UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended MARCH 31, 2005

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from          to

Commission File Number      1-6479-1

 

OVERSEAS SHIPHOLDING GROUP, INC.

(Exact name of registrant as specified in its charter)

 

DELAWARE		13-2637623
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)
511 Fifth Avenue, New York, New York		10017
(Address of principal executive offices)		(Zip Code)
(212) 953-4100
Registrant’s telephone number, including area code
No Change
Former name, former address and former fiscal year, if changed since last report

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.                          YES   ý  NO  o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).             
YES  ý  NO  o

 

APPLICABLE ONLY TO CORPORATE ISSUERS

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.

 

Common Shares outstanding as of May 3, 2005 –  39,444,813

 

 

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

IN THOUSANDS

 

		MARCH 31, 2005			DECEMBER 31, 2004
		(UNAUDITED)
ASSETS
Current Assets:
Cash and cash equivalents		$	146,118		$	479,181
Voyage receivables		108,060			144,237
Other receivables		26,977			12,815
Inventories and prepaid expenses		18,734			9,384
Total Current Assets		299,889			645,617
Capital Construction Fund		275,138			268,414
Vessels, at cost, less accumulated depreciation of $434,732 and $473,162		2,605,437			1,422,239
Vessels under Capital Leases, less accumulated amortization of $55,134 and $53,940		31,467			24,382
Vessel Held for Sale		—			9,744
Investments in Joint Ventures		218,975			227,701
Other Assets		83,019			82,701
Total Assets		$	3,513,925		$	2,680,798
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Accounts payable and sundry liabilities and accrued expenses		$	86,141		$	80,047
Federal income taxes		181			90,943
Short-term debt and current installments of long-term debt		36,357			25,024
Current obligations under capital leases		6,496			4,729
Total Current Liabilities		129,175			200,743
Long-term Debt		1,595,802			863,466
Obligations under Capital Leases		47,680			42,717
Deferred Federal Income Taxes ($108,069 and $105,424), Deferred Credits and Other Liabilities		149,406			147,500
Shareholders’ Equity		1,591,862			1,426,372
Total Liabilities and Shareholders’ Equity		$	3,513,925		$	2,680,798

 

See notes to condensed consolidated financial statements.

 

2

 

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS (UNAUDITED)

 

		THREE MONTHS ENDED
		MARCH 31, 2005			MARCH 31, 2004
Shipping Revenues:
Time and bareboat charter revenues, including vessels operating in certain pools, $4,679 and $5,766 received from a 37.5% owned joint venture and $13,959 in 2005 received from a 50% owned joint venture		$	257,865		$	174,106
Voyage charter revenues		17,542			20,025
		275,407			194,131
Voyage expenses		(8,220		)	(5,149		)
Time Charter Equivalent Revenues		267,187			188,982
Ship Operating Expenses:
Vessel expenses		43,800			24,863
Time and bareboat charter hire expenses		25,801			8,247
Depreciation and amortization		36,359			24,210
General and administrative		16,021			13,794
Total Ship Operating Expenses		121,981			71,114
Income from Vessel Operations		145,206			117,868
Equity in Income of Joint Ventures		17,673			3,980
Operating Income		162,879			121,848
Other Income		24,125			10,355
		187,004			132,203
Interest Expense		22,831			17,515
Income before Federal Income Taxes		164,173			114,688
Provision/(Credit) for Federal Income Taxes		(746		)	38,500
Net Income		$	164,919		$	76,188
Weighted Average Number of Common Shares Outstanding:
Basic		39,435,079			38,359,890
Diluted		39,499,100			38,440,020
Per Share Amounts:
Basic net income		$	4.18		$	1.99
Diluted net income		$	4.18		$	1.98
Cash dividends declared		$	0.175		$	0.175

 

3

 

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

IN THOUSANDS

(UNAUDITED)

 

		THREE MONTHS ENDED
		MARCH 31, 2005			MARCH 31, 2004
Net cash provided by operating activities		$	93,926		$	79,791
Cash Flows from Investing Activities:
Expenditures for vessels, including $9,211 in 2004 related to vessels under construction		(542		)	(9,397		)
Proceeds from disposal of vessels		77,159			5,886
Acquisition of interests in joint ventures that own VLCCs		—			(2,292		)
Acquisition of Stelmar Shipping Ltd., net of cash acquired of $107,911		(742,433		)	—
Investments in and advances to joint ventures		(1,034		)	(34,447		)
Distributions from joint ventures		15,050			—
Other – net		6,678			3,455
Net cash (used in) investing activities		(645,122		)	(36,795		)
Cash Flows from Financing Activities:
Issuance of common stock, net of issuance costs		—			115,503
Issuance of long-term debt, net of issuance costs		752,250			146,704
Payments on debt and obligations under capital leases		(526,886		)	(14,226		)
Cash dividends paid		(6,902		)	(6,869		)
Issuance of common stock upon exercise of stock options		166			1,997
Other – net		(495		)	(65		)
Net cash provided by financing activities		218,133			243,044
Net (decrease)/increase in cash and cash equivalents		(333,063		)	286,040
Cash and cash equivalents at beginning of period		479,181			74,003
Cash and cash equivalents at end of period		$	146,118		$	360,043

 

See notes to condensed consolidated financial statements.

 

4

 

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

DOLLARS IN THOUSANDS

(UNAUDITED)

 

											Unearned								Accumulated
					Paid-in						Compensation								Other
		Common			Additional			Retained			Restricted			Treasury Stock					Comprehensive
		Stock*			Capital			Earnings			Stock			Shares		Amount			Income/(Loss)**			Total
Balance at January 1, 2005		$	40,791		$	199,054		$	1,203,528		$	(1,360	)	1,391,280		$	(17,579	)	$	1,938		$	1,426,372
Reclassification upon adoption of FAS 123(R)					(1,360		)				1,360											—
Net Income								164,919														164,919
Net Unrealized Holding Gains on Available-For-Sale Securities																			2,333			2,333
Effect of Derivative Instruments																			4,592			4,592
Comprehensive Income																						171,844
Cash Dividends Declared								(6,902		)												(6,902		)
Deferred Compensation Related to Options Granted					158																	158
Issuance of Restricted Stock Awards					(436		)							(41,746	)	436						—
Amortization of Restricted Stock Award					203																	203
Options Exercised and Employee Stock Purchase Plan					121									(3,588	)	45						166
Tax Benefit Related to Options Exercised					21																	21
Balance at March 31, 2005		$	40,791		$	197,761		$	1,361,545		$	—		1,345,946		$	(17,098	)	$	8,863		$	1,591,862
Balance at January 1, 2004		$	39,591		$	108,549		$	829,824		$	—		3,685,326		$	(48,454	)	$	(12,435	)	$	917,075
Net Income								76,188														76,188
Net Unrealized Holding Gains on Available-For-Sale Securities																			1,634			1,634
Effect of Derivative Instruments																			(2,276		)	(2,276		)
Comprehensive Income																						75,546
Cash Dividends Declared								(6,869		)												(6,869		)
Issuance of Common Stock		1,200			87,289									(2,000,000	)	27,014						115,503
Issuance of Restricted Stock Award					1,148						(1,785		)	(50,000	)	637						—
Amortization of Restricted Stock Award											89											89
Options Exercised and Employee Stock Purchase Plan					183									(133,485	)	1,814						1,997
Tax Benefit Related to Options Exercised					610																	610
Balance at March 31, 2004		$	40,791		$	197,779		$	899,143		$	(1,696	)	1,501,841		$	(18,989	)	$	(13,077	)	$	1,103,951

 

*                      Par value $1 per share; 60,000,000 shares authorized; and 40,790,759 shares issued at March 31, 2005 and December 31, 2004, respectively.

