Aircastle Limited
Aircastle LTD (Form: 10-Q, Received: 08/01/2014 06:04:05)
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
  _______________________________________________________________
FORM 10-Q
  _______________________________________________________________
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2014

or

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from            to            

Commission File number 001-32959
_______________________________________________________________
  AIRCASTLE LIMITED
(Exact name of registrant as specified in its charter)
  _______________________________________________________________
Bermuda
98-0444035
(State or other jurisdiction of
incorporation or organization)
(IRS Employer
Identification No.)
 
 
c/o Aircastle Advisor LLC
300 First Stamford Place, 5 th  Floor, Stamford, CT
06902
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code     (203) 504-1020
_______________________________________________________________
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   þ     NO   ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES   þ     NO   ¨
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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer
þ
Accelerated filer
¨
Non-accelerated filer
o   (Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES   ¨     NO   þ
As of July 28, 2014 , there were 81,007,388 outstanding shares of the registrant’s common shares, par value $0.01 per share.


Table of Contents

Aircastle Limited and Subsidiaries
Form 10-Q
Table of Contents
 
 
 
Page
No.
 
 
Item 1.
 
 
Consolidated Balance Sheets as of December 31, 2013 and June 30, 2014
 
Consolidated Statements of Income for the three and six months ended June 30, 2013 and 2014
 
Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2013 and 2014
 
Consolidated Statements of Cash Flows for the six months ended June 30, 2013 and 2014
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Item 4.
 
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.

2

Table of Contents

PART I. — FINANCIAL INFORMATION
Item 1.        Financial Statements
Aircastle Limited and Subsidiaries
Consolidated Balance Sheets
(Dollars in thousands, except share data)
 
 
December 31,
2013
 
June 30,
2014
 
 
 
(Unaudited)
ASSETS
 
 
 
Cash and cash equivalents
$
654,613

 
$
187,532

Accounts receivable
2,825

 
6,041

Restricted cash and cash equivalents
122,773

 
101,358

Restricted liquidity facility collateral
107,000

 
65,000

Flight equipment held for lease, net of accumulated depreciation of $1,430,325 and $1,407,022
5,044,410

 
5,577,966

Net investment in finance leases
145,173

 
72,600

Unconsolidated equity method investment
21,123

 
21,838

Other assets
153,976

 
179,232

Total assets
$
6,251,893

 
$
6,211,567

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
LIABILITIES
 
 
 
Borrowings from secured financings (including borrowings of ACS Ireland VIEs of $152,545 and $85,478, respectively)
$
1,586,835

 
$
1,552,493

Borrowings from unsecured financings
2,150,527

 
2,200,000

Accounts payable, accrued expenses and other liabilities
111,661

 
131,675

Lease rentals received in advance
49,235

 
52,215

Liquidity facility
107,000

 
65,000

Security deposits
118,804

 
130,611

Maintenance payments
442,432

 
433,703

Fair value of derivative liabilities
39,992

 
4,757

Total liabilities
4,606,486

 
4,570,454

 
 
 
 
Commitments and Contingencies


 


 
 
 
 
SHAREHOLDERS’ EQUITY
 
 
 
Preference shares, $.01 par value, 50,000,000 shares authorized, no shares issued and outstanding

 

Common shares, $.01 par value, 250,000,000 shares authorized, 80,806,975 shares issued and outstanding at December 31, 2013; and 81,007,388 shares issued and outstanding at June 30, 2014
808

 
810

Additional paid-in capital
1,562,106

 
1,562,736

Retained earnings
158,398

 
134,909

Accumulated other comprehensive loss
(75,905
)
 
(57,342
)
Total shareholders’ equity
1,645,407

 
1,641,113

Total liabilities and shareholders’ equity
$
6,251,893

 
$
6,211,567

The accompanying notes are an integral part of these unaudited consolidated financial statements.

3


Aircastle Limited and Subsidiaries
Consolidated Statements of Income
(Dollars in thousands, except per share amounts)
(Unaudited)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2014
 
2013
 
2014
Revenues:
 
 
 
 
 
 
 
Lease rental revenue
$
157,918

 
$
183,231

 
$
314,508

 
$
357,566

Finance lease revenue
4,114

 
3,897

 
7,998

 
7,884

Amortization of lease premiums, discounts and lease incentives
(8,709
)
 
414

 
(15,790
)
 
(6,177
)
Maintenance revenue (including contra maintenance revenue of $0 and $0 for the three months ended and $0 and $16,382 for the six months ended June 30, 2013 and 2014, respectively)
13,185

 
36,182

 
30,051

 
39,224

Total lease revenue
166,508

 
223,724

 
336,767

 
398,497

Other revenue
3,870

 
2,422

 
9,800

 
4,252

Total revenues
170,378

 
226,146

 
346,567

 
402,749

 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
Depreciation
72,079

 
75,784

 
141,979

 
149,711

Interest, net
66,656

 
60,494

 
125,808

 
124,757

Selling, general and administrative (including non-cash share based payment expense of $1,053 and $1,228 for the three months ended and $1,864 and $2,218 for the six months ended June 30, 2013 and 2014, respectively)
13,182

 
14,057

 
26,467

 
28,001

Impairment of Aircraft

 
28,306

 
6,199

 
46,569

Maintenance and other costs
6,138

 
2,646

 
9,550

 
4,509

Total expenses
158,055

 
181,287

 
310,003

 
353,547

 
 
 
 
 
 
 
 
Other income (expense):
 
 
 
 
 
 
 
Gain on sale of flight equipment
21,317

 
884

 
22,509

 
1,994

Loss on extinguishment of debt

 
(36,570
)
 

 
(36,570
)
Other
2,946

 

 
4,161

 
757

Total other income (expense)
24,263

 
(35,686
)
 
26,670

 
(33,819
)
 
 
 
 
 
 
 
 
Income from continuing operations before income taxes
36,586

 
9,173

 
63,234

 
15,383

Income tax provision
3,732

 
6,558

 
7,316

 
7,441

Earnings of unconsolidated equity method investment, net of tax

 
521

 

 
971

Net income
$
32,854

 
$
3,136

 
$
55,918

 
$
8,913

 
 
 
 
 
 
 
 
Earnings per common share — Basic:
 
 
 
 
 
 
 
Net income per share
$
0.48

 
$
0.04

 
$
0.82

 
$
0.11

 
 
 
 
 
 
 
 
Earnings per common share — Diluted:
 
 
 
 
 
 
 
Net income per share
$
0.48

 
$
0.04

 
$
0.82

 
$
0.11

 
 
 
 
 
 
 
 
Dividends declared per share
$
0.165

 
$
0.200

 
$
0.330

 
$
0.400

The accompanying notes are an integral part of these unaudited consolidated financial statements.

4


Aircastle Limited and Subsidiaries
Consolidated Statements of Comprehensive Income
(Dollars in thousands)
(Unaudited)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2014
 
2013
 
2014
 
 
 
 
 
 
 
 
Net income
$
32,854

 
$
3,136

 
$
55,918

 
$
8,913

Other comprehensive income, net of tax:
 
 
 
 
 
 
 
Net change in fair value of derivatives, net of tax expense of $193 and $0 for the three months ended and $311 and $804 for the six months ended June 30, 2013 and 2014, respectively
8,127

 
12

 
11,953

 
382

Net derivative loss reclassified into earnings
9,711

 
8,854

 
17,985

 
18,181

Other comprehensive income
17,838

 
8,866

 
29,938

 
18,563

Total comprehensive income
$
50,692

 
$
12,002

 
$
85,856

 
$
27,476


The accompanying notes are an integral part of these unaudited consolidated financial statements.

