Enviva Inc.
Q3 2017 Earnings Call Transcript

Published: 2 Nov 2017

[Operator:]

Good day. And welcome to the Enviva Partner's Third quarter 2017 Conference Call and webcast. [Operator Instructions]. I would now like to turn the conference over to Ray Kaszuba, Vice President and Treasurer. Please go ahead.

[Ray Kaszuba:]

Thank you. Good morning. And welcome to the Enviva Partners, LP third quarter 2017 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 Steven 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’ll be making some forward-looking statements and we’ll 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 press release issued this morning, and is posted on the investor relations section of our website, www.envivabiomass.com, as well as our 10-K and other recent filings with the SEC. We assume no obligation to update any forward-looking statements to reflect new or changed events or circumstances. Reconciliations of non-GAAP measures to GAAP measures may also be found in today's press release. In addition, all references to 2016 amounts are as reported in our 10-Q file today. 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 you'll note from our earnings release this morning we had a strong quarter operationally. The process improvements discussed during our second quarter conference call which we undertook to maintain a leadership position in the industry are now behind us and we exited the quarter with a production profile in excess of the nameplate capacity of our facilities were roughly 2.8 million metric tons per year. With our production at or perhaps a bit better than we expected and it's associated strong operating cash flow we generated our highest ever EBITDA even which underpinned a 16% increase in our distribution over the third quarter of 2016. This is our 9th consecutive quarterly increase, a track record we have maintained since our initial public offering and one we expect to continue. The fourth quarter is shaping up to be stronger than any quarter we've ever had driven by the strong operating performance of our facilities so we continue to expect to deliver a per unit distribution for full year 2017 of at least $2.36. In early October we also completed the dropdown acquisition of the Wilmington terminal from our sponsors joint venture with John Hancock. Deepwater export terminals like Wilmington and our assets in Chesapeake and Panama City are the most critical pieces of the industry's value chain. In addition to volumes from our Samson plant the Wilmington terminal receives stores and loads would tell us from a third party production plant and is also expected to handle pallets from the plant our sponsor is currently building in Hamlet North Carolina. With capacity of the terminal approximately 3 million tons per year in Wilmington which translates to another two to three production facilities that terminal capacity is a key platform to support the long term demand growth expected from Asia and Europe. I will spend more time at the end of the call for some broader market commentary but I do want to provide a quick update on our contracting activities. Certainly growth opportunities in Asia are paramount, we are diligently progressing through definitive documentation for the 650,000 metric ton per year 15 year MOU announced during the last call and are in late stage negotiations with several other potential counter parties for not only the material long term supply contracts for which we and our sponsor will need to build additional plants and ports forth but also for near term smaller orders beginning as early as 2018. Although Asian volumes are a key focus area for us I'd like to remind everyone that European demand continues to dominate the market and substantial growth in this geography continues to materialize. As a case in point I will note the incremental volumes with both NG and Dong now called Orsted. Earlier this year we announced that we had reached an agreement with NG to sell 450,000 metric tons over 2.5 years starting in mid-2017 and that 2018 and 2019 volumes were subject to certain conditions. I'm pleased to announce that those conditions are now satisfied and the 2018 and 2019 volumes are firm. In addition we've also agreed with DONG, Orsted to sell an incremental 200,000 metric tons from late 2018 through mid-2021. In all nice additions to the longer term contracted book which now includes [indiscernible] DRAX, DONG, [indiscernible] NG, RWE and MGC That's an important progress on our objective to increase customer diversification, more on customers, markets and geographies a bit later. But now I'd like to hand it over to Steve who's got our solid financial performance for the quarter in more detail.

