Hilliard Terry - EVP & CFO Phil Brewer - President & CEO Robert Pedersen - President & CEO, Textainer Equipment Management Limited

Michael Webber - Wells Fargo Securities Helane Becker - Cowen and Company Doug Mewhirter - SunTrust Robinson Humphrey

Welcome to the Q2 2016 Textainer Group Holdings earnings conference. [Operator Instructions]. I will now turn the call over to Executive Vice President and Chief Financial Officer, Hilliard Terry. Mr. Terry, you may begin.

Thank you and welcome to Textainer's 2016 second quarter conference call. Joining me on this morning's call are filled Phil Brewer, TGH President and Chief Executive Officer. At the end of our prepared remarks, Robert Pedersen, TEM President and Chief Executive Officer, will join us for the Q&A. Before I turn the call over to Phil, I would like to point out that this conference call contains forward-looking statements in accordance with U.S. Securities laws. These statements involve risks and uncertainties, are only predictions and may differ materially from actual future events or results. Finally, the Company's views, estimates, plant and outlook, as described within this call, may change subsequent to this discussion. The Company is under no obligation to modify or update any or all of the statements that are made. Please see the Company's annual report on Form 20-F for the year ended December 31, 2015, filed with the Securities and Exchange Commission on March 11, 2016 and, going forward, any subsequent quarterly filings on Form 6-K for additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements. I would also like to point out that during this call we will discuss non-GAAP financial measures. Such measures are not prepared in accordance with generally accepted accounting principles. A reconciliation of the non-GAAP financial measure to the most directly comparable GAAP measure will be provided either on this conference call or can be found in today's earnings press release. At this point, I would now like to turn the call over to Phil for his opening comments.

Thank you, Hilliard. I would like to welcome you to Textainer's second quarter 2016 earnings call. Our results are a reflection of the challenging market conditions we face, driven in large part by the low prices for new and used containers. Low new container prices means low rental rates for new, depo and lease renewal containers which explains the decline in our lease rental income to $120.2 million. Low used container prices are the reason for the $19.5 million of impairments we recognize. These are the two primary factors leading to our adjusted net income for the quarter of $3 million or $0.05 per share. Excluding just the impairments, our adjusted net income would have been $21.8 million or $0.38 per share. It is worth noting that, although lease rental income declined 6.3% from the year ago quarter, it declined far less than the drop in new container rental rates over that same time, due largely to the structure of our leases and the long term nature of our fleet. We saw much stronger lease-out demand during the second quarter than we had anticipated. Our un-booked depo inventory decreased by 40% and is at the lowest level we have seen in a year as we benefited from the three highest lease-out booking weeks in our history. Our unallocated new container inventory is similarly low. Utilization improved one percentage point and is 95.1% currently. This is a significant increase in utilization over such a short period, especially considering that at the same time the volume of container returns remained relatively high. This increase was due to the previously mentioned increase in demand and shipping lines picking up booked containers faster than normal. Our high utilization also is indicative of the fact that 85% of our fleet is subject to long term and finance leases, of which only 8.5% mature in 2016. In general, our leases are structured so that a majority of containers are returned in Asia where lease-out demand is strongest. The substantial majority of our off-lease inventory is in Asia. New container prices increased over the quarter from approximately $1200 to $1500 and subsequently declined to $1400 which is still more than $200 above the low point of the year. Used container prices did not similarly increase, but they did stop declining, remaining relatively flat during the quarter. This may be an indication that prices have reached the bottom. While we do not like to sell used containers at today's prices, we believe selling the containers is the right financial decision and makes much more sense than paying to store old containers that are unlikely to be leased out in the near term. The storage costs incurred are unlikely to be recovered. We have invested $423 million year to date purchasing more than 250,000 TEU of attractively priced containers. These containers were leased out at terms which were better than those generated by containers leased earlier this year or during the last half of last year. Not only are these containers less risky due to their low purchase prices, but they also can be expected to perform very well over their useful lives as they depreciate. The credit quality of certain of our shipping line customers is a major concern. While consolidation has strengthened some lines, credit risk overall has increased. Freight rates are at historically low levels due to excess vessel capacity and are not expected to improve materially in the near term, due to vessel capacity growing at a faster rate than trade. As a result, two major Asian shipping lines have entered into restructuring negotiations with their creditors. One has concluded a successful restructuring and remains current in its payments. The other is currently in discussions with its creditors, including Textainer and other container lessors and is paying only part of its outstanding payables. It is not possible at this point to predict whether a successful restructuring will be concluded. We're also closely monitoring several other smaller lessees. Our adjusted EBITDA of $95.6 million for the quarter was approximately equal to the first quarter. While we remain confident in our ability to generate cash, we believe preserving cash during these challenging times helps ensure that we have the resources to take advantage of opportunities that today's market conditions may produce. As a result, we declared a dividend of $0.03 per share, a significant decline from the prior dividend. While we're not pleased to cut our dividend, we believe this action is in the best interest of our shareholders and Company. The dividend is equal to 60% of this quarter's adjusted net income. We do not see a significant improvement in new or used container prices through year-end, meaning impairments are likely to remain at their current level for the foreseeable future. Additionally, our results will continue to be negatively affected by rate reductions from the repricing of maturing leases. We expect the increase in demand we saw during the second quarter may decrease slightly, but will continue into the third quarter. We also believe that the industry will benefit from the low level of new container manufacturing. New dry freight container production is expected to be no more than 1.5 million TEU this year compared to 2.5 million TEU produced last year and 3.2 million TEU in 2014. Since approximately 1.5 million TEU are disposed annually and refrigerated container production is also expected to be below last year's record levels, the world's container fleet is unlikely to grow and may decline this year. Furthermore, new container inventory at the factories is only approximately 600,000 TEU, well below the 1.1 million TEU peak reached last year. Containers are not in an oversupply situation. Should there be an unexpected spike in demand as has often happened in the past, the container leasing market could strengthen quickly. Let me repeat what I have said many times in the past. Our industry is and always has been cyclical. Textainer has been in business for 37 years and has successfully managed through many cycles. We believe containers purchased at today's low prices will provide attractive returns over their useful lives. With our low leverage, we believe we're well positioned for the challenging market conditions we expect. I will now turn the call over to Hilliard.

