F-1/A 1 d453129df1a.htm AMENDMENT NO. 2 TO FORM F-1 Amendment No. 2 to Form F-1
Table of Contents

As filed with the Securities and Exchange Commission on April 1, 2013

Registration Statement No. 333-186947

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

AMENDMENT NO. 2

TO

FORM F-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

KNOT Offshore Partners LP

(Exact name of Registrant as specified in its charter)

 

 

 

Republic of the Marshall Islands   4400  

98-1098373

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification No.)

2 Queen’s Cross, Aberdeen, Aberdeenshire AB15 4YB, United Kingdom, +44 1224 618420

(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)

 

 

Watson, Farley & Williams (New York) LLP

1133 Avenue of the Americas

New York, New York 10036

(212) 922-2200

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies to:

Catherine S. Gallagher

Adorys Velazquez

Vinson & Elkins L.L.P.

2200 Pennsylvania Avenue NW, Suite 500W

Washington, DC 20037

(202) 639-6500

 

Sean T. Wheeler

Charles E. Carpenter

Latham & Watkins LLP

811 Main Street, Suite 3700

Houston, Texas 77002

(713) 546-5400

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

If any of the securities being registered on this Form are being offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.    ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class of

Securities to be Registered

 

Amount

to be

Registered(1)

 

Proposed

Maximum

Aggregate Offering

Price Per Unit(2)

 

Proposed

Maximum

Aggregate

Offering Price(1)(2)

  Amount of
Registration Fee(2)(3)

Common units representing limited partner interests

  8,567,500   $21.00   $179,917,500   $24,541

 

 

(1) Includes common units issuable upon exercise of the underwriters’ option to purchase additional common units.
(2) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(a) based on a bona fide estimate of the maximum aggregate offering price.
(3) $13,640 of the registration fee was paid on February 28, 2013.

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 

 

 


Table of Contents

The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

SUBJECT TO COMPLETION, DATED APRIL 1, 2013

PRELIMINARY PROSPECTUS

LOGO

KNOT Offshore Partners LP

7,450,000 Common Units

Representing Limited Partner Interests

$        per common unit

 

 

This is the initial public offering of our common units. We currently expect the initial public offering price to be between $19.00 and $21.00 per common unit. We are selling 7,450,000 common units. To the extent the underwriters sell more than 7,450,000 common units in this offering, the underwriters have an option to purchase up to 1,117,500 additional common units.

We are a Marshall Islands limited partnership formed to own, operate and acquire shuttle tankers under long-term charters. Our initial fleet of shuttle tankers will be contributed to us by Knutsen NYK Offshore Tankers AS, a leading independent owner of crude oil shuttle tankers. Although we are organized as a partnership, we have elected to be treated as a corporation solely for U.S. federal income tax purposes. The common units have been approved for listing on the New York Stock Exchange, subject to official notice of issuance, under the symbol “KNOP.”

 

 

We are an “emerging growth company,” and we are eligible for reduced reporting requirements. See “Summary—Implications of Being an Emerging Growth Company.” Investing in our common units involves risks. Please read “Risk Factors” beginning on page 22.

These risks include the following:

 

   

We may not have sufficient cash from operations following the establishment of cash reserves and payment of fees and expenses to enable us to pay the minimum quarterly distribution on our units.

 

   

We will be required to make substantial capital expenditures to maintain and expand our fleet, which will reduce our cash available for distribution.

 

   

Our debt levels may limit our flexibility in obtaining additional financing, pursuing other business opportunities and paying distributions to unitholders.

 

   

Our growth depends on the continued growth in demand for offshore oil transportation.

 

   

We depend on Knutsen NYK Offshore Tankers AS and certain of its affiliates to assist us in operating and expanding our business.

 

   

Unitholders have limited voting rights, and our partnership agreement restricts the voting rights of unitholders who are resident in Norway or own more than 4.9% of our common units.

 

   

Our general partner and its affiliates own a 57.4% interest in us and have conflicts of interest and limited duties to us and our unitholders, which may permit them to favor their own interests to your detriment.

 

   

Even if public unitholders are dissatisfied, they cannot initially remove our general partner without the consent of Knutsen NYK Offshore Tankers AS.

 

   

Our general partner has a limited call right that may require you to sell your common units at an undesirable time or price.

 

   

You will experience immediate and substantial dilution of $4.82 per common unit.

 

   

U.S. tax authorities could treat us as a “passive foreign investment company,” which would have adverse U.S. federal income tax consequences to U.S. unitholders.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

     Per
Common Unit
     Total  

Public offering price

   $                    $                

Underwriting discount(1)(2)

   $                    $                

Proceeds, before expenses, to KNOT Offshore Partners LP(1)(3)

   $                    $                

 

(1) Excludes an aggregate structuring fee of $        million payable to Merrill Lynch, Pierce, Fenner & Smith Incorporated and Citigroup Global Markets Inc.
(2) See “Underwriting” for further information.
(3) Excludes offering expenses payable by us as described in “Expenses Related to This Offering.”

The underwriters expect to deliver the common units to purchasers on or about                    , 2013 through the book-entry facilities of the Depositary Trust Company.

 

 

 

 

BofA Merrill Lynch

  Citigroup   

Barclays

 

 

 

DNB Markets

  

UBS Investment Bank

Raymond James    RBC Capital Markets

 

                    , 2013


Table of Contents

LOGO


Table of Contents

We are responsible for the information contained in this prospectus and in any free writing prospectus we prepare or authorize. We have not authorized anyone to provide you with different information, and we take no responsibility for any other information others may give you. We are not, and the underwriters are not, making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should not assume that the information contained in this prospectus is accurate as of any date other than the date of this prospectus.

 

 

TABLE OF CONTENTS

 

SUMMARY

     1   

KNOT Offshore Partners LP

     1   

Our Relationship with Knutsen NYK Offshore Tankers AS

     3   

Business Opportunities

     3   

Competitive Strengths

     4   

Business Strategies

     5   

Risk Factors

     5   

Implications of Being an Emerging Growth Company

     6   

Formation Transactions

     6   

Simplified Organizational and Ownership Structure After this Offering

     8   

Our Management

     9   

Principal Executive Offices and Internet Address; SEC Filing Requirements

     9   

Summary of Conflicts of Interest and Fiduciary Duties

     9   

The Offering

     12   

Summary Financial and Operating Data

     18   

RISK FACTORS

     22   

Risks Inherent in Our Business

     22   

Risks Inherent in an Investment in Us

     38   

Tax Risks

     46   

FORWARD-LOOKING STATEMENTS

     50   

USE OF PROCEEDS

     52   

CAPITALIZATION

     54   

DILUTION

     56   

OUR CASH DISTRIBUTION POLICY AND RESTRICTIONS ON DISTRIBUTIONS

     58   

General

     58   

Forecasted Results of Operations for the Twelve Months Ending March 31, 2014

     60   

Forecast Assumptions and Considerations

     62   

Forecasted Cash Available for Distribution

     67   

HOW WE MAKE CASH DISTRIBUTIONS

     70   

Distributions of Available Cash

     70   

Operating Surplus and Capital Surplus

     71   

Subordination Period

     74   

Distributions of Available Cash From Operating Surplus During the Subordination Period

     75   

Distributions of Available Cash From Operating Surplus After the Subordination Period

     76   

General Partner Interest

     76   

Incentive Distribution Rights

     76   

Percentage Allocations of Available Cash From Operating Surplus

     77   

KNOT’s Right to Reset Incentive Distribution Levels

     77   

 

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Distributions From Capital Surplus

     80   

Adjustment to the Minimum Quarterly Distribution and Target Distribution Levels

     81   

Distributions of Cash Upon Liquidation

     81   

SELECTED HISTORICAL FINANCIAL AND OPERATING DATA

     83   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     87   

Overview

     87   

Items You Should Consider When Evaluating Our Historical Financial Performance and Assessing Our Future Prospects

     89   

Factors Affecting Our Results of Operations

     91   

Important Financial and Operational Terms and Concepts

     92   

Customers

     93   

Insurance

     93   

Results of Operations

     94   

Liquidity and Capital Resources

     99   

Cash Flows

     101   

Borrowing Activities

     102   

Contractual Obligations

     107   

Off-Balance Sheet Arrangements

     107   

Critical Accounting Estimates

     107   

Recent Accounting Pronouncements

     111   

Quantitative and Qualitative Disclosures About Market Risk

     111   

INDUSTRY

     114   

The Offshore Oil Industry

     114   

Shuttle Tanker Characteristics

     115   

Shuttle Tanker Markets

     118   

BUSINESS

     126   

Overview

     126   

Our Relationship with Knutsen NYK Offshore Tankers AS

     127   

Business Opportunities

     128   

Competitive Strengths

     128   

Business Strategies

     130   

Our Fleet

     130   

Customers

     132   

Charters

     132   

Competition

     133   

Classification, Inspection and Maintenance

     134   

Safety, Management of Ship Operations and Administration

     135   

Crewing and Staff

     136   

Risk of Loss, Insurance and Risk Management

     136   

Environmental and Other Regulation

     137   

Properties

     145   

Legal Proceedings

     145   

Taxation of the Partnership

     146   

MANAGEMENT

     147   

Management of KNOT Offshore Partners LP

     147   

Directors and Executive Officers

     149   

Reimbursement of Expenses of Our General Partner

     150   

Executive Compensation

     150   

Compensation of Directors

     150   

Arild Vik Employment Agreement

    
150
  

 

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SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     151   

CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

     152   

Distributions and Payments to our General Partner and Its Affiliates

     152   

Agreements Governing the Transactions

     153   

Contribution Agreement

     161   

Other Related Party Transactions

     161   

CONFLICTS OF INTEREST AND FIDUCIARY DUTIES

     163   

Conflicts of Interest

     163   

Fiduciary Duties

     166   

DESCRIPTION OF THE COMMON UNITS

     169   

The Units

     169   

Transfer Agent and Registrar

     169   

Transfer of Common Units

     169   

THE PARTNERSHIP AGREEMENT

     171   

Organization and Duration

     171   

Purpose

     171   

Cash Distributions

     171   

Capital Contributions

     171   

Voting Rights

     171   

Applicable Law; Forum, Venue and Jurisdiction

     173   

Limited Liability

     174   

Issuance of Additional Interests

     175   

Tax Status

     175   

Amendment of the Partnership Agreement

     175   

Merger, Sale, Conversion or Other Disposition of Assets

     178   

Termination and Dissolution

     178   

Liquidation and Distribution of Proceeds

     178   

Withdrawal or Removal of our General Partner

     179   

Transfer of General Partner Interest

     180   

Transfer of Ownership Interests in General Partner

     180   

Transfer of Incentive Distribution Rights

     180   

Change of Management Provisions

     181   

Limited Call Right

     181   

Board of Directors

     181   

Meetings; Voting

     182   

Status as Limited Partner or Assignee

     183   

Indemnification

     183   

Reimbursement of Expenses

     184   

Books and Reports

     184   

Right to Inspect Our Books and Records

     184   

Registration Rights

     184   

UNITS ELIGIBLE FOR FUTURE SALE

     185   

MATERIAL U.S. FEDERAL INCOME TAX CONSIDERATIONS

     186   

Election to be Treated as a Corporation

     186   

U.S. Federal Income Taxation of U.S. Holders

     186   

U.S. Federal Income Taxation of Non-U.S. Holders

     191   

Backup Withholding and Information Reporting

     191   

NON-UNITED STATES TAX CONSIDERATIONS

     193   

Marshall Islands Tax Consequences

     193   

Norwegian Tax Consequences

     193   

United Kingdom Tax Consequences

     194   

 

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UNDERWRITING

     195   

Conflicts of Interest

     197   

Notice to Prospective Investors in the European Economic Area

     197   

Notice to Prospective Investors in the United Kingdom

     198   

Notice to Prospective Investors in Germany

     198   

Notice to Prospective Investors in the Netherlands

     199   

Notice to Prospective Investors in Switzerland

     199   

SERVICE OF PROCESS AND ENFORCEMENT OF CIVIL LIABILITIES

     200   

LEGAL MATTERS

     201   

EXPERTS

     201   

EXPENSES RELATED TO THIS OFFERING

     202   

WHERE YOU CAN FIND MORE INFORMATION

     202   

INDUSTRY AND MARKET DATA

     203   

INDEX TO FINANCIAL STATEMENTS

     204   

APPENDIX  A—Form of First Amended and Restated Agreement of Limited Partnership of
KNOT Offshore Partners LP

     A-i   

 

 

 

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SUMMARY

This summary highlights information contained elsewhere in this prospectus. Unless we otherwise specify, all references to information and data in this prospectus about our business and fleet refer to our business and fleet to be contributed to our partnership upon the closing of this offering. Prior to the closing of this offering, our partnership will not own any vessels. You should read the entire prospectus carefully, including the historical financial statements of KNOT Offshore Partners LP Predecessor and the notes to those financial statements. The information presented in this prospectus assumes, unless otherwise noted, (1) an initial public offering price of $20.00 per common unit and (2) that the underwriters’ do not exercise their option to purchase additional common units. You should read “Risk Factors” for more information about important risks that you should consider carefully before buying our common units. Unless otherwise indicated, all references to “dollars” and “$” in this prospectus are to, and amounts are presented in, U.S. Dollars.

References in this prospectus to “KNOT Offshore Partners,” “we,” “our,” “us” and “the Partnership” or similar terms when used in a historical context refer to Knutsen NYK Offshore Tankers AS and its vessels and the subsidiaries that hold interests in the vessels in our initial fleet. When used in the present tense or prospectively, those terms refer to KNOT Offshore Partners LP or any one or more of its subsidiaries, or to all such entities unless the context otherwise indicates. References in this prospectus to “our predecessor” refer to KNOT Offshore Partners LP Predecessor. For the year ended December 31, 2012, our predecessor had revenues and net income of $65.7 million and $4.2 million, respectively. Please read “—Summary Financial and Operating Data” beginning on page 18 for an overview of our predecessor’s operating results and financial position.

References in this prospectus to “our general partner” refer to KNOT Offshore Partners GP LLC, the general partner of KNOT Offshore Partners. References in this prospectus to “KNOT UK” refer to KNOT Offshore Partners UK LLC, a wholly owned subsidiary of the Partnership. References in this prospectus to “KNOT” refer, depending on the context, to Knutsen NYK Offshore Tankers AS and to any one or more of its direct and indirect subsidiaries, other than us. References in this prospectus to “TSSI” refer to TS Shipping Invest AS and references to “NYK” refer to Nippon Yusen Kaisha, each of which holds a 50% interest in KNOT. References in this prospectus to “KNOT Management” are to KNOT Management AS, a wholly owned subsidiary of KNOT. References in this prospectus to “KOAS UK” refer to Knusten OAS (UK) Ltd., a wholly-owned subsidiary of TSSI. References in this prospectus to “KOAS” refer to Knutsen OAS Shipping AS, a wholly owned subsidiary of TSSI. References in this prospectus to “BG Group,” “Statoil” and “Transpetro” refer to BG Group Plc, Statoil ASA and Petrobras Transporte S.A., respectively, and certain of each of their subsidiaries that are our customers.

KNOT Offshore Partners LP

We are a limited partnership formed to own, operate and acquire shuttle tankers under long-term charters, which we define as charters of five years or more. Our initial fleet of shuttle tankers will be contributed to us by Knutsen NYK Offshore Tankers AS, or KNOT, which is jointly owned by TS Shipping Invest AS, or TSSI, and Nippon Yusen Kaisha, or NYK. TSSI is controlled by our Chairman and is a private Norwegian company with ownership interests in shuttle tankers, liquefied natural gas, or LNG, tankers and product/chemical tankers. NYK is a Japanese public company with a fleet of approximately 800 vessels, including bulk carriers, containerships, tankers and specialized vessels. Upon completion of this offering, KNOT will own our 2.0% general partner interest, all of our incentive distribution rights and a 55.4% limited partner interest in us.

Upon the closing of this offering, we will have a modern fleet of shuttle tankers that will operate under long-term charters with major oil and gas companies engaged in offshore production such as BG Group, Statoil and Transpetro. We intend to operate our vessels under long-term charters with stable cash flows and to grow our position in the shuttle tanker market through acquisitions from KNOT and third parties. We also believe we can grow organically by continuing to provide reliable customer service to our charterers and leveraging KNOT’s relationships, expertise and reputation.

 

 

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A shuttle tanker is a specialized ship designed to transport crude oil and condensates from offshore oil field installations to onshore terminals and refineries. Shuttle tankers are equipped with sophisticated loading systems and dynamic positioning systems that allow the vessels to load cargo safely and reliably from oil field installations, even in harsh weather conditions. Shuttle tankers were developed in the North Sea in 1977 as an alternative to pipelines.

Upon the closing of this offering, our initial fleet will consist of:

 

   

the Fortaleza Knutsen, a shuttle tanker built in 2011 that is currently operating under a bareboat charter that expires in March 2023 with Petrobras Transporte S.A., or Transpetro;

 

   

the Recife Knutsen, a shuttle tanker built in 2011 that is currently operating under a bareboat charter that expires in August 2023 with Transpetro;

 

   

the Bodil Knutsen, a shuttle tanker built in 2011 that is currently operating under a time charter that expires in May 2016 with Statoil ASA, or Statoil, with options to extend until May 2019; and

 

   

the Windsor Knutsen, a shuttle tanker built in 2007 and retrofitted from a conventional crude oil tanker to a shuttle tanker in 2011 that is currently operating under a time charter that expires in April 2014 with BG Group Plc, or BG Group, with options to extend until April 2016.

In addition, while we believe the Bodil Knutsen and the Windsor Knutsen will be chartered through the option periods, KNOT has agreed to guarantee the payments of the hire rate under such vessel’s existing charters for a period of five years from the closing date of this offering.

Pursuant to the omnibus agreement we will enter into with KNOT at the closing of this offering, we will have the right to purchase from KNOT any shuttle tankers operating under charters of five or more years. This right will continue throughout the entire term of the omnibus agreement.

We will have the right to purchase the following five additional newbuild shuttle tankers from KNOT:

 

   

the Carmen Knutsen, a shuttle tanker that was delivered in January 2013 and is operating under a time charter that expires in January 2018 with Repsol YPF, with options to extend until January 2021.

 

   

Hull 2531, a shuttle tanker that is scheduled for delivery in the third quarter of 2013. Upon delivery, Hull 2531 will operate under a time charter that expires in the third quarter of 2018 with Ente Nazionale Indrocarburi S.p.A., or Eni, with options to extend until the third quarter of 2023.

 

   

Hull 2532, a shuttle tanker that is scheduled for delivery in the third quarter of 2013. Upon delivery, Hull 2532 will operate under a time charter that expires in the third quarter of 2018 with Eni, with options to extend until the third quarter of 2023.

 

   

Hull 2575, a shuttle tanker that is scheduled for delivery in the fourth quarter of 2013. Upon delivery, Hull 2575 will operate under a time charter that expires in the fourth quarter of 2023 with ExxonMobil Corporation, or Exxon, with options to extend until the fourth quarter of 2028.

 

   

Hull 574, a shuttle tanker currently being built by Cosco (Zhoushan) Shipyard Co., Ltd., or Cosco, that is scheduled for delivery in late 2014. Upon delivery, Hull 574 will operate under a time charter that expires in late 2024 with Repsol Sinopec Brasil BV, or Repsol Sinopec, with options to extend until late 2029.

We will have the right to purchase the Carmen Knutsen within 24 months after the closing of this offering and will have the right to purchase Hull 2531, Hull 2532, Hull 2575 and Hull 574 within 24 months after each such vessel’s respective acceptance by its charterer, in each case subject to reaching an agreement with KNOT

 

 

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regarding the purchase price in accordance with the provisions of the omnibus agreement. Acceptance by the charterer occurs after the vessel has been delivered to the charterer and the charterer completes all inspections and testing of the vessel in compliance with charter requirements.

Pursuant to a joint venture agreement, KNOT is the exclusive vehicle for TSSI’s and NYK’s shuttle tanker business. Knutsen Shuttle Tankers 19 AS, a wholly owned subsidiary of a company jointly owned by TSSI and NYK, is the current party to the shipbuilding contract with Cosco for Hull 574 and in accordance with the joint venture agreement, an option has been granted to KNOT to acquire Knutsen Shuttle Tankers 19 AS. KNOT will be required under the omnibus agreement to exercise such option on or prior to acceptance of Hull 574 by Repsol Sinopec.

Our Relationship with Knutsen NYK Offshore Tankers AS

We believe that one of our principal strengths is our relationship with KNOT. We believe our relationship with KNOT will give us access to KNOT’s relationships with major international oil and gas companies, shipbuilders, financing sources and suppliers and its technical, commercial and managerial expertise, which we believe will allow us to compete more effectively when seeking additional customers. As of March 15, 2013, the KNOT fleet consisted of 22 shuttle tankers (including the vessels in our initial fleet) and four newbuilds on order, and one product/chemical tanker. In addition, KNOT, through its wholly owned subsidiary KNOT Management AS, or KNOT Management, owns the ship management services relating to the shuttle tankers in our fleet, which allows for a fully integrated shipping operation, providing newbuild supervision, project development, crewing, technical management and various other maritime services.

KNOT, whose predecessor was formed in 1987, is jointly owned by TSSI and NYK. In December 2010, NYK made an investment in KNOT in return for a 50% equity interest. The investment by NYK helped KNOT to continue to expand its fleet.

Business Opportunities

We believe the following factors create opportunities for us to successfully execute our business strategy and plan and grow our business.

 

   

Growing offshore oil production. According to the International Energy Agency, or IEA,—World Energy Outlook 2012, the demand for oil and oil-derived products is expected to continue to grow steadily in the coming years, reaching approximately 99.7 million barrels per day, or bpd, by 2035, up from 87.4 million bpd in 2011. In addition, offshore discoveries are expected to play an important role in the future, as IEA projects that deepwater production will expand from 4.8 million bpd in 2011 to 8.7 million bpd in 2035.

 

   

Increased demand for shuttle tanker services. We believe demand for shuttle tankers will increase from the continued growth in deepwater offshore oil production because production from deep waters and remote areas may be too expensive or technically demanding to transport via pipeline. As offshore oil production expands into harsh environments, high specification shuttle tankers will be needed to service those fields. Shuttle tankers are equipped with sophisticated loading systems and dynamic positioning systems that allow the vessels to load cargo safely and reliably from oil field installations, even in harsh weather conditions. Shuttle tankers provide a more flexible option than pipelines for the transportation of oil over long distances and from deeper waters and harsher environments where pipelines may not be economically or technologically feasible. As of March 15, 2013, the world shuttle tanker fleet consisted of 72 vessels. According to Fearnley Consultants AS, or Fearnley Consultants, 60 new shuttle tankers will be needed by 2020 to satisfy estimated demand.

 

 

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Customer demand for established, high quality operators. Many offshore projects, particularly those located in deep waters or remote locations, have a heightened reliance on their shuttle tanker provider due to the long-term nature of their contracts, the stringent technical requirements of shuttle tankers and the high degree of experience and expertise required of its crew. As a result, the major oil and gas companies are highly selective in their choice of shuttle tanker providers due to the high level of capital investment in their offshore projects and the requirement for uninterrupted production from the oil fields. We believe that KNOT’s long-standing reputation for customer service and reliability will cause major oil and gas companies to favor it over less experienced operators.

Competitive Strengths

We believe that our future prospects for success are enhanced by the following aspects of our business:

 

   

Relationship with leading shuttle tanker operator. We believe we will benefit from our relationship with KNOT in the future. We believe charterers award new business to established participants in the shuttle tanker market because of their technical, commercial and managerial expertise. For example, over the past ten years, all but one new tenders and time-charter contract awards in the North Sea have been won by KNOT, the second largest shuttle tanker owner, and one other established company. We believe that KNOT’s 25-year history of providing offshore loading and transportation services to major integrated oil companies will enable it to attract additional long-term charters for shuttle tankers that will be required to be offered to us pursuant to the omnibus agreement in the event their terms equal or exceed five years.

 

   

Built-in growth opportunities. In addition to our initial fleet of four shuttle tankers, we will have the right to purchase from KNOT five newbuild shuttle tankers. Additionally, we will have the right to purchase additional shuttle tankers in KNOT’s fleet if they are placed under charters of five years or more. This right will continue throughout the entire term of the omnibus agreement. We believe these acquisition opportunities, as well as future acquisition opportunities, will provide us with a way to grow our distributions per unit.

 

   

Enhanced growth opportunities through our relationship with KNOT. We believe our relationship with KNOT will provide us with many benefits that we believe will drive growth in distributions per unit, including opportunities to acquire other vessels, strong customer relationships, leading operational expertise, enhanced shipyard relationships, access to KNOT’s relationships with leading financing providers and a large pool of experienced and qualified global seafarers.

 

   

Sustainable cash flow supported by charters with leading energy companies. Our services will be integrated with the offshore oil fields we will serve and are a critical part of our customers’ logistics solutions. Each shuttle tanker in our fleet will operate under a long-term, fixed-rate charter with leading oil and gas companies, including BG Group, Statoil and Transpetro, with an average remaining duration of 8.1 years as of December 31, 2012 (including KNOT’s guarantee of the hire rates under the charters for the Bodil Knutsen and the Windsor Knutsen through the option periods). In addition, these charters contain fixed escalation provisions to offset the effects of increases in operating expenses.

 

   

Modern fleet equipped with the latest technology. Our initial fleet will be one of the youngest shuttle tanker fleets in operation worldwide, with an average age of 2.7 years as of December 31, 2012, compared to 10.6 years for the global shuttle tanker fleet. Both our initial fleet and the five newbuild shuttle tankers that we will have the right to purchase from KNOT will be equipped with the latest advanced shuttle tanker technology, including advanced dynamic positioning technology, or DP2, and will be able to operate in the harsh weather environments in the North Sea. We believe the significant investment needed to build shuttle tankers with the highly customized specifications required by our customers and train personnel to create operational efficiencies creates a significant barrier to entry for new competitors.

 

 

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Financial flexibility to support our growth. We believe we will have access to public debt and equity markets in order to pursue expansion opportunities. We expect to have a moderate level of indebtedness at the time of our initial public offering. In addition, we expect to have access to approximately $20 million of additional borrowings under our credit facilities following the closing of this offering that could be used for working capital and acquisitions.

We can provide no assurance, however, that we will be able to utilize our strengths described above. For further discussion of the risks that we face, please read “Risk Factors.”

Business Strategies

Our primary business objective is to increase quarterly distributions per unit over time by executing the following strategies:

 

   

Pursue strategic and accretive acquisitions of shuttle tankers on long-term, fixed-rate charters. We will seek to leverage our relationship with KNOT to make strategic and accretive acquisitions. Under the omnibus agreement that we will enter into with KNOT, we will have the right to purchase five newbuild vessels, delivered or expected to be delivered to charterers during 2013 and 2014. Additionally, during the term of the omnibus agreement, we will have the right to purchase from KNOT any newbuild shuttle tanker under a long-term charter agreement or existing shuttle tanker in the KNOT fleet that enters into a long-term charter agreement of five years or more.

 

   

Expand global operations in high-growth regions. As offshore exploration and production activity increases worldwide, we will seek to expand in proven areas, such as the North Sea and Brazil, and in new markets as they develop. We believe that KNOT’s leading market position, operational expertise and strong customer relationships will enable us to have early access to new projects worldwide.

 

   

Manage our fleet and deepen our customer relationships to provide a stable base of cash flows. We intend to maintain and grow our cash flows by focusing on strong customer relationships and actively seeking the extension and renewal of existing charters in addition to new opportunities to serve our customers. KNOT charters its current fleet to a number of the world’s leading energy companies. We believe the close relationships that KNOT has with these companies will provide attractive opportunities as offshore activity is expected to grow in coming years. We will continue to incorporate safety, health, security and environmental stewardship into all aspects of vessel design and operation in order to satisfy our customers and comply with national and international rules and regulations.

We can provide no assurance, however, that we will be able to implement our business strategies described above. For further discussion of the risks that we face, please read “Risk Factors.”

Risk Factors

An investment in our common units involves risks associated with our business, our partnership structure and the tax characteristics of our common units. Please read carefully the risks described under “Risk Factors” beginning on page 22 of this prospectus.

 

 

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Implications of Being an Emerging Growth Company

Our predecessor had less than $1.0 billion in revenue during its last fiscal year, which means that we qualify as an “emerging growth company” as defined in the Jumpstart Our Business Startups Act, or the JOBS Act. An emerging growth company may take advantage of specified reduced reporting and other burdens that are otherwise applicable generally to public companies. These provisions include:

 

   

the ability to present only two years of audited financial statements and only two years of related Management’s Discussion and Analysis of Financial Condition and Results of Operations in the registration statement of its initial public offering;

 

   

exemption from the auditor attestation requirement in the assessment of the emerging growth company’s internal control over financial reporting;

 

   

exemption from new or revised financial accounting standards applicable to public companies until such standards are also applicable to private companies; and

 

   

exemption from compliance with any new requirements adopted by the Public Company Accounting Oversight Board, or the PCAOB, requiring mandatory audit firm rotation or a supplement to the auditor’s report in which the auditor would be required to provide additional information about the audit and financial statements.

We may take advantage of these provisions until the end of the fiscal year following the fifth anniversary of our initial public offering or such earlier time that we are no longer an emerging growth company. We will cease to be an emerging growth company if we have more than $1.0 billion in annual revenues, have more than $700 million in market value of our common units held by non-affiliates, or issue more than $1.0 billion of non-convertible debt over a three-year period. We may choose to take advantage of some, but not all, of these reduced burdens. For as long as we take advantage of the reduced reporting obligations, the information that we provide unitholders may be different than information provided by other public companies. We are choosing to “opt out” of the extended transition period relating to the exemption from new or revised financial accounting standards and, as a result, we will comply with new or revised financial accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies. Section 107 of the JOBS Act provides that our decision to opt out of the extended transition period for complying with new or revised financial accounting standards is irrevocable.

Formation Transactions

General

We were formed on February 21, 2013 as a Marshall Islands limited partnership to own, operate and acquire shuttle tankers under charters of five or more years. Prior to the closing of this offering, our partnership will not own any vessels.

Prior to the closing of this offering, we and KNOT will enter into transactions by which, among other things, we will acquire the Windsor Knutsen and the Bodil Knutsen and the entity that owns the Fortaleza Knutsen and the Recife Knutsen. In addition, we will acquire the general partner of the entity that owns the Fortaleza Knutsen and the Recife Knutsen.

At or prior to the closing of this offering, the following transactions will occur:

 

   

we will issue to KNOT 1,117,500 common units and all of our subordinated units, representing a 55.4% limited partner interest in us, and all of our incentive distribution rights, which will entitle KNOT to increasing percentages of the cash we distribute in excess of $0.43125 per unit per quarter;

 

 

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we will issue to KNOT Offshore Partners GP LLC, a wholly owned subsidiary of KNOT, general partner units, representing a 2.0% general partner interest in us;

 

   

we will sell 7,450,000 common units to the public in this offering, representing a 42.6% limited partner interest in us; and

 

   

we will use the proceeds from this offering to repay $118.9 million of outstanding borrowings under our vessel financing agreements, to pre-fund approximately $3.0 million of our one-time entrance tax into the Norwegian tonnage tax regime and the remainder for general partnership purposes.

