Advanced Emissions Solutions, Inc.
Q4 2019 Earnings Call Transcript

Published: 17 Mar 2020

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the Advanced Emissions Solutions Q4 2019 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions]I would now like to hand the conference over to your speaker today, Ryan Coleman, Investor Relations. Thank you. Please go ahead.

[Ryan Coleman:]

Thank you, Chris. Good morning, everyone, and thanks for joining us today for our fourth quarter and full year 2019 earnings results call. With me on the call today are Heath Sampson, President and Chief Executive Officer; and Greg Marken, Chief Financial Officer.This conference call is being webcast live within the Investor section of our website and a downloadable version of today's presentation is available there as well. A webcast replay will also be available on our site and you can contact the Alpha IR Group for Investor Relations support at 312-445-2870.Let me remind you that the presentation and remarks made today include forward-looking statements as defined in Section 21E of the Securities Exchange Act. These statements are based on information currently available to us, and involve risks and uncertainties that could cause actual future results, performance and business prospects and opportunities to differ materially from those expressed in or implied by these statements.These risks and uncertainties include, but are not limited to, those factors identified on Slide 2 of today's slide presentation, in our Form 10-K for the year ended December 31, 2019 and other filings with the Securities and Exchange Commission. Except as expressly required by the securities laws, the company undertakes no obligation to update those factors or any forward-looking statements to reflect future events, developments, or changed circumstances or for any other reason.In addition, it is very important to review the presentation and today's remarks in conjunction with the GAAP references in the financial statements.So with that, I'd like to turn the call over to Heath Sampson. Heath?

[Heath Sampson:]

Thanks, Ryan, and thanks to everyone for joining us this morning. Before we get started, I want to empathize with everyone that is trying to manage through this COVID-19 pandemic. Although health and safety are most pressing to everyone, the financial market and many of our shareholders are also under extreme pressure to manage their portfolios. I will touch on how we think about COVID-19 and our operations later in the call.Let’s now begin on Slide 3 and review our fourth quarter and year. Within our Refined Coal segment, we saw record distributions for Tinuum for the full-year that were 40% higher than 2018. The increase was driven by four additional operating facilities that were added in 2019, which brought roughly $15 million incremental tons during the year. All four of these facilities were also royalty bearing, which drove the 12% increase in royalties, compared to 2018.Despite the full year increases, both distributions and royalties were lower in the fourth quarter. The fourth quarter decline was driven by significant decreases in coal-fired power generation, which resulted in restructured lease contracts between Tinuum and its largest customer and the closure of two utilities that Tinuum had refined coal facilities at, all of it – all of which we discussed on the third quarter call. That being said, we are not done adding refined coal volume in 2020.At the same time, we also expect additional headwinds due to poor coal-fired power generation. As such, it is not prudent to announce how much net incremental volume we expect in 2020. We will update incremental volume expectations as each deal happens.In our PGI segment, we made significant strategic and commercial progress throughout the year, but we were disappointed with the financial performance of these assets in 2019, almost exclusively due to poor coal-fired power dispatch.Although aggregate power generation remained flat compared to 2018, cheap alternative fuel sources, coupled with mild weather in both the winter and summer months, resulted in approximate decline of 15% of coal-fired power generation in the U.S. in 2019.While depressed coal burn affects the entirety of our business, it is a sharper effect on our more nascent PGI segment. As a result of these headwinds, total volume and revenues were materially lower than anticipated. We've been responding by focusing on what we can control, managing cost and diversifying the business.Overall, we executed well in 2019, and we're able to secure long-term agreements for 92% of the customers that were up for renewal. We achieved the highest win rate in company history on the new opportunities at 60%.So, while we're not able to overcome the decline in coal-fired power, these are encouraging developments as we look forward to the long-term potential and the competitive position of these cornerstone assets. It is clear that we offer highly competitive activated carbon solutions in this marketplace. Our PGI assets remain some of the best in the industry. They are underutilized and we have a plan to help them realize their full potential.One of the key components of that plan is a heightened focus on non-coal markets. And we have identified several additional industrial and water market opportunities that allow us to further diversify our product portfolio. We spent much of 2019 building out the internal infrastructure and sales team to better pursue and compete within these non-coal markets. We expect those efforts to build on our existing momentum into 2020.We also believe that competitive landscape within the activated carbon industry will ultimately trend towards rationalization among market participants in the supply and demand equilibrium, and we expect to be best positioned to strategically capitalize on those changes.In the meantime, we remain acutely focused on this segment on winning share in markets, where we have the right to win, filling our plants capacity with more diversified revenue streams, and leveraging our complete product solutions package. I'll talk more about our outlook for the PGI segment later in the call.Moving to our capital allocation priorities. In 2019, we continue to return significant capital to our equity holders, as we delivered over $24 million to our shareholders during the year through our dividend program and share repurchases.In November, the Board authorized additional dollars for share repurchases and we continue to purchase opportunistically. In aggregate, we spent roughly $5.8 million in 2019 to repurchase 533,000 outstanding shares.Lastly, we are reaffirming even after our normal quarterly distributions, our net cash flow outlook from the RC segment to total between $150 and $175 million through the end of 2021.In the near-term, we are focused on completing our current incremental volume opportunities. However, we are also at a point where we need to plan for the refined [indiscernible] in 2022. There’s an opportunity to save money by streamlining operations, renegotiating contracts, and reducing costs. I’ll walk everyone though the pushes and pulls on that later in the call.Before I hand the call to Greg, I’d like to take a moment to thank Ron Eller, Tinuum CEO, who recently announced his retirement. Ron's leadership has been instrumental to the success of this business, and we wish him a happy and healthy retirement. Rick Dowd will be stepping into replace Ron as Tinuum CEO.Rick previously served as Tinuum CFO, and thus, we have worked closely with Rick for several years. The transition was smooth and we look forward to continue to work with Rick in the Tinuum team.I'll discuss our forward outlook in greater detail after Greg reviews our fourth quarter and full-year results. Greg?

