TAL International Group's CEO Discusses Q4 2012 Results - Earnings Call Transcript

Feb.14.13 | About: Triton International (TRTN)

TAL International Group, Inc. (TAL) Q4 2012 Earnings Call February 14, 2013 9:00 AM ET

Executives

John Burns - SVP & CFO

Brian Sondey - President & CEO

Analysts

Michael Webber - Wells Fargo

Art Hatfield - Raymond James

Sal Vitale - Sterne Agee

Ken Hoexter - Bank of America Merrill Lynch

Rick Shane - JPMorgan

Daniel Furtado - Jefferies

Doug Mewhirter - SunTrust Robinson Humphrey

Operator

Good morning and welcome to the TAL International Group Fourth Quarter 2012 Earnings Release and Conference Call. All participants will be in listen-only mode. (Operator Instructions) After today’s presentation, there will be an opportunity to ask questions. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Mr. John Burns, Senior Vice President and Chief Financial Officer. Please go ahead sir.

John Burns

Thank you. Good morning and thank you for joining us today on today's call. We are here to discuss TAL’s fourth quarter and full year 2012 results which were reported yesterday evening. Joining me on this morning's call from TAL is Brian Sondey, President and CEO.

Before I turn the call over to Brian, I would like to point out that this conference call may contain forward-looking statements as the term is defined under the Private Securities Litigation Reform Act of 1995 regarding expectations for future financial performance. It is possible that the company's future financial performance may differ from expectations due to a variety of factors.

Any forward-looking statements made on this call are based on certain assumptions and analysis made by the company in light of its experience and perception of historical trends, current conditions, expected future development and other factors it believes are appropriate and any such statements are not a guarantee of future performance and actual results or developments may vary materially from those projected.

Finally, the company's views, estimates, plans and outlook as described on 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 herein despite any subsequent changes the company makes in its views, estimates, plans or outlook. These statements involve risks and uncertainties and are only predictions and may differ materially from actual future events or results. For a discussion of such risks and uncertainties, please see the Risk Factors located in the company’s annual report filed on Form 10-K with the SEC.

With these formalities out of the way, I’ll now turn the call over to Brian Sondey. Brian?

Brian Sondey

Thanks John. Welcome to TAL's fourth quarter 2012 earnings conference call. TAL's results in the fourth quarter of 2012 provided a strong finish to another outstanding year. In the fourth quarter of 2012, we generated $1.60 in adjusted pretax or cash income per share and our operating performance remained at a very high level despite the start of the slow season for container shipping.

Our utilization averaged 97.7% for the quarter and currently stands at the same high level. Our leasing revenue increased 3% from the third quarter as we benefited from a full quarter of revenue on containers put on hire during the summer. And used container disposal prices held up well and remained well in excess of their long-term historical range.

TAL's results for the full year of 2012, reflected another year of outstanding operating performance and aggressive investment in growth. We generated $6.05 of adjusted pretax income per share. Utilization averaged 97.9% for the year and we invested almost $875 million in our container fleet leading to 20% in our revenue earning assets and 16% growth in our leasing revenue.

While we achieved record profitability for both the fourth quarter and full year of 2012, our profitability has been increasing more slowly than our asset or leasing revenue. For the first part of the year, depreciation expense was increasing as a portion of our leasing revenue. This is mainly the result of a quirk in our fleet demographics. We purchased few containers in late 1990s and early 2000, so the portion of older, fully depreciated containers in our fleet has been shrinking. This effect is mostly been played out and we expect depreciation expense to more closely follow our asset growth going forward.

Moderating used container sale prices also impacted the growth of our pre-tax income. Used container sale prices remained well above their long-term historical range, but they have been slowly moderating after reaching a peak in the summer of 2011, which is leading to a gradual drop in our disposal gains. We expect used container disposal prices and our disposal gains to continue to moderate in 2013.

Overall though, I think it is most important to note that we achieved another year of record profitability in 2012 and that we continue to generate exceptional returns on our assets and our equity. The large investments we have made in our fleet have also locked in long-term benefits from the strong markets we've seen over the last few years. The vast majority of our new container purchases have been placed on multi-year, long-term leases, significantly growing our base of recurring leasing revenue and providing a strong foundation for profitability, cash flow and dividends for years to come.

TAL’s strong performance in 2012 was supported by attractive market fundamentals. Strong growth in intra-Asia and other regional trades offset weak performance of the main East West trades and led to moderately positive global trade growth for the year. Demand for leased containers was further supported by our customers’ increased reliance on leasing. We estimate that roughly two-thirds of new containers were purchased by leasing companies in 2012 and we were also able to complete several large sale lease-back transactions where a number of our customers sold parts of their existing old container fleets to us. Unlimited direct buying by our customers in 2012 also had the effect of constraining the overall volume of new containers produced. This helped us maintain a very high level of utilization and supported our used container disposal prices.

