Hilliard C. Terry, III - EVP and CFO Philip K. Brewer - President and CEO Robert D. Pedersen - President and CEO of Textainer Equipment Management Limited

Helane Becker - Cowen & Co.

Welcome to the Q3 2016 Textainer Group Holdings Ltd. Earnings Conference Call. My name is Danielle and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded. I will now turn the call over to Executive Vice President and Chief Financial Officer, Hilliard Terry. Mr. Terry, you may begin. Hilliard C. Terry, III: Thank you and welcome to Textainer's 2016 third quarter conference call. Joining me on this morning's call are 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, plans 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. As 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 comments. Philip K. Brewer: Thank you, Hilliard. I would like to welcome you to Textainer's third quarter 2016 earnings call. Our third quarter 2016 results were significantly negatively affected by several factors, primarily Hanjin Shipping's bankruptcy filing but also ongoing impairments due to low used container prices and our decision to reduce residual values for certain equipment types. Unfortunately, the magnitude of the impact of these factors obscures some positive developments we are seeing in our industry, such as a stronger-than-expected lease out market, higher rental rates and increases in both new and used container prices. Lease rental income decreased 14.2% from the prior year quarter to $110.9 million. After adjusting for the loss of $4.8 million in revenue from Hanjin, the decline in lease rental income was 10.5%. Container impairments to write down containers waiting disposal to their fair market value totaled $16.5 million for the quarter. Depreciation expense increased by $15 million as a result of our change in depreciation policy. $4.4 million of this increase was a one-time write-down of already fully depreciated containers and $10.6 million represents an ongoing increase in quarterly depreciation. Hilliard will discuss the changes in our depreciation policy in greater detail. The biggest negative impact on our results was Hanjin's bankruptcy filing, which reduced our results by $44 million due to impairments, increased bad debt expense and lost revenue, net of insurance receivables related to the specific impairments. Textainer's adjusted net loss for the quarter was $52.3 million or $0.92 per diluted common share. Utilization for the quarter was surprisingly strong at 95.4%, which included equipment on lease to Hanjin. Our utilization continues to benefit from the fact that 83% of our fleet is subject to long term and finance leases, of which only 8.5% matured in 2016 and 7.2% will mature in 2017. Hanjin was the world's seventh largest container shipping line. Hanjin had a 3% market share, approximately 100 ships, with a combined capacity of 600,000 TEU and a container fleet of 1 million TEU. By any measure, Hanjin's bankruptcy is several times larger than any previous shipping line bankruptcy. The size of the bankruptcy combined with Hanjin's abrupt ceasing of operations created a logistical challenge for alliance partners, terminals, shippers, container lessors and many others. The net book value of the containers in our fleet on lease to Hanjin at the time of its bankruptcy was $280.2 million, comprised of $88.2 million of containers on finance leases and $192 million of containers on operating lease. The net book value of the containers effectively owned by Textainer is $237 million, or 85% of this total. To date, we have recovered or approved for recovery 41% of the Hanjin containers. We are actively negotiating the release of an additional 26% of the containers with terminals, depots and other third parties, although we cannot say at this time whether all of these negotiations will result in a successful recovery. Most of the remaining containers are either being recovered in small lots or will be addressed once the major negotiations are concluded. It is difficult to accurately predict total recoveries because the outcome of these negotiations is uncertain and many containers are still in transit and/or containing cargo. At this point, we estimate that we will recover between 70% to 90% of the containers leased to Hanjin. Following are some of the steps we have taken to recover our containers; assigned one of our most senior executives to work full-time has set up an internal team focused on locating and recovering Hanjin containers; created an IT recovery tool which staff in the field used to determine acceptable cost parameters for recovering containers; arrested several vessels in order to pressure Hanjin to provide us with more assistance in recovering containers; and informed our insurers regarding Hanjin. We maintain $80 million of insurance after a $5 million deductible covering lost containers, recovery and repair costs and lost revenue. We expect our losses will exceed the amount of our coverage, due largely to lost revenue and the projected sizable recovery costs. Now I would like to talk about some of the positive developments I mentioned earlier. New container prices currently are approximately $1,600 per CEU. This represents an increase of more than $400 since the first quarter. In addition, next year's requirement to use waterborne paint for containers manufactured throughout China is expected to increase production cost by $100 to $150 per container. Given that both of the two major public container manufacturers reported significant losses for the first half of the year, we expect the manufacturers to use this requirement and recent increases in steel prices to push for additional increases in container prices. Through the end of the third quarter, we invested approximately $470 million purchasing more than 285,000 TEU of attractively priced new and used containers. Similar to the uptick in new container prices, used container prices have stopped declining and are increasing in certain locations, in some