5


Aircastle Limited and Subsidiaries
Consolidated Statements of Cash Flows
(Dollars in thousands)
(Unaudited)
 
Six Months Ended June 30,
 
2013
 
2014
Cash flows from operating activities:
 
 
 
Net income
$
55,918

 
$
8,913

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation
141,979

 
149,711

Amortization of deferred financing costs
8,781

 
6,987

Amortization of net lease discounts and lease incentives
15,790

 
6,177

Deferred income taxes
3,237

 
3,999

Non-cash share based payment expense
1,864

 
2,218

Cash flow hedges reclassified into earnings
17,985

 
18,181

Security deposits and maintenance payments included in earnings
(25,538
)
 
(40,006
)
Gain on sale of flight equipment
(22,509
)
 
(1,994
)
Loss on extinguishment of debt

 
36,570

Impairment of aircraft
6,199

 
46,569

Other
(3,817
)
 
(91
)
Changes in certain assets and liabilities:
 
 
 
Accounts receivable
(410
)
 
(3,619
)
Other assets
4,834

 
(1,914
)
Accounts payable, accrued expenses and other liabilities
(3,824
)
 
(20,438
)
Lease rentals received in advance
(7,050
)
 
2,742

Net cash provided by operating activities
193,439

 
214,005

Cash flows from investing activities:
 
 
 
Acquisition and improvement of flight equipment and lease incentives
(331,067
)
 
(834,467
)
Proceeds from sale of flight equipment
253,909

 
246,037

Restricted cash and cash equivalents related to sale of flight equipment

 
7,600

Aircraft purchase deposits and progress payments
(1,869
)
 
(3,785
)
Net investment in finance leases
(11,605
)
 
(14,258
)
Collections on finance leases
4,052

 
6,219

Unconsolidated equity method investment and associated costs

 
(159
)
Distributions from unconsolidated equity method investment in excess of earnings

 
651

Principal repayments on debt investment
42,001

 

Other
(829
)
 
(405
)
Net cash used in investing activities
(45,408
)
 
(592,567
)
Cash flows from financing activities:
 
 
 
Issuance of shares net of repurchases
(7,940
)
 
(2,091
)
Proceeds from notes and term debt financings

 
803,200

Securitization and term debt financing repayments
(294,064
)
 
(827,512
)
Debt extinguishment costs

 
(32,835
)
Deferred financing costs
(557
)
 
(15,834
)
Restricted secured liquidity facility collateral

 
42,000

Secured liquidity facility collateral

 
(42,000
)
Restricted cash and cash equivalents related to financing activities
(81,664
)
 
13,815

Security deposits and maintenance payments received
104,787

 
83,144

Security deposits and maintenance payments returned
(33,975
)
 
(44,577
)
Payments for terminated cash flow hedges

 
(33,427
)
Dividends paid
(22,565
)
 
(32,402
)
Net cash (used in) provided by financing activities
(335,978
)
 
(88,519
)
Net increase (decrease) in cash and cash equivalents
(187,947
)
 
(467,081
)
Cash and cash equivalents at beginning of period
618,217

 
654,613

Cash and cash equivalents at end of period
$
430,270

 
$
187,532

Supplemental disclosures of cash flow information:
 
 
 
Cash paid for interest, net of capitalized interest
$
100,374

 
$
112,386

Cash paid for income taxes
$
529

 
$
3,630

Supplemental disclosures of non-cash investing activities:
 
 
 
Purchase deposits, advance lease rentals, security deposits and maintenance payments assumed in asset acquisitions
$
21,958

 
$
18,522

Term debt financings assumed in asset acquisitions
$
84,721

 
$
39,061

Advance lease rentals, security deposits, and maintenance payments settled in sale of flight equipment
$
35,475

 
$
17,533

The accompanying notes are an integral part of these unaudited consolidated financial statements.

6


Aircastle Limited and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
June 30, 2014



Note 1. Summary of Significant Accounting Policies
Organization and Basis of Presentation
Aircastle Limited (“Aircastle,” the “Company,” “we,” “us” or “our”) is a Bermuda exempted company that was incorporated on October 29, 2004 under the provisions of Section 14 of the Companies Act of 1981 of Bermuda. Aircastle’s business is investing in aviation assets, including acquiring, leasing, managing and selling high utility commercial jet aircraft. From time to time, we also make investments in other aviation assets, including debt investments secured by commercial jet aircraft.
Aircastle is a holding company that conducts its business through subsidiaries. Aircastle directly or indirectly owns all of the outstanding common shares of its subsidiaries. The consolidated financial statements presented are prepared in accordance with U.S. generally accepted accounting principles (“US GAAP”). We operate in one segment.
The accompanying consolidated financial statements are unaudited and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim financial reporting and, in our opinion, reflect all adjustments, including normal recurring items, which are necessary to present fairly the results for interim periods. Operating results for the periods presented are not necessarily indicative of the results that may be expected for the entire year. Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with US GAAP have been omitted in accordance with the rules and regulations of the SEC; however, we believe that the disclosures are adequate to make information presented not misleading. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 .
The Company’s management has reviewed and evaluated all events or transactions for potential recognition and/or disclosure since the balance sheet date of June 30, 2014 through the date on which the consolidated financial statements included in this Form 10-Q were issued.

Principles of Consolidation
The consolidated financial statements include the accounts of Aircastle and all of its subsidiaries. Aircastle consolidates seven Variable Interest Entities (“VIEs”) of which Aircastle is the primary beneficiary. All intercompany transactions and balances have been eliminated in consolidation.
We consolidate VIEs in which we have determined that we are the primary beneficiary. We use judgment when deciding (a) whether an entity is subject to consolidation as a VIE, (b) who the variable interest holders are, (c) the potential expected losses and residual returns of the variable interest holders, and (d) which variable interest holder is the primary beneficiary. When determining which enterprise is the primary beneficiary, we consider (1) the entity’s purpose and design, (2) which variable interest holder has the power to direct the activities that most significantly impact the entity’s economic performance, and (3) the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE. When certain events occur, we reconsider whether we are the primary beneficiary of VIEs. We do not reconsider whether we are a primary beneficiary solely because of operating losses incurred by an entity.
Effective June 1, 2014, the Company adopted the Financial Accounting Standards Board (the “FASB”) Accounting Standards Update (“ASU”) 2014-08 (“ASU 2014-08 ”), Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360), Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity , which changes the criteria for determining which disposals can be presented as discontinued operations and modifies related disclosure requirements. This ASU raises the threshold for disposals to qualify as discontinued operations by focusing on strategic shifts that have or will have a major effect on an entity’s operations and financial results. This ASU also allows companies to have significant continuing involvement and continuing cash flows with the disposed component and requires additional disclosures for discontinued operations and new disclosures for individually material disposal transactions that do not meet the definition of a discontinued operation. ASU 2014-08 applies prospectively to new disposals and new classifications of disposal groups as held for sale after the effective date and should be applied prospectively. Early adoption of the guidance is permitted for new disposals (or new classifications as held for sale) that have not been reported in financial

7


Aircastle Limited and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
June 30, 2014


statements previously issued or available for issuance. The adoption of ASU 2014-08 did not have a material impact on the Company’s consolidated financial statements.

Use of Estimates
The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. While Aircastle believes that the estimates and related assumptions used in the preparation of the consolidated financial statements are appropriate, actual results could differ from those estimates.

Proposed Accounting Pronouncements
In May 2013, the FASB issued re-exposure draft, “Leases” (the “Lease Re-ED”), which would replace the existing guidance in the Accounting Standards Codification (“ASC”) 840 (“ASC 840”), Leases . In March 2014, the FASB decided that the accounting for leases by lessors would basically remain unchanged from the concepts existing in current ASC 840 accounting. In addition, the FASB decided that a lessor should be precluded from recognizing selling profit and revenue at lease commencement for any sales-type or direct finance lease that does not transfer control of the underlying asset to the lessee. This requirement aligns the notion of what constitutes a sale in the lessor accounting guidance with that in the forthcoming revenue recognition standard, which evaluates whether a sale has occurred from the customer’s perspective. We anticipate that the final standard may have an effective date no earlier than 2017. We believe that when and if the proposed guidance becomes effective, it will not have a material impact on the Company’s consolidated financial statements.
On May 28, 2014, the FASB and the International Accounting Standards Board (the “IASB”) (collectively, the Boards), jointly issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). Lease contracts within the scope of ASC 840, Leases, are specifically excluded from ASU No. 2014-09. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which a company expects to be entitled in exchange for those goods or services. The standard is effective for public entities beginning after December 15, 2016. The standard allows for either “full retrospective” adoption, meaning the standard is applied to all of the periods presented, or “modified retrospective” adoption, meaning the standard is applied only to the most current period presented in the financial statements. The Company is currently evaluating its existing revenue recognition policies to determine the affect this new guidance will have on the Company’s consolidated financial statements.

