**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM10-Q**

 

**(MarkOne)**

| **ý** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|------------|-----------------------------------------------------------------------------------------------|
| ** ** | ** **                                                                                    |
|       | **For the quarterly period ended  September 30, 2004**                              |
|       |                                                                                          |
|       | **OR**                                                                                        |
|       |                                                                                          |
| **o**      | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For thetransition period from              to              **

 

**CommissionFile Number 0-10795**

 

| ** **                                                       | **Boeing  Capital Corporation**                                     | ** **                            |
|------------------------------------------------------------------|---------------------------------------------------------------------|---------------------------------------|
| (Exact  name of registrant as specified in its charter)          |
| ** **                                                       | ** **                                                          | ** **                            |
| ** **                                                       | **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) 965-4002**                                                  |                                  |
| (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 stock shares outstanding at October 27, 2004:50,000 shares

 

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

 

 

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**Table of Contents**

 
| **Part I.**   | **Financial Information (Unaudited)** |                                                                                     |
|---------------|---------------------------------------|------------------------------------------------------------------------------------------|
|          |                                  |                                                                                     |   |
|          | Item  1.                              | Financial  Statements                                                                    |   |
|          |                                  | Condensed  Consolidated Balance Sheets                                                   |   |
|          |                                  | Condensed  Consolidated Statements of Operations                                         |   |
|          |                                  | Condensed  Consolidated Statements of Shareholder’s Equity and Comprehensive Income |   |
|          |                                  | Condensed  Consolidated Statements of Cash Flows                                         |   |
|          |                                  | Notes  to Condensed 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.****     FinancialInformation**

 

**Item 1.****    FinancialStatements**

**Boeing Capital Corporation andSubsidiaries**

Condensed ConsolidatedBalance Sheets

(Unaudited)

 
| ** **                                                                                             | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(Dollars in millions, except par value)**                                                            | ** ** | **2004**               | ** ** | **2003**              | ** ** |
| ASSETS                                                                                                 |       |                   |       |                  |       |
| Cash and cash equivalents                                                                              |       | $                      | 585        |                  | $          | 716 |   |
| Receivables:                                                                                           |       |                   |       |                  |       |
| Financing leases                                                                                       |       | 3,453                  |       | 3,573                 |       |
| Notes and other receivables                                                                            |       | 2,269                  |       | 2,379                 |       |
|                                                                                                   |       | 5,722                  |       | 5,952                 |       |
| Allowance for losses on receivables                                                                    |       | (232                   | )          | (303                  | )          |
|                                                                                                   |       | 5,490                  |       | 5,649                 |       |
|                                                                                                   |       |                   |       |                  |       |
| Equipment under operating leases, net of  accumulated depreciation                                     |       | 3,583                  |       | 3,406                 |       |
| Investments                                                                                            |       | 219                    |       | 475                   |       |
| Assets held for sale or re-lease, net of  accumulated depreciation                                     |       | 177                    |       | 232                   |       |
| Assets of discontinued operations                                                                      |       | 234                    |       | 2,135                 |       |
| Other assets                                                                                           |       | 191                    |       | 223                   |       |
|                                                                                                   |       | $                      | 10,479     |                  | $          | 12,836 |   |
|                                                                                                   |       |                   |       |                  |       |
| LIABILITIES AND SHAREHOLDER’S EQUITY                                                              |       |                   |       |                  |       |
| Liabilities:                                                                                           |       |                   |       |                  |       |
| Accounts payable and accrued expenses                                                                  |       | $                      | 169        |                  | $          | 156 |   |
| Other liabilities                                                                                      |       | 341                    |       | 249                   |       |
| Accounts with Boeing and Boeing Capital  Services Corporation                                          |       | 189                    |       | 58                    |       |
| Deferred income taxes                                                                                  |       | 1,102                  |       | 1,242                 |       |
| Debt:                                                                                                  |       |                   |       |                  |       |
| Senior                                                                                                 |       | 7,164                  |       | 9,153                 |       |
| Subordinated                                                                                           |       | 4                      |       | 24                    |       |
|                                                                                                   |       | 8,969                  |       | 10,882                |       |
|                                                                                                   |       |                   |       |                  |       |
| Commitments and contingencies – Note 9                                                            |       |                   |       |                  |       |
|                                                                                                   |       |                   |       |                  |       |
| Minority interest                                                                                      |       | 8                      |       | 12                    |       |
|                                                                                                   |       |                   |       |                  |       |
| Shareholder’s equity:                                                                             |       |                   |       |                  |       |
| Common stock - $100 par value; authorized  100,000 shares; shares issued and outstanding 50,000 shares |       | 5                      |       | 5                     |       |
| Capital in excess of par value                                                                         |       | 1,270                  |       | 1,263                 |       |
| Accumulated other comprehensive loss, net  of tax                                                      |       | (3                     | )          | (10                   | )          |
| Income retained for growth                                                                             |       | 230                    |       | 684                   |       |
|                                                                                                   |       | 1,502                  |       | 1,942                 |       |
|                                                                                                   |       | $                      | 10,479     |                  | $          | 12,836 |   |

 

See Notes to Condensed Consolidated FinancialStatements.

 

3

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**Boeing Capital Corporation andSubsidiaries**

Condensed ConsolidatedStatements of Operations

(Unaudited)

 
| ** **                                                           | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|----------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                           | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| **(Dollars in millions)**                                            | ** ** | **2004**               | ** ** | **2003**               | ** ** | **2004** | ** ** | **2003** | ** ** |
| REVENUES                                                             |       |                   |       |                   |       |   |   |   |   |
| Finance lease income                                                 |       | $                      | 60         |                   | $          | 54 |   | $ | 175 |   | $ | 172 |   |
| Interest income on notes receivable                                  |       | 46                     |       | 49                     |       | 138 |   | 127 |   |
| Operating lease income                                               |       | 110                    |       | 99                     |       | 326 |   | 303 |   |
| Investment income                                                    |       | 5                      |       | 13                     |       | 25 |   | 38 |   |
| Net gain on disposal                                                 |       | 15                     |       | 45                     |       | 34 |   | 43 |   |
| Other                                                                |       | 17                     |       | 27                     |       | 35 |   | 60 |   |
|                                                                 |       | 253                    |       | 287                    |       | 733 |   | 743 |   |
|                                                                 |       |                   |       |                   |       |   |   |   |   |
| Equity in income from joint venture                                  |       | —                 |       | 1                      |       | — |   | — |   |
|                                                                 |       | 253                    |       | 288                    |       | 733 |   | 743 |   |
|                                                                 |       |                   |       |                   |       |   |   |   |   |
| EXPENSES                                                             |       |                   |       |                   |       |   |   |   |   |
| Interest expense                                                     |       | 89                     |       | 90                     |       | 262 |   | 269 |   |
| Depreciation expense                                                 |       | 56                     |       | 54                     |       | 165 |   | 157 |   |
| Provision for losses                                                 |       | (51                    | )          | 6                      |       | (42 | ) | 146 |   |
| Operating expenses                                                   |       | 20                     |       | 13                     |       | 48 |   | 38 |   |
| Asset impairment expense                                             |       | 29                     |       | 28                     |       | 73 |   | 76 |   |
| Debt redemption costs                                                |       | 52                     |       | —                 |       | 52 |   | — |   |
| Other                                                                |       | (1                     | )          | 3                      |       | 31 |   | 29 |   |
|                                                                 |       | 194                    |       | 194                    |       | 589 |   | 715 |   |
|                                                                 |       |                   |       |                   |       |   |   |   |   |
| Minority interest                                                    |       | 1                      |       | —                 |       | 4 |   | — |   |
|                                                                 |       |                   |       |                   |       |   |   |   |   |
| Income from continuing operations before  provision for income taxes |       | 60                     |       | 94                     |       | 148 |   | 28 |   |
| Provision for income taxes                                           |       | 21                     |       | 38                     |       | 50 |   | 5 |   |
| Income from continuing operations                                    |       | 39                     |       | 56                     |       | 98 |   | 23 |   |
|                                                                 |       |                   |       |                   |       |   |   |   |   |
| Income (loss) from discontinued operations,  net of tax              |       | (1                     | )          | 8                      |       | 15 |   | 24 |   |
| Net gain on disposal of discontinued operations,  net of tax         |       | 19                     |       | —                 |       | 33 |   | — |   |
| Net income                                                           |       | $                      | 57         |                   | $          | 64 |   | $ | 146 |   | $ | 47 |   |

** **

See Notes to Condensed Consolidated Financial Statements.

 

4

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**Boeing Capital Corporation andSubsidiaries**

Condensed ConsolidatedStatements ofShareholder’s Equity and Comprehensive Income

(Unaudited)

 
| **(Dollars in millions, except stated value)**                                 | ** ** | **Total** | ** ** | **Common  Stock** | ** ** | **Capital in Excess of  Par Value** | ** ** | **Accumulated  Other  Comprehensive  Loss** | ** ** | **Income  Retained  for  Growth** | ** ** | ** ** | **Comprehensive  Income** | ** ** |
|--------------------------------------------------------------------------------|------------|-----------|------------|-------------------|------------|-------------------------------------|------------|---------------------------------------------|------------|-----------------------------------|------------|------------|---------------------------|------------|
| **Balance at January 1, 2003**                                       | ** ** | **$**     | **1,656**  | ** **        | **$**      | **5**                               | ** ** | **$**                                       | **1,090**  | ** **                        | **$**      | **(17**    | **)**                     | **$**      | **578** |   |   |   |   |
| Capital contributions from Boeing and  Boeing Capital Services Corporation (1) |       | 141       |       | —            |       | 141                                 |       | —                                      |       | —                            |       |       |                      |       |
| Net income                                                                     |       | 47        |       | —            |       | —                              |       | —                                      |       | 47                                |       |       | $                         | 47         |   |
| Unrealized gain on derivative instruments,  net of tax                         |       | 6         |       | —            |       | —                              |       | 6                                           |       | —                            |       |       | 6                         |       |
| Unrealized loss on investments, net of tax                                     |       | (1        | )          | —            |       | —                              |       | (1                                          | )          | —                            |       |       | (1                        | )          |
| **Balance at September 30, 2003**                                    | ** ** | **$**     | **1,849**  | ** **        | **$**      | **5**                               | ** ** | **$**                                       | **1,231**  | ** **                        | **$**      | **(12**    | **)**                     | **$**      | **625** | ** ** | ** ** | **$** | **52** | ** ** |
|                                                                           |       |      |       |              |       |                                |       |                                        |       |                              |       |       |                      |       |
| **Balance at January 1, 2004**                                       | ** ** | **$**     | **1,942**  | ** **        | **$**      | **5**                               | ** ** | **$**                                       | **1,263**  | ** **                        | **$**      | **(10**    | **)**                     | **$**      | **684** |   |   |   |   |
| Capital contributions from Boeing and  Boeing Capital Services Corporation (2) |       | 7         |       | —            |       | 7                                   |       | —                                      |       | —                            |       |       |                      |       |
| Cash dividends to Boeing                                                       |       | (600      | )          | —            |       | —                              |       | —                                      |       | (600                              | )          |       |                      |       |
| Net income                                                                     |       | 146       |       | —            |       | —                              |       | —                                      |       | 146                               |       |       | $                         | 146        |   |
| Reclassification adjustment for losses  realized in net income, net of tax     |       | 9         |       | —            |       | —                              |       | 9                                           |       | —                            |       |       | 9                         |       |
| Unrealized loss on investments, net of tax                                     |       | (2        | )          | —            |       | —                              |       | (2                                          | )          | —                            |       |       | (2                        | )          |
| **Balance at September 30, 2004**                                    | ** ** | **$**     | **1,502**  | ** **        | **$**      | **5**                               | ** ** | **$**                                       | **1,270**  | ** **                        | **$**      | **(3**     | **)**                     | **$**      | **230** | ** ** | ** ** | **$** | **153** | ** ** |

 

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(1)          Balance represents $136 million of cashcontributions and $5 million of non-cash contributions from Boeing and BoeingCapital Services Corporation.

(2)          Balance represents $7 million of non-cashcontributions from Boeing and Boeing Capital Services Corporation.

 

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

 

See Notes to Condensed Consolidated FinancialStatements.

 

5

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**Boeing Capital Corporation andSubsidiaries**

Condensed ConsolidatedStatements of Cash Flows

(Unaudited)

 
| ** **                                                                         | ** ** | **Nine Months Ended**  | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                         | ** ** | **September 30,** | ** ** |
| **(Dollars in millions)**                                                          | ** ** | **2004**               | ** ** | **2003** | ** ** |
| OPERATING ACTIVITIES                                                               |       |                   |       |   |   |
| Net income (1)                                                                     |       | $                      | 146        |   | $ | 47 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                   |       |   |   |
| Depreciation and amortization expense                                              |       | 184                    |       | 198 |   |
| Net gain on disposal of discontinued  operations                                   |       | (52                    | )          | — |   |
| Net gain on disposal                                                               |       | (47                    | )          | (49 | ) |
| Provision for losses                                                               |       | (42                    | )          | 146 |   |
| Net (gain) loss on derivative instruments  and investments                         |       | 4                      |       | (31 | ) |
| Asset impairment and other related charges                                         |       | 74                     |       | 104 |   |
| Share-based plans expense                                                          |       | 7                      |       | 5 |   |
| Other non-cash adjustments related to  discontinued operations                     |       | 26                     |       | 17 |   |
| Provision (benefit) from deferred income  taxes                                    |       | (135                   | )          | 136 |   |
| Change in assets and liabilities:                                                  |       |                   |       |   |   |
| Other assets                                                                       |       | 23                     |       | 61 |   |
| Accrued interest                                                                   |       | (9                     | )          | (28 | ) |
| Accounts payable and accrued expenses                                              |       | 13                     |       | (64 | ) |
| Other liabilities                                                                  |       | (48                    | )          | (8 | ) |
| Accounts with Boeing and Boeing Capital  Services Corporation                      |       | 131                    |       | 52 |   |
| Other                                                                              |       | (6                     | )          | (13 | ) |
| Net cash provided by operating activities                                          |       | 269                    |       | 573 |   |
|                                                                               |       |                   |       |   |   |
| INVESTING ACTIVITIES                                                               |       |                   |       |   |   |
| Proceeds from disposal of discontinued  operations                                 |       | 1,867                  |       | — |   |
| Net change in short-term leases, notes and  other receivables                      |       | —                 |       | 126 |   |
| Purchase of investments                                                            |       | (11                    | )          | (33 | ) |
| Proceeds from available-for-sale  investments                                      |       | 21                     |       | 29 |   |
| Proceeds from held-to-maturity investments                                         |       | 233                    |       | 59 |   |
| Purchase of equipment for operating leases                                         |       | (186                   | )          | (509 | ) |
| Proceeds from disposition of equipment and  receivables                            |       | 223                    |       | 178 |   |
| Collection of leases, notes and other  receivables                                 |       | 223                    |       | 399 |   |
| Collection of leases, notes and other  receivables of discontinued operations      |       | 127                    |       | 196 |   |
| Origination of leases, notes and other  receivables                                |       | (295                   | )          | (1,143 | ) |
| Net cash provided (used) by investing  activities                                  |       | 2,202                  |       | (698 | ) |
|                                                                               |       |                   |       |   |   |
| FINANCING ACTIVITIES                                                               |       |                   |       |   |   |
| Net change in commercial paper and  short-term bank debt                           |       | —                 |       | (73 | ) |
| Proceeds from debt issuance                                                        |       | —                 |       | 812 |   |
| Repayment of debt                                                                  |       | (2,002                 | )          | (688 | ) |
| Cash dividends paid to Boeing                                                      |       | (600                   | )          | — |   |
| Capital contributions from Boeing and  Boeing Capital Services Corporation         |       | —                 |       | 136 |   |
| Net cash provided (used) by financing  activities                                  |       | (2,602                 | )          | 187 |   |
| Net increase (decrease) in cash and cash  equivalents                              |       | (131                   | )          | 62 |   |
| Cash and cash equivalents at beginning of  year                                    |       | 716                    |       | 686 |   |
| Cash and cash equivalents at end of period                                         |       | $                      | 585        |   | $ | 748 |   |

 

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(1)          Includes net income of $48 million and $24million from discontinued operations for the nine months endedSeptember 30, 2004 and 2003, respectively.

