Good afternoon and welcome to the KNOT Offshore Partners Third Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to John Costain, CEO. Please go ahead.

Thank you. If any of you have not seen the earnings release or slide presentation, they’re both available on the Investors section of our website. On today’s call, our review will include non-U.S. GAAP measures such as distributable cash flow, DCF and adjusted 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, and now onto the presentation. KNOT Offshore Partners, KNOP’s focus is on the Shuttle Tanker segment. This asset is deal specific and an integral part of the logistic supply chain that provides a vital service transporting oil from the offshore oil production units to shore side. In effect, a midstream mobile pipeline business with fully contracted revenues, stable non-volume based revenue streams. KNOP trades at a significant yield premium to the Alerian Index, which represents around 75% of MLPs by market cap. Unlike most of these MLPs, however, we are operating in a space. We’re seeing substantial oil production growth and consequently the supply of Shuttle Tanker is tightening as demand grows. We have a young fleet and after record-breaking set of results in the previous quarter, but to-date, we reported our latest best ever financial results for the third quarter of 2016. These are our highest ever revenues and operating income. Together with our highest ever adjusted EBITDA and distributable cash flow has a very solid financial situation. We’re also pleased to announce latest additions to the MLP,…

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Michael Webber with Wells Fargo. Please go ahead.

Hey, good morning, guys, how are you?

Hi, Michael. How are you?

Good. Just to quickly touch based on the drop and any sort of corresponding distribution increase. I could have missed it in the prepared remarks. I know I didn’t see it in the release. But what’s the thought process around eventually bumping the distribution following the dropdown and/or any timing around that decision?

Well, we haven’t – we decided this at present moment time to use the additional funds from the Raquel to strengthen – further strengthen the balance sheets and improve our cover ratios, because in the medium-term, obviously, we’ve taken more leverage with this drop and with the cover that we have today, we can we repay the debt quite substantially. I mean, at the moment, the 135 coverage be used over time to reduce the leverage in the MLP in the last – since we did the last drop at the end that we have repaid, we will have when we receive this vessels we’ll be repaid around US$60 million, and by the end of 2016, we will repay the similar amount. So we see that we need to keep the coverage. We’re not raising new equity, or doing something else. So that’s really the thinking behind it today.

Right, and that makes sense. So when you look at the, I guess, the amort and the balloon schedule the next couple of years, I believe, you’ve got $155 million and a balloon payment coming in 2018 along with kind of a $50 million amort schedule in 2017 and something similar in 2018. So it’s pretty lumpy in 2018 and into 2019, which…?

The 2018 is really related to the Hilda and Torill. I mean, obviously, we’ll wait to see how the charters –what’s in the structure the new charters have and what we can raise against the vessels. Obviously, if the charter wants the term deal, it makes it easier to actually increase leverage on the ships. If we he wants optionality, we’ll probably just renew at the current level. So it’s really, we don’t know what the outcome is for these things until actually happens and therefore it’s quite good to stay flexible really, and not push it all out to distributions

Of course. And maybe if I back away from that for a second and kind of the question on the dividend was within the context of your equity currency, kind of looking at that amort schedule. So maybe just big picture, when you see that 2018 and 2019 schedule coming up, you’ve got good contract coverage. You’ve the possibility of raising the distribution here, but you want to build some cover. How do you – when can you realistically address the 2018 and 2019 balloon payments to actually refi those, and then how do you prioritize your kind of your toolkit in terms of your levers you can use, including new equity or organic actually to try to handle that?

We’d like to have a little bit of flexibility, because obviously we don’t want to press. We don’t like to press the charter on the rates, it’s more. He should come to us and decide what he wants to do. It’s just needs a negotiation. It gives them more flexibility. And at some point, they will come to us and ask about the renewal on the ships. I would expect, because the ships the two the Hilda and Torill are specialized. And then I think in 2019, they’ll start look at the Petrobras ships that starting to come and it’s quite a lots of refinancing at that point, but the contracts still had a lot of cover on them. So we see that we’re quite relaxed about it, this area is not something. But it’s something we haven’t got lots of visibility on in terms of how much you can actually until you actually finalize negotiations and then talk to the banks we haven’t got lot of visibility on exactly how much cash flow we’ll have in that. So it’s better to wait and see and this is why one of the reasons why if we’re not going to market gain equity, we’re better off just dropping the ship and maybe put it in the distribution increase in the corporate.

