Ole Hjertaker - CEO Harald Gurvin - CFO

John Reardon - Western International Magnus Fyhr - Seaport Global Richard Diamond - Strait Line Capital

Welcome to the Second Quarter 2016 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 Mr. Ole Hjertaker, the CEO. Please go ahead, sir.

Thank you and welcome all to Ship Finance International and our second quarter conference call. With me here today I have our CFO, Harald Gurvin and 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 declared a quarterly dividend of $0.45 per share. The dividend represents $1.80 per share on an annualized basis or nearly 12% dividend yield based on closing price of $15.16 yesterday. This is the 50th consecutive dividend and we have now paid over $1.7 billion in dividends since 2004 which is more than $21 per share. Aggregate charter revenues recorded in the quarter including 100%-owned subsidiaries accounted for [indiscernible] investment in associate was $159 million and the EBITDA equivalent cash flow in the second quarter was approximately $128 million. Last 12 months, the EBITDA equivalent cash flow has been $545 million from our assets. The reported net income for the quarter was $38.8 million or $0.42 per share. This is after more than $6 million of non-cash mark to market of interest rate swaps and other non-cash items. Adjusted for these items, the net income would have been $0.48 per share. And we continue our fleet renewal and have recently sold an older [indiscernible] intake and delivery of a new building container vessel. And this process is important in order to maintain and build our distribution capacity over time. We have a long term perspective and over the last 10 years, we have invested on average more than $700 million per year and increased our charter backlog significantly. If you look at distribution of charter revenues per segment, this is changing over time as well, with a continuing rebalancing from offshore container and drybulk vessels. In the second quarter, 32% of revenues was from the offshore segment, down from 40% one year ago and more than 50% a year before that. And with the delivery of the new container vessels, we expect the relative share from this segment to continue increase going forward. We have now taken delivery of all three container vessels to Maersk Line. The last vessel was delivered in May and we will have full cash flow effect in the third quarter. The charter period is five-year fixed plus two optional years and we estimate average EBITDA from these vessels to more than $32 million per year after all vessels [indiscernible] have been delivered. We also have two large 19,200 TEU container vessels in the pipeline with scheduled delivery in late 2016 and early 2017. This is in combination with long term bareboat charters to Mediterranean Shipping Company or MSC, the world's second-largest container line. We estimate average EBITDA from these vessels to $31 million per year after delivery and financing is by way of a finance lease matching the term of the charter. This financing is without recourse to Ship Finance and the remaining net CapEx is $30 million or $50 million per vessel payable on delivery. In addition, we have two 114,000 deadweight ton product tankers, also called LR2 type, under construction with delivery scheduled for second half 2017. The vessels have been chartered out on time charter basis for a period of seven to 12 years to Philip 66. The exact period will be set later this year but the minimum period represents a backlog of approximately $113 million. The aggregate annual EBITDA contribution from the vessels is estimated to approximately $11 million on average. Remaining yard payments on these vessels are approximately $43 million per vessel and we will arrange debt financing in due course. Given the financial strength of our charter and experience from other recent financings, we believe this deal will be very easy finance and we have already received interest from several financing institutions. Divesting of older vessels is part of the Company's strategy to renew and diversify the fleet and we have recently sold the 18-year-old VLCC Front Vanguard with delivery in early July. Net proceeds from the sale was approximately $24 million, including approximately $300,000 compensation due from Frontline. The vessel will be used for a storage project and will therefore exit conventional trading in the spot market, effectively reusing capacity in the market. In July, we also agreed to amend the charters for five offshore supply vessels with an affiliate of Deep Sea Supply. The old charter guarantor was a 50-50 owned joint venture between Deep Sea and the Brazilian company BTG Pactual. Deep Sea is now in the process of acquiring the remaining shares of the joint venture company and following the acquisition Deep Sea will be your charter guarantor going forward. Ship Finance has agreed to reduce the charter rates until May 2018 in exchange for extending the charter period by three years and introducing a 50-50 profit share on charter revenues earned by the vessels. This will be combined with a prepayment of $17 million on our bank loan facilities equal to scheduled amortization until May 2018. The net effect on our distributable cash flow will be neutral, with reduced charter higher balance by reduced loan amortization and lower interest expenses. We will effectively increase our backlog by approximately $21 million and still maintain this distributable cash flow from the vessels. In addition, we will now have optionality through the 50% profit share which could be valuable in a market recovery scenario. We now have 11 VLCCs and two Suezmaxes remaining on charter to a subsidiary, Frontline, down from nearly 50 vessels at the peak in 2004. The profit-sharing arrangement on these vessels gives us interesting leverage through the tanker market and peaks in already from $20,000 per day for the VLCC's. Last year, we also changed a profit split calculation basis from annual to quarterly basis, adding optionality value for us. And as we can see on the right side of this slide, the actual charter revenues were significantly higher than the backlog going into the quarter, illustrating the upside potential from profit-sharing arrangements and spot trading vessels. The forward market, as illustrated by the TD3 forward rates on the left side of the slide, is currently quoted at $27,000 per day for the fourth quarter this year which is below first and second quarter, but still at levels