 

See Notes to Condensed Consolidated FinancialStatements.

 

6

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| ** **                                                           | ** ** | **Nine Months Ended**  | ** ** |
|----------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                           | ** ** | **September 30,** | ** ** |
| **(Dollars in millions)**                                            | ** ** | **2004**               | ** ** | **2003** | ** ** |
| NON-CASH INVESTING AND FINANCING  ACTIVITIES:                        |       |                   |       |   |   |
| Decrease to financing receivables                                    |       | $                      | 161        |   | $ | 92 |   |
| Addition of equipment under operating  leases                        |       | $                      | (149       | ) | $ | (98 | ) |
| Reduction (addition) of assets held for  sale or re-lease            |       | $                      | 46         |   | $ | (32 | ) |
| Decrease to investments                                              |       | $                      | —     |   | $ | 22 |   |
| Assumption of debt                                                   |       | $                      | —     |   | $ | 42 |   |
| Mark-to-market for fair value hedge  derivatives and underlying debt |       | $                      | 3          |   | $ | (1 | ) |

 

See Notes to Condensed Consolidated Financial Statements.

 

7

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**BoeingCapital Corporation and Subsidiaries**

Notes toCondensed Consolidated Financial Statements

September 30, 2004

(Unaudited)

 

**Note 1 –Basis of Presentation**

 

Boeing Capital Corporation(together with its subsidiaries, referred to as “us”, “we”, “our” or the “Company”)is an indirect wholly owned subsidiary of The Boeing Company (“Boeing”). BoeingCapital Services Corporation owns 100% of our stock and is an indirect whollyowned subsidiary of Boeing and a largely inactive holding company. We preparedthe accompanying unaudited condensed consolidated financial statements inaccordance with accounting principles generally accepted in the United Statesof America for interim financial information and with the instructions to Form10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all ofthe information and footnotes required by accounting principles generallyaccepted in the United States of America for complete financial statements. Inour opinion, the accompanying condensed consolidated financial statementsreflect all adjustments, consisting of normal recurring accruals, that arenecessary to present fairly the condensed consolidated balance sheets and therelated condensed consolidated statements of operations, shareholder’s equityand comprehensive income and cash flows for the interim periods presented.Operating results for the nine-month period ended September 30, 2004,are not necessarily indicative of the results that may be expected for the yearending December 31, 2004. The condensed consolidated financialstatements should be read in conjunction with the notes to consolidatedfinancial statements included in our Form 10-K for the year ended December 31, 2003,which contains the latest available audited consolidated financial statementsand notes.

 

Certain reclassifications of previouslyreported amounts have been made in the condensed consolidated financialstatements to conform to current reporting.

 

As discussed in Note 2, on May 24, 2004, weentered into a purchase and sale agreement with General Electric CapitalCorporation (“GECC”) to sell substantially all of the assets related to ourCommercial Financial Services business. The purchase agreement called for thesale of the assets to take place in a series of closings, commencing on May 31, 2004and ending no later than July 30, 2004. Based upon mutual agreementbetween the parties, the final closing date has been extended to occur within60 days subsequent to September 30, 2004. By the end of May 2005, weintend to dispose of the remaining assets identified to the CommercialFinancial Services business that are not subject to the purchase and saleagreement with GECC. As a result, our condensed consolidated financialstatements and related footnote disclosures reflect the Commercial FinancialServices business as discontinued operations for all periods. In addition,unless specifically noted, amounts disclosed in the notes to condensedconsolidated financial statements are from continuing operations.

 

In conjunction with the disposal of ourCommercial Financial Services business during the second quarter of 2004 andconsistent with our strategic priority to support the sale of Boeing productsand services by arranging, structuring or providing financing, we reassessedour external segment reporting structure in accordance with Statement ofFinancial Accounting Standards (“SFAS”) No. 131, “Disclosures aboutSegments of an Enterprise and Related Information.” This reassessment includedan evaluation of our internal operating structure, which took into account thelevel for which management makes operating decisions and assesses performance,as well as the economic characteristics shared by our internal operatingsegments. Accordingly, we determined we have one reportable segment forexternal segment reporting purposes, primarily consisting of our AircraftFinancial Services business.

 

**Note 2 –Discontinued Operations**

 

On May 2, 2004,Boeing’s Board of Directors approved a plan to sell all of the assets and businessoperations of our Commercial Financial Services business. This plan wasapproved by our Board of Directors on May 21, 2004. On May 24, 2004,we entered into a purchase and sale agreement with GECC to sell substantiallyall of the assets related to our Commercial Financial Services business. Thepurchase agreement called for the sale of the assets to take place in a seriesof closings, commencing on May 31, 2004 and ending no later than July 30, 2004.Based upon mutual agreement between the parties, the final closing date hasbeen extended to occur within 60 days subsequent toSeptember 30, 2004.

 

8

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We intend to dispose of theremaining assets identified to the Commercial Financial Services business bythe end of May 2005 that are not subject to the purchase and sale agreementwith GECC. As a result, our condensed consolidated financial statements andrelated footnote disclosures reflect the Commercial Financial Services businessas discontinued operations. Income associated with the Commercial FinancialServices business, net of applicable income taxes, is shown as income fromdiscontinued operations for all periods presented in accordance with SFAS No.144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” Inaddition, the assets of this business have been reclassified and presented asassets of discontinued operations. There are no liabilities related to theCommercial Financial Services business that will be assumed by GECC or areexpected to be assumed by other buyers, other than those specific liabilitiesassociated with the portfolio assets sold, such as security deposits andmaintenance reserves.

 

The purchase price paid or tobe paid for the assets transferred at each closing is determined based on thenet asset value of the assets, plus a total premium of $140 million that waspaid as of June 30, 2004. The assets sold or to be sold to GECCconsist of leases and financing arrangements having a carrying value of $1,879million as of May 31, 2004. As of September 30, 2004, wehad received $1,867 million in cash proceeds from this sale, and we expect toreceive approximately $163 million in additional cash proceeds by the finalclosing date. The purchase price is subject to adjustment after closing basedon an independent audit of our determination of net asset value, and furtheradjustments based on gains or losses on assets after closing.

 

We expect to recognize a total gain ofapproximately $63 million ($40 million net of tax) due to the sale of theCommercial Financial Services assets to GECC. The gain will be calculated asthe $140 million premium less the increase in our reserve for future portfoliolosses; estimated sales and excise taxes; and investment banking, transactionand legal fees. Based upon an analysis that considered collateral values andthe creditworthiness of the counterparties, we had established a liability of$89 million at September 30, 2004, to reserve for probable future portfoliolosses, which included $54 million previously reported as an allowance forlosses on receivables transferred to GECC. After the completion of the sales ofcertain remaining assets to GECC, future adjustments may be taken ascircumstances dictate and will be recorded as part of our continuingoperations.

 

In the second quarter of 2004, we recognizeda net gain on disposal of discontinued operations of $21 million ($14 millionnet of tax). This included a gain of $38 million ($25 million net of tax)related to the sale of assets to GECC and a loss of $17 million ($11 millionnet of tax) related to the revaluation of the remaining Commercial FinancialServices assets to the lower of carrying value or fair value less costs tosell. This revaluation loss related principally to two 737 Boeing Business Jets(“BBJs”) that were on lease to Boeing and were part of the Commercial FinancialServices portfolio classified as assets of discontinued operations. Earlytermination of the lease under terms of the intercompany contract would haverequired Boeing to purchase the BBJs for a stipulated amount based on the dateof the termination. Since we, as well as Boeing, are reporting the CommercialFinancial Services business as discontinued operations following the same basisof accounting, we recorded the valuation loss on the BBJs, which we continue toown, and elected not to enforce Boeing’s obligation to purchase the BBJs at thecontractually stipulated value. Both parties elected to terminate theintercompany leases on May 31, 2004. As a result, our reported netgain on disposal of discontinued operations is the same as that reported by ourparent, Boeing. We will realize the proceeds of any future dispositions,including any related gains or losses.

 

In the third quarter of 2004, we recognizedan additional gain on disposal of discontinued operations of $31 million ($19million net of tax). This included a gain of $20 million ($12 million net oftax) related to the sale of assets to GECC and a gain of $11 million ($7million net of tax) related to the reclassification to continuing operations ofa valuation loss recorded on one BBJ during the second quarter of 2004. Boeing’sreassessment of its near term executive fleet requirements resulted in one BBJ beingretained in its executive fleet. As a result, we plan to enter into a leaseagreement with Boeing effective in the fourth quarter of 2004. Accordingly, theaircraft’s fair value of $43 million and valuation loss on disposal of $11million were reclassified to continuing operations. We have not restated our financialstatements for periods prior to the three months endedSeptember 30, 2004 for amounts relating to the BBJ aircraft beingretained and used as we have determined that the amounts are not material toour financial statements.

 

9

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Operating results of thediscontinued operations were as follows:

 
| ** **                                                   | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|--------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                   | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| **(Dollars in millions)**                                    | ** ** | **2004**               | ** ** | **2003**               | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenues                                                     |       | $                      | —     |                   | $          | 57 |   | $ | 96 |   | $ | 171 |   |
|                                                         |       |                   |       |                   |       |   |   |   |   |
| Income (loss) from discontinued operations                   |       | $                      | (2         | )                      | $          | 13 |   | $ | 23 |   | $ | 38 |   |
| Provision (benefit) for income taxes                         |       | (1                     | )          | 5                      |       | 8 |   | 14 |   |
| Income (loss) from discontinued operations,  net of tax      |       | $                      | (1         | )                      | $          | 8 |   | $ | 15 |   | $ | 24 |   |
|                                                         |       |                   |       |                   |       |   |   |   |   |
| Net gain on disposal of discontinued  operations             |       | $                      | 31         |                   | $          | — |   | $ | 52 |   | $ | — |   |
| Provision for income taxes                                   |       | 12                     |       | —                 |       | 19 |   | — |   |
| Net gain on disposal of discontinued  operations, net of tax |       | $                      | 19         |                   | $          | — |   | $ | 33 |   | $ | — |   |

 

The major classes of assetsrelated to discontinued operations, all of which were held for sale, were asfollows:

 
| ** **                                                         | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(Dollars in millions)**                                          | ** ** | **2004**               | ** ** | **2003**              | ** ** |
| Finance leases                                                     |       | $                      | 10         |                  | $          | 724 |   |
| Notes and other receivables                                        |       | 104                    |       | 727                   |       |
| Allowance for losses on receivables                                |       | —                 |       | (48                   | )          |
| Equipment under operating leases, net of  accumulated depreciation |       | 82                     |       | 686                   |       |
| Assets held for sale or re-lease, net of  accumulated depreciation |       | 38                     |       | 46                    |       |
| Assets of discontinued operations                                  |       | $                      | 234        |                  | $          | 2,135 |   |

 

**Note 3 –Portfolio Quality**

 

The portfolio of receivables,equipment under operating leases, investments and assets held for sale orre-lease consisted of the following:

 
| ** **                                                         | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(Dollars in millions)**                                          | ** ** | **2004**               | ** ** | **2003**              | ** ** |
| Receivables:                                                       |       |                   |       |                  |       |
| Finance leases                                                     |       | $                      | 3,453      |                  | $          | 3,573 |   |
| Notes and other receivables                                        |       | 2,269                  |       | 2,379                 |       |
|                                                               |       | 5,722                  |       | 5,952                 |       |
|                                                               |       |                   |       |                  |       |
| Equipment under operating leases, net of  accumulated depreciation |       | 3,583                  |       | 3,406                 |       |
| Investments                                                        |       | 219                    |       | 475                   |       |
| Assets held for sale or re-lease, net of  accumulated depreciation |       | 177                    |       | 232                   |       |
| Total portfolio                                                    |       | $                      | 9,701      |                  | $          | 10,065 |   |

 

Included in assets held for sale or re-lease,net of accumulated depreciation, at September 30, 2004, was $94million of notes receivable that have been identified as available-for-sale andstated at the lower of carrying value or estimated fair value.