[Greg Marken:]

Thanks, Heath. Let's start on Slide 4 for our financial review. Earnings from equity method investments totaled $12 million in 2019, compared to $16 million in the fourth quarter of last year, while full-year earnings were significantly higher at $69 million, compared to $54 million in 2018.As Heath mentioned, the full-year increase was driven by the four incremental refined coal facilities invested with third parties in 2019 compared to 2018, partially offset by lower net lease payments and equity earnings from Tinuum beginning in the period ended September 30, 2019, as well as the unexpected closure of two utilities in the third quarter where Tinuum had operating facilities.Also on January 1 of 2019, Tinuum adopted the new revenue and lease accounting rules. We recorded a cumulative adjustment of $27.4 million related to our company's percentage of Tinuum Group's cumulative effect adjustment that increased our retained earnings, but those amounts will now not impact future earnings.ADES no longer has cumulative cash distributions in excess of our cumulative pro rata share of Tinuum Group’s net income. Therefore, the company recognized equity earnings by recording our pro rata share of Tinuum Group’s net income, rather than based on cash distributions for the year ended December 31, 2019.However, in 2020, we expect that our GAAP equity earnings will be significantly less than 2019, due to Tinuum having recognized two refined coal facility transactions as point in time sales during 2019. In addition to the impacts of Tinuum’s change in depreciable lives for refined coal facilities, the closure of two utilities in the third quarter where Tinuum had operating facilities and lower net lease payments due from their largest customer.However, this does not affect the timing, or the total projected future cash flows from our RC segment, and we expect to see cash distribution significantly exceed GAAP earnings from our equity method investments in both 2020 and 2021.Revenue for the fourth quarter and full-year were both higher than 2018. Fourth quarter revenue totaled $16 million versus $11 million in 2018, while full-year revenue of $70 million was higher than $24 million in 2018. The increases were driven by consumables revenue as a result of the full-year impact of the Carbon Solutions acquisition and to a lesser extent, by higher royalty earnings for the full-year.Royalties totaled $4.1 million in the fourth quarter and $16.9 million for the full-year, lower by 4% and higher by 12% year-over-year, respectively. During 2019, we had 16 RC facilities generating royalties to the company, compared to 12 during 2018, which drove the full-year increase. The fourth quarter decline was, again, as Heath mentioned a result of the impacts of the lower net lease payments due from Tinuum’s largest customer and Tinuum’s change in depreciable lives for refined coal facilities.Royalty income is based upon a percentage of the per ton pre-tax margin, inclusive of impacts related to depreciation expense and other applicable expenses. Our long-term royalty earnings expectations were updated as part of that restructuring from roughly $0.40 to $0.25 to $0.30 per ton based on coal burn expectations within the refined coal contracts going forward.Net income was higher in the fourth quarter compared to the prior year, driven by lower income tax expense year-over-year, which was caused by a decrease in the valuation allowance for our deferred tax assets.Full year net income was $35.5 million in 2019, flat when compared to 2018. Net income was impacted by higher equity method earnings and margin contribution from sales, but was offset by higher operating expenses due to the full-year impact of the Carbon Solutions operation, integration, legal and depreciation and amortization expenses.Earnings were also negatively impacted by $5 million on a full-year basis related to the amortization of a step-up in basis of acquired finished goods inventory in connection with purchase accounting adjustments.Fourth quarter EBITDA was $10 million, compared to $14 million in 2018. The decline was a result of lower equity earnings and operating earnings compared to the prior year. Full-year EBITDA was higher at $62 million, compared to $49 million in 2018. The full-year increase was driven by significantly higher depreciation and amortization expense and higher interest expense in 2019 compared to 2018.At the end of 2018, we entered into a $70 million three-year senior term loan to fund the acquisition of Carbon Solutions. This term loan has mandatory amortization requirement subject to quarterly principal payments of $6 million, which began in March 2019.During the fourth quarter, we made a [$6 million] principal payment, reducing the term loan principal balance, including the current portion to $40 million as of the end of the year. In 2019, we made principal payments totaling $30 million. We