Octave Specialty Group Inc (OSG) 2004 Q4 法說會逐字稿

Good morning ladies and gentlemen. And welcome to the Overseas Shipholding Group fourth quarter and year-end 2004 earnings conference call. At this time all participants have been placed on a listen-only mode. The floor will be open for your questions following today's presentation. It is now my pleasure to introduce your host, Mr. Jim [Adelson,] General Counsel. Sir, you may begin.

Thank you. Before we start, let me just say the following -- This conference call may contain forward-looking statements regarding OSG's prospects, including the outlook for tanker markets, change in the oil trading patterns, prospects for certain strategic alliances, the ability to attract and retain customers, the ability to integrate the former Stelmar operations, and anticipate levels of new buildings and scrapping, and the forecast of world economic activity and world oil demands. Factors, risks, and uncertainties that could cause the actual results to differ from the expectations reflected in these forward-looking statements are described in OSG's annual report on Form 10-K. With that out of the way I would like to turn the call over to our CEO and President, Morten Arntzen. Morten?

Good morning, everyone. Thank you for joining. I hope that most of you received our Press Release and have been able to review it. I'm not going to repeat what is in the Press Release, but I will emphasize some of the key points in there.

I think as all of you on the call are aware, 2004 was a terrific year for the tanker industry and the fourth quarter was exceptional. This was the best year and the best quarter in 32 years. And this reflected in our results with net income for 2004 of $401 million, a 331 percent gain from 2003. We made $121 million, which at that time was a record for the Company. The fourth quarter we had record net income of 211 million or $5.36 per share, 10 times higher than the number we attained a year earlier of 21 million. EBITDA was a robust 655 million for the year, compared with 320 million the year before. And obviously this was driven by a very strong rate environment, you could look at the average TCE rate for the full-year last year was $75,400 a day, and for the fourth quarter our VLCCs averaged $109,600 a day. Similar to the Aframaxes in 2004 for the 3-month period the last 3 months were $57,600 a day and for the full-year 38,000. These are exceptional numbers. We are very pleased with our financial results and we will take specific questions on all aspects of it after I finish the early remarks.

Let's look at the highlights of the Company, because this was in many ways a transformational year for OSG. Perhaps the most important thing was as a result of the Jobs Creation Act of 2004, which President Bush signed into law in October, OSG is on a level playing field for the first time since 1986 with regard to taxes. We had been paying 35 percent on tax rate on all our income from our foreign Flag ships. This is no longer the case. To illustrate how important the Jobs Creation Act is for OSG in this tax change, let's just take a quick look at the fourth quarter.

You see our earnings of the fourth quarter of 211 million. If we had been the 35 percent tax environment on that number we would have paid $73 million in tax on that. Slightly less than the $77 million reversal of the net deferred liabilities. So if you look at the difference between the tax and deferred liabilities we would have made 208 million rather than 211 million. That number, 208, is more indicative of the kind of earnings momentum that you can expect from OSG going forward. We no longer have a 35 percent tax stone to carry around our international fleet, which is where the majority of our earnings obviously are made.

Let's take a look at the financial profile. I have said on all the prior calls that part of OSG's long-term strategy is to maintain one of the stronger financial profiles in the industry. This has not changed. We acquired Stelmar on January 20th. This was a total cost of 1.3 -- $1.35 million, including the assumption of debt. We did not issue any new equity as we added 40 ships to our fleet and creating world-class platforms in both product tankers and Panamax tankers. Despite spending $1.3 billion both Moody's S&P maintained our credit rating at BB+. I think this demonstrates how strong at our balance sheet is. It also should not be surprising if you look at the details we have now $1.4 billion in shareholders' equity at 12/31/04. Even after the Stelmar acquisition we have $700 million in liquidity, a combination of cash, tax adjusted CCF funds, and undrawn lines. We also have a modern fleet with a massive difference between the market value of the fleet and the book value of the fleet. Equally as important, the majority of our debt is mortgage free, unlike the majority of the industry which borrows on a strict letter-mortgage basis.

