**United StatesSecurities and Exchange Commission**

 

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**Washington, D.C.  20549**

 

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**Form 10-Q**

 
| **ý** | **Quarterly  Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934**                                                                                                                                                                                                                                                                                                               |
|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                                                                                                                                                                                                                                             |
|       | **For the quarterly period ended  March 31, 2004**                                                                                                                                                                                                                                                                                                                                                          |
|       |                                                                                                                                                                                                                                                                                                                                                                                                             |
|       | **OR**                                                                                                                                                                                                                                                                                                                                                                                                           |
|       |                                                                                                                                                                                                                                                                                                                                                                                                             |
| **o**      | **Transition  Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934**                                                                                                                                                                                                                                                                                                              |
|       |                                                                                                                                                                                                                                                                                                                                                                                                             |
|       | **For the transition period from                                to                                ** |

 

**Commission File Number 0-10795**

 

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| **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) 393-2914**                                                                       |
| (Registrant’s telephone number, including  area code)                               |

 

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

 

Indicate by check mark whether the registrantis an accelerated filer (as de  fined 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 April 28, 2004:  50,000 shares

 

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

 

 

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# **Table of Contents**

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

#  

2

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# **Part I**

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

**Boeing CapitalCorporation and Subsidiaries**

## **ConsolidatedBalance Sheets**

(Unaudited)

 
| **(Dollars in millions, except par  value)**                                                    |   | **March 31,  2004** |   | **December 31,  2003** |   |
|-------------------------------------------------------------------------------------------------|--------|--------------------------|--------|-----------------------------|--------|
| ASSETS                                                                                          |   |                     |   |                        |   |
| Cash and cash equivalents                                                                       |   | $                        | 354    |                        | $      | 716 |   |
| Receivables:                                                                                    |   |                     |   |                        |   |
| Financing leases                                                                                |   | 4,189                    |   | 4,297                       |   |
| Notes and other receivables                                                                     |   | 3,232                    |   | 3,106                       |   |
|                                                                                            |   | 7,421                    |   | 7,403                       |   |
| Allowance for losses on receivables                                                             |   | (351                     | )      | (351                        | )      |
|                                                                                            |   | 7,070                    |   | 7,052                       |   |
|                                                                                            |   |                     |   |                        |   |
| Equipment under operating leases, net of  accumulated depreciation                              |   | 4,085                    |   | 4,092                       |   |
| Investments                                                                                     |   | 453                      |   | 475                         |   |
| Equipment held for sale or re-lease, net of  accumulated depreciation                           |   | 253                      |   | 278                         |   |
| Other assets                                                                                    |   | 236                      |   | 223                         |   |
|                                                                                            |   | $                        | 12,451 |                        | $      | 12,836 |   |
|                                                                                            |   |                     |   |                        |   |
| LIABILITIES AND SHAREHOLDER’S EQUITY                                                       |   |                     |   |                        |   |
| Liabilities:                                                                                    |   |                     |   |                        |   |
| Accounts payable and accrued expenses                                                           |   | $                        | 75     |                        | $      | 156 |   |
| Other liabilities                                                                               |   | 226                      |   | 249                         |   |
| Accounts due to Boeing and Boeing Capital  Services Corporation                                 |   | 97                       |   | 58                          |   |
| Deferred income taxes                                                                           |   | 1,249                    |   | 1,242                       |   |
| Debt:                                                                                           |   |                     |   |                        |   |
| Senior                                                                                          |   | 8,772                    |   | 9,153                       |   |
| Subordinated                                                                                    |   | 24                       |   | 24                          |   |
|                                                                                            |   | 10,443                   |   | 10,882                      |   |
|                                                                                            |   |                     |   |                        |   |
| Commitments and contingencies – Note 8                                                     |   |                     |   |                        |   |
|                                                                                            |   |                     |   |                        |   |
| Minority interest                                                                               |   | 11                       |   | 12                          |   |
|                                                                                            |   |                     |   |                        |   |
| Shareholder’s equity:                                                                      |   |                     |   |                        |   |
| Common stock - $100 par value; authorized  100,000 shares; issued and outstanding 50,000 shares |   | 5                        |   | 5                           |   |
| Capital in excess of par value                                                                  |   | 1,265                    |   | 1,263                       |   |
| Accumulated other comprehensive loss, net  of tax                                               |   | (13                      | )      | (10                         | )      |
| Income retained for growth                                                                      |   | 740                      |   | 684                         |   |
|                                                                                            |   | 1,997                    |   | 1,942                       |   |
|                                                                                            |   | $                        | 12,451 |                        | $      | 12,836 |   |

 

See Notes to Consolidated Financial Statements.

 

3

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# **Boeing Capital Corporation and Subsidiaries**

## **ConsolidatedStatements of Operations**

(Unaudited)

 
|                                                       |   | **Three  Months Ended  March 31,** |   |
|------------------------------------------------------------|--------|-----------------------------------------|--------|
| **(Dollars in millions)**                                  |   | **2004**                                |   | **2003** |   |
| REVENUES                                                   |   |                                    |   |   |   |
| Finance lease income                                       |   | $                                       | 72     |   | $ | 77 |   |
| Interest income on notes receivable                        |   | 57                                      |   | 54 |   |
| Operating lease income                                     |   | 130                                     |   | 125 |   |
| Investment income                                          |   | 10                                      |   | 11 |   |
| Net gain on disposal                                       |   | 26                                      |   | — |   |
| Other                                                      |   | 12                                      |   | 16 |   |
|                                                       |   | 307                                     |   | 283 |   |
|                                                       |   |                                    |   |   |   |
| Equity in loss from joint venture                          |   | —                                  |   | (1 | ) |
|                                                       |   | 307                                     |   | 282 |   |
| EXPENSES                                                   |   |                                    |   |   |   |
| Interest expense                                           |   | 103                                     |   | 111 |   |
| Depreciation expense                                       |   | 67                                      |   | 63 |   |
| Provision for losses                                       |   | 9                                       |   | 140 |   |
| Operating expenses                                         |   | 18                                      |   | 16 |   |
| Asset impairment expense                                   |   | 13                                      |   | 42 |   |
| Other                                                      |   | 11                                      |   | 23 |   |
|                                                       |   | 221                                     |   | 395 |   |
|                                                       |   |                                    |   |   |   |
| Minority interest                                          |   | 1                                       |   | — |   |
| Income (loss) before provision (benefit)  for income taxes |   | 87                                      |   | (113 | ) |
| Provision (benefit) for income taxes                       |   | 31                                      |   | (49 | ) |
| Net income (loss)                                          |   | $                                       | 56     |   | $ | (64 | ) |

 

See Notes to Consolidated Financial Statements.

 

4

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

ConsolidatedStatements of Shareholder’s Equityand Comprehensive Income

(Unaudited)

 
| **(Dollars  in millions, except stated value)**                                |   | **Common  Stock** |       | **Capital in  Excess of  Par Value** |       | **Accumulated  Other  Comprehensive  Income (Loss)** |   | **Income  Retained  for Growth** |       |   | **Comprehensive  Income** |       |
|--------------------------------------------------------------------------------|--------|-------------------|------------|--------------------------------------|------------|------------------------------------------------------|--------|----------------------------------|------------|--------|---------------------------|------------|
| **Balance at  December 31, 2002**                                         |   | **$5**            | ** ** | **$****1,090**                       | ** ** | **$(17**                                             | **)**  | **$578**                         | ** ** |   | **$51**                   | ** ** |
| Capital contributions from Boeing and  Boeing Capital Services Corporation (1) |   | —            |       | 173                                  |       | —                                               |   | —                           |       |   |                      |       |
| Net income                                                                     |   | —            |       | —                               |       | —                                               |   | 106                              |       |   | $106                      |       |
| Unrealized gain on derivative instruments,  net of tax                         |   | —            |       | —                               |       | 7                                                    |   | —                           |       |   | 7                         |       |
| **Balance at  December 31, 2003**                                         |   | **$5**            | ** ** | **$****1,263**                       | ** ** | **$(10**                                             | **)**  | **$****684**                     | ** ** |   | **$113**                  | ** ** |
| Capital contributions from Boeing and  Boeing Capital Services Corporation (2) |   | —            |       | 2                                    |       | —                                               |   | —                           |       |   |                      |       |
| Net income                                                                     |   | —            |       | —                               |       | —                                               |   | 56                               |       |   | $56                       |       |
| Unrealized loss on derivative instruments,  net of tax                         |   | —            |       | —                               |       | (1                                                   | )      | —                           |       |   | (1                        | )          |
| Unrealized loss on investments, net of tax                                     |   | —            |       | —                               |       | (2                                                   | )      | —                           |       |   | (2                        | )          |
| **Balance at  March 31, 2004**                                            |   | **$5**            | ** ** | **$****1,265**                       | ** ** | **$(13**                                             | **)**  | **$****740**                     | ** ** |   | **$53**                   | ** ** |

 

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| (1)    |   | Balance represents $167 million of cash contributions from Boeing and  Boeing Capital Services Corporation and $6 million of non-cash contributions  from Boeing and Boeing Capital Services Corporation. |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)    |   | Balance represents $2 million of non-cash contributions from Boeing  and Boeing Capital Services Corporation.                                                                                             |
|   |   |                                                                                                                                                                                                      |

The Company has authorized 100,000 shares of Series A preferred stockwith no par value and a $5,000 stated value. No shares were issued andoutstanding at March 31, 2004 and December 31, 2003.

 

See Notes to Consolidated Financial Statements.

 

5

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

Consolidated Statements of Cash Flows

(Unaudited)

 
|                                                                                      |   | **Three  Months Ended  March 31,** |       |
|-------------------------------------------------------------------------------------------|--------|-----------------------------------------|------------|
| **(Dollars in millions)**                                                                 |   | **2004**                                | ** ** | **2003** | ** ** |
| OPERATING ACTIVITIES                                                                      |   |                                    |       |   |   |
| Net income (loss)                                                                         |   | $                                       | 56         |   | $ | (64 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided by operating activities: |   |                                    |       |   |   |
| Depreciation and amortization expense                                                     |   | 69                                      |       | 64 |   |
| Net gain on disposal                                                                      |   | (26                                     | )          | — |   |
| Provision for losses                                                                      |   | 9                                       |       | 140 |   |
| (Gain) loss on derivative instruments                                                     |   | (3                                      | )          | 4 |   |
| Asset impairment and other related charges                                                |   | 13                                      |       | 63 |   |
| Share-based plans expense                                                                 |   | 2                                       |       | 2 |   |
| Benefit (provision) from deferred income  taxes                                           |   | 7                                       |       | (55 | ) |
| Change in assets and liabilities:                                                         |   |                                    |       |   |   |
| Other assets                                                                              |   | 37                                      |       | 14 |   |
| Accrued interest                                                                          |   | 9                                       |       | (26 | ) |
| Accounts payable and accrued expenses                                                     |   | (81                                     | )          | (59 | ) |
| Other liabilities                                                                         |   | (24                                     | )          | (13 | ) |
| Accounts with Boeing and Boeing Capital  Services Corporation                             |   | 39                                      |       | 10 |   |
| Other                                                                                     |   | 1                                       |       | — |   |
|                                                                                      |   | 108                                     |       | 80 |   |
| INVESTING ACTIVITIES                                                                      |   |                                    |       |   |   |
| Net change in short-term leases, notes and  other receivables                             |   | (12                                     | )          | 69 |   |
| Purchase of investments                                                                   |   | (10                                     | )          | — |   |
| Proceeds from available-for-sale  investments                                             |   | 21                                      |       | — |   |
| Proceeds from held-to-maturity investments                                                |   | 19                                      |       | 19 |   |
| Purchase of equipment for operating leases                                                |   | (92                                     | )          | (158 | ) |
| Proceeds from disposition of equipment and  receivables                                   |   | 111                                     |       | 4 |   |
| Collection of leases, notes and other  receivables                                        |   | 118                                     |       | 209 |   |
| Origination of leases, notes and other  receivables                                       |   | (193                                    | )          | (217 | ) |
|                                                                                      |   | (38                                     | )          | (74 | ) |
| FINANCING ACTIVITIES                                                                      |   |                                    |       |   |   |
| Net change in commercial paper and  short-term bank debt                                  |   | —                                  |       | (73 | ) |
| Proceeds from issuance of debt                                                            |   | —                                  |       | 46 |   |
| Repayment of debt                                                                         |   | (432                                    | )          | (66 | ) |
| Capital contributions from Boeing and  Boeing Capital Services Corporation                |   | —                                  |       | 84 |   |
|                                                                                      |   | (432                                    | )          | (9 | ) |
| Net decrease in cash and cash equivalents                                                 |   | (362                                    | )          | (3 | ) |
| Cash and cash equivalents at beginning of  year                                           |   | 716                                     |       | 686 |   |
| Cash and cash equivalents at end of period                                                |   | $                                       | 354        |   | $ | 683 |   |
|                                                                                      |   |                                    |       |   |   |
| NON-CASH INVESTING AND FINANCING  ACTIVITIES:                                             |   |                                    |       |   |   |
| Mark-to-market for derivatives on  underlying debt                                        |   | $                                       | 48         |   | $ | (19 | ) |
| Capital contributions from Boeing and  Boeing Capital Services Corporation                |   | $                                       | 2          |   | $ | 2 |   |

 

See Notes to ConsolidatedFinancial Statements.

