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Executives

Victor Garcia – COO

John Nishibori – President and CEO

Gary Sawka – Interim Chief Financial Officer

Analysts

Bob Napoli – Piper Jaffray

Sameer Gokhale – KBW

Daniel Furtado – Jefferies

Andrew Bolsovec (ph)

CAI International Inc. (CAP) Q3 2010 Earnings Conference Call November 2, 2010 5:00 PM ET

Operator

Good day, ladies and gentlemen, and welcome to your CAI International Q3 2010 Earnings Conference Call. (Operator Instructions). As a reminder, today’s conference is being recorded. And now I would like to introduce your host for today, Victor Garcia, Chief Operating Officer.

Victor Garcia

Good afternoon, and thanks for joining us today. Certain statements made during this conference call may be forward looking and are made pursuant to Safe Harbor Provisions of Section 21E of the Securities and Exchange Act of 1934, and involve risks and uncertainties that can cause actual results to differ materially from current expectations, including but not limited to utilization rates, economic conditions, customer demand, increased competition, and container investment plans and others. We refer you to the documents that CAI International has filed with the Securities and Exchange Commission, including an annual report on Form 10K, the quarterly reports filed on Form 10Q, and its reports on Form 8K. These documents contain additional important factors that could cause actual results to differ from current expectations and from forward-looking statements contained in this conference call.

I would now like to introduce John Nishibori, our President and Chief Executive Officer. John, please go ahead.

John Nishibori

Thank you. Welcome to CAI’s 2010 Q3 earnings conference call. The market demand for our services remains very strong, and we continue to benefit from this demand through the high utilization of our fleet. We recorded over $9 million in net income for the quarter, or $0.50 per share. In each of the last two quarters we have reported over 14% sequential growth in revenue, over 34% sequential growth in operating income, and over 60% growth in net income. We are excited about these results and expect that the continued high utilization of our fleet and with the capital expenditure investment we are making, that the financial momentum will continue in the coming quarters. I would like to hand it over to Victor Garcia, our Chief Operating Officer, to discuss in greater detail our operating results and market environment.

Victor Garcia

Thank you, John. As John mentioned, during the Q3 our utilization remained strong and has averaged 98.1%, a 3% increase in utilization from the average utilization recorded during the Q2 of 2010. Utilization for the past two quarters has neared full utilization levels, however we do not believe our financial momentum has peaked and that we are in the early stages of a multi-year recovery in world trade and container demand.

The financial update for this quarter, and for future quarters, will be the sequential revenue and net income impacts from the level of investments we have made. During this quarter, we took delivery of 40,500 TEUs. Some of those units will show the full revenue impact during the Q4. Through the end of the Q3, we purchase or committed to purchase, over $200 million in containers. We have committed to additional investments in the Q4, and now expect to purchase or commit to purchase over $250 million for the year.

To put this year’s investments in perspective, we estimate that our investment in containers this year will represent over 70% of the net booked value of containers CAI had on its balance sheet at the end of 2009. Because of our investment level this year and our expected investment level in 2011, we believe we should continue to grow revenue and net income at a faster pace than our industry overall.

Our container rental revenue this quarter increased 23% sequentially from the Q2 of 2010, and operating income increased 35%. Our earnings per share for the quarter were $0.50 per fully diluted share, compared to $0.31 during the Q2 of 2010, and $0.18 during the Q3 of 2009.

As you can see by our results this year, this is a good time for CAI and the container leasing industry, and we believe we are in the early phases of a multi-year improvement in demand for containers. This year we are benefiting from the increased demand as occurred from the return of world trade growth in 2010, and the underinvestment in containers that’s occurred over the past two years. Parson’s Research estimates that world trade growth will increase 11.5% this year, and 10.4% in 2011. That level of growth has been consistent with historical long-term growth in world trade. A 10% increase in world trade growth in 2011, coupled with a 5% to 6% attrition rate of the world container fleet, is expected to provide strong support for new container investment over the next few quarters.

