Textainer Group Holdings Ltd (TGH) 2013 Q3 法說會逐字稿

Welcome to the Textainer third-quarter 2013 earnings conference call. My name is Richard and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded. I will now turn the call over to Hilliard Terry, Executive Vice President and Chief Financial Officer. You may begin

Thank you, and welcome to our 2013 third-quarter earnings conference call. Joining me on this morning's call are Phil Brewer, TGH President and Chief Executive Officer. At the end of our prepared remarks, Robert Pederson, TEM President and Chief Executive Officer, will join us for the Q&A.

Before I turn the call over to Phil, I'd like to point out that this call contains forward-looking statements in accordance with US Securities Laws. These statements involve risk and uncertainties, are only predictions, and may differ materially from actual future events or results. Finally, the Company's views, estimates, plans, and outlook, as described within this call, may change subsequent to this discussion. The Company is under no obligation to modify or update any, or all, of the statements that are made. Please see the Company's annual report on Form 20-F for the year ended December 31, 2012, filed with the Securities and Exchange Commission on March 15, 2013, and any subsequent quarterly filings on Form 6-K for additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements.

I would also like to point out that during this call, we will discuss non-GAAP financial measures. As such measures are not prepared in accordance with generally accepted accounting principles, a reconciliation of the non-GAAP financial measure to the most directly comparable GAAP measure will be provided, either on this conference call, or can be found in today's earnings press release. At this point, I would now like to turn the call over to Phil for his opening comments.

Thank you, Hilliard. Welcome to Textainer's third-quarter 2013 earnings conference call. During the third quarter we saw strong increases in revenue and EBITDA. Total revenue increased 8.4% compared to the year ago quarter, setting a new quarterly record. More impressively, lease revenue increased 21%, even though utilization averaged 94.1%, more than 3% below its level of one year ago. Another positive note is that interest expense was almost flat compared to third quarter 2012, even though our average debt balance increased by almost 35%. We enjoyed a significant reduction in our average interest costs compared to the prior year quarter as result of the refinancings we have completed this year.

Our growth and EBITDA was in line with our revenue growth, demonstrating our strong cash flow. Net income was negatively affected by the increase in depreciation expense resulting from a reserve for container write-offs; the fact that older, fully-depreciated containers are being disposed from our fleet while we are adding newer, higher-cost containers; and purchased leaseback containers often must be depreciated over only a few years. Net income was also affected by $4.3 million of bad debt expense, about 3 times the usual amount. The container write-off and part of the bad debt expense relate to six small lessees, which are in default. These lessees account for less than 0.5% of our fleet.

Historically, in default situations, we recover more than 90% of our containers, with about 80% being recovered within the first six months, and the remaining 10% to 20% recovered during the subsequent 6 to 12 months. For these specific lessees, we believe recoveries may not follow this pattern, because containers are in locations where recovery is often uneconomical due to heavy damage, liens for storage costs, and repositioning expenses. Nonetheless, we still expect to recover more than a majority of the containers on lease to these lessees. We believe this issue is isolated to a few small lessees located in Asia, primarily China. We do not see any indication that we might see similar container write-offs with our top lessees, or with lessees in other locations. Last quarter we recorded an increase in bad debt expense related to a regional Asian shipping line, which declared bankruptcy. Even though recovery efforts only began five months ago, to date we have recovered 95% of the previously on-lease units from this customer.

We have always focused on lessee diversification. We have found that limiting the percentage of our fleet on lease to any single lessee results in increased demand for depot containers, reduces the credit and operating risk of our overall fleet, and limits our dependence on our largest customers. Indeed, as result of our lessee diversification efforts, some of the containers which we recently recovered from the defaulting lessees were immediately put on lease to other smaller, but more credit-worthy lessees. It is also worth noting that some of the defaulting lessees came from fleets we acquired over the past several years. Notwithstanding these defaults, these acquisitions have proven to be very successful and profitable transactions for Textainer.

We have invested $827 million in new and used containers for lease out in 2013, $629 million of which has been invested this year. Our fleet is just shy of 3 million TEU. Our own fleet by itself exceeds 2.2 million TEU, which we believe is larger than any other container lessor. We continued to see a decline in trading container sales, as shipping lines disposed of containers by a purchase leaseback transactions instead of trading deals. Purchased leaseback containers are considered in-fleet containers, and the sales are reflected in gain-loss on sale containers. Indicative of the strength of our cash flow and commitment to shareholders, we announced a dividend of $0.47 per share. We remain focused on paying a dividend which is both sustainable and provides the proper mix between rewarding shareholders and maintaining capital for future investments. Unlike others in our industry, we have maintained or increased our dividend every quarter since going public in 2007.

We did see an increase in container demand from May through mid-August. Since the beginning of the second quarter we have leased out more containers than were turned in. Utilization has remained relatively steady, because we added more containers than we disposed. Utilization averaged 94.1% for the third quarter; however, it has increased slightly to 94.2% currently, and is 0.4% above the lowest level we saw during the quarter. Utilization is within 1% of its level at the start of the second quarter, an indication of how stable utilization has been for most of the year.

