**United StatesSecurities and Exchange Commission**

 

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**Washington, D.C.  20549**

 

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# **Form10-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, 2003**                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| **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**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |

 

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**Boeing Capital Corporation**

(Exact name of registrant as specified in itscharter)

 

| **Delaware**                                                                              |   | **95-2564584**                        |
|-------------------------------------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction of  Incorporation or Organization)                           |   | (I.R.S. Employer  Identification No.) |
|                                                                                      |   |                                  |
| **500 Naches Ave., SW, 3rd  Floor **•**  Renton,  Washington  98055** |
| (Address of principal executive offices)                                                  |
|                                                                                      |   |                                  |
| **(425) 393-2914**                                                                        |
| (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 registrantis an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes  o No  ý

 

No common stock is held by non-affiliates ofthe registrant. Common shares outstanding at August 4, 2003:  50,000 shares

 

Registrant meets the conditions set forth inGeneral Instruction I(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**

#  

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

 

2

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# **Part I**

#  

# **Item 1. Financial Statements**

**Boeing CapitalCorporation and Subsidiaries**

Consolidated Balance Sheets

(Unaudited)

 
| **(Dollars in millions, except par  value)**                                                    |   | **June 30,  2003** | ** ** | **December 31,  2002** | ** ** |
|-------------------------------------------------------------------------------------------------|--------|-------------------------|------------|-----------------------------|------------|
| ASSETS                                                                                          |   |                    |       |                        |       |
| Cash and  cash equivalents                                                                      |   | $                       | 574        |                        | $          | 686 |   |
| Receivables:                                                                                    |   |                    |       |                        |       |
| Financing  leases                                                                               |   | 4,400                   |       | 4,550                       |       |
| Notes and  other receivables                                                                    |   | 3,136                   |       | 2,878                       |       |
|                                                                                            |   | 7,536                   |       | 7,428                       |       |
| Allowance  for losses on receivables                                                            |   | (393                    | )          | (260                        | )          |
|                                                                                            |   | 7,143                   |       | 7,168                       |       |
|                                                                                            |   |                    |       |                        |       |
| Equipment under operating leases,  net of accumulated depreciation                              |   | 3,626                   |       | 3,506                       |       |
| Investments                                                                                     |   | 561                     |       | 517                         |       |
| Equipment held for sale or  re-lease, net of accumulated depreciation                           |   | 260                     |       | 311                         |       |
| Other assets                                                                                    |   | 387                     |       | 375                         |       |
|                                                                                            |   | $                       | 12,551     |                        | $          | 12,563 |   |
|                                                                                            |   |                    |       |                        |       |
| LIABILITIES AND SHAREHOLDER’S EQUITY                                                       |   |                    |       |                        |       |
| Liabilities:                                                                                    |   |                    |       |                        |       |
| Accounts payable and accrued  expenses                                                          |   | $                       | 121        |                        | $          | 127 |   |
| Other liabilities                                                                               |   | 192                     |       | 220                         |       |
| Accounts due to Boeing and  BCSC                                                                |   | 158                     |       | 22                          |       |
| Deferred income taxes                                                                           |   | 1,053                   |       | 1,073                       |       |
| Debt:                                                                                           |   |                    |       |                        |       |
| Senior                                                                                          |   | 9,243                   |       | 9,441                       |       |
| Subordinated                                                                                    |   | 24                      |       | 24                          |       |
|                                                                                            |   | 10,791                  |       | 10,907                      |       |
|                                                                                            |   |                    |       |                        |       |
| Commitments and contingencies  – Note 9                                                    |   |                    |       |                        |       |
|                                                                                            |   |                    |       |                        |       |
| Shareholder’s equity:                                                                      |   |                    |       |                        |       |
| Common Stock - $100 par value;  authorized 100,000 shares; issued and outstanding 50,000 shares |   | 5                       |       | 5                           |       |
| Capital in excess of par value                                                                  |   | 1,207                   |       | 1,090                       |       |
| Accumulated other  comprehensive loss, net of tax                                               |   | (13                     | )          | (17                         | )          |
| Income retained for growth                                                                      |   | 561                     |       | 578                         |       |
|                                                                                            |   | 1,760                   |       | 1,656                       |       |
|                                                                                            |   | $                       | 12,551     |                        | $          | 12,563 |   |

 

See Notes to ConsolidatedFinancial Statements.

 

3

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**BoeingCapital Corporation and Subsidiaries**

## **Consolidated Statements of Operations**

(Unaudited)

 
|                                                       |   | **Three Months Ended  June 30,** |       | **Six Months Ended  June 30,** |       |
|------------------------------------------------------------|--------|---------------------------------------|------------|-------------------------------------|------------|
| **(Dollars in millions)**                                  |   | **2003**                              | ** ** | **2002**                            | ** ** | **2003** | ** ** | **2002** | ** ** |
| REVENUES                                                   |   |                                  |       |                                |       |   |   |   |   |
| Finance lease income                                       |   | $                                     | 74         |                                | $          | 76 |   | $ | 151 |   | $ | 149 |   |
| Interest  income on notes receivable                       |   | 51                                    |       | 56                                  |       | 105 |   | 103 |   |
| Operating  lease income                                    |   | 127                                   |       | 99                                  |       | 252 |   | 193 |   |
| Investment  income                                         |   | 14                                    |       | 11                                  |       | 25 |   | 19 |   |
| Net gain  on disposal                                      |   | 2                                     |       | 6                                   |       | 2 |   | 7 |   |
| Other                                                      |   | 19                                    |       | 7                                   |       | 35 |   | 12 |   |
|                                                       |   | 287                                   |       | 255                                 |       | 570 |   | 483 |   |
|                                                       |   |                                  |       |                                |       |   |   |   |   |
| Equity in  loss from joint venture                         |   | —                                |       | (1                                  | )          | (1 | ) | (1 | ) |
|                                                       |   | 287                                   |       | 254                                 |       | 569 |   | 482 |   |
|                                                       |   |                                  |       |                                |       |   |   |   |   |
| EXPENSES                                                   |   |                                  |       |                                |       |   |   |   |   |
| Interest  expense                                          |   | 111                                   |       | 99                                  |       | 222 |   | 189 |   |
| Depreciation  expense                                      |   | 64                                    |       | 50                                  |       | 127 |   | 97 |   |
| Provision  for losses                                      |   | 9                                     |       | 9                                   |       | 149 |   | 17 |   |
| Operating  expenses                                        |   | 18                                    |       | 15                                  |       | 34 |   | 28 |   |
| Asset  impairment expense                                  |   | 9                                     |       | 3                                   |       | 51 |   | 4 |   |
| Other                                                      |   | 4                                     |       | 5                                   |       | 27 |   | 8 |   |
|                                                       |   | 215                                   |       | 181                                 |       | 610 |   | 343 |   |
|                                                       |   |                                  |       |                                |       |   |   |   |   |
| Income  (loss) before provision (benefit) for income taxes |   | 72                                    |       | 73                                  |       | (41 | ) | 139 |   |
| Provision  (benefit) for income taxes                      |   | 25                                    |       | 26                                  |       | (24 | ) | 50 |   |
| Net  income (loss)                                         |   | $                                     | 47         |                                | $          | 47 |   | $ | (17 | ) | $ | 89 |   |

 

See Notes to Consolidated FinancialStatements.

 

4

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**Boeing Capital********Corporation and Subsidiaries**

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

(Unaudited)

 
| **(Dollars in millions except stated value)**             |   | **Preferred  Stock(1)** |       | **Common  Stock** |   | **Capital in  Excess of  Par Value** |       | **Accumulated  Other  Comprehensive  Income (Loss)** |      | **Income  Retained  for Growth** |   | **Comprehensive  Income (Loss)** |   |
|-----------------------------------------------------------|--------|-------------------------|------------|-------------------|--------|--------------------------------------|------------|------------------------------------------------------|-----------|----------------------------------|--------|----------------------------------|--------|
| **Balance at December 31, 2001**                     |   | **$**                   | **50**     | ** **        | **$**  | **5**                                | ** ** | **$**                                                | **804**   | ** **                       | **$**  | **(19**                          | **)**  | **$** | **531** | ** ** | **$** | **133** | ** ** |
| Preferred  stock redemption                               |   | (50                     | )          | —            |   | —                               |       | —                                               |      | —                           |   |                             |   |
| Capital  contributions from Boeing and BCSC(2)            |   | —                  |       | —            |   | 286                                  |       | —                                               |      | —                           |   |                             |   |
| Net income                                                |   | —                  |       | —            |   | —                               |       | —                                               |      | 49                               |   | $                                | 49     |   |
| Cash  dividend declared                                   |   | —                  |       | —            |   | —                               |       | —                                               |      | (2                               | )      | —                           |   |
| Unrealized  loss on derivative instruments, net of tax    |   | —                  |       | —            |   | —                               |       | (2                                                   | )         | —                           |   | (2                               | )      |
| Unrealized  gain on investments, net of tax of $3 million |   | —                  |       | —            |   | —                               |       | 4                                                    |      | —                           |   | 4                                |   |
| **Balance at December 31, 2002**                     |   | **$**                   | **—** | ** **        | **$**  | **5**                                | ** ** | **$**                                                | **1,090** | ** **                       | **$**  | **(17**                          | **)**  | **$** | **578** | ** ** | **$** | **51** | ** ** |
| Capital  contributions from Boeing and BCSC(3)            |   | —                  |       | —            |   | 117                                  |       | —                                               |      | —                           |   |                             |   |
| Net loss                                                  |   | —                  |       | —            |   | —                               |       | —                                               |      | (17                              | )      | $                                | (17    | ) |
| Unrealized  gain on derivative instruments, net of tax    |   | —                  |       | —            |   | —                               |       | 2                                                    |      | —                           |   | 2                                |   |
| Unrealized  gain on investments, net of tax               |   | —                  |       | —            |   | —                               |       | 2                                                    |      | —                           |   | 2                                |   |
| **Balance at June 30, 2003**                         |   | **$**                   | **—** | ** **        | **$**  | **5**                                | ** ** | **$**                                                | **1,207** | ** **                       | **$**  | **(13**                          | **)**  | **$** | **561** | ** ** | **$** | **(13** | **)** |

 

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(1)          Preferred stock has nopar value; 100,000 shares authorized: Series A; $5,000 stated value; no sharesissued and outstanding at June 30, 2003 and December 31, 2002.

(2)          Balance represents $85million of cash contributions from Boeing and $201 million of non-cashcontributions from Boeing and BCSC.

(3)          Balance represents $114million of cash contributions from Boeing and $3 million of non-cashcontributions from Boeing and BCSC.

 

See Notes to Consolidated FinancialStatements.

 

5

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**Boeing Capital********Corporation and Subsidiaries**

Consolidated Statements of Cash Flows

(Unaudited)

 
|                                                                                     |   | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------------|--------|-------------------------------------|------------|
| **(Dollars in millions)**                                                                |   | **2003**                            | ** ** | **2002** | ** ** |
| OPERATING ACTIVITIES                                                                     |   |                                |       |   |   |
| Net income (loss)                                                                        |   | $                                   | (17        | ) | $ | 89 |   |
| Adjustments  to reconcile net income (loss) to net cash providedby operating activities: |   |                                |       |   |   |
| Depreciation  and amortization expense                                                   |   | 130                                 |       | 101 |   |
| Net gain  on disposal                                                                    |   | (2                                  | )          | (7 | ) |
| Provision  for losses                                                                    |   | 149                                 |       | 17 |   |
| Non-cash  asset impairment and other charges                                             |   | 73                                  |       | 4 |   |
| Share-based  plans expense                                                               |   | 3                                   |       | 3 |   |
| Deferred  income taxes                                                                   |   | (13                                 | )          | 146 |   |
| Change in  assets and liabilities:                                                       |   |                                |       |   |   |
| Accrued  interest                                                                        |   | (25                                 | )          | (54 | ) |
| Accounts  with Boeing and BCSC                                                           |   | 136                                 |       | 286 |   |
| Other  assets                                                                            |   | 16                                  |       | (91 | ) |
| Accounts  payable and accrued expenses                                                   |   | (6                                  | )          | (30 | ) |
| Other  liabilities                                                                       |   | (25                                 | )          | 20 |   |
| Other,  net                                                                              |   | (15                                 | )          | 2 |   |
|                                                                                     |   | 404                                 |       | 486 |   |
| INVESTING  ACTIVITIES                                                                    |   |                                |       |   |   |
| Net  change in short-term leases, notes and other receivables                            |   | 93                                  |       | 29 |   |
| Transfer  of net assets from Boeing                                                      |   | —                              |       | (186 | ) |
| Purchase  of investments                                                                 |   | (55                                 | )          | (322 | ) |
| Principal  reduction on available-for-sale investments                                   |   | 15                                  |       | 6 |   |
| Principal  reduction on held-to-maturity investments                                     |   | 34                                  |       | 9 |   |
| Purchase  of equipment for operating leases                                              |   | (292                                | )          | (425 | ) |
| Proceeds  from disposition of equipment and receivables                                  |   | 96                                  |       | 56 |   |
| Collection  of leases, notes and other receivables                                       |   | 382                                 |       | 401 |   |
| Origination  of leases, notes and other receivables                                      |   | (674                                | )          | (1,281 | ) |
|                                                                                     |   | (401                                | )          | (1,713 | ) |
| FINANCING  ACTIVITIES                                                                    |   |                                |       |   |   |
| Net  change in commercial paper and short-term bank debt                                 |   | (73                                 | )          | 296 |   |
| Proceeds  from issuance of debt                                                          |   | 152                                 |       | 974 |   |
| Repayment  of debt                                                                       |   | (308                                | )          | (350 | ) |
| Payment  of cash dividends                                                               |   | —                              |       | (2 | ) |
| Capital  contributions from Boeing                                                       |   | 114                                 |       | — |   |
|                                                                                     |   | (115                                | )          | 918 |   |
| Net  decrease in cash and cash equivalents                                               |   | (112                                | )          | (309 | ) |
| Cash and  cash equivalents at beginning of year                                          |   | 686                                 |       | 400 |   |
| Cash and  cash equivalents at end of period                                              |   | $                                   | 574        |   | $ | 91 |   |

 

See Notes to Consolidated Financial Statements.

