Enviva Inc.
Q1 2018 Earnings Call Transcript

Published: 3 May 2018

[Operator:]

Good day and welcome to the Enviva's First Quarter 2018 Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would like now to turn the conference over to Ray Kaszuba, Treasurer. Please go ahead.

[Ray Kaszuba:]

Good morning and welcome to the Enviva Partners' LP First Quarter Financial Results Conference Call. We appreciate your interest in Enviva Partners and thank you for participating today. On this morning's call, we have John Keppler, Chairman and CEO and Steve Reeves, Chief Financial Officer. Our agenda will be for John and Steve to discuss our financial results release this morning and provide an update on our current business outlook. We will then open up the phone lines for questions. Before we get started, a few housekeeping items. First, please keep in mind that during the course of our remarks and the subsequent Q&A session, we will be making some forward-looking statements and we will refer to certain non-GAAP measures. Our forward-looking statements or comments about future expectations are subject to a variety of business risks. Information concerning the risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements can be found in our release issued this morning, which is posted on the Investor Relations section of our website, www.envivabiomass.com, as well as in our 10-K and our other recent filings with the SEC. We assume no obligation to update any forward-looking statements to reflect new or changed events or circumstances. During this call, we will be using GAAP and non-GAAP figures and we want to be clear on the basis of each. As of January 1, 2018, the partnership adopted as - revenue from contracts with customers unless otherwise indicated the financial results for the three months ended March 31, 2018 discussed on this call are prepared on this basis. In addition to presenting our financial results in accordance with GAAP in certain cases we have provided financial results excluding the full financial impact of the Chesapeake incident. References to the full financial impact of the Chesapeake incident included the approximate cost incurred to March 31, 2018 in connection with emergency responses disposal of Wood Pellet inventory, asset disposal and repair as well as associated business continuity expenses which include incremental logistics cost and loss of margin on incremental Wood Pellet production offset by insurance recoveries received to-date. Reconciliation of non-GAAP measures to GAAP measures may also be found in today's press release. I would now like to turn it over to John.

[John Keppler:]

Thank you, Ray. Good morning, everyone and thanks for joining us today. As we reported in our earnings release published this morning, we had a decent quarter, especially in light of the events that transpire involving our Chesapeake Terminal. First and foremost, our underlying operations continue to demonstrate the year-over-year productivity improvements we expect. Second, our business responded well to the challenges presented by the fire at the Chesapeake Terminal and we expect to resume normal operations by the end of the second quarter. And last, the business continues to progress towards our growth and diversification goals and the overall market environment has never been better. Before I highlight, the first quarter's results, it is important to note that as we communicated in our press release following the incident and in the special letter to investors, we published last month, the fire we experienced at the Chesapeake Terminal did disrupt our cost position during the quarter and will again in the second quarter. I'll let Steve go into the balance of the stills of the incident shortly but would like to take the time to describe the strength of the underlying operating performance of the business as we believe the effects of the incident itself are temporary in nature and that substantially all of the costs of the incident are recoverable. First, the improvements in our production profile that we discussed last year continued into 2018 as our facility's increased production by 4% over the same period of last year. This increase was after and approximately 25,000 ton or additional 4% derate the Mid-Atlantic plant as we overcame the initial delays associated with our extended logistic chain, following the Chesapeake incident. On an apples-to-apple basis, the plants were up nicely over the Q1 2017 production profile and on an adjusted EBITDA basis, Q1 was still up over the same seasonally soft first quarter of last year despite the complications of the Chesapeake incident. The net-net, the core business is performing better than last year and at rates that contributes to our expected organic annual EBITDA growth in the 7% to 10% range. Given this continued stable and growing underlying operating performance our Board has elected to declare a quarterly distribution of $0.625 per unit. This represents the 12.6% increase over the corresponding quarter of last year and this is our 11th consecutive quarterly increase. As we have previously expressed, our Board in the normal course evaluates coverage on an annual basis due to the modest seasonality and timing attributes of our business. The timing of insurance recoveries exacerbates that this year, but as I indicated, the underlying business is healthy. And we expect no change to its overall trajectory due to the temporary issues associated with the Chesapeake incident. On the customer front, you will also note from our release that we have continue to extend an increased our contracted position with our long-standing customer NG both for both its internal European consumption as well as its global trading operations. It is worth noting, that although it occurred in the serious of transactions we have now largely recontracted our original volumes with NG. while we do not have additional specifics to you now at this time, our negotiations with the existing customers and perspective customers in both the European and Japanese markets continue on track, and we expect to announce several incremental contracts during the course of the year. I would like to now hand it over to Steve to discuss financial results. Before we turning to provide an update on the market and where we see additional growth opportunities.

