News Column

WILLIS LEASE FINANCE CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 11, 2014

Overview

Our core business is acquiring and leasing, primarily pursuant to operating leases, commercial aircraft engines and related aircraft equipment; and the selective purchase and sale of commercial aircraft engines (collectively "equipment"). In 2013, the Company launched a new, wholly-owned subsidiary, Willis Aeronautical Services, Inc. ("WASI"). WASI primarily engages in selling aircraft engine parts and materials through the acquisition or consignment of aircraft and engines from third parties.

Critical Accounting Policies and Estimates

There have been no material changes to our critical accounting policies and estimates from the information provided in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Critical Accounting Policies and Estimates included in our 2013 Form 10-K.

Results of Operations



Three months ended June 30, 2014, compared to the three months ended June 30, 2013:

Lease Rent Revenue. Lease rent revenue for the three months ended June 30, 2014 increased 0.2% to $24.8 million from the comparable period in 2013. There was little change in the size of the lease portfolio from the prior year. The aggregate of net book value of lease equipment at June 30, 2014 and 2013 was $1,016.5 million and $1,015.3 million, respectively, an increase of 0.1%. The average utilization for the three months ended June 30, 2014 and 2013 was 81% and 83%, respectively. At June 30, 2014 and 2013, respectively, approximately 82% and 83% of equipment held for lease by book value was on lease.

During the three months ended June 30, 2014, we added $15.5 million of equipment and capitalized costs to the lease portfolio. During the three months ended June 30, 2013, we added $13.8 million of equipment and capitalized costs to the lease portfolio.

Maintenance Reserve Revenue. Our maintenance reserve revenue for the three months ended June 30, 2014 increased 23.5% to $14.6 million from $11.8 million for the comparable period in 2013. The increase was due to higher maintenance reserve revenues recognized related to the termination of long term leases in the three months ended June 30, 2014 than in the year ago period.

Gain on Sale of Leased Equipment. During the three months ended June 30, 2014, we sold two engines and other related equipment generating a net gain of $1.6 million. During the three months ended June 30, 2013, we sold one engine and an auxiliary power unit and other related equipment generating a net gain of $0.8 million.

Other Revenue. Our other revenue consists primarily of management fee income, lease administration fees as well as net spare parts sales and third party consignment commissions earned by our WASI subsidiary. Other revenue increased to $1.3 million from $0.6 million for the comparable period in 2013 primarily due to an increase in WASI commissions on third party spare parts sales and an increase in fees earned related to engines managed on behalf of third parties.

Depreciation and Amortization Expense. Depreciation and amortization expense increased 10.9% to $15.7 million for the three months ended June 30, 2014 from $14.2 million in the comparable period in 2013, due to changes in estimates of useful lives and residual values on certain older engine types that occurred in 2013 but did not affect the second quarter of 2013. As of July 1, 2013, we adjusted the depreciation for certain older engine types. It is our policy to review estimates regularly to reflect the cost of equipment over the useful life of these engines. The 2013 change in depreciation estimate resulted in a $2.1 million increase in depreciation for the three months ended June 30, 2014. The net effect of the 2013 change in depreciation estimate is a reduction in net income of $1.3 million or $0.16 in diluted earnings per share for the three months ended June 30, 2014 over what net income would have otherwise been had the change in depreciation estimate not been made.

Write-down of Equipment. A write-down of equipment totaling $2.2 million was recorded in the three months ended June 30, 2014 due to a management decision to consign four engines for part-out and sale, in which the assets net book value exceeds the estimated proceeds from part-out. A write-down of equipment totaling $2.0 million was recorded in the three months ended June 30, 2013 due to a management decision to consign an engine for part-out and sale, in which the assets net book value exceeds the estimated proceeds from part-out.

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General and Administrative Expenses. General and administrative expenses increased 0.6% to $9.3 million for the three months ended June 30, 2014, from $9.2 million in the comparable period in 2013, due primarily to increases in employee benefit costs ($0.1 million), corporate aircraft expenses ($0.1 million), temporary employee costs ($0.1 million), rent and office expenses ($0.1 million) and taxes, fees and licenses ($0.1 million), which was partially offset by a decrease in salary expense ($0.4 million).