 

6

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|                                               |   | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------|--------|-------------------------------------|------------|
| **(Dollars in millions)**                          |   | **2003**                            | ** ** | **2002** | ** ** |
| NON-CASH INVESTING AND FINANCING  ACTIVITIES:      |   |                                |       |   |   |
| Transfer of receivables                            |   | $                                   | —     |   | $ | (110 | ) |
| Decrease  to notes and other receivables           |   | $                                   | 4          |   | $ | — |   |
| Addition  of available-for-sale investments        |   | $                                   | —     |   | $ | (5 | ) |
| Decrease  to available-for-sale investments        |   | $                                   | 5          |   | $ | — |   |
| Addition  to other assets                          |   | $                                   | (5         | ) | $ | — |   |
| Transfer  of accounts with Boeing and BCSC         |   | $                                   | —     |   | $ | 92 |   |
| Change in  accounts with Boeing and BCSC           |   | $                                   | (4         | ) | $ | — |   |
| Assumption  of debt                                |   | $                                   | —     |   | $ | 115 |   |
| Mark-to-market  for derivatives on underlying debt |   | $                                   | 29         |   | $ | 52 |   |
| Transfer  of net assets from Boeing                |   | $                                   | —     |   | $ | (195 | ) |
| Capital contributions  from Boeing and BCSC        |   | $                                   | 3          |   | $ | 198 |   |

 

The following table represents thetransfer of net assets from Boeing. For the six months ended June 30,2002, transfer of net assets from Boeing is comprised of cash transfers of $186million and non-cash transfers of $195 million. There were no non-cashtransfers of net assets from Boeing for the six months ended June 30,2003.

 
| **(Dollars in millions)**                                        |   | **Six Months Ended  June 30, 2002** | ** ** |
|------------------------------------------------------------------|--------|------------------------------------------|------------|
| SUPPLEMENTAL DISCLOSURE FOR TRANSFER OF NET  ASSETS FROM BOEING: |   |                                     |       |
| Financing assets                                                 |   | $                                        | (386       | ) |
| Allowance  for losses on receivables                             |   | 2                                        |       |
| Accounts  due from Boeing and BCSC                               |   | (9                                       | )          |
| Other  liabilities                                               |   | 1                                        |       |
| Deferred  income taxes                                           |   | 11                                       |       |
| Transfer of net assets  from Boeing                              |   | $                                        | (381       | ) |

 

See Notes to Consolidated FinancialStatements.

 

7

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**Boeing Capital********Corporation and Subsidiaries**

###### Notes to Consolidated Financial Statements

June 30,2003

(Unaudited)

 

Note 1 – General

 

BoeingCapital Corporation (together with its subsidiaries, referred to as “us”, “we”,“our” or the “Company”) is an indirect wholly owned subsidiary of The BoeingCompany (“Boeing”). We prepared the accompanying unaudited consolidatedfinancial statements in accordance with accounting principles generally acceptedin the United States of America for interim financial information and with theinstructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly,they do not include all of the information and footnotes required by accountingprinciples generally accepted in the United States of America for completefinancial statements. In our opinion, the accompanying consolidated financialstatements reflect all adjustments, consisting of normal recurring accruals,that are necessary to present fairly the consolidated balance sheets and therelated consolidated statements of operations, shareholder’s equity andcomprehensive income (loss) and cash flows for the interim periods presented.Operating results for the six-month period ended June 30, 2003, are notnecessarily indicative of the results that may be expected for the year endingDecember 31, 2003. The statements should be read in conjunction with theNotes to the Consolidated Financial Statements included in our Form 10-K forthe year ended December 31, 2002, which contains the latest availableaudited consolidated financial statements and notes.

 

We are a commercial finance company. Ourprimary operations include two principal financial reporting segments: AircraftFinancial Services and Commercial Financial Services. Our portfolio consists offinancing leases, notes and other receivables, equipment under operating leases(net of accumulated depreciation), investments and equipment held for sale orre-lease (net of accumulated depreciation).

 

Boeing Capital Services Corporation (“BCSC”)owns 100% of our stock and is an indirect wholly owned subsidiary of Boeing anda largely inactive holding company.

 

Certain reclassifications of previouslyreported amounts have been made in the consolidated financial statements toconform to the 2003 presentation.

 

#### Note 2– Standards Issuedand Not Yet Implemented

####  

In January 2003, the FinancialAccounting Standards Board (“FASB”) issued FASB Interpretation No. 46(“FIN 46”), “Consolidation of Variable Interest Entities,” which clarifiesthe application of Accounting Research Bulletin No. 51, “ConsolidatedFinancial Statements,” relating to consolidation of certain entities. First,FIN 46 requires identification of our participation in variable interestentities (“VIEs”), which are defined as entities with a level of investedequity insufficient to fund future activities to operate on a stand-alone basisor whose equity holders lack certain characteristics of a controlling financialinterest. Then, for an entity identified as a VIE, FIN 46 sets forth amodel to evaluate potential consolidation based on an assessment of which partyto the VIE, if any, bears a majority of the exposure to the expected losses, orstands to gain from a majority of the expected returns. FIN 46 also setsforth certain disclosures regarding interests in VIEs that are deemedsignificant, even if consolidation is not required. The provisions ofFIN 46 became effective July 1, 2003 for VIEs created on or beforeJanuary 31, 2003, and became immediately effective for VIEs created afterJanuary 31, 2003. The impact of adopting FIN 46 is discussed in Note10.

 

8

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InApril 2003, the FASB issued Statement of Financial Accounting Standards(“SFAS”) No. 149, “Amendment of Statement 133 on Derivative Instrumentsand Hedging Activities,” which is effective for contracts entered into ormodified and hedging relationships designated after June 30, 2003. ThisStatement amends and clarifies financial accounting and reporting forderivative instruments, including certain derivative instruments embedded inother contracts and for hedging activities under SFAS No. 133, “Accountingfor Derivative Instruments and Hedging Activities.” Implementation of thisstandard is not expected to have a material effect on our earnings, cash flowsor financial position.

 

Note 3 – Portfolio Quality

 
| **(Dollars in millions)**                                                        |   | **June 30,  2003** | ** ** | **December 31,  2002** | ** ** |
|----------------------------------------------------------------------------------|--------|-------------------------|------------|-----------------------------|------------|
| Receivables:                                                                     |   |                    |       |                        |       |
| Financing leases                                                                 |   | $                       | 4,400      |                        | $          | 4,550 |   |
| Notes and  other receivables                                                     |   | 3,136                   |       | 2,878                       |       |
|                                                                             |   | 7,536                   |       | 7,428                       |       |
|                                                                             |   |                    |       |                        |       |
| Equipment  under operating leases, net of accumulated depreciation               |   | 3,626                   |       | 3,506                       |       |
| Investments                                                                      |   | 561                     |       | 517                         |       |
| Equipment held for sale  or re-lease, net of accumulated depreciation            |   | 260                     |       | 311                         |       |
| Total  portfolio                                                                 |   | $                       | 11,983     |                        | $          | 11,762 |   |
|                                                                             |   |                    |       |                        |       |
| Non-performing  assets:                                                          |   |                    |       |                        |       |
| Nonaccrual  receivables                                                          |   | $                       | 710        |                        | $          | 171 |   |
| Non-performing  equipment under operating leases, net ofaccumulated depreciation |   | 102                     |       | 63                          |       |
| Equipment  held for sale or re-lease, net of accumulated depreciation            |   | 260                     |       | 311                         |       |
|                                                                             |   | $                       | 1,072      |                        | $          | 545 |   |
|                                                                             |   |                    |       |                        |       |
| Ratio of  nonaccrual receivables to total receivables                            |   | 9.4                     | %          | 2.3                         | %          |
| Ratio of  total non-performing assets to total portfolio                         |   | 8.9                     | %          | 4.6                         | %          |

 

The increases in the above ratios areprimarily due to the bankruptcy filing by Hawaiian Holding, Inc. (“Hawaiian”),as discussed further in Note 9.

 

Income recognition on an accrual basis isgenerally suspended for leases and notes and other receivables at the date whena full recovery of income and principal becomes doubtful. Income recognition isresumed when the lease or notes and other receivables become contractuallycurrent and performance is demonstrated to be resumed. Any cash received in theinterim is recorded to income to the extent that it is accruable undercontractual terms, and any cash received in excess of such accruable amountsreduce the carrying value of the receivable.

 

The following table summarizes ourreceivables and equipment under operating leases with amounts greater than 90days past due with income still accruing:

 
| **(Dollars in millions)**         |   | **June 30,  2003** | ** ** | **December 31,  2002** | ** ** |
|-----------------------------------|--------|-------------------------|------------|-----------------------------|------------|
| Receivables                       |   | $                       | 494        |                        | $          | 2 |   |
| Equipment  under operating leases |   | —                  |       | 19                          |       |
|                              |   | $                       | 494        |                        | $          | 21 |   |

 

9

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The $494 million represents receivables fromUnited, which are collateralized with B-767s and B-777s. We believe that thereis adequate collateral coverage to justify accruing income on the receivables.For the six months ended June 30, 2003, we received $30 million on thesereceivables. Subsequent to June 30, 2003, we received $11 million on thesereceivables.

 

Note 4 – Allowance for Losses on Receivables

 
| **(Dollars in millions)**                                                                          |   | **June 30,  2003** | ** ** | **December 31,  2002** | ** ** |
|----------------------------------------------------------------------------------------------------|--------|-------------------------|------------|-----------------------------|------------|
| Allowance for losses on receivables at beginning of  year                                          |   | $                       | 260        |                        | $          | 140 |   |
| Provision for losses                                                                               |   | 149                     |       | 136                         |       |
| Write-offs,  net of recoveries                                                                     |   | (16                     | )          | (18                         | )          |
| Allowance  transferred from Boeing and BCSC                                                        |   | —                  |       | 2                           |       |
| Allowance  for losses on receivables at end of period                                              |   | $                       | 393        |                        | $          | 260 |   |
|                                                                                               |   |                    |       |                        |       |
| Allowance  as a percentage of total receivables                                                    |   | 5.2                     | %          | 3.5                         | %          |
| Net  write-offs as a percentage of average receivables                                             |   | 0.2                     | %          | 0.3                         | %          |
|                                                                                               |   |                    |       |                        |       |
| More than  90 days delinquent:                                                                     |   |                    |       |                        |       |
| Amount of  delinquent installments                                                                 |   | $                       | 29         |                        | $          | 15 |   |
| Total  receivable balance related to delinquent installments                                       |   | $                       | 797        |                        | $          | 50 |   |
| Total  receivable balance related to delinquent installments as a percentage of  total receivables |   | 10.6                    | %          | 0.7                         | %          |
| Total of  all receivables due from delinquent obligors                                             |   | $                       | 1,764      |                        | $          | 51 |   |
| Total of  all receivables due from delinquent obligors as a percentage of total  receivables       |   | 23.4                    | %          | 0.7                         | %          |

 

AtJune 30, 2003, United Airlines, Inc. (“United”) represented $1.2 billionof our total receivables portfolio. Of this amount, $586 million representedreceivables that had installments that were more than 90 days delinquent atJune 30, 2003. During the first half of 2003, we received cash of $39million from United, of which $31 million related to receivables more than 90days delinquent.

 

AtJune 30, 2003, Hawaiian represented $466 million of our total receivablesportfolio. Of this amount, $95 million represented receivables that hadinstallments that were more than 90 days delinquent at June 30, 2003.During the first half of 2003, we received cash of $22 million from Hawaiian,of which $4 million related to receivables more than 90 days delinquent.

