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Edited Transcript of KNOP earnings conference call or presentation 29-Aug-19 4:00pm GMT

Q2 2019 Knot Offshore Partners LP Earnings Call

Aberdeenshire Sep 11, 2019 (Thomson StreetEvents) -- Edited Transcript of Knot Offshore Partners LP earnings conference call or presentation Thursday, August 29, 2019 at 4:00:00pm 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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* James Altschul;Aviation Advisory Service;President

* Marc Joseph Solecitto

Barclays Bank PLC, Research Division - Research Analyst

* Robert Silvera;R.E. Silvera and Associates;President

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Presentation

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Operator [1]

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Good afternoon, and welcome to the KNOT Offshore Partners Second 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.

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

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Thank you, and welcome, everybody. If any of you have not read the earnings release or the slide presentation, they're both available on the Investors 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. The earnings release includes a reconciliation of these non-GAAP measures to the most directly comparable GAAP financial measures.

A quick reminder that any forward-looking statements made during today's call are subject to risks and uncertainties, and these are discussed at length 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.

As this is my first earnings call since taking over from John Costain, I'd like to take this opportunity to give a very brief background for those of you who don't know. I joined KNOT as Chief Executive Officer and Chief Financial Officer in June 2019. I am a fellow of the Institute of Chartered Accountants in England and Wales, and I've recently served as the Chief Financial Officer of Biggin Hill Airport Limited, a private business aviation airport in London. Before that, I've spent around 9 years as the Finance Director at NYK's energy transport business in the EMEA region, NYK being a shareholder and KNOT sponsor. Prior to this, I was NYK's European Head of Tax for around 6 years, having worked previously in various audits and tax roles for KPMG, the global audit accounting firm, including as the member of their oil and gas group.

Introduction. KNOT Offshore Partners, KNOP, focuses on the shuttle tanker segment. These ships transport oil from production units to shoreside effectively in mobile pipeline business and form an integral part of supply chain. Each new vessel is usually built for an individual charterer and on delivery is chartered to them for a period of time, typically ranging from 5 to 10 or more years. The ship charter contract does not rely or depend on the volume of oil produced by the field, nor on the underlying oil price. It's always with a strong credit counter-party and therefore provides a very stable source of long-term income.

In our sector to date, there's been no speculative ordering of tankers by vessel owners and we have solid growth outlook in the sector. Our sponsor, Knutsen NYK, has placed all their younger vessels in the MLP. All have long-term charters after construction, and all remain strategically important to their respective charterers. The MLP and the 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.

Oil production is moving further offshore into new fields, particularly in Brazil and the Barents Sea. And shuttle tankers, therefore, operate in a space which is now seeing substantial oil production growth. Such growth is also occurring in geographical areas where there is a strong need to use our modern DP2 shuttle tankers to transport products, and we believe this will continue in the coming years. In addition to demands for new vessels, the shuttle tanker fleet is naturally aging and will need replacing in the medium term. Our sponsor Knutsen NYK is, according to Clarkson Platou Research, possibly the largest shipping group in the world, and NYK is a major company in the Mitsubishi family. Since the partnership's IPO in April 2013, the fleet has grown 300% to 16 vessels, with today an average age of just 6 years.

Now turning to the presentation. This presentation is similar in style to what you may have heard in the past. But in future, we intend to gradually include more shuttle tanker market insight and analysis as this is something that our investors have told us they would welcome.

So turning to Slide 3, Q2 2019 Financial Highlights and Recent Events. For the second quarter of 2019, the partnership's results were, again, very solid and very stable. Total revenue of $70.9 million, operating income of $31.9 million, net income of $8.2 million and adjusted EBITDA of $54.4 million. The partnership generated distributable cash of $26.1 million and continued to declare a cash distribution of $0.52 per unit in the quarter. This gives coverage of 1.45x for Q2.

During the quarter, the fleet operated with a 100% utilization for the scheduled operations. And since that IPO in 2013, we have operated with an average of 99.7% utilization, excluding scheduled maintenance and dockings. There are also no dry-docking scheduled for any of the partnership's fleet during the remainder of 2019. Our current distribution has remained unchanged since 2015. It's around an 11% yield on today's unit price.

During the quarter, we have agreed with Shell for them to take up the next 1-year option on the Windsor Knutsen, meaning this vessel, the first to be put into the MLP, is now contracted to October 2020.

