Management’s Discussion and Analysis

Management’s Discussion and Analysis

The technology will allow the production of end user aeronautical information with forward and backward date effectivity, and will allow the extraction of the information on a near real time basis. Furthermore, the technology will allow the creation of packages of aeronautical information, which can be tailored to individual customers worldwide. These acquired IPR&D projects were completed during 2001, with the full range and production of the technology anticipated in the first quarter of 2002. The completed technology can only be used for its specific and intended purpose and as such no alternative future uses exist. The valuation methodology was determined using the income approach, and a risk-adjusted discount rate of 15% was used to discount the project cash flow. During the year ended December 31, 2001, Jeppesen had completed all IPR&D projects for a total cost of $18 million.

Other acquisitions resulting in the recognition of IPR&D during 2000 using a similar income approach included Continental Graphics Corp. ($7 million IPR&D) and Autometric, Inc. ($5 million IPR&D).

Income Taxes

The 2001 effective income tax rate of 20.7% includes a one-time benefit of $343 million reflecting a settlement with the Internal Revenue Service relating to research credit claims on McDonnell Douglas Corporation fixed-price government contracts applicable to the 1986-1992 federal income tax returns. Absent this settlement, the effective tax rate for 2001 would be 30.3%, which varies from the federal statutory tax rate of 35%, principally due to Foreign Sales Corporation (FSC) and Extraterritorial Income (ETI) exclusion tax benefits of $222 million. Offsetting this benefit are state income taxes and the non-deductibility of certain goodwill, principally the goodwill acquired by the acquisition of the aerospace and defense units from Rockwell International Corporation in 1996.

The effective income tax rates of 29.0% for 2000 and 30.5% for 1999 also vary from the federal statutory tax rate principally due to FSC benefits of $291 million in 2000 and $230 million in 1999.

In February 2000, the World Trade Organization (WTO) Appellate Body upheld a panel decision that U.S. FSC tax provisions constituted a prohibited export subsidy. In response, in November 2000, the United States enacted legislation to repeal the FSC tax provisions, subject to transition rules, and enacted replacement legislation (the Extraterritorial Income Exclusion Act of 2000). The European Union objected to this ETI exclusion, and in November 2001 asked the WTO to authorize trade sanctions on a list of goods, including aircraft, produced in the United States. In January 2002, the Appellate Body of the WTO upheld a ruling that the United States had failed to withdraw the prohibited FSC export subsidy. The U.S. Government is currently reviewing its options in response to this decision. It is not possible to predict what impact, if any, this issue will have on future earnings pending final resolution of the challenge.

Acquisitions in 2000

On October 6, 2000, the Company acquired the Hughes Electronics Corporation (Hughes) space and communications and related businesses. The acquisition was accounted for under the purchase method, by which the purchase price was allocated to the net assets acquired based on preliminary estimates of their fair values. The original purchase price was $3,849 million, initial goodwill was valued at $740 million and the other intangible assets were valued at $631 million. During the period from acquisition to the third quarter of 2001, the Company completed its assessment of the net assets acquired and goodwill was increased to a balance of $2,166 million. Included in goodwill are certain claims submitted to Hughes for resolution as contractual purchase price contingencies. The Company anticipates finalizing the Hughes purchase price allocation during late 2002 or early 2003, at the conclusion of arbitration procedures related to these contingencies. Other adjustments were recorded to reflect finalization of fair value assessments for the net assets acquired and the impact of the Company’s accounting policies on acquired balances.

Other acquisitions in 2000 included Jeppesen Sanderson, Inc. for $1,524 million in cash, Continental Graphics Corp. for $183 million in cash, and Autometric, Inc. for $119 million in cash.

Labor Negotiations and Workforce Levels

As of December 31, 2001, the Company’s principal collective bargaining agreements were with the International Association of Machinists and Aerospace Workers (IAM), representing 24% of employees (current agreements expiring September and October 2002, and May 2004); the Society of Professional Engineering Employees in Aerospace (SPEEA), representing 14% of employees (current agreements expiring in December 2002 and February 2004); the United Automobile, Aerospace and Agricultural Implement Workers of America (UAW), representing 4% of employees (current agreements expiring September 2002, May 2003, and April 2004); and Southern California Professional Engineering Association (SCPEA), representing 2% of employees (current agreement expiring March 2005).

The Company’s workforce level was 188,000 at December 31, 2001.

1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, 15, 16, 17, 18, 19, 20