Good day, and welcome to the Second Quarter 2018 Earnings Conference Call. [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 investors section on our website. On today's call, our review will include non-U.S. gap measures such as distributable cash flow and adjusted earnings before interest, taxation, depreciation, and amortization, the EBITDA. The earnings release includes a reconciliation of these non-GAAP measures to the normal, 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 focuses on the shuttle tanker segment. Each vessel is usually built to an individual charter specification. Under non-volume-based contracts, we transport oil from the offshore production units to shoreside, in effect we're midstream mobile pipeline business. The chartered vessel forming an integral component of the charter supply chain. Shuttle tankers operate in a niche space. In our sector to date, there has been no speculative ordering of tankers by vessel owners. So given the solid growth outlook from the sector, the partnership should yield stable and sustainable revenues longer-term. Our sponsor Knutsen NYK has placed all their younger vessels in the MLP. All have long-term charters after construction, and all remain strategically important in their respective charters. Taken together with the partnership, the Knutsen Group has 29 shuttle tankers, numerically this equates to the largest fleet on the water. Our sponsor is a very experienced operator, having been involved in the design and construction of shuttle tankers for well over 30 years, including being involved with the development…

[Operator Instructions]. Your first question comes from Hillary Cacanando of Wells Fargo.

So you have a healthy target distribution coverage ratio and you've been saying that you're focusing on increasing your coverage ratio and deleveraging first, before perhaps increasing your distributions. What does the target -- like what are the ratios that you are looking for, I guess, for you to start feeling comfortable [indiscernible] distribution?

I think we need to -- I mean, first of all, today, with the MLP operating, we actually don't need to refinance it for three years, and we are -- we can pay this recent cash flow [indiscernible] without looking to releverage or do anything. I mean that's the first objective, to make it easy, for the MLP to function. And that we have had to refinance a fair bit to pull all these ships in, and now we've done that. We've got good coverage ratio. I see the -- I mean, this is a sizable business with lots of people involved and I want to keep it stable and going forward, it has to be a long-term investment. So we are happy to build the coverage. We see -- I mean, once we -- once -- I mean, there's a lot of questions over the inventory that we don't have, but that will come. And obviously, the market has changed a lot, and we have another competitor in the market who has been very aggressive, and has won a lot of tenders lately. But the market is there and we -- we're back in and talking to people. So in the interest of time, that will happen. I think as far as the distribution change goes, I don't think the policy will change until we have a bit more clear view of where we're going with the business and how the contracts have accreted the arm, and the sponsor, how he's doing. I'm not -- I don't have a primary goal to push the distribution at all. I think, at the current year, and the current unit price, I'd like to keep it all very stable, and keep the distribution very comfortable. I think, it's working for us. And…

So there's really no target, distribution coverage or target EBITDA that we should be looking forward?

No, I think, it could go higher. I mean, we could go up. I mean, to me, I think it could get to -- I think go to 200% maybe. I don't think that's possible at the moment. But it depends on how creative the contracts are. So the last thing with having -- with having this headroom, we can be in the market and contract vessels even directly into the MLP, if needs be. I mean, I think we need to grow the MLP because if we had a bit more liquidity in the units, so like, it was like 25% more liquidity would be in the Alerian and that would have been a natural improvement in the unit price just because you've got attractive funds in. You basically got -- I calculate probably about 400,000, 500,000 units would be in these sort of funds. Today we're already closed-end funds. And they're quite comfortable with what we're doing. So I've talked to a lot of them, I think, until you've got a clear pattern, what we can make some mathematical models as to what it's going to look like and how it's going to go. But you know, I think, I've looked at it quite closely on how we perform, and I think people do appreciate the stability of it all. And at the end of the day, there's a pension. And that we also have very big businesses. I mean, Knutsen is a sizeable organization and the accounts of the MLP don't really reflect that. Probably to shore side staff there. So it's important to keep it stable. -- a stable MLP which is our long-term future.

