Octave Specialty Group Inc (OSG) 2004 Q2 法說會逐字稿

Welcome to the Overseas Shipholding Group second-quarter 2004 earnings conference call. At this time, all participants 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 turn the floor over to your host, Robert Cowen, Senior VP and Chief Operating Officer. Sir, you may begin.

Thank you very much, and welcome. This conference call may contain forward-looking statements regarding the Company's prospects -- including the outlook for tanker markets, changing oil trading partners, 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.

With that said, I'd like to now turn the conference call over to OSG's CEO, Morten Arntzen. Morten?

Thank you, Bob. Good morning.

I will start by going through the quarter results; I'm then going to review some of the highlights of the last quarter as well as the last few weeks; I'm going to discuss our financial profile; talk a little bit about the current environment we're operating in; and then open the floor up to questions.

Starting with the results, you see in the first six months of the year, we had income of -- net income of 121.5 million. That compared with 86 million in the same period last year. And we had EBITDA for the first six months of 270 million compared with 192 million the same period last year.

Net income for the first six months of 2004 exceeded the full year income for 2003, which was 121.3 million. Obviously, that's just barely. But we can say with some pleasure that the first six months of 2004 were the best year in the Company's history.

Looking at the first quarter, net income rose to 45 million compared with 41.8 in the second quarter last year, and EBITDA rose to 113 million compared with 98 million in the second quarter last year. I think if you look at the quarter-to-quarter results, there was some improvement, obviously, compared to last year. But I think you should remember, the second quarter of last year -- which was a very good quarter -- rates benefited from a number of factors, including -- the lingering effects of the Iraqi war, the strike in Venezuela and the problems there with (indiscernible), and the Nigerian civil strike.

In the second quarter of this year and the current period, there have been no major events or exogenous factors in the world that have driven the rates up; it has been primarily driven on supply and demand. So we're quite satisfied with that result, and that gives us some comfort going into the rest of the year.

Let me switch over and talk about some of the highlights during the quarter and in the last few weeks. We talked about our acquisition -- our acquisition of the ULCCs at the last conference call. That acquisition was completed in July. We took delivery of all four ships last month, the last two this Tuesday. In that case, you know we own 49.9 percent interest in four 442,000 deadweight ton tankers. These are the largest in the world. They are double hull; three were built in 2002 and one in 2003.

When we bought these -- acquired these assets from Hellespont, we told you that we said they would be a good investment if we were able to trade them as effectively as the prior owner. However, we bought them because we believe that trading in the tankers international network, we would be able to get superior utilization of these ships and trade them more effectively for our clients.

While it's too early to tell you if we were right, the results so far are promising. The first cargo of the four vessels under the OSG and TI umbrellas was a cargo of fuel oil from Singapore -- from Rotterdam to Singapore. This is only the second time that one of these ships has carried cargo on that pattern, and it is with a new charter -- a company that has never used the ship before.

The second cargo is going to be going from the gulf of the U.S. West Coast with a traditional client of the ships. And notably, in both cases we are being paid without a discount for the extra carrying capacity of these ships. These ships carry 3.2 million barrels of oil compared with your standard fields VLCC which can carry 2 million. So while it's too early, the initial results are very promising. And if we are able to trade these things as efficiently as we do with the VLCCs, we think we will enjoy good results from them going forward.

The second thing we announced last quarter was that we were acquiring two U.S. Flag Jones Act product carriers. Those came into our fleet on April 29. They were on a bare boat (ph) charter to an oil major, which has continued that charter. And so they are now earning money in the fleet.

The third event which is important to talk a little bit about (indiscernible) the Company agreed to sell the Olympia, a 1990-built single hull VLCC, to a third-party without charter back. We sold that for a price of almost $40 million. That transaction will close this quarter, and we will recognize a $12.4 million gain from that transaction.

It's important that you understand why we did that. The way we approach our tanker business, we believe it's critical to have sufficient scale in the segments we operate so that we can take on clients and contracts and improve the utilization of the fleet. In the VLCC segment through Tankers International, and in the Aframax segment through Aframax International, we have that scale.

In Tankers International, we are the number one player in the world. In Aframax International, the Aframax segment, we are the number two player in the world. We have that scale. And in both pools, we have a core of modern double hull ships that will insure that we are always able to do that, which will give us an advantage in the market.

However, at the same time, there are ships in our fleet that either for age or technical reasons are less than optimal for our operations. The Olympia -- if some of you had checked -- is the only single hull VLCC we've wholly-owned ourselves. She was 14 years old, and we were able to take a very healthy gain by selling them in the current market. In doing so we have relieved ourselves of the residual risk on a single hull tanker, and we have taken what we think is a fairly nifty profit.

