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TAL International Group, Inc. (NYSE:TAL)

Q3 2010 Earnings Conference Call

October 28, 2010 9:00 AM ET

Executives

Jeff Casucci – VP, Treasury and IR

Brian Sondey – President and CEO

John Burns – SVP and CFO

Analysts

Jon Langenfeld – Baird

Art Hatfield – Morgan Keegan

Sal Vitale – Stern Agee

Greg Lewis – Credit Suisse

Brendan Sheehan – KBW

Daniel Furtado – Jefferies

Operator

Good morning and welcome to the TAL International Group third quarter 2010 earnings call. All participants will be in listen lonely mode. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Jeff Casucci. Please go ahead.

Jeff Casucci

Good morning and thank you for joining us on today’s call. We are here to discuss TAL’s third quarter 2010 results which were 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 any or all of the statement it has 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 annual report filed on Form 10-K with the SEC.

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

Brian Sondey

Thanks Jeff. Welcome to TAL’s third quarter 2010 earnings conference call. With our outstanding performance in the third quarter, TAL has entered a new phase in the second half of 2010. The first half of 2010 was mainly about recovery, and TAL’s income improved rapidly as trade volumes and our utilization recovered from the 2009 global recession.

The second half of 2010 is about growth and we are now increasingly seeing the benefits of our aggressive investment this year as containers are being delivered and placed on hire in very large numbers.

The strength of the leasing market and the benefits of our aggressive investment are apparent in our third quarter operating statistics. In the third quarter over 90,000 TEU drive containers were picked up by customers while less than 9,000 TEU were dropped off.

Utilization continued to move upwards and our utilization averaged 98.1% in the third quarter and 98.6% as of October 27. Used container sale prices now exceed peak 2008 levels and our average dry container lease rates increased 6.3% during the third quarter as 2009 incentive deals expired and new containers were placed on hire at very high lease rates. Our average dry container lease rates now exceed our average rates in 2008.

The strength in our operational performance and our aggressive investment, led to significant growth in our top and bottom line financial measures. Leasing revenue increased 13.5% from the second quarter of 2010 to the third quarter, as more of our new units were delivered and placed on hire.

Adjusted EBITDA increased 18.5% from the second quarter to the third quarter and our adjusted pretax income increased 28.9% due to our revenue growth, operating expense reductions and strong used container disposal gains.

TAL continues to benefit from strong leasing demand and a global shortage of containers. Containerized trade volumes have recovered sharply in 2010 and container volumes are generally reaching or exceeding pre-crisis levels, especially in the Asian export markets that drive most of our leasing demand.

At the same time, global container capacity remains constrained. Due to a complete lack of buying in 2009, ongoing disposals, the impact of vessels still steaming and container factory production constraints in 2010. This combination of recovering trade volumes and restricted container capacity has resulted in a severe global shortage of containers this year and exceptional leasing demand.

TAL continued to invest aggressively in the third quarter and we have reached a record level of investment and growth in 2010. So far this year, we’ve ordered $875 million of new containers for delivery in 2010. This includes over 300,000 TEU of dry containers and over 24,000 TEU of refrigerated containers.

We’ve also made significant investments this year in our tank container product line as we have seen strong demand for this equipment as well. The vast majority of the equipment we’ve ordered has already been firmly committed to leases, and for leases we have completed, the average duration for our leases is about 6 ½ years for new dry containers and about 5 ½ years for new refrigerated containers.

Our aggressive investment this year has been supported by both our covering trade volumes and by a shift in the balance of owned versus leased containers. Historically, shipping lines have owned 55% to 60% of the containers they operate and lease 40% to 45% from leasing companies like TAL.

This year, shipping lines have been reluctant to commit to large new container orders, even as cargo volumes and their financial performance have improved. Many of the major shipping lines faced large losses in 2009 and many have significant vessel expansion programs that require large, ongoing capital outlays.

As a result, most of the major shipping lines have preferred to avoid making large investments this year in new containers, given our willingness and ability to step in and make the investments for them.

As indicated in the press release, we’ve increased our dividend to $0.40 per share this quarter. This increase reflects our improved financial performance and our current expectations that our market environment will remain favorable for some time.

We’ve been increasing our dividend rapidly this year, as our performance has improved. Going forward, we anticipate fewer changes and expect to evaluate the size of the dividend on an annual basis in the future.

I’ll now hand the call over to John Burns, our CFO, who will review our financial performance in more detail.

John Burns

Thank you Brian. As Brian noted, adjusted pretax income jumped 29% in the third quarter to $28.6 million or $0.93 per share from $22.2 million or $0.72 per share in the second quarter. These solid results reflect a full quarter of peak utilization levels and the early benefits of our substantial current year container investment spending.

