# **UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

 

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** **

**Washington, D.C. 20549**

** **

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# **Form 10-Q**

#  

| ý                              | ** ** | **QUARTERLY REPORT PURSUANT  TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                         |
|-------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                |       |                                                                                                                                                                                                                                                                                      |
|                                |       | **For  the quarterly period ended June 30, 2004**                                                                                                                                                                                                                                    |
|                                |       |                                                                                                                                                                                                                                                                                      |
| **OR**                              |
|                                |       |                                                                                                                                                                                                                                                                                      |
| o                                   | ** ** | **TRANSITION REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                        |
|                                |       |                                                                                                                                                                                                                                                                                      |
|                                |       | **For  the transition period from                       to                     ** |
|                                |       |                                                                                                                                                                                                                                                                                      |
| **Commission  File Number 0-10795** |

#  

# **Boeing Capital Corporation**

(Exact name of registrant asspecified in its charter)

 
| **Delaware**                     | ** ** | **95-2564584**      |
|----------------------------------|------------|---------------------|
| (State or other jurisdiction  of |       | (I.R.S. Employer    |
| incorporation or organization)   |       | Identification No.) |

 

**500 NachesAve., SW, 3rd Floor **•**  Renton, Washington  98055**

(Address of principal executiveoffices)

 

**(425) 393-2916**

(Registrant’s telephone number,including area code)

 

Indicate by check mark whether the registrant (1)has filed all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months, and (2) hasbeen subject to such filing requirements for the past 90 days.     Yes ý   No o

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes  o  No  ý

 

No common stock is held by non-affiliates of theregistrant. Common stock shares outstanding at July 28, 2004:  50,000 shares

 

Registrant meets the conditions set forth inGeneral Instruction H(1)(a) and (b) of Form 10-Q and is therefore filing thisForm with the reduced disclosure format.

 

 

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**Table of Contents**

#  

| ** ** | ** ** | ** **                                                                                      | **Page** |
|------------|------------|-------------------------------------------------------------------------------------------------|----------|
|       |       |                                                                                            |     |
| Part I.    |       | Financial  Information                                                                          |     |
|       |       |                                                                                            |     |
| Item 1.    |       | Financial Statements                                                                            |     |
|       |       | Condensed Consolidated Balance Sheets                                                           | 3        |
|       |       | Condensed Consolidated Statements of  Operations                                                | 4        |
|       |       | Condensed Consolidated Statements of  Shareholder’s Equity and Comprehensive Income (Loss) | 5        |
|       |       | Condensed Consolidated Statements of Cash  Flows                                                | 6        |
|       |       | Notes to Condensed Consolidated Financial  Statements                                           | 8        |
|       |       |                                                                                            |     |
| Item 2.    |       | Management’s  Narrative Analysis of Results of Operations                                  | 22       |
|       |       |                                                                                            |     |
| Item 4.    |       | Controls  and Procedures                                                                        | 28       |
|       |       |                                                                                            |     |
| Part II.   |       | Other Information                                                                               |     |
|       |       |                                                                                            |     |
| Item 1.    |       | Legal Proceedings                                                                               | 28       |
|       |       |                                                                                            |     |
| Item 5.    |       | Other  Information                                                                              | 29       |
|       |       |                                                                                            |     |
| Item 6.    |       | Exhibits  and Reports on Form 8-K                                                               | 32       |
|       |       |                                                                                            |     |
| Signatures | 35         |

 

2

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**Part I****.****              Financial Information**

#  

# **Item 1.****          ****Financial Statements**

**Boeing CapitalCorporation and Subsidiaries**

## **Condensed Consolidated BalanceSheets**

(Unaudited)

 
| **(Dollars  in millions, except par value)**                                                    | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ASSETS                                                                                          |       |                    |       |                        |       |
| Cash and cash equivalents                                                                       |       | $                       | 1,666      |                        | $          | 716 |   |
| Receivables:                                                                                    |       |                    |       |                        |       |
| Financing leases                                                                                |       | 3,471                   |       | 3,573                       |       |
| Notes and other receivables                                                                     |       | 2,488                   |       | 2,379                       |       |
|                                                                                            |       | 5,959                   |       | 5,952                       |       |
| Allowance for losses on receivables                                                             |       | (302                    | )          | (303                        | )          |
|                                                                                            |       | 5,657                   |       | 5,649                       |       |
|                                                                                            |       |                    |       |                        |       |
| Equipment under operating leases, net of  accumulated depreciation                              |       | 3,492                   |       | 3,406                       |       |
| Investments                                                                                     |       | 432                     |       | 475                         |       |
| Equipment held for sale or re-lease, net of  accumulated depreciation                           |       | 148                     |       | 232                         |       |
| Assets of discontinued operations                                                               |       | 571                     |       | 2,135                       |       |
| Other assets                                                                                    |       | 164                     |       | 223                         |       |
|                                                                                            |       | $                       | 12,130     |                        | $          | 12,836 |   |
|                                                                                            |       |                    |       |                        |       |
| LIABILITIES AND SHAREHOLDER’S EQUITY                                                       |       |                    |       |                        |       |
| Liabilities:                                                                                    |       |                    |       |                        |       |
| Accounts payable and accrued expenses                                                           |       | $                       | 205        |                        | $          | 156 |   |
| Other liabilities                                                                               |       | 363                     |       | 249                         |       |
| Accounts due to Boeing and Boeing Capital  Services Corporation                                 |       | 226                     |       | 58                          |       |
| Deferred income taxes                                                                           |       | 1,086                   |       | 1,242                       |       |
| Debt:                                                                                           |       |                    |       |                        |       |
| Senior                                                                                          |       | 8,432                   |       | 9,153                       |       |
| Subordinated                                                                                    |       | 24                      |       | 24                          |       |
|                                                                                            |       | 10,336                  |       | 10,882                      |       |
|                                                                                            |       |                    |       |                        |       |
| Commitments and contingencies – Note 9                                                     |       |                    |       |                        |       |
|                                                                                            |       |                    |       |                        |       |
| Minority interest                                                                               |       | 9                       |       | 12                          |       |
|                                                                                            |       |                    |       |                        |       |
| Shareholder’s equity:                                                                      |       |                    |       |                        |       |
| Common stock - $100 par value; authorized  100,000 shares; shares issued and outstanding 50,000 |       | 5                       |       | 5                           |       |
| Capital in excess of par value                                                                  |       | 1,267                   |       | 1,263                       |       |
| Accumulated other comprehensive loss, net  of tax                                               |       | —                  |       | (10                         | )          |
| Income retained for growth                                                                      |       | 513                     |       | 684                         |       |
|                                                                                            |       | 1,785                   |       | 1,942                       |       |
|                                                                                            |       | $                       | 12,130     |                        | $          | 12,836 |   |

 

See Notes to Condensed Consolidated FinancialStatements.

 

3

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**Boeing Capital Corporation and Subsidiaries**

## **Condensed ConsolidatedStatements of Operations**

(Unaudited)

 
| ** **                                                                            | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| **(Dollars  in millions)**                                                            | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| REVENUES                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Finance lease income                                                                  |       | $                                     | 58         |                                | $          | 58 |   | $ | 115 |   | $ | 118 |   |
| Interest income on notes receivable                                                   |       | 47                                    |       | 40                                  |       | 92 |   | 78 |   |
| Operating lease income                                                                |       | 107                                   |       | 102                                 |       | 216 |   | 204 |   |
| Investment income                                                                     |       | 10                                    |       | 14                                  |       | 20 |   | 25 |   |
| Net gain (loss) on disposal                                                           |       | 1                                     |       | —                              |       | 19 |   | (2 | ) |
| Other                                                                                 |       | 6                                     |       | 18                                  |       | 18 |   | 33 |   |
|                                                                                  |       | 229                                   |       | 232                                 |       | 480 |   | 456 |   |
|                                                                                  |       |                                  |       |                                |       |   |   |   |   |
| Equity in loss from joint venture                                                     |       | —                                |       | —                              |       | — |   | (1 | ) |
|                                                                                  |       | 229                                   |       | 232                                 |       | 480 |   | 455 |   |
| EXPENSES                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Interest expense                                                                      |       | 89                                    |       | 90                                  |       | 173 |   | 179 |   |
| Depreciation expense                                                                  |       | 54                                    |       | 52                                  |       | 109 |   | 103 |   |
| Provision for losses                                                                  |       | 4                                     |       | 4                                   |       | 9 |   | 140 |   |
| Operating expenses                                                                    |       | 16                                    |       | 14                                  |       | 28 |   | 25 |   |
| Asset impairment expense                                                              |       | 31                                    |       | 8                                   |       | 44 |   | 48 |   |
| Other                                                                                 |       | 22                                    |       | 4                                   |       | 32 |   | 26 |   |
|                                                                                  |       | 216                                   |       | 172                                 |       | 395 |   | 521 |   |
|                                                                                  |       |                                  |       |                                |       |   |   |   |   |
| Minority interest                                                                     |       | 2                                     |       | —                              |       | 3 |   | — |   |
|                                                                                  |       |                                  |       |                                |       |   |   |   |   |
| Income (loss) from continuing operations  before provision (benefit) for income taxes |       | 15                                    |       | 60                                  |       | 88 |   | (66 | ) |
| Provision (benefit) for income taxes                                                  |       | 3                                     |       | 21                                  |       | 29 |   | (33 | ) |
| Income (loss) from continuing operations                                              |       | 12                                    |       | 39                                  |       | 59 |   | (33 | ) |
|                                                                                  |       |                                  |       |                                |       |   |   |   |   |
| Income from discontinued operations, net of  tax                                      |       | 7                                     |       | 8                                   |       | 16 |   | 16 |   |
| Net gain on disposal of discontinued  operations, net of tax                          |       | 14                                    |       | —                              |       | 14 |   | — |   |
| Net income (loss)                                                                     |       | $                                     | 33         |                                | $          | 47 |   | $ | 89 |   | $ | (17 | ) |

 

See Notes to Condensed Consolidated FinancialStatements.

 

4

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**Boeing Capital**** ****Corporation andSubsidiaries**

CondensedConsolidated Statements of Shareholder’s Equity and Comprehensive Income (Loss)

(Unaudited)

 
| **(Dollars in millions, except  stated value)**                                | ** ** | **Total** | ** ** | **Common  Stock** | ** ** | **Capital in  Excess of  Par Value** | ** ** | **Accumulated  Other  Comprehensive  Loss** | ** ** | **Income  Retained  for Growth** | ** ** | **Comprehensive  Income (Loss)** | ** ** |
|--------------------------------------------------------------------------------|------------|-----------|------------|-------------------|------------|--------------------------------------|------------|---------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| **Balance at January 1, 2003**                                            | ** ** | **$**     | **1,656**  | ** **        | **$**      | **5**                                | ** ** | **$**                                       | **1,090**  | ** **                       | **$**      | **(17**                          | **)**      | **$** | **578** | ** ** | ** ** | ** ** | ** ** |
| Capital contributions from Boeing and  Boeing Capital Services Corporation (1) |       | 117       |       | —            |       | 117                                  |       | —                                      |       | —                           |       |                             |       |   |
| Net loss                                                                       |       | (17       | )          | —            |       | —                               |       | —                                      |       | (17                              | )          |                             | $          | (17 | ) |
| Unrealized gain on derivative instruments, net of  tax                         |       | 2         |       | —            |       | —                               |       | 2                                           |       | —                           |       |                             | 2          |   |
| Unrealized gain on investments, net of tax                                     |       | 2         |       | —            |       | —                               |       | 2                                           |       | —                           |       |                             | 2          |   |
| **Balance at June 30, 2003**                                              | ** ** | **$**     | **1,760**  | ** **        | **$**      | **5**                                | ** ** | **$**                                       | **1,207**  | ** **                       | **$**      | **(13**                          | **)**      | **$** | **561** | ** ** | ** ** | **$** | **(13** | **)** |
| ** **                                                                     |       |      |       |              |       |                                 |       |                                        |       |                             |       |                             |       |   |
| **Balance at January 1, 2004**                                            | ** ** | **$**     | **1,942**  | ** **        | **$**      | **5**                                | ** ** | **$**                                       | **1,263**  | ** **                       | **$**      | **(10**                          | **)**      | **$** | **684** | ** ** | ** ** | ** ** | ** ** |
| Capital contributions from Boeing and  Boeing Capital Services Corporation (2) |       | 4         |       | —            |       | 4                                    |       | —                                      |       | —                           |       |                             |       |   |
| Cash dividends to Boeing                                                       |       | (260      | )          | —            |       | —                               |       | —                                      |       | (260                             | )          |                             |       |   |
| Net income                                                                     |       | 89        |       | —            |       | —                               |       | —                                      |       | 89                               |       |                             | $          | 89 |   |
| Reclassification adjustment for losses realized in  net income, net of tax     |       | 10        |       | —            |       | —                               |       | 10                                          |       | —                           |       |                             | 10         |   |
| Unrealized gain on derivative instruments, net of  tax                         |       | 1         |       | —            |       | —                               |       | 1                                           |       | —                           |       |                             | 1          |   |
| Unrealized loss on investments, net of tax                                     |       | (1        | )          | —            |       | —                               |       | (1                                          | )          | —                           |       |                             | (1         | ) |
| **Balance at June 30, 2004**                                              | ** ** | **$**     | **1,785**  | ** **        | **$**      | **5**                                | ** ** | **$**                                       | **1,267**  | ** **                       | **$**      | **—**                       | ** ** | **$** | **513** | ** ** | ** ** | **$** | **99** | ** ** |

 

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(1)          Balance represents$114 million of cash contributions and $3 million of non-cash contributionsfrom Boeing and Boeing Capital Services Corporation.

(2)          Balance represents$4 million of non-cash contributions from Boeing and Boeing Capital ServicesCorporation.