that would generate significant profit shares for us. At this level, the net contribution per share from the crude oil tankers is estimated to nearly $0.20 per share if the rates materialize. And in addition, we also have the dividend potential from our $11 million Frontline shares with a dividend payout of $2.2 million due in the third quarter alone based on the $0.20 dividend announced today. In total, we will then have received more than $13 million in cash dividends from Frontline the last 12 months. And in addition to the Frontline vessels, we also have exposure to the crude oil tanker market through two modern Suezmax tankers which have traded in a pool with sister vessels owned by Frontline. For these vessels, the average charter rate in the second quarter was approximately 29,500 per trading day compared to a breakeven level of approximately $17,000 per day after interest and amortization for the vessels. Over the next year and a half, we have covered nearly 3/4 of the vessel days with a combination of charters with Floor A and [indiscernible] which will create a buffer if markets stay soft and still with some upside if and when markets strengthens. In light of the weak charter markets for rigs, we have the last few quarters discussed our drilling rig exposure on an asset-by-asset basis. In 2008, we acquired West Towers and West Hercules at a cost price of more than $850 million per rig and we finance them with $700 million in the bank market. These deals were all on the back of strong sub-charters for the rigs and we structured it with front-heavy charter payments. We also have limited corporate guarantees on these loans. Now 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. Seadrill has announced that they are in a dialogue with the banks and other stakeholders in order to negotiate a broader package of measures to improve liquidity and bridge them to a recovery in the market. This is expected to take some time to complete and they guide towards the end of the year. We cannot of course comment on this process, but Seadrill has never missed a charter payment to us and is continuing to pay us the full agreed charter rate and we continue our steep scheduled repayment profile on the loans. The average net bareboat rate for the two Deepwater units is below $150,000 per day on average which is only 40% of the initial charter rate. One of the rigs is the harsh environment rig West Hercules which was upgraded for a very substantial amount in connection with full renterization for Arctic operations a few years ago. The rig has been operating for Statoil in Canada until recently and is now idle in Norway and being marketed for new contracts, while the other semisubmersible rig, the West Polaris, is in layup in Spain for the moment. The harsh environment jack-up drilling rig, West Linus, has a sub-charter to Conoco Phillips at the rate of $326,000 per day until 2019 and there is no termination right for Conoco Phillips in that charter as long as the rig performs on the charter. 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 at a significantly lower rate, giving Seadrill a comparably low breakeven rate. We also own the 2007 build jack-up drilling rig Soehanah. This is a modern 375-foot jack-up drilling rig built in Singapore and the rig is currently idle in Indonesia and is being marketed for new work. Apexindo, who has chartered the rig since 2011, is covering all expenses relating to the rig for the time being and we're planning a full special survey on the rig which is estimated to be finalized by the end of the year. This rig is currently debt free and the illustration on this page demonstrates the rapid delevering of the drilling assets and at least illustrates the limited recourse to our balance sheet. Aggregate low [ph] balance for all the rigs is now around $900 million which is less than 50% of the initial loan amounts. Of this, only a quarter is guaranteed by Ship Finance and the rest is nonrecourse to our balance sheet. We have also depreciated these assets significantly over the charter period and book values way below initial levels and also below charter-free evaluations as quoted by rig brokers despite a significant drop in rig values. And three of our rigs have significant charter coverage still. We have a $4 billion fixed-rate order backlog after our recent acquisitions. And with a rebalancing of its portfolio, the container segment now stands at nearly $1.1 billion. The estimated EBITDA equivalent in backlog is more than $3.3 billion or around $35 per share. Most of our vessels are charted out on long term basis and we have approximately nine years weighted average charter coverage, with a relatively similar charter coverage in all of our segments. Full details on a vessel-by-vessel basis and including all the new lease structures is available by contacting us via our webpage under the contact heading. On our webpage we also have a fleet map function where you can see where our vessels are at any given time, updated daily. The charter backlog does not include any contribution from the various profit-sharing arrangements, nor does it include cash flows from the two Suezmax vessels operated in the pool arrangement with Frontline. It also excludes the nine container vessels and bulkers in the short term market and also the jack-up rig, Soehanah. As the backlog portal 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 not only have a diversified fleet, but also a diversified customer base with 16 chartering counterparties in total. If we then switch to our performance last 12 months, the normalized contribution from our projects, including vessels accounted for as investments and associates, the EBITDA, defined as charter hire plus profit share less OpEx and general administrative expenses, was $545 million in the period. Net interest was $96 million or approximately $1 per share and our normalized ordinary debt installments relating to the Company's projects was $187 million or nearly $2 per share, in the 12 month period. This is excluding prepayments relating to sale of other assets. Net contribution after this is $262 million or $2.80 per share, over the last 12 months. For the same period, we have declared dividends of $1.80 per share or $168 million in aggregate which is well below our historic average payout ratio of approximately 70% to 75% since 2004. And with that, I will give the word over to our CFO, Harald Gurvin, who will take us through the numbers for the second quarter.