We have ordered over $875 million of new containers for delivery during 2010 and over 90% of these containers are committed to lease with an average term of more than six years. This extraordinary investment level exceeds our previous record of just over $500 million in 2008, and when combined with our low level of investment in 2009, results on an average annual CapEx of nearly $400 million since going public in 2005.

This aggressive investment began to make a meaningful impact on leasing revenue during the third quarter as indicated by the increase of over $10 million or 13% from the second quarter. We expect leasing revenue to continue to grow sequentially through the first quarter of 2011 as the fourth quarter benefits from a full period of over 90,000 TEU placed on hire during the third quarter and the balance of over 100,000 TEU ordered and committed to lease are picked up during this quarter and early in the first quarter of 2011.

Operating expenses continue to drop, down $1.6 million or 24% from the second quarter as we benefited from a full quarter of peak utilization which kept storage expense very low. Also, we continue to experience extremely re-deliveries which minimized our repair expense.

The ongoing shortage of containers continue to push used container sale prices to historical levels resulting in a gain on sale of $8.5 million in the third quarter, up $1.3 million from the second quarter. We anticipate used container sale prices will remain strong as long as the existing shortage of containers persists.

However, sales volume and related gains are likely to decrease in the fourth quarter if the low levels of re-deliveries we are experiencing continue. While this is likely to reduce fourth quarter, these container sales are simply deferred into the future.

Our aggressive level of investment has been funded by continued strong operational cash flows and nearly $800 million of new financing facilities closed this year. We are particularly pleased with the recent issuance of two term notes securitizations totaling $400 million which were rated single A by S&P.

The strong rating demonstrates the strength and stability of our portfolio and confidence in our fleet management capabilities. As we noted in our earnings release, we terminated $250 million notional value of interest rate swaps scheduled to expire in 2011 and partially replaced these swaps with longer dated swaps and this, along with the attractive rates on our two recent ABS facilities will reduce our average effective interest rate by approximately 60 basis points going forward.

Also as noted in our press release yesterday, TAL filed a universal shelf registration statement on Form S3 with the Securities and Exchange Commission registering up to $300 million of securities as part of our ongoing process of providing ourselves financing flexibility.

As Brian mentioned, TAL has declared a $0.40 dividend for payment in December. Because of the accelerated depreciation on lease and equipment, these dividend distributions have and we believe will continue to qualify as a return of capital rather than a taxable dividend for U.S. tax purposes. As always, investors should consult a tax advisor to determine the proper treatment of TAL’s dividend distribution.

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

Brian Sondey

Thanks John. I’ll now finish the prepared part of the call with some thoughts on our outlook. In general, we expect our market environment to remain favorable. While the fourth quarter typically marks the beginning of the slow season for dry containers, we expect our utilization to remain exceptionally high through the end of 2010 and into 2011.

We also expect to see strong sequential lease revenue growth into the first quarter of 2011, just based on our existing orders as new equipment continues to be delivered and placed on hire. Starting in the fourth quarter, we also expect to benefit from a decrease in our average effective interest rate.

However, we expect decreasing disposal gains to mitigate some of the revenue and other benefits we expect to see in the fourth quarter so that we expect our adjusted pretax income in the fourth quarter to hold relatively steady from the third quarter level.

Looking forward into 2011, we expect our pretax income to increase from the fourth quarter of 2010 as the effects of our fleet investment and favorable market conditions further accumulate.

In summary, our market environment remains exceptionally favorable and with our third quarter performance, we have shifted smoothly from recovery to growth. The large fleet investments we have made this year, from a 13% sequential increase in revenue in the third quarter have contributed to a 29% sequential increase in our adjusted pretax income.

We expect strong sequential revenue growth to continue into next year as orders units continue to be delivered and placed on hire. We expect or profitability to hold steady from the third quarter 2010 to the fourth quarter before pushing upwards in 2011, and we have increased our dividend due to our improving performance and expectations for sustained, favorable market conditions.

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

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Jon Langenfeld from Baird. Please go ahead sir.

Jon Langenfeld – Baird

Good morning. I know you talked about the asset deployment base on a TEU basis, but could you give us some idea on a dollar basis? The $875 million of capital, how much of that was deployed through the third quarter and then how much of that do you expect to be deployed in the fourth quarter versus the carryover into 2011?

Brian Sondey

I don’t have the exact numbers with us. We have chart we included in our investor presentation that shows it on a dollar basis. Just over $600 million was accepted through the end of the third quarter and there tends to be a delay anywhere from in the 30 day range to actual on hire the units.

