Octave Specialty Group Inc (OSG) 2003 Q4 法說會逐字稿

Welcome to the Overseas Shipholdings Group fourth quarter and year-end 2003 earnings conference call. During the presentation all participants will be in a listen-only mode. Afterwards, we will conduct a question and answer session. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded Thursday, February 12, 2004. I would now like to turn the conference over to Mr. Bob Cowen, Senior Vice President and Chief Operating Officer.

Good morning. This conference call may include forward-looking statements regarding the Company's prospects, including the outlook for tanker markets, changing oil trading patterns, prospects for certain strategic alliances, anticipated levels of new building and scrapping, and the forecast of world economic activity and world oil demand. Factors, risks and uncertainties that could cause actual results to differ from expectations reflected in these forward-looking statements are described in the Company's annual report on Form 10-K.

I would now like to turn the conference call over to OSG's CEO, Morten Arntzen.

Good morning. I am joined on the call by Myles Itkin, the Chief Financial Officer; Bob Johnston (ph), the Chief Commercial Officer; Peter Swift (ph) who runs all the technical operations for OSG; and you've already heard from Bob Cowen.

Starting off, it is delightful to be able to announce record earnings for the company, over $121 million in net income last year compared to a loss of 17 million the year before, and $21 million profit in the last quarter compared to 7 the year before. These are tremendous earnings. I would like to take full credit for them, but as I joined the company on January 2nd, I think all the kudos have to go to the existing management team and the staff of OSG. Fantastic results.

We benefited in 2003 from very strong tanker rates, very strong in the first quarter, quite good rates in the second quarter. As usual, they slumped somewhat in the third quarter and then picked up again in the fourth quarter, particularly in December, and we closed the year with Aframax rates around $70,000 a day and VLCCs around $90,000 a day. The good news is that in the first two months of 2004, that strong rate environment has continued, and VLCC rates have broken through the 100,000 level from time to time. This establishes a very good earnings base for the first quarter of 2004.

Let me go through some of the highlights, some of which were in the press release. As has been the policy of OSG for really a long time, we go out in the bond market and get attractive long-term financing. We have done that. In March we concluded a 10-year, 200 million public debt offering unsecured issue. In June we (indiscernible) our shareholder space and increased the dividend by around 17 percent and, as you know, we have been paying a dividend here at OSG since 1974. In August and October, OSG entered into two senior unsecured revolving credit facilities aggregating 330 million, replacing facilities that would have expired in 2005, and on terms that were advantageous to ones that we were replacing.

On the tanker (ph) side in 2003, we took the liberty of two more of our new buildings, the Overseas Rosalyn at VL, and in February the Overseas Sophie, an Aframax tanker. And our new building program was completed when we took delivery of the Overseas Kathy (ph) last week. That is another 112,000 (indiscernible) Aframax tankers. So we will enjoy full-year earnings for the two vessels and most of the year for the Overseas Kathy. In the Aframax international pool, our very successful Aframax pool, we added two members in 2003, two very strong Italian shipping companies, and that pool continues to perform well. We did dispose of two of our older Panamax (indiscernible) carriers as part of the company's fleet modernization program.

In April OSG acquired full ownership of two VLCCs, the Meridian Lion and the Equatorial Lion, from a 50 percent joint venture partner with a major oil company. The one ship, the Equatorial Lion, remains on charter to the oil company. We also towards the end of the year completed the sale and charter back under what we think were very favorable terms of the VLCC Meridian Lion and two capesize bulk carriers.

Finally, towards the end of the year, the Company reached an agreement in principle with our joint venture partner covering six jointly-owned VLCCs and the agreement divides the six between us. We will take three of the ships on a 100 percent ownership basis. For those who are interested in names, it's the Dundee, Sakura 1 and Tanabe. And we expect that agreement to close in the first quarter of 2004. That should not have an effect on earnings as we are going from 100 percent -- from 50 percent in six to 100 percent in 3.

Let me talk a little bit about the financial profile of the Company. We closed the year with 917 million in equity and substantial liquidity. We think we have now one of the strongest balance sheets in the industry. We paid down -- reduced long-term debt by as much as 193 million last year, and as a result, the adjusted debt to capital decreased to just below 38 percent for the Company.

