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Edited Transcript of TGH earnings conference call or presentation 6-Aug-19 9:00pm GMT

Q2 2019 Textainer Group Holdings Ltd Earnings Call

HAMILTON Aug 12, 2019 (Thomson StreetEvents) -- Edited Transcript of Textainer Group Holdings Ltd earnings conference call or presentation Tuesday, August 6, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Michael K. Chan

Textainer Group Holdings Limited - Executive VP & CFO

* Olivier Ghesquiere

Textainer Group Holdings Limited - President, CEO & Director

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Conference Call Participants

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* Conor T. Cunningham

Cowen and Company, LLC, Research Division - Associate

* Michael C. Brown

Keefe, Bruyette, & Woods, Inc., Research Division - Associate

* Scott Jean Valentin

Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst

* Ed Yuen

SOLEBURY TROUT LLC - MD

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Presentation

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Operator [1]

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Greetings. Thank you, and welcome to Textainer's Second Quarter 2019 Earnings Conference Call. (Operator Instructions) As a reminder, today's conference call is being recorded. I will now turn the conference over to your host today, Mr. Ed Yuen, Investor Relations for Textainer's Group Holdings Group (sic) [Textainer Group Holdings Limited]. Please proceed, sir.

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Ed Yuen, SOLEBURY TROUT LLC - MD [2]

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Thank you. Certain statements made during this conference call may 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. The company's views, estimates, plans and outlook as described within this call may change after 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, 2018 filed with the Securities and Exchange Commission on March 25, 2019, and going forward any subsequent quarterly filings on Form 6-K for additional information concerning factors that may cause actual results to differ materially from those in the forward-looking statements.

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 measures to the most directly comparable GAAP measures will be provided either on this conference call or can be found in today's earnings press release.

Finally, along with our earnings release today, we have also provided slides accompanying our comments on today's call. Both the earnings release and the earnings call presentation can be found on Textainer's Investor Relations website at investor.textainer.com.

I would now like to turn the call over to Olivier Ghesquiere, Textainer's President and Chief Executive Officer, for his opening comments.

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Olivier Ghesquiere, Textainer Group Holdings Limited - President, CEO & Director [3]

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Thank you, Ed. Good afternoon, everyone, and thank you for joining us today for Textainer's Second Quarter 2019 Earnings Call. I'll begin by reviewing the highlights of our second quarter results, and then I'll provide some perspective on the industry. Michael will then go over our financial results in greater detail, after which, we will open the call to your questions.

We are pleased with our performance in the second quarter, where we delivered stable lease rental income of $155.1 million and adjusted EBITDA of $114.7 million, despite the slow market activity in the second quarter that has persisted in the third quarter to date. New container activity continues to be driven by macro headwinds such as slow European trade, a slowdown in Chinese economy and ongoing trade disputes.

While overall market growth remains muted, Textainer has been proactive and disciplined with new lease opportunities. During the second quarter, our fleet grew by 190,000 TEU as we made container investment at attractive rates and double-digit returns. This was achieved as we successfully targeted replacement demand opportunities, with some of our strong customer's relationship to achieve mutually beneficial deals when new container prices reach a low point in the earlier part of the year.

We expect to see the full impact of the net TEU growth-to-lease rental income to be completely realized in the third quarter, though partially offset by a reduction in further additional CapEx.

At the end of the second quarter, we owned approximately 81% of our fleet, which stood at 3.6 million TEU. Overall, there have been very few significant deal from shipping lines, and new container prices have decreased to the current level of approximately $1,750 per CEU primarily driven by weak new container demand. Rental rate for new container lease outs have declined in line with new container prices, but the total volume of new deal was small, and we do not believe that they were representative of normal market conditions.

As we have mentioned in prior call, this management team is focused on a disciplined growth strategy, and we have not chased down rates on the few competitive open tenders.

During the second quarter, our utilization remained strong at 97.9%. While demand for new lease outs was low, we continue to see a moderate manageable level of turning and an attractive container resale environment. The market supply remained stable with total new drive and inventory slightly above 1 million TEU, representing only 3-month supply in a normal market environment.

In addition, there was very limited new container ordering in the past few months, and we are starting to see factory shutdowns, which are positive signs for the industry utilization and inventory level.

While the general market activity remains low, we're particularly pleased with our cost control initiatives. We achieved further declines in both G&A and direct cost in the second quarter as compared to the first quarter and prior year. We intend to continue working on minimizing cost level going forward.