So one way to think about it is by the end of the third quarter, let’s say something around two-thirds of the units were delivered, but a decent portion of that amount was delivered during the third quarter so that we only had a partial period of revenue from those third quarter deliveries.

And so as we go into the fourth quarter, we get a full period of revenue for the equipment that was brought in during the third, and then a whole period from the equipment that was brought in – excuse me – on a partial period was brought in on one time hire in the fourth quarter.

And then similarly, as you go into 2011, we’ll get a full period then in the first quarter of ‘11 from the equipment that went on hire in the fourth quarter, and that’s what builds the revenue growth through the first part of next year.

Jon Langenfeld – Baird

And will any material amount of that 875 that you talked about thus far, will a material amount of that fall into the first quarter? I know some of it’s depending on timing, but what are your thoughts?

Brian Sondey

Well as John mentioned, we’ve, in terms of committing to existing leases, something around 90% of our orders have already been committed to lease and we expect almost all of those units to go on hire during 2010.

We have started to order for supply early next year as a part of the units haven’t been yet committed to leases, really were ordered in anticipation of say January and February supply. But it really just depends on what happens in the fourth quarter.

We are finding customer inquiries continuing to come in and as we continue to get more inquiries, we’ll put those on hire and then restock for supply next year.

Jon Langenfeld – Baird

OK, good. And then can you give us a little kind of view of depreciation and how that should trend? I know you have some boxes coming off here in November that reset that, but should we think of that kind of next year a good run rate to closer to $35 million on a quarterly basis?

Brian Sondey

We don’t like to provide too much specific guidance on sub components of our income statement. One way we think about depreciation though is if you think about what’s coming into the fleet, you know this year we’ve added as we said almost $900 million worth of equipment and given where container prices are now; our annual depreciation on that equipment is something around 5.5 to 6%.

So if you think about it, you can start with where depreciation was last year. You can add in 5.5% of what we’ve purchased, and then as you noted, you have to take out depreciation from those units that are becoming fully depreciated this year, and also, there’s some take out of depreciation for units that we sell. Some of the units are less than their full accounting life.

There’s not a huge portion of units reaching the end of depreciable life this year just given the specifics of our container fleet age profile, but it’s something in the range of $1 million a quarter coming out, and so you get pretty close probably to depreciation by taking what it was at the beginning of this year, adding the depreciation from the units we’ve purchased and subtracting that kind of million per quarter.

Jon Langenfeld – Baird

OK, good. Thank you. And then how do you think about utilization? You basically have just deployed a third of our fleet, or a little bit more than a third of your asset dollars on long term leases. We’re at record high utilization. But how do you think that trends and how do you look at that over the next year or so?

Brian Sondey

Well we think in general, utilization is likely to stay very, very high, and there’s a number of reasons for it. One is as you were alluding to, is that we’ve placed a lot of units on long term lease this year and that has the natural effect of supporting utilization almost regardless of market conditions.

Other things that are happening is right now a huge gap between the market rates that shipping lines have to pay when they pick up containers now, versus the average rates that shipping lines are paying on the leases that they’re holding.

And so there’s a big incentive for the shipping lines to hang on to the existing containers they have, and we’re finding that our drop off volumes are remaining exceptionally low even after the peak season ended for dry containers, and part of that reason is because equipment is tight, but part of it also we think is because of this gap between average rates currently and market rates if they have to pick up new equipment.

And then finally, there’s very little sale inventory in the market right now, so that to the extent you get older containers dropped off, they’re going to be sold very quickly. And so the combination of very starting utilization, a lease portfolio that’s increasingly moved toward long term leases and strong incentives for the lines to hold on to equipment they have and then when the stuff comes off, sort of a ready market to either lease it or sell it, all of those things are going to contribute we think to a very high utilization into next year.

Jon Langenfeld – Baird

OK, good. And then what is the average age of the lease contract now in terms of the fleet?

Brian Sondey

The average age of the containers has been coming down this year as we’ve been buying a lot of equipment, and we expect it to be a little bit over six years by the end of the year.

Jon Langenfeld – Baird

And then the average duration left on the leases?

Brian Sondey

We disclose that in our Q. I think it’s around 50 months. We’re just frantically shuffling papers to confirm that.

Jon Langenfeld – Baird

That’s fine. And then the last question I had for you, when you think about the containers that you’re selling, how much is the container volume, numbers sold versus the price of the sale, so just looking at $8.5 million, is the volume increased and the price as well increased, or how should we think of the mix there?

Brian Sondey

If you look from the second quarter to the third, most of the increase, in fact most of the increase from last year into this year is all coming from price. In fact, the volume is coming down. What’s been happening so far is that drop off volumes really since March of this year have been exceptionally low, sort of like 20% of normal.