As most of you know, on January 13, we filed a shelf registration and then very shortly thereafter, on the 26th, we went and sold 3.2 million shares of common stock at $36.13 per share and generated net proceeds to the Company of 115 million. If you just added that 115 million to the balance sheet using year-end numbers, it gets our adjusted debt to capital just below 30. It is a very strong balance sheet, and we think that will be one of the competitive advantages for OSG going forward.

If you look now -- switching over to the future. We have now finished the fleet renewal program and we have one of the youngest, most modern fleets in the Aframax and VLCC sectors. We have taken enormous cost out of this business over the last five years, and you read (ph) about that in the past. That process is largely finished. That does not mean that we're not going to try to reduce costs where we can and that we will continue to look at that. But the Company's inward focus on getting out cost and (indiscernible) competitive is largely complete, very successful and that's reflected in the bottom line.

The technical team in Newcastle and New York has continued to perform outstandingly during this whole period. We think this is a very strong skill set for growth. We have said we are embarking now -- we have finished our fleet renewal program. We are embarking on period of disciplined growth. We will be spending less time inwardly focused and more time outwardly focused. That does mean that we are going to be chasing opportunities across the globe. We will be looking broader. We will probably be assessing more, inspecting more, but not chasing. We have the technical base on which to grow; we have the financial muscle with which to look at, in our opinion, pretty much anything that the segments we would look at have to offer; and we have a very modern fleet, so don't have a rush to have to do anything. It will be very disciplined growth, and that will become more of the focus for the Company than it has been in the past. But the accomplishments in the past will enable us to do it going forward.

I think with that -- I think I have covered most of the highlights. And I think I would rather turn it over to questions, if there are any.

(OPERATOR INSTRUCTIONS) Natasha Boyden from Sidoti & Company.

I just wanted to follow up with your assertion (ph) that you might expand into other businesses. Outside of tankers, what might you look at?

I think as we look at expansion, we will continue to look at expansion in our core tanker business; so that it certainly one of the areas. You know that we have a U.S. flag business, which is much smaller than our foreign flag business. And we think there may be opportunities for OSG in that area, and we will certainly be looking hard at that. We do have some product tankers and we might -- we will be looking at that area. It is an area we have expertise and understand and have the technical ability to grow into.

We may very well look at the chemical tanker segment, because again, we have technical expertise in that area and it is a segment we believe we have the financial profile and technical profile to go after. We will be looking at the L&D (ph) segment. It is a natural segment for OSG to go into, and are actually doing a fair amount of work with that over the last six months. We are not going to go far afield. We are not going be going into non-shipping areas for the time being. We are going to focus on growing (ph) those shipping areas that play into our existing technical and financial strengths. And the only other part of that is extreme customer focus. Does that answer your question?

Yes, it does. Just in terms of the domestic business, I know that the OSG fleet is fairly old, as is most of the U.S. fleet. Would you be looking at actually doing new builds in the domestic market or do you see some kind of assets out there that you could purchase?

I think the answer is both. We are always studying the new building markets, both for U.S. flag and for foreign flat. We don't have any immediate plans to contract in new buildings in the U.S. But we're certainly not ruling it out and we are certainly following what is possible. I think that in the short-run, it is more likely that it would involve ships' conversions, other businesses.

Okay. Moving on to the rates. Obviously, they have been very high this first quarter. I was wondering if you could just give us a sense of what you're seeing for the first quarter. And then, as you mentioned, for last year in the second quarter, the rates stayed fairly high. Do you think that could happen again in the second quarter? Are there any kind of drivers that would do that or do you expect the seasonality to kick in?

Predicting rates in the tanker market is beyond my skills. I think our expectation is that rates -- the rate pattern you have seen in the last three, four years of extreme volatility in rates, but on average, rates are better than the preceding ten years, we think is likely to be the scenario for this year. But you could see very dramatic movements in rates -- falls of 50 percent in a month and increases of the 50 percent in a month. But on average, still an overall attractive rate environment across the year. We would expect rates to be softer in a summer months than in the winter, and we would expect probably the fourth quarter to be stronger than the third quarter for that reason.