As I said, in 2009 there was minimal investment in (inaudible) containers. In 2010, overall container production is estimated to be approximately half the level of the 3 million TEU production that it has averaged over the five years prior to 2009. However, it is estimated that the container lessors have purchased approximately 70% of the container production in 2010 as opposed to approximately 40% to 45% in a normal year production level. Shipping lines have improved their financial position this year, and so we expect that they will be more active in purchasing containers in 2011. However, we do expect that they will continue to be more dependent on the leasing community in 2011 than the historical average, which will provide strong demand for CAI.

Because of the high utilization, the number of containers available to be sold has declined, resulting in rising prices for older containers. We are seeing strong demand for secondary sale containers in all regions where we sell, and we expect such demand to remain strong as long as utilization for all lessors remains at or near current levels. As I said, these are good times in our business, and we expect these strong trends to continue into 2011 and beyond as the world economies grow, particularly in emerging markets. We believe that demand for containers is more impacted by trade in and around Asia, with China in particular as a focus. We believe the growth of the Asian economies, which is a secular growth trend, is more important to demand for containers than the container demand in and around the United States.

The performance in our managed portfolios has also improved over the course of this year. We believe that this has made container investors more interested in container investment. We remain focused on growing our managed container business and are expecting to sell containers to investors in 2011. I will now hand over the call to Gary Sawka, our Interim Chief Financial Officer, to go over the financial results for the quarter.

Gary Sawka

Thank you. Good afternoon. Earlier today we reported 2010 Q3 net income attributable to common stockholders of $9.2 million, or $0.50 per fully diluted share on an average share count of 18.2 million. This compares to net income of $3.2 million, or $0.18 a share, for the Q3 of 2009, with an average fully diluted share count of 17.9 million. The $0.50 per fully diluted share for the Q3 of 2010 included a $2.1 million tax benefit due to the reduction in accrued tax liability. Without this tax benefit, net income attributable to CAI common stockholders for the Q3 of 2010 would have been $0.39 per fully diluted share, a 117% increase compared to the Q3 of 2009 and a 26% increase compared to the Q2 of 2010.

Total revenue for the Q3 was $20.1 million, an increase of $4.4 million from the total revenue for the Q3 of 2009. Container rental revenue was $17.2 million during the Q3, compared to $13.4 million in the Q3 of 2009 and $14 million in the Q2 of 2010. The container rental increase over the comparable periods, is due to increasing utilization of our fleet and the additional investment in containers made during the first nine months of 2010. Management fee income during the Q3 was $2.2 million, compared to $1.8 million in the Q3 of 2009. Management fee increased due to improved financial performance in our managed portfolios and from management fees earned by our subsidiary CAIJ. Our managed container portfolios have been experiencing improved utilization, which is increasing revenue and reducing storage and handling costs, thus improving profitability of the fund. We receive a percentage of the fund’s income as a management fee.

While we did not book any gains on the sale of container portfolios in this quarter, I would like to elaborate on transactions with two Japanese investor groups. In our earnings release we referred to the transfer of 25,500 TEUs of older containers to these investor groups. These two transactions had many of the characteristics of our previous container sales to Japanese investor groups. We sold the containers under a container sales agreement and issued the investors groups a bill of sale. Along with the sale we entered into new management agreements with the investors for those assets. The difference in these two transactions was that CAI negotiated into the agreement a fixed price purchase option granted to CAI on the units, which in part results in CAI consolidating the financial performance of the fund’s operations into CAI’s financial results. The fund’s net operating income for the Q3 of 2010 of $49,000, has been recorded as net income attributable to non-controlling interests on our consolidated statements of income.

We have not completed any sales to European investor groups this year, which historically have comprised a majority of our container funds sales. However, we continue to speak with the rangers of container funds and believe that as performance improves for the shipping industry and container leasing funds, there will be incremental interest for new container programs.