It looks like we will begin 2013 in much the same way we finished 2012. Most of our customers are indicating that they expect trade growth to be moderately positively again in 2013 and some are expressing more optimism that the major East West trades will return to solid growth this year which would have a disproportionate impact on container demand due to the longer voyage times on these trade lines. We expect leasing companies to continue to purchase a majority of new containers in 2013. Though we have seen several shipping lines place container orders over the last few months to take advantage of seasonally lower new container prices.

Market leasing rights for new container transactions are also aggressive right now as key financing has become readily available for smaller and mid-sized container leasing companies as well as for larger companies like TAL. Still we expect to have a wide range of investment opportunities this year as many of our customers continue to rely on leasing for even their base load container requirements and we are off to a good start in 2013 with our investment program and leasing transactions. Year-to-date, we have already invested over $200 million in containers for delivery in 2013 for new container purchases and sale lease-back transactions.

As mentioned in the press release, we are increasing our dividend again this quarter to $0.64 per share. This increase reflects our continue strong performance and our expectations that market conditions will remain favorable for sometime. The increased dividend also reflects the growth of our long term lease portfolio and the growing share of our profitability coming from recurring leasing revenues.

I will now hand the call over to John Burns, our CFO.

John Burns

Thank you, Brian. As we noted in our earnings release, adjusted pretax income for the fourth quarter was $53.7 million or $1.60 per share, up 2% from the fourth quarter of last year. This fourth quarter figures included change in the residual values used in our depreciation calculations which reduced depreciation expense by $5.2 million for the quarter.

Leasing revenue increased approximately 12% from the prior year’s fourth quarter. As we realized the benefit of our significant ongoing investment in new and sale lease back containers. This solid topline revenue growth was partially offset by a $3 million drop in disposal gains reflecting a 15% declined in used container sale prices from the high levels realized in the fourth quarter of 2011 and $2.5 million increase in operating expense resulting from several items.

First, a higher repair activity in support of our releasing activities. Two, increasing body control cost related to container production. And higher storage costs reflecting 1% decline in utilization from the prior year’s fourth quarter.

As we noted in the earnings release, we have increased the residual values used in our container depreciation calculation after conducting our annual review of historical disposal prices. Based on this review, we reset the residual values to take into account the sales prices we've realized since the residuals were last reset in the fourth quarter of 2010 and our expectations for future disposal prices.

The new residual values are generally in line to somewhat below our public peers depending on equipment type. Over time, the entire residual values will lead to reduced disposal gains offsetting the decrease and depreciation expense. However, for the next few years the change in residual values will not have a significant impact on disposal gains because we have over 65,000 units that were fully depreciated to the prior residual amounts and these units are likely to make up the majority of container sales over the next two to three years.

As a result, for the next few years we expect the change in our residual values to lead to increased profitability compared to what we would have achieved with our previous residual estimates. Based on our fleet at year end, the increase in residual values would result in a reduction and depreciation expense for 2013 of approximately $19 million or $0.57 per diluted shares on a pretax basis.

For 2013, we expect depreciation expense as a percentage of leasing revenues to be roughly in line with the fourth quarter of 2012. We have historically looked to lock in our interest costs over the period of our leases by matching the duration of our lease portfolio with the duration of fixed interest rates.

However, in this very low interest rate environment, we've extended the duration of our locked in interest rate position to beyond the remaining lease lives and closer to the remaining life of the container fleet.

To accomplish this, we've extended the average remaining term of our interest rate swaps by approximately two years. Over last three years, we've invested over $2.5 billion in containers, growing our fleet by over 100% during that period. This growth has been achieved without a material increase in the cost of our infrastructure leading to significant expansion in our operating margins and demonstrating the scalability of our business.

For example, our administrative costs in 2008 were approximately $46 million or 14.5% of leasing revenues. And in 2012, they were $44 million or 8.5% of leasing revenue. As Brian noted, we've increased our quarterly dividend to $0.64 representing a relatively high payout ratio on our adjusted net income, but representing only 40% payout ratio of adjusted pretax income.

We based our dividend payout on pretax income as we have not paid cash taxes and do not expect to pay cash taxes for a long time because of the accelerated tax depreciation on our container fleet. This beneficial tax position also results in our dividend distribution typically qualifying as a return on capital rather than a taxable dividend for US tax purposes. As always, investors should consult with the tax advisor to determine the proper treatment of TAL’s dividend distribution.

I will now return you to Brian for some additional comments.