 

10

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*Non-Performing Assets*

 

Non-performing assets (assets either notrecognizing income on an accrual basis or equipment without current contractuallease revenue) consisted of the following:

 
| ** **                                                         | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(Dollars in millions)**                                          | ** ** | **2004**               | ** ** | **2003**              | ** ** |
| Assets placed on non-accrual status:                               |       |                   |       |                  |       |
| Non-accrual receivables                                            |       | $                      | 1,103      |                  | $          | 450 |   |
| Equipment under operating leases, net of  accumulated depreciation |       | 92                     |       | 77                    |       |
| Assets held for sale or re-lease, net of  accumulated depreciation |       | 177                    |       | 232                   |       |
|                                                               |       | $                      | 1,372      |                  | $          | 759 |   |
|                                                               |       |                   |       |                  |       |
| Ratio of non-accrual receivables to total  receivables             |       | 19.3                   | %          | 7.6                   | %          |
| Ratio of total non-performing assets to  total portfolio           |       | 14.1                   | %          | 7.5                   | %          |

 

At September 30, 2004and December 31, 2003, ATA Holdings Corp. (“ATA”) represented $705million and $743 million, respectively, of our total receivables portfolio. Dueto ATA’s continued financial difficulties, in the third quarter of 2004 weplaced ATA’s portfolio on non-accrual status. Additionally, we provided aspecific impairment allowance to adequately reserve for our collateral exposureon our finance leases and note receivable with ATA. At bothSeptember 30, 2004 and December 31, 2003, ATA had no receivableswith installments more than 90 days delinquent.

 

At September 30, 2004and December 31, 2003, Hawaiian Airlines, Inc. (“Hawaiian”)represented $392 million and $436 million, respectively, of our totalreceivables portfolio and $68 million and $70 million, respectively, of ourtotal equipment under operating leases portfolio. In September 2004 we reachedan agreement with the bankruptcy trustee for the Hawaiian estate relating tothe restructuring of all of our leases and on the amount of our unsecured claimresulting from Hawaiian’s bankruptcy. The claim amount represented costs andlosses incurred by us for the period of time prior to the September 2004settlement and losses that would be incurred by us based on the differencebetween the restructured and the original lease payments. OnSeptember 27, 2004, following a request by Hawaiian’s trustee, thebankruptcy court approved our unsecured claim against the Hawaiian estate andalso approved the new terms of our restructured leases. In September we soldour unsecured claim to RC Aviation LLC (“Ranch”) for $53 million. In connectionwith the approval of our claim by the bankruptcy court, we recorded $35 millionof income relating to costs and lost revenues prior to the approval of theclaim by the bankruptcy court. Additionally, as a result of the approval of ourrestructured lease terms, we recorded a net reduction in the provision forlosses of $8 million due to reduced collateral exposure associated with financelease receivables, partially offset by a restructuring charge. This netreduction in the provision for losses of $8 million was effectively recorded asincome in the third quarter as a result of the adjustment to the allowance forlosses on receivables discussed in Note 4. The remaining $10 million ofreceipts were accounted for as unearned income attributable to an operatinglease. Prior to Hawaiian’s bankruptcy, we accounted for all of our 717 leasesand two of our three 767 leases as finance leases. Subsequent to the approvalof the restructured lease terms, we will continue to account for these leasesas finance leases. We reduced the carrying value of some of the finance leasesas a result of this restructure to ensure that the new implicit rate in eachlease is in no case lower than the implicit rate prior to the restructure. As aresult of Hawaiian’s bankruptcy settlement, effectiveOctober 1, 2004, our Hawaiian portfolio will be taken off ofnon-accrual status.

 

We generally suspend incomerecognition on an accrual basis (and place assets and customers on non-accrualstatus) when we evaluate that a full recovery of income and principal relatedto leases and notes and other receivables becomes doubtful. Generally, we alsoplace accounts greater than 90 days past due on non-accrual status. We resume incomerecognition when the lease or notes and other receivables become contractuallycurrent and performance is demonstrated to have been resumed. To the extentthat income is accruable under contractual terms, we record any cash receivedin the interim as income. During the nine months ended September 30, 2004,we received cash and reported income of $0.3 million attributable tonon-performing assets deemed non-performing as of September 30, 2004.

 

At September 30, 2004we had $2 million of receivables or rent due on equipment under operatingleases with amounts past due greater than 90 days with income still accruing.At December 31, 2003, we had no receivables or equipment underoperating leases with amounts past due greater than 90 days with income stillaccruing.

 

11

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* *

*ImpairedReceivables*

 

The carrying amounts ofimpaired receivables, as defined below, are as follows:

 
| ** **                                               | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(Dollars in millions)**                                | ** ** | **2004**               | ** ** | **2003**              | ** ** |
| Impaired receivables with specific  impairment allowance |       | $                      | 1,177      |                  | $          | 483 |   |
| Impaired receivables with no specific  allowance         |       | 1,184                  |       | 1,122                 |       |
|                                                     |       | $                      | 2,361      |                  | $          | 1,605 |   |

 

In accordance with SFAS No. 114, “Accountingby Creditors for Impairment of a Loan,” we determine a receivable is impairedwhen, based on current information and events, it is probable that we will beunable to collect amounts due according to the original contractual terms ofthe receivable agreement, without regard to any subsequent restructurings. Factorsconsidered in assessing uncollectibility include, but are not limited to, acustomer’s extended delinquency, requests for restructuring and filings forbankruptcy. We determine a specific impairment allowance based on thedifference between the carrying value of the receivable and the estimated fairvalue of the related collateral. Each quarter, we review customer creditratings, published historical credit default rates, Boeing and other guarantees(if applicable) and third-party aircraft valuations as a basis to validate thereasonableness of the allowance for losses on receivables. There can be noassurance that actual results will not differ from estimates and values or thatconsideration of these factors in the future will not result in an increase tothe allowance for losses on receivables.

 

As noted above, due to ATA’s continuedfinancial difficulties, in the third quarter of 2004 we provided a specificimpairment allowance to adequately reserve for our collateral exposure relatedto our finance leases and note receivable with ATA. AtSeptember 30, 2004, $705 million of our impaired receivables withspecific impairment allowance related to receivables from ATA secured by 757aircraft and a note receivable.

 

At September 30, 2004 andDecember 31, 2003, respectively, $392 million and $436 million, ofour impaired receivables with specific impairment allowance related toreceivables from Hawaiian secured by 717 and 767 aircraft.

 

At September 30, 2004 andDecember 31, 2003, respectively, $1,141 million and $1,076 million,of our impaired receivables with no specific allowance related to receivablesfrom United Airlines (“United”), adequately secured by 767 aircraft and 777aircraft. During the third quarter of 2003, we completed a restructuring ofthese receivables, as discussed further in Note 9. Although United isperforming under the terms of the restructuring atSeptember 30, 2004, according to the guidelines of SFAS No. 114, anyreceivable not performing under the original contract terms, even though it isperforming under the restructured agreement, continues to be deemed impaired.

 

*Receivables More than 90 DaysDelinquent*

 

The following table presents informationrelated to receivables that are more than 90 days delinquent.

 
| ** **                                                                                        | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(Dollars in millions)**                                                                         | ** ** | **2004**               | ** ** | **2003**              | ** ** |
| Amount of delinquent installments                                                                 |       | $                      | 6          |                  | $          | 10 |   |
| Total receivable balance related to  delinquent installments                                      |       | $                      | 9          |                  | $          | 61 |   |
| Total receivable balance related to  delinquent installments as a percentage of total receivables |       | 0.2                    | %          | 1.0                   | %          |
| Total of all receivables due from  delinquent obligors                                            |       | $                      | 149        |                  | $          | 450 |   |
| Total of all receivables due from  delinquent obligors as a percentage of total receivables       |       | 2.6                    | %          | 7.6                   | %          |

 

AtSeptember 30, 2004, Hawaiian had no receivables with installmentsmore than 90 days delinquent. At December 31, 2003, Hawaiian owed $47million of receivables of which installment payments of $3 million were morethan 90 days delinquent.

 

*Impact ofIntercompany Agreements and Guarantees*

 

At September 30, 2004,we were the beneficiary of $2,897 million of guarantees from Boeing withrespect to our portfolio transactions totaling $4,463 million ($3,209 millionof receivables, $1,131 million of equipment under operating leases and $123million of investments), which mitigates our risk. AtSeptember 30, 2004, we were also the beneficiary of $15 million ofguarantees from unrelated parties with respect to portfolio transactionstotaling $19 million.

 

12

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**Note 4 –Allowance for Losses on Receivables**

 

The following table reconcilesthe changes in the allowance for losses on receivables.

** **
| ** **                                                | ** ** | **Nine Months Ended**  | ** ** |
|-----------------------------------------------------------|------------|------------------------|------------|
| ** **                                                | ** ** | **September 30,** | ** ** |
| **(Dollars in millions)**                                 | ** ** | **2004**               | ** ** | **2003** | ** ** |
| Allowance for losses on receivables at  beginning of year |       | $                      | 303        |   | $ | 219 |   |
| Provision for losses                                      |       | (42                    | )          | 146 |   |
| Write-offs, net of recoveries                             |       | (29                    | )          | (58 | ) |
| Allowance for losses on receivables at end  of period     |       | $                      | 232        |   | $ | 307 |   |
|                                                      |       |                   |       |   |   |
| Allowance as a percentage of total  receivables           |       | 4.1                    | %          | 5.0 | % |
| Net write-offs as a percentage of average  receivables    |       | 0.9                    | %          | 1.2 | % |

 

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

 
| ** **                     | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(Dollars in millions)**      | ** ** | **2004**               | ** ** | **2003**              | ** ** |
| Allocated to specific reserves |       | $                      | 209        |                  | 90.1       | % | $ | 105 |   | 34.7 | % |
| Allocated for general purposes |       | 23                     |       | 9.9                   | %          | 198 |   | 65.3 |   |
|                           |       | $                      | 232        |                  | 100.0      | % | $ | 303 |   | 100.0 | % |

 

We generally determine a specific impairmentallowance based on the difference between the carrying value of the receivableand the estimated fair value of the related collateral when we believe thereceivable is impaired, as discussed in Note 3.

 

The allocation for general purposesrepresents our best estimate of losses existing in the remaining receivablesconsidering delinquencies, loss experience, collateral values, guarantees, riskof individual credits, historical default rates, results of periodic creditreviews and the general state of the economy and airline industry.

 

We review the adequacy of thegeneral allowance attributable to the remaining pool of receivables (afterexcluding receivables subject to a specific allowance) by assessing both thecollateral exposure and the applicable default rate. Collateral exposure for aparticular receivable is the excess of the carrying value over the applicablefair value of the related collateral. A receivable with an estimated fair valuein excess of the carrying value is considered to have no collateral exposure.

 

In prior periods, thecollateral value was determined based on averaging values obtained frompublished industry data. In the third quarter of 2004, we began determining thecollateral value based on a median approach. The applicable default rate isdetermined using two components: customer credit ratings and weighted-averageremaining contract term. Credit ratings are identified for each customer in theportfolio. Customer credit ratings are updated based on current rating agencyinformation or our internal credit reviews. In prior periods, we calculated theweighted average life for the entire portfolio. In the third quarter of 2004,we began determining the weighted-average life for each receivable.

 

We have entered into agreementswith certain customers that would entitle us to look beyond the specificcollateral underlying the receivable for purposes of determining the collateralexposure as described above. Should the proceeds from the sale of theunderlying collateral asset resulting from a default condition be insufficientto cover the carrying value of our receivable (creating a shortfall condition),these agreements, for example, would permit us to take the actions necessary tosell or retain certain other assets in which the customer has an equityinterest and use the proceeds to cover the shortfall.

 

13

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Prior to the third quarter of2004, the calculation of the general allowance did not take into accountcollateral exposure mitigation for certain receivables that could arise fromenforcing the agreements described in the previous paragraph because weconcluded it was not probable that we would take the actions necessary torealize such exposure mitigation for those receivables. Such actions couldinclude making significant investments in securities with a senior collateralposition. During the third quarter of 2004, we reassessed the feasibility toenforce such agreements in the event of default and determined that it wasappropriate to now realize the impact of these agreements on certainreceivables for purposes of determining the general allowance. Thisdetermination resulted in a lower aggregate collateral exposure, which in turnresulted in a reduction to the general allowance of $59 million.

 

We determined that as of September 30, 2004,the allowance for losses on receivables of $232 million was adequate to coverour collateral exposure. In the third quarter of 2004, we recorded a reductionto the allowance for losses, which resulted in income of $51 million, presentedas a reduction in the provision for losses. The factors attributing to the reductionin the provision for losses in the third quarter of 2004 were $59 million ofbenefit described in the preceding paragraph; $25 million of net benefit due torefinements in the methodology for measuring collateral values; $8 million ofnet benefit due to reduced collateral exposure associated with Hawaiianreceivables, partially offset by a Hawaiian restructuring charge; $5 million ofnet benefit principally due to reduced collateral exposure; a $42 million increasein the requirement in the allowance account resulting from the determinationthat receivables from ATA were subject to a specific impairment, as discussedin Note 3; and a $4 million increase to our general reserve. Additionally, inthe third quarter of 2004 we decreased the allowance for losses on receivables$19 million as a result of write-offs, net of recoveries.

 

*Impact of Intercompany Guarantees*

 

At September 30, 2004, we were thebeneficiary of $2,014 million of guarantees from Boeing with respect toreceivables totaling $3,209 million. Intercompany guarantees primarily relateto residual value guarantees, first loss deficiency guarantees and rentalguarantees. Due to intercompany guarantees from Boeing, our accountingclassification of certain third-party leases may differ from the accountingclassification in the consolidated Boeing financial statements. As a result ofthese intercompany guarantees, the required balance for the allowance forlosses on receivables and the required provision for losses we recognized havebeen mitigated.

 

The following table reconciles, on a pro formabasis, the changes in the allowances for losses on receivables excluding theimpact of intercompany guarantees from Boeing and any related accountingclassification differences.

 
| ** **                                                | ** ** | **Nine Months Ended**  | ** ** |
|-----------------------------------------------------------|------------|------------------------|------------|
| ** **                                                | ** ** | **September 30,** | ** ** |
| **(Dollars in millions)**                                 | ** ** | **2004**               | ** ** | **2003** | ** ** |
| Allowance for losses on receivables at  beginning of year |       | $                      | 400        |   | $ | 299 |   |
| Provision for losses                                      |       | 40                     |       | 208 |   |
| Write-offs, net of recoveries                             |       | (46                    | )          | (81 | ) |
| Allowance for losses on receivables at end  of period     |       | $                      | 394        |   | $ | 426 |   |

 

During the third quarter of 2004, Boeingrecognized an addition to the provision for losses of $48 million in additionto the $51 million reduction to the provision for losses we recognized, as discussedabove, resulting in a net consolidated reduction to the provision for losses of$3 million at the consolidated Boeing level. The additional provision forlosses of $48 million resulted principally from recognizing collateral exposurethat is mitigated at the BCC level due to intercompany guarantees, including aportion of the ATA portfolio subject to a specific allowance as of the thirdquarter of 2004.

