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Advanced Emissions Solutions, Inc. (NASDAQ:ADES)
Q2 2020 Earnings Call
Aug 11, 2020, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Good morning, everyone, and thank you for joining us today for our second-quarter 2020 earnings results call. With me on the call today are Greg Marken, interim president, chief executive officer, and treasurer; and Chris Bellino, chief accounting officer. This conference call is being webcast live within the investors section of our website, and a downloadable version of today's presentation is available there as well. A webcast replay will also be available on our site, and you can contact Alpha IR Group for Investor Relations support at (312) 445-2870.

Let me remind you that the presentation and remarks made today include forward-looking statements as defined in Section 21E of the Securities and Exchange Act. These statements are based on information currently available to us and involve risks and uncertainties that could cause actual future results performance and business prospects and opportunities to differ materially from those expressed in or implied by these statements. These risks and uncertainties include, but are not limited to, those factors identified on Slide 2 of today's slide presentation and our Form 10-Q for the quarter ended June 30, 2020, and other filings with the Securities and Exchange Commission. Except as expressly required by securities laws, the company undertakes no obligation to update those factors or any forward-looking statements to reflect future events, developments or changed circumstances or for any other reason.

In addition, it's very important to review the presentation in today's remarks in conjunction with the GAAP references in the financial statements. So with that, I'd like to turn the call over to Greg.

Greg Marken -- Interim President, Chief Executive Officer, and Treasurer

Thanks, Ryan, and thanks to everyone for joining us this morning. Before we begin, I'd like to introduce our Chief Accounting Officer Chris Bellino, who is joining me on this morning's call. Chris has been with ADES for five years and has been invaluable to us serving in a variety of roles during that time. She will continue to join me on earnings conference calls as I serve in the interim CEO role.

I'd also like to give a brief update on our mitigation efforts related to the pandemic. We are proud to continue to operate as an essential service provider and are focusing on things within our control to respond appropriately to the economic disruption resulting from the crisis. Our No. 1 priority will always be our employees' health and safety, and we have taken measures to protect our team.

We have updated safe workplace protocols and are continuing to offer our employees the ability to work from home where it is possible. When it became apparent to us that our operations could be interrupted, we sequestered certain operating plant personnel to build inventory balances in advance of any potential disruption. Our goal was to ensure that we would have sufficient inventory to properly serve our essential customers in the event that the plant were to experience a COVID outbreak and require a temporary pause in our operations, which has been seen throughout the country in certain manufacturing environments during this pandemic. Thankfully, we have not experienced this type of event to date.

However, these actions have allowed us to continue to meet our customers' needs, and we remain in frequent contact with these customers to ensure that they meet their Emissions Control and purification requirements. We also took steps to protect our financial position. We evaluated our capital structure and all noncore capital spending. Our focus was to prioritize liquidity and organic investment to ensure manufacturing capabilities.

In accordance with that focus, we paused all share repurchases and suspended our dividend. We have also restricted corporate travel and limited backfilling open positions in addition to other measures. And as previously discussed, we applied for and were granted a $3.3 million loan through the SBA to ensure we were able to retain our workforce through the early stages of this crisis. The impact of that is recorded in our financial statements as debt, though we expect the loan to be forgiven and recorded as debt forgiveness in the income statement, once the debt forgiveness process can be completed.

Let's turn to Slide 3 for a high-level review of our second quarter. We'll start with our Refined Coal or the RC segment. Tinuum distributions to ADES for the second quarter were $15.4 million, which is 17% lower than last year. The lower distributions were the result of renegotiated contracts in the third quarter of 2019 at Tinuum that resulted in lower net lease payments to the company.

Also contributing to the decline has been the decreased coal burn, driven by chief alternative energy sources, as well as by the lower aggregate energy demand in the U.S. from lower overall economic activity during the second quarter. Our RC segment operating income in the second quarter was $10.8 million, compared to $24.6 million in the prior year. Again, driven by lower earnings from Tinuum, as well as point in time recognition during the second-quarter 2019 related to incremental RC facilities contracted during that period.