In addition, at or prior to the closing of this offering:

 

   

we will amend certain of our existing vessel financing agreements to permit the transactions pursuant to which we will acquire our initial fleet and to include a $20 million revolving credit facility;

 

   

we will enter into an omnibus agreement with KNOT, our general partner and others governing, among other things:

 

   

to what extent we and KNOT may compete with each other;

 

   

our option to purchase the Carmen Knutsen within 24 months after the closing of this offering, any of Hull 2531, Hull 2532, Hull 2575 and Hull 574 from KNOT within 24 months after KNOT notifies our board of directors of their respective acceptances by their charterers upon reaching an agreement with KNOT regarding the respective purchase prices;

 

   

certain rights of first offer on shuttle tankers operating under charters of five or more years as described under “Certain Relationships and Related Party Transactions—Agreements Governing the Transactions—Omnibus Agreement;”

 

   

KNOT’s provision of certain indemnities to us; and

 

   

KNOT’s guarantee of the payment of the hire rate under the existing Bodil Knutsen and Windsor Knutsen charters for a period of five years following the closing date of this offering.

 

   

we will enter into an administrative services agreement with KNOT Offshore Partners UK LLC, or KNOT UK, pursuant to which:

 

   

KNOT UK will agree to provide us administrative services; and

 

   

KNOT UK will be permitted to subcontract certain of the administrative services provided under the administrative services agreement to KOAS UK and KOAS; and

 

   

our operating subsidiaries will enter into amended technical management agreements with KNOT Management that govern the crew, technical and commercial management of the vessels in our fleet.

For further details on our agreements with KNOT and its affiliates, including amounts involved, please read “Certain Relationships and Related Party Transactions.”

Holding Company Structure

We are a holding entity and will conduct our operations and business through subsidiaries, as is common with publicly traded limited partnerships, to maximize operational flexibility. We believe that conducting our operations through a publicly traded limited partnership will offer us the following advantages:

 

   

access to the public equity and debt capital markets;

 

   

a lower cost of capital for expansion and acquisitions; and

 

   

an enhanced ability to use equity securities as consideration in future acquisitions.

 

 

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Simplified Organizational and Ownership Structure After this Offering

The following diagram depicts our simplified organizational and ownership structure after giving effect to the offering and related transactions described above, assuming no exercise of the underwriters’ option to purchase additional common units:

 

     Number of Units      Percentage  Ownership(1)  

Public Common Units(2)

     7,450,000         42.6

Knutsen NYK Offshore Tankers AS Common Units(2)

     1,117,500         6.4   

Knutsen NYK Offshore Tankers AS Subordinated Units

     8,567,500         49.0   

General Partner Units

     349,694         2.0   
  

 

 

    

 

 

 
     17,484,694         100.0
  

 

 

    

 

 

 

 

LOGO

 

(1) Reflects percentage ownership interests, including the general partner interest. Upon completion of this offering, the public and KNOT will own 43.5% and 56.5%, respectively, of the total outstanding common and subordinated units assuming the underwriters do not exercise their option to purchase 1,117,500 additional common units.
(2)

Assumes the underwriters do not exercise their option to purchase 1,117,500 additional common units. If the underwriters exercise any part of their option to purchase additional common units, the number of common

 

 

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  units shown to be owned by KNOT will be reduced by the number of common units purchased in connection with any such exercise, and the number of common units purchased by the underwriters pursuant to such exercise will be sold to the public instead of being issued to KNOT. Accordingly, the exercise of the underwriters’ option will not affect the total number of units outstanding. If the underwriters’ option is exercised in full, then KNOT would own 0% of the common units and the public would own 100% of the common units.
(3) Each of the Fortaleza Knutsen, Recife Knutsen, Windsor Knutsen and Bodil Knutsen are owned by certain vessel owning subsidiaries.

Our Management

Our partnership agreement provides that our general partner will irrevocably delegate to our board of directors the authority to oversee and direct our operations, management and policies on an exclusive basis. Certain of our directors will also serve as directors of KNOT or its affiliates. Our Chief Executive Officer and Chief Financial Officer is solely devoted to our business and will not be employed by KNOT or its affiliates other than us and our subsidiaries. For more information about these individuals, please read “Management—Directors and Executive Officers.”

Pursuant to the administrative services agreement, we will reimburse KNOT UK, and KNOT UK will reimburse KOAS UK and KOAS, as applicable, for the reasonable costs and expenses incurred in connection with providing administrative services to us. We expect that KNOT UK will pay KOAS UK and KOAS, collectively, approximately $1.0 million in total under the administrative services agreement for the twelve months ending March 31, 2014. For a more detailed description of this arrangement, please read “Certain Relationships and Related Party Transactions—Agreements Governing the Transactions—Administrative Services Agreement.”

In addition, our operating subsidiaries will be party to certain technical management agreements, which will be amended in connection with this offering, with KNOT Management, that govern the crew, technical and commercial management of the vessels in our fleet. We expect that our operating subsidiaries will pay KNOT Management approximately $0.9 million in total under the amended technical management agreements for the twelve months ending March 31, 2014. For a more detailed description of this arrangement, please read “Certain Relationships and Related Party Transactions—Agreements Governing the Transactions—Technical Management Agreements.”

Principal Executive Offices and Internet Address; SEC Filing Requirements

Our registered and principal executive offices are located at 2 Queen’s Cross, Aberdeen, Aberdeenshire AB15 4YB, United Kingdom, and our phone number is +44 1224 618420. We expect to make our periodic reports and other information filed with or furnished to the United States Securities and Exchange Commission, or the SEC, available, free of charge, through our website at www.knotoffshorepartners.com, which will be operational after this offering, as soon as reasonably practicable after those reports and other information are electronically filed with or furnished to the SEC. Please read “Where You Can Find More Information” for an explanation of our reporting requirements as a foreign private issuer.

Summary of Conflicts of Interest and Fiduciary Duties

Our general partner and our directors will have a legal duty to manage us in a manner beneficial to our unitholders, subject to the limitations described under “Conflicts of Interest and Fiduciary Duties.” This legal duty is commonly referred to as a “fiduciary duty.” Our directors also will have fiduciary duties to manage us in a manner beneficial to us, our general partner and our limited partners. As a result of these relationships, conflicts of interest may arise between us and our unaffiliated limited partners on the one hand, and KNOT and its affiliates, including

 

 

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our general partner, on the other hand. The resolution of these conflicts may not be in the best interest of us or our unitholders. In particular:

 

   

certain of our directors will also serve as directors of KNOT or its affiliates and as such will have fiduciary duties to KNOT or its affiliates that may cause them to pursue business strategies that disproportionately benefit KNOT or its affiliates or which otherwise are not in the best interests of us or our unitholders;

 

   

our partnership agreement permits our general partner to make a number of decisions in its individual capacity, as opposed to in its capacity as our general partner, which entitles our general partner to consider only the interests and factors that it desires, and it has no duty or obligations to give any consideration to any interest of or factors affecting us, our affiliates or any unitholder; when acting in its individual capacity, our general partner may act without any fiduciary obligation to us or the unitholders whatsoever;

 

   

KNOT and its affiliates may compete with us, subject to the restrictions contained in the omnibus agreement, and could own and operate shuttle tankers under charters of five years or more that may compete with our vessels if the Partnership does not acquire such vessels with offers;

 

   

any agreement between us, on the one hand, and our general partner and its affiliates, on the other, will not grant to the unitholders, separate and apart from us, the right to enforce the obligations of our general partner and its affiliates in our favor;

 

   

borrowings by us and our affiliates do not constitute a breach of any duty owed by our general partner or our directors to our unitholders, including borrowings that have the purpose or effect of: (i) enabling our general partner or its affiliates to receive distributions on any subordinated units held by them or the incentive distribution rights or (ii) hastening the expiration of the subordination period;

 

   

KNOT, as the holder of the incentive distribution rights, has the right to reset the minimum quarterly distribution and the cash target distribution levels upon which the incentive distributions payable to KNOT are based without the approval of unitholders or the conflicts committee of our board of directors at any time when there are not subordinated units outstanding and we have made cash distributions to the holders of the incentive distribution rights at the highest level of incentive distribution for each of the prior four consecutive fiscal quarters; in connection with such resetting and the corresponding relinquishment by KNOT of incentive distribution payments based on the cash target distribution levels prior to the reset, KNOT will be entitled to receive a number of newly issued common units and general partner units based on a predetermined formula described under “How We Make Cash Distributions—KNOT’s Right to Reset Incentive Distribution Levels”; and

 

   

in connection with the offering, we will enter into agreements, and may enter into additional agreements, with KNOT and certain of its subsidiaries, relating to the purchase of additional vessels, the provision of certain services to us by KNOT, KNOT Management and their affiliates and other matters. In the performance of their obligations under these agreements, KNOT and its subsidiaries, other than our general partner, are not held to a fiduciary duty standard of care to us, our general partner or our limited partners, but rather to the standard of care specified in these agreements.

For a more detailed description of our management structure, please read “Management—Directors and Executive Officers and “Certain Relationships and Related Party Transactions.”

Although a majority of our directors will over time be elected by our common unitholders, our general partner will have influence on decisions made by our board of directors. Our board of directors will have a conflicts committee composed of independent directors. Our board of directors may, but is not obligated to, seek approval of the conflicts committee for resolutions of conflicts of interest that may arise as a result of the relationships between KNOT and its affiliates, on the one hand, and us and our unaffiliated limited partners, on the other. There can be no assurance that a conflict of interest will be resolved in favor of the partnership.

 

 

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For a more detailed description of the conflicts of interest and fiduciary duties of our general partner and its affiliates, please read “Conflicts of Interest and Fiduciary Duties.” For a description of our other relationships with our affiliates, please read “Certain Relationships and Related Party Transactions.”

In addition, our partnership agreement contains provisions that reduce the standards to which our general partner and our directors would otherwise be held under Marshall Islands law. For example, our partnership agreement limits the liability and reduces the fiduciary duties of our general partner and our directors to our unitholders. Our partnership agreement also restricts the remedies available to unitholders. By purchasing a common unit, you are treated as having agreed to the modified standard of fiduciary duties and to certain actions that may be taken by our general partner, its affiliates or our directors, all as set forth in the partnership agreement. Please read “Conflicts of Interest and Fiduciary Duties” for a description of the fiduciary duties that would otherwise be imposed on our general partner, its affiliates and our directors under Marshall Islands law, the material modifications of those duties contained in our partnership agreement and certain legal rights and remedies available to our unitholders under Marshall Islands law.

 

 

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The Offering

 

Common units offered to the public

7,450,000 common units.

 

  8,567,500 common units if the underwriters exercise in full their option to purchase additional common units.

 

Units outstanding after this offering

8,567,500 common units and 8,567,500 subordinated units, representing a 49.0% and 49.0% limited partner interest in us, respectively. If the underwriters do not exercise their option to purchase additional common units, we will issue common units to KNOT upon the option’s expiration for no additional consideration. Accordingly, the exercise of the underwriters’ option will not affect the total number of common units outstanding. In addition, our general partner will own a 2.0% general partner interest in us.

 

Use of proceeds

We intend to use the net proceeds from this offering (approximately $131.9 million, after deducting underwriting discounts and commissions and structuring fees and estimated offering expenses payable by us) to repay $118.9 million of debt and to pre-fund approximately $3.0 million of our one-time entrance tax into the Norwegian tonnage tax regime. The remainder of the net proceeds will be available for general partnership purposes.

 

  The net proceeds from any exercise of the underwriters’ option to purchase additional common units (approximately $20.9 million, if exercised in full, after deducting the underwriting discounts and commissions) will be used to make a cash distribution to KNOT.

 

Cash distributions

We intend to make minimum quarterly distributions of $0.375 per common unit ($1.50 per unit on an annualized basis) to the extent we have sufficient cash from operations after establishment of cash reserves and payment of fees and expenses, including payments to our general partner. In general, we will pay any cash distributions we make each quarter in the following manner:

 

   

first, 98.0% to the holders of common units and 2.0% to our general partner, until each common unit has received a minimum quarterly distribution of $0.375 plus any arrearages from prior quarters;

 

   

second, 98.0% to the holders of subordinated units and 2.0% to our general partner, until each subordinated unit has received a minimum quarterly distribution of $0.375; and

 

   

third, 98.0% to all unitholders, pro rata, and 2.0% to our general partner, until each unit has received an aggregate distribution of $0.43125.

 

 

Within 45 days after the end of each fiscal quarter (beginning with the quarter ending June 30, 2013), we will distribute all of our available

 

 

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cash to unitholders of record on the applicable record date. We will adjust the minimum quarterly distribution for the period from the closing of the offering through June 30, 2013 based on the actual length of the period. Our ability to pay our minimum quarterly distribution is subject to various restrictions and other factors described in more detail under the caption “Our Cash Distribution Policy and Restrictions on Distributions.”

 

  If cash distributions to our unitholders exceed $0.43125 per unit in a quarter, holders of our incentive distribution rights (initially, KNOT) will receive increasing percentages, up to 48.0%, of the cash we distribute in excess of that amount. We refer to these distributions as “incentive distributions.” We must distribute all of our cash on hand at the end of each quarter, less reserves established by our board of directors to provide for the proper conduct of our business, to comply with any applicable debt instruments or to provide funds for future distributions. We refer to this cash as “available cash,” and we define its meaning in our partnership agreement. The amount of available cash may be greater than or less than the aggregate amount of the minimum quarterly distribution to be distributed on all units.

 

  We believe, based on the estimates contained in and the assumptions listed under “Our Cash Distribution Policy and Restrictions on Distributions—Forecasted Cash Available for Distribution,” that we will have sufficient cash available for distribution to enable us to pay the minimum quarterly distribution of $0.375 on all of our common and subordinated units for each quarter through March 31, 2014. However, unanticipated events may occur that could adversely affect the actual results we achieve during the forecast period. Consequently, our actual results of operations, cash flows and financial condition during the forecast period may vary from the forecast, and such variations may be material. Prospective investors are cautioned to not place undue reliance on the forecast and should make their own independent assessment of our future results of operations, cash flows and financial condition.

 

  Please read “Our Cash Distribution Policy and Restrictions on Distributions—Forecasted Cash Available for Distribution.”

 

Subordinated units

KNOT will initially own all of our subordinated units. The principal difference between our common units and subordinated units is that in any quarter during the subordination period the subordinated units are entitled to receive the minimum quarterly distribution of $0.375 per unit only after the common units have received the minimum quarterly distribution and arrearages in the payment of the minimum quarterly distribution from prior quarters. Subordinated units will not accrue arrearages. The subordination period generally will end if we have earned and paid at least $0.375 on each outstanding common and subordinated unit and the corresponding distribution on the general partner’s 2.0% interest for any three consecutive four-quarter periods ending on or after March 31, 2016.

 

 

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  For purposes of determining whether the subordination period will end, the three consecutive four-quarter periods for which the determination is being made may include one or more quarters with respect to which arrearages in the payment of the minimum quarterly distribution on the common units have accrued, provided that all such arrearages have been repaid prior to the end of each such four-quarter period. If the subordination period ends as a result of us having met the tests described above, all subordinated units will convert into common units on a one-for-one basis, and the common units will no longer be entitled to arrearages.

 

  Please read “How We Make Cash Distributions—Subordination Period.”

 

KNOT’s right to reset the target distribution levels

KNOT, as the initial holder of all of our incentive distribution rights, has the right, at a time when there are no subordinated units outstanding and it has received incentive distributions at the highest level to which it is entitled (48.0%) for each of the prior four consecutive fiscal quarters, to reset the initial cash target distribution levels at higher levels based on the distribution at the time of the exercise of the reset election. If KNOT transfers all or a portion of the incentive distribution rights it holds in the future, then the holder or holders of a majority of our incentive distribution rights will be entitled to exercise this right. Following a reset election by KNOT, the minimum quarterly distribution amount will be reset to an amount equal to the average cash distribution amount per common unit for the two fiscal quarters immediately preceding the reset election (we refer to such amount as the “reset minimum quarterly distribution amount”), and the target distribution levels will be reset to correspondingly higher levels based on the same percentage increases above the reset minimum quarterly distribution amount as our current target distribution levels.

 

  In connection with resetting these target distribution levels, KNOT will be entitled to receive a number of common units equal to that number of common units whose aggregate quarterly cash distributions equaled the average of the distributions to it on the incentive distribution rights in the prior two quarters. For a more detailed description of KNOT’s right to reset the target distribution levels upon which the incentive distribution payments are based and the concurrent right of KNOT to receive common units and general partner units in connection with this reset, please read “How We Make Cash Distributions—KNOT’s Right to Reset Incentive Distribution Levels.”

 

Issuance of additional units

We can issue an unlimited number of additional units, including units that are senior to the common units in rights of distribution, liquidation and voting, on the terms and conditions determined by our board of directors, without the consent of our unitholders. Please read “Units Eligible for Future Sale” and “The Partnership Agreement—Issuance of Additional Interests.”

 

 

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Board of directors

We will hold a meeting of the limited partners every year to elect one or more members of our board of directors and to vote on any other matters that are properly brought before the meeting. Our general partner has the right to appoint three of the seven members of our board of directors who will serve as directors for terms determined by our general partner. At our 2013 annual meeting, the common unitholders will elect four of our directors. The four directors elected by our common unitholders at our 2013 annual meeting will be divided into four classes to be elected by our common unitholders annually on a staggered basis to serve for four-year terms. The majority of our directors will be non-United States citizens or residents.

 

Voting rights

Except as otherwise described herein, each outstanding common unit is entitled to one vote on matters subject to a vote of common unitholders. However, to preserve our ability to claim an exemption from U.S. federal income tax under Section 883 of the U.S. Internal Revenue Code of 1986, as amended, or the Code, if at any time, any person or group owns beneficially more than 4.9% of any class of units then outstanding (excluding units held by Norwegian Resident Holders in the election of the elected directors as discussed below), any such units owned by that person or group in excess of 4.9% may not be voted on any matter and will not be considered to be outstanding when sending notices of a meeting of unitholders, calculating required votes (except for purposes of nominating a person for election to our board of directors), determining the presence of a quorum or for other similar purposes under our partnership agreement, unless otherwise required by law. The voting rights of any such unitholders in excess of 4.9% will effectively be redistributed pro rata among the other common unitholders holding less than 4.9% of the voting power of all classes of units entitled to vote. Our general partner, its affiliates and persons who acquired common units with the prior approval of our board of directors will not be subject to this 4.9% limitation except with respect to voting their common units in the election of the elected directors.

 

  In addition, common unitholders that are Norwegian Resident Holders will not be eligible to vote in the election of the elected directors. Norwegian Resident Holders are all persons (including individuals, entities, partnerships, trusts and estates) that are residents of Norway for purposes of the Norwegian Tax Act. The voting rights of any such Norwegian Resident Holders will effectively be redistributed pro rata among the remaining common unitholders (subject to the limitation described above for 4.9% common unitholders) in these elections.

 

 

You will have no right to elect our general partner on an annual or other continuing basis. Our general partner may not be removed except by a vote of the holders of at least 662/3% of the outstanding units, including any units owned by our general partner and its

 

 

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affiliates, voting together as a single class. Upon consummation of this offering, KNOT will own 1,117,500 of our common units and all of our subordinated units, representing a 55.4% limited partner interest in us. If the underwriters’ option to purchase additional common units is exercised in full, KNOT will not own any of our common units and will own all of our subordinated units, representing a 49.0% limited partner interest in us. As a result, you will initially be unable to remove our general partner without its consent, because KNOT will own sufficient units upon completion of this offering to be able to prevent the general partner’s removal. Please read “The Partnership Agreement—Voting Rights.”

 

Limited call right

If at any time our general partner and its affiliates own more than 80.0% of the outstanding common units, our general partner has the right, but not the obligation, to purchase all, but not less than all, of the remaining common units at a price equal to the greater of (x) the average of the daily closing prices of the common units over the 20 trading days preceding the date three days before the notice of exercise of the call right is first mailed and (y) the highest price paid by our general partner or any of its affiliates for common units during the 90-day period preceding the date such notice is first mailed. Our general partner is not obligated to obtain a fairness opinion regarding the value of the common units to be repurchased by it upon the exercise of this limited call right.

 

U.S. federal income tax considerations

Although we are organized as a partnership, we have elected to be treated as a corporation solely for U.S. federal income tax purposes. Consequently, all or a portion of the distributions you receive from us will constitute dividends for such purposes. The remaining portion of such distributions will be treated first as a non-taxable return of capital to the extent of your tax basis in your common units and, thereafter, as capital gain. We estimate that if you hold the common units that you purchase in this offering through the period ending December 31, 2016, the distributions you receive, on a cumulative basis, that will constitute dividends for U.S. federal income tax purposes will be approximately 70% of the total cash distributions you receive during that period. Please read “Material U.S. Federal Income Tax Considerations—U.S. Federal Income Taxation of U.S. Holders—Ratio of Dividend Income to Distributions” for the basis of this estimate. Please also read “Risk Factors—Tax Risks” for a discussion relating to the taxation of dividends. For a discussion of other material U.S. federal income tax consequences that may be relevant to prospective unitholders who are individual citizens or residents of the United States, please read “Material U.S. Federal Income Tax Considerations.”

 

Non-U.S. tax considerations

Our vessel owning subsidiaries have been organized under the laws of the Kingdom of Norway and we, KNOT UK and our general partner are expected to be managed and controlled in the United Kingdom.

 

 

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Nonetheless, other than any Norwegian or United Kingdom unitholders, unitholders are not expected to be taxable in Norway or the United Kingdom with respect to the income we earn or the distributions we pay to them. For a discussion of material Norwegian, Marshall Islands and United Kingdom income tax considerations that may be relevant to prospective unitholders, please read “Non-United States Tax Considerations.” Please also read “Risk Factors—Tax Risks” for a discussion of the risk that unitholders may be attributed the activities we undertake in various jurisdictions, including Norway, for taxation purposes.

 

Conflicts of Interest

Affiliates of DNB Markets, Inc. are lenders on our $160 million senior secured loan facility, our $19 million junior secured loan facility and our $120 million senior secured loan facility and are expected to receive more than 5% of the net proceeds of this offering. Because DNB Markets, Inc. is an underwriter in this offering, it is deemed to have a “conflict of interest” pursuant to Rule 5121(f)(5)(C)(i) of the Financial Institution Regulatory Authority, Inc., or FINRA. Accordingly, this offering is being made in compliance with the requirements of FINRA Rule 5121. Pursuant to that rule, the appointment of a “qualified independent underwriter” is not required in connection with this offering as the members primarily responsible for managing the public offering do not have a conflict of interest, are not affiliates of any member that has a conflict of interest and meet the requirements of paragraph (f)(12)(E) of Rule 5121. See “Underwriting—Conflicts of Interest.”

 

Exchange listing

The common units have been approved for listing on the New York Stock Exchange, subject to official notice of issuance, under the symbol “KNOP.”

 

 

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Summary Financial and Operating Data

The following table presents, in each case for the periods and as of the dates indicated, summary historical financial and operating data of KNOT Offshore Partners LP Predecessor, which includes (1) the subsidiaries of KNOT that own the Fortaleza Knutsen and the Recife Knutsen and (2) the Bodil Knutsen and the Windsor Knutsen and all of their related assets, liabilities, revenues, expenses and cash flows. This acquisition will be accounted for as a reorganization under common control and has therefore been recorded at KNOT’s historical book values. The summary historical financial data of KNOT Offshore Partners LP Predecessor as of and for the years ended December 31, 2011 and 2012 has been derived from the audited combined carve-out financial statements of KNOT Offshore Partners LP Predecessor, prepared in accordance with accounting principles generally accepted in the United States, or U.S. GAAP, which are included elsewhere in this prospectus.

The following financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the historical combined carve-out financial statements of KNOT Offshore Partners LP Predecessor and the notes thereto, our unaudited pro forma combined balance sheet and the notes thereto and our forecasted results of operations for the twelve months ending March 31, 2014, in each case included elsewhere in this prospectus.

The results of operations for the year ended December 31, 2011 reflect the operations of the Fortaleza Knutsen, the Windsor Knutsen, the Bodil Knutsen and the Recife Knutsen from March 2011, April 2011, May 2011 and August 2011, respectively, when they commenced operations under their respective charters.

 

 

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Our results of operations, cash flows and financial conditions could differ from those that would have resulted if we operated autonomously or as an entity independent of KNOT in the periods for which historical financial data is presented below, and such data may not be indicative of our future operating results or financial performance.

 

     Year Ended December 31  
     2011            2012         
     (dollars in thousands)  

Statement of Operations Data:

    

Total revenues

   $ 43,909      $ 65,653   

Voyage expenses(1)

     2,653        —     
  

 

 

   

 

 

 

Net voyage revenues

     41,256        65,653   
  

 

 

   

 

 

 

Vessel operating expenses(2)

     10,795        13,000   

Depreciation and amortization

     16,229        21,181   

General and administrative expenses

     927        1,395   
  

 

 

   

 

 

 

Operating income

     13,305        30,077   
  

 

 

   

 

 

 

Interest income

     34        19   

Interest expense

     (9,650     (13,471

Other finance expense

     (2,741     (3,378

Realized and unrealized loss on derivative instruments

     (15,489     (6,031

Net loss on foreign currency transactions

     (3,037     (1,771
  

 

 

   

 

 

 

Income (loss) before income taxes

     (17,578     5,445   

Income tax benefit (expense)

     1,240        (1,261
  

 

 

   

 

 

 

Net income (loss)

   $ (16,338   $ 4,184   
  

 

 

   

 

 

 

Balance Sheet Data (at end of period):

    

Cash and cash equivalents

   $ 3,189      $ 1,287   

Vessels and equipment, net

     517,897        496,768   

Total assets

     534,603        515,250   

Long-term debt (including current portion)

     375,933        347,850   

Owner’s equity

     67,370        100,633   

Cash Flow Data:

    

Net cash provided by operating activities

   $ 11,473      $ 19,307   

Net cash used in investing activities

     (138,104     (52

Net cash provided by (used in) financing activities

     126,445        (21,156

Fleet Data:

    

Number of shuttle tankers in operation at end of period

     4        4   

Average age of shuttle tankers in operation at end of period (years)

     1.7        2.7   

Total calendar days for fleet

     988.7        1,464   

Total operating days for fleet(3)

     973.6        1,377   

Other Financial Data:

    

EBITDA(4)

   $ 8,267      $ 40,078   

Adjusted EBITDA(4)

     29,534        51,258   

Capital expenditures:

    

Expenditures for vessels and equipment

   $ 133,781      $ 52   

Expenditures for drydocking

     3,739        —     

 

(1) Voyage expenses are all expenses unique to a particular voyage, including bunker fuel expenses, port fees, cargo loading and unloading expenses, canal tolls and agency fees.

 

 

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(2) Vessel operating expenses include crewing, repairs and maintenance, insurance, stores, lube oils and communication expenses.
(3) The operating days for our fleet is the total number of days in a given period that the vessels were in our possession less the total number of days off-hire. We define days off-hire as days lost to, among other things, operational deficiencies, drydocking for repairs, maintenance or inspection, equipment breakdowns, special surveys and vessel upgrades, delays due to accidents, crewing strikes, certain vessel detentions or similar problems, our failure to maintain the vessel in compliance with its specifications and contractual standards or to provide the required crew, or periods of commercial waiting time during which we do not earn charter hire.

 

(4) Non-GAAP Financial Measures

EBITDA and Adjusted EBITDA. EBITDA is defined as earnings before interest, depreciation and amortization and taxes. Adjusted EBITDA is defined as earnings before interest, depreciation and amortization, taxes and other financial items (including other finance expense, realized and unrealized loss on derivative instruments and net loss on foreign currency transactions). EBITDA is used as a supplemental financial measure by management and external users of financial statements, such as our lenders, to assess our financial and operating performance and our compliance with the financial covenants and restrictions contained in our financing agreements. Adjusted EBITDA is used as a supplemental financial measure by management and external users of financial statements, such as investors, to assess our financial and operating performance. We believe that adjusted EBITDA assists our management and investors by increasing the comparability of our performance from period to period and against the performance of other companies in our 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, depreciation and amortization and taxes, 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. We believe that including adjusted EBITDA as a financial and operating measure benefits investors in (a) selecting between investing in us and other investment alternatives and (b) monitoring our ongoing financial and operational strength in assessing whether to continue to hold common units.

EBITDA and adjusted EBITDA should not be considered alternatives to net income, operating income, cash flow from operating activities or any other measure of financial performance presented in accordance with U.S. GAAP. EBITDA and adjusted EBITDA exclude some, but not all, items that affect net income, and these measures may vary among other companies. Therefore, EBITDA and adjusted EBITDA as presented below may not be comparable to similarly titled measures of other companies. The following tables reconcile EBITDA and adjusted EBITDA to net income (loss) and net cash provided by operating activities, the most directly comparable U.S. GAAP financial measures, for the periods presented:

 

     Year Ended December 31,  
           2011                  2012         
     (dollars in thousands)  

Reconciliation to net income (loss):

    

Net income (loss)

   $ (16,338   $ 4,184   

Interest income

     (34     (19

Interest expense

     9,650        13,471   

Depreciation and amortization

     16,229        21,181   

Income tax (benefit) expense

     (1,240     1,261   
  

 

 

   

 

 

 

EBITDA

   $ 8,267      $ 40,078   

Other financial items(a)

     21,267        11,180   
  

 

 

   

 

 

 

Adjusted EBITDA

   $ 29,534      $ 51,258   
  

 

 

   

 

 

 

 

 

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     Year Ended December 31,  
           2011                  2012         
     (dollars in thousands)  

Reconciliation to net cash provided by operating activities:

    

Net cash provided by operating activities

   $ 11,473      $ 19,307   

Interest income

     (34     (19

Interest expense

     9,650        13,471   

Amortization of contract intangibles / liabilities

     868        1,518   

Amortization of deferred debt issuance cost

     (658     (982

Unrealized loss on derivative instruments

     (8,923     (549

Unrealized loss on foreign currency transactions

     (3,056     (579

Other items

     (2,677     426   

Changes in operating assets and liabilities:

    

Decrease (increase) in trade accounts receivable

     93        6   

Decrease (increase) in receivables from owners and affiliates

     (386     —     

Decrease (increase) in inventories

     (218     71   

Decrease (increase) in other current assets

     211        5,048   

Increase (decrease) in trade accounts payable

     7,874        334   

Increase (decrease) in accrued expenses

     (324     342   

Increase (decrease) in prepaid revenue

     (5,626     1,684   
  

 

 

   

 

 

 

EBITDA

   $ 8,267      $ 40,078   

Other financial items(a)

     21,267        11,180   
  

 

 

   

 

 

 

Adjusted EBITDA

   $ 29,534      $ 51,258   
  

 

 

   

 

 

 

 

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

 

 

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RISK FACTORS

Limited partner interests are inherently different from the capital stock of a corporation, although many of the business risks to which we are subject are similar to those that would be faced by a corporation engaged in a similar business. You should carefully consider the following risk factors together with all of the other information included in this prospectus in evaluating an investment in our common units.

If any of the following risks were actually to occur, our business, financial condition, results of operations and ability to make cash distributions to our unitholders could be materially adversely affected. In that case, we might not be able to make distributions on our common units, the trading price of our common units could decline and you could lose all or part of your investment.

Risks Inherent in Our Business

We may not have sufficient cash from operations following the establishment of cash reserves and payment of fees and expenses to enable us to pay the minimum quarterly distribution on our common units and subordinated units.