Similar to comments made by our competitors during their earnings calls, we expect container demand to remain muted and to see similar utilization levels for the fourth quarter. Returns remain under pressure, due in part to the ease with which all lessors can borrow at attractive rates and buy new containers. Prior to 2012, four container lessors had accessed the asset back market, raising a total of $1.9 billion. Since the beginning of 2012, a total of $4.8 billion has been raised by 10 companies. Surprisingly to us, the borrowing costs differ very little, regardless of the size, experience, financial strength, or past performance of the lessor. Add to this the fact that the manufacturers can deliver ordered containers in less than two months, and it is obvious why the competition for every lease-out opportunity is very strong. We expect these highly competitive market conditions to continue for the near term.

While we remain selective in the deals that we pursue, we are focused on maintaining or growing our market share. New container prices remain below $2,100 per CEU. Used container prices are 10% to 20% below where they were one year ago, but the rate of decline in prices has slowed down and prices have leveled off in certain regions. We expect both new and used prices to remain around current levels for the near term. Total dry freight container production in 2013 is projected to be approximately 2.2 million TEU, with lessors expected to purchase about half of this amount.

Last quarter we mentioned a need for prudent investing by container lessors. At the time we made that statement, we estimated that -new-build factory inventory totaled in excess of 1 million TEU. To date that level is approximately 580,000 TEU, of which we estimate slightly more than 80% is for leasing companies. This level of inventory is not considered excessive. Lessors have again shown that they exercise prudence, investing in new containers where there is sufficient demand to justify such purchases. Our industry has more than benefited from disciplined investing and continues to do so.

We expect rental rates remain under pressure and our performance to be flat or slightly down in the fourth quarter. As a result, we will continue to drive economies of scale. Achieving a 3 million TEU fleet is not just a major milestone in the history of the container leasing industry, but it also helps us achieve what we believe is the lowest overhead cost per CEU of any major lessor. With our low operating costs, 83% of our fleet subject to long-term and financed leases, and only 2.3 times leverage, we believe we are very well-positioned to take advantage of market developments during the fourth quarter and in 2014. I will now turn the call over to Hilliard.

Thank you, Phil. Turning to the quarterly results, we recorded $133 million of total revenue. Revenue grew by 9% compared to the year-ago period. The primary driver of our revenue growth was the 21% increase in lease rental income, as a result of the large increase in the size of our own fleet when compared to last year. As Phil mentioned, our own fleet now totals 2.2 million TEU. The increase in lease rental income was partially offset by lower per diem rates and a decrease in utilization of our owned fleet. This quarter's revenue was also dampened by lower management fees due to the decrease in the size of our managed fleet from a third to less than a quarter of our total fleet, given the number of managed fleet acquisitions that occurred toward the end of last year.

We also saw a large decrease in the sales of trading containers due to a smaller number of containers we were able to source and sell. Gains on sale of containers decreased 14% due to a decrease in the average sales proceeds, and was partially offset by an increase in the volume of containers sold versus last year. Total operating expenses were up 30% year over year. About half of this increase was due to the provision for bad debt above our normal run rate, and a charge in the quarter for the unrecoverable container assets. Excluding these unusual items, and using a normalized run rate for bad debt expense, operating expenses would have been up 16%. The primary driver of OpEx growth was the increased depreciation expense, which is the largest component of total operating expenses. Also, direct container expenses increased as storage costs, handling expenses, maintenance, and repair expenses increased due to lower utilization rates in the quarter, coupled with the fact that we own a larger percentage of our total fleet versus the year-ago quarter. Depreciation expense was $42 million for the quarter; however, excluding the unusual item, depreciation expense was up 11%, or 40% year over year, as a result of our larger owned fleet and a few factors that impact depreciation expense. These factors include PLBs becoming the primary source of supply for our resale business, and in most cases, we depreciate these containers over a short depreciation period, which results in higher depreciation expense initially. Additionally, older, in-fleet units we sell are often fully depreciated, while they are replaced by higher cost units with higher depreciation. Lastly, when compared to dry containers, a higher percentage of refrigerated containers' prices is depreciated annually. As the percentage of refrigerated containers in our fleet increases, so does depreciation expense.

If you look at our overall annualized depreciation expense as a percent of gross container asset value, it's 4% this quarter. Over the past two years, our annualized depreciation expense has ranged between 3.5% and 4.5% of gross container value. As we've stated in previous quarters, depending on the mix of dry and reefer business going forward, and on new container prices, we expect depreciation to trend within this range.