[Steve Reeves:]

Thanks, John. As Ray has mentioned unless otherwise indicated in the financial results in the three months ended March 31, 2018 discussed in this call are prepared in accordance with ASC-606. As noted in our Letter to Investors, cost directly associated with the Chesapeake incidence saw including the event management, inventory loss and disposal, and equipment loss and repair net of insurance recoveries received to date have been added back in our calculation of adjusted EBITDA. Associated effects to our operations including incremental logistics cost and the temporary curtailment of production as to the logistics chain was put into place, net of insurance recoveries have not been added back in adjusted EBITDA unless other indicated. We expect these associated costs to extend through the point that the Chesapeake Terminal has returned to operations at the end of the second quarter. We also expect substantially all costs related to the incident to be recoverable from insurance or other responsible parties. However, due to the timing of the incurrence of the cost and the ultimate recovery, quarterly results will be affected. While the cost we incurred before insurance proceeds are received, we have ample sources of liquidity to accommodate the short-term effect of this incident. For the quarter, first quarter of 2018 on a GAAP basis, net revenue was $125.8 million, representing an increase of 2.7% over the corresponding period of 2017. Pulp sales revenue was $122.8 million as compared to pulp sales of $119 million for the first quarter of last year. For the quarter, we sold 648,000 metric tons of wood pulps as compared to 623,000 metric tons during the first quarter of 2017. At ASC-606 been in effect last year, we would have reported pulp sales revenue of $127.9 million on sales of 667,000 metric tons. As we have said in the past, our sales are generally ratable over the course of the year of that can be affected by shift timing around quarter-end. With the sales book of approximately 3 million tons for 2018, the 648,000 tons sold in the quarter are roughly 100,000 tons below simple quarterly average. The difference is largely a function of the mutually agreed deferral of customer shipments to later quarters based on their inventory positions and related the Chesapeake incident. The shipments will be fulfilled later in the year from higher ending inventories at the end of the quarter, new production and existing sources of supply. The margin impact of the 43,000 tons of products lost in the dome has been recovered and is recorded in other income. We believe substantially all of the value of the 25,000 tons lost due to the curtailment of production are recoverable from insurance or other responsible parties. For the first quarter of 2018, gross margin was negative $4.5 million a decrease of $20.9 million from the same period in 2017 due mainly to $19.6 million of expenses net of insurance recoveries received to date related to the Chesapeake incident. On a reported basis, adjusted gross margin per metric ton was $7.35 for the first quarter of 2018. Excluding the full financial impact of the Chesapeake incident, adjusted gross margin per metric ton would have been $38.11 for the quarter, which was roughly flat to the adjusted gross margin per metric ton of $38.57 for the first quarter of 2017, adjusted for the impact of ASC-606 for comparison purposes only. On a GAAP basis, net loss for the quarter of 2018 was $19.3 million versus a small net loss of $45,000 for the correspondent quarter of 2017. The decrease is mainly due to $19.5 million of expenses related to the Chesapeake incident again net of insurance recoveries. Adjusted EBITDA for the first quarter of 2018 was $17.6 million, as compared to $21.3 million for the corresponding quarter of 2017. Excluding the full financial impact of the Chesapeake incident, adjusted EBITDA would have been $21.8 million for the first quarter of 2018. Distributable cash flow prior to any distributions attributable to - distribution rates paid to the general partner was $8.8 million for the first quarter of 2018, which covers the first quarter 2018 distribution at 0.46 times. For the timing reasons we have discussed, we expect the second quarter will have coverage below one-time and we may not achieve the $50 million to $55 million EBITDA target for the first half of the year that we mentioned in our call in February. However, as we believe that substantially all the cost resulting from the Chesapeake incident will be recoverable. We expect that the full year adjusted EBITDA guidance of $118 million to $122 million as well as the distributable cash flow guidance of $79.5 million to $83.5 million we provided during our last earnings release remains achievable, partially dependent on the amount and the timing of recoveries matures in other responsible parties. We also expect our annual coverage ratio to increase to levels you've come to expect from us. As such, the partnership reaffirms full year 2018 per unit distribution guidance of at least $2.53 with continued quarter-over-quarter increases expected throughout the year. From a liquidity perspective, despite the incremental expense associated with the Chesapeake incident, we were undrawn on our $100 million revolving credit facility at the end of the first quarter of 2018 and our first debt maturity is in 2020. Support of our internal growth rates that John mentioned, we continue to implement modest growth capital projects to drive greater throughput and margin per ton. With recent examples including the expansion of our use of sawdust, which requires investment in dry storage at our production facilities and increasing our use of soft wood recurring enhanced emissions control equipment. So, I hand it back over to John, I would like to note that after the first quarter distributions paid, we will have met the requirements for the termination of the subordination period of our sponsored subordinated units and they will convert to common units. As we have said in the past, the sponsor remains committed to the business hence for its prospects. Now, I'd like to turn back to John.

