1) Description of Business

KNOT Offshore Partners LP (the “Partnership”) is a publicly traded Marshall Islands limited partnership initially formed for the purpose of acquiring 100% ownership interests in four shuttle tankers owned by Knutsen NYK Offshore Tankers AS (“KNOT”) in connection with the Partnership’s initial public offering of common units (the “IPO”) which was completed in April 2013.

As of June 30, 2015, the Partnership had a fleet of nine shuttle tankers, the Windsor Knutsen, the Bodil Knutsen, the Recife Knutsen, the Fortaleza Knutsen, the Carmen Knutsen, the Hilda Knutsen, the Torill Knutsen, the Dan Cisne, and the Dan Sabia, each referred to as a “Vessel” and, collectively, as the “Vessels.” The Vessels operate under fixed long-term charter contracts to charterers, except for the Windsor Knutsen. In April 2014, the Partnership was notified that BG Group Plc (“BG Group”) would not exercise its option to extend the Windsor Knutsen time charter after the expiration of its initial term. In July 2014, the vessel was re-delivered. In June 2014, the Partnership entered into a new two-year time charter contract, which was subsequently amended in June 2015, with BG Group for the Windsor Knutsen that will commence in the fourth quarter of 2015. The time charter with BG Group has six one-year extension options. Prior to the commencement of its time charter with BG Group, the Windsor Knutsen will be employed under a time-charter with KNOT. The time charter for the Bodil Knutsen expires in 2016 and contains customer options for extension through 2019. The Recife Knutsen and the Fortaleza Knutsen are under bareboat charter contracts that expire in 2023. The time charter for the Carmen Knutsen expires in 2018 and contains customer options for extension through 2021. The time charters for the Hilda Knutsen and the Torill Knutsen each expire in 2018 and contain a customer option for extension through 2023. The Dan Cisne and the Dan Sabia are under bareboat charter contracts that expire in 2023 and 2024, respectively.

2) Summary of Significant Accounting Policies

(a) Basis of Preparation

The accompanying unaudited condensed consolidated and combined carve-out financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and applicable rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”) for interim financial information. All intercompany balances and transactions are eliminated. The unaudited condensed consolidated and combined carve-out financial statements do not include all the disclosures and information required for a complete set of annual financial statements; and, therefore, these unaudited condensed consolidated and combined carve-out financial statements should be read in conjunction with the audited consolidated and combined carve-out financial statements for the year ended December 31, 2014, which are included in the Partnership’s Annual Report on Form 20-F (the “20-F”).

Under the Partnership’s First Amended and Restated Agreement of Limited Partnership (the “Partnership Agreement”), KNOT Offshore Partners GP LLC, a wholly owned subsidiary of KNOT, and the general partner of the Partnership (the “General Partner”), has irrevocably delegated to the Partnership’s board of directors the power to oversee and direct the operations of, manage and determine the strategies and policies of the Partnership. During the period from the Partnership’s IPO in April 2013 until the time of the Partnership’s first annual general meeting (“AGM”) on June 25, 2013, the General Partner retained the sole power to appoint, remove and replace all members of the Partnership’s board of directors. From the first AGM, four of the seven board members became electable by the common unitholders and accordingly, from this date, KNOT, as the owner of the General Partner, no longer retains the power to control the Partnership’s board of directors and, hence, the Partnership. As a result, the Partnership is no longer considered to be under common control with KNOT and as a consequence, the Partnership will not account for any vessel acquisitions from KNOT after June 25, 2013 as a transfer of equity interests between entities under common control.

In June 2014, December 2014, and June 2015, the Partnership acquired from KNOT a 100% interest in the subsidiaries that own and operate the Hilda Knutsen and the Torill Knutsen, the Dan Cisne, and the Dan Sabia, respectively. Accordingly, the results of these acquisitions are consolidated into the Partnership’s results from the respective dates of their acquisition. The Partnership accounted for these acquisitions as an acquisition of a business.

(b) Significant accounting policies

The accounting policies adopted in the preparation of the unaudited condensed consolidated and combined carve-out interim financial statements are consistent with those followed in the preparation of the Partnership’s audited consolidated and combined carve-out financial statements for the year ended December 31, 2014, as contained in the Partnership’s 20-F.

 

(c) Accounting pronouncement not yet adopted

In May 2014, the Financial Accounting Standards Board (or FASB) and the International Accounting Standards Board (IASB) issued a comprehensive revenue recognition standard that will supersede existing revenue guidance under US GAAP and IFRS, Accounting Standards Update 2014-09, Revenue from Contracts with Customers, (or ASU 2014-09) for U.S. GAAP. ASU 2014-09 will require an entity to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This update creates a five-step model that requires an entity to exercise judgment when considering the terms of the contract(s) which include (i) identifying the contract(s) with the customer, (ii) identifying the separate performance obligations in the contract, (iii) determining the transaction price, (iv) allocating the transaction price to the separate performance obligations, and (v) recognizing revenue when each performance obligation is satisfied. In August 2015, FASB issued an ASU (ASU 2015-14) to defer by one year the effective dates of its new revenue recognition standard for public and non-public entities reporting under US GAAP. As a result, the standard (ASU 2014-09) will be effective for public entities for annual reporting periods beginning after December 15, 2017 (2018 for calendar-year public entities) and interim periods therein. ASU 2014-09 shall be applied retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. Early adoption is not permitted under U.S. GAAP. The Partnership is evaluating the effect of adopting this new accounting guidance.

In August 2014, FASB issued Presentation of Financial Statements – Going Concern (Subtopic 205-40), Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (ASU 2014-15). ASU 2014-15 requires management to evaluate whether there are conditions and events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the financial statements are issued (or available to be issued when applicable) and, if so, disclose that fact. Management will be required to make this evaluation for both annual and interim reporting periods, if applicable. Management also is required to evaluate and disclose whether its plans alleviate that doubt. The standard is effective for annual periods after December 15, 2016 and interim periods within annual periods beginning after December 15, 2016. Early adoption is permitted. The Partnership is evaluating the effect of adopting this new accounting guidance. The Partnership does not expect the adoption of this standard to have a material impact on the consolidated and combined financial statements.

In April 2015, the FASB issued ASU 2015-03, Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. ASU 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. For KNOT Offshore Partners LP as a public business entity, the guidance is effective for annual and interim periods beginning after 15 December 2015. Early adoption is permitted. The Partnership has not yet adopted ASU 2015-03, Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. The adoption of the new standard will have an impact on the balance sheets and reduce total assets and total liabilities. Also the implementation will be applied retrospectively.

3) Segment Information

The Partnership has not presented segment information as it considers its operations to occur in one reportable segment, the shuttle tanker market. As of June 30, 2015, the Partnership’s fleet consisted of nine vessels and operated under five time charters and four bareboat charters. As of June 30, 2014, the Partnership’s fleet consisted of seven vessels and operated under five time charters and two bareboat charters. Under the time charters and bareboat charters, the charterer, not the Partnership, controls the choice of which trading areas the applicable Vessel will serve. Accordingly, the Partnership’s management, including the chief operating decision makers, does not evaluate performance according to geographical region.

