to examination in major state and foreign jurisdictions for the 2001-2007 tax years, for which no individually material unrecognized tax benefits exist. During the third quarter of 2007 we received an Internal Revenue Service (IRS) audit report for the 2002-2003 tax years and have filed an appeal. We have also filed appeals with the IRS for the 1998-2001 tax years. We believe appropriate provisions for all outstanding issues have been made for all jurisdictions and all open years.

 

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:

 

Unrecognized Tax Benefits – January 1, 2007		$	1,097
Gross increases – tax positions in prior periods			181
Gross decreases – tax positions in prior periods			(85	)
Gross increases – current-period tax positions			89
Lapse of statute of limitations			(10	)
Unrecognized Tax Benefits – December 31, 2007		$	1,272

 

As of December 31 and January 1, 2007, the total amount of unrecognized tax benefits was $1,272 and $1,097, of which $1,032 and $905 would affect the effective tax rate, if recognized. These amounts are primarily associated with U.S. federal tax issues such as the tax benefits from the Foreign Sales Corporation/Extraterritorial Income (FSC/ETI) tax rules, the amount of research and development tax

 

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credits claimed, U.S. taxation of foreign earnings, and valuation issues regarding charitable contributions claimed. Also included in these amounts are accruals for domestic state tax issues such as the allocation of income among various state tax jurisdictions and the amount of state tax credits claimed.

 

It is reasonably possible that within the next 12 months we and the IRS will resolve some of the matters presently under consideration at appeals for 1998-2003 which may increase or decrease unrecognized tax benefits for all open tax years. Settlement could increase earnings in an amount ranging from $0 to $130 based on current estimates. Audit outcomes and the timing of audit settlements are subject to significant uncertainty.

 

The Research and Development credit expired on December 31, 2007. The credit provided a 2.4% and a 0.7% reduction in the 2007 and 2006 effective tax rate. Congress is currently considering bills that will extend the credit. If the Research and Development credit is not legislatively enacted there could be an unfavorable impact on our 2008 effective income tax rate.

 

Note 5 – Accounts Receivable

 

Accounts receivable at December 31 consisted of the following:

 

		2007				2006
U.S. government contracts		$	2,838			$	2,667
Commercial customers			1,232				1,423
Other 1			1,742				1,278
Less valuation allowance			(72	)			(83	)
		$	5,740			$	5,285

 

1

Included $498 and $538 of reinsurance receivables held by Astro Ltd., a wholly owned subsidiary, which operates as a captive insurance company and $683 and $308 related to non-U.S. military contracts at December 31, 2007 and 2006.

 

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

 

		2007			2006
Unbillable
Current		$	825		$	830
Expected to be collected after one year			520			705
		$	1,345		$	1,535
Claims
Current		$	18		$	10
Expected to be collected after one year			128			84
		$	146		$	94

 

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

 

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Note 6 – Inventories

 

Inventories at December 31 consisted of the following:

 

		2007				2006
Long-term contracts in progress		$	13,159			$	12,329
Commercial aircraft programs			11,710				8,743
Commercial spare parts, used aircraft, general stock materials and other			3,401				2,888
			28,270				23,960
Less advances and progress billings			(18,707	)			(15,855	)
		$	9,563			$	8,105

 

Delta launch program inventories that will be sold at cost to United Launch Alliance L.L.C. (ULA) under an inventory supply agreement that terminates on March 31, 2021 are included in long-term contracts in progress inventories. At December 31, 2006, the inventory balance was $1,860. No sales have occurred through December 31, 2007. As part of its integration ULA is continuing to assess the future of the Delta II program. During the third quarter of 2007, ULA determined that certain Delta II inventory is not fully recoverable. As a result we recorded charges of $31 for non-recoverable Delta II inventory and $39 for our share of the loss recorded by ULA related to Delta II. Future decisions regarding the Delta II program could reduce our earnings by up to $100 (see Note 12).

 

As a normal course of our Commercial Airplanes segment production process, our inventory may include a small quantity of airplanes that are completed but unsold. As of December 31, 2007 and 2006, the value of completed but unsold aircraft in inventory was insignificant. Inventory balances included $234 subject to claims or other uncertainties relating to the A-12 program as of December 31, 2007 and 2006 (See Note 21).

 

Commercial aircraft program inventory includes amounts credited in cash or other consideration (early issued sales consideration), to airline customers totaling $1,355 and $1,375 as of December 31, 2007 and 2006.