Unfortunately, during the quarter, we incurred $9.1 million in impairment and $3.3 million in bad debt expenses to recognize the potential exposure from a nonperforming, midsize regional shipping line. This customer is continuing to operate and attempting to restructure with some recently announced government support. We believe this incident to be an isolated credit issue, and we currently do not have any significant concern with customer credits.

To provide some context, Textainer has had a long-standing relationship with this customer, and there was no recent history of credit issue. The company was profitable over the last 2 financial years, and conditions that led to the default arose from alleged financial misfeasance reported this quarter. We remain cautiously optimistic that the government-led restructuring will ultimately allow this carrier to regain market confidence and become current in their obligation, but we do believe it is prudent to recognize this impairment now as we actively seek redelivery of our containers and have filed an insurance claim for the matter.

The financial impact to Textainer is contained as our exposure is capped at our insurance policy deductible of $10 million, and the total container value of these leases is well below our coverage limits.

Our management team continues to be proactively taking expedient steps to address credit concern and limit exposure as soon as potential issues are identified.

Turning now to our outlook for the balance of the year. We believe new container demand will remain muted in the third quarter. The outlook for Q4 remains uncertain, pending economic activity level and ongoing trade negotiation. This will result in limited additional supply of new container as well as likely additional factory closure, which will help stabilize the overall container supply.

The IMF recently revised its 2019 global growth forecast to 3.2%, and we expect global container throughput growth to remain well above 2.5%. We believe these level are still supportive of moderate shipping volume growth. There is innate replacement demand for containers that are coming to the end of their life and will need to be replaced with new production.

We expect container lessors utilization to remain high and continue to support strong [resale] prices. And finally, we believe shipping lines will continue to increase their reliance on container leasing companies as they focus their liquidity on necessary CapEx related to new ships and compliance with the IMO 2020 emissions regulations. We continue to believe leasing companies will represent approximately 60% of total purchases.

In summary, our performance is reflective of the low level of market activity in the second quarter, which has continued into the third quarter. While there were a few significant lease out opportunities, we managed to grow our fleet by securing specific replacement opportunities at attractive yields with several of our valued customer relationships. We expect the slow growth environment to persist in the short term, given the current macro headwinds. However, the fundamentals of our business remain positive as evidenced by the industry high utilization rate, limited new orders and favorable container resale environments.

We continue to normalize our cost and keep our balance sheet well positioned while waiting for any possible uptake which will eventually materialize.

I will now turn the call over to Michael, who will give you a little more color about our financial results for the past quarter.

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Michael K. Chan, Textainer Group Holdings Limited - Executive VP & CFO [4]

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Thank you, Olivier. I will now focus on the key drivers of our financial results.

Q2 lease rental income was $155.1 million, a decrease of only $400,000 as compared to Q1. This included the impact of higher CapEx in the second half of Q2 offset by a slight decrease in utilization. Q2 trading container margin was $3.4 million, an increase of $800,000 compared to Q1 due to an increase in per-unit margins and the number of trading containers sold.

Q2 gains on sales-owned fleet containers net was $5.4 million, a decrease of $1.4 million compared to Q1 and included a reduction in average gains per container sold. While average gains per container sold decreased, the resale container price environment is still favorable.

Q2 direct container expense for the owned fleet was $10.8 million, a decrease of $0.9 million compared to Q1, primarily due to a decrease in repositioning expense and maintenance expense. We are pleased with this improvement and believe our direct container expense reflects a lower baseline level going forward.

Q2 container impairment included a $9.1 million charge for estimated unrecoverable containers held by a nonperforming lessee. Bad debt expense also included a $3.3 million reserve for receivables due from the same lessee.

As discussed earlier by Olivier, this lessee continues to operate and is undergoing a new restructuring program with involvement from a significant government-controlled entity with experience in asset management.

While we are cautiously optimistic that the program will improve the lessee's operating performance, we believe it is still prudent to recognize these charges in Q2.

Q2 depreciation expense was $61.7 million or relatively flat compared to Q1. Q2 general and administrative expense was $9.4 million, down $0.4 million from Q1, primarily due to a reduction in compensation costs and professional fees. We are pleased that this reflects an improved baseline level going forward.

