Knot Offshore Partners LP (KNOP) 2018 Q4 法說會逐字稿

Good afternoon, and welcome to the KNOT Offshore Partners LP Earnings Release Fourth Quarter 2018 Conference Call. (Operator Instructions) Please note, this event is being recorded. I would like to now turn the conference over to John Costain. Please go ahead.

Thank you. If any of you have not read the earnings release or slide presentation, they're both available on the Investor 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, amortization, the EBITDA. The earnings release includes a reconciliation of these non-U. S. 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 focuses on the shuttle tanker segment. The individual tankers field specific and integral components in the offshore value production chain. Shuttle tankers operate in a niche space and under non-volume-based contracts, transport oil from the offshore production units to shore side. Being built to the charterer's requirements, the tankers are generally used on specific oil fields, enabling the partnership to yield both sustainable and stable revenue longer term.

Oil production continues to move further offshore, so shuttle tankers operate in a space which will see substantial growth in the coming years.

Our sponsor is a very experienced operator, having been involved in the design and construction of this type of vessel, growing its fleet organically for more than 30 years, and is part of one of the largest shipping groups in the world, Nippon Yusen or NYK. NYK is a member of Mitsubishi Keiretsu.

Now, the presentation. Slide 3. For the fourth quarter 2018, the partnership generated another very solid set of results. Total revenue of $70.9 million, operating income of $33 million, net cash flow of $8.8 million and adjusted EBITDA of $55.4 million. The partnership generated distributable cash flow at $27.3 million after declaring a cash distribution of $0.52 per unit, this gives a coverage of 1.51x for the quarter.

During the quarter, the fleet operated with 99.7% utilization for scheduled operations, and 98.3% utilization taking into account the scheduled dry docking of Ingrid Knutsen, which was off-hire for 20 days in Q4.

Since our initial public offering in the 2013, we've declared and paid common unit distributions of $11.34. And our current distribution has remained unchanged since 2015 at over 11% on the current unit price.

On 17th of December, 2018, the partnership and a subsidiary of Royal Dutch Shell agreed to suspend Windsor Knutsen's time charter contract for a minimum of 12 months and the maximum of -- sorry, minimum of 10 months and a maximum of 12 months. The suspension period commenced March 4, 2019, and the vessel now operates under a time charter with subsidiary of NYK, Knutsen on the same terms as the existing time charter contract with Shell.

The remaining period of the original extension is then reinstated at end of this period.

A new CEO has been appointed. Gary Chapman has many years of experience in shipping. He will bring a fresh new perspective for the partnership and further strengthen ties with NYK, having worked with them for many years in various senior roles.

Slide 4. The income statement. Total revenues were $70.9 million for the 3 months ended 31st December, Q4. This compares to $70.7 million for the 3 months ended 30th September, Q3. The increase in revenues was due to increased earnings from the Hilda Knutsen, Torill Knutsen as the vessels completed their first schedule and special survey drydockings by the beginning of the fourth quarter. This increase was partially offset by reduced revenues from Ingrid Knutsen due to the off-hire period for the vessel as a result of its first scheduled survey drydocking, which commenced in the fourth quarter.

Vessel operating expenses for the fourth quarter of 2018 were $14.2 million, a decrease of $1.1 million from the third quarter. The increase was due to the positioning bunker cost of scheduled drydocking of Hilda and Torill Knutsen, these took place in Q3. Lower operating costs on average are also due to the strengthening of the U.S. dollar against Norwegian Kroner. The decrease was partially offset by increased costs for the Ingrid Knutsen, which went off-hire in Q4 due to its rescheduled dry -- its scheduled drydocking.

G&A expenses were $1.3 million in Q4, as Q3. Depreciation was $22.5 million for Q4, an increase of $0.1 million from Q3, mainly due to increased depreciation for Ingrid and Torill Knutsen due to dry docking additions. As a result, operating income for Q4 of 2018 was $33 million compared to $31.7 million in Q3.

Interest expense for Q4 was $13.4 million, which was a decrease of $0.1 million from Q3. Realized and unrealized gain and losses-- sorry, losses on derivative instruments was $10.9 in the fourth quarter compared to a gain of $3 million in the second -- third quarter. The unrealized noncash element for the mark-to-market loss was $11.3 million compared to a gain of $2.1 million in Q3. Of unrealized losses for Q4, $9.9 million relates to interest rates swaps and $1.4 million to foreign currency contracts. Net income for Q4 was, therefore, reduced to $8.8 million compared to $20.9 million for Q3.