The following table presents revenues and percentage of consolidated and combined revenues for customers that accounted for more than 10% of the Partnership’s consolidated and combined revenues during the six months ended June 30, 2015 and 2014. All of these customers are subsidiaries of major international oil companies, except KNOT, which is currently chartering the Windsor Knutsen until she is delivered to BG Group in fourth quarter of 2015.

 

		Three Months Ended June 30,																Six Months Ended June 30,
(U.S. Dollars in thousands)		2015								2014								2015								2014
Fronape International Company, a subsidiary of Petrobras Transporte S.A.		$	9,206				25	%		$	6,289				28	%		$	17,882				24	%		$	12,512				29	%
Eni Trading and Shipping S.pA			11,686				32	%			—				—				23,190				32	%			—				—
Statoil ASA			5,783				16	%			5,646				26	%			11,481				16	%			11,113				25	%
Repsol Sinopec Brasil, S.A., a subsidiary of Repsol Sinopec Brasil, B.V.			5,070				13	%			5,070				23	%			10,085				14	%			10,085				23	%
Brazil Shipping I Limited, a subsidiary of BG Group Plc			—				—				5,111				23	%			—				—				10,172				23	%
KNOT			5,236				14	%			—				—				10,414				14	%			—				—

4) Goodwill Impairment Charge

During the three months ended June 30, 2015, the Partnership concluded that indicators of impairment were present due to a significant reduction in the price of the Partnership’s common units during the past few months. Consequently, the Partnership performed an interim vessel and goodwill impairment analysis as of June 30, 2015 on its fleet, concluding that there was no impairment to the vessels’ values. However, the Partnership determined that the carrying value of the goodwill exceeded its fair value. The impairment charge relates mainly to capitalized goodwill which arose in 2008 when the Partnership’s predecessor acquired the Windsor Knutsen and three other vessels then under construction, in a transaction that was then accounted for as a step transaction. As a result, a goodwill impairment charge of $6.2 million was recognized in the condensed consolidated and combined carve-out financial statements for the three and six months ended June 30, 2015. The fair value was determined using the present value of the expected future cash flows discounted at a rate equivalent to a market participant’s weighed average cost of capital. The estimates and assumptions regarding expected future cash flows and appropriate discount rates are in part based upon existing contracts, future shuttle tanker rates, historical experience, financial forecasts and industry trends and conditions. This non-cash impairment charge, which does not affect the Partnership’s operations, cash flows, liquidity, or any of its loan covenants, reduced the Partnership’s remaining goodwill balance to zero as of June 30, 2015.

5) Derivative Instruments

The unaudited condensed consolidated and combined carve-out financial statements include the results of interest rate swap contracts to manage the Partnership’s exposure related to changes in interest rates on its variable rate debt instruments and the results of foreign exchange forward contracts to manage its exposure related to changes in currency exchange rates on its operating expenses, mainly crew expenses, in currency other than U.S. Dollars and on its contract obligations. The Partnership does not apply hedge accounting for derivative instruments. The Partnership does not speculate using derivative instruments.

By using derivative financial instruments to economically hedge exposures to changes in interest rates, the Partnership exposes itself to credit risk and market risk. Derivative instruments that economically hedge exposures are used for risk management purposes, but these instruments are not designated as hedges for accounting purposes. Credit risk is the failure of the counterparty to perform under the terms of the derivative instrument. When the fair value of a derivative instrument is positive, the counterparty owes the Partnership, which creates credit risk for the Partnership. When the fair value of a derivative instrument is negative, the Partnership owes the counterparty, and, therefore, the Partnership is not exposed to the counterparty’s credit risk in those circumstances. The Partnership minimizes counterparty credit risk in derivative instruments by entering into transactions with major banking and financial institutions. The derivative instruments entered into by the Partnership do not contain credit risk-related contingent features. The Partnership has not entered into master netting agreements with the counterparties to its derivative financial instrument contracts.

Market risk is the adverse effect on the value of a derivative instrument that results from a change in interest rates, currency exchange rates or commodity prices. The market risk associated with interest rate contracts is managed by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken.

The Partnership assesses interest rate risk by monitoring changes in interest rate exposures that may adversely impact expected future cash flows and by evaluating economical hedging opportunities.

The Partnership has historically used variable interest rate mortgage debt to finance its vessel construction or conversions. The variable interest rate mortgage debt obligations expose the Partnership to variability in interest payments due to changes in interest rates. The Partnership believes that it is prudent to limit the variability of a portion of its interest payments. To meet this objective, the Partnership entered into London Interbank Offered Rate (“LIBOR”)-based interest rate swap contracts to manage fluctuations in cash flows resulting from changes in the benchmark interest rate of LIBOR. These swaps change the variable rate cash flow exposure on the mortgage debt obligations to fixed cash flows. Under the terms of the interest rate swap contracts, the Partnership receives LIBOR-based variable interest rate payments and makes fixed interest rate payments, thereby creating the equivalent of fixed rate debt for the notional amount of its debt hedged.

As of June 30, 2015, the Partnership had entered into various interest swap agreements for a total notional amount of $412.3 million to hedge against the interest rate risks of its variable rate borrowings. Under the terms of the interest rate swap agreements, the Partnership receives interest based on three or six month LIBOR and pays a weighted average interest rate of 1.55%.

 

As of June 30, 2015 and December 2014, the total notional amount of the Partnership’s outstanding interest rate swap contracts that were entered into in order to hedge outstanding or forecasted debt obligations were $412.3 million and $382.3 million, respectively. As of June 30, 2015 and December 31, 2014, the carrying amount of the interest rate swaps contracts were net liabilities of $4.4 million and $1.7 million, respectively. See Note 6 —Fair Value Measurements.

Changes in the fair value of interest rate swap contracts are reported in realized and unrealized gain (loss) on derivative instruments in the same period in which the related interest affects earnings.

The Partnership and its subsidiaries utilize the U.S. Dollar as their functional and reporting currency, because all of their revenues and the majority of their expenditures, including the majority of their investments in 9 vessels and their financing transactions, are denominated in U.S. Dollars. The Partnership’s predecessor also from time to time contracted vessels with contractual obligations to pay the yards in currencies other than the U.S. Dollar. Payment obligations in currencies other than the U.S. Dollar, and in particular operating expenses in Norwegian Kroner (NOK), expose the Partnership to variability in currency exchange rates. The Partnership believes that it is prudent to limit the variability of a portion of its currency exchange exposure. To meet this objective, the Partnership entered into foreign exchange forward contracts to manage fluctuations in cash flows resulting from changes in the exchange rates towards the U.S. Dollar. The agreements change the variable exchange rate to fixed exchange rates at agreed dates.

As of June 30, 2015 and December 31, 2014, the total contract amount in foreign currency of the Partnership’s outstanding foreign exchange forward contracts that were entered into to economically hedge outstanding future payments in currencies other than the U.S. Dollar were NOK 166.6 million and NOK 127.9 million, respectively. As of June 30, 2015 and December 31, 2014, the carrying amount of the Partnership’s foreign exchange forward contracts was a liability of $3.9 million and $2.7 million, respectively. See Note 6 —Fair Value Measurements.