Q2 interest expense including realized hedging gains was $37.1 million, an increase of $1 million from Q1, driven primarily by higher average debt balance due to CapEx. Our Q2 effective interest rate was 4.3% and remains one of the lowest in our industry.

Q2 unrealized loss on interest rate swaps, collars and caps net was $10.1 million, primarily resulting from a decrease in the forward LIBOR curve at the end of the quarter, which reduced the spot mark-to-market value of our interest rate derivatives used for long-term hedging purposes. We intend to hold the underlying hedges until maturity, therefore, any unrealized gain or loss will net to 0 over the life of the hedge.

While we had an income tax benefit of $0.2 million for Q2, we continue to expect our annualized income tax rate to be in the mid-single digits.

Q2 net income was $0.3 million or $0.01 per diluted common share. Q2 adjusted net income was $9 million or $0.16 per diluted common share. Adjusted net income for the quarter excluded the noncash unrealized loss on interest rate swaps, caps and collars and a gain from an insurance recovery and legal settlement. Had we excluded the impact of charges associated with the nonperforming lessee, Q2 adjusted net income would've totaled $21.4 million, relatively stable compared to the previous quarter. Q2 adjusted EBITDA was $114.7 million, down $3.4 million when compared to Q1.

Turning now to our liquidity. We ended Q2 with a cash position inclusive of restricted cash of $244 million, an increase of $24.5 million from the prior quarter.

Finally, subsequent to the end of Q2 on July 29, we announced the completion of an amendment to extend the term and lower pricing on our $1.2 billion warehouse credit facility. The revolving period of the facility was extended by 3 years to July 2022. And the spread was reduced by 15 basis points to 1.75%. We are very pleased with the continued support of our bank group on this transaction, which improves Textainer's capital structure and financial flexibility.

This concludes our prepared remarks. Thank you all for your time today. Operator, please open the line for questions

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Helane Becker with Cowen.

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Conor T. Cunningham, Cowen and Company, LLC, Research Division - Associate [2]

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This is actually Connor Cunningham in for Helane. So I just wanted to go back to the CapEx replacement comment that you had. So I was a little surprised to see the size of investment, but obviously, you spoke to, like, it being more replacement than growth. But can you -- when you talk about container replacement like annually, like from an industry level, how many containers need to be ordered to just keep the fleet flat on a year-to-year basis?

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Olivier Ghesquiere, Textainer Group Holdings Limited - President, CEO & Director [3]

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Are you talking for the industry or for Textainer specifically?

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Conor T. Cunningham, Cowen and Company, LLC, Research Division - Associate [4]

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The industry as a whole, yes.

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Olivier Ghesquiere, Textainer Group Holdings Limited - President, CEO & Director [5]

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Yes. For the industry as a whole, we estimate that about 5% of the total world fleet needs to be replaced annually, which in itself represents probably 1.5 million TEU a year of drive and equipment. So it's about half of the production in a normal year.

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Conor T. Cunningham, Cowen and Company, LLC, Research Division - Associate [6]

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Okay. Perfect. And then just I want to come -- I want to talk a little bit about the trade war that's going on. So -- and maybe coming at it from a little bit differently -- a different angle. So I think, originally, when the trade war started, the consensus due to like global trade would slow, and that's pretty much played out as one would expect, but can you speak to maybe anything that you've seen that surprised you as a result of dispute? Like -- it seems like trade lanes are shifting pretty quickly overall and that's been -- and maybe that's been like consistent with your thoughts, or just any thoughts around on what surprised you around the trade war, that would be helpful.

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Olivier Ghesquiere, Textainer Group Holdings Limited - President, CEO & Director [7]

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Well, there are several very interesting that -- that have happened. I think for me, probably the most surprising thing has been to see how well shipping volumes have held up when this whole trade tariff were initially implemented, I would personally have expected a more direct impact. The reality is that the volumes have held up very strongly. Ships have remained very full over the duration. And one of the big conclusion is that, initially, the tariffs have not had an immediate direct impact on the volumes. They have more of a psychological impact in terms of driving new demand and especially new investment in China. But I think that they haven't affected immediately the volume. There was a big surge last year, and I think that we are still, in a way, paying the price today for that big surge because we're now in kind of a lull, and we have been in a slow market for maybe 9 months or a little bit more than that, certainly from a [leading] perspective. But shipping lines have continued to enjoy fairly large volumes. What we've also seen is a shift in some production to other countries. There's been a lot of talking about Vietnam picking up a lot of opportunities, their exports are up 20%. But I would say that's something that we had started to observe even before the tariffs were implemented. It's certainly been accelerated by the situation, but it had started before, and it was driven primarily by the fact that production costs over the years have become uneconomical in China, and producers were looking at shifting production. And Vietnam's probably the #1 beneficiary of that, but we see other countries benefiting from that, I mean, we see India, we see Bangladesh, we see Thailand benefiting. So there has been some shift in production but that, I think, will materialize over a longer period of time than over just a few months.