Brian Sondey

Thanks John. It currently seems that many of the market factors which supported our (inaudible) in 2012 will continue into 2013 and the balance of container supply and demand seems likely to remain in our favor. Because of this, we expect to benefit from another year of high utilization, strong profitability and attractive growth.

The first quarter is usually our weakest quarter of the year due to the seasonally weak trade volumes for dry containers. This typically leads to net off-hires, a like decrease in our utilization and relatively low dry container disposal volumes. This year, we also expect to use container sales prices to continue to moderate toward historical ranges.

However, one of our customers has notified us that they intend to declare about 1,500 containers as lost and we expect the resulting gain to offset much of the typical first quarter seasonal weakness. As a result, we expect our adjusted pretax income to hold relatively steady from the fourth quarter of 2012 to the first quarter of 2013.

After the first quarter, we expect increase in leasing revenue from our ongoing fleet investments to offset further impacts from normalizing disposal gains and we expect to continue to generate very high levels of profitability and returns throughout the year.

I will now open up the call for questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) Our first question will come from Michael Webber of Wells Fargo. Please go ahead.

Michael Webber - Wells Fargo

I wanted to touch on a couple of things and first of all, the $200 million number year-to-date you threw out that's a pretty big number. I am assuming (inaudible) annualize that and get to $1.6 billion in spending this year, but I am sure how we should we think about that within the context of the first quarter obviously you are free buying quite a bit, can you keep that up for the back half, can you may be put that number in terms of the context because that’s bigger than most of us were expecting?

Brian Sondey

Yeah it’s a little bit bigger than we have been this time of year but I think part of it depends on how we count it, some of our competitors have reported a lower number but I am not sure we are that different. When we talk about our capital spending, we typically count containers in the year that they are expected to be delivered. So fair number of containers that were counting us part of that $200 million, we ordered in November or December and they are expected to be produced in January, February and March and so to be honest, it’s not a huge number and I wouldn’t say that number of times seven or eight whatever or nine.

We continue to think that the market is very favorable for us. We do expect trade growth again to be moderately positive and if anything I would say our customers are a bit more optimistic for 2013 at this point than they were this time last year for 2012. Again in addition as we mentioned, we expect leasing companies to continue to make up the majority of new container purchases and expect for most of our customers there are direct purchases to be somewhat limited and so we are optimistic.

But I think the most important thing for capital spending is that we want to do profitable business the right way and we build our shop of equipments there in the off season and hopefully buy at good prices and then I think it’s taken off as we do deals we replace it and we never really have a great sense of exactly where we are going to get to until we get there at the end of the year, but as you know we feel good about 2013 for sure.

Michael Webber - Wells Fargo

That makes sense, continued breakdown that $200 million in terms of what was priced this year versus what was priced in Q4 and then may be you can give a breakdown in terms of equipment type?

Brian Sondey

To be honest, I don't even, what we priced in November, December and January we always just track it as what we have ordered for delivery van and what remains uncommitted. And it’s a fairly you know, we operate at wide range of equipments types in our fleet and I don't think that the orders are materially different mix than our fleet in general.

Michael Webber - Wells Fargo

Okay, all right, so it is stay with historical patterns, as maybe shifting to utilization, you guys were able to keep utilization flat during a period in which your two competitors are 100 basis point or more declines, can you maybe talk to what drove that and then what helped you to maintain better efficiency than it appears last quarter?

Brian Sondey

Yeah, I think it’s just a different way we approached the business to some extend. I think we have always taken the approach that we want to be very easy for our customers to pick up our containers and we want to be relatively keep for them to hold and we want to be a very kind of difficult for them to drop off and so we intend to focus on long-term leases, even more than that we tend to probably be the tightest in the industry about logistical flexibility. We really focus on getting our containers back and allowing off-hires really only in places where we can put them back to work which if the shipping lines after return containers in the top demand areas where they need more, and they might just want to save the fractional cost of off-hire and keep the containers in their fleet.

And I think that is the main thing and you don't return for that focus on duration and logistical control, we do sometimes offer competitive rights to get those things, but it’s a trade up we like and we typically do find whenever whatever seasonally or heading into a slower market that our utilization attends to hold up well relative to peers just because of that focus.

Michael Webber - Wells Fargo

We've heard some commentary in another call of around deals getting a bit more competitive which would make a little bit of sense considering there are smaller new entrants into this space and pretty wide availability of capital, can you maybe talk to any sort of yield compression you guys are seeing out there on the market and how you think that would trend throughout the first half of the year.

Brian Sondey

We've definitely seen I'd say over the last quarter or two a very aggressive competition for new deals, and my thought is that mainly its coming from the fact that not only are the larger companies in the industry being able to tap cheap financing in the asset backed markets and chief bank financing, but that relatively cheap financing is now extending to all players in the market. So there is increased competition for every deal, and typically we do see that in the slow season, shipping lines now are doing leasing transactions not to pick up containers in February and March but to prebook containers for April, May, June and July and so they do have the luxury of time to put a competitive process in place for their requirements at this point.

