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Teekay Shipping Corporation (NYSE:TK)

Q1 FY08 Earnings Call

May 15, 2008, 11.00 AM ET

Executives

David Drummond - IR Officer

Bjorn Moller - President and CEO

Vincent Lok - EVP and CFO

Analysts

Jonathan Chappell - JP Morgan

Urs Dur - Lazard Capital

Gregory Lewis - Credit Suisse

Justine Fisher - Goldman Sachs

Timothy Mullen - Virginia National Bank

Daniel Burke - Johnson Rice

Operator

Good morning ladies and gentlemen, thank you for standing by. Welcome to Teekay Corporation First Quarter 2008 Earnings Release Conference Call. During the call, all participants will be in a listen-only mode. Afterwards, you will be invited to participate in a question-and-answer session. [Operator Instructions] As a reminder, this call is being recorded.

And now, for opening remarks and introductions, I would like to turn the call over to Mr. Bjorn Moller, Teekay's President and Chief Executive Officer and Mr. Vince Lok, Teekay's Chief Financial Officer. Please go ahead, sir.

David Drummond - Investor Relations Officer

Before Mr. Moller begins, I would like to direct all participants to our website at www.teekay.com, where you will find the copy of the first quarter 2008 earnings presentation. Mr. Moller and Mr. Lok will review this presentation during today's conference call.

Please allow me to remind you that our discussion today contains forward-looking statements. Actual results may differ materially from those projected by those forward-looking statements. Additional information concerning factors that could cause actual results to materially differ from those in the forward-looking statements is contained in our earnings release and earnings release presentation available on our website.

I will now turn it over to Mr. Moller to begin.

Bjorn Moller - President and Chief Executive Officer

Thank you Dave. Good morning ladies and gentlemen. Thanks for joining us for our first quarter earnings call. As usual, I am joined by our CFO, Vince Lok and for the Q&A session, we also have our Chief Strategy Officer Peter Evensen available.

Starting with the highlights for the quarter on slide number three, we earned net income on an operating basis of $60.8 million, or $0.83 per share. Cash flow from vessel operations or CFVO, was $184.8 million with approximately one-third coming from our spot business and the reminder from our fixed-rate business. We repurchased close to 500,000 of our shares for $20.5 million, or around $41 per share.

Q1 average tanker rates were higher than the previous quarter and this improving trend has continued into Q2 where we are currently enjoying very high tanker rates due to strong fundamentals. And as I will be describing this morning, we are actively executing in our 2008 strategy which we presented to you last quarter.

Slide number four provides you with the quick reminder of that 2008 value creation strategy, which is to grow each of our subsidiaries accretively through drop downs of existing and future assets from Teekay Corporation and from third-party acquisitions. The Benefits to Teekay are two-fold, to increase the performance fees we've received from our daughter companies, thereby increasing free cash flow and return on invested capital at Teekay and to increase the share price of our daughter companies in order to raise the sum of parts value.

On slide number five, we highlight our recent progress in executing on this strategy and I'll spend a few minutes talking you through these developments. It was another exit quarter for Teekay LNG Partners, shown in the box on the bottom-left of the slide. We dropped down the two Kenai LNG carriers which auto back [ph] to Teekay for ten years plus options. And this month, we also dropped down the first of four RasGas 3 LNG carriers.

TGP management plans to recommend distribution increases in connection with these drop downs. TGP completed a $200 million follow on equity offering of which Teekay participated for $50 million. The General Partner owned 100% by Teekay will soon move up to the 25% tier in the incentive distribution rights.

The box above TGP marked gas, shows new business developed by Teekay for dropdown from TGP at a future date. As you will have seen from our earnings release, Teekay announced it will be taking over from IM Skaugen the new building contracts for two multigas vessels to be constructed in China. On delivery in 2010, these ships will be dropped down for TGP who will charter them to Skaugen for 15 years.

Looking next Teekay tankers in the middle column, TNK declared its first full quarter dividend of $0.70 per share, representing an annualized yield of approximately 12%. Teekay dropped down Suezmax tankers to TNK, early in the second quarter. This early fleet growth coupled with the rise in Q2 tanker rates points to a very attractive dividend payment for TNK for the current quarter. Teekay is entitled to an incentive fee of 20% of dividends paid above $3.20 per share. At the corporate level Teekay sold four Handymax product tankers for $175 million. These ships which were acquired as part of the OMI transaction last year, were not considered call to Teekay.

Finally turning to Teekay Offshore Partners on the right, Teekay announced it has offered TOO a dropdown of 25% of OPCO, if agreed this transaction should provide accretive growth to TOO and move the GP up the IDR splits from its current level of 2%. At the Teekay level, in the offshore sector, the Siri FPSO went on hire in Brazil, where it now pioneering the offshore production of heavy oil with an API of below 12.

We continue to see a lot of opportunities in the offshore productions storage and transportation area. Teekay Petrojarl is actively bidding on new FPSO projects, but we are continuing our disciplined approach in an environment, where many our competitors are experiencing cost overruns and project delays. We are confident that we can compete in this space as illustrated in Petrojarl's recent bid for 2P [ph] project in Brazil. Although that contract was awarded to another contractor, who had one of the few existing idle FPSO units, we know from the subsequent publication by Petrobras of all bids that Petrojarl submitted the most competitive bid among those offering a conversion solution.

