TAL International Group CEO Discusses Q2 Results - Earnings Call Transcript

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TAL International Group, Inc. (OTC:LNET) Q2 2012 Earnings Call July 26, 2012 9:00 AM ET

Executives

Jeff Casucci - Vice President, Treasury and Investor Relations

Brian Sondey - President and Chief Executive Officer

John Burn - Senior Vice President and Chief Financial Officer

Analysts

Michael Webber - Wells Fargo

Helane Becker - Dahlman Rose

Sal Vitale - Stern Agee

Ken Hoexter - Bank of America

Jordan Hymowitz - Philadelphia Financial

Operator

Good morning and welcome to the TAL International Group Second Quarter 2012 Earnings Conference Call. All participants will be in listen-only mode. (Operator Instructions). Please note, this event is being recorded.

I would now like to turn the conference over to Mr. Jeff Casucci, Vice President, Treasury and Investor Relations. Please go ahead, sir.

Jeff Casucci

Thank you. Good morning and thank you for joining us on today's call. We are here to discuss TAL's second quarter 2012 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 Burn, 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 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 differ materially from those projected.

Finally, the company's views, estimates, plans and outlook as described within this call may change subsequent to this discussion. The company is under no obligation to modify or update any or all of the statements that is made herein despite any subsequent changes the company may make in its views, estimates, plans or outlook for the future. These statements involve risks and uncertainties, are only predictions and may differ materially from actual future events or results.

For a discussion of such risks and uncertainties, please see the risk factors listed in the company's annual report filed on Form 10-K with the SEC.

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

Brian Sondey

Thanks Jeff. Welcome to TAL's second quarter 2012 earnings conference call. Tal continued to deliver outstanding operational and financial performance in the second quarter of 2012. We generated almost $52 million in adjusted pre-tax or cash income for the quarter.

Our existing fleet continued to perform exceptionally well. Utilization averaged almost 98% for the quarter and used container sale prices held steady during the quarter at historically high levels, and we continued to invest heavily in new and sale-leaseback containers ensuring that 2012 will be another year of strong growth for TAL.

Sales performance continues to be supported by attractive market fundamentals. Trade growth remained solidly despite global economic headwinds, a recession Europe and disappointing growth in the United States, and minimal trade growth in the main east west trade lands.

The growth in inter-Asia North-South and other regional trades continues to be strong. Overall growth in global containerized trade volumes is still expected to be 5% to 7% in 2012. The supply and demand balance for containers remained in our favor.

People inventories of used equipment remained unusually low and the production of new containers so far this year has been moderate. We estimate that the production of new containers in the first half of 2012 was down roughly 30%, compared to new production in the first half of last year.

Our shipping line customers continued to be very cautious about purchasing new containers directly and they remained interested in pursuing sale-leaseback transactions for their existing owned containers.

We estimate that leasing companies have purchased roughly two-thirds of new production so far this year, which is an even larger share than in 2010 or 2011, and we have completed several sizable sale-leaseback transactions with our customers this year.

This combination of moderate trade growth, tight container inventories and a market share shift from owned to leased containers remains the basic formula allowing us to achieve high utilization strong profitability and aggressive growth at a time when global economic conditions seem challenging.

As I mentioned, we will have another strong investment year in 2012. Through July 25th, we have ordered about $750 million of new or sale-leaseback containers for delivery in 2010. Roughly 75% of containers are committed to leases with a number of the world's largest shipping lines.

Pick-ups for lease commitments have been slower than expected as renewed global instability has taken some of the momentum out of the traditional summer peak season. Because of this, we expect that our pace of investment in new containers to slow in the second half of the year. Though the risk potential for further sale-leaseback transactions, and due to our strong start this year, we will achieve asset growth over 15% in 2012, just based on our existing orders. The large number of new and sale-leaseback containers that remained committed to go on hire will support strong pick-up activity and growth in our leasing revenue in the third quarter.

As mentioned in the press release, we are increasing our dividend this quarter to $0.60 per share. This increase reflects our continued strong performance and expectations that market conditions will remain favorable. The increased dividend also reflects the strong growth of our long-term lease portfolio and the resulting increasing in our recurring leasing revenues.

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

John Burns

Thank you, Brian. We're pleased to report another very strong quarter of operating and financial results. As we noted in the press release, adjusted pre-tax income was $52 million, or $1.54 per share for the quarter. Essentially flat from the $1.53 per share in the second quarter last year as lower used container sale prices and disposal gains offset a significant increase in leasing revenue.

Leasing revenue increased 20% from the prior-year second quarter. This increase is a result of several items. First and most significantly, we realized the full benefit of the $775 million in container investments made during 2011, and the initial benefits of our current year's investment.

Secondly, the current quarter's revenue includes approximately $3 million in lease termination fees related to customers' existing certain trade lines. Third, we experienced an increase in re-delivery fees reflecting a modest increase in Misc units delivered. These items were partially offset by 1% reduction in average utilization versus the prior year quarter.

Adjusted EBITDA increased 11.5% from the prior-year quarter to $136 million. Increase in EBITDA trailed our top line growth largely due to $3.7 million lower gain on sale and slightly higher operating expense reflecting the small reduction in utilization.

Lower gain on sales due to a 20% decline in container disposal prices from the prior year as the exceptionally high prices realized in 2011 eased as the supply of disposal units in depots increased slightly with this decline in utilization.

Adjusted pre-tax income of $1.54 was essentially flat despite the 20% increase in leasing revenue and the 11.5% increase in adjusted EBITDA, as depreciation expense increased at faster rate than leasing revenue.