In addition to the strong balance sheet our fleet is very young. If you looked at, and we mentioned in the Press Release on the Aframaxes, the average age of our fleet is 6.8 years, compared with the world-market average of 10.2. And for the Panamaxes a young 4.4 average for our fleet, compared with 13.9. And for the Handysize it's 9.7 versus 13.8. If you look at our VLCC fleet it has an average age of 5.2 years, compared to a world average of 8.7. Our fleet is, in fact, the envy of the industry. So if you look at all this and take this altogether liquidity, financial flexibility, hidden value in our fleet, young fleet, we still have the capacity to make it -- to assess and pursue growth opportunities if they rise. And we also have the strength to survive in difficult markets should they happen, which at this time is not something we are expecting.

We've talked in the last couple calls about the OSG Fleet Asset Management and I have mentioned that we are going to be more aggressively managing our asset base. In the last year I think you all remember we sold 2, the last 2 single-hull VLCC's. This year so far we closed on January 19th, the sale-leaseback of our 4 older Bostonmaxes. We sold them and transferred the residual risk to a third-party and then took them back on charter at attractive terms. Just last week we committed to selling our last single-hull Panamax tanker, the Mary Ann for north of a $16,000 million, which for your information is roughly twice what that ship was valued just a year ago. We now have only 3 single-hull ships left in our own fleet. And all 3 of those markets, all 3 of those ships are for sale in the market and if we are able to get the kind of prices we want, and we are being fairly demanding on price, we will sale those also.

Moving on to another thing we have talked about and that is the LNG business. I think since we have talked last we have now formally signed the joint venture agreement with Qatar Gas Transportation Company, and Qatar Gas Transportation Company may not be known to everybody on the call, but they raised an impressive $1.6 billion in equity on the Doha exchange last month. They're going to become a very important force in the shipping world, particularly in the gas sector and others, so we are very pleased to have them as a partner. We have centered our LNG business in Newcastle and we will build it up from there. This reflects our view that in the LNG business you need to lead with your technical expertise. It's a demanding trade. As you know we have our main operations for our crude tankers up in Newcastle. This is a good place for it. We will be bidding on additional LNG contracts, but we will only bid at levels that give attractive or decent returns for OSG.

Another big change in 19 -- in the last year was our recommitment to the U.S. Flag business. This is one of the few segments in shipping in which there is high barrier entry, there's high margin business, there's lots of long-term business, and there's a competitive landscape. And most important there is an acute need for investment in this sector. During 2004 in the spring we bought to secondhand U.S. Flag Product tankers and then earlier this year, as we mentioned in the Press Release, we signed 4 agreements with the Maritime Administration of the U.S. Department of Transportation to enter 3 U.S. Flag Product Carriers and 1 U.S. Flag Pure Car Carrier into the U.N. program. Those of you may have known that we used to have just the 1 U.S. Flag Car Carrier in there, now have 4. We're committed to growing in the U.S. Flag space and in deed are pursuing possibilities of building a series of ships in the U.S. at a U.S. shipyard, but there's not much more I can say to that than that we are working very hard on it.

Finally, let's talk about Stelmar, which is obviously a very big deal for us. We signed a definitive agreement to acquire Stelmar on December 13th, 7 days later we closed. On January 20th of 2005 Stelmar's 40-ship fleet came into OSG's and creating a 100-ship vessels shipping behemoth. This gave OSG leading positions in both the product tanker and the Panamax crude segments. In addition to our world-leading position in the VLCC segment and our No. 2 position in the world in the Aframax segment. Now because as many of you are familiar, the Stelmar process was a long one. We were able to do very extensive due diligence. We had as many as 40 people at OSG involved in that process. So we knew what we were investing in. We knew that we were getting a good fleet. We also knew that we were getting a world-class technical operation. And as a result of that we've already made the decision on how we are going to organize the new OSG.

Newcastle, henceforth, will become the center from which all of OSG's crude tankers are managed. It will be our crude tanker center of excellence. Athens will be the center from which all our Product tankers are managed, they will be our Product tanker center of excellence. All the people decisions regarding this merger have already taken place. And we are now very quickly moving onto integration. We have 6 teams, 2 headed by former Stelmar employees and 4 headed by OSGM employees that are looking at what we call the "key issues." The key issues and the key areas where there are significant savings for OSG.