Yes, I mean, like on the topic of MLPs, I mean, we've seen a lot of -- I mean, it's been kind of been challenging in the last couple of years and we've seen lot of roll-ups and consolidations into the parent on the traditional energy MLP space...

Yes. We're not that flushed with cash.

Yes, on the viability of the MLP structure, in the Marine MLP space, I mean, is this something that you think will happen eventually as well? Rolling up to the parent and consolidations?

With our MLP, I'll be disappointed. I think, personally, I think, we should, we will -- I mean, we've raised a lot of capital last year, and it would be a shame to end it. I think, it's got a lot of mileage, I mean, the MLPs are changing. But they are definitely changing their, the growth story, the distribution growth story and lots of the mature MLPs is out. I mean, almost -- except for Shell and 1 or 2 others, they basically are not really -- they're not many traditional growth story MLPs there. And when we're paying 9.5%, it's almost dishonest to say we will be comfortable bumping that up and putting across. If you put a distribution, you're putting it across the full unit base. That is to stay stable and be really comfortable during distribution entries before you do one. So I think this is definite -- it's going to be a year or two really before we know what we're doing in MLP in terms of how it's expanding, how big it's going to get. And I think it's got an attractive value proposition, but obviously we -- I mean, obviously, with the banks, if we go to Wells Fargo or someone and say we want to issue some units, then they'd say, well, we'd like to see an increase in distribution. So if you're doing anything in the market, it's dishonest to say why would you push the distribution, and weaken the MLP effectively. What we're doing, we're financially weakening that. I want to make a strong financial vehicle. And if we have to raise distribution to make it attractive to get units away, then maybe we do that. But today, there's no need. We look very stable, we can have fleet -- we can have vessels occasionally, there've been a couple of years of time, just to leverage that without raising the equity. And today, if we're not achieving a lot of contracts then we could just be putting 1 or 2 ships into the MLP to maintain its position. There's, obviously, [indiscernible] you have to watch ships occasionally even without raising equity and that should take you to a leverage par. I mean, so that's -- and we're doing a bit of that already, if you do an ATM, I mean, that's possible. I look at our yield, it's fine, I'm comfortable with all. I talk to people both in the sponsors and in the investors. And I think, generally, people have got used to what we're doing. But yes, obviously, you've got over 200% cover or something, or the market recovers and you start winning orders and then the situation changes completely. But look at us today, since we've got no inventory. So why would you push the distribution? That's where I see is really. That's the way I see it, I'm not saying anyone sees it that way but...

The next question comes from Robert Favera of RE Favera and Associates Marine Surveyors.

My first question deals with the IMO 2020 sulfur content on fuel. Can you give us some color on how that may impact you?

Well, obviously, the vessels are time chartered, it's a charterer's expense, but the better vessels, with a more economic ships and newer vessels, will renew at a better rate because they burn less bunkers. I guess that's how it would impact us. In Brazil, we've done heavy fuel oil in Brazil, and the supply by the refineries in Brazil, it's almost -- it's 1%, sulfur content, it's quite low in South America. So we -- I think that they -- a lot of the Brazilian refineries could get compliance with the 0.5 on heavy fuel oil. Because if they don't, the vessels will have to burn marine diesel, but that's a charterer's problem. But I think within a year or 2, the Brazilian fuels will be compliant because the fuel content -- the sulfur content is low down there. In the North Sea, the SECA zone in Barents Sea is there have been quite onerous environmental requirements for -- since 2015, where they had -- I think it was [indiscernible] knocks actually down to 0.1 or something from one in the harbor. So basically, we've had to burn marine diesel on those vessels, or the charterer has. Basically it's a pricing issue, these ships are time charted, so if a vessel burns LNG and LNG becomes more effective, and they want to run it because it complies, then maybe they'll get a better rate. But I suspect not, I mean, it's almost the Tier 3 compliance or Tier 2. We build ships at Tier 2 because actually, weirdly, ships with scrubbers are less efficient, and they've got more deadweight, they also discharge sulfates into the sea, which is not with an open-loop system, which is not totally desirable. In fact, I think an open-loop system personally is a weak solution,…

Well thank you so much for the additional insight on. And I had no understanding of some of that. And you've spoken a lot about debt, okay? The total debt, et cetera, which we have increased a little bit because of the additional ships, et cetera. Now the market is, obviously, pricing us as a high risk operation since we're getting 9.5% based on the prices on stock and dividend, et cetera. And...