continue to expect to pay off this balance in less than its stated term of three years.We ended the year with total cash of $17.1 million, compared to $23.8 million at the end of 2018 and $20.2 million as of September 30 of this year. The largest driver of the reduction in our cash balance was the use of capital to reduce the outstanding balance in our term loan, repurchases of outstanding shares, dividends paid, and higher operating costs and capital expenditures related to the acquisition of Carbon Solutions have also contributed to the change. We also continue to classify $5 million of this cash as long-term restricted cash due to restrictions from the term loan.Our outstanding share count currently sits just above $18 million as a result of the share repurchase activity we engaged in during the year. Throughout the year, we repurchased approximately 533,000 shares for total consideration of $5.8 million including 277,000 shares repurchased in the fourth quarter for $2.9 million. We have always remained opportunistic in reducing our share account and will evaluate opportunities to buy back shares going forward.As Heath mentioned, the Board approved an additional $7.1 million in November. As of the end of the year, we have just over $7 million remaining.I'll now turn the call back over to Heath.

[Heath Sampson:]

Thanks, Greg. I'd like to take a moment to discuss our outlook before taking questions.Turning to Slide 5, you can see our expected future RC cash flows. Based on the 20 invested facilities as of year-end and even after our normal quarterly distributions, we are reaffirming our expectation of $150 million to $175 million of after-tax cash flows to ADES through the end of 2021.As a reminder, these – this 20 facility number was updated in September of last year, due to the unexpected closure of two utilities during the third quarter sites at which Tinuum had two invested RC facilities.The reduction also included the two facilities that were placed in service in 2009, and thus, met their 10-year expiration date during the fourth quarter. Only one of these two facilities were invested and operated. And given that these expirations were also expected, they have always been included in our forward cash flow guidance.As noted earlier, we also believe that we have line of sight into adding incremental volume in 2020 and look forward to disclosing them as they occur. While we will continue to engage existing and potential tax equity partners for incremental investment in refined coal, it's important that we also plan for the refined coal cessation.We have just two years remaining for a refined coal business, with some incremental growth expected. As such, Tinuum will look to save money, while ensuring a consistently produce refined coal. Additionally, we will also respond to the quickly changing coal-fired power generation decline by reducing cash costs. We will target at least $5 million in reductions on an annualized basis, while optimizing our products and manufacturing process. We need to do both lower costs and diversify our product offerings.Turning to Slide 6, we outlined some of what we see as the key opportunities for us to maximize the potential of our activated carbon assets. As expected, but not at this velocity, coal-fired power generation continues to decline, which has forced us to turn to the adjacent market opportunities earlier than plant.We have talked about some of the non-coal industrial applications for activated carbon, we – where we have begun to gain traction with our products. These are industries that are similarly bound by regulations and the application of our products in those markets have been ahead of our initial expectations.We have also built out the internal infrastructure to better compete with the new municipal water markets. Our product portfolio and commercial strategy in these water markets is greatly improved, and we are carrying solid momentum in these markets, as we expect to see more fruitful results in 2020.Back throughout 2017 and 2018, we talk about the highly fragmented nature of the emissions control market we operated. Today, the activated carbon industry remains highly fragmented and market rationalization will be a key catalyst for growth as we expand into new markets.As this market rationalization occurs, we believe we’ll be in the best position to capitalize on emerging opportunities, given the high-quality and cost advantage characteristics of the assets we possess in this market.Flipping to Slide 7. We have added a slide to show the changing projections for the coal-fired power market in the U.S. You can see how incorrect the government agency experts have been and how quickly these expectations have fallen each forecast year. And specifically, the precipitous decline expected in 2020 from when we underwrote this asset in December 2018.This unexpected decline was the result of the convergence of four factors

