TAL International Group's CEO Discusses Q1 2014 Results - Earnings Call Transcript

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TAL International Group, Inc. (NYSE:TAL)

Q1 2014 Earnings Conference Call

April 24, 2014 9:00 AM ET

Executives

John Burns - SVP and CFO

Brian Sondey - President and CEO

Analysts

Steven Clark - Keefe Bruyette & Woods

Gregory Lewis - Credit Suisse

Donald McLee - Wells Fargo Securities

John Mims - FBR Capital Markets

Sal Vitale - Sterne, Agee

Rick Shane - JPMorgan

Doug Mewhirter - SunTrust

Art Hatfield - Raymond James

Operator

Good morning, and welcome to the First Quarter 2014 Earnings 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.

And I would like to turn the conference over to John Burns, Senior Vice President and CFO. Please go ahead.

John Burns

Thank you. Good morning and thank you for joining us on today’s call. We are here to discuss TAL’s first quarter 2014 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. 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 developments and other factors it believes are appropriate. 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 in the 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 for the future. 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.

These formalities out of the way, I will now turn you over to Brian.

Brian Sondey

Thanks, John. Welcome to TAL International’s first quarter 2014 earnings conference call. TAL achieved solid results in the first quarter of 2014. We generated adjusted pre-tax income of $1.41 per share, while down from last year, this level of profitability still represents an 18% annualized return on our adjusted equity in the seasonally most challenging quarter of the year. TAL’s solid performance is mainly being driven by our high utilization. Our utilization averaged 97.1% during the first quarter and also currently stands at 97.1.

Our high utilization continues to be supported by a generally favorable supply and demand balance for containers. Trade growth was less than 4% last year. But the production of new containers was also fairly limited. In addition, few containers were produced in the first quarter of this year and factory inventories remained well down from peak levels reached in 2013. Our high utilization is also supported by TAL’s strong lease portfolio, our investment discipline and our industry-leading remarketing and operating capabilities.

Over 75% of our containers on hire are covered by long-term or financed leases and these leases have an average remaining duration of almost four years. In addition, we are highly focused on ensuring that our containers are returned to strong demand locations at the end of their leases, which significantly reduces remarketing risk and container operating costs. TAL’s extensive global operating infrastructure, our deep customer relationships and excellent reputation for customer service and reliability also help us generate second and third leases for our used containers, enabling us to maintain strong utilization and a long useful life for our container fleet. Due to these strengths, TAL’s fleet performance and returns on equity are at the upper-end of our industry.

Our overall market environment remains mixed. Leasing demand was better than expected in January and we generated an unusually strong number of container pickups. The leasing activity slowed in February after the Lunar New Year and overall first quarter activity was more normal. General expectations currently seem to be that trade growth in 2014 will be a little better than it was last year and we’re seeing pickup volumes improve from February into March and April.

We’re also hearing from a number of customers that spot container shortages could become more widespread if trade volumes remain on their current trajectory. The market for new investment remains challenging despite the lower current level of factory inventory and expectations for somewhat improved trade growth. Container prices and lease rates increased about 10% in January due to the unexpectedly strong leasing demand and container factory closures, but lease rates and container prices have both drifted back down. Several leasing companies remain highly focused on investment volume and deal share despite the reduced level of current investment returns, which has helped compete away the early improvement in rates.

Low cost debt financing also remains widely available to smaller and mid-sized container leasing companies. Really for the first time, we’re seeing limited rating or financing spread differentiation between debt issued by the large more established leasing companies like TAL and debt issued by newer and less capable players. We’ve have a hard time understanding this development given the critical role that investment discipline and logistical operating and remarketing capabilities play in maintaining the performance of the container portfolio, especially as the containers age and expire off their initial leases.

As mentioned in our press release, we declared a dividend of $0.72 per share this quarter. This represents a payout of 51% of our adjusted pre-tax income in the first quarter. As we’ve discussed on our last call, we think this payout ratio provides a good balance between returning a large portion of our strong cash flow to investors, while retaining sufficient equity to fund the growth of our business.

I will now hand the call back to John Burns.

John Burns

Thank you, Brian. As we note in our earning release, TAL International posted adjusted pre-tax income for the first quarter of 47.5 million or $1.41 per share, down 13.5% from the prior year quarter. The change in pre-tax income from the prior year was driven by three key items. First, 5.2% increase in leasing revenue from the prior year as we benefited from ongoing investment to new and sale leaseback containers. Second, a 1.3 million reduction in interest expense from the prior quarter despite an 8% growth in revenue earnings assets as we benefited from a lower overall effective interest rate on our debt. The third and biggest item impacting the first quarter was a $7.2 million decrease in our gain on sale from the prior year quarter, largely due to the ongoing moderation of disposal prices. Dry container disposal prices were down nearly 20% from the prior year’s quarter as supply and demand continued to moderate leading to more units available for sale.

