Risk Factors

We generally make sales under purchase orders that are subject to cancellation, modification or rescheduling without significant penalties to our customers. 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. Since a significant portion of our backlog is related to orders from commercial airlines, further adverse developments in the commercial airline industry could cause customers to reschedule or terminate their contracts with us.

We are dependent on the availability of energy sources, such as electricity, at affordable prices. We are also 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 foreign companies. We are dependent upon the ability of our large number of suppliers and subcontractors to meet performance specifications, quality standards, and delivery schedules at anticipated costs, and their failure to do so would adversely affect production schedules and contract profitability, while jeopardizing our ability to fulfill commitments to our customers. We maintain an extensive qualification and performance surveillance system to control risk associated with such reliance on third parties.

We depend on a limited number of customers, including the U.S. Government and 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 has ended. The loss of the U.S. Government or any of the major commercial airlines as customers could significantly reduce our revenues and our opportunity to generate a profit. Several of the commercial airlines, including United Airlines and Hawaiian Holdings, Inc. have filed for bankruptcy protection.

Sales outside the U.S. (principally export sales from domestic operations) by geographic area are included in Note 23. Approximately 2% of total sales were derived from non-U.S. operations for the year ended December 31, 2003 and 1% for each year ended December 31, 2001 and 2002. Approximately 41% of our contractual backlog at December 31, 2003, was with non-U.S. customers. Sales outside the United States are influenced by U.S. Government foreign policy, international relationships, and trade policies of governments worldwide. Relative profitability is not significantly different from that experienced in the domestic market.

Consolidated Results of Operations and Financial Condition

We operate in six principal segments: Commercial Airplanes; Aircraft and Weapon Systems (A&WS), Network Systems, Support Systems, and Launch and Orbital Systems (L&OS) collectively Integrated Defense Systems (IDS); and Boeing Capital Corporation (BCC). All other activities fall within the Other segment, principally made up of Boeing Technology, Connexion by Boeing^SM and Air Traffic Management.

Our Commercial Airplanes operations principally involve development, production and marketing of commercial jet aircraft and providing related support services, principally to the commercial airline industry worldwide.

IDS operations principally involve research, development, production, modification and support of the following products and related systems: military aircraft, helicopters and missiles, space systems, missile defense systems, satellites and satellite launching vehicles, rocket engines, and information and battle management systems. Although some IDS products are contracted in the commercial environment, the primary customer is the U.S. Government.

BCC is primarily engaged in the financing of commercial and private aircraft and commercial equipment. However, on November 12, 2003, we announced that we will refocus BCC's strategic direction to concentrate on supporting the operations of our business units. On January 15, 2004, we also announced additional steps, consistent with our new strategy, including the evaluation of strategic alternatives related to BCC's commercial equipment finance group.

Boeing Technology is an advanced research and development organization focused on innovative technologies, improved processes and the creation of new products. Connexion by Boeing^SM provides two-way broadband data communications service for global travelers. Air Traffic Management develops new approaches to a global solution to address air traffic management issues. Financing activities other than those carried out by BCC are also included within the Other segment classification.

Consolidated Results of Operations

Revenues

Lower revenues in 2003 are primarily due to reduced deliveries of our commercial airplanes. The reduced deliveries are the result of the airline industry's reduced need for additional new aircraft. However, the overall decrease in commercial airplane revenues is partially offset by increased revenues driven by increased deliveries of Joint Direct Attack Munitions (JDAM); increased volume in homeland security, spares and maintenance, and proprietary programs; and the start up of Future Combat Systems. The lower revenues in 2002 compared to 2001 principally reflect decreased deliveries in the Commercial Airplanes segment, offset by growth in the IDS segment revenues.

Based on current schedules and plans, we project total 2004 revenues to be approximately $52 billion.