Note 2. Fair Value Measurements
Fair value measurements and disclosures require the use of valuation techniques to measure fair value that maximize the use of observable inputs and minimize use of unobservable inputs. These inputs are prioritized as follows:
Level 1: Observable inputs such as quoted prices in active markets for identical assets or liabilities.
Level 2: Inputs other than quoted prices included within Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities or market corroborated inputs.
Level 3: Unobservable inputs for which there is little or no market data and which require us to develop our own assumptions about how market participants price the asset or liability.
The valuation techniques that may be used to measure fair value are as follows:
The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.
The income approach uses valuation techniques to convert future amounts to a single present amount based on current market expectation about those future amounts.
The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost).

8


Aircastle Limited and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
June 30, 2014


The following tables set forth our financial assets and liabilities as of December 31, 2013 and June 30, 2014 that we measured at fair value on a recurring basis by level within the fair value hierarchy. Assets and liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to their fair value measurement. 
 
 
 
Fair Value Measurements at December 31, 2013 Using Fair Value Hierarchy
 
Fair Value as of December 31, 2013
 
Quoted Prices
In Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Valuation
Technique
Assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
654,613

 
$
654,613

 
$

 
$

 
Market
Restricted cash and cash equivalents
122,773

 
122,773

 

 

 
Market
Total
$
777,386

 
$
777,386

 
$

 
$

 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
Derivative liabilities
$
39,992

 
$

 
$
39,992

 
$

 
Income
 
 
 
Fair Value Measurements at June 30, 2014 Using Fair Value Hierarchy
 
Fair Value as of June 30, 2014
 
Quoted Prices
In Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Valuation
Technique
Assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
187,532

 
$
187,532

 
$

 
$

 
Market
Restricted cash and cash equivalents
101,358

 
101,358

 

 

 
Market
Total
$
288,890

 
$
288,890

 
$

 
$

 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
Derivative liabilities
$
4,757

 
$

 
$
4,757

 
$

 
Income

Our cash and cash equivalents, along with our restricted cash and cash equivalents balances, consist largely of money market securities that are considered to be highly liquid and easily tradable. These securities are valued using inputs observable in active markets for identical securities and are therefore classified as Level 1 within our fair value hierarchy. Our interest rate derivatives included in Level 2 consist of United States dollar-denominated interest rate derivatives, and their fair values are determined by applying standard modeling techniques under the income approach to relevant market interest rates (cash rates, futures rates, swap rates) in effect at the period close to determine appropriate reset and discount rates and incorporates an assessment of the risk of non-performance by the interest rate derivative counterparty in valuing derivative assets and an evaluation of the Company’s credit risk in valuing derivative liabilities.
The following tables reflect the activity for the classes of our assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and six months ended June 30, 2013 and 2014 , respectively:

9


Aircastle Limited and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
June 30, 2014


 
Assets
 
Debt Investments
 
Three Months Ended June 30,
 
Six Months Ended June 30, 2014
 
2013
 
2014
 
2013
 
2014
Balance at beginning of period
$

 
$

 
$
40,388

 
$

Total gains/(losses), net:
 
 
 
 
 
 
 
        Included in other revenue

 

 
1,613

 

Settlements

 

 
(42,001
)
 

Balance at end of period
$

 
$

 
$

 
$


For the three and six months ended June 30, 2013 and 2014 , we had no transfers into or out of Level 3; however, we settled the debt investment during the first quarter of 2013.
We measure the fair value of certain assets and liabilities on a non-recurring basis, when US GAAP requires the application of fair value, including events or changes in circumstances that indicate that the carrying amounts of assets may not be recoverable. Assets subject to these measurements include our investment in an unconsolidated joint venture and aircraft. We account for our investment in an unconsolidated joint venture under the equity method of accounting and record impairment when its fair value is less than its carrying value. We record aircraft at fair value when we determine the carrying value may not be recoverable. Fair value measurements for aircraft in impairment tests are based on an income approach which uses Level 3 inputs, which include the Company’s assumptions and appraisal data as to future cash proceeds from leasing and selling aircraft.

Aircraft Valuation
During the second quarter of 2014, we impaired two Boeing 747-400 converted freighters, one of which is off-lease and the other which has a scheduled lease expiry in December 2014. We intend to sell both aircraft rather than reinvest in further maintenance necessary for releasing, and we classified one as Flight Equipment Held for Sale in Other Assets on our consolidated Balance Sheet. For the off-lease aircraft, we recorded an impairment charge totaling $17,419 during the three months ended June 30, 2014. We previously recorded maintenance revenue of $3,853 and reversed lease incentives of $857 during the three months ended December 31, 2013 when this aircraft was returned to us. For the aircraft with a scheduled lease expiry in December 2014, we recorded an impairment charge totaling $10,723 and recorded maintenance revenue of $5,986 and reversed lease incentives of $3,626 during the six months ended June 30, 2014.
During the first quarter of 2014, we impaired two aircraft, one Boeing 737-400, which was returned to us as scheduled by the lessee and one Boeing 747-400 converted freighter, for which we agreed to an early lease termination with our customer. For these two aircraft, we recorded impairment charges totaling $18,263 and recorded maintenance revenue of $17,176 during the three months ended March 31, 2014.
During the first quarter of 2013 , we impaired two aircraft, one Airbus A319-100 aircraft and one Boeing 767-300ER aircraft, each of which was returned to us early by the respective lessee. For these two aircraft, we recorded impairment charges totaling $6,199 and recorded maintenance revenue of $9,019 and other revenue of $876 during the six months ended June 30, 2013 .
        

Financial Instruments
Our financial instruments, other than cash, consist principally of cash equivalents, restricted cash and cash equivalents, accounts receivable, accounts payable, amounts borrowed under financings and interest rate derivatives. The fair value of cash, cash equivalents, restricted cash and cash equivalents, accounts receivable and accounts payable approximates the carrying value of these financial instruments because of their short-term nature.

10


Aircastle Limited and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
June 30, 2014


The fair value of our Securitization, which contains a third party credit enhancement, is estimated using a discounted cash flow analysis, based on our current incremental borrowing rates of borrowing arrangements that do not contain third party credit enhancements. The fair values of our ECA term financings and bank financings are estimated using a discounted cash flow analysis, based on our current incremental borrowing rates for similar types of borrowing arrangements. The fair value of our Senior Notes is estimated using quoted market prices.
 The carrying amounts and fair values of our financial instruments at December 31, 2013 and June 30, 2014 are as follows:
 
December 31, 2013
 
June 30, 2014
 
Carrying  Amount
of Asset
(Liability)
 
Fair Value
of Asset
(Liability)
 
Carrying  Amount
of Asset
(Liability)
 
Fair Value
of Asset
(Liability)
Securitizations
$
(828,871
)
 
$
(779,901
)
 
$
(497,001
)
 
$
(466,589
)
ECA term financings
(493,708
)
 
(506,227
)
 
(471,978
)
 
(494,552
)
Bank financings
(264,256
)
 
(268,435
)
 
(583,514
)
 
(589,012
)
Senior Notes
(2,150,527
)
 
(2,325,965
)
 
(2,200,000
)
 
(2,396,401
)
All of our financial instruments are classified as Level 2 with the exception of our Senior Notes, which are classified as Level 1.

