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DryShips (NASDAQ:DRYS)

Q3 2012 Earnings Call

November 15, 2012 9:00 am ET

Executives

Ziad Nakhleh - Chief Financial Officer

George Economou - Chairman, Chief Executive Officer and President

Analysts

Michael Webber - Wells Fargo Securities, LLC, Research Division

Keith Mori - Barclays Capital, Research Division

Salvatore Vitale - Sterne Agee & Leach Inc., Research Division

Operator

Thank you for standing by, ladies and gentlemen, and welcome to the DryShips Conference Call on their Third Quarter 2012 Financial Results.

We have with us Mr. George Economou, Chairman and Chief Executive Officer; Mr. Ziad Nakhleh, Chief Financial Officer of the company. [Operator Instructions] I must advise you that this conference is being recorded today, Thursday, November 15, 2012.

Matters discussed in this release may constitute forward-looking statements. Forward-looking statements reflect current views with respect to future events and financial performance and may include statements concerning plans, objectives, goals, strategies, future events or performance and underlying assumptions and/or other statements, which are other than statements of historical facts.

Please take a moment to read the Safe Harbor statement on Page 2 of the slide presentation. Risks and uncertainties are further described in the report filed by DryShips with the U.S. Securities and Exchange Commission.

And I'll pass the floor to Mr. Nakhleh. Please go ahead, sir.

Ziad Nakhleh

Thank you. Good morning. For the third quarter -- I'm on Slide 4. For the third quarter of 2012, DryShips posted a U.S. GAAP net loss of $51.3 million or $0.13 per share, which includes class survey cost for the Eirik Raude of $16.8 million, certain noncash non-recurring items totaling $18.3 million relating to the full repayment of Ocean Rig's $1.04 billion DNB-led facility and finally mark-to-market gains on interest rate swaps of $3.7 million.

Our shipping segments continued to be cash-flow negative as a result of drybulk vessels coming off lucrative charters and spot market rates hovering around historic lows. The bright spots for the quarter are positive EBITDA of $141 million and cash provided by operations, mainly fueled by our offshore segment. For the remainder of this presentation, we'll be primarily focusing on our shipping segments' operations. For additional information on our drilling segment, please refer to Ocean Rig's third quarter presentation available on www.oceanrig.com.

Slide 5. Our capital structure as of the end of September, 2012 is satisfactory, as evidenced by a 53% gross debt-to-capitalization and 41% net debt-to-capitalization ratios. Our gearing will be negatively impacted once we execute and draw down on the Ocean Rig's $1.35 billion facility, as well as other financings for our shipping fleet.

We have close to $1 billion of cash on our balance sheet. Of that cash flow, approximately $670 million is being financed at Ocean Rig level our free cash balance, i.e. this is the cash we have access to, as of September 30, 2012, was $131 million. Only a de minimis level of cash is with banks in Greece.

Slide 6. Here, we present our Drybulk newbuilding program, which is more or less unfinanced. All these vessels are being built in China, and thus, we are reaching out to Chinese lenders, including ECAs, policy banks and leasing companies, to secure some level of financing. Progress is slow on this front.

Liquidity is critical for DryShips, and we are working with the shipyards to optimize our newbuilding program. Discussions with the yard include deferral of payments and deliveries, discounts and zealous credit, among other items. These are challenging times, so we expect this process to be tough and drawn out. However, we believe we can reach some kind of solution with the yards.

We caution that we have CapEx due in 2013 amounting to $253 million, most of which is unfinanced.

Slide 7. On this slide, we present our Tanker CapEx, which tankers are all being built at Samsung Heavy Industries in Korea. In October, we signed a loan agreement with ABN AMRO, Korea Development Bank and Korea Trade Insurance Corporation, or KSURE, for a $107.7 million senior secured term loan facility to finance 3 tankers -- Alicante, Mareta and Bordeira. As you can see, our Tanker newbuilding program is nearly fully financed, and this reflects the seriousness of local lenders to finance Korean shipyards. We caution that while only 2 vessels remain unfinanced, their remaining CapEx amounts to approximately $140 million payable in 2013.

Slide 8. This slide details our secured debt profile of the Drybulk and Tanker segments as of September 30, 2012. Our shipping segment has approximately $300 million amortization of secured bank debt through to December 31, 2014. And this does not even include offshore debt.

On top of this, we'll have the maturity of our $700 million convertible bond in December of 2014. The final point is that we want -- the final point we want to make is that we estimate the fair market value of all of our vessels at the end of September to be around $1.1 billion, while the shipping debt, including convertible bond, amount to about approximately $1.7 billion.

On to Slide 9. We continue to perform under all our loan agreements, in that we mean payments of principal and interest, and have no issues with any of our lenders. However, we are in technical breach of VMC clauses in certain loan facilities. As of September 30, 2012, the total of such VMC shortfalls amounted to approximately $96 million. We are in discussion with the affected lenders to remedy such breaches by way of waivers, cash prepayments or cash collateral or finally by pledging Ocean Rig shares.