 

Our portfolio at the end of the second quarter of 2003totaled $12.0 billion, of which $8.9 billion was related to Boeing products,primarily commercial aircraft. The continuing effects of the current airlineindustry downturn have caused significant reductions in commercial aircraftvalues. Older and/or out-of-production aircraft types have experienced the mostsignificant declines in value, while newer aircraft types have seen moremoderate declines. Published sources and recent market transactions indicatethat values for various aircraft types used as collateral in our portfolioremain depressed. Aircraft valuations could decline materially if significantnumbers of aircraft, particularly types with relatively few operators, areidled on account of further airline bankruptcies or restructurings. At the sametime, the credit ratings of many airlines, particularly in the United States,have remained at low levels. Each quarter, we review customer credit ratings,published historical credit default rates, Boeing and other guarantees (ifapplicable) and third-party aircraft valuations as a basis to validate thereasonableness of the allowance for losses on receivables. In light ofdeteriorating customer credit ratings and liquidity, as well as the decline inaircraft values, we determined that a special increase in the allowance forlosses on receivables of $130 million was warranted at the end of the firstquarter of 2003. The changes in customer credit ratings and aircraft valueswere not significant enough to warrant a special increase in the allowance forlosses on receivables during the second quarter of 2003; however, there can beno

 

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assurance that consideration of such factorsin the future will not result in a requirement to increase the allowance forlosses on receivables. As a result of the $130 million increase, the allowanceat June 30, 2003 increased to 5.2% of total receivables, up from 3.5% atDecember 31, 2002.

 

Boeing is currently involved in key campaignsthat may determine the continuation of the B-757 program. At June 30,2003, $1.2 billion of our portfolio was collateralized by B-757 aircraft ofvarious vintages. At June 30, 2003, we were the beneficiary under $240million of guarantees from Boeing covering $305 million of our B-757 portfolio.Future decisions relating to B-757 production, as well as overall marketconditions, could result in declines in B-757 collateral values, which in turncould result in a requirement to increase the allowance for losses onreceivables due to additional collateral exposure, resulting in a potentialmaterial adverse effect on our earnings or financial position; however, we arecurrently unable to predict the likelihood or impact of such an outcome.

 

Receivable Write-offs and Recoveries, by Segment:

 
| **(Dollars in millions)**       |   | **Six Months Ended  June 30,  2003** | ** ** | **Year Ended  December 31,  2002** | ** ** |
|---------------------------------|--------|-------------------------------------------|------------|-----------------------------------------|------------|
| Aircraft Financial  Services:   |   |                                      |       |                                    |       |
| Write-offs                      |   | $                                         | 9          |                                    | $          | 7 |   |
| Recoveries                      |   | —                                    |       | —                                  |       |
|                            |   | 9                                         |       | 7                                       |       |
|                            |   |                                      |       |                                    |       |
| Commercial  Financial Services: |   |                                      |       |                                    |       |
| Write-offs                      |   | 7                                         |       | 12                                      |       |
| Recoveries                      |   | —                                    |       | (1                                      | )          |
|                            |   | 7                                         |       | 11                                      |       |
|                            |   | $                                         | 16         |                                    | $          | 18 |   |

 

We review a specific receivable forimpairment when, based on current information and events, it is probable thatwe will be unable to collect amounts due according to the contractual terms ofthe receivable agreement. Factors considered in assessing uncollectibilityinclude a customer’s extended delinquency, requests for restructuring andfilings for bankruptcy. We determine a specific impairment allowance based onthe difference between the carrying value of the receivable and the estimatedfair value of the related collateral.

 

The carrying amounts of impaired receivablesare as follows:

 
| **(Dollars in millions)**                                   |   | **June 30,  2003** | ** ** | **December 31,  2002** | ** ** |
|-------------------------------------------------------------|--------|-------------------------|------------|-----------------------------|------------|
| Impaired  receivables with specific impairment allowance(1) |   | $                       | 602        |                        | $          | 146 |   |
| Impaired  receivables with no specific allowance(2)         |   | 1,227                   |       | 1,221                       |       |
|                                                        |   | $                       | 1,829      |                        | $          | 1,367 |   |

 

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(1)          At June 30, 2003 andDecember 31, 2002, impaired receivables of $602 million and $146 million,respectively, had a specific impairment allowance for losses on receivables of$157 million and $50 million, respectively.

(2)          Of the $1,227 million and $1,221million at June 30, 2003 and December 31, 2002, respectively, $1,090million and $1,097 million, respectively, relate to the receivables from Unitedsecured by B-767s and B-777s. We believe that such aircraft represent adequatecollateral based, in part, on Boeing guarantees; therefore, no specific reservehas been established.

 

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The allocation of the allowance for losses onreceivables between specific impairments and general purposes is as follows:

 
| **(Dollars in millions)**         |   | **June 30,  2003** | ** ** | **December 31,  2002** | ** ** |
|-----------------------------------|--------|-------------------------|------------|-----------------------------|------------|
| Allocated to specific reserves    |   | $                       | 157        |                        | 39.9       | % | $ | 50 |   | 19.2 | % |
| Allocated for general purposes(1) |   | 236                     |       | 60.1                        |       | 210 |   | 80.8 |   |
|                              |   | $                       | 393        |                        | 100.0      | % | $ | 260 |   | 100.0 | % |

 

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(1)          The allocation for general purposesrepresents our best estimate of losses in the remaining receivables consideringdelinquencies, loss experience, collateral, guarantees, risk of individualcredits, historical default rates, results of periodic credit reviews and thegeneral state of the economy and airline industry.

 

At June 30, 2003, we were the beneficiaryunder $2.8 billion of guarantees, principally from Boeing, with respect to theportfolio relating to transactions totaling $4.0 billion (33.3% of our totalportfolio), which mitigates our risk.

 

Actual results could differ from estimatesand values, and there can be no assurance that the allowance for losses will besufficient to cover losses on receivables.

 

Note 5 – Investments

 

The following table shows the impact of investments we accounted forunder Statement of Financial Accounting Standards (“SFAS”) No. 115,“Accounting for Certain Investments in Debt and Equity Securities.” We recordavailable-for-sale securities in investments at estimated fair value.Unrealized gains/losses of available-for-sale securities are recorded inaccumulated other comprehensive income/loss, net of tax; however, losses deemedother than temporary are recorded as a reduction to investment income. Werecord held-to-maturity securities at amortized cost. The unrealizedgains/losses of held-to-maturity securities are not recorded in theconsolidated financial statements and are shown in the table below forinformational purposes only; however, losses deemed other than temporary arerecorded as a reduction to investment income.

 

Fair values for investment securities arebased on quoted market prices, where available. If quoted market prices are notavailable, fair values are based on pricing models or quoted market prices ofcomparable instruments. The majority of our securities are illiquid non-tradedsecurities; therefore, the fair values are generally based on pricing models.In order to use pricing models, we request spread levels over certain benchmarkinterest rates from external sources to use for calculations in the pricingmodels. Those spread levels and certain benchmark interest rates are selectedusing similar public securities, senior tranches in the transaction or otherrelevant pricing information as marketplace proxies for our non-tradingsecurities. Using this methodology, our estimate of fair value for the enhancedequipment trust certificates (“EETCs”) is less than our estimate of the currentvalue of the collateral supporting the EETCs.

 

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Available-for-sale and held-to-maturityinvestments consisted of the following:

 
| **(Dollars in millions)**   |   | **Amortized****Cost** |   | **Gross  Unrealized  Gain** |   | **Gross  Unrealized  Loss** |   | **Estimated Fair  Value** |   |
|-----------------------------|--------|-----------------------|--------|-----------------------------|--------|-----------------------------|--------|---------------------------|--------|
| **June 30, 2003**      |   |                  |   |                        |   |                        |   |                      |   |
| Available-for-Sale:         |   |                  |   |                        |   |                        |   |                      |   |
| Equity                      |   | $                     | 3      |                        | $      | 1                           |   | $                         | — |   | $ | 4 |   |
| Debt                        |   | 38                    |   | 1                           |   | —                      |   | 39                        |   |
| Held-to-Maturity:           |   |                  |   |                        |   |                        |   |                      |   |
| Debt(1)                     |   | 475                   | (2)    | —                      |   | (113                        | )      | 362                       |   |
|                        |   | $                     | 516    |                        | $      | 2                           |   | $                         | (113   | ) | $ | 405 |   |
|                        |   |                  |   |                        |   |                        |   |                      |   |
| **December 31,  2002** |   |                  |   |                        |   |                        |   |                      |   |
| Available-for-Sale:         |   |                  |   |                        |   |                        |   |                      |   |
| Equity                      |   | $                     | 3      |                        | $      | —                      |   | $                         | — |   | $ | 3 |   |
| Debt                        |   | 4                     |   | —                      |   | —                      |   | 4                         |   |
| Held-to-Maturity:           |   |                  |   |                        |   |                        |   |                      |   |
| Debt(1)                     |   | 490                   |   | —                      |   | (239                        | )      | 251                       |   |
|                        |   | $                     | 497    |                        | $      | —                      |   | $                         | (239   | ) | $ | 258 |   |

 

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

(2)          Related to the $475 million atJune 30, 2003, we had $18 million in guarantees from Boeing and $6 millionin guarantees from a third party.

 

At June 30, 2003 and December 31,2002, available-for-sale and held-to-maturity investments totaled $518 millionand $497 million, respectively, of which none were considered investment gradesecurities.

 

At December 31, 2001, anavailable-for-sale security was transferred to held-to-maturity at its fairvalue with $20 million of unrealized loss recorded as a component ofaccumulated other comprehensive income/loss, net of tax. As of June 30,2003, $2 million of that $20 million unrealized loss was amortized fromaccumulated other comprehensive income/loss to investment income.

 

At July 1, 2002, two available-for-salesecurities were transferred to held-to-maturity at their fair values with $6million of net unrealized gain recorded as a component of accumulated othercomprehensive income/loss, net of tax. At June 30, 2003, $2 million ofthat $6 million net unrealized gain was amortized from accumulated othercomprehensive income/loss to investment income.

 

At October 1, 2002, anavailable-for-sale security was transferred to held-to-maturity at its fairvalue, which was equal to its amortized cost.

 

At June 30, 2003, maturities of debtinvestments were as follows:

 
|                        |   | **Available-for-Sale** |       | **Held-to-Maturity**      |       |
|-----------------------------|--------|------------------------|------------|---------------------------|------------|
| **(Dollars in millions)**   |   | **Amortized  Cost**    | ** ** | **Estimated  Fair Value** | ** ** | **Amortized  Cost** | ** ** | **Estimated  Fair Value** | ** ** |
| Due in less than one year   |   | $                      | —     |                      | $          | — |   | $ | 15 |   | $ | 11 |   |
| Due from  one to five years |   | 34                     |       | 34                        |       | 329 |   | 247 |   |
| Due from  six to ten years  |   | —                 |       | —                    |       | 62 |   | 47 |   |
| Due after  ten years        |   | 4                      |       | 5                         |       | 69 |   | 57 |   |
|                        |   | $                      | 38         |                      | $          | 39 |   | $ | 475 |   | $ | 362 |   |

 

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We also have a 50% interest with ATA HoldingsCorp. (“ATA”) in BATA Leasing, LLC (“BATA”) with a carrying value of $20million and $19 million at June 30, 2003 and December 31, 2002,respectively, which is recorded in investments on the consolidated balancesheets and accounted for under the equity method. BATA was established toconvert 24 B-727 passenger aircraft to full cargo configuration and thenre-lease such aircraft.

 

In the second quarter of 2003, we enteredinto a financing arrangement with a third party. This arrangement wasestablished to lease five B-767 aircraft; two of which were placed under leaseas of June 30, 2003. This investment had a carrying value of $22 millionat June 30, 2003, which is recorded in investments on the balance sheetand accounted for under the equity method.

 

Note 6 – Impairment Review for Equipment Under Operating Leases andHeld for Sale or Re-Lease

 

We review these assets for potentialimpairment when events or circumstances indicate that the carrying amount ofthese assets may not be recoverable. For the second quarter of 2003, wereviewed all aircraft and equipment held for sale or re-lease and under operatingleases maturing within two years or where known events may indicate impairment.We consider assets under operating lease or held for re-lease impaired when theexpected undiscounted cash flow over the remaining useful life is less than thebook value. We use various assumptions when determining the expectedundiscounted cash flow. These assumptions include expected future lease rates,lease terms, end of economic life value of the aircraft or equipment, periodsin which the asset may be held in preparation for a follow-on lease,maintenance costs, remarketing costs and the remaining economic life of theasset. We state assets held for sale at the lower of carrying amount or fairvalue less costs to sell.

 

When we determine that impairment is indicatedfor an asset, the amount of the impairment loss is the excess of the bookvalue, less asset value guarantees, if applicable, over the fair value of theasset. For aircraft assets, we use the average published value from multiplesources based on the type and age of the asset to determine the fair value.However, if the features or utilization of the aircraft varies significantlyfrom the generic aircraft attributes covered by outside publications, we applyjudgment based on the attributes of the specific aircraft to determine fairvalue. For the six months ended June 30, 2003 and 2002, we recordedpre-tax non-cash charges totaling $51 million and $4 million, respectively, torecord impairments of portfolio assets as a result of continued declines inmarket values and rents for aircraft and equipment.