Note 3. Lease Rental Revenues and Flight Equipment Held for Lease
Minimum future annual lease rentals contracted to be received under our existing operating leases of flight equipment at June 30, 2014 were as follows:
Year Ending December 31,
Amount
Remainder of 2014
$
356,704

2015
672,220

2016
588,472

2017
449,088

2018
326,299

Thereafter
883,681

Total
$
3,276,464

Geographic concentration of lease rental revenue earned from flight equipment held for lease was as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
Region
2013
 
2014
 
2013
 
2014
Europe
33
%
 
28
%
 
33
%
 
29
%
Asia and Pacific
38
%
 
38
%
 
38
%
 
40
%
North America
9
%
 
10
%
 
9
%
 
10
%
South America
9
%
 
15
%
 
9
%
 
12
%
Middle East and Africa
11
%
 
9
%
 
11
%
 
9
%
Total
100
%
 
100
%
 
100
%
 
100
%
The classification of regions in the tables above and in the table and discussion below is determined based on the principal location of the lessee of each aircraft.

11


Aircastle Limited and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
June 30, 2014


For the three months ended June 30, 2013 , one customer accounted for 8% of lease rental revenue and four additional customers accounted for a combined 23% of lease rental revenue. No other customer accounted for more than 5% of lease rental revenue. For the three months ended June 30, 2014 , one customer accounted for 9% of lease rental revenue and an additional two customers separately accounted for 11% of lease rental revenue. No other customer accounted for more than 5% of lease rental revenue.
For the six months ended June 30, 2013 , one customer accounted for 8% of lease rental revenue and four additional customers accounted for a combined 23% of lease rental revenue. No other customer accounted for more than 5% of lease rental revenue. For the six months ended June 30, 2014 , one customer accounted for 6% of lease rental revenue and an additional two customers separately accounted for 10% of lease rental revenue. No other customer accounted for more than 5% of lease rental revenue.
The following table sets forth revenue attributable to individual countries representing at least 10% of total revenue (including maintenance revenue) based on each lessee’s principal place of business:
 
Three Months Ended June 30,
 
2013
 
2014
Country
Revenue
 
Percent of
Total
Revenue
 
Number
of
Lessees
 
Revenue
 
Percent of
Total
Revenue
 
Number
of
Lessees
India (1) (3)
$

 
%
 

 
$
25,707

 
11
%
 
1

United States (2) (3)

 
%
 

 
24,390

 
11
%
 
5

China (4)
17,610

 
10
%
 
4

 
$

 
%
 

            
(1) Total revenue for the three months ended June 30, 2014 includes $ 19,582 of maintenance revenue related to scheduled lease terminations.
(2) Total revenue for the three months ended June 30, 2014 includes $ 5,986 of maintenance revenue related to aircraft impairment.
(3) Total revenue was less than 10% for the three months ended June 30, 2013 .
(4) Total revenue was less than 10% for the three months ended June 30, 2014 .

 
Six Months Ended June 30,
 
2013
 
2014
Country
Revenue
 
Percent of
Total
Revenue
 
Number
of
Lessees
 
Revenue
 
Percent of
Total
Revenue
 
Number
of
Lessees
China (1)
$
36,913

 
11
%
 
4

 

 
%
 

United States (1)
33,002

 
10
%
 
7

 
$

 
%
 

            
(1) Total revenue was less than 10% for the six months ended June 30, 2014 .

Geographic concentration of net book value of flight equipment (includes net book value of flight equipment held for lease and net investment in finance leases) was as follows:

12


Aircastle Limited and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
June 30, 2014


 
December 31, 2013
 
June 30, 2014
Region
Number
of
Aircraft
 
Net Book
Value %
 
Number
of
Aircraft (1)
 
Net Book
Value %
Europe
64

 
30
%
 
62

 
27
%
Asia and Pacific
56

 
41
%
 
46

 
40
%
North America
19

 
10
%
 
21

 
9
%
South America
14

 
7
%
 
13

 
14
%
Middle East and Africa
7

 
11
%
 
6

 
10
%
Off-lease
2

(2)  
1
%
 


%
Total
162

 
100
%
 
148

 
100
%
 
_______________

(1)
At June 30, 2014, excludes two aircraft classified as Flight Equipment Held for Sale.
(2)
Consisted of two Boeing 747-400 converted freighter aircraft, one of which was subject to a commitment to lease and was delivered to our customer in the first quarter of 2014 and the other is included in Flight Equipment Held for Sale.

At December 31, 2013 and June 30, 2014 , no country represented at least 10% of net book value of flight equipment based on each lessee’s principal place of business.
  At December 31, 2013 and June 30, 2014 , the amounts of lease incentive liabilities recorded in maintenance payments on the consolidated balance sheets were $28,611 and $26,742 , respectively.

Note 4. Net Investment in Finance Leases
At June 30, 2014 , our net investment in finance leases represents four aircraft leased to two customers in the United States, one aircraft leased to a customer in Canada and one aircraft leased to a customer in Croatia. The following table lists the components of our net investment in finance leases at June 30, 2014 :
 
 
Amount
Total lease payments to be received
 
$
57,971

Less: Unearned income
 
(18,630
)
Estimated residual values of leased flight equipment (unguaranteed)
 
33,259

    Net investment in finance leases
 
$
72,600



At June 30, 2014 , minimum future lease payments on finance leases are as follows:
Year Ending December 31,
 
Amount
Remainder of 2014
 
$
6,466

2015
 
12,889

2016
 
12,889

2017
 
11,974

2018
 
4,080

Thereafter
 
9,673

    Total
 
$
57,971




13


Aircastle Limited and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
June 30, 2014



Note 5. Unconsolidated Equity Method Investment
On December 19, 2013, the Company formed a joint venture to invest in leased aircraft with an affiliate of Ontario Teachers’ Pension Plan (“Teachers’ “) in which we have a 30% equity interest. Teachers’ holds more than 5% of our common shares. Accordingly, the formation of the joint venture and the sale of the A330 aircraft to the joint venture was submitted to, and approved by, our Audit Committee in December of 2013 under our related party policy. The assets and liabilities of this joint venture are off our balance sheet and we only record our net investment under the equity method of accounting.
While the Company has no obligation to make additional investments in the joint venture, we have agreed to return to the joint venture any portion of distributions from the joint venture which comprise lessee maintenance payments, to the extent that the joint venture must reimburse such maintenance payments to the lessee. The Company has recorded a $2,141 guarantee liability which is reflected in Maintenance payments on the balance sheet.
Investment in joint venture at December 31, 2013
 
$
21,123

Investment in joint venture
 
1,418

Earnings from joint venture, net of tax
 
971

Distributions
 
(1,674
)
Investment in joint venture at June 30, 2014
 
$
21,838

 
 
 


Note 6. Variable Interest Entities
Aircastle consolidates seven VIEs of which it is the primary beneficiary. The operating activities of these VIEs are limited to acquiring, owning, leasing, maintaining, operating and, under certain circumstances, selling the 15 aircraft discussed below.
Securitizations
In connection with Securitization No. 1, two of our subsidiaries, ACS Aircraft Finance Ireland plc (“ACS Ireland”) and ACS Aircraft Finance Bermuda Limited (“ACS Bermuda”) issued Class A-1 notes, and each has fully and unconditionally guaranteed the other’s obligations under the notes. In connection with Securitization No. 2, two of our subsidiaries, ACS Aircraft Finance Ireland 2 Limited (“ACS Ireland 2”) and ACS 2007-1 Limited (“ACS Bermuda 2”) issued Class A-1 notes and each has fully and unconditionally guaranteed the other’s obligations under the notes. ACS Ireland and ACS Ireland 2 are collectively referred to as the “ACS Ireland VIEs”. In February 2014, we repaid the outstanding amount plus accrued interest and fees due under Securitization No. 1 and ACS Ireland became a wholly owned subsidiary of Aircastle.
Aircastle is the primary beneficiary of ACS Ireland 2, as we have both the power to direct the activities of the VIE that most significantly impacts the economic performance of such VIE and we bear the significant risk of loss and participate in gains through Class E-1 Securities. Although Aircastle has not guaranteed the ACS Ireland 2 debt, Aircastle wholly owns ACS Bermuda 2 which has fully and unconditionally guaranteed the ACS Ireland 2 VIE obligations. The activity that most significantly impacts the economic performance is the leasing of aircraft. Aircastle Advisor (Ireland) Limited (Aircastle’s wholly owned subsidiary) is the remarketing servicer and is responsible for the leasing of the aircraft. An Irish charitable trust owns 95% of the common shares of ACS Ireland 2. The Irish charitable trust’s risk is limited to its annual dividend of $2 . At June 30, 2014 , the assets of ACS Ireland 2 include seven aircraft transferred into the VIE at historical cost basis in connection with Securitization No. 2.
The assets of the ACS Ireland 2 as of June 30, 2014 are $189,908 . The liabilities of the ACS Ireland 2, net of $40,351 Class E-1 Securities held by the Company, which is eliminated in consolidation, as of June 30, 2014 are $155,415 .