 

We have authorized 100,000 shares of Series Apreferred stock with no par value and a $5,000 stated value. No shares wereissued and outstanding at June 30, 2004 and 2003.

 

See Notes to Condensed Consolidated FinancialStatements.

 

5

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**Boeing Capital**** ****Corporation andSubsidiaries**

CondensedConsolidated Statements of Cash Flows

(Unaudited)

 
| ** **                                                                                | ** ** | **Six Months Ended****June 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| **(Dollars  in millions)**                                                                | ** ** | **2004**                              | ** ** | **2003** | ** ** |
| OPERATING ACTIVITIES                                                                      |       |                                  |       |   |   |
| Net income (loss) (1)                                                                     |       | $                                     | 89         |   | $ | (17 | ) |
| Adjustments to reconcile net income (loss) to net  cash provided by operating activities: |       |                                  |       |   |   |
| Depreciation and amortization expense                                                     |       | 111                                   |       | 105 |   |
| Net gain on disposal of discontinued operations                                           |       | (21                                   | )          | — |   |
| Net (gain) loss on disposal                                                               |       | (32                                   | )          | (2 | ) |
| Provision for losses                                                                      |       | 9                                     |       | 140 |   |
| Net (gain) loss on derivative instruments and  investments                                |       | (11                                   | )          | (41 | ) |
| Asset impairment and other related charges                                                |       | 45                                    |       | 70 |   |
| Share-based plans expense                                                                 |       | 4                                     |       | 3 |   |
| Other non-cash adjustments related to discontinued  operations                            |       | 26                                    |       | 37 |   |
| Benefit from deferred income taxes                                                        |       | (161                                  | )          | (13 | ) |
| Change in assets and liabilities:                                                         |       |                                  |       |   |   |
| Other assets                                                                              |       | (12                                   | )          | 16 |   |
| Accrued interest                                                                          |       | 42                                    |       | 2 |   |
| Accounts payable and accrued expenses                                                     |       | 49                                    |       | (6 | ) |
| Other liabilities                                                                         |       | (52                                   | )          | (25 | ) |
| Accounts with Boeing and Boeing Capital Services  Corporation                             |       | 179                                   |       | 136 |   |
| Other                                                                                     |       | 1                                     |       | (1 | ) |
| Net cash provided by operating activities                                                 |       | 266                                   |       | 404 |   |
|                                                                                      |       |                                  |       |   |   |
| INVESTING ACTIVITIES                                                                      |       |                                  |       |   |   |
| Proceeds from disposal of discontinued operations                                         |       | 1,581                                 |       | — |   |
| Net change in short-term leases, notes and other  receivables                             |       | —                                |       | 93 |   |
| Purchase of investments                                                                   |       | (10                                   | )          | (55 | ) |
| Proceeds from available-for-sale investments                                              |       | 21                                    |       | 15 |   |
| Proceeds from held-to-maturity investments                                                |       | 37                                    |       | 34 |   |
| Purchase of equipment for operating leases                                                |       | (138                                  | )          | (292 | ) |
| Proceeds from disposition of equipment and  receivables                                   |       | 109                                   |       | 96 |   |
| Collection of leases, notes and other receivables                                         |       | 155                                   |       | 265 |   |
| Collection of leases, notes and other receivables  of discontinued operations             |       | 106                                   |       | 117 |   |
| Origination of leases, notes and other receivables                                        |       | (253                                  | )          | (674 | ) |
| Net cash provided (used) by investing activities                                          |       | 1,608                                 |       | (401 | ) |
|                                                                                      |       |                                  |       |   |   |
| FINANCING ACTIVITIES                                                                      |       |                                  |       |   |   |
| Net change in commercial paper and short-term bank  debt                                  |       | —                                |       | (73 | ) |
| Proceeds from issuance of debt                                                            |       | —                                |       | 152 |   |
| Repayment of debt                                                                         |       | (664                                  | )          | (308 | ) |
| Cash dividends paid to Boeing                                                             |       | (260                                  | )          | — |   |
| Capital contributions from Boeing and Boeing Capital  Services Corporation                |       | —                                |       | 114 |   |
| Net cash used by financing activities                                                     |       | (924                                  | )          | (115 | ) |
| Net increase (decrease) in cash and cash  equivalents                                     |       | 950                                   |       | (112 | ) |
| Cash and cash equivalents at beginning of year                                            |       | 716                                   |       | 686 |   |
| Cash and cash equivalents at end of period                                                |       | $                                     | 1,666      |   | $ | 574 |   |

 

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(1)          Includes net income of $30 million and $16 million from discontinuedoperations for the six months ended June 30, 2004 and 2003, respectively.

 

See Notes to Condensed Consolidated FinancialStatements.

 

6

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| ** **                                                                 | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------------------|------------|
| **(Dollars  in millions)**                                                 | ** ** | **2004**                            | ** ** | **2003** | ** ** |
| NON-CASH INVESTING AND FINANCING  ACTIVITIES:                              |       |                                |       |   |   |
| Decrease to notes and other receivables                                    |       | $                                   | —     |   | $ | 4 |   |
| Decrease to available-for-sale investments                                 |       | $                                   | —     |   | $ | 5 |   |
| Addition to other assets                                                   |       | $                                   | —     |   | $ | (5 | ) |
| Change in accounts with Boeing and Boeing  Capital Services Corporation    |       | $                                   | —     |   | $ | (4 | ) |
| Mark-to-market for fair value hedge  derivatives and underlying debt       |       | $                                   | (61        | ) | $ | 29 |   |
| Capital contributions from Boeing and  Boeing Capital Services Corporation |       | $                                   | 4          |   | $ | 3 |   |

 

SeeNotes to Condensed Consolidated Financial Statements.

 

7

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**Boeing Capital********Corporation andSubsidiaries**

###### Notes to Condensed Consolidated Financial Statements

June 30, 2004

(Unaudited)

 

**Note 1 – Basis of Presentation**

 

Boeing Capital Corporation (together with itssubsidiaries, referred to as “us”, “we”, “our” or the “Company”) is an indirectwholly owned subsidiary of The Boeing Company (“Boeing”). Boeing CapitalServices Corporation owns 100% of our stock and is an indirect wholly ownedsubsidiary of Boeing and a largely inactive holding company. We prepared theaccompanying unaudited condensed consolidated financial statements inaccordance with accounting principles generally accepted in the United Statesof America for interim financial information and with the instructions to Form10-Q and Article 10 of Regulation S-X. Accordingly, they do not includeall of the information and footnotes required by accounting principlesgenerally accepted in the United States of America for complete financialstatements. In our opinion, the accompanying condensed consolidated financialstatements reflect all adjustments, consisting of normal recurring accruals,that are necessary to present fairly the condensed consolidated balance sheetsand the related condensed consolidated statements of operations, shareholder’sequity and comprehensive income (loss) and cash flows for the interim periodspresented. Operating results for the six-month period ended June 30, 2004,are not necessarily indicative of the results that may be expected for the yearending December 31, 2004. The condensed consolidated financial statementsshould be read in conjunction with the notes to consolidated financialstatements included in our Form 10-K for the year ended December 31, 2003,which contains the latest available audited consolidated financial statementsand notes.

 

Certain reclassifications of previously reportedamounts have been made in the condensed consolidated financial statements toconform to current reporting.

 

As discussed in Note 2, on May 24, 2004,we entered into a purchase and sale agreement with General Electric CapitalCorporation (“GECC”) to sell substantially all of the assets related to ourCommercial Financial Services business. The purchase agreement called for thesale of the assets to take place in a series of closings, commencing onMay 31, 2004 and ending no later than July 30, 2004. We intend todispose of the remaining assets identified to the Commercial Financial Servicesbusiness that are not subject to the purchase and sale agreement with GECC. Asa result, our condensed consolidated financial statements and related footnotedisclosures reflect the Commercial Financial Services business as discontinuedoperations for all periods. In addition, unless specifically noted, amountsdisclosed in the notes to condensed consolidated financial statements are fromcontinuing operations.

 

In conjunction with the disposal of our CommercialFinancial Services business and consistent with our strategic priority tosupport the sale of Boeing products and services by arranging, structuring orproviding financing, we reassessed our external segment reporting structure inaccordance with Statement of Financial Accounting Standards (“SFAS”)No. 131, “Disclosures about Segments of an Enterprise and RelatedInformation.” This reassessment included an evaluation of our internaloperating structure, which took into account the level for which managementmakes operating decisions and assesses performance, as well as the economiccharacteristics shared by our internal operating segments. Accordingly, wedetermined we have one reportable segment for external segment reportingpurposes, primarily consisting of our Aircraft Financial Services business.

 

**Note 2 – Discontinued Operations**

 

OnMay 2, 2004, Boeing’s Board of Directors approved a plan to sell all ofthe assets and business operations of our Commercial Financial Servicesbusiness. This plan was approved by our Board of Directors on May 21,2004. On May 24, 2004, we entered into a purchase and sale agreement withGECC to sell substantially all of the assets related to our CommercialFinancial Services business. The assets to be sold to GECC consist of leasesand financing arrangements having a carrying value of $1.9 billion as ofMay 31, 2004. The purchase agreement called for the sale of the assets totake place in a series of closings, commencing on May 31, 2004 and endingno later than July 30, 2004. Final closing may occur subsequent toJuly 30, 2004, subject to mutual agreement between the parties.

 

8

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Asof June 30, 2004, we had received $1.6 billion in cash proceeds from thissale, and we expect to receive approximately $450 million in additional cashproceeds through the date of the completion of the sales. The purchase price tobe paid for the assets transferred at each closing is determined based on thenet asset value of the assets, plus a total premium of $140 million. Thepurchase price is subject to adjustment after closing based on an independentaudit of our determination of net asset value, and further adjustments based ongains or losses on assets after closing.

 

Basedupon an analysis that considered collateral values and the creditworthiness ofthe counterparties, we established a liability of $90 million at June 30,2004, attributable to the assets sold, which included $54 million previouslyreported as an allowance for losses on receivables transferred to GECC.****Future adjustments may be taken as circumstances dictate.

 

Weintend to dispose of the remaining assets identified to the CommercialFinancial Services business that are not subject to the purchase and saleagreement with GECC. As a result, our condensed consolidated financialstatements and related footnote disclosures reflect the Commercial FinancialServices business as discontinued operations. Income associated with theCommercial Financial Services business, net of applicable income taxes, isshown as income from discontinued operations for all periods presented inaccordance with SFAS No. 144, “Accounting for the Impairment or Disposalof Long-Lived Assets.” In addition, the assets of this business have been reclassifiedand presented as assets of discontinued operations. There are no liabilitiesrelated to the Commercial Financial Services business that will be assumed byGECC or other buyers.

 

Inthe second quarter of 2004, we recognized a net gain on disposal ofdiscontinued operations of $21 million ($14 million net of tax). This includeda gain of $38 million ($25 million net of tax) related to the sale of assets toGECC and a loss of $17 million ($11 million net of tax) related to therevaluation of the remaining Commercial Financial Services assets to the lowerof carrying value or fair value less costs to sell. This revaluation loss related principally to two 737 Boeing Business Jets(“BBJs”) on lease to Boeing and are part of the Commercial Financial Servicesportfolio classified as assets of discontinued operations. Early termination ofthe lease under terms of the intercompany contract would have required Boeingto purchase the BBJs for a stipulated amount based on the date of thetermination. Since we, as well as Boeing, will report the Commercial FinancialServices business as discontinued operations following the same basis ofaccounting, we recorded the valuation loss on the BBJs, which we continue toown, and elected not to enforce Boeing’s obligation to purchase the BBJs at thecontractually stipulated value. Both parties elected to terminate theintercompany lease on May 31, 2004. As a result, our reported net gain ondisposal of discontinued operations will be the same as that reported by ourparent, Boeing. We will realize the proceeds of any future dispositions,including any related gains or losses.

 

Uponcompletion of the sale to GECC, we expect to recognize a total gain ofapproximately $42 million ($27 million net of tax).

