11/8/2023

speaker
Operator

Welcome to SFL's third quarter 2023 conference call. My name is Sande Borgli and I'm an analyst in SFL. Our CEO Ole Gjerklarki will start the call by briefly going through the highlights of the quarter. Following that, our Chief Operating Officer Trim Kjøhli will comment on vessel performance matters before our CFO Aksel Olesen will take us through the financials. The call will be to do so before the Q&A session. 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. Forward-looking statements are not guarantees of future performance. These statements are based on our current plans and expectations and are inherently subject to risk 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 but are not limited to conditions in the shipping, offshore, and credit markets. You should therefore place undue reliance on these forward-looking statements. Please refer to our filings within the Securities and Exchange Commission for a more detailed discussion of risk and uncertainties which may have a direct bearing on our operating results and our financial condition. Then I will leave the word over to our CEO Ole Hjertake with highlights for the third quarter.

speaker
Ole Hjertake

Thank you Sanda. The charter revenues were $214 million in the quarter which is up 23% from the previous quarter primarily due to the drilling rig Hercules no back in service. The EBITDA equivalent cash flow in the quarter was approximately $130 million which was also higher than the second quarter and over the last 12 months the EBITDA equivalent cash flow has been $485 million in total. The net income came in at around $29 million in the quarter or 23 cents per share. The net income was impacted by some one-off items in the quarter including gains on a vessel sale in the third quarter and some -to-market effects. This was offset by two tankers that were dry docked in the quarter and then on schedule of around 14 days on the Jacob rig liners due to repair works on the top drive with associated higher uptakes in the quarter. In line with the improved results and commitment to return value to our shareholders we're also increasing our quarterly dividend to $25 per share. We have not paid dividends every quarter since our inception in 2004 and this has accumulated to $30 per share or more than $2.6 billion in total. And we have a robust charter backlog supporting continued dividend capacity going forward. Our fixed rate backlog stands at approximately $3.4 billion and importantly the backlog is concentrated around long-term charters to very strong end users. This transition has been gradual as we have changed the business model from a maritime leasing company to maritime infrastructure provider over the last 10 years. This includes switching from primarily bare-boat charters or financing arrangements to long-term time charters to end users. And I would note that the backlog figure excludes revenues from the vessels traded in the short-term market and also excludes future profit share optionality which we have seen can contribute significantly to our net income. In September we took delivery of the first of our four dual fuel car carrier new builds. The vessel named Emden will go and charter to Volkswagen Group for 10 years together with Assista vessel and we will deliver the vessels to Volkswagen in Europe. The short-term market is piping hot right now and we have secured a very attractive interim charter from the shipyard in Asia to Europe generating around $8.5 million in EBDA per vessel over a period of only two months. In addition to the new bills we also have two existing vessels on charter to Volkswagen that have been extended for approximately additionally three years firm plus extension options generating approximately $23.5 million in EBDA per vessel per year. We have a very close business relationship with Merckline with 17 vessels on long-term charters. Merckline recently exercised an option to extend a time charter for a 9,500 TU vessel until mid 2025. This is at a higher rate than the current charter rate adding $13 million to the charter backlog. In addition we have a profit share relating to scrubber benefits on that vessel where our share currently is 70 percent. In the third quarter we also fully repaid a Norwegian Kroner denominated bond loan issued in 2018 where there was $48 million remaining at maturity. This was paid down from our cash balance. This loan was originally the equivalent of approximately $85 million and the rest had already been repurchased opportunistically in the market. We have recently raised significant amounts in the new debt funding at very attractive terms in Asia and don't see a need to refinance the recently repaid bond loan with new financing in the near term. And after the extensive SPS and upgrade works to our harsh environment semi-submersible Hercules in the first half of 2023 the rig has been in Canada and drilled a well for ExxonMobil. This was finalized in September and since then the rig has mobilized to Namibia with a stopover in Las Palmas and is scheduled to start drilling for Gulf Energia in Namibia next week. This is for two wells plus an optional well testing estimated to take around four months including mobilization. When we calculate average day rates we include mobilization of the rig from Las Palmas and back and this is compensated by the customer. This started in early October and the estimated contract value is approximately $50 million implying a day rate of approximately $435,000 per day for the period. After Namibia the rig will move back to Canada to commence a contract with Equinor. The contract is for one well plus one optional well and the duration for the firm contract period is six to seven months including transit to and from Canada implying a day rate of approximately $520,000 per day for the period. The rig will then be open for new contracts from the fourth quarter 2024 onwards. This rig is one of only a handful harsh environment ultra deep water semi-submersible rigs available and market analysts are positive to long-term market prospects based on recent tender activity and a tighter supply demand balance. And with that I will give the word over to our Chief Operating Officer Trum Schoenling.

