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Executives

John Coustas - President & CEO

Evangelos Chatzis - CFO

Analysts

Gregory Lewis - Credit Suisse

Urs Dur - Clarkson Capital

Danaos Corporation (DAC) Q4 2012 Earnings Call February 12, 2013 9:00 AM ET

Operator

Thank you for standing by, ladies and gentlemen, and welcome to the Danaos Corporation Conference Call on the Fourth Quarter and Year End 2012 Financial Results. We have with us Dr. John Coustas, President and Chief Executive Officer; and Mr. Evangelos Chatzis, Chief Financial Officer of the company. At this time all participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session. (Operator Instructions) I must advice you the conference is being recorded today Tuesday, February 12, 2013.

We now pass the floor to one of your speakers today Mr. Chatzis. Please go ahead sir.

Evangelos Chatzis

Thank you, operator. Good morning everyone and thank you for joining us this morning. Before we begin I quickly want to remind everyone that management remarks this morning may contain certain forward-looking statements, and that actual results could differ materially from those projected today. These forward-looking statements speak as of today and we undertake no obligation to update them. Factors that might affect future results are discussed in our filings with the SEC and we encourage you to review these detailed Safe Harbor and Risk Factor disclosures.

Please also note but where we feel appropriate we will continue to refer to non-GAAP financial measures such as EBITDA, adjusted EBITDA, and adjusted net income to evaluate our business. Reconciliations of non-GAAP financial measures to GAAP financial measures are included in our earnings release and the accompanying materials.

Now let me turn the call over to Dr. Coustas who will provide the broader review of the quarter.

John Coustas

Thank you, Evangelos. Good morning everyone and thank you for joining our today's call to discuss for fourth quarter '12 and whole year 2012. Despite the challenging container market environment, in 2012 we managed to maintain the Company's profitability at the 2011 levels.

The adjusted net income for 2012 came in at $60.5 million or $0.55 per share, compared to $61.2 million or $0.56 per share for 2011, effectively remaining stable, while adjusted EBITDA increased by 35.5% to $431.7 million for 2012 compared to $318.6 million in 2011 as a result of our fleet expansion program that was concluded this year.

Demand and supply fundamentals for 2012 confirm that this has been a sluggish year, with supply outpacing demand by almost 3%. Although there are signs that this disparity may be somehow moderated in the coming quarters, we still expect supply to outpace demand in 2013.

Mainlane trade volumes in 2012 expanded by a mere 1% on average, while the Asia - Europe trade contracted by almost 3.5%, mainly due to the ongoing weakness in European consumer demand. At the same time, this is the route that has faced the biggest inflow of new tonnage with deliveries of the large post 10,000 TEU containerships. We expect this trend will continue in 2013 as vessels ordered during the early 2011 mini-boom are being delivered.

On the other hand, it was non-mainlane trade growth that to a certain extent saved the day expanding by around 6.5% mainly on the back of strong intra-Asia and North-South trade growth. This growth facilitated cascading that helped ease the supply pressure in the mainlane trades, but at the expense of the charter market as liner operators have been increasingly utilizing their own tonnage and are generally less inclined to renew expiring charters. It has to be noted that almost 85% of idle capacity, which currently stands at 5% of the world fleet is now charter owned tonnage. This of course also reflects on us, as we currently have seven vessels on cold lay-up.

In summary, the combined effect of the above is that the weakness of growth on the longer haul mainlanes has resulted in global TEU-mile growth increasing by just 4% in 2012, with supply increasing by almost 7% for the same period, while this imbalance has mostly affected asset values, time-charter earnings and employment potential of mid-size vessels. In this context we are currently investigating to make selective acquisitions within 2013 to renew part of our older fleet.

The good news is that liner operators have so far managed the situation effectively with a variety of cost reduction initiatives, as well as supply control strategies such as service rationalization, idling of tonnage, scrapping and extra slow steaming, through which they have managed to maintain freight rates at decent levels. This is positive, as the financial health of the liner companies is important for containership lessors like us, since the majority of our tonnage is deployed under long-term time charters.

