Overseas Shipholding Group, Inc.
Q2 2018 Earnings Call Transcript

Published: 9 Aug 2018

[Operator:]

Good morning, and welcome to the Overseas Shipholding Group Second Quarter 2018 Earnings Conference Call. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Sam Norton. Sir, please go ahead.

[Samuel Norton:]

Thank you, Steven. Good morning, everyone, and thank you all for joining Dick Trueblood, Molly Arcia, Princeton McFarland and me for our second quarter 2018 earnings call. We welcome the opportunity to provide added depth and perspective to our written public disclosures and appreciate your taking time to listen in on this call. Prior to beginning our review of the past quarter, I would like to direct everyone to the narrative on Pages 1 and 2 of the PowerPoint presentation available on our website regarding forward-looking statements, estimates and other information, which may be provided during the course of this call. The contents of this narrative are an important part of this presentation, and I urge everyone to read and consider them carefully. We will be offering you more than just an historical perspective on OSG today, and our presentation includes forward-looking statements, including statements about future results. These statements are subject to uncertainties and risks. Actual results may differ materially from projections and could be affected by a variety of risk factors, including factors beyond our control. For a discussion of these factors, we refer you specifically to our annual report on Form 10-K for the fiscal year ended December 31, 2017, our Form 10-Q for the first quarter of 2018 and our other filings with the SEC, which are available at the SEC's Internet site, www.sec.gov, as well as our own website, www.osg.com. Forward-looking statements in this presentation speak only as of the date of those materials and we assume no obligation to update forward-looking statements or the reasons why actual results could differ. In addition, our presentation today includes certain non-GAAP financial measures, which we define and reconcile to GAAP in our second quarter earnings release furnished to the SEC and which is also posted on our website. Turning now to the specifics of our recently completed quarter. We saw a moderation of the improving tankers spot market conditions witnessed in prior quarters, offset by an increase in demand for our ATBs. The moderation in the tanker spot market appears to be rooted in seasonal factors and we believe that the fundamentals that underpin the recovery underway in the Jones Act tanker market are continuing to support optimism for the future. In stark contrast to the decline in tanker TCE contribution during the second quarter was a robust rebound in the TCE contribution from our ATB fleet, which more than offset the decline in tanker earnings. We believe this reflects a preference of some of our customers to move smaller cargo sizes during the quarter, favoring employment of our ATBs over tankers and resulting in positive implications for our ATB earnings. Combined with another solid quarter for our niche businesses, our aggregate performance produced encouraging results that continued to give us confidence and the improving prospects for our key revenue generation streams. Please turn to Slide 4. Let's focus first on the tanker market and our performance. The scattered chart presented in Slide 4 provides an updated picture of tankers spot rates over the past 12 months. Evident in the recent months has been a drop in nominal TCE rates. Rising fuel costs have had a visible impact on TCE results, as we have been unable to pass those costs due to our charterers. A deceleration of the velocity of spot fixtures is also apparent and seasonal inventory management decisions by our core customers led to a derth of spot cargoes on the market as the quarter progressed. As a result, our tanker sport vessel utilization rates have dropped over the quarter, falling from 73% for 337 spot trading days during the first quarter to 53% for 282 spot trading days for the second quarter. We are executing on the strategy of opportunistically moving from short-term trading in the spot market to our objective of obtaining profitable time-charter contracts for the majority of our fleet. And furthering that objective, we have made encouraging progress. We delivered two tankers to oil majors during the quarter on the time-charter contracts extending to early December 2019. We have also redeployed the Overseas Chinook as a conventional tanker on a six month time charter in domestic crude oil trades, following a redelivery from the shuttle tanker service in which she was previously engaged. A fourth vessel, the Overseas Boston, was extended in July under her existing contract, which will now run through early December 2019. Our increased spot market exposure has been our intentional strategy over the past 18 months. We consider the normalized market in which our vessels trade to be the one that should be characterized by stable, longer-term chartering relationships with our customer base. As of the end of July, 3 of our 10 tankers were trading in the spot market. Three rebuild ATBs were also trading spots. Considerations about the appropriate amount of capacity to remain active in spot market remain a regular management discussion point. Our principal end-user base is vulnerable to any potential marine transportation supply shortage, as the marine