[John Keppler:]

Thanks, Steve. Before we discuss the market outlook, I would like to make one final point on the Chesapeake incident. While unfortunate in its occurrence, in many ways, the incident and our response validate our business model and portfolio approach and demonstrate our reliability as the preeminent supplier to the industry. I would note that terminal operations were the only substantial aspect of our business where we subcontracted the operations of our assets to the third party. We have now brought those operations in-house at our Chesapeake and Wilmington terminals. As we look forward, our strategy continues to be to fully contract our production capacity and our weighted average remain in terms of off-take contract is nine years with revenue backlog from firm contracts of $6 billion. According to independent industry experts, global industrial wood pulp demand increased by 15% in 2017. It was expected to increase by compound average growth rate of 18% per year through 2021, driven by continued growth in the European industrial pulp market and rapid expansion in Asia, demonstrated by several recent noteworthy developments. Let's start with Europe, where demand continues to quickly grow to meet the binding 2020 renewable energy mandates. These binding legal obligations becomes potentially far more restricted by 2030 where new policy mandates a 35% reduction in carbon emissions. A few highlights from across the continent illustrate the growing opportunity. In the Netherlands, the government has stated its intent to close the country's largest natural gas field and is encouraging to 200 largest users of natural gas to convert to an alternative source of energy preferably renewable. This just further enhance the interest in biomass industrial heat projects, which are beginning to access a government incentive program for industrial steam projects using wood pulps. The Dutch government recently allocated a further €6 billion to low carbon energy projects including this program. The Dutch government has also launched a program to take a quarter of Dutch homes about €2 million off of natural gas by 2030 with the goal of the complete phase out of natural gas from all Dutch homes by 2050 In Germany, the new energy minister has stated coal emissions need to fall by 60% in order to reach the country's binding 2030 carbon reduction mandates. With all German nuclear generation is expected to be retired by 2022, and an ongoing need for dispatchable heat and electricity, industrial scale biomass is expected to become an increasingly attractive option. In addition to these positive development, during the first quarter, we delivered several bulk shipments into the French heating market and recently executed a firm contract to deliver a large bulk shipment to one of the largest power distributors in Italy. Shifting to Japan, METI has already approved 14 gigawatts of biomass capacity as of September 2017, far exceeding its original target. Additionally, a number of major utilities have received METI approval for their feed-in tariffs since that time. And introducing new development to launch, is it several projects are currently being developed without necessarily relying on feed-in tariff. As only 7 of the 42 operable nuclear power reactors have restarted, we continue to uncertainty around in nuclear restart, and the Japanese government push to reduced carbon emissions and increase renewable generation will be important drivers going forward. Another important potential market is South Korea, where the countries sustainable certification system starts to take effect on October 1st of this year is likely challenging from many existing suppliers, particularly in South East Asia. And they result in a structural step shift in utility company's biomass for general practices. Potential supply dislocations like this have emerged for a variety of reasons beyond those of sustainability and the gallery which is why our customers seek stability of the sustainability harvest and robust natural resource of the Southeast United States and to derisk their fuel supply chain with the benefit of the portfolio plants and forts that indeed deliver. As a result, in light of the recent European and Japanese contracts that we have announced, and the negotiations that are progressing for several other contracts in those geographies, I also want to provide an update on our sponsors' activities developing the plants and forts capacity intended to serve this and other rolling demand. Our sponsors' first joint venture was John Hancock, continues to construct a production facility in Hamlet, North Carolina. Nameplate 600,000 metric tons for your facility based on the design of our existing facilities which our sponsors anticipate could begin production in the first half of the 2019. As we previously described, last quarter our sponsor extends its development relationship with John Hancock with a new joint venture. The first investment with the new JV was the acquisition of the production facility in Greenwood, South Carolina was closed in the first quarter. The JV is expected to complete its ramp and invest incremental capital subject to the receipt of the necessary permit to increase the production of the plant to 600,000 metric tons for year run rate in 2019. As a result, the visible dropdown inventory today consists of the additional EBITDA from our Wilmington Terminal with volumes from the Hamlet plant. The Hamlet plant itself which is expected to supply the Macquarie backed MGCT [ph] site project in the UK and the Greenwood plant which lines up quite nicely to the long-term demand from Asia. We expect the second portion of the Wilmington terminal dropdown to be completed in early 2019 and then one plant dropdown acquisition in 2019 and the other in 2020. In addition, the new Hancock JV is expected to develop at least two additional production facilities as well as a terminal and supported additional off-take contract. Here our focused has been on the development of the deep-water marine terminal with a Pascagoula, Mississippi and additional plans and across the model, including a side under evaluation in Louisville, Mississippi. Our sponsors' practice has been to fully contract, develop, derisk and then drop the facilities into the partnership once they have received full scale operations. Our sponsors' exception is that it will make a final investment decision on the Pascagoula Fort and Louisville plant around the end of the year. To ramp up my prepared remarks, well the Chesapeake incident has a short-term impact on our result. The underlying long-term fundamentals of our business process. Durable cash flow generation with the substantial platform for growth would enables us to increase per unit distributions overtime. As you know, I'm fond of saying we're just getting started and that certainly still the case. As we close, I would like to thank all the great people at Enviva for their dedication, resilience and hard work. I could not be more proud of our associates as they managed the Chesapeake incident while keeping everyone safe. Operator, can you please open the line for questions.