Our hope is that that will mitigate to some extent as we head towards the peak season and that guys like us that can maintain big shelves of equipment will be rewarded for that with better pricing as the demands become more urgent, and we typically do see that in years where there's reasonably good trade volumes. But certainly competition is tough for deals which again is why I mentioned at the beginning we much more focus on how many deals we can do profitability and be happy with rather than just some kind of number on CapEx.

Michael Webber - Wells Fargo

That makes sense, maybe Brian to kind of put it into some sort of context, yields right now are they still within that normal historical band kind of in the low double digit range or are we seeing them kind of break out lower, just trying to get a gauge on exactly how competitive that pricing environment is.

Brian Sondey

I don't want to get into too many faults of our pricing model, but certainly we not only have the cash on cash returns, typically we look at a bunch of things and we try to evaluate lease pricing, but the most important thing we look at I think what you are referring to which is our expected equity return over the life of the equipment. But we also look at what people refer to kind of the cash on cash number, which is say the ratio of leasing revenue to the cost of the equipment. And that second number, that ratio of the cash on cash has fallen a lot over the last year or so, but a lot of that is just due to the very cheap interest rates and so as financing costs have fallen pretty dramatically say by a 100 or 200 basis points over the last year that has a sort of a direct impact on cash on cash but that doesn't in itself comprise the equity returns. But we've also seen some compression on the equity returns as well, not catastrophic for sure and we wouldn't do deals that fell below our target threshold, but we are seeing more of the transactions hovering around the bottom end of our range as opposed to being kind of spread across our target return range.

Operator

Our next question will come from Art Hatfield - Raymond James.

Art Hatfield - Raymond James

A couple of my questions you touched on with Mike, Brian can you talk a little bit about the 1500 containers that are going to get declared lost, how that transaction gets handled with the customer and if because they are lost will you be able to put on containers back with that customer.

Brian Sondey

Yeah, so typically all of our leases have a clause that if there's a real bonafide loss and then sometimes it requires documentation from the customer and so on that the containers truly are lost or destroyed that there is a casualty clause and they can buy out the containers from us. Typically those are set at very conservative levels to make sure that we don’t suffer a kind of loss of market value on equipments or something and so usually it's a very favorable price for us and in this case its just a customer where the equipment is located and probably they are just not going to get it back in no practical way and so the equipment is lost. It’s really something that they declared. So as for our lease agreement though, they will pay us out for that equipment. We do not have a right in this case to require them to pick up replacement containers, but again it's not, while it’s a meaningful number in terms of the quarterly gain and profitability. It's not a meaningful portion of our fleet and it's about 1500 containers in our fleet, out of 2 million TEU. So it's not like, I don’t think we’re going to notice a drop in leasing revenue. It's just a gain, you know, sort of changes the earnings trend from the fourth quarter to the first.

Art Hatfield - Raymond James

And we think about, and you may not want to mention with the total number of the gain that you generate here but if we were to think about earnings, ex this issue, we just see the normal seasonal debt from Q4 to Q1.

Brian Sondey

Yeah, exactly.

Operator

Our next question will come from Sal Vitale of Sterne Agee. Please go ahead.

Sal Vitale - Sterne Agee

So, just a quick question, just following up on the lost containers here. Should we think about that in terms of their 1,500 containers we make it some assumption of a gain on sales of each container and your gain on sale will be higher by that amount for the quarter?

Brian Sondey

Yeah, that’s right and because you guys have mentioned the contracts are written to make it relatively unattractive for customers to claim they lost their containers. They gain on a per container basis that we usually realize from a declaration of loss containers is higher on a per container basis than we might typically get when we sell containers, and so it’s the combination of just the volume of equipment that will add to the normal volume that we sell plus the fact that the per unit gain on these is high.

Sal Vitale - Sterne Agee

Okay and then just on your P&L, the leasing fees other portion of operating leases was that roughly 5.5 million similar to last quarter?

Brian Sondey

It was very similar but its 6 million 6.0 for the fourth quarter.

Sal Vitale - Sterne Agee

So just following up on the CapEx. So you mentioned just want to make sure I understand so the 200 million of CapEx you are saying that some of that was ordered in 2012, so does that mean that some of that was already part of the 875 million that you did in 2012?

