PARAGON SHIPPING INC 20-F 2008
Documents found in this filing:
TABLE OF CONTENTS
Paragon Shipping Inc., or the Company, desires to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and is including this cautionary statement in connection with this safe harbor legislation. This document and any other written or oral statements made by us or on our behalf may include forward-looking statements, which reflect our current views with respect to future events and financial performance. The words “believe”, “except,” “anticipate,” “intends,” “estimate,” “forecast,” “project,” “plan,” “potential,” “will,” “may,” “should,” “expect” and similar expressions identify forward-looking statements.
Please note in this annual report, “we”, “us”, “our”, “The Company”, all refer to Paragon Shipping Inc. and its subsidiaries.
The forward-looking statements in this document are based upon various assumptions, many of which are based, in turn, upon further assumptions, including without limitation, management’s examination of historical operating trends, data contained in our records and other data available from third parties. Although we believe that these assumptions were reasonable when made, because these assumptions are inherently subject to significant uncertainties and contingencies which are difficult or impossible to predict and are beyond our control, we cannot assure you that we will achieve or accomplish these expectations, beliefs or projections.
In addition to these important factors and matters discussed elsewhere herein, important factors that, in our view, could cause actual results to differ materially from those discussed in the forward-looking statements include the strength of world economies, fluctuations in currencies and interest rates, general market conditions, including fluctuations in charter hire rates and vessel values, changes in demand in the dry-bulk shipping industry, changes in the Company's operating expenses, including bunker prices, drydocking and insurance costs, changes in governmental rules and regulations or actions taken by regulatory authorities, potential liability from pending or future litigation, general domestic and international political conditions, potential disruption of shipping routes due to accidents or political events, and other important factors described from time to time in the reports filed by the Company with the Securities and Exchange Commission.
Item 1. Identity of Directors, Senior Management and Advisers
Item 2. Offer Statistics and Expected Timetable
Item 3. Key Information
The following table sets forth our selected consolidated financial data and other operating data and are stated in U.S. dollars, other than share and fleet data. The selected consolidated financial data in the table as of December 31, 2006 and 2007, for the period from inception (April 26, 2006) to December 31, 2006 and for the year ended December 31, 2007, is derived from our audited consolidated financial statements and notes thereto which have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) and have been audited by Deloitte Hadjipavlou Sofianos & Cambanis S.A., an independent registered public accounting firm and member of Deloitte Touche Tohmatsu. The following data should be read in conjunction with Item 5. “Operating and Financial Review and Prospects” the consolidated financial statements, related notes and other financial information included elsewhere in this annual report.
Some of the following risks relate principally to the industry in which we operate and our business in general. Other risks relate principally to the securities market and ownership of our common shares. The occurrence of any of the events described in this section could significantly and negatively affect our business, financial condition, operating results or cash available for dividends or the trading price of our common shares.
Industry Specific Risk Factors
Charter hire rates for drybulk carriers may decrease in the future, which may adversely affect our earnings
The drybulk shipping industry is cyclical with attendant volatility in charter hire rates and profitability. The degree of charter hire rate volatility among different types of drybulk carriers has varied widely. Although charter hire rates decreased slightly during 2005 and the first half of 2006, since July 2006, charter rates have risen sharply and are currently near their historical highs reached during October and November 2007. Charter hire rates for Panamax and Capesize drybulk carriers have declined from their historical high levels during the first quarter in 2008. Because we generally charter our vessels pursuant to one-to two year time charters, we are exposed to changes in spot market rates for drybulk carriers and such changes may affect our earnings and the value of our drybulk carriers at any given time. We cannot assure you that we will be able to successfully charter our vessels in the future or renew existing charters at rates sufficient to allow us to meet our obligations or to pay dividends to our shareholders. The supply of and demand for shipping capacity strongly influences freight rates. Because the factors affecting the supply and demand for vessels are outside of our control and are unpredictable, the nature, timing, direction and degree of changes in industry conditions are also unpredictable.
Factors that influence demand for vessel capacity include:
The factors that influence the supply of vessel capacity include:
In addition to the prevailing and anticipated freight rates, factors that affect the rate of newbuilding, scrapping and laying-up include newbuilding prices, secondhand vessel values in relation to scrap prices, costs of bunkers and other operating costs, costs associated with classification society surveys, normal maintenance and insurance coverage, the efficiency and age profile of the existing fleet in the market and government and industry regulation of maritime transportation practices, particularly environmental protection laws and regulations. These factors influencing the supply of and demand for shipping capacity are outside of our control, and we may not be able to correctly assess the nature, timing and degree of changes in industry conditions.
We anticipate that the future demand for our drybulk carriers will be dependent upon continued economic growth in the world's economies, including China and India, seasonal and regional changes in demand, changes in the capacity of the global drybulk carrier fleet and the sources and supply of drybulk cargo to be transported by sea. The capacity of the global drybulk carrier fleet seems likely to increase and there can be no assurance that economic growth will continue. Adverse economic, political, social or other developments could have a material adverse effect on our business and operating results.
An over-supply of drybulk carrier capacity may lead to reductions in charter hire rates and profitability
The market supply of drybulk carriers has been increasing, and the number of drybulk carriers on order are near historic highs. These newbuildings were delivered in significant numbers starting at the beginning of 2006 and continued to be delivered in significant numbers through 2007. As of January 2008, newbuilding orders had been placed for an aggregate of more than 48.0% of the current global drybulk fleet, with deliveries expected during the next 48 months. An over-supply of drybulk carrier capacity may result in a reduction of charter hire rates. If such a reduction occurs, upon the expiration or termination of our vessels’ current charters we may only be able to re-charter our vessels at reduced or unprofitable rates or we may not be able to charter these vessels at all.
An economic slowdown in the Asia Pacific region could have a material adverse effect on our business, financial position and results of operations
A significant number of the port calls made by our vessels involve the loading or discharging of drybulk commodities in ports in the Asia Pacific region. As a result, a negative change in economic conditions in any Asia Pacific country, but particularly in China, may have an adverse effect on our business, financial position and results of operations, as well as our future prospects. In recent years, China has been one of the world's fastest growing economies in terms of gross domestic product, which has had a significant impact on shipping demand. We cannot assure you that such growth will be sustained or that the Chinese economy will not experience negative growth in the future. Moreover, a slowdown in the economies of the United States, the European Union or certain Asian countries may adversely affect economic growth in China and elsewhere. Our business, financial position, results of operations, ability to pay dividends as well as our future prospects, will likely be materially and adversely affected by an economic downturn in any of these countries.
The market values of our vessels may decrease, which could limit the amount of funds that we can borrow under our senior secured credit facilities or cause us to breach covenants in our senior secured credit facilities and adversely affect our operating results
The fair market values of drybulk carriers have generally experienced high volatility. The market prices for secondhand drybulk carriers reached historic highs in 2007. You should expect the market value of our vessels to fluctuate depending on general economic and market conditions affecting the shipping industry and prevailing charter hire rates, competition from other shipping companies and other modes of transportation, types, sizes and ages of vessels, applicable governmental regulations and the cost of newbuildings. If the market value of our fleet declines, we may not be able to draw down the full amount of our senior secured credit facilities that we have entered into and we may not be able to obtain other financing or incur debt on terms that are acceptable to us or at all. Further, while we believe that the current aggregate market value of our drybulk vessels will be in excess of amounts required under the senior secured credit facilities that we have entered into, a decrease in these values could cause us to breach some of the covenants that are contained in our senior secured credit facilities and in future financing agreements that we may enter into from time to time. If we do breach such covenants and we are unable to remedy the relevant breach, our lenders could accelerate our debt and foreclose on our fleet. In addition, if the book value of one of our vessels is impaired due to unfavorable market conditions or a vessel is sold at a price below its book value, we would incur a loss that could adversely affect our operating results. Please see the section of this annual report entitled “The Drybulk Shipping Industry” for information concerning historical prices of drybulk carriers.
World events could affect our results of operations and financial condition
The threat of future terrorist attacks in the United States or elsewhere continues to cause uncertainty in the world’s financial markets and may affect our business, operating results and financial condition. The continuing conflict in Iraq may lead to additional acts of terrorism and armed conflict around the world, which may contribute to further economic instability in the global financial markets. These uncertainties could also adversely affect our ability to obtain additional financing on terms acceptable to us or at all. In the past, political conflicts have also resulted in attacks on vessels, mining of waterways and other efforts to disrupt international shipping, particularly in the Arabian Gulf region. Acts of terrorism and piracy have also affected vessels trading in regions such as the South China Sea. Any of these occurrences could have a material adverse impact on our operating results, revenues and costs.
Our operating results are subject to seasonal fluctuations, which could affect our operating results and the amount of available cash with which we can pay dividends
We operate our vessels in markets that have historically exhibited seasonal variations in demand and, as a result, in charter hire rates. This seasonality may result in quarter-to-quarter volatility in our operating results, which could affect the amount of dividends that we pay to our stockholders from quarter to quarter. The drybulk carrier market is typically stronger in the fall and winter months in anticipation of increased consumption of coal and other raw materials in the northern hemisphere during the winter months. In addition, unpredictable weather patterns in these months tend to disrupt vessel scheduling and supplies of certain commodities. As a result, our revenues have historically been weaker during the fiscal quarters ended June 30 and September 30, and, conversely, our revenues have historically been stronger in fiscal quarters ended December 31 and March 31. While this seasonality has not materially affected our operating results, it could materially affect our operating results and cash available for distribution to our stockholders as dividends in the future.
Rising fuel prices may adversely affect our profits
The cost of fuel is a significant factor in negotiating charter rates. As a result, an increase in the price of fuel beyond our expectations may adversely affect our profitability. The price and supply of fuel is unpredictable and fluctuates based on events outside our control, including geo-political developments, supply and demand for oil, actions by members of the Organization of the Petroleum Exporting Countries and other oil and gas producers, war and unrest in oil producing countries and regions, regional production patterns and environmental concerns and regulations.
We are subject to regulation and liability under environmental laws that could require significant expenditures and affect our cash flows and net income and could subject us to increased liability under applicable law or regulation
Our business and the operation of our vessels are materially affected by government regulation in the form of international conventions and national, state and local laws and regulations in force in the jurisdictions in which the vessels operate, as well as in the countries of their registration. Because such conventions, laws, and regulations are often revised, we cannot predict the ultimate cost of complying with them or their impact on the resale prices or useful lives of our vessels. Additional conventions, laws and regulations may be adopted that could limit our ability to do business or increase the cost of our doing business and that may materially adversely affect our operations. We are required by various governmental and quasi-governmental agencies to obtain certain permits, licenses, certificates, and financial assurances with respect to our operations.
The operation of our vessels is affected by the requirements set forth in the United Nations' International Maritime Organization's International Management Code for the Safe Operation of Ships and Pollution Prevention, or ISM Code. The ISM Code requires shipowners, ship managers and bareboat charterers to develop and maintain an extensive "Safety Management System" that includes the adoption of a safety and environmental protection policy setting forth instructions and procedures for safe operation and describing procedures for dealing with emergencies. The failure of a shipowner or bareboat charterer to comply with the ISM Code may subject it to increased liability, may invalidate existing insurance or decrease available insurance coverage for the affected vessels and may result in a denial of access to, or detention in, certain ports.
The operation of drybulk carriers has certain unique operational risks which could affect our earnings and cash flow
The operation of certain ship types, such as drybulk carriers, has certain unique risks. With a drybulk carrier, the cargo itself and its interaction with the vessel can be an operational risk. By their nature, drybulk cargoes are often heavy, dense, easily shifted, and react badly to water exposure. In addition, drybulk carriers are often subjected to battering treatment during unloading operations with grabs, jackhammers (to pry encrusted cargoes out of the hold) and small bulldozers. This treatment may cause damage to the vessel. Vessels damaged due to treatment during unloading procedures may be more susceptible to breach to the sea. Hull breaches in drybulk carriers may lead to the flooding of the vessels’ holds. If a drybulk carrier suffers flooding in its forward holds, the bulk cargo may become so dense and waterlogged that its pressure may buckle the vessel’s bulkheads leading to the loss of a vessel. If we are unable to adequately maintain our vessels we may be unable to prevent these events. Any of these circumstances or events could negatively impact our business, financial condition, results of operations and ability to pay dividends. In addition, the loss of any of our vessels could harm our reputation as a safe and reliable vessel owner and operator.
Maritime claimants could arrest one or more of our vessels, which could interrupt our cash flow
Crew members, suppliers of goods and services to a vessel, shippers of cargo and other parties may be entitled to a maritime lien against a vessel for unsatisfied debts, claims or damages. In many jurisdictions, a claimant may seek to obtain security for its claim by arresting a vessel through foreclosure proceedings. The arrest or attachment of one or more of our vessels could interrupt our cash flow and require us to pay large sums of money to have the arrest or attachment lifted. In addition, in some jurisdictions, such as South Africa, under the "sister ship" theory of liability, a claimant may arrest both the vessel which is subject to the claimant's maritime lien and any "associated" vessel, which is any vessel owned or controlled by the same owner. Claimants could attempt to assert "sister ship" liability against one vessel in our fleet for claims relating to another of our vessels.
Governments could requisition our vessels during a period of war or emergency, resulting in a loss of earnings
A government could requisition one or more of our vessels for title or for hire. Requisition for title occurs when a government takes control of a vessel and becomes her owner, while requisition for hire occurs when a government takes control of a vessel and effectively becomes her charterer at dictated charter rates. Generally, requisitions occur during periods of war or emergency, although governments may elect to requisition vessels in other circumstances. Although we would be entitled to compensation in the event of a requisition of one or more of our vessels, the amount and timing of payment would be uncertain. Government requisition of one or more of our vessels may negatively impact our revenues and reduce the amount of cash we have available for distribution as dividends to our shareholders.
Company Specific Risk Factors
Our earnings and the amount of dividends that we are able to pay in the future may be adversely affected if we do not successfully employ our vessels
We employ our drybulk carriers primarily on one and two year time charters. Period charters provide relatively steady streams of revenue, but vessels committed to period charters may not be available for spot voyages during periods of increasing charter hire rates, when spot voyages might be more profitable. Charter hire rates for drybulk carriers are volatile, and in the past charter hire rates for drybulk carriers have declined below operating costs of vessels. If our vessels become available for employment in the spot market or under new period charters during periods when market prices have fallen, we may have to employ our vessels at depressed market prices, which would lead to reduced or volatile earnings. We cannot assure you that future charter hire rates will enable us to operate our vessels profitably or to pay you dividends.
Our charterers may terminate or default on their charters, which could adversely affect our results of operations and cash flow
Our charters may terminate earlier than the dates indicated in this annual report. The terms of our charters vary as to which events or occurrences will cause a charter to terminate or give the charterer the option to terminate the charter, but these generally include a total or constructive total loss of the related vessel, the requisition for hire of the related vessel or the failure of the related vessel to meet specified performance criteria. In addition, the ability of each of our charterers to perform its obligations under a charter will depend on a number of factors that are beyond our control. These factors may include general economic conditions, the condition of the drybulk shipping industry, the charter rates received for specific types of vessels and various operating expenses. The costs and delays associated with the default by a charterer of a vessel may be considerable and may adversely affect our business, results of operations, cash flows and financial condition and our ability to pay dividends.
We cannot predict whether our charterers will, upon the expiration of their charters, recharter our vessels on favorable terms or at all. If our charterers decide not to re-charter our vessels, we may not be able to recharter them on terms similar to the terms of our current charters or at all. In the future, we may also employ our vessels on the spot charter market, which is subject to greater rate fluctuation than the time charter market.
If we receive lower charter rates under replacement charters or are unable to recharter all of our vessels, the amounts available, if any, to pay dividends to our shareholders may be significantly reduced or eliminated.
Investment in derivative instruments such as freight forward agreements could result in losses
From time to time, we may take positions in derivative instruments including freight forward agreements, or FFAs. FFAs and other derivative instruments may be used to hedge a vessel owner's exposure to the charter market by providing for the sale of a contracted charter rate along a specified route and period of time. Upon settlement, if the contracted charter rate is less than the average of the rates, as reported by an identified index, for the specified route and time period, the seller of the FFA is required to pay the buyer an amount equal to the difference between the contracted rate and the settlement rate, multiplied by the number of days in the specified period. Conversely, if the contracted rate is greater than the settlement rate, the buyer is required to pay the seller the settlement sum. If we take positions in FFAs or other derivative instruments and do not correctly anticipate charter rate movements over the specified route and time period, we could suffer losses in the settling or termination of the FFA. This could adversely affect our results of operation and cash flow.
We cannot assure you that we will pay dividends
Our policy is to pay quarterly dividends in February, May, August and November of each year as described in "Our Dividend Policy." However, we may incur other expenses or liabilities that would reduce or eliminate the cash available for distribution as dividends. Our loan agreements, including our existing and new senior secured credit facilities, may also prohibit our declaration and payment of dividends under some circumstances.
In addition, the declaration and payment of dividends will be subject at all times to the discretion of our board of directors. The timing and amount of dividends will depend on our earnings, financial condition, cash requirements and availability, fleet renewal and expansion, restrictions in our loan agreements, the provisions of Marshall Islands law affecting the payment of dividends and other factors. Marshall Islands law generally prohibits the payment of dividends other than from surplus or while a company is insolvent or would be rendered insolvent upon the payment of such dividends. There can be no assurance that dividends will be paid in the anticipated amounts and frequency set forth in this annual report or at all.
We may have difficulty effectively managing our planned growth, which may adversely affect our ability to pay dividends
Since the completion of our initial public offering in August 2007, we have taken delivery of four Panamax drybulk carriers and one Supramax drybulk carrier. The addition of these vessels to our fleet has resulted in a significant increase in the size of our fleet and imposes significant additional responsibilities on our management and staff. While we expect our fleet to grow further, this may require us to increase the number of our personnel. We will also have to increase our customer base to provide continued employment for the new vessels.
