Management's Discussion and Analysis

Management’s Discussion and Analysis
Results of Operations, Financial Condition and Business Environment

Merger with McDonnell Douglas Corporation
On August 1, 1997, McDonnell Douglas Corporation merged with the Company through a stock-for-stock exchange in which 1.3 shares of Company stock were issued for each share of McDonnell Douglas stock outstanding. The merger has been accounted for as a pooling of interests, and the discussion and analysis that follows reflects the combined results of operations and financial condition of the merged companies.

Information, Space and Defense Systems Segment Reporting
In 1998 the Information, Space and Defense Systems Group of the Company was reorganized into two groups: the Military Aircraft and Missile Systems Group and the Space and Communications Group, which will be reported as separate business segments for 1998 and on.

Results of Operations

Revenues
Operating revenues for 1998 were $56.2 billion, compared with $45.8 billion in 1997 and $35.5 billion in 1996. The higher revenues for both 1998 and 1997 reflect the increased deliveries in both the Commercial Airplanes and the Information, Space and Defense Systems segments. The 1998 and 1997 revenues include the operations of the aerospace and defense units acquired from Rockwell International Corporation in December 1996.

Revenues by industry segment:

Forward-Looking Information Is Subject to Risk and Uncertainty

Certain statements in this release contain “forward-looking” information that involves risk and uncertainty, including projections for year 2000 date conversion, production rates, deliveries, customer financing, sales, revenues, margins, earnings, cash, scheduled launches of products, research and development expense, inventory turn rates, employment, asset utilization, and other trend projections. This forward-looking information is based upon a number of assumptions, including assumptions regarding demand, internal performance, customer financing, customer, supplier and subcontractor performance, customer model and feature selections, government policies and actions, and price escalation. Actual future results and trends may differ materially depending on a variety of factors, including the Company’s successful execution of internal performance plans, including research and development, production recovery, production rate increases and decreases, production system initiatives and other cost-reduction efforts; the cyclical nature of the Company’s business; volatility of the market for certain products; continued integration of McDonnell Douglas Corporation; product performance risks associated with regulatory certifications of the Company’s commercial aircraft by the U.S. Government and foreign governments; other regulatory uncertainties; collective bargaining labor disputes; performance issues with key suppliers, subcontractors and customers; customer model and feature selections, governmental export and import policies; factors that result in significant and prolonged disruption to air travel worldwide; global trade policies; worldwide political stability and economic conditions, particularly in Asia; price escalation trends; changing priorities or reductions in the U.S. Government defense and space budgets; termination of government contracts due to unilateral government action or failure to perform; and legal proceedings.

Commercial Airplanes
Commercial Airplanes products and services accounted for 63%, 59% and 56% of total operating revenues for the years 1998, 1997 and 1996, respectively. Total commercial jet aircraft deliveries by model, including deliveries under operating lease, which are identified by the number in parentheses, were as follows:

The MD-80 and MD-90 aircraft will not be produced after early 2000. Final delivery of the MD-11 aircraft will be in 2001. First delivery of the 717 aircraft (formerly the MD-95) is scheduled for mid-1999.

Total commercial aircraft deliveries for 1999 are currently projected to be in the range of 620 aircraft, including approximately 360 777s and Next-Generation 737s. Based on current plans, Commercial Airplanes revenues for 1999 are expected to be in the $38 billion range. Total commercial aircraft deliveries for 2000 are currently projected to be in the range of 480 aircraft. Commercial aircraft transportation trends are discussed in the Commercial Airplanes Business Environment and Trends section.

Commercial Airplanes sales by geographic region:

Information, Space and Defense Systems
Information, Space and Defense Systems segment revenues were $19.9 billion in 1998, compared with $18.1 billion in 1997 and $14.9 billion in 1996. The 1998 revenues of $19.9 billion are composed of $13.0 billion for Military Aircraft and Missiles and $6.9 billion for Space and Communications. Revenues for 1998 and 1997 include the aerospace and defense operations acquired from Rockwell in 1996. A 14-week labor strike at the St. Louis, Missouri, facilities delayed certain deliveries in 1996, principally involving military aircraft.

The Company’s Information, Space and Defense Systems business is broadly diversified, and no program accounted for more than 15% of total 1996-1998 segment revenues.

The principal contributors to 1998 Information, Space and Defense Systems revenues included the Military Aircraft and Missiles programs of C-17, F-15, F/A-18 C/D, F/A-18 E/F, and AH-64 Apache; and the Space and Communications programs of the International Space Station, E-3 AWACS (Airborne Warning and Control System) updates and 767 AWACS, and the Delta II space launcher. Classified projects for the U.S. Government also continued to contribute to revenues.

Deliveries of selected production units were as follows:

Military Aircraft and Missiles segment revenues for 1999 are projected to be in the $12 billion range, and 1999 revenues for Space and Communications are projected to be in the $7 billion range.

Segment business trends are discussed in the Information, Space and Defense Systems Business Environment and Trends section.

Customer and Commercial Financing/Other
Operating revenues in the Customer and Commercial Financing/Other segment were $730 million in 1998, compared with $746 million in 1997 and $603 million in 1996. The major revenue components include commercial aircraft financing and commercial equipment leasing.

Additional information about revenues and earnings contributions by business segment is presented on the Segment Information pages.

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Based on current schedules and plans, the Company projects total 1999 revenues to be approximately $58 billion.

Earnings
Net earnings for the three years include a significant special charge in addition to earnings fluctuations associated with the Company’s share-based plans as summarized below (net of income tax):

In the fourth quarter of 1997, the Company completed an assessment of the financial impact of its post-merger strategy decisions related to its McDonnell Douglas Corporation commercial aircraft product lines, and recorded a special pretax charge of $1,400 million, or $876 million after tax, relative to these decisions. The charge principally represented an inventory valuation adjustment based on post-merger assessments of the market conditions and related program decisions. Also included in the charge were valuation adjustments in connection with customer financing assets and commitments.

The share-based plans are discussed on Shareholder Value pages and in Note 16 to the consolidated financial statements.

Comparative net earnings (exclusive of special charges and share-based plans):

Comparative earnings of $1,216 million for 1998 were $584 million higher than for 1997 primarily due to higher commercial aircraft deliveries in 1998, a higher loss recognized in 1997 for the Next-Generation 737 ($218 million after tax), merger-related expenses of $120 million in 1997, and prior years’ defense-related partnership research and development tax credits amounting to $57 million recognized in 1998. Additionally, interest income was lower in 1998.

Comparative net earnings for 1997 were $1,273 million lower than for 1996 primarily due to commercial aircraft production inefficiencies associated with significant production rate increases. Additionally, 1997 results included increased research and development spending ($182 million after tax), merger-related expenses, and increased interest and debt expense ($75 million after tax). Partially offsetting these factors were the earnings associated with the higher sales levels in 1997 and increased interest income of $25 million after tax. The 1996 results included $199 million of after-tax income related to the settlement of certain Information, Space and Defense Systems segment contract issues and recognition of prior years’ tax benefits.

Based on current plans and schedules, total Company net earnings for 1999, including share-based plans, are expected to be in the range of $1.5 billion to $1.8 billion, excluding potential favorable tax claim settlements.

Operating results trends are not significantly influenced by the effect of changing prices since most of the Company’s business is performed under contract.

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