Operating Earnings

Lower operating earnings in 2003 reflect lower planned commercial airplane deliveries, charges related to the decision to end production of the 757 program, goodwill impairment charges, charges related to the satellite and launch businesses, lower pension income, and an increase in other expenses, as described below. We delivered 100 fewer commercial airplanes in 2003 compared to 2002, and recognized a $184 million charge associated with the decision to end production of the 757 program. We also recognized $913 million in goodwill charges as a result of a goodwill impairment analysis triggered by the reorganization of our Military Aircraft and Missile Systems and Space and Communications segments into IDS; $572 million recorded at IDS and $341 million recorded at the Commercial Airplanes segment. 2003 operating earnings were negatively impacted by a $1.1 billion charge related to the satellite and launch businesses. We experienced lower pension income due to declining interest rates and negative pension asset returns in 2001 and 2002, the impact of which is amortized into earnings in future periods. We also incurred a charge due to higher estimated cleanup costs, increased workers' compensation claims, and increased legal expense. These factors were partially offset by continued growth and strong operating performance in our portfolio of defense businesses and by continued improvements in operating efficiencies at Commercial Airplanes.

2001 operating earnings were significantly impacted by $935 million of pre-tax special charges related to the events of September 11, 2001. (See Note 3.) Excluding the September 11, 2001 special charges of $935 million, operating earnings in 2002 were $1,059 million lower than 2001 operating earnings. This decrease in operating earnings reflected lower commercial airplane deliveries partially offset by production efficiencies in the Commercial Airplanes segment and higher deliveries of IDS products. IDS operating earnings also decreased as commercial satellite losses offset growth and performance on other programs. In addition, $426 million of asset impairment charges and additional valuation reserves related to customer and commercial financing assets were recorded by BCC and the Other segment during 2002.

We generated net periodic benefit income related to pensions of $67 million in 2003, $404 million in 2002 and $920 million in 2001. Not all net periodic pension benefit income or expense is recognized in net earnings in the year incurred because it is allocated to production as product costs, and a portion remains in inventory at the end of a reporting period. Accordingly, the operating earnings for 2003, 2002, and 2001, included $147 million, $526 million and $802 million, respectively, of pension income.

Although our pension plan investment returns were 17 percent for the plan year ended September 30, 2003, interest rates continued to decline. Accordingly, we expect our pension investment returns over the long term to decrease, as reflected in our 25 basis point reduction of the expected long-term asset return rate (from 9.00 percent in 2003 to 8.75 percent in 2004). This is expected to reduce pension income reflected in operating earnings from $147 million in 2003 to pension expense in the range of $350 million to $400 million in 2004. In 2005, the pension impact to earnings will depend on market conditions and discretionary funding, but based upon current assumptions, we expect to recognize non-cash pension expense estimated to range from $600 million to $700 million.

Net Earnings

Other income in 2003 increased over 2002 primarily due to the receipt of $397 million of interest income associated with a $1.1 billion partial settlement of federal income tax audits relating to tax years 1992 through 1997. Interest and debt expense increased due to the debt issuances and repayments in 2003.

The increase in 2003 net earnings over 2002 reflects the federal tax settlement mentioned above, partially offset by lower operating earnings.

Other income in 2001 included $210 million of interest income associated with federal income tax audit settlements; 2002 did not include similar interest income. Also contributing to lower other income in 2002 was $46 million of losses on long-held equity investments. Interest and debt expense increased from 2001 to 2002 due to higher levels of debt, primarily associated with the increased customer and commercial financing activities of BCC. Net earnings in 2002 reflected a $1,827 million charge related to the adoption of Statement of Financial Accounting Standards (SFAS) No. 142.

Research and Development

Research and development expenditures involve design, development and related test activities for defense systems, new and derivative commercial jet aircraft, advance space, other company-sponsored product development, and basic research and development. These expenditures are either charged directly against earnings or are included in amounts allocable as reimbursable overhead costs on U.S. Government contracts. In addition, Boeing Technology, our advanced research and development organization, focuses on improving our competitive position by investing in certain technologies and processes that apply to multiple business units. Technology investments currently being pursued within Boeing Technology include network-centric operations, affordable structures and manufacturing technology, lean and efficient design processes and tools, lean support and service initiatives, advanced platform systems and safe and clean products.