Our future growth will primarily depend on our ability to:
Growing any business by acquisition presents numerous risks, such as undisclosed liabilities and obligations, the possibility that indemnification agreements will be unenforceable or insufficient to cover potential losses and difficulties associated with imposing common standards, controls, procedures and policies, obtaining additional qualified personnel, managing relationships with customers and integrating newly acquired assets and operations into existing infrastructure. We cannot give any assurance that we will be successful in executing our growth plans or that we will not incur significant expenses and losses in connection with our future growth. If we are not able to successfully grow the size of our company or increase the size of our fleet, our ability to pay dividends may be adversely affected.
The expansion of our fleet may impose significant additional responsibilities on our management and staff, and the management and staff of Allseas Marine S.A., or Allseas, which is responsible for all of the commercial and technical management functions for our fleet and is an affiliate of our chairman and chief executive officer, Mr. Michael Bodouroglou, and may necessitate that we, and they, increase the number of personnel. Allseas may have to increase its customer base to provide continued employment for our fleet, and such costs will be passed on to us by Allseas.
We are dependent on Allseas for the commercial and technical management our fleet
The only employees we currently have are Mr. Bodouroglou, our chief executive officer, George Skrimizeas, our chief operating officer, Christopher Thomas, our chief financial officer, and Maria Stefanou, our internal legal counsel and corporate secretary and we currently have no plans to hire additional employees. As we subcontract the commercial and technical management of our fleet, including crewing, maintenance and repair, to Allseas, the loss of Allseas’ services or its failure to perform its obligations to us could materially and adversely affect the results of our operations. Although we may have rights against Allseas if it defaults on its obligations to us, you will have no recourse directly against Allseas. Further, we expect that we will need to seek approval from our lenders to change our commercial and technical manager.
Allseas is a privately held company and there is little or no publicly available information about it
The ability of Allseas to continue providing services for our benefit will depend in part on its own financial strength. Circumstances beyond our control could impair Allseas’ financial strength, and because it is privately held it is unlikely that information about its financial strength would become public unless Allseas began to default on its obligations. As a result, an investor in our shares might have little advance warning of problems affecting Allseas, even though these problems could have a material adverse effect on us.
Our chairman and chief executive officer has affiliations with Allseas which may create conflicts of interest
Our chairman and chief executive officer is the beneficial owner of all of the issued and outstanding capital stock of Allseas. These responsibilities and relationships could create conflicts of interest between us, on the one hand, and Allseas, on the other hand. These conflicts may arise in connection with the chartering, purchase, sale and operations of the vessels in our fleet versus vessels managed by other companies affiliated with Allseas and Mr. Bodouroglou. Allseas may give preferential treatment to vessels that are beneficially owned by related parties because Mr. Bodouroglou and members of his family may receive greater economic benefits. In particular, Allseas currently provides management services to five drybulk carriers, other than the vessels in our fleet, that are owned by entities affiliated with Mr. Bodouroglou, and such entities may acquire additional vessels that will compete with our vessels in the future. Mr. Bodouroglou granted to us the right to purchase the remaining five vessels for which Allseas provides management services which was declined, as well as a right of first refusal over future vessels that he or entities affiliated with him may seek to acquire in the future. However, we may not exercise our right to acquire all or any of these vessels in the future, and such vessels may compete with our fleet. These conflicts of interest may have an adverse effect on our results of operations.
Servicing our outstanding debt and any future indebtedness that we incur will limit funds available for other purposes such as the payment of dividends
In addition to our current outstanding indebtedness, we expect to incur additional secured debt. While we do not intend to use operating cash to pay down principal, we must dedicate a portion of our cash flow from operations to pay the interest on our debt. These payments limit funds otherwise available for working capital, capital expenditures and other purposes. We will have to incur debt in order to expand our fleet, which could increase our ratio of debt to equity. The need to service our debt may limit funds available for other purposes, including distributing cash to our shareholders, and our inability to service debt could lead to acceleration of our debt and foreclosure on our fleet.
Our senior secured credit facilities contain restrictive covenants that may limit our liquidity and corporate activities
Our senior secured credit facilities impose operating and financial restrictions on us. These restrictions may limit our ability to:
Therefore, our discretion is limited because we may need to obtain consent from our lenders in order to engage in certain corporate actions. Our lenders’ interests may be different from ours, and we cannot guarantee that we will be able to obtain our lenders’ consent when needed. This may prevent us from taking actions that are in our shareholders’ best interest.
Our credit facilities impose certain conditions on the payment of dividends
The terms of our credit facilities contain a number of financial covenants and general covenants that require us to, among other things, maintain vessel market values of at least 140% and in case of a dividend declaration at least 154% (a ratio which we will determine quarterly and at each dividend payment date) of the outstanding facility amount, minimum cash balances and insurance including, but not limited to, hull and machinery insurance in an amount at least equal to the fair market value of the vessels financed, as determined by third party valuations. We may not be permitted to pay dividends under our credit facilities if we are in default of any of these loan covenants or if we do not meet specified debt coverage ratios.
Our ability to obtain additional debt financing may be dependent on the performance of our then existing charters and the creditworthiness of our charterers
The actual or perceived credit quality of our charterers, and any defaults by them, may materially affect our ability to obtain the additional capital resources that we will require to purchase additional vessels or may significantly increase our costs of obtaining such capital. Our inability to obtain additional financing at all or at a higher than anticipated cost may materially affect our results of operation and our ability to implement our business strategy.
Purchasing and operating previously owned, or secondhand, drybulk carriers may result in increased operating costs and off-hire days for our vessels, which could adversely affect our earnings
While we normally inspect secondhand vessels prior to purchase, this does not provide us with the same knowledge about their condition that we would have had if these vessels had been built for and operated exclusively by us, and accordingly, we may not discover defects or other problems with such vessels prior to purchase. If this were to occur, such hidden defects or problems, when detected, may be expensive to repair, and if not detected, may result in accidents or other incidents for which we may become liable to third parties. Generally, we do not receive the benefit of warranties on secondhand vessels.
In the highly competitive international shipping industry, we may not be able to compete for charters with new entrants or established companies with greater resources
We employ our vessels in a highly competitive market that is capital intensive and highly fragmented. Competition arises primarily from other vessel owners, some of whom have substantially greater resources than we do. Competition for the transportation of drybulk cargo by sea is intense and depends on price, location, size, age, condition and the acceptability of the vessel and its operators to the charterers. Due in part to the highly fragmented market, competitors with greater resources could enter the drybulk shipping industry and operate larger fleets through consolidations or acquisitions and may be able to offer lower charter rates and higher quality vessels than we are able to offer.
We may be unable to attract and retain key management personnel and other employees in the shipping industry, which may negatively impact the effectiveness of our management and results of operations
Our success depends to a significant extent upon the abilities and efforts of our management team. We have entered into employment agreements with each of our chairman and chief executive officer, chief operating officer, chief financial officer and our internal legal counsel and corporate secretary. We have consulting agreements with companies beneficially owned by the chief executive officer, the chief operating officer, the chief financial officer and the internal legal counsel and corporate secretary. Our success will depend upon our ability to hire and retain key members of our management team. The loss of any of these individuals could adversely affect our business prospects and financial condition. Difficulty in hiring and retaining personnel could adversely affect our business, results of operations and ability to pay dividends. We do not intend to maintain “key man” life insurance on any of our officers.
Risks associated with operating ocean-going vessels could affect our business and reputation, which could adversely affect our revenues and stock price
The operation of ocean-going vessels carries inherent risks. These risks include the possibility of:
Any of these circumstances or events could increase our costs or lower our revenues. The involvement of our vessels in an environmental disaster may harm our reputation as a safe and reliable vessel owner and operator.
We may not have adequate insurance to compensate us if we lose our vessels or to compensate third parties
We are insured against tort claims and some contractual claims (including claims related to environmental damage and pollution) through memberships in protection and indemnity associations or clubs, or P&I Associations. We also procure hull and machinery insurance and war risk insurance for our fleet. We insure our vessels for third party liability claims subject to and in accordance with the rules of the P&I Associations in which the vessels are entered. We can give no assurance that we will be adequately insured against all risks. We may not be able to obtain adequate insurance coverage for our fleet in the future. The insurers may not pay particular claims. Our insurance policies contain deductibles for which we will be responsible and limitations and exclusions which may increase our costs or lower our revenue.
We cannot assure you that we would be able to renew our insurance policies on the same or commercially reasonable terms, or at all, in the future. For example, more stringent environmental regulations have led in the past to increased costs for, and in the future may result in the lack of availability of, protection and indemnity insurance against risks of environmental damage or pollution. Any uninsured or underinsured loss could harm our business and financial condition. In addition, our insurance may be avoidable by the insurers as a result of certain of our actions, such as our ships failing to maintain certification with applicable maritime self-regulatory organizations. Further, we cannot assure you that our insurance policies will cover all losses that we incur. Any claims covered by insurance would be subject to deductibles, and since it is possible that a large number of claims may be brought, the aggregate amount of these deductibles could be material.
Our vessels may suffer damage and we may face unexpected drydocking costs, which could affect our cash flow and financial condition
If our vessels suffer damage, they may need to be repaired at a drydocking facility. The costs of drydocking repairs are unpredictable and can be substantial. We may have to pay drydocking costs that our insurance does not cover. The loss of earnings while these vessels are being repaired and repositioned, as well as the actual cost of these repairs, would decrease our earnings and cash flow.
The aging of our fleet may result in increased operating costs in the future, which could adversely affect our earnings
In general, the cost of maintaining a vessel in good operating condition increases with the age of the vessel. Our current fleet consists of seven Panamax drybulk carriers, three Handymax drybulk carriers and one Supramax drybulk carrier with an aggregate capacity of approximately 706,358 dwt and a weighted average age of seven years as of December 31, 2007. As our fleet ages, we will incur increased costs. Older vessels are typically less fuel efficient and more costly to maintain than more recently constructed vessels due to improvements in engine technology. Cargo insurance rates increase with the age of a vessel, making older vessels less desirable to charterers. Governmental regulations and safety or other equipment standards related to the age of vessels may also require expenditures for alterations or the addition of new equipment to our vessels and may restrict the type of activities in which our vessels may engage. We cannot assure you that, as our vessels age, market conditions will justify those expenditures or enable us to operate our vessels profitably during the remainder of their useful lives.
Because we generate all of our revenues in U.S. dollars but incur a portion of our expenses in other currencies, exchange rate fluctuations could have an adverse impact on our results of operations
We generate substantially all of our revenues in U.S. dollars but certain of our expenses are incurred in currencies other than the U.S. dollar. This difference could lead to fluctuations in net income due to changes in the value of the U.S. dollar relative to these other currencies, in particular the Euro. Expenses incurred in foreign currencies against which the U.S. dollar falls in value could increase, decreasing our net income and cash flow from operations. For example, during 2007, the value of the U.S. dollar declined by approximately 12% as compared to the Euro.
We may have to pay tax on United States source income, which would reduce our earnings
Under the United States Internal Revenue Code of 1986, or the Code, 50% of the gross shipping income of a vessel owning or chartering corporation, such as ourselves and our subsidiaries, that is attributable to transportation that begins or ends, but that does not both begin and end, in the United States is characterized as United States source shipping income and such income is subject to a 4% United States federal income tax without allowance for deductions, unless that corporation qualifies for exemption from tax under Section 883 of the Code and the Treasury Regulations.
We do not expect that we and each of our subsidiaries will qualify for this statutory tax exemption for the 2007 taxable year, although we anticipate that we will qualify for this exemption beginning with the 2008 taxable year. There are factual circumstances beyond our control that could cause us to be unable to obtain the benefit of this tax exemption in future years and thereby remain subject to United States federal income tax on our United States source income. Due to the factual nature of the issues involved, we can give no assurances on our tax-exempt status or that of any of our subsidiaries.
If we or our subsidiaries are not entitled to this exemption under Section 883 for any taxable year, we or our subsidiaries would be subject for those years to a 4% United States federal income tax on our U.S.-source shipping income under Section 887 of the Code. The imposition of this taxation could have a negative effect on our business and would result in decreased earnings available for distribution to our stockholders.
For the 2007 taxable year, we estimate that our maximum United States federal income tax liability will be $0.17 million under Section 887. Please see the section of this annual report entitled "Taxation" under item 10.E. for a more comprehensive discussion of the United States federal income tax consequences.
United States tax authorities could treat us as a "passive foreign investment company", which could have adverse United States federal income tax consequences to United States holders
A foreign corporation will be treated as a "passive foreign investment company," or PFIC, for United States federal income tax purposes if either (1) at least 75% of its gross income for any taxable year consists of certain types of "passive income" or (2) at least 50% of the average value of the corporation's assets produce or are held for the production of those types of "passive income." For purposes of these tests, "passive income" includes dividends, interest, and gains from the sale or exchange of investment property and rents and royalties other than rents and royalties which are received from unrelated parties in connection with the active conduct of a trade or business. For purposes of these tests, income derived from the performance of services does not constitute "passive income." United States stockholders of a PFIC are subject to a disadvantageous United States federal income tax regime with respect to the income derived by the PFIC, the distributions they receive from the PFIC and the gain, if any, they derive from the sale or other disposition of their shares in the PFIC.
Based on our current and proposed method of operation, we do not believe that we will be a PFIC with respect to any taxable year. In this regard, we intend to treat the gross income we derive or are deemed to derive from our time chartering activities as services income, rather than rental income. Accordingly, we believe that our income from our time chartering activities does not constitute "passive income," and the assets that we own and operate in connection with the production of that income do not constitute passive assets.
There is, however, no direct legal authority under the PFIC rules addressing our proposed method of operation. Accordingly, no assurance can be given that the United States Internal Revenue Service, or IRS, or a court of law will accept our position, and there is a risk that the IRS or a court of law could determine that we are a PFIC. Moreover, no assurance can be given that we would not constitute a PFIC for any future taxable year if there were to be changes in the nature and extent of our operations.
If the IRS were to find that we are or have been a PFIC for any taxable year, our United States stockholders will face adverse United States tax consequences. Under the PFIC rules, unless those stockholders make an election available under the Code (which election could itself have adverse consequences for such stockholders, such stockholders would be liable to pay United States federal income tax at the then prevailing income tax rates on ordinary income plus interest upon excess distributions and upon any gain from the disposition of our common shares, as if the excess distribution or gain had been recognized ratably over the stockholder's holding period of our common shares.
We are a holding company, and we depend on the ability of our subsidiaries to distribute funds to us in order to satisfy our financial obligations and to make dividend payments
We are a holding company and our subsidiaries conduct all of our operations and own all of our operating assets. We have no significant assets other than the equity interests in our subsidiaries. As a result, our ability to make dividend payments depends on our subsidiaries and their ability to distribute funds to us. If we are unable to obtain funds from our subsidiaries, our board of directors may exercise its discretion not to declare or pay dividends. We do not intend to obtain funds from other sources to pay dividends.
As we expand our business, we may need to improve our operating and financial systems and will need to recruit suitable employees and crew for our vessels
Our current operating and financial systems may not be adequate as we expand the size of our fleet and our attempts to improve those systems may be ineffective. In addition, as we expand our fleet, we will need to recruit suitable additional seafarers and shoreside administrative and management personnel. While we have not experienced any difficulty in recruiting to date, we cannot guarantee that we will be able to continue to hire suitable employees as we expand our fleet. If we or our crewing agent encounter business or financial difficulties, we may not be able to adequately staff our vessels. If we are unable to grow our financial and operating systems or to recruit suitable employees as we expand our fleet, our financial performance may be adversely affected and, among other things, the amount of cash available for distribution as dividends to our stockholders may be reduced.
Because our seafaring employees are covered by industry-wide collective bargaining agreements, failure of industry groups to renew those agreements may disrupt our operations and adversely affect our earnings
Our vessel owning subsidiaries employ approximately 500 seafarers. All of the seafarers employed on the vessels in our fleet are covered by industry-wide collective bargaining agreements that set basic standards. We cannot assure you that these agreements will prevent labor interruptions. Any labor interruptions could disrupt our operations and harm our financial performance.
If Allseas is unable to perform under its vessel management agreements with us, our results of operations may be adversely affected
As we expand our fleet, we will rely on Allseas to recruit suitable additional seafarers and to meet other demands imposed on Allseas. We cannot assure you that Allseas will be able to meet these demands as we expand our fleet. If Allseas’ crewing agents encounter business or financial difficulties, they may not be able to adequately staff our vessels. If Allseas is unable to provide the commercial and technical management service for our vessels, our business, results of operations, cash flows and financial position and our ability to pay dividends may be materially adversely affected.
Our operations outside the United States expose us to global risks that may interfere with the operation of our vessels
We operate as an international company and primarily conduct our operations outside the United States. Changing economic, political and governmental conditions in the countries where we are engaged in business or where our vessels are registered affect us. In the past, political conflicts, particularly in the Arabian Gulf, resulted in attacks on vessels, mining of waterways and other efforts to disrupt shipping in the area. Acts of terrorism and piracy have also affected vessels trading in regions such as the South China Sea. Future hostilities or other political instability in regions where our vessels trade could affect our trade patterns, increase the risk of attacks on our vessels and adversely affect our operations and performanc.
It may not be possible for investors to enforce U.S. judgments against us
We and all our subsidiaries are incorporated in jurisdictions outside the United States and substantially all of our assets and those of our subsidiaries are located outside the United States. In addition, all of our directors and officers are non-residents of the United States, and all or a substantial portion of the assets of these non-residents are located outside the United States. As a result, it may be difficult or impossible for United States investors to serve process within the United States upon us, our subsidiaries or our directors and officers or to enforce a judgment against us for civil liabilities in United States courts. In addition, you should not assume that courts in the countries in which we or our subsidiaries are incorporated or where our or the assets of our subsidiaries are located (1) would enforce judgments of United States courts obtained in actions against us or our subsidiaries based upon the civil liability provisions of applicable United States federal and state securities laws or (2) would enforce, in original actions, liabilities against us or our subsidiaries based on those laws.