The following table presents the realized and unrealized gains and losses that are recognized in earnings as net gain (loss) on derivative instruments for the three and six months ended June 30, 2015 and 2014:

 

		Three Months Ended June 30,								Six Months Ended June 30,
(U.S. Dollars in thousands)		2015				2014				2015				2014
Realized gain (loss)
Interest rate swap contracts		$	(1,333	)		$	(700	)		$	(2,359	)		$	(1,254)
Foreign exchange forward contracts			—				—				—				500
Unrealized gain (loss)
Interest rate swap contracts			1,241				(1,642	)			(1,834	)			(1,294)
Foreign exchange forward contracts			345				—				(1,177	)			(248)
Total realized and unrealized (loss) gain			253				(2,342	)			(5,370	)			(2,296)

 

6) Fair Value Measurements

(a) Fair Value of Financial Instruments

The following table presents the carrying amounts and estimated fair values of the Partnership’s financial instruments as of June 30, 2015 and December 31, 2014. Fair value is defined as the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

 

		June 30, 2015								December 31, 2014
(U.S. Dollars in thousands)		Carrying     Amount				Fair Value				Carrying     Amount				Fair Value
Financial assets:
Cash and cash equivalents		$	71,403			$	71,403			$	30,746			$	30,746
Non-current derivative assets:
Interest rate swap contracts			955				955				2,966				2,966
Financial liabilities:
Current derivative liabilities:
Interest rate swap contracts			5,332				5,332				4,708				4,708
Foreign exchange forward contract			3,919				3,919				2,742				2,742
Non-current derivative liabilities:
Interest rate swap contracts			—				—				—				—
Long-term debt, current and non-current			618,832				618,832				613,221				613,221

The carrying amounts shown in the table above are included in the consolidated and combined carve-out balance sheets under the indicated captions. The carrying value of trade accounts receivable, trade accounts payable and receivables/payables to owners and affiliates approximate their fair value.

The fair values of the financial instruments shown in the above table as of June 30, 2015 and December 31, 2014 represent the amounts that would be received to sell those assets or that would be paid to transfer those liabilities in an orderly transaction between market participants at that date. Those fair value measurements maximize the use of observable inputs. However, in situations where there is little, if any, market activity for the asset or liability at the measurement date, the fair value measurement reflects the Partnership’s own judgment about the assumptions that market participants would use in pricing the asset or liability. Those judgments are developed by the Partnership based on the best information available in the circumstances, including expected cash flows, appropriately risk-adjusted discount rates and available observable and unobservable inputs.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments:

 

•

Cash and cash equivalents and restricted cash: The fair value of the Partnership’s cash balances approximates the carrying amounts due to the current nature of the amounts.

 

•

Foreign exchange forward contracts: The fair value is calculated using mid-rates (excluding margins) as determined by counterparties based on available market rates as of the balance sheet date. The fair value is discounted from the value at expiration to the current value of the contracts.

 

•

Interest rate swap contracts: The fair value of interest rate swap contracts is determined using an income approach using the following significant inputs: the term of the swap, the notional amount of the swap, discount rates interpolated based on relevant LIBOR swap curves and the rate on the fixed leg of the swap.

 

•

Long-term debt: With respect to long-term debt measurements, the Partnership uses market interest rates and adjusts that rate for all necessary risks, including its own credit risk. In determining an appropriate spread to reflect its credit standing, the Partnership considered interest rates currently offered to KNOT for similar debt instruments of comparable maturities by KNOT’s and the Partnership’s bankers as well as other banks that regularly compete to provide financing to the Partnership. As all long-term debt of the Partnership was refinanced in the period from June 2014 to November 2014, the fair value is based on the margin obtained in the refinancing and therefore the fair value equals the carrying value as of June 30, 2015 and December 31, 2014.

(b) Fair Value Hierarchy

The following table presents the placement in the fair value hierarchy of assets and liabilities that are measured at fair value on a recurring basis (including items that are required to be measured at fair value or for which fair value is required to be disclosed) as of June 30, 2015 and December 31, 2014:

 

						Fair Value Measurements at Reporting Date Using
(U.S. Dollars in thousands)		June 30,      2015				Quoted Price     in Active Markets for Identical Assets (Level  1)				Significant Other     Observable     Inputs (Level 2)				Significant   Unobservable   Inputs (Level 3)
Financial assets:
Cash and cash equivalents		$	71,403			$	71,403			$	—			$	—
Non-current derivative assets:
Interest rate swap contracts			955				—				955				—
Financial liabilities:
Current derivative liabilities:
Interest rate swap contracts			5,332				—				5,332				—
Foreign exchange forward contracts			3,919				—				3,919				—
Non-current derivative liabilities:
Interest rate swap contracts			—				—				—				—
Long-term debt, current and non-current			618,832				—				618,832				—

 

						Fair Value Measurements at Reporting Date Using
(U.S. Dollars in thousands)		December 31,      2014				Quoted Price     in Active Markets for Identical Assets (Level  1)				Significant Other   Observable     Inputs (Level 2)				Significant   Unobservable   Inputs (Level 3)
Financial assets:
Cash and cash equivalents		$	30,746			$	30,746			$	—			$	—
Non-current derivative assets:
Interest rate swap contracts			2,966				—				2,966				—
Financial liabilities:
Current derivative liabilities:
Interest rate swap contracts			4,708				—				4,708				—
Foreign exchange forward contracts			2,742				—				2,742				—
Non-current derivative liabilities:
Interest rate swap contracts			—				—				—				—
Long-term debt, current and non-current			613,221				—				613,221				—

The Partnership’s accounting policy is to recognize transfers between levels of the fair value hierarchy on the date of the event or change in circumstances that caused the transfer. There were no transfers into or out of Level 1, Level 2 or Level 3 as of June 30, 2015 and December 31, 2014

7) Long-Term Debt

As of June 30, 2015 and December 31, 2014, the Partnership had the following debt amounts outstanding:

 

(U.S. Dollars in thousands)		Vessel		June 30,      2015				December 31,   2014
$220 million loan facility		Windsor Knutsen, Bodil Knutsen, Carmen Knutsen		$	204,286			$	212,142
$20 million revolving credit facility		Windsor Knutsen, Bodil Knutsen, Carmen Knutsen			—				20,000
$140 million loan facility		Fortaleza Knutsen & Recife Knutsen			131,250				135,625
$117 million loan facility		Hilda Knutsen			84,260				86,724
$117 million loan facility		Torill Knutsen			85,496				87,960
$172.5 million loan facility		Dan Cisne, Dan Sabia			113,540				58,770
$12.0 million Seller’s Credit					—				12,000
Total long-term debt					618,832				613,221
Less current installments					42,718				38,718
Less $12.0 million Seller’s Credit					—				12,000
Long-term debt, excluding current installments and Seller’s Credit				$	576,114			$	562,503

The Partnership’s outstanding debt of $618.8 million as of June 30, 2015 is repayable as follows:

 

(US $ in thousands)		Period   repayment				Balloon   repayment
Remainder of 2015		$	21,359			$	—
2016			43,118				—
2017			43,518				—
2018			42,587				136,500
2019			23,332				237,678
2020 and thereafter			57,800				12,940
Total		$	231,714			$	387,118

As of June 30, 2015, the interest rates on the Partnership’s loan agreements were LIBOR plus a fixed margin ranging from 2.125% to 2.5%.

