Form 10-Q
Page 36
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
Operations (continued):
International Flag Handysize Product Carriers
| | | Spot Market TCE Rates Handysize Product Carriers* | |
| | | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | | 2010 | | | 2009 | | | 2010 | | | 2009 | |
| Average | | $ | 7,700 | | | $ | 3,000 | | | $ | 7,900 | | | $ | 6,900 | |
| High | | $ | 18,500 | | | $ | 7,100 | | | $ | 18,500 | | | $ | 18,200 | |
| Low | | $ | 2,900 | | | $ | 0 | | | $ | 1,700 | | | $ | 0 | |
*Based on 60% trans-Atlantic and 40% Caribbean movements to the U.S. Atlantic Coast
Rates for Product Carriers operating in the Caribbean and trans-Atlantic trades averaged $7,700 per day during the third quarter of 2010, over twice the average for the third quarter of 2009 and approximately 18% over the second quarter of 2010. Product Carrier rates for the first nine months of 2010 averaged 14% above those realized during the same period in 2009.
Oil demand in Latin America increased by 5% during the third quarter of 2010 compared with the same timeframe in 2009. The combination of increased demand for products, especially middle distillates, and unexpected refinery downtime in the Caribbean and South America created an arbitrage opportunity for imports into this area. High refining utilization levels in the U.S. in the third quarter produced incremental volumes of diesel that were exported from Gulf Coast refineries to both Latin America and Europe, benefiting product tanker rates. There were also additional movements from Asia into Latin America to meet rising distillate demand. However, trans-Atlantic movements of gasoline from Europe to the U.S. were subdued as U.S. refining runs in the third quarter were at a high enough level to meet gasoline demand without the need for additional imports.
At the beginning of this year there were 87 large Product Carriers used to store clean products. By the end of September 2010 this number had been reduced to 33, implying that 54 additional Product Carriers had to compete for cargoes.
The world Handysize fleet consisted of 1,517 vessels (65.5 million dwt) at September 30, 2010, of which 131 were single-hulled. The orderbook stood at 272 vessels (12.8 million dwt), equivalent to 20% of the existing Handysize fleet, based on deadweight tons.
U.S. Flag Jones Act Product Carriers and Articulated Tug Barges (“ATBs”)
| | | Average Spot Market TCE Rates | |
| | | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | | 2010 | | | 2009 | | | 2010 | | | 2009 | |
| 45,000 dwt Tankers | | $ | 39,600 | | | $ | 33,100 | | | $ | 38,300 | | | $ | 37,200 | |
| 30,000 dwt ATBs | | $ | 26,200 | | | $ | 23,000 | | | $ | 25,600 | | | $ | 25,200 | |
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
Operations (continued):
Rates for Jones Act Product Carriers and ATBs averaged $39,600 per day and $26,200 per day, respectively, during the third quarter of 2010, approximately 20% and 14% above their respective third quarter 2009 rates. Rates for both vessel types were, however, approximately 4% below their second quarter 2010 rates as fuel costs increased and there were fewer trans-Gulf movements into Florida.
U.S. Gulf Coast refinery utilization rates in the third quarter of 2010 averaged 91% compared with 86% in the third quarter of 2009. This resulted in an increase in inventory levels as well as an increase in middle distillate exports. An accident at Mexico’s Cadereyta refinery in early September damaged production units, reducing throughput volumes. To compensate for this reduction in throughput volumes, additional quantities of gasoline were moved on ATBs from Gulf Coast refineries into Brownsville, Texas for uploading into a product pipeline that runs into Mexico.
The Delaware Bay lightering business transported an average of 238,000 b/d during the third quarter of 2010, an increase of 6% compared with the second quarter of 2010 and 2% higher than the third quarter of 2009. Two refineries, Delaware City and Eagle Point remained shut down. The increase in lightering volumes reflected higher demand from other refineries operating on the U.S. East Coast. The Delaware City refinery, sold by Valero to PBF Holding Company LLC, is now undergoing significant maintenance and is forecast to restart operations during the first half of 2011, which would be beneficial to OSG’s lightering activities. PBF Holding Company LLC has also recently purchased the Paulsboro refinery located in Delaware Bay from Valero.
Three Jones Act vessels were delivered and three were scrapped (including two older gas turbine double hull vessels) during the third quarter of 2010, resulting in 62 vessels available for trading in the Jones Act coastwise market at the end of the quarter compared with 68 vessels at September 30, 2009. There were eight Jones Act vessels in lay-up at the end of the third quarter of 2010 compared with nine vessels in lay up at September 30, 2009. Three more vessels are expected to be delivered and one scrapped in the fourth quarter, which would result in a year-end Jones Act fleet of 64 vessels.
From the fourth quarter of 2010 through 2014, nine tankers and barges in the 160,000 to 420,000 barrel size range will be added to the fleet based on the current orderbook. An equal number of vessels should be phased out in accordance with OPA 90 regulations by December 31, 2014. In addition, there are currently seven double hull vessels over 25 years old that may be scrapped or taken out of service by 2014 because of commercial obsolescence.
Outlook
The most recent economic outlook issued by the International Monetary Fund (“IMF”) forecasts that world GDP growth in 2010 will be 4.7% and 2011 growth will reach 4.2%. Based on these forecast, the International Energy Agency (“IEA”) predicts that world oil demand will increase by 2.5% (2.15 million b/d) in 2010 and by 1.4% (1.2 million b/d) in 2011.
Form 10-Q
Page 38
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
Operations (continued):
Tanker rates to date in the fourth quarter of 2010 have been lower than the average rates realized during the third quarter of 2010. There is currently no incentive to use tankers for either crude oil or clean product floating storage purposes. Additional newbuildings scheduled to enter the market during the fourth quarter of 2010 will exacerbate the current oversupply situation placing additional downward pressure on tanker rates. U.S. crude oil imports are forecast to decline in the fourth quarter of 2010 compared with the prior quarter as an increase in refinery maintenance activities combined with high inventory levels will likely reduce oil import requirements.
Asian refinery runs, however, are expected to increase by almost one million b/d by year-end 2010 compared with the third quarter due to a seasonal increase in demand of approximately 800,000 b/d, as refineries in Asia come out of summer maintenance and as new refining capacity in China starts up. PetroChina’s 200,000 b/d Guangxi refinery will begin to process crude oil in the fourth quarter and is configured to take low-sulfur crude oil from West Africa as its primary feedstock. Crude oil imports into China are forecast to hit record levels in the fourth quarter and to increase further in 2011 as China’s refining capacity continues to expand. Additionally, the Brent-Dubai spread now favors the use of West African crudes over Middle East crudes by Asian refiners, which should generate additional tonne-mile demand during the fourth quarter.
Tanker rates could continue to be supported by the tanker delays caused by the current port workers strike at Fos/Lavera. The strike has disrupted runs at some refineries and caused plant shutdowns at others, especially in France, where Total has started to halt operations at all its plants. An expected increase in fourth quarter Nigerian crude oil production and increased production in Brazil and the North Sea (due to seasonal factors such as the end of maintenance activities), compared with the third quarter, could also increase tanker tonne-mile demand in the fourth quarter.
The total supply of tankers is forecast to grow by 4% to 5% in 2010 as newbuilding deliveries will be offset by single-hull deletions. There is a minimal change expected in the VLCC fleet as about sixty-three newbuilding deliveries will be offset by an equal number of single-hull deletions. The Panamax fleet is forecast to show a net tonnage decline for 2010 as deletions are forecast to exceed newbuilding deliveries. The expected overall increase in fleet growth during 2010 is therefore centered in Suezmaxes and Aframaxes.
Oil demand growth in non-OECD areas in 2011 is forecast to increase by 1.5 million b/d while demand in OECD areas is forecast to decline by approximately 300,000 b/d. Refining capacity in Asia is forecast to grow by approximately 800,000 b/d in line with oil demand growth. Asia will require increased volumes of imported oil from West Africa, South America and the Middle East since Asian oil production is forecast to remain at 2010 levels.
Forecast changes in supply patterns during 2011 could also have a positive effect on tonne-mile demand. Expected production declines of 200,000 b/d in the North Sea and 160,000 b/d in Mexico could necessitate additional longer haul seaborne movements into Europe and the U.S., respectively. New Caspian production could become available to Europe via the B-T-C pipeline, which would provide a boost to both Aframax and Suezmax employment. The Delaware City refinery on the U.S. East Coast that is capable of processing sour crudes is expected to restart operations in the spring of 2011 and will likely source incremental quantities of crude oil from the Middle East and/or from Colombia and Brazil, where production increases of 120,000 b/d and 200,000 b/d, respectively, are forecast to occur in 2011.