**               Amounts are net of tax.

 

See notes to condensed consolidated financial statements.

 

5

 

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

 

Notes to Unaudited Condensed Financial Statements

 

Note A — Basis of Presentation:

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  Operating results for the three month period ended March 31, 2005 are not necessarily indicative of the results that may be expected for the year ended December 31, 2005.

 

The balance sheet at December 31, 2004 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

 

For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

 

Note B — Change in Accounting Principle:

 

At March 31, 2005, the Company had three stock-based compensation plans under which options have been granted.  These plans are more fully described in Note J to the Company’s 2004 Annual Report on Form 10-K.

 

On December 16, 2004, the Financial Accounting Standards Board issued Statement No. 123(R) (“FAS 123R”), “Share-Based Payment,” amending Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“FAS 123”) and requiring that all share-based payments to employees be recognized in the financial statements.  Generally, the approach to accounting for share-based payments in FAS 123R is similar to the approach described in FAS 123, however, pro forma footnote disclosure is no longer an alternative to financial statement recognition.  This statement becomes effective in the first interim or annual period beginning after December 15, 2005.

 

Prior to January 1, 2005, the Company accounted for those plans under the recognition and measurement provisions of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB 25”) and related Interpretations, as permitted by FAS 123.  No stock-based employee compensation cost was recognized in the condensed consolidated statement of operations for the three months ended March 31, 2004, because options granted under those plans had an exercise price equal to the market value of the stock on the date of grant.  Effective January 1, 2005, the Company adopted the fair value recognition provisions of FAS 123(R) using the modified-prospective transition method.  Under that transition method, compensation cost recognized in the three months ended March 31, 2005 includes compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2005, based on the grant date fair value estimated in accordance with the original provisions of FAS 123, and compensation cost for all share-based payments granted subsequent to January 1, 2005, based on the grant-date fair value estimated in accordance with the provisions of FAS 123(R).  Results for prior periods have not been restated.

 

6

 

As a result of adopting FAS 123(R) on January 1, 2005, the Company’s income before federal income taxes and net income for the three months ended March 31, 2005, are $202,000 and $131,000 lower, respectively, than if it had continued to account for share-based compensation under APB 25.  Basic and diluted net income per share for the three months ended March 31, 2005 would have been $4.19 and $4.18, respectively, if the Company had not adopted FAS 123(R), compared with reported basic and diluted net income per share of $4.18 and $4.18, respectively.

 

The following table presents the effects on net income and net income per share if the Company had applied the fair value recognition provisions of FAS 123 to stock-based compensation for the three months ended March 31, 2004 (in thousands, except per share amounts):

 

Net income, as reported		$	76,188
Deduct: Total stock-based compensation expense determined under fair value based method for all awards, net of tax		(68		)
Pro forma net income		$	76,120
Per share amounts:
Basic – as reported		$	1.99
Basic – pro forma		$	1.98
Diluted – as reported		$	1.98
Diluted – pro forma		$	1.98

 

Note C — Acquisition of Stelmar Shipping Ltd.:

 

On January 20, 2005, the Company acquired 100% of the issued and outstanding common stock of Stelmar Shipping Ltd. (“Stelmar”), a leading international provider of petroleum product and crude oil transportation services with one of the world’s largest and most modern Handysize and Panamax tanker fleets. Accordingly, the operating results of the Stelmar fleet have been included in the Company’s condensed consolidated financial statements commencing January 21, 2005. Under the terms of the merger agreement, holders of Stelmar’s common stock received $48.00 per share in cash for an aggregate consideration of approximately $844 million.  Taking into account the assumption of Stelmar’s outstanding debt, the total purchase price was approximately $1.35 billion.  The Company funded the acquisition and the refinancing of Stelmar’s debt with $675 million of borrowings under new credit facilities and $675 million of cash and borrowings under long-term credit facilities in existence as of December 31, 2004.

 

7

 

The following table summarizes the fair value of the assets acquired and liabilities assumed by the Company at the date of the Stelmar acquisition (in thousands):

 

Assets:
Current assets		$	150,736
Vessels		1,257,573
Vessels under capital leases		8,280
Other assets		10,928
Total assets acquired		1,427,517
Liabilities:
Current liabilities, including current installments of long-term debt		102,907
Long-term debt		467,604
Obligations under capital lease		6,662
Total liabilities assumed		577,173
Net assets acquired (cash consideration)		$	850,344

 

The Company’s purchase price allocation is subject to change, and is expected to be finalized by December 31, 2005.

 

The following unaudited pro forma consolidated financial information reflects the results of operations for the three months ended March 31, 2005 and 2004, as if the acquisition of Stelmar had occurred on January 1, 2004 and after giving effect to purchase accounting adjustments (in thousands, except per share amounts):

 

		THREE MONTHS ENDED MARCH 31,
		2005			2004
Pro forma time charter equivalent revenues		$	285,262		$	236,582
Pro forma net income		172,169			85,298
Pro forma per share amounts:
Basic net income		$	4.37		$	2.22
Diluted net income		$	4.36		$	2.22

 

These pro forma results have been prepared for comparative purposes only and do not purport to be indicative of what operating results would have been had the acquisition actually taken place on January 1, 2004.  In addition, these results are not intended to be a projection of future results and do not reflect any synergies that might be achieved from the combined operations.

 

8

 

Note D — Business and Segment Reporting:

 

The Company has three reportable segments: Foreign Flag Crude Tankers and Handysize Product Carriers which participate in the international market, and U.S. Flag vessels. Following the acquisition of Stelmar in the first quarter of 2005, the Company revised its reportable segments. Segment information as of March 31, 2004 and for the three months then ended have been reclassified to conform to the 2005 presentation. Segment results are evaluated based on income from vessel operations before general and administrative expenses. The Company uses time charter equivalent revenues to analyze fluctuations in revenues between periods and to make decisions regarding the deployment and use of its vessels.  The accounting policies followed by the reportable segments are the same as those followed in the preparation of the Company’s consolidated financial statements.

