UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

ANNUAL REPORT

 

 

(Mark One)

SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2007

 

OR

 

SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from _______________ to _______________

Commission file number 001-31616

 

 

Registrant’s telephone number, including area code: (310) 788-1999

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

NONE

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES  x   NO  o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES  o   NO  x

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES  x   NO  o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES  o   NO  x

 

As of June 30, 2007 and February 25, 2008, there were 45,267,723 shares of Common Stock, no par value, outstanding, all of which were held by affiliates.

 

Registrant meets the conditions set forth in General Instruction I(1)(a) and (b) of Form 10-K and is therefore filing this form with the reduced disclosure format.

 

 

INTERNATIONAL LEASE FINANCE CORPORATION

 

2007 FORM 10-K ANNUAL REPORT

 

 

TABLE OF CONTENTS

 

 

Item 1.   Business

 

General

 

International Lease Finance Corporation (the “Company,” “ILFC,” “management,” “we,” “our,” “us”) primarily acquires new commercial jet aircraft from The Boeing Company, or Boeing, and Airbus S.A.S., or Airbus, and leases these aircraft to airlines throughout the world. In conjunction with our 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 investors and/or owners of aircraft portfolios for a management fee. From time to time we provide asset value guarantees and loan guarantees to the buyers of aircraft, or to the lenders, for a fee. We also remarket and sell aircraft owned or managed by others for a fee.

 

As of December 31, 2007, we owned 900 jet aircraft, had nine aircraft in the fleet that were classified as finance and sales-type leases and provided fleet management services for 100 aircraft. See “Item 2.  Properties — Flight Equipment .” At December 31, 2007, we had contracted with Boeing and Airbus to purchase 234 new aircraft for delivery through 2017 with an estimated purchase price of $20.1 billion, of which 73 will deliver in 2008 with an estimated aggregate purchase price of $4.2 billion. See “Item 2.  Properties — Commitments. ”

 

We maintain a variety of flight equipment to provide a strategic mix and balance so as to meet our customers’ needs and to maximize our opportunities. To minimize the time that our aircraft are not leased to customers, we concentrate our aircraft purchases on models of new and used aircraft which we believe will have the greatest airline demand and operational longevity.

 

We typically finance the purchase of aircraft with borrowed funds and internally generated cash flows. Management accesses the capital markets for funds at times and on terms and conditions considered appropriate. We may, but do not usually, engage in financing transactions for specific aircraft. We rely significantly on short- and medium-term financing, and thereby attempt to more closely match the lease terms of our aircraft. To date, we have been able to purchase aircraft on terms which have permitted us to lease our aircraft portfolio at a profit and have been able to obtain the necessary funding from the capital and bank markets.

 

The airline industry is cyclical, economically sensitive and highly competitive. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. ” Our continued success in the future is largely dependent on management’s ability to develop customer relationships for leasing, sales, remarketing and management services with airlines and other customers best able to maintain their economic viability and survive in the competitive environment in which they operate.

 

The Company is incorporated in the State of California and its principal offices are located at 10250 Constellation Blvd., Suite 3400, Los Angeles, California 90067. Our telephone number, telecopier number and website address are (310) 788-1999, (310) 788-1990, and www.ilfc.com, respectively. We make available our SEC EDGAR filings, free of charge, on our website or by written request to us. The information on our website is not part of or incorporated by reference into this report.

 

We are an indirect wholly owned subsidiary of American International Group, Inc. (“AIG”). AIG is a holding company which, through its subsidiaries, is engaged in a broad range of insurance and insurance-related activities in the United States and abroad. AIG’s primary activities include both general insurance and life insurance and retirement services operations. Other significant activities include financial services and asset management. The common stock of AIG is listed on, among others, the New York Stock Exchange.

 

Aircraft Leasing

 

We lease most of our aircraft under operating leases. The cost of the aircraft is not fully recovered over the term of the initial lease, and we retain the benefit as well as assume the risk of the residual value of the aircraft. In accordance with accounting principles generally accepted in the United States of America, rentals are reported ratably as revenue over the lease term, as they are earned. The aircraft under operating leases are included as Flight

equipment under operating lease on our Consolidated Balance Sheets and are depreciated to an estimated salvage value over the estimated useful lives of the aircraft. On occasion we enter into finance and sales-type leases where the full cost of the aircraft is substantially recovered over the term of the lease. With respect to these leases, we record lease payments received as a reduction in the net investment in the finance/sales-type leases and interest income using an interest rate implicit in the lease. The aircraft under finance and sales-type leases are recorded on our Consolidated Balance Sheets in Net investment in finance and sales-type leases. At December 31, 2007, we accounted for 900 aircraft as operating leases and nine aircraft as finance and sales-type leases.

 

The initial term of our current leases range in length from two years to 17 years. See “Item 2. Properties — Flight Equipment ” for information regarding scheduled lease terminations. We attempt to maintain a mix of short-, medium- and long-term leases to balance the benefits and risks associated with different lease terms and changing market conditions. Varying lease terms help to mitigate the effects of changes in prevailing market conditions at the time aircraft become eligible for re-lease or are sold.

 

All leases are on a “net” basis with the lessee responsible for all operating expenses, which customarily include fuel, crews, airport and navigation charges, taxes, licenses, registration and insurance. In addition, the lessee is responsible for normal maintenance and repairs, airframe and engine overhauls, and compliance with return conditions of flight equipment on lease. We may, in connection with the lease of a used aircraft, agree to contribute to the cost of certain major overhauls or modifications depending on the condition of the aircraft at delivery. Under the provisions of many leases, for certain airframe and engine overhauls, we reimburse the lessee for costs incurred up to, but not exceeding, related overhaul rentals the lessee has paid to us. Such rentals are included in the caption Rental of flight equipment in our Consolidated Statements of Income. We provide a charge to operations based on the estimated reimbursements during the life of the lease. This amount is included in Provision for overhauls in our Consolidated Statements of Income.

 

The lessee is responsible for compliance with all applicable laws and regulations with respect to the aircraft. We require our lessees to comply with the standards of either the United States Federal Aviation Administration (the “FAA”) or its foreign equivalent. We periodically inspect our leased aircraft. Generally, we require a deposit as security for the lessee’s performance of obligations under the lease and the condition of the aircraft upon return. In addition, the leases contain extensive provisions regarding our remedies and rights in the event of a default by the lessee and specific provisions regarding the condition of the aircraft upon return of the aircraft. The lessee is required to continue to make lease payments under all circumstances, including periods during which the aircraft is not in operation due to maintenance or grounding.

 

Some foreign countries have currency and exchange laws regulating the international transfer of currencies. When necessary we require, as a condition to any foreign transaction, that the lessee or purchaser in a foreign country obtain the necessary approvals of the appropriate government agency, finance ministry or central bank for the remittance of all funds contractually owed in U.S. Dollars. We attempt to minimize our currency and exchange risks by negotiating most of our aircraft leases and all of our sales transactions in U.S. Dollars. All guarantees obtained to support various lease agreements are denominated for payment in the same currency as the lease.

 

To meet the needs of a number of airlines, some of our leases are negotiated in Euros. As the Euro to U.S. Dollar exchange rate fluctuates, airlines’ interest in entering into Euro denominated lease agreements will change. Once we agree to the rental payment currency with an airline, the negotiated currency remains for the term of the lease. We have hedged part of our future Euro denominated lease payments receivable cash flows through February 2010. As a result, the economic risk arising from foreign currency has, to date, been immaterial to us.

 

Management obtains and reviews relevant business materials from all prospective lessees and purchasers before entering into a lease or extending credit. Under certain circumstances, the lessee may be required to obtain guarantees or other financial support from an acceptable financial institution or other third parties.