[Steven Reeves:]

Thanks John. As a reminder references in my comments to the prior year will be to the recap financials included in the press release that reflect the effects of the Samson plant as though it was included for the full period. This was due to the common control nature of last year's drop transaction. For the third quarter of 2017, we generated net revenue of $131.5 million, an increase of 18.7% or $20.7 million from the corresponding quarter of 2016. Included in that revenue were product sales of $125.4 million on volume of 668,000 metric tons of wood pallets as compared to 534,000 metric tons for the third quarter of 2016. Product sales increased $21.8 million from the corresponding quarter of last year due to the greater sales volumes primarily due to ton sold under the DONG contract that was acquired in connection with the Samson drop down transaction which is partially offset by lower pricing that was a function of contract mix. Other revenue decreased to $6 million for the third quarter of 2017 compared to $7.2 million for the same period in 2016. This decrease was due primarily to lower revenues from transactions related to market dislocations as compared to a $5.7 million transaction reported last year associated with a third party power producer that could not meet its contractual obligations. This is partially offset by additional sources of other revenue. Gross margin decreased to $21.1 million in the third quarter of 2017 from $22.4 million in the corresponding period in 2016 due primarily to higher depreciation expense as a result of the Samson acquisition, the mix of customer and shipping contracts, the decrease in other revenue and higher production costs. However higher sales volumes offset a large portion of those costs. Adjusted gross margin per metric ton for the third quarter of 2017 was $46.49 compared to $56.88 for the corresponding quarter of last year. Excluding the $5.7 million we earned related to the transaction in other revenue for the third quarter of 2016 as I mentioned earlier the adjusted gross margin per ton for that period would have been $46.25. A net income of $6.3 million adjusted EBITDA improved to $26.1 million in the third quarter of 2017 from $22.9 million in the corresponding period last year. An increase of $3.2 million or 13.9% driven by the factors I previously mentioned as well as the decrease in general and administrative expenses attributable to plant development activities related to the Samson plant. Net income for the third quarter of 2017 decreased by $4 million due to higher depreciation expense and an increase in interest expense as a result the issuance of the senior unsecured notes last year. After maintenance capital expenditures of $857,000 interest expense net of amortization of debt issuance costs and original issue discount of $7.3 million and incentive distribution rights for our general partner of $1.1 million, distributable cash flow for the third quarter of 2017 was $16.9 million to our limited partners which covers the $0.615 distribution announced today at 1.04 times consistent with the expectations for the third quarter we communicated during our last earnings call. As we've discussed previously this is a business designed with strong cash flow capacity. This continued in third quarter with strong operating cash flow during the quarter resulting in $76.3 million in operating cash flow for Year-to-date. As John mentioned we completed the dropdown acquisition of Wilmington terminal after the end of the quarter. We funded the initial payment primarily with a drawn on our revolver. We subsequently issued $55 million of additional senior unsecured notes at a premium of 106.25% at par representing a yield to maturity of 6.7% and use the net proceeds principally to repay the revolver borrowing. We're pleased with this add-on bond financing which was completed at a strong mark and maintains our financial flexibility as we plan for continued long term growth. With only the fourth quarter remaining in the year we maintained the midpoint of our full year 2017 guidance we communicated on our last earnings call well narrowing the range. We project earned net income in the range of $19.5 million to $21.5 million with associated adjusted EBITDA of between $104 million and $106 million which includes the impact of the recently acquired Wilmington terminal. We expect maintenance capital expenditures of $4.5 million and interest -- amortization of debt issuance cost and original issue discounts to be $30 million. As a result the partnership expects to generate distributable cash flow of $69.5 million to $71.5 million for the year prior to any incentive distribution store general partner. As we mentioned during our last earnings call we expect the fourth quarter to be strong driven by the strong operating performance of our plants and favourable contract mix with $30.5 million to $32.5 million in adjusted EBITDA for the quarter. In addition we confirm our distribution guidance of at least $2.36 per unit for 2017 although on coverage for the full year that will somewhat tighter long term target of 1.15 times mainly due to the financial performance in the second quarter as a result of the processes improvements they are now behind us. We expect to provide full year 2018 guidance during our next earning's call but as we have consistently stated we seek to increase our distribution on a quarterly basis. From a liquidity perspective we are undrawn on our $100 million revolving facility following the repayment of the revolver with the proceeds of the note issuance. Now I would like to turn it back to John.