Thank you, Ole. On this slide, we're shown a pro forma illustration of cash flows for the second quarter compared to the first quarter. Please note that this is only a guideline to assess the Company's performance and is not in accordance with U.S. GAAP. For the second quarter, total charter revenues before profit share were $143.4 million or $1.53 per share, slightly down from $146.2 million in the previous quarter. Revenues for Suezmaxes were down in the quarter due to lower revenues from the two Suezmaxes trading in the short term market. Revenues from liners were up in the quarter following delivery of the second and third of the container vessels to Maersk line in February and May, respectively. The three vessels were the [indiscernible] earnings effect in the third quarter. Earnings from offshore were down due to the sale of the offshore supply vessel Sea Bear in the first quarter and the jack-up drilling rig Soehanah being idle in the second quarter. We recorded a profit share of $14 million under the 50% profit-share agreement with Frontline, down from $24.7 million in the previous quarter. The tanker market softened towards the end of the second quarter and has remained soft into the third quarter. We also recorded a profit share of approximately $100,000 on rig into some of the [indiscernible] driver carriers. Revenues from financial investments were slightly up in the quarter, mainly due to increased dividends received on our shareholding in Frontline. But overall, this summarizes to an EBITDA of $128 million for the quarter or $1.37 per share, down from $139.5 million in the previous quarter. We then move on to the profit and loss statement as reported under U.S. GAAP. As we have described in previous earnings calls, our accounting statements are slightly different than those of a traditional shipping company. As our business strategy focuses on long term charter contracts, a large part of our activities are classified as capital leasing. As a result, a significant portion of our charter revenues are excluded from U.S. GAAP operating revenues and have set book [indiscernible] revenues classified as repayment of investment and finance leases, resulting associates and long term investments and interest income from associates. If you wish to get more understanding of our accounts, we will also this quarter publish a separate webcast which explains the financiers' accounting and investments in associates in more detail. This webcast can be viewed on our website, Shipfinance.bm, under investor relations and webcast. Overall for the quarter, we reported total operating revenues according to U.S. GAAP of $104 million which includes the profit share from Frontline. Total operating expenses were $60 million, resulting in an operating income of $44 million. We recorded a negative non-cash mark to market of derivatives of $3.3 million during the quarter and $3.8 million non-cash amortization of deferred charges. So overall and according to U.S. GAAP, the Company reported net income of $39 million or $0.42 per share. Adjusted for non-cash items, the result was $45 million or $0.48 per share. Moving on to the balance sheet, we showed $82 million of consolidated cash at the end of the quarter, excluding amounts freely available for drawdown under revolving facilities available-for-sale securities of $120 million includes investment in senior secured bonds with a fair value of $33 million at quarter-end and also our 11 million shares in Frontline. The three rigs on charter to Seadrill are included in the balance sheet under investment in associates and amount due from related parties long term. Our investment in the subsidiaries owning the units is in the form of both equity and shareholder loans from the parent company. The total equity investment in the rigs is just a combination of the two and the splits between equity and shareholder loans from quarter to quarter will depend on the intercompany accounting. Stockholders' equity was approximately $1.1 billion, giving a book equity ratio of 39% at the end of the quarter. Then looking at our liquidity and capital expenditure status, the Company had total available liquidity of approximately $247 million at the end of the quarter which includes approximately $165 million freely available under revolving credit facilities. In addition, our 11 million shares in Frontline have a market value of approximately $89 million based on the closing share price yesterday. Moving on to the CapEx, we had four new buildings under construction at quarter-end, all chartered out on long term charters to strong counterparts. We have entered into agreements with two large container vessels, with expected delivery in late 2016 and early 2017. The vessels will be financed through a 15-year financial lease agreement matching the charter with MSC. The financing is nonrecourse through Ship Finance and the net remaining CapEx is limited to $15 million per vessel payable upon delivery. We also have the two new-building prototankers under construction, with scheduled delivery during the second half of 2017. The remaining CapEx before financing is approximately $43 million per vessel. We have not yet arranged financing, but given the strength of our charter at Phillips 66 and our strong standing in the bank market, we expect to secure a competitive financing well before delivery. On the debt side, we had approximately $1.6 million of consolidated interest bank debt outstanding at quarter-end which includes $1.1 billion in bank loans and approximately $500 million in the senior unsecured note. In addition, our 100% owned subsidiaries, accounted for as investments in associates, had approximately $930 million in bank loans at quarter-and. The debt in these subsidiaries is not included in the consolidated accounts. The Company has no bank or bond maturities until the fourth quarter 2017, while we continue our scheduled debt amortization of close to $50 million per quarter and we're in compliance with all financial covenants under our loan agreement at quarter-end. It is worth noting that not only has Ship Finance been profitable and paid dividends each of the 50 quarters since the Company was established, we have also been in full compliance with all financial covenants on our loan agreement which gives us a very strong standing in the bank market. Now to summarize, the Board has declared a quarterly cash dividend of $0.45 per share for the quarter. This represents a dividend yield of 11.9% based on the closing share price as of yesterday. Net income for the quarter was $39 million or $0.42 per share. Adjusted for non-cash items, the result was $0.48 per share. The fleet renewal and diversification continues with the sale of all the vessels and delivery of container vessels with long term charters. We have adjusted the agreements with Deep Sea Supply, increasing their charter backlog and getting optionalities through a profit share without impacting distribution and capacities. We have a strong liquidity position and limited remaining CapEx. And with that, I give the word back to the operator, who will open the line for any questions.