Thank you, Phil. Lease rental income was $120.2 million, down 6.3% year over year, due to a 6.1% decrease in average per diem rental rates and a 2.8 percentage point decline in utilization and a small decrease in the size of our own fleet. Our earnings results were significantly impacted by impairments on equipment held for sale. In the second quarter, we had $19.5 million or $0.33 per share, of equipment impairment as we wrote down containers in our existing sales inventory and containers recently designated for disposal to their net realizable value. This was up sequentially from the $17.3 million we reported in the first quarter. We expect to report a similar level of impairments on equipment held for sale until we see an increase in the used container prices or the volume of containers moving to our sales inventory slows, neither of which is expected in the next several quarters. On the expense side, direct container expenses increased $4.6 million or 46%, year over year to $14.6 million for the quarter. $3.4 million or close to three quarters of the increase was due to higher storage expense as a result of a decrease in utilization versus this time last year. Direct container expenses decreased slightly from the first quarter as a result of a slight increase in utilization versus the previous quarter. Depreciation expense was $51.8 million for the quarter, up $7.1 million or 15.9% year over year. As a reminder, included in the increase was $4.6 million of additional expense resulting from the Q3 2015 change in residual values of our 40-foot high cube containers. The remaining portion of the increase was due to the larger size of our owned fleet of refrigerated containers with a small offset from the decrease in the size of our owned fleet of dry containers and lower new container prices. When compared to dry containers, a higher percentage of our refrigerated containers prices are depreciated annually. As the percentage of refrigerated containers in our fleet increases, so does depreciation expense. Annualized depreciation expense for the quarter was 4.6% of average gross container value on our balance sheet and we expect annualized depreciation to be 4.4% to 4.8% of average gross container value. Bad debt expense was $1.8 million or 1.4% of total revenue. The current environment remains challenging for our customers. The increased credit challenges among our customers may result in trends above our historical run rate. We continue to be very proactive in our credit and collections activities. Our interest expense, including realized hedging costs, but excluding the write-off of unamortized bank fees and unrealized losses on interest rate swaps, was $22.4 million for the quarter, essentially the same when compared to the year ago quarter. We continue to benefit from our refinancing activities over the past year. Our average effective interest rate which includes realized hedging costs, is currently 2.97%, an increase of 6 basis points when compared to the year ago quarter, due to a year-over-year increase in the benchmark rate, mostly offset by reduced hedging costs. During the quarter, we amended our corporate financing facilities without any increase in pricing. We believe this was a very good outcome as others have had to pay higher spreads and, in some cases, banks have not been willing to recommit. Although interest rates remain at low levels, we see indications that access to the banking capital markets financing by lessors is becoming more difficult and more expensive. As of quarter end, 79% of our debt was fixed or hedged which is close to the percentage of our owned fleet, subject to long term and finance leases. The weighted average remaining term of our fixed and hedged debt is 47 months. The weighted average remaining term of our long term and finance leases is 40 months. Adjusted net income for the quarter was $3 million or $0.05 per diluted common share. Turning to the balance sheet, as of June 30, our cash position was $105 million, would stand by our available liquidity of more than $550 million. Total assets were $4.4 billion and you will see the receivable for insurance proceeds is now $6.8 million versus $11.4 million at the beginning of the year, reflecting receipt of cash payments from our insurance claim. We continue to generate strong cash flow during these challenging market conditions, given the long term structure of our fleet. Additionally, the maximum level of lease maturities in any one year is less than 9% of our total fleet. Moreover, our statement of cash flows show how much of a decline in net income is related to non-cash items such as the increase in container impairments and increased depreciation expense and year to date we have generated approximately $150 million of cash from operating activities. We declared a dividend of $0.03 per share which equals 60% of our adjusted net income. As a reminder, some or all such distributions may be treated by U.S. shareholders as a return of capital rather than dividends. Thank you for your attention and now I would like to open the call up for questions. Operator, can you inform the participants of the procedures for the Q&A?