 

Deferred production costs represent commercial aircraft programs production costs incurred on in-process and delivered units in excess of the estimated average cost of such units. As of December 31, 2007 and 2006, the balance of deferred production costs and unamortized tooling related to commercial aircraft programs, except the 777 program, was insignificant relative to the programs’ balance-to-go estimates. As of December 31, 2007 and 2006, all significant excess deferred production costs or unamortized tooling costs are recoverable from existing firm orders for the 777 program. The deferred production costs and unamortized tooling are summarized in the following table:

 

		2007			2006
Deferred production costs:
777 program		$	1,043		$	871
Unamortized tooling:
777 program			256			329

 

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Note 7 – Exit Activity and Divestitures

 

During August 2006, we decided that we would exit the Connexion by Boeing high speed broadband communications business. Our decision resulted in a pre-tax charge of $320, which has been recognized in Loss/(gain) on dispositions/business shutdown, net during 2006 as outlined below:

 

Contract termination costs1		$	142
Write-off of assets2			492
Early contract terminations3			(314	)
Total		$	320

 

1	Included termination fees associated with operating leases as well as supplier and customer costs

2	Primarily included write-off of capital lease assets

3	Primarily early terminations of capital lease obligations

 

As of December 31, 2006, $52 was recorded in Accounts payable and other liabilities related to contract termination costs, which was substantially paid out during 2007 to complete the business shutdown. The exit of the Connexion by Boeing business resulted in cash expenditures of $177 during 2006.

 

On February 28, 2005, we completed the stock sale of Electron Dynamic Devices Inc. (EDD) to L-3 Communications. EDD was a separate legal entity wholly owned by us. The corresponding net assets of the entity were $45 and a net pre-tax gain of $25 was recorded in the Network and Space Systems (N&SS) segment of IDS from the sale of the net assets. In addition, there was a related pre-tax loss of $68 recorded in Accounting differences/eliminations for net pension and other postretirement benefit curtailments and settlements. In 2006, a $15 gain was recorded for a subsequent purchase price adjustment on the sale.

 

On August 2, 2005, we completed the sale of the Rocketdyne Propulsion and Power (Rocketdyne) business to United Technologies Corporation for cash proceeds of approximately $700 under an asset purchase agreement. This divestiture includes assets and sites in California, Alabama, Mississippi, and Florida. The Rocketdyne business primarily develops and builds rocket engines and provides booster engines for the space shuttle and the Delta family as well as propulsion systems for missile defense systems. A net pre-tax gain of approximately $578 was recorded predominantly in the N&SS segment and a related pre-tax loss of $200 for estimated pension and postretirement curtailments and settlements was recorded in our Other segment.

 

On June 16, 2005, we completed the sale of substantially all of the assets at our Commercial Airplanes facilities in Wichita, Kansas and Tulsa and McAlester, Oklahoma under an asset purchase agreement to a new entity which was subsequently named Spirit Aerosystems, Inc. (Spirit). Transaction consideration given to us included cash of approximately $900, together with the transfer of certain liabilities and long-term supply agreements that provide us with ongoing cost savings. The consolidated net loss on this sale recorded in 2005 was $287, including pension and postretirement impacts. We recognized a loss of $103 in 2005 in the Consolidated Statement of Operations as Gain on dispositions, net, of which $68 was recognized by the Commercial Airplanes segment and $35 was recognized as Accounting differences/eliminations and Unallocated expense. The remaining loss of $184 related to estimated pension and postretirement curtailments and settlements, was recorded in our Other segment. In 2006, a $15 gain was recorded for a subsequent purchase price adjustment on the sale.

 

See Note 12 for discussion of the environmental indemnification provisions of these agreements.

 

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Note 8 – Customer Financing

 

Customer financing at December 31 consisted of the following:

 

		2007				2006
Aircraft financing
Notes receivable		$	770			$	1,790
Investment in sales-type/finance leases			2,676				2,914
Operating lease equipment, at cost, less accumulated depreciation of $1,024 and $913			3,601				4,159
Other equipment financing
Notes receivable			115				33
Operating lease equipment, at cost, less accumulated depreciation of $90 and $149			138				248
Less allowance for losses on receivables			(195	)			(254	)
		$	7,105			$	8,890

 

Interest rates on fixed-rate notes ranged from 5.50% to 10.33%, and interest rates on variable-rate notes ranged from 6.92% to 10.90%.

 

The components of investment in sales-type/finance leases at December 31 were as follows:

 

		2007				2006
Minimum lease payments receivable		$	3,814			$	4,475
Estimated residual value of leased assets			751				701
Unearned income			(1,889	)			(2,262	)
		$	2,676			$	2,914

 

Aircraft financing operating lease equipment primarily includes jet and commuter aircraft. At December 31, 2007 and 2006, aircraft financing operating lease equipment included $86 and $259 of equipment available for re-lease. At December 31, 2007 and 2006, we had firm lease commitments for $86 and $253 of this equipment.

 

When our Commercial Airplanes segment is unable to immediately sell used aircraft, it may place the aircraft under an operating lease. It may also finance the sale of new aircraft with a note receivable. The carrying amount of the Commercial Airplanes segment used aircraft under operating leases and aircraft sales financed with notes receivable included as a component of customer financing totaled $156 and $480 as of December 31, 2007 and 2006.

 

Impaired receivables and the allowance for losses on those receivables consisted of the following at December 31:

 

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		2007			2006