It is worth mentioning that we have recently established a Teekay office in Brazil to increase our marketing in this important offshore oil and gas growth market. Petrojarl is also actively negotiating contract extensions on some of its existing FPSO units, as it seeks to re-price current rates in line with today's stronger markets.

Finally, let me say to those of you, who have been asking or better financial information on Teekay to illuminate the effect of our dropdown strategy, we heard you. In Appendix B to the earnings release, we have shown these aggregated financial statements for Teekay and its publicly-listed subsidiaries for the first time and Vince will walk you through this new reporting format during his comments and we look forward to your feedback.

On slide number six, we show are updated sum of parts the value which currently stands at $63.44 per Teekay share. As you saw in the previous slide, we are working hard to raise the sum of parts. We also believe that as we continue to execute on our value creating strategy, we will narrow the current 25% GAAP between the sum of parts value and Teekay share price.

Turning to slide number seven, I would like to discuss the spot tanker market which is phenomenally strong at the moment. In fact based on rates so far this quarter, this is shaping up to be the strongest Q2 spot tanker market on record. We have booked 65% of our Q2 Aframax spot days at an average TCE of $38,000 a day and we have booked 60% of our Q2 Suezmax spot days at and average TCE of $62,000 a day. Current market rates for both of these segments are well above these levels.

In light of this strong market, we are pleased to be able to reflect on having executed a number of fleet growth initiatives. Our acquisition of OMI which is now approaching its one year anniversary and our more recent acquisition of ConocoPhillips's six year Aframax fleet, we are well timed. Also, the six Suezmax new buildings we have scheduled for delivery in the next 12 months were ordered at favorable prices that should translate into a low net income breakeven of $23,000 a day. This means that in a $60,000 a day spot market, each of these ships would add approximately $0.18 of EPS annually to Teekay Corporation's results.

When we look at what's driving tanker rates, it's comforting to realize that the market appears less driven by short-term events and more by solid fundamentals. On the following few slides, I'll review the three reasons we see for the current strong market.

Turning to slide eight, reason number one is strong tanker demand growth, driven by both higher oil volumes and growing average transportation distances. While oil demand is flat to slightly negative in the U.S and Europe, demand is powering ahead in non-OECD countries. China and developing Asia currently account for 70% of global oil demand growth. In Q1, China oil imports were up by 15% year-on-year. Newly published statistics by China highlight that a full a 35% of its imports are now being sourced from the Atlantic basin, three times the volumes of five years ago. This highlights the fact that in both terms the marginal barrel of oil is being produced in the Atlantic and it's being consumed in the Pacific.

There is the related trend of new or growing long hold trade routes such as Venezuela to China and India, Brazil to California, Angola to China and so on. In other words, it takes more tankers to move to same amount of oil than it used to. Reason number two, for the strong market on slide number nine, is that the required additional tankers to move that oil may not actually become available due to limited supply growth.

In Q1, the World Tanker Fleet grew by only 0.6% from the end of 2007. Deliveries were almost entirely offset by ships being converted to offshore or dry bulk use and also scrapping activity re-emerged due to record high prices for scraps steel. Many observers have predicted net fleet growth this year based on the published order book. The table on this slide takes a closer look at 2008 fleet numbers. The number of new building deliveries projected by Clarkson's is shown in the column marked 2008 deliveries as per CRS.

Based on our first-hand experience of a six month delay on our own Suezmax new buildings in China which are been built at a relatively well established shipyard. We have adjusted Clarkson's expected 2008 deliveries in the next column on the basis that half of schedule 2008 Chinese new buildings will be delayed by six months. This would for example reduce Suezmax deliveries from 21 for Clarkson to 17 per our calculations.

The deletion figures for this... in this sold plus conversion and scrap column are a Teekay estimates. They include ships which have already left the fleet this year, plus ships mandated out in 2008 by the IMO, plus tankers sold in 2007 for conversion, but which have not yet converted, plus 50% of ships reported sold in 2008 year-to-date for conversion. We have conservatively assumed no further conversion sales, nor any voluntary scraping for the remainder of 2008. Based on these, in our opinion, realistic assumptions overall Aframax, Suezmax and VLCC fleet growth could be as little as 1% this year, as shown in the right hand column.

Reason number three for the strong market on slide 10, is what we have termed operational constraints. This is a list of factors which in aggregate meaningfully reduce the effective utilization of the world fleet. Single-hull discrimination continues to grow. Korea which has been a leading user of single-hull tonnage has set aggressive reduction targets for single-hull use. The 20% of the world tankers that made up for single-hull fleet is feeling the net tightened around it. A growing number of ship days are being lost due to a variety of infrastructure of bottlenecks, such as ships waiting to unload due to lack of shore tank capacity, ships serving as floating storage, as we are currently seeing in Iran, where 1.5% of the world tanker fleet is tied up, or ships being used as hidden storage by all traders. Stressed repair yards lengthening the average dry docking stay for ships.