 

During the life of the lease, situations may arise whereby we will have to restructure leases with our lessees. Historically, restructurings have involved the voluntary termination of leases prior to lease expiration, the arrangement of subleases from the primary lessee to another airline and the rescheduling of lease payments and extension of the lease terms. In many situations where we repossess an aircraft, we export the aircraft from the

lessee’s jurisdiction. In the majority of these situations, we have obtained the lessee’s cooperation and the return and export of the aircraft was immediate. In some situations, however, the lessees have not fully cooperated in returning aircraft. In those cases we have taken legal action in the appropriate jurisdictions. This process has delayed the ultimate return and export of the aircraft. In addition, in connection with the repossession of an aircraft, we may be required to pay outstanding mechanic, airport, and navigation fees and other liens on the repossessed aircraft. These charges could relate to other aircraft that we do not own but were operated by the lessee.

 

Flight Equipment Marketing

 

We may sell our leased aircraft at or before the expiration of their leases. The buyers of our aircraft include the aircraft’s lessee and other aircraft operators, financial institutions, private investors and third party lessors. From time to time, we engage in transactions to buy aircraft for resale. In other cases, we assist our customers in acquiring or disposing of aircraft by providing consulting services and procurement of financing from third parties. Any gain or loss on disposition of leased aircraft is included in the caption Flight equipment marketing in our Consolidated Statements of Income.

 

From time to time, we are engaged as an agent for airlines and various financial institutions in the disposition of their surplus aircraft on a fee basis. We generally act as an agent under an exclusive remarketing contract whereby we agree to sell aircraft on a commercially reasonable basis within a fixed time period. These activities generally augment our primary activities and also serve to promote relationships with prospective sellers and buyers of aircraft. We may, from time to time, participate with banks, other financial institutions and airlines to assist in financing aircraft purchased by others and by providing asset guarantees, put options, or loan guarantees collateralized by aircraft on a fee-basis.

 

We plan to continue to engage in providing marketing services to third parties on a selective basis involving specific situations where these activities will not conflict or compete with, but rather will complement, our leasing and selling activities.

 

Fleet Management Services

 

We provide fleet management services to third party operating lessors who are unable or unwilling to perform this service as part of their own operation. We typically provide many of the same services that we perform for our own fleet. Specifically, we provide leasing, re-leasing and sales services on behalf of the lessor for which we charge a fee. The fees for fleet management services are included in Interest and other in our Consolidated Statements of Income.

 

Financing/Source of Funds

 

We purchase new aircraft directly from manufacturers and used aircraft from airlines and other owners. The purchase price of flight equipment is financed using internally generated funds, secured and unsecured commercial bank financings and the issuance of commercial paper and public and private debt. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. ”

 

 

 

During 2005, we had one customer, Air France, that accounted for 10% or more of total Rental of flight equipment revenue ($364.6 million or 10.5%). No single customer accounted for more than 10% of total revenues in 2007 or 2006.

 

Revenues include rentals of flight equipment to foreign airlines of $4,175,987,000 in 2007, $3,604,495,000 in 2006, and $3,095,612,000 in 2005, comprising 91.0%, 90.5% and 88.9%, respectively, of total Rentals of flight equipment revenue. See Note H of Notes to Consolidated Financial Statements . Lease revenues from the rental of flight equipment have been reduced by payments received by our customers from the notional accounts established by the aircraft and engine manufacturers.

 

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 in any year based on each airline’s principal place of business for the years indicated:

 

 

Competition

 

The leasing, remarketing and sale of jet aircraft is highly competitive. We face competition from aircraft manufacturers, banks, financial institutions, other leasing companies, aircraft brokers and airlines. In recent years we have seen increased competition due to several new companies entering the aircraft leasing market. Competition

for leasing transactions is based on a number of factors including delivery dates, lease rates, terms of lease, other lease provisions, aircraft condition and the availability in the market place of the types of aircraft to meet the needs of the customers. We believe we are a strong competitor in all of these areas. However, past overcapacity in the market place increased competition from other entities leasing aircraft, which caused downward pressure on lease rates, lease revenue and aircraft values. Recently, the overcapacity has been absorbed in the market place, and we now see higher lease rates on newly signed leases.

 

Government Regulation

 

The U.S. Department of State (“DOS”) and the U.S. Department of Transportation (“DOT”), including the FAA, an agency of the DOT, exercise regulatory authority over air transportation in the United States.

 

The DOS and DOT, in general, have jurisdiction over the economic regulation of air transportation, including the negotiation with foreign governments of the rights of U.S. carriers to fly to other countries and the rights of foreign carriers to fly to and within the United States. We are not directly subject to the regulatory jurisdiction of the DOS and DOT or their counterpart organizations in foreign countries related to the operation of aircraft for public transportation of passengers and property.

 

Our relationship with the FAA consists of the registration with the FAA of those aircraft which we have leased to U.S. carriers and to a number of foreign carriers where, by agreement, the aircraft are to be registered in the United States. When an aircraft is not on lease, we may obtain from the FAA, or its designated representatives, a U.S. Certificate of Airworthiness or a ferry flight permit for the particular aircraft.

 

Our involvement with the civil aviation authorities of foreign jurisdictions consists largely of requests to register and deregister our aircraft on those countries’ registries.

 

The U.S. Department of Commerce (“DOC”) exercises regulatory authority over exports. We are subject to the regulatory authority of the DOS and DOC as it relates to the export of aircraft for lease and sale to foreign entities and the export of parts to be installed on our aircraft. These Departments have, in some cases, required us to obtain export licenses for parts installed in aircraft exported to foreign countries.

 

Through its regulations, the DOC and the U.S. Department of Treasury (through its Office of Foreign Assets Control) impose restrictions on the operation of U.S. made goods, such as aircraft and engines, in sanctioned countries. In addition, they impose restrictions on the ability of U.S. companies to conduct business with entities in those countries.

 

The Patriot Act of 2001 reinforced the authority of the U.S. Secretary of State and the U.S. Secretary of the Treasury to (i) designate individuals and organizations as terrorists and terrorist supporters and to freeze their U.S. assets and (ii) prohibit financial transactions with U.S. persons, including U.S. individuals, entities and charitable organizations. We comply with the provisions of this Act and we closely monitor our activities with foreign entities.

 

A bureau of the U.S. Department of Homeland Security, U.S. Customs and Border Protection, enforces regulations related to the export of our aircraft as well as the import of our aircraft into the United States for maintenance or lease and the importation of parts for installation on our aircraft. We monitor our imports and exports for compliance with U.S. Customs regulations.

 

As an indirect wholly-owned subsidiary of AIG, we are subject to examination and review by the U.S. Department of Treasury’s Office of Thrift Supervision (“OTS”), the entity which was selected by AIG to be its financial regulator under a European Union directive applicable to financial conglomerates.

 

Employees

 

We operate in a capital intensive rather than a labor intensive business. As of December 31, 2007, we had 171 full-time employees, which we considered adequate for our business operations. Management and administrative personnel will expand, as necessary, to meet our future growth needs. None of our employees is covered by a collective bargaining agreement and we believe that we maintain excellent employee relations. We provide certain employee benefits including retirement, health, life, disability and accident insurance plans, some of which are established and maintained by our parent, AIG.

Insurance

 

Our lessees are required to carry those types of insurance which are customary in the air transportation industry, including comprehensive liability insurance and aircraft hull insurance. In general, we are an additional insured on liability policies carried by the lessees. We obtain certificates of insurance from the lessees’ insurance brokers. All certificates of insurance contain a breach of warranty endorsement so that our interests are not prejudiced by any act or omission of the operator-lessee. Lease agreements generally require hull and liability limits to be in U.S. Dollars, which are shown on the certificate of insurance.