 

**Note 5 – Investments**

 

The following table shows the impact ofinvestments we accounted for under SFAS No. 115, “Accounting for CertainInvestments in Debt and Equity Securities.” We record available-for-salesecurities in investments at estimated fair value. Unrealized gains/losses relatedto available-for-sale securities are recorded in accumulated othercomprehensive income/loss, net of tax; however, losses deemed other thantemporary are recorded as asset impairment expense. We record held-to-maturitysecurities at amortized cost. Unrealized gains/losses related toheld-to-maturity securities are not recorded in the condensed consolidatedfinancial statements and are shown in the table below for informationalpurposes only; however, losses deemed other than temporary are recorded asasset impairment expense.

 

14

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Fair values for investment securities arebased on bid quotes from investment bank dealers, where available. Since themajority of our securities are illiquid non-traded securities, fair values arebased on quoted dealer estimates. We substantiate these quoted dealer estimatesby performing a reasonableness test. Our general practice is to request spreadlevels over U.S. Treasury benchmarks from dealers and compare those levels to thoseof similar public securities. The amount that would ultimately be realized in asale or other transaction could differ significantly from this estimate.

 

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

 
| **(Dollars in millions)**        | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gain** | ** ** | **Gross  Unrealized  Loss** | ** ** | **Estimated  Fair  Value** | ** ** |
|----------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------|------------|----------------------------|------------|
| **September 30, 2004** |       |                |       |                        |       |                        |       |                       |       |
| Available-for-Sale               |       | $                   | 10         |                        | $          | —                      |       | $                          | (2         | ) | $ | 8 |   |
| Held-to-Maturity(1)(3)           |       | 210                 | (2)        | —                      |       | (51                         | )          | 159                        |       |
|                             |       | $                   | 220        |                        | $          | —                      |       | $                          | (53        | ) | $ | 167 |   |
|                             |       |                |       |                        |       |                        |       |                       |       |
| **December 31, 2003**  |       |                |       |                        |       |                        |       |                       |       |
| Available-for-Sale               |       | $                   | 20         |                        | $          | 1                           |       | $                          | —     |   | $ | 21 |   |
| Held-to-Maturity(1)              |       | 453                 |       | —                      |       | (57                         | )          | 396                        |       |
|                             |       | $                   | 473        |                        | $          | 1                           |       | $                          | (57        | ) | $ | 417 |   |

 

----

(1)          Primarily consists of pass-through trust certificates, commonly knownas equipment trust certificates (“ETCs”).

(2)          Related to the $210 million at September 30, 2004, we had $10million in guarantees from Boeing and $6 million in guarantees from a thirdparty.

(3)          These securities have been in a continuous unrealized loss position for12 months or longer.

 

During the third quarter of 2004, we sold toBoeing at net book value of $182 million a D tranche subordinated debt securityissued by a trust sponsored by Delta Air Lines, Inc. (“Delta”). This included$2 million of accumulated other comprehensive income.

 

At September 30, 2004, ourheld-to-maturity investments included $205 million of subordinated debtinvestments in several enhanced equipment trust certificates (“EETCs”). TheseEETCs are financing arrangements that are regularly used by airlines to financepools of aircraft. Approximately $173 million of the above amount relates toinvestments that were acquired in 2002. Due to the commercial aviation marketdownturn, these securities have been in a continuous unrealized loss positionfor 12 months or longer. Despite the unrealized loss position of thesesecurities, we have concluded that these EETC investments are notother-than-temporarily impaired. This assessment was based on the value of theunderlying collateral to the securities, the term of the securities, and bothinternal and third-party credit reviews and analyses of the counterparties,principally major domestic airlines. Accordingly, we have concluded that it isprobable that we will be able to collect all amounts due according to thecontractual terms of these debt securities.

 

At September 30, 2004, ourheld-to-maturity investments also included $5 million of an investment inmandatorily redeemable preferred stock that had been in a continuous unrealizedloss position for 12 months or longer. Despite the unrealized loss position of thissecurity, we have concluded that the investment is not other-than-temporarilyimpaired. This assessment was based on the value of the underlying collateralto the security, the term of the security, and both internal and third-partycredit reviews and analyses of the counterparties, principally major domesticairlines. Accordingly, we have concluded that it is probable that we will beable to collect all amounts due according to the contractual terms of the debtsecurity.

 

At September 30, 2004, our held-to-maturityinvestments included an investment in mandatorily redeemable preferred stock inATA that had been in a continuous unrealized loss position since 2001. Duringthe second quarter of 2004, our assessment of ATA’s continued financialdifficulties led us to conclude that the unsecured preferred stock investmentmaturing in 2015 was other-than-temporarily impaired. Accordingly, we loweredthe carrying value of this investment to its fair value, resulting in a pre-taxnon-cash charge to asset impairment expense of $29 million. Of this amount, $17million of pre-tax unrealized loss ($11 million net of tax) was reclassifiedfrom accumulated other comprehensive income/loss to asset impairment expense. Duringthe third quarter of 2004, we reassessed the fair value of this investment,resulting in an additional pre-tax non-cash charge to asset impairment expenseof $18 million, which reduced the carrying value of the investment to zero.

 

15

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At September 30, 2004 and December 31, 2003,none of our available-for-sale and held-to-maturity securities was consideredinvestment grade securities.

 

At September 30, 2004, maturitiesof available-for-sale and held-to-maturity securities were as follows:

 
| ** **                 | ** ** | **Available-for-Sale** | ** ** | **Held-to-Maturity**       | ** ** |
|----------------------------|------------|------------------------|------------|----------------------------|------------|
| **(Dollars in millions)**  | ** ** | **Amortized  Cost**    | ** ** | **Estimated  Fair  Value** | ** ** | **Amortized  Cost** | ** ** | **Estimated  Fair  Value** | ** ** |
| Due from one to five years |       | $                      | —     |                       | $          | — |   | $ | 124 |   | $ | 94 |   |
| Due from six to ten years  |       | 10                     |       | 8                          |       | 54 |   | 39 |   |
| Due after ten years        |       | —                 |       | —                     |       | 32 |   | 26 |   |
|                       |       | $                      | 10         |                       | $          | 8 |   | $ | 210 |   | $ | 159 |   |

 

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

 

When events or circumstances indicate (and noless than annually), we review the carrying amount of all aircraft and equipmentunder operating lease and held for sale or re-lease for potential impairment.For the third quarter of 2004, we reviewed all aircraft and equipment underoperating lease and held for sale or re-lease maturing within two years orwhere known events may indicate impairment. We recognize an impairment loss foraircraft and equipment under operating lease and held for re-lease when theexpected undiscounted cash flow over the remaining economic useful life is lessthan the book value. We use various assumptions when determining the expectedundiscounted cash flow. These assumptions include expected future lease rates,lease terms, end of economic useful life value of the aircraft or equipment,periods in which the asset may be held in preparation for a follow-on lease,maintenance costs, remarketing costs and the remaining economic useful life ofthe asset. We state assets held for sale at the lower of carrying amount orfair value less costs to sell.

 

When we determine that impairment isindicated for an asset, the amount of the impairment loss is the excess of thebook value less asset value guarantees, if applicable, over the fair value ofthe asset. For aircraft assets, we use the average published value frommultiple sources based on the type and age of the asset to determine the fairvalue. However, if the features or aircraft usage varies significantly from thegeneric aircraft attributes covered by outside publications, we apply judgmentbased on the attributes of the specific aircraft to determine fair value. Forthe nine months ended September 30, 2004 and 2003, we recordedpre-tax non-cash charges totaling $26 million and $76 million, respectively, torecord impairments of aircraft and equipment under operating lease and held forsale or re-lease.

 

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**Note 7 – Debt and CreditAgreements**

 
| ** **                                                             | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(Dollars in millions)**                                              | ** ** | **2004**               | ** ** | **2003**              | ** ** |
| Senior debt:                                                           |       |                   |       |                  |       |
| Variable rate (three-month LIBOR plus 0.6%)  note due 2012             |       | $                      | 5          |                  | $          | 5 |   |
| 4.75% note due 2008                                                    |       | 503                    |       | 504                   |       |
| 5.65% note due 2006                                                    |       | 520                    |       | 1,032                 |       |
| 5.75% note due 2007                                                    |       | 747                    |       | 749                   |       |
| 5.80% note due 2013                                                    |       | 612                    |       | 610                   |       |
| 6.10% note due 2011                                                    |       | 780                    |       | 774                   |       |
| 6.50% note due 2012                                                    |       | 759                    |       | 759                   |       |
| 7.10% note due 2005                                                    |       | —                 |       | 499                   |       |
| 7.375% note due 2010                                                   |       | 542                    |       | 544                   |       |
| 3.44% Euro medium-term note due 2004                                   |       | 51                     |       | 61                    |       |
| Non-recourse variable rate (one-month LIBOR  plus 1.1%) note due 2012  |       | 42                     |       | 43                    |       |
| 4.84% - 5.79% non-recourse notes due  through 2013                     |       | 40                     |       | 41                    |       |
| 3.15% - 6.75% retail medium-term notes due  through 2017               |       | 874                    |       | 874                   |       |
| 2.05% - 7.64% medium-term notes due through  2023                      |       | 1,400                  |       | 2,240                 |       |
| 1.69% secured debt, proceeds of  securitization due through 2009       |       | —                 |       | 89                    |       |
| 1.67% - 7.35% capital lease obligations due  through 2015              |       | 289                    |       | 329                   |       |
|                                                                   |       | 7,164                  |       | 9,153                 |       |
|                                                                   |       |                   |       |                  |       |
| Subordinated debt:                                                     |       |                   |       |                  |       |
| 8.31% medium-term note due 2004                                        |       | —                 |       | 20                    |       |
| Non-recourse variable rate note due 2012  (one-month LIBOR plus 2.46%) |       | 4                      |       | 4                     |       |
|                                                                   |       | 4                      |       | 24                    |       |
|                                                                   |       | $                      | 7,168      |                  | $          | 9,177 |   |

 

On February 16, 2001, we filed apublic shelf registration of $5,000 million of debt securities with theSecurities and Exchange Commission (“SEC”). As of September 30, 2004,an aggregate amount of $402 million, allocated to our Series XI medium-termprogram, remains available for potential debt issuance.

 

On February 22, 2002, we filed apublic shelf registration of $5,000 million of debt securities with the SEC. Asof September 30, 2004, an aggregate amount of $3,019 million (whichincludes $119 million of retail medium-term notes) remains available forpotential debt issuance.

 

On June 6, 2002, we established a$1,500 million Euro medium-term note program. As of September 30, 2004,an aggregate amount of $1,440 million remains available for potential debtissuance.

 

The most restrictive provisions of variousdebt agreements require us to (a) limit the payment of cash dividends to theextent that our consolidated assets would be less than 115% of our consolidatedliabilities (excluding deferred taxes) after dividend payments and (b) restrictthe amount of liens on our property to secure indebtedness to 15% or less ofconsolidated assets, other than liens specifically excluded. At September 30, 2004,as well as during the period, we were in compliance with these and all debtcovenants.

 

Since November 21, 2003, $750 millionof Boeing’s five-year revolving credit line expiring in 2008 has beenexclusively available to us. This is in addition to $1,250 million of Boeing’s$2,500 million 364-day revolving credit line, which is exclusively available tous. At September 30, 2004, there were no amounts outstanding underthese agreements.

 

During the third quarter of 2004, we redeemed$1,000 million face value of our outstanding senior notes. This included theentire principal balance, equal to $500 million face value, of our 7.10% seniornotes due 2005 and $500 million face value of our 5.65% senior notes due 2006.We recognized a loss of $52 million related to this early debt redemption.

 

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**Note 8 – Derivative FinancialInstruments**

 

We account for derivatives pursuant to SFASNo. 133, “Accounting for Derivative Instruments and Hedging Activities,” asamended. This standard requires that we recognize all derivative instruments inthe 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 effects of these strategies on the condensed consolidated financialstatements.

 

*Fair Value Hedges*

 

Interest rate swaps, under which we agree topay variable rates of interest, are designated as fair value hedges offixed-rate debt. For the nine months ended September 30, 2004 and2003, we recorded $12 million and $9 million, respectively, of gains related tothe basis adjustment of certain terminated interest rate swaps in interestexpense. During the next twelve months, we expect to amortize a $16 milliongain from the amount recorded in the basis adjustment of certain terminatedfair value hedge relationships to interest expense.

 

During the first quarter of 2003, we alsoheld forward-starting interest rate swap agreements to fix the cost of fundinga firmly 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 charge of $21 million.For the nine months ended September 30, 2003, we recorded $1 millionof losses related to ineffectiveness due to the forward-starting interest rateswaps in interest expense.

 

*Cash Flow Hedges*

 

The cash flow hedges we use include certaininterest rate swaps and cross currency swaps. Interest rate swap contractsunder which we agree to pay fixed rates of interest are designated as cash flowhedges of variable-rate debt obligations. In addition, cross currency swapcontracts under which we agree to pay fixed functional currency rates of interestare designated as cash flow hedges of fixed non-functional currency debtobligations. As of September 30, 2004 and December 31, 2003,we recorded net unrealized losses of $1.5 million ($0.9 million net of tax) and$3 million ($2 million net of tax), respectively, in accumulated othercomprehensive income/loss associated with our cash flow hedging transactions.

 

For the nine months ended September 30, 2004and 2003, unrealized losses (net of tax) of $0.4 million and unrealized gains(net of tax) of $0.3 million, respectively, included in accumulated othercomprehensive income/loss were reclassified to interest expense (for interestswaps) or other expense (for cross currency swaps). During the next twelvemonths, we expect to reclassify to interest expense a loss (net of tax) of $1million from the amount recorded in accumulated other comprehensiveincome/loss.

