Octave Specialty Group Inc (OSG) 2004 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Overseas Shipholding Group first quarter 2004 earnings conference call. All of the lines have been placed on a listen-only mode and the floor will be open for questions following the presentation. It is now my pleasure to introduce your host, Robert Cowen, SVP and COO. Sir, you may begin.

Thank you and 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 forecasts of world economic activity and world oil demand. Factors, risks and uncertainties that could cause actual results to differ from expectations reflecting in these forward-looking statements are described in the Company's annual report on Form 10K.

With that, I'd like to turn the conference over to our President and CEO, Morton Arntzen.

Good morning. I will walk you through some of the highlights on the results, some of the actions we've taken, a few comments on the outlook and, then, we'll turn it over to questions.

I think most of you would have seen our press release already, but I'll go over some of the key points. We reported $76m in net income for the first quarter, up 72 percent from the first quarter of 2003, or $1.99 per share. EBITDA for the first quarter was $156.4m, up 65 percent from $94m in the first quarter of 2003. I'd say a superb first quarter results following on a superb 2003.

We did report the TC rates that OSG earned in the key segments. For the VL's, that was 74.2000 a day, compared to 59.9 in the first quarter of 2003. In the Aframax's, we were up to 36,004, compared with 33,001. On the products, 19,004, compared to 15,009. It is important that you note that some of the other tanker companies reported somewhat differently than us. They simply report the "spot" rate earned by their key segments and, in our case, the V's and Aframaxes. If we just reported spot rates, those rates would be somewhat higher. These include the lended results of our spot activity, the time charter out activity, the COA and the Aframax FFAs. So, it is a blended result, nevertheless, it actually shows you that we had a superb first quarter.

On a balance sheet basis, we ended up the quarter with in excess of $1.1b in equity and almost a $1b in liquidity. That liquidity includes cash, including a tax haircut for our CCF Funds, and undrawn committed bank lines. Looking at balance sheet strength on the leverage ratio, the way we measure it, liquidity adjusted debt to capital at the end of the first quarter was 26.47 percent, down from 37.6 at year-end.

Another key metric of the balance sheet strength is the age of the fleet. If you look at our fleet and take into account the time charters-in vessels, as well as the ULCC's that we will be taking over, we think 2004 in the second quarter, the average age of our fleet is 4.8 years, compared with the world average for VLCCs of 7.9. If you look at our Aframax fleet, including the two-time charters in ships, the average age is 6.2, compared with 9.7 average age for the world fleet.

On a balance sheet basis, we have the strongest - - or, certainly, amongst the stronger - - balance sheet in the industry. We have as much liquidity, if not more liquidity, than anybody in the industry. We have one of the youngest fleets, if not the youngest fleet, in the industry. I should point out that when we talk about the age of our fleet, we are talking about our foreign fleet, we are not mixing in the U.S. Flag fleet, which is a different business. As I think most of you know, the U.S. Flag fleet, in general, is a much older fleet, both for OSG and for the industry as a whole.

So, we have a very strong balance sheet, a lot of liquidity and a very young fleet and that's where we'd like to be.

Switching over to some of the key events during the first quarter, I think the most important one was the announcement we made a couple of week's back that we have acquired, with our partner, Euronev [ph] and TI, four modern ULCCs. The three ULCCs were built in 2002 and one in 2003. They will come into our fleet, we are hoping, in the course of the spring and early summer. These ships will be in a tax-efficient joint venture and they will all trade in the TI pool along side the VLC, the 46 VLCCs that are in the pool today. It's important to understand that this is not an asset play of any sort, this is more of an operating investment. These ships will strengthen the TI pool. It will enable us to offer clients of TI, our VLCC clients, cheaper sources of transportation in alternative ways of getting long haul crude at a lower price. We believe there is a lot of upside in these ships for OSG and for TI. The current owners of the ships trade these four ships, these four VLCCs and nothing else. We will have these along side TI's fleet of 46 VLCCs. We believe that we will be able to generate COA business with them, we believe we'll be able to find back haul business for them and find new ways to trade them for our customers.