In June 2014, the Partnership’s subsidiaries KNOT Shuttle Tankers 18 AS, KNOT Shuttle Tankers 17 AS and Knutsen Shuttle Tankers 13 AS entered into a senior secured loan facility in an aggregate amount of $240 million (the “Senior Secured Loan Facility”). The Senior Secured Loan Facility consists of (i) a $220 million term loan (the “Term Loan Facility”) and (ii) a $20 million revolving credit facility (the “Revolving Credit Facility”). The Revolving Credit Facility was undrawn as of June 30, 2015. In June 2014, the Partnership’s subsidiary Knutsen Shuttle Tankers XII AS entered into a senior secured loan facility in the amount of $140 million (the “New Fortaleza and Recife Facility”). The New Fortaleza and Recife Facility was drawn in November 2014. The $117 million secured loan facility (the “Hilda Facility”) was entered into in 2011 in connection with financing the building of Hilda Knutsen. In connection with the Partnership’s acquisition of Knutsen Shuttle Tankers 14 AS, the company that owns the Hilda Knutsen, on June 30, 2014, the Hilda Facility was amended prior to the acquisition. The $117 million secured loan facility (the “Torill Facility”) was entered into in 2011 in connection with financing the building of Torill Knutsen. In connection with the Partnership’s acquisition of Knutsen Shuttle Tankers 15 AS, the company that owns the Torill Knutsen, on June 30, 2014, the Torill Facility was amended prior to the acquisition. In April 2014, KNOT’s subsidiaries owning the Dan Cisne and Dan Sabia, as the borrowers, entered into a $172.5 million senior secured loan facility in connection with the purchase of the vessels from J. Lauritzen. In connection with the Partnership’s acquisition of KNOT Shuttle Tankers 20 AS, the company that owns the Dan Cisne, in December 2014, the $172.5 million senior secured loan facility was split into a tranche related to the Dan Cisne (the “Dan Cisne Facility”) and a tranche related to Dan Sabia (the “Dan Sabia Facility”). In connection with the Partnership’s acquisition of KNOT Shuttle Tankers 20 AS, the company that owns the Dan Cisne, in December 2014, the Dan Cisne Facility was amended prior the acquisition, and in connection with the Partnership’s acquisition of KNOT Shuttle Tankers 21 AS, the company that owns the Dan Sabia, in June 2015, the Dan Sabia Facility was amended prior the acquisition.

 

In connection with the June 2015 Offering (see Note 13), the Partnership used a part of the net proceeds to repay the $20.0 million revolving credit facility, the $12.0 million Seller’s Credit provided by KNOT in connection with the acquisition of the Dan Cisne and $7.5 million of the Dan Sabia Facility.

The Partnership and KNOT Shuttle Tankers AS have guaranteed the facilities listed above. As of June 30, 2015, the Borrowers and the Partnership were in compliance with all covenants under the facilities listed above.

8) Income Taxes

Components of Current and Deferred Tax Expense

After the reorganization of the Partnership’s predecessor’s activities into the new group structure in February 2013, all profit from continuing operations in Norway is taxable within the Norwegian Tonnage Tax regime (“the tonnage tax regime”). The consequence of the reorganization was a one-time entrance tax into the tonnage tax regime due to the Partnership’s acquisition of the shares in the subsidiary that owns the Fortaleza Knutsen and the Recife Knutsen. Under the tonnage tax regime, the tax is based on the tonnage of the vessel and operating income is tax free. The net financial income and expense remains taxable as ordinary income tax for entities subject to the tonnage tax regime. For the portion of activities subject to the tonnage tax regime, tonnage taxes are classified as vessel operating expenses while the current and deferred taxes arising on net financial income and expense are reflected as income tax expense in the consolidated and combined carve-out financial statements.

The total amount of the entrance tax was estimated to be approximately $3.0 million, which was recognized in the three months ended March 31, 2013. The entrance tax is payable over several years and is calculated by multiplying the tax rate by the declining balance of the gain, which will decline by 20% each year. The amount payable will be effected by the change in tax rate which was reduced to 27 % in 2014 from 28 % in 2013 and the fluctuation in currency rates. Approximately $0.6 million of the estimated entrance tax was paid during 2014 and $0.2 and $0.1 million was paid during the first quarter of 2015 and the second quarter of 2015, respectively. UK income tax is presented as income taxes payable, while $1.3 million is presented as non-current deferred taxes payable. Profit and loss from continuing operation before income taxes was taxable to Norway and significant components of current and deferred income tax expense attributable to income from continuing operations for the three months ended June 30, 2015 and 2014 as follows:

 

		Three Months Ended June 30,										Six Months Ended June 30,
(US $ in thousands)		2015				2014						2015				2014
Income before income taxes		$	6,890			$	2,479					$	14,079			$	8,922
Income tax benefit (expense)			(3	)			18						(6	)			(1)
Effective tax rate			0	%			0	%					0	%			0	%

A valuation allowance for deferred tax assets is recorded when it is more likely than not that some of or all of the benefit from the deferred tax assets will not be realized. The valuation allowances relate to the financial loss carry forwards and other deferred tax assets for tonnage tax that, in the judgment of the Partnership, are more-likely-than not to be realized reflecting the Partnership’s cumulative loss position for tonnage tax. In assessing the realizability of deferred tax assets, the Partnership considers whether it is more-likely-than-not that some portion or all of the deferred tax assets will not be realized taking into account all the positive and negative evidence available, and there are no deferred tax assets recognized as of June 30, 2015 and December 31, 2014.

9) Related Party Transactions

(a) Related Parties

Net expenses (income) from related parties included in the unaudited condensed consolidated and combined carve-out statements of operations for the three and six months ended June 30, 2015 and 2014 are as follows:

 

		Three Months Ended June 30,								Six Months Ended June 30,
(US $ in thousands)		2015				2014				2015				2014
Statements of operations:
Time charter and bareboat revenues:
Charter revenues from KNOT (1)		$	5,236			$	—			$	10,414			$	—
Operating expenses:
Technical and operational management fee from KNOT to Vessels (2)			579				329				1,163				658
General and administrative expenses:
Administration fee from KNOT (3)			177				103				363				289
Administration fee from KOAS (3)			86				123				170				230
Administration fee from KOAS UK (3)			37				37				74				74
Administration and management fee from KNOT (4)			37				22				72				44
Accounting service fee from KNOT (5)			31				25				31				25
Finance income (expense):
Financing service fee from KNOT to Vessels (6)			—				(50	)			—				(50	)
Interest expense charged from KNOT (7)			(123	)			(124	)			(268	)			(252	)
Total		$	4,166			$	(813	)		$	8,272			$	(1,622	)

 

 

(1)

Charter revenue from KNOT: Pursuant to the Omnibus Agreement KNOT entered into with the Partnership at the time of the IPO, agreed to guarantee the payments of the hire rate under the initial charters of each of the Bodil Knutsen and the Windsor Knutsen for a period of five years from the closing date of the IPO. BG Group, the charterer of the Windsor Knutsen, did not exercise its option to extend the Windsor Knutsen time charter after the expiration of its initial term, and on July 29, 2014 KNOT and the Partnership entered into a time charter for the vessel at a rate of hire that would have been in effect during the option period under the previous BG Group time charter. See Note 9(b)—Related Party Transactions—Guarantees and Indemnifications.