 

Insurance premiums are paid by the lessee, with coverage acknowledged by the broker or carrier. The territorial coverage is, in each case, suitable for the lessee’s area of operations. The certificates of insurance contain, among other provisions, a provision prohibiting cancellation or material change without at least 30 days advance written notice to the insurance broker (who is obligated to give us prompt notice), except in the case of hull war insurance policies, which customarily only provide seven days advance written notice for cancellation and may be subject to shorter notice under certain market conditions. Furthermore, the insurance is primary and not contributory, and all insurance carriers are required to waive rights of subrogation against us.

 

The stipulated loss value schedule under aircraft hull insurance policies is on an agreed value basis acceptable to us and usually exceeds the book value of the aircraft. In cases where we believe that the agreed value stated in the lease is not sufficient, we purchase additional Total Loss Only coverage for the deficiency.

 

Aircraft hull policies contain standard clauses covering aircraft engines. The lessee is required to pay all deductibles. Furthermore, the hull war policies contain full war risk endorsements, including, but not limited to, confiscation (where available), seizure, hijacking and similar forms of retention or terrorist acts.

 

The comprehensive liability insurance listed on certificates of insurance include provisions for bodily injury, property damage, passenger liability, cargo liability and such other provisions reasonably necessary in commercial passenger and cargo airline operations. Such certificates of insurance list combined comprehensive single liability limits of not less than $250 million. As a result of the terrorist attacks on September 11, 2001, the insurance market unilaterally imposed a sublimit on each operator’s policy for third party war risk liability in the amount of $50 million. We require each lessee to purchase higher limits of third party war risk liability or obtain an indemnity from their government.

 

In late 2005, the international aviation insurance market unilaterally introduced exclusions for physical damage to aircraft hulls caused by dirty bombs, bio-hazardous materials and electromagnetic pulsing. Exclusions for the same type of perils could be introduced into liability policies.

 

Separately, we purchase contingent liability insurance and contingent hull insurance on all aircraft in our fleet and maintain other insurance covering the specific needs of our business operations. Insurance policies are generally placed or reinsured through AIG subsidiaries. AIG charges us directly for these insurance costs. We believe our insurance is adequate both as to coverage and amount.

 

Code of Ethics and Conduct

 

Our employees are subject to AIG’s Code of Conduct designed to assure that all employees perform their duties with honesty and integrity. In the second quarter of 2004, AIG adopted the AIG Director, Executive Officer, and Senior Financial Officer Code of Business Conduct and Ethics, which covers such directors and officers of AIG and its subsidiaries, including us and our Chairman of the Board and Chief Executive Officer (principal executive officer), Vice Chairman and Chief Financial Officer (principal financial officer), and Senior Vice President, Chief Accounting Officer and Controller (principal accounting officer). Both of these Codes appear in the Corporate Governance section of www.aigcorporate.com .

 

Forward-Looking Statements

 

This annual report on Form 10-K contains or incorporates statements that constitute forward-looking statements. Those statements appear in a number of places in this Form 10-K and include statements regarding, among other matters, the state of the airline industry, our access to the capital markets, our ability to restructure leases and repossess aircraft, the structure of our leases, regulatory matters pertaining to compliance with governmental regulations and other factors affecting our financial condition or results of operations. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” and “should” and variations of these words and similar

expressions, are used in many cases to identify these forward-looking statements. Any such forward-looking statements are not guarantees of future performance and involve risks, uncertainties and other factors that may cause our actual results, performance or achievements, or industry results, to vary materially from our future results, performance or achievements, or those of the industry, expressed or implied in such forward-looking statements. Such factors include, among others, general industry economic and business conditions, which will, among other things, affect demand for aircraft, availability and creditworthiness of current and prospective lessees, lease rates, availability and cost of financing and operating expenses, governmental actions and initiatives and environmental and safety requirements, as well as the factors discussed under “Item 1A. Risk Factors .” We will not update any forward-looking information to reflect actual results or changes in the factors affecting the forward-looking information.

Item 1A.   Risk Factors

 

Risk Factors Affecting International Lease Finance Corporation

 

Our business is subject to numerous risks and uncertainties, as described below and in the section titled “Item 7A. 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 upon the financial strength of our customers. Their ability to compete effectively in the market place and manage these risks has a direct impact on us. These risks include:

 

 

To the extent that our customers are affected by these risk factors, we may experience:

 

Airframe, Engine and Other Manufacturer Risks

 

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. Further, competition between the manufacturers for market share is intense and may lead to instances of deep discounting for certain aircraft types and may negatively impact our competitive pricing. Should the manufacturers fail to respond appropriately to changes in the market environment or fail to fulfill their contractual obligations, we may experience:

 

 

Borrowing Risks

 

Liquidity  — We are 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:

 

 

Interest Rate Risks  — We are impacted by fluctuations in interest rates. Our lease rates are generally fixed over the life of the lease. Changes, both increases and decreases, in our cost of borrowing, as reflected in our composite interest rate, directly impact our net income. 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.

 

The interest rates that we obtain on our debt financing are a result of several components including credit spreads, swap spreads and new issue premiums. These are all in addition to the underlying Treasury or LIBOR rates, as applicable. Volatility in our perceived risk of default, our parent’s risk of default or in a market sector’s risk of default can all have an impact on our cost of funds.

 

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. Operating leases bear a greater risk of realizations of residual values, because only a portion of the equipment’s value is covered by contractual cash flows at lease inception. If both demand for aircraft and market lease rates decrease and the conditions continue for an extended period, they could affect the market value of aircraft in our fleet and may result in impairment charges in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-lived Assets” (“SFAS 144”). See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Polices and

Estimates — Flight Equipment. ” Further, deterioration of aircraft values may create losses related to our aircraft asset value guarantees.

 

Obsolescence Risk  — Aircraft are long-lived assets requiring long lead times to develop and manufacture. 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. As aircraft in our fleet approach obsolescence, demand for that particular model and type will decrease. This may result in declining lease rates, impairment charges in accordance with SFAS 144, or losses related to aircraft asset value guarantees.

 

Credit Risk —  Our business depends on the credit worthiness of our customers. If the credit quality of our customer base materially decreases, it may negatively affect our business, financial condition, results of operations and cash flows.

 

In addition to customer credit risk associated with originating loans and leases, we are also exposed to other forms of credit risk, including the counterparty to our derivative transactions, asset value guarantees, loan guarantees and put options. These counterparties include financial institutions, other third party lessors, and our customers.

 

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.

 

Foreign Currency Risk  — We negotiate some of our leases in Euros to meet the demands of a number of airlines. If the Euro exchange rate to the U.S. Dollar deteriorates, we will record less lease revenue on those lease payments that are not hedged.

 

Relationship with AIG — While neither AIG nor any of its subsidiaries is a co-obligor or guarantor of our debt securities, circumstances affecting AIG can have an impact on us. For example, concurrent with ratings actions recently taken on AIG by Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. (“S&P”), Moody’s Investors Service, Inc. (“Moody’s”) and Fitch, Inc. (“Fitch”), actions were taken, or statements were made, with respect to our ratings. Accordingly, we can give no assurance how further changes in circumstances related to AIG would impact us.

 

Accounting Pronouncements  — The Financial Accounting Standards Board (“FASB”) in coordination with its international counterpart, the International Accounting Standards Board (“IASB”), have begun a joint project to perform a comprehensive review of the U.S. and international accounting standards related to leasing. The FASB and IASB are expected to recommend new standards that may significantly affect our financial position and results of operations and the way our customers operate in ways that we are unable to determine at this time. We continue to monitor the activities of this joint project as it progresses.

Item 1B.   Unresolved Staff Comments

 

None

Item 2.   Properties

 

Flight Equipment

 

Management frequently reviews opportunities to acquire suitable commercial jet aircraft based not only on market demand and customer airline requirements, but also on our fleet portfolio mix, leasing strategies, and likely timeline for development of future aircraft. Before committing to purchase specific aircraft, management 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, trends in local, regional, and worldwide air travel, fuel economy, environmental considerations (e.g. nitrogen oxide emissions, noise standards), operating costs, and anticipated obsolescence.

