Octave Specialty Group, Inc.

Thank you. Good morning, everyone, and welcome to OSG's earnings release conference call for the second quarter of 2016.

Before we begin, I would like to start off by advising everyone on the call with us today of the following.

During this conference call, OSG's management may make forward-looking statements regarding OSG or the industry in which it operates, which could include, without limitation, statements about the outlook for the tanker and articulated tug/barge markets, change in oil trading patterns, forecast of the world and regional economic activity and demand for and production of oil and petroleum products; OSG's strategy; expectations regarding revenues and expenses, including both G&A expenses and vessel expenses; estimated bookings and TCE rates for the second half of 2016 and other periods; estimated capital expenditures for 2016 and another periods; projected scheduled drydock and off-hire days; OSG's consideration of a potential spinoff or other strategic alternatives and its ability to achieve its financing and other objectives; and regulatory developments in the United States and elsewhere. Any such forward-looking statements take into account various assumptions made by management based on its experience and perception of historical trends, current conditions, expected and future developments and other factors management believes are appropriate to consider in the circumstances.

Forward-looking statements are subject to a number of risks, uncertainties and assumptions, many of which are beyond the control of OSG, which may cause actual results to differ materially from those implied or expressed by the forward-looking statements. Factors, risks and uncertainties that could cause OSG's actual results to differ from expectations include those described in OSG's annual report on Form 10-K for 2015, its quarterly report on Form 10-Q for the second quarter of 2016 and in other filings that OSG has made or in the future may make with the U.S.

Securities and Exchange Commission.

With that out of the way, I would like to turn the call over to our President and Chief Executive Officer, Captain Ian Blackley. Ian?

Thanks, James. Good morning, everyone, and thank you for joining us for our 2016 second quarter earnings call.

On the call today with me here are Rick Oricchio, our CFO; Lois Zabrocky, Head of our International business; James Small, our General Counsel, who you have just heard from; and Brian Tanner, Head of Investor Relations. Also joining us today is Sam Norton, who recently became Head of our Domestic business.

He has been a member of OSG's Board of Directors for the past 2 years. Welcome, Sam.

Let me begin today on Slide 3 with second quarter 2016 highlights and some more recent events. I am pleased to report second quarter results today with adjusted EBITDA in the quarter of $110 million and TCE revenues of $216 million and net income of $30 million.

In the second quarter, we accelerated the payment of $29 million in principal amount of bank debt, and in July, we accelerated an additional $20 million. We continue to strengthen the capital structure of our businesses as we position them to be standalone companies.

During the second quarter, we made open-market purchases of approximately 8 million Class A warrants. We also bought back additional Class A common shares through our 10b-18 program during the quarter.

We have now completed approximately 40% of our $200 million 2-year equity repurchase plan, which we announced in November of last year.

During the quarter, we were added to the Wilshire 5000 Total Market Index and Russell family of indexes. And on June 28, we rejoined the New York Stock Exchange Big Board, increasing our exposure within the institutional investment community and helping to enhance the trading liquidity of our stock.

Before I move to discussing our business segments, I want to provide an update on our strategic process. We've taken many steps to enhance shareholder value this year, including dividend and equity buyback.

With the filing of a Form 10 on July 15, we've taken the next step towards separating our businesses, which we believe will unlock greater value for OSG shareholders.

And finally, as an important step in the execution of our plans to create 2 standalone publicly-traded companies. Following the separation, each company and each board will be better able to focus on their own businesses and more effectively pursue their distinct operating priorities and strategies.

By removing those complexities and limitations associated with the combined International and Jones Act business, each will have more flexibly to capitalize on opportunities for long-term growth and profitability.

Sam's appointment was another important step and put in place the leadership of our U.S. Flag business early in the process, helping to ensure a seamless transition when we separate.

We plan to provide further details about the board and the management teams of the separate companies as they are confirmed.

As I have discussed in prior calls, our preference was to merge our International business with another tanker company, which would provide a combined entity with greater scale and liquidity and help to promote consolidation within the international tanker industry. Currently, we are not in negotiation and discussion with any potential merger partners.

And while we also have been open to opportunities that will create value, our focus today is on separation. We expect that the separation will be a key to a spinoff of OSG International later this year.

