Earnings Call Transcript - DAC Q2 2022

Operator, Operator

Good day, and welcome to the Danaos Corporation Conference Call to discuss the financial results for the three months ended June 30, 2022. As a reminder, today's call is being recorded. Hosting the call today is Dr. John Coustas, Chief Executive Officer of Danaos Corporation; and Mr. Evangelos Chatzis, Chief Financial Officer of Danaos Corporation. Dr. Coustas and Mr. Chatzis will be making some introductory comments, and then we will open the call to a question-and-answer session. I would now like to turn the conference over to Mr. Evangelos Chatzis, Chief Financial Officer. Please go ahead.

Evangelos Chatzis, CFO

Thank you, operator, and good morning everyone, and thank you for joining us today. Before we begin, I quickly want to remind everyone that management's remarks this morning may contain certain forward-looking statements and that actual results could differ materially from those projected today. These forward-looking statements are made 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 the detailed safe harbor and risk factor disclosures. Please also note that whether we feel appropriate, we will continue to refer to non-GAAP financial measures such as EBITDA, adjusted EBITDA, and adjusted net income to evaluate our business. Reconciliations of non-GAAP financial measures to GAAP financial measures are included in our earnings release and accompanying materials. With that, let me now turn the call over to Dr. John Coustas, who will provide a broad overview of the quarter.

John Coustas, CEO

Thank you, Evangelos. Good morning, and thank you all for joining today's call to discuss our results for the second quarter of 2022. Danaos' business model continued to generate strong results in the second quarter, more than doubling our adjusted net income compared with a year ago. Given our fixed charter coverage over the next 12 months, we expect these metrics to improve further. At the same time, however, we're closely following economic conditions and the potential impact on our industry. A confluence of factors including high energy prices, inflation, and the effects of the war in Ukraine will likely result in slowing economic growth and negatively impact trade volumes. On the other hand, efficiencies in the charter side and the COVID resurgence in China are keeping vessel utilization high with increased waiting times in port. Additionally, increasing fuel costs will likely prompt liner companies to use vessel shading as soon as vessels are available. However, we do not expect that to happen until the second quarter of 2023 and onwards. Environmental regulations, particularly the CII Compliance, are leading liner companies to redesign their operating rigs with lower speeds to ensure they do not breach requirements and to also assure their customers that they are actively reducing CO2 emissions. These mitigating factors point to a weakening rather than a collapse of the market, with resulting rates much higher than pre-pandemic levels. For the time being, charter rates are holding firm as the available economy is very tight. The company is very well positioned with a strong liquidity position and a balance sheet that can sustain severe deterioration of economic conditions. This is reflected in upgrades by both S&P and Moody's to the highest level among public shipping companies, validating our efforts to create a leader in our sector. We are also insulated from rising interest rates as we have reduced our floating rate debt nearly equal to our cash and marketable securities. We will continue to use our balance sheet opportunistically with a continued focus on state-of-the-art buildings with environmental profiles that give us great confidence about the future of our already ordered six green new buildings. We are also continuing to return value to our shareholders through our dividends and our share buyback program, with a huge number of outstanding shares reduced by approximately 2% in the course of about one month. With that, I will hand the call back to Evangelos, who will take you through the financials of the quarter.

