Overseas Shipholding Group, Inc.
Q4 2017 Earnings Call Transcript

Published: 9 Mar 2018

[Operator:]

Good day, and welcome to the Overseas Shipholding Group Fourth Quarter and Full Year 2017 Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note that today’s event is being recorded. I would now like to turn the conference over to Mr. Sam Norton, President and CEO of Overseas Shipholding Group. Please go ahead.

[Sam Norton:]

Thank you, Andrea. Good morning, everyone, and thank you all for joining Dick Trueblood and me for our 2017 fourth quarter earnings call. We welcome the opportunity to provide added depth and perspective to our written public disclosures and appreciate your taking the time to listening on this call. Prior to beginning our review of the past quarter, I would like to direct everyone to the narrative on pages 2 and 3 of the PowerPoint presentation available on our Web site regarding forward-looking statements, estimates and other information, which maybe 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 a 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, 2016, our Form 10-Q for the first, second and third quarters of 2017, our Form 10-K for the fiscal year ended December 31, 2017 which we anticipate being filed later today and our other filings with the SEC, which are available at the SEC’s Internet site, www.sec.gov as well as our own Web site www.osg.com. Forward-looking statements in this presentation speak only as to the date of these 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 in our fourth quarter earnings release furnished to the SEC, and which is also posted on our Web site. Kindly turn to Slide 5 in the presentation deck. As highlighted in our press release this morning, we have in recent months been witness to a robust recovery of spot market rates, the result of which we believe to be the progressive emergence of demand catalyst that we’ve been highlighting in our communications over the past year. As depicted in the graphic presented in Slide 5, the time charter equivalent rates for the round voyage calculations on tankers have risen steadily over the past eight months to levels now firmly above $60,000 per day. As noted in the past, nominal round voyage time charter equivalent rates need to be understood in conjunction with the utilization rates to fully reconcile market rates with our financial statements. Nonetheless, we have seen improvements in utilization rates as well, particularly over the past three months. Increased employment activity for our ATB fleet has also been evidenced. Given these developments, we have ever greater confidence that we have seen the bottom of our spot and time charter rate market. Firm spot market rates are a strong indicator of a tightening market. Consistent with the narrative of recent quarters, we now see all three key elements supporting the sustained recovery as contributing to improving market conditions, namely; one, an increased demand for coast-wide crude oil transportation driven largely by a persistent discount of domestic crude price to international prices. Two, episodic but important spikes in demand for refined product movements created by weather events, system disruptions, and the lack of storage capacity in the colonial and plantation pipelines to respond quickly to such episodes. And finally, a gradual reduction in supply of vessels. In addition to the two OSG ATBs removed from service during the second half of 2017, we count four other older ATBs and one tanker that have now been removed from the market during the same period. We consider it highly likely that further reductions in available supply will occur over the remainder of 2018. A further and important leading indicator to a sustainable recovery is the reemergence of time charter inquiries from our principal customer base. During the first quarter, we have fixed one of our tankers to an oil major for delivery early April for up to 18 months. At this time, we have out on offer three other tankers for similar periods at offer rates approaching $60,000 per day. In addition, we have during the first quarter agreed with one of our Delaware Bay refining customers to a three-year lightering contract commencing April 1st at minimum annual volumes more than twice the levels previously agreed. The other annually renewable contract with the third of our refining customers has also been renewed for 2018. Improved market conditions have also translated to a better environment for our conventional ATBs. We have in recent weeks succeeded in securing with our existing customer base over 800 days of fixed time charter cover at profitable rates for 2018. The progressive and anticipated transition of our vessel assets away from legacy time charter contracts of the past to what is today a greater exposure to the spot market is we believe a transitional condition. Considerations about the appropriate amount of capacity to remain active in the spot market are a regular management discussion point. Attaining the stability of cash flow offered by time charters and multiyear contracts of affreightment remains a fundamental objective of our chartering approach. We consider the normalized market in which our vessels trade to be one that should be characterized by stable, longer-term chartering relationships with our core customer base. As the data suggests, we are more exposed currently to the spot market than any of our competitors. At the end of February, four of our nine conventional tankers were trading in the spot market. Three rebuilt ATBs were also trading spot. Broker reports indicate that a total of 36 front-haul spot fixtures for Jones Act tank vessels in excess of 150,000 barrels were concluded during the fourth quarter, 23 tanker movements and 13 fixtures on large ATBs. OSG vessels covered 28 of those voyages or 78% of the total. During the first two months of this year, 27 spot fixtures have been concluded of which 16 were done on OSG vessels. To place these numbers in perspective, the current spot trading activity in the Jones Act tanker and ATB sector is nearly twice the volume of the average of 6.5 total fixtures per month over the past 10 years. Balancing supply availability in an uncertain demand environment is a persistent challenge. Tactically, we have chosen consciously to accept increased spot exposure with a belief that committing vessels for long periods and sustained loss making rates is an unattractive option when measured against the upside of being positioned to benefit from a recovery in rates. We are heartened by the recent market developments which have served to strengthen our convictions as the wisdom of this position. The importance of the reemergence of longer period contract activity to the long-term value proposition of OSG cannot be overstated. Time charter inquiries are a clear affirmation of our view of tightening supply conditions. Our principal end-user base is vulnerable to any potential supply shortage and time charter commitments are a strong indicator of a growing recognition of the need for greater certainty of access to transportation capacity. Our firming spot rates are a positive development. Short voyages on the Jones