As always, there are a number of temporary factors influencing the fleet as well and finally and this is probably a factor which tends to be overlooked by many observers, is the effect of high bunker prices. The optimal economical speed of a ship is the function of the price of fuel and the prevailing fleet market. More than a year ago, when bunker prices were well below today's levels, the major container lines began slow steaming their ships due to pressures on operating margins. The result was the significant contraction in container shipping capacity.

Based on today's bunker prices of close to $600 per ton, a modern Suezmax tanker needs to generate a TCE of more than $50,000 a day to justify maintaining full speed 15 knots. Below the TCE level, it is more economical to reduce speed to 14 knots, doing so, however, would mean taking approximately 6% more days to complete a given a voyage.

At a macro level, this equation represents a major self regulating factor in tank supply that should put a flow on the spot rates at a high TCE level. It is interesting to note that in 2004, the previous peak year for tanker rates, bunker prices were less than one-third of today's levels and, therefore, did not provide anywhere near the same underpinning to market rates, as is the case now.

On slide 11, we reintroduce a graph from the past, showing the close correlation between global fleet utilization and spot tanker rates. It is generally accepted that 90% represents full utilization of the world tanker fleet and above this level, spot rates tends to spike dramatically. According to Platou, world tanker fleet utilization is now back above 90% explaining the market strength we are currently enjoying. While it is still too early to rule out the prospect of seasonal weakness later this summer, fundamentals points to a very tight tanker market overall for 2008.

I'll now hand it over to Vince for the financials. Vince?

Vincent Lok - Executive Vice President and Chief Financial Officer

Thanks Bjorn and good morning everyone. Net income for the first quarter was $60.8 million or $0.83 per share when excluding the items listed in the Appendix A of our earrings release, which relates mainly to unrealized losses from foreign exchange translation and interest rates swaps.

Looking at our operating segments on slide 13, we generated $185 million in cash flow from vessel operations or CFVO during the first quarter, compared to $138 million in the previous quarter. The offshore segment CFVO declined by $2 million from the fourth quarter of 2007, mainly reflecting an increase in the number of off-hire days in our shuttle tanker and FPSO fleets due to unexpected repairs. Partially offset by a decrease in vessel operating expenses.

In the first quarter, two of our shuttle tankers incurred a total of 102 days of unscheduled off-hire, which resulted in a $3.8 million reduction in revenues. Our new Siri FPSO commenced its charter in Brazil on February 1st. However, the CFVO from this unit was not material in the first quarter due to start up cost and that full production did not commence until early in the second quarter. We estimate that the second quarter CFVO for the offshore segment will be slightly higher than the first quarter, because the full impact from the Siri FPSO and lower expected off-hire days will mostly be offset by higher maintenance cost for the offshore fleet, as we begin to move into the usual summer maintenance season in the North Sea.

CFVO from the fixed-rate tanker segment increased by $1 million, primarily due to the net increase in the fleet size. For the second quarter, we expect CFVO from the fixed-rate tanker segment to increase to approximately $26 million, as a result of the addition of two MR product tankers, which recently commenced five years charters to ConocoPhillips.

We had another strong quarter in our liquefied gas segment, generating a record high CFVO of $39 million, up $4 million in the prior quarter. The increase was the result of the acquisition of the two Kenai LNG carriers in December 2007, partially offset by the impact of five off-hire days on the Catalunya Spirit in the first quarter. We expect the gas segment CFVO to decrease to approximately $37 million in the second quarter, due to the scheduled dry docking of two LNG carriers and one LPG carrier.

The first RasGas 3 LNG carrier delivered in May, however, as these vessels are equity accounted for, since we own a 40% interest in these vessels. The results will not be reflected, you know, reported CFVO going forward. The CFVO contribution from our spot tanker segment increased by $43 million, compared to the prior quarter, primarily due to the increase in spot tanker rates and an increase in the size of the spot tanker fleet resulting from the acquisition of the ConocoPhillips vessels.

In order to improve the comparability of our TCE results to market indices, in our earnings release we have split out the TCEs and the revenue days within our spot tanker segments between charters that are less than one year, which we referred to hear as spot and charters one to three years in initial [ph] length which is referred to as time-charter.

Our spot Aframax and Suezmax fleets earned an average TCE of 36,200 and 46,700 per day respectively, in the first quarter and as Bjorn mentioned earlier, the spot rates so for in the second quarter are above the first quarter levels.

Turning next to slide 14 and reviewing the remaining income statement figures in comparison to the prior quarter, G&A expenses were $67.7 million, compared to $60.1 million in the prior quarter, this increase was primarily due to higher business development cost, particularly in our offshore segment. The timing of certain expenditures and the continuing depreciation of the U.S dollar. As noted at the bottom of the income statement in our earnings release we had certain foreign exchange hedges in place which did not get hedge accounting treatment, had we been able to get up hedge accounting treatment, the reported G&A cost would have been roughly $2 million in lower in the first quarter.

We expect G&A expenses in the second quarter to be slightly lower than in the first quarter. We incurred $1.5 million in restructuring charges during the first quarter. These costs related to the re-crewing of a tanker from Australia crew to international crew. An equivalent amount was paid to us by the customer, which is included in our revenues. The increase to net interest expense was mainly related to unrealized loses from interest rate swaps, which has not been designated as hedges as well the acquisition of the Kenai LNG carriers in December 2007. The total amount of these unrealized loses from interest swaps was $11.5 million in the first quarter compared to $5.8 million in the prior quarter.

