KNOT Offshore Partners LP Common Units representing Limited Partner Interests

Good day and welcome to the Not Offshore Third Quarter Earnings Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touchtone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Gary Chapman, CEO. Please go ahead.

Thank you and welcome everybody. You can find our earnings release and the slide presentation on our website at offshorepartners.com. Partnership owns and operates shuttle tankers where our ships transport oil from offshore production units to shoreside and are an essential part of the supply chain for our customers, all of whom are large names in the oil and energy market. Our call today, as usual, will include the non-US GAAP measures of distributable cash flow and adjusted earnings before interest, taxation, depreciation and amortisation, EBITDA. The earnings release includes a reconciliation of these non-GAAP measures to the most directly comparable GAAP financial measures, and please remember that any forward-looking statements made during today's call are subject to risks and uncertainties that are further discussed in our annual and quarterly SEC filings. 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. I refer you to slide 2 and our 2019-20F for further details. On to slide 3, our third quarter 2020 highlights. The partnership is again proud to report one of its best-ever set of quarterly results, driven by 100% fleet utilisation and no scheduled downtime in the quarter. Total revenues were £71.3 million, operating income £30.9 million and net income £25.1 million. We declared and paid a cash distribution of 52 cents per common unit, now for the 21st successive quarter. Quarterly adjusted EBITDA was 53.3 million for the quarter, with distributable cash flow of 28.9 million and a robust coverage ratio of 1.6. At the end of the quarter, the partnership had 585 million of remaining firm contracted forward revenue, excluding options. We're again able to report that we've not experienced any material business interruptions or material adverse financial effects arising from COVID-19, and we continue to focus on the health and safety of our crew and the safety of our operations. The charterer of the Windsor Knudsen will re-deliver the vessel to us on the 25th of November 2020, and today there are new rechartering opportunities under active discussion for commencement in 2021, whereby the partnership would also seek one or more short-term charters for the vessel in any intervening period. On this basis, and given the diversification of our charter portfolio, our strong distribution coverage and our available liquidity, the partnership does not currently anticipate this expiration will have a material adverse effect on the partnership's financial position in 2020 or 2021, even if utilisation of the Windsor Knudsen falls below the 99% to 100% levels historically achieved, as we expect it might in the near term. To slide four, where we take a step back for a moment to outline some of the unique aspects of our business that may not always be fully appreciated, but which we believe are important components of the partnership as a good long-term investment. We're a market leader in the operation of Shuttle Tankers with more than 30 continuous years of experience and investment in this business. Something that is important for many of our U.S. unit holders is that KNOP is classified as a corporation for U.S. federal income tax purposes Therefore, we issue Form 1099 to report our distributions and not Form K1. Our vessels are specialised assets with limited replacement risk and they represent critical infrastructure required by our customers to deliver oil production from projects that have significant upfront investments, long lifespans and often low marginal production costs. Most of our vessels have operational flexibility as they typically are capable of servicing many different fields. At the same time, there are high barriers to entry due to the specialist nature of our vessels, the capital cost and technical specification over and above a conventional tanker, and the need for an operating track record in this niche market. We have a diverse set of financially strong contractual counterparties. Our contracts are fixed rate and typically one to seven years, and once in operation they do not depend on oil price fluctuations, and it is our customers that bear the risk of vessel utilisation and operational fuel costs. Our management strategy, as it has been since our IPO, is to operate the business on a prudent basis and focus on long-term stability as far as possible, providing our unit holders with an attractive distribution supported by long-term contracted cash flow. We have a diversified revenue stream where no individual vessel contract in our fleet accounts or is currently expected to account for more than 10% of total EBITDA, meaning we're not disproportionately dependent on any single contractor. Our debt repayment profile is accelerated compared to a straight-line debt amortization profile, and recently we have consistently paid down around $80 million each year. In addition, we have access to attractive debt finance through a wide portfolio of lenders that helps us diversify our finance risk, and we have several key relationship lenders. On to slide five, the income statement, where I'll highlight a few relevant points. For this third quarter of 2020, we recorded very strong total revenues of £71.3 million above all recent quarters. Vessel operating expenses for the third quarter were up slightly at £16.7 million. The increase is mainly due to higher crew expenses for the fleet in the third quarter related to crew changes and increased travel costs due to COVID-19 and a one-off claim of £0.6 million related to off-hire for the Tordis Knutson in the second quarter of 2019, which was only claimed by the Charterer during