Act trade make achieving high utilization rates a challenge. Time charter contracts shift the risk of optimizing utilization from the owner to the charter and are thus favorable to the company when considering anticipated bottom line results. Importantly, our analysis of available Jones Act tankers indicate that between now and the end of 2019, there exists only two vessels outside of the OSG fleet that will be available to offer for time charter inquiries seeking vessels less than 20 years of age. Any increase in time charter demand will thus likely be favorable to OSG. Please turn to Slide 6. Commencing in the third quarter of 2017, we have elected to provide additional disclosure to assist you in understanding the importance of our niche businesses and giving us the confidence to accept heightened volatility in our conventional tanker and ATB markets. Our niche market activities provided $21.9 million of vessel operating contribution during the fourth quarter and $101.4 million for the 12 months ended December 31. Looking historically over the past three years, these businesses have made a vessel operating contribution of US$102 million on average. Volumes averaged only 117,000 barrels a day in the fourth quarter providing time charter equivalent returns of $42,802 per day over the period. Average time charter equivalent returns from these assets for the full year fell to $61,645 per day as it compared to 2016 levels of $72,271 per day, principally as a result of the disappointing fourth quarter results. And a nearly $5 million decline in vessel operating contribution from our niche businesses seen in the fourth quarter of 2017 as compared to the third quarter was primarily the result of reduced lightering volumes carried by our Delaware Bay lightering ATBs. Factors influencing this decline include increased use of Jones Act tankers bringing crude oil to the Delaware Bay refineries on the Gulf of Mexico, seasonal mild weather which allowed greater utilization of offshore lightering in competition with the services we offer and seasonal run rates of refinery serve that were below historical expectations. Notwithstanding the lower than expected contribution from our lightering activities in the fourth quarter, full year performance was consistent with both expectations and historical averages. Further, we remain confident that the full year results for lightering assets during 2018 will be consistent with what we have seen historically. As noted earlier, we have renewed contracts of affreightment with two of the three refinery customers that we serve at significantly higher take-or-pay volumes. One of the renewed contracts is for an extended period of three years commencing in April of 2018. Viewed together with the take-or-pay minimums which exists in our long-term contract of affreightment with Philadelphia Energy Solutions, committed lightering volumes and revenues secured for 2018 are already at 90% of levels achieved for 2017 with considerable scope for increasing these figures. Our two tankers operating in Maritime Security Program continue to provide quality cash flows for our business. Our MSP vessels derived a substantial percentage of revenues in our income transporting cargoes reserved for U.S.-flag vessels under MARAD Cargo Preference Program. The Cargo Preference Program works to promote and facilitate a U.S. maritime transportation system and oversee the administration of and compliance with U.S. cargo preference laws and regulations. Those laws require shippers to use U.S. flag to transport any government-impelled, ocean-borne cargoes. Among the currently available government-impelled cargoes is a contract the company has with the government of Israel to deliver fuel which the government of Israel has in the past funded with grants from the U.S. government. OSG has been nominated to perform a historically consistent minimum of seven voyages under this contract in 2018 providing committed employment at attractive rates with the equivalent of approximately one ship year. The government of Israel holds options to extend this contract for two years beyond October 2018 and OSG is working towards a successful outcome that would ensure the exercise of these options under conditions favorable to the company. Finally, OSG remains the only provider of Jones Act shuttle tankers in the U.S. Gulf today. Current discussions indicate that one of those vessels, the Overseas Chinook, will likely return in the short term at least to trading as a conventional tanker following expected redelivery from Petrobras in May of this year. Two remaining shuttle tankers are expected to continue to provide high-quality earnings for the foreseeable future. Benefits from our ongoing efforts to be more efficient with general and administrative costs as well as in our efforts to streamline some of our vessel operating costs continue to positively influence cash flow. General and administrative costs for the quarter were $6.4 million comparable to levels seen in Q3. For the full year 2017, we have achieved a $14.1 million reduction in general and administrative expenses as compared with 2016. Looking ahead, we believe that we have largely succeeded in realizing this steady-state run rate that is appropriate for the current scale of our business. Please turn to Slide 7. We continue to view the prospect for increasing demand for domestic crude oil transportation as an important swing factor in determining the extent and timing of restoring a healthy balance between available vessels supply. The key to understanding this potential demand catalyst is the relative price differentials of the U.S. produced crude oil available at marine terminals in the Gulf of Mexico as compared with internationally sourced crudes, including the cost of transportation on international flag vessels from foreign markets. While the easily accessible benchmark prices to compare our WTI and Brent, the more nuanced understanding of this price relationship is better achieved by looking at the WTI’s Houston price quote as compared with the Nigerian benchmark referred to in the industry as Bonny Light. The graphic in Slide 7 shows the changing differential seen in these benchmark price levels. The widening WTI Houston/Bonny Light spread over the periods shown in contrast to the WTI/Brent spread is helpful in understanding why demand for domestic crude oil transportation is firmed over the past six months even in the face of a narrowing WTI/Brent spread. Expectations are that increased supply of shale oil available in the U.S. Gulf in the future should sustain and perhaps even result in a widening of the WTI Houston/Bonny Light spreads from current levels. A byproduct of a widening price spread would be to make crude oil available with the U.S. Gulf Coast marine terminals at cost effective options for Gulf Coast and East Coast refineries. A favorable impact on Jones Act tanker rate developments would continue if this were to recur. 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 February 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 the 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 fourth quarter and full year results during 2017. Dick?

