Enviva Inc.
Q4 2017 Earnings Call Transcript

Published: 22 Feb 2018

[Operator:]

Good morning and welcome to the Enviva Partner’s Q4 2017 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Ray Kaszuba, Treasurer. Please go ahead.

[Ray Kaszuba:]

Thank you. Good morning and welcome to the Enviva Partners’ fourth quarter and full year 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 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. On October 2, 2017, we consummated the acquisition of the fully operational terminal in Wilmington, North Carolina. Because this was a transfer was a transfer between entities under common control, GAAP requires us to recast all financial results of the Partnership to include the results of the Wilmington Drop-Down since the date the acquired entity was originally organized. Such that, Wilmington’s results are now included in our GAAP results for each period presented in our earnings release and certain intercompany transactions between us and Wilmington were eliminated. The effect of this recast is to present financial statements as if we had developed a Wilmington terminal in the Partnership when in fact it is our sponsor’s stated strategy to develop new projects outside of the Partnership. Unless otherwise indicated, our financial results are recast on this basis and we will make it clear when we use figures that are not recasted. Reconciliation 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-K or earnings 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 announced in our earnings release published this morning, we closed out a pretty good 2017. We were particularly pleased with the way the fourth quarter shaped up and are very encouraged by the progress we have made expanding our customer diversification with new contracts, new customers and new geography. With respect to the fourth quarter, consistent with our guidance on the basis of strong production and more than 800,000 tons sold, we generated our highest quarterly EBITDA. This strong operating and financial performance enabled our fourth quarter distribution of $0.62 per unit, a 16% increase over the fourth quarter of 2016 and resulted in a per unit distribution for full year 2017 of $2.36, again consistent with our guidance. I would also add that our most recent distribution was our 10th consecutive increase, a track record we have maintained every quarter since our IPO and one which we believe underpins our distribution philosophy. You will also note that our release highlighted significant contracting activity. In Europe, during the fourth quarter, we entered into off-takes with NG and Ørsted to supply volumes incremental to our existing contracts with these utilities. These contracts further extend our relationships in Europe and demonstrate continued growth in the European market. In Japan, I am happy to announce that we have successfully converted the MoU we previously announced into U.S. dollar denominated definitive agreements for a total of 630,000 metric tons per year starting in 2022 and running for at least 15 years. Our counterparty, one of the premier trading houses in Japan, has entered into a long-term take-or-pay contract directly with the partnership for 180,000 tons per year and a similar long-term take-or-pay contract with our sponsor’s new joint venture with John Hancock for an additional 450,000 tons per year. Our customer will supply these tons to the largest dedicated biomass project in Japan announced yet to-date. The contract is subject to certain CPs including a final investment decision which we expect to be satisfied by the end of 2018 at which point the contracts will become firm. In addition, the partnership has entered into a firm U.S. dollar denominated long-term off-take contract with Marubeni Corporation to supply 100,000 metric tons per year for 10 years commencing in 2022 to the new power plant in Japan. Although these long-term take-or-pay contracts come online in a few years I would also add that the Japanese market needs tons today and we are entering into smaller short-term agreements with companies like Mitsui for deliveries in 2018. I expect that as the Asian markets continue to grow and we will continue to grow along with them delivering both short-term and long-term volumes to customers seeking the reliable high-quality sustainable fuel supply Enviva is known for. Our sponsor’s new joint venture with John Hancock is an important catalyst that our sponsor expects will develop and acquire incremental capacity to serve this fast-growing market. The first investment transaction of the new $525 million joint venture was to acquire the Greenwood facility in South Carolina, which is subject to receiving the necessary permits. It plans to expand to 600,000 metric ton per year run-rate over the next year or so. Current and future products will be terminal through the partnership’s Wilmington Port facility. As part of this transaction the partnership entered into off-take agreement to purchase the production of the Greenwood facility for just over 4 years. This secured source of supply, lines up pretty well with the incremental volumes we recently signed and provides certainty in a market that is pretty short supply and appears to be getting even shorter. While we are happy with what we have done many of you know and found us saying we are just getting started and here is what we expect for 2018. We expect 2018 to be another year of safely and sustainably making more high-quality tons. We expect to maintain our leadership position as the preferred supplier around the world, extending our fully contracted position and further diversifying our portfolio of long-term customers. We expect to generate between $118 million and $122 million in adjusted EBITDA in 2018. And we expect to distribute at least $2.53 per limited partner unit for the year before accounting for dropdowns or other acquisitions. I would like to now hand it over to Steve to discuss financial results before returning to provide an update on the market and where we see additional growth opportunities.

