Enviva Inc.
Q3 2016 Earnings Call Transcript

Published: 6 Nov 2016

[Operator:]

Good day, and welcome to the Enviva Third Quarter Results Conference Call and Webcast. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Ray Kaszuba. Please go ahead.

[Ray Kaszuba:]

Thank you. Good morning, and welcome to Enviva Partners LP third quarter 2016 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 for the third quarter released this morning and provide an update on our current business outlook. We will then open 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 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 our 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 2015 amounts are as reported on our 10-Q filed today. I would now like to turn it over to John.

[John Keppler:]

Thank you, Ray. Good morning, everyone, and thanks for joining us on today's call. It's been a busy and a quite successful quarter at Enviva. We’ve continued the strong operating and financial performance you've come to expect from us. And with that, as well as being the largest supplier in the world, we've also been able to participate meaningfully and profitably from dislocations in the market. We've also completed major strides towards growth, not only at the partnership level, but also with additional development upstairs at our sponsor, that the partnership will ultimately have the opportunity to acquire. This plan executed with a day-to-day focus on operational excellence and a long-term contracted position translates into a consistent durable cash flows that can grow per unit distributions over time. As you saw in our results published this morning, our strong operating and financial performance and momentum through the third quarter enabled us to again set our highest ever quarterly adjusted EBITDA, and to declare our fifth consecutive distribution increase, which has been our track record every quarter since our IPO, representing an increase of more than 20% over the third quarter of last year. As you also saw, we are pleased to announce that we have agreed to terms on our second drop-down transaction. The accretive acquisition of the Sampson plant along with a 10-year, 420,000 ton off-take contract with DONG Energy, and a 15-year 95,000 ton off-take contract with the sponsor's JV to supply a portion of the 1 million ton per year MGT project, which is now firm. The purchase price is $175 million, which given the expected EBITDA profile of $22 million growing to $27 million is consistent with valuation metrics from our previous contracted pellet plant acquisitions. We expect the transaction to close by early January subject to customary closing conditions. It's important to note that with this drop, we further diversify our customer base, bringing our number of substantial long-term contracted counterparties to five. We significantly increased our product sales backlog to $5.7 billion, and we reinforce our weighted average contract term of nearly a decade. More immediately, it enables us to provide EBITDA guidance for the full-year of 2017 in the range of $110 million to $114 million without accounting for any drops or other acquisitions beyond Sampson, and a forecast distribution per unit of at least $2.35 for the full year. Steve will provide additional detail on how we are viewing full year 2016 and 2017 given the Sampson drop. Financing for the transaction will be provided by $30 million in equity issued to our sponsor's joint venture partner, and a portion of the recently announced $300 million bond issuance. That debt issue is the first and most significant step of a transformative financing plan, one that not only raises the funds needed for the Sampson drop-down acquisition, but also strategically repositions the partnership with significant flexibility for financing future growth, namely with the anticipated increase in our revolver to $100 million. We've talked consistently about the three pillars of our growth. First, the continued growth in our cash flows driven by our long-term contracted position and the underlying 1% to 2% productivity increases we expect annually from our assets, which are made possible by debottlenecking activities and continuous improvement in our cost position, as well as opportunities to deploy modest growth CapEx. As many of the plant production costs are fixed, incremental production volumes come with robust margins. The second area of growth continues to progress as well. The growing identified drop-down inventory from our sponsor developed to take advantage of new capacity required to serve the needs of generators seeking a drop in renewable replacement for coal. And third, we are a proven acquirer in an industry where interesting opportunities may also be present for third-party acquisitions. As I mentioned in the past, we are just getting started and I'm excited about the growth ahead of us, which the flexibility afforded by our recent financing activities is expected to provide a foundation for funding that growth. We believe the opportunities that I just outlined coupled with conservative financial policies will enable us to continue to increase our per-unit distributions and drive unitholder value. I'll spend some more time on the growth component before we open it up to Q&A, but I'd like to now hand it over to Steve to discuss our quarterly results and financing activities in more detail.