We may not have sufficient cash from operations to pay the minimum quarterly distribution of $0.375 per unit on our common units and subordinated units. The amount of cash we can distribute on our units principally depends upon the amount of cash we generate from our operations, which may fluctuate from quarter to quarter based on the risks described in this section, including, among other things:

 

   

the rates we obtain from our charters;

 

   

the price and level of production of, and demand for, crude oil;

 

   

the level of our operating costs, such as the cost of crews and insurance;

 

   

the number of off-hire days for our fleet and the timing of, and number of days required for, drydocking of vessels;

 

   

the supply of shuttle tankers;

 

   

prevailing global and regional economic and political conditions;

 

   

changes in local income tax rates;

 

   

currency exchange rate fluctuations; and

 

   

the effect of governmental regulations and maritime self-regulatory organization standards on the conduct of our business.

In addition, the actual amount of cash we will have available for distribution will depend on other factors, including:

 

   

the level of capital expenditures we make, including for maintaining or replacing vessels, building new vessels, acquiring existing vessels and complying with regulations;

 

   

our debt service requirements, including fluctuations in interest rates, and restrictions on distributions contained in our debt instruments;

 

   

the level of debt we will incur if we exercise our option to purchase the Carmen Knutsen, Hull 2531, Hull 2532, Hull 2575 or Hull 574 from KNOT;

 

   

fluctuations in our working capital needs;

 

   

our ability to make, and the level of, working capital borrowings; and

 

   

the amount of any cash reserves, including reserves for future maintenance and replacement capital expenditures, working capital and other matters, established by our board of directors.

 

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The amount of cash we generate from our operations may differ materially from our profit or loss for the period, which will be affected by non-cash items. As a result of this and the other factors mentioned above, we may make cash distributions during periods when we record losses and may not make cash distributions during periods when we record net income.

The assumptions underlying our forecast of cash available for distribution are inherently uncertain and are subject to risks and uncertainties that could cause actual results to differ materially from those forecasted.

The forecast of cash available for distribution set forth in “Our Cash Distribution Policy and Restrictions on Distributions” includes our forecast of operating results and cash flows for the twelve months ending March 31, 2014. The financial forecast has been prepared by management and we have not received an opinion or report on it from our or any other independent auditor. The assumptions underlying the forecast are inherently uncertain and are subject to significant business, economic, regulatory and competitive risks and uncertainties that could cause actual results to differ materially from those forecasted. If we do not achieve the forecasted results, we may not be able to pay the full minimum quarterly distribution or any amount on our common units or subordinated units, in which event the market price of the common units may decline materially.

Our ability to grow and to meet our financial needs may be adversely affected by our cash distribution policy.

Our cash distribution policy, which is consistent with our partnership agreement, requires us to distribute all of our available cash (as defined in our partnership agreement) each quarter. Accordingly, our growth may not be as fast as businesses that reinvest their available cash to expand ongoing operations.

In determining the amount of cash available for distribution, our board of directors approves the amount of cash reserves to set aside, including reserves for future maintenance and replacement capital expenditures, working capital and other matters. We also rely upon external financing sources, including commercial borrowings, to fund our capital expenditures. Accordingly, to the extent we do not have sufficient cash reserves or are unable to obtain financing, our cash distribution policy may significantly impair our ability to meet our financial needs or to grow.

We must make substantial capital expenditures to maintain the operating capacity of our fleet, which will reduce cash available for distribution. In addition, each quarter we are required to deduct estimated maintenance and replacement capital expenditures from operating surplus, which may result in less cash available to unitholders than if actual maintenance and replacement capital expenditures were deducted.

We must make substantial capital expenditures to maintain and replace, over the long-term, the operating capacity of our fleet. We estimate that maintenance and replacement capital expenditures will average approximately $11.9 million per year, including $10.8 million for replacing current vessels at the end of their useful lives. Maintenance and replacement capital expenditures include capital expenditures associated with the removal of a vessel from the water for inspection, maintenance and/or repair of submerged parts (or drydocking) and modifying an existing vessel or acquiring a new vessel to the extent these expenditures are incurred to maintain or replace the operating capacity of our fleet. These expenditures could vary significantly from quarter to quarter and could increase as a result of changes in:

 

   

the cost of labor and materials;

 

   

customer requirements;

 

   

the size of our fleet;

 

   

the cost of replacement vessels;

 

   

length of charters;

 

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governmental regulations and maritime self-regulatory organization standards relating to safety, security or the environment; and

 

   

competitive standards.

Our partnership agreement requires our board of directors to deduct estimated, rather than actual, maintenance and replacement capital expenditures from operating surplus each quarter in an effort to reduce fluctuations in operating surplus (as defined in our partnership agreement). The amount of estimated maintenance and replacement capital expenditures deducted from operating surplus is subject to review and change by our conflicts committee at least once a year. In years when estimated maintenance and replacement capital expenditures are higher than actual maintenance and replacement capital expenditures, the amount of cash available for distribution to unitholders will be lower than if actual maintenance and replacement capital expenditures were deducted from operating surplus. If our board of directors underestimates the appropriate level of estimated maintenance and replacement capital expenditures, we may have less cash available for distribution in future periods when actual capital expenditures exceed our previous estimates.

If capital expenditures are financed through cash from operations or by issuing debt or equity securities, our ability to make cash distributions may be diminished, our financial leverage could increase or our unitholders may be diluted.

Use of cash from operations to expand or maintain our fleet will reduce cash available for distribution to unitholders. Our ability to obtain bank financing or to access the capital markets for future offerings may be limited by our financial condition at the time of any such financing or offering as well as by adverse market conditions resulting from, among other things, general economic conditions and contingencies and uncertainties that are beyond our control. Our failure to obtain the funds for future capital expenditures could have a material adverse effect on our business, financial condition, results of operations and ability to make cash distributions to our unitholders. Even if we are successful in obtaining necessary funds, the terms of such financings could limit our ability to pay cash distributions to unitholders. In addition, incurring additional debt may significantly increase our interest expense and financial leverage, and issuing additional equity securities may result in significant unitholder dilution and would increase the aggregate amount of cash required to maintain our current level of quarterly distributions to unitholders, both of which could have a material adverse effect on our ability to make cash distributions.

Our debt levels may limit our flexibility in obtaining additional financing, pursuing other business opportunities and paying distributions to you.

Upon completion of this offering and the related transactions, we estimate that our consolidated debt will be approximately $221.6 million. Following this offering, we will continue to have the ability to incur additional debt. Please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.” Our level of debt could have important consequences to us, including the following:

 

   

our ability to obtain additional financing, if necessary, for working capital, capital expenditures, acquisitions or other purposes may be impaired or such financing may not be available on favorable terms;

 

   

we will need a substantial portion of our cash flow to make principal and interest payments on our debt, reducing the funds that would otherwise be available for operations, future business opportunities and distributions to unitholders;

 

   

our debt level may make us more vulnerable than our competitors with less debt to competitive pressures or a downturn in our industry or the economy generally;

 

   

our debt level may limit our flexibility in responding to changing business and economic conditions; and

 

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if we are unable to satisfy the restrictions included in any of our financing agreements or are otherwise in default under any of those agreements, as a result of our debt levels or otherwise, we will not be able to make cash distributions to you, notwithstanding our stated cash distribution policy.

Our ability to service our debt depends upon, among other things, our future financial and operating performance, which will be affected by prevailing economic conditions and financial, business, regulatory and other factors, some of which are beyond our control. If our operating results are not sufficient to service our current or future indebtedness, we will be forced to take actions such as reducing distributions, reducing or delaying our business activities, acquisitions, investments or capital expenditures, selling assets, restructuring or refinancing our debt, or seeking additional equity capital or bankruptcy protection. We may not be able to effect any of these remedies on satisfactory terms, or at all.

Financing agreements containing operating and financial restrictions may restrict our business and financing activities.

The operating and financial restrictions and covenants in our financing agreements and any future financing agreements could adversely affect our ability to finance future operations or capital needs or to engage, expand or pursue our business activities. For example, the financing agreements may restrict the ability of us and our subsidiaries to:

 

   

incur or guarantee indebtedness;

 

   

change ownership or structure, including mergers, consolidations, liquidations and dissolutions;

 

   

make dividends or distributions;

 

   

make certain negative pledges and grant certain liens;

 

   

sell, transfer, assign or convey assets;

 

   

make certain investments; and

 

   

enter into a new line of business.

In addition, our financing agreements require us to comply with certain financial ratios and tests, including, among others, maintaining a minimum liquidity, maintaining positive working capital, ensuring that EBITDA exceeds interest payable, any amounts payable for interest rate swap and debt installments calculated on a four quarter rolling average basis, maintaining a minimum collateral value, and maintaining a minimum book equity ratio. Historically, our predecessor, its guarantors and the KNOT Group (as defined in each of the facilities discussed below) have not always been in compliance with such financial covenants under the financing agreements. For example, the borrower under the $160 million senior secured loan facility and the $19 million junior secured loan facility, or the Fortaleza and Recife Facilities, was not in compliance with the minimum liquidity and positive working capital covenants as of June 30, 2011. The borrower received a waiver of such covenants under the Fortaleza and Recife Facilities as of June 30, 2011. The guarantor of the $120 million senior secured loan facility, or the Bodil Facility, was not in compliance with the minimum liquidity covenant as of September 30, 2011, and the KNOT Group was not in compliance with the interest coverage covenant as of December 31, 2011 and June 30, 2012. The borrower received a waiver of such covenants under the Bodil Facility. The KNOT Group was not in compliance with the interest coverage covenant under the $27.3 million junior secured loan facility, or the Windsor Conversion Facility, as of December 31, 2011. The borrower received a waiver of such covenants under the Windsor Conversion Facility. Our ability to comply with the restrictions and covenants, including financial ratios and tests, contained in our financing agreements is dependent on future performance and may be affected by events beyond our control, including prevailing economic, financial and industry conditions. If market or other economic conditions deteriorate, our ability to comply with these covenants may be impaired.

 

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If we are unable to comply with the restrictions and covenants in the agreements governing our indebtedness or in current or future debt financing agreements, there could be a default under the terms of those agreements. In addition, if KNOT does not fulfill its obligations under the omnibus agreement to guarantee the payments of the hire rate under the time charter for the Windsor Knutsen, this could result in an event of default under the $85 million senior secured loan facility secured by the Windsor Knutsen. If a default occurs under these agreements, lenders could terminate their commitments to lend and/or accelerate the outstanding loans and declare all amounts borrowed due and payable. We have pledged our vessels as security for our outstanding indebtedness. If our lenders were to foreclose on our vessels in the event of a default, this may adversely affect our ability to finance future operations or capital needs or to engage in, expand or pursue our business activities. If any of these events occur, we cannot guarantee that our assets will be sufficient to repay in full all of our outstanding indebtedness, and we may be unable to find alternative financing. Even if we could obtain alternative financing, that financing might not be on terms that are favorable or acceptable. Any of these events would adversely affect our ability to make distributions to our unitholders and cause a decline in the market price of our common units. Please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

Restrictions in our debt agreements may prevent us or our subsidiaries from paying distributions.

The payment of principal and interest on our debt reduces cash available for distribution to us and on our units. In addition, our and our subsidiaries’ financing agreements prohibit the payment of distributions upon the occurrence of the following events, among others:

 

   

failure to pay any principal, interest, fees, expenses or other amounts when due;

 

   

failure to notify the lenders of any material oil spill or discharge of hazardous material, or of any action or claim related thereto;

 

   

breach or lapse of any insurance with respect to vessels securing the facilities;

 

   

breach of certain financial covenants;

 

   

failure to observe any other agreement, security instrument, obligation or covenant beyond specified cure periods in certain cases;

 

   

default under other indebtedness;

 

   

bankruptcy or insolvency events;

 

   

failure of any representation or warranty to be correct;

 

   

a change of ownership, as defined in the applicable agreement; and

 

   

a material adverse change, as defined in the applicable agreement.

In connection with this offering, we will amend certain of our existing vessel financing agreements to permit the transactions pursuant to which we will acquire our initial fleet and to include a $20 million revolving credit facility with a syndicate of banks, which we refer to as the revolving credit facility. We expect that the amended vessel financing agreements, and the revolving credit facility, will contain covenants and provisions relating to events of default similar to those contained in our existing vessel financing agreements. Furthermore, we expect that our future financing agreements will contain similar provisions. For more information regarding these financing agreements, please read “Management’s Discussion and Analysis of Financial Conditions and Results of Operations—Liquidity and Capital Resources.”

The failure to consummate or integrate acquisitions in a timely and cost-effective manner could have an adverse effect on our financial condition and results of operations.

Acquisitions that expand our fleet are an important component of our strategy. For example, we intend to purchase the Carmen Knutsen, Hull 2531, Hull 2532, Hull 2575 and Hull 574 from KNOT if we are able to reach an agreement with KNOT regarding their purchase price. Under the omnibus agreement that we will enter into with KNOT in connection with the closing of this offering, we will have the right to purchase the Carmen Knutsen at any time within 24 months after the closing of this offering and Hull 2531, Hull 2532, Hull 2575 and

 

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Hull 574 at any time within 24 months after KNOT notifies our board of directors of their respective acceptances by their charterers. We will not be obligated to purchase any of these vessels at the applicable determined price, and, accordingly, we may not complete the purchase of any of such vessels. Furthermore, even if we are able to agree on a price with KNOT, there are no assurances that we will be able to obtain adequate financing on terms that are acceptable to us.

We believe that other acquisition opportunities may arise from time to time, and any such acquisition could be significant. Any acquisition of a vessel or business may not be profitable at or after the time of acquisition and may not generate cash flow sufficient to justify the investment. In addition, our acquisition growth strategy exposes us to risks that may harm our business, financial condition, results of operations and ability to make cash distributions to our unitholders, including risks that we may:

 

   

fail to realize anticipated benefits, such as new customer relationships, cost-savings or cash flow enhancements;

 

   

be unable to attract, hire, train or retain qualified shore and seafaring personnel to manage and operate our growing business and fleet;

 

   

decrease our liquidity by using a significant portion of available cash or borrowing capacity to finance acquisitions;

 

   

significantly increase our interest expense or financial leverage if we incur additional debt to finance acquisitions;

 

   

incur or assume unanticipated liabilities, losses or costs associated with the business or vessels acquired; or

 

   

incur other significant charges, such as impairment of goodwill or other intangible assets, asset devaluation or restructuring charges.

In addition, unlike newbuilds, existing vessels typically do not carry warranties as to their condition. While we generally inspect existing vessels prior to purchase, such an inspection would normally not provide us with as much knowledge of a vessel’s condition as we would possess if it had been built for us and operated by us during its life. Repairs and maintenance costs for existing vessels are difficult to predict and may be substantially higher than for vessels we have operated since they were built. These costs could decrease our cash flow and reduce our liquidity.

Certain acquisition and investment opportunities may not result in the consummation of a transaction. In addition, we may not be able to obtain acceptable terms for the required financing for any such acquisition or investment that arises. We cannot predict the effect, if any, that any announcement or consummation of an acquisition would have on the trading price of our common units. Our future acquisitions could present a number of risks, including the risk of incorrect assumptions regarding the future results of acquired vessels or businesses or expected cost reductions or other synergies expected to be realized as a result of acquiring vessels or businesses, the risk of failing to successfully and timely integrate the operations or management of any acquired vessels or businesses and the risk of diverting management’s attention from existing operations or other priorities. We may also be subject to additional costs related to compliance with various international laws in connection with such acquisition. If we fail to consummate and integrate our acquisitions in a timely and cost-effective manner, our business, financial condition, results of operations and cash available for distribution could be adversely affected.

Our charters are subject to early termination under certain circumstances and any such termination could have a material adverse effect on our results of operations and cash available for distribution to unitholders.

Upon completion of the offering, our fleet will consist of four shuttle tankers. If any of our vessels are unable to generate revenues as a result of the expiration or termination of its charter or sustained periods of off-hire time, our results of operations and financial condition could be materially adversely affected. Each of our

 

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charters terminates automatically if the applicable vessel is lost or missing or damage to the vessel results in a constructive total loss. The customer, under certain circumstances, may also have an option to terminate a time charter if the vessel is requisitioned by any government for a period of time in excess of the time period specified in the time charter or if at any time we are in default under the time charter. In addition, either party may terminate a charter in the event of the outbreak of war between specified countries. Under our bareboat charters, the charter is deemed terminated as of the date of any compulsory acquisition of the vessel or requisition for title by any governmental or other competent authority. For more information regarding the termination of our charters, please read “Business—Charters.”

We may experience operational problems with vessels that reduce revenue and increase costs.

Shuttle tankers are complex and their operation technically challenging. Marine transportation operations are subject to mechanical risks and problems. Operational problems may lead to loss of revenue or higher than anticipated operating expenses or require additional capital expenditures. Any of these results could harm our business, financial condition, results of operations and ability to make cash distributions to our unitholders.

We will initially derive all of our revenues from three customers, and the loss of any such customers could result in a significant loss of revenues and cash flow.

We will initially derive all of our time charter and bareboat revenues from three customers. For the year ended December 31, 2012, BG Group, Transpetro and Statoil accounted for approximately 23%, 38% and 34%, respectively, of our revenues.

If we lose a key customer, we may be unable to obtain replacement long-term charters and may become subject to the volatile spot market, which is highly competitive and subject to significant price fluctuations. In addition, if a customer exercises its right to terminate a charter, we may be unable to re-charter such vessel on terms as favorable to us as those of the terminated charter.

The loss of any of our key customers could have a material adverse effect on our business, financial condition, results of operations and ability to make cash distributions to our unitholders.

We depend on subsidiaries of KNOT to assist us in operating our businesses and competing in our markets.

In connection with this offering, we and our operating subsidiaries will enter into various services agreements with certain subsidiaries of KNOT, including KNOT Management, pursuant to which such subsidiaries will provide to us certain administrative, financial and other services and to our operating subsidiaries substantially all of their crew, technical and commercial management services (including vessel maintenance, periodic drydocking, cleaning and painting, performing work required by regulations and human resources and financial services) and other advisory and technical services, including the sourcing of new contracts and renewals of existing contracts. Our operational success and ability to execute our growth strategy depends significantly upon the satisfactory performance of these services by the KNOT subsidiaries. Our business will be harmed if such subsidiaries fail to perform these services satisfactorily or if they stop providing these services to us or our operating subsidiaries.

Our ability to compete to enter into new charters and expand our customer relationships depends largely on our ability to leverage our relationship with KNOT and its reputation and relationships in the shipping industry. If KNOT suffers material damage to its reputation or relationships, it may harm the ability of us or our subsidiaries to:

 

   

renew existing charters upon their expiration;

 

   

obtain new charters;

 

   

successfully interact with shipyards;

 

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obtain financing on commercially acceptable terms; or

 

   

maintain satisfactory relationships with suppliers and other third parties.

If our ability to do any of the things described above is impaired, it could have a material adverse effect on our business, financial condition, results of operations and ability to make cash distributions to our unitholders.

Our growth depends on continued growth in demand for offshore oil transportation services.

Our growth strategy focuses on expansion in the shuttle tanker sector. Accordingly, our growth depends on continued growth in the demand for offshore oil transportation services. Factors beyond our control that affect the offshore oil transportation industry may have a significant impact on our business, financial condition, results of operations and ability to make cash distributions to our unitholders. In the past, the market for offshore oil transportation services and the prices charged for shipping the products that shuttle tankers carry have been cyclical. Fluctuations in the hire rate we can charge our customers result from changes in the supply of carrying capacity and demand for the crude oil carried. The factors affecting supply and demand for shuttle tankers and supply and demand for crude oil transported by shuttle tankers are outside of our control, and the nature, timing and degree of changes in industry conditions are unpredictable.

The factors that influence the demand for shuttle tanker capacity include:

 

   

changes in the actual or projected price of oil, which could impact the exploration for or development of new offshore oil fields or the production of oil at certain fields we service;

 

   

levels of demand for and production of oil, which, among other things, is affected by competition from alternative sources of energy, other factors making consumption of oil more or less attractive or energy conservation measures;

 

   

changes in the production of oil in areas linked by pipelines to consuming areas, the extension of existing, or the development of new, pipeline systems in markets we may serve, or the conversion of existing non-oil pipelines to oil pipelines in those markets;

 

   

changes in laws and regulations affecting the shuttle tanker industry;

 

   

global and regional economic and political conditions, particularly in oil-consuming regions, as well as environmental concerns and regulations, which could impact the supply of oil and gas as well as the demand for various types of vessels; and

 

   

changes in trading patterns, including changes in the distances that cargoes are transported.

The factors that influence the supply of shuttle tanker capacity include:

 

   

the number of deliveries of new vessels under construction or on order;

 

   

the scrapping rate of older vessels;

 

   

oil and gas company policy with respect to technical vessel requirements; and

 

   

the number of vessels that are off-hire.

Reduced demand for shuttle tanker services or an increase in the supply of shuttle tanker capacity would have a material adverse effect on our future growth and could harm our business, results of operations and financial condition.

An economic downturn could have a material adverse effect on our revenue, profitability and financial position.

We depend on our customers’ willingness and ability to fund operating and capital expenditures to provide crude oil shuttle tankers for new or expanding offshore projects. Future adverse economic conditions may lead to

 

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a decline in our customers’ operations or ability to pay for our services, which could result in decreased demand for our vessels. There has historically been a strong link between the development of the world economy and demand for energy, including oil and natural gas. The world economy is currently facing a number of challenges. As a result of the credit crisis in Europe, in particular in Greece, Italy, Ireland, Portugal and Spain, the European Commission created the European Financial Stability Facility, or the EFSF, and the European Financial Stability Mechanism, or the EFSM, to provide funding to Eurozone countries in financial difficulties that seek such support. In March 2011, the European Council agreed on the need for Eurozone countries to establish a permanent stability mechanism, the European Stability Mechanism, or the ESM, which will be activated by mutual agreement, to assume the role of the EFSF and the EFSM in providing external financial assistance to Eurozone countries after June 2013. Despite these measures, concerns persist regarding the debt burden of certain Eurozone countries and their ability to meet future financial obligations and the overall stability of the euro. An extended period of adverse development in the outlook for European countries could reduce the overall demand for oil and have a negative impact on our customers. These potential developments, or market perceptions concerning these and related issues, could affect our business, financial position, results of operations and ability to make cash distributions to our unitholders.

Moreover, the recent global financial and credit crisis has reduced the availability of liquidity and credit to fund the continuation and expansion of industrial business operations worldwide. The continued shortage of liquidity and credit combined with recent substantial losses in worldwide equity markets could lead to an extended worldwide economic recession. Such deterioration of the worldwide economy has resulted in reduced demand for oil and natural gas, exploration and production activity and transportation of oil and natural gas that could lead to a decrease in the hire rate earned by our vessels and a decrease in new charter activity. In addition, the current state of global financial markets and current economic conditions might adversely impact our ability to issue additional equity at prices that will not be dilutive to our existing unitholders or preclude us from issuing equity at all. We also cannot be certain that additional financing will be available if needed and to the extent required, on acceptable terms or at all. If additional financing is not available when needed, or is available only on unfavorable terms, we may be unable to meet our obligations as they come due or we may be unable to expand our existing business, complete shuttle tanker acquisitions or otherwise take advantage of business opportunities as they arise.

Furthermore, the current credit crisis and recession has had and could continue to have an impact on our customers and/or suppliers including, among other things, causing them to fail to meet their obligations to us. Similarly, the current credit crisis could affect lenders participating in our financing agreements, making them unable to fulfill their commitments and obligations to us. Any reductions in activity owing to such conditions or failure by our customers, suppliers or lenders to meet their contractual obligations to us could adversely affect our business, financial position, results of operation and ability to make cash distributions to our unitholders.

Our growth depends on our ability to expand relationships with existing customers and obtain new customers, for which we will face substantial competition.

One of our principal objectives is to enter into additional long-term, fixed-rate charters. The process of obtaining new long-term charters is highly competitive, most often involves an intensive screening process and competitive bids and often extends for several months. Shuttle tanker charters are awarded based upon a variety of factors relating to the vessel operator, including:

 

   

industry relationships and reputation for customer service and safety;

 

   

experience and quality of ship operations;

 

   

quality, experience and technical capability of the crew;

 

   

relationships with shipyards and the ability to get suitable berths;

 

   

construction management experience, including the ability to obtain on-time delivery of new vessels according to customer specifications;

 

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willingness to accept operational risks pursuant to the charter, among other things such as allowing termination of the charter for force majeure events; and

 

   

competitiveness of the bid in terms of overall price.

Our ability to win new charters will depend upon a number of factors, including our ability to:

 

   

successfully manage our liquidity and obtain the necessary financing to fund our growth;

 

   

attract, hire, train and retain qualified personnel and ship management companies to manage and operate our fleet;

 

   

identify and consummate desirable acquisitions, joint ventures or strategic alliances; and

 

   

identify and capitalize on opportunities in new markets.

We expect substantial competition for providing services for potential shuttle tanker projects from a number of experienced companies. Many of our competitors have significantly greater financial resources than do we or KNOT. This increased competition may cause greater price competition for charters. As a result of these factors, we may be unable to expand our relationships with existing customers or to obtain new customers on a profitable basis, if at all, which would have a material adverse effect on our business, financial condition, results of operations and ability to make cash distributions to our unitholders.

An increase in the global supply of shuttle tanker capacity without a commensurate increase in demand may have an adverse effect on hire rates and the values of our vessels, which could have a material adverse effect on our business, financial condition, results of operations and ability to make cash distributions to our unitholders.

The supply of shuttle tankers in the industry is affected by, among other things, assessments of the demand for these vessels by oil companies. Any over-estimation of demand for vessels may result in an excess supply of new shuttle tankers. This may, in the long term when existing contracts expire, result in lower hire rates and depress the values of our vessels. In such an event, our business, financial condition, results of operations and ability to make cash distributions to our unitholders may be adversely affected.

During periods of high utilization and high hire rates, industry participants may increase the supply of shuttle tankers by ordering the construction of new vessels. This may result in an over-supply of shuttle tankers and may cause a subsequent decline in utilization and hire rates when the vessels enter the market. Lower utilization and hire rates could adversely affect revenues and profitability. Prolonged periods of low utilization and hire rate could also result in the recognition of impairment charges on shuttle tankers if future cash flow estimates, based upon information available at the time, indicate that the carrying value of these shuttle tankers may not be recoverable. Such impairment charge may cause lenders to accelerate loan payments under our financing agreements, which could adversely affect our business, financial condition, results of operations and ability to make cash distributions to our unitholders.

The required drydocking of our vessels could be more expensive and time consuming than we anticipate, which could adversely affect our cash available for distribution to unitholders.

We must periodically drydock each of our vessels for inspection, repairs and maintenance and any modifications required to comply with industry certification or governmental requirements. Generally, we will drydock each vessel every 60 months until the vessel is 15 years old, after which drydocking takes place every 30 months. The required drydocking of our vessels could be more expensive and time consuming than we anticipate, which could adversely affect our cash available for distribution. The drydocking of our vessels will require significant capital expenditures and will result in loss of revenue while our vessels are off-hire. Any significant increase in the number of days of off-hire due to such drydocking or in the costs of any repairs could have a material adverse effect on our ability to pay distributions to our unitholders. Although we do not anticipate that more than

 

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one of our vessels will be out of service at any given time, we may underestimate the time required to drydock any of our vessels or unanticipated problems may arise. If more than one of our vessels is required to be out of service at the same time, if a vessel is drydocked longer than expected or if the cost of repairs during drydocking is greater than budgeted, our cash available for distribution to unitholders could be adversely affected.

We may be unable to re-charter our vessels upon termination or expiration of their existing charters.

We will be dependent upon charters for our vessels to generate revenues and we may be adversely affected if we fail to renew or are unsuccessful in winning new charters, or if our existing charters were terminated. Our ability to re-charter our shuttle tankers following expiration of existing charters and the rates payable upon any renewal or replacement charters will depend upon, among other things, the state of the shuttle tanker market. For example, an oversupply of shuttle tankers can significantly reduce their charter rates. A termination or renegotiation of our existing charters or a failure to secure new employment at the expiration of our current charters may have a negative effect on our business, financial condition, results of operations and ability to make cash distributions to our unitholders.

Delays in deliveries of newbuild vessels could harm our operating results.

The delivery of any newbuilds we may order could be delayed, which would delay our receipt of revenues under the charters or other contracts related to the vessels. In addition, under some charters we may enter into that are related to a newbuild, if our delivery of the newbuild to our customer is delayed, we may be required to pay liquidated damages during the delay. For prolonged delays, the customer may terminate the charter and, in addition to the resulting loss of revenues, we may be responsible for additional, substantial liquidated damages.

The completion and delivery of newbuilds could be delayed because of:

 

   

quality or engineering problems;

 

   

changes in governmental regulations or maritime self-regulatory organization standards;

 

   

work stoppages or other labor disturbances at the shipyard;

 

   

bankruptcy or other financial crisis of the shipbuilder;

 

   

a backlog of orders at the shipyard;

 

   

political or economic disturbances;

 

   

weather interference or a catastrophic event, such as a major earthquake or fire;

 

   

requests for changes to the original vessel specifications;

 

   

shortages of or delays in the receipt of necessary construction materials, such as steel;

 

   

inability to finance the construction or conversion of the vessels; or

 

   

inability to obtain requisite permits or approvals.

If delivery of a vessel is materially delayed, it could adversely affect our results of operations and financial condition and our ability to make cash distributions.

Compliance with safety and other vessel requirements imposed by classification societies may be very costly and may adversely affect our business.

The hull and machinery of every large, oceangoing commercial vessel must be classed by a classification society authorized by its country of registry. The classification society certifies that a vessel is safe and seaworthy in accordance with the applicable rules and regulations of the country of registry of the vessel and the Safety of Life at Sea Convention. The Fortaleza Knutsen, the Recife Knutsen, the Windsor Knutsen and the Bodil Knutsen are certified by Det Norske Veritas.

 

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As part of the certification process, a vessel must undergo annual surveys, intermediate surveys and special surveys. In lieu of a special survey, a vessel’s machinery may be on a continuous survey cycle, under which the machinery would be surveyed periodically over a five-year period. Each of the vessels in our existing fleet is on a planned maintenance system approval, and as such the classification society attends onboard once every year to verify that the maintenance of the equipment onboard is done correctly. Each of the vessels in our existing fleet is required to be qualified within its respective classification society for drydocking once every five years subject to an intermediate underwater survey done using an approved diving company in the presence of a surveyor from the classification society.

If any vessel does not maintain its class or fails any annual survey, intermediate survey or special survey, the vessel will be unable to trade between certain ports and will be unemployable. We would lose revenue while the vessel was off-hire and incur costs of compliance. This would negatively impact our revenues and reduce our cash available for distribution to unitholders.

Over time, the value of our vessels may decline, which could adversely affect our operating results.

Vessel values for shuttle tankers can fluctuate substantially over time due to a number of different factors, including:

 

   

prevailing economic conditions in oil and energy markets;

 

   

a substantial or extended decline in demand for oil;

 

   

increases in the supply of vessel capacity;

 

   

the cost of retrofitting or modifying existing vessels, as a result of technological advances in vessel design or equipment, changes in applicable environmental or other regulations or standards, or otherwise; and

 

   

a decrease in oil reserves in the fields and other fields in which our shuttle tankers might otherwise be deployed.