Depreciation has increased more rapidly than leasing revenue since the beginning of 2011. As the fully depreciated portion of our fleet has shrunk from 17% at the beginning of 2011 to 12% at the end of 2011, and 8% at June of this year.

The main reason for the reduction in the portion of our fleet that is fully depreciated is the very low levels of investment by TAL in the late 1990s, resulting in fewer units becoming fully depreciated over the last two years.

The significant growth in our fleet size over the last few years has also contributed to this change. This aggressive investment has added significant value by locking in a much higher level of long-term recurring revenues and cash flows and reduced the average age of our fleet. The results have reduced relative size of the older fully depreciated portion of our fleet.

We expect the impact of these changing fleet demographics to stabilize over the next several quarters. Looking forward to the third quarter, we expect a substantial amount of the containers committed to lease to be picked up and we expect revenues to increase, so this will be partially offset by the elimination of the lease termination fee income recognized in the second quarter. In addition, we expect disposal prices to remain stable through the end of the dry container peak season.

While current market conditions remain quite favorable for us, we remain concerned about credit risk. The current freight rate environment, along with lower bunker cost is certainly positive news for shipping line customers, and many are expected to be profitable in the second quarter.

However, excess vessel capacity persists and is anticipated that the volume of new vessels entering service over the next several years will be in excess of trade growth. Accordingly, freight rates and our customers' financial customers are expected to remain under pressure, and therefore the potential for credit losses remains elevated.

While we'll continue to pay close attention to any possible signs of any credit losses, the financial challenge is, our customers are facing continues to drive the shift from ownership to leasing, allowing us to invest and grow our business aggressively.

As Brian noted, we have increased our quarter dividend to $0.60, while representing the high payout ratio based on our adjusted net income, but it represents only a 40% payout ratio of adjusted pre-tax income.

We believe, the pre-tax payout ratio is the relevant measure as we accrue income taxes at a 35% rate, but have not paid cash taxes since going public in 2005, and do not expect to pay cash taxes for a long time, because of the accelerated tax depreciation on our container fleets.

We've increased our dividend 9 off the last 10 quarters, and the amount of the dividend by 100% over the same period, and the 40% pre-tax payout ratio remains well below approximately 50% payout ratio we had during the pre-crisis period.

I'll now return you to Brian for some additional comments.

Brian Sondey

Thanks, John. It currently seems that attractive market conditions will continue and we expect to achieve strong operational and financial performance for the rest of the year.

We expect that utilization will remain near record levels and expect the used container sale prices to hold steady through the summer peak season. We expect container pick-ups and our leasing revenue to accelerate in the third quarter as the large block of containers committed to lease go on hire.

The sequential growth in leasing revenue will be partially offset by the absence of the lease termination fees we benefitted from in the second quarter. Overall, we expect our adjusted pre-tax income to hold steady or increase slightly from the second quarter of 2012 to the third.

In summary, we are very pleased with our outstanding performance so far this year. Renewed global economic challenges have taken some of the momentum out of the peak shipping season, but trade growth remained solid and leasing market fundamentals remain highly attractive.

2012 will be another strong investment year for TAL, and our existing investments are already sufficient to drive 15% growth in our revenue earning assets this year. Our utilization and other key operating metrics remain near peak levels. We continue to generate exceptional investment returns, cash flow and profitability and we have increased our dividend again this quarter to $0.60 per share.

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

Question-and-Answer Session

Operator

(Operator Instructions). Our first question this morning will come from Michael Webber of Wells Fargo. Please go ahead.

Michael Webber - Wells Fargo

Brian, I wanted to jump in and talk about, I guess, the termination payments that happened in Q2. Can you guys just kind of quantify that and then was that [MIFC] earlier in the year and can you guys maybe disclose, which counterparty actually returned the boxes. Then, can you kind of quantify any sort of impact on Q3 utilization depending on when they brought them back. There's minority being employed, Give us a little bit of color in terms of what that could do in guess to your utilization mix?

Brian Sondey

Sure. It was about $3million impact in the second quarter, and it was not Misc. We in fact had a very small, maybe dual exposure to them. I don't want to get into too much of the customer specifics, but it was a customer that was exiting one of the trades where they operated and had containers on long-term leases and didn't have any really contractual right to exist the leases, so we negotiated a settlement to allow them to drop the boxes early, all into Asia, where we have strong demand and pay a fee for that ability to drop non-contractually.

There wasn't a huge number of containers. It was a few thousand dry containers, and so it wouldn't have a huge impact on our utilization, especially measured on a TEU basis, but obviously as the units came back, it takes some time to redeploy them and so some of that $3 million wasn't just right down on the bottom line, because there were some lost leasing revenue and some higher operating expenses associated with taking the boxes and finding the homes, but we do expect them to find homes fairly easily given that there are still fairly young containers and came back in very strong demand areas.

Michael Webber - Wells Fargo

Got you. There should be minimal impact of that in term of the utilization?

Brian Sondey

Yes. It's already in there, so.

Michael Webber - Wells Fargo

Okay. Great. I wanted to jump I guess at some of your earlier comments around peak season and some momentum coming out and that's certainly indicative of the slower pick-up speeds. Can you maybe just provide some context around that I guess relative to what we saw last year in terms of pick-up speeds and kind of how you see this year progressing relative to 2011?

Brian Sondey

Yes. Interesting. (Inaudible) some of the same dynamics that we've seen this year, compared to we saw last year. On both cases, we did a lot of early transactions with customers, where I think customers at the beginning of the year were fairly optimistic about trade volume growth. There was the appearance of a recovery in the States, I think, both in the winter of 2011, as well as the winter of 2012.

