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Danaos Corporation (NYSE:DAC)

Q3 2012 Earnings Call

November 6, 2012 9:00 am ET

Executives

John Coustas – President and Chief Executive Office

Evangelos Chatzis – Chief Financial Officer

Analysts

Gregory Lewis – Credit Suisse

Operator

Good afternoon, thank you for standing by ladies and gentlemen, and welcome to the Danaos Corporation Conference Call on the Third Quarter 2012 Financial Results. We have with us Dr. John Coustas, President and Chief Executive Officer; and Mr. Evangelos Chatzis, Chief Financial Officer of the company. At this time all participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session. (Operator Instructions) I must advice you the conference is being recorded today Tuesday, November 6, 2012.

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

Evangelos Chatzis

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

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

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

John Coustas

Thank you, Evangelos. Good morning everyone and thank you for joining today's call to discuss our results for third quarter of 2012. Before we begin I’d like to extend message of support to all those affected by Hurricane Sandy, which was also the reason for postponing our results for about a week, and sincere refit to everyone for a return back to normal as soon as possible.

Company’s performance with the first nine months of 2012 is a testament to the resilience of our business model during a challenging period for the container market. Adjusted net income stands at $48.8 million or $0.44 per share for the nine months ended September 30, 2012 compared to $45 million or $0.41 per share for the same period one year-ago.

Adjusted EBITDA has reached $319.3 million for nine months ended September 30, 2012 compared to $229.8 million for the same period one year-ago, as a result of our fleet expansion program concluded in the previous quarter.

In terms of macro-economic fundamentals, the European financial crisis has been at the forefront of a global economic slowdown this year, with the expectation that European GDP will marginally contract in 2012. This has also impacted economic growth in the United States, which has been sluggish, but still expected to do better than 2011, while it is now clear that the pace of growth in China will moderated. This global slowdown has adversely affected container trade growth and it is clear that the industry is currently facing a demand supply imbalance.

On the bright side, liner companies have demonstrated the ability to manage capacity prudently. And freight rates have been restored and maintained at healthy levels through gradual general rate increases over the last two quarters. The positive results of this strategy for the liner companies have already been evident in the second and third quarter financial results while if discipline is maintained this trend can be sustainable.

On the charter market, as the big ships are being delivered and absorbed in the main trade lanes, cascading has placed considerable pressure on the mid-size vessels. This pressure is not expected to ease before the second half of 2013 when the drought of new ordering of the last 18 months will start to show and hopefully Europe will have sorted out its issues.

We also want to point out that our focus on controlling costs has paid off as we have managed to bring down daily vessel operating expenses by approximately 5% year-on-year, to $5,924 per day for the nine months ended September 30, 2012 compared to $6,220 per day for the same period last year.

Our model largely insulated from the weak market at from the current revenue stream, 95% of revenues are contracted over the next 12 months with only 2% at stake through re-chartering and effectively from where we stand today, an improvement in market fundamentals is a one way option to further improving our financial results.

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'll handover the call over to Evangelos who will take you through the financials for the quarter.

Evangelos Chatzis

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

Following the completion of our new building program, during the third quarter, we had an average of 64 containerships compared to 56.4 containerships for the same period in 2011. Our adjusted net income was $15.6 million or $0.14 per share for the quarter, down by $2 million or $0.02 per share when compared to the adjusted net income of $17.6 million or $0.16 per share for the third quarter of 2011.

Although the addition of 8 new vessels to our fleet over the course of the last year was accretive to the bottom line, this $2 million decrease in adjusted net income between the two quarters is attributed to the softening of the charter market that has eventually triggered the cold lay up of 5 vessels until today and has also affected the re-chartering of another 7 vessels that currently run at operating break even levels while they had a positive contribution to earnings during the third quarter of 2011.