speaker
Trum Schoenling

Thank you Olle. Over the years we have changed both our fleet composition and structure and we are now a maritime infrastructure company with 73 maritime assets in our portfolio and our backlog from owned shipping assets stands at $3.4 billion. The current fleet is made up of 15 dry bulk vessels, 36 container ships, 13 tankers, two drilling rigs and seven car carriers where four are on the water and three are under construction in China. The remaining new buildings are scheduled for delivery over the next seven months starting in November. We have evolved from having a single asset class chartered to one single customer to a diversified fleet and multiple counterparties and the fleet composition has varied from originally 100% tankers via majority offshore assets 10 years ago to container vessels now being the largest segment with just under 50% of the backlog. Most of our vessels are in long-term charters but we have over the last 10 years completely transformed the company's operating model and have moved away from financing type bare boat charters and instead assumed full operating exposure. This makes us relevant for large industrial end users like Volkswagen, Maersk, Appagloid and others. In the third quarter 94% of charter revenues from all assets came from time charter contracts and only 6% from bare boats or dry leases. In addition to fixed rate charter revenues we've had significant contribution to cash flow from profit share arrangements over time both relating to charter rates and cost savings on fuel. Last 12 months the aggregate profit share has been more than 16 million dollars. Out of the current 73 vessels we have 13 on bare boat type contracts and 60 on time charter and spots. Our operation is quite complex with vessels across multiple sectors and we have our own commercial operation out of Oslo as well as operational management out of Singapore and Stavanger. Our OPEC's philosophy is to continuously invest in our fleet to optimize the vessels performance and maintain a high level of service to our customers. This includes investing to minimize off-fire as well as investments to increase cargo carrying capacity and reducing energy consumption. This has become increasingly important with the implementation of IMO carbon intensity indicator which will impact vessels operational profile including routing and speed. EU ETS is also another hot issue becoming live from next year. In Q3 we had a total of over 6300 operating days defined as calendar days less technical off-fire and dry dockings. Three vessels have been dry docked in the quarter and our overall utilization across the shipping fleet was 99% in Q3 and .5% for the drilling rigs. For the rigs as Ola explained operating days are days on rate or in transit covered by mobilization fees less days off-fire and days spent in port not on drilling rate. One of the key ESG targets for SFL is the reduction of emissions on our fleet. Such reduction can either be met by fleet renewal in more efficient ships and with greener fuels increased efficiency of existing fleet or a combination of both. As part of our fleet renewal program we have four LNG dual fuel carriers under construction in China of which one was delivered during the quarter so three left. These vessels are among the most modern and efficient ships in the car carrier market. The hull has been improved and optimized with the new hull form with an S-bow as can be seen in the picture and the LNG fuel system is of a high pressure type and the vessels are adapted for both -to-ship and -to-ship LNG bunkering. In LNG mode we expect a 25% lower carbon footprint per vehicle carried compared to a standard 6500 CEU conventional PCTC. The vessels are also fitted with the shore connection for zero emissions operation in port and in addition to being able to carry EVs they will the ships will also be able to carry hydrogen fuel cell vehicles. The first ship Emden is on her first voyage from Asia to Europe under Hyundai Glovis and she will deliver to Volkswagen in about one week's time. And with that I will give the word over to our CFO Axel Olesen who will take us through the financial highlights of the quarter.