Brian Sondey

I was trying to explain and so it gets a little confusing as you have to pick some kind of event that’s going to allow you to allocate the capital spending between the years, and so the (inaudible) if you could choose you could decide you can count the equipment when you order it, you could count equipment when it gets delivered, you could count equipment when it goes on hire but to try to be consistent and make sure that we do not double count what we have adopted over many years is the count equipment as CapEx for the year in which it’s delivered. So for example, if we order containers in November for delivery in January that will be counted as part of the year in January and so some of the containers they are not 200 million that we have already ordered for 2013 again those might be orders we placed in November but those containers are being delivered this year. I don’t know how our peers decide how to draw the line between one year’s CapEx and the next, but we do not double count one year to the next.

Sal Vitale - Sterne Agee

Okay, so the 200 is separate and distinct from the 875 you have in your release for 2012

Brian Sondey

That is exactly right.

Sal Vitale - Sterne Agee

Okay, and then so did you mention earlier what the breakdown of that was new versus sale lease back.

Brian Sondey

We didn't mention it and typically we don't like to give an exact breakout, but its majority new containers.

Sal Vitale - Sterne Agee

Okay, so majority new containers, okay, if I think about that in terms of just what your forecast is for global container production in 2013, are you thinking somewhere in the ballpark it’s a 2.7 million to 3 million to use?

Brian Sondey

Yeah, to be honest to don't really worry too much about what we think the whole year is going to be. We like to put equipment up on the shelf and maintain an inventory of equipment somewhere between 100 million and 200 million unchanged and we get to the upper end of that inventory as we feel better about the year which is a combination if we are really buying at the right prices and relatively optimistic on trade growth and optimistic on leasing share. As those things are true we push the inventory up, higher as it opposites to we go lower and we just we look at what deals we win and as we win deals and we replace equipment on the shop and we kind of get to where we get to.

I think the great strength of this business is that you don't have to make thing on future expectations that you can play market as it comes and that's what we are doing, I think if trade growth ends up somewhere in the expected range of 5% or 6%, it’s likely that by the end of the year something like $2.7 million or so $2.8 million TEU will be produced but those are future orders that are replaced throughout the year and we kind of get there, and we get there.

Sal Vitale - Sterne Agee

Right, okay, and so just if that number just turn out to be say $2.7 million, $2.8 million on assuming that similar percentage of the new container orders are replaced the lessors and also assuming that your market share is constant; I get to some number like call it 500-ish or $500 million to $600 million of CapEx for TAL just on the new container side, does that sound about right?

Brian Sondey

We don't like to give forecast for component items of our performance, but, and again we don't typically focus on we need to get our particular market share, but we do think as I said, it looks like its going to be another fertile year for investment with trade growth ends up being 5% to 6% to 7%, I think that's a pretty good back drop, again I think we will continue to see shifting market share from own to lease equipment and certainly we feel we are as competitive and more competitive than anybody in winning new deals and if all those things are not being as we expect I think there's going to be another very good year for CapEx.

Sal Vitale - Sterne Agee

Do you think conceptually and I know its kind of hard to peg what your purchase lease backs will be because its opportunistic, they are opportunistic types of transactions, but just broadly do you expect it to be 50-50 or 70-30 one way or the other?

Brian Sondey

I would say probably not 50-50, I mean you ever really know; we've been very active in the sale lease-back market over the last few years, but still the vast majority of our container purchases have been new. The sale lease-backs are a nice way. We like the deals, there is less utilization risk, you can be very creative in how you structure those deals to be kind of exactly meet what the customer wants in terms of pricing versus flexibility and so on and we expect to be active, you know, our hope is it will be another good contribution to our CapEx, but the bulk of our CapEx has been and we expect it to be new equipment.

Sal Vitale - Sterne Agee

Just last question, can you give a sense for the $200 million you've done thus far, when you expect it to be fully delivered in generating revenue?

Brian Sondey

I mean, it will be fully delivered shortly, probably the orders we place, maybe run for production through March, you know we've done a fair bit of leasing transactions already this year in terms of committing units to lease, but again, most of those are set up with somewhat flexible pick up timing where this time of the year most customers do not have significant container requirements, but they expect to have them later in the year. And so they really be picked up as we see trade volumes start to grow, I mean typically that's been, we see the peak season starting to built in April and to May and June, if that happens we would expect those units to start converting into revenue at that time. But again, really it just depends on when trade volumes start to pick up on a seasonal basis.

Operator

Our next question will come from Ken Hoexter of Bank of America Merrill Lynch.

Ken Hoexter - Bank of America Merrill Lynch

Can you just give a couple of thoughts here on sale lease-backs, talk about the process of the discussions how long they move on for and how advanced some discussions maybe with the line of companies at this point?

Brian Sondey

Yeah, it really depends based upon the size of the deal and who the customer is, I mean certain customers have done a series of sale lease-backs over the last few years and for those customers the discussions tend to be pretty fast, because they have a structure that they like and its really just a question of getting leasing companies to put prices on the units and quote per diems and things. And they could come up on a you know Monday and be finished by a Friday.

