TOPS

Business Context and Reporting Period

Company: TOP SHIPS INC.
Filing Type: Form 20-F (Annual Report)
Period Ended: December 31, 2008
Business Overview: Top Ships Inc. is an international provider of seaborne transportation services, operating a fleet of tankers and drybulk vessels. The company reported results for two segments: Tanker Fleet and Drybulk Fleet. During 2008, the company significantly reduced its fleet size by selling seven owned Suezmax tankers and one Panamax drybulk vessel, while simultaneously unwinding sale-and-leaseback agreements to reduce charter hire expenses. The company diversified into the drybulk sector in late 2007, which contributed significantly to 2008 profitability.

Key Financial Metrics (Year Ended Dec 31, 2008)

Note: All debt was classified as current liabilities in 2008 due to covenant breaches and cross-default provisions.

Material Changes vs. Prior Period

• Profitability Turnaround: The company returned to profitability in 2008 with a net income of $25.6 million, compared to a net loss of $49.1 million in 2007. Operating income improved by $90.8 million.
• Revenue Composition: Total revenue increased slightly by 2.0%. However, Tanker Fleet revenue decreased by 34.1% due to fleet reduction, while Drybulk Fleet revenue surged by 3,663.9% as the segment entered its first full year of operation.
• Expense Reduction: Charter hire expenses dropped 43.0% to $53.7 million following the termination of six sale-and-leaseback agreements. Voyage expenses decreased 34.9% due to fewer vessels operating in the spot market.
• Debt Restructuring: Total indebtedness decreased to $342.5 million. Due to breaches of financial covenants (asset cover ratio, adjusted net worth), the entire debt balance was reclassified as current liabilities.
• Non-GAAP Metric: Average Daily Time Charter Equivalent (TCE) rate increased 30.8% to $35,862, driven by high rates on drybulk vessels and improved tanker utilization.

Guidance, Outlook, Risks, and Contingencies

Going Concern Uncertainty

The independent auditors issued an unqualified opinion with an explanatory paragraph emphasizing substantial doubt about the company's ability to continue as a going concern. This is due to:

• Covenant Breaches: The company is in breach of minimum asset cover, adjusted net worth, and liquidity covenants with multiple lenders (RBS, HSH Nordbank, DVB, Alpha Bank, Emporiki Bank).
• Waivers and Negotiations: As of the filing date, waivers were received from HSH Nordbank and Alpha Bank until March 31, 2010. Negotiations were ongoing with RBS, DVB, and Emporiki Bank. Failure to secure waivers could result in debt acceleration.
• Liquidity Shortfall: The company reported a working capital deficit of $329.8 million. Management estimates a cash shortfall of $57.7 million for the coming 12 months, assuming lenders do not accelerate debt. The company plans to address this via an equity offering in the second half of 2009.

Market Risks

• Charter Rates: The Baltic Drybulk Index (BDI) and Baltic Tanker Indices declined significantly in late 2008. While the company has mitigated risk by securing long-term time and bareboat charters for most of its fleet, spot market exposure remains for one drybulk vessel.
• Asset Impairment: Management performed impairment tests as of December 31, 2008, and concluded no impairment was necessary. However, the filing notes that continued depressed charter rates could trigger future impairment charges.
• Derivatives: The company incurred a $12.0 million loss on financial instruments in 2008 due to adverse interest rate fluctuations and the termination of a derivative product.

Key Facts for Investor Verification

• Debt Acceleration Risk: Verify the status of covenant waivers with RBS, DVB, and Emporiki Bank. If waivers are not granted, the $342.5 million debt could be called immediately, which the company states it cannot repay.
• Equity Financing: Confirm the initiation and success of the planned equity offering in the second half of 2009 to cover the projected cash shortfall.
• Lease Termination Costs: Verify the impact of termination fees paid in 2009 ($14.25 million total for five leases) on remaining cash reserves.
• PFIC Status: Note the risk that the company may be classified as a Passive Foreign Investment Company (PFIC) for U.S. tax purposes if the fleet composition remains heavily weighted toward bareboat charters (67% as of March 2009).
• Stock Price Volatility: The stock price dropped significantly from a high of $10.62 in 2008 to a low of $0.77 in March 2009, reflecting market concerns over the company's liquidity and covenant breaches.