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Thank you, and welcome to Textainer’s Second Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be provided at that time. As a reminder, today's conference call is being recorded.
I will now turn the call over to Ed Yuen, Investor Relations for Textainer Group Holdings Limited. Please proceed.
Thank you. Certain statements made during this conference call may contain forward-looking statements in accordance with U.S. securities laws. These statements involve risks and uncertainties and are only predictions and may differ materially from actual future events or results. The Company's views, estimates, plans and outlook, as described within this call, may change after the discussion. The Company is under no obligation to modify or update any or all statements that are made. Please see the Company's annual report on Form 20-F for the year ended December 31, 2019, filed with the Securities and Exchange Commission on March 30, 2020, and going forward, any subsequent quarterly filings on Form 6-K for additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements.
During this call, we will discuss non-GAAP financial measures. As such measures are not prepared in accordance with generally accepted accounting principles, a reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures will be provided either on this conference call or can be found in today's earnings press release.
Finally, along with our earnings release today, we have also provided slides to accompany our comments on today's call. Both the earnings release and the earnings call presentation can be found on Textainer's Investor Relations website at investor.textainer.com.
I would now like to turn the call over to Olivier Ghesquiere, Textainer's President and Chief Executive Officer, for his opening comments.
Thank you, Ed. Good afternoon, everyone, and thank you for joining us today.
I'll begin by reviewing the highlights of our second quarter results, and then I'll provide some perspective on the industry. Michael will then go over our financial results in greater detail after which we will open the call for your questions.
We are pleased with our performance in the second quarter, which proved resilient in spite of the global economic downturn and is enjoying a strong start to third quarter. For the second quarter, we delivered stable lease rental income of $145 million and adjusted EBITDA of $110 million, while improving our adjusted net income to $15 million.
The COVID-related disruption on trade continued to suppress container demand during the second quarter. While China was able to reopen their economy in March, trade worsened as the rest of the world implemented their own quarantine measures. Supply chain was significantly disrupted and buyers increasingly delayed or canceled cargo orders. Overall, global container trade during the first half of 2020 was approximately 7% lower as compared to the first half of 2019.
Started to see a stabilization in trade activity by mid-June, leading to a market turnaround in lease out demand that continues to dictate. The existing container inventory at factories held by lessor, which should at a level of about 600,000 TEU has by now been almost entirely committed. In addition, we have seen increased booking of available depot inventory and an increase in leasing rates and yields.
The recent increase in container demand is driven by several factors. First, trade activity has picked up as a result of the traditional seasonal summer increase for cargo to Europe and North America. Secondly, this has been compounded by the need to restock inventory and catch up on order previously canceled or delayed during the initial implementation of quarantine measures. In addition, we believe container demand is also driven by the impact of supply chain disruption caused by the pandemic. And finally, the impact of these factors has been amplified by the fact that for most of the past six quarters, shipping lines remained focused on cost optimization, thereby limiting their container fleet sizes.
New container prices remained relatively consistent during the second quarter, dipping slightly below $2,000 per CEU and have since increased to $2,100 per CEU as of today. Disciplined pricing has been generally supported by production capacity reduction implemented by container factories earlier in the year and are now benefiting from current market turnaround and increase in demand. The container resale environment remains limited and relatively consistent through most of the second quarter. However, over the past several weeks, we have now also seen an improvement in resale demand and prices, particularly for high cube.
Given the stronger than expected financial performance of shipping lines during the first half of 2020 and access to government support during the pandemic, the perceived elevated credit risk has now mostly moderated, and we are pleased to report that we have not encountered any notable credit issue this year.
Despite the ongoing challenging environment, shipping lines efficiently cut their cargo capacity driving a significant increase to their freight rate, while also benefiting from low fuel costs. Nonetheless, we continue to work closely with our customers to avoid any unpleasant surprises.
