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DryShips Inc. (NASDAQ:DRYS)

Q1 2013 Earnings Conference Call

May 23, 2013 9:00 a.m. ET

Executives

George Economou - Chairman, President, and Chief Executive Officer

Ziad Nakhleh - Chief Financial Officer

Analysts

Joshua Katzeff - Deutsche Bank

Michael Webber - Wells Fargo Securities

Oliver Corlett - R.W. Pressprich

Operator

Thank you for standing by, ladies and gentlemen and welcome to the DryShips Conference Call on the First Quarter 2013 Financial Results. We have with us Mr. George Economou, Chairman and Chief Executive Officer; and Mr. Ziad Nakhleh, Chief Financial Officer of the company. At this time all participants are in a listen-only mode. (Operator Instructions) I must advise you that this conference is being recorded today on Thursday, May 23, 2013.

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 other statements, which are other than statements of historical facts. Please take a moment to read the Safe Harbor statement on page two 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 now I'll pass the floor to Mr. Nakhleh. Please go ahead, sir.

Ziad Nakhleh

Good morning everyone, and thank you for participating in DryShips first quarter conference call. I am on slide four. For the first quarter 2013 DryShips posted a U.S. GAAP net loss of $116.6 million or $0.30 per share, which include losses on the sale of four newbuilding drybulk vessels of $75.3 million. Our losses adjusted for these onetime items amounted to $41.3 million or $0.10 per share.

For the first quarter of 2013, our group reported revenues of $300 million, adjusted EBITDA of $112 million and generated cash from operating activities of $106 million. During the quarter our group repaid bank debt of $74 million. For the remainder of this presentation, we will be primarily focusing on our shipping segments operations. For additional information on our drilling segment please refer to Ocean Rig's first quarter presentation available on www.ocean-rig.com.

Slide five. During the first quarter 2013, our shipping operations were profit and cash flow negative. On one hand we had certain above market charters in the drybulk segment, and on the other all our tankers and a large number of our bulkers were earning spot market rates which were below our cash breakeven levels. For the quarter our average TCE, time charger equivalent levels were 12.8000 for our tankers and 11.4000 for our bulkers per day.

On to slide six which highlights the most recent developments across the group. In March and April 2013, the company sold its Capesize bulk carriers Hull 1241 and 1242, to an unaffiliated third party and sold its very large ore carriers, Hulls 1239 and 1240, to an entity related to Mr. George Economou. These four vessels had remaining yard installments of approximately $178 million against which the company had no committed debt. Under the terms of the sales agreement, the company will make payments or had made payments of $29 million only, thus eliminating approximately $149 million in capital expenditure.

On February 28, 2013, the company signed definitive documentation for $1.35 billion syndicated secured term loan facility to partially finance the construction costs of the newbuilding drillships Ocean Rig Mylos, Ocean Rig Skyros and the Ocean Rig Athena, scheduled for delivery in August, October and November 2013, respectively. The DNB and Nordea led facility has a five-year term and a repayment profile of 11 years and bears interest at LIBOR plus a margin.

Finally, on February 14, 2013, the company completed a public offering of an aggregate of 7.5 million common shares of Ocean Rig owned by DryShips. The company received approximately $123.1 million of net proceeds from the public offering.

Turning to slide seven. The [lucrative] charters entered into at the height of the drybulk market are running out on a staggered basis. For 2013, we have 48% fix rate coverage and then this [falls] to 31% in 2014. As we have said in previous slides, we have significant leverage to the drybulk and tanker spot markets and positive developments in these sectors could provide a substantial boost to our bottom line. Our strategy at the current time is to place all our vessels, both dry and wet, on the spot markets. While we are not that bullish on prospects for both these segments for this year, we want to be ready for an eventual rebound. In this respect, our projected cash flows are sensitive to changes in spot rates.

During 2013, 2014, we have approximately 8000 and 13,700 spot fleet capacity days respectively. Which means that a 10,000 per day increase in average charter rates will add another $80 million and $137 million of additional EBITDA respectively for our shipping segment in those years. On to slide nine. On this slide we present our last remaining tankers under construction at Samsung Heavy Industries in Korea, which we took delivery in the first quarter of 2013 with $107.7 million senior secured term loan facility from ABN AMRO, Korea Development Bank and Korea Trade Insurance Corporation. Our tanker newbuilding program is now fully financed and on the water.