I think, also the euro crisis kind of really accelerated in both years towards the second quarters, and I think both of those things took a little bit of steam and optimism out of the peak season and therefore led to slower pick-ups than expected. I think also there was just a shift in a way customers are using us that we're still trying to get used to in the sense that before the last few years customers really just used us for their unexpected requirements. It was tended to be around the peak season, and so we tended to see a relatively short lead time between doing transactions and seeing pick-ups, where customers now are using us more for their kind of annual planning and to some extent I think just maybe that naturally leads to a longer time between doing the lease deals and when they get pick-ups, and so I think it's a mix of both things.

I think similar factors in both, 2011 and 2012, I think we will see and really contractually have to see an acceleration of pick-ups in the third quarter, and so we will see much more leasing revenue coming from the new containers in the third quarter than we saw in the second quarter, but in both cases what we missed to some extent is that we didn't have a chance to re-up with new containers. The hope as you put a lot of containers out to lease early in the year, they get picked up in the second quarter and you do a new round of deals in the third quarter in both, 2011 and 2012, that kind of second loading of the some round of deals will really happen, but that said, we put a lot of equipment to work this year, because of the market share shifts.

Michael Webber - Wells Fargo

Right. Got you. That's very helpful. In terms of your units, there's market share gains your group and then you guys specifically are getting. Yesterday, I think you guys were talking to kind of a 65%, 70% kind of ratio in terms of what the lessors are acquiring now with (Inaudible) kind of being the big buyer out there in the liners side. Any change there? I mean, have you seen any other major lines coming and step-up their purchases there? I guess, any mid-material change in the dynamics since your investor day?

Brian Sondey

No. no, it's very similar. Again, about two-thirds, as you noted, going to the leasing companies, and off the one-third that's going to the shipping lines. The vast majority of that with one company, Maersk.

We have seen, there's a few other shipping lines that have placed some orders, but those orders in general have been fairly limited in their impact on the overall production, but also limited in the containers even those companies are taking, and so it still remains situation where just given the financial challenges of the shipping lines, most prefer not to tie up their capital in containers.

Michael Webber - Wells Fargo

Got you. Fair enough. There's a couple more, and I'll turn it over. You guys have been a bit more restrained and measured, I guess, in terms of your reefer purchases over the last year than I guess some of your competitors that are building market share there, but can you guys maybe give us a bit of a read in terms of what you are seeing there in terms of reefer pieces, and then how that's shaping up on a year-over-year basis?

Brian Sondey

Sure. We've actually bought a lot of reefer. I would say our reefer investment in 2010, 2011 and 2012 is probably somewhere between two and three times our normal reefer investment that we had before the crisis, and so that actually hasn't gone down. In fact may even have gone up over the last few years as a portion of our buying, and the big thing driving that has just been that, just like in dry, as we are seeing a market share shift from owned to leased reefer containers, but there it's even stronger, because the leasing share, wherein dry containers historically was maybe 40% or 45%, and reefers historically was like 20% to 25%, and we are seeing the majority of reefers being leased as well, so a very dramatic change in reefers, and we've also invested a lot of reefers this year.

What we were talking about on our investor day and continue to talk about is just the margin pricing has gone to the point at which we see it being less attractive than dry container investments and there are some new competitors that have tried to build up a presence in reefer leasing, they also perhaps don't have a tremendous amount of experience in leasing older units, and typically you get a shorter useful life with reefers, you get a lower residual value relative to initial purchase price and there is more age discrimination on reefers, because the equipment does wear-out over time.

You need to get a higher initial lease rate relative to your cost of your investment to have the same return on refers that you get on dry containers and we are seeing some of these new guys pricing the deals much more like dry containers deals than we've historically would like to see, and at that kind of price level, we would rather allocate investment away going forward from reefers to dries. That said, reefer deal still come up and we still do them and we are still a very big player in that market.

Michael Webber - Wells Fargo

Got you. All right. That makes a lot of sense. I will turn it over and hop back into queue. That's a lot for the time, Brian.

Operator

Our next question will come from Helane Becker of Dahlman Rose. Please go ahead.

Helane Becker - Dahlman Rose

Thanks very much, operator. Hi, guys. Just a couple of little things. One, I noticed that you said, I think as of yesterday or the day before 75% have been picked up. Can you say what percent was actually picked up at the end of the quarter?

Brian Sondey

Yes. In terms of the 75%, Helane, that's the amount that customers have committed to pick up. The amount that was actually picked up by the end of the quarter was much smaller than that. Typically, we don't or we haven't at least in the past disclosed exactly when the containers were picked up, but the revenue impact from the new containers in the second quarter was probably, my guess is around 25% or so of the annual revenue impact you might expect when all the containers go on hire, so you don't really see a strong impact from the new container investments on the revenue until you get a lot of them picked up and typically it really starts to weight in the third quarter and fourth quarter, because even the containers picked up in the second quarter, but just say on average they have picked up in the middle of may, so you only get a partial quarters worth of revenue on those anyway, so 75% are committed. A good portion of that 75% didn't contribute much to revenue in the second quarter.

Helane Becker - Dahlman Rose

Okay. Then I just have a clarification question. In one of your comments in the press release, you said that lower used container sale prices offset the benefits of your fleet growth, and then in your prepared remarks you just said used prices stayed high, so what should I think about? How should I think about that?

Brian Sondey

It does seem (Inaudible) victory.

Helane Becker - Dahlman Rose

What did you actually mean?