[Operator Instructions]. Our first question comes from Michael Webber with Wells Fargo. You may begin.

Phil, I just wanted to start off with something you mentioned in your prepared remarks around some of the restructurings and the accounts payable. I would presume you're talking about HMM and Hanjin which have been in the news for quite a while. HMM, it looks like has reached an agreement with some of their vessel owners to renegotiate charters by 20% off of an ask of about 30%, giving equity and extending the contracts. Hanjin seems yet to settle, but is that the right kind of comp we should be thinking about in terms of any conversations you guys may or may not be having or can you maybe just delineate the differences between your conversations and what we might be seeing with some of the lumpier asset providers or they have larger asset providers? I know you can't really get too specific on individual counterparties, but just kind of an overview.

I would just note that with Hyundai, they actually didn't seek any concessions from container lessors. They did seek concessions from other creditors, including from ship charters and to date remain current on their payments. With respect to Hanjin, the discussions are ongoing. There are some requests for concessions from lessors, in this case which didn't happen with Hyundai, but I really think I can't be a whole lot more specific than that at the moment. The discussions are ongoing. As I noted in my initial comments and I would just reiterate, at this point it is very difficult to tell where these discussions will end up.

Fair enough. Kind of along those lines, if we think about the west here, the liner space and the continued consolidation or quasi consolidation we're seeing there with HMM has joined M2 and we have seen kind of reshuffling of those alliances. How is that impacting for demand for boxes? I know it is a pretty soft environment and you are not seeing a lot of demand to begin with. But in terms of conversations you guys are having, is it creating a ripple one way or the other, kind of if you isolate that specific variable?

The alliances in isolation don't really create the cargo demand. We're looking at cargo demand growth and available vessel capacity and I am sure you follow the numbers and you have seen that the available vessel capacity has actually dropped in recent months and that goes for all the various vessel sizes. And so I think, when you look at it in total, cargo volumes are definitely up. Some of our customers are reporting 3%, maybe even higher, in that cargo volume rise in this peak period. Interesting, when you look at the shipping line focus right now, in previous years when we were talking about this issue, we were talking about capacity -- vessel size. Now it seems like the hunt is who is in the biggest alliance. You look at these constellations, that is really where the focus is. How can they come up and compete with each other in total size. But it really does not have any direct correlation to cargo loadings right now.

Right. We're just thinking about if they are looking [indiscernible] optimized capacity. Obviously, vessel capacity has been ratcheting higher, while box capacity has been much more rational. Just know if there is any sort of flow-through in terms of a reluctance to order because they are looking at rationalizing capacity with--

I think that is absolutely happening. You can see that from the order book. I mean, remaining orders right now at the lowest ratio, they have been in many years at 17%. It has not been that low for many, many years, so I think they have definitely made their adjustments and want to utilize the alliance capacity to a greater extent by not just adding additional vessels.

