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Edited Transcript of KNOP earnings conference call or presentation 21-Nov-19 5:00pm GMT

Q3 2019 Knot Offshore Partners LP Earnings Call

Aberdeenshire Nov 22, 2019 (Thomson StreetEvents) -- Edited Transcript of Knot Offshore Partners LP earnings conference call or presentation Thursday, November 21, 2019 at 5:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Gary Chapman

KNOT Offshore Partners LP - CEO & CFO

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Conference Call Participants

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* Gregory Robert Lewis

BTIG, LLC, Research Division - MD and Energy & Shipping Analyst

* Robert Silvera

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Presentation

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Operator [1]

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Good morning, and welcome to the KNOT Offshore Partners Third Quarter 2019 Earnings Results Conference Call. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Gary Chapman. Please go ahead, sir.

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [2]

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Thank you, Ben. Thank you. Welcome, everybody. The earnings release and slide presentation are both available on our Investor Relations section of our website. On today's call, our review will include non-U. S. GAAP measures such as distributable cash flow and adjusted earnings before interest, tax, depreciation and amortization, the EBITDA. Earnings release includes a reconciliation of these non-GAAP measures to the most directly comparable GAAP financial measures.

Please be reminded that any forward-looking statements made during today's call are subject to risks and uncertainties and these are discussed in our annual and quarterly SEC filings.

As you know, actual events and results can differ materially from those forward-looking statements, and the partnership does not undertake a duty to update any forward-looking statements. Just by way of a recap, KNOT Offshore Partners, KNOP, focuses on the shuttle tanker segment to whereby our ships, transport oil from production units to shoreside, effectively a mobile pipeline business, and they form an integral part of the supply chain. Our sponsor, Knutsen NYK, has placed all of their younger assets in the MLP, and all have long-term charters after construction. The MLP and sponsor combined are the largest operator of shuttle tankers with 29 vessels on the water together with 2 FSOs, and today, 3 more shuttle tankers on order. Our sponsor has been involved in the design, construction and operation of shuttle tankers for well over 30 years. And so we believe our expertise is unrivaled. Each new vessel is almost always built for an individual charter, and importantly, our ship charter contracts do not rely or depend on the volume of oil produced by a field, nor on the short-term underlying oil price as we always fix with strong credit counterparties. And therefore, KNOP is set up to provide a stable and steady source of income. In our sector, to date, there has been no speculative ordering of tankers by vessel owners, and we have a strong growth outlook, something that I'll come back to later.

In addition to demand for new vessels for new projects, the shuttle tanker fleet is naturally aging and will need replacing in the medium term. However, KNOP's vessels have an average life -- average age of only around 6 years, and so there's much earning capacity remaining.

Now turning to Slide 3. Q3 2019 financial highlights and recent events. Again, KNOP's results were very solid and very stable. Total revenue of $71 million, operating income of $32.4 million, net income of $14.1 million and adjusted EBITDA of $54.8 million, with distributable cash generated of $28 million and a continuation of the cash distribution of $0.52 per unit, returning an annual yield of around 10.9% on a $19 unit price.

We finished the quarter with a distribution coverage ratio of 1.55. During the quarter, the fleet operated with 99.7% utilization for scheduled operations. And since our IPO in 2013, we've operated with an average of 99.7%, excluding all scheduled maintenance and dockings. There were no drydockings in the quarter, and as disclosed previously, none are planned during the remainder of 2019. There's just 1 vessel scheduled to undergo drydocking in 2020, which we expect will take place in the early part of the year.

During the quarter, Shell agreed to take up the next 1-year option on the Windsor Knutsen, meaning this vessel, the first one that was put into the MLP, is now contracted to October 2020. In October '19, Equinor exercised its option to extend the charter of the Bodil Knutsen by 1 additional year until May 2021. And again, in October, Eni exercised its option to extend the time charter of the Torill Knutsen by 1 additional year until November 2020. It's perhaps just worth saying at this junction that these such charter renewal decision points, as firm fixed periods come to an end, are a natural element of KNOP's business. Typically, a new-build vessel charter contract will contain a fixed charter period of between 5 and perhaps 10 years, plus charter's options for additional periods of, say, 5 to 15 years, depending on an oilfield's production volume, profile of volumes, et cetera. This allows the charter to control access to the vessel for a long period of time. It also gives them some flexibility. But more often than not, we have seen charters extend their charter periods and continue with the vessels as for the Windsor, Bodil and Torill in this quarter. As once oil fields are producing, shuttle tankers are needed and in some cases, only certain vessels can service certain fields, giving KNOP more assurance that those vessel options will be taken up as they fall due.