Brian Sondey

It really depends on what you are measuring against, and so what we meant is, when you compare the second quarter of 2011 to the second quarter of 2012, used container prices actually fell a fair bit, probably about 20%, but used container prices were at their historical peak level in the second quarter of 2012, probably 100% higher than they were typically or maybe even more than that. While they have gone down 20% from that peak level they remain very high compared to both, our book values as well as historical averages.

Helane Becker - Dahlman Rose

Okay. Got you. Thank you. Then just one last question. With respect to acquisitions. If you are seeing a slowdown maybe in pick-ups, do you think you would order less equipment for deliver in September, since we are in what? Beginning of August, so anything you order now it would be September, right? So, would you think of not actually placing orders for September then?

Brian Sondey

What we like to do is to maintain a shelf of equipment somewhere between 100 million to 200 million, and while we have that shelf of equipment, we typically are fairly cautious about adding to it.

Our shelf of equipment is in that range just toward the upper end of that range now just because of the seasonality. I think we commented both, in the press release, also in our comments that because of the large amount of equipment waiting to get picked up as well as the limited time left in the peak season for dry containers, we don't really contemplate a large amount of additional new container orders for this year.

You never really know, and in fact sometimes we start to buy for next year at the end of the current year and so we may start to add containers towards the end of the year, but really that would be for anticipating deals next year, but we don't anticipate a large additional new orders of dry containers for near-term deliveries.

Helane Becker - Dahlman Rose

Okay, so the $750 million that you've invested is probably towards the end of the?

Brian Sondey

It's getting towards the high end of where we are going to get to. That's said, we did make a caveat that sale-leaseback transactions are very unpredictable and not really seasonally oriented, because their container is already in our customer fleets and there still was a good possibility that we'll do more of those in the second half of the year.

Operator

Our next question will come from Bill Carcache of Nomura. Please go ahead.

Bill Carcache - Nomura

Good morning. Thank you. Hey, Brian. Based on one of the comments that you made, I am trying to see if I understood this correctly and if this thought process works. I believe you mentioned that only 25% of the annual benefit to revenues has kind of been enjoyed so far given that the pick-ups have been pushed out. Then if we look at increase in lease revenues is basically being $21.3 million year-over-year. If that's basically 25% of the total increase just back of the envelop. Does that suggest that total increase from our pick-ups of $85 million, which we just $21.3 million year-over-year this quarter that's a $63.9 million left once the other pick-ups come, so is that much of your potential revenue upside or is that kind of a decent way of quantifying potential revenue acceleration.

Brian Sondey

Not really, and it's because a lot of the 20% growth from the second quarter of last year to the second quarter this year. Came from the pick-ups in 2011, and so we saw a very much the same effect in 2011. In fact we see it every year, so if you think about the revenue from say in the second quarter of 2011 through the fourth quarter of 2011, those were all the pick-ups and revenue generated by the $775 million we invested last year, so most of the change from Q2 '11 to Q2 '12 was from containers we brought last year.

In terms of the math of how much revenue will come from our investments this year, you probably right. It probably is in the $80 million annual kind of revenue from the new containers we are buying this year and the used containers, but it's not going to be $80 million on top of 2011. Just because you we selling containers and so on, but it's going to be substantial revenue growth nonetheless. Did that answer your question.

Bill Carcache - Nomura

No. That's very helpful color. Thank you. Again, on the pick-ups drilling into that a little bit more, are there any contractual consequences to a late pick-up. Just I guess I am trying to understand the economics of a late pick-up. What does that mean? Can you walk through that a little bit?

Brian Sondey

Sure. Typically when we do transaction, especially when we do transactions early in the year, when the customer doesn't have immediate, urgent need for the equipment, we give customers what's called a build-up period, and it's a period of time where the customers have flexibility about when they pick up the unit. As soon as they pick it up, it starts generating revenue, but during that build-up period, which typically is perhaps three to six months long, there is no penalty for picking everything up at the end of the build-up period.

Typically, at the end of the build-up period, we have the ability to just force everything on hire, whether it's actually picked up or not, but really do we have to do that? Usually customers by the time, we get to the end of the build-up period, they have requirements for the unit.

Bill Carcache - Nomura

Okay. Can you give some perspective? If we look back to kind of the last down turn in periods of economic weakness, is that an issue where you have to enforce, because customers potentially extend beyond that three to six-month long build up period that you mentioned.

Brian Sondey

It happens occasionally. I can't necessary say. I can co-relate it in our strong years and weak year, because even in very strong markets, customers over estimate their needs and not everything has picked up and you have to have conversations with them about what we are going to do about that, and we try to take a pretty constructive approach and I wouldn't say we go to every customer the day the build-up period ends and say everything is on hire, but we insist on getting value for it. Sometimes, we do actually put it all to one hire, in fact a lot of times, but obviously you try to be constructive and cooperative in that process and give customers lead times for that, or perhaps you get an extra month for build-up period. You've increased the lease time more than that to try to compensate us for any lost value.

In general, I don't want to get too much into specifics of how we manage that, but the vast majority of containers are picked up and we expect them when we picked up this year as well during the build-up period.

Operator

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

Unidentified Analyst

Good morning, guys. This is actually Derek in for Art. Hey, just wanted to get some more clarity on the lower pick-ups in 2Q. Sorry to beat this dead horse. You mentioned 25% had been picked up. If we go back and think about how you are kind of projecting 2Q pick-ups, what would you say was the order of magnitude of the shortfall? Just kind of getting the sense of how big the deferral from your projects were into 3Q.