 

6

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

###### Notesto Consolidated Financial Statements

March 31, 2004

(Unaudited)

 

Note 1 – General

 

BoeingCapital Corporation (together with its subsidiaries, referred to as “us”, “we”,“our” or the “Company”) is an indirect wholly owned subsidiary of The BoeingCompany (“Boeing”). We prepared the accompanying unaudited consolidatedfinancial statements in accordance with accounting principles generallyaccepted in the United States of America for interim financial information andwith the instructions to Form 10-Q and Article 10 of Regulation S-X.Accordingly, they do not include all of the information and footnotes requiredby accounting principles generally accepted in the United States of America forcomplete financial statements. In our opinion, the accompanying consolidatedfinancial statements reflect all adjustments, consisting of normal recurringaccruals, that are necessary to present fairly the consolidated balance sheetsand the related consolidated statements of operations, shareholder’s equity andcomprehensive income and cash flows for the interim periods presented.Operating results for the three-month period ended March 31, 2004, are notnecessarily indicative of the results that may be expected for the year endingDecember 31, 2004. The statements should be read in conjunction with theNotes to the Consolidated Financial Statements included in our Form 10-K forthe year ended December 31, 2003, which contains the latest availableaudited consolidated financial statements and notes.

 

We are a commercial finance company. At March 31, 2004, ourprimary operations included two principal financial reporting segments:Aircraft Financial Services and Commercial Financial Services. Our portfolioconsists of financing leases, notes and other receivables, equipment underoperating leases (net of accumulated depreciation), investments and equipmentheld for sale or re-lease (net of accumulated depreciation).

 

InNovember 2003, we announced a significant change in our strategicdirection, moving from a focus on growing the portfolio to a focus onsupporting Boeing’s major operating units and managing overall corporateexposures. For the commercial aircraft market, this means we will befacilitating, arranging and providing financing to Boeing Commercial Airplanes’customers. For our space and defense markets, this means we will be primarilyengaged in arranging and structuring financing solutions for Boeing’sIntegrated Defense Systems government customers. This new strategic directionis likely to include the sale or wind-down of our Commercial Financial Servicesbusiness or portfolio. In addition, we will be enhancing our risk managementactivities to reduce exposures associated with the current portfolio. We expectto satisfy any external funding needs through access to our traditional capitalmarket funding sources.

 

Historically,we competed in the commercial equipment leasing and finance markets, primarilyin the United States, against a number of large-ticket competitors, mainlylarger leasing companies and banks. On January 15, 2004, we announcedthat we have retained Credit Suisse First Boston, LLC to explore strategicoptions for the future of our Commercial Financial Services business. Theoptions being examined include a sale of the operation itself, sale of theportfolio or a phased wind-down of the existing portfolio. We continue toexplore these strategic options.

 

On January 15, 2004, wealso announced that we intend to relocate our administrative operationscurrently in Long Beach, California to our headquarters in Renton, Washington.Our infrastructure is being consolidated in Renton to reduce cost, increaseefficiency and improve productivity. Approximately 90 employees will beaffected. The move is expected to be complete by September 2004.

 

Boeing Capital Services Corporation owns 100% of our stock and is anindirect wholly owned subsidiary of Boeing and a largely inactive holdingcompany.

 

7

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Certain reclassifications of previously reported amounts have been madein the consolidated financial statements to conform to the 2004 presentation,none of which affected net income or shareholder’s equity.

 

Note 2 – Portfolio Quality

 
| **(Dollars in millions)**                                                                |   | **March 31,  2004** |   | **December 31,  2003** |   |
|------------------------------------------------------------------------------------------|--------|--------------------------|--------|-----------------------------|--------|
| Receivables:                                                                             |   |                     |   |                        |   |
| Financing  leases                                                                        |   | $                        | 4,189  |                        | $      | 4,297 |   |
| Notes and  other receivables                                                             |   | 3,232                    |   | 3,106                       |   |
|                                                                                     |   | 7,421                    |   | 7,403                       |   |
|                                                                                     |   |                     |   |                        |   |
| Equipment  under operating leases, net of accumulated depreciation                       |   | 4,085                    |   | 4,092                       |   |
| Investments                                                                              |   | 453                      |   | 475                         |   |
| Equipment  held for sale or re-lease, net of accumulated depreciation                    |   | 253                      |   | 278                         |   |
| Total portfolio                                                                          |   | $                        | 12,212 |                        | $      | 12,248 |   |
|                                                                                     |   |                     |   |                        |   |
| Non-performing  assets:                                                                  |   |                     |   |                        |   |
| Nonaccrual  receivables                                                                  |   | $                        | 487    |                        | $      | 497 |   |
| Non-performing  equipment under operating leases, net of   accumulated depreciation |   | 88                       |   | 85                          |   |
| Equipment  held for sale or re-lease, net of accumulated depreciation                    |   | 253                      |   | 278                         |   |
|                                                                                     |   | $                        | 828    |                        | $      | 860 |   |
|                                                                                     |   |                     |   |                        |   |
| Ratio of  nonaccrual receivables to total receivables                                    |   | 6.6                      | %      | 6.7                         | %      |
| Ratio of  total non-performing assets to total portfolio                                 |   | 6.8                      | %      | 7.0                         | %      |

 

Income recognition on an accrual basis is generally suspended forleases and notes and other receivables at the date when a full recovery ofincome and principal becomes doubtful. Accounts greater than 90 days past dueare generally placed on non-accrual. Income recognition is resumed when thelease or notes and other receivables become contractually current andperformance is demonstrated to be resumed. To the extent that income isaccruable under contractual terms, any cash received in the interim is recordedto income. During the three months ended March 31, 2004, we received cashand reported income of $6 million and $4 million, respectively, on theMarch 31, 2004 non-performing assets.

 

The following table summarizes our receivables and equipment underoperating leases with amounts greater than 90 days past due with income stillaccruing:

 
| **(Dollars in millions)**         |   | **March 31,****2004** |   | **December 31,****2003** |   |
|-----------------------------------|--------|----------------------------|--------|-------------------------------|--------|
| Receivables                       |   | $                          | 8      |                          | $      | 20 |   |
| Equipment  under operating leases |   | 44                         |   | 21                            |   |
|                              |   | $                          | 52     |                          | $      | 41 |   |

 

During the three months ended March 31, 2004, we received $1million on these accounts.

 

8

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Note 3 – Allowance for Losses on Receivables

 
| **(Dollars in millions)**                                                                         |   | **Three  Months Ended  March 31,  2004** |   | **Year Ended  December 31,  2003** |   |
|---------------------------------------------------------------------------------------------------|--------|-----------------------------------------------|--------|-----------------------------------------|--------|
| Allowance for losses on receivables at  beginning of year                                         |   | $                                             | 351    |                                    | $      | 260 |   |
| Provision for losses                                                                              |   | 9                                             |   | 169                                     |   |
| Write-offs, net of recoveries                                                                     |   | (9                                            | )      | (78                                     | )      |
| Allowance for losses on receivables at end  of period                                             |   | $                                             | 351    |                                    | $      | 351 |   |
|                                                                                              |   |                                          |   |                                    |   |
| Allowance as a percentage of total  receivables                                                   |   | 4.7                                           | %      | 4.7                                     | %      |
| Net write-offs as a percentage of average  receivables                                            |   | 0.1                                           | %      | 1.0                                     | %      |
|                                                                                              |   |                                          |   |                                    |   |
| More than 90 days delinquent:                                                                     |   |                                          |   |                                    |   |
| Amount of delinquent installments                                                                 |   | $                                             | 12     |                                    | $      | 15 |   |
| Total receivable balance related to  delinquent installments                                      |   | $                                             | 422    |                                    | $      | 93 |   |
| Total receivable balance related to  delinquent installments as a percentage of total receivables |   | 5.7                                           | %      | 1.3                                     | %      |
| Total of all receivables due from  delinquent obligors                                            |   | $                                             | 483    |                                    | $      | 509 |   |
| Total of all receivables due from  delinquent obligors as a percentage of total receivables       |   | 6.5                                           | %      | 6.9                                     | %      |

 

AtMarch 31, 2004 and December 31, 2003, Hawaiian represented $415million and $439 million, respectively, of our total receivables portfolio. Ofthis amount, $368 million and $47 million represented receivables that hadinstallments of $4 million and $3 million that were more than 90 daysdelinquent at March 31, 2004 and December 31, 2003, respectively.

 

Our portfolio at the end of the first quarter of 2004 totaled $12.2 billion, of which$9.5 billion was related to Boeing products, primarily commercial aircraft.While monthlytraffic levels were at or above traffic levels carried by the airlines in 2000,the effects of the airline industry downturn caused significantreductions in commercial aircraft values. Older and/or out-of-productionaircraft types experienced the most significant declines in value, while neweraircraft types experienced more moderate declines. Published sources and recentmarket transactions indicate that values for various aircraft types used ascollateral in our portfolio remain depressed. Aircraft valuations could declinematerially if significant numbers of aircraft, particularly types withrelatively few operators, are idled on account of further airline bankruptciesor restructurings. At the same time, the credit ratings of many airlines,particularly in the United States, have remained at low levels. Each quarter,we review customer credit ratings, published historical credit default rates,Boeing and other guarantees (if applicable) and third-party aircraft valuationsas a basis to validate the reasonableness of the allowance for losses onreceivables. There can be no assurance that consideration of these factors inthe future will not result in an increase to the allowance for losses onreceivables. The allowance at both March 31, 2004 and December 31,2003 was 4.7% of total receivables.

 

InOctober 2003, Boeing announced the decision to end production of the B-757program, with the final aircraft scheduled to be produced in late 2004. TheB-757 will continue to be supported by Boeing. There are over 1,000 B-757aircraft currently in service with approximately 90 operators. Closures ofother aircraft programs in the past have not necessarily caused extraordinarydeclines in the secondary value of the aircraft involved. Due to the impacts ofSeptember 11, 2001 and the downturn in the airline industry, B-757 valueshave already declined.

 

9

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AtMarch 31, 2004, $1.5 billion of our portfolio was collateralized by B-757aircraft. This is comprised of $1.3 billion of passenger aircraft (36 aircraftat 12 operators). At March 31, 2004, we were the beneficiary underguarantees from Boeing covering $593 million of this portion of our portfolio.The remainder of the portfolio is B-757 freighter conversions on long-termlease. While we continue to believe in the utility and marketability of theB-757, we are unable to predict how the end of B-757 production, as well asoverall market conditions, may impact B-757 values and rental rates. Should theB-757 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. Future declines in rental rates couldalso result in additional impairment charges under Statement of FinancialAccounting Standards (“SFAS”) No. 144 on operating lease aircraft. Whilewe are unable to predict the likelihood of these impacts occurring, suchimpacts could result in a potential material adverse effect on our earnings,cash flows or financial position.

 

Duringthe fourth quarter of 2003, Boeing lost a major B-717 sales campaign, thusincreasing the possibility of B-717 program termination. Boeing CommercialAirplanes continues to aggressively market the B-717 aircraft. Programcontinuity is dependent on the outcome of Boeing’s current sales campaigns. AtMarch 31, 2004, $2.3 billion of our portfolio was collateralized by B-717aircraft. At March 31, 2004, we were the beneficiary under $1.5 billion ofguarantees from Boeing covering $2.2 billion of our portfolio. While wecontinue to believe in the utility and marketability of the B-717, we areunable to predict how an ending of B-717 production, as well as overall marketconditions, would impact B-717 values and rental rates. Should the B-717 suffera significant 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. Future declines in rental rates, if significant, couldresult in additional impairment charges under SFAS No. 144 on operatinglease aircraft. While we are unable to predict the likelihood of these impactsoccurring, such impacts could result in a potential material adverse effect onour earnings, cash flows or financial position.

 

Receivable Write-offs and Recoveries, by Segment:

 
| **(Dollars in millions)**      |   | **Three  Months Ended  March 31,  2004** |   | **Year Ended  December 31,  2003** |   |
|--------------------------------|--------|-----------------------------------------------|--------|-----------------------------------------|--------|
| Aircraft Financial Services:   |   |                                          |   |                                    |   |
| Write-offs                     |   | $                                             | 10     |                                    | $      | 67 |   |
| Recoveries                     |   | —                                        |   | —                                  |   |
|                           |   | 10                                            |   | 67                                      |   |
|                           |   |                                          |   |                                    |   |
| Commercial Financial Services: |   |                                          |   |                                    |   |
| Write-offs                     |   | —                                        |   | 12                                      |   |
| Recoveries                     |   | (1                                            | )      | (1                                      | )      |
|                           |   | (1                                            | )      | 11                                      |   |
|                           |   | $                                             | 9      |                                    | $      | 78 |   |

 

In accordance with SFAS No. 114, “Accounting by Creditors forImpairment of a Loan,” we review a receivable for impairment when, based oncurrent information and events, it is probable that we will be unable tocollect amounts due according to the original contractual terms of thereceivable agreement, without regard to any subsequent restructurings. Factorsconsidered in assessing uncollectibility include a customer’s extendeddelinquency, requests for restructuring and filings for bankruptcy. Wedetermine a specific impairment allowance based on the difference between thecarrying value of the receivable and the estimated fair value of the relatedcollateral.