With a strong 97% contract coverage and only 3% of our current revenue stream at stake through re-chartering over the next 12 months, we are largely insulated from the effects of the weak charter market, while expect our EBITDA and free cash flow generation to be safeguarded.

At the same time, we continue to be one of the most cost competitive operators in the market. Our daily vessel operating expenses actually came down by 5.4% year-on-year to $5,907 per day for 2012 from $6,246 per day in 2011.

With a resilient business model both from an operating and financial standpoint, we will continue to manage our fleet efficiently, while in 2013 we will focus on rapidly de-leveraging the company and creating value for our shareholders.

With that, I'm handing over the call back to Evangelos who will take you through the financials for the quarter.

Evangelos Chatzis

Thank you, and thanks again to all of you joining us today. I'll briefly review the results for the fourth quarter and then give the chance to participants to place questions.

Following the completion of our new building program, during the fourth quarter of 2012, we had an average of 64 containerships compared to 57.9 containerships for the same period in 2011. Our adjusted net income was $11.7 million or $0.11 per share for the quarter, down by $4.4 million or $0.04 per share when compared to the adjusted net income of $16.1 million or $0.15 per share for the fourth quarter of 2011.

Although the increase in the average number of vessels in our fleet by six new building deliveries over the course of the last year was accretive to the bottom line, this $4.4 million decrease in our adjusted net income between the two quarters is attributed to the softening of the charter market that eventually triggered the quarterly gap of seven vessels until the end of the year and has also affected the earnings generation capacity of a further seven ships that currently run at operating breakeven levels, while they had a positive contribution to EBITDA during the fourth quarter of 2011.

As we do not expect the charter market improvement in the near term, it is likely that these pressures will persist throughout the coming year. The good news is that we are largely insulated from a weak charter market as 97% of our current revenue stream is contracted for 2013.

It is also worth at this point to note that beside the chartering risk, which is obviously manageable, the most important driver in our earnings to date is related to the hedging we have in place through interest rate swaps. Indicatively, our adjusted net income for 2012 that currently stands at $60.5 million would have been almost $196 million if the current interest rate swaps were not in place. These swaps start expiring from the fourth quarter of 2014 through the end of 2015 and then we expect a significant improvement in earnings given the market expectations for persisting the low interest rates. With an average charted duration of 9.7 years, well exceeding the two and a half years remaining duration of the swaps, we believe we will be able to take advantage of the anticipated low LIBOR environment on the back of solid contracted income generation.

Operating revenues increased by 18.3% or $23.5 million to $151.8 million in this quarter from a $128.3 million the fourth quarter of 2011, as a result of the increase in the average number of vessels in our fleet and actually an increase by 14.5% in the average daily charter rate that our operating fleet has earned up to $28,500 per day in the current quarter from $24,900 per day in the fourth quarter of 2011.

Vessel operating expenses decreased by 3.8% or $1.2 million to $30.5 million in the current quarter from $31.7 million in the fourth quarter of 2011, in fact that daily operating cost for the current quarter decreased by 7.3% to $5,857 per vessel per day, compared to $6,318 average daily operating cost for the fourth quarter of 2011, indicative of our determination and focus to control costs.

G&A expenses decreased by 25.7% or $1.8 million to $5.2 million in the current quarter from $7 million in the fourth quarter of 2011, mainly as a result of a non-cash stock-based compensation expense of $2.1 million recorded in the fourth quarter of 2011, compared to only $0.1 million in the current quarter.

Interest expense increased by 45.6% or $7.3 million to $23.3 million in the current quarter from $16 million in the fourth quarter of 2011. The change in interest expense was mainly due to the increase in our average debt by $420 million to $3.4 billion in the current quarter from $3 billion in the fourth quarter of 2011.

Additionally, since our new building program has been concluded no interest was capitalized in the current quarter, compared to $3.2 million of interest capitalize in the fourth quarter of 2011.