Going forward, you can expect to see us continuously monitoring the market and doing selective dispositions, as well as acquisitions, but dispositions of noncore ships. This will some cases be in the form of outright sales, such as with the Olympia; in some cases it will be sales with bare-boat or time charter back. But we will constantly be monitoring the market to see if it makes more sense to stead (ph) some of these less than optimal vessels.

The last thing that was significant in the fourth quarter in June, the final of OSG's fleet received the International Ship Security Certificate -- ISPS -- in advance of the mandatory implementation date. This process was driven by our Center of Technical Excellence in Newcastle and assisted by a U.S. flag team in New York. And it reflects OSG's continued commitment to technical excellence at sea.

Let me move on and talk a little bit about the financial profile of OSG. We believe we ended up the quarter in even better financial shape than we ended the prior quarter. Shareholders equity rose to $1.14 billion. Total cash at quarter-end, including our CCF funds, was 659 million. At the end of the quarter we had 680 million in unsecured long-term revolving credit facilities, with 470 million of available capacity in those revolvers.

In addition, in July we entered into a bilateral for a $100 million revolving credit seven-year facility unsecured, increasing our unsecured availability of funds to $570 billion. So we find ourselves at the end of the quarter, we think, in excellent financial shape; in fact, we think that distinguishes us from almost all our competitors in the tanker segment, and with the capacity to consider any size opportunity that we would encounter in the market.

Let me talk finally a little bit about the current environment for the tankers. As you've all seen, the first two quarters of this year were extremely strong for OSG and extremely strong for the industry. If you remember the third quarter of last year, it was the weakest quarter of the year and it was considerably less than the first quarter and considerably less than the second quarter. So far, the third quarter of 2004 has remained strong; indeed, it's been trending up since the end of June.

We look at the fixtures -- we've been doing on average, and what we're seeing the market doing on average, is somewhere in the 5 to $10,000 range better for VLCCs in the third quarter, and probably 2 to $3000 a day better on average for the market in the Aframax segment. So looking forward for this quarter, rates are trending up; on average they're better than the last quarter; not as good as the first quarter. And, obviously, we haven't locked in on our results, but the quarter looks promising.

What is driving those rates, I think we've talked about before -- there's been very strong demand across the globe for crude oil, both in the U.S., China, India. We believe the Chinese demand grew by approximately 20 percent in the first quarter of 2004, and we believe that worldwide demand we're projecting will grow about 3.3 or 3.4 percent for the entire year, which is in excess of the fleet growth we see for 2004. Right now, OPEC is pumping, producing about 29 million barrels of crude per day. And that's very good for long haul traffic and very good for the tanker market.

So summing up, we are very pleased with our first six months results. We are very comfortable with the short-term outlook, both in this quarter and for the remainder of the year. And we feel that we are well-positioned to look at opportunities as they come up.

With that, we're ready to open the floor to questions.

(OPERATOR INSTRUCTIONS). Natasha Boyden, Sidoti and Company.

Congratulations on a good quarter. I just have a question regarding your strategy. You've primarily been a spot rate operator. I'm curious as to whether you have -- whether you have been thinking about potentially locking in revenue on time charters, or if you're going to continue on a spot focus going forward?

I think as applies to the crude, the Aframax and VLCC segments, right now we think that continuing with the higher spot exposure with the kind of levels we have makes sense. And right now in the short run, especially the outlook I just talked about, the gap between spot rates and time charter rates is currently 20 to $25,000 a day. We will continue with the heavy spot exposure. I should add to that -- if you look at our financial profile with the amount of liquidity we have, the equity, the leverage we have, we think we can probably tolerate more spot exposure than most of our competitors. But until such time as we get more skeptical about the market or see -- more likely to see time charters rates moving up, we will stay with spot exposure there. In the product tanker segment, you might see us doing some more fixtures because time charter rates are a bit more attractive there relative to spot. And clearly, the U.S. flag, we have a pretty heavy time charter commitment; that's a pretty steady income stream we have there.

Okay. In terms of the acquisition environment, obviously, you do have a very strong balance sheet. Have you considered entering into different classes of vessels. Obviously, you're focused on Vs and Aframaxes; would you look more at the Handimax or the Panamax area, or you're going to continue focusing on the larger?