During the quarter, the sponsor has awarded a new long-term charter with Total for 1 newbuild vessel, where Total would charter the vessel for either 5, 7 or 10 years, which they must declare not later than 6 months before delivery with then options for up to 15 years in total. But of course, we cannot guarantee that the vessel will be purchased by KNOP and dropped down into the MLP, so it must be offered under our agreement with our sponsor. Should it be dropped down, this will continue the growth story of KNOP, further evidencing our assertion of steady stable growth.

In the quarter, we also saw the closing of the renewal of our unsecured revolving credit facility with NTT Finance Corporation for USD 25 million, now extended to 2 years. MLP has no refinancing following June until 2022.

On Slide 4, the Income Statement, you will see total revenues of $70.9 million for the second quarter compared to $70.6 million for the first quarter of 2019. The increase relates to having 100% utilization in Q2 compared to 99.8% in Q1, plus there was 1 extra operating day in Q2. Vessel operating expenses for Q2 were $15.3 million, an increase of $0.8 million from Q1. This was mainly resulting from the timing of certain expenditure over the first half of the year, plus certain extra cost incurred on the Windsor Knutsen related to crew training for new operations being performed in Ghana. Admin and general expenses were $1.3 million for Q2, as they were in Q1, and depreciation for Q2 was also unchanged at $22.4 million.

Interest expense for Q2 is $13.2 million. It's a bit decrease of $0.5 million from Q1 due to slightly lower average LIBOR rates on a minor proportion of our debt that is not hedged. Losses on delivery -- derivative instruments was $10.3 million for Q2 compared to a loss of $5.9 million in Q1. Most of this is unrealized and due to changes in the long-term interest rates. As a result of all of the above, net income for Q2 was $8.2 million compared to $12.9 million for Q1.

Slide 5, Adjusted EBITDA. In Q2, the partnership generated adjusted EBITDA of $54.4 million compared to $54.8 million for Q1. Adjusted EBITDA refers to earnings before interest, tax, depreciation, amortization and other financial items, and it 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 the vessel, younger fleets tend to produce slightly lower EBITDAs for every dollar invested. Annuity effect reduces the annual loss in the earlier years, which is factored into replacement CapEx calculation for the distributable cash flow.

On Slide 6, Distributable Cash Flow. This is another non-U. S. GAAP financial measure used in estimate 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 preferred units and other noncash items. There is an estimate for maintenance and replacement capital for dry-docking and capital expenditure, which are required to maintaining long-term operating capacity of the vessels and therefore the revenue generated by the partnership's capital assets. DCF, as it's called, was $26.1 million in Q2 in comparison to $25.7 million in Q1, and we maintained our distribution level at $0.52 per unit, equivalent to an annual distribution of $2.08. The distribution cover ratio remains healthy at 1.45x at the end of Q2. This is despite increase in the replacement CapEx charge for the fleet by $629,000. As the fleet ages, we increase this provision. By comparison, the average cover ratio was 1.5x for the full year in 2018. A high coverage ratio gives the partnership more flexibility regarding the capital base and distributions going forward.

On Slide 7, the Balance Sheet. At the end of Q2, the partnership had $71.1 million in available liquidity, which consisted of cash, cash equivalents of $42.4 million and $28.7 million of capacity under its revolving credit facilities. The revolving credit facilities now mature in August 2021 and September 2023. We have predictable cash flow and a very healthy liquidity position. The partnership's total interest-bearing debt outstanding at the end of Q2 was $1.045 billion, compared to $1.037 billion in the accounts net of debt issuance costs, which compares to $1.069 billion in the previous quarter. So we're seeing a continual repayment this quarter of about $23 million. The average margin paid on the partnership's outstanding debt was approximately $2.1 million over LIBOR.

In Q2, the partnership had interest rate swap agreements totaling $572 million, and that compares to $552 million at the end of quarter 1. The partnership receives interests based on LIBOR and pays at an average interest rate of 1.88%. These have an average maturity of around 4.4 years. Whilst the partnership net income is impacted by changes in the mark-to-market swap valuations, cash flow is stabilized, mitigating the interest rate impacts from the DCF. We have recently seen lower interest rates in the U.S. and also increasing replacement capital provisions charged on our vessels as they get older. However, our coverage ratio remains at a high level, and our full year estimates for 2019 look solid.