[Dick Trueblood:]

Thanks, Sam. Now let’s review the fourth quarter and full year 2017 results in more detail. Please turn to Slide 10. TCE revenues for the quarter totaled $83 million, a decrease of $27 million, or 24%, compared with the fourth quarter of 2016. The decline was primarily driven by the shift from fixed rate long-term time charters despite market activity that occurred throughout 2017. Our spot market day exposure increased 92% compared to Q4 of 2016. Additionally, the increasing emphasis on the age of vessel being considered for voyages resulted in lower utilization in day rates on our rebuild ATBs compared to the prior year. The decline in rebuild ATB performance during the quarter in comparison to the fourth quarter of 2016 represented 45% of the total TCE decline. Our Delaware Bay lightering revenues decreased 8.9 million as we saw movements of crude oil from the Gulf of Mexico via MR tankers to the refineries and the seasonal persistence of offshore lightering. The Jones Act tankers revenue contribution decreased 7.2 million principally due to our increasing spot market activity. This decrease was partially offset by a $1.3 million revenue increase from our non-Jones Act MR tankers. TCE revenues for the full year of 2017 were $361 million, a decrease of $85 million or 19% compared with the full year 2016. Again, this was primarily due to the increase in spot market days where we earned below our effective daily rates. This represented a $77 million decrease in TCE revenues. Most of the decrease was attributable to our rebuild ATBs. Please move to Slide 11. Our fourth quarter 2017 adjusted EBITDA was $23 million, down 54% from $50 million in Q4 2016. The decrease was primarily driven by the decline in TCE revenues discussed previously. Our margin decreased from 46% at TCE to 28%. For the 12-month period, 2017 adjusted EBITDA decreased from $176 million to $111 million and our margin decreased to 31% of TCE compared to 40% 2016. This was driven by the revenue decrease which was partially offset by our cost reduction efforts. Moving to Slide 12. Net income from continuing operations for the fourth quarter was $54 million compared with net income from continuing operations of $56 million for the fourth quarter of 2016. We recorded a tax benefit of $60 million in Q4 2017. The Tax Cuts & Jobs Act among other provisions reduced the total tax rate from 35% to 21%. Under U.S. GAAP, we will require to adjust our net deferred tax liability in 2017 to reflect the impact of this loss. As a result, we recognize the non-cash tax benefit of approximately $54.2 million. In the prior year, the company recognized the non-cash tax benefit of $64 million from the reversal of the deferred tax liability on the unremitted earnings of International Seaways. In the fourth quarter of 2017, we recognized an impairment loss of $5.8 million on certain of our vessels. During Q4 of 2016, we experienced an impairment loss of $6.6 million. Additionally, Q4 2016 included $11 million of severance costs. Net income from continuing operations for the full year of 2017 was $54 million compared with a net loss of $1 million for the full year of 2016. The increase reflects a reduction in vessel impairment charges of $91 million in comparison to 2016, a $14.1 million reduction in general and administrative expenses, lower depreciation expense due to the 2016 asset impairments and a $6 million decrease in interest expense related to the reduction in outstanding debt. These items offset the $85 million decrease in TCE revenues experienced in 2017. Net loss from discontinued operations for 2016 fourth quarter was $340.2 million. Net loss from discontinued operations for the full year 2016 was 292.6 million. There were no discontinued operations in 2017. Please turn to Slide 13. As we move from left to right, we began 2017 with total cash of $207 million which included $16 million of restricted cash. During 2017, we generated $111 million of adjusted EBITDA and we expended $8 million on dry docking and improvements to our vessels. During 2017, we repurchased and repaid $84 million of our 8.125% Notes fully retiring all amounts that had been outstanding which continued our deleveraging efforts. The result was we ended the quarter with $166 million of cash, including $0.3 million of restricted cash. Please turn to Slide 14. Continuing our discussion of cash and liquidity, as we mentioned on the previous slide, we have $166 million of cash at year end including $0.3 million of restricted cash. Our total debt at year end was $456 million. We also have a $75 million revolver which is presently undrawn. Mining our undrawn revolver with unrestricted cash, we had $241 million of liquidity at year 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 law and we will be making a $28 million payment in March 2018. With $313 million of equity, our net debt to equity ratio is 0.9x and our net debt to adjusted EBITDA leverage was 2.6x. This concludes my comments on the financial statements. I'd like now to turn the call back to Sam for his closing remarks.

