Item 1. Business
General
International Lease Finance Corporation (the “Company”) is primarily engaged in the acquisition of new commercial jet aircraft and the leasing of those aircraft to airlines throughout the world. In addition to its leasing activity, the Company regularly sells aircraft from its leased aircraft fleet to third party lessors and airlines. In some cases the Company provides fleet management services to companies with aircraft portfolios for a management fee. The Company also remarkets and sells aircraft owned by others for a fee. The Company, in terms of the number and value of transactions concluded, is a major owner-lessor of commercial jet aircraft.
As of December 31, 2003, the Company’s lease portfolio consisted of 611 owned jet aircraft, and nine aircraft classified as finance leases. Additionally, the Company provided fleet management services for 69 jet aircraft. See “Item 2.
Item 2. Properties
Flight Equipment
The Company’s management frequently reviews opportunities to acquire suitable commercial jet aircraft based not only on market demand and customer airline requirements, but also on the Company’s fleet portfolio mix criteria and leasing strategies. Before committing to purchase specific aircraft, the Company takes into consideration factors such as estimates of future values, potential for remarketing, trends in supply and demand for the particular type, make and model of aircraft and engines, and anticipated obsolescence. As a result, certain types and vintages of aircraft do not necessarily fit the profile for inclusion in the Company’s portfolio of aircraft owned and used in its leasing operations.
At December 31, 2003, all of the Company’s fleet was Stage III compliant, meaning that the aircraft hold or are capable of holding a noise certificate issued under Chapter 3 of Volume 1, Part II of Annex 16 of the Chicago Convention or have been shown to comply with the Stage III noise levels set out in Section 36.5 of Appendix C of Part 36 of the Federal Aviation Regulations of the United States. At December 31, 2003, the average age of the Company’s aircraft was 5.22 years.
The following table shows the scheduled lease terminations (for the minimum noncancelable period) by aircraft type for the Company’s operating lease portfolio at December 31, 2003:
This schedule excludes five aircraft which were not subject to lease at December 31, 2003, all of which were subsequently leased. As of March 5, 2004, leases covering 16 of the 27 aircraft with lease expiration dates in 2004 had been extended or leased to other customers.
Commitments
At December 31, 2003, the Company had committed to purchase the following new aircraft at an estimated aggregate purchase price (including adjustment for anticipated inflation) of approximately $25.7 billion for delivery as shown:
(a)
The Company has the right to designate the size of the aircraft within the specific model type at specific dates prior to contractual delivery.
(b)
Under the terms of the contract with Airbus, the Company intends to exercise its right to redesignate these aircraft to other aircraft types.
At December 31, 2003, the Company had committed to purchase the following 25 used aircraft at an estimated aggregate purchase price of approximately $500.0 million:
At December 31, 2003, the Company had options to purchase the following new aircraft at an estimated aggregate purchase price (including adjustment for anticipated inflation) of approximately $704.8 million for delivery as shown:
(a)
The Company has the right to designate the size of the aircraft within the specific model type at specific dates prior to contractual delivery.
Management anticipates that a significant portion of such aggregate purchase price will be funded by incurring additional debt. The exact amount of the indebtedness to be incurred will depend upon the actual purchase price of the aircraft, which can vary due to a number of factors, including inflation, and the
percentage of the purchase price of the aircraft which must be financed. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
The new aircraft listed above are being purchased pursuant to master agreements with each of The Boeing Company (“Boeing”) and AVSA, S.A.R.L., the sales subsidiary of Airbus Industrie (“Airbus”). These agreements establish the pricing formulas (which include certain price adjustments based upon inflation and other factors) and various other terms with respect to the purchase of aircraft. Under certain circumstances, the Company has the right to alter the mix of aircraft type ultimately acquired. As of December 31, 2003, the Company had made non-refundable deposits (exclusive of capitalized interest) with respect to the aircraft which the Company has committed to purchase of approximately $600.0 million and $520.0 million with Boeing and Airbus, respectively.
As of March 5, 2004, the Company had entered into contracts for the lease of new aircraft deliverable through 2010 as follows:
The Company will need to find customers for aircraft presently on order and not subject to contract and any new aircraft ordered and will need to arrange financing for portions of the purchase price of such equipment. Although the Company has been successful to date in placing its new aircraft on lease and has been able to obtain adequate financing in the past, there can be no assurance as to the future continued availability of lessees or of sufficient amounts of financing on terms acceptable to the Company.
Facilities
The Company’s principal offices are located at 10250 Constellation Blvd., Suite 3400, Los Angeles, California. The Company occupies space under leases which expire in 2015. As of March 1, 2004, the Company occupied approximately 127,000 square feet of office space. The leases provide for annual rentals of approximately $9,000,000, and the rental payments thereunder are subject to certain indexed escalation provisions.
Item 3.
Item 3. Legal Proceedings
The Company is not a party to any significant legal proceedings.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The Company is indirectly wholly owned by AIG and the Company’s common stock is not listed on any national exchange or traded in any established market. During the years ended December 31, 2003, 2002 and 2001, the Company paid cash dividends to its parent company of $49,000,000, $26,000,000, and $83,500,000, respectively. It is the intention of the Company to pay its parent company an annual dividend of at least 7% of net income subject to the dividend preference of any preferred stock outstanding. Under the most restrictive provisions of the Company’s borrowing arrangements, consolidated retained earnings at December 31, 2003 in the amount of $1,623,165,000 were unrestricted as to the payment of dividends.
Item 6.
Item 6. Selected Financial Data
The following table summarizes selected consolidated financial data and certain operating information of the Company. The selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements and notes thereto and “Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
International Lease Finance Corporation (“the Company”, “we”, “our”, “us”) primarily acquires new jet transport aircraft from Boeing and Airbus and leases these aircraft to airlines throughout the world. In addition to this leasing activity, we sell aircraft from our leased aircraft fleet to other leasing companies, financial services companies and airlines. In some cases, we provide fleet management services to companies with aircraft portfolios for a management fee. We have also provided asset value guarantees and loan guarantees to the buyers of aircraft or to financial institutions for a fee. We also remarket and sell aircraft owned or managed by others for a fee.
As of December 31, 2003, we owned 611 aircraft, had nine aircraft in the fleet that were classified as finance leases, and provided fleet management services for 69 aircraft. We have contracted with Airbus and Boeing to buy 438 new aircraft for delivery through 2010 with an estimated purchase price of $25.7 billion, 84 of which will deliver during 2004.
Our primary source of revenue is from operating leases. One measure of profitability we use is a ratio called lease margin, which is calculated using lease revenue minus total expenses divided by lease revenue. Lease margins have contracted over the last two years as a result of higher incidents of restructurings of leases with troubled airlines and repossessions of aircraft from lessees. The airline industry has been faced with many challenges such as higher fuel costs, terrorism and Severe Acute Respiratory Syndrome (“SARS”), among others. The market lease rate for aircraft decreased as excess aircraft were available from airlines with reduced capacity, idled aircraft and airlines which ceased operations over the past two years. We believe the airline industry is improving and lease rates will recover over a period of prolonged economic recovery. We are well-positioned in the current industry environment with signed lease agreements for all of our 2004 deliveries of new aircraft. There is, however, a lag between changes in market conditions and their impact on our results, as contracts that are signed during times of lower lease rates are still in effect as the market lease rates rise. Therefore, the improvement in the airline industry has yet to be completely reflected in our financial performance. Recent market trends indicate a modest increase in lease rates for the most desirable Airbus and Boeing twin engine single aisle and wide body aircraft for placements beginning in the second half of 2004 and beyond. Airline passenger and cargo traffic worldwide has again exhibited measured growth since late 2003. If such traffic growth can be sustained, it should benefit the economic recovery of the commercial airline industry.
Risk Factors Affecting International Lease Finance Corporation
Our business is subject to numerous risks and uncertainties, as described below and in the section titled “Quantitative and Qualitative Disclosures about Market Risk”.
Overall Airline Industry Risk
We operate as a supplier and financier to airlines. The risks affecting our airline customers are generally out of our control and impact our customers to varying degrees. As a result, we are indirectly impacted by all the risks facing airlines today. Our ability to succeed is dependent on the financial strength of our customers. Our customers’ ability to compete effectively in the market place and manage these risks has a direct impact on us. These risks include:
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Demand for air travel
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Competition between carriers
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Fuel prices and availability
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Labor costs
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Maintenance costs and stoppages
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Employee labor contracts
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Air traffic control infrastructure constraints
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Insurance costs
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Security, terrorism and war
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Health concerns
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Equity and borrowing capacity
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Environmental concerns
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Government regulation
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Interest rates
To the extent that our customers experience the negative impact of these risk factors, we may experience
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A downward pressure on demand for the aircraft in our fleet and reduced market lease rates and lease margins.
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A higher incident of lessee defaults and repossessions resulting in lower lease margins due to maintenance, consulting and legal costs associated with the repossession, as well as lost revenue for the time the aircraft are off lease and possibly lower lease rates from the new lessees.
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A higher incident of situations where we engage in restructuring lease rates for our troubled customers which reduces overall lease margins.
•
An inability to immediately place new and used aircraft when they become available through our purchase commitments and regular lease terminations on commercially accepted terms, resulting in lower lease margins due to aircraft not earning revenue and resulting in storage, insurance and maintenance costs.
Manufacturer Risk
The supply of jet transport aircraft, which we purchase and lease, is dominated by two airframe manufacturers, Boeing and Airbus, and a limited number of engine manufacturers. As a result, we are dependent on the manufacturers’ success in remaining financially stable, producing aircraft and related components which meet the airlines’ demands, both in type and quantity and fulfilling their contractual obligations to us. We have mitigated this risk, to the extent possible, by maintaining good relationships with all the manufacturers and monitoring their financial stability and production plans. Should the manufacturers fail to respond appropriately to changes in the market environment or fail to fulfill their contractual obligations, we may experience:
•
Missed or late delivery of aircraft ordered by us and an inability to meet our contractual obligations to our customers, resulting in lost or delayed revenues, lower growth rates and strained customer relationships.
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An inability to acquire aircraft and related components on terms which will allow us to lease those aircraft to customers at a profit, resulting in lower growth rates or a contraction in our fleet.
