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Advanced Emissions Solutions, Inc. (ADES) Q3 2020 Earnings Call Transcript

By Motley Fool Transcribing - Nov 11, 2020 at 1:30AM

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ADES earnings call for the period ending September 30, 2020.

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Advanced Emissions Solutions, Inc. ( ADES 3.25% )
Q3 2020 Earnings Call
Nov 10, 2020, 9:00 a.m. ET


  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Ladies and gentlemen, thank you for standing by and welcome to the Advanced Emissions Solutions Q3 2020 earnings call. [Operator instructions] I'm going to hand the conference over to Ryan Coleman, investor relations. Please go ahead.

Ryan Coleman -- Investor Relations

Thank you and good morning, everyone, and thank you for joining today for our third-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 investor 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 the 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 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, the factors identified on Slide 2 of today's slide presentation, in our Form 10-Q for the quarter-ended September 30, 2020, and other filings with the Securities and Exchange Commission. Except as expressly required by securities law, 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 this presentation and 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 Marken.

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

Thanks, Ryan, and thanks to everyone for joining us this morning. Yesterday, after markets closed, we reported third-quarter results that were largely in line with our expectations for the quarter. Tinuum was able to lease an additional refined coal facility to a third-party investor and also sold its remaining interest in another. Tinuum also announced the contractual closure of an additional facility since quarter end in October.

These transactions demonstrate the ongoing investor interest in leasing these facilities as we have discussed previously this year. In the PGI segment, we beat our internal forecast while volumes exceeded prior-year levels. I continue to be encouraged by our competitive position in the market as well as our progress toward diversifying our Red River plants production across numerous industries and applications. And most importantly, we've made great progress toward laying the foundation for the company's post-refined coal future and announced our 15-year master supply agreement with Cabot Corporation on September 30.

This is an important step toward diversifying the business and capturing the value of the assets we purchased, and we feel fortunate to have an established and committed business partner in Cabot going forward. I'll talk more about the nature of that agreement as well as our outlook at the segment level later in the call. But first, let's turn to Slide 3 for a high-level review of the quarter. Third-quarter distributions from Tinuum totaled $9.7 million during the quarter and royalty income totaled $3.6 million.

The lower distributions were the result of renegotiated contracts in the third quarter of 2019 that resulted in lower net lease payments to the company and timing of cash distributions from Tinuum. Also contributing to the decline has been the decreased coal burn driven by cheap alternative energy sources as well as by lower aggregate energy demand in the U.S. from lower overall economic activity during the past two quarters, largely driven by the pandemic. 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.

Because of that, we believe adjusted refined coal segment EBITDA helps to portray an additional year-over-year comparison of the earnings and associated cash flows of the segment. In our PGI segment, our third-quarter revenue was down roughly 4%, while our segment operating loss was $1.3 million. Adjusted EBITDA in the segment was slightly better than breakeven. Cheap alternative fuel sources contribute to weakness in our PGI segment.

However, we have been able to largely offset this pressure as we have greatly diversified our product mix away from coal-fired power generation with the success we have had in industrial markets. We had another strong quarter of execution, and we expect to continue to maintain high renewal rates with our existing customers. Our focus here remains on filling the plant's capacity, diversifying our product mix, and capturing the low-cost nature of the asset. Our agreement with Cabot is a significant step toward achieving each of these initiatives.

From a consolidated perspective, our net profit in the third quarter was $5 million. Our consolidated adjusted EBITDA was $8.7 million, compared to $18.5 in the prior year, mainly driven by lower cash distributions from Tinuum. Regarding our capital allocation, we are continuing to prioritize debt reduction and cash preservation during the pandemic. We reduced our term loan balance to $22 million and continue to expect to pay off the note in less than its stated three-year term.

We remain focused on the cost containment and have maintained our pause on all noncore capital spending. Our focus has been to prioritize liquidity and organic investment to ensure manufacturing capabilities. During the year, we have also restricted corporate travel and limited backfilling open positions prior to the completion of the supply agreement, in addition to other measures. In the third quarter, we reduced our other operating expenses by roughly 24% and have improved our overall liquidity positions from last quarter.