Okay, that makes sense. Just within that context and looking at the option theory associated with a number of these vessels, what’s the window prior to that option kicking in, where they actually need to notify you whether or not they’re going to be keeping the vessel? Can you get some visibility into that kind of six to nine months ahead of time, or is it a tighter window?

Yes, yes, usually six months normally with an option they have to acquire. Yeah.

Okay.

And the way the shuttle tanker market is today, it’s pretty tight. I mean, we’ve actually time chartered out to one of our competitors and there isn’t a lot of tonnage around. So we’re not worried about this. We think that the market will stay reasonably tight now. And as I alluded to in the call, we’re starting to see inquiries about new ships again. So new opportunities open up a bit, but it’s early days yet. It’s been very quiet for last year, but I think it’s functioning the way the capital markets have been generally and the shipbuilding market as well. But it’s starting to change because of the new ships.

Right. That makes sense. Just one more for me and I’ll turn it over. I believe you mentioned, or you mentioned earlier somewhere there’s an active tender for two shuttles in the market right now, and I think there’s another one coming down the pipe that we read about. Given the state, from a financial standpoint of some of your competitors, maybe your larger competitors, where they’re still digging out from some balance sheet issues, how competitive are those dynamics? And is it materially different today than, say, it was two to three years ago in terms of who you’re seeing at the table next to you, kind of vying for this business?

I mean I don’t think it helps; it’s not very easy to comment on the new competitors. But we obviously, from our perspective, we’re happy that were in good position to contract. And I can’t really comment on the other MLP sort of other businesses…

Have they been any more or less competitive in terms of the tendering process?

I would say that we can be pretty competitive, because we can finance pretty well the ships. We really have a very good reputation and therefore leverage is easy for the financing. So – but I don’t – I mean it’s difficult for me to comment how the business do the contracting, we just have our own business model and that’s that.

Right, but you’re seeing fewer players kind of vying for the same business because they’re busier, right? That’s kind of all I’m getting at.

I would expect the usual suspects would be invited, Michael.

Okay, okay. That’s helpful. All right, I will turn it over, but thank you for the time, guys.

Your next question comes from Spiro Dounis with UBS Securities. Please go ahead.

Hey, good afternoon, John. How are you?

I’m good, Spiro. And how are you?

Good, good, not too bad. I think you’re the only green stock on my screen today, so congrats on that. Just wanted to pick up on some where Mike left off, just around maybe equitizing this drop at a later date. And I don’t want to put words in your mouth, but it sounds like maybe you’re still not thrilled with where the units are trading. So to the extent the yield compresses, things get better, unit price goes up, just maybe some thoughts around doing issuance later, repaying some of these seller’s loan earlier than expected and then raising the distribution on the back of that. Is that a path you could take or a possibility?

Yes. In order to better strengthen the balance sheet and increase our finance flexibility, we would definitely make opportunistic issuances of equity given the right pricing level. It’s not our major focus because obviously we have to acquire ships over time because every, every year the MLP is significantly deleveraging and we’d like to keep a reasonably decent level of leverage and grow the MLP. So since the Ingrid drop and, say, to the end 2017, we will basically have repaid nearly $120 million in debt. And therefore, we like to keep a bit of – it’s good to keep a bit of leverage because today it’s quite a nice way of building the distribution. But yes, we definitely see opportunities to expand the business, we definitely would like to take more equity. I think the main points about the drop that that’s happen today is it shows the sponsors majorly, they’re keen on keeping MLP as a viable business and pushing it forward. I think it’s really a positive development, because obviously we’ve had a very difficult time in the last 12 months, like a lot of MLPs. And this just shows major commitment and that’s good.