If operation of a vessel is not profitable, or if we cannot redeploy a vessel at attractive rates upon termination of its charter, rather than continue to incur costs to maintain and finance the vessel, we may seek to dispose of it. Our inability to dispose of the vessel at a reasonable value could result in a loss on its sale and adversely affect our business, financial condition, results of operations and ability to make cash distributions to our unitholders. Further, if we determine at any time that a vessel’s future useful life and earnings require us to impair its value on our financial statements, we may need to recognize a significant charge against our earnings. Additionally, lenders may accelerate loan repayments should there be a loss in the market value of our vessels. Such repayment could adversely affect our business, financial condition, results of operations and ability to make cash distributions to our unitholders.

Climate change and greenhouse gas restrictions may adversely impact our operations and markets.

Due to concern over the risk of climate change, a number of countries and the International Maritime Organization, or IMO, have adopted, or are considering the adoption of, regulatory frameworks to reduce greenhouse gas emissions from vessels. These regulatory measures include, among others, adoption of cap and trade regimes, carbon taxes, increased efficiency standards and incentives or mandates for renewable energy. Compliance with changes in laws, regulations and obligations relating to climate change could increase our costs related to operating and maintaining our vessels and require us to install new emission controls, acquire allowances or pay taxes related to our greenhouse gas emissions or administer and manage a greenhouse gas emissions program. Revenue generation and strategic growth opportunities may also be adversely affected.

Adverse effects upon the oil industry relating to climate change, including growing public concern about the environmental impact of climate change, may also adversely affect demand for our shuttle tanker services.

 

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Although we do not expect that demand for oil will lessen dramatically over the short term, in the long term climate change may reduce the demand for oil or increased regulation of greenhouse gases may create greater incentives for use of alternative energy sources. Any long-term material adverse effect on the oil industry could have a significant financial and operational adverse impact on our business that we cannot predict with certainty at this time.

Our international operations will expose us to political, governmental and economic instability, which could harm our operations.

Because our operations will be conducted in various countries, they may be affected by economic, political and governmental conditions in the countries where we engage in business or where our vessels are registered. Any disruption caused by these factors could harm our business, including by reducing the levels of oil exploration, development and production activities in these areas. We may derive some of our revenues from shipping oil from politically unstable regions. Conflicts in these regions have included attacks on ships and other efforts to disrupt shipping. Hostilities or other political instability in regions where we operate or where we may operate could have a material adverse effect on the growth of our business, financial condition, results of operations and ability to make cash distributions to our unitholders. In addition, tariffs, trade embargoes and other economic sanctions by the United States or other countries against countries in Southeast Asia or elsewhere as a result of terrorist attacks, hostilities or otherwise may limit trading activities with those countries, which could also harm our business, financial condition, results of operations and ability to make cash distributions to our unitholders. Finally, a government could requisition one or more of our vessels, which is most likely during war or national emergency. Any such requisition would cause a loss of the vessel and/or a termination of the charter and could harm our business, financial condition, results of operations and ability to make cash distributions to our unitholders.

Marine transportation is inherently risky, particularly in the extreme conditions in which our vessels operate. An incident involving significant loss of product or environmental contamination by any of our vessels could harm our reputation and business.

Vessels and their cargoes and the oil production facilities we service are at risk of being damaged or lost because of events such as:

 

   

marine disasters;

 

   

bad weather;

 

   

mechanical failures;

 

   

grounding, capsizing, fire, explosions and collisions;

 

   

piracy;

 

   

human error; and

 

   

war and terrorism.

The Bodil Knutsen currently operates in the North Sea. Harsh weather conditions in this region and other regions in which our vessels operate may increase the risk of collisions, oil spills or mechanical failures.

An accident involving any of our vessels could result in any of the following:

 

   

death or injury to persons, loss of property or damage to the environment and natural resources;

 

   

delays in the delivery of cargo;

 

   

loss of revenues from charters;

 

   

liabilities or costs to recover any spilled oil or other petroleum products and to restore the ecosystem affected by the spill;

 

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governmental fines, penalties or restrictions on conducting business;

 

   

higher insurance rates; and

 

   

damage to our reputation and customer relationships generally.

Any of these results could have a material adverse effect on our business, financial condition, results of operations and ability to make cash distributions to our unitholders. In addition, any damage to, or environmental contamination involving, oil production facilities serviced could suspend that service and result in loss of revenues.

Our insurance may not be sufficient to cover losses that may occur to our property or as a result of our operations.

The operation of shuttle tankers is inherently risky. All risks may not be adequately insured against, and any particular claim may not be paid by insurance. Any claims relating to our operations covered by insurance would be subject to deductibles, and since it is possible that a large number of claims may be brought, the aggregate amount of these deductibles could be material. Certain insurance is maintained through mutual protection and indemnity associations, and as a member of such associations we may be required to make additional payments over and above budgeted premiums if member claims exceed association reserves. The agreed deductible on each vessel averages $150,000 for the shuttle tankers in our initial fleet.

We may be unable to procure adequate insurance at commercially reasonable rates in the future. For example, more stringent environmental regulations have led in the past to increased costs for, and in the future may result in the lack of availability of, insurance against risks of environmental damage or pollution. A catastrophic oil spill or marine disaster could exceed the insurance, and any uninsured or underinsured loss could harm our business, financial condition, results of operations and ability to make cash distributions to our unitholders. In addition, the insurance may be voidable by the insurers as a result of certain actions, such as vessels failing to maintain certification with applicable maritime self-regulatory organizations.

Changes in the insurance markets attributable to terrorist attacks may also make certain types of insurance more difficult to obtain. In addition, the insurance that may be available may be significantly more expensive than existing coverage.

Terrorist attacks, piracy, increased hostilities or war could lead to further economic instability, increased costs and disruption of business.

Terrorist attacks, piracy and the current conflicts in the Middle East, and other current and future conflicts, may adversely affect our business, financial condition, results of operations and ability to raise capital and future growth. Continuing hostilities in the Middle East may lead to additional armed conflicts or to further acts of terrorism and civil disturbance in the United States or elsewhere, which may contribute further to economic instability and disruption of oil production and distribution, which could result in reduced demand for our services.

In addition, oil production facilities, shipyards, vessels, pipelines, oil fields or other infrastructure could be targets of future terrorist attacks and our vessels could be targets of pirates or hijackers. Any such attacks could lead to, among other things, bodily injury or loss of life, vessel or other property damage, increased vessel operational costs, including insurance costs, and the inability to transport oil to or from certain locations. Terrorist attacks, war, piracy, hijacking or other events beyond our control that adversely affect the distribution, production or transportation of oil to be shipped by us could entitle customers to terminate their charters, which would harm our business, financial condition, results of operations and ability to make cash distributions to our unitholders.

 

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Acts of piracy on ocean-going vessels have recently increased in frequency, which could adversely affect our business, financial condition, results of operations and ability to make cash distributions to our unitholders.

Acts of piracy have historically affected ocean-going vessels trading in regions of the world such as the South China Sea and the Gulf of Aden off the coast of Somalia. In recent years, the frequency and severity of piracy incidents has significantly increased, particularly in the Gulf of Aden and the Indian Ocean. If such piracy attacks result in regions in which our vessels are deployed being named on the Joint War Committee Listed Areas, war-risk insurance premiums payable for such coverage could increase significantly and such insurance coverage might become more difficult to obtain. In addition, crew costs, including costs that may be incurred to the extent we employ onboard security guards, could increase in such circumstances. We may not be adequately insured to cover losses from these incidents, which could have a material adverse effect on us. In addition, hijacking as a result of an act of piracy against our vessels, or an increase in cost or unavailability of insurance for our vessels, could have a material adverse impact on our business, financial condition, results of operations and ability to make cash distributions to our unitholders.

The offshore oil transportation industry is subject to substantial environmental and other regulations, which may significantly limit operations or increase expenses.

Our operations will be affected by extensive and changing international, national and local environmental protection laws, regulations, treaties and conventions in force in international waters and the jurisdictional waters of the countries in which our vessels operate, as well as the countries of our vessels’ registration, including those governing oil spills, discharges to air and water and the handling and disposal of hazardous substances and wastes. Many of these requirements are designed to reduce the risk of oil spills and other pollution.

In addition, we believe that the heightened environmental, quality and security concerns of insurance underwriters, regulators and charterers will generally lead to additional regulatory requirements, including enhanced risk assessment and security requirements and greater inspection and safety requirements on vessels. These requirements are likely to add incremental costs to our operations and the failure to comply with these requirements may affect the ability of our vessels to obtain the required certificates for entry into the different ports where we operate and could also impact our ability to obtain insurance. We expect to incur substantial expenses in complying with these laws and regulations, including expenses for vessel modifications and changes in operating procedures.

These requirements can affect the resale value or useful lives of our vessels, require a reduction in cargo capacity, ship modifications or operational changes or restrictions, lead to decreased availability of insurance coverage for environmental matters or result in the denial of access to certain jurisdictional waters or ports or detention in certain ports.

Under local, national and foreign laws, as well as international treaties and conventions, we could incur material liabilities, including cleanup obligations, natural resource damage claims and fines and penalties in the event that there is a release of petroleum or hazardous substances from our vessels or otherwise in connection with our operations. We could also become subject to personal injury or property damage claims relating to the release of petroleum or hazardous substances associated with our operations. In addition, oil spills and failure to comply with applicable laws and regulations may result in administrative and civil penalties, criminal sanctions or the suspension or termination of our operations, including, in certain instances, seizure or detention of our vessels. Please see “Business—Environmental and Other Regulation.”

Exposure to currency exchange rate fluctuations results in fluctuations in cash flows and operating results.

Our reporting currency and the functional currency of our operating subsidiaries is the U.S. Dollar. Our operating subsidiaries will be party to certain technical management agreements with KNOT Management, which govern the crew, technical and commercial management of the vessels in our fleet. Under the technical

 

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management agreements, KNOT Management will be paid for reasonable direct and indirect expenses incurred in providing the services, including operating expenses relating to our fleet. A majority of the operating expenses are in currencies other than the U.S. Dollar. Fluctuating exchange rates may result in increased payments by us under the services agreements if the strength of the U.S. Dollar declines relative to such other currencies.

Many seafaring employees are covered by collective bargaining agreements and the failure to renew those agreements or any future labor agreements may disrupt operations and adversely affect our business, financial condition, results of operations and ability to make cash distributions to our unitholders.

A significant portion of seafarers that crew certain of our vessels and primarily Norwegian based onshore operational staff that provide services to us are employed under collective bargaining agreements. We and our operating subsidiaries may become subject to additional labor agreements in the future. We and our operating subsidiaries may suffer labor disruptions if relationships deteriorate with the seafarers or the unions that represent them. The collective bargaining agreements may not prevent labor disruptions, particularly when the agreements are being renegotiated. Salaries are typically renegotiated annually or bi-annually for seafarers and annually for onshore operational staff, and higher compensation levels will increase our costs of operations. Although these negotiations have not caused labor disruptions in the past, any future labor disruptions could harm our operations and could have a material adverse effect on our business, financial condition, results of operations and ability to make cash distributions to our unitholders.

KNOT may on our behalf be unable to attract and retain qualified, skilled employees or crew necessary to operate our business or may have to pay substantially increased costs for its employees and crew.

Our success will depend in large part on KNOT’s ability to attract, hire, train and retain highly skilled and qualified personnel. In crewing our vessels, we require technically skilled employees with specialized training who can perform physically demanding work. Competition to attract, hire, train and retain qualified crew members is intense, and crew manning costs continue to increase. If we are not able to increase our hire rates to compensate for any crew cost increases, our business, financial condition, results of operations and ability to make cash distributions to our unitholders may be adversely affected. Any inability we experience in the future to attract, hire, train and retain a sufficient number of qualified employees could impair our ability to manage, maintain and grow our business.

Maritime claimants could arrest our vessels, which could interrupt our cash flow.

If we are in default on some kinds of obligations, such as those to our lenders, crew members, suppliers of goods and services to our vessels or shippers of cargo, these parties may be entitled to a maritime lien against one or more of our vessels. In many jurisdictions, a maritime lien holder may enforce its lien by arresting a vessel through foreclosure proceedings. In a few jurisdictions, claimants could try to assert “sister ship” liability against one vessel in our fleet for claims relating to another of our vessels. The arrest or attachment of one or more of our vessels could interrupt our cash flow and require us to pay to have the arrest lifted. Under some of our present charters, if the vessel is arrested or detained as a result of a claim against us, we may be in default of our charter and the charterer may terminate the charter. This would negatively impact our revenues and reduce our cash available for distribution to unitholders.

Lack of diversification and adverse developments in the shuttle tanker market or the conventional oil tanker market would negatively impact our results.

Although our vessels will also be able to operate as conventional oil tankers, we are focused on dynamic positioning offshore shuttle tankers. Due to our lack of diversification, any adverse development in this market and/or the conventional oil tanker market could have a material adverse effect on our business, financial condition, results of operations and ability to make cash distributions to our unitholders.

 

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Risks Inherent in an Investment in Us

KNOT and its affiliates may compete with us.

Pursuant to the omnibus agreement that we and KNOT will enter into in connection with the closing of this offering, KNOT and its controlled affiliates (other than us, our general partner and our subsidiaries) generally will agree not to acquire, own, operate or charter certain shuttle tankers operating under charters of five years or more. The omnibus agreement, however, contains significant exceptions that may allow KNOT or any of its controlled affiliates to compete with us, which could harm our business. Please read “Certain Relationships and Related Party Transactions—Agreements Governing the Transactions—Omnibus Agreement—Noncompetition.”

Unitholders have limited voting rights, and our partnership agreement restricts the voting rights of Norwegian Resident Holders and unitholders owning more than 4.9% of our common units.

Unlike the holders of common stock in a corporation, holders of common units have only limited voting rights on matters affecting our business. We will hold a meeting of the limited partners every year to elect one or more members of our board of directors and to vote on any other matters that are properly brought before the meeting. Common unitholders will be entitled to elect only four of the seven members of our board of directors. The elected directors will be elected on a staggered basis and will serve for four-year terms. Our general partner in its sole discretion will appoint the remaining three directors and set the terms for which those directors will serve. The partnership agreement also contains provisions limiting the ability of unitholders to call meetings or to acquire information about our operations, as well as other provisions limiting the unitholders’ ability to influence the manner or direction of management. Unitholders will have no right to elect our general partner, and our general partner may not be removed except by a vote of the holders of at least 66 2/3% of the outstanding common and subordinated units, including any units owned by our general partner and its affiliates, voting together as a single class.

Our partnership agreement further restricts unitholders’ voting rights by providing that Norwegian Resident Holders will not be eligible to vote in the election of elected directors. Further, if any person or group owns beneficially more than 4.9% of any class of units then outstanding, any such units owned by that person or group in excess of 4.9% may not be voted on any matter and will not be considered to be outstanding when sending notices of a meeting of unitholders, calculating required votes (except for purposes of nominating a person for election to our board of directors), determining the presence of a quorum or for other similar purposes, unless required by law. The voting rights of any unitholders not entitled to vote on a specific matter will effectively be redistributed pro rata among the other common unitholders. Our general partner, its affiliates and persons who acquired common units with the prior approval of our board of directors will not be subject to the 4.9% limitation except with respect to voting their common units in the election of the elected directors.

Our general partner and its affiliates own a 57.4% interest in us and have conflicts of interest and limited fiduciary and contractual duties to us and our common unitholders, which may permit them to favor their own interests to your detriment.

Following this offering, KNOT will own a 55.4% limited partner interest in us, assuming no exercise of the underwriters’ option to purchase additional common units, and will own and control our general partner. Certain of our directors are directors of KNOT or its affiliates, and, as such, they have fiduciary duties to KNOT or its affiliates that may cause them to pursue business strategies that disproportionately benefit KNOT or its affiliates or which otherwise are not in the best interests of us or our unitholders. Conflicts of interest may arise between KNOT and its affiliates (including our general partner), on the one hand, and us and our unitholders, on the other hand. As a result of these conflicts, our general partner and its affiliates may favor their own interests over the interests of our unitholders. Please read “—Our partnership agreement limits our general partner’s and our directors’ fiduciary duties to our unitholders and restricts the remedies available to unitholders for actions taken by our general partner or our directors.” These conflicts include, among others, the following situations:

 

   

neither our partnership agreement nor any other agreement requires our general partner or KNOT or its affiliates to pursue a business strategy that favors us or utilizes our assets, and KNOT’s officers and

 

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directors have a fiduciary duty to make decisions in the best interests of the shareholders of KNOT, which may be contrary to our interests;

 

   

our partnership agreement permits our general partner to make a number of decisions in its individual capacity, as opposed to in its capacity as our general partner. Specifically, our general partner will be considered to be acting in its individual capacity if it exercises its call right, pre-emptive rights or registration rights, consents or withholds consent to any merger or consolidation of the partnership, appoints any directors or votes for the election of any director, votes or refrains from voting on amendments to our partnership agreement that require a vote of the outstanding units, voluntarily withdraws from the partnership, transfers (to the extent permitted under our partnership agreement) or refrains from transferring its units or general partner interest or votes upon the dissolution of the partnership;

 

   

our general partner and our directors have limited their liabilities and reduced their fiduciary duties under the laws of the Marshall Islands, while also restricting the remedies available to our unitholders, and, as a result of purchasing common units, unitholders are treated as having agreed to the modified standard of fiduciary duties and to certain actions that may be taken by our general partner and our directors, all as set forth in the partnership agreement;

 

   

our general partner is entitled to reimbursement of all reasonable costs incurred by it and its affiliates for our benefit;

 

   

our partnership agreement does not restrict us from paying our general partner or its affiliates for any services rendered to us on terms that are fair and reasonable or entering into additional contractual arrangements with any of these entities on our behalf;

 

   

our general partner may exercise its right to call and purchase our common units if it and its affiliates own more than 80.0% of our common units; and

 

   

our general partner is not obligated to obtain a fairness opinion regarding the value of the common units to be repurchased by it upon the exercise of its limited call right.

Although a majority of our directors will over time be elected by common unitholders, our general partner will likely have substantial influence on decisions made by our board of directors. Please read “Certain Relationships and Related Party Transactions,” “Conflicts of Interest and Fiduciary Duties” and “The Partnership Agreement.”

Our partnership agreement limits our general partner’s and our directors’ fiduciary duties to our unitholders and restricts the remedies available to unitholders for actions taken by our general partner or our directors.

Our partnership agreement provides that our general partner will irrevocably delegate to our board of directors the authority to oversee and direct our operations, management and policies on an exclusive basis, and such delegation will be binding on any successor general partner of the partnership. Our partnership agreement also contains provisions that reduce the standards to which our general partner and directors would otherwise be held by Marshall Islands law. For example, our partnership agreement:

 

   

permits our general partner to make a number of decisions in its individual capacity, as opposed to in its capacity as our general partner. Where our partnership agreement permits, our general partner may consider only the interests and factors that it desires, and in such cases it has no fiduciary duty or obligation to give any consideration to any interest of, or factors affecting us, our affiliates or our unitholders. Decisions made by our general partner in its individual capacity will be made by its board of directors, which will be appointed by KNOT. Specifically, pursuant to our partnership agreement, our general partner will be considered to be acting in its individual capacity if it exercises its call right, pre-emptive rights or registration rights, consents or withholds consent to any merger or consolidation of the partnership, appoints any directors or votes for the election of any director, votes or refrains from

 

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voting on amendments to our partnership agreement that require a vote of the outstanding units, voluntarily withdraws from the partnership, transfers (to the extent permitted under our partnership agreement) or refrains from transferring its units or general partner interest or votes upon the dissolution of the partnership;

 

   

provides that our general partner and our directors are entitled to make other decisions in “good faith” if they reasonably believe that the decision is in our best interests;

 

   

generally provides that affiliated transactions and resolutions of conflicts of interest not approved by the conflicts committee of our board of directors and not involving a vote of unitholders must be on terms no less favorable to us than those generally being provided to or available from unrelated third parties or be “fair and reasonable” to us and that, in determining whether a transaction or resolution is “fair and reasonable,” our board of directors may consider the totality of the relationships between the parties involved, including other transactions that may be particularly advantageous or beneficial to us; and

 

   

provides that neither our general partner nor our officers or our directors will be liable for monetary damages to us, our limited partners or assignees for any acts or omissions unless there has been a final and non-appealable judgment entered by a court of competent jurisdiction determining that our general partner or our officers or directors or those other persons engaged in actual fraud or willful misconduct.

In order to become a limited partner of our partnership, a common unitholder is required to agree to be bound by the provisions in the partnership agreement, including the provisions discussed above. Please read “Conflicts of Interest and Fiduciary Duties—Fiduciary Duties.”

Our partnership agreement provides that our general partner will delegate all its management activities in relation to us to our board of directors and we expect that arrangements will be in place such that any activities that would otherwise constitute regulated activities under the Financial Services and Markets Act 2000 (Regulated Activities Order) 2001 were they to be performed in the United Kingdom (and that would not fall within a suitable exemption) will be performed outside of the United Kingdom. However, there can be no assurance that this will not change (deliberately or otherwise) over time and there is no current intention for our general partner, us, or any of our subsidiaries to seek authorization from the Financial Services Authority in the United Kingdom, which would be required for any person to lawfully carry out such regulated activities in the United Kingdom.

Fees and cost reimbursements, which KNOT Management will determine for services provided to us and our subsidiaries, will be substantial, will be payable regardless of our profitability and will reduce our cash available for distribution to you.

Pursuant to the amended technical management agreements, our subsidiaries will pay fees for services provided to them by KNOT Management, and will reimburse KNOT Management for all expenses incurred on their behalf. These fees and expenses will include all costs and expenses incurred in providing the crew, technical and commercial management of the vessels in our fleet to our subsidiaries. In addition, our operating subsidiaries will pay KNOT Management a management fee equal to 5% of its costs and expenses incurred in connection with providing these services to our operating subsidiaries. We expect the amount of these fees and expenses to be approximately $0.9 million for the twelve months ending March 31, 2014.

In addition, pursuant to an administrative services agreement, KNOT UK will provide us with certain administrative services. KNOT UK will be permitted to subcontract certain of the administrative services provided under this agreement to KOAS UK and KOAS. We will reimburse KNOT UK, and KNOT UK will reimburse KOAS UK and KOAS, as applicable, for their reasonable costs and expenses incurred in connection with the provision of the services subcontracted to KOAS UK and KOAS under the administrative services agreement. In addition, KNOT UK will pay to KOAS UK and KOAS, as applicable, a service fee in U.S. Dollars equal to 5% of the costs and expenses incurred in connection with providing services. We expect that KNOT UK will pay KOAS UK and KOAS, collectively, approximately $1.0 million in total for the services subcontracted to them under the administrative services agreement for the twelve months ending March 31, 2014.

 

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For a description of the amended technical management agreements and the administrative services agreement, please read “Certain Relationships and Related Party Transactions.” The fees and expenses payable pursuant to the amended technical management agreements and the administrative services agreement will be payable without regard to our business, results of operation and financial condition. The payment of fees to and the reimbursement of expenses of KNOT Management and certain other affiliates of KNOT could adversely affect our ability to pay cash distributions to you.

Our partnership agreement contains provisions that may have the effect of discouraging a person or group from attempting to remove our current management or our general partner, and even if public unitholders are dissatisfied, they will be unable to remove our general partner without KNOT’s consent, unless KNOT’s ownership interest in us is decreased, all of which could diminish the trading price of our common units.

Our partnership agreement contains provisions that may have the effect of discouraging a person or group from attempting to remove our current management or our general partner.

 

   

The unitholders will be unable initially to remove our general partner without its consent because our general partner and its affiliates will own sufficient units upon completion of this offering to be able to prevent its removal. The vote of the holders of at least 66 2/3% of all outstanding common and subordinated units voting together as a single class is required to remove the general partner. Following the closing of this offering, KNOT will own 56.5% of the outstanding common and subordinated units, assuming no exercise of the underwriters’ option to purchase additional common units.

 

   

If our general partner is removed without “cause” during the subordination period and units held by our general partner and KNOT are not voted in favor of that removal, all remaining subordinated units will automatically convert into common units, any existing arrearages on the common units will be extinguished, and our general partner will have the right to convert its general partner interest and the holders of the incentive distribution rights will have the right to convert such incentive distribution rights into common units or to receive cash in exchange for those interests based on the fair market value of those interests at the time. A removal of our general partner under these circumstances would adversely affect the common units by prematurely eliminating their distribution and liquidation preference over the subordinated units, which would otherwise have continued until we had met certain distribution and performance tests. Any conversion of the general partner interest or incentive distribution rights would be dilutive to existing unitholders. Furthermore, any cash payment in lieu of such conversion could be prohibitively expensive. “Cause” is narrowly defined to mean that a court of competent jurisdiction has entered a final, non-appealable judgment finding our general partner liable for actual fraud or willful or wanton misconduct in its capacity as our general partner. Cause does not include most cases of charges of poor business decisions, such as charges of poor management of our business by the directors appointed by our general partner, so the removal of our general partner because of the unitholders’ dissatisfaction with the general partner’s decisions in this regard would most likely result in the termination of the subordination period.

 

   

Common unitholders will be entitled to elect only four of the seven members of our board of directors. Our general partner in its sole discretion will appoint the remaining three directors.

 

   

Election of the four directors elected by common unitholders is staggered, meaning that the members of only one of four classes of our elected directors will be selected each year. In addition, the directors appointed by our general partner will serve for terms determined by our general partner.

 

   

Our partnership agreement contains provisions limiting the ability of unitholders to call meetings of unitholders, to nominate directors and to acquire information about our operations as well as other provisions limiting the unitholders’ ability to influence the manner or direction of management.

 

   

Unitholders’ voting rights are further restricted by the partnership agreement provision providing that if any person or group owns beneficially more than 4.9% of any class of units then outstanding, any such

 

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units owned by that person or group in excess of 4.9% may not be voted on any matter and will not be considered to be outstanding when sending notices of a meeting of unitholders, calculating required votes (except for purposes of nominating a person for election to our board of directors), determining the presence of a quorum or for other similar purposes, unless required by law. The voting rights of any such unitholders in excess of 4.9% will effectively be redistributed pro rata among the other common unitholders holding less than 4.9% of the voting power of all classes of units entitled to vote. Our general partner, its affiliates and persons who acquired common units with the prior approval of our board of directors will not be subject to this 4.9% limitation except with respect to voting their common units in the election of the elected directors.

 

   

There are no restrictions in our partnership agreement on our ability to issue equity securities.

The effect of these provisions may be to diminish the price at which the common units will trade.

The control of our general partner may be transferred to a third party without unitholder consent.

Our general partner may transfer its general partner interest to a third party in a merger or in a sale of all or substantially all of its assets without the consent of the unitholders. In addition, our partnership agreement does not restrict the ability of the members of our general partner from transferring their respective membership interests in our general partner to a third party.

Substantial future sales of our common units in the public market could cause the price of our common units to fall.

We have granted registration rights to KNOT and certain of its affiliates. These unitholders have the right, subject to some conditions, to require us to file registration statements covering any of our common, subordinated or other equity securities owned by them or to include those securities in registration statements that we may file for ourselves or other unitholders. Upon the closing of this offering and assuming no exercise of the underwriters’ option to purchase additional common units, KNOT will own 1,117,500 common units and 8,567,500 subordinated units and all of the incentive distribution rights. Following their registration and sale under the applicable registration statement, those securities will become freely tradable. By exercising their registration rights and selling a large number of common units or other securities, these unitholders could cause the price of our common units to decline.

You will experience immediate and substantial dilution of $4.82 per common unit.

The assumed initial public offering price of $20.00 per common unit (the midpoint of the range set forth on the cover of this prospectus) exceeds pro forma net tangible book value of $15.18 per common unit. Based on the assumed initial public offering price, you will incur immediate and substantial dilution of $4.82 per common unit. This dilution results primarily because the assets contributed by our general partner and its affiliates are recorded at their historical cost, and not their fair value, in accordance with U.S. GAAP. Please read “Dilution.”

KNOT, as the initial holder of all of the incentive distribution rights, may elect to cause us to issue additional common units to it in connection with a resetting of the target distribution levels related to its incentive distribution rights without the approval of the conflicts committee of our board of directors or holders of our common units and subordinated units. This may result in lower distributions to holders of our common units in certain situations.

KNOT, as the initial holder of all of the incentive distribution rights, has the right, at a time when there are no subordinated units outstanding and it has received incentive distributions at the highest level to which it is entitled (48.0%) for each of the prior four consecutive fiscal quarters, to reset the initial cash target distribution levels at higher levels based on the distribution at the time of the exercise of the reset election. Following a reset election by KNOT, the minimum quarterly distribution amount will be reset to an amount equal to the average

 

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cash distribution amount per common unit for the two fiscal quarters immediately preceding the reset election (such amount is referred to as the “reset minimum quarterly distribution”), and the target distribution levels will be reset to correspondingly higher levels based on the same percentage increases above the reset minimum quarterly distribution amount.

In connection with resetting these target distribution levels, KNOT will be entitled to receive a number of common units equal to that number of common units whose aggregate quarterly cash distributions equaled the average of the distributions to it on the incentive distribution rights in the prior two quarters. We anticipate that KNOT would exercise this reset right in order to facilitate acquisitions or internal growth projects that would not be sufficiently accretive to cash distributions per common unit without such conversion; however, it is possible that KNOT could exercise this reset election at a time when it is experiencing, or may be expected to experience, declines in the cash distributions it receives related to its incentive distribution rights and may therefore desire to be issued our common units, rather than retain the right to receive incentive distributions based on the initial target distribution levels. As a result, a reset election may cause our common unitholders to experience dilution in the amount of cash distributions that they would have otherwise received had we not issued additional common units to KNOT in connection with resetting the target distribution levels related to KNOT’s incentive distribution rights. Please read “How We Make Cash Distributions—Incentive Distribution Rights” and “How We Make Cash Distributions—KNOT’s Right to Reset Incentive Distribution Levels.”

We may issue additional equity securities, including securities senior to the common units, without your approval, which would dilute your ownership interests.

We may, without the approval of our unitholders, issue an unlimited number of additional units or other equity securities. In addition, we may issue an unlimited number of units that are senior to the common units in right of distribution, liquidation and voting. The issuance by us of additional common units or other equity securities of equal or senior rank will have the following effects:

 

   

our unitholders’ proportionate ownership interest in us will decrease;

 

   

the amount of cash available for distribution on each unit may decrease;

 

   

because a lower percentage of total outstanding units will be subordinated units, the risk that a shortfall in the payment of the minimum quarterly distribution will be borne by our common unitholders will increase;

 

   

the relative voting strength of each previously outstanding unit may be diminished; and

 

   

the market price of the common units may decline.

Upon the expiration of the subordination period, the subordinated units will convert into common units and will then participate pro rata with other common units in distributions of available cash.

During the subordination period, which we define elsewhere in this prospectus, the common units will have the right to receive distributions of available cash from operating surplus in an amount equal to the minimum quarterly distribution of $0.375 per unit, plus any arrearages in the payment of the minimum quarterly distribution on the common units from prior quarters, before any distributions of available cash from operating surplus may be made on the subordinated units. Distribution arrearages do not accrue on the subordinated units. The purpose of the subordinated units is to increase the likelihood that during the subordination period there will be available cash from operating surplus to be distributed on the common units. Upon the expiration of the subordination period, the subordinated units will convert into common units and will then participate pro rata with other common units in distributions of available cash. See “How We Make Cash Distributions—Subordination Period,” “—Distributions of Available Cash From Operating Surplus During the Subordination Period” and “—Distributions of Available Cash From Operating Surplus After the Subordination Period.”