Technical Expense. Technical expenses consist of the cost of engine repairs, engine thrust rental fees, outsourced technical support services, engine storage and freight costs. These expenses decreased by $1.8 million to $2.4 million for the three months ended June 30, 2014, from $4.2 million in the comparable period in 2013 due primarily to a decrease in engine maintenance costs due to lower repair activity.

Net Finance Costs. Net finance costs decreased 4.6% to $9.4 million for the three months ended June 30, 2014, from $9.9 million in the comparable period in 2013, due primarily to the $0.4 million interest expense recorded a year ago related to the derivative instrument in place during the three months ended June 30, 2013, which subsequently terminated in November 2013. The notes payable balance at June 30, 2014 and 2013, was $753.8 million and $744.5 million, respectively, an increase of 1.2%. As of June 30, 2014, $384.1 million of our debt is tied to one-month U.S. dollar LIBOR which decreased from an average of 0.20% for the three months ended June 30, 2013 to an average of 0.15% for the three months ended June 30, 2014 (average of month-end rates). As of June 30, 2014 and 2013, one-month LIBOR was 0.16% and 0.19%, respectively.

To mitigate exposure to interest rate changes, we periodically enter into interest rate swap agreements. As of June 30, 2013, one swap agreement had a notional outstanding amount of $100.0 million with a remaining term of five months and a fixed rate of 2.10%. This interest rate swap agreement matured in November 2013. In the three months ended June 30, 2013, $0.4 million was realized on the statement of income as an increase in interest expense as a result of this swap. No swap agreements existed during the three months ended June 30, 2014. For the three months ended June 30, 2014 and June 30, 2013, interest expense was reduced by $0.1 million resulting from interest rate swaps.

Income Tax Expense. Income tax expense (benefit) for the three months ended June 30, 2014 and 2013 was $1.3 million and $(7.8 million), respectively. The effective tax rate for the three months ended June 30, 2014 and 2013 was 37.7% and (413.6%), respectively. The effective rate for the six months ended June 30, 2013 differs from the U.S. federal statutory rate primarily due to an income tax benefit of $8.6 million related to an extraterritorial income ("ETI") adjustment recorded in the year ago period for certain of our engines. We recognized this income tax benefit in the year ago period resulting from adjustments made to the tax basis of certain of our engines due to a decision in a recent court case on behalf of another company in which our circumstances are similar. The Company records tax expense or benefit for unusual or infrequent items discretely in the period in which they occur. Our tax rate is subject to change based on changes in the mix of assets leased to domestic and foreign lessees, the proportions of revenue generated within and outside of California, the amount of executive compensation exceeding $1.0 million as defined in IRS code 162(m) and numerous other factors, including changes in tax law.

Six months ended June 30, 2014, compared to the six months ended June 30, 2013:

Lease Rent Revenue. Lease rent revenue for the six months ended June 30, 2014 increased 5.0% to $51.7 million from $49.2 million for the comparable period in 2013. This increase primarily reflects an increase in the size of the average lease portfolio during the six-month period, which translated into a higher amount of equipment on lease. The average aggregate net book value of lease equipment at June 30, 2014 and 2013 was $1,021.7 million and $1,006.2 million, respectively, an increase of 1.5%. The average utilization for the six-month periods ended June 30, 2014 and 2013 was 84% and 83%, respectively. At June 30, 2014 and 2013, approximately 82% and 83%, respectively, of equipment held for lease by book value was on lease.

During the six months ended June 30, 2014, we added $23.5 million of equipment and capitalized costs to the lease portfolio. During the six months ended June 30, 2013, we added $92.5 million of equipment and capitalized costs to the lease portfolio.

Maintenance Reserve Revenue. Our maintenance reserve revenue for the six months ended June 30, 2014 increased 36.0% to $28.6 million from $21.0 million for the comparable period in 2013, primarily as a result of higher maintenance reserve revenues recognized related to the termination of long term leases in the current period compared to the year ago period.