speaker
Glovis

Thank you Trim. On this slide we have shown our performance illustration of cash flows for the third quarter. Please note that this is only a guideline to assess the company's performance and it's not in accordance with US GAAP and also net of extraordinary and non-cash items. The company generated gross charter hire of approximately 214 million in the third quarter including approximately 2.6 million of profit share with approximately 94% of the revenue coming from a fixed chart rate backlog which currently stands at 3.4 billion providing us with strong visibility on the cash flows going forward. In the third quarter the container fleet generated gross charter hire of approximately 91 million including approximately 2.6 million in profit share related to fuel savings on seven of our large container vessels. During the quarter we took delivery of the first of our four dual fuel LNG car carriers. With four car carriers on charter at the end of the quarter our gross charter hire increased approximately 9 million in the third quarter compared to approximately 6 million in the second quarter. Our tanker fleet generated approximately 30 million in gross charter hire during the third quarter compared to approximately 35 million in the previous quarter. During the quarter two Suismax tankers were off fire for a total of 46 days in connection with scheduled periodic dry dockings. These costs are expense directly for our shipping fleet and OPEX for the tankers in the quarters was therefore higher than normal. The company has 15 dry bulk car carriers, bulk carriers which eight were employed on long-term charters during the quarter. The vessels generated approximately 20 million in gross charter hire in the third quarter. Seven of these vessels were employed in the spot and short-term market and contributed approximately 6.2 million in net charter hire during the quarter compared to approximately 7.2 million in the previous quarter. SFL owns two harsh environment-driven rigs the Jacob rig Linus and the semi-submersible rig Hercules. During the third quarter the rigs generated approximately 64 million in contract revenues compared to approximately 19 million in the second quarter. The Linus is currently under long-term contract to ConocoPhillips Scandinavia until the end of 2028. In the third quarter the rig generated approximately 16.6 million in contract revenues which is down from the approximately 19 million in the second quarter as the rig was off-hire for approximately 16 days relating to an unscheduled repair of the top drive. Due to the repair works the OPEX for the rig was also 2 million higher than budgeted for during the quarter. Hercules completed the drilling contract for ExxonMobil in Canada in September and has now been mobilized to Namibia which is expected to commence a contract with Galp Energia shortly. During the quarter the rig recorded approximately 48 million in contract revenues as the mobilization fees paid by ExxonMobil and associated costs is recognized over the actual drilling period pursuant to US GAAP. The same principle has been applied for the mobilization fees due after the drilling contract was completed. Our operating and DNA expenses for the quarter was 86 million compared to 68 million in the previous quarter primarily due to Hercules being back in operation, scheduled dry dockings and downtime and repair on the Linus. This summarizes an adjusted EBITDA for approximately 130 million in the third quarter compared to 109 million in the previous quarter. We then move on to the profit and loss the income as reported on the US GAAP. As we have described in previous hearing calls our accounting statements are different from those of a traditional shipping company and as our business strategy focuses on long-term charter contracts a large part of our activities are classified as capital leasing. Therefore a significant portion of our charter revenues are excluded from US GAAP operating revenues. This includes repayment of investment in sales type, direct financing leases and leaseback assets and revenues from entities classified as investment in associates for accounting purposes. The reserve quarter report total operating revenues according