 

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The carrying amounts of impaired receivables are as follows:

 
| **(Dollars in millions)**                                    |   | **March 31,  2004** |   | **December 31,  2003** |   |
|--------------------------------------------------------------|--------|--------------------------|--------|-----------------------------|--------|
| Impaired receivables with specific  impairment allowance (1) |   | $                        | 542    |                        | $      | 535 |   |
| Impaired receivables with no specific  allowance (2)         |   | 1,140                    |   | 1,171                       |   |
|                                                         |   | $                        | 1,682  |                        | $      | 1,706 |   |

 

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(1)            At March 31, 2004 andDecember 31, 2003, impaired receivables of $542 million and $535 million,respectively, had a specific impairment allowance for losses on receivables of$134 million and $123 million, respectively.

(2)            Of the $1,140 million and $1,171million at March 31, 2004 and December 31, 2003, respectively, $1,078million and $1,076 million, respectively, relate to the receivables from UnitedAirlines (“United”) secured by B-767s and B-777s. During the third quarter of2003, we completed a restructuring of these receivables, as discussed furtherin Note 8. Although United is performing under the terms of the restructuringat March 31, 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.

 

The allocation of the allowance for losses on receivables betweenspecific reserves and general purposes is as follows:

 
| **(Dollars in millions)**          |   | **March 31,  2004** |   | **December 31,  2003** |   |
|------------------------------------|--------|--------------------------|--------|-----------------------------|--------|
| Allocated to specific reserves     |   | $                        | 134    |                        | 38.2   | % | $ | 123 |   | 35.0 | % |
| Allocated for general purposes (1) |   | 217                      |   | 61.8                        |   | 228 |   | 65.0 |   |
|                               |   | $                        | 351    |                        | 100.0  | % | $ | 351 |   | 100.0 | % |

 

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

 

At March 31, 2004, we were the beneficiary under $2.9 billion ofguarantees, principally from Boeing, with respect to portfolio transactionstotaling $4.5 billion (36.9% of our total portfolio), which mitigates our risk.

 

Actual results could differ from estimates and values, and there can beno assurance that the allowance for losses will be sufficient to cover losseson receivables.

 

Note 4 – Investments

 

The following table shows the impact of investments we accounted forunder SFAS No. 115, “Accounting for Certain Investments in Debt and EquitySecurities.” We record available-for-sale securities in investments atestimated fair value. Unrealized gains/losses of available-for-sale securitiesare recorded in accumulated other comprehensive income/loss, net of tax;however, losses deemed other than temporary are recorded as a reduction toinvestment income. We record held-to-maturity securities at amortized cost. Theunrealized gains/losses of held-to-maturity securities are not recorded in theconsolidated financial statements and are shown in the table below forinformational purposes only; however, losses deemed other than temporary arerecorded as a reduction to investment income.

 

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Fair values for investment securities are based on quoted marketprices, where available. If quoted market prices are not available, fair valuesare based on pricing models or quoted market prices of comparable instruments.The majority of our securities are illiquid non-traded securities; therefore,the fair values are generally based on pricing models. In order to use pricingmodels, we request spread levels over certain benchmark interest rates fromexternal sources to use for calculations in the pricing models. Those spreadlevels and certain benchmark interest rates are selected using similar publicsecurities, senior classes in the transaction or other relevant pricinginformation as marketplace proxies for our non-trading securities. Using thismethodology, our estimate of fair value for the enhanced equipment trustcertificates (“EETCs”) and equipment trust certificates (“ETCs”) may be lessthan our estimate of the current value of the collateral supporting the EETCsand ETCs.

 

Available-for-sale and held-to-maturity investments consisted of thefollowing:

 
| **(Dollars in millions)**   |   | **Amortized  Cost** |   | **Gross  Unrealized  Gain** |   | **Gross  Unrealized  Loss** |   | **Estimated  Fair  Value** |   |
|-----------------------------|--------|---------------------|--------|-----------------------------|--------|-----------------------------|--------|----------------------------|--------|
| **March 31, 2004**     |   |                |   |                        |   |                        |   |                       |   |
| Available-for-Sale:         |   |                |   |                        |   |                        |   |                       |   |
| Debt                        |   | $                   | 10     |                        | $      | —                      |   | $                          | (1     | ) | $ | 9 |   |
| Held-to-Maturity:           |   |                |   |                        |   |                        |   |                       |   |
| Debt (1)(3)                 |   | 443                 | (2)    | —                      |   | (52                         | )      | 391                        |   |
|                        |   | $                   | 453    |                        | $      | —                      |   | $                          | (53    | ) | $ | 400 |   |
|                        |   |                |   |                        |   |                        |   |                       |   |
| **December 31,  2003** |   |                |   |                        |   |                        |   |                       |   |
| Available-for-Sale:         |   |                |   |                        |   |                        |   |                       |   |
| Debt                        |   | $                   | 20     |                        | $      | 1                           |   | $                          | — |   | $ | 21 |   |
| Held-to-Maturity:           |   |                |   |                        |   |                        |   |                       |   |
| Debt (1)                    |   | 453                 |   | —                      |   | (57                         | )      | 396                        |   |
|                        |   | $                   | 473    |                        | $      | 1                           |   | $                          | (57    | ) | $ | 417 |   |

 

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

(2)          Related to the $443 million atMarch 31, 2004, we had $10 million in guarantees from Boeing and $6million in guarantees from a third party.

(3)          These securities have been in acontinuous unrealized loss position for 12 months or longer.

 

AtMarch 31, 2004, our held-to-maturity investments included $408 million ofinvestments in several EETCs. These EETCs are financing arrangements that aresecured by pools of aircraft that are regularly utilized by airlines to financeaircraft. Approximately $374 million of the above amount relates to investmentsthat were acquired in 2002. Due to the commercial aviation market downturn,these securities have been in a continuous unrealized loss position for 12months or longer. Despite the unrealized loss position of these securities, wehave concluded that these investments are not other-than-temporarily impaired.This assessment was based on the strength of the underlying collateral to thesecurities, the duration of the maturity, and both internal and third-partycredit reviews and analyses of the counter parties, 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 these debtsecurities.

 

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AtMarch 31, 2004, our held-to-maturity investments also included $35 millionof investments in mandatorily redeemable preferred stock that has been in acontinuous unrealized loss position for 12 months or longer. Despite theunrealized loss position of these securities, we have concluded that theseinvestments are not other-than-temporarily impaired. This assessment was basedon the duration of the maturity, and both internal and third-party creditreviews and analyses of the issuers. Accordingly, we have concluded that it isprobable that we will be able to collect all amounts due according to thecontractual terms of the debt securities.

 

At March 31, 2004 and December 31, 2003, available-for-saleand held-to-maturity investments totaled $452 million and $474 million,respectively, of which none were considered investment grade securities.

 

At December 31, 2001, an available-for-sale security wastransferred to held-to-maturity at its fair value with $20 million ofunrealized loss recorded as a component of accumulated other comprehensiveincome/loss, net of tax. As of March 31, 2004, $3 million of that $20million unrealized loss was amortized from accumulated other comprehensive income/lossto investment income.

 

At July 1, 2002, two available-for-sale securities weretransferred to held-to-maturity at their fair values with $6 million of netunrealized gain recorded as a component of accumulated other comprehensiveincome/loss, net of tax. At March 31, 2004, $3 million of that $6 millionnet unrealized gain was amortized from accumulated other comprehensiveincome/loss to investment income.

 

At October 1, 2002, an available-for-sale security was transferredto held-to-maturity at its fair value, which was equal to its amortized cost.

 

At March 31, 2004, maturities of debt investments 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 |   | $                      | — |                      | $      | — |   | $ | 321 |   | $ | 275 |   |
| Due from six to ten years  |   | 10                     |   | 9                         |   | 58 |   | 52 |   |
| Due after ten years        |   | —                 |   | —                    |   | 64 |   | 64 |   |
|                       |   | $                      | 10     |                      | $      | 9 |   | $ | 443 |   | $ | 391 |   |

 

Note 5 – Impairment Review for Equipment Under Operating Leases andHeld for Sale or Re-Lease

 

We review all aircraft and equipment held for sale or re-lease andunder operating lease for potential impairment when events or circumstancesindicate, and no less than annually, that the carrying amount of these assetsmay not be recoverable. For the first quarter of 2004, we reviewed all aircraftand equipment held for sale or re-lease and those assets under operating leaseswith carrying amounts in excess of fair value or where known events orcircumstances may indicate impairment. We recognize an impairment loss forassets under operating lease or held for re-lease when the expectedundiscounted cash flow over the remaining useful life is less than the bookvalue. We use various assumptions when determining the expected undiscounted cashflow. These assumptions include expected future lease rates, lease terms, endof economic life value of the aircraft or equipment, periods in which the assetmay be held in preparation for a follow-on lease, maintenance costs,remarketing costs and the remaining economic life of the asset. We state assetsheld for sale at the lower of carrying amount or fair value less costs to sell.

 

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When we determine that impairment is indicated for an asset, the amountof the impairment loss is the excess of the book value less asset valueguarantees, if applicable, over the fair value of the asset. For aircraftassets, we use the average published value from multiple sources based on thetype and age of the asset to determine the fair value. However, if the featuresor use of the aircraft varies significantly from the generic aircraftattributes covered by outside publications, we apply judgment based on theattributes of the specific aircraft to determine fair value. For the threemonths ended March 31, 2004 and 2003, we recorded pre-tax non-cash chargestotaling $13 million and $42 million, respectively, to record impairments ofportfolio assets as a result of continued declines in market values andprojected future rents for aircraft and equipment.

 

For a discussion of the B-757 and B-717 programs see Note 3.

 

Note 6 – Debt and Credit Agreements

 
| **(Dollars in millions)**                                              |   | **March 31,  2004** |   | **December 31,  2003** |   |
|------------------------------------------------------------------------|--------|--------------------------|--------|-----------------------------|--------|
| Senior debt:                                                           |   |                     |   |                        |   |
| Variable rate (three-month LIBOR plus 0.6%)  note due 2012             |   | $                        | 5      |                        | $      | 5 |   |
| 4.75% note due 2008                                                    |   | 515                      |   | 504                         |   |
| 5.65% note due 2006                                                    |   | 1,038                    |   | 1,032                       |   |
| 5.75% note due 2007                                                    |   | 747                      |   | 749                         |   |
| 5.80% note due 2013                                                    |   | 619                      |   | 610                         |   |
| 6.10% note due 2011                                                    |   | 779                      |   | 774                         |   |
| 6.50% note due 2012                                                    |   | 767                      |   | 759                         |   |
| 7.10% note due 2005                                                    |   | 499                      |   | 499                         |   |
| 7.375% note due 2010                                                   |   | 557                      |   | 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                          |   |
| 5.02% - 5.79% non-recourse notes due  through 2013                     |   | 41                       |   | 41                          |   |
| 3.15% - 6.75% retail medium-term notes due  through 2017               |   | 875                      |   | 874                         |   |
| 1.32% - 7.64% medium-term notes due through  2023                      |   | 1,921                    |   | 2,240                       |   |
| 1.69% secured debt, proceeds of  securitization due through 2009       |   | —                   |   | 89                          |   |
| 1.67% - 7.35% capital lease obligations due  through 2015              |   | 316                      |   | 329                         |   |
|                                                                   |   | 8,772                    |   | 9,153                       |   |
|                                                                   |   |                     |   |                        |   |
| Subordinated debt:                                                     |   |                     |   |                        |   |
| 8.31% medium-term note due 2004                                        |   | 20                       |   | 20                          |   |
| Non-recourse variable rate note due 2012  (one-month LIBOR plus 2.46%) |   | 4                        |   | 4                           |   |
|                                                                   |   | 24                       |   | 24                          |   |
|                                                                   |   | $                        | 8,796  |                        | $      | 9,177 |   |

 

On February 16, 2001, we filed a publicshelf registration of $5.0 billion of debt securities with theSecurities and Exchange Commission (“SEC”), which was declared effective onFebruary 26, 2001. Effective October 31, 2001, we allocated $1.0billion to the Series XI medium-term note program. Effective June 20,2002, the remaining $750 million under the shelf registration was allocated tothis program. As of the filing date of this Report, an aggregate amount of $402million remains available under the Series XI medium-term program for potentialdebt issuance.

 

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OnFebruary 22, 2002, we filed a public shelf registration of $5.0 billion ofdebt securities with the SEC, which was declared effective on March 4,2002. We allocated $1.0 billion to establish a new retail medium-term noteprogram involving the sale of notes with a minimum denomination of $1,000. Asof the filing date of this Report, an aggregate amount of $3.0 billion (whichincludes $119 million of retail medium-term notes) remains available forpotential debt issuance.