And we’ve been maintaining disposal volumes because we had a relatively sale stack at the beginning of the year because of all the units that were dropped off last year. So far this year for the first three quarters, we’ve been selling more containers than were getting dropped off, but the inventory really started to dwindle toward the end of the second quarter and then kind of fully ran out over the course of the third, and that did start to constrain our sales volume in the third quarter.

But the combination of having some beginning inventory to sell plus the very high prices we got in the third quarter led to the very high sale gains. Looking forward, we expect if anything, prices to move upwards due to the short inventory out there, but now that our sale inventory is essentially sold out, our ongoing disposal volumes will be constrained by ongoing drop off volumes and drop off volumes remain very, very low.

Jon Langenfeld – Baird

Great. Thanks for all the color.

Operator

Your next question is from Art Hatfield, Morgan Keegan. Please go ahead.

Art Hatfield – Morgan Keegan

Morning everyone. Brian, can you more specifically I guess with regards to the fleet, can you give us what the TEU count was at the end of Q3?

Brian Sondey

At the end of the third quarter we had 1.32 million TEU.

Art Hatfield – Morgan Keegan

And what’s that going to be at the end of Q4?

Brian Sondey

We estimate it will be somewhere around a little under 1.4, so 1.375 ish or something in there.

Art Hatfield – Morgan Keegan

That’s fair. That’s close enough. And as you look at lease rates and you’ve talked a lot over the year how they’ve moved upwards throughout the year. What are you seeing now and can you talk a little bit about how seasonality may play into lease rates over the next couple quarters and when we could expect to see those move directionally one way or the other?

Brian Sondey

Well lease rates are still very high relative to our portfolio average, still in the range probably of a 50% premium for a five year long term lease on a new container relative to the average rates that we have on our long term lease portfolio, and that’s really been driven just by the very high new build prices for containers.

There’s some seasonality effect in the sense that the manufacturers during the third quarter of this year were able to push prices upwards because of the peak demand for dry containers and the remaining short capacity. Prices have come down a little bit, maybe in the little bit under 10% range. They’ve come down from August through November, but they’re still very high compared to where they have been in the past and the combination of the high new container prices and just strong demand for containers is keeping lease rates up.

Going forward, we expect that again, lease rates will mainly be driven by new container prices but unless we see a significant drop in new container prices, which we don’t really expect, we think we’ll continue to see this tailwind on our leasing rates and continue to see our leasing rates move upwards as new containers come in at the higher rate.

Also we are starting to get into renewal discussions with customers on existing leases and having a fair bit of success on pushing those up and just because the market is so strong and we’re very determined to get that improvement in value for us.

Art Hatfield – Morgan Keegan

One other question today. You’ve talked about a lot of, you mentioned the lower drop off volumes that you’ve had and customers doing that to maybe keep their cost down a little bit as they see the costs of a new lease. They’re not able to do that in perpetuity. Can you talk a little bit about how that may play out from a length of time standpoint or a duration standpoint when these customers are going to have to really start to drop those containers and accept new ones?

Brian Sondey

As you know, we generally don’t allow our customers to keep our units on lease forever after the leases expire. For most of our leases, we have what’s called a bill down period after the lease expires that typically gives the customer somewhere between six months or 12 months to bring the containers back while enjoying the lease rates under the original lease.

Usually after that bill down period expires, the lease rates increase significantly. And so if you think about the timing, the market for us first got really strong in terms of the lease rates especially towards the middle of the second quarter.

And so for the balance of 2010, even though container supply was very short and container lease rates and prices were very high, we didn’t really have too much unilateral ability to go to customers and increase the rates on their existing container.

That is starting to change. We’re starting to see the bill down periods expire for leases that expired in 2010, and those are the discussions that we’re having where we are pushing rates upwards or encouraging the customer to bring the units back.

But in general, I think we’re having a good level of success in moving the rates upwards. There’s certainly a good understanding by our customer base out there that market conditions are strong for leasing companies, that containers are needed and new bill prices are very high, so that there’s a reasonable win/win solution to move the containers up towards a lease reflecting more the current market conditions.

Art Hatfield – Morgan Keegan

And I’m sorry, I’ve got one last question. As we look at the operating expense line and thing about that going forward, can you mention kind of what the biggest drivers are to that that kind of have the biggest effect on that line item?

Brian Sondey

The biggest driver is probably storage, and so when containers aren’t on hire to customers, we pay to store them in our depots, and so our OpEx is inversely proportional to our utilization.