cases by $200 or more. We believe that used prices have at least hit a bottom and are optimistic that they will continue to strengthen, especially if the increase in new prices holds. However, this trend could be undermined if substantial quantities of Hanjin's own containers or those owned by other third parties are put to sale. Our Board of Directors recognizes the value shareholders place on dividends. However, in light of current market conditions and taking into account the best interest of our shareholders and Company, our Board made a very difficult decision to eliminate Textainer's dividend. This decision was not made lightly and will be reviewed quarterly as market conditions change. It is unfortunate that the Hanjin bankruptcy and ongoing impairments are overshadowing significant recent improvements in the lease out market. Some of these improvements have already been mentioned, such as the increases in new and used container prices. Additionally, we saw much stronger lease out demand during the third quarter than we had anticipated. Our lease out-to-turn in ratio for the third quarter was 1.7-to-1, the highest level it has been all year. Inventory at factories is approximately 380,000 TEU, which is the lowest level in more than five years. Considering that perhaps 75% of this total is owned by leasing companies and the majority is already booked for lease out, the quantity available for lease out is surprisingly low. Our unbooked depot inventory is 30% lower than in January, which is especially impressive in light of the significant quantity of Hanjin redeliveries. The majority of our off-lease inventory is in Asia. More importantly, rental rates on new and used container lease outs have increased significantly. Some recent new container lease outs have been at yields greater than 10%, which is a level we have not seen in four years. Whether this trend continues will depend on the ongoing strength of the demand, the quantity of new containers purchased by shipping lines and lessors, and the extent to which shipping lines rely on leasing as opposed to buying. New production this year is at a historically low level, with 1.6 million TEU to 1.7 million TEU projected to be built, compared to 2.9 million TEU last year and 3.4 million TEU in 2014. Keeping in mind that 1.5 million TEU are disposed annually, the world's container fleet will show little, if any, growth this year. Although shipping lines continue to face the problem of excess capacity, freight rates have increased since their lows during the second quarter, due in part to Hanjin. More than 7% of container vessel capacity is currently idled and that amount is expected to increase to between 8% to 9% as Hanjin's remaining vessels are returned. Demolitions this year are forecasted to total 3% to 4% of the fleet, which is high on an historical basis. These factors should help support freight rates but other factors, such as new vessel deliveries projected at 6% to 7% next year and more cascading as ultra-large vessels continue to be delivered, work in the opposite direction and are magnified given projections of 2% to 3% trade growth in 2017. These factors are likely to spur more mergers and/or acquisitions among shipping lines, similar to the recently announced integration among Japan's three major shipping lines, the acquisitions this past year of APL by CMA and of UASC by Hapag-Lloyd and the merger between Cosco and China Shipping Lines. There is no doubt that these are difficult times for the container leasing industry. We have been in business for 37 years and the conditions we are seeing today are as challenging as we have ever seen. We expect container impairments, increased depreciation expense and the cost of the Hanjin recovery to depress our earnings for the coming quarters. Unfortunately, these factors are obscuring some very positive trends in our leasing business, primarily increases in new and used container prices and rental rates. The little growth in the world's container fleet this year and the expectation of continued limited growth in 2017 increase the likelihood that these positive trends continue. The cycles in our industry have always been difficult to predict but there are signs that we are at the bottom of this one. I will now turn the call over to Hilliard. Hilliard C. Terry, III: Thank you, Phil. I will discuss the key factors including our results this quarter and provide more detail on the impact of the Hanjin bankruptcy to start. The Hanjin bankruptcy reduced lease rental income by $4.8 million, increased container impairments by $22.2 million and bad debt expense by $17.1 million. As Phil mentioned, the net effect of these items was a $44 million or $0.78 per share reduction in net income. I will walk through in a little more detail the financial implications of the Hanjin bankruptcy as well as other factors influencing this quarter's results. I mentioned we have $22.2 million of container impairments related to the Hanjin bankruptcy. This amount is comprised of $17.4 million due to the write-down of finance lease containers to their fair market value, and $4.8 million due to the impairment of containers which we currently project to be unrecoverable, net of estimated insurance proceeds related to those containers. I should note that we have not abandoned any containers yet. Since we are currently expected to recover 70% to 90% of the containers, as an initial step we wrote off 10% of our Hanjin exposure or $24.9 million after taking into account the write-down of the finance lease containers. Our estimated insurance proceeds related to this write-off is $20.1 million. Netting the two amounts results in the stated $4.8 million impairment. The other components of the Hanjin impact are the reduced lease rental income that I mentioned previously of $4.8 million, and $17.1 million of additional bad debt expense as we fully reserved Hanjin's outstanding receivables net of expected insurance proceeds. In addition, Textainer maintained