 

OnJune 6, 2002, we established a $1.5 billion Euro medium-term note program.As of the filing date of this Report, an aggregate amount of $1.4 billionremains available for potential debt issuance.

 

Themost restrictive provisions of various debt agreements require us to (a) limitthe payment of cash dividends to the extent that our consolidated assets wouldbe less than 115% of our consolidated liabilities (excluding deferred taxes)after dividend payments and (b) restrict the amount of liens on our property tosecure indebtedness to 15% or less of consolidated assets, other than liensspecifically excluded. At March 31, 2004, as well as during the period, wewere in compliance with these and all debt covenants.

 

As of November 21, 2003, Boeing made $750 million of its five-yearrevolving credit line expiring in 2008 exclusively available to us. This is inaddition to $1.25 billion of Boeing’s $2.5 billion 364-day revolving creditline, which is exclusively available to us. At March 31, 2004, there wereno amounts outstanding under these agreements.

 

Note 7 – Derivative Financial Instruments

 

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

 

We are exposed to a variety of market risks, including the effects ofchanges in interest rates and foreign currency exchange rates. We manage theseexposures, in part, with the use of derivatives. In particular, we enter intointerest rate swap and cross currency swap contracts with a number of majorfinancial institutions. Since we believe it is unlikely that any of ourcounterparties will be unable to perform under the terms of derivativefinancial instruments, we generally do not require collateral or other securitysupporting derivative contracts with our counterparties. The following is asummary of our risk management strategies and the effect of these strategies onthe consolidated financial statements.

 

*Fair Value Hedges*

 

Interest rate swaps, under which we agree to pay variable rates ofinterest, are designated as fair value hedges of fixed-rate debt. For the threemonths ended March 31, 2004 and 2003, we recorded $4 million and $2million, respectively, of gains related to the basis adjustment of certainterminated interest rate swaps in interest expense. During the next twelvemonths, we expect to amortize a $16 million gain from the amount recorded inthe basis adjustment of certain terminated fair value hedge relationships tointerest expense.

 

During the first quarterof 2003, we also held forward-starting interest rate swap agreements to fix thecost of funding a firmly committed lease for which payment terms are determinedin advance of funding. This type of hedge relationship mitigates the changes infair value of the hedged portion of the firm commitment caused by changes ininterest rates. The net change in fair value of the swap and the hedged portionof the firm commitment is reported in earnings. At the end of the first quarterof 2003, the forward-starting interest rate swaps no longer qualified for fairvalue hedge accounting treatment and we recognized a pre-tax charge of $21million. For the three months ended March 31, 2003, we recorded $1 millionof losses related to ineffectiveness due to the forward-starting interest rateswaps in interest expense.

 

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*Cash Flow Hedges*

 

Thecash flow hedges we use include certain interest rate swaps and cross currencyswaps. Interest rate swap contracts under which we agree to pay fixed rates ofinterest are designated as cash flow hedges of variable-rate debt obligations.In addition, cross currency swap contracts under which we agree to pay fixedfunctional currency rates of interest are designated as cash flow hedges offixed non-functional currency debt obligations. As of March 31, 2004 andDecember 31, 2003, we recorded net unrecognized losses of $4 million ($2million net of tax) and $3 million ($2 million net of tax), respectively, inaccumulated other comprehensive income/loss associated with our cash flow hedgingtransactions.

 

For the three months ended March 31, 2004 and 2003, unrealizedlosses (net of tax) of $0.2 million and $0.1 million, respectively, included inaccumulated other comprehensive income/loss were reclassified to interestexpense (for interest swaps) or other expense (for cross currency swaps).During the next twelve months, we expect to reclassify to interest expense aloss (net of tax) of $0.3 million from the amount recorded in accumulated othercomprehensive income/loss.

 

*Non-hedging Derivative Instruments*

 

Wehold certain interest exchange agreements and related interest rate swaps. Theintent of these interest rate swaps is to economically hedge the exposurescreated by the interest exchange agreements. However, since the exposures beinghedged are derivative instruments, this relationship does not qualify for hedgeaccounting. As a result, changes in fair value of both instruments areimmediately recognized in income. As of March 31, 2004 andDecember 31, 2003, we recorded net losses of $1.2 million ($0.8 millionnet of tax) and $1.4 million ($0.9 million net of tax), respectively, inaccumulated other comprehensive income/loss associated with these interest rateswaps. For the three months ended March 31, 2004 and 2003, the interestexchange agreements resulted in losses of $0.6 million and $1 million,respectively, and the related interest rate swaps resulted in gains of $0.1million and $0.7 million, respectively. For the three months endedMarch 31, 2004 and 2003, unrealized losses (net of tax) of $0.1 millionand $0.2 million, respectively, from accumulated other comprehensiveincome/loss and gains of $0.5 million and $0.8 million, respectively, from thebasis adjustment to underlying liabilities were amortized to interest expense. Duringthe next twelve months, we expect to amortize to interest expense a $0.4million loss (net of tax) from the amount recorded in accumulated othercomprehensive income/loss and a $2 million gain from the basis adjustment tounderlying liabilities.

 

During 2001, we received warrants and a conversion option on notes inconnection with a certain financing transaction. In June 2003, theremainder of the conversion feature of the convertible notes was exercised infull and the shares realized were sold in the third quarter of 2003, along withtwo-thirds of the warrants, resulting in gains of $9 million. As ofMarch 31, 2004 and December 31, 2003, the remaining warrants for thisand other transactions were reflected in other assets at a fair value of $8million for both periods. We recorded the initial fair values of the warrantsand conversion option on notes as a discount to notes receivable of $20million. For the three months ended March 31, 2004 and 2003, the warrantsand conversion feature of the convertible notes recorded in other assets hadchanges in fair value, resulting in a reduction to other income of $0.2 millionand an addition to other income of $7 million, respectively.

 

Note 8 – Commitments and Contingencies

 

*Litigation*

 

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

 

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*Restructuring Requests*

 

Unitedaccounted for $1.2 billion (9.5%) of our total portfolio at both March 31,2004 and December 31, 2003. At March 31, 2004, the United portfoliowas secured by security interests in two B-767s and 13 B-777s and by anownership and security interests in five B-757s. As of March 31, 2004,United was our second largest customer. United filed for Chapter 11bankruptcy protection on December 9, 2002. During the third quarter of2003, we completed a restructuring of United’s aircraft loans and leases. Thereceivables associated with a security interest in the two B-767s and 13 B-777swere restructured with terms that did not necessitate a troubled debtrestructuring charge to the allowance for losses on receivables. The leaseterms attributable to the five B-757s in which we hold an ownership andsecurity interest were revised in a manner that reclassified these leases asoperating leases. Additionally, we had previously assigned to a third party therights to a portion of the lease payments on these five B-757s. As a result ofthis lease restructuring, we recorded operating lease equipment with a value of$84 million and non-recourse debt of $42 million (representing the obligationattributable to the assignment of future lease proceeds) at the time ofrestructuring. As of March 31, 2004, United was current on all of itsobligations related to these 20 aircraft.

 

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

 

American Trans Air Holdings Corp. (“ATA”) accounted for $730 millionand $743 million (6.0% and 6.1%) of our total portfolio at March 31, 2004and December 31, 2003, respectively. At March 31, 2004, the ATAportfolio primarily consisted of 12 B-757s and an investment in ATA mandatorilyredeemable preferred stock with a face amount of $50 million. InNovember 2002, ATA received a loan of $168 million administered by theAirline Transportation Stabilization Board. In the third quarter of 2003, we agreedto restructure certain outstanding leases by extending their terms anddeferring a portion of their rent payments for a limited period of time. Theterms of the restructured leases did not result in a charge to the allowancefor losses on receivables. ATA was obligated to meet certain requirements as acondition for the terms of the restructured leases to remain in effect. Theserequirements included the completion of an exchange offering on its publiclytraded debt, which would result in a deferral of the principal debt maturitydate. ATA satisfied those requirements in January 2004.

 

Based on our current assessment of the financial condition of ATA,which takes into account factors such as the successful exchange offering ofits publicly traded debt, we believe it is probable that we will collect underthe terms of our investment in ATA mandatorily redeemable preferred stock. Wehave therefore concluded that no other-than-temporary impairment is warrantedfor this preferred stock investment. We will continue to review ATA’s financialcondition and our expectation of collecting under the terms of our investmentin ATA’s mandatorily redeemable preferred stock.

 

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Hawaiian accounted for $485 million and $509 million (4.0% and 4.2%) ofour total portfolio at March 31, 2004 and December 31, 2003,respectively. At March 31, 2004, the Hawaiian portfolio primarilyconsisted of 11 B-717s and three B-767s. Hawaiian filed for Chapter 11bankruptcy protection on March 21, 2003. We permitted Hawaiian to returntwo B-717s leased by us. These B-717s were leased to a third party in the firstquarter of 2004. In February 2004, we filed in court, as a co-proponentwith Corporate Recovery Group, a Hawaiian plan of reorganization, which wouldinclude among other things a revision of our lease terms resulting in asubstantial decrease in our rentals from Hawaiian. Taking into account thespecific reserves allocated for the Hawaiian receivables, we do not expect thatour transactions with Hawaiian will have a material adverse effect on ourearnings, cash flows or financial position. In the event that futurenegotiations or proceedings result in the return of a substantial number ofaircraft, there could be a material adverse effect on our earnings, cash flowsor financial position, at least until such time as the aircraft are sold orredeployed for adequate consideration.

 

Viacao Aerea Rio-Grandense (“VARIG”) accounted for $421 million and$424 million (3.4% and 3.5%) of our total portfolio at March 31, 2004 andDecember 31, 2003, respectively. At March 31, 2004, the VARIGportfolio consisted of two B-737s and nine MD-11s. In recent years, VARIG hasrepeatedly defaulted on its obligations under leases with us, which hasresulted in deferrals and restructurings, some of which are ongoing. Boeing hasprovided us with first loss deficiency and partial rental guarantees coveringapproximately $322 million of the VARIG obligations. Taking into account theseguarantees, we do not expect the VARIG transactions, including the impact ofany restructurings, to have a material adverse effect on our earnings, cashflows or financial position.

 

We have reviewed our obligations due from our customers forcollectibility and have established specific or general allowances as we deemednecessary. In addition to the customers discussed above, some other customershave requested a restructuring of their transactions with us. We have notreached agreement on any other restructuring requests that we believe wouldhave a material adverse effect on our earnings, cash flows or financialposition.

 

*Outstanding Funding Commitments*

 

At March 31, 2004, we had commitments to provide leasing and otherfinancing totaling $107 million. 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 $107 million maybe funded in less than one year.

 

Additionally, Boeing and Boeing Capital Services Corporation had unfundedaircraft financing commitments at March 31, 2004 of $1.5 billion. Based onhistorical experience, we do not anticipate that we will fund all of these commitments.However, if we were required to fund all unfunded commitments:

 

•                  up to $291 million maybe funded in less than one year,

•                  an additional $1.1billion may be funded in one to three years, and

•                  an additional $100million may be funded in four to five years.

 

We expect to ultimately fund a portion of these unfunded commitments.The portion that we fund may require credit enhancements or other guaranteesupport from Boeing as necessary to allow us to meet our underwriting andinvestment criteria.

 

18

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AtMarch 31, 2004, we were subject to maximum guarantor obligations of $124million; however, $7 million of that amount has been indemnified by Boeing andis included in the amount guaranteed by Boeing. Guarantor obligations areprimarily comprised of residual value and other guarantees provided by us.Losses, if any, related to this exposure, net of collateral, are not expectedto have a material adverse effect on our earnings, cash flows or financial position.

 

Note 9 – Off-Balance SheetArrangements

 

We are a party to off-balance sheet arrangements, including guarantorobligations and variable interests in unconsolidated entities.

 

*Guarantor Obligations*

 

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

 
| **(Dollars in millions)**  |   | **Maximum  Potential  Payments** |   | **Estimated  Proceeds  From  Collateral/Recourse** |   | **Carrying  Amount of  Liabilities (2)** |   |
|----------------------------|--------|----------------------------------|--------|----------------------------------------------------|--------|------------------------------------------|--------|
| **March 31, 2004**    |   |                             |   |                                               |   |                                     |   |
| Residual value guarantees  |   | $                                | 117    |                                               | $      | 117                                      |   | $ | 4 |   |
| Deficiency guarantees (1)  |   | 7                                |   | —                                             |   | —                                   |   |
|                       |   | $                                | 124    |                                               | $      | 117                                      |   | $ | 4 |   |
|                       |   |                             |   |                                               |   |                                     |   |
| **December 31, 2003** |   |                             |   |                                               |   |                                     |   |
| Residual value guarantees  |   | $                                | 120    |                                               | $      | 119                                      |   | $ | 4 |   |
| Credit guarantees          |   | 25                               |   | 25                                                 |   | —                                   |   |
| Deficiency guarantees (1)  |   | 7                                |   | —                                             |   | —                                   |   |
|                       |   | $                                | 152    |                                               | $      | 144                                      |   | $ | 4 |   |

 

----

(1)            This amount is indemnified by Boeing.