 

At December 31, 2007, all of our fleet was Stage III compliant. This means 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, 2007, the average age of aircraft in our fleet was 6.3 years.

 

The following table shows the scheduled lease terminations (for the minimum noncancelable period) by aircraft type for our operating lease portfolio at December 31, 2007:

 

 

 

As of February 25, 2008, leases covering 41 of the 45 aircraft with lease expiration dates in 2008 had been extended or leased to other customers.

 

 

 

 

We anticipate that a portion of the aggregate purchase price will be funded by incurring additional debt. The exact amount of the indebtedness to be incurred will depend, in part, upon the actual purchase price of the aircraft, which can vary due to a number of factors, including inflation. 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 Boeing and 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, we have the right to alter the mix of aircraft type ultimately acquired. As of December 31, 2007, we had made non-refundable deposits (exclusive of capitalized interest) with respect to the aircraft which we have committed to purchase of approximately $310 million with Boeing and $380 million with Airbus.

 

Under arrangements with manufacturers, in certain circumstances the manufacturers had established notional accounts for our benefit, to which they credited amounts when we purchased and took delivery of and leased aircraft. Amounts credited to the notional accounts were used at our direction to protect us from certain events, including loss when airline customers defaulted on lease payment obligations, to provide lease subsidies and other incentives to our airline customers in connection with leases of certain aircraft and to reduce our cost of aircraft purchased. The amounts credited were recorded as a reduction in Flight equipment under operating leases. At December 31, 2007, we had closed one notional account and were in the process of closing the remaining accounts. Future amounts received from the manufacturers will be recorded as a reduction to Flight equipment under operating leases.

 

As of February 25, 2008, we had entered into contracts for the lease of new aircraft scheduled to be delivered through 2017 as follows:

 

 

We will need to find customers for aircraft presently on order, and for any new aircraft ordered, and not subject to a lease or sale contract, and we will need to arrange financing for portions of the purchase price of such equipment. Although we have been successful to date in placing new aircraft on lease and have 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 acceptable terms.

 

Facilities

 

Our principal offices are located at 10250 Constellation Blvd., Suite 3400, Los Angeles, California. We occupy space under a lease which expires in 2015. As of February 29, 2008, we occupied approximately 127,000 square feet of office space. The lease provides for annual rentals of approximately $9 million, and the rental payments thereunder are subject to step rent provisions over the term of the lease. We have exercised an option to lease an additional 22,068 square feet starting in March 2009.

 

 

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. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations .”

 

 

 

 

 (a) See Exhibit 12.

 

 

 (c) See “Item 2. Properties — Flight Equipment. ”

 

Overview and Industry Condition

 

ILFC primarily acquires new jet transport aircraft from Boeing and Airbus and leases these aircraft to airlines throughout the world. In addition to our 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 investors and/or owners of aircraft portfolios for a management fee. We have also provided asset value guarantees and a limited number loan guarantees to buyers of aircraft or to financial institutions for a fee. Additionally, we remarket and sell aircraft owned or managed by others for a fee.

 

As of December 31, 2007, we owned 900 aircraft, had nine aircraft in the fleet that were classified as finance and sales-type leases, and provided fleet management services for 100 aircraft. We have contracted with Airbus and Boeing to buy 234 new aircraft for delivery through 2017 with an estimated purchase price of $20.1 billion, 73 of which will deliver during 2008. We anticipate the purchases to be financed in part by operating cash flows and in part by incurring additional debt.

 

Our 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, fuel prices and shortages, labor stoppages, insurance costs, recessions, and other political or economic events adversely affecting world or regional trading markets. Our revenues and income will be affected by our customers’ ability to react to and cope with the volatile competitive environment in which they operate, as well as our own competitive environment.

 

Improvements seen in airline industry performance and the resulting increase in demand for our aircraft over the past few years are materializing in our financial results. We have seen lease rates strengthen for both newly delivered aircraft and re-leases of existing aircraft. However, we believe that the airline industry may experience a future slow down. A slow down in the airline industry could have a negative impact on future lease rates. We experienced significant increases in Income before income taxes in 2007 compared to 2006. The increases resulted from a number of positive factors impacting our business in 2007 including (i) an increase in lease rates for aircraft that have returned and been delivered to new lessees; (ii) an increase in the size of our fleet by 76 aircraft during the year ended December 31, 2007; and (iii) the receipts of $31.5 million for the sale of our claims against bankrupt airlines. In April 2007, we obtained hedge accounting for all our existing eligible swap agreements, which reduces volatility in earnings in subsequent periods. Further, in 2006 we incurred $20.1 million in expenses related to the Varig bankruptcy and expenses of $9.1 million related to a Canadian court ruling on Nav Canada charges, which did not reoccur in 2007.

 

Prior to 2007, we received tax benefits under the Foreign Sales Corporation (“FSC”) law and its successor regime, the Extraterritorial Income Act (“ETI”). In October 2004, Congress passed a bill, the American Jobs Creation Act of 2004, repealing the corporate export tax benefits under the ETI, after the World Trade Organization (“WTO”) ruled the export subsidies were illegal. Under the bill, ETI export tax benefits for corporations ceased to exist beginning with the year 2007. Our effective tax rate has risen to a rate consistent with the expected statutory rate. See Note G of Notes to Consolidated Financial Statements for additional information.

 

We derive approximately 90% of our revenues from airlines outside of the United States. A key factor in our success has been a concentrated effort to maximize our lease placements in regions that are strengthening, such as in Asia, Europe and the Middle East, and to minimize placements in regions that are under stress. At December 31, 2007, we believe we are well positioned in the current industry environment with signed leases for all of our 2008 deliveries of new aircraft.

 

In 2005, ILFC and Airbus signed a purchase agreement covering A350 aircraft. Subsequently, Airbus advised us of delays and ILFC requested a redesign of the A350 aircraft. During 2007, we concluded our contract discussions with Airbus related to the delays and redesign and converted the existing A350 aircraft to the newly designed A350XWB, and now have 20 new A350XWBs on order.

 

We have ordered 74 787-8s and 9s from Boeing with the first ten to deliver in 2010. Boeing has announced a nine-month delay in planned initial deliveries of the 787s. We are in active discussions with Boeing on the potential

effects of delivery delays for specific ILFC aircraft and delay compensation and penalties for which Boeing may be liable to us.

 

Airbus, Boeing and the engine manufacturers have recently submitted preliminary proposals to ILFC for the acquisition of certain additional new Airbus and Boeing aircraft for deliveries in the 2010 to 2016 timeframe. As of February 29, 2008, no commitments have been made and no assurances can be given as to the likely outcome of future negotiations.

 

Critical Accounting Policies and Estimates

 

Management’s discussion and analysis of our financial condition and results of operations are based upon our 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 management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue, depreciation, overhaul reserves, and contingencies. We base our 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.

 

We believe the following are our critical accounting policies, some of which require significant judgments and estimates, used in the preparation of the consolidated financial statements.

 

Lease Revenue : We lease flight equipment principally under operating leases and report rental income ratably over the life of the lease. The difference between the rental income recorded and the cash received under the provisions of the lease is included in Lease receivables and other assets on our 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 our Consolidated Balance Sheets until earned. Lease revenues from the rental of flight equipment have been reduced by payments received directly by us or by our customers from the aircraft and engine manufacturers.

 

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 : We market flight equipment and recognize gains and losses when leased equipment is sold and the risk of ownership of the equipment is passed to the new owner. We also engage in marketing aircraft on behalf of independent third parties. We recognize revenue for these transactions when services are rendered and an obligation to pay exists in accordance with the contract. The portion of sales proceeds as a result of payments made to buyers directly by the aircraft manufacturers are not included in marketing revenue but are recorded as a reduction to the overall basis of the flight equipment.

