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Textainer Group Holdings Ltd (TGH) Q4 2018 Earnings Conference Call Transcript

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Textainer Group Holdings Ltd  (NYSE: TGH)
Q4 2018 Earnings Conference Call
Feb. 21, 2019, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Thank you and welcome to Textainer Fourth Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, instructions will be provided at that time. As a reminder, today's conference call is being recorded.

I will now turn the call over to Ed Yuen (ph), Investor Relations for Textainer Group Holdings Limited.

Ed Yuen -- Investor Relations

Thank you. Certain statements made during this conference call may contain forward-looking statements in accordance with US 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 31st, 2017 filed with the Securities and Exchange Commission on March 14th, 2018 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.

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, we've also provided slides to accompany 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.

Olivier Ghesquiere -- President & Chief Executive Officer

Thank you, Ed. Good morning everyone and thank you for joining us today for Textainer's fourth quarter 2018 earnings call. I'll begin by reviewing the highlights of our fourth quarter and full year results and then I will provide some perspective on the industry. Michael will then go over our financial results in greater detail, after which we will open the call for your questions.

For the full year 2018, we delivered lease rental income of $612.7 million, an increase of $63.3 million or 11.5% over the prior year. Please note that we are now reporting lease rental income, including of our managed fleet. Michael will go more into the detail of this reporting change that does not impact our earnings.

We leased out over 500,000 TEU during the year. Three quarters of which was new production, at an average yield of 11%. We delivered adjusted EBITDA growth of 18.3% to $443.1 million. Adjusted net income was $51.5 million or $0.90 per diluted common share, as compared to $23.2 million or $0.41 per diluted common share in the prior year.

Our average utilization for the year was 98.1%, an improvement of 170 basis points over the prior year, with our current utilization standing at 98.3%. At year-end, we owed approximately 79% of our fleet, which stood at 3.4 million TEU. While we are pleased with our performance for the full year, the strength in the market that we saw through the first nine months of the year, did not carry through to the end of the year. This is not unexpected, given traditional seasonality patterns, as demand for new containers is typically softer during the fourth and first quarter of the year. Concerns and uncertainty around the ongoing trade friction and slower global economic growth forecast served as additional headwinds to market activity this quarter.

Accordingly, lease rental income of $157.1 million for the fourth quarter was essentially flat sequentially to the third quarter, as we saw a low level of on-hire activity and reduced production volume.

In addition, during the fourth quarter, we incurred $4.6 million in impairments related to delinquent lessees. As previously communicated, we've taken a fresh look at the business and are being proactive in optimizing our portfolio. We believe with these actions, our efforts are now largely completed, and we do not expect there will be any notable impairment in the first quarter of 2019. In addition, during the fourth quarter, we finally arrived at a settlement arrangement with insurers related to the Hanjin claim, and we recognized a gain in insurance recovery of $8.7 million.

As we look at the industry through the global perspective, we are cautiously optimistic about the market outlook. Our perspective is driven by the following; while the threat of a widening trade war, Brexit and steeper than anticipated slowdown in China were cited by the IMF as it recently trimmed global growth outlook for 2019 to 3.5% from 3.7%, we believe this revised level is still supportive of shipping volume and trade 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. Utilization remains high, the market supply appears balanced, as new production inventory is reasonable at 780,000 TEU, and lessors and shipping lines have not been placing large new additional orders.

During the fourth quarter, our utilization was strong at 98.6%, while demand for new lease out was low, we continue to see favorable low level of turn-ins and attractive container resale environment. We have seen a modest improvement in lease-out activity in January, but the overall environment remained muted, leading up to the Chinese New Year. New container prices have recently come down to about $1,700 per CEU, driven by a combination of the decline of steel prices, a depreciating renminbi, and softer demand. However, we believe new container prices may increase, as seasonal demand picks up in the second quarter of 2019.

And finally, we believe shipping lines will continue to increase their reliance on container leasing companies, as they focus their liquidity unnecessary CapEx related to new ships compliant with IMO 2020. At the end of December, total dry van production reached 4 million TEU, with over 60% of purchases going to leasing companies. We expect demand for leasing to remain strong.