Form 10-Q
Page 39
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
Operations (continued):
The tanker supply in 2011 is forecast to grow 7% to 9% depending on the number of order cancellations and deliveries deferred into later years. While current crude future prices do not support holding oil in storage, the new sanctions against Iran concerning letters of credit, financing, transfer of funds, etc make it more difficult for Iran to market its crudes. Japan and Europe have stated that are cutting back on Iranian crude oil imports, and if this occurs, a need could develop for more tankers to be utilized for storage purposes which would absorb some of the existing surplus tonnage and thus enhance 2011 rates.
Growth in the world Handysize fleet is forecast to average approximately 3% per year in the 2011 through 2014 period. Growth in tonne-mile demand during this timeframe is expected to exceed this growth in supply, reducing the current over-supply situation. Growth in tonne-mile demand will be driven by longer-haul cargoes from India into both Europe and the U.S., as India's export capacity increases. Diesel demand is also forecast to increase throughout the world providing arbitrage opportunities for exports from the U.S. to Europe and South America. Growth in naphtha demand in Asia will result in additional movements from the Middle East. This annual increase in product tonne-mile demand should result in improved fundamentals.
Fundamentals in the U.S. Flag tanker markets are forecast to improve. The Jones Act fleet is forecast to decline by 8% between October 2010 and year-end 2011. Eight tankers are expected to be scrapped while three newbuildings, including one vessel to be employed as a shuttle tanker, will enter the fleet.
Freight rates remain highly sensitive to severe weather and geopolitical events. Hurricanes in the Gulf of Mexico could have a pronounced effect on freight rates for both crude oil and product movements depending on the extent to which upstream and downstream facilities are affected. Winter-related delays in the Bosporus straits could increase tanker utilization rates in the coming months. Geopolitical events, such as violence in Nigeria’s oil producing Niger delta, escalating tensions with Iran and other regional conflicts in the Middle East, could also cause changes in supply patterns that could significantly impact rates. Additionally, any changes in OPEC production quotas will have an impact on tanker utilization and rates.
Update on Critical Accounting Policies:
The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require the Company to make estimates in the application of its accounting policies based on the best assumptions, judgments, and opinions of management. For a description of all of the Company’s material accounting policies, see Note A to the Company’s consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.
Form 10-Q
Page 40
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
Update on Critical Accounting Policies (continued):
Vessel Impairment
The carrying values of the Company’s vessels may not represent their fair market value at any point in time since the market prices of second-hand vessels tend to fluctuate with changes in charter rates and the cost of newbuildings. Historically, both charter rates and vessel values tend to be cyclical. The Company records impairment losses only when events occur that cause the Company to believe that future cash flows for any individual vessel will be less than its carrying value. The carrying amounts of vessels held and used by the Company are reviewed for potential impairment whenever events or changes in circumstances indicate that the carrying amount of a particular vessel may not be fully recoverable. In such instances, an impairment charge would be recognized if the estimate of the undiscounted future cash flows expected to result from the use of the vessel and its eventual disposition is less than the vessel’s carrying amount. This assessment is made at the individual vessel level as separately identifiable cash flow information for each vessel is available.
In developing estimates of future cash flows, the Company must make assumptions about future charter rates, ship operating expenses, and the estimated remaining useful lives of the vessels. These assumptions are based on historical trends as well as future expectations. Although management believes that the assumptions used to evaluate potential impairment are reasonable and appropriate, such assumptions are highly subjective.
During the third quarter of 2009, the Company recorded impairment charges aggregating $12,500,000 to write-down the carrying amount of two U.S. Flag vessels, an older double-hulled tanker with an inefficient gas turbine engine and one of its four single-hulled vessels (scheduled to drydock in 2010), which had limited remaining useful lives, to their estimated fair values as of September 30, 2009. During the first quarter of 2010, the Company determined that the continued weak conditions in the U.S. Flag markets represented an impairment indicator. The Company reviewed future cash flows for these two U.S. Flag vessels and the other three single-hulled vessels in its U.S. Flag fleet. The Company considered the then-current market values and the scheduled 2010 drydockings on two of the single-hulled tankers in evaluating prospects for continued operation of such vessels. The estimates of the undiscounted cash flows for the other single-hulled vessel scheduled to drydock in 2010 and the double-hulled tanker referred to above did not support recovery of such vessels’ carrying value. Accordingly, the Company recorded an impairment charge of $3,607,000 to write-down their carrying values to their estimated net fair values as of March 31, 2010, using estimates of discounted future cash flows for each of the vessels. The estimates of undiscounted cash flows as of March 31, 2010 for each of the remaining three single-hulled vessels (including the vessel for which an impairment charge was recorded in the third quarter of 2009) indicated that their carrying amounts were recoverable.
Form 10-Q
Page 41
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
Update on Critical Accounting Policies (continued):
During the second quarter of 2010, the Company continued to experience difficulty employing its single-hulled U.S. Flag vessels. The April 2010 explosion and sinking of the drilling rig, Deepwater Horizon, and the subsequent oil spill in the Gulf of Mexico resulted in proposed legislation that is expected to impact drilling and transportation services in the Gulf of Mexico. Such legislation currently under consideration includes provisions that could impact single-hulled vessels trading to the LOOP and performing lightering operations and impose restrictions on activities in the Exclusive Economic Zone, among other matters. In addition, discussions were held with regulators and the Delaware Bay lightering customers concerning the future composition of the U.S. Flag lightering fleet and the requirement for vessels to have vapor-balancing capabilities. As a result of these conditions, the Company concluded that impairment indicators were present and performed an impairment analysis for its four single-hulled U.S. Flag vessels and a 1981-built U.S. Flag ATB engaged in lightering in the Delaware Bay. One of the four single-hulled vessels completed a grain voyage to the East Coast of Africa in early June and was subsequently delivered to buyers on July 1, 2010. The Company’s estimate of undiscounted future cash flows for the other four U.S. Flag vessels included its expectation for future market rates, a reduced likelihood of future employment opportunities, the timing and cost of upcoming drydockings in 2010 and 2011, the potential cost of modifications to the ATB engaged in lightering and the potential impact of legislation described above. The Company’s estimates of undiscounted future cash flows for three of its four single-hulled vessels, including the one sold in July, and the lightering ATB did not support recovery of such vessels’ carrying value at June 30, 2010. Accordingly, the Company recorded an impairment charge of $12,446,000 to write-down their carrying values to their estimated fair values at June 30, 2010.
During March 2010, OSG was informed by one of the major refineries along the U.S. Gulf that it would no longer accept the Company’s two single-hulled Aframaxes employed in the International Crude Tankers segment’s lightering business, commencing April 1, 2010. OSG has a 50% interest in the residual value of these two Aframaxes, which are chartered-in. These single-hulled Aframaxes are not subject to the IMO phase out until 2013. The Company considered the impact of the resulting likely reduction in utilization on estimated future charter rates and was in the process of considering alternate employment or use for these vessels, which have additional features compared with standard Aframaxes. The estimates of the undiscounted future cash flows as of March 31, 2010 for these two vessels indicated that their carrying amounts at March 31, 2010 were recoverable. During the second quarter, both of these vessels had substantial idle time awaiting employment. In addition, the Company reconsidered its ability to employ these two single-hulled Aframaxes in lightering in the Gulf of Mexico after the explosion and sinking of the Deepwater Horizon, also taking into consideration proposed legislation that would ban single hull tankers from serving lightering zones in the Gulf of Mexico effective January 1, 2011. These events have also exerted downward pressure on prospective rates for alternative employment for these vessels. Given the revised employment outlook for these two vessels, the Company reevaluated the prospects for drydocking these vessels in 2011 and renewing the charters upon their expiry in 2011 and no longer considers it likely that these charters will be extended. Based on its evaluation of undiscounted future cash flows, the Company concluded that both single-hulled Aframaxes were impaired at June 30, 2010. Accordingly, the Company recorded an impairment charge of $12,730,000 to write-down the carrying values of the intangible assets and costs related to the charters to their estimated fair values at June 30, 2010.
The Company continued to experience difficulty in employing its single-hulled U.S. Flag vessels and two single-hulled International Flag Aframaxes engaged in lightering in the U.S. Gulf during the third quarter of 2010. However, no additional information was identified during the quarter that would suggest that the assumptions used in the Company’s June 30, 2010 evaluation of the future cash flows for these vessels have changed. Accordingly, no impairment tests were performed as of September 30, 2010. It is possible that the Company’s estimates of undiscounted cash flows may change in the future, resulting in the need for additional write-downs of one or more of the vessels discussed above.