Slide 8, our long-term contracts with leading energy companies. For the Windsor Knutsen, as disclosed previously, the partnership agreed with Shell as the charter -- to suspend the vessel's time charter contract. The suspension period commenced March 4, 2019, and will last between a minimum of 10 months and a maximum of 12 months. During the suspension period, the Windsor Knutsen 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 are written to KNOP as a result of this arrangement.

Bodil Knutsen is our largest shuttle tanker operating in the North Sea. It's ice class and on charter to Statoil until 2020. They have 4 further 1-year annual extension options. Torill and Hilda Knutsen operate on the Goliat, which is the first field developed in the Barents Sea. After initial 5-year term on both vessels, Hilda time charter have extended it for 4 more years and the first of 5 annual extension options has been exercised on the Torill Knutsen. Dan Sabia, Dan Cisne and 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. For Raquel, there are options to extend until 2030. The Ingrid Knutsen is on time charter until 2024 to a Norwegian subsidiary of ExxonMobil with charterer's option to extend by up to 5 more 1-year periods. Tordis, Vigdis and Lena Knutsen are on 5-year charters to the 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 option to extend until 2028. Overall, the KNOP fleet has an average remaining fixed contract duration of 3.2 years and an additional 4.4 years on average in charterer's options.

Slide 9. In September 2018, the sponsor, Knutsen NYK, entered into newbuild long-term charters with Equinor for 2 Suezmax DP2 shuttle tankers. As previously disclosed, these are constructed at Hyundai Heavy Industries and are scheduled for delivery in the second half of 2020. On this slide, the new vessel to Total is also showing, the details of which I covered earlier on Slide 3.

Slide 10. KNOT Offshore Partners should be considered as a mobile pipeline business with fully contracted revenue streams. This quarter, we yet again reported another very strong performance, revenues, EBITDA and distributable cash flow. And KNOP is well placed to compete in future tenders and currently has 3 vessels on order through its sponsor. We have a solid and profitable contract base generated by our modern DP2 fleet, which by the end of June has an average age of only 6 years.

Together with our sponsor, we operate the largest fleet of shuttle tankers in the world. And since the formation of KNOP, we've had very high levels of vessel utilization, averaging around 99.7%. And financially, this translates into high and increasing predictable revenues, adjusted EBITDA, distributable cash flows and more vessels -- as more vessels are added to the fleet, this will grow. No one has more expertise in operating these vessels than KNOT Offshore Partners.

Today, we see tight supplies in the shuttle tanker market and a growing demand into the future. And with a knowledgeable and financially strong and supportive sponsor, we continue to promote KNOP. Thank you very much.

And that concludes the narrative for the slides. If anyone has any questions, I'll be very happy to take them. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Robert Silvera with R.E. Silvera & Associates.

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Robert Silvera;R.E. Silvera and Associates;President, [2]

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Welcome to the company. And thank you for doing a reasonable job. I noticed that from the end of last year till now, your number of common unitholders has dropped from 631,000 to 613,000 approximately. Could you tell us what the average price, I assume, you bought these back at was?

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

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Robert, I'm afraid, on the top of my head, I don't know that information. Is there a way that I can get back to you in the future?

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Robert Silvera;R.E. Silvera and Associates;President, [4]

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Sure. My phone number is area code 865 in the United States. 882-1064.

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

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Sure. Let me call you back, if not today, then tomorrow.

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Robert Silvera;R.E. Silvera and Associates;President, [6]

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Fine. Okay. If I am not here, just leave a message on the phone to answer the question.

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

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No problem.

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Robert Silvera;R.E. Silvera and Associates;President, [8]

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Okay. The other thing is, are you trying at all to pick up any of the convertible preferred units? You haven't done that.

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [9]

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No. At this time, no. We're not.

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Robert Silvera;R.E. Silvera and Associates;President, [10]

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No. It's not trading at any discount to [25]?

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [11]

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No. I don't think so.

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Robert Silvera;R.E. Silvera and Associates;President, [12]

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All right. Okay. That's pretty much it for me. You're going to continue to reduce debt on schedule, you don't anticipate accelerating debt repayment?

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [13]

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No. I mean given the current yields on the shares and where we are in terms of wanting to grow the MLP and the unit price, I think we need to look at all of our options and -- to keep the business very stable. We want to maintain our distribution as we have been since 2015. But equally, we want to grow the business, so we've got to look at all of our options in order to make sure that if the 3 vessels or 1 of the 3 vessels are offered to the MLP we're in a position to take those on if the pricing is correct and appropriate.

