Earnings Call Transcript - KNOP Q2 2022

Operator, Operator

Hello and welcome to today's KNOT Offshore Partners Second Quarter 2022 Earnings Results Conference Call. My name is Bailey, and I'll be your moderator for today's call. All lines will be muted during the presentation portion of the call with an opportunity for the questions-and-answers at the end. [Operator Instructions] I would now like to pass the conference over to our host, Gary Chapman, Chief Executive Officer with KNOT Offshore Partners. Gary, please go ahead.

Gary Chapman, CEO

Thank you, Bailey. And welcome, everybody, to our second quarter 2022 Earnings Call. The earnings release and this presentation are also available on our website at knotoffshorepartners.com if you want to view them. Slide two reminds about the nature of today's presentation. In particular, with regards to the inclusion of forward-looking statements, which are made in good faith, but which contain risks and uncertainties, meaning that actual results may be materially different. The partnership does not have or undertake a duty to update such forward-looking statements, and for further information, please consult our annual and quarterly SEC filings. Today's presentation also includes certain non-US GAAP measures, and our earnings release includes a reconciliation of these to the most directly comparable GAAP measures. On to slide three of the presentation, highlights of the second quarter and subsequent. We announced a cash distribution of $0.52 for the quarter, marking the 28th consecutive time at this level under our 1099 structure, which was the 37th consecutive distribution made since the partnership first listed in 2013. We maintained 100% scheduled fleet utilization during the second quarter, with 90.5% taking into account the scheduled dry dockings of the Lena, Anna, Vigdis, and Windsor Knutsen vessels. We were able to conclude a further sale and leaseback agreement with respect to the total Knutsen, generating net proceeds of approximately $39 million after fees and expenses, and we used the majority of these funds to purchase the Synnove Knutsen from our sponsor Knutsen MYK, or as we refer to it, KNOT. The total purchase price of the Synnove Knutsen was $119 million, including the assumption of the debt associated with the vessel. We've nearly concluded a number of charters this quarter, including a new three-year deal with Eni for the Ingrid Knutsen to commence in January 2024, replacing an existing contract with an early redelivery of the vessel. The Vigdis Knutsen took over the time charter contract for PetroChina, which also exercised their first option for an additional period of 12 months, extending the vessel's employment to at least September 2023. The Tordis Knutsen is expected to go on charter to TotalEnergies in September 2022 for a fixed period of three months with charterers' options to extend by up to nine further months, subject to agreement on customary operational terms. Lena Knutsen has also secured a charter with TotalEnergies that commenced on August 21, 2022, for a period of six months with charterers' options to extend by up to six further months. Windsor Knutsen is anticipated to be chartered to a major oil company from around January 2023 for a fixed period of one year, with the charters' option to extend by one further year, subject to customary operational terms. Finally, we remain in discussions with an oil major for the Brasil Knutsen for a one-year time charter contract with options to extend, expected to commence in or around September 2022, and we are hopeful that this can be concluded soon. Slide four notes that in April 2022, Anna Knutsen commenced a charter with TotalEnergies for two years with options for the charterer to extend the time charter by up to three further one-year periods. The Bodil Knutsen is continuing to operate on a time charter with Knutsen NYK at a somewhat favorable rate compared to Knutsen NYK, which could last until June 2023, pending funding of the new employment for the vessel. We received news that Eni would redeliver the Hilda Knutsen to us around September 2022, and following their dry dock, the Windsor Knutsen would be absent from other employment until the end of this year. We are working hard to secure further charters for these vessels. We, of course, continue to discuss with our customers other opportunities, and we have seen an upturn in market activity in Brazil continuing into the second quarter. The North Sea market, where four of our vessels operate, is taking longer to return to the higher levels of production we're predicting, mainly following the delays caused by the initial onset of COVID. We believe this could take several more quarters to resolve. In particular, we await the large Johan Castberg field in the Barents Sea coming on stream, which has faced delays during COVID and construction issues. We continue to take precautions against COVID in our business, and we have been able to avoid any serious or sustained operational impacts from the pandemic. There have been no effects on the partnership's contractual position. As of June 30, 2022, we had $487 million of remaining contracted forward revenue, excluding options, and $123.5 million in available liquidity, which included cash and cash equivalents of $88.5 million. We utilized around $32 million on July 1, 2022, in connection with the acquisition of the Synnove Knutsen. Slides five through eight summarize our financial results, and I will allow you to read these for yourselves but will mention just a few points. On slide five, while we generated good numbers across scheduled operations, our revenue, operating income, and adjusted EBITDA were all predictably impacted by the off-hire incurred due to the vessel drydocks. Five of the six vessels due for dry dock in 2022 have now completed or nearly completed, with the sixth vessel due late in the fourth quarter of 2022 into the first quarter of 2023. Our operating expenses were also higher this quarter, partly due to increased bunker costs related to our time-chartered vessels that needed to transit to and from their dry docks. When time-chartered vessels are on hire, fuel is a cost for our customers, but these vessels are off-hire during dry dock, and with fuel costs increasing, this has impacted us. Crew and crew-related costs remained challenging due to the ongoing effects of COVID, particularly regarding travel, quarantine, and logistics costs. However, we have seen further easing in some parts of the world, so hopefully, such cost increases have peaked. With a wide and geographically spread supplier base, we believe we have some protection against certain elements of inflation that are occurring in many countries at this time. Nevertheless, this is something that we, like all companies, are keeping under close review. Our interest expenses are up this quarter, primarily due to increased LIBOR rates related to the proportion of our debt that is floating rate. On slide seven, you can see our cash and cash equivalents balance at the end of the quarter of $88.5 million, which, when you deduct the approximate $32 million utilized on July 1 for the acquisition of the Synnove Knutsen, is slightly down from the first-quarter balance. Again, this is predictable given the planned dry docks that have occurred. The distribution coverage ratio was 0.51 for the second quarter of 2022, and as we have disclosed previously, while there's a tendency to focus heavily on this figure each quarter, the partnership and the Board take a longer, more rounded view. When deciding on the payment of a distribution, we do not mechanically link it to the distribution coverage ratio for that quarter; rather, we consider many factors, including our liquidity position, the outlook for the business, and our market and strategic interests, and anything else that we consider to be relevant. We feel this approach allows us to operate in the best interest of our unitholders in the long term, and we continue to encourage all of our stakeholders to think the same way. Slide nine provides an update on our contracted revenue and charter portfolio. I don't intend to read through this slide as we've already covered many of the contractual updates; however, I would like to highlight that although the charter picture is not smooth right now, we have succeeded in filling some of the gaps we had in 2022 and are, of course, working hard to continue our efforts. We had remaining forward contracted revenue of $487 million, excluding options, an average remaining firm charter of 1.7 years, and charters having options to extend these charters by an average of 2.4 years. I have included the Synnove Knutsen here, despite not having purchased it until July 1, as I believe this is more useful for readers of the presentation. Then on slide 10, we have the potential dropdown vessels held by our sponsor KNOT that the partnership may choose to purchase in the future. There are no material changes to this slide this quarter compared to the previous quarter, other than the removal of the Synnove Knutsen due to its purchase on July 1. Slide 11 addresses the delivery schedules for FPSOs, many of which were delayed due to early pandemic CapEx reductions having overall timelines normalized, particularly in Brazil. I can also refer you to Appendix C of this presentation, the slide we have used previously, which shows the numerous FPSOs Petrobras has ordered for operation in Brazil. Current high oil prices against project level breakevens at or below $35 per barrel and producer optimism regarding continued high prices are encouraging further investment in production capacity and, in the shorter term, providing trading opportunities. Importantly, new FPSO ordering activity for the Brazilian Pre-salt reflects funded commitments to increase production in shuttle tanker-serviced deep offshore fields. The more mature North Sea market saw the milestone arrival into Norway during the second quarter of this year of the delayed Johan customer FPSO intended for the shuttle tanker-serviced Barents Sea. Scheduled to start in late 2024 to early 2025, proven volumes today are estimated between 400 million and 650 million barrels, with production expected to run for 30 years. Once on stream, this field will be the source of substantial activity. On slide 12, following earlier CapEx program delays across the energy industry and increasing newbuild prices, we understand that only one new shuttle tanker order has been placed in 2022. This constitutes just over 1% of the current 79 shuttle tankers in service today. This limited ordering activity, with the main shipyard effectively full with containership and LNG carrier orders through 2025, means that the total order book for shuttle tankers is quickly dwindling, with only four likely to deliver before 2025, all of which we understand have already been assigned to long-term charters. As a result, oil production growth in the mid-term may suffer from a lack of available tonnage, and newbuild shuttle tanker prices are up around 30% since the second half of 2021. This situation should highlight the competitiveness of the existing fleet and vessels. On slide 13, our near-term priorities, which are quite simple and consistent. Continue to focus on safety, maintain high scheduled operational utilization in line with our historic track record, ensure the remaining dry docks in 2022 are successfully completed, keep close dialogue with our customers to ensure we can respond to opportunities as they arise, and work hard to secure employment for our vessels that remain open in 2022 and 2023, with particular emphasis on the North Sea. We believe that by targeting these objectives, we will be keeping the best long-term interest of the Partnership unitholders at heart. In summary for this quarter from slide 12, we have strong utilization at 100% for scheduled operations, generated distributable cash flow of $9.4 million following several dry docks in the quarter, paid a quarterly distribution of $0.52 for the 28th consecutive quarter, had $487 million of remaining contracted forward revenue excluding options at quarter-end, and no refinancing due until the third quarter of 2023. As a reminder, the partnership's operations are not exposed to short-term fluctuations in oil prices, the volume of oil transported, or global oil storage capacity, and our charter rates are not as volatile as found in other shipping segments, either upwards or downwards. Opportunities continue to be discussed with our customers, and we remain optimistic that we can secure further profitable charters for our vessels in the intervening periods. The activity we are witnessing in our main market, Brazil, is very encouraging, though we're concerned about the speed of recovery in oil production in the North Sea at this moment. Nonetheless, the significant mid- to long-term expansion of offshore oil production in pre-salt Brazil alongside some growth in the North Sea Barents Sea continues to be supported by a large number of committed FPSO orders, and with low marginal costs of oil production, we maintain a positive outlook for the mid- to long-term shuttle tanker market. Thank you very much for listening to the short presentation. That concludes the formal part of today's presentation, and I'll be happy to answer any questions.

Operator, Operator

Thank you. [Operator Instructions] The first question today comes from the line of Richard Diamond from Castlewood Capital. Please go ahead, your line is now open.

Richard Diamond, Analyst

Yes, good morning, Gary. I understand a tanker cannot become a shuttle tanker, but at some point a shuttle tanker could be used as a tank given that Afra and Suezmax rates are at $53,000 and $49,000 per day. At what point, and I'm not saying KNOP, but could competitors' shuttle tankers go into tanker service?

Gary Chapman, CEO

Hi, Richard. Thanks for that question. Yes, obviously the conventional market, as you say, allows shuttle tankers to transition into that realm, but not the other way around. Certainly, the conventional market serves as a fallback for us. With recent rates improving, as you've mentioned, it becomes more appealing, particularly as an alternative to ensuring that our vessels don't sit idle. The best value we see is when our vessels are operated as shuttle tankers, which is our primary objective. However, if rates continue to rise as they have, and any of our vessels, particularly those in the North Sea, remain idle for an extended period, we will certainly explore alternatives, such as entering the conventional market. I would caveat that by noting that headline rates are not always achievable, especially when we factor in utilization issues, gaps between individual voyages or charters, and potentially costly repositioning. Nonetheless, it's a positive fallback position for our vessels if rates continue to climb, and shuttle tanker utilization for some of our vessels does not materialize as quickly as we anticipated.

Richard Diamond, Analyst

Yes, thank you very much.

Gary Chapman, CEO

Thanks, Richard.

Operator, Operator

Thank you. The next question today comes from the line of Liam Burke from B. Riley Securities. Please go ahead, your line is now open.

Liam Burke, Analyst

Thank you. Hi, Gary. How are you?

Gary Chapman, CEO

Hello, Liam. I'm very well, thank you. How are you?

Liam Burke, Analyst

I'm fine, thank you. I had a question on OpEx. You pretty much explained why you had the bump sequentially from roughly $20 million to $23 million. But if I adjust for drydocking, fuel expenses, and then account for higher crew costs, are we talking about a quarterly run rate of high teens or low 20s?

Gary Chapman, CEO

You're asking about rates for OpEx? For vessel operating expenses. Yes, I think the charges for this quarter have been largely driven by bunker costs related to the dry-docked vessels. Most of these had to transit from Brazil back to Europe and then back again. Therefore, that creates a sizable fuel cost alongside COVID-related increases, which have resulted in additional costs beyond our typical range. If we consider the trends of our OpEx over time, we are certainly above where we ordinarily prefer to be. However, last year's periods and now, we have also added an extra vessel. Historically, our fleet OpEx was around $18 million to $20 million per quarter typically. So the $23 million reported for this quarter is indeed out of line, but we'd expect it to revert to a more normalized trend, maybe slightly higher than before due to COVID, but certainly not remaining at $23 million.

Liam Burke, Analyst

Got it. Thank you. And then on your liquidity, you had $32 million in the purchase of the new vessel. As we look into the second half of the year, you've got lower drydocking. You will have better utilization. How do you balance your liquidity position with the unit payouts and potential dropdowns?

Gary Chapman, CEO

Let me take that last point first. I think we saw an opportunity to do a sale and leaseback that allowed us to release funds for the purchase while keeping some liquidity, which has also contributed to our bank balance. Regarding future balances, we had concentrated dry docks, which we prepared for and anticipated. We consistently try to take a long-term view, balancing all of these factors. I think it's clear that we're fairly conservative and aim for stability, looking to differentiate between temporary divergences versus more fundamental issues. Hence, when we assess our business, we emphasize the need to sign charters, which is what we are diligently working to accomplish. Achieving this will maintain balance.

Liam Burke, Analyst

Terrific. Gary, thank you.

Gary Chapman, CEO

Thanks very much, Liam.

Operator, Operator

Thank you. [Operator Instructions] The next question today comes from the line of Robert Silvera from R.E. Silvera & Associates. Please go ahead, your line is now open.

Robert Silvera, Analyst

Hi, Gary. Tough quarter to say the least given the challenges from COVID and the ships looking for business. Obviously, the market did not favor the 0.51 coverage ratio, so we're down a little bit in the market at about $0.60 a share. You spoke about rates. Okay. You're negotiating for rates to fill empty ships in the future. The future looks strong as you've stated because of the Brazilian market. What kind of balance do you see? Are you having to give concession versus our current rates? Or do you see the opportunity, even though we haven't booked them right now, to get higher rates?

Gary Chapman, CEO

The first point I want to reiterate is that we don't experience the same level of rate volatility in our smaller market that you see in larger markets, whether conventional tankers or other shipping. Rates have remained relatively stable within our range for quite some time. During this period, we haven’t secured the highest rates within that band, but that is merely a function of supply and demand, particularly as we observe in the North Sea. Nevertheless, we are always targeting longer-term charters with our customers. We tend to offer lower rates for longer charters and slightly higher rates for shorter ones. Operating within this principle, our relatively small market includes perhaps a dozen customers and a few key suppliers of tonnage. The market functions well; there's competition, and everyone understands the need to maintain relationships for future dealings. There may be times when we can’t secure the highest rates, but we still inhabit a tight market. Even with the current softness, we are speaking about only a few vessels out of 79. We believe this situation is temporary, and activity in Brazil has made several customers realize that if they don't act, they could miss opportunities with available tonnage. The slide we presented this quarter highlights the future supply of vessels entering the market, which is quite limited over the next three to four years. Overall, rates are driven by supply and demand, and we strive to maximize rates without being unreasonable. We consistently pursue longer-term charters with our customers when opportunities present themselves because it best supports our objectives for our unitholders.

Robert Silvera, Analyst

Yes, there is definitely a tension right now between supply and demand, so I understand that. When you commit to fixed rates on a contract for a specified period, there’s no variability in cash flow; is that correct, or is there flexibility for adjustments up or down?

Gary Chapman, CEO

Some contracts may indeed include an OpEx annual escalation increase. A portion of the charter rate may rise each year, or some contracts can be flat. We do not have any contracts that allow a customer to pay less, unless the vessels are off-hire, but that's a different matter altogether.

Robert Silvera, Analyst

Okay, good. Let me ask this question. Beyond replacing older equipment, what benefits would the company see in taking on additional dropdowns?

Gary Chapman, CEO

Acquiring additional dropdowns provides us with income diversification and creates a stronger income stream. I would note that the average age of our fleet remains only 8.5 years.Aside from a couple of exceptions, particularly the Windsor Knutsen, our vessels are in excellent operational health for their prime. Regarding that vessel, we’ve successfully secured employment well into 2027 and 2028, including options. Hence, age doesn't pose a significant issue for us. Bringing in more vessels will improve our size and economies of scale.

Robert Silvera, Analyst

Will that positively affect income, leading to a rise in stock price and potential for an increased dividend?

Gary Chapman, CEO

I believe that perspective is somewhat premature and potentially misguided at this point. I cannot predict our unit price's movements; otherwise, I would have been quite wealthy. From our standpoint, we believe dropdowns at competitive pricing from our sponsor will add value to our operations. This particularly holds true regarding income diversification and risk spread across more assets. Whether this leads to a shift in distributions remains uncertain at this stage and would be irrational for me to comment on right now, especially since we are currently not close to executing any dropdown.

Robert Silvera, Analyst

Good. The last thing I have is a suggestion. Although in the past you have not done so, it could serve as a confidence builder factor. If the company were to explore selling put options on the stock price, say at $16 or $15 a share, they could use existing cash as backup to purchase shares if they are sold. This could demonstrate management's confidence in the business and its outlook while generating a small amount of positive cash flow. Would this be worth considering?

Gary Chapman, CEO

We regularly evaluate various ideas. In this scenario, I think it’s unlikely we would pursue that route as we prefer to gain confidence from our investors through our operations rather than financial maneuvers. When we execute our business successfully, the finances take care of themselves, and the unit price will adjust accordingly. Thus, while I appreciate what you’re suggesting, I don’t foresee us taking that approach. We would prioritize focusing our efforts on signing more profitable charters rather than attempting to provide artificial support to the unit price.

Robert Silvera, Analyst

While the cash flow may be minimal, it would signal confidence in the future of the company, reflecting the management's commitment to the plan, and it could positively impact the marketplace perception. If, for instance, you look at October, which is just 57 days away, the October 21, $15 put option is currently trading at $0.30 a share. It suggests that if it were exercised, the company would effectively be buying its own shares at $14.70, excluding commissions. Additionally, you could consider larger volumes, generating additional cash flow. I believe this warrants further research!

Gary Chapman, CEO

I fully understand your viewpoint. In our context, our sponsor maintains a 26% to 29% stake in the business, indicating their substantial investment and confidence. There are various methods to showcase that. Ultimately, while I will reflect on your proposal post-call, I maintain that such a path is unlikely for us, as we prefer that our business speaks for itself.

Robert Silvera, Analyst

I think it would be beneficial to conduct research on how feasible this approach is, especially given the current market conditions. You can execute options on a larger scale, providing attractive returns, and it would also enhance your credibility with shareholders. Thank you for considering this!

Gary Chapman, CEO

I will certainly take a look at this, Robert, once we conclude the call.

Robert Silvera, Analyst

Great, Gary. I look forward to our next conversation. Keep up the great work. I'm very proud to be a shareholder of KNOP.

Gary Chapman, CEO

Thank you. I appreciate your support.

Operator, Operator

Thank you. There are no further questions registered, so I'd like to pass the conference back over to Gary Chapman for closing remarks.

Gary Chapman, CEO

Thank you, everybody. I wish you a good day, and I appreciate your time today.

Operator, Operator

Thank you all. This concludes today’s conference call. Thank you for your participation. You may now disconnect your line.