As we continue to navigate an uncertain market environment, our team remains focused on executing against our strategic priority to improve profitability. We are seeking opportunity to lower operating cost and speed up turnaround time. We're focused on quality revenue with double-digit average cash-on-cash yield, and we intend to continue to improve our fleet yield, through organic growth and optimized repricing of existing leases. We are taking a profit-oriented approach to lease reviews and extension, and we'll leverage the favorable resale environment for used container, to dispose off equipment, if a potential expansion does not achieve our targeted yields.

We're taking a stricter and more proactive approach to identify and initiate recovery of equipment held by customers on the verge of default, in order to limit future losses. We intend to invest in the business, to maintain adequate new production inventory and better serve customer needs on short notice. However, we will be measured and disciplined with yields on leases and will only see growth under the right returns.

And finally, we've further strengthened the leadership team with the addition of a new Controller, and a VP of Marketing, and I believe we now have one of the best team in the industry.

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.

Michael Chan -- Executive Vice President & Chief Financial Officer

Thank you, Olivier. I will now focus on the key drivers of our financial results. Q4 lease rental income was $157.1 million or flat sequentially compared to $157.8 million in Q3, as higher utilization and an increase in average per diem rates were partially offset by a slight decrease in fleet size. For the year, lease rental income increased $63.3 million or 11.5% year-over-year to $612.7 million, driven by higher utilization, an increase in fleet size, and an increase in the average rental rates of the fleet.

Q4 gains on sale of owned fleet containers was $9.6 million compared to $8.5 million in Q3 due to an increase in the number of containers sold, partially offset by a reduction in average gain per container sold. For the year, gains on sale of owned fleet containers net was $36.1 million compared to $26.2 million in the prior year, due to an increase in average gain for container sold, partially offset by a slight reduction in the number of containers sold. Q4 direct container expense was $15.1 million, a decrease of $1.4 million compared to Q3, primarily due to $1.2 million in lower repositioning expense.

For the year direct container expense was $58.8 million, a decrease of $1.5 million from the prior year, primarily due to $6.8 million in lower storage costs resulting from higher average utilization, partially offset by $4.4 million in container recovery costs, incurred for lessees that became insolvent in 2018. Q4 container impairment was $8.2 million and primarily consisted of $4.6 million in estimated unrecoverable containers held by delinquent lessees, and a $3.6 million impairment to write down the value of containers held-for-sale to their estimated fair value less cost to sell.

For the year, container impairment was $26.8 million consisting primarily of $12.6 million in estimated unrecoverable containers, held by delinquent lessees and $13 million in impairments to write down the value of containers, held-for-sale to net realizable value. These impairments included $6.9 million from unleasable containers moved to disposal, primarily reefer units, many of them recovered from Hanjin, for which there was limited commercial marketability.

The current container resale environment remains favorable, and we continue to opportunistically evaluate our portfolio to maximize the value of these containers, while also saving storage expense and providing an opportunity to redeploy capital to higher-yielding assets on a long-term basis.

Q4 depreciation expense was $61.1 million, an increase of $700,000 from Q3. For the year, depreciation expense was $235.7 million, an increase of $4.7 million from the prior year, primarily due to a larger fleet size in 2018. This was partially offset by the depreciation decrease, resulting from an increase in future residual values effective July 1, 2017. Q4 general and administrative expense was $10.7 million, down $1.8 million from Q3, primarily due to $2.4 million in costs associated with departing senior executive personnel recorded in Q3, with no comparable charge in Q4. For the year, general and administrative expense increased $4.6 million from the prior year, primarily driven by $2.4 million in costs associated with departing senior executive personnel, and a $1 million increase in our short-term incentive compensation costs.

In Q4, we recognized the gain on insurance recovery of $8.7 million, related to the final insurance settlement of the Hanjin bankruptcy for insurable costs, including primarily unrecovered containers and incurred container recovery costs, net of the insurance deductible. We collected the remaining outstanding portion of the final settlement during January and early February 2019.