The existing owners have earned a good return, or a decent return, with these ships we believe. If we're not able to generate any of the upside trading we believe we will generate a decent return. If we're able to trade these things, you know, for clients the kind of service we believe, we believe there's a lot of upside in these ships, in addition to strengthening the TI pool. So, we're very excited about this acquisition going forward.

The second announcement that we made, which was at the end of last week, was that we had acquired two U.S. Flag product carriers. This is consistent with the strategy we talked about in the conference call last quarter where we said we would be looking at strengthening our U.S. Flag position and we have done so. These two ships, which are 7000 dead weight tons bigger than our existing two tankers, are, effectively, sister ships to the two we have. They're currently on bare-boat charters to an oil major. Those bare-boat charters, theoretically, could run to the open lives of these two vessels, if all the options are exercised. They may also come back to us at an earlier date because the oil major has the ability to do so. If the oil major keeps them for the life, we'll have a good return. If they put them back to us, we believe we'll have a better return because we believe we can earn more trading these than on the current financial arrangements. Either way, we think it's a good deal and it strengthens our U.S. Flag business.

The third thing I'll mention, and it's in the press release, which is a bit of a departure for OSG. During the first quarter, we entered into eight time charter-in arrangements, taking a 40 percent interest in two new building VLCCs for five years, one of which delivers in the fourth quarter of this year and one early in 2005. We took a 15 percent interest in the 2000 build VLCC for five years. We took a 30 percent interest in a 2003 build VLCC for two years and a 50 percent interest in two VLCCs for three years. In addition, we charted in two Aframax tankers for five years. These were all-time charter basis. The reason why you have the percentage investments in those, we do these with our partners in Aframax International and Tankers International. If you look at the equivalent ownership, the first quarter would be the equivalent of acquiring 2.25 VLCCs and one Aframax. So, if you take that activity along with the ULCCs, we've added close to 2000 operating days to OSG's fleet for the next two years. So we are taking steps to increase both the top line and the bottom line of the company.

Let me flip a little bit over to the outlook, we did mention it in the press release. As of the press release date, we had, roughly, 56 percent of this quarter for the VLs and 52 percent of the period for the Aframax, six. That number is actually somewhat better today because we've done some more fixing activity. So far, we're averaging just north of $60,000 a day for our VLCCs in the second quarter and just a tad below $30,000 a day for the Aframaxes in the second quarter. That is not as high as the first quarter, but the second quarter is almost always seasonally weaker than the first quarter, but they are numbers well in excess of what you're use to for the second quarter. So, we had a terrific first quarter, the second quarter was off to a very good start. We had the seasonal downturn, that we would have expected, a seasonal downturn we expect to continue into the third quarter and then would expect a pickup in the fourth quarter in lines with what we saw last year. So, all in all, we feel very good about the first quarter. We feel, so far, very good about the second quarter and, generally, very optimistic about the outlook for the year. We've taken some acquisition and charter-in decisions that will enhance the top line to the bottom line of the company and so we feel good about the activities we've so far been doing this year.

I think, with that I will turn it over to any questions that people have about the results, about the investments we've made and open it up.

Ladies and gentlemen, we will now begin the question and answer session. If you have a question, please press *1 on your touch tone key pad. If, at any point, your question has been answered, you may press the # key to remove yourself. We ask that you pick up your speaker phone to maximize sound quality. Again, if you do have a question, please press *1 on your touch tone key pad at this time. Please hold as we poll for questions. Your first question comes from John Chappell of J. P. Morgan.

Good morning. You seem to have left out in the press release, it's probably on purpose, the amount you're spending on the ULCCs and the U.S. Flag product carriers. There's been a lot of rumors about the ULCCs and I'm sure they're probably accurate, but can you tell us what the capital outlays are going to be for these acquisitions?

Yes. For the two product tankers we've paid, combined, $40.5m and for the ULCCs, it's $112m per ULCC.

OK.

What you saw in the broker reports out in the market was accurate.

You said the delivery will probably be late spring, early summer. Do you expect to make this entire capital outlay in the second quarter or will some of it, maybe, carry over into the third quarter depending on the delivery dates of the ULCCs?