Risks Relating to Our Common Shares
There is no guarantee that there will continue to be an active and liquid public market for you to resell our common shares in the future
The price of our common shares may be volatile and may fluctuate due to factors such as:
The drybulk shipping industry has been highly unpredictable and volatile. The market for common shares in this industry may be equally volatile.
We are incorporated in the Marshall Islands, which does not have a well-developed body of corporate law
Our corporate affairs are governed by our amended and restated articles of incorporation and bylaws and by the Marshall Islands Business Corporations Act, or the BCA. The provisions of the BCA resemble provisions of the corporation laws of a number of states in the United States. However, there have been few judicial cases in the Marshall Islands interpreting the BCA. The rights and fiduciary responsibilities of directors under the laws of the Marshall Islands are not as clearly established as the rights and fiduciary responsibilities of directors under statutes or judicial precedent in existence in the United States. The rights of stockholders of the Marshall Islands may differ from the rights of stockholders of companies incorporated in the United States. While the BCA provides that it is to be interpreted according to the laws of the State of Delaware and other states with substantially similar legislative provisions, there have been few, if any, court cases interpreting the BCA in the Marshall Islands and we cannot predict whether Marshall Islands courts would reach the same conclusions as United States courts. Thus, you may have more difficulty in protecting your interests in the face of actions by the management, directors or controlling stockholders than would stockholders of a corporation incorporated in a United States jurisdiction which has developed a relatively more substantial body of case law.
Our chairman and chief executive officer and Innovation Holdings, which is beneficially owned by our chairman and chief executive officer and members of his family, collectively hold approximately 19.3% of our total outstanding common shares which enables considerable control over matters on which our shareholders are entitled to vote
Mr. Michael Bordouroglou, our President and chief executive officer, beneficially own 5,203,288 shares, or approximately 19.3% of our outstanding common shares, the vast majority of which is held indirectly through entities over which he exercise sole voting power. Please see Item 7.A. “Major Stockholders.” While Mr. Bordouroglou and the non-voting shareholders of these entities have no agreement, arrangement or understanding relating to the voting of our common shares that they own, they effectively control the outcome of matters on which our shareholder are entitled to vote, including the election of directors and other significant corporate actions. The interests of these shareholders may be different from your interests.
Anti-takeover provisions in our organizational documents could make it difficult for our shareholder to replace or remove our current board of directors or have the effect of discouraging, delaying or preventing a merger or acquisition, which could adversely affect the market price of our common shares
Several provisions of our amended and restated articles of incorporation and bylaws could make it difficult for our shareholders to change the composition of our board of directors in any one year, preventing them from changing the composition of management. In addition, the same provisions may discourage, delay or prevent a merger or acquisition that shareholders may consider favorable.
These provisions include:
In addition, we have adopted a shareholder rights plan pursuant to which our board of directors may cause the substantial dilution of any person that attempts to acquire us without the approval of our board of directors.
These anti-takeover provisions, including provisions of our shareholder rights plan, could substantially impede the ability of public stockholders to benefit from a change in control and, as a result, may adversely affect the market price of our common shares and your ability to realize any potential change of control premium.
Item 4. Information on the Company
A. History and development of the Company
Paragon Shipping Inc. is a Marshall Islands company formed on April 26, 2006. Our executive offices are located at 15 Karamanli Ave, Voula 16673, Athens, Greece. Our telephone number at this address is +30 210 891 4600. Allseas Marine S.A., or Allseas, is responsible for all commercial and technical management functions for our fleet. Allseas is an affiliate of our chairman and chief executive officer, Michael Bodouroglou.
We are a global provider of shipping transportation services. We specialize in transporting drybulk cargoes, including such commodities as iron ore, coal, grain and other materials along worldwide shipping routes. Our current fleet consists of seven Panamax drybulk carriers, three Handymax drybulk carriers and one Supramax drybulk carrier with an aggregate capacity of approximately 706,358 dwt and a weighted average age of seven years as of December 31, 2007. Since inception we grew our fleet to four drybulk carriers by December 31, 2006 and in 2007 we took delivery of the other seven vessels comprising our current fleet of eleven vessels.
We concluded a private placement in November 2006 pursuant to which we issued a total of 9,062,000 Class A common shares, which we also refer to as our “common shares,” and 1,849,531 warrants to purchase Class A common shares to certain institutional investors and issued an additional 2,250,000 Class A common shares and 450,000 warrants to purchase Class A common shares to Innovation Holdings, S.A., or Innovation Holdings, an entity beneficially owned by our chairman and chief executive officer, Mr. Michael Bodouroglou. In addition, we issued 2,003,288 Class B common shares to Innovation Holdings at the time of our private placement in November 2006. On July 16, 2007 a shelf registration statement (file no 333-143481) covering the resale of 11,097,187 of our Class A common shares and 1,849,531 of our warrants was declared effective by the U.S. Securities and Exchange Commission.
On August 15, 2007 we completed our initial public offering of 10,300,000 Class A common shares and on September 13, 2007 issued an 697,539 Class A common shares upon the partial exercise of the over-allotment option granted to the underwriters of our initial public offering. Those offerings generated $175,960,624 in gross proceeds at an offering price of $16.00 per share, before deduction of underwriters’ commissions and expenses of $11,437,440. In addition, certain selling shareholders sold an aggregate of 318,728 Class A common shares in the over-allotment option at the same price per share. Following our initial public offering, all the 2,003,288 Class B common shares were converted into Class A common shares on a one-for-one basis. Our common shares commenced trading on the Nasdaq Global Market under the symbol “PRGN” on August 10, 2007.
As of April 16, 2008 our total outstanding common shares was 26,961,612.
In October and December 2006 we entered into purchase agreements for the initial six Panamax and Handymax drybulk carriers of our fleet, for an aggregate purchase price of $210.35 million, excluding certain pre-delivery expenses. These six vessels were delivered to us in December 2006 and January 2007 and funded with the net proceeds of our private placement and the sale of Class A common shares and warrants to Innovation Holdings, together with drawings under our senior secured credit facility. In July 2007 we entered into agreement to purchase three additional drybulk carriers, one Supramax and two Panamax, for an aggregate purchase price of $180.9 million, excluding certain pre-delivery expenses, which we funded with the net proceeds of our initial public offer in August 2007 and with drawings under the revolving bridge loan facility with Commerzbank AG. These three vessels were delivered to us in August and September, 2007. In October 2007, we entered into purchase agreements for two additional Panamax drybulk carriers for an aggregate purchase price of $178.0 million which we funded with drawings under our existing credit facilities. These two vessels were delivered to us in November and December 2007, respectively.
B. Business overview
As of December 31, 2007, our fleet consisted of seven Panamax drybulk carriers, three Handymax drybulk carriers and one Supramax drybulk carrier.
The following table presents certain information concerning the drybulk carriers in our fleet as of April 16, 2008.
(1) This table shows gross daily charter rates and does not reflect commissions payable by us to third party chartering brokers, our charterers and Allseas ranging from 2.50% to 6.25% including, in each case, 1.25% to Allseas.
(2) The date range provided represents the earliest and latest date on which the charterer may redeliver the vessel to us upon termination of the charter.
(3) The daily charter rate for Sapphire Seas decreases to $26,750 as of June 24, 2008 and decreases to $22,750 as of June 24, 2009.
(4) On March 17, 2008 we agreed with Korea Line Corp. to enter into a new time charter agreement regarding the next employment of Pearl Seas at a gross daily charter rate of $51,300 for a period of 35 to 37 months, and a commission of 5.00%. The time charter will commence within the range August 1, 2008 to October 5, 2008 and will expire within the range July 1, 2011 to November 5, 2011.
Each of our vessels is owned through a separate wholly-owned subsidiary.
Our vessels operate worldwide within the trading limits imposed by our insurance terms and do not operate in areas where United States, European Union or United Nations sanctions have been imposed.
Management of Our Fleet
Allseas is responsible for the technical and commercial management of our vessels. Technical management services include arranging for and managing crews, maintenance, drydocking, repairs, insurance, maintaining regulatory and classification society compliance and providing technical support. Commercial management services include chartering, monitoring the mix of various types of charters, such as time charters and voyage charters, monitoring the performance of our vessels, the sale and purchase of vessels, and finance and accounting functions. Allseas, which is based in Athens, Greece, was formed in 2000 as a ship management company and currently provides the commercial and technical management for sixteen drybulk carriers including the eleven vessels in our fleet. The other five vessels are managed for affiliates of Allseas. We believe that Allseas has established a reputation in the international shipping industry for operating and maintaining a fleet with high standards of performance, reliability and safety. Allseas is 100% owned and controlled by Mr. Michael Bodouroglou, our chairman and chief executive officer.
Pursuant to separate management agreements that we have entered into with Allseas for each of our vessels, the terms of which have been approved by our independent directors, we are obligated to pay Allseas a technical management fee of $650 (based on a U.S. dollar/Euro exchange rate of 1.268:1.00) per vessel per day on a monthly basis in advance, pro rata for the calendar days the vessel is owned by us. The management fee is adjusted quarterly based on the U.S. dollar/Euro exchange rate as published by EFG Eurobank Ergasias S.A. two days prior to the end of the previous calendar quarter. For the first quarter in 2007 the management fee was $675 per day, for the second quarter in 2007 was $683 per day, for the third quarter in 2007 was $687 per day and for the fourth quarter in 2007 was $725 per day. The management fee increased to $764 per day as of January 1, 2008 commensurate with inflation on an annual basis, by reference to the official Greek inflation rate for the previous year, as published by the Greek National Statistical Office. In 2007, an amount of 250,000 was paid to Allseas for legal and accounting services that were provided throughout the year and were not covered by the management agreements mentioned above. We also pay Allseas a fee equal to 1.25% of the gross freight, demurrage and charter hire collected from the employment of our vessels. Allseas also earns a fee equal to 1.0% calculated on the price as stated in the relevant memorandum of agreement for any vessel bought or sold on our behalf, with the exception of the two vessels in our fleet that we acquired from entities affiliated with our chairman and chief executive officer. Additional drybulk carriers that we may acquire in the future may be managed by Allseas or unaffiliated management companies. During 2007, we incurred $2,076,678 in management fees and $841,442 and $4,172,000 in chartering and vessel commissions, respectively. A historical breakdown of the amounts incurred is presented in the following table.
Chartering of the fleet
We primarily employ our vessels on time charters for a medium to long-term period of time. We may also employ our vessels in the spot charter market, on voyage charters or short-term time charters, which generally last from 10 days to three months. A time charter, whether for a longer period or in the spot charter market for a short-term period, is generally a contract to charter a vessel for a fixed period of time at a set daily rate. Under time charter, the charterer pays voyage expenses such as port, canal and fuel costs. A spot market voyage charter is generally a contract to carry a specific cargo from a load port to a discharge port for an agreed upon total amount and we pay voyage expenses such as port, canal and fuel costs. Whether our drybulk carriers are employed in the spot market or on time charters, we pay for vessel operating expenses, which include crew costs, provisions, deck and engine stores, lubricating oil, insurance, maintenance and repairs. We are also responsible for each vessel's intermediate and special survey costs.
Our assessment of a charterer’s financial condition and reliability is an important factor in negotiating employment for our vessels. Our largest customer is Morgan Stanley and our other customers include STX Pan Ocean, AS Klaveness, Express Sea Transport, Korea Line Corp., Bunge S.A., Vesspucci Marine C.V., San Juan Navigation, D’Amato Shipping. For the year ended December 31, 2007, approximately 63% of our revenue was derived from four charterers who individually accounted for more than 10% of our time charter revenue, as follows:
The Drybulk Shipping Industry
The global drybulk carrier fleet may be divided into four categories based on a vessel's carrying capacity. These categories consist of:
The supply of drybulk carriers is dependent on the delivery of new vessels and the removal of vessels from the global fleet, either through scrapping or loss. As of January 2008, the global drybulk carrier orderbook amounted to 129 million dwt, or 48.0% of the existing fleet. The level of scrapping activity is generally a function of scrapping prices in relation to current and prospective charter market conditions, as well as operating, repair and survey costs. The average age at which a vessel is scrapped over the last five years has been 26 years. However, due to recent strength in the drybulk shipping industry, the average age has increased.
The demand for drybulk carrier capacity is determined by the underlying demand for commodities transported in drybulk carriers, which in turn is influenced by trends in the global economy. Seaborne drybulk trade increased by slightly more than 2% annually during the 1980s and 1990s. However, this rate of growth has increased dramatically in recent years. Between 2001 and 2007, trade in all drybulk commodities increased from approximately 2.1 billion tons to 3.0 billion tons, equivalent to a compound average growth rate of 5.2%. Demand for drybulk carrier capacity is also affected by the operating efficiency of the global fleet, with port congestion, which has been a feature of the market since 2004, absorbing tonnage and therefore leading to a tighter balance between supply and demand. In evaluating demand factors for drybulk carrier capacity, it is important to bear in mind that drybulk carriers can be the most versatile element of the global shipping fleets in terms of employment alternatives. Drybulk carriers seldom operate on round trip voyages. Rather, the norm is triangular or multi-leg voyages. Hence, trade distances assume greater importance in the demand equation.
We operate in markets that are highly competitive and based primarily on supply and demand. We compete for charters on the basis of price, vessel location, size, age and condition of the vessel, as well as on our reputation. Allseas arranges our charters through the use of brokers, who negotiate the terms of the charters based on market conditions. We compete primarily with other owners of drybulk carriers, many of which may have more resources than us and may operate vessels that are newer, and therefore more attractive to charterers, than our vessels. Ownership of drybulk carriers is highly fragmented and is divided among publicly listed companies, state controlled owners and independent shipowners. Some of our publicly listed competitors include Diana Shipping Inc. (NYSE: DSX), DryShips Inc. (Nasdaq: DRYS), Excel Maritime Carriers Ltd. (NYSE: EXM), Eagle Bulk Shipping Inc. (Nasdaq: EGLE), Genco Shipping and Trading Limited (NYSE: GNK), Navios Maritime Holdings Inc. (Nasdaq: BULK), OceanFreight Inc. (Nasdaq: OCNF) and Quintana Maritime Limited (Nasdaq: QMAR).
Entities affiliated with our chairman and chief executive officer currently own drybulk carriers, and may in the future seek to acquire additional drybulk carriers. One or more of these vessels may be managed by Allseas and may compete with the vessels in our fleet. Mr. Bodouroglou and entities affiliated with him, including Allseas, might be faced with conflicts of interest with respect to their own interests and their obligations to us. Mr. Bodouroglou has entered into an agreement with us pursuant to which he and the entities which he controls will grant us a right of first refusal on any drybulk carrier that these entities may acquire in the future.
Charter Hire Rates
Charter hire rates fluctuate by varying degrees amongst the drybulk carrier size categories. The volume and pattern of trade in a small number of commodities (major bulks) affect demand for larger vessels. Because demand for larger drybulk vessels is affected by the volume and pattern of trade in a relatively small number of commodities, charter hire rates (and vessel values) of larger ships tend to be more volatile. Conversely, trade in a greater number of commodities (minor bulks) drives demand for smaller drybulk carriers. Accordingly, charter rates and vessel values for those vessels are subject to less volatility. Charter hire rates paid for drybulk carriers are primarily a function of the underlying balance between vessel supply and demand, although at times other factors, such as sentiment may play a role. Furthermore, the pattern seen in charter rates is broadly mirrored across the different charter types and between the different drybulk carrier categories.
In the time charter market, rates vary depending on the length of the charter period and vessel specific factors such as age, speed and fuel consumption. In the voyage charter market, rates are influenced by cargo size, commodity, port dues and canal transit fees, as well as delivery and re-delivery regions. In general, a larger cargo size is quoted at a lower rate per ton than a smaller cargo size. Routes with costly ports or canals generally command higher rates than routes with low port dues and no canals to transit. Voyages with a load port within a region that includes ports where vessels usually discharge cargo or a discharge port within a region that includes ports where vessels load cargo also are generally quoted at lower rates. This is because such voyages generally increase vessel utilization by reducing the unloaded portion (or ballast leg) that is included in the calculation of the return charter to a loading area.
Within the drybulk shipping industry, the charter hire rate references most likely to be monitored are the freight rate indices issued by the Baltic Exchange. These references are based on actual charter hire rates under charter entered into by market participants as well as daily assessments provided to the Baltic Exchange by a panel of major shipbrokers. The Baltic Panamax Index is the index with the longest history.
Vessel prices, both for newbuildings and secondhand vessels, have increased significantly as a result of the strength of the drybulk shipping industry. Because sectors of the shipping industry (drybulk carrier, tanker and container ships) are in a period of prosperity, newbuilding prices for all vessel types have increased significantly due to a reduction in the number of berths available for the construction of new vessels in shipyards.
In the secondhand market, the steep increase in newbuilding prices and the strength of the charter market have also affected vessel prices. With vessel earnings at relatively high levels and a limited availability of newbuilding berths, the ability to deliver a vessel early has resulted in a premium to the purchase price. Consequently, secondhand prices of five year old Panamax and Capesize drybulk carriers have reached higher levels than those of comparably sized newbuildings.
Permits and Authorizations
We are required by various governmental and quasi-governmental agencies to obtain certain permits, licenses and certificates with respect to our vessels. The kinds of permits, licenses and certificates required depend upon several factors, including the commodity transported, the waters in which the vessel operates, the nationality of the vessel's crew and the age of a vessel. We have been able to obtain all permits, licenses and certificates currently required to permit our vessels to operate. Additional laws and regulations, environmental or otherwise, may be adopted which could limit our ability to do business or increase the cost of us doing business.
Environmental and Other Regulations
Government regulation significantly affects the ownership and operation of our vessels. We are subject to international conventions, national, state and local laws and regulations in force in the countries in which our vessels may operate or are registered.