In addition in the prior year’s first quarter, we recognized $2.5 million gain from a customer declaring 3,000 CEUs of our containers lost. This gain was not repeated this quarter. Overall our gain on sales continues to be impacted by lower level of disposal volume of high margin original TAL units. We purchased few new containers in the late 99s and early 2000s, and as a result, we had fewer of these units to sale age. We’ve made up for the lower volume of the original TAL units with the sale of older units purchased through sale leaseback transactions. However, these units typically generate lower per unit gains than the original TAL units because they were purchased for prices higher than the net book value of like vintage original TAL units.

The 5.2% growth in leasing revenue was driven by our ongoing fleet growth partially offset by a small reduction in utilization and an approximate 4% reduction in average per diem rates. The decrease in average per diem rates was largely due to lower container prices, aggressive competition, and widely available low cost financing. The lower per diem rate environment not only impacts pricing on new containers, but also negatively impacts the renewal or releasing of existing units. Over the next year, we have very limited lease explorations. However, the container prices and lease rates remain low for the next several years. We will face increased pressure from re-pricing as portions of our high price 2010 and 2011 leases expire.

At March 31, we estimate that the current market lease rates are roughly 20% below our portfolio average, but the gap is even higher for our 2010 and 2011 vintage units reflecting the high prices of new containers purchased in those years. Lease explorations for those units will generally begin in 2015 and explorations are spread fairly evenly through 2020. Therefore, market lease rates would need to remain at current low levels for several years to impact a large portion of this portfolio, even then the impact would be spread out over a long period of time.

As we noted earlier, interest expense for the first quarter was actually down $1.3 million from the prior year quarter, despite the 8% increase in our revenue earning assets reflecting our lower effective interest rate. Over the last year, we’ve had lowered our effective interest rate by nearly 50 basis points, to 3.85%.

Looking forward, market interest rates stay where they are, we could see some further improvement in our overall effective interest rate, but our overall rate is approaching current market levels. In addition to lower and our effective interest rate, the actions we have taken have increased the portion of our debt portfolio with fixed interest rates more than 85% with the weighted average remaining term of over 60 months. This position protects us from the risk of increased interest rates for a number of years.

Overall, our solid profitability continues to be supported by a tight control of direct operating and administrative expenses. While our direct operating expenses were up $2.7 million from the prior year quarter, it represents only 6% of revenue which remains well below that of other industry players. Similarly administrative expenses remained low at approximately 8% of leasing revenue and flat from the prior year.

And now I’ll turn you to Brian for some additional comments.

Brian Sondey

Thanks, John. In general we expect our operating performance to improve as we head from the first quarter to the seasonally stronger part of the year. We expect our utilization will remain high and expect our disposal gains will begin to stabilize due to seasonal demand and as used container selling prices are getting closer to their historical range. We also expect further benefits to our financing costs from first and second quarter refinancing activity. As a result, we expect our adjusted pre-tax income to increase slightly from the first quarter for the second quarter of 2014. And we expect our financial performance to continue to increase slightly from the second quarter through the end of the year.

I will now open up the call for questions.

Question-And-Answer Session

Operator

We will now begin the question-and-answer session. (Operator Instructions) The first question comes from Steven Clark from KBW. Please go ahead.

Steven Clark - Keefe Bruyette & Woods

Good morning. Thanks for taking my questions. Just first question I want to hit upon would be guidance. I believe last time you gave guidance for the full year of pre-tax income to be down year-over-year. I was wondering if you gave any further updates on that?

Brian Sondey

The guidance we gave last time I think was for income to be down sequentially from Q4 to Q1 and then for the full year as you know to be below 2013. I think that’s still the case. We have guided now to some sequential improvements from the first quarter to the second and third and fourth quarters as we benefit from the stronger demand both for leasing continuous and used containers due to seasonality. And as we have mentioned, also, due to this -- we believe at least that there is more stability in our gain on sale, and it’s that drop in gain that’s explained most of the negative move over the last few quarters. As that stabilizes and we benefit from the seasonality, that should improve us sequentially. But still we expect that overall it will be below 2013 results, mainly because of lower gain but also I know the year of a tight pricing environment.

Steven Clark - Keefe Bruyette & Woods

Got it. And then just to hit upon the direct operating expense line, it seems like it has been picking up sequentially over the past couple of quarters. I was just wondering, how should we think about that going forward?

