TAL-2014.6.30-10Q
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 

FORM 10-Q
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended June 30, 2014
Or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from                             to   
Commission file number- 001-32638
TAL International Group, Inc.
(Exact name of registrant as specified in the charter)
Delaware
(State or other jurisdiction of
incorporation or organization)
 
20-1796526
(I.R.S. Employer
Identification Number)
 
 
 
100 Manhattanville Road, Purchase, New York
(Address of principal executive office)
 
10577-2135
(Zip Code)
 
 
 
(914) 251-9000
(Registrant's telephone number including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) 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 requirement for the past 90 days. Yes ý    No o
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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý    No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer ý
 
Accelerated Filer o
 
Non-accelerated filer o
 
Smaller reporting company o
 
 
 
 
(Do not check if a 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 o    NO ý
As of July 18, 2014, there were 33,994,440 shares of the Registrant's common stock, $0.001 par value outstanding.
 

TAL International Group, Inc.
Index


Table of Contents

 
 
Page No.
 
 
 
 
 

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This quarterly report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, that involve substantial risks and uncertainties. In addition, we, or our executive officers on our behalf, may from time to time make forward-looking statements in reports and other documents we file with the Securities and Exchange Commission, or SEC, or in connection with oral statements made to the press, potential investors or others. All statements, other than statements of historical facts, including statements regarding our strategy, future operations, future financial position, future revenues, projected costs, prospects, plans and objectives of management are forward-looking statements. The words "expect," "estimate," "anticipate," "predict," "believe," "think," "plan," "will," "should," "intend," "seek," "potential" and similar expressions and variations are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words.
Forward-looking statements in this report are subject to a number of known and unknown risks and uncertainties that could cause our actual results, performance or achievements to differ materially from those described in the forward-looking statements, including, but not limited to, the risks and uncertainties described in the section entitled "Risk Factors" in our Annual Report on Form 10-K filed with the SEC on February 20, 2014, in this report as well as in the other documents we file with the SEC from time to time, and such risks and uncertainties are specifically incorporated herein by reference.
Forward-looking statements speak only as of the date the statements are made. Except as required under the federal securities laws and rules and regulations of the SEC, we undertake no obligation to update or revise forward-looking statements to reflect actual results, changes in assumptions or changes in other factors affecting forward-looking information. We caution you not to unduly rely on the forward-looking statements when evaluating the information presented in this report.
PART I—FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS

The consolidated financial statements of TAL International Group, Inc. ("TAL" or the "Company") as of June 30, 2014 and December 31, 2013 and for the three and six months ended June 30, 2014 and June 30, 2013 included herein have been prepared by the Company, without audit, pursuant to U.S. generally accepted accounting principles and the rules and regulations of the SEC. In addition, certain information and note disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. These financial statements reflect, in the opinion of management, all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the results for the interim periods. The results of operations for such interim periods are not necessarily indicative of the results for the full year. These financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company's Annual Report on Form 10-K filed with the SEC, on February 20, 2014 from which the accompanying December 31, 2013 Balance Sheet information was derived, and all of our other filings filed with the SEC from October 11, 2005 through the current date pursuant to the Exchange Act.

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TAL INTERNATIONAL GROUP, INC.
Consolidated Balance Sheets
(Dollars in thousands, except share data)
(Unaudited)
 
June 30,
2014
 
December 31,
2013
ASSETS:
 
 
 
Leasing equipment, net of accumulated depreciation and allowances of $977,884 and $910,713
$
3,474,259

 
$
3,414,904

Net investment in finance leases, net of allowances of $1,057 and $1,057
239,915

 
257,176

Equipment held for sale
50,314

 
58,042

Revenue earning assets
3,764,488

 
3,730,122

Unrestricted cash and cash equivalents
57,802

 
68,875

Restricted cash
29,516

 
29,126

Accounts receivable, net of allowances of $863 and $948
83,838

 
74,174

Goodwill
74,523

 
74,523

Deferred financing costs
28,642

 
29,087

Other assets
11,567

 
11,898

Fair value of derivative instruments
12,189

 
27,491

Total assets
$
4,062,565

 
$
4,045,296

LIABILITIES AND STOCKHOLDERS' EQUITY:
 
 
 
Equipment purchases payable
$
61,579

 
$
112,268

Fair value of derivative instruments
3,616

 
1,900

Accounts payable and other accrued expenses
50,331

 
63,022

Net deferred income tax liability
383,727

 
358,255

Debt
2,868,075

 
2,817,933

Total liabilities
3,367,328

 
3,353,378

Stockholders' equity:
 
 
 
Preferred stock, $0.001 par value, 500,000 shares authorized, none issued

 

Common stock, $0.001 par value, 100,000,000 shares authorized, 37,006,283 and 36,858,778 shares issued respectively
37

 
37

Treasury stock, at cost, 3,011,843 shares
(37,535
)
 
(37,535
)
Additional paid-in capital
502,327

 
498,854

Accumulated earnings
230,625

 
220,492

Accumulated other comprehensive (loss) income
(217
)
 
10,070

Total stockholders' equity
695,237

 
691,918

Total liabilities and stockholders' equity
$
4,062,565

 
$
4,045,296

   



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

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TAL INTERNATIONAL GROUP, INC.
Consolidated Statements of Income
(Dollars and shares in thousands, except earnings per share)
(Unaudited)
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2014
 
2013
 
2014
 
2013
Leasing revenues:
 
 
 
 
 
 
 
Operating leases
$
139,489

 
$
136,304

 
$
278,819

 
$
270,358

Finance leases
4,724

 
3,152

 
9,677

 
6,250

Other revenues
510

 
725

 
994

 
1,362

Total leasing revenues
144,723

 
140,181

 
289,490

 
277,970

 
 
 
 
 
 
 
 
Equipment trading revenues
18,794

 
31,781

 
31,281

 
50,067

Equipment trading expenses
(16,579
)
 
(27,494
)
 
(27,418
)
 
(43,105
)
Trading margin
2,215

 
4,287

 
3,863

 
6,962

 
 
 
 
 
 
 
 
Net gain on sale of leasing equipment
2,461

 
8,026

 
5,557

 
18,287

 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
Depreciation and amortization
54,237

 
49,832

 
108,040

 
99,149

Direct operating expenses
8,267

 
6,218

 
16,949

 
12,180

Administrative expenses
11,128

 
10,614

 
22,960

 
22,518

Provision for doubtful accounts
5

 
1,585

 
36

 
1,503

Total operating expenses
73,637

 
68,249

 
147,985

 
135,350

Operating income
75,762

 
84,245

 
150,925

 
167,869

Other expenses:
 
 
 
 
 
 
 
Interest and debt expense
26,888

 
28,303

 
54,507

 
57,186

Write-off of deferred financing costs
3,729

 
2,578

 
4,899

 
2,578

Net loss (gain) on interest rate swaps
582

 
(5,268
)
 
955

 
(8,420
)
Total other expenses
31,199

 
25,613

 
60,361

 
51,344

Income before income taxes
44,563

 
58,632

 
90,564

 
116,525

Income tax expense
15,201

 
20,756

 
31,191

 
41,129

Net income
$
29,362

 
$
37,876

 
$
59,373

 
$
75,396

Net income per common share—Basic
$
0.87

 
$
1.13

 
$
1.77

 
$
2.25

Net income per common share—Diluted
$
0.87

 
$
1.12

 
$
1.76

 
$
2.24

Cash dividends paid per common share
$
0.72

 
$
0.66

 
$
1.44

 
$
1.30

Weighted average number of common shares outstanding—Basic
33,619

 
33,484

 
33,614

 
33,477

Dilutive stock options and restricted stock
178

 
196

 
168

 
181

Weighted average number of common shares outstanding—Diluted
33,797

 
33,680

 
33,782

 
33,658

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

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TAL INTERNATIONAL GROUP, INC.
Consolidated Statements of Comprehensive Income
(Dollars in thousands)
(Unaudited)
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2014
 
2013
 
2014
 
2013
Net income
$
29,362

 
$
37,876

 
$
59,373

 
$
75,396

Other comprehensive (loss) income:
 
 
 
 
 
 
 
Change in fair value of derivative instruments designated as cash flow hedges (net of income tax effect of $(3,379), $7,951, $(6,237) and $7,076, respectively)
(6,217
)
 
14,553

 
(11,412
)
 
12,952

Amortization of loss on terminated derivative instruments designated as cash flow hedges (net of income tax effect of $263, $269, $517 and $546, respectively)
485

 
496

 
946

 
1,002

Foreign currency translation adjustment
144

 
1

 
179

 
(345
)
Other comprehensive (loss) income, net of tax
(5,588
)
 