Brian Sondey

To be honest, when we put together our forecast we don't believe we have any great ability to predict exactly when containers are going to be picked up. In addition, the revenue impact in new containers takes time to build. The profitability impact takes even more time to build. Just in the sense that the youngest containers on an accounting basis have the highest cost associated with them and have typically not a huge impact on profitability right out of the gate, so I don't think there was a tremendous, say, shift in income from the second quarter to the third quarter because of the delay, but you it has some impact, but it wasn't, say, dramatically altering of the quarter.

When I said 25% impact, I was talking about the revenue. Again, because you get only a partial period of the revenue in the quarter that the units picked, the percentage of units picked up is probably higher than that, but again it's nothing that dramatic in terms of the change from quarter-to-quarter. Other than having the late pick-ups kind of prevents us from having a large second round of capital spending to sort of the peak season because the early deals are affectively serving the peak season.

Unidentified Analyst

Okay, and you may or may not be able to answer this, but I thought I would just throw it out there. We're seeing a couple or few of your shareholders be pretty active in some of their shares throughout the first half of the year. Would you say Jordan Group, in particular is kind of at a point where they are comfortable holding on to what they have or can you just kind of talk about the thought process from their perspective?

Brian Sondey

I can't really talk too much about that. They don't share their thought process with us. We in fact try not to get involved with it. As you know, they have two different blocks earlier this year. I think at least on a teach the good news there is that the remaining block they have just around 12% is much smaller than it used to be, so that the overhang if there is one should be less, but to be honest I have really no insight on what they are in terms of when they think it would be good time to bring that to market.

Operator

Our next question will come from Sal Vitale of Stern Agee.

Sal Vitale - Stern Agee

Good morning, gentlemen. Just a few quick housekeeping items. First, can you give me the quarter end TEU account both, total and excluding trading.

Brian Sondey

Sure. The total TEUs at the end of the quarter, and again this will be the table in the Q that comes out in a few days, is $1.786 million. That includes all containers and of that portion about 65,000 TEUs are trading containers.

Sal Vitale - Stern Agee

Okay. That's helpful. Thanks. Then regarding the $3 million in lease termination fees, so that's included in operating leases as part of leasing fees and other, correct?

Brian Sondey

It's included in per D.M. revenue? Sorry? It will be included in per D.M. revenue.

It's in for D.M. revenue. Okay. On the leasing fees and other line, I think last quarter was $6.4 million. What was that this quarter?

Brian Sondey

5.5.

Sal Vitale - Stern Agee

Okay. That's helpful. Then if I just go to the year to-date orders $750, I think last quarter you had reported it was about $450 million, so that $300 million increase without giving out too much in terms of specifics, but just ballpark how much of the increase was from sale-leasebacks.

Brian Sondey

We don't like to give all the details on sale-lease backs sometimes are much more negotiated on a customized kind of one-on-one basis than new container deals, and we don't want to give competitors too much of a roadmap into what we're up to.

The sale-leasebacks sort of like last year, they are meaningful part of our capital spending, but certainly a minority where our new containers are well more than half of in fact the vast majority of our buying, but the sale-leasebacks are meaningful and they add up to good business.

Sal Vitale - Stern Agee

Okay. Then just based on that, even if we we're in a slower environment, where there are less orders, between now and year end, you can still see some substantial increases from sale-leasebacks alone, correct? Depending on what comes across? Correct?

Brian Sondey

Absolutely. We certainly could and we are seeing more customers and being interested in the idea and that's created opportunities for these deals. I think while talked a few moments ago that we're expecting new orders to be fairly limited for the next couple of months. I do think there is opportunity for new sale-leaseback.

Sal Vitale - Stern Agee

Okay. Can you just give us some parameters in terms of if you look at deals? One is a new container order versus, say, the same dollar amount of container, sale-leasebacks. Could you give us some sense like the return, difference between the two? Are they very similar?

Brian Sondey

I think about returns, so typically when you say leaseback transaction, it's for middle aged or older equipment that has a shorter remaining life than, say, a new container would. Because of their shorter remaining life, typically the leasing revenue is higher, say, year when leasing revenue will be higher compared to the cost of the equipment then it would be for a new container, because of the shorter remaining life.

If you think about from like an investment return standpoint, I would say the investment returns are fairly similar, but the one benefit of sale-leaseback transaction is you take much less speculative risk, typically for new equipment or buying it ahead of the point which have a customer and lease identified for it, and so we're always taking some market as we are always taking some risk if the market changes, or the equipment prices go down between the time that you buy the equipment and put it on lease. For sale-leaseback, those two things happened at the same time, so the return is much more certain.

Sal Vitale - Stern Agee

Okay. (Inaudible) to clarify. If you look at it from an accounting, return on equity, return and say year one all will be on higher on the service back.

Brian Sondey

That is probably similar. The lease revenue compared to the equipment cost will be higher, but the ROE is probably similar.

Sal Vitale - Stern Agee

Okay. That's helpful. Then just quick question on the pick-ups, and you may have addressed this on an earlier question, but what happens in a case that a customer delay their pick in 2Q, and now they decide to delay it even further. What is your recourse there, because you don't start generating revenue until it's picked up.

Brian Sondey

Right. We talked a little bit about it. Typically, we have the ability to put these on hire laterally at the end of that build-up period, and because of that most customers do pick up all the equipment by the end of the build-up period, but sometimes there is a negotiation, but we try to make sure we get fair value if we are going to push it a little bit, we get fair value for it, but it happens quite rarely. We expect the vast, vast majority of our containers commit to lease to be picked up within the contractual build-up periods.

Sal Vitale - Stern Agee

Okay. Then just a last question on the pick-ups there. We're at the end of July now. In terms of the amount that has not yet has been picked up. I guess the quantity of the $750 million that has not yet been picked up, how much of it do you expect to be picked up in 2Q, and would that be backend weighted or kind of in the middle. How do you think about that?