But very volatile. There is a lot of exogenous factors you can't really predict. Port congestion in China, congestion in the Bosporus, what happens with the pipeline in Iraq -- things like that. Right now, all those are helping to support rates. Those will be addressed at varying speeds or may not be addressed across the year. Generally, a positive rate environment but very volatile.

I wondered if there is any update on the tax legislations that would affect OSG? Is there any update on that?

I am going to turn that over to Bob Cowen, because has been following that day-to-day here.

The tax legislation, as you know, has been introduced in a much wider bill by Chairman Thomas of the Ways and Means Committee. It's a broad foreign tax bill, and there are many pulls and tugs on the movement of that tax legislation forward. So it is really not possible to predict. I would just say that we continue to be pleased that there is a lot of support to correcting the tax situation for people in OSG's position so that we are on competitive footing, and we are pleased with that support, and we would hope that it would continue to receive good consideration in Washington.

Thank you very much.

Justin Fisher (ph) from Goldman Sachs.

Can you break down the percentage of your fleet that is on time charters versus the percentage of your fleet that operates in the spot market?

Approximately by vessel count, 20 percent is on time and (indiscernible) charter.

What type of ship is that mostly?

Substantially, U.S. flag crude carriers.

If you had to raise more money in order to make an acquisition, do you have a preference of whether you would use equity or debt to do so?

That's a difficult question to answer. I think we have emphasized that the balance sheet looks very strong now. I think interest rate levels are attractive. It would really depend on the nature of the acquisition, the amount of risk we were taking on. Is it more likely that we would go out and raise debt now than more equity? I think that is likely, but it really depends on the nature of the acquisition and the amount of risk we would be taking on. We are comfortable we can take on quite a bit more debt now if we needed to.

So if there was a larger acquisition, then you would be more likely to use one or the other?

Probably.

Okay. Great, thank you. Congratulations on the good quarter.

Oliver Korlet (ph) from Jefferies.

Congratulations on a good quarter there. I have a capital of questions. Following up on the question about the time charter versus the spot allocation, do you have any plans to change that or are you going to continue to be mostly in the spot market going forward?

I think we are constantly looking for what the possibilities are for longer-term deployment (ph) for the tankers. But there really has not been much that has been particularly attractive over the last six or nine months. We will continue to look at it, we will assess that. But unlike the dry bulk market where there have been very attractive long-term charter deals available, that has not been the case with tankers. But if tanker rates do move up and we can lock in some longer-term rates, we absolutely will consider it.

What kind of rates do you see offered in that market (indiscernible) to tanker --?

I'll tell what sort of the thinking would be. If you look back over the last four years -- and I have already said we think the next four years will probably look -- the next year will look more like the last four years than the last 10 -- if people were offering us rates that were below that four-year average, we wouldn't find that interesting. That average the last four years is probably in the 33 to 35 range on TC (ph) basis. If we start seeing offers of longer-term charters reasonably above that, we would give it serious consideration. But so far, that has not been the case.

Okay. Just a housekeeping question or two. Could you break out the revenue expenses from your income statement into the investment expenses, charter hire and depreciation and amortization?

For the full year, (indiscernible) expenses nearly 90 million; time and (indiscernible) charter hire expenses, 20 million; D&A, 90 million; G&A, a little under 40 million.

The G&A just for the fourth quarter seems to take a bit of a jump there. Can you explain that?

The bulk of that -- more than 50 percent of that can be explained by the severance arrangements with certain senior executives, the former CEO, among others -- and that is the bulk of the increase. That shouldn't be recurring.

What about drydocking for the coming year and capital spending. Can you give us some idea?

As far as capital expenditure is concerned, we have completed our capital program with the payment of a little over $8 billion for the Overseas Kathy. And our average drydock CAPEX has been in the 13 odd million dollar area.

Okay. On the capital construction fund, what exactly is your plan about that hoard (ph). What are the guidelines on what might happen with that?

We currently have a program registered with MERED (ph) that would direct us towards the construction of three product carriers.