[John Keppler:]

Thanks. Before we open the lines for Q&A I'd like to take a few minutes to provide an update on the growing market for wood pallets which then drives our plants, for the plants and ports needed to supply potentially new off take contracts. Our strategy continues to be to fully contract our production capacity and our weighted average remain in term of off take contracts is 9.7 years with a revenue backlog of firm contracts at $5.5 billion. We're also focused on further diversification of our customer base in Europe and increasingly Asia and to that end we are now supplying alignment facilities [ph] in United Kingdom. We expect to deliver our first vessel [indiscernible] in Martinique before the end of the year. We have extended our relationships with NG and DONG as I mentioned earlier on the call. Looking forward the favorable tailwinds in our industry continue with experts forecasting worldwide demand increase 18% per year through 2021 with further substantial growth to 2030 and beyond. A significant part of that growth is from Asia as Japan is targeting 6 to 7.5 gigawatts of biomass power capacity by 2030 representing 15 million to 20 million metric tons a year of demand. The recent feed in tariff program designed to enable this capacity actually received applications for 15 gigawatts of biomass power capacity significantly exceeding expectations and approvals for the feed in tariff are beginning to become public. Several utilities and trading houses have announced new dedicated and co-power [ph] biomass project. As I mentioned earlier we are in late stage negotiations with several potential counter parties representing material volumes for off take contracts as long as 20 years. Last quarter we announced a memorandum of understanding for the sole source supply of 650,000 metric tons per year for 15 years to the largest dedicated biomass project announced to-date in Japan and that continued to move forward towards definitive documentation as expected. Elsewhere in Asia, South Korea imported a record amount of wood pallets in the third quarter up 70% since last year to meet the growing demand of its biomass powered power facilities. Today that demand is typically fulfilled using short term tenders, but as more biomass power capacity is built largely on a project finance basis the market is beginning to see a shift towards longer term take or pay off take contracts for the reliable credit worthy fuel supply required to meet the demand for biomass. Shifting to our current core market of Europe demand continues to grow as the 2020 renewable and mandates approach. In Belgium NG received a five year extension to run its 180 megawatt Max Green facility on biomass. The facility uses approximately 800,000 metric tons per year of wood pallets at full capacity. In Germany, coal fired power generation needs to be reduced substantially by 2030 in order to meet the commitments under the Paris Climate Change accord just as some policymakers call for a complete phase out of coal. Many coal fired combined heat and power facilities or system relevant assets and the conversion of coal fired power plants to biomass power generation has proven to be an effective lower cost complement to intermittent sources of renewable power. In the United Kingdom the government awarded a contract for difference for CFD to an 85 megawatt biomass fired CHP project in Grangemouth, Scotland under the latest UK government auction. The government has announced a further CFD auction around including biomass CHP to take place in the spring of 2019. In the Netherlands, €6 billion were made available to renewable energy projects under the autumn round of the renewable incentive program called the SE Plus. Given the category for biomass co-firing it had already realised €3.6 billion in subsidies in prior rounds, we expect several large scale industrial steam projects will be successful in this round leading to further enhanced wood pallet demand in the Dutch market. Worldwide the markets are growing and I'll tell you that we are in a unique position to capitalize on the demand growth in particular in the Japanese market which places a premium on long term supply that can grow alongside expected demand. In contrast to other regions the U.S. Southeast presents a flat marginal cost curve for incremental production and with the reliability and [indiscernible] provides to our customers through a portfolio of plants and ports that benefit from this robust scalable raw material base we are positioned with a durable competitive advantage. That advantage translates today to roughly a 20% market share for Enviva that in an industry that is seeing substantial increases in long term demand underpins the first of the three pillars of growth you've heard me consistently talk about. That first pillar is investments in new plant and port capacity that ultimately are made available to the partnership. We have now successfully completed three dropdown since our IPO. Our sponsor continues to evaluate sites in the South Eastern United States for additional production facilities which could utilize untapped capacity at our existing terminals as well as incremental terminal locations. Our sponsors joint venture with John Hancock continues to progress construction of the newest production facility in Hamlet North Carolina which our sponsor anticipates could begin material production in the first quarter of 2019. Our practice has been to fully contract, develop, derisk and then drop the facilities into the partnership once they have achieved that full scale operations. As you may recall as partial consideration for the Samson dropdown acquisition undertaken by the partnership last year we issued approximately 1.1 million common units at attractive terms to affiliates of John Hancock. We have been informed that they sold them this week which may account for the heavier than usual trading volume. The proceeds on that equity sale are being realized at the same time as our sponsor and it's joint venture partner are fulfilling capital calls to fund the completion of the Hamlet plant. We do note that the incremental liquidity in our units achieved as a result of the sale is consistent with the interest of many of our investors about increasing our public flow. While a significant step changes in our growth will occur from drops the second pillar and one that defines our quarter over quarter consistent growth is driven organically through contract price escalators and the production cost reductions and throughput improvements that lead to the underlying 1% to 2% productivity increases we expect from our assets annually. As many of the plant production costs are fixed incremental production lines come with robust margin. So drops coupled with organic growth are core pillars of our planned growth strategy and a complemented by a third pillar, third party acquisitions which is a proven acquirer of the sources of accretive growth in the past where the assets and the opportunities made sense and were consistent with our core business. So net-net a good quarter underpinned by robust production increases strong operating cash flow and expansion of our contracted position. We've continued to make investments in plant and port infrastructure, a strategy that has led to an annualized growth rate in our quarterly distribution of 19% since our IPO. Looking forward we expect additional plants and ports to serve the substantial new contracted demand on the horizon coupled with solid execution and productivity increases that will further drive the cash flow growth that should enable us to increase our per unit distributions each quarter. As we close I would like to thank all the great people in Enviva for their dedication and hard work. Our team is focused on keeping our plants, ports and most importantly each other, save each and every day. That’s the foundation that result in another solid quarter and a platform for long term growth. Operator, can we please open the lines for questions.