Form 10-Q
Page 42
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
Results from Vessel Operations:
During the third quarter of 2010, TCE revenues increased marginally by $1,260,000, or 1%, to $208,558,000 from $207,298,000 in the third quarter of 2009 primarily due to a 161 day increase in revenue days. During the third quarter of 2010, approximately 63% of the Company’s TCE revenues were derived from spot earnings, compared with 43% in the third quarter of 2009. In the third quarter of 2010, approximately 37% of TCE revenues were generated from fixed earnings, which comprise time or bareboat charters (“term”) and synthetic time charters (which represent earnings for certain vessels operating in pools that have been converted to synthetic time charters through hedging with FFAs and bunker swaps that qualify as cash flow hedges). Fixed earnings represented 57% of the Company’s TCE revenues in the third quarter of 2009. During the first nine months of 2010, TCE revenues decreased by $78,391,000, or 10%, to $670,081,000 from $748,472,000 in the first nine months of 2009. During the first nine months of 2010, approximately 65% of the Company’s TCE revenues were derived from spot earnings compared with 50% in the first nine months of 2009.
OSG operates most of its crude oil tankers in commercial pooling arrangements (“Pools”). The Pools' cargo commitments make them attractive, but such cargo commitments limit the Pools’ ability to support any significant portfolio of time charters. Accordingly, OSG enters into forward freight agreements (“FFAs”) and bunker swaps seeking to create synthetic time charters. The results of derivative positions that qualify for hedge accounting treatment and that are effective are reflected in TCE revenues in the periods to which such hedges relate. The Company achieved average TCE rates for VLCCs of $32,578 per day for 92 days and $38,920 per day for 890 days covered by such effective hedges for the third quarter of 2010 and 2009, respectively. The September 30, 2010 mark-to-market for derivative positions that qualify for hedge accounting treatment, which are considered to be effective, are recorded in accumulated other comprehensive income/(loss) (equity). The actual results of these hedge positions will be reflected in the Company's earnings in October, the period to which the positions relate.
Reliance on the spot market contributes to fluctuations in the Company’s revenue, cash flow, and net income, but affords the Company greater opportunity to increase income from vessel operations when rates rise. On the other hand, time and bareboat charters provide the Company with a predictable level of revenues.
During the third quarter of 2010, the loss from vessel operations decreased by $678,000 to $15,521,000 from $16,199,000 in the third quarter of 2009. During the first nine months of 2010, results from vessel operations decreased by $141,494,000 to a loss of $28,349,000 from income of $113,145,000 in the first nine months of 2009. As previously discussed, the results from vessel operations in the third quarter and first nine months of 2010 included nil and $28,783,000, respectively, of impairment charges compared with $12,500,000 of impairment charges in the third quarter and first nine months of 2009. The loss from vessel operations in the first nine months of 2010 also included losses on vessel sales and a reduction in shipyard contract termination costs previously recognized of $490,000 and $627,000, respectively, compared with gains on vessel sales of $140,625,000 and shipyard contract termination costs of $27,074,000 in the corresponding prior year period.
Form 10-Q
Page 43
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
Results from Vessel Operations (continued):
See Note C to the condensed financial statements for additional information on the Company’s segments, including equity in income/(loss) of affiliated companies and reconciliations of (i) time charter equivalent revenues to shipping revenues and (ii) income/(loss) from vessel operations for the segments to income/(loss) before federal income taxes, including net income attributable to noncontrolling interest, as reported in the consolidated statements of operations.
Information with respect to the Company’s proportionate share of revenue days for vessels operating in companies accounted for using the equity method is shown below in the discussion of “Equity in Income of Affiliated Companies.”
International Crude Tankers (dollars in thousands)
| | | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | | 2010 | | | 2009 | | | 2010 | | | 2009 | |
| TCE revenues | | $ | 95,294 | | | $ | 99,805 | | | $ | 353,423 | | | $ | 387,936 | |
| Vessel expenses | | | (23,139 | ) | | | (24,606 | ) | | | (75,484 | ) | | | (74,608 | ) |
| Charter hire expenses | | | (45,702 | ) | | | (51,367 | ) | | | (140,215 | ) | | | (184,251 | ) |
| Depreciation and amortization | | | (18,275 | ) | | | (18,523 | ) | | | (55,718 | ) | | | (54,818 | ) |
Income from vessel operations (a) | | $ | 8,178 | | | $ | 5,309 | | | $ | 82,006 | | | $ | 74,259 | |
| Average daily TCE rate | | $ | 21,266 | | | $ | 21,204 | | | $ | 26,170 | | | $ | 27,509 | |
Average number of owned vessels (b) | | | 26.0 | | | | 25.0 | | | | 25.9 | | | | 24.7 | |
| Average number of vessels chartered-in under operating leases | | | 23.6 | | | | 27.1 | | | | 24.3 | | | | 28.0 | |
Number of revenue days (c) | | | 4,481 | | | | 4,707 | | | | 13,505 | | | | 14,102 | |
Number of ship-operating days:(d) | | | | | | | | | | | | | | | | |
| Owned vessels | | | 2,392 | | | | 2,300 | | | | 7,058 | | | | 6,739 | |
| Vessels bareboat chartered-in under operating leases | | | 460 | | | | 599 | | | | 1,365 | | | | 1,786 | |
| Vessels time chartered-in under operating leases | | | 1,533 | | | | 1,610 | | | | 4,563 | | | | 5,126 | |
| Vessels spot chartered-in under operating leases | | | 178 | | | | 283 | | | | 708 | | | | 737 | |
| (a) | Income/(loss) from vessel operations by segment is before general and administrative expenses, severance and relocation costs, shipyard contract termination costs and gain/(loss) on disposal of vessels and impairment charges (vessel and goodwill). |
| (b) | The average is calculated to reflect the addition and disposal of vessels during the period. |
| (c) | Revenue days represent ship-operating days less days that vessels were not available for employment due to repairs, drydock or lay-up. Revenue days are weighted to reflect the Company’s interest in chartered-in vessels. |
| (d) | Ship-operating days represent calendar days. |
Form 10-Q
Page 44
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
Results from Vessel Operations (continued):
The following tables provide a breakdown of TCE rates achieved for the three and nine months ended September 30, 2010 and 2009, between spot and fixed earnings and the related revenue days. The Company has entered into FFAs and related bunker swaps as hedges against the volatility of earnings from operating the Company’s VLCCs in the spot market. These derivative instruments seek to create synthetic time charters because their intended impact is to create a level of fixed TCE earnings, which because of basis risk may vary (possibly substantially) from the targeted rate. From the perspective of a vessel owner, such as the Company, the results of these synthetic time charters are intended to be substantially equivalent to results from time chartering vessels in the physical market. The impact of these derivatives, which qualify for hedge accounting treatment, are reported together with time charters entered in the physical market under “Fixed Earnings.” The information in these tables is based, in part, on information provided by the pools or commercial joint ventures in which the segment’s vessels participate.
| Three months ended September 30, | | 2010 | | | 2009 | |
| | | Spot Earnings | | | Fixed Earnings | | | Spot Earnings | | | Fixed Earnings | |
| VLCCs: | | | | | | | | | | | | |
| Average rate | | $ | 32,017 | | | $ | 32,578 | | | $ | 22,977 | | | $ | 38,920 | |
| Revenue days | | | 1,245 | | | | 92 | | | | 436 | | | | 890 | |
| Suezmaxes: | | | | | | | | | | | | | | | | |
| Average rate | | $ | 19,185 | | | $ | — | | | $ | 14,000 | | | $ | — | |
| Revenue days | | | 285 | | | | — | | | | 206 | | | | — | |
| Aframaxes: | | | | | | | | | | | | | | | | |
| Average rate | | $ | 16,036 | | | $ | 20,980 | | | $ | 13,421 | | | $ | 30,972 | |
| Revenue days | | | 1,857 | | | | 87 | | | | 1,810 | | | | 313 | |
| Panamaxes: | | | | | | | | | | | | | | | | |
| Average rate | | $ | 16,557 | | | $ | 17,102 | | | $ | 14,298 | | | $ | 24,940 | |
| Revenue days | | | 458 | | | | 364 | | | | 592 | | | | 368 | |
| Nine months ended September 30, | | 2010 | | | 2009 | |
| | | Spot Earnings | | | Fixed Earnings | | | Spot Earnings | | | Fixed Earnings | |
| VLCCs: | | | | | | | | | | | | |
| Average rate | | $ | 41,087 | | | $ | 44,314 | | | $ | 35,488 | | | $ | 41,786 | |
| Revenue days | | | 3,350 | | | | 522 | | | | 1,548 | | | | 2,432 | |
| Suezmaxes: | | | | | | | | | | | | | | | | |
| Average rate | | $ | 27,798 | | | $ | — | | | $ | 26,455 | | | $ | — | |
| Revenue days | | | 798 | | | | — | | | | 658 | | | | — | |
| Aframaxes: | | | | | | | | | | | | | | | | |
| Average rate | | $ | 18,654 | | | $ | 21,739 | | | $ | 21,538 | | | $ | 35,695 | |
| Revenue days | | | 5,641 | | | | 475 | | | | 5,415 | | | | 742 | |
| Panamaxes: | | | | | | | | | | | | | | | | |
| Average rate | | $ | 20,549 | | | $ | 17,959 | | | $ | 20,236 | | | $ | 26,430 | |
| Revenue days | | | 1,359 | | | | 1,088 | | | | 1,798 | | | | 1,236 | |
Form 10-Q
Page 45
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
Results from Vessel Operations (continued):
During the third quarter of 2010, TCE revenues for the International Crude Tankers segment decreased by $4,511,000, or 5%, to $95,294,000 from $99,805,000 in the third quarter of 2009 reflecting decreases in average blended rates for VLCCs and average time charter rates for Panamaxes, as well as a 226 decrease in revenue days. The decline in average rates earned by the VLCCs reflected a reduction in fixed coverage from FFAs and related bunker swaps. The decrease in revenue days is primarily due to decreases in chartered-in vessels in the Panamax and Aframax fleets. Results for the third quarter of 2010 reflect substantial idle time as well as poor returns achieved for the two double-sided Aframaxes in the OSG Lightering business, one of which was repositioned to the Far East during the quarter.