The spinoff and exact timing remain subject to approval of the OSG Board of Directors and the satisfaction of various other conditions, including the effectiveness of the Form 10 filed with SEC. We look forward to completing the spinoff as quickly as we can so we can focus on unlocking the full potential of each business.

Please turn now to Slide 4 and an update on each of our segments. The outcome of the Brexit vote caught financial markets by surprise and added some downside risk for the global economy.

Although equity markets have recovered, global GDP growth in 2016 was marked down slightly to 3.1% from 3.2%.

In the crude sector, the attractive fundamentals, with the low oil prices leading to increasing demand, high oil supply and some stockpiling, that led us to a strong tanker market in 2015 and the first half of 2016 are coming more into balance as we move into the second half of this year. Global oil supply is no longer growing as it was in 2015, with higher OPEC output 2016 being offset by non-OPEC decline.

Within OPEC, the increased production by Iran and Iraq has been partially offset by supply disruptions in Nigeria and operational challenges in both Venezuela and Libya. Non-OPEC oil supply has declined, led by the U.S, where production was 8.5 million barrels per day in July, the lowest since August 2014.

Global oil demand has remained strong, with estimated growth of 1.4 million barrels per day for 2016, taking demand to 95.3 million barrels per day. China continues to be the main growth driver in the crude market, with first half imports running at some 14% above the same period in 2015, with crude imports in the second quarter averaging 7.8 million barrels per day.

This significant year-to-date increase is tempered somewhat by concerns that China crude import growth is higher than end-user demand. Growing crude inventories could result in demand for imports in China this year beginning to slow to a pace more consistent with estimated end-user demand in China plus a growing product export market.

India's oil imports continue to grow and it has overtaken Japan as the third largest consumer of crude oil. First half imports were up 12% to 4.3 million barrels per day compared to the same period last year.

With its increasing dependency on imported crude to meet its energy needs, India plans to finish building to 3 SPRs in 2016. The expected capacity of these SPRs is 39 million barrels.

And the government has announced plans for the second phase that would add an additional 91 million barrels by 2020.

The late second quarter and into the third quarter is typically one of the weaker periods of the year for crude tanker demand as refinery turnaround and scheduled maintenance impacts oil demand. The seasonal slowdown this year has been greater than anticipated due to weaker refining margins compared to last year, which led to a reduction in refinery throughput and the opportunity is being taken to complete maintenance deferred from 2015.

And finally, throughput is expected to recover as we move through the third quarter and peak summer driving demand draws down current high inventories.

On the supply side, fleet growth will remain elevated through the end of the next year, with a significant number of crude tankers scheduled to be delivered in 2016 and 2017. Looking further ahead, there has been little newbuild ordering through the first half of this year, a positive trend and a disciplined approach, we would like to see continue, which would result in lower fleet growth beyond 2017.

In the second quarter, our VLCC spot rate was $47,000 per day; the Aframax spot rate, $23,500 per day; and the Panamax blended rate was $20,500 per day, all strong returns. On our MRs, we delivered a healthy $14,700 per day in the quarter.

While we believe the long-term fundamentals for the product tanker market remain positive with strong underlying demand, we are currently experiencing a period of short-term softness. When you consider the high-inventory levels and the significant number of MRs that was delivered in the first half of this year, the market has been relatively resilient.

We believe market should begin to tighten late in the third quarter as we move through the seasonally weak period and start to get a winter market uplift. Additionally, European refineries recently lowered utilization by 5% in an effort to increase drawdowns can improve the upcoming winter margin.

Longer term, the outlook is positive as like the crude fleet, the MR fleet builds is expected to reduce as there has been little ordering of newbuilds so far this year. With continued lower crude oil prices and strong demand for petroleum products, particularly gasoline, we expect these supply/demand fundamentals continue to support a strong product tanker market.

Please turn now to Slide 5. In our U.S.

Flag business, the market continues to be impacted by the declines in U.S. crude oil production, delivery of newbuild tonnage and high inventories in the U.S.

that driven down refinery margins and slowed demand for both crude and product shipments. On top of this, a number of Jones Act tankers and ATBs have either been redelivered from time charters or are not being fully utilized are now being offered for relet.

