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Management’s
Discussion and Analysis Operating Profit Commercial
Airplanes Production problems experienced on the commercial aircraft programs reached unexpected levels late in the third quarter of 1997. During this period, the Company was in the midst of an unprecedented production rate build-up for the 7-series commercial aircraft programs, and experienced a number of challenges, including raw material shortages, internal and supplier parts shortages, and productivity inefficiencies associated with adding thousands of new employees. These factors resulted in significant out-of-sequence work. The breadth and complexity of the entire commercial aircraft production process, especially during this time of substantial production rate increases, presented a situation where disrupted process flows caused major inefficiencies throughout the entire process chain. The 747 and 737 production lines were halted for approximately one month early in the fourth quarter of 1997. The recovery plan continued throughout 1998. The Company delivered 74 777 aircraft in 1998, compared with 59 in 1997, and 165 Next-Generation 737 models (737-600/700/800) in 1998, compared with 3 in 1997. New commercial jet aircraft programs normally have lower gross profit margins due to initial tooling amortization and higher unit production costs in the early years of a program averaged over the initial production quantity. A pretax forward loss of $350 million was recognized in the first quarter of 1998 in addition to the $700 million recognized in the third quarter of 1997 for the Next-Generation 737 program. Consequently, there was no gross profit for the Next-Generation 737 program in 1998. Deliveries of the 777 and the Next-Generation 737 will constitute a much larger proportion of Commercial Airplanes sales in 1999 than they did in 1998. With respect to the 717 program, for which deliveries begin in 1999, no gross profit will be initially recognized. The Company has significant exposures related to the 717 program, principally related to supplier commitments beyond firm backlog. The commercial jet aircraft market and the airline industry remain extremely competitive. Competitive pressures and increased lower-fare personal travel have combined to cause a long-term downward trend in passenger revenue yields worldwide (measured in real terms). Over the past five years, airplane capacity increases in the United States have lagged air travel growth, resulting in stable or increasing passenger yields. In Asia, slowing economies, reduced business travel, and currency devaluations are contributing to sharply lower yields. 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. The overall Commercial Airplanes segment operating profit margin for 1998 was 0.2% and is currently projected to be in the 2% to 3% range for 1999.
Information, Space and Defense Systems In 1998 the Company announced that it would exit the market for commercial helicopters. As part of that strategic decision, the Company transferred its interest in the Civil Tiltrotor program to Bell Helicopter Textron in early 1998. Also, in the first quarter of 1999, the Company sold the MD 500, MD 600 and MD Explorer light commercial helicopter product lines to RDM Holding, Inc., a European-based industrial group. Segment operating profits for 1996 included $114 million of pretax earnings related to the settlement of various contract issues. Excluding joint venture losses and settlement of contract issues, the Information, Space and Defense Systems segment operating margin before research and development was approximately 12.7% in 1998 and 12% for each of the years 1997 and 1996. A significant percentage of Information, Space and Defense Systems segment business has been in developmental programs under cost-reimbursement-type contracts, which generally have lower profit margins than fixed-price-type contracts. Current major developmental programs include the International Space Station, F/A-18 E/F, F-22 Fighter, Joint Strike Fighter, V-22 Osprey tiltrotor aircraft, the RAH-66 Comanche helicopter, and the National Missile Defense (NMD) Lead System Integration (LSI). The F/A-18 E/F and V-22 Osprey tiltrotor aircraft programs are currently transitioning to low-rate initial production, and the F-22 Raptor has received long-lead funding for low-rate initial production. Although program expenditures are normally committed based on orders under contract, the Company currently has significant exposure related to long-lead requirements for the F-15 program for deliveries beyond 2000. Joint venture losses will continue in 1999, principally from development and administrative costs on the Sea Launch program. The Sea Launch assembly and command ship and the launch platform were completed in June 1998. Boeing is a 40% partner in Sea Launch with RSC Energia (25%) from Russia, Kvaerner Maritime (20%) from Norway, and KB Yuzhnoye/PO Yuzhmach (15%) from Ukraine. The first launch from this sea-based platform will be a demonstration payload. Hughes Space & Communications International, Inc., and Space Systems/Loral are the first Sea Launch customers, with announced orders for 18 launches plus options. Technical failure on the initial launch could substantially impair the prospect for additional customers’ acceptance and could consequently result in significant reduction to the value of the Sea Launch program assets. Ongoing viability of the Sea Launch program will depend on consistent launch reliability. The Company and Lockheed Martin are 50/50 partners in United Space Alliance, which is responsible for all ground processing of the Space Shuttle fleet and for space-related operations with the U.S. Air Force. United Space Alliance also performs the modification, testing and checkout operations required to ready the Space Shuttle for launch. Although the joint venture operations are not included in the Company’s consolidated statements, the Company’s proportionate share of joint venture earnings is recognized in income. The Military Aircraft and Missiles segment operating profit margin for 1998 was 9.9% and is currently projected to be in the 9.5% to 10.5% range in 1999. The Space and Communications segment operating profit margin for 1998 was 3.6%, and is projected to be in the 4% to 5% range for 1999. Research
and Development Research and development expense: In 1998 total research and development expense was $1.9 billion, about the same as in 1997. A decline in the Commercial Airplanes segment research and development expense was largely offset by an increase in the Space and Communications segment. Research and development expense had increased in 1997 by $291 million relative to 1996, primarily due to the inclusion of the aerospace and defense units acquired from Rockwell in 1996, and spending in commercial space and communications activities. Commercial Airplanes research and development expense for 1997 was approximately the same as in 1996. Research and development expense by segment is included on Segment Information pages. Commercial
Airplanes The following chart summarizes the time horizon between go-ahead and certification/first delivery for major Commercial Airplanes derivatives and programs. Information,
Space and Defense Systems . . . . . . . Total Company research and development expenditures for 1999 will be influenced by the timing of commercial aircraft derivative programs and commercial space and communication activities. Based on current programs and plans, research and development expense for 1999 is expected to be in the $1.6 billion to $1.8 billion range, with about half related to the Commercial Airplanes segment. Research and development activities are further discussed in the Strategic Investments for Long-Term Value section.
Income Taxes The income tax provision for 1997 is a tax credit resulting from application of the tax rate to a pretax loss. The relatively high effective 1997 income tax rate of 47.8% reflects additional benefits, principally Foreign Sales Corporation tax benefits of $79 million. These benefits were partially offset by the nondeductibility of goodwill and merger costs. The 1996 effective income tax rate of 26.7% reflects tax benefits of $125 million related to prior years, as well as Foreign Sales Corporation tax benefits of $110 million. Over the past three years, excluding tax benefits related to prior periods and the impact of special charges, the effective income tax rate has been about 30%. The Company expects the comparable 1999 rate to continue to be in that range. Additional information relating to income taxes is found in Note 11 to the consolidated financial statements.
Labor Negotiations and Workforce Levels The Company believes that bargaining agreements in the best interest of both the represented employees and the Company are attainable, and the Company’s stated objective is to reach a settlement without disruption. The effects of a strike on the results of operations and financial position are uncertain, but could be material depending on the strike duration. The Company’s workforce level at December 31, 1998, was 231,000. The year-end 1999 workforce level is projected to be in the range of 200,000 to 210,000.
Derivative Instruments and Hedging Activities
The Boeing Company and Subsidiaries |