A variety of government and private entities subject our vessels to both scheduled and unscheduled inspections. These entities include the local port authorities (United States Coast Guard, harbor master or equivalent), classification societies; flag state administrations (country of registry) and charterers, particularly terminal operators. Certain of these entities require us to obtain permits, licenses and certificates for the operation of our vessels. Failure to maintain necessary permits or approvals could require us to incur substantial costs or temporarily suspend the operation of one or more of our vessels.
We believe that the heightened level of environmental and quality concerns among insurance underwriters, regulators and charterers is leading to greater inspection and safety requirements on all vessels and may accelerate the scrapping of older vessels throughout the drybulk shipping industry. Increasing environmental concerns have created a demand for vessels that conform to the stricter environmental standards. We are required to maintain operating standards for all of our vessels that emphasize operational safety, quality maintenance, continuous training of our officers and crews and compliance with United States and international regulations. We believe that the operation of our vessels is in substantial compliance with applicable environmental laws and regulations applicable to us as of the date of this annual report.
International Maritime Organization
The United Nation's International Maritime Organization, or IMO, has negotiated international conventions that impose liability for oil pollution in international waters and a signatory's territorial waters. In September 1997, the IMO adopted Annex VI to the International Convention for the Prevention of Pollution from Ships to address air pollution from ships. Annex VI was ratified in May 2004, and became effective in May 2005. Annex VI set limits on sulfur oxide and nitrogen oxide emissions from ship exhausts and prohibits deliberate emissions of ozone depleting substances, such as chlorofluorocarbons. Annex VI also includes a global cap on the sulfur content of fuel oil and allows for special areas to be established with more stringent controls on sulfur emissions. Our fleet has conformed to the Annex VI regulations.
The operation of our vessels is also affected by the requirements set forth in the IMO's Management Code for the Safe Operation of Ships and Pollution Prevention, or ISM Code. The ISM Code requires ship owners and bareboat charterers to develop and maintain an extensive “Safety Management System” that includes the adoption of a safety and environmental protection policy setting forth instructions and procedures for safe operation and describing procedures for dealing with emergencies. The failure of a ship owner or bareboat charterer to comply with the ISM Code may subject such party to increased liability, may decrease available insurance coverage for the affected vessels and may result in a denial of access to, or detention in, certain ports. As of December 31, 2006 and 2007, each of our vessels was ISM code-certified.
The United States Oil Pollution Act of 1990
The United States Oil Pollution Act of 1990, or OPA, established an extensive regulatory and liability regime for the protection and cleanup of the environment from oil spills. OPA affects all owners and operators whose vessels trade in the United States, its territories and possessions or whose vessels operate in United States waters, which includes the United States' territorial sea and its two hundred nautical mile exclusive economic zone.
Under OPA, vessel owners, operators and bareboat charterers are “responsible parties” and are jointly, severally and strictly liable (unless the spill results solely from the act or omission of a third party, an act of God or an act of war) for all containment and clean-up costs and other damages arising from discharges or threatened discharges of oil from their vessels. OPA defines these other damages broadly to include:
Under amendments to OPA that became effective on July 11, 2006, the liability of responsible parties is limited to the greater of $950 per gross ton or $0.8 million per non-tank vessel that is over 300 gross tons (subject to possible adjustment for inflation). These limits of liability do not apply if an incident was directly caused by violation of applicable United States federal safety, construction or operating regulations or by a responsible party's gross negligence or willful misconduct, or if the responsible party fails or refuses to report the incident or to cooperate and assist in connection with oil removal activities.
We currently maintain pollution liability coverage insurance in the amount of $1 billion per incident for each of our vessels. If the damages from a catastrophic spill were to exceed our insurance coverage it could have an adverse effect on our business and results of operation.
OPA requires owners and operators of vessels to establish and maintain with the United States Coast Guard evidence of financial responsibility sufficient to meet their potential liabilities under the OPA. Current United States Coast Guard regulations require evidence of financial responsibility in the amount of $900 per gross ton for non-tank vessels, which includes the OPA limitation on liability of $600 per gross ton and the United States Comprehensive Environmental Response, Compensation, and Liability Act, or CERCLA, liability limit of $300 per gross ton. We expect the United States Coast Guard to increase the amounts of financial responsibility to reflect the July 2006 increases in liability. Under the regulations, vessel owners and operators may evidence their financial responsibility by showing proof of insurance, surety bond, self-insurance or guaranty. Under OPA, an owner or operator of a fleet of vessels is required only to demonstrate evidence of financial responsibility in an amount sufficient to cover the vessels in the fleet having the greatest maximum liability under OPA.
The United States Coast Guard's regulations concerning certificates of financial responsibility provide, in accordance with OPA, that claimants may bring suit directly against an insurer or guarantor that furnishes certificates of financial responsibility. In the event that such insurer or guarantor is sued directly, it is prohibited from asserting any contractual defense that it may have had against the responsible party and is limited to asserting those defenses available to the responsible party and the defense that the incident was caused by the willful misconduct of the responsible party. Certain organizations, which had typically provided certificates of financial responsibility under pre-OPA laws, including the major protection and indemnity organizations, have declined to furnish evidence of insurance for vessel owners and operators if they are subject to direct actions or are required to waive insurance policy defenses.
The United States Coast Guard's financial responsibility regulations may also be satisfied by evidence of surety bond, guaranty or by self-insurance. Under the self-insurance provisions, the ship owner or operator must have a net worth and working capital, measured in assets located in the United States against liabilities located anywhere in the world, that exceeds the applicable amount of financial responsibility. We have complied with the United States Coast Guard regulations by providing a certificate of responsibility from third party entities that are acceptable to the United States Coast Guard evidencing sufficient self-insurance.
OPA specifically permits individual states to impose their own liability regimes with regard to oil pollution incidents occurring within their boundaries, and some states have enacted legislation providing for unlimited liability for oil spills. In some cases, states, which have enacted such legislation, have not yet issued implementing regulations defining vessels owners' responsibilities under these laws. We intend to comply with all applicable state regulations in the ports where our vessels call.
Other Environmental Initiatives
Although the United States is not a party thereto, many countries have ratified and currently follow the liability plan adopted by the IMO and set out in the International Convention on Civil Liability for Oil Pollution Damage of 1969, or the 1969 Convention. Under this convention, and depending on whether the country in which the damage results is a party to the 1992 Protocol to the International Convention on Civil Liability for Oil Pollution Damage, a vessel’s registered owner is strictly liable for pollution damage caused in the territorial waters of a contracting state by discharge of persistent oil, subject to certain complete defenses. The limits on liability outlined in the 1992 Protocol use the International Monetary Fund currency unit of Special Drawing Rights, or SDR. Under an amendment that became effective in November 2003 for vessels of 5,000 to 140,000 gross tons (a unit of measurement for the total enclosed spaces within a vessel), liability is limited to approximately 4.51 million SDR plus approximately 631 SDR for each additional gross ton over 5,000. For vessels of over 140,000 gross tons, liability is limited to approximately 89.77 million SDR. The exchange rate between SDRs and dollars was 0.608088 SDR per dollar on March 31, 2008. As the 1969 Convention calculates liability in terms of basket currencies, these figures are based on currency exchange rates on March 31, 2008. Under the 1969 Convention, the right to limit liability is forfeited where the spill is caused by the owner’s actual fault; under the 1992 Protocol, a shipowner cannot limit liability where the spill is caused by the owner’s intentional or reckless conduct. Vessels trading in jurisdictions that are parties to these conventions must provide evidence of insurance covering the liability of the owner. In jurisdictions where the 1969 Convention has not been adopted, including the United States, various legislative schemes or common law govern, and liability is imposed either on the basis of fault or in a manner similar to that convention. We believe that our protection and indemnity insurance will cover the liability under the plan adopted by the IMO.
Vessel Security Regulations
A variety of initiatives intended to enhance vessel security have been adopted since the terrorist attached on the United States of September 11, 2001. On November 25, 2002, the Maritime Transportation Security Act of 2002, or the MTSA, came into effect. To implement certain portions of the MTSA, in July 2003, the United States Coast Guard issued regulations requiring the implementation of certain security requirements aboard vessels operating in waters subject to the jurisdiction of the United States. Similarly, in December 2002, amendments to the International Convention for the Safety of Life at Sea, or SOLAS, created a new chapter of the convention dealing specifically with maritime security. The new chapter came into effect in July 2004 and imposes various detailed security obligations on vessels and port authorities, most of which are contained in the newly created International Ship and Port Facilities Security Code or ISPS Code. Among the various requirements are:
The United States Coast Guard regulations, intended to align with international maritime security standards, exempt non-United States vessels from MTSA vessel security measures provided such vessels have on board a valid International Ship Security Certificate, or ISSC, that attests to the vessel's compliance with SOLAS security requirements and the ISPS Code. We have implemented the various security measures addressed by the MTSA, SOLAS and the ISPS Code.
Inspection by Classification Societies
Every seagoing vessel must be “classed” by a classification society. The classification society certifies that the vessel is “in class,” signifying that the vessel has been built and maintained in accordance with the rules of the classification society and complies with applicable rules and regulations of the vessel's country of registry and the international conventions of which that country is a member. In addition, where surveys are required by international conventions and corresponding laws and ordinances of a flag state, the classification society will undertake them on application or by official order, acting on behalf of the authorities concerned.
The classification society also undertakes on request other surveys and checks that are required by regulations and requirements of the flag state. These surveys are subject to agreements made in each individual case or to the regulations of the country concerned.
For maintenance of the class, regular and extraordinary surveys of hull, machinery, including the electrical plant, and any special equipment classed are required to be performed as follows:
Annual Surveys. For seagoing ships, annual surveys are conducted for the hull and the machinery, including the electrical plant and where applicable for special equipment classed, at intervals of 12 months from the date of commencement of the class period indicated in the certificate.
Intermediate Surveys. Extended annual surveys are referred to as intermediate surveys and typically are conducted two and one-half years after commissioning and each class renewal. Intermediate surveys may be carried out on the occasion of the second or third annual survey.
Class Renewal Surveys. Class renewal surveys, also known as special surveys, are carried out for the ship's hull, machinery, including the electrical plant and for any special equipment classed, at the intervals indicated by the character of classification for the hull. At the special survey the vessel is thoroughly examined, including audio-gauging to determine the thickness of the steel structures. Should the thickness be found to be less than class requirements, the classification society would prescribe steel renewals. The classification society may grant a one year grace period for completion of the special survey. Substantial amounts of money may have to be spent for steel renewals to pass a special survey if the vessel experiences excessive wear and tear. In lieu of the special survey every four or five years, depending on whether a grace period was granted, a ship owner has the option of arranging with the classification society for the vessel's hull or machinery to be on a continuous survey cycle, in which every part of the vessel would be surveyed within a five year cycle. At an owner's application, the surveys required for class renewal may be split according to an agreed schedule to extend over the entire period of class. This process is referred to as continuous class renewal.
All areas subject to survey as defined by the classification society are required to be surveyed at least once per class period, unless shorter intervals between surveys are prescribed elsewhere. The period between two subsequent surveys of each area must not exceed five years.
Most vessels are also drydocked every 30 to 36 months for inspection of the underwater parts and for repairs related to inspections. If any defects are found, the classification surveyor will issue a “recommendation” which must be rectified by the ship owner within prescribed time limits.
Most insurance underwriters make it a condition for insurance coverage that a vessel be certified as “in class” by a classification society which is a member of the International Association of Classification Societies. All our vessels are certified as being “in class” by Lloyd's Register of Shipping. All new and secondhand vessels that we purchase must be certified prior to their delivery under our standard purchase contracts and memorandum of agreement. If the vessel is not certified on the date of closing, we have no obligation to take delivery of the vessel.
Risk of Loss and Liability Insurance
The operation of any drybulk vessel includes risks such as mechanical failure, collision, property loss, cargo loss or damage and business interruption due to political circumstances in foreign countries, hostilities and labor strikes. In addition, there is always an inherent possibility of marine disaster, including oil spills and other environmental mishaps, and the liabilities arising from owning and operating vessels in international trade. OPA, which imposes virtually unlimited liability upon owners, operators and demise charterers of vessels trading in the United States exclusive economic zone for certain oil pollution accidents in the United States, has made liability insurance more expensive for ship owners and operators trading in the United States market.
While we maintain hull and machinery insurance, war risks insurance, protection and indemnity cover, increased value insurance and freight, demurrage and defense cover for our operating fleet in amounts that we believe to be prudent to cover normal risks in our operations, we may not be able to achieve or maintain this level of coverage throughout a vessel's useful life. Furthermore, while we believe that our present insurance coverage is adequate, not all risks can be insured, and there can be no guarantee that any specific claim will be paid, or that we will always be able to obtain adequate insurance coverage at reasonable rates.
Hull & Machinery and War Risks Insurance
We maintain marine hull and machinery and war risks insurance, which covers the risk of actual or constructive total loss, for all of our vessels. Our vessels are covered up to at least fair market value with deductibles of between $75,000 and $100,000 per vessel per incident. We also maintain increased value coverage for each of our vessels. Under this increased value coverage, in the event of total loss of a vessel, we will be entitled to recover amounts not recoverable under the hull and machinery policy that we have entered into due to under-insurance.
Protection and Indemnity Insurance
Protection and indemnity insurance is provided by mutual protection and indemnity associations, or P&I Associations, which insure our third party liabilities in connection with our shipping activities. This includes third-party liability and other related expenses resulting from the injury or death of crew, passengers and other third parties, the loss or damage to cargo, claims arising from collisions with other vessels, damage to other third-party property, pollution arising from oil or other substances and salvage, towing and other related costs, including wreck removal. Protection and indemnity insurance is a form of mutual indemnity insurance, extended by protection and indemnity mutual associations, or “clubs.” Subject to the “capping” discussed below, our coverage, except for pollution, is unlimited.
Our current protection and indemnity insurance coverage for pollution is $1 billion per vessel per incident. The fourteen P&I Associations that comprise the International Group insure approximately 90% of the world's commercial tonnage and have entered into a pooling agreement to reinsure each association's liabilities. As a member of a P&I Association, which is a member of the International Group, we are subject to calls payable to the associations based on the group's claim records as well as the claim records of all other members of the individual associations and members of the pool of P&I Associations comprising the International Group.
C. Organizational structure
Paragon Shipping Inc. is the sole owner of all of the issued and outstanding shares of the subsidiaries listed on Exhibit 8.1 to our annual report on Form 20-F for the fiscal year ended December 31, 2007.
D. Property, plants and equipment
We do not own any real property. We lease office space in Athens, Greece from Granitis Glyfada Real Estate Ltd, a company beneficiary owned by our chief executive officer.
Item 4A. Unresolved Staff Comments
Item 5. Operating and Financial Review and Prospects
The following management's discussion and analysis should be read in conjunction with our historical consolidated financial statements and their notes included elsewhere in this report. This discussion contains forward-looking statements that reflect our current views with respect to future events and financial performance. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, such as those set forth in the section entitled “Risk Factors” and elsewhere in this annual report.
A. Operating results
We are Paragon Shipping Inc., a company incorporated in the Republic of the Marshall Islands in April 2006 to provide drybulk shipping services worldwide. We are a provider of international seaborne transportation services, carrying various drybulk cargoes including iron ore, coal, grain, bauxite, phosphate and fertilizers. We commenced operations in December 2006 and completed our initial public offering in August 2007. Our current fleet consists of seven Panamax drybulk carriers, one Supramax drybulk carrier and three Handymax drybulk carriers.
Allseas is responsible for all commercial and technical management functions for our fleet. Allseas is an affiliate of our chairman and chief executive officer, Michael Bodouroglou.
We primarily employ our vessels on period charters. We may also employ our vessels in the spot charter market, on voyage charters or trip time charters, which generally last from 10 days to three months. A spot market voyage charter is generally a contract to carry a specific cargo from a load port to a discharge port for an agreed upon total amount. Under spot market voyage charters, we pay voyage expenses such as port, canal and fuel costs. A spot market trip time charter and a period time charter are generally contracts to charter a vessel for a fixed period of time at a set daily rate. Under trip time charters and period time charters, the charterer pays voyage expenses such as port, canal and fuel costs. Whether our drybulk carriers are employed in the spot market or on time charters, we pay for vessel operating expenses, which include crew costs, provisions, deck and engine stores, lubricating oil, insurance, maintenance and repairs. We are also responsible for each vessel's intermediate and special survey costs.
RESULTS OF OPERATIONS
Our revenues consist of earnings under the charters that we employ our vessels on. We believe that the important measures for analyzing trends in the results of our operations consist of the following:
LACK OF HISTORICAL OPERATING DATA FOR VESSELS BEFORE THEIR ACQUISITION
Consistent with shipping industry practice, other than inspection of the physical condition of the vessels and examinations of classification society records, neither we nor our affiliated entities conduct any historical financial due diligence process when we acquire vessels. Accordingly, neither we nor our affiliated entities have obtained the historical operating data for the vessels from the sellers because that information is not material to our decision to make acquisitions, nor do we believe it would be helpful to potential investors in assessing our business or profitability. Most vessels are sold under a standardized agreement, which, among other things, provides the buyer with the right to inspect the vessel and the vessel's classification society records. The standard agreement does not give the buyer the right to inspect, or receive copies of, the historical operating data of the vessel. Prior to the delivery of a purchased vessel, the seller typically removes from the vessel all records, including past financial records and accounts related to the vessel. In addition, the technical management agreement between the seller's technical manager and the seller is automatically terminated and the vessel's trading certificates are revoked by its flag state following a change in ownership.
