Hilliard Terry - CFO and EVP Philip Brewer - President, CEO & Director Olivier Ghesquiere - EVP of Leasing

Helane Becker - Cowen and Company Douglas Mewhirter - SunTrust Robinson Humphrey

Welcome to the Q2 2017 Textainer Group Holdings Limited Earnings Conference Call. My name is Paula, and I will be your operator for today's call. [Operator Instructions]. 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.

Thank you, and welcome to Textainer's Second Quarter Conference Call. Joining me on this morning's call are Phil Brewer, President and Chief Executive Officer. At the end of our prepared remarks, Olivier Ghesquiere, Executive Vice President of Leasing, will join us for the Q&A. Before I turn the call over to Phil, I'd like to point out that this conference call contains forward-looking statements in accordance with the 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 after to this discussion. The company is under no obligation to modify or update any or all statements that are made. Please see the company's Annual Report on Form 20-F for the year ended December 31, 2016, filed with the Securities and Exchange Commission on March 27, 2017, 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 the 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. Additionally, this quarter, we've also included slides to accompany our comments on today's call. The Q2 earnings call presentation can be found on our IR website next to the link for this webcast. 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 2017 Earnings Call. We are extremely excited by the positive trends we are seeing, both in the lease-up markets and in our performance. Demands for both new and depot containers is strong, and lease terms and rental rates remain very attractive. Container prices were stable during the quarter and have recently started to increase. Our key operating metrics continue to improve. Lease rental income, gains on sale and utilization are increasing. Container impairments and direct container expense are decreasing. While we are disappointed that certain largely nonrecurring and noncash items have delayed our return to profitability, we expect to be GAAP-profitable during the second half of this year. Let me note some of the positive trends we are seeing. Demands for both new and depot containers remained so strong that our inventories of both are at or close to historical lows. Container prices remained relatively stable during the quarter at around $2,150 per CEU and have increased recently by approximately $50 per CEU. The manufacturers are full through September. Containers ordered today will be delivered in October. Our CapEx is increasing. We have purchased or ordered approximately $275 million of new containers year-to-date. Rental rates remain in the low to mid-$0.70 per CEU per day range, providing cash-on-cash returns above 12%. Used container prices continue to improve, up as much as 100% since the low point last year and 25% or more over just the last quarter. Used prices are now significantly above our depreciation residual values. Our lease rental income increased for the second consecutive quarter after having decreased each quarter during 2014 and 2015. Utilization continues to increase, averaging 96.3% for the quarter and is currently at 96.6%. Our utilization continues to benefit from the fact that 84% of our fleet is subject to long-term and finance leases. Now withstanding these positive improvements, Textainer had an adjusted net loss of $1.2 million or $0.02 per diluted common share for the quarter, an improvement of 87% from the prior quarter. The primary reasons for this loss were amortization of financing costs, increase in interest expense, increase in our GAAP tax expense due to a temporary shift in the geography of income sourcing and increase in depreciation expense due to changes to our depreciation policy last year. Except for the increase in interest expense, these items are one-off and/or noncash. Due to the need to recover Hanjin containers and restrictions under our bank facilities, our investment in new containers was extremely limited during the first quarter. That changed during the second quarter. We issued $920 million in 2 series of asset-backed notes. The proceeds were used primarily to pay down other debt and bank facilities, freeing up liquidity. We have purchased or ordered approximately $275 million of new containers. More than half of these containers have already been leased out or are committed to leases once they leave the manufacturer. The cash-on-cash returns are above 12%, and we expect returns on equity in the mid- to high-teens. Perhaps, more importantly, at maturity, most of the leases allow containers to be returned only in China or a few other Asian locations. The rental of these containers, combined with continued lease outs of depot and ex-Hanjin containers, will contribute to the ongoing increase in our revenues and our projected second half return to profitability. We were very pleased to assume the management of the 182,000 TEU fleet of dry freight and refrigerated containers from Magellan Maritime Services on the 1st of August. The containers were purchased by an affiliate of Buss Global, a current owner of containers in our fleet. We completed this transaction within 3 weeks of receiving fleet data demonstrating, again, Textainer's expertise at seamlessly assuming management