(2)            Amounts included in other liabilities.

 

We have issued residual value guarantees. Under these arrangements, weare obligated to make payments to a guaranteed party if the related aircraft orequipment fair values fall below a specified amount at a future time. Theseobligations are collateralized principally by commercial aircraft, and expirewithin the next 12 years.

 

We have issued credit and deficiency guarantees. Under thesearrangements, we are obligated to make payments to a guaranteed party if theoriginal debtor or lessee does not make payments. Current outstanding creditand deficiency guarantees expire within the next eight years.

 

19

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*Material Variable Interests in Unconsolidated Entities*

 

Our investments in ETCs, EETCs and special purpose entities (“SPEs”) areincluded in the scope of Revised Interpretation No. 46 (“FIN 46(R)”),“Consolidation of Variable Interest Entities,” but do not requireconsolidation. Airlines regularly utilize an SPE called a Pass Through Trust tofinance aircraft. The Pass Through Trust enables the airline to aggregate alarge number of aircraft secured notes into one trust vehicle, facilitating theissuance of larger bonds called pass-through certificates. The most commonforms of pass-through certificates issued by airlines are ETCs and EETCs. ETCsand EETCs provide investors with tranched rights to cash flows from a financialinstrument, as well as a collateral position in the related asset. While theunderlying classes of equipment notes vary by maturity and/or coupon dependingupon tenor or level of subordination of the specific equipment notes and theircorresponding claim on the aircraft, the basic function of the Pass ThroughTrust in an ETC or EETC remains to passively hold separate debt investments toenhance liquidity for investors, who in turn pass this liquidity benefitdirectly to the airline in the form of a lower coupon and/or greater debtcapacity. We participate in several ETCs and EETCs as an investor. We are alsoan investor in entities engaged in financing arrangements with third partiesand are accounting for these investments under the equity method.

 

We are a subordinated lender to certain SPEs that are utilized by theairlines, lenders and loan guarantors including, for example, the Export-ImportBank of the United States. We also use other SPEs that are fully consolidatedin our financial statements. Both SPE arrangements are used for other businessreasons, including:

 

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

•                  to perfect securityinterests for us as well as, in some cases, that of third-party lenders incertain leveraged lease transactions.

 

Our receivables from these SPEs and investment in ETCs and EETCsaggregated $610 million at March 31, 2004, which represents our maximum exposureto economic loss. During the three months ended March 31, 2004, werecorded revenues of $13 million and had cash inflows of $49 million relatingto these investments. At March 31, 2004, the variable interest entities(“VIEs”) in which we have invested had total assets of approximately $6.1billion and related debt (which is non-recourse to us) of approximately $5.5billion.

 

Included in the portfolio balances are $156 million and $201 million atMarch 31, 2004 and December 31, 2003, respectively, of investments inentities engaged in financing accounted for under the equity method.

 

Note 10 – Segment Information

 

Ourprimary operations at March 31, 2004 included two principal financialreporting segments: Aircraft Financial Services and Commercial FinancialServices. Currently, Aircraft Financial Services is active in providing leaseand debt financing to domestic and international airlines. Commercial FinancialServices provides lease and loan financing to a broad range of commercial andindustrial customers. Other is comprised of Space and Defense FinancialServices.

 

OnJanuary 15, 2004, we announced that we have retained Credit Suisse FirstBoston, LLC to explore strategic options for the future of our CommercialFinancial Services business. The options being examined include a sale of theoperation itself, sale of the portfolio or a phased wind-down of the existingportfolio. We continue to explore these strategic options.

 

20

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Information about our operations in our financial reporting segments issummarized as follows:

 
|                                                        |   | **Three  Months Ended  March 31,** |       |
|-------------------------------------------------------------|--------|-----------------------------------------|------------|
| **(Dollars in millions)**                                   |   | **2004**                                | ** ** | **2003** | ** ** |
| Revenues:                                                   |   |                                    |       |   |   |
| Aircraft Financial Services                                 |   | $                                       | 247        |   | $ | 220 |   |
| Commercial Financial Services                               |   | 56                                      |       | 59 |   |
| Other                                                       |   | 4                                       |       | 4 |   |
|                                                        |   | $                                       | 307        |   | $ | 283 |   |
| Interest expense (allocated):                               |   |                                    |       |   |   |
| Aircraft Financial Services                                 |   | $                                       | 82         |   | $ | 88 |   |
| Commercial Financial Services                               |   | 19                                      |       | 22 |   |
| Other                                                       |   | 2                                       |       | 1 |   |
|                                                        |   | $                                       | 103        |   | $ | 111 |   |
| Depreciation expense:                                       |   |                                    |       |   |   |
| Aircraft Financial Services                                 |   | $                                       | 54         |   | $ | 50 |   |
| Commercial Financial Services                               |   | 12                                      |       | 12 |   |
| Other                                                       |   | 1                                       |       | 1 |   |
|                                                        |   | $                                       | 67         |   | $ | 63 |   |
| Income (loss) before provision (benefit)  for income taxes: |   |                                    |       |   |   |
| Aircraft Financial Services                                 |   | $                                       | 72         |   | $ | (127 | ) |
| Commercial Financial Services                               |   | 14                                      |       | 13 |   |
| Other                                                       |   | 1                                       |       | 1 |   |
|                                                        |   | $                                       | 87         |   | $ | (113 | ) |

 

Our portfolio assets by segment were asfollows:

 
| **(Dollars in millions)**                                             |   | **March 31,  2004** |   | **December 31,  2003** |   |
|-----------------------------------------------------------------------|--------|--------------------------|--------|-----------------------------|--------|
| Aircraft Financial Services:                                          |   |                     |   |                        |   |
| Financing leases                                                      |   | $                        | 3,527  |                        | $      | 3,573 |   |
| Notes and other receivables                                           |   | 2,460                    |   | 2,321                       |   |
| Equipment under operating leases, net of  accumulated depreciation    |   | 3,244                    |   | 3,216                       |   |
| Investments                                                           |   | 453                      |   | 475                         |   |
| Equipment held for sale or re-lease, net of  accumulated depreciation |   | 211                      |   | 232                         |   |
|                                                                  |   | 9,895                    |   | 9,817                       |   |
|                                                                  |   |                     |   |                        |   |
| Commercial Financial Services:                                        |   |                     |   |                        |   |
| Financing leases                                                      |   | 662                      |   | 724                         |   |
| Notes and other receivables                                           |   | 737                      |   | 750                         |   |
| Equipment under operating leases, net of  accumulated depreciation    |   | 708                      |   | 729                         |   |
| Equipment held for sale or re-lease, net of  accumulated depreciation |   | 42                       |   | 46                          |   |
|                                                                  |   | 2,149                    |   | 2,249                       |   |
| Other                                                                 |   | 168                      |   | 182                         |   |
|                                                                  |   | $                        | 12,212 |                        | $      | 12,248 |   |

 

21

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The total assets by segment were as follows:

 
| **(Dollars in millions)**     |   | **March 31,  2004** |   | **December 31,  2003** |   |
|-------------------------------|--------|--------------------------|--------|-----------------------------|--------|
| Aircraft Financial Services   |   | $                        | 10,063 |                        | $      | 10,254 |   |
| Commercial Financial Services |   | 2,196                    |   | 2,372                       |   |
| Other                         |   | 192                      |   | 210                         |   |
|                          |   | $                        | 12,451 |                        | $      | 12,836 |   |

 

Note 11 – Relationship and Transactions with Boeing

 

*Support Agreement*

 

On December 23, 2003, we entered into a support agreement (the“Support Agreement”) with Boeing with these principal features:

 

•                  Boeing will maintain 51% or greaterownership of us,

•                  Boeing will make contributions to us, ifneeded, to the extent that our fixed-charge coverage would fall below1.05-to-1, and

•                  Boeing will make contributions to us, ifneeded, to maintain our tangible net worth at a level of at least $50 million.

 

The Support Agreement may not be modified or terminated unless (a)two-thirds of the debtholders consent or (b) the modification or terminationdoes not adversely affect the credit ratings of our debt. This SupportAgreement is not a guarantee of any of our indebtedness, nor is it directlyenforceable against Boeing.

 

*Intercompany Transactions*

 

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

 

Intercompany guarantees primarily relate to residual value guarantees,first loss deficiency guarantees and rental guarantees. At March 31, 2004,we were the beneficiary under $2.8 billion of guarantees from Boeing. Werecorded the following activity under the intercompany guarantee agreements:

 
|                                                                      |   | **Three Months Ended  March 31,** |       |
|---------------------------------------------------------------------------|--------|----------------------------------------|------------|
| **(Dollars in millions)**                                                 |   | **2004**                               | ** ** | **2003** | ** ** |
| Guarantee payments applied to income                                      |   | $                                      | 4          |   | $ | 19 |   |
| Guarantee payments applied to reduce net  asset value of related aircraft |   | 2                                      |       | 4 |   |
|                                                                      |   | 6                                      |       | 23 |   |
| Fees                                                                      |   | (1                                     | )          | (1 | ) |
| Net guarantees received                                                   |   | $                                      | 5          |   | $ | 22 |   |

 

Fora period of time, Boeing has also agreed to provide interest rate subsidies,non-guarantee concessions and rental payments on restructured third partyleases. For the three months ended March 31, 2004 and 2003, we recognizedincome of $11 million and $15 million, respectively, under these subsidies.

 

22

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Additionally, as provided for under the terms of the intercompanyguarantee agreements, Boeing recorded additional charges of $34 million and $58million, respectively, for the three months ended March 31, 2004 and 2003,respectively, related to asset impairments, accrued expenses and allowance forlosses on receivables in our portfolio.

 

For the three months ended March 31, 2004 and 2003, we recordedfinancing revenues**(revenue fromfinancing leases, notes and other receivables and equipment under operatingleases) from Boeing, exclusive of guarantees and subsidies, of $13million and $9 million, respectively.

 

We recognized new business volume of $268 million and $326 million forthe three months ended March 31, 2004 and 2003, respectively, related toour purchase of aircraft and equipment from Boeing.

 

23

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

 

Forward-LookingInformation Is Subject to Risk and Uncertainty

 

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

 

Our actual results and future trends may differ materially from our forward-looking statements depending ona variety of factors including our relationship with Boeing, as well asstrategic decisions of Boeing relating to us, the effects of theSeptember 11, 2001 terrorist attacks or future terrorist threats orattacks and their continuing impact on the airline industry, wars, SARS orother diseases, the capital equipment requirements of United States domesticand foreign businesses, general economic conditions, and in particular,economic conditions in the airline industry and the continued operation,viability and growth of major airline customers, capital availability and cost,changes in laws and tax benefits, the tax position of Boeing (including theapplicability of the alternative minimum tax), competition from other financialinstitutions, our successful execution of internal operating plans, includingthe transition of our Long Beach, California adminstrative groups to Renton,Washington, defaults or bankruptcies by customers (especially airlines),adverse developments in the value of collateral or owned assets (especiallyaircraft), termination of aircraft manufacturing programs, regulatoryuncertainties, legal proceedings and an adverse development in rating agencycredit ratings or assessments.

 

**Business Environment and Trends**

## ** **

InNovember 2003, we announced a significant change in our strategicdirection, moving from a focus on growing the portfolio to a focus onsupporting Boeing’s major operating units and managing overall corporateexposures. For the commercial aircraft market, this means we will befacilitating, arranging and providing financing to Boeing Commercial Airplanes’customers. For our space and defense markets, this means we will be primarilyengaged in arranging and structuring financing solutions for Boeing’sIntegrated Defense Systems government customers. This new strategic directionis likely to include the sale or wind-down of our Commercial Financial Servicesbusiness or portfolio. In addition, we will be enhancing the risk managementactivities to reduce exposures associated with the current portfolio. We expectto satisfy any external funding needs through access to our traditional capitalmarket funding sources.

 

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Historically,we competed in the commercial equipment leasing and finance markets, primarilyin the United States, against a number of large-ticket competitors, mainlylarger leasing companies and banks. Commercial Financial Services’ portfolioencompasses multiple industries and a wide range of equipment, includingcorporate aircraft, machine tools and production equipment, containers andmarine equipment, chemical, oil and gas equipment and other equipment types.Contract terms are generally between three and ten years, and current average transactionsize is $12 million. At March 31, 2004, 17.6% of our portfolio was relatedto commercial equipment leasing and financing activities. On January 15,2004, we announced that we have retained Credit Suisse First Boston, LLC toexplore strategic options for the future of our Commercial Financial Servicesbusiness. The options being examined include a sale of the operation itself,sale of the portfolio or a phased wind-down of the existing portfolio. We continue to explore these strategicoptions.