Consistent with shipping industry practice, we treat the acquisition of vessels, (whether acquired with or without charter) from unaffiliated parties as the acquisition of an asset rather than a business. We intend to acquire vessels free of charter, although the three drybulk vessels we acquired during the third quarter in 2007 and the two drybulk vessels we acquired in the fourth quarter in 2007, had time charters attached, and we may, in the future, acquire additional vessels with time charters attached. Where a vessel has been under a voyage charter, the vessel is delivered to the buyer free of charter, and it is rare in the shipping industry for the last charterer of the vessel in the hands of the seller to continue as the first charterer of the vessel in the hands of the buyer. In most cases, when a vessel is under time charter and the buyer wishes to assume that charter, the vessel cannot be acquired without the charterer's consent and the buyer entering into a separate direct agreement with the charterer to assume the charter, as we have done in connection with the five vessels we acquired in the third and the fourth quarter in 2007. The purchase of a vessel itself does not generally transfer the charter, because it is a separate service agreement between the vessel owner and the charterer.
When we purchase a vessel and assume or renegotiate a related time charter, we must take the following steps before the vessel will be ready to commence operations:
The following discussion is intended to help you understand how acquisitions of vessels affect our business and results of operations:
Our business is comprised of the following main elements:
The employment and operation of our vessels requires the following main components:
The management of financial, general and administrative elements involved in the conduct of our business and ownership of our vessels requires the following main components:
The principal factors that affect our profitability, cash flows and shareholders' return on investment include:
TIME CHARTER REVENUES
Time charter revenues are driven primarily by the number of vessels that we have in our fleet, the number of voyage days during which our vessels generate revenues and the amount of daily charter hire that our vessels earn under charters, which, in turn, are affected by a number of factors, including our decisions relating to vessel acquisitions and disposals, the amount of time that we spend positioning our vessels, the amount of time that our vessels spend in drydock undergoing repairs, maintenance and upgrade work, the age, condition and specifications of our vessels, levels of supply and demand in the drybulk carrier market and other factors affecting spot market charter rates for our vessels.
Vessels operating on period time charters provide more predictable cash flows, but can yield lower profit margins than vessels operating in the spot charter market during periods characterized by favorable market conditions. Vessels operating in the spot charter market generate revenues that are less predictable but may enable us to capture increased profit margins during periods of improvements in charter rates although we are exposed to the risk of declining charter rates, which may have a materially adverse impact on our financial performance. If we employ vessels on period time charters, future spot market rates may be higher or lower than the rates at which we have employed our vessels on period time charters.
TIME CHARTER EQUIVALENT (TCE)
A standard maritime industry performance measure used to evaluate performance is the daily time charter equivalent, or daily TCE. Daily TCE revenues are voyage revenues minus voyage expenses divided by the number of voyage days during the relevant time period. Voyage expenses primarily consist of port, canal and fuel costs that are unique to a particular voyage, which would otherwise be paid by a charterer under a time charter, as well as commissions. We believe that the daily TCE neutralizes the variability created by unique costs associated with particular voyages or the employment of vessels on time charter or on the spot market and presents a more accurate representation of the revenues generated by our vessels.
The average daily TCE rate of our fleet of vessels acquired and delivered as of December 31, 2007 was $28,563 for the year ended December 31, 2007. The average daily TCE rate for the fleet of four vessels acquired and delivered as of December 31, 2006 was $25,460 for the period from inception (April 26, 2006) to December 31, 2006. The increase in the average daily TCE rate of our fleet reflects the higher time charter rates prevailing in the market during 2007 compared to 2006. Furthermore, it reflects the change in the composition of our fleet of vessels in 2007 which comprised of seven Panamax drybulk carriers, three Handymax drybulk carriers and one Supramax drybulk carrier operating in aggregate for 2,622 calendar days, from three Panamax drybulk carriers and one Handymax drybulk carrier operating in aggregate for 185 calendar days in 2006.
OUT OF MARKET ACQUIRED TIME CHARTERS
When vessels are acquired with time charters attached and the charter rate on such charters is above or below market, we include the fair value of the above or below market charter in the cost of the vessel on a relative fair value basis and records a corresponding asset or liability for the above or below market charter. The fair value is computed as the present value of the difference between the contractual amount to be received over the term of the time charter and the management's estimate of the then current market charter rate for equivalent vessels at the time of acquisition. The asset or liability record is amortized over the remaining period of the time charter as a reduction or addition to time charter revenue.
Accordingly, the relative fair value of time charters acquired and recorded in “Below market acquired time charters” in the consolidated balance sheet before accumulated amortization, was $165,000 for the period from inception (April 26, 2006) to December 31, 2006, in respect of the Kind Seas and 59,377,344 for the year ended December 31, 2007, in respect of the Crystal Seas, Sapphire Seas, Pearl Seas, Diamond Sea, Coral Seas and Golden Seas. The amount recorded in below market acquired time charters is amortized over the remaining period of the time charter as an increase to time charter revenue. Amortization of below market acquired time charters was $41,250 and $8,423,492 for the period from inception (April 26, 2006) to December 31, 2006 and for the year ended December 31, 2007, respectively. Two of the vessels’ time charters expired and the relevant amount was fully amortized during 2007.
VESSEL OPERATING EXPENSES
Our vessel operating expenses include crew wages and related costs, the cost of insurance, expenses relating to repairs and maintenance, the costs of spares and consumable stores, tonnage taxes, other miscellaneous expenses and dry-docking expenses. We elected to change our method of accounting for dry-docking costs in 2007, from the deferral method to direct expense method and we applied the direct expense method in our first dry-docking that occurred in the fourth quarter in 2007. We decided to change our method of accounting as we believe that the direct expense method eliminates the significant amount of time and subjectivity that is needed to determine which costs and activities related to dry-docking should be deferred. For the year ended December 31, 2007 the effect in net income by applying the direct expense method was the cost of the dry-docking of $1.18 million or $0.07 per share, basic and diluted. We anticipate that our vessel operating expenses, which generally represent fixed costs, will increase as a result of the enlargement of our fleet. Other factors beyond our control, some of which may affect the shipping industry in general, including, for instance, developments relating to market prices for insurance and difficulty in obtaining crew, may also cause these expenses to increase.
DEPRECIATION AND AMORTIZATION
We depreciate our vessels on a straight-line basis over their estimated useful lives determined to be 25 years from the date of their initial delivery from the shipyard. Depreciation is based on cost less estimated residual value.
We pay Allseas management fee that is adjusted according to the management agreements based on the Euro/U.S. dollar exchange rate as published by EFG Eurobank Ergasias S.A. two days prior to the end on the previous calendar quarter. For the year ended December 31, 2007 an additional amount of $250,000 was paid to Allseas for legal, accounting and finance services that were provided throughout the year and were not covered under the management agreements mentioned above.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses include share based compensation that had a major impact in general and administrative expenses both in 2006 and 2007. In addition, general and administrative expenses include the cost of remuneration to directors and officers, a bonus award for executive officers, other professional services, fares and traveling expenses, directors and officers insurance and other expenses for our operations.
INTEREST AND FINANCE COSTS
We have incurred interest expense and financing costs in connection with vessel-specific debt of our subsidiaries. We used a portion of the proceeds of our initial public offering in August 2007 to repay part of our then-outstanding debt. We have incurred financing costs and we also expect to incur interest expenses under our credit facilities in connection with debt incurred to finance future acquisitions.
PERIOD FROM INCEPTION (APRIL 26, 2006) THROUGH DECEMBER 31, 2006 AND FOR THE YEAR ENDED DECEMBER 31, 2007
As of December 31, 2006 we had four vessels operating in our fleet namely: “Deep Seas”, “Blue Seas”, “Calm Seas” and “Kind Seas”, each of which was delivered to us in 2006. In January 2007, we took delivery of two additional vessels, the “Clear Seas” and “Crystal Seas”. In August and September 2007 we took delivery of three additional vessels, the “Sapphire Seas”, “Pearl Seas,” and the “Diamond Seas” and in November and December 2007 we took delivery of two additional vessels, the “Coral Seas” and the “Golden Seas”. The analysis that follows is a result of the delivery of these eleven vessels. The average number of vessels in our fleet was 7.18 in the year ended December 31, 2007 compared to 0.74 in the period from inception (April 26, 2006) through December 31, 2006.
CONVERSION OF CLASS B COMMON SHARES; OPTION VESTING
During the year ended December 31, 2007, we recognized non-cash compensation expense of $18.3 million in connection with the conversion of the 2,003,288 Class B common shares that were issued to Innovation Holdings at the time of our private placement in the fourth quarter of 2006, into Class A common shares on a one-for-one basis upon completion of our initial public offering in August 2007. The terms for the conversion of Class B common shares into Class A common shares stated that they were automatically converted on a one-for-one basis upon the completion of a public offering raising at least $50.0 million in gross proceeds or at the occurrence of a change in control (as defined in the Amended and Restated Articles of Incorporation). The conversion feature of the Class B common shares represent share-based compensation expense to Mr. Bodouroglou for his services as an employee of the Company in ensuring timely registration of the Class A common shares issued through the private placement and the successful completion of a public offering raising at least $50 million in gross proceeds. In this regard, there were two share-based payments awards—one attributable to the 1,738,588 outstanding Class B common shares on November 21, 2006 (date of the private placement) after adjustment for the 15% provision, and the second one on December 18, 2006 for the issuance of the 246,700 Class B common shares.
In determining the compensation expense attributable to the conversion feature, we utilized the fair value of our Class B common shares based on the fact that substantially all of the value of our Class B common shares was inherent in the conversion feature. Without the conversion feature, the Class B common shareholders would not be entitled to voting rights nor to receive dividends. We valued the Class B common shares using the fair value of our Class A common shares of $9.11 per share and determined the fair value of our Class A common shares by deducting the fair value of 1¤5 of one warrant of $.89 from the $10 price per unit in the private placement. In estimating the value of the Class B common shares, we did not consider the probability of occurrence of the successful completion of a public offering raising $50 million in gross proceeds in accordance with paragraph 48 of SFAS No. 123(R). Accordingly, we measured the maximum compensation expense that was finally recorded to be $18.3 million ($9.11 ´ 2,003,288 shares).
We recognized additional compensation expense in connection with the vesting of options to acquire 250,000 Class A common shares held by our chief executive officer upon completion of our initial public offering in August 2007. See note 13 to our consolidated financial statements included in this annual report.
Our principal sources of funds are our operating cash flows, borrowings under our credit facilities and equity provided by our shareholders. Our principal uses of funds are capital expenditures to grow our fleet, maintenance costs to ensure the quality of our drybulk carriers, comply with international shipping standards and environmental laws and regulations, fund working capital requirements, make principal repayments on loan facilities, and pay dividends to our shareholders. If we do not acquire any additional vessels beyond our current fleet, we believe that our forecasted operating cash flows will be sufficient to meet our liquidity needs for the next two to three years assuming the charter market does not deteriorate to the low rate environment that prevailed subsequent to the Asian financial crisis in 1999. If we do acquire additional vessels, we will rely on borrowings under our existing senior secured credit facilities, proceeds from future equity offerings and revenues from operations to meet our liquidity needs going forward.
Our business is capital intensive and its future success will depend on our ability to maintain a high-quality fleet through the acquisition of newer drybulk vessels and the selective sale of older drybulk vessels. These acquisitions will be principally subject to management's expectation of future market conditions as well as our ability to acquire drybulk carriers on favorable terms. For a full description of our credit facilities please refer to the discussion under the heading “LOAN FACILITIES” below.
Our dividend policy will also impact our future liquidity position. See ‘‘Item 8. Financial Information — Dividend Policy.’’
We have limited our exposure to interest rate fluctuations that will impact our future liquidity position through the swap agreements as stated in “Item 11. Quantitative and Qualitative Disclosures about Market Risk”. For a full description of our swap agreements please refer to the discussion under the heading “INTEREST RATE SWAP” below.
The warrants to purchase our common shares detached from our common shares on July 16, 2007 upon the effectiveness of a shelf registration statement covering 11,097,187 common shares and 1,849,531 warrants. We have not listed the warrants to purchase our common shares for trading on the Nasdaq Global Market. The warrants, as amended on May 7, 2007, may be exercised for payment at an exercise price of $10.00 per common share, however, there is no obligation on the holder of a warrant to do so.
HSH Nordbank Senior Secured Credit Facility (the "Facility"):> On December 18, 2006 we entered into a loan agreement with HSH Nordbank that, subject to certain conditions, provided us with an amount of up to $95.3 million. On January 9, 2007 the loan agreement was supplemented to include the partial financing of Crystal Seas and an increase in the amount available under the facility of up to $109.5 million. At dates coinciding with the delivery of the vessels and pursuant to this facility, we borrowed $77.44 million and $108.3 million at December 31, 2006 and in January 2007, respectively, to fund a portion of the acquisition of the first six vessels. The total loan principal amount at December 31, 2006 and up to July 25, 2007 of $77.4 million and $108.3 million respectively, was due in June 21, 2010 in one single payment.
On July 25, 2007, we repaid in full the outstanding amount of $108.3 million under the term HSH Nordbank senior secured credit facility, by drawing the same amount under a Commerzbank AG revolving bridge loan facility The purpose of the loan was to finance the acquisition costs of the vessels Sapphire Seas, Pearl Seas and Diamond Seas and to refinance the term $108.3 million HSH Nordbank senior secured credit facility. The Commerzbank AG revolving bridge loan facility was later replaced by the Commerzbank AG Senior Secured Revolving Credit Facility described below.
Commerzbank AG Senior Secured Revolving Credit Facility:> On November 29, 2007 we signed a loan agreement for $250.0 million. Until Commerzbank AG transfers $50.0 million of its commitments to other banks or financial institutions, the maximum principal amount which shall be available to us is limited to $200.0 million. Under the terms of the loan agreement, we are required to make periodic interest payments and to repay any principal amount drawn under the credit facility on the final maturity date which will be no later than December 31, 2010. Borrowings under the senior secured revolving credit facility bear interest at an annual interest rate of LIBOR plus a margin of 1.10% if the leverage ratio (defined as the ratio of our total outstanding liabilities by the total assets, adjusted for the difference between the fair market value and book value of the vessels securing the facility and for any lease transaction relating to the vessels) is greater than 55%, and 0.95% if the leverage ratio is equal to or less than 55%.
The senior secured revolving credit facility is secured by a first priority mortgage on five vessels, a first assignment of all freights, earnings, insurances, and cross default with all ship-owning companies owned by us. The purpose of the senior secured revolving credit facility was to refinance five mortgaged vessels and in part-finance up to 50% of the lower of the fair market value and the purchase price of future drybulk carrier acquisitions. The senior secured revolving credit facility contains several financial and other covenants and includes events of default, including those relating to a failure to pay principal or interest, a breach of covenant, representation and warranty, a cross-default to other indebtedness and non-compliance with security documents. Furthermore, the senior secured revolving credit facility prohibits us from paying dividends if we are in default on the facility and if, after giving effect to the payment of the dividend, we are in breach of a covenant. We were in breach of the indebtedness to EBITDA ratio covenant as of December 31, 2007. This breach was subsequently waived by the lender. We believe we will comply with the covenant within the first quarter 2008. The amount available to be drawn down under this senior secured revolving credit facility at December 31, 2007 was $61.0 million. Any undrawn amounts under the facility are subject to 0.25% annual commitment fee.
Bayerische Hypo-und Vereinsbank AG Secured Credit Facility:> On November 19, 2007 we entered into a secured credit facility with Bayerische Hypo-und Vereinsbank AG that, subject to certain provisions, provided us with an amount of up to $100.0 million to be used in financing up to 50% of the lower of the aggregate market value and the purchase price of three vessels and of future drybulk carrier acquisitions. Under the terms of the loan agreement, we are required to make periodic interest payments and to repay any principal amount drawn under the credit facility on the final maturity date which will be no later than December 31, 2010. Borrowings under the secured credit facility bear interest at an annual interest rate of LIBOR plus a margin of 1.40% if the leverage ratio (defined as the ratio of our total outstanding liabilities by the total assets, adjusted for the difference between the fair market value and book value of the vessels securing the facility and for any lease transaction relating to the vessels) is greater than 55%, and 1.20% if the leverage ratio is equal to or less than 55%.
The facility is secured by a first priority mortgage on three vessels, a first assignment of all freights, earnings, insurances, and cross default with all ship-owning companies owned by us. The secured credit facility contains financial and other covenants and includes customary events of default, including those relating to a failure to pay principal or interest, a breach of covenant, representation and warranty, a cross-default to other indebtedness and non-compliance with security documents and prohibits us from paying dividends if we are in default on the facility and if, after giving effect to the payment of the dividend, we are in breach of a covenant. We were in breach of the indebtedness to EBITDA ratio covenant as of December 31, 2007. This breach was subsequently waived by the lender. We believe we will comply with the covenant within the first quarter 2008. The amount available to be drawn down under this secured credit facility at December 31, 2007 was $10.0 million. Any undrawn portion of the facility amount is subject to 0.375% annual commitment fee.
Bank of Scotland plc Secured Revolving Credit Facility:> On December 4, 2007 we entered into a secured revolving credit facility with Bank of Scotland plc that, subject to certain conditions, provided us with an amount of up to $89.0 million to be used in part-financing or re-financing the acquisition of two vessels and of future drybulk carrier acquisitions. Under the terms of the loan agreement, we are required to make quarterly interest payments and to reduce the initial facility limit by 20 quarterly mandatory limit reductions, commencing three months after the delivery date of the second vessel as follows: twelve payments of $2,250,000 each and eight payments of $562,500 each, plus a final repayment of up to $57,500,000 on the final maturity date which will be no later than December 31, 2012. Subject to the scheduled mandatory facility limit reductions, the facility limit will be available for drawing throughout the facility duration on a fully revolving basis. In the balance sheet as at December 31, 2007, an amount of $9.0 million was recorded as current portion of a long-term debt and an amount of $80.0 million was recorded as long-term debt. Drawn amounts bear interest at the rate of LIBOR plus a margin of 1.30% if the leverage ratio (defined as the ratio of our total outstanding liabilities by the total assets, adjusted for the difference between the fair market value and book value of the vessels securing the facility and for any lease transaction relating to the vessels) is greater than 55%, and 1.15% if the leverage ratio is equal to or less than 55%.