14


Aircastle Limited and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
June 30, 2014


ECA Term Financings
Aircastle, through various subsidiaries, each of which is owned by a charitable trust (such entities, collectively the “Air Knight VIEs”), has entered into eight different twelve -year term loans, which are supported by guarantees from Compagnie Francaise d’ Assurance pour le Commerce Exterieur, (“COFACE”), the French government sponsored export credit agency (“ECA”). We refer to these COFACE-supported financings as “ECA Term Financings.”
Aircastle is the primary beneficiary of the Air Knight VIEs, as we have the power to direct the activities of the VIEs that most significantly impact the economic performance of such VIEs and we bear the significant risk of loss and participate in gains through a finance lease. The activity that most significantly impacts the economic performance is the leasing of aircraft of which our wholly owned subsidiary is the servicer and is responsible for managing the relevant aircraft. There is a cross collateralization guarantee between the Air Knight VIEs. In addition, Aircastle guarantees the debt of the Air Knight VIEs.
The only assets that the Air Knight VIEs have on their books are financing leases that are eliminated in the consolidated financial statements and deferred financing costs. The related aircraft, with a net book value as of June 30, 2014 of $656,434 were included in our flight equipment held for lease. The consolidated debt outstanding of the Air Knight VIEs as of June 30, 2014 is $471,978 .

Note 7. Secured and Unsecured Debt Financings
The outstanding amounts of our secured and unsecured term debt financings were as follows:
 
At December 31, 2013
 
At June 30, 2014
Debt Obligation
Outstanding
Borrowings
 
Outstanding
Borrowings
 
Interest Rate (1)
 
Final Stated
Maturity (2)
Secured Debt Financings:
 
 
 
 
 
 
 
Securitization No. 1 (3)
$
225,034

 
$

 
—%
 
Securitization No. 2
603,837

 
497,001

 
0.46%
 
06/14/37
ECA Term Financings
493,708

 
471,978

 
3.02% to 3.96%
 
12/3/21 to 11/30/24
Bank Financings
264,256

 
583,514

 
1.05% to 5.09%
 
09/15/15 to 04/19/25
Total secured debt financings
1,586,835

 
1,552,493

 
 
 
 
 
 
 
 
 
 
 
 
Unsecured Debt Financings:
 
 
 
 
 
 
 
Senior Notes due 2017
500,000

 
500,000

 
6.75%
 
04/15/17
Senior Notes due 2018 (4)
450,527

 

 
—%
 
Senior Notes due 2018
400,000

 
400,000

 
4.625%
 
12/05/18
Senior Notes due 2019
500,000

 
500,000

 
6.250%
 
12/01/19
Senior Notes due 2020
300,000

 
300,000

 
7.625%
 
04/15/20
Senior Notes due 2021

 
500,000

 
5.125%
 
03/15/21
2014 Revolving Credit Facility (5)

 

 
N/A
 
03/31/18
Total unsecured debt financings
2,150,527

 
2,200,000

 
 
 
 
 
 
 
 
 
 
 
 
Total secured and unsecured debt financings
$
3,737,362

 
$
3,752,493

 
 
 
 
 
        
(1)
Reflects the floating rate in effect at the applicable reset date plus the margin for Securitization No. 2 and six of our Bank Financings. All other financings have a fixed rate.
(2)
For Securitization No. 2, all cash flows available after expenses and interest are applied to debt amortization.
(3)
In February 2014, we repaid the outstanding amount plus accrued interest and fees due under Securitization No. 1 and terminated the related interest rate derivative, for a total cash payment of $255,186 , with proceeds from our December 2013 issuance of our Senior Notes due 2018.
(4)
Proceeds from the issuance of our Senior Notes due 2021 were used to pay-off the balance of our 9.75% Senior Notes due 2018 plus accrued interest of $10,238 and the call premium of $32,835 on April 25, 2014.

15


Aircastle Limited and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
June 30, 2014


(5)
On March 31, 2014, we amended and restructured our existing $335,000 2013 Revolving Credit Facility with a new unsecured revolving credit facility (the “2014 Revolving Credit Facility”).  The 2014 Revolving Credit Facility was increased to $450,000 , has a term of four years and is scheduled to expire in March 2018 and was undrawn at June 30, 2014.

The following Securitization includes a liquidity facility commitment described in the table below: 
 
 
 
Available Liquidity
 
 
 
 
Facility
Liquidity Facility Provider
 
December 31,
2013
 
June 30,
2014
 
Unused
Fee
 
Interest Rate
on any Advances
Securitization No. 2
HSH Nordbank AG
 
$
65,000

 
$
65,000

 
0.50%
 
1M Libor + 0.75
 


Secured Debt Financings:

Securitizations

In February 2014, we repaid the outstanding amount plus accrued interest and fees due under Securitization No.1 and terminated the related interest rate derivative, for a total cash payment of $255,186 , with proceeds from our December 2013 issuance of our Senior Notes due 2018.


Bank Financings
In February 2014, we entered into two floating rate loans and one fixed rate loan totaling $303,200 secured by two Boeing 777-300ER aircraft and one Airbus A330-200 aircraft we acquired in 2013. In March 2014, we assumed two floating rate loans totaling $40,809 in connection with the acquisition of two Boeing 737-800 aircraft.
We include these loan facilities in “Bank Financings”. Aircastle Limited has guaranteed the repayment of these Bank Financings.

Unsecured Debt Financings:

Senior Notes due 2021

On March 26, 2014, Aircastle Limited issued $500,000 aggregate principal amount of Senior Notes due 2021 (the “2021 Senior Notes”). The 2021 Senior Notes will mature on March 15, 2021 and bear interest at the rate of 5.125% per annum, payable semi-annually on March 15 and September 15 of each year, commencing on September 15, 2014. Interest will accrue on the 2021 Senior Notes from March 26, 2014. Proceeds from the issuance were used to pay-off the outstanding amount of our 9.75% Senior Notes due 2018 plus accrued interest of $10,238 , and the call premium of $32,835 on April 25, 2014. We also wrote off $3,735 of debt issuance costs associated with the pay-off of the Senior Notes due 2018. Both the call premium and the write-off of debt issuance costs are included in Other income (expense) - Loss on Extinguishment of Debt on our consolidated statement of income.

2014 Revolving Credit Facility

On March 31, 2014, we amended and restructured our existing $335,000 2013 Revolving Credit Facility with the 2014 Revolving Credit Facility.  The 2014 Revolving Credit Facility was increased to $450,000 , has a term of four years and is scheduled to expire in March 2018.

As of June 30, 2014 , we are in compliance with all applicable covenants in all of our financings.


