TAL EDUCATION 10-K 2006
Documents found in this filing:
ANNUAL REPORT PURSUANT TO SECTION
13 OR 15(d) OF THE SECURITIES
For The Fiscal Year Ended December
For the Transition Period from to
Commission file number- 001-32638
TAL International Group,
Securities registered pursuant to Section 12(b) of the Act: Common Stock, par value $0.001 per share
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirement for the past 90 days. Yes No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act (Check one):
Large accelerated filer Accelerated filer Non-accelerated filer
Indicate by check mark whether the registrant is a shell company (as defined in the Exchange Act Rule 12b-2). Yes No
As of December 31, 2005, the last business day of the Registrant’s most recently completed fiscal quarter, there were 32,882,208 shares of the Registrant’s common stock outstanding, and the aggregate market value of such shares held by non-affiliates of the Registrant (based upon the closing sale price of such shares on the New York Stock Exchange on December 31, 2005) was approximately $176,921,000. Shares of Registrant’s common stock held by each executive officer and director and by each entity or person that, to the Registrant’s knowledge, owned 5% or more of Registrant’s outstanding common stock as of December 31, 2005 have been excluded in that such persons may be deemed to be affiliates of the Registrant. This determination of affiliate status is not necessarily a conclusive determination for other purposes.
As of March 1, 2006, there were 32,882,208 shares of the Registrant’s common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Proxy Statement relating to the registrant's Annual Meeting of Stockholders to be held on May 22, 2006, are incorporated by reference into Part III hereof.
CAUTIONARY STATEMENT FOR PURPOSES OF THE ‘‘SAFE HARBOR’’ PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This Annual Report on Form 10-K contains certain forward-looking statements, including, without limitation, statements concerning the conditions in our industry, our operations, our economic performance and financial condition, including, in particular, statements relating to our business and growth strategy and service development efforts. The Private Securities Litigation Reform Act of 1995 provides a ‘‘safe harbor’’ for certain forward-looking statements so long as such information is identified as forward-looking and is accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those projected in the information. When used in this Annual Report on Form 10-K, the words ‘‘may’’, ‘‘might’’, ‘‘should’’, ‘‘estimate’’, ‘‘project’’, ‘‘plan’’, ‘‘anticipate’’, ‘‘expect’’, ‘‘intend’’, ‘‘outlook’’, ‘‘believe’’ and other similar expressions are intended to identify forward-looking statements and information. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. These forward-looking statements are based on estimates and assumptions by our management that, although we believe to be reasonable, are inherently uncertain and subject to a number of risks and uncertainties. These risks and uncertainties include, without limitation, those identified under the caption Item 1A. ‘‘Risk Factors’’ in this annual report and in our registration statement on Form S-1 (File No. 333-126317) filed with the Securities and Exchange Commission (‘‘SEC’’), as such registration statement became effective on October 11, 2005, and all of our other filings filed with the SEC from October 11, 2005 through the current date pursuant to the Securities Exchange Act of 1934.
We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as otherwise required by law. Reference is also made to such risks and uncertainties detailed from time to time in our filings with the SEC.
WEBSITE ACCESS TO COMPANY'S REPORTS AND CODE OF ETHICS
Our Internet website address is www.talinternational.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available free of charge through our website as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission. Our Code of Ethics is also available on our website.
SERVICE MARKS MATTERS
The following items referred to in this annual report are registered or unregistered service marks in the United States and/or foreign jurisdictions pursuant to applicable intellectual property laws and are the property of us and our subsidiaries: TALSM, Tradex®, Trader® and Greyslot®.
ITEM 1. BUSINESS
We were formed in 1963 and are one of the world's largest and oldest lessors of intermodal freight containers. Intermodal freight containers are large, standardized steel boxes used to transport freight by ship, rail or truck. Because of the handling efficiencies they provide, intermodal freight containers are the primary means by which many goods and materials are shipped internationally.
Our operations include the acquisition, leasing, re-leasing and subsequent sale of multiple types of intermodal containers, as well as chassis used for the transportation of containers domestically via rail and roads. As of December 31, 2005, our fleet consisted of approximately 613,911 containers and chassis, including approximately 76,830 containers under management for third parties, representing approximately 988,000 twenty-foot equivalent units (TEU). We also believe that we are the world's
largest seller of used containers. We have an extensive global presence, offering leasing services through 19 offices in 12 countries and approximately 194 third party container depot facilities in 42 countries as of December 31, 2005. Our customers are among the world's largest shipping lines and include, among others, APL-NOL, CMA-CGM, Hanjin Shipping, Maersk Line, Mediterranean Shipping Company and NYK Line.
We lease three principal types of containers: (1) dry freight containers, which are used for general cargo such as manufactured component parts, consumer staples, electronics and apparel, (2) refrigerated containers, which are used for perishable items such as fresh and frozen foods, and (3) special containers, which are used for heavy and oversized cargo such as marble slabs, building products and machinery. As of December 31, 2005, dry, refrigerated and special containers represented approximately 87%, 6% and 7% of our fleet on a unit basis, respectively. Our chassis leasing business, which we re-entered in the fourth quarter of 2005, represented under 1% of our fleet on a unit basis as of December 31, 2005. For each of the fiscal years 2005, 2004 and 2003, dry, refrigerated and special containers represented approximately 60%, 30% and 10% of our leasing revenues, respectively.
We lease our containers on a per diem basis to our customers under three types of leases: long-term leases, service leases and finance leases. Long-term leases, typically with terms of three to eight years, provide us with stable cash flow and low transaction costs by requiring customers to maintain specific containers on-hire for the duration of the lease. Service leases command a premium per diem rate in exchange for providing customers with a greater level of operational flexibility by allowing the pick-up and drop-off of containers during the lease term. Finance leases, which are typically structured as full payout leases, provide for a predictable recurring revenue stream with the lowest daily cost to the customer because customers are generally required to retain the container for the duration of its useful life. Our leases require lessees to maintain the containers in good operating condition, defend and indemnify us from liabilities relating to the containers’ contents and handling and return the containers to specified drop-off locations. As of December 31, 2005, 89% of our containers were on-hire to customers, with 59% of our containers on long-term leases, 26% on service leases or long-term leases whose fixed terms have expired but for which the related units remain on-hire and for which we continue to receive rental payments and 4% on finance leases. As of December 31, 2005, our long-term leases had an average remaining lease term of 31 months. In addition, 8% of our containers were available for lease and 3% were available for sale.
We believe that we are the world's largest seller of used containers, having sold over 50,000 used containers in each of the last five years on behalf of ourselves and third parties. We manage our own container disposals, act as the disposal agent for a number of our shipping line customers and buy and sell used containers on an opportunistic basis.
Our total revenues primarily consist of leasing revenues derived from the lease of our owned containers and, to a lesser extent, fees received for managing containers owned by third parties and equipment trading revenue. The most important driver of our profitability is the extent to which leasing revenues, which are driven primarily by our owned container fleet size, utilization and average rental rates, exceed our operating costs, which primarily consist of depreciation and amortization, interest expense, direct operating expenses and administrative expenses. We seek to exceed a targeted return on our investment over the life cycle of each container by managing container utilization, per diem lease rates, drop-off restrictions and the used container sale process.
TAL International Group, Inc. (‘‘TAL’’ or ‘‘the Company’’) was formed on October 26, 2004 and commenced operations on November 4, 2004 when it acquired all of the outstanding capital stock of Trans Ocean Ltd. (‘‘Trans Ocean’’ or ‘‘TOL’’) and TAL International Container Corporation (‘‘TAL International Corporation’’or "TALI") from TA Leasing Holding Co., Inc. (‘‘the Acquisition’’). Prior to the consummation of the Acquisition, Trans Ocean and TAL International Corporation were subsidiaries of an international insurance and finance company. Prior to the Acquisition, Trans Ocean and TAL International Corporation provided long-term leases, service leases and finance leases, maritime container management services and subsequent sale of multiple types of intermodal containers through a worldwide network of offices, third party depots and other facilities.
According to Drewry Shipping Consultants Limited, as of December 2005, the container shipping industry was an approximately $185.0 billion industry, as measured by the annual gross revenues of shipping lines. Containers provide a secure and cost-effective method of transporting raw materials, component parts and finished goods because they can be used in multiple modes of transport. By making it possible to move cargo from a point of origin to a final destination without repeated unpacking and repacking, containers reduce freight and labor costs. In addition, automated handling of containers permits faster loading and unloading of vessels, more efficient utilization of transportation equipment and reduced transit time. The protection provided by sealed containers also reduces cargo damage and the loss and theft of goods during shipment.
Over the last twenty-five years, containerized trade has grown at a rate greater than that of general worldwide economic growth. According to Clarkson Research Studies (‘‘Clarkson’’), worldwide containerized cargo volume grew in every year from 1980 through 2004, attaining a compound annual growth rate (‘‘CAGR’’) of 10.0% during that period. Furthermore, Clarkson projected that loaded container liftings, which is a measure of volume in the industry, is expected to increase by 10.1% in both 2005 and 2006. We believe that this projected growth is due to several factors, including the shift in global manufacturing capacity to lower labor cost areas such as China and India, the continued integration of developing high growth economies into global trade patterns, the continued conversion of cargo from bulk shipping into containers and the growing liberalization and integration of world trade.