As we do not expect the charter market improvement in the near term, it is likely that these pressures will persist throughout next year and will affect the further 3 vessels that face renewal of existing accretive charters within the next four months. The good news is that thanks to our strong charter contract coverage for next year, we face limited further downside.

The annual run rate EBITDA contribution of our 49 vessels on long term charters stand at approximately 435 million per year, which is translated to 97% contracted EBITDA while the 15 vessels that are currently running on short term charters or have been laid up represent only 3% of EBITDA and this is what is effectively a breakthrough re-chartering.

As we are currently at the bottom of the market, we consider the potential EBITDA generating capacity of our vessels on the spot market as a one way option to improving our results when the market recovers. It is worth at this point to note that beside re-chartering risk which is manageable, the most important driver in our earnings to date is related to the hedging we have in place through interest rate swaps.

Indicatively our adjusted net income for the nine months of 2012 that currently stand at $48.8 million would have been a $146.9 million or $98.1 million higher if the current interest rate swaps were not in place. These swaps start expiring from the fourth quarter of 2014 through the end of 2015, and at that point we expect a significant improvement in earnings given the market expectations for persisting low interest rates.

We have average charter duration of 9.9 years, well exceeding the two and a half years duration of the swaps. We will be able to fully take advantage of the anticipated low LIBOR environment on the back of solid contracted income generation.

Operating revenues increased by 24% or $30.3 million to $156.3 million in this quarter from $126 million in the third quarter of 2011 as a result of the increase in the average number of vessels in our fleet and an increase by 9% in the average daily charter rate that our fleet has earned after 26,500 per day in the current quarter from 24,300 a day in the third quarter of 2011.

Vessel operating expenses effectively remained stable between the two quarters in nominal terms while the daily operating cost for the current quarter decreased by almost 8% to $5,835 per vessel per day compared to $6,321 average daily operating cost for the third quarter of 2011 and this is indicative of our determination and focus to control costs.

G&A expenses increased by 8.5% or $0.4 million to $5.1 million in the current quarter from $4.7 million in the third quarter of 2011. This increase is the result of increased fees to our Manager due to the increase in the average number of vessels in the fleet.

Interest expense increased by 68.1% or $9.8 million to $24.2 million in the current quarter from $14.4 million in the third quarter of 2011. The change in interest expense was mainly due to the increase in our average debt by $550 million to $3.42 billion in the current quarter from $2.87 billion in the third quarter of 2011. Additionally, since our new building program has been concluded, no interest was capitalized in the current quarter compared to $3.2 million of interest capitalization in the third quarter of 2011.

Realized loss on swaps increased by $6.4 million to $41.7 million in this quarter compared to $35.3 million in the third quarter of 2011. This increase between the two quarters is attributed to the fact that no realized losses have been deferred in the current quarter following the delivery of our new buildings whereas $7 million of realized losses have been deferred to OCI in the third quarter of 2011, the above partially offset by slightly higher LIBOR rates between the quarters.

Please also note that effective July 1, 2012 we have discontinued the application of hedge accounting due to the compliance burden associated with this accounting policy. As a result, all unrealized mark to market movements are now flowing through our income statement and are being adjusted accordingly in our adjusted net income. Finally, as a result of the growth of our fleet, adjusted EBITDA increased by $30 million or 34.8% to $116.2 million in the third quarter of 2012 from $86.2 million in the third quarter of 2011.

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

Question-and-Answer Session

Operator

Thank you very much indeed gentlemen. (Operator Instructions) Gentlemen, you have a question from Credit Suisse from Gregory Lewis. Please ask your question sir.

Gregory Lewis – Credit Suisse

Thank you and good afternoon.

John Coustas

Hi, Greg.

Evangelos Chatzis

Hi, Greg.

Gregory Lewis – Credit Suisse

Hi. John, at this point given what’s going on the East Coast of the United States, what kind of impact does that had on the container shipping industry? Is that creating any delays? Maybe you can just provide any color on that, I think that will be pretty helpful.