Brian Sondey

We think in the next few quarters that there should be probably a little more stability in that line as well. It had gone over the last few quarters due to some moderation in our utilization, I think, down a little less than a percentage point over the last year that drives higher storage costs, a little higher repairs due to the drop-off volumes, and so doesn’t affect that. Also we’ve seen the size of our sale inventory increased over the last year. Those containers that are waiting for sale don’t make it into our utilization. I don’t believe also there are included in the other leasing companies utilization, since they are not being put available for leasing. But we do pay to store those containers, and so that also has an effect on the operating expenses. That said we do think our utilization is going to be relatively stable and maybe slightly up over the next few quarters. Similarly, we expect our sale inventory to be stable as well. And so at least in the next few quarters operating expenses should be more stable than it have been.

Steven Clark - Keefe Bruyette & Woods

Alright, great. Thanks for the color. Last question I have was around trade growth. I was wondering, if you could provide some color around various geographies and what you’re seeing, are there any areas that are weak or areas that are stronger?

Brian Sondey

In terms of the trade growth, usually we get it from our customers. We don’t really see exactly which trade lanes are driving demand for our containers. Regardless of the trade lane most of the demand remains in Asia and in China specifically, regardless of what had served in the -- the train is packed until you on the states or to Asia to Europe or into Asia, or whatever. I would say anecdotally we hear that the trades into the U.S. are performing a bit better than last year. That even trade into Europe is more stable than it was. It was decreasing for a while. Maybe it’s going to be flat to slightly up this year. There is concerns of our weakness in China, which probably influences trade volumes intra Asia. But in general I would say the main message we get from customers is that trade volumes are like good, and trade growth a little bit improved from 2013, but certainly not back to the historical pattern of 8% to 10% growth.

Steven Clark - Keefe Bruyette & Woods

Right. Thanks for taking my questions.

Brian Sondey

Sure.

Operator

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

Gregory Lewis - Credit Suisse

Yes, thank you and good morning.

Brian Sondey

Hi. Good morning.

Gregory Lewis - Credit Suisse

Brian just staying with the overall market, I guess my first question is around the recent merger between Hapag-Lloyd and CSAV, know that potential -- you know the closing of the transaction. As we think about, I guess my first question around that is, what type of impact, if any, do we think that merger has on overall box demand? And I guess, in leading up to that merger are we seeing more boxes get being returned from those companies?

Brian Sondey

It’s a good question, I think in general there’s not a lot of direct impact on container demand coming out of a merger, I think all the shipping lines have been highly focused on the last few years about wringing out every excess cost they could out of their operations. And one of the things they’ve done is really to try to get much more tight and efficient in their container fleets. And so at least I don’t think there’s a perception by either of the companies and certainly we’re not expecting that the merger is going to result in a huge opportunity to push out container capacity, and my guess is the savings that they are talking about are coming mainly from trying to utilize their vessels better, maybe increasing the loading factors. I’m focusing the cargo on the most efficient ships and so pushing out the least efficient ships and then perhaps on the people side of things and cost savings.

But that said we’re not intimately familiar with what they expect to do with the merger. I think the other thing we actually focus on more quite frankly is just how is our relationship with each of the companies and we’d like mergers where the companies are combining and the companies that you’re closest with are going to be in the driver’s seat for the combined entity, you don’t like the ones where the opposite happens and we feel that we have been to those companies we think we have worked with each of them well, and we don’t think it’s going to have significant impact on containers generally our business has been difficult.

Gregory Lewis - Credit Suisse

Okay, great. And then just one other follow-up for me, you mentioned the factories I guess being closed it in the February timeframe. I guess my question is when did the factories come back online and at this point do we have any sense for how many ships they are running?

Brian Sondey

The factories as I understand it, they closed very early for Chinese New Year probably -- they slowed down production at the end of last year probably after ThanksGiving almost and then maybe entirely stopped production sometime toward the end of January. But I think these are first post Chinese New Year boxes were really maybe started being built right at the end of February into early March. And in terms of the ship capacity the different manufacturers as I understand that have taken different approaches, some have, are actually now actively up running two ships a day, others remain pretty cautious.

In terms of production volumes the overall production in the first quarter is going to be pretty low, was pretty low because of the limited time the factories are open in January and then the delayed opening. And we have seen a number of shipping line orders especially come in for production in the second quarter, I think that’s driving some of the ships activity from some of the manufacturers. But I think like last year most of our customers this is the time if they’re going to order for the year they’re going to do it for the second quarters, they have boxes available for the peak season. And so we don’t think that this sort of pertains a big rush of the shipping lines back into the market and regardless of ship capacity I think we’re going to see overall production again this year relatively limited and probably also again majority leasing company just as I think a lot of the shipping lines will be still be relatively cautious on how they buy their boxes.