I think what we've said pretty openly is we like very much where we are in the VLCC and Aframax segment. And as opportunities come up to buy, to charter in, we will continue to do that. Right now in the product tankers segment, we do not have the scale that we would like, and we will look at acquisitions in that area. That could be single vessel acquisitions; that could be charter in; that could be fleet acquisitions. And we're constantly (technical difficulty) in the market for that. (technical difficulty) flag, you know we acquired the two product tankers in the second quarter. We have also said very clearly we are going to grow in the U.S. flag market. That may also come through acquisitions. It may come through the new building program that the government is currently out discussing. It may be through other means, through chartering in. I also said that we are looking at the LNG segment. We in fact have submitted proposals in some of the competitions for longer-term contracts. We are not going to enter that segment unless we're able to get long-term contracts that both are secure and give us a decent return. And if that means we do something this year that would be traffic; if it means we have to wait three or four years, then we will do that. We have also looked at the chemical tanker segment, but right now think it would be more sensible for us to grow in the product tanker space and the other areas, and then look at that further down the road -- unless something very cheap came up.

Jon Chappell, JP Morgan.

Looking at your balance sheet, obviously, you have the liquidity there to make a big move if you need. But your cash balance has grown significantly over the last six months. You have intimated in the past that asset prices might be a little high for you to chase right now. Could there be a big debt pay down, or probably more enticing, possibly like a onetime special dividend that some of your peers have been doing, given your high cash balance?

I think right now what -- we've put ourselves in a position to consider really what alternatives are out there, opportunities. We are assessing a number of them right now. All of those opportunities that we are assessing right now look to be accretive to earnings. I don't know if they're going to happen. But in the short run right now, we see enough opportunities out there -- even at today's levels -- that we may be able to do some smart transactions. The dividend gets looked at every quarter by the Board. As you know, we have increased it in the past. We have no plans to do it today, but the Board will systematically look at that every quarter.

Jin Chun, Dahlman Rose Weiss.

Congratulations on the second quarter. I just had to know -- the spot rates your fleet earned appeared very strong, especially in the Aframax section. Could you first comment on that? Because in the release, you noted the Caribbean market was at a lower number than the Company reported.

I'm happy to. Having scale in the crude market is very important, and the one thing scale gives you is the ability to take on contracts. And I'm not talking about long time time-charter commitments, though that's something to do. But big contracts to move significant amounts of crude for the oil majors, some of the independents and state-owned companies. In AI, Aframax International, we have a portfolio of (indiscernible) 10 to 15 contracts right now. Those are not available to most owners of Aframax tankers. There's a few of the bigger players that can do that, because we have ships available at the right loading points at almost all times. We'd also do some (indiscernible) business in between. So we have that ability and that is reflected in the higher utilization of the rates. That's also the case with the VLCCs, and that's why we end up getting relatively better rates in the market on average over time. That's why that scale is very important to us.

Okay. I was just wondering if you could help me sort out the elements that may have kept second quarter (indiscernible) just shy of consensus estimates. Looking through the financial statement, it appears that perhaps a higher-than-expected tax rate, G&A, and possibly the less calendar day due to the sale of the Olympia, would appear to be the major items. Am I on the right track here? Would you elaborate?

(indiscernible) the Olympia, that won't come in until this quarter. So the Olympia is in there for the full quarter. The two new product tankers didn't come in until the end of April, and the ULCCs did not come in in the second quarter. The other lines, we had about a $5.6 million increase in the tax provision; we had about a $3.4 million increase in the interest line, and that has more to do with we did a fixed-rate issue in the first quarter. If you recall, in February we moved to more fixed-rate debt. And February we did $150 million 20-year unsecured bond issue at 7.5 percent. In hindsight, we look delighted with that result. But it did push up the net interest expense. Because of the unwinding of some of the joint ventures on the VLCCs, depreciation was up by about 3 million. And then we had a number of onetime events, including the final settlements with the pension plan (technical difficulty) pension obligations to Mort Hyman, the prior CEO. We have had consultants in assisting us with a strategic plan. And those -- that money went through in the first and second quarter, and then some of the onetime consulting fees also associated with the prior CEO. All those things are non-repeating items, so those will not continue in the next year. I think that covers most of it. Myles, did I miss anything?

No. You had most of it right there.

I was wondering then if you were able to provide an updated normalized number going forward, say, for '04, maybe even to '05 for G&A and interest expense then?

I think G&A you can look at something in the neighborhood of approximately 8 million per quarter, (multiple speakers) escalating it some inflation rates about 2.5 percent. And as it relates to interest expense, you can pretty well annualize the quarter.

(OPERATOR INSTRUCTIONS). Justine Fisher, Goldman Sachs.

First of all, what was CapEx for the quarter?

Myles, do you have the exact number off the top of your head?

No. Let me just riddle through some papers here and I will get it. What is your next question, Justine?