Given that, we expect utilization to stay very high. We do expect storage to remain very controlled. We are expecting at some point here to see drop volumes increase. Containers continue to age and customers are going to want to eventually start bringing back some of our oldest containers.

When that happens, that does have a natural effect of moving our repair expenses up, but overall it tends to be a net positive both because we typically don’t spend all the repair money on oldest containers. We use some of that money to subsidize the sale value.

And then secondly, we are getting very big gains right now. So that to the extent the drop off volumes increase, that should help us drive higher gains.

Art Hatfield – Morgan Keegan

Great. Thank you. That’s all I’ve got today.

Operator

Your next question is from Sal Vitale – Stern Agee. Please go ahead.

Sal Vitale – Stern Agee

Good morning. Really nice quarter. Have a few questions. First question, I apologize if I missed this. I was on another call. I hopped on a little late. So year to date to October 27, you’ve done $875 million. That’s orders placed, correct?

Brian Sondey

It’s orders placed for delivery in 2010.

Sal Vitale – Stern Agee

OK. Delivery 2010. What’s your target internally? What are you thinking in terms of by the end of the year what that number would be?

Brian Sondey

It shouldn’t change too much more from that number. Again, we typically think of that number by calendar year delivery date and so given that, we’re almost in November. We’re just about getting to the point where the production lead time even for orders we place today would push us into 2011.

So it may change a little bit, but it shouldn’t change all that much. Really, we’re kind of shifting our focus at least to thinking about investments for early next year.

Sal Vitale – Stern Agee

OK. But so you’re saying in terms of what will be ordered and delivered in 2010, you’re pretty much done, but what about over the next two months, the additional orders you place. Is that another $100 million or so? Is there any ...

Brian Sondey

It really depends on market conditions. We are actively starting to stock the shelf for expected business early next year, and those numbers and orders aren’t reflecting in the totals. We in general, think that next year is going to be an attractive investment year as well, but a lot of the same dynamics that played into our favor this year including reasonably strong trade growth, a reluctance of a number of the major lines to buy equipment for themselves, and some constraints facing the smaller players. Some of those are starting to ease.

But in general we expect a fairly attractive investment environment and are certainly thinking about our opportunity for 2011 according.

Sal Vitale – Stern Agee

So do you think that it’s, 2011 could be a $600 or $700 million year?

Brian Sondey

We try to not give specific guidance on sort of sub components of our future performance, but we do think that it’s going to be good attractive investment opportunities, and we don’t have to approach the year by placing orders up front. We tend to place frequent smaller orders and as customers come in and commit to units, we replace them on the shelf, and that’s really how we get to sort of a full year’s worth of investment.

That said, we’re going to probably have a bigger shelf than usual this year just given our expectations that customer demand should be stronger than usual. But again, we’re going to adjust as we get into the year.

Sal Vitale – Stern Agee

Ok. And then if I could just switch to your results. And again I apologize if you talked about this earlier, but did you provide a breakout of the operating leases line? I know that was $81.25 million, because I know there’s a breakout between container lease and the leasing fees and other.

Brian Sondey

We didn’t disclose it in the press release or the call, but we do provide a breakout in the Q that we can give you now. For the three months of the third quarter, the total leasing revenue was $85.7 million. That included $4.5 million of finance lease revenue and $5.2 million of fee and ancillary fee revenue, things like drop off fees and repair fees and things like that.

Sal Vitale – Stern Agee

So that $5.2 million, that’s a sequential increase from what was $3.9 million in Q2, correct?

Brian Sondey

That’s right. It’s historically still low, but it’s up a little bit from the second quarter and not because of drop off volumes. We had one particular customer that had containers out for a very long time and they started to come back and drove an increase in that number.

Sal Vitale – Stern Agee

OK, so there was a drop off volume for that particular customer but not more fleet wise.

Brian Sondey

Drop off volumes in general were just about as low as they were for the second quarter.

Sal Vitale – Stern Agee

OK. And then if I look at your equipment trading margin, I think that was about $1.7 million for the quarter, that’s the revenue minus the expense? Have I got that right?

Brian Sondey

Yes.

Sal Vitale – Stern Agee

Is that historically seasonally, is that historically on point for the third quarter?

Brian Sondey

I wouldn’t say that business is entirely seasonal. It’s driven more by what’s happening with resale prices and what’s happening with our inventory resale units. It’s been up this year, certainly compared to last year. As the resale prices have pushed higher than we expected, and so we got larger gains than we had expected when we brought in units for our trading inventory.

The $.17 million probably isn’t untypical for what we do on average over the last three, four years or something like that, but again it’s not really driven by seasonality. And then next quarter, similar to the view that we have with our own units, which is that we’re going to be constrained on volume, we also expect to be constrained on volume in the trading business.