Vessel expenses decreased by $1,467,000 to $23,139,000 in the third quarter of 2010 from $24,606,000 in the third quarter of 2009. The decrease was principally attributable to a decrease in average daily vessel expenses of $383 per day related to lower crew costs and repair expenses in the current period. Charter hire expenses decreased by $5,665,000 to $45,702,000 in the third quarter of 2010 from $51,367,000 in the third quarter of 2009, principally as a result of 321 fewer chartered-in days in the current quarter.
During the first nine months of 2010, TCE revenues for the International Crude Tankers segment decreased by $34,513,000, or 9%, to $353,423,000 from $387,936,000 in the first nine months of 2009. This decline was principally attributable to lower average time charter rates achieved for Aframaxes and Panamaxes in the first nine months of 2010 as prior charters expired and were replaced at lower rates and reductions in revenue days for the Aframax and Panamax sectors of 300 and 587 days, respectively. The spot Aframax rate for the 2010 period reflects substantial idle and repositioning time for the two double-sided Aframaxes in the OSG Lightering business during the second and third quarters of 2010.
Vessel expenses increased by $876,000 to $75,484,000 in the first nine months of 2010 from $74,608,000 in the first nine months of 2009 reflecting an increase in average daily vessel expenses of $220 per day. The increase in average daily vessel expenses for the first nine months of 2010 was primarily due to the timing of fees and services and the delivery of stores and spares in the current period. Offsetting the impact of the increase in average daily vessel expenses was a 102 day decline in owned and bareboat chartered-in days. Charter hire expenses decreased by $44,036,000 to $140,215,000 in the first nine months of 2010 from $184,251,000 in the first nine months of 2009, reflecting a decrease of 1,013 chartered-in days and substantially lower profit share due to owners of chartered-in VLCCs, Aframaxes and OSG Lightering vessels.
Form 10-Q
Page 46
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
Results from Vessel Operations (continued):
International Product Carriers (dollars in thousands)
| | | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | | 2010 | | | 2009 | | | 2010 | | | 2009 | |
| TCE revenues | | $ | 47,892 | | | $ | 45,966 | | | $ | 143,444 | | | $ | 180,732 | |
| Vessel expenses | | | (15,727 | ) | | | (17,598 | ) | | | (48,212 | ) | | | (61,751 | ) |
| Charter hire expenses | | | (23,458 | ) | | | (25,649 | ) | | | (73,783 | ) | | | (81,612 | ) |
| Depreciation and amortization | | | (9,088 | ) | | | (7,926 | ) | | | (26,859 | ) | | | (31,362 | ) |
| Income/(loss) from vessel operations | | $ | (381 | ) | | $ | (5,207 | ) | | $ | (5,410 | ) | | $ | 6,007 | |
| Average daily TCE rate | | $ | 15,218 | | | $ | 16,242 | | | $ | 15,861 | | | $ | 18,623 | |
| Average number of owned vessels | | | 15.0 | | | | 12.0 | | | | 14.3 | | | | 13.7 | |
| Average number of vessels chartered-in under operating leases | | | 21.5 | | | | 19.2 | | | | 20.2 | | | | 23.0 | |
| Number of revenue days | | | 3,147 | | | | 2,830 | | | | 9,044 | | | | 9,705 | |
| Number of ship-operating days: | | | | | | | | | | | | | | | | |
| Owned vessels | | | 1,380 | | | | 1,104 | | | | 3,914 | | | | 3,740 | |
| Vessels bareboat chartered-in under operating leases | | | 872 | | | | 915 | | | | 2,501 | | | | 3,991 | |
| Vessels time chartered-in under operating leases | | | 1,104 | | | | 854 | | | | 3,013 | | | | 2,296 | |
The following tables provide a breakdown of TCE rates achieved for the three and nine months ended September 30, 2010 and 2009 between spot and fixed earnings and the related revenue days. The information is based, in part, on information provided by the commercial joint ventures in which certain of the segment’s vessels participate.
| Three months ended September 30, | | 2010 | | | 2009 | |
| | | Spot Earnings | | | Fixed Earnings | | | Spot Earnings | | | Fixed Earnings | |
| Panamax Product Carriers: | | | | | | | | | | | | |
| Average rate | | $ | 15,915 | | | $ | — | | | $ | 14,813 | | | $ | — | |
| Revenue days | | | 184 | | | | — | | | | 364 | | | | — | |
| Handysize Product Carriers: | | | | | | | | | | | | | | | | |
| Average rate | | $ | 13,057 | | | $ | 22,193 | | | $ | 11,766 | | | $ | 22,333 | |
| Revenue days | | | 2,089 | | | | 782 | | | | 1,279 | | | | 1,095 | |
Form 10-Q
Page 47
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
Results from Vessel Operations (continued):
| Nine months ended September 30, | | 2010 | | | 2009 | |
| | | Spot Earnings | | | Fixed Earnings | | | Spot Earnings | | | Fixed Earnings | |
| Panamax Product Carriers: | | | | | | | | | | | | |
| Average rate | | $ | 19,314 | | | $ | — | | | $ | 18,935 | | | $ | 19,429 | |
| Revenue days | | | 763 | | | | — | | | | 1,011 | | | | 282 | |
| Handysize Product Carriers: | | | | | | | | | | | | | | | | |
| Average rate | | $ | 13,110 | | | $ | 21,085 | | | $ | 17,376 | | | $ | 21,003 | |
| Revenue days | | | 5,431 | | | | 2,582 | | | | 3,661 | | | | 4,405 | |
During the third quarter of 2010, TCE revenues for the International Product Carriers segment increased by $1,926,000, or 4%, to $47,892,000 from $45,966,000 in the third quarter of 2009. This increase in TCE revenues reflected an increase in revenue days for modern Handysize Product Carriers of 579 days, partially offset by the impact of two Panamax Product Carriers being out-of-service for the entire quarter while they underwent repairs.
Vessel expenses decreased by $1,871,000 to $15,727,000 in the third quarter of 2010 from $17,598,000 in the third quarter of 2009, principally due to the two Panamax Product Carriers that were out-of-service and undergoing repairs during the quarter, and a decrease in average daily vessel expenses for the modern Handysize Product Carriers of $817 per day. This decrease in average daily vessel expenses resulted from lower crew costs and the timing of delivery of lubricating oils, stores and spares. These decreases were partially offset by a 320 day increase in owned and bareboat chartered-in days for modern Handysize Product Carriers. Charter hire expenses decreased by $2,191,000 to $23,458,000 in the third quarter of 2010 from $25,649,000 in the third quarter of 2009, due to the recognition of certain third party recoveries of approximately $5,200,000 on the two Panamax Product Carrier undergoing repairs as a reduction of charter hire expense. This decrease was partially offset by a net 207 day increase in time chartered-in days during the current quarter, which was the result of the program to replace older single-hull Handysize Product Carriers, which redelivered in 2009, with modern vessels. Depreciation and amortization increased by $1,162,000 to $9,088,000 in the third quarter of 2010 from $7,926,000 in the third quarter of 2009 principally due to the delivery of two Handysize Product Carriers in 2010.
During the first nine months of 2010, TCE revenues for the International Product Carriers segment decreased by $37,288,000, or 21%, to $143,444,000 from $180,732,000 in the first nine months of 2009. This decrease in TCE revenues resulted primarily from the decrease in average rates earned on the Handysize Product Carriers operating in the spot market and a 661 day reduction in revenue days. This decrease in revenue days was principally related to the redelivery of the older, single-hull Handysize Product Carriers (all 13 of which had redelivered to the owners at the expiry of their respective charters by August 2009), the sale of two Panamax Product Carriers in the second quarter of 2009 and out-of-service days on two other Panamax Product Carriers, which were out-of-service for repairs for a significant portion of the second quarter and the entire third quarter of 2010. Spot days for the Handysize Product Carrier fleet as a percentage of total revenue days increased to 68% from 45% in the first nine months of 2009. This shift combined with a reduction in average spot rates negatively impacted segment results.