 

Operatingresults of the discontinued operations were as follows:

 
| ** **                                                   | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended   June 30,** | ** ** |
|--------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| **(Dollars in millions)**                                    | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenues                                                     |       | $                                     | 40         |                                 | $          | 55 |   | $ | 96 |   | $ | 114 |   |
|                                                         |       |                                  |       |                                 |       |   |   |   |   |
| Income from discontinued operations                          |       | $                                     | 11         |                                 | $          | 12 |   | $ | 25 |   | $ | 25 |   |
| Provision for income taxes                                   |       | 4                                     |       | 4                                    |       | 9 |   | 9 |   |
| Income from discontinued operations, net of  tax             |       | $                                     | 7          |                                 | $          | 8 |   | $ | 16 |   | $ | 16 |   |
|                                                         |       |                                  |       |                                 |       |   |   |   |   |
| Net gain on disposal of discontinued  operations             |       | $                                     | 21         |                                 | $          | — |   | $ | 21 |   | $ | — |   |
| Provision for income taxes                                   |       | 7                                     |       | —                               |       | 7 |   | — |   |
| Net gain on disposal of discontinued  operations, net of tax |       | $                                     | 14         |                                 | $          | — |   | $ | 14 |   | $ | — |   |

 

9

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Themajor classes of assets related to discontinued operations, all of which wereheld for sale, were as follows:

 
| **(Dollars in millions)**                                             | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-----------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Financing leases                                                      |       | $                       | 135        |                        | $          | 724 |   |
| Notes and other receivables                                           |       | 167                     |       | 727                         |       |
| Allowance for losses on receivables                                   |       | —                  |       | (48                         | )          |
| Equipment under operating leases, net of  accumulated depreciation    |       | 182                     |       | 686                         |       |
| Equipment held for sale or re-lease, net of  accumulated depreciation |       | 87                      |       | 46                          |       |
| Assets of discontinued operations                                     |       | $                       | 571        |                        | $          | 2,135 |   |

 

**Note 3 – Portfolio Quality**

 
| **(Dollars  in millions)**                                                              | ** ** | **June 30,****2004** | ** ** | **December 31,  2003** | ** ** |
|-----------------------------------------------------------------------------------------|------------|---------------------------|------------|-----------------------------|------------|
| Receivables:                                                                            |       |                      |       |                        |       |
| Financing leases                                                                        |       | $                         | 3,471      |                        | $          | 3,573 |   |
| Notes and other receivables                                                             |       | 2,488                     |       | 2,379                       |       |
|                                                                                    |       | 5,959                     |       | 5,952                       |       |
|                                                                                    |       |                      |       |                        |       |
| Equipment under operating leases, net of  accumulated depreciation                      |       | 3,492                     |       | 3,406                       |       |
| Investments                                                                             |       | 432                       |       | 475                         |       |
| Equipment held for sale or re-lease, net of  accumulated depreciation                   |       | 148                       |       | 232                         |       |
| Total portfolio                                                                         |       | $                         | 10,031     |                        | $          | 10,065 |   |
|                                                                                    |       |                      |       |                        |       |
| Non-performing assets:                                                                  |       |                      |       |                        |       |
| Nonaccrual receivables                                                                  |       | $                         | 419        |                        | $          | 450 |   |
| Non-performing equipment under operating leases,  net of  accumulated depreciation |       | 75                        |       | 77                          |       |
| Equipment held for sale or re-lease, net of  accumulated depreciation                   |       | 148                       |       | 232                         |       |
|                                                                                    |       | $                         | 642        |                        | $          | 759 |   |
|                                                                                    |       |                      |       |                        |       |
| Ratio of nonaccrual receivables to total  receivables                                   |       | 7.0                       | %          | 7.6                         | %          |
| Ratio of total non-performing assets to total  portfolio                                |       | 6.4                       | %          | 7.5                         | %          |

 

Incomerecognition on an accrual basis is generally suspended for leases and notes andother receivables at the date when a full recovery of income and principalbecomes doubtful. Accounts greater than 90 days past due are generally placedon non-accrual. Income recognition is resumed when the lease or notes and otherreceivables become contractually current and performance is demonstrated tohave been resumed. To the extent that income is accruable under contractualterms, any cash received in the interim is recorded to income. During the sixmonths ended June 30, 2004, we received cash of $12 million and reportedincome of $12 million.

 

Atboth June 30, 2004 and December 31, 2003, we had no receivables orequipment under operating leases with amounts past due greater than 90 dayswith income still accruing.

 

10

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**Note 4 – Allowance for Losses onReceivables**

 
| ** **                                                                                        | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| **(Dollars  in millions)**                                                                        | ** ** | **2004**                           | ** ** | **2003** | ** ** |
| Allowance for losses on receivables at beginning  of year                                         |       | $                                  | 303        |   | $ | 219 |   |
| Provision for losses                                                                              |       | 9                                  |       | 140 |   |
| Write-offs, net of recoveries                                                                     |       | (21                                | )          | (9 | ) |
| Allowance transferred from Boeing and Boeing  Capital Services Corporation                        |       | 11                                 |       | — |   |
| Allowance for losses on receivables at end of  period                                             |       | $                                  | 302        |   | $ | 350 |   |
|                                                                                              |       |                               |       |   |   |
| Allowance as a percentage of total receivables                                                    |       | 5.1                                | %          | 5.9 | % |
| Net write-offs as a percentage of average  receivables                                            |       | 0.3                                | %          | 0.2 | % |
|                                                                                              |       |                               |       |   |   |
| More than 90 days delinquent:                                                                     |       |                               |       |   |   |
| Amount of delinquent installments                                                                 |       | $                                  | 11         |   | $ | 26 |   |
| Total receivable balance related to delinquent  installments                                      |       | $                                  | 237        |   | $ | 740 |   |
| Total receivable balance related to delinquent  installments as a percentage of total receivables |       | 4.0                                | %          | 12.4 | % |
| Total of all receivables due from delinquent  obligors                                            |       | $                                  | 419        |   | $ | 1,704 |   |
| Total of all receivables due from delinquent  obligors as a percentage of total receivables       |       | 7.0                                | %          | 28.5 | % |

 

AtJune 30, 2004 and 2003, Hawaiian Holdings, Inc. (“Hawaiian”) represented$412 million and $463 million, respectively, of our total receivablesportfolio. Of this amount, $230 million and $95 million represented receivablesthat had installments of $5 million and $4 million that were more than 90 daysdelinquent at June 30, 2004 and 2003, respectively.

 

Our portfolio at the end of the second quarter of2004 totaled $10.0 billion, of which $9.2 billion was related to Boeingproducts, primarily commercial aircraft. While monthly traffic levels continueto be at or above traffic levels carried by the airlines in 2000, the effects ofthe 2001 to 2003 airline industry downturn continue to impact commercialaircraft values. Published sources and recent market transactions indicate thatvalues for various aircraft types serving as collateral in our portfolio remaindepressed. Older and/or out-of-production aircraft types have experienced themost significant declines in value, while newer aircraft types have experiencedmore moderate declines. Aircraft valuations could decline materially ifsignificant numbers of aircraft, particularly types with relatively fewoperators, are idled on account of further airline bankruptcies orrestructurings. At the same time, the credit ratings of many airlines,particularly in the United States, have remained at low levels.

 

InOctober 2003, Boeing announced the decision to end production of the 757program, with the final aircraft scheduled to be produced in late 2004.Closures of other aircraft programs in the past have not necessarily causedextraordinary declines in the secondary value of the aircraft involved.However, due to the impacts of September 11, 2001 and the prolongeddownturn in the airline industry, 757 aircraft values have already declined.While we continue to believe in the utility and marketability of the 757aircraft, we are unable to predict whether or how the end of the 757 program,as well as overall market conditions, may impact 757 aircraft values and rentalrates. At June 30, 2004, $1.6 billion of our portfolio was collateralizedby 757 aircraft. This included $1.3 billion of passenger aircraft (35 aircraftat 11 operators). At June 30, 2004, we were the beneficiary underguarantees from Boeing covering $633 million of this portion of our portfolio.The remainder of the 757 portfolio consisted of converted freighters on long-termlease. Should the 757 aircraft suffer a significant decline in utility andmarket acceptance, the aircraft values may decline, which in turn could alsoresult in an increase to the allowance for losses on receivables. While we areunable to predict the likelihood of these impacts occurring, such impacts couldresult in a potential material adverse effect on our earnings, cash flowsand/or financial position.

 

11

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The717 program continuity is dependent on the outcome of Boeing’s current salescampaigns. While we continue to believe in the utility and marketability of the717 aircraft, we are unable to predict whether or how an ending of the 717program, as well as overall market conditions, would impact 717 aircraft valuesand rental rates. At June 30, 2004, $2.3 billion of our portfolio wascollateralized by 717 aircraft. At June 30, 2004, we were the beneficiaryunder $1.6 billion of guarantees from Boeing covering $2.2 billion of ourportfolio. Should the 717 aircraft suffer a significant decline in utility andmarket acceptance, the aircraft values may decline, which in turn could alsoresult in an increase to the allowance for losses on receivables. While we areunable to predict the likelihood of these impacts occurring, such impacts couldresult in a potential material adverse effect on our earnings, cash flowsand/or financial position.

 

Inaccordance with SFAS No. 114, “Accounting by Creditors for Impairment of aLoan,” we review a receivable for impairment when, based on current informationand events, it is probable that we will be unable to collect amounts dueaccording to the original contractual terms of the receivable agreement,without regard to any subsequent restructurings. Factors considered in assessinguncollectibility include, but are not limited to, a customer’s extendeddelinquency, requests for restructuring and filings for bankruptcy. Wedetermine a specific impairment allowance based on the difference between thecarrying value of the receivable and the estimated fair value of the relatedcollateral. Each quarter, we review customer credit ratings, publishedhistorical credit default rates, Boeing and other guarantees (if applicable)and third-party aircraft valuations as a basis to validate the reasonablenessof the allowance for losses on receivables. There can be no assurance thatactual results will not differ from estimates and values or that considerationof these factors in the future will not result in an increase to the allowance forlosses on receivables.

 

Thecarrying amounts of impaired receivables are as follows:

 
| **(Dollars  in millions)**                               | ** ** | **June 30,  2004** | ** ** | **December 31,****2003** | ** ** |
|----------------------------------------------------------|------------|-------------------------|------------|-------------------------------|------------|
| Impaired receivables with specific impairment  allowance |       | $                       | 489        |                          | $          | 483 |   |
| Impaired receivables with no specific allowance  (1)     |       | 1,116                   |       | 1,122                         |       |
|                                                     |       | $                       | 1,605      |                          | $          | 1,605 |   |

 

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(1)          Of the $1,116million and $1,122 million at June 30, 2004 and December 31, 2003,respectively, $1,073 million and $1,076 million, respectively, related to thereceivables from United Airlines (“United”) secured by 767 aircraft and 777aircraft. During the third quarter of 2003, we completed a restructuring ofthese receivables, as discussed further in Note 9. Although United isperforming under the terms of the restructuring at June 30, 2004, accordingto the guidelines of SFAS No. 114, any receivable not performing under theoriginal contract terms, even though it is performing under the restructuredagreement, continues to be deemed impaired.

 

Theallocation of the allowance for losses on receivables between specific reservesand general purposes is as follows:

 
| **(Dollars  in millions)**         | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Allocated to specific reserves     |       | $                       | 110        |                        | 36.4       | % | $ | 105 |   | 34.7 | % |
| Allocated for general purposes (1) |       | 192                     |       | 63.6                        |       | 198 |   | 65.3 |   |
|                               |       | $                       | 302        |                        | 100.0      | % | $ | 303 |   | 100.0 | % |

 

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(1)          The allocationfor general purposes represents our best estimate of losses in the remainingreceivables considering delinquencies, loss experience, collateral values,guarantees, risk of individual credits, historical default rates, results ofperiodic credit reviews and the general state of the economy and airlineindustry.

 

AtJune 30, 2004, we were the beneficiary under $2.9 billion of guarantees,principally from Boeing, with respect to portfolio transactions totaling $4.5billion (45.0% of our total portfolio), which mitigates our risk.

 

12

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**Note 5 – Investments**

 

The following table shows the impact of investmentswe accounted for under SFAS No. 115, “Accounting for Certain Investmentsin Debt and Equity Securities.” We record available-for-sale securities ininvestments at estimated fair value. Unrealized gains/losses ofavailable-for-sale securities are recorded in accumulated other comprehensiveincome/loss, net of tax; however, losses deemed other than temporary arerecorded as asset impairment expense. We record held-to-maturity securities atamortized cost. The unrealized gains/losses of held-to-maturity securities arenot recorded in the condensed consolidated financial statements and are shownin the table below for informational purposes only; however, losses deemedother than temporary are recorded as asset impairment expense.

 

Fairvalues for investment securities are based on quoted market prices from investmentbank dealers, where available. Since the majority of our securities areilliquid non-traded securities, fair values are based on quoted dealerestimates. We substantiate these quoted dealer estimates by performing areasonableness test. Our general practice is to request spread levels over U.S.Treasury benchmarks from dealers and compare those levels to that of similarpublic securities.

 

Available-for-saleand held-to-maturity securities consisted of the following:

 
| **(Dollars  in millions)**    | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gain** | ** ** | **Gross  Unrealized  Loss** | ** ** | **Estimated Fair  Value** | ** ** |
|-------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------|------------|---------------------------|------------|
| **June 30, 2004**        |       |                |       |                        |       |                        |       |                      |       |
| Available-for-Sale            |       | $                   | 11         |                        | $          | —                      |       | $                         | (2         | ) | $ | 9 |   |
| Held-to-Maturity  (1)(3) |       | 422                 | (2)        | —                      |       | (108                        | )          | 314                       |       |
|                          |       | $                   | 433        |                        | $          | —                      |       | $                         | (110       | ) | $ | 323 |   |
|                          |       |                |       |                        |       |                        |       |                      |       |
| **December 31, 2003**    |       |                |       |                        |       |                        |       |                      |       |
| Available-for-Sale            |       | $                   | 20         |                        | $          | 1                           |       | $                         | —     |   | $ | 21 |   |
| Held-to-Maturity (1)          |       | 453                 |       | —                      |       | (57                         | )          | 396                       |       |
|                          |       | $                   | 473        |                        | $          | 1                           |       | $                         | (57        | ) | $ | 417 |   |

 

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(1)          Primarilyconsists of pass-through trust certificates, commonly known as EETCs.

(2)          Related to the$422 million at June 30, 2004, we had $10 million in guarantees fromBoeing and $5 million in guarantees from a third party.

(3)          Thesesecurities have been in a continuous unrealized loss position for 12 months orlonger.

 

AtJune 30, 2004, our held-to-maturity investments included $400 million ofsubordinated debt investments in several EETCs. These EETCs are financingarrangements that are regularly used by airlines to finance pools of aircraft.Our largest holding of EETC investments with a single customer at June 30,2004, was $185 million in D tranche subordinated debt issued by a trustsponsored by Delta Air Lines, Inc. Approximately $369 million of the aboveamount relates to investments that were acquired in 2002. Due to the commercialaviation market downturn, these securities have been in a continuous unrealizedloss position for 12 months or longer. Despite the unrealized loss position ofthese securities, we have concluded that these EETC investments are notother-than-temporarily impaired. This assessment was based on the value of theunderlying collateral to the securities, the term of the securities, and bothinternal and third-party credit reviews and analyses of the counterparties,principally major domestic airlines. Accordingly, we have concluded that it isprobable that we will be able to collect all amounts due according to thecontractual terms of these debt securities.