John Coustas

Yeah. To be honest, we didn’t have any vessels in the area to have any direct let’s say feeling of what’s been affected. I mean definitely of course all traffic which was heading to New York was either diverted or delayed. But to be honest as far as our fleet is concerned, we didn’t have any direct impact.

Gregory Lewis – Credit Suisse

Okay. And then if I would just sort of shift over to your fleet, I mean you had I think you laid up an extra vessel this quarter. As I look down, as I look at vessels that are potentially rolling off contract, it looks like you have one maybe later this month and then one or two at the start of next year. Given where the market is, should we anticipate those vessels being laid up or is it going to be more something where to probably kept employed at around cash operating cost.

John Coustas

I don’t really know, for the vessels that are let’s say available now, the chances are definitely lower to get some kind of employment. For the other vessels that are actually coming in March of next year, definitely the chances are much better, let’s say, to continue to find some employment.

Gregory Lewis – Credit Suisse

Okay. So when you are talking to your customers at this point, I guess we are in November now and it’s something where the demand for tonnage – I mean if we think about more of a normalized environment, the demand for tonnage typically picks up. There is a pick up in February, March or is it more than April, May event normally?

John Coustas

Practically everybody waits to see what happens after the Chinese New Year.

Gregory Lewis – Credit Suisse

Okay.

John Coustas

That’s really when the market start to show how strong this is going to be. Practically we are talking about let’s say March, April kind of – let's say strength, I mean whatever strength is going to happen is going to be around these months.

Gregory Lewis – Credit Suisse

Okay. And then in the press release, I think you mentioned that some of the vessels were chartered at around breakeven levels. Should we think about that as the cash vessel OpEx that you reported, is that sort of the guideline we should be using or is it potentially a little bit higher than that?

John Coustas

More or less it depends on the vessels. We have – if there is a vessel that hedge for examining this charter at $8,000 a day when it has – let's say $8,000 OpEx, there is a vessel that is chartered, let's say at $6,000 a day when it has $6,500 OpEx. So it's – we are not talking about really big difference to be honest.

Evangelos Chatzis

Greg, just to give you some color, the average seven vessels that you mentioned on average are running at $7,500 a day.

Gregory Lewis – Credit Suisse

Okay, perfect. And then just one final question on the interest expense, it's a little bit higher than what you’re expecting this quarter. As we think about how that flows now, there is the cash we can place, is it something where we should think about, it just gradually winding down over the next sort of what almost two years and then when the swaps roll off and gaps down, is that the right way we should be trying to model out interest expense?

John Coustas

As we say, interest expense at present is hedged and runs up to last quarter of 2014 when it starts really tailing of within the next two quarters. So practically, I mean really for Danaos, the biggest in income driver will be difference in interest cost which is much, much greater than any let's say incremental income we may have from re-chartering.

Gregory Lewis – Credit Suisse

Okay.

John Coustas

So, hopefully when we're going to have a better market and a lower interest rate cost from 2015 that will definitely magnify dramatically our earnings.

Gregory Lewis – Credit Suisse

Okay, but so far that we were to think about how the Danaos is going to finish the year, is it sort of as a rough guideline, may be we should assume interest expense just down a few percent?

Evangelos Chatzis

Greg, you should not expect something materially different from during the fourth quarter than what we reported in the third quarter.

Gregory Lewis – Credit Suisse

Okay, perfect.

Evangelos Chatzis

And in 2013 deleveraging commences effectively from the end of the first quarter onwards, and this will bring down debt considerably. You will see in our earnings, in our balance sheet, the current portion of the debt is what we expect to pay down with the next 12 months.

Gregory Lewis – Credit Suisse

Okay, perfect. Thank you for the time.

John Coustas

Okay. Thanks, Greg.

Operator

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

John Coustas

Thank you very much everyone for joining this conference call. We appreciate your time and continued interest in our story. Thanks very much for your time.

Operator

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

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