 

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Note 7 – Debt and Credit Agreements

 
| **(Dollars in millions)**                                                                                            |   | **June 30,  2003** | ** **  | **December 31,  2002** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|--------|-------------------------|-------------|-----------------------------|------------|
| Senior debt:                                                                                                         |   |                    |        |                        |       |
| Commercial  paper                                                                                                    |   | $                       | —      |                        | $          | 73 |   |
| Variable  rate (three-month LIBOR plus 0.6%) note due 2012                                                           |   | 5                       |        | 5                           |       |
| 5.65%  note due 2006                                                                                                 |   | 1,046                   |        | 1,041                       |       |
| 5.75%  note due 2007                                                                                                 |   | 748                     |        | 748                         |       |
| 5.80%  note due 2013                                                                                                 |   | 625                     |        | 617                         |       |
| 6.10%  note due 2011                                                                                                 |   | 785                     |        | 781                         |       |
| 6.50%  note due 2012                                                                                                 |   | 775                     |        | 766                         |       |
| 7.10%  note due 2005                                                                                                 |   | 499                     |        | 499                         |       |
| 7.375%  note due 2010                                                                                                |   | 554                     |        | 549                         |       |
| 2.02% -  3.41% Euro medium-term note due 2004                                                                        |   | 60                      |        | 51                          |       |
| Non-recourse  variable rate (one-month LIBOR plus 1.1%)note due 2012                                                 |   | 43                      |        | 44                          |       |
| 13.84% -  14.28% non-recourse notes due through 2003,including a premium based on an imputed  interest rate of 6.10% |   | 1                       |        | 6                           |       |
| 3.15% -  6.75% retail medium-term notes due through 2017                                                             |   | 631                     |        | 487                         |       |
| 1.12% -  7.64% medium-term notes due through 2017                                                                    |   | 2,890                   |        | 3,113                       |       |
| 1.63%  secured debt, proceeds of securitization due through 2009                                                     |   | 243                     |        | 299                         |       |
| 1.49% -  9.22% capital lease obligations due through 2008                                                            |   | 338                     |        | 362                         |       |
|                                                                                                                 |   | 9,243                   |        | 9,441                       |       |
|                                                                                                                 |   |                    |        |                        |       |
| Subordinated  debt:                                                                                                  |   |                    |        |                        |       |
| 8.31%  medium-term note due 2004                                                                                     |   | 20                      |        | 20                          |       |
| Non-recourse  variable rate note due 2012 (one-month LIBORplus 2.46%)                                                |   | 4                       |        | 4                           |       |
|                                                                                                                 |   | 24                      |        | 24                          |       |
|                                                                                                                 |   | $                       |  9,267 |                        | $          |  9,465 |   |

 

On February 16, 2001, wefiled a public shelf registration of $5 billion of debtsecurities with the Securities and Exchange Commission (“SEC”), which wasdeclared effective on February 26, 2001. Effective October 31, 2001,we allocated $1 billion to the Series XI medium-term note program.Effective June 20, 2002, the remaining $750 million under the shelfregistration was allocated to this program. As of the filing date, an aggregateamount of $427 million remains available under the Series XI medium-termprogram for potential debt issuance.

 

On February 22, 2002, we filed a public shelf registration of $5billion of debt securities with the SEC, which was declared effective onMarch 4, 2002. We allocated $1 billion to establish a new retailmedium-term note program involving the sale of notes with a minimumdenomination of $1,000. As of the filing date, an aggregate amount of $3.8billion (which includes $365 million of retail medium-term notes) remainsavailable for potential debt issuance.

 

On June 6, 2002, we established a $1.5 billion Euro medium-termnote program. As of the filing date, an aggregate amount of $1.4 billionremains available for potential debt issuance.

 

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The provisions of various debt agreements require us to (a) limit thepayment of cash dividends to the extent that our consolidated assets would beless than 115% of our consolidated liabilities (excluding deferred taxes) afterdividend payments and (b) restrict the amount of liens on our property, otherthan liens specifically excluded, to secure indebtedness such that thoserestricted liens not exceed 15% of consolidated assets. At June 30, 2003,as well as during the period, we were in compliance with these and all of ourvarious other debt covenants.

 

As of November 4, 2002, $500 million ofBoeing’s five-year revolving credit line expiring in 2005 was made exclusivelyavailable to us. In addition, $1.5 billion of Boeing’s $3 billion 364-dayrevolving credit line continues to be exclusively available to us. AtJune 30, 2003, there were no amounts outstanding under these agreements.

 

Note 8 – Derivative Financial Instruments

 

We account for derivatives pursuant to SFASNo. 133, “Accounting for Derivative Instruments and Hedging Activities,”as amended. This standard requires that we recognize all derivative instrumentsin the financial statements and measure them at fair value regardless of thepurpose or intent for holding them.

 

We are exposed to a variety of market risks,including the effects of changes in interest rates and foreign currencyexchange rates. We manage these exposures, in part, with the use ofderivatives. In particular, we enter into interest rate swap and cross currencyswap contracts with a number of major financial institutions. Since we believeit is unlikely that any of our counterparties will be unable to perform underthe terms of derivative financial instruments, we generally do not requirecollateral or other security supporting derivative contracts with ourcounterparties. The following is a summary of our risk management strategiesand the effect of these strategies on the consolidated financial statements.

 

*Fair Value Hedges*

 

Interest rate swaps, under which we agree topay variable rates of interest, are designated as fair value hedges offixed-rate debt. During the first quarter of 2003, we also heldforward-starting interest rate swap agreements to fix the cost of funding afirmly committed lease for which payment terms are determined in advance offunding. This type of hedge relationship mitigates the changes in fair value ofthe hedged portion of the firm commitment caused by changes in interest rates.The net change in fair value of the swap and the hedged portion of the firmcommitment is reported in earnings. At the end of the first quarter of 2003,the forward-starting interest rate swaps no longer qualified for fair valuehedge accounting treatment and we recognized a pre-tax non-cash charge of $21million.

 

For the six months endedJune 30, 2003 and 2002, we recorded $5 million and $0.3 million,respectively, of gains related to the basis adjustment of certain terminatedinterest rate swaps in interest expense. For the six months ended June 30,2003 and 2002, we recorded $1 million and $2 million, respectively, of lossesrelated to ineffectiveness due to the forward-starting interest rate swaps ininterest expense. During the next twelve months, we expect to amortize a $16million gain from the amount recorded in the basis adjustment of certainterminated fair value hedge relationships to interest expense.

 

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*Cash Flow Hedges*

 

The cash flow hedges we use include certaininterest rate swaps and cross currency swaps. Interest rate swap and crosscurrency swap contracts under which we agree to pay fixed rates of interest aredesignated as cash flow hedges of variable-rate debt obligations. In addition,cross currency swap contracts under which we agree to pay fixed functionalcurrency rates of interest are designated as cash flow hedges of fixednon-functional currency debt obligations. As of June 30, 2003 andDecember 31, 2002, we recorded net unrecognized losses of $8 million ($5million net of tax) and $9 million ($6 million net of tax), respectively, inaccumulated other comprehensive income/loss associated with our cash flowhedging transactions.

 

For the six months ended June 30, 2003and 2002, unrealized losses (net of tax) included in accumulated other comprehensiveincome/loss of $0.2 million and $0.3 million, respectively, were reclassifiedto interest expense. During the next twelve months, we expect to reclassify tointerest expense a loss (net of tax) of $0.4 million from the amount recordedin accumulated other comprehensive income/loss.

 

*Non-hedging Derivative Instruments*

 

We hold certain interest exchange agreements and related interest rateswaps. The intent of these interest rate swaps is to economically hedge theexposures created by the interest exchange agreements. However, since theexposures being hedged are derivative instruments, this relationship does notqualify for hedge accounting. As a result, changes in fair value of bothinstruments are immediately recognized in income. As of June 30, 2003 andDecember 31, 2002, we recorded net losses of $1 million ($0.7 million netof tax) and $2 million ($1 million net of tax), respectively, in accumulatedother comprehensive income/loss associated with these interest rate swaps. Forthe six months ended June 30, 2003 and 2002, the interest exchangeagreements resulted in losses of $2 million and gains of $1 million,respectively, and the related interest rate swaps resulted in gains of $1million and losses of $2 million, respectively. For the six months endedJune 30, 2003 and 2002, unrecognized losses (net of tax) of $0.4 millionand $1 million, respectively, from accumulated other comprehensive income/lossand gains of $2 million for both periods from the basis adjustment tounderlying liabilities were amortized to interest expense. During the nexttwelve months, we expect to amortize to interest expense a $1 million loss (netof tax) from the amount recorded in accumulated other comprehensive income/lossand a $2 million gain from the basis adjustment to underlying liabilities.

 

During 2001, we received warrants and aconversion option on notes in connection with a certain financing transaction.In June 2003, the remainder of the conversion feature of the convertiblenotes was exercised in full. As of December 31, 2002, the conversionfeature of the convertible notes was reflected in other assets at a fair valueof $1 million. As of June 30, 2003 and December 31, 2002, warrantsfor this and other transactions were reflected in other assets at a fair valueof $21 million and $4 million, respectively. We recorded the initial fairvalues of the warrants and conversion option on notes as a discount to notesreceivable of $20 million and are being amortized to other income. For the sixmonths ended June 30, 2003 and 2002, we amortized gains from the discounton notes receivable to other income of $1 million and $3 million, respectively.During the next twelve months, we expect to amortize to other income a gain of$1 million from the discount on notes receivable. For the six months endedJune 30, 2003 and 2002, the warrants and conversion feature of theconvertible notes recorded in other assets had changes in fair value, resultingin an addition to other income of $20 million and a reduction to other incomeof $3 million, respectively.

 

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Note 9 – Commitments and Contingencies

 

*Litigation*

 

Various legal proceedings and claims are pending or have been assertedagainst us, many of which are covered by third parties, including insurancecompanies. We believe that the final outcome of such proceedings and claimswill not have a material adverse effect on our earnings, cash flows orfinancial position.

 

*Significant Customer Contingencies*

 

United accounted for $1.2 billion (9.9% and 10.1%) of our totalportfolio at June 30, 2003 and December 31, 2002, respectively. AtJune 30, 2003, the United portfolio was secured by security interests intwo B-767s and 13 B-777s and by an ownership and security interest in fiveB-757s. As of June 30, 2003, United was our second largest customer.United filed for Chapter 11 bankruptcy protection on December 9,2002. On February 7, 2003, United agreed to perform under the loanagreements securing the B-767s and B-777s by bringing its payments under thoseagreements current. Since April 10, 2003, United has made interest onlypayments on the notes and some reduced rental payments on the B-757s.Discussions with United are continuing on a full restructuring of the varioustransactions. Future negotiations may result in changes to the agreements inrespect of the aircraft with United. Until United emerges from bankruptcy or wetake possession of the collateral, United has the right to reject or abandonits transactions with us. In the event that future negotiations or proceedingsresult in the return of a substantial number of aircraft, there could be amaterial adverse effect on our earnings, cash flows or financial position, atleast until such time as the aircraft are sold or redeployed for adequateconsideration.

 

ATA accounted for $667 million and $611million (5.6% and 5.2%) of our total portfolio at June 30, 2003 andDecember 31, 2002, respectively. At June 30, 2003, the ATA portfolioprimarily consisted of 11 B-757s and an investment in ATA preferred stock witha face amount of $50 million, which is included in the portfolio at itscarrying value. In November 2002, ATA received a loan of $168 millionadministered by the Airline Transportation Stabilization Board. ATA hasrequested that we restructure certain outstanding leases by deferring a portionof its rent payments for a limited period of time. We have reached agreement,subject to certain conditions, on the terms of the restructuring and we areworking on the definitive documentation. This restructuring is not expected tohave a material adverse effect on our earnings, cash flows or financialposition.

 

Hawaiian accounted for $537 million and $479 million (4.5% and 4.1%) ofour total portfolio at June 30, 2003 and December 31, 2002, respectively.At June 30, 2003, the Hawaiian portfolio primarily consisted of 13 B-717sand three B-767s. Hawaiian filed for Chapter 11 bankruptcy protection onMarch 21, 2003. With bankruptcy court approval, we have reached anagreement releasing Hawaiian from its obligation to take delivery of a newB-767 that was scheduled for delivery to Hawaiian in April 2003. We arecurrently re-marketing that aircraft. Taking into account the specific reservesallocated at the end of the second quarter of 2003 for the Hawaiianreceivables, we do not expect that our transactions with Hawaiian will have amaterial adverse effect on our earnings, cash flow or financial position. Inthe event that future negotiations or proceedings result in the return of asubstantial number of aircraft, there could be a material adverse effect on ourearnings, cash flows or financial position, at least until such time as theaircraft are sold or redeployed for adequate consideration.

 

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Viacao Aerea Rio-Grandense (“VARIG”) accounted for $439 million and$452 million (3.7% and 3.8%) of our total portfolio at June 30, 2003 andDecember 31, 2002, respectively. At June 30, 2003, the VARIGportfolio consisted of two B-737s and nine MD-11s. In recent years, VARIG hasrepeatedly defaulted on its obligations under leases with us, which hasresulted in deferrals and restructurings some of which are still ongoing.Boeing has provided us with first loss deficiency and partial lease rentalguarantees covering approximately $323 million of the VARIG obligations. Takinginto 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 or financial position.