The facility is secured by a first priority mortgage on the two vessels, a first assignment of all freights, earnings, insurances, and cross default with all ship-owning companies owned by us. The facility contains financial and other covenants and includes customary events of default, including those relating to a failure to pay principal or interest, a breach of covenant, representation and warranty, a cross-default to other indebtedness and non-compliance with security documents and prohibits us from paying dividends if we are in default on the facility and if, after giving effect to the payment of the dividend, we are in breach of a covenant. The full amount was drawn down under this facility. Any undrawn portion of the facility amount is subject to 0.5% annual commitment fee.
First Business Bank S.A. Secured Revolving Credit Facility:> On April 16, 2008 we entered into a secured revolving credit facility with First Business Bank S.A. for up to $30.0 million to provide us with working capital. The full amount of $30.0 million was drawn down under this facility. Under the terms of the loan agreement we are required to make periodic interest and capital payments to reduce the initial facility limit commencing from the drawdown date of the loan as follows: twelve payments of $0.85 million each and twenty payments of $0.69 million each, plus a final repayment of up to $6.0 million on the final maturity date which will be in eight years from the drawdown date of the loan. Drawn amounts under the secured revolving credit facility bear interest at an annual interest rate of LIBOR plus a margin of 1.20%.
The facility is secured by a first priority mortgage on one vessel, a first assignment of all freights, earnings, insurances, and cross default with all ship-owning companies owned by us. The ship-owning company of the mortgaged vessel is a party to this facility as corporate guarantor. The facility contains financial and other covenants and includes customary events of default, including those relating to a failure to pay principal or interest, a breach of covenant, representation and warranty, a cross-default to other indebtedness and non-compliance with security documents and prohibits us from paying dividends if we are in default on the facility and if, after giving effect to the payment of the dividend, we are in breach of a covenant. The full amount was drawn down under this facility. Any undrawn portion of the facility amount is subject to 0.375% annual commitment fee.
INTEREST RATE SWAP
Effective December 20, 2007, we entered into an interest rate swap with Bayerische Hypo-und Vereinsbank AG on a notional amount of $50.0 million, based on expected principal outstanding under our credit facility, in order to manage interest costs and the risk associated with changing interest rates. Under the terms of the swap, we make quarterly payments to Bayerische Hypo-und Vereinsbank AG on the relevant amount at a fixed rate of 5% if 3 month LIBOR is greater than 5%, at three months LIBOR if 3 month LIBOR is between 3.15% and 5%, and at 3.15% if 3 month LIBOR is equal to or less than 3.15%. Bayerische Hypo-und Vereinsbank AG makes quarterly floating-rate payments to us for the relevant amount based on the 3 month LIBOR. The term of the derivative is 3 years and coincides with the maturity of the senior secured credit facility with Bayerische Hypo-und Vereinsbank AG of which a maximum of $50.0 million was conditional on entering into the interest-rate swap.
Effective December 20, 2007, we entered into an interest rate multi callable swap with Bayerische Hypo-und Vereinsbank AG on a notional amount of $50.0 million, based on expected principal outstanding under our credit facility, in order to manage interest costs and the risk associated with changing interest rates. Under the terms of the swap, Bayerische Hypo-und Vereinsbank AG makes a quarterly payment to us based on 3 month LIBOR less 3.5% on the relevant amount if 3 month LIBOR is greater than 3.5%. If 3 month LIBOR is less than 3.5% Bayerische Hypo-und Vereinsbank AG receives an amount from us based on 3.5% less 3 month LIBOR for the relevant amount. If LIBOR is equal to 3.5% no amount is due or payable to us. Bayerische Hypo-und Vereinsbank AG may at its sole discretion cancel permanently this swap agreement commencing on March 20, 2008 up to and including September 20, 2010 upon five business days notice. The term of the derivative is 3 years and coincides with the maturity of our senior secured credit facility with Bayerische Hypo-und Vereinsbank AG.
Effective December 21, 2007, we entered into an interest rate swap with Bank of Scotland plc on a notional amount of $50.0 million, based on expected principal outstanding under our credit facility, in order to manage interest costs and the risk associated with changing interest rates. Under the terms of the swap, we make quarterly payments to Bank of Scotland plc on the relevant amount at a fixed rate of 5% if 3 month LIBOR is greater than 5%, at three months LIBOR if 3 month LIBOR is between 3.77% and 5%, and at 3.77% if 3 month LIBOR is equal to or less than 3.77%. Bank of Scotland plc makes quarterly floating-rate payments to us for the relevant amount based on the 3 month LIBOR. The swap transaction effectively limits our expected floating-rate interest obligation under its secured revolving credit facility with Bank of Scotland plc to a range of 3.77% and 5%, exclusive of margin due to its lenders. The term of the derivative is 5 years and coincides with the maturity of our secured revolving credit facility with the Bank of Scotland plc of which a maximum of $50.0 million was conditional on entering into the interest-rate swap.
On January 15, 2008 the HSH Nordbank interest rate swap has been novated to Commerzbank AG and the $3.0 million restricted cash that was placed as security deposit for the contractual obligation under the interest rate swap agreement with HSH Nordbank, has been released. All other terms of the interest rate swap agreement remained unchanged.
C. Research and development, patents and licenses
We incur from time to time expenditures relating to inspections for acquiring new vessels that meet our standards. Such expenditures are insignificant and they are expensed as they incur.
D. Trend information
Our results of operations depend primarily on the charter hire rates that we are able to realize. Charter hire rates paid for drybulk carriers are primarily a function of the underlying balance between vessel supply and demand.
The demand for drybulk carrier capacity is determined by the underlying demand for commodities transported in drybulk carriers, which in turn is influenced by trends in the global economy. According to analysts, between 2001 and 2007, trade in all drybulk commodities increased from approximately 2.1 billion tons to 3.0 billion tons, equivalent to a compound average growth rate of 5.2%.
The increasingly active grain market, with Asia again the largest contributor to growth, should be incremental for transportation distances as shipments are being sourced from origins such as the Black Sea, the U.S. Gulf and Argentina. One of the primary reasons for the resurgence in drybulk trade has been the growth in imports by China of iron ore, coal and steel products during the last five years. The driver of this dramatic upsurge in charter rates was primarily the high level of demand for raw materials imported by China. Rates declined somewhat in 2006, but in 2007 have risen again to record highs on the strength of continued high demand for drybulk shipping capacity. During the first quarter in 2008 the charter hire rates for Panamax and Capesize drybulk carries have declined from their historical highs but still remain close to those levels. Demand for drybulk carrier capacity is also affected by the operating efficiency of the global fleet, with port congestion, which has been a feature of the market since 2004, absorbing tonnage and therefore leading to a tighter balance between supply and demand.
It is expected that increases in cargo demand will continue in 2008, and this is likely to be broadly matched by increases in tonnage supply. Factors affecting the supply and demand balance such as the ton-mile effect and congestion will continue having a generally beneficial effect on this balance. Given the imbalance in iron ore flows, it is more likely than not that the second half of 2008 will be stronger than the first half. Risks on the downside include the down side risks of the whole commodity cycle, the growing bottlenecks in cargo generation and over investment in ships and shipbuilding capacity.
The supply of drybulk carriers is dependent on the delivery of new vessels and the removal of vessels from the global fleet, either through scrapping or loss. Currently, newbuilding statistics from shipping analysts, show that approximately 129 million tons dwt of drybulk vessels are on order, representing approximately 48% of the existing fleet. These vessels are scheduled for delivery over the next four years. The level of scrapping activity is generally a function of scrapping prices in relation to current and prospective charter market conditions, as well as operating, repair and survey costs. The average age at which a vessel is scrapped over the last five years has been 26 years. However, due to recent strength in the drybulk shipping industry, the current average age at which drybulk vessels are being scrapped has increased.
E. Off-balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
F. Contractual Obligations
The following table sets forth our contractual obligations, in thousands of U.S.$, and their maturity dates as of December 31, 2007:
G. Safe Harbor
See section “forward looking statements” at the beginning of this annual report.
We adopted a shareholders rights plan on January 4, 2008 and declared a dividend distribution of one preferred share purchase right to purchase one one-thousandth of our Series A Participating Preferred Stock for each outstanding share of our common stock, par value $0.001 per share to shareholders of record at the close of business on February 1, 2008. Each right entitles the registered holder, upon the occurrence of certain events, to purchase from us one one-thousandth of a share of Series A Participating Preferred Stock at an exercise price of $75, subject to adjustment. The rights will expire on the earliest of (i) February 1, 2018 or (ii) redemption or exchange of the rights. The plan was designed to enable us to protect shareholder interests in the event that an unsolicited attempt is made for a business combination with or takeover of us. We believe that the shareholder rights plan should enhance the Board’s negotiating power on behalf of shareholders in the event of a coercive offer or proposal. We are not currently aware of any such offers or proposals and adopted the plan as a matter of prudent corporate governance.
Critical Accounting policies
The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of those financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses and related disclosure of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.
Critical accounting policies are those that reflect significant judgments or uncertainties, and potentially result in materially different results under different assumptions and conditions. We have described below what we believe are our most critical accounting policies that involve a high degree of judgment and the methods of their application. For a description of all of our significant accounting policies, see Note 2 to our consolidated financial statements included elsewhere herein.
Revenue and Expenses: Revenues are generated from voyage and time charter agreements.
Time Charter Revenues:> Time charter revenues are recorded over the term of the charter as service is provided. When two or more time charter rates are involved during the life term of a charter agreement, the Company is recognizing revenue on a straight line basis. Time charter revenues received in advance are recorded as deferred income, until charter service is rendered.
When vessels are acquired with time charters attached and the charter rate on such charters is above or below market, we allocate the fair value of the above or below market charter to the cost of the vessel on a relative fair value basis and records a corresponding asset or liability for the above or below market charter. The fair value is computed as the present value of the difference between the contractual amount to be received over the term of the time charter and the management's estimate of the then current market charter rate for equivalent vessels at the time of acquisition. The asset or liability record is amortized over the remaining period of the time charter as a reduction or addition to charter hire revenue.
Impairment of Long-Lived Assets:> We apply SFAS No. 144 "Accounting for the Impairment or Disposal of Long-lived Assets", which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. The standard requires that, long-lived assets and certain identifiable intangibles held and used or disposed of by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. An impairment loss for an asset held for use should be recognized when the estimate of undiscounted cash flows, excluding interest charges, expected to be generated by the use of the asset is less than its carrying amount. Measurement of the impairment loss is based on the fair value of the asset. In this respect, we regularly review the carrying amount of the vessels to determine if they are recoverable and no amount has been deemed necessary to be recorded as an impairment loss, following impairment tests we carried out.
Vessel Depreciation:> Depreciation is computed using the straight-line method over the estimated useful life of the vessels, after considering the estimated salvage value. Each vessel's salvage value is equal to the product of its lightweight tonnage and estimated scrap rate.
We estimate the useful life of the Company's vessels to be 25 years from the date of initial delivery from the shipyard (secondhand vessels are depreciated from the date of their acquisition through their remaining estimated useful life).
Vessel Cost: > Vessels are stated at cost, which consists of the contract price less discounts, plus any material expenses incurred upon acquisition (delivery expenses and other expenditures to prepare the vessel for her initial voyage). Subsequent expenditures for conversions and major improvements are also capitalized when they appreciably extend the life, increase the earning capacity or improve the efficiency or safety of the vessels. Repairs and maintenance are charged to expense as incurred.
Dry-Docking and Special Survey Costs:> For the period from inception (April 26, 2006) to December 31, 2006 we followed the deferral method of accounting for dry-docking costs whereby actual costs incurred are deferred and are amortized on a straight-line basis over the period through the expected date of the next dry-docking but no dry-docking costs were incurred during this period. In the fourth quarter in 2007, we elected to change our method of accounting for dry-docking costs, to the direct expense method as we believe that the direct expense method eliminates the significant amount of time and subjectivity that is needed to determine which costs and activities related to dry-docking should be deferred. In respect of SFAS No. 154, "Accounting Changes and Error Corrections, a Replacement of APB Opinion No. 20 and SFAS 3" ("SFAS 154") there is no prior-period information that has been retrospectively adjusted as the first dry-docking only occurred in the fourth quarter in 2007. For the year ended December 31, 2007 the effect in net income by applying the direct expense method was the cost of the dry-docking of $1.18 million or $0.07 per share, basic and diluted.
Recent Accounting Pronouncements:> In September 2006, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 157, "Fair Value Measurement" ("SFAS 157"). SFAS 157 addresses standardizing the measurement of fair value for companies that are required to use a fair value measure for recognition or disclosure purposes. The FASB defines fair value as "the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date." SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. We are currently evaluating the impact, if any, of SFAS 157 on its financial position, results of operations and cash flows.
In June 2006, the FASB issued Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" (FIN 48), which supplements SFAS No. 109, "Accounting for Income Taxes", by defining the confidence level that a tax position must meet in order to be recognized in the financial statements. The Interpretation requires that the tax effects of a position be recognized only if it is "more-likely-than-not" to be sustained based solely on its technical merits as of the reporting date. The more-likely-than-not threshold represents a positive assertion by management that a company is entitled to the economic benefits of a tax position. If a tax position is not considered more-likely-than-not to be sustained based solely on its technical merits, no benefits of the position are to be recognized.
Moreover, the more-likely-than-not threshold must continue to be met in each reporting period to support continued recognition of a benefit. At adoption, companies must adjust their financial statements to reflect only those tax positions that are more-likely-than-not to be sustained as of the adoption date. Any necessary adjustment would be recorded directly to retained earnings in the period of adoption and reported as a change in accounting principle. This Interpretation is effective as of the beginning of the first fiscal year beginning after December 15, 2006. In 2007, the adoption of FIN 48 did not have a material impact on our financial position, results of operations or cash flows.
In September 2006, the FASB Staff issued FSP No. AUG AIR-1, "Accounting for Planned Major Maintenance Activities," ("FSP No. AUG AIR-1"). FSP No. AUG AIR-1 prohibits the use of the accrue-in-advance method of accounting for planned major maintenance activities in annual and interim financial reporting periods, if no liability is required to be recorded for an asset retirement obligation based on a legal obligation for which the event obligating the entity has occurred. FSP No. AUG AIR-1 also requires disclosures regarding the method of accounting for planned major maintenance activities and the effects of implementing the FSP. The guidance in FSP No. AUG AIR-1 is effective for us as of January 1, 2007. No planned major maintenance activities took place during the period from inception (April 26, 2006) to December 31, 2006. There were two planned major maintenance activities, that took place in the fourth quarter in 2007 following the adoption of the new policy and we accounted for those expenses by adopting the direct expense method and recorded those expenses as incurred for the year ended December 31, 2007. The new accounting principle will be presented in all periods presented in future earning releases and filings. The retrospective effect in net income and per share information will be nil as there was no planned major maintenance activity before the adoption of the new accounting principle. For the year ended December 31, 2007 the effect in net income by applying the direct expense method was the cost of the dry-docking of $1,184,140 or $0.07 per share, basic and diluted.
On September 13, 2006, the SEC released staff accounting bulleting ("SAB") No. 108, which provides guidance on materiality. SAB No. 108 states that registrants should use both a balance sheet approach and an income statement approach when quantifying and evaluating the materiality of a misstatement, contains guidance on correcting errors under the dual approach, and provides transition guidance for correcting errors existing in prior years. If prior-year errors that had been previously considered immaterial (based on the appropriate use of the registrant's prior approach) now are considered material based on the approach in the SAB, the registrant need not restate prior period financial statements. SAB No. 108 is effective for annual financial statements covering the first fiscal year ending after November 15, 2006. This statement is effective for us for the fiscal year ending December 31, 2006 and onwards. SAB No. 108 did not have a material impact on our financial position and results of operations.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" ("SFAS 159"), which permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS 159 is effective as of the beginning of an entity's first fiscal year that begins after November 15, 2007. Earlier adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provisions of FASB Statement No. 157, "Fair Value Measurements." We are currently evaluating the impact of SFAS 159, but do not expect the adoption of SFAS 159 to have a material impact on our financial consolidated position, results of operations or cash flows.
In December 2007, the FASB issued SFAS No. 141 (revised), “Business Combinations” (“SFAS 141 (revised)”). SFAS No. 141 (revised) relates to the business combinations and requires the acquirer to recognize the assets acquired, the liabilities assumed, and any non controlling interest in the acquiree at the acquisition date, measured at their fair values as of that date. This Statement applies prospectively to business combinations for which the acquisitions date is on or after the beginning of the first reporting period beginning on or after December 15, 2008. An entity may not apply it before that date. We are currently evaluating the impact, if any, of SFAS No. 141 (revised) on its financial position, results of operations and cash flows.
Item 6. Directors, Senior Management and Employees
A. Directors and Senior Management
Set forth below are the names, ages and positions of our directors and executive officers. Our board of directors is elected annually, and each director elected holds office for a three year term or until his successor shall have been duly elected and qualified, except in the event of his death, resignation, removal or the earlier termination of his term of office. Officers are elected from time to time by vote of our board of directors and hold office until a successor is elected. The business address for each director and executive officer is c/o Paragon Shipping Inc., 15 Karamanli Ave, Voula 16673, Athens, Greece.
Our board of directors is elected annually, and each director elected holds office for a three year term or until his successor shall have been duly elected and qualified, except in the event of his death, resignation, removal or the earlier termination of his term of office.
Mr. Dimitrios Sigalas became a member of our board of directors on March 20, 2008 upon the resignation of Mr. Ian Davis, who served as a member of our board of directors since our initial public offering until his resignation effective March 20, 2008.
Biographical information with respect to each of our directors and executive officers is set forth below.