 

AtJune 30, 2004, our held-to-maturity investments also included $22 millionof investments in mandatorily redeemable preferred stock that had been in acontinuous unrealized loss position for 12 months or longer. Of this amount,$17 million was related to an investment in mandatorily redeemable preferredstock in ATA Holdings Corp. (“ATA”). ATA’s continued financial difficulties ledus to conclude that the unsecured preferred stock investment maturing in 2015is other-than-temporarily impaired. Accordingly, during the second quarter of2004 we lowered the carrying value of this investment to its fair value,resulting in a pre-tax non-cash charge to asset impairment expense of $29million. Of this amount, $17 million of pre-tax unrealized loss ($11 millionnet of tax) was reclassified from accumulated other comprehensive income/lossto asset impairment expense due to the other than temporary impairment of theheld-to-maturity investment.

 

13

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AtJune 30, 2004 and December 31, 2003, none of our available-for-saleand held-to-maturity securities was considered investment grade securities.

 

AtJune 30, 2004, maturities of available-for-sale and held-to-maturitysecurities were as follows:

 
| ** **                 | ** ** | **Available-for-Sale** | ** ** | **Held-to-Maturity**      | ** ** |
|----------------------------|------------|------------------------|------------|---------------------------|------------|
| **(Dollars  in millions)** | ** ** | **Amortized  Cost**    | ** ** | **Estimated  Fair Value** | ** ** | **Amortized  Cost** | ** ** | **Estimated  Fair Value** | ** ** |
| Due from one to five years |       | $                      | —     |                      | $          | — |   | $ | 317 |   | $ | 226 |   |
| Due from six to ten years  |       | 11                     |       | 9                         |       | 57 |   | 45 |   |
| Due after ten years        |       | —                 |       | —                    |       | 48 |   | 43 |   |
|                       |       | $                      | 11         |                      | $          | 9 |   | $ | 422 |   | $ | 314 |   |

 

**Note 6 – Impairment Review for Equipmentunder Operating Leases and Held for Sale or Re-Lease**

 

Whenevents or circumstances indicate (and no less than annually), we review thecarrying amount of all aircraft and equipment under operating lease and heldfor sale or re-lease for potential impairment. For the second quarter of 2004,we reviewed all aircraft and equipment under operating lease and held for saleor re-lease maturing within two years or where known events may indicateimpairment. We recognize an impairment loss for aircraft and equipment underoperating lease and held for re-lease when the expected undiscounted cash flowover the remaining useful life is less than the book value. We use variousassumptions when determining the expected undiscounted cash flow. Theseassumptions include expected future lease rates, lease terms, end of economiclife value of the aircraft or equipment, periods in which the asset may be heldin preparation for a follow-on lease, maintenance costs, remarketing costs andthe remaining economic life of the asset. We state assets held for sale at thelower of carrying amount or fair value less costs to sell.

 

Whenwe determine that impairment is indicated for an asset, the amount of theimpairment loss is the excess of the book value less asset value guarantees, ifapplicable, over the fair value of the asset. For aircraft assets, we use theaverage published value from multiple sources based on the type and age of theasset to determine the fair value. However, if the features or use of theaircraft varies significantly from the generic aircraft attributes covered byoutside publications, we apply judgment based on the attributes of the specificaircraft to determine fair value. For the six months ended June 30, 2004and 2003, we recorded pre-tax non-cash charges totaling $15 million and $48million, respectively, to record impairments of aircraft and equipment underoperating lease and held for sale or re-lease.

 

SeeNote 4 for a discussion on the 757 and 717 programs.

 

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**Note 7 – Debt and CreditAgreements**

 
| **(Dollars  in millions)**                                             | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Senior debt:                                                           |       |                    |       |                        |       |
| Variable rate (three-month LIBOR plus 0.6%)  note due 2012             |       | $                       | 5          |                        | $          | 5 |   |
| 4.75% note due 2008                                                    |       | 494                     |       | 504                         |       |
| 5.65% note due 2006                                                    |       | 1,025                   |       | 1,032                       |       |
| 5.75% note due 2007                                                    |       | 747                     |       | 749                         |       |
| 5.80% note due 2013                                                    |       | 603                     |       | 610                         |       |
| 6.10% note due 2011                                                    |       | 768                     |       | 774                         |       |
| 6.50% note due 2012                                                    |       | 749                     |       | 759                         |       |
| 7.10% note due 2005                                                    |       | 499                     |       | 499                         |       |
| 7.375% note due 2010                                                   |       | 530                     |       | 544                         |       |
| 3.44% Euro medium-term note due 2004                                   |       | 51                      |       | 61                          |       |
| Non-recourse variable rate (one-month LIBOR  plus 1.1%) note due 2012  |       | 42                      |       | 43                          |       |
| 4.84% - 5.79% non-recourse notes due  through 2013                     |       | 40                      |       | 41                          |       |
| 3.15% - 6.75% retail medium-term notes due  through 2017               |       | 874                     |       | 874                         |       |
| 1.59% - 7.64% medium-term notes due through  2023                      |       | 1,702                   |       | 2,240                       |       |
| 1.69% secured debt, proceeds of  securitization due through 2009       |       | —                  |       | 89                          |       |
| 1.67% - 7.35% capital lease obligations due  through 2015              |       | 303                     |       | 329                         |       |
|                                                                   |       | 8,432                   |       | 9,153                       |       |
|                                                                   |       |                    |       |                        |       |
| Subordinated debt:                                                     |       |                    |       |                        |       |
| 8.31% medium-term note due 2004                                        |       | 20                      |       | 20                          |       |
| Non-recourse variable rate note due 2012  (one-month LIBOR plus 2.46%) |       | 4                       |       | 4                           |       |
|                                                                   |       | 24                      |       | 24                          |       |
|                                                                   |       | $                       | 8,456      |                        | $          | 9,177 |   |

 

On February 16, 2001, we filed a public shelfregistration of $5.0 billion of debt securities with the Securities andExchange Commission (“SEC”). As of June 30, 2004, an aggregate amount of$402 million, allocated to our Series XI medium-term program, remains availablefor potential debt issuance.

 

OnFebruary 22, 2002, we filed a public shelf registration of $5.0 billion ofdebt securities with the SEC. As of June 30, 2004, an aggregate amount of$3 billion (which includes $119 million of retail medium-term notes) remainsavailable for potential debt issuance.

 

OnJune 6, 2002, we established a $1.5 billion Euro medium-term note program.As of June 30, 2004, an aggregate amount of $1.4 billion remains availablefor potential debt issuance.

 

Themost restrictive provisions of various debt agreements require us to (a) limitthe payment of cash dividends to the extent that our consolidated assets wouldbe less than 115% of our consolidated liabilities (excluding deferred taxes)after dividend payments and (b) restrict the amount of liens on our property tosecure indebtedness to 15% or less of consolidated assets, other than liensspecifically excluded. At June 30, 2004, as well as during the period, wewere in compliance with these and all debt covenants.

 

SinceNovember 21, 2003, $750 million of Boeing’s five-year revolving creditline expiring in 2008 has been exclusively available to us. This is in additionto $1.25 billion of Boeing’s $2.5 billion 364-day revolving credit line, whichis exclusively available to us. At June 30, 2004, there were no amountsoutstanding under these agreements.

 

OnJuly 26, 2004, we redeemed $1.0 billion face value of our outstanding seniornotes. See Note 12 for a discussion on our July 26, 2004 debt redemption.

 

15

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**Note 8 – Derivative FinancialInstruments**

 

Weaccount for derivatives pursuant to SFAS No. 133, “Accounting forDerivative Instruments and Hedging Activities,” as amended. This standardrequires that we recognize all derivative instruments in the financialstatements and measure them at fair value regardless of the purpose or intentfor holding them.

 

Weare exposed to a variety of market risks, including the effects of changes ininterest rates and foreign currency exchange rates. We manage these exposures,in part, with the use of derivatives. In particular, we enter into interestrate swap and cross currency swap contracts with a number of major financialinstitutions. Since we believe it is unlikely that any of our counterpartieswill be unable to perform under the terms of derivative financial instruments,we generally do not require collateral or other security supporting derivativecontracts with our counterparties. The following is a summary of our riskmanagement strategies and the effect of these strategies on the condensedconsolidated financial statements.

 

*Fair Value Hedges*

 

Interest rate swaps, under which we agree to payvariable rates of interest, are designated as fair value hedges of fixed-ratedebt. For the six months ended June 30, 2004 and 2003, we recorded $8million and $5 million, respectively, of gains related to the basis adjustmentof certain terminated interest rate swaps in interest expense. During the nexttwelve months, we expect to amortize a $16 million gain from the amountrecorded in the basis adjustment of certain terminated fair value hedgerelationships to interest expense.

 

Duringthe first quarter of 2003, we also held forward-starting interest rate swapagreements to fix the cost of funding a firmly committed lease for whichpayment terms are determined in advance of funding. This type of hedgerelationship mitigates the changes in fair value of the hedged portion of thefirm commitment caused by changes in interest rates. The net change in fairvalue of the swap and the hedged portion of the firm commitment is reported inearnings. At the end of the first quarter of 2003, the forward-startinginterest rate swaps no longer qualified for fair value hedge accountingtreatment and we recognized a pre-tax charge of $21 million. For the six monthsended June 30, 2003, we recorded $1 million of losses related toineffectiveness due to the forward-starting interest rate swaps in interestexpense.

 

*Cash Flow Hedges*

 

Thecash flow hedges we use include certain interest rate swaps and cross currencyswaps. Interest rate swap contracts under which we agree to pay fixed rates ofinterest are designated as cash flow hedges of variable-rate debt obligations.In addition, cross currency swap contracts under which we agree to pay fixedfunctional currency rates of interest are designated as cash flow hedges offixed non-functional currency debt obligations. As of June 30, 2004 andDecember 31, 2003, we recorded net unrealized gains of $1.3 million ($0.8million net of tax) and net unrealized losses of $3 million ($2 million net oftax), respectively, in accumulated other comprehensive income/loss associatedwith our cash flow hedging transactions.

 

Forthe six months ended June 30, 2004 and 2003, unrealized losses (net oftax) of $0.3 million and $0.2 million, respectively, included in accumulatedother comprehensive income/loss were reclassified to interest expense (forinterest swaps) or other expense (for cross currency swaps). During the nexttwelve months, we expect to reclassify to interest expense a loss (net of tax)of $1 million from the amount recorded in accumulated other comprehensiveincome/loss.

 

16

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*Non-hedging Derivative Instruments*

 

Wehold certain interest exchange agreements and related interest rate swaps. Theintent of these interest rate swaps is to economically hedge the exposurescreated by the interest exchange agreements. However, since the exposures beinghedged are derivative instruments, this relationship does not qualify for hedgeaccounting. As a result, changes in fair value of both instruments areimmediately recognized in income. As of June 30, 2004 andDecember 31, 2003, we recorded net unrealized losses of $1.1 million ($0.7million net of tax) and $1.4 million ($0.9 million net of tax), respectively,in accumulated other comprehensive income/loss associated with these interestrate swaps. For the six months ended June 30, 2004 and 2003, the interestexchange agreements resulted in realized losses of $6 million and $2 million,respectively, and the related interest rate swaps resulted in gains of $5million and $1 million, respectively. For the six months ended June 30,2004 and 2003, unrealized losses (net of tax) of $0.2 million and $0.4 million,respectively, from accumulated other comprehensive income/loss and gains of $1million and $2 million, respectively, from the basis adjustment to underlyingliabilities were amortized to interest expense. During the next twelve months,we expect to amortize to interest expense a $0.4 million loss (net of tax) fromthe amount recorded in accumulated other comprehensive income/loss and a $2 milliongain from the basis adjustment to underlying liabilities.

 

During2001, we received warrants and a conversion option on notes in connection witha certain financing transaction. In June 2003, the remainder of theconversion feature of the convertible notes was exercised in full and theshares realized were sold in the third quarter of 2003, along with two-thirdsof the warrants, resulting in gains of $9 million. As of June 30, 2004 andDecember 31, 2003, the remaining warrants for this and other transactionswere reflected in other assets at a fair value of $10 million and $8 million,respectively. We recorded the initial fair values of the warrants andconversion option on notes as a discount to notes receivable of $20 million.For the six months ended June 30, 2004 and 2003, the warrants andconversion feature of the convertible notes recorded in other assets hadchanges in fair value, resulting in an addition to other income of $1 millionand $20 million, respectively.

 

**Note 9 – Commitments and Contingencies**

 

*Litigation*

 

Variouslegal proceedings and claims are pending or have been asserted against us, manyof which are covered by third parties, including insurance companies. Webelieve that the final outcome of these proceedings and claims will not have amaterial adverse effect on our earnings, cash flows and/or financial position.

 

*Restructurings and RestructuringRequests*

 

Unitedaccounted for $1.2 billion (11.5%) of our total portfolio at both June 30,2004 and December 31, 2003. At June 30, 2004, the United portfoliowas secured by security interests in two 767 aircraft and 13 777 aircraft andby an ownership and security interests in five 757 aircraft. At June 30,2004, United was our second largest customer. United continues to operate underChapter 11 bankruptcy protection. On June 28, 2004, United’sapplication to obtain federal loan guarantees was denied by the AirlineTransportation Stabilization Board, which also withdrew United’s eligibility toreapply. Subsequent to June 30, 2004, United successfully extended itsdebtor-in-possession financing credit facilities through June 30, 2005subject to approval by the bankruptcy court and increased its available fundsby $500 million. United is continuing to pursue alternative financing throughprivate investors. During the third quarter of 2003, we completed arestructuring of United’s aircraft loans and leases. The receivables associatedwith a security interest in the two 767 aircraft and 13 777 aircraft wererestructured with terms that did not necessitate a troubled debt restructuringcharge to the allowance for losses on receivables. The lease terms attributableto the five 757 aircraft in which we hold an ownership and security interestwere revised in a manner that reclassified these leases as operating leases. AtJune 30, 2004, United was current on all of its obligations related tothese 20 aircraft.