Form 10-Q
Page 48
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
Results from Vessel Operations (continued):
Vessel expenses decreased by $13,539,000 to $48,212,000 in the first nine months of 2010 from $61,751,000 in the first nine months of 2009. This change was principally the result of a decrease of 1,316 owned and bareboat chartered-in days. Charter hire expenses decreased by $7,829,000 to $73,783,000 in the first nine months of 2010 from $81,612,000 in the first nine months of 2009 due to the recognition of recoveries on the two Panamax Product Carriers discussed above, as well as a net 773 day reduction for chartered-in vessels in the current year. The impact of the decrease in days was partially offset by modern Handysize Product Carriers being time chartered-in at higher average rates than the older Handysize Product Carriers that were redelivered in 2009, all of which were bareboat chartered-in. Depreciation and amortization decreased by $4,503,000 to $26,859,000 in the first nine months of 2010 from $31,362,000 in the first nine months of 2009, principally due to the expiration of the charters on the older Handysize Product Carriers discussed above.
In 2005 the Company reflagged two Handysize Product Carriers (the Overseas Maremar and the Overseas Luxmar) under the U.S. Flag and entered them in the U.S. Maritime Security Program (the "Program"). Each of the vessel owning companies receives a subsidy, which was increased to $2,900,000 in 2009 that is intended to offset the increased cost incurred by such vessels from operating under the U.S. Flag. Since these vessels trade primarily in the international market, they continue to be reflected in the International Product Carrier segment.
Other International (dollars in thousands)
| | | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | | 2010 | | | 2009 | | | 2010 | | | 2009 | |
| TCE revenues | | $ | 4,105 | | | $ | 1,978 | | | $ | 8,451 | | | $ | 5,869 | |
| Vessel expenses | | | (502 | ) | | | (552 | ) | | | (1,464 | ) | | | (1,601 | ) |
| Charter hire expenses | | | (2,026 | ) | | | — | | | | (2,459 | ) | | | — | |
| Depreciation and amortization | | | (1,562 | ) | | | (1,692 | ) | | | (4,660 | ) | | | (4,907 | ) |
| Income/(loss) from vessel operations | | $ | 15 | | | $ | (266 | ) | | $ | (132 | ) | | $ | (639 | ) |
| Average daily TCE rate | | $ | 22,310 | | | $ | 21,500 | | | $ | 22,008 | | | $ | 21,500 | |
| Average number of owned vessels | | | 1.0 | | | | 1.0 | | | | 1.0 | | | | 1.0 | |
| Average number of vessels chartered in under operating leases | | | 1.0 | | | | — | | | | 0.4 | | | | — | |
| Number of revenue days | | | 184 | | | | 92 | | | | 384 | | | | 273 | |
| Number of ship-operating days: | | | | | | | | | | | | | | | | |
| Owned vessels | | | 92 | | | | 92 | | | | 273 | | | | 273 | |
| Vessels time chartered-in under operating leases | | | 92 | | | | — | | | | 111 | | | | — | |
As of September 30, 2010, the Company operated two other International Flag vessels, a Pure Car Carrier and a LPG Carrier. The Pure Car Carrier, which is owned by the Company, is employed on a long-term charter. The LPG Carrier is chartered-in by the Company under a short-term charter that commenced in June 2010 and is due to expire in December 2010.
Form 10-Q
Page 49
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
Results from Vessel Operations (continued):
U. S. Segment (dollars in thousands)
| | | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | | 2010 | | | 2009 | | | 2010 | | | 2009 | |
| TCE revenues | | $ | 61,267 | | | $ | 59,549 | | | $ | 164,763 | | | $ | 173,935 | |
| Vessel expenses | | | (24,641 | ) | | | (23,917 | ) | | | (70,585 | ) | | | (72,191 | ) |
| Charter hire expenses | | | (19,882 | ) | | | (16,489 | ) | | | (53,856 | ) | | | (43,579 | ) |
| Depreciation and amortization | | | (13,270 | ) | | | (12,836 | ) | | | (40,096 | ) | | | (38,661 | ) |
| Income/(loss) from vessel operations | | $ | 3,474 | | | $ | 6,307 | | | $ | 226 | | | $ | 19,504 | |
| Average daily TCE rate | | $ | 38,598 | | | $ | 37,010 | | | $ | 36,424 | | | $ | 35,708 | |
| Average number of owned vessels | | | 14.5 | | | | 14.0 | | | | 15.2 | | | | 15.3 | |
| Average number of vessels chartered in under operating leases | | | 8.3 | | | | 7.0 | | | | 7.6 | | | | 6.2 | |
| Number of revenue days | | | 1,587 | | | | 1,609 | | | | 4,523 | | | | 4,871 | |
| Number of ship-operating days: | | | | | | | | | | | | | | | | |
| Owned vessels | | | 1,338 | | | | 1,288 | | | | 4,157 | | | | 4,171 | |
| Vessels bareboat chartered-in under operating leases | | | 766 | | | | 644 | | | | 2,081 | | | | 1,706 | |
During the third quarter of 2010, TCE revenues for the U.S. segment increased by $1,718,000, or 3%, to $61,267,000 from $59,549,000 in the third quarter of 2009. The increase in TCE revenues reflects the delivery of the Overseas Cascade, which commenced a five-year time charter on April 1, 2010, the delivery of two bareboat chartered-in Jones Act Product Carriers, one in May 2010 and the other in August 2010, both of which commenced three-year charters upon delivery, and an increase in lightering volumes. Partially offsetting these increases were the sale of one single hull tanker in July 2010 and the lay-up of five vessels for a total of 460 days compared with four vessels and 284 lay-up days in last year’s third quarter.
Vessel expenses increased by $724,000 to $24,641,000 in the third quarter of 2010 from $23,917,000 in the third quarter of 2009, due to an increase of 172 owned and bareboat chartered-in days during the current quarter, partially offset by the impact of the increase in lay-up days discussed above. Charter hire expenses increased by $3,393,000 to $19,882,000 in the third quarter of 2010 from $16,489,000 in the third quarter of 2009, reflecting the delivery of the two bareboat chartered-in Jones Act Product Carriers referred to above.
During the first nine months of 2010, TCE revenues for the U.S. segment decreased by $9,172,000, or 5%, to $164,763,000 from $173,935,000 in the first nine months of 2009. The decrease was primarily attributable to six vessels being in lay-up for a total of 1,436 days during 2010 due to the weak market conditions compared with 917 lay-up days in 2009, as well as lower rates earned on ATBs due to the expiry of time charters with higher daily rates than were available in the spot market. Partially offsetting these decreases were the delivery of the Overseas Cascade and four bareboat chartered-in Jones Act Product Carriers since the beginning of 2009, which, in total, added 556 revenue days.
Form 10-Q
Page 50
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
Results from Vessel Operations (continued):
Vessel expenses decreased by $1,606,000 to $70,585,000 in the first nine months of 2010 from $72,191,000 in the first nine months of 2009, principally due to the significant increase in lay-up and dry-dock days during 2010. Charter hire expenses increased by $10,277,000 to $53,856,000 in the first nine months of 2010 from $43,579,000 in the first nine months of 2009, principally due to the delivery of the chartered-in Jones Act Product Carriers referred to above.
