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Edited Transcript of KNOP earnings conference call or presentation 24-May-19 4:00pm GMT

Q1 2019 Knot Offshore Partners LP Earnings Call

Aberdeenshire May 28, 2019 (Thomson StreetEvents) -- Edited Transcript of Knot Offshore Partners LP earnings conference call or presentation Friday, May 24, 2019 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* John A. Costain

KNOT Offshore Partners LP - CEO & CFO

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Conference Call Participants

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* Hillary Cacanando

Wells Fargo Securities, LLC, Research Division - Associate Analyst

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Presentation

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Operator [1]

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Good afternoon, and welcome to the KNOT Offshore Partners LP Earnings Release First Quarter 2019 Conference Call. (Operator Instructions)

Please note that this event is being recorded. I would now like to turn the conference over to Mr. John Costain. Please go ahead.

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John A. Costain, KNOT Offshore Partners LP - CEO & CFO [2]

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Thank you. 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, taxation, 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. The Partnership does not undertake a duty to update any forward-looking statements.

Introduction. KNOT Offshore Partners, KNOP, focuses on the shuttle tanker segment. Each vessel is usually built to an individual charter specifications. On the non-volume-based contracts, we transport oil from the shoreside production units to shore side, effectively mobile pipeline business. The chartered vessels form an integral component of the chartered supply chain. Shuttle tankers operate in a niche space. And in our sector to date, there has been no speculative ordering of tankers by vessel owners. We have a solid growth outlook also in this sector.

Our sponsor, Knutsen NYK, has placed all their younger assets in the MLP. All have long-term charters at the construction, and all remain strategically important to their respective charterers. The MLP and sponsor combined are the largest operator of shuttle tankers, with 29 vessels on the water and 3 on order. Our sponsor has plenty of experience having been involved in the design and construction of shuttle tankers for well over 30 years, including being involved with the development of the design in the pioneering days, growing their fleet organically over that time.

Oil production is moving further offshore as new fields open, particularly in Brazil and the Barents Sea. And these tankers, therefore, operate in a space which is seeing substantial oil production growth. This should continue in the coming years. In addition, much of the shuttle tanker fleet is 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 initial public offering in April 2013, the fleet has grown 300% to 16 vessels with today, an average age of just under 6 years.

Now turning to the presentation. Looking at Slide 3, Q1 2019 financial highlights and recent events. For the first quarter of 2019 Q1, the Partnership generated another very solid set of results. Total revenue of $70.5 million, operating income of $32.4 million and net income of $12.9 million and adjusted EBITDA of $54.8 million.

The Partnership generated distributable cash flow of $25.7 million. And after declaring a cash distribution of $0.52 a unit, this gives us a coverage of 1.43x for the quarter.

During the quarter, the fleet operated with 99.8% utilization for the scheduled operations. There are also no dry-dockings scheduled for any of the Partnership's fleet during the remainder of 2019.

Since our initial public offering in 2013, we've declared and paid common unit distributions of $11.86. Our current distribution has remained unchanged since 2015 at 11% on the unit price.

On December 17, 2018, the Partnership and a subsidiary of Royal Dutch Shell agreed to suspend the Windsor Knutsen's charter contract for a minimum of 10 months and a maximum of 12 months. The suspension period commenced on the 4th of March, and the vessel now operates under a time charter with a subsidiary of Knutsen NYK on the same terms as the existing time charter contract with Shell. The remaining period is then reinstated at the end.

On 14th of May 2019, the Partnership obtained approval to extend the maturity of its $25 million unsecured revolving credit facility, maturing in August 2019, on the same commercial terms. The refinancing is expected to close in June 2019.

Gary Chapman will take over as CEO on the 1st of June. He has many years' experience in shipping, and he will bring a fresh new perspective to the Partnership matters and further strengthen ties with NYK having worked for them over many years in various senior roles.