Slide 5. Adjusted EBITDA. In Q4, the partnership generated an EBITDA of $55.4 million compared to $54.1 million in Q3. Adjusted EBITDA refers to earnings before interest, taxation, depreciation and amortization and other financial items that provide 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 lower EBITDAs for every dollar invested. The annuity effect reduces the annual loss in the early years, which is factored into the replacement CapEx calculation for distributable cash flow.

Slide 6. Distributable cash flow, another non-U. S. GAAP measure, scrutinized by investors to establish distribution sustainability. Distributable cash flow or DCF represent the net income adjusted for depreciation, unrealized gains and losses on derivatives, distributions in Series A preference units and other noncash items. And maintenance and replacement capital for drydocking and capital expenses, which are required to maintain long-term operating capacity of and, therefore, the revenue generated by the partnership capital assets.

DCF was $27.2 million in Q4 in comparison to $26.3 million in Q3. We maintain our distribution level for Q4 at $0.52 per unit equivalent to an annual distribution of $2.08.

The distribution coverage ratio was a healthy, our highest ever, 1.51x for Q4. Impacting the calculation this quarter was the drydocking of Ingrid Knutsen and its first special survey drydocking. This vessel operates in the North Sea. The average coverage ratio was 1.50x for the full year 2018, which compares to 1.26 for 2017. The distribution in excess of 11% at the current unit price today our largest investor, Knutsen NYK, would prefer increased coverage through investments [effect] deleveraging rather than increasing dividends. The growing coverage ratio gives the partnership more flexibility regarding both capital base and distributions going forward.

Slide 7. At the end of Q4, the partnership had $70.4 million in available liquidity, which consisted of cash and cash equivalents of $41.7 million and $28.7 million of capacity under its revolving credit facilities. The revolving credit facilities mature in August 2019 and September 2023. We have a predicable cash flow under healthy liquidity position.

The partnership's total interest-bearing debt outstanding as of December 31, 2018, was $1.87 million -- sorry, $1,087 million or $1,077 million net of debt issuance cost. The average margin paid on the partnership's outstanding debt in Q4 was approximately 2.1% over LIBOR.

At the end of Q4, the partnership interest rate swap agreements totaling $556 million, of which the partnership received interest based on LIBOR and pays at an average interest rate of 1.86%. These have an average maturity of approximately 4.9 years.

Whilst the partnership's net income is impacted by changes in the mark-to-market swap valuations, the cash flow is stabilized, mitigating the interest rate rise impact on the distributable cash flow. We also see rising interest rates in the U.S. in 2018. And together with increased replacement CapEx in 2019, as the vessels get older, our coverage will slightly be impacted this year. But overall, 2019 again looks very solid.

Slide 8. Long-term contracts. The Bodil Knutsen, our largest shuttle tanker operator in the North Sea is ICE class and is on charter to Statoil until May 2020. Following the end of that charter, there are 4 further annual extension options, Torill and Hilda operate in the Goliat, first field developed in the Barents Sea, and it currently represents the world's most northerly offshore development.

After initial 5-year term, both vessels, the Hilda time charter was extended for 4 more years. And in October, the first of 5 one-year annual extensions was exercised on the Torill.

Four of our vessels are on long-term bareboat charter through to 2023 with Petrobras Transpetro. Dan Sabia and Dan Cisne are a unique size and Fortaleza and Recife have shallow drafts with lots of thruster capacity.

Delivered in 2013, Carmen is on charter direct to Repsol Sinopec until 2023. The Ingrid was delivered in 2013 and operates in the North Sea on a time charter for Standard Marine Tønsberg. This will expire in the first quarter of 2024. The charter has options to extend the charter by up to 5 one-year periods.

Raquel Knutsen was delivered in March 2015, and operates under a charter that will expire in the first quarter of 2025 to Repsol Sinopec in Brazil. There are options to extend them till 2030.

Tordis, Vigdis and Lena Knutsen are on 5-year charters to Brazil Shipping 1, a subsidiary of Shell. These will expire in 2022. The charter has options to extend with 2 additional 5-year options, totaling 15 years.

Brasil and Anna Knutsen are on charter to Galp Energia until 2022 with options to extend until 2028.

The KNOT fleet have an average remaining fixed contract duration of 3.7 years and an additional 4.4 years on average in charterer's option.

Whilst we currently have no -- whilst we currently only have 2 drop-down candidates, which means the near-term equity requirement is very limited, given the market outlook, we expect to grow the MLP significantly in coming years.

In summary, 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. As of today, it is not making accretive investments. This quarter reports another very strong quarterly performance, record revenues, EBITDA and distributable cash flow.

For the full year, we set records for all the key financial measures, revenue, EBITDA, distributable cash flow, unit distribution coverage and net income.

KNOT is well placed to complete in future tenders and currently 2 vessels are on order. We have a solid and profitable contract base, generated by our modern fleet, which by the end of December, has an average age of around 5.75 years. Since the formation of KNOT, we have had very high levels of vessel utilization, on average about 99.6%, which financially translates into high and increasingly predictable revenues, adjusted EBITDA, and discounted cash flow as more vessels are added to the fleet.

No one has more expertise in 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 and with tenders back, the sponsor expects to go a further dropdown inventory. We have a large and financially strong supported sponsor who knows this market as well as anymore.

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

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

Quick question. Why was Windsor Knutsen charter suspended? Was -- just want to get an idea of what's the reason there?

Well, we -- they actually -- Shell approached us about a few months ago and said, they had a bit of surplus capacity in Brazil on the shuttle tankers. And they were asking us if we were interested in chartering a ship from them, and we obviously needed a vessel in West Africa. They weren't initially prepared to give us the Windsor, but they said, okay. We asked them for one of our ships if we were going to do that. In the end, they agreed to let us have the Windsor back. So we are going to use it in West Africa on a contract we have there for 8 to 10 months, probably the sponsor is using it.

So -- and he is paying a back-to-back rate, which is the same as what was on the CP with Shell. And effectively that means that the MLP will see rather than the next escalator kicking in, they will continue with that charter at the back end of the substitution period. So effectively, it extends this period on the vessel for the partnership and that's really what's happened. Shell, obviously, production hasn't quite been enough to [try for] vessels 100% and they have just been a bit more efficient in approach because if we needed a ship and we said we'd take one of ours back.

Okay. Got it. So there's no -- so this isn't a situation where, like, they could -- the suspension could continue after the...

No, no. They have got a firm period on that. They wanted the ship. They're happy with the Windsor. It's just that we said if we were going to charter a ship it had to be one of ours, that's why we got 4 ships out on charter to Shell in Brazil. And we'd rather have one of our ships than somebody else's, logically, in a closed rate.

Okay, okay. And then the Bodil Knutsen, the extension option. Are they -- I think the last one was at a lower rate, the last extension, right?

Yes. They are at lower rates. Yes, that's correct.

So the remaining ones, are they going to be at lower rates?

They -- there's an escalator on. So the lower rate is increased until basically it starts of at a lower level, but it escalates every year.

So, like, for the next one, that would be higher than -- that would be higher than the current rate? But...

No the current rate is the old charter rate and then the new rate -- the first new rate is lower and then the next new rate is still lower, but it's higher than the lower -- the other rate, if you know what I mean. So there's an escalator on the option periods, basically.

Okay. So it will be higher than the previous one? Okay, got it.

Yes, but not -- yes, yes.

(Operator instructions) Our next question comes from Ben Brownlow of Raymond James.

Just to follow up on the Windsor Knutsen. Just on a few months around the timing there. What's -- any specific variables that will influence the recommencement of that charter with Shell?

No. I mean, it's basically starts on the 4th of March, and it runs for between 10 and 12 months. And then Shell take the share back through -- run down the remainder of the one-year option, and then the other options kick in if they want them.

Okay. And you said they were back to back, so there is absolutely no cash left behind from repositioning or anything like that?

It's no different from the rate. No.

Okay. And on the Bodil Knutsen. Can you just give some color around, kind of, the demand backdrop you're seeing there around the Johan Castberg field?

Well, I mean, I'm not sure. The thing is, with this -- the Bodil has always been 1 million barrel ship, slightly more than that. And generally in the North Sea most of the vessels are Aframax size, now Statoil are toying with the idea of moving the ship, they might move it to Brazil, they might keep it in what -- in the Barents Sea. I mean, I don't -- we don't know exactly what their plans are at this stage, I mean, I would -- I mean, I'm obviously not going to be in the job for much longer. But I think that's an open discussion with Statoil but they definitely want the ship long term, it's just how they deploy the asset.

It's always been a bit of a -- that's why we've had to take a bit of a haircut on the rate because it's always been bit of a non-standard ship like the Windsor is as well. These 2 vessels were not really built specifically for the fields that they're operating on now. The Windsor is an ICE-class tanker working in Brazil. And the Bodil is a Suezmax tanker, which was built with the idea of the Barents Sea in mind, just because it's ICE class, but it's -- there hasn't been an awful lot of development yet in the Barents Sea and at the moment, most ships are being built to Aframax size, be it -- just because the voyages are shorter really.

And so I don't know what -- at the moment, Statoil will keep the ship anyway. There's no doubt about it. The rates, they're happy with the rate and they want to keep the ship long term. And there's not that many shuttle tankers around, to be honest, so the demand is quite tight. So I don't see any issue there. It's just a case of what they want to do with the ship longer term.

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

I'd just like to say thank you, and this is probably my second to last earnings call, I'll probably will one at the end of May.

Pardon me, Mr. Costain, a couple of questioners just came in. Would you like to accept?

Okay. Yes, I'll take them. Yes, no problem.

Our next question comes from Robert Silvera of R.E. Silvera and Associates.

John, thank you very much for doing such a good job, and I'm sorry to see you leave. But obviously, you have future plans and that's good. My question is this. Right now, you have a coverage ratio of 1.51x. Do you have an upper target in mind or anything like that for the future, that if you reach that, you would increase the dividend? Is there any thinking like that going on?

I mean, it's hard for me to say, obviously, because I'm not strategically involved anymore with the business, but I think you've always got to look at how the capital market is because this is an MLP and you use the distributions and means to sell the MLP. And with it being a shipping company as well, if you're not adding vessels, you increase the distribution, you weaken the MLP in a way because today, you can see, it's obviously got a lot stronger because we've added assets without pushing the distribution.

And if the equity market's closed, it's hard to burn too much equity. You don't want to do it in terms of the sponsor. Obviously, the unit holder likes to receive cash. But it's -- that's the balance you've got to strike with. I mean, at the end of the day, we are at the moment a very -- got a decent yield and the numbers look fine. So, I mean, I don't think they'll change anything. I think -- also Knutsen NYK does nearly 30% of the units. So they don't want to damage their own stake. And that's also healthy for the individual unit holders because they can see the sponsor has real investment in the MLP. So that's really what I try to emphasize, but I wouldn't like to comment too much on it because, obviously, I -- my time finishes at the end of May, so I don't really have a lot of input on the -- on the distribution policy really but I think what they're doing is very sensible today.

Okay. Well, what has troubled me is, if the distribution, as past conference call said, is going to be pretty much fixed at the $0.52 a quarter and $2.08 for the year. If it stays fixed like that, the stock price has seemed to been depreciating just as the assets. The ships are depreciating. So I guess, it's a perception thing by the market...

Yes. You'd have to -- on using new ships, that's the thing, that's the key because, obviously, these vessels deleverage. That's basically what we do with the excess cash, we just pay bank debt down so we end up with less debt on the ships. And then you -- as the assets come along, you try and buy through leverage rather than approaching the market for equity. And that's the way you deal with it or at least take a portion of the vessel through releveraging. And that's how we've built the last 2 or 3 ships.

So the more you save on distribution, the more you can do that. And in the longer run, and it's a long game, it's better because, obviously, if you can invest at a decent rate -- and you have to bear in mind as well the sponsor is a business, and they have to buy ships and they have to raise equity and they have to trade the vessels. And accordingly, the MLP market is closed to a lot of smaller MLPs. I would say, the midstream space is not the best, and you have to conserve a bit of equity where you can. When the market reopens again, you can be a lot more optimistic and you can really maybe push the distribution and raise capital.

What do you see in the strategy that's now being carried out that would at least keep the price of the stock steady in the $21 range?

Well, I mean, obviously -- I think the changes in management doesn't really help. I think whenever you see solid results, every quarter you see solid results from the company's [putting] a footprint down, people get more comfortable with it. It sends out a message, and over time the history and the quality -- the continued quality of the balance sheet, it helps -- building a distribution is fine in the short term, but it's a short-term fix if you are not having assets and you are not being able to raise equity. It's more difficult. So you have to balance it. It's definitely a balancing act, it always was.

And we're quite a mature MLP today in a way, we've been trading for 6 years now. But yes, I know where you're coming from. And I -- my preferences today in the current market is to be a bit conservative really. I mean, I think, it's a sensible approach. At the end of the day, you've got to bear in mind as well this is -- a lot of people have been -- have got a lot of careers invested in this business, and a lot of -- the sponsor's a big company. So it's important to keep stability and keep a good footprint and a good trading history.

All right. Well, that's what has concerned us. As a company who is invested in you as a company, love the dividends. But if the price is eroding on the stock at the same rate that the dividends are being paid, the net is not a good number.

To be fair, it's only happened in the last 2 or 3 months, I mean, you shouldn't stock watch too much. As long as our earnings come out well and you get a good distribution, it's fine. I mean, we retained -- the balance sheet looks...

Well, we are in it for the long game, but we want to be comfortable that the stability of the stock price is there and the strategy on you guys should be such that you maintain that price of the stock at $20 to $22, somewhere in that neighborhood and not down at $17.5, $18. Because in effect for this last year, we've lost the total of the distribution.

Well, yes, but it's a book loss. I mean, it'll come back.

(Operator Instructions) Our next question comes from David Starkey of Morgan Stanley.

John, congratulations on your job and situation. It's been nice working with you over the years.

Yes. Thank you, David.

I have a question on the -- obviously, the stock price is a little frustrating, but we've seen this before. And today, we're getting a good reaction to the consistently strong numbers you've been putting up. The question I have where you talked about the strategy of not raising the distribution, but starting to pay down some of that debt. And I was wondering what kind of goals you have in mind over the years and to do that and to clean the balance sheet up or get it even stronger?

Well, it's -- I mean, a lot -- I mean, shipping has been quite volatile in terms of asset values. And it's difficult to gauge how the -- also, we've seen AET move into market as well. So the market is growing quite rapidly, but -- and the competitor coming in changes the mix a little bit. And you don't really know how things are going to settle down. So it's an interesting environment. And it's good to have -- in the current environment, it's good to have the flexibility on capital that we do have by having a bit stronger balance sheet. I mean, it's better -- if you can avoid having too many prefs or bonds in the balance sheet, it's always helpful because you keep the equity story going then more strongly. And that's quite important.

The sponsor is very important because he's got a large amount of common units. And, really, that's probably been the strategy behind what's driving the policy of a stable, stable environment. We haven't added a lot of ships to the MLP in the last 2 or 3 years. That's been good in one way because there hasn't been the equity out there. People don't want to put it into midstream understandably. But on the other hand, for us, it can be quite frustrating because we haven't grown in scale, which would have allowed the normal pattern of an MLP.

So it's mainly been -- it's a little bit of a trap. I mean, investors are contrarian at the moment. They want to see growth, they just don't want to see it now. And they don't want to be asked for equity now, but they want to see there's a future. So it's -- as you know yourself, it must be very difficult running a fund today with a midstream. It's not the best place to be. But I mean, I think, this shows we are a solid company now.

Well, as you mentioned, the consistency of the long-term results have been good and that should be worth something over time. Are you comfortable with hedging strategy going forward with your replacement here?

Yes. I mean, I think, it's safe. But I don't really know the guy, to be honest. I think the nice thing is he's got a good background within NYK, which shows that NYK are very committed to the MLP and that's very good -- that side of it.

The people that are running your hedging, are they going to be remaining in place?

Sorry?

The people that are actually...

Sorry if I didn't quite catch it.

Needed the hedge trading and things to keep the balance sheet...

Yes. I mean, opportunistically. I mean, obviously, it's not so cheap now to hedge as it was when we did those hedges. We'd like to keep between about 50% and 70% of the interest charge hedged because -- I mean, you try and match up when you fix the charters with the interest rates at that time. So obviously, it makes sense to produce a stable income for the level of hedging. But you look at it today and it's not what it was in terms of pricing, I mean, it's come off a lot admittedly this quarter as you can see from our losses on our portfolio, but we generally just ignore the day-to-day movements and we just try and take it opportunistically. We have done in the past. And that's been good, I mean, the last 2 years. Obviously, hedging's not always been a great story.

Yes, (inaudible) stabilized now and we won't see too much more in the way of increases on the LIBOR?

No. I think you're right. I think it's all going to stabilize, there's not much of an [odd] there either way whether you buy a hedge or not. Today, I think, that game is over, isn't it?

This concludes our question-and-answer session. I would like to turn the conference back over to John Costain for any closing remarks.

Okay. Thank you. I'd just have to say thanks for all the interest and time on these calls. And it's been interesting asking some -- answering some of the questions you've put forward. And I'll probably speak to you one last time next time. And hopefully, some of you will go out there buy the [innings]. Thank you.

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