As we have discussed on past earnings calls, given the impacts of timing of revenue recognition and accelerated noncash depreciation by Tinuum, our equity earnings are significantly reduced compared to the cash distributions we will receive. As a result of this, we believe adjusted Refined Coal segment EBITDA helped to portray an additional year-over-year comparison of the earnings and associated cash flows of the segment. RC segment adjusted EBITDA in the second quarter was $18.1 million, compared to $22.6 million in the prior year. In our PGI segment, our financial performance also remains challenged by lower aggregate power generation and coal dispatch, as well as changes in product mix.

During the quarter, we took an impairment charge of roughly $26 million related to long-lived assets, of which $23 million was related to the PGI segment. Chris will cover the circumstances of that impairment in greater detail in a moment. In the meantime, our focus here remains on areas where we have the right to win, filling the plant's capacity and leveraging our holistic solutions package. Our execution has remained strong despite lower volumes, and we expect to continue to maintain high renewal rates with our existing customers.

While the financial performance of the segment has been below our initial expectations, we remain confident in the quality of the asset and our position in the marketplace as a provider of choice. I'll talk more about this after the financial review. From a consolidated perspective, our net loss in the second quarter was $23.8 million, primarily driven by the aforementioned impairment charge. Excluding this impairment charge, net income would have been $2.3 million for the second quarter and $0.4 million for the first half of the year.

Our consolidated adjusted EBITDA was $12.3 million, compared to $15.1 million in the prior year. Pertaining to our capital allocation, we are continuing to prioritize debt reduction and cash preservation during the pandemic. We remain focused on cost containment and have improved our overall liquidity position from last quarter. Looking ahead, we are updating our projected after-tax cash flows from the IRC segment to be between $100 million and $125 million through the end and remember that our financials are provided as of the close of the second quarter.

And thus, this does not include the additional Refined Coal transactions we announced in July. We estimate that these two transactions will provide additional future cash flows to ADES of $5 million to $7 million due to additional rent payments and savings of Tinuum operating costs. Although we expect coal-fired power generation to remain down through the rest of 2020, driven by record low natural gas prices and increasing renewable energy generating capacity, we still see select opportunities for both of our segments. In our RC segment, our primary goal is to protect our projected Refined Coal cash flow stream and to seek to add to those cash flows were able.

These distributions will continue to facilitate our capital allocation plans as we work to improve performance in our activated carbon assets. In our PGI segment, we remain intently focused on finding ways to fill the plant capacity and win volumes where we are most competitive. Due to the challenging market conditions during the last 12 months, we have been working to strategically secure additional volumes to fill our Red River plant to better capture the low-cost nature of the asset and improve its earnings profile. We have spent considerable time and effort building out our product capabilities and internal sales infrastructure, and we are beginning to have success on new contract awards for material supply agreements in markets outside of power generation.

So far this year, we are in line where we expected to be with our growing water business, and we continue to see encouraging traction with industrial markets. We are remaining focused on identifying other non-power generation markets to diversify away from the power generation applications for activated carbon. With that, I'd like to turn the call over to Chris, who will review our second-quarter and year-to-date financial performance.

Chris Bellino -- Chief Accounting Officer

Thank you, Greg. Let's turn to Slide 4 for the financial review. Starting with earnings from equity method investments, the second-quarter earnings from equity method investments totaled $8.2 million, compared to $20.9 million for the second quarter of 2019. The first-half earnings from equity method investments were $16.4 million, compared to $42.6 million for the first half of 2019.

The decreases during the second quarter and first half were mainly the result of lower earnings from Tinuum Group, resulting from decreased aggregate coal-fired power generation, higher depreciation and all Tinuum Group RC facilities as a result of a reduction in their estimated useful lives during the third quarter of 2019. The decrease is also a result of Tinuum Group's previous restructuring of its RC facility leases with its largest customer. This decreased net lease payments and equity earnings beginning in Q3 of 2019 also contributing to the declines of the impact of point in time revenue recognition of certain RC contracts by Tinuum Group during 2019 compared to the current year. Moving on to revenues, net loss and net income.

The second-quarter consolidated revenue was $11.5 million, compared to $15.6 million in the second quarter of 2019. First-half revenue was $23.7 million, compared to $34.9 million in the first-half 2019. The decreases in revenue were primarily the result of lower consumable revenue and lower volumes that were negatively impacted by low coal-fired power dispatch and overall decreases in power generation driving reduced demand, as well as lower royalty income. Second-quarter royalty earnings for Tinuum Group totaled $3.3 million, compared to $4.2 million for the second quarter of 2019.