16


Aircastle Limited and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
June 30, 2014


Note 8. Dividends
The following table sets forth the quarterly dividends declared by our board of directors for the periods covered in this report: 
Declaration Date
Dividend
per Common
Share
 
Aggregate
Dividend
Amount
 
Record Date
 
Payment Date
February 18, 2013
$
0.165

 
$
11,268

 
March 4, 2013
 
March 15, 2013
May 1, 2013
$
0.165

 
$
11,297

 
May 31, 2013
 
June 14, 2013
August 2, 2013
$
0.165

 
$
13,330

 
August 30, 2013
 
September 13, 2013
October 29, 2013
$
0.200

 
$
16,163

 
November 29, 2013
 
December 13, 2013
February 21, 2014
$
0.200

 
$
16,201

 
March 7, 2014
 
March 14, 2014
May 5, 2014
$
0.200

 
$
16,202

 
May 30, 2014
 
June 13, 2014

Note 9. Earnings Per Share
We include all common shares granted under our incentive compensation plan which remain unvested (“restricted common shares”) and contain non-forfeitable rights to dividends or dividend equivalents, whether paid or unpaid (“participating securities”), in the number of shares outstanding in our basic earnings per share calculations using the two-class method. All of our restricted common shares are currently participating securities.
Under the two-class method, earnings per common share is computed by dividing the sum of distributed earnings allocated to common shareholders and undistributed earnings allocated to common shareholders by the weighted average number of common shares outstanding for the period. In applying the two-class method, distributed and undistributed earnings are allocated to both common shares and restricted common shares based on the total weighted average shares outstanding during the period as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2014
 
2013
 
2014
Weighted-average shares:
 
 
 
 
 
 
 
Common shares outstanding
67,828,919

 
80,389,996

 
67,862,513

 
80,388,691

Restricted common shares
631,368

 
643,590

 
508,288

 
572,452

Total weighted-average shares
68,460,287

 
81,033,586

 
68,370,801

 
80,961,143

 
 
 
 
 
 
 
 
Percentage of weighted-average shares:
 
 
 
 
 
 
 
Common shares outstanding
99.08
%
 
99.21
%
 
99.26
%
 
99.29
%
Restricted common shares
0.92
%
 
0.79
%
 
0.74
%
 
0.71
%
Total
100.00
%
 
100.00
%
 
100.00
%
 
100.00
%

The calculations of both basic and diluted earnings per share are as follows: 

17


Aircastle Limited and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
June 30, 2014


 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2014
 
2013
 
2014
Earnings per share – Basic:
 
 
 
 
 
 
 
Net income
$
32,854

 
$
3,136

 
$
55,918

 
$
8,913

Less: Distributed and undistributed earnings allocated to restricted common shares (a)
(303
)
 
(25
)
 
(416
)
 
(63
)
Earnings available to common shareholders – Basic
$
32,551

 
$
3,111

 
$
55,502

 
$
8,850

 
 
 
 
 
 
 
 
Weighted-average common shares outstanding – Basic
67,828,919

 
80,389,996

 
67,862,513

 
80,388,691

 
 
 
 
 
 
 
 
Earnings per common share – Basic
$
0.48

 
$
0.04

 
$
0.82

 
$
0.11

 
 
 
 
 
 
 
 
Earnings per share – Diluted:
 
 
 
 
 
 
 
Net income
$
32,854

 
$
3,136

 
$
55,918

 
$
8,913

Less: Distributed and undistributed earnings allocated to restricted common shares(a)
(303
)
 
(25
)
 
(416
)
 
(63
)
Earnings available to common shareholders – Diluted
$
32,551

 
$
3,111

 
$
55,502

 
$
8,850

 
 
 
 
 
 
 
 
Weighted-average common shares outstanding – Basic
67,828,919

 
80,389,996

 
67,862,513

  
80,388,691

Effect of dilutive shares (b)

 

 

 

Weighted-average common shares outstanding – Diluted
67,828,919

 
80,389,996

 
67,862,513

  
80,388,691

 
 
 
 
 
 
 
 
Earnings per common share – Diluted
$
0.48

 
$
0.04

 
$
0.82

  
$
0.11

 
        
(a)
For the three months ended June 30, 2013 and 2014, distributed and undistributed earnings to restricted shares is 0.92% and 0.79% of net income. For the six months ended June 30, 2013 and 2014, distributed and undistributed earnings to restricted shares is 0.74% and 0.71% of net income. The amount of restricted share forfeitures for all periods present is immaterial to the allocation of distributed and undistributed earnings.
(b)
For the three and six months ended June 30, 2013 and 2014 , we had no dilutive shares.


Note 10. Income Taxes
Income taxes have been provided for based upon the tax laws and rates in countries in which our operations are conducted and income is earned. The Company received an assurance from the Bermuda Minister of Finance that it would be exempted from local income, withholding and capital gains taxes until March 2035. Consequently, the provision for income taxes relates to income earned by certain subsidiaries of the Company which are located in, or earn income in, jurisdictions that impose income taxes, primarily Ireland, Singapore and the United States.
The sources of income from continuing operations before income taxes and earnings of unconsolidated equity method investment for the three and six months ended June 30, 2013 and 2014 were as follows: 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2014
 
2013
 
2014
U.S. operations
$
791

 
$
756

 
$
1,196

 
$
1,521

Non-U.S. operations
35,795

 
8,417

 
62,038

 
13,862

Total
$
36,586

 
$
9,173

 
$
63,234

 
$
15,383



18


Aircastle Limited and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
June 30, 2014


All of our aircraft-owning subsidiaries that are recognized as corporations for U.S. tax purposes are non-U.S. corporations. These non-U.S. subsidiaries generally earn income from sources outside the United States and typically are not subject to U.S. federal, state or local income taxes unless they operate within the U.S., in which case they may be subject to federal, state and local income taxes. The aircraft owning subsidiaries resident in Ireland, Mauritius and Singapore are subject to tax in those respective jurisdictions.
We have a U.S. based subsidiary which provides management services to our non-U.S. subsidiaries and is subject to U.S. federal, state and local income taxes. We also have Ireland and Singapore based subsidiaries which provide management services to our non-U.S. subsidiaries and are subject to tax in those respective jurisdictions.
The consolidated income tax expense for the three and six months ended June 30, 2013 and 2014 was determined based upon estimates of the Company’s consolidated effective income tax rates for the years ending December 31, 2013 and 2014, respectively.
The Company’s effective tax rate for the three and six months ended June 30, 2013 was 10.2% and 11.6% respectively, compared to 71.5% and 48.4% respectively, for the three and six months ended June 30, 2014 . Movements in the effective tax rates are generally caused by changes in the proportion of the Company’s pre-tax earnings in taxable and non-tax jurisdictions. For the six months ended June 30, 2014 , the interim period effective tax rate reflects the loss on extinguishment of debt in the amount of $36,570 related to Bermuda operations, which was treated as a discrete item with no tax benefit.
Differences between statutory income tax rates and our effective income tax rates applied to pre-tax income consisted of the following: 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2014
 
2013
 
2014
Notional U.S. federal income tax expense (benefit) at the statutory rate
$
12,805

 
$
3,211

 
$
22,132

 
$
5,384

U.S. state and local income tax, net
52

 
40

 
86

 
119

Non-U.S. operations:
 
 
 
 
 
 
 
Bermuda
(8,989
)
 
2,811

 
(12,865
)
 
6,240

Ireland
410

 
2,537

 
(491
)
 
(752
)
Singapore
171

 
(1,282
)
 
147

 
(2,477
)
Other
(806
)
 
(771
)
 
(1,876
)
 
(1,369
)
Non-deductible expenses in the U.S.
97

 
19

 
199

 
318

Other
(8
)
 
(7
)
 
(16
)
 
(22
)
Income tax provision
$
3,732

 
$
6,558

 
$
7,316

 
$
7,441


Note 11. Interest, Net
The following table shows the components of interest, net: 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2014
 
2013
 
2014
Interest on borrowings, net settlements on interest rate derivatives, and other liabilities (1)
$
50,823

 
$
48,172

 
$
99,414

 
$
99,857

Hedge ineffectiveness losses
(24
)
 
6

 
104

 
59

Amortization of interest rate derivatives related to deferred losses
9,711

 
8,854

 
17,985

 
18,181

Amortization of deferred financing fees (2)
6,346

 
3,567

 
8,781

 
6,987

Interest Expense
66,856

 
60,599

 
126,284

 
125,084

Less interest income
(200
)
 
(105
)
 
(476
)
 
(327
)
Interest, net
$
66,656

 
$
60,494

 
$
125,808

 
$
124,757


19


Aircastle Limited and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
June 30, 2014



(1) For the three and six months ended June 30, 2013, includes the loan termination fee of $2,954 related to two ECA aircraft sold in June 2013.
(2) For the three and six months ended June 30, 2013, includes the write-off of deferred financings fees of $3,825 related to the repayment of two ECA Financings.