When we announced this deal, we said that it was done on the basis of no synergies. We had not assumed we would get any synergies, though we expected we would. Since closing, we have refinanced all of Stelmar's debt that was done the first week after we acquired them, and that will save us about $2.5 million per annum. Since then we've also rebid most of our insurances for an additional 2.5 million of annual savings between the 2 companies. We expect to find additional synergies in purchasing, crewing, and in the commercial area.

Equally as important as the synergies, and they are going to be a lot more significant than when we announced the deal, is that we were able to improve upon our technical performance. We are looking at the best practices in Stelmar and the best practices in an OSG for the all important area of quality, safety, security, and the environment. We will do -- we will adopt the best practices from both companies and we have a large team of employees from both companies working that. When all this is done both from a revenue standpoint, from a technical standpoint, we are a lot happier with the acquisition today than when it was announced on the 12/13.

Let's talk about one other thing, which I think is worth mentioning, which is in the Press Release, but I will just underscore it, and that is that OSG did manage to get their Section 404 compliance under the Sarbanes-Oxley Act. And we will get a clean opinion from orders expressing the effectiveness of OSG's internal control over financial reporting and management's assessment of the effectiveness of internal controls over financial reporting. No material weaknesses or deficiencies were found. And I think this underscores OSG's commitment to running a proper transparent public company.

As I usually do, I will talk a little bit about the outlook for this quarter as we're more than halfway through it. The market has remained strong, albeit very well volatile and not as good as the entire fourth quarter. Based on what we have done so far and what we have locked in on voyages now, we see VLCC rates in the quarter averaging somewhere in the low 80,000 level. For the Aframax we see rates averaging in the low $40,000-a-day level. Not as good as the fourth quarter but still very strong rates. For Stelmar, I think there was a fairly good directional view on the Street of Stelmar's earnings forecast prospects for 2005. All I can add to that is that as their ships have come off charter, in almost all cases we have been able to increase the rates earned on those ships. So you take this all together, the strong V market, the strong Aframax market, the Stelmar earnings, and then remember that we are tax free, and I can say this will be a very encouraging, every good quarter for OSG. With that, I will open it up to the floor to any questions.

Thank you. (OPERATOR INSTRUCTIONS). Our first question is coming from Jon Chappell with J.P. Morgan. Please go ahead.

Good morning. Morten, I have more of an industry macro question for you. Back in early mid-January when the rates were kind of crumbling, you were probably one of the most vocal people saying that you hadn't seen the OPEC cuts really hitting your ships. Now as the rates have recovered can you tell us a little bit of what you had seen from OPEC, have they been -- cheating is kind of an ugly word -- but have they been overproducing a little bit? Has that been driving the recovery? And just kind of what you see 3 weeks down the road when they meet on March 16th?

What I said back then really is the same thing I would say now, and that is that we have not seen any slowdown in activity. And if you went back to 2003, the last time that OPEC announced cuts there was that same real falloff in rates. About as precipitous has happened in February, and then once the owners started figuring out that in fact that there were going to be as many cargos as there had been, rates got pushed back up.

You're seeing a fleet that is getting utilized somewhere between 95 percent and 97 percent utilization of the tanker fleet; the big tanker fleet. In that environment you're going to have a lot of volatility. And if 1 month there are too many ships in the Gulf you could have falloff. Another month where there are too few, rates can go up 30, $40,000 a day. And so what were seeing is a volatile market in an environment where you have high utilization of the fleet, and in that environment you're going to have generally good earnings for the tanker industry, and so far we're not seeing any slowdown whatsoever in the OPEC liftings. If anything it looks like they may be creeping up a bit.

This is regards to the new tax issue, do we look at the CCF any differently there or is it treated the same?

It's treated the same.

Okay. So when you mentioned your tax adjusted CCF we should still use about a 35 percent tax rate on that?

Yes. Jerry, agreed?

Yes.

Okay. And then finally if we could just get a breakdown of the what you call "running expenses" in the Press Release to [vessel] operating expenses in D&A? Cost came in much higher than we expected. I assume a lot of that has to do with preparing for the Stelmar integration?

Jerry, do you want to give a breakdown of that?

Bear with me a second.

Running expenses run about 80 for the full-year $274 million. G&A about $52 million. For the 3 months 85 million and 19 million respectively.

Yes, I have that 85, can you break that out between D&A and vessel expenses, time and bareboat charter hire expense; if possible?