We’ve done a lot of deals with our customers especially at the end of last year and the beginning of this one, where we bought containers that were still in their fleet, leased them back, and then the customer drops them off and we own those containers.

So we have a fairly large trading fleet but almost all those containers are staying on hire with the customers so that our trading inventory of units on the ground is very low, and we do think that will constrain the trading margin in the fourth quarter.

Sal Vitale – Stern Agee

OK. Understood. And then just on the net gain from equipment sales, that was about $8.5 million the fourth quarter. That increase I guess whether you look at it sequentially or year on year, but let’s look at it sequentially from 2Q, the increase there is I think you said earlier more price than unit, correct? Units are probably down significantly?

Brian Sondey

Units are down a little, second quarter to the third, but we expect a much more substantial reduction from the third quarter to the fourth.

Sal Vitale – Stern Agee

In units.

Brian Sondey

In units. From price we actually expect to push upwards.

Sal Vitale – Stern Agee

So overall proceeds, overall gain could actually be above the 8.5.

Brian Sondey

No, we expect it to be down noticeably just because the volume is going to be so much smaller and so the basic dynamic that’s going to be playing out from the third quarter to the fourth quarter is we expect leasing revenue to increase significantly again, and we expect our effective interest rate to decrease, creating sort of a nice increase in the sort of gross margin of leasing revenue over interest expense. But that improvement is going to be offset by decreasing disposal gains and probably decreased trading margin.

Sal Vitale – Stern Agee

Understood. And then just I’ll leave you with one final question. This is big picture, just looking at the container shortage that’s still prevailing in the industry, what’s your sense that in 2011 that production of containers in China could be significantly higher than what a lot of market observers are forecasting right now, because if that would happen, then that would pretty much alleviate the shortage and take prices down a few notches. So I’m just curious, what’s your sense of that shortage ending earlier rather than later?

Brian Sondey

To some extent the extreme shortage that we saw in 2010 has already, has probably been mitigated. In 2010 shipping lines and leasing companies literally couldn’t get containers if they wanted them just because the factories hadn’t yet been able to ramp up production to the point of meeting the demand that was out there really at any price, and that had the effect of driving up prices quickly and creating very, very high demand for existing containers on the ground, whether new or depot units.

Into 2011, we’re not expecting that same level of production constraints that the factories have been fairly successful in ramping up their production, probably have the capacity today to produce something in the range of three million TEU for next year.

And so we don’t think we’re going to see sustained period like we did over the summertime of three or four months where the factories just couldn’t meet the orders. That said, we do expect containers to remain in very tight supply and that’s just because manufacturing capacity doesn’t mean that shipping lines or the lease companies jump in and place orders.

And the manufacturers, they don’t build inventory. They build a specific sales to the specific leasing or shipping lines and so we think the supply demand for containers is going to remain very tight, one because it’s going to end the year at essentially zero capacity, secondly, there’s probably some pent up demand for disposals as in 2010 leasing companies and shipping lines kept units in service that they normally wouldn’t.

And then we do expect a moderate to good amount of growth in trade volume in 2011. And all those things, we are likely to contribute to the strong demand for production. And so even though the manufacturers have increased their capacity, we think overall supply and demand balance is going to remain very favorable for us.

Sal Vitale – Stern Agee

OK. And is it your expectation that that three million TEU’s that you think might happen next year in terms of container production, do you think that that can get to four million, which I think the peak was a little over four million.

Brian Sondey

It all depends on trade growth. And so if trade growth – I’ll tell you the ranges I’ve seen and talking with customers and also looking at market forecasts, somewhere between 5% and 10% next year. I wouldn’t say anybody has a tremendous amount of confidence in their forecast.

But if trade growth is in the 10% growth, we easily could see production get into that four million level, but again, I think people sometimes make a mistake when they focus on manufacturing production capacity. It certainly if all the lines ran – excuse me – if all the factories ran two shifts and two lines for the full year of 2011, they could produce the boxes, but they would only do that if the shipping lines and lease companies jumping in with massive orders early in the year.

Given that container prices are fairly high and given the shipping lines remain a little nervous about their own freight rates in ‘11, and that some of the small lease companies still have some financial constraints, we don’t see that happening, and so that’s really the basic supply and demand is what’s driving our view more than the factory production capability.

Sal Vitale – Stern Agee

OK. Thank you.

Operator

The next question is from Greg Lewis, Credit Suisse. Please go ahead.

Greg Lewis – Credit Suisse

Thank you and good morning. Brian, you mentioned I think in your last question, where do new box prices stand right now?