the third quarter of 2020. Depreciation held steady and on track, as did our general and admin costs. Interest expense for quarter three was £6.6 million, a decrease of almost £2 million from the prior quarter, again driven by lower LIBOR on average across all our credit facilities that are not hedged. All of the unrealised gain for the third quarter of 2020 is related to a mark-to-market gain on interest rate swaps. Often much of the financial volatility we might seem to show is unrealised, non-cash, driven by the mark-to-market valuation change of our interest rate swaps, and because we don't apply hedge accounting, we have to report this volatility through our income statement. This volatility would only affect our cash position, however, if we decided to terminate our swaps mid-contract. For these reasons, we believe that the adjusted EBITDA metric is a better representation of our performance and cash flows. Slide six, adjusted EBITDA. Based on a very clean operational performance in the quarter, we're able to report another consistent adjusted EBITDA of 53.3 million. Slide seven, distributable cash flow or DCF. DCF was 28.9 million in the third quarter. and the distribution cover at the end of the quarter is 1.6. The modest decrease in distributable cash flow is mainly due to higher crew expenses for the fleet in the third quarter, related to crew changes and increased travel costs due to the COVID-19 pandemic, and the off-hire claim related to the Taurus Knudsen. This was partially offset by one extra operational day in the third quarter and lower interest expense on average due to a decrease in the US LIBOR rate during the third quarter. We again maintained our distribution level at 52 cents per unit, equivalent to an annual distribution of $2.08. Slide 8, balance sheet. At the end of the third quarter, the partnership had 79 million in available liquidity, which consisted of cash and cash equivalents of 50.3 million and 28.7 million of capacity under our revolving credit facilities. The revolving credit facilities mature in August 2021 and September 2023. The partnership's total interest-bearing debt, outstanding as of September 30, 2020, was £941.5 million, down from £960 million at the end of the second quarter, and the average margin paid on the partnership's outstanding debt in this quarter remained the same as last quarter, at approximately 2.1% over LIBOR. As of the end of the third quarter, the partnership had entered into various interest rate swap agreements for a total notional amount of £499 million, down from £627 million at the end of last quarter, to hedge against the interest rate risks of its variable rate borrowings. Based on this in the quarter, we received interest based on three- or six-month LIBOR and paid a weighted average interest rate of 1.82% under the interest rate swap agreements, which have an average maturity of approximately 4.3 years. As mentioned, we don't apply hedge accounting, so our reported gap financial results are impacted by changes in the market value of these financial instruments. However, cash flow is stabilised by them, mitigating interest rate risk on distributable cash flow. Slide 9, an update on our contracted revenue and charter portfolio. At the end of the quarter, we had £585 million of contracted forward revenue remaining to the partnership, an average remaining charter period of 2.2 years, and our customers have options to extend these charters by a further 3.9 years on average. Shell, as charter of the Windsor Knutson, will re-deliver the vessel to us on the 25th of November 2020, and we are actively discussing new rechartering opportunities for commencement in 2021. And we would also seek one or more short-term charters for the vessel in any intervening period. As I mentioned at the top of the call today, we do not currently anticipate the Windsor Knutson will have a material adverse effect on the partnership's financial position in 2020 or 2021 on this basis. Additionally, we are in ongoing discussions with Equinor and we expect to receive notification of their declaration decision for the next option on the Bodal Knudsen by mid-December 2020, though the vessel's current firm contract period runs to May 2021. Equinor have three one-year annual extension options available to them. The vessel is currently trading in Brazil before going to its next scheduled dry docking in February 2021. These are the two main chartering points for this quarter and as you can see they are the only two vessels in our fleet coming off their fixed charters before 2022. Our other vessels are still under contract as shown and are performing well. It remains important to recognise that charter renewal decision points are a natural part of our business and that our average remaining fixed charter duration will fluctuate over time as existing charters reduce and new ones come in, whether from new drop-downs or recharters. We are, however, a market leader in the operation of shuttle tankers with more than 30 years' experience, so although there is perhaps more potential variability in the partnership's charter outlook today than in recent pasts, for our management team this is not unusual, and we believe that we are well placed and capable to manage the business going forward. Please also recall that our customers need shuttle tankers as part of their supply chain and our vessels operate as an integral component in projects where the upfront costs are relatively high, but where marginal lifting costs for a barrel of oil can be as low as $5. Essentially, once these projects commence, they tend to continue producing and our shuttle tankers are the only way that continued production can happen. This stable business provides us with a strong distribution coverage ratio, and I'll reiterate that no single vessel contract counts for more than 10% of our EBITDA. Slide 10. Our sponsor, KNOT, now