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A market place with too many aircraft available, creating a downward pressure on demand for the aircraft in our fleet and reduced market lease rates.
•
Poor customer support from the manufacturers of aircraft and components resulting in a reduced demand for a particular manufacturer’s product, creating a downward pressure on demand for those aircraft in our fleet and reduced market lease rates for those aircraft.
Borrowing Risks
Liquidity - We are heavily dependent on our ability to borrow the necessary funds to finance the purchase of aircraft and to have sufficient funds to repay our existing debt obligations. Our liquidity is dependent on having continued access to debt markets and maintaining our credit ratings. We manage this risk by maintaining access to many debt markets throughout the world. With insufficient liquidity we could potentially experience:
•
An inability to acquire aircraft, for which we have signed contracts, resulting in lower growth, lost revenue and strained manufacturer and customer relationships.
•
An inability to meet our debt maturities as they become due, resulting in payment defaults, non-compliance with debt covenants, reduced credit ratings and an inability to access certain debt markets.
Interest Rate Risks - We are impacted by fluctuations in interest rates. Our lease rates are generally fixed. Changes, both increases and decreases, in our cost of borrowing, as reflected in our composite interest rate, directly impact our lease margin. We manage the interest rate volatility and uncertainty by maintaining a
balance between fixed and floating rate debt, through derivative instruments and through matching debt maturities with lease maturities.
Other Risks
Residual Value - We bear the risk of re-leasing or selling the aircraft in our fleet that are subject to operating leases at the end of their lease terms. If demand for aircraft decreases, our average fleet age may increase because of an inability to sell, and market lease rates may decrease. Should this condition continue for an extended period, it could affect the market value of aircraft in our fleet and may result in impairment charges in accordance with Statement of Financial Accounting Standard (“SFAS”) No. 144 “Accounting for the Impairment or Disposal of Long-lived Assets”. See Management Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Polices and Estimates - Flight Equipment.
Obsolescence Risk - Aircraft are long-lived assets requiring long lead times to develop and manufacturer. As a result, aircraft of a particular model and type tend to become obsolete and less in demand over time, when newer more advanced and efficient aircraft are manufactured. This life cycle, however, can be shortened by world events, government regulation or customer preferences. We manage this risk by purchasing and maintaining a mix of flight equipment which we feel will meet our customer’s long-term needs, and will have the greatest airline demand and operational longevity. As aircraft in our fleet approach obsolescence, demand for that particular model and type will decrease. This may result in lease margins compressing or may result in impairment charges in accordance with SFAS 144.
Key Personnel - Our future success is dependent upon, among other things, the retention of our executive management team. There can be no assurance that we will be able to retain our executive officers and other key employees. The loss of the services of any of our executive officers or key employees could disrupt our operations.
Industry Condition
The Company’s sources of revenue are principally from scheduled and charter airlines and companies associated with the airline industry. The airline industry is cyclical, economically sensitive and highly competitive. Airlines and related companies may be affected by political or economic instability, terrorist activities, changes in national policy, competitive pressures on certain air carriers, fuel shortages, labor stoppages, insurance cost, recessions, and other political or economic events adversely affecting world or regional trading markets. The Company’s revenues and income will be affected by its customers’ ability to react to and cope with the volatile competitive environment in which they operate as well as the Company’s own competitive environment.
The Company generates approximately 20% of its revenue from customers based in Asia and the Pacific region, and has many other customers who operate flights to and from those areas. Travel between Asia and the rest of the world was negatively affected during 2003 by the outbreak of SARS. Many airlines in Asia and those traveling to Asia curtailed flights in response to the reluctance of people to travel to Asia during the first six months of 2003. Travel to Asia has, however, returned to historical levels since the World Health Organization lifted warnings against visits to SARS affected countries in the second quarter of 2003.
From time to time, certain of the Company’s customers have experienced economic difficulties resulting in the Company’s participation in customer restructurings. Such restructurings have involved the voluntary early termination of leases, the replacement of leased aircraft with smaller, less expensive leased aircraft, the arrangement of subleases from the primary lessee to another airline and the rescheduling of payments. In addition, in certain circumstances, the Company has repossessed aircraft.
As a result of the September 11, 2001 terrorist attacks on the United States, the general slowdown of the worldwide economy, both before and after the attacks, and world political unrest, many United States and international commercial air carriers have reduced capacity, idled aircraft, furloughed employees and initiated cost reduction programs and some have filed for bankruptcy protection and/or ceased operations. Many airlines still face significant economic challenges. Air carriers are experiencing increased competition from low
cost carriers, a reduction in passenger traffic and an actual or potential increase in costs, including insurance premiums, fuel cost and security costs. These factors combined with the potential for future terrorist attacks, the national and international responses to terrorist attacks, and other acts of war have created many economic and political uncertainties, which could adversely affect the Company’s business and revenues in the short and long-term in ways that cannot presently be predicted.
The effects of the worsening economic conditions, participation in customer restructurings and requirements to re-lease aircraft from airlines which have ceased operations during 2002 and 2003 had a negative impact on the Company’s results of operations in 2003. During 2003, two of the Company’s customers, Avianca (one owned aircraft) and Hawaiian Airlines (four owned aircraft), filed for protection under Chapter 11 of the United States Bankruptcy Code and four of the Company’s customers, Air Canada (eleven owned and one managed aircraft), Aero Lloyd Flugreisen (eight owned aircraft), Eagle Aviation (one owned and one managed aircraft) and Aeris (three owned and one managed aircraft), filed for protection under their respective country’s bankruptcy laws. The Company subsequently renegotiated the leases or placed the aircraft previously leased to those airlines with other airlines.
The Company experienced a decrease in its lease margin during 2003 due to the factors mentioned above. Management believes that this trend will likely continue until economic conditions and the global political environment stabilize and improve, and these improvements can be reflected in lease rates received from our lessees.
On October 16, 2003, Boeing announced that it had decided to complete production of the 757 jetliner in late 2004. At December 31, 2003, the Company owned 59 757s, all of which were on lease to airlines. As a result, the Company reviewed and reduced the residual values on the Boeing 757 aircraft type to an internally established value to more appropriately reflect management’s expectations of future values. The change in estimate will be recorded prospectively, commencing January 1, 2004 and will have an immaterial effect on the Company’s financial position and results of operations. The Company believes that the market place had already reflected this event in market lease rates and market values for these aircraft prior to the announcement, and the Company has already considered this event in its most recent impairment analysis. The analysis did not result in an impairment charge.
Critical Accounting Policies and Estimates
The Company’s discussion and analysis of its financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to revenue, depreciation, overhaul reserves, and contingencies. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. The results form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions and conditions.
The Company believes the following are the Company’s critical accounting policies, some of which require significant judgments and estimates, used in the preparation of the consolidated financial statements.
Lease Revenue: The Company, as lessor, leases flight equipment principally under operating leases and reports income ratably over the life of the lease as rentals become receivable under the provisions of the lease. The straight-line receivable is recorded in “Accrued interest, other receivables and other assets” on the Company’s Consolidated Balance Sheets. Past-due rentals are recognized on the basis of management’s assessment of collectibility. In certain cases, leases provide for additional rentals based on usage. The usage may be calculated based on hourly usage or on the number of cycles operated, depending on the lease contract. A cycle is defined as one take-off and landing. The usage is typically reported monthly by the lessee. Rentals received, but unearned under the lease agreements, are recorded in “Rentals received in advance” on the Company’s Consolidated Balance Sheets until earned.
Costs related to reconfiguration of aircraft cabins and other lessee specific modifications are capitalized and amortized over the life of the lease.
Flight Equipment Marketing: The Company markets flight equipment and recognizes this revenue when the equipment is sold and the risk of ownership of the equipment is passed to the new owner.
Flight Equipment: Flight equipment is stated at cost. Purchases, major additions and modifications and capitalized interest are capitalized. Normal maintenance and repairs, airframe and engine overhauls and compliance with return conditions of flight equipment returned from lease are provided for and paid for by the lessee. Generally, aircraft, including aircraft acquired under capital leases, are depreciated using the straight-line method over a 25 year life from the date of manufacture to a 15% residual value. Out of production aircraft types are depreciated using the straight line method over a 25 year life from the date of manufacture to an established residual value for each aircraft type. At the time assets are retired or sold, the cost and accumulated depreciation are removed from the related accounts and the difference, net of proceeds, is recorded as a gain or loss. The Company’s management is very active in the airline industry and reviews quarterly issues affecting the Company’s fleet, including events and circumstances that may affect impairment of aircraft values (e.g. residual value, useful life and current and future revenue generating capacity). Management evaluates aircraft in the fleet, as necessary, based on these events and circumstances in accordance with SFAS 144. SFAS 144 requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets is measured by comparing the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. These evaluations for impairment are significantly impacted by estimates of future revenues and other factors which involves some amount of uncertainty. The Company has, to date, not had any impairment writedown of aircraft.
Capitalized Interest: The Company borrows funds to finance progress payments for the construction of flight equipment ordered. The Company allocates the total interest incurred on such borrowings. This amount is capitalized and included in the cost of the equipment.
Provision for Overhauls: Under the provisions of many leases, the Company receives overhaul rentals based on the usage of the aircraft. For certain airframe and engine overhauls, the lessee is reimbursed by the Company for costs incurred up to, but not exceeding, related overhaul rentals paid to the Company by the lessee for usage of the aircraft.
Overhaul rentals are included under the caption “Rental of flight equipment” in the Company’s Consolidated Statement of Income. The Company provides a charge to operations for reimbursements at the time the overhaul rentals are paid by the lessee, based on overhaul rentals received and the estimated reimbursements during the life of the lease. The Company periodically evaluates the appropriateness of its reserve for these reimbursements and its reimbursement rate, and then adjusts the provision for overhauls accordingly.
