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Danaos Corporation (NYSE:DAC)

Q2 2013 Earnings Conference Call

July 30, 2013 10:00 am ET

Executives

John Coustas – President and Chief Executive Officer

Evangelos Chatzis – Secretary and Chief Financial Officer

Analysts

Omar M. Nokta – Global Hunter Securities LLC

Mark Suarez – Euro Pacific Capital

Gregory Lewis – Credit Suisse

Operator

Thank you for standing by, ladies and gentlemen, and welcome to the Danaos Corporation Conference Call on the Second Quarter 2013 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 advise you that the conference is being recorded today, Tuesday, July 30, 2013.

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

Evangelos Chatzis

Thank you, operator, and good morning everyone and thank you for joining us today. Before we begin, I quickly want to remind everyone that management’s 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 that. Factors that might affect future results are discussed in our filings with the SEC and we encourage you to review the detailed Safe Harbor and risk factors disclosures.

Please also note that 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 accompanying materials.

Now, let me turn the call over to Dr. Coustas who will provide the broad overview of this quarter.

John Coustas

Thank you, Evangelos. Good morning, everyone, and thank you joining today’s call to discuss our results for the second quarter of 2013.

Despite the ongoing challenging state of the containership market we are reporting yet another solid quarter with adjusted net income of $11.8 million, or $0.11 a share and adjusted EBITDA of $107.4 million for the second quarter of the year.

Our adjusted net income was lower by $4.4 million when compared to second quarter of 2012 as a result of the softening of the charter market between the two periods. However, as the vessels that have been re-chartered at the current low rates deployed under short-term charters are currently running at operating break-even levels, an improvement in the charter market is a one-way option to the improvement of our results.

Effectively, over the next 12 months 97% of revenues are contracted with only 3% at stake through re-chartering. We currently have two vessels on cold lay-up compared to seven vessels laid up in the beginning of the year.

As previously reported, we are executing a fleet modernization program based on which during the first half of the year we sold five of the older vessels with an average age of 25 years for $32.8 million, while we have already utilized $17 million of these sales proceeds for the purchase of two 2,500 TEU geared containerships with an average age of 13.4 years. These two new vessels have already been chartered for one year and operate in niche markets.

We have already commenced the rapid deleveraging of the company through our free cash flow generation. During the first half of the year we have reduced debt by $75.7 million while we anticipate to pay down debt by approximately a further $100 million until the end of the year.

On the market front the situation is stagnant. While the liner companies are struggling to absorb the influx of the mega containerships amidst a weak demand environment in the main-lane trades, particularly in the Europe-Far East trade with GDP in the Eurozone expected to marginally contract in 2013 and the growth figures in China not being as robust as initially anticipated.

The U.S. economy seems to be rebounding, but this is not in itself enough to drive a market improvement. The peripheral trades are doing much better and at the moment this is the only bright side of the market. The order book is currently at only 20% of the current fleet, but it’s clear that the surplus in shipyard capacity and the very low new building prices being offered pose a risk to the timing of the recovery of the market.

The liner companies are once again taking initiatives to mitigate losses such as announcements for General Rate Increases and the success of these measures remains to be seen. A significant initiative in this direction is the recent announcement for the formation of the P3 network by the world’s three largest carriers; Maersk, MSC and CMA-CGM, which will be operative from the second quarter of 2014. Such a network will undoubtedly optimize the operating performance of the anticipated 255 vessels or 2.6 million TEU that participate in the scheme, and offer the lowest operating costs in the market.

On the other hand, the necessary cascading of tonnage will continue exerting pressure on the charter market for the Panamax vessels ranging between 3,000 - 5,000 TEU.

We will continue our efforts to manage the fleet efficiently and 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 financial report. Thank you.

Evangelos Chatzis

Thank you, and good morning everyone, and thanks again to all of you for joining us today. I will briefly review the results for the quarter and then give the chance to the participants of the call to place questions.