This, together with what we see to be strong forward demand for shuttle tankers, means KNOP is confident that as charter renewals arise over the coming years, contracts will be renewed or options taken or if necessary, where there are no options remaining, new charter contracts can be entered into. Just as a caveat, we, of course, do need to remind listeners that there can be no guarantee that this will be the case.

On Slide 4, the income statement. You'll see the total revenues of $71 million for the third quarter compared to $70.9 million for the second quarter of '19. The increase is mainly related to there being 1 more operational day in the third calendar quarter compared to second. This increase was partly offset by reduced earnings from the Bodil Knutsen due to its reduced daily rate from May '19 when the vessel begun operating under its new charter, plus slightly lower by 0.3% utilization for the fleet during the third quarter. Vessel operating expenses for the third quarter were controlled at $15 million, a decrease of $0.3 million from the $15.3 million in the second quarter of '19. The decrease was mainly due to the strengthening of the U.S. dollar against the Norwegian krone.

Admin and general expenses were essentially unchanged from Q2 at $1.2 million as was depreciation at $22.4 million. Overall, this left us with slightly higher operating income of $32.4 million compared to $32 million in Q2. Interest expense for Q3 was $12.5 million, a decrease of $0.7 million from $13.2 million in Q2. The decrease being mainly due to lower LIBOR on average across all credit facilities that are not hedged. Loss on derivative instruments was $5.7 million for Q3 compared to a loss of $10.3 million in Q2. Most of this was unrealized and due to changes in long-term interest rates. As a result of all of the above, net income for Q3 was $14.1 million compared to $8.2 million for Q2.

On Slide 5, adjusted EBITDA. In Q3, the partnership generated adjusted EBITDA of $54.8 million compared to $54.4 million for Q2. Adjusted EBITDA refers to earnings before interest, tax, depreciation and amortization and other financial items and provides a proxy for cash flow. Adjusted EBITDA is, of course, a non-U. S. GAAP measure that can be used to measure partnership performance. With a wasting asset like a vessel, younger fleets tend to produce slightly lower EBITDAs for every dollar invested. The annuity factor reduces the annual loss in the earlier years, which is factored into the replacement CapEx calculation for the distribution cash flow.

On to Slide 6, the distributable cash flow. This is another non-U. S. GAAP financial measure used in estimates of distribution sustainability. Distributable cash flow represents the net income adjusted for depreciation, unrealized gains and losses on derivatives and foreign exchange. Also, the distributions on Series A convertible preference units and other noncash items. There's an estimate for maintenance and replacement capital for drydocking and capital expenditure, which is required to maintain long-term operating capacity, and therefore, the revenue generated by the partnership's capital assets.

Distributable cash flow was $28 million in Q3 in comparison to $26.1 million in Q2, and the distribution cover at the end of Q3 was 1.55x. In the quarter, we maintained our distribution level of $0.52 per unit equivalent to an annual distribution of $2.08. The high coverage ratio gives the partnership flexibility regarding both capital base and distributions going forward.

On Slide 7, the balance sheet. At the end of Q3, the partnership had $73.5 million in available liquidity, which consisted of cash, cash equivalents of $44.8 million, and $28.7 million of capacity under its revolving credit facilities. The credit facilities mature in August '21 and September '23. And KNOP has no other refinancing falling due until 2022. We continue to have a predictable cash flow and a healthy liquidity position, which gives KNOP flexibility to both continue to pay a level of distributions while also looking to future growth in the shuttle tanker market. The partnership's total interest-bearing debt outstanding at September 30 was down to $1.027 billion from $1.045 billion at the end of Q2, and the average margin paid on the partnership's outstanding debt during Q3 was approximately 2.1% over LIBOR, and that's unchanged from Q2.

At the end of Q3, the partnership had entered into various interest rate swap agreements for a total notional amount of $568 million to hedge against the interest rate risks of its variable rate borrowings. At the same date, we receive interest based on 3 or 6-month LIBOR and pay a weighted average interest rate of 1.87% under the interest rate swap agreements, which have an average maturity of approximately 4.2 years. As we don't apply hedge accounting for derivative instruments, our financial results are impacted by changes in the market value of financial instruments. However, cash flow is stabilized, mitigating interest rate risk on our distributable cash flow. All in all, 2019 full year estimates remain on track and look very solid.