Slide 4, the income statement. The total revenues were $70.5 million for 3 months ended 31 March 2019, Q1. And this compares to $70.9 million for the 3 months ended 31 December 2018, Q4. The decrease was mainly related to 2 less operational earnings days in Q1. Vessel operating expenses for Q1 were $14.5 million, an increase of $0.3 million from Q4. The increase is mainly due to higher operating costs on average for the fleet due to a strengthening of the Norwegian kroner against the U.S. dollar. The increase was partially offset by decreased costs for Ingrid Knutsen, which finished its scheduled dry-docking in Q4.

Admin and general expenses were $1.3 million for Q1 as they were in Q4. Depreciation for Q1 was $22.4 million, a slight decrease from Q4. As a result, operating income for Q1 was $32.4 million compared to $33.0 million in Q4. Interest expense for Q1 was $13.7 million, an increase of $0.3 million from Q4 due to slightly higher average LIBOR rates.

Loss on derivative instruments was $5.9 million for Q1 compared to a loss of $10.9 million in Q4. Most of this was unrealized and due to changes in the long-term interest rates. Net income for Q1 was $12.9 million compared to $8.8 million for Q4.

Slide 5. Adjusted EBITDA. In Q1, the Partnership generated EBITDA of $54.8 million compared to $55.4 million for Q4. Adjusted EBITDA refers to earnings before interest, taxation, depreciation, amortization and other financial items, and it provides a proxy for cash flow. Adjusted EBITDA, of course, is a non-U. S. GAAP measure used by our investors 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 effect reduces the annual loss in the earlier years, which is factored into replacement Capex calculation for the distributable cash flow.

Distributable cash flow. This is another non-U. S. GAAP financial measure scrutinized by investors 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 distribution on Series A convertible pref units and other noncash items.

There is an estimate for maintenance and replacement capital for dry-docking and capital expenditure, which are required to maintain long-term operating capacity of, and therefore, the revenue generated by the Partnership's capital assets.

DCF was $25.7 million in Q1. The comparison, $27.3 million in Q4. And we maintained our distribution level for Q4 at $0.52 per unit equivalent to an annual distribution of $2.08.

The distribution cover ratio is still a healthy 1.43 for Q1.

Impacting the calculation this year, we have increased the replacement Capex charge for the fleet by USD 629,000. As the fleet ages, we increased the provision because of the annuity effect. By comparison, the average coverage ratio was 1.5 for the full year in 2018. With a distribution of 11% at the current unit price today, our largest investor, Knutsen NYK, would prefer to: increase coverage through investments; and secondly, deleveraging, rather than increasing dividends distribution. The high coverage ratio gives the Partnership more flexibility regarding both capital base and distributions going forward.

Slide 7, the balance sheet. At the end of Q1, the Partnership had $71.8 million in available liquidity, which consisted of cash and cash equivalents of $43.1 million and $28.7 million of capacity under its revolving credit facilities. The revolving credit facilities, following extension, will mature in August 2021 and September 2023. We have a predictable cash flow, a healthy liquidity position.

The Partnership's total interest-bearing debt outstanding at the end of Q1 was $1.069 billion, and that compares to $1.059 billion -- right, that's $1.059 billion in the accounts net of debt issuance cost, which compares to $1.087 million -- billion, sorry, in the previous quarter. So we're seeing a slight repayment of about $18 million. The average margin paid on the Partnership's outstanding debt during Q1 was approximately 2.1% over LIBOR.

In Q1, the Partnership had interest rate swap agreements totaling $552 million, and that compares to $556 million in Q4, end of Q4. The Partnership receives interests based on LIBOR and pays an average interest rate of 1.86%. These have an average maturity of around 4.7 years.

Whilst the Partnership net income is impacted by changes in the mark-to-market swap valuation, the cash flow is stabilized, mitigating the interest rate impacts from the DCF. We have recently seen higher interest rates in the U.S. and also increasing replacement capital provisions charged on our vessels as they get older. However, our coverage remains at a high level, and our full year estimates for 2019 look solid.

Slide 8, long-term contracts by leading energy companies. Bodil Knutsen is our largest shuttle tanker operating in the North Sea. It is 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 an initial 5-year term on both vessels, Hilda time charter extended it for 4 more years in October. And the first of 5 annual extension options was 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. For Raquel, there are options to extend until 2030.