 

We have reviewed our obligations due from our customers forcollectibility and have established specific or general allowances as we deemednecessary. A number of our customers, including several of our largercustomers, have requested a restructuring of their transactions with us. Wehave not reached agreement on any restructuring requests that we believe wouldhave a material adverse effect on our earnings, cash flows or financialposition. Future agreements or restructuring requests, negotiations or defaults(including bankruptcies) by our customers may have a material adverse effect onour earnings, cash flows or financial position.

 

*Outstanding Funding Commitments*

 

At June 30, 2003, we had commitments toprovide leasing and other financing totaling $468 million. Based on historicalexperience, we anticipate that not all of thesecommitments will be utilized. However, if we were required to fund all unfundedcommitments:

 

•                  up to $168 million may be funded inless than one year, and

•                  an additional $300 million may befunded in one to three years.

 

Additionally, Boeing and BCSC had unfundedcommercial aircraft financing commitments at June 30, 2003 of $3.0billion. Based on historical experience, we do notanticipate that we will fund all of these commitments. However, if we wererequired to fund all unfunded commitments:

 

•                  up to $1.0 billion may be funded inless than one year, and

•                  an additional $2.0 billion may befunded in one to three years.

 

We expect to ultimately fund a portion of theseunfunded commitments. The portion that we fund may require credit enhancementsor other guarantee support from Boeing as necessary for us to meet ourunderwriting and investment criteria.

 

In conjunction with prior asset dispositionsand certain guarantees, at June 30, 2003, we were subject to maximumguarantor obligations of $142 million; however, $7 million of such amount hasbeen indemnified by Boeing and is included in the amounts guaranteed by Boeing.Guarantor obligations are primarily comprised of residual value and otherguarantees provided by us. Losses, if any, related to such exposure, net ofcollateral, are not expected to be significant to us.

 

19

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Note 10 – Off-Balance Sheet Arrangements

 

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

 

*Guarantor Obligations*

 

The following table provides quantitative data regarding our thirdparty guarantees. The maximum potential payment amounts represent a “worst-casescenario,” and do not necessarily reflect results expected by us. Estimatedproceeds from collateral and recourse represent the anticipated values ofassets we could liquidate or receive from other parties to offset our paymentsunder guarantees. The carrying amount of liabilities recorded on theconsolidated balance sheets reflects our best estimate of future payments wemay be required to make as part of fulfilling our guarantor obligations.

 
| **(Dollars  in millions)**  |   | **Maximum  Potential  Payments** |       | **Estimated  Proceeds  From  Collateral/Recourse** |       | **Carrying  Amount of  Liabilities(2)** |       |
|-----------------------------|--------|----------------------------------|------------|----------------------------------------------------|------------|-----------------------------------------|------------|
| **June 30, 2003**      |   |                             | ** ** |                                               | ** ** |                                    | ** ** |
| Residual value guarantees   |   | $                                | 110        |                                               | $          | 110                                     |       | $ | 4 |   |
| Credit guarantees           |   | 25                               |       | 25                                                 |       | —                                  |       |
| Deficiency guarantees(1)    |   | 7                                |       | —                                             |       | —                                  |       |
|                        |   | $                                |  142  |                                               | $          |  135                               |       | $ |  4 |   |
|                        |   |                             |       |                                               |       |                                    |       |
| **December 31,  2002** |   |                             |       |                                               |       |                                    |       |
| Residual value guarantees   |   | $                                | 90         |                                               | $          | 90                                      |       | $ | 1 |   |
| Credit guarantees           |   | 25                               |       | 25                                                 |       | —                                  |       |
| Deficiency guarantees(1)    |   | 7                                |       | —                                             |       | —                                  |       |
|                        |   | $                                |  122  |                                               | $          |  115                               |       | $ |  1 |   |
|                             |        |                                  |            |                                                    |            |                                         |            |  |  |  |  |  |  |

 

----

(1)          Thisamount is indemnified by Boeing.

(2)          Amountsincluded in other liabilities.

 

We have issued various residual value guarantees. Under thesearrangements, we are obligated to make payments to a guaranteed party in theevent the related aircraft or equipment fair values fall below a specifiedamount at a future point in time. These obligations are collateralizedprincipally by commercial aircraft, and expire within the next 13 years.

 

We have issued credit and deficiency guarantees. Under thesearrangements, we are obligated to make payments to a guaranteed party in theevent that payments are not made by the original debtor or lessee. Currentoutstanding credit and deficiency guarantees expire within the next nine years.

 

20

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*Material Variable Interests in Unconsolidated Entities*

 

Airlines regularly utilize a special purpose entity (“SPE”) called aPass Through Trust to finance aircraft. The Pass Through Trust enables theairline to aggregate a large number of aircraft secured notes into one trustvehicle, facilitating the issuance of larger bonds called pass-throughcertificates. The most common forms of pass-through certificates issued byairlines are equipment trust certificates (“ETCs”) and EETCs. ETCs and EETCs provideinvestors with tranched rights to cash flows from a financial instrument, aswell as a collateral position in the related asset. While the underlyingclasses of equipment notes vary by maturity and/or coupon depending upon tenoror level of subordination of the specific equipment notes and theircorresponding claim on the aircraft, the basic function of the Pass ThroughTrust in an ETC or EETC remains to passively hold separate debt investments toenhance liquidity for investors, who in turn pass this liquidity benefitdirectly to the airline in the form of a lower coupon and/or greater debtcapacity. We participate in several ETCs and EETCs as an investor.

 

We are a subordinated lender to certain SPEs that are utilized by theairlines, lenders and loan guarantors including, for example, the Export-ImportBank of the United States. We also utilize other SPEs that are fullyconsolidated in our financial statements. Both SPE arrangements are utilized toisolate individual transactions for legal liability or tax purposes, or toperfect security interests from our perspective as well as, in some cases, thatof a third-party lender in certain leveraged lease transactions.

 

Our receivables from SPEs and investment in ETCs and EETCs aggregated$688 million at June 30, 2003, which represents our maximum exposure toeconomic loss. Accounting losses, if any, from period to period coulddiffer.  During the six months endedJune 30, 2003, we recorded revenues of $28 million and had cash inflows of$70 million relating to these investments. At June 30, 2003, the VIEs inwhich we have invested had total assets of approximately $6.4 billion andrelated debt (which is non-recourse to us) of approximately $5.7 billion.

 

We have assessed the application of FIN 46 as it relates to ourvariable interests described above. While we are currently not required toconsolidate these investments, we have concluded that we will not be requiredto consolidate our investments in ETCs and EETCs, but will be required toconsolidate a portion of our interest in SPEs that we lend to upon fulladoption of FIN 46. At July 1, 2003, the date of implementation, weexpect to consolidate a certain VIE arrangement, and as a result of thisconsolidation we will record operating lease assets of $192 million,non-recourse debt of $205 million and ($9) million for the cumulative effect ofan accounting change net of tax of $4 million. Our adoption of FIN 46 is not expected to have an ongoing materialadverse effect on our earnings, cash flows or financial position.

 

Note 11 – Segment Information

 

Our primary operations atJune 30, 2003 included two principal financial reporting segments:Aircraft Financial Services and Commercial Financial Services. Currently,Aircraft Financial Services is active in providing lease and debt financing todomestic and international airlines. Commercial Financial Services provideslease and loan financing to a broad range of commercial and industrialcustomers. Other is comprised of Space and Defense Financial Services.

 

21

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We evaluate the performance of our reportingsegments based on results of operations. Information about our operations inour financial reporting segments is summarized as follows:

 
|                                                        |   | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------------------------|--------|-------------------------------------|------------|
| **(Dollars in millions)**                                   |   | **2003**                            | ** ** | **2002** | ** ** |
| Revenues:                                                   |   |                                |       |   |   |
| Aircraft  Financial Services                                |   | $                                   | 448        |   | $ | 364 |   |
| Commercial  Financial Services                              |   | 114                                 |       | 117 |   |
| Other                                                       |   | 8                                   |       | 2 |   |
|                                                        |   | $                                   | 570        |   | $ | 483 |   |
|                                                        |   |                                |       |   |   |
| Interest  expense (allocated):                              |   |                                |       |   |   |
| Aircraft  Financial Services                                |   | $                                   | 177        |   | $ | 144 |   |
| Commercial  Financial Services                              |   | 43                                  |       | 44 |   |
| Other                                                       |   | 2                                   |       | 1 |   |
|                                                        |   | $                                   | 222        |   | $ | 189 |   |
|                                                        |   |                                |       |   |   |
| Depreciation  expense:                                      |   |                                |       |   |   |
| Aircraft  Financial Services                                |   | $                                   | 101        |   | $ | 74 |   |
| Commercial  Financial Services                              |   | 24                                  |       | 23 |   |
| Other                                                       |   | 2                                   |       | — |   |
|                                                        |   | $                                   | 127        |   | $ | 97 |   |
|                                                        |   |                                |       |   |   |
| Income  (loss) before provision (benefit) for income taxes: |   |                                |       |   |   |
| Aircraft  Financial Services                                |   | $                                   | (68        | ) | $ | 112 |   |
| Commercial  Financial Services                              |   | 25                                  |       | 27 |   |
| Other                                                       |   | 2                                   |       | — |   |
|                                                        |   | $                                   | (41        | ) | $ | 139 |   |

 

The portfolio assets by segmentwere as follows:

 
| **(Dollars in millions)**                                             |   | **June 30,  2003** | ** ** | **December 31,  2002** | ** ** |
|-----------------------------------------------------------------------|--------|-------------------------|------------|-----------------------------|------------|
| Aircraft Financial Services:                                          |   |                    |       |                        |       |
| Financing leases                                                      |   | $                       | 3,648      |                        | $          | 3,670 |   |
| Notes and  other receivables                                          |   | 2,259                   |       | 1,964                       |       |
| Equipment  under operating leases, net of accumulated depreciation    |   | 2,804                   |       | 2,672                       |       |
| Investments                                                           |   | 561                     |       | 517                         |       |
| Equipment  held for sale or re-lease, net of accumulated depreciation |   | 223                     |       | 288                         |       |
|                                                                  |   | 9,495                   |       | 9,111                       |       |
|                                                                  |   |                    |       |                        |       |
| Commercial Financial Services:                                        |   |                    |       |                        |       |
| Financing  leases                                                     |   | 752                     |       | 880                         |       |
| Notes and  other receivables                                          |   | 834                     |       | 875                         |       |
| Equipment  under operating leases, net of accumulated depreciation    |   | 759                     |       | 760                         |       |
| Equipment  held for sale or re-lease, net of accumulated depreciation |   | 37                      |       | 23                          |       |
|                                                                  |   | 2,382                   |       | 2,538                       |       |
| Other                                                                 |   | 106                     |       | 113                         |       |
|                                                                  |   | $                       | 11,983     |                        | $          | 11,762 |   |

 

22

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The total assets by segment wereas follows:

 
| **(Dollars in millions)**     |   | **June 30,  2003** | ** **   | **December 31,  2002** | ** ** |
|-------------------------------|--------|-------------------------|--------------|-----------------------------|------------|
| Aircraft Financial Services   |   | $                       | 9,924        |                        | $          | 9,761 |   |
| Commercial Financial Services |   | 2,504                   |         | 2,678                       |       |
| Other                         |   | 123                     |         | 124                         |       |
|                          |   | $                       |  12,551 |                        | $          |  12,563 |   |

 

Included in the portfolio balances above are $336 millionand $378 million at June 30, 2003 and December 31 2002, respectively,of investments in entities engaged in financing accounted for under the equitymethod.

 

Note 12 – Transactions with Boeing

 

We entered into certaintransactions with Boeing in the form of intercompany guarantees and othersubsidies.

 

Intercompany guarantees primarily relate to residual value guarantees,first loss deficiency guarantees and rental guarantees. At June 30, 2003,we were the beneficiary under $2.8 billion of guarantees from Boeing. Werecorded the following activity under the intercompany guarantee agreements:

 
|                                                                      |   | **Six Months Ended****June 30,** |       |
|---------------------------------------------------------------------------|--------|---------------------------------------|------------|
| **(Dollars  in millions)**                                                |   | **2003**                              | ** ** | **2002** | ** ** |
| Guarantee payments  applied to income                                     |   | $                                     | 35         |   | $ | 26 |   |
| Guarantee payments  applied to reduce net asset value of related aircraft |   | 10                                    |       | 4 |   |
|                                                                      |   | 45                                    |       | 30 |   |
| Fees                                                                      |   | (2                                    | )          | (1 | ) |
| Net guarantee payments  received                                          |   | $                                     | 43         |   | $ | 29 |   |

 

For a period of time, Boeing has also agreed to provide interest ratesubsidies, non-guarantee concessions and rental payments on restructured thirdparty leases. For the six months ended June 30, 2003 and 2002, werecognized income of $26 million and $21 million, respectively, under suchsubsidies.

 

Additionally, as provided for under the terms of the intercompanyguarantee agreements, Boeing recorded charges of $52 million and $22 million,respectively, for the six months ended June 30, 2003 and 2002, related toasset impairments, accrued expenses and adjustments to its allowance for losseson receivables in our portfolio.