Jon, why don't we just send those to you, okay?

That would be great. Thanks.

Anyway the charter and expense [indiscernible] have increased.

All right. Thank you.

Thank you. Our next question is coming from Doug Maverick with Jefferies & Company. Please go ahead.

Yes, hi, this is Magnus Fyhr. Congratulations to a great quarter. Just 1 question. On the Product tanker market the medium-range product carriers seen a lot of volatility in the quarter, I don't know if looking at Stelmar, you said that you contacted some of the vessels at higher rates. Can you kind of give us, maybe some fixtures there and what you're seeing here for the first quarter and onward?

Yes. I think what we've been seeing, you're absolutely right, has been volatile. The time charters fixes that we've been able to do have been at slightly better rates. The spot market rates have been extremely volatile, but you're still talking about fixtures for time charter for 2 to 3 years in the mid-20s, low to mid-20s, and you're seeing spot rates, obviously, at -- they're fluctuating a lot more wildly, but on average obviously higher than that in the 30s. So the rates are still holding fairly well. I wouldn't call the material difference from what you would have had, Magnus, into your forecast of Stelmar from last year.

Okay. What about the strategy going forward for Stelmar, you said you had contracted some in the spot and some on the renewal on time charter. Will you try to see more spot there or kind of continue with Stelmar's, time charter strategy?

Stelmar had a strategy directed from the Board that they would have their ships on time charter, 70 percent of their ships on time charter at all time, and if they ever fell below that the structuring of the chartering group was to go out and fix it. Even if the chartering group thought that at that time it made more sense to be in the spot market. We are not going to have any set rules like that. We are going to look at -- we are going to come up with our own rate before it gets to the market for the spot market. We're going to compare those with time charter opportunities. And if we find time charter opportunities that are above in excess of what we think we will earn on average in the spot market, then we will seize those opportunities. Otherwise we will continue to [trade] them spot.

So what I will -- I think you will see is -- because there are a lot of attractive time charter opportunities I think you'll see it slipping more to something like a 50/50 spot versus time charter basis. But we will have no hesitancy to operate these ships spot. And as you look back at any period, 5 or 10-year period that's been a very good strategy.

Okay. Very good. Thanks.

Thank you. Our next question is coming from Harvey Stober with Dahlman Rose & Company. Please go ahead.

Thank you, very much. You made a point of talking about the number of vessels you have that are on an unincumbered basis, and you borrowed during the last several months at 7.5 percent, also on an unencumbered basis. If you borrow on an encumbered basis on ships, you're paying LIBOR plus 100, or maybe a little bit less. So obviously you're willing to borrow at a 300 plus basis point premium to that just to be on an unencumbered basis. So maybe you can share what you see as --?

I think if an apples-to-apples comparison to that would be that if we're borrowing on a floating rate on an unencumbered basis it's at a rate of LIBOR plus 80. If we borrow on an encumbered basis it has recently been in the neighborhood of LIBOR plus 50. The 7.5 percent facility you're talking about has a 20-year duration. So there's considerable difference between the short-term variable borrowing rates and that which we would seek in the long-term markets. 20-year bullet unsecured debt for a shipping company is more a closely approximates equity as opposed to debt. So one may want to view it within that context.

I think I would just elaborate on that. Part of our strategy is to always have our balance sheet in the position that if a large attractive opportunity was to be made available to us such as Stelmar, we want to be in a position to do that, acquire it, yet still maintain a strong profile. By having -- pretty significant slug of unsecured long-term debt in our balance sheet makes it easier for us to do that.

Okay. Very good. The other question I wanted to ask, your making a pretty big bet on LNG, some of your competitors have complained about the potential returns that unless you're dramatically leveraging in that area the returns just don't merit the participation. You talked about attractive returns, but could you elaborate a little bit on how much you'll be leveraging in the area and what those return hurdles are to make it attractive for you?

We're not allowed to divulge the terms of those contracts under very strict confidentiality agreements. What I can tell you is when we bid those contracts we assumed that we would have 80 percent financing and we would return in excess of our costs of capital. No we've already arranged 85 percent financing for those vessels, so we've improved upon that, and we've also during the negotiations have managed to improve on some other things.