The income tax expense in the first quarter of 2008 was in line with expectations when excluding the effective foreign exchange rates. Excluding the effects of these foreign exchange rates, we expect our tax recovery in the second quarter to be approximately $10 million which includes a $5 million one time cash tax recovery.

Foreign exchange loss in the first quarter of 2008 was $29 million which was mainly due to unrealized translation losses. Excluding the minority interest portion of the items in Appendix A, minorities interest expense in the fourth... in the first quarter would have been roughly $12.6 million, which has increased from $7.1 million in the previous quarter, due to the impact of the Teekay Tankers IPO for fourth quarter. Going forward, minority interest expense will of course vary depending on the results of Teekay Tankers.

In keeping with our Asset Manager focus, for the first time we have also presented our balance sheet and income statements on a disaggregated basis, separately showing the results of each of our publicly listed subsidiaries and of the parent company on a stand-alone basis. We hope that this supplemental information will be useful, particularly in illuminating the free cash flow generated by the parent company and to illustrate the strength of Teekay's balance sheet on a stand-alone basis.

As you can see on slide 15, most of Teekay's consolidated debt resides in its various subsidiaries and is now on a re-course to Teekay Corporation. As at March 31st, Teekay's standalones net debt was just under $1.4 billion. However, this amount is declining rapidly. For instance, in early April Teekay Corp sold two Kenai LNG carriers to TGP for $230 million and to Suezmax tankers to Teekay tankers for about $190 million. Pro forma for these two transactions, Teekay's standalone net debt was below $1 billion. As we continue to execute on our plan to drop down more assets in to our daughter companies, Teekay standalone's balance sheet should quickly deliver, which will provide us with further financial strength and flexibility going forward.

Slide 16 shows that this aggregated income statement and cash flow from vessel operations. For simplicity, we have included Teekay's standalone 74% direct interest in OPCO's results, under the Teekay offshore columns. Teekay standalone generates a significant amount of cash flow which was $49 million in the first quarter. Further, when Teekay Petrojarl's current FVSO contract resets at current market rates, there is significant upside to it's cash flow from vessel operations.

Slide 17 illustrates the amount of cash flow generated during the first quarter from Teekay standalone's perspective. The distributions received from TGP, TNK, TOO and OPCO totaled $51 million in the first quarter. These cash flows are expected to increase as we grow the distributions in each of our daughter companies. It is also important to note that we are still at the early levels of the GP incentive distributions which can grow exponentially as we start to move into the higher splits and as we grow the absolute size of each of our daughter companies.

Together with the $34 million in net cash flow from the standalone assets, the total cash flow generated by the parent company in the first quarter was $85 million, or a $1.16 per share which is attractive free cash flow yield, especially when you consider the upside potential of our FVSOs and our GPs.

Slide 18 shows the number of new billings scheduled to deliver into our fleet during the reminder of 2008. All these vessels are fully financed and are either committed or suitable to be dropped down into our daughter companies. Our new building delivery pipeline provide us with built-in growth in 2008 to further help increase our cash flows. We'll now turn it over to Bjorn to conclude.

Bjorn Moller - President and Chief Executive Officer

Thank you, Vince. I just want to say that we are very excited about the progress we are making in our strategic approach with the news to report in each of our daughter companies and we are very excited about the momentum of the tanker market and Teekay's recent growth in that sector as well. So with that, we would like to open it up to questions from the analysts and investors.

Question And Answer

Operator

Thank you. [Operator instructions]. Your first question today will come from Jonathan Chappell of JP Morgan. Please go ahead.

Jonathan Chappell - JP Morgan

Thank you. Good morning, guys.

Bjorn Moller - President and Chief Executive Officer

Hi, Jon.

Jonathan Chappell - JP Morgan

Bjorn, can you remind us on the Petrojarl contract renewals, when do they officially expire? How early before those expirations are you attempting to get the kind of mark-to-market rate and really what's your alternative if you can't get the current contracts renewed at market rates, are there other potential opportunities for those assets?

Bjorn Moller - President and Chief Executive Officer

Yes, we... I guess that's on disclosure and it's on Petrojarl annual report, but essentially the series FPSO which is now producing in Brazil, is on a two option one year contract that's been widely publicized and discussions in the early stages ongoing production opportunity for that vessel, but that's not suppressing that we are confident that ship will probably spend all or most of its technical and operational life in Brazil. We have currently two contracts in the North Sea that are likely to end in 2010 and one of them is under active negotiation and the other one, I guess is under consideration. So, I would hope that we would have something in the next couple of quarters to report.

On the renewal side, hopefully, we'll have some new projects that we can also secure.

Jonathan Chappell - JP Morgan

Okay. Sticking with the offshore segment, the refinery shut down disruptions earlier in the second quarter in the North Sea, did that have any significant impact on your shuttle tanker business or any of your business out in that area?

