Last Thursday, Excel Maritime (EXM) posted an extremely confusing earnings report, again. The report is filled with a great number of usual non-cash items, unusual non-cash items and other extraordinary gains and expenses.
The most confusing part of the report is “Time Charter fair value amortization” in the income statement, which makes up the majority of revenues.
Favorable and unfavorable time charters appeared in the balance sheet of the company after acquisition of Quintana Maritime a year ago. Some of Quintana's vessels had long-term contracts at rates, significantly lower than prevailing market at the time of the acquisition. As a result, those vessels were bought for a lower price than similar charter-free ships.
Instead of simply recording bought vessels at the paid price, Excel Maritime elected to record them at the market price of contract-free ships, while at the same time creating a liability called “fair value of unfavorable time charters”, for the difference. This liability would amortize over the duration of below-the-market contracts.
Such accounting is in compliance with GAAP and does make some economic sense in the environment of stable charter rates and ship values. In a stable world, after the expiration of an “unfavorable charter”, the vessel should start earning higher cash revenue, while at the same time keeping its market value. The reality turned out to be quite different.
Since the time of Quintana acquisition, market charter rates went down by 75%, while ship values reduced by about 65%. What used to be below-the-market contracts, recorded as liabilities, had become significantly above-the-market charters. Amortization of “unfavorable charters” lost any economic sense whatsoever.
The absurdity of the gain resulting from such amortization can be clearly seen in case of the accelerated amortization of the time charter value of M/V Sandra and M/V Coal Pride, shown in the latest report.
A long-term contract for M/V Sandra at $39,000 a day was cancelled and the new contract was signed at weighted average rate of $26,500 a day. Does not look like great news. What was the accounting result of these operations in the latest quarterly report? A gain of $51.5 million! The reason is that cancelling an “unfavorable charter” should have resulted in signing the new one at a higher rate. However, the current market is quite different.
Why is it happening, and does proper GAAP accounting really produce such incoherent results? The answer is no, if used correctly. The problem lies in the inflated value of long-lived assets in the balance sheet with an offsetting “unfavorable charter” liability. Under the FASB 144 statement, the company should have impaired the value of long-lived assets. Unfortunately, requirements for the impairment are too loose and subjective, so the management preferred to keep the book value at a way too inflated level.
Interpreting the financial statements of Excel Maritime has become a difficult task for a lot of investors. The majority of analysts exclude time charter fair value amortization from their revenue and earnings estimates, but the company does not openly disclose the resulting numbers excluding adjustments. It does provide all the necessary information to calculate it, though. Here is a quote from the press release:
The Company reported net income for the quarter of $118.0 million or $2.57 per weighted average number of share as compared to net income of $35.1 million or $1.76 per weighted average number of share for the first quarter of 2008.
The results for the first quarter of 2009 include a non-cash item of $6.7 million relating to the unrealized gain from the valuation of interest rate swaps and $0.1 million gain on sale of a vessel. Net income, excluding the above items, for the quarter would amount to $111.2 million or $2.42 per weighted average diluted share.
Included in the above adjusted net income are also the amortization of favorable and unfavorable time charters that were fair valued upon acquiring Quintana on April 15, 2008 amounting to a net income of $67.8 million ($1.48 per weighted average diluted share), a non-cash gain of $51.5 million ($1.12 per weighted average diluted share) related to the accelerated amortization of the time charter value of M/V Sandra and M/V Coal Pride assumed upon Quintana Maritime Limited ("Quintana") acquisition due to their termination and the amortization of stock based compensation expense of $2.4 million ($0.05 per weighted average diluted share).
Since the management prefers not to show the final result, we have to calculate it.
$2.42 - $1.48 - $1.12 + $0.05 = -$0.13
So, the company posted a loss of $0.13 per share excluding one-time items.
Disclosure: Short EXM.