length between production and commission points is not easily replicated. As the supply surplus diminishes, we expect competitive forces to encourage our customer base to secure greater visibility of access to forward transportation capacity through extended time-charter contracts. Time-charter contracts shift the risk of optimizing utilization from the owner to the charterer and thus favorable to the company, when considering anticipated bottom line results. As such, the importance of the reemergence of longer period contract activity due to long-term value proposition of OSG cannot be overstated. The result of this recent contracting activity is that 67% of total tanker operating days for the balance of 2018 are now fixed on time-charter contracts, offering improved visibility of cash flow to be derived from this asset class. Historical pattern suggests that we should anticipate a seasonal upturn in spot market demand to occur as we move through the third and fourth quarters with an expectation of return to utilization rates for spot trading tankers in the first quarter. Let us now turn to our ATB performance. Results from the second quarter exceeded expectations with vessel operating contribution of this asset class topping $5 million, twice the level seen in the first quarter. Charter utilization rates, which approached 80% of available days for spot trading ATBs, way behind this improvement in earnings. As a comparison ATB spot utilization rates during the first quarter were below 60%. An incident involving the OSG 243 Independence in late June will negatively impact ATB contribution for the current quarter. In both carrier hit OSG's barge, while she was moored alongside at a terminal in Houston. As a result, the unit will be out of service for roughly 60 days undergoing repairs. While repair costs are largely covered by insurance an estimated revenue loss of $1.2 million will occur, most of which will fall in Q3. While we will pursue this claim against the bulk carrier owner, we may not be successful and even if we are, we cannot predict how much of this loss we will be able to recover. Please turn to Slide 5. We continue to closely monitor domestic crude oil market trends and better gauge improving demand developments for the Jones Act trade. As noted in past presentations, pricing differential between domestic and international crude prices are important factor in understanding changes in demand for domestic crude oil transportation. The blue line in the chart in Slide 5 traces the price differential between Bonny Light and WTI Houston. The red and green shaded areas beneath the blue line illustrate a landed price differentials when taking into consideration transportation costs. Period shown in green indicate periods of favoring domestic purchases on a landed cost basis. The red shaded areas indicate periods of disfavor. During the recently completed quarter, widespread pricing disruptions caused by lack of pipeline takeaway capacity from Permian fields as well as market fostering around recent OPEC meetings, tightened the volatility of the key crude price relationships that impact our business. A wide open arc through much of April and May turn negative in June, likely contributing to the soft tanker market conditions we witnessed at the end of the quarter. The yard opened up again in mid-July, however, and most analysts continue to believe that this positive arc will be present more often than not through the end of 2019. Significant in this respect was a time charter contract fixed towards the end of the quarter for a competitive vessel, which switched from clean to dirty trades. The combined picture of Slides 4 and 5 underlines our conviction that incremental demand for coastwise transport of domestic crude oil remains an important factor in gauging both the speed and the extent of market recovery in the Jones Act petroleum trades. Importantly, rising crude oil prices across-the-board should be stimulative to continue to expand some of domestic overproduction. And general expectations are that prevailing discounts international prices will continue as a result. A byproduct of a widening oil price spread is to make crude oil available at U.S. Gulf Coast Marine terminals, a cost-effective option for Gulf Coast and East Coast refiners, with what we have seen to be favorable implications on Jones Act freight rates. In addition to positive demand developments in crude oil trade, episodic, but important spikes in demand for refined product movements, created by weather events, system disruptions and the lack of surge capacity in the Colonial and Plantation Pipeline system to respond quickly to such episodes, provide further support for a building recovery. Please turn to Slide 6. We would now like to focus on the importance of our niche businesses and giving us the confidence to accept heightened volatility in our conventional tanker and ATB markets. While the second quarter contribution of these assets dropped off the high levels that we achieved during the first quarter, we were pleased with the overall results. Revenue recognition timing skewed results somewhat favorably to the first versus the second quarter as well as our customers renewal of long-term commitments for our lightering vessels resulted in pricing adjustments that were slightly lower in the just completed quarter. When viewed across the two quarters, the half year operating contribution of our niche