control with no disruption to lessees, depots or container owners. Current new container inventory at factories is less than 300,000 TEU, a decline from the 500,000 TEU level we saw at the start of the quarter and the lowest level we have seen at this time of year in many, many years. As I've said many times, there is not an excess supply of containers in the world. Utilization is high, new container and depot inventories are low, and new orders are in line with demand. Approximately 1.6 million TEU have been built or ordered year-to-date. We expect new production to total 2.3 million TEU by year end, not a large production year by historical standards. After deducting annual disposals of, perhaps, 4% of the total fleet, it is clear that the growth of the world's container fleet is in line with market demand. New container prices have continued to increase and are likely to increase further as we approach the winter. Used container prices have increased more than 25% over just the last quarter and are now at a level significantly above our revised residual values. We do not expect used containers prices to strengthen much beyond their current levels, but prices will continue to be supported by the limited quantity of containers being put to sale. Ignoring traditional seasonal cyclicality, we expect demand to remain strong for the foreseeable future due to a number of trends, some of which I have already mentioned and most of which appear to be sustainable, including new production capacities limited due in part to the use of waterborne paint; new container inventories low; depot inventories being leased out even in some traditionally weak locations; utilization is high for all lessors; shipping lines are relying more on lessors for containers, including some lines that have tended to buy more than lease in the past; and lessors have purchased approximately 60% of the containers produced this year. The financial performance of most shipping lines has improved dramatically since last year. Demand is strong and projected 2017 trade growth has been revised upwards to 4%. Vessel capacity still exceeds demand, but for the first time in many years, trade growth is greater than the projected 3% increase in capacity after projected demolitions. Freight rates are estimated to be up on average by 16% over the last year and have been much less volatile than in past years. Operating costs are down. Although vessel capacity growth will be higher next year with the remaining order book of 3 million TEU, most observers are projecting a demand capacity balance by 2019, assuming no significant ordering of new ships in the meantime. Perhaps more than improving financial performance, increasing consolidation is the biggest factor impacting the shipping line industry. The number of global liners has been reduced from 20 to 11 in just 2 years. Once we complete the acquisition of [indiscernible], Maersk will have a fleet about 13x larger than Xines [ph], the world's 10th largest line. Drewry projects that by 2021, the top 7 carriers will control 3/4 of the world's container fleet. For lessors, this trend is a double-edged sword. On the one hand, credit risk is declining as the lines become larger and more financially sound. On the other hand, the market power of the largest lines is increasing as diversification among lessees is decreasing. Ultimately, we believe that the very largest lessors like Textainer will benefit from this trend due to economies of scale and the ability to provide large quantity of containers in demand locations worldwide. In addition to these many positive factors, we are especially excited about our future due to the significant revenue upside we project from lessor's repricing over the coming years. As can be seen in the investor presentation Hilliard mentioned earlier, which is on our website, leases maturing from 2018 through 2021 have average rates of $0.56 per CEU per day declining to $0.36 per CEU per day. These rates are below current market rates today, and the gap increases significantly each year going forward. As leased leases reprice, we are projecting significant increases in revenues and eventually gains on sale. For example, we purchased more than 170,000 TEU of new containers during the first half of 2016 for prices averaging more than 30% below today's prices. The current rental rates for these containers are below today's levels, but we project a significant upside when their lease is repriced. We believe these containers will be excellent investments over their lives, given their historically low purchase prices. In light of this built-in upside, we are surprised at Textainer's current valuation. The investor presentation shows that we have maintained a stable book value per share, but our share price has declined versus book over time. We are investing in new containers at very attractive rates, and our low leverage provides us the flexibility to continue doing so. We are focused on investing only when the projected returns justify the investment. Impairments on containers put to sale have turned into gains on sale. The impact of Hanjin is largely over. It seems as though neither today's positive trends nor the projected upside as our fleet reprices are fully recognized by the market. Let me repeat that we are very excited about the market outlook and our prospects. I will now turn the call over to Hilliard.