Gregory Lewis - Credit Suisse

Okay, perfect. Brian and John, thanks for the time.

Operator

Our next question comes from Donald McLee of Wells Fargo. Please go ahead.

Donald McLee - Wells Fargo Securities

Good morning guys.

Brian Sondey

Good morning.

Donald McLee - Wells Fargo Securities

In your comments you mentioned that January was a unusually period to begin the year but it looks like your utilization trending lower relative to last year’s Q1, is that a byproduct of the current rate environment or it was actually just slower for the remainder of the quarter?

Brian Sondey

It was a variety of factors, certainly the activity in February was weak, I think just reflecting the fact of how strong January was and just the impacts of Chinese New Year. In addition, as the sales prices have come down, we balanced our decisions around when we sell containers and when release containers and that rebalancing resulted us pulling some containers back into our leasing fleet that we previously thought would be targeted for sale and that had an impact on utilization as well, but a pretty marginal one. I think overall the change in utilization was I mean maybe a couple of basis points over the quarter, but not too significant.

Donald McLee - Wells Fargo Securities

Got you, got you, and then just referring to activity heading into Q2, you mentioned that that was improving as well, how has that played out for yields on new deals in the current market, are you still seeing some deals with single-digit returns or has that improved as well?

Brian Sondey

From a pricing standpoint as you said, the lease rates improved on an absolute basis in January, reflecting I think a brief period of higher container prices as well as just increased demand for immediate availability of leasing units. We’re sensing I think a lot of that pricing improvement that we saw in January has been competed away and then similarly in terms of box prices, we’ve seen a lot of the January increase I think come back out of the market. Lease yields I guess we’re probably referring to is maybe the ratio of the year one revenue relative to the cost of the equipment that is still back down in single-digit for sure.

Donald McLee - Wells Fargo Securities

Alright thanks guys, that’s helpful, that’s all my questions.

Operator

Our next question comes from John Mims of FBR Capital. Please go ahead.

John Mims - FBR Capital Markets

Hey good morning, thanks for taking my question, so Brian let me dig into some of the industry numbers that you threw out there from -- looking first at the factory inventory where are TEUs on the ground now versus where they were last year?

Brian Sondey

Yes so, the latest estimates that we have and then again these are all estimates for TEU on the ground is probably something in the 600,000 TEU range, which is up a little bit from where it was in January but still at a pretty good place. Last year I think maybe by the end of the second quarter, it got up to well over a 1 million TEU on the ground and that was really as -- the number of leasing companies and shipping lines built a lot of inventory in the first part of the year expecting trade growth to be better than it was and it didn’t materialize. There was a bit of an excess inventory. In general we view 600,000 TEU has been pretty light for this time of the year.

John Mims - FBR Capital Markets

So, is there a relationship between your utilization and inventory levels? I mean I know it’s still high but it is down 60 basis points year-over-year, if inventory stay low should that utilization rate drift up into the 98% this year or…?

Brian Sondey

Well there is an indirect relationship. So like I mentioned before that we don’t include sale inventory at our utilization and we also do not include factory inventory in our utilization again I think that’s consistent across the leasing industry. This is because we tend to load up on inventory just before we have demand and it would be a bit of a unreliable indicator of demand, if we included that inventory in utilization. So, the fact that the factory inventory is down that doesn’t directly impact the calculation of our utilization.

On the other hand though to the extent that there is less inventory available in the factories to lease to customers typically that has a beneficial impact on the demand for used containers. And so in general, we like to see that inventory being lower in the factory both because it -- I mean it’s less, you would think at least less aggressive competition to get the containers leased out coupled with perhaps an increased reliance on the existing depot fleet of used containers.

John Mims - FBR Capital Markets

Sure. No, no that makes perfect sense. On new builds now to what extent you’re placing orders, what are the lead times that you’re getting from factories for orders placed in April and what are current prices and how are current prices trending?

Brian Sondey

Yes it really depends on where you want the equipment. Right now, we’re seeing a lot of demand centered in the southern part of China and there we have seen lead times push out to be perhaps a couple of months from those manufactures. In another places in China where there is less demand, you can get boxes produced pretty fast. In terms of prices, prices in January moved from say the low 2,000s at the end of 2013 up to above 2,200 in January. The prices are certainly back down. We’re actually quite frankly waiting to see where they settle. But my guess is it’s going to be right settling somewhere between where they got to in January and where they were in December but very much remains to be seen where they settle and where they trend through the year. I think where they go from here is going to be dependent on what level of trade growth we’d see. If trade growth ends up meeting expectation ending better than last year that will provide support for container prices through the summer. If we see trade growth falling short of expectations again, there could be further pressure on our container prices from here.