[Steve Reeves:]

Thanks, John. And as a reminder unless otherwise indicated, I will be referring to the financial results on a recast basis to reflect the effects of the Wilmington Drop-Down as though it had been owned by the partnership for the full period. GAAP requires us to recast all financial statements due to the common control nature of the drop transaction. For the full year 2017, on a GAAP basis net revenue was $543.2 million representing an increase of 17% over 2016. Pellet sales revenue was $522.3 million as compared to pellet sales of $444.5 million last year. For the year, we sold 2.72 million metric tons of wood pellets as compared to 2.35 million metric tons in 2016. The increase is primarily due to tons sold under the off-take agreement with Ørsted acquired as part of the Sampson dropdown in late 2016. Gross margin increased $2 million to $78.8 million for the full year of 2017 as compared to 2016 driven by higher sales volumes and lower production costs, partially offset by higher depreciation and disposal costs. Adjusted gross margin per metric ton was flat year-over-year. Net income on a GAAP basis for the year was $14.4 million versus $13.5 million in 2016, an increase of $900,000. Excluding the results of the Wilmington terminal for the period of partnership did not actually own it which is the basis that is comparable to the latest guidance we provided. Net income would have been $20.6 million and adjusted EBITDA would have been $105.4 million for 2017, an increase of $21.9 million from 2016 due to increased revenue and lower production costs. Distributable cash flow prior to any distributions attributable to incentive distribution rights paid to the general partner would have been $70.8 million which covers the full year 2017 distribution of 1.08x, consistent with the expectation we provided most recently for the year. For the fourth quarter of 2017 on a GAAP basis, we generated net revenue of $161 million, an increase of 27.3% or $34.5 million from the corresponding quarter of 2016. Included in net revenue were product sales of $156.1 million on volume of 805,000 metric tons of wood pellets as compared to 632,000 metric tons for the fourth quarter of 2016. Product sales increased $34.9 million from the corresponding quarter of last year to the greater sales volume primarily relating to tons sold under the aforementioned Ørsted contract. Gross margin increased to $25.7 million in the fourth quarter of 2017 from $19.2 million in the corresponding period in 2016 due primarily to higher sales volumes and lower production and raw material costs offset partially by higher depreciation expense as a result of the Drop-Down transactions. Adjusted gross margin per metric ton for the fourth quarter of 2017 was $47.43 compared to $42.95 for the corresponding quarter of last year. The increase is the result of the higher sales volumes and lower costs I mentioned. Our net income of $7.9 million, adjusted EBITDA was $31.9 million for the fourth quarter of 2017. After maintenance capital expenditures of $1.5 million, interest expense net of amortization of debt issuance cost and original issue discount of $8.4 million and incentive distribution rights for our general partner of $1.1 million. Distributable cash flow for the fourth quarter of 2017 was $20.9 million to our limited partners which covers the $0.62 distribution we announced at 1.28 times for the quarter. That brings me to 2018. This year we projected our net income in the range of $28.5 million to $32.5 million with associated adjusted EBITDA of between $118 million and $122 million. We expect maintenance capital expenditures of $5 million and interest plus amortization of debt issuance costs and original issue discount to be $33.5 million. As a result, the Partnership expects to distribute to generate distributable cash flow of $79.5 million to $83.5 million for the full year prior to any incentive distributions to our general partner. As John mentioned earlier on the call on this basis, we expect to distribute at least $2.53 per common and subordinated unit for 2018. The guidance does not include any impact of further drop-downs for acquisitions. As we have said in the past, although deliveries to our customers are generally ratable over the year, seasonality and the mix and timing of customer shipments can impact results, which may vary quarter to quarter. We have good visibility into our shipping schedule and contract mix by quarter for the full year of 2018 and we expect the profile to look a lot like 2017 where the back half was a significant step up from the first half with fourth quarter being the strongest by a fair bit. More specifically, we expect adjusted EBITDA for the first half of the year to be in the range of $50 million to $55 million weighted towards the second quarter with the strong back half of 2018 to achieve the full year adjusted EBITDA guidance of $118 million to $122 million. I will note that the full year 2018 coverage is expected to be in the range of 1.12 times to 1.18 times, but some quarters in 2018 maybe below that. As we have described previously, our Board evaluates our distribution and coverage on an annual basis. As many of you are likely aware, Generally Accepted Accounting Principles are changing with regard to revenue recognition. Our analysis of the new standard is that it will not affect the timing of our revenue recognition compared to our past practice. What will change is the presentation of certain purchase and sale transactions, where because of our position in the market we are able to capitalize on market dislocations on the supply or demand side. These transactions were previously presented on a net basis in other revenue and now will be presented gross in product sales and cost of sales. Please bear in mind that the simply presentation does not change the underlying economics or cash flows. As we report our 2018 results under the new standard, we plan to provide context related to the change. From a liquidity perspective, we are undrawn on our $100 million revolving credit facility and our first debt maturity is 2020. Before I hand it back to – over to John just because we have received a few questions related to the new tax reform legislation, I want to mention quickly mention that we do not believe that any impact to Enviva Partners or unitholders will be material or different from that experienced by other MLPs generally. Now, I would like to turn it back to John.

