Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Jeff Casucci -- VP, Treasury & IR

Brian Sondey -- President and CEO

John Burns -- SVP and CFO

Analysts

Arthur Hatfield -- Morgan Keegan

Jon Langenfeld -- Robert W. Baird

Gregory Lewis -- Credit Suisse

Rick Shane -- Jefferies & Company

TAL International Group, Inc. (TAL) Q2 2009 Earnings Call Transcript August 5, 2009 9:00 AM ET

Operator

Welcome to the TAL International second quarter 2009 results conference call. As a reminder, all participants are in a listen-only mode. There will be an opportunity for you to ask questions at the end of today's presentation. (Operator instructions). The conference is being recorded.

At this time, I would like to turn the conference over to Jeff Casucci, Vice President, Treasury and Investor Relations of TAL International. Please go ahead.

Jeff Casucci

Thank you. Good morning and thank you for joining us on today's call. We are here to discuss TAL's second quarter 2009 results, which we reported yesterday evening.

Joining me on this morning's call from TAL are Brian Sondey, President and Chief Executive Officer and John Burns, Senior Vice President and Chief Financial Officer.

Before I turn the call over to Brian and John, I would like to point out that this conference call may contain forward-looking statements, as that 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 condition, expected future developments, and other factors it believes are appropriate. Any such statements are not a guarantee of future performance, and actual results or developments may differ materially from those projected.

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 is made herein, despite any subsequent changes the company may make in its views, estimates, plans, or outlook for the future.

These statements involve risks and uncertainties, 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 listed in the company's 2009 Annual Report filed on Form 10-K with the SEC on March 2, 2009.

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

Brian Sondey

Thanks, Jeff. Welcome to TAL's second quarter 2009 earnings conference call.

We are pleased that TAL continues to generate a solid level of profitability, despite the fact that we are now 10 months into the weakest global trade environment we have seen in decades.

Our adjusted pretax income was $70 million for the second quarter of 2009 or $0.55 per share. Our adjusted pretax or cash return on equity was 17%. We generated $71 million of adjusted EBITDA and we continue to use our cash flow to make attractive investments and de-lever our balance sheet.

Our market environment remains quite challenging. Global containerized trade volumes remain well below the level achieved in 2008, and there is little doubt that we will experience the first ever annual decrease in global containerized trade in 2009. Leasing demand remains weak, as containers remain in an oversupply situation. Container drop-offs continued to be high, pick-ups are still low, and our container utilization continues to deteriorate. In addition, the excess inventory of containers continues to create challenges for our used container disposals and container trading margins. However, we are seeing signs that the pressure we face from excess container capacity is starting to moderate.

Our core utilization, excluding factory units, decreased 2.6% in the second quarter to reach 85.9% as of June 30, but utilization fell only 0.6% in June and it fell only 0.3% in July. Our customers are reporting that they thought volumes for the last few months have improved noticeably from where they were earlier this year. And though our transport volumes remain below the level achieved in the summer of 2008, a number of our customers are reporting that their operating container fleets are approaching the right size, and several customers are starting to face container shortages.

For containers, the process of returning supply and demand situation to greater balance is helped by two important features of our business. First, as I discussed before, the ordering cycle for new containers is short. So leasing companies and shipping lines were able to rapidly shut off new container production when the market started to deteriorate last fall. In addition, we estimate that 4% to 6% of containers are sold out of ocean service each year, due to the age and condition of the containers.

Because of these two features, the global container fleet has been shrinking 1% to 2% for a quarter since last fall, and we expect this reduction to continue as long as there are excess containers on the ground in China. As a result, we should not need trade volumes to fully recover to pre-crisis levels, before we see the supply and demand situation for containers return to a more healthy balance.

In the meantime, while we remain in an excess supply situation, we should continue to get strong support from our lease portfolio. 65% of our containers are currently on long-term or finance leases. And this has ensured that the extremely weak market conditions have impacted our utilization and leasing revenue only gradually. We have also been able to extend the average remaining duration of our long-term leases this year. As of June 30, the weighted average remaining lease term of our long-term lease portfolio was 47 months, up from 38 months at the beginning of the year. This increase in the average remaining duration primarily comes from a number of lease extension transactions that we completed this year.

While it seems the pressure we face from excess container capacity is starting to moderate, the risks we face from customer defaults remain significant. Our customers have been suffering this year from a combination of reduced cargo volumes and severely depressed freight rates, and more shipping lines are reporting large operating losses in 2009.