Bad debt expense was $4 million, roughly about $2.9 million above our normalized run rate of 1% of revenues. This overage was primarily related to a single customer, as Phil mentioned earlier, and was specifically for the costs involved in the recovery of container assets. Counterparty risk is always at the top of our mind, and something we manage day-in and day-out. We continue to be very vigilant in our credit and collection processes. In fact, our DSO has improved by 8% over the past year, a testament to our collections efforts. In certain cases, we have been proactive in reducing supply and redeploying assets leased to certain customers. We remain comfortable with the overall risk profile of counterparties in our fleet. In spite of the provision recorded this quarter, we continue to believe the normalized run rate for bad debt expense should trend around 0.5% to 1% of revenue on a longer-term basis, and we expect our positive DSO trends to continue.

Below the operating income line, our interest expense was $20 million for the quarter versus $19 million in the year-ago quarter. While our debt balances increased by 35% from Q3 of last year, interest expense was only up by 3%, due to our ability to lower the Company's funding costs. Our average effective interest rate is currently at 3.55%, down 29 basis points when compared to the second quarter, and down 121 basis points when compared to the year-ago quarter. We successfully lowered our funding costs and locked an attractive long-term debt. Earlier in the quarter we established a $300 million asset-backed revolving credit facility for older containers at LIBOR plus 225 basis points. In early September we issued $300 million of asset-backed term notes with a coupon of 3.90% using a new trust structure. Both financings increased our future financing flexibility and liquidity.

Periods of softness oftentimes gives rise to the best opportunities. We have the lowest leverage of any of our public company competitors, and that provides dry powder to take advantage of growth opportunities. Increasing our leverage can help improve our return on equity, an option not available to more highly-levered competitors. For every half turn in our leverage, we can effectively increase our return on equity by 2.5 percentage points. The flexibility we have built into our low-cost funding provides us the ability to lever up for the right opportunity.

Income taxes for the quarter were a little less than $1 million compared to a benefit in the year ago quarter. Our effective tax rate varies from quarter to quarter due to discrete and one-time items. As a result, the effective tax rate recognized on a single quarter is not necessarily indicative of the effective tax rate for the full year. We do not expect our annual effective tax rate for 2013 to differ materially from historical effective rates. Adjusted EBITDA of $106 million was up 9% year over year, a clear indication of our continued strong cash generation. Adjusted net income, which excludes unrealized gains on interest-rate swaps for the quarter, was $39 million, resulting in adjusted EPS of $0.70 for the quarter. Excluding the unusual items and assuming a normalized bad debt expense, adjusted EPS would have been $0.83 for the quarter.

We declared a dividend of $0.47 per share, while we continue to target a dividend level of approximately 50% of adjusted net income, this quarter's payout is higher, at 67%. If you adjust for the unusual items in Q3, the dividend payout would have been within the targeted payout range. We believe it's important to provide our shareholders with stable and sizable dividends, and our yield is currently around 5%. Even in periods where we experience unusual items, the Board is willing to look through those items and maintain dividends, even at higher absolute payout. We are focused on the long-term outlook and remain committed to a policy of stable or increasing dividends.

Turning to our balance sheet, as of September 30 our cash position was $137 million, our total assets were $3.9 billion, and our leverage ratio was 3.3 to 1.

Thank you for your attention, and now I'd like to open up the call to questions. Operator, can you inform the participants of the procedures to participate in the Q&A?

Thank you. We will now begin the question-and-answer session. (Operator Instructions) Michael Webber, Wells Fargo

Hello. Good morning, guys.

Morning, Mike.

I wanted to jump in and talk about the competitive pricing environment. And certainly, and your all's commentary is in line with what we've been hearing all quarter. I'm just curious as to maybe how that's trended -- you quoted a date, even, that maybe since we hit the summer period to now. Has that eased off after things got a bit more competitive to start the year? Or has that kind of been more of a consistent easing in terms of both per diems, and then I would guess, kind of net spreads?

Hi Mike. It's Robert here. I would say pricing has remained pretty consistent throughout the year. It's been competitive. All the time the supply demand picture has been pretty stable.

The picture we have seen is there have been more availability than deal size out there. That means that every time we compete on a transaction, we have five, six, seven competitors competing for the same volume, and that has clearly made the market more competitive. I think that's been the story all year. I think that's the story right now, as well.

Okay. That's helpful. Phil, in your prepared remarks, you mentioned a little under 600,000 in terms of new inventory, about 80% of which is owned by lessors. Last year, we saw a bit of a prebuy in early Q4 -- not huge, but a bit of an uptick from what we've seen in the past. Seems like most industry participants were bit more comfortable with where our asset values were potentially going to trend. Do you think we could see that this year? Or is that new inventory level enough to keep that in check?

Well, Mike, I think part of the reason we saw stronger buying in the fourth quarter the last couple of years is because there was an expectation that container prices would rise going into the following year. Right now, I'd say that expectation is not quite so strong. Given that, it's very difficult to predict whether there's going to be strong buying in the fourth quarter or not. I'd say right now the outlook looks like it's less likely than in the past years, but it's difficult to say at the moment.