[Operator:]

[Operator Instructions]. The next question comes from Mr. Brian Maguire from Goldman Sachs. Please go ahead.

[Unidentified Analyst:]

This is Derek [ph] on for Brian. Just really quickly, it looks like the average price per ton fell just a little bit sequentially there just curious if there's anything to highlight and if maybe it was more related to the seasonality or just some contractual pass-throughs of maybe lower input cost that goes through to your customers.

[Steven Reeves:]

It is largely just a function of how contracts mix out from quarter to quarter. There is some variation in our contracts and the mix of individual contracts will give you some volatility on that that metric from quarter to quarter.

[Unidentified Analyst:]

Okay. And then just curious if you could speak a little bit to how input costs have been tracking for you guys and if you've experienced maybe any impacts from hurricanes in the quarter there, I know there is some wet weather in the south.

[Steven Reeves:]

Sure. Input cost have been a good story for us this year they've been on a steady decline through the year for variety of reasons including some good effort relative to our sourcing group. With respect to the hurricane specifically we really saw no impact from those there's no damage to our facilities. It didn't really effect the fiber supply particularly. We closed at least some of our facilities just for the safety of our employees for a short period of time but that came right back up and there was really no material effect in the quarter.

[Operator:]

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

[Ryan Levine:]

Would you be able to provide some EBITDA guidance related to the new DONG contracts that start next year and go through 2021?

[John Keppler:]

We don’t provide specifics relative to individuals contracts, I think that would be imprudent from a commercial perspective.

[Ryan Levine:]

Is it fair to say that the EBITDA per ton for that contract is comparable to what you're seeing elsewhere with your European customers?

[John Keppler:]

I think the way that we characterize that is that you've seen very stable adjusted gross margin per ton generation and modest increases due to the productivity that we're able to achieve our asset, that’s a trend that we would expect to maintain.

[Ryan Levine:]

Okay. And then in your guidance it looks like there is an asset impairment and disposal charge for Q4, what does that relate to and is that anticipated to continue into next year?

[John Keppler:]

Sure. You know from time to time what we do in our maintenance CapEx there will be assets to get disposed of as part of that activity. So there will always be some level of small noise associated with that as we go forward.

[Ryan Levine:]

What assets are you disposing?