15,050

 
(10,287
)
 
13,609

Comprehensive income
$
23,774

 
$
52,926

 
$
49,086

 
$
89,005

   



















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

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TAL INTERNATIONAL GROUP, INC.
Consolidated Statements of Cash Flows
(Dollars in thousands)
(Unaudited)
 
Six Months Ended 
 June 30,
 
2014
 
2013
Cash flows from operating activities:
 
 
 
Net income
$
59,373

 
$
75,396

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
108,040

 
99,149

Amortization of deferred financing costs
3,861

 
3,563

Amortization of net loss on terminated derivative instruments designated as cash flow hedges
1,463

 
1,548

Net (gain) on sale of leasing equipment
(5,557
)
 
(18,287
)
Net loss (gain) on interest rate swaps
955

 
(8,420
)
Write-off of deferred financing costs
4,899

 
2,578

Deferred income taxes
31,191

 
40,989

Stock compensation charge
3,419

 
2,977

Changes in operating assets and liabilities:
 
 
 
Net equipment purchased for resale activity
(4,627
)
 
(6,760
)
Net realized loss on interest rate swaps terminated prior to their contractual maturities 
(1,700
)
 
(24,235
)
Other changes in operating assets and liabilities
(23,109
)
 
(26,274
)
Net cash provided by operating activities
178,208

 
142,224

Cash flows from investing activities:
 
 
 
Purchases of leasing equipment and investments in finance leases
(289,766
)
 
(372,576
)
Proceeds from sale of equipment, net of selling costs
83,503

 
71,983

Cash collections on finance lease receivables, net of income earned
24,100

 
19,446

Other
97

 
(268
)
Net cash (used in) investing activities
(182,066
)
 
(281,415
)
Cash flows from financing activities:
 
 
 
Stock options exercised and stock related activity
(234
)
 
(304
)
Financing fees paid under debt facilities
(8,246
)
 
(7,871
)
Borrowings under debt facilities
912,935

 
868,207

Payments under debt facilities and capital lease obligations
(862,871
)
 
(682,140
)
(Increase) decrease in restricted cash
(390
)
 
7,277

Common stock dividends paid
(48,409
)
 
(43,528
)
Net cash (used in) provided by financing activities
(7,215
)
 
141,641

Net (decrease) increase in unrestricted cash and cash equivalents
$
(11,073
)
 
$
2,450

Unrestricted cash and cash equivalents, beginning of period
68,875

 
65,843

Unrestricted cash and cash equivalents, end of period
$
57,802

 
$
68,293

Supplemental non-cash investing activities:
 
 
 
Equipment purchases payable
$
61,579

 
$
39,193

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

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TAL INTERNATIONAL GROUP, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


Note 1—Description of the Business, Basis of Presentation and Recently Adopted Accounting Pronouncements
A.    Description of the Business
TAL International Group, Inc. ("TAL" or the "Company") leases intermodal transportation equipment, primarily maritime containers, and provides maritime container management services, through a worldwide network of offices, third party depots and other facilities. The Company operates in both international and domestic markets. The majority of the Company's business is derived from leasing its containers to shipping line customers through a variety of long-term and short-term contractual lease arrangements. The Company also sells its own containers and containers purchased from third parties for resale. TAL also enters into management agreements with third party container owners under which the Company manages the leasing and selling of containers on behalf of the third party owners.
B.    Basis of Presentation
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the reported amounts of revenues and expenses during the reporting period and disclosure of contingent assets and liabilities at the date of the financial statements. Actual results could differ from those estimates.
The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany transactions and balances have been eliminated in consolidation. Certain reclassifications have been made to the accompanying prior period financial statements and notes to conform to the current year's presentation.
In the second quarter of 2014, the Company has revised the Income Statement presentation for the three months and six months ended June 30, 2014 and June 30, 2013 by removing the line item “Total revenues” and moving “Equipment trading revenues” and  “Equipment trading expenses”  line items together and adding a line for “Trading margin”.  The Company believes that this new presentation better highlights the trends in leasing revenues and the relative size and contribution of the Equipment trading segment.
C.    New Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) ("ASU No. 2014-09"). This new standard will replace all current U.S. GAAP guidance on this topic and eliminate all industry-specific guidance. Leasing revenue recognition is specifically excluded from this ASU, and therefore, the new standard will only apply to Equipment Trading revenues and sales of leasing equipment. ASU No. 2014-09 is effective for interim and annual periods beginning after December 15, 2016, with early application prohibited. ASU 2014-09 allows for either full retrospective or modified retrospective adoption. The Company is evaluating the transition method that will be elected and the potential effects of adopting the provisions of ASU No. 2014-09.
D.    Business Combination
Effective July 1, 2013, the Company acquired the assets and business of Martec Leasing for $11.9 million. Martec Leasing is a worldwide supplier of rolltrailers. Of the total purchase price, the Company allocated $8.5 million to Leasing equipment, $0.8 million to Other assets representing the acquisition date fair value of above-market leases, and $2.6 million to Goodwill, in its consolidated balance sheet. The Company believes that the acquisition of Martec Leasing complements our current leasing business by expanding our product types available for our existing customer base.

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TAL INTERNATIONAL GROUP, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Note 2—Fair Value of Financial Instruments
The Company believes that the carrying amounts of its cash and cash equivalents, accounts receivable, equipment purchases payable, and accounts payable approximated their fair value as of June 30, 2014 and December 31, 2013.
Fair value represents the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company utilizes the following fair value hierarchy when selecting inputs for its valuation techniques, with the highest priority given to Level 1:
Level 1—Financial assets and liabilities whose values are based on observable inputs such as quoted prices for identical instruments in active markets (unadjusted).
Level 2—Financial assets and liabilities whose values are based on observable inputs such as (i) quoted prices for similar instruments in active markets; (ii) quoted prices for identical or similar instruments in markets that are not active; or (iii) model-derived valuations in which all significant inputs are observable in active markets.
Level 3—Financial assets and liabilities whose values are derived from valuation techniques based on one or more significant unobservable inputs.
The Company does not measure net investment in finance leases or debt at fair value in its consolidated balance sheets. The fair value, which was measured using Level 2 inputs, and the carrying value of the Company's net investment in finance leases and debt are listed in the table below as of the dates indicated (in thousands).
 
June 30,
2014
 
December 31,
2013
Assets
 
 
 
Net investment in finance leases - carrying value
$
240,972

 
$
258,233

Net investment in finance leases - estimated fair value
$
243,021

 
$
265,745

Liabilities
 
 
 
Debt—carrying value
$
2,868,075

 
$
2,817,933

Debt—estimated fair value
$
2,897,777

 
$
2,787,582

The Company estimated the fair value of its net investment in finance leases and debt instruments based on the net present value of its future receipts or payments, using a discount rate which reflects the Company's estimate of current market interest rates and spreads as of the balance sheet date.
Note 3—Dividends
The Company paid the following quarterly dividends during the six months ended June 30, 2014 and 2013 on its issued and outstanding common stock:
Record Date
Payment
Date
 
Aggregate
Payment
 
Per Share
Payment
June 3, 2014
June 24, 2014
 
$24.2 Million
 
$0.72
March 3, 2014
March 24, 2014
 
$24.2 Million
 
$0.72
June 4, 2013
June 25, 2013
 
$22.1 Million
 
$0.66
March 7, 2013
March 28, 2013
 
$21.4 Million
 
$0.64

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TAL INTERNATIONAL GROUP, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Note 4—Capital Stock and Stock Options
Stock Based Compensation Plans
The Company records compensation cost relating to stock based payment transactions in accordance with ASC 718. The cost is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense over the employee's requisite service period (generally the vesting period of the equity award) on a straight-line basis.
The Company recognized compensation costs in administrative expenses related to restricted shares granted in 2012, 2013 and 2014 under the Company's stock based compensation plans of $1.6 million and $1.1 million during the three months ended June 30, 2014 and 2013, respectively, and $3.4 million and $3.0 million during the six months ended June 30, 2014 and 2013, respectively.
Total unrecognized compensation cost of approximately $8.4 million as of June 30, 2014 related to restricted shares granted during 2012, 2013 and 2014 will be recognized over the remaining weighted average vesting period of approximately 2.0 years.
During the six months ended June 30, 2014, plan participants exercised 2,950 options which had been granted under the 2005 Management Omnibus Incentive Plan. Plan participants tendered 6,695 shares, all of which were subsequently retired by the Company, to satisfy payment of the exercise price, and in certain instances withholding taxes related to activity under the Company's stock compensation plans.
No further grants will be made under the 2005 Management Omnibus Incentive Plan but the terms of the 2005 Management Omnibus Incentive Plan will continue to apply to awards previously granted under the plan.
On March 14, 2014, the Company's Board of Directors adopted and on April 22, 2014, the Company's shareholders approved the 2014 Equity Incentive Plan. No grants have been made and no shares have been issued under the 2014 Equity Incentive Plan.
Accumulated Other Comprehensive (Loss) Income
Accumulated other comprehensive (loss) income consisted of the following as of the dates indicated (in thousands and net of tax effects):
 