Got you. That's fair. One more for you, and this is probably difficult to say at the moment, but if we just kind of think about the way things have trended in the space -- it's more competitive, top-line growth has been relatively muted, and it seems like, as we look at 2014, we would probably need to see both of those things ease in terms of the environment getting a bit less competitive. And we probably need to see an uptick in top line top-line growth or returns to really kind of reverse course here.

When you look at -- obviously, you have no control over pricing from smaller players and your competitors -- but when you just kind of look at what you might have of yuan in terms of top-line growth, what do you think we would need to see, to see profitability turn, just from an opportunity set perspective? Is it 3 million TEU of new box demand next year? Do you think that's enough to give everyone enough room to kind of ease -- kind of turn things around and ease this pressure, or do you think it's more?

Mike, I think you asked the exact same question to some of our competitors earnings calls. I'd like to say that there was a very simple answer. I think part of the answer is this -- as we see greater demand for containers, then the individual deal sizes also increase. Right now, many of the deals we're seeing in the market are relatively small, so any one of the leasing companies can provide most, if not all, of the containers that are being requested. As the demand increases, we see deal sizes increase, as well. And that, frankly, plays to the hand of the larger container leasing companies, where we are able to meet the demands to provide most, if not all, the containers for the very large deals.

Generally, the shipping lines prefer not to deal with six, seven different lessees -- lessors at one time. So, that certainly is advantageous to us when the deal sizes are larger. I think there's a few other things to keep in mind, and one is -- in this environment, some of the things that are very, very important are, for example, economies of scale. And we believe we are the -- we have the lowest overhead cost per container of any of the lessors. Another factor to keep in mind is that we've seen the change from trading containers to purchase leaseback containers over the past two years and that has led to muted trading results among those of the container leasing companies that are active in that business.

The purchase leaseback containers generally have gone on lease for a year, two years, three years. We'll start to see some of those containers coming off of their leases over the next, I'd say, probably a year from now and then going forward. As that happens, you'll start to see -- I would expect you'll start to see, if we price these deals properly -- gains on sales as we dispose of the containers. And that will also be beneficial moving forward for those of us who are active in that business.

Got you. That's really helpful, and that increased leverage to a turn for larger players is interesting.

Mike, could I just add one point to that question there -- I think there's one key number you need to keep in mind, and that is the fact that earlier this year, inventory-at factories was more than 1 million TEU. That's less than 600,000 TEU right now, actually the last number we heard was less than 580,000 TEU. With 82% of that inventory being leasing company inventory, and if we work those numbers back to our situation, more than half of that is actually moved out.

That is a different environment. That is a more positive outlook. That means that the leasing industry has refrained from just buying big, sitting on massive numbers, and potentially being more desperate to activate stuff they've already purchased. It's a different story when you buy for demand than just buying for stuff that you already have, but you want to place. But that is really a very big, important number that the fact that we went from 1.2 million TEU to less than 600,000 TEU

Got you. Okay. That makes sense. Thank you, guys, for the time. I appreciate it

Thank you, Mike

John Mims, FBR Capital Markets.

Just as a quick point of clarification -- the six little shipping lines that were in default -- I know it's a small percentage of your fleet, but how many other small lines are out there that are inside of your customer base?

Well, the total exposure we have to these type of shipping lines, remains a very, very small percentage of our fleet. Similar to, I believe, all of the competitors in our industry. We follow the 80/20 rule, where our top 20 lessees comprise about 80% of our fleet. So the amount you'll see on lease to these type of lessees is extremely small. I would just add that we believe we have gone far in accommodating the needs to recognize the impairments and the bad debt reserve for these lessees. In fact, I think it's quite likely that some of the containers that we've currently listed as impaired, we may ultimately recover.

We had a very unique situation here where there was one lessee that frankly engaged in fraud. It was not even a lessee that had been on our problem accounts report and was paying normally -- when the owner of the shipping line disappeared. That led to some confusion in terms of identifying where our containers were located because the staff at the shipping line also -- many of them also left. However, our team in China has been going to the depots and terminals, and we've been able to identify the location of many of the containers. Some of them we've concluded are simply uneconomical to recover. That's the reason for this. So we view it as a pretty unique situation. Our total exposure in this area, even beyond those six lessees, is simply a very small percentage of our fleet.

Sure. Okay. No, no. That's helpful. Because I know you do a lot on the credit side as far as reviewing these guys, so the fraud part definitely makes sense. Phil, let me ask you another on the pricing, just to go back to there, when you said you expect pricing to remain flat in the near term. What's near term for you? Is that just more of a uncertainty about fourth quarter, or are you willing to venture any kind of projections into what pricing could do in the beginning of the year?

Right now we think that container prices are likely to remain -- both new container prices and used container prices are likely to remain relatively stable through the end of the first quarter, given the early Chinese New Year this year and then after Chinese New Year, generally we have a relatively slow period, so I'd say our visibility right now would go to the end of the first quarter. We expect relatively stable prices through that time.