 

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In establishing cash reserves, our board of directors may reduce the amount of cash available for distribution to you.

Our partnership agreement requires our board of directors to deduct from operating surplus cash reserves that it determines are necessary to fund our future operating expenditures. These reserves also will affect the amount of cash available for distribution to our unitholders. Our board of directors may establish reserves for distributions on the subordinated units, but only if those reserves will not prevent us from distributing the full minimum quarterly distribution, plus any arrearages, on the common units for the following four quarters. As described above in “—Risks Inherent in Our Business—We must make substantial capital expenditures to maintain and replace the operating capacity of our fleet, which will reduce cash available for distribution. In addition, each quarter we are required to deduct estimated maintenance and replacement capital expenditures from operating surplus, which may result in less cash available to unitholders than if actual maintenance and replacement capital expenditures were deducted,” our partnership agreement requires our board of directors each quarter to deduct from operating surplus estimated maintenance and replacement capital expenditures, as opposed to actual maintenance and replacement capital expenditures, which could reduce the amount of available cash for distribution. The amount of estimated maintenance and replacement capital expenditures deducted from operating surplus is subject to review and change by our board of directors at least once a year, provided that any change must be approved by the conflicts committee of our board of directors.

Our general partner has a limited call right that may require you to sell your common units at an undesirable time or price.

If at any time our general partner and its affiliates own more than 80.0% of the common units, our general partner will have the right, which it may assign to any of its affiliates or to us, but not the obligation, to acquire all, but not less than all, of the common units held by unaffiliated persons at a price not less than the then-current market price of our common units. Our general partner is not obligated to obtain a fairness opinion regarding the value of the common units to be repurchased by it upon the exercise of this limited call right. As a result, you may be required to sell your common units at an undesirable time or price and may not receive any return on your investment. You may also incur a tax liability upon a sale of your units. For additional information about the limited call right, please read “The Partnership Agreement—Limited Call Right.”

At the completion of this offering and assuming no exercise of the underwriters’ option to purchase additional common units, KNOT, which owns and controls our general partner, will own 13.0% of our common units. At the end of the subordination period, assuming no additional issuances of common units, no exercise of the underwriters’ option to purchase additional common units and the conversion of our subordinated units into common units, KNOT will own 56.5% of our common units.

You may not have limited liability if a court finds that unitholder action constitutes control of our business.

As a limited partner in a partnership organized under the laws of the Marshall Islands, you could be held liable for our obligations to the same extent as a general partner if you participate in the “control” of our business. Our general partner generally has unlimited liability for the obligations of the partnership, such as its debts and environmental liabilities, except for those contractual obligations of the partnership that are expressly made without recourse to our general partner. In addition, the limitations on the liability of holders of limited partner interests for the obligations of a limited partnership have not been clearly established in some jurisdictions in which we do business. Please read “The Partnership Agreement—Limited Liability” for a discussion of the implications of the limitations on liability of a unitholder.

We can borrow money to pay distributions, which would reduce the amount of credit available to operate our business.

Our partnership agreement allows us to make working capital borrowings to pay distributions. Accordingly, if we have available borrowing capacity, we can make distributions on all our units even though cash generated by our operations may not be sufficient to pay such distributions. Any working capital borrowings by us to make

 

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distributions will reduce the amount of working capital borrowings we can make for operating our business. For more information, please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

Increases in interest rates may cause the market price of our common units to decline.

An increase in interest rates may cause a corresponding decline in demand for equity investments in general, and in particular for yield-based equity investments such as our common units. Any such increase in interest rates or reduction in demand for our common units resulting from other relatively more attractive investment opportunities may cause the trading price of our common units to decline.

There is no existing market for our common units, and a trading market that will provide you with adequate liquidity may not develop. The price of our common units may fluctuate significantly, and you could lose all or part of your investment.

Prior to this offering, there has been no public market for the common units. After this offering, there will be only 7,450,000 publicly traded common units, assuming no exercise of the underwriters’ option to purchase additional common units. We do not know the extent to which investor interest will lead to the development of a trading market or how liquid that market might be. You may not be able to resell your common units at or above the initial public offering price. Additionally, the lack of liquidity may result in wide bid-ask spreads, contribute to significant fluctuations in the market price of the common units and limit the number of investors who are able to buy the common units.

Unitholders may have liability to repay distributions.

Under some circumstances, unitholders may have to repay amounts wrongfully returned or distributed to them. Under the Marshall Islands Limited Partnership Act, or the Marshall Islands Act, we may not make a distribution to you if the distribution would cause our liabilities to exceed the fair value of our assets. Marshall Islands law provides that for a period of three years from the date of the impermissible distribution, limited partners who received the distribution and who knew at the time of the distribution that it violated Marshall Islands law will be liable to the limited partnership for the distribution amount. Assignees who become substituted limited partners are liable for the obligations of the assignor to make contributions to the partnership that are known to the assignee at the time it became a limited partner and for unknown obligations if the liabilities could be determined from the partnership agreement. Liabilities to partners on account of their partnership interest and liabilities that are non-recourse to the partnership are not counted for purposes of determining whether a distribution is permitted.

We have no history operating as a separate publicly traded entity and will incur increased costs as a result of being a publicly traded limited partnership.

We have no history operating as a separate publicly traded entity. As a publicly traded limited partnership, we will be required to comply with the SEC’s reporting requirements and with corporate governance and related requirements of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, the SEC and the securities exchange on which our common units will be listed. We will incur significant legal, accounting and other expenses in complying with these and other applicable regulations. We anticipate that our incremental general and administrative expenses as a publicly traded limited partnership will be approximately $2.5 million annually and will include costs associated with annual reports to unitholders, tax return preparation, investor relations, registrar and transfer agent’s fees, incremental director and officer liability insurance costs and officer and director compensation.

We are an “emerging growth company” and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common units less attractive to investors.

We are an “emerging growth company,” as defined in the JOBS Act, and we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not

 

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“emerging growth companies” as described under “Summary—Implications of Being an Emerging Growth Company.” We cannot predict if investors will find our common units less attractive because we may rely on these exemptions. If some investors find our common units less attractive as a result, there may be a less active trading market for our common units and our unit price may be more volatile.

In addition, under the JOBS Act, our independent registered public accounting firm will not be required to attest to the effectiveness of our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act for so long as we are an emerging growth company. For as long as we take advantage of the reduced reporting obligations, the information that we provide unitholders may be different than information provided by other public companies.

We have been organized as a limited partnership under the laws of the Marshall Islands, which does not have a well-developed body of partnership law.

Our partnership affairs are governed by our partnership agreement and by the Marshall Islands Act. The provisions of the Marshall Islands Act resemble provisions of the limited partnership laws of a number of states in the United States, most notably Delaware. The Marshall Islands Act also provides that it is to be applied and construed to make it uniform with the Delaware Revised Uniform Partnership Act and, so long as it does not conflict with the Marshall Islands Act or decisions of the Marshall Islands courts, interpreted according to the non-statutory law (or case law) of the State of Delaware. There have been, however, few, if any, court cases in the Marshall Islands interpreting the Marshall Islands Act, in contrast to Delaware, which has a fairly well-developed body of case law interpreting its limited partnership statute. Accordingly, we cannot predict whether Marshall Islands courts would reach the same conclusions as the courts in Delaware. For example, the rights of our unitholders and the fiduciary responsibilities of our general partner under Marshall Islands law are not as clearly established as under judicial precedent in existence in Delaware. As a result, unitholders may have more difficulty in protecting their interests in the face of actions by our general partner and its officers and directors than would unitholders of a similarly organized limited partnership in the United States.

Because we are organized under the laws of the Marshall Islands, it may be difficult to serve us with legal process or enforce judgments against us, our directors or our management.

We are organized under the laws of the Marshall Islands, and substantially all of our assets are located outside of the United States. In addition, our general partner is a Marshall Islands limited liability company, and our directors and officers generally are or will be non-residents of the United States, and all or a substantial portion of the assets of these non-residents are located outside the United States. As a result, it may be difficult or impossible for you to bring an action against us or against these individuals in the United States if you believe that your rights have been infringed under securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the Marshall Islands and of other jurisdictions may prevent or restrict you from enforcing a judgment against our assets or the assets of our general partner or our directors or officers. For more information regarding the relevant laws of the Marshall Islands, please read “Service of Process and Enforcement of Civil Liabilities.”

Tax Risks

In addition to the following risk factors, you should read “Business—Taxation of the Partnership,” “Material U.S. Federal Income Tax Considerations” and “Non-United States Tax Considerations” for a more complete discussion of the expected material U.S. federal and non-U.S. income tax considerations relating to us and the ownership and disposition of our common units.

We will be subject to taxes, which will reduce our cash available for distribution to you.

We and our subsidiaries may be subject to tax in the jurisdictions in which we are organized or operate, reducing the amount of cash available for distribution. In computing our tax obligation in these jurisdictions, we are required to take various tax accounting and reporting positions on matters that are not entirely free from

 

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doubt and for which we have not received rulings from the governing authorities. We cannot assure you that upon review of these positions the applicable authorities will agree with our positions. A successful challenge by a tax authority could result in additional tax imposed on us or our subsidiaries, further reducing the cash available for distribution. In addition, changes in our operations or ownership could result in additional tax being imposed on us or our subsidiaries in jurisdictions in which operations are conducted. Please read “Business—Taxation of the Partnership.”

U.S. tax authorities could treat us as a “passive foreign investment company,” which would have adverse U.S. federal income tax consequences to U.S. unitholders.

A non-U.S. entity treated as a corporation for U.S. federal income tax purposes will be treated as a “passive foreign investment company,” or PFIC, for U.S. federal income tax purposes if at least 75.0% of its gross income for any taxable year consists of “passive income” or at least 50.0% of the average value of its assets produce, or are held for the production of, “passive income.” For purposes of these tests, “passive income” includes dividends, interest, gains from the sale or exchange of investment property, and rents and royalties other than rents and royalties that are received from unrelated parties in connection with the active conduct of a trade or business. For purposes of these tests, income derived from the performance of services does not constitute “passive income.” U.S. unitholders of a PFIC are subject to a disadvantageous U.S. federal income tax regime with respect to the income derived by the PFIC, the distributions they receive from the PFIC, and the gain, if any, they derive from the sale or other disposition of their interests in the PFIC.

Based on our current and projected method of operation, and an opinion of our U.S. counsel, Vinson & Elkins L.L.P., we believe that we will not be a PFIC for our current taxable year, and we expect that we will not be treated as a PFIC for any future taxable year. We have received an opinion of our U.S. counsel in support of this position that concludes that the income our subsidiaries earn from our present time-chartering activities should not constitute passive income for purposes of determining whether we are a PFIC. In addition, we have represented to our U.S. counsel that we expect that more than 25.0% of our gross income for our current taxable year and each future year will arise from such time-chartering activities or other income our U.S. counsel has opined does not constitute passive income, and more than 50.0% of the average value of our assets for each such year will be held for the production of such nonpassive income. Assuming the composition of our income and assets is consistent with these expectations, and assuming the accuracy of other representations we have made to our U.S. counsel for purposes of their opinion, our U.S. counsel is of the opinion that we should not be a PFIC for our current taxable year or any future year. This opinion is based and its accuracy is conditioned on representations, valuations and projections provided by us regarding our assets, income and charters to our U.S. counsel. While we believe these representations, valuations and projections to be accurate, the shipping market is volatile and no assurance can be given that they will continue to be accurate at any time in the future.

Moreover, there are legal uncertainties involved in determining whether the income derived from time-chartering activities constitutes rental income or income derived from the performance of services. In Tidewater Inc. v. United States, 565 F.3d 299 (5th Cir. 2009), the Fifth Circuit held that income derived from certain time-chartering activities should be treated as rental income rather than services income for purposes of a provision of the Code relating to foreign sales corporations. In that case, the Fifth Circuit did not address the definition of passive income or the PFIC rules; however, the reasoning of the case could have implications as to how the income from a time charter would be classified under such rules. If the reasoning of this case were extended to the PFIC context, the gross income we derive or are deemed to derive from our time-chartering activities may be treated as rental income, and we would likely be treated as a PFIC. In published guidance, the Internal Revenue Service, or IRS, stated that it disagreed with the holding in Tidewater, and specified that time charters similar to those at issue in the case should be treated as service contracts. We have not sought, and we do not expect to seek, an IRS ruling on the treatment of income generated from our time-chartering activities, and the opinion of our counsel is not binding on the IRS or any court. As a result, the IRS or a court could disagree with our position. No assurance can be given that this result will not occur. In addition, although we intend to conduct our affairs in a manner to avoid, to the extent possible, being classified as a PFIC with respect to any taxable year, we

 

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cannot assure you that the nature of our operations will not change in the future, or that we will not be a PFIC in the future. If the IRS were to find that we are or have been a PFIC for any taxable year (and regardless of whether we remain a PFIC for any subsequent taxable year), our U.S. unitholders would face adverse U.S. federal income tax consequences. Please read “Material U.S. Federal Income Tax Considerations—U.S. Federal Income Taxation of U.S. Holders—PFIC Status and Significant Tax Consequences” for a more detailed discussion of the U.S. federal income tax consequences to U.S. unitholders if we are treated as a PFIC.

We may have to pay tax on U.S. source income, which would reduce our cash flow.

Under the Code, U.S. source gross transportation income generally is subject to a 4% U.S. federal income tax without allowance for deduction of expenses, unless an exemption from tax applies under a tax treaty or Section 883 of the Code and the Treasury Regulations promulgated thereunder. U.S. source gross transportation income consists of 50% of the gross shipping income that is attributable to transportation that begins or ends, but that does not both begin and end, in the United States.

We expect that our vessel-owning subsidiaries will qualify for an exemption from U.S. tax on any U.S. source gross transportation income under the Convention Between the United States of America and the Kingdom of Norway with Respect to Taxes on Income and Property, or the U.S.-Norway Tax Treaty, and we intend to take this position for U.S. federal income tax purposes. However, if we acquire interests in vessel-owning subsidiaries in the future that are not Norwegian residents for purposes of the U.S.-Norway Tax Treaty, U.S. source gross transportation income earned by those subsidiaries would generally be subject to a 4% U.S. federal income tax unless the exemption under Section 883 of the Code applied. In general, the Section 883 exemption provides that if a non-U.S. corporation satisfies the requirements of Section 883 of the Code and the Treasury Regulations thereunder, it will not be subject to the 4% U.S. federal income tax referenced above on its U.S. source gross transportation income. The Section 883 exemption does not apply to income attributable to transportation that begins and ends in the United States.

The vessels in our fleet do not currently engage in transportation that begins and ends in the United States, and we do not expect that our subsidiaries will in the future earn income from such transportation. If, notwithstanding this expectation, our subsidiaries earn income in the future from transportation that begins and ends in the United States, that income would not be exempt from U.S. federal income tax under the U.S.-Norway Tax Treaty or Section 883 of the Code and would be subject to a 35% net income tax in the United States.

The imposition of U.S. federal income tax on our income could have a negative effect on our business and would result in decreased earnings available for distribution to our unitholders. For a more detailed discussion, see the section entitled “Business—Taxation of the Partnership—United States.”

You may be subject to income tax in one or more non-U.S. jurisdictions as a result of owning our common units if, under the laws of any such jurisdiction, we are considered to be carrying on business there. Such laws may require you to file a tax return with, and pay taxes to, those jurisdictions.

We intend to conduct our affairs and cause each of our subsidiaries to operate its business in a manner that minimizes income taxes imposed upon us and our subsidiaries. Furthermore, we intend to conduct our affairs and cause each of our subsidiaries to operate its business in a manner that minimizes the risk that unitholders may be treated as having a permanent establishment or taxable presence in a jurisdiction where we or our subsidiaries conduct activities simply by virtue of their ownership of our common units. However, because we are organized as a partnership, there is a risk in some jurisdictions, including Norway, that our activities or the activities of our subsidiaries may rise to the level of a taxable presence that is attributed to our unitholders for tax purposes. We have obtained confirmation from the United Kingdom HM Revenue & Customs that unitholders should not be treated as trading in the United Kingdom merely by virtue of their ownership of our common units. If you are attributed such a taxable presence in a jurisdiction, you may be required to file a tax return with, and to pay tax in, that jurisdiction based on your allocable share of our income. In addition, we may be required to obtain

 

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information from you in the event a tax authority (including in the United Kingdom) requires such information to submit a tax return. We may be required to reduce distributions to you on account of any tax withholding obligations imposed upon us by that jurisdiction in respect of such allocation to you. The United States may not allow a tax credit for any foreign income taxes that you directly or indirectly incur by virtue of an investment in us.

The ratio of dividend income to distributions on our common units is subject to business, economic and other uncertainties as well as tax reporting positions with which the IRS may disagree, which could result in a higher ratio of dividend income to distributions and adversely affect the value of our common units.

We estimate that approximately 70% of the total cash distributions made to a purchaser of common units in this offering who owns those units from the date of this offering through December 31, 2016 will constitute dividend income for U.S. tax purposes. The remaining portion of the distributions will be treated first as a nontaxable return of capital to the extent of the purchaser’s tax basis in its common units and thereafter as capital gain. These estimates are based on certain assumptions that are subject to business, economic, regulatory, competitive and political uncertainties beyond our control. In addition, these estimates are based on current U.S. federal income tax law and tax reporting positions that we will adopt and with which the IRS could disagree. As a result of these uncertainties, these estimates may be incorrect and the actual percentage of total cash distributions that will constitute dividend income could be higher, and any difference could adversely affect the value of the common units. Please read “Material U.S. Federal Income Tax Considerations—U.S. Federal Income Taxation of U.S. Holders—Ratio of Dividend Income to Distributions.”

 

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FORWARD-LOOKING STATEMENTS

Statements included in this prospectus concerning plans and objectives of management for future operations or economic performance, or assumptions related thereto, including our financial forecast, contain forward-looking statements. In addition, we and our representatives may from time to time make other oral or written statements that are also forward-looking statements. Such statements include, in particular, statements about our plans, strategies, business prospects, changes and trends in our business, and the markets in which we operate as described in this prospectus. In some cases, you can identify the forward-looking statements by the use of words such as “may,” “could,” “should,” “would,” “expect,” “plan,” “anticipate,” “intend,” “forecast,” “believe,” “estimate,” “predict,” “propose,” “potential,” “continue” or the negative of these terms or other comparable terminology.

Forward-looking statements appear in a number of places and include statements with respect to, among other things:

 

   

forecasts of our ability to make cash distributions on the units and the amount of any borrowings that may be necessary to make such distributions;

 

   

our future financial condition or results of operations and our future revenues and expenses;

 

   

expected compliance with financing agreements and the expected effect of restrictions and covenants in such agreements;

 

   

statements about shuttle tanker market trends, including charter hire rates and factors affecting supply and demand;

 

   

the repayment of debt;

 

   

our anticipated growth strategies;

 

   

the effect of the worldwide economic slowdown and financial crisis in the global market;

 

   

fluctuations in currencies and interest rates;

 

   

general market conditions, including fluctuations in charter hire rates and vessel values;

 

   

changes in our operating expenses, including drydocking and insurance costs;

 

   

our ability to make additional borrowings and to access public equity and debt capital markets;

 

   

planned capital expenditures and availability of capital resources to fund capital expenditures;

 

   

future supply of, and demand for, crude oil;

 

   

our ability to maintain long-term relationships with major oil and gas companies engaged in offshore production;

 

   

our ability to leverage KNOT’s relationships and reputation in the shipping industry;

 

   

our ability to purchase vessels from KNOT in the future, including the Carmen Knutsen, Hull 2531, Hull 2532, Hull 2575 and Hull 574;

 

   

our continued ability to enter into long-term, fixed-rate charters;

 

   

our ability to maximize the use of our vessels, including the redeployment or disposition of vessels no longer under long-term charters;

 

   

expected pursuit of strategic opportunities, including the acquisition of vessels;

 

   

our ability to compete successfully for future chartering and newbuild opportunities;

 

   

acceptance of a vessel by its charterer;

 

   

termination dates and extensions of charters;

 

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the expected cost of, and our ability to comply with, governmental regulations and maritime self-regulatory organization standards, as well as standard regulations imposed by our charterers applicable to our business;

 

   

expected demand in the offshore and crude oil shipping sectors in general and the demand for vessels in particular;

 

   

availability of skilled labor, vessel crews and management;

 

   

our anticipated incremental general and administrative expenses as a publicly traded limited partnership and our fees and expenses payable under the amended technical management agreements and the administrative services agreement;

 

   

the anticipated taxation of our partnership and distributions to our unitholders;

 

   

estimated future maintenance and replacement capital expenditures;

 

   

our ability to retain key employees;

 

   

customers’ increasing emphasis on environmental and safety concerns;

 

   

potential liability from any pending or future litigation;

 

   

potential disruption of shipping routes due to accidents, political events, piracy or acts by terrorists;

 

   

future sales of our common units in the public market; and

 

   

our business strategy and other plans and objectives for future operations.

These and other forward-looking statements are made based upon management’s current plans, expectations, estimates, assumptions and beliefs concerning future events impacting us and therefore involve a number of risks and uncertainties, including those risks discussed in “Risk Factors.” The risks, uncertainties and assumptions involve known and unknown risks and are inherently subject to significant uncertainties and contingencies, many of which are beyond our control. We caution that forward-looking statements are not guarantees and that actual results could differ materially from those expressed or implied in the forward-looking statements.

We undertake no obligation to update any forward-looking statement or statements to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for us to predict all of these factors. Further, we cannot assess the impact of each such factor on our business or the extent to which any factor, or combination of factors, may cause actual results to be materially different from those contained in any forward-looking statement.

 

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USE OF PROCEEDS

We expect to receive net proceeds of approximately $131.9 million from the sale of 7,450,000 common units offered by this prospectus, assuming an initial public offering price of $20.00 per unit (the midpoint of the range set forth on the cover of this prospectus) and after deducting underwriting discounts and commissions and structuring fees and estimated offering expenses payable by us. We will use approximately $121.9 million of the net proceeds from this offering to:

 

   

repay approximately $34.8 million of borrowings under the $160 million senior secured loan facility;

 

   

repay approximately $9.6 million of borrowings under the $19 million junior secured loan facility;

 

   

repay approximately $52.1 million of borrowings under the $120 million senior secured loan facility, or the Bodil Facility;

 

   

repay all of our borrowings outstanding (approximately $22.4 million) under the $27.3 million junior secured loan facility, or the Windsor Conversion Facility; and

 

   

to pre-fund approximately $3.0 million of our one-time entrance tax into the Norwegian tonnage tax regime.

We will use the remainder of the net proceeds from this offering of approximately $10 million for general partnership purposes. The $160 million senior secured loan facility bears interest at a rate of LIBOR plus a margin of 3.0% and matures in two tranches in March 2016 and August 2016. At December 31, 2012, the three-month LIBOR plus applicable spread on the $160 million senior secured loan facility was 3.312%. The $19 million junior secured loan facility bears interest at a rate of LIBOR plus a margin of 4.5% and matures in two tranches in March 2016 and August 2016. At December 31, 2012, the three-month LIBOR plus applicable spread on the junior secured loan facility was 4.812%. The Bodil Facility bears interest at a rate of LIBOR plus a margin ranging from 0.6% to 3.0% and matures in February 2016. At December 31, 2012, the three-month LIBOR plus applicable spread on the Bodil Facility was 2.394%. The Windsor Conversion Facility bears interest at a rate of LIBOR plus a margin of 3.75% and matures in May 2015. At December 31, 2012, the three-month LIBOR plus applicable spread on the Windsor Conversion Facility was 4.061%. Please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Borrowing Activities—Vessel Financing Agreements” for a description of these credit facilities.

For a discussion of the entrance tax, please read “Our Cash Distribution Policy and Restrictions on Distributions—Forecast Assumptions and Considerations—Summary of Significant Accounting Policies—Income Taxes.”

We have granted the underwriters a 30-day option to purchase up to 1,117,500 additional common units. If the underwriters exercise their option to purchase additional common units, we will use the net proceeds (approximately $20.9 million, if exercised in full, after deducting underwriting discounts and commissions) to make a cash distribution to KNOT. If the underwriters do not exercise their option to purchase any additional common units, we will issue 1,117,500 common units to KNOT at the expiration of the option period. If and to the extent the underwriters exercise their option to purchase additional common units, the number of units purchased by the underwriters pursuant to such exercise will be issued to the public and the remainder, if any, will be issued to KNOT. Accordingly, the exercise of the underwriters’ option will not affect the total number of units outstanding or the amount of cash needed to pay the minimum quarterly distribution on all units. Please read “Underwriting.”

 

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A $1.00 increase or decrease in the assumed initial public offering price of $20.00 per common unit would cause the net proceeds from this offering, after deducting the estimated underwriting discounts, commissions and structuring fees and estimated offering expenses payable by us, to increase or decrease, respectively, by approximately $7.0 million. In addition, we may also increase or decrease the number of common units we are offering. Each increase of 1.0 million common units offered by us, together with a concomitant $1.00 increase in the assumed initial public offering price to $21.00 per common unit, would increase net proceeds to us from this offering by approximately $26.6 million. Similarly, each decrease of 1.0 million common units offered by us, together with a concomitant $1.00 decrease in the assumed initial public offering price to $19.00 per common unit, would decrease the net proceeds to us from this offering by approximately $24.7 million.

 

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CAPITALIZATION

The following table shows:

 

   

our historical cash and capitalization as of December 31, 2012; and

 

   

our pro forma cash and capitalization as of December 31, 2012, which reflects the offering and the other transactions described in the unaudited pro forma combined balance sheet included elsewhere in this prospectus.

This table is derived from and should be read together with the historical combined carve-out financial statements of KNOT Offshore Partners LP Predecessor and the unaudited pro forma combined balance sheet and the accompanying notes contained elsewhere in this prospectus. You should also read this table in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

     As of December 31, 2012  
     Historical      Pro Forma  
     (dollars in thousands)  

Cash and cash equivalents

   $ 1,287       $ 14,235   
  

 

 

    

 

 

 

Debt:(1)

     

Revolving credit facility(2)

   $ —           —     

Current portion of long-term debt

     28,833         22,751   

Non-current portion of long-term debt

     319,017         206,209   
  

 

 

    

 

 

 

Total debt(3)

     347,850         228,960   
  

 

 

    

 

 

 

Equity:

     

Owner’s/partners’ equity

   $ 100,633       $ —     

Held by public:

     

Common units(4)

        131,890   

Held by general partner and its affiliates:

     

Common units(4)

        15,504   

Subordinated units(4)

        118,867   

General partner interest(4)

        4,852   
  

 

 

    

 

 

 

Equity attributable to KNOT Offshore Partners

     100,633         271,112   
  

 

 

    

 

 

 

Total capitalization(5)

   $ 448,483       $ 500,072   
  

 

 

    

 

 

 

 

(1) All of our outstanding debt is secured by our vessels. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”
(2) At or prior to the closing of this offering, we will amend our existing vessel financing agreements to, among other things, include a revolving credit facility. We do not expect to draw under this credit facility at the closing of this offering. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Borrowing Activities.”
(3) As of March 31, 2013, we had approximately $340.5 million of total debt outstanding.
(4) Equity attributable to common units held by public represents the net proceeds of the offering. Equity attributable to the general partner and its affiliates represent pro forma net assets contributed by KNOT before the allocation of net proceeds, allocated pro rata to the common, subordinated and general partner units. See “Unaudited Pro Forma Combined Balance Sheet” note 3(g). No allocation has been attributed to IDRs owned by the general partner, based on an assumption that these rights have nominal value at the time of this offering.
(5)

A $1.00 increase or decrease in the assumed initial public offering price of $20.00 per common unit would cause the net proceeds from this offering, after deducting the estimated underwriting discounts and commissions and structuring fees and estimated offering expenses payable by us, to increase or decrease, respectively, by approximately $7.0 million. In addition, we may also increase or decrease the number of

 

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  common units we are offering. Each increase of 1.0 million common units offered by us, together with a concomitant $1.00 increase in the assumed initial public offering price to $21.00 per common unit, would increase net proceeds to us from this offering by approximately $26.6 million. Similarly, each decrease of 1.0 million common units offered by us, together with a concomitant $1.00 decrease in the assumed initial public offering price to $19.00 per common unit, would decrease the net proceeds to us from this offering by approximately $24.7 million.

 

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DILUTION

Dilution is the amount by which the offering price will exceed the net tangible book value per common unit after this offering. Based on the assumed initial public offering price of $20.00 per common unit, on a pro forma basis as of December 31, 2012, after giving effect to this offering of common units, the application of the net proceeds in the manner described under “Use of Proceeds” and the formation transactions related to this offering, our pro forma net tangible book value would have been $265.4 million, or $15.18 per common unit. Purchasers of common units in this offering will experience substantial and immediate dilution in net tangible book value per common unit for financial accounting purposes, as illustrated in the following table.

 

Assumed initial public offering price per common unit

    $ 20.00   

Pro forma net tangible book value(1) per common unit before this offering(2)

  $ 13.30     

Increase in net tangible book value(1) per common unit attributable to purchasers in this offering

    1.88     
 

 

 

   

Less: Pro forma net tangible book value per common unit after this offering(3)

      15.18   
   

 

 

 

Immediate dilution in net tangible book value per common unit to purchasers in this offering(4)(5)

    $ 4.82   
   

 

 

 

 

(1) Pro forma net tangible book value is defined as pro forma total assets minus goodwill and pro forma total liabilities. See “Unaudited Pro Forma Combined Balance Sheet” note 4.
(2) Determined by dividing the total number of units (1,117,500 common units, 8,567,500 subordinated units and the 2.0% general partner interest represented by 349,694 general partner units to be issued to our general partner and its affiliates for their contribution of assets and liabilities to us) into the net tangible book value of the contributed assets and liabilities.
(3) Determined by dividing the total number of units (8,567,500 common units, 8,567,500 subordinated units and the 2.0% general partner interest represented by 349,694 general partner units to be outstanding after this offering) into our pro forma net tangible book value, after giving effect to the application of the net proceeds of this offering.
(4) Each $1.00 increase or decrease in the assumed initial public offering price of $20.00 per common unit would increase or decrease, respectively, our pro forma net tangible book value by approximately $7.0 million, or approximately $0.94 per common unit, and change the dilution per common unit to investors in this offering by approximately $0.60 per common unit, after deducting the estimated underwriting discounts, commissions and structuring fees and estimated offering expenses payable by us. We may also increase or decrease the number of common units we are offering. An increase of 1.0 million common units offered by us, together with a concomitant $1.00 increase in the assumed initial public offering price to $21.00 per common unit, would result in a pro forma net tangible book value of approximately $292.0 million, or $16.60 per common unit, and dilution per common unit to investors in this offering would be $4.40 per common unit. Similarly, a decrease of 1.0 million common units offered by us, together with a concomitant $1.00 decrease in the assumed initial public offering price to $19.00 per common unit, would result in an pro forma net tangible book value of approximately $240.6 million, or $14.60 per common unit, and dilution per common unit to investors in this offering would be $4.40 per common unit. The information discussed above is illustrative only and will be adjusted based on the actual public offering price and other terms of this offering determined at pricing.
(5) Because the total number of units outstanding following this offering will not be impacted by any exercise of the underwriters’ option to purchase additional common units and any net proceeds from such exercise will not be retained by us, there will be no change to the dilution in net tangible book value per common unit to purchasers in the offering due to any exercise of the option.