[Operator:]

Thank you. [Operator Instructions] The first question is Amit Dayal with H. C. Wainwright. Your line is open.

[Amit Dayal:]

Thank you. Good morning, everyone.

[Heath Sampson:]

Good morning.

[Amit Dayal:]

Heath, just to – good morning. Just to begin with, are there any other core plant closures expected in your projections?

[Heath Sampson:]

No, they're not. The two in 2019, specifically, one was surprised, but based on what we're seeing in the states that these – our facilities are located, we don't foresee anything happening, nor are we projecting any more closures.

[Amit Dayal:]

And in your slides, you're indicating you might add one more in 2020, do you think there's an opportunity to add more than one?

[Heath Sampson:]

Yes. So, we do think that there's opportunity. We are in discussions to add more than one. So, – but really, next six months are probably the most critical point for us to adding those additional facilities, as well as additional volume.And then as I noted, committing to what that incremental volume is going to mean from a financial perspective is similar to we've had in the past, but we're also evaluating this dynamic coal-fired power dispatch. So, we'll announce kind of what we think that net incremental volume is going to be, as each of those deals happen over the next coming months.

[Amit Dayal:]

Understood. And then in terms of your efforts to lower operating costs, what exactly are we focused on? Is it personal or any other aspect of the operations?

[Heath Sampson:]

It's across the Board. It’s personal. It's all the normal SG&A cost that you'd expect to be reducing from legal to consulting. And then even – and it is not in our cost estimates. We’ll continue to get efficient, whether that's on the product optimization side or manufacturing side. So, it is across the Board.

[Amit Dayal:]

Understood. And then when you’re looking at non-mercury related growth opportunities, I mean, water has been sort of one area of focus, but contribution from these efforts, how long should we – is it a year away, two years away? How far away are we from getting active contribution from…

[Heath Sampson:]

2019 was a very important year for us. We invested a lot in equipment and processes and have improved our product capabilities, as well as realigned our commercial staff. So 2020, we expect significant increase in these opportunities and look forward to give an update as each quarter goes by.Just a reminder, why that – why we feel good about the opportunity to continue to grow there is really because of this manufacturing asset that we have. If you remember, this asset had an investment of over $400 million, and it’s the newest asset in the – in North America.So for us, we have the cornerstone asset and the capability to make activated carbon. So really for us, it was understanding the markets, rounding out our application capabilities and then some nominal investments to ensure that we can properly test and we did all that in 2019.So, again, we’re really encouraged about this year and see meaningful growth in that. And it was – we had a graphic on one of the slides that showed that. It's not complete guidance, but it is aligned to what we think this growth that we expect primarily in water and industrial products from mercury, again, expect a lot of that in 2020.

[Amit Dayal:]

Understood. That’s all, guys. Thank you so much.

[Heath Sampson:]

Okay. Thank you.

[Operator:]

There are no further questions at this time. I’ll turn the call back to Mr. Sampson for any closing remarks.

[Heath Sampson:]

Well, great. Well, thanks, everybody for joining us the call today and your continued support. We look forward to updating you on our next quarter. Have a great day, everyone.

[Operator:]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.