John Mims - FBR Capital Markets

Right. But you were to call CIMC or someone today and place an order you would think that the rate that they would quote you now for let’s say a June delivery in Southern China would be closer to 2,000 or closer to the 2,200?

Brian Sondey

I don’t want to give out our exact expectation for container prices, but yes I would just say we expect that perhaps in the middle and where we end up we’d have to wait and see. And again, we don’t want to again give this granular detail on our purchasing cost.

John Mims - FBR Capital Markets

Yes, that’s fair enough, fair enough. Two quick ones and then I’ll turn it back. From the order book you’ve seen so far you mentioned some shippers coming into the market, what’s the split between the leasing companies and shippers now in the order book?

Brian Sondey

So, for first quarter production, it was -- which we kind of picked up the tail of orders from last year and the early orders that were placed in January, it was very heavily leasing company. And a sense -- and so most of the boxes that have already been produced in 2014, I believe is majority leasing company. I’d say the orders that have been placed in last month or so are majority shipping lines. As I mentioned, I think this is the time the shipping lines are going to order, they will order if they’re going to order. And so in total right now I would guess, probably, there is more shipping line orders in total for 2014, than there are from leasing companies, but again this is just really for last year and it’s kind of expected this time of year my guess would be that orders from here will be more oriented toward the leasing companies.

John Mims - FBR Capital Markets

Okay. Then last question. Are there any when you look at the market broadly speaking, are there, do you see any attractive sale leaseback opportunities or third-party fleets that you could acquire in terms like lumpier growth outside of the new build market?

Brian Sondey

There certainly are sale leaseback opportunities out there, we’ve done some this year and we think we’ll continue to see deals out there driven by the desire of the shipping lines to take advantage of the aggressive leasing market and the fact that also leasing companies I think perhaps workout higher residuals, we really focused on the sale value of the units and so on, perhaps and value of these older units maybe more than the shipping lines view. But like for the new build market the bidding for these, that we expect deals especially the bigger ones are, it’s aggressive.

John Mims - FBR Capital Markets

Great, okay. Okay thanks very much for the time.

Brian Sondey

Yes, thank you.

Operator

Our next question comes from Sal Vitale from Sterne, Agee. Please go ahead.

Sal Vitale - Sterne, Agee

Well good morning Brian and good morning John.

Brian Sondey

Good morning.

Sal Vitale - Sterne, Agee

So you covered a lot of ground, I just have a few additional questions. So first if I look at your cost, if I look at the G&A, that’s crept up a little less than a couple of quarters 11.8 million. How do we think about that going forward, was there anything quarter specific in the 11.8?

Brian Sondey

Yes generally, I think we talked a bit in the last call about it, that our G&A expenses tend to peak in the first quarter. And it has to do with the way that our share grants vest to employees and to directors in the first quarter. In addition, there was a couple of organizational restructuring items that were in the first quarter, nothing dramatic, but enough to move the number a little bit. I think our view of the G&A cost is that they are mainly pretty stable. And we have actually been able to get a lot of economies of scale over the last five years by growing the assets in revenue pretty rapidly while holding that number flat. And we expect to see that number mostly move sideways going forward.

Sal Vitale - Sterne, Agee

Okay, that’s helpful, thank you. And then let’s see, if you look at the pickups for the month of April thus far are they pretty much in line with historical performance?

Brian Sondey

Every year it is different, but I’d say we -- well we saw again very strong January, a pretty weak February, and now we are seeing perhaps a more normal ramp in volumes from March into April. As I said and within my conversations with our customers, there is some optimism around volumes, that the ships are sailing relatively full and that trade growth again maybe is a little better than last year, perhaps a little ahead of expectations. And that has translated into reasonably okay pickups for us in March and April and the real hope is that we will see this trajectory continue. I think really 2012 and 2013 were disappointing in the sense that we didn’t see much of a peak season in the summer time. That in both cases, and perhaps the global economy, but also trade volumes kind of faded through the summer and I think everyone in the industry is hoping that this year will be more like it was with volumes building through the second quarter into the summer. And if that happens, I think that will be quite good for demand and hopefully support of container prices and lease rates but given the experience last few years we need to like to see it happen first.

Sal Vitale - Sterne, Agee

Sure. And then just one other question, a little bit more color on the movement in box prices since January should be drifted lower. I guess I have more -- my question is more historically, the upper trajectory in box prices, refresh my memory, usually begins in early 2Q and peaks out in the autumn, is that correct?