Bjorn Moller - President and Chief Executive Officer

I think what happened in the North Sea was, of course the freight market was strengthening and that caused our customers to try and use the shuttle tankers for slightly longer voyages. They have, I guess, under the time charter provision, the right to go for... to different destinations, they pay the same day rate, which is like in the mid 50s a day. And so if it's a weak spot market, they will typically shuttle the crude from nearby storage gathering facilities and ship it out on VL Suezmax's Trans-Atlantic, but if the spot market is very hot, they actually can choose to directly deliver crude oil in shuttle tankers into the Mediterranean, the U.S. and so typically if you have a disrupted market, especially in a firm freight market, then they tend to use up more shuttle days, so we certainly would not have suffered any idle time from that.

Jonathan Chappell - JP Morgan

Okay. And then finally, there is large discrepancies in different Aframax markets over the last several weeks and months, kind of grew up on TK understanding that half your business is done in the Pacific Basin and half basically in the Caribs. Are you more flexible now, are you getting more exposure to potentially the North Sea in the Med markets which had been hotter of late, recently?

Bjorn Moller - President and Chief Executive Officer

Yes, we are, we are still using the same rule of thumb, but I guess we have a more varied underlying trading platform. I think in the fourth and sorry, the vessel base sold in the second quarter reflect the fact that the first month of the second quarter April was quite a bit weak in the Pacific than it was in the Atlantic, but that has since caught up. So the current day rates in the Indo-Pacific are 40,000 to 45,000 and that's similar to the Caribbean market.

So, we are certainly doing more in the Mediterranean and of course with our Suezmax business, we're generally doing a lot more in the Atlantic than we are on Pacific. So, we have moved a few ships from the Pacific into the Mediterranean this last few months in response to the strong rates. We've also traded couple of LR2 product carriers from clean into dirty to take advantage of that big differential. So, we're quite flexible.

Jonathan Chappell - JP Morgan

Okay, very helpful. Thanks, Bjorn.

Operator

Thank you. And your next call will come from Mr. Urs Dur of Lazard Capital Markets. Please go ahead?

Urs Dur - Lazard Capital

Good morning, guys.

Bjorn Moller - President and Chief Executive Officer

Good morning, Urs.

Urs Dur - Lazard Capital

Hi. Saw you on CNBC this morning, guess, you were up early. I was wondering if you could discuss because I appreciate your position on the order book and I tend to have a general agreement. How many conversions are you seeing on the Aframax side or is that specified in the presentation? I didn't quite see that.

Bjorn Moller - President and Chief Executive Officer

Well, I think the number we used in our presentation was 45 for Aframaxes.

Urs Dur - Lazard Capital

Okay.

Bjorn Moller - President and Chief Executive Officer

So, of course we are only assuming that half of the vessels sold scrap this year would go, and all of the ships sold, sorry, let me repeat that. Half of the ships sold for conversion in '08 so far, half of those assumed to actually go ahead this year, whereas all of the ships that were sold as conversion last year, we assume will get done by the time the year is over. So we think that's a pretty conservative assumption.

Urs Dur - Lazard Capital

Do you see next year in your assumptions going forward. Next year, similar tightness, and do you see issues in regards to scrapping going forward, considering this the phase out, there is going to be an awful lot of tonnage that will be legislatively redundant and of the vast majority of the trading world. Do you see bottlenecks for scrapping and do you see a similar tightness next year with the fleet growth?

Bjorn Moller - President and Chief Executive Officer

Well, we definitely have more inflow of new tonnage next year, that's quite understood. But again, we think China will have a bigger share next year and they will have the same domino effect of delays. So that's one thing that will possibly mitigate the incoming tonnage, but it's still going to be big number. So the question is how can that be absorbed? And on that front, I would say, clearly, I don't think anybody is talking about 2015 phase out of single-hulls, the question is is it 2010 or are people going to start phasing the vessels out even sooner? Of course that depends on the market, it would be a bit of a self-rule [ph] filling support of the market if the market where to weaken.

Urs Dur - Lazard Capital

Yes.

Bjorn Moller - President and Chief Executive Officer

I think it will very quickly get people scrapping their ships at $700, $800 a ton light ship scrap price, and you will also of course, with the dry market being at a record level, a strong demand for offshore there is really no reason single-hulls tankers will not really be phased out of it. So, that's even before we get to what the demand side is. So, I would say that there are so many wild cards I think that are going to disrupt the ability of the order book to overpower the market. And I mean this is a slow speed thing that I described, is a very significant factor. If Suezmax rates were to drop below 50,000 a day, if people being rational, essentially you would see 6% of the supply side disappear overnight.

Urs Dur - Lazard Capital

Yes.

Bjorn Moller - President and Chief Executive Officer

Significant.

Urs Dur - Lazard Capital

That would be... so we will see, you right, a lot of wild cards. Finally, you mentioned and one sees it if one looks at consensus across the board in tankers that, people sort of expect seasonal slowdowns in third quarter or in the summer. I was wondering if you... you mentioned it just very briefly, but if you have any insight as to what the potential causes of that could be and what the potential offsets to that could be. Do you have any insight that you can provide there?

Bjorn Moller - President and Chief Executive Officer

Well, I think a lot is going to be depending on stocking patterns this year, which relate to contango versus backwardation, so I guess if you are going to see continued backwardation then you know, you probably are not going to see any stock building over the... or limited stock building, over summer then you might get a weaker summer whereas if you get more of a contango then I think you could see a run through replenished stocks in some of the markets where stocks are available on the low side.