For the shipping line, the problem of reduced trade volumes in 2009 is compounded by large order booked vessels that will lead the significant growth in vessel fleet over the next several years. As a result, excess vessel capacity and weak freight rates are likely to persist; well, after the supply and demand situation for containers moves back into balance. While the increase in trade volumes over the last few months is providing some relief to our customers, we do not expect significant improvement in their financial performance or a significant reduction in our credit risk until trade volumes recover much more substantially.

As we discussed on our last call, the current market environment does create opportunities as well as challenges. We continue to take advantage of what we believe are unique, high investment opportunities made possible by the severe economic and financial conditions. Since the economic crisis started last fall, these unique opportunities have included a number of purchase lease back transactions with some the world's largest shipping lines, the repurchase of 1.9 million shares of our common stock at an average price well below our tangible book value per share and for a very low multiple of our free cash flow, and the repurchase of two tranches of our debt at substantial discounts to par value. Year-to-date in 2009, we have invested over $85 million in these types of transactions.

Because of the strength of our cash flow, we have been able to reduce our leverage this year, despite the difficult market conditions and the investments we have made. The leverage ratio I focus on most closely is the ratio of our net debt to our revenue earning assets. In general, for the last several years, we have managed our investments and dividend policy to maintain this ratio in the mid to upper 70% range. However, as you know, at the beginning of 2009, we decided to effectively suspend our dividend program partially so we can build a larger equity cushion.

At the end of the second quarter, the ratio of our net debt to revenue earning assets was down to 71% compared to 75% as of December 31, 2008 and 76% as of June 30, 2008. We expect this ratio to continue to decrease over the next few quarters, even if market conditions do not improve.

Now I would like to introduce John Burns, our new CFO. As you may have seen in the 8-K we filed on June 9, John Burns has moved from his position as Senior Vice President of Business Development to become our Chief Financial Officer.

Before I provide little more background on John, I would first like to thank our former CFO, Chand Khan, for his many years of great work at TAL. Chand joined TAL in 1984 as a manager in our accounting department. Over the years, Chand rose up through the ranks and became our chief financial officer in 2002. As CFO, Chand was instrumental in our business and financial success, and he played a critical role in the sale of TAL from TransAmerica in 2004 and our initial public offering in 2005. Chand's capabilities and tremendous sense of ethics and loyalty to TAL will be missed. Fortunately though, Chand will continue to work with us on a consulting basis over the next several years.

John Burns joined TAL in 1996 as a director of internal audits. John worked his way up through our audit and accounting groups, and served as our CFO for several years, while we were a division of TransAmerica Finance. John then moved over to the business side of TAL, where he initially oversaw marketing and lease pricing, and most recently had responsibility for our business development, treasury, and credit functions. Given his varied career path within TAL, John will bring a deep understanding of both the operating and financial issues we face.

John will now take over the call to provide more detail on our numbers.

John Burns

Thank you, Brian.

As Brian noted, the weak containerized trade volumes and resulting weak demand for these containers is negatively impacting our financial results. However, the impact on our financial results has been slowed by the long-term nature of our portfolio, our lease extension deals, and our solid credit collection performance.

As we note in the earnings release, we adjusted EBITDA, pretax income and net income to exclude unrealized gains on interest-rate swaps and on debt extinguishment, as we believe these adjusted figures does reflect the company’s operational performance.

Our adjusted EBITDA, which includes principal payments on finance leases, totaled $71.2 million for the second quarter, a decrease of 4.5% from the first quarter and a decrease of 6.5% from the second quarter last year. Adjusted pretax income for the second quarter of 2009 was $17 million, a decrease of 18% from the first quarter and a decrease of 36% from the prior year period. Our adjusted pretax earnings per share was $0.55 for the second quarter, down from $0.65 in the first quarter and $0.81 in the second quarter 2008.

Adjusted net income for the second quarter 2009 was $10.9 million, a decrease of 18% from the first quarter and a decrease of 37% from the second quarter of 2008. Adjusted EPS was $0.35 per share, down from $0.42 for the second quarter of 2009 and $0.52 from the second quarter of 2008. Our earnings per share for the second quarter of 2009 benefited slightly from these earlier periods due to our share repurchase program.

Leasing revenue for the quarter was $79.4 million, a decrease of $3.8 million from the first quarter this year, but an increase over the second quarter last year of $1.5 million. The increase over last year was largely a result of a 2% decrease in our fleet size. The change from the first quarter 2009 is the result of three key items.