Phil, maybe kind of transitioning to asset prices. We have seen a delay in bumps, late spring, summer from the move in steel prices earlier in the year and kind of late 2015 and you mentioned didn't necessarily expect a big flow-through towards the end of the year, but we may or may not be at a bottom. There are some new water-based tanks initiatives going on with some staggered phase-ins in kind of northern and southern China. How do you think that ends up impacting box prices? And I guess the real question is, it might be a bit early, but do you think there would be any issue in passing through the full amount of any sort of increase on to your customer base?

Well, when you started this question, I thought you were actually headed toward used box prices and I can see you are talking about new box prices.

I was going to get there, too, so you might as well answer both.

Well, then, maybe I will touch on both. New box prices, as we said, came up off the lows at the beginning of the year and we have seen them retreat a little bit. They are still $200 above the lows from the beginning of the year. You are right about the waterborne paint. That is initially adding to the cost of containers, except that there is really not a whole lot of ordering going on right now anyway. So you won't see a lot of whether it is lessors or shipping lines paying for containers with waterborne paint. However, it does look like that will be enforced and you will see a price increase, at least in southern China initially and then slowly working its way through the rest of China. As those costs -- frankly, we think that over time, those costs may be negotiated out. But, initially, they are likely to be in place. And, yes, that will affect the pricing of containers as long as those premiums exist on new containers. We do think that, between now and the end of the year, it is very unlikely to see an increase in new container prices. You may even see a slight reduction. But let's just say that they are going to remain somewhere around where they are right now which is in the $1400 or slightly less than $1400 range for a new 20-foot container. As far as used container prices, the bad news is that they are at very, very low levels. The good news is that, over the last quarter, we have seen a very, very minor change in used container prices. I can't promise you that we're at a bottom, but certainly it is the first time we have seen this minimal amount of change over a three-month period. With the slight increase in new container prices, I am hopeful that we don't continue to see a decline in used container prices. However, I don't think used container prices are going to recover for quite some time because we have a significant amount of inventory, not just Textainer, but I mean, frankly, we're selling our containers as is evident by the impairments. But there is inventory in the market to sell and I think you're going to see used container prices delay behind any increase in new container prices by at least, say, three, four months. So we don't expect a used container price improvement for some time.

Could I just go back and the initial question about new production, just in relation to whether we have been able to pass these increases on to our customers, the answer is yes and more than that, actually. We clearly use the high demand and the fact that people were actually waiting for containers to increase what is our low margins, but at least they are better now in every deal we close.

Phil, just to go back to that idea, in terms of utilization ticking up, we're seeing a bit of seasonality. You have got the waterborne paint issue that may or may not get phased in at some point, but the general idea being that used boxes could be more attractive. From a customer perspective, does that slow the decision in terms of disposals at all or is it too far out?

No, it has not slowed our decision in terms of disposals. We still decide whether or not to dispose a container on the same criteria we always have which is what is the value of that asset, where it is, what are the repair costs, lease-out prospects, how old is it, condition, etcetera. All those factors and that is how we decide to sell a container. I mean, our experience has told us that delaying decisions to sell containers are generally not prudent decisions. You end up incurring far more in storage expense than you would ever recover and hoping that prices increase over time. Obviously, we're not happy where prices are, where you can certainly see the impairments we're taking every quarter. But I think those levels of impairments are a very clear indication that we continue to run our business in the same way we have always run it which is we try to make the best financial decision with our assets with the information we have at that time. The current container prices, current market lease-out conditions.

And, similarly, with the idea of trying to get too cute, so I kind of appreciate that. I guess one more for me and I will turn it over and Phil, just kind of higher level, if quarter on quarter, even year on year, obviously we have seen some consolidation in the space. Two of your largest competitors, there are a number of either smaller public or smaller private slugs of boxes. I'm just curious, given where valuations are and what is happening in the space, kind of financial constraints, I guess theoretically aside, are you seeing an uptick or any change, I guess, year on year on activity or discussions or pitches or anything like that? Is there any sort of read-through we can get in terms of post Talon/Trident consolidation?

I would just say that I have to believe there will be additional consolidation in our industry. I can't tell you it is going to happen in a month, but if you ask me, is our industry going to look different a year, year and a half from now, I would certainly think it will. I think there will be additional consolidation.

And our next question comes from Helane Becker with Cowen and Company. You may begin.

Mike covered most of our questions, but just, Phil, without getting too political, I am kind of wondering, as you think about the election and changes in the world, not only in the United States, but Brexit and so on, how do you think that affects world trade going forward?

