SFL

Business Context and Reporting Period

Company: Ship Finance International Limited (SFL)
Filing Type: Form 6-K (Preliminary Financial Results Press Release)
Reporting Period: Quarter ended September 30, 2016
Business Overview: SFL operates a diversified fleet of 73 vessels and rigs, primarily chartered on long-term fixed-rate contracts. The company focuses on shipping and offshore markets, with significant exposure to crude oil tankers, drilling units, and dry bulk carriers.

Key Financial Metrics

Note: GAAP revenues exclude $7.2 million classified as repayment of investment in finance leases and $48.3 million from assets classified as 'investment in associate'. Adjusted EBITDA includes these items.

Material Changes vs. Prior Period

• Revenue Decline: Total charter revenues decreased by approximately $10 million (6.3%) compared to Q2 2016, primarily driven by a softer crude oil tanker market.
• Profit Share Reduction: Profit share income from crude carriers on charter to Frontline dropped to $5.4 million in Q3 from $14.0 million in Q2 due to market softness.
• Net Income Decrease: Net income fell by $6.5 million (16.7%) quarter-over-quarter, resulting in a decrease in EPS from $0.42 to $0.35.
• Asset Sales: The company successfully sold the VLCC Front Vanguard in July 2016 for net proceeds of approximately $24 million with no material P&L effect. An agreement was reached in November to sell the VLCC Front Century for approximately $24.2 million.
• Charter Amendment: Terms for five offshore support vessels were amended, reducing rates until May 2018 but extending the charter period by three years and adding a 50% profit share provision, increasing backlog by $21 million.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• Backlog: Fixed-rate charter backlog stands at approximately $3.9 billion with a weighted average charter period of nearly 9 years.
• Capital Markets: In October 2016, SFL issued $225 million in senior unsecured convertible notes due 2021 (5.75% interest). Proceeds were used to repurchase a significant portion of existing 2018 convertible notes, reducing the outstanding 2018 notes to approximately $184 million. Net cash proceeds from this transaction were approximately $40 million.
• Strategy: Management remains committed to a conservative profile, focusing on long-term charters. They anticipate opportunities in the current market due to low asset prices and a challenging banking environment for competitors.
• Drilling Market: The drilling market remains soft. The rig Soehanah is currently undergoing a survey and is being marketed for new employment in South-East Asia and the Middle East.

Risks and Contingencies

• Market Volatility: Fluctuations in charter hire rates, vessel values, and crude oil prices pose significant risks.
• Counterparty Performance: Risks related to the performance of charterers and counterparties, though most clients have performed well during the downturn.
• Regulatory and Political: Changes in governmental rules, import/export controls, and political conditions affecting shipping routes.
• Accounting Treatment: Three subsidiaries (drilling units) are accounted for as 'investments in associates' under U.S. GAAP, meaning their operating revenues and expenses are not consolidated, potentially obscuring full operational visibility in GAAP figures.

Investor Verification Checklist

• Convertible Note Impact: Verify the dilution impact and interest cost implications of the new 2021 Notes versus the repurchased 2018 Notes.
• Drilling Rig Employment: Monitor the re-chartering status of the Soehanah rig and the broader drilling market recovery.
• Profit Share Volatility: Assess the sustainability of profit share income given the recent sharp decline in the crude oil tanker market.
• Asset Sales Execution: Confirm the closing and net proceeds of the Front Century sale expected in Q1 2017.
• Liquidity Position: Review the utilization of the $175 million revolving credit facility and cash burn rate relative to the $238 million liquidity position.