Urs Dur - Lazard Capital

Okay, excellent, thank you very much.

Bjorn Moller - President and Chief Executive Officer

Thank you, Urs.

Urs Dur - Lazard Capital

Yes.

Operator

Thank you. And the next question will be from Greg Lewis of Credit Suisse. Please go ahead.

Gregory Lewis - Credit Suisse

Good morning, gentlemen.

Bjorn Moller - President and Chief Executive Officer

Hello.

Gregory Lewis - Credit Suisse

I guess, a follow-up on Urs' last question, I mean, given what's happening in China with strong demand and questions surrounding the order book, it almost sounds like we are looking at potentially '09 being better than that was previously expected say 3 months ago. Are you sort of comfortable with that sort of --?

Bjorn Moller - President and Chief Executive Officer

Yes, I think that... I think that is a generally firming undertone. I mean, the fact that we are looking at the strongest Q2 on record now at a time when we should have been seeing through the usual seasonal weakness, is mind boggling. And the fact that it's based on fundamentals rather than sort of disruption events speaks volumes I think. So I mean, you look at how difficult it is to get drydocking space, how long ship... time ships are taking repairing, how much it's costing, the value of scraps deals, if you have a ship that's due to be phased out in 2010 or is being discriminated out why stick around, so I think you could actually see a lot of front loading of the single-hull phased out.

Gregory Lewis - Credit Suisse

Okay. So then given like the strong environment, I mean clearly we're in now and potentially that we will be in... is it more becoming more of a challenge for you to sort of charter in tonnage at what you would consider to be attractive rates?

Bjorn Moller - President and Chief Executive Officer

Well, the market is firmer now than it was, I still think you can... I mean what has so far been different between tanker business and drydock businesses is to drive our time charter rates have really gone up very significant and you can do five year charters at very high rates, if you have a vessel. In the tanker side, it's really difficult to cover a ship long-term at high rates and conversely, it's relatively easy to charter in a vessel for 3 or 5-year period.

So, the issue is, are you getting the right quality of ships, the right quality of owners and of course in our case, we have the luxury of our newbuilding program which is going to add operating leverage to us at a very good time. So, we'll be opportunistic, I think there will be some seasonality and people have amazingly short memories. The ship owners will adjust their rates based on a relatively shallow dip in the markets sometimes, so we will play with it.

Gregory Lewis - Credit Suisse

Okay, great. And then I just have a few quick questions. One was on slide seven, when you referred to that spot guidance, is that just for, I know that's for the spot segment, but is that for just the spot vessels in the spot segment or is that the aggregate of the spot fleet, which includes the longer term ex-time charters?

Bjorn Moller - President and Chief Executive Officer

Yeah that guidance is just for the spot portion of the spot segment so, it's less than one year component.

Gregory Lewis - Credit Suisse

Okay, great. And then my other question was, and Vince, you sort of mentioned the typical seasonal slowdown in the shuttle tanker business in Q2. Looking... clearly, we are in the middle of Q2 at this point, is that going to be primarily in Q2 or should we sort of expect that... that the sort of straddle into Q3 as well?

Vincent Lok - Executive Vice President and Chief Financial Officer

Yes, typically it's higher in the second quarter and gradually declines as we head into the fall. So, it will continue into the early part of the third quarter, but then likely activity levels pick up near the end of the third quarter

Gregory Lewis - Credit Suisse

Okay. But it will primarily be in Q2?

Vincent Lok - Executive Vice President and Chief Financial Officer

That's usually the peak seasonal maintenance period.

Gregory Lewis - Credit Suisse

Okay. Sure and then actually you know just one last question, you mentioned that you converted a couple of your LR tankers into crude tankers?

Bjorn Moller - President and Chief Executive Officer

Yes, with the trading vessels.

Gregory Lewis - Credit Suisse

Yes, yes for the trading... roughly that's sort of clean those tanks to get them back in the product fleet like, what's sort of the timing and the cost of that?

Bjorn Moller - President and Chief Executive Officer

That depends what the last cargos are and so on. In our case, we have a number of contracts to carry condensate in the Atlantic Basin, which some of which are not that color sensitive, so you can actually use those cargos as clean up cargos, which allows you to make the clean up and return process a lot easier. So, it's not a major factor.

Gregory Lewis - Credit Suisse

Okay, great. Thank you.

Bjorn Moller - President and Chief Executive Officer

Thank you.

Operator

Thank you. And your next question will come from Justine Fisher of Goldman Sachs. Please go ahead.

Justine Fisher - Goldman Sachs

Good morning.

Bjorn Moller - President and Chief Executive Officer

Hi, Justine.

Justine Fisher - Goldman Sachs

I think that bondholders are probably excited to see the unit offerings from the MLPs going to pay down debt and I was wondering if there is any, I mean, I know you can't comment on how imminent they might be, but I mean, well, is it... I mean, how many... how often do you may be plan to do that or how much more of those can we expect? Are those going to be on a regular basis or...?