Brian Sondey

Yes that’s usually the case. Again, because of the trade volumes are doing the same thing. So usually you’d see container prices lowest in the fourth quarter of the year and maybe early first quarter when there is very little current need for containers and so buying is mostly on speculation, and then building towards the middle of the year as shipping lines and leasing companies have a better opportunity to buy the actual demand and the manufacturers taking an advantage of that. Both last year and so far this year at least we have not seen that pattern. We have seen container prices actually weaken towards the second quarter. And again the hope is that if see trade volumes actually hold up like they usually have, that that might provide support and we will see a more traditional pattern from here, but again I think we need to see where it goes from here, depending I think mainly on just -- again what happens with overall trade volumes and demand.

Sal Vitale - Sterne, Agee

Okay, that’s helpful. Thank you.

Operator

Our next question comes from Rick Shane of JPMorgan. Please go ahead.

Rick Shane - JPMorgan

Thanks guys for taking my questions, they have actually all been asked and answered.

Brian Sondey

Okay, well thanks Rick.

Operator

Our next question comes from Doug Mewhirter of SunTrust. Please go ahead.

Doug Mewhirter - SunTrust

Hi. Good morning, most of my questions have been answered. One specific question and then one maybe broader, bigger picture question. So your box trading operation actually had a fairly strong quarter which -- and to me was the dynamics how it relates to gain on sale, but it’s interesting how your gain on sale revenue was ticked down, but actually you’ve held your margins fairly intact in the trading, is that sort of a -- are they normally disconnected or is there some dynamic in the trading business which has showed more strength?

Brian Sondey

Yes that’s not unusual. And it’s because the gain on sale item is driven by sale of our own boxes. And we appreciate our containers to fixed residual sort of regardless of -- we don’t change those fixed residuals depending on the current circumstances in the market. Those are long-term estimates, or what we think sales prices will be over the next 10 years or something like that. And so the gain on sale item is primarily driven by the absolute level of used container sale prices. And the gain will shrink as the absolute price comes down and grow as the absolute price goes up. The trading business it’s a margin business, and so in a weak environment for container prices we’re buying low.

And so we think everyone should be looking at I think as you’ve described here is the spread of the trading revenue less the trading cost not focusing either on the revenue or the cost and isolation and because again that business we’re buying containers and typically flipping them for sale in a short period of time, and it’s something that we think we are good at both because we’ve a very extensive sale network and we’ve got the ability to -- to some extent just make a margin by buying boxes wholesale and selling them on a more retail basis, but also we’ve also got great visibility into what’s happening to global container prices, to new prices, to used prices, to demand and so we’re a very knowledgeable buyer and so we know when to buy and when to hold off and those things for us make a margin in most markets.

Doug Mewhirter - SunTrust

Okay. Thanks for that. And a bigger picture, there has been a lot of news headlines around these container shipping alliances where the big lions are cooperating and trying to rationalize capacity among the major routes. You gave some insightful comments about the Hapag-Lloyd, CSAV merger do you treat alliances relatively similar to do mergers where all your really paying attention to if the total box volume, the fact that they’re going to be concentrated on possibly fewer ships it doesn’t really impact your business or is there -- do you have to maybe approach those customers differently because there some of their ships are tied in alliances?

Brian Sondey

Yes, I’d say a couple of things. First is that alliances have been going on for a very long time. The P3 got the sort of alliance now, between Maersk and MSC and CMA is gaining a lot of attention publicly, but it’s certainly not really new innovation, it’s new for those companies which in the past had tended to operate much more independently. But I’d say the mid-sized shipping lines most of all have always, well not always, but certainly in the last 10 or 20 years been operating on the major trades in these alliances. And so again it’s nothing really new for the industry.

And there is a big difference in how containers are traded though between an alliance and a merger. The alliance is generally share vessels and they do this to help and improve load factors and take out vessels by sharing the capacity. And they also -- the P3 one of the major motivations was to be able to focus the cargos on the most fuel efficient ships and so by pooling the biggest and most fuel efficient ships between Maersk and MSC and CMA, they increased the average size of the vessels and average fuel efficiency of the vessels on the major trades. But in all the previous alliances end in the P3, the container fleets will not be shared, and the thing that makes sharing containers so difficult across companies is that they tend to have the same demand locations where they all want containers in the same surplus locations where nobody want the containers. And it makes container sharing extremely difficult because they all want to pick up where there is demand and drop off where there is not and it gets very complicated thinking about how to allocate the costs to a shared fleet of equipment.