Okay and then one last one for me and I'll turn it back over. But when you look at that flat pricing environment, and to Hilliard's comments on the -- on your leverage and where you stack up as the least levered in the space, at what point -- what do you need to see before you're willing to go ahead and pull the trigger and make some opportunistic purchases to take advantage of the pricing environment? Now do you think prices could come in some, or are you waiting to see a little bit more on the demand side before you willing to go out on spec a little more?

Well, we're always looking at the market, and looking at container prices, and making exactly that decision as to whether or not we should be buying, we should be holding. I think there's still a bit of uncertainty in the market, so it's very hard for us to say what's the right time. But I can promise you that if we think that it makes sense for us to be buying containers based on the prices we are being offered and where we see demand, that we will act.

Right. Fair enough. Okay. Thanks a lot.

Thank you.

Ken Hoexter, Bank of America

Phil, I think you talked about opportunities, or maybe it was Hilliard, on terms of large scale -- or talked about opportunities in the market. Are you thinking about large-scale type acquisitions, or is it still talked in like the sale leasebacks you engaged in last year? Do you think we could see if you're getting some over ordering and maybe too much pressure? Is now the time you want, if you got leverage capability, is that some -- a direction you would want to head in, in terms of consolidating the market?

I think all of us in the industry feel that some level of consolidation in the market in our industry would be positive. Certainly, if you look at the recent past, when there's been transactions, they haven't resulted in consolidation. I believe that some point in the future -- I'm not sure if the time is now -- but at some point in the future, we will see consolidation. But believe me, if there's opportunities out there, whether it's a purchase leaseback, whether it's new containers, whether it's buying parts of our own fleet, or, frankly, any type of acquisition opportunity, we will be aggressively looking at it.

Ken, I would just add -- my point was, for the right reason, we have the ability to increase leverage. If you look at the return on equity that we've been able to deliver, it's been consistently at or, and in some cases, above some of our peers, and that's even with our lower leverage. If you look at some of the deals that we done on the financing front, we've worked to increase our flexibility and ability to lever up -- be it through the new series allocation trust structure that we utilized with the recent bond issuance, or even the facility for used containers. All of these deals provide more flexibility and enables us to increase leverage for the right reason.

So given that, I guess you're still not seeing those returns structurally decline. If you've got now, I think somebody mentioned earlier -- Robert, I think mentioned five to seven bidders per contract versus used to be one, two, or three -- are you seeing those level of returns structurally decline?

I'm not sure I understand the question, Ken. But if you're asking, are we seeing a level of returns on individual lease-out transactions decline, yes, of course. Everybody in the industry has said exactly that, and certainly they have. I think they've reached a level of stability. We haven't seen further declines over the past, say, couple of quarters. Is that your question?

Yes, I guess it's more a pricing issue, I guess, in terms of -- but whether it was -- it becomes structural at this point, if you have that many more containers with that -- or competitors with that much more access to capital. Let me jump on, just to a quick follow-up, clean-up question. You were talking about -- you recovered 95% of the unleased units for the bankrupt customer? Does that mean there are still leased units out to the customer?

No, I'm sorry. Let me be clear on that. And then I think this is an important point I'd like to emphasize, so I appreciate your bringing it up -- is to point out that we don't see any fundamental change in the historical recovery rates for containers in default situations. I mentioned we had an unfortunate experience with one lessee here where there was a example, essentially, of fraud, but you take another lessee, which was quite public default in the second quarter of a regional Korean lessee, and we only started recovering those containers five months ago, and we have already recovered 95% of those containers. So it's just demonstrating that our ability to recover containers in a default situation is still following the historical pattern. So the containers are not on lease to that customer. The customers was put into default. We're looking to recover the containers. We've filed a claim with the bankruptcy proceedings in Korea in that particular incidence, including for our recovery costs, but we are currently now involved in recovering the containers.

Appreciate the time. I guess if I could -- just one more on, in terms of the liner customers, at the beginning of this year they had stepped up, maybe increasing their participation in purchasing boxes that may be ahead of the typical kind of 50-50 split. Have you seen that? It sounds like you keep mentioning the 50% level -- have we seen that -- their entrance since the market decline, and are they back to normal buying cycles,or do you anticipate any change as you move into the beginning of the year?

Well, we were actually not surprised about the situation and we're not surprised about the situation the way they ended up this year here. We always thought that it was going to end up about 50-50 at the end of the year. What happened early in the year was we had a later Chinese New Year. You had what everybody perceived -- just cheap container prices, and there was quite a lot of lower cost capital being offered to certain shipping lines that they really opportunistic decided to go out and activate. When we got through second and third quarter, particularly third quarter, purchases were dominated by leasing companies. And I think if there is an uptick in purchases in the fourth quarter, I think you'll also see that on behalf of leasing companies. So the fact that we end up about 50-50, but I think was predictable.