Financial Condition
The Company borrows funds to purchase new and used flight equipment (see “Item 2. Properties - Commitments”), including funds for progress payments during the construction phase, and to pay existing debt obligations as they mature. These funds are borrowed principally on an unsecured basis from various sources. During 2003, the Company borrowed $8.7 billion (excluding commercial paper) and $2.1 billion was provided by operating activities to meet its needs. As of December 31, 2003, the Company had committed to purchase 438 new aircraft from Boeing and Airbus at an estimated aggregate purchase price of approximately $25.7 billion for delivery through 2010, of which the Company currently anticipates taking delivery of 84 aircraft in 2004 with an estimated aggregate purchase price of $4.6 billion. The Company also holds options to purchase 11 additional new aircraft deliverable through 2008 at an estimated aggregate purchase price of approximately $704.8 million. In addition, the Company had committed to purchase 25 used aircraft at an estimated purchase price of $500.0 million. The Company currently expects to fund expenditures for capital requirements as well as liquidity needs from a combination of available cash balances, internally generated
funds and financing arrangements. At December 31, 2003, 2002 and 2001, the Company’s debt financing and capital lease obligations were comprised of the following:
The above amounts represent the Company’s anticipated settlement of its currently outstanding debt obligations. Certain adjustments required to present currently outstanding debt obligations have been recorded and presented separately on the face of the balance sheet, including adjustments related to foreign currency and interest rate hedging activities. Composite interest rates and percentage of total debt at fixed rate reflect the effect of derivative instruments.
Public Debt
The Company has the ability to borrow under various public debt financing arrangements as follows:
(a)
Includes $1.08 billion, which was incorporated into the registration statement from a prior registration statement, increasing the maximum offering from $5.0 billion to $6.08 billion.
(b)
The Company has hedged the foreign currency risk of the notes through operating lease payments or derivatives.
(c)
This is a perpetual program. As a bond issue matures, the principal amount of that bond becomes available for new issuances under the program.
Capital Lease Obligations
The Company has Export Credit Lease financings which provide ten year, amortizing loans in the form of capital lease obligations. The interest rate on 62.5% of the original financed amount is 6.55% and the interest
rate on 22.5% of the original financed amount is fixed at rates varying between 6.18% and 6.89%. These two tranches are guaranteed by various European Export Credit Agencies. The remaining 15% of the original financed amount was prepaid by the Company. The remaining outstanding debt matures through 2005. The flight equipment associated with the obligations and included in Flight equipment under operating leases on the balance sheet, had a net book value of $0.8 billion at December 31, 2003.
Synthetic Lease Obligations
In 1995, 1996 and 1997, the Company, through subsidiaries, entered into sale-leaseback transactions providing proceeds to the Company in the amounts of $413.0 million, $507.6 million and $601.9 million, respectively, each relating to seven aircraft. The transactions resulted in the sale and leaseback of these aircraft under one year operating leases, each with six one year extension options for a total of seven years for each aircraft. The Company has not recorded any gains related to the transactions. The Company has the option to either buy back the aircraft or redeliver the aircraft for a fee to the lessor at the end of any lease period. The lease rates equate to fixed principal amortization and floating interest payments based on LIBOR or commercial paper pricing. The Company repurchased three aircraft before the lease termination, which were sold to third parties, and repurchased the remaining eleven aircraft from the 1995 and 1996 sale-leaseback transactions when the leases expired in December 2002 and September 2003, respectively. If the Company does not negotiate extensions of the one year operating lease terms as they expire in September 2004, it will be required to borrow additional funds at the maturity of the transactions and reacquire the seven aircraft. The estimated remaining minimum lease payments (exclusive of the interest component of rent) and buy-back amounts, at the contractual end of the transactions are $462.7 million. As discussed under New Accounting Pronouncements, the Company’s adoption of Financial Accounting Standards Board Interpretation (“FIN”) No. 46 resulted in the consolidation of the remaining entity, starting December 31, 2003. The Company recorded flight equipment of $462.7 million, synthetic lease obligations of $464.2 million, a net decrease in other liabilities of $3.9 million and an after tax gain of $2.4 million as a cumulative effect of an accounting change and ceased to record rent expense for the operating leases starting January 1, 2004.
Bank Term Debt
In January 1999, the Company entered into an Export Credit Facility, up to a maximum of $4.3 billion, for approximately 75 aircraft delivered through 2001. The Company used the facility to fund 85% of each aircraft’s purchase price. This facility is guaranteed by various European Export Credit Agencies. The Company financed 62 aircraft using $2.8 billion under this facility over ten years with interest rates from 5.753% to 5.898%. The debt is collateralized by a pledge of the shares of a subsidiary of the Company which holds title to the aircraft financed under the facility.
During the twelve months ended December 31, 2003, the Company entered into various bank financings for a total funded amount of $1.3 billion. The financings mature through 2009. One tranche of one of the loans totaling $410 million was funded in Japanese yen and swapped to US dollars. The interest rates are LIBOR based with spreads ranging from .375% to 1.625% at December 31, 2003.
Commercial Paper
The Company currently has a $4.8 billion Commercial Paper Program. Under this program, the Company may borrow in minimum increments of $100,000 for a period from one day to 270 days. Notwithstanding the program’s size, it is the Company’s intention to sell commercial paper not to exceed 75% of the aggregate amount of the backup facilities available (see Bank Commitments). The weighted average interest rate of the Company’s outstanding commercial paper was 1.07%, 1.46% and 4.10%, at December 31, 2003, 2002, and 2001, respectively.
Bank Commitments
As of December 31, 2003, the Company had committed revolving loans and lines of credit with 26 commercial banks aggregating $4.2 billion. These revolving loans and lines of credit principally provide for
interest rates that vary according to the pricing option in effect at the time of borrowing. Pricing options include prime, a range from .25% over LIBOR to .50% over LIBOR based upon utilization, or a rate determined by a competitive bid process with the banks. The revolving loans and lines of credit are subject to facility fees of up to .10% of amounts available. This financing is used primarily as backup for the Company’s maturing debt and other obligations.
Other Variable Interest Entities
The Company has sold aircraft to entities owned by third parties and has from time to time issued asset value guarantees or loan guarantees related to the aircraft sold. The Company has determined nine such entities each owning one aircraft are Variable Interest Entities (“VIEs”) which it is a primary beneficiary in. In accordance with FIN 46, the Company consolidated these entities at December 31, 2003. As a result of the consolidation, assets increased by $57.1 million and liabilities increased by $68.1 million. In addition, the Company recorded an after-tax charge of $11.0 million as a cumulative effect of an accounting change.
The Company has not established any other unconsolidated entities for the purpose of facilitating off-balance sheet arrangements or for other contractually narrow or limited purposes. The Company has, however, from time to time established subsidiaries, entered into joint ventures or created other partnership arrangements with the limited purpose of leasing aircraft or facilitating borrowing arrangements.
Derivatives
In the normal course of business, the Company employs a variety of derivative products to manage its exposure to interest rates and the resulting impact of changes in interest rates on earnings, with the objective to lower its overall borrowing cost and to maintain its optimal mix of variable and fixed rate interest obligations. The Company only enters into derivative transactions to hedge interest rate risk and currency risk and not to speculate on interest rates or currency fluctuations. These derivative products include interest rate swap agreements, currency swap agreements, and interest rate floors.
The counterparty to the Company’s derivative instruments is AIG Financial Products Corp. (“AIGFP”), a related party with the highest ratings available from the credit rating agencies. The derivatives are subject to a bilateral security agreement which, in certain circumstances, may allow one party to the agreement to require the second party to the agreement to provide collateral. Failure of the instruments or counterparty to perform under the derivative contracts could have a material impact on the Company’s results of operations.
Common and Preferred Stock
The Company received $400.0 million from AIG for the issuance of Series A Preferred Stock and repurchased $250.0 million of its Market Auction Preferred Stock during the year ended December 31, 2001.
During the year ended December 31, 2002, the Company repurchased $50.0 million of its Market Auction Preferred Stock, cancelled $400.0 million of its Series A Preferred Stock and issued 3,951,398 shares of its common stock for the value of the cancelled Series A Preferred Stock and 2,428,599 shares of its common stock for $250 million. AIG has no obligation to contribute additional equity to the Company.
Market Liquidity Risks
The Company is in compliance with all covenants or other requirements set forth in its credit agreements. Further, the Company does not have any rating downgrade triggers that would automatically accelerate the maturity dates of its debt. However, a downgrade in the Company’s credit rating could adversely affect the Company’s ability to borrow on, renew existing, or obtain access to new financing arrangements and would increase the cost of such financing arrangements. For example, a downgrade in credit rating could preclude the Company from issuing commercial paper under its current program.
Turmoil in the airline industry, continued political unrest in the Middle East and worldwide health issues have led to increased uncertainty in the debt markets in which the Company borrows funds. While the Company has been able to borrow the funds necessary to finance operations in the current market
environment, additional turmoil in the airline industry or political environment could limit the Company’s ability to borrow funds from its current funding sources. Should this occur the Company would seek alternative sources of funding, including securitizations, manufacturer’s financings, drawings upon its revolving loans and lines of credit facilities or additional short term borrowings. If the Company was unable to obtain sufficient funding, it would negotiate with manufacturers to defer deliveries of certain aircraft.
The following summarizes the Company’s contractual obligations at December 31, 2003, and the possible effect of such obligations on the Company’s liquidity and cash flows in future periods.
Existing Commitments (Exclusive of Interest)
Contingent Commitments
(a)
Includes synthetic lease obligations of seven aircraft.
(b)
From time to time the Company participates with banks, airlines and other financial institutions to assist in financing aircraft acquired by others by providing asset guarantees, put options, or loan guarantees collateralized by aircraft. As a result, should the Company be called upon to fulfill its obligations, the Company would have recourse to the value of the underlying aircraft. To the extent that the value of the underlying aircraft is less than the guarantee, the Company would record a contingent loss. At December 31, 2003 no losses were recorded as the underlying values of the aircraft were higher than or equal to the guaranteed value. Guarantees entered into after December 31, 2002, are recorded at fair value in accordance with FIN No. 45 “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees at Indebtedness of Others.” See Note A - Summary of Significant Accounting Policies.
Results of Operations
Revenues from the rentals of flight equipment increased 9.8% to $2,941.1 million in 2003 compared to $2,677.9 million in 2002 and 8.3% in 2002 compared to $2,473.8 million in 2001 due to an increase in the number of aircraft available for operating lease, partially offset by an increase in the number of aircraft being reconfigured and redelivered and therefore not earning revenues for some part of the year. Revenues were also negatively impacted by lower lease rates and restructured rents, as a result of the slowdown in the airline
industry that was exacerbated after the September 11, 2001 terrorist attacks. At December 31, 2003 the Company’s fleet, on which it earns rental revenue, consisted of 609 aircraft compared to 556 at December 31, 2002 and 471 at December 31, 2001. The cost of the leased fleet, which includes aircraft subject to sale-leaseback transactions from which rental income is earned, increased to $34.0 billion in 2003 from $30.6 billion in 2002 and $25.8 billion in 2001.