 

Information about the Company’s reportable segments as of and for the three months ended March 31, 2005 and 2004 follows:

 

		Foreign Flag
In thousands		Crude Tankers			Product Carriers			Other			U.S. Flag			Totals
Three months ended March 31, 2005:
Shipping revenues		$	208,576		$	39,676		$	5,406		$	21,749		$275,407
Time charter equivalent revenues		205,191			35,962			6,284			19,750			267,187
Depreciation and amortization		24,145			6,239			864			5,111			36,359
Income from vessel operations		142,327			14,631			(2,416		)	6,685			161,227	*
Equity in income of joint ventures		16,369			—			(83		)	1,387			17,673
Gain on disposal of vessels		12,902			—			—			—			12,902
Investments in joint ventures at  March 31, 2005		126,183			—			91,602			1,190			218,975
Total assets at March 31, 2005		2,193,747			640,100			91,969			105,426			3,031,242
Three months ended March 31, 2004:
Shipping revenues		155,297			8,126			8,943			21,765			194,131
Time charter equivalent revenues		154,147			6,789			8,761			19,285			188,982
Depreciation and amortization		18,810			1,191			499			3,710			24,210
Income from vessel operations		114,676			3,462			4,642			8,882			131,662	*
Equity in income of joint ventures		2,664			—			—			1,316			3,980
Gain on disposal of vessels		(8		)	—			(32		)	2,903			2,863
Investments in joint ventures at  March 31, 2004		13,321			—			—			1,251			14,572
Total assets at March 31, 2004		1,543,139			44,085			1,428			77,140			1,665,792

 

*                 Segment totals for income from vessel operations are before general and administrative expenses.

 

For vessels operating in pools or on time or bareboat charters, shipping revenues are substantially the same as time charter equivalent revenues.

 

For the three months ended March 31, 2004, the Foreign Flag Crude Tankers segment now includes two Panamaxes. The joint venture that is constructing four LNG Carriers is included in the Other Foreign Flag segment.

 

9

 

Reconciliations of total assets of the segments to amounts included in the consolidated balance sheets follow:

 

		IN THOUSANDS AS OF
		MARCH 31, 2005			MARCH 31, 2004
Total assets of all segments		$	3,031,242		$	1,665,792
Corporate cash and securities, including Capital Construction Fund		421,256			614,537
Other unallocated amounts		61,427			57,401
Consolidated total assets		$	3,513,925		$	2,337,730

 

Note E — Joint Ventures and Certain Pooling Arrangements:

 

Stelcape Limited

 

Stelcape Limited (“Stelcape”), in which the Company has a 50% interest, was formed in April 2004 to commercially manage the Panamax fleets of the two partners.  As of March 31, 2005, Stelcape managed a fleet of 13 modern Panamaxes.  Nine of the Company’s Panamaxes, including four that are on time charter to the partner, participate in Stelcape.

 

Joint Ventures

 

As of March 31, 2005, the Company is a partner in joint ventures that own six Foreign Flag vessels (four V Pluses, one VLCC and one Aframax), and one joint venture that has four LNG Carriers under construction.

 

In March 2005, the joint venture that owned the Aframax, Compass I, entered into a contract to sell its vessel. The vessel was delivered to the buyer in April 2005, at which time a gain of approximately $11,200,000 (of which the Company’s share is $5,600,000) was recognized.

 

In February 2004, the Company completed a transaction with its partner covering six joint-venture companies, each of which owned a VLCC.  This transaction provided for an exchange of joint-venture interests and cash of approximately $2,300,000 paid by the Company and resulted in the Company owning 100% of the Dundee, Sakura I and Tanabe, and the joint venture partner owning 100% of the Edinburgh, Ariake and Hakata.  The results of the Dundee, Sakura I and Tanabe are included in the Foreign Flag Crude Tankers segment from the effective date of transaction.  In connection with the above transaction, the Company advanced $34,447,000, representing its share of the amounts required to repay the combined bank debt of such joint ventures.

 

10

 

In April 2004, the Company formed a joint venture with a Tankers pool partner to acquire four 442,000 dwt V Pluses, three built in 2002 and one built in 2003.  OSG has a 49.9% interest in this joint venture.  The joint venture took delivery of the four V Pluses in July 2004. The total purchase price for these vessels of $448,000,000 was financed by the joint venture through a long-term bank loan of $290,000,000 and subordinated partner loans and capital contributions. In connection with the bank financing, the partners severally issued guaranties on a pro rata basis aggregating $190,000,000.  The amount of such guaranties will decrease as the outstanding balance of the bank loan is reduced below $190,000,000.  As of March 31, 2005, the outstanding balance of subordinated partner loans advanced by the Company was $69,788,000.

 

In November 2004, the Company formed a joint venture whereby companies in which OSG holds a 49.9% interest ordered four 216,000 cbm LNG Carriers. Upon delivery in 2007 and 2008, these vessels will commence 25-year time charters to Qatar Liquefied Gas Company Limited (II). The aggregate construction cost for such newbuildings of $908,000,000 will be financed by the joint venture through long-term bank financing and partner contributions.  OSG has advanced $90,635,000 to such joint venture as of March 31, 2005, representing its share of working capital and the first installment under the construction contracts.  The aggregate unpaid costs of $726,500,000 will be funded through bank financing that will be nonrecourse to the partners.

 

A condensed summary of the results of operations of the joint ventures follows:

 

		IN THOUSANDS FOR THE THREE MONTHS ENDED MARCH 31,
		2005			2004
Time charter equivalent revenues		$	85,623		$	51,473
Ship operating expenses		45,444			40,245
Income from vessel operations		40,179			11,228
Other income		185			—
Interest expense*		(4,107		)	(574		)
Net income		$	36,257		$	10,654

 

*           Includes interest on subordinated loans payable to the joint venture partners of $1,732 (three months ended March 31, 2005) and $55 (three months ended March 31, 2004).  The Company’s share of such interest is eliminated in recording the results of the joint ventures by the equity method.

 

As of March 31, 2005, the joint ventures in which the Company participates had total bank debt of $255,266,000 and subordinated loans payable to all joint venture partners of $139,804,000.  The Company’s percentage interests in these joint ventures ranged from 30% to 50%.  The Company’s guaranties in connection with the joint ventures’ bank financings, which are otherwise nonrecourse to the joint venture partners, aggregate $94,810,000 at March 31, 2005.  These guaranties remain outstanding until the related debt matures in September 2016.