[John Keppler:]

Once we do maintenance capital we replace say a cyclone or something along those lines and to the extent that specially you know -- they said that the asset life still existed on the books there would be a disposal associated with that. So it's not assets that are taking out service that aren't being replaced.

[Operator:]

[Operator Instructions]. The next question come from Mr. Pavel Molchanov from Raymond James. Please go ahead.

[Pavel Molchanov:]

So as we're on the cusp of 2018 just as a high level what percentage of your anticipated volumes for 2018 are contracted as of today?

[John Keppler:]

We're fully contracted.

[Pavel Molchanov:]

Okay, got it. And then a question about an Asia-Pacific, potential Asia-Pacific market that has not been getting a lot of attention while we saw last month the Government of Australia put out a new admissions policy that has a very explicit emphasis on baseload flow generation and preserving their coal fired power plants you know given that this is very similar or [indiscernible] to what we've seen in the UK and so forth in Europe. I'm curious if you've had any interest coming in from Australian generators with regard to beginning to blend pallets?

[John Keppler:]

I would answer it this way that any generator facing an emerging regulatory set which is in sensing baseload flow generation and seeking to reduce emissions ultimately focuses on biomass conversions, they're the lowest cost alternative, they represent the lowest system cost and present attractive opportunity. So as that comes into relief I think and certainly into a broader perspective from a generator set I think that will be interesting potentially over time.

[Pavel Molchanov:]

Okay. But it sounds like it's kind of premature at this stage to for you guys to get into any discussion on that.

[John Keppler:]

I think generally the industry weathers in Australia, New Zealand, continent of Europe, we talked about Asia. The intense focus on baseload flow generation and low cost alternatives for carbon emissions reduction tends to ultimately result in biomass conversion and we think that's generally a good thing.

[Operator:]

The next question comes from Richard Hayden from THC [ph]. Please go ahead.

[Unidentified Analyst:]

Could you remind me what the nameplate capacity was prior to the productivity improvements you indicated is now 2.8 million metric tons?

[John Keppler:]

Sure. It was a little bit shy of that and so a little bit less than the 2.8 million we're seeing today and again I think as we talked in the prepared remarks we exited the quarter on top of that and so we're encouraged but we need to maintain that momentum.

[Unidentified Analyst:]

And what was it prior to say for the first quarter there?

[John Keppler:]

2.75 I think.

[Operator:]

The next question comes from Mr. Lin Shen from HITE. Please go ahead.

[Lin Shen:]

I think you have been working to try to extend your market Asia especially in Japan for some time. I guess maybe even talk a little bit about what are the challenge you're facing now you think may be able to solve that over the next couple of months?

[John Keppler:]

So Lin if I understood the question correctly you're more broadly talking about the Japan contracting profile. Again we're extremely pleased with the progress that we're making. This is a market because of it's robust growth and it's acceleration we've chosen to communicate a little more discreetly about the opportunities to give some visibility into that market's potential and it's emerging contracting profile. Again that's a market that as I shared is targeting 6 to 7 gigawatts the most recent FIT applications were for 2X that, so the generator, the trading house demand in the investments in both the new dedicated biomass plants that we will provide for distributed generation on those basis as well as co-firing within the large utility set, very robust demand. Most of that materializes in terms of beginning of the deliveries in the 2021, 2020 timeframe. And so today it is a process of extensive diligence, extensive of contract negotiations as what I would say is a relatively conservative market begins to execute binding long term off takes that can go as long as 20 years. So we're very excited about the progress we're making. I think that as we shared last quarter the execution of sole source MOU is indicative of our presence in the market, our continued contracting activity that we expect to be in a position over the next two to three quarters to provide for a lot more visibility in terms of the specifics, counterparties and the tenure of those contracts. You'll note that you have heard me talk in the past, we have offices in Tokyo today, we have a number of people there supporting that market. It's a continued reflection of the investment we're making there because of the expectations we have for the market.

[Operator:]

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

[John Keppler:]

Everyone thank you so much for joining us today. We appreciate your time and attention and we very much look forward to our next conversation. Have a great day.

[Operator:]

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