Realized losses on interest rates swaps increased by $3.8 million to $38.7 million in this quarter, compared to $34.9 million in the fourth quarter of 2011. This increase between the two quarters is attributed to the fact that no realized losses have been deferred in the current quarter following of course the delivery of all of our new buildings whereas $6.4 million of realized losses have been deferred to OCI in the fourth quarter of 2011, all above partially offset by reduced notional swap amounts between the two quarters as some swaps expired during 2012. It is worth now been heard that as a result of these swap expirations, the company will no longer be in a normal hedging position from Q1 of 2013 onwards.

Just to remind you that effective July 1, 2012 we have discontinued the application of hedge accounting due to the compliance burden associated with this accounting policy. As a result, all unrealized mark-to-market movements are now flowing through our income statement and are being adjusted accordingly in our adjusted net income presentation.

During the fourth quarter of 2012, we recorded an impairment loss of $129.6 million for 13 of our older ships built in the late '80s or early '90s that are either employed on short-term charter or have been laid up. Following this impairment charge, we expect our depreciation expense going forward to be lower by $3.7 million per quarter or $14.8 million on an annual basis when compared to 2012.

On to more recent news on January 17, 2013, we enter into an agreement to sell vessel Independence for a gross sale consideration of $7 million, and expect to deliver the vessel to its buyers in the following days. The Independence build in 1986 is a 27 year old ship and has been on cold lay-up since the fourth quarter of 2011.

Finally, it is worth noting that as a result of the growth of our fleet, adjusted EBIDTA increased by $23.6 million or 26.6% to $112.4 million in the current quarter from $88.8 million in the fourth quarter of 2011.

With that, I would like to thank you for listening to this first part of our call. Dr. Coustas and myself would now take your questions. Operator?

Question-and-Answer Session

Operator

Thank you very much indeed sir. (Operator instruction) Your first question from Credit Suisse comes from Gregory Lewis. Please ask your question sir.

Gregory Lewis - Credit Suisse

John the decision to write-down those 13 odd vessels, could you provide a little bit more color behind that and now that these vessels have been written down like what happened, what was the impact in other words, where sort of the value that you're carrying those asset from on your books currently?

John Coustas

Well, these vessels practically where on our books at values that we leave that did not really reflect the reality. So we wanted really to take whatever charges there, go some terms of sound, let's say financial and accounting principles, and because we want to have a very clean balance sheet.

Gregory Lewis - Credit Suisse

So, in other words, we shouldn't I mean, I guess you announced the sale of the Independence for $7 million, relative to where you had that vessel on your books, I mean is there going to be gain associated with that vessel, now that those vessels are impaired we expect some of mid potentially some of these other vessels to be sold, it is that the way we should be thinking about it or that we shouldn't read too much instinct the sale of the Independence?

John Coustas

Yeah, well, the Independence specifically is more or less at par with where it was. So that does not really create any profit and loss from, yeah any future we're talking about very small amounts. But overall we decided in order to let's say to be compliance with all the SEC requirements to take the extra charge because actually these vessels do not have let's say any kind of long-term charters. On the vessels that have long-terms charters, of course they are let's say market value is such, it's not so relevant, the charter free market value. But for these kinds of vessels that are practically charter free and also some of them are also laid-up, you should really reflect the scrap value.

Gregory Lewis - Credit Suisse

And then just in the presentation, in the Danoas's corporate presentation that's out in the markets, when I look at sort of the high case, the base case, and the low case, when I think about the low case, does that -- how does that treat these vessels that have now been impaired. Does that assume that they're going to be operating in say if I were to look at 2014, like a -- does the low case assume a recovery in the market and that that these reselling impaired vessels will be operating in 2014?

John Coustas

Well in this, yeah, in the low case, practically these vessels were at practically break-even rate. So practically zero contribution to -- of EBIDTA. So really there is not going to be any kind of effect by, for example the, let's says by these vessels, something we assumed, let's say maybe re-chartering, but at break-even levels.

Operator

Thank you. (Operator Instructions) Now from Clarkson Capital, you have a question from Urs Dur. Please ask you question sir.