(2)

Technical and operational management fee from KNOT to Vessels: KNOT provides technical and operational management of the vessels on time charter including crewing, purchasing, maintenance and other operational services. In addition, there is also a charge for 24-hour emergency response services provided by KNOT for all vessels managed by KNOT.

(3)

Administration fee from KNOT and Knutsen OAS Shipping AS (“KOAS”) and Knutsen OAS (UK) Ltd. (“KOAS UK”): Administration costs include the compensation and benefits of KNOT management and administrative staff as well as other general and administration expenses. Net administration costs are total administration cost plus a 5% margin, reduced for the total fees for services delivered by the administration staffs (the accounting service fees (see (5) below).

(4)

Administration and management fee from KNOT: For bareboat charters, the shipowner is not responsible for providing crewing or other operational services and the customer is responsible for all vessel operating expenses and voyage expense. For the bareboat vessels the shipowner has administration and management agreement with KNOT for general monitoring and follow up of the vessels.

(5)	Accounting service fee from KNOT: KNOT invoiced each subsidiary a fixed fee for the preparation of the statutory financial statements.

(6)	Financing service fee from KNOT to Vessels: KNOT invoiced each vessel for a fixed amount in relation to new loan facilities for vessel financing as compensation for the time and cost of loan negotiations with external banks.

(7)	Interest expense charged from KNOT: KNOT invoiced interest (expense) income for any outstanding payables to (receivable from) owners and affiliates to the vessel-owning subsidiaries.

(b) Guarantees and Indemnifications

Pursuant to the Omnibus Agreement, KNOT agreed to guarantee the payments of the hire rate under the initial charters of each of the Bodil Knutsen and the Windsor Knutsen for a period of five years from the closing date of the IPO.

In April 2014, the Partnership was notified that BG Group would not exercise its option to extend the Windsor Knutsen time charter after the expiration of its initial term. The vessel was re-delivered on July 28, 2014. In order to comply with its obligations under the Omnibus Agreement, on July 29, 2014, KNOT and the Partnership entered into a time charter for the vessel at a rate of hire that would have been in effect during the option period under the previous BG Group time charter. This charter will be effective until the new BG Group time charter commences in the fourth quarter of 2015.

Under the Omnibus Agreement, KNOT has agreed to indemnify the Partnership until April 15, 2018, against certain environmental and toxic tort liabilities with respect to certain assets that KNOT contributed or sold to the Partnership to the extent arising prior to the time they were contributed or sold. However, claims are subject to a deductible of $0.5 million and an aggregate cap of $5 million.

 

In addition, pursuant to the Omnibus Agreement, KNOT agreed to indemnify the Partnership for any defects in title to certain assets contributed or sold to the Partnership and any failure to obtain, prior to April 15, 2013, certain consents and permits necessary to conduct the Partnership’s business, which liabilities arise within three years after the closing of the IPO on April 15, 2013.

(c) Transactions with Management and Directors

See Note 9(a) for a discussion of the allocation principles for KNOT’s administrative costs, including management and administrative staff, included in the consolidated and combined carve-out statements of operations.

(d) Amounts Due from (to) Related Parties

Balances with related parties consisted of the following:

 

(U.S. Dollars in thousands)		At June 30,     2015						At December 31,    2014
Balance Sheets:
Trading balances due from KOAS		$	26					$	77
Trading balances due from KNOT and affiliates			70						53
Trading balances due from TSSI and affiliates			1						—
Amount due from related parties		$	97					$	130
Trading balances due to KOAS		$	206					$	423
Trading balances due to KNOT and affiliates			244						205
Trading balances due to TSSI			6						—
Amount due to related parties		$	456					$	628

Amounts due from (to) related parties are unsecured and intended to be settled in the ordinary course of business. They primarily relate to vessel management and other fees due to KNOT and KOAS.

(e) Trade accounts payables

Trade accounts payables to related parties are included in total trade accounts payables in the balance sheet. The balances to related parties consisted of the following:

 

(U.S. Dollars in thousands)		At June 30,     2015						At December 31,    2014
Balance Sheets:
Trading balances due to KOAS		$	429					$	792
Trading balances due to KNOT and affiliates			266						241
Trading balances due to TSSI			2						—
Trade accounts payables to related parties		$	697					$	1,033

10) Commitments and Contingencies

Assets Pledged

As of June 30, 2015 and December 31, 2014, Vessels with a book value of $1,103 million and $1,022 million, respectively, were pledged as security held as guarantee for the Partnership’s long-term debt and interest rate swap obligations. See Note 5 —Derivative Instruments and Note 7 —Long-Term Debt.

Claims and Legal Proceedings

From time to time, the Partnership is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the consolidated and combined carve-out financial position, results of operations or cash flows.

 

Insurance

The Partnership maintains insurance on all the Vessels to insure against marine and war risks, which include damage to or total loss of the Vessels, subject to deductible amounts that average $0.150 million per Vessel, and loss of hire.

Under the loss of hire policies, the insurer will pay a compensation for the lost hire rate agreed in respect of each Vessel for each day, in excess of 14 deductible days, for the time that the Vessel is out of service as a result of damage, for a maximum of 180 days. In addition, the Partnership maintains protection and indemnity insurance, which covers third-party legal liabilities arising in connection with the Vessels’ activities, including, among other things, the injury or death of third-party persons, loss or damage to cargo, claims arising from collisions with other vessels and other damage to other third-party property, including pollution arising from oil or other substances. This insurance is unlimited, except for pollution, which is limited to $1 billion per vessel per incident. The protection and indemnity insurance is maintained through a protection and indemnity association, and as a member of the association, the Partnership may be required to pay amounts above budgeted premiums if the member claims exceed association reserves, subject to certain reinsured amounts. If the Partnership experiences multiple claims each with individual deductibles, losses due to risks that are not insured or claims for insured risks that are not paid, it could have a material adverse effect on the Partnership’s results of operations and financial condition.

11) Earnings per Unit and Cash Distributions

The calculations of basic and diluted earnings per unit (1) are presented below:

 

(US $ in thousands, except per unit data)		Three  Months Ended  June 30, 2015				Three  Months Ended  June 30, 2014				Six  Months Ended  June 30, 2015				Six  Months Ended   June 30, 2014
Post IPO net income attributable to the members of KNOT Offshore Partners LP		$	6,887			$	2,497			$	14,073			$	8,921
Less: Distributions paid (2)			14,747				9,945				26,800				17,560
Under (over) distributed earnings			(7,860	)			(7,448	)			(12,727	)			(8,639	)
Under (over) distributed earnings attributable to:
Common unitholders			(5,292	)			(4,788	)			(8,569	)			(5,371	)
Subordinated unitholders			(2,411	)			(2,511	)			(3,903	)			(3,095	)
General Partner			(157	)			(149	)			(255	)			(173	)
Weighted average units outstanding (basic and diluted) (in thousands):
Common unitholders			15,346				8,719				14,581				8,643
Subordinated unitholders			8,568				8,568				8,568				8,568
General Partner			488				353				472				351
Earnings per unit (basic and diluted):
Common unitholders		$	0.280			$	0.140			$	0.553			$	0.505
Subordinated unitholders (3)			0.287				0.143				0.671				0.511
General Partner			0.262				0.141				0.557				0.507
Cash distributions declared and paid in the period per unit (4)			0.510				0.435				0.510				0.435
Subsequent event: Cash distributions declared and paid per unit relating to the period (5)			0.510				0.435				0.510				0.435

 

(1)	Earnings per unit have been calculated in accordance with the cash distribution provisions set forth in the Partnership’s Partnership Agreement.