Wonderful. Appreciate the time. Thank you.

Thank you, Ken.

Sal Vitali, Sterne, Agee.

Good morning, gentlemen.

Good morning, Sal.

Just first on the $4.7 million charge for the impairment of containers, if I heard you correctly earlier, you said you believe that you may have over reserved for them. So, would you expect at some point, in your P&L in the future, some kind of reversal of that of a portion of that $4.7 million charge?

Sal, may be -- what I meant to say is that we reserve what we feel was the appropriate amount based on the information we have currently. It's just that every day we are monitoring this situation. And when we made the reserve, it was our best estimate as to the level of container recovers we'd be able to achieve with this particular lessee. But each day as we approach the point in time in which we had to finally make a decision, we found we were identifying more containers. But we had to make a cut-off at some point and make a decision. Should we end up recovering more containers than we thought? I don't -- first off, from an accounting perspective -- I don't think there is any write-back of assets, as I understand it. But second, I don't expect it to be material in any event.

Okay that's helpful. I appreciate that. And then switching to the bad debt expense of $4.3 million, just a clarification there, that relates -- you basically said you've recovered 95% of the containers for that bankruptcy at this point, correct?

Yes.

I guess what I'm getting at is going forward, we shouldn't see any more increase in your bad debt or any more bad debt expense related to that. Is that safe to assume?

We don't think you'll see anything material.

Okay. That's helpful. And then I think, Hilliard, earlier you mentioned that your sales on gains of -- you mentioned that the sales on gains were down sequentially due to a combination of lower sales prices partially offset by higher volume. Can you give us a sense of what the sequential decline in the average sales price was?

I can tell you that used container prices, Sal, have declined between 10% to 20% year to year. But right now, fortunately, we're seeing that the rate of decline has leveled off, while I believe used container prices could trend down slightly. I also think that they may have -- if they're not at a bottom, they're very close to a bottom. We expect them to remain stable, relatively stable through the end of this year and into the first quarter of next year. It's unlikely that used container prices are going to start increasing until we start seeing increases in new container prices. Right now there's enough containers available in the used container market that buyers are not really buying for inventory purposes, because they know that if they need the containers, they can turn around and get them immediately. So as a result, we don't see that pull to pull the prices up over the next two quarters.

Okay. That makes sense. And then just on the current factory inventory you mentioned is close to about 580,000 now. If I look at the size of the fleet, that comes out to about less than 2% of the size of the global fleet. Can you give me a sense for -- at this point in the year -- what it is typically? Is that typically above/below trend?

Yes. This is definitely below where we would normally see inventory, and it probably equates to about two, three months of consumption in a normal market. So this is low. We think the number is low because the lead times at factories is also short. You can probably place an order today and get containers three, four weeks from now. Shipping lines know that, leasing companies know that, and I think that's probably holding some buyers back. Because they don't have to make big decisions right now because they feel that if they place an order tomorrow, that it will probably be only be three, four weeks and they'll have the equipment available.

Okay. And then a last question on the container impairment -- given this experience, or is there any heightened level of scrutiny in the leased portfolios of your -- of smaller lessees?

That's an excellent question. Thanks. I think we noted earlier when we started off, that in fact our DSO has improved dramatically since third quarter last year. And we think the overall credit profile of our lessee and of our fleet -- it's actually much better than it was several years ago, for example, during 2009, when our industry went through a pretty severe downturn. Having said that, though, yes. As we've gone through this process, we've stood back and said, is there anything that we need to do that we're not doing. Hilliard and I have been involved in discussions with both our credit department in-house, as well as our regional offices, to explore how we are handling the credit.

And it's important to note that our marketing people -- our marketing staff are responsible for collections themselves, which we think in the past has worked, and continues to work well, to minimize our credit risk. But doing business, we also maintain a philosophy that we don't want any single lessee to be more than -- in fact, more than 15%. Right now we don't have anyone more than 14% of our entire fleet, and only two that are above 10%. We try to diversify our exposure among lessees. We've never let anyone get to be 18%, 19% of our fleet, for example. We think that this policy has served us well over time. And even in the situation we are talking about now, where we are out trying to recover containers from some, what we'll call -- off the grid -- locations, we found other lessees that are willing to take those containers once we've identified them and recover them. And we think that our broad exposure among a group of lessees has helped us in that regard.

So, yes, every once in a while you have a problem like we face right now with this, as I mentioned, these few small lessees, although one is responsible for the bulk of the charge, and as I mentioned, it was a fraud situation. But we don't think overall it indicates that we have a problem with our credit policy. In fact, we recognize that these kind of things might happen once in a while when you also try to maintain a diverse group of lessees.

Thank you. That was helpful.

Thank you.

(Operator Instructions) Justin Yagerman, Deutsche Bank.

Hello. Good morning, guys.