Cash Flow
Hedges
 
Foreign
Currency
Translation
 
Accumulated Other Comprehensive (Loss) Income
Balance as of December 31, 2013
$
10,959

 
$
(889
)
 
$
10,070

Change in fair value of derivative instruments designated as cash flow hedges
(15,252
)
 

 
(15,252
)
Reclassification of realized loss on interest rate swap agreements designated as cash flow hedges
3,840

 

 
3,840

Amortization of net loss on derivative instruments previously designated as cash flow hedges
946

 

 
946

Foreign currency translation adjustment

 
179

 
179

Other comprehensive income (loss)
(10,466
)
 
179

 
(10,287
)
Balance as of June 30, 2014
$
493

 
$
(710
)
 
$
(217
)

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TAL INTERNATIONAL GROUP, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Note 4—Capital Stock and Stock Options (Continued)
 
Cash Flow
Hedges
 
Foreign
Currency
Translation
 
Accumulated Other Comprehensive Income (Loss)
Balance as of December 31, 2012
$
(7,481
)
 
$
(949
)
 
$
(8,430
)
Change in fair value of derivative instruments designated as cash flow hedges
11,767

 

 
11,767

Reclassification of realized loss on interest rate swap agreements designated as cash flow hedges
1,185

 

 
1,185

Amortization of net loss on derivative instruments previously designated as cash flow hedges
1,002

 

 
1,002

Foreign currency translation adjustment

 
(345
)
 
(345
)
Other comprehensive income (loss)
13,954

 
(345
)
 
13,609

Balance as of June 30, 2013
$
6,473

 
$
(1,294
)
 
$
5,179

The following table presents reclassifications out of Accumulated other comprehensive (loss) income for the period indicated (in thousands):
 
Amounts Reclassified From Accumulated Other Comprehensive (Loss) Income
Affected Line Item
in the Consolidated
Statements of Income
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2014
 
2013
 
2014
 
2013
Realized loss on interest rate swap agreements, designated as cash flow hedges
$
2,950

 
$
1,832

 
$
5,853

 
$
1,832

Interest and debt expense
Amortization of net loss on derivative instruments previously designated as cash flow hedges
748

 
765

 
1,463

 
1,548

Interest and debt expense
Amounts reclassified from Accumulated other comprehensive income
3,698

 
2,597

 
7,316

 
3,380

Income before income taxes
Income tax (benefit)
(1,266
)
 
(919
)
 
(2,530
)
 
(1,193
)
Income tax expense
Amounts reclassified from Accumulated other comprehensive income
$
2,432

 
$
1,678

 
$
4,786

 
$
2,187

Net income

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TAL INTERNATIONAL GROUP, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Note 5—Net Investment in Finance Leases
The following table represents the components of the net investment in finance leases (in thousands):
 
June 30,
2014
 
December 31,
2013
Gross finance lease receivables
$
295,006

 
$
320,149

Allowance on gross finance lease receivables
(1,057
)
 
(1,057
)
Gross finance lease receivables, net of allowance
293,949

 
319,092

Unearned income
(54,034
)
 
(61,916
)
Net investment in finance leases
$
239,915

 
$
257,176

The Company evaluates potential losses in its finance lease portfolio by regularly reviewing the specific receivables in the portfolio and analyzing historical loss experience. The Company's historical loss experience on its gross finance lease receivables, after considering equipment recoveries, was less than 1%. Net investment in finance lease receivables is generally charged off after an analysis is completed which indicates that collection of the full balance is remote.
In order to estimate its allowance for losses contained in the gross finance lease receivables, the Company categorizes the credit worthiness of the receivables in the portfolio based on internal customer credit ratings, which are reviewed and updated, as appropriate, on an ongoing basis. The internal customer credit ratings are developed based on a review of the financial performance and condition, operating environment, geographical location and trade routes of our customers.
The categories of gross finance lease receivables based on the Company's internal customer credit ratings can be described as follows:
        Tier 1—These customers are typically large international shipping lines who have been in business for many years and have world class operating capabilities and significant financial resources. In most cases, the Company has had a long commercial relationship with these customers and currently maintains regular communication with them at several levels of management, which provides TAL with insight into the customer's current operating and financial performance. In the Company's view, these customers have the greatest ability to withstand cyclical down turns and would likely have greater access to needed capital than lower rated customers. The Company views the risk of default for Tier 1 customers to range from minimal to modest.     
  Tier 2—These customers are typically either smaller shipping lines with less operating scale or shipping lines with a high degree of financial leverage, and accordingly the Company views these customers as subject to higher volatility in financial performance over the business cycle. The Company generally expects these customers to have less access to capital markets or other sources of financing during cyclical down turns. The Company views the risk of default for Tier 2 customers as moderate.
        Tier 3—Customers in this category exhibit volatility in payments on a regular basis, thus they are considered non-performing. The Company has initiated or implemented plans to recover equipment on lease to these customers and believes that default is likely, or has already occurred.
Based on the above categories, the Company's gross finance lease receivables are as follows (in thousands):
 
June 30,
2014
 
December 31,
2013
Tier 1
$
269,727

 
$
283,172

Tier 2
25,279

 
36,977

Tier 3

 

Gross finance lease receivables
$
295,006

 
$
320,149

The Company considers an account past due when a payment has not been received in accordance with the terms of the related lease agreement. As of June 30, 2014, approximately $1.6 million of the Company's Tier 1 gross finance lease receivables and $0.1 million of the Company's Tier 2 gross finance lease receivables were past due, substantially all of which were aged approximately 31 days. As of June 30, 2014, none of the Company's gross finance lease receivables were in non-accrual status. The Company categorizes customers as non-accrual based on the credit ratings described above and recognizes income on gross finance lease receivables in non-accrual status as collections are made.

12

Table of Contents
TAL INTERNATIONAL GROUP, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Note 5—Net Investment in Finance Leases (Continued)
The following table represents the activity of the Company's allowance on gross finance lease receivables for the periods presented (in thousands):
 
Beginning
Balance
 
Additions/
(Reversals)
 
Ending
Balance
Finance Lease—Allowance for doubtful accounts:
 
 
 
 
 
For the six months ended
 
 
 
 
 
June 30, 2014
$
1,057

 
$

 
$
1,057

Note 6—Debt
Debt consisted of the following (amounts in thousands):
 
June 30,
2014
 
December 31,
2013
Asset backed securitization (ABS) term notes
$
1,368,737

 
$
1,303,128

Term loan facilities
848,186

 
865,089

Asset backed warehouse facility
65,000

 
83,000

Revolving credit facilities
484,000

 
450,000

Capital lease obligations
102,152

 
116,716

Total Debt
$
2,868,075

 
$
2,817,933

As of June 30, 2014, the Company had $1,422.7 million of debt outstanding on facilities with fixed interest rates and $1,445.4 million of debt outstanding on facilities with interest rates based on floating rate indices (primarily LIBOR). The Company economically hedges the risks associated with fluctuations in interest rates on a portion of its floating rate borrowings by entering into interest rate swap agreements that convert a portion of its floating rate debt to a fixed rate basis, thus reducing the impact of interest rate changes on future interest expense. As of June 30, 2014, the Company had interest rate swaps in place with a net notional amount of $986.0 million to fix the floating interest rates on a portion of its floating rate debt obligations.
The Company is subject to certain financial covenants under its debt facilities, and as of June 30, 2014, was in compliance with all such covenants.
Asset Backed Securitization Term Notes
On May 20, 2014, TAL Advantage IV LLC, an indirect wholly owned subsidiary of the Company, prepaid all of the outstanding principal balance of the TAL Advantage IV LLC Series 2012-1 Notes.

On May 19, 2014, TAL Advantage V LLC (“TAL Advantage V”), an indirect wholly owned subsidiary of the Company, completed the offering of $70 million Series 2014-2 Fixed Rate Asset-Backed Notes, Class A-1, $150 million Series 2014-2 Fixed Rate Asset-Backed Notes, Class A-2, and $18 million Series 2014-2 Fixed Rate Asset-Backed Notes, Class B. 