[Operator:]

We will now begin the question-and-answer session. [Operator Instructions] The first question come from Brian Maguire with Goldman Sachs. Please go ahead.

[Derrick Laton:]

Hey good morning guys this is Derrick Laton on for Brian.

[Steve Reeves:]

Good morning, Derrick.

[Derrick Laton:]

Appreciate the color you gave there on. What the adjusted gross profit would have been excluding Chesapeake. And just kind of looking at the average price per ton in the quarter, fell a little bit sequentially there. I am just curious if there was any impact from Chesapeake on that or maybe it's just a function of customer mix, any color there would be helpful?

[Steve Reeves:]

That was just fundamentally a customer mix, the issue had the - had no impact on that.

[Derrick Laton:]

Okay, great. Thanks for that. And then in regard to your growth prospects out there for wining new contracts. Just curious if you could talk a little bit about the landscape that you are seeing now and maybe any increase in competition and pricing, how many of those new contracts and areas and Europe and in Asia?

[John Keppler:]

No, thanks, great question. I would say that as I indicated in my prepared remarks, the market environment is not better. The growth profile that we see both within our European customer base and I think the most recently contracted NG volumes are a good indication of that. As Europe continues to grow and the prospects for growth continue, a pace with the historical growth rate. The emerging market in Asia and as we have discussed and describe, largely intermediate by trading houses and I think we have been clearing and some of the progress we have made their last quarter with the announcement of the Marubeni long-term contract. Because it's a trading in the intermediate market, I think it's you're going to do a global participant base and to give example that as well. Certain notable markets, notable geographies. Our progress certainly with the largest biomass project announced here today, the 630,000-metric ton per year contract that we have previously describe continues to ride on track and we expect the conditions pressing into that contract confirm by the end of the year, as well as multiple incremental contract to be announce by the end of the year both in Asia as well as Europe.

[Derrick Laton:]

Great. That's really helpful. Thanks. And then maybe just one last one. Lot of the companies here throughout earnings season so far reports some wet weather particularly down the south are lot of your assets, I was just curious if you saw any those of impacts to your operations in the quarter?

[John Keppler:]

No, we haven't, we just had a normal seasonal effect, nothing of the ordinary.

[Derrick Laton:]

Great, thanks very much.

[John Keppler:]

Thanks, Derrick.

[Operator:]

The next question comes from Ryan Levine with Citi. Please go ahead.

[Ryan Levine:]

Good morning. Regarding the comments you made around the Japanese contract, given the Boe for biomass what's the driver the projects without [indiscernible] in Japan?

[John Keppler:]

I think as the Japanese government has continued to emphasize, they have a generation mix target that I think includes approximately about 44% of non-fossil fuel generation. With the questions around the likelihood of nuclear restarts, that pushes increasing pressure on and frankly the opportunity as a result of that for utilization of biomass either on a coal-fired basis, the logical coal-fired basis or a new dedicated biomass field basis and I think that many of our utility customers and their joint venture and development partners are beginning to evaluate those investments outside of the context of a direct FIT.

[Ryan Levine:]

Okay. And then switching gears to Chesapeake, what was included in $16.5 million term loan event line item in your DCF calculation? And then also the adjusted, your further adjusted EBITDA number that you put out I think it will takes about $4.2 million of incremental EBITDA adjustment, I was curious what was included in that number as well?