[John Keppler:]

Thanks, Steve. As we look forward, our strategy continues to be to fully contract our production capacity and our weighted average remaining term of off-take contracts is 9.5 years with revenue backlog from firm contracts of $5.8 billion, not including the Japanese contract mentioned earlier, which we expect to become firm by the end of 2018, further extending the weighted average term and increasing the backlog. There have been several noteworthy developments in the market both in our current core market of Europe as well as Asia that underpinned more than 18% annual growth rate in demand for wood pellets expected by industry experts through 2021 with further significant growth to 2030. Let’s start with Europe, as expected demand continues to quickly grow to meet the binding 2020 renewable energy mandates and as more stringent mandates are set. The European Union continues to progress its policy setting process for the 2030 mandates for renewable energy and reduction of carbon emissions, which is expected to conclude within the year. Of note, the European Parliament recently voted to increase the share of renewable energy generation to 35% by 2030 substantially higher than the 20% goal for 2020. Dispatchable and baseload biomass fired generation and combined heat and power have proven to be effective lower cost complements to intermittent sources of renewable power, which should make them valuable options as the mandates become stronger and more and more intermittent sources of renewable power are used. In Germany, the currently forming coalition government has announced it will seek to significantly reduce coal-fired generation to help meet its 2030 carbon target. Certain coal-fired combined heat and power facilities are system relevant assets and it can be cost effectively converted the biomass fired generation. In the UK, the government affirmed an additional renewable obligation certificate, or ROC, an incentive for DRAX, which DRAX said will allow it to convert a fourth unit to biomass from coal by the end of the year expecting to drive increased and more stable demand for wood pellets across its power plants. In the Netherlands, €6 billion were made available to renewable energy projects during the spring 2018 round of the renewal incentive program called the SDE-plus. We expect this trend will result in additional incentives to several large scale industrial steam projects using wood pellets, which is expected to drive further growth. In addition, you have heard me talk about opportunities in the heating market for wood pellets in Europe and we have recently executed contracts to deliver several shipments to the operator of the district heating loop in Paris demonstrating the flexibility afforded in our portfolio of production facilities and off-take contracts. Shifting to Asia, where significant growth is expected as the Japanese governments target 6 to 7.5 gigawatts of biomass fired capacity by 2030 representing 15 million to 20 million metric tons a year of demand. The government has actually approved 13 gigawatts of biomass fired generation from the 2017 feed-in tariff applications, well in excess of expectations. In addition to the recent European Japanese contracts that we have announced, we are progressing negotiations for several other contracts in both geographies, representing significant volumes for as long as 20 years as expected demand continues to grow fairly dramatically around the world. We have positioned the company with a durable competitive advantage to capitalize on that demand growth and the premium the market puts on long-term proven supply with the reliability Enviva provides to our customers through a portfolio of plants and terminals that benefit from the robust, scalable raw material basin of the Southeastern United States and proven capability to develop plant and terminal infrastructure at the sponsor level. The three pillars of growth you have heard me talk about align with that long-term positioning. First, while we tend to focus on growth from drop-downs, what’s exciting is that we have strong underlying organic growth in our business driving year-over-year cash flow increases. Based on our productivity improvements, cost reduction initiatives, opportunities to leverage fixed costs and pricing step-ups in our long-term off-take agreements, we believe we can organically grow adjusted EBITDA from the $105 million level last year by 7% to 10% on a compound basis going forward before considering the benefit of drop-downs or other acquisitions. And the second pillar of our growth is exactly that, investments in new plants and terminal infrastructure that are ultimately made available to the Partnership for acquisition from our sponsor. I quickly mentioned earlier that our sponsor recently announced that it has extended its development relationship with John Hancock with a new joint venture. In the new JV, Hancock will invest 75% of the $525 million in capital, while our sponsor will invest 25% and continue to serve as the managing member and operator. The first investment of the new JV is the acquisition which closed last week of the production facility in Greenwood, South Carolina. The JV is expected to complete its ramp and invest incremental capital to increase the production of the plant to 600,000 metric tons per year run rate in 2019. In addition to the agreement plan, the new JV is expected to develop at least two additional production facilities and a terminal in support of additional capacity needed to fulfill a portion of the long-term growth anticipated in the industry. Our sponsor’s practice has been to contract, develop, de-risk and then drop the facilities into the partnership once they have achieved full scale operations. With our growing European and Asian pipeline of contract opportunities this development activity is essential to meeting our expected share of demand. Our sponsor’s existing joint venture with John Hancock continues to construct the production facility in Hamlet, North Carolina which our sponsor anticipates could begin production in the first quarter of 2019. As we previously announced in the fourth quarter we dropped the Wilmington terminal from our sponsor’s JV, bringing another critical piece of the supply chain into the partnership portfolio. The Wilmington terminal will receive store and load the production of the Hamlet plant driving incremental EBITDA of the partnership. Pursuant to the contribution agreement for the Wilmington terminal the partnership will make a second payment to the JV related to the long-term committed throughput and cash flow commencing upon first deliveries of the Hamlet plant. To the visible dropdown inventory today consists of the additional EBITDA from the Wilmington terminal driven by the volumes from the Hamlet plant. The Hamlet plant itself which is contracted to supply the Macquarie backed MGT site project in the UK and the Greenwood plant which lines up quite nicely to the long-term demand expected 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 which is all upside to the guidance we have provided. So it drops along with annual organic growth are complemented by the third pillar of our growth strategy. Third-party acquisitions directly made by the partnership with the assets and opportunities make sense and are consistent with our core business. We bought the solid platform to capitalize on the expected long-term growth, that’s the strategy that has led to several accomplishments since our IPO that we are very proud of, but I am even more excited about the future. The foundation of Enviva’s culture is saying what we are going to do, going out and doing it and maybe doing a little bit better. And for 2018 we expect to continue to leave the industry in safety to maintain operational excellence and continue to leverage productivity improvements, to capitalize on our leading position to further extend and diversify our contracted position adding to the more than a dozen customers we have today. To organically grow adjusted EBITDA delivering between $118 million and $122 million and to distribute at least $2.53 per unit. Before we open up for Q&A, I would like to thank all the great people at Enviva for their dedication and hard work. Our team including our newest colleagues in Greenwood, South Carolina is focused on keeping our plants, ports and most importantly each other safe everyday. Operator, can we please open line for questions?