And so, there isn’t any expectation for us at least I don’t think for the companies involved that there will be any real pooling of the container fleets which might have a more direct impact on demand for us. And so really it’s just a, I think, primarily a way to economize on the vessels given a merger of course -- it’s not one company and they can pool the equipment although again we don’t tend to find in a merger results in a big sort of accessing of container capacity.

Doug Mewhirter - SunTrust

Okay thanks for the answer and that’s all my questions.

Operator

Our next question comes from Ken Hoexter of Bank of America. Please go ahead.

Unidentified Analyst

Hi. Good morning, Brain and John, this is Sean calling from Ken’s team. I know a lot of questions have been asked. I know you said you lowered your interest rate in the last quarter down to 3.8%, down 50 basis points. Can you just talk about moves you think you can make in the second and third quarter to lower that in a interplay kind of between interest rate swaps and refinancing and if you have much room to lower that? Given the great job you’ve done already.

Brian Sondey

Yes, thanks. We do have some facilities that are currently above markets and as the opportunities present themselves we’ll look to refinance those down to current market. We’ve taken a lot of the ones that were above market and refinanced those as we have the opportunity. Similarly, we’ve rebalanced their swap portfolio and locked in lower rates on the swap portfolio. So a lot of that heavy lifting has been done and like I said we’re within an effective rate of 3.85 for the first quarter, we’re getting pretty close to what current market rates are. Our last ABS the issuance with the A notes was at about 3.55 and like I said we were at 3.85 average, we’re certainly getting close, but we think there is a little bit room left.

John Burns

In particular it’s about refinancing the facilities that remain above that average.

Unidentified Analyst

Okay, great. That’s helpful, and just my last question. I know that you’ve sighted and you’re seeing aggressive financing available for competitors out there, I assume you’re still seeing that and what’s the dynamic between the competition you’re seeing from leasing companies with that financing versus shipping line competition?

Brian Sondey

Yes so our comments mainly haven’t targeted towards what we’re seeing on the leasing companies which is, really as I have tried to mention a lack of differentiation between the rating agencies and lenders to some extent between the rates available to the large full established leasing companies and the rates and ratings available to companies with much less history and much less extensive ability to operate equipment as it ages and maintain utilization over the lifetime of the equipment. And the impact on that is of course there’s a reduced tearing and competitiveness and so to the extent that we’re not being paid for in our interest expense at least for our much more extensive operation that makes it easier for small leasing companies to compete on rate and take aggressive stance.

And then in addition just the absolute amount of money made available for these mid-sized and very small players despite their lack of experience and scale has allowed them to take bigger bites out of deals, and which I think for, while we have been maybe then not to response as aggressively to that, some other larger companies have in trying to preserve their deal share and that’s had a bigger impact on the market. And as I said it’s something that we find very surprising that I think experience and the capability of a leasing company is very important in a business where the initial lease covers perhaps only 40% of the container’s life and the ability to get good performance out of the old equipment is heavily influenced by the structure of the first lease, logistics of the lease, the ability of the company to operate equipment overtime, to remarket it in small batches all of which takes a lot of experience and a very extensive infrastructure I mean marketing group which a lot of these companies do not have and we again talked it’s a quite a surprising development.

In terms of the shipping lines I think also yes there has been recently more financing available to them as well and we did aftermath of the financial crisis. Shipping lines had a much more difficult time finding rolling financing sources I think that’s opened up again. But then again I think despite that we’ll continue to see across perhaps more reliance on leasing than there was historically.

Unidentified Analyst

Okay, great. That’s very helpful, thank you.

Operator

Our next question comes from Art Hatfield of Raymond James. Please go ahead.

Art Hatfield - Raymond James

Hey Brian and John. Good morning. One question if I could Brian. You’ve got this business it’s a significant cash machine for you and we’ve seen great volatility really in the fundamentals over the last five-six years within the industry and you guys have done an excellent job of taking advantage of opportunities as they’ve come to you. Admittedly there are some headwinds going forward and that’s going to happen in any business but -- and I apologize for the long premise to my question, but have you thought about or is there anything with regards to potentially looking at diversifying the business in a way that maybe can, not that there’s instability in your earnings right now but just kind of diversify a little bit away from container leasing should we see greater volatility in the business going forward?

Brian Sondey

That’s a great question and it is something we think about a lot, I think as you pointed out we have got a lot if cash flow in this business and one of our frequent discussions internally with management, with our Board as well is what to do with all that cash flow, we’ve been paying a high dividend and we hope shareholders value that, but given the more challenging returns in some of the core investment areas, there is a lot of thought about what to do with the extra cash.