Morning, Justin

Just wanted a couple points clarification. As I think about the fourth quarter and your commentary around the environment, I'm assuming you're basing that off of an operational number, which would exclude the write downs in the quarter. So when I think about the transition from Q3 to Q4, that that kind of flat to down-ish environment is just on a strictly operational basis, and we're not at this point thinking about any residual from these claims spilling over?

Correct, Justin. We just excluded those items when we thought about that.

Okay, great. And then in terms of Cap Ex thoughts here, as we get to the end of the year, where are you -- at this point, where do you think 2013 ends from a CapEx standpoint? And then looking out to 2014, obviously, a crystal ball is pretty tough, given the environment, but I'd be curious about initial thoughts on capital that you'd like to put out next year.

Obviously, Justin, at the moment it's pretty difficult for us to make any predictions. We've already said that we -- I know one of the very first questions I was asked was about leasing company purchases of containers in the fourth quarter -- I think it's very difficult to say where that will go, given that nobody really expect container prices to rise dramatically in the beginning of next year. And as Robert mentioned, right now it's very easy to buy containers and have them delivered in a very short period of time. So where our Cap Ex ends out for the -- through the end of the year, it will be higher than where it is now, certainly. I'm sure we will invest some amount in containers in the fourth quarter. But honestly, it's difficult to predict that amount. And I think it would be surprising if Cap Ex going into the first quarter of next year is also somewhat muted. Beyond that, it's really -- my crystal ball isn't bright enough to see into the second and third quarters of next year.

That's really fair. And Phil, I thought it was interesting -- on the back of Mike's question, where you talked a little bit about how sale leasebacks can turn into gains on containers as we look out. When I think about that conversion, how do you think about that from an accretion standpoint? Is that going to show up in trading container sales? Or is that just when you buy containers and then dispose of them? How should we be thinking about where that shows up, and what kind of accretion you could get from that in 2014?

Well, from an accounting perspective, it's going to show up on gain on sale containers, not on a trading container line, because once we do a purchase leaseback, those containers are considered part of our fleet and not trading containers, because they're obviously -- their own buyouts and they're on lease to a shipping line. We've seen this movement from change from trading business to purchase leaseback activity generally occur over the last two years, and many of the purchase leaseback transactions were for minimum on higher periods of two, three, four years. So, four years would be at the upper end. I would say most of them are two and three years.

So you'll start to see those containers, at least the leases, ending -- the minimum on a higher period ending, I would say starting towards the latter half of next year and then going forward. Now it doesn't mean that the shipping line has to return the containers at that time, only that they may be -- that they're able to do so. I can't speak for my competitors, but we certainly price these deals with the expectation that when we get those containers back, we will recognize a reasonably attractive gain on the disposal of the asset.

All right. That's definitely interesting. Phil or Hilliard, can you talk though a little bit, as we face an environment where interest rates probably start going up as opposed to down next year, we'll see -- but can you talk a little bit about how you think about the impacts to your overall business? Obviously, there's a flow through in terms of the lease yield., and also in terms of any kind of floating debt that you guys are holding at this point. Maybe if you could talk about those two pieces of the equation and how your business has usually fared in a rising interest-rate environment, since we've only seen the opposite of that for the past several years?

Sure, Justin. Thanks for that question. As interest rates go up, overall, we think it's very beneficial, because the primary reason it's beneficial is because we are looking to do a few things here. We're looking to put new containers on lease, we're also looking to roll over containers that are currently on lease under maturing term leases, and we're looking to lease out containers that are currently in depots. For the latter two, as interest rates move up and then the rental rates on new containers move up, as you can imagine, it becomes easier and more attractive to lease out a depot container or your negotiations on the extension of a term lease become somewhat easier, as well, because the environment for new containers -- new container rental rates has also increased.

Just to add to that, you asked about our debt and about how we are hedged. If you look at the average remaining lease term, I think it's around 40 months or somewhere between three to four years. If you look at our debt, although it shows only 30% of our debt being fixed, the floating rate portion of our debt is also hedged. And if you look at the remaining duration of those hedges and the remaining duration of our debt, it's slightly longer than the average remaining lease term. So I think we are protected.

That makes a lot of sense. And it was very helpful. Thank you. Last question -- Phil, I think in the release or in your prepared remarks, you mentioned a recent, modest pickup in demand. Was curious if that's just observations on rates on liners as we've seen November 1 GRIs go into effect, or if you think there's something else driving that, if it's just kind of normal holiday season -- what that feels like -- that would be kind of late? What do you think is driving that as you think about where we are on demand here in early November?

Hello, Justin. It's Robert here. When you look at the two last years, 2011 and 2012, the demand picture quarter by quarter was different than it's been historically. The peak season during those two years was actually the second quarter. This year we were back to a normal traditional year, where the third quarter was the peak. The peak wasn't extreme, but it was a lot better than the previous two quarters when you compare this year. We look at our container intake -- it was significant in the third quarter, and the bookings that we were awarded were significant as well. Clearly, that has slowed off a little bit here as the Christmas cargo has been shipped from Asia. But demand, when I talk to the shipping lines, has actually continued a little bit longer than they expected.