Slide ten. Here we present the latest status of our drybulk newbuilding programs. As we have previously mentioned, we recently sold four units. To VLOCs and two Capes vessels, voiding $149 million in capital expenditure. We have two VLOCs under constructions and both these vessels have time charters and committed debt from China Development Bank. In fact, we actually took delivery of one today and drew down the required amount from the lender. The second vessel is expected to be delivered on June 10, 2013.

We also have four Ice Class bulkers under construction in China. However, they deliver in 2014 which gives us enough time to consider our options. The [backstop] here is that these vessels are worth approximately $32 million each today, which approximates the remaining yard payments for these vessels. In other words, if one had to sell these vessels today, we would not be required to make a payment to cover the shortfall. As a result of the above, we believe our newbuilding program has been optimized, only approximately $44 million in additional equity is required for 2013.

On to slide 11. This slide details the secure debt profile of the drybulk and tanker segments as of March 31, 2013. Our shipping segment has approximately $508 million amortization of debt through to the end of 2015. Including balloons and loan maturities of approximately $136 million which we intend to refinance. In addition to our secured debt, our convertible bonds mature at the end of 2014 and we have started to consider our cash and non-cash options in this respect. It is interesting to note that the debt amortization in 2013-2014 equates to approximately $8,100 per vessel day. Any rescheduling of this amount will materially decrease our cash breakeven levels. At the current time we are in discussions with lenders to reschedule debt repayments, among other things, which would help to meaningfully reduce our cash breakeven. We will revert with more details once we formally consummate the transaction.

Slide 12. The fair market value of our shipping assets are slightly higher than the face value of the related bank debt. And on this slide we have shown here that there is surplus value at DryShips of approximately $1.1 billion or $2.7 per share. Today, DryShips owns approximately 78.3 million shares of Ocean Rig, out of which it has formally pledged 9.4 million to various parties which will automatically revert back to us at certain dates in the future. In addition, we have reached an agreement in principle with a certain lender to pledge approximately 6.2 million shares of Ocean Rig based on today's prices. We envisage that we will need to pledge additional shares to reschedule our repayment schedules under our existing credit facilities.

On to the industry section on slide 14. During the first quarter of 2013, we saw robust demand for both iron ore and coal. More specifically, we had seen that Brazil and Australia's Q1 combined iron ore exports were up 11% year-over-year. China, Japan and South Korea Q1 iron ore imports were up 4% year-over-year, and China and Japan's Q1 combined coal imports were up 12% year-over-year. During the same period the Capesize and Panamax fleet has shown significant growth as well. More specifically, these fleets have grown 9% and 13% year-over-year respectively. Unfortunately, the robust growth of exports has been not been adequate to sustain drybulk freight rates as evidenced by the significant year-over-year reduction.

The Capesize 4TC Index average around $6000 per say during the first quarter of 2013, representing a drop of 13% compared to the same period in 2012. The Panamax 4TC Index averaged around 7000 per day representing a drop of 12% compared to Q1 of 2012. Going forward, one can only by cautious as there are various elements that could potentially affect the demand for drybulk commodities. Here is a shortlist of some of the. Expected new iron ore production might lower prices below production cost, thus limiting export volumes. Chinese officials still committed to cool down the domestic real estate market. Chinese PMI shows no signs of strong growth and steel prices in China have come under pressure as year-to-date prices are down about 5%.

On slide 15, we talk about drybulk supply. While there are many things potentially affecting demand for raw materials, the significant outstanding order book is another potential hurdle that we need to go over to see a sustainable recovery in this sector. The important factors we see right now in the supply side are, drybulk demolition, although in 2012 we saw significant amount of vessels being scrapped, so far in 2013 the pace has been somewhat slow because of the significant improvement in sentiment and expectation that rates will recover in the second half of 2013.

Secondly, the improvement in sentiment during the fourth quarter of 2012 and the first quarter of 2013 has resulted in new orders being placed. For example, so far in 2013 we have about $15 million deadweight of new capacity ordered for delivery in 2014 and 2015. On to slide 16, and we will now switch to industry section of the crude tanker market.