(2)

This refers to distributions made or to be made in relation to the period irrespective of the declaration and payment dates and based on the number of units outstanding at the record date. This includes cash distributions to the IDR holder (KNOT) for the three months ended June 30, 2015 and 2014 of $0.5 million and of $0.0 million, respectively, and for the six months ended June 30, 2015 and 2014 of $0.9 million and of $0.0 million, respectively.

(3)

This includes the net income attributable to the IDR holder. The IDRs generally may not be transferred by KNOT until March 31, 2018. The net income attributable to IDRs for the three months ended June 30, 2015 and 2014 is $0.5 million and $0.0 million, respectively, and for the six months ended June 30, 2015 and 2014 is $0.9 million and $0.0 million, respectively.

(4)	Refers to cash distributions declared and paid during the period.

(5)	Refers to cash distributions declared and paid subsequent to the period end.

 

As of June 30, 2015, 67.3% of the Partnership’s total number of units outstanding representing limited partner interests were held by the public (in the form of 18,807,500 common units, representing 100% of the Partnership’s common units) and 30.7% of such units were held by KNOT (in the form of 8,567,500 subordinated units, representing 100% of the Partnership’s subordinated units). In addition, KNOT, through its ownership of the General Partner, held the 2% general partner interest (in the form of 558,674 general partner units).

Earnings per unit are determined by dividing net income by the weighted-average number of units outstanding during the applicable period. The General Partner’s, common unitholders’ and subordinated unitholders’ interest in net income are calculated as if all net income was distributed according to the terms of the Partnership Agreement, regardless of whether those earnings would or could be distributed. The Partnership Agreement does not provide for the distribution of net income. Rather, it provides for the distribution of available cash, which is a contractually defined term that generally means all cash on hand at the end of each quarter less the amount of cash reserves established by the Partnership’s board of directors to provide for the proper conduct of the Partnership’s business, including reserves for maintenance and replacement capital expenditures and anticipated capital requirements. In addition, KNOT, as the initial holder of all IDRs, has the right, at the 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. Unlike available cash, net income is affected by non-cash items, such as depreciation and amortization, unrealized gains and losses on derivative instruments and unrealized foreign currency gains and losses.

Under the Partnership Agreement, during the subordination period, 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 per quarter, plus 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.

Distributions of available cash from operating surplus will be made in the following manner for any quarter during the subordination period:

 

•

first, 98.0% to the common unitholders, pro rata, and 2.0% to the General Partner, until each outstanding common unit has received a minimum quarterly distribution of $0.375;

 

•

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

 

•

third, 98.0% to the subordinated unitholders, pro rata, and 2.0% to the General Partner until each subordinated unit has received a minimum quarterly distribution of $0.375.

In addition, KNOT currently holds all of the IDRs in the Partnership. IDRs represent the rights 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.

If for any quarter:

 

•

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

 

•

the Partnership has 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.

then, the Partnership will distribute any additional available cash from operating surplus for that quarter among the unitholders and the General Partner in the following manner:

 

•

first, 98.0% to all unitholders, pro rata, and 2.0% to the 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 the General Partner and 13.0% to the holders of the IDRs, 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 the General Partner and 23.0% to the holders of the IDRs, 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 the General Partner and 48.0% to the holders of the IDRs, 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 the General Partner maintains its 2.0% general partner interest and that the Partnership does not issue additional classes of equity securities.

12) Business Acquisitions

In June 2015, December 2015 and June 2014, the Partnership acquired from KNOT equity interests in certain subsidiaries which own and operate the Dan Sabia, the Dan Cisne and the Hilda Knutsen and Torill Knutsen.

The Board and the Conflicts Committee approved the purchase price for each transaction. The Conflicts Committee retained a financial advisor to assist with its evaluation of the transactions. The details of each transaction are as follows:

 

 

(US $ in thousands)				Provisional Dan Sabia     June 15, 2015								Final Dan Cisne      December  15, 2015								Final Hilda Knutsen and Torill Knutsen      June 30, 2014
Purchase consideration (1)		$			41,186					$			18,230					$			114,293
Less: Fair value of net assets acquired:
Vessels and equipment (2)					103,389								103,400								335,000
Cash					4,343								1,574								8,997
Inventories					-								-								395
Other current assets					25								-								1,939
Amounts due from related parties					935								-								4
Long-term debt					(64,470)								(82,164)								(221,812)
Other long-term liabilities					-								-								(4,774)
Derivatives liabilities					(802)								(968)								(348)
Trade accounts payable					(4)								(35)								(390)
Accrued expenses					(335)								(825)								(1,360)
Prepaid charter and deferred revenue					(442)								-								(1,487)
Amounts due to related parties					(1,453)								(2,752)								(2,338)
Sub total					41,186								18,230								113,826
Difference between the purchase price and fair value of net assets acquired		$			-					$			-					$			467
Goodwill (3)					-								-								467
Difference between the purchase price and allocated values		$			-					$			-					$			-

 

 

 

(1)	The purchase price comprises the following:

 

 

 

(US $ in thousands)						Provisional Dan Sabia     June 15, 2015										Final Dan Cisne     December  15, 2015										Final Hilda     Knutsen and Torill       Knutsen June 30, 2014
Cash consideration paid to KNOT		$					38,531					$					8,836					$					113,306
Purchase price adjustments							2,655										(2,606)										987
Seller’s credit																	12,000
Total purchase consideration		$					41,186					$					18,230					$					114,293

 

 

 

(2)	Vessels and equipment includes allocation to dry docking for the following vessels: Hilda Knutsen of $2,042, Torill Knutsen of $2,166. For the Dan Sabia and Dan Cisne $389 and $400 of the purchase price adjustments were allocated to the respective vessel.

(3)	The goodwill recognized in connection with the acquisitions of the Hilda Knutsen and Torill Knutsen is attributable primarily to the organization, including structure, systems, skills and abilities.

Dan Sabia

On June 15, 2015, the Partnership’s wholly owned subsidiary, KNOT Shuttle Tankers AS, acquired KNOT’s 100% interest in KNOT Shuttle Tankers 21 AS, the company that owns and operates the Dan Sabia. The purchase price was $103.0 million less assumed bank debt of $64.5 million and other purchase price adjustments of $2.7 million. The cash portion of the purchase price was financed with the proceeds from the Partnership’s public offering of 5,000,000 common units which closed June 2, 2015. See Note 13 – Equity Offerings. The Partnership accounted for this acquisition as an acquisition of a business. The purchase price of the acquisition has been allocated to the identifiable assets acquired. The allocation of the purchase price to acquired identifiable assets was based on their fair values at the date of acquisition. The Partnership is in the process of finalizing the accounting for the acquisition of the Dan Sabia and the amounts shown in the fair value allocation are provisional.

Revenue and profit contributions

Since the acquisition date, the Dan Sabia business has contributed revenues of $0.4 million and net income of $0.1 million to the Partnership for the period from June 15, 2015 to June 30, 2015.