 

11

 

Note F — Derivatives:

 

As of March 31, 2005, the Company is a party to floating-to-fixed interest rate swaps, which are being accounted for as cash flow hedges, with various major financial institutions covering notional amounts aggregating approximately $380,217,000 pursuant to which it pays fixed rates ranging from 4.6% to 8.3% and receives floating rates based on LIBOR (approximately 3.1% as of March 31, 2005). These agreements contain no leverage features and have various maturity dates ranging from August 2005 to August 2014. In addition, the Company has an interest rate swap maturing in July 2005 with a notional amount of $6,800,000 that no longer qualifies as a cash flow hedge because the underlying debt was repaid.  As of March 31, 2005, the Company has recorded a liability of $5,302,000 related to the fair values of all of these swaps in other liabilities.

 

Note G —  Debt:

 

In January 2005, the Company concluded two debt agreements aggregating $675,000,000.  The proceeds from these borrowings were used in funding the acquisition of Stelmar and the refinancing of its debt.  One of the agreements is a $500,000,000 seven-year unsecured revolving credit agreement.  Borrowings under this facility bear interest at a rate based on LIBOR and the terms, conditions and financial covenants contained therein are comparable to those contained in the Company’s existing long-term facilities.  The other agreement is a $175,000,000 term loan secured by five of Stelmar’s Handysize Product Carriers.  The secured loan has a term of twelve years and bears interest at a rate based on LIBOR. The principal is repayable in 23 equal semi-annual payments of $5,303,000 and a final balloon payment of $53,030,000 due July 2016.

 

In July and November 2004, the Company concluded two seven-year unsecured revolving credit facilities aggregating $255,000,000.  The terms, conditions and financial covenants contained in these agreements are more favorable than those contained in the long-term revolving credit facility that matures in December 2006 (the “2006 Facility”).  Borrowings under both of the new facilities bear interest at a rate based on LIBOR plus a margin. In December 2004, in consideration of entering into these two new revolving credit facilities, the Company reduced the amount available under the 2006 Facility to $200,000,000 from $350,000,000.

 

In February 2004, the Company issued $150,000,000 principal amount of senior unsecured notes pursuant to a Form S-3 shelf registration filed January 13, 2004. The notes, which are due in February 2024 and may not be redeemed prior to maturity, have a coupon of 7.5%. The Company received proceeds of approximately $146,605,000 (reduced from $146,704,000 at March 31, 2004), after deducting expenses.

 

As of March 31, 2005, the Company had unsecured long-term credit facilities aggregating $1,285,000,000, of which $506,000,000 was unused.  In addition, the Company had two short-term credit facilities expiring in August 2005 aggregating $65,000,000, all of which was unused at March 31, 2005.

 

12

 

Agreements related to long-term debt provide for prepayment privileges (in certain instances with penalties), limitations on the amount of total borrowings and secured debt (as defined), and acceleration of payment under certain circumstances, including failure to satisfy the financial covenants contained in certain of such agreements. The most restrictive of these covenants requires the Company to maintain net worth as of March 31, 2005 of approximately $1,018,000,000 (increasing quarterly by an amount related to net income).

 

As of March, 31, 2005, approximately 21.7% of the net book amount of the Company’s vessels, representing 12 Foreign Flag tankers and three U.S. Flag Crude Tankers, is pledged as collateral under certain debt agreements.

 

Interest paid, excluding capitalized interest, amounted to $28,862,000 and $20,971,000 for the three months ended March 31, 2005 and 2004, respectively.

 

Note H — Taxes:

 

On October 22, 2004, the President of the U.S. signed into law the American Jobs Creation Act of 2004. The Jobs Creation Act reinstated tax deferral for OSG’s foreign shipping income for years beginning after December 31, 2004.  Effective January 1, 2005, the earnings from shipping operations of the Company’s foreign subsidiaries are not subject to U.S. income taxation as long as such earnings have not been repatriated to the U.S.  The Company intends to permanently reinvest these earnings, as well as the undistributed income of its foreign companies accumulated through December 31, 1986, in foreign operations.  Accordingly, no provision for U.S. income taxes on the shipping income of its foreign subsidiaries was required in 2005. Further, no provision for U.S. income taxes on the Company’s share of the undistributed earnings of the less than 50%-owned foreign shipping joint ventures was required as of March 31, 2005 because it is intended that such earnings ($70,257,000 at March 31, 2005) will be indefinitely reinvested; the unrecognized deferred U.S. income taxes attributable thereto approximated $24,600,000.

 

As of March 31, 2005 undistributed earnings on which U.S. income taxes have not been provided aggregated approximately $870,000,000, including $119,000,000 earned prior to 1976; the unrecognized deferred U.S. income tax attributable to such undistributed earnings approximated $304,000,000.

 

Because of the enactment of the Jobs Creation Act and because foreign shipping income will be permanently reinvested, the Company reduced its deferred tax liabilities by $77,423,000 with a corresponding reduction in income tax expense in the fourth quarter of 2004.

 

During 2002, the Company established a valuation allowance of $3,640,000 against the deferred tax asset resulting from the write-down of certain marketable securities. The valuation allowance was established because the Company could not be certain that the full amount of the deferred tax asset would be realized through the generation of capital gains in the future. During the three months ended March 31, 2004, the Company reduced the valuation allowance by $650,000, reflecting capital gains recognized.  The reduction in the valuation allowance was recorded as a reduction in the provision for federal income taxes in the accompanying consolidated statement of operations for the three months ended March 31, 2004.  The valuation allowance was reduced to zero by December 31, 2004.

 

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The components of the provision/(credit) for federal income taxes follow:

 

		IN THOUSANDS FOR THE THREE MONTHS ENDED MARCH 31,
		2005			2004
Current		$	437		$	26,500
Deferred		(1,183		)	12,000
		$	(746	)	$	38,500

 

Actual federal income taxes paid during the three months ended March 31, 2005 amounted to $91,100,000, all of which related to 2004. Actual income taxes paid during the three months ended March 31, 2004 amounted to $15,000,000, all of which related to 2003.

 

Note I — Capital Stock and Stock Compensation:

 

In January 2004, the Company awarded 50,000 shares of common stock at no cost to its new chief executive officer.  Restrictions limit the sale or transfer of these shares until they vest, which occurs ratably over a four-year period.  During the restriction period, the shares will have voting rights and cash dividends will be paid if declared.  At the date of the award, the fair market value of the Company’s common stock was $35.70 per share.  Accordingly, $1,785,000 was recorded as unearned compensation in shareholders’ equity as of the award date.  Such amount is being amortized to compensation expense over four years using the straight-line method.  In addition, the Company granted the new chief executive officer stock options to purchase 100,000 shares of common stock at an exercise price of $35.70 per share (the market price at the date of the grant).  Options granted vest and become exercisable over a three-year period and expire ten years from the date of the grant.