Well, shipping generally because of the way the market has gone, it seemed quite high risk. The fact that we're probably -- we have some of the best contracts I've seen, certainly in tankers. Because they were actually contracts. They are fabulous contracts, but obviously, you still got the shipping industry risk a little bit, and the market has fallen a bit for vessels and people are always focused on the renewals. But while these ships are our long-term assets, [indiscernible] we paid for them. And they've agreed a string of rates and options and that hopefully -- mostly, we basically get close to that, if not exactly the figure that we get in the charter. But it varies, and we intend to give them a little bit of a reduction, but not massive. Because, obviously, you have to build the ship and it's the cost of [indiscernible]. I mean these contracts are not massively profitable, so the leverage has to be there. The leverage is there by the banks. Because obviously, if you got 10-year excellent money on a time charter and it's a needed asset because you can't monetize the oil flow otherwise is a pipeline, you're going to get good financing in terms of just a consequences, the quality of the contracts you've got. You might as well take the bank to it. I mean, don't forget the sponsor on 25% to 26% of the units anyway. So you quite like our distribution. You're not going to sit down and say, well, I'm going to have it low leverage and low distribution. And you're going to say, I'd like to take some money out of it. So if you do, and that's why we, thus, end up where we are.

But one of the things I was concerned about is changing interest rates. We do have floating interest rates to go along with current LIBOR. And by the looks of it, more time is going to mean more higher rates for us. And obviously more cost on it.

Yes, but don't forget, it increases the entry cost of the new vessels coming in because the old ships are getting paid down. So actually, gives you a competitive challenge with an aging fleet. It's not all bad of a use. It's just a different use. But you are right. You are right, and it has an impact. We've covered -- we hedged about 4 years forward, that's why you see these big exchange -- we made these big profits on derivative contracts because we actually hedged around, about 60% on our debt coverage, but the rest of it isn't hedged. And we will be -- we've achieved lower margins a bit on the financings because part of the reason is because the LIBOR rate is going up on the banks. In a higher LIBOR environment, they're actually happier to take your money because they're getting more interest, so they actually lower the margins a little bit. So you see when we negotiate, we'd be doing that by 2.5% to 2.125% because you actually achieve the LIBOR fare.

The way of looking at -- that's the way I've been looking at it lately because the price is kind of stuck between $21.50 and $22. And the dividend is staying exactly the same. So it's a very stable thing, which is what you're trying to achieve. But the -- increasing the size of the business then, increasing the number of ships, if we're going to stay exactly the same in both price and dividend, what we're really doing is, increasing the benefit of the moneylenders and not the shareholders, particularly. So in the long run, is there any possibility that you can buy back some of the preferred, not change the regular dividend, but buy-in the preferred?

We don't want to buy in the preferred because after 10 years, there is a financial penalty on the preferred shareholder. I think he placed it at 70% of book. So you can't -- he wants his money back after 10 years, if it is still a preferred. Otherwise, it's a nice conversion. It's $24.67 now with strike. So actually he has to strike it per unit. It -- that preferred is a really nice stuff -- it's a really nice preferred, and I like it. But as I was alluding to in the call, if you've got preferred, then you should -- it's not the moneylenders are losing, because they know that they're going to get paid on these contracts. They are very, very good. If you pay a high distribution, just -- you're just hurting the common unitholders in the long run. You're just destabilizing the [indiscernible].

I'm trying to understand the logic of why you don't want to buy back any preferred to reduce out $1.8 million per quarter?