Slide 8, turning to our long-term contracts with our leading energy companies. For the Windsor Knutsen, the partnership agreed with Shell, as the charter, to suspend the vessel's time charter contract. The suspension period commenced March 4 and will last between a minimum of 10 months and a maximum of 12 months. During the suspension period, the Windsor has been operating under a time charter contract with Knutsen Shuttle Tankers Pool AS on the same terms as the existing time charter contract with Shell, meaning no financial losses arisen to KNOP as a result of this arrangement. Due to the recent contract extension, the vessel is now fixed until October 2020.

Bodil Knutsen is our largest shuttle tanker operating in the North Sea. It's ICE class and on charter to Statoil until 2020. There are 4 further 1-year annual extension options. Torill and Hilda Knutsen operate in the Goliat Field, which is the first field developed in the Barents Sea. After initial 5-year terms on both vessels, the Hilda time charter extended for 4 more years, and the first 5 annual extension options have been exercised on Torill Knutsen.

Dan Sabia, Dan Cisne, Fortaleza and Recife Knutsen are on long-term bareboat charters through to 2023 with Petrobras Transpetro. Carmen and Raquel Knutsen are on charter to Repsol Sinopec until 2023 and 2025, respectively. And for Raquel, there are options to extend until 2030. Ingrid Knutsen is on time charter until 2024 with charter's options to extend by up to 5 more 1-year periods. Tordis, Vigdis and Lena Knutsen are on 5-year charters to Brazil Shipping, a subsidiary of Shell. These will expire in 2022, and the charterer has options to extend for further 10 years. The Brasil and Anna Knutsen are on charter to Galp Energia until 2022 with charterer's options to extend until 2028. Today, the KNOP fleet has an average remaining fixed contract duration of 3.1 years and there are additional 4.3 years on average in the charterer's options.

Turning to Slide 9. As disclosed in previous quarter, KNOP now has 3 vessels in the pipeline at sponsor level that could be dropped into the MLP, beginning from the middle of 2020. This information is unchanged at the end of Q3, and with 2 of the vessels fixed charters declared, there is an average fixed charter period of 6 years with the first 2 of those vessels. The acquisition by KNOP of any drop-down vessel in the future is, of course, subject to the approval of the Boards of Directors of each of KNOP and Knutsen NYK. And therefore, please do be reminded that there can be no absolute assurance that any potential drop-downs will occur.

Slide 10. I mentioned above and on the previous call that we believe that the shuttle tanker market has a solid growth outlook. And as part of these calls, we'd like to start to provide listeners with some more color around this statement. This particular slide was produced by Rystad Energy for KNOP. Rystad Energy is an independent energy research and business intelligence company that the partnership uses to help analyze a host of different market data sets. What we're seeing is that oil production is moving further offshore into new fields with new licenses, particularly in Brazil, where this slide focuses. There are also other areas such as the Barents Sea, which in the interest of time, cannot be covered today. In Brazil, the growth is occurring in geographical areas where we believe there is a strong need to use modern DP2 shuttle tankers, such as those operated by KNOP, for example, in the pre-salt areas. Not only that, the growth in Brazil is occurring in fields that are at least under development, making them more certain to come onstream, and these projects are being conducted by a wider group of utility and oil companies than ever before, many of which will want to control their own shuttle tanker capacity. It's also worth noting that pre-salt projects in Brazil are typically competitive in terms of average breakeven prices and payback times, making them attractive to developers. These are some of the reasons why KNOP management believes that demand for new-build offshore shuttle tankers will continue to rise over time based on the requirement to replace older tonnage in the North Sea and Brazil and further expand to fulfill requirements in deepwater offshore production areas such as pre-salt in Brazil and the Barents Sea. As the largest shuttle tanker operator in Brazil today with 12 vessels, KNOP is well placed for these developments. Just before I do move off of this slide, I am just bound to finally remind listeners that these such forward-looking views and statements made by the partnership may, of course, ultimately differ from what actually happens.

Slide 11. This quarter, KNOP has again reported another very strong performance across revenue, EBITDA and distributable cash flow and is well placed in facing the growing market. We have a strong and solid contract base generated by our modern and still young DP2 fleet. And together with our sponsor, we operate the largest fleet of shuttle tankers in the world. And since the formation of KNOP, we have had very high levels of vessel utilization, averaging around 99.7%. And financially, this translates into high and predictable revenues, adjusted EBITDA and cash flows. No one has more expertise in operating shuttle tankers, and we see tight supply and growing demand. Thank you. And that concludes the narrative for the slides. And if anyone has any questions, I'd be happy to take them.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Greg Lewis with BTIG.