Gain on Sale of Leased Equipment. During the six months ended June 30, 2014, we sold five engines and other related equipment generating a net gain of $1.9 million. During the six months ended June 30, 2013, we sold eight engines and other related equipment generating a net gain of $1.5 million.

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Other Revenue. Our other revenue consists primarily of management fee income, lease administration fees as well as net spare parts sales and third party consignment commissions earned by our WASI subsidiary. Other revenue increased to $3.0 million from $1.5 million for the comparable period in 2013 primarily due to an increase in WASI commissions on third party spare parts sales and an increase in fees earned related to engines managed on behalf of third parties.

Depreciation and Amortization Expense. Depreciation and amortization expense increased 13.1% to $31.4 million for the six months ended June 30, 2014 from the comparable period in 2013, due to growth in the lease portfolio and changes in estimates of useful lives and residual values on certain older engine types that occurred in 2013 but did not affect the first six months of 2013.

Write-down of Equipment. A write-down of equipment totaling $2.5 million was recorded in the six-month period ended June 30, 2014 due to a management decision to consign five engines for part-out and sale, in which the assets net book value exceeds the estimated proceeds from part-out. A write-down of equipment totaling $2.0 million was recorded in the six-month period ended June 30, 2013 due to a management decision to consign an engine for part-out and sale, in which the assets net book value exceeds the estimated proceeds from part-out.

General and Administrative Expenses. General and administrative expenses increased 8.4% to $18.9 million for the six months ended June 30, 2014, from the comparable period in 2013, due primarily to increases in corporate aircraft expenses ($0.4 million), consulting fees ($0.3 million), travel and entertainment expenses ($0.3 million), accounting and legal fees ($0.3 million), employee benefit costs ($0.2 million) and temporary employee costs ($0.2 million), which was partially offset by a decrease in third party marketing expense ($0.3 million).

Technical Expense. Technical expenses consist of the cost of engine repairs, engine thrust rental fees, outsourced technical support services, sublease engine rental expense, engine storage and freight costs. These expenses decreased by $2.0 million to $3.9 million for the six months ended June 30, 2014, from $5.9 million in the comparable period in 2013 due to decreases in engine maintenance costs due to lower engine repair activity ($1.6 million) and storage and freight costs ($0.3 million).

Net Finance Costs. Net finance costs decreased 1.7% to $18.8 million for the six months ended June 30, 2014, from the comparable period in 2013, due primarily to the $0.8 million interest expense recorded a year ago related to the derivative instrument in place during the six months ended June 30, 2013, which subsequently terminated in November 2013. The notes payable balance at June 30, 2014 and 2013, was $753.8 million and $744.5 million, respectively, an increase of 1.2%. As of June 30, 2014, $384.1 million of our debt is tied to one-month U.S. dollar LIBOR which decreased from an average of 0.20% for the six months ended June 30, 2013 to an average of 0.15% for the six months ended June 30, 2014 (average of month-end rates). At June 30, 2014 and 2013, one-month LIBOR was 0.16% and 0.19%, respectively.

To mitigate exposure to interest rate changes, we periodically enter into interest rate swap agreements. As of June 30, 2013, one swap agreement had a notional outstanding amount of $100.0 million with a remaining term of five months and a fixed rate of 2.10%. This interest rate swap agreement matured in November 2013. In the six months ended June 30, 2013, $0.8 million was realized through the income statement as an increase in interest expense, respectively, as a result of this swap. No swap agreements existed during the six months ended June 30, 2014. For the six months ended June 30, 2014 and June 30, 2013, interest expense was reduced by $0.2 million resulting from interest rate swaps.