Evangelos Chatzis, CFO

Thank you, John, and good morning again to everyone. And thanks again for joining us this morning. I will briefly review the results for the quarter and then give call participants the opportunity to ask questions. We are reporting adjusted EPS for the second quarter of 2022 of $7.59 per share, or adjusted net income of $157.1 million compared to adjusted EPS of $3.34 per share, or $68.9 million for the second quarter of 2021. The increase of $88.2 million in adjusted net income between the two quarters is a result of an increase in operating revenues of $104.5 million and a $13.9 million net dividend booked in relation to our ZIM equity holding, partially offset by higher total operating expenses of $20.2 million, mainly due to the increase in the average size of our fleet by 11 vessels between the two quarters; a $7.8 million increase in net finance expenses; and a $2.2 million decrease in income from Gemini that was fully consolidated in the third quarter of 2021. More specifically, operating revenues increased by $104.5 million to $250.9 million in the current quarter, compared to $146.4 million in the second quarter of 2021. This increase is attributed to a $62 million increase in revenues as a result of higher charter rates and $23.9 million in incremental revenues due to the vessel additions to our fleet between the two quarters. Revenue also increased by $2.9 million mainly due to straight-line revenue recognition accounting, along with a further increase in NAV by another $15.7 million due to the amortization of assumed charter liabilities from recent vessel acquisitions. Vessel operating expenses increased by $7.7 million to $40.6 million in the current quarter, compared to $32.9 million in the second quarter of 2021, mainly as a result of the increase in the average number of vessels in our fleet, while the average daily operating costs increased to $6,463 per day for the current quarter, compared to $6,241 per day in the second quarter of 2021. This increase was due mainly to COVID-related increases in crew remuneration and higher insurance premiums due to a tightening of the insurance market between the two periods. Our daily operating expenses still remain one of the most competitive in the industry. G&A expenses remained stable at $7.1 million in both the current quarter and the second quarter of 2021. Interest expense excluding the amortization of finance costs decreased by $1.4 million to $12.9 million in the current quarter, compared to $14.3 million in the second quarter of 2021. This is a combined result of a $2.2 million decrease in interest expense due to a reduction in our average indebtedness by approximately $311 million between the two periods, partially offset by an increase in debt service costs by approximately 44 basis points, mainly as a result of rising interest rates. We also saw a $0.7 million decrease in interest expense due to capitalizing interest on vessels under construction. Additionally, we reduced positive recognition through our income statement of accumulated accrued interest by $1.5 million that had been accrued in 2018 in relation to financing that was consummated. As a result of the financing arrangements we put in place in April of 2021, the recognition of such cumulative interest has decreased. Adjusted EBITDA increased by 85.2% or $88.4 million to $192.1 million in the current quarter from $103.7 million in the second quarter of 2021 for the reasons outlined earlier on this call. We also encourage you to review our updated investor presentation posted on our website, as well as subsequent event disclosures. A few of the highlights follow. During the second quarter, we substantially reduced leverage by early debt and lease repayments of $434 million and realized a gain of $22.9 million in relation to this debt extinguishment. This early prepayment combined with scheduled debt repayments and a new credit facility of $130 million that was put in place in the current quarter overall has led to a reduction of the corporate net debt to last 12 months adjusted EBITDA ratio to below one, specifically to 0.9x. Currently, 15 of the company's vessels are debt-free, and this early debt repayment will reduce debt and lease amortization to approximately $25 million run rate per quarter going forward. Through the end of July, we have repurchased 409,200 shares of our common stock in the open market for $25.1 million, executing under our $100 million share repurchase program. As of the end of the second quarter, our contracted cash revenue backlogs stand at $2.3 billion with a 3.6-year average charter duration, while contract coverage is at 99% for 2022 and 80% for 2023, with even 2024 already contracted at 55%. Our investor presentation contains analytical disclosure on our contracted charter books and all other matters discussed. With that, I would like to thank you for listening to this first part of our call. Operator, we are now ready to open the call to Q&A.

Operator, Operator

Thank you. We will now begin the question-and-answer session. Our first question comes from Omar Nokta with Jefferies. Please go ahead.

Omar Nokta, Analyst

Thank you. Hey guys. Good afternoon, John and Evangelos. Well, congratulations again, on a very strong quarter. And really nice to see you guys taking advantage of the situation, really paying down debt and further strengthening that balance sheet. I wanted to ask about the 15 ships that are unencumbered debt, as you say they're worth charter free 1.6 billion. If I recall, you've agreed to sell two of them previously. How should we think about the remaining 13? Are those sales candidates? Are those assets that you are holding on to with added flexibility? But how do you just generally view those ships in the announced framework going forward?