[Steve Reeves:]

Thanks, John. Net revenue for the third quarter of 2016 was $109.8 million, representing a decrease of 5.8% over the corresponding quarter of 2015. Pellet sales revenue was $102.6 million on sales of 534,000 metric tons of pellets, a decrease of $12.5 million from the corresponding quarter of 2015 of $115.1 million on 602,000 tons sold. The decrease was driven by the timing of product delivered to our customers. As I have mentioned in the past, the timing of customer shipments can impact short-term results, which may vary somewhat quarter-to-quarter, with less impact over a longer period of time as deliveries to our customers are generally ratable over the year. As more fully discussed in the Recent Development section of our quarterly report on Form 10-Q, we also had a partially deferred shipment that also accounts for the difference between the actual results and the preliminary results provided in October. Other revenue of $5.7 million due primarily to a payment from a third-party pellet producer, who, because it was unable to meet the volume, quality and sustainability requirements of its counterparty and committed to purchase a series of shipments from us despite into its own off-take contract. From the third-party producer - when the third-party producer deferred and ultimately canceled the shipments, we were contractually entitled to make whole payments which are recorded in other revenue. While we benefited from these payments in the third quarter, the transaction has resulted in adjustments to the shipments schedule for the remainder of the year to accommodate those sales. As a result, not all of the benefit of this transaction will read through to the full-year, as we expect year-end results to include more finished goods inventory. We do however, expect full-year results to be in line with our slightly better or slightly better than our full-year EBITDA guidance, which we are confirming. The transaction is an example of the type of opportunities we expect as the market leader to capitalize upon when market experienced some dislocation. Gross margin increased $6.3 million to $22.9 million for the third quarter of 2016, as compared to the corresponding period of 2015, principally driven by the make-whole payment in other revenue and a favorable cost position of our pellets, offset by lower volumes sold due to the shipment timing and the deferred shipment. Adjusted gross margin per metric ton also improved relative to the third quarter of 2015 from $40.12 per ton to $54.97 per ton or excluding the aforementioned transaction of other revenue $44.39 per ton. This represents a nice increase of approximately 11% over the previous quarter. On net income of $13 million, adjusted EBITDA improved $25.5 million for the third quarter of 2016, a nearly 29% increase from the corresponding quarter of last year, driven by many of the factors that improved gross margin. After maintenance capital expenditures of $1.4 million, interest expense net of amortization of debt issuance costs and original issue discount of $2.9 million and incentive distribution rights for our general partner of $302,000, distributable cash flow for the third quarter of 2016 was $20.9 million to our limited partners, which covers the $0.53 distribution announced yesterday at 1.57 times. As John mentioned, we issued $300 million in bonds earlier this week, with the proceeds deposited into an escrow account until the Sampson drop-down acquisition closes. At the time of the drop, bond proceeds in excess of what is required for the purchase of the Sampson asset and associated contracts, will be used to pay down existing term loan debt. At the same time, an amendment to our existing credit agreement is triggered allowing for an increase in our revolver capacity from $25 million to $100 million. We are pleased with our initial bond issuance as it pre-funds the upcoming drop-down acquisition, limiting any capital market execution risk, but also restructures our balance sheet, extends maturities and provide significant financial flexibility as we plan for continued long-term growth. In addition to the bond issuance, we will issue $30 million in equity as consideration for the Sampson acquisition. Because we've pre-funded the drop-down acquisition and the proceeds are in escrow, we will incur interest expense until the drop occurs that is not part of our prior guidance, and we are therefore adjusting full-year 2016 guidance. As we now expect full-year net income in the range of $34 million to $36 million, and full-year adjusted EBITDA to be in line with our slightly better than our guidance of $86 million to $88 million, interest less amortization of debt issuance costs and original issue discount is now expected to be $16 million, and maintenance capital expenditures is expected to be $4 million. As a result, we expect full-year distributable cash flow to be $66 million to $68 million, and we still expect to distribute at least $2.10 per common and subordinated unit, which we anticipate will result in full-year distribution coverage well in excess of our stated 1.15 times goal. Due to the fourth quarter being somewhat of a transition period with the pre-financing of the Sampson transaction, we thought it's beneficial to provide guidance for 2017. Just for clarity, it should be noted that all amounts reflect the acquisition of the Sampson plant and associated contracts, but do not give effect to any other potential drops or other acquisitions occurring this year, not even the Port of Wilmington. We project our net income in the range of $31 million to $35 million with associated adjusted EBITDA of between $110 million and $114 million. We expect maintenance capital expenditures of $5 million and interest less amortization of debt issuance costs and original issue discount to be between $29 million. As a result, the partnership expects to generate distributable cash flow of $76 million to $80 million for the year prior to any incentive distributions to our general partner. Although deliveries to our customers are generally ratable over the year, the mix and timing of customer shipments can cause results to vary somewhat quarter-to-quarter. As a result, our Board evaluates our distribution and coverage on an annual basis. And with that, we expect to distribute at least $2.35 per common and subordinated unit for 2017. This is an approximately 12% increase over 2016 expectations and again that's before considering the Wilmington drop or incremental cash flow from our other major growth buckets. I want to mention a few additional items from a finance perspective. We commenced an At-The-Market equity issuance program in August and have been disciplined with our approach issuing approximately 282,000 units to-date for net proceeds of $7.2 million. We expect to continue to issue units under the program. With the Lynemouth contract and then the MGT contract going firm in the quarter, we now have, albeit relatively small, an exposure to the pounds sterling. To mitigate this exposure, we have entered into pound sterling denominated shipping contracts related to these volumes and begun to hedge our net exposure to sterling cash flows related to sales in 2017 to 2020. Also during the third quarter, we entered into an interest rate swap to hedge the floating interest rate risk from our term loans. Before I hand it back to John, we have received a few questions about how our facilities fared during Hurricane Matthew and associated rain and flooding. Not only are the facilities designed to withstand severe weather, but we also have systems in place to prepare for these types of events. As a result, damage was limited and minor where it occurred. We did close the Port of Chesapeake and Ahoskie plant for a day primarily from a safety perspective to keep our employees off the road during the storm, but each facility was back running the next day. Now I would like to turn it back to John.