Brian Sondey

We expect pick-ups to be fairly high right through the third quarter. We saw strong pick-ups so far in July and expect that to continue right through the end of September and some of those units we'll push into October and so on, but I think by the time we get to the end of October, most of the units committed to lease will be on hire.

Operator

(Operator Instructions). The next question will come from Rick Shane from JPMorgan. Please go ahead.

Rick Shane - JPMorgan

Hey, Brian. Thanks for taking my questions. Most of have already been asked and answered, but just wanted to follow-up a little bit on the sale-leaseback question. When you do sale-leaseback transactions given the older age of the boxes, is your expectation that this is going to be the final lease for those containers or do you expect you are going to put them back on the higher once that lease ends?

Brian Sondey

Usually, we assume that's going to be the last lease. One, because of the age of the equipment, but two there's also re-marketing issues. If we want to lease those containers to somebody else, typically the containers in a sale-leaseback have the customers, logos and colors and well as the customers' serial numbers, and if were to take it back from one customer and put into our leasing fleet. It's certainly possible, but there's an additional expense associated with re-marketing that container to our fleet, and typically it's just more economic the structure of the lease to take to the end of the life.

Rick Shane - JPMorgan

Okay. That actually also answer my second question, because it really sounds those boxes ultimately once that lease expires, gets sold. The follow-up question that is, and I think it's self-explanatory given that context. You guys have always emphasized that the specs and build quality on your boxes are the high end of the industry and I was wondering how you verify that the box as you are buying in sale-leaseback transactions you won't be able to inspect them in a same way meet that build quality.

Brian Sondey

It's a good question. I think as we have talked before, we spend a lot of time and energy and money making sure best we can that our new production containers are being built as we specify them and we've got people all over the factories in China to make that happen and do lots of laboratory testing, materials make up and things like that. We think smaller leasing companies don't put those same resources into that and perhaps don't get the same kind of life we do out of the equipment.

For sale-leaseback containers, we do some inspections and so typically what we're doing with larger transactions, we'll ask random sampling of containers that we can go visit into customer's depots, so we understand how the containers are aging and the type of conditions we expect to get at the end of the lease when we'll be installing the equipment, but we also know pretty well how different customers operate their fleets and their quality they typically put into their boxes and the amount of money they put into the boxes during in-service maintenance, so we have a pretty good sense by customer, what the condition of the boxes like would be and we factored it into the price.

Operator

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

Ken Hoexter - Bank of America

Good morning. I am sorry if you mentioned this earlier, but the trading revenues scaled up during the quarter as did the expenses, the cost we are trading look like a smaller margin. Can you kind of walk through what occurred on the trading side a bit?

Brian Sondey

Yes. We always suggest people when they look at our trading business that they look at the margin of the revenues less the expenses. The accounting for that isn't like at least we would have expected when we got into the business. The revenue is the full sale value of older boxes we sell and the trading expenses is the full purchase price of older boxes to sell in our trading boxes, and so those two things always stay very tightly connected to each other and what really matters is the margin.

I am not sure I can exactly describe why saw a slight compression of the margin in the second quarter in general. We continue to make a good business month-after-month on selling trading containers. My guess is it just has to do with sort of the particular that which boxes were dropped off by our customers and sold by us. We've got a lot of containers in our fleet that we've purchased over the last two or three years and so were brought at very different purchase prices.

Boxes that have been in the fleet longer that we bought during, say, 2009 or early 2010, earn a much lower values than some of the stuff we bought recently, and so that margin can fluctuate around a little bit based upon what being dropped off. In general that we've got a lot of value baked into our trading fleet because of majority of the tender trading fleet have been in there for quite a while and hire the customers waiting to come back.

Ken Hoexter - Bank of America

All right. Good. I appreciate that. Real simplified. Then further, what are you seeing in terms of current rates for the used sales?

Brian Sondey

Yes. Used prices are still very high. They are down, say, in the middle of 2011, say, the used 20-foot container probably was into the middle 1,800 or something like that for a used even a 15-year old, 20-foot container which was a very high portion of the cost of new equipment at that time. Prices have come down about 20%, so that used prices now for 20-foot on the middle of 1,500s, but that's still very high relative to historical norms.

Ken Hoexter - Bank of America

It seemed like when we came to the year, you weren't anticipating buying as much as clearly you've done already. It sounds right now into the back half, you are going to be slow, or I think you even said that you are very little in terms of new orders.

Can you kind of flush out what maybe that a little bit in terms of timing, what you've got kind of left on the order book already. What drove it a lot higher than you thought just given the market has been relatively soft what do you think kind of scaled that buying through the first half?

Brian Sondey

Yes. I think it was really just the dramatic shift from owned to leased, so if you think about the last two years, we saw in 2010 a fairly dramatic shift from owned to leased, where leasing was probably in the range of 60% of buy and 2010 as really the shipping lines were still struggling to recover from the crisis.

In the first part of 2011, when most containers were produced, the shipping lines kind of stepped back in a little bit and the share of owned and leased new production in 2011 was probably closer to 50-50, so a little bit up from where it was historically, but not quite as strong as it was in 2010, and our assumption was that was going to continue at maybe a slightly elevated leasing share but a little bit weaker than 2010.

In fact in 2012, we saw the leasing share really jump again. Again, our guess is something around two-thirds being leased with really no shipping line other Maersk buying aggressively. While we've been a little bit underwhelmed by overall trading volumes and they've come in a less than most people thought where they were going to be. We've been overwhelmed by the strength of the shift from owned to lease, both in the form of the new equipment as well as the sale-leasebacks and that's where we're driving it.

