CAI International, Inc.
Q2 2017 Earnings Call Transcript

Published: 27 Jul 2017

[Operator:]

Good day, ladies and gentlemen, and welcome to the CAI International Q2 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference Timothy Page, CFO. Sir, you may begin.

[Timothy Page:]

Good afternoon and thank you for joining us today. Certain statements made during this conference call maybe forward-looking and are made pursuant to the Safe Harbor provisions of Section 21E of the Securities and Exchange Act of 1934 and involve risks and uncertainties that would cause actual results to differ materially from our current expectations including, but not limited to, economic conditions, expected results, customer demand, increased competition and others. We refer you to the documents that CAI International has filed with the Securities and Exchange Commission, including its Annual Report on Form 10-K, its Quarterly Reports filed on Form 10-Q and its reports on Form 8-K. These documents contain additional important factors that could cause actual results to differ from current expectations and from forward-looking statements contained in this conference call. Finally, we remind you that the company’s views, expected results, plans, outlook and strategies as detailed in this call might change subsequent to this discussion. If this happens, the company is under no obligation to modify or update any of the statements the company made during this discussion regarding its views, estimates, plans, outlook, or strategies for the future. I’ll now turn the call over to our President and Chief Executive Officer, Victor Garcia.

[Victor Garcia:]

Thank you, Tim. Good afternoon and welcome to CAI’s second quarter 2017 earnings conference call. Along with our earnings release today, we have also posted on our website under the investor section a presentation on our results and our view of the state of our company and industry. We will not be going through specific slides in the prepared remarks, but can address any questions related to the presentation on this call. For the quarter, we reported a revenue increase of 15% from the second quarter of 2016 and lease related revenue increased 6%. During the quarter, we reported net income of $12.6 million or $0.65 per fully diluted share. Our net income has increased 140%, as compared to the $5.3 million reported in the first quarter of 2017. The improvement in our net income is due to increased utilization of our fleet, revenue from new investment and containers, renegotiation of expiring leases at higher rates, and a gain on sale of used equipment. It has been a strong focus for us to improve our return on equity after dealing with a low return environment over the last three years. We had expected to reach double-digit return on equity on an annualized basis in the second half of this year. Based on this quarter's results we are now operating at 11% annualized return on equity. This is one quarters to two quarters ahead of our previous expectation and is reflective of the strong market environment. We expect our return on the equity to improve further over the course of this year as our results benefit from higher utilization we are currently experiencing, and that has flow provided by the new investment that will be delivered in the second and third quarters. Beyond investment, we’re also very focused on improving the return on our existing assets. We continue to seek opportunities to increase per diem rates on low per diem leases that are expiring this year. We expect to report a gain on sale of equipment in the third quarter. However, we expect the gain to be less than what we reported this quarter, due to the limited availability of equipment to sell. We currently only have approximately 28,000 TEUs of owned equipment off hire at depots, approximately 1/3 of which is designated for sale. We are excited about the momentum we have during the quarter and expect demand to remain strong for the remainder of the year. During the second quarter, we had approximately 63,000 TEUs delivered from the factories, representing $120 million of equipment. We have an additional $227 million of investment due to be delivered in the third quarter virtually all of which is on committed leases. To date, we have committed $381 million in container investment that we have placed on leases that average over eight years. These investments not only will improve our results over the coming quarter, but provide a foundation for sustainable cash flow for the next several years. During the quarter, we increased our average owned container fleet utilization to 97.2%, compared to 95.7% during the first quarter of 2017. Utilization of our own fleet is currently 97.9% and we expect utilization to increase further as we continue to lease out the limited depot equipment we have available and add additional factory lease outs. In our discussion with shipping line customers, we believe that the pace of demand has increased so far in July and indications are that demand for containers will remain strong through the remainder of the year. We have had quick pick-ups of factory equipment by our customers, which we believe is an indication of the strong demand they are experiencing. Our rail business continues to work through a challenging competitive environment. We have found that lease rates on new investment continue to be aggressive and believe that competitors are prioritizing placing units on lease at low rates rather than having units go into storage. We believe that the decline in overall new production is providing the foundation for a recovery and then the market overall should improve over the next few quarters. Despite the difficult market environment, during the quarter, we have placed 189 rail cars on lease of which 150 are new rail cars to be delivered in the third and fourth quarter. Despite the difficult environment, the equipment we have to be delivered is spread amongst several equipment types, which we believe gives us a better opportunity to place equipment on lease and attractive rates. Our logistic group faced some difficult market conditions in the United States during the quarter, due to subdued overall economic activity, and aggressive pricing from asset owning transportation companies. However, we continue to add new customers and volume and there continues to be growing cross selling opportunities between container leasing logistics and rail. We think each of the segments benefit from each other and enhance the value of their respective customers. We expect that cooperation and momentum to develop further in 2017. In summary, we are very well positioned for what is a strong year for container equipment. We expect to continue to increase utilization and benefit from improvement in new investment returns that should result in improving quarterly results over the course of this year. I will now turn over the call to Tim Page, our Chief Financial Officer to review the financial results for the quarter in greater detail.