Bjorn Moller - President and Chief Executive Officer

We have a defined plan for the drop downs. Of course it's market sensitive, but it also depends upon going through the... where we have a drop down it depends upon going through the conflicts committee process. As we announced today, we are going through that process on Teekay Offshore in order to have another 25% of OPCO, move into Teekay Offshore. And the other ones are on a more of an opportunistic basis, but we are committed towards that schedule of trying to move more assets down into the daughters where it will have a lower cost of capital.

Justine Fisher - Goldman Sachs

Can you remind us which assets are left at the top?

Bjorn Moller - President and Chief Executive Officer

We have of course all the... our shareholding in Petrojarl is up at the top and we have about 30 tankers up there that are eligible to go down into Teekay tankers. And then we have a few more fixed rate tankers that don't automatically belong up there as well as of course 75% which we hope soon to be 50% of the OPCO or the offshore franchise.

Justine Fisher - Goldman Sachs

So as far as the physical assets are concerned, there is only 30 tankers and then a few fixed rate tankers as well?

Bjorn Moller - President and Chief Executive Officer

That's correct.

Justine Fisher - Goldman Sachs

And is the goal to get all those out of OPCO?

Bjorn Moller - President and Chief Executive Officer

The goal isn't to get them out of OPCO, the goal was to sell the rest of OPCO down into Teekay Offshore, but ultimately, as it relates to those 30 tankers, yes, we would like to have them inside of Teekay Tankers.

Vincent Lok - Executive Vice President and Chief Financial Officer

The 30 tankers are distinct from OPCO those are small tankers.

Justine Fisher - Goldman Sachs

And so the process would work whereby Teekay just continually dropped assets down until Teekay Corp, I guess as a holding company follow the MLPs and that's it?

Bjorn Moller - President and Chief Executive Officer

Well, Teekay also is generating new transactions right, on top of that so we can re-employ the funds as well into new projects, which as we have said is part of our asset manager, we are always looking at developing new projects and then there is the warehousing component going on as well, so we hope if we can reemploy the money in good projects going forward, then of course, we'll have to look at returning it to the shareholders. But right know, we have great opportunities in our Offshore franchise and then of course we also have the trading of the conventional tankers that we do up at Teekay where we in-charter in ships and then we charter them out and play the spot market.

Justine Fisher - Goldman Sachs

But they still, I mean, those still aren't owned assets and so ultimately it seems like there may be few... there may be no real owned physical asset at Teekay Corp. and while Teekay Corp may be a conduit for additional growth projects, eventually those will be dropped down to, right?

Bjorn Moller - President and Chief Executive Officer

Yes. But all this takes a certain amount of time and with our FPSOs we have... so yes, you are right in principle that, that could happen, but that assumes that all those people we have dedicated toward business development can find some great projects in the offshore realm and or the shipping realm. I think the ConocoPhillips transaction, for example, in December, which moved us closer into one of a... one of what we would call a strategic customer, is the right kind of thing that you are going to see Teekay moving towards, because more customers want to use us for their outsourcing needs. So, we actually see a wealth of opportunities up at Teekay. Having said that, we are also cognizant of trying to close the... some of the parts.

Justine Fisher - Goldman Sachs

Okay. And I have a question on the LNG market. I know that Teekay's LNG vessels are on very long-term charters, and so, doesn't really affect you, but just qualitatively, have you guys... given the fact that you are probably the first of the public tanker companies in the U.S. to get into LNG years ago, have you been disappointed by the way that markets unfolded?

Bjorn Moller - President and Chief Executive Officer

I think we have... are realistic about the market, which is that, so much money is going into gas right now that it can't fulfill all of the projects. So the projects have been delayed. This isn't anything new, we saw this in the early 80s when people were going to build a lot of refineries, those refineries ended up being delayed or sometimes not being built as the case, was in the Mid East.

But there is a resource issue as I am sure you will hear from other companies that are trying to build the liquefaction. So, we have noticed that and of course we had to change our model and our model involves going out and then buying more LNG vessels on the water with long term contracts, where you see Kenai you just saw us look at the Skaugen transaction, we think there is a lot of great opportunities there in order to consolidate what was a fragmented market. So, for us, the big question is changing the model, but definitely the amount of tenders have moved on, we are also moving into more value-added strategies.

If it's hard to get a liquefaction plant built on land, we are looking, for example, at floating LNG, because you can build those cheaper in shipyards and other offshore fabrication yards and then you can float them into other places. So, that's all part of our strategy, and that's certainly what you are seeing worldwide. This huge build out as people try to tap into the resources.

Justine Fisher - Goldman Sachs

Okay, thanks. And then just one last question, how many of the senior notes are outstanding at the end of the quarter?

Vincent Lok - Executive Vice President and Chief Financial Officer

Roughly about $250 million.

Justine Fisher - Goldman Sachs

Okay, thanks.

Operator

Thank you. Your next question will come from Tim Mullen of Virginia National Bank. Please go ahead.

Timothy Mullen - Virginia National Bank

Good morning. As a follow up on that, on your slide 15, with the disaggregated balance sheet, what is the make up of the long-term debt on capital leases, particularly I'm wondering what part of that is made up of leases, the parent company only number?