Brian Sondey

They’re somewhat changing. New box prices peaked probably around $2,800 for a 20 foot container for delivery in August and September and right now my guess is they’re around in the $2,600 range.

Greg Lewis – Credit Suisse

OK. So they’ve been pretty steady for the last couple months.

Brian Sondey

Yeah.

Greg Lewis – Credit Suisse

So when I think about your un-contracted or un-leased fleet, as a percentage of what you’ve ordered thus far this year, how much of that is un-contracted at this point?

Brian Sondey

We have something around 90% or maybe a little more than 90% of what we’ve ordered has been committed to lease and the balance remains to be committed. Most of those are units that haven’t been (inaudible) and a portion of them are, we are producing some units in December that we’re really expecting to lease out in the first part of ‘11.

But if you think about 10% of $900 million is around a little under $100 million. That’s about the shelf that we want.

Greg Lewis – Credit Suisse

OK. And those were ordered I’m assuming around $2,600 per box?

Brian Sondey

It varies. Mostly yes, but that also includes some reapers and some tanks and some other products that have other prices of course.

Greg Lewis – Credit Suisse

OK great. And then switching gears a little bit, it’s been talked about your gains from equipment sales. As we look at the balance sheet, you look like equipment held for sales has decreased about $10 million quarter over quarter. As we look into December, can we sort of expect another $10 million decrease or – because we’re hearing that the price environment’s strong. Should we think that we could see half of those disappear or potentially even more in the fourth quarter?

Brian Sondey

It’s a good question and we actually wondering ourselves just how low can inventory go? Typically our sale inventory might range from two months of sale volume to three months of sale volume. It’s already to the point where it’s below one month of normal sale volume and there is some frictional time that’s required as we get units back, we estimate them for repairs.

We do fix some of the sale boxes to make them cargo worthy, especially in export markets. So it pushed down some. In fact, I think it already has pushed down some from the end of September to the end of October. But I’m not sure how low it can go, we’re going to have to see.

Greg Lewis – Credit Suisse

OK great. And then just really quickly, you mentioned as of October 27 your fleet utilization was 98.6 and as you think about utilization on a one week or a ten day moving period, are we at the peak or have we maybe seen the peak in utilization, ten, couple weeks ago, or are we sort of there right now?

Brian Sondey

It depends how you measure it. For us, we include our sale inventory as a subtraction to utilization, where I think a lot of the other leasing companies exclude sale inventory from the calculation and so we’ve been pushing upwards even from say end of September through the end of October just because our sale inventory keeps coming down.

In terms of our leasing fleet, I think the last I looked was we probably had a $1.3 million TEU of, like we’ve got 1,500 TEU of dry containers available and that’s mostly units that have been dropped off and are being repaired. So it really just shows that we can’t get any higher than that and if we do see further changes from 98.6, it’s mainly just going to be driven by what happens to our sale inventory.

Greg Lewis – Credit Suisse

OK great. Thanks for the time guys.

Operator

The next question is from Sameer Gokhale, KBW. Please go ahead.

Brendan Sheehan – KBW

Hi, good morning. This is actually Brendan Sheehan [ph] in for Sameer. Most of my questions have been answered. I guess so just bigger picture, it seems like you I guess and a bunch of your competitors are making significant investments in new containers and most of the new production capacity I guess is accounted for. I guess if you could just talk about what kind of opportunities there are? Has there been any movement in terms of maybe acquiring some management rights or purchasing some containers on sale/lease transaction.

Brian Sondey

There has been a fair bit of MA activity over the last few years. A lot of deals that were done in 2008 and 2009 were as you suggest, purchases of management rights. We didn’t participate in any of those, but there were a number of transactions done.

This year, the M&A activity has centered around some of the bigger companies. There’s a company called Kronos which is kind of a mid-sized leasing company that was sold in the middle of this year to a private equity firm.

We saw an IPO yesterday I think, CQ did an IPO and there’s been talk of other larger leasing companies being made available for sale as well. We look at those transactions, but in general we haven’t done them in the past. We’ve look at a lot of stuff.

I’d say mostly we’ve been outbid. Whenever we think about doing an acquisition, whether it’s a management rights or a portfolio of equipment or a company, we always compare it to the returns we expect to get when we just buy new containers and can control the quality of the production and lease them ourselves, and do the credit analysis ourselves.

And what we have found generally is that the returns available in the acquisitions in our view at least, were not up to the same level as we expect when we buy new equipment, and so we’ve been saving our capital and focusing it on just organic growth. That said, we will continue to look at acquisitions as they come along.