Yes, because basically, there has to be cheap competitive common unit. And it's not part of the mechanism. The mechanism is that if we -- if they run out, then they take a discount on redemption quite significant. So they won't get paid out at the common unit rate. They get paid out significantly less. There is a discount on them. So it's not advisable for us to do that, and we've already won the preferred for two years now, is it?

Is that preferred -- is that preferred callable?

Yes, but we have to pay the spot price. And I got to check with the [indiscernible]. It's not advisable for us because if we call it, we have to issue common units effectively.

Have to replace that money?

Yes, yes. Because we are quite tight for cash, as you can see. And it's actually cheaper than common unit, and it has been nice -- I mean, as a quid pro quo, obviously this sits on top of the common unit holder. So while they've got these disadvantages, it's a nice -- it's a fair deal. I like the deal, it's a very fair deal because actually, they have residual risk as well. After 10 years, they did take quite a hits on those press. But they have to receive an 8% yield. I won't -- I mean, basically, you can turn any 10% yield to the common unit holder. And it does increase the risk levels. So -- and you can't look at the contracts. The quality of these contracts is very high, and you can't -- [indiscernible] in the market and they are very aggressive because they want the business. It drives the accretion levels down if we want to do the contracts. So even though there's so many ships that people will order different elements, we know the market very well. And we know what that will cost, and we know where we're comfortable going with charter rates. And if we see -- if we think it's over competitive, we're just staying out, and that's just how it is. But some are [indiscernible] markets is very, very good. I mean, we've seen, I think, AET has won seven contracts in the last year. And obviously, we've taken an order of six ships. We are talking to people, and they're quite keen, especially, the Statoil was very keen to give us some contracts, but it's going to be on the right terms. And I can't say too much because of nothing been firmly agreed, if you know what I mean, but I'm not worried about it. I think, genuinely sometimes it's just better to sit out of it. There is only so many ships that people want to place with an owner and only so many berths they have to use and only ships they can construct. So sometimes you can go a bit aggressive into market,these happen....

But we don't see ourselves increasing our fleet at this point, right?

No. Because the sponsor has to order the ship, and it takes -- I'll be just honest, I've got ideas. We're obviously quite a large group of vessels. But I prefer personally to keep as a shuttle tanker business. And I think actually in view of NYK commencing today. But obviously, there are plenty of older vessels out there, and it just goes on to 6 to 12 months and they're not getting anywhere with anything, then we have to reappraise because we've sunk a lot of effort and time into building those MLT to where it is today. And it would be, not something that they would want to abandon, I don't think, you know what I mean. And that's basically what you're saying to close it out and move it down. Even then it's still a nice -- it's still got a nice -- it was not much risk to do that. It's not particularly sexy investment, but it's not a risk, you know what I mean?

The next question comes from Ben Brownlow of Raymond James.

Just a few quick modeling questions. On the Hilda and the Windsor, the charter extension there, any meaningful change in the day rates with those?

No.

Okay. And for the third quarter, it seems like the Torill, the five year survey was pushed up a little bit from the fourth quarter to I guess, towards the end of fourth quarter?

Yes, it's late September. It's going to be an investment delivered in November, mostly just at -- it maybe in early November when it was still [indiscernible]. So yes, it's probably a few. Will we continue? I don't know. It must have been the scheduling around but, obviously, it's not far off. Exactly it's five year dates [indiscernible] whereas the Hilda has been on the five year dates, it has actually arrived. I guess, it just depends on when they have discussions with charterer, but you do have some latitude on when you dock these ships. I mean, you don't dock them on the anniversary dates, it depends on the yard availability and charterer. It is closed because the charter was delivered in November '13. So it's -- it possibly was early November 2nd or 3rd or something. But it has rolled it forward to that because of the 15- to 20-day docking. So yes, you're right, it's going to be late September, so probably 2 or 3 weeks early.

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

Thank you, Operator. And thank you for your questions. It was very -- it's always good to have people on the call who listen to our business and I do appreciate it. Thank you very much.

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