And as a reminder, we continue to carry a credit default insurance policy that covers certain costs and losses for customer default, including lost revenue and recovery costs or replacement value of containers. As we look forward to the balance of the third quarter, we expect the recent improvements in trade volumes and related container lease-out to continue till the end of the summer, leading to an increase in our container utilization rate and revenue. We also fully expect shipping lines to show further strengthening in their financial performance driven by the recent increases in freight rates.
In closing, we are pleased with our performance in the second quarter and are encouraged by the rebound in activity during the third quarter to-date. COVID-19 pandemic continues to create uncertainty and market challenges. However, we remain optimistic with our outlook for the rest of the year. Textainer remains well-positioned to participate in the rebound in market activity with a strong balance sheet, healthy liquidity and optimized capital structure and demonstrated expense control and efficiency.
I will now turn the call over to Michael, who will give you a little more color about our financial results for the past quarter.
Thank you, Olivier. I will now focus on the key drivers of our financial results. Q2 lease rental income was $145 million, relatively consistent with Q1, primarily due to a slight reduction in utilization. While market activity remained muted, we were pleased with the stability of Q2 lease rental income. This was supported by reliable revenue stream from our lease portfolio, which includes a 86% composition of long-term fixed rate leases.
As Olivier had commented, with the recent increase in container resale activity, we expect utilization and lease rental income to improve during the second half of this year. Q2 gain on sale of owned fleet containers was $6 million, also relatively consistent with Q1. Both sales volume and average gain per container sold were consistent with the prior quarter. We're pleased that the container resale price environment remains favorable. Q2 direct container expense for the owned fleet was $15 million, an increase of $2 million compared to Q1. This was mostly due to higher storage costs and handling expenses associated from lower utilization.
Q2 depreciation expense was $64 million, a decrease of $3 million as compared to Q1, due primarily to improve Mark to market value adjustments on certain containers held for sale. We realized a container lessee you default recovery of $2 million in Q2, due to a cash settlement received in full from a small customer default, which was previously written off in 2018.
Q2 G&A expense was $10 million and after removing expected cyclical items, remains consistent at normalized levels. We continue to improve the quality of our spending in G&A through among other methods and enhancement of our technology tools and staff talent.
We benefited from a bad recovery of $0.3 million in Q2, driven by improvements in collections and our general [Technical Difficulty] credit profile. However, we maintained a conservative approach and a healthy reserve on the receivables, given the continued weakness in global economic conditions.
We’re very pleased to see the improvement in overall collections, which continue through today. We'd like to recognize our team for a job well done and continuing to extensively monitor credit and closely communicate with our customers.
Q2 interest expense net of realized hedging cost was $33 million, a $4 million decreased as compared to Q1. This was driven by lower rates and lower outstanding debt in Q2. We’re pleased our Q2 average effective interest rate improved to 3.62%, which is 39 basis points lower than Q1. We had a net unrealized non-cash gain on derivative instruments of $1 million in Q2 as compared to a noncash loss of $15 million in Q1. This improvement was primarily driven by an increase in the forward LIBOR curve at the end of Q2 versus Q1, which is used to measure the mark to market value of our interest rate derivatives used for long-term hedging purposes.
Q2 net income [Technical Difficulty] $16 million or $0.30 per diluted common share. Q2 adjusted net income was $15 million or $0.28 per diluted common share. Q2 adjusted EBITDA was $110 million, which was relatively consistent with Q1.
Turning now to our share repurchase. During Q2, we repurchased over 1.6 million shares of Textainer common stock in the open market at an average price of $8.33 per share. On an accumulated basis through the end of Q2, we've repurchased approximately 8% of our outstanding shares. At the end of Q2, we had approximately 12 million still available under the plan, and we will continue to repurchase opportunistically as we move forward and consistent with our capital allocation plan.
Looking at our balance sheet and liquidity, we remain focused on maintaining a strong balance sheet and very healthy liquidity through both, our well-structured bank facilities as well as cash reserves.