 

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*Non-hedging DerivativeInstruments*

 

We hold certain interest exchange agreementsand related interest rate swaps. The intent of these interest rate swaps is toeconomically hedge the exposures created by the interest exchange agreements.However, since the exposures being hedged are derivative instruments, thisrelationship does not qualify for hedge accounting. As a result, changes infair value of both instruments are immediately recognized in income. As of September 30, 2004and December 31, 2003, we recorded net unrealized losses of $0.9million ($0.6 million net of tax) and $1.4 million ($0.9 million net of tax),respectively, in accumulated other comprehensive income/loss associated withthese interest rate swaps. For the nine months ended September 30, 2004and 2003, the interest exchange agreements resulted in realized losses of $7million and $6 million, respectively, and the related interest rate swapsresulted in realized gains of $6 million and $4 million, respectively. For the ninemonths ended September 30, 2004 and 2003, unrealized losses (net oftax) of $0.3 million and $0.5 million, respectively, from accumulated othercomprehensive income/loss and gains of $1 million and $2 million, respectively,from the basis adjustment to underlying liabilities, were amortized to interestexpense. During the next twelve months, we expect to amortize to interestexpense a $0.3 million loss (net of tax) from the amount recorded inaccumulated other comprehensive income/loss and a $1 million gain from thebasis 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 convertible noteswas exercised in full and the shares realized were sold in the third quarter of2003, along with two-thirds of the warrants, resulting in gains of $9 million.As of September 30, 2004 and December 31, 2003, theremaining warrants for this and other transactions were reflected in otherassets at a fair value of $6 million and $8 million, respectively. We recordedthe initial fair values of the warrants and conversion option on notes as adiscount to notes receivable of $20 million. For the nine months ended September 30, 2004and 2003, the warrants and conversion feature of the convertible notes recordedin other assets had changes in fair value, resulting in a reduction to otherincome of $2 million and an addition to other income of $32 million,respectively.

 

**Note 9 – Commitments andContingencies**

 

*Litigation*

 

Various legal proceedings and claims arepending or have been asserted against us, many of which are covered by thirdparties, including insurance companies. We believe that the final outcome ofthese proceedings and claims will not have a material adverse effect on ourearnings, cash flows and/or financial position.

 

*Restructurings and RestructuringRequests*

 

United accounted for $1,141 million and$1,159 million (11.8% and 11.5%) of our total portfolio at September 30, 2004and December 31, 2003, respectively. At September 30, 2004,the United portfolio was secured by security interests in two 767 aircraft and13 777 aircraft and by an ownership and security interests in five 757aircraft. At September 30, 2004, United was our second largestcustomer. United continues to operate under Chapter 11 bankruptcy protection.On June 28, 2004, United’s application to obtain federal loanguarantees was denied by the Airline Transportation Stabilization Board, whichalso withdrew United’s eligibility to reapply. On August 20, 2004,United obtained approval from the bankruptcy court to extend itsdebtor-in-possession financing credit facilities throughJune 30, 2005 and increase its available funds by $500 million.United is continuing to pursue alternative financing through private investors.During the third quarter of 2003, we completed a restructuring of United’saircraft loans and leases. The receivables associated with a security interestin the two 767 aircraft and 13 777 aircraft were restructured with terms thatdid not necessitate a troubled debt restructuring charge to the allowance forlosses on receivables. The lease terms attributable to the five 757 aircraft inwhich we hold an ownership and security interest were revised in a manner thatreclassified these leases as operating leases. At September 30, 2004,United was current on all of its obligations related to these 20 aircraft.

 

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United retains certain rights by operatingunder Chapter 11 bankruptcy protection, including the right to reject therestructuring terms with its creditors and return aircraft, including ouraircraft. The terms of our restructuring with United, which were approved bythe federal bankruptcy court, set forth the terms under which all 20 aircraftfinanced by us are expected to remain in service upon United’s emergence fromChapter 11 protection. If United exercises its right to reject the agreed uponrestructuring terms, the terms of all of the leases and loans with United wouldimmediately revert to the original terms, which are generally less favorable toUnited. United would retain its rights under Chapter 11 to return our aircraftin the event of a reversion to the original lease and loan terms.

 

ATA accounted for $705 million and $743million (7.3% and 7.4%) of our total portfolio at September 30, 2004and December 31, 2003, respectively. At September 30, 2004,the ATA portfolio primarily consisted of 12 757 aircraft and an investment inATA mandatorily redeemable preferred stock with a face value of $50 million. OnOctober 26, 2004, ATA filed for Chapter 11 bankruptcy protection. At September30, 2004, we had established reserves that adequately cover our collateralexposure on our finance leases and note receivable with ATA. In November 2002,ATA received a loan of $168 million administered by the Airline TransportationStabilization Board. In the third quarter of 2003, we agreed to restructurecertain outstanding leases by extending their terms and deferring a portion ofthe rent payments for a limited period of time. The terms of the restructuredleases did not result in a charge to the allowance for losses on receivables.At September 30, 2004, ATA was current on all of its obligationsrelated to our portfolio. During the third quarter of 2004, ATA requested thatwe restructure our finance lease terms and provide additional short-termfinancing support. We are currently evaluating the requests from ATA.

 

During the second quarter of 2004, ourassessment of ATA’s continued financial difficulties led us to conclude thatthe unsecured preferred stock investment maturing in 2015 wasother-than-temporarily impaired. Accordingly, we lowered the carrying value ofthis investment to its fair value, resulting in a pre-tax non-cash charge toasset impairment expense of $29 million. During the third quarter of 2004, wereassessed the fair value of this investment, resulting in an additionalpre-tax non-cash charge to asset impairment expense of $18 million, whichreduced the carrying value of the investment to zero.

 

Additionally, during the third quarter of2004, our assessment of ATA’s continued financial difficulties led us toconclude that our portfolio of finance leases with ATA was specifically impaired.Accordingly, we increased our allowance for losses on receivables byapproximately $42 million in order to adequately reserve for the amount bywhich the carrying value of the ATA related assets exceeded the assets’collateral values. If we did not have loss guarantees from Boeing for ATA’sfinance leases and notes receivable, we would have increased our allowance forlosses on receivables by $74 million in total. Taking into account the specificreserves allocated for the ATA receivables, we do not expect that ourtransactions with ATA will have a material adverse effect on our earnings, cashflows and/or financial position. While we believe that we have provided for anadequate allowance for losses on receivables on ATA’s finance leases and notesreceivable, in the event that future negotiations or proceedings result in thereturn of a substantial number of aircraft, there could be a material adverseeffect on our earnings, cash flows and/or financial position, at least untilsuch time as the aircraft are sold or redeployed for adequate consideration.

 

Hawaiian accounted for $460 million and $506million (4.7% and 5.0%) of our total portfolio at September 30, 2004and December 31, 2003, respectively. At September 30, 2004,the Hawaiian portfolio consisted of 11 717 aircraft and three 767 aircraft.Hawaiian filed for Chapter 11 bankruptcy protection on March 21, 2003.In December 2003 and January 2004, we permitted Hawaiian to return two 717aircraft leased by us. These 717 aircraft were leased to a third party in thefirst quarter of 2004.

 

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In September 2004 we reached anagreement with the bankruptcy trustee for the Hawaiian estate relating to therestructuring of all of our leases and on the amount of our unsecured claimresulting from Hawaiian’s bankruptcy. The claim amount represented costs andlosses incurred by us for the period of time prior to the September 2004settlement and losses that would be incurred by us based on the differencesbetween the restructured and the original lease payments. OnSeptember 27, 2004, following a request by Hawaiian’s trustee, thebankruptcy court approved our unsecured claim against the Hawaiian estate andalso approved the new terms of our restructured leases. In September we soldour unsecured claim to Ranch for $53 million. In connection with the approvalof our claim by the bankruptcy court, we recorded $35 million of incomerelating to costs and lost revenues prior to the approval of the claim by thebankruptcy court. Additionally, as a result of the approval of our restructuredlease terms, we recorded a net reduction in the provision for losses of $8million due to reduced collateral exposure associated with finance leasereceivables, partially offset by a restructuring charge. This net reduction inthe provision for losses of $8 million was effectively recorded as income inthe third quarter as a result of the adjustment to the allowance for losses onreceivables discussed in Note 4. The remaining $10 million of receipts wereaccounted for as unearned income attributable to an operating lease.****Prior to Hawaiian’s bankruptcy, we accounted for all of our717 leases and two of our three 767 leases as finance leases. Subsequent to theapproval of the restructured lease terms, we will continue to account for theseleases as finance leases. We reduced the carrying value of some of the financeleases as a result of this restructure to ensure that the new implicit rate ineach lease is in no case lower than the implicit rate prior to the restructure.

 

Hawaiian retains certain rightsby operating under Chapter 11 bankruptcy protection, including the right toreject restructuring terms with its creditors and return aircraft, includingour aircraft. The terms of our restructuring with Hawaiian, which were approvedby the federal bankruptcy court, set forth the terms under which all 14aircraft financed by us are expected to remain in service upon Hawaiian’semergence from Chapter 11 protection.

 

Viacao Aerea Rio-Grandense(“VARIG”) accounted for $407 million and $424 million (4.2% and 4.2%) of ourtotal portfolio at September 30, 2004 andDecember 31, 2003, respectively. At September 30, 2004, theVARIG portfolio consisted of two 737 aircraft and nine MD-11 aircraft. Inrecent years, VARIG has repeatedly defaulted on its obligations under leaseswith us, which has resulted in deferrals and restructurings, some of which areongoing. Boeing has provided us with first loss deficiency and partial rentalguarantees covering $321 million of the VARIG obligations. Taking into accountthese guarantees, we do not expect the VARIG transactions, including the impactof any restructurings, to have a material adverse effect on our earnings, cashflows and/or financial position.

 

We have reviewed ourobligations due from our customers for collectibility and have establishedspecific or general allowances as we deemed necessary. In addition to thecustomers discussed above, some other customers have requested a restructuringof their transactions with us. We have not reached agreement on any otherrestructuring requests that we believe would have a material adverse effect onour earnings, cash flows and/or financial position.

 

*Outstanding FundingCommitments*

 

AtSeptember 30, 2004, we had commitments to provide leasing and otherfinancing totaling $71 million, which included $31 million of intercompanycommitments with Boeing. Based on historical experience, we do not anticipatethat all of these commitments will be utilized. However, if we were required tofund all unfunded commitments:

 

•                  up to $71 million may be funded in less thanone year.

 

Additionally, Boeing and BoeingCapital Services Corporation had unfunded aircraft financing commitments atSeptember 30, 2004 of $1,453 million. Based on historical experience,we do not anticipate that we will fund all of these commitments. However, if wewere required to fund all unfunded commitments:

 

•                  up to $407 million may be funded in less thanone year,

•                  an additional $823 million may be funded inone to three years, and

•                  an additional $223 million may be funded infour to five years.

 

We expect to ultimately fund aportion of these unfunded commitments.

 

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**Note 10 –Off-Balance Sheet Arrangements**

 

We are a party to off-balancesheet arrangements, including guarantor obligations and variable interests inunconsolidated entities.

 

*GuarantorObligations*

 

The following table providesdata regarding our third party guarantees. The maximum potential paymentamounts represent a “worst-case scenario,” and do not necessarily reflectresults that we expect. Estimated proceeds from collateral and recourserepresent the anticipated values of assets we could liquidate or receive fromother parties to offset our payments under guarantees. The carrying amount ofliabilities recorded on the condensed consolidated balance sheets reflects ourbest estimate of future payments we may be required to make as part offulfilling our guarantor obligations.

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

 

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(1)          This amount is indemnified by Boeing.

(2)          Amounts included in other liabilities.

 

We have issued residual valueguarantees. Under these arrangements, we are obligated to make payments to aguaranteed party if the related aircraft or equipment fair values fall below aspecified amount at a future time. These obligations are collateralizedprincipally by commercial aircraft, and expire within the next six years.

 

We have issued credit anddeficiency guarantees. Under these arrangements, we are obligated to makepayments to a guaranteed party if the original debtor or lessee does not makepayments. Current outstanding credit and deficiency guarantees expire withinthe next eight years.

 

*Material VariableInterests in Unconsolidated Entities*

 

Our investments in ETCs, EETCsand special purpose entities (“SPEs”) are included in the scope of RevisedInterpretation No. 46 (“FIN 46(R)”), “Consolidation of Variable InterestEntities,” but do not require consolidation. Airlines regularly utilize an SPEcalled a Pass Through Trust to finance aircraft. The Pass Through Trust enablesthe airline to aggregate a large number of aircraft secured notes into onetrust vehicle, facilitating the issuance of larger bonds called pass-throughcertificates. The most common forms of pass-through certificates sponsored byairlines are ETCs and EETCs. ETCs and EETCs provide investors with tranchedrights to cash flows from a financial instrument, as well as a collateralposition in the related asset. While the underlying classes of equipment notesvary by maturity and/or coupon depending upon tenor or level of subordinationof the specific equipment notes and the corresponding claim on the aircraft,the basic function of the Pass Through Trust in an ETC or EETC remains topassively hold separate debt investments to enhance liquidity for investors,who in turn pass this liquidity benefit directly to the airline in the form ofa lower coupon and/or greater debt capacity. We participate in several ETCs andEETCs as an investor. We are also an investor in entities engaged in financingarrangements with third parties and are accounting for these investments underthe equity method.

 

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Additionally, we are asubordinated lender to certain SPEs that are utilized by the airlines, lendersand loan guarantors including, for example, the Export-Import Bank of theUnited States. We also use other SPEs that are fully consolidated in ourfinancial statements. Both SPE arrangements are used for other businessreasons, including:

 

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

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

 

Our receivables from these SPEsand investment in ETCs and EETCs aggregated $278 million atSeptember 30, 2004, which represents our maximum exposure to economicloss. During the nine months ended September 30, 2004, we recordedrevenues of $37 million and had cash inflows of $85 million relating to theseinvestments. At September 30, 2004, the variable interest entities(“VIEs”) in which we have invested had total assets of $3,255 million andrelated debt (which is non-recourse to us) of $2,977 million.