Turning to our OPEX numbers, our total operating expense for the Q3 of 2010 was $10 million, compared to $10.8 million during the Q3 of 2009. Storage and handling costs decreased over $1.2 million as compared to the Q3 of 2009, a result of the lower number of off-hire units this past quarter. MG&A was $5 million for both quarters. Depreciation was $5.4 million, up $1.1 million as compared to the $4.2 million during the Q2 of 2009, and as a result of the substantial investment in new containers in recent quarters.

During the quarter we recorded a foreign exchange loss of $116,000, due primarily to a revaluation of assets and liabilities of our European subsidiaries. Most of our assets and revenue is US dollar-based but we have some revenue and assets recorded in Euros and British pounds. Gain on disposition of containers of $1.8 million was $852,000 above the comparable amount in the Q3 of 2009. Our gain this quarter was lower than the $2.5 million recorded in the Q2 of 2010, due to selling fewer units, however the selling prices on older containers has continued to increase in recent quarters.

Net interest expense was $1.4 million for the Q3 of 2010, which represents an increase of approximately $448,000 when compared to the Q3 of 2009. While we continued to benefit from the low floating-rate interest environment that prevailed throughout the quarter, this benefit was offset by the larger amount of borrowings to fund our container purchases. As to income taxes, we reported a net tax benefit of $519,000, which as we discussed at the beginning of my presentation, was the result of a $2.1 million tax benefit due to a reduction in accrued tax liability. Without this tax benefit, our income tax expense was $1.6 million, which translates into an effective tax rate of 18.7% for the Q3 compared to 19.3% in the Q3 of 2009. This lower ETR is due to the increasing portion of profitability coming from our international operations. It is our expectation that the effective tax rate in 2010 will be approximately 17.7% for the year, which again is due to our current expectation of increasing contribution of profitability that our international subsidiaries will have to our overall pretax income. We would note, however, that on a sequential quarter over quarter basis there may be variability around the downtrend of the effective tax rate.

Finally, net income attributable to common stockholders for the three months ended September 30th, 2010, was $9.2 million, compared to net income of $3.2 million for the comparable period in 2009. Operator, please open the line for questions.

Question-and-Answer Session

Operator

Okay. (Operator Instructions.) Okay, and I’m showing just a couple questions in our queue. Our first is coming from Robert Napoli of Piper Jaffrey. Please go ahead, sir.

Bob Napoli – Piper Jaffray

Good afternoon, everybody, and Victor, congratulations on your promotion and Gary, welcome to the team, even if it is temporary.

Victor Garcia

Thank you, Bob.

Bob Napoli – Piper Jaffray

And I have a question on the growth in the quarter. You did, obviously we were looking for strong growth but you had somewhat stronger growth in assets than what we had forecasted. I was wondering what the average of the containers and container assets on the balance sheet were for the quarter. Just trying to come up with the yield, the revenue yield on the portfolio.

Victor Garcia

The assets that came in over the course of the quarter, I think they came in in the second and third month of the quarter. So I don’t have the exact average net booked value in front of me right now, but I could try to follow up with you. But I can tell you that not as much came in in September, more came in in October, I’m sorry – in the first month of the quarter. More came in in the second and third month of the quarter.

Bob Napoli – Piper Jaffray

Okay. Can you maybe give a feel for pricing? How much is pricing up on new containers and also on re-leasing? And what terms are you putting? Are you putting these on, Victor, still with five to seven year terms.

Victor Garcia

Depending on the customer we are putting in anywhere from five to ten year terms, and the pricing environment as far as the yields on the new box prices is around the same as it was in the prior quarter. We just don’t have as much equipment coming out of the depot in the Q3 as we did in the Q2, so the out of depot equipment is not as big a factor this quarter.

Bob Napoli – Piper Jaffray

And what you are re-leasing, the rollover, what type of pricing are you getting on those containers?

Victor Garcia

Well, pricing is up anywhere over 50% from where old lease rates were. So they’ve gone up considerably, and we haven’t seen a diminution from that in the Q3.