businesses of $52.2 million tracked almost exactly the results obtained in the first half of 2017, highlighting the stability of these earning streams. Time charter equivalent earnings of $63,999 per day in our lightering business, followed on from nearly $71,000 per day recorded in the first quarter. We have seen consistently higher than minimum volumes with our customers in the Delaware Bay in recent months and with minimum take-or-pay volumes now established at higher levels than has historically been the case. We are confident that the financial performance of this activity will now track, if not exceed historical norms for the balance of the year. Our two tankers operating in the Maritime Security Program continue to provide quality cash flows for our business. Our MSP vessels derive a substantial percentage of revenues earned from transporting cargoes reserved for U.S. Flag vessels under MARAD's Cargo Preference Program. The Cargo Preference Program works to promote and facilitate the U.S. maritime transportation system and oversees the administration of and compliance with U.S. cargo preference laws and regulations. Those laws require shippers to use U.S. Flag vessels to transport any government-impelled ocean-borne cargoes. Among the currently available government impelled cargoes are fuel movements carried out by the Military Sealift Command on behalf of various branches of the U.S. Armed Forces. OSG secured three such cargoes during the second quarter, which when, combined with regular movements made under the contract of affreightment serving the government of Israel, drove time charter equivalent earnings for these two vessels to $32,493 per day for the quarter, a 15% gain over a year earlier comparable figures. The good start to the year these vessels contributed nearly 18% of our niche market vessel operating contribution for first half of 2018. OSG remains the only provider of Jones Act shuttle tankers in U.S. Gulf today. During the quarter, the Overseas Chinook returned to trading as a conventional tanker following redelivery from Petrobras in mid-May. The two remaining shuttle tankers are expected to continue to provide high-quality earnings for the foreseeable future. Please turn to Slide 7. Since quarter end, we've announced two important newbuild initiatives that signal our commitment to maintaining a leading position in key trades within which we operate. The first of these initiatives involves the construction of 2 50,000 deadweight class product chemical tankers at Hyundai Mipo Dockyard for anticipated delivery during the second half of 2019. These tankers will be constructed to comply with MARPOL Annex VI Regulation 13 Tier III standards regarding nitrogen oxide emissions within emission control areas. In addition, each vessel will have installed exhaust gas cleaning system, often referred to as scrubbers, meet the standards of MARPOL Annex VI Regulation 14 standards regarding sulfur oxide emission. The early delivery position offered by Hyundai for these vessels was an important factor in the decision to contract for their construction. The installed exhaust gas cleaning systems will allow these new vessels to continue to use heavy fuel oil following delivery. New International Maritime Organization rules which come into effect in January of 2020 will prohibit heavy fuel use for vessels without scrubber systems. The universe of scrubber equipped vessels in initial years following introduction of the new IMO rules will be very small as a percentage of the global fleet. As a result, it is widely expected that a significant price differential between new IMO rules compliant fuel and traditional heavy fuel oil will open up. Scrubber equipped vessels should thus gain a meaningful cost advantage in voyage cost with favorable implications on anticipated TCE results to these vessels. The second initiative is a contract in constructing a new 204,000 barrel barge in Gunderson Marine, providing our customers forward visibility of continued service beyond the expected sunset period for our existing rebuild ATBs. With existing tugs available to be paired with the new barge, we see this incremental investment as a cost-effective strategy to leverage our existing customer relationships in order to maintain market share. Fuel costs also weighed heavily in the design of this barge, which will be the largest ever built by Gunderson Marine. Once completed, the capacity of the new barge will be between 10% and 35% larger than a significant majority of barges against, which it will compete for business. A lower-price per delivered barrel will thus be achievable, as comparable fuel cost will be able to be spread across greater transported cargo volumes per voyage. In a rising fuel price environment, we believe this advantage will prove important in our efforts to secure contract employment for this barge in due course. Please turn to Slide 8. Before I hand things over to Dick to take you through a review of the past quarter's financial results, it is useful to recall that as of the end of July 2018, OSG owned or operated an active fleet of 22 vessels. Our active fleet includes tankers and articulated tug barges, of which 20 operate under the Jones Act and two operate internationally in U.S. Maritime Security Program. With this picture having now been refreshed, I will turn the call over to Dick to provide additional details on our second quarter results for 2018. Dick?