 

In January 2004, pursuant to a Form S-3 shelf registration filed on January 13, 2004, the Company sold 3,200,000 shares of its common stock at a price of $36.13 per share, after underwriting discounts and commissions of $0.47 per share, thereby generating proceeds of $115,513,000 (increased from $115,503,000 at March 31, 2004), after deducting expenses.

 

In the first quarter of 2005, the Company awarded a total of 41,746 shares of common stock at no cost to certain of its employees, including senior officers. At the dates of the awards, the fair market value of the Company’s stock ranged from $52.40 to $62.23 per share.  Accordingly, $1,808,000 was recorded as unearned compensation expense in shareholders’ equity as of the award dates, and is being amortized over four years using the straight-line method. In addition, options covering 43,707 shares were granted at $52.40 per share (the market price at the date of the grant) under the Company’s 2004 Stock Incentive Plan. Such options were valued using the Black-Scholes option pricing model and expire ten years from the grant date.  Compensation expense will be recognized ratably over the three-year vesting period.

 

The weighted average grant-date fair values of options granted during the three months ended March 31, 2005 and 2004 were $19.38 and $12.69 per share, respectively.

 

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Note J — Accumulated Other Comprehensive Income/(Loss):

 

The components of accumulated other comprehensive income/(loss), net of related taxes, in the consolidated balance sheets follow:

 

		IN THOUSANDS AS OF
		MARCH 31, 2005			DECEMBER 31, 2004
Unrealized gains on available-for-sale securities		$	16,242		$	13,909
Unrealized losses on derivative instruments		(3,195		)	(7,787		)
Minimum pension liability		(4,184		)	(4,184		)
		$	8,863		$	1,938

 

Note K — Leases:

 

1.                     Charters-in:

 

In November 2004, the Company entered into sale-leaseback agreements, which closed in January 2005 for four of its Handysize Product Carriers, which leases are classified as operating leases. The aggregate gain on the transaction of approximately $9,900,000 is being amortized over the term of each lease, ranging from 42 to 48 months, as a reduction of time and bareboat charter hire expenses. The lease agreements contain no renewal or purchase options.

 

As of March 31, 2004, the Company had 34 chartered-in vessels, three (two U.S. Flag Product Carriers and a Foreign Flag Handysize Product Carrier) under capital leases and 31 (nine VLCCs, five Aframaxes, three Foreign Flag Dry Bulk Carriers, 12 Handysize Product Carriers and two U.S. Flag Dry Bulk Carriers) under operating leases.  The future minimum commitments under charters-in are as follows:

 

In thousands at March 31, 2005		Capital			Operating
2005		$	9,339		$	74,522
2006		11,882			88,645
2007		11,882			79,556
2008		11,888			75,726
2009		10,778			50,679
Thereafter		16,985			40,936
Net minimum lease payments		72,754			410,064
Less amount representing interest		(18,578		)	—
Present value of net minimum lease payments		$	54,176		$	410,064

 

The above table reflects the acquisition of the 40-vessel Stelmar fleet, which includes 11 vessels that are bareboat chartered in.

 

15

 

2.                     Charters-out:

 

The future minimum revenue expected to be received on noncancelable time charters and bareboat charters are as follows:

 

In thousands at March 31, 2005
2005		$	199,157
2006		146,137
2007		88,562
2008		64,436
2009		35,877
Thereafter		1,060
Net minimum lease payments		$	535,229

 

The above table reflects the addition of Stelmar’s fleet. Charters on four of the Stelmar vessels provide for profit sharing between the Company and the charterer when rates earned exceed a base rate, as defined in each of the agreements.  Because two of such agreements provide that profit sharing be determined annually on the anniversary of delivery of the vessels onto the charters, the Company’s share, if any, of TCE revenues in excess of the base rate will not be recognized until June of each year.

 

Note L — Pension and Other Postretirement Benefit Plans:

 

The components of the net periodic benefit cost for the Company’s domestic plans follow:

 

		IN THOUSANDS FOR THE THREE MONTHS ENDED MARCH 31,
		PENSION BENEFITS						OTHER BENEFITS
		2005			2004			2005			2004
Cost of benefits earned		$	466		$	383		$	18		$	24
Interest cost on benefit obligation		538			508			53			74
Expected return on plan assets		(626		)	(578		)	—			—
Amortization of prior-service costs		39			268			(63		)	(38		)
Amortization of transition obligation		—			—			5			5
Recognized net actuarial loss/(gain)		63			35			14			10
Net periodic benefit cost		480			616			27			75
Loss on settlement		1,318			4,077			—			—
Net period benefit cost after settlement		$	1,798		$	4,693		$	27		$	75

 

The Company previously disclosed in its financial statements for the year ended December 31, 2004 that there was no required contribution to the Company’s defined benefit plan for the 2004 plan year.  Further, the Company believes that there will be no required contribution for the 2005 plan year, although it expects that it could make a deductible contribution of an amount not in excess of $3,500,000 for the 2005 plan year.  As of March 31, 2005, no such contributions were made.

 

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Note M — Other Income:

 

Other income consists of:

 

		IN THOUSANDS FOR THE THREE MONTHS ENDED MARCH 31,
		2005			2004
Investment income:
Interest and dividends		$	3,322		$	1,759
Realized gain on sale of securities, net		6,675			5,795
		9,997			7,554
Gain on sale of vessels		12,902			2,863
Gain on derivative transactions		201			—
Miscellaneous — net		1,025			(62		)
		$	24,125		$	10,355

 

During the three months ended March 31, 2005, the Company sold two Foreign Flag Panamaxes (Diane and Mary Ann).  During the three months ended March 31, 2004, the Company sold one U.S. Flag Crude Tanker (Overseas Boston).

 

Note N — Agreements with Executive Officers:

 

The Company entered into an agreement dated June 23, 2003 in connection with the retirement, effective December 31, 2003, of the Company’s former chief executive officer.  The agreement provided, among other matters, for the payment of the former chief executive officer’s unfunded, nonqualified pension plan obligation in January 2004, at which time the Company recognized, as a charge to earnings, a settlement loss of $4,077,000 in accordance with the provisions of Statement of Financial Accounting Standards No. 88, “Employers Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits” (“FAS 88”).

 

The Company entered into an agreement dated January 31, 2005 with one of its senior officers in connection with his retirement, effective January 31, 2005.  The agreement provides, among other matters, for payments aggregating approximately $1,150,000 to be made to such senior officer in accordance with his severance protection agreement.  Accordingly, the Company recognized this $1,150,000 expense in the first quarter of 2005.  The severance protection agreement also provided for the payment of the senior officer’s unfunded, nonqualified pension plan obligation in the first quarter of 2005.  At the time such payment of approximately $3,098,000 was made, the Company recognized, as a charge to earnings, a settlement loss of $1,318,000 in accordance with the provisions of FAS 88.