 

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Unitedretains certain rights by operating under Chapter 11 bankruptcyprotection, including the right to reject the restructuring terms with itscreditors and return aircraft, including our aircraft. The terms of ourrestructuring with United, which were approved by the federal bankruptcy court,set forth the terms under which all 20 aircraft financed by us are expected toremain in service upon United’s emergence from Chapter 11 protection. IfUnited exercises its right to reject the agreed upon restructuring terms, theterms of all of the leases and loans with United would immediately revert tothe original terms, which are generally less favorable to United. United wouldretain its rights under Chapter 11 to return our aircraft in the event of areversion to the original lease and loan terms.

 

ATAaccounted for $722 million and $743 million (7.2% and 7.4%) of our totalportfolio at June 30, 2004 and December 31, 2003, respectively. AtJune 30, 2004, the ATA portfolio primarily consisted of 12 757 aircraftand an investment in ATA mandatorily redeemable preferred stock with a facevalue of $50 million. In November 2002, ATA received a loan of $168million administered by the Airline Transportation Stabilization Board. In thethird quarter of 2003, we agreed to restructure certain outstanding leases byextending their terms and deferring a portion of the rent payments for alimited period of time. The terms of the restructured leases did not result ina charge to the allowance for losses on receivables.

 

ATA’s continued financial difficulties led us toconclude that the unsecured preferred stock investment maturing in 2015 isother-than-temporarily impaired. Accordingly, during the second quarter of 2004we lowered the carrying value of this investment to its fair value, resultingin a pre-tax non-cash charge to asset impairment expense of $29 million.

 

Hawaiianaccounted for $481 million and $506 million (4.8% and 5.0%) of our totalportfolio at June 30, 2004 and December 31, 2003, respectively. AtJune 30, 2004, the Hawaiian portfolio primarily consisted of 11 717aircraft and three 767 aircraft. Hawaiian filed for Chapter 11 bankruptcyprotection on March 21, 2003. We permitted Hawaiian to return two 717aircraft leased by us. These 717 aircraft were leased to a third party in thefirst quarter of 2004. In February 2004, we filed in court, as a co-proponentwith Corporate Recovery Group, a plan of reorganization for Hawaiian, whichwould include among other things a revision of our lease terms resulting in asubstantial decrease in our rentals from Hawaiian. Taking into account thespecific reserves allocated for the Hawaiian receivables, we do not expect thatour transactions with Hawaiian will have a material adverse effect on ourearnings, cash flows and/or financial position. In the event that futurenegotiations or proceedings result in the return of a substantial number ofaircraft, there could be a material adverse effect on our earnings, cash flowsand/or financial position, at least until such time as the aircraft are sold orredeployed for adequate consideration.

 

Viacao Aerea Rio-Grandense (“VARIG”) accounted for$415 million and $424 million (4.1% and 4.2%) of our total portfolio atJune 30, 2004 and December 31, 2003, respectively. At June 30,2004, the VARIG portfolio consisted of two 737 aircraft and nine MD-11aircraft. In recent years, VARIG has repeatedly defaulted on its obligationsunder leases with us, which has resulted in deferrals and restructurings, someof which are ongoing. Boeing has provided us with first loss deficiency andpartial rental guarantees covering $322 million of the VARIG obligations.Taking into account these guarantees, we do not expect the VARIG transactions,including the impact of any restructurings, to have a material adverse effecton our earnings, cash flows and/or financial position.

 

We have reviewed our obligations due from ourcustomers for collectibility and have established specific or generalallowances as we deemed necessary. In addition to the customers discussedabove, some other customers have requested a restructuring of theirtransactions with us. We have not reached agreement on any other restructuringrequests that we believe would have a material adverse effect on our earnings,cash flows and/or financial position.

 

*Outstanding Funding Commitments*

 

AtJune 30, 2004, we had commitments to provide leasing and other financingtotaling $110 million, which included $75 million of intercompany commitmentswith Boeing. Based on historical experience, we do not anticipate that all of these commitments will be utilized.However, if we were required to fund all unfunded commitments:

 

•                  up to $110 million may be funded in less than one year.

 

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Additionally,Boeing and Boeing Capital Services Corporation had unfunded aircraft financingcommitments at June 30, 2004 of $3.3 billion. Based on historicalexperience, wedo not anticipate that we will fund all of these commitments. However, if wewere required to fund all unfunded commitments:

 

•                  up to $409 million may be funded in less than one year,

•                  an additional $1.8 billion may be funded in one to three years,

•                  an additional $593 million may be funded in four to five years,and

•                  an additional $493 million may be funded in a period extending beyondfive years.

 

Weexpect to ultimately fund a portion of these unfunded commitments.

 

**Note 10****– Off-BalanceSheet Arrangements**

 

We are a party to off-balance sheet arrangements,including guarantor obligations and variable interests in unconsolidatedentities.

 

*Guarantor Obligations*

 

The following table provides data regarding ourthird party guarantees. The maximum potential payment amounts represent a“worst-case scenario,” and do not necessarily reflect results that we expect.Estimated proceeds from collateral and recourse represent the anticipatedvalues of assets we could liquidate or receive from other parties to offset ourpayments under guarantees. The carrying amount of liabilities recorded on thecondensed consolidated balance sheets reflects our best estimate of futurepayments we may be required to make as part of fulfilling our guarantorobligations.

 
| **(Dollars in millions)**  |   | **Maximum  Potential  Payments** |   | **Estimated  Proceeds  From  Collateral/Recourse** |   | **Carrying  Amount  of Liabilities (2)** |   |
|----------------------------|--------|----------------------------------|--------|----------------------------------------------------|--------|------------------------------------------|--------|
| **June 30, 2004**     |   |                             |   |                                               |   |                                     |   |
| Residual value guarantees  |   | $                                | 75     |                                               | $      | 75                                       |   | $ | 4 |   |
| Deficiency guarantees (1)  |   | 7                                |   | —                                             |   | —                                   |   |
|                       |   | $                                | 82     |                                               | $      | 75                                       |   | $ | 4 |   |
|                       |   |                             |   |                                               |   |                                     |   |
| **December 31, 2003** |   |                             |   |                                               |   |                                     |   |
| Residual value guarantees  |   | $                                | 75     |                                               | $      | 75                                       |   | $ | 4 |   |
| Credit guarantees          |   | 25                               |   | 25                                                 |   | —                                   |   |
| Deficiency guarantees (1)  |   | 7                                |   | —                                             |   | —                                   |   |
|                       |   | $                                | 107    |                                               | $      | 100                                      |   | $ | 4 |   |

 

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(1)          This amount isindemnified by Boeing.

(2)          Amounts includedin other liabilities.

 

We have issued residual value guarantees. Underthese arrangements, we are obligated to make payments to a guaranteed party ifthe related aircraft or equipment fair values fall below a specified amount ata future time. These obligations are collateralized principally by commercialaircraft, and expire within the next six years.

 

We have issued credit and deficiency guarantees.Under these arrangements, we are obligated to make payments to a guaranteedparty if the original debtor or lessee does not make payments. Currentoutstanding credit and deficiency guarantees expire within the next eightyears.

 

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*Material Variable Interests in Unconsolidated Entities*

 

Our investments in ETCs, EETCs and special purposeentities (“SPEs”) are included in the scope of Revised Interpretation No. 46(“FIN 46(R)”), “Consolidation of Variable Interest Entities,” but do notrequire consolidation. Airlines regularly utilize an SPE called a Pass ThroughTrust to finance aircraft. The Pass Through Trust enables the airline to aggregatea large number of aircraft secured notes into one trust vehicle, facilitatingthe issuance of larger bonds called pass-through certificates. The most commonforms of pass-through certificates sponsored by airlines are ETCs and EETCs.ETCs and EETCs provide investors with tranched rights to cash flows from afinancial instrument, as well as a collateral position in the related asset.While the underlying classes of equipment notes vary by maturity and/or coupondepending upon tenor or level of subordination of the specific equipment notesand the corresponding claim on the aircraft, the basic function of the PassThrough Trust in an ETC or EETC remains to passively hold separate debtinvestments to enhance liquidity for investors, who in turn pass this liquiditybenefit directly to the airline in the form of a lower coupon and/or greaterdebt capacity. We participate in several ETCs and EETCs as an investor. We arealso an investor in entities engaged in financing arrangements with thirdparties and are accounting for these investments under the equity method.

 

Additionally, we are a subordinated lender tocertain SPEs that are utilized by the airlines, lenders and loan guarantorsincluding, for example, the Export-Import Bank of the United States. We alsouse other SPEs that are fully consolidated in our financial statements. BothSPE arrangements are used for other business reasons, including:

 

•                  to isolateindividual transactions for legal liability or tax purposes, or

•                  to perfectsecurity interests for us as well as, in some cases, that of third-partylenders in certain leveraged lease transactions.

 

Our receivables from these SPEs and investment inETCs and EETCs aggregated $559 million at June 30, 2004, which representsour maximum exposure to economic loss. During the six months endedJune 30, 2004, we recorded revenues of $25 million and had cash inflows of$78 million relating to these investments. At June 30, 2004, the variableinterest entities (“VIEs”) in which we have invested had total assets of $5.7billion and related debt (which is non-recourse to us) of $5.1 billion.

 

**Note 11 –Transactions with Boeing**

 

Weentered into certain transactions with Boeing in the form of intercompanyguarantees and other subsidies.

 

Intercompany guarantees primarily relate toresidual value guarantees, first loss deficiency guarantees and rentalguarantees. At June 30, 2004, we were the beneficiary under $2.9 billionof guarantees from Boeing. We recorded the following activity under theintercompany guarantee agreements:

 
|                                                                      |   | **Six Months Ended  June 30,** |   |
|---------------------------------------------------------------------------|--------|-------------------------------------|--------|
| **(Dollars in millions)**                                                 |   | **2004**                            |   | **2003** |   |
| Guarantee payments applied to income                                      |   | $                                   | 8      |   | $ | 35 |   |
| Guarantee payments applied to reduce net asset  value of related aircraft |   | 3                                   |   | 10 |   |
|                                                                      |   | 11                                  |   | 45 |   |
| Fees                                                                      |   | (1                                  | )      | (2 | ) |
| Net guarantees received                                                   |   | $                                   | 10     |   | $ | 43 |   |

 

Fora period of time, Boeing has also agreed to provide interest rate subsidies,non-guarantee concessions and rental payments on restructured third partyleases. For the six months ended June 30, 2004 and 2003, we recognizedincome of $21 million and $26 million, respectively, under these agreements.

 

Additionally, as provided for under the terms ofthe intercompany guarantee agreements, Boeing recorded additional charges of$34 million and $52 million, respectively, for the six months endedJune 30, 2004 and 2003, respectively, related to asset impairments,accrued expenses and allowance for losses on receivables in our portfolio.

 

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For the six months ended June 30, 2004 and2003, we recorded financing revenues**(revenuefrom financing leases, notes and other receivables and equipment underoperating leases) from Boeing, exclusive of guarantees and subsidies, of $9million and $13 million, respectively.

 

We recognized new business volume of $376 millionand $784 million for the six months ended June 30, 2004 and 2003,respectively, related to our purchase of aircraft and equipment from Boeing.

 

During the second quarter of 2004, we agreed tonullify an intercompany stipulated loss contract with Boeing on two BBJaircraft. See Note 2 for a discussion on the nullification of the intercompanystipulated loss contract.

 

Additionally, during the second quarter of 2004,$11 million of allowance for losses on receivables was transferred from Boeingpursuant to an intercompany agreement that was subsequently terminated.

 

**Note 12 - Subsequent Event**

 

OnJuly 26, 2004, we exercised our right to redeem $1.0 billion face value ofour outstanding senior notes. This redemption included the entire principalamount, equal to $500 million face value, of our 7.10% senior notes due 2005 ata redemption price equal to 105.30% of the principal amount of the notestogether with interest accrued to the redemption date. We also redeemed $500million face value of our 5.65% senior notes due 2006 at a redemption priceequal to 104.81% of the principal amount of the notes together with interestaccrued to the redemption date. We expect to recognize a loss of $52 millionduring the third quarter of 2004 related to this early debt redemption. Thistransaction will be reflected in our September 30, 2004 condensedconsolidated financial statements. 

 

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**Item 2****.  Management’s Narrative Analysis of Results of Operations**

 

**Forward-Looking Information Is Subject toRisk and Uncertainty**

 

From time to time, we may make statements thatcontain projections or “forward-looking” information (as defined in the PrivateSecurities Litigation Reform Act of 1995) that involve risk and uncertainty.The words “aim”, “plan”, “likely”, “believe”, “expect”, “anticipate”, “intend”,“estimate”, “will”, “should”, “could”, “may”, and other expressions thatindicate future events and trends identify forward-looking statements. Thesestatements are not guaranties of future performance and involve risks,uncertainties and assumptions that are difficult to predict. Forward-lookingstatements are based upon assumptions as to future events that may not prove tobe accurate. Actual outcomes and results may differ materially from what weexpress or forecast in these forward-looking statements. As a result, thesestatements speak only as of the date they were made and we undertake noobligation to publicly update or revise any forward-looking statements. Certain statements in this Form 10-Q, andparticularly in the notes to condensed consolidated financial statements inItem 1 of Part I, Item 2 of Part I, Item 1 of Part II, and Item 5 of Part IImay contain forward-looking information. The subject matter of these statementsmay include, but are not limited to, wars, the effects of theSeptember 11, 2001 terrorist attacks or future terrorist threats orattacks, the effects of Severe Acute Respiratory Syndrome (“SARS”) or otherdiseases, the impact on us of strategic decisions by Boeing, the level of newfinancing opportunities made available to us by Boeing, future earnings, costs,expenditures, losses, liquidity, residual values and various businessenvironment trends including the state of the economy, in general, and theairline industry, in particular. In addition to those contained herein,forward-looking statements and projections may be made by us orally or inwriting including, but not limited to, various sections of our filings with theSecurities and Exchange Commission under the Securities Act of 1933 and theSecurities Exchange Act of 1934.