According to Containerisation International, container lessors’ ownership was approximately 9.8 million TEU or approximately 45.1% of the total worldwide container fleet of approximately 21.6 million TEU as of the end of 2005. The percentage of owned versus leased containers utilized by shipping lines has ranged from approximately 45% to 48% over the last decade according to Containerisation International. In general, leasing containers helps shipping lines improve their overall container fleet efficiency and provides the shipping lines with an alternative source of equipment financing. Given the uncertainty and variability of export volumes, and the fact that shipping lines have difficulty in accurately forecasting their container requirements at a port-by-port level, the availability of containers for lease significantly reduces a shipping line's need to purchase and maintain larger container inventory buffers. In addition, the flexibility provided by operating leases also allows the shipping lines to adjust their container fleet sizes both seasonally and over time and helps to balance trade flows. Leasing containers also provides shipping lines with an additional source of funding to help them manage a high-growth, asset-intensive business.
Container leasing rates are typically a function of, among other things, new container prices (which are heavily influenced by steel prices), interest rates and the container supply and demand balance at a particular time and location. Average leasing rates on an entire portfolio of container leases respond more gradually to changes in new container prices, because lease agreements can only be re-priced upon the expiration of the lease. In addition, the value that lessors receive upon resale of containers is closely related to the cost of new containers.
As of December 31, 2005, we operated approximately 988,000 TEU of containers and chassis. Our container fleet consists of three types of containers: dry containers, refrigerated containers and special containers. The containers that we lease are either owned outright by us, leased-in from third-parties, or owned by third-parties and managed by us. The table below summarizes the composition of our fleet by the type of unit:
We operate our business through 19 worldwide offices located in 12 different countries as of December 31, 2005. Our operations include a global sales force, a global container operations group, a container resale group, and a logistics services group. Our headquarters are located in Purchase, New York.
Intermodal containers are designed to meet a number of criteria outlined by the International Standards Organization (ISO). The standard criteria include the size of the container and the gross weight rating of the container. This standardization ensures that containers can be used by the widest possible number of transporters and it facilitates container and vessel sharing by the shipping lines. The standardization of the container is also an important element of the container leasing business since we can operate one fleet of containers that can be used by all of our major customers.
Our container fleet consists of three types of containers:
A chassis is a rectangular, wheeled steel frame, generally 23½ or 40 feet in length, built specifically for the purpose of transporting a container. Longer sized chassis, designed solely to accommodate domestic containers, can be up to 53 feet in length. Once mounted, the chassis and container are the functional equivalent of a trailer. When mounted on a chassis, the container may be trucked either to its destination or to a railroad terminal for loading onto a rail car. Our chassis are primarily used in the United States and are seldom used in other countries. As of December 31, 2005, our fleet included approximately 1,210 chassis, which accounted for under 1% of our total fleet.
Most of our revenues are derived from leasing our fleet of containers to our core shipping line customers. The vast majority of our container leases are structured as operating leases, though we also provide customers with finance leases. Regardless of lease type, we seek to exceed our targeted return on our container investments over the life cycle of each container by managing container utilization, lease rates, drop-off restrictions and the used container sale process.
Our lease products provide numerous operational and financial benefits to our shipping line customers. These benefits include:
Operating Leases. Operating leases are structured to allow customers flexibility to pick-up containers on short notice and to drop-off containers prior to the end of their useful life. Because of this flexibility, most containers will go through several pick-up and drop-off cycles. Our operating lease contracts specify a per diem rate for each container on-hire, where and when such containers can be returned, how the customer will be charged for damage and the charge for lost or destroyed containers, among other things.
We categorize our operating leases as either long-term leases or service leases. Long-term lease terms typically range from three to eight years with an average term of approximately five years at lease inception. Our long-term leases require our customers to maintain all units on-hire for the duration of the lease term, and they provide us with predictable recurring cash flow. As of December 31, 2005, 59% of our containers were on-hire under long-term leases. As of December 31, 2005, our long-term leases had an average remaining duration of 31 months, assuming no leases are renewed. However, we believe that many of our customers will renew leases for containers that are less than sale age at the expiration of the lease. In addition, our containers typically remain on-hire at the contractual per diem rate for an additional six to twelve months beyond the end of the contractual lease term due to the logistical requirements of our customers having to return containers to specific drop-off locations.
Some of our long-term leases give our customers Early Termination Options (‘‘ETOs’’). If exercised, ETOs allow customers to return containers prior to the expiration of the long-term lease. However, if an ETO is exercised, the customer is required to pay a penalty per diem rate that is applied retroactively to the beginning of the lease. As a result of this retroactive penalty, ETOs have historically rarely been exercised.
Service leases allow our customers to pick-up and drop-off containers during the term of the lease, subject to contractual limitations. Service leases provide the customer with a higher level of flexibility than term leases and, as a result, typically carry a higher per diem rate. The terms of our service leases range from twelve months to five years although, because containers can be returned during the term of a service lease and since service leases are generally renewed or modified and extended upon expiration, lease term does not dictate expected on-hire time for our containers on service leases. As of December 31, 2005, 26% of our containers were on-hire under service leases and these containers have been on-hire for an average of 44 months.
Finance Leases. Finance leases provide our customers with an alternative method to finance their container acquisitions. Finance leases typically have lease terms ranging from five to ten years. Finance leases are generally structured for specific quantities of containers (usually new containers), generally require the customer to keep the containers on-hire for their remaining useful life, and provide the customer with a purchase option at the end of the lease term. The daily cost of a finance lease is typically less than the daily cost of an operating lease. As of December 31, 2005, approximately 4% of our containers were on-hire under finance leases.
Lease Documentation. In general, our lease agreements consist of two basic elements, a master lease agreement and a lease addendum. Lease addenda contain the business terms (including daily rate, term duration and drop-off schedule, among other things) for specific leasing transactions, while master lease agreements outline the general rights and obligations of the lessor and lessee under all of
the lease addenda covered by the master lease agreement (lease addenda will specify the master lease agreement that governs the lease addenda). For most customers, we have a small number of master lease agreements (often one) and a large number of lease addenda.
Our master lease agreements generally require the lessees to pay rentals, depot charges, taxes and other charges when due, to maintain the containers in good condition and repair, to return the containers in good condition in accordance with the return conditions set forth in the master lease agreement, to use the containers in compliance with all laws, and to pay us for the value of the container as determined by us if the container is lost or destroyed. The default clause gives us certain legal remedies in the event that the lessee is in breach of the lease.
The master lease agreements generally contain an exclusion of warranties clause and require lessees to defend and indemnify us in most instances from third-party claims arising out of the lessee's use, operation, possession or lease of the containers. Lessees are required to maintain all risks physical damage insurance, comprehensive general liability insurance and to indemnify us against loss. We also maintain our own off-hire physical damage insurance to cover our containers when they are not on-hire to lessees and third-party liability insurance for both on-hire and off-hire containers.
Re-leasing, Logistics Management, Depot Management and Used Container Sales.
We believe that managing the period after our containers' first lease is the most important aspect of our business. Successful management of this period requires disciplined logistics management, extensive re-lease capability, careful cost control and effective sales of used containers.
Re-Leasing. Since our operating leases allow customers to return containers, we typically are required to place containers on several leases during their useful lives. Initial lease transactions for new containers can usually be generated with a limited sales and customer service infrastructure because initial leases for new containers typically cover large volumes of units and are fairly standardized transactions. Used containers, on the other hand, are typically leased out in small transactions and are structured to accommodate pick-ups and returns in a variety of locations. As a result, to maintain high utilization of older equipment, leasing companies benefit from having a large number of customers and maintaining a high level of operating contact with these customers. In addition, the utilization of older containers is highly influenced by the worldwide supply and demand balance of containers at a particular time.
Logistics Management. Since the Asian financial crisis in the late 1990's, the shipping industry has been characterized by large regional trade imbalances, with loaded containers generally flowing from export-oriented economies in Asia to North America and Western Europe. Because of these trade imbalances, shipping lines have an incentive to return leased containers in North America and Europe to reduce the cost of empty container backhaul. For several years after the Asian financial crisis, the return of large numbers of containers to North America and Europe reduced utilization for TAL and the rest of the leasing industry and significantly increased container positioning costs as leasing companies were forced to ship empty containers back to high container demand areas in Asia.
In the aftermath of the Asian financial crisis, we embarked on a program to reduce logistical and utilization risk by increasing the percentage of our containers on long-term lease or finance lease and restricting the ability of our customers to return containers outside of Asian demand locations. From December 31, 2000 to December 31, 2005, the portion of our containers on long-term lease and finance leases increased from 48% to 63%, the annual number of dry containers returned in North America and Europe from service leases fell by 61%, the number of idle dry containers available for lease fell by 68% and our empty container positioning cost fell by 85%.