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Gregory Robert Lewis, BTIG, LLC, Research Division - MD and Energy & Shipping Analyst [2]

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I guess just broadly speaking, as we think about the FPSO market, where it stands today in terms of new units hitting the market, whether that's in Brazil or elsewhere, anyway we can kind of quantify that number? And as we think about those new FPSOs hitting the market, how should we be thinking about the appetite for these new units coming online? How should we be thinking about the appetite in terms of whether the customers are thinking about new builds or potentially even just recycling existing shuttle tankers on the market?

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [3]

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Yes. I mean, that's obviously an incredibly difficult question to answer. Every charter is different. They've all got a different profile. They all operate in different fields that have different profiles. They've all got different appetites for doing operational things themselves. Some like to pass a lot of that work outside to other people. Some of them like to control a lot of that internally. I'm probably not going to give you a very good answer, I think. But I think what we are seeing -- if you step back up a little bit, and that's kind of what we try to do with this Brazil slide, is to really just show that however, the utility companies and all majors want to do it and there are various ways, the demand for offtake and shuttle tankers in Brazil is looking strong. And particularly, you'll notice the pre-salt, which are the black dots on the graph, the predictions that we've got are very strong. So I think it will be different for every customer of ours. It will be different for every field up to a point. And obviously, the geography and the title, the strength of tides and the depth of water, et cetera, all play a part. So we think there'll be room for everybody to do well out of the growth in Brazil, and we expect and very much hope that we'll get our fair share of that.

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Gregory Robert Lewis, BTIG, LLC, Research Division - MD and Energy & Shipping Analyst [4]

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Okay. And then just so as I think about that, maybe bigger picture, as we look back and realizing that the FPSO market is looking set to grow after kind of stalling out over a period of time. Is it generally -- maybe is it kind of like a 50-50 split? Or is it more of a 50-50 split or more of like a 80-20 split? Is that kind of not the right way to think about it?

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [5]

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I'm -- I think you're asking me to sort of looking into the future there. I really am not sure I can answer that question. I'll be honest with you. It's such a difficult thing to know how people are going. And I think whatever I say I will be wrong.

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Gregory Robert Lewis, BTIG, LLC, Research Division - MD and Energy & Shipping Analyst [6]

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Welcome to my world. Okay. And then just as a -- as we think about the stability of the cash, I mean, clearly, clearly, the company's dividend has been kind of -- it's been an attractive steady dividend for a handful of years. I mean, at this point, as we think about it, the yield is probably a little bit on the high side, pushing around 11%. And just thinking about that, does that limit really the appetite of not to kind of drop-down assets? I mean it almost looks like maybe you're not getting rewarded maybe the way you should be for the stability of your cash flows.

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [7]

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Yes. I think and I said this on the previous call last quarter, I think the company does feel that a little bit. That's the reality. I think it's not pushing us in a particular direction, really, because I think what we've got is a sort of financial issue if you like. We've got a strong shuttle tanker market. We've got strong operations. We've got a good setup. Our challenge is to translate and access all of that through the financial markets through the MLP. And it's -- yes, it's disappointing a little bit where our yield is. But then you look at everybody else and pretty much everybody else in this space is in that position and companies much bigger than us. So what we're not doing is focusing too heavily on the negatives, and we're very much trying to focus on the positives, and so what we believe is a really good story to investors that, at some point, the market will turn, at some point, the energy will come back into a little bit more fashion, maybe investment will flow back in. But at this stage, it's causing us some difficulties to access and grow our business. But we're really trying not to focus on that in the message that we're giving to the market because that's a problem for us to try to solve as best we can. But it's not affecting our strategy, if you see what I mean.

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Operator [8]

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Our next question comes from Philip (inaudible), private investor.

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Unidentified Participant, [9]

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I'm just curious, how will the new IMO-2020 fuel regulation affect our vessels? Basically, I understand that fuel users could be using 3.5% sulfur. And so, as of January 1 of next year, it should go down to 0.05%. Is there any expectation of additional expenses, are our fleets can handle the lower sulfur?

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [10]

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Yes. I mean, certainly, the fleet can handle it for sure. It's -- generally speaking, fuel is a cost of our charterer. It's not a cost for us. So on the whole, we are not overly concerned. There are some vessels out there that run on LNG, which are much more expensive. But again, that would also get companies and charterers out of it. But the simple answer to the question is that we, as the owner, are not overly concerned about that because, as I said, exactly it's a cost for our customer, our charterer.

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Unidentified Participant, [11]

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Okay. So it flows back to the customer. That's already built in?

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [12]

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Yes, it's a variable cost of operating the vessel, and we charter the vessel, and it's up to the charterer to put the fuel in the tank, so to speak.