[Timothy Page:]

Thank you, Victor. Good afternoon everyone. As we indicated in our earnings release and Victor further described in his comments, this was the strongest quarter we have had in several years. Total revenue in the quarter was $82.7 million, as compared to $81.5 million in the first quarter, an increase of 1.5%. Net income in the quarter was $12.6 million as compared to $5.3 million in Q1, an increase of 140%. Net income per fully diluted share in the quarter was $0.65, compared to $0.27 in Q1, an increase of 137%. The incremental growth in net income in the quarter was driven by the strength of our container business. So, I’m going to focus most of my comments on the container results for the quarter and what our expectations for the container business are for the coming quarters. Container lease revenue increased by 3.6%, as compared to Q1 2017. However, included in the first quarter was $2.2 million of revenue related to Hanjin per diem revenue we recovered from our insurance carrier, which wasn’t normal recurring revenue. If you adjust the first quarter for that item, container revenue in the second quarter actually increased about 8%, as compared to Q1. The increase in container revenue occurred, primarily as a result of several factors. First, the average utilization of our owned fleet increased 1.5 percentage points from 95.7% in Q1 to 97.2% in Q2. Second, we benefited from a full quarter's worth of per diem revenue from the approximately 20,000 TEU of new factory equipment we leased out over the course of the first quarter. Lastly, and most importantly, we leased out approximately 63,000 TEU of new factory containers in the second quarter with the book value of about $120 million. While these lease sales were heavily weighted towards the end of the quarter their impact on the bottom line was still significant. Looking forward, we expect average utilization in Q3 to increase from what it was in Q2, but the pace of quarter-to-quarter increase is going to be somewhat less as we are approaching what is effectively full utilization. In Q3, we are going to get the benefit of having the equipment we leased out in the second quarter for an entire quarter. Most significantly as we indicated and Victor mentioned, we have approximately $227 million of new container lease outs queued up to start during the third quarter. This incremental new business is not only going to contribute significantly to Q3 results, but will also drive Q4 results. Besides the significant lease revenue growth we experienced in the quarter, several other factors were also significant bottom-line contributors to the second quarter results. First, we had a gain on sales of used equipment during the quarter of 1.7 million as contrasted with the loss on sale of equipment in the first quarter of $0.9 million, a pretax swing of $2.6 million. During the quarter, we saw average selling prices of containers per CEU increase about 18% or a little over $150 per CEU, compared to what they were in the first quarter. Compared to Q4 of 2016 average prices are up over 60%, about $390 per CEU. As Victor mentioned, while we expect average selling prices to continue to rise because we have a very low level of off lease equipment we expect our overall gain on sale of used equipment will be a bit lowered in Q3 than what we saw in Q2. Second, as a result of the improvement in utilization I mentioned earlier, we saw container storage cost drop over $1 million in Q2, as compared to Q1. We’ve seen an over 80% drop in the run rate of storage expenses over the past five quarters. We expect storage cost to decrease further in Q3, but the rate of decrease will be less in Q2, again, because we are approaching full utilization. Third, because the vast majority of our pretax income year-to-date has been generated by internationally sourced container operations, which is subject to a low non-US tax rate our consolidated tax rate has decreased to 3.5% for the year to date 2017. We are expecting that the tax rate for the remainder of this year will remain at that level. Overall, consolidated G&A expense in Q2 was $9.7 million, as compared to $10.7 million in Q1. About half of the changes related to the timing of things like professional fees T&E and other miscellaneous expenses. The other half was a reduction in contingent earnout consideration. Our run rate level for G&A expense in the coming quarters will be more in-line with Q1 levels. Interest and other expense in the quarter increased to $12.1 million, as compared to $12 million in Q1 and was primarily a function of the impact of the Fed rate increases that occurred during the first half of the year and their impact on the floating rate portion of our debt. Interest expense in the coming quarters will increase as LIBOR has increased and total debt levels will increase as we pay for the container investments we have made. During the quarter, our owned fleet increased approximately 25,000 CEU or 2.4% as compared to where it was at the end of Q1. This is the first quarter since Q4 of 2015 that our owned fleet has increased, as over the past almost 1.5 years we had been focused on disposing of vital assets in order to reduce cost and to position ourselves to have the capital available to take advantage when the market container leasing recovered. We are now benefiting significantly from that strategy, a strategy, which while painful at the time is now and will continue to pay significant dividends in coming quarters as we benefit from high utilization and the high levels of investment we’ve been able to make this year. At the end of Q2, we had approximately $2 billion of revenue earning assets $1.6 billion of containers and 0.4 billion of railcars. We invested approximately $95 million in Q2 almost all of it in containers. We currently have $227 million of container purchase commitments for a delivery in Q3, and as I mentioned virtually all of this is leased out already and at rates that generate incremental ROEs in the 20% to 25% range. At the end of the second quarter, we had total funded debt net of restricted cash and cash other than variable interest entities of approximately $1.46 billion. In June, we increased the commitment amount under one of our revolving credit facilities from $775 million to $960 million. At the end of June, the undrawn amount available for us for container related revolving credit facilities was $419 million, undrawn rail commitments were $257 million. On July 6, we closed the $253 million asset backed securitization. This 10-year fixed-rate facility was prized very attractively at 3.7%. Pro forma for this new facility, our ratio of fixed debt to floating rate debt at the end of Q2 would have been approximately 50/50. That concludes our comments operator. Please open the call for questions.