 

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Note O — Legal Matters:

 

On October 1, 2003, the U.S. Department of Justice served a grand jury subpoena directed at the Company’s Foreign Flag Product Carrier, the Uranus, and the Company’s handling of waste oils.  The U.S. Department of Justice has subsequently served related subpoenas requesting documents concerning the Uranus and other vessels in the Company’s fleet and a number of witnesses have appeared before the grand jury.  The Company has been cooperating with the investigation and in the fall of 2004 commenced negotiations with the U.S. Department of Justice to resolve the investigation.  In 2004, the Company made a provision (in the amount of $6.0 million) for anticipated fines and contributions to environmental protection programs associated with a possible settlement of the investigation, and in the first quarter of 2005, the Company made an additional $4.0 million provision for such items.  Negotiations with the U.S. Department of Justice are continuing and while management of the Company believes that the total fines and contributions to environmental programs associated with a settlement of the investigation may range from $10.0 million to $13.0 million, there can be no assurance that a satisfactory settlement can be achieved or that the provision or the estimated range will be sufficient to cover such fines and contributions.

 

The Company has incurred costs of approximately $606,000 in the first three months of 2005 and $665,000 in the first three months of 2004 in connection with the above investigation.  Such costs have been included in general and administrative expenses in the accompanying condensed consolidated statement of operations. In the opinion of management any liability as a result of the U.S. investigation will likely not be material to the Company’s business or financial condition.

 

Note P — Subsequent Events:

 

In April 2005, the Company entered into a contract to sell the Eclipse, a single hull Suezmax, for delivery to the buyers during the second quarter for a gain of approximately $7,000,000.

 

18

 

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

General:

 

The Company is one of the largest independent bulk shipping companies in the world. The Company’s operating fleet consists of 99 vessels aggregating 13.3 million deadweight tons, including six vessels that are owned by joint ventures in which the Company has an average interest of 47%, and 28 vessels that have been chartered in under operating leases. The Company has less than a 100% interest in six of the chartered-in VLCCs, with an average participation interest of 37%, and three of the chartered-in Aframaxes, in which the Company has an average participation interest of 58%.  In addition, the Company has a participation interest of 40% in the time charter-in of one VLCC, which is scheduled to commence upon its delivery from a shipyard in mid 2005.  Four LNG Carriers are scheduled to be delivered in late 2007 and early 2008 to a joint venture in which the Company has a 49.9% interest.

 

Acquisition of Stelmar Shipping Ltd.

 

On January 20, 2005, OSG acquired Stelmar Shipping Ltd. (“Stelmar”), a leading international provider of petroleum product and crude oil transportation services with one of the world’s largest and most modern Handysize and Panamax tanker fleets.  Accordingly, the operating results of the Stelmar fleet have been reflected in the Company’s condensed consolidated financial statements commencing January 21, 2005.  Under the terms of the merger agreement, holders of Stelmar’s common stock received $48.00 per share in cash for an aggregate consideration of approximately $844 million.  Taking into account the assumption of Stelmar’s outstanding debt, the total purchase price was approximately $1.35 billion.  The Company funded the acquisition and the refinancing of Stelmar’s debt with $675 million of borrowings under new credit facilities and $675 million of cash and borrowings under long-term credit facilities in existence as of December 31, 2004.  Stelmar’s 40 vessel fleet consists of 24 Handysize, 13 Panamax and three Aframax tankers. Stelmar’s fleet includes two chartered-in Aframax and nine chartered-in Handysize vessels.  Stelmar, through its maintenance of a modern fleet and commitment to safety, has earned an excellent reputation for providing high-quality transportation services to major oil companies, oil traders and state-owned oil companies.

 

Operations:

 

The Company’s revenues are highly sensitive to patterns of supply and demand for vessels of the size and design configurations owned and operated by the Company and the trades in which those vessels operate. Rates for the transportation of crude oil and refined petroleum products from which the Company earns a substantial majority of its revenue are determined by market forces such as the supply and demand for oil, the distance that cargoes must be transported, and the number of vessels expected to be available at the time such cargoes need to be transported. The demand for oil shipments is significantly affected by the state of the global economy and level of OPEC’s exports. The number of vessels is affected by newbuilding deliveries and by the removal of existing vessels from service, principally because of scrapping. The Company’s revenues are also affected by the mix of charters between spot (voyage charter) and long-term (time charter). Because shipping revenues and voyage expenses are significantly affected by the mix between voyage charters and time charters, the Company manages its vessels based on TCE revenues. Management makes economic decisions based on anticipated TCE rates and evaluates financial performance based on TCE rates achieved.

 

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Overview

 

Despite a drop-off in activity in January following a very strong fourth quarter, the tanker markets steadied themselves as the demand for oil showed little sign of letting up.  At first, as oil prices sagged, OPEC contemplated reducing its quota, which had a depressing affect on freight rates. When it became evident that demand was still strong, OPEC instead announced an increase in its quota and made it clear that more oil would be made available if necessary.  Increased availability of crude oil relative to a year ago in the Caribbean and the Former Soviet Union (“FSU”), and expansions to existing U.S. refinery capacity were positive developments for Aframaxes, Panamaxes and Handysize Product Carriers.  U.S. imports of crude and oil products continued to rise, spurred by rising gasoline demand, fuel oil substitution for natural gas, high diesel fuel consumption due to a healthy domestic trucking market and the seasonal pickup in heating oil demand.  Although the fleet continued to grow during the quarter, overall tanker supply and demand remained closely balanced, contributing to the significant volatility in freight rates.  Continued high earnings and a generally favorable outlook for the coming years, reduced the scrapping of older single hull tonnage that had been predicted to occur by the April 5, 2005 IMO deadline.  Some vessels were modified to extend their MARPOL lives, and others must trade in areas where the regulations do no apply.

 

The tables below show the daily TCE rates that prevailed in markets in which the Company’s vessels operated for the periods indicated. It is important to note that the spot market is quoted in Worldscale rates. The conversion of Worldscale rates to the following TCE rates necessarily requires the Company to make certain assumptions as to brokerage commissions, port time, weather delays, port costs, speed and fuel consumption, all of which will vary in actual usage. In each case, the rates may differ from the actual TCE rates achieved by the Company because of the timing and length of voyages and the portion of revenue generated from long-term charters.

 

Foreign Flag VLCCs

 

		Spot Market TCE Rates VLCCs in the Arabian Gulf
		Q1-2005			Q1-2004
Average		$	61,500		$	75,200
High		$	109,500		$	112,400
Low		$	28,700		$	39,000

 

During the first quarter of 2005, rates for modern VLCCs trading out of the Arabian Gulf averaged $61,500 per day, 62% lower than the average for the previous quarter, which experienced the highest rates in more than 30 years, and 18% lower than the average for the first quarter of 2004. The volatility in VLCC rates experienced in 2004 continued into 2005 as VLCC rates peaked at $109,500 per day in late February before dropping to $28,700 per day in mid March. Rates recovered to end March at levels exceeding $40,000 per day.

