Space and Communications

Revenues

Space and Communications segment revenues were $11.0 billion in 2002, compared with $10.4 billion in 2001 and $8.0 billion in 2000. The segment remains broadly diversified. The contributors to 2002 Space and Communications segment revenues included five market segments: Integrated Battlespace, Missile Defense, Human Space Flight and Exploration, Launch and Satellite and Homeland Security. The increase in revenues from 2001 to 2002 was primarily due to increased activity in Missile Defense offset by decreases in Launch and Satellite due to continued market downturn. 2001 revenues were higher than 2000 revenues due primarily to increased activity on Integrated Battlespace programs and the acquisition of Boeing Satellite Systems (BSS) in October 2000.

Deliveries of production units were as follows:

Space and Communications segment revenues for 2003 are projected to be in the $12 billion range. The greatest growth is expected in the Integrated Battlespace market as Space and Communications has become the DoD’s leading industry partner in executing the military transformation with the capture of the Future Combat Systems program, Joint Tactical Radio System, and the Family of Advanced Beyond Line-of-Sight Terminals program. Missile Defense expects continued growth as the Missile Defense Agency continues its emphasis on the development of various missile defense capabilities.

Operating Earnings

Space and Communications segment operating earnings for 2002 were $357 million compared with $619 million in 2001 and $(243) million in 2000, and the related operating margins were 3.3%, 6.0% and (3.0)% for 2002, 2001 and 2000, respectively. The 2002 operating results include a $100 million pre-tax charge to write-down an equity investment in Teledesic, LLC. Also contributing to the 2002 decreased operating earnings was cost growth on Satellite programs and the continued downturn in the Launch and Commercial Satellite market. The 2000 operating results included a pre-tax charge of $505 million associated with the in-process research and development from the acquisition of the Hughes space and communications businesses and Autometric businesses, along with $78 million in costs associated with a Delta III demonstration launch in August 2000.

The 2002 segment operating margins were reduced from 2001 due to factory cost, schedule performance and a satellite contract termination in the commercial satellite business along with 737 AEW&C development cost growth. The reduced 2002 margins were offset by favorable commercial space contract actions, improved margins for Integrated Battlespace, and Ground-based Midcourse Defense program performance. The 2001 operating margins were improved over the 2000 operating margins primarily due to reduced new product development expenses associated with the Delta IV RS-68 engine as it completed developmental engine certification and transitioned to production. The Company projects that 2003 operating earnings will continue to be impacted by new program development expenses but to a lesser degree than in prior years, primarily due to the transition of the Delta IV launch vehicle into production.

In February 2002, Space and Communications undertook a reorganization of its commercial satellite manufacturing activities in response to poor performance compounded by unfavorable market conditions. The impact to earnings by Satellite program cost growth was partially offset by favorable contractual actions. The net impact to the year for BSS was a reduction in operating earnings of approximately $146 million. Progress has been made in implementing process improvements and program management best practices, however, factory problems that arise out of acceptance testing continue to impact existing contracts. As a result, completion schedules have slipped which has resulted in exposing the Company to the risk of contract Termination for Default (TFD) notification.

During the fourth quarter of 2002, the Company received a TFD notification on a commercial satellite contract that had an expected delivery beyond the contractual TFD date. The customer no longer required the satellite for their current business base. The Company is currently marketing the satellite, which was adjusted to the estimated net realizable value. Early in the first quarter of 2003, the Company passed the TFD dates for two commercial satellite contracts. Management believes a TFD situation for each of these contracts is not likely to result in a material financial impact due to continuing legal, production, and contractual efforts in work.

Certain launch and satellite contracts include provisions for replacement launch services or hardware if specified performance criteria are not met. The Company has historically purchased insurance to cover these obligations when allowed under the terms of the contract. Due to recent events, the current insurance market reflects unusually high premium rates and also suffers from a lack of capacity to handle all insurance requirements. Although the Company does not intend to do so, it may elect to forego the procurement of third-party insurance and, instead, retain such risks internally. Management believes the contract cost estimates have sufficient provisions to cover the expected value for these risks.