First, we completed several lease extension transactions with customers, in which we agreed to lower (inaudible) levels in exchange for term extensions and reduced (inaudible). Second, despite the lease extensions, coal utilization, excluding factory units, dropped by 2.6% during the second quarter to 85.9%. Third, the negative impact of these first two items was partially offset by fees generated by the early termination of certain lease contracts with one customer.

The decreased utilization of shipping containers worldwide has also put downward pressure on used container selling prices. And accordingly, our trading margins and gain on sales owned containers are both down from the first quarter this year and the second quarter last year. Our equipment trading revenue was down $6.4 million from the first quarter this year and down $14.3 million from the second quarter last year. These decreases are a result of weaker demand for these containers and correspondingly lower selling prices. Because of these market conditions, we have substantially reduced our purchase of resale containers and concentrated our container sales efforts at disposing our own sale inventory, which has grown as a result of increase in redeliveries.

Along with the drop in equipment trading revenue, we have experienced a significant reduction in the margins on these sales. In second quarter 2009, the equipment trading margin was $165,000, down $1.1 million from the first quarter and down $3.6 million from the second quarter last year. Reduced margins are largely a result of the downward trend in selling prices during 2009. We typically have a lag of several months between the time we buy and sell used containers. Therefore, when prices are falling, we will experience smaller margins than normal. In addition, since we have limited our purchasing of resale containers this year, we have had fewer higher-margin new deals to offset the lower margins on the older inventory.

The falling sale prices for used containers has also negatively impacted the gain on sale of our own equipment. For the second quarter, we recorded a gain of $2.4 million, down $1.2 million from the first quarter this year and down $3.8 million from the second quarter last year. Our provision for (inaudible) accounts was $100,000 for the second quarter, down $200,000 from the first quarter and down $100,000 from the second quarter of 2008. Despite the very difficult trading conditions for our shipping line customers, we have not experienced any significant customer defaults during 2009, and our collections remain strong with only $1.9 million in accounts receivable over 60 days past due.

However, we remain concerned that we may see an increase in the number and size of customer defaults in 2009, due to the poor performance and actual performance of the shipping lines, combined with the constrained capital markets. But these concerns have been somewhat tempered recently by the demonstrated ability of several lines to raise capital from various stakeholders despite the difficult market conditions.

Due to the weak demand for lease containers during 2009, our investment in new containers has been minimal compared to prior years; and for the remainder of the year, we expect our traditional investment in new factory containers will continue to be limited. However, we will continue to optimistically invest in transactions such as sale-leasebacks, debt and stock buybacks, and other attractive investments that tend to arise in challenging environments such as this.

We generated nearly $146 million in adjusted EBITDA during the first six months of 2009, which, together with limited new container procurement, enabled us to reduce our leverage and take advantage of the unique investment opportunities Brian highlighted.

Because of our continued strong cash flows and a close matching of the amortization of our debt with the run-off of our assets, we anticipate we will continue to build liquidity and reduce our leverage through the remainder of 2009. We are pleased with our performance in this challenging environment and cautiously optimistic about the remainder of the year.

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

Brian Sondey

Thanks, John. I will now finish the prepared part of the call with some thoughts on our current outlook.

Trade volumes and leasing demand remained weak, especially compared to what we typically experience in the peak summer season for dry containers. And while we are seeing some improvement in cargo volumes and the pressure from excess container capacity seems to be moderating, we are not expecting a sharp rebound in cargo volumes just yet, and we expect the general oversupply situation for containers to last a while longer. As a result, we expect that our utilization will continue to slide in the third quarter, though at a much slower pace than in the first half of the year. We expect that our disposal gains and trading margins will remain pressured until we see the excess supply of containers significantly reduce.

Our average lease rates will also be further impacted this year by the lease extension deals we have completed in the second and third quarters of 2009, and as a result, we expect TAL's profitability to continue to trend down until the combination of the recovery in trade volumes and the gradual reduction in the global container fleet bring the supply and demand balance for containers more into our favor. However, as long as you don't face major customer defaults, the strength of our lease portfolio should help us maintain solid profitability throughout 2009 and we expect to continue to build our net worth and reduce leverage, even while our market remains weak.

In summary, we are pleased that we remain solidly profitable in the second quarter, despite facing extremely difficult market conditions. Market conditions are likely to remain challenging for a while longer, and we continue to face excess container capacity, decreasing utilization, and pressure on disposal prices and trading margins. But slightly improved global transport volumes and the ongoing reduction in the global container fleet seem to be moving the container supply and demand situation back toward balance. And even if market fundamentals do not materially improve in 2009, we expect to remain solidly profitable throughout the year.