The Ingrid Knutsen is on time charter until 2024 to Norwegian subsidiary of ExxonMobil, with charter's options to extend by up to 5 1-year periods.

Tordis, Vigdis, Lena Knutsen are on 5-year charters to Brazil Shipping 1, a subsidiary of Shell. These will expire in 2022, and the charter has options to extend for a further 10 years. The Brasil and Anna Knutsen are on charter for Galp Energy until 2022, with charter's options to extend until 2028.

The KNOT fleet has an average remaining fixed contract duration of 3.4 years and an additional 4.4 years on average in charterers' option.

In September 2018, sponsor, Knutsen NYK, entered into newbuild long-term charters with Equinor for 2 Suezmax DP shuttle tankers. These are constructed at Hyundai Heavy Industries and will -- are scheduled for delivery in the second half of 2022. In addition -- 2020, sorry. In addition, in December 2018, they ordered a new Suezmax DP shuttle tanker to be constructed by Cosco Shipyard in China for delivery early 2021. This shuttle tanker will operate in the COA pool if not contracted under long-term charter before delivery.

Slide 10. KNOT Offshore Partners should be considered a mobile pipeline business with fully contracted revenue streams. KNOT has an elevated yield compared to most MLPs and is focused on building coverage and deleveraging. This quarter we report another very strong performance, revenues, EBITDA and distributable cash flow.

KNOT is well placed to compete in future tenders and currently has 3 vessels on order. We have a solid and profitable contract base generated by our modern fleet, which by the end of March, has an average age of a little under 6 years.

Together with our sponsor, we operate the largest fleet of shuttle tankers. Since the formation of KNOT, we have had very high levels of vessel utilization, average around 99.6%. And financially, this translates into high and increasingly predictable revenues, adjusted EBITDA, distributable cash flows and more vessels are added to the fleet. No one has more expertise in the -- operating these sophisticated shuttle tankers than KNOT Offshore Partners, and we operate these vessels with real expertise.

Today, supply is tightening, and the market is expanding. We have a large and financially strong, supportive sponsor who knows this market as well as anyone.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Hillary Cacanando from Wells Fargo Securities.

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Hillary Cacanando, Wells Fargo Securities, LLC, Research Division - Associate Analyst [2]

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The -- so just looking at the drop-down inventory, there's 2, I guess, not delivering until 2020. So is the right way to think about, I guess, potential drop-down is that there -- that you are not going to purchase anything until at least 2020? So we shouldn't expect anything this year?

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John A. Costain, KNOT Offshore Partners LP - CEO & CFO [3]

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That's correct, Hillary, yes. And also the -- obviously, the third ship that they've ordered, but that's with a view to the -- they've got the COA pool and that's with a view to potentially get the long-term charter on that. If somebody comes along and wants the ship, we probably will look to -- the sponsor will probably look to get it covered and then maybe order another ship. But that's what they're thinking. They have got enough internal cargoes to actually just order a new tanker vessel. So potentially, there are 3 candidates, but today, there's only 2.

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Hillary Cacanando, Wells Fargo Securities, LLC, Research Division - Associate Analyst [4]

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And then, I guess also, in terms of potential distribution increase. I know you've -- in the past, you've said that the, I guess, that the equity with the yield at current levels is not attractive. But like what -- is there -- at what point would you consider that -- consider increasing the distribution? Would you...

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John A. Costain, KNOT Offshore Partners LP - CEO & CFO [5]

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Well, I think if you look at the market, it's -- yes. I mean I can't really decide on the distribution policy anymore because obviously yes, it's my last earnings call. And I'm not -- it's not really going to be my decision going forward as to what to do with the distribution. But my view has been that with the market the way it is and the difficulty in raising equity, we don't really want to press the distribution issue. So it's better to build coverage and keep the MLP very stable. And look, I think we could actually add a ship or 2 in the future from leverage, and that's really quite desirable. So I think ultimately, when you're being -- when you're paying these sort of levels of yield, it's telling you something about the markets really. And I don't think necessarily -- you're better off presenting, well, presenting good figures and a high yield than pushing the distribution. And obviously, it weakens -- it will weaken the MLP in the short term.