 

Flight Equipment : Flight equipment under operating leases is stated at cost. Purchases, major additions and modifications and 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. We generally depreciate passenger aircraft, including those acquired under capital leases, using the straight-line method over a 25 year life from the date of manufacture to a 15% residual value. We modified the useful life and the residual value of freighter aircraft to a 35 year life and a zero residual value in 2007. The effect of the change was not material to our financial position or results of operations. If the aircraft is out of production, we have established a specific residual value for each aircraft type. Because of the significant cost of aircraft carried in Flight equipment under operating leases on our Consolidated Balance Sheets, any change in the assumption of useful life or residual values for all aircraft could have a significant impact on our results of operations.

 

Under arrangements with the manufacturers, in certain circumstances the manufacturers had established notional accounts for our benefit, to which they credited amounts when we purchased and took delivery of and

leased aircraft. Amounts credited to the notional accounts were used at our direction to protect us from certain events, including loss when airline customers defaulted on lease payment obligations, to provide lease subsidies and other incentives to our airline customers in connection with leases of certain aircraft and to reduce our cost of aircraft purchased. The amounts credited to the notional accounts were recorded as a reduction to the basis of aircraft purchased at the time the amounts were made available to us. At December 31, 2007, we had closed one notional account and were in the process of closing the remaining accounts. Future amounts received from the manufacturers will be recorded as a reduction to the basis of aircraft purchased. Since cost is reduced, future depreciation is also reduced.

 

 

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.

 

Management is very active in the airline industry and reviews issues affecting our fleet on a quarterly basis, 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 Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”) at least annually. 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. These evaluations for impairment are significantly impacted by estimates of future revenues and other factors which involve some amount of uncertainty. 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. Estimated cash flows consist of current contractual lease rates, future projected lease rates and estimated scrap values for each aircraft. The factors considered in estimating the undiscounted cash flows may change in future periods due to changes in contracted lease rates, economic conditions, technology, airline demand for a particular aircraft type and many of the risk factors discussed in Item 1A. “Risk Factors .” We have, to date, not recorded any impairment charges related to aircraft.

 

Provision for Overhauls : Under the provisions of many leases, we receive overhaul rentals based on the usage of the aircraft. For certain airframe and engine overhauls, the lessee is reimbursed for costs incurred up to, but not exceeding, related overhaul rentals paid by the lessee for usage of the aircraft.

 

Overhaul rentals are included under the caption Rental of flight equipment in our Consolidated Statements of Income. We provide a charge to operations for estimated future reimbursements at the time the overhaul rentals are paid by the lessee. The charge is based on overhaul rentals received and the estimated reimbursements during the life of the lease. The historical payout rate is subject to significant fluctuations. Using its judgment, management periodically evaluates the appropriateness of the reserve for these reimbursements and its reimbursement rate, and then adjusts the provision for overhauls accordingly. This evaluation requires significant judgment. If the reimbursements are materially different than our estimates, there will be a material impact on our results of operations.

 

Derivative Financial Instruments: In the normal course of business we utilize derivative instruments to manage our exposure to interest rate risks and foreign currency risks. We account for derivative instruments in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended and interpreted (“SFAS 133”). Accounting for derivatives is very complex. All derivatives are recognized on the balance sheet at their fair value. We obtain the values on a quarterly basis from AIG. When hedge treatment is achieved under SFAS 133, the changes in market values related to the effective portion of the derivatives are recorded in other comprehensive income or in income, depending on the designation of the derivative as a cash flow hedge or a fair value hedge. The ineffective portion of the derivative contract is recorded in income. At designation of the hedge, we choose a method of effectiveness assessment, which we must use for the life of the contract. We use the “hypothetical derivative method” when we assess effectiveness. The calculation involves setting up a hypothetical derivative that mirrors the hedged item, but has a zero-value at the hedge designation date. The cumulative change in market value of the actual derivative instrument is compared to the cumulative change in market value of the hypothetical derivative. The difference is the calculated ineffectiveness and is recorded in income.

 

Income Taxes: We are included in the consolidated federal income tax return of AIG. Our tax provision is calculated 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 and Extraterritorial Income Exclusion provisions of the Internal Revenue Code to the extent they are currently realizable in AIG’s consolidated return. We calculate our provision using the asset and liability approach in accordance with the provisions of SFAS No. 109, “Accounting for Income Taxes.” This method gives consideration to the future tax consequences of temporary differences between the financial reporting basis and the tax basis of assets and liabilities based on currently enacted tax rates. Deferred tax liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

 

Financial Condition

 

We borrow funds to purchase new and used flight equipment (see “Item 2. Properties — Commitments ”), including funds for progress payments during aircraft construction, and to pay off maturing debt obligations. The funds are borrowed principally on an unsecured basis from various sources. During 2007, we borrowed $3.8 billion (excluding commercial paper) and $3.3 billion was provided by operating activities. As of December 31, 2007, we had committed to purchase 234 new aircraft from Boeing and Airbus at an estimated aggregate purchase price of approximately $20.1 billion for delivery through 2017. We are scheduled to take delivery of 73 new aircraft in 2008 with an estimated aggregate purchase price of $4.2 billion. We expect to fund expenditures for aircraft and to meet liquidity needs from a combination of available cash balances, internally generated funds and financing arrangements. Our borrowing strategy will, over time, result in approximately 15% of our debt, excluding commercial paper, maturing in any one year. Management continues to explore new funding sources and ways to diversify our investor base. Our debt financing was comprised of the following at the following dates:

 

 

The above amounts represent our anticipated settlement of our outstanding debt obligations and includes cumulative foreign exchange adjustments in the amount of $55.3 million at December 31, 2006 and $49.7 million at December 31, 2005, related to debt that we had not hedged through derivative instruments, but for which we had mitigated our foreign exchange exposure by offsetting Euro denominated lease payments. At December 31, 2007, the debt had matured and the unhedged portion was paid off using the offsetting lease payments. Certain adjustments required to present currently outstanding economically hedged debt obligations have been recorded and presented separately on the face of the Consolidated Balance Sheets, including adjustments related to foreign currency and interest rate hedging activities. We have eliminated the currency exposure arising from foreign currency denominated notes by either economically hedging the notes through swaps or through the offset provided by operating lease receipts denominated in the related currency. Foreign currency denominated debt is translated into U.S. Dollars using exchange rates as of each balance sheet date. The foreign exchange adjustments for the foreign currency denominated debt economically hedged with foreign currency swaps were $968.6 million, $677.4 million and $197.1 million at December 31, 2007, 2006, and 2005, respectively. Composite interest rates and the percentage of total debt at fixed rates reflect the economic effect of derivative instruments.

 

 

 

 

 

Bank Term Debt

 

In January 1999, we entered into an Export Credit Facility, for up to a maximum of $4.3 billion, for aircraft delivered through 2001. We used the facility to fund 85% of each aircraft’s purchase price. The facility is guaranteed by various European Export Credit agencies. We financed 62 aircraft using $2.8 billion under this facility which amortizes over ten years with interest rates from 5.753% to 5.898%. We have collateralized the debt by a pledge of the shares of a subsidiary which holds title to the aircraft financed under the facility. At December 31, 2007, $664 million was outstanding under this facility and the net book value of the related aircraft was $2.6 billion.

 

We have an Export Credit Facility for up to a maximum of $3.64 billion, for Airbus aircraft to be delivered through May 2008. The facility is used to fund 85% of each aircraft’s purchase price. This facility becomes available as the various European Export Credit agencies provide their guarantees for aircraft based on a six-month forward-looking calendar. The financing is for a ten-year fully amortizing loan per aircraft at an interest rate determined through a bid process. We have collateralized the debt by a pledge of the shares of a subsidiary which holds title to the aircraft financed under this facility. As of December 31, 2007, 36 aircraft were financed under this facility and $1.9 billion was outstanding.