The Company’s Lease Margin (revenues from rentals of flight equipment less total expenses divided by revenues from rentals of flight equipment (as a percentage)) decreased to 21.7% in 2003 compared to 23.2% in 2002. In 2002, the Lease Margin decreased from 24.7% in 2001. Lease rates and interest rates on borrowings are the two components used to determine Lease Margin that are subject to the most uncertainty and are the principal causes for the fluctuations in the Lease Margin. Lease rates are impacted by the current interest rate market as operating leases are a form of financing. Lease rates are also impacted by demand for a particular aircraft type to fit the airlines requirements for capacity and efficiency compounded by the availability of those aircraft in the market place.
The Company’s Lease Margin has been favorably impacted by the downward trend in interest rates during 2003 and 2002. The benefit of these interest rate reductions has been offset by decreasing lease rates on returned and redelivered aircraft at lower lease rates than previously earned. Idle and excess aircraft in the market place has increased competition for the lease of aircraft. The Company expects that this downward pressure on lease rates will continue to impact Lease Margin as the effects of restructurings, repossessions and re-leases are realized in lease rates. Further, as interest rates are at historically low levels, the Company expects that the Lease Margin will experience further downward pressure as current interest rates climb. The Company experienced low Lease Margins in the mid-nineties, which resulted from the lingering impacts on lease rates from leases negotiated around the time of the Gulf War, compounded by a high interest environment and higher leverage. Due to the varying terms of the Company’s leases and borrowings, the effects of events and circumstances which cause changes in lease rates and interest rates in the current market place, may not fully materialize in the Company’s results of operations for three to five years.
ILFC Historical Operating and Lease Margins
In addition to its leasing operations, the Company engages in the marketing of flight equipment throughout the lease term, as well as the sales of flight equipment on a principal and commission basis. Revenue from flight equipment marketing was $64.3 million in 2003 compared to $66.3 million in 2002 and $62.9 million in 2001. The fluctuations were principally affected by a downturn in the market for flight equipment as well as the different types and the number of the flight equipment marketed in each period. The
Company sold 42 aircraft during 2003 (37 of which were sold to a related party, see “Related Party Transactions” for more information), compared to 8 in 2002 and 7 in 2001. In addition, the Company sold 6 engines during 2003, compared to 7 engines during 2002 and 5 engines during 2001.
Interest expense increased to $944.6 million in 2003 from $846.4 million in 2002 and $792.6 million in 2001, as a result of an increase in average debt outstanding, to finance aircraft acquisitions, to $20.3 billion in 2003, from $17.4 billion in 2002 and $14.7 billion in 2001 (excluding the effect of debt discount and foreign exchange adjustments). This increase was partially offset by a decrease in the average composite borrowing rate to 4.8% in 2003 from 4.9% in 2002 and 5.7% in 2001. The Company’s composite borrowing rate fluctuated as follows:
ILFC Composite Interest Rates and Prime Rates
The Company adopted SFAS No. 133 “Accounting for Derivatives and Hedging Activities” on January 1, 2001 (see notes to the consolidated financial statements). The transition adjustment in the amount of $15.2 million is accounted for as the cumulative effect of an accounting change. Interest expense for the years ended December 31, 2003, 2002 and 2001 includes a benefit of $1.7 million, $4.8 million and $0.6 million, respectively, related to hedging activities.
Depreciation of flight equipment increased to $1,124.8 million in 2003 from $954.2 million in 2002 and $802.8 million in 2001 due to an increase in the depreciable base of the fleet. The depreciable base of flight equipment during the same periods increased to $34.0 billion at December 31, 2003 from $29.6 billion in 2002 and $24.4 billion in 2001.
Provisions for overhauls increased to $112.6 million in 2003 from $90.7 million in 2002 and $94.4 million in 2001 due to an increase in the aggregate number of hours flown on which the Company collects overhaul revenue and against which the provision is computed.
The Company, in prior periods, entered into sale-leaseback transactions. Flight equipment rent related to the transactions decreased to $43.3 million in 2003, from $75.4 million in 2002 and $108.0 million in 2001 due to the maturing of two sale-leaseback transactions, one in December 2002 and one in September 2003, principal reductions, and a change in the lease rates resulting from changes in interest rates, affecting the floating rate component of the lease rates. The Company, through a subsidiary, had sale-leaseback transactions relating to 7 aircraft as of December 31, 2003. At December 31, 2003 the Company consolidated
the entity in accordance with FIN 46, and will cease to record rent expense starting January 1, 2004. Instead the payments will be applied to interest and to pay down principal of recorded synthetic lease obligations of $464.2 million.
Selling, general and administrative expenses was $78.4 million in 2003 compared to $88.9 million in 2002 and $65.2 million in 2001 primarily due to changes in costs related to the repossession cost and re-delivery of aircraft from one lessee to another.
The effective tax rate was 31.4% in 2003, 33.4% in 2002 and 33.4% in 2001. The Company’s effective tax rate fluctuates as a result of the effect of state taxes, foreign taxes and benefits related to the Company’s Foreign Sales Corporation and Extraterritorial Income Exclusion provisions of the Internal Revenue Code.
The Company performed an impairment review of all aircraft in its fleet as of June 30, 2003, in accordance with SFAS 144. No impairments have been recognized related to aircraft, as the existing service potential of the aircraft in the Company’s portfolio has not been diminished. Further, the Company has been able to re-lease the aircraft without diminution in lease rates to an extent that would warrant an impairment write down.
Accumulated other comprehensive income (loss) changed $144.2 million to $5.4 million in 2003 compared to $(138.6) million in 2002 primarily due to a change in the market value of cash flow hedges offset by an increase in the Euro exchange rate to the U.S. Dollar. See Note L - Financial Instruments in the Notes to the Consolidated Financial Statements.
Related Party Transactions
The Company contracted to sell 37 aircraft to a trust during the third quarter of 2003 for approximately $1.0 billion. The first 34 aircraft were transferred as of December 31, 2003, with the remaining three expected to be transferred in 2004. The trust is primarily funded and owned by other AIG subsidiaries and is consolidated by AIG. Neither the trust nor the subsidiaries are consolidated by the Company. The transaction was structured similar to a securitization, in which the trust acquired the aircraft based on values assigned by independent appraisers. Further, an unaffiliated third party acted as capital market advisor and initial purchaser of the notes of the securitization. The Company recorded gains in the amount of $23.2 million related to the transaction. The gain is included in “Flight equipment marketing” in the Company’s Consolidated Statements of Income. The Company will continue to manage the aircraft sold to the trust for a fee.
On January 14, 2004, the Company contracted to sell 34 aircraft to a different trust for approximately $1.0 billion. The first 23 aircraft were transferred as of March 1, 2004, with the remaining 11 expected to be transferred in 2004. The 2004 transaction is structured similarly to the 2003 transaction, and the trust is consolidated by AIG.
New Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board (“FASB”) issued FIN No. 46, “Consolidation of Variable Interest Entities” (“VIEs”). FIN 46 changes the method of determining whether certain entities should be consolidated in the Company’s consolidated financial statements. An entity is subject to FIN 46 and is called a VIE if it has (i) equity that is insufficient to permit the entity to finance its activities without additional subordinated financial support from other parties or (ii) equity investors that cannot make significant decisions about the entity’s operations, or that do not absorb the expected losses or receive the expected returns of the entity. A VIE is consolidated by its primary beneficiary, which is the party that has a majority of the expected losses or a majority of the expected residual returns of the VIE, or both. All other entities not considered VIEs are evaluated for consolidation under existing guidance. In December 2003, the FASB issued a revision to FIN 46, (“FIN 46R”).
The provisions of FIN 46R are to be applied immediately to VIEs created after January 31, 2003, and to VIEs in which the Company obtains an interest after that date. For VIEs in which the Company holds a variable interest that it acquired before February 1, 2003, FIN 46R was applied as of December 31, 2003. For
any VIEs that must be consolidated under FIN 46R that were created before February 1, 2003, the assets, liabilities and noncontrolling interest of the VIEs would be initially measured at their carrying amounts with any difference between the net amount added to the balance sheet and any previously recognized interest being recognized as the cumulative effect of an accounting change. At December 31, 2003 the Company determined it was a primary beneficiary in one entity through which it had entered into sale-lease back transactions for seven aircraft and nine entities for which it had provided asset value guarantees and loan guarantees. As a result of the consolidation of these companies, in accordance with the transition provisions of FIN 46R, assets increased by $519.8 million and liabilities increased by $528.4 million. The Company recorded an after-tax charge of $8.6 million as a cumulative effect of accounting change.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Measuring potential losses in fair values has recently become the focus of risk management efforts by many companies. Such measurements are performed through the application of various statistical techniques. One such technique is Value at Risk (VaR), a summary statistical measure that uses historical interest rates and foreign currency exchange rates which estimates the volatility and correlation of these rates and prices to calculate the maximum loss that could occur over a defined period of time given a certain probability.
The Company believes that statistical models alone do not provide a reliable method of monitoring and controlling market risk. While VaR models are relatively sophisticated, the quantitative market risk information generated is limited by the assumptions and parameters established in creating the related models. Therefore, such models are tools and do not substitute for the experience or judgment of senior management.
The Company is exposed to market risk and the risk of loss of fair value and possible liquidity strain resulting from adverse fluctuations in interest rates and foreign exchange prices. The Company statistically measures the loss of fair value through the application of a VaR model on a quarterly basis. In this analysis the net fair value of the Company’s operations is determined using the financial instrument assets and other assets and liabilities. This includes tax adjusted future flight equipment lease revenues and financial instrument liabilities, which includes future servicing of current debt. The impact of current derivative positions is also taken into account.