Dan Cisne

On December 15, 2014, the Partnership’s wholly owned subsidiary, KNOT Shuttle Tankers AS, acquired KNOT’s 100% interest in KNOT Shuttle Tankers 20 AS, the company that owns and operates the Dan Cisne. The purchase price was $103.0 million, less assumed bank debt of $82.2 million less other purchase price adjustments of $2.6 million. The Partnership accounted for this acquisition as an acquisition of a business.

Hilda Knutsen & Torill Knutsen

On June 30, 2014, the Partnership’s wholly owned subsidiary, KNOT Shuttle Tankers AS, acquired KNOT’s 100% interest in: (i) Knutsen Shuttle Tankers 14 AS, the company that owns and operates the Hilda Knutsen and (ii) Knutsen Shuttle Tankers 15 AS, the company that owns and operates the Torill Knutsen. The purchase price of Knutsen Shuttle Tankers 14 AS was $166.0 million, net of $109.6 million of outstanding indebtedness related to the vessel. The purchase price of the Knutsen Shuttle Tankers 15 AS was $169.0 million, net of $112.1 million of outstanding indebtedness related to the vessel. The cash portion of the purchase prices was financed with proceeds from the Partnership’s public offering of 4,600,000 common units which closed on June 27, 2014. See Note 13—Equity Offerings. The purchase prices were subsequently adjusted by a working capital adjustment of $1.0 million. The Partnership accounted for these acquisitions as the acquisitions of businesses.

The table below shows comparative summarized consolidated pro forma financial information for the Partnership for the six months ended June 30, 2015 and 2014, giving effect to the Partnership’s acquisition and financing of the Dan Sabia, the Dan Cisne, the Hilda Knutsen and the Torill Knutsen as if these acquisitions had taken place on January 1, 2014.

 

 

(US $ in thousands)		Six Months Ended        June 30, 2015				Six Months Ended         June 30, 2014
Revenue		$	77,702			$	76,940
Net income			15,038				19,236

Included in the pro forma adjustments are depreciation related to the purchase price allocation performed on the acquired identifiable assets as if the acquisitions had taken place on January 1, 2014. In addition, the pro forma adjustments include finance expenses related to the increased borrowings as if the acquisitions had taken place on January 1, 2014.

13) Equity Offerings

 

(US $ in thousands)		June 2015 Offering      As of June 30,      2015				2014 Offering    As of June 30,    2014
Gross proceeds received (1)		$	121,224			$	133,447
Less: Underwriters’ discount			4,300				4,381
Less: Offering expenses			321				315
Net proceeds received			116,603				128,751

 

(1)

Includes General Partner’s 2% proportional capital contribution.

On June 2, 2015, the Partnership sold 5,000,000 common units, representing limited partner interests, in an underwritten public offering (the “June 2015 Offering”). In connection with the June 2015 Offering, the General Partner contributed a total of $2.4 million in order to maintain its 2% general partner interest in the Partnership. The Partnership’s total net proceeds from the June 2015 Offering and the related General Partner’s contribution were $116.6 million.

The Partnership used the net proceeds from the June 2015 Offering to fund the cash portion of the purchase price of the Dan Sabia and to repay the Revolving Credit Facility, the $12.0 million Seller’s Credit and $7.5 million of the Dan Sabia Facility. The remainder of the net proceeds will be available for general partnership purposes.

On June 27, 2014, the Partnership sold 4,600,000 common units, representing limited partner interests, in an underwritten public offering and granted the underwriters a 30-day option to purchase an additional 690,000 common units. In connection with the offering, the Partnership’s general partner contributed a total of $2.7 million in order to maintain its 2% general partner interest in the Partnership. The Partnership’s total net proceeds from the public offering and the related General Partner’s contribution were $128.8 million as of June 30, 2014. In connection with the partial exercise by the underwriters of their option to purchase additional common units, on July 14, 2014 and July 24, 2014, the Partnership issued and sold 150,000 common units and 490,000 common units, respectively, and the General Partner made an additional $0.4 million aggregate capital contribution to the Partnership in order to maintain its 2% general partner interest in the Partnership.

The Partnership used the net proceeds from the June 2014 offering and related capital contribution by the general partner to fund the cash portion of the purchase prices of the Hilda Knutsen and the Torill Knutsen and for general partnership purposes.

The following table shows the movement in the number of common units, subordinated units and general partner units from the time of the IPO until June 30, 2015.

 

(in units)		Common Units				Subordinated Units				General Partner Units
April 2013, Initial Public Offering (IPO)			8,567,500				8,567,500				349,694
December 31, 2013			8,567,500				8,567,500				349,694
June 2014			4,600,000				—				93,877
July 2014			640,000				—				13,062
December 31, 2014			13,807,500				8,567,500				456,633
June 2015			5,000,000				—				102,041
June 30, 2015			18,807,500				8,567,500				558,674

14) Subsequent Events

The Partnership has evaluated subsequent events from the balance sheet date through September 4, 2015, the date at which the unaudited condensed consolidated and combined carve-out financial statements were available to be issued, and determined that there are no other items to disclose, except as follows:

On August 12, 2015, the Partnership announced that the Partnership’s board of directors has authorized the Partnership to repurchase up to 666,667 common units. The board of directors of KNOT Offshore Partners GP LLC (the “General Partner”) has concurrently authorized the General Partner to purchase up to 333,333 common units of the Partnership. All purchases of common units will be at prevailing prices on the open market or in privately negotiated transactions, as permitted by securities laws and other legal requirements. All purchases will be made pursuant to a single program and will be allocated two-thirds to the Partnership and one-third to the General Partner. The program will conclude by August 31, 2016. There is no obligation to purchase any specific number of common units and the program may be modified, suspended, extended or terminated be at any time. Any common units repurchased by the Partnership under the program will be cancelled.

On August 14, 2015, the Partnership paid a quarterly cash distribution of $0.51 per unit with respect to the quarter ended June 30, 2015. The aggregate amount of the paid distribution was $14.7 million.

(a) Basis of Preparation

The accompanying unaudited condensed consolidated and combined carve-out financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and applicable rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”) for interim financial information. All intercompany balances and transactions are eliminated. The unaudited condensed consolidated and combined carve-out financial statements do not include all the disclosures and information required for a complete set of annual financial statements; and, therefore, these unaudited condensed consolidated and combined carve-out financial statements should be read in conjunction with the audited consolidated and combined carve-out financial statements for the year ended December 31, 2014, which are included in the Partnership’s Annual Report on Form 20-F (the “20-F”).

Under the Partnership’s First Amended and Restated Agreement of Limited Partnership (the “Partnership Agreement”), KNOT Offshore Partners GP LLC, a wholly owned subsidiary of KNOT, and the general partner of the Partnership (the “General Partner”), has irrevocably delegated to the Partnership’s board of directors the power to oversee and direct the operations of, manage and determine the strategies and policies of the Partnership. During the period from the Partnership’s IPO in April 2013 until the time of the Partnership’s first annual general meeting (“AGM”) on June 25, 2013, the General Partner retained the sole power to appoint, remove and replace all members of the Partnership’s board of directors. From the first AGM, four of the seven board members became electable by the common unitholders and accordingly, from this date, KNOT, as the owner of the General Partner, no longer retains the power to control the Partnership’s board of directors and, hence, the Partnership. As a result, the Partnership is no longer considered to be under common control with KNOT and as a consequence, the Partnership will not account for any vessel acquisitions from KNOT after June 25, 2013 as a transfer of equity interests between entities under common control.