 

For the six months ended June 30, 2003 and 2002, we recordedrevenues from Boeing, exclusive of guarantees and subsidies, of $22 million and$11 million, respectively.

 

We recognized new business volume of $784 million and $1,261 millionfor the six months ended June 30, 2003 and 2002, respectively, related toour purchase of aircraft and equipment from Boeing.

 

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**Item 2. Management’s NarrativeAnalysis of Results of Operations**

 

Forward-LookingInformation Is Subject to Risk and Uncertainty

 

From time to time, we may make statementsthat contain projections or “forward-looking” information (as defined in thePrivate Securities Litigation Reform Act of 1995) that involve risk anduncertainty. The words “aim”, “plan”, “likely”, “believe”, “expect”,“anticipate”, “intend”, “estimate”, “will”, “should”, “could”, “may”, and otherexpressions that indicate future events and trends identify forward-looking statements.These statements are not guaranties of future performance andinvolve risks, uncertainties and assumptions that are difficult to predict.Forward-looking statements are based upon assumptions as to future events thatmay not prove to be accurate. Actual outcomes and results may differ materiallyfrom what we express or forecast in these forward-looking statements. As aresult, these statements speak only as of the date they were made and weundertake no obligation to publicly update or revise any forward-lookingstatements. Certain statements in thisForm 10-Q, and particularly in the Notes to Consolidated Financial Statementsin Item 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 such statementsmay include, but not be limited to wars, the effects of the September 11,2001 terrorist attacks or future terrorist threats or attacks, the impact on usof strategic decisions of Boeing, the level of new financing opportunities madeavailable to us by Boeing, future earnings, business volume, 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.

 

Our actual results and future trends maydiffer materially from our forward-lookingstatements depending on a variety of factors including our relationshipwith Boeing, as well as strategic decisions of Boeing relating to us, theeffects of the September 11, 2001 terrorist attacks or future terroristthreats or attacks and their continuing impact on the airline industry, wars,Severe Acute Respiratory Syndrome (“SARS”), the capital equipment requirementsof United States domestic and foreign businesses, general economic conditions,and in particular, economic conditions in the airline industry and thecontinued operation, viability and growth of major airline customers, capitalavailability and cost, changes in laws and tax benefits, the tax position ofBoeing (including the applicability of the alternative minimum tax),competition from other financial institutions, our successful execution ofinternal operating plans, defaults or bankruptcies by customers (especiallyairlines), adverse developments in the value of collateral or owned assets(especially aircraft), termination of aircraft manufacturing programs,regulatory uncertainties, legal proceedings and an adverse development inrating agency credit ratings or assessments.

 

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

 

Overview

 

Our net loss was $17 million for the six months endedJune 30, 2003 compared with net income of $89 million for the same periodin 2002, a decrease of $106 million. The $106 million decline results primarilyfrom pre-tax non-cash charges totaling $202 million (see breakdown ofcomponents in the following paragraph), of which $193 million was recognized inthe first quarter of 2003. These charges were recognized in response to themuch-publicized deterioration in the credit worthiness of our airlinecustomers, airline bankruptcy filings and the continued decline in commercialaircraft and general equipment asset values.

 

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The pre-tax non-cash charges of $202 million consisted of:

 

# •                              A special pre-taxprovision for losses of $130 million recorded in the first quarter of 2003 toincrease and strengthen the allowance for losses on receivables,

# •                              $51 million inpre-tax impairment losses, of which $42 million was recognized in the firstquarter of 2003, primarily attributable to valuations of aircraft underoperating lease and equipment held for sale or re-lease, and

•                              A $21 million pre-tax write-off in the firstquarter of 2003 of forward-starting interest rate swaps that no longerqualified for fair value hedge accounting treatment.

 

Our portfolio at June 30, 2003 totaled $12.0 billion compared with $11.8 billion at December 31, 2002 and $11.1 billion at June 30, 2002. Our 2003 new business volume is expected to be significantly less than that recorded in 2002 as a result of reduced demand for commercial aircraft financings. The outlook for our net portfolio growth in 2003 has been reduced from approximately $2.0 billion to between $1.0 billion to $1.5 billion. In 2004, the outlook is reduced from approximately $2.0 billion to between $1.5 billion to $2.0 billion. As a result, our revenue growth outlook will slightly moderate. Our outlook for return on assets is unchanged at approximately break even in 2003 and approximately 1% in 2004.

 

Results of Operations

 

*Financing revenues*(revenue fromfinancing leases, notes and other receivables and equipment under operatingleases) were as follows:

 
|                                |   | **Six Months  Ended  June 30,** |       |
|-------------------------------------|--------|--------------------------------------|------------|
| **(Dollars in millions)**           |   | **2003**                             | ** ** | **2002** | ** ** |
| Finance lease income                |   | $                                    | 151        |   | $ | 149 |   |
| Interest income on notes receivable |   | 105                                  |       | 103 |   |
| Operating lease income              |   | 252                                  |       | 193 |   |
|                                |   | $                                    |  508  |   | $ |  445 |   |

 

Financing revenues**for the six months ended June 30,2003 were $508 million compared with $445 million for the same period in 2002,an increase of $63 million (14.2%). New business volume and portfolio transfersfrom Boeing were primarily responsible for the increase in revenue.

#  

## ***Investment income***forthe six months ended June 30, 2003 was $25 million compared with $19million for the same period in 2002, an increase of $6 million (31.6%). Theincrease was primarily due to a gain of $5 million on the sale of common stockthat was received as a result of a financing transaction.

## ** **

*Other income* for the six monthsended June 30, 2003 was $35 million compared with $12 million for the sameperiod in 2002, an increase of $23 million. Higher recognized gains onderivatives of $21 million, interest income on short-term investments of $3million and fee income of $2 million offset by a decrease in miscellaneousincome of $3 million were primarily responsible for the increase in 2003.

 

*Interest expense* for the sixmonths ended June 30, 2003 was $222 million compared with $189 million forthe same period in 2002, an increase of $33 million (17.5%). Higher debtassociated with the growth in the portfolio, offset by lower effective interestrates, was primarily responsible for the increase.

 

*Depreciation expense* (on equipmentunder operating leases and equipment held for re-lease) for the six monthsended June 30, 2003 was $127 million compared with $97 million for thesame period in 2002, an increase of $30 million (30.9%). Growth in equipmentunder operating leases was primarily responsible for the increase.

 

25

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*Provision for losses* for the sixmonths ended June 30, 2003 was $149 million compared with $17 million forthe same period in 2002, an increase of $132 million. The provision for lossesis comprised of a general provision and an additional provision. The generalprovision, which primarily relates to the growth in the receivables portfolio,was $19 million for the six months ended June 30, 2003 compared with $17million for the same period in 2002. The additional provision was $130 millionand was recorded at the end of the first quarter of 2003 in 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.

 

*Operating expenses*, which consistsof general and administrative expenses, for the six months ended June 30,2003 was $34 million compared with $28 million for the same period in 2002, anincrease of $6 million (21.4%). Higher administrative and staffing costs andprofessional services fees were primarily responsible for the increase inoperating expenses.

 

*Asset impairment expense* for the sixmonths ended June 30, 2003 was $51 million compared with $4 million forthe same period in 2002, an increase of $47 million. The $51 million impairmentlosses for the six months ended June 30, 2003, of which $42 million wasrecognized in the first quarter of 2003, resulted from reduced projected cashflows and deteriorated aircraft values for operating lease assets.

 

*Other expenses* for the sixmonths ended June 30, 2003 were $27 million compared with $8 million forthe same period in 2002, an increase of $19 million. The increase was primarilyattributable to a $21 millionwrite-off in the first quarter of 2003 of forward-starting interest rate swaps thatno longer qualified for fair value hedge accounting treatment, which was slightlyoffset by a decrease of $2 million in aircraft maintenance and storage andother expenses.

 

*Provision (benefit) for incometaxes* for the six months ended June 30, 2003 was ($24) million comparedwith $50 million for the same period in 2002, a change of $74 million. Thepre-tax loss recorded for the six months ended June 30, 2003 wasprincipally responsible for the benefit for income taxes.

 

## **BusinessEnvironment and Trends**

## ** **

The commercial aviation market downturn remainssevere, particularly in key U.S. domestic, transatlantic and transpacificmarkets, with trends varying between carriers and regions. Air travel volumesin all areas of the world are below the volumes carried by the airlines in2000. The downturn is impacting demand across aircraft types. Economic growthhas been slow to recover due to worldwide industrial over-capacity and poordemand. The world’s largest and most developed economies are all facing varyingdegrees of this problem despite stimulative fiscal and monetary policies. Thiseconomic sluggishness combined with increased air travel security costs, theoutbreak of SARS in Asia, and ongoing airline restructuring has put severedownward pressure on airline revenues, earnings and growth. We continue tocarefully monitor the commercial aviation market conditions.

 

The downturn in the airline industry and the resultingdecline in the collateral values of aircraft and airline credit ratings, aswell as additional bankruptcy filings by certain airline customers included inour portfolio were primarily responsible for our recognition of non-cashcharges in the first quarter of 2003 to strengthen the allowance for losses onreceivables and recognize impairments on certain assets. Any additional impactsmay be dependent upon the duration of the current economic and airline industrydecline, or any significant defaults, repossessions or restructurings at a timewhen depressed aircraft values and lease rates make it difficult to sell orredeploy such aircraft. Aircraft valuations could decline materially ifsignificant numbers of aircraft, particularly types with relatively fewoperators, are idled on account of further airline bankruptcies orrestructurings.

 

26

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Boeing is currently involved in key campaigns that may determine thecontinuation of the B-757 program. At June 30, 2003, $1.2 billion of ourportfolio was collateralized by B-757 aircraft of various vintages. AtJune 30, 2003, we were the beneficiary under $240 million of guaranteesfrom Boeing covering $305 million of our B-757 portfolio. Future decisionsrelating to B-757 production, as well as overall market conditions, could erodecollateral value and rental rates. Lower collateral values could result in arequirement to increase the allowance for losses on receivables. Futuredeclines in rental rates could result in additional impairment charges underSFAS No. 144. We are unable to predict the likelihood of thisoccurring or the related impact. However, this could result in a materialadverse effect on our earnings or financial position.

 

At June 30, 2003, we had $260 million ofassets that were held for sale or re-lease, of which $28 million wereidentified with a firm contract to sell or place on lease. Additionally, approximately$297 million of our portfolio is currently scheduled to come off lease duringthe next twelve months and become subject to replacement into the market. Theinability to place or sell such assets of the portfolio into revenue-generatingservice could pose a potential risk to results of operations.

 

#### Liquidity and Capital Resources

####  

We have significant liquidity requirements, primarily to fund ouroperating expenses and satisfy debt payments, and to fund our ongoing financingcommitments. We satisfy these liquidity needs from the following sources:

 

•                  cash fromoperations and other receipts from our portfolio,

•                  issuance ofcommercial paper and other debt,

•                  securitizationprogram, and

•                  borrowings undercommitted credit facilities.

 

We attempt to schedule receipts from our portfolio to correspond to ourexpense and debt payments as they become due. We satisfy a significant portionof our cash requirements from diversified global funding sources and do notdepend on any one lender. We believe that we have adequate liquidity sourcesand access to the capital markets to allow us to fulfill our commitments during2003.

 

Risks that could affect our sources of liquidity include:

 

•              a severe orprolonged downturn in the economy,

•              additionalrestructurings, defaults or bankruptcies by airlines, and

•              a decrease in ourcredit ratings.

 

During the first half of 2003, we issued $152 million in new seniordebt, primarily to finance new business. We also rely on the issuance ofcommercial paper as a short-term funding source. During the first half of 2003,our outstanding commercial paper balances ranged from zero to $73 million, witha weighted average effective interest rate of 1.63% and a daily averageoutstanding balance for the period of $7 million. We had no commercial paperborrowings outstanding at June 30, 2003.

 

Our assets and liabilities expose us tointerest rate risk to the extent that those assets and liabilities are notexactly matched according to currency or maturity and repricingcharacteristics. The types and terms of borrowing and hedging instruments thatare available to us in the market and possible changes in asset terms limit ourability to match assets and liabilities. We attempt to keep this mismatch risksmall, partly through the use of interest rate and currency swaps, and we donot believe we are materially exposed to gains or losses due to interest rateor currency changes.

 

27

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Financing-related interest expensefor the six months ended June 30, 2003 was $222 million, compared with$189 million for the same period in 2002. Leverage (debt-to-equity ratio) atJune 30, 2003 was 5.3-to-1, as compared with 5.7-to-1 at the end of 2002and 5.2-to-1 at June 30, 2002.

 

##### **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 credit ratings as of the filing date:**

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

 

On July 15, 2003, Moody’s Investors Service(“Moody’s”) placed Boeing’s and our senior and subordinated credit ratings onnegative watch for possible downgrade. This action primarily relates to theplacement of Boeing’s ratings under review for possible downgrade by Moody’s asa result of certain second quarter 2003 charges recognized by Boeing.

