SFL

Business Context and Reporting Period

Company: Ship Finance International Limited (SFL Corp Ltd.)
Filing Type: Form 6-K (Report of Foreign Private Issuer)
Reporting Period: Six months ended June 30, 2010 (Unaudited)
Filing Date: November 12, 2010

SFL is a Bermuda-based international ship-owning company. As of June 30, 2010, its fleet consisted of 31 oil tankers, eight OBOs (configured for drybulk), one drybulk carrier, eight container vessels, one jack-up drilling rig, six offshore supply vessels, two chemical tankers, and three ultra-deepwater drilling units. The company operates through subsidiaries and partnerships globally. A significant portion of its revenue (72%) is derived from related party transactions, primarily with Frontline Ltd.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Total operating revenues decreased by approximately 12% ($21.5 million) compared to the prior year. This was primarily driven by a reduction in direct financing and sale-type lease interest income ($14.2 million decrease) and finance lease service revenues ($6.3 million decrease). These declines resulted from vessel sales in 2009 and early 2010, and the reclassification of four non-double hull tankers from finance leases to operating leases.
• Net Income Increase: Despite lower operating revenues, net income increased by 5% ($4.4 million). This was largely due to a $27.7 million gain on the sale of two vessels (Front Vista and Front Lord) in the current period, offsetting the revenue decline. Additionally, the prior year included a $26.8 million vessel impairment charge which was absent in the current period.
• Expense Reduction: Total operating expenses decreased significantly by $31.8 million. Ship operating expenses dropped 13% due to vessel sales and charter changes. The absence of the $26.8 million impairment charge in 2010 was a major factor in the expense reduction.
• Interest Expense: Interest expense decreased by $10.6 million, primarily due to lower interest-bearing debt levels (specifically the repayment of unsecured fixed-rate debt and repurchase of Senior Notes) and lower LIBOR rates (0.35% average in 2010 vs. 1.04% in 2009).
• Other Financial Items: Shifted from a net gain of $27.6 million in 2009 to a net cost of $13.8 million in 2010. The 2009 gain included a $20.6 million gain on the repurchase of Senior Notes. The 2010 cost was driven by $13.1 million in mark-to-market losses on financial instruments.

Guidance, Outlook, and Risks

Management Commentary & Outlook: The company maintains a diversified asset base across eight asset types. Most vessels are on long-term fixed-rate charters (4 to 17 years remaining), providing stable cash flows. The company has contracted for newbuildings (one container vessel and seven drybulk carriers) with deliveries between 2010 and 2012, most of which are already secured on medium-to-long-term charters.

Subsequent Events (Post-June 30, 2010):

• Declared a dividend of $0.35 per share in August 2010.
• Agreed to acquire three Supramax drybulk carriers for ~$100.7 million and two additional Supramax carriers for ~$61 million, with long-term charters secured.
• Placed a new senior unsecured bond loan of NOK 500 million (~$85 million) in October 2010.
• Sold the vessel Front Sabang in August 2010 for net proceeds of $13.2 million.

Risks and Contingencies:

• Concentration Risk: Frontline Ltd. accounted for 72% of operating revenues. The company relies heavily on the performance of this related party.
• Regulatory Risk: Six non-double hull VLCCs are subject to IMO regulations restricting operations from 2010 onwards, with charterers holding termination options.
• Interest Rate Risk: While the company uses swaps to fix rates on $1.1 billion of debt, it remains exposed to floating rates on the remainder of its debt portfolio.
• Counterparty Risk: Significant exposure to related parties (Frontline, Seadrill, Deep Sea, Golden Ocean) regarding lease payments and purchase options.

Investor Verification Checklist

• Related Party Dependence: Verify the stability of the 72% revenue concentration with Frontline Ltd. and the terms of the profit-sharing agreements.
• Asset Sales Impact: Confirm the sustainability of net income given the $27.7 million one-time gain on asset sales in the current period.
• Debt Maturity Profile: Review the debt repayment schedule, noting $92.8 million due in the remaining six months of 2010 and $214.6 million due in 2011.
• Non-Double Hull Vessels: Assess the risk of charter terminations for the six non-double hull VLCCs subject to IMO regulations.
• Derivative Valuation: Examine the $13.1 million mark-to-market loss on financial instruments and the effectiveness of the interest rate swap hedging program.