The Company calculates the VaR with respect to the net fair value by using the historical simulation methodology. This methodology entails re-pricing all assets and liabilities under explicit changes in market rates within a specific historical time period. In this case, the most recent three years of historical information for interest rates and foreign exchange rates were used to construct the historical scenarios at December 31, 2003 and 2002 respectively. For each scenario, each financial instrument is re-priced. Scenario values for the Company’s operations are then calculated by netting the values of all the underlying assets and liabilities. The final VaR number represents the maximum adverse deviation in fair market value incurred by these scenarios with 95% confidence (i.e. only 5% of historical scenarios show losses greater than the VaR figure). A one month holding period is assumed in computing the VaR figure. The following table presents the average, high and low VaRs for the Company’s operations with respect to its fair value as of December 31, 2003 and 2002, respectively:
ILFC Market Risk
Item 8.
Item 8. Financial Statements and Supplementary Data
The response to this Item is submitted as a separate section of this report.
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
(a) The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in its filings under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the periods specified in the rules and forms of the Securities and Exchange Commission. Such information is accumulated and communicated to management of the Company, including the Chairman of the Board and Chief Executive Officer and the Vice Chairman, Chief Financial Officer and Chief Accounting Officer (collectively the “Certifying Officers”), as appropriate, to allow timely decisions regarding required disclosure. The management of the Company, including the Certifying Officers, recognizes that any set of controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.
(b) As of the end of the period covered by this Annual Report on Form 10-K, The Company has carried out an evaluation, under the supervision and with the participation of management, including the Certifying Officers, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based upon that evaluation, the Certifying Officers concluded that disclosure controls and procedures provide reasonable assurance that the information required to be disclosed is recorded, processed, summarized, and reported within the periods specified by the Securities and Exchange Commission.
(c) There have been no changes in the Company’s internal controls over financial reporting identified in connection with the evaluation referred to above that occurred during the Company’s fourth quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting.
PART III
Item 14.
Item 14. Principal Accountant Fees and Services
Aggregate fees for professional services rendered to the Company by PricewaterhouseCoopers LLP (“PricewaterhouseCoopers”) for the years ended December 31, 2003 and 2002, were:
(a)
Audit fees consists of fees for professional services provided in connection with the audits of the Company’s financial statements, services rendered in connection with the Company’s registration statements filed with the Securities and Exchange Commission, the delivery of consents and issuance of comfort letters.
(b)
Audit Related fees consist of fees for consulting on various accounting issues.
(c)
Tax fees consist of the aggregate fees for services rendered for tax compliance, tax planning and tax advice.
The Company’s parent’s audit committee (“the audit committee”) approves all audit and non-audit services rendered by PricewaterhouseCoopers. The audit committee also reviews non-audit fees to ensure the
auditors’ independence is maintained. The audit committee has approved non-audit services for consulting accounting related issues and tax compliance in the amount of $516,000 for the year ended December 31, 2004.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a)(1) and (2): Financial Statements and Financial Statement Schedule: The response to this portion of Item 15 is submitted as a separate section of this report.
(a)(3) and (c): Exhibits: The response to this portion of Item 15 is submitted as a separate section of this report.
(b)
Reports on Form 8-K: Current Report on Form 8-K:
Form 8-K, event date November 7, 2003 (Item 7)
INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES
FORM 10-K
Items 8, 15(a), and 15(c)
INDEX OF CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
The following consolidated financial statements of the Company and its subsidiaries required to be included in Item 8 are listed below:
The following financial statement schedule of the Company and its subsidiaries is included in Item 15(a)(2):
All other financial statements and schedules not listed have been omitted since the required information is included in the consolidated financial statements or the notes thereto, or is not applicable or required.
The following exhibits of the Company and its subsidiaries are included in Item 15(c):
REPORT OF INDEPENDENT AUDITORS
To The Shareholders and Board of Directors
International Lease Finance Corporation
Los Angeles, California:
In our opinion, the accompanying consolidated financial statements listed in the accompanying index appearing under Item 15(a)(1) on page 26 present fairly, in all material respects, the financial position of International Lease Finance Corporation and its subsidiaries (the “Company”) at December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule for the year ended December 31, 2003 listed in the accompanying index appearing under Item 15(a)(2) on page 26 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and the financial statement schedule are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note A to the consolidated financial statements, on December 31, 2003, the Company adopted Financial Accounting Standards Board Interpretation No. 46 “Consolidation of Variable Interest Entities.”
PricewaterhouseCoopers LLP
Los Angeles, California
February 11, 2004
INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share and per share amounts)
See accompanying notes.
INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands)
See accompanying notes.
INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(Dollars in thousands)
See accompanying notes.
INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Dollars in thousands)
See accompanying notes.
INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands)
Note A - Summary of Significant Accounting Policies
Organization: International Lease Finance Corporation (the “Company”) is primarily engaged in the acquisition of new commercial jet aircraft and the leasing of those aircraft to airlines throughout the world. In addition to its leasing activity, the Company regularly sells aircraft from its leased aircraft fleet and aircraft owned by others to third party lessors and airlines and in some cases provides fleet management services to these buyers. The Company, in terms of the number and value of transactions concluded, is a major owner-lessor of commercial jet aircraft.
Parent Company: International Lease Finance Corporation is an indirect wholly owned subsidiary of American International Group, Inc. (“AIG”). AIG is a holding company which through its subsidiaries is primarily engaged in a broad range of insurance and insurance-related activities in the United States and abroad. AIG’s primary activities include both general and life insurance operations. Other significant activities include financial services and retirement services and asset management.
Principles of Consolidation: The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries and certain variable interest entities, for which the Company is the primary beneficiary, as discussed under Adoption of New Accounting Pronouncements. Investments of less than 20% in other entities are carried at cost. Investments of between 20% and 50% in other entities are carried under the equity method. All significant intercompany balances and transactions have been eliminated in consolidation.
Intercompany Allocations and Fees: The Company is party to cost sharing agreements with AIG. Generally, these agreements provide for the allocation of costs based upon either a specific identification basis or a proportional cost allocation basis. The charges aggregated $1,458 (2003), $1,198 (2002) and $1,001 (2001). The Company also pays AIG a fee related to management services provided for certain foreign subsidiaries. The fees aggregated $561 (2003), $388 (2002) and $759 (2001). The Company earned management fees from a trust consolidated by AIG for the management of aircraft sold to the trust. These management fees aggregated $1.3 million (2003).
Lease Revenue: The Company, as lessor, leases flight equipment principally under operating leases and reports income ratably over the life of the lease as rentals become receivable under the provisions of the lease. The straight-line receivable is recorded in “Accrued interest, other receivables, and other assets” on the balance sheet. Past-due rentals are recognized on the basis of management’s assessment of collectibility. In certain cases, leases provide for additional rentals based on usage. The usage may be calculated based on hourly usage or on the number of cycles operated, depending on the lease contract. A cycle is defined as one take-off and landing. The usage is typically reported to the Company monthly by the lessee.
Rentals received, but unearned under the lease agreements are recorded in “Rentals received in advance” on the balance sheet until earned.
Costs related to reconfiguration of the aircraft cabin and other lessee specific modifications are capitalized as pre-paid lease cost and amortized over the life of the lease.
Flight Equipment Marketing: The Company is a marketer of flight equipment. Marketing revenues include all revenues from such operations consisting of net gains on sales of flight equipment and commissions. The Company recognizes marketing revenue when flight equipment is sold and the risk of ownership of the equipment is passed to the new owner.
Provision for Overhauls: Under the provisions of many leases, the Company receives overhaul rentals based on the usage of the aircraft. For certain airframe and engine overhauls, the lessee is reimbursed by the Company for costs incurred up to, but not exceeding, related overhaul rentals paid to the Company by the lessee for usage of the aircraft.
INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
Note A - Summary of Significant Accounting Policies (Continued)
Overhaul rentals are included under the caption Rental of flight equipment in the income statement. The Company provides a charge to operations for reimbursements at the time the overhaul rentals are paid by the lessee, based on overhaul rentals received and the estimated reimbursements during the life of the lease. The Company periodically evaluates its reserve for these reimbursements and its reimbursement rate, and adjusts the provision for overhauls accordingly.
Cash: Cash includes cash on hand, time deposits and cash held in trust for Internal Revenue Code Section 1031 exchanges.
Flight Equipment: Flight equipment is stated at cost. Purchases, major additions and modifications and capitalized interest are capitalized. Normal maintenance and repairs, airframe and engine overhauls, and compliance with return conditions of flight equipment on lease are provided for and paid for by the lessee.
Generally, aircraft, including aircraft acquired under capital leases, are depreciated using the straight-line method over a 25 year life from the date of manufacture to a 15% residual value. Out of production aircraft types are depreciated using the straight line method over a 25 year life from the date of manufacture to an established residual value for each aircraft type.
At the time assets are retired or sold the cost and accumulated depreciation are removed from the related accounts and the difference, net of proceeds, is recorded as a gain or loss.
The Company’s management is very active in the airline industry and reviews quarterly issues affecting the Company’s fleet, including events and circumstances that may affect impairment of aircraft values (e.g. residual values, useful life, current and future revenue generating capacity). Management evaluates aircraft in the fleet, as necessary, based on these events and circumstances in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets.”
Capitalized Interest: The Company borrows certain funds to finance progress payments for the construction of flight equipment ordered. The interest incurred on such borrowings is capitalized and included in the cost of the equipment.
Deferred Debt Issue Costs: Deferred debt issue costs incurred in connection with debt financing are amortized over the life of the debt using the interest method and are charged to interest expense.