Vincent Lok - Executive Vice President and Chief Financial Officer

The parent company number, very little, most of that is sitting in Teekay LNG where we have leases on the Suezmaxes and on a few of the LNG vessels. So, most of that in Teekay parent's is long-term, is in the from of debt and bonds

Timothy Mullen - Virginia National Bank

Okay, very good. And also thank you for adding that disaggregated stuff, that's very helpful.

Bjorn Moller - President and Chief Executive Officer

Thank you.

Operator

[Operator Instructions]. And your next question will come from Daniel Burke of Johnson Rice. Please go ahead.

Daniel Burke - Johnson Rice

Good morning.

Bjorn Moller - President and Chief Executive Officer

Hi, Dan.

Daniel Burke - Johnson Rice

I was curious on the sale of the OMI or the former OMI product carriers, do you still have the other four, I think and why are they non-core and then you're changing it all your outlook on the product sector?

Bjorn Moller - President and Chief Executive Officer

Okay. The four Handymaxes are... Handymaxes and the MRs even though they are relatively close in terms of dead weight, size, they actually are relatively distinct markets. So, to have four of each doesn't actually give you eight vessels in a particular pond. So, we determined that on the basis of other priorities around offshore and gas and spot tanker crude assets, it wasn't very likely that we would... to go with enough capital to build up a meaningful position in those two segments. So, we had the opportunity to unload the Handymax tankers, we still have the four MR tankers, two of those were placed on five-year charters to ConocoPhillips at attractive rates and the other two are trading... well, actually, they are I think either just coming off some time charters that we have inherited, but they are not... they are not a long-term charter at this time.

Daniel Burke - Johnson Rice

Okay. So now real change in hike?

Bjorn Moller - President and Chief Executive Officer

So just to add, sorry, I mean this is the... it's a market with a lot of units, so there are number of fairly sizeable constellations have been formed by A.P. Moller and others where they have, where they are running like 50, 70 ships. But to have 4 ships or 2 ships, it is not a back up, so that is not the game Teekay plays on.

Daniel Burke - Johnson Rice

Okay. And then just one other one, Bjorn. A lot of security around situations in Chinese shipyards, you mentioned that you're personally seeing six month delay, any more color on, is it componentary issues? Just general slowdown, any more color you can give on in your experience specifically what's creating that delay?

Bjorn Moller - President and Chief Executive Officer

There are a number of factors. One is quality, and we have pretty high standards, so a sizeable supervision team will drive the Chinese shipyards not [ph] and so we are happy with the welding. So, we will check blocks and have them represented and so on so, that's one factor. And the other factor is just supply chain and the fact that the yards are not as productive as I think they are expected to be. So, it's a combination of factors.

Daniel Burke - Johnson Rice

Okay, great. Thanks for that.

Bjorn Moller - President and Chief Executive Officer

Thank you.

Operator

Thank you. The next question will come from Rupesh Sahu [ph] of Titan Capital. Please go ahead.

Unidentified Analyst

Yes. With regards to the OPCO dropdown to TOO, do you have any initial thoughts on what... how TOO will finance that either via debt or equity or combination? And then also, how do you... how you value OPCO... what's the preliminary plan on valuing the drop down?

Vincent Lok - Executive Vice President and Chief Financial Officer

As it relates to the first part of the question, how will you finance it? That has to be done through equity, that isn't an asset that you can necessarily leverage. As it goes to the second one, Teekay has made an offer to Teekay Offshore and Teekay Offshore conflicts committee is evaluating that and is in active discussions in order to arrive at a price that is beneficial to Teekay Offshore.

Unidentified Analyst

So would Teekay then accept TOO equity or is would TOO do a secondary offering to third party investors?

Vincent Lok - Executive Vice President and Chief Financial Officer

I don't think I want to be drawn on exactly what the financial plans is going to be at this point.

Unidentified Analyst

Okay. Will it be fair to say that the dropdown prices that you offer TOO is less than the indicative price of TOO's trading... did you understand me?

Vincent Lok - Executive Vice President and Chief Financial Officer

Yes, I think that's the fair assumptions that, unless you do that the deal is not going to be accretive and there is no point in Teekay Offshore buying any asset unless it's an accretive asset.

Unidentified Analyst

All right. You wouldn't care to give us some sort of discount, will you?

Vincent Lok - Executive Vice President and Chief Financial Officer

I would not want to be drawn on what that value is right now.

Unidentified Analyst

Okay. But then and also I guess, last question, TOO's assets if I understand, are predominantly meaning like 85% or more of their asset value, it really stopped, is that plus or minus, correct?

Vincent Lok - Executive Vice President and Chief Financial Officer

Yes.

Unidentified Analyst

Okay, thank you very much.

Vincent Lok - Executive Vice President and Chief Financial Officer

Thank you.

Bjorn Moller - President and Chief Executive Officer

Thank you.

Operator

Thank you and there are no further questions at this time, please continue.

Bjorn Moller - President and Chief Executive Officer

Okay. We would like to thank you very much for attending. This an exciting time in the tanker market, we look forward to reporting to you next quarter. Have a great day. Thank you.

Operator

Thank you ladies and gentlemen this concludes the conference call for today. You may now disconnect your lines and have a great afternoon.

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Source: Teekay Corp. Q1 2008 Earnings Call Transcript
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