 

The downturn in rates that began in December 2004 was attributable to several factors. Growth in oil demand slowed from the very high levels of last year, particularly in China, where early 2004 demand growth ran at an unsustainable high rate. Still, global oil demand in the first quarter of 2005 was estimated at 84.6 million barrels per day (“b/d”), about the same level as the previous quarter, and 2.6%

 

20

 

higher than the comparable quarter in 2004. Seasonally mild weather in the Northern Hemisphere for most of January through mid February reduced heating oil requirements. However, the onset of colder weather conditions in late February and early March, as well as continuing problems in Japan’s nuclear power sector, led to higher oil demand towards the end of the first quarter of 2005.

 

In response to slowing demand at the end of 2004, OPEC decided to cut production back to its target level of 27.0 million b/d from January 1, 2005. Although the impact on the physical market was limited, the psychological effect of the announcement of a production cut put significant downward pressure on VLCC rates. However, the onset of colder weather and rising crude oil prices prompted OPEC to reassess its position. Moves to curb production were therefore short-lived, and extra cargoes were made available in key VLCC loading regions. OPEC raised its quota to 27.5 million b/d effective April 1 and a further 500,000 b/d increase is contemplated should oil prices remain high.

 

Vessel supply developments also exerted downward pressure on freight rates during the first quarter of 2005, as nine VLCCs (2.8 million dwt) were delivered while no vessels were scrapped. The world VLCC fleet grew to 462 vessels (134.6 million dwt) at March 31, 2005 from 456 vessels (132.7 million dwt) at the start of 2005.  Seven newbuilding orders (2.1 million dwt) were placed during the first quarter of 2005 compared with eight vessels (2.4 million dwt) in the fourth quarter of 2004. As a result, the orderbook contracted to 86 vessels (26.1 million dwt) at March 31, 2005, equivalent to 19.4%, based on deadweight tons, of the existing VLCC fleet.

 

Foreign Flag Aframaxes

 

		Spot Market TCE Rates Aframaxes in the Caribbean
		Q1-2005			Q1-2004
Average		$	37,000		$	46,800
High		$	65,000		$	75,000
Low		$	20,000		$	15,000

 

The downturn in Aframax spot freight rates that began in December 2004 continued into the first quarter of 2005. Rates for Aframaxes operating in the Caribbean trades averaged $37,000 per day, 47% less than the average for the previous quarter and 21% less than the average for the first quarter of 2004 as oil production decreased from the fourth quarter in key Aframax loading areas, including the FSU and the North Sea.

 

Non-OPEC production growth has been driven in recent years by the FSU.  Although oil production in the FSU fell during the first quarter of 2005 to an estimated 11.4 million b/d, 0.5% less than the previous quarter, FSU exports have held steady. After a pronounced weather-induced decline in January, FSU seaborne exports averaged 5.9 million b/d in the first quarter of 2005, unchanged from the previous quarter.  Although Aframax fixtures in the Black Sea increased by 12.7% relative to the preceding quarter, the first quarter of 2005 also saw a marked reduction in weather delays for tankers transiting the Bosporus Straits relative to the first quarter of 2004, when sustained transit delays for tankers reduced the availability of Aframax tonnage in the Mediterranean.  The reduction in delays in 2005 increased the availability of suitable tonnage and had a dampening affect on rates.

 

21

 

Although Venezuela’s conventional crude oil production is stagnating, synthetic crude production is estimated to have increased from 0.4 million b/d at the end of 2004 to 0.6 million b/d at the end of the first quarter of 2005. Total Latin America production of conventional crude rose to an estimated 6.3 million b/d in the first quarter of 2005, 1.1% more than the previous quarter.  North American refiners have added the equivalent of approximately 270,000 barrels per day of refining capacity since last spring in response to last year’s record refining margins, a positive development for Aframax owners.

 

The world Aframax fleet increased to 636 vessels (63.7 million dwt) at March 31, 2005 from 627 vessels (62.5 million dwt) at December 31, 2004, as Aframax deliveries exceeded deletions. This continued expansion of the Aframax fleet exerted downward pressure on rates during the first quarter of 2005.  With newbuilding orders dropping during the first quarter of 2005 to 13 vessels (1.5 million dwt) from 22 vessels (2.4 million dwt) during the fourth quarter of 2004, the orderbook contracted to 172 vessels (18.8 million dwt) at March 31, 2005, equivalent to 29.5%, based on deadweight tons, of the existing Aframax fleet.

 

Foreign Flag Panamaxes

 

		Spot Market TCE Rates Panamaxes — Dirty Products
		Q1-2005			Q1-2004
Panamax Average		$	40,300		$	42,700
Panamax High		$	62,200		$	55,000
Panamax Low		$	31,800		$	28,700

 

Rates for Panamaxes trading in crude and dirty products averaged $40,300 per day during the first quarter of 2005. Although 28% less than the average for the previous quarter and 6% less than the corresponding quarter in 2004, they remained close to historic highs. A 5.5% year-over-year increase in the size of the Panamax fleet constrained rates despite strong demand for crude and residual fuel oil. Rates peaked in January as seasonal strength carried over from the previous quarter.

 

First quarter U.S. crude and residual fuel oil imports increased sharply over the comparable year ago period, boosting demand for quality double hull Panamaxes in the Caribbean and the west coast of Central America.  High domestic natural gas prices provided a strong incentive to substitute fuel oil for natural gas. Strong demand for fuel oil in Europe precluded transatlantic arbitrage trades, increasing U.S. energy users’ dependence on fuel oil supplies from the Caribbean.  In the meantime, more stringent IMO regulations and an increasing preference by the oil majors for double hull over single hull vessels widened the premium that double hull vessels command over single hull vessels.

 

The world Panamax fleet rose to 295 vessels (19.5 million dwt) at March 31, 2005 from 290 vessels (19.1 million dwt) at December 31, 2004. Newbuilding orders increased to 14 vessels (0.8 million dwt) during the first quarter of 2005, compared with 11 vessels (0.8 million dwt) the previous quarter. The orderbook contracted to 188 vessels (12.6 million dwt) at March 31, 2005, equivalent to 64.6%, based on deadweight tons, of the existing Panamax fleet.