During the second quarter of 2013, we had an average of 60.9 containerships compared to 62.2 containerships for the second quarter of 2012, while during the current quarter we sold two of the oldest vessels in our fleet, the Honour and the Elbe for a net sale consideration of $14 million.

The Honour had been on cold lay-up while the Elbe was sold after being delivered to us following termination of its charter. Implementing our fleet renewal program during the first half of the year we have sold five of our oldest vessels while we have purchased as mentioned earlier two 2,500 TEU geared containerships that have been charted for a year.

Following the already consummated sales and the reactivation of Melisande during the first quarter of the year we currently have two vessels on cold lay-out. Given the state of the market we currently do not anticipate to reactivate these two vessels before the second quarter of the next year.

Our adjusted net income was $11.8 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 $16.2 million or $0.15 per share for the second quarter of 2012. This decrease is attributable to the softening of the charter market during the last 12 months that led to the cold lay-up of certain vessels and to the re-chartering at lower rates of certain other vessels.

That currently run at operating break-even levels, while they have a positive contribution to operating income during the second quarter of 2012, as well as of course as to the two vessels sales in the current quarter. It is worth at this point to note that beside the chartering rates, which is manageable as 97% of our revenues is contracted for the next 12 months. The most important driver in our earnings today is related to hedging that we have in place to the interest rate swaps.

Indicatively our adjusted net income for the second quarter of 2013 that currently stands at $11.8 million would have been $48 million if the current interest rate swaps were not in place. These swaps start expiring from the fourth quarter of 2014 to the end of 2015 and at that point we expect a significant improvement in earnings given the market expectations for persisting low interest rates.

With our average charter duration at 9.3 years well exceeding the 2.5 years of remaining duration of the swaps, we believe that we will be able to take advantage of the anticipated low LIBOR environment on the back of solid contracted income generation.

Operating revenues effectively remain the same between the two quarters, as the decrease in revenues due to lower re-charterings or lay-ups, was offset by the incremental revenues of the three 13,000 TEU containerships that were added to our fleet during the course of the second quarter of last year and they were fully utilized during the current quarter.

Vessel operating expenses increased by 0.6% or $0.2 million to $31.6 million in the current quarter from $31.4 million in the second quarter of 2012.

The daily operating cost in the current quarter was $6,160 per vessel per day. Slightly higher than the almost $6,000 average daily operating cost for the second quarter of last year and this is attributing to slightly higher schedule repairs and maintenance expenses. Still this daily operating expenses are one of the most competitive in the industry.

G&A expenses decreased by $0.5 million to $4.7 million in the current quarter from $5.2 million in the second quarter of 2012, mainly as a result of the decrease in the average number of vessels in our fleet between the two quarters.

Interest expense increased by 8.4% or $1.8 million to $23.3 million in the current quarter, from $21.5 million in the second quarter of 2012. The change in interest expense was mainly due to the higher average indebtedness between the two quarters, which was by $68 million. Actually it was $3.35 billion in the current quarter, from $3.28 billion in the second quarter of 2012.

Additionally, since our new building program has been concluded, no interest was capitalized in the current quarter, compared to $1.2 million of interest capitalized in the second quarter of last year. As we are rapidly de-leveraging the Company’s balance sheet with effectively all of the generated free cash flow, we expect finance costs to continuously improve in the coming quarters.

Realized losses of interest rates swaps decreased by $1.4 million to $37.2 million in this quarter, compared to $38.6 million in the second quarter of 2012. This decrease is attributable to the lower average notional amount of swaps between the two quarters. As there is amount of swap expirations partially offset by the $2.2 million of realized losses that have been capitalized last year in association with our new buildings while there was no capitalization of swap expenses during the current quarter. It’s worth noting here that as a result of these swap expirations the Company is no longer in a normal hedging position.

To conclude adjusted EBITDA increased by $0.7 million to $107.4 million in the current quarter, from $106.7 million in the second quarter of 2012.

With that I would like to thank you for listening to this first part of our call. We’ll now take your questions. Operator?

Question-and-Answer Session

Operator

Thank you very much, sir. Now from Global Hunter Securities, you have the question from Omar Nokta. Please ask your question.