The product tankers are already into our fleet, so we've taken those over. With the ULCCs, you can't precisely pinpoint when they will come in. We would expect at least two, if not three, to come in in the second quarter and, possibly, one this month, at the end of the month, the last one early in the third quarter. These go on very long voyages and you know the issues of that. We will get close to half a year's earnings on the ULCCs and about seven month's earnings from the product carriers, for modeling purposes.

And continuing on the modeling front, the G&A jumped in the fourth quarter and I kind of thought that was one-time issues, maybe with bonuses and whatnot, but it jumped again pretty significantly in the first quarter. Is this $13.8m the type of run-rate that we should look at going forward or are there some outstanding things there?

Miles may correct me, but $4.1m of that is the pension adjustment for settling the pension obligations to Mort Hyman. That is a one-time event. There's also some legal fees associated with the Uranus process that, I think, we've been disclosing now for quite a while. We would hope that's a one-time event, but those things can drag on. The big number was the pension adjustment that is a one-time event.

John, you can think of 8.5 as a run-rate per quarter.

Great. Two quick follow-ups at well. You mentioned that you have two ships that have already received the International Ship Certification. With less than two months to go, you still have a long way to go. I'm sure you're going to be on schedule for that, but are there any cost issues in the second quarter that go along with getting your entire fleet under the certification?

I'll let Peter Swift answer that one.

The main cost is already made. We're not going to see an increase in cost. All the spade work is done, we have all the manuals in place. We're right at the final phase and we're probably about 25 percent of the way through getting the ships completely certified at the moment.

OK. Thanks, Peter, and one last question for Morton. In the last conference call you kind of hinted at the fact that you thought that second-hand prices were probably a little bit high and newbuild as well. With all that liquidity that you have and expansion at the forefront here, what are your views presently on values of assets out there and how are you going to attack your expansion initiatives?

Well, I think, someone answered the question, we time charter it in and we enter the time charter commitments for an equivalent of 2.25 ships vis-à-vis one Aframax in the first quarter. There's been arbitrage between the charter-in rates and the acquisition rates. What is important is that not all shipping companies can avail themselves of that opportunity because they don't have the balance sheet, called the "chop", that the market will accept. OSG's name is good for five year time targets so we have that option that others may not have. We've taken advantage of that. The ULCCs were an interesting acquisition. Not every owner could do that. The ULCCs, for a stable investment for a financial buyer or a small ship owner, it's much more difficult. There's probably five or six other companies that have the kind of fleet size that you can optimally trade those. Not as much competition for those as for a VLCC in the market today. Right now, second-hand rates for VLCCs and Aframaxes that goes through the broker market are at levels that we're passing and, so, we're not chasing those. The U.S. Flag product tankers were differently, again, there's less players in that. They were on charter. If they stay on charter for their live, we make a good return. If they come back to us and we can trade them, we will make a better return.

OK. Thanks a lot.

But I will say, we are out looking at what opportunities are out there and we are open for business in that way. We're doing the work, but we're not going to chase super sky-high values.

That's fair. Thank you.

Your next question comes from Jin Chung [ph] with Dahlman, Rose, Weiss.

Good morning, gentlemen. Fabulous results. I just wanted to get this straight on the ULCC story. Basically, with this current rate environment and the dynamics of the industry, you are seeing as an attractive investment and an upside due to your relationship with Tankers International. Can you help us quantify that potential upside? What would you see as a reasonable expectation for that?

As we look to this investment and the organization has spent an enormous amount of time analyzing, analyzing every single lifting these ships have made, to try to determine what is the relationship between what an ULCC can earn - - These ULCCs can carry 3.2m barrels of oil, a VLCC can carry 2m barrels of oil. I'm not saying that is a direct guideline for the relationship in earnings. That's directionally correct. Obviously, these ships need a little bit more of our time to unload them. You lighter them in most cases, so you have to factor that into your equation. We would expect that they would earn significantly more than a VLCC if we're trading properly. The relative cargo capacity is directionally the way to look at them. It depends upon our ability to trade these things smartly and attract clients to the benefits that they have. We have some more work ahead of us, but I believe we can do that.