On to the company update on Slide 11. And let me just focus on recent developments I haven't discussed so far. Pursuant to the company's previous announcements relating to potential contract awards for the Ocean Rig Poseidon and Ocean Rig Athena, we have been awarded 2 3-year contracts for each rig for drilling in Angola from 2 different major integrated oil companies.

Another major development is the progress of the syndication for a $1.35 billion loan facility to finance the remaining payments of the 3 drillship newbuildings delivering in 2013. As we've already mentioned, this financing will have 3 tranches: a commercial tranch and 2 ECA tranches. As of today, we have already received conditional commitments for the commercial tranch and for 1 of the ECA tranches. We expect to finalize these transactions in a first quarter of 2013.

Turning to Slide 12. The lucrative charters entered into at the height of the markets are running out on a staggered basis. We currently have 44% coverage for the last quarter of 2012. For 2013, this falls to 33% and then even further to 22% in 2014. At the current time, we have significant levels of the Drybulk and Tanker spot markets, and positive developments in these sectors could provide a substantial boost to our bottom line.

On to the industry overview. Turning to Slide 14. During the third quarter, everyone's focus in the drybulk sector has been the negative news coming out of China, including the cooling of its economy. So China's steel production accounts for about 50% of global output, and therefore, such focus is easily understandable. During the third quarter, we saw Chinese PMI reaching levels below 50, confirming the contraction of their industrial output. This had an effect on prices of key commodities such as steel, iron ore and coal. This trend seems to have reversed somewhat in October as seasonally the fourth quarter is a period during which inventories need to be replenished.

Turning to Slide 15. While China is shaking up the demand in the industry, the steel significant outstanding order book is continuing to supply growth at levels expected to outpace demand growth.

On Slide 16. The crude oil market is undergoing the most significant change of recent times. New technologies, including hydraulic fracturing of underground rock formations, have boosted the U.S. oil domestic production, increasing it to about 6.5 million barrels per day. As a comparison, Saudi Arabia's current production is just under 10 million barrels per day. And according to a recent report from the Internal -- International Energy Agency, USA's production is poised to surpassed Saudi's in the next decade. This will make the U.S. self-reliant in terms of oil demand as their imports, which are already declining, could potentially go to 0. Obviously, this does not bode well for the shipping industry.

In addition, during the month of October, China's crude oil domestic production was at the highest level ever, potentially capping incrementally to import oil.

Turning to Slide 17. It seems that the 2 largest economies in the world are shifting their efforts to secure oil supply on domestic grounds, which by default will reduce the requirements for transportation of crude oil. This contradicts the growth trend of the oil tanker fleet, as this orderbook shows, that the fleet supply is poised to increase further during the next 2 years since the fleet is very modern and scrapping might be kept to a minimum.

And this marks the end of the industry section. And I now turn the call over to Mr. Economou for closing remarks.

George Economou

Thank you, Ziad. We're on the last slide, 19. In closing, I would like to clarify for everybody that DryShips is a pure shipping company. 2/3 of its fleet are exposed to the spot market in 2013. We're just holders of shares in Ocean Rig. It's completely different from us. In other words, DryShips does not have any access whatsoever to Ocean Rig's financial resources.

As mentioned earlier, the drybulk markets are weak and facing multiple challenges going forward. In the Drybulk and Tanker segments, spot charter rates continue to hover at historic lows and that the values have dropped precipitously in the last 3 years. The Tanker charter market lacks liquidity, and rates are very low, in fact, well below our cash breakeven levels.

Our Drybulk fleet still has contract coverage of 44% for the remainder of 2012 and 33% in 2013. However, unless the freight market recovers, DryShips will continue to face severe financial difficulty. Because we have significant capital expenditures to finance our newbuilding program, which is something we are proactively financing with the shipyards.

However, there is a severe lack of liquidity from traditional lenders as they contract their balance sheets to meet Basel III requirements and, in some cases, aggregate the sector completely.

This marks the end of our Q3 earnings presentation and we now open the floor for questions. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question todays comes the line of Michael Webber of Wells Fargo.

Michael Webber - Wells Fargo Securities, LLC, Research Division

Just a couple of questions here. And first, I wanted to jump in to something with you, Ziad. You mentioned in the deck the shortfall on your VMC at $96 million. And then in the release, you talked to about $77.2 million and potentially a collateral you might potentially need to put up to bring those back into compliance. Can you help us make sense of those 2 numbers?

Ziad Nakhleh

Yes, the $96 million is the full shortfall theoretically. In addition to cash, we actually have some vessels that are not collateralized today, and we can actually pledge these vessels. So that's the difference between what cash we have put up and the total shortfall.

Michael Webber - Wells Fargo Securities, LLC, Research Division

Right. Okay, right. That's helpful. I've heard, George or Ziad, you mentioned the $253 million in CapEx next year and that is certainly something that's kind of weigh on the stock. At what point, and I guess, how do you think about either putting that money up and/or walking away from those commitments versus essentially selling down your stake in Ocean Rig to make those commitments? If push comes to shove, do you walk away from those or do you raise funds by selling down your more profitable and more valuable assets?

George Economou

No, no. We do not intend on selling down Ocean Rig. We will try to sort it out by walking away from the contracts if we cannot get any other satisfactory results. But no, we're not walking away. We're not selling Ocean Rig stock.