In addition to restructuring our leases, we increased our operational focus on moving empty containers as cheaply as possible. To accomplish this, we developed an in-house group of experts, which we call Greyslot, to manage our empty container positioning program. As part of their mandate to reposition our empty containers, Greyslot maintains frequent contact with various shipping lines and vessel owners to identify available vessel space, and our success with managing our own positioning program has led to additional revenue opportunities. For the last several years Greyslot
has acted as a broker of empty vessel space for moving additional empty containers for third parties. Our third-party customers include leasing companies and shipping lines, and such third-party business currently represents a majority of the containers moved by Greyslot. While we have made important strides over the last few years in our logistics management, logistical risk remains an important element of our business due to competitive pressures, changing trade patterns and other market factors and uncertainies.
Depot Management. As of December 31, 2005, we manage our container fleet through approximately 194 third-party owned and operated depot facilities located in 42 countries. Depot facilities are generally responsible for repairing containers when they are returned by lessees and for storing the containers while they are off-hire. We have a worldwide operations group that is responsible for managing our depot contracts and they also periodically visit the depot facilities to conduct inventory and repair audits. We also supplement our internal operations group with the use of independent inspection agents.
We are in constant communication with our depot partners through the use of electronic data interchange, or EDI. Our depots gather and prepare all information related to the activity of our equipment at their facilities and transmit the information via EDI and the Internet to us. The information we receive from our depots updates our fully integrated container fleet management and tracking system.
Most of the depot agency agreements follow a standard form and generally provide that the depot will be liable for loss or damage of equipment and, in the event of loss or damage, will pay us the previously agreed loss value of the applicable containers. The agreements require the depots to maintain insurance against container loss or damage and we carry insurance to cover the risk that the depot's insurance proves insufficient.
Our container repair standards and processes are generally managed in accordance with standards and procedures specified by the Institute of International Container Lessors, or the IICL. The IICL establishes and documents the acceptable interchange condition for containers and the repair procedures required to return damaged containers to the acceptable interchange condition. At the time that containers are returned by lessees, the depot arranges an inspection of the containers to assess the repairs required to return the containers to acceptable IICL condition. This inspection process also splits the damage into two components, customer damage and normal wear and tear. Items typically designated as customer damage include dents in the container and debris left in the container, while items such as rust are typically designated as normal wear and tear.
Our leases are structured so that the lessee is responsible for the customer damage portion of the repair costs, and customers are billed for damages at the time the containers are returned. We sometimes offer our customers a container repair service program whereby we, for an additional payment by the lessee (in the form of a higher per-diem rate or a flat fee at off-hire), assume financial responsibility for all or a portion of the cost of repairs upon return of the containers (but not of total loss of containers), up to a pre-negotiated amount.
Used Container Sales. Our in-house used container sales group, Trader, has a worldwide team of container specialists that manage the sale process for our used containers. Trader also manages the used container sale process for a number of our customers and buys and sells used containers opportunistically. Trader has sold over 50,000 used containers in each of the last five years on behalf of us and third parties, and we believe that we are the world's largest seller of used containers. The sale age of our used containers typically average between 10 and 14 years. Trader generally sells to domestic storage companies, freight forwarders (who often use the containers for one-way trips into less developed countries) and other purchasers of used containers. We believe that our ability to sell containers directly to end users provides us with a higher and more reliable source of residual value for our containers than would be available if we, like many of our competitors, relied primarily on our container depots for container disposals.
The sale prices we receive for our used containers are influenced by many factors, including the level of demand for used containers compared to the number of used containers available for disposal
in a particular location, the cost of new containers, and the level of damage on the containers. The gain or loss that we recognize on the sale of containers is determined by the price we receive for our used containers compared to the net book value on the containers sold. While our total revenue is primarily made up of leasing revenue, gains or losses on the sale of used containers can have a significant positive or negative impact on our profitability.
A portion of our container fleet is managed for third-party owners. Our management agreements fall into two general categories, (1) stand-alone pools, for which our systems track revenues and operating expenses attributable to specific containers and the container owners receive payments based on the net revenues of their own containers, and (2) co-mingled pools, in which the container owners receive payments based upon the average net revenues of similar containers in our fleet. In both structures, we receive management fees that are a percentage of net revenues. If operating expenses were to exceed revenues, the owners are obligated to pay the excess or we may deduct the excess, including our management fee, from future net revenues. We typically receive a commission for selling or disposing containers, though in some cases, we are compensated for sales through a percentage sharing of sale proceeds over an agreed upon floor amount. Typically the terms of the management agreements are 10 to 12 years from the acceptance dates of containers under the agreement.
We may be subject to environmental liability in connection with our current or historical operations that could adversely affect our business and financial prospects despite insurance coverage and terms of the leases and other arrangements for use of the containers that purport to place the responsibility for environmental liability on the end user. In certain countries like the United States, the owner of a leased container may be liable for the costs of environmental damage from the discharge of the contents of the container even though the owner is not at fault. We have and will seek to maintain off-hire physical damage insurance to cover our containers when they are not on-hire to lessees and third-party liability insurance for both on-hire and off-hire containers. We also have and will continue to require lessees to obtain all risks physical damage insurance, comprehensive general liability insurance and to provide us with indemnity against loss. Nevertheless, such insurance or indemnities may not fully protect us against damages arising from environmental damage.
Countries that are signatories to the Montreal Protocol on the environment agreed in November 1992 to restrict the use of environmentally destructive refrigerants, banning production (but not use) of chlorofluorocarbon compounds (‘‘CFCs’’) beginning in January 1996. Since then, the environmental impact of CFCs has become increasingly prominent. On January 1, 2001, it became illegal for environmentally destructive refrigerants to be handled, other than for disposal, in most of the countries that are members of the European Union. CFCs are used in the operation, insulation and manufacture of refrigerated containers. All of our refrigerated containers purchased since June 1993 use non-CFC refrigerant gas in the operation and insulation of the containers, although a reduced quantity of CFCs are still used in the container manufacturing process. The replacement refrigerant used in our new refrigerated containers may also become subject to similar governmental regulations. In the past, we have retrofitted certain refrigerated containers with non-CFC refrigerants. Less than 3% of our refrigerated containers still use CFC refrigerants.
We diligently monitor our customers' performance and our lease exposures on an ongoing basis. Our credit management processes are aided by the long payment experience we have with most of our customers, and our broad network of relationships in the shipping industry that provide current information about our customers' market reputations. Credit criteria may include, but are not limited to, customer payment history, customer financial position and performance (e.g., net worth, leverage, profitability), trade routes, country of domicile, social and political climate, and the type of, and location of, containers that are to be supplied.
We have benefited from strong credit performance over the last several years. Over the last five years, our write offs of customer receivables have averaged 0.20% (20 basis points) of our average total assets over such period, and we believe that our receivables and days outstanding are low for the container leasing industry. We attribute this credit performance to several factors—some of which are specific to our company, and some of which are attributable to the industry generally.
Industry factors providing credit protection include the strong growth in the container industry, effective collection tools, our high recovery rate for containers in default situations and the re-marketability of our container fleet. The strong growth in the container industry helps minimize the risk of customer defaults since the core assets of a poorly performing shipping line, its ships and containers, are generally needed to meet the demand for world containerized trade. As a result, poorly performing shipping lines are often acquired by others. In addition, the law in several major port locations is highly favorable to creditors and many of our large customers call on ports that will allow us to arrest, or seize, the customers' ships or bunkers, or repossess our containers if the customer is in default under our container leases. We have historically recovered approximately 90% of our containers that were the subject of defaulted contracts and we are able to re-market these repossessed containers through our worldwide sales infrastructure. However, we typically incur operating expenses such as repairs and positioning when containers are recovered after a customer default.
Company factors supporting our strong credit performance include our long previous history as part of a large finance company, our focus on collections and our sales compensation structure that does not provide commissions based on container volumes.
The vast majority of our revenues and expenses are denominated in U.S. dollars, and we do not engage in currency hedging. However, our operations and used container sales in locations outside of the U.S. have some exposure to foreign currency fluctuations, and trade growth and the direction of trade flows can be influenced by large changes in relative currency values.
Marketing and Customer Service
Our global sales and customer service force is responsible for developing and maintaining relationships with senior operations staff at our shipping line customers, negotiating lease contracts and maintaining day-to-day coordination with junior level staff at our customers. This close customer communication helps us to negotiate lease contracts that satisfy both our financial return requirements and our customers' operating needs and ensures that we are aware of our customers' potential equipment shortages and that they are aware of our available container inventories. Many of our sales people have been with us for over twenty years and we believe that the quality of our customer relationships and the level of communication with our customers represent an important advantage for us.
