SFL

Business Context and Reporting Period

Company: Ship Finance International Limited (SFL)
Filing Type: Form 6-K (Foreign Private Issuer)
Reporting Period: Second Quarter ended June 30, 2012 (Preliminary results announced August 28, 2012)
Business Overview: SFL operates a fleet of 68 vessels and rigs, primarily chartered on long-term, fixed-rate contracts to provide stable cash flows. The company is actively renewing its fleet, having delivered seven new drybulk vessels and sold six older OBOs and VLCCs over the preceding year.

Key Financial Metrics

Note: GAAP revenues exclude $14.8 million classified as repayment of investments and $88.0 million of charter revenues from assets classified as 'investment in associate'.

Material Changes vs. Prior Period

• Net Income Surge: Net income increased significantly from $39.0 million in Q1 to $61.2 million in Q2, driven primarily by a one-time book gain of $21.7 million related to the termination of Horizon Lines charters.
• EBITDA Decline: Adjusted EBITDA decreased slightly from $154 million to $151 million, reflecting stable underlying operations despite the accounting gain.
• Cash Sweep Accumulation: The cash sweep agreement with Frontline generated $16.3 million in Q2, bringing the year-to-date total to $29.9 million.
• Asset Portfolio Shift: The company continued its fleet renewal strategy, selling older assets and taking delivery of newbuildings, resulting in a reduction of net capital expenditure requirements for the remainder of 2012.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• Market Conditions: Management notes a challenging spot market for many segments, with secondhand and newbuilding prices falling to decade lows. However, the crude oil tanker market softened in Q3 after a firm Q2.
• Investment Strategy: SFL remains conservative but views low asset prices and tight banking conditions as potential opportunities for selective investment in modern assets to build long-term distribution capacity.
• Capital Expenditures: Remaining net capital expenditures are low, estimated at approximately $3 million for the second half of 2012 and $23 million for 2013, as most newbuildings are already financed.
• Dividend Policy: The company has paid dividends for 34 consecutive quarters and maintains a strategy of long-term fixed-rate charters to support predictable dividend capacity.

Risks and Contingencies

• Charterer Default: Hong Xiang failed to pay charter hire for approximately three months on four Handysize drybulk carriers. While sub-charter collections recovered some amounts, SFL is aggressively pursuing recovery of the remaining receivables and damages from Hong Xiang and its parent company, Beijing Jianlong Group.
• Market Volatility: A persistent soft market could adversely affect the cash sweep receivable for the full year. Feeder-size container vessel rates remain soft ($6,000–$7,500/day).
• Accounting Treatment: Significant assets (drilling units and container vessels) are accounted for as "investments in associates" rather than consolidated subsidiaries, meaning their operating revenues and expenses are not fully reflected in the consolidated income statement.

Key Facts for Investor Verification

• One-Time Gains: Verify the sustainability of Q2 earnings, as the $21.7 million gain from Horizon Lines charter termination is non-recurring.
• Non-GAAP Reconciliation: Review the reconciliation of Net Income to EBITDA, noting the exclusion of $88 million in charter revenues from "investment in associate" assets.
• Receivable Risk: Monitor the recovery status of the $4.2 million trade receivable related to Hong Xiang and the potential for further legal action.
• Cash Sweep Thresholds: Assess the impact of softening crude oil tanker markets on the $29.9 million year-to-date cash sweep accumulation from Frontline.
• Deferred Equity: Note that Stockholders' Equity excludes $159.2 million of deferred equity related to Frontline vessel acquisitions, which is amortized over time.