As pointed out before in previous presentations, everyone's focus is the domestic crude oil production in the U.S. New technologies including hydraulic fracturing of underground rock formations have transformed the U.S. oil domestic production pushing April's production to approximately 7.3 million barrels per day. This production level is the highest we have seen during the last 20 years. Actually, to point out how significant this is, if one was to assume that the average six month growth rate of production stays the same, the U.S. will be producing the same volumes as Saudi Arabia in about one year from now. As one would imagine, an increase of domestic production is providing cheap alternative for domestic refiners and has hampered oil imports into the U.S. This at least seems to be the trend for the last (inaudible) as evidenced by the bottom graph of this slide.

Slide 17. It is clear that the biggest customer of all is looking at its backyard for cheap energy by which (inaudible) will reduce the requirement for transportation of crude to cover domestic demand. Sadly enough this contradicts the growth trends of the crude oil tanker fleet, as this order book shows the fixed price poised to increase further during the next two years since the fleet is very modern and scrapping might be kept to a minimum. This marks the end of the industry section. I will now turn the call over to Mr. Economou for closing remarks.

George Economou

Thank you, Ziad. We are on slide 19. In closing, I would like to clarify for everybody's benefit once again, that DryShips is a pure shipping company with a very predominantly spot exposure in 2013 and beyond. We are just holders of shares in Ocean Rig who is completely ring fenced from us. In other words, DryShips does not have any access whatsoever to Ocean Rig's financial resources. The results of our efforts to optimize our newbuilding program speak for themselves.

At the current time we have only four unfinanced vessels under construction which will deliver in 2014. This gives us more than enough time to consider our options. Our next priority is to amend our bank loan facilities to defer principal repayments, which would reduce our cash breakeven meaningfully, especially during 2013 and 2014. In the previous quarter we estimated that DryShips will need to raise approximately $300 million in cash through 2014 with $100 million needed in late '13. As a result of our efforts to reduce our capital expenditure, our cash needs for 2013 from now on are significant lower.

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

Question-and-Answer Session

Operator

(Operator Instructions) And your first question today comes from the line of Justin Yagerman of Deutsche Bank. Please go ahead.

Joshua Katzeff - Deutsche Bank

It's actually Josh Katzeff on for Justin. I just wanted to start with, I guess your shareholding in Ocean Rig. On the call earlier this morning, the focus is on maybe a dividend and we saw your shares [sell] over in February. I guess now that you have restructured some of your newbuilding and you are looking towards your secure debt, how do you think about monetizing that stake in the near term. I mean is the focus on maybe getting cash flow from a dividend or should we expect further shares [sold]?

George Economou

Well, as we said, we are monitoring the negative cash flow in DryShips. And what we had said before was $300 million through to 2014 and $100 million needed in 2013. We think that for 2013 which is after (inaudible) be significantly lower, closer to $50 million. As we said on the call before, we are working, in the next year (inaudible) to be able to provide a dividend. I don’t know that this will come in 2013, so most probably and unless we achieve the savings of the $30 million on the retraction of the bankers, till then we would have to sell some more shares. But these are going to be minimum.

Joshua Katzeff - Deutsche Bank

Got it. And then I guess going to the remaining CapEx, there are the four Ice Class, the four Panamaxes. Can you talk about maybe timing within the year for the 2013 payments on those? Is that something that’s coming up near term or is it towards the backend of the year?

George Economou

Well, as we have done in the past and I don’t want to go into a lot of detail on this call, we have been able to manage both a delay in payment and also not taking delivery of vessels if we don’t think that they fit the purpose that they were originally contracted for. So we are not worried about spending a lot of money on further equity payments on these vessels. And we always have the option of selling them when there is demand of them and not have to put any equity. But that’s as much as I can say, we are trying to minimize cash flow out of the company.

Joshua Katzeff - Deutsche Bank

Got it. So is that $50 million inclusive of the remaining 2013 Panamax payments?

George Economou

That’s correct.

Joshua Katzeff - Deutsche Bank

I guess switching over to your secured debt drivers (inaudible) restructurings, but debt repayment fulfillment. I guess with regard to the share pledges, can you just talk about, how maybe those have worked and maybe just broadly the mechanisms in those? If Ocean Rig's increase, do you get to release some shares or if the asset buyers increase, do you get to release shares?