Thank you, Phil. I will review the major drivers of our results for the quarter and provide more color on the financial impact of certain items Phil mentioned in his comments. Lease rental income was $108.8 million, an increase of 1% compared to the previous quarter, and this was our second consecutive quarterly increase. Management fees increased both sequentially and year-over-year. The addition of the recently announced Magellan containers will add to our managed fleet and generate approximately $2 million of incremental management fees and sales commissions on an annual basis. Our strong market and higher used container prices resulted in a $5.7 million year-over-year increase in gains on sale. This increase incurred even though the quantity of containers sold decreased by 35%. Lessees are retaining fewer containers, and of those being returned in, a higher percentage are being re-leased as opposed to being sold. Thus, reducing the quantity of containers sold. We, again, recorded a reversal on previously recorded impairments on held-for-sale containers due to increased used container prices. However, some of this was offset by the impairment of containers from problem lessees, all of which netted to a reversal of less than $1 million. Healthy used container prices will continue to drive gains on sale as we've seen in previous years. Depreciation expense was $59.6 million for the quarter, up $7.9 million year-over-year and down very slightly from the first quarter. As you know, last year's change in our depreciation policy adds around $40 million of annual depreciation expense. Annualized depreciation expense for the quarter was 5.2% of average container cost. Direct container expense was $14.9 million, down $4.8 million or 24% compared to the first quarter. The sequential decrease was due to higher utilization, which resulted in lower storage and handling expenses. For the quarter, our interest expense including realized hedging cost was $29.9 million, essentially flat with the first quarter and up $7.5 million from the year-ago quarter. We amended several bank facilities to replace legacy EBIT-focused covenants with more appropriate cash flow focused metrics. Additionally, we set up a short-term facility to retire other asset-backed notes, which also lacks similar covenants and issued 2 new ABS notes to repay some of our short-term revolving debt facilities. The increase in interest expense reflects the cost of these amendments, note issuances and the revised financing costs resulting from our actions. Our average effective interest rate, which includes realized hedging cost, is currently 4.04%, an increase of 108 basis points when compared to the year-ago quarter. 60 basis points of the increase was due to an increase in spread as several below-market facilities were repriced to current market rates as a part of the amendment process. 22 basis points of the increase was due to the amortization of incremental fees or deferred debt issuance costs, while the balance resulted from an increase in LIBOR. Sequentially, our effective rate remains relatively flat, and we are working to improve our funding cost going forward. As of the end of the quarter, over 77% of our debt was either fixed or hedged compared to 84% of our own fleet being subject to long-term and finance leases. The weighted average remaining term of our fixed and hedged debt is 35 months, and the weighted average remaining term of our long-term and finance leases is 41 months. On last quarter's call, we mentioned we are working to access longer-term debt markets and expand our funding sources. I am pleased to report that during the quarter, we issued $920 million of ABS notes. The first issuance of the $420 million was used to refinance existing ABS notes. The second issuance of $500 million was used to pay down 2 of our revolving facilities used to purchase new containers. Both issuances were extremely well received by fixed income investors and were up to 6x oversubscribed. As a result, we were able to tighten pricing versus other recent issuances by competitors. We are now in the process of refinancing our $1.2 billion warehouse facility with more attractive terms and a higher advance rate, which will enable us to reduce our financing costs and further take advantage of the attractive leasing returns we are seeing in our market today. The Hanjin bankruptcy continues to unfold better than we expected, and the impact is now largely behind us. To date, we've re-leased close to 60% of the recovered Hanjin containers, and we expect to complete the re-leasing of the recently recovered containers over the coming month. We have now received $40 million of insurance proceeds for our owned and managed fleet, have lower-than-expected repositioning expenses and expect the ultimate losses not covered by insurance will be minimal. The focus today is completing our final insurance claim, which will be submitted in the next 30 days, and to continue redeploying the recovered containers so that they begin to generate cash as quickly as possible. Income tax expense for the quarter increased to $4 million versus last year, primarily due to a shift in the calculation of income sourcing. The adjusted net loss for the quarter was $1.2 million or $0.02 per share. This excluded the onetime runoff of unamortized deferred debt issuance costs, unrealized losses on interest rate swaps and noncontrolling interest. Adjusted EBITDA was $91 million for the quarter, and our cash position increased by $55 million, some of which was due to the insurance proceeds and the balance due to cash generated by our business. At this point, I'd like to thank you for your attention. And now I'd like to open the call up for questions. Operator, can you inform the participants of the procedures for the Q&A?