I appreciate the color on the ULCC voyages that you were talking about, about how the first couple of ships have been chartered. Would you be able to tell us at what rate they were?

I wouldn't be able to tell you that, but you take the current VLCC rates, multiply it by the carrying capacity, and you pretty much will get the -- the increased carrying capacity, I think you'll be directionally correct.

As far as -- you said that you would get around 40 -- or you sold the Olympia for 40 million --

Just short of 40 million, yep.

What are you going to do with the proceeds of the sale and what are the net proceeds going to be?

I think the Olympia is not secured, so it will be -- the full proceeds will be just shy of $40 million. We had to make incremental equity and subordinated debt investments in the ULCCs; to a certain extent it's going to be funding that. Otherwise it will be a buildup in cash.

Okay. Just to go over the revolver availability; I just didn't get the last number. So it's a 570 million total availability that you have now, after that new July facility?

Yes.

All of your revolvers are unsecured, right?

Correct.

In the press release it says that you've changed -- I noted that there were some minor tweaks in the '03 numbers, and it says that you had changed it to represent -- to conform to a newer presentation. What were the reasons for those changes. It just said some members have been reclassified to conform to the (multiple speakers)

Those are rather minimal changes.

Yes, they are. But was there (indiscernible) this shifting around of a couple million here and there, as far as how you account for some vessel versus voyage expenses, or --? I guess the voyage expense line didn't change.

No.

Okay. And then, as far as the Jones Act market is in concerned, you're looking -- I know you said you're looking to make acquisitions there; any particular segment of the Jones Act market that you're looking at?

What we've been trying to do, I think, in explaining our growth strategy is we want to try to grow in the areas that we're in. Because if you grow in the areas you're in -- one, you're familiar with the technical operations, the commercial market, and you're less likely to screw it up and more likely to succeed. We're currently in the dry bulk market for the U.S. flag. We're in the product tanker. And we have a car carrier. And I think we would look at expense (indiscernible) -- we will look at expense in all three segments. We're not going to go outside of those three segments today, though. And we see opportunities in all three.

Would you look at maybe some of the oil carrying barges in the Jones Act segment?

Right now we have not looked at that segment. Will we look at that down the road? Yes. But I think in the short run we want to stick to those areas with which we're most familiar and which we have the capacity to take -- to expand our fleet today.

Is there a liquid market for -- I know it's not too liquid (indiscernible) a sort of trading market as far as secondhand ships go for Jones Act product tankers and dry bulk carriers?

The answer is no. And in fact, one of the things we like about the Jones Act is that it's not a liquid market; it's a very stable long-term market. And if you look at what product tankers have earned over the last three years, what the dry bulk vessels have earned, what our crude carriers have earned -- it's a fairly stable long-term business. It's never going to have the kind of margins that -- like crude -- foreign flag crude tankers have in great markets. But over a longer period of time, it becomes a pretty dependable source of EBITDA. And there just is not that much competition for assets, which we find attractive. There's also not as much available. But when you're in it, you're in it as a long-term operator. And that's the (technical difficulty).

I guess then -- I know that you said you're looking at the new builds and at chartering in or buying secondhand ships. But that -- I guess that statement would lead us to believe that maybe the new builds and the chartering in would be more likely, just given that there's not a very large secondhand vessel market for Jones Act ships?

I think some of the opportunities on the (technical difficulty) and car carrier side involve buying foreign flag assets and bringing them in under MSP programs. And we are in that market right now and we will look to expand that market. The building -- just so nobody gets too scared -- the building program we're talking about is one in which the Department of Defense would be making rather significant subsidies for the construction to handle the difference between building in the U.S. and overseas. So we're not going on a speculative new building program today. But ships come up from time to time. A lot of the U.S. flag ships are owned under long-term leases, and when those expire they come up. While it's not a deep market, there are opportunities.

Justine?

The CapEx number; I almost forgot.

If you're looking at it for the six months, expenditures for vessels were about 50.7 million and investments and joint ventures about 59.4.

Walter Levato (ph), Passport (ph).

What is the length of the time charter you have for the vessels that you have time chartered in? I think you have a few VLCCs?

I think they have -- there's a break -- they're various durations; they're as short as a year, as long as seven years. But I would say on average, probably about three years, probably.

Okay.

The (indiscernible) I believe are five years.

That's correct.

Is time chartering in more tonnage something you're looking at doing, or not really?