First-half royalty earnings from Tinuum Group were $6.4 million, compared to $8.4 million for the first half of 2019. Royalty income is based upon a percentage of a per ton per tax margin inclusive of impacts related to depreciation expense and other allocable expenses. The lower royalty earnings in the first half were due to increased depreciation and lower rent payments to Tinuum, which also impacted the company's equity earnings. Royalty earnings are expected to be negatively impacted due to these changes in both 2020 and in 2021.

As of June 30, 2020, we had 20 RC facilities invested with 16 that are generating royalties, which does not include the previously announced transactions during the month of July. During the quarter, the company recorded a consolidated pre-tax noncash impairment charge of $26.1 million. The majority of this charge, roughly $23 million was related to our PGI segment's long-lived asset group, such as certain plant- and mine-related long-lived assets. Consolidated net loss during the second quarter was $23.8 million, compared to net profit at $8.1 million in 2019.

First-half net loss was $25.7 million, compared to net income of $22.5 million last year. Decreases in income, primarily driven by the aforementioned, impairment charge and lower earnings from Tinuum. Excluding this impairment charge, net income was $2.3 million for the second quarter of this year and $0.4 million for the first half of this year as well. Consolidated adjusted EBITDA was $12.3 million for the second quarter, compared to $15.1 million in 2019.

The first-half consolidated adjusted EBITDA was $23.1 million, compared to $33.1 million in 2019. The decreases in consolidated adjusted EBITDA were driven by lower earnings and distributions from equity method investments. This was partially offset by higher depreciation and amortization expense. In terms of cash, we ended the second quarter with a cash balance inclusive of restricted cash of $21.7 million, an increase of point -- $4.7 million since year-end December 31, 2019.

The $5 million in long-term restricted cash remains due to conditions related to the term loan. We will continue to focus on cash preservation and ensuring that we have proper liquidity to serve our customers. Wrapping up with an update on current and long-term debt of the company. During the second quarter, we made a $6 million principal payment on the term loan, reducing the principal balance, including the current portion to $28 million as of June 30, 2020.

Total borrowings came in at $36 million, compared to $44 million at year-end 2019. The $36 million is comprised of the $28 million term loan and the $3.3 million of funds that we secured from the SBA potentially forgivable loan program, while the remainder is comprised of capital leases. So now I'm going to turn it back over to Greg for his closing remarks.

Greg Marken -- Interim President, Chief Executive Officer, and Treasurer

Thank you, Chris. Turning to Slide 5, you can see our expected future Refined Coal cash flows. Based on the 20 invested facilities and cash distributions received during the second quarter, we are updating our expectation of after-tax cash flows to ADES to be between $100 million and $125 million through the end of 2021. Tinuum continues to remain in active discussions with potential tax equity investors in our pipeline.

As I mentioned, this total does not include two previously announced July transactions, which we expect to add between $5 million to $7 million of additional cash flows to this total. Exclusive of a tax credit extension, we have just six quarters remaining with our Refined Coal business. As such, Tinuum is taking appropriate steps to adjust its cost structure, while ensuring that their assets reliably produce Refined Coal. Naturally, we are also responding, and we'll look to lower our cash cost dedicated to the Refined Coal segment.

Slide 6 reflects the opportunities we have identified and continue to execute against for our activated carbon assets. As we have discussed in prior calls, we had always underwritten declining coal dispatch in our assumptions when we acquired the activated carbon assets. However, the rate of decline in both 2019 and again, thus far in 2020 has been faster than our initial expectations. This declining aggregate coal-fired dispatch has prevented us from filling our Red River plant to greater capacity with power generation volume.

In response, we have proactively accelerated our focus on other adjacent market opportunities. We have done significant work since the acquisition of Carbon Solutions in December of 2018 to respond to this changing landscape. We have talked about some of the non-power generation industrial applications for activated carbon where we have gained traction with our products. The success we have seen here has continued, and we remain on track with our forecast in water markets.