[John Keppler:]

Thanks, Steve. Before we open the lines to Q&A, I'd like to take a few minutes to provide an update on the market and potential implications for Enviva. As I've mentioned in the past, our strategy is to fully contract the production capacity of the partnership, and we are substantially balanced with our sales book for the foreseeable future. We are also focused on diversifying our customer base with potential new customers in Europe and Asia, and the pending drop-down further improves our off-take diversification with the addition of DONG Energy, alongside Drax, Engie and the new customers from contracts executed recently, which supply MGT and Lynemouth. With respect to MGT, in August, the partnership's 15-year contract to supply 375,000 tons became firm as the conditions precedent to the effectiveness of the contract were satisfied. Deliveries under the contract commence in 2019, and run through 2034. And you may recall that we also have a firm off-take contract to supply 800,000 tons per year to the Lynemouth facility in the UK, which is expected to commence in 2017. With the contracts that are expected to be a part of the Sampson drop-down acquisition, the partnership's weighted average remaining contract term is expected to be 9.7 years as of January 2017. In addition, there have been several market developments that continue to demonstrate the long-term demand fundamentals that underpin the growth of the industry. First, the Paris Climate Agreement is expected to become legally binding in early November. And it is expected to foster further requirements for greenhouse gas emission reductions and renewable energy generation. To-date, it has been signed and ratified by 85 countries including the United States, China and the members of the European Union. Japan is also expected to ratify in the short-term consistent with their desire to reduce greenhouse gas emissions. And speaking of Japan, 3.2 gigawatts of biomass-fired capacity has already been approved, implying more than 10 million tons per year of wood pellet demand, including projects sponsored by Sumitomo, Mitsubishi and Nippon Paper. The industry expects long-term off-take contracts to support this demand based on the 20-year feed-in tariff system in place backed by the Japanese government. In the Netherlands, the second round of 2016 applications for the renewable incentive program, called the SDE+, commenced in September. After the first round in 2016 was oversubscribed, the budget for the second was increased to EUR5 billion, up from EUR4 billion. And that's after the overall 2016 budget was substantially increased from EUR3.5 billion to EUR8 billion. Several biomass projects were awarded for EUR2.5 billion in the first round, RWE [indiscernible] have already announced they have applied for the second round and more applications are expected. In the UK, post Brexit I might add, the government continues to confirm its commitment to reducing carbon emissions and to renewable energy. As both Houses of the UK Parliament agreed to an amendment extending the government's powers to award new contract for difference or CfD incentives for new low-carbon energy projects out to 2026, which compared to an original end date for these powers of 2020 as contained in the 2013 Energy Act. In Denmark, the largest power producer, DONG Energy, began burning wood pellets at two facilities, continuing the progress towards its stated requirement that half of the power and heat production at its Danish power stations be based on biomass by 2020. In addition, DONG has provided a new tender for 1.2 million more tons of wood pellets over the next three years. With these recent developments, along with the tailwinds the industry is experiencing, we expect significant demand to continue to materialize in Europe and Asia in the near-term. As a result, our sponsor continues to invest heavily in Asia with resources now in Tokyo and is looking to staff an in-country manager and a few strategic full-time employees there. And we are also turning our attention to specific opportunities in the Netherlands, Belgium and new markets like Germany. As the largest and most reliable supplier in the market, we are excited about extending our contracted position and further