General and Administrative Expenses
During the third quarter of 2010, general and administrative expenses decreased by $3,228,000 to $25,085,000 from $28,313,000 in the third quarter of 2009, principally because of the following:
| | · | a favorable change in foreign exchange rates that resulted in gains of $1,492,000; and |
| | · | lower consulting, legal and travel and entertainment costs of $2,125,000, which includes approximately $1,714,000 of costs incurred in the third quarter of 2009 in connection with the tender offer for all of the outstanding publicly held common units of OSG America L.P. |
During the first nine months of 2010, general and administrative expenses decreased by $8,327,000 to $76,393,000 from $84,720,000 in the first nine months of 2009, principally because of the following:
| | · | a reduction in compensation and benefits paid to shore-based staff of $2,429,000; |
| | · | a favorable change in foreign exchange rates that resulted in gains of $1,722,000; and |
| | · | lower consulting, legal and travel and entertainment costs of $3,406,000, which includes approximately $1,714,000 of costs incurred in 2009 in connection with the tender offer for all of the outstanding publicly held common units of OSG America L.P. |
Equity in Income of Affiliated Companies:
During the third quarter of 2010, equity in results of affiliated companies decreased by $2,645,000 to a loss of $165,000 from income of $2,480,000 in the third quarter of 2009. During the first nine months of 2010, equity in results of affiliated companies decreased by $11,576,000 to a loss of $5,508,000 from income of $6,068,000 in the nine months ended September 30, 2009. The changes are the result of delays in the completion of the conversion of two ULCCs by the FSO joint venture and the de-designation of an interest rate swap covering the FSO Africa’s portion of the FSO joint venture’s debt outstanding. As a result of delays in the completion of the conversion of the TI Asia to an FSO, the joint venture chartered-in the TI Oceania, a ULCC wholly owned by the Company, as a temporary replacement floating storage unit. Charter hire received from MOQ from early August 2009 through the vessel’s redelivery in January 2010 was substantially offset by liquidated damages payable by the joint venture to MOQ under the service contracts. The FSO Africa completed conversion in March
Form 10-Q
Page 51
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
Equity in Income of Affiliated Companies (continued):
2010 and costs incurred subsequent thereto, including fuel costs incurred while at anchorage, have been reflected in profit and loss. The FSO Africa was idle from its delivery through August 30, 2010, at which time it commenced a three year service contract with MOQ. Because of MOQ’s notification that it was cancelling the service contract for the FSO Africa, the joint venture recorded a charge in the first quarter of 2010 attributable to the de-designation of interest rate swaps that were being accounted for as cash flow hedges. The change in the fair value of the FSO Africa interest rate swaps resulted in charges of $6,067,000 and $23,538,000 in the third quarter and first nine months of 2010, respectively. The Company’s share of such charges, $3,033,000 and $11,769,000 in the third quarter and first nine months of 2010, respectively, were recognized in results from affiliated companies. For more information with respect to the conversion of the two ULCCs to FSOs see below in the discussion of “Liquidity and Sources of Capital.”
Additionally, the Company has a 37.5% interest in ATC, a company that operates U.S. Flag tankers to transport Alaskan crude oil for BP. ATC earns additional income (in the form of incentive hire paid by BP) based on meeting certain predetermined performance standards. Such income is included in the U.S. segment.
The following tables summarize OSG’s proportionate share of the revenue days for the respective vessels held in its vessel owning equity method investments, excluding ATC. Revenue days are adjusted for OSG’s percentage ownership in order to state the revenue days on a basis comparable to that of a wholly owned vessel. The ownership percentages reflected below are the Company’s actual ownership percentages as of September 30, 2010 and 2009.
| Three months ended September 30, | | 2010 | | | 2009 | |
| | | Revenue Days | | | % of Ownership | | | Revenue Days | | | % of Ownership | |
| LNG Carriers operating on long-term charters | | | 184 | | | | 49.9 | % | | | 184 | | | | 49.9 | % |
| FSOs operating on long-term charter | | | 62 | | | | 50.0 | % | | | — | | | | — | |
| ULCC operating as temporary FSO | | | — | | | | — | | | | 35 | | | | 50.0 | % |
| | | | 246 | | | | | | | | 219 | | | | | |
| Nine months ended September 30, | | 2010 | | | 2009 | |
| | | Revenue Days | | | % of Ownership | | | Revenue Days | | | % of Ownership | |
| LNG Carriers operating on long-term charters | | | 546 | | | | 49.9 | % | | | 545 | | | | 49.9 | % |
| FSOs operating on long-term charter | | | 150 | | | | 50.0 | % | | | — | | | | — | |
| ULCC operating as temporary FSO | | | 11 | | | | 50.0 | % | | | 35 | | | | 50.0 | % |
| | | | 707 | | | | | | | | 580 | | | | | |
Form 10-Q
Page 52
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
Interest Expense:
The components of interest expense are as follows (in thousands):
| | | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | | 2010 | | | 2009 | | | 2010 | | | 2009 | |
| Interest before impact of swaps and capitalized interest | | $ | 17,435 | | | $ | 10,070 | | | $ | 47,448 | | | $ | 33,184 | |
| Impact of swaps | | | 3,016 | | | | 3,171 | | | | 9,512 | | | | 7,719 | |
| Capitalized interest | | | (2,712 | ) | | | (2,308 | ) | | | (7,735 | ) | | | (7,695 | ) |
| Interest expense | | $ | 17,739 | | | $ | 10,933 | | | $ | 49,225 | | | $ | 33,208 | |
The Company’s issuance of $300,000,000 principal amount of 8.125% senior unsecured notes in March 2010 and use of the net proceeds to reduce amounts borrowed under the long-term revolving credit facility, resulted in an increase in interest expense for the three and nine months ended September 30, 2010. Interest expense for the nine months ended September 30, 2010 also includes a $1,029,000 write off of the unamortized balance of deferred finance charges with respect to the $200,000,000 secured revolving credit facility, which the Company terminated in June 2010. The above increases were offset by the prepayment on July 1, 2010 of $42,174,000 of fixed rate term loans with a weighted average interest rate of 6%. Such prepayment was funded using funds borrowed under the long-term revolving credit facility.
Interest expense increased by $6,806,000 to $17,739,000 in the third quarter of 2010 from $10,933,000 in the third quarter of 2009 as a result of increases in the average amount of variable debt outstanding of $193,030,000, as well as an increase in the average rate paid on floating rate debt of 40 basis points to 1.5% from 1.1% in 2009 and the issuance of 8.125% senior unsecured notes, net of the impact of the prepayment of 6% term loans, described above.
Interest expense increased by $16,017,000 to $49,225,000 in the first nine months of 2010 from $33,208,000 in the first nine months of 2009 as a result of increases in the average amount of variable debt outstanding of $234,090,000, the issuance of the 8.125% senior unsecured notes, net of the impact of the prepayment of 6% term loans, and the impact from interest rate swaps resulting from the decline in LIBOR rates for the 2010 period compared with the comparable period of 2009. These increases were partially offset by a decrease in the average rate paid on floating rate debt of 10 basis points to 1.4% from 1.5% in 2009.
Provision/(Credit) for Federal Income Taxes:
The income tax benefits for the three and nine months ended September 30, 2010 and 2009 were based on the pre-tax results of the Company’s U.S. subsidiaries, adjusted to include non-shipping income of the Company’s foreign subsidiaries and reflect the reversal of previously established deferred tax liabilities.
Form 10-Q
Page 53
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
Provision/(Credit) for Federal Income Taxes (continued):
On October 22, 2004, the President of the U.S. signed into law the American Jobs Creation Act of 2004. The Jobs Creation Act reinstated tax deferral for OSG’s foreign shipping income for years beginning after December 31, 2004. Effective January 1, 2005, the earnings from shipping operations of the Company’s foreign subsidiaries are not subject to U.S. income taxation as long as such earnings are not repatriated to the U.S. Because the Company intends to permanently reinvest these earnings in foreign operations, no provision for U.S. income taxes on such earnings of its foreign subsidiaries is required after December 31, 2004.
EBITDA:
EBITDA represents operating earnings excluding net income/(loss) attributable to the noncontrolling interest, which is before interest expense and income taxes, plus other income and depreciation and amortization expense. EBITDA is presented to provide investors with meaningful additional information that management uses to monitor ongoing operating results and evaluate trends over comparative periods. EBITDA should not be considered a substitute for net income/(loss) attributable to the Company or cash flow from operating activities prepared in accordance with accounting principles generally accepted in the United States or as a measure of profitability or liquidity. While EBITDA is frequently used as a measure of operating results and performance, it is not necessarily comparable to other similarly titled captions of other companies due to differences in methods of calculation. The following table reconciles net income/(loss) attributable to the Company, as reflected in the condensed consolidated statements of operations, to EBITDA (in thousands):
| | | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | | 2010 | | | 2009 | | | 2010 | | | 2009 | |
| Net income/(loss) attributable to Overseas Shipholding Group, Inc. | | $ | (31,754 | ) | | $ | (19,624 | ) | | $ | (78,964 | ) | | $ | 93,332 | |
| Credit for income taxes | | | (1,516 | ) | | | (1,850 | ) | | | (3,624 | ) | | | (6,153 | ) |
| Interest expense | | | 17,739 | | | | 10,933 | | | | 49,225 | | | | 33,208 | |
| Depreciation and amortization | | | 42,195 | | | | 40,977 | | | | 127,333 | | | | 129,748 | |
| EBITDA | | $ | 26,664 | | | $ | 30,436 | | | $ | 93,970 | | | $ | 250,135 | |
Liquidity and Sources of Capital:
Working capital at September 30, 2010 was approximately $460,000,000 compared with $634,000,000 at December 31, 2009. Current assets are highly liquid, consisting principally of cash, interest-bearing deposits and receivables. In July 2010, the Company withdrew the balance remaining in the Capital Construction Fund in connection with the construction of two U.S. Flag ATBs.
Net cash provided by operating activities in the first nine months of 2010 approximated $35,000,000 (which is not necessarily indicative of the cash to be provided by operating activities for the year ending December 31, 2010) compared with $206,000,000 provided by operating activities in the first nine months of 2009. Current financial resources, together with cash anticipated to be generated from operations, are expected to be adequate to meet requirements in the next year.