 

Commercial aviation has been impacted by aneconomic downturn that began in 2001 and continued through 2003. In addition,the industry suffered a severe shock from the terrorist attacks ofSeptember 11, 2001. Overall, during the first quarter of 2004, economicgrowth in all regions was positive. Monthly traffic levels were at or abovetraffic levels carried by the airlines in 2000. The world’s airlines areexpected to collectively generate a small profit in 2004, led by the low-costcarriers in the U.S. and Europe. European network airlines are expected to showbetter results than their U.S. counterparts for their current fiscal year end.Likewise, Asian airlines are expected to fare better overall than their U.S.counterparts since traffic to and from Asia has nearly rebounded to pre-SARSlevels. This outlook continues to be uncertain as world oil and fuel pricesremain above long-term levels. High fuel prices are now expected to result inlosses among the large U.S. carriers that could offset profits generatedelsewhere. Exogenous shocks still represent further major uncertainties for theairline industry. Recurrence of disease outbreaks like the 2003 SARS outbreakin Asia, new armed conflict, and/or terrorist attacks all represent threats tothe airline industry’s recovery.

 

Aircraft values and lease rates are also impactedby the number and type of aircraft that are parked and currently out ofservice. Approximately 2,000 aircraft (12% of world fleet) are currentlyparked, including in production aircraft types. In years prior to 2001, theparked fleet was approximately 4% to 6% of the world fleet, and was comprisedmainly of out of production aircraft. In general, aircraft values and leaserates should improve as parked aircraft are returned to service.

 

Published sources and recent market transactionsindicate that values for various aircraft types serving as collateral in ourportfolio remain depressed. At the same time, the credit ratings of manyairlines, particularly in the United States, have remained at low levels. Asubstantial portion of our portfolio is concentrated among U.S. commercialairline customers. Certain customers have filed for bankruptcy protection orrequested lease or loan restructurings; these negotiations were in variousstages as of March 31, 2004. These bankruptcies or restructurings couldhave a material adverse effect on our earnings, cash flows or financialposition.

 

In October 2003, Boeing announced the decision to end productionof the B-757 program, with the final aircraft scheduled to be produced in late2004. The B-757 will continue to be supported by Boeing. There are over 1,000B-757 aircraft currently in service with approximately 90 operators. Closuresof other aircraft programs in the past have not necessarily caused extraordinarydeclines in the secondary value of the aircraft involved. Due to the impacts ofSeptember 11, 2001 and the downturn in the airline industry, B-757 valueshave already declined.

 

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At March 31, 2004, $1.5 billion of our portfolio wascollateralized by B-757 aircraft. This is comprised of $1.3 billion ofpassenger aircraft (36 aircraft at 12 operators). At March 31, 2004, wewere the beneficiary under guarantees from Boeing covering $593 million of thisportion of our portfolio. The remainder of the portfolio is B-757 freighterconversions on long-term lease. While we continue to believe in the utility andmarketability of the B-757, we are unable to predict how the end of B-757production, as well as overall market conditions, may impact B-757 values andrental rates. Should the B-757 suffer a significant decline in utility andmarket acceptance, the aircraft values may decline, which in turn could alsoresult in an increase to the allowance for losses on receivables. Futuredeclines in rental rates could result in additional impairment charges underSFAS No. 144 on operating lease aircraft. While we are unable to predictthe likelihood of these impacts occurring, such impacts could result in apotential material adverse effect on our earnings, cash flows or financialposition.

 

Duringthe fourth quarter of 2003, Boeing lost a major B-717 sales campaign, thusincreasing the possibility of B-717 program termination. Boeing CommercialAirplanes continues to aggressively market the B-717 aircraft. Programcontinuity is dependent on the outcome of Boeing’s current sales campaigns. AtMarch 31, 2004, $2.3 billion of our portfolio was collateralized by B-717aircraft. At March 31, 2004, we were the beneficiary under $1.5 billion ofguarantees from Boeing covering $2.2 billion of our portfolio. While wecontinue to believe in the utility and marketability of the B-717, we areunable to predict how an ending of B-717 production, as well as overall marketconditions, would impact B-717 values and rental rates. Should the B-717 suffera significant 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. Future declines in rental rates, if significant, couldresult in additional impairment charges under SFAS No. 144 on operatinglease aircraft. While we are unable to predict the likelihood of these impactsoccurring, such impacts could result in a potential material adverse effect onour earnings, cash flows or financial position.

 

At March 31, 2004, we had $253 million of assets that wereheld for sale or re-lease, of which $87 million were identified with a firmcontract to sell or place on lease. In the next 12 months, leases related toapproximately $272 million (2.2%) of our portfolio expire and we must re-leaseor sell 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 of Operations**

##### ** **

Overview

 

Our net income was $56 million for the threemonths ended March 31, 2004 compared with a net loss of $64 million forthe same period in 2003, a change of $120 million. The increase in net incomeis primarily attributable to the following:

 

•                  gains from assetsales of $26 million in the first quarter of 2004,

•                  absence ofadditional provision for losses during the first quarter of 2004 as comparedwith $130 million for the same period in 2003,

•                  asset impairmentexpense of $13 million in the first quarter of 2004 as compared with $42million for the same period in 2003, and

•                  offset by the taxeffect of the above items.

 

26

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We completed our quarterly portfolio review forthe first quarter of 2004. Based upon current market conditions we recordedasset impairment expense of $13 million and concluded an additional provisionfor losses was not required for the first quarter of 2004. By comparison, in thefirst quarter of 2003, we recognized $130 million in additional provision and$42 million of asset impairment expense. The 2003 amounts were driven by thedecline in the credit worthiness of our customers over the preceding two yearsand the fact that aircraft equipment values had dropped significantly over thepast few years. We carefully monitor the credit worthiness of our customers andthe relative value of aircraft equipment since we remain at risk to defaultsand decreases in the value of aircraft equipment and their associated leaserates. While equipment risk is inherent in our business, this risk has beenmagnified over the past few years by the lingering weakness in the airlineindustry and the resulting oversupply of aircraft equipment.

 

Our portfolio at March 31, 2004 totaled $12.2 billion, which is essentially unchanged from December 31, 2003, and up from the March 31, 2003 portfolio balance of $11.7 billion. Our new business volume for the three months ended March 31, 2004 is 21.3% less than that recorded for the same period in 2003 primarily as a result of reduced demand for commercial aircraft financings. Asset run-off was $251 million for the three months ended March 31, 2004 compared with $301 million for the same period in 2003 and $1.2 billion for the year ended December 31, 2003. We are anticipating minimal portfolio change primarily as a result of our change in business strategy as discussed in “Business Environment and Trends” and to a lesser extent, due to lower demand for commercial aircraft financings. Specifically, we expect minimal portfolio change in 2004 and less than $0.5 billion in 2005, compared with $0.5 billion in 2003. Our total revenues are expected to approximate $1.1 billion in 2004 and $1.2 billion in 2005. We also expect our return on assets to be greater than 1.0% in both 2004 and 2005, compared with 0.8% in 2003. The foregoing outlook assumes the gradual run-off of the Commercial Financial Services portfolio and excludes the impact of any sale or disposition of the Commercial Financial Services segment.

 

Results of Operations

 

*Financing revenues*(revenue fromfinancing leases, notes and other receivables and equipment under operatingleases) were as follows:
|                                |   | **Three  Months Ended  March 31,** |       |
|-------------------------------------|--------|-----------------------------------------|------------|
| **(Dollars in millions)**           |   | **2004**                                | ** ** | **2003** | ** ** |
| Finance lease income                |   | $                                       | 72         |   | $ | 77 |   |
| Interest income on notes receivable |   | 57                                      |       | 54 |   |
| Operating lease income              |   | 130                                     |       | 125 |   |
|                                |   | $                                       | 259        |   | $ | 256 |   |

 

# Financingrevenues**for the three monthsended March 31, 2004 were $259 million compared with $256 million for thesame period in 2003, an increase of $3 million (1.2%). The fluctuations withineach component of financing revenues closely follow the change in portfolio mixfrom the first quarter of 2003 to the same period in 2004.

#  

## ***Investmentincome***for the three months ended March 31, 2004 was$10 million compared with $11 million for the same period in 2003, a decreaseof $1 million (9.1%). The decrease was primarily due to lower income recognizedfor debt and equity investments.

 

27

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*Net gain on disposal* for the three months ended March 31,2004 was $26 million compared with no such gains for the same period in 2003.In the first quarter of 2004, an $18 million gain on sale of a portion of anotes receivable within the Aircraft Financial Services portfolio and a $6million gain on sale of an asset within the Commercial Financial Servicesportfolio were primarily responsible for the increase. 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 are returned.There can be no assurance that we will recognize these gains in the future.

 

*Other income* for the three months ended March 31, 2004 was $12 millioncompared with $16 million for the same period in 2003, a decrease of $4 million(25.0%). The decrease was primarily due to the following:

 

•                  the absence of $8million realized derivative gain earned in the first quarter of 2003,

•                  commitment feeincome decreased $2 million due to lower fundings in the first quarter of 2004as compared with the same period in 2003,

•                  interest incomeon short-term investments decreased $1 million due to lower short terminvestment balance in the first quarter of 2004 as compared with the sameperiod in 2003,

•                  no broker feeincome was earned in the first quarter of 2004 as compared with $1 million inthe same period in 2003, and

•                  offset by $9million increase in income related to supplemental rents for aircraftmaintenance on expired leases in the first quarter of 2004.

 

*Equity in loss from jointventure* for the three months ended March 31, 2004 was nil compared with aloss of $1 million for the same period in 2003. The 2003 loss consisted of thenet loss from operations in our interest in the BATA joint venture, which wepreviously accounted for under the equity method. In the third quarter of 2003,an amendment to the BATA agreement was finalized by ATA and us, which gave usmajority control in the management of the business and affairs of BATA. As aresult, BATA is now consolidated.

 

*Interest expense* for the threemonths ended March 31, 2004 was $103 million compared with $111 millionfor the same period in 2003, a decrease of $8 million (7.2%). The decline ininterest expense is primarily due to a 6.0% reduction in the debt balances.

 

*Depreciation expense* (on equipmentunder operating leases and equipment held for re-lease) for the three monthsended March 31, 2004 was $67 million compared with $63 million for thesame period in 2003, an increase of $4 million (6.3%). Growth in equipmentunder operating leases was primarily responsible for the increase.

 

*Provision for losses* for the threemonths ended March 31, 2004 was $9 million compared with $140 million forthe same period in 2003, a decrease of $131 million (93.6%). The provision forlosses is comprised of a general provision and an additional provision. Thegeneral provision, which primarily relates to the size of the receivablesportfolio, was $9 million for the three months ended March 31, 2004compared with $10 million for the same period in 2003. No additional provisionwas recorded for the first quarter of 2004 compared with $130 million recordedfor the same period in 2003. The additional provision in the first quarter of2003 was in recognition of the deterioration in the credit worthiness of ourairline customers, airline bankruptcy filings and the continued decline incommercial aircraft and general equipment asset values. The provision forlosses maintains the allowance for losses on receivables at a level we deem tobe adequate to cover anticipated losses. Any additional provision to be takenin the future may be dependent upon the duration of the current economic andairline industry decline, or any significant defaults, repossessions orrestructurings at a time when depressed aircraft values and lease rates make itdifficult to sell or redeploy such aircraft. Aircraft valuations could declinematerially if significant numbers of aircraft, particularly types withrelatively few operators, are idled on account of further airline bankruptciesor restructurings.

 

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*Operating expenses*, which consistsof general and administrative expenses, for the three months ended March 31,2004 was $18 million compared with $16 million for the same period in 2003, anincrease of $2 million (12.5%). Higher administrative costs were primarilyresponsible for the increase in operating expenses. In the first quarter of2004, we announced that we intend to relocate our administrative operationscurrently in Long Beach, California to our headquarters in Renton, Washington.As a result, we expect our annual 2004 operating expenses to show a one-timeincrease of approximately $4 million to $6 million.

 

*Asset impairment expense* for the threemonths ended March 31, 2004 was $13 million compared with $42 million forthe same period in 2003, a decrease of $29 million. The $13 million impairmentlosses for the three months ended March 31, 2004 resulted from reducedprojected cash flows and deteriorated aircraft values for particular operatinglease assets and assets held for sale or re-lease.

 

*Other expenses* for the threemonths ended March 31, 2004 were $11 million compared with $23 million forthe same period in 2003, a decrease of $12 million. The decrease was primarilyattributable to a $21 millionwrite-off in the first quarter of 2003 of forward-starting interest rate swaps thatno longer qualified for fair value hedge accounting treatment, which was offset by anincrease of $9 million in aircraft maintenance and storage expenses in thefirst quarter of 2004.

 

*Provision (benefit) for incometaxes* for the three months ended March 31, 2004 was $31 millioncompared with ($49) million for the same period in 2003, a change of $80million. The pre-tax income for the first quarter of 2004 compared with thepre-tax loss for the same period in 2003 was primarily responsible for theincrease.

 

#### Liquidityand Capital Resources

####  

We have liquidity requirements, primarily to fund ongoing financingcommitments, meet debt obligations and to fund our operating expenses. We planto satisfy these liquidity needs from the following sources:

 

•      cash from operations and other receiptsfrom our portfolio,

•      issuance of commercial paper and otherdebt,

•      asset securitization, and

•      borrowings under committed creditfacilities.