John Coustas, CEO

Well, first of all Omar, welcome back. It's nice to have you covering us as being one of the first analysts that covered us since 2006. So I think you've got probably the most extensive knowledge of the company from all analysts covering us. Yes, as I said, these 15 ships are not held for sale. Of course, as we sold the ships, if we get a very interesting purchase proposal, we can never deny, but for the time being, these ships are part of the company. They provide terrific security to our unsecured debt holders, which makes the bond rock solid.

Omar Nokta, Analyst

Got it. Thanks, John. And thanks for your words towards me. It's been a pleasure following Danaos for so long, and it has come such a long way here especially in the past two years. And one of the next questions I wanted to ask is, as you highlighted your methanol new buildings as you prepare for stricter regulations upcoming, if you think about strategically deploying capital today in anticipation of that, do you see more incremental capital going towards the new buildings? Or do you try to find second-hand ships that are younger and eco-friendly, similar to the ones, those ships you acquired last summer?

John Coustas, CEO

We are open to all possibilities that make sense. For the time being, second-hand ships are pretty expensive. We do not want a very high capital burden on all our vessels. If we make an investment, we definitely need to focus on green technology because, at some stage, the whole fleet needs to adapt to the IMO commitments. For the time being, there is pressure for a much more aggressive investment strategy towards green buildings, and we're following that closely so we remain competitive.

Omar Nokta, Analyst

Yes, definitely. And, John, one final question, just more market-related. Obviously, we've seen you guys have been at the forefront of chartering your ships on longer and longer-term contracts. How would you characterize the market today, vis-à-vis this backdrop of easing freight rates and uncertainty ahead? How would you characterize liner's appetite today for fixing ships that come open say in '23?

John Coustas, CEO

There's no doubt that people are, in general, more conservative. There are requirements around. So the issue here is not that liner companies do not have requirements. It's just that because we're talking about 2023, nobody feels the urge to pay top of the market at this moment and hopes that by waiting, they might be able to acquire the ship at a lower rate. So it's not so much that there is no demand; it's just that people are holding off in the hope of being able to commit to ships at a lower level. On the other hand, exactly because the owners are not in distress, they are not prepared to make concessions like they did in the past just to secure a deal. We will have to see how the world situation develops before any chartering decisions are made.

Omar Nokta, Analyst

Got it. Thanks, John. Very helpful. Appreciate it. And congrats again. I'll turn it over.

John Coustas, CEO

Thank you. Thank you, Omar. Thank you.

Operator, Operator

Our next question comes from Chris Wetherbee with Citigroup. Please go ahead.

Chris Wetherbee, Analyst

Yes, hi, thanks for taking the call. John, you talked about the normalization in the market, I think at higher levels than what we've seen in the past. I know this is a difficult question to answer, but I'm curious what you think that means. So where do we think that sort of the maybe 2023, 2024 normalization in the market? What does that look like in terms of the level of rates? We know there are continuing constraints and obviously supply chain challenges, but any sort of thoughts you have on the magnitude of potential normalization would be very helpful.

John Coustas, CEO

Yes, well Chris, in general, the long-term rates in the market are dictated by a combination of actual new building costs and financial costs. Both are very high today, which means that there is no incentive for anyone to align a ship for a longer period unless compensated well based on these two factors. This is why no one will go and build ships today unless they are properly compensated. This also keeps an anchor in the second-hand market, since if someone can afford a long-term new ship, they will likely go for a remarkably short-term charter of an existing ship until the situation becomes clearer.

Chris Wetherbee, Analyst

Okay, that's helpful. I appreciate that perspective. And maybe just thinking about the balance sheet, what do we think the right level of debt is? Obviously, from an EBITDA perspective, we're running at a pretty robust level here. And maybe there's a normalization coming. How much work do you think you need to do from here, in terms of paying down debt, and how do you balance that with share buybacks and incremental investments in the fleet?