Ken Hoexter - Bank of America

Last, just to follow-up on that, and last question would be, have you noticed and if they are doing more leasing are they may be changing the term. Is it all wanting to go a little bit shorter because they are not buying, so they are bit more nervous on committing that capacity or is there any relation between the two in terms of what they are willing to book with you?

Brian Sondey

Not really. I'll tell you. Maybe there's a pressure for the customer to go longer when they saw the two leased, because we are providing that base level of capacity that the customer knows they need, and typically again you might even see a little bit of longer duration and we have over the last few years. It's in our duration to push out a little bit.

I think the customers aren't leasing primarily, because they are nervous about trade volumes. I think they are leasing primarily, because they don't want to tie up capital in containers. They don't have to.

Operator

Our next question will be a follow-up from Michael Webber of Wells Fargo. Please go ahead.

Michael Webber - Wells Fargo

Hey, Brian. Just wanted to hop on quickly and you mentioned the quality of your boxes that came up in the previous question. Then we've seen more both in [Singamos] and CIMC rollout new production facility assuming CMIS's first Phase 1 started in July 1. Have you guys got any boxes from that production facility any takeaways there, and then it might be a bit too early, but do you have sense yet in terms of what that means from for the breakevens and what it could mean for box pricing and yields?

Brian Sondey

We haven't taken any boxes from those new facilities yet, but both [Singamos] and CIMC are very capable manufacturers, and we don't anticipate with them that you have significant, say, breaking in problems with their factories.

They are always doing some additions or upgrades to their network of manufacturing facilities as importance of different location changes. For example, volumes out of middle of China and north of China have been growing relative to South China for the last few years. They've been adding capacity in Shanghai and north of Shanghai, as regular thing that they are doing and also the newer factors are more automated and higher quality production facilities, but really in general, we've always maintained. I think it's still the case that.

It's not really the factories that drive production capacity or the amount of boxes produced in the year. It's the amount of labors factories employ and factories are very labor-intensive, and the factories this year have maintained a pretty lean staffing through the year similar to the fact that overall box production is quite low, so I don't expect at least any dramatic of these new facilities.

Michael Webber - Wells Fargo

I think the overall production possibility relative in line new versus old. I think we're just trying to get a sense on what if it could change their breakeven, right? Get their cost basis goes up. If they gain some more efficiencies on whether or not you are seeing kind of maybe a change in the way they think about their margins with those new facilities.

Brian Sondey

I don't think so. I think even with the older less efficient facilities, the majority of the box cost was the materials, and are being the steel the wood and the paint and so on. The margin for labor and for say return on capital of the factor already was pretty small. I think new factories are little more efficient than the old ones, but there is not a huge amount of margin in there already anyway.

Operator

Our next question will come from Brian Hogan of William Blair.

Brian Hogan - William Blair

Thank you. Around the secondary market, I'll lead into that would actually be, are your customers holding on to containers longer. Are they taking them out to, say, 17 years, what's?

Brian Sondey

Yes. They definitely are. We are seeing, where five or six years ago, when the shipping lines were making lots of money, I think they were much more sensitive about how their boxes looked, and they was say some pressure to move boxes out of their fleets when they got to 12 or 13 years old.

We are seeing most customers, even those that had been most cosmetically sensitive in the past now holding on to boxes to 15, 16, 17 years old just because economically it makes sense to do so.

Brian Hogan - William Blair

Sure. I believe depreciate straight-line over 13 years. What percentage of your fleet is fully depreciated?

Brian Sondey

Yes. Right now, it's something John had talked about in his comments. Right now for it's quite small and it's really just a factor of kind of the history of our procurement. We bought very few units in the late 1990s and early 2000s just because of the former parent Transamerica had been acquired by AEGON at that time and they weren't that enthusiastic about the non-insurance businesses, and because of that kind of lack of production in those units vintages that would not be fully depreciated, we have very few of them in our fleet, and that's created some accounting drag on our earnings as our depreciation has grown faster than revenue for the last couple of years as that fully depreciated portion has gone down.

I said there is no cash flow impact and now we get the same or better cash flows out of our newer containers and the older ones, but from an accounting basis, yeah you love to have those fully depreciated units, and despite the fact they were selling very old because we produced very few units in those times, we have got a small fleet right now.

Brian Hogan - William Blair

Sure. Then units pricing being 1,500. I believe your current depreciation schedule is the 900 to 1,200 from the size of the container. Other competitors have moved their depreciation schedules higher over the past couple of years. I believe you are definitely at the lower end of the range…

Brian Sondey

Yes. We're sticking hard to low end of the range for the public leasing companies and I think yes there has been a several rounds of companies raising their residual estimates over the last few years.

We raised them at the end of 2010 to, I think $900 for 20-foot. 1,100 for 40, and 1,200 for a high cube. Those right now I think are both quite a bit lower than Textainer and I think that's somewhat lower than CAIs as well.

Brian Hogan - William Blair

Have you thought about moving it higher?

Brian Sondey

We always look at it. We always liked, I think be on the conservative end of things when it comes to accounting, but clearly it's a conversation given the persistence of our…

John Burn

This is John. I'd just add that, yes we are at the low end relative to the public competitors. It's something we look at all the time. I'd say one thing is, we still a very tight supply and demand right now in the marketplace and certainly, we don't know where the sale prices end when you back to an equilibrium, so it would be list we are making a long-term. This is a 13-year decision from our perspective, where prices will be from time you buy it to when you dispose, depreciation or so. It's a long-term decision that we take look at it and try to make it based on long-term factors.