Income Tax Expense. Income tax expense (benefit) for the six months ended June 30, 2014 and 2013 was $3.7 million and ($6.8 million), respectively. The effective tax rate for the six months ended June 30, 2014 and 2013 was 36.4% and (150.9%), respectively. The effective rate for the six months ended June 30, 2013 differs from the U.S. federal statutory rate primarily due to an income tax benefit of $8.6 million related to an extraterritorial income ("ETI") adjustment recorded in the year ago period for certain of our engines. We recognized this income tax benefit in the year ago period resulting from adjustments made to the tax basis of certain of our engines due to a decision in a recent court case on behalf of another company in which our circumstances are similar. Our tax rate is subject to change based on changes in the mix of assets leased to domestic and foreign lessees, the proportions of revenue generated within and outside of California, the amount of executive compensation exceeding $1.0 million as defined in IRS code 162(m) and numerous other factors, including changes in tax law.

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Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers, which supersedes most of the current revenue recognition requirements. The core principle of the new guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. New disclosures about the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers are also required. This guidance is effective for the Company in the first quarter of 2017 and early application is not permitted. Entities must adopt the new guidance using one of two retrospective application methods. We are currently evaluating the standard to determine the impact of its adoption on the consolidated financial statements.

In July 2013, the FASB issued ASU 2013-11, "Income Taxes - Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists" which is part of Accounting Standards Codification ("ASC") 740: Income Taxes. The new guidance requires an entity to present an unrecognized tax benefit and an NOL carryforward, a similar tax loss, or a tax credit carryforward on a net basis as part of a deferred tax asset, unless the unrecognized tax benefit is not available to reduce the deferred tax asset component or would not be utilized for that purpose, then a liability would be recognized. We adopted this ASU as of January 1, 2014. The adoption of this ASU did not have a material impact on our Consolidated Financial Statements.

Liquidity and Capital Resources

We finance our growth through borrowings secured by our equipment lease portfolio. Cash of approximately $10.0 million and $69.0 million in the six-month periods ended June 30, 2014 and 2013, respectively, was derived from this activity. In these same time periods, $43.8 million and $21.5 million, respectively, was used to pay down related debt. Cash flow from operating activities was $34.4 million and $38.6 million in the six-month periods ended June 30, 2014 and 2013, respectively.

At June 30, 2014, $7.8 million in cash and cash equivalents and restricted cash were held in foreign subsidiaries. We do not intend to repatriate the funds held in foreign subsidiaries to the United States. In the event that we decide to repatriate these funds to the United States, we would be required to accrue and pay taxes upon the repatriation.

Our primary use of funds is for the purchase of equipment for lease. Purchases of equipment (including capitalized costs) totaled $23.2 million and $92.1 million for the six-month periods ended June 30, 2014 and 2013, respectively.

Cash flows from operations are driven significantly by payments made under our lease agreements, which comprise lease revenue, security deposits and maintenance reserves, and are offset by net finance costs and general and administrative costs. Note that cash received from maintenance reserve arrangements for some of our engines on lease are restricted per our WEST II debt agreement. Cash from WEST II engine maintenance reserve payments, that can be used to fund future maintenance events, are held in the restricted cash account equal to the maintenance obligations projected for the subsequent six months, and are subject to a minimum balance of $9.0 million. The lease revenue stream, in the short-term, is at fixed rates while a portion of our debt is at variable rates. If interest rates increase, it is unlikely we could increase lease rates in the short term and this would cause a reduction in our earnings and operating cash flows. Revenue and maintenance reserves are also affected by the amount of equipment off lease. Approximately 82%, by book value, of our assets were on-lease at June 30, 2014 compared to 83% at June 30, 2013. The average utilization rate was 84% and 83% for the six-month periods ended June 30, 2014 and June 30, 2013, respectively. If there is any increase in off-lease rates or deterioration in lease rates that are not offset by reductions in interest rates, there will be a negative impact on earnings and cash flows from operations.

At June 30, 2014, notes payable consists of loans totaling $753.8 million, payable over periods of approximately 3 months to 8 years with interest rates varying between approximately 2.4% and 5.5%.