While the total volume we have won in these markets has been unable to fully offset the decline in power generation, we are seeing early signs of our competitive position in the marketplace and are encouraged by the trajectory of our role in these adjacent markets. We are also seeing early successes in other growing market opportunities, utilizing existing product technologies and capabilities that may provide additional volumes in areas where the historical Carbon Solutions business had not competed. The efforts by our team to continue to identify new areas to compete within our overall competitive market is key in managing through this time period. Additionally, there remains potential for an improved environment from the first half of 2020 due to increased power generation demand, higher natural gas prices and impacts from the economy slowly opening, coupled with the work the team has done related to industrial and water applications.

We also expect supply and demand to ultimately rationalize in the industry in the coming years, which may include restructurings and M&A. Given today's imbalanced market, we are evaluating strategic opportunities to increase and diversify our addressable markets. We believe we'll be in position to capitalize on the opportunities given the premier quality and cost advantageous nature of the assets we possess in this market, which has the potential to increase our earnings profile. Slide 7 shows the changing projections for coal-fired power in the U.S.

The graph on the left side reflects the steep downward revisions to coal-fired power generation expectations from the EIA. In response, the figure on the right-hand side of the slide is our internal estimates around how we intend to diversify our products away from coal-fired power generation. As I said, these efforts are already well under way, and we are encouraged by our early successes. In spite of the decline in the power generation market, Emissions Control regulations whether they are in force at the state or federal level, will continue to remain in place.

As such, certain industries and power utilities will remain bound by Emission caps and will need steady long-term providers of a full suite of Emissions Control Solutions to serve as holistic partners to meet regulatory hurdles. We expect to be that provider, given our quality asset base, existing customer relationships and technological expertise. As we have mentioned, we are currently in ongoing negotiations with external parties that would allow us to leverage the new product and capabilities that we have built over the last year. If we're successful in closing some of the larger opportunities in our pipeline, this would greatly increase the current utilization rates for the asset, diversify the customer base, including decrease in exposure to power generation markets and more fully leverage the low-cost nature of the plant.

We believe the fixed cost absorption that would result from these contracts would greatly improve the profitability and efficiency of the Red River plant. We feel as though we have made great progress since our last update in May, and this work remains of the highest strategic importance for us. Slide 8 provides an update on our capital allocation program. We implemented our shareholder return initiatives during the second quarter of 2017 and since that time, we have returned $106.4 million to shareholders via dividends and share repurchases.

We've also paid down $42 million of the $70 million term loan that funded the acquisition of Carbon Solutions in late 2018. As we discussed last quarter, in order to improve our financial flexibility, we suspended our quarterly cash dividend and put a pause on share repurchases. These initiatives were important pillars of our capital allocation plan. So we did not make the decision lightly.

But ultimately, it was important to preserve the roughly $5 million per quarter as we work our way through this crisis. In the near term, debt reduction will remain a priority as the term loan is subject to mandatory quarterly principal payments of $6 million. We continue to expect to pay off the full balance of the loan prior to the end date of December 31, 2021. And finally, Slide 9 outlines our priorities for the remainder of the year.

Our first priority is to continue to maximize and protect our net Refined Coal cash flows. Although Tinuum is marching toward the end of the tax credit generation period, there remain incremental opportunities for invested facilities, while simultaneously adjusting their cost structure. We will also continue to leverage the best-in-class asset we have to win where our products and capabilities allow us to do so. This will entail filling the plant's capacity with incremental wins in the market opportunities we spoke about, as well as continuing to seek additional opportunities upon the expected market rationalization, while reducing cash costs.

As such, we are on track to our previously provided target of at least $5 million in reductions on an annualized basis, while optimizing our products and manufacturing processes. These cost mitigation actions were put into place before the current crisis, so they are exclusive of any cost changes related to the pandemic. Lastly, we've shifted our near-term capital allocation focused to risk mitigation and cash preservation. We will continue to deleverage, but the shareholder return component of our capital allocation plan remains on hold to preserve liquidity.

With that, we will take your questions.

Questions & Answers:


Operator

[Operator instructions] And there are no questions at this time. I would like to turn the call back over to Greg for closing remarks.

Greg Marken -- Interim President, Chief Executive Officer, and Treasurer

Thanks, again, everyone, for joining the call this morning and for your continued support. Stay healthy. And we look forward to providing our next update.

Operator

[Operator signoff]

Duration: 24 minutes

Call participants:

Greg Marken -- Interim President, Chief Executive Officer, and Treasurer

Chris Bellino -- Chief Accounting Officer

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