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Hillary Cacanando, Wells Fargo Securities, LLC, Research Division - Associate Analyst [6]

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Right. What's your view of the MLP market actually? I mean where do you...

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John A. Costain, KNOT Offshore Partners LP - CEO & CFO [7]

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Personally -- I mean I think the MLP market has changed quite a lot over the last few years. I mean I see a lot of the big companies, they still got to raise equity as well and I think, genuinely, just got to keep a solid vehicle because I think if you -- I mean I know some of the bigger MLPs that raise quite a lot of capital, their unit price has suffered quite heavily because there doesn't seem to be an awful lot of liquidity in the market. I mean lots of the funds are closed-end funds that may basically have a large slice of the MLP units, and they have been struggling to attract new investors. I mean I think a lot of the conversions that the MLPs have gone through have made investors shy away from the MLP investment space generally, and it has suffered over the last few years because some of the MLPs basically have migrated away. And I think investors like to know what they're buying. And I think that that's suffered. I mean I also think with the -- we're a bit small and also we -- that's a problem. I mean it's hard to grow in this market.

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Hillary Cacanando, Wells Fargo Securities, LLC, Research Division - Associate Analyst [8]

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So you think the MLP market is still viable, like you don't think there -- like is there any chance that KNOT could actually, sometime in the future, be rolled up to the parent? Or...

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John A. Costain, KNOT Offshore Partners LP - CEO & CFO [9]

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Yes. I think -- I mean, you're thinking about it intelligently, Hillary. I think there's always a chance of that. But ultimately, you have to message properly. And at the moment, we intend to continue as an MLP. If there was any decision that could change the way the Partnership is going to operate, then it would be well time posted. So it wouldn't just be sprung on paper, but -- I mean, you can never say never with any company or any MLP going forward what's it going to do. I mean what you can see from the way KNOT's operated over the last 6 years, the contracts are really very stable and they're very good quality. For all the other issues around the MLP space, this is a very solid investment, and it may not be -- you may be right, it may not be in the long run. Again, I'm not involved after this call, so I can't really decide on if that will have any say in the strategy, and that's something the sponsor will have to think about going forward. But it's like every MLP you talk to, you're not going to get a straightforward answer and say, "No, we'll stay an MLP for 10, 15 years" because nobody has that level of visibility. I mean we -- you know that the marine space MLPs are no longer included in the Alerian, and that's obviously interesting because it impacts the amount of liquidity and the units of companies that are outside that Alerian index.

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Hillary Cacanando, Wells Fargo Securities, LLC, Research Division - Associate Analyst [10]

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Well, John, and it was really nice working with you for the past couple of years. Wish you good luck.

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John A. Costain, KNOT Offshore Partners LP - CEO & CFO [11]

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And you, Hillary. Thanks. No, I'm fine. I'm looking forward to have a simple life, I think. It's having the 2 areas of shipping in my involvement. It's been quite -- it's been fascinating actually. I've enjoyed it. And certainly, you and Michael have been 2 of the best analysts we've had, and I appreciate the fact you've stayed interested in this.

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Hillary Cacanando, Wells Fargo Securities, LLC, Research Division - Associate Analyst [12]

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We always say KNOT has been a quiet executor. You guys have been executing when everyone else has cut their distribution. And so thank you, and good luck. It was very (inaudible).

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John A. Costain, KNOT Offshore Partners LP - CEO & CFO [13]

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Thanks, Hillary. And you.

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Operator [14]

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(Operator Instructions) There are currently no participants in the Q&A. This concludes our question-and-answer session. I would like to turn the conference back over to Mr. John Costain for closing remarks.

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John A. Costain, KNOT Offshore Partners LP - CEO & CFO [15]

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Thank you, everyone, who's listened in, and I appreciate all your interest in the units. And hopefully, you'll stay with us, or you'll invest to become a bigger investor in the MLP. And hopefully, it goes from strength to strength over the coming years. Thank you all, and I'll sign off now. Bye.

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Operator [16]

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This conference is now concluded. Thank you for attending today's presentation. You may now disconnect, and have a good day.