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Robert Silvera;R.E. Silvera and Associates;President, [14]

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So your strategy for increasing the MLP is through acquisition of drop-downs?

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

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Yes, yes. And we hope to finance that in the most appropriate way we possibly can at the time, given market conditions.

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Robert Silvera;R.E. Silvera and Associates;President, [16]

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Okay. What would be the earliest drop-down available from NYK?

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

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From our sponsor, the first delivery is around the middle -- is scheduled to be around the middle of 2020. So at this stage, that's the sort of time frame. We're not expecting any drop-down before that.

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Robert Silvera;R.E. Silvera and Associates;President, [18]

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Are there -- one of the questions from me, are there any other or are there any incentive distribution rights in existence? I haven't noticed that one way or another.

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

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Yes, there are.

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Robert Silvera;R.E. Silvera and Associates;President, [20]

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Is there any outlook for that being eliminated?

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

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It's -- we constantly talk about that. But at the moment, we have no plans. I think at the moment, it's not the sort of top of our radar, top of our list to do that or to address that. But yes, at some point, we very well might do.

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Operator [22]

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Our next question comes from Jim Altschul with Aviation Advisory Service.

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James Altschul;Aviation Advisory Service;President, [23]

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A couple of questions. I think one you sort of alluded to in passing, but with regard to the 3 drop-downs, the -- would you -- how -- do you have any thoughts as to how you might finance them? Would you need to issue more equity? Or would you be able to do it entirely with debt? Or...

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [24]

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Well, we've got a very good cash coverage at the moment, first and foremost. The model for the company has always been to find an accretive deal and finance that through new equity at the right price. I think today, we -- the market is difficult for us, given the prices of units and the yields. And the general sentiment towards the energy stocks, I think we get caught up in that category. At this stage, we've got luckily a few months and a couple of quarters to sort how we are going to do it, but it may be that when you look at our leverage, we may be able to just increase that just slightly without going over what is comfortable, we would never do that, plus with the cash we have. Otherwise, we may look to the main sponsor unitholders in NYK and Knutsen. So there are a few options for us. And at the moment, we're still in the process of evaluating where we think we'll be. Clearly, there's also the possibility that in 6 months' time the market is different.

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James Altschul;Aviation Advisory Service;President, [25]

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Looking at the kind of -- I guess the first of the 3 potential drop-downs would be 3114. What if -- if you were to take that upon delivery, when -- approximately when would that delivery be? And by when would you have to nail down some financing?

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [26]

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Well, the delivery is scheduled for the middle of 2020, so whether it's Q2 or Q3, at the moment, I don't want to say. But I -- the -- everyone is pulling in the same direction here in terms of the drop-down itself. I think specifically, we would want to take the drop-down after delivery because it derisks for us in the MLP, and that would tend to suggest it would be in Q3. We don't have a desperate need to do it before delivery. We don't have to do it before delivery, but we are guided to some degree by the offer that is made from the KNOT sponsor. So I think at the moment, we have some time to work out what it is that we're going to do and how we're going to do it and we do have some ideas for that. And we do think it's possible having studied those ideas already.

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James Altschul;Aviation Advisory Service;President, [27]

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Oh, good. Sorry to interrupt you. Please continue.

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [28]

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No. I was just going to say we'll be -- I've set out previously the various options that we think are there for us at the moment. There are also banks and other financial institutions who are offering us more complex sources of finance, let's say. But I think, at this stage, we want to really concentrate on keeping the structure and the transparency of the financing this MLP as clear and as simple as possible. The business that we operate is, hopefully, very clear and simple. We want this financing as much as possible to be the same. So we're trying very hard to keep this attractive to investors by the simplicity of what we're doing.

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James Altschul;Aviation Advisory Service;President, [29]

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Appreciate that. Just 2 more questions, then I'll shut up. The Torill Knutsen, now reference to -- according to the Slide 8, that charter, the fixed contract currently runs through the end of 2019, but reference -- you also made reference to a 1 year -- the first of several 1-year extension options. Does that option take it to the end of 2019? Or is it now going to go to the end of 2020?

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [30]

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Very good question. I'm afraid I don't know at the top of my head about that. Apologies. Probably by the next quarter I think I will have all of this information on the tip of my tongue. But at the moment, the slide is showing this to the end of 2019 as the firm period. I suspect that option is -- has already been taken or is very close to being taken.

