BA

Business Context and Reporting Period

This Form 10-Q covers The Boeing Company for the quarterly period ended March 31, 2006. The company operates primarily through Commercial Airplanes, Integrated Defense Systems (IDS), and Boeing Capital Corporation (BCC). In 2006, IDS was realigned into three capabilities-driven businesses: Precision Engagement and Mobility Systems, Network and Space Systems, and Support Systems. The financial statements reflect this realignment and the retrospective adoption of EITF 02-16 regarding vendor concessions.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased by $1,583 million (12.5%) year-over-year, driven primarily by a $2,293 million increase in Commercial Airplanes revenues due to higher aircraft deliveries (98 jets in Q1 2006 vs. 70 in Q1 2005). This was partially offset by a $420 million decline in IDS revenues.
• Profitability: Operating earnings rose by $272 million. Commercial Airplanes operating earnings increased by $315 million, while IDS operating earnings decreased by $33 million.
• Expense Increases: Research and development (R&D) expenses increased by $256 million to $748 million, primarily due to increased spending on the 787 program and the absence of supplier development cost-sharing payments received in the prior year.
• Tax Rate: The effective tax rate increased to 29.1% from 12.0% in Q1 2005. The prior year's lower rate was driven by a non-recurring change in valuation allowances related to foreign deferred tax assets.
• Accounting Change: The company adopted a new accounting method for vendor concessions effective January 1, 2006, treating them as a reduction in cost of products rather than revenue. This change reduced reported revenues and costs by $446 million for Q1 2006 and was applied retrospectively to Q1 2005.

Outlook, Risks, and Contingencies

• 787 Program: Undelivered firm orders for the 787 increased to 341 units. First delivery is targeted for 2008. R&D spending remains elevated.
• 767 Program: While recent orders were obtained, the prospect of the program extending into a USAF tanker contract has diminished. Management notes it is "reasonably possible" a decision to complete production could be made in 2006, which would reduce margins but not necessarily result in a forward loss.
• Legal Proceedings:
  • A-12 Litigation: Ongoing dispute with the U.S. Navy regarding contract termination. A loss provision of $350 million exists; potential additional loss could be $275 million if termination for default is upheld, plus potential payment of unliquidated progress payments.
  • EELV Litigation: Civil lawsuit with Lockheed Martin regarding alleged possession of proprietary data is stayed pending a joint venture agreement. If the transaction fails, claims could be reinstated.
  • Shareholder Derivative: Settlement reached regarding corporate governance; final approval hearing scheduled for June 2006.
• Customer Financial Health: Significant exposure to customers in bankruptcy or restructuring, including Northwest Airlines ($491 million portfolio), VARIG ($347 million), and Delta Air Lines ($123 million). Management does not expect these to have a material adverse effect.
• Sea Launch: Net maximum exposure to loss is estimated at $127 million.

Investor Verification Checklist

• 787 R&D Spend: Verify the trajectory of 787 development costs and the timeline for supplier cost-sharing payments to return.
• 767 Production Decision: Monitor for any announcement regarding the completion of the 767 production line and its impact on margins.
• A-12 Litigation Outcome: Track the status of the U.S. Court of Federal Claims proceedings regarding the A-12 contract termination.
• Customer Restructurings: Review the final terms of lease/loan restructurings with Northwest Airlines, VARIG, and Delta to assess potential asset impairments.
• United Launch Alliance (ULA): Confirm regulatory approval status for the joint venture with Lockheed Martin, which impacts future launch revenue recognition.