I would now like to open up the discussion for questions.

Question-and-Answer Session

Operator

(Operator instructions).

The first question is from Mr. Arthur Hatfield of Morgan Keegan. Please go ahead, sir.

Arthur Hatfield -- Morgan Keegan

Thank you. Good morning, everybody. Brian, just a couple of questions about the pricing dynamics. First, theoretically, when we get back into balance of supply and demand, how long does it typically take for pricing to start to accelerate after you see that balance? And then secondly, are you seeing anything structurally within the business that is changing how pricing is measured or agreed upon? Are there any structural changes in the pricing aspect of your business? And also, again, the question about lag.

Brian Sondey

Well, I think -- we talked before that usually in our business, lease pricing is really driven by container prices, that usually, there is a very high correlation between the supply and demand for containers, given the short ordering cycle for the containers. And so, again in most market environments, the thing that drives lease rates is just container prices and a little bit of competition among the leasing companies and some supply and demand dynamics. This year is a little different, in that the main thing driving lease pricing right now is just the bet about how long is it going to take until the supply and demand situation for containers comes back into balance.

And so, you are seeing leasing companies agreeing to put containers on hire to customers, and this includes us, at rates below the level we typically would do relative to where we think container prices are, just because, in our view at least, like we sell for more quarters, before the excess inventory of containers gets absorbed. And so to some extent, there is benefits to be had by putting containers on hire now to avoid storage costs, generate some revenue doing the period when they might not be on hire otherwise.

Going forward, once you get back to a situation where the supply and demand of containers is back into balance, I think it is actually going to be a decent pricing environment for us. In terms of container prices, steel prices in China have held up pretty well and there has been a lot of new stories recently about prices moving up even further on the -- or I guess premised on the domestic demand for steel in China. And in addition, we think the competition we face from ownership of containers directly by shipping lines as well as competition from smaller leasing companies that in the past have been funded by the KG markets, that should be I think more limited in the next several years than it was before the summer of 2008, and that should be helpful to the pricing environment.

Arthur Hatfield -- Morgan Keegan

Do you have a measure right now, kind of how much excess capacity is in the marketplace?

Brian Sondey

We don’t have a great measure, but there is a lot of anecdotal evidence and just industry speculation. The numbers I typically see is that people talk about something in the range of two million to three million TEU of containers being on the ground in China. That compares to a total container fleet of about 25 million TEU. Two or three million sounds like a relatively big number, but I think people should keep in mind that usually three million or more TEU are produced every year, and there is going to be very little container production this year, as low as just two to three million TEU is very small relative to the total size of the global container (inaudible). And so will really take much of an improvement in global trade volumes, we think at least to eat into that inventory.

Arthur Hatfield -- Morgan Keegan

Great. Just one last thing then. When you look at the end of life markets for a container, when you sell those containers, do you see anything changing structurally or are we just seeing kind of near-term cyclical issues in those markets?

Brian Sondey

You know, we don't see anything dramatically different there. We have actually sold pretty good volume of our own equipment this year. I think as John described, our volume of third-party sales is down just because we are a little cautious about buying into this market as well as just want to focus our sales efforts on our own equipment. On prices, have been trending down since the fourth quarter of 2008, but it has been a very slow trend and quite frankly, I'm pretty pleased with the way resale prices and volumes are holding up. I think it just comes down fundamentally to containers are pretty handy things, and even in an economy like this one, there still are a lot of people that seem to want to be able to buy 200 to 400 square feet of wind and water tight storage for not all that much money.

Arthur Hatfield -- Morgan Keegan

Great. Thanks for your time, Brian.

Brian Sondey

Thanks, Art.

Operator

The next question comes from Jon Langenfeld of Robert W. Baird. Please go ahead with your question.

Jon Langenfeld -- Robert W. Baird

Hey, good morning, guys. What do you think the bank’s longer term view is, Brian, of the leverage and do you think there is any fundamental change in terms of how they would lease debt relative to equity on a given transaction?