 

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The following table sets forth the number of units that we will issue and the total consideration contributed to us by our general partner and its affiliates and by the purchasers of common units in this offering upon consummation of the transactions contemplated by this prospectus.

 

     Units Acquired     Total Consideration  
     Number      Percent     Amount      Percent  

General partner and its affiliates(1)(2)

     10,034,694         57.4   $ 139,222,500         51.3

New investors

     7,450,000         42.6        131,889,500         48.7   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

     17,484,694         100   $ 271,112,000         100
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) Upon consummation of the transactions contemplated by this prospectus, our general partner and its affiliates will own an aggregate of 1,117,500 common units, 8,567,500 subordinated units and the 2.0% general partner interest represented by 349,694 general partner units.
(2) The assets contributed by our general partner and its affiliates were recorded at historical book value, rather than fair value, in accordance with U.S. GAAP. Book value of the consideration provided by our general partner and its affiliates, as of December 31, 2012, was $139.2 million.

 

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OUR CASH DISTRIBUTION POLICY AND RESTRICTIONS ON DISTRIBUTIONS

You should read the following discussion of our cash distribution policy and restrictions on distributions in conjunction with specific assumptions included in this section. In addition, you should read “Forward-Looking Statements” and “Risk Factors” for information regarding statements that do not relate strictly to historical or current facts and certain risks inherent in our business.

General

Rationale for Our Cash Distribution Policy

Our cash distribution policy reflects a judgment that our unitholders will be better served by our distributing our available cash (after deducting expenses, including estimated maintenance and replacement capital expenditures and reserves) rather than retaining it. Because we believe we will generally finance any expansion capital expenditures from external financing sources, we believe that our investors are best served by our distributing all of our available cash. Our cash distribution policy is consistent with the terms of our partnership agreement, which requires that we distribute all of our available cash quarterly (after deducting expenses, including estimated maintenance and replacement capital expenditures and reserves).

Limitations on Cash Distributions and Our Ability to Change Our Cash Distribution Policy

There is no guarantee that unitholders will receive quarterly distributions from us. Our distribution policy is subject to certain restrictions and may be changed at any time, including:

 

   

Our unitholders have no contractual or other legal right to receive distributions other than the obligation under our partnership agreement to distribute available cash on a quarterly basis, which is subject to the broad discretion of our board of directors to establish reserves and other limitations.

 

   

We will be subject to restrictions on distributions under our financing agreements. Our financing agreements contain material financial tests and covenants that must be satisfied in order to pay distributions. If we are unable to satisfy the restrictions included in any of our financing agreements or are otherwise in default under any of those agreements, as a result of our debt levels or otherwise, we will not be able to make cash distributions to you, notwithstanding our stated cash distribution policy. These financial tests and covenants are described in this prospectus in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

 

   

We are required to make substantial capital expenditures to maintain and replace our fleet. These expenditures may fluctuate significantly over time, particularly as our vessels near the end of their useful lives. In order to minimize these fluctuations, our partnership agreement requires us to deduct estimated, as opposed to actual, maintenance and replacement capital expenditures from the amount of cash that we would otherwise have available for distribution to our unitholders. In years when estimated maintenance and replacement capital expenditures are higher than actual maintenance and replacement capital expenditures, the amount of cash available for distribution to unitholders will be lower than if actual maintenance and replacement capital expenditures were deducted.

 

   

Although our partnership agreement requires us to distribute all of our available cash, our partnership agreement, including provisions contained therein requiring us to make cash distributions, may be amended. During the subordination period, with certain exceptions, our partnership agreement may not be amended without the approval of non-affiliated common unitholders. After the subordination period has ended, our partnership agreement can be amended with the approval of a majority of the outstanding common units. KNOT will own approximately 13.0% of our common units and all of our subordinated units outstanding immediately after the closing of this offering. Please read “The Partnership Agreement—Amendment of the Partnership Agreement.”

 

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Even if our cash distribution policy is not modified or revoked, the amount of distributions we pay under our cash distribution policy and the decision to make any distribution is determined by our board of directors, taking into consideration the terms of our partnership agreement.

 

   

Under Section 51 of the Marshall Islands Act, we may not make a distribution to you if the distribution would cause our liabilities to exceed the fair value of our assets.

 

   

We may lack sufficient cash to pay distributions to our unitholders due to decreases in total operating revenues, decreases in hire rates, the loss of a vessel, increases in operating or general and administrative expenses, principal and interest payments on outstanding debt, taxes, working capital requirements, maintenance and replacement capital expenditures or anticipated cash needs. Please read “Risk Factors” for a discussion of these factors.

Our ability to make distributions to our unitholders depends on the performance of our subsidiaries and their ability to distribute cash to us. The ability of our subsidiaries to make distributions to us may be restricted by, among other things, the provisions of existing and future indebtedness, applicable limited partnership and limited liability company laws in the Marshall Islands and Norway and other laws and regulations.

Our Ability to Grow Depends on Our Ability to Access External Expansion Capital

Because we distribute all of our available cash, we may not grow as quickly as businesses that reinvest their available cash to expand ongoing operations. We expect that we will rely upon external financing sources, including bank borrowings and the issuance of debt and equity securities, to fund acquisitions and expansion and investment capital expenditures. As a result, to the extent we are unable to finance growth externally, our cash distribution policy will significantly impair our ability to grow. To the extent we issue additional units in connection with any acquisitions or other capital expenditures, the payment of distributions on those additional units may increase the risk that we will be unable to maintain or increase our per unit distribution level, which in turn may affect the available cash that we have to distribute on each unit. There are no limitations in our partnership agreement on our ability to issue additional units, including units ranking senior to the common units. The incurrence of additional borrowings or other debt by us to finance our growth would result in increased interest expense, which in turn may affect the available cash that we have to distribute to our unitholders.

Initial Distribution Rate

Upon completion of this offering, our board of directors will adopt a policy pursuant to which we will declare an initial quarterly distribution of $0.375 per unit for each complete quarter, or $1.50 per unit on an annualized basis, to be paid no later than 45 days after the end of each fiscal quarter (beginning with the quarter ending June 30, 2013). This equates to an aggregate cash distribution of $6.6 million per quarter, or $26.2 million per year, in each case based on the number of common units, subordinated units and general partner units outstanding immediately after completion of this offering. Our ability to make cash distributions at the initial distribution rate pursuant to this policy will be subject to the factors described above under “—General—Limitations on Cash Distributions and Our Ability to Change Our Cash Distribution Policy.”

The table below sets forth the number of outstanding common units, subordinated units and general partner units upon the closing of this offering and the aggregate distribution amounts payable on such units during the year following the closing of this offering at our initial distribution rate of $0.375 per unit per quarter ($1.50 per unit on an annualized basis).

 

     Number of
Units
     Distributions  
        One Quarter     Four Quarters  

Common units

     8,567,500       $ 3,212,813      $ 12,851,250   

Subordinated units

     8,567,500         3,212,813        12,851,250   

General partner units(1)

     349,694         131,135        524,541   
  

 

 

    

 

 

   

 

 

 

Total

     17,484,694       $ 6,556,760 (2)    $ 26,227,041   
  

 

 

    

 

 

   

 

 

 

 

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(1) The number of general partner units is determined by multiplying the total number of units deemed to be outstanding (i.e., the total number of common and subordinated units outstanding divided by 98.0%) by the general partner’s 2.0% general partner interest.
(2) Actual payments of distributions on the common units, subordinated units and the general partner units are expected to be approximately $5.5 million for the period between the estimated closing date of this offering (April 15, 2013) and the end of the fiscal quarter in which the closing date of this offering occurs.

If the underwriters do not exercise their option to purchase additional common units, we will issue common units to KNOT at the expiration of the option period. If and to the extent the underwriters exercise their option to purchase additional common units, the number of common units purchased by the underwriters pursuant to such exercise will be issued to the underwriters and the remainder, if any, will be issued to KNOT. Any such units issued to KNOT will be issued for no additional consideration. Accordingly, the exercise of the underwriters’ option will not affect the total number of units outstanding or the amount of cash needed to pay the minimum quarterly distribution on all units.

During the subordination period, before we make any quarterly distributions to subordinated unitholders, our common unitholders are entitled to receive payment of the full minimum quarterly distribution plus any arrearages in distributions from prior quarters. Please read “How We Make Cash Distributions—Subordination Period.” We cannot guarantee, however, that we will pay the minimum quarterly distribution or any amount on the common units in any quarter.

As of the closing date of this offering, our general partner will be entitled to 2.0% of all distributions that we make prior to our liquidation. Our general partner’s initial 2.0% interest in these distributions may be reduced if we issue additional units in the future and our general partner does not contribute a proportionate amount of capital to us to maintain its initial 2.0% general partner interest. Our general partner has the right, but not the obligation, to contribute a proportionate amount of capital to us to maintain its current general partner interest.

Forecasted Results of Operations for the Twelve Months Ending March 31, 2014

In this section, we present in detail the basis for our belief that we will be able to pay our minimum quarterly distribution on all of our outstanding units for the twelve months ending March 31, 2014. We present two tables, consisting of:

 

   

Forecasted Results of Operations for the twelve months ending March 31, 2014; and

 

   

Forecasted Cash Available for Distribution for the twelve months ending March 31, 2014,

as well as the significant assumptions upon which the forecast is based.

We present below a forecast of our expected results of operations for the twelve months ending March 31, 2014. Our forecast presents, to the best of our knowledge and belief, our expected results of operations for the forecast period. Although we anticipate exercising our options to purchase each of the Carmen Knutsen, Hull 2531, Hull 2532, Hull 2575 and Hull 574 from KNOT, the timing of such purchases is uncertain and each such purchase is subject to reaching an agreement with KNOT regarding the purchase price of the vessel and the availability of financing, which we anticipate would be from external sources. As a result, our forecast does not reflect the expected results of operations or related financing of any of such vessels.

Our financial forecast reflects our judgment, as of the date of this prospectus, of conditions we expect to exist and the course of action we expect to take during the twelve months ending March 31, 2014. Our financial forecast is based on assumptions that we believe to be reasonable with respect to the forecast period as a whole. The assumptions and estimates used in the financial forecast are inherently uncertain and represent those that we believe are significant to our financial forecast. We believe that we have a reasonable objective basis for those assumptions. To the extent that there is a shortfall during any quarter in the forecast period, we believe we would be able to make working capital borrowings to pay distributions in such quarter and would be able to repay such borrowings in a subsequent quarter, because we believe the total cash available for distribution for the forecast

 

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period will be more than sufficient to pay the aggregate minimum quarterly distribution to all unitholders. We believe our actual results of operations will approximate those reflected in our financial forecast, but we can give no assurance that our forecasted results will be achieved. There will likely be differences between our financial forecast and the actual results and those differences could be material. Our operations are subject to numerous risks that are beyond our control. If the financial forecast is not achieved, we may not be able to pay cash distributions on our units at the initial distribution rate stated in our cash distribution policy or at all.

Our forecast of our results of operations is a forward-looking statement and should be read together with the historical combined carve-out financial statements of KNOT Offshore Partners LP Predecessor, our unaudited pro forma combined balance sheet and the accompanying notes included elsewhere in this prospectus and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We do not, as a matter of course, make public projections as to future revenues, earnings or other results. The financial forecast has been prepared by and is the responsibility of our management. However, our management has prepared the financial forecast set forth below in support of our belief that we will have sufficient cash available to allow us to pay the minimum quarterly distribution on all of our outstanding units during the forecast period. In addition, in the view of our management, the accompanying financial forecast was prepared on a reasonable basis, reflects the best currently available estimates and judgments, and presents, to the best of our knowledge and belief, the expected course of action and our expected future financial performance. However, this information is not fact and should not be relied upon as being necessarily indicative of future results, and readers of this prospectus are cautioned not to place undue reliance on the financial forecast.

When considering our financial forecast, you should keep in mind the risk factors and other cautionary statements included under the heading “Risk Factors” elsewhere in this prospectus. Any of the risks discussed in this prospectus or unanticipated events could cause our actual results of operations, cash flows and financial condition to vary significantly from the financial forecast and such variations may be material. Prospective investors are cautioned to not place undue reliance on the financial forecast and should make their own independent assessment of our future results of operations, cash flows and financial condition.

We are providing the financial forecast to supplement the historical combined carve-out financial statements of KNOT Offshore Partners LP Predecessor in support of our belief that we will have sufficient cash available to allow us to pay cash distributions on all of our units for each quarter in the twelve-month period ending March 31, 2014 at our stated initial distribution rate. Please read “—Forecast Assumptions and Considerations—Summary of Significant Forecast Assumptions” for further information as to the assumptions we have made for the financial forecast.

We do not undertake any obligation to release publicly the results of any future revisions we may make to the financial forecast or to update the financial forecast to reflect events or circumstances after the date of this prospectus, even in the event that any or all of the underlying assumptions are shown to be in error. Therefore, we caution you not to place undue reliance on this information.

Neither our independent registered public accounting firm, nor any other independent registered public accounting firm, has compiled, examined or performed any procedures with respect to the forecasted financial information contained herein, nor has it expressed any opinion or given any other form of assurance on such information or its achievability, and it assumes no responsibility for such forecasted financial information. Our independent registered public accounting firm’s report included in this prospectus relates to the historical financial information of KNOT Offshore Partners LP Predecessor. That report does not extend to the tables and the related forecasted financial information contained in this section and should not be read to do so.

 

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KNOT OFFSHORE PARTNERS LP

FORECASTED RESULTS OF OPERATIONS

 

(dollars in thousands)    Twelve Months
Ending

March 31, 2014
 
     (unaudited)  

Total revenues

   $ 65,797   

Voyage expenses

     —     
  

 

 

 

Net voyage revenues

     65,797   

Operating expenses:

  

Vessel operating expenses

     13,709   

Depreciation and amortization

     21,743   

General and administrative expenses

     3,000   
  

 

 

 

Total operating expenses

   $ 38,452   
  

 

 

 

Operating income

     27,345   

Financial income (expenses):

  

Interest income

     —     

Interest expense

     8,489   

Other finance expense

     —     

Realized and unrealized gain/(loss) on derivative instruments

     —     

Net gain/(loss) on foreign currency transactions

     —     
  

 

 

 

Net financial expenses

   $ 8,489   
  

 

 

 

Income before income taxes

     18,856   

Income taxes

     —     
  

 

 

 

Net income attributable to KNOT Offshore Partners LP owners

   $ 18,856   
  

 

 

 

General partner’s interest in net income

   $ 377   

Limited partners’ interest in net income

     18,479   

Net income per:

  

Common unit (basic and diluted)

   $ 1.08   

Subordinated unit (basic and diluted)

   $ 1.08   

General partner unit (basic and diluted)

   $ 1.08   

Please read the accompanying summary of significant accounting policies and forecast assumptions.

Forecast Assumptions and Considerations

Basis of Presentation

The accompanying financial forecast and related notes present our forecasted results of operations for the twelve months ending March 31, 2014, based on the assumption that:

 

   

we will issue to KNOT 1,117,500 common units and 8,567,500 subordinated units, representing a 55.4% limited partner interest in us, and all of our incentive distribution rights, which will entitle KNOT to increasing percentages of the cash we distribute in excess of $0.43125 per unit per quarter;

 

   

we will issue to our general partner, a wholly owned subsidiary of KNOT, 349,694 general partner units, representing a 2.0% general partner interest in us;

 

   

we will sell 7,450,000 common units to the public in this offering, representing a 42.6% limited partner interest in us;

 

   

we will use approximately $118.9 million of the proceeds from this offering to repay borrowings outstanding under certain of our vessel financing agreements; and

 

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we will amend the Bodil Facility to be a $50 million term loan facility and a $20 million revolving credit facility.

Summary of Significant Accounting Policies

Organization. We are a Marshall Islands limited partnership formed to own, operate and acquire shuttle tankers under long-term charters. Our general partner is KNOT Offshore Partners GP LLC.

Principles of Combination. The financial forecast includes our accounts and those of the wholly and partially owned subsidiaries we will control. All intercompany transactions have been eliminated in consolidation.

Use of Estimates. The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant items subject to such estimates and assumptions include the useful lives of the vessels in our initial fleet; the valuation of derivatives and other contingencies.

Reporting Currency. Our financial forecast is stated in U.S. Dollars. The functional currency of our vessel-owning subsidiaries is the U.S. Dollar. Since such subsidiaries operate in the international shipping market, all revenues are U.S. Dollars denominated and the majority of the expenditures are made in U.S. Dollars. Transactions involving other currencies during the year are converted into U.S. Dollars using the exchange rates in effect at the time of the transactions. As of the balance sheet date, monetary assets and liabilities that are denominated in currencies other than the U.S. Dollar are translated to reflect the year-end exchange rates. Resulting gains or losses are reflected separately in the statement of operations.

Revenue Recognition. We recognize revenues from time charters and bareboat charters as operating leases on a straight line basis over the term of the charter, net of any commissions. Under time charters, revenue is not recognized during days the vessel is off-hire. Revenue is recognized from delivery of the vessel to the charterer, until the end of the lease term. Under time charter, we are responsible for providing the crewing and other services related to the vessel’s operations, the cost of which is included in the daily hire rate, except when off-hire. Fees received from customers for customized equipment are deferred and recognized over the period. Under bareboat charters, we provide a specified vessel for a fixed period of time at a specified day rate.

Voyage Expenses. Voyage expenses are all expenses unique to a particular voyage, including bunker fuel expenses, port fees, cargo loading and unloading expenses, canal tolls and agency fees. Voyage expenses are paid by the customer under time charter and bareboat charters. Voyage expenses are paid by the shipowner for spot contracts and during periods of off-hire and are recognized when incurred.

Vessel Operating Expenses. Vessel operating expenses include crewing, repairs and maintenance, insurance, stores, lube oils and communication expenses. Vessel operating expenses are paid by the shipowner for time-charters, spot contracts and during off-hire and are recognized when incurred. Vessel operating expenses are typically paid by the customer under bareboat charters.

Cash and Cash Equivalents. We consider all highly liquid investments with an original maturity date of three months or less when purchased to be cash equivalents.

Vessels and Equipment. Vessels and equipment are stated at the historical acquisition or construction cost, including capitalized interest, supervision, technical and delivery cost, net of accumulated depreciation and impairment loss, if any. Expenditures for subsequent conversions and major improvements are capitalized provided that such costs increase the earnings capacity or improve the efficiency or safety of the vessels.

 

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Generally, we drydock each vessel every 60 months until the vessel is 15 years old, after which drydocking takes place every 30 months thereafter as required for the renewal of certifications issued by classification societies. For vessels operating on time charters, we capitalize the costs directly associated with the classification and regulatory requirements for inspection of the vessels, major repairs and improvements incurred during drydocking. Drydocking cost is amortized on a straight-line basis over the period until the next planned drydocking takes place. We expense costs related to routine repairs and maintenance performed during drydocking or as otherwise incurred. For vessels that are newly built or acquired, an element of the cost of the vessel is allocated to a drydock component initially and amortized on a straight-line basis over the period until the next planned drydocking. When significant drydocking expenditures occur prior to the expiration of this period, we expense the remaining unamortized balance of the original drydocking cost in the month of the subsequent drydocking. For vessels operating on bareboat charters, the charter party bears the cost of any drydocking.

Vessels are depreciated to their estimated residual value, which is calculated based on the weight of the ship and estimated steel price. Any cost related to the disposal is deducted from the residual value.

Impairment of Long-Lived Assets. Vessels and equipment, vessels under construction, and intangible assets subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances require a long-lived asset or asset group be tested for possible impairment, we first compare undiscounted cash flows expected to be generated by that asset or asset group to its carrying value. If the carrying value of the long-lived asset or asset group is not recoverable on an undiscounted cash flow basis, an impairment is recognized to the extent that the carrying value exceeds its fair value. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values and third party independent appraisals, as considered necessary.

Debt Issuance Costs. Debt issuance costs, including fees, commissions and legal expenses, are deferred and presented as other non-current assets. Debt issuance costs of term loans are amortized over the term of the relevant loan. Amortization of debt issuance costs is included in interest expense.

Derivative Instruments. We may, from time to time, enter into interest rate swap transactions to hedge a portion of our exposure to floating interest rates. These transactions involve the conversion of floating rates into fixed rates over the life of the transactions without an exchange of underlying principal. In addition, from time to time we enter into foreign currency swap contracts to reduce risk from foreign currency fluctuations.

Income Taxes. Under the tonnage tax regime, we do not anticipate that we or our subsidiaries will incur any income taxes payable in any jurisdiction during the forecast period. However, as tax law is based on interpretations and applications of the law, which are only ultimately decided by the courts of a particular jurisdiction, significant judgment is involved in determining our provision for income taxes in the ordinary course of our business. We recognize tax liabilities based on our assessment of whether our tax positions are more likely than not sustainable, based on the technical merits of each position and having regard to the relevant taxing authority’s widely understood administrative practices and precedent. Our Norwegian subsidiaries will be subject to Norwegian tonnage tax based upon the net tonnage of their available cargo space rather than income generated from operating the vessels, which is tax free. Based on our current vessels and the applicable rate of taxation, we expect to be liable for $107,000 in Norwegian tonnage tax for the twelve months ending March 31, 2014. This amount has been included in our forecasted vessel operating expenses. In addition, under the Norwegian tonnage tax regime, net financial income, which is any income other than income generated from operating the vessels, is subject to the regular corporate income tax rate of 28%. Our forecasted results of operations assumes that we will not incur any net financial income during the forecast period that would result in a taxable profit. Any tax losses for one year may be carried forward to future periods. We expect that a valuation allowance will be required such that our net deferred tax benefit will be reduced to zero during the forecast period.

We will be subject to a one-time entrance tax into the Norwegian tonnage tax regime due to our acquisition of the shares in the subsidiary that owns the Fortaleza Knutsen and the Recife Knutsen. The entrance tax arises

 

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when a related party seller is taxed under the ordinary tax regime and the buyer is taxed under the tonnage tax regime. The tax is based on the difference between the market value of the shares and the seller’s tax value of the shares as of the date of contribution. We have estimated the total amount of the entrance tax to be approximately $3 million. However, such amount will vary depending on the factors present at the date of the transaction. The entrance tax on this gain is payable over several years and is calculated by multiplying the tax rate of 28% by the declining balance of the gain, which will decline by 20% each year. The tax for 2013 is expected to be approximately $0.6 million, which would be payable in the fourth quarter of 2014.

Net Income Per Unit. The calculation of the forecasted basic and diluted earnings for the twelve months ending March 31, 2014 is set forth below:

 

(dollars in thousands)   Common
Unitholders
    Subordinated
Unitholders
    General Partner  

Partners’ interests in forecasted net income

  $ 9,239      $ 9,239      $ 377   

Forecasted weighted average number of units outstanding

    8,567,500        8,567,500        349,694   

Forecasted net income per unit

  $ 1.08      $ 1.08      $ 1.08   

Summary of Significant Forecast Assumptions

Vessels. The forecast reflects or assumes the following about our fleet:

 

   

365 days of operation under a bareboat charter for the Fortaleza Knutsen;

 

   

365 days of operation under a bareboat charter for the Recife Knutsen;

 

   

358 days of operation under a time charter for the Bodil Knutsen; and

 

   

358 days of operation under a time charter for the Windsor Knutsen.

We have assumed that we will not make any acquisitions during the forecast period.

Voyage Revenues. Our forecasted voyage revenues are based on estimated average expected daily hire rates multiplied by the total number of days our vessels are expected to be on-hire during the twelve months ending March 31, 2014. We have built into our forecast 2% off-hire for the time-charter vessels in our fleet; for the vessels on bareboat charter we have assumed no off-hire as operating risk is for the charterers’ account. The amount of actual off-hire time depends upon, among other things, the time a vessel spends in drydocking for repairs, maintenance or inspection, equipment breakdowns or delays due to accidents, crewing strikes, certain vessel detentions or similar problems as well as failure to maintain the vessel in compliance with its specifications and contractual standards or to provide the required crew.

The hire rate payable under our time charters is fixed and payable monthly in advance, in U.S. Dollars, and increases annually based on a fixed percentage increase or fixed schedule to enable us to offset expected increases in operating costs. The hire rate payable under our bareboat charters is fixed and payable monthly in advance, in U.S. Dollars. For more information on the components of the hire rate payable under our charters, please read “Business—Charters—Hire Rate.”

Voyage Expenses. Under time charter and bareboat charter contracts, the charterer typically pays the voyage expenses. If we, as shipowner, pay the voyage expenses, we typically pass the approximate amount of these expenses on to our customers by charging higher rates under the contract or billing the expenses to them. We, as shipowner, are responsible for any voyage expenses incurred during periods of off hire under our time charters. However, we do not expect any voyage expenses incurred during periods of off hire to be substantial and therefore, our forecast assumes that we will not incur any voyage expenses during the forecast period.

Vessel Operating Expenses. Our forecasted vessel operating expenses assumes that all of our vessels are operational during the twelve months ending March 31, 2014. Vessel operating expenses primarily relate to our vessels operating under time charters. The forecast takes into account increases in crewing and other labor related

 

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costs driven predominantly by an increase in demand for qualified and experienced officers and crew. In addition, our forecast assumes approximately $107,000 in Norwegian tonnage tax for the twelve months ending March 31, 2014 relating to our vessels operating under both time charters and bareboat charters. In addition, in our calculation of forecasted vessel operating expenses, we have assumed that our operating subsidiaries will incur approximately $0.9 million of costs and fees pursuant to the amended technical management agreements that our operating subsidiaries will enter into with KNOT Management. Please read “Certain Relationships and Related Party Transactions—Agreements Governing the Transactions—Technical Management Agreements.”

Depreciation and Amortization. Our forecasted depreciation and amortization expense includes only the vessels in our initial fleet. Vessels and equipment are stated at cost less accumulated depreciation. The cost of vessels and equipment less the estimated residual value is depreciated on a straight-line basis over the assets’ remaining economic useful lives, which we estimate to be 24 years, 24 years, 24 years and 20 years for the Fortaleza Knutsen, the Recife Knutsen, the Bodil Knutsen and the Windsor Knutsen, respectively. The economic useful life for shuttle tankers operated worldwide has generally been estimated to be 25 years. In addition, a portion of the purchase price for the Bodil Knutsen included an estimate of expenses relating to its first scheduled drydocking. These estimated drydocking expenses were capitalized and will be amortized over the five years until its first scheduled drydocking.

General and Administrative Expenses. Forecasted general and administrative expenses for the twelve months ending March 31, 2014 are based on the assumption that we will incur approximately $2.5 million in incremental expenses as a result of being a publicly traded limited partnership. These expenses will include costs associated with annual reports to unitholders, tax return preparation, investor relations, registrar and transfer agent’s fees, incremental director and officer liability insurance costs and officer and director compensation. In addition, these expenses include approximately $1.0 million of costs and fees that KNOT UK will incur pursuant to the applicable subcontract to the administrative services agreement that we will enter into with KNOT UK. Please read “Certain Relationships and Related Party Transactions—Agreements Governing the Transactions—Administrative Services Agreement.”

Interest Income. We have assumed that any cash surplus balances will not earn any interest during the forecast period.

Interest Expense. Our financial forecast for the twelve months ending March 31, 2014 assumes we will have an average outstanding loan balance of approximately $214.4 million with an estimated weighted average interest rate of 4% per annum.

Foreign Exchange Gain/(Loss). We receive all of our revenues in U.S. Dollars. However, a portion of our expenses are denominated in Norwegian Kroner, or NOK. For purposes of this financial forecast, we have assumed an exchange rate of 1 U.S. Dollar to 6 NOK for the twelve months ending March 31, 2014. Please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Items You Should Consider When Evaluating Our Historical Financial Performance and Assessing Our Future Prospects.”

Derivative Financial Instruments. The derivative instruments entered into by the KNOT Group will not be transferred to us upon the closing of this offering. We have assumed that we will not enter into any interest rate swap transactions or foreign currency swap contracts during the twelve months ending March 31, 2014.

Taxes. We have assumed that we will not incur any income tax expense for the twelve months ending March 31, 2014.

Maintenance and Replacement Capital Expenditures. Our partnership agreement requires our board of directors to deduct from operating surplus each quarter estimated maintenance and replacement capital expenditures, as opposed to actual maintenance and replacement capital expenditures, in order to reduce disparities in operating surplus caused by fluctuating maintenance and replacement capital expenditures, such as drydocking and vessel replacement. The actual cost of replacing the vessels in our fleet will depend on a number

 

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of factors, including prevailing market conditions, hire rates and the availability and cost of financing at the time of replacement. Our board of directors, with the approval of the conflicts committee, may determine that one or more of our assumptions should be revised, which could cause our board of directors to increase the amount of estimated maintenance and replacement capital expenditures. We may elect to finance some or all of our maintenance and replacement capital expenditures through the issuance of additional common units, which could be dilutive to our existing unitholders. Please read “Risk Factors—Risks Inherent in Our Business—We must make substantial capital expenditures to maintain the operating capacity of our fleet, which will reduce cash available for distribution. In addition, each quarter we are required to deduct estimated maintenance and replacement capital expenditures from operating surplus, which may result in less cash available to unitholders than if actual maintenance and replacement capital expenditures were deducted.”

Drydocking Capital Expenditures. Because of the substantial capital expenditures we are required to make to maintain our fleet, our initial annual estimated drydocking costs for our vessels for estimating maintenance and replacement capital expenditures will be $1.1 million per year.

Replacement Capital Expenditures. Because of the substantial capital expenditures we are required to make to maintain our fleet, our initial annual estimated replacement capital expenditures for estimating maintenance and replacement capital expenditures will be $10.8 million per year, including financing costs, for replacing our shuttle tankers at the end of their useful lives. The $10.8 million for future vessel replacement is based on assumptions and estimates regarding the remaining useful lives of the vessels, a long-term net investment rate equivalent to our current expected long-term borrowing costs, vessel replacement values based on current market conditions and residual value of the vessels at the end of their useful lives based on current steel prices.

Regulatory, Industry and Economic Factors. Our financial forecast for the twelve months ending March 31, 2014 is based on the following assumptions related to regulatory, industry and economic factors:

 

   

no material nonperformance or credit-related defaults by suppliers, customers or vendors;

 

   

no new regulation or interpretation of existing regulations or governmental action that, in either case, would be materially adverse to our business;

 

   

no material accidents, environmental incidents, releases, weather-related incidents, unscheduled downtime or similar unanticipated events;

 

   

no major adverse change in the markets in which we operate resulting from oil production disruptions, reduced demand for oil or significant changes in the market price for oil; and

 

   

no material changes to market, regulatory and overall economic conditions or in prevailing interest rates.

Forecasted Cash Available for Distribution

The table below sets forth our calculation of forecasted cash available for distribution to our unitholders and general partner based on the Forecasted Results of Operations set forth above. Based on the financial forecast and related assumptions, we forecast that our cash available for distribution generated during the twelve months ending March 31, 2014 will be approximately $28.7 million. This amount would be sufficient to pay 100% of the minimum quarterly distribution of $0.375 per unit on all of our common units and subordinated units for the four quarters ending March 31, 2014.