John Nishibori

This is John. During the Q2 we were looking at five to seven year leases on a cash on cash basis against new containers of anywhere from 14.5% to 17%, and that basically has not changed during the Q3. In terms of absolute per diems, obviously it’s much higher than before, simply because the container prices have gone up. So but that’s pretty much where we are.

Bob Napoli – Piper Jaffray

And from a- I’d like to understand the Japanese investor group, the sale, the transaction that you did. So with the buyback, the fixed purchase price option, you are still- I mean those containers are sold but they’re still showing up on your balance sheet and you’ll earn income over the life of the containers as opposed to a one-time gain on sale plus a management fee? Is that- And how much was that? How much did you sell into those funds dollar wise?

Victor Garcia

We sold about- We had two transactions during the quarter. We sold about $17 million of equipment to these two funds. The underlying economics of the transaction are the same as what we’ve done in the other deals, except in this case we negotiated in the purchase option for the containers at a future date. Because of that we consolidated that entity into our results, so the revenue associated with that will show up on our results, and we’ll have a line item of net income attributable to non-controlling interests. But the economics of what we had in terms of looking at it from a business standpoint is exactly the same as it was before. We collect a- Most of the cash flow goes to the investors because they invested the capital. We get the equivalent of a management fee for that deal, and we get essentially the return. We would have recorded approximately a $1.1 million gain if we didn’t have this purchase option, so because we did have this purchase option we had to account for it differently. And so we don’t have that, but we should be able to realize that gain over the life of the fund life.

Bob Napoli – Piper Jaffray

So it’s very efficient financing, same economics but you’ll just recognize the economics on a GAAP accounting basis over time. Will you do more of those types of transactions?

Victor Garcia

We’re looking at a number of different things. I’m not sure that we’ll do many more of those – that was a specific situation, a specific opportunity.

Bob Napoli – Piper Jaffray

Okay. And the last question on the KG funds and the other funds, and the traditionals. I mean with the demand that you’re seeing and the growth in the investments, do you, you said you’re seeing more interest. Do you expect to get something consummated with those funds in the near term?

Victor Garcia

As we said the last couple of quarters, I mean there is interest in looking at investing in containers. Some people have already created some funds and invested in containers. It takes some time for people to set up and analyze the opportunities, to raise the equity capital to invest in these funds, so it’s taking a while. The feedback that we’ve gotten is that people believe that container investment, given the current outlook for the business, is attractive. And we are aware of people who are looking to invest in containers in 2011.

John Nishibori

And Bob, although it’s small, the Japanese funds, they have been increasing very consistently. We now have relationships with quite a large number of investors in Japan, so we remain optimistic with the Japanese funds. For example, this quarter we did $17 million instead of the $5 million or $6 million that we used to do. So in this case what we did was, for conservatism’s sake we have consolidated those, but the demand is there. That’s my feeling.

Bob Napoli – Piper Jaffray

Thank you. Thank you, John. Thanks, Victor.

Operator

Okay, thank you. And we’ll take our next question coming from Sameer Gokhale from KBW. Sameer, please go ahead.

Sameer Gokhale – KBW

Congratulations to both of you as well on your new roles with the company. My company was, the first question was on the fixed price purchase contract. You talked about the accounting a little bit but is there going to be some sort of market valuation adjustment as well every quarter? Because if I understand it correctly, basically at the end of the term of this arrangement you basically agree to buy back the containers at a certain price. And I would assume that relative to the market price of those assets you have to mark these things to market. Is that the way it works or maybe not?

Victor Garcia

No. We have an option to but we don’t expect to have to mark to market the option that we have on these containers.

Sameer Gokhale – KBW

Okay. So it’s not treated like some sort of guaranteed price that needs to be adjusted relative to the market price every quarter. It’s just a fixed price and you don’t really need to mark it to market at all.

Victor Garcia

No.