to US GAAP for approximately 205 million which is less than approximately 214 million of charter hire actually received for reasons just mentioned. During the quarter the company recorded profit share income of approximately 2.6 million from fuel savings from some of the large container vessels and a car carrier. As previously mentioned the Hercules was back in operation during the third quarter and contributed with 48 million in contract revenue. Furthermore this net result was impacted by non-recurring and non-cash items including a gain from the sale of the Wiel CZ Landrich wisdom for approximately 2 million. A net positive -to-mark effect from stops of approximately 2.3 million, a positive -to-mark effect from equity investments of 300 000 and a decrease of 300 000 on credit loss provisions. Due to corporate taxes and withholding taxes in Canada the company also recorded approximately 2.3 million of taxes in the third quarter related to the Hercules as well also expects to pay similar types of customer taxes in Namibia. So overall and according to US GAAP the company reported a net profit of approximately 29.3 million or 23 cents per share compared to approximately 17 million or 13 cents per share in the previous quarter. In terms of near-term outlook we expect lower revenues for the Hercules in fourth quarter due to a long mobilization period from Canada to Namibia where the rig is due to commence the contract to Gulf Energy shortly. As mentioned previously revenue from the Hercules will due to US GAAP accounting standards will recognize only from the drilling commencement date and hence mobilization fees will be allocated throughout and respective quarters of drilling operations. For car carriers revenues are set to increase as we have three new buildings delivering from Q4 to Q2 with the second vessel being delivered from the yard in China second half of November. Following the handover to Volkswagen of the first and second new building during Q4 and Q2 the SFL conductor and SFL composer will continue the charters to Volkswagen for another three years plus optional years with an estimated EBITDA contribution of 23.5 million per vessel per year. Moving on to the balance sheet at quarter end SFL had approximately 118 million of cash and cash equivalents. Furthermore the company and market was securities approximately 6.2 million based on market prices at the end of the quarter. During the quarter the company fully redeemed a knock bond for which 49 million was outstanding with cash on balance sheet. The 136 million on the three car carriers under construction has been fully financed by 194 million of net senior YOLKO financing yet to be drawn. During the quarter the company redelivered the real Cecilia and Bush wisdom pulling a declaration of a purchase option. The sale had a 10 million positive cash effect after repayment of secured debt relating to the vessel and the corresponding book gain of approximately 2 million has been recorded in the third quarter. So based on Q3 numbers the company had a book equity ratio of approximately 28.4 percent. Then to conclude the company has delivered another strong quarter with growth in both revenues and EBITDA. The board has declared a 79 consecutive cash dividend to increase the dividend to 25 cents per share. This represents a dividend yield of approximately 9 percent based on the closing share price last Friday. The company has a strong balance sheet and liquidity position. So far in 2023 the company has secured new financing arrangements of more than a billion dollars and we recently repaid a knock bond with cash on balance sheet. Furthermore our three new buildings are fully financed with attractive long-term financing which will free up additional liquidity upon delivery. Our fixed chart rate backlog currently stands at 3.4 billion which provides us with strong visibility on our cash flow going forward. And finally with the Hercules now back in operation and delivery of new building car carriers together with new contracts for existing vessels it's a strong revenue generation in the quarters to come as vessels are delivered and new charters commencing. And with that we conclude the presentation and move on to the Q&A session.