Financial Instruments: In the normal course of business, the Company utilizes derivative financial instruments to manage its exposure to interest rate risks and foreign currency risks. The Company accounts for derivatives in accordance with SFAS No. 133 “Accounting for Derivatives and Hedging Activites”. All derivatives are recognized on the balance sheet at their fair value. On the date that the Company enters into a derivative contract, it designates the derivative as (1) a hedge of (a) the fair value of a recognized asset or liability or (b) an unrecognized firm commitment (a “fair value” hedge); (2) a hedge of (a) a forecasted transaction or (b) the variability of cash flows that are to be received or paid in connection with a recognized asset or liability (a “cash flow” hedge); or (3) a foreign-currency fair value or cash flow hedge (a “foreign currency” hedge). Changes in the fair value of a derivative that is highly effective and that is designated and qualifies as a fair-value hedge, along with changes in the fair value of the hedged asset or liability that are attributable to the hedged risk, are recorded in current-period earnings. Changes in the fair value of a derivative that is highly effective and that is designated and qualifies as a cash flow hedge, to the extent that the hedge is effective, are recorded in accumulated other comprehensive income, until earnings are affected by the variability of cash flows of the hedged transaction (e.g. until periodic settlements of the variable-rate asset or liability are recorded in earnings). Any hedge ineffectiveness (which represents the amount by which the changes in the fair value of the derivative exceed the variability in the cash flows of the forecasted transaction)
INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
Note A - Summary of Significant Accounting Policies (Continued)
is recorded in current-period earnings. Changes in the fair value of a derivative that is highly effective and that is designated and qualifies as a foreign currency hedge are recorded in either current-period earnings or other accumulated comprehensive income, depending on whether the hedging relationship satisfies the criteria for a fair value or cash flow hedge. Changes in the fair value of derivative financial instruments that did not qualify for hedge treatment under SFAS 133 are reported in current-period earnings.
The Company formally documents all relationships between hedging instruments and hedged items, as well as risk management objectives and strategies for undertaking various hedge transactions. This includes linking all derivatives that are designated as fair value, cash flow, or foreign currency hedges to specific assets or liabilities on the balance sheet. The Company also assesses (both at the hedge’s inception and on an ongoing basis) whether the derivatives that are used in hedging transactions have been highly effective in offsetting changes in the fair value or cash flow of hedged items and whether those derivatives may be expected to remain highly effective in future periods. When it is determined that a derivative is not (or has ceased to be) highly effective as a hedge, the Company will discontinue hedge accounting prospectively, as discussed below.
The Company will discontinue hedge accounting prospectively when (1) it determines that the derivative is no longer effective in offsetting changes in the fair value or cash flows of a hedged item; (2) the derivative expires or is sold, terminated, or exercised; or (3) management determines that designating the derivative as a hedging instrument is no longer appropriate.
When hedge accounting is discontinued due to the Company’s determination that the derivative no longer qualifies as an effective fair value hedge, the Company will continue to carry the derivative on the balance sheet at its fair value, but will cease to adjust the hedged liability for changes in fair value. In all situations in which hedge accounting is discontinued and the derivative remains outstanding, the Company will carry the derivative at its fair value on the balance sheet, recognizing changes in the fair value in current-period earnings.
Other Comprehensive Income (Loss): The Company reports comprehensive income or loss in accordance with SFAS No. 130, “Reporting Comprehensive Income.” The Company’s other comprehensive income (loss) reported in shareholders’ equity as Accumulated other comprehensive income (loss) consists of adjustments of debt denominated in a foreign currency, translated into US dollars using the current exchange rates and the gains and losses associated with changes in fair value of derivatives designated as cash flow hedges in accordance with SFAS 133.
Guarantees: The Company accounts for guarantees in accordance with Financial Accounting Standards Board (“FASB”) Interpretation (“FIN”) No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others.” Guarantees entered into after December 31, 2002 are included in Accrued interest, and other payables on the 2003 balance sheet.
Income Taxes: The Company and its U.S. subsidiaries are included in the consolidated federal income tax return of AIG. The provision for federal income taxes is calculated, generally on a separate return basis adjusted to give recognition to the effects of net operating losses, foreign tax credits and the benefit of the Foreign Sales Corporation (“FSC”) and Extraterritorial Income Exclusion (“ETI”) provisions of the Internal Revenue Code to the extent they are currently realizable in AIG’s consolidated return. Income tax payments are made pursuant to a tax payment allocation agreement whereby AIG credits or charges the Company for the corresponding increase or decrease (not to exceed the separate return basis calculation) in AIG’s current taxes resulting from the inclusion of the Company in AIG’s consolidated tax return. Intercompany payments are made when such taxes are due or tax benefits are realized by AIG.
INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
Note A - Summary of Significant Accounting Policies (Continued)
The Company and its U.S. subsidiaries are included in the combined state unitary tax returns of AIG, including California. The Company also files separate returns in certain other states, as required. The provision for state income taxes is calculated, generally on a separate return basis giving effect to the AIG unitary rate and credits and charges allocated to the Company by AIG, based upon the combined filings and the resultant current tax payable.
The deferred tax liability is determined based on the difference between the financial statement and tax basis of assets and liabilities and is measured at the enacted tax rates that will be in effect when these differences reverse. Deferred tax expense is determined by the change in the liability for deferred taxes (“Liability Method”). Current income taxes on the balance sheet principally represent amount receivable or payable from/to AIG under the tax sharing agreements.
Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
Reclassifications: Certain amounts have been reclassified in the 2002 and 2001 financial statements to conform to the Company’s 2003 presentation.
Adoption of New Accounting Pronouncements: In January 2003, the FASB issued FIN No. 46, “Consolidation of Variable Interest Entities” (“VIE”). FIN 46 changes the method of determining whether certain entities should be consolidated in the Company’s consolidated financial statements. An entity is subject to FIN 46 and is called a VIE if it has (i) equity that is insufficient to permit the entity to finance its activities without additional subordinated financial support from other parties or (ii) equity investors that cannot make significant decisions about the entity’s operations or that do not absorb the expected losses or receive the expected returns of the entity. A VIE is consolidated by its primary beneficiary, which is the party that has a majority of the expected losses or a majority of the expected residual returns of the VIE, or both. All other entities not considered VIEs are evaluated for consolidation under existing guidance. In December 2003, the FASB issued a revision to FIN 46, (“FIN 46R”).
The provisions of FIN 46R apply immediately to VIEs created after January 31, 2003 and to VIEs in which the Company obtains an interest after that date. For VIEs in which the Company holds a variable interest that it acquired before February 1, 2003, FIN 46R was applied as of December 31, 2003. For any VIE that must be consolidated under FIN 46R that was created before February 1, 2003, the assets, liabilities and non-controlling interest of the VIEs would be initially measured at their carrying amounts with any difference between the net amount added to the balance sheet and any previously recognized interest being recognized as the cumulative effect of an account change. The Company’s adoption of FIN 46 had the following effect on the Company’s financial statements:
Off Balance Sheet Arrangements: The Company’s off balance sheet arrangements in the form of sale-leaseback transactions entered into in 1997 exist to facilitate financing of aircraft at favorable rates. As a result of the adoption of FIN 46R at December 31, 2003, the Company recorded flight equipment of $462.7 million, synthetic lease obligations of $464.2 million, a net decrease in other liabilities of $3.9 million and an after tax gain of $2.4 million as a cumulative effect of accounting change.
Other Variable Interest Entities: The Company has provided financing or guaranteed third party financing to entities owned by independent third parties and existing for the purpose of owning and leasing one aircraft each. The financing agreements are collateralized by the aircraft. As a result at the adoption of FIN 46R, the Company recorded a net increase in assets of $57.1 million, liabilities of $68.1 million and recorded an after-tax charge of $11.0 million as a cumulative effect of accounting change.
INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
Note A - Summary of Significant Accounting Policies (Continued)
Other New Accounting Pronouncements: In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS 150 requires certain financial instruments previously classified as either entirely equity or between the liability section and equity section of the balance sheet be classified as liabilities. SFAS 150 was effective for quarter ended September 30, 2003.
The Company adopted Emerging Issues Task Force (“EITF”) issue 02-16 “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor” which provides guidance on accounting for cash considerations received by a customer from a vendor as either a reduction of cost of sales, as revenue, or as reduction of cost incurred by the customer to sell the vendor’s product. The adoption of EITF 02-16 did not have a significant impact on its results of operations, financial position or cash flows.
These statements have no effect on the operations of the Company at December 31, 2003, and the adoption did not have any impact on the Company’s results of operations, financial position, or cash flows.
Note B - Notes Receivable
Notes receivable are primarily from the sale of and collaterized by flight equipment and are summarized as follows:
Included above are notes receivable of $31,582 (2003) and $53,032 (2002) representing restructured lease payments.
At December 31, 2003, the minimum future payments on notes receivable are as follows:
INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
Note C - Net Investment in Finance Leases
The following lists the components of the net investment in finance leases:
At December 31, 2003, minimum future lease payments on finance leases are as follows:
Note D - Investments
Investments consist of the following:
(a)
In 2000, the Company invested $30,000 in American Trans Air (“ATA”) non-voting preferred stock.
(b)
In 2002, the Company received International Aircraft Investors non-voting preferred stock as a partial settlement of notes receivables in the amount of $14,019. At December 31, 2003, the Company determined that International Aircraft Investors is a Variable Interest Entity and that it is the primary beneficiary, as defined by FIN 46, and consolidated the entity, in accordance with FIN 46. The preferred stock was eliminated in consolidation.
(c)
In 2001, the Company contributed an aircraft with a net book value of $11,372 for a 99% interest in 21937, LLC, a joint venture that leases the aircraft to a third party. This investment is not consolidated due to the Company’s lack of effective control in the joint venture.
INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
Note D - Investments (Continued)
(d)
In 2000, the Company invested $5,000 for a 50% interest in ILTU Ireland (“ILTU”), an Irish corporation. ILTU presently owns one Boeing 767-300 on lease to an airline. The Company has guaranteed a loan from a related party to ILTU (see Note K).
Note E - Debt Financing and Capital Lease Obligations
Debt financing and capital lease obligations are comprised of the following:
The above amounts represent the Company’s anticipated settlement of its currently outstanding debt obligations. Certain adjustments required to present currently outstanding debt obligations have been recorded and presented separately on the face of the balance sheet, including adjustments related to foreign currency and interest rate hedging activities.
Commercial Paper
The Company has a $4.8 billion Commercial Paper Program. Under this program, the Company may borrow in minimum increments of $100 for a period from one day to 270 days. The weighted average interest rate of the Company’s outstanding commercial paper was 1.07%, 1.46% and 4.10% at December 31, 2003, 2002 and 2001 respectively.