One thing I've learned in shipping whether it's LNG [rising] that anybody wins a contract bid too low, and anybody that bought a company paid too much, and I call that just "sour grapes." We're happy with the deals we did and we wouldn't do a deal if it wasn't profitable.

Okay. Thank you.

Thank you. Our next question is coming from Justine Fisher with Goldman Sachs. Please go ahead.

Hi. I just have a couple questions related to time chartering and sale-leasebacks. You noted that neither of the rating agencies actually took action to downgrade OSG's rating, but the Company remains on negative outlooks by Moody's. And part of the reason I guess is that Moody's expects additional sale-leasebacks by OSG going forward and they look at debt on a lease-adjusted basis. Do you have -- I don't know if you can disclose this information, but are you planning to do many more sale-leasebacks much like the ones that you did in January with the 4 Bostonmaxes?

We're evaluating a series of transactions from out-right sales to sale-leaseback transactions of varying durations. Our discussions with the rating agencies address the issue of lease adjusted debt to capital evaluating the time charter components on a charter back on a net present value basis. The expectation is based upon what we see during the course of 2005 and perhaps somewhat early within 2005 we will have deleverage to the level we were at prior to the acquisition. So I don't expect that the rating agencies will have any issues whatever form the debt takes.

Would you look to do sale-leaseback transactions for much of your international fleet as well or is it --?

You mean for much of it? No. For a portion of it though perhaps.

But it could be both the OSG International Fleet -- they could take place in OSG International Fleet, the Stelmar Fleet, or the [Jones] actually?

It could take place in any category for, but it would be for a discrete number of assets as opposed to something significantly larger.

Okay, and then I guess I know that you haven't broken out yet what the time charter hire expense et cetera, with the breakdown of that $85 million running expense was. But do you have -- in light of the fact that sale-leasebacks are increasing do you have a run rate for time charter hire expense that we can expect going forward?

For 2005, if you were taking a look at time and bareboat charter hire expense, and you were thinking about a run rate -- and this is not going to be exact -- but think about something in the neighborhood of 30 million per quarter.

Probably a little slightly less than that, I would say slightly less than [indiscernible] approximation.

Okay. And that includes the 4 Bostonmaxes, but nothing there -- obviously [indiscernible] to be announced?

That would include, yes, -- the 30 per quarter anticipates a couple other vessels potentially in the third quarter of this year.

Okay. Great. Thank you.

You're welcome.

Thank you. Our next question is coming from Philippe Lanier with Banc of America Securities. Please go ahead.

Good morning gentlemen. Let me reiterate what Justine asked in the quarter. The question I had one question kind of on the macro side and the one question specifically on your cost levels. On the macro side given your intention to perhaps expand in the U.S. market again and the demand that you see there could you perhaps quantify where you see the pricing power between you and the shipyards and finding new assets in that area?

You know, that's a question I think I would rather sit down with a very tall beer and discuss over a long period of time. Building a ship today, a commercial vessel in the U.S., is not like going to Korea or Japan where you can go to a series of yards, they will have a design, you will negotiate a contract, and you know that you will get the ship at cost, on time, exactly according to the specifications.

In the U.S., which in many ways has abandoned commercial shipbuilding, large shipbuilding, you're going to have to work much more closely with the yard. It's going to be more of a partnership then I would say in adversarial relationship. And you're going to have to figure out how you get from where the yards are today in terms of cost, to where you need to be to make the ships commercially viable. So it's a much different -- it's more of a partnership than your usual adversarial bidding-type approach.

Okay. But do you feel positive about the conversations you are having with the shipyards on an appropriate pricing for your given return levels?

I would hate to get anybody's hopes up, but I think that one of the yards we're working with we think can get there. I think they know how to do. We have confidence in their ability. But it requires a series of ships and it will be hard work, but that's our goal. That is our goal.

Great. Sounds good. And then just on the cost side, given where your G&A is in this quarter and given the integration on Stelmar, is it possible to offer you guys to give some sort of guidance on what the '05 G&A number might look like?

I think the '05 number is going to be somewhat higher than average, if we could however think in terms of steady state numbers going forward. You probably could feel comfortable in the 55 to $60 million area.

I should point out that the integration will have a separate cost. We obviously have the Uranus issue and then we have -- we are moving offices -- headquarter offices in New York. We are moving our technical office in Newcastle and we are also moving our office in Athens. So there will be some unusual 1-year -- one-time costs associated with all 3 of those moves.