[Operator:]

[Operator Instructions] And our first question comes from Doug Mewhirter from SunTrust. Your line is now open.

[Doug Mewhirter:]

Hi, good evening. In terms of the top competitive environment, it sounds like there is still quite a few less orders on the sidelines, by your estimation how many leasers, distinct leasers are out there, actively spending capital expenditures in Q2 including you?

[Victor Garcia:]

In the second quarter or currently?

[Doug Mewhirter:]

Either way.

[Victor Garcia:]

Okay. In the second quarter it was - we believe it was primarily three leasing companies and we have seen some ordering by some additional leasing companies towards the August September timetable. So, we expect that we are probably going to see more competition in the third quarter as people tried to put that equipment on a lease, but overall I would say the ordering from those companies seems to be moderate, generally speaking.

[Doug Mewhirter:]

Okay, thanks for that. In terms of the factories, it sounds like they are trying to hold the line on prices, steel prices are still high, what about their overall production capacity because I know that they had some, they had to retool because of the water-based paint and it was sort of slow coming online, did they try to milk that a little bit as well to try to help restrict supply? What is basically there - how much could they Flex now to a higher demand for their products?

[Victor Garcia:]

I think the transfer over to water paint has reduced overall monthly production capacity. I would say that what we’ve seen in terms of availability of equipment has been pretty consistent. We can typically get equipment delivered, 6 weeks to 8 weeks out and we’ve been able to pretty much consistently do that. So, I think there has been adequate capacity by the manufacturers. I think the demands that they are seeing has given them some comfort that to maintain prices around the current levels that we saw a few months ago, and so it’s been pretty stable. As far as we’re concerned, all the equipment, largely all the equipment that we have ordered we already have one long-term leases, so we are fully covered.

[Doug Mewhirter:]

Okay. My last question on, speaking on those long-term leases, and you talked about getting a lot of 8 year leases, I am trying to understand maybe without revealing any competitive insights of course, but sort of what the psychology is at the bargaining table, are they - because it sounds in this up cycle to me it wouldn't make sense to, I guess lock in much higher lease rates for 8 years unless it is just a matter of leverage and just where do you have a better bargaining position. Where is the give and take and then the current lease negotiations?