Form 10-Q
Page 54
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
Liquidity and Sources of Capital (continued):
The Company’s reliance on the spot market contributes to fluctuations in cash flows from operating activities. Any decrease in the average TCE rates earned by the Company’s vessels in quarters subsequent to September 30, 2010, compared with the actual TCE rates achieved during the first nine months of 2010, will have a negative comparative impact on the amount of cash provided by or used in operating activities. The Company enters into forward freight agreements to hedge a portion of the results of its VLCC fleet, recognizing that such contracts have basis risk. Most of these contracts are exchange-based, which significantly reduces counterparty risk.
In order to increase liquidity, the Company periodically evaluates transactions, which may result in either the sale or the sale and leaseback of certain vessels in its fleet. The Company continues to monitor and evaluate the timing of repurchases of stock under its share buyback program. Because of weakness in the financial and credit markets there is currently a greater focus on maintaining cash balances. The Company continually reviews the amount of its regular quarterly dividend to determine whether it is sustainable at current levels as part of its strategy to provide growth in returns to stockholders while maintaining a strong balance sheet. Future dividends, similar to the stock repurchase program, will be evaluated as part of managing the balance sheet and cash.
On July 1, 2010, the Company prepaid fixed rate secured term loans due through 2014 with an outstanding balance of $42,174,000. The weighted average interest rate of this debt is 6.0%. The Company funded this repayment with borrowings from its $1,800,000,000 unsecured credit facility. The unsecured credit facility has a floating rate based on LIBOR, which was approximately 0.3% at September 30, 2010.
On June 24, 2010, the Company terminated its $200,000,000 secured revolver credit facility.
On March 9, 2010, pursuant to a Form S-3 shelf registration, the Company sold 3,500,000 shares of its common stock at a price of $45.33 per share. The Company received net proceeds of $158,266,000, after deducting estimated expenses. OSG used the net proceeds from this offering for working capital purposes and the repayment of outstanding indebtedness under its unsecured revolving credit facility.
On March 29, 2010, pursuant to a Form S-3 shelf registration filed on March 4, 2010, the Company issued $300,000,000 principal amount of senior unsecured notes. The notes are due in March 2018 and have a coupon of 8.125%. The Company received net proceeds of approximately $289,745,000, after deducting underwriting discounts and commissions and estimated expenses. OSG used the net proceeds from the offering to reduce outstanding indebtedness under its unsecured revolving credit facility.
The indentures pursuant to which the Company’s senior unsecured notes were issued require the Company to secure its senior unsecured notes equally and comparably with any other unsecured indebtedness in the event OSG is required to secure such debt.
As of September 30, 2010, OSG had $1,800,000,000 of long-term unsecured credit availability, of which approximately $675,000,000 had been borrowed and an additional $1,783,000 had been used for letters of credit. The Company’s long-term revolving credit facility matures as follows: $150,000,000 (2011), $150,000,000 (2012) and $1,500,000,000 (2013). The current financial resources available under the unsecured credit facility are significant and remain a stable source of funds for the Company especially in the current weak financial and tight credit markets. The availability under the unsecured credit facility plus cash on hand and cash expected to be generated from operations should be sufficient to allow the Company to meet both its operating and capital requirements for vessels under construction in the short and medium term.
Form 10-Q
Page 55
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
Liquidity and Sources of Capital (continued):
In March 2010, Moody’s Investors Service (“Moody’s”) affirmed the Ba2 corporate family rating of the Company. In addition, Moody’s downgraded the rating for the Company’s senior unsecured debt to Ba3 from Ba2 and changed the ratings outlook to negative. Moody’s downgrade of the senior unsecured rating is a consequence of a shift in the composition of the Company’s debt capital, to one with a higher proportion of senior secured debt. Further increases in debt, either from share repurchases or acquisitions or additional charter-in commitments could result in additional downgrades, as could a protracted downturn in freight rates. The Company’s debt agreements do not contain downgrade triggers.
The Company was in compliance with all of the financial covenants contained in the Company’s debt agreements as of September 30, 2010 and projects continued compliance over the next twelve months. Certain of the Company’s debt agreements contain loan-to-value clauses, which could require OSG, at its option, to post additional collateral or prepay a portion of the outstanding borrowings should the value of the vessels securing borrowings under each of such agreements decrease below their current valuations.
The financing agreements impose operating restrictions and establish minimum financial covenants. Failure to comply with any of the covenants in the financing agreements could result in a default under those agreements and under other agreements containing cross-default provisions. A default would permit lenders to accelerate the maturity of the debt under these agreements and to foreclose upon any collateral securing that debt. Under those circumstances, the Company might not have sufficient funds or other resources to satisfy its obligations.
Off-Balance Sheet Arrangements
As of September 30, 2010, the affiliated companies in which OSG held an equity interest had total bank debt outstanding of $1,202,429,000, of which $851,935,000 was nonrecourse to the Company.
In February 2008, MOQ awarded two service contracts to a joint venture between OSG and Euronav NV for terms of approximately eight years, ending in the second half of 2017, to provide to MOQ two vessels, the FSO Asia and the FSO Africa, to perform Floating, Storage and Offloading (“FSO”) services in the Al Shaheen field off shore Qatar after each vessel had been converted to an FSO. The Company has a 50% interest in this joint venture. The first ULCC, the TI Asia, which was wholly owned by Euronav NV, was sold to the joint venture in October 2008 for approximately $200,000,000. The second ULCC, the TI Africa, which was wholly owned by OSG, was sold to the joint venture in January 2009 for approximately $200,000,000. The joint venture financed the purchase of the vessels through long-term secured bank financing and partner loans. The joint venture entered into a $500,000,000 credit facility, which was secured by the service contracts, to partially finance the acquisition of the two ULCCs and the cost of conversion. Approximately $350,494,000 was outstanding under this facility on September 30, 2010, with the outstanding amount of this facility being subject to acceleration, in whole or in part, on termination of one or both of such service contracts. In connection with the secured bank financing, the partners severally issued 50% guaranties. The joint venture has entered into floating-to-fixed interest rate swaps with major financial institutions covering notional amounts aggregating $439,622,000 as of September 30, 2010, which pay fixed rates of 3.9% and receive floating rates based on LIBOR. These agreements commenced in the third quarter of 2009 and have maturity dates ranging from July to September 2017.
Form 10-Q
Page 56
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
Liquidity and Sources of Capital (continued):
After experiencing construction delays, effective hook-up of the FSO Asia was completed on January 5, 2010. The conversion of the TI Africa to an FSO also experienced construction delays. On January 21, 2010, MOQ notified the joint venture partners that it was canceling the service contract for the FSO Africa due to the delayed delivery. The conversion of the FSO Africa was completed on March 14, 2010. As a result of the cancellation of the service contract of the FSO Africa, the joint venture partners were required to post $143,000,000 in cash collateral in consideration of the banks agreeing to waive, for a period ending in the fourth quarter of 2010, the acceleration of amounts outstanding under the facility related to the FSO Africa, which aggregated $143,000,000 as of January 21, 2010. The outstanding balance under the facility applicable to the FSO Africa and the amount of collateral posted was reduced to $122,000,000 as of September 30, 2010. As of March 31, 2010, the Company concluded that it was no longer probable that the forecasted transaction applicable to the FSO Africa swaps would occur. Accordingly, in the first quarter of 2010, the Company recognized a loss of $4,548,000, representing its share of amounts previously included in accumulated other comprehensive income/(loss) by the joint venture applicable to the FSO Africa swaps, which have a remaining notional balance of approximately $219,811,000 at September 30, 2010.
In November 2004, the Company formed a joint venture with Qatar Gas Transport Company Limited (Nakilat) whereby companies in which OSG holds a 49.9% interest ordered four 216,000 cbm LNG Carriers. Upon delivery in 2007 and 2008, these vessels commenced 25-year time charters to Qatar Liquefied Gas Company Limited (II). The aggregate construction cost for such newbuildings of $918,026,000 was financed by the joint venture through long-term bank financing that is nonrecourse to the partners and partner contributions. The joint venture has entered into floating-to-fixed interest rate swaps with a group of major financial institutions that are being accounted for as cash flow hedges. The interest rate swaps cover notional amounts aggregating approximately $826,884,000, pursuant to which it pays fixed rates of approximately 4.9% and receives a floating rate based on LIBOR. These agreements have maturity dates ranging from July to November 2022.