[Richard Trueblood:]

Thanks, Sam. Now let's review the second quarter of 2018 results in more detail. Please turn to Slide 10. During 2018, we operated two fewer vessels than during the first half of 2017. The TCE revenue contribution of these vessels during the first half of 2017 was $5.9 million. Additionally in late June 2018, OSG 243 was involved in an incident while moored alongside a Terminal in Houston. We expect OSG 243 to return to service in mid-August after repairs are completed, having lost approximately 60 days of revenue. TCE revenues for the quarter totaled $86 million, a decrease of $5 million or 5% compared with the second quarter of 2017. Pretax profit decreased $1.4 million in the same comparable time periods. The decline in addition to the vessel reduction was also driven by the shift from fixed-rate, long-term time-charters to spot market activities that occurred throughout 2017. Spot market days exposure increased 39% compared to Q2 2017. During the second quarter of 2018, the impact of fewer operating rebuild ATBs reduced total ATB revenue days by 167. During the quarter, we saw an impairment shift on the part of our customers to movements of smaller cargoes, which benefited our ATBs. As a result, our ATB recorded their best performance since the second quarter of 2017. The Jones Act tankers revenue contribution decreased $3 million, due to the shift in time charter activities to increased spot market presence. During the second quarter of 2018, 16% of our Jones Act tanker revenues resulted from spot market activities compared to 5% in the comparable year-ago period. The Delaware Bay lightering revenues decreased slightly by $1 million and our non-Jones Act tanker revenues increased $2 million. Sequentially, TCE revenues decreased $2.8 million or 3% from the first quarter 2018. And pretax profit of $3.4 million represented $1.4 million decline from 2018's first quarter. We experienced a sequential decrease in our tankers spot utilization rates during the quarter from 73% to 53%, as we experienced the seasonal slowdown during June. Spot market activity shift utilization risk to vessel operators, while time-charters place utilization risk with the charterers. Additionally, TCE revenues were reduced by increased fuel cost that owners have not been able to fully pass-through to charterers. The impact of increased demand for smaller cargo movements in the second quarter of 2018 resulted in the doubling of ATB vessel operating contribution from first quarter 2018. Our niche business activities continue to provide a strong stable platform to our business. In late May 2018, the Overseas Chinook, which was operating as a shuttle tanker was redelivered to us. It was subsequently placed on a time charter as a conventional tanker with another customer. Lightering volumes continued at levels consistent with those experienced in the first quarter of 2018, resulting in another solid quarterly performance. Let's move to Slide 11. Taking a more granular look at TCE revenues. During the second quarter of 2018 compared to the 2017 second quarter, we experienced revenue declines across most elements of our business. However, more importantly, this slide demonstrates the trends we have experienced during the last five quarters. Lightering revenues with the exception of the fourth quarter of 2017 have remained relatively consistent, while quarterly performance of our non-Jones Act tankers have increased during this time period. During the second quarter of 2018, we saw customer preference for smaller cargo moves, which favored ATB utilization. Our ATBs recorded revenues at their highest level since Q2 2017, even though there were two fewer vessels operating. The higher utilization levels and increased rates resulted in an average spot market daily rate of $21,000 compared to $7,000 in Q2 2017. Our Jones Act handysize product tankers recorded a revenue decrease of $3 million compared to the second quarter of 2017. The current quarter's Jones Act tanker performance experienced a $3.2 million revenue decline from the first quarter of 2018. Seasonal softness manifested itself in June with lower utilization levels and a resultant decline in average spot market daily earnings from $42,000 to $32,000. Utilization levels dropped from 73% to 53%. Spot market TCE rates moderated somewhat to the mid-$50,000 range. Spot market days increased from 173 in the second quarter of 2017 to 282 days in 2018 second quarter. Moving to slide 12. Second quarter 2018 adjusted EBITDA was $23.3 million, down 21% from $29.6 million in Q2 of 2017. The decrease was primarily driven by the decline in TCE revenues discussed previously. Looking at a sequential adjusted EBITDA the second quarter of 2018 represented 11% decrease from the first quarter of 2018 as TCE revenues decreased 3%. Moving to Slide 13. Net income was $3.1 million in the second quarter of 2018, down $200,000 from the second quarter of 2017. Second quarter 2018 net income declined $600,000 from the first quarter of 2018. This represents a solid continuation of profitability achieved in the first quarter of 2018. Please turn to slide 14. Moving from left to right, we began the quarter with total cash of $112 million, which included $200,000 of restricted cash. During the second quarter, we generated $23 million of adjusted EBITDA. Working capital changes contributed $4 million of cash. We expended $2 million on dry docking and improvements to our vessels and we incurred $6 million of cash interest payments. The result was we ended the quarter with $131 million of cash, including $200,000 restricted cash. Please turn to Slide 15. Continuing our discussion of cash and liquidity, as we mentioned on the previous slide, we have $131 million of cash at June 30, 2018, $200,000 of which is restricted. Our total debt was $381 million, this represents a $138 million reduction in outstanding indebtedness since June 2017. We also have a $75 million revolver, which is currently undrawn. Providing our undrawn revolver with cash, we have $206 million of liquidity at quarter end. We're not subject to any amortization on our term loan. We do remain subject to the excess cash flow sweep provisions of this loan. However, considering the voluntary $47 million prepayment we made in March, we do not anticipate having to make cash flow sweep payment in February of 2019. With $321 million of equity, our net debt-to-equity ratio was 0.8x, down from 1.2x at June 30, 2017. Our $380 million term loan matures in August 5, 2019. We began evaluating alternatives in early 2018 to refinance this loan. We are actively engaged in the process of refinancing this obligation, which we expect to successfully complete prior maturity. This concludes my comments on the financial statements. I would now like to now turn the call back to Sam for his closing comments.