Q4 interest expense, including realized hedging gains, was $35.3 million, an increase of $900,000 from Q3. For the year, interest expense including realized hedging gains, was $133.2 million, an increase of $14.5 million compared to the prior year, driven primarily by higher average debt balance due to CapEx and higher interest rates.

Unrealized loss on interest rate swaps, collars and caps, net was $8 million for the quarter and $5.8 million for the year, primarily resulting from a notable decrease in the forward LIBOR curve at the end of 2018, which reduced the carrying value of our interest rate derivatives at year-end. Longer tenured and higher fixed rate swaps were also required to be traded to replace expiring, lower fixed rate swaps.

Income tax expense was $800,000 for Q4 and $2 million for the year, reflecting a 5.6% and a 3.6% effective tax rate respectively. We continue to expect our annualized income tax rate to normalize in the mid-single digits. Q4 net income was $12.2 million or $0.01 per diluted common share. For the year, net income was $50.4 million or $0.88 per diluted common share. Q4 adjusted net income was $11.9 million or $0.21 per diluted common share. This excluded a $8.7 million gain on insurance recovery, and $8 million unrealized loss on interest rate swaps and caps.

For the year, adjusted net income was $51.5 million or $0.90 per diluted common share. This excluded an $8.7 million gain on insurance recovery, a $5.8 million unrealized loss on interest rate swaps and caps, $2.4 million of costs, mostly associated with departing senior executive personnel, and a $900,000 write-off of unamortized debt issuance costs, for refinancing certain debt in connection with the amendment of our revolving credit facility.

Q4 adjusted EBITDA was $115 million, up $1.3 million or 1.1% when compared to Q3. For the year, adjusted EBITDA was $443.1 million, up $68.5 million or 18.3% when compared to the prior year.

Turning now to our balance sheet, we ended Q4 with a cash position inclusive of restricted cash at $224.9 million. As a reminder, on September 30, we executed an amendment to expand our revolving credit facility from $700 million to $1.5 billion, while also extending it to five year term and repricing it lower by 50 basis points.

We believe our financing platform is well positioned and well-priced to adequately fund our future CapEx plans. As we discussed in our Q3 call on October 31st, 2018. We purchased the remaining non-controlling interest at TW Container Leasing for approximately $29.7 million. The purchase provided a sole ownership of a portfolio of mostly seasoned finance leases, with an asset book value of over $100 million.

Finally, as noted in the earnings release earlier this afternoon, in connection with preparing our 2018 financial statements, we reevaluated our fleets management agreements for managed containers, and determined that these agreements convey to the company, the right to control the managed fleet, therefore beating the accounting definition of a lease based on US GAAP guidance, As a result, lease management fee income previously presented on a net basis was reclassified and presented on a gross basis for all periods presented. This reclassification has no impact to underlying income from operations or net income, as well, no resulting changes to the consolidated balance sheets and consolidated statements of cash flows.

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

Questions and Answers:

Operator

(Operator Instructions) Our first question is from Helane Becker with Cowen and Company. Please proceed with your question. Helane, please tell us if you -- there you go.

Helane Becker -- Cowen and Company -- Analyst

Yeah. Got it. I'm sorry, had to unmute, rather. Hi guys. Thank you very much for the time. So just a couple of questions. I think, Olivier, you said that your cash on cash returns were in the low double digits. So are you seeing -- you mentioned on the repricings, are you having -- are your customers accepting higher rates, as you go to reprice containers? That's my first question. And then my second question is on, it's probably a question for Michael, on the balance sheet; I am just kind of wondering if the accounts receivable line being up so much from year-end 2017 to year end 2018 is reflective of concerns about customers. I mean, are there -- or is it just the size of the fleet grew so much that accounts for that increase? Thanks.

Olivier Ghesquiere -- President & Chief Executive Officer

Hi, Helane. How are you? On your first question on the cash on cash and on the repricing, I think that's a very interesting question, because clearly, prices of new containers have dropped fairly rapidly since the third quarter of the year, and normally repricing is closely tied to the prices on new container. What we're seeing, however, is that because that drop has been so sudden, it hasn't fully translated on the prices of our depot containers and certainly our depot lease-out rates have remained much stronger than the rates on the new containers. I think because most of those leases can go on shorter-term and in a very uncertain environment, customers like to take containers on short maturities.