At June 30, 2014, we had a revolving credit facility to finance the acquisition of aircraft engines for lease as well as for general working capital purposes. On June 4, 2014, we entered into a Second Amended and Restated Credit Agreement which increased this revolving credit facility to $700.0 million from $450.0 million and extended the maturity date by five years to June 2019. Debt issuance costs totaling $4.7 million were incurred related to the new facility. As of June 30, 2014 and December 31, 2013, $357.0 million and $88.0 million was available under this facility, respectively. The initial interest rate on the facility is LIBOR plus 2.50%. Quarterly, the interest rate is adjusted based on the Company's leverage ratio, as calculated under the terms of the revolving credit facility. Under the revolving credit facility, all subsidiaries except WEST II and WOLF jointly and severally guarantee payment and performance of the terms of the loan agreement. The guarantee would be triggered by a default under the agreement.

On September 17, 2012, we closed an asset-backed securitization ("ABS") through a newly-created, bankruptcy-remote, Delaware statutory trust, Willis Engine Securitization Trust II, or "WEST II", of which the Company is the sole beneficiary. WEST II issued and sold $390 million aggregate principal amount of Class 2012-A Term Notes (the "Notes") and received $384.9 million in net proceeds. We used these funds, net of transaction expenses and swap termination costs, in combination with our revolving credit facility to pay off the prior WEST notes totaling $435.9 million. At closing, 22 engines were pledged as collateral from WEST to the Company's revolving credit facility, which provided the remaining funds to pay off the WEST notes.

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The assets and liabilities of WEST II will remain on the Company's balance sheet. The current portfolio of 71 commercial jet aircraft engines and leases thereof secures the obligations of WEST II under the ABS. The Notes have no fixed amortization and are payable solely from revenue received by WEST II from the engines and the engine leases, after payment of certain expenses of WEST II. The Notes bear interest at a fixed rate of 5.50% per annum. The Notes may be accelerated upon the occurrence of certain events, including the failure to pay interest for five business days after the due date thereof. The Notes are expected to be paid 10 years from the issuance date by September 17, 2022. The legal final maturity of the Notes is September 15, 2037.

In connection with the transactions described above, effective September 17, 2012, the Company entered into a Servicing Agreement and Administrative Agency Agreement with WEST II to provide certain engine, lease management and reporting functions for WEST II in return for fees based on a percentage of collected lease revenues and asset sales. Because WEST II is consolidated for financial statement reporting purposes, all fees eliminate upon consolidation.

At June 30, 2014 and December 31, 2013, $361.5 million and $370.6 million of WEST II term notes were outstanding, respectively. The assets of WEST II are not available to satisfy our obligations or any of our affiliates other than the obligations specific to WEST II. WEST II is consolidated for financial statement presentation purposes. WEST II's ability to make distributions and pay dividends to the Company is subject to the prior payments of its debt and other obligations and WEST II's maintenance of adequate reserves and capital. Under WEST II, cash is collected in a restricted account, which is used to service the debt and any remaining amounts, after debt service and defined expenses, are distributed to the Company. Additionally, a portion of maintenance reserve payments and all lease security deposits are accumulated in restricted accounts and are available to fund future maintenance events and to secure lease payments, respectively. Cash from maintenance reserve payments are held in the restricted cash account equal to the maintenance obligations projected for the subsequent six months, and are subject to a minimum balance of $9.0 million.

On September 18, 2013, we completed the acquisition of the fifty percent membership interest held by the other joint venture partner in WOLF, with the transaction being accounted for as an asset acquisition. As a result of the transaction, we now own one hundred percent of WOLF and it is consolidated for financial statement presentation purposes. The WOLF assets and liabilities and the results of operations have been included in the accompanying consolidated financial statements as of the acquisition date, September 18, 2013. Two term notes with an original principal amount of $36.0 million, with a current balance outstanding of $25.9 million as of June 30, 2014, are included in Notes payable. The two term notes are non-recourse to the Company, have a maturity date of May 28, 2017 and interest is payable at one-month LIBOR plus 4.0%.

The assets of WOLF are not available to satisfy our obligations or any of our affiliates other than the obligations specific to WOLF. WOLF's ability to make distributions to the Company is subject to the prior payments of all of its debt and other obligations. Under WOLF, cash related to parts sales and leasing of engine assets is collected in a restricted account and used to pay certain operating expenses, service the debt, and upon full debt repayment are distributed to the Company.