has seven vessels that could be sold or dropped down into the NLP. These have an average fixed contract period of 5.6 years, with an average of a further 8.1 years extension options. We think this high-value list of contracts demonstrates the market's trust in our management team and sponsor, and shows that the market is still active and growing, an example being the increased involvement from Chinese interests, such as PetroChina, who are helping to expand the market. The partnership is currently targeting the purchase of the first of these vessels, the Tover Knudsen, before the year end using a combination of internal cash and debt. If successful, this will strengthen our contracted cash flow and our average remaining contract duration without diluting our existing equity. The next potential vessel drop-down will be discussed with our sponsor next year, based on the general status of the market, sources of available funds, and our liquidity position, amongst other things. The acquisition by KNOP of any drop-down vessels in the future is subject to the approval of our independent conflicts committee, as well as the board of directors of each of KNOP and the sponsor KNOT, and there can be no assurance that any potential drop-downs, including the one intended for December 2020, will actually occur. Slide 11, this next slide is taken from a presentation made by Fernley Consultants. We included this slide in the last presentation, but retained it here as we believe it represents very well the estimated oil production development in Brazil for shuttle tankers and how, despite some potential delays, the trajectory remains very positive in the shuttle tanker market. Whilst we believe the numbers of barrels per day shown here for 2021 and beyond are quite conservative, The gradient of the red line that we have added was representative before April 2020, whereas the blue line, which we have also added and that follows the new trend we are seeing, remains broadly what we expect in the coming five years. Certainly by 2030 and possibly before then, we are currently forecasting no material difference as between the pre- and post-COVID growth scenarios. As a general guideline, as much depends on the location of wells and the timing and operational requirements for our customers, Fernley Consultants estimates that each incremental increase of 75,000 to 80,000 barrels of oil per day in Brazil would employ one new shuttle tanker, and that the comparable figure for the North Sea is around 40,000 to 45,000 barrels of oil per day. Fernley also say that these figures may be conservative if operators conduct more long-haul trades, such as to ports in Uruguay and in the Barents Sea as the market grows. What will also support shuttle tanker rates is that we expect a number of older vessels may leave the shuttle tanker market within the next one to two years. The summary here is that although there may be some challenges in the short term with a slightly softer economic climate and sentiment towards energy and shipping, and we have seen some new developments in Brazil and the North Sea being pushed out 12 to 24 months, they're not cancelled as a result of near-term capex cuts by some of the large oil exploration and production companies. For many of the solid reasons I outlined above, we still see strong mid- to long-term growth for the industry. Slide 12. So our near-term priorities are to continue to operate our vessels safely and efficiently and to look after the health and safety of our crew and employees, to secure new employment for the Windsor Knutson, and as mentioned, work is actively ongoing and we're confident in the prospects for the vessels. We will continue to target the purchase of the next drop-down vessel, the Tover Knudsen, from our sponsor in December 2020, financed using internal funds and debt. If this is successful, it will strengthen Knopp's partnerships contracted cash flow and average remaining contract duration without diluting our existing equity, and it will provide us with extra liquidity and resilience going into 2021. Should the transaction go ahead, we believe that maintaining and strengthening the coverage of the current distribution at its current level, as well as improving our liquidity, would best serve the interests of our unit holders. We expect to conclude the negotiation of a new three-year $25 million unsecured revolving credit facility for general corporate purposes, which will provide liquidity and mitigate refinance risk on an existing RCF that matures in August 2021. And of course, as always, we continue our ongoing close dialogue with our customers concerning their demand outlook, operations and rechartering for all of our other vessels. Slide 13, closing with a brief summary before Q&A. Another strong and stable operational quarter with 100% utilisation for scheduled operations. Distributable cash flow of £28.9 million with coverage of 1.6. which continues to give the partnership a degree of flexibility to manage any short- to mid-term headwinds. We maintained our quarterly distribution of 52 cents for the 21st consecutive quarter. We had £585 million of remaining contracted forward revenue, excluding options at the end of the quarter. The partnership's operations are not exposed to short-term fluctuations in oil prices, the volume of oil transported or global oil storage capacities. We're continuing to target the purchase of the next drop-down vessel from our sponsor in December 2020 to be financed using internal funds and debt. And we remain confident not only that the partnership is well-placed to navigate through any market uncertainty that may continue in 2021, but also that the ShuttleTanker market's fundamentals and growth prospects remain strong and very supportive of our business over the mid to long term. That concludes the presentation and I'll be very happy to take any questions.

And at this time, we will begin the question and answer session. To ask a question, you may press star then one on your touch tone phone. If you're using a speaker phone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. And our first question today will come from Igor Levy with BTIG. Please go ahead.

Good day. So with the shell returning view, With Shell returning the Windsor-Newtson back to the company, does this suggest at all an increased risk that Shell will not renew the other three vessels that expire in the next one to two years? And have they indicated why they didn't renew this one in particular? Is it the age of the vessel? And have they given any indication of their intent to the remaining ones?

Thank you, Igor. We don't see a link between the Windsor and the other three vessels. I think they're independent decisions. I think what Shell are thinking with the Windsor, I think, is really their consideration. We're not party to that level of detail. I think we see the Windsor as a single ship at a point in time, and we don't necessarily see it as indicative of the market as a whole. I think that's the simple answer to the question that you've asked.

Okay. And they haven't talked about the other three yet. It's too early, I assume.

We're in contact with Shell about those vessels, yes. But at the moment, we have nothing to report as we're talking to all of our charters.

Great. And do you have any thoughts around long-term strategy for maybe like the five to ten year strategy around maintaining exposure to uh shuttle tankers and oil production versus potentially expanding into other asset classes and if so what have you looked at at this time we haven't looked at any other asset classes we think there's plenty of growth opportunity within shuttle tankers which is where our speciality is so

Again, the short answer is no, we haven't. We think there's enough in shuttle tankers to keep us busy for quite a number of years yet.

All right. Well, that's all for me. Thank you.

Thank you, Igor.

And again, if you'd like to ask a question, please press star then 1. Our next question will come from Robert Silvera with RE Silvera and Associates. Please go ahead.

Hi. First of all, I wanted to thank you for a job well done. Obviously, running the business in this COVID environment and running 100% virtually is a great achievement in this market. My first question comes for your long-term debt, which you have reduced from $911 million roughly at the end of last year to $827 million. almost $100 million. Can you tell me, was any of that debt reduction extra payments or was it all scheduled repayment?

They were all scheduled repayments based on the profile agreed with the bank. But as I said in my presentation, that schedule is slightly faster than a straight line profile.

Okay. But you made no extra payments then?

We made no extra payments beyond our contracted repayment schedule.

Schedule, right. Okay, that's good. Now, I'd like to ask you about risk, okay? When we are at the current time yielding over 15%, obviously the market wants because when there is high risk, they consider it, when there's high interest, there is high risk. What do you anticipate doing to reduce the image in the marketplace of KNOP being such a high risk security at the mere $13 or so that we sell for now?

Yeah, that's a good question. I think What we're going to do from 2021 onwards, in fact, probably from December, we're increasing our investor relations activities and giving that a higher priority than we have done in the past. I think it's a difficult situation when we're surrounded by lots of companies and many bigger companies that are also yielding very high numbers and that we perhaps are in that same bracket as everybody else. All we can do is keep coming back to what we think is a good story and a good investment thesis for people and pushing our story out there more. Obviously there are risks in our business just as there are in every other business, but we keep sort of trying to get our message across and we're going to try and do that more strongly and all we can do is do our best in that regard.

Okay. You talk about a possible drop down in December of 2020 from the parent. That's great. If it has a positive effect, might this mean, since you have a 1.6 coverage ratio now, that with a drop down, we could see an increase in the dividend?

At the moment, the decision we've taken is that we feel the distribution is in the right place, regardless of this drop-down. We're still committed to growth of the distribution in the long term, but right now we don't want to jeopardize stability and the longevity and the prudence that we've shown so far. So I think for this particular drop-down, we don't feel the timing is right to increase the distribution.

Okay. But given the current conditions with the business, with the ships that are employed, would not the drop-down then increase our distributable cash flow, which could then apply to faster reduction of debt, which would change the image of risk in the marketplace? I mean, I'd love to see that rather than the increase in the dividend. Stay with the $0.52. That's fine. address debt more aggressively and get the image changed that way, that the company is of such a high risk that it yields over 15%.

Yeah, and that's a good point. I think, you know, the yield, as I've said before, is a difficult thing for us to manage when we're surrounded by other companies that also yield double digits. And I think the drop down for us, you know, it brings many benefits. It strengthens our coverage and distribution capacity. It lengthens the contract firm period. It diversifies our income across more assets. It improve liquidity. We have no equity dilution from this particular transaction if it goes ahead. And while this will modestly increase our debt, but nonetheless, we're repaying on a slightly accelerated profile. So it's only a temporary increase for a transaction that we think adds a lot of value. And therefore, it speaks for itself as a self-funded transaction. So I think the deal by itself stands very well, actually, by itself. And by not increasing the distribution, if that's the decision that we take, then I think the transaction as a whole will be well received.

Good. Well, I look forward to that. Last conference call we had, virtually the next day, there was a surprise in so much as one of our large shareholders dispersed a large number of shares, a large percentage. I believe B&W did that. Are there any more surprises coming like that that you anticipate?

Robert, I obviously can't speak for unit holders and what they do and the actions that they take, but certainly I'm not aware of anything that's like that. But As I say, I can't possibly answer that question. I don't know what our unit holders are thinking.

Did they give you any indication the last time that they were going to sell those shares, that large block of shares?

No, they didn't give us any indication, and I wouldn't have expected them to, to be honest.

Okay, so they did it literally the next day after our conference call, and it hit us as a surprise.

Yeah, well, our unit holders are free to buy and sell whenever they want.

I understand that, but I thought they might have alerted you to the fact that they were going to do that, but apparently they did not do that. So it came as a surprise to you as well as to the rest of the shareholders. And, of course, a move like that is discouraging to the marketplace and is doing a good job on holding the price of this stock down. For the company, as well as it's been run, this is kind of absurd that it should be yielding 15%. It should be at least back to where it used to be in the 2022 range for what you're distributing and doing it steadily and doing it with well coverage. It's hard to understand how the marketplace isn't smart enough to see what a benefit this company is the way it's run. I'm hoping that you can change that image in the marketplace because taking down new drop-downs and things and still getting the same dividend and the same stock price is kind of discouraging. It makes one think that the only ones who are really benefiting are the banks, although if they're smart enough, new shareholders will buy in at this price, and if they are assured that the risk is not as high as it appears to be, It's a great investment with a great cash flow. So I guess that's my input. I don't have any more questions other than that.

Okay.

Thank you very much for this.

And our next question will come from Richard Diamond with Castlewood Capital. Please go ahead.

Hey. Gary, I think you're doing a great job. And sometimes when you have a missed price security, as we do in this case, the market does come around. In the meanwhile, I appreciate you're doing everything you can that's under your control. I was just asking, I don't want to jump the gun, but can you give us a little bit of a preview what you may do next year in terms of IR research?

IR activities?

IR activities, sorry.

Like I said, we plan to attend more conferences. We hopefully will do a non-deal roadshow, NDR, in the first quarter of next year. We're registering, for example, to be at the Wells Midstream Conference on the 8th and 9th of December this year. And we've got some external IR resources now supporting us. So we see that as a really important part of our strategy to better get our message out there. I think When you look at our unit holder base, it's changed a little bit over the last year or two years, and I think it's important that we get our message out as much as we possibly can and do as much as we can, and then it's really up to the market after that.

Well, mispricing and security is how I make my living, so I know I'm confident that a concerted effort will get us from the bandwidth. Thank you very much.

Thank you, Richard.

And this will conclude our question and answer session. I'd like to turn the conference back over to Gary Chapman for any closing remarks.

Thank you, everybody, for joining, and I wish you all a very good day. Thank you for listening.

Ladies and gentlemen, the conference has now concluded. Thank you for attending today's presentation, and at this time you may now disconnect your lines.