Hilliard Terry - Executive Vice President and CFO Philip Brewer - President and Chief Executive Officer Olivier Ghesquiere - Executive Vice President of Leasing

Helane Becker - Cowen and Company, LLC Douglas Mewhirter - SunTrust Robinson Humphrey, Inc. Wayne Archambo - Monarch Partners Asset Management, LLC

Welcome to the Q3 2017 Textainer Group Holdings Limited Earnings Conference Call. My name is Paulette, 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. [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 2017 third quarter conference call. Joining me on this morning's call are Phil Brewer, Textainer 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 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 our 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, 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 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 call or can be found in today's earnings press release. At this point, I'd 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 third quarter 2017 earnings call. We are very excited about our third quarter results. Lease rental income increased 3% to $112.2 million compared to the second quarter. After having decreased each quarter from 2014 through 2015, lease rental income has increased every quarter this year. Cash-on-cash returns on new dry freight term leases have remained around 12%, with longer lease terms and Asia-focused returns scheduled. We project the containers leased at these rates will provide returns on equity in the mid-teens. Adjusted net income for the quarter was $18.6 million, representing a return to profitability after the challenges we faced over the last 1.5 years from historically low new and used container prices and rental rates and the bankruptcy of Hanjin. We expect to continue to be profitable moving forward. Utilization averaged 96.7% for the quarter and is currently at 97.2%. Our utilization has increased 300 basis points since the beginning of the year. With our very low depot inventory, further significant increases in utilization are unlikely. Our lease-out to turn-in ratio for the year is 1.4:1 after adjusting for Hanjin returns. We are continuing the strong CapEx we started last quarter to take advantage of today's favorable market conditions, having invested around $500 million year-to-date. More than 70% of the 225,000 TEU of new containers we have ordered, either are on hire or committed to be leased. We also purchased 17,000 TEU of older containers in our managed fleet at a very attractive price. Given the delayed start of our new container purchases until the second quarter, we are very pleased with our level of CapEx and the impact these containers will have on our performance in future quarters. Separately, we successfully completed the integration of the 182,000 TEU Magellan fleet. We continue to look for opportunities to grow our managed fleet. The important market metrics, new and used container prices, rental rates, utilization either continued to improve during the quarter or remained stable at attractive levels. Lease-out demand has slowed during the last month, but we generally expect weaker demand this time of year. Our inventory of depot containers remains at an historically low level. Container prices were relatively stable during the quarter, and today, are around $2,300 per CEU. Containers ordered today will be delivered in December or later. Production during the winter, especially in Northern China, will be constrained due to the problems of applying waterborne paint in cold temperatures. Due to these constraints and recent increases in steel prices, we expect new container prices to remain stable even if the order book declines. If we see significant new orders late in the fourth quarter, price increases are likely. To ensure that we meet our customers' demands both before and after Lunar New Year, we have ordered containers for delivery through year-end. Re-sell prices have doubled over the last 12 months, but are no longer increasing at the rapid rate we saw during the first half of the year. We expect sales prices to remain around today's high levels as the quantity of containers being put to sale is limited due to high utilization at both lessors and shipping lines. Approximately 2.8 million TEU have been built or ordered year-to-date, with 60% of this production purchased by lessors. We expect new dry freight production to exceed 3 million TEU by year-end, with reefer production estimated at 90,000 units. Given the reduced level of reefer production over the past two years, we believe reefer rates could start to improve as we enter the traditional fourth quarter demand season. Nonetheless, until we see a national improvement, we are withholding any significant investment in reefers. The inventory of new dry freight containers at factories is approximately 400,000 TEU. Keep in mind that the inventory was close to 700,000 TEU at the beginning of the year and more than 1 million TEU 2 years ago. With utilization at such high levels, worldwide depot inventory is very low. We expect rental rates to remain around the current levels given the disciplined ordering of new containers by lessors and shipping lines, the limited depot inventory, the constraints on new production during the winter and projections for continued growth in container trade. Global container throughput growth is projected to be approximately 6% for 2017, the highest level we have seen in many years. Container trade growth is projected to be 1.7 times global GDP growth, reversing the downward trend of the container trade through GDP multiplier over the last several years. The IMF is predicting global GDP growth of 3.7% for 2018, a slight improvement on 2017, suggesting that the strong improvement in container trade should continue through next year. The financial performance of our lessees continues to improve. After years of losses, the shipping lines are expected to generate $6 billion in profits this year. Increasing consolidation continues to be the biggest factor affecting the shipping line industry. In 2016, the top 16 carriers had a market share of 77%. Today, the top seven carriers have a similar market share and the top four lines have a market share of almost 60%. As the lines consolidate, the quantity of containers they need at one time increases. More and more, we see the lines turning to the largest lessors to meet their needs. Textainer is the second largest lessor in the world, with a fleet of 3.2 million TEU. Our economies of scale and ability to provide large quantities of containers in demand locations worldwide enables us to benefit from this consolidation. Hanjin is behind us. New container prices have been stable around their current level and may increase further during the winter. We have invested approximately $500 million, primarily in new containers for lease out at very attractive rates, and our low leverage provides us the flexibility to continue doing so. We are investing only when the projected returns justify doing so. The increase in re-sell prices has turned what were impairments last year into gains on sale this year. We're the second largest lessor in an industry where economies of scale are critical. Our results have improved each quarter this year. We will benefit over the coming years as our leased portfolio reprices. For these reasons, we are very optimistic about the outlook for both Textainer and our industry. I will now turn the call over to Hilliard.