We believe that we have strong, long standing relationships with our largest customers, most of whom we have had a relationship with for over 20 years. We currently have containers on-hire to more than 300 customers, although approximately 72% of our containers are on-hire to our 20 largest customers. Our customers are mainly international shipping lines, but we also lease containers to freight forwarding companies and manufacturers. Our five largest customers accounted for approximately 45% of our 2005 leasing revenues. Our largest customer is APL-NOL, and has been for the last several years. A default by any of these major customers could have a material adverse impact on our business, financial condition and future prospects.
Systems and Information Technology
We have a proprietary, fully integrated container fleet management system. The system tracks all of our containers individually by container number, provides design specifications for the equipment,
tracks on-hire and off-hire transactions, matches each on-hire container to a lease contract and each off-hire container to a depot contract, maintains the major terms for each lease contract, calculates the monthly bill for each customer and tracks and bills for container repairs. Our system is EDI capable, which means it can receive and process container activity transactions electronically.
In addition, our system allows our business partners to conduct business with us through the Internet. It allows customers to check our container inventories, review design specifications, request clearances for returning containers (the system will issue the clearance electronically if the return to the specified location is currently allowed by the contract covering the container), request bookings for container pick-ups and review and approve repair bills.
We have long relationships with all of our major suppliers. We purchase most of our containers in China. There are two large manufacturers of dry and special containers and three large manufacturers of refrigerated containers. Our operations staff reviews the designs for our containers and periodically audits the production facilities of our suppliers. In addition, we use our Asian operations group and third party inspectors to visit factories when our containers are being produced to provide an extra layer of quality control. Nevertheless, defects in our containers do sometimes occur. We work with the manufacturers to correct these defects, and our manufacturers have generally honored their warranty obligations in such cases.
We compete with approximately 10 other major container leasing companies, many smaller lessors, manufacturers of container equipment and companies offering finance leases as distinct from operating leases. It is common for the shipping lines that are our customers to utilize several leasing companies to meet their container needs.
Our competitors compete with us in many ways, including pricing, lease flexibility, supply reliability and customer service. In times of weak demand or excess supply, leasing companies often respond by lowering leasing rates and increasing the logistical flexibility offered in their lease agreements. In addition, new entrants into the leasing business have been attracted by the high rate of containerized trade growth in recent years, and they are often aggressive on pricing and lease flexibility.
While we are forced to compete aggressively on price, we attempt to emphasize our supply reliability and high level of customer service to our customers. We invest heavily on ensuring adequate container availability in high demand locations, dedicate large portions of our organization to building customer relationships, maintain close day-to-day coordination with customers' operating staffs and have developed powerful and user-friendly systems that allow our customers to transact with us through the Internet. We believe that our close customer relationships, experienced staff, reputation for market leadership, scale efficiencies and proprietary systems provide important competitive advantages.
As of December 31, 2005, we employed approximately 191 people, in 19 offices, in 12 countries. We believe that our relations with our employees are good and we are not a party to any collective bargaining agreements.
ITEM 1A. RISK FACTORS
Risks Related to Our Business and Industry
Container leasing demand is affected by numerous market factors as well as external political and economic events and a decrease in the volume of world trade and other operating factors may adversely affect our container leasing business.
Demand for containers depends largely on the rate of world trade and economic growth. Cyclical recessions can negatively affect lessors' operating results because during economic downturns or periods of reduced trade, such as those that occurred in 2001 and 2002, shipping lines tend to lease fewer containers, or lease containers only at reduced rates, and tend to rely more on their own fleets to satisfy a greater percentage of their requirements. Thus, a decrease in the volume of world trade may adversely affect our container utilization and lease rates and lead to reduced revenue, reduced capital investment, increased operating expenses (such as storage and positioning) and reduced financial performance. Such cyclical downturns may occur again in the future. In the late 1990's, the economic downturn in Asia, lower prices for new containers and the consolidation of shipping lines adversely affected the container leasing business. These events may reoccur.
Other general factors affecting demand for leased containers, container utilization and per diem rental rates include the available supply and prices of new and used containers, including the market acceptance of new container types and overbuying by competitors and customers, changes in the operating efficiency of customers, economic conditions and competitive pressures in the shipping industry, including fluctuations in ship charter and freight rates and expansion, containership fleet overcapacity or undercapacity, consolidation or withdrawal of individual customers in that industry, shifting trends and patterns of cargo traffic, Acts of God such as droughts, storms, or other natural disasters, flu or other pandemics that result in economic disruptions that may disrupt or interfere with trade. The availability and terms of equipment financing, fluctuations in interest rates and foreign currency values, import/export tariffs and restrictions, customs procedures, foreign exchange controls and other governmental regulations and political or economic factors that are inherently unpredictable and may be beyond our control. Any of the aforementioned external factors may have a material adverse affect on our business. For example, in 2005 the inventory of new containers held at container factories by leasing companies and shipping lines increased substantially despite continued growth in the volume of world trade. We believe that this container inventory build-up was mainly caused by our customers achieving improved container operating efficiency in 2005 due to an unexpected reduction in port and rail congestion relative to the significant congestion problems that were experienced in 2004. The build-up of container inventories in Asia by our customers reduced our volume of leasing transactions in 2005 and caused our container utilization to decline slightly since December 31, 2004. Additionally, as a result of a recent market build-up of inventories of new equipment, we reduced our container orders for the third and fourth quarters of 2005.
Equipment prices and lease rates may decrease.
Lease rates depend on the type and length of the lease, the type and age of the equipment, competition (as more fully discussed herein), and other factors more fully discussed herein. Container lease rates also move with the fluctuations in prices for new containers. Because steel is the major component used in the construction of new containers, the price for new containers, as well as prevailing container lease rates, are both highly correlated with the price of steel. For example, container prices and market leasing rates increased by over 40% from the middle of 2003 to the middle of 2005 primarily due to an increase in the price of steel in China, while during the second half of 2005 container prices and market leasing rates decreased significantly primarily due to reductions in the cost of steel in China. In addition, new container prices and lease rates declined in the late 1990’s, because of, among other factors, a drop in worldwide steel prices and a shift in container manufacturing from Taiwan and Korea to areas with lower labor costs in mainland China.
In addition, leasing rates can be negatively impacted by the entrance of new leasing companies, overproduction of new containers by factories and over-buying by shipping lines and leasing
competitors. For example, during 2001 and again in the second quarter of 2005, overproduction of new containers, coupled with a build-up of container inventories in Asia by leasing companies and shipping lines, led to decreasing utilization rates and more aggressive lease pricing from some of our competitors. In the event that the container shipping industry were to be characterized by over-capacity in the future, or if available supply of containers were to increase significantly as a result of, among other factors, new companies entering the business of leasing and selling containers, both utilization and lease rates can be expected to decrease, thereby adversely affecting the revenues generated by our container leasing business.
Sustained Asian economic instability could reduce demand for leasing.
A number of the shipping lines to which we lease containers are entities domiciled in Asian countries. In addition, many of our customers are substantially dependent upon shipments of goods exported from Asia. From time to time, there have been economic disruptions, financial turmoil and political instability in this region. If these events were to occur in the future, they would adversely affect these customers and lead to a reduced demand for leasing of our containers or otherwise adversely affect us.
Our customers may decide to lease fewer containers.
We, like other suppliers of leased containers, are dependent upon decisions by shipping lines to lease rather than buy their equipment. Should shipping lines decide to buy a larger percentage of the containers they operate, our utilization rate would decrease, resulting in decreased leasing revenue, increased storage costs and increased positioning costs. Most of the factors affecting the decisions of our customers are outside our control.
We face extensive competition in the container leasing industry.
We may be unable to compete favorably in the highly competitive container leasing and sales business. We compete with approximately 10 other major leasing companies, many smaller lessors, manufacturers of container equipment, companies offering finance leases as distinct from operating leases, promoters of container ownership and leasing as a tax shelter investment, shipping lines, which sometimes lease their excess container stocks, and suppliers of alternative types of equipment for freight transport. Some of these competitors may have greater financial resources and access to capital than we do. Additionally, some of these competitors may have large, underutilized inventories of containers, which could lead to significant downward pressure on lease rates and margins.
Competition among container leasing companies depends upon many factors, including, among others, lease rates, lease terms (including lease duration, drop-off restrictions and repair provisions), customer service, and the location, availability, quality and individual characteristics of equipment. New entrants into the leasing business have been attracted by the high rate of containerized trade growth in recent years, and new entrants have generally been less disciplined than we are in pricing and structuring leases. As a result, the entry of new market participants together with the already highly competitive nature of our industry, may undermine our ability to maintain a high level of container utilization or achieve our growth plans.
The age of our container fleet may become a competitive disadvantage.
As of December 31, 2005, the average age of the containers in our fleet was 8.8 years. We believe that the average age of some of our competitors’ container fleets is lower than the average age of our fleet, and customers generally have a preference for younger containers. Historically, we have been successful marketing our older equipment by positioning older containers to areas where demand is very strong, offering incentives for customers to extend containers on lease, and providing greater drop-off location flexibility for containers approaching sale age. However, our marketing strategies for older containers may not continue to be successful, particularly if demand for containers in general becomes weaker.