But is it also important that these are unique in the fact that they're the only ones out there that are young and the modern end double haul?

The only double haul ones. The last one built for these was 1981. These have a much shallower draft than the traditional ULCCs, they have a narrower beam. They, basically, can load in all the major loading ports and they can discharge in more ports than the traditionally ULCC. The traditional ULCC was, basically, go to the Gulf, come back to the U.S. with cargo and go back empty, back and forth. These will be able to do a lot more than that.

So there are no restrictions and that's what is so important in keeping all the variables into the play, the back haul? I see.

Just to make it clear, these cannot go into all the ports that the VLCC can, but we can lighter them in a whole lot of places the VLCC can.

Sufficiently, it has access to the current VLCC market?

Absolutely.

Could you give us an update on your estimated liquidity post these transactions?

We'll finance the ULCCs to the extent of 65 to 70 percent. We have used internal resources to acquire the U.S. product carriers.

Right, the fund?

No, not the capital construction fund. The capital construction fund has remained the same. We've just used cash resources.

I see. Why wouldn't you draw down from the capital construction fund?

You can't use the CCF funds today for Jones Act [ph] trades.

OK. Thank you. Once again, gentlemen, great quarter.

The floor remains open for questions at this time. If you do have a question, please press *1 on your touch tone key pad at this time. All questions will be taken in the order they are received. Our next question comes from Natasha Boyden of Sidoti and Company.

Hi, gentlemen, great quarter. Congratulations. Just a follow-up on sort of the announcements that China was going to moderate growth on our economy, we, obviously, saw some downturn across the board last week. Are you seeing anything to that extent and what's your take on that?

We're actually seeing the opposite. One of the reasons we've been able to get a number of current [inaudible] forward in this quarter is because they're going to China. That's the one thing. The ULCCs, I don't want to put too much emphasis on those, but we have discussed that with some of our Chinese clients and they believe they will be able to use these to take incremental crude into China to meet the demand which they perceive to use to grow. We are seeing nothing other than a normal seasonal downturn, but at much higher levels than we normally get with no slow down in our Chinese activity and we're a big player there.

OK. That's reassuring to hear. Also, you just mentioned that CCF fund, that you couldn't use it for Jones Act trade, is that right?

Coast-wise trading.

Coast-wise, that's make sense. Lastly, is there any update on tax situation with the issue going through Congress?

I'll let Robert Cowen answer that question.

The Senate has, again, taken up debate on a foreign tax bill as of yesterday. It is a long involved and partisan process. There are over 80 amendments that they have to address. No one can predict, that I've heard lately, when this process ends and how it ends exactly, but the Senate is debating a foreign tax bill. Our strategy has been - - we are in the House foreign tax bill - - if the bill moves in the Senate, the next question is does the House bill move. There are many reasons, primarily the World Trade Organization decision that's overhanging this that should encourage action this year on a tax bill, so we just have to wait and see what happens.

OK. Great. Then, lastly, is there any update or any issue going on with security with tankers? Is there anything going on there or are things pretty much staying as they were last quarter?

We see it much the same as the last quarter, if you look at the whole worldwide scene.

OK. Thank you very much.

Our next question comes from Justine Fisher with Goldman Sachs.

Good morning. I just have two quick questions. First of all, would you be able to give us your cash balance at the end of the quarter as opposed to the overall liquidity number? Also, I don't know if you have the number in front of you, if you have a percentage of your trade of your VLCC business that you do with China?

The cash balance is $360m. That's not including the CCF. That's just cash.

Not including the CCF, right. That's just cash and cash equivalent?

Right.

Then, the percentage of the trade that you do with the VLCCs with China?

That's a breakdown that we don't provide. I don't think we'll be providing that in the future.

Finally, would you be able to give some examples of ships that you might be able to use CCF funds to acquire in the future?