Actual payments of distributions on the common units, subordinated units and the general partner units are expected to be approximately $5.5 million for the period between the estimated closing date of this offering (April 15, 2013) and the end of the fiscal quarter in which the closing date of this offering occurs.

You should read “—Forecast Assumptions and Considerations—Summary of Significant Forecast Assumptions” included as part of the financial forecast for a discussion of the material assumptions underlying our forecast of adjusted EBITDA that is included in the table below. Our forecast is based on those material

 

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assumptions and reflects our judgment of conditions we expect to exist and the course of action we expect to take. The assumptions disclosed in our financial forecast are those that we believe are significant to generate the forecasted adjusted EBITDA. If our estimate is not achieved, we may not be able to pay distributions on the common units at the initial distribution rate of $0.375 per unit per quarter ($1.50 per unit on an annualized basis). Our financial forecast and the forecast of cash available for distribution set forth below have been prepared by our management. This calculation represents available cash from operating surplus generated during the period and excludes any cash from working capital borrowings, capital expenditures and cash on hand on the closing date.

Adjusted EBITDA should not be considered an alternative to net income, operating income, cash flow from operating activities or any other measure of financial performance calculated in accordance with U.S. GAAP.

When considering our forecast of cash available for distribution for the twelve months ending March 31, 2014, you should keep in mind the risk factors and other cautionary statements under the headings “Forward-Looking Statements” and “Risk Factors” elsewhere in this prospectus. Any of these factors or the other risks discussed in this prospectus could cause our results of operations to vary significantly from those set forth in the financial forecast and the forecast of cash available for distribution set forth below.

KNOT OFFSHORE PARTNERS LP

FORECASTED CASH AVAILABLE FOR DISTRIBUTION

 

    Twelve Months Ending
March 31, 2014(1)
 
(dollars in thousands, except per unit amounts)   (unaudited)  

Adjusted EBITDA(2)

  $ 49,088   

Adjustments for cash items, entrance tax expenditures, estimated maintenance and replacement capital expenditures:

 

Less:

 

Cash interest expense

    8,489   

Cash interest income

    —     

Cash income tax expense

    —     

Drydocking capital expenditure reserves(3)

    1,140   

Replacement capital expenditure reserves(3)

    10,780   

Pre-funded entrance tax(4)

    600   

Add:

 

Proceeds retained from this offering to pre-fund entrance tax(4)

    600   
 

 

 

 

Cash available for distribution

  $ 28,679   
 

 

 

 

Expected distributions:

 

Distributions per unit

  $ 1.50   

Distributions to our public common unitholders(5)

    11,175   

Distributions to KNOT—common units(5)

    1,676   

Distributions to KNOT—subordinated units(5)

    12,851   

Distributions to general partner units

    525   
 

 

 

 

Total distributions(6)

  $ 26,227   
 

 

 

 

Excess

  $ 2,452   

Annualized minimum quarterly distribution per unit

  $ 1.50   

Aggregate distributions based on annualized minimum quarterly distribution

  $ 26,227   

Percent of minimum quarterly distributions payable to common unitholders

    100

Percent of minimum quarterly distributions payable to subordinated unitholder

    100

 

(1) The forecast is based on the assumptions set forth in “—Forecast Assumptions and Considerations—Summary of Significant Forecast Assumptions.”

 

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(2) Adjusted EBITDA is a non-GAAP financial measure. Adjusted EBITDA means earnings before interest, other financial items, depreciation and amortization and taxes is used as a supplemental financial measure by management and external users of financial statements, such as investors, to assess our financial and operating performance. We believe that adjusted EBITDA assists our management and investors by increasing the comparability of our performance from period to period and against the performance of other companies in our 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, depreciation and amortization and taxes, 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. We believe that including adjusted EBITDA as a financial and operating measure benefits investors in (a) selecting between investing in us and other investment alternatives and (b) monitoring our ongoing financial and operational strength in assessing whether to continue to hold common units.

Adjusted EBITDA should not be considered an alternative to net income, operating income, cash flow from operating activities or any other measure of financial performance presented in accordance with U.S. GAAP. Adjusted EBITDA excludes some, but not all, items that affect net income, and these measures may vary among other companies. Therefore, adjusted EBITDA as presented below may not be comparable to similarly titled measures of other companies. The following table reconciles adjusted EBITDA to net income, the most directly comparable U.S. GAAP financial measure.

 

     Twelve Months  Ending
March 31, 2014
 
(dollars in thousands)    (unaudited)  

Net income attributable to KNOT Offshore Partners LP owners

   $ 18,856   

Interest income

     —     

Interest expense

     8,489   

Other financial items(a)

     —     

Depreciation and amortization

     21,743   

Income taxes

     —     
  

 

 

 

Adjusted EBITDA

   $ 49,088   
  

 

 

 

 

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

 

(3) Our partnership agreement requires that an estimate of the maintenance and replacement capital expenditures necessary to maintain our asset base be subtracted from operating surplus each quarter, as opposed to amounts actually spent. Please read “How We Make Cash Distributions—Operating Surplus and Capital Surplus—Capital Expenditures.”
(4) Pre-funded entrance tax expenditures are related to the approximately $3.0 million one-time entrance tax into the Norwegian tonnage tax regime. We expect to pay approximately $0.6 million in 2013, with the remainder to be paid over several years. For a more complete discussion of the entrance tax, please read “—Forecast Assumptions and Considerations—Summary of Significant Accounting Policies—Income Taxes.”
(5) Assumes the underwriters’ option to purchase additional common units is not exercised.
(6) Represents the amount required to fund distributions to our unitholders and our general partner for four quarters based upon our minimum quarterly distribution rate of $0.375 per unit.

Forecast of Compliance with Debt Covenants. Our ability to make distributions could be affected if we do not remain in compliance with the restrictions and covenants of our financing agreements. Our fleet is subject to several financing agreements, which will be amended in connection with this offering. We have assumed that we will be in compliance with all of the covenants in such financing agreements during the forecast period. Please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” for a further description of our financing agreements, including these financial covenants.

 

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HOW WE MAKE CASH DISTRIBUTIONS

Distributions of Available Cash

General

Within 45 days after the end of each quarter, beginning with the quarter ending June 30, 2013, we will distribute all of our available cash (defined below) to unitholders of record on the applicable record date. We will adjust the minimum quarterly distribution for the period from the closing of this offering through June 30, 2013, based on the actual length of the period.

Definition of Available Cash

Available cash generally means, for each fiscal quarter, all cash on hand at the end of the quarter (including our proportionate share of cash on hand of certain subsidiaries we do not wholly own):

 

   

less, the amount of cash reserves (including our proportionate share of cash reserves of certain subsidiaries we do not wholly own) established by our board of directors and our subsidiaries to:

 

   

provide for the proper conduct of our business (including reserves for future capital expenditures and for our anticipated credit needs);

 

   

comply with applicable law, any of our debt instruments or other agreements; and/or

 

   

provide funds for distributions to our unitholders and to our general partner for any one or more of the next four quarters;

 

   

plus, all cash on hand (including our proportionate share of cash on hand of certain subsidiaries we do not wholly own) on the date of determination of available cash for the quarter resulting from (1) working capital borrowings made after the end of the quarter and (2) cash distributions received after the end of the quarter from any equity interest in any person (other than a subsidiary of us), which distributions are paid by such person in respect of operations conducted by such person during such quarter. Working capital borrowings are generally borrowings that are made under a revolving credit facility and in all cases are used solely for working capital purposes or to pay distributions to partners.

Intent to Distribute the Minimum Quarterly Distribution

We intend to distribute to the holders of common units and subordinated units on a quarterly basis at least the minimum quarterly distribution of $0.375 per unit, or $1.50 per unit per year, to the extent we have sufficient cash on hand to pay the distribution after we establish cash reserves and pay fees and expenses. The amount of available cash from operating surplus needed to pay the minimum quarterly distribution for one quarter on all units outstanding immediately after this offering and the related distribution on the 2.0% general partner interest is approximately $6.6 million.

There is no guarantee that we will pay the minimum quarterly distribution on the common units and subordinated units in any quarter. Even if our cash distribution policy is not modified or revoked, the amount of distributions paid under our policy and the decision to make any distribution is determined by our board of directors, taking into consideration the terms of our partnership agreement. We will be prohibited from making any distributions to unitholders if it would cause an event of default, or an event of default is then existing, under our financing agreements. Please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” for a discussion of the restrictions contained in our financing agreements that may restrict our ability to make distributions.

 

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Operating Surplus and Capital Surplus

General

All cash distributed to unitholders will be characterized as either “operating surplus” or “capital surplus.” We treat distributions of available cash from operating surplus differently than distributions of available cash from capital surplus.

Definition of Operating Surplus

Operating surplus for any period generally means:

 

   

$17.0 million; plus

 

   

all of our cash receipts (including our proportionate share of cash receipts of certain subsidiaries we do not wholly own) after the closing of this offering (provided that cash receipts from the termination of an interest rate, currency or commodity hedge contract prior to its specified termination date will be included in operating surplus in equal quarterly installments over the remaining scheduled life of such hedge contract), excluding cash from (1) borrowings, other than working capital borrowings, (2) sales of equity and debt securities, (3) sales or other dispositions of assets outside the ordinary course of business, (4) capital contributions or (5) corporate reorganizations or restructurings; plus

 

   

working capital borrowings (including our proportionate share of working capital borrowings for certain subsidiaries we do not wholly own) made after the end of a quarter but before the date of determination of operating surplus for the quarter; plus

 

   

interest paid on debt incurred (including periodic net payments under related hedge contracts) and cash distributions paid on equity securities issued (including the amount of any incremental distributions made to the holders of our incentive distribution rights and our proportionate share of such interest and cash distributions paid by certain subsidiaries we do not wholly own), in each case, to finance all or any portion of the construction, replacement or improvement of a capital asset (such as a vessel) in respect of the period from such financing until the earlier to occur of the date the capital asset is put into service or the date that it is abandoned or disposed of; plus

 

   

interest paid on debt incurred (including periodic net payments under related hedge contracts) and cash distributions paid on equity securities issued (including the amount of any incremental distributions made to the holders of our incentive distribution rights and our proportionate share of such interest and cash distributions paid by certain subsidiaries we do not wholly own), in each case, to pay the construction period interest on debt incurred (including periodic net payments under related interest rate swap agreements), or to pay construction period distributions on equity issued, to finance the construction projects described in the immediately preceding bullet; less

 

   

all of our “operating expenditures” (which includes estimated maintenance and replacement capital expenditures and is further described below) of us and our subsidiaries (including our proportionate share of operating expenditures by certain subsidiaries we do not wholly own) immediately after the closing of this offering; less

 

   

the amount of cash reserves (including our proportionate share of cash reserves for certain subsidiaries we do not wholly own) established by our board of directors to provide funds for future operating expenditures; less

 

   

any cash loss realized on dispositions of assets acquired using investment capital expenditures; less

 

   

all working capital borrowings (including our proportionate share of working capital borrowings by certain subsidiaries we do not wholly own) not repaid within twelve months after having been incurred.

If a working capital borrowing, which increases operating surplus, is not repaid during the twelve-month period following the borrowing, it will be deemed repaid at the end of such period, thus decreasing operating

 

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surplus at such time. When such working capital borrowing is in fact repaid, it will not be treated as a reduction in operating surplus because operating surplus will have been previously reduced by the deemed repayment.

As described above, operating surplus includes a provision that will enable us, if we choose, to distribute as operating surplus up to $17.0 million of cash we receive in the future from non-operating sources, such as asset sales, issuances of securities and long-term borrowings, that would otherwise be distributed as capital surplus. In addition, the effect of including, as described above, certain cash distributions on equity securities or interest payments on debt in operating surplus would be to increase operating surplus by the amount of any such cash distributions or interest payments. As a result, we may also distribute as operating surplus up to the amount of any such cash distributions or interest payments we receive from non-operating sources.

Operating expenditures generally means all of our cash expenditures, including but not limited to taxes, employee and director compensation, reimbursement of expenses to our general partner, repayment of working capital borrowings, debt service payments and payments made under any interest rate, currency or commodity hedge contracts (provided that payments made in connection with the termination of any hedge contract prior to the expiration of its specified termination date be included in operating expenditures in equal quarterly installments over the remaining scheduled life of such hedge contract), provided that operating expenditures will not include:

 

   

deemed repayments of working capital borrowings deducted from operating surplus pursuant to the last bullet point of the definition of operating surplus above when such repayment actually occurs;

 

   

payments (including prepayments and payment penalties) of principal of and premium on indebtedness, other than working capital borrowings;

 

   

expansion capital expenditures, investment capital expenditures or actual maintenance and replacement capital expenditures (which are discussed in further detail under “—Capital Expenditures” below);

 

   

payment of transaction expenses (including taxes) relating to interim capital transactions; or

 

   

distributions to partners.

Capital Expenditures

For purposes of determining operating surplus, maintenance and replacement capital expenditures are those capital expenditures required to maintain over the long term the operating capacity of or the revenue generated by our capital assets, and expansion capital expenditures are those capital expenditures that increase the operating capacity of or the revenue generated by our capital assets. In our partnership agreement, we refer to these maintenance and replacement capital expenditures as “maintenance capital expenditures.” To the extent, however, that capital expenditures associated with acquiring a new vessel or improving an existing vessel increase the revenues or the operating capacity of our fleet, those capital expenditures would be classified as expansion capital expenditures.

Investment capital expenditures are those capital expenditures that are neither maintenance and replacement capital expenditures nor expansion capital expenditures. Investment capital expenditures largely will consist of capital expenditures made for investment purposes. Examples of investment capital expenditures include traditional capital expenditures for investment purposes, such as purchases of equity securities, as well as other capital expenditures that might be made in lieu of such traditional investment capital expenditures, such as the acquisition of a capital asset for investment purposes.

Examples of maintenance and replacement capital expenditures include capital expenditures associated with drydocking, modifying an existing vessel or acquiring a new vessel to the extent such expenditures are incurred to maintain the operating capacity of or the revenue generated by our fleet. Maintenance and replacement capital expenditures will also include interest (and related fees) on debt incurred and distributions on equity issued (including the amount of any incremental distributions made to the holders of our incentive distribution rights) to

 

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finance the construction of a replacement vessel and paid in respect of the construction period, which we define as the period beginning on the date that we enter into a binding construction contract and ending on the earlier of the date that the replacement vessel commences commercial service or the date that the replacement vessel is abandoned or disposed of. Debt incurred to pay or equity issued to fund construction period interest payments, and distributions on such equity (including the amount of any incremental distributions made to the holders of our incentive distribution rights), will also be considered maintenance and replacement capital expenditures.

Because our maintenance and replacement capital expenditures can be very large and vary significantly in timing, the amount of our actual maintenance and replacement capital expenditures may differ substantially from period to period, which could cause similar fluctuations in the amounts of operating surplus, adjusted operating surplus and available cash for distribution to our unitholders than if we subtracted actual maintenance and replacement capital expenditures from operating surplus each quarter. Accordingly, to eliminate the effect on operating surplus of these fluctuations, our partnership agreement will require that an amount equal to an estimate of the average quarterly maintenance and replacement capital expenditures necessary to maintain the operating capacity of or the revenue generated by our capital assets over the long term be subtracted from operating surplus each quarter, as opposed to the actual amounts spent. In our partnership agreement, we refer to these estimated maintenance and replacement capital expenditures to be subtracted from operating surplus as “estimated maintenance capital expenditures.” The amount of estimated maintenance and replacement capital expenditures deducted from operating surplus is subject to review and change by our board of directors at least once a year, provided that any change must be approved by our conflicts committee. The estimate will be made at least annually and whenever an event occurs that is likely to result in a material adjustment to the amount of our maintenance and replacement capital expenditures, such as a major acquisition or the introduction of new governmental regulations that will affect our fleet. For purposes of calculating operating surplus, any adjustment to this estimate will be prospective only. For a discussion of the amounts we have allocated toward estimated maintenance and replacement capital expenditures, please read “Our Cash Distribution Policy and Restrictions on Distributions.”

The use of estimated maintenance and replacement capital expenditures in calculating operating surplus will have the following effects:

 

   

it will reduce the risk that actual maintenance and replacement capital expenditures in any one quarter will be large enough to make operating surplus less than the minimum quarterly distribution to be paid on all the units for that quarter and subsequent quarters;

 

   

it may reduce the need for us to borrow to pay distributions;

 

   

it will be more difficult for us to raise our distribution above the minimum quarterly distribution and pay incentive distributions to KNOT; and

 

   

it will reduce the likelihood that a large maintenance and replacement capital expenditure in a period will prevent KNOT from being able to convert some or all of its subordinated units into common units since the effect of an estimate is to spread the expected expense over several periods, mitigating the effect of the actual payment of the expenditure on any single period.

Definition of Capital Surplus

Capital surplus generally will be generated only by:

 

   

borrowings other than working capital borrowings;

 

   

sales of debt and equity securities; and

 

   

sales or other dispositions of assets for cash, other than inventory, accounts receivable and other current assets sold in the ordinary course of business or non-current assets sold as part of normal retirements or replacements of assets.

 

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Characterization of Cash Distributions

We will treat all available cash distributed as coming from operating surplus until the sum of all available cash distributed since we began operations equals the operating surplus as of the most recent date of determination of available cash. We will treat any amount distributed in excess of operating surplus, regardless of its source, as capital surplus. As described above, operating surplus does not reflect actual cash on hand that is available for distribution to our unitholders. For example, it includes a provision that will enable us, if we choose, to distribute as operating surplus up to $17.0 million of cash we receive in the future from non-operating sources, such as asset sales, issuances of securities and long-term borrowings, that would otherwise be distributed as capital surplus. We do not anticipate that we will make any distributions from capital surplus.

Subordination Period

General

During the subordination period, which we define below, the common units will have the right to receive distributions of available cash from operating surplus in an amount equal to the minimum quarterly distribution of $0.375 per unit, plus any arrearages in the payment of the minimum quarterly distribution on the common units from prior quarters, before any distributions of available cash from operating surplus may be made on the subordinated units. Distribution arrearages do not accrue on the subordinated units. The purpose of the subordinated units is to increase the likelihood that during the subordination period there will be available cash from operating surplus to be distributed on the common units.

Definition of Subordination Period

The subordination period will extend until the second business day following the distribution of available cash from operating surplus in respect of any quarter, ending on or after March 31, 2016, that each of the following tests are met:

 

   

distributions of available cash from operating surplus on each of the outstanding common units and subordinated units equaled or exceeded the sum of the minimum quarterly distribution for each of the three consecutive, non-overlapping four-quarter periods immediately preceding that date;

 

   

the “adjusted operating surplus” (as defined below) generated during each of the three consecutive, non-overlapping four-quarter periods immediately preceding that date equaled or exceeded the sum of the minimum quarterly distributions on all of the outstanding common units and subordinated units during those periods on a fully diluted weighted average basis and the related distribution on the 2.0% general partner interest during those periods; and

 

   

there are no outstanding arrearages in payment of the minimum quarterly distribution on the common units.

If the unitholders remove our general partner without cause, the subordination period may end before March 31, 2016.

For purposes of determining whether the tests in the bullets above have been met, the three consecutive, non-overlapping four-quarter periods for which the determination is being made may include one or more quarters with respect to which arrearages in the payment of the minimum quarterly distribution on the common units have accrued, provided that all such arrearages have been repaid prior to the end of each such four-quarter period.

If the expiration of the subordination period occurs as a result of us having met the tests described above, each outstanding subordinated unit will convert into one common unit and will then participate pro rata with the other common units in distributions of available cash.

 

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Definition of Adjusted Operating Surplus

Adjusted operating surplus for any period generally means:

 

   

operating surplus generated with respect to that period (excluding any amounts attributable to the item described in the first bullet point under “—Operating Surplus and Capital Surplus—Definition of Operating Surplus” above); less

 

   

the amount of any net increase in working capital borrowings (including our proportionate share of any changes in working capital borrowings of certain subsidiaries we do not wholly own) with respect to that period; less

 

   

the amount of any net reduction in cash reserves for operating expenditures (including our proportionate share of cash reserves of certain subsidiaries we do not wholly own) over that period not relating to an operating expenditure made during that period; plus

 

   

the amount of any net decrease in working capital borrowings (including our proportionate share of any changes in working capital borrowings of certain subsidiaries we do not wholly own) with respect to that period; plus

 

   

the amount of any net increase in cash reserves for operating expenditures (including our proportionate share of cash reserves of certain subsidiaries we do not wholly own) over that period required by any debt instrument for the repayment of principal, interest or premium; plus

 

   

the amount of any net decrease made in subsequent periods to cash reserves for operating expenditures initially established with respect to such period to the extent such decrease results in a reduction in adjusted operating surplus in subsequent periods.

Adjusted operating surplus is intended to reflect the cash generated from operations during a particular period and therefore excludes net increases in working capital borrowings and net drawdowns of reserves of cash generated in prior periods.

Effect of Removal of Our General Partner on the Subordination Period

If the unitholders remove our general partner other than for cause and units held by our general partner and its affiliates are not voted in favor of such removal:

 

   

the subordination period will end and each subordinated unit will immediately convert into one common unit and will then participate pro rata with the other common units in distributions of available cash;

 

   

any existing arrearages in payment of the minimum quarterly distribution on the common units will be extinguished; and

 

   

our general partner will have the right to convert its general partner interest into common units or to receive cash in exchange for that interest.

Distributions of Available Cash From Operating Surplus During the Subordination Period

We will make distributions of available cash from operating surplus for any quarter during the subordination period in the following manner:

 

   

first, 98.0% to the common unitholders, pro rata, and 2.0% to our general partner, until we distribute for each outstanding common unit an amount equal to the minimum quarterly distribution for that quarter;

 

   

second, 98.0% to the common unitholders, pro rata, and 2.0% to our general partner, until we distribute for each outstanding common unit an amount equal to any arrearages in payment of the minimum quarterly distribution on the common units for any prior quarters during the subordination period;

 

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third, 98.0% to the subordinated unitholders, pro rata, and 2.0% to our general partner, until we distribute for each subordinated unit an amount equal to the minimum quarterly distribution for that quarter; and

 

   

thereafter, in the manner described in “—General Partner Interest” and “—Incentive Distribution Rights” below.

The preceding paragraph is based on the assumption that our general partner maintains its 2.0% general partner interest and that we do not issue additional classes of equity securities.

Distributions of Available Cash From Operating Surplus After the Subordination Period

We will make distributions of available cash from operating surplus for any quarter after the subordination period in the following manner:

 

   

first, 98.0% to all unitholders, pro rata, and 2.0% to our general partner, until we distribute for each outstanding unit an amount equal to the minimum quarterly distribution for that quarter; and

 

   

thereafter, in the manner described in “—General Partner Interest” and “—Incentive Distribution Rights” below.

The preceding paragraph is based on the assumption that our general partner maintains its 2.0% general partner interest and that we do not issue additional classes of equity securities.

General Partner Interest

Our partnership agreement provides that our general partner initially will be entitled to 2.0% of all distributions that we make prior to our liquidation. Our general partner has the right, but not the obligation, to contribute a proportionate amount of capital to us to maintain its 2.0% general partner interest if we issue additional units. Our general partner’s 2.0% interest, and the percentage of our cash distributions to which it is entitled, will be proportionately reduced if we issue additional units in the future and our general partner does not contribute a proportionate amount of capital to us in order to maintain its 2.0% general partner interest. Our general partner will be entitled to make a capital contribution in order to maintain its 2.0% general partner interest in the form of the contribution to us of common units based on the current market value of the contributed common units.

Incentive Distribution Rights

Incentive distribution rights represent the right to receive an increasing percentage of quarterly distributions of available cash from operating surplus after the minimum quarterly distribution and the target distribution levels have been achieved. KNOT will hold the incentive distribution rights following completion of this offering. The incentive distribution rights may be transferred separately from any other interest, subject to restrictions in the partnership agreement. Except for transfers of incentive distribution rights to an affiliate or another entity as part of a merger or consolidation with or into, or sale of substantially all of the assets to, such entity, the approval of a majority of our common units (excluding common units held by our general partner and its affiliates), voting separately as a class, generally is required for a transfer of the incentive distribution rights to a third party prior to March 31, 2018. Please read “The Partnership Agreement—Transfer of Incentive Distribution Rights.” Any transfer by KNOT of the incentive distribution rights would not change the percentage allocations of quarterly distributions with respect to such rights.

If for any quarter:

 

   

we have distributed available cash from operating surplus to the common and subordinated unitholders in an amount equal to the minimum quarterly distribution; and

 

   

we have distributed available cash from operating surplus on outstanding common units in an amount necessary to eliminate any cumulative arrearages in payment of the minimum quarterly distribution;

 

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then, we will distribute any additional available cash from operating surplus for that quarter among the unitholders and our general partner in the following manner:

 

   

first, 98.0% to all unitholders, pro rata, and 2.0% to our general partner, until each unitholder receives a total of $0.43125 per unit for that quarter (the “first target distribution”);

 

   

second, 85.0% to all unitholders, pro rata, 2.0% to our general partner and 13.0% to the holders of the incentive distribution rights, pro rata, until each unitholder receives a total of $0.46875 per unit for that quarter (the “second target distribution”);

 

   

third, 75.0% to all unitholders, pro rata, 2.0% to our general partner and 23.0% to the holders of the incentive distribution rights, pro rata, until each unitholder receives a total of $0.5625 per unit for that quarter (the “third target distribution”); and

 

   

thereafter, 50.0% to all unitholders, pro rata, 2.0% to our general partner and 48.0% to the holders of the incentive distribution rights, pro rata.

In each case, the amount of the target distribution set forth above is exclusive of any distributions to common unitholders to eliminate any cumulative arrearages in payment of the minimum quarterly distribution. The percentage interests set forth above assume that our general partner maintains its 2.0% general partner interest and that we do not issue additional classes of equity securities.

Percentage Allocations of Available Cash From Operating Surplus

The following table illustrates the percentage allocations of the additional available cash from operating surplus among the unitholders, our general partner and the holders of the incentive distribution rights up to the various target distribution levels. The amounts set forth under “Marginal Percentage Interest in Distributions” are the percentage interests of the unitholders, our general partner and the holders of the incentive distribution rights in any available cash from operating surplus we distribute up to and including the corresponding amount in the column “Total Quarterly Distribution Target Amount,” until available cash from operating surplus we distribute reaches the next target distribution level, if any. The percentage interests shown for the unitholders, our general partner and the holders of the incentive distribution rights for the minimum quarterly distribution are also applicable to quarterly distribution amounts that are less than the minimum quarterly distribution. The percentage interests shown for our general partner include its 2.0% general partner interest only and assume that our general partner has contributed any capital necessary to maintain its 2.0% general partner interest.

 

    

Total Quarterly
Distribution Target
Amount

   Marginal Percentage Interest in
Distributions
       
        Unitholders     General Partner     Holders of IDRs  

Minimum Quarterly Distribution

   $0.375      98.0     2.0     0

First Target Distribution

   up to $0.43125      98.0     2.0     0

Second Target Distribution

  

above $0.43125

up to $0.46875

     85.0     2.0     13.0

Third Target Distribution

  

above $0.46875

up to $0.5625

     75.0     2.0     23.0

Thereafter

   above $0.5625      50.0     2.0     48.0

KNOT’s Right to Reset Incentive Distribution Levels

KNOT, as the initial holder of our incentive distribution rights, has the right under our partnership agreement to elect to relinquish the right of the holders of our incentive distribution rights to receive incentive distribution payments based on the initial cash target distribution levels and to reset, at higher levels, the minimum quarterly distribution amount and cash target distribution levels upon which the incentive distribution payments to KNOT would be set. KNOT’s right to reset the minimum quarterly distribution amount and the cash

 

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target distribution levels upon which the incentive distributions payable to KNOT are based may be exercised, without approval of our unitholders or the conflicts committee of our board of directors, at any time when there are no subordinated units outstanding and we have made cash distributions to the holders of the incentive distribution rights at the highest level of incentive distribution for each of the prior four consecutive fiscal quarters. If at the time of any election to reset the minimum quarterly distribution amount and the cash target distribution levels KNOT and its affiliates are not the holders of a majority of the incentive distribution rights, then any such election to reset shall be subject to the prior written concurrence of our board of directors that the conditions described in the immediately preceding sentence have been satisfied. The reset minimum quarterly distribution amount and cash target distribution levels will be higher than the minimum quarterly distribution amount and the cash target distribution levels prior to the reset such that there will be no incentive distributions paid under the reset cash target distribution levels until cash distributions per unit following this event increase as described below. We anticipate that KNOT would exercise this reset right in order to facilitate acquisitions or internal growth projects that would otherwise not be sufficiently accretive to cash distributions per common unit, taking into account the existing levels of incentive distribution payments being made to KNOT.

In connection with the resetting of the minimum quarterly distribution amount and the cash target distribution levels and the corresponding relinquishment by KNOT of incentive distribution payments based on the cash target distribution levels prior to the reset, KNOT will be entitled to receive a number of newly issued common units based on a predetermined formula described below that takes into account the “cash parity” value of the average cash distributions related to the incentive distribution rights received by KNOT for the two quarters prior to the reset event as compared to the average cash distributions per common unit during this period. We will also issue an additional amount of general partner units in order to maintain the general partner’s ownership interest in us relative to the issuance of the additional common units.

The number of common units that KNOT would be entitled to receive from us in connection with a resetting of the minimum quarterly distribution amount and the cash target distribution levels then in effect would be equal to (x) the average amount of cash distributions received by KNOT in respect of its incentive distribution rights during the two consecutive fiscal quarters ended immediately prior to the date of such reset election divided by (y) the average of the amount of cash distributed per common unit during each of these two quarters. The issuance of the additional common units will be conditioned upon approval of the listing or admission for trading of such common units by the national securities exchange on which the common units are then listed or admitted for trading.

Following a reset election, the minimum quarterly distribution amount will be reset to an amount equal to the average cash distribution amount per unit for the two fiscal quarters immediately preceding the reset election (such amount is referred to as the “reset minimum quarterly distribution”) and the cash target distribution levels will be reset to be correspondingly higher such that we would distribute all of our available cash from operating surplus for each quarter thereafter as follows:

 

   

first, 98.0% to all unitholders, pro rata, and 2.0% to our general partner, until each unitholder receives an amount equal to 115.0% of the reset minimum quarterly distribution for that quarter;

 

   

second, 85.0% to all unitholders, pro rata, 2.0% to our general partner and 13.0% to the holders of the incentive distribution rights, pro rata, until each unitholder receives an amount per unit equal to 125.0% of the reset minimum quarterly distribution for that quarter;

 

   

third, 75.0% to all unitholders, pro rata, 2.0% to our general partner and 23.0% to the holders of the incentive distribution rights, pro rata, until each unitholder receives an amount per unit equal to 150.0% of the reset minimum quarterly distribution for that quarter; and

 

   

thereafter, 50.0% to all unitholders, pro rata, 2.0% to our general partner and 48.0% to the holders of the incentive distribution rights, pro rata.

 

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The following table illustrates the percentage allocation of available cash from operating surplus between the unitholders, our general partner and the holders of the incentive distribution rights at various levels of cash distribution levels pursuant to the cash distribution provision of our partnership agreement in effect at the closing of this offering as well as following a hypothetical reset of the minimum quarterly distribution and cash target distribution levels based on the assumption that the average quarterly cash distribution amount per common unit during the two fiscal quarters immediately preceding the reset election was $0.70.

