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MANAGEMENT'S DISCUSSION AND ANALYSIS
Revenues The increase in IDS revenues from 2002 to 2003 was primarily driven by additional production aircraft and Joint Direct Attack Munitions (JDAM) deliveries and F/A-22 Raptor volume in A&WS; increased volume in homeland security, proprietary programs and the start up of Future Combat Systems in Network Systems; increased volume in spares, maintenance and Life Cycle Customer Support (LCCS) in Support Systems; and increased Delta launch deliveries in L&OS.
Increased revenues from 2001 to 2002 were primarily driven by additional aircraft, rotorcraft and JDAM deliveries from production programs and amounts recognized on a cost-reimbursement basis for development programs such as F/A-22 Raptor and V-22 Osprey in A&WS; increased volume in Missile Defense in Network Systems and increased volume in spares, modernization, maintenance and LCCS in Support Systems.
Operating earnings The decrease in IDS's operating earnings from 2002 to 2003 reflects increased operating losses recorded for the L&OS segment, partially offset by strong performance from the A&WS, Network Systems and Support Systems segments.
A&WS earnings were driven by strong performance from the segment's major production programs and an increased revenue base as well as 2002 cost growth that did not impact 2003. Support Systems also had another outstanding year driven by an increased revenue base along with improved performance in many of the segment's businesses. Network Systems segment earnings improved from 2002 primarily due to increased revenues in homeland security, Future Combat Systems and proprietary programs, partially offset by cost growth on military satellite programs and a $55 million pre-tax non-cash charge related to our investment in a joint venture that lost an imagery contract award, as a result this venture has now been dissolved. The L&OS segment was impacted by a goodwill impairment charge of $572 million and a charge of $1.0 billion as a result of continued weakness in the commercial space launch market, higher mission and launch costs on the Delta IV program, and cost growth in the satellite business. L&OS earnings in 2003 were also adversely impacted by adjustments to certain joint venture investments resulting in a net write-down of $27 million.
Operating results increased slightly from 2001 to 2002 primarily due to strong performance from the A&WS and Support Systems segments, while the Network Systems segment was impacted by a 737 Airborne Early Warning & Control $100 million development cost growth. The L&OS segment was impacted by cost growth on satellite programs, a $100 million pre-tax charge to write-down an equity investment and continued downturn in the launch and commercial satellite market.
Backlog The increase in contractual backlog of 14% from 2002 to 2003 is attributed to the capture of orders for Apache helicopters by Greece & Kuwait, the F/A-18 E/F Multi Year II contract and the initial funding for the EA-18G from the U.S. Navy in the A&WS segment. Network Systems backlog grew primarily from orders received for the GMD and Turkey 737 AEW&C programs coupled with the initial funding of the Future Combat Systems program. Support Systems backlog grew primarily from orders received for C-17 sustainment and KC-10 support. L&OS backlog decreased from 2002 to 2003 primarily due to Delta IV EELV contract terminations.
The increase in contractual backlog of 17% from 2001 to 2002 is primarily attributed to the capture of several key international awards including the Korean F-15 Eagle contract and the Italian 767 Tanker contract, coupled with production rate increases on several domestic programs in the A&WS segment. Network Systems backlog grew primarily from orders received from the Department of Transportation for Airport Security and orders received for proprietary programs. Support Systems backlog also grew from the previously mentioned Korean and Italian awards and a C-17 sustainment contract. L&OS backlog remained constant from 2001 to 2002 with orders for Delta IV launch vehicles and a NASA award for space flight payload processing offsetting the decline in commercial satellite backlog.
Revenues A&WS increased revenues in 2003 were primarily driven by additional deliveries on JDAM, F/A-18E/F Super Hornet, F-15E Eagle and F/A-22 Raptor volume, partially offset by lower rotorcraft deliveries. The increase in revenues between 2002 and 2001 were due to increased aircraft deliveries on C-17 Globemaster, F/A-18E/F Super Hornet, F-15E Eagle, AH-64 Apache and JDAM.
Deliveries of units for principal production programs, including deliveries under operating lease, which are identified by parentheses, were as follows:
Operating earnings A&WS 2003 operating earnings reflect increased revenues, strong performance on our major production programs and a $45 million favorable adjustment related to the F-15 Eagle program. The favorable adjustment represents usage in 2003 of some of the inventory we impaired in 1999. The 2002 earnings results reflect strong profits on our major production programs. 2002 results also include a gain of $42 million related to the divestiture of an equity investment and a favorable adjustment of $24 million attributable to F-15 Eagle program charges taken in 1999. The segment operating earnings for 2001 include the recognition of $48 million of charges relating to asset reductions attributable to reduced work volume at the Philadelphia site, and $46 million of charges associated with the Joint Strike Fighter program and idle manufacturing assets. The 2001 operating earnings also included a favorable adjustment of $57 million attributable to F-15 Eagle program charges taken in 1999.