On January 10, 2014, we extended the term of an existing loan that was scheduled to mature on January 11, 2014. The loan has a term of 4 years with a maturity date of January 11, 2018. Interest is payable at one-month LIBOR plus 2.25% and principal and interest is paid quarterly. The loan is secured by three engines. The balance outstanding on this loan is $15.1 million and $15.8 million as of June 30, 2014 and December 31, 2013, respectively.

On September 28, 2012, we closed on a loan for a five year term totaling $8.7 million. Interest is payable at a fixed rate of 5.50% and principal and interest is paid quarterly. The loan is secured by one engine. The funds were used to purchase the engine secured under the loan. The balance outstanding on this loan is $7.9 million and $8.2 million as of June 30, 2014 and December 31, 2013, respectively.

On September 30, 2011, we closed on a loan for a three year term totaling $4.0 million. Interest is payable at a fixed rate of 3.94% and principal and interest is paid monthly. The loan is secured by our corporate aircraft. The funds were used to refinance the loan for our corporate aircraft. The balance outstanding on this loan is $0.3 million and $1.0 million as of June 30, 2014 and December 31, 2013, respectively.

On July 16, 2014, we closed on a loan for a ten year term totaling $13.4 million. Interest is payable at a fixed rate of 2.75% for the initial five years of the loan and principal and interest is paid monthly. The loan provided 100% of the funding for the purchase of a corporate aircraft.

At June 30, 2014 and 2013, one-month LIBOR was 0.16% and 0.19%, respectively.

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Virtually all of the above debt is subject to our ongoing compliance with the covenants of each financing, including debt/equity ratios, minimum tangible net worth and minimum interest coverage ratios, and other eligibility criteria including customer and geographic concentration restrictions. In addition, under these facilities, we can typically borrow up to 85% of an engine's net book value and 65% of spare part's net book value. Therefore we must have other available funds for the balance of the purchase price of any new equipment to be purchased or we will not be permitted to draw on these facilities. The facilities are also cross-defaulted against other facilities. If we do not comply with the covenants or eligibility requirements, we may not be permitted to borrow additional funds and accelerated payments may become necessary. Additionally, much of the above debt is secured by engines to the extent that engines are sold, repayment of that portion of the debt could be required.

At June 30, 2014, we are in compliance with the covenants specified in the revolving credit facility Credit Agreement, including the Interest Coverage Ratio requirement of at least 2.25 to 1.00, and the Total Leverage Ratio requirement to remain below 5.0 to 1.00. As defined in the revolving credit facility Credit Agreement, the Interest Coverage Ratio is the ratio of Earnings before Interest, Taxes, Depreciation and Amortization and other one-time charges (EBITDA) to Consolidated Interest Expense and the Total Leverage Ratio is the ratio of Total Indebtedness to Tangible Net Worth. At June 30, 2014, we are in compliance with the covenants specified in the WEST II indenture and servicing agreement.

Approximately $30.9 million of our debt is repayable during the next 12 months. Such repayments consist of scheduled installments due under term loans. Repayments are funded by the use of unrestricted cash reserves and from cash flows from ongoing operations. The table below summarizes our contractual commitments at June 30, 2014:

Payment due by period (in thousands) Less than More than Total 1 Year 1-3 Years 3-5 Years 5 Years Long-term debt obligations $ 753,820$ 30,891$ 64,053$ 407,409$ 251,467 Interest payments under long-term debt obligations 174,604 30,454 57,158 48,867 38,125 Operating lease obligations 3,897 1,067 1,758 1,072 - Purchase obligations 28,027 28,027 - - - Total $ 960,348$ 90,439$ 122,969$ 457,348$ 289,592



We have estimated the interest payments due under long-term debt by applying the interest rates applicable at June 30, 2014 to the remaining debt, adjusted for the estimated debt repayments identified in the table above. Actual interest payments made will vary due to changes in the rates for one-month LIBOR.