When it comes to repricing of existing long-term leases, that is a different question. Very clearly, we are feeling a little bit of pressure coming, but it's more a kind of a wait-and-see game at the moment, because a lot of people, including ourselves expect price of new containers to bounce back. So we're sort of like play for time, and hoping that by the time we really have to renegotiate the prices or the rental rates up, price will have come back up.

The second element, I think which is important to us is that, resale price of containers have remained fairly strong, and that puts us in a slightly stronger position, because we are now able to essentially postpone reducing rates or actually not acceding to customer request to reprice lower, because we'd rather take the containers and sell them, because we estimate that is a more profitable situation.

So, in a nutshell. I don't think we are seeing a major impact in having to reprice or long-term leases downwards at the moment. I hope this answers your question Helane.

Michael Chan -- Executive Vice President & Chief Financial Officer

Helane this is Michael here. Thank you so much Olivier. On top of that, what's interesting is that, if you look at the underpinning our average per diem rate of the fleet during Q4, it actually went up as -- as compared to Q3, by about $0.005, which is a great underpinning metric here. We're doing our best to manage the renegotiations as well as Olivier mentioned. We're in a very advantageous environment, given the very strong resale environment making -- taking a box back, not averse to us actually, given that we price sell it for a nice gain. That translates to being in a key position and actually showing a good underpinning metric of a higher premium rate on average for Q4. Helane your second -- go ahead?

Helane Becker -- Cowen and Company -- Analyst

Could I just follow that up real quickly with -- what's your lease -- average lease term on new containers? Olivier, I think you said, your customers were going shorter, but we heard from CAI yesterday that their lease term is 8.5 years and Triton also mentioned last week, their average lease terms are closer to seven years now, and I'm kind of wondering how yours compare?

Olivier Ghesquiere -- President & Chief Executive Officer

Now we're talking about new container leaseouts. I mean, our average is still closer to six years. I think, we exclude our finance lease from our calculation. But six years is the average for operating lease-up new containers. When I was referring to short-term maturities, I'm referring to leaseouts of depot containers, which can go out on leases of anywhere between one to three years.

Helane Becker -- Cowen and Company -- Analyst

Okay, thanks. And then on -- sorry on the balance sheet question, Michael?

Michael Chan -- Executive Vice President & Chief Financial Officer

Certainly. Hi Helane. Interestingly, at the end of the year, one of our major lessee relationships reached out to us and asked to temporarily delay payment on a short-term basis, whereby they made the payment after the fiscal year-end, early part of January. So is an accommodation for them. What happened was that, it caused the AR balance to be higher at calendar year-end. But it dropped within the week right after year-end. This is merely something that was negotiated between us and the lessee. No issues in terms of credit by all means, but it was -- in a sense, a relationship favor if you will, whereby that balance normalized right after end of the year.

Helane Becker -- Cowen and Company -- Analyst

Okay. And then are you seeing an environment in which you think there can be increased industry consolidation?

Olivier Ghesquiere -- President & Chief Executive Officer

It's a good question. I don't think the situation has changed fundamentally. I think that we're likely to see more consolidation among big shipping lines. There's a few company, a few names that keep on coming up. Quite clearly, the environment remains competitive, and I think that there is a clear demonstration that size matters in this industry. So, I think we can expect more consolidation on the shipping side. I think, if your question also refers to leasing companies, I see probably a little bit less potential for consolidation. There has been talk about certain opportunities on the market for transactions, but I don't see an immediate opportunity in terms of consolidation among lessors.

Helane Becker -- Cowen and Company -- Analyst

That's great. Thanks very much, gentlemen.

Olivier Ghesquiere -- President & Chief Executive Officer

Thank you, Helane.

Operator

(Operator Instructions). Our next question is from Michael Brown with KBW. Please proceed with your question.

Michael Brown -- KBW -- Analyst

Hi, good afternoon guys.

Olivier Ghesquiere -- President & Chief Executive Officer

HI Michael.