Thank you, Phil. I will review the major drivers of our results this quarter. Our positive momentum continues, so my comparisons will be relative to the second quarter of this year. Lease rental income was $112.2 million, an increase of $3.4 million or 3% compared to the previous quarter. The increase in lease rental income was driven by higher utilization, an increase in available days and a slight increase in the relative size of our own fleet. As Phil mentioned, we had invested approximately $500 million year-to-date. Given the timing of deliveries, our third quarter lease outs were back-end loaded and had limited impact on our third quarter results. 70% of the containers are now on lease or committed to be picked up, and the remainder are likely to be leased soon. As a result of these lease outs, lease revenue will increase in the fourth quarter and even more so in the first quarter and beyond. Gains on sale of containers from our fleet were $8 million, up $2.1 million or 36% from the second quarter of this year. Healthy used container prices continue to drive gains on containers sold. However, we expect volumes to moderate because of high utilization levels and limited available inventory. Direct container expense was $11 million, down $3.9 million or 26% compared to the second quarter. The sequential decrease was due to higher utilization, resulting in lower storage and handling expenses and lower repositioning expenses as we leased out containers from lower demand locations in lieu of repositioning, given the strong market. This quarter also had one-time items that reduced direct container expenses a little more than normal. The ongoing run rate will likely be a bit higher. As you may recall, last year we reduced our residual values after a prolonged period of declining sales prices. However, resell prices strengthened significantly, and we had to reverse previously recorded impairments on containers held for sale. This quarter, we made the decision to increase our residual values by $50 per container on each of our three primary dry container types. As a result, depreciation expense was $55.4 million, down $4.3 million quarter-over-quarter, primarily due to this change and partially offset by an increase in the size of our own fleet. Annualized depreciation expense for the quarter was 4.9% of average container cost, and we expect the run rate to remain close to this level. We believe the changes we've made in our depreciation policy better reflect our long-term view of used container prices over the cycle. Even after this increase, our residual values are equal to or lower than our public company peers. For the quarter, our interest expense, excluding realized hedging cost, was $29.9 million, essentially flat with the second quarter even with increased borrowings. During the quarter, we successfully refinanced our $1.2 billion warehouse facility, reducing the spread from LIBOR plus 275, down to LIBOR plus 190, and increased our advance rate, enabling additional capacity for increased fleet growth. After the close of the quarter, we also amended several of our corporate facilities, further increasing our capacity to grow in a strong lease-out market and support our customers. We have close to $900 million of liquidity and are well positioned to take advantage of growth opportunities throughout next year. We will continue to be opportunistic in our approach to the financing markets. Our average effective interest rate, which includes realized hedging cost is currently 4.11% relatively flat when compared to the second quarter. As of the quarter end, over 79% of our debt was either fixed or hedged compared to 84% of our own fleet subject to long-term and finance leases. The weighted average remaining term of our fixed and hedged debt is 33 months and the weighted average remaining term of our long-term and financed leases is 40 months. We filed our final insurance claim pertaining to the Hanjin bankruptcy and continue to redeploy the recovered containers. To date, we received $50 million of insurance proceeds for our owned and managed fleet. We are in final discussions with the insurers on our lessee default policy and expect to conclude on the remainder soon. I am also pleased to report that we successfully renewed our lessee default policy on October 1. This quarter, we recorded a tax benefit of $4.8 million. Our tax rate is affected by items, such as tax rates in various jurisdictions, the relative amount of income we earn in those jurisdictions applied against our forecast in added income and discrete items that may occur in any given period. As we have now returned to profitability, and anticipate remaining profitable going forward, we expect the tax benefit recorded in the third quarter to be offset by an almost equivalent tax expense in the fourth quarter. Apart from this adjustment, we expect our annualized tax rate next year will normalize in the mid-single digits. This quarter marks our return to profitability. Adjusted net income for the quarter was $18.6 million or $0.33 per diluted common share, excluding unrealized gains on interest rate swaps and non-controlling interest. Several items that are onetime or unusual in Q3 will not be repeated in Q4. Direct container expenses may increase, and we also expect to record a tax expense equal to this quarter's benefit, resulting in approximately a $10 million swing in income taxes. We expect that our GAAP net income will be lower in Q4 than in Q3, however, we will see improvements on the topline as lease rental incomes continue to increase and the key drivers of our growth continue. We expect to show growth and further improve profitability as we move into 2018. Adjusted EBITDA was $101 million for the quarter, up 50% or $33 million when compared to Q3 of last year. In fact, our adjusted EBITDA and margin have continued to increase each quarter since the beginning of the year, and our cash position has increased by $41 million during the same period, some of which is due to the receipt of insurance proceeds, but the balance is due to the generation of cash by our business. Thank you, and now I'd like to open up the call to questions. Operator, can you inform the participants of the procedures for the Q&A?