Research and development The A&WS segment continues to pursue business opportunities where it can use its customer knowledge, technical strength and large-scale integration capabilities to provide transformational solutions. Research and development activities continue to be focused on the 767 Tanker program, as reflected in the increased expenditures in 2002 and 2003 over 2001. This program represents a significant opportunity to provide state of the art refueling capabilities to potential domestic and international customers. It demonstrates the synergistic value of our diversified company-wide portfolio in providing best value solutions to our customers. Italy and Japan have signed contracts for the 767 Tanker system with first aircraft delivery scheduled in 2005, and discussions continue with the USAF on how we may fulfill their tanker requirement. The outcome of the USAF proposal could have an impact on the amount of research and development expenditures that we would incur.
Investments in Unmanned Systems continue to leverage our capabilities in architectures, system-of-systems integration and weapon systems technologies to provide transformational capabilities for the U.S. military. This segment's research and development expenditures are focused on unmanned systems programs and technologies, and reflect the current business environment. Other research and development efforts include upgrade and technology insertions to enhance the capability and competitiveness of current product lines such as Airborne Electronic Attack, Precision Weapons and advanced Rotorcraft systems.
Backlog The increase in contractual backlog from 2002 to 2003 is primarily attributed to the capture of several key awards including the F/A-18 E/F Multi Year II contract, Apache helicopter new builds, and the initial funding for the EA-18G. Backlog also increased due to rate increase on the F/A-22 low rate initial production and weapon orders for Small Diameter Bomb (SDB), Harpoon, and SLAM-ER.
The increase in contractual backlog of 7% from 2001 to 2002 is primarily attributed to the capture of several key international awards including the Korean F-15 Eagle contract and the Italian 767 Tanker contract. Backlog also increased due to rate increases on several domestic programs in low rate initial production including V-22 Osprey and the F/A-22 Raptor. The F/A-18E/F Super Hornet program backlog increased moderately as the customer continues to increase production rate. The JDAM program backlog also increased moderately with additional orders from both the Navy and Air Force.
On February 23, 2004, the U.S. Government announced plans to terminate for convenience the RA-66 Comanche contract. Boeing and United Technologies each had a 50% contractual relationship in the program. The announcement did not have an impact on 2003 financial results. The program represented less than 1% of our projected 2004 revenues.
Revenues Increased revenues for the Network Systems segment in 2003 were primarily driven by increased activity in proprietary and homeland security programs, ramp up of the Future Combat Systems program and the successful launch of a Naval satellite (UHF F11). The increase in revenues from 2001 to 2002 is primarily due to increased activity in network-centric warfare activity and Missile Defense.
Operating earnings Network Systems 2003 earnings results were primarily driven by increased revenue mentioned earlier. 2003 results were adversely impacted by cost growth on military satellite programs and a $55 million pre-tax non-cash charge related to our investment in Resource 21, a venture that lost an imagery contract award, and as a result the venture has now been dissolved. 2002 results were impacted by cost growth on military satellite programs and the 737 AEW&C development program. Network Systems 2002 earnings increased relative to 2001 primarily due to the increased revenue offset partially by charges mentioned above.
Research and development The Network Systems research and development funding continues to be focused on the development of communications and command & control capabilities that support a network-centric architecture approach. 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. Investments were made in Global Situational Awareness concepts to develop communication system architectures in order to support various business opportunities including Future Combat Systems, Joint Tactical Radio System, FAB-T and GMD.
A major contributor to our support of these DoD transformation programs is the investment in the Boeing Integration Center (BIC) where our network-centric operations concepts are developed in partnership with our customers. We will also continue to make focused investments that will lead to the development of next-generation space intelligence systems. Along with slightly increased funding to support this area of architecture and network-centric capabilities development, we also increased our investment in advanced missile defense concepts. Also, in 2003 we made a significant decision and allocated a larger investment than in previous years to continue to pursue the homeland security market. Research and development funding was used to develop and tailor the network-centric capabilities, already being applied to many DoD opportunities in this emerging market.
Backlog The 75% increase in contractual backlog from 2002 to 2003 is mainly attributed to orders for the GMD and Turkey 737 AEW&C programs coupled with the initial funding of the Future Combat Systems program. The increase in contractual backlog of 41% from 2001 to 2002 is primarily attributed to the capture of orders for proprietary programs and an order by the Department of Transportation for Airport Security.