 

We attempt to schedule our debt payments to correspond to ourscheduled receipts from our portfolio. We satisfy a significant portion of ourcash requirements from diversified global funding sources and do not depend onany one lender. We believe that we have adequate liquidity sources and accessto the capital markets to allow us to fulfill our current commitments. If thisbelief does not prove to be correct, we would be required to restrict our newbusiness volume, unless we obtained access to other sources of capital at ratesthat allow for a reasonable return on new business.

 

Risks that could affect our sources 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.

 

Due to the weakened condition of the airlineindustry, especially following the events of September 11, 2001, wereduced our leverage to account for the related increased business risks. Wecontinually assess our leverage, generally as measured by our debt-to-equityratio, in light of the risks in our business. These risks include, among others,the exposure in our portfolios, general market conditions, especially thoseassociated with our customers; future financing commitments; and our ability toaccess the capital markets.

 

29

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On December 23, 2003, we entered into asupport agreement with Boeing that included a liquidity provision. Under thisprovision, Boeing has committed itself to make contributions to us to theextent our fixed charge coverage falls below 1.05-to-1.

 

*Interest Rate Exposure*

 

Our assets and liabilities expose us to interestrate risk to the extent that those assets and liabilities are not exactlymatched according to currency or maturity and repricing characteristics. Thetypes and terms of borrowing and hedging instruments that are available to usin the market and possible changes in asset terms limit our ability to matchassets and liabilities. We attempt to keep this mismatch risk small, 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*

 

During the first three months of 2004, we did not issue any new seniordebt. Historically, we have also relied on the issuance of commercial paper asa short-term funding source. We had no commercial paper borrowings outstandingat March 31, 2004.

 

*Financing Interest Expense*

 

Our financing-relatedinterest expense for the three months ended March 31, 2004 was $103million, compared with $111 million for the same period in 2003. Leverage(debt-to-equity ratio) at March 31, 2004 was 4.4-to-1, as compared with4.7-to-1 at the end of 2003 and 5.6-to-1 at March 31, 2003. For adiscussion regarding our change in leverage, see “Liquidity and CapitalResources.”

 

##### **Credit Ratings**

##### ** **

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

 

##### **We have the following credit ratings as of the filing date:**

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

 

On December 17, 2003, Moody’s InvestorsService (“Moody’s”) confirmed our senior and short-term debt ratings.

 

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

 

Given our current ratingsand ratings outlook from the various credit rating agencies, we believe we haveready access to the capital markets. Our credit ratings are more closely tiedwith those of Boeing than ever before due to the new support agreement put inplace between Boeing and us in December 2003. Our ratings and spreadscould be impacted positively or negatively by changing perceptions of Boeing,which in turn may reflect changing views of the airline industry or the defenseindustry or of Boeing’s competitive positions in them. It is always possiblethat such changes could affect our access to the capital markets.

 

30

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##### **Segment Operations**

##### ** **

At March 31, 2004, our primary operationsincluded two principal financial reporting segments: Aircraft FinancialServices and Commercial Financial Services. We also have an Other segment,comprised of Space and Defense Financial Services. The determination ofsegments is based upon our internal organization.

 

In November 2003, we announced a significantchange in our strategic direction, moving from a focus on growing the portfolioto a focus on supporting Boeing’s major operating units and managing overallcorporate exposures. For the commercial aircraft market, this means we will befacilitating, arranging and providing financing to Boeing Commercial Airplanes’customers. For our space and defense markets, this means we will be primarilyengaged in arranging and structuring financing solutions for Boeing’sIntegrated Defense Systems government customers. This new strategic directionis likely to include the sale or wind-down of our Commercial Financial Servicesbusiness or portfolio. In addition, we will be enhancing the risk managementactivities to reduce exposures associated with the current portfolio.

 

Aircraft Financial Services arranges or providesfinancing to facilitate the purchase or lease of new Boeing commercial aircraftand represented 81.0% of our total portfolio at March 31, 2004. AircraftFinancial Services assists Boeing commercial aircraft customers in arrangingfinancing. At March 31, 2004, we owned 341 commercial aircraft and hadpartial ownership or security interest in an additional 223 aircraft, includingthose owned in joint ventures, EETC, ETC and other investment transactions.

 

Commercial Financial Services’ portfolio encompasses multipleindustries and a wide range of equipment, including corporate aircraft, machinetools and production equipment, containers and marine equipment, chemical, oiland gas equipment and other equipment types. Commercial Financial Servicesrepresented 17.6% of our total portfolio at March 31, 2004. OnJanuary 15, 2004, we announced that we have retained Credit Suisse FirstBoston, LLC to explore strategic options for the future of our CommercialFinancial Services business. The options being examined include a sale of theoperation itself, sale of the portfolio or a phased wind-down of the existingportfolio. We continue to explore these strategic options.

 

Space and Defense Financial Services handles funding arrangements forsatellites, military airplanes and other advanced technology products. Thisportfolio represented 1.4% of our total portfolio at March 31, 2004.

 

###### *Aircraft Financial Services*

######  

*Revenues* for thethree months ended March 31, 2004 were $247 million compared with $220million for the same period in 2003, an increase of $27 million (12.3%). An $18million gain on sale of a portion of a notes receivable in the first quarter ofthe 2004 compared with no such gains for the same period in 2003 was primarilyresponsible for the increase. The remaining increase in revenues closelyfollows the increase in portfolio balances from the first quarter of 2003 tothe same period in 2004.

 

*Interest expense*(allocated) for the three months ended March 31, 2004 was $82 millioncompared with $88 million for the same period in 2003, a decrease of $6 million(6.8%). Lower debt (allocated) associated with lower leverage was primarilyresponsible for the decrease.

 

# *Depreciationexpense* for the three months ended March 31, 2004 was $54 millioncompared with $50 million for the same period in 2003, an increase of $4million (8.0%). Growth in equipment under operating leases was responsible forthe increase.

 

31

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*Income (loss) before provision (benefit) forincome taxes* for the three months ended March 31,2004 was $72 million compared with a loss of $127 million for the same periodin 2003, a change of $199 million. The net income for the three months endedMarch 31, 2004 included pre-tax charges of $13 million, compared with $191million for the same period in 2003. The 2003 charges were recognized inresponse to the deterioration in the credit worthiness of our airlinecustomers, airline bankruptcy filings and the continued decline in commercialaircraft asset value.

 

*Commercial Financial Services*

 

*Revenues* for the three months ended March 31, 2004 were $56 millioncompared with $59 million for the same period in 2003, a decrease of $3 million(5.1%). The decrease was primarily due to reductions of $9 million in financingrevenues that closely follow the decrease in the portfolio from the firstquarter of 2003 to the same period in 2004, offset by $6 million gain on sale of assets.

 

*Interest expense* (allocated) for the three months ended March 31, 2004 was $19 million compared with $22 million for the same period in 2003, a decrease of $3 million (13.6%). The decrease is primarily attributable to lower debt (allocated) associated with the lower leverage.

 

Giventhe new strategic focus of our company (as previously discussed), the resultsof operations for 2004 and 2005 would decline or be eliminated, depending onwhether the Commercial Financial Services portfolio is gradually wound down orsold.

 

**Item 4. Controls and Procedures**

 

Evaluation of Disclosure Controls and Procedures

 

Our principalexecutive officer and principal financial officer, based on their evaluation ofour disclosure 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 thisQuarterly Report on Form 10-Q, have concluded that our disclosure controls andprocedures are adequate and effective for the purposes set forth in the definitionin Exchange Act rules.

 

Changes in Internal Controls

 

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

 

# **Part II**

#  

**Item1.  Legal Proceedings**

 

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

 

32

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**Item5.  Other Information**

 

New Business Volume

 

The following table shows the new business volume for each of oursegments:

 
|                           |   | **Three  Months Ended****March 31,** |       |
|--------------------------------|--------|-------------------------------------------|------------|
| **(Dollars in millions)**      |   | **2004**                                  | ** ** | **2003** | ** ** |
| Aircraft Financial Services    |   | $                                         | 276        |   | $ | 354 |   |
| Commercial  Financial Services |   | 17                                        |       | 18 |   |
| Other                          |   | 2                                         |       | 3 |   |
|                           |   | $                                         | 295        |   | $ | 375 |   |

 

Portfolio Balances

 

The following table shows the portfolio balances for each of oursegments:

 
| **(Dollars in millions)**     |   | **March 31,  2004** |   | **December 31,  2003** |   |
|-------------------------------|--------|--------------------------|--------|-----------------------------|--------|
| Aircraft Financial Services   |   | $                        | 9,895  |                        | $      | 9,817 |   |
| Commercial Financial Services |   | 2,149                    |   | 2,249                       |   |
| Other                         |   | 168                      |   | 182                         |   |
|                          |   | $                        | 12,212 |                        | $      | 12,248 |   |

 

The following table summarizes the net change inour total portfolio:

 
| **(Dollars in millions)**                   |   | **Three  Months Ended  March 31,  2004** |   | **Year Ended  December 31,  2003** |   |
|---------------------------------------------|--------|-----------------------------------------------|--------|-----------------------------------------|--------|
| New business volume                         |   | $                                             | 295    |                                    | $      | 2,044 |   |
| Non-cash consolidation of BATA Leasing, LLC |   | —                                        |   | 21                                      |   |
| Non-cash items from customer restructuring  |   | —                                        |   | (8                                      | )      |
| Portfolio impairment                        |   | (13                                           | )      | (102                                    | )      |
| Asset run-off                               |   | (251                                          | )      | (1,208                                  | )      |
| Depreciation expense                        |   | (67                                           | )      | (261                                    | )      |
| Net change in portfolio balance             |   | $                                             | (36    | )                                       | $      | 486 |   |

 

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Significant Concentrations

 

The following table includes our five largest customers at March 31,2004, with their related portfolio balances at December 31, 2003:

 
|                      |   | **March 31,  2004** |   | **December 31,  2003** |   |
|---------------------------|--------|--------------------------|--------|-----------------------------|--------|
| **(Dollars in millions)** |   | **Net Asset  Value**     |   | **% of Total  Portfolio**   |   | **Net Asset  Value** |   | **% of Total  Portfolio** |   |
| AirTran                   |   | $                        | 1,510  |                        | 12.4   | % | $ | 1,483 |   | 12.1 | % |
| United                    |   | 1,159                    |   | 9.5                         |   | 1,159 |   | 9.5 |   |
| American                  |   | 813                      |   | 6.7                         |   | 861 |   | 7.0 |   |
| ATA                       |   | 730                      |   | 6.0                         |   | 743 |   | 6.1 |   |
| Hawaiian                  |   | 485                      |   | 4.0                         |   | 509 |   | 4.2 |   |
|                      |   | $                        | 4,697  |                        |   |   | $ | 4,755 |   |   |   |

 

Our largest customer, AirTran Holdings, Inc. (“AirTran”), accounted for$1.5 billion of our total portfolio at both March 31, 2004 andDecember 31, 2003. Our AirTran portfolio includes investments in AirTranEETCs totaling $34 million and $33 million at March 31, 2004 andDecember 31, 2003, respectively. At March 31, 2004, the AirTranportfolio primarily consisted of 65 B-717s and the above-mentioned investments.AirTran signed an agreement with us in October 2002 to lease 22 of the 24B-717 aircraft returned by American Airlines (“American”), as discussed below.These aircraft were delivered during 2003.

 

Oursecond largest customer, United, accounted for $1.2 billion of our totalportfolio at both March 31, 2004 and December 31, 2003. AtMarch 31, 2004, the United portfolio was secured by security interests intwo B-767s and 13 B-777s and by an ownership and security interest in fiveB-757s. United filed for Chapter 11 bankruptcy protection onDecember 9, 2002. During the third quarter of 2003, we completed a restructuringof United’s aircraft loans and leases. The receivables associated with asecurity interest in the two B-767s and 13 B-777s were restructured with termsthat did not necessitate a troubled debt restructuring charge to the allowancefor losses on receivables. The lease terms attributable to the five B-757s inwhich we hold an ownership and security interest were revised in a manner thatreclassified these leases as operating leases. Additionally, we had previouslyassigned to a third party the rights to a portion of the lease payments onthese five B-757s. As a result of this lease restructuring, we recordedoperating lease equipment with a value of $84 million and non-recourse debt of$42 million (representing the obligation attributable to the assignment offuture lease proceeds) at the time of restructuring. As of March 31, 2004,United was current on all of its obligations related to these 20 aircraft.

 

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

 

Our third largest customer, American, accounted for $813 million and$861 million of our total portfolio at March 31, 2004 andDecember 31, 2003, respectively. At March 31, 2004, the Americanportfolio consisted of leases and loans on nine B-767s, two B-777s, 39 MD-83s,four MD-82s and subordinated debt in one B-777. We financed final deliverypayments on nine B-767s and two B-777s during 2003. We believe that all ofAmerican’s final delivery payment loans are adequately collateralized.