Second quarter U.S. crude production averaged 8.8 million barrels a day, 656,000 barrels per day below the second quarter 2015 average.

Specifically, Eagle Ford shale, a major source of demand for the Jones Act trade, declined some 390,000 barrels per day in June 2016 compared to the prior-year period.

While the decline in U.S. crude production has led to a decrease in demand for coast-wide transportation of domestic crude, the narrowed spread between Brent and WTI has made it more attractive for U.S.

Northeast refineries to import foreign crude. Imports to U.S.

Northeast refineries are up 47% in 2016 versus last year, with the majority of this is coming from West Africa. As a result, we've seen a pickup in our Delaware lightering volume, benefiting our modern lightering ATBs.

Our lightering volumes averaged 180,000 barrels a day in the second quarter, up from 145,000 in the first quarter and more than double 86,000 barrels a day in the comparable 2015 period.

Another positive effect of the decline in crude oil prices has been the continued increase in gasoline consumption. In the second quarter of 2016, gasoline demand averaged 9.5 million barrels per day, up 4% over the same period in 2015.

According to data released by the Federal Highway Administration, U.S. driving reached 1.3 trillion miles year-to-date through May, up 3.3% compared with the same period a year ago and on pace to beat 2015's record-setting year.

This has driven stronger demand in the Jones Act clean product trade, including Florida, where the majority of the gasoline consumed in the state is transported on Jones Act vessels and where we employ a significant part of our Jones Act fleet. This strong demand for gasoline will ultimately lower inventories and more spot prices should reappear as a result.

Last week, we saw the first drawdown in gasoline and crude inventories in the U.S. for some time, which is a positive development.

On the supply side, newbuild deliveries will continue through the end of next year. There are 15 vessels remaining in the order book, with 6 deliveries expected in 2016 and 9 in 2017.

There are, however, 23 vessels in the Jones Act that are of 30 years older, so we would eventually expect to see some of those scrapped as the newer vessels deliver.

On our rebuilt ATB fleet, we began the year with a total of 800 potential open days. To date, we have successfully concluded new time charters on 5 of these units, reducing potential open days for the remainder for this year to only 52.

We also recently signed a 6-month charter extension on a tanker, with contracts due to expire in the fourth quarter.

Overall, as of today, more than 92% of our U.S. Flag revenue days for 2016 are fixed on time charter or seaway and 58% for 2017.

I will now turn the call over to Rick to provide additional details on our second quarter results.

Thanks, Ian. Let's move directly to reviewing the second quarter results in more detail.

Please turn to Slide 7.

TCE revenues for the second quarter totaled $216 million, a decrease of $19.5 million or 8% compared with the second quarter of 2015. The decrease was primarily driven by lower daily rates earned by the International Flag fleet.

TCE revenues for the first half of 2016 were $453 million, a decrease of $4 million or 1% compared with the first half of 2015. The decrease for the first half was primarily due to lower rate in the International Product Crude Carrier segment.

Second quarter TCE revenues for the International Crude Tankers segment totaled $67 million, down 13% compared with the same period a year ago. This decrease resulted from softening in daily rates across vessel types in the segment.

Nearly 2/3 of the revenue decrease in the quarter, as compared to the same period a year ago, was attributable to lower average daily TCE rates in the Aframax fleet. Declining rates in the VLCC and Panamax sectors also contributed to the decrease.

TCE revenues were $154 million for the first half of 2016, an increase of $10 million compared with the first half of 2015. The VLCC spot rate was $56,500 per day for the first half of 2016.

The Aframax spot rate was $27,400 per day, and the Panamax blended rate was $23,200 per day.

Additionally, revenue days for the segment increased 5% compared to the first half of 2015, primarily driven by ULCC, the Laura Lynn, exiting layup and commencing a time charter for storage in April 2015, which has now been extended through March 2017, and the 83 fewer drydock days as compared to the same period a year ago.

Ian highlighted the solid performance in our second quarter spot rates and discussed factors that have caused spot rates to soften this summer. In our third quarter, we have booked 66% of the available VLCC spot days at an average of approximately $29,200 per day; 54% of the available Aframax spot days at an average of $16,200 per day; and 42% of the available Panamax spot days at an average of approximately $14,300 per day.