[Operator Instructions]. We will take our first question from Richard Diamond from Strait Line Capital. Please go ahead. Your line is open.

I have two lengthy questions. The first question is can you address the opportunities that are being created for SFL, as lesser-quality credits do not have access to ship financing? And I know in the short term it hurts residual values, but I would think in the long term it could create interesting opportunities for SFL. The second question would be can you speculate on the impact of the Hanjin bankruptcy today? While the financial press seems to be ignoring it, ships and cargoes are being arrested globally. Would one expect a quite -- a flight to quality by transportation managers to the Maersks and Haphagloids of this world?

On your first question, yes, we do see opportunities. We're, I would say, constantly screening potential new transactions and will of course -- if and when we do things, we will of course make any proper announcement. I do think that we see more opportunities with the relatively stronger charter in counterparties -- also as you alluded to, because financing institutions, in particular the banks, are getting way more restrictive, is our impression and they really want stronger companies backstopping deals before they want to extend loan facilities. Also because we have access to other various capital instruments, we're present in bond market, we're present in the convertible loan market, equity market, et cetera. That again gives the banks a good comfort that we have access to different sources of capital and not only the bank market capital. We haven't done any new deals and haven't announced any new deals the last six months. But if you look over time and over the last 10 years, is down around $7 billion of new transactions. So on average, it has been a good healthy number and we have increased our backlog. I am confident that we will find other good interesting investment opportunities also going forward and I would say all across our investment segments. And even though offshore seems to be quite soft now, we also think that that could also be an opportunity where you could potentially invest in reasonably priced assets and get good charter coverage. But as I said, we cannot comment on deal specifics because we do announce that if and when we do something. To your second question, we cannot comment specifically on Hanjin. We observe the same thing as you do in the news that they are in the process of filing for court protection. And I think it is too early to tell exactly what impact that will have for the vessels to have in their own fleet and also their charter fleet. I would say that we have seen several chartering opportunities over the last couple of years with that name and also with, I would say, other relatively soft names from a credit perspective. We have refrained from doing long term charters with those entities simply because of the risk of this happening. So our focus in the liner side has been to deal with the stronger market leaders and then hopefully avoid situations like we see in Hanjin today where vessels seem to be arrested.