Sameer Gokhale – KBW

Okay. So that releases the volatility, any potential impact on the income statement, which is good. The other question I had was in terms of the range of container investment in 2011, can you give us a sense for that? How are you thinking about that? It seems like this year you’re on track to invest the $200 million. How much more could you invest next year? How much more in funding facilities would you be comfortable in seeking next year? Can you talk about your funding capacity and the like as well?

Victor Garcia

I think this year, we said in the prepared remarks we’re on pace for investing over $250 million this year. We think next year, we’re optimistic about next year’s opportunities, so we can see investing somewhere similarly in that range. And we think there will be the market appetite for that. As far as funding, we closed our bank facility in August. We’ve been having discussions amongst a number of different parties about other financing vehicles. We think the market has improved significantly in terms of accessing senior debt capital and at a much more cost effective rate, and we’ll be looking to put that in place over the course of the next few months to make available additional credit to finance some of the purchases we expect for next year.

Sameer Gokhale – KBW

Okay. And if you can just remind me, I mean the structures- You talked a little bit about the terms on these new leases, containers are contracted for five to ten years and the like. If you look at this from the perspective of valuations for these containers a few years down the road, how should we think about that again? Let’s say a container comes off lease in five years – if the market values or lease rates are a lot lower then… This is something that I think everyone in the industry may have to work through, but how do you think about that? Because if you’re so far off in the future to think about prices five years, seven years from now.

Victor Garcia

Well, two comment related to that. Part of the reason why lease terms are getting longer is that we’re more comfortable at the higher price point on containers having a longer lease to amortize down that incremental cost and get a return on that incremental capital that goes into the container. So part of our strategy of hedging that risk is by having a longer-term lease, so that when it comes off of that lease you have less capital in that asset. The other point we would make is I know that container prices have gone up materially over the course of this year, and the natural inclination is to think that it’s going to come back down, but the container prices had gone up to as high as $3000 twenty years ago.

So it’s not a foregone conclusion that the most recent history that we’ve had of containers in the $1800 to $2000 range will be what is expected to occur over the next two, three, four years. There are a number of reasons why you could expect that container prices would continue to stay at or above current levels given the decline in the dollar, the strengthening of the (inaudible), labor cost increases, a number of factors; fuel prices. So it’s not a foregone conclusion but we try to hedge our position in case that does occur so that we’re protected on the downside.

Sameer Gokhale – KBW

Okay. And then just lastly in terms of the tax rate, you had given some sort of expectation for longer term, I guess the tax rate to be in the 10%, 11% range. Is that still your expectation or does this tax adjustment that you recorded this quarter somehow change that going forward?

Victor Garcia

No, I don’t think the tax adjustment in this quarter will affect our long-term view. This quarter, this year we’re expecting somewhere in the 17% to 18% effective tax rate. I think what we guided for was that we should expect roughly a 4 percentage point decrease annually. I think the guidance of 10% to 11% is a reasonable guidance, but there is the possibility of a further reduction. But we will have to look at that as we get close to it. There are a number of assumptions that go into that.

Sameer Gokhale – KBW

Okay. Alright, thank you.

Victor Garcia

Thank you.

Operator

Thank you. (Operator Instructions.) And our next question is coming from Daniel Furtado from Jefferies. Daniel, go ahead.

Daniel Furtado – Jefferies

Hey, everybody. Good job on a nice quarter. Two real quick questions, I think. Just so I understand the response to Bob’s question about the new TEUs brought on in the quarter. Is it ballpark to say that if I assume half of those were in effect for the Q3, so say 20,250 was kind of the revenue impact for the quarter? Or would you consider it a little bit higher than that?

Victor Garcia

I don’t think it’d be higher than that; I think it’d be at or slightly less than that half number. So a half is probably a good range.

Daniel Furtado – Jefferies

Okay, okay, great. And then I missed the very first couple minutes of the call so I apologize, but can you help me understand what you’re seeing from the manufacturer side coming out of China? I’m trying to gauge on how active new container production is according to what you’re seeing and how that breaks down from a reefer versus dry box business.