[Operator:]

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

[Derrick Laton:]

Hi, good morning guys. This is Derrick Laton sitting in for Brian.

[John Keppler:]

Hi, good morning, Derrick.

[Derrick Laton:]

I just wanted, if you could talk a little bit about your operational performance in the quarter, I know you guys highlighted a pretty strong third quarter, just want to see how things are progressing and trending there relative to your expectations in fourth quarter and as we are looking ahead to 2018?

[John Keppler:]

Sure, yes. We presented I think a very strong quarter to Steve, very strong fourth quarter. We sold little over 800,000 tons in the quarter. Obviously, we benefited from a little bit of inventory carry-in but of a strong operating performance. I think as we have guided to in the past year the first quarter the year for seasonal factors, it’s always a relatively more challenging quarter given the ambient temperature is in and the higher moisture content and that pattern continues in 2018, but nothing that is beyond what we would normally expect at this time here.

[Derrick Laton:]

Great. And then just one follow-on there, speaking on some of the fiber cost and some of the weather we have seen already in the first quarter, I am just curious how input costs are turning for you guys and are you seeing any kind of fiber price inflation that you may not be able to offset or you are just going to continue to pass that through on your contractual structures?

[John Keppler:]

Sure, yes. So I think the overall trend continues to be very favorable for us from a fiber procurement perspective. Again, the dynamics in the first quarter, if you look at it on a continuous quarter basis, it is a little more expensive in the first quarter around weather events, which have occurred, but nothing extraordinary or unusual relative to past practice.

[Derrick Laton:]

Great. Thanks for the color guys. I appreciate it.

[Operator:]

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

[Ryan Levine:]

Good morning. I am just curious what is the rationale for creating this new development JV why a separate one than your existing structure?