Michael Webber - Wells Fargo Securities, LLC, Research Division

Okay. Right. That's good to hear. Ziad, just in going through your deck, and forgive me if I missed this in the prepared remarks, but it does look like you have already delayed on delivery dates on several of these assets. Is that -- have you guys already kind of reached kind of quiet agreements with some of these shipyards? And if so, is there more to come? It does look like some of these delivery dates have been pushed back?

George Economou

Yes, we are. We are delayed and the reason we are delayed is to gain more time to make an agreement with the yards, even if that means that we have to walk away.

Michael Webber - Wells Fargo Securities, LLC, Research Division

Right, that's helpful. One more for you George and I'll turn it over. And since I got you, we've got -- here we see some modest pockets of strength, I guess, it was in the drybulk market in the back half of the year, but overall it's been obviously pretty weak. You've been pretty successful in timing the market over the past couple of years. I just want to kind of get your thoughts personally around the potential drybulk recovery in '13 or '14. And I guess when do see that shaping up and how do you look at it?

George Economou

Well, just look at the orderbook, if you look at the orderbook, there is -- it consists of 18% to 20% of the drybulk fleet, and the growth in demand is with the order of 4% to 5%. You will not really have some attrition, about 4% to 5%. So that still leaves an overhang I would say of 9% even when you go through '13. So it doesn't look likely, especially for the smaller sizes, we actually gauge that we may see a rebound as late as -- as early as Q4 next year. The market is going to be bad, and there's a lot of ships that have been delayed for various reasons, either because of lack of funds, whether it's equity or financing, or because people will want to delay, and this is very usual in the last month or 2 months of the year to get a new year on the rest of the new. Maybe you're reading that in China. Because they pack them next to each other, sometimes, they may be an obstruction to safe navigation in their rivers.

Operator

Your next question comes from the line of Brandon Oglenski of Barclays.

Keith Mori - Barclays Capital, Research Division

This is Keith Mori filling in for Brandon today. Can we just talk a little bit more about the order book on the Drybulk side? Can you maybe talk a little bit about the commentary that you guys are having with the shipyards? And give us a couple of scenarios that will be advantageous, I guess, to both of you, both the shipyard as well as yourself, that maybe you could reach in the coming few quarters.

George Economou

Well, one way out is you pay the difference in the yard of what's the best that can be sold for today and what's the balance or the capital is and then make a deal with the yard, and they sell it to somebody else. That's probably the only easy deal to be done. Otherwise, you would have to put equity in, which it is not something that we want to do because we don't have it and we would need to sell Ocean Rig stock, and we're not going to do that.

Keith Mori - Barclays Capital, Research Division

Okay. And I guess maybe thinking about the current fleet as well. We've seen Capesize rates come up here a little bit. What's maybe the market's appetite, what's your appetite to maybe sign up 1, 2-year contracts at these levels to maybe get to a neutral cash on those contracts compared to operating them on a difficult spot market?

George Economou

Yes. The problem is not in the Capes. The problem is in the Panamax because you cannot find period rates. If you were to find period rates in the Panamax, they would be in the order of $7,000, maybe $8,000 per day. So you're not really doing much but covering your operating expense plus $1,000 per day. On the Capes, you can still find. But just to give you an idea, even if you were to book a 5-year contract today in the market, it would be on a new ship, a little bigger than ours, 180 would $18,500 per day. And I would say the 1-year rate would be around $10,000 a day. So this is what we have to take, and we're considering and even entering a 1-year $10,000 a day just to get through the next year. But I would probably not fix for 2, maybe 1 or 1.5, something like that.

Operator

Your next question from the line of Sal Vitale of Sterne Agee.

Salvatore Vitale - Sterne Agee & Leach Inc., Research Division

I just have a quick question. I noticed here in the report that you pledged 7.8 million shares of Ocean Rig to remedy a VMC clause shortfall. How do we think about that? Is that an option that you have in terms of pledging Ocean Rig shares to the shipyards in lieu of cash? Is there any limitation to how many shares you can pledge in that regard?

George Economou

No, no. This are not to the shipyards. The loan agreement, most, if not all, the loan agreements, when you have a breach in the value maintenance clause, the banks will ask you for additional security. And that can be, if you don't want to prepay, which -- if you don't have the cash, you don't have an ability, so the additional security can come in any other form that is acceptable to the banks. And Ocean Rig shares is something that we have used and we'll continue to use in the bank. But it usually asks you for a little bit more than what the breach is. So it's not to the shipyards, it's to the banks.

Salvatore Vitale - Sterne Agee & Leach Inc., Research Division

Right. And is there also an option for the shipyards sort of in terms of revenue?

George Economou

No, no, no. The shipyards, they want cash. I mean, don't forget that they have spent the money. It's not sound that you can do it to the shipyards. No.

Operator

[Operator Instructions] There appears to be no further questions at this time. Please continue.

George Economou

Thank you, operator, and I guess this marks the end of the call. Thank you.

Ziad Nakhleh

Thank you.

Operator

Thank you. That does conclude our conference for today. Thank you, all, for participating. You may now disconnect.

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