Separate from our RC segment, we expect the supply agreement with Cabot to materially improve the economics of our activated carbon assets and our consolidated financial performance. As we ramp up production over the next four to five quarters, we expect that we will reduce our power generation exposure to less than 50% of our portfolio, and we expect the agreement to yield relative to our current operations incremental annual revenue growth of 30% to 40% and incremental annual EBITDA growth of $10 million to $15 million. While this agreement is a critical step, power generation still does comprise a significant portion of our current product portfolio, and the market remains challenged by cheap alternative fuel sources and the impact of the pandemic. We have spent considerable time and effort organically building out our product capabilities and internal sales infrastructure, and our offering is growing increasingly competitive in non-power generation markets like industrial and municipal water.

As a result of these efforts, we believe we are on-target to more than double our water-related volumes on an annualized basis year over year by the time we reach December of this year. We remain focused on identifying other non-power generation markets and opportunities, in addition to the diversification that Cabot agreement will provide away from power generation. I'll talk more about some of these efforts, but first, I'd like to turn the call over to Chris to review our third-quarter financial performance.

Christine Bellino -- Chief Accounting Officer

Thank you, Greg. Let's turn to Slide 4 for our financial review. Third-quarter earnings from equity method investments were $9.5 million compared to $14.4 million for the third quarter of 2019. The decrease was primarily due to lower earnings from Tinuum Group resulting from higher depreciation on all Tinuum Group refined coal facilities due to a reduction in their estimated useful lives during the third quarter of 2019.

Also contributing to the decline was Tinuum Group restructuring RC facilities leases with its largest customer, which decreased net lease payments and equity earnings beginning in the quarter -- third quarter of 2019. Third-quarter revenue was $19.5 million, compared to $19.1 million in the third quarter of 2019. The increase in revenue was a result of higher consumable revenue, partially offset by lower royalty income. Royalty earnings from Tinuum Group was $3.6 million, compared to $4.4 million for the third quarter of 2019.

Royalty income is based upon a percentage of the pre ton -- sorry, per-ton pre-tax margin, inclusive of impacts related to depreciation expense and other allocable expenses. The lower royalty earnings in the third quarter and year to date were due to increased depreciation and lower rent payments to Tinuum, which also impacted the company's equity earnings. As we have stated, royalty earnings are expected to be negatively impacted due to these changes in both 2020 and 2021. Including the refined coal transaction, we announced in October, we now have 22 RC facilities invested with 17 that are generating royalties.

The third-quarter net income was $5 million compared to $3.9 million in 2019. The decrease in net income was mainly driven by lower income tax expense compared to last year. Q3 of 2019 included an increase in the valuation allowance on deferred tax assets, driving higher tax expense. Third-quarter consolidated adjusted EBITDA was $8.7 million compared to $18.5 million in 2019.

The increase in consolidated adjusted EBITDA was driven by higher cash distributions from the company's equity-method investments. We ended the third quarter with a cash balance inclusive of restricted cash of $25 million, an increase of a $7.9 million since December 31, 2019, and a $3.3 million increase from the end of the second quarter. During the quarter, we also made a $6 million principal payment on our term loan, reducing the principal balance, including the current portion, to $22 million. Total borrowings now stand at $30 million compared to $44 million at year-end 2019.

That $30 million is comprised of the $22 million term loan, $3.3 million of funds we secured from the SBA potentially forgivable loan program, while the remainder is comprised of finance leases. Overall, we're pleased with where our liquidity position and term loan balance currently stand. And as Greg stated, we expect our financial performance to improve as we ramp up production related to the supply agreement with Cabot. Now, I'll turn it back over actually 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 21 invested facilities as of quarter end and cash distributions received during the quarter, we are updating our expectation of after-tax cash flows to be between $90 million and $110 million to ADES through the end of 2021.

As we mentioned, this total does not include the transaction announced in October, which we expect to add between $5 million to $7 million of additional cash flows to this total. Tinuum continues to remain active -- in active discussions with potential tax equity investors in our pipeline. However, as we march toward the end of the tax credit period, the ability to obtain incremental invested facilities is much more limited. In response to the approaching 2021 expiration date, Tinuum continues to take steps to adjust its cost structure while ensuring that their assets reliably produce refined coal.

