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KNOT Offshore Partners LP (NYSE:KNOP)
Q3 2020 Earnings Call
Nov 19, 2020, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day and welcome to the KNOT Offshore Third Quarter Earnings Call. [Operator Instructions]

I would now like to turn the conference over to Gary Chapman, CEO. Please go ahead.

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

Thank you. Welcome, everybody. You can find our earnings release and slide presentation on our website at knotoffshorepartners.com. Partnership owns and operates shuttle tankers where our ships transport oil from offshore production units to shore side 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 will include the non-U.S. GAAP measures of distributable cash flow and adjusted earnings before interest, tax, depreciation amortization, 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, and I refer you to Slide 2 and our 2019 20-F for further details.

Onto 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 utilization and no schedule 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 cash distribution of $0.52 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 our robust coverage ratio of 1.6.

At the end of the quarter, the partnership had $585 million, the 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 charter of the Windsor Knutsen will redeliver the vessel to us on November 25, 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 an 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 exploration will have a material adverse effect on the partnership's financial position in 2020, or 2021. Even if utilization of the Windsor Knutsen falls below the 99% to 100% levels historically achieved, as we expect it might in the near term. To Slide 4, 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 US unit holders is that canopy is classified as a corporation for US federal income tax purposes. Therefore, we issue Form 1099 to report our distributions and not Form K1.

Our vessels are specialized 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 life spans, 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 costs 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 utilization 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 contract.

Our debt repayment profile is accelerated compared to a straight line depth amortization profile. And recently we have consistently paid down around $80 million each year. In addition, we have access to attractive debt financed through a wide portfolio of lenders. That helps us diversify our finance risk, and we have several key relationship lenders.

Onto Slide 5, 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 into the third quarter, related to crew changes and increased travel costs due to COVID-19. And a one off claim of $0.6 million [Phonetic] related to off higher for the Torill Knutsen in the second quarter of 2019, which was only claimed by the charter during the third quarter of 2020. Depreciation held steady and on track, as did our general and admin costs. Interest expense for quarter $6.6 million, a decrease of almost $2 million from the prior quarter again driven by lower liable on average across all our credit facilities that are not hedged.

One of the unrealized gains 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 unrealized 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.

The Slide 6, 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 7, distributable cash flow or DCF was $28.9 million in the third quarter and the distribution cover at the end of the quarter is $1.6 million. 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 offside claim related to the Torill Knutsen. This is 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 of $0.52 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 $28.07 million of capacity under our revolving credit facilities. The revolving credit facilities mature in August 2021 and September 2023.

The partnerships total interest bearing debt outstanding as of September 30, 2020 was $941.05 million down from $960 million at the end of the second quarter, and the average margin paid on the partnerships 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 months 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 GAAP financial results are impacted by changes in the market value of these financial instruments. However, cash flow is stabilized 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 and have 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 further 3.9 years on average. Shall this charter of the Windsor Knutsen will redeliver the vessel to us on November 25, 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 Knutsen, we 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 Bodil Knutsen by mid-December 2020. The vessels current firm contract period runs to May 2021. Equnior 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 recognize that charter renewal decision points are a natural part of our business. And that's 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 partnerships charter outlook today than in recent past. For our management team, this is not unusual, and we believe that we're 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 operators are 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 accounts for more than 10% of our EBITDA.

Slide 10 as sponsor KNOP 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 markets 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 Torill Knutsen before the year ends 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 among other things. The acquisition by KNOP, if 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 in response to 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.

Last, we believe the numbers of barrels per day shown here for 2021 and beyond are quite conservative. The gradients 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 at 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. Certainly 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 is that although there may be some challenges in the short term with a slightly softer economic climate and sentiment toward 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. So 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 Windsor Knutsen, and as I mentioned, work is actively ongoing and we're confident in the prospects for the vessel. We will continue to target the purchase of the next drop down vessel the Windsor Knutsen from our sponsor in December 2020, financed using internal funds and debt. If this is successful, it will strengthen KNOPs 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% utilization for scheduled operations. Distributable cash flow of $28.9 million with coverage of $1.6 million, which continues to give the partnership a degree of flexibility to manage any short term midterm headwinds. We maintained our quarterly distribution of $0.52 for the 25th consecutive quarter. We have $595 million remaining contracted forward revenue excluding options at the end of the quarter. The partnerships operations are not exposed to short term fluctuations in oil prices, the volume of oil transported or global storage capacity.

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 shuttle tanker markets 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.

Questions and Answers:

Operator

[Operator Instructions] Our first question today will come from Igor Levi with BTIG. Please go ahead.

Igor Levi -- BTIG -- Analyst

Good day. With Shell returning the Windsor Knutsen back to the company, does this suggest that 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 that the age of the vessel? And have they given any indication of their intent to the remaining ones?

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

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 you know what Shell are thinking with the Windsor I think is really their consideration. We would 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.

Igor Levi -- BTIG -- Analyst

Okay, and they haven't talked about the other three to earlier I assume.

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

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

Igor Levi -- BTIG -- Analyst

Great. And do you have any thoughts around long term strategy? Maybe like the five to 10 year strategy around maintaining exposure to shuttle tankers and oil production versus potentially expanding into other asset classes, and if so what have you looked at?

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

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

Igor Levi -- BTIG -- Analyst

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

Operator

Our next question will come from Robert Silvera with R.E. Silvera & Associates. Please go ahead.

Robert Silvera -- R.E. Silvera & Associates -- Analyst

Hi, first of all, I want 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?

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

Nominal 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.

Robert Silvera -- R.E. Silvera & Associates -- Analyst

Okay. But you made no extra payments, then.

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

We made no extra payments beyond contracted repayment schedule.

Robert Silvera -- R.E. Silvera & Associates -- Analyst

Okay, that's good. Now, I'd like to ask you about risk. When we are at the current time yielding over 15%, obviously the market, 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, that the mere $13 or so that we sell for now?

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

Yes, 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, then 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, you know, we perhaps are in that same bracket as everybody else. What, 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 best in that regard.

Robert Silvera -- R.E. Silvera & Associates -- Analyst

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

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

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 in 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.

Robert Silvera -- R.E. Silvera & Associates -- Analyst

But given the current conditions with the business with the ships that are employed, would not 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. But perhaps 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%?

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

Yes, and that's a good point. I think -- 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, it brings many benefits, it strengthens our coverage and distribution capacity, it lengthens the contract term period, diversifies our income across more assets, it improves liquidity, we have no equity dilution from this particular transaction if it goes ahead. And you know, 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.

Robert Silvera -- R.E. Silvera & Associates -- Analyst

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

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

Robert, I obviously can't speak for our unitholders 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 unitholders are thinking.

Robert Silvera -- R.E. Silvera & Associates -- Analyst

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

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

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

Robert Silvera -- R.E. Silvera & Associates -- Analyst

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

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

Yes, well, our unit holder, they're free to buy and sell whenever.

Robert Silvera -- R.E. Silvera & Associates -- Analyst

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 prices 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. It's kind of discouraging 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.

Operator

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

Richard Diamond -- Castlewood Capital -- Analyst

Hey, Gary, I think you're doing a great job and sometimes when you have a miss price security as we do in this case. You know, 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?

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

IR activities.

Richard Diamond -- Castlewood Capital -- Analyst

IR activities, sorry.

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

Yes. Like I said, we plan to attend more conferences; we hopefully will do a non-dual ratio MDR in the first quarter of next year. We're registering, for example, to be at the wells midstream conference on the eighth and ninth of December this year. And we've got some extra 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 up to the market after that.

Richard Diamond -- Castlewood Capital -- Analyst

Well, mispricing in securities, how I make my living. So, you know, I know of confidence that a concerted effort will get us some bandwidth. Thank you very much.

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

Thank you, Richard.

Operator

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.

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

Now, thank you everybody for joining. And I wish you all a very good day. Thank you for listening.

Operator

[Operator Instructions]

Duration: 32 minutes

Call participants:

Gary Chapman -- Chief Executive Officer and Chief Financial Officer

Igor Levi -- BTIG -- Analyst

Robert Silvera -- R.E. Silvera & Associates -- Analyst

Richard Diamond -- Castlewood Capital -- Analyst

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