[Victor Garcia:]

It’s a combination of the supply demand situation, the amount of competition, but also certain shipping lines tend to lease for a longer periods of time. Certain lines look at more five-year leases, but other lines will be willing to commit to 8-plus year leases. We had a greater portion of our equipment going out with lines that we wanted to be longer term with.

[Doug Mewhirter:]

Okay thanks. That’s all my questions.

[Victor Garcia:]

Great.

[Operator:]

And our next question comes from Helane Becker from Cowen. Your line is now open.

[Helane Becker:]

Thank you operator, hi gentlemen, thank you for the time. I just have a couple of questions. One is, I noticed that there is some opportunity to do, tracing and tracking of your new containers, and I’m kind of wondering if your new containers come with that ability and then, a; and b, if it makes sense even to do that?

[Victor Garcia:]

We haven't gotten any request and we don't believe anybody who is purchasing containers puts RFID chips on their containers. Customers haven’t demanded it and so there hasn't been a requirement. And from our standpoint, we don't control where the asset goes because the customer does, so being able to track it continuously is really not something that is imperative to us. So unless the customer required it for their own purposes we wouldn't be looking for it.

[Helane Becker:]

Okay. And then my next question is, in the first paragraph of the press release you talk about the increase in revenue and containers due to the investment in the our own fleet and an increase in utilization offset by a decrease in lease rates, so I'm just kind of wondering is that a significant decrease in lease rates that you see? I would have thought lease rates were increasing not decreasing?

[Victor Garcia:]

Generally speaking, lease rates - the trend is that lease rates are increasing. It’s just a mix of how the portfolio laid out, but what I would say, the environment that we’ve been in the last really nine months has been for a rising per diem rates, both on new equipment and in depot equipment going out of the factory.

[Helane Becker:]

Right. That's what I was thinking. Can you say three things? One, if you order a container today when you get it, so what that time frame is? Two, what new container prices are kind of going for right now? And three what the sort of average three lease rate is?

[Victor Garcia:]

If we order containers today, we probably will be looking at late September or October delivery. Container prices are on a 20-foot equivalent basis would be between 2150 and 2200 on a 20-foot. Lease rates, generally speaking are in the low-to-mid 70s for that type of equipment.

[Helane Becker:]

Okay that’s what I was thinking. That lease September, early October that’s kind of a longer time frame right than it has been in the past?

[Victor Garcia:]

Well we’re basically in August, so we are talking about August, September, 8 weeks we could start getting some containers. Six weeks to eight weeks.

[Helane Becker:]

Okay. Yes, because normally you can go what three to four right?

[Victor Garcia:]

No. Typically it’s six weeks to eight weeks out.

[Helane Becker:]

Okay. And then my last question is, on the factories that shut earlier this year, I know some of them never reopened or might not reopen or open late, can you say as, how much if any capacities come out of the manufacturing group on a permanent basis?

[Victor Garcia:]

I don't think there has been from a physical capacity standpoint. A lot of factories that have come out of production, I believe there has been one facility that has not been brought back on, but largely speaking the factories have come back on. Although they are probably producing on a number of TEU per month at a lower level than they were before the changeover to water-based payment.

[Helane Becker:]

Okay. Thank you very much sir.

[Victor Garcia:]

Thank you.

[Operator:]

[Operator Instructions] And our next question comes from Brian Hogan from William Blair. Your line is now open.

[Brian Hogan:]

Good afternoon.

[Victor Garcia:]

Hi, Brian.

[Brian Hogan:]

A few questions. One on capital deployment, couple of questions around that actually, how much do you plan to do like in the full year, I mean obviously you said that you committed 381 through the third quarter, I mean this fourth-quarter you kind of expect to be much lighter or is it not too early to tell at this point? And then follow it up with that, like what you're leverage where it is, how much can you deploy and would you raise capital if necessary if these current attractive lease rates continue, what your average is at?

[Victor Garcia:]

As far as where we are in terms of investment for the remainder of the year, when you get to September or October that’s the bulk of when customers will want to pick up equipment for the holiday season. So, the bulk of our investment on the container side is where you have been made, although we continue to have some opportunities for investment, but not at the pace at which we’ve been investing. If the market did continue in a much greater way, you know there is a limit on how much we can invest, but I would say that we are generating increasing cash flows and our ability to continue to purchase increases as we continue to get additional cash flow coming in.