In the International Product Carrier segment, second quarter TCE revenue totaled $34 million, down 19% compared to the second quarter of 2015. This decrease resulted primarily from significant period-over-period decreases in average daily spot rates earned by our MR fleet to $14,700 per day.

Contributing to the decline was a 108-day decrease in revenue days, resulting primarily from the sale of the Luxmar in July 2015. These decreases were partially offset by the LR1 blended rate increasing to approximately $21,300 per day in the second quarter, up 10% from the comparable 2015 period.

TCE revenues were $72 million for the first half of 2016, a decrease of $14 million compared with the first half of 2015. The MR spot rate was $15,400 per day for the first half of 2016.

We have booked approximately 36% of our third quarter MR spot days at a rate of approximately $12,000 per day.

In the U.S. Flag segment, second quarter TCE revenue totaled $115 million, a decrease of $1 million compared with the same period a year ago.

During the quarter, our TCE revenue increases were driven by a 76-day increase in revenue days, resulting from fewer drydock and repair days, and our Delaware Bay lightering volumes more than doubling to 180,000 barrels per day. These revenue increases were offset by a decline in coast-wise voyages that were available to the ATBs employed in our Delaware Bay lightering business in the second quarter of 2015 that were not available in the second quarter of 2016.

TCE revenues were $227 million for the first half of 2016 less compared with the first half of 2015.

Moving on to Slide 8. Net income for the second quarter was $30 million compared with $58 million in second quarter of 2015.

Net income for the first half of 2016 was $81 million compared with $101 million in the first half of 2015. The decrease in the comparative 2016 period reflects the impact of lower TCE revenues, increases in depreciation and amortization expenses and higher income taxes due to noncash deferred tax provision recorded on our foreign earnings, partially offset by lower interest expense.

Adjusted EBITDA was $110 million for the second quarter, a decrease of $20 million compared with the second quarter of 2015. These decreases were driven by the decline in TCE revenues, resulting from a softer rate environment, as I described earlier.

Adjusted EBITDA was $240 million for the first half of 2016, a decrease of $4 million compared with the same period last year.

Please turn to Page 9. From a liquidity standpoint, we ended the quarter with approximately $461 million of cash, including $5 million of restricted cash, compared with $522 million at the end of 2015.

We also have access to undrawn revolving credit facilities of $125 million, bringing our total liquidity to $586 million.

In the quarter, we purchased and retired $19 million of Class A warrants in common stock at an average share equivalent price of $11.59. In the second quarter, we accelerated the payment of $20 million in principal amount of our domestic subsidiary term loans.

In addition, in July, we accelerated another $20 million of such loan. We also accelerated $9 million of principal amount related to our international term loan.

Our cumulative delevering activities, along with scheduled amortization, will reduce our 2016 interest expense to approximately $70 million, down $31 million as compared to 2015. Our total gross leverage at the end of the second quarter of 2016 was 2.4x our last 12 months adjusted EBITDA compared to 4.2x in the same period a year ago.

We began the second quarter with total cash of $417 million, which included $15 million of restricted cash.

During the second quarter of 2016, we earned $110 million of adjusted EBITDA. We spent approximately $1 million on drydocking and improvements to our vessels; $32 million on equity buybacks, of which $19 million was related to buybacks in the quarter and $13 million was related to buyback initiated at the end of the first quarter but were not settled until the second quarter; as well as spending $31 million on delevering activities.

We ended the quarter with total cash of $461 million, of which $455 million is unrestricted cash.

With that, I would now like to turn the call back to Ian for his closing comments.

Thanks, Rick. Our second quarter and first half results were strong, plus our International segment rates have softened this summer, with the fundamentals remaining positive.

In our domestic business, we do face a challenging market due to the decline in U.S. crude production, high inventories and delivery of newbuild tonnage.

But the sustained global oil price environment is also driving record U.S. gasoline consumption, helping to offset the impact.

Strategically, we continue to make good progress towards separating our International and Domestic businesses by creating 2 independent public companies. With an increased ability to focus on the long-term growth and profitability of both businesses, we believe each will be better positioned to enhance shareholder value.