Form 10-Q
Page 57
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
Liquidity and Sources of Capital (continued):
Aggregate Contractual Obligations
A summary of the Company’s long-term contractual obligations, excluding operating lease obligations for office space, as of September 30, 2010 follows (in thousands):
| | | Balance of 2010 | | | 2011 | | | 2012 | | | 2013 | | | 2014 | | | Beyond 2014 | | | Total | |
Debt (1) | | $ | 19,172 | | | $ | 116,849 | | | $ | 122,247 | | | $ | 857,380 | | | $ | 108,331 | | | $ | 1,121,723 | | | $ | 2,345,702 | |
Operating lease obligations (chartered-in vessels)(2) | | | 95,565 | | | | 361,053 | | | | 299,829 | | | | 241,304 | | | | 225,176 | | | | 478,682 | | | | 1,701,609 | |
Construction contracts (3) | | | 175,803 | | | | 193,750 | | | | — | | | | — | | | | — | | | | — | | | | 369,553 | |
(1) Amounts shown include contractual interest obligations. The interest obligations for floating rate debt of $1,323,936 as of September 30, 2010, have been estimated based on the fixed rates stated in related floating-to-fixed interest rate swaps, where applicable, or the LIBOR rate at September 30, 2010 of 0.3%. The Company is a party to floating-to-fixed interest rate swaps covering notional amounts aggregating $401,828 at September 30, 2010 that effectively convert the Company’s interest rate exposure from a floating rate based on LIBOR to an average fixed rate of 4.0%.
(2) As of September 30, 2010, the Company had charter-in commitments for 53 vessels on leases that are, or will be, accounted for as operating leases. Certain of these leases provide the Company with various renewal and purchase options.
(3) Represents remaining commitments under shipyard construction contracts or estimates thereof, excluding capitalized interest and other construction costs.
OSG has used interest rate swaps to convert a portion of its debt from a floating rate to a fixed rate based on management’s interest-rate outlook at various times. These agreements contain no leverage features and have various final maturity dates from March 2011 to August 2014.
OSG expects to finance vessel commitments from working capital, cash anticipated to be generated from operations, existing long-term credit facilities, and additional long-term debt, as required. The amounts of working capital and cash generated from operations that may, in the future, be utilized to finance vessel commitments are dependent on the rates at which the Company can charter its vessels. Such charter rates are volatile.
Risk Management:
The Company is exposed to market risk from changes in interest rates, which could impact its results of operations and financial condition. The Company manages this exposure to market risk through its regular operating and financing activities and, when deemed appropriate, through the use of derivative financial instruments. The Company manages its ratio of fixed-to-floating rate debt with the objective of achieving a mix that reflects management's interest rate outlook at various times. To manage this mix in a cost-effective manner, the Company, from time-to-time, enters into interest rate swap agreements, in which it agrees to exchange various combinations of fixed and variable interest rates based on agreed upon notional amounts. The Company uses such derivative financial instruments as risk management tools and not for speculative or trading purposes. In addition, derivative financial instruments are entered into with a diversified group of major financial institutions in order to manage exposure to nonperformance on such instruments by the counterparties.
Form 10-Q
Page 58
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
Risk Management (continued):
The Company seeks to reduce its exposure to fluctuations in foreign exchange rates through the use of foreign currency forward contracts and through the purchase of bulk quantities of currencies at rates that management considers favorable. For these contracts, which qualify as cash flow hedges for accounting purposes, hedge effectiveness is assessed based on changes in foreign exchange spot rates with the change in fair value of the effective portions being recorded in accumulated other comprehensive loss. As of September 30, 2010, the Company has recorded an asset of $581,000 related to the fair values of these contracts, which settle monthly between October 2010 and May 2011 and cover approximately ₤1,000,000 and €2,286,000 per month.
OSG's management regularly reviews the strategic decision with respect to the appropriate ratio of spot charter revenues to fixed rate charter revenues taking into account its expectations about spot and time charter forward rates. Decisions to modify fixed rate coverage are implemented in either the physical markets through changes in time charters or in the FFA markets, thus managing the desired strategic position while maintaining flexibility of ship availability to customers. OSG enters into Forward Freight Agreements and bunker swaps with an objective of economically hedging risk. The Company enters into FFAs and bunker swaps as economic hedges, some of which qualify as cash flow hedges for accounting purposes, seeking to reduce its exposure to changes in the spot market rates earned by some of its vessels in the normal course of its shipping business. By using FFAs and bunker swaps, OSG manages the financial risk associated with fluctuating market conditions. FFAs and bunker swaps generally cover periods ranging from one month to one year and involve contracts entered into at various rates with the intention of offsetting the variability of the TCE earnings from vessels operating in certain of the pools in which it participates. FFAs and bunker swaps are executed predominantly through NOS ASA, a Norwegian clearing house, or LCH, London Clearing House. NOS ASA and LCH require the posting of collateral by all participants. The use of a clearing house reduces the Company’s exposure to counterparty credit risk.
The Company’s VLCCs are deployed and earn revenue through a commercial pool that operates on multiple routes on voyages of varying durations, which differs from the standard routes associated with the related hedging instruments. Therefore, the FFA and bunker hedges that qualify as cash flow hedges for accounting purposes have basis risk. The TCE rates for the pools are computed from the results of actual voyages performed during the period whereas the rates used for settling FFA and bunker hedges are calculated as simple averages of the daily rates for standard routes reported with each daily rate weighted equally. High volatility tends to weaken the statistical relationship between pool performance and the FFA market results.
Form 10-Q
Page 59
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
Risk Management (continued):
The second half of 2008 experienced extremely high volatility both in freight rates and bunker prices. The Tankers International pool's VLCC earnings do not fluctuate as much as TD-3 since the pool’s cargo system with longer Arabian Gulf to Western destination and West Africa to Eastern destination combination voyages smoothes out the pool’s earnings. The historical difference in volatility between TD-3 and Tankers International pool's earnings was analyzed and the volume of the hedge position optimized to maximize correlation. However, due to the above mentioned basis risk, price volatility and other factors, the actual TCE rates achieved for the synthetic time charters may differ, possibly substantially, from expected rates. For the third quarter of 2010, the synthetic TCE rate achieved for VLCCs approximated $32,578 per day. In addition, the Company's derivative positions that expired on September 30, 2010 sought to achieve synthetic time charters for 31 days for VLCCs in October 2010.
The Company also seeks to reduce its exposure to future increases in fuel prices in the normal course of its International Crude Tankers lightering business, which includes a number of fixed rate Contracts of Affreightment, by entering into stand alone bunker swaps. During August 2010, the Company entered into an agreement with a counterparty to purchase 787 metric tons per month of fuel oil for $429.57 per metric ton. This contract settles on a net basis at the end of each calendar month from September 2010 through June 2011 based on the average daily closing prices, as quoted by the Baltic Exchange, of the commodity during each month. This swap, representing an aggregate volume of 7,874 metric tons of fuel, does not qualify as a cash flow hedge for accounting purposes. As of September 30, 2010, the Company has recorded an asset of $144,000 related to the fair value of this contract.
The shipping industry's functional currency is the U.S. dollar. All of the Company's revenues and most of its operating costs are in U.S. dollars.
Available Information
The Company makes available free of charge through its internet website, www.osg.com, its Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”), as amended, as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the Securities and Exchange Commission.
The Company also makes available on its website, its corporate governance guidelines, its code of business conduct, and charters of the Audit Committee, Compensation Committee and Corporate Governance and Nominating Committee of the Board of Directors.
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
Controls and Procedures
As of the end of the period covered by this Quarterly Report on Form 10-Q, an evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”). Based on that evaluation, the Company’s management, including the CEO and CFO, concluded that the Company’s current disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports the Company files or submits under the Exchange Act is (i) recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms and (ii) accumulated and communicated to the Company’s management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. There have been no changes in the Company’s internal control over financial reporting during the period covered by this Quarterly Report which have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II – OTHER INFORMATION
Item 1A. Risk Factors
There have been no material changes in the Company’s risk factors from those disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 and Quarterly Report on Form 10-Q for the periods ended March 31, 2010 and June 30, 2010.
See Exhibit Index on page 62.
Form 10-Q
Page 61
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | OVERSEAS SHIPHOLDING GROUP, INC. |
| | (Registrant) |
| | |
| Date: November 5, 2010 | /s/ Morten Arntzen |
| | Morten Arntzen |
| | Chief Executive Officer and President |
| | |
| Date: November 5, 2010 | /s/ Myles R. Itkin |
| | Myles R. Itkin |
| | Executive Vice President, Chief Financial Officer and Treasurer |
Form 10-Q
Page 62
OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
EXHIBIT INDEX
| 31.1 | | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a), as amended. |
| | | |
| 31.2 | | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a), as amended. |
| | | |
| 32 | | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| | | |
| NOTE: | | Instruments authorizing long-term debt of the Registrant and its subsidiaries, where the amounts authorized thereunder do not exceed 10% of total assets of the Registrant on a consolidated basis, are not being filed herewith. The Registrant agrees to furnish a copy of each such instrument to the Commission upon request. |