 

Although credit ratings may impact the rate atwhich we can borrow funds, a credit rating is not a recommendation to buy, sellor hold securities. In addition, a credit rating is subject to revision orwithdrawal at any time by the assigning rating organization.

 

##### **Segment Operations**

##### ** **

We provide financial services through two primary reporting segments:Aircraft Financial Services and Commercial Financial Services. Other iscomprised of Space and Defense Financial Services. The determination ofsegments is based upon our internal organization and operational and financialmeasurement practices. We evaluate the performance of our reporting segmentsbased on results of operations.

 

Aircraft Financial Services provides financing to buy or leasecommercial airplanes and represented 79.2% of our total portfolio atJune 30, 2003. Services provided by Aircraft Financial Services extend tonew and used Boeing and non-Boeing aircraft. Aircraft Financial Services alsoassists Boeing commercial aircraft customers to structure and arrange for loanand lease products. At June 30, 2003, we owned 331 commercial aircraft andhad partial ownership or security interest in an additional 233 aircraft,including those owned in joint ventures, EETC and other investmenttransactions.

 

Commercial Financial Services’ portfolio encompasses multipleindustries and a wide range of equipment, including corporate aircraft,ocean-going vessels, machine tools, shipping containers, printing presses,paper and cardboard manufacturing equipment and a wide variety of other industrialand manufacturing equipment. Commercial Financial Services represented 19.9% ofour total portfolio at June 30, 2003.

 

Space and Defense Financial Services provides lease and loan financingand advisory services for military-related products and commercial spacesystems. This portfolio represented 0.9% of our total portfolio atJune 30, 2003.

 

28

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*Aircraft Financial Services*

 

*Revenues* for the sixmonths ended June 30, 2003 were $448 million compared with $364 millionfor the same period in 2002, an increase of $84 million (23.1%). A largerportfolio, resulting from new business volume and portfolio transfers fromBoeing, an increase in gains on derivatives and fee income were primarilyresponsible for the increased revenues. This increase was slightly offset bylosses on disposal of assets.

 

*Interest expense*(allocated) for the six months ended June 30, 2003 was $177 millioncompared with $144 million for the same period in 2002, an increase of $33million (22.9%). Higher debt associated with the growth in the portfolio,offset by lower effective interest rates, was primarily responsible for theincrease.

 

# *Depreciation expense*for the six months ended June 30, 2003 was $101 million compared with $74million for the same period in 2002, an increase of $27 million (36.5%). Growthin equipment under operating leases was responsible for the increase.

#  

# *Income (loss) before provision (benefit) forincome taxes* for the six months ended June 30,2003 was ($68) million compared with $112 million for the same period in 2002,a change of $180 million. In addition to the aforementioned items, income (loss) beforeprovision (benefit) for income taxes was reduced by:

#  

# •                              $130 million ofspecial provision for losses recognized in the first quarter of 2003 toincrease and strengthen the allowance for losses on receivables,

# •                              $49 million in charges for impairment of portfolioassets, of which $40 million was recognized in the first quarter of 2003,related to aircraft under operating lease and equipment held for sale orre-lease, and

•                              $21 million charge for the write-off in thefirst quarter of 2003 of forward-starting interest rate swaps that no longerqualified for fair value hedge accounting treatment.

 

# *Commercial FinancialServices*

 

# *Income (loss) before provision (benefit) forincome taxes* for the six months ended June 30,2003 was $25 million compared with $27 million for the same period in 2002, adecrease of $2 million (7.4%). A smaller portfolio, which resulted from portfoliorun off and decreased new business volume, was primarily responsible for thedecrease.

#  

##### **Standards Issuedand Not Yet Implemented**

 

InJanuary 2003, the FASB issued FIN 46, “Consolidation of VariableInterest Entities,” which clarifies theapplication of Accounting Research Bulletin No. 51, “ConsolidatedFinancial Statements,” relating to consolidation of certain entities. First,FIN 46 requires identification of our participation in VIEs, which aredefined as entities with a level of invested equity insufficient to fund futureactivities to operate on a stand-alone basis or whose equity holderslack certain characteristics of a controlling financial interest. Then, for an entity identified as a VIE,FIN 46 sets forth a model to evaluate potential consolidation based on anassessment of which party to the VIE, if any, bears a majority of the exposureto the expected losses, or stands to gain from a majority of the expectedreturns. FIN 46 also sets forth certain disclosures regarding interests inVIEs that are deemed significant, even if consolidation is not required. Theprovisions of FIN 46 became effective July 1, 2003 for VIEs createdon or before January 31, 2003, and became immediately effective for VIEscreated after January 31, 2003. At July 1, 2003, the date ofimplementation, we expect to consolidate a certain VIE arrangement, and as aresult of this consolidation we will record operating lease assets of $192million, non-recourse debt of $205 million and ($9) million for the cumulativeeffect of an accounting change net of tax of $4 million. Our adoption of FIN 46 is not expected to have an ongoing materialadverse effect on our earnings, cash flows or financial position.

 

29

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In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instrumentsand Hedging Activities,” which is effective for contracts entered into ormodified and hedging relationships designated after June 30, 2003. ThisStatement amends and clarifies financial accounting and reporting forderivative instruments, including certain derivative instruments embedded inother contracts and for hedging activities under SFAS No. 133, “Accounting for DerivativeInstruments and Hedging Activities.” Implementation of this standard is notexpected to have a material effect on our earnings, cash flows or financialposition.

 

**Item 4. Controls and Procedures**

 

Evaluation of Disclosure Controls andProcedures

 

Our principalexecutive officer and principal financial officer, based on their evaluation ofour disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 (c)) as of a date within 90 days prior to the filing of this QuarterlyReport on Form 10-Q, have concluded that our disclosure controls and proceduresare adequate and effective for the purposes set forth in the definition inExchange Act rules.

 

Changes in Internal Controls

 

There were nosignificant changes in our internal controls or in other factors that couldsignificantly affect our internal controls subsequent to the date of theirevaluation.

 

# **Part II**

 

**Item 1. Legal Proceedings**

 

Various legal proceedings and claims are pending or have been assertedagainst us, many of which are covered by third parties, including insurancecompanies. We believe that the final outcome of such proceedings and claimswill not have a material adverse effect on our earnings, cash flows orfinancial position.

 

**Item 5. Other Information**

 

New Business Volume(1)

 

New business volume is summarized as follows:

 
|                           |   | **Six Months Ended  June 30,** | ** **  |
|--------------------------------|--------|-------------------------------------|-------------|
| **(Dollars in millions)**      |   | **2003**                            | ** **  | **2002** | ** ** |
| Aircraft Financial Services    |   | $                                   | 915         |   | $ | 1,668 |   |
| Commercial  Financial Services |   | 96                                  |        | 363 |   |
| Other                          |   | 10                                  |        | 2 |   |
|                           |   | $                                   |  1,021 |   | $ |  2,033 |   |

 

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(1)          Excludes transfers from Boeing, unless new financingoccurred in current year.

 

30

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Portfolio balances are summarized as follows:

 
| **(Dollars in millions)**     |   | **June 30,  2003** | ** ** | **December 31,  2002** | ** ** |
|-------------------------------|--------|-------------------------|------------|-----------------------------|------------|
| Aircraft Financial Services   |   | $                       | 9,495      |                        | $          | 9,111 |   |
| Commercial Financial Services |   | 2,382                   |       | 2,538                       |       |
| Other                         |   | 106                     |       | 113                         |       |
|                          |   | $                       | 11,983     |                        | $          | 11,762 |   |

 

The following table summarizes the net change in our totalportfolio:

 
| **(Dollars in millions)**                 |   | **Six Months Ended  June 30,  2003** | ** ** | **Year Ended  December 31,  2002** | ** ** |
|-------------------------------------------|--------|-------------------------------------------|------------|-----------------------------------------|------------|
| New  business volume                      |   | $                                         | 1,021      |                                    | $          | 3,415 |   |
| Financing  assets transferred from Boeing |   | —                                    |       | 386                                     |       |
| Portfolio  impairment                     |   | (52                                       | )          | (100                                    | )          |
| Asset  run-off                            |   | (621                                      | )          | (913                                    | )          |
| Depreciation  expense                     |   | (127                                      | )          | (223                                    | )          |
| Net  change in portfolio balance          |   | $                                         | 221        |                                    | $          | 2,565 |   |

 

Significant Concentrations

 

The following table includes our five largestcustomers at June 30, 2003, with their related portfolio balances atDecember 31, 2002:

 
|                       |   | **June 30, 2003** |   | **December 31, 2002** |   |
|----------------------------|--------|------------------------|--------|----------------------------|--------|
| **(Dollars  in millions)** |   | **Net Asset Value**    |   | **% of Total  Portfolio**  |   | **Net Asset Value** | ** ** | **% of Total  Portfolio** | ** ** |
| AirTran                    |   | $                      | 1,370  |                       | 11.4   | % | $ | 1,069 |   | 9.1 | % |
| United                     |   | 1,182                  |   | 9.9                        |   | 1,190 |   | 10.1 |   |
| American                   |   | 825                    |   | 6.9                        |   | 381 |   | 3.2 |   |
| ATA                        |   | 667                    |   | 5.6                        |   | 611 |   | 5.2 |   |
| Boeing                     |   | 551                    |   | 4.6                        |   | 878 |   | 7.5 |   |
|                       |   | $                      | 4,595  |                       |   |   | $ | 4,129 |   |   |   |

 

Our largest customer, AirTran Holdings, Inc. (“AirTran”), accounted for$1.4 billion and $1.1 billion of our total portfolio at June 30, 2003 andDecember 31, 2002, respectively. Our AirTran portfolio includesinvestments in AirTran EETCs and common stock totaling $40 million at both June 30,2003 and December 31, 2002. At June 30, 2003, the AirTran portfolioprimarily consisted of 54 B-717s and the above-mentioned investments. OnOctober 23, 2002, Boeing announced that AirTran signed an agreement withus to lease 22 of the 24 B-717 aircraft returned by American. The B-717aircraft are scheduled for delivery throughout 2003, 13 of which were deliveredduring the first half of 2003.****Subsequent to June 30, 2003, AirTranannounced it had placed an order with Boeing for 100 new B-737s, of which 50are firm orders and 50 are options, and an additional order for up to tenB-717s.

 

Our second largest customer, United, accounted for $1.2 billion of ourtotal portfolio at both June 30, 2003 and December 31, 2002. AtJune 30, 2003, the United portfolio was secured by security interests intwo B-767s and 13 B-777s and by an ownership and security interest in fiveB-757s. United filed for Chapter 11 bankruptcy protection onDecember 9, 2002. On February 7, 2003, United agreed to perform underthe loan agreements securing the B-767s and B-777s by bringing its paymentsunder those agreements current. Since April 10, 2003, United has madeinterest only payments on the notes and some

 

31

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reduced rental payments on the B-757s. Discussions with United arecontinuing on a full restructuring of the various transactions. Futurenegotiations may result in changes to the agreements in respect of the aircraftwith United. Until United emerges from bankruptcy or we take possession of thecollateral, United has the right to reject or abandon its transactions with us.In the event that future negotiations or proceedings result in the return of asubstantial number of aircraft, there could be a material adverse effect on ourearnings, cash flows or financial position, at least until such time as theaircraft are sold or redeployed for adequate consideration.

 

Our third largest customer, American, accounted for $825 million and$381 million of our total portfolio at June 30, 2003 and December 31,2002, respectively. At June 30, 2003, the American portfolio consisted ofleases and loans on two B-757s, seven B-767s, two B-777s, 39 MD-83s, fourMD-82s and subordinated debt in one B-777. We financed final delivery paymentsthen due on seven B-767s and two B-777s during the first half of 2003 and oneadditional B-767 in July 2003. In addition, Boeing has a commitment toprovide backstop loan financing for one B-767 delivery in August 2003. Thebackstop loan financing for the final delivery payment was exercised byAmerican subsequent to June 30, 2003 and will be secured by the deliveredaircraft. We believe that all such delivery payment loans are adequatelycollateralized.

 

Our fourth largest customer, ATA, accountedfor $667 million and $611 million of our total portfolio at June 30, 2003and December 31, 2002, respectively. At June 30, 2003, the ATAportfolio primarily consisted of 11 B-757s and an investment in ATA preferredstock with a face amount of $50 million, which is included in the portfolio atits carrying value. In November 2002, ATA received a loan of $168 millionadministered by the Airline Transportation Stabilization Board. ATA hasrequested that we restructure certain outstanding leases by deferring a portionof its rent payments for a limited period of time. We have reached agreement,subject to certain conditions, on the terms of the restructuring and we areworking on the definitive documentation. This restructuring is not expected tohave a material adverse effect on our earnings, cash flows or financialposition.

 

Our fifth largest customer, Boeing, accounted for $551 million and $878million of our total portfolio at June 30, 2003 and December 31,2002, respectively. During the second quarter of 2002, American returned 24B-717 aircraft. Boeing guarantees a substantial portion of the rental streamsof these aircraft; thus, in effect Boeing became the lessee under these leases.On October 23, 2002, Boeing announced that AirTran signed an agreementwith us to lease 22 of the 24 B-717 aircraft returned by American. The 22 B-717aircraft are scheduled for delivery throughout 2003, 13 of which were deliveredduring the first half of 2003. The remaining two B-717 aircraft were placed onlease during October 2002.