 

From time to time we enter into funded bank financing agreements. As of December 31, 2007, we had a total of $1.1 billion outstanding, which have varying maturities through February 2012. The interest rates are LIBOR based with spreads ranging from 0.300% to 1.625% at December 31, 2007.

 

Subordinated Debt

 

In December of 2005, ILFC entered into two tranches of subordinated debt totaling $1.0 billion. Both mature on December 21, 2065, but each tranche has a different call option. The $600 million tranche has a call date of December 21, 2010 and the $400 million tranche has a call date of December 21, 2015. The note with the 2010 call date has a fixed interest rate of 5.90% for the first five years. The note with the 2015 call date has a fixed interest rate of 6.25% for the first ten years. Both tranches have interest rate adjustments if the call option is not exercised. If the

call option is not exercised, the new interest rate will be a floating quarterly reset rate based on the initial credit spread of 1.55% and 1.80%, respectively, plus the highest of (i) 3 month LIBOR, (ii) 10-year constant maturity treasury and (iii) 30-year constant maturity treasury.

 

Commercial Paper

 

We currently have a $6.0 billion Commercial Paper Program. Under this program, we may borrow a minimum of $100,000 for periods from one day to 270 days. It is our intention to only sell commercial paper to a maximum amount of 75% of the total amount of the backup facilities available (see “Bank Commitments” below). The weighted average interest rate of the outstanding commercial paper was 4.63%, 5.30% and 4.17%, at December 31, 2007, 2006, and 2005, respectively.

 

Bank Commitments

 

As of December 31, 2007, we had committed unsecured revolving credit agreements with an original group of 35 banks aggregating $6.5 billion, consisting of a $2.0 billion five-year tranche that expires in October of 2009, a $2.0 billion five-year tranche that expires in October of 2010 and a $2.5 billion five-year tranche that expires in October 2011. These revolving credit agreements 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 1.85% over LIBOR based upon utilization, or a rate determined by a competitive bid process with the banks. The revolving credit agreements are subject to facility fees of .10% of amounts available. This financing is used as backup for our maturing debt and other obligations. We expect to replace or extend these credit agreements on or prior to their expiration dates. At December 31, 2007, we had not drawn on our revolving loans and lines of credit.

 

Other Variable Interest Entities

 

We have sold aircraft to entities owned by third parties and from time to time we have provided financing, issued asset value guarantees or loan guarantees related to the aircraft sold. We have determined that ten such entities, each owning one aircraft, are Variable Interest Entities (“VIEs”) in which we are deemed the primary beneficiary. In accordance with Financial Accounting Standards Board Interpretations No. 46R, “Consolidation of Variable Interest Entities” (“FIN46R”), we consolidate these entities. The assets and liabilities of these entities are presented separately on our Consolidated Balance Sheets. We do not have legal control over and we do not own the assets, nor are we directly obligated for the liabilities of these entities.

 

We have not established any other unconsolidated entities for the purpose of facilitating off-balance sheet arrangements or for other contractually narrow or limited purposes. We have, 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, we employ a variety of derivative products to manage our exposure to interest rates risks and foreign currency risks. We enter into derivative transactions only to economically 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 and currency swap agreements. At December 31, 2007, we had interest rate derivative contracts and foreign currency derivative contracts that we accounted for as cash flow hedges in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” as amended and interpreted (“SFAS 133”).

 

We had four foreign currency swaps that did not qualify for hedge accounting under SFAS 133 prior to April 1, 2007, when those contracts were redesignated. At December 31, 2007, all our eligible derivative contracts are accounted for as cash flow hedges in accordance with FAS 133.

 

When interest rate and foreign currency swaps are effective as cash flow hedges under the technical requirements of SFAS 133, they offset the variability of expected future cash flows, both economically and for financial reporting purposes. We have historically used such instruments to effectively mitigate foreign currency

and interest rate risks. The effect of our ability to apply hedge accounting for the swaps is that changes in their fair values are recorded in other comprehensive income instead of in earnings each reporting period. As a result, reported net income will not be directly influenced by changes in interest rates and currency rates.

 

The counterparty to our derivative instruments is AIG Financial Products Corp. (“AIGFP”), a related party. 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, for which there was no collateral outstanding at December 31, 2007 or 2006. In addition, the derivatives are not subject to a master netting agreement. Failure of the instruments or counterparty to perform under the derivative contracts would have a material impact on our results of operations.

 

Market Liquidity Risks

 

We are in compliance with all covenants or other requirements set forth in our credit agreements. Further, we do not have any rating downgrade triggers that would automatically accelerate the maturity dates of any debt. However, a downgrade in our credit rating could adversely affect our 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 reduce our ability to issue commercial paper under our current program.

 

While we have been able to borrow the funds necessary to finance operations in the current market environment, prolonged disruptions in the credit markets, turmoil in the airline industry or political environment could limit our ability to borrow funds from our current funding sources. Should this occur, we would seek alternative sources of funding, including securitizations and manufacturer’s financings, drawings upon our revolving loans and lines of credit facilities or seek additional short term borrowings. If we were still unable to obtain sufficient funding, we could negotiate with manufacturers to defer deliveries of certain aircraft.

 

Credit Market Environment

 

During the second half of 2007, disruption in the global credit markets coupled with the re-pricing of credit risk created extremely difficult market conditions in the financial markets. These conditions resulted in greater volatility, less liquidity and widening of credit spreads. It is difficult to predict how long these conditions will exist and how our credit spreads will continue to be affected, potentially making our borrowings more expensive.

The following summarizes our contractual obligations at December 31, 2007.

 

Existing Commitments

 

 

 

 

 

 

 

 

 

Results of Operations

 

2007 Compared to 2006

 

Revenues from rentals of flight equipment increased 15.1% to $4,587.6 million in 2007 from $3,984.9 million in 2006. The number of aircraft in our fleet increased to 900 at December 31, 2007 compared to 824 at December 31, 2006. Revenues from rentals of flight equipment increased (i) $532.0 million due to the addition of aircraft to our fleet that earned revenue during the entire year, or part thereof, in 2007 compared to no or partial earned revenue during 2006; (ii) $26.4 million related to aircraft in our fleet during both years that were redelivered or had lease rate changes during 2007; and (iii) $96.0 million due to an increase in the number of leases which include overhaul provisions, resulting in an increase in the aggregate number of hours flown, on which we collect overhaul revenue. The increases were offset by a $51.7 million decrease related to aircraft in service during the period ended December 31, 2006 and sold prior to December 31, 2007. Each aircraft in our fleet was subject to a signed lease agreement or a signed letter of intent at December 31, 2007.

 

In addition to leasing operations, we engage in the marketing of our flight equipment throughout the lease term, as well as the sale of third party owned flight equipment on a principal and commission basis. Revenues from flight equipment marketing decreased to $30.6 million in 2007, compared to $71.4 million in 2006 due to a decrease in the number and type of flight equipment sold in 2007 compared to 2006. During the year ended December 31, 2007, we sold nine aircraft, one of which was accounted for as a finance lease and one of which was converted from an operating lease to a sales-type lease. During the same period in 2006, we sold 21 aircraft, two of which were accounted for as sale-lease back transactions. We also sold one engine during 2007 compared to four engines during 2006.

 

Interest and other revenue increased to $111.6 million in 2007 compared to $86.3 million in 2006 due to (i) the sale of claims against bankrupt airlines for $31.5 million; (ii) distributions on stock received as a result of a settlement related to an airline bankruptcy in the amount of $2.2 million; and (iii) other minor changes aggregating an increase of $1.6 million. These increases were offset by lower fees and deposit forfeitures due to nonperformance by customers in the amount of $10.0 million.