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Conor T. Cunningham, Cowen and Company, LLC, Research Division - Associate [8]

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Okay. Great. And last one for me. Just on the current environment with demand that's relatively low for new containers and just moderate trade growth going forward due to the dispute, have you guys -- is there an opportunity for you to convert your managed fleet to owned? I would think that, that would be a pretty accretive way to drive TEU volumes to you guys at a higher level. Any thoughts there will be great.

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Michael K. Chan, Textainer Group Holdings Limited - Executive VP & CFO [9]

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Well, thank you. We're certainly on the lookout for that. That's a very attractive investment proposition for us. A couple of good things related to that, we typically can get that equipment at a good basis. And one attractive characteristic also is that if we buy a fleet that's already under our current management, that equipment is already on lease. So earning revenues from day 1 of ownership so certainly something that we always watch for and are open to.

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Conor T. Cunningham, Cowen and Company, LLC, Research Division - Associate [10]

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But is there any barriers from that occurring, like -- is it more like your customers have to want to give up the containers? Is that kind of how you view it?

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Michael K. Chan, Textainer Group Holdings Limited - Executive VP & CFO [11]

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Sometimes we see that. Some customers may have requirements to exit their position. So we provide them a good opportunity to liquidate and transfer the cash that change [your] position. I think it's a good opportunity and option for them to get out on a very quick flexible basis, and if they think about it, we are the likely buyers of that. We understand asset very well, and we can respond quickly, too. So I don't really see too many barriers in them going in that direction. In fact, I think it's a good option for them to look at that as a potential exit.

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Operator [12]

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Our next question comes from Scott Valentin with Compass Point.

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Scott Jean Valentin, Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst [13]

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Just trying to get more, I guess, information on the credit. It sounds like there is a potential for recovery. Is that recovery of the receivable, or do you see recovery of the -- right off the containers? I'm trying to sense -- it sounds like that it only continues to operate or anticipates continuing to operate. So just wondering the probability of maybe collecting in the out periods.

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Olivier Ghesquiere, Textainer Group Holdings Limited - President, CEO & Director [14]

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Scott, no, you rightly point out that we've decided to be prudent and to be proactive in this case, but the company continues to operate. There's actually a government-related agency that is trying to restructure the company. And certainly, we hope that over the long term -- but we don't think it will be a short-term solution, over the long term, we will be able to recover, first of all, some of our account receivable but most importantly, our container, and that would possibly allow us to minimize our losses. What we've done right now is we've been conservative, and we've taken the hit, so to speak so that we can really recognize it fully in our books and then focus completely on trying to minimize our losses going forward.

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Scott Jean Valentin, Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst [15]

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Okay. That's helpful. And then just thinking about in a low CapEx environment, and it's a high cash flow business, just wondering how you think about -- what you do with that cash flow? Do you pay down debt and delever the balance sheet? Or do you find other uses for it?

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Michael K. Chan, Textainer Group Holdings Limited - Executive VP & CFO [16]

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Well, we're finding that a good allocation of the cash is towards CapEx so long as that CapEx is at attractive yields. So right now, that is taking much of our cash, is because of those ARPUs that have risen in, for example, Q2. On an ongoing basis, we'll certainly assess what's the best use of our cash. But right now, we like the proposition provided by CapEx. But again, assuming that it hits the yields and our -- and is indeed are -- is attractive for us, has good tenure as well and good credit, also.

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Scott Jean Valentin, Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst [17]

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Okay. And then just on per diems and container prices, you mentioned containers prices are pretty low for this time of year, I think $1,750 is the kind of the price you mentioned. And I guess I've heard from other container lessors that it's difficult for factories to make money at that level. So just wondering, do the per diems reflect that low price of containers? And two, you mentioned, I think the IRRs or the returns are still double digit, just want to confirm that.