speaker
Operator

Thank you Axel. We will now open up for a Q&A session. For those of you who are following this presentation through Zoom please use the raised hand function to ask a question. When your name is called out please unmute your speaker to ask your question. Thank you.

speaker
spk02

Yeah hey guys um can you hear me?

speaker
Ole Hjertake

Absolutely.

speaker
spk02

Thank you. Yeah I couldn't find the raised hand um function so um I figured I'd just hop in. This is Greg from uh Greg Lewis. Hey hey hey all how are you? Yeah hi Greg. Um I had a few questions I was hoping we could walk through um you know it was good to see the um the the the dividend increase um you know and you know I guess two things. One is as you think about managing the trajectory of the dividend over the next I know one to two years how should we think about balancing you know potential dividend growth and and the and the drilling rigs just because you know it seems you know it's it's clearly a very cyclical industry. We're clearly in a strong part of the cycle and those assets look like they're going to probably the Hercules looks like it's going to be able to generate a lot of cash here you know over the next two to three years um but maybe not as you know it's definitely a more volatile asset than say your car carriers or container ships so just trying to understand how you think about you know uses of cash from the Hercules as we recontract this over the next couple of years.

speaker
Ole Hjertake

Yeah I appreciate that I mean the Hercules as you mentioned you know we just spent quite a bit of money on that rig in the first and second quarter of the year and when it was out of service and now it's it's really really only got started so the charter rate in Canada you know that was fixed you know more than a year ago so it was at a lower rate so that the charter rate should be mounting now as it is expected to start drilling in Namibia already next week and the charter rate in Namibia is you know on based on the you know if we include both mobilization to and from Namibia and the drilling rate should be well above the drilling rate we had or the rate we had in Canada and then it's going back to Canada later next year for an even higher rate and in fact you know the the drilling rate we have on Hercules it's the highest you know drilling rate I would say in this cycle to date so this rig is a very capable unit and customers are clearly willing to pay the services. Of nature you know that market is a shorter term charter market so it's not this is not a market where you normally get sort of 10 you know 8, 10 you know 15 year charters it's typically shorter charters and we have deliberately not been so keen on fixing it long term because we see this market really building and you don't really want to fix something at the low end of the cycle we think this is a cycle that has legs and therefore we're holding back a little bit before we want to what we say look for really long-term charters on that unit. I think if we were to look at long-term charters for the unit you would have to accept lower rates than what we are fixing it at currently so but so that's one asset of course it's a big asset but also if you look at the history of that drilling rig I mean this is a drilling that used to be uncharted to seed drill. Seed drill ended up in two chapter 11s you know we were offered in the last round a very you know I was in our minds a very poor quality treatment in the restructuring we decided to take it back and I think you know I think we could be honest and say it's been a really good decision from the company side to do that because returns we've had on this rig now with the rates we see is spectacularly better than the alternative would have been but you know that is the history and the setting around that rig. If you look at some of the other assets look at the car carriers that I think it's sort of a segment we used to have two vessels then we ordered the four vessels then we bought another vessel and then we have these quite spectacular both the transportation leg if you could call it that on two of these vessels where we make more than 10% of construction cost just moving the vessel from Asia to Europe so you have a lot of other bits and pieces here that's also generating a lot of cash flow and then we have the re-chartering of the two older vessels to Volkswagen where we increased the dividend by you know times five compared to where it was originally you know simply because we own those assets and we negotiated it and Volkswagen seemed to be quite happy with the service we provide them so there is not the rig is one piece but there are also other elements in our portfolio that is also adding and of course our mindset is yes our principal objective in SFL is to return cash to shareholders I mean that's why we're here otherwise there wouldn't be any point in having a company like SFL if we don't really do that over time and it's been 79 quarters now and we've been always made money operationally every single quarter based on our distribution so I think yes we are I think that we are really just at the starting point in our minds so where we in terms of cash flow from some of these assets so hopefully there is more there is more dividend potential also going forward.

speaker
spk02

Yeah, super helpful, thank you for that. I did want to ask kind of a bigger picture question, clearly across the more conventional shipping space where it's definitely a market that you continue to look at and have assets and as you know, sofras gone up, spreads have gone up, how has that changed the potential opportunities for SFL i.e. I'm talking to some ship owners and they're looking at -9% or even higher borrowing costs, has that created more opportunities for SFL i.e. is the transactions team busy here as we sit here in November relative to maybe where they were earlier this year or is it hey the market's been good for a couple years and it's kind of