 

One of our ten largest customers, Hawaiian,accounted for $537 million and $479 million of our total portfolio atJune 30, 2003 and December 31, 2002, respectively. At June 30,2003, the Hawaiian portfolio primarily consisted of 13 B-717s and three B-767s.Hawaiian filed for Chapter 11 bankruptcy protection on March 21,2003. With bankruptcy court approval, we have reached an agreement releasingHawaiian from its obligation to take delivery of a new B-767 that was scheduledfor delivery to Hawaiian in April 2003. We are currently re-marketing thataircraft. Taking into account the specific reserves allocated at the end of thesecond quarter of 2003 for the Hawaiian receivables, we do not expect that ourtransactions with Hawaiian will have a material adverse effect on our earnings,cash flow or financial position. In the event that future negotiations orproceedings result in the return of a substantial number of aircraft, therecould be a material adverse effect on our earnings, cash flows or financialposition, at least until such time as the aircraft are sold or redeployed foradequate consideration.

 

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Aircraft Financial Services Portfolio

 

The Aircraft Financial Services portfolioconsisted of the following commercial aircraft types(1):

 
| **(Dollars in millions)**        |   | **Receivables(2)** |   | **Operating  Leases(2)** |   | **Investments(5)** |   | **Held for  Sale or  Re-Lease** |   | **Total** |   |
|----------------------------------|--------|--------------------|--------|--------------------------|--------|--------------------|--------|---------------------------------|--------|-----------|--------|
| **June 30, 2003**           |   |               |   |                     |   |               |   |                            |   |      |   |
| B-717                            |   | $                  | 1,832  |                     | $      | 246                |   | $                               | — |      | $      | — |   | $ | 2,078 |   |
| B-737                            |   | 82                 |   | 684                      |   | —             |   | 19                              |   | 785       |   |
| B-747                            |   | 225                |   | 241                      |   | —             |   | —                          |   | 466       |   |
| B-757                            |   | 812                |   | 359                      |   | —             |   | 22                              |   | 1,193     |   |
| B-767                            |   | 630                |   | 375                      |   | —             |   | 15                              |   | 1,020     |   |
| B-777                            |   | 1,206              |   | —                   |   | —             |   | —                          |   | 1,206     |   |
| DC-9(3)                          |   | 81                 |   | —                   |   | —             |   | 6                               |   | 87        |   |
| MD-80(3)                         |   | 365                |   | 108                      |   | —             |   | 26                              |   | 499       |   |
| MD-90(3)                         |   | 86                 |   | —                   |   | —             |   | 51                              |   | 137       |   |
| DC-10(3)                         |   | 58                 |   | 38                       |   | —             |   | —                          |   | 96        |   |
| MD-11(3)                         |   | 171                |   | 700                      |   | —             |   | 74                              |   | 945       |   |
| Other  Aircraft and Equipment(4) |   | 359                |   | 53                       |   | —             |   | 10                              |   | 422       |   |
| Asset  Pools(6)                  |   | —             |   | —                   |   | 512                |   | —                          |   | 512       |   |
| Other(7)                         |   | —             |   | —                   |   | 49                 |   | —                          |   | 49        |   |
|                             |   | $                  | 5,907  |                     | $      | 2,804              |   | $                               | 561    |      | $      | 223 |   | $ | 9,495 |   |
|                             |   |               |   |                     |   |               |   |                            |   |      |   |
| **December 31, 2002**       |   |               |   |                     |   |               |   |                            |   |      |   |
| B-717                            |   | $                  | 1,838  |                     | $      | 122                |   | $                               | — |      | $      | — |   | $ | 1,960 |   |
| B-737                            |   | 81                 |   | 705                      |   | —             |   | 19                              |   | 805       |   |
| B-747                            |   | 240                |   | 247                      |   | —             |   | —                          |   | 487       |   |
| B-757                            |   | 820                |   | 333                      |   | —             |   | 23                              |   | 1,176     |   |
| B-767                            |   | 319                |   | 309                      |   | —             |   | 26                              |   | 654       |   |
| B-777                            |   | 1,076              |   | —                   |   | —             |   | —                          |   | 1,076     |   |
| DC-9(3)                          |   | 95                 |   | 6                        |   | —             |   | —                          |   | 101       |   |
| MD-80(3)                         |   | 391                |   | 118                      |   | —             |   | 18                              |   | 527       |   |
| MD-90(3)                         |   | 119                |   | —                   |   | —             |   | 36                              |   | 155       |   |
| DC-10(3)                         |   | 62                 |   | 57                       |   | —             |   | 4                               |   | 123       |   |
| MD-11(3)                         |   | 175                |   | 717                      |   | —             |   | 152                             |   | 1,044     |   |
| Other  Aircraft and Equipment(4) |   | 418                |   | 58                       |   | —             |   | 10                              |   | 486       |   |
| Asset  Pools(6)                  |   | —             |   | —                   |   | 474                |   | —                          |   | 474       |   |
| Other(7)                         |   | —             |   | —                   |   | 43                 |   | —                          |   | 43        |   |
|                             |   | $                  | 5,634  |                     | $      | 2,672              |   | $                               | 517    |      | $      | 288 |   | $ | 9,111 |   |

 

----

(1)          Excludes corporate aircraft of $931million and $950 million at June 30, 2003 and December 31, 2002,respectively, which are included in the Commercial Financial Servicesportfolio.

(2)          Includes owned aircraft and aircraftcollateralizing receivables, some of which are subordinated.

(3)          Out of production, but currently supported byBoeing with respect to parts and other services.

(4)          Some of these aircraft are out ofproduction, but are supported by the manufacturer or other third party part andservice providers.

(5)          Represents aircraft and equipmentcollateralizing EETCs, ETCs and other trust-related interests and otherinvestments held by us.

 

33

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(6)          Investments are supported by asset poolssecured by various commercial aircraft types.

(7)          Represents investments in mandatorilyredeemable preferred stock, common stock and bonds.

 

At June 30, 2003, we owned 331commercial aircraft and had partial ownership or security interest in anadditional 233 aircraft, including those owned in joint ventures, EETC andother investment transactions.

 

At June 30, 2003, $8.5 billion (95.3%) of the Aircraft FinancialServices portfolio, excluding investments, was collateralized by Boeingproducts.

 

AtJune 30, 2003, the Aircraft Financial Services portfolio (excludinginvestments) was comprised of the following aircraft vintages:

 
| 2003 – 1999                               |   | 61.3  | %      |
|------------------------------------------------|--------|-------|--------|
| 1998 – 1994                               |   | 14.3  |   |
| 1993 – 1989                               |   | 15.1  |   |
| 1988 – 1984                               |   | 4.5   |   |
| 1983 and  older                                |   | 2.1   |   |
| Secured by  pooled assets and other collateral |   | 2.7   |   |
|                                           |   | 100.0 | %      |

 

Guarantees

 

AtJune 30, 2003, we were the beneficiary under $2.8 billion of guaranteeswith respect to our portfolio relating to transactions totaling $4.0 billion.Any guarantee call by us would be net of realization of underlying residualvalues, partial rent payments, re-lease rental payments or other mitigatingvalue received.

 

The guarantees in our favor areeither full or partial in nature and include, but are not limited to, residualvalue guarantees, first loss deficiency guarantees and rental guarantees.Residual value guarantees provide a specified asset value at the end of a leaseagreement in the event of a decline in market value of the financed aircraft.First loss deficiency guarantees cover a specified portion of our losses onaircraft financed by us in the event of a loss upon disposition of the aircraftfollowing a default by the lessee. Rental guarantees are whole or partialguarantees covering us against the lessee’s failure to pay rent under the leaseagreement or our inability to re-lease these aircraft at or above a specifiedrent level.

 

Thefollowing table summarizes such guarantees:

 
| **(Dollars in millions)** |   | **Domestic  Airlines** |   | **Foreign  Airlines** |   | **Domestic  Equipment** |   | **Other** |   | **Total** |   |
|---------------------------|--------|------------------------|--------|-----------------------|--------|-------------------------|--------|-----------|--------|-----------|--------|
| Amounts  guaranteed by:   |   |                   |   |                  |   |                    |   |      |   |      |   |
| Boeing  and subsidiaries  |   | $                      | 2,295  |                  | $      | 431                     |   | $         | 58     |      | $      | 8 |   | $ | 2,792 |   |
| Other(1)                  |   | 14                     |   | —                |   | —                  |   | —    |   | 14        |   |
|                      |   | $                      | 2,309  |                  | $      | 431                     |   | $         | 58     |      | $      | 8 |   | $ | 2,806 |   |

 

----

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

 

34

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Guarantee amounts by aircraft type or equipment at June 30, 2003 aresummarized as follows:

 
| **(Dollars in millions)**                |   | **Guarantee** |   | **Net Asset Value** |   |
|------------------------------------------|--------|---------------|--------|---------------------|--------|
| B-717                                    |   | $             | 1,334  |                | $      | 2,013 |   |
| B-757                                    |   | 240           |   | 305                 |   |
| Out of  production twin-aisle aircraft   |   | 369           |   | 566                 |   |
| Out of  production single-aisle aircraft |   | 95            |   | 136                 |   |
| Other  Boeing and regional aircraft      |   | 702           |   | 945                 |   |
| Other equipment                          |   | 58            |   | 58                  |   |
| Other                                    |   | 8             |   | 8                   |   |
|                                     |   | $             | 2,806  |                | $      | 4,031 |   |

 

During the six months endedJune 30, 2003, we recognized income of $35 million under these guarantees,all of which were from Boeing.

 

Portfolioby Region

 

At June 30, 2003, portfolionet asset values were represented in the following regions:

 
| **(Dollars in millions)** |   | **Aircraft  Financial  Services** |   | **Commercial  Financial  Services** |   | **Other** |   | **Total** |   | **% of Total Portfolio** |   |
|---------------------------|--------|-----------------------------------|--------|-------------------------------------|--------|-----------|--------|-----------|--------|--------------------------|--------|
| **Region**                |   |                              |   |                                |   |      |   |      |   |                     |   |
| United  States            |   | $                                 | 6,697  |                                | $      | 1,923     |   | $         | 106    |                     | $      | 8,726 |   | 72.8 | % |
| Europe                    |   | 1,025                             |   | 80                                  |   | —    |   | 1,105     |   | 9.2                      |   |
| Asia                      |   | 871                               |   | 75                                  |   | —    |   | 946       |   | 7.9                      |   |
| Latin  America            |   | 733                               |   | 203                                 |   | —    |   | 936       |   | 7.8                      |   |
| Africa                    |   | 61                                |   | 54                                  |   | —    |   | 115       |   | 1.0                      |   |
| Australia                 |   | 64                                |   | —                              |   | —    |   | 64        |   | 0.5                      |   |
| Canada                    |   | 42                                |   | 15                                  |   | —    |   | 57        |   | 0.5                      |   |
| Caribbean                 |   | 2                                 |   | 32                                  |   | —    |   | 34        |   | 0.3                      |   |
|                      |   | $                                 | 9,495  |                                | $      | 2,382     |   | $         | 106    |                     | $      | 11,983 |   | 100.0 | % |

 

**Item 6. Exhibits and Reports on Form 8-K**

 
| A.     | Exhibits     |
|--------|--------------|
|   |         |
|   | Exhibit 12   | Computation of Ratio of Income to Fixed Charges. |
|   |         |   |
|   | 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. |

 

35

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|   | 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. |
|--------|---------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                |                                                                                                                                                                                                                                                                                 |
| B.     | Reports on Form 8-K |
|   |                |                                                                                                                                                                                                                                                                                 |
|   | 1.                  | Form 8-K dated April 10, 2003, for the purpose of filing the  press release, dated April 10, 2003, related to the non-cash charges  recorded in the first quarter of 2003.                                                                                                 |
|   |                |                                                                                                                                                                                                                                                                                 |
|   | 2.                  | Form 8-K dated April 23, 2003, to release earnings for the  quarter ended March 31, 2003.                                                                                                                                                                                  |
|        |                     |                                                                                                                                                                                                                                                                                      |  |

 

36

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**Signatures**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned, its principal financial officer andby its principal accounting officer, thereunto duly authorized.

 

 
|                | **Boeing Capital Corporation**                                                                                                          |
|---------------------|-----------------------------------------------------------------------------------------------------------------------------------------|
|                |                                                                                                                                    |
|                |                                                                                                                                    |
| August 4, 2003 | /S/ STEVEN W. VOGEDING                                                                                                                  |   |
|                | Steven W. Vogeding  Vice President and Chief Financial  Officer (Principal Financial Officer) and  Registrant’s Authorized Officer |
|                |                                                                                                                                    |   |
|                |                                                                                                                                    |   |
|                | /S/ JILL C. RICHLING                                                                                                                    |   |
|                | Jill C. Richling  Controller (Principal Accounting Officer)                                                                             |

 

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