We have made purchase commitments to secure the purchase of three engines and one aircraft and related equipment for a gross purchase price of $29.8 million, for delivery in 2014. As of June 30, 2014, non-refundable deposits paid related to these purchase commitments were $1.9 million. In October 2006, we entered into an agreement with CFM International ("CFM") to purchase new spare aircraft engines. The agreement specifies that, subject to availability, we may purchase up to a total of 45 CFM56-7B and CFM56-5B spare engines over a five year period, with options to acquire up to an additional 30 engines. Our outstanding purchase order with CFM for one engine represents deferral of an engine delivery originally scheduled for 2009 and is included in our commitments to purchase in 2014.

We occupy space in Novato under a lease that covers approximately 20,534 square feet of office space and expires September 30, 2018. The remaining lease rental commitment is approximately $2.3 million. Equipment leasing, financing, sales and general administrative activities are conducted from the Novato location. We sub-lease office and warehouse space for our operations in San Diego, California. This lease expires October 31, 2014, and the remaining lease commitment is approximately $50,000. We lease office and warehouse space in Shanghai, China. The office lease expires December 31, 2014 and the warehouse lease expires July 31, 2017 and the remaining lease commitments are approximately $32,000 and $22,000, respectively. We lease office space in London, United Kingdom. The lease expires December 21, 2015 and the remaining lease commitment is approximately $111,000. We lease office space in Blagnac, France. The lease expires December 31, 2014 and the remaining lease commitment is approximately $10,000. We lease office space in Dublin, Ireland. The lease expires May 15, 2017 and the remaining lease commitment is approximately $34,000. We lease office and warehouse space in Boynton Beach, Florida. The lease expires October 29, 2019 and the remaining lease commitment is approximately $1.3 million.

We believe our equity base, internally generated funds and existing debt facilities are sufficient to maintain our level of operations for the next twelve months. A decline in the level of internally generated funds, such as could result if the amount of equipment off-lease increases or there is a decrease in availability under our existing debt facilities, would impair our ability to sustain our level of operations. We continually discuss additions to our capital base with our commercial and investment banks. If we are not able to access additional capital, our ability to continue to grow our asset base consistent with historical trends will be impaired and our future growth limited to that which can be funded from internally generated capital.

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Management of Interest Rate Exposure

At June 30, 2014, $384.1 million of our borrowings were on a variable rate basis at various interest rates tied to one-month LIBOR. Our equipment leases are generally structured at fixed rental rates for specified terms. Increases in interest rates could narrow or result in a negative spread, between the rental revenue we realize under our leases and the interest rate that we pay under our borrowings. We periodically enter into interest rate derivative instruments to mitigate our exposure to interest rate risk and not to speculate or trade in these derivative products. We currently have no interest rate swap agreements in place.

We record derivative instruments at fair value as either an asset or liability. We use derivative instruments (primarily interest rate swaps) to manage the risk of interest rate fluctuation. Hedge accounting is only applied where specific criteria have been met and it is practicable to do so. In order to apply hedge accounting, the transaction must be designated as a hedge and the hedge relationship must be highly effective. The hedging instrument's effectiveness is assessed utilizing regression analysis at the inception of the hedge and on at least a quarterly basis throughout its life. All of the transactions that we have designated as hedges are accounted for as cash flow hedges. The change in fair value on a derivative instrument designated as a cash flow hedge is reported as a component of accumulated other comprehensive income and is reclassified into earnings in the period during which the transaction being hedged affects earnings or it is probable that the forecasted transaction will not occur. As of June 30, 2014, we had $0.2 million in accumulated other comprehensive income related to a previously held derivative instrument designated as a cash flow hedge. This amount is being reclassified into interest expense through December 2014, the remaining term of the associated debt. The hedge accounting for these derivative instrument arrangements (deceased) / increased net finance costs by ($0.2 million) and $0.8 million for the six months ended June 30, 2014 and June 30, 2013, respectively. This incremental cost for the swaps effective for hedge accounting was included in net finance costs for the respective periods. For further information see Note 6 to the unaudited consolidated financial statements.

For any interest rate swaps that we enter into, we will be exposed to risk in the event of non-performance of the interest rate hedge counter-parties. We anticipate that we may hedge additional amounts of our floating rate debt in the future.


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