separate customer insolvency related insurance for accounts receivable for certain customers in its portfolio. Our insurance providers are well-established companies with at least a single A rating. To provide the most accurate view of the ultimate P&L impact, we have netted the expected insurance proceeds against losses recorded to date and recorded an insurance receivable on our balance sheet. This receivable will increase as we write off container and/or incur recovery cost and will decline as we receive actual cash payments from the insurance companies. Lastly, we have provided a reconciliation of the impact of the Hanjin bankruptcy in our quarterly IR slide deck, just in case you missed any of the previously mentioned items. Moving onto non-Hanjin related items, the non-Hanjin container impairments were $16.5 million in the third quarter, as we wrote down containers in our existing sales inventory and containers recently designated for disposal to their net realizable value. This was down sequentially from the $19.5 million we reported in the second quarter and consistent with the run rate we expect to report quarterly over the near-term or until we see that the recent increase in used container prices continues or the volume of containers moving to our sales inventory slows which should happen if the recent increase in demand continues. Due to an extended period of lower sales prices and longer useful lives, we made the decision to change several aspects of our depreciation policy. Depreciation expense was $68.2 million for the quarter, up $16.6 million year-over-year. The change in our depreciation policy increased depreciation expense by $15 million or $0.26 per share during the quarter and we expect the ongoing increase in depreciation expense to have $11 million or $0.19 per share impact in Q4 2016 and beyond. We reduced our 20-foot standard container residual values from $1,050 to $950, our 40-foot high cube container residual values from $1,450 to $1,300, our 40 foot standard container residual values were reduced from $1,300 to $1,150, and our 40 foot folding flat container residual values from $2,000 to $1,700. Partially offsetting the reduction in residual values was the increase in useful lives of our 40 foot standard containers from 13 to 14 years, our 20 foot folding flat containers and our 20 foot open top containers from 14 years to 15 years, and our 40 foot folding flat containers from 14 years to 16 years. A table summarizing these changes is also included in our press release and quarterly slide deck. The remaining portion of this increase was due to the larger number of refrigerated containers in our owned fleet, partially offset by lower new container prices and a decrease in the size of our owned fleet of dry containers. Annualized depreciation expense for the quarter was 5.8% of average container cost or 4.6% excluding the impact of the change in the residual value. We expect annualized depreciation expense to be roughly 5.4% to 5.6% of average container cost. Direct container expense increased $2.4 million or 17.8% year-over-year to $15.7 million for the quarter. $1.7 million or a little over two-thirds of the increase was due to higher storage expense as a result of decreased utilization versus this time last year and higher repositioning expense. For the quarter, our interest expense, including realized hedging costs but excluding the write-off of unamortized bank fees and unrealized losses on interest rate swaps, was $23.5 million, a $1 million increase compared to the year ago quarter. This increase was due to an increase in the average interest rates, partially offset by a decrease in average debt balances. Our average effective interest rate, which includes realized hedging costs, is currently 3.13%, an increase of 22 basis points when compared to the year ago quarter. On the financing front, we amended several of our facilities to accommodate the impact of the Hanjin bankruptcy in our EBIT to interest coverage test. This will slightly increase our borrowing costs on a go forward basis. Although interest rates remain at low levels, access to bank and capital markets financing by lessors will be more difficult and expensive as financing counterparties re-evaluate the risk within the container leasing industry following the Hanjin bankruptcy. As of quarter end, over 78% of our debt was fixed or hedged compared with 83% of our owned fleet subject to long-term and finance leases. The weighted average remaining term of our fixed and hedged debt is 44 months and the weighted average remaining term of our long-term and finance leases is 43 months. Summing it all up, the adjusted net loss for the quarter was $52.3 million or $0.92 per diluted common share. The Hanjin bankruptcy again reduced earnings by $44 million or $0.78 per share. The change in our depreciation policy reduced earnings by $15 million or $0.26 per share. Turning to the balance sheet, as of September 30, our cash position was $92 million with standby liquidity of more than $500 million, and our total assets were $4.4 billion. In spite of this quarter's loss, we generated $223 million of cash from operating activities and our net cash position increased by $2.6 million when compared to the nine months this time last year. We expect to have significant cash expenses as we recover Hanjin containers, and in some cases reposition these containers to higher demand locations. During the recovery period, we will continue to generate significant cash from operations, get recovered containers repositioned, redeployed and generating cash as quickly as possible. Based on our experience, we expect to start receiving the cash from the insurance proceeds several months after we finalize our claim, but the finalized payments may not occur until the last months of 2017 or as late as early 2018. Thank you for your attention, and now I'd like to open up the call for questions. Operator, can you inform the participants of the procedures for the Q&A?