In June 2014, December 2014, and June 2015, the Partnership acquired from KNOT a 100% interest in the subsidiaries that own and operate the Hilda Knutsen and the Torill Knutsen, the Dan Cisne, and the Dan Sabia, respectively. Accordingly, the results of these acquisitions are consolidated into the Partnership’s results from the respective dates of their acquisition. The Partnership accounted for these acquisitions as an acquisition of a business.

(b) Significant accounting policies

The accounting policies adopted in the preparation of the unaudited condensed consolidated and combined carve-out interim financial statements are consistent with those followed in the preparation of the Partnership’s audited consolidated and combined carve-out financial statements for the year ended December 31, 2014, as contained in the Partnership’s 20-F.

(c) Accounting pronouncement not yet adopted

In May 2014, the Financial Accounting Standards Board (or FASB) and the International Accounting Standards Board (IASB) issued a comprehensive revenue recognition standard that will supersede existing revenue guidance under US GAAP and IFRS, Accounting Standards Update 2014-09, Revenue from Contracts with Customers, (or ASU 2014-09) for U.S. GAAP. ASU 2014-09 will require an entity to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This update creates a five-step model that requires an entity to exercise judgment when considering the terms of the contract(s) which include (i) identifying the contract(s) with the customer, (ii) identifying the separate performance obligations in the contract, (iii) determining the transaction price, (iv) allocating the transaction price to the separate performance obligations, and (v) recognizing revenue when each performance obligation is satisfied. In August 2015, FASB issued an ASU (ASU 2015-14) to defer by one year the effective dates of its new revenue recognition standard for public and non-public entities reporting under US GAAP. As a result, the standard (ASU 2014-09) will be effective for public entities for annual reporting periods beginning after December 15, 2017 (2018 for calendar-year public entities) and interim periods therein. ASU 2014-09 shall be applied retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. Early adoption is not permitted under U.S. GAAP. The Partnership is evaluating the effect of adopting this new accounting guidance.

In August 2014, FASB issued Presentation of Financial Statements – Going Concern (Subtopic 205-40), Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (ASU 2014-15). ASU 2014-15 requires management to evaluate whether there are conditions and events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the financial statements are issued (or available to be issued when applicable) and, if so, disclose that fact. Management will be required to make this evaluation for both annual and interim reporting periods, if applicable. Management also is required to evaluate and disclose whether its plans alleviate that doubt. The standard is effective for annual periods after December 15, 2016 and interim periods within annual periods beginning after December 15, 2016. Early adoption is permitted. The Partnership is evaluating the effect of adopting this new accounting guidance. The Partnership does not expect the adoption of this standard to have a material impact on the consolidated and combined financial statements.

In April 2015, the FASB issued ASU 2015-03, Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. ASU 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. For KNOT Offshore Partners LP as a public business entity, the guidance is effective for annual and interim periods beginning after 15 December 2015. Early adoption is permitted. The Partnership has not yet adopted ASU 2015-03, Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. The adoption of the new standard will have an impact on the balance sheets and reduce total assets and total liabilities. Also the implementation will be applied retrospectively.

Goodwill Impairment Charge

During the three months ended June 30, 2015, the Partnership concluded that indicators of impairment were present due to a significant reduction in the price of the Partnership’s common units during the past few months. Consequently, the Partnership performed an interim vessel and goodwill impairment analysis as of June 30, 2015 on its fleet, concluding that there was no impairment to the vessels’ values. However, the Partnership determined that the carrying value of the goodwill exceeded its fair value. The impairment charge relates mainly to capitalized goodwill which arose in 2008 when the Partnership’s predecessor acquired the Windsor Knutsen and three other vessels then under construction, in a transaction that was then accounted for as a step transaction. As a result, a goodwill impairment charge of $6.2 million was recognized in the condensed consolidated and combined carve-out financial statements for the three and six months ended June 30, 2015. The fair value was determined using the present value of the expected future cash flows discounted at a rate equivalent to a market participant’s weighed average cost of capital. The estimates and assumptions regarding expected future cash flows and appropriate discount rates are in part based upon existing contracts, future shuttle tanker rates, historical experience, financial forecasts and industry trends and conditions. This non-cash impairment charge, which does not affect the Partnership’s operations, cash flows, liquidity, or any of its loan covenants, reduced the Partnership’s remaining goodwill balance to zero as of June 30, 2015.

The following table presents revenues and percentage of consolidated and combined revenues for customers that accounted for more than 10% of the Partnership’s consolidated and combined revenues during the six months ended June 30, 2015 and 2014. All of these customers are subsidiaries of major international oil companies, except KNOT, which is currently chartering the Windsor Knutsen until she is delivered to BG Group in fourth quarter of 2015.

 

		Three Months Ended June 30,																Six Months Ended June 30,
(U.S. Dollars in thousands)		2015								2014								2015								2014
Fronape International Company, a subsidiary of Petrobras Transporte S.A.		$	9,206				25	%		$	6,289				28	%		$	17,882				24	%		$	12,512				29	%
Eni Trading and Shipping S.pA			11,686				32	%			—				—				23,190				32	%			—				—
Statoil ASA			5,783				16	%			5,646				26	%			11,481				16	%			11,113				25	%
Repsol Sinopec Brasil, S.A., a subsidiary of Repsol Sinopec Brasil, B.V.			5,070				13	%			5,070				23	%			10,085				14	%			10,085				23	%
Brazil Shipping I Limited, a subsidiary of BG Group Plc			—				—				5,111				23	%			—				—				10,172				23	%
KNOT			5,236				14	%			—				—				10,414				14	%			—				—

The following table presents the realized and unrealized gains and losses that are recognized in earnings as net gain (loss) on derivative instruments for the three and six months ended June 30, 2015 and 2014:

 

		Three Months Ended June 30,								Six Months Ended June 30,
(U.S. Dollars in thousands)		2015				2014				2015				2014
Realized gain (loss)
Interest rate swap contracts		$	(1,333	)		$	(700	)		$	(2,359	)		$	(1,254)
Foreign exchange forward contracts			—				—				—				500
Unrealized gain (loss)
Interest rate swap contracts			1,241				(1,642	)			(1,834	)			(1,294)
Foreign exchange forward contracts			345				—				(1,177	)			(248)
Total realized and unrealized (loss) gain			253				(2,342	)			(5,370	)			(2,296)

The following table presents the carrying amounts and estimated fair values of the Partnership’s financial instruments as of June 30, 2015 and December 31, 2014. Fair value is defined as the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

 

		June 30, 2015								December 31, 2014
(U.S. Dollars in thousands)		Carrying     Amount				Fair Value				Carrying     Amount				Fair Value
Financial assets:
Cash and cash equivalents		$	71,403			$	71,403			$	30,746			$	30,746
Non-current derivative assets:
Interest rate swap contracts			955				955				2,966				2,966
Financial liabilities:
Current derivative liabilities:
Interest rate swap contracts			5,332				5,332				4,708				4,708
Foreign exchange forward contract			3,919				3,919				2,742				2,742
Non-current derivative liabilities:
Interest rate swap contracts			—				—				—				—
Long-term debt, current and non-current			618,832				618,832				613,221				613,221