Urs Dur - Clarkson Capital

And I know I can do the calculation, but can you just tell us where you are net debt to cap wise after this impairment and certainly most listeners and pretty myself as to where you might stand. Obviously the banks didn't have a problem with this impairment and doesn't hurt you in any sort of covenant issue or is your reorganized debt from some time ago cover you in the States obviously?

John Coustas

Well we're this is really nothing to do first of all our bank covenant relates to the actually to the charter attached value of our fleet. And as you know, in terms of covenants the charter attached valuation of the fleet is around --

Evangelos Chatzis

$1.5 billion.

John Coustas

No, no, the charter adjusted value is around $1.5 billion.

Urs Dur - Clarkson Capital

Okay, and it does still look like to investors and gradually the stock has been moving up a lot since December so that's, obviously it's good for you and your Investor Presentation is out there and I think it does tell your story well. But to the investor then look at the debt level and say well now I'm going to worry about the contract counterparty and the container business still looks a bit stressed and oversupplied. So can you talk to the health of your counterparties specifically if you can see CMA-CGM, HMM those guys just to let us know where they stand right now and what you think of the overall container market with those guys?

John Coustas

Actually the older liner guys had relatively I mean good performance in 2012 okay, it was a bit weaker in the fourth quarter, but there is nothing like, the blood we have seen for example in 2009, or in the beginning of 2012. They have managed capacity pretty well and that is why we see that rates have held up relatively well. I mean for example if Europe we've seen the rates go down let's say the box rate to $1200 per day whereas back in 2009 these rates were down to something like $500 at some stage. So yeah, we're not talking about really, any kind of let's say boom scenario but not doom as well. CMA-CGM closed the year with profit overall and Maersk as well and most of the guys are really in the black. So I don't think really that there is significant counterparty risk at the moment.

What is really the story today in the container market is more on the charter fleet because of the kind of the very low market in the expiries, which they have all the vessels, which was a single company KG vessels are insolvent and that creates a bit of turmoil in the charter market and that's where really most of the distressed stories concentrate.

Urs Dur - Clarkson Capital

And you're pretty confident with the overall condition of HMM at this time its 30% of your revenue?

John Coustas

Yes, I mean, 100% we don't have the slightest doubt, HMM is a very solid company.

Urs Dur - Clarkson Capital

Yeah, I know, I know I just wondered to get you mention it that's great. I appreciate what you're saying there and then on the presentation that is on your website again I think it's rather informative, it does say one of the final words we are well positioned to participate in the next growth cycle and we've seeing some growth in other of your competitors and they have a may be a bit more access to equity at this point in time and I know that a lot of the liner majors want to "re-fleet" and get to more efficient ship types to improve competitiveness going forward and replace older ships. How do you guys think, what kind of structure would be most interesting for you and where do you think you could compete again with the debt level where it is? I know you've a lot of contracted revenue and again things have been improving for you certainly but how soon do you think you could compete in new projects and should we expect any growth this year?

John Coustas

Well to be honest we've first of all we've various kind of ideas of how let's say to overcome the question of equity. Because, through participation of other external investors in the joint projects and actually in the last project we have participated but it's just that the returns that as the project ended up were not really to, I mean to our comfort.

Urs Dur - Clarkson Capital

Yeah, they were pretty tight, I agree.

John Coustas

Yeah. And on the other hand what we're currently also really the process is to renew let's say the older fleet that we have with newer vessels.

Urs Dur - Clarkson Capital

Well, especially since the KGs are dead and there aren't that many competitors it would be -- I look forward to seeing what kind of structure might work because the market is competitive and returns are light but we'll see. Okay. I appreciate your time. Just one last thing, Evangelos, since you called me off-line I just have a quick question about how I work something in the model. So, when you've time later if possible.

Evangelos Chatzis

Sure.

Operator

(Operator Instructions) Gentlemen, there appear to be no further questions at this time. Please continue.

John Coustas

Okay. Thanks everyone for joining our conference call and for your continued interest in Danaos and we look forward to our next call next quarter. Thank you.

Operator

And with many thanks to our, both our speakers today this then concludes our conference. Thank you for participating. You may now disconnect.

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