George Economou

Yes. That’s all. They didn’t (inaudible) in some cases you have (inaudible) releases in any case, because those we have done some time ago.

Joshua Katzeff - Deutsche Bank

Okay. And the banks have been willing to take shares and continue to be, I guess, open to take further shares in order to kind of, I guess (inaudible) issues or potentially postpone?

George Economou

Yeah. They are. And don’t forget that we have an excellent relation with the banks because we have been both on the public and the private side. We pay them without delaying any payments or postponing any payments so far. So we are a lot ahead in goodwill with the banks that a lot of competitors have just decided they cannot pay anymore. So we do have the cooperation. We are thankful to the banks for helping us in difficult times.

Joshua Katzeff - Deutsche Bank

And just one more question before I turn it over. I just want to confirm that you don’t have any covenant issues I guess at the moment except for your pending deal with the $6.2 million -- 6.2 million Ocean rig shares.

George Economou

Well, these amounts have been detailed but not more than what we have disclosed in the previous statements.

Ziad Nakhleh

Yeah. I mean, Josh, look at our 6-K that we are going to be filing tonight. So we have several loan to value [breaches] but these are nothing new. They have been ongoing for the last couple of quarters.

Operator

Thank you. Your next question comes from the line of Michael Webber of Wells Fargo. Please go ahead.

Michael Webber - Wells Fargo Securities

Josh touched on most of my questions, but I want to kind of zero in on the four vessels you guys sold during the quarter to related parties. Curious, whether there was other interest and how you arrived at that $29 million?

George Economou

Well, first of all they were not all sold to related parties. Two of them were and two of them were not. But what is exactly the question you are asking?

Michael Webber - Wells Fargo Securities

How did you arrive at the $29 million payment from DryShips, the remaining payment on the installments? Basically, how did you come up with the value on the assets?

George Economou

That’s correct. It's the value of the remaining payments that we made to the yard versus the money you get from the buyers of these assets.

Michael Webber - Wells Fargo Securities

Right. And the buyers are related parties?

George Economou

No.

Ziad Nakhleh

As we said before, only two are and two are not.

Michael Webber - Wells Fargo Securities

Okay. I guess from the two that were, I mean were these marketed? Was there other interest out there? How did the related parties transaction come about?

George Economou

Well, I probably would have Ziad answer to that, on related parties.

Ziad Nakhleh

First of all, as Mr. Economou was saying, these four assets, two were to third parties, two were with entities affiliated with Mr. Economou. We got bona fide offers for these four vessels from these two different parties. Went through the motions of -- the normal motions, getting fair valuations for the assets, negotiating with the other parties, for both these types of transactions. And these were the arm length prices that we ended up with for both sets of transactions.

Michael Webber - Wells Fargo Securities

Got you. I mean, I have been just going through the motions on them. There was a time, I think it was about a year ago, where you guys were pretty public about not having any related party transactions going forward. How should shareholders interpret the fact that we have had this going to related party again?

George Economou

I think if you look at it, if you want to look at it objectively, DryShips took delivery of the vessels that had charters and let go four vessels that didn’t have. We were only able to get where it was offers or valuations on two, and we sold the two that were taking by the related party, related party paid more than the highest valuations offer we had. So again, we don’t think that we did anything, any dis-favor to the public company.

Ziad Nakhleh

Yeah, Mike, I mean we here at DryShips and especially as CFO, we wanted to get rid of these four non-performing assets. They had no charters, they had no bank debt. So, (inaudible) third party as long as I get an arm's length price, that’s what I care about.

Michael Webber - Wells Fargo Securities

Right now, I think I understand they needed to be sold but I wanted to give you a chance to address the related part aspect considering the history. I guess the only question I had, and it might be a moot point considering where the shares are trading, but we do see kind of a continued optimism in this space, be it realistic or not. Is an ATM, another ATM potentially on the table down the line, or is new equity out the window at this point.

George Economou

No, we haven’t done an ATM for a very very long time. It's not consideration at all.

Operator

Thank you. Your next question comes from the line of Oliver Corlett of R.W. Pressprich. Please go ahead.

Oliver Corlett - R.W. Pressprich

I wonder if you could just, a couple of housekeeping things here. Can you tell us how much CapEx you had at DryShips only in the quarter?

George Economou

Sorry, can you repeat?