diversifying our customer base. We're also encouraged by the opportunities this demand could facilitate through additional drop-downs from our sponsor as it builds new, fully contracted production capacity, that would add to its inventory of potential near term drop-down assets. These currently include the contracted Port of Wilmington terminal, which we expect to have an opportunity to acquire in 2017. The port is substantially complete and now receiving deliveries. Additional sponsor-led development includes the build-and-copy production plant we have permitted in Hamlet County, North Carolina that is in detailed design, and additional sites under evaluation in Mississippi and Alabama, as well as sites positioned around the existing terminal capacity at the Port of Chesapeake and the Port of Wilmington. In addition, our sponsor is evaluating the option of building and operating a marine export terminal at the Port of Pascagoula, Mississippi. So, while we are pretty pleased with the recent quarterly results and have agreed the terms for the Sampson drop-down acquisition, I'm most excited about the long-term potential growth of Enviva. This quarter's results once again demonstrate the stability of our growing cash flows, underpinned by our long-term off-take contracts and solid operating performance at our world-class assets that continue to underwrite the long-term growth prospects for Enviva. Thank you all for listening. As we close, I would like to thank all the dedicated Enviva associates for their hard work, resulting in another strong quarter. Operator, can you please open the line for questions?

[Operator:]

[Operator Instructions] The first question will come from line of Brian Maguire with Goldman Sachs.

[Kia Pourkiani:]

This is actually Kia Pourkiani sitting in for Brian. So, the first question I had was, how much visibility do you have on the timing of the shipments to your customers, and would you expect that variability to kind of decline as you expand your customer base?

[Steve Reeves:]

We have a fair amount of visibility relative to when we get close into the end of the quarter. We set the actual shipping date [indiscernible] not to get into too technical terms, roughly 30 days prior to the shipment. So we'll know within a kind of a week's horizon when the ship will come and when it won't. I think relative to your question on variability, I think as you scale, each shipment becomes less material, I think to the overall quantum, so you'll see less variability relative to the total for the quarter perhaps would be the way to think about it.

[Kia Pourkiani:]

And then my second question was just on markets such as Asia. I know you mentioned the Paris Climate Agreement and how you see some opportunity there. Do you have any idea of what type of - size of that market is, and if they're currently sourcing wood pellets, where they are getting them from?

[John Keppler:]

Absolutely. Our Asian customers set resides principally in two jurisdictions, South Korea and Japan. South Korea has been consuming roughly 1.5 million to 2 million tons a year for the last several years, under a renewable portfolio standard that principally drives co-firing activities where they combust wood pellets alongside coal to meet their binding renewable obligations. In Japan, it's a little bit different. In Japan it is a focus on incremental capacity development. Japan is not only short against its binding renewable energy obligations expectations, but also capacity, given the outcome of the Fukushima nuclear disaster. And so there our customers set people like Sumitomo, like Mitsubishi are investing alongside independent power producers and the major utilities in new distributed generation, typically power plants of 100 megawatts to 200 megawatts, distributed across the Japanese islands, under a 20 year feed-in tariff system. And so these are new builds and projects that some are already on line, principally procuring from British Columbia today, as well as some volumes from Southeast Asia, but the preponderance of that growth is expected to come from the Southeast US with a very stable marginal cost curve for the growing demand, one that we expect to receive roughly about 10 million tons per year in an as built set of capacity.