 

**Note 11 –Transactions withBoeing**

 

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

 

Intercompany guaranteesprimarily relate to residual value guarantees, first loss deficiency guaranteesand rental guarantees. At September 30, 2004, we were the beneficiaryunder $2,897 million of guarantees from Boeing with respect to our portfoliotransactions totaling $4,463 million ($3,209 million of receivables, $1,131million of equipment under operating leases and $123 million of investments),which mitigates our risk. We recorded the following activity under theintercompany guarantee agreements:

 
| ** **                                                                | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| **(Dollars in millions)**                                                 | ** ** | **2004**                                  | ** ** | **2003** | ** ** |
| Guarantee payments applied to income                                      |       | $                                         | 17         |   | $ | 29 |   |
| Guarantee payments applied to reduce net  asset value of related aircraft |       | 4                                         |       | 23 |   |
|                                                                      |       | 21                                        |       | 52 |   |
| Fees                                                                      |       | (2                                        | )          | (3 | ) |
| Net guarantee payments                                                    |       | $                                         | 19         |   | $ | 49 |   |

 

Boeing has also agreed toprovide interest rate subsidies, non-guarantee concessions and rental paymentson restructured third party leases. For the nine months endedSeptember 30, 2004 and 2003, we recognized income of $31 million and$38 million, respectively, under these agreements.

 

Additionally, as providedfor under the terms of the intercompany guarantee agreements, Boeing recordedadditional charges of $84 million and $66 million, respectively, for the ninemonths ended September 30, 2004 and 2003, related to assetimpairments, accrued expenses and allowance for losses on receivables in ourportfolio.

 

For the nine months endedSeptember 30, 2004 and 2003, we recorded financing revenues (revenuefrom financing leases, notes and other receivables and equipment underoperating leases) from Boeing, exclusive of guarantees and subsidies, of $15million and $18 million, respectively.

 

For the nine months endedSeptember 30, 2004 and 2003, we recognized new business volume of$428 million and $1,400 million related to our purchase of aircraft andequipment from Boeing.

 

During the third quarter of2004, we sold to Boeing at net book value of $182 million a D tranchesubordinated debt security issued by a trust sponsored by Delta. This included$2 million of accumulated other comprehensive income.

 

During the second quarter of2004, we agreed to nullify an intercompany stipulated loss contract with Boeingon two BBJ aircraft. See Note 2 for a discussion on the nullification of theintercompany stipulated loss contract.

 

In September 2004 as aresult of Boeing’s decision to retain one BBJ as part of its executive fleet,we reclassified one BBJ from discontinued operations to continuing operationsat its fair value of $43 million. We also reclassified an $11 million valuationloss on disposal that was recorded during the second quarter of 2004 tocontinuing operations. See Note 2 for a discussion on the reclassification ofthe BBJ to continuing operations.

 

Additionally, during the secondquarter of 2004, $11 million of allowance for losses on receivables wastransferred from Boeing and charged to the allowance pursuant to anintercompany agreement that was subsequently terminated.

 

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

 

**Forward-LookingInformation Is Subject to Risk and Uncertainty**

 

From time to time, we may makestatements that contain projections or “forward-looking” information (asdefined in the Private Securities Litigation Reform Act of 1995) that involverisk and uncertainty. The words “aim”, “plan”, “likely”, “believe”, “expect”,“anticipate”, “intend”, “estimate”, “will”, “should”, “could”, “may”, and otherexpressions that indicate future events and trends identify forward-lookingstatements. 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 this Form 10-Q, and particularly in the notesto condensed consolidated financial statements in Item 1 of Part I, Item 2 ofPart I, Item 1 of Part II, and Item 5 of Part II may contain forward-looking information.The subject matter of these statements may include, but are not limited to,wars, the effects of the September 11, 2001 terrorist attacks or futureterrorist threats or attacks, the impact on us of strategic decisions byBoeing, the level of new financing opportunities made available to us byBoeing, future earnings, costs, expenditures, losses, liquidity, residualvalues and various business environment trends including the state of theeconomy, in general, and the airline industry, in particular. In addition tothose contained herein, forward-looking statements and projections may be madeby us orally or in writing including, but not limited to, various sections ofour filings with the Securities and Exchange Commission under the Securities Actof 1933 and the Securities Exchange Act of 1934.

 

Our actual results and futuretrends may differ materially from our forward-looking statements depending on avariety of factors including, but not limited to, our relationship with Boeing,as well as strategic decisions of Boeing relating to us, the effects of theSeptember 11, 2001 terrorist attacks or future terrorist threats or attacks andthe continuing impact on the airline industry, wars, the capital equipmentrequirements of United States domestic and foreign businesses, general economicconditions, and in particular, economic conditions in the airline industry andthe continued operation, viability and growth of major airline customers,capital availability and cost, changes in laws and tax benefits, the taxposition of Boeing (including the applicability of the alternative minimumtax), competition from other financial institutions, our successful executionof internal operating plans and strategy, including the transition of our LongBeach, California administrative groups to Renton, Washington, defaults orbankruptcies by customers (especially airlines), adverse developments in thevalue of collateral or owned assets (especially aircraft), termination ofaircraft manufacturing programs, regulatory uncertainties, legal proceedingsand an adverse development in rating agency credit ratings or assessments.

 

**Business Environment andTrends**

 

Our strategic direction hasshifted from a focus on growing the portfolio to a focus on supporting Boeing’smajor operating units and managing overall corporate exposures. For thecommercial aircraft market, we facilitate, arrange and provide financing toBoeing Commercial Airplanes’ customers. For our space and defense markets, weprimarily engage in arranging and structuring financing solutions for Boeing’sIntegrated Defense Systems’ customers. In addition, we are continuing toenhance our risk management activities to manage exposures associated with ourcurrent portfolio and future business activities. We expect to satisfy anyexternal funding needs through access to our traditional capital market fundingsources.

 

On May 24, 2004,we entered into a purchase and sale agreement with General Electric CapitalCorporation (“GECC”) to sell substantially all of the assets related to ourCommercial Financial Services business. The assets sold or to be sold to GECCconsist of leases and financing arrangements having a carrying value of $1,879million as of May 31, 2004. The purchase agreement called for the saleof the assets to take place in a series of closings, commencing onMay 31, 2004 and ending no later than July 30, 2004. Basedupon mutual agreement between the parties, the final closing date has beenextended to occur within 60 days subsequent to September 30, 2004. Bythe end of May 2005, we intend to dispose of the remaining assets identified tothe Commercial Financial Services business that are not subject to the purchaseand sale agreement with GECC. See Note 2 of the notes to condensed consolidatedfinancial statements for a discussion on the disposition of our CommercialFinancial Services business.

 

AtSeptember 30, 2004, our primary operations consisted of AircraftFinancial Services. Our portfolio consisted of financing leases, notes andother receivables, equipment under operating leases, investments and assetsheld for sale or re-lease.

 

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Commercial aviation has beenimpacted by an economic downturn that began in 2001 and continued through 2003.In addition, the industry suffered a severe shock from the terrorist attacks ofSeptember 11, 2001, generating on-going traveler concerns andadditional costs for security.

 

World-wide economic growthcontinued during the third quarter of 2004. Led by the strong economic growthin the U.S. and China, with improving conditions in Japan and Europe, world airtravel levels are above traffic levels carried by the airlines in 2000. Thisstrong volume of air travel will not necessarily generate strong airlineprofits because of a weak pricing environment and persistently high oil andfuel prices. Airlines are in an increasingly competitive situation withfast-growing low-cost, low-fare competitors placing significant pricingpressure in an increasing number of air travel markets. Persistently high oiland fuel prices are placing cost pressure on airlines, increasing world-wideairline operating costs by billions of dollars. The ability of airlines to passthese costs on to their customers is limited by the competitive environment.Consequently, the profit outlook for many airlines is falling. Some airlines,particularly large U.S. network carriers, are facing significant losses againin 2004 and face significant financial difficulties. Exogenous shocks stillrepresent further major uncertainties for the airline industry. Recurrence ofdisease outbreaks like the 2003 severe acute respiratory syndrome outbreak inAsia, new armed conflict, and/or terrorist attacks focused on air travel allrepresent threats to the airline industry’s recovery.

 

Aircraft values and leaserates are also impacted by the number and type of aircraft that are parked andcurrently out of service. The number of parked aircraft has declined byapproximately 100 aircraft from the number of aircraft parked atJune 30, 2004, reaching a new post-September 11, 2001 low in terms ofboth the number of parked aircraft and the parked percentage of the activefleet. Approximately 1,800 aircraft (10.4% of current world fleet)****continue to be parked, including both in production and outof production aircraft types.

 

Our portfolio at the end ofthe third quarter of 2004 totaled $9,701 million, of which $9,113 million wasrelated to Boeing products, primarily commercial aircraft. While monthlytraffic levels continue to be at or above traffic levels carried by theairlines in 2000, the effects of the airline industry downturn continue toimpact commercial aircraft values. Published sources and recent markettransactions indicate that values for various aircraft types serving ascollateral in our portfolio remain depressed. Older and/or out-of-productionaircraft types have experienced the most significant declines in value, whilenewer aircraft types have experienced more moderate declines. Aircraftvaluations could decline materially if significant numbers of aircraft,particularly types with relatively few operators, are idled on account offurther airline bankruptcies or restructurings. At the same time, the creditratings of many airlines, particularly in the United States, have remained atlow levels. A substantial portion of our portfolio is concentrated among U.S.commercial airline customers. Certain customers have filed for bankruptcyprotection or requested lease or loan restructurings; these negotiations werein various stages as of September 30, 2004. These bankruptcies orrestructurings could have a material adverse effect on our earnings, cash flowsand/or financial position. See Note 9 of the notes to condensed consolidatedfinancial statements for a discussion on our restructurings and restructuringrequests.

 

In October 2003, Boeingannounced the decision to end production of the 757 program, with the finalaircraft scheduled to be produced in late 2004. Closures of other aircraftprograms in the past have not necessarily caused extraordinary declines in thesecondary value of the aircraft involved. However, due to the impacts ofSeptember 11, 2001 and the prolonged downturn in the airlineindustry, 757 aircraft values have already declined. While we continue to believein the utility and marketability of the 757 aircraft, we are unable to predictwhether or how the end of the 757 program, as well as overall marketconditions, may impact 757 aircraft values and rental rates. AtSeptember 30, 2004, $1,552 million of our portfolio wascollateralized by 757 aircraft. This included $1,312 million of passengeraircraft (35 aircraft at 11 operators). At September 30, 2004, wewere the beneficiary under guarantees from Boeing covering $629 million of thisportion of our 757 portfolio. The remainder of the 757 portfolio consisted ofconverted freighters on long-term lease. Should the 757 aircraft suffer asignificant decline in utility and market acceptance, the aircraft values maydecline, which in turn could also result in an increase to the allowance forlosses on receivables. While we are unable to predict the likelihood of theseimpacts occurring, such impacts could result in a potential material adverseeffect on our earnings, cash flows and/or financial position.

 

The 717 program continuityis dependent on the outcome of Boeing’s current sales campaigns. During thenine months ended September 30, 2004, firm orders for six additional aircrafthad been received and during October 2004, firm orders for 2 additional aircrafthad been received. While we continue to believe in the utility andmarketability of the 717 aircraft, we are unable to predict whether or how anending of the 717 program, as well as overall market conditions, would impact717 aircraft values and rental rates. At September 30, 2004, $2,328million of our portfolio was collateralized by 717 aircraft. AtSeptember 30, 2004, we were the beneficiary under $1,625 million ofguarantees from Boeing covering $2,234 million of our 717 portfolio. Should the717 aircraft suffer a significant decline in utility and market acceptance, theaircraft values may decline, which in turn could also result in an increase tothe allowance for losses on receivables. While we are unable to predict thelikelihood of these impacts occurring, such impacts could result in a potentialmaterial adverse effect on our earnings, cash flows and/or financial position.

 

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AtSeptember 30, 2004, we had $177 million of assets that were held forsale or re-lease, of which $158 million were identified with a firm contract tosell or place on lease. In the next 12 months, leases related to approximately$273 million (2.8%) of our portfolio expire and we will need to re-lease orsell these assets into the market. If we are unable to place or sell theseassets into revenue-generating service, our results of operations could beimpacted.

 

Consolidated Results ofOperations

 

*Overview*

 

Our net income was $146million for the nine months ended September 30, 2004 compared with$47 million for the same period in 2003, a change of $99 million. The increasein net income is primarily attributable to the following factors, which aredescribed without tax effect:

 

•                  decrease in the provision for losses of $188million,

•                  net gain on disposal of discontinuedoperations of $52 million during the first nine months of 2004, and

•                  debt redemption costs of $52 million duringthe first nine months of 2004.

 

We completed our portfolioreview for the third quarter of 2004. Based upon current market conditions, werecorded asset impairment expense of $29 million and recorded a $51 milliondecrease to the provision for losses during the third quarter of 2004. Duringthe nine months ended September 30, 2004, we recorded assetimpairment expense of $73 million and recorded a $42 million reduction in theprovision for losses. The factors attributing to the reduction in the provisionfor losses for the nine months ended September 30, 2004 were $59million of benefit due to our evaluation of the effect of default,subordination and security agreements; $25 million of net benefit due torefinements in the methodology for measuring collateral values; $8 million ofnet benefit due to reduced collateral exposure associated with Hawaiianreceivables, partially offset by a Hawaiian restructuring charge; $5 million ofnet benefit principally due to reduced collateral exposure; a $42 millionincrease in the requirement in the allowance account resulting from thedetermination that receivables from ATA were subject to a specific impairment;and a $13 million increase to our general reserve. Asset impairment expenseduring the three and nine months ended September 30, 2004, included$18 million and $47 million, respectively, related to an other than temporaryimpairment of a held-to-maturity investment. By comparison, during the firstnine months of 2003 we recognized $76 million of asset impairment expense andrecorded a provision for losses of $146 million. The 2003 amounts were drivenby the decline in the credit worthiness of our customers over the preceding twoyears and the fact that aircraft equipment values had dropped significantlyover the past few years. We carefully monitor the credit worthiness of ourcustomers and the relative value of aircraft equipment since we remain at riskto defaults and decreases in the value of aircraft equipment and the associatedlease rates. While equipment risk is inherent in our business, this risk hasbeen magnified over the past few years by the lingering weakness in the airlineindustry and the resulting oversupply of aircraft equipment.