We ended Q2 with a cash position, inclusive of restricted cash of $281 million as well as ample available capacity under our existing credit facilities. During Q2, we used strong and consistent cash flows from our long-term lease agreements to reduce our average debt outstanding and further strengthen our balance sheet. Both our short term credit facilities and long-term ABS financing platforms are performing well and in great shape. We do not have any debt maturities or refinancing requirements this year and remain financially well-positioned to address any potential stresses and uncertainty from weak market conditions or alternatively any sustained increase in market demand.
This concludes our prepared remarks. Thank you all for your time today. Operator, please open the line for questions.
Thank you. At this time we will conduct a question-and-answer session. [Operator Instructions] Our first question comes from Michael Brown with KBW. Please proceed.
I just wanted to start on credit, great to see that customer credit has really remained benign through this really challenging environment, and then actually for you guys this quarter, you've got some recovery that came in. As we think about really the coming quarters, I mean, we're still not really in the clear here, but it does seem like the environment is certainly better than I feared a couple months ago. But, are there really any other cracks out there that we should kind of keep an eye on? It sounds like the bigger shipping lines are in certainly good financial condition, and some have gotten some government support. But, are there smaller players out there that typically were probably the ones more at risk anyways, we should still be concerned about and how do we think about potential financial impact from maybe the smaller players?
Thank you, Mike. I must say, we are certainly feeling a lot more relaxed about the situation now than we were at the beginning of the pandemic. In April, we were having I would say daily calls to make sure that we would monitor our payments very carefully. And I must say that that has worked out very, very well. We made very close contacts with our customers and they have been very helpful. Now, the reason why the issue has really faded away, it's primarily because shipping lines have acted very well in controlling capacity, thereby maintaining their freight rates. And I think there's a very big lesson here from the 2016 crisis where Hanjin went bankrupt and where shipping lines were going after each other's throat and fighting for market share. In this environment, I think that they all realize that this should be really detrimental and would be a big danger for them. So, they've been really disciplined and they've all kept capacity that maintained the ocean freight rates. They have been benefited from much lower fuel cost, which was a blessing.
And I also like to say that a secondary effect of them reducing capacity has meant that they have been able to start charging more normal ocean freight rates on the return. As you may know, traditionally, shipping lines charge a full fare on the originating trade from Asia to Europe or North America and then they kind of subsidize and wait [ph] all the way back. But because there was so little capacity available, they have also been able to charge much for a decent rate, if not normal ocean freight rate. So, all that has really had them. And that was even before the current turnaround in the market that we have witnessed since July. In addition, we've also taken a lot of confidence from the fact that the government has shown willingness to help the weaker players. So, I think they've also learned from the Hanjin disaster and realized that it made a lot of sense in time of great uncertainty to come to the help of the weaker players. And we've seen several governments coming with indirect or even a direct help to their shipping line.
And more to your question about the smaller line, whether we see some issue there. I'm going to say we feel very positive, the payment has actually improved or that ratio is better than it was one year ago at the same time. And we certainly see the smaller shipping lines, also starting to benefit from the regaining in activity and the danger of the COVID sort of like drifting away. So, we feel very good about it. And we certainly don't anticipate any default between now and the end of the year.
Okay, great. And a lot of good commentary about what you're seeing in the current quarter and the pickup in activity, how does that translate to your CapEx opportunities in the second half? And how should I think about how that could also play out for your utilization rate? It looks like 2Q could be a near term trough here. But, as you're seeing this pickup in demand, I guess [Technical Difficulty] and how that could play out [Technical Difficulty] obviously we don't know how this will play out, but just [Technical Difficulty] what you're expecting right now?
Thanks, Mike. As Michael explained, we're feeling very good about the situation of our financing facility and our ability to deploy CapEx. And we certainly see this market environment as a great opportunity for us to buy more containers. So, I think you can expect to see probably more CapEx in the second half of the year, as opposed to the first half of the year. But another very big benefit that we are likely to see over the coming quarters is that the fleet utilization is also likely to get some support from the current market. And to your point about the utilization rate, we fully expect our utilization rate to move progressively up and we certainly think that we could increase our utilization rate by at least 200 basis points by the end of the year.