Michael Bodouroglou> has been our chairman and chief executive officer since June 2006. Mr. Bodouroglou has co-founded and co-managed an independent shipping group since 1993 and has served as co-managing director of Eurocarriers and Allseas, which he co-founded, since 1994 and 2000, respectively. Mr. Bodouroglou disposed of his interest in Eurocarriers in September 2006. Prior to founding Eurocarriers, Mr. Bodouroglou served from 1984 to 1992 as technical superintendent for Thenamaris (Ships Management) Inc., where he was responsible for all technical matters of a product tanker fleet. Mr. Bodouroglou served as technical superintendent for Manta Line, a dry cargo shipping company, in 1983 and as technical superintendent for Styga Compania Naviera, a tanker company, from 1981 to 1983. Mr. Bodouroglou graduated from the University of Newcastle-upon-Tyne in the United Kingdom with a Bachelor of Science in Marine Engineering, with honors, in 1977, and received a Masters of Science in Naval Architecture in 1978. Mr. Bodouroglou is a member of the Cayman Islands Shipowners' Advisory Council and is also a member of the Board of Academic Entrepreneurship of the Free University of Varna, Bulgaria.
George Skrimizeas> has been our executive director and chief operating officer since June 2006. Mr. Skrimizeas has been general manager of Allseas since May 2006. From 1996 to 2006, Mr. Skrimizeas has held various positions in Allseas, Eurocarriers and their affiliates, including general manager, accounts and human resources manager, and finance and administration manager. Mr. Skrimizeas worked as account manager for ChartWorld Shipping from 1995 to 1996 and as accounts and administration manager for Arktos Investments Inc. from 1994 to 1995. From 1988 to 1994, Mr. Skrimizeas was accounts and administration manager for Candia Shipping Co. S.A. and accountant and chief accounting officer—deputy human resources manager in their Athens, Romania, Hong Kong and London offices. Mr. Skrimizeas received his Bachelor of Science degree in Business Administration from the University of Piraeus, Greece in 1988 and completed the coursework necessary to obtain his Masters of Science in Finance from the University of Leicester, in the United Kingdom, in 2002. Mr. Skrimizeas is a member of the Hellenic Chamber of Economics and the Association of Chief Executive Officers.
Christopher J. Thomas> has been our chief financial officer since October 2006. Prior to joining us, Mr. Thomas served as director, vice president, treasurer and chief financial officer of DryShips Inc., a Nasdaq-listed drybulk company. Since November 2001, Mr. Thomas has been an independent financial consultant to numerous international shipowning and operating companies. Mr. Thomas is also on the board of directors of TOP Ships Inc., which is a publicly listed company with securities registered under the Exchange Act. From 1999 to 2004, Mr. Thomas was the chief financial officer and a director of Excel Maritime Carriers Ltd. which is also a publicly traded company currently listed on the New York Stock Exchange. Prior to joining Excel, he was Financial Manager of Cardiff Marine Inc. and Alpha Shipping plc. Mr. Thomas holds a degree in Business Administration from Crawley University, England.
Nigel D. Cleave> is a non-executive director. In 2006, Mr. Cleave was appointed to his current position as chief executive officer of Epic Ship Management Limited, a ship management company engaged in the provision of a complete range of ship management services on behalf of an international clientele base, with offices located in Cyprus, Singapore, Germany, the U.K. and the Philippines. Prior to this, Mr. Cleave served as group managing director of Dobson Fleet Management Limited from 1993 to 2006, a ship management company based in Cyprus and, prior to his position at Dobson, Mr. Cleave was the deputy general manager for Hanseatic Shipping Company Limited from 1991 to 1993. From 1988 to 1991, Mr. Cleave held fleet operation roles with PPI Lines, including that of fleet operations manager. From 1975 to 1986, Mr. Cleave held various positions at The Cunard Steamship Company plc, including navigation cadet officer, third officer, second officer, financial and planning assistant, assistant to the group company secretary and assistant operations manager. Mr. Cleave graduated from the Riversdale College of Technology in the United Kingdom with an O.N.C. in Nautical Science in 1979. Mr. Cleave is a board member of the Marine Shipping Mutual Insurance Company Limited, and is the Chairman of the Cayman Islands Shipowners' Advisory Council. Mr. Cleave is a Fellow of the Chartered Institute of Shipbrokers, acts as a Member of the Cyprus Committee of Germanischer Lloyd and the Cyprus Technical Committee of DnV (both being advisory committees covering technical related issues with the Classification Society). Mr. Cleave also serves as the Chairman of the Mission to Seafarers Cyprus Branch.
Bruce Ogilvy> is a non-executive director. From 2003 to 2005 Mr. Ogilvy served as a consultant to Stelmar Tankers (Management) Ltd. and from 1992 to 2002, he was managing director of Stelmar Tankers (U.K.) Ltd., a subsidiary of Stelmar Tankers (Management) Ltd., through which the group's commercial business, including chartering and sale and purchase activities, were carried out. In 1992, Mr. Ogilvy joined Stelios Haj-Ioannou to form Stelmar Tankers (Management) Ltd., and served on its board of directors from its inception to 2002. During his ten years with Stelmar Tankers (Management) Ltd., Stelmar Shipping Ltd. completed an initial public offering on the New York Stock Exchange in 2001 and a secondary listing in 2002. Prior to his association with Stelmar Tankers (Management) Ltd., Mr. Ogilvy served in various capacities, including chartering and sale and purchase activities with Shell International. Mr. Ogilvy graduated from Liverpool University, in the United Kingdom, in 1963 with a degree as Ship Master. Mr. Ogilvy served on the Council of Intertanko, an industry body that represents the interests of independent tanker owners, since 1994 and on its Executive Board from 2003 until 2005. Mr. Ogilvy has been an active member of the Chartered Institute of Shipbrokers for nearly 30 years. He served as Chairman of the London Branch from 1999 to 2001 and currently serves as Chairman of the Institute.
Dimitrios Sigalas> has been a non-executive director since March 2008. Mr. Sigalas was appointed to his current position as shipping journalist to the Greek daily newspaper “Kathimerini” in 1988. Prior to this he served within the chartering department of Glafki (Hellas) Maritime Corporation an Athens based shipowning company which he joined in 1972. In 1980 Mr. Sigalas was appointed to Head of the Dry and Tanker Chartering Department within Glafki (Hellas) Maritime Corporation. Mr. Sigalas graduated from Cardiff University, Wales, with a diploma in Shipping.
The aggregate compensation that we paid members of our senior management in 2007 was approximately $1.63 million. This amount does not reflect an additional amount of $3.87 million bonus awards in the aggregate, that was paid to certain of our senior executive officers for 2007 performance. We paid aggregate compensation of $165,520 to members of our senior management in 2006. Each of our non-employee directors received annual compensation in the aggregate amount of $30,000 per year, plus reimbursements for actual expenses incurred while acting in their capacity as a director. Our officers and directors are eligible to receive awards under our equity incentive plan which is described below under “Equity Incentive Plan”. During 2006, we granted options to our chief executive officer and other directors and officers and restricted common shares to our directors and officers, other than our chief executive officer, as described below under “Equity Incentive Plan”. We do not have a retirement plan for our officers or directors. We also recognized non-cash compensation expenses of $18.25 million in connection with the conversion of our Class B common shares and vesting of certain equity awards upon consummation of our initial public offering.
C. Board Practices
Our board of directors has determined that each of Messrs. Cleave, Sigalas and Ogilvy, constituting a majority of our board of directors, is independent under the Nasdaq Global Market listing requirements and the rules and regulations promulgated by the SEC. We have established an audit committee comprised of three members, all of whom are independent, which is responsible for reviewing our accounting controls and recommending to the board of directors the engagement of our outside auditors. The members of the audit committee are Nigel Cleave, Bruce Ogilvy and Dimitrios Sigalas. Mr. Cleave serves as the chairman of our audit committee.
The audit committee is responsible for assisting our Board of Directors with its oversight responsibilities regarding the integrity of our financial statements, our compliance with legal and regulatory requirements, our independent registered public accounting firm's qualifications and independence, and the performance of our internal audit functions. We have not determined that any member of our Audit Committee constitutes a financial expert as such term is defined in Item 407 of SEC Regulation S-X. Our board of directors has determined that each member of the audit committee does have the financial experience required by NASDAQ Marketplace Rule 4350(d)(2) and other relevant experience necessary to carry out the duties and responsibilities of the company's audit committee.
We have established a compensation committee responsible for recommending to the board of directors our senior executive officers' compensation and benefits. We have also established a nominating and corporate governance committee which is responsible for recommending to the board of directors nominees for directors for appointment to board committees and advising the board with regard to corporate governance practices. The members of each of the compensation committee and the nominating and corporate governance committee are Messrs. Cleave, Ogilvy, and Sigalas.
Corporate Governance Practices
We have certified to Nasdaq that our corporate governance practices are in compliance with, and are not prohibited by, the laws of the Republic of the Marshall Islands. Therefore, we are exempt from many of Nasdaq's corporate governance practices other than the requirements regarding the disclosure of a going concern audit opinion, submission of a listing agreement, notification of material non-compliance with Nasdaq corporate governance practices and the establishment of an audit committee in accordance with Nasdaq Marketplace Rules 4350(d)(3) and 4350(d)(2)(A)(ii). The practices we follow in lieu of Nasdaq's corporate governance rules are as follows:
In lieu of obtaining shareholder approval prior to the issuance of designated securities, we will comply with provisions of the Marshall Islands Business Corporations Act, or BCA, providing that the board of directors approves share issuances.
As a foreign private issuer, we are not required to solicit proxies or provide proxy statements to Nasdaq pursuant to Nasdaq corporate governance rules or Marshall Islands law. Consistent with Marshall Islands law and as provided in our bylaws, we will notify our shareholders of meetings between 15 and 60 days before the meeting. This notification will contain, among other things, information regarding business to be transacted at the meeting. In addition, our bylaws provide that shareholders must give us between 150 and 180 days advance notice to properly introduce any business at a meeting of shareholders.
Other than as noted above, we expect to be in full compliance with all other Nasdaq corporate governance standards applicable to U.S. domestic issuers.
D. Crewing and Shore Employees
We currently have four shoreside personnel, our chief executive officer, Michael Bodouroglou, our chief operating officer, George Skrimizeas, our chief financial officer, Christopher Thomas and our internal legal counsel and corporate secretary, Maria Stefanou. In addition, we employee through our wholly-owned vessel owning subsidiaries approximately 500 seafarers that crew the vessels in our fleet. Allseas is responsible for recruiting, either directly or through a crewing agent, the senior officers and all other crew members for our vessels. We believe the streamlining of crewing arrangements helps to ensure that all our vessels will be crewed with experienced seamen that have the qualifications and licenses required by international regulations and shipping conventions.
The following table presents the average number of shoreside personnel and the number of seafaring personnel employed by our vessel owning subsidiaries during the periods indicated.
E. Share Ownership>
With respect to the total amount of common stock owned by all of our officers and directors, individually and as a group, see Item 7 “Major Stockholders and Related Party Transactions”.
Equity Incentive Plan
We adopted an equity incentive plan, which we refer to as the plan, under which our officers, key employees and directors are eligible to receive equity awards. We have reserved a total of 1,500,000 shares of common shares for issuance under the plan. Our board of directors administers the plan. Under the terms of the plan, our board of directors are able to grant new options exercisable at a price per common share to be determined by our board of directors but in no event less than fair market value of the common share as of the date of grant. The plan also permits our board of directors to award restricted stock, restricted stock units, stock appreciation rights and unrestricted stock. All options will expire ten years from the date of the grant. The plan will expire ten years from the completion of the private placement.
Upon the completion of our private placement in the forth quarter of 2006, we granted our chairman and chief executive officer options to purchase an aggregate of 500,000 common shares, all of which have been exercised. Of these options, 250,000 vested immediately upon the closing of the private placement and the balance vested upon the completion of our initial public offering in August 2007. We also granted our other executive officers and directors and employees of Allseas options to purchase an aggregate of 70,000 of our common shares, which initially vested ratably over a four year period from the date of grant. The vesting terms of the options were amended by our board of directors on the first anniversary of the grant date such that all options vested immediately. All of the options granted at the closing of the private placement have an exercise price of $12.00 per common share.
We also granted an aggregate of 40,000 restricted common shares to our executive officers and directors, other than our chief executive officer, and to employees of Allseas upon the completion of the initial closing of our private placement in the fourth quarter of 2006, which continue to vest ratably over four years. In addition, we granted 46,500 restricted common shares to our directors, executive officers and certain employees of Allseas on August 27, 2007 following the completion of our initial public offering that vest ratably over two years from the grant date.
On December 28, 2007 we granted 20,000 additional restricted common shares to our directors, executive officers and employees, that vest ratably over three years from December 31, 2007. In addition, on December 31, 2007, 6,000 restricted common shares were authorized to be granted to employees of Allseas and the vesting schedule of outstanding restricted shares were amended so that December 31 of the relevant year is the vesting date for restricted shares that vest in the second half of the year and June 30 of the relevant year is vesting date for shares that vest in the first half of the year.
Item 7. Major Shareholders and Related Party Transactions
The following table sets forth information regarding (i) the owners of more than five percent of outstanding common shares that we are aware of and (ii) the total number of common shares owned by all of our officers and directors, individually and as a group, in each case as of March 6, 2008. All of the shareholders, including the shareholders listed in this table, are entitled to one vote for each common share held.
B. Related Party Transactions
Commercial and Technical Management Agreements
We outsource the technical and commercial management of our vessels to Allseas pursuant to management agreements with an initial term of five years. Our chairman and chief executive officer, Mr. Bodouroglou, is the sole shareholder and managing director of Allseas. These agreements automatically extend to successive five year terms, unless, in each case, at least one year's advance notice of termination is given by either party. We are obligated to pay Allseas a technical management fee of $650 (based on a Euro/U.S. dollar exchange rate of 1.00:1.268) per vessel per day on a monthly basis in advance, pro rata for the calendar days these vessels are owned by us. The management fee is adjusted quarterly based on the Euro/U.S. dollar exchange rate as published by EFG Eurobank Ergasias S.A. two days prior to the end of the previous calendar quarter. For the first quarter in 2007 the management fee was $675 per day, for the second quarter in 2007 was $683 per day, for the third quarter in 2007 was $687 per day and for the fourth quarter in 2007 was $725 per day. The management fee increased as of January 1, 2008 by reference to the official Greek inflation rate for the previous year, as published by the Greek National Statistical Office. During 2007 an amount of $250,000 was paid to Allseas for legal, accounting and finance services that were provided throughout the year and were not covered under the management agreements described above. We also pay Allseas 1.25% of the gross freight, demurrage and charter hire collected from the employment of our vessels. Allseas will also earn a fee equal to 1.0% of the purchase price of any vessel bought or sold on our behalf, calculated in accordance with the relevant memorandum of agreement. Management fees were $170,750 and $2,076,678 for the period from inception (April 26, 2006) through December 31, 2006 and for the year ended December 31, 2007, respectively. As at December 31, 2006, the chartering and vessel commissions incurred and due to Allseas amounted to $6,661 and $825,000, respectively. During 2007, chartering and vessels commissions incurred were $841,442 and $4,172,000, respectively, and $976,923 of such commissions were due to Allseas at December 31, 2007.
Right of First Refusal
Our chairman and chief executive officer, Michael Bodouroglou, has entered into a letter agreement with us which includes a provision requiring Mr. Bodouroglou to use commercially reasonable efforts to cause each company controlled by Mr. Bodouroglou to allow us to exercise a right of first refusal to acquire any drybulk carrier, after Mr. Bodouroglou or an affiliated entity of his enters into an agreement that sets forth terms upon which he or it would acquire a drybulk carrier. Pursuant to this letter agreement, Mr. Bodouroglou will notify a committee of our independent directors of any agreement that he or an affiliated entity has entered into to purchase a drybulk carrier and will provide the committee of our independent directors a seven calendar day period in respect of a single vessel transaction, or a 14 calendar day period in respect of a multi-vessel transaction, from the date that he delivers such notice to our audit committee, within which to decide whether or not to accept the opportunity and nominate a subsidiary of ours to purchase the vessel or vessels, before Mr. Bodouroglou will accept the opportunity or offer it to any of his other affiliates. The opportunity offered to us will be on no less favorable terms than those offered to Mr. Bodouroglou and his affiliates. A committee of our independent directors will require a simple majority vote to accept or reject this offer.
Acquisition of Blue Seas and Deep Seas
We purchased the Blue Seas and the Deep Seas from corporate entities controlled by our chairman and chief executive officer. The purchase price that we paid for these two vessels is equal to the price paid by the affiliated seller. We also reimbursed approximately $0.40 million to those entities for pre-delivery expenses. The amount paid over and above the carrying value of these vessels in the books of our affiliated entities at the date purchased by us is treated as a deemed dividend to Innovation Holdings as explained below. We purchased the remaining four vessels in our initial fleet from unaffiliated third parties. We did not pay Allseas a 1% fee with respect to our acquisition of these two vessels, although we paid Allseas a 1% fee, which is approximately $1.4 million, with respect to the acquisition of the other four vessels in our initial fleet.
The vessels purchased from our affiliated entities are reflected in our financial statements using the historical carrying value since the transaction was between parties under common control. The amount paid for these acquisitions of the Blue Seas and the Deep Seas in excess of the carrying value on the books of our affiliated entities of $2.9 million is treated as a deemed dividend to Innovation Holdings at the date of delivery to us.
Registration Rights Agreement
In connection with the Class A common shares and warrants sold in the private placement, we agreed to register for resale on a shelf registration statement under the Securities Act of 1933, as amended, and applicable state securities laws, up to 2,250,000 of our Class A common shares and 450,000 warrants held by Innovation Holdings 12 months following the registration of our Class A common shares issued in the private placement. We are obligated to pay all expenses incidental to the registration, excluding underwriting discounts and commissions.
