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Teekay Offshore Partners L.P. (NYSE:TOO)

Q2 2008 Earnings Call Transcript

August 8, 2008 12:00 pm ET

Executives

Kent Alekson – IR

Peter Evensen – CEO

Vince Lok – CFO

Analysts

Darren Horowitz – Raymond James

Stephen Williams – Simmons & Co.

Ron Londe – Wachovia

George Dess – Private Investor

Operator

Ladies and gentlemen, thank you for standing by. Welcome to Teekay Offshore first [ph] 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. Now for opening remarks and introductions, I would like to turn the call over to Mr. Peter Evensen, Chief Executive Officer of Teekay Offshore GP. Please go ahead sir.

Kent Alekson

Before Mr. Evensen begins, I would like to direct all participants to our web site at www.teekayoffshore.com where you will find a copy of the second quarter 2008 earnings release. 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 as a result of various important factors. Additional information concerning these factors is contained in our earnings release available on our web site. I will now turn the call over to Mr. Evensen to begin.

Peter Evensen

Thank you, Kent. Good morning, ladies and gentlemen, and thank you for joining us for our second quarter earnings call. This morning I am joined by Teekay Corporation’s CFO, Vince Lok and its Corporate Controller, Brian Fortier [ph], who are online from Vancouver.

As we did in the prior quarter, I’d like to focus today’s call on the high level results of the second quarter and the strategic opportunities for the partnerships rather than having a detailed discussions of financials results, which is also already provided in our earnings release. As a result, we have not prepared a slide presentation; however, we’re more than happy to take any financial or strategic questions as part of the Q&A.

Before I begin, I would like to note that we have determined that we will need to restate our historical financial results to adjust our accounting for certain derivatives under hedge accounting rules, and the results presented in our Q2 earnings release do not reflect these adjustments and should be considered preliminary. I will discuss this issue in more detail at the end of the call, but I should note that the restatements are all non-cash adjustments and therefore, they do not or will not affect the partnership’s distributable cash flow, liquidity or partner’s equity.

The second quarter results for Teekay Offshore were very strong. During the second quarter, we generated $10.5 million of distributable cash flow, which is up 54% from the previous quarter. This increase was mainly due to very high fleet utilization in our shuttle tanker fleet as well as the partial benefit from the acquisition of the 25% interest in OPCO on June 18.

We were also starting to see an upward weight trend for shuttle tanker illustrated by recent renewals of certain smaller contracts. We declared a cash distribution of $0.40 per unit, which is payable on August 14 to all unit holders of record on August 7. Excluding the cash distribution related to the units issued in our follow-on offering on June 18, our coverage ratio for the quarter was a very healthy 1.20 times.

As I referred to earlier on June 18, the Partnership acquired an additional 25% interest in Teekay Offshore Operating L.P. also known as OPCO from the parent of our general partner Teekay Corporation. Concurrently OPCO acquired two Aframax lightering vessels from Teekay Corporation. We now own 51% of OPCO, while Teekay Corporation owns the remaining 49%.

As a result of these acquisitions, we intend to recommend a 12% to 15% distribution increase to our board of directors, which will be effective for the third quarter distribution to be paid in November. On July 9, Teekay Corporation completed the acquisition of the remaining 35% of Teekay Petrojarl that it didn’t already own. Based on pre-existing agreements, Teekay is now obligated to offer us Teekay Petrojarl's existing FPSO’s that have a remaining contract term greater than three years within a year of acquisition. We are very excited about the potential distribution growth that would come with these FPSO dropdown opportunities and to become involved directly in FPSOs.

I’d like to take a few minutes to discuss our plans to restate our financial results from 2006 through to the end of the second quarter of 2008. During the process of finalizing our second quarter results, it was determined that certain of our derivative instruments did not technically qualify for hedge accounting treatment under SFAS 133, the accounting standard for Derivative Instruments and Hedging Activities.

These Derivative Instruments were used to hedge our interest rate risks and to-date have been accounted for as hedges. Accounting for Hedging Activities is an extremely complex area. In excess of a hundred implementation guidelines have been issued in addition to the SFAS 133 standard. We recently discovered that the hedge documentation we prepared relating to certain of our derivatives did not meet all of the strict technical requirements of SFAS 133.

Accordingly, we will have to restate our financial results to recognize the change in the fair value of such derivatives through the income statement rather than as a component of accumulated other comprehensive income, which is a component of partner’s equity on our balance sheet. Therefore, the restatement will result in greater fluctuations in reported net income, but will not have an impact on our distributable cash flow, our liquidity or total partner’s equity.

Also the restatement will not affect any of our financial covenants on our loan documentation. It is important to note that this is strictly a change in accounting treatment for such derivatives. The derivative instruments that are the subject of this restatement have provided and continue to provide effective economic hedges, even though they don’t technically qualify as hedges for accounting purposes.

Economic hedges are important to us given the fixed rate, long-term nature of our revenue stream and we will continue to enter into interest rate hedges as we deem prudent to manage our interest rate risk. As the necessity for restatement was discovered very recently, we and our auditors are currently reviewing all of our hedge documentation and we are going to finalize the restatement amounts for the current period and applicable previous periods as soon as possible. We will release the restated results and (inaudible) previous filings with the SEC as required.

So in summary, while we take this accounting issue very seriously and are working diligently to address it, the issue does not affect the partnership’s cash flow. We’re otherwise pleased with the partnership’s results for this quarter. The opportunity for the partnership to acquire FPSOs is now clearly on the horizon and we’re excited about the potential distribution increases these acquisitions could bring.

Thank you for listening. And operator, I’m now available to take questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Your first question comes from Darren Horowitz of Raymond James; please go ahead.

Darren Horowitz – Raymond James

Hello, Peter, how are you? My first question on the FSO side as it relates to net voyage revenues, it arrived a little bit above our expectations and I was just curious, in the prepared remarks you talked about the reimbursement of fuel costs. When we look at what happened here in the second quarter, is that the applicable run rate going forward?

Peter Evensen

Vince, do you want to take that?

Vince Lok

On some of our FSO contracts, there is a flow-through of costs. So on a net basis, it doesn’t make a difference on the cash flows. In terms of the run rates, the third quarter numbers included a little bit of a catch up from previous periods. So it’s not quite exactly a run rate, but again on a net cash flow basis, there is no difference.

Darren Horowitz – Raymond James

Okay.

Peter Evensen

We were just trying to get a little bit closer to the pin [ph] on a gross basis.

Darren Horowitz – Raymond James

Vince, a quick question for you on the operating expense side. When you look at escalation there and you look at the current quarter and what it reflects sequentially, should we assume that kind of run rate going forward for the back half of the year?

Vince Lok

As you know, we do most of our shuttle tanker maintenance during the summer months, right alongside with the offshore field maintenance. So, the third quarter OpEx is expected to be somewhat similar to the second quarter, given that the maintenance will continue into the summer months. But we typical expect that number to come down in the winter market.

Darren Horowitz – Raymond James

Okay, I appreciate it. And then just one big picture question, if we could, on discussing the FPSO opportunity that’s on the horizon, can you give us a sense for what would be the timing that is suitable for you and also more important than that, when you talk about the potential for distribution increases and ultimately how accretive such an acquisition could mean to your cash flow curve, can you give us a little bit more clarity maybe quantifying the type of run rate that you expect should a transaction like this materialize?

Peter Evensen

Because those FPSOs are big-ticket items, they have to be offered at fair market value from Teekay Corporation to the partnership. However having said that, the accretion on an FPSO should be more than – for example OPCO, which has to be a 100% equity funded deal. When we’re looking at FPSOs, particularly with their longer-term nature of the contracts, we are able to put more debt on them, so per dollar they should be much more accretive. I can’t give you the exact accretion because we don't have the actual – first of all, there isn’t a generic FPSO; it all depends upon the contracts and how they’re put out. But, in general though, they will be more accretive than an OPCO transaction.

Darren Horowitz – Raymond James

Okay. If you were to go out and let’s just say, facilitate a transaction today, what would your incremental cost of that be?

Vince Lok

I would think on a fixed rate basis, it would be no more than 6% including margin.

Darren Horowitz – Raymond James

Okay. And for a transaction of this magnitude and because of the contract associated with it, would it be fair to say that it would be somewhere around 80% financial debt?

Vince Lok

Depending upon the contract, we would probably finance it 60% to 80%. That’s a function again of the stock price. If the stock price isn't high, we probably would go for a higher percentage of debt financing because that helps the accretion.

Darren Horowitz – Raymond James

Sure, fair enough. I appreciate it, thank you.

Vince Lok

Thank you.

Operator

Thank you. Your next question comes from Stephen Williams of Simmons; please go ahead.

Stephen Williams – Simmons & Co.

Very good news that the FPSO business is moving forward. I just have another question related to that; I mean moving forward, is there any plan yet to move into the kind of floating LNG production side?

Peter Evensen

Yes, we have a joint venture of the Teekay Corporation, which has a few joint venture partners that is working on floating LNG projects. I have to say that a lot of people are looking at floating LNGs, but there aren’t exactly clear tenders out there. Some other competitors have signed letters of interest, but these aren’t with major companies. But we are working with several customers and on several different opportunities for floating LNG. So, I think that that clearly is something that we have targeted as an area, but I don’t think near term, you’re necessarily going to see that. But for us, those contracts unless it was a pure LNG FPSO, it was floating LNG, we probably would find it in Teekay LNG partners not in Teekay Offshore Partners.

Stephen Williams – Simmons & Co.

Okay, thank you.

Operator

Thank you. (Operator instructions) Your next question comes from Ron Londe, Wachovia; please go ahead.

Ron Londe – Wachovia

I am just curious you kind of mention that you had some ships that are renewing terms; can you give us some idea of what kind of increases you’re getting?

Peter Evensen

Yes. Hi Ron, we are getting 10% to 15% higher, so while we were in the low 50,000, we’re now aiming to be in 60,000 plus on these contracts. These aren’t our bigger contracts, those are not up for renegotiation right now, but they are smaller contracts. So quite clearly, we’re trying to push through increases and we’re able to do that. I think that sets up well for the four shuttle tanker new buildings that Teekay Corporation has on order at Teekay Corporation and which must be offered to the partnership by delivery.

Ron Londe – Wachovia

There seems to be a record work-over going on in the North Sea right now. Was there any benefit to the second quarter from taking some of your vessels and leading them [ph] to other markets?

Peter Evensen

Yes, what you’re talking about is that when we don’t use our ships as shuttle tankers, we can trade them as conventional tankers and conventional tanker rates were quite high in the second quarter. Unfortunately, we were pretty much sold out on the second quarter, so the strong results regarding the second quarter weren’t a function of having put them in the conventional market. But in the third quarter, where we have a little bit more tonnage and rates are still high in the third quarter, as well as we have a few special projects that we are able to get higher returns on than what we normally would, so I don’t expect that the downtime maintenance in the third quarter will affect us as much as it has in previous years.

Ron Londe – Wachovia

Okay, thank you.

Operator

Thank you. Your next question comes from George Dess, Private Investor; please go ahead.

George Dess – Private Investor

Yes, good afternoon. I was wondering what portion if any of the long-term debt of the company is self amortizing, if the company makes sensible and [ph] interest payments on any of debts or it just interest payments.

Peter Evensen

We have several facilities, but most of our facilities are for the time being non-amortizing. However, we do have some facilities that amortize, which is why we keep a sufficient amount of liquidity, such that when you put all of the loan facilities together, including our undrawn revolving credits, we are not paying back any – net-net, we are not paying back any – we aren't amortizing any principal.

George Dess – Private Investor

Okay, thank you.

Operator

Thank you. There are no further questions at this time. I will turn the conference back to Mr. Evensen for closing remarks.

Peter Evensen

Okay, thank you very much. Have an enjoyable summer and we look forward to reporting to you next quarter on our third quarter when we will have the full ramifications of our recent acquisition. Thank you very much.

Operator

Ladies and gentlemen, this does conclude your conference call for today. You may now disconnect your line and have a great day.

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