Well, most analysts have said that they don't expect Brexit to have any material impact on the level of container trade. As far as the impact of the U.S. elections, Helane, I would simply say that I think that where the world is in a situation where international trade is such an integral part of how all companies and countries operate, that I don't expect election in the U.S. to have a dramatic effect on container trade.

And then, with the prices you are seeing on the containers now, are you rethinking depreciation at all?

Helene, we look at our depreciation policy frequently on a quarterly basis. When you think about sort of residual values and what have you, you really have to take a long term view, i.e. you are thinking about where you are going to sell containers in 13 years. But, if actual sales prices remained well below residual values for some extended period of time, then you would look to make some sort of change. If you look back in Q3, we did make that change with our 40-foot-high cubes. But, again, it is something that, likewise, when container prices go up, you don't quickly change your depreciation policy in the opposite direction, either. So, again, I think the point here is that you have to take a very long term view.

Okay. And then, have any of your biggest customers come to you for thinking about containers into the peak shipping season? You said, I think, Phil, that you were seeing pickups quicker which may be different than we have been seeing in the past year or so. So maybe I was a little surprised to hear that.

Yes. We were happily surprised as well, I have got to admit. In the first quarter, we were expecting some sort of improvement, but, honestly, not anywhere near to the level that we have seen. Our ratio between lease-outs and re-deliveries has completely turned upside down. June was the peak, but as surprising as positive is, this strong demand is continuing right now. We have bookings into September and we have not seen that in many years, to be honest. So I think it just shows what we have always said of these calls here. There is no global surplus of containers. And the fact that new production levels are low and disposals are high calls for replacement and that is what is partly happening now but at a modest pace, but at some stage will happen at a much more rapid pace.

Can I just -- to make sure that it is clearly understood, when Robert said upside down, that was a positive comment. Because what he was referring to is that earlier in the year, our turn-ins were dramatically in excess of our lease-outs on a weekly basis, almost a 2 to 1 ratio. And what he is saying now is it has switched. We're not to lease-outs to everyone turning. But the ratio has switched dramatically and lease-outs are in excess of turn-ins. So just wanted to make that clear.

And our next question comes from Doug Mewhirter with SunTrust. You may begin.

Just thinking about CapEx, it looks like you had slowed a little bit, although you are still buying a fair amount. And I realize you are mindful of your capital levels and balance sheet, given the choice to cut the dividend. How do you think about CapEx for the back half of the year, knowing that you usually kind of front load this. And is there any room for anything like either a share repurchase or a deleveraging buying back some of your debt, if you are not going to keep up the pace of CapEx?

Right now. Well, we have said all along this year that we don't expect CapEx this year to exceed CapEx last year. Last year I think it was slightly over $600 million. This year, we're a little over $400 million year to date and I would say we still stick by that. I don't think we will exceed last year's level of CapEx. In fact, you may see that CapEx between now and the end of the year is not all that dramatic, frankly. Of course, it will depend on the opportunities we see in the market. Right now, we're looking at the proper ways to handle our cash. I mean, our EBITDA was, this second quarter, was pretty much the same as it was in the first quarter. So we're still generating cash. As you noted, we decided to cut the dividend, given the challenging market conditions we face, but if the CapEx opportunities are there, we do believe that buying containers at the price levels we're seeing right now is an extremely good use of cash. We feel we made some very good purchases earlier in the year when container prices were at absolute historic lows. You know, if you are a container leasing company and you are not buying containers when prices are $1200 for a 20-foot container, then I have to seriously ask, when are you going to buy containers. I mean if these assets are going to be among the best performing assets in our fleet. So that is sort of how we look at the beginning of the year and that is how we're looking at towards the end of the year.

And just to clarify, is there any opportunity for either deleveraging or share repurchases? I wasn't sure if there was any kind of daylight there between CapEx and capital capacity.

Well again, I think really, as Phil said, the primary focus is on sort of investing in the business. There, also, Doug, in times like this could be opportunities that could arise that we may want to take advantage of in terms of inorganic type growth. So we just think preserving cash right now, because this downturn has been pretty prolonged and extended, is the right thing to do. And I wouldn't rule out the other options that you mentioned, either.

We have no further questions at this time. I will now turn the call back to Hilliard Terry.

Thank you, everyone, for joining us for our Q2 earnings call. Look forward to speaking to you as we progress through Q3. If you have any questions, feel free to give us a call. Thank you.

Thank you very much. We look forward to speaking to you at the end of the next quarter.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.