 

    

Quarterly
Distribution
per Unit
Prior to Reset

   Marginal Percentage
Interest in Distribution
         

Quarterly
Distribution per Unit
following
Hypothetical Reset

        Unitholders     General
Partner
    Holders of
IDRs
   

Minimum Quarterly Distribution

   $0.375      98.0     2.0     0   $0.70

First Target Distribution

   up to $0.43125      98.0     2.0     0   up to $0.805(1)

Second Target Distribution

  

above $0.43125

up to $0.46875

     85.0     2.0     13.0  

above $0.805

up to $0.875(2)

Third Target Distribution

  

above $0.46875

up to $0.5625

     75.0     2.0     23.0  

above $0.875

up to $0.875(3)

Thereafter

   above $0.5625      50.0     2.0     48.0   above $1.05

 

(1) This amount is 115.0% of the hypothetical reset minimum quarterly distribution.
(2) This amount is 125.0% of the hypothetical reset minimum quarterly distribution.
(3) This amount is 150.0% of the hypothetical reset minimum quarterly distribution.

The following table illustrates the total amount of available cash from operating surplus that would be distributed to the unitholders, the general partner and the holders of the incentive distribution rights based on an average of the amounts distributed per quarter for the two quarters immediately prior to the reset. The table assumes that there are 17,135,000 common units and 349,694 general partner units outstanding, representing a 2.0% general partner interest, and that the average distribution to each common unit is $0.70 for the two quarters prior to the reset. The assumed number of outstanding units assumes the conversion of all subordinated units into common units and no additional unit issuances.

 

    Quarterly
Distribution
per Unit
Prior to
Reset
    Common
Unitholders
Cash
Distributions
Prior to Reset
          General Partner and IDR
Holders Cash Distributions

Prior to Reset
       
        Additional
Common
Units
    2.0%
General
Partner
Interest
    IDRs     Total     Total
Distributions
 

Minimum Quarterly Distribution

  $ 0.375          $ 6,425,625            0          $ 131,135      $ 0      $ 131,135      $ 6,556,760   

First Target Distribution

  $ 0.43125        963,844            0            19,670        0        19,670        983,514   

Second Target Distribution

  $ 0.46875        642,563            0            15,119        98,274        113,393        755,956   

Third Target Distribution

  $ 0.56250        1,606,406            0            42,838        492,631        535,469        2,141,875   

Thereafter

  $ 0.56250        2,356,063            0            94,243        2,261,820        2,356,063        4,712,125   
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    $ 11,994,500            0          $ 303,005      $ 2,852,726      $ 3,155,730      $ 15,150,230   
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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The following table illustrates the total amount of available cash from operating surplus that would be distributed to the unitholders, the general partner and the holders of the incentive distribution rights with respect to the quarter in which the reset occurs. The table reflects that as a result of the reset there are 21,210,323 common units and 432,864 general partner units outstanding, and that the average distribution to each common unit is $0.70. The number of additional common units was calculated by dividing (x) $2,852,726 as the average of the amounts received by KNOT in respect of its incentive distribution rights for the two quarters prior to the reset as shown in the table above by (y) the $0.70 of available cash from operating surplus distributed to each common unit as the average distributed per common unit for the two quarters prior to the reset.

 

                      General Partner and IDR
Holders Cash Distributions

After Reset
       
    Quarterly
Distribution
per Unit
After Reset
    Common
Unitholders
Cash
Distributions
After Reset
    Additional
Common
Units
    2.0%
General
Partner
Interest
    IDRs     Total     Total
Distributions
 

Minimum Quarterly Distribution

  $ 0.70        $ 11,994,500        2,852,726      $ 303,005      $         0      $ 3,155,730      $ 15,150,230   

First Target Distribution

  $ 0.805        0        0        0        0        0        0   

Second Target Distribution

  $ 0.875        0        0        0        0        0        0   

Third Target Distribution

  $ 1.05          0        0        0        0        0        0   

Thereafter

  $ 1.05          0        0        0        0        0        0   
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    $ 11,994,500        2,852,726      $ 303,005      $ 0      $ 3,155,730      $ 15,150,230   
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Assuming that it continues to hold a majority of our incentive distribution rights, KNOT will be entitled to cause the minimum quarterly distribution amount and the cash target distribution levels to be reset on more than one occasion, provided that it may not make a reset election except at a time when the holders of the incentive distribution rights have received incentive distributions for the prior four consecutive fiscal quarters based on the highest level of incentive distributions that the holders of incentive distribution rights are entitled to receive under our partnership agreement.

Distributions From Capital Surplus

How Distributions From Capital Surplus Will Be Made

We will make distributions of available cash from capital surplus, if any, in the following manner:

 

   

first, 98.0% to all unitholders, pro rata, and 2.0% to our general partner, until the minimum quarterly distribution is reduced to zero, as described below;

 

   

second, 98.0% to the common unitholders, pro rata, and 2.0% to our general partner, until we distribute for each common unit an amount of available cash from capital surplus equal to any unpaid arrearages in payment of the minimum quarterly distribution on the common units; and

 

   

thereafter, we will make all distributions of available cash from capital surplus as if they were from operating surplus.

The preceding paragraph is based on the assumption that our general partner maintains its 2.0% general partner interest and that we do not issue additional classes of equity securities.

Effect of a Distribution from Capital Surplus

The partnership agreement treats a distribution of capital surplus as the repayment of the consideration for the issuance of the units, which is a return of capital. Each time a distribution of capital surplus is made, the minimum quarterly distribution and the cash target distribution levels will be reduced in the same proportion as

 

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the distribution had to the fair market value of the common units prior to the announcement of the distribution. Because distributions of capital surplus will reduce the minimum quarterly distribution, after any of these distributions are made, it may be easier for KNOT to receive incentive distributions and for the subordinated units to convert into common units. However, any distribution of capital surplus before the minimum quarterly distribution is reduced to zero cannot be applied to the payment of the minimum quarterly distribution or any arrearages.

Once we reduce the minimum quarterly distribution and the cash target distribution levels to zero, we will then make all future distributions 50.0% to the holders of units, 2.0% to our general partner and 48.0% to the holders of the incentive distribution rights (initially, KNOT). The 2.0% interests shown for our general partner assumes that our general partner maintains its 2.0% general partner interest.

Adjustment to the Minimum Quarterly Distribution and Target Distribution Levels

In addition to adjusting the minimum quarterly distribution and cash target distribution levels to reflect a distribution of capital surplus, if we combine our units into fewer units or subdivide our units into a greater number of units, we will proportionately adjust:

 

   

the minimum quarterly distribution;

 

   

the cash target distribution levels; and

 

   

the initial unit price.

For example, if a two-for-one split of the common and subordinated units should occur, the minimum quarterly distribution, the cash target distribution levels and the initial unit price would each be reduced to 50.0% of its initial level. If we combine our common units into a lesser number of units or subdivide our common units into a greater number of units, we will combine our subordinated units or subdivide our subordinated units, using the same ratio applied to the common units. We will not make any adjustment by reason of the issuance of additional units for cash or property.

Distributions of Cash Upon Liquidation

If we dissolve in accordance with the partnership agreement, we will sell or otherwise dispose of our assets in a process called liquidation. We will apply the proceeds of liquidation in the manner set forth below.

If, as of the date three trading days prior to the announcement of the proposed liquidation, the average closing price for our common units for the preceding 20 trading days (or the current market price) is greater than the sum of:

 

   

any arrearages in payment of the minimum quarterly distribution on the common units for any prior quarters during the subordination period; plus

 

   

the initial unit price (less any prior capital surplus distributions and any prior cash distributions made in connection with a partial liquidation);

then the proceeds of the liquidation will be applied as follows:

 

   

first, 98.0% to the common unitholders, pro rata, and 2.0% to our general partner, until we distribute for each outstanding common unit an amount equal to the current market price of our common units;

 

   

second, 98.0% to the subordinated unitholders, pro rata, and 2.0% to our general partner, until we distribute for each subordinated unit an amount equal to the current market price of our common units; and

 

   

thereafter, 50.0% to all unitholders, pro rata, 48.0% to holders of incentive distribution rights and 2.0% to our general partner.

 

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If, as of the date three trading days prior to the announcement of the proposed liquidation, the current market price of our common units is equal to or less than the sum of:

 

   

any arrearages in payment of the minimum quarterly distribution on the common units for any prior quarters during the subordination period; plus

 

   

the initial unit price (less any prior capital surplus distributions and any prior cash distributions made in connection with a partial liquidation);

then the proceeds of the liquidation will be applied as follows:

 

   

first, 98.0% to the common unitholders, pro rata, and 2.0% to our general partner, until we distribute for each outstanding common unit an amount equal to the initial unit price (less any prior capital surplus distributions and any prior cash distributions made in connection with a partial liquidation);

 

   

second, 98.0% to the common unitholders, pro rata, and 2.0% to our general partner, until we distribute for each outstanding common unit an amount equal to any arrearages in payment of the minimum quarterly distribution on the common units for any prior quarters during the subordination period;

 

   

third, 98.0% to the subordinated unitholders, pro rata, and 2.0% to our general partner, until we distribute for each outstanding subordinated unit an amount equal to the initial unit price (less any prior capital surplus distributions and any prior cash distributions made in connection with a partial liquidation); and

 

   

thereafter, 50.0% to all unitholders, pro rata, 48.0% to holders of incentive distribution rights and 2.0% to our general partner.

The immediately preceding paragraph is based on the assumption that our general partner maintains its 2.0% general partner interest and that we do not issue additional classes of equity securities.

 

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SELECTED HISTORICAL FINANCIAL AND OPERATING DATA

The following table presents, in each case for the periods and as of the dates indicated, selected historical financial and operating data of KNOT Offshore Partners LP Predecessor, which includes (1) the subsidiaries of KNOT that own the Fortaleza Knutsen and the Recife Knutsen and (2) the Bodil Knutsen and the Windsor Knutsen and all of their related assets, liabilities, revenues, expenses and cash flows. This acquisition will be accounted for as a reorganization under common control and has therefore been recorded at KNOT’s historical book values. The selected historical combined financial data of KNOT Offshore Partners LP Predecessor as of and for the years ended December 31, 2011 and 2012 has been derived from the audited combined carve-out financial statements of KNOT Offshore Partners LP Predecessor, prepared in accordance with U.S. GAAP, which are included elsewhere in this prospectus.

The following financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the historical combined carve-out financial statements of KNOT Offshore Partners LP Predecessor and the notes thereto, our unaudited pro forma combined balance sheet and the notes thereto and our forecasted results of operations for the twelve months ending March 31, 2014 included elsewhere in this prospectus.

The results of operations for the year ended December 31, 2011 reflect the operations of the Fortaleza Knutsen, the Windsor Knutsen, the Bodil Knutsen and the Recife Knutsen from March 2011, April 2011, May 2011 and August 2011, respectively, when they commenced operations under their respective charters.

 

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Our financial position, results of operations and cash flows could differ from those that would have resulted if we operated autonomously or as an entity independent of KNOT in the periods for which historical financial data are presented below, and such data may not be indicative of our future operating results or financial performance.

 

     Year Ended December 31,  
             2011                 2012          
     (dollars in thousands)  

Statement of Operations Data:

    

Total revenues

   $ 43,909      $ 65,653   

Voyage expenses(1)

     2,653        —     
  

 

 

   

 

 

 

Net voyage revenues

     41,256        65,653   
  

 

 

   

 

 

 

Vessel operating expenses(2)

     10,795        13,000   

Depreciation and amortization

     16,229        21,181   

General and administrative expenses

     927        1,395   
  

 

 

   

 

 

 

Operating income

     13,305        30,077   
  

 

 

   

 

 

 

Interest income

     34        19   

Interest expense

     (9,650     (13,471

Other finance expense

     (2,741     (3,378

Realized and unrealized loss on derivative instruments

     (15,489     (6,031

Net loss on foreign currency transactions

     (3,037     (1,771
  

 

 

   

 

 

 

Income (loss) before income taxes

     (17,578     5,445   

Income tax benefit (expense)

     1,240        (1,261
  

 

 

   

 

 

 

Net income (loss)

   $ (16,338   $ 4,184   
  

 

 

   

 

 

 

Balance Sheet Data (at end of period):

    

Cash and cash equivalents

   $ 3,189      $ 1,287   

Vessels and equipment, net

     517,897        496,768   

Total assets

     534,603        515,250   

Long-term debt (including current portion)

     375,933        347,850   

Owner’s equity

     67,370        100,633   

Cash Flow Data:

    

Net cash provided by operating activities

   $ 11,473      $ 19,307   

Net cash used in investing activities

     (138,104     (52

Net cash provided by (used in) financing activities

     126,445        (21,156

Fleet Data:

    

Number of shuttle tankers in operation at end of period

     4        4   

Average age of shuttle tankers in operation at end of period (years)

     1.7        2.7   

Total calendar days for fleet

     988.7        1,464   

Total operating days for fleet(3)

     973.6        1,377   

Other Financial Data:

    

EBITDA(4)

   $ 8,267      $ 40,078   

Adjusted EBITDA(4)

     29,534        51,258   

Capital expenditures:

    

Expenditures for vessels and equipment

   $ 133,781      $ 52   

Expenditures for drydocking

     3,739        —     

 

(1)

Voyage expenses are all expenses unique to a particular voyage, including bunker fuel expenses, port fees, cargo loading and unloading expenses, canal tolls and agency fees.

 

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(2) Vessel operating expenses include crewing, repairs and maintenance, insurance, stores, lube oils and communication expenses.
(3) The operating days for our fleet is the total number of days in a given period that the vessels were in our possession less the total number of days off-hire. We define days off-hire as days lost to, among other things, operational deficiencies, drydocking for repairs, maintenance or inspection, equipment breakdowns, special surveys and vessel upgrades, delays due to accidents, crewing strikes, certain vessel detentions or similar problems, our failure to maintain the vessel in compliance with its specifications and contractual standards or to provide the required crew, or periods of commercial waiting time during which we do not earn charter hire.
(4) Non-GAAP Financial Measures

EBITDA and Adjusted EBITDA. EBITDA is defined as earnings before interest, depreciation and amortization and taxes. Adjusted EBITDA is defined as earnings before interest, depreciation and amortization, taxes and other financial items (including other finance expense, realized and unrealized loss on derivative instruments and net loss on foreign currency transactions). EBITDA is used as a supplemental financial measure by management and external users of financial statements, such as our lenders, to assess our financial and operating performance and our compliance with the financial covenants and restrictions contained in our financing agreements. Adjusted EBITDA is used as a supplemental financial measure by management and external users of financial statements, such as investors, to assess our financial and operating performance. We believe that adjusted EBITDA assists our management and investors by increasing the comparability of our performance from period to period and against the performance of other companies in our 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, depreciation and amortization and taxes, 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. We believe that including adjusted EBITDA as a financial and operating measure benefits investors in (a) selecting between investing in us and other investment alternatives and (b) monitoring our ongoing financial and operational strength in assessing whether to continue to hold common units.

EBITDA and adjusted EBITDA should not be considered alternatives to net income, operating income, cash flow from operating activities or any other measure of financial performance presented in accordance with U.S. GAAP. EBITDA and adjusted EBITDA exclude some, but not all, items that affect net income, and these measures may vary among other companies. Therefore, EBITDA and adjusted EBITDA as presented below may not be comparable to similarly titled measures of other companies. The following tables reconcile EBITDA and adjusted EBITDA to net income (loss) and net cash provided by operating activities, the most directly comparable U.S. GAAP financial measures, for the periods presented:

 

     Year Ended December 31,  
             2011                     2012          
     (dollars in thousands)  

Reconciliation to net income (loss):

    

Net income (loss)

   $ (16,338   $ 4,184   

Interest income

     (34     (19

Interest expense

     9,650        13,471   

Depreciation and amortization

     16,229        21,181   

Income tax (benefit) expense

     (1,240     1,261   
  

 

 

   

 

 

 

EBITDA

   $ 8,267      $ 40,078   

Other financial items(a)

     21,267        11,180   
  

 

 

   

 

 

 

Adjusted EBITDA

   $ 29,534      $ 51,258   
  

 

 

   

 

 

 

 

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

 

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     Year Ended December 31,  
             2011                     2012          
     (dollars in thousands)  

Reconciliation to net cash provided by operating activities:

    

Net cash provided by operating activities

   $ 11,473      $ 19,307   

Interest income

     (34     (19

Interest expense

     9,650        13,471   

Amortization of contract intangibles / liabilities

     868        1,518   

Amortization of deferred debt issuance cost

     (658     (982

Unrealized loss on derivative instruments

     (8,923     (549

Unrealized loss on foreign currency transactions

     (3,056     (579

Other items

     (2,677     426   

Changes in operating assets and liabilities:

    

Decrease (increase) in trade accounts receivable

     93        6   

Decrease (increase) in receivables from owners and affiliates

     (386     —     

Decrease (increase) in inventories

     (218     71   

Decrease (increase) in other current assets

     211        5,048   

Increase (decrease) in trade accounts payable

     7,874        334   

Increase (decrease) in accrued expenses

     (324     342   

Increase (decrease) in prepaid revenue

     (5,626     1,684   
  

 

 

   

 

 

 

EBITDA

   $ 8,267      $ 40,078   

Other financial items(a)

     21,267        11,180   
  

 

 

   

 

 

 

Adjusted EBITDA

   $ 29,534      $ 51,258   
  

 

 

   

 

 

 

 

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

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion of our financial condition and results of operations in conjunction with the historical combined carve-out financial statements and related notes of KNOT Offshore Partners LP Predecessor included elsewhere in this prospectus. Among other things, those financial statements include more detailed information regarding the basis of presentation for the following information. The combined carve-out financial statements of KNOT Offshore Partners LP Predecessor have been prepared in accordance with U.S. GAAP and are presented in U.S. Dollars.

Some of the information contained in this discussion includes forward-looking statements based on assumptions about our future business. Our actual results could differ materially from those contained in those forward-looking statements. Please read “Forward-Looking Statements” for more information. You should also review the “Risk Factors” for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by those forward-looking statements.

Prior to the closing of this offering, our partnership will not own any vessels. The following discussion assumes that our business was operated as a separate entity prior to its inception. The entities that own the Fortaleza Knutsen and the Recife Knutsen and the newly formed entities that will acquire the Bodil Knutsen and the Windsor Knutsen and all of their related assets, liabilities, revenues, expenses and cash flows (collectively, the “Predecessor”) will be accounted for as a reorganization under common control and have therefore been recorded at KNOT’s historical book values. The combined carve-out financial statements, the results of which are discussed below, have been carved out of the consolidated financial statements of Knutsen NYK Offshore Tankers AS, or KNOT, which operated the vessels in our fleet during the periods presented. KNOT’s vessels and other assets, liabilities, revenues, expenses and cash flows that do not relate to the vessels or time charter contracts to be acquired by us are not included in our combined carve-out financial statements. Our financial position, results of operations and cash flows reflected in our combined carve-out financial statements include all expenses allocable to our business, but may not be indicative of those that would have been incurred had we operated as a separate public entity for all periods presented or of future results. Our independent registered public accounting firm’s audit report included in this prospectus relates to historical combined carve-out financial statements of KNOT Offshore Partners LP Predecessor. That audit report does not extend to the tables contained in this section and should not be read to do so. Accordingly, the following financial information has been derived from the historical combined carve-out financial statements and accounting records of the Predecessor and reflects significant assumptions and allocations. Other than as discussed below under “—Items You Should Consider When Evaluating Our Historical Financial Performance and Assessing Our Future Prospects,” the vessels and all of their related assets, liabilities, revenues, expenses and cash flows contributed to us in connection with this offering reflect all of the net assets included in the combined carve-out financial statements in the periods discussed below. We manage our business and analyze and report our results of operations in a single segment.

Overview

We are a limited partnership formed to own, operate and acquire shuttle tankers under long-term charters, which we define as charters of five years or more. Our initial fleet of shuttle tankers will be contributed to us by KNOT. KNOT is jointly owned by TS Shipping Invest AS, or TSSI, and Nippon Yusen Kaisha, or NYK. TSSI is controlled by our Chairman and is a private Norwegian company with ownership interests in shuttle tankers, LNG tankers and product/chemical tankers. NYK is a Japanese public company with a fleet of approximately 800 vessels, including bulk carriers, containerships, tankers and specialized vessels.

Upon the closing of this offering, we will have a modern fleet of shuttle tankers that will operate under long-term charters with major oil and gas companies engaged in offshore production such as BG Group, Statoil and Transpetro. We intend to operate our vessels under long-term charters with stable cash flows and to grow our

 

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position in the shuttle tanker market through acquisitions from KNOT and third parties. We also believe we can grow organically by continuing to provide reliable customer service to our charterers and leveraging KNOT’s relationships, expertise and reputation.

Our Fleet

Upon the closing of this offering, our initial fleet will consist of:

 

   

the Fortaleza Knutsen, a shuttle tanker built in 2011 that is currently operating under a bareboat charter that expires in March 2023 with Petrobras Transporte S.A., or Transpetro;

 

   

the Recife Knutsen, a shuttle tanker built in 2011 that is currently operating under a bareboat charter that expires in August 2023 with Transpetro;

 

   

the Bodil Knutsen, a shuttle tanker built in 2011 that is currently operating under a time charter that expires in May 2016 with Statoil ASA, or Statoil, with options to extend until May 2019; and

 

   

the Windsor Knutsen, a shuttle tanker built in 2007 and retrofitted from a conventional crude oil tanker to a shuttle tanker in 2011 that is currently operating under a time charter that expires in April 2014 with BG Group Plc, or BG Group, with options to extend until April 2016.

Pursuant to the omnibus agreement we will enter into with KNOT at the closing of this offering, we will have the right to purchase from KNOT any shuttle tankers operating under charters of five or more years. This right will continue throughout the entire term of the omnibus agreement. In addition, we will have the right to purchase the newbuild shuttle tanker the Carmen Knutsen within 24 months after the closing of this offering and will have the right to purchase four additional newbuild shuttle tankers, Hull 2531, Hull 2532, Hull 2575 and Hull 574, from KNOT within 24 months after KNOT notifies our board of directors of each vessel’s respective acceptances by their charterers, in each case, if their respective purchase price is agreed upon by us in accordance with the provisions of the omnibus agreement.

Our Charters

We generate revenues by charging customers for the transportation of their crude oil using our vessels. These services are provided under the following basic types of contractual relationships:

 

   

Time charters, whereby the vessels that we operate and are responsible for the crewing of are chartered to customers for a fixed period of time at hire rates that are generally fixed and increase annually based on a fixed percentage increase or fixed schedule to enable us to offset expected increases in operating costs. Under our time charters, hire payments may be reduced if the vessel does not perform to certain of its specifications, such as if the average vessel speed falls below a guaranteed speed or the amount of fuel consumed to power the vessel under normal circumstances exceeds a guaranteed amount, and the customer is responsible for any voyage expenses incurred; and

 

   

Bareboat charters, whereby customers charter our vessels for a fixed period of time at rates that are generally fixed, but the customers are responsible for the vessel operation and bear the operating and voyage expenses, including crewing and other operational services.

The table below compares the primary features of a time charter and a bareboat charter:

 

     Time Charter    Bareboat Charter

Typical charter length

   One year or more    One year or more

Hire rate basis(1)

   Daily    Daily

Voyage expenses(2)

   Customer pays    Customer pays

Vessel operating expenses(2)

   Owner pays    Customer pays

Off-hire(3)

   Varies    Customer typically pays

 

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(1) “Hire” rate refers to the basic payment from the charterer for the use of the vessel.
(2) Defined below under “—Important Financial and Operational Terms and Concepts.”
(3) “Off-hire” refers to the time a vessel is not available for service. Our time charters contain provisions whereby the customer is generally not required to pay the hire rate during “off-hire.” Our bareboat charters do not contain such provisions.

Historical Employment of Our Fleet

The following table describes the operations of the vessels in our fleet during the periods for which historical results for KNOT Offshore Partners LP Predecessor are presented.

 

Vessel

  

Description of Historical Operations

Fortaleza Knutsen

   Delivered in March 2011. Has operated under a long-term bareboat charter with Transpetro, which commenced on delivery.

Recife Knutsen

   Delivered in August 2011. Has operated under a long-term bareboat charter with Transpetro, which commenced on delivery.

Bodil Knutsen

   Delivered in February 2011 from the shipyard. Completed an interim spot voyage and testing prior to commencing operations under a long-term time charter with Statoil in May 2011.

Windsor Knutsen

   Delivered in May 2007. Operated as a conventional crude oil tanker under short-term time charters and in the spot market from its delivery until commencement of retrofitting in November 2010. Has operated under long-term time charter with BG Group since April 2011 following completion of its retrofitting as a shuttle tanker.

Items You Should Consider When Evaluating Our Historical Financial Performance and Assessing Our Future Prospects

You should consider the following facts when evaluating our historical results of operations and assessing our future prospects:

 

   

The size of our fleet continues to change. Our historical results of operations reflect changes in the size and composition of our fleet due to certain vessel conversions and deliveries. For example, the Windsor Knutsen was built in 2007 and operated as a conventional crude oil tanker until November 2010 when it entered the shipyard to be retrofitted from a conventional crude oil tanker to a shuttle tanker. In addition, each of the Fortaleza Knutsen, Recife Knutsen and Bodil Knutsen were delivered from the shipyard during 2011 and did not have any historical operations prior to that time. In addition, pursuant to the omnibus agreement, we will have the right to purchase from KNOT any shuttle tankers operating under charters of five or more years, and we will have the right to purchase from KNOT five additional newbuild shuttle tankers, the Carmen Knutsen, Hull 2531, Hull 2532, Hull 2575 and Hull 574, if its respective purchase price is agreed upon in accordance with the provisions of the omnibus agreement. Furthermore, we may grow through the acquisition in the future of additional vessels as part of our growth strategy.

 

   

Upon completion of this offering, our leverage and associated finance expenses will be reduced. We intend to amend our existing financing agreements in connection with this offering, repay certain outstanding balances with the proceeds of this offering, and, therefore, expect to have less debt outstanding and lower interest expense upon completion of this offering. Also, a majority of our external vessel financing agreements have been guaranteed by either KNOT or TSSI for which a guarantee commission was paid. Following the completion of this offering, we will guarantee the obligations of our subsidiaries directly under the vessel financing agreements and therefore will not

 

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incur any guarantee commissions on a going forward basis. For descriptions of our existing financing agreements, please read “—Liquidity and Capital Resources—Borrowing Activities.” In addition, our historical operations have relied on funding from related parties, which will be treated as a net contribution of capital upon the closing of this offering. We do not expect to have funding from related parties after the closing of this offering.

 

   

Our historical results of operations are affected by significant losses relating to derivative transactions. Our historical results of operations reflect significant losses relating to interest rate swap and foreign exchange contracts. These existing derivative instruments entered into by KNOT will not be transferred to us upon the closing of this offering. From time to time, we may enter into (1) interest rate swap transactions to economically hedge all or a portion of our exposure to floating interest rates and (2) foreign currency swap contracts to economically hedge risk from foreign currency fluctuations.

 

   

Our historical results of operations are affected by fluctuations in currency exchange rates. All of the vessels in our initial fleet are on time charters and bareboat charters with hire rates payable in U.S. Dollars. In addition, we will have the right to purchase from KNOT five additional newbuild shuttle tankers that will operate under time charters with hire rates payable in U.S. Dollars. Approximately 30% and 27% of the vessel operating expenses related to our vessels operating under time charters are denominated in U.S. Dollars and approximately 48% and 57% of such vessel operating expenses are denominated in Norwegian Kroner, or NOK, for the years ended December 31, 2011 and 2012, respectively. The composition of our vessel operating expenses may vary over time depending upon the location of future charters and/or the composition of our crews. All of our financing and interest expenses are also denominated in U.S. Dollars. We anticipate that all of our future financing agreements will also be denominated in U.S. Dollars.

 

   

Our historical results of operations reflect allocated administrative costs that may not be indicative of future administrative costs. The administrative costs included in our historical results of operations have been determined by allocating certain of KNOT’s administrative costs, after deducting costs directly charged to KNOT’s subsidiaries for services provided by the administrative staff and shareholder costs, to us principally based on the size of our fleet in relation to the size of KNOT’s fleet. These allocated costs may not be indicative of our future administrative costs. In connection with this offering, we will enter into an administrative services agreement with KNOT UK, pursuant to which KNOT UK will provide us with certain administrative services. KNOT UK will be permitted to subcontract certain of the administrative services provided under this agreement to KOAS UK and KOAS. We will reimburse KNOT UK, and KNOT UK will reimburse KOAS UK and KOAS, as applicable, for their reasonable costs and expenses incurred in connection with the provision of the services subcontracted to KOAS UK and KOAS under the administrative services agreement. In addition, KNOT UK will pay to KOAS UK and KOAS, as applicable, a service fee in U.S. Dollars equal to 5% of the costs and expenses incurred in connection with providing services.

 

   

We will incur additional general and administrative expense as a publicly traded partnership. We expect we will incur approximately $2.5 million in additional general and administrative expenses as a publicly traded limited partnership that we have not previously incurred, including costs associated with annual reports to unitholders, investor relations, registrar and transfer agent fees, audit fees, legal fees, incremental director and officer liability insurance costs and directors’ compensation.

 

   

We will be subject to a one-time entrance tax into the Norwegian tonnage tax regime. Our Norwegian subsidiaries will be subject to a one-time entrance tax into the tonnage tax regime due to our acquisition of the shares in the subsidiary that owns the Fortaleza Knutsen and the Recife Knutsen. The entrance tax arises when the related party seller is taxed under the ordinary tax regime and the buyer is taxed under the tonnage tax regime. The tax is based on the difference between the market value of the shares and the seller’s tax value of the shares as of the date of contribution. The entrance tax on this gain is payable over several years and is calculated by multiplying the tax rate of 28% by the declining balance of the gain, which will decline by 20% each year. For a discussion of the

 

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estimated amounts of the entrance tax, please read “Our Cash Distribution Policy and Restrictions on Distributions—Forecast Assumptions and Considerations—Summary of Significant Accounting Policies—Income Taxes.”

 

   

Our historical results of operations reflect income taxes for part of the activities under the ordinary tax regime in Norway. We expect that our Norwegian subsidiaries will be subject only to Norwegian tonnage tax rather than a combination of ordinary taxation and tonnage taxation as reflected in the combined carve-out financial statements. Under the tonnage tax regime, the tax is based on the tonnage of the vessel and operating income is tax free. Tonnage tax is calculated based on the vessel’s net tonnage (in thousands), according to its certificate, multiplied by the days in operation and the applicable dayrate. The net financial income and expense remains taxable as ordinary income tax at the regular corporate income tax rate of 28% for Norwegian subsidiaries subject to the tonnage tax regime. Based upon the expected change in tax status of our Norwegian subsidiaries, the majority of the deferred tax assets and liabilities included in the combined carve-out balance sheets will be reversed with an offset to the income statement upon entering the tonnage tax regime.

Factors Affecting Our Results of Operations

We believe the principal factors that will affect our future results of operations include:

 

   

our ability to successfully employ our vessels at economically attractive hire rates as long-term charters expire or are otherwise terminated;

 

   

our ability to maintain good relationships with our existing customers and to increase the number of customer relationships, including whether BG Group and Statoil exercise their options to extend their time charters of the Windsor Knutsen and the Bodil Knutsen, respectively, for three years;