[Samuel Norton:]

Thank you, Dick. Please turn to Slide 16. To summarize the views that we have expressed during his presentation, time charter activity for both our conventional tankers as well as some of our barges has been on the rise and a willingness for our customers to accept the larger exposure to utilization risk as evidenced by important period fixtures secured during the first half of this year. While seasonal softness in sport tanker rates has slowed the momentum of recent market gains, we remain confident that the mix of our revenue streams will continue to provide a solid foundation to capture the benefits of the continuing arc of improving fundamentals. Our niche businesses once again performed well and progress in securing more long-term charter contracts during recent months, coupled with the resilience of our ATB earnings streams gives us cause to believe that our commercial strategy is sound. Generally, we consider the market to be tighter than what it appears on a static analysis. We continue to be latent catalysts to demand-side surprises and supportive of our chartering strategy of leveraging rising spot market rates to secure more attractive long-term charter commitments for employment of our vessels. Predictable progression towards a rebalance of supply should occur over the coming quarters as tightening age restrictions imposed by our core customer base progressively limit the acceptability for use in-service of vessels exceeding 20 years of age. The largely uncontracted status of our conventional tanker fleet beyond 2018 leaves us well positioned to benefit from the emerging tightness and availability of supply. Importantly, new contract signings for additions to our fleet position OSG well to reap economic rewards, which are expected to materialize in the wake of new regulation coming into force over the next two years. Favorable fundamentals indicate that the trends we have witnessed over the past year should strengthen over the foreseeable future, a development, which were to occur would allow the unrealized potential of the operating leverage of our business model to become more readily visible in the quarters that lie ahead. We will now open up the call to questions. Steven?