[Sam Norton:]

Thank you, Dick. To summarize the views that we have expressed during this presentation, we are encouraged by the spot market rate developments that we’ve seen in recent months. Our niche market businesses helped provide us with a stable platform to accept the consequences of transitioning out of an oversupplied market. We continue to view latent catalyst demand side surprise that’s supportive of our view to stay the course on maintaining our current strategy for employment of our vessels. Generally, we consider the market in real times to be tighter than what has appeared on a static analysis and that a predictable progression towards a rebalance of supply will occur over the coming quarters as tightening age restrictions imposed by our core customer base progressively limit the acceptability for use in service the vessels exceeding 20 years of age. These developments give us reason to be optimistic and a restoration of sustainably profitable spot and longer-term charter rates for Jones Act vessels could well arrive sooner than current consensus thinking, 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. Operator?

[Operator:]

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from Alvin Perlini of CF Partners [ph]. Please go ahead.

[Unidentified Analyst:]

Thank you. Sam, thanks very much for the presentation. Just wanted to clarify one of the comments you made regarding one of your shuttle tankers. Did I hear you correctly mentioning that the tanker would be redelivered?

[Sam Norton:]

That’s correct. We are still in discussions with the charter, and so that’s not a final decision, but the current requirements of the charter for their periodic offloads from their loading storage and offloading vessel in Gulf of Mexico indicate to us that they will be satisfied with the use of one vessel as opposed to the current two. That vessel in fact has been trading – they have sublet the vessel to trade in the conventional tanker market for much of the past six months, and we would expect that we would do the same with the vessel once it is redelivered in May.

[Unidentified Analyst:]

Thank you. And one more question relating to the scrapping that you addressed right at the beginning of your presentation. Given the strength that you mentioned in terms of the Jones Act market, do you expect that more of the older assets will continue to be removed or do you expect a slowdown in the pace of those removals?

[Sam Norton:]

It’s our expectation that the pace of removal of assets from the market will largely be uninfluenced by the spot market rates. And we say that because it’s not necessarily the economics of the nominal rates that determine the economic performance of these assets. It is the combination of the nominal rates coupled with the utilization rates that ultimately defines the cash flow capability of these assets. And it is our experience certainly on our own vessels but we observe on other vessels as well that the older vessels find it progressively more difficult when operating in the spot market to retain utilization rates that justify their existence even at higher nominal spot market rates. And as an indication, we see ATB rates in the market today on the spot basis in the upper $20,000 per day range. They have not risen quite as much as the tanker rates, but they are as well materially improved from what we saw in the summer of last year. Nonetheless, if a vessel is achieving a round voyage equivalent of 20 – let’s call it $27,000-$28,000 per day, if that vessel is only operating or only attaining a utilization rate at 50%, then its effective return is really $13,000-$14,000 per day, which is I would argue largely breakeven rates of return. And the utilization rates are depressed or are lower than what the spot market rates would indicate largely because of the vetting requirement of the oil majors and the terminal operators that through their compliance departments find reasons to reject older vessels from calling at terminals or carrying cargoes. And this is a theme that we have highlighted much in the last year and a half and we see that trend in fact continuing. Vetting constraints and customer acceptability of older assets continues to be a problem for older assets.