So, we're feeling very comfortable on both sides in terms of fleet utilization and in terms of our ability to deploy CapEx. One element that I have to mention is that manufacturers have also been limiting production capacity to some extent. So, obviously, the negative of that is that there isn’t as much production available as there probably would have been last year or in a less controlled environment. But on the other hand, the positive aspect for us is that prices have also remained a little bit firmer, but more importantly for us a lot more stable and probably a lot more stable for the foreseeable future. So, I think those two elements are certainly very, very positive for the long-term outlook for Textainer.
Mike, it’s Michael. If I might add on top of Olivier's comments there, as we expect utilization to improve, one thing to note also is that we're very happy that we're able to lease out some of our depo units as well. The ability to do that has two positive impacts maybe, improves our lease rental income, of course, but also reduces our storage expense in addition to that. So, two benefits there that will show up in the second half of the year.
As you mentioned the expenses, I was hoping, if you could put a little finer point, how you're thinking about maybe the sequential expenses here. My number is [Technical Difficulty] depreciation expense was kind of one of the pieces. So, any color that you could provide to think about the third quarter here from [Technical Difficulty] direct operating expenses, depreciation expense, et cetera?
Yes. So, Mike, if I look at direct operating expenses linked straight to utilization, so, you see some improvement there. We expect our storage to come down. As we worked on really focusing in on reducing the line on them, I think we've done a good job there. But if utilization tick down, [Technical Difficulty] I think, we're alluding to the fact that there's going to be certainly some improvement after Q2. And in line with that I'd expect direct container expense to start coming down actually because of the decrease in storage. Depreciation, that's certainly -- will go up with added CapEx out there of course.
Couple of things, we did have improved values at our containers held for sale, which has the impact of being part of small pieces of that line item. So, improved values of our held for sale inventory improved that line item, depreciation. But on an ongoing basis, I'd expect that to start picking up gradually as we deploy CapEx, but that is a good thing associated with deploying CapEx at good yields is that you're going to have depreciation of course.
G&A, we're quite happy with that line. It's pretty normalized. There a few cyclical items embedded in there in Q1, but I think you could kind of rely upon that level being say mid-9 area, or 9.8, as being something normalized, as we try to focus in on that spend as well.
As we noted earlier in the comments, we really feel it's important to spend wisely there. So, as we focus in on our staffing costs, we want to get a lot of productivity out of what we spend there. And as we alluded to earlier as well, we're investing quite a bit into our IT where we should be able to leverage really good efficiencies on an ongoing basis when that goes live.
And maybe just one last, I want to ask about the inorganic growth opportunity. It seems like you've got more certainty about the operating environment or at least a little more [Technical Difficulty]. So, as [Technical Difficulty] is there any opportunities for inorganic growth that you [Technical Difficulty] your eye on? And I guess, conversely, is there any partnering with another institution?
On the first question, Mike, I would say that the M&A market, as we all know, it's been pretty quiet given the environment. So, we don't really see that many opportunities out there. We're obviously monitoring very closely and remaining open to any opportunity that may arise. But, we're not actively pursuing any specific opportunity at the moment. So, I would expect that the M&A front is probably going to remain a little bit quiet until markets kind of stabilized. And I would guess that that will at least take until the end of the year before we see movements on that front certainly.
Got it. Yes. I appreciate that. I know it seems like recovering quickly, but still some more room to go. [Technical Difficulty] that's all of the questions that I had. I appreciate all the color.
Thank you, Mike.
Thank you. At this time, I would like to turn the call back over to Olivier for closing comments.
Yes. Thank you very much, everybody, for listening in. And we very much look forward to you joining us for our next call and hopefully some good news on our third quarter earnings release. Thank you very much.
Thank you, everyone. This does conclude today's teleconference. You may disconnect your lines at this time and thank you for your participation.