Oliver Corlett - R.W. Pressprich

The CapEx for DryShips excluding Ocean Rig in Q1?

George Economou

How much we paid for CapEx for Q1?

Oliver Corlett - R.W. Pressprich

Yeah. And also how much debt you amortized in the quarter when you paid that?

George Economou

Well, tonight we are going to file the statements of cash flows on the both 6-Ks.

Oliver Corlett - R.W. Pressprich

Okay. Good.

George Economou

I am actually looking at them, so look and check them up with the SEC website after this call tonight. It's all there.

Oliver Corlett - R.W. Pressprich

Good. Now, again, on the newbuilds that you sold. You said some were in March and some were in April. When are the -- is the cash -- $29 million cash payment already out of your balance sheet or is that coming up? And also the loss, will some of the loss -- has all of the loss been taken or would some loss be taken in Q2?

Ziad Nakhleh

No, all the loss have been taken in Q1.

Oliver Corlett - R.W. Pressprich

Okay.

Ziad Nakhleh

So that’s [out].

Oliver Corlett - R.W. Pressprich

And the cash payment has been made, your cash is post the $29 million?

George Economou

The $29 million, only $5 million hasn’t been made to date.

Oliver Corlett - R.W. Pressprich

So you have got $5 million you did not pay.

George Economou

Yeah.

Oliver Corlett - R.W. Pressprich

Okay. One small question on the tanker fleet. I notice that your daily vessel operating expenses jumped up a fair amount in the quarter. Can you say what was behind that?

George Economou

That was the new deliveries. That we had just taken delivery of these three vessels. We took delivery with the ABN AMRO. And always when you have new deliveries, you first, let's call first quarter, in operation you will have higher OpEx.

Oliver Corlett - R.W. Pressprich

So you would expect that number to go down in the next couple of quarters?

George Economou

Yeah, logically. Since we have no more deliveries.

Ziad Nakhleh

Yeah, I mean it's always been like that. I mean whether it's with the newbuilding or a second hand, you have an increase of operating expenses in the first, 3-4-5 months and then go down.

Oliver Corlett - R.W. Pressprich

Right, okay. Now you have said, I think previously, that you were possibly expecting a dividend at Ocean Rig or at least an MLP event at Ocean Rig within 2013. But I think you just said that you didn’t think there would be any dividend in 2013. Have I got that right?

George Economou

Yeah. I think we are always trying to get as close as we can. You know under the facility that we have to date, you can only have dividend which is 3% of your net income. So that is quite restrictive. So as we said in previous call, we are looking at further amendment and/or refinancing of the existing facilities on the absolute level, so we can consider an MLP situation.

Oliver Corlett - R.W. Pressprich

Okay. And just one more question. On the -- when you talked about the drybulk market, you mentioned that there is some optimism that was provoking newbuild orders in addition to what we have already seen in drybulk. So speaking of someone who has sort of looked at the market from more or less the outside, doesn’t it seem a little crazy that anybody would be ordering new drybulk ships now? Where are these orders coming from? Are they subsidized by government somewhere? I don’t understand why a rational person would buy, would order a new drybulk capacity right now?

George Economou

Well, the answer is because not everybody thinks like you and we haven’t to deal with you. No, there are no subsidies. It just that prices are historically low. So people say, the first thing that comes to mind is, well, how much further can they go? But then the market we don’t think is going to be very hot in any time soon. It's a very fragmented industry so not everybody has the same considerations. And unfortunately, as much as we have advocated in [many] ways, calls and speeches, that we shouldn’t have any more orders, you do have the yard capacity and the yards will try and sell their capacity, whether by selling "very economic future ships or cheap ships". So that’s the name of the game.

Oliver Corlett - R.W. Pressprich

Right. And as I understand it, the proportion of the fleet that’s less than ten years old is now pretty high so we can't really expect very much scrapping going forward. Is that more or less right?

George Economou

Well, in present, yeah. In most categories, you are absolutely right. There will be mainly a little bit more scrapping in the smaller vessels because they -- it's the technological advancement, it's the size that charters are going to bigger sizes. But you are absolutely correct.

Operator

(Operator Instructions) We have no further questions at this time, please continue.

George Economou

Thanks everybody in this call and we will talk to again soon. 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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