Derivatives

 

Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Investments and Hedging Activities” (“FAS 133”) requires the Company and OSG Crude to recognize all derivatives on the balance sheet at fair value. If the derivative is an effective hedge, a change in the fair value is either offset against the change in fair value of the hedged item or recognized in other comprehensive income until the hedged item is recognized in income. The ineffective portion of effective hedges is immediately recognized in income. Derivatives that are not effective hedges are fully adjusted through income.

 

The Company uses an interest rate swap to convert interest-bearing debt from floating to fixed rate. The swap is designated and qualify as a cash flow hedge. The Company assumes no ineffectiveness since the interest rate swap meets the conditions required under FAS 133 to apply the critical terms method for prepayable debt.

 

Comprehensive Income

 

Accumulated other comprehensive income consists entirely of unrealized gains and losses on the Company’s interest rate derivative instrument.

 

Foreign currency

 

The functional currency of the Company and each of the Vessel subsidiaries is the U.S. dollar. Monetary assets and liabilities denominated in other currencies are translated at the year end exchange rates. Foreign currency revenues and expenses are translated at transaction date exchange rates. Exchange gains and losses are included in the determination of net income.

 

Use of estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

 

Note B—Accounts payable and accrued expenses:

 

Accounts payable and accrued expenses consist of the following:

 

		September 30, 2007				December 31, 2006
Interest		$	2,846,000			$	2,835,000
Insurance			-				213,000
Accounts payable			143,000				57,000
Other			600,000				351,000
		$	3,589,000			$	3,456,000

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Note C--Debt:

 

On October 18, 2005, the Company entered into a $401,000,000 secured credit facility with The Royal Bank of Scotland for a term of ten years, with no principal amortization for the first five years. The credit facility consists of a $236,000,000 term loan, a $150,000,000 vessel acquisition facility and a $15,000,000 working capital facility. The Company is the borrower under the credit facility and each of its seven Vessel owning subsidiaries has guaranteed its performance thereunder. The facility is secured by, among other things, first priority mortgage on the Company's seven Vessels, assignment of earnings and insurances and the Company's rights under the time charters for the Vessels and the ship management agreements, and a pledge of the balances in the Company's bank accounts. The credit facility provides that the Company may not pay dividends if the charter-free market value of the Company's vessels that secure the credit facility is less than 135% of the Company's borrowings under the facility plus the actual or notional cost of terminating any interest rate swaps that the Company enters, if there is a continuing default under the credit facility or if the payment of the dividend would result in a default or breach of a loan covenant. Interest is payable quarterly in arrears.

 

Borrowings under the term loan and the working capital facility bear interest at an annual rate of LIBOR plus a margin of 0.70%. Borrowings under the vessel acquisition portion of the credit facility bear interest at an annual rate of LIBOR plus a margin of 0.85%. To reduce the exposure to fluctuations in interest rates, the Company has entered into a five year interest rate swap effective October 18, 2005 pursuant to which the interest rate on $236,000,000 of the term loan was fixed at 5.6%. The Company is required to pay a commitment fee of 0.3% per annum, which will be payable quarterly in arrears, on the undrawn portion of the facility.

 

In connection with the acquisition of the Overseas Newcastle and Overseas London, the Company has entered into an agreement with the Royal Bank of Scotland to increase the credit facility by $19 million to $420 million. Through September 30, 2007, the Company borrowed an additional $7,000,000 to fund the deposits for the vessel acquisitions.

 

On October 16, 2007, the Company entered into a floating-to-fixed interest rate swap with a notional amount of $100,000,000 pursuant to which the Company pays a fixed rate of 5.94% and receives a floating rate based on LIBOR. The swap expires on January 18, 2013. This swap was entered into to fix the interest rate on the expected borrowings to fund the acquisition of the Overseas Newcastle and Overseas London.

 

The Company will be required to repay the term loan commencing three months after the fifth anniversary of the facility closing date (October 18, 2005) in twenty quarterly installments of $6,062,500 and a final repayment of $114,750,000 occurring simultaneously with the last quarterly repayment. In addition, the vessel acquisition facility will reduce (with any excess borrowing becoming repayable at the time of reduction) quarterly commencing three months after the fifth anniversary of the facility closing date in increments of $7,500,000. The working capital facility will also reduce (with any excess borrowing becoming repayable at the time of reduction) commencing three months after the fifth anniversary of the facility closing date in twenty quarterly installments of $750,000.

 

As of September 30, 2007 and December 31, 2006, all of the net book amount of the Company's seven Vessels, is pledged as collateral under the debt agreement.

 

The carrying amounts of the loans approximate their fair value.

 

 

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Note D--Derivatives:

 

As of September 30, 2007, the Company is party to a floating-to-fixed interest rate swap that is being accounted for as a cash flow hedge with a notional amount of $236,000,000 pursuant to which the Company pays a fixed rate of 5.6% and receives a floating rate based on LIBOR. The swap expires on October 18, 2010. As of September 30, 2007, the Company has recorded a liability of $1,141,893 in gain/(loss) on interest rate swap relating to the fair value of the swap. This unrealized loss has been recorded to accumulated other comprehensive income/(loss). The fair value of interest rate swaps is the estimated amount that the Company would receive or pay to terminate the agreement at the reporting date.