[Operator Instructions] Our first question comes from Helane Becker of Cowen & Co. Go ahead, Helane.

So just a couple of questions. One, on the repricing of new containers, or of used containers rather, how much longer does that last? Philip K. Brewer: This is Phil. The increase that we've seen in used container prices has actually occurred pretty recently, over the past two months or so, and it's largely concentrated in Asia at the current time. In some cases though, we have seen prices of certain types of containers, especially 40 foot high cube containers, increase by several hundred dollars, $300 or more in some cases. Now at this point, it's difficult to say whether this trend will continue. I think as we noted in our opening statements, it will depend to some degree on whether the trend we're seeing an increase in new container prices holds and it will also depend a lot on the quantity of containers being put to sale. We see a very strong lease out market at the moment. So, containers that in the past we might have put to sale, some of them will likely be leased out, not put to sale and thus decreasing the quantity of containers put to sale. But the uncertainty that I noted earlier is whether or not we see a high number of Hanjin containers put to sale by the various owners of those containers.

Okay. And then are you finding that there's demand from Hanjin's competitors for some of those containers? Philip K. Brewer: Are you talking on the lease-out side or for the purchase side? I'm sorry I'm not sure I understand.

I'm sorry, on the lease-out side, are Hanjin's competitors seeking to lease increased numbers of containers? Robert D. Pedersen: It's Robert here. I would say, definitely yes. There is a shortage of containers in the marketplace right now. As Phil alluded to in the script, inventories at factories are amazingly low. And I think I have mentioned in previous earnings calls that there really has been no global surplus of containers. So when you suddenly have a Hanjin situation, it would take 1 million TEU out of circulation. That creates a definite undersupply situation that needs to be filled and it's going to be filled by additional new production shipping line orders but even more so reactivation of the Hanjin containers, both from the locations where we are recovering them but also the ones that we're repositioning into, heavy demand locations.

Okay. And then you increased the useful lives. Is that to go to an industry standard? Philip K. Brewer: No, there is no industry standard per se. The terminations we make on residual values and useful lives are based on our own – the results we have in selling or leasing out containers. As we see that the containers remain in our fleet for longer periods of time, then we'll increase the useful life of those containers for depreciation purposes. Similarly, as we see changes in sales prices over a period of time, then we'll make changes to the residual values. I would note that the changes to the useful lives are largely to containers that do not comprise significant portions of our fleet, including in fact 40 foot standards which are decreasing as a major equipment size. And the other ones are all specialized containers. Hilliard C. Terry, III: This is Hilliard. Just to add, the data we have shows that the changes in the useful lives really has been actually data that we've seen for the last five years. So, we have pretty substantial data supporting the changes that we just made.

Okay, great. Thanks very much. Those are my questions.

[Operator Instructions] I am showing no further questions at this time. Philip K. Brewer: I'd like to thank all of you for listening to our earnings call and we look forward to speaking to you next year after we've completed our 2016 results. Thank you very much.

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