[Steve Reeves:]

Sure, we do a distinction - this is Steve. We do a distinction between the reason we discrete events of the event itself which included the control of the event, the disposable of the inventory, the write-off and the disposable of the inventory as well as the associated write-off or and repair of the fixed assets as being represented of about $16 million net of insurance recoveries in the cash flow statement. Within the add back to adjusted EBITDA to get back from 2017 to 2021, the $4 million delta that reflects for lack of a better word, the business continuity implications. So, of an elongated supply chain the longer trucking hauls from the Mid-Atlantic region to the, Wilmington terminal for instance as well as setting up the temporary storage facilities in the North region. We expect all of those to be recoverable from insurance, but we separated the two items along those lines.

[Ryan Levine:]

So, it appears that even $4.9 million is recoverable by insurance?

[Steve Reeves:]

That's our belief here. The insurance of the responsible parties. Yeah.

[Ryan Levine:]

Okay. And then are there any timing delays for shipments and what's the financial implication to that?

[Steve Reeves:]

Yeah. You saw yeah but a little higher inventory. So, there is little, we have to readjust the shipping schedule in process. So, we have probably little higher inventory than we would have otherwise expected. So that will those shipments will occur through the balance of the year as we've indicated. We're not going to miss any shipments to our customers. Unrelated to the incidence itself certain of our customers have happened from time-to-time under our take or pay contracts request. And we commercially discussed adjustments to timing and there were some early, some deferrals coming out the first quarter into the back half of the year. So, full year, we'll still hit our meet our contractual obligation as well as to our shipping, our customer obligations.

[Ryan Levine:]

Okay. And then last question. So, then are you saying that the we should experience some decline in Q2 as well and then a pickup in Q3 as the timing gets adjusted?

[Steve Reeves:]

Yeah, so exactly. So that has more to do I think with the fact that we will still have the longer logistics chain in the second quarter until the terminal comes back up that which we're projecting to be at the end of the second quarter. So, we'll continue to incur again for a lack of a better word business continuity cost with the elongated supply chain or extended supply chain through the second quarter and the recoveries against those into - from insurance of all responsible parties will occur in the back half. So, there will be as John indicated in this call, we have a dramatic effect on quarterly results. So, I think for the full year you should expect us to be back to our full year guidance.

[Ryan Levine:]

Thank you.

[Steve Reeves:]

Thanks, Ryan.

[Operator:]

The next question comes from Pavel Molchanov with Raymond James. Please go ahead.

[Pavel Molchanov:]

Thanks for the taking the question guys. You've referenced the recent comments by the German Minister. And the Europe's largest power market moves towards potential full phase out of cold. I am curious kind of the extent of your conversations with the perspective off takers in Germany specifically. And in particular if you can address kind of Eon, one of your historical customers. How they might be thinking about their domestic market in Germany vis-a-vis pulp.

[Steve Reeves:]

Well, thanks Pavel. I think we need to be a little bit sensitive about talking about any one customer specifically prior to their publicly announced plans. But what I would describe is for any of the major German generators. And those are the large multinational ones and I would also add that more regional and localized effort generators. These are system critical assets currently running on coal to generate both thermal energy and condensing power. These are very important grid relevant system critical assets to German Industry and to German power generation. And with a complete phase out of coal, and the no nuclear strategy, it's going to be very, very difficult for that country to achieve those goals without the adoption of something like biomass. And so, what I would specifically answer your question is, the generator led discussions are increasing at a pace consistent with the expectations that there will be an into coal and there will be a limited to know appetite for nuclear. And that creates a very interesting market opportunity for us overtime.

[Pavel Molchanov:]

Okay. That's helpful. And regarding the kind of the near-term distribution strategy. So, obviously in Q1, you ran a net negative coverage or less than one times coverage in Q2. There is a good chance you'll be below one times as well. Is it safe to say that starting in Q3, you're targeting getting back to a more normalized coverage level of at least I think 1.1 times that you've historically looked out?

[Steve Reeves:]

Yes, so obviously, I've agree with your socio there that after the first quarter's below on and we expect the second quarter to be below one as well. We expect to back half to recover and therefore be over our historical target in order to get us back to the full year's target of 1.15 times which we haven't changed.

[Pavel Molchanov:]

Okay. Appreciate it, guys.

[Operator:]

This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

[John Keppler:]

Thank you. And for all on the call, thank you again for joining us today. We really appreciate your time and attention. And we very much look forward to our next conversation. Thank you.

[Operator:]

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