Yes, and that actually kind of segues into my next question, which was around the sponsor’s appetite to grow. And once again, you mentioned those tenders. Just curious – are there any cash needs at the sponsor level that would maybe precipitate either another drop-down or an equity raise to help fund, maybe these new two shuttle tankers that you potentially could win. Just trying to get a sense of if you win those, what does that mean right here and now for the MLP?

I think at that moment, it doesn’t mean a lot, because the deposits are not very large on these contracts these days. I think it’s about 15%, I would say. That’s not something we’d worry about. I think they’re not that short of cash they would make a strategic decision in a few weeks over winning a contract like that. I mean, we have – we do have some reserves quite considerable. So I don’t think it makes much difference to be honest.

Gotcha, and sorry if I missed it. Was there any sort of timing around when we might hear about these tenders? Is it a next six months deal, or even closer than that?

I don’t actually know, but I would expect it would be six months something like that. I would expect whether we win or not, the good thing is the market’s opening up again and people are starting to make inquiry. I mean, we’re not going to win all the contracts and now our competitors are not going to win contracts. But there are contracts out there and there’s an appetite to buy again, and that’s positive.

Oh, it was a good sign. All right. That’s it for me. Thanks, John.

Thanks.

The next question comes from Nick Raza with Citi. Please go ahead.

Thank you. I just had a couple of quick follow-up questions. is there – John, is there a level of leverage that you can point us towards in terms of where you think the partnership should be or would be ideal? Just so we can sort of measure where – at which point in time you will sort of initiate dropdowns or do a distribution increase?

That’s a good question, Nick. It obviously depends on the – a little bit on the retail banking market as well. But we like to target about five, the ratio of the bidder over interest. And we find at the moment, the easiest way to actually releverage the MLP is to drop a new ship in highly leveraged or more leverage than the average, because obviously you’d have to be financed existing play then, so it makes sense to keep the leverage going that way, I mean, with a young fleet like this. We are deleveraging on a straight line basis, but the write-down of the ship is really more of an annuity. So you do get a gap and basically that’s the cover on our distribution, because we go in with a fairly neutral cash flow. And so we’d always try and keep every drop, we’d always try and push the leverage on the drop. And then I mean, I think, today it’s probably fine. I mean, by the end of 2017, we’ll be actually on probably more normalized leverage, I guess.

So around that five times if you sort of foresee, assuming net of balloon payments and any other obligations that you may have…?

Yes, the balloons…

Go ahead.

The balloons we just expect to refinance. I mean, generally, you can assume that because the ships are relatively young, the market is a very stable market, you would expect to have no problems refinancing the balloon. If we can’t, at least, increase the leverage, at least, before the balloon and refinance this. It’s a function of the market being a bit tight financially. But generally, we would look to increase the level of debt when we refinance through the works on the balloon.

Fair enough.

So we don’t consider it an ordinary payment.

Fair enough. And then as a sort of an offbeat question, I mean, some of your competitors – one of your competitors is arguably in sort of a financial duress. Is there a thought to sort of buying out other folks’ shuttle tanker operations outright?

Well, we’ve always looked at them we bought the lowest in fleet few years ago. It’s not something we – the price has to be right, to be honest with you, and the contracts have to be good. We – yes, we’re always interested, but today that’s not on the agenda.

Fair enough. That’s all I had, guys. Thank you so much.

The next question comes from Ben Brownlow with Raymond James. Please go ahead.

Hey, John, congratulations on the quarter and the dropdown.

Thanks, Ben.

On the pace of growth with the remaining four dropdown vessels, can you just comment about how you’re thinking about that? Is that largely dependent on the capital markets?

Yes, I think so. I mean, I think the sponsor is pretty strong and can keep the yield strip outside of the MLP, if he wants to. He saw an opportunity, because we have quite a lot of – cash on the balance sheet and we’ve deleveraged a fair bit to drop a ship in. I think we – if we don’t look for a sources of capital then I think it’s likely that we will wait a little bit to continue to grow. It just depends on how the market reacts to our units over time. And then if we get the opportunity, we might go onto the market and raise equity, do a bond issue, don’t really know. We’d have to think about really. But today, we – we’re just happy that we got a ship in, it’s probably, it’s pushed the MLP as we can be, to be honest, it stretched a little bit, because we have taken a seller credit. But the commercial debt is fine The debt position is pretty safe. I think the whole thing is pretty good. The cover is very good and we’ll see next year if things – all things being equal, we’ll see an even higher level of cover on the fleet, which is good.