 

*Results of Operations*

 

Financing revenues (revenuefrom financing leases, notes and other receivables and equipment underoperating leases) were as follows:

 
| ** **                          | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------|------------|-------------------------------------------|------------|
| **(Dollars in millions)**           | ** ** | **2004**                                  | ** ** | **2003** | ** ** |
| Finance lease income                |       | $                                         | 175        |   | $ | 172 |   |
| Interest income on notes receivable |       | 138                                       |       | 127 |   |
| Operating lease income              |       | 326                                       |       | 303 |   |
|                                |       | $                                         | 639        |   | $ | 602 |   |

 

Financing revenues for thenine months ended September 30, 2004 were $639 million compared with$602 million for the same period in 2003, an increase of $37 million (6.1%).The fluctuations within each component of financing revenues closely follow thechange in portfolio mix from the first nine months of 2003 to the same periodin 2004.

 

*Investment income* for the nine months endedSeptember 30, 2004 was $25 million compared with $38 million for thesame period in 2003, a decrease of $13 million (34.2%). The decrease wasprimarily due to the reduction in our investment balances.

 

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*Net gain on disposal* for the nine months endedSeptember 30, 2004 was $34 million compared with $43 million for thesame period in 2003, a decrease of $9 million (20.9%). The decrease wasprimarily due to a $45 million gain on sale of notes receivable in the thirdquarter of 2003, partially offset by a $34 million gain on sale of notesreceivable during the first nine months of 2004. These types of gains areintermittent in nature and depend in part on market conditions at the time ofdisposal and our decision to sell or re-lease when equipment is returned. Therecan be no assurance that we will recognize these gains in the future.

 

*Other income* for the nine months ended September 30, 2004was $35 million compared with $60 million for the same period in 2003, adecrease of $25 million (41.7%). The decrease was primarily due to a $38million realized derivative gain earned in the first nine months of 2003,partially offset by a $15 million settlement related to our unsecured claimresulting from Hawaiian’s bankruptcy during the first nine months of 2004.

 

*Interest expense* for the nine months endedSeptember 30, 2004 was $262 million compared with $269 million forthe same period in 2003, a decrease of $7 million (2.6%). The decline ininterest expense is primarily due to the reduction in the debt balances.

 

*Depreciation expense* (on equipment under operating leases andequipment held for re-lease) for the nine months ended September 30, 2004was $165 million compared with $157 million for the same period in 2003, anincrease of $8 million (5.1%). Growth in equipment under operating leases wasprimarily responsible for the increase.

 

*Provision for losses* for the nine months ended September 30, 2004was a $42 million reduction compared with $146 million of expense for the sameperiod in 2003, a decrease in expense, period over period, of $188 million. Thefactors attributing to the reduction in the provision for losses for the ninemonths ended September 30, 2004 were $59 million of benefit due toour evaluation of the effect of default, subordination and security agreements;$25 million of net benefit due to refinements in the methodology for measuringcollateral values; $8 million of net benefit due to reduced collateral exposureassociated with Hawaiian receivables, partially offset by a Hawaiianrestructuring charge; $5 million of net benefit principally due to reducedcollateral exposure; a $42 million increase in the requirement in the allowanceaccount resulting from the determination that receivables from ATA were subjectto a specific impairment; and a $13 million increase to our general reserve. Bycomparison, during the first nine months of 2003 we recognized a provision forlosses of $146 million due to our recognition of the deterioration in thecredit worthiness of our airline customers, airline bankruptcy filings and thecontinued decline in commercial aircraft and general equipment asset values.The provision for losses maintains the allowance for losses on receivables at alevel we deem to be adequate to cover anticipated losses. Any additionalprovision to be taken in the future may be dependent upon the duration of thecurrent economic and airline industry decline, or any significant defaults,repossessions or restructurings at a time when depressed aircraft values andlease rates make it difficult to sell or redeploy the aircraft. Aircraftvaluations could decline materially if significant numbers of aircraft,particularly types with relatively few operators, are idled on account offurther airline bankruptcies or restructurings.

 

*Operating expenses*, which consists of general andadministrative expenses, for the nine months ended September 30, 2004were $48 million compared with $38 million for the same period in 2003, anincrease of $10 million (26.3%). Higher operating expenses were due tonon-recurring costs associated with consolidating our operations to Renton,Washington, and the implementation of our revised strategy.

 

*Asset impairment expense* for the nine months endedSeptember 30, 2004 was $73 million compared with $76 million for thesame period in 2003, a decrease of $3 million (3.9%). During the first ninemonths of 2004, asset impairment expense included $47 million related to another than temporary impairment of a held-to-maturity investment, $15 millionof specific impairment charges related primarily to aircraft trading during thesecond quarter of 2004, and $11 million of valuation loss on one BBJ reclassifiedfrom discontinued operations to continued operations as a result of Boeing’sdecision to retain the aircraft in its executive fleet. The asset impairmentexpense in the comparable period of 2003 was due to a decline in the values ofaircraft equipment under operating leases and held for sale or re-lease.

 

*Debt redemption costs*for the nine months endedSeptember 30, 2004, was $52 million compared with zero for the sameperiod in 2003. This was a result of our redemption of $1,000 million facevalue of outstanding senior notes during the third quarter of 2004.

 

*Other expenses* for the nine months endedSeptember 30, 2004 were $31 million compared with $29 million for thesame period in 2003, an increase of $2 million (6.9%). The increase wasprimarily attributable to an increase of $43 million in aircraft maintenanceand storage expenses in the first nine months of 2004, partially offset by a$20 million decrease related to the Hawaiian bankruptcy claim settlement and a$21 million write-off in the first quarter of 2003 of forward-starting interestrate swaps that no longer qualified for fair value hedge accounting treatment.

 

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*Minority interest* for the nine months endedSeptember 30, 2004, was $4 million compared with zero for the sameperiod in 2003. The income during the first nine months of 2004 related to ourinterest in the BATA joint venture.

 

*Provision for income taxes* for the nine months endedSeptember 30, 2004 was $50 million compared with $5 million for thesame period in 2003, an increase of $45 million. The higher pre-tax income forthe first nine months of 2004 compared with the same period in 2003 wasprimarily responsible for the increase. During the nine months endedSeptember 30, 2003, the difference between the effective income taxrate and the federal statutory rate was primarily due to an extraterritorialincome tax benefit.

 

*Income from discontinuedoperations, net of tax*,for the nine months ended September 30, 2004 was $15 million comparedwith $24 million for the same period in 2003, a decrease of $9 million (37.5%).Income from discontinued operations includes the operating results of ourCommercial Financial Services business that we disposed of in May 2004. TheCommercial Financial Services revenues for the nine months endedSeptember 30, 2004 was $96 million compared with $171 million for thesame period in 2003, a decrease of $75 million (43.9%).

 

*Net gain on disposal ofdiscontinued operations, net of tax*, for the nine months ended September 30, 2004 was $33million compared with zero for the same period in 2003. This included a netgain of $37 million related to the sale of assets of our Commercial FinancialServices business to GECC and a net loss of $4 million related to the revaluationof a discontinued operations asset held for sale atSeptember 30, 2004, to the lower of carrying value or fair value lesscosts to sell.

 

**Liquidity and CapitalResources**

 

We have liquidityrequirements, primarily to fund ongoing financing commitments, meet debtobligations and to fund our operating expenses. We plan to satisfy theseliquidity needs from the following sources:

 

•                  cash from operations and other receipts fromour portfolio,

•                  issuance of commercial paper and other debt,

•                  asset securitization, and

•                  borrowings under committed credit facilities.

 

We attempt to schedule ourdebt payments to correspond to our scheduled receipts from our portfolio. Wesatisfy a significant portion of our cash requirements from diversified globalfunding sources and do not depend on any one lender. We believe that we haveadequate liquidity sources and access to the capital markets to allow us tofulfill our current commitments. If this belief does not prove to be correct,we would be required to restrict our new business volume, unless we obtainedaccess to other sources of capital at rates that allow for a reasonable returnon new business.

 

Per the sales agreement withGECC, we will receive total proceeds of approximately $2,030 million for thesale of our Commercial Financial Services business, of which we received atotal of $1,867 million as of September 30, 2004. The proceeds fromthe Commercial Financial Services sale will be used primarily to pay costsassociated with the Commercial Financial Services sale, settle related deferredtax positions, fund new business volume, repurchase debt, and make dividendpayments to Boeing. As discussed in “Debt Issuances and Redemptions” below,during the third quarter of 2004 we repurchased $1,000 million face value of outstandingdebt.

 

Risks that could affect oursources of liquidity include among others:

 

•                  a severe or prolonged downturn in theeconomy,

•                  additional restructurings, defaults orbankruptcies by airlines, and

•                  a decrease in our credit ratings.

 

Additional potential risksthat could affect our sources of liquidity are outlined in our forward-lookingstatement.

 

We continually assess ourleverage, generally as measured by our debt-to-equity ratio, in light of therisks in our business. These risks include, among others, the exposure in ourportfolios; general market conditions, especially those associated with ourcustomers; and our ability to access the capital markets.

 

OnDecember 23, 2003, we entered into a support agreement with Boeingthat included a liquidity provision. Under this provision, Boeing has committeditself to make contributions to us to the extent our fixed charge coveragefalls below 1.05-to-1 and to maintain our tangible net worth at a level of atleast $50 million.

 

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*Interest Rate Exposure*

 

Our assets and liabilitiesexpose us to interest rate risk to the extent that those assets and liabilitiesare not exactly 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 manage this mismatch risk, partlythrough the use of interest rate and currency swaps, and we do not believe weare exposed to material gains or losses due to interest rate or currencychanges.

 

*Debt Issuances andRedemptions*

 

During the first nine monthsof 2004, we did not issue any new senior debt. During the first nine months of2004, we repaid $2,002 million of debt. We had no commercial paper borrowingsoutstanding at September 30, 2004.

 

During the third quarter of2004, we redeemed $1,000 million face value of our outstanding senior notes.This included the entire principal balance, equal to $500 million face value,of our 7.10% senior notes due 2005 and $500 million face value of our 5.65%senior notes due 2006. We recognized a loss of $52 million related to thisearly debt redemption.

 

*Financing Interest Expense*

 

Our financing-relatedinterest expense for the nine months ended September 30, 2004 was$262 million, compared with $269 million for the same period in 2003. Leverage(debt-to-equity ratio) at September 30, 2004 was 4.8-to-1 comparedwith 4.7-to-1 at December 31, 2003 and 5.2-to-1 atSeptember 30, 2003.

 

**Credit Ratings**

 

Our access to capital atrates that allow for a reasonable return on new business can be affected bycredit rating agencies’ ratings of our debt.

 

We have the following creditratings as of the filing date:

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

 

Given our current ratingsand ratings outlook from the various credit rating agencies, we believe we haveready access to the capital markets. Due to the December 2003 support agreementestablished with Boeing, our credit ratings and spreads are very closely tiedwith those of Boeing. Our ratings and spreads could be impacted positively ornegatively by changing perceptions of Boeing, which in turn may reflectchanging views of the airline industry or the defense industry or of Boeing’scompetitive positions in them. It is possible that these changes could affectour access to the capital markets.

 

**Item 4. Controls and Procedures**

 

**Evaluation of DisclosureControls and Procedures**

 

Our principal executiveofficer and principal financial officer, based on their evaluation of ourdisclosure controls and procedures (as defined in Exchange Act Rules 13a -15(e)and 15d –15(e)) as of the end of the period covered by this Quarterly Report onForm 10-Q, have concluded that our disclosure controls and procedures areadequate and effective for the purposes set forth in the definition in ExchangeAct rules.

 

**Changes in InternalControls**

 

There were no significantchanges in our internal controls or in other factors that could significantlyaffect our internal controls subsequent to the date of their evaluation.

 

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**Part II. Other Information**

 

**Item 1. Legal Proceedings**

 

Various legal proceedingsand claims are pending or have been asserted against us, many of which arecovered by third parties, including insurance companies. We believe that thefinal outcome of these proceedings and claims will not have a material adverseeffect on our earnings, cash flows and/or financial position.

 

**Item 5. Other Information**

 

**Summary of PortfolioChanges**

 

The following tablesummarizes the net change in our total portfolio:

 
| **(Dollars in millions)**                   | ** ** | **Nine Months Ended  September 30,  2004** | ** ** | **Year Ended  December 31,  2003** | ** ** |
|---------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------|------------|
| New business volume                         |       | $                                               | 492        |                                    | $          | 1,774 |   |
| Non-cash consolidation of BATA Leasing, LLC |       | —                                          |       | 21                                      |       |
| Non-cash items from customer restructuring  |       | —                                          |       | (8                                      | )          |
| Portfolio impairment                        |       | (73                                             | )          | (98                                     | )          |
| Asset run-off                               |       | (618                                            | )          | (702                                    | )          |
| Depreciation expense                        |       | (165                                            | )          | (213                                    | )          |
| Net change in portfolio balance             |       | $                                               | (364       | )                                       | $          | 774 |   |

 

**Significant Concentrations**

 

The following table includes our five largestcustomers at September 30, 2004, with their related portfoliobalances at December 31, 2003:

 
| ** **                | ** ** | **September 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|---------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| **(Dollars in millions)** | ** ** | **Net Asset Value**              | ** ** | **% of Total  Portfolio**       | ** ** | **Net Asset Value** | ** ** | **% of Total  Portfolio** | ** ** |
| AirTran                   |       | $                                | 1,537      |                            | 15.8       | % | $ | 1,483 |   | 14.7 | % |
| United                    |       | 1,141                            |       | 11.8                            |       | 1,159 |   | 11.5 |   |
| American                  |       | 790                              |       | 8.1                             |       | 861 |   | 8.6 |   |
| ATA                       |       | 705                              |       | 7.3                             |       | 743 |   | 7.4 |   |
| Hawaiian                  |       | 460                              |       | 4.7                             |       | 506 |   | 5.0 |   |
|                      |       | $                                | 4,633      |                            |       |   | $ | 4,752 |   |   |   |
|                           |            |                                  |            |                                 |            |  |  |  |  |  |  |  |

 

Our largest customer, AirTran Holdings, Inc.(“AirTran”), accounted for $1,537 million and $1,483 million of our totalportfolio at September 30, 2004 and December 31, 2003,respectively. Our AirTran portfolio includes investments in AirTran EETCstotaling $32 million and $33 million at September 30, 2004 andDecember 31, 2003, respectively. At September 30, 2004, theAirTran portfolio primarily consisted of 67 717 aircraft and EETC investments.