Term Loan Facilities
On April 2, 2014, TAL International Container Corporation, a direct wholly owned subsidiary of the Company entered into a $350 million term loan agreement. The proceeds were used to prepay the outstanding principal balance on certain term loan facilities in the amount of $194.6 million, to prepay all of the outstanding principal balance of the TAL Advantage II LLC Series 2008-1 Notes in the amount of $119.6 million, and for general corporate purposes.




13

Table of Contents
TAL INTERNATIONAL GROUP, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Note 7—Derivative Instruments
Interest Rate Swaps
The Company has entered into interest rate swap agreements to manage interest rate risk exposure. The majority of interest rate swap agreements utilized by TAL effectively modify the Company's exposure to interest rate risk by converting a portion of its floating rate debt to a fixed rate basis, thus reducing the impact of interest rate changes on future interest expense. Such agreements involve the receipt of floating rate amounts in exchange for fixed rate interest payments over the lives of the agreements without an exchange of the underlying principal amounts. In limited instances, the Company has also entered into interest rate swap agreements that involve the receipt of fixed rate amounts in exchange for floating rate interest payments. The counterparties to the Company's interest rate swap agreements are highly rated financial institutions. In the unlikely event that the counterparties fail to meet the terms of the interest rate swap agreements, the Company's exposure is limited to the interest rate differential on the notional amount at each monthly settlement period over the life of the agreements. The Company does not anticipate any non-performance by the counterparties. Substantially all of the assets of certain indirect, wholly owned subsidiaries of the Company have been pledged as collateral for the underlying indebtedness and the amounts payable under the interest rate swap agreements for each of these entities. In addition, certain assets of TAL International Container Corporation, a direct wholly owned subsidiary of the Company, are pledged as collateral for the $450 million senior secured revolving credit facility and the amounts payable under certain interest rate swap agreements.
As of June 30, 2014, the Company had net interest rate swap agreements in place to fix the floating interest rates on a portion of the borrowings under its debt facilities as summarized below:
Net Notional
Amount(1)
 
Weighted Average
Fixed Leg (Pay) Interest Rate(2)
 
Weighted Average
Remaining Term(2)
$986 Million
 
1.47%
 
5.2 years
_______________________________________________________________________________

(1)
As of June 30, 2014, the net notional amount outstanding on the Company's interest rate swap agreements is comprised of $1,148.5 million of pay-fixed rate/receive-floating rate agreements and $162.5 million of pay-floating rate/receive-fixed rate agreements. The Company entered into the pay-floating rate/receive-fixed rate agreements at the parent company level to offset the cash flows on certain pay-fixed rate/receive-floating rate agreements of certain wholly owned subsidiaries. The pay-floating rate/receive-fixed rate and pay-fixed rate/receive-floating rate agreements have terms that offset each other.

(2)
The calculations of weighted average fixed (pay) leg interest rate and weighted average remaining term on the Company's interest rate swap agreements reflect the impact of the pay-floating rate/receive-fixed rate agreements and the pay-fixed rate/receive-floating rate agreements they offset.
During the six months ended June 30, 2014, the Company paid $1.7 million to terminate certain designated interest rate swap agreements with an aggregate notional amount of $150.0 million.
The Company recognized amortization of accumulated other comprehensive (loss) income attributable to losses on terminated interest rate swap agreements that had been designated as cash flow hedges in interest and debt expense of $0.7 million and $0.8 million for the three months ended June 30, 2014 and 2013, respectively, and $1.5 million for both the six months ended June 30, 2014 and 2013.
The following table represents pre-tax amounts in accumulated other comprehensive (loss) income related to interest rate swap agreements (in millions) expected to be recognized in income over the next 12 months:
 
Six Months Ended June 30, 2014
Change in fair value of derivative instruments designated as cash flow hedges

($11.3
)
Amortization of loss on terminated derivative instruments designated as cash flow hedges

($2.7
)

14

Table of Contents
TAL INTERNATIONAL GROUP, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Note 7—Derivative Instruments (Continued)
Amounts recorded in accumulated other comprehensive (loss) attributable to these terminated interest rate swap agreements may be recognized in earnings immediately in conjunction with a termination of the related debt balances.
Fair Value of Derivative Instruments
Under the criteria established by ASC 820, the Company has elected to use the income approach to value its interest rate swap and foreign currency rate swap agreements, using observable Level 2 market expectations at the measurement date and standard valuation techniques to convert future amounts to a single present amount (discounted) assuming that participants are motivated, but not compelled to transact. The Level 2 inputs for the interest rate swap and forward valuations are limited to quoted prices for similar assets or liabilities in active markets (specifically futures contracts and spot currency rates) and inputs other than quoted prices that are observable for the asset or liability (specifically forward currency points, LIBOR cash and swap rates, basis swap adjustments and credit risk at commonly quoted intervals).
Location of Derivative Instruments in Financial Statements
 
Fair Value of Derivative Instruments
(In Millions)
 
Asset Derivatives
 
Liability Derivatives
 
June 30, 2014
 
December 31, 2013
 
June 30, 2014
 
December 31, 2013
Derivative Instrument
Balance
Sheet
Location
 
Fair
Value
 
Balance
Sheet
Location
 
Fair
Value
 
Balance
Sheet
Location
 
Fair
Value
 
Balance
Sheet
Location
 
Fair
Value
Interest rate swap contracts, designated as cash flow hedges
Fair value of derivative instruments
 
$
11.9

 
Fair value of derivative instruments
 
$
27.0

 
Fair value of derivative instruments
 
$
2.3

 
Fair value of derivative instruments
 
$
1.4

Interest rate swap contracts, not designated
Fair value of derivative instruments
 
0.3

 
Fair value of derivative instruments
 
0.3

 
Fair value of derivative instruments
 
1.3

 
Fair value of derivative instruments
 
0.5

Foreign exchange contracts, not designated
Fair value of derivative instruments
 

 
Fair value of derivative instruments
 
0.2

 
Fair value of derivative instruments
 

 
Fair value of derivative instruments
 

Total derivatives
 
 
$
12.2

 
 
 
$
27.5

 
 
 
$
3.6

 
 
 
$
1.9

 
Effect of Derivative Instruments on Consolidated Statements of Income and
Consolidated Statements of Comprehensive Income
(In Millions)
 
 
 
Three Months Ended June 30,
 
Six Months Ended 
 June 30,
 
Location of (Gain) Loss on
Derivative Instruments
 

2014
 
2013
 
2014
 
2013
Realized loss on interest rate swap agreements
Interest expense
 
$
3.3

 
$
2.9

 
$
6.5

 
$
6.0

Unrealized loss (gain) on interest rate swap agreements, designated as cash flow hedges
Other comprehensive income
 
9.6

 
(22.5
)
 
17.6

 
(20.0
)
Net loss (gain) on interest rate swaps, not designated
Net loss (gain) on interest rate swaps
 
0.6

 
(5.3
)
 
1.0

 
(8.4
)
Foreign exchange agreements, not designated
Administrative expenses
 

 
0.2

 
0.1

 
0.2


15

Table of Contents
TAL INTERNATIONAL GROUP, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Note 8—Segment and Geographic Information
Industry Segment Information
The Company conducts its business activities in one industry, intermodal transportation equipment, and has two reporting segments:
Equipment leasing—the Company owns, leases and ultimately disposes of containers and chassis from its lease fleet, as well as manages leasing activities for containers owned by third parties.

Equipment trading—the Company purchases containers from shipping line customers, and other sellers of containers, and resells these containers to container retailers and users of containers for storage or one-way shipment. Included in the Equipment trading segment revenues are leasing revenues from equipment purchased for resale that is currently on lease until the containers are dropped off.
The following tables show segment information for the periods indicated and the consolidated totals reported (dollars in thousands):
 
Three Months Ended June 30,
 
2014
 
2013
 
Equipment
Leasing
 
Equipment
Trading
 
Totals
 
Equipment
Leasing
 
Equipment
Trading
 
Totals
Total leasing revenues
$
141,423

 
$
3,300

 
$
144,723

 
$
137,264

 
$
2,917

 
$
140,181

Trading margin

 
2,215

 
2,215

 

 
4,287

 
4,287

Net gain on sale of leasing equipment
2,461

 

 
2,461

 
8,026

 

 
8,026

Depreciation and amortization expense
53,889

 
348

 
54,237

 
49,373

 
459

 
49,832

Interest and debt expense
26,308

 
580

 
26,888

 
27,643

 
660

 
28,303

Income before income taxes(1)
44,643

 
4,231

 
48,874

 
50,216

 
5,726

 
55,942

_______________________________________________________________________________

(1)
Segment income before income taxes excludes net losses on interest rate swaps of $0.6 million and net gains on interest rate swaps of $5.3 million for the three months ended June 30, 2014 and 2013, respectively, and the write-off of deferred financing costs of $3.7 million and $2.6 million for the three months ended June 30, 2014 and 2013, respectively.