Note 12. Commitments and Contingencies
At June 30, 2014 , we had commitments to acquire seven aircraft for $490,155 . Three aircraft are mid-aged, current technology narrow-bodies which we expect will close during the third quarter of 2014. The other four aircraft are Boeing 777-300ERs to be purchased from and leased back to LATAM once the existing financings are repaid. We now expect this transaction to be completed during the first half of 2015.

Note 13. Derivatives
The objective of our hedging policy is to adopt a risk averse position with respect to changes in interest rates. Accordingly, we have entered into a number of interest rate derivatives to hedge the current and expected future interest rate payments on our variable rate debt. Interest rate derivatives are agreements in which a series of interest rate cash flows are exchanged with a third party over a prescribed period. The notional amount on an interest rate derivative is not exchanged. Our interest rate derivatives typically provide that we make fixed rate payments and receive floating rate payments to convert our floating rate borrowings to fixed rate obligations to better match the largely fixed rate cash flows from our investments in flight equipment.
We held the following interest rate derivatives as of June 30, 2014
 
Derivative Liabilities
Hedged Item
Current
Notional
Amount
 
Effective
Date
 
Maturity
Date
 
Future
Maximum
Notional
Amount
 
Floating
Rate
 
Fixed
Rate
 
Balance Sheet
Location
 
Fair
Value
Interest rate derivatives designated as cash flow hedges:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Securitization No. 2
$
422,276

 
Jun-12
 
Jun-17
 
$
422,276

 
1M LIBOR
 
1.26%
to
1.28%
 
Fair value of
derivative
liabilities
 
$
4,757

 

In connection with the repayment of Securitization No. 1., two interest rate derivatives hedging the facility were terminated on February 18, 2014, resulting in a net deferred loss of $26,863 which is being amortized into interest expense using the effective interest method over the original hedge term.
The weighted average interest pay rates of these derivatives at December 31, 2013 and June 30, 2014 were 3.03% and 1.27% , respectively.
For the six months ended June 30, 2014 , the amount of loss reclassified from accumulated other comprehensive income (“OCI”) into interest expense related to net interest settlements on active interest rate derivatives was $4,044 . The amount of loss expected to be reclassified from OCI into interest expense over the next 12 months related to net interest settlements on active interest rate derivatives is $5,319 .
Our interest rate derivatives involve counterparty credit risk. As of June 30, 2014 , our interest rate derivatives are held with JP Morgan Chase Bank NA and Wells Fargo Bank NA. Both of our counterparties or guarantors of these counterparties are considered investment grade (senior unsecured ratings of Aa3 or above) by Moody’s Investors Service. Both are also considered investment grade (long-term foreign issuer ratings of AA- or above) by Standard and Poor’s. We do not anticipate that either of these counterparties will fail to meet their obligations.

20


Aircastle Limited and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
June 30, 2014


In addition to the derivative liability above, another component of the fair value of our interest rate derivatives is accrued interest. As of June 30, 2014 , accrued interest payable included in accounts payable, accrued expenses, and other liabilities on our consolidated balance sheet was $289 related to interest rate derivatives designated as cash flow hedges.
Following is the effect of interest rate derivatives on the statement of financial performance for the six months ended June 30, 2014
Effective Portion
 
Ineffective Portion
Derivatives in
ASC 815
Cash Flow
Hedging
Relationships
 
Amount of
Gain or (Loss)
Recognized in
OCI on
Derivative
(a)
 
Location of
Gain or (Loss)
Reclassified from
Accumulated
OCI into Income
 
Amount of
Gain or (Loss)
Reclassified from
Accumulated
OCI into Income  (b)
 
Location of
Gain or (Loss)
Recognized in
Income on Derivative
 
Amount of
Gain or (Loss)
Recognized in
Income on
Derivative
(c)
Interest rate derivatives
 
$(3,577)
 
Interest expense
 
$(22,140)
 
Interest expense
 
$(62)
 
        
(a)
This represents the change in fair market value of our interest rate derivatives since year end, net of taxes, offset by the amount of actual cash paid related to the net settlements of the interest rate derivatives for the six months ended June 30, 2014 .
(b)
This represents the amount of actual cash paid, net of taxes, related to the net settlements of the interest rate derivatives for the six months ended June 30, 2014 plus any effective amortization of net deferred interest rate derivative losses.
(c)
This represents both realized and unrealized ineffectiveness incurred during the six months ended June 30, 2014 .

Derivatives Not Designated as Hedging Instruments under ASC 815
 
Location of Gain
or (Loss)
Recognized in Income
On Derivative
 
Amount of Gain
or (Loss)
Recognized in Income on
Derivative
Interest rate derivatives
 
Other income (expense)
 
$
681


On an ongoing basis, terminated interest rate derivative notionals are evaluated against debt forecasts. To the extent that interest payments are deemed remote to occur, deferred gains or losses are accelerated into interest expense as applicable.
For the six months ended June 30, 2014 , the amount of deferred net loss reclassified from OCI into interest expense related to our terminated interest rate derivatives was $17,633 . The amount of deferred net loss expected to be reclassified from OCI into interest expense over the next 12 months related to our terminated interest rate derivatives is $30,924 , of which $11,313 relates to Term Financing No. 1 interest rate derivatives terminated in 2012, $11,211 relates to Securitization No. l interest rate derivatives terminated in 2014, $5,890 relates to ECA Term Financings for New A330 Aircraft, $1,283 relates to other financings and $1,227 relates to Term Financing No. 1 derivatives terminated in 2008.
For the six months ended June 30, 2014 , the amount of effective deferred loss reclassified from OCI into interest expense related to our designated active interest rate derivative was $548 .
The following table summarizes amounts charged directly to the consolidated statement of income for the three and six months ended June 30, 2013 and 2014 , respectively, related to our interest rate derivatives:

21


Aircastle Limited and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
June 30, 2014


 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2014
 
2013
 
2014
Interest expense:
 
 
 
 
 
 
 
Hedge ineffectiveness losses
$
(24
)
 
$
6

 
$
104

 
$
59

Amortization:
 
 
 
 
 
 
 
Accelerated amortization of deferred losses (1)
2,027

 
3

 
2,027

 
3

Amortization of loss on designated interest rate derivative
404

 

 
745

 
548

Amortization of deferred losses
7,280

 
8,851

 
15,213

 
17,630

Total Amortization
9,711

 
8,854

 
17,985

 
18,181

Total charged to interest expense
$
9,687

 
$
8,860

 
$
18,089

 
$
18,240

 
 
 
 
 
 
 
 
Other income:
 
 
 
 
 
 
 
Mark to market gains on undesignated interest rate derivatives
$
1,657

 
$

 
$
2,872

 
$
681

Total charged to other income
$
1,657

 
$

 
$
2,872

 
$
681

        
(1) For the three and six months ended June 30, 2013 , represents accelerated amortization of deferred hedge losses related to two aircraft sold in June 2013.

Note 14. Other Assets
The following table describes the principal components of other assets on our consolidated balance sheet as of:
 
December 31,
2013
 
June 30,
2014
Deferred debt issuance costs, net of amortization of $61,104 and $46,996, respectively
$
52,464

 
$
57,848

Deferred federal income tax asset
1,218

 
1,046

Lease incentives and lease premiums, net of amortization of $41,136 and $21,722, respectively
72,181

 
62,119

Flight equipment held for sale
9,474

 
36,939

Aircraft purchase deposits
10,000

 
3,000

Other assets
8,639

 
18,280

Total other assets
$
153,976

 
$
179,232

 


Note 15. Accounts Payable, Accrued Expenses and Other Liabilities
The following table describes the principal components of accounts payable, accrued expenses and other liabilities recorded on our consolidated balance sheet as of:
 
December 31,
2013
 
June 30,
2014
Accounts payable and accrued expenses
$
30,204

 
$
21,005

Deferred federal income tax liability
33,178

 
38,864

Accrued interest payable
39,213

 
27,133

Lease discounts, net of amortization of $6,458 and $4,900 respectively
9,066

 
44,673

Total accounts payable, accrued expenses and other liabilities
$
111,661

 
$
131,675



22


Aircastle Limited and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
June 30, 2014



Note 16. Accumulated Other Comprehensive Loss
The following table describes the principal components of accumulated other comprehensive loss recorded on our consolidated balance sheet as of:
Changes in accumulated other comprehensive loss by component (a)
Three Months Ended June 30, 2014
 
Six Months Ended June 30, 2014
Beginning balance
$
(66,208
)
 
$
(75,905
)
Amount recognized in other comprehensive loss on derivatives, net of tax benefit of $15 and tax expense of $721, respectively
(1,197
)
 
(3,577
)
Amounts reclassified from accumulated other comprehensive loss into income, net of tax expense of $15 and $83, respectively
10,063

 
22,140

   Net current period other comprehensive income
8,866

 
18,563

Ending balance
$
(57,342
)
 
$
(57,342
)
        

(a) All amounts are net of tax. Amounts in parentheses indicate debits.