[Operator Instructions]. And our first question comes from Helane Becker from Cowen and Company.

Just a couple of questions. On the 2016 leases that you are referencing, Phil, that will be re-leased, are those on standard 5-year leases? Or were you able to put them on shorter-term leases?

No. The leases we've been doing over the years have generally been 5-year leases.

Is there any way you can terminate those leases and put them on more compensatory rates early?

No, that's not possible.

Okay. Worth a try. And the other thing, I think you or Hilliard mentioned that the number of problem lessees had declined or -- I mean, can you just update us on how many problem children you have right now?

We don't see any major problems among -- or we don't see any problems among any of the major shipping lines, Helane. We generally do have issues with a few smaller shipping lines throughout the world every quarter. There's always a few on our problem accounts list that we're dealing with all the time. But right at the moment, we don't foresee any issues with any of the major shipping lines that we deal with. Maybe I'd like to add just a bit more -- a bit further observation with respect to your earlier question. Yes, we have the 2016, the equipment we put on lease in 2016, that's a generally on a 5-year lease. But, of course, we have a fleet -- fleets maturing every year. And if you look at the presentation that we posted on our website, you'll see that every year for the next several years, we have leases repricing that are rates well-below today's market rate. So while it may be unfortunate that the 2016 containers won't come up for renewal for several years, the containers we put on lease prior to that will, and we expect them to reprice at significant increases, all of which is indicated in the presentation that we put on our website.

Okay. And then related to that, Phil, when you reprice, and on the comments that I think Hilliard also made about repricing at higher or at current rates, I think there's a slide that talks about if you priced everything at $0.65. Is that profit that falls to the bottom line? Or does it have to stop in SG&A somewhere?

No, there's no reason to expect that our SG&A would increase simply because we're repricing leases. Essentially, that additional revenue is going to fall through the bottom line.

[Operator Instructions]. And our next question comes from Doug Mewhirter from SunTrust.

I had a couple of questions. First on the CapEx. I think I know the answer to this, but you mentioned $275 million year-to-date. I assume that the vast majority of that was after June 30 because on the cash flow statement, it only shows $25 million year-to-date.

Yes, Olivier Ghesquiere speaking. You're correct. The vast majority of the investment came in with deliveries starting in the second quarter and spreading throughout to the third quarter.

Okay. Thanks for that. On the direct expenses, it's probably a little bit higher than I thought. And is that because even though your storage costs are going down because your utilization is improving, are you incurring an unusual amount of, I guess, handling or movement charges because your lease-out activity is so high and plus maybe there's any kind of residual Hanjin recovery cost that was in the quarter as well?

Doug, if you look at the handling and storage and what have you, well, storage, that's lower. Handling is a bit -- that's down as well. But I think you did point to the fact that there is a bit more repositioning expenses. And that's just from Hanjin primarily. But that's, #1, much lower than we expected it to be, and we expect that to wane. So I would say, kind of, going forward you should see that move in line as you would expect with utilization.

Doug, if I could just add a little bit. I think we've already noted that the -- while the impact of Hanjin on us was severe, it is largely in the rearview mirror now. And ultimately, the impact was not as large as we'd expected. I know in the past we talked about having costs a good bit higher than what we thought was our insurance coverage, and now it looks like both are going -- the 2 are going to be pretty much in line. We're readying to file our final claim at the end of this month. But that cost related to Hanjin, the recovery cost, the repositioning cost came in a good bit below what we'd projected at the time of the bankruptcy.

Okay. Thanks for that. That's very helpful. And just one last question, just a follow-up on Hanjin containers. The redeployment of, I guess, the excess -- the ones that you've recovered, I would assume that you would be getting market rates for those containers. And also, are they in convenient locations where they would make them relatively easy to redeploy? Or will there be some delay because they might be a little bit in out-of-the-way locations? And with that also, maybe impact the price or yield would you be getting for them?

Olivier Ghesquiere here again. Just -- I think we have had really 2 phases in the Hanjin recovery and the remarketing or reactivation of those units. The very first units we recovered late last year at the time when the market was still very difficult, and it was not easy to activate those containers. So the first unit that went back on lease, went on lease at terms that are certainly lower than the current terms in the market. But as we are moving forward, you are correct to say that we are achieving pretty much the same rate as we would achieve for the rest of the fleet. And that the differential we are suffering between the original rate, the Hanjin containers are only then the lease rate we're getting now is reduced really to a very small proportion.

And we're showing no further questions. I will now turn the call back to Hilliard Terry for closing remarks.

Thank you, everyone, for joining us. And we look forward to speaking with you as we progress through the quarter. And if you have any questions, we're available for follow-up questions as well. Thanks a lot, and thanks for joining us.

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