Bank Commitments
As of December 31, 2003, the Company had committed revolving loans and lines of credit with 26 commercial banks aggregating $4.2 billion. These revolving loans and lines of credit principally provide for interest rates that vary according to the pricing option in effect at the time of borrowing. Pricing options include prime, a range from .25% over LIBOR to .50% over LIBOR based upon utilization, or a rate determined by a competitive bid process with the banks. The revolving loans and lines of credit are subject to facility fees of up to .10% of amounts available. Such financing is used primarily as backup for the Company’s maturing debt and other obligations. The Company had not drawn any funds under its committed revolving loans and lines of credit at December 31, 2003 and 2002, respectively.
Public Debt
As of December 31, 2003, the Company had two effective shelf registration statements: one with respect to $6.08 billion in debt securities including a $2.88 billion Medium-Term Note program, which was fully sold as of December 31, 2003, and a $1.0 billion Retail Medium-Term Note Program, under which $357.2 million of notes were sold through December 31, 2003; and, one with respect to $5.00 billion in debt securities including a $1.0 billion Medium-Term Note program, under which $0.65 billion of notes were sold through December 31, 2003.
INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
Note E - Debt Financing and Capital Lease Obligations (Continued)
Public Term Debt
The Company has issued the following Notes which provide for a single principal payment at maturity and cannot be redeemed prior to maturity:
The Company has a Euro Medium-Term Note Program for $5.0 billion, under which $3.4 billion (2.9 billion and £300 million) in notes were outstanding at December 31, 2003. The program is perpetual. As a bond issue matures, the principal amount of that bond becomes available for new issuances under the program. The Company has eliminated the currency exposure arising from the notes by either hedging the notes through swaps or through the offset provided by operating lease payments. The Company translates the debt into U.S. Dollars using current exchange rates. The foreign exchange adjustment for the foreign currency denominated notes was $697,435 (2003) and $264,880 (2002).
INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
Note E - Debt Financing and Capital Lease Obligations (Continued)
Public Medium-Term Notes
At December 31, 2003 the Company’s Medium-Term Notes bear interest at rates varying between 1.39% and 8.26%, with maturities from 2004 through 2011. The Medium-Term Notes provide for a single principal payment at the maturity of the respective note and cannot be redeemed by the Company prior to maturity.
Bank Term Debt
In January 1999, the Company entered into an Export Credit Facility for up to a maximum of $4.3 billion, for up to 75 aircraft to be delivered from 1999 through 2001. The Company had the right, but was not required, to use the facility to fund 85% of each aircraft’s purchase price. This facility is guaranteed by various European Export Credit Agencies. The interest rate varies from 5.753% to 5.898% depending on the delivery date of the aircraft. At December 31, 2003, the Company had financed 62 aircraft and had $1.8 billion outstanding debt under this facility. The debt is collateralized by a pledge of the shares of a subsidiary of the Company which holds title to the aircraft financed under the facility. The flight equipment associated with the obligations, included in flight equipment under operating leases on the balance sheet, had a net book value of $3.0 billion (2003) and $3.1 billion (2002).
During the twelve months ended December 31, 2003, the Company entered into various bank financings for a total funded amount of $1.3 billion. The financings mature through 2009. One tranche of one of the loans totaling $410 million was funded in Japanese yen and swapped to U.S. Dollars. The interest rates are LIBOR based with spreads ranging from 0.375% to 1.625% at December 31, 2003.
Capital Lease Obligations
The Company’s capital lease obligations provide 10 year, fully amortizing debt in two interest rate tranches. The first 62.5% of the original debt is at a fixed rate of 6.55%. The second 22.5% of the original debt is at fixed rates varying between 6.18% and 6.89%. These two tranches are guaranteed by various European Export Credit Agencies. The remaining 15% of the original financed amount was prepaid by the Company. The remaining outstanding debt matures through 2005. The flight equipment associated with the obligations, and included in Flight equipment under operating leases on the balance sheet, had a net book value of $824,436 (2003) and $892,404 (2002).
The following is a schedule by years of future minimum lease payments under capitalized leases together with the present value of the net minimum lease payments as of December 31, 2003:
Synthetic Lease Obligations
In 1997, the Company, through a subsidiary, entered into sale-leaseback transactions providing proceeds to the Company in the amount of $601.9 million relating to seven aircraft. The transactions resulted in the sale and leaseback of these aircraft under one year operating leases with six one year extension options for a total of seven years for each aircraft. The Company has not recorded any gains related to the transactions. The Company has the option to either buy back the aircraft or redeliver the aircraft for a fee to the lessor at the end
INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
Note E - Debt Financing and Capital Lease Obligations (Continued)
of any lease period. The lease rates equate to fixed principal amortization and floating interest payments based on LIBOR or commercial paper pricing. The Company consolidated the transaction at December 31, 2003 in accordance with FIN 46 and will amortize the principal portion of the debt with the lease payments during 2004.
Maturities of debt financing, capital lease obligations and synthetic lease obligations (excluding commercial paper and deferred debt discount) at December 31, 2003 are as follows:
Other
Under the most restrictive provisions of the related borrowings, consolidated retained earnings at December 31, 2003, in the amount of $1,623,165, are unrestricted as to payment of dividends based on consolidated tangible net worth requirements.
See Note L - Financial Instruments.
The Company has entered into various debt and derivative transactions with AIGFP, a related party. The Company executed $1,897,500 and $1,690,454 notional amount of derivative instruments with AIGFP during 2003 and 2002, respectively.
Note F - Shareholders’ Equity
Preferred Stock
The Board of Directors is authorized to issue up to 20,000,000 shares of preferred stock that may be issued in one or more series and with such stated value and terms as may be determined by the Board of Directors.
Series A Preferred Stock
In December 2001, the Company issued 40 shares of Series A preferred shares with a liquidation value of $10 million per share. AIG, as holder of the Series A Preferred Stock, was entitled to quarterly dividends at a rate of 5% per annum. The Series A Preferred Stock was nonconvertible, and was redeemable at the Company’s option. In September 2002, pursuant to an agreement with the holder, the Company cancelled the outstanding shares of Series A preferred shares. The Company issued 3,951,398 shares of Common Stock for the value of the cancelled Series A preferred shares.
Market Auction Preferred Stock
The Market Auction Preferred Stock (“MAPS”) have a liquidation value of $100 thousand per share and are not convertible. The dividend rate, other than the initial rate, for each dividend period for each series is reset approximately every 7 weeks (49 days) on the basis of orders placed in an auction. The Company repurchased Series C, D, F, G and H of the MAPS in the fourth quarter of 2001 and Series E in the first and
INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
Note F - Shareholders’ Equity (Continued)
second quarters of 2002 for the liquidation values and no gain or loss was recognized. During 2001 the Company extended the Series A MAPS to 5 years at a dividend rate of 5.90%. At December 31, 2003, the dividend rate for Series B MAPS was 1.54%.
Common Stock
On September 24, 2002, the Company issued 3,951,398 shares of Common Stock to AIG in exchange for the value of the cancelled Series A preferred shares. On December 4, 2002, the Company issued and sold 2,428,599 shares of Common Stock to AIG for proceeds of $250,000.
Other Comprehensive Income
The Other Comprehensive Income consists of fair value adjustments of cash flow derivative instruments and foreign currency adjustment of liabilities denominated in a foreign currency. The debt was translated into US dollars using the current exchange rate. The cash flow derivatives were adjusted using market values obtained from a related party broker-dealer.
Note G - Rental Income
Minimum future rentals on non-cancelable operating leases and subleases of flight equipment which have been delivered at December 31, 2003 are as follows:
Additional rentals earned by the Company based on the lessees’ usage aggregated $289,405 (2003), $249,503 (2002) and $235,099 (2001). Flight equipment is leased, under operating leases, with remaining terms ranging from one to 15 years.
Note H - Flight Equipment Rent and Off Balance Sheet Arrangements
During 1995, 1996 and 1997, the Company, through subsidiaries, entered into sale-leaseback transactions providing proceeds to the Company in the amounts of $412,626, $507,600 and $601,860, respectively, each relating to seven aircraft. The transactions resulted in the sale and leaseback of these aircraft under one-year operating leases, each with six one-year extension options for a total of seven years for each aircraft. The existing one-year leases at December 31, 2003, mature on September 20, 2004. The Company repurchased three aircraft before the lease terminated, which were sold to third parties, and repurchased the remaining eleven aircraft from the 1995 and 1996 sale-leaseback transactions when the leases expired in December 2002 and September 2003, respectively. The lease rates equate to fixed principal amortization and floating interest payments based on LIBOR or commercial paper pricing. The Company adopted FIN 46 during the financial year ended December 31, 2003 and determined that the entity related to the remaining sale-leaseback transaction was a VIE in which the Company was a primary beneficiary as defined by FIN 46. As a result, the
INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
Note H - Rental Expense (continued)
Company consolidated the remaining entity at December 31, 2003 and recorded flight equipment of $462.7 million, synthetic lease obligations in the amount of $464.2 million, a net decrease in other liabilities of $3.9 million and an after tax gain of $2.4 million as a cumulative effect of accounting change.
Note I - Income Taxes
The provision (benefit) for income taxes is comprised of the following:
(a)
Including U.S. tax on foreign income
(b)
Deferred taxes were also provided (charged) to other comprehensive income of $(77,572) (2003), $47,380 (2002) and $(32,661) (2001), respectively, and for cumulative effect of accounting change of $4,653 (2003) and $8,180 (2001).
The deferred tax liability consists of the following deferred tax liabilities (assets):
INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
Note I - Income Taxes (Continued)
A reconciliation of the computed expected total provision for income taxes to the amount recorded is as follows:
(a)
Includes realized foreign tax credits in 2003 and realized Canadian tax credits in 2001 for taxes paid in prior years.
During 2002, the Company settled an open audit issue with the Internal Revenue Service which required the Company to capitalize for tax purposes certain overhaul reimbursements made between 1991 and 2001. The adjustment had no impact on the total provision but required the Company to establish a current tax liability and a corresponding deferred tax asset of $25,663 in 2002. Such amount is reflected in the Company’s 2002 current and deferred provision.
Federal tax benefits provided by the Extraterritorial Income Exclusion (“ETI”) and the Foreign Sales Corporation (“FSC”) may not be available in 2004. The World Trade Organization has ruled that these are unfair export subsidies, and the European Union has begun to impose trade sanctions as a result of these subsidies not being repealed by the United States. The United States has proposed legislation to repeal the ETI and FSC export benefits and possibly provide other tax benefits to domestic corporations. The effect this proposed legislation will have on the Company will not be determinable until the legislation is finalized.