Brian Sondey

You know, that is a good question. In the past, we have typically set up our facilities to provide something in the range of 82% advance rate against the equipment. You know, most of the deals that we have done since the crisis first started last fall has been smaller transactions and some of those, we're getting high advance rates. In fact, some of them, we get 100% against the equipment, they are sort of very specific, almost like leasing type transactions. And so we have been maintaining on the deals we have done so far we've been maintaining leverage pretty well. I guess we're taken down our overall corporate leverage partially just as something that we wanted to do strategically, but the leverage and the facilities themselves hasn't come down all that much. That said, the facilities we have been putting in place are much smaller than the types of facilities we were arranging before the summer of 2008.

And so, I think it is somewhat of an open question, when the banks get back in more aggressively or whatever source we go to for more substantial financing facilities, just what is the leverage going to be for those, but I think that our performance in this environment is really showing that there is a reason why we have been able to get a decent amount of leverage in the past, that our lease portfolio provides great visibility on revenue and cash flow, even in very challenging markets and I think all of our interest coverage ratios in our facilities are in great shape and we are hopeful at least that we will be able to continue to borrow at decent advance rates against the equipment.

Jon Langenfeld -- Robert W. Baird

And do you think at 82% -- do you think that it is still -- I mean, it sounds like from what you are saying that you are hopeful that they can -- they still view the market like that longer-term.

Brian Sondey

Yes, I think it is hard to say if 82% is the number we are going to hit or exactly what it is going to be, but I think our facilities continue to perform very well, and I hope that as banks -- when they start lending more aggressively again that they can take that into account, but certainly, lot of banks that were putting significant amount of capital into the shipping industry are pulling back to some extent and we are going to have to go out and find new sources of capital and we're doing that right now to sort of fill in the gaps.

Jon Langenfeld -- Robert W. Baird

Got you. And then, do you get the sense that the number of boxes (inaudible) I think typically 4% a year?

Brian Sondey

4% to 6%.

Jon Langenfeld -- Robert W. Baird

4% to 6%? Okay. And then, do you get the sense that over the last 12 to 18 months, that that has been lower because carriers and/or leasing companies have just tried to extend the box life?

Brian Sondey

You know, it is hard to say. We don't get really good statistics on the container fleet throughout the year, there are couple of surveys that are done by a few magazines that usually at a point in time, couple of times during the year they kind of get a snapshot and so I don't right now have a great macro view on whether the overall disposal rate is up or down. My sense is that it is probably not all that much changed from where it was. On the one hand, as you know it, there is very little buying of new containers and so there is a greater willingness of the shipping lines to hold onto older equipment that they have use for. But at the same time, Carl one of the down and shipping lines and leasing companies have been looking to turn excess inventory into cash. And so that has been a motivation to sell. As best we can tell that the market remains quite healthy and volumes are probably about where they have been.

Jon Langenfeld -- Robert W. Baird

Okay. Fair enough. And then, just a couple of numbers. What is the average age of your fleet at this point?

Brian Sondey

At the end of 2008, I think it was just about seven years. This year, it has gone up a little bit because of the lack of investment in our continued efforts to push out and extend the life of the equipment. My guess is it is somewhere between like seven-and-a-quarter and a little bit over that type of range.

Jon Langenfeld -- Robert W. Baird

And then, what was the average utilization in the quarter, all in?

Brian Sondey

You know, we look at utilization two ways. One is, where we have our overall utilization, which includes everything including our factory units on the ground and the other one is core utilization, which excludes those units. Average overall, including the factory units was 85.1% for the quarter.

Jon Langenfeld -- Robert W. Baird

I’m sorry. 81.5%?

Brian Sondey

85.1%. And then, core utilization, excluding the factory units, looks like it was 87.2% to 87.3%, on average.

Jon Langenfeld -- Robert W. Baird

So your factory units then have not --

Brian Sondey

About 2%, a little over 2% of the fleet.

Jon Langenfeld -- Robert W. Baird

All right. So very consistent with the last several quarters. And then your -- what about the for-sale, that was like 4.5% at the end of the first quarter, where does that stand?

Brian Sondey

Yes, that has gone up. It is about 5.2% at the end of June 30. And basically, what is happening is just the containers are coming off higher, much faster this year than they have in previous years, especially in the first two quarters of the year. And so, we have been getting more units moved over into the sales pack we have been able to sell, and again that is one reason why we have been pulling back on buying and training containers. You know, my sense is we will -- over time, clean that out pretty effectively and just we have taken the view that given now that we are probably only a couple of quarters away from the supply and demand of global containers coming back toward balance and more in our favor, we don’t want to cut price significantly on our inventory of sale containers just to move volume, as we do expect to set it better supply and demand balance, we are now having to wait too long for that.