Over the last 24 months, we have generated $888 million of adjusted EBITDA and continue to provide significant cash flow that gives us flexibility to consider additional opportunities to create value for our shareholders and strengthen the balance sheet of our businesses as we prepare to separate.

We will now open the call up to questions. Operator?

Couple of quick ones from me. First of all, do you have any updates on the status of the FSOs or the FSO joint venture?

Do you have any visibility on what's going to happen there?

Lois?

Yes. Thanks for the question, Erik.

So we are looking forward to Northern oil company being combined, so Total has taken over from -- or will take over from Maersk Oil Qatar. And they're, at this moment, in the -- working on getting that organized, and then we expect to be able to engage.

But you are not yet been engaged or in discussions with Total?

We are not going to comment on exactly where we stand there. But when we have firm developments, we will let you know.

All right. And second question related to the Jones Act market.

You did say that you had charted out 5 ATBs this quarter and that you have limited days open, but you also mentioned that you could be looking at -- you'd be retiring some of these ATBs. And my question is kind of multiple, I guess, because first of all, what kind of CapEx are you looking at for those ATBs?

And then does these charter rates that you now secured today, I assume that they defend taking them through that CapEx cost? Could you sort of comment on how you're thinking about the ATBs at this point?

So Erik, what I said was that we'll pick those units during the course of this year, and we have done that. And as you know, we don't comment on individual charter rates, but we believe the average TCE rate for ATBs in 2016 is going to be around $35,000 per day.

In terms of retiring these units, as we have said in the past, their next special service maintenance has been 2019 and 2020. We'll continue to trade them as long we can trade them profitably.

And when it comes to a decision on CapEx, we will see what charters are available at that time in the marketplace and make a decision at that time.

All right. And the final question is on the Jones Act product tankers.

You did show a charter rate in the range of 20-some thousand for the few spot days you have during the quarter -- yes, 20,500 approximately. It's sort of -- is that the running rate for spot tonnage in the Jones Act market these days?

It's interesting -- it’s currently an interesting market. Over the last 6 weeks or so, there has been very few spot cargos available.

So the vessels that are in the spot market are fairly challenging to trade. And we had the Overseas Houston that we deliver from our time charter in the middle of June, and we ran her on a short coast-wide voyage, which resulted in that number that you're quoting.

The key is currently picked. So we currently have no tankers that are not picked.

All right. And then my final question related to the financials.

Just could you -- can you just give us the cash positions in OIN and OBS, respectively? It might be in the 10-Q but I couldn't see it.

Rick, can you get that?

Yes. So the cash balance -- unrestricted cash balance at June 30 at OIN is approximately $279 million; and at OBS, approximately $153 million.

Recently, the Iranians have come back into the oil export market in size. And I was wondering, has that changed the dynamic of Persian Gulf oil shipping?

I mean, has it been good or bad? I hear they have a big fleet that they carry a lot of their stuff on.

Could you comment on that?

Yes. This is Lois.

As far as tonne miles, the Iranians coming back on in force has been a negative, particularly for the VLCC fleet, especially when combined with the reduction of crude coming from the Western Hemisphere, East. It's just longer tonne miles if we come -- if we bring the crude from Venezuela or West Africa, and shorter if they're coming from the AG to the East.

I read from the 10-Q that you received a Wells Notice on July 25 this year. Could you please comment on that?

How material is it? And what could the potential damage be given potential outcome?

Erik, this is James Small, the General Counsel. I mean, the SEC investigation is continuing.

As you know, we disclosed in the 10-Q that we recently received the Wells Notice, we're in the process of responding to that. I would point you to that disclosure, and we have no further comments beyond what's in the 10-Q at this time.

Okay. And just one more question on your strategy in the International Flag business.

Are you doing any approaches to doing time charters at the moment? Or do you prefer to keep your employment status as it is?

Yes. At present, we have posted 10 ships on time charter.

And right now, the time charters that are being executed in the market are very short and at depressed rate. So I think at the moment, we're likely to keep our status as is.

So thank you, everyone, for giving us your time to get in the call. And we look forward to talking to you at the end of the third quarter if not before.

Thank you.