[Operator Instructions]. We will now take our next question from John Reardon from Western International. Please go ahead. Your line is open.

I would like to start out by saying I've been following Ship Finance for a number of years. And at the risk of sounding like a cheerleader, I want to commend you and your team for doing a great job in managing this Company through what has been difficult conditions from time to time. Given the cyclicality of this business that you address, are we seeing any green shoots or elements of that? I once was told that the cure to high prices is high prices and the cure to low prices is low prices. Are we seeing any of the low-price cures starting to show up?

Well, we certainly have seen the pressure on secondhand values and we have also seen yards quoting lower prices to fill an increasing gap in the backlog they have. This is not unusual. I would say this is a classic sizable feature in these markets and we have to remember that the segments we're in, shipping and offshore, are notoriously cycled and have always been that. And one of the elements of this is the, call it, seeming disconnect between the supply and demand side where the shipyards, i.e. the supply side, they don't really care much about how much money the ship owners make or whether a specific vessel is profitable enough. They really just want to build it. At the same time, we see ship owners in peaking markets getting very bullish and start ordering vessels maybe at peak prices. And also unfortunately we see the banks in peak markets that's when we typically see banks willing to extend more leverage. So, again, trying to be disciplined in this market, we think that's the way to go in order to build a long term sustainable business model and I would say there is no surprise in what's going on. Perhaps the offshore -- you would call it the offshore prices has been deeper than many anticipated, but we think that that is also going to recover and certainly if you own quality assets.

We will now take our next question from Magnus Fyhr from Seaport Global. Please go ahead. Your line is open.

I had a question on the payout ratio, I mean at 64%, it is very low compared to your peers. And just looking going forward, with the potentially lower profit-sharing from Frontline, there was about 30% of the last 12 months distributed cash flow and also some in-surge [ph] regarding Seadrill. You have a lot of cushion there but how comfortable are you? Maybe you can talk a little bit about how that ratio could be a little bit higher going forward.

Yes, you're absolutely correct. We have what I would call a healthy payout ratio. If you look at the last 12 years, we had nearly $100 million difference between what we define as distributable cash flow and actual dividends declared. And if you look at the aggregate profit share from tankers, that is less than the difference between the payout ratio and the distributable cash flow. So you could argue that you take away all that cash flow from the tankers and you still would support the dividend capacity. And at the same time, if you look at the whole Seadrill, I would say in a meltdown scenario where there was no cash flow at all from Seadrill, the net cash flow there in the last 12 months was around $60 million, again, well below the difference between the distributable cash flow in the dividends. So I would say that it's a -- and then on top of that, we have more than $240 million of available cash. So we have good investment capacity that could, we hope, be put to use to build a distribution capacity. So we think there is a good cushion and we think it's prudent to be disciplined. And while we have investment capacity, we focus on trying to do the right deals. And we try to focus on doing the deals that was generated in long term returns for shareholders and not get tempted and spend it all on the first deal we see.

Right. Are you comfortable to mention any levels, 75%, 80%? Is that a comfortable level?

Well, we don't have a specific percentage level target. Over time, we have paid out the higher relative percentage. I think it's sort of in the 70% to 75% range over time, if you look at it over the last 12 years. So we're definitely below the average payout ratio. I would say the dividend which is set on a quarterly basis by our Board, is based on a long term sustainable basis more so than I would say quarter-to quarter performance because as we know, the results may vary from quarter to quarter. We focus long term.

Thank you. There are no further questions. And I would like to turn the program back to the speakers for any additional or closing remarks.

Thank you. Then I would like to thank everyone participating in our second 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 contacts pages on our webpage, www.shipfinance.bm. Thank you.