 

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Foreign Flag Handysize Product Carriers

 

		Spot Market TCE Rates Handysize Product Carriers in the Caribbean
		Q1-2005			Q1-2004
Handysize Average		$	27,300		$	29,200
Handysize High		$	32,500		$	34,500
Handysize Low		$	19,000		$	18,900

 

Rates for Handysize Product Carriers operating in the Caribbean trades averaged $27,300 per day during the first quarter of 2005, 8% less than the average for the previous quarter and 7% less than the corresponding quarter in 2004, as continuing fleet expansion put pressure on rates.  Despite healthy demand growth, U.S. imports of refined oil products averaged 3.0 million b/d during the first quarter of 2005, 1.3% less than the previous quarter, but 5.3% more than the equivalent quarter in 2004. Similar to the situation in other tanker segments, rates backed off from historically high levels, but the tight balance between supply and demand remained unchanged.  Demand for gasoline continued to grow with increasing reliance on imports to comply with new government regulations requiring low-sulphur blends. Diesel oil consumption continued at high levels, commensurate with expanded trucking activity, and heating oil requirements in the U.S. rose as temperatures turned much colder from mid February onward.  Colder temperatures in Europe and refinery turnarounds impacted European distillate supplies and resulted in a backhaul movement of gasoil to Europe, reducing the availability of quality tonnage from the Caribbean. Fewer Handysize Product Carriers moved into the dirty products trades this winter than in the same period of 2004, when restrictions on Suezmax and Aframax movements through the Bosporus Straits pulled many smaller vessels into this trade.

 

The world Handysize Product Carrier fleet expanded to 530 vessels (21.8 million dwt) at March 31, 2005 from 524 vessels (21.5 million dwt) at December 31, 2004. Newbuilding orders placed during the first quarter of 2005 totaled 20 vessels (0.9 million dwt) compared with 32 vessels (1.4 million dwt) in the preceding quarter. The orderbook rose to 175 vessels (8.0 million dwt) on March 31, 2005, equivalent to 36.6%, based on deadweight tons, of the existing Handysize fleet.

 

Update on Critical Accounting Policies:

 

The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require the Company to make estimates in the application of its accounting policies based on the best assumptions, judgments, and opinions of management.  For a description of all of the Company’s material accounting policies, see Note A to the Company’s consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

 

23

 

Market Value of Marketable Securities

 

In accordance with Statement of Financial Accounting Standards No. 115 (“FAS 115”), the Company’s holdings in marketable securities are classified as available for sale and, therefore, are carried on the balance sheet at fair value (determined using period-end sales prices on U.S. or foreign stock exchanges) with changes in carrying value being recorded in accumulated other comprehensive income/(loss) until the investments are sold.  Accordingly, these changes in value are not reflected in the Company’s statements of operations.  If, however, pursuant to the provisions of FAS 115 and Staff Accounting Bulletin No. 59, the Company determines that a material decline in the fair value below the Company’s cost basis is other than temporary, the Company records a noncash impairment loss as a charge in the statement of operations in the period in which that determination is made.  As a matter of policy, the Company evaluates all material declines in fair value for impairment whenever the fair value of a stock has been below its cost basis for six consecutive months. In the period in which a decline in fair value is determined to be other than temporary, the carrying value of that security is written down to its fair value at the end of such period, thereby establishing a new cost basis.

 

As of March 31, 2005, the Capital Construction Fund held a diversified portfolio of marketable equity securities with an aggregate cost basis of $44,199,000 and an aggregate fair value of $68,744,000. The gross unrealized losses on equity securities held in the Capital Construction Fund as of March 31, 2005, aggregated $425,000.  None of the securities with unrealized losses as of March 31, 2005 had a fair value that had been materially below its carrying value for more than six months.

 

Income from Vessel Operations:

 

During the first quarter of 2005, TCE revenues increased by $78,205,000, or 41%, to $267,187,000 from $188,982,000 in the first quarter of 2004, resulting from an increase in average daily TCE rates for vessels operating in the spot market and a 2,986 day increase in revenue days. During the first quarter of 2005, approximately 74% of the Company’s TCE revenues were derived in the spot market, including vessels in pools that predominantly perform voyage charters, compared with 87% in the first quarter of 2004.  In the first quarter of 2005, approximately 26% of TCE revenues were generated from time or bareboat charters (“term”) compared with 13% in the first quarter of 2004.  The increase in percentage contribution from term charters reflects the time charter focus of the former Stelmar fleet.

 

Reliance on the spot market contributes to fluctuations in the Company’s revenue, cash flow, and net income, but affords the Company greater opportunity to increase income from vessel operations when rates rise.  On the other hand, time and bareboat charters provide the Company with a predictable level of revenues.

 

During the first quarter of 2005, income from vessel operations increased by $27,338,000, or 23%, to $145,206,000 from $117,868,000 in the first quarter of 2004. The improvement resulted principally from an increase in revenue days as a result of the Stelmar acquisition (see Note D to the condensed financial statements for additional information on the Company’s segments).

 

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Foreign Flag Crude Tankers

 

		THREE MONTHS ENDED MARCH 31,
		2005			2004
TCE revenues (in thousands)		$	205,191		$	154,147
Vessel expenses (in thousands)		(21,456		)	(16,227		)
Time and bareboat charter hire expenses (in thousands)		(17,263		)	(4,434		)
Depreciation and amortization (in thousands)		(24,145		)	(18,810		)
Income from vessel operations (in thousands)(a)		$	142,327		$	114,676
Average daily TCE rate		$	50,428		$	53,954
Average number of vessels (b)		38.9			30.4
Average number of vessels chartered in under operating leases		6.7			1.6
Number of revenue days(c)		4,069			2,857
Number of ship-operating days(d)		4,106			2,910

 

(a)          Income from vessel operations by segment is before general and administrative expenses.

 

(b)         The average is calculated to reflect the addition and disposal of vessels during the period.

 

(c)          Revenue days represent ship-operating days less days that vessels were not available for employment due to repairs,  drydock or lay-up.

 

(d)         Ship-operating days represent calendar days.

 

Daily TCE rates earned by certain classes of vessels operating in the Foreign Flag Crude Tanker segment for the three months ended March 31, 2005 and 2004 were as follows:

 

		THREE MONTHS ENDED MARCH 31,
		2005			2004
VLCCs		$	82,749		$	74,280
Aframaxes		37,409			36,464
Panamaxes		24,670			16,363

 

During the first quarter of 2005, TCE revenues for the Foreign Flag Crude Tanker segment increased by $51,044,000, or 33%, to $205,191,000 from $154,147,000 in the first quarter of 2004.  This improvement in TCE revenues resulted from an increase in the average TCE rate earned for VLCCs and Aframaxes and an increase in the number of revenue days.  Revenue days increased by 1,212 principally for the following reasons, partially offset by a reduction of 267 days attributable to the sale of two VLCCs (Olympia and Dundee) and one Panamax (Diane) subsequent to March 31, 2004:

 

•                  the acquisition of Stelmar adding three Aframaxes (two of which are bareboat chartered in) and 13 Panamaxes;

•                  the participation in the charter-in of six VLCCs, which commenced between February and September 2004; and

•                  the participation in the charter-in of three Aframaxes, which commenced between March and September 2004.

 

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