Jon Langenfeld -- Robert W. Baird

And what was the -- you had a comment in your prepared remarks, I just missed what it was. There is a 165 number, something about your domestic trading profit, I don't know if you were talking about per unit or for the overall division.

Brian Sondey

Overall trading model number $165,000, which is obviously down quite substantially from the profit margins we were making last year. And really, I think John tried to describe this, a couple of things happening there. One is just container prices have come down significantly. And so, when say we entered into a lot of the sale volume we do as part of a sale, we stack transactions for blocks of equipment, and so I think something like 40% or more of our containers in our sale inventory were purchased through lease back transactions in 2008, back when container prices were higher, we made a lot of good margins on the boxes from those deals that we sold in 2008, but the remaining boxes from those deals, as they come off higher from the customers, and we are making much smaller margins.

The second thing that is happening is, we're just not replacing the inventory. And so, typically, I always think there is two elements to our trading margin. One is, the trading margin that we typically price into the deals and we buy containers and the second is the inventory profit or loss that we get while we hold the containers between the time we buy and sell them. That first element really isn’t around this year, that we are not buying containers at the new lower price at the typical margins you might expect, and so all we're really getting then is this sort of lower reduced margin from the containers that we have bought previously when container prices were higher.

We do evaluate the portfolio of trading equipment every quarter, and if there are embedded losses we take it during the quarter and that can lay on the margin as well, because it is reflected in the number. But in general, we just expect that margin to be fairly small until either a container -- use container prices go up or we start buying more used containers as part of our trading business.

Jon Langenfeld -- Robert W. Baird

Okay. And then one of your competitors commented on the typical recovery they kind of see the 20-footers start to pick up and then some of the 40-foot high cubes. Would you share that view and have you seen anything along those lines?

Brian Sondey

I mean, it is generally true that the typical rhythm of the year is that we got good 20-foot demand earlier in the year, which typically is thought to be inter-Asia cargo and (inaudible) raw materials, kind of the first stages of production. And then demand shifts over the summer time for 40-foot and 40-foot high cube containers as finished goods are coming out of the factories in Asia to the U.S. and Europe. And it is definitely, I agree that that is the typical rhythm that we've seen this year, that 20-foots during the first part of the year were our best performing product and very weak demand for 40s and high cubes. And we have seen some improved demand in the (inaudible) for 40-foots and high cubes recently. And so hopefully, that is a sign that things are moving back toward normal, but again, we certainly wouldn't say we have gotten all the way back to normal yet.

Jon Langenfeld -- Robert W. Baird

Got it, got it. And then just a couple of things. What about the pricing? How should we think about just conceptually the pricing concessions to extend the lease terms, could you just maybe bucket -- are we talking a couple of additional years of life and then how would this compare to the lease extensions you did back in 2005?

Brian Sondey

Well, in 2005, most of the deals we did, it was a relatively very healthy market for leasing back then, there wasn't a global oversupply of containers to any large extent at least. And in 2005, the deals were mainly geared toward extending our oldest units on hire to get extra revenue life out of those units and it was very much of a trade-off of taking lower revenue now for overall higher NPV on the lease.

This year, we have really two objectives on the lease extension deals. One is, the same where we have been very active in extending leases to get extra revenue life out of our oldest containers and I mentioned that the average remaining duration in the lease portfolio increased from I think 38 months in the beginning of the year to 47 months now. And a lot of that is just keeping our oldest containers on hire into the 13th to 14th year. In addition to that sort of general strategy we always have, this year, we've also made concessions to temporarily cut off hires, that we do have a view that supply and demand for containers is bad right now, but likely to be much more in our favor in a couple of quarters. And so, we have been willing to give concessions to keep containers on hire through 2009.

And so some of those concessions will go away as we get into 2010, and again our premise is that supply and demand will be much better for us at that time, obviously, we will have to see. And so, this quarter, as you will see in the Q when we put it out, the impact on our average rates was fairly substantial, something in the range of 5% on our dry containers and reefers, and that is a combination of this sort of permanent lease extension deals on equipment that we are taking out to the end of its useful life, together with some of these temporary deals that provide discounts this year in return for limiting off-hires this year. And that part of it will go away in 2010 and then it really will be a plus, as it always is, to remarket those containers and find other ones.

Jon Langenfeld -- Robert W. Baird

And that would apply to how many containers, could you guess, what percent of the fleet?

Brian Sondey

You know, I didn't (inaudible) that number, but it is a substantial amount. I would say it was almost all of our large customers, we have done some transaction.