John Coustas, CEO

Well, I think you know exactly because shipping is a cyclical industry, it's important to see how your debt-to-EBITDA moves through the cycles. Of course now, it's a very strong market, and we have a debt-to-EBITDA of 0.9. If we take into account some of our other marketable securities, it's even lower than that. But this is really the moment where we are at the top of the cycle. We haven't done any significant expansion, and we believe that, through a weakening market and without material expansion, this could go as maximum up to about three, which is the level we want to maintain as we are very much aware that our rating is directly influenced by these ratios. We consider a very high rating as key to our future as it allows us to borrow at better rates than our competitors.

Chris Wetherbee, Analyst

Okay, that's clear. It's helpful. I appreciate the time today. Thanks so much.

John Coustas, CEO

Okay, thank you. Thank you, Chris.

Operator, Operator

Our next question comes from an unknown speaker. Please proceed.

Unidentified Analyst, Analyst

Hello, everyone. I would like to first congratulate you on the recent quarter. The financial statement looks amazing, and definitely you did a great job there. I would like to ask a question; I had the issue at the beginning of the call so maybe I missed it. And you mentioned it before, but regarding the buyback program, you mentioned to the SEC that the program will be around $100 million. The recent financial statement mentioned that 25% of it. I wonder if there will be a continuation of the program or any changes to it. In case you're going to extend it or complete the plan as declared at the beginning? Thank you very much.

John Coustas, CEO

None of the plan remains in place. We have executed the share buyback at leverage that we want to be accretive for shareholders. Additionally, this was done in a period of pretty slow market during the summer since we declared the share buyback, which means that we could not really buy many more shares during that period of time due to liquidity constraints.

Unidentified Analyst, Analyst

Yes, I totally get it. So the program remains the same, and you will complete it to $100 million eventually.

John Coustas, CEO

If I may, the program by nature is opportunistic, right? It is in place, and there is no expiration date. It's up to the board to decide whether they want to discontinue it at any point. It's an open program, which we will seek to execute in the best possible way for our shareholders. The board reviews these matters periodically, so I cannot give you a perfect answer, but that's how it stands.

Unidentified Analyst, Analyst

I see. Thank you very much. Good luck.

John Coustas, CEO

Thank you.

Operator, Operator

Our next question comes from Climent Molins with Value Investor's Edge. Please go ahead.

Climent Molins, Analyst

Good morning, gentlemen. Thank you for taking my questions. Following up on the repurchase authorization, you've already used a quarter of that. But you continue to trade at a significant discount to NAV, so further repurchases are very attractive. What's your current view on the trade-off between increasing the dividend and additional repurchases?

John Coustas, CEO

Well, first of all, we said the repurchase program remains in place. As I said, we'll use it in the best interests of our shareholders. Regarding the dividend, for the time being, it remains steady, and any reevaluation of the dividend will definitely not occur earlier than 12 months from the previous rates.

Climent Molins, Analyst

All right, that's helpful. Your balance sheet is now very strong and will continue to strengthen going forward. Do you still believe new building pricing is attractive, or do you prefer to take a wait-and-see approach going forward?

John Coustas, CEO

For the time being, we do not see any attractive opportunities. But as I said, this is the nature of shipping; it's cyclical. We are best positioned compared to everyone else to jump into interesting opportunities when they arise.

Climent Molins, Analyst

That's all for me. Thank you very much for taking my questions and congratulations on this quarter.

John Coustas, CEO

Thank you.

Operator, Operator

It appears we have no further questions at this time. I would like to turn the call back over to Dr. Coustas for any further comments or closing remarks.

John Coustas, CEO

Thank you all for joining this conference call and for your continued interest in our story. I look forward to hosting you on our next earnings call. Have a nice day.

Operator, Operator

Thank you. This concludes today's teleconference. We would like to thank everyone for their participation. Have a wonderful afternoon.