[John Keppler:]

That’s a great question Ryan. I think it’s a reflection of the continued interest of both Hancock and our sponsor in maintaining that development relationship. There were certain attributes, the initial joint venture that’s certainly I will call it Hancock wanted frankly to have the opportunity to invest incremental capital beyond 50-50 basis that we started with. And so the longevity and the opportunities that we have been able to continue to create in what is a relatively long-dated market for our product lined up pretty well with the investment philosophy of Hancock and so we structured a new opportunity to enable that to continue very favorably for each of the parties.

[Ryan Levine:]

Yes. Enviva have a right of first offer or other types of contractual rights to give participation in the development assets at that entity at the new joint venture?

[John Keppler:]

So, let me make sure that we clarify the entities. The – our sponsor is in the joint venture with John Hancock. And our sponsor has the right similar to the first joint venture to compel the sale of those assets or membership interest assuming certain thresholds from that consistent within the ROFO that exists for the partnership between it and its sponsor as part of the initial ROFO undertaken at the IPO, which is a 5-year deal.

[Ryan Levine:]

Okay. And then regarding the 10-year Japanese contract, what are the renewal options that are in that agreement, are there any or what’s the next step as contracts were to expire?

[John Keppler:]

So, what – I think the general expectation both of the parties to do that contract as well as the industry generally is that the assets and the operations of these biomass facilities will continue to run well, well beyond the initial term of any off-take agreement and well beyond the 20-year feed-in tariff that underpins the Japanese development.

[Ryan Levine:]

Okay. Is there any contractual re-openers or is it subject to negotiation?

[John Keppler:]

Yes, no, there is not a re-opener, there is a – it will be renegotiation as and when appropriate.

[Ryan Levine:]

Okay. And then in your 2018 guidance what are the cost reduction assumptions that you have taken to that – in that outlook?

[Steve Reeves:]

Sure. So as we look at the guidance, we are obviously picking up that the port terminals for full year by the limit in terminal for full year. But we are assuming continued productivity consistent with what we have got during the past in the 1% to 2% range.

[Ryan Levine:]

And then the MOU comments in your prepared remarks, did I hear that right, that it’s subject to a final investment decision later this year, before that would become a firm contract, is that the current expectation?

[John Keppler:]

That’s right, Ryan. As we talked about this particular agreement in the past and notably the Japanese market generally, we have tried to provide additional visibility and clarity given the growing nature of that market. The – this is a very large contract that we announced previously was in an MOU stage, giving some visibility into this sort of the difference that an MOU may mean in that market compared to some others and guided to the fact that we would be endeavoring to convert that to a definitive agreement in the first half of this year. We have now done that. These are now definitive agreements subject to certain CPs. One material one is naturally the final investment decision by the counterparty, which we expect the results later this year and that the contract would become firm and binding by the end of this year.

[Ryan Levine:]

Okay. Thank you.

[Operator:]

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

[Pavel Molchanov:]

Thanks for taking the question. On your kind of baseline 2018 revenue outlook, can you give an approximate mix among the different customers or off-takers?

[Steve Reeves:]

I will take off top of my head. Well, I think you are going to see maybe I could characterize it this way as we look at 2018 is a significant expansion in terms of the number of different customers. We are going to be dealing with kind of in the dozen range I still think we will be concentrated around 3 or 4 kind of main that represent roughly 75% of the book, DRAX being the largest of those.

[Pavel Molchanov:]

Okay. And maybe between DRAX and NG, would that be maybe 75% of the total?

[Steve Reeves:]

I think it’s little bit less than that actually.

[Pavel Molchanov:]

Less, okay. And then kind of along the lines of customer – ongoing customer diversification, you mentioned in the press release the German coalition government looming coal phase-out decision given that it’s I suppose not official yet, have you already been having any preliminary dialogue with potential German buyers who might be preparing for that before it even happens?

[John Keppler:]

Pavel, you are spot on, this is John. The utility set in many of the generators not surprisingly I have been reading the tealeaves stuff for sometime given the nuclear reductions and the challenges that they have to maintain baseload both electric and thermal generation. Right, many of these assets are combined heat and power facilities, system relevant not just to the grid, but frankly more importantly, the industrial steam applications that drive significant traction of German manufacturing in and around these assets. It’s very, very important to understand the lifetime and the potential to continue to utilize these assets in a low coal or no coal future and so as you surmised we have been in some fairly detailed discussions with a number of those generators.

[Pavel Molchanov:]

Alright. Appreciate it guys.

[Operator:]

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to John Keppler for any closing remarks.

[John Keppler:]

Well, thank you all again for joining us today. We certainly appreciate your time and attention. Obviously, a lot of great things going on in the business and we 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.