Well, thank you very much for your answers and I will be happy to take you up on that [indiscernible].

Sounds good.

Thank you. Our next question is coming from John Kartsonas with Smith Barney. Please go ahead.

Yes, good morning. Most of my questions have been answered here. But could you give me a breakdown of how many of the Stelmar vessels are currently in spot?

It's about, I'd say half of the Panamax Fleet. I think it's 6 on times, 7 on spot, and I think on the Product tankers it's also about the same level.

About half, right?

About half.

And do you have a number of how many you expect to come, let's say, off time charter the first --?

Eleven vessels come off time charter during the course of 2005. Eleven --.

2005? Okay. Thanks very much.

Thank you. Our next question is a follow-up coming from Harvey Stober with Dahlman Rose & Company. Please go ahead.

Thanks. I just wanted to know what your mindset is regarding your -- regarding VLCCs in general. Is the mindset to grow or sink -- [Laughter] I'm sorry, grow or shrink the --?

We're not seeking any thing. [Laughter].

Exactly, grow or shrink your portfolio going forward?

I think we've been pretty consistent that we like our position in the VLCC market. Through tankers or national we are the biggest player in the VLCC market in the world. We have studied our returns and compared them with the market and smaller players and we do it quite well. One of the reasons we do well is we are big enough to take on very big contracts. There is only 4 or 5 institutions that can do that.

If you look at the outlook -- our outlook for the VLCC market the next 5 years it's fairly attractive. I think what we've said is in the next 5 years we think we will look more like the last 5 years, and that environment, assuming you can get a hold of a ship at a reasonable price in either a time charter in or purchase, we would increase. You won't see us paying crazy levels for VLCCs. VLCCs are being circled in the market today for as much as 150 million per copy. So there is some optimism out there.

Okay. Thank you.

Thank you. Our next question is coming from Alexander [Inactman] with [Montoll] Financials. Please go ahead.

Good morning, gentleman and congratulations on a super year. My question is with regards to the gains that you benefited from this year and obviously the tax advantage situation that you're in is significant. I would like to ask you with regards to the rest of the gains year-over-year what you attribute to the bulk of the advantage versus say where you were a year ago? And how you see that advantage playing out throughout the next year? Okay, if you could kind of break it down, I'd appreciate it.

Myles, I'm going to throw that one to you.

Fundamentally, the year-over-year gains predominantly a function of rates and if you were to look at daily operating expenses as well, they were highly contained if not slightly reduced as there's been a general rise within the industry. So attributable to higher revenue, which is predicated upon time -- basically the time charter rates earned by each category of assets and lower operating expenses. We have a fairly sanguine view on the revenue and of the equation going forward and operating expenses are being well-controlled. We think that there are some fleet wide benefits to be derived through the Stelmar integration, which should effect both further revenue enhancement and expense reductions.

That's great. And where are you recognizing the highest margins, in what segment of the group are you recognizing the highest margins and --?

It's in VLCCs at the moment.

Okay. Thanks so much.

Thank you. Our next question is coming from Justin Yagerman with Bear Stearns. Please go ahead.

Good morning, gentlemen. Just wanted to get a breakout of the tax credit in the quarter. Is that just a reversal of this year of some sort or --?

No. What it really is, is all fundamentally deferred tax liability reflects timing difference as a result of the Jobs Creation Act and the fact that our foreign shipping and the fact that our foreign shipping is no longer subject to taxation we will no longer have a tax liability associated with those timing difference reversals.

Right. So what brings you to the $15.3 billion credit in the quarter?

$15 million credit is a result of -- if you back out the reversal of deferred taxes, which was $77 million you would get -- you would get a net provision of roughly 62. But the 15 million reflects the reversal of $77 million worth of cumulative deferred tax timing differences that will not be paid -- that will not have to be paid because we intend to permanently reinvest our earnings.

Okay. Thank you.

Thank you. There appears to be no further questions at this time. I will turn the floor back over to you for any further closing remarks.

Thank you very much. I appreciate the questions. If people have specific questions or details we're happy to take them. You know our phone numbers and we will take the time to answer them. Thank you very much.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day.