Omar M. Nokta – Global Hunter Securities LLC

Hi, thank you. Good afternoon guys.

John Coustas

Hi.

Evangelos Chatzis

Hello, Omar.

Omar M. Nokta – Global Hunter Securities LLC

Hi, I just wanted to, congratulations on the purchase of those geared containerships. And I was just wondering, could you provide us a sense of what you’re seeing in the marketplace right now, for charter rates versus a 12 months on a geared 2,500 TEU ship versus a gearless vessels?

John Coustas

Well, rates really are not going to be any better. It’s just as the employment prospect of a geared vessel are probably better. For the time being all these ships are, I mean geared ships are maybe under slight premium to say gearless vessel of the same size, but in any case we’re talking of numbers, which are pretty close to operating costs.

The only difference is, as I say, that the geared vessels are not so much affected by the cascading because of the trades which they operate. It maybe affected by, let’s say, other changes in the structure of the trade, but not by the cascading in itself. And that’s why we think that also on the basis that nothing really is practical being built in this sector. We may have, let’s say, a more healthy market in a couple of years.

Omar M. Nokta – Global Hunter Securities LLC

Okay. And would you – presumably I guess in this market as you look to deploy more of the capital you’ve currently raised ahead of sales, would you be looking more into geared ships of similar size so that even though you are paying small upfront payments just due to the fact that they are priced pretty much at scrap, that you would be looking for geared ships just at least to get employment in the near-term?

John Coustas

Yeah, I think we will look for geared ships. Of course that is one hand because we believe that these ships will have, let’s say, relatively better prospects. But on the other hand, one, let’s say, important consideration is that this is a segment that we do not have any exposure and we would like really to take the opportunity to have the presence also in this area.

Omar M. Nokta – Global Hunter Securities LLC

Okay. And then just also I wanted to ask one final question. You have some of your oldest ships built in 1989, 1991, those I think are rolling off contract this quarter. What do see, do you see yourself also looking to sell those either for scrap or just selling them in the open market? And then taking those proceeds also and maybe deploying them in the secondhand market today?

John Coustas

Yeah, I mean we have earmarked a number of vessels, let’s say, as potential for – let’s say for disposal. We will see how the market develops, but, yes it’s likely that, yes, some of them maybe disposed this second half.

Omar M. Nokta – Global Hunter Securities LLC

Okay. And then, just sorry, one more. I just wanted to double check. In the comments earlier you’d mentioned the two vessels that are currently in lay-up, you don’t expect to bring those back online prior to 2Q 2014, did I get that right?

John Coustas

Well, no. I mean, we have requested to reactivate the vessels, but it’s pointless to reactivate them as a relatively low premium to OpEx. Let’s say there is a meaningful, really profit to make out of the charter, we will do it, otherwise it’s pointless just to go through all the risks of reactivating a vessel. And also, we are contributing in a negative way to the market this way.

Omar M. Nokta – Global Hunter Securities LLC

That makes sense. All right, well, thank you very much.

John Coustas

Thank you, Omar.

Operator

Thank you, sir. Now your next question from Euro Pacific Capital comes from Mark Suarez. Please ask your question, sir.

Mark Suarez – Euro Pacific Capital

Hi, there. Good morning. Good afternoon. Thanks for taking my questions. Just to go back on the two-year vessels you talked about. What was the source of that deal? Was it from brokers, lenders or operators? I just want to get a sense as to how you managed to purchase those two vessels?

John Coustas

These vessels were purchased, let’s say, practically from the open market.

Mark Suarez – Euro Pacific Capital

Got you. And can you talk a little bit about what sort of charters you managed to lock them in at? Are they at a premium to OpEx levels or break-even? What sort of charters do you manage to get for them?

John Coustas

No, they are you know pretty much, because these were reported also, there is nothing really big secrete about that, these are around in the region of $7.500 a day which is at a slight premium to OpEx.

Mark Suarez – Euro Pacific Capital

And is the idea here to continue to lock them as one-year charters or is there a possibility of doing maybe shorter charters to sort of take advantage of the upturn in the market coming next year?