Jon Langenfeld -- Robert W. Baird

So then the last question I have is just -- and kind of in the context of understanding the puts and takes of utilization, the default slowing and the pricing maybe get a little bit worse sequentially. You know, your rate of deterioration on a sequential basis of earnings has been pretty consistent I guess from the third to the fourth and then four to the first and first to the second. Should that rate start to slow or speed up or remain the same relative to all these puts and takes?

Brian Sondey

Yes. We try not to get too specific into our forecast. We do think that until we see a more substantial recovery in a better balance of supply and demand that we will continue to go down. You know, there is a number of things that you point out that ought to slow the rate of the deterioration that utilization is going to drop, we think much more slowly in the third quarter than it did in the first and the second. Our disposal performance has been actually very strong so far in the third quarter in terms of volumes going up and (inaudible) staying relatively solid. And so that would – those things (inaudible) in order to slow down. On the other hand, as we do the suspension deals, the rate concessions do accumulate and that does place for the pressure. All in, I don't think it should be tremendously different from the rate of change that we experienced in the last couple of quarters, but it is hard to say exactly if it should be the same or a little bit more.

Jon Langenfeld -- Robert W. Baird

Sure. Good context. Thank you.

Operator

The next question comes from Gregory Lewis of Credit Suisse. Please go ahead.

Gregory Lewis -- Credit Suisse

Thank you and good morning. Brian, my first question is related to -- you made mention of it in your press release and then you mentioned it a few times on the call today about major customer defaults potentially occurring. Have you had any discussions with any of your customers or are you hearing anything that leads you to believe that this is a real concern?

Brian Sondey

No. As we look at the portfolio on a customer-by-customer basis, it looks -- each customer looks very good and you get comfortable that the likelihood of a default in any particular case, certainly you wouldn't bet it is going to happen. These are very big companies, in many cases, $10 billion or more of revenue on an annual basis, many billions of net worth on an accounting basis. They entered this period of crisis in great financial shape after several years of record profitability. Many of the customers are part of larger industrial transport groups that overall are performing okay and several of the customers have either explicit or implicit government ties. And so all that together, as you look at the individual customers, they look pretty good.

However, the shipping lines are facing the toughest market that we have seen in many, many years and so that raises just the level of uncertainty. And in addition I think part of our concern comes out of the fact that we actually feel pretty good about the basic business equation that because of the lack of container buying and the steady erosion of the global container fleet, coupled with the fact that perhaps the inventory destocking is running its course in the U.S. and Europe and we are seeing some improvement in trade volumes, we feel quite good that supply and demand moved back into a balance in a relatively near-term and our lease portfolio is in great shape and should carry us through to that time with pretty solid profitability. And the only thing that could thought to be the fly in the ointment is if our customers don’t honor the obligations that they have in their leases. And so as we move through the last couple of quarters where the business was looking very unstable and was hard to say where bottom was, we feel we found it and we feel it is starting to move in the other direction and so feel better about the basic business fundamentals, which leaves credit as our primary concern, just to make sure that those leases are honored.

Gregory Lewis -- Credit Suisse

Okay, great. And then this really quick follow-up on that. There has been some reports now that a major German liner company has been going out and looking to get great concessions on existing leases and assets. Have you had any discussions with any of your customers regarding potentially taking in a haircut to existing leasing contracts?

Brian Sondey

Well, we've had conversations with probably everybody about restructuring the leases, as I was saying, and every shipping line is under operating pressure and financial pleasure and all the -- of our clients actually tend to be saying that -- equivalent to vice president of operations or something -- have been tasked with cutting their budgets. And they are talking to us about how they get savings on their business with us.

Generally, what we try to do is to look for ways so that the structure would win transactions. What we need, we want to reduce the flow of off-hires this year to just kind of keep containers on hire until supply and demand is more in our favor. We also like the idea of extending our oldest containers on lease that extend the revenue earning life of the equipment. And so generally, we respond to those inquiries with yes, we can talk with you and yes, we can provide some savings, but our contracts are contracts and it has to be give and take discussion, where we look to help with your immediate needs and you look to give us long term value. And that is the way we put all these things.

Gregory Lewis -- Credit Suisse

Okay, great. And then just my last question is regarding -- you mentioned the early termination of one of -- containers with one of your customers. Could you provide some color on that regarding say, like how many containers was it, potentially who the customer was and if you can't do that, maybe what region of the world they are operating in?