[Operator:]

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

[Ryan Levine:]

Just trying to get a little more color around the Japanese opportunity. Given the competition with Southeast Asia and other areas of the world, do you expect that Southeast US coal - wood pellet to become economic after a certain amount of supply has exhausted in other parts of the world, where you are competitive today and it's just a matter of negotiating contracts with the suppliers there?

[John Keppler:]

What I would tell you is we deliver at cost parity today. That's principally driven by the relative fiber advantage in the Southeast US and the robust forest resources that provide for that stability on a long-term basis, and frankly driven by the ability for us to deliver under long-term contracted positions with our shipping partners into Asia. Over time, in addition to the match of those volumes from places like British Columbia, the marginal cost curve is very different in British Columbia versus Southeast US. In the British Columbia market, it is principally based around sawmill residuals, so the supply of material able to be produced into wood pellets is inherently limited by the production profile and one that I would say as declining in British Columbia of that byproduct material. So the incremental cost of acquiring that ton of fiber in British Columbia is just much more exorbitant than we see in the Southeast US, where today the business model is much more driven around the underlying harvest residuals or underlying level of harvesting activity that has continued to supply a far excess growth to drain ratio resulting in a very flat marginal cost curve. I would add that the increase in sustainability requirements that the Japanese market is seeing over the South Korean market make places like the Southeast US where we lead in sustainability certifications and the ability to document the supply chain generates products sustainably provides for durable competitive advantage as well.

[Ryan Levine:]

And then to follow up on that, in terms of the 3.2 gigs that you're highlighting here, what's the process in order to secure those contracts given the feed-in tariffs in Japan?

[John Keppler:]

On an annual basis, the government received applications from qualified projects, and those qualified projects need to come with certifications on financeability as well as the documentation of the supply chain. So, underpinning that application for its certification and the feed-in tariff the - our counterparties need to come to the table with the framework of a supply chain, and a reasonable contracted position. Those deadlines are in the first half of the year, and so we would expect to be in a position to describe more fully the opportunities and the specific contracted positions we expect to realize during the course of the first half of next year.

[Ryan Levine:]

Is it that the focus of the team that's on the ground in Japan?

[John Keppler:]

That's right, complemented by some of our senior executives at the sponsor here as well.

[Operator:]

The next question is from Pavel Molchanov of Raymond James.

[Pavel Molchanov:]

Kind of taking a look at the balance sheet, there is obviously some moving parts over the next couple of months. But my math is that after the drop-down, your debt-to-EBITDA ratio on 2017 will be roughly 3.5 times. So first, is that math accurate? And second, how much higher could you envision that going?

[John Keppler:]

It's probably little closer to 3.25 times on a net basis, so that's pretty close. I think that we're pretty comfortable at 3 times at our current size and that would still be our longer-term goal, as there are opportunities. We spike up to say 3.5 on a very short-term horizon, I think that's possible, but over a longer horizon, we'd like to keep it at 3 times EBITDA.

[Pavel Molchanov:]

And I know you don't give a formal shipment guidance for 2017, but of the shipments that are embedded in your EBITDA and DCF targets, how much of that is currently contracted?

[John Keppler:]

It's materially contracted for the full year.

[Pavel Molchanov:]

Essentially 100%?

[John Keppler:]

Yes.

[Operator:]

[Operator Instructions] This concludes our question-and-answer session. I would now like to turn the conference back to management for any closing remarks.

[John Keppler:]

Thank you all again for joining us on the quarterly conference call. We're pretty excited about what we've been able to accomplish at the beginning of the year, we outlined a couple of key objectives including the execution of the Sampson drop. We're certainly within line of sight of closing that, the terms are agreed. The underlying base business continues to perform extremely well, and we're very excited about what this means for 2017 and beyond given the growth the industry continues to experience and our market leading position in that. We'll look forward to connecting soon. And again, thanks for everyone participating. Have a great day.

[Operator:]

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