Thank you very much.

John Chippo (ph) from JP Morgan.

Good morning. Morton, I would just like to hear your opinion on asset prices, where they stand right now. Obviously, consolidation is a primary, top-of-the-line issue for you right now. But prices have gone up precipitously the last few months. Can you just give us some feedback on what you see sort the asset prices now versus historical levels?

I think you probably answered your own question. The levels we are seeing -- we were inspecting a couple of ships, in fact as recently as last week. At the levels at which they are going for second-hand (ph) VLCCs are levels at which if you ever balked (ph) in the past, you would never make money. That is not criticizing the people that are paying these high levels. They may end up making money. We do think history still has some lessons to teach us with regard to when to invest and not. And these levels today of close to 90 million for 2 and 3-year-old VLCCs is high. And close to 50 million for 10-year-old doubles, we think is high but perhaps achievable.

We are not going to be chasing assets at those levels. As I said, we have gone through the fleet renewal. We have one of the youngest fleets in the business. We don't expect these levels to be sustainable for the long run, because they just aren't. And I think that is really it.

But right now, the shipping markets -- 2003 was as good a year as you have ever seen, and what you expect is that rates get bid up and that is what has happened. There is a lot of euphoria out there. But we're not going to get carried away. We will take a sober assessment of what we look at.

So when you look at the current asset prices, you would say they look more along the lines of where rates were in 2003 rather than the last four-year average?

Yes.

Okay, thank you.

Michael Perera (ph) from UBS.

My question was with respect to rates and it has already been asked and answered.

Ethan Silverman from Silver Tree Capital.

I have three questions that come from a different place. If I can ask them one at a time, I would appreciate it. Your good clients are seeing much higher prices for their own businesses. Do they have any leverage coming to you after seeing their own businesses affected by what you have to charge them?

The oil companies?

Yes.

I think the reality is even if VL rates go from $10,000 a day to $100,000 a day, the cost of that in terms of the cost per gallon at the gas pump is still a matter of cents. The second part of it is that all our competitors are similarly exposed. So most of the oil companies have been disinvesting from shipping -- not all of them. And very few have been entering into long-term charters. They all get affected by the same rates. It is different in the dry bulk sector, where the cost of freight is having a material effect upon the cost of steel, for example. But not in the main businesses we are in.

The legislation as part of a wider bill going through this year, can you characterize why that might have a higher probability of passing with your attachment as opposed to the one that didn't work last year?

I think if you go back to '86 when they changed the legislation, OSG testifies that the results of that would probably be that there would be less and less ships under U.S. company control. That has been the case. And you flash forward to 2004, there are not very many remaining large U.S. shipping companies owning these type of assets. We are probably the only one. I think that has dawned upon a lot of people in Washington, that they need to retain a strong, viable marine presence in the U,S. And I think that is the change. Things actually happened as we had forecast they would.

But in terms of the other things that are going into the bill that cover other issues, is there more of a likelihood now than what was proposed in the past last year?

Foreign tax legislation is being driven now by a World Trade Organization decision adverse to the U.S. rules in the foreign tax area that don't relate specifically to shipping. We are part of that package of different items in the foreign tax area. The reason that there is more impetus this year for foreign tax legislation is that the World Trade Organization decision adverse to the U.S. starts to bite when the EU can start introducing some countervailing duties, I believe. And we're not in a position to assess whether the effect of all these will drive the legislation forward this year.

But certainly there is more impetus generally for a foreign tax bill this year than there was last year because of this impending World Trade Organization decision. The bill last year is still pending. It is a two-year session of Congress, and that bill is still pending for the same reasons it was introduced last year.

Generally, companies take on the attitude and direction of their top management, and there has been a change there. Could you just give a color or texture of what the Company's pro forma might look like, given the change at the top, if any?

I'll try to answer that question. I think what is really funny about joining OSG is I wasn't brought in here to fix OSG or to do a (indiscernible) revolution. This was an extremely well-run company with a terrific platform. And a lot of the tough cost-cutting had been done; the fleet renewal program was practically finished. I think my coming on and taking more outward outlook has as much to do with how the Company has been evolving as it is me joining it.