Slide 6 reflects the growth channels that we have been discussing where we either currently are active or have identified as future opportunities. We remain the provider of choice for coal-fired power plants bound by Mercury and Air Toxics Standard. However, as we have discussed, the decline in coal-fired power has exceeded EIA forecasts, and there will continue to be future changes to the supply of power generation from coal-fired sources. In response, we knew we needed to be more aggressive so we 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 although outside of the PGI segment, we are exceeding our expectations going into the year within the water market, as I discussed earlier. However, our total volume does remain under pressure as these adjacent markets have not been able to fully offset the decline during the past two years in power generation.

We are also seeing early successes and other growing market opportunities, utilizing existing product technologies and capabilities that may provide additional volumes in areas where the historical Carbon Solutions business has not competed. The supply agreement that we reached with Cabot is an important step because it plays a critical role in each of these opportunities. The deal allows us to scale our production and realize the low-cost nature of our plant, which, in turn, makes us more competitive in markets we pursue and opens doors to new markets altogether. The agreement is also reflective of the changes we have said we expect to see in the market.

Although this agreement was significant, we will continue to evaluate select strategic opportunities to increase and diversify our addressable markets as they arise, and we believe that we will be in a position to capitalize on the opportunities given the quality of our assets. Additionally, given higher natural gas prices and the effect of colder winter months, coupled with the fact that we sill scale production in conjunction with the Cabot deal, we expect to begin to see the performance of the business improve. Slide 7 provides a quick recap of the terms and the impact of the supply agreement we reached with Cabot. We entered into a 15-year agreement to supply Cabot with lignite-activated carbon products, including PAC and GAC.

This announcement is an important step toward the creation of the company's post-refined coal future. This will allow us to secure material incremental volume and better capture the low-cost manufacturing capabilities of our plant. It also expands our end customer markets product portfolio beyond our current suite of products and capabilities and will allow us to enter and deepen our presence in markets such as food and beverage, pharmaceuticals and other liquid and gas purification applications, in addition to other markets. This deal is a testament to the quality of the activated carbon assets we possess and is an example of the opportunities available to us to grow and scale this business.

As I said earlier, over the next four to five quarters, as we work through the launch of this agreement and the runoff of existing inventory balances that were produced at much lower overall volumes relative to the largely fixed cost manufacturing base, we expect to see, relative to our current operations, incremental annual revenue of 30% to 40%, incremental annual EBITDA growth of $10 million to $15 million, and a reduction of our power generation exposure to less than 50% of our product portfolio. We began supplying Cabot with activated carbon products immediately on October 1. We also took over Cabot's lignite mine that previously supplied Cabot's Marshall, Texas facility. Reclamation activities related to this mine have already begun, and we expect that 70% of the reclamation costs will be completed in the first 24 months.

Cabot will share in the cost to complete these activities. Looking ahead, we believe additional opportunities will present themselves, and our competitive position we have in the industry leaves us well-positioned to capitalize on them. Slide 8 provides an update on our overall 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 have also paid down $48 million of the $70 million term loan that funded the acquisition of Carbon Solutions in late 2018. In the near term, preserving our liquidity position and debt reduction will remain priorities 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 reiterates our priorities for the remainder of the year.

Our first priority is to continue to maximize and protect our net RC cash flows. Although Tinuum is marching toward the end of the tax credit generation period, there remains incremental opportunities for invested facilities while simultaneously adjusting their cost profile. We will also continue to leverage the best-in-class asset that we have to win where our products and capabilities allow us to do so. This will entail ramping production over the next four to five quarters in conjunction with the Cabot deal, filling the plant's capacity with incremental wins and the market opportunities we spoke about as well as continuing to seek additional opportunities on the expected market rationalization.

As such, we are on track to meet our previously targeted goal 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 focus to risk mitigation and cash preservation. We will continue to deleverage, but the shareholder return component of our capital allocation plans remain on hold to preserve liquidity.

With that, thanks again, everyone, for joining the call this morning and for your continued support. Stay healthy, and we look forward to our next update.

Questions & Answers:


[Operator signoff]

Duration: 21 minutes

Call participants:

Ryan Coleman -- Investor Relations

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

Christine Bellino -- Chief Accounting Officer

More ADES analysis

All earnings call transcripts

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