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Table of Contents
TAL INTERNATIONAL GROUP, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Note 8—Segment and Geographic Information (Continued)
 
Six Months Ended June 30,
 
2014
 
2013
 
Equipment
Leasing
 
Equipment
Trading
 
Totals
 
Equipment
Leasing
 
Equipment
Trading
 
Totals
Total leasing revenues
$
282,690

 
$
6,800

 
$
289,490

 
$
272,159

 
$
5,811

 
$
277,970

Trading margin

 
3,863

 
3,863

 

 
6,962

 
6,962

Net gain on sale of leasing equipment
5,557

 

 
5,557

 
18,287

 

 
18,287

Depreciation and amortization expense
107,313

 
727

 
108,040

 
97,954

 
1,195

 
99,149

Interest and debt expense
53,274

 
1,233

 
54,507

 
55,803

 
1,383

 
57,186

Income before income taxes(1)
88,325

 
8,093

 
96,418

 
101,218

 
9,465

 
110,683

Equipment held for sale at June 30
30,914

 
19,400

 
50,314

 
24,308

 
14,754

 
39,062

Goodwill at June 30
73,523

 
1,000

 
74,523

 
70,898

 
1,000

 
71,898

Total assets at June 30
3,997,999

 
64,566

 
4,062,565

 
3,796,077

 
69,441

 
3,865,518

Purchases of leasing equipment and investments in finance leases(2)
286,652

 
3,114

 
289,766

 
361,110

 
11,466

 
372,576

_______________________________________________________________________________

(1)
Segment income before income taxes excludes net losses on interest rate swaps of $1.0 million and net gains on interest rate swaps of $8.4 million for the six months ended June 30, 2014 and 2013, respectively, and the write-off of deferred financing costs of $4.9 million and $2.6 million for the six months ended June 30, 2014 and 2013, respectively.
(2)
Represents cash disbursements for purchases of leasing equipment and investments in finance lease as reflected in the consolidated statements of cash flows for the periods indicated, but excludes cash flows associated with the purchase of equipment held for resale.
There are no intercompany revenues or expenses between segments. Additionally, certain administrative expenses have been allocated between segments based on an estimate of services provided to each segment. A portion of the Company's equipment purchased for resale was purchased through certain sale-leaseback transactions with our shipping line customers. Due to the expected longer term nature of these transactions, these purchases are reflected as leasing equipment as opposed to equipment held for sale and the cash flows associated with these transactions are and will be reflected as purchases of leasing equipment and proceeds from the sale of equipment in investing activities in the Company's consolidated statements of cash flows.
Geographic Segment Information
The Company earns most of its leasing revenues from international containers which are deployed by its customers in a wide variety of global trade routes. Substantially all of the Company's leasing related revenue is denominated in U.S. dollars. The following table represents the geographic allocation of leasing revenues for the periods indicated based on customers' primary domicile (in thousands):
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2014
 
2013
 
2014
 
2013
Total leasing revenues:
 
 
 
 
 
 
 
United States of America
$
8,136

 
$
7,965

 
$
16,175

 
$
16,008

Asia
65,187

 
61,390

 
129,259

 
119,608

Europe
64,858

 
64,864

 
130,852

 
130,631

Other International
6,542

 
5,962

 
13,204

 
11,723

Total
$
144,723

 
$
140,181

 
$
289,490

 
$
277,970

As most of the Company's containers are used internationally, where no one container is domiciled in one particular place for a prolonged period of time, substantially all of the Company's long-lived assets are considered to be international.

17

Table of Contents
TAL INTERNATIONAL GROUP, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Note 8—Segment and Geographic Information (Continued)
The following table represents the geographic allocation of equipment trading revenues for the periods indicated based on the location of sale (in thousands):
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2014
 
2013
 
2014
 
2013
Total equipment trading revenues:
 
 
 
 
 
 
 
United States of America
$
2,251

 
$
2,383

 
$
3,073

 
$
5,194

Asia
10,468

 
20,405

 
16,251

 
30,572

Europe
5,270

 
6,228

 
10,698

 
5,962

Other International
805

 
2,765

 
1,259

 
8,339

Total
$
18,794

 
$
31,781

 
$
31,281

 
$
50,067

Note 9—Commitments and Contingencies
Residual Value Guarantees
During 2008, the Company entered into commitments for equipment residual value guarantees in connection with certain finance leases that were sold or brokered to financial institutions. The guarantees represent the Company's commitment that these assets will be worth a specified amount at the end of certain lease terms (if the lessee does not default on the lease) which expire in 2016. At June 30, 2014, the maximum potential amount of the guarantees under which the Company could be required to perform was approximately $27.1 million. The carrying values of the guarantees of $1.1 million have been deferred and are included in accounts payable and accrued expenses. Under the criteria established by ASC 820, the Company performed fair value measurements of the guarantees at origination using Level 2 inputs, which were based on significant other observable inputs other than quoted prices, either on a direct or indirect basis. The Company accounts for the residual value guarantees under Accounting Standards Codification 460, Guarantees. The Company expects that the market value of the equipment covered by the guarantees will equal or exceed the value of the guarantees and therefore, no contingent loss has been provided as of June 30, 2014.
Purchase Commitments
At June 30, 2014, commitments for capital expenditures totaled approximately $228.9 million.
Note 10—Income Taxes
The consolidated income tax expense for the three and six months ended June 30, 2014 and 2013 was determined based upon estimates of the Company's consolidated effective income tax rates for the year ending December 31, 2014 and the year ended December 31, 2013. The difference between the consolidated effective income tax rate and the U.S. federal statutory rate is primarily attributable to state income taxes, foreign income taxes and the effect of certain permanent differences.
Note 11—Subsequent Events
Quarterly Dividend
On July 22, 2014, the Company's Board of Directors approved and declared a $0.72 per share quarterly cash dividend on its issued and outstanding common stock, payable on September 24, 2014 to shareholders of record at the close of business on September 3, 2014.

18

Table of Contents

ITEM 2.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

        The following discussion and analysis of the consolidated financial condition and results of operations of TAL International Group, Inc. and its subsidiaries should be read in conjunction with related consolidated financial data and our annual audited consolidated financial statements and related notes thereto included in our Annual Report on Form 10-K filed with the SEC on February 20, 2014. The statements in this discussion regarding industry outlook, our expectations regarding our future performance, liquidity and capital resources and other non-historical statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described under "Risk Factors" and "Forward-Looking Statements" in our Form 10-K. Our actual results may differ materially from those contained in or implied by any forward-looking statements.
Our Company
We are one of the world's largest and oldest lessors of intermodal containers and chassis. Intermodal containers are large, standardized steel boxes used to transport freight by ship, rail or truck. Because of the handling efficiencies they provide, intermodal containers are the primary means by which many goods and materials are shipped internationally. Chassis are used for the transportation of containers domestically.
We operate our business in one industry, intermodal transportation equipment, and have two business segments:
Equipment leasing—we own, lease and ultimately dispose of containers and chassis from our lease fleet, as well as manage containers owned by third parties.

Equipment trading—we purchase containers from shipping line customers, and other sellers of containers, and resell these containers to container retailers and users of containers for storage or one-way shipment.
Operations
Our operations include the acquisition, leasing, re-leasing and subsequent sale of multiple types of intermodal containers and chassis. As of June 30, 2014, our total fleet consisted of 1,298,201 containers and chassis, including 18,133 containers under management for third parties, representing 2,130,650 twenty-foot equivalent units (TEU). We have an extensive global presence, offering leasing services through 17 offices in 11 countries and approximately 230 third party container depot facilities in approximately 40 countries as of June 30, 2014. Our customers are among the largest shipping lines in the world. For the six months ended June 30, 2014, our twenty largest customers accounted for 80.4% of our leasing revenues, our five largest customers accounted for 51.5% of our leasing revenues, and our largest customer, CMA CGM, accounted for 16.5% of our leasing revenues.