Note E--Accumulated other comprehensive income/(loss):

 

The accumulated other comprehensive income arises from unrealized gain/(loss) on derivative instruments. Comprehensive income/(loss) was ($2,854,000) and $2,403,000 for the nine months ended September 30, 2007 and 2006, respectively.

 

Note F--Taxes:

 

No income taxes have been provided herein because the Company is a foreign corporation that would not be subject to United States federal income taxes. Further, the Company is not subject to income taxes imposed by the Marshall Islands, the country in which it is incorporated.

 

Note G--Stock Compensation:

 

In connection with the IPO, the Company awarded a total of 6,250 shares of restricted common stock to its officers. These shares are non-transferable until they vest, which occurs ratably over a four-year period. The aggregate fair market value of the shares on the grant date, $75,000, is being amortized to compensation expense over the vesting period of four years, using the straight-line method. In addition, also in connection with the IPO, the Company awarded its officers stock options to purchase a total of 69,448 shares of common stock at an exercise price of $12.00 per share. These stock options vest ratably over a three-year period and expire ten years from the date of grant. The Company follows Financial Accounting Standards Board Statement No. 123 (R), “Share-Based Payment” and related Interpretations in accounting for its stock-based compensation. The fair value of the options granted were estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions: risk free interest rate of 4.69%, dividend yield of 10.42%, expected stock price volatility of 0.31 and expected life of 6 years. The aggregate fair market value of the stock options on the grant date, $75,000, is being amortized to compensation expense over the vesting period of three years, using the straight-line method.

On February 19, 2007, the officers exercised 23,514 options in a “cash-less” exercise and 4,704 shares were issued.

 

The Company awarded a total of 3,000 shares of restricted common stock to its directors on May 10, 2006. These restricted shares vested on October 18, 2006. At the date of the award, the fair market value of the Company's common stock was $12.79 per share. The aggregate fair market value of the shares on the grant date was amortized to expense over five months, using the straight-line method.

 

 

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The Company awarded a total of 24,397 shares of restricted common stock to its officers on November 8, 2006, of which 6,250 shares vest in three equal amounts in May 2007, May 2008 and May 2009 subject to continued employment and 18,147 shares vest in three equal amounts in May 2007, May 2008 and May 2009 subject to certain market conditions.  At the date of the award, the fair market value of the Company's common stock was $13.785 per share. The aggregate fair market value of the shares on the grant date is being amortized to expense from November 2006 to May 2009.

 

The Company awarded a total of 10,842 shares of restricted common stock to its directors on November 8, 2006, of which 3,000 shares vest in three equal amounts in May 2007, May 2008 and May 2009 subject to continued office and 7,842 shares vest in three equal amounts in May 2007, May 2008 and May 2009 subject to certain market conditions. At the date of the award, the fair market value of the Company's common stock was $13.785 per share. The aggregate fair market value of the shares on the grant date is being amortized to expense from November 2006 to May 2009.

The Company awarded a total of 30,406 shares of restricted common stock to its officers on May 9, 2007, of which 8,989 shares vest in three equal amounts in May 2008, May 2009 and May 2010 subject to continued employment and 21,417 shares vest in three equal amounts in May 2008, May 2009 and May 2010 subject to certain market conditions.  At the date of the award, the fair market value of the Company's common stock was $16.10 per share. The aggregate fair market value of the shares on the grant date is being amortized to expense from May 2007 to May 2010.

 

The Company awarded a total of 9,861 shares of restricted common stock to its directors on May 9, 2007, of which 3,000 shares vest in three equal amounts in May 2008, May 2009 and May 2010 subject to continued office and 6,861 shares vest in three equal amounts in May 2008, May 2009 and May 2010 subject to certain market conditions. At the date of the award, the fair market value of the Company's common stock was $16.10 per share. The aggregate fair market value of the shares on the grant date is being amortized to expense from May 2007 to May 2010.

 

Total stock-based compensation expense was $265,211 and $71,295 for the nine months ended September 30, 2007 and 2006, respectively.

Note H--Charters-out:

 

The future minimum revenues expected to be received on the time charters for the Company's seven Vessels and the related revenue days (revenue days represent calendar days, less days that Vessels are not available for employment due to repairs or drydock) are as follows:

		Amount			Revenue Days
October 1 to December 31, 2007		$	18,308,000		644
2008			73,090,200		2,562
2009			73,146,000		2,555
2010			70,830,200		2,407
2011			43,434,000		1,328
Thereafter			4,610,100		127
Net minimum charter payments		$	283,418,500		9,623

Future minimum revenues do not include any additional hire from the profit sharing component of the charter agreements. Revenues from a time charter are not received when a Vessel is off-hire, including time required for normal periodic maintenance of the Vessel. In arriving at the minimum future charter revenues, an estimated time off-hire to perform periodic maintenance on each Vessel has been deducted, although there is no assurance that such estimate will be reflective of the actual off-hire in the future.

 

 

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Note I--Subsequent events:

 

In November 2007, the Company declared a dividend of $11,109,779 or $0.37 per share, payable on December 12, 2007 to stockholders of record as of December 3, 2007.

 

 

 

 

 

 

 

 

 

 

 

 

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