We look at that market everyday. A think that at the beginning of the year, there was quite a large arbitrage between what you could charter in ships and what you could buy ships for. The advantage we have is that most owners will not charter ships to other owners, either for credit risk reasons or just out of practice. Because of our size, because of the big pools that we're in and run, we have the ability to do that. And that's what we did. Charter rates subsequently went up during the second quarter, and we would only charter in ships if the returns that we would get based on the implied capital we'd put against it are sufficient, given our outlooks for the market. Right now we don't see a lot of time charter opportunities on the Afra and VLCC market. That could change in a month, that could change in two months. But that's -- we're in that market everyday.

What would be the rates at which you could charter in right now a VLCC or an Aframax for a year, let's say?

There hasn't been a lot, but it looks like a VLCC -- for a year for VLCC you're well north of $40,000 a day. Maybe Bob Johnson should answer that one.

No more than -- I think you're right on; a V right now is going to -- it's certainly going to start with a 4 and probably significant -- in the high -- mid to high 4s; I think in the Aframaxes right now you're probably looking at the mid to high 20s.

The one-year market right now is just going through the roof.

What is the -- you don't have any new building commitments?

We have no new building commitments today, and at the levels that the yards are quoting us today and in many cases yards insisting on steel price adjustment clauses in contracts, I would not expect us to be contracting. We don't think these new building prices stay at these levels forever, and we are content to wait. I think the second part of it is, we have one of the youngest if not the youngest tanker fleets in the world. We don't need to order new buildings in order to average down the age of our fleet; ours is generally a new fleet. So we will be patient and wait.

Walter, you will remember we initiated a fleet modernization and expansion program in 1997, and have taken delivery on approximately 27 vessels with an aggregate cost of about $1 billion. (multiple speakers) began fleet modernization and expansion well before our competition.

(OPERATOR INSTRUCTIONS). Jin Chun, Dahlman Rose Weiss.

I just had a follow-up question regarding the ULCCs. Can you comment within your plans, if the ability for the used (ph) trade in line, per deadweight ton with the VLCCs -- was that within expectation? Does it exceed expectations considerably? Could you help characterize that for me, please?

I'll characterize it. When we made that acquisition, we were -- it was, I think, a fairly bold acquisition. I think in hindsight now, I think the market's conclusion is we got away with a terrific purchase. We made assumptions in our budget that just for planning purposes, that we would have -- they would be discount to VLCC rates, but we did not expect -- that was not going to be our commercial profile. But from a planning standpoint, we did that. What we expected was that if we were able to integrate these ships in the TI, into their global contract network and trading patterns, that we would be able to earn an undiscounted rate compared to VLCCs and utilize the extra carrying capacity to earn significantly more. Again, it's too early to state any conclusions, but the first results are promising.

Excellent. I was just wondering if I could get some further clarification on my earlier question. Would you be able to quantify for us the total effect of the onetime expense items for the second quarter, and also to give us a tax rate outlook for the balance of the year?

If you're looking on a provision basis, figure the provision -- exclusive of earnings at joint ventures -- would be -- where we hold less than 50 percent -- would be approximately 35 percent. And as it relates to G&A expenses for the second quarter in comparison to the prior year's quarter, it's about -- the 1.5 million increase in that is represented by nonrecurring items. So in the prior year's quarter it was about 7.9 million.

So is this an effective change in guidance for the tax rate?

No, not really.

Okay. It's just -- it's the impact relative to earnings on the joint ventures, which you (multiple speakers) quite a bit --

(multiple speakers) hold the joint ventures, so those earnings will not be subject to a provision.

Oliver Corrolet (ph), Jefferies.

I just had a question about the ULCC transaction. What is the timing, and will it happen all in the third quarter? On the flow of funds, where will it appear -- in the joint venture, investments and joint ventures? And will there be associated debt financing? How will it all wash out in the flow of funds in the balance sheet?

Myles, you want to go through that?

Sure. The ULCCs are acquired in the joint venture, in which we hold a 49.9 percent interest. Approximately 65 percent of the value of the vessels was financed via debt, and 35 in the form of equity contributions and shareholder loans. So it will -- the earnings on that entity will be picked up through the line equity and joint ventures.

Could you also give some guidance on drydocking for the rest of the year?

I'm sorry; I couldn't hear your question.

Drydocking for the rest of year; what's the picture there?

The total expenses this year will be approximately $22 million for drydocking and CapEx on vessels, so the capital expenditure portion of vessels. Steady-state, just repair and maintenance drydock for us is approximately in the neighborhood of 13 to 15 million per year.

At this time there are no further questions in the queue. I would like to turn the floor back over to Mr. Arntzen for any closing remarks.

Thank you very much for the questions. We're getting more, which I appreciate. If you have things you want to take up directly with myself or Myles Itkin, please feel free to do so. And I look forward to talking to everybody a quarter from now. Thank you.

Thank you. That does conclude today's teleconference.