For example, in the past, we've been able to use it for non-contiguous Jones Act trades like trades from Alaska. You can use it for U.S. vessels that trade in the foreign trades, U.S. vessels that trade to Hawaii. Those are the principle ones. Also, there is currently outstanding in RFP by the government for up to five product tankers that would be part of the Maritime Security Program beginning in 2005 and that can be financed, a portion of that comes out of the owner's pocket. It can be financed, in our case, by CCF funds because these would be, again, U.S. Flag vessels that we trade foreign. You can also use it, I believe, to acquire U.S. Flag vessels that would trade foreign, for example, on the grain side, the U.S. Food Aid Program, and so on. We've been in that business for quite some time.

I think the real concept is if you take a look at, other than Alaska and Hawaii, predominantly what you're doing is U.S. to foreign and it goes across, virtually, all of the trades. It can be a crude trade, a container trade, a grain trade, car carrier.

OK. Great. Thank you so much.

Our next question is from Natasha Boyden with Sidoti and Company.

Just a follow-up question, in terms of looking into the tanker acquisition candidates and expanding your business, I think the L&G was mentioned last quarter and I was wondering, is that still an area that you're looking at or are you just focusing more now on your existing tanker business?

No, we continue to look at that segment and we don't rule out being a player in that segment. I think, long run, you all know the fundamentals of it. It is probably the highest growth area of the energy transportation markets. I'll repeat, we're not going to go in if we have to give our equity away, it's going to be on the basis that we can guarantee some return on the investment. It would with an intention to make that one of the platforms that we have here at OSG.

OK. Thanks very much.

The floor remains open for questions at this time. If you do have a question, please press *1 on your touch tone key pad at this time. Our next question is from Walter Levato [ph] of Passport Capital.

Good morning. Two questions. First, I might have missed this, have you given information on what rates you time charted in those vessels?

No, we haven't.

OK. Second, vessel prices have moved up and, arguably, are expensive. What's your view on the valuation of some of the public companies out there that could argue that they're not that expensive and, given your liquidity level being quite easy for you to absorb some of your peers, so how do you view the valuation that the market is giving?

You're giving me a question where there's personal opinion and there's corporate opinion. We look very carefully at related industries. We look at the oil field services industry and their multiples have, historically, been better than ours. If you go back in time, as they emerge from their problems, they traded a lot closer to NAV and track that and over time, as people recognize the cash-generating abilities of these companies, they gradually got re-priced. We would hope that, if the tanker industry continues to generate the kind of earnings that it has, the cash it has, that we would have a similar effect. I'm not sure I can really say much more than that. I think that if we continue what we're doing, that's the direction we're headed.

OK. We see that the industry is in the process of consolidating, in general, obviously, but it could consolidate in the public market as well?

I think consolidation in the tanker world and the shipping world, in general, will continue. You talk about some of the security measures that are necessary. These things are costly, you need infrastructure to do that and it's going to favor companies that have scale and real management processes and real management teams. That's happening. The clients want it to happen and I think it will continue.

OK. Thank you very much.

Our last question is coming from Oliver Corrolet [ph] of Jefferies and Company.

Good morning. I just have a couple of questions, again, about the ULCCs. The vessel operating expenses for those ships, we haven't really seen any comparable ones because these are [inaudible], can you give us some ballpark idea of operating expenses? Also, given the sort of increased [inaudible] potential of these huge boats, what is the insurance situation in terms of the amount of coverage and the premiums?

I'll touch on the insurance first, there's absolutely no problem insuring these. There's exactly the same cover available as there is for traditional VLCCs. The premium is slightly more because the value is slightly more, but, other than that, they're exactly the same as existing Vs.

So, the disaster portion of the coverage is how much per incident?

It's $1b, the same as it is across the whole tanker industry for everybody.

OK. On the operating expenses?

Operating expenses run approximately $7000 a day, plus dry dock.

OK. Thank you very much.

Ladies and gentlemen, there appears to be no further questions at this time. I'd like to turn the floor over to the speakers for any closing or final comments.

I think we had some very good questions. I think you have a pretty good overview of what our results were and what we have done and look forward to coming back to you in three months. If people have direct questions, they can always call us. We're here and we're available and we will try to answer those that we can. Thank you very much.

Thank you, ladies and gentlemen. This does conclude today's Overseas Shipholding Group first quarter 2004 earnings conference call. You may disconnect your lines at this time and have a great day.