Lease of Office Space
We lease office space in Athens, Greece from Granitis Glyfada Real Estate Ltd., a company beneficiary owned by our chief executive officer commencing on October 1, 2007. The term of the lease is for five years and commenced on October 1, 2007 and expires on September 30, 2012. The monthly lease payment for the first year is Euro 2,000, plus 3.6% tax and thereafter it will be adjusted annually for inflation increases.
C. Interests of Experts and Counsel
Item 8. Financial information
A. Consolidated statements and other financial information
See Item 18.
To our knowledge, we are not currently a party to any material lawsuit that, if adversely determined, would have a material adverse effect on our financial position, results of operations or liquidity. As such, we do not believe that pending legal proceedings, taken as a whole, should have any significant impact on our financial statements. From time to time in the future we may be subject to legal proceedings and claims in the ordinary course of business, principally personal injury and property casualty claims. Those claims, even if lacking merit, could result in the expenditure of significant financial and managerial resources. We have not been involved in any legal proceedings which may have, or have had a significant effect on our financial position, results of operations or liquidity, nor are we aware of any proceedings that are pending or threatened which may have a significant effect on our financial position, results of operations or liquidity.
We intend to pay quarterly dividends to the holders of our common shares in February, May, August and November of each year in amounts substantially equal to our available cash flow from operations during the previous quarter, less cash expenses for that quarter (principally vessel operating expenses and interest expense) and any reserves our board of directors determines we should maintain for reinvestment in our business. These reserves may cover, among other things, drydocking, intermediate and special surveys, liabilities and other obligations, interest expense and debt amortization, acquisitions of additional assets and working capital.
On May 17, 2007 we declared a dividend of $0.4375 per Class A and Class B common share in respect of the period from the commencement of our operations through March 31, 2007, which we paid to holders of our Class A common shares on May 31, 2007 and on July 20, 2007 we declared a dividend of $0.4375 per Class A and Class B common share in respect of the period from April 1, 2007 through June 30, 2007 payable to shareholders of record on July 23, 2007. In addition, on June 26, 2007 we declared a special dividend of $0.60 per existing Class A and Class B common share payable to our shareholders of record on July 2, 2007.
Since our initial public offering in August 2007, we have declared and paid dividends of $0.875 per common share, representing our cash available from operations for 2007. On November 15, 2007 we declared a dividend of $0.4375 per common share in respect of the period from July 1, 2007 through September 30, 2007 payable to shareholders of record on November 21, 2007. On February 12, 2008 we declared a dividend of $0.4375 per common share in respect of the period from October 1, 2007 through December 31, 2007 payable to shareholders of record on February 19, 2008.
The declaration and payment of any dividend is subject to the discretion of our board of directors. We intend to expand our fleet through acquisitions of additional vessels in a manner that is accretive to earnings and free cash flow per share. We expect to fund our future vessel acquisitions through a combination of cash from operations, borrowings under our credit facilities and future equity offerings. In periods when we make acquisitions, our board of directors may limit the amount or percentage of our cash from operations available to pay dividends. In addition, the timing and amount of dividend payments will depend on our earnings, financial condition, cash requirements and availability, the restrictions in our senior secured credit facility, the provisions of Marshall Islands law affecting the payment of dividends and other factors. Because we are a holding company with no material assets other than the shares of our subsidiaries, which will directly own the vessels in our fleet, our ability to pay dividends will depend on the earnings and cash flow of our subsidiaries and their ability to pay dividends to us. We cannot assure you that, after the expiration or earlier termination of our charters, we will have any sources of income from which dividends may be paid.
We believe that, under current law, after our shares are listed on the Nasdaq Global Market, our dividend payments from earnings and profits will be eligible for treatment as "qualified dividend income" and as such non-corporate United States stockholders that satisfy certain conditions will generally be subject to a 15% United States federal income tax rate with respect to such dividend payments. Distributions in excess of our earnings and profits will be treated first as a non-taxable return of capital to the extent of a United States stockholder's tax basis in its common stock on a dollar-for-dollar basis and thereafter as a capital gain. Proposed legislation in the United States Congress would, if enacted, make it unlikely that our dividends would qualify for the reduced rates. As of the date hereof, it is not possible to predict whether such proposed legislation would be enacted. Please see the section of this annual report entitled "United States Taxation and Marshall Islands Tax Considerations" for additional information relating to the tax treatment of our dividend payments.
B. Significant Changes
There have been no significant changes since the date of the annual financial statements included in this annual report.
Item 9. Listing Details
The trading market for shares of our common stock is the Nasdaq Global Market, on which our shares trade under the symbol “PRGN”. The following table sets forth the high and low closing prices for shares of our common stock since our initial public offering on August 9, 2007, as reported by the Nasdaq Global Market:
Item 10. Additional Information
Our amended and restated articles of incorporation and amended and restated bylaws have been filed as exhibit 3.1 and 3.2 to our Registration Statement on form F-1 filed with the Securities and Exchange Commission on June 4, 2007 with file number 333-143481 The information contained in these exhibits is incorporated by reference herein.
Information regarding the rights, preferences and restrictions attaching to each class of the shares is described in section “Description of Capital Stock” in our Registration Statement on Form F-1 filed with the Securities and Exchange Commission on July 19, 2007 with file number 333-144687, provided that since the date of that Registration Statement, our outstanding shares of common stock has increased to 26,961,612 as of April 4, 2008.
We refer you to Item 7.B for a discussion of our registration rights agreement with our stockholders of record before our initial public offering and agreements with companies controlled by our chairman and chief executive officer, Mr. Michael Bordouroglou. Other than these agreements, we have no material contracts, other than contracts entered into in the ordinary course of business, to which the Company or any affiliate of the Company is a party.
Under Marshall Islands law, there are currently no restrictions on the export or import of capital, including foreign exchange controls or restrictions that affect the remittance of dividends, interest or other payments to non-resident holders of our common stock.
United States Taxation
The following discussion is based upon the provisions of the U.S. Internal Revenue Code of 1986, as amended (the “Code”), existing and proposed U.S. Treasury Department regulations, administrative rulings, pronouncements and judicial decisions, all as of the date of this Annual Report. This discussion assumes that we do not have an office or other fixed place of business in the United States. Unless the context otherwise requires, the reference to Company below shall be meant to refer to both the Company and its vessel owning and operating subsidiaries.
Taxation of the Company’s Shipping Income: In General
The Company anticipates that it will derive substantially all of its gross income from the use and operation of vessels in international commerce and that this income will principally consist of freights from the transportation of cargoes, hire or lease from time or voyage charters and the performance of services directly related thereto, which the Company refers to as “shipping income.”
Shipping income that is attributable to transportation that begins or ends, but that does not both begin and end, in the United States will be considered to be 50% derived from sources within the United States. Shipping income attributable to transportation that both begins and ends in the United States will be considered to be 100% derived from sources within the United States. The Company is not permitted by law to engage in transportation that gives rise to 100% U.S. source income. Shipping income attributable to transportation exclusively between non-U.S. ports will be considered to be 100% derived from sources outside the United States. Shipping income derived from sources outside the United States will not be subject to U.S. federal income tax.
The Company’s vessels will operate in various parts of the world, including to or from U.S. ports. Unless exempt from U.S. taxation under Section 883 of the Code, the Company will be subject to U.S. federal income taxation, in the manner discussed below, to the extent its shipping income is considered derived from sources within the United States.
In the year ended December 31, 2007, approximately 12%, of the Company’s shipping income was attributable to the transportation of cargoes either to or from a U.S. port. Accordingly, 6% of the Company’s shipping income would be treated as derived from U.S. sources for the year ended December 31, 2007. In the absence of exemption from tax under Section 883, the Company would have been subject to a 4% tax on its gross U.S. source shipping income equal to approximately $0.17 million for the year ended December 31, 2007.
Application of Code Section 883
Under the relevant provisions of Section 883 of the Code and the final regulations promulgated thereunder, or the final regulations, a foreign corporation will be exempt from U.S. taxation on its U.S. source shipping income if:
The U.S. Treasury Department has recognized each of the Marshall Islands, the country of incorporation of the Company and certain of its subsidiaries, and Liberia, the country of incorporation of certain of the Company’s subsidiaries, as a qualified foreign country. Accordingly, the Company and each of its subsidiaries satisfy the country of organization requirement.
For the 2007 tax year, the Company believes that it will be unlikely to satisfy the 50% Ownership Test. Therefore, the eligibility of the Company and each subsidiary to qualify for exemption under Section 883 is wholly dependent upon being able to satisfy the Publicly Traded Test.
As a result of the Company’s concentrated ownership prior to being listed on the Nasdaq Global Market, the Company does not believe that it satisfied the Publicly-Traded Test for the 2007 tax year. As a result, the Company will be subject to U.S. federal income tax on its U.S. source shipping income as described in more detail below.
The Company anticipates that it will satisfy the Publicly-Traded Test and qualify for the benefits of Section 883 for the 2008 tax year since its Class A common stock, is anticipated to be “primarily traded” and “regularly traded” on the Nasdaq Global Market. However, there is no assurance this will be the case and there can be no assurance that the Company will qualify for the benefits of Section 883 for the 2008 tax year or any subsequent tax year.
Taxation in Absence of Internal Revenue Code Section 883 Exemption
Assuming that the Company does not qualify for the benefits of Section 883 for the 2007 tax year, the Company and each of its subsidiaries will be subject to a 4% tax imposed on its shipping income derived from U.S. sources by Section 887 of the Code on a gross basis, without the benefit of deductions. Since under the sourcing rules described above, no more than 50% of the Company’s shipping income would be treated as being derived from U.S. sources, the maximum effective rate of U.S. federal income tax on the Company’s shipping income would never exceed 2% under the 4% gross basis tax regime.
Based on its shipping income derived from U.S. sources for 2007, the Company will be subject to U.S. federal income tax of approximately $0.17 million under Section 887.
Gain on Sale of Vessels.
Regardless of whether the Company qualifies for exemption under Section 883, the Company will not be subject to United States federal income taxation with respect to gain realized on a sale of a vessel, provided the sale is considered to occur outside of the United States under United States federal income tax principles. In general, a sale of a vessel will be considered to occur outside of the United States for this purpose if title to the vessel, and risk of loss with respect to the vessel, pass to the buyer outside of the United States. It is expected that any sale of a vessel by the Company will be considered to occur outside of the United States.
Marshall Islands Tax Considerations
We are incorporated in the Marshall Islands. Under current Marshall Islands law, we are not subject to tax on income or capital gains, and no Marshall Islands withholding tax will be imposed upon payments of dividends by us to our stockholders.
We file reports and other information with the SEC. These materials, including this annual report and the accompanying exhibits, may be inspected and copied at the public reference facilities maintained by the Commission at 100 F Street, N.E., Washington, D.C. 20549, or from the SEC’s website http://www.sec.gov. You may obtain information on the operation of the public reference room by calling 1 (800) SEC-0330 and you may obtain copies at prescribed rates.
Item 11. Quantitative and Qualitative Disclosures about Market Risk
The international drybulk industry is a capital intensive industry, requiring significant amounts of investment. Much of this investment is provided in the form of long term debt. Our debt usually contains interest rates that fluctuate with London Inter-Bank Offered Rate ("LIBOR"). Increasing interest rates could adversely impact future earnings. In order to mitigate this specific market risk we entered into interest rate swap agreements. The purpose of the agreements was to manage interest cost and the risk associated with changing interest rates by limiting our exposure to interest rate fluctuations within the ranges stated below. Interest rate fluctuations at all times during 2006 and 2007 were within the cap and floor range, thus we paid three month LIBOR. The maximum annualized impact in terms of total debt interest payable owing to a one percent increase in interest rates, would have been approximately $3.2 million in the year ended December 31, 2007, as an indication of the extent of our sensitivity to interest rates changes, based upon our debt level at December 31, 2007.
Foreign exchange rate fluctuation
We generate all of our revenues in United States dollars and currently incur approximately 11% of our expenses in currencies other than United States dollars (mainly in Euros). For accounting purposes, expenses incurred in currencies other than into United States dollars, are converted into United States dollars at the exchange rate prevailing on the date of each transaction. We have not hedged currency exchange risks and our operating results could be adversely affected as a result. However due to our relatively low percentage exposure to currencies other than our base currency which is the United States dollar we believe that such currency movements will not have a material effect on us and as such we do not hedge these exposures as the amounts involved do not make hedging economic. The impact of a 10% increase in exchange rates, on the current level of expenses incurred in currencies other than United States dollars, is approximately $0.7 million.
Item 12. Description of Securities Other than Equity Securities
Item 13. Defaults, Dividend Arrearages and Delinquencies
Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds
Warrant Agreement Amendment
We entered into a Warrant agreement in connection with the private placement whereby we issued one fifth of a Warrant, which was attached to each Class A common share. In total 2,299,531 Warrants were issued by us. Each Warrant entitles the holder to purchase one Class A common share at an exercise price of $10.00 per share and became exercisable upon the public offering of our Class A common shares and may be exercised at any time thereafter until expiration. Each Warrant expires on November 21, 2011. In total 660,000 warrants had been exercised as of December 31, 2007 and the number of warrants as at December 31, 2007 was 1,639,531.
We and the majority of the Warrant holders agreed to amend the exercise features of the Warrants on May 7, 2007; which agreement is binding to all Warrant holders. The Warrants, as amended, may only be exercised through physical settlement, removing the prior exercise terms which also allowed the Warrant holders at their option for a cash settlement.
On October 26, 2007 the 450,000 Warrants issued to Innovation Holdings were exercised and on November 1, 2007 another 210,000 Warrants were exercised by another shareholder. We received in total $6.6 million in net proceeds and 660,000 common shares were issued from the exercise of those warrants at an exercise price of $10.00 per share.
Item 15. Controls and Procedures
a) Disclosure Controls and Procedures
Management, including our chief executive officer and chief financial officer, has conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Disclosure controls and procedures are defined under SEC rules as controls and other procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within required time periods. Disclosure controls and procedures include controls and procedures designed to ensure that information is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosures.
Based upon that evaluation, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures are effective.
b) Management’s Annual Report on Internal Control over Financial Reporting / c) Attestation Report of the Registered Public Accounting Firm
This annual report does not include a report of management’s assessment regarding internal control over financial reporting or an attestation report of the company’s registered public accounting firm on the Company’s internal control over financial reporting due to a transition period established by rules of the Securities and Exchange Commission for newly public companies.
d) Changes in Internal Control over Financial Reporting
There have been no changes that occurred during the period covered by this annual report that has materially affected, or is reasonably likely to affect, our internal control over financial reporting.
Item 16A. Audit Committee Financial Expert
We have not determined that any member of our Audit Committee constitutes a financial expert as such term is defined in Item 407 of SEC Regulation S-X. We do not believe it is necessary to have a financial expert, as defined in Item 407 of SEC Regulation S-X, because our board of directors has determined that each member of the audit committee does have the financial experience required by NASDAQ Marketplace Rule 4350(d)(2) and other relevant experience necessary to carry out the duties and responsibilities of the company's audit committee.
Item 16B. Code of Ethics
We have adopted a code of ethics that applies to officers and employees. Our code of ethics is posted in our website: http://www.Paragonship.com, under “Code of Ethics” and was filed as Exhibit 99.2 to the Form 6-K filed with the Securities and Exchange Commission on August 15, 2007 with number 001-33655. Copies of our Code of Ethics are available in print upon request to Paragon Shipping Inc., 15 Karamanli Ave., Voula 16673, Athens, Greece. We intend to satisfy any disclosure requirements regarding any amendment to, or waiver from, a provision of this Code of Ethics by posting such information on our website.
Item 16C. Principal Accountant Fees and Services
Our principal Accountants, Deloitte Hadjipavlou Sofianos & Cambanis S.A., an independent registered public accounting firm and member of Deloitte Touche Tohmatsu, have billed us for audit, audit-related and non-audit services as follows:
Audit fees paid to Deloitte Hadjipavlou, Sofianos and Cambanis S.A. in respect of 2006 were compensation for professional services rendered for the audit of the consolidated financial statements of the Company at December 31, 2006 and for the registration statements in connection with the initial public offering.
Audit fees paid to Deloitte Hadjipavlou, Sofianos and Cambanis S.A. in respect of 2007 were compensation for professional services rendered for the audit of the consolidated financial statements of the Company at December 31, 2007 and for the review of the quarterly financial information in 2007.
Item 16D. Exemptions from the Listing Standards for Audit Committees
Our Audit Committee consists of three independent members of our Board of Directors. Our Audit Committee also conforms to each other requirement applicable to audit committees as required by the applicable listing standards of the Nasdaq Global Market.
Item 16E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers
Item 17. Financial Statements
See Item 18.
Item 18. Financial Statements
The following financial statements beginning on page F-1 are filed as a part of this annual report.
Item 19. Exhibits
The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.
Dated: May 2, 2008
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Paragon Shipping Inc.
We have audited the accompanying consolidated balance sheets of Paragon Shipping Inc (the "Company") as of December 31, 2006 and 2007 and the related consolidated statements of operations, shareholder's equity, and cash flows for the period from April 26, 2006 (inception) to December 31, 2006 and for the year ended December 31, 2007. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of their internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Paragon Shipping Inc. as of December 31, 2006 and 2007, and the results of its operations and its cash flows for the period from April 26, 2006 (inception) to December 31, 2006 and for the year ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America.
Hadjipavlou, Sofianos & Cambanis S.A.
March 28, 2008
Paragon Shipping Inc.
CONSOLIDATED BALANCE SHEETS
As of December 31, 2006 and 2007
(Expressed in United States Dollars)
The accompanying notes are an integral part of the consolidated financial statements
Paragon Shipping Inc.
CONSOLIDATED STATEMENT OF OPERATIONS
For the period from inception (April 26, 2006) to December 31, 2006 and for the year ended December 31, 2007
The accompanying notes are an integral part of the consolidated financial statements
Paragon Shipping Inc.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY