Ole Hjertaker - CEO

Magnus Fyhr - GMP Securities Marcelo Brisac - Armory Fotis Giannakoulis - Morgan Stanley

Good day. And welcome to the Q3 2015 Ship Finance International Limited Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ole Hjertaker, CEO. Please go ahead.

Thank you and welcome everyone to Ship Finance International and our third quarter conference call. Our CFO, Harald Gurvin had to attend an out of town funeral today, so I'm today joined by our Senior Vice President, Andre Reppen. Before we begin our presentation, I would like to note that this conference call will contain forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. Words such as expects, anticipates, intends, estimates, or similar expressions are intended to identify these forward-looking statements. These statements are based on our current plans and expectations and involve risks and uncertainties that could cause future activities and results of operations to be materially different from those set forth in the forward-looking statements. Important factors that could cause actual results to differ include conditions in the shipping, offshore, and credit markets. For further information, please refer to Ship Finance's reports and filings with the Securities and Exchange Commission. The Board has again increased the dividend by $0.01 to $0.45 per share. This dividend represents $1.80 per share on an annualized basis or 10.7% dividend yield based on closing price of $16.85 yesterday. This is the 47th consecutive dividend and we have now paid more than $20 per share in dividends since 2004. Reported net income for the quarter was $45.5 million or $0.49 per share. But if we add back non-cash items and adjusted for sale of a vessel in the quarter, the earnings per share would have been $0.61 per share. Aggregate charter revenues recorded in the quarter, including 100% owned subsidiaries accounted for as investment in associate was $167 million and the EBITDA equivalent cash flow in the third quarter was approximately $136 million. Last 12 months, the EBITDA equivalent cash flow has been $536 million. Profit share contribution was nearly $18 million in the quarter, mainly from the front-end vessels, but also some profits related to five Handysize bulkers. The distribution of charter revenues per segment is changing with a shift from offshore to container and drybulk vessels. In the third quarter, 37% of revenues was from the offshore segment, down from 54% one year ago, and with the delivery of the new bulkers and container vessels, we expect the relative share from these two segments to increase next quarter. In the second quarter, we announced the acquisition of 8 Capesize bulkers in a sale leaseback transaction with Golden Ocean. The vessels are built between 2009 and 2013, and all vessels were delivered to us during the third quarter. The deal includes a 33% profit share, and while there was no profit share from these vessels in the third quarter, there are nearly 40 quarters remaining of these charters with profit split optionality in each of them. Excluding profit share contribution, the transaction added $480 million to our fixed rate charter backlog. In June, we announced the acquisition of three newbuilding container vessels between 9,300 and 9,500 TEU. The vessels are under construction at two shipyards and first vessel is due for delivery later this week, and the other two vessels are scheduled for first quarter 2016 and second quarter. The vessels have been chartered out to Maersk Line for a period of 5 years fixed plus two years options, and the transaction added more than $200 million to our fixed rate backlog. We estimate average EBITDA from these vessels to more than $32 million per share after delivery, and net of financing, the remaining CapEx was $36 million at quarter end. We've also recently agreed to acquire some other large container vessels with scheduled delivery in 2016 and 2017. This is in combination with long-term charters to a large container line, but due to confidentiality issues we can unfortunately not disclose any details relating to the vessels or the charters at the moment. The financing is already sourced, and net CapEx for Ship Finance is limited to approximately $45 million with the majority payable on delivery of the vessels. While we cannot comment any further on this transaction at the moment, we see the transaction as accretive and it meets our risk return preferences. The new Frontline profit share arrangement contributed $16.6 million in the quarter, nearly double the cash contribution we had in previous quarters based on the old agreement with Frontline. This was based on Frontline VLCCs generating average $45,600 per day and Suezmaxes $28,100 per day respectively as reported by Frontline earlier today. Going forward, based on near-term market guiding by Frontline, where they say that 80% of VLCC days in the fourth quarter has been covered at $68,500 per day on average, the profit split in the fourth quarter could be significantly higher despite the recent sale of the old Suezmax tankers. In July, Frontline and Frontline 2012 announced their agreement to merge and the special general meetings are scheduled for November 30. Our shareholders on share holding after the merger will be approximately 7%, and we look forward to the potential for dividends from Frontline on the back of a strong tanker market where they indicate that the dividend could be declared and paid already in December. Divesting all the vessels is a part of the company’s strategy to renew and diversify the fleet, and we have recently agreed to sell three older Suezmax tankers. In September and October, we sold 20-year-old vessels Front Glory and Front Splendour; and in December, we will sell the 17-year-old vessel Mindanao. All the sales have been to unrelated third parties and the price level achieved reflects the current strong tanker market. Following the sale of the three Suezmax tankers, we will have 12 VLCCs and two Suezmaxes remaining on charter to a subsidiary of Frontline. The new profit sharing arrangement gives us interesting leverage to the tanker market and takes in at relatively low levels. And the profit splits is now calculated and paid on a quarterly basis. The forward market as illustrated by the TD3 forward rates currently quoted at approximately $50,000 per day for 2016 indicates expectations for a fair market at least the next 12 months. At this level, the net contribution per share from the Frontline vessels would be above $0.30 per share per quarter after profit split. But there is outside potential here, and if the guiding from Frontline for fourth quarter VLCC earnings at $68,500 per day for 80% of vessel days should materialize, we would be outside the graph as illustrated here on this slide. And in addition, we also have cash flow from the amortizing Frontline notes and dividend potential. In addition to the Frontline vessels, we also have exposure to the crude oil tanker market through two modern Suezmax tankers. For these vessels, the average charter rate was approximately $44,000 per trading day compared to our breakeven level of approximately $17,000 per day after interest and amortization for the vessels. As there have been a lot of focus on the drilling sector recently in light of low oil price and the softening charter market for rigs, I think it is worthwhile to take a quick look at our drilling assets and counterparties. In 2008, we acquired three ultra-deepwater drilling assets from Seadrill at a cost price of more than $850 million per rig and we financed them with $700 million in the bank market. These deals were all on the back of strong subcharters for the rigs and we structured it with front heavy charter payments. Seadrill exercised the purchase option for one other rigs last year and for the two other rigs we have amortized more than 50% of the loans, and Seadrill is currently enjoying significantly lower charter rates on the rigs compared to where we started. The average drybulk equivalent charter rate for the two deepwater rigs is approximately $140,000 per day and one other rigs still have a subcharter of around $450,000 per day until 2017. The harsh environment jackup drilling rig West Linus has the subcharter to ConocoPhillips at the rate of $330,000 per day until 2019 and there is no termination right for ConocoPhillips in that charter as long as to rig the forms. And during this charter the debt will be reduced from $475 million initially to $237.5 million after only five years. Thereafter we will still have 10 years remaining charter to Seadrill, but then as a significantly lower rate for Seadrill giving them a comfortably low breakeven rate. We also have a jackup drilling rig on charter to Indonesia based Apexindo. This is a 375-foot jackup drilling rig built in 2007 in Singapore and which has been working for Total in Indonesia from new until September this year. The chartering counterparty is a Dutch subsidiary of Apexindo but fully guaranteed by the parent. Given the soft drilling market and near-term outlook for employment in Southeast Asia, we may make some adjustment to this charter, but we have reduced leverage to only $25 million currently so we should have good flexibility from a breakeven perspective. The broker value as an illustration for this vessel -- for this rig, sorry, was more than $140 million in September, so there is significant bump to the leverage we have and also to a book value which is less than $100 million historically. But given the soft drilling markets currently we expect of course negative pressure on broker valuations going forward in the segment. The graph on the page is illustrating the initial leverage when we acquired these rigs and outstanding loan balance net of undrawn committed amounts of $175 million at quarter end. This illustration clearly demonstrates the breadth of delevering they have had always built-in to our drilling rig finances. Most of our vessels are charted out on long-term basis and we still have nearly nine years weighted average charter coverage. Full details on a vessel by vessel basis and including the new Frontline structures and the three 9,300 to 9,500 container vessels, it's available by contacting us via or webpage under the contact heading in Investor Relations. We have more than $4 billion of fixed rate order backlog and this is excluding the recent agreement to acquire some large container vessels. The estimated EBITDA equivalent backlog is more than $3.2 billion or around $0.34 per share. These numbers includes the new and reduced base rate from the front-end vessels and do not include any contribution from the various profit spilt arrangement nor does it include cash flows from the two Suezmax vessels operated in the spot market. As the backlog is based on fixed rate charters only, we have not included revenues from any vessels after the end of the current charter period. And we keep expanding our customer base and have now 17 chartering counterparties in total. If we then switch to our performance last four months, the normalized contribution from our projects including vessels accounted for us investment in association based on U.S. GAAP. The EBITDA which we define as charter higher plus profit share less operating expenses and general and administrative costs was $536 million in the period. Net interest was $103 million or approximately $1.10 per share and our normalized ordinary debt installments relating to the company's project was around $190 million or approximately $2 per share. This is excluding prepayments relating to sale of all their assets. Net contributions after this is $244 million or $2.60 per share in the last 12 months. For the same period we have declared dividends of $1.74 per share or $163 million in aggregate. This is well below our historic average payout ratio of approximately 75% since 2004. On the operational performance slide, we have shown our pro forma illustration of cash flows for the third quarter compared to the second quarter. Please note that this is only a guideline to assess the company's performance and this is not accordance with U.S. GAAP. For the third quarter, total charter revenues before profit split were $146 million or $1.56 per share up from $134 million in the previous quarter. The main reason for the increase is the delivery of the eight Capesize drybulk carriers in the third quarter, which on average where on charter for 60% of the quarter. These will have full cash flow effect in the fourth quarter. Revenues for the VLCCs and Suezmaxes on charter to Frontline were also slightly up during the quarter following the realized agreement effective July 1, while the revenues from the two Suezmaxes trading in the spot market grew up due to the strong spot market in the third quarter. Vessel operating expenses and general and administrative expenses were $33 million compared to $26 million in the previous quarter. The increase is due to the delivery of the eight Capesize drybulk carriers and also increased operating expenses on the tankers and charter to Frontline, which increased from $6,500 per day to $9,000 per day under the revised agreement. We recorded a profit share of $16.6 million under the new 50% profit share agreement with Frontline which is now payable on a quarterly basis and we also recorded approximately $1 million profit share relating to five of the Handysize drybulk carriers. So overall, this summarizes to an EBITDA of $136 million for the quarter or $1.45 per share up from $125 million in the previous quarter. We then move on to the profit and loss statement as reported on the U.S. GAAP. As we have described in the previous earnings calls, our accounting statements are slightly different than those on -- of a traditional shipping company. As our business strategy focuses long-term charter contracts, a large part of our activities are classified as front-end leases. And as a result, a significant portion of our charter revenues are excluded from U.S. GAAP operating revenues and instead booked as revenues classified as repayment of investment in finance lease in our profit and loss statement. We also have some revenues classified as results in associates and long-term investments and also interest income from associates which are effectively charter higher when cash flow coming from our 100% owned subsidiaries. If you wish to gain more understanding of our accounts, we have also this quarter published a separate webcast which explains the finance leasing accounting and the investments in associate in more detail. This webcast can be viewed on our Web site which is shipfinance.bm under Investor Relations and sub-heading webcasts. Overall, for the quarter, we report total operating revenues according to U.S. GAAP of $111 million which includes $16.6 million in profit sharing from Frontline. As mentioned, the increasing both charter revenues and OpEx is mainly due to the eight drybulk carriers which is an average wear on charter for 60% to the quarter and the increased fixed OpEx on the Frontline vessels. We also recorded a gain of $3.4 million on the sale of the 20-year-old Suezmax tanker Front Glory and subsequent to quarter end; we have sold two more Suezmax tankers, the first of which has already been delivered and the second with expected delivery in December. Total operating expenses were $55.5 million resulting in net operating income of $59 million. We also recorded a negative non-cash mark-to-market or derivatives of $12.4 million during the quarter and $2.8 million non-cash deferred charges. So overall, and according to U.S. GAAP, the company reported net income of $45.5 million or $0.49 per share and adjusted for one-off and non-cash items, the result was $57 million or $0.61 per share. Moving to the balance sheet, we showed $60 million of consolidated cash end of the quarter, in addition, we had approximately $229 million freely available -- for draw down under revolving credits. Available for sale securities of $40 million relate to investments in tradable securities as a short-term liquidity placement. In addition, we have $114 million in amortizing Frontline notes which are included in amount due from related parties on the current and long-term assets. The notes are conservatively reported in our balance sheet at 74% of par value on average at quarter end. Investment in associates includes our 55 million shares in Frontline with a book value of $150 million. On the debt side, we had approximately $1.8 billion of consolidated interest bearing debt outstanding at quarter end, which includes approximately $1.1 billion in bank loans and $630 million in senior unsecured notes. In addition our 100% owned subsidiaries accounted for investment in associate at approximately $850 million in bank loans at quarter end. The debt in these subsidiaries are not included in the consolidated accounts. Stockholders equity was approximately $1.2 billion at the end of the third quarter giving a book equity ratio of 38%. Then looking at our liquidity remaining CapEx, as mentioned the company had total available liquidity of approximately $289 million at the end of the quarter which includes the $60 million cash on hand and the $229 million availability under revolving credit lines. We also had a total of $155 million in available for sale of securities and note at quarter end including the $114 million Frontline notes as previously described. On the CapEx side, we have total remaining CapEx of $246 million at quarter end relating to the three new building container vessels we agreed to acquire in June. We have arranged a bank financing of $210 million at very attractive terms to part finance acquisition and the net remaining CapEx is limited to $12 million per vessel, which is payable on delivery of the relevant vessel from the shipyards. The first vessel is expected to be delivered later this week and the two remaining vessels in the first and second quarter next year. Subsequent to quarter end, we have also entered into agreements for certain other large container vessels with expected delivery in late 2016 and early 2017. The estimated net CapEx on these vessels is $45 million after financing. We are comfortable in compliance with all financial covenants under our loan agreements at quarter end and we have very limited refinancing requirement over the next years. It is worth nothing that the finance has been in full compliance with all financial covenants for each of the 47 quarters since the company was established which gives us a very strong standing in the banking market. Then to summarize, the Board has declared an increased quarterly cash dividend of $0.45 per share for the quarter. This represents a dividend yield of 10.7% based on closing price yesterday. Net income for the quarter was $45 million or $0.49 per share but adjusted for one of the non-cash items the result was $0.61 per share. We have continued upside potential than the new profit share agreement with Frontline and there are good prospects for dividends from Frontline going forward. We have taken delivery of all eight Capesize dry bulk carriers, which immediately commenced our 10 year charters to Golden Ocean and we have agreed to acquire several newbuilding container vessels with long term charters. And we have significant investment capacity available for new accretive investments. And with that, I give the word over back to the operator, who will open the line up for questions.

Thank you. [Operator Instructions] We will now take our first question from Magnus Fyhr of GMP Securities. Please go ahead. Your line is open.

Thank you. Congrats to a great quarter and increase in dividend. Just a couple of questions. Starting you continue to see new investments in the container area, is that where I mean given the weakness in drybulk and offshore, is that where we're going to expect most of the investments going forward or with the asset values lagging in the tanker market, could you potentially see some opportunities there?

Yes. We're looking at opportunities, I would say across the board in all our segments. I would say, we would be more careful at the moment in the offshore space simply because of the dynamics in that market, but we are looking at other opportunities both on tankers, container vessels, and drybulk vessels at the moment. For container vessels, what we have seen is the technology change where we see that the liner companies are very interested still in the new and modern more efficient units. While the bigger problem, I think will be for older units, which don't have the new eco features and which are designed for much higher speeds, basically made much more narrow and therefore have different loading capacities. So despite the relatively -- the very soft books -- you call it books rate market for the liner companies, they are still very keen to get more of the efficient assets, which is maybe illustrated by the vessel that we will take delivery of later this week where the charter at Maersk is urging us to get that vessel ready as quick as we can simply because they want to slot into their services. So we see more opportunities there, and I think if anything with the relative softness in some of the market segments that makes it more interesting to invest, because when we invest, we invest for the long-run and not necessarily on the backlog short-term movements in the underlying spot market. So investing in the low-end like we did for the drybulk vessels, we invested assets at whole quite substantially in value made that entry point more interesting.

And do you think the tankers are a little too far into the cycle or are there opportunities there that you are currently looking at?

Well, there are definitely opportunities there as well. You generally don't see that many long-term charter opportunities on the tanker side, but we are looking at some opportunities there as well, and of course, if we see deals that match our risk reward parameters, we would be keen also to invest in tankers. I would say generally, the replacement costs, the newbuilding prices are at relatively low levels -- historic low levels, I would say. And that could make an interesting entry point into many of these segments if you are investing for the long run.

Right. And moving over, I mean you have the strong liquidity position, can you elaborate a little bit, you have a convert coming due early next year, a little bit of your thoughts there and what your options are?

Yes. We have $125 million convertible loan coming due in February, and for that loan, we have of course several options, I mean we can repay it with our cash at hand or we can even settle that to convertible with shares. We will of course not comment anything specifically on that until we have to which is essentially 30 days before maturity of that bond loan, but I think given our strong liquidity position, I don't think anyone would doubt our ability to what you say -- to take that out in cash or utilize any of the other options if we think that is more beneficial for the company.

Okay. Thank you. That's all I had.

Yes. Thank you.

Thank you. We will now take our next question from Marcelo Brisac of Armory. Please go ahead. Your line is open.

Hi, good afternoon, and thank you very much for the call. I was just wondering, if you can clarify a little bit what were the charges on derivatives, and I understand they were non-cash, we are just trying to see where they are coming from, is there any offset to that or if eventually the non-cash item is going to become a cash item, just trying to understand a little bit here. Thank you.

Yes. Thank you. We had $12.4 million in non-cash mark-to-market on derivatives which are interest rate swaps. What we have focused on for the company is to ensure that we have long-term hedges in place for financings, which is also matching the cash flow. Under U.S. GAAP, there is a very rigorous analysis leading up to whether it qualifies for hedge accounting where it will not flow over P&L and whether it does not specifically qualify for hedge accounting in the U.S. GAAP and therefore flows over the P&L. And the consequence of that given our significant hedge portfolio is that $12.4 million -- there was a $12.4 million impact this quarter. Last quarter, we had a positive impact of around $5 million. So this could go both ways depending on interest rate levels. Of course, when interest levels comes down, we have a negative impact and if it goes up, we have a positive impact. At least when you look at the interest rate levels currently where you have five-year swap rates at 1.6% which is close to 10 year low levels., I would say that we could hope that there would be more, call it, upside potential than downside potential with interest rates moving up. Overall, I would say that our agenda here is to ensure that we hedge our cash flows and whether or not we are qualified for hedge accounting on the U.S. GAAP, we think is secondary, but of course we see that from time-to-time where we have movements in interest debt levels, we have this what we say, unfortunate non-cash movements on our P&L.

And so basically that's a hedge to your financing and the offset to debt would be lower financing expenses over the next several years, right?

That is correct. So typically when we make a charter, for instance for the three container vessels that we have recently acquired, we have agreed to a $210 million financing for these containerships, but -- and we have not yet hedged interest under those loans. That is something we would probably do overtime because we believe that when we have made the charter, we have this ability in cash flows, we have structured the financing, then we think it makes sense for us to also look in the interest rate curve effectively so we don't, what we say, speculate on interest rate movements over time. I would also say that when we make investments of course we make assumptions for interest rate levels -- long-term interest debt level swap rates on forward curves and generally over the last few years we have managed to swap at more attractive levels than what we have used in our calculations when leading up to the investments.

Okay. Thank you.

Thank you.

Thank you. We will now take our next question from Fotis Giannakoulis at Morgan Stanley. Please proceed. Your line is open.

Yes. Hi, Ole. And congratulations for a great quarter. I want to ask you how do you view the residual risk in terms of the offshore vessels? I understand that the debt is -- it is at quite low levels, but is there anything there that we should be concerned, any restructuring or renegotiating of the contracts? And also, how do you view the investment of this capital when this contracts expire and you will have to recover the cash flow from new projects?

Yes. The main bulk of our rig exposure is linked to Seadrill, and two, deepwater rigs we acquired in 2008 and one jackup drilling rig we acquired in 2014. All these three rigs have 15 year charters, whether our purchase obligations or quick call at the end of the charter for each of them. So that means that for instance, the West Hercules, which has a charter running up to 2023, there is a purchase obligation at the end of Seadrill at $135 million. So when we get on to 2023, they have to repurchase it at that level and then we have to reinvest that capital. We believe that we -- hopefully should be able to reinvest that capital in an accretive manner. If we are not able to reinvest it, of course, then we would sit with that amount in cash. The same also goes for West Taurus very similar deal their purchase obligation is $149 million and for the West Linus, again, this is the charter that runs out to 2029 there is purchase obligation of -- let me just think -- I have to get back to you on that -- its all spread out in the charter backlog that we distribute over time. But -- so we have a yes, we have a reinvestment issue at the very end of the charter period, but we think that is manageable from an overall portfolio perspective. We also have a jackup drilling rig at 2007 built rig, which is on a shorter charter to an Indonesian operator called Apexindo. That charter -- the sub-charter has ended so the rate case ideal at the moment, but here we are looking at our modern rig, we think it's got a long remaining useful life. And we will see what we could do -- maybe we could adjust the rates on what and stretch it or there are alternatives there. But nothing I would say that would be material or dramatic for the company.

Given the situation in both offshore market and the drybulk sector, have there been any discussions over potential restructuring of this contract in exchange for longer duration or higher upside? And also if you would like to comment about the opportunities in the drybulk, I heard earlier Herman Billung talking about that if you had more capital he would love to invest at the current asset prices, whether you share this use and whether we can see you getting into more sale lease back transactions in the drybulk sector?

Yes. I cannot speak -- discuss specific kind of discussions we might have, but I would maybe just make a general comment, which is -- I will be using Frontline as an illustration -- where we agree to restructuring with Frontline back in 2011 leading up to the final adjustment earlier this year, where we -- and what we got out of that was a combination of cash back in 2011, we got our cash sweep structure and now we got an improved profit split of lower base rate levels. So our objective is of course, all the way to take care of our interest, our shareholders interest and try to maximize upside if and when there are -- if and when there is requirement to do some adjustments. But on an overall basis, from a portfolio perspective, it's a very small proportion of our activity that could be potentially at -- call it -- at risk of having to do some adjustments. But rest assured we will make sure we take care of our company's interest.

And regarding the opportunity for drybulk?

Exactly. So regarding opportunities in drybulk, we see of course, the drybulk market being at almost historic low levels, quite right now. Of course, when we make our investments, we make investments based on the long run and not what we say short-term fluctuations in the market. What we see now is we have quite attractive replacement cost levels. And of course, in soft markets, you could also be able to pick up assets at very attractive prices from, what we say motivated sellers. So yes, we could definitely do more -- we also do more charters in the drybulk market similar type of deals that we did with Golden Ocean. But of course, if you look at these different segments over time, we have seen that in the drybulk space there have been much more, we call it counterparty defaults than they have been in most of the other segments. So we have to be very careful with who we charter to and how we structure the deal. So we don't risk in soft markets that they are not able to pay the charter.

Thank you very much, Ole.

Thank you.

Thank you. [Operator Instructions] We do not have any further questions at this time. I will pass it back to the speakers.

Thank you. Then, I would like to thank everyone for participating in our third quarter conference call. If you have any follow-up questions, there are contact details in the press release or you can get in touch with us through the contact pages on our webpage shipfinance.bm. Thank you.

That would conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.