Other transactions, typically with either very big transactions, like we did one or two very sizeable ones last year and especially with companies that haven't done these kind of deals before you know those discussions can take longer time, can be a month or a month and a half even between the time you first discussed the transaction and the time you get it done.

I would say over the last 12 or 18 months its always some deals in the marketplace that we are looking at and others are looking at and its really just a question of what's our position in those deals, how aggressive do we want to be and whether we're going to win them or not. But they are very hard to predict, especially the bigger ones, because it's not always clear which shipping lines are going to be interested and willing to pull the trigger on those transactions.

And again, there is nothing that I do want to comment on being looming in the near future, but again, we do feel optimistic that the shipping lines will continue to see the value in monetizing their container assets at a time when container values are high and also we can bring really a lot of operating flexibility to the shipping line and these structures and I think they see the value on that as well. So we're hopeful that there will continue to be opportunities for us there.

Ken Hoexter - Bank of America Merrill Lynch

Okay. So just to clarify then by putting in the release, that’s just a one avenue of growth. It wasn’t that you are anticipating kind of a larger step up in pace, and something in the sale lease back?

Brian Sondey

With our CapEx year-to-date there is some meaningful sale lease back in there and again not a majority, but a nice transaction and we do think it will continue to be part of the mix for 2013.

Ken Hoexter - Bank of America Merrill Lynch

Wonderful. And then you walk through the D&A math earlier, just curious, what made the change now; was there a noticeable shift in the sell price of assets or just want to understand the thought process on that?

John Burns

Sure. Ken it’s John; we changed our residuals last in 2010 in the fourth quarter. We do an annual review and look at the situation. In 2010, we got the numbers we had for residuals, it made a lot of sense that that point, looking back over the long period of time and where residuals were at that point in time. You know, subsequent to that determination, you know, we saw very strong markets in 2011. We've seen residuals remain relatively high. So at this point in time, we thought that as we look forward, we thought that increasing those made sense. I think we also look there is a long-term number we are looking at what residuals would be over 10-15 years.

So without just look at the current sell prices on a standalone basis, we look at we think prices will be over that long period of time and we do think there has been somewhat of a shift up in that and largely because we have seen somewhat of a shift in the new build prices. We think that the long-term relationship between new build prices and the disposal prices will eventually get there somewhere in the 40% to 50%, sale price has been 40 to 50% on new build prices but we have seen what we think it may be a long-term increase in new build prices.

Brian Sondey

And I think the other thing just to note is that we look at the same information our competitors do and again about long-term trends and sell prices of new and used equipment and we were over the last couple of years way above our residuals in terms of the realized sale prices and there is a lot of room to come down.

Most of our public competitors at least had revised their residual prices earlier. I think either at some time in the middle or toward end of 2011 and so our residuals were lagging those significantly. With the change we just made, we don’t do it to get in line with our competitors but it is something we look at and this change kind of brings us more into line although probably we are still a little conservative relative to at least our public peers.

Ken Hoexter - Bank of America Merrill Lynch

Appreciate that and if I could just wrap up with two numbers then, one, how you have seen new build prices where do you see them now and how you have seen them trend over the past couple of months?

Brian Sondey

Sure, the new build prices were probably reached a low point at least near-term low point sometime in October, November at that 2,200 or thereabouts. Our guess is that when the factory is reopen after Chinese New Year and they will be in the upper 2,300, to 2,400 but somewhere in that range but we will see, so they moved on about little less than 10% from the low point reached in the fourth quarter.

Ken Hoexter - Bank of America Merrill Lynch

Okay, and then my second number question, actually there were two, just CapEx, with this $200 million I understand some of the carryover but would you suggest to this point given that magnitude that your goal would be to increase CapEx above 875 from last year or is it do you not make that proclamation this early?

Brian Sondey

Yeah, we don't make that proclamation because the fact, I mean is really for two reasons, one is just its hard to predict what the year is going to bring and we don't have to and we have the great benefit of being able to play the market as it comes due to the short ordering cycle for containers. And then secondly again, mainly it’s because we are much more focused on doing good deals than doing lots of deals.

We would be happier with $600 million of well priced CapEx than $900 million of poorly priced deals and again we hope to do a big number of well priced deals, but again we are really focused on making sure the investments we make, it makes sense. And so, again it’s hard to predict but we do feel as I said, it is going to be another very fruitful year for us so, of high utilization, strong profitability and lot of investment opportunities.

Operator

The next question will come from Rick Shane of JPMorgan. Please go ahead.