19

Table of Contents

The following tables provide the composition of our equipment fleet as of the dates indicated (in units, TEUs and cost-equivalent units, or "CEU"):
 
Equipment Fleet in Units
 
June 30, 2014
 
December 31, 2013
 
June 30, 2013
 
Owned
 
Managed
 
Total
 
Owned
 
Managed
 
Total
 
Owned
 
Managed
 
Total
Dry
1,104,005

 
16,818

 
1,120,823

 
1,087,462

 
17,971

 
1,105,433

 
1,044,302

 
19,343

 
1,063,645

Refrigerated
66,293

 
51

 
66,344

 
63,967

 
63

 
64,030

 
60,125

 
84

 
60,209

Special
54,396

 
1,264

 
55,660

 
55,295

 
1,466

 
56,761

 
54,718

 
1,596

 
56,314

Tank
8,940

 

 
8,940

 
8,100

 

 
8,100

 
7,004

 

 
7,004

Chassis
13,495

 

 
13,495

 
13,724

 

 
13,724

 
13,377

 

 
13,377

Equipment leasing fleet
1,247,129

 
18,133

 
1,265,262

 
1,228,548

 
19,500

 
1,248,048

 
1,179,526

 
21,023

 
1,200,549

Equipment trading fleet
32,939

 

 
32,939

 
40,374

 

 
40,374

 
37,854

 

 
37,854

Total
1,280,068

 
18,133

 
1,298,201

 
1,268,922

 
19,500

 
1,288,422

 
1,217,380

 
21,023

 
1,238,403

Percentage
98.6
%
 
1.4
%
 
100.0
%
 
98.5
%
 
1.5
%
 
100.0
%
 
98.3
%
 
1.7
%
 
100.0
%
 
Equipment Fleet in TEUs
 
June 30, 2014
 
December 31, 2013
 
June 30, 2013
 
Owned
 
Managed
 
Total
 
Owned
 
Managed
 
Total
 
Owned
 
Managed
 
Total
Dry
1,785,811

 
29,629

 
1,815,440

 
1,759,100

 
31,875

 
1,790,975

 
1,685,545

 
34,543

 
1,720,088

Refrigerated
126,725

 
89

 
126,814

 
122,466

 
113

 
122,579

 
115,354

 
149

 
115,503

Special
98,440

 
2,153

 
100,593

 
99,473

 
2,481

 
101,954

 
98,285

 
2,702

 
100,987

Tank
8,940

 

 
8,940

 
8,100

 

 
8,100

 
7,004

 

 
7,004

Chassis
24,056

 

 
24,056

 
24,505

 

 
24,505

 
23,826

 

 
23,826

Equipment leasing fleet
2,043,972

 
31,871

 
2,075,843

 
2,013,644

 
34,469

 
2,048,113

 
1,930,014

 
37,394

 
1,967,408

Equipment trading fleet
54,807

 

 
54,807

 
65,102

 

 
65,102

 
63,113

 

 
63,113

Total
2,098,779

 
31,871

 
2,130,650

 
2,078,746

 
34,469

 
2,113,215

 
1,993,127

 
37,394

 
2,030,521

Percentage
98.5
%
 
1.5
%
 
100.0
%
 
98.4
%
 
1.6
%
 
100.0
%
 
98.2
%
 
1.8
%
 
100.0
%
 
Equipment Fleet in CEUs
 
June 30, 2014
 
December 31, 2013
 
June 30, 2013
 
Owned
 
Managed
 
Total
 
Owned
 
Managed
 
Total
 
Owned
 
Managed
 
Total
Operating Leases
2,318,769

 
27,808

 
2,346,577

 
2,260,404

 
30,232

 
2,290,636

 
2,196,305

 
32,940

 
2,229,245

Finance Leases
210,017

 
831

 
210,848

 
210,535

 
830

 
211,365

 
149,366

 
825

 
150,191

Equipment trading fleet
121,308

 

 
121,308

 
138,742

 

 
138,742

 
135,137

 

 
135,137

Total
2,650,094

 
28,639

 
2,678,733

 
2,609,681

 
31,062

 
2,640,743

 
2,480,808

 
33,765

 
2,514,573

Percentage
98.9
%
 
1.1
%
 
100.0
%
 
98.8
%
 
1.2
%
 
100.0
%
 
98.7
%
 
1.3
%
 
100.0
%
In the equipment fleet tables above, we have included total fleet count information based on CEU. CEU is a ratio used to convert the actual number of containers in our fleet to a figure based on the relative purchase prices of our various equipment types to that of a 20 foot dry container. For example, the CEU ratio for a 40 foot standard height dry container is 1.6, and a 40 foot high cube refrigerated container is 10.0. The CEU ratios used in this calculation are from our debt agreements and may differ slightly from current actual cost ratios and CEU ratios used by others in the industry.
We lease five types of equipment: (1) dry freight containers, which are used for general cargo such as manufactured component parts, consumer staples, electronics and apparel, (2) refrigerated containers, which are used for perishable items such as fresh and frozen foods, (3) special containers, which are used for heavy and over-sized cargo such as marble slabs, building products and machinery, (4) tank containers, which are used to transport bulk liquid products such as chemicals, and

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(5) chassis, which are used for the transportation of containers domestically. Our in-house equipment sales group manages the sale process for our used containers and chassis from our equipment leasing fleet and buys and sells used and new containers and chassis acquired from third parties.
The percentage of our equipment fleet by equipment type as of June 30, 2014 and the percentage of our leasing revenues by equipment type for the six months ended June 30, 2014 are as follows:
Equipment Type
Percent of
total fleet in
units
 
Percent of total fleet in CEUs
 
Percent of
leasing
revenues
Dry
86.4
%
 
59.1
%
 
64.0
%
Refrigerated
5.1

 
24.1

 
20.7

Special
4.3

 
5.0

 
7.4

Tank
0.7

 
5.3

 
3.5

Chassis
1.0

 
2.0

 
2.0

Equipment leasing fleet
97.5

 
95.5

 
97.6

Equipment trading fleet
2.5

 
4.5

 
2.4

Total
100.0
%
 
100.0
%
 
100.0
%
We generally lease our equipment on a per diem basis to our customers under three types of leases: long-term leases, finance leases and service leases. Long-term leases, typically with initial contractual terms ranging from three to eight years, provide us with stable cash flow and low transaction costs by requiring customers to maintain specific units on-hire for the duration of the lease. Finance leases, which are typically structured as full payout leases, provide for a predictable recurring revenue stream with the lowest cost to the customer because customers are generally required to retain the equipment for the duration of its useful life. Service leases command a premium per diem rate in exchange for providing customers with a greater level of operational flexibility by allowing the pick-up and drop-off of units during the lease term. We also have expired long-term leases whose fixed terms have ended but for which the related units remain on-hire and for which we continue to receive rental payments pursuant to the terms of the initial contract. Some leases have contractual terms that have features reflective of both long-term and service leases and we classify such leases as either long-term or service leases, depending upon which features we believe are predominant.
The following table provides a summary of our equipment leasing fleet portfolio by lease type, based on CEUs as of the dates indicated below:
Lease Portfolio
June 30,
2014

December 31,
2013

June 30,
2013
Long-term leases
67.2
%
 
68.0
%
 
65.3
%
Finance leases
8.9

 
9.2

 
6.9

Service leases
17.7

 
18.0

 
20.5

Expired long-term leases (units on-hire)
6.2

 
4.8

 
7.3

Total
100.0
%
 
100.0
%
 
100.0
%
As of June 30, 2014, December 31, 2013 and June 30, 2013, our long-term and finance leases combined had average remaining contract terms of approximately 44 months, 44 months, and 43 months, respectively, assuming no leases are renewed.

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Operating Performance
Our profitability is primarily determined by the extent to which our leasing and other revenues exceed our ownership, operating and administrative expenses. Our profitability is also impacted by the gains or losses that we realize on the sale of our used equipment and the net sales margins on our equipment trading activities.
Our leasing revenues are primarily driven by the size of our owned fleet, our equipment utilization and the average lease rates in our lease portfolio. Our leasing revenues also include ancillary fees driven by container pick-up and drop-off volumes. Leasing revenues for the second quarter of 2014 increased 3.2% from the second quarter of 2013.
Owned fleet size.    As of June 30, 2014, our owned fleet included 2,650,094 CEUs, an increase of 1.5% from December 31, 2013 and 6.8% from June 30, 2013. The increase in our fleet size over the second quarter of 2013 was primarily due to our purchases of new containers and the completion of several large sale-leaseback transactions during the second half of 2013 and the first half of 2014. These investments were supported by a moderate level of global trade growth and the continued market share shift from owned to leased containers. Most forecasters are projecting global trade growth will be between 5% and 6% this year. Our customers have continued to lease a larger than normal share of their new container requirements due to strains on their financial performance created by excess vessel capacity and weak freight rates.
As of July 23, 2014, we have purchased over $460 million of containers for delivery in 2014 through new orders and sale-leaseback transactions.
Utilization.    Our average utilization was 97.3% during the second quarter of 2014, an increase from 97.1% in the first quarter and down slightly from 97.5% in the second quarter of 2013. Our utilization remains historically high due to the relatively tight supply/demand balance for containers and the high percentage of our units that are on-hire to customers on long-term or finance leases. In general, we expect that our utilization will remain at a high level in 2014, though over time we expect our utilization will moderate gradually as the global supply and demand for containers normalizes.
The following tables set forth our equipment fleet utilization(1) for the periods indicated below:
 