[Unidentified Analyst:]

Thank you. And can I just ask a final question related to the MR time charters that you mentioned. So you said that you’ve signed one for 18 months in the high 50s of starting in April, and you have inquires for three others for that sort of timeframe. Is that correct?

[Sam Norton:]

That’s correct.

[Unidentified Analyst:]

Are you thinking of tying up more assets on those or are you waiting for longer charters or what’s the strategy?

[Sam Norton:]

As was stated in my remarks, we consider longer-term charters with our core customer base as being the normalized condition for our business. And we also recognize that trading in the spot market exposes us to risks of optimizing utilization which some of our customers are better suited to manage than we are given that we don’t have a visibility of forward cargo flows that our customers have. So in a normalized circumstance, we would expect the majority of our portfolio to be fixed on longer-term charters. And to the extent that we’re now seeing charter rates that are providing returns that begin to provide some degree of profitability is something that we’ll begin to look more carefully at. I think it would be an overstatement to state that we would put all of our vessels on time charter in the immediate future, but we certainly see the rate development and the inquiry levels as a significant improvement over what we saw six months ago and indicative of a return to health of our overall business.

[Unidentified Analyst:]

Thank you.

[Operator:]

Our next question comes from Phoebe Clarke of Redwood. Please go ahead.

[Phoebe Clarke:]

Hi, guys. I just have two questions about lightering. First, you mentioned that you had renewed two of the three contracts. Just wondered on the status of the third? And then secondly, under the new contract you said there was higher take-or-pay. Should we expect a return to the rates we saw kind of late last year or early this year kind of high 60s, low 70s or is the fourth quarter kind of 40 range more of the run rate?

[Sam Norton:]

So, Phoebe, to be clear, we have one contract of affreightment that has been in place for many years with Philadelphia Energy Solutions and that contract runs through 2020. The other two contracts that we have historically renewed annually, one with Monroe Delta and the other with PBF, those are the two that we’ve renewed in recent weeks. And one of them has been renewed for a period of three years as opposed to one year. Also, as I stated earlier, the take-or-pay minimums that exist in the Philadelphia Energy Solutions remain consistent as they have been in the past. And the take-or-pay minimums that we have agreed with the other two refineries are at levels of approximately twice what had been committed in the past. It is the increase in the committed take-or-pay level that give us confidence to believe that 2018 time charter equivalent returns will approach or potentially exceed the levels that we’re seeing across 2017 on average.

[Phoebe Clarke:]

Okay, great. Just one last follow up on that. So this fourth quarter you mentioned a bunch of different things that affected that effective rate including weather and movements on Jones Act vessels. Is the Jones Act part of that? It sounds like you’re saying that’s picking up. So is that going to continue to be a stress around lightering? And is that a significant part of the pressure?

[Sam Norton:]

I think our views are that and we’ve stated this in the past that there is some argument to be made that increased movements of crude oil from the Gulf of Mexico in the Delaware Bay would impact on our lightering operations. It is largely in response to observing that development that we chose to get out ahead of that or also watching those happen in the fourth quarter and engage with our refining customers to discuss contractual terms that would highlight minimum take-or-pay volumes as opposed to some of the features that had existed in the contract structures that we had in the past. So I think I would repeat again. We are very comfortable today that for the foreseeable future of the combination of the committed take-or-pay volumes and the overall requirements of the refineries in the Delaware Bay will lead us to remain with a very stable financial performance from our lightering business for the foreseeable future.

[Phoebe Clarke:]

Great. Thanks.

[Operator:]

This concludes our question-and-answer session. I would now like to turn the conference back over to Mr. Sam Norton for any closing remarks.

[Sam Norton:]

Thank you, Andrea. I believe that we’ve completed our remarks and would just like to thank everyone again for joining us and we look forward to talking to you again in a few months’ time. Have a good day.

[Operator:]

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.