Good. And on the valuation approach, would you look at the Raquel kind of on a similar valuation versus the other four drops?

Don’t know how much. That’s obviously decided by the conflicts committee and the fairness opinion we get as to what level is correct or appropriate. I mean, ultimately, with the MLP, because of the way the marine space is, you have a young fleet. It’s quite highly leveraged and deleverages quite quickly. You have to drop in assets accretively obviously, but you have to keep dropping assets into get the full value of the MLP, keep the leverage there, because the contracts that we have either with oil majors or with national oil companies generally they’re very, very strong contracts and they do yield. We do yield stable revenues. So to get the maximum benefit out there, you have to keep acquiring assets and dropping them in. So that they’re – otherwise, you just end up deleveraging the MLP over time. And it’s not – at this level of yield, it doesn’t really work. We can today with 10 ships, we can drop another ship in every ones two years and improve the outlook. Of course, it depends on what people’s view of the market is and what the banking sector’s view of the shipping is. But all things being equal, that will be the case. So we have to keep growing really to make it work for commitment with [Multiple speakers].

That makes sense. And then just switching over just quick – one or two quick more. On the Windsor, any discussions there on the extension? And can you just remind us kind of what the rate revision on that?

Well, what we had on that, yes, we had about 6% to 7% reduction in the rate. The – that’s the structure of the contract now. It’s going to be one option, one option, one. Why would they renegotiate that, because ultimately they want the flexibility that was part of the deal to get the three BG ships that we had at the time, now they’re Shell ships. And that was – that would be agreed. We agreed to give them a bit of flexibility like in the Windsor on that short contracts. And also, that’s really how it’s risen, so it has not much changed. And similarly the Bodil is not, that’s what we’ve agreed to, so that’s what we’ll stick to. And I wouldn’t expect any problem with that. It will get exercised. It’s not quite flexible because going forward, the market’s getting tighter as well.

Okay. And the Bodil that was at the very similar rate to the prior contractor right?

Yes.

Okay. Thank you.

A little bit less, but similar.

[Operator Instructions] The next question comes from Lin Shen with HITE Asset Management. Please go ahead.

Hi, good afternoon. Thanks for taking my question. When I see the slide, Page 11, you have a chart, which is back to February 2016, early this year’s supply demand forecast. So can you talk about what are you seeing now, or your current forecast on next year? Do you see the gap for demand supply should be very positive for your business?

Yes. I mean, I actually like the fact the market has quite – taken quite time. It’s developing reasonably at a nice pace. So I think – well, the graphs that were previously quite – they have actually reduced the demand and the supply difference in the balance. We – I’m happy with this, because it means that orders are done in a gradual and nice way. If you had a massive surplus or shortage of ships within the space of a year or two, you might end up with a frenzy of orders and it’s not always necessarily the most disciplined way to run a business. So I think we can see – empirical evidence tells us, because the sponsor has a really with their fleet they’re fully utilized, and also our competitors are having the same problem. They are not compared to us. One of our competitors come to us moved actually time charter ship-outs for them for several years. So they just can’t get it. So there is definitely a shortage here, how this market pans out, depends on how quickly the fields are opened up and how good the oil flows are from these fields, I mean, certainly if you believe the press releases of some of the oil majors and national oil companies, you will see that the outlook is very positive. And so we’re optimistic. Can’t say that the figures will develop as firms project. But I think the outlook is very, very positive for the Shuttle Tanker. And as of today, we can see that there is really a lot more interest in the market. It’s starting to be a better movement and we’re seeing orders, which is quite a positive thing.

Thank you very much.

This concludes our question-and-answer session and the conference is also now concluded. Thank you for attending today’s presentation. You may now disconnect.