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James Altschul;Aviation Advisory Service;President, [31]

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Well, I mean I don't doubt that at all. What about this basic rule of investment, look out for the downside and the upside will take care of itself? Let us suppose the option is not exercised. Would you have other potential operators you could contact? And how long would it take to reposition that ship, find a new customer, and I don't know, to what extent you'd have to do some work to get it ready for their preferences?

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [32]

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Yes. There is certainly some fields where you may even need modifications. So typically, for those sorts of fields, we typically get the charterers pay for those. I think to answer your question, there are -- there is a tightness of supply in the shuttle tanker market today. If a vessel were to come off charter, I think we'll be confident that we would be able to find something else. And the fallback position is that we would enter it in -- we could enter it into potentially the COA pool that we have on -- which is essentially a more revolving short-term pool that is operated by our sponsor KNOT. So ultimately, we would be confident that we could very quickly find a place and a utilization for the vessel.

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Operator [33]

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(Operator Instructions) We do have a follow-up question from Mr. Robert Silvera with R.E. Silvera & Associates.

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Robert Silvera;R.E. Silvera and Associates;President, [34]

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Once again after hearing about the 3 drop-downs, my question is this, if you begin to take those drop-downs, do you anticipate growing the dividend at all?

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [35]

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Good question, Robert. We would always like to grow the dividend and the distribution. I mean that's what the -- the purpose of we're trying to do here is be successful and grow the MLP. I think at the moment, however, given where the market is, we can't make any promises on that and we don't want to give away our equity, if you like, for fear of not being able to then grow the MLP in the future. And today's yields, given where our price -- our unit price is, we don't, at the moment, see a growth of the distribution. Now I can't say that, that will stay the same forever or even in the next year. But at the moment, we don't have an intention to increase the distribution [and expand] the vessels.

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Robert Silvera;R.E. Silvera and Associates;President, [36]

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Okay. So if those new vessels come on we can still anticipate basically the same dividend?

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [37]

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I think that's the baseline position. It's perhaps a way of saying it in the -- if we can increase it and we think it's sensible and sustainable. And I think that's the most important point for us. And we've tried very hard to be sensible and sustainable in the way that we've run this MLP. So we won't increase the distribution, if we don't think we can achieve that.

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Robert Silvera;R.E. Silvera and Associates;President, [38]

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Okay. Well, our philosophy is looking at it. As the future goes on, 1 of 2 things, either share price increases or dividend increases. To just stay static is I think what has been hurting the price. We are perceived as a static situation and not as a growing MLP. That's one of the problems. So as long as you're addressing that with that in mind, I'm happy. So...

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [39]

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Yes. I mean we always are. But equally, given the stability of the business and the way in which we have strong operations and predictability and, to a large degree, a lot of transparency, we kind of feel as well that the market is perhaps undervaluing where the MLP actually is today and maybe that's perhaps a result of why the sentiments across oil and shipping and the wider economy. So we would always like to grow the distribution, of course, we would. And -- but equally, we need to be very careful and sensible.

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Robert Silvera;R.E. Silvera and Associates;President, [40]

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Sensibly.

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [41]

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Yes, exactly. And if it's not possible, then unfortunately, we have to wait some time.

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Robert Silvera;R.E. Silvera and Associates;President, [42]

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All right. Because I -- the last thing I want to see is our business exists really just for the benefit of lenders. Okay.

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [43]

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Yes, of course.

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Operator [44]

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(Operator Instructions) Our next question comes from Marc Solecitto with Barclays.

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Marc Joseph Solecitto, Barclays Bank PLC, Research Division - Research Analyst [45]

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Just as a follow-up to one of your responses earlier. Just curious if you had a max leverage target in mind with respect to potential funding for future drop-downs.

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [46]

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Yes. Sure. We're in the region of 4.5 at the moment, and I think we feel that the business could comfortably sit between 4.5 and 5. We would never look to go over 5. That's our kind of guidance, if you like, as to where we feel the business is.

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Operator [47]

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(Operator Instructions) If there are no further questions, I would like to turn over the call back to Gary Chapman for any closing remarks.

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Gary Chapman, KNOT Offshore Partners LP - CEO & CFO [48]

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Well, thank you to everyone who's listened in. We genuinely believe KNOP is currently undervalued by the market, given the stable nature of the business and the operational record and growth prospects. So please do support us, and I look forward to hopefully supporting you and speaking to you next time. Thank you very much.

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Operator [49]

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