In the past, the last sort of market we saw that was somewhat like this, was perhaps in 2006 and 2007 again right as the financial bubble was reaching its peak and we did see in that market, sort of that an unhealthy level of a pricing and competition especially from some smaller players, and those years we added a couple of new products, we brought in a tank container product line which has been a great area of investment for us, a chassis product line it got started in that year as well, we have focused on some specialty container types which helped us build out our fleet offering.

And we’re certainly thinking about those kinds of opportunities again and I think we’ve got a really powerful international organization that knows how to operate these type of assets, we’ve got a customer base that needs lots of different types of equipment and it is something we’re looking at a bit more aggressively. That said I don’t think, I can’t promise we’re going to go out and find some silver bullet solutions to really change the picture of the current environment to a best environment for us, but I think in markets like this we do try to look for some more creative options out there to take advantage of the operating capabilities we have.

Art Hatfield - Raymond James

And I know, like you said I mean you can’t promise anything, but would it be something where you’d want to get kind of away from and generally what you’re doing now where you mentioned you have got great expertise in the things that you do, but is there something that you can add that would create somewhat of a reduce I guess the correlation of the existing products that you have?

Brian Sondey

As I said that’s something we would look at, I think I would have to look at any opportunity that came along on the basis of that opportunity. That I can’t see is quite frankly going out and starting something or buying something that’s totally different from the things that we do. I think someone else can, the investor can just invest in those companies on their own, but I do think there is a lot of connection between the type of things that we’re good at on an operating basis, the types of things that we’re able to finance very efficiently, and our systems could run efficiently and other types of transportation assets or other types of assets. And so I think we would always look for some linkages, I mean their operating capabilities or customers, certainly would be a benefit, like in the tank market for example, it’s actually entirely different customer base. And there is some difference in the dynamics between what happens there and what happens with the containers. But again I think we would be focused on making sure that there is some inherent connection of business that gives us a reason to think we’re good -- we are going to be good at it.

Art Hatfield - Raymond James

I appreciate your patience on my fishing expedition. Thanks for the time.

Brian Sondey

Okay thanks Art.

Operator

Our next question is a follow-up from Sal Vitale from Sterne, Agee. Please go ahead.

Sal Vitale - Sterne, Agee

Well just one quick follow-up on the lease expiration schedule, John you had mentioned that the expirations on the high rate 2010-2011 investment leases, generally begin in 2015. I guess, two question, number one, I assume that’s towards the back end of the year. And then also, isn’t there typically a build-down period which could be as long as, say six months or even a little longer where the lease has already expired but you continue to collect that particular lease rate?

John Burns

Yes that’s right. Sal, we -- leases that we wrote in 2010 and 2011, pretty much start expiring, I’d say, in the middle of the year. Just because, just given the rhythm of the way our contracts work, where usually there is a build-up period. And that goes for a couple of months. And so we really saw the volume start to kick in, I guess say in the first-second quarter of 2010 and so, the kind of five and a quarter -- five and a half year period. It starts to come in towards the end -- middle to end of next year. As you point out and also it takes time for shipping lines to return the boxes even if their leases aren’t renewed and so usually at the back of the envelope you might say, okay perhaps it takes a year they could bring the boxes back which is maybe on average another six months of on-hire higher time. So this isn’t a factory that this sort of lease role over in pricing. It is in fact a really, wouldn’t pick in significantly until end of 2015, beginning in 2016. And so we started talking about it though, just because it is something that’s out there and low container prices, low lease rates are seem to be hanging in for a little while. We were hopeful in January that we would see perhaps the market get more back to normal from a pricing environment, our container prices and lease rates which would be quite beneficial for this pricing.

And so you can -- lease rates and container prices will have to remain low for a really long time, and other several years. To really hit a good portion of our 2010-2011 containers, but it is something that’s out there. And if lease rates do remain where they are, it will begin to have a bigger effect, beginning towards the end of next year and then really running through 2020. So we were pretty thoughtful of the time. We knew that we are buying a lot of equipment. And we knew they were going on high value leases, and so we made sure we avoided a sort of cliff of lease expirations. But again, it will be a much bigger issue if rates remain where they are until the end of next year, that’s for us right now.

Sal Vitale - Sterne, Agee

Okay, that’s helpful. Thank you very much.

Operator

This now concludes our question-and-answer session. I would like to turn the conference back over to Mr. Brian Sondey, President and CEO, for any closing remarks. Please go ahead.

Brian Sondey

So, thank you. Just wanted to thank everyone again for your interest and support of TAL and we look forward to talking with you again. Thank you.

Operator

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

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