 

Interest expense increased to $1,612.9 million in 2007 compared to $1,469.7 million in 2006 as a result of (i) an increase in average debt outstanding (excluding the effect of debt discount and foreign exchange adjustments), primarily borrowed to finance aircraft acquisitions, to $29.7 billion in 2007 compared to $27.5 billion in 2006 and (ii) an increase in interest rates. Our average composite interest rate increased to 5.20% in 2007 from 5.12% in 2006.

Our composite borrowing rates fluctuated as follows:

 

ILFC Composite Interest Rates and Prime Rates

 

 

We account for derivatives under SFAS No. 133, “Accounting for Derivatives and Hedging Activities” as amended (“SFAS 133”). Income effect from derivatives, net of change in hedged items due to changes in foreign exchange rates was an expense of $5.3 million and a $49.7 million benefit for the years ended December 31, 2007 and 2006, respectively. The income effect includes expense from derivatives with no hedge accounting treatment under SFAS 133, net of foreign exchange gain or loss on the economically hedged item, of $16.0 million in 2007 compared to $36.8 million benefit in 2006. We began applying hedge accounting for all our swap contracts at the beginning of the second quarter of 2007. At December 31, 2006, we had four contracts that did not qualify for hedge accounting. See Note K of Notes to Consolidated Financial Statements .

 

Depreciation of flight equipment increased 10.6% to $1,736.3 million in 2007 compared to $1,570.3 million in 2006 due to the increased cost of the fleet to $52.2 billion in 2007 from $47.2 billion in 2006.

 

Provision for overhauls increased to $290.1 million in 2007 compared to $249.2 million in 2006 due to an increase in the aggregate number of hours flown, on which we collect overhaul revenue, which results in an increase in the estimated future reimbursements.

 

Selling, general and administrative expenses increased to $152.3 million in 2007 compared to $148.1 million in 2006 due to (i) an increase of $9.6 million in 2007 employee related expenses compared to 2006 and (ii) a $3.9 million charge taken in 2007 related to dissolving a joint venture. The increases were offset by a charge in the amount of $9.1 million related to a Canadian court ruling taken in 2006, which did not reoccur in 2007 (see Note J of Notes to the Consolidated Financial Statements ); and (iii) other minor savings aggregating $0.2 million.

 

Other expenses consist of a $20.1 million charge related to a notes receivable write-down in 2006 related to a lessee under bankruptcy protection.

 

Our effective tax rate for the year ended December 31, increased to 33.9% in 2007 from 30.3% in 2006. The increase is primarily due to a complete phase-out of the Extraterritorial Income Act benefit exclusion as of December 31, 2006 as a result of the 2004 enactment of the American Jobs Creation Act and a complete phase out of Foreign Sales Corporation benefits. The result of the phase out was an increase in the provision of $51.6 million for the year ended December 31, 2007 compared to the same period in 2006, which increased our effective tax rate by 5.6%. See Note G of Notes to Consolidated Financial Statements.

In 2002 and 2003 we participated in certain tax planning activities with our parent, AIG and related entities, which provided certain tax and other benefits to the AIG consolidated group. As a result of our participation in these activities, AIG shared a portion of the tax benefits of these activities attributable to us, which aggregated $245.0 million. We repaid $160.0 million of those tax benefits to AIG in 2007 and the remainder is due in 2009. The liability is recorded in Tax benefit sharing payable to AIG on the Consolidated Balance Sheet.

 

Accumulated other comprehensive (loss) income was $(106.2) million and $2.7 million at December 31, 2007 and 2006, respectively, primarily due to changes in market values of cashflow hedges. See Note E of Notes to the Consolidated Financial Statements .

 

We performed impairment reviews of all aircraft in our fleet as of June 30, 2007 and 2006, in accordance with SFAS 144. No impairments have been recognized related to aircraft, as the existing service potential of the aircraft in our portfolio has not been diminished. Further, we have been able to re-lease the aircraft without diminution in lease rates to an extent that would warrant an impairment write down.

 

2006 Compared to 2005

 

Revenues from rentals of flight equipment increased 14.4% to $3,984.9 million in 2006 from $3,482.2 million in 2005. The number of aircraft in our fleet increased to 824 at December 31, 2006 compared to 746 at December 31, 2005. Revenues from rentals of flight equipment increased (i) $502.5 million due to the addition of aircraft to our fleet that earned revenue during the entire period, or part thereof, in 2006 compared to no or partial earned revenue during 2005 and (ii) $55.4 million due to an increase in the number of leases which include overhaul provisions, resulting in an increase in the aggregate numbers of hours flown, on which we collect overhaul revenue. The increases were offset by (i) a $35.7 million decrease related to lost revenue on aircraft repossessed from airlines under bankruptcy protection and (ii) a $19.5 million decrease related to aircraft in service during the period ended December 31, 2005 and sold prior to December 31, 2006. We had one aircraft in our fleet that was not subject to a signed lease agreement or a signed letter of intent at December 31, 2006.

 

In addition to leasing operations, we engage in the marketing of our flight equipment throughout the lease term, as well as the sale of third party owned flight equipment on a principal and commission basis. Revenues from flight equipment marketing increased to $71.4 million in 2006 compared to $66.7 million in 2005 due to higher revenues related to equipment sold in 2006 compared to 2005. We sold 21 aircraft, two of which were accounted for as sale-lease-back transactions, and four engines during the year ended December 31, 2006, compared to 29 aircraft, eleven of which were accounted for as sale-leaseback transactions, and three engines during the same period in 2005.

 

Interest and other revenue increased to $86.3 million in 2006 compared to $61.4 million in 2005 due to (i) an increase in fees and deposit forfeitures due to non-performance by customers in the amount of $10.0 million; (ii) 2005 charges related to reserves for asset value guarantees and other fee based services in the amount of $7.9 million that did not reoccur in 2006; (iii) an increase in foreign exchange gain in the amount of $8.6 million; and (iv) an increase in interest income in the amount of $4.8 million. These increases were offset by lower revenue from VIE’s of $6.4 million.

 

Interest expense increased to $1,469.7 million in 2006 compared to $1,164.4 million in 2005 as a result of (i) an increase in average debt outstanding (excluding the effect of debt discount and foreign exchange adjustments), primarily borrowed to finance aircraft acquisitions, to $27.5 billion in 2006 compared to $24.7 billion in 2005 and (ii) an increase in interest rates. Our average composite interest rate increased to 5.12% in 2006 from 4.67% in 2005.

 

We account for derivatives under SFAS No. 133, “Accounting for Derivatives and Hedging Activities” as amended. Income effect from derivatives, net of change in hedged items due to changes in foreign exchange rates was a benefit in the amounts of $49.7 million and $46.1 million for the years ended December 31, 2006 and 2005, respectively. The income effect includes income from derivatives with no hedge accounting treatment under FAS 133 in the amount of $36.8 million in 2006 and $48.7 million in 2005 (see Note K of Notes to Consolidated Financial Statements ).

 

Depreciation of flight equipment increased 14.4% to $1,570.3 million in 2006 compared to $1,372.1 million in 2005 due to the increased cost of the fleet to $47.2 billion in 2006 from $42.1 billion in 2005.

 

Provision for overhauls decreased to $249.2 million in 2006 compared to $260.0 million in 2005 due to a decrease in expected overhaul related expenses.

Selling, general and administrative expenses increased to $148.1 million in 2006 compared to $135.8 million in 2005 due to (i) a charge in the amount of $9.1 million related to a Canadian court ruling (see Note J of Notes to the Consolidated Financial Statements ) and (ii) an increase of $6.9 million in 2006 employee related expenses compared to 2005, primarily due to an increase in employee benefit charges from AIG and an increase in the number of employees from 160 to 172; offset by minor savings in the amount of $3.7 million.

