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KNOT Offshore Partners LP (KNOP) Q3 2019 Earnings Call Transcript

By Motley Fool Transcribers - Nov 21, 2019 at 3:00PM

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KNOP earnings call for the period ending September 30, 2019.

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KNOT Offshore Partners LP ( KNOP 2.40% )
Q3 2019 Earnings Call
Nov 21, 2019, 12:00 p.m. ET


  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Good morning and welcome to the KNOT Offshore Partners Third Quarter 2019 Earnings Results Conference Call. All participants will be in listen-only mode. [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.

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

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-US 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, whereby our ships transport oil from production units to shore side, 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 two FSOs and today three 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 contract do not rely or depend on the volume of oil produced by the field, nor on the short-term underlying oil price as we always fix with strong credit counterparties, and therefore KNOP 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, the 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 six 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, $28 million on 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 at 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 dry docking in the quarter and as disclosed previously, not a plan during the remainder of 2019, that's just one vessel scheduled to undergo drydocking 2020 which we expect will take place in the early part of the year. During the quarter, Shell agreed to take up the next one-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 one additional year until May 2021. And again, in October, Eni exercised its option to extend the time charter of the Torill Knutsen by one additional year until November 2020.

It's perhaps just worth saying at this junction that these such charter renewal decision points is firm fixed period has come to an end or a natural element of KNOP's business typically a newbuild vessel charter contract will contain a fixed charter period of between five and perhaps 10 years, plus charter's options for additional periods of, say, five to 15 years depending on an oil field's production profile or volumes, etc. This allows the charter's control access to the vessel for a long period of time. It also gives them some flexibility, but more often than not, we are seeing charters extend their charter periods and continue with the vessels as for the Windsor, Bodil and Torill in this quarter.

As once oil fields of producing, shuttle tankers are needed and in some cases only certain vessels can service certain fields getting 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, the 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 that 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 one more operational day in the third calendar quarter compared to second. This increase is partly offset by reduced earnings from the Bodil Knutsen due to its reduced daily rate from May '19 when the vessel began 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 is mainly due to the strengthening of the US dollar against the Norwegian kroner.

Admin and general expenses were essentially unchanged from Q2 of $1.2 million as well as depreciation of $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 in 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-US 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 effect 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-US 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 non-cash items.

There is 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 1.55 times. 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 June till 2022. We continue to have a predictable cash flow and a healthy liquidity position, which gives KNOP flexibility to both continue to pay 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 received interest based on three or six-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 were impacted by changes in the market value of financial instruments. However, cash flow is stabilized mitigating interest rate risk on 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 is 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 loss has 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. They have four further one-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 five-year terms on both vessels, the Hilda time charterer extended for four more years and the first of five 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 charterer's options to extend by up to five more one-year periods. Tordis, Vigdis and Lena Knutsen are on five-year charters to Brazil Shipping, a subsidiary of Shell. These will expire in 2022 and the charter 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 three 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 two of the vessels fixed charters declared, there is an average fixed charter period of six years with the first two of those vessels. The acquisition by KNOP of any dropdown 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 pleased to be reminded that there can be no absolute assurance that any potential dropdowns 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 the 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 set. 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 dependency 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 sales that are at least under development, making them more certain to come on stream, and these projects have been conducted by a wider group of utility and oil companies than ever before, many of which we want to control their own shuttle tanker capacity. It's also worth noting the 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 newbuild 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 in the Barents Sea.

The largest shuttle tanker operator in Brazil today with 12 vessels KNOP is well placed for these developments. Just before I do move off this slide, I am just bound to find to 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've 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'll be happy to take them.

Questions and Answers:


We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Greg Lewis with BTIG. Please go ahead, sir.

Gregory Lewis -- BTIG -- Analyst

Yes. Thank you and good afternoon, and thank you for the slide on the outlook -- and thank you for the slide on the outlook for Brazil. I guess, just broadly speaking, as we think about the FPSO market where it stands today in terms of new units heading the market whether that's in Brazil or or elsewhere, any way 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 be thinking about the appetite in terms of whether the customers are thinking about newbuilds or potentially even just recycling existing shuttle tankers on the market?

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

Yeah. I mean, that's obviously an incredibly difficult question to answer.

Gregory Lewis -- BTIG -- Analyst


Gary Chapman -- Chief Executive Officer and Chief Financial Officer

Every charterer 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, and 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 in oil 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-salts, which 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 depths of water, etc, 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 will get our fair share of that.

Gregory Lewis -- BTIG -- Analyst

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 to set to grow after kind of stalling out over a period of time, is it generally, maybe -- is it the kind of like, I guess, like a 50-50 split or is it -- is a 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?

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

I think you're asking me to sort of a -- now looking into the future there, I really not sure I can answer that question. I'll be honest.

Gregory Lewis -- BTIG -- Analyst


Gary Chapman -- Chief Executive Officer and Chief Financial Officer

It's such a difficult thing to know how people are going. And I think whatever I say will be wrong.

Gregory Lewis -- BTIG -- Analyst

Welcome to my world. Okay. And then, just as we think about the stability of the cash, I mean, 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 KNOT to a kind of drop down assets? I mean, it almost looks like you maybe you're not getting rewarded that maybe the way you should be for the stability of your cash flows.

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

Yeah. I think -- and I said this on the previous calls last quarter, I think the company does feel that a little bit, that's the reality. I think it's not pushing those 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 challenges to translate and access all of that through the financial markets through the MLP.

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 the company is much bigger than us. So, what we're not doing is focusing too heavily on the negatives, and we are very much trying to focus on the positives and sell what we believe is a really good story to investors. Some point in the market will turn, 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.

Gregory Lewis -- BTIG -- Analyst

Okay, perfect. Thank you very much.

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

Thank you.


Our next question comes from Philip Fithcold [Phonetic], Private Investor. Please go ahead, sir.

Philip Fithcold -- Analyst

Hi. Thank you for taking my call. I'm just curious, how will the new IMO there 2020 fuel the regulation effect our vessels. Basically I understand, the fuel -- it could be using 3.5% solvents as of January 1st of next year. It should go down to 0.05%. Is there any expectation of additional expenses or if we can handle the lower sulfur? Thank you.

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

Yeah. I mean, certainly the fleet can handle it for sure. Generally speaking, fuel is the 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 in charterer's out of it, but the simple answer to the question is that we, as the owner, are not overly concerned about that because, as a said, that is a cost to our customer on charterer.

Philip Fithcold -- Analyst

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

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

Yeah. 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.

Philip Fithcold -- Analyst

Okay. All right. Thank you.


[Operator Instructions] Our next question comes from Robert Silvera with R.E. Silvera Marine Surveyors. Please go ahead, sir.

Robert Silvera -- R.E. Silvera Marine Surveyors -- Analyst

Hi. Congratulations first on the job well done. The dropdown potential vessels with the new holes being designed to handle with their propulsion systems, scrubbers or some other methodology, the parent company. Now, they're going after for this three that could possibly become dropdowns.

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

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

Robert Silvera -- R.E. Silvera Marine Surveyors -- Analyst

Yeah, I realize that.

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

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

Robert Silvera -- R.E. Silvera Marine Surveyors -- Analyst

I see.

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

Is that answering your question?

Robert Silvera -- R.E. Silvera Marine Surveyors -- Analyst

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...

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

Yes, to the point. Yeah. It's always a balance because we are 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 five 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 the balance, because if we've got a customer that's going to take the vessel for five 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.

Robert Silvera -- R.E. Silvera Marine Surveyors -- Analyst

Very good. We're very pleased as shareholders with your achieved distribution coverage ratio of 1.55 and with the way the business is running and the future at Brazil, etc. I wouldn't like to suggest that perhaps the company would consider designing the dividend rather than being a steady $0.52 every quarter to keep it tied to a 1.50 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 1.5. We'd love to see you consider that.

And I think that would affect 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 dropdowns 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 approach.

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

Yeah. And thank you for that. It's a very good idea. And we'd 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 build up. 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 the coverage ratio, it's a good one and we'll throw it in the public with all the ideas that we've got for sure.

Robert Silvera -- R.E. Silvera Marine Surveyors -- Analyst

Good. The other thing I'm convinced of is, the observed low interest rates that are in the world right now both non-domestic to US 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 will be for our borrowing interest rates.

Okay, that's all. I have to offer and thank you very much for taking an idea of 1.5 under consideration. And then, the marketplace knows that. No [Phonetic], 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 as well, there are just only going to do $0.52. Yeah, good steady business and all of that, but there is no potential for growth and there is inflation in the world, small now but who knows what it will be later.

Gary Chapman -- Chief Executive Officer and Chief Financial Officer


Robert Silvera -- R.E. Silvera Marine Surveyors -- Analyst

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. Thank you, guys.

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

Yeah. Thank you. Thank you for that.


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

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

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


[Operator Closing Remarks]

Duration: 32 minutes

Call participants:

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

Gregory Lewis -- BTIG -- Analyst

Philip Fithcold -- Analyst

Robert Silvera -- R.E. Silvera Marine Surveyors -- Analyst

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