Rick Shane - JPMorgan

I want to focus a little bit on the expense side both the operating expenses and the interest expense, John has walked through some of the reasons that the administrative and direct operating expenses were higher, but I love to drop down into that little bit more. I am assuming at the higher (inaudible) repair costs are sort of one-time in nature and not something that we should think about recurring in our models going forward?

Brian Sondey

Yeah, I think that's true, we did at the end of the year a large transaction for pick up of all the repairs and we kind of had a rush process of getting all those repaired in time to put those units on higher and until they have the effect kind of fun loading some repair expense from probably repairs we would have made in the first or second quarter into the fourth quarter to get those units ready for pickup because it was a nice transaction for us and so that didn't push repair expense up a little bit.

In terms of the admin expenses are actually pretty flat and then it have been one of the nice economies we've achieved as we've grown as John tried to point out. The storage expense is going up a little bit probably it is a recurring one. You know we've seen utilization you know, its still exceptionally high but we were running utilization at close to 99% for much of say from the second half of 2010 through the end of 2011 and now its gradually drifted from exceptionally high to just really, really high that's pushing storage expense up a little bit and we expect that to continue.

Rick Shane - JPMorgan

Right and frankly, there has been tremendous operating leverage on that line item related to utilization over the last couple of years. So the direct operating expenses, the bucket was $2 million higher year-over-year and the third item that John pointed to is the higher quality control items as well, can you, I guess the one question is that do you guys have agents who do your QC for you in Asia or are they direct employees?

Brian Sondey

Mostly it’s direct employees. I think one of the things that we really focus on I think its true for most of the bigger container leasing companies as we spend an awful lot of time and money and resources on making sure we get the containers produced the way we order them. And we do lots of testing, you know, of materials, we send lots of people to watch their production process and so on and that ends up being costly. I think this year we did make a determination for our spending to buy a bit more counter seasonally for dry containers especially to take advantage of typical lower pricing in the fourth quarter. I think we did that perhaps a bit more in 2012 than we did in 2011 and so that probably drove that price that operating expenses line up a little bit on a quarter-to-quarter basis.

Rick Shane - JPMorgan

Got it. Okay that's helpful and so when we, I would sort of I guess put that in the less sort of linear like when you put the repairs, when you think about that $2 million then how much would you attribute to each of those three items, is it pretty equal between the three or is it more related to storage costs?

Brian Sondey

It’s pretty equal between them.

Rick Shane - JPMorgan

Thanks for all the precision on that. The other item a little bit contrary to how we would have expected with the interest expense which fell modestly and I don't want to put too fine a point on it, but when you think about what average balances were, it doesn't, it contradicts what we would have anticipated in our model, can you help me understand what's going on there is it just we don't have good average balances or was there a reduction in funding cost or some roll off of amortization structure or something like that?

John Burns

Yeah, sure, Rick its John, one of the things I mentioned here is we use swaps to manage our floating rate debt and as interest rates have gone exceptional low, we felt that it would be worthwhile to extend the average remaining term to, we typically try to match the lease portfolio. So with the idea that has the lease portfolio, lease come up for renewal, they get replace at current lease rates with lease rates so low, we basically look to extend swap portfolio. In doing so, we cancel some that had a short remaining term, had to pay some cash and you will see that in the cash flows and enter in to longer-term swaps at lower rates, at current market rates.

Brian Sondey

Somewhat of a counter intuitive thing is that we, as John pointed out, we canceled a bunch of short duration swaps and replace them with much longer duration swaps to better take advantage of the current interest rate environment. But just because the way interest rates have moved over the last few years that cancellation and extension of our interest rate swap portfolio actually lowered the average effective interest rate.

Operator

Our next question will come from Daniel Furtado of Jefferies. Please go ahead.

Daniel Furtado - Jefferies

The first question I had is does inflation factor in to the residual value expectations at all?

Brian Sondey

For sure. Quite frankly when I talk with our investors, I would say, some of the investors that come to buy our stock are those that have relatively bullish on inflation. The main component of container prices and steel prices and obviously commodity prices move with inflation, and so to the extent that there continues to be inflation or commodity inflation or just inflation in general, that would have the effective increase in future new build container prices, which we believe, has a direct correlation than the future residual prices. To be honest, I don't think we factor in future inflation in to resetting these residuals, and if there is, we're probably very much in the low side. But we kind of looked again at history and looked at current levels of new build prices and when we thought they would go, say, without significant inflation and set our revised residuals on that basis.

Daniel Furtado - Jefferies

And so is it I am not getting carried away if well may be I am. But if we assume when we get into a higher materially higher inflationary environment then there is a potential for the depreciation expense to actually move lower on a percentage basis because of that relationship?

Brian Sondey

Inflation in general was very good for us because it increases the releasing value of the fleet and the sale value to fleet for sure.