 

Ouractual results and future trends may differ materially from our forward-looking statements depending ona variety of factors including, but not limited to, our relationship withBoeing, as well as strategic decisions of Boeing relating to us, the effects ofthe September 11, 2001 terrorist attacks or future terrorist threats orattacks and the continuing impact on the airline industry, wars, SARS or otherdiseases, the capital equipment requirements of United States domestic andforeign businesses, general economic conditions, and in particular, economicconditions in the airline industry and the continued operation, viability andgrowth of major airline customers, capital availability and cost, changes inlaws and tax benefits, the tax position of Boeing (including the applicabilityof the alternative minimum tax), competition from other financial institutions,our successful execution of internal operating plans and strategy, includingthe transition of our Long Beach, California administrative groups to Renton,Washington, defaults or bankruptcies by customers (especially airlines),adverse developments in the value of collateral or owned assets (especiallyaircraft), termination of aircraft manufacturing programs, regulatoryuncertainties, legal proceedings and an adverse development in rating agencycredit ratings or assessments.

 

## **Business Environment and Trends**

## ** **

Ourstrategic direction has shifted from a focus on growing the portfolio to afocus on supporting Boeing’s major operating units and managing overallcorporate exposures. For the commercial aircraft market, we facilitate, arrangeand provide financing to Boeing Commercial Airplanes’ customers. For our spaceand defense markets, we primarily engage in arranging and structuring financingsolutions for Boeing’s Integrated Defense Systems’ customers. In addition, weare continuing to enhance our risk management activities to manage exposuresassociated with our current portfolio and future business activities. We expectto satisfy any external funding needs through access to our traditional capitalmarket funding sources.

 

OnMay 24, 2004, we entered into a purchase and sale agreement with GeneralElectric Capital Corporation (“GECC”) to sell substantially all of the assetsrelated to our Commercial Financial Services business. The assets to be sold toGECC consist of leases and financing arrangements having a carrying value of$1.9 billion as of May 31, 2004. The purchase agreement called for thesale of the assets to take place in a series of closings, commencing onMay 31, 2004 and ending no later than July 30, 2004. Final closingmay occur subsequent to July 30, 2004, subject to mutual agreement betweenthe parties. See Note 2 of the notes to condensed consolidated financialstatements for a discussion on the disposition of Commercial FinancialServices.

 

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At June 30, 2004, our primary operationsconsisted of Aircraft Financial Services. Our portfolio consisted of financingleases, notes and other receivables, equipment under operating leases (net ofaccumulated depreciation), investments and equipment held for sale or re-lease(net of accumulated depreciation).

 

Commercialaviation has been impacted by an economic downturn that began in 2001 andcontinued through 2003. In addition, the industry suffered a severe shock fromthe terrorist attacks of September 11, 2001, generating on going travelerconcerns and additional costs for security.

 

World-wideeconomic growth continued during the second quarter of 2004. Led by the strongeconomic growth in the U.S. and China, world air travel levels were at or abovetraffic levels carried by the airlines in 2000. This strong volume of airtravel will not necessarily generate strong airline profits because of a weakpricing environment and persistently high oil and fuel prices. Airlines are inan increasingly competitive situation with fast-growing low-cost, low-fare competitorsplacing significant pricing pressure in an increasing number of air travelmarkets. Persistently high oil and fuel prices are placing cost pressure onairlines, increasing world-wide airline operating costs by billions of dollars.The ability of airlines to pass these costs on to their customers is limited bythe competitive environment. Consequently, some airlines, particularly largeU.S. network carriers, are facing significant losses again in 2004 and may facesignificant financial difficulties. Exogenous shocks still represent furthermajor uncertainties for the airline industry. Recurrence of disease outbreakslike the 2003 SARS outbreak in Asia, new armed conflict, and/or terroristattacks focused on air travel all represent threats to the airline industry’srecovery.

 

Aircraft values and lease ratesare also impacted by the number and type of aircraft that are parked andcurrently out of service. Approximately 1,900 aircraft (11% of world fleet)continue to be parked, including both in production and out of productionaircraft types. This is a decrease of approximately 100 aircraft from thenumber of aircraft parked at March 31, 2004.

 

Published sources and recent market transactionsindicate that values for various aircraft types serving as collateral in ourportfolio remain depressed. At the same time, the credit ratings of manyairlines, particularly in the United States, have remained at low levels. Asubstantial portion of our portfolio is concentrated among U.S. commercialairline customers. Certain customers have filed for bankruptcy protection orrequested lease or loan restructurings; these negotiations were in variousstages as of June 30, 2004. These bankruptcies or restructurings couldhave a material adverse effect on our earnings, cash flows and/or financialposition. See Note 9 of the notes to condensed consolidated financialstatements for a discussion on our restructurings and restructuring requests.

 

In October 2003, Boeing announced the decisionto end production of the 757 program, with the final aircraft scheduled to beproduced in late 2004. Closures of other aircraft programs in the past have notnecessarily caused extraordinary declines in the secondary value of theaircraft involved. However, due to the impacts of September 11, 2001 andthe prolonged downturn in the airline industry, 757 aircraft values havealready declined. While we continue to believe in the utility and marketabilityof the 757 aircraft, we are unable to predict whether or how the end of the 757program, as well as overall market conditions, may impact 757 aircraft valuesand rental rates. At June 30, 2004, $1.6 billion of our portfolio wascollateralized by 757 aircraft. This included $1.3 billion of passengeraircraft (35 aircraft at 11 operators). At June 30, 2004, we were thebeneficiary under guarantees from Boeing covering $633 million of this portionof our portfolio. The remainder of the 757 portfolio consisted of convertedfreighters on long-term lease. Should the 757 aircraft suffer a significant declinein utility and market acceptance, the aircraft values may decline, which inturn could also result in an increase to the allowance for losses onreceivables. While we are unable to predict the likelihood of these impactsoccurring, such impacts could result in a potential material adverse effect onour earnings, cash flows and/or financial position.

 

The717 program continuity is dependent on the outcome of Boeing’s current salescampaigns. While we continue to believe in the utility and marketability of the717 aircraft, we are unable to predict whether or how an ending of the 717program, as well as overall market conditions, would impact 717 aircraft valuesand rental rates. At June 30, 2004, $2.3 billion of our portfolio wascollateralized by 717 aircraft. At June 30, 2004, we were the beneficiaryunder $1.6 billion of guarantees from Boeing covering $2.2 billion of ourportfolio. Should the 717 aircraft suffer a significant decline in utility andmarket acceptance, the aircraft values may decline, which in turn could alsoresult in an increase to the allowance for losses on receivables. While we areunable to predict the likelihood of these impacts occurring, such impacts couldresult in a potential material adverse effect on our earnings, cash flowsand/or financial position.

 

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At June 30, 2004, we had $148 million ofassets that were held for sale or re-lease, of which $70 million wereidentified with a firm contract to sell or place on lease. In the next 12months, leases related to approximately $218 million (2.2%) of our portfolioexpire and we will need to re-lease or sell these assets into the market. If weare unable to place or sell these assets into revenue-generating service, ourresults of operations could be impacted.

 

##### **ConsolidatedResults of Operations**

##### ** **

Overview

 

Ournet income was $89 million for the six months ended June 30, 2004 comparedwith a net loss of $17 million for the same period in 2003, a change of $106million. The increase in net income is primarily attributable to the followingfactors, which are described without tax effect:

 

•                  net gain on disposal of discontinuedoperations of $21 million during the first six months of 2004,

•                  net gains from asset sales of $19 million inthe first six months of 2004 as compared with net losses of $2 million for thesame period in 2003, and

•                  provision for losses of $9 million duringthe first six months of 2004 as compared with $140 million for the same periodin 2003.

 

Wecompleted our portfolio review for the second quarter of 2004. Based uponcurrent market conditions, we recorded asset impairment expense of $31 millionand recorded a $4 million general provision for losses during the secondquarter of 2004. During the six months ended June 30, 2004, we recordedasset impairment expense of $44 million and recorded a $9 million generalprovision for losses. Asset impairment expense during the three and six monthsended June 30, 2004, included $29 million related to an other thantemporary impairment of a held-to-maturity investment. No additional provisionfor losses was recorded during the three and six months ended June 30,2004. By comparison, during the first six months of 2003 we recognized $48million of asset impairment expense and recorded a general provision for lossesof $10 million and an additional provision for losses of $130 million. The 2003amounts were driven by the decline in the credit worthiness of our customersover the preceding two years and the fact that aircraft equipment values haddropped significantly over the past few years. We carefully monitor the creditworthiness of our customers and the relative value of aircraft equipment sincewe remain at risk to defaults and decreases in the value of aircraft equipment andthe associated lease rates. While equipment risk is inherent in our business,this risk has been magnified over the past few years by the lingering weaknessin the airline industry and the resulting oversupply of aircraft equipment.

 

Our portfolio at June 30, 2004 totaled $10.0 billion, which is essentially unchanged from December 31, 2003, slightly up from the June 30, 2003 portfolio balance of $9.7 billion. Our new business volume for the six months ended June 30, 2004 is 56.6% less than that recorded for the same period in 2003 primarily as a result of reduced demand for commercial aircraft financings. Asset run-off was $281 million for the six months ended June 30, 2004 compared with $396 million for the same period in 2003 and $702 million for the year ended December 31, 2003. As a result of the disposition of our Commercial Financial Services business in the second quarter of 2004, we have revised our 2004 and 2005 projections to exclude the operating results of the Commercial Financial Services business. Accordingly, we expect our portfolio to remain relatively flat for 2004, and to remain below $0.5 billion of growth in 2005. Our total revenues are expected to approximate $1.0 billion in both 2004 and 2005. We also expect our return on assets to be approximately 0.8% in 2004, and greater than 1.0% in 2005. The change in our return on assets expectations from greater than 1.0% to 0.8% was the result of a $52 million charge related to the early extinguishment of $1.0 billion in debt from the proceeds of the sale of the Commercial Financial Services business, which will occur during the third quarter of 2004.

 

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Resultsof Operations

 

*Financing revenues*(revenue from financingleases, notes and other receivables and equipment under operating leases) wereas follows:
|                                |   | **Six Months  Ended  June 30,** |       |
|-------------------------------------|--------|--------------------------------------|------------|
| **(Dollars in millions)**           |   | **2004**                             | ** ** | **2003** | ** ** |
| Finance lease income                |   | $                                    | 115        |   | $ | 118 |   |
| Interest income on notes receivable |   | 92                                   |       | 78 |   |
| Operating lease income              |   | 216                                  |       | 204 |   |
|                                |   | $                                    | 423        |   | $ | 400 |   |

 

# Financing revenues**for the six months ended June 30,2004 were $423 million compared with $400 million for the same period in 2003,an increase of $23 million (5.8%). The fluctuations within each component offinancing revenues closely follow the change in portfolio mix from the firstsix months of 2003 to the same period in 2004.

#  

## ***Investment income***for the six months ended June 30, 2004 was $20 million comparedwith $25 million for the same period in 2003, a decrease of $5 million (20.0%).The decrease was primarily due to lower income recognized for debt and equityinvestments.

## ** **

*Net gain (loss) on disposal* for the six months endedJune 30, 2004 was $19 million compared with ($2) million for the sameperiod in 2003, a change of $21 million. The increase was primarily due to an$18 million gain on sale of a portion of a notes receivable during the firstquarter of 2004. These types of gains are intermittent in nature and depend inpart on market conditions at the time of disposal and our decision to sell orre-lease when equipment is returned. There can be no assurance that we willrecognize these gains in the future.

 

*Other income* for the six months endedJune 30, 2004 was $18 million compared with $33 million for the sameperiod in 2003, a decrease of $15 million (45.5%). The decrease was primarilydue to a $19 million realized derivative gain earned in the first six months of2003. No such gain was recognized during the same period in 2004.

 

*Equity in loss from joint venture* for the six monthsended June 30, 2004 was nil compared with a loss of $1 million for thesame period in 2003. The 2003 loss consisted of the net loss from operations inour interest in the BATA joint venture, which we previously accounted for underthe equity method. In the third quarter of 2003, an amendment to the BATAagreement was finalized by ATA and us, which gave us majority control in themanagement of the business and affairs of BATA. As a result, BATA is nowconsolidated.

 

*Interest expense* for the sixmonths ended June 30, 2004 was $173 million compared with $179 million forthe same period in 2003, a decrease of $6 million (3.4%). The decline ininterest expense is primarily due to an 8.8% reduction in the debt balances.

 

*Depreciation expense* (on equipment underoperating leases and equipment held for re-lease) for the six months endedJune 30, 2004 was $109 million compared with $103 million for the sameperiod in 2003, an increase of $6 million (5.8%). Growth in equipment underoperating leases was primarily responsible for the increase.

