Backlog

Commercial Airplanes segment contractual firm backlog balances were $68.2 billion at December 31, 2002, $75.9 billion at December 31, 2001, and $89.8 billion at December 31, 2000. Contractual firm backlog for Commercial Airplanes segment excludes customers deemed by management to be high risk or in bankruptcy as of the reporting date. The contractual backlog decline reflects the impact that the economic downturn has had on the airline industry. The decline in backlog of $7.7 billion from December 31, 2001 to December 31, 2002, and $13.9 billion from December 31, 2000 and December 31, 2001, represents higher delivery volume on all airplane programs relative to new orders.

December 31, 2002, backlog does not include the anticipated order of 100 U.S. Air Force 767 tankers. This order is anticipated to become a firm contract during 2003.

Business Environment and Trends

Overview The worldwide market for commercial jet airplanes continues to be predominantly driven by long-term trends in airline passenger traffic. The principal factors underlying long-term traffic growth are sustained economic growth, both in developed and emerging countries, and political stability. Demand for the Company’s commercial airplanes is further influenced by airline industry profitability, world trade policies, government-to-government relations, environmental constraints imposed upon airplane operations, technological changes, and price and other competitive factors.

Airline industry environment Commercial aviation has been impacted by an economic downturn that began in 2001 and continued through 2002. In addition, the industry suffered a tremendous shock from the terrorist attacks of September 11, 2001. Air travel in most areas of the world has not recovered to the volume carried by the airlines in 2000, which is affecting profitability for many airlines. U.S. full service airlines have suffered the greatest losses. Holiday traffic in 2002 for the U.S. airlines showed an improvement and most carriers indicated better financial performance. However, this improvement was for only a short period of time and the major U.S. full service airlines reported significant losses for 2002. In contrast, low fare airlines in the U.S. and in Europe are reporting positive financial results and are growing. European network airlines are expected to show better results than their U.S. counterparts for the fiscal period ending in March of 2003. Traffic between Asia and Europe has rebounded to pre-September 11 levels. This trend combined with stronger traffic within the region is offsetting the slow growth over the Pacific permitting most Asian airlines to show profits.

Our timetable for industry recovery has been delayed. We presently see 2003 to be the year of recovery for world air travel; late 2003/early 2004 to be the year of airline profitability recovery; 2004 to be the year of airplane order recovery; and 2005 to be the year of delivery recovery. The major uncertainty that is curbing economic growth and a stronger and sooner rebound in the industry is the Iraqi situation — in terms of timing, scale of military engagement, effect on oil prices, and clarity of political resolution.

The Company’s 20-year forecast of the average long-term growth rate in passenger traffic is 4.9% annually, based on projected average worldwide annual economic real growth of 2.9%. Based on global economic growth projections over the long term, and taking into consideration an increasingly competitive environment, increasing utilization levels of the worldwide airplane fleet and requirements to replace older airplanes, the Company projected almost a $5 trillion market for new airplanes and services over the next 20 years. This is a long-term forecast; historically, while factors such as the Gulf War and ticket charges for security have had significant impact over the span of several years, they have not dramatically affected the longer term trends in the world economy, and therefore, the Company’s market outlook.

Airline deregulation Worldwide, the airline industry has experienced progressive deregulation of domestic markets and increasing liberalization of international markets. Twenty-five years ago virtually all air travel took place within a framework of domestic and international regulatory oversight. Since then, an increasing number of countries, most notably the United States, Australia, Japan and the countries in Western Europe, have eliminated restrictive regulations for domestic airline markets and promoted a more open-market climate for international services. These trends are expected to continue, but at varying rates in different parts of the world. At the end of the next decade, an estimated two-thirds of air travel will be in open markets. Liberalization of government regulations, together with increased airplane range capabilities, gives airlines greater freedom to pursue optimal fleet-mix strategies. This increased flexibility allows the airlines to accommodate traffic growth by selecting the best mix of flight frequencies and airplane size and capabilities for their route systems. In intercontinental markets, more liberal bilateral air service agreements provide an important stimulus to opening new city-pair markets, which favor increased flight frequency over capacity growth. In parallel with regulatory liberalization, improvements in airplane range performance will continue to allow airlines to expand the number of direct city-to-city routes, thus reducing the reliance on indirect routes through central hubs that require larger capacity airplanes.

Industry competitiveness The Company currently faces aggressive international competitors that are seeking to increase market share. This competitive factor was demonstrated by the decision of Airbus to introduce the A380, a proposed aircraft with passenger seating greater than the 747, to increase market share at the upper end of the large airplane market. This market environment has resulted in intense pressures on pricing and other competitive factors. The Company’s focus on improving processes and other cost reduction efforts is intended to enhance its ability to pursue pricing strategies that enable the Company to maintain leadership at satisfactory margins. Additionally, the Company’s extensive customer support services network for airlines throughout the world plays a key role in maintaining high customer satisfaction. As an example, on-line access is available to all airline customers for engineering drawings, parts lists, service bulletins and maintenance manuals.

The commercial jet aircraft market and the airline industry remain extremely competitive. Competitive pressures and increased lower-fare travel have combined to cause a long-term downward trend in passenger revenue yields worldwide (measured in real terms). Market liberalization within Europe has enabled low-cost airlines to enter the market. These airlines increase the downward pressure on airfares, similar to the competitive environment in the United States. Airfares between Asia and the United States are among the lowest yield (airfare divided by revenue passenger miles) of any in the world. These factors result in continued price pressure on the Company’s products. Major productivity gains are essential to ensure a favorable market position at acceptable profit margins.