John Coustas

Yeah, practically in containers, you very rarely get lets say I mean two, three, four month charters, I'm that’s really the exception. So if someone needs the ship, he will take it for a year or so. So it’s not really a question of our choice give it, but in general the strategy yes is to keep it as short as possible.

Mark Suarez – Euro Pacific Capital

Okay. And just to go back to the five remaining mortgage vessels that you have earmarked, I know you mentioned your intention to sell them off, if I hear you correctly. Do you have a sense of the timing as to when that is going to happen? Could that happen all in the second half or do you think that could overlap into 2014?

John Coustas

I think that practically we will try to really to decide within this year, what we will do with the ships.

Mark Suarez – Euro Pacific Capital

Okay. And do you have a target as to how many new vessels you want to purchase assuming obviously that you get the you complete all these remaining selling of the vessels there or do you have like a target in mind, in terms of how many you mentioned gearshifts going actually intersecting that segment do you have a number in mind if you will how many vessels you want to acquire?

John Coustas

Well first of all we need to find let's say suitable candidate and once we do we probably the intention is really to utilize as much as possible from these proceeds.

Mark Suarez – Euro Pacific Capital

Okay. And then the final question with regards to the laid up vessels is there any chance of maybe selling them off or I mean if you can be activating at a reasonable time that you think makes sense from a cash flow perspective may be just setting up it will make more sense or is that now something you’re thinking about?

John Coustas

I don't think really, I mean these are the ships that we have really that we are keeping to-date totally up. Our vessels which we believe they have the potential to compete in a better markets. So they are not really candidates for scrapping.

Mark Suarez – Euro Pacific Capital

Okay. I think that is all I have for now. Thanks for your time.

John Coustas

Thank you very much.

Operator

(Operator Instructions) And you now have a question from Credit Suisse from Greg Lewis. Please ask your question.

Gregory Lewis – Credit Suisse

Hi, good afternoon gentlemen. Can I apologize if you addressed this earlier on the call. But I mean clearly a few of your competitors have opted to partner with larger private equity firms at this stage in the game forming JVs. Is that something Danaos is exploring and I guess my question is, if it’s not given the potential for private equity alternative investments whatever we want to call them. It seems like there is real appetite from that side of the equation to want to make investments and partner up with shipping companies such as yourself.

John Coustas

Well, it’s true that we are really, we are discussing with a number of firms about possible cooperation. I think is that because really at least as far as let’s say the Danaos Corporation is concerned, due to the capital restrictions, I mean that we had through the restructuring such kind of joint venture deals are not very, let’s say very simple to, I mean to manage as they require you know a number of approvals from the banks and it is a bit as you know banks do not move very quickly to date. So they would require consent from all our banks, so that is bit of a deterrent.

We are looking at some alternative schemes to be honest that the vessels let’s say are acquired privately with let’s say with the option of the public entry to acquire them at later stage. But we don’t really to be honest; we don’t see any kind of deals that have how can I say any returns, which are appealing. On the other hand because of the low prices, there has been a considerable number of speculative ordering on the ships of let’s say on large ships or ships of let’s say 9,000 TEU. And although we’re talking about something more than 20 ships on speculation in this segment. Charters at present are a bit let’s say reluctant to grow and commit into charter contracts because they are trying mainly to concentrate on the existing ships that have been built on speculation. And they believe that they can get a better deal through the people who have already let’s say committed.

Gregory Lewis – Credit Suisse

Okay, perfect. Thank you for the time, John. Have a great summer.

Unidentified Company Representative

Thank you.

Operator

Thank you, sir. And at this point there are no further questions. So I now pass the floor back for closing remarks to Dr. John Coustas.

John Coustas

Thank you, operator. Thanks everyone for joining this conference call and your continued interest in our story. We look forward to our next earning calls and wish you a nice summer. Thank you.

Operator

And with many thanks to both our speakers today. That does conclude our conference. Thank you for participating. You may now all disconnect.

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