 

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*Provision for losses* for the sixmonths ended June 30, 2004 was $9 million compared with $140 million forthe same period in 2003, a decrease of $131 million (93.6%). The provision forlosses includes a general provision and an additional provision. The generalprovision, which primarily relates to the size of the receivables portfolio,was $9 million for the six months ended June 30, 2004 compared with $10million for the same period in 2003. An additional provision of $130 millionwas recorded during the first six months of 2003 due to our recognition of thedeterioration in the credit worthiness of our airline customers, airlinebankruptcy filings and the continued decline in commercial aircraft and generalequipment asset values. The provision for losses maintains the allowance forlosses on receivables at a level we deem to be adequate to cover anticipatedlosses. Any additional provision to be taken in the future may be dependentupon the duration of the current economic and airline industry decline, or anysignificant defaults, repossessions or restructurings at a time when depressedaircraft values and lease rates make it difficult to sell or redeploy theaircraft. Aircraft valuations could decline materially if significant numbersof aircraft, particularly types with relatively few operators, are idled onaccount of further airline bankruptcies or restructurings.

 

*Operating expenses*, which consistsof general and administrative expenses, for the six months ended June 30,2004 was $28 million compared with $25 million for the same period in 2003, anincrease of $3 million (12.0%). Higher operating expenses were due tonon-recurring costs associated with consolidating our operations to Renton,Washington, and the implementation of our revised strategy.

 

*Asset impairment expense* for the sixmonths ended June 30, 2004 was $44 million compared with $48 million forthe same period in 2003, a decrease of $4 million (8.3%). During the first sixmonths of 2004, asset impairment expense included $29 million related to an other than temporary impairment of aheld-to-maturity investment and $15 million of specific impairment chargesrelated primarily to aircraft trading during the second quarter of 2004. The assetimpairment expense in the comparable period of 2003 was due to a decline in thevalues of aircraft equipment under operating leases and held for sale orre-lease.

 

*Other expenses* for the sixmonths ended June 30, 2004 were $32 million compared with $26 million forthe same period in 2003, an increase of $6 million (23.1%). The increase wasprimarily attributable to an increase of $28 million in aircraft maintenanceand storage expenses in the first six months of 2004, partially offset by a $21million write-off in the first quarter of 2003 of forward-starting interestrate swaps that no longer qualified for fair value hedge accounting treatment.

 

*Minority interest* for the six months ended June 30, 2004, was $3 million compared withnil for the same period in 2003. The income during the first six months of 2004related to our interest in the BATA joint venture.

 

*Provision (benefit) for incometaxes* for the six months ended June 30, 2004 was $29 million comparedwith ($33) million for the same period in 2003, a change of $62 million. Thepre-tax income for the first six months of 2004 compared with the pre-tax lossfor the same period in 2003 was primarily responsible for the increase. Duringthe six months ended June 30, 2003, the difference between the effectiveincome tax rate and the federal statutory rate was primarily due to anextraterritorial income tax benefit.

 

*Incomefrom discontinued operations, net of tax*, for the sixmonths ended June 30, 2004 and 2003, was $16 million. Income fromdiscontinued operations includes the operating results of our CommercialFinancial Services business that we disposed of in May 2004. The CommercialFinancial Services revenues for the six months ended June 30, 2004 was $96million compared with $114 million for the same period in 2003, a decrease of$18 million (15.8%).

 

*Netgain on disposal of discontinued operations, net of tax*, for the sixmonths ended June 30, 2004 was $14 million compared with nil for the sameperiod in 2003. This included a net gain of $25 million related to the sale ofassets of our Commercial Financial Services business to GECC and a net loss of$11 million related to the revaluation of discontinued operations assets heldfor sale at June 30, 2004, to the lower of carrying value or fair valueless costs to sell.

 

26

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#### **Liquidity and Capital Resources**

####  

We have liquidity requirements, primarily to fundongoing financing commitments, meet debt obligations and to fund our operatingexpenses. We plan to satisfy these liquidity needs from the following sources:

 

•                  cash fromoperations and other receipts from our portfolio,

•                  issuance ofcommercial paper and other debt,

•                  assetsecuritization, and

•                  borrowings undercommitted credit facilities.

 

We attempt to schedule our debt payments tocorrespond to our scheduled receipts from our portfolio. We satisfy asignificant portion of our cash requirements from diversified global fundingsources and do not depend on any one lender. We believe that we have adequateliquidity sources and access to the capital markets to allow us to fulfill ourcurrent commitments. If this belief does not prove to be correct, we would berequired to restrict our new business volume, unless we obtained access toother sources of capital at rates that allow for a reasonable return on newbusiness.

 

Per the sales agreement with GECC, we will receivetotal proceeds of $2.1 billion for the sale of our Commercial FinancialServices business, of which we received a total of $1.6 billion as ofJune 30, 2004. The proceeds from the Commercial Financial Services salewill be used primarily to pay costs associated with the Commercial FinancialServices sale, settle related deferred tax positions, fund new business volume,repurchase debt, and make dividend payments to Boeing. As discussed in “DebtIssuances and Redemptions” below, on July 26, 2004, we completed therepurchase of $1.0 billion face value of outstanding debt.

 

Risks that could affect our sources of liquidity includeamong others:

 

•              a severe orprolonged downturn in the economy,

•              additionalrestructurings, defaults or bankruptcies by airlines, and

•              a decrease in ourcredit ratings.

 

Following the events ofSeptember 11, 2001, we reduced our leverage to account for the relatedincreased business risks. We continually assess our leverage, generally asmeasured by our debt-to-equity ratio, in light of the risks in our business.These risks include, among others, the exposure in our portfolios; generalmarket conditions, especially those associated with our customers; and ourability to access the capital markets.

 

On December 23,2003, we entered into a support agreement with Boeing that included a liquidityprovision. Under this provision, Boeing has committed itself to makecontributions to us to the extent our fixed charge coverage falls below1.05-to-1 and to maintain our tangible net worth at a level of at least $50million.

 

*Interest Rate Exposure*

 

Our assets and liabilities expose us to interestrate risk to the extent that those assets and liabilities are not exactlymatched according to currency or maturity and repricing characteristics. Thetypes and terms of borrowing and hedging instruments that are available to usin the market and possible changes in asset terms limit our ability to matchassets and liabilities. We manage this mismatch risk, partly through the use ofinterest rate and currency swaps, and we do not believe we are exposed tomaterial gains or losses due to interest rate or currency changes.

 

*Debt Issuances and Redemptions*

 

During the first six months of 2004, we did notissue any new senior debt. During the first six months of 2004, we repaid $664million of debt. We had no commercial paper borrowings outstanding atJune 30, 2004.

 

OnJuly 26, 2004, we redeemed $1.0 billion face value of our outstandingsenior notes. This included the entire principal balance, equal to $500 millionface value, of our 7.10% senior notes due 2005 and $500 million face value ofour 5.65% senior notes due 2006. See Note 12 of the notes to condensedconsolidated financial statements for a discussion on our July 26, 2004debt redemption.

 

27

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*Financing Interest Expense*

 

Ourfinancing-related interest expense for the six months ended June 30, 2004was $173 million, compared with $179 million for the same period in 2003.Leverage (debt-to-equity ratio) at both June 30, 2004 andDecember 31, 2003, was 4.7-to-1, compared with 5.3-to-1 at June 30, 2003.

 

##### **Credit Ratings**

##### ** **

Our access to capital at rates that allow for areasonable return on new business can be affected by credit rating agencies’ratings of our debt. Our credit ratings have been closely tied to those ofBoeing.

 

##### **We have the following creditratings as of the filing date:**

##### ** **

| **Debt**     |   | **Standard  &  Poor’s** |   | **Moody’s  Investors  Service** |   | **Fitch  Ratings** |   |
|--------------|--------|----------------------------------|--------|--------------------------------------|--------|--------------------|--------|
| Short-term   |   | A-1                              |   | P-2                                  |   | F-1                |   |
| Senior       |   | A                                |   | A3                                   |   | A+                 |   |
| Subordinated |   | A-                               |   | Baa1                                 |   | A                  |   |

 

Givenour current ratings and ratings outlook from the various credit ratingagencies, we believe we have ready access to the capital markets. Due to theDecember 2003 support agreement established with Boeing, our creditratings and spreads are very closely tied with those of Boeing. Our ratings andspreads could be impacted positively or negatively by changing perceptions ofBoeing, which in turn may reflect changing views of the airline industry or thedefense industry or of Boeing’s competitive positions in them. It is possiblethat these changes could affect our access to the capital markets.

 

**Item 4****.  Controls andProcedures**

 

**Evaluation of Disclosure Controls and Procedures**

 

Ourprincipal executive officer and principal financial officer, based on theirevaluation of our disclosure controls and procedures (as defined in ExchangeAct Rules 13a -15(e) and 15d –15(e)) as of the end of the period covered bythis Quarterly Report on Form 10-Q, have concluded that our disclosure controlsand procedures are adequate and effective for the purposes set forth in thedefinition in Exchange Act rules.

 

**Changes in Internal Controls**

 

Therewere no significant changes in our internal controls or in other factors thatcould significantly affect our internal controls subsequent to the date oftheir evaluation.

 

# **Part II.  Other Information**

#  

**Item1.  LegalProceedings**

 

Various legal proceedings and claims are pending orhave been asserted against us, many of which are covered by third parties,including insurance companies. We believe that the final outcome of theseproceedings and claims will not have a material adverse effect on our earnings,cash flows and/or financial position.

 

28

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**Item 5****.  Other Information**

 

**Summary of Portfolio Changes**

 

Thefollowing table summarizes the net change in our total portfolio:

 
| **(Dollars in millions)**                   |   | **Six Months  Ended  June 30,  2004** |   | **Year Ended  December 31,  2003** |   |
|---------------------------------------------|--------|--------------------------------------------|--------|-----------------------------------------|--------|
| New business volume                         |   | $                                          | 401    |                                    | $      | 1,774 |   |
| Non-cash consolidation of BATA Leasing, LLC |   | —                                     |   | 21                                      |   |
| Non-cash items from customer restructuring  |   | —                                     |   | (8                                      | )      |
| Portfolio impairment                        |   | (45                                        | )      | (98                                     | )      |
| Asset run-off                               |   | (281                                       | )      | (702                                    | )      |
| Depreciation expense                        |   | (109                                       | )      | (213                                    | )      |
| Net change in portfolio balance             |   | $                                          | (34    | )                                       | $      | 774 |   |

 

**Significant Concentrations**

 

The followingtable includes our five largest customers at June 30, 2004, with theirrelated portfolio balances at December 31, 2003:

 
|                      |   | **June 30,  2004** |   | **December 31,  2003** |   |
|---------------------------|--------|-------------------------|--------|-----------------------------|--------|
| **(Dollars in millions)** |   | **Net Asset  Value**    |   | **% of Total  Portfolio**   |   | **Net Asset  Value** |   | **% of Total  Portfolio** |   |
| AirTran                   |   | $                       | 1,521  |                        | 15.2   | % | $ | 1,483 |   | 14.7 | % |
| United                    |   | 1,153                   |   | 11.5                        |   | 1,159 |   | 11.5 |   |
| American                  |   | 802                     |   | 8.0                         |   | 861 |   | 8.6 |   |
| ATA                       |   | 722                     |   | 7.2                         |   | 743 |   | 7.4 |   |
| Hawaiian                  |   | 481                     |   | 4.8                         |   | 506 |   | 5.0 |   |
|                      |   | $                       | 4,679  |                        |   |   | $ | 4,752 |   |   |   |

 

Our largest customer, AirTran Holdings, Inc.(“AirTran”), accounted for $1.5 billion of our total portfolio at bothJune 30, 2004 and December 31, 2003. Our AirTran portfolio includesinvestments in AirTran EETCs totaling $31 million and $33 million atJune 30, 2004 and December 31, 2003, respectively. At June 30,2004, the AirTran portfolio primarily consisted of 66 717 aircraft and EETCinvestments.

 

Our third largest customer, American, accounted for$802 million and $861 million of our total portfolio at June 30, 2004 andDecember 31, 2003, respectively. At June 30, 2004, the Americanportfolio consisted of leases on 39 MD-83 aircraft and four MD-82 aircraft,subordinated debt in one 777 aircraft, and final delivery payment loans on nine767 aircraft and two 777 aircraft, which are adequately collateralized.

 

SeeNote 9 of the notes to condensed consolidated financial statements for adiscussion on our customer restructuring requests with United, ATA andHawaiian.