Lessee defaults may adversely affect our financial condition and results of operations and cash flow by decreasing revenues and increasing storage, positioning, collection and recovery expenses.
Our containers are leased to numerous customers. Rent and other compensation, as well as indemnification for damage to or loss of containers, is payable under the leases and other arrangements by the end users. Inherent in the nature of the leases and other arrangements for use of the containers is the risk that once the lease is consummated, we may not receive, or may experience delay in realizing, all of the compensation and other amounts to be paid in respect of the containers. A delay or diminution in amounts received under the leases and other arrangements could adversely affect our business and financial prospects and our ability to make payments on our debt.
The cash flow from the containers, principally lease rentals, management fees, proceeds from the sale of owned containers and commissions earned on container agency and brokerage activities, is affected significantly by the ability to collect payments under leases and other arrangements for the use of the containers and the ability to replace cash flows from terminating leases by re-leasing or selling containers on favorable terms. All of these factors are subject to external economic conditions and the performance by lessees and service providers that will not fully be within our control.
When lessees or sublessees of containers default, we may fail to recover all of our containers, and the containers we do recover may be returned in locations where we will not be able to efficiently re-lease or sell them. We may have to reposition these containers to other places where we can re-lease or sell them, which could be expensive depending on the locations and distances involved. As a result, we may lose lease or management revenues and incur additional operating expenses in repossessing and storing the equipment. We do not currently maintain insurance to cover such defaults. While in recent years defaults by lessees, as measured by our historical experience and reflected on our financial statements as an allowance for doubtful accounts, have not been material as a percentage of our assets, future defaults may nevertheless be material and any such future defaults could have a material adverse effect on our business condition and financial prospects.
We are dependent upon continued demand from our large customers.
Our largest customers account for a significant portion of our revenues. Our five largest customers represented approximately 45% of our revenues for our 2005 fiscal year, with our single largest customer representing approximately 18% during such period. Furthermore, several consolidating acquisitions were announced in 2005 which will increase the concentration of our customer base. The loss, default or significant reduction of orders from any of our large customers, and especially our single largest customer, could have a material adverse effect on our business, financial condition and future prospects.
Gains and losses associated with container sales may fluctuate and adversely affect our operating results.
Although our revenue primarily depends upon equipment leasing, our profitability is also affected by the residual values of our containers upon the expiration of their leases because, in the ordinary course of our business, we sell certain containers when such containers are returned to us. The volatility of the residual values of such containers may be significant. These values, which can vary substantially, depend upon, among other factors, worldwide steel prices, applicable maintenance standards, refurbishment needs, comparable new equipment costs, used equipment availability, inflation rates, market conditions, materials and labor costs and equipment obsolescence. Most of these factors are outside of our control. Operating leases, which represent the predominant form of leases in our portfolio, are subject to greater residual value risk than finance leases.
Containers are typically sold if it is in our best interest to do so after taking into consideration the book value, remaining useful life, repair condition, suitability for leasing or other uses and the prevailing local sales price for containers. As these considerations vary, gains or losses on sale of equipment will also fluctuate and may be significant if we sell large quantities of containers.
In 2005, we recognized a gain of $9.7 million from the sale of used containers compared to a loss of $3.2 million in 2004. In 2005, selling prices for used containers were supported by strong demand
for used containers, a reduced availability of used containers in North America and Europe following the successful clearing of excess container inventories by us and other leasing companies from 2002 to 2004, and high prices for new containers. While used container prices remained strong in the fourth quarter of 2005, we expect that they may come under pressure in 2006 if new container prices remain at their current level.
Changes in market price, availability or transportation costs of containers in China could adversely affect our ability to maintain our supply of containers.
China is currently the largest container producing nation in the world, and we currently purchase substantially all of our dry and special containers from two manufacturers based in China and substantially all of our refrigerated containers from three manufacturers based in China. In the event that it were to become more expensive for us to procure containers in China or to transport these containers at a low cost from China to the locations where they are needed by our customers, because of further consolidation among container suppliers, increased tariffs imposed by the United States or other governments or for any other reason, we would have to seek alternative sources of supply. We may not be able to make alternative arrangements quickly enough to meet our equipment needs, and the alternative arrangements may increase our costs.
Our business strategies entail risk and we may not be able to realize our plans with regard to these strategies.
As discussed herein, in order to grow our business, we expect to employ various strategies, including consummating strategic acquisitions and investing in our container fleet. Unanticipated issues may arise in the implementation of these contemplated strategies, which could impair our ability to expand our business as expected. For example:
Any of the above risks could adversely affect our financial position and results of operations. Furthermore, the execution of our plans could result in our having greater losses than we have historically experienced and could have a material adverse effect on our business.
If we are unable to meet future capital requirements, our business may be adversely affected.
We periodically make capital investments to, among other things, maintain and expand our container fleet. As we maintain and grow our business, we may have to incur significant capital expenditures. We believe that we will be able to fund these expenditures through cash flow from operations and borrowings under our senior secured credit facility and our asset securitization facility. However, future borrowings may not be available under such facilities and we may not be able to refinance such facilities on commercially reasonable terms or at all. Additionally, we may not have, and may not be able to obtain, adequate funds to make all necessary capital expenditures when required, and the amount of future capital expenditures may materially exceed our anticipated or current expenditures. If we are unable to make necessary capital expenditures, our profitability could suffer.
We may incur costs associated with relocation of leased equipment.
When lessees return equipment to locations where supply exceeds demand, we routinely reposition containers to higher demand areas. Positioning expenses vary depending on geographic
location, distance, freight rates and other factors, and may not be fully covered by drop-off charges collected from the last lessees of the equipment or pick-up charges paid by the new lessees. In addition, demand may not be as great as anticipated after positioning has occurred, which may result in equipment remaining idle. Although we currently seek to limit the number of containers that can be returned and impose surcharges on containers returned to areas where demand for such containers is not expected to be strong, future market conditions may not enable us to continue such practices. In addition, we cannot assure you that we have accurately anticipated which port locations will be characterized by weak or strong demand in the future, and our current contracts will not provide much protection against positioning costs if ports that we expect to be strong demand ports turn out to be surplus container ports at the time leases expire.
Manufacturers of our equipment may be unwilling or unable to honor manufacturer warranties covering defects in our equipment.
We obtain warranties from the manufacturers of our equipment. When defects in the containers occur, we work with the manufacturers to identify and rectify the problem. For example, we, along with some of our competitors and one of our lessees, currently have identified cracks in rails in certain containers manufactured in two factories in China in 2003 and 2004. To date, the manufacturer has agreed to be responsible for the repair of the containers, even though the cause of the problem has not yet been identified. However, there is no assurance that the manufacturer will continue to honor its warranty obligations or that manufacturers will be willing or able to honor such warranty obligations in the future. If defects are discovered in containers that are not covered by manufacturer warranties we could be required to expend significant amounts of money to repair the containers and/or the useful life of the containers could be shortened and the value of the containers reduced.
We rely on our information technology systems to conduct our business. If these systems fail to adequately perform these functions, or if we experience an interruption in their operation, our business and financial results could be adversely affected.
The efficient operation of our business is highly dependent on two of our information technology systems: our equipment tracking system and our ‘‘Tradex’’ customer interface system. For example, these systems allow customers to place pick-up and drop-off orders on the Internet, view current inventory and check contractual terms in effect with respect to any given container lease agreement. We correspondingly rely on such information systems to track transactions, such as repairs and changes to book value, and movements associated with each of our owned or managed containers. We use the information provided by these systems in our day-to-day business decisions in order to effectively manage our lease portfolio and improve customer service. The failure of these systems to perform as we anticipate could disrupt our business and results of operation and cause our relationships with our customers to suffer. In addition, our information technology systems are vulnerable to damage or interruption from circumstances beyond our control, including fire, natural disasters, power loss and computer systems failures and viruses. Any such interruption could have a material adverse effect on our business.
A number of key personnel are critical to the success of our business.
Most of our senior executives and other management-level employees have been with us for over ten years and have significant industry experience. We rely on this knowledge and experience in our strategic planning and in our day-to-day business operations. Our success depends in large part upon our ability to retain our senior management, the loss of one or more of whom could have a material adverse effect on our business. Our success also depends on our ability to retain our experienced sales force and technical personnel as well as recruiting new skilled sales, marketing and technical personnel. Competition for these persons in our industry is intense and we may not be able to successfully recruit, train or retain qualified personnel. If we fail to retain and recruit the necessary personnel, our business and our ability to obtain new customers and provide acceptable levels of customer service could suffer.
The international nature of the container industry exposes us to numerous risks.
Our ability to enforce the end users' obligations under the leases and other arrangements for use of the containers will be subject to applicable law in the jurisdiction in which enforcement is sought. As the containers are predominantly located on international waterways, it is not possible to predict, with any degree of certainty, the jurisdictions in which enforcement proceedings may be commenced. For example, repossession from defaulting lessees may be difficult and more expensive in jurisdictions whose laws do not confer the same security interests and rights to creditors and lessors as those in the United States and in jurisdictions where recovery of equipment from the defaulting lessee is more cumbersome. As a result, the relative success and expedience of enforcement proceedings with respect to the containers in various jurisdictions also cannot be predicted.