And that leads me to the second question, the GRI issue and the vessel capacity issue. As you know, the lines have gone out in the big Asia-Europe trade and introduced some pretty hefty GRIs effective the first of November. It should be noted, and I think, Mike Weber wrote that in a note this morning, and I think he was correct in his write-up that freight rates dropped a lot, pre-this GRI, and the net effect will be more muted than what we actually see. But, I would also say that there is still a surplus of vessels and excess capacity out there. The lines, even if they have started laying up some of the larger vessels, and I'm talking about the 7000, 8000 TEU vessels.

That did not happen last year, that did not happen earlier this year, but they are actually being laid up right now, and that's a good sign. Meaning that the lines are showing signs that they want to do more capacity managements to stimulate the supply demand situation and thereby get freight rates up to a better level, and importantly in the Europe-Asia trade, actually keep a nice piece of that 1 November GRI. Do I think it will stick the 100%? Absolutely not. None of the previous GRIs this year has done that, but I actually think some of it will stick this time.

We shall see. All right, guys. Appreciate the time. Thank you very much.

Thank you

Bill Carache, Nomura Securities.

Thanks. Good morning, guys. I think almost everything has been covered. I just had one question -- I was hoping that perhaps you could comment on whether you're seeing any kind of deviation in the relative attractiveness of returns on the different types of containers? You talk about your plan to invest in tank containers in the coming months, and I wondered if you could maybe go through and talk about -- if not necessarily quantifying, but perhaps qualitatively give us some perspective on relative attractiveness.

Sure. Let me first comment on the tank situation. Right now, we've committed to invest a little bit more than $10 million in tanks through the end of this year. Some of them probably won't be delivered until the early part of next year. What we see in the tank market is that the tank market is equally as competitive as the reefer market that we're in, and that's the dry freight market that we're in. The level -- I would say the level of competition among those three equipment types and including the specials, in which we also have in our fleet, it's high. The level of competition is high across all the asset classes.

Okay. And one last question -- I would love to get your thoughts on -- we've seen over the last -- over three years a consistent increase on your dividend as we've seen earnings increase. Now that we're -- your comments this quarter on being committed to maintaining the current dividend and what we've seen, given the outlook for the operating outlook that you mentioned. Is it for modeling purposes, would you say that it's prudent -- the upward trajectory in the dividend certainly doesn't continue. It's kind of flattish from here. Is that fair?

Every single quarter we make a decision on our dividend, based on our performance that quarter. I know our Board is committed and has certainly demonstrated that commitment over the time that we've been public to pay a fair and appropriate return to the shareholders. For example, in 2009, when our results were under pressure, we never cut our dividend. We maintained our dividend. I certainly defer to the Board and their ability to make that decision on a quarterly basis. The Board will make that decision on a quarterly basis.

Understood. Thanks for taking my questions, guys. Thanks.

Helane Becker, Cowen and Company.

Thanks very much, operator. Hi, gentlemen. Thanks for all the time. Actually, all my questions have been asked and answered, at least more than once.

Thanks, Helane.

Helane, but we were looking forward to a question from you. (laughter)

Everybody asked all the other questions. But thanks, anyway.

Thank you, Helane. Appreciate your time.

Doug Mewhirter, SunTrust Robinson

Hi. I just have one last question on my list. Looking at the box factories, obviously, their production levels have been dropping, probably even below a replacement rate for the fleet. Is there a certain breaking point for them, where they would be willing to shut down or radically scale back production, and are we close to that? Can you see a certain price per dry -- per 20 foot dry box as sort of a point of no return for them, or an uncle point? Or do you think that there's still a lot of leeway that they have where they can still make adjustments without having to dramatically scale back production? Thanks

It's Robert here. That's a good question, something we discuss internally all the time. The manufacturers have reduced capacity. We think that the theoretical production capacity is between 5.5 and 6 million TEU a year, and they are producing 2.2 or something like that. So clearly, that's way below capacity. We know for a fact that some of the manufacturers have shut down certain production lines. Some of them have reduced capacity by 20%, 30%. Everybody wants to try to avoid a shutdown.

Shutting down a production line is expensive. It's also a question mark. Can you maintain the skilled workers, particularly the welders, during that period? So they really want to try to avoid that situation. Having said that, we don't expect container prices to drop significantly. I think that we have seen manufacturers actually be prepared to extend shutdown periods, maintenance periods, times -- immediately after Chinese New Year, for example, to stimulate demand. And we would probably see that happening before prices being slashed further.

Okay. Thanks for that answer. That's all my questions.

Thank you.

We have no further questions at this time. Please go ahead with your final remarks.

I would like to thank everybody for taking the time to attend our third-quarter earnings conference call. We look forward to speaking to you in a few months as we wrap up the year. Thank you very much.

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