Reclassifications from accumulated other comprehensive loss (a)
Three Months Ended June 30, 2014
 
Six Months Ended June 30, 2014
 
 
 
 
Amount of effective amortization of net deferred interest rate derivative losses (b)
$
8,854

 
$
18,181

Effective amount of net settlements of interest rate derivatives, net of tax expense of $15 and $83, respectively (b)
1,209

 
3,959

   Amount of loss reclassified from accumulated other comprehensive loss into income (c)
$
10,063

 
$
22,140

            

(a) All amounts are net of tax.
(b) Included in interest expense.
(c) This represents the effective amounts of actual cash paid related to the net settlements of the interest rate derivatives plus any effective amortization of net deferred interest rate derivative losses (see Note 13. - Derivatives).



23


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This management’s discussion and analysis of financial condition and results of operations contains forward-looking statements that involve risks, uncertainties and assumptions. You should read the following discussion in conjunction with our historical consolidated financial statements and the notes thereto appearing elsewhere in this report. The results of operations for the periods reflected herein are not necessarily indicative of results that may be expected for future periods, and our actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including but not limited to those described under “Risk Factors” and included in our Annual Report on Form 10-K for the year ended December 31, 2013 filed with the Securities and Exchange Commission (the “SEC”). Please see “Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995” for a discussion of the uncertainties, risks and assumptions associated with these statements. Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States, or US GAAP, and, unless otherwise indicated, the other financial information contained in this report has also been prepared in accordance with US GAAP. Unless otherwise indicated, all references to “dollars” and “$” in this report are to, and all monetary amounts in this report are presented in, U.S. dollars.
Certain items in this Quarterly Report on Form 10-Q (this “report”), and other information we provide from time to time, may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 including, but not necessarily limited to, statements relating to our ability to acquire, sell, lease or finance aircraft, raise capital, pay dividends, and increase revenues, earnings, EBITDA, Adjusted EBITDA and Adjusted Net Income and the global aviation industry and aircraft leasing sector. Words such as “anticipates,” “expects,” “intends,” “plans,” “projects,” “believes,” “may,” “will,” “would,” “could,” “should,” “seeks,” “estimates” and variations on these words and similar expressions are intended to identify such forward-looking statements. These statements are based on management’s current expectations and beliefs and are subject to a number of factors that could lead to actual results materially different from those described in the forward-looking statements; Aircastle can give no assurance that its expectations will be attained. Accordingly, you should not place undue reliance on any forward-looking statements contained in this report. Factors that could have a material adverse effect on our operations and future prospects or that could cause actual results to differ materially from Aircastle expectations include, but are not limited to, capital markets disruption or volatility which could adversely affect our continued ability to obtain additional capital to finance new investments or our working capital needs; government fiscal or tax policies, general economic and business conditions or other factors affecting demand for aircraft or aircraft values and lease rates; our continued ability to obtain favorable tax treatment in Bermuda, Ireland and other jurisdictions; our ability to pay dividends; high or volatile fuel prices, lack of access to capital, reduced load factors and/or reduced yields, operational disruptions caused by political unrest and other factors affecting the creditworthiness of our airline customers and their ability to continue to perform their obligations under our leases and other risks detailed from time to time in Aircastle’s filings with the Securities and Exchange Commission (“SEC”) including as previously disclosed in Aircastle’s 2013 Annual Report on Form 10-K, and elsewhere in this report. In addition, new risks and uncertainties emerge from time to time, and it is not possible for Aircastle to predict or assess the impact of every factor that may cause its actual results to differ from those contained in any forward-looking statements. Such forward-looking statements speak only as of the date of this report. Aircastle Limited expressly disclaims any obligation to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in its expectations with regard thereto or change in events, conditions or circumstances on which any statement is based.

WEBSITE AND ACCESS TO COMPANY’S REPORTS
The Company’s Internet website can be found at www.aircastle.com. Our annual reports on Forms 10-K, quarterly reports on Forms 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”) are available free of charge through our website under “Investors — SEC Filings” as soon as reasonably practicable after they are electronically filed with, or furnished to, the SEC.
Statements and information concerning our status as a Passive Foreign Investment Company (“PFIC”) for U.S. taxpayers are also available free of charge through our website under “Investors — SEC Filings”.
Our Corporate Governance Guidelines, Code of Business Conduct and Ethics, and Board of Directors committee charters (including the charters of the Audit Committee, Compensation Committee, and Nominating and Corporate Governance Committee) are available free of charge through our website under “Investors — Corporate Governance”. In

24


addition, our Code of Ethics for the Chief Executive and Senior Financial Officers, which applies to our Chief Executive Officer, Chief Financial Officer, Chief Accounting Officer, Treasurer and Controller, is available in print, free of charge, to any shareholder upon request to Investor Relations, Aircastle Limited, c/o Aircastle Advisor LLC, 300 First Stamford Place, 5th Floor, Stamford, Connecticut 06902.
The information on the Company’s website is not part of, or incorporated by reference, into this report, or any other report we file with, or furnish to, the SEC.

OVERVIEW
We acquire, lease, and sell commercial jet aircraft with large, global operator bases and long useful lives. As of June 30, 2014 , our portfolio consisted of 148 aircraft leased to 63 lessees located in 37 countries. Our aircraft fleet is managed by an experienced team based in the United States, Ireland and Singapore. Typically, our aircraft are subject to net leases whereby the lessee is generally responsible for maintaining the aircraft and paying operational, maintenance and insurance costs, although in a majority of cases, we are obligated to pay a portion of specified maintenance or modification costs. From time to time, we also make investments in other aviation assets, including debt investments secured by commercial jet aircraft. As of June 30, 2014 , the net book value of our flight equipment and finance lease aircraft was $5.65 billion compared to $5.19 billion at the end of 2013. Our revenues and net income for the three and six months ended June 30, 2014 were $226.1  million and $3.1  million, and $402.7 million and $8.9 million, respectively.
Commercial air travel and air freight activity have been long-term growth sectors, broadly correlated with world economic activity and expanding at a rate of one to two times the rate of global GDP growth. The expansion of air travel has driven a rise in the world aircraft fleet. There are currently more than 18,000 commercial mainline passenger and freighter aircraft in operation worldwide. This fleet is expected to continue expanding at an average annual rate, net of retirements, of approximately 3.6% through 2033. In addition, aircraft leasing companies own an increasing share of the world’s commercial jet aircraft, and now account for more than one-third of this fleet.
Notwithstanding the sector’s long-term growth, the aviation markets have been, and are expected to remain, subject to economic cyclicality. The industry is also susceptible to external shocks, such as regional conflicts, terrorist events and to disruptions caused by severe weather events and other natural phenomena. Mitigating these risks is the portability of the assets, allowing aircraft to be redeployed in locations where demand is higher.
Air traffic data for the first five months of 2014 showed a continued strong trend in passenger market growth. Air cargo traffic showed slow improvement as world trade and economic growth increased.  According to the International Air Transport Association, during 2014 global passenger traffic increased by 6.2% and air cargo traffic increased by