Research and development expense increased in 2003, principally reflecting IDS's continued focus on the 767 Tanker program development as well as the development of communication system architectures in order to support various business opportunities including Future Combat Systems, Joint Tactical Radio System, FAB-T and Global Missile. In 2003, research and development expenses decreased at Commercial Airplanes due to reduced spending on the development of the 747-400ER. Commercial Airplanes' research and development expenses are expected to increase in 2004 due to spending on the 7E7 program. Research and development highlights for each of the major business segments are discussed in more detail in Segment Results of Operations and Financial Condition.

Income Taxes

The 2003 effective income tax rate of (30.5)% varies from the federal statutory tax rate of 35%, principally due to tax benefits from federal tax refunds, Foreign Sales Corporation (FSC) and Extraterritorial Income (ETI) Exclusion tax benefits of $115 million, partially offset by tax charges related to the non-deductibility for tax purposes of significant portions of goodwill impairment charges. This rate also reflects tax credits, state income taxes, charitable donations and tax-deductible dividends.

The effective income tax rates of 27.1% for 2002 and 20.7% for 2001 also vary from the federal statutory tax rate principally due to FSC and ETI benefits of $195 million in 2002 and $222 million in 2001. The 2001 income tax rate also reflects a one-time benefit reflecting a settlement with the Internal Revenue Service (IRS) relating to research credit claims on McDonnell Douglas Corporation fixed price government contracts applicable to the 1986-1992 federal income tax returns.

Beginning in 1999 and continuing through 2002 the European Union (EU) issued a series of objections with the World Trade Organization (WTO) to both U.S. FSC and ETI provisions. The WTO agreed with the EU and ruled that the FSC and ETI provisions constitute prohibited export subsidies. In response the WTO authorized the EU to impose retaliatory tariffs. A list issued by the EU, of products upon which the retaliatory tariff would be imposed, does not include our products. President Bush has stated that the U.S. will bring its tax laws into compliance with the WTO ruling. Both the House Ways and Means Committee and the Senate Finance Committee are continuing to assess alternatives for a replacement of the ETI legislation. It is not possible to predict what impact this issue will have on future earnings pending final resolution of these matters. If ETI is repealed and replacement legislation is not enacted, our loss of the benefit could be substantial.

Income taxes have been settled with the IRS for all years through 1981, and IRS examinations have been completed through 1997. During 2003 a partial settlement was reached with the IRS for the years 1992-1997 and we received a $1.1 billion refund (of which $397 million represents interest). Also, in January and February 2004, we received federal tax refunds and a notice of approved refunds totaling $145 million (of which, $40 million represents interest). The refunds related to a settlement of the 1996 tax year and the 1997 partial tax year for McDonnell Douglas Corporation, which we merged with on August 1, 1997. The notice of approved refunds related to the 1985 tax year. These events resulted in a $727 million increase in net earnings for the year ended December 31, 2003. We believe adequate provisions for all outstanding issues have been made for all open years.

Backlog

Contractual backlog of unfilled orders excludes purchase options, announced orders for which definitive contracts have not been executed, and unobligated U.S. and foreign government contract funding. The increase in contractual backlog from 2002 to 2003 related to increases in contractual backlog for A&WS and Network Systems, offset by decreases for Commercial Airplanes. A&WS obtained orders for the Apache helicopters from Greece and Kuwait, the F/A-18 E/F Multi Year II contract and the initial funding for the EA-18G from the U.S. Navy while Network Systems obtained orders for the Ground- Based Midcourse Defense program and Turkey 737 AEW&C programs coupled with the initial funding of the Future Combat Systems (FCS) program. Commercial Airplanes' decrease in contractual backlog reflects the impact that the economic downturn has had on the airline industry.

The decrease in contractual backlog from 2001 to 2002 related to higher delivery volumes on all airplane programs relative to new orders.