 

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Our fourth largest customer, ATA, accounted for $730 million and $743million of our total portfolio at March 31, 2004 and December 31,2003, respectively. At March 31, 2004, the ATA portfolio primarilyconsisted of 12 B-757s and an investment in ATA mandatorily redeemable preferredstock with a face amount of $50 million. In November 2002, ATA received aloan of $168 million administered by the Airline Transportation StabilizationBoard. In the third quarter of 2003, we agreed to restructure certainoutstanding leases by extending their terms and deferring a portion of theirrent 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.ATA was obligated to meet certain requirements as a condition for the terms ofthe restructured leases to remain in effect. These requirements included thecompletion of an exchange offering on its publicly traded debt, which wouldresult in a deferral of the principal debt maturity date. ATA satisfied those requirementsin January 2004.

 

Based on our current assessment of the financial condition of ATA,which takes into account factors such as the successful exchange offering ofits publicly traded debt, we believe it is probable that we will collect underthe terms of our investment in ATA mandatorily redeemable preferred stock. Wehave therefore concluded that no other-than-temporary impairment is warrantedfor this preferred stock investment. We will continue to review ATA’s financialcondition and our expectation of collecting under the terms of our investmentin ATA’s mandatorily redeemable preferred stock.

 

Our fifth largest customer, Hawaiian, accounted for $485 million and$509 million of our total portfolio at March 31, 2004 andDecember 31, 2003, respectively. At March 31, 2004, the Hawaiianportfolio primarily consisted of 11 B-717s and three B-767s. Hawaiian filed forChapter 11 bankruptcy protection on March 21, 2003. We permitedHawaiian to return two B-717s leased by us. These B-717s were leased to a thirdparty in the first quarter of 2004. In February 2004, we filed in court,as a co-proponent with Corporate Recover Group, a Hawaiian plan ofreorganization, which would include among other things a revision of our leaseterms resulting in a substantial decrease in our rentals from Hawaiian. Takinginto account the specific reserves allocated for the Hawaiian receivables, wedo not expect that our transactions with Hawaiian will have a material adverseeffect on our earnings, cash flows or financial position. In the event thatfuture negotiations or proceedings result in the return of a substantial numberof aircraft, there could be a material adverse effect on our earnings, cashflows or financial position, at least until such time as the aircraft are soldor redeployed for adequate consideration.

 

35

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Aircraft Financial Services Portfolio

 

Our Aircraft Financial Services portfolio consisted of the followingaircraft types:

 
| **(Dollars  in millions)**       |   | **Receivables  (1)** |   | **Operating  Leases (1)** |   | **Investments  (4)** |   | **Held for  Sale or  Re-Lease** |   | **Total** |   |
|----------------------------------|--------|----------------------|--------|---------------------------|--------|----------------------|--------|---------------------------------|--------|-----------|--------|
| **March 31, 2004**          |   |                 |   |                      |   |                 |   |                            |   |      |   |
| B-717                            |   | $                    | 1,786  |                      | $      | 469                  |   | $                               | — |      | $      | — |   | $ | 2,255 |   |
| B-727 (2)                        |   | —               |   | 14                        |   | —               |   | 19                              |   | 33        |   |
| B-737                            |   | 70                   |   | 662                       |   | —               |   | —                          |   | 732       |   |
| B-747                            |   | 223                  |   | 435                       |   | —               |   | —                          |   | 658       |   |
| B-757                            |   | 1,027                |   | 446                       |   | —               |   | 56                              |   | 1,529     |   |
| B-767                            |   | 744                  |   | 371                       |   | —               |   | —                          |   | 1,115     |   |
| B-777                            |   | 1,180                |   | —                    |   | —               |   | —                          |   | 1,180     |   |
| DC-9 (2)                         |   | 3                    |   | 1                         |   | —               |   | 1                               |   | 5         |   |
| MD-80 (2)                        |   | 353                  |   | 97                        |   | —               |   | 12                              |   | 462       |   |
| MD-90 (2)                        |   | 83                   |   | —                    |   | —               |   | 49                              |   | 132       |   |
| DC-10 (2)                        |   | 32                   |   | 36                        |   | —               |   | —                          |   | 68        |   |
| MD-11 (2)                        |   | 159                  |   | 668                       |   | —               |   | 72                              |   | 899       |   |
| Other Aircraft and Equipment (3) |   | 327                  |   | 45                        |   | —               |   | 2                               |   | 374       |   |
| Asset Pools (5)                  |   | —               |   | —                    |   | 417                  |   | —                          |   | 417       |   |
| Other (6)                        |   | —               |   | —                    |   | 36                   |   | —                          |   | 36        |   |
|                             |   | $                    | 5,987  |                      | $      | 3,244                |   | $                               | 453    |      | $      | 211 |   | $ | 9,895 |   |
|                             |   |                 |   |                      |   |                 |   |                            |   |      |   |
| **December 31,  2003**      |   |                 |   |                      |   |                 |   |                            |   |      |   |
| B-717                            |   | $                    | 1,785  |                      | $      | 394                  |   | $                               | — |      | $      | 18 |   | $ | 2,197 |   |
| B-727 (2)                        |   | —               |   | 14                        |   | —               |   | 20                              |   | 34        |   |
| B-737                            |   | 74                   |   | 671                       |   | —               |   | —                          |   | 745       |   |
| B-747                            |   | 228                  |   | 441                       |   | —               |   | —                          |   | 669       |   |
| B-757                            |   | 867                  |   | 489                       |   | —               |   | 22                              |   | 1,378     |   |
| B-767                            |   | 745                  |   | 362                       |   | —               |   | 14                              |   | 1,121     |   |
| B-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       |   |
| Other Aircraft and Equipment (3) |   | 352                  |   | 50                        |   | —               |   | 5                               |   | 407       |   |
| Asset Pools (5)                  |   | —               |   | —                    |   | 432                  |   | —                          |   | 432       |   |
| Other (6)                        |   | —               |   | —                    |   | 43                   |   | —                          |   | 43        |   |
|                             |   | $                    | 5,894  |                      | $      | 3,216                |   | $                               | 475    |      | $      | 232 |   | $ | 9,817 |   |

 

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

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

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

(4)          Represents aircraft and equipmentcollateralizing EETCs, ETCs and other trust-related interests and otherinvestments that we hold.

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

(6)          Represents investments in mandatorilyredeemable preferred stock and common stock.

 

36

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In addition to theaircraft in our Aircraft Financial Services portfolio, we had corporateaircraft in our Commercial Financial Services and Other portfolios of $971million and $947 million at March 31, 2004 and December 31, 2003,respectively.

 

At March 31, 2004,we owned 341 commercial aircraft and had partial ownership or security interestin an additional 223 aircraft, including those owned in joint ventures, EETC,ETC and other investment transactions.

 

AtMarch 31, 2004, $9.1 billion (96.0%) of our Aircraft Financial Servicesportfolio, excluding investments, was collateralized by Boeing products.

 

At March 31, 2004, our Aircraft Financial Services portfolio(excluding investments) was comprised of the following aircraft vintages:

 
| 2004 – 2000            |   | 57.5  | %      |
|-----------------------------|--------|-------|--------|
| 1999 – 1995            |   | 22.0  |   |
| 1994 – 1990            |   | 11.7  |   |
| 1989 – 1985            |   | 4.9   |   |
| 1984 and older              |   | 2.2   |   |
| Secured by other collateral |   | 1.7   |   |
|                        |   | 100.0 | %      |

 

Guarantees

 

At March 31, 2004,we were the beneficiary under $2.9 billion of guarantees, primarily issued byBoeing, with respect to our portfolio transactions totaling $4.5 billion. Anyguarantee calls that we make would be net of realization of underlying residualvalues, partial rent payments, re-lease rental payments or other mitigatingvalue received.

 

The guarantees in our favor are either fullor partial in nature and include residual value guarantees, first lossdeficiency guarantees and rental guarantees. Residual value guarantees providea specified asset value at the end of a lease agreement in the event of adecline 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 tablesummarizes our guarantees at March 31, 2004:

 
| **(Dollars in millions)** |   | **Domestic  Airlines** |   | **Foreign  Airlines** |   | **Domestic  Equipment** |   | **Total** |   |
|---------------------------|--------|------------------------|--------|-----------------------|--------|-------------------------|--------|-----------|--------|
| Amounts guaranteed by:    |   |                   |   |                  |   |                    |   |      |   |   |   |   |   |
| Boeing and subsidiaries   |   | $                      | 2,373  |                  | $      | 405                     |   | $         | 58     |   | $ | 2,836 |   |
| Other (1)                 |   | 16                     |   | —                |   | —                  |   | 16        |   |
|                      |   | $                      | 2,389  |                  | $      | 405                     |   | $         | 58     |   | $ | 2,852 |   |

 

----

(1)          Excludes guarantees made by entities affiliated withthe primary obligor.

 

37

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Guarantee amounts by aircraft type or equipment at March 31, 2004are summarized as follows:

 
| **(Dollars in millions)**               |   | **Guarantee** |   | **Net Asset  Value** |   |
|-----------------------------------------|--------|---------------|--------|----------------------|--------|
| B-717                                   |   | $             | 1,542  |                 | $      | 2,158 |   |
| B-757                                   |   | 593           |   | 593                  |   |
| Out of production twin-aisle aircraft   |   | 367           |   | 537                  |   |
| Out of production single-aisle aircraft |   | 87            |   | 116                  |   |
| Other Boeing and regional aircraft      |   | 205           |   | 1,038                |   |
| Other equipment                         |   | 58            |   | 58                   |   |
|                                    |   | $             | 2,852  |                 | $      | 4,500 |   |

 

During the three months ended March 31,2004, we recognized income of $4 million under these guarantees, all of whichwere from Boeing.

 

Portfolio by Region

 

At March 31, 2004, portfolio net assetvalues were represented in the following regions:

 
| **(Dollars in millions)** |   | **Aircraft  Financial  Services** |   | **Commercial  Financial  Services** |   | **Other** |   | **Total** |   | **% Total of    Portfolio** |   |
|---------------------------|--------|-----------------------------------|--------|-------------------------------------|--------|-----------|--------|-----------|--------|-----------------------------|--------|
| **Region**                |   |                              |   |                                |   |      |   |      |   |                        |   |
| United States             |   | $                                 | 6,982  |                                | $      | 1,679     |   | $         | 168    |                        | $      | 8,829 |   | 72.3 | % |
| Europe                    |   | 1,211                             |   | 98                                  |   | —    |   | 1,309     |   | 10.7                        |   |
| Latin America             |   | 675                               |   | 238                                 |   | —    |   | 913       |   | 7.5                         |   |
| Asia                      |   | 848                               |   | 39                                  |   | —    |   | 887       |   | 7.3                         |   |
| Africa                    |   | 69                                |   | 53                                  |   | —    |   | 122       |   | 1.0                         |   |
| Australia                 |   | 61                                |   | —                              |   | —    |   | 61        |   | 0.5                         |   |
| Canada                    |   | 47                                |   | 13                                  |   | —    |   | 60        |   | 0.5                         |   |
| Caribbean                 |   | 2                                 |   | 29                                  |   | —    |   | 31        |   | 0.2                         |   |
|                      |   | $                                 | 9,895  |                                | $      | 2,149     |   | $         | 168    |                        | $      | 12,212 |   | 100.0 | % |

 

38

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

 
| A.     | Exhibits     |   |                                                                                                                                                                                                                                                                                           |
|--------|--------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |         |   |                                                                                                                                                                                                                                                                                           |
|   | Exhibit 12   |   | Computation of Ratio of Income to Fixed Charges.                                                                                                                                                                                                                                               |
|   |         |   |                                                                                                                                                                                                                                                                                           |
|   | Exhibit 31.1 |   | Certification of President pursuant to Rules 13a-15(e) of the  Securities Exchange Act of 1934, as adopted pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002.                                                                                                                    |
|   |         |   |                                                                                                                                                                                                                                                                                           |
|   | Exhibit 31.2 |   | Certification of Chief Financial Officer pursuant to Rules 13a-15(e)  of the Securities Exchange Act of 1934, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                      |
|   |         |   |                                                                                                                                                                                                                                                                                           |
|   | Exhibit 32.1 |   | Certification of President pursuant to 18 U.S.C. Section 1350,  as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.  This document is being furnished in accordance with Securities and Exchange  Commission Release Nos. 33-8212 and 34-47551.               |
|   |         |   |                                                                                                                                                                                                                                                                                           |
|   | 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 January 15, 2004, for the purpose of disclosing  that Boeing Capital Corporation is exploring options for the Commercial  Financial Services segment and will consolidate its infrastructure. |
|   |                |   |   |
|   | 2.                  |   | Form 8-K dated February 2, 2004, for the purpose of disclosing  information relating to Boeing Capital Corporation that was contained in The  Boeing Company’s press release and Webcast of fourth quarter and full year  2003 financial results, dated January 29, 2004. |

 

39

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Signatures

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned, its principal financial officer and by its principal accountingofficer, thereunto duly authorized.

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

 

40

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