Revenues Support Systems increased revenues in 2003 were driven by increased volume in spares for tactical aircraft, LCCS, Maintenance & Modification, and Contractor Logistical Support & Services (CLSS). Increased revenues between 2002 and 2001 were primarily driven by increased volume in spares for tactical aircraft, Modernization and Upgrade, LCCS and Maintenance & Modification.
Operating earnings Support Systems operating earnings increased in 2003 and 2002, primarily due to the higher base of revenues identified above. 2003 operating earnings were also improved due to performance in the Spares & Technical Data and LCCS businesses. 2002 operating earnings also benefited from improved performance in the Maintenance & Modification and LCCS businesses along with a non-recurring gain related to the divestiture of an equity investment.
Research and development Support Systems continue to focus investment strategies on its core businesses including CLSS, LCCS, Maintenance and Modifications, Modernization and Upgrades, Spares and Technical Data, and Training Systems and Services. We have made investments to continue the development and implementation of innovative disciplined tools, processes and systems as market discriminators. Examples of successful programs stemming from the investments include the C-17 Globemaster Sustainment Partnership, C-130U Gunship 4 Buy and C-130 Avionics modernization program.
Backlog The increase in contractual backlog of 11% from 2002 to 2003 is attributed to orders for C-17 sustainment and KC-10 support as well as orders in the CLSS business. The increase in contractual backlog of 78% from 2001 to 2002 is attributed to growth throughout the various Aerospace Support businesses. Primary contributors were the follow-on order for the C-17 sustainment contract, Italian 767 Tanker Integrated Fleet Support and Korean F-15 spares and ground support equipment.
Revenues Higher L&OS revenues in 2003 were primarily driven by increased Delta launch deliveries. Decreased revenues between 2002 and 2001 were primarily driven by the downturn in the launch and commercial satellite market.
Deliveries of production units were as follows:
Operating earnings L&OS 2003 operating earnings were negatively impacted by a first quarter goodwill impairment charge of $572 million and a second quarter charge of $1 billion based on continued weakness in the commercial space launch market, higher mission and launch costs on the Delta IV program, and cost growth in the satellite business. The 2003 results also include adjustments we made to our equity investments in Ellipso, SkyBridge and the liquidation of our investment in Teledesic resulting in a net write-down of $27 million. The 2002 results include a $100 million pre-tax charge to write-down our equity investment in Teledesic, LLC. Also contributing to the 2002 decreased operating earnings was cost growth on commercial satellite programs and the continued downturn in the launch and commercial satellite market. The 2001 operating results were driven by increased volume on International Space Station offset by investments in the Delta IV expendable launch vehicle and RS-68 engine.
In 2003, we continued a reorganization of our 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. Progress has been made in implementing process improvements and program management best practices, however, factory problems identified during acceptance testing continue to impact existing contracts. As a result, completion schedules have slipped exposing us to a first quarter 2004 risk of $125 million for contract TFD. In the first quarter of 2004, we will approach the TFD date on a commercial satellite contract, however we believe a TFD on this contract is not likely due to continuing production and contractual efforts in process.
We are a 50-50 partner with Lockheed Martin in a joint venture called United Space Alliance, which is responsible for all ground processing of the Space Shuttle fleet and for space-related operations with the USAF. United Space Alliance also performs modifications, testing and checkout operations that are required to ready the Space Shuttle for launch. United Space Alliance operations are performed under cost-plus-type contracts. Our 50% share of joint venture earnings is recognized as income. The segment's operating earnings include earnings of $52 million, $68 million and $72 million, for 2003, 2002 and 2001, respectively, attributable to United Space Alliance. These results include all known or expected impacts related to the Space Shuttle program based on the findings from the Columbia Accident Investigation Board (CAIB) investigation.
Research and development Our research and development investment in L&OS declined as some versions of the Delta IV expendable launch vehicle reached operational status. Continued investment in the Delta IV program into 2004 will be made to support the demonstration flight of the Delta IV Heavy vehicle. We also continue to make investments in this segment to develop technologies and systems solutions to support our NASA customer in the development of new space systems. We have also prudently invested research and development resources in the satellite manufacturing business to enhance existing designs to meet evolving customer requirements.
Backlog The contractual backlog decrease of 52% in 2003 was primarily due to the adjustment in the Delta IV Launch manifest. The adjustment was a result of missions lost on the EELV (see "EELV Suspension" in 2004 Risk Factors section) contract and a continued weakness in the commercial space market and sales on the existing orders. Additional factors that resulted in a decrease in contractual backlog for 2003 were termination of a Loral launch contract due to a customer's financial solvency and a customer's conversion of three satellite orders to future options.
Contractual backlog remained constant from 2001 to 2002 with higher orders for Delta IV launch vehicles and a NASA award for space flight payload processing partially offset by a decline in commercial satellite backlog due to decreased new orders and sales on existing orders.