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Olivier Ghesquiere, Textainer Group Holdings Limited - President, CEO & Director [18]

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Yes. I think -- I like to draw a distinction between the larger replacement deal that we've been able to secure. Essentially without going too much into detail, we secured those deals very early in the year. We took advantage of the manufacturing price that dipped very briefly, very early in the year. And there was a unique opportunity, actually, several unique opportunities there for us to be able to invest and achieve our double-digit returns while still providing our customer with a very attractive deals. If you look at the market the way it is today, there has been very, very few open tenders, and it is fair to say that the rates have been unattractive. And we've, for that matter, stayed out of those open tenders, and we're basically sitting and waiting with our existing inventory, which we believe is limited and perfectly adequate for us to maintain, waiting for the market to pick up. But the cash-on-cash yields have certainly dropped, but again, there has been so few deals that it's hard to tell that this would be fully representative of a normal market environment.

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Operator [19]

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(Operator Instructions) Our next question comes from Michael Brown with KBW.

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Michael C. Brown, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [20]

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So I just wanted to start off on CapEx again. I saw that strong first half, $640 million, and it sounds like with a more tepid outlook going forward, I kind of appreciate your commentary about kind of a lower expectation going forward. But I guess any color that you could provide on your expectation there for the full year. And it sounds like you had kind of some benefits from some larger replacement deals coming through. Are those kind of one-offs, or should we expect that more of those could come through?

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Olivier Ghesquiere, Textainer Group Holdings Limited - President, CEO & Director [21]

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At this point in time, we don't expect more of those to come through. We're very much thinking that we are not going to see a typical peak season. What we have seen over the last, shall I say, 3, 4 weeks is what I would call a little bubbling in the market. There has been a little bit of activity. We have leased out some depot units. I think that some of our competitors have leased out some depot units. Nothing dramatic but still something positive that indicates that volume have increased a little bit. I think at the same time, you see that ocean freight rates on Europe -- on Asia, Europe -- and Asia, North America have also gone up over the last few weeks. So there is a little bit moving. Now we don't expect this surge to be a very major surge or a typical surge as we've seen in the previous year. So we don't anticipate that there will be many opportunities for us to implement new CapEx or invest more into container. I think the big question for us is really what happens for the fourth quarter. And at this point in time, we remain optimistic about the fourth quarter. We feel that the U.S., the consumer demand remains strong, we feel that demand will still be there for the end-of-the-year holiday, which are driving the demand. And typically, we also have then the buildup to the Chinese Lunar New Year that starts taking place in the last quarter. But I think more fundamentally, we have now been in a fairly slow market for almost 9 months or 10 months. Every month that passes means that shipping lines will reach a level where they have to start replacing some of the older containers they have in their fleet. So we remain kind of hopeful that towards the end of the year, we will see a recovery in demand to normal levels.

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Michael C. Brown, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [22]

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Great. Thanks. And then just to follow up on the CapEx, the $440 million this quarter, was that really to support kind of one customer or a couple of customers? I'm just trying to get kind of an idea of the activity this quarter.

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Michael K. Chan, Textainer Group Holdings Limited - Executive VP & CFO [23]

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Well, there are several customers in there. One larger one was involved, of course, but there's several in there.

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Michael C. Brown, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [24]

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Great. And then last quarter, you guys kind of gave guidance on the lease rental income, you guided to essentially being kind of flat in the second quarter, and that's kind of really where it did come in this quarter. So I was actually wondering if you had some guidance for the third quarter.

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Michael K. Chan, Textainer Group Holdings Limited - Executive VP & CFO [25]

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Yes. We're thinking that third quarter could be flat compared to Q2. And reasons for that is that we did put some CapEx to work in Q2, but as we mentioned earlier, there is that normal attrition that every fleet experiences. So we're selling boxes at good prices, but that will bring down lease rental income a bit. However, that would be buffered by the CapEx that we put in place, so potentially, there could be a bit of a flattening of lease rental income if you were to look at Q3 versus Q2.

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Operator [26]

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At this time, I would like to turn the conference back over to Olivier Ghesquiere for closing comments.

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Olivier Ghesquiere, Textainer Group Holdings Limited - President, CEO & Director [27]

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Thank you for taking the time to listen to us today. And I look forward to updating everyone on our progress during the next call. Thank you.

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Operator [28]

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This concludes today's teleconference. You may disconnect your lines at the time, and thank you for [participation. Goodbye].