Michael Chan -- Executive Vice President & Chief Financial Officer

HI Michael.

Michael Brown -- KBW -- Analyst

Just wanted to dig in first on the impairment charges this quarter. So last quarter, you basically said that the impairments that were related to kind of the cleanup activity, that was generally complete. Sounds like this quarter, there were some additional write-offs on the legacy on Hanjin portfolio, sounds like the reefer units specifically. So, I mean what occurred during the quarter that you discovered that there is kind of more containers to dispose and then how can we be sure that really the cleanup efforts are done at this point?

Olivier Ghesquiere -- President & Chief Executive Officer

Yeah, Mike. Thanks for that question. In the fourth quarter, we had -- actually we had two lessees that we had payment plans, if you will, and we deliver schedules associated with them. They failed to honor them during the fourth quarter. So, these are a couple of workouts. Smaller in size to what we counted earlier, in say the third quarter. But nonetheless, theu disappointed us and that they didn't honor their payment terms and delivery terms. Given that facts, we felt it was prudent to go ahead and impair the the boxes that were with these guys. So we went ahead and proactively took that impairment in Q4. We're still working with these customers and trying to get them to adhere to the payment and delivery plans, but -- and we're also pursuing legal actions. But at the same time, from an accounting standpoint, we thought it would be probably best to record it in Q4. Again, smaller number of impairments, but nonetheless we're not happy with that, of course.

Mike, I think the first part of your question. You alluded to some Hanjin remaining. I don't think it has anything to do with Hanjin in the impairment this month. The second part is really due to the ongoing impairment as we put container to disposal. I think, because we are impairing containers on individual basis, we always have a few containers that we end up selling below book value. But they really have to be seen in the context of the global disposal of assets and all the other containers on which we actually realize gains, and those $3.6 million impairment on some containers have to be viewed in line with the $9.6 million gain on sales that we also realized for the quarter.

Michael Brown -- KBW -- Analyst

Okay, thank you for the clarification. And then just focusing on leasing revenues. I mean, it sounds like we're in the midst of the seasonally slow period. And so, as we look to the first quarter, clearly, there is less days in the quarter. So really, would you expect kind of leasing revenues to decline sequentially; and if so, can you kind of frame the magnitude of the decline, given, we really didn't see that last year?

Olivier Ghesquiere -- President & Chief Executive Officer

It's a very good question. I think that more than the number of days for the quarter, we would look at the general macroeconomic environment. And it's a reality that the fourth quarter of the year was slow, and because of that, we are not expecting revenues to increase in the first quarter. If anything, we're expecting revenues to be to be flat over the first quarter. But primarily as a result of not having on-hire, a lot of container in the last quarter of the year.

We also expect the first quarter to remain fairly soft, and certainly, as I mentioned earlier, we have seen a much smaller build up to Chinese New Year than we had seen last year. Last year, we had seen a very strong buildup to Chinese New Year, which really helped boost up the revenue. But this year, there was a fairly fairly small increase. It was positive, but it was much smaller than last year, and I think that we will have to wait until the second quarter of this year, until we really see the impact of the seasonal activity that will help to boost our revenue top line.

Michael Brown -- KBW -- Analyst

Okay, great. Thank you for taking my questions.

Olivier Ghesquiere -- President & Chief Executive Officer

Thank you, Michael.

Operator

Ladies and gentlemen, we have reached the end of our question-and-answer session. I would like to turn the call back over to management for closing remarks.

Olivier Ghesquiere -- President & Chief Executive Officer

Okay, well thank you everybody for attending our call and we look forward to meeting you again next quarter for continuation of the Textainer story. Thank you very much.

Michael Chan -- Executive Vice President & Chief Financial Officer

Thank you.

Operator

Thank you. This concludes today's conference. You may disconnect your lines at this time and thank you for your participation.

Duration: 31 minutes

Call participants:

Ed Yuen -- Investor Relations

Olivier Ghesquiere -- President & Chief Executive Officer

Michael Chan -- Executive Vice President & Chief Financial Officer

Helane Becker -- Cowen and Company -- Analyst

Michael Brown -- KBW -- Analyst

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