[Brian Hogan:]

Sure. It is an awful lot of cash to do that. Your ROEs on your new investment, I think last quarter you said they were in their 20s, and I would assume that’s still the case, are ROEs and your new investments comfortably into the 20% range?

[Victor Garcia:]

That was in Tim’s prepared remarks and yes as we look to model that out based on the returns we’ve gotten and our costs of capital on the debt side, cost of debt, it pencils into those kind of numbers?

[Brian Hogan:]

Great. And then trying to think about other contribution from the recent investments, you know 120 million invested in the second quarter, you get a full impact in the third quarter, how much of a bump is that? Because all of a sudden you got 227 investing coming on during the third quarter, I mean I was just trying to quantify the amount of bump is like a 4% ROA, any proper way to think about that, and then kind of quantify it from here or is it, what’s the best way?

[Victor Garcia:]

4% ROA is a good benchmark. We can't go more into specifics because we don't want to go into providing guidance on a quarterly basis, but generally speaking as you said when we make investments and pay for investments during a quarter, part of it is reflected in that same quarter and then the full quarter effect is in the following quarter. So, the third quarter investments will see some benefit in the third quarter, but the full effect will be in the fourth quarter.

[Brian Hogan:]

Sure. And the last one is kind of a bigger picture and it’s kind of for competition related also your customers in your shipping lines, all the consolidation that has been going on, I mean do you see it as a near term benefit and a longer term, you know the customer concentration, they take back some of their, may be some marketing power and heads to some risk of - because of the concentration or how do you frame the shipping line consolidation?

[Victor Garcia:]

Well I think the consolidation as it’s played out it’s actually been somewhat beneficial because the companies that have been acquired have not been historically had a high percentage of leased equipment in their fleets. The companies that acquire them have utilized leasing more. So, as a percentage we will actually, there is a potential of having more leased equipment out in the industry because of who the acquirers are. I think there are also, if you look at the three Japanese companies shipping lines that are coming together, historically they were funded more by parents, by their parents, now they are an independent company, they could come out and be more of a user of leasing. As far as the competitive dynamics, we still think that there is a good balance of shipping lines out there to market not only the major ones, but some other original ones, but clearly the consolidation if it continues much further it is going to limit some of that flexibility that we have, but everything that we’ve been gearing around in terms of broadening our business through diversification and providing higher value services through the logistics is in part reflecting what we thought was going to be a consolidating environment and we’re continuing to try to adapt ourselves to how the whole supply chain changes.

[Brian Hogan:]

Okay. Actually one more, actually it’s logistics business, obviously you are not that big of a contributor when you look at the gross profit that generates, but just looking at the gross profit margin if you will last year 3Q, 4Q is running 14.9 and first quarter bounced up to 16.7, that was kind of business mix in this quarter is backed on the 14.9%, what are the gross margin percentage that’s reasonable, is it the 15-ish percent range and then how fast did the revenues be growing?

[Victor Garcia:]

The gross margin is going to jump around depending on the composition of each of the companies in the market environment, but here in that tight range of 15% to 16%. As far as growth we are very focused on it. We have continued to add people and brought in some recognized talent into the company to help jumpstart additional growth. We don't have a target range that we want to come out and suggest here, but I think we do, we are looking for higher growth in those segments, and our positioning for it.

[Brian Hogan:]

Alright, thank you for your time.

[Victor Garcia:]

Thank you. I just want to clarify the lease rate question we had earlier. It is really a mix issue and it has to do with the fact that we’ve released out, while the lease rates are really good on long-term leases. They are still lower than what we get on interchange leases, and we just have more long-term leases now because of everything that we put out for release in the first six months of the year. So just the math, it is just a mix issue between long-term and interchange on a percentage basis. So, it’s not, there is not any fundamental issue there just a math issue.

[Operator:]

And at this time, I’m showing no further questions. I would like to turn the call back over to Victor Garcia, President and CEO for any closing remarks.

[Victor Garcia:]

Appreciate everyone's time for coming on the call. We look forward to coming and speaking about our third-quarter results in a matter of a few months. Thank you very much.

[Operator:]

Ladies and gentlemen thank you for participation in today's conference. And this does conclude the program. You may all disconnect. Everyone have a great day.