John Nishibori

At the beginning of the year, they were just catching up frantically. However, I think they pretty much are in a position to do two shifts or three shifts or whatever to meet the market demand. So I don’t see the manufacturing as a bottleneck going forward. However, production I believe will still be limited because of the demands, from a demands side, i.e., shipping companies. I don’t think the shipping companies are still ready to make massive investments like they used to do in the past. I think this trend will continue next year and based on that, I think you will see the actual manufacturing activity to remain fairly flat or about the same level possibly, let’s say maybe during the Q1 next year and then slightly increase as the year goes by. But we do not see the manufacturing capacity as a bottleneck anymore.

Daniel Furtado – Jefferies

Okay, that’s great color. I appreciate that, John. And so I guess the way I understand this is that the containers are more or less readily available for you. There’s just less guys in line trying to buy them off the manufacturers in China than there were in the bubble.

John Nishibori

I didn’t get that question.

Victor Garcia

I think that’s basically right. I think that over the long term the major issue is not manufacturing capacity, because manufacturing capacity is there. I think it’s demand driven, and the difference in our industry versus a shipping industry is that the lead time is fairly short – two months to get equipment. So the potential for an oversupply situation to a great degree is not as strong because when we start seeing the market turn down, as we have in this past downturn, we stop producing and we believe our competitors will act rationally and stop purchasing, and shipping lines will probably not be purchasing unless there is a really opportunistic opportunity to buy containers at a very low price. What we’ve seen from the manufacturers is that they’re much more willing to shut down production than to lower price, and if that dynamic works we think that the governor will be demand – the companies’ demand for containers.

Daniel Furtado – Jefferies

And that, thanks, Victor. And that demand, I guess the more rational behavior from the manufacturers that you’re seeing today, that’s a marked difference from just a few years ago, isn’t it?

Victor Garcia

I wouldn’t say a few years ago. I think in the early, say eight to ten years ago when we went through the last downturn, I think there was much more of a view to operating even maybe at below variable costs as a way to keep people employed. I don’t think that that has been viewed as a sound way to manage through a downturn, so I think that’s a structural change in the business.

Daniel Furtado – Jefferies

Okay, great. Hey, well thanks for the color and good job on the quarter, guys.

Victor Garcia

Thank you.

John Nishibori

Thank you.

Operator

Okay, thank you. We’ll take our next question coming from Andrew Bolsovec (ph) from (inaudible) Capital.

Andrew Bolsovec

Hi, guys. This is Andrew Bolsovec. How are you?

Victor Garcia

Great.

Andrew Bolsovec

Can I ask you a little bit- You alluded to funding for next year. I mean if you’re going to spend another $250 million roughly on containers in 2011, can you sort of give us an idea of how you think about leveraging the balance sheet?

Victor Garcia

I think we mentioned in last quarter’s call that our view is that we should be able to more efficiently manage our balance sheet by operating at a close, between 2.5 times and 3 times on a debt to equity basis. So we’re well below that point, so we think we can comfortably look at the investment plans that we’re talking about with cash flow being generated to operate in that environment.

Andrew Bolsovec

Okay. So does that mean you think that there’s not going to be a need to raise equity in the next twelve months?

Victor Garcia

I think the raising of equity is a board level decision, so the board will look at a number of things to consider as to whether or not we need the capital. But what I’m indicating is that when we look at our investment plans for this year or for next year, it’s not predicated on looking at an equity rate.

Andrew Bolsovec

Okay. Okay, great. Thanks very much.

Operator

Okay, thank you. (Operator Instructions.) I’m showing no further questions.

Victor Garcia

Great. Well thank you all for joining us on our call and we look forward to speaking with you in three months.

Operator

Okay, ladies and gentlemen, this does conclude your conference. You may now disconnect and have a great day.

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