[Operator:]

[Operator Instructions]. And our first question comes from Elvis Pellumbi with CFP.

[Elvis Pellumbi:]

Sam, Dick, thanks for the presentation. I had a question - my first question relates to the newbuild program that Sam described. Could you give us a little bit more color as to whether the MRs you're ordering in Korea, will they be used differently or the same way as your existing MRs? And then if you could shed a little bit more color on the barge because I wanted to understand whether that is contracted or whether will be placed in the spot market? And then lastly, in relation to the newbuilds, if you could describe your thoughts on the financing?

[Samuel Norton:]

Thanks, Elvis. I'll try and take the first couple of questions and then Dick can address the financing issue. We together with other constituents that operate within the U.S. Flag community are consistently looking for opportunities to try and expand the presence of U.S. Flag vessels trading outside of the Jones Act market. We believe that there is momentum to suggest that opportunities for additional U.S. Flag vessels could well arise in the next year or two. And to a large extent, our optimism about that has driven us to be - to take the steps to order these new vessels. As a fallback position, we consider the likelihood of these vessels participating in freights that are currently served by our Mykonos and Santorini, the two international flag vessels that we have to be a comfortable home for those vessels in the future. But we don't exclude the possibility or give the ambition of trying to place these vessels ultimately in U.S. Flag in addition to the Santorini and the Mykonos, should the opportunities that we think could arise appear. As far as the barge is concerned, we have two tugs that are currently coupled with older barges that were rebuild in the first decade of the century. And the barges - the barge that we have contracted with Gunderson has been designed and constructed to be paired with either of those two tugs. The delivery of the barge is two years hence and we believe that within that period of construction that we will market and seek to place this vessel on a longer term contract with one of our core customers during that period. We have no specific contracted position at the moment, but certainly, as was evidenced by the performance of the ATBs during the first - excuse me, the second quarter of this year, we do have confidence that there is continuing demand for utilization of ATPs and that this ATB in particular, once it's delivered, the barge will have favorable economics due to its size and will be - and will therefore be easier to market than we think the existing conventional fleet of ATBs that are slightly smaller. Dick, do you want to touch on the financing point?

[Richard Trueblood:]

Yes, happy to. Elvis, we are in the process of actually finalizing the placement of permanent [indiscernible] for the two new build MR tankers, which neither of our equity contributions will walk away the financing of those for about seven year time period into the future.

[Samuel Norton:]

Barge?

[Richard Trueblood:]

The barge is the new effort at this point for financing and I don't - that is part of my current agenda of projects to do, and that'll be fairly easy to place.

[Samuel Norton:]

I remind you that the barge will deliver in the second quarter.

[Elvis Pellumbi:]

Yes, I appreciate that. You do, you do, fair enough. One final question from me, Sam. You mentioned in the Jones Act section of your presentation that a competitor fixed a time charter at the end of the quarter. Could you give us a little bit more color in terms of the tenor and the day rate, even if you don't want to mention, who it was?

[Samuel Norton:]

The tenor was less than a year and the day rates were consistent with rates that we've seen in the last quarter. And I think you can figure those out. I think the most significant thing is about not the rate itself or the tenor, but that a vessel that had previously been trading in the clean market changed over to dirty, increasing the number of vessels trading in the dirty market and that to us is significant because it underscores a continuing confidence that the arbitrage that we speak to in all of these presentations is likely to remain open for the next year, which, of course, is favorable overall to the tankers in the Jones Act.

[Operator:]

[Operator Instructions]. I'm showing no further questions. This concludes our question-and-answer session. Ladies and gentlemen, this also concludes our conference for today. Thank you for attending today's presentation. And you may now disconnect.