Quarter Ended
 
June 30,
2014
 
March 31,
2014
 
December 31,
2013
 
September 30,
2013
 
June 30,
2013
Average Utilization
97.3
%
 
97.1
%
 
97.0
%
 
97.3
%
 
97.5
%


June 30,
2014
 
March 31,
2014
 
December 31,
2013
 
September 30,
2013
 
June 30,
2013
Ending Utilization
97.7
%
 
96.9
%
 
97.2
%
 
97.0
%
 
97.5
%
_______________________________________________________________________________

(1)Utilization is computed by dividing our total units on lease (in CEUs) by the total units in our fleet (in CEUs)
excluding new units not yet leased and off-hire units designated for sale.
Average lease rates.    Average lease rates in the second quarter of 2014 for our dry container product line decreased by 2.3% from the first quarter of 2014 and 5.5% from the second quarter of 2013, excluding the impact of sale-leaseback transactions. Lower new container prices, widespread availability of attractively priced financing, and extremely aggressive competition for new leasing transactions continue to pressure market lease rates, and market lease rates for dry containers are currently well below our portfolio average. Low market lease rates negatively impact our overall average lease rates as we add new containers to our fleet and as existing containers either have leases renegotiated and re-priced at expiration or as the containers are dropped-off from older leases with higher lease rates and picked-up onto new leases with lower lease rates. We expect our dry container lease rates will continue to decrease in 2014 and if market lease rates remain near their current low level for an extended period of time, we expect the decrease in our average dry container lease rates will accelerate in 2015 and 2016 due to the large number of leases with high lease rates that are scheduled to expire in those years.
Average lease rates in the second quarter of 2014 for our refrigerated container product line decreased by 0.4% from the first quarter of 2014 and 4.8% from the second quarter of 2013. For several years, our average lease rates for refrigerated containers have been negatively impacted by historically low market leasing rates. The cost of refrigeration machines included in refrigerated containers has trended down over the last few years, which has led to lower refrigerated container prices and lease rates. Lease rates for new refrigerated containers are also being negatively impacted by the widespread availability of attractively priced financing and aggressive competition.

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The average lease rates for special containers were approximately 4.4% higher in the second quarter of 2014 compared to the second quarter of 2013, excluding the impact of sale-leaseback transactions. This increase is mainly the result of the drop-off and sale of older special containers that were on leases with rates well below our portfolio average.
Equipment disposals.    During the second quarter of 2014, we recognized a $2.5 million gain on the sale of our used containers compared to a gain of $8.0 million in the second quarter of 2013.
In the second quarter of 2014, our gain on sale was negatively impacted by lower average sale prices and the higher cost of equipment sold. Our average used container selling prices decreased approximately 20% from the second quarter of 2013 as leasing companies and shipping lines have increased disposal volumes in response to the gradual normalization of the container supply/demand balance. We expect used container selling prices will continue to trend down toward historical levels as the global supply and demand balance for containers continues to normalize.
Our gain on equipment disposals has also been negatively impacted by a decrease in the disposal volume of original TAL dry containers. Current used dry container sale prices remain well above our long-term estimated residual values, and the per unit gains on the disposal of original TAL dry containers remain relatively high. However, TAL purchased few new containers in the late 1990’s and early 2000’s, and as a result, we have a limited amount of original TAL dry containers currently available for sale. We have supplemented our original TAL container fleet with the purchase of older containers through more recent sale-leaseback transactions, but we have typically purchased these containers at prices higher than the net book values of our older original TAL containers, resulting in lower per unit disposal gains from our sale-leaseback containers.
Equipment ownership expenses.    Our ownership expenses, which consist of depreciation and interest expense, increased by $3.0 million or 3.8% in the second quarter of 2014 as compared to the second quarter of 2013. This increase in our ownership expenses was less than the increase in the average net book value of our revenue earning assets, which increased by approximately 5.7% from the second quarter of 2013 to the second quarter of 2014 reflecting the addition of new and sale-leaseback containers.
Depreciation expense increased $4.4 million or 8.8% in the second quarter 2014 as compared to the second quarter of 2013 mainly due to the net increase in the size of our depreciable fleet. Depreciation expense increased faster than our revenue earning assets mainly reflecting a decrease in the portion of our fleet that is fully depreciated. TAL purchased few new containers in the late 1990's and early 2000's, and as a result, we have relatively few original TAL containers reaching the end of their depreciable lives. We expect the portion of fully depreciated containers in our fleet will continue to trend down for the next several years.
Interest expense decreased $1.4 million or 4.9% in the second quarter of 2014 as compared to the second quarter of 2013. The decrease was due to a decrease in our average effective interest rate, partially offset by an increase in our average outstanding debt. Our average effective interest rate decreased to 3.70% in the second quarter of 2014 as compared to 4.06% in the second quarter of 2013 reflecting the refinancing of selected debt facilities with lower cost debt and the issuance of new debt at interest rates lower than those on our existing debt facilities. Our average outstanding debt increased by 4.33% mainly due to the 5.7% increase in average revenue earning assets.
Credit performance.     We recorded a small provision for doubtful accounts during the second quarter of 2014 compared to a $1.6 million provision for doubtful accounts during the second quarter of 2013. During the second quarter of last year, we recorded a provision related to payment defaults and estimated recovery costs for several small regional shipping lines. We had no such defaults this year. While our credit performance was strong during the second quarter of 2014, our overall concern about credit risk remains heightened due to the difficult market conditions facing our shipping line customers. Most of the major shipping lines reported modest or negative profitability over the last few years due to persistent excess vessel capacity and weak freight rates. Several large shipping lines are also currently undertaking significant financial restructurings due to high current financial leverage and ongoing sizable losses. In addition, it is anticipated that the volume of new vessels entering service over the next several years will cause the global container vessel fleet to grow at a higher rate than global containerized trade. As a result, we expect freight rates and our customers' financial performance to remain under pressure.
Operating expenses.    Direct operating expenses were $8.3 million in the second quarter of 2014, compared to $6.2 million in the second quarter of 2013. This increase was mainly due to higher storage and handling costs resulting from higher volume of re-deliveries, slightly lower utilization, and an increase in the number of containers held for sale. The number of containers held for sale increased by 8,557 TEU from June 30, 2013 to June 30, 2014. In addition, we also incurred higher repair and repositioning costs as a result of the higher volume of re-deliveries.
Our administrative expenses increased $0.5 million to $11.1 million in the second quarter of 2014 compared to $10.6 million in the second quarter of 2013. This increase was due to increased incentive compensation partially offset by a reduction in foreign exchange losses on our Euro and GBP denominated assets and liabilities.

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Dividends
We paid the following quarterly dividends during the six months ended June 30, 2014 and 2013 on our issued and outstanding common stock:
Record Date
Payment Date
 
Aggregate
Payment
 
Per Share
Payment
June 3, 2014
June 24, 2014
 
$24.2 Million
 
$0.72
March 3, 2014
March 24, 2014
 
$24.2 Million
 
$0.72
June 4, 2013
June 25, 2013
 
$22.1 Million
 
$0.66
March 7, 2013
March 28, 2013
 
$21.4 Million
 
$0.64
Historically, most of our dividends have been treated as a non-taxable return of capital, and based on our current estimates we believe that our dividends paid in 2014 will also be treated as a non-taxable return of capital to TAL shareholders. The taxability of the dividends to TAL shareholders does not impact TAL's corporate tax position. Investors should consult with a tax adviser to determine the proper tax treatment of these distributions.