speaker
Ole Hjertake

we screened or did really work on more than 20 billion dollars of potential deal flow and we ended up doing one in the end for various reasons. I think this year has been the volume has been lower in aggregate and I think with the rising interest rate market it's also I would say the way we see it, it's a time lag from where the underlying metrics and interest rates is one, asset replacement cost is another, maybe to a certain degree operating expenses to the extent there has been a little inflation in those metrics, it takes a little time for that to filter through in a customer's willingness to pay off for those services. So that's why I think in 2023 has been I would say the more interesting deal flow opportunities has been I would say on a gross number a little lower than 22 but I think this is going to pick up again. But I think the ones I mean if you look at the ones who offer more of financing structures maybe for them there is more deal flow opportunity right now simply because funding cost is higher and therefore the alternative cost of doing like a beer boat type lease is relatively smaller. But we have strategically moved a little away from the beer boat type offering because what I've seen is that for those kind of deals you typically do that with intermediaries, you don't do a beer boat deal with an end user and therefore there is a risk element here that I think is underappreciated. Right now most of the shipping segments are booming, strong markets, nobody talks about it but we've been through this over 20 years now, we've seen some cycles over the years. So our focus is do deals with strong counterparties and users, focus on getting the right deals done and don't be nervous if there is a quarter when you do that many deals. The deal flow is out there, there is a continued need for transportation assets and logistics solutions on the water but just don't be desperate to do a deal because that's when you answer to that. We are constantly screening deal opportunities, we are looking at opportunities, we cannot communicate specifically what we look at but there are deals that could potentially be done but we try to be disciplined, it's got to be the right type of asset, we have to focus on the right, as we call it, residual value exposure i.e. what kind of residual risk are we willing to take on after a deal, what's the financing structure and maybe importantly who's the counterparty, is this counterparty strong enough and in underlying volatile market or is this counterparty someone who can honor their obligation also in a down cycle? Because that's what we've seen over the years is that anybody can do a deal in an upcycle market, you just pay a little more than the next guy, the problem is how do you manage the down cycles and that's something that we hope our history brings along is that yes, markets are volatile but we managed through some pretty rough cycles and hopefully we're set up to deal even better with cycles going forward.

speaker
spk02

Okay great and then I did just have one other question on the balance I noticed we saw sequentially some of the long-term lease liability went into short-term lease liability, is that just going to unwind or should we think about that being either renewed or extended over the next call?

speaker
Glovis

Thanks for your example here so I think you should look at that as our ordinary traditional debt on the vessels that there are opportunities to basically roll this going forward as well. We haven't finally concluded if we kind of do a new YOLCO or do that bit traditional bank financing but both options are likely so I could just assume rolling that on on the same level.

speaker
spk02

Okay perfect thank you for that thanks everybody. Thank you.

speaker
Operator

What else do you follow in this presentation? Presume the raised sand function can be found on the reactions in the toolbar.

speaker
spk01

Oh which happened and the next question

speaker
Operator

will come from Richard Diamond. Please unmute your speaker.

speaker
Richard Diamond

Yeah great quarter, great job building cash. Ola you and the team have incredible deal flow at SFL. What do you think are the most interesting areas looking out to the fourth quarter and next year?

speaker
Ole Hjertake

Yeah thanks for that Richard and thanks for the kind words. You know we are focusing across the board, our preference are for deals that are I would say logistics sort oriented i.e. where we go into a logistics chain with counterparties you know so car carriers for instance is a segment that we've been spending quite a bit of time on. We've grown a bit grown a lot in that segment and we still think there could be interesting opportunities on the container side. Yes the market is volatile and yes you know it's not the super cycle we saw a year or two ago but there's still underlying you know demand for transportation capacity and certainly with the modern high-end assets the more fuel efficient that is reducing both you know the energy footprint or emissions footprint per loaded box where that matters and that's also where we have concentrated our investments. We've also seen some opportunities on the tanker side so I would say there are opportunities across the board here. The only segment you can say we don't have in our portfolio that would be natural would be LNG in particular but our dilemma there has been you know one it's sort of the you know the investment level in that segment and the charter rates where you don't really amortize down so much of the investment which means that we have been a little conservative in our willingness to take on residual exposure in that segment. But otherwise we are active across the board and looking opportunities and I think we have quite good access to Dealflow.

speaker
Richard Diamond

Thank you.

speaker
spk01

Yes

speaker
Ole Hjertake

thank

speaker
spk01

you. Thank you.

speaker
Operator

As

speaker
spk01

there are no further questions from the audience

speaker
Operator

I would like to thank everyone for participating in this conference call. If you have any follow-up questions to management there are contact details in the press release or you can get in touch with us through the contact pages on our webpage .sflcorp.com. Thank you very much.

Disclaimer

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