In terms of sale/lease back transactions, one of the somewhat surprises to me this year is that we haven’t seen more, and on the one hand you can say it’s almost a little bit irrational in the sense that some of the major lines have been willing not to buy equipment and to focus on leasing it in.

Where they’ve been unwilling to sell existing equipment and to sell lease back transactions because our financing cost that we include in those leases is higher than their own, and it’s hard to say exactly why that is.

I think maybe it’s just simpler for them to think about outsourcing the new procurement but leaving existing stuff as it is. But that’s been the market that we just haven’t seen that many, at least not large sell/lease back opportunities this year. We saw some at the end of ‘08 and ‘09, but we haven’t really seen many this year.

Brendan Sheehan – KBW

That’s excellent. Thank you very much.

Operator

The next question is from Daniel Furtado from Jefferies. Please go ahead.

Daniel Furtado – Jefferies

Morning, thanks for your time. Great quarter. Just two quick questions. I guess the first is, and I apologize if you’ve gone over this. If you have just let me know. The swap termination, is there going to be an expense recognized in 4Q for that?

Brian Sondey

There won’t. The swaps that were terminated were scheduled to expire in 2011, and we terminated them early mostly so we could extend them, and there wasn’t much hedge value left in the swaps given they expired next year and we’ve done a lot of extending to our lease portfolio and rewriting leases and putting units on very long lease terms this year.

And so it was a pretty good opportunity to keep our swap portfolio relatively the same size, but just extend the durations. There isn’t a gain or a loss on the termination in the P&L because we’ve already recognized it.

Almost all the swaps in our portfolio were not designated as hedges and so every quarter we have this unrealized gain or loss on the swap. These particular swaps had been done at fixed rates higher than the current market, so we’d already taken unrealized losses associated with these swaps and because we’ve already taken those through the P&L, there’s no further effect of their termination.

Daniel Furtado – Jefferies

Got you. And how about the impact to the interest rate you’re going to pay? I assume the fixed pay on these swaps is substantially lower, and how do we think about that as it – I guess with the notional balances, how it may or may not impact your interest expense on a go forward.

John Burns

The way we look at it is that those transactions together with the ABS transactions, we think will lower fourth quarter interest expense by about 60 basis points and somewhat further into the first quarter.

Daniel Furtado – Jefferies

Excellent. Thanks for the color there. And then the other thing, again, please just let me know if you’ve covered this, but you mind giving us a little bit of commentary just kind of the puts and takes between the reefer and the dry box market, what you’re seeing? Obviously the dry box market I think is pretty well publicized what’s going on there, but just kind of how you view those two opportunities in today’s market?

Brian Sondey

I’d say in general over time, we’ve been in both the reefer and dry box business for a very long time and had substantial presence in both for 20, 30 years. Over time we generally think those products have very similar return characteristics, similar performance characteristics and so we really invest in whatever products our customers want. We don’t have a particular agenda about a certain percentage of dry’s or reefers.

This year there are some different dynamics and there were last year as well. In 2009 was a very tough year for dry boxes. A lot of consumer discretionary items come in dry boxes and as the recession hit and spending dropped and inventory destocking hit, we saw large reductions in trade volume with dry boxes leading to excess fleets and large drop offs and poor utilization and no buying.

Reefer boxes on the other hand remained in fairly good demand in 2009. They carry mainly food and all of us here in the Northern Hemisphere still wanted our fresh fruits and vegetables through the winter time and so on, and just wanted it throughout the year, and so we didn’t see a big drop off in volume. We didn’t see a big drop off in utilization, and also the factories remained open.

And what that meant was as you headed into 2010, you didn’t have the same production constraints in the reefers as we did in the dry’s, and so we didn’t see kind of extreme shortages of reefers or extreme leasing demand like we did on the dry’s just because the factories have stayed open the whole time.

That said, we bought an awful lot of reefers this year, not again for the same reasons. And the reefers, we’ve bought a lot of units and leased them out to customers I think mainly because of the substitution effect. The customers haven’t wanted to put their own dollars into buying new containers and so they’re outsourcing the additions to the fleet to leasing and that’s made for a very good investment year for us as well.

But if you look at the utilization or the price changes on reefers, you’re not seeing the same extreme levels of utilization or extreme increases in lease rates or new equipment prices because the factories are not in a shortage situation.

Daniel Furtado – Jefferies

Excellent. Thanks and congratulations on the quarter again.

Operator

Having no further questions, this concludes our question and answer session. I would like to turn the conference back over to Brian Sondey for any closing remarks.

Brian Sondey

I’d just like to thank everybody again for your continued interest in TAL and we look forward to speaking with you soon. Thank you.

Operator

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

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