We are also subject to risks inherent in conducting business across national boundaries, any one of which could adversely impact our business. These risks include, but are not limited to:
Any one or more of these factors could impair our current or future international operations and, as a result, harm our overall business.
As a U.S. corporation, we are subject to the Foreign Corrupt Practices Act, and a determination that we violated this act may affect our business and operations adversely.
As a U.S. corporation, we are subject to the regulations imposed by the Foreign Corrupt Practices Act (FCPA), which generally prohibits U.S. companies and their intermediaries from making improper payments to foreign officials for the purpose of obtaining or keeping business. Any determination that we have violated the FCPA could have a material adverse effect on us.
The lack of an international title registry for containers increases the risk of ownership disputes.
Pursuant to the terms of the Acquisition, the seller represented and warranted to us that Trans Ocean and TAL International Corporation had good and marketable title to the containers they
purported to own and valid leasehold interests in containers they purported to lease. However, there is no internationally recognized system of recordation or filing to evidence Trans Ocean's and TAL International Corporation's title to the containers. The lack of a title recordation system with respect to the containers could result in disputes with creditors of prior owners of Trans Ocean and TAL International Corporation or the containers owned or leased-in from time to time, or creditors of the end users.
We may incur costs associated with new security regulations.
We may be subject to regulations promulgated in various countries, including the United States, seeking to protect the integrity of international commerce and prevent the use of containers for international terrorism or other illicit activities. For example, the Container Safety Initiative, the Customs-Trade Partnership Against Terrorism and Operation Safe Commerce are among the programs administered by the U.S. Department of Homeland Security that are designed to enhance security for cargo moving throughout the international transportation system by identifying existing vulnerabilities in the supply chain and developing improved methods for ensuring the security of containerized cargo entering and leaving the United States. Moreover, the International Convention for Safe Containers, 1972 (CSC), as amended, adopted by the International Maritime Organization, applies to new and existing containers and seeks to maintain a high level of safety of human life in the transport and handling of containers by providing uniform international safety regulations. As these regulations develop and change, we may incur increased compliance costs due to the acquisition of new, compliant containers and/or the adaptation of existing containers to meet any new requirements imposed by such regulations. Additionally, certain companies are currently developing or may in the future develop products designed to enhance the security of containers transported in international commerce. Regardless of the existence of current or future government regulations mandating the safety standards of intermodal shipping containers, our competitors may adopt such products or our customers may require that we adopt such products in the conduct of our container leasing business. In responding to such market pressures, we may incur increased costs, which could have a material adverse effect on our financial condition and results of operations.
Terrorist attacks could negatively impact our operations and our profitability and may expose us to liability.
Terrorist attacks may negatively affect our operations. Such attacks have contributed to economic instability in the United States and elsewhere, and further acts of terrorism, violence or war could similarly affect world trade and the industries in which we and our customers operate. In addition, terrorist attacks or hostilities may directly impact ports our containers come in and out of, depots, our physical facilities or those of our suppliers or customers and could impact our sales and our supply chain. A severe disruption to the worldwide ports system and flow of goods could result in a reduction in the level of international trade and lower demand for our containers. The consequences of any terrorist attacks or hostilities are unpredictable, and we may not be able to foresee events that could have an adverse effect on our operations.
It is also possible that one of our containers could be involved in a terrorist attack. Although our lease agreements require our lessees to indemnify us against all damages arising out of the use of our containers, and we carry insurance to potentially offset any costs in the event that our customer indemnifications prove to be insufficient, we may not be fully protected from liability arising from a terrorist attack which utilizes one of our containers.
Environmental liability may adversely affect our business and financial situation.
We are subject to federal, state, local and foreign laws and regulations relating to the protection of the environment, including those governing the discharge of pollutants to air and water, the management and disposal of hazardous substances and wastes and the cleanup of contaminated sites. We could incur substantial costs, including cleanup costs, fines and third-party claims for property damage and personal injury, as a result of violations of or liabilities under environmental laws and
regulations in connection with our current or historical operations. Under some environmental laws in the United States and certain other countries, the owner of a leased container may be liable for environmental damage, cleanup or other costs in the event of a spill or discharge of material from a container without regard to the owner's fault. While we maintain certain insurance relating to both on-hire and off-hire containers and require lessees to obtain similar insurance and to provide us with indemnity against certain losses, such insurance and indemnities may not cover or be sufficient to protect us against losses arising from environmental damage. Under the terms of the stock purchase agreement in respect of the Acquisition, the seller is obligated to indemnify us for certain environmental liabilities relating to the operation of the business prior to our acquisition. This indemnification, however, may not be sufficient to reimburse us for all losses relating to environmental liabilities.
Many countries, including the United States, restrict, prohibit or otherwise regulate the use of chlorofluorocarbon compounds (‘‘CFCs’’) due to their ozone depleting and global warming effects. CFCs have historically been used in the manufacture and operation of older refrigerated containers, including some containers purchased in the past by Trans Ocean and TAL International Corporation, which we acquired in the Acquisition and which are currently used in approximately 3% of our refrigerated containers. Regulation of CFCs or other refrigerants may become stricter in the future. Market pressure or government regulation of refrigerants and synthetic insulation materials may require refrigerated containers using non-conforming substances to be retrofitted with non-CFC refrigerants at substantial cost to us. The replacement refrigerant used in our new refrigerated containers also may become subject to similar market pressures or governmental regulation. In addition, refrigerated containers that are not retrofitted may command lower prices in the market for used containers once we retire these containers from our fleet.
Certain liens may arise on our containers.
Depot operators, repairmen and transporters may come into possession of the containers from time to time and have sums due to them from the lessees or sublessees of the containers. In the event of nonpayment of those charges by the lessees or sublessees, we may be delayed in, or entirely barred from, repossessing the containers, or be required to make payments or incur expenses to discharge such liens on the containers.
Fluctuations in foreign exchange rates could reduce our profitability.
The majority of our revenues and costs are billed in U.S. dollars. Most of our non-U.S. transactions are individually of small amounts and in various denominations and thus are not suitable for cost-effective hedging. In addition, almost all of our container purchases are paid for in U.S. dollars.
Our operations and used container sales in locations outside of the U.S. have some exposure to foreign currency fluctuations, and trade growth and the direction of trade flows can be influenced by large changes in relative currency values. Adverse or large exchange rate fluctuations may negatively affect our results of operations and financial condition.
In 2005, the government of China implemented a plan to change the currency peg for the Chinese Yuan Renimbi to a basket of currencies rather than just the U. S. Dollar. In addition, the government of China announced an intention to allow the value of the Yuan Renimbi to appeciate about 3% versus the U. S. Dollar. Since the amount of our revenues and expenses denominated in Yuan Renimbi is quite small relative to our overall revenue and expenses, we expect that the direct effects to us of the announced devaluation will be limited.
Increases in the cost of or the lack of availability of insurance could increase our risk exposure and reduce our profitability.
Our lessees and depots are required to maintain all risks physical damage insurance, comprehensive general liability insurance and to indemnify us against loss. We also maintain our own contingent liability insurance and off-hire physical damage insurance. Nevertheless, lessees and depots
insurance or indemnities and our insurance may not fully protect us. The cost of such insurance may increase or become prohibitively expensive for us and our customers and such insurance may not continue to be available.
We also maintain director and officer liability insurance. The Sarbanes-Oxley Act of 2002 and new regulations of the New York Stock Exchange may make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to incur substantial costs to maintain increased levels of coverage or it may not continue to be available.
Other Risks Related to our Business
We are a ‘‘controlled company’’ within the meaning established by the New York Stock Exchange and, as a result, qualify for, and intend to rely on, exemptions from certain corporate governance requirements.
The Resolute Fund, L.P., its affiliated funds and the other parties to a shareholders agreement among the investors who acquired our company in November 2004, as well as management and certain of our other shareholders, as a group, control a majority of our outstanding common stock, and, as a result, we are considered a ‘‘controlled company’’ within the meaning of the corporate governance standards of the New York Stock Exchange. Under these rules, a ‘‘controlled company’’ is exempt from complying with certain corporate governance requirements, including (1) the requirement that a majority of the board of directors consist of independent directors, (2) the requirement that we have a nominating/corporate governance committee that is composed entirely of independent directors and (3) the requirement that we have a compensation committee that is composed entirely of independent directors. As a result, our board of directors does not consist of a majority of independent directors nor does our board of directors have compensation and nominating/corporate governance committees consisting entirely of independent directors. Accordingly, investors do not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance requirements of the New York Stock Exchange.
Our strategy to selectively pursue complementary acquisitions may present unforeseen integration obstacles or costs.