Brian Sondey

Yes, I don't want to get too much specifically into the details of the customer or the discussion, but it was just a case where the customer had containers on long-term lease. They -- the duration of that lease went for actually a number of years in some cases past this one, and the cowboy probably 20,000 containers or something in that range. The customer, strategically was deciding to shrink the size of their fleet, they didn't have all the flexibility that they wanted in their lease portfolio. They are direct customer that we're very close with and we agreed to essentially let them break the lease contract and start bringing containers back early, but they agree to pay a penalty for that that covered a good portion of that. They would have paid us for the remaining duration of the lease term.

As a leasing company, we have an ability to redeploy the equipment eventually, and so, it just was again one of these, I think a nice win-win situation where the customer had a strategic interest in reducing the container fleet right now. We felt we could remarket the containers during the remaining duration of the lease successfully and we are able to give them flexibility and hopefully preserve value for us.

Gregory Lewis -- Credit Suisse

Thank you for your time.

Operator

Your next question comes from Rick Shane of Jefferies & Company. Please go ahead.

Rick Shane -- Jefferies & Company

Thanks, guys, for taking my question. Just a couple here at this point. The provision was actually down sequentially and down year-over-year for the first time. Should we glean anything into that? How do you determine your provision? Is it based upon sort of general economic expectation or is it a function of what you see specific to your portfolio?

Brian Sondey

It is very specific provision. For our operating leases, it is not like financial asset accounting, where we -- the asset we have is the container, rather than the lease contract with the customer. And for our container assets, which is the majority of our balance sheet, we don't keep a general reserve against that equipment on hire, again sort of saying the general possibility that a customer may go default. And so our provision for most of our -- most of the vision you have is actually a specific provision against specific receivables, or our allowance that we have is mostly a specific allowance against specific receivables.

For our finance lease portfolio, we do have a general reserve based upon our historical loss experience. But we didn’t generate any really new significant customer defaults so far in 2009, and so we just haven't had to add to those allowances very much this year, as the provisions have been small.

Rick Shane -- Jefferies & Company

Okay, great. And then, I'm fascinated by the dynamics, I mean, obviously you have a long-standing partnership with the manufacturers in China. And there is this unique dynamic that they basically shut down production. This is unprecedented what we have seen in terms of the length of the shutdown. What are the conversations like with the manufacturers at this point? How long do they expect to be shut down? And again, I realize that you want to be a little bit circumspect in what you are saying about your conversations, because it is interesting competitive information, but how long will it take them to gear up the factories once there are orders that are placed and what is your expectation on when we could see that develop?

Brian Sondey

Well, I think one of the nice features of our business is that the majority of the price of the container is variable cost. And for most of the cost is the steel that goes into the container, another big chunk is the wood (inaudible), and then there is also, paint is fairly expensive. And so, in addition, in China, one of the reasons why I think manufacturers go there is that labor to some extent is a variable cost as well there. And the factories go from two ships to one ship, they go from one ship to close, they just send all the workers home.

And so, because of that, because the variable costs are -- I don't know, 85%, 90% or more of the cost of the container, there really isn't an incentive for the manufacturers to build containers into inventory, on the hope they can lease them or sell them down the road, just because the risks that they take in terms of equipment price changes and the investment they would need to make in the inventory outlay the opportunity I guess to continue to cover fixed costs by keeping the factory.

And so, what you always find in markets that are not nearly as bad as this is that the manufacturers very flexibly respond to whatever demand there is by either upsizing the production force or downsizing it. And again, it is only building to order, it is not building to inventory for the manufacturers. And so we're talking with manufacturers to sort of keeping general touch about what is happening with input prices and are there any orders out there by shipping lines or leasing companies, but quite frankly, there is very little discussion about actually ordering sizable numbers of containers, and I think factories are just quite practical on -- as long as there is 2.5 million TEU containers or whatever it is sitting on the ground in China, and as long as financing is relatively scarce, there's just no one in the industry that has any interest in building large number of containers.

Rick Shane -- Jefferies & Company

Great, thank you. I will limit myself to two questions.

Operator

(Operator instructions) There are no more questions at this time. I would now like to turn the conference back over to Brian Sondey for closing remarks.

Brian Sondey

Well, I would just like to thank everyone for your ongoing interest and support of TAL and we will be looking forward to talking to you next time. Thank you very much.

Operator

Thank you all very much for participating in the TAL results conference call. This concludes today's event. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: TAL International Group, Inc. Q2 2009 Earnings Call Transcript
This Transcript
All Transcripts