 

Our third largest customer, AmericanAirlines, Inc. (“American”), accounted for $790 million and $861 million of ourtotal portfolio at September 30, 2004 and December 31, 2003,respectively. At September 30,  2004, the American portfolioconsisted of leases on 39 MD-83 aircraft and four MD-82 aircraft, subordinateddebt in one 777 aircraft, and final delivery payment loans on nine 767 aircraftand two 777 aircraft, which are adequately collateralized.

 

See Note 9 of the notes to condensedconsolidated financial statements for a discussion on our customerrestructuring requests with United, ATA and Hawaiian.

 

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**Portfolio by Product Type**

 

Our portfolio consisted of the followingproduct types:

 
| **(Dollars in millions)**        | ** ** | **Receivables (1)** | ** ** | **Operating  Leases (1)** | ** ** | **Investments (4)** | ** ** | **Held for  Sale or  Re-Lease** | ** ** | **Total** | ** ** |
|----------------------------------|------------|---------------------|------------|---------------------------|------------|---------------------|------------|---------------------------------|------------|-----------|------------|
| **September 30, 2004** |       |                |       |                      |       |                |       |                            |       |      |       |
| 717                              |       | $                   | 1,814      |                      | $          | 514                 |       | $                               | —     |      | $          | — |   | $ | 2,328 |   |
| 727 (2)                          |       | 1                   |       | 23                        |       | —              |       | 11                              |       | 35        |       |
| 737                              |       | 86                  |       | 706                       |       | —              |       | —                          |       | 792       |       |
| 747                              |       | 133                 |       | 424                       |       | —              |       | 13                              |       | 570       |       |
| 757                              |       | 984                 |       | 446                       |       | —              |       | 122                             |       | 1,552     |       |
| 767                              |       | 725                 |       | 379                       |       | —              |       | —                          |       | 1,104     |       |
| 777                              |       | 1,072               |       | —                    |       | —              |       | —                          |       | 1,072     |       |
| DC-9 (2)                         |       | —              |       | 1                         |       | —              |       | 1                               |       | 2         |       |
| MD-80 (2)                        |       | 346                 |       | 104                       |       | —              |       | —                          |       | 450       |       |
| MD-90 (2)                        |       | 81                  |       | 34                        |       | —              |       | 15                              |       | 130       |       |
| DC-10 (2)                        |       | 23                  |       | 25                        |       | —              |       | 14                              |       | 62        |       |
| MD-11 (2)                        |       | 150                 |       | 715                       |       | —              |       | —                          |       | 865       |       |
| Space and Defense Equipment      |       | —              |       | 151                       |       | —              |       | —                          |       | 151       |       |
| Other Aircraft and Equipment (3) |       | 307                 |       | 19                        |       | —              |       | 1                               |       | 327       |       |
| Assets Pools (5)                 |       | —              |       | —                    |       | 213                 |       | —                          |       | 213       |       |
| Other                            |       | —              |       | 42                        |       | 6                   | (6)        | —                          |       | 48        |       |
|                             |       | $                   | 5,722      |                      | $          | 3,583               |       | $                               | 219        |      | $          | 177 |   | $ | 9,701 |   |
|                             |       |                |       |                      |       |                |       |                            |       |      |       |
| **December 31, 2003**  |       |                |       |                      |       |                |       |                            |       |      |       |
| 717                              |       | $                   | 1,785      |                      | $          | 394                 |       | $                               | —     |      | $          | 18 |   | $ | 2,197 |   |
| 727 (2)                          |       | —              |       | 14                        |       | —              |       | 20                              |       | 34        |       |
| 737                              |       | 74                  |       | 671                       |       | —              |       | —                          |       | 745       |       |
| 747                              |       | 228                 |       | 441                       |       | —              |       | —                          |       | 669       |       |
| 757                              |       | 867                 |       | 489                       |       | —              |       | 22                              |       | 1,378     |       |
| 767                              |       | 745                 |       | 362                       |       | —              |       | 14                              |       | 1,121     |       |
| 777                              |       | 1,185               |       | —                    |       | —              |       | —                          |       | 1,185     |       |
| DC-9 (2)                         |       | 3                   |       | 1                         |       | —              |       | 1                               |       | 5         |       |
| MD-80 (2)                        |       | 356                 |       | 81                        |       | —              |       | 30                              |       | 467       |       |
| MD-90 (2)                        |       | 84                  |       | —                    |       | —              |       | 50                              |       | 134       |       |
| DC-10 (2)                        |       | 52                  |       | 37                        |       | —              |       | —                          |       | 89        |       |
| MD-11 (2)                        |       | 163                 |       | 676                       |       | —              |       | 72                              |       | 911       |       |
| Space and Defense Equipment      |       | 35                  |       | 147                       |       | —              |       | —                          |       | 182       |       |
| Other Aircraft and Equipment (3) |       | 375                 |       | 50                        |       | —              |       | 5                               |       | 430       |       |
| Assets Pools (5)                 |       | —              |       | —                    |       | 432                 |       | —                          |       | 432       |       |
| Other                            |       | —              |       | 43                        |       | 43                  | (6)        | —                          |       | 86        |       |
|                             |       | $                   | 5,952      |                      | $          | 3,406               |       | $                               | 475        |      | $          | 232 |   | $ | 10,065 |   |

 

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

(2)          Outof production, but currently supported by Boeing with respect to parts and otherservices.

(3)          Some of these aircraftare out of production, but are supported by the manufacturer or other thirdparty part and service providers.

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

(5)          Investmentsare supported by asset pools secured by various commercial aircraft types.

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

 

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AtSeptember 30, 2004, we owned 336 commercial aircraft and had partialownership or security interest in an additional 161 aircraft, including thoseowned in joint ventures, EETC, ETC and other investment transactions.

 

AtSeptember 30, 2004, $9,113 million (96.1%) of our portfolio,excluding investments, was collateralized by Boeing products.

 

AtSeptember 30, 2004, our aircraft related portfolio (excludinginvestments) was comprised of the following aircraft vintages:

 
| 2004 - 2000                 |   | 59.4  | %      |
|-----------------------------|--------|-------|--------|
| 1999 - 1995                 |   | 21.4  |   |
| 1994 - 1990                 |   | 11.2  |   |
| 1989 - 1985                 |   | 4.8   |   |
| 1984 and older              |   | 2.1   |   |
| Secured by other collateral |   | 1.1   |   |
|                        |   | 100.0 | %      |

 

**Portfolioby Region**

 

AtSeptember 30, 2004, portfolio net asset values were represented inthe following regions:

 
| **(Dollars in millions)** | ** ** | **Net Asset Value** | ** ** | **% of Total  Portfolio** | ** ** |
|---------------------------|------------|---------------------|------------|---------------------------|------------|
| **Region**                |       |                |       |                      |       |
| United States             |       | $                   | 6,896      |                      | 71.1       | % |
| Europe                    |       | 1,229               |       | 12.6                      |       |
| Asia                      |       | 784                 |       | 8.1                       |       |
| Latin America             |       | 630                 |       | 6.5                       |       |
| Australia                 |       | 59                  |       | 0.6                       |       |
| Africa                    |       | 57                  |       | 0.6                       |       |
| Canada                    |       | 46                  |       | 0.5                       |       |
|                      |       | $                   | 9,701      |                      | 100.0      | % |

 

**Guarantees**

 

AtSeptember 30, 2004, we were the beneficiary under $2,912 million ofguarantees, primarily issued by Boeing, with respect to our portfoliotransactions totaling $4,482 million. Any guarantee calls that we make would benet of realization of underlying residual values, partial rent payments,re-lease rental payments or other mitigating value received.

 

The guarantees in our favor areeither full or partial in nature and include residual value guarantees, firstloss deficiency guarantees and rental guarantees. Residual value guaranteesprovide a specified asset value at the end of a lease agreement in the event ofa decline in market value of the financed aircraft. First loss deficiencyguarantees cover a specified portion of our losses on aircraft that we financein the event of a loss upon disposition of the aircraft following a default bythe lessee. Rental guarantees are whole or partial guarantees covering usagainst the lessee’s failure to pay rent under the lease agreement or ourinability to re-lease these aircraft at or above a specified rent level.

 

The following table summarizesour guarantees at September 30, 2004:

 
| **(Dollars in millions)** | ** ** | **Domestic  Airlines** | ** ** | **Foreign  Airlines** | ** ** | **Total** | ** ** |
|---------------------------|------------|------------------------|------------|-----------------------|------------|-----------|------------|
| Amounts guaranteed by:    |       |                   |       |                  |       |      |       |
| Boeing and subsidiaries   |       | $                      | 2,507      |                  | $          | 390       |       | $ | 2,897 |   |
| Other (1)                 |       | 15                     |       | —                |       | 15        |       |
|                      |       | $                      | 2,522      |                  | $          | 390       |       | $ | 2,912 |   |

 

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

 

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Guarantee amounts by aircrafttype at September 30, 2004 are summarized as follows:

 
| **(Dollars in millions)**               | ** ** | **Guarantee** | ** ** | **Net Asset Value** | ** ** |
|-----------------------------------------|------------|---------------|------------|---------------------|------------|
| 717                                     |       | $             | 1,625      |                | $          | 2,234 |   |
| 757                                     |       | 629           |       | 629                 |       |
| Out of production twin-aisle aircraft   |       | 360           |       | 506                 |       |
| Out of production single-aisle aircraft |       | 86            |       | 112                 |       |
| Other Boeing and regional aircraft      |       | 212           |       | 1,001               |       |
|                                    |       | $             | 2,912      |                | $          | 4,482 |   |

 

During the nine months endedSeptember 30, 2004, we recognized income of $17 million under theseguarantees, all of which were from Boeing.

 

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

 

A.           Exhibits

 
| Exhibit 12   |   | Computation of Ratio of  Income to Fixed Charges.                                                                                                                                                                                                                                |
|--------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |   |                                                                                                                                                                                                                                                                             |
| Exhibit 15   |   | Report of Independent  Registered Public Accounting Firm.                                                                                                                                                                                                                        |
|         |   |                                                                                                                                                                                                                                                                             |
| Exhibit 31.1 |   | Certification of President  pursuant to Rules 13a-15(e) of the Securities Exchange Act of 1934, as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                           |
|         |   |                                                                                                                                                                                                                                                                             |
| Exhibit 31.2 |   | Certification of Chief  Financial Officer pursuant to Rules 13a-15(e) of the Securities Exchange Act  of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                                            |
|         |   |                                                                                                                                                                                                                                                                             |
| Exhibit 32.1 |   | Certification of President  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. This document is being furnished in accordance  with Securities and Exchange Commission Release Nos. 33-8212 and 34-47551.                |
|         |   |                                                                                                                                                                                                                                                                             |
| Exhibit 32.2 |   | Certification of Chief  Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. This document is being  furnished in accordance with Securities and Exchange Commission Release Nos.  33-8212 and 34-47551. |

 

B.             Reports on Form 8-K

 

1.               Form 8-K dated July 29, 2004, forthe purpose of disclosing information relating to Boeing Capital Corporationthat was contained in The Boeing Company’s press release and webcast of secondquarter 2004 financial results, dated July 28, 2004.

 

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REPORT OF INDEPENDENTREGISTERED PUBLIC ACCOUNTING FIRM

 

Boardof Directors and Shareholder

BoeingCapital Corporation

 

We have reviewed the accompanying condensedconsolidated balance sheet of Boeing Capital Corporation and subsidiaries (the“Company”) as of September 30, 2004, and the related condensedconsolidated statements of operations for the three-month and nine-month periodsended September 30, 2004 and 2003, and of shareholder’s equity andcomprehensive income and cash flows for the nine-month periods endedSeptember 30, 2004 and 2003. These interim financial statements arethe responsibility of the Company’s management.

 

We conducted our reviews in accordance withstandards of the Public Company Accounting Oversight Board (United States). Areview of interim financial information consists principally of applyinganalytical procedures and making inquiries of persons responsible for financialand accounting matters. It is substantially less in scope than an auditconducted in accordance with the standards of the Public Company AccountingOversight Board (United States), the objective of which is the expression of anopinion regarding the financial statements taken as a whole. Accordingly, we donot express such an opinion.

 

Based on our reviews, we are not aware of anymaterial modifications that should be made to such condensed consolidatedinterim financial statements for them to be in conformity with accountingprinciples generally accepted in the United States of America.

 

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

 

We have previously audited, in accordance withstandards of the Public Company Accounting Oversight Board (United States), theconsolidated balance sheet of the Company and subsidiaries as ofDecember 31, 2003, and the related consolidated statements ofoperations, shareholder’s equity and comprehensive income, and cash flows forthe year then ended (not presented herein); and in our report datedJanuary 29, 2004, we expressed an unqualified opinion on thoseconsolidated financial statements. In our opinion, the information set forth inthe accompanying condensed consolidated balance sheet as ofDecember 31, 2003 is fairly stated, in all material respects, inrelation to the consolidated balance sheet from which it has been derived.

 

 
| /S/ Deloitte & Touche  LLP |   |
|--------------------------------|--------|
|                           |
| Seattle, Washington            |
| October 27, 2004     |

 

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**Signatures**

 

Pursuant to the requirements ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned, its principal financial officerand by its principal accounting officer, thereunto duly authorized.

 
| ** **                 | **Boeing Capital Corporation**                                                                                      |
|----------------------------|---------------------------------------------------------------------------------------------------------------------|
|                       |                                                                                                                |
| October 27, 2004 | /S/ RUSSELL A. EVANS                                                                                                |   |
|                       | Russell A. Evans                                                                                                    |
|                       | Vice President and Chief  Financial Officer (Principal  Financial Officer) and Registrant’s Authorized Officer |
|                       |                                                                                                                |
|                       |                                                                                                                |
|                       | /S/ KEVIN J. MURPHY                                                                                                 |   |
|                       | Kevin J. Murphy                                                                                                     |
|                       | Controller (Principal Accounting Officer)                                                                           |

 

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