We may selectively pursue complementary acquisitions and joint ventures. Acquisitions involve a number of risks and present financial, managerial and operational challenges, including:
In addition, we may encounter unforeseen obstacles or costs in the integration of acquired businesses. Also, the presence of one or more material liabilities of an acquired company that are unknown to us at the time of acquisition may have a material adverse effect on our business. Our acquisition and joint venture strategy may not be successfully received by customers, and we may not realize any anticipated benefits from acquisitions or joint ventures.
We have a substantial amount of debt outstanding on a consolidated basis and have significant debt service obligations which could adversely affect our financial condition or our ability to fulfill our obligations and make it more difficult for us to fund our operations.
We have a significant amount of debt outstanding on a consolidated basis. As of December 31, 2005, we have outstanding indebtedness of $858.0 million under our asset securitization facility and our senior secured credit facility. In addition, we have a capital lease obligation in the amount of $14.6 million. Our interest and debt expense for the fiscal year ended December 31, 2005 was $72.4 million. As of December 31, 2005, the percentage of our total debt to total assets was 67%.
Our substantial debt could have important consequences for investors, including the following:
We may not generate sufficient revenues to service and repay our debt and have sufficient funds left over to achieve or sustain profitability in our operations, meet our working capital and capital expenditure needs or compete successfully in our markets.
Despite our substantial leverage, we and our subsidiaries will be able to incur additional indebtedness. This could further exacerbate the risks described above.
We and our subsidiaries may be able to incur substantial additional indebtedness in the future. Although our senior secured credit facility and our asset securitization facility contain restrictions on the incurrence of additional indebtedness, such restrictions are subject to a number of qualifications and exceptions, and, under certain circumstances, indebtedness incurred in compliance with such restrictions could be substantial. To the extent that new indebtedness is added to our and our subsidiaries' current debt levels, the risks described above would increase.
We will require a significant amount of cash to service and repay our outstanding indebtedness and our ability to generate cash depends on many factors beyond our control.
Our ability to make payments on and repay our indebtedness and to fund planned capital expenditures will depend on our ability to generate cash in the future.
We cannot assure investors that:
Financial, business, economic and other factors, many of which we cannot control, will affect our ability to generate cash in the future and to make these payments.
If we cannot generate sufficient cash from our operations to meet our debt service and repayment obligations, we may need to reduce or delay capital expenditures, the development of our business generally and any acquisitions. In addition, we may need to refinance our debt, obtain additional financing or sell assets, which we may not be able to do on commercially reasonable terms or at all.
Our senior secured credit facility and asset securitization facility impose significant operating and financial restrictions, which may prevent us from pursuing certain business opportunities and taking certain actions.
Our senior secured credit facility and asset securitization facility impose, and the terms of any future indebtedness may impose, significant operating, financial and other restrictions on us and our subsidiaries. These restrictions will limit or prohibit, among other things, our ability to:
These restrictions could adversely affect our ability to finance our future operations or capital needs and pursue available business opportunities. A breach of any of these restrictions could result in a default in respect of the related indebtedness. If a default occurs, the relevant lenders could elect to declare the indebtedness, together with accrued interest and fees, to be immediately due and payable and proceed against any collateral securing that indebtedness, which will constitute substantially all of our material container assets.
The price of our common stock may be highly volatile and may decline regardless of our operating performance.
The trading price of our common shares is likely to be subject to wide fluctuations. Factors affecting the trading price of our common shares may include:
In addition, if the market for comparable company stocks or the stock market in general experiences loss of investor confidence, the trading price of our common shares could decline for reasons unrelated to our business or financial results. The trading price of our common shares might also decline in reaction to events that affect other companies in our industry even if these events do not directly affect us.
We do not expect to pay any dividends in the foreseeable future.
We do not anticipate paying any cash dividends to holders of our common stock in the foreseeable future. In addition, our senior secured credit facility and asset securitization facility include restrictions on our ability to pay cash dividends. Agreements governing future indebtedness will likely contain similar restrictions on our ability to pay cash dividends. Consequently, investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investment.
We are uncertain of our ability to obtain additional financing for our future capital needs.
We believe that cash from operations and existing cash, together with available borrowings under our senior secured credit facility and asset securitization facility will be sufficient to meet our working capital, capital expenditure and expense requirements for at least the next twelve months. However, we may need to raise additional funds in order to fund our business, expand our sales activities, develop new or enhance existing products and/or respond to competitive pressures. Additional financing may not be available on terms favorable to us, or at all.
If securities analysts do not publish research or reports about our business or if they downgrade our stock, the price of our stock could decline.
The trading market for our common shares relies in part on the research and reports that industry or financial analysts publish about us or our business. We do not control these analysts. Furthermore, if one or more of the analysts who do cover us downgrades our stock, the price of our stock could decline. If one or more of these analysts ceases coverage of our company, we could lose visibility in the market, which in turn could cause our stock price to decline.
Implementation of required public company corporate governance and financial reporting practices and policies increases our costs significantly and require our management to devote substantial time to comply therewith and we may be unable to provide the required financial information in a timely and reliable manner.
As a newly public company, we incur significant legal, accounting and other expenses that we did not incur as a private company. The Sarbanes-Oxley Act of 2002, as well as new rules subsequently implemented by the Securities and Exchange Commission and the New York Stock Exchange, have imposed various new requirements on public companies, including changes in corporate governance practices. Our management and other personnel need to devote a substantial amount of time to these new requirements. Moreover, these rules and regulations increase our legal and financial compliance costs and make some activities more time-consuming and costly. For example, these new rules and regulations make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to incur substantial costs to maintain increased levels of coverage.
In addition, the Sarbanes-Oxley Act of 2002 requires, among other things, that we maintain effective internal controls for financial reporting and disclosure controls and procedures. In particular, commencing in fiscal 2006, we must perform system and process evaluation and testing of our internal controls over financial reporting to allow management and our independent registered public accounting firm to report on the effectiveness of our internal controls over financial reporting. Our management may not be able to timely and effectively implement controls and procedures that adequately respond to these increased regulatory and reporting requirements. While we currently have an internal audit function, we will need to hire additional accounting and financial staff with appropriate public company experience and technical accounting knowledge. Moreover, if we are not
able to comply with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 in a timely manner, or if we or our independent registered public accounting firm identify deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses, we could suffer a loss of investor confidence in the reliability of our financial statements, the market price of our stock could decline and we could be subject to sanctions or investigations by the New York Stock Exchange, the Securities and Exchange Commission or other regulatory authorities. Any failure by us to timely implement these required public company corporate governance and financial reporting practices and policies could materially and adversely impact our financial condition and results of operation and the price of our common stock.
Adverse changes in business conditions could negatively impact our income tax provision or cash payments.
Our deferred tax liability balance includes a deferred tax asset for U.S. federal and various states resulting from net operating loss carryforwards. A reduction to our future earnings, which will lower taxable income, may require us to record a tax charge against earnings, in the form of a valuation allowance, if it is determined it is more-likely-than-not that some or all of the loss carryforwards will not be realized.
In addition, under certain conditions, if our future investment in new containers and chassis is significantly less than estimated, we may fail to benefit from future accelerated depreciation for income tax purposes, resulting in taxable income being greater than our reported book income. If this occurs we could become a cash taxpayer sooner than we currently project.
ITEM 1B. UNRESOLVED STAFF COMMENTS
ITEM 2. PROPERTIES
Office Locations. As of December 31, 2005, our employees are located in 19 offices in 12 different countries. We have seven offices in the U.S. including our headquarters in Purchase, New York. We have 12 offices outside the U.S. We lease all of our office space. In addition, we have agents dedicated to our business in South Korea.
The following table summarizes the facilities we leased as of December 31, 2005:
Office Location—U.S. Properties
Office Location—International Properties
ITEM 3. LEGAL PROCEEDINGS
From time to time we are a party to litigation matters arising in connection with the normal course of our business. While we cannot predict the outcome of these matters, in the opinion of our management, any liability arising from these matters will not have a material adverse effect on our business. Nevertheless, unexpected adverse future events, such as an unforeseen development in our existing proceedings, a significant increase in the number of new cases or changes in our current insurance arrangements could result in liabilities that have a material adverse impact on our business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On October 5, 2005, upon unanimous written consent, our stockholders authorized the following:
Our common stock has been traded on the New York Stock Exchange under the symbol ‘‘TAL’’ since October 2005. Prior to that time, there was no public market for our common stock.
On March 1, 2006, the closing price of the common stock was $21.55, as reported on the New York Stock Exchange. On that date, there were approximately 36 holders of record of the common stock and approximately 493 beneficial holders, based on information obtained from the Company’s transfer agent.
As reported on the New York Stock Exchange, the high and low sales prices for our common stock during our fiscal quarter ending December 31, 2005 were $20.89 per share and $17.05 per share, respectively.