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Results of Operations
The following table summarizes our results of operations for the three and six months ended June 30, 2014 and 2013 (in thousands of dollars):
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2014
 
2013
 
2014
 
2013
Leasing revenues:
 
 
 
 
 
 
 
Operating leases
$
139,489

 
$
136,304

 
$
278,819

 
$
270,358

Finance leases
4,724

 
3,152

 
9,677

 
6,250

Other revenues
510

 
725

 
994

 
1,362

Total leasing revenues
144,723

 
140,181

 
289,490

 
277,970

 
 
 
 
 
 
 
 
Equipment trading revenues
18,794

 
31,781

 
31,281

 
50,067

Equipment trading expenses
(16,579
)
 
(27,494
)
 
(27,418
)
 
(43,105
)
Trading margin
2,215

 
4,287

 
3,863

 
6,962

 
 
 
 
 
 
 
 
Net gain on sale of leasing equipment
2,461

 
8,026

 
5,557

 
18,287

 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
Depreciation and amortization
54,237

 
49,832

 
108,040

 
99,149

Direct operating expenses
8,267

 
6,218

 
16,949

 
12,180

Administrative expenses
11,128

 
10,614

 
22,960

 
22,518

Provision for doubtful accounts
5

 
1,585

 
36

 
1,503

Total operating expenses
73,637

 
68,249

 
147,985

 
135,350

Operating income
75,762

 
84,245

 
150,925

 
167,869

Other expenses:
 
 
 
 
 
 
 
Interest and debt expense
26,888

 
28,303

 
54,507

 
57,186

Write-off of deferred financing costs
3,729

 
2,578

 
4,899

 
2,578

Net loss (gain) on interest rate swaps
582

 
(5,268
)
 
955

 
(8,420
)
Total other expenses
31,199

 
25,613

 
60,361

 
51,344

Income before income taxes
44,563

 
58,632

 
90,564

 
116,525

Income tax expense
15,201

 
20,756

 
31,191

 
41,129

Net income
$
29,362

 
$
37,876

 
$
59,373

 
$
75,396



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Comparison of Three Months Ended June 30, 2014 to Three Months Ended June 30, 2013
Leasing revenues.    The principal components of our leasing revenues are presented in the following table. Per diem revenue represents daily usage revenue earned under operating lease contracts; fee and ancillary lease revenue represent fees billed for the pick-up and drop-off of containers in certain geographic locations and billings of certain reimbursable operating costs such as repair and handling expenses; and finance lease revenue represents interest income earned under finance lease contracts.
 
Three Months Ended 
 June 30,
 
2014
 
2013
 
(in thousands)
Leasing revenues:
 
 
 
Operating lease revenues:
 
 
 
Per diem revenue
$
132,727

 
$
130,949

Fee and ancillary lease revenue
6,762

 
5,355

Other revenues
510

 
725

Total operating lease revenue
139,999

 
137,029

Finance lease revenue
4,724

 
3,152

Total leasing revenues
$
144,723

 
$
140,181

Total leasing revenues were $144.7 million in the three months ended June 30, 2014, compared to $140.2 million in the same period in 2013, an increase of $4.5 million, or 3.2%.
Per diem revenue increased by $1.8 million, or 1.4%, compared to the three months ended June 30, 2013. The primary reasons for this increase are as follows:
$6.3 million increase due to an increase of approximately 100,000 CEUs in the average number of containers on-hire under operating leases; partially offset by a
$4.5 million decrease due to lower average per diem rates.
Fee and ancillary lease revenue increased by $1.4 million in the three months ended June 30, 2014 compared to the same period in 2013. This increase was primarily due to a higher number of refrigerated and special container re-deliveries in the second quarter of 2014. Per unit reimbursable repair costs are typically relatively high for refrigerated and special containers.
Finance lease revenue increased by $1.6 million in the three months ended June 30, 2014, compared to the same period in 2013, primarily due to an increase in the average size of our finance lease portfolio partially offset by a decrease in the portfolio average interest rate.
Equipment Trading Activities.    Equipment trading revenues represent the proceeds on the sale of equipment purchased for resale. Equipment trading expenses represent the cost of equipment sold, including costs associated with the acquisition, maintenance and selling of trading inventory, such as positioning, repairs, handling and storage costs, and estimated direct selling and administrative costs.
 
Three Months Ended 
 June 30,
 
2014
 
2013
 
(in thousands)
Equipment trading revenues
$
18,794

 
$
31,781

Equipment trading expenses
(16,579
)
 
(27,494
)
Equipment trading margin
$
2,215

 
$
4,287

The equipment trading margin decreased by $2.1 million in the three months ended June 30, 2014 compared to the same period in 2013. Equipment trading margin decreased by $0.9 million due to lower sales volumes and decreased by $1.2 million due to lower per unit margins on equipment sold resulting from declining selling prices.

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Net gain on sale of leasing equipment.    Gain on sale of equipment was $2.5 million for the three months ended June 30, 2014 compared to $8.0 million in the same period in 2013, a decrease of $5.5 million. The primary reasons for this decrease are as follows:
$6.2 million decrease due to a 20% decline in used dry container selling prices; partially offset by a
$0.7 million increase due to an increase in sales volume.
Depreciation and amortization.    Depreciation and amortization was $54.2 million in the second quarter of 2014, compared to $49.8 million in the second quarter of 2013, an increase of $4.4 million or 8.8%. Depreciation expense increased $5.3 million primarily due to the net increase in the size of our depreciable fleet, partially offset by a decrease of $0.9 million due to equipment becoming fully depreciated.
Direct operating expenses.    Direct operating expenses primarily consist of our costs to repair equipment returned off lease, to store the equipment when it is not on lease and to reposition equipment that has been returned to locations with weak leasing demand.
Direct operating expenses were $8.3 million in the three months ended June 30, 2014, compared to $6.2 million in the same period in 2013, an increase of $2.1 million. This increase was mainly due to higher storage and handling costs of $1.2 million due to slightly lower utilization and an increase in the number of containers held for sale, a $0.4 million increase due to higher repair expense, and a $0.3 million increase due to higher equipment re-positioning expense.
Administrative expenses.    Administrative expenses were $11.1 million in the second quarter of 2014 compared to $10.6 million in the same period in 2013, an increase of $0.5 million or 4.7%. This increase was due to increased incentive compensation partially offset by a reduction in foreign exchange losses on our Euro and GBP denominated assets and liabilities.
Provision for doubtful accounts.    Our provision for doubtful accounts was minimal in the second quarter of 2014, compared to a provision for doubtful accounts of $1.6 million in the second quarter of 2013. During the second quarter of last year, we recorded a provision related to payment defaults and estimated recovery costs for several small regional shipping lines. We had no such defaults this year.
Interest and debt expense.    Interest and debt expense was $26.9 million in the second quarter of 2014, compared to $28.3 million in the second quarter of 2013, a decrease of $1.4 million. Interest and debt expense decreased by $2.6 million due to a lower effective interest rate of 3.70% in the second quarter of 2014 compared to 4.06% in the prior year quarter. This was partially offset by a $1.2 million increase due to a higher average debt balance of $2,875.2 million in the second quarter of 2014, compared to $2,755.9 million in the prior year quarter.
Net loss (gain) on interest rate swaps.    Net loss on interest rate swaps was $0.6 million in the three months ended June 30, 2014, compared to a gain of $5.3 million in the same period in 2013. The fair value of our interest rate swap agreements decreased during the second quarter of 2014 due to a decrease in long term interest rates. Under the majority of our interest rate swap agreements, we make interest payments based on fixed interest rates and receive payments based on the applicable prevailing variable interest rate. As long term interest rates decreased during the second quarter of 2014, the current market rate on interest rate swap agreements with similar terms decreased relative to our existing interest rate swap agreements, which caused the fair value of our existing interest rate swap agreements to decrease during the quarter.
Income tax expense.    Income tax expense was $15.2 million in the three months ended June 30, 2014, compared to $20.8 million in the same period in 2013. The effective tax rates for the three months ended June 30, 2014 and 2013 were 34.1% and 35.4%, respectively. Our effective tax rate decreased due to changes in state apportionment factors for several states which lowered our state effective tax rate.
While we record income tax expense, we do not currently pay any significant federal, state or foreign income taxes due to the availability of net operating loss carryovers and accelerated tax depreciation for our equipment. The majority of the expense recorded for income taxes is recorded as a deferred tax liability on the balance sheet. We anticipate that the deferred income tax liability will continue to grow for the foreseeable future.


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Comparison of Six Months Ended June 30, 2014 to Six Months Ended June 30, 2013
Leasing revenues.    The principal components of our leasing revenues are presented in the following table. Per diem revenue represents daily usage revenue earned under operating lease contracts; fee and ancillary lease revenue represent fees billed for the pick-up and drop-off of containers in certain geographic locations and billings of certain reimbursable operating costs such as repair and handling expenses; and finance lease revenue represents interest income earned under finance lease contracts.
 
Six Months Ended 
 June 30,
 
2014
 
2013
 
(in thousands)
Leasing revenues:
 
 
 
Operating lease revenues:
 
 
 
Per diem revenue
$
264,730

 
$
259,666

Fee and ancillary lease revenue
14,089

 
10,692

Other revenues
994

 
1,362

Total operating lease revenue
279,813

 
271,720

Finance lease revenue
9,677

 
6,250

Total leasing revenues
$
289,490

 
$
277,970

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