Daniel Furtado - Jefferies

I got that I wasn’t sure if they would manifest through expenses which it sound like it does. The second question and I apologize if I miss this, but did you discuss pick up and drop off activity just broadly in the quarter. We don’t necessarily need specifics because I think we will see that in your presentation at some point, but just kind of how those flows were and how they compare seasonally?

Brian Sondey

Yeah sure, typically since in terms of numbers of containers typically it’s dominated by dry containers pickups and drop offs, and usually the first quarter is the weakest where we get relatively few pickups and seasonally more drop offs. I will say the first quarter both the end of the fourth quarter and the beginning of the first quarter are holding up very well that drop offs some containers are pretty low despite the seasonality, and while we haven’t seen a lot of hiccups we have seen some. So I would say it’s on a net basis probably a bit stronger than it was this time last year and not dramatically so but may be a little bit.

Daniel Furtado - Jefferies

I appreciate you may not be able to answer this question, but you made commentary in your forward outlook that the reduction in container prices in the fourth quarter potentially spurred some purchases from the container liners. How do we think about that going forward? Is there a linear relationship or do you see a price for new containers at which liners will become more aggressive or is it just simply the lower they go the more likely they are going to be aggressive and there is really nothing scientific about it.

Brian Sondey

I couldn't come up with the mathematical formula to describe how shipping line purchases relate to new container prices. But we have seen in general though that shipping lines intend to purchase a bit more opportunistically then leasing the finance. Our business is renting containers to our customers and maintaining equipment availability, so we need to buy containers just to keep our doors open. We have to buy container regardless of what’s happening with new container prices, although of course we do try to match that to our lease rates.

In terms of shipping lines I think a lot of them they do tend to maybe avoid buying containers when they are expensive and them rely on leasing a bit more on those times and the opposite when containers are low. The container prices they are not low historically, I mean 2200 and 2400 where they have been over the last quarter or two that’s actually reasonably high price for containers over the last 10 years or so, but it’s low looking back at leasing history.

And just given the fact that [lines] have relied so heavily on leasing over the last year or two, some of them took the opportunity of the seasonal decrease in container prices to do some buying in the fourth quarter.

Operator

Your next question will come from Doug Mewhirter of SunTrust Robinson Humphrey. Please go ahead.

Doug Mewhirter - SunTrust Robinson Humphrey

Two general questions, first based on your stock of the manufactures, I don't know they shut down for the Chinese New Year. How do you think, does it sound like they are during out was maybe a little bit extra people on the shift or do you think that they are still going to try to hold back a little bit when they start backup?

Brian Sondey

My guess is they will maintain a relatively conservative stance. I don't think we've seen a say a huge rush towards ordering by anybody over the last couple of months. There's been some steady ordering by leasing companies and maybe again as I described a little more ordering of our shipping lines, but I don't think that the manufacturers are going to open up at the Chinese New Year going double shifts in all locations or anything and again its very much like us. They've got some opportunity to sort of play the market as it comes. They can add labor capacity and not overnight but relatively quickly within a quarter or so. And I think they will open up at moderate production levels and see how it goes, but again that remains to be seen.

Doug Mewhirter - SunTrust Robinson Humphrey

My second and last question is more balance sheet type question, could you just remind me what kind of leverage ratios you are comfortable with in terms of your balance sheet and you could whatever number you usually go by either debt to equity or debt to equity including your tax deferral or debt to capital.

Brian Sondey

The number that we think is best and the number that most of our debt agreements are geared around is the ratio of our net debt to a revenue earning assets, and by looking at that that has the effect of including deferred taxes effectively as equity which we think makes sense and typically we like to keep that ratio of net debt to revenue earning assets somewhere around 75%. Sometimes it gets a point or two lower or point or two higher, but that's the type of place we like to operate.

Operator

Ladies and gentlemen the final question this morning will come from a follow-up from Sal Vitale with Sterne Agee.

Sal Vitale - Sterne Agee

John just a quick clarification, earlier you mentioned the depreciation change would comprise $0.57 per share, is that for 2012 or for 2013.

John Burns

That's based on the ending fleet at 12/31/12 you know would that change it would be about $19 million reduction in depreciation expense. So the $0.57 was basically that on a pretax basis.

Brian Sondey

That's a pretax number Sal.

Operator

Ladies and gentlemen this will conclude our question-and-answer session. I would like to turn the conference back over to Mr. Brian Sondey for any closing remarks.

Brian Sondey

Thank you just want to again thank everyone for your participation on the call and look forward to keeping in touch over the course of the year. Thanks.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.

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Tal International (TAL): Q4 EPS of $1.04 beats by $0.09. Revenue of $151.8M misses by $1.05M. (PR)