I think that -- I've been 25 years in the industry and I don't know (ph) how many millions of miles I have logged traveling around the globe the last few years. So if there's (indiscernible) change. We will seek more inputs from all across the globe on possibilities for the Company. But I would call that more maybe hastening the natural evolution of the Company. I think that would be the biggest change. The platform here is very sounds. We're not going to try to change the soul of the Company. We're going to try to grow it in a smart fashion.

That is very helpful. Thanks so much.

Walter Lavalta (ph) from Passport (ph) Capital.

I had a question -- couple questions. The first one was regarding your liquidity. You might have mentioned this earlier in the call -- $770 million. Can you break that down of what it is composed of?

There is cash at year end of roughly 74 million; approximately $450 million worth of available line capacity under revolvers of five to seven year duration; and the substantial portion of the balance is the tax-effected CCF (ph).

(multiple speakers) 115 from the new equity issue.

So much more liquidity do you need at this point? You are generating significant amounts of cash flow. Unless you make an acquisition in the next quarter or two, what are you going to start doing with the cash?

That is the million dollar question. I think OSG -- we differentiate ourselves from most of the companies in the shipping industry by our scale; not all, by any means. We do want to be in a position to be able to assess whatever opportunities are out there, be they large or small. We think where we are today, we can look at most acquisitions, for example, in the industry. There are some that would require incremental amounts of debt and/or equity. But we want to be in a position to do that because then the likelihood of us finding the right situation (indiscernible) acting upon quickly will happen.

Along those lines, you mentioned that (indiscernible) prices are high. What types of owners or companies are looking to sell for reasonable prices?

I think you've seen some very big companies sell assets recently. More of the acquisitions have been, for the most part, by private companies or in a lot of cases, Germans KGs, these German tax partnerships. My guess is they would have been collectively the biggest acquirer of tanker assets, as well as other types of ship (indiscernible) classes the last -- certainly the last year and probably the last two, three years.

Regarding the seasonality, everyone talks about weak second quarter or spring. And I was wondering if you could point me to where I can see that, where I can -- what statistics I can go look at to show me that in fact tanker fixings (ph) drop, some kind of drop in the spring?

Any one of the services that provides data on the industry -- Clarksons, MSI, Marsoft, Fearnley's -- will reflect those trends. So you will see that the fixture rates follow seasonal patterns. The information is readily available and if you separately would like it, why don't you just call and we will provide it to you.

Thank you very much.

Helane Becker from the Benchmark Company.

Actually, my questions have been asked and answered.

Jin Chun from Gilford Securities.

Congratulations on 2003, gentleman. Have some more general questions. From what I can gather from your earlier answers regarding acquisitions, you would not be interested in pursuing the Teekay model in terms of expanding the services of your fleet beyond transporting crude?

I think that the acquisitions that Teekay has made would be in the segments that barely (ph) touch the ones we are in today. And the answer is we would look at them if they become available at prices that makes sense.

Okay.

Shuttle tankers certainly would be right in our back yard. Right now, we're not looking at it, but would we rule it out -- no.

That's good to hear. Also, just wanted a little more color on the commercial operation system completion. Could you elaborate with an example the benefits before and after becoming fully Web enabled now?

We use the commercial operations system to fully support the Aframax pool, which we are the manager of. What this enable all our pool partners to do is complete transparency of all of the vessels, the vessels' operations, all the voyages, all the revenue and all of the distributions. Through this complete transparency, it generates the utmost trust that we need, and they are able to see everything that happens in the entire pool for all the ships. And it has been very, very successful.

And it also would help translate into more efficient spot chartering, perhaps?

It gives you more information to make those chartering decisions, yes.

Great. Fantastic. Thank you very much.

(OPERATOR INSTRUCTIONS) Gentleman, I am not showing any further questions at this time. I will turn the conference call back to you.

I think we'll wrap up. I thank everybody for listening. Thank you for the questions. If people did have specific things they want to raise with us, please call and we will try to accommodate them with data we can give them. And look forward to 2004. Thank you very much.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.