Initial Public Offering
On October 17, 2005, we sold 11.5 million shares of our common stock at a price of $18.00 per share in an initial public offering (‘‘IPO’’) which generated net proceeds of approximately $189.2 million, after deducting underwriter discounts and other offering expenses. We used the net proceeds of this offering, together with additional borrowings under an asset securitization facility and an amended and restated senior secured credit facility and available cash, to repay the entire outstanding principal and accrued cash interest due on our then outstanding senior unsecured credit agreement which was approximately $288.0 million on October 17, 2005. Related to the IPO, the following activities also occurred:
On October 21, 2005, the underwriters, in connection with our IPO, exercised their over-allotment option in part to purchase 1.0 million additional shares of common stock from certain of our stockholders. We did not receive any proceeds from the sale of the shares pursuant to the over-allotment option. The underwriters waived their rights with respect to the remaining 725,000 shares of common stock covered by the over-allotment option.
We have never paid cash dividends on our common stock, and did not repurchase any of our shares during fiscal 2005. Any future declaration and payment of dividends will be subject to the
discretion of our Board of Directors, will be subject to applicable law, and will depend on our results of operations, earnings, financial condition, contractual limitations, cash requirements, future prospects, and other factors deemed relevant by the Board of Directors. The Board of Directors has no current intention of paying any cash dividends on our common stock. In addition, certain provisions of our senior secured credit facility and asset securitization facility restrict our ability to pay dividends or make other distributions on our common stock.
Share Repurchase Program
On March 13, 2006, our Board of Directors authorized a stock buyback program for the repurchase of up to 1,500,000 shares of our common stock. Stock repurchases under this program may be made through open market and privately negotiated transactions at times and in such amounts as a committee of our Board of Directors deems appropriate. The timing and actual number of shares repurchased will depend on a variety of factors including price, corporate and regulatory requirements, restrictions regarding a repurchase program included in our credit facilities and other market conditions. The stock repurchase program does not have an expiration date and may be limited or terminated by the Board of Directors at any time without prior notice.
Unregistered Sales of Equity Securities
The following sets forth information regarding unregistered securities sold by us in 2005.
In April 2005, we sold 53,667 shares of our common stock and 1,205 shares of our Series A 12.0% cumulative senior preferred stock for an aggregate offering price of $1,205,529 to certain of our managers and other employees.
In connection with our initial public offering, in October 2005, all 201,205 then outstanding shares of our Series A 12.0% cumulative senior preferred stock were converted into 11,178,035 shares of our common stock. We received no proceeds from this conversion.
In 2005, we granted options to purchase (i) 53,667 shares of common stock under our 2004 Management Stock Plan which have an exercise price of approximately $0.01 per share and (ii) 612,195 shares of common stock under our 2005 Management Omnibus Incentive Plan which have an exercise price equal to our initial public offering price of $18.00 per share. No shares of common stock have been issued upon exercise of any of these options. All options were granted under Rule 701 promulgated under the Securities Act or, in the case of employees who are officers or directors of us or are accredited investors, Section 4(2) of the Securities Act.
There were no underwriters employed in connection with any of the transactions set forth above. The recipients of securities in each such transactions represented their intention to acquire the securities for investment only and not with a view to any distribution thereof. Appropriate legends were affixed to the share certificates and other instruments issued in such transactions. All recipients were given the opportunity to ask questions and receive answers from our representatives concerning our business and financial affairs. Each of the recipients that were employees of TAL had access to such information through their employment with TAL.
Securities Authorized for Issuance Under Equity Compensation Plans
Our Equity Compensation Plan Information table is incorporated by reference to our Proxy Statement, which will be filed with the Securities and Exchange Commission no later than 120 days after the close of the Company’s fiscal year ended December 31, 2005.
The following table sets forth certain selected historical financial, operating and other data of TAL International Group, Inc. (the ‘‘Successor’’) and Trans Ocean and certain operations of TAL International Container Corporation on a combined basis (collectively, the ‘‘Predecessor’’). The summary historical consolidated statement of operations data, balance sheet data and other financial
data for the fiscal year ended December 31, 2005 and for the two months ended December 31, 2004 were derived from the Successor's audited consolidated financial statements and related notes appearing elsewhere in this Form 10-K. The summary historical combined consolidated statement of operations data, balance sheet data and other financial data for the ten months ended October 31, 2004 and for the years ended December 31, 2003 (appearing elsewhere in this Form 10-K), 2002 and 2001 were derived from the Predecessor’s audited combined consolidated financial statements and related notes. The historical results are not necessarily indicative of the results to be expected in any future period.
All actual common share and per share data have been adjusted to retroactively reflect the 101.5052-to-1 stock split that occurred on October 5, 2005.
The statements in this discussion regarding industry outlook, our expectations regarding our future performance, liquidity and capital resources and other non-historical statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described under ‘‘Risk Factors’’ and ‘‘Forward-Looking Statements’’ as discussed eslewhere in this Form 10-K. Our actual results may differ materially from those contained in or implied by any forward-looking statements.
We are one of the world's largest and oldest lessors of intermodal freight containers. Intermodal freight containers are large, standardized steel boxes used to transport freight by ship, rail or truck. Because of the handling efficiencies they provide, intermodal freight containers are the primary means by which many goods and materials are shipped internationally.
Our operations include the acquisition, leasing, re-leasing and subsequent sale of multiple types of intermodal containers, as well as chassis used for the transportation of containers domestically via rail and roads. As of December 31, 2005, our fleet consisted of 613,911 containers and chassis, including
76,830 containers under management for third parties, representing approximately 988,000 twenty-foot equivalent units (TEU). We have an extensive global presence, offering leasing services through 19 offices in 12 countries and approximately 194 third party container depot facilities in 42 countries as of December 31, 2005. Our customers are among the world's largest shipping lines and include, among others, APL-NOL, CMA-CGM, Hanjin Shipping, Maersk Line, Mediterranean Shipping Company and NYK Line.
We lease three principal types of containers: (1) dry freight containers, which are used for general cargo such as manufactured component parts, consumer staples, electronics and apparel, (2) refrigerated containers, which are used for perishable items such as fresh and frozen foods, and (3) special containers, which are used for heavy and oversized cargo such as marble slabs, building products and machinery. We also manage our own container disposals, act as the disposal agent for a number of our shipping line customers, and buy and sell used containers through our Trader group. As of December 31, 2005, dry, refrigerated, special containers and Trader represented approximately 85%, 6%, 7% and 2% of our fleet on a unit basis, respectively. Our chassis equipment, which was purchased in the fourth quarter of 2005, represented under 1% of our fleet on a unit basis as of December 31, 2005.
The following tables provide the composition of our equipment fleet as of the dates indicated below (in both units and TEU’s):
We lease our containers on a per diem basis to our customers under three types of leases: long-term leases, service leases and finance leases. Long-term leases, typically with terms of three to eight years, provide us with stable cash flow and low transaction costs by requiring customers to maintain specific containers on-hire for the duration of the lease. Service leases command a premium per diem rate in exchange for providing customers with a greater level of operational flexibility by allowing the pick-up and drop-off of containers during the lease term. Finance leases, which are typically structured as full payout leases, provide for a predictable recurring revenue stream with the lowest daily cost to the customer because customers are generally required to retain the container for the duration of its useful life. As of December 31, 2005, approximately 89% of our containers were
on-hire to customers, with approximately 59% of our containers on long-term leases, approximately 26% on service leases or long-term leases whose fixed terms have expired but for which the related units remain on-hire and for which we continue to receive rental payments, and approximately 4% on finance leases. In addition, approximately 8% of our containers were available for lease and approximately 3% were available for sale.
The following table provides a summary of our lease portfolio, based on units in the fleet as of the dates indicated below:
Our profitability is primarily determined by the extent to which our leasing and other revenues exceed our ownership, operating and administrative expenses. Our profitability is also impacted by the gain or loss that we realize on the sale of our used containers.
Operating conditions in 2005 were generally favorable. Growth in world containerized trade has created strong demand for containers for the last several years, and this, combined with the high percentage of our containers on long-term lease has resulted in high utilization for our container fleet. In addition, prices for new containers were high for most of 2004 and 2005, leading to increased market leasing rates and increasing leasing average rates for our dry container product line. Strong demand for used containers in North America and Europe and high prices for new containers also allowed us to achieve high average sale prices for our used containers.
However, while overall conditions remain favorable, our fleet size and utilization were negatively impacted in the second half of 2005 by a build up of excess inventory of new containers in China. In 2005, many leasing companies and shipping lines placed large container orders in the first half of the year due to expectations for continued strong growth in world trade. While growth in overall container liftings is estimated by Clarkson to have been over 10% in 2005, it is our understanding that most shipping lines achieved an unexpected improvement in operating efficiency in 2005 which allowed them to accomodate much of their volume growth with minimal increases in the size of their operated container fleets. We believe that this improved efficiency was mainly a result of a reduction in the congestion that slowed operations at North American and European ports and caused rail delays in 2004. The combination of large orders in the first half of 2005 and the improvement in our customers’ operating efficiency resulted in a substantial build-up of new container inventories by mid year. We estimate that at the peak of the build-up during the summer of 2005, there were over 800,000 TEU of new containers available at container factories in China.
The following table sets forth our average container fleet utilization for the years ended December 31, 2005, 2004 and 2003: