Knot Offshore Partners LP Earnings Release—interim Results for the Quarter Ended March 31, 2016

OREANDA-NEWS. Knot Offshore Partners LP Earnings Release—interim Results for the Quarter Ended March 31, 2016.

Highlights

For the three months ended March 31, 2016, KNOT Offshore Partners LP (“KNOT Offshore Partners” or the “Partnership”) (NYSE:KNOP):

• Generated total revenues of $42.0 million, operating income of $19.2 million and net income of $10.7 million.
• Generated Adjusted EBITDA of $33.1 million (1).
• Generated distributable cash flow of $17.9 million (1).
• Achieved strong operational performance with 99.8% utilization of the fleet for scheduled operations and 97.5% utilization taking into account the planned drydocking of the Bodil Knutsen, which was completed within 20.5 days.

In addition:

• End March, 2016, the first oil was loaded from Goliat field in the Barents Sea to the Hilda Knutsen. The Hilda Knutsen and Torill Knutsen are two of the three winterized shuttle tankers specially built to operate on this Arctic oil and gas field, which is expected to be in production for 15 years.
• Completed the first drydocking of the Bodil Knutsen within time and budget. The Bodil Knutsen went back on charter with Statoil on March 1, 2016.
• Due to the increase in the price of the Partnership’s common units from $13.49 at December 31, 2015 to $16.40 on March 31, 2016, the Partnership elected not to repurchase any common units under its common unit repurchase program during the first quarter of 2016.

Subsequent events:

• On April 15, 2016, the Partnership declared a cash distribution of $0.52 per unit with respect to the quarter ended March 31, 2016 to be paid on May 16, 2016 to unitholders of record as of the close of business on May 4, 2016.
• The Partnership expects that the subordinated units held by Knutsen NYK Offshore Tankers AS (“Knutsen NYK”) will convert to common units in May 2016 after the payment of the first quarter distribution.

Financial Results Overview

Total revenues were $42.0 million for the three months ended March 31, 2016 (the “first quarter”) compared to $42.5 million for the three months ended December 31, 2015 (the “fourth quarter”), a decrease of $0.5 million. The decrease was mainly due to reduced revenues from the Bodil Knutsen as a result of its drydocking during the first quarter. This decrease was partially offset by the full quarterly earnings for the Ingrid Knutsen in the first quarter of 2016 compared to 77 days in fourth quarter of 2015, as the acquisition of the Ingrid Knutsen took place on October 15, 2015.

Vessel operating expenses for the first quarter of 2016 were $7.6 million, consistent with expenses in the fourth quarter of 2015 despite the fact that the Ingrid Knutsen had 15 more days of operation in first quarter of 2016. Vessel operating expenses in the first quarter of 2016 also include bunkers consumed for the mobilization before and after drydocking of the Bodil Knutsen. General and administrative expenses were at $1.3 million for the first quarter of 2016, an increase of $0.2 million compared to the fourth quarter of 2015 mainly due to year end close expenses.

As a result, operating income for the first quarter of $19.2 million compared to $20.4 million in the fourth quarter of 2015.

Net income for the three months ended March 31, 2016 was $10.7 million compared to $17.6 million for the three months ended December 31, 2015. Net income was impacted by the recognition of realized and unrealized losses on derivative instruments of $3.2 million in the first quarter of 2016 as compared to a gain of $2.1 million in the fourth quarter of 2015. The unrealized non-cash element of the mark-to-market losses was a $2.3 million loss for the three months ended March 31, 2016 and a $4.9 million gain for the three months ended December 31, 2015. Of the unrealized loss for the first quarter of 2016, $4.4 million related to mark-to-market losses on interest rate swaps due to a decrease in long term interest rates. This loss was partially offset with an unrealized gain of $2.1 million on foreign exchange contracts due to strengthening of the Norwegian Kroner (NOK) against the U.S. Dollar.

Net income for the three months ended March 31, 2016 increased by $3.5 million compared to net income for the three months ended March 31, 2015. The increase was primarily due to (i) an increase in operating income of $3.2 million due to earnings from the Dan Sabia and the Ingrid Knutsen being included in the Partnership’s results of operations from June 15, 2015 and October 15, 2015, respectively, and (ii) a $1.2 million decrease in total finance expense primarily caused by a $3.2 million realized and unrealized loss on derivative instruments in the three months ended March 31, 2016 compared to a $5.6 million realized and unrealized loss on derivative instruments in the three months ended March 31, 2015. The overall increase in operating income was partially offset by a $1.3 million reduction in operating income due to the Bodil Knutsen drydocking during the first quarter of 2016.

All ten of the Partnership’s vessels operated well throughout the first quarter of 2015 with 99.8% utilization of the fleet for scheduled operations and 97.5% utilization taking into account the Bodil Knutsen drydocking.

Distributable cash flow was $17.9 million for the first quarter of 2016 (resulting in a coverage ratio of 1.19), compared to $18.1 million for the fourth quarter of 2015. The decrease in distributable cash flow is because of reduced earnings on the Bodil Knutsen as a result of its drydocking partially offset by a full quarter of earnings from the Ingrid Knutsen. The distribution declared for the first quarter of 2016 was $0.52 per unit, equivalent to an annual distribution of $2.08.

Financing and Liquidity

As of March 31, 2016, the Partnership had $48.8 million in available liquidity which consisted of cash and cash equivalents of $28.8 million and an undrawn revolving credit facility of $20 million. The undrawn revolving credit facility is available until June 10, 2019. The Partnership’s total interest bearing debt outstanding as of March 31, 2016 was $663.1 million ($659.4 million net of debt issuance cost). The average margin paid on the Partnership’s outstanding debt during the quarter ended March 31, 2016 was approximately 2.3% over LIBOR.

As of March 31, 2016, the Partnership had entered into foreign exchange forward contracts, selling a total notional amount of $35.0 million against the NOK at an average exchange rate of NOK 8.28 per 1.0 U.S. Dollar. These foreign exchange forward contracts are economic hedges for certain vessel operating expenses and general expenses in NOK.

As of March 31, 2016, the Partnership had entered into various interest rate swap agreements for a total notional amount of $410.0 million to hedge against the interest rate risks of its variable rate borrowings. In March 2016, the Partnership extended $125 million of interest swap agreements and in April 2016, extended an additional $25 million of interest swap agreements. These $150 million of interest rate swaps have an average interest rate of 1.4% and extended the tenor of the Partnership’s existing interest rate swaps by an average of 2.3 years from the second half of 2018 to the second half of 2020. As of March 31, 2016, Partnership receives interest based on three or six month LIBOR and pays a weighted average interest rate of 1.54% under its interest rate swap agreements, which have an average maturity of approximately 3.6 years. The Partnership does not apply hedge accounting for derivative instruments, and its financial results are impacted by changes in the market value of such financial instruments.

As of March 31, 2016, the Partnership’s net exposure to floating interest rate fluctuations on its outstanding debt was approximately $224.3 million based on total interest bearing debt outstanding of $663.1 million, less e interest rate swaps of $410.0 million and less cash and cash equivalents of $28.8 million.

The Partnership’s outstanding interest bearing debt of $663.1 million as of March 31, 2016 is repayable as follows:

		Annual repayment				Balloon repayment
(US $ in thousands)
Remainder of 2016		$	41,104			$	—
2017			50,084				—
2018			48,495				154,927
2019			28,582				237,678
2020			17,650				—
2021 and thereafter			71,650				12,940
Total		$	257,565			$	405,545

Torill Knutsen and Hilda Knutsen - Goliat field

The Goliat field is the world’s most northerly offshore development and is the first field to come on stream in the Barents Sea. It represents an important milestone as nearly half of the undiscovered resources for the Norwegian shelf are in the Barents Sea.

According to the operator of the Goliat field, the estimated lifetime of the field is 15 years with recoverable reserves equivalent to approximately 178 million barrels of oil. Start-up production volume is expected to be approximately 100,000 barrels per day.

The Hilda Knutsen and the Torill Knutsen are two of three specially built winterized shuttle tankers which operate on the Goliat field. In March 2016, the first oil from the Goliat field was loaded on to the Hilda Knutsen.

The Hilda Knutsen and Torill Knutsen are on five-year contracts with Ente Nazionale Idrocarburi S.p.A.(“ENI”). ENI has the option to extend each such charter by an additional five years. As of March 31, 2016, the remaining fixed contract durations are 2.4 years and 2.6 years for the Hilda Knutsen and Torill Knutsen respectively.

Drydocking

In February 2016, the Bodil Knutsen completed its first special survey drydocking on time and on budget.

Fortaleza Knutsen, which is on long-term bareboat charter to Petrobras Transporte S.A. (“Transpetro”) completed its first special survey drydocking in April. Under the terms of its bareboat contract, Transpetro is responsible for all vessel operating and voyage expenses including drydock costs. Thus, the drydocking has not resulted in any off-hire or any costs for the Partnership. During 2016, the Recife Knutsen and Dan Cisne are expected to complete their first special surveys, and the cost and off-hire associated with these surveys will be paid by the charterer.

Partnership Matters

On April 1, 2016, the Partnership announced that Mr. Yoshiyuki Konuma was stepping down from the board of directors of the Partnership. Mr. Takuji Banno has been appointed by the Partnership’s general partner to replace Mr. Konuma. Mr. Banno has served as the General Manager, Offshore Business Group, Energy Division of Nippon Yusen Kabushiki Kaisha since April 2012. From April 2011 to April 2012, he served as Director of Yusen Logistics (Singapore) Pte. Ltd. From October 2006 to April 2011, he was Director of NYK Logistics (Asia) Pte. Ltd. From June 2002 to October 2006, he was Manager of the LNG Group of Nippon Yusen Kabushiki Kaisha. Mr. Banno joined Nippon Yusen Kabushiki Kaisha in April 1990 and has a master’s degree in Business Administration from the University of Wisconsin-Madison.

Outlook

To date, during the second quarter of 2016, utilization of the Partnership’s fleet has been 100%. Operating income and distributable cash flow are expected to improve commencing with the second quarter of 2016, as there is no further scheduled off-hire for any of the Partnership’s vessels for the remainder of 2016.

As of March 31, 2016, the Partnership’s fleet of ten vessels had an average remaining fixed contract duration of 5.3 years. In addition, the charterers of the Partnership’s time charter vessels have options to extend their charters by an additional 2.5 years on average.

The Partnership has or expects to receive options to acquire five vessels controlled by Knutsen NYK pursuant to the terms of the omnibus agreement. One of these vessels, the Raquel Knutsen, delivered in 2015 and is chartered to Repsol Sinopec Brazil under a time charter that expires in 2025, with options to extend until 2030. Four vessels are under construction in South Korea and China. As of March 31, 2016, the average remaining fixed contract duration for these vessels is 5.9 years. In addition, the charterers have options to extend these charters by 11.2 years on average.

Pursuant to the omnibus agreement, the Partnership also has the option to acquire from Knutsen NYK any offshore shuttle tankers that Knutsen NYK acquires or owns that are employed under charters for periods of five or more years.

There can be no assurance that the Partnership will acquire any vessels from Knutsen NYK.

The Board believes that there may be opportunities for growth of the Partnership, which may include current identified acquisition candidates, and that the demand for offshore shuttle tankers will continue to grow over time based on identified projects. Future developments will influenced by the rate of growth of offshore oil production activities when the existing projects are completed.

The Board is pleased with the results of operations of the Partnership for the quarter ended March 31, 2016.

About KNOT Offshore Partners LP

KNOT Offshore Partners owns operates and acquires shuttle tankers under long-term charters in the offshore oil production regions of the North Sea and Brazil. KNOT Offshore Partners owns and operates a fleet of ten offshore shuttle tankers with an average age of 4.3 years.

KNOT Offshore Partners is structured as a publicly traded master limited partnership. KNOT Offshore Partners’ common units trade on the New York Stock Exchange under the symbol “KNOP.”

The Partnership plans to host a conference call on Wednesday, May 11, 2016 at noon (Eastern Time) to discuss the results for the first quarter of 2016, and invites all unitholders and interested parties to listen to the live conference call by choosing from the following options:

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

		Three Months Ended																Year Ended December 31
(USD in thousands)		March 31, 2016					December 31, 2015							March 31, 2015				2015
Time charter and bareboat revenues (1)				$ 41,826				$ 42,417							$ 36,071				$ 154,750
Other income (2)				200				120							149				274
Total revenues				42,026				42,537							36,220				155,024
Vessel operating expenses				7,647				7,636							6,807				27,543
Depreciation				13,892				13,464							11,400				48,844
General and administrative expenses				1,308				1,058							1,068				4,290
Goodwill impairment charge				—				—							—				6,217
Total operating expenses				22,847				22,158							19,275				86,894
Operating income				19,179				20,379							16,945				68,130
Finance income (expense):
Interest income				2				5							1				8
Interest expense				(5,029	)			(4,731		)					(4,186	)			(17,451)
Other finance expense				(267	)			(326		)					(20	)			(504)
Realized and unrealized gain (loss) on derivative instruments (3)				(3,184)				2,145							(5,623	)			(9,695)
Net gain (loss) on foreign currency transactions				(35	)			30							72				(105)
Total finance expense				(8,513)				(2,877)							(9,756)				(27,747)
Income before income taxes				10,666				17,502							7,189				40,383
Income tax benefit (expense)				(3)				65							(3)				59
Net income				10,663				17,567							7,186				40,442
Weighted average units outstanding (in thousands of units):
Common units				18,627				18,770							13,808				16,702
Subordinated units				8,568				8,568							8,568				8,568
General partner units				559				571							457				519

(1) Time charter revenues for the first quarter of 2016 include a non-cash item of approximately $1.3 million in reversal of contract liability provision, income recognition of prepaid charter hire and accrued income for the Carmen Knutsen based on average charter rate for the fixed period. Time charter revenues for the fourth and first quarters of 2015 include a non-cash item of approximately $0.9 million in reversal of contract liability provision and income recognition of prepaid charter hire.
(2) Other income for the first quarter of 2016 and fourth quarter of 2015 is related to guarantee income from Knutsen NYK. Pursuant to the Omnibus Agreement, Knutsen NYK agreed to guarantee the payments of the hire rate that is equal to or greater than the hire rate payable under the initial charters of the Bodil Knutsen and the Windsor Knutsen for a period of five years from the closing date of the IPO. In October 2015, the Windsor Knutsen commenced operating under a new BG Group time charter. The hire rate for the new charter is below the initial charter hire rate and the difference between the new hire rate and the initial rate is paid by Knutsen NYK.
(3) The mark-to-market net loss related to interest rate swaps and foreign exchange contracts for the three months ended March 31, 2016 includes realized losses of $0.9 million and unrealized losses of $2.3 million. Of the net unrealized loss for this quarter, $2.1 million gain relates to foreign exchange contracts and hedging the Partnership’s operational costs in NOK.
The mark-to-market net gain related to interest rate swaps and foreign exchange contracts for the three months ended December 31, 2015 includes unrealized gain of $4.9 million and realized loss of $2.7 million. Of the realized gain for this quarter, $1.1 million relates to foreign exchange contracts and hedging the Partnership’s operational costs in Norwegian Kroner (NOK).
The mark-to-market net loss related to interest rate swaps and foreign exchange contracts for the first quarter of 2015 includes unrealized loss of $4.6 million and realized loss of $1.0 million. Of the unrealized loss for this quarter, $1.5 million relates to foreign exchange contracts hedging operational costs in NOK.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEET

		At March 31, 2016				At December 31, 2015
(USD in thousands)
ASSETS
Current assets:
Cash and cash equivalents		$	28,782			$	23,573
Amounts due from related parties			123				58
Inventories			864				849
Derivative assets			243				—
Other current assets (1)			1,859				1,800
Total current assets			31,871				26,280
Long-term assets:
Vessels and equipment:
Vessels			1,351,589				1,351,219
Less accumulated depreciation			(169,686	)			(158,292)
Net property, plant, and equipment			1,181,903				1,192,927
Derivative assets			194				695
Accrued income			461				—
Total assets		$	1,214,429			$	1,219,902
LIABILITIES AND PARTNERS’ EQUITY
Current liabilities:
Trade accounts payable		$	2,564			$	1,995
Accrued expenses			6,052				3,888
Current portion of long-term debt (1)			48,535				48,535
Derivative liabilities			3,884				5,138
Income taxes payable			122				249
Contract liabilities			1,518				1,518
Prepaid charter and deferred revenue			6,857				3,365
Amount due to related parties			618				848
Total current liabilities			70,150				65,536
Long-term liabilities:
Long-term debt (1)			610,894				619,187
Derivative liabilities			4,488				1,232
Contract liabilities			9,378				9,757
Deferred tax liabilities			927				877
Other long-term liabilities			2,171				2,543
Total liabilities			698,008				699,132
Equity:
Partners’ equity:
Common unitholders			408,388				411,317
Subordinated unitholders			97,814				99,158
General partner interest			10,219				10,295
Total partners’ equity			516,421				520,770
Total liabilities and equity		$	1,214,429			$	1,219,902

(1) Effective January 1, 2016, the Partnership implemented ASU 2015-03, Interest – Imputation of Interest (Subtopic 835-30), Simplifying the Presentation of Debt Issuance Costs, which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability rather than as an asset. The recognition and measurement guidance for debt issuance costs is not affected. Therefore, these costs will continue to be amortized as interest expense using the effective interest method. The new guidance is applied retrospectively for all periods presented. As of March 31, 2016 and December 31, 2015 the carrying amount of the deferred issuance cost was $3.7 million and $4.0 million, respectively.

UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN PARTNERS’ CAPITAL

			Partners’ Capital												Accumulated Other Comprehensive Income (Loss)				Total Partners’ Capital/Owner’s Equity
			Common Units				Subordinated Units				General Partner
Consolidated balance at December 31, 2014			$	307,544			$	103,680			$	8,141		$		—			$	419,365
Net income				4,098				2,952				136				—				7,186
Other comprehensive income				—				—				—				—				—
Cash distributions				(6,765	)			(4,471	)			(224)				—				(11,460)
Consolidated balance at March 31, 2015				304,877				102,161				8,053				—				415,091
Consolidated balance at December 31, 2015				411,317				99,158				10,295				—				520,770
Net income				6,757				3,691				215				—				10,663
Other comprehensive income				—				—				—				—				—
Cash distributions				(9,686)				(5,035)				(291)				—				(15,012)
Consolidated balance at March 31, 2016			$	408,388			$	97,814			$	10,219			$	—			$	516,421

UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

		Three months ended March 31,
(USD in thousands)		2016		2015
Cash flows provided by operating activities:
Net income		$ 10,663		$ 7,186
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation		13,892		11,400
Amortization of contract intangibles / liabilities		(380)		(379)
Amortization of deferred revenue		(478)		(479)
Amortization of deferred debt issuance cost		287		284
Drydocking expenditure		2,538		—
Income tax expense		3		3
Income taxes paid		(134)		(214)
Unrealized (gain) loss on derivative instruments		2,259		4,597
Unrealized (gain) loss on foreign currency transactions		(44)		15
Changes in operating assets and liabilities
Decrease (increase) in amounts due from related parties		(65)		(43)
Decrease (increase) in inventories		(15)		(164)
Decrease (increase) in other current assets		(59)		(639)
Increase (decrease) in trade accounts payable		523		(130)
Increase (decrease) in accrued expenses		2,165		1,077
Decrease (increase) in accrued revenue		(461)		—
Increase (decrease) prepaid revenue		3,598		(156)
Increase (decrease) in amounts due to related parties		(230)		(227)
Net cash provided by operating activities		34,062		22,131
Cash flows from investing activities:
Disposals (additions) to vessel and equipment		(330)		52
Net cash used in (provided by) investing activities		(330)		52
Cash flows from financing activities:
Accumulated interest expense on long-term debt from related parties		—		263
Repayment of long-term debt		(8,580)		(8,579)
Payment on debt issuance cost		—		(8)
Cash distribution		(15,012)		(11,460)
Net cash provided by (used in) financing activities		(23,592)		20,047
Effect of exchange rate changes on cash		145		(136)
Net increase in cash and cash equivalents		5,209		2,000
Cash and cash equivalents at the beginning of the period		23,573		30,746
Cash and cash equivalents at the end of the period		$ 28,782		$ 32,746

APPENDIX A—RECONCILIATION OF NON-GAAP FINANCIAL MEASURES

Distributable Cash Flow (“DCF”)

Distributable cash flow represents net income adjusted for depreciation, unrealized gains and losses from derivatives, unrealized foreign exchange gains and losses, goodwill impairment charges, other non-cash items and estimated maintenance and replacement capital expenditures. Estimated maintenance and replacement capital expenditures, including estimated expenditures for drydocking, represent capital expenditures required to maintain over the long-term the operating capacity of, or the revenue generated by, the Partnership’s capital assets. Distributable cash flow is a quantitative standard used by investors in publicly-traded partnerships to assist in evaluating a partnership’s ability to make quarterly cash distributions. Distributable cash flow is a non-GAAP financial measure and should not be considered as an alternative to net income or any other indicator of KNOT Offshore Partners’ performance calculated in accordance with GAAP. The table below reconciles distributable cash flow to net income, the most directly comparable GAAP measure.

(USD in thousands)		Three Months Ended March 31, 2016 (unaudited)				Three Months Ended December 31, 2015 (unaudited)
Net income		$	10,663			$	17,567
Add:
Depreciation			13,892				13,464
Other non-cash items; deferred costs amortization debt			287				289
Unrealized losses from interest rate derivatives and foreign exchange currency contracts			4,348				—
Less:
Estimated maintenance and replacement capital expenditures (including drydocking reserve)			(7,894)				(7,516)
Other non-cash items; deferred revenue and accrued income			(1,319)				(858)
Unrealized gains from interest rate derivatives and foreign exchange currency contracts			(2,089)				(4,864)
Distributable cash flow		$	17,888			$	18,082
Distributions declared		$	15,095			$	15,012
Coverage ratio			1.19				1.20

Adjusted EBITDA

Adjusted EBITDA refers to earnings before interest, other financial items, taxes, goodwill impairment charges and depreciation. Adjusted EBITDA is a non-GAAP financial measure used by investors to measure the Partnership’s performance.

The Partnership believes that Adjusted EBITDA assists its management and investors by increasing the comparability of its performance from period to period and against the performance of other companies in its industry that provide Adjusted EBITDA information. This increased comparability is achieved by excluding the potentially disparate effects between periods or companies of interest, other financial items, taxes, goodwill impairment charges and depreciation, which items are affected by various and possibly changing financing methods, capital structure and historical cost basis and which items may significantly affect net income between periods. The Partnership believes that including Adjusted EBITDA as a financial measure benefits investors in (a) selecting between investing in the Partnership and other investment alternatives and (b) monitoring the Partnership’s ongoing financial and operational strength in assessing whether to continue to hold common units. Adjusted EBITDA is a non-GAAP financial measure and should not be considered as an alternative to net income or any other indicator of Partnership performance calculated in accordance with GAAP. The table below reconciles Adjusted EBITDA to net income, the most directly comparable GAAP measure.

(USD in thousands)		Three Months Ended March 31, 2016 (unaudited)				Three Months Ended December 31, 2015 (unaudited)
Net income		$	10,663			$	17,567
Interest income			(2)				(5)
Interest expense			5,029				4,731
Depreciation			13,892				13,464
Income tax benefit (expense)			3				(65)
EBITDA			29,585				35,692
Other financial items (a)			3,486				(1,849)
Adjusted EBITDA		$	33,071			$	33,843

(a) Other financial items consist of other finance expense, realized and unrealized gain (loss) on derivative instruments and net gain (loss) on foreign currency transactions