Unobligated backlog includes U.S. and foreign government definitive contracts for which funding has not been appropriated. The FCS and F/A-18 programs were the primary contributors for the increase in unobligated backlog in 2003.

For segment reporting purposes, we report Commercial Airplanes contractual backlog for airplanes built and sold to other segments. Commercial Airplanes relieves contractual backlog upon the sale of these airplanes to other segments.

IDS contractual backlog includes the modification performed on intracompany airplane purchases from Commercial Airplanes. IDS relieves contractual backlog for the modification performed on airplanes received from Commercial Airplanes upon delivery to the customer or at the attainment of performance milestones.

Liquidity and Capital Resources

Primary sources of our liquidity and capital resources include cash flow from operations and substantial borrowing capacity through commercial paper programs and long-term capital markets, as well as unused borrowing on revolving credit line agreements. The primary factors that affect our investment requirements and liquidity position, other than operating results associated with current sales activity, include the following: timing of new and derivative programs requiring both high developmental expenditures and initial inventory buildup; growth and contractions in business cycles, including growth and expansion requirements and requirements associated with reducing sales levels; customer financing assistance; the timing of federal income tax payments/refunds as well as interest and dividend payments; our stock repurchase plan; internal investments; and potential acquisitions and divestitures.

Cash Flow Summary

Non-cash items Non-cash items in earnings primarily include depreciation, amortization, share-based plans expense, impairments, valuation provisions, and pension income. Non-cash items and corresponding amounts are listed in our Consolidated Statements of Cash Flows.

Working capital During 2003, our investment in working capital decreased, principally due to the following items:

• a decrease in inventory related to the following:
  • the downturn of the commercial aviation market, which has resulted in less demand for the production of commercial airplanes,
  • a build-up of inventory related to international and space programs, offset by an increase in IDS billings,
• an increase in advances in excess of related costs at IDS for military aircraft contracts, partially offset by reduced advance payments at Commercial Airplanes due to reduced orders as a result of the depressed commercial aviation market, and
• an increase to our investment in working capital due to $1.7 billion of discretionary pension contributions (see discussion below regarding pensions), offset by
• a decrease in income taxes payable related to tax payments made, receipt of cash for partial tax settlement, and a tax expense from current earnings.

Net cash provided by operations includes intracompany cash of $1.7 billion, $2.7 billion and $3.0 billion for 2003, 2002 and 2001, respectively, resulting from the sale of aircraft by the Commercial Airplanes segment for customers who received financing from BCC. An offsetting use of cash was reported as an investing activity.

Pensions 2003 operating cash flow included $1.7 billion of cash funding to the pension plans. Almost all of the contributions were voluntary to improve the funded status of our plans. We expect pension funding requirements to be approximately $100 million in 2004. However, we are evaluating a discretionary contribution to our plans in the range of $1.0 billion (pre-tax) during the first quarter of 2004, and will consider making additional contributions later in the year.

We measure our pension plan using a September 30 year-end for financial accounting purposes. Although in 2003, actual investment returns were well in excess of the expected rate of 9.0%, we reduced our expected rate of return on plan assets by 25 basis points to 8.75% beginning in 2004 which reflects expected performance over the long-term. The expected long-term rate of return on plan assets is based on long-term target asset allocations of 56% equity, 28% fixed income, 7% real estate, and 9% other. Current allocations are within 1 to 10% of each of the long-term targets. Historically low interest rates (a key factor when estimating plan liabilities), caused us to recognize a $358 million increase to the accrued pension plan liability and a $226 million after-tax decrease to the accumulated other comprehensive income account within shareholders' equity in the fourth quarter of 2003. This non-cash charge did not impact earnings or cash flow, and could reverse in future periods if interest rates increase or market performance and plan returns increase. We use a discount rate that is based on a point-in-time estimate as of each annual September 30 measurement date. Although future changes to the discount rate are unknown, had the discount rate increased or decreased by 25 basis points, pension liabilities in total would have decreased $1.2 billion or increased $1.3 billion, respectively.