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Operator [13]

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(Operator Instructions)

Our next question comes from Robert Silvera with R. E. Silvera Marine Surveyors.

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Robert Silvera, [14]

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Congratulations first on job well done. The drop-down potential vessels with the new hauls, are they being designed to handle with their propulsion systems, either scrubbers or some other methodology? The parent company, which would know they going after for those 3 that could possibly become drop-downs?

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [15]

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At this point in time, I don't believe that they are putting any scrubber technology on the vessels. On the whole, it's a customer choice.

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Robert Silvera, [16]

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Yes, I realize that.

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [17]

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If, for example -- yes. Yes. So I mean, if the customer wants some scrubber technology on their vessel, we would look to do it, but it would be their cost. It would all come back through the charter rate and the cost of the vessel. Is that answering your question?

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Robert Silvera, [18]

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Yes. And then what you're telling me then is that they basically are designing these ancillary features, the customer is, rather than the parent company? I'm thinking of it in terms of what makes the ship more attractive?

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [19]

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Yes, to a point -- yes, it's always a balance. Because we're obviously concerned with the very long term and making sure that we have a vessel that is attractive, not just to the first initial charterer that may have it for 5 or 10 years, but actually is then subsequently attractive for the general market if we have to recharter it. So we're not keen to be putting lots of bells and whistles on ships that are not necessary. But equally, we have to strike a balance because if we've got a customer that's going to take the vessel for 5 to 10 years, and they want something, and they're prepared to pay for it, then, on the whole, we generally try to accommodate that.

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Robert Silvera, [20]

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Very good. We're very pleased as shareholders with your achieved distribution coverage ratio of 1.55x and with the way the business is running and the future at Brazil, et cetera. I would like to suggest that perhaps the company would consider designing the dividend rather than being the steady $0.52 every quarter to keep it tied to a 1.50x coverage ratio. So as you achieve better coverage ratios in the future, that extra cash would go into the dividend and keep the coverage ratio at 1.5x. We'd love to see you consider that. And I think that would effect the results of your good performance as far as the share price is concerned, when people see the possibilities of the rising dividend based on your overall performance, which has been so good for years now. And you'll get better rewarded for that.

In the meantime, extra cash, I'd love to see you build it, go in the normal amortization of debt, but at the same time, build cash for possible upcoming drop-downs and things like that, which would give us our money at a lower interest rate because we are cash rich, so to speak. That's something that we feel, as shareholders, we would appreciate that kind of an approach.

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [21]

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Yes. And thank you for that. It's a very good idea, and we try to think about all of these sorts of strategies and approaches. I think not just for KNOP, but the MLP market generally had quite an easy ride between 2013 and 2015, '16. It was easy to raise common unit equity, less so today. And I think as a result of that, we and others are facing different choices today. So we've been quite prudent with not increasing the distribution any further. We've been quite prudent in letting the coverage ratio buildup, but we need to look after the company, and that also means coming out with a longer-term strategy as to how we can best please everybody, whether it's through growth, whether it's through distributions, whether it's through the message that we give to the market. So your idea of fixing a coverage ratio, yes, it's a good one, and we'll throw it in the pot with all the ideas that we've got, for sure.

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Robert Silvera, [22]

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Good. The other thing I'm convinced of is the absurd low interest rates that are in the world right now, both nondomestic to U.S. and overseas as well, this is not going to last forever. And so the stronger we are cash-wise going into the future, the better off we'll be for our borrowing interest rates. So -- okay, and that's all I have to offer, and I thank you very much for taking that idea of 1.50x under consideration. And the minute that the marketplace knows that.

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [23]

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Thank you, Robert.

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Robert Silvera, [24]

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then they'll, I think, respond to the potential that fixed $0.52 is not there. And so I think that's what's been hurting you, the fact that the marketplace is, well, they're just only going to do $0.52, yes, it's a good, steady business and all of that. But there's no potential for growth, and there is inflation in the world, small now, but who knows where it'll be later.

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [25]

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Yes.

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Robert Silvera, [26]

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But anyhow, we can change the perception of the company's attitude toward the dividend even though basically, we'll be paying pretty much exactly the same thing.

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [27]

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Yes. Yes, thank you. Thank you for that.

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Operator [28]

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This concludes our question-and-answer session. I would now like to turn the conference back over to Gary Chapman for closing remarks.

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [29]

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Okay. Thank you to everyone who has listened in. I just want to wish you a good day, and we'll look forward to speaking in the next quarter. Thank you very much.

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Operator [30]

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The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.