Brian Sondey

Right now, certainly we are low at the low end of the public industry.

Brian Hogan - William Blair

And finally switching gears on leverage, what are your thoughts on leverage picking out there where are you comfortable of your leverage ratio?

Brian Sondey

I think the first comment I always like to make on leverage is that we encourage you look at the metric we think is most appropriate, and we think people want to look at the ratio of our net debt to our revenue earning asset, and that's the way all of our debt facilities are structured and we can borrow a certain percentage of the asset value of the equipment and that's not just for TAL, but really all leasing companies in the space.

Historically, we've kept that ratio of net debt to revenue earning assets somewhere between, I'd say 70% and 77% or so. Right now, we're around 74% or 75% and we think that's about sweet spot for us, where I think we've got a lot of stickiness to our revenues and so makes sense to have some debt. The debt is also very efficient. Most recent ABS deal we did was a 10-year amortizing transaction with an average life right around five years with a yield of a 3.9, so it make sense to utilize that stuff as you can, but we don't want to have too much debt to the point at which it constrains our ability to react to the good markets or bad markets.

One thing I would say about leverage though, as I think a lot of the analysts and sometimes when I talk to investors the way we scream, they look at it without look at the right measures. A lot of times people look at measures on accounting debt-to-equity and it looks like we have much higher leverage than our peers, just because again we accrue for taxes that we don't pay, because we are U.S. based and they are not as we've got a very large deferred tax balance and it makes it look like we've got a lot of debt compared to our accounting equity, but all of our bank facilities kind of treat deferred taxes implicitly as equity and we certainly encourage investors and analysts to the same. If you do that, our leverage looks fairly in line with our peers.

Operator

Ladies and gentlemen, we do have time for just one more question which will come from Jordan Hymowitz of Philadelphia Financial. Please go ahead.

Jordan Hymowitz - Philadelphia Financial

I was just wondering, could you comment on the pricing increases or the stabilization from the big container companies. Has that continued to be kind of flat, so their outlook is improving, so to speak?

Brian Sondey

You mean the shipping lines?

Jordan Hymowitz - Philadelphia Financial

Yes.

Brian Sondey

Yes, we saw, 2011 was a very difficult year for our customers driven by vessel over capacity leading to lower freight rates coupled with rising fuel costs really squeezing their margins and almost everybody in the industry, significantly negative, results for 2011.

That continued into the first quarter of this year but the sort of real concentrated effort by the major lines, especially Maersk, but also the other majors, just shifted their focus where they were nasty market share we were in 2011. I think they have all agreed that was, maybe, destructive for the industry and for themselves and have shifted to rate restoration and profitability restoration in 2012 and freight rates up are really significantly.

I think in Asia to Europe, they are up in the range of 100% or more even and very large increases in the Asia to the U.S. and even some of the regional trades are up, even though they weren’t that impacted negatively in 2011. Also, fuel prices are down. Since the end of the first quarter this year and so that combination of much improved freight rates and lower fuel costs, we hear from our customers at least that most exact to be break even to profitable in the second quarter and then profitable in the third quarter.

So definitely a much improved outlook from where they had been a year ago. I think the one thing we do caution people on those it’s, I think, there is still time left to be played in this game. That there are still vessels expected to come in for the next couple of years and the existing overcapacity, we will have a hard time being worked off given that deliveries are expected to be in the same range as trade growth.

So I think the shipping lines are really going to have maintain this focus on profitability to keep things together but that said, they have been amazingly disciplined to doing that this year and certainly a much better outlook now than we had 12 months ago.

It’s one other reason why our payments and credit losses continued to be very low.

Jordan Hymowitz - Philadelphia Financial

So, I mean, given that the biggest risk to your industry is that the container shipping industry actually goes bankrupt you would feel that the chances of a major shipping company going BK today or much less than you felt three months ago or six months ago?

Brian Sondey

Certainly we see credit risks being a lot less.

Jordan Hymowitz - Philadelphia Financial

That’s what I am getting at.

Brian Sondey

Usually BK, we care about different kinds of BK, probably than lot of investors. Usually for us, I think we have talked in the past that if the company goes through a significant financial restructuring because of two months debt whether in back the fleet quarter outside of it, we are usually not affected and so all the restructurings that have happened with the major shipping lines in 2009, where debt got rescheduled and in some cases, debt got turned into equity or new equity was forced into the business, we weren’t really brought into any of those conversations.

Really, if a customer wants to use its ships and use our containers they have to pay us. So typically some kind of chapter 11 is styled BK while it makes us very nervous we typically don’t get impacted by that and given that all of our big customers are major asset owners, our hope is and our assumption is that even if they do go, ultimately to some kind of restructuring, we are going to come out okay and that is one reason why we were all nervous last year of the financial situation of our customers. We weren’t terrified.

I think in terms of the relative risk, it’s down from where it was before. Just because of the freight rate improvements and the fuel cost decreases but the shipping lines still remain in a more precarious situation than they were four or five years ago and so relative to historical risks they are up.

Jordan Hymowitz - Philadelphia Financial

Okay, thank you.

Brian Sondey

Thanks, Jordan.

Operator

And ladies and gentlemen, that will conclude our question and answer session. I would like to turn the conference back over to President and CEO Brian Sondey for any closing remarks.

Brian Sondey

Just like to thank all of you again for your time and interest in the company and look forward to catching up with you over the quarter. Thank you.

Operator

This conference has now concluded. We thank you for attending today’s presentation. You may now disconnect.

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