 

29

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**Portfolio by Product Type**

 

Ourportfolio consisted of the following product types:

 
| **(Dollars in millions)**        |   | **Receivables  (1)** |   | **Operating  Leases (1)** |   | **Investments  (4)** |   | **Held for  Sale or  Re-Lease** |   | **Total** |   |
|----------------------------------|--------|----------------------|--------|---------------------------|--------|----------------------|--------|---------------------------------|--------|-----------|--------|
| **June 30, 2004**           |   |                 |   |                      |   |                 |   |                            |   |      |   |
| 717                              |   | $                    | 1,800  |                      | $      | 494                  |   | $                               | — |      | $      | — |   | $ | 2,294 |   |
| 727  (2)                         |   | —               |   | 19                        |   | —               |   | 13                              |   | 32        |   |
| 737                              |   | 90                   |   | 673                       |   | —               |   | —                          |   | 763       |   |
| 747                              |   | 195                  |   | 430                       |   | —               |   | —                          |   | 625       |   |
| 757                              |   | 1,070                |   | 441                       |   | —               |   | 56                              |   | 1,567     |   |
| 767                              |   | 704                  |   | 386                       |   | —               |   | —                          |   | 1,090     |   |
| 777                              |   | 1,171                |   | —                    |   | —               |   | —                          |   | 1,171     |   |
| DC-9 (2)                         |   | —               |   | —                    |   | —               |   | 1                               |   | 1         |   |
| MD-80 (2)                        |   | 349                  |   | 95                        |   | —               |   | 12                              |   | 456       |   |
| MD-90 (2)                        |   | 82                   |   | —                    |   | —               |   | 49                              |   | 131       |   |
| DC-10 (2)                        |   | 25                   |   | 27                        |   | —               |   | 14                              |   | 66        |   |
| MD-11 (2)                        |   | 155                  |   | 728                       |   | —               |   | —                          |   | 883       |   |
| Space and Defense Equipment      |   | —               |   | 135                       |   | —               |   | —                          |   | 135       |   |
| Other Aircraft and Equipment (3) |   | 318                  |   | 22                        |   | —               |   | 3                               |   | 343       |   |
| Asset Pools (5)                  |   | —               |   | —                    |   | 408                  |   | —                          |   | 408       |   |
| Other                            |   | —               |   | 42                        |   | 24                   | (6)    | —                          |   | 66        |   |
|                             |   | $                    | 5,959  |                      | $      | 3,492                |   | $                               | 432    |      | $      | 148 |   | $ | 10,031 |   |
|                             |   |                 |   |                      |   |                 |   |                            |   |      |   |
| **December 31, 2003**       |   |                 |   |                      |   |                 |   |                            |   |      |   |
| 717                              |   | $                    | 1,785  |                      | $      | 394                  |   | $                               | — |      | $      | 18 |   | $ | 2,197 |   |
| 727 (2)                          |   | —               |   | 14                        |   | —               |   | 20                              |   | 34        |   |
| 737                              |   | 74                   |   | 671                       |   | —               |   | —                          |   | 745       |   |
| 747                              |   | 228                  |   | 441                       |   | —               |   | —                          |   | 669       |   |
| 757                              |   | 867                  |   | 489                       |   | —               |   | 22                              |   | 1,378     |   |
| 767                              |   | 745                  |   | 362                       |   | —               |   | 14                              |   | 1,121     |   |
| 777                              |   | 1,185                |   | —                    |   | —               |   | —                          |   | 1,185     |   |
| DC-9 (2)                         |   | 3                    |   | 1                         |   | —               |   | 1                               |   | 5         |   |
| MD-80 (2)                        |   | 356                  |   | 81                        |   | —               |   | 30                              |   | 467       |   |
| MD-90 (2)                        |   | 84                   |   | —                    |   | —               |   | 50                              |   | 134       |   |
| DC-10 (2)                        |   | 52                   |   | 37                        |   | —               |   | —                          |   | 89        |   |
| MD-11 (2)                        |   | 163                  |   | 676                       |   | —               |   | 72                              |   | 911       |   |
| Space and Defense Equipment      |   | 35                   |   | 147                       |   | —               |   | —                          |   | 182       |   |
| Other Aircraft and Equipment (3) |   | 375                  |   | 50                        |   | —               |   | 5                               |   | 430       |   |
| Asset Pools (5)                  |   | —               |   | —                    |   | 432                  |   | —                          |   | 432       |   |
| Other                            |   | —               |   | 43                        |   | 43                   | (6)    | —                          |   | 86        |   |
|                             |   | $                    | 5,952  |                      | $      | 3,406                |   | $                               | 475    |      | $      | 232 |   | $ | 10,065 |   |

 

----

(1)          Includes ownedaircraft and aircraft collateralizing receivables, some of which aresubordinated.

(2)          Out of production,but currently supported by Boeing with respect to parts and other services.

(3)          Some of theseaircraft are out of production, but are supported by the manufacturer or otherthird party part and service providers.

(4)          Representsaircraft and equipment collateralizing EETCs, ETCs and other trust-relatedinterests and other investments that we hold.

 

30

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(5)          Investments are supportedby asset pools secured by various commercial aircraft types.

(6)          Includesinvestments in mandatorily redeemable preferred stock and common stock.

 

AtJune 30, 2004, we owned 337 commercial aircraft and had partial ownershipor security interest in an additional 224 aircraft, including those owned injoint ventures, EETC, ETC and other investment transactions.

 

AtJune 30, 2004, $9.2 billion (96.0%) of our portfolio, excludinginvestments, was collateralized by Boeing products.

 

At June 30, 2004, our aircraft relatedportfolio (excluding investments) was comprised of the following aircraftvintages:

 
| 2004 - 2000                 |   | 58.0  | %      |
|-----------------------------|--------|-------|--------|
| 1999 - 1995                 |   | 21.8  |   |
| 1994 - 1990                 |   | 11.4  |   |
| 1989 - 1985                 |   | 5.0   |   |
| 1984 and older              |   | 2.1   |   |
| Secured by other collateral |   | 1.7   |   |
|                        |   | 100.0 | %      |

 

**Guarantees**

 

AtJune 30, 2004, we were the beneficiary under $2.9 billion of guarantees,primarily issued by Boeing, with respect to our portfolio transactions totaling$4.5 billion. Any guarantee calls that we make would be net of realization ofunderlying residual values, partial rent payments, re-lease rental payments orother mitigating value received.

 

The guarantees in our favor are either full orpartial in nature and include residual value guarantees, first loss deficiencyguarantees and rental guarantees. Residual value guarantees provide a specifiedasset value at the end of a lease agreement in the event of a decline in marketvalue of the financed aircraft. First loss deficiency guarantees cover aspecified portion of our losses on aircraft that we finance in the event of aloss upon disposition of the aircraft following a default by the lessee. Rentalguarantees are whole or partial guarantees covering us against the lessee’sfailure to pay rent under the lease agreement or our inability to re-leasethese aircraft at or above a specified rent level.

 

Thefollowing table summarizes our guarantees at June 30, 2004:

 
| **(Dollars in millions)** |   | **Domestic  Airlines** |   | **Foreign  Airlines** |   | **Total** |   |
|---------------------------|--------|------------------------|--------|-----------------------|--------|-----------|--------|
| Amounts guaranteed by:    |   |                   |   |                  |   |      |   |
| Boeing and subsidiaries   |   | $                      | 2,476  |                  | $      | 396       |   | $ | 2,872 |   |
| Other (1)                 |   | 15                     |   | —                |   | 15        |   |
|                      |   | $                      | 2,491  |                  | $      | 396       |   | $ | 2,887 |   |

 

----

(1)          Excludesguarantees made by entities affiliated with the primary obligor.

 

Guarantee amounts by aircraft type atJune 30, 2004 are summarized as follows:

 
| **(Dollars in millions)**               |   | **Guarantee** |   | **Net Asset  Value** |   |
|-----------------------------------------|--------|---------------|--------|----------------------|--------|
| 717                                     |   | $             | 1,582  |                 | $      | 2,195 |   |
| 757                                     |   | 633           |   | 633                  |   |
| Out of production twin-aisle aircraft   |   | 367           |   | 528                  |   |
| Out of production single-aisle aircraft |   | 86            |   | 114                  |   |
| Other Boeing and regional aircraft      |   | 219           |   | 1,021                |   |
|                                    |   | $             | 2,887  |                 | $      | 4,491 |   |

 

During the six months ended June 30, 2004, werecognized income of $8 million under these guarantees, all of which were fromBoeing.

 

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**Portfolio by Region**

 

At June 30, 2004, portfolio net asset values wererepresented in the following regions:

 
| **(Dollars in millions)** |   | **Net Asset  Value** |   | **% of Total  Portfolio** |   |
|---------------------------|--------|----------------------|--------|---------------------------|--------|
| **Region**                |   |                 |   |                      |   |
| United States             |   | $                    | 7,133  |                      | 71.1   | % |
| Europe                    |   | 1,223                |   | 12.2                      |   |
| Asia                      |   | 847                  |   | 8.4                       |   |
| Latin America             |   | 663                  |   | 6.6                       |   |
| Australia                 |   | 60                   |   | 0.6                       |   |
| Africa                    |   | 58                   |   | 0.6                       |   |
| Canada                    |   | 45                   |   | 0.4                       |   |
| Caribbean                 |   | 2                    |   | 0.1                       |   |
|                      |   | $                    | 10,031 |                      | 100.0  | % |

 

**Item 6****.  Exhibits andReports on Form 8-K**

 
| A.     | Exhibits     |                                                                                                                                                                                                                                                                                                                                                |
|--------|--------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |         |                                                                                                                                                                                                                                                                                                                                                |
|   | Exhibit 10.1 | Purchase and Sale Agreement, dated May 24, 2004, among Boeing Capital  Corporation, BCC Equipment Leasing Corporation, McDonnell Douglas Overseas  Finance Corporation, Boeing Capital Loan Corporation and General Electric  Capital Corporation, incorporated herein by reference to Exhibit 10.1 to our  Form 8-K dated June 24, 2004.      |
|   |         |                                                                                                                                                                                                                                                                                                                                                |
|   | Exhibit 10.2 | Amendment and Joint Waiver, dated as of May 31, 2004, among Boeing  Capital Corporation, BCC Equipment Leasing Corporation, McDonnell Douglas  Overseas Finance Corporation, Boeing Capital Loan Corporation and General  Electric Capital Corporation, incorporated herein by reference to Exhibit  10.2 to our Form 8-K dated June 24, 2004. |
|   |         |                                                                                                                                                                                                                                                                                                                                                |
|   | Exhibit 12   | Computation of Ratio of Income to Fixed Charges.                                                                                                                                                                                                                                                                                                    |
|   |         |                                                                                                                                                                                                                                                                                                                                                |
|   | Exhibit 15   | Report of Independent Registered Public Accounting Firm.                                                                                                                                                                                                                                                                                            |
|   |         |                                                                                                                                                                                                                                                                                                                                                |
|   | Exhibit 31.1 | Certification of President pursuant to Rules 13a-15(e) of the  Securities Exchange Act of 1934, as adopted pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002.                                                                                                                                                                         |
|   |         |                                                                                                                                                                                                                                                                                                                                                |
|   | Exhibit 31.2 | Certification of Chief Financial Officer pursuant to Rules 13a-15(e)  of the Securities Exchange Act of 1934, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                           |
|   |         |                                                                                                                                                                                                                                                                                                                                                |
|   | Exhibit 32.1 | Certification of President pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. This  document is being furnished in accordance with Securities and Exchange  Commission Release Nos. 33-8212 and 34-47551.                                                                    |
|   |         |                                                                                                                                                                                                                                                                                                                                                |
|   | Exhibit 32.2 | Certification of Chief Financial Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. This document is being furnished in accordance  with Securities and Exchange Commission Release Nos. 33-8212 and  34-47551.                                                     |

 

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| B.     | Reports on Form 8-K |
|--------|---------------------|
|   |                |   |
|   | 1.                  | Form 8-K dated April 30, 2004, for the purpose of disclosing  information relating to Boeing Capital Corporation that was contained in The  Boeing Company’s press release and webcast of first quarter 2004 financial  results, dated April 28, 2004. |
|   |                |   |
|   | 2.                  | Form 8-K dated May 24, 2004, for the purpose of disclosing that  Boeing Capital Corporation has entered into an agreement to sell our  Commercial Financial Services business to GE Commercial Finance, the  business-to-business financial services unit of General Electric [NYSE: GE].  The transaction includes approximately $2 billion in assets. |

 

33

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM

 

 

Shareholder and Board of Directors

Boeing Capital Corporation

 

We have reviewed the accompanying condensed consolidatedbalance sheet of Boeing Capital Corporation and subsidiaries (the “Company”) asof June 30, 2004, and the related condensed consolidated statements ofoperations for the three-month and six-month periods ended June 30, 2004and 2003, and of shareholder’s equity and comprehensive income (loss) and ofcash flows for the six-month periods ended June 30, 2004 and 2003. Theseinterim financial statements are the responsibility of the Company’smanagement.

 

We conducted our reviews in accordance with standardsof the Public Company Accounting Oversight Board (United States). A review ofinterim financial information consists principally of applying analyticalprocedures and making inquiries of persons responsible for financial andaccounting matters. It is substantially less in scope than an audit conductedin accordance with the standards of the Public Company Accounting OversightBoard (United States), the objective of which is the expression of an opinionregarding the financial statements taken as a whole. Accordingly, we do notexpress such an opinion.

 

Basedon our reviews, we are not aware of any material modifications that should bemade to such condensed consolidated interim financial statements for them to bein conformity with accounting principles generally accepted in the UnitedStates of America.

 

As discussed in Note 2 to the condensedconsolidated interim financial statements, the Company has discontinued asignificant portion of its Commercial Financial Services business in May 2004.The gain on sale and results prior to the sale are included in income fromdiscontinued operations in the accompanying condensed consolidated interimfinancial statements.

 

We have previouslyaudited, in accordance with standardsof the Public Company Accounting Oversight Board (United States), theconsolidated balance sheet of the Company and subsidiaries as of December 31, 2003, and the relatedconsolidated statements of operations, shareholder’s equity and comprehensiveincome (loss) and cash flows for the year then ended (not presented herein);and in our report dated January 29, 2004, we expressed an unqualifiedopinion on those consolidated financial statements. In our opinion, theinformation set forth in the accompanying condensed consolidated balance sheet asof December 31, 2003 is fairly stated, in all material respects, inrelation to the consolidated balance sheet from which it has been derived.

 

 
| /s/ Deloitte & Touche LLP |   |
|-------------------------------|--------|
|                          |
| Seattle, Washington           |
| July 27, 2004            |

 

34

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Signatures

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned, itsprincipal financial officer and by its principal accounting officer, thereuntoduly authorized.

 

 
|               | **Boeing Capital Corporation**                        |   |
|--------------------|-------------------------------------------------------|--------|
|               |                                                  |   |
|               |                                                  |   |
| July 28, 2004 | /S/ RUSSELL A. EVANS                                  |   |
|               | Russell A. Evans                                      |   |
|               | Chief Financial Officer (Principal Financial Officer) |
|               | and Registrant’s Authorized Officer              |   |
|               |                                                  |   |
|               |                                                  |   |
|               | /S/ KEVIN J. MURPHY                                   |   |
|               | Kevin J. Murphy                                       |   |
|               | Controller (Principal Accounting Officer)             |

 

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