 

Other expenses consist of the following charges:

 

 

Our effective tax rate for the year ended December 31, 2006 was 30.3% compared to 35.0% for the same period in 2005. The decrease is due to audit adjustments and related interest charged in 2005, offset by a larger 2006 tax benefit received under the Extraterritorial Income Act.

 

In 2002 and 2003 we participated in certain tax planning activities with our parent, AIG and related entities, which provided certain tax and other benefits to the AIG consolidated group. As a result of our participation in these activities, AIG shared a portion of the tax benefits of these activities attributable to us, which aggregated $245.0 million. We are required to repay those tax benefits to AIG in 2007 and 2009. The liability is recorded in Tax benefit sharing payable to AIG on the Consolidated Balance Sheet.

 

Accumulated other comprehensive income (loss) was $2.7 million and $66.4 million at December 31, 2006 and 2005, respectively, primarily due to changes in market values of cashflow hedges. See Note E of Notes to the Consolidated Financial Statements .

 

We performed impairment reviews of all aircraft in our fleet as of June 30, 2006 and 2005, in accordance with SFAS 144. No impairments have been recognized related to aircraft, as the existing service potential of the aircraft in our portfolio has not been diminished. Further, we have been able to re-lease the aircraft without diminution in lease rates to an extent that would warrant an impairment write down.

 

New Accounting Pronouncements

 

In June 2006, the FASB issued FIN 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109.”

 

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.”

 

On February 14, 2008, the FASB issued FASB Staff Position 157-1, “Application of SFAS No. 13 and Other Accounting Pronouncements that Address Fair Value Measurements for Purposes of Lease Classification or Measurement Under Statement 13.”

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.”

 

In December 2007, the FASB issued SFAS 160, “Noncontrolling interest in Consolidated Financial Statements, an amendment of Accounting Research Bulletin No. 51.”

 

For further discussion of these recent accounting standards and their application to us, see Note A of Notes to Consolidated Financial Statements.

 

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 and equity prices and 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.

We believe 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.

 

We are 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. We statistically measure the loss of fair value through the application of a VaR model on a quarterly basis. In this analysis the net fair value of our 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 estimated impact of current derivative positions is also taken into account.

 

We calculate the VaR with respect to the net fair value by using historical scenarios. 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, 2007 and 2006. For each scenario, each financial instrument is re-priced. Scenario values for our 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 net 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 on a combined basis and of each component at market risk for our operations with respect to its fair value for the periods ended December 31, 2007 and 2006. The VaR decreased, despite the year-to-year growth in lease income, primarily due to significant decreases in the U.S. Dollar yields and yield volatilities.

 

 

The VaR calculation reflects the fact that we currently have more financial liabilities (debt) than financial assets (present value of lease payments).

Item 8.   Financial Statements and Supplementary Data

 

The response to this Item is submitted as a separate section of this report.

 

Item 9A.   Controls and Procedures

 

(A) Evaluation of Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our 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 our management, including the Chairman of the Board and Chief Executive Officer and the Vice Chairman and Chief Financial Officer (collectively the “Certifying Officers”), as appropriate, to allow timely decisions regarding required disclosure. Our management, 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.

We have evaluated, under the supervision and with the participation of management, including the Certifying Officers, the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as of the end of the year covered by this annual report. Based on that evaluation, our Certifying Officers have concluded that our disclosure controls and procedures were effective as of December 31, 2007.

 

(B) Management’s Report on Internal Control over Financial Reporting

 

Management of ILFC is responsible for establishing and maintaining adequate internal control over financial reporting. ILFC’s internal control over financial reporting is a process, under the supervision of the Certifying Officers, designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of ILFC’s financial statements for external purposes in accordance with GAAP.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.

 

ILFC management, including the Certifying Officers, conducted an assessment of the effectiveness of ILFC’s internal control over financial reporting as of December 31, 2007 based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). ILFC management has concluded that, as of December 31, 2007, ILFC’s internal control over financial reporting was effective based on the criteria in Internal Control — Integrated Framework issued by the COSO.

 

This annual report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit us to provide only management’s report in this annual report.

 

Variable Interest Entities

 

Our consolidated balance sheets include assets in the amount of $112.1 million and $124.7 million and liabilities in the amount of $7.0 million and $8.2 million at December 31, 2007 and 2006, respectively, and we recorded a net loss of $3.8 million in 2007, a net loss of $7.5 million in 2006 and a net gain of $1.8 million in 2005 related to Variable Interest Entities (“VIEs”). Our assessment of disclosure controls and procedures, as described above, includes the VIEs. Each of the VIEs has a discrete number of assets and we, as lender and guarantor to the VIEs, have been provided sufficient information to conclude that our procedures with respect to these VIEs are effective in providing reasonable assurance that the information required to be disclosed by us relating to these entities is reconciled, processed, summarized and reported within the periods specified by the Securities and Exchange Commission and is accumulated and communicated to our management, including the Certifying Officers, as appropriate, to allow timely decisions regarding required disclosure. However, management has been unable to assess the effectiveness of internal control over financial reporting at those entities, due to our inability to dictate or modify the controls of those entities, or to assess those controls.

 

(C) Changes in Internal Control Over Financial Reporting

 

Other than the remediation of the derivative accounting material weakness described below, there were no changes during the year ended December 31, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Prior to March 31, 2007, our management had concluded that our disclosure controls and procedures were not effective due to the material weakness in our internal control over financial reporting with respect to derivative accounting. This control deficiency, which management first determined to be a material weakness under the Public Company Accounting Oversight Board’s Auditing Standard No. 2 in our Annual Report on Form 10-K for the year ended December 31, 2005, largely related to inadequate hedge documentation, as required under SFAS 133 and incorrect methodology when assessing effectiveness of our interest and foreign currency swaps. We undertook several remedial steps during the three

months ended March 31, 2007 as well as during the year ended December 31, 2006, as described below, to enhance controls. As of March 31, 2007, we believe we had taken the necessary steps to remediate the material weakness. Before concluding that the material weakness was remediated, management implemented and evaluated its new controls and procedures for derivative accounting and determined that these procedures were operating effectively for a sufficient period of time and subjected them to appropriate tests in order to conclude that they are operating effectively. Accordingly, management concluded that the material weakness in our internal control over financial reporting with respect to derivative accounting was remediated as of March 31, 2007.

 

Remediation of material weakness

 

During Fiscal 2006 and 2007, the following remedial steps were taken to strengthen internal controls to address the material weakness described above:

 

 

Accordingly, management concluded that this material weakness was remediated as of March 31, 2007.

Item 9B.  Other Information

 

None.

 

PART III

 

Item 14.   Principal Accountant Fees and Services

 

Aggregate fees for professional services rendered to us by PricewaterhouseCoopers LLP (“PwC”) for the years ended December 31, 2007 and 2006, were:

 

 

 

 

 

AIG’s audit committee (“the audit committee”) approves all audit and non-audit services rendered by PwC.

PART IV

 

Item 15.   Exhibits and Financial Statement Schedules

 

(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 (b): Exhibits: The response to this portion of Item 15 is submitted as a separate section of this report.

INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES

 

FORM 10-K

Items 8, 15(a), and 15(b)

 

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):

 

Report of Independent Registered Public Accounting Firm

 

To The Shareholders and Board of Directors

of International Lease Finance Corporation:

 

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, shareholders’ equity and cash flows present fairly, in all material respects, the consolidated financial position of International Lease Finance Corporation and its subsidiaries (the “Company”) at December 31, 2007 and 2006, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards 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.

 

/s/ PricewaterhouseCoopers LLP

Los Angeles, California

 

February 25, 2008