Note J - Other Information
Concentration of Credit Risk
The Company leases and sells aircraft to airlines and others throughout the world. The lease receivables and notes receivable are from entities located throughout the world. The Company generally obtains deposits on leases and obtains collateral in flight equipment on notes receivable. The Company has no single customer which accounts for 10% or more of revenues.
Segment Information
The Company operates within one industry: the leasing, sales and management of flight equipment.
Revenues include rentals of flight equipment to foreign airlines of $2,625,315 (2003), $2,317,619 (2002) and $2,173,778 (2001).
INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
Note J - Other Information (Continued)
The following table sets forth the dollar amount and percentage of total rental revenues attributable to the indicated geographic areas based on each airline’s principal place of business for the years indicated:
The following table sets forth revenue attributable to individual countries representing at least 10% of total revenue based on each airline’s principal place of business for the years indicated:
Currency Risk
The Company attempts to minimize its currency and exchange risks by negotiating most of its aircraft leases in US dollars. Some of the Company’s leases, however, are negotiated in Euros to meet the needs of a growing number of airlines. These Euro denominated leases are primarily used as a hedge against Euro denominated debt obligations of the Company. Therefore, the Company’s foreign currency gain (loss) has not been material to the Company’s consolidated financial statements to date.
Employee Benefit Plans
The Company’s employees participate in various benefit plans sponsored by AIG, including a noncontributory qualified defined benefit retirement plan, various stock option and purchase plans and a voluntary savings plan (401(k) plan).
AIG’s US plans do not separately identify projected benefit obligations and plan assets attributable to employees of participating affiliates. AIG’s projected benefit obligations exceeded the plan assets at December 31, 2003 by $478,000.
Note K - Commitments and Contingencies
Aircraft Orders
At December 31, 2003, the Company had committed to purchase 463 new and used aircraft deliverable from 2004 through 2010 at an estimated aggregate purchase price (including adjustment for anticipated inflation) of approximately $26.2 billion.
The Company also had options to purchase an additional 11 new aircraft deliverable through 2008 at an estimated aggregate purchase price of $704.8 million.
INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
Note K - Commitments and Contingencies (Continued)
Aircraft orders (continued)
Most of these purchase commitments and options to purchase new aircraft are based upon master agreements with each of The Boeing Company (“Boeing”) and AVSA, S.A.R.L., the sales subsidiary of Airbus Industrie (“Airbus”).
The Boeing aircraft (models 737, 747 and 777), and the Airbus aircraft (models A318, A319, A320, A321, A330, A340 and A380) are being purchased pursuant to agreements executed by the Company and Boeing or Airbus. These agreements establish the pricing formulas (which include certain price adjustments based upon inflation and other factors) and various other terms with respect to the purchase of aircraft. Under certain circumstances, the Company has the right to alter the mix of aircraft type ultimately acquired. As of December 31, 2003, the Company had made non-refundable deposits (exclusive of capitalized interest) on the aircraft which the Company has committed to purchase of approximately $600.0 million and $520.0 million with Boeing and Airbus, respectively.
Management anticipates that a significant portion of the aggregate purchase price will be funded by incurring additional debt. The exact amount of the indebtedness to be incurred will depend upon the actual purchase price of the aircraft, which can vary due to a number of factors, including inflation, and the percentage of the purchase price of the aircraft which must be financed.
Asset Value Guarantees
The Company has guaranteed a portion of the residual value of 23 aircraft to financial institutions. These guarantees expire at various dates through 2013 and generally provide for the Company to pay the difference between the fair market value of the aircraft and the guaranteed value up to certain specified amounts, or, at the option of the Company, purchase the aircraft for the guaranteed value. At December 31, 2003, the maximum exposure if the Company were to pay under such guarantees was $68,089. In addition, the Company has written put options for 15 aircraft in the amount of $678,413.
Other Guarantees
The Company has guaranteed certain obligations for entities in which it has an investment. The Company guaranteed seven loans at December 31, 2003, all but one collateralized by aircraft, aggregating $150,363. As a result of the Company’s adoption of FIN 46, the Company consolidated the entities with loan guarantees collateralized by aircraft and recorded liabilities in the amount of $54,905 related to these entities.
Stand by Lines of Credit
The Company has extended unsecured lines of credit to two entities in the amount of $65,000.
INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
Note K - Commitments and Contingencies (Continued)
Leases
The Company has operating leases for office space and office equipment extending through 2015. Rent expense was $3,575, $3,475 and $3,221 for the years ended 2003, 2002 and 2001 respectively. Commitments for minimum rentals under the noncancelable leases at the end of 2003 are as follows:
Note L - Financial Instruments
In the normal course of business, the Company employs a variety of derivative transactions with the objective of lowering its overall borrowing cost and maintaining its optimal mix of variable and fixed rate interest obligations. These derivative products include interest rate swap agreements, currency swap agreements, and interest rate floors. The Company enters into derivative transactions only to hedge interest rate and currency risk and not to speculate on interest rates or currency fluctuation.
All derivatives are recognized on the balance sheet at their fair value and the change in fair value is recorded in operating income or other comprehensive income depending on the designation of the hedging instrument.
Credit risk exposure arises from the potential that the counterparty may not perform under these derivative transactions. The Company’s counterparty for all of its derivatives is AIGFP, a related party with the highest ratings available from the credit rating agencies. The Company has executed $1,897,500 and $1,690,454 notional amount of derivative instruments with AIGFP during 2003 and 2002, respectively. The Company currently does not require, nor is it required by its counterparty, to provide collateral for its positions with the Company although it can in certain circumstances.
Failure of AIGFP to perform under the agreement with respect to these transactions could have an material effect on the Company’s results of operations.
The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying value reported on the balance sheet for cash and cash equivalents approximates its fair value.
Notes receivable: The fair values for notes receivable are estimated using discounted cash flow analyses, using interest rates currently being offered for similar loans to borrowers with similar credit ratings.
Investments: It was not practicable to determine the fair value of most of the Company’s investments in the common and preferred stocks of other companies because of the lack of a quoted market price. The carrying amount of these investments at December 31, 2003 represents the original cost or original cost plus the Company’s share of earnings of the investment. For investments held by the
INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
Note L - Financial Instruments (Continued)
Company that had a quoted market price at December 31, 2003, the Company used such quoted market price in determining the fair value of such investments.
Debt financing: The carrying value of the Company’s commercial paper and term debt maturing within one year approximates its fair value. The fair value of the Company’s long-term debt is estimated using discounted cash flow analyses, based on the Company’s spread to US Treasury bonds for similar debt at year-end.
Guarantees: As of December 31, 2003, the Company’s maximum commitment under the guarantees was $68,089. It is not practical to determine the fair value of the Company’s guarantees. The Company regularly reviews the underlying values of the collateral aircraft, to determine its exposure under these guarantees. At December 31, 2003, the Company had not recorded any liabilities related to these guarantees, as the market values of the aircraft equaled or exceeded the guaranteed value. The Company adopted FIN 45 for guarantees entered into after December 31, 2002. Guarantees in the amount of $3,000 (2003) are included in Accrued interest and other liabilities on the Company’s balance sheet related to guarantees entered into after December 31, 2002.
The carrying amounts and fair values of the Company’s financial instruments at December 31, 2003 and 2002 are as follows:
Derivatives:
The Company uses derivatives to manage exposures to interest rate and foreign currency risks. The Company recorded hedge ineffectiveness in interest expense related to cross currency fair value hedges in the amount of $(700) (2003), $1,000 (2002) and $1,000 (2001). Hedge ineffectiveness related to cash flow hedges for the period was immaterial to the Company for years 2003, 2002 and 2001. In accordance with the transition provision of SFAS 133, the Company recorded the following cumulative effect adjustments in earnings as of January 1, 2001, net of taxes:
INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
Note L - Financial Instruments (Continued)
In addition, the Company recorded the following net-of-tax cumulative effect adjustments in other comprehensive income as of January 1, 2001:
During the twelve months ended December 31, 2003, 2002 and 2001, the Company recorded the following in earnings in accordance with SFAS 133:
At December 31, 2003, 2002 and 2001, the Company’s accumulated other comprehensive income (loss) consisted of the following:
During the twelve months ended December 31, 2003, $31,038 (net) was reclassified from accumulated other comprehensive income to interest expense when interest was paid or received on the Company’s cash flow hedges. The Company estimates that within the next twelve months it will amortize into earnings $63,434 of the pre-tax balance in accumulated other comprehensive income under cash flow hedge accounting in connection with the Company’s program to convert debt from floating to fixed rates.
Note M - Related Party Transactions
The Company contracted to sell 37 aircraft to a trust during the third quarter of 2003 for approximately $1.0 billion. The first 34 aircraft were transferred as of December 31, 2003, the remaining three are to be transferred in 2004. Notes Receivable include $69,149 related to the transaction. The trust is primarily funded and owned by other subsidiaries of AIG and is consolidated by AIG. Neither the trust nor the subsidiary is consolidated by the Company. The transaction was structured similar to a securitization, in which the trust acquired the aircraft based on values assigned by independent appraisers. Further, an unaffiliated third party acted as capital market advisor and initial purchaser of the notes of the securitization. The Company recorded gains in the amount of $23.2 million related to the transaction. The gain is included in Flight equipment marketing in the Company’s income statement. The Company will continue to manage the aircraft sold to the trust for a fee.
INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
Note M - Related Party Transactions (Continued)
Subsequent event:
On January 14, 2004, the Company contracted to sell 34 aircraft to a different trust for approximately $1.0 billion. The first 23 aircraft were transferred as of March 1, 2004, with the remaining 11 expected to be transferred in 2004. The 2004 transaction is structured similarly to the 2003 transaction, and the trust is consolidated by the AIG.
INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(a)
Reimbursements to lessees for overhauls performed and amounts transferred to buyers for aircraft sold.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: March 11, 2004
INTERNATIONAL LEASE FINANCE CORPORATION
By
/s/ STEVEN F. UDVAR-HAZY
Steven F. Udvar-Hazy
Chairman of the Board and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.