Thank you. [Operator Instructions] And our first question comes from Helane Becker from Cowen. Please go ahead.

Thanks operator. Hi guys. Thank you for the time.

Thank you.

Just a couple of questions, first is one of the questions I've been getting actually from investors recently is given this recent strength in the stock price, would you consider selling equity here?

Helane, that's a good question. Obviously, our two public peers have been in the equity markets recently. I think a real strength Textainer has is that we're underlevered relative to our peers, and we will remain in that position. So, the biggest concern we have at the moment is not raising additional equity. We do expect to continue investing in new containers going forward if we feel that to do so we do need to raise equity that could be considered at that time. But right now, for us, that's not a pressing concern.

And Helane, I would just add, the $900 million of liquidity, that's actual buying power that we have. If you look at the availability in our facilities, it's actually above $1 billion, but the $900 million represents actual buying power.

Yes, I was actually going to ask that question next, so thanks for anticipating that question. And then on just a process question, I think for you, Hilliard, for depreciation. So, is this level that we saw in the third quarter, the level I should think about for the going-forward quarters?

Helane, holding everything else the same, I would say yes. We think that if you look at our depreciation expenses as a percentage of our gross container assets, it's around 4.9% and we think we should stay at that level.

Right, so I'm understanding that correctly - I keep that number - keep that percentage flat as I grow your level of containers you get, right?

Correct.

Okay, and then there was just one other thing you had a small amount for bad debt expense in the quarter. Is that something we should be concerned about?

I didn't even mention bad debt expense because it was negligible this quarter. So, it's nothing that I would be concerned about.

Okay, great. Okay, thank you very much. Those are my questions really.

Thank you very much Helane.

Our next question comes from Doug Mewhirter from SunTrust. Please go ahead.

Hi, thanks and good morning. The buying-power question was asked and answered, thanks. But I have one additional question on the average lease duration. Obviously, that seems to be stretching out now that the market is sort of tightening up and it's stretched out in your favor. What was the average lease duration of your sort of newly booked leases? And also, are you, I guess, leaning back towards finance leases as well or do you like the structure of an operating lease better?

I'll answer the question on the lease duration. You're perfectly right to point out that the current market environment is favorable to longer duration, and we're now essentially negotiating terms, which are around seven years, sometimes more, as opposed to a more traditional and typical contractual duration, which was more like five years before the current uptick in the market.

Doug, I'd just like to add a little bit to that. We are not looking at doing finance leases currently. I know that some of our competitors have done longer-term leases than what we've mentioned here. Often those leases are either finance leases or a type of finance lease and/or you need to look at who exactly is the lessee in question. And the business that we want to do is generally has a term of about seven to eight years.

Okay, thanks. That's helpful. And actually, just one follow-up question and a more macro question. It seems like Europe has sort of spurred the worldwide demand. Is that sort of what you're seeing when you're talking with your customers? I know that they don't necessarily tell you that "we need containers for this particular route", but in just terms of talking with your customers, does that seem to be the case, where Europe seems to be leading the charge on this worldwide container volume or are other trade lines also unusually strong?

No, what is probably true is earlier this year. Europe was certainly leading some uptick in container demand. This year, the total throughput is expected to be above 6%, which is pretty high and the forecast for next year is for 4.5%. But that is pretty much spread out on all trade routes. It's really in Europe, Asia, its North America, Asia and its inter-Asia trade. We don't see a particular uptick in the European trade.

Okay, thanks. That's all my question.

Thanks Doug.

[Operator Instructions] And our next question comes from Wayne Archambo from Monarch Partners. Please go ahead.

You mentioned a $900 million of buying power available. Are there entities out there that you'd be interested in purchasing? I mean, what does the market look like on the M&A front?

Hi, Wayne, that's a fair question. I believe that there should be additional consolidation in our industry. I think it may happen over the next couple of years. At the moment, though I don't know among, which participants in the industry that consolidation is likely to happen or will happen, but I do think our industry would benefit from additional consolidation.

And just to be clear, the buying power that I was referring to was for CapEx and container assets as well.

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

Thank you. Thank you for joining us for our Q3 earnings call. We look forward to talking to you as we progress through Q4. Thanks again for joining us.

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