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Advanced Emissions Solutions, Inc. (NASDAQ:ADES)
Q4 2020 Earnings Call
Mar 11, 2021, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Advanced Emissions Solutions' Q4 2020 earnings call. [Operator instructions] I would now like to hand the conference over to your speaker today, Wyatt Turk, investor relations. Thank you. Please go ahead.

Wyatt Turk -- Investor Relations

Thank you. Good morning, everyone, and thank you for joining us today for our fourth-quarter and full-year 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 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 our site and you can contact Alpha IR Group for investor relations support at 312-445-2870. Let me remind you that the presentation or 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 the actual future results, performance and business prospects and the 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 two of today's slide presentation, in our Form 10-K for the year ended December 31, 2020, and other filings with the Securities and Exchange Commission.

Except as expressly required by the 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 is very important to review the 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.

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

Thanks, Wyatt. And thanks to everyone for joining us this morning. Before we begin, I would like to take a moment to thank Chris Bellino, who has joined me on our past few earnings calls and will be retiring at the end of the month. Chris has been with ADES for six years and has served in a variety of roles during that time and has been integral to the company's success.

We wish her well in retirement and thank her for her service to the company. After market closed yesterday, we published our fourth-quarter and full-year results that were aligned with our expectations. Tinuum was able to complete two additional transactions in the fourth quarter, bringing our invested facilities up to 23 now, which continues to support our forecasted after-tax cash flows and our investment in our go-forward strategy as a provider of choice for activated carbon solutions. The performance of our activated carbon business exceeded the fourth quarter of 2019 and we are carrying the encouraging business momentum into 2021.

We once again beat our internal volume forecast and are now turning to optimizing our current product mix to enhance the earnings profile of the segment. And just last month, we announced a second supply agreement with Cabot to sell our activated carbon and other products through Cabot sales channels in Europe, the Middle East and Africa, which is incremental to the 15-year master supply agreement we announced in September. I'll talk more about the detailed strategy and progress around these two agreements, but first let's turn to slide three for a high-level review of the quarter and year. Fourth-quarter distributions from Tinuum totaled $20.2 million during the quarter and royalty income totaled 35 -- or $3.5 million.

Full-year distributions totaled $62.4 million and full-year royalties were $13.4 million. Fourth-quarter distributions from Tinuum were up 18% based on new facility closures over the last year. On an annual basis, the lower full-year 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. 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 in 2020 were significantly reduced compared to the cash distributions we received.

Because of that, we believe adjusted RC segment EBITDA helps to portray an additional year-over-year comparison of the earnings and associated cash flows of the segment. RC segment adjusted EBITDA for the fourth quarter increased 15% to $23.5 million compared to Q4 of last year. Full-year RC segment adjusted EBITDA was $74.6 million compared to $89.3 million in 2019. Moving to the activated carbon business.

I'd like to point out that we've renamed this segment to better reflect its long-term positioning and more expansive scope. We expect our solutions to serve far more markets than where we originally provided products upon acquiring Carbon Solutions. So what we previously called power generation and industrials, or PGI, has now been updated to advanced purification technologies, or APT for short. In the APT segment, our fourth-quarter revenue was up roughly 25% to $14.9 million, while our segment operating income was $0.7 million.

Adjusted EBITDA in the segment was $2.3 million, an improvement against a $1.4 million adjusted EBITDA loss in Q4 of last year. Our APT segment saw another strong quarter of execution with our existing customers and was positively impacted by the Cabot supply agreement. Our main focus over the past several quarters has been filling the plant's capacity. Having now obtained a capacity utilization level more in line with our longer-term run rate, we are now beginning to pivot to a broader focus of moving upstream in terms of customer and product mix.

This involves identifying margin accretive volume opportunities, which will enhance the margin and earnings profile of the segment over time. Similar to the RC segment, competing alternative fuel sources also contributed to weakness in this segment in fiscal 2020. However, we have been able to largely offset this volume pressure as we have greatly diversified our product mix away from coal-fired power generation with the success we have had in industrial and water markets in addition to the Cabot supply agreement. We also saw higher natural gas prices during the fourth quarter, as well as the early months of 2021, partially driven by colder temperatures across the U.S., which positively impacted coal-fired power generation and related demand for certain of our products by those customers.

On that note, I would like to take a moment to acknowledge the energy crisis that occurred in Texas and the weather impacts across the Southern Plains. From an operational perspective, we were forced to limit certain operations, most significantly due to transportation constraints related to both incoming raw materials and outgoing finished product. Although we lost some product production due to these weather conditions, we had sufficient inventory to supply in situations that transportation and driver availability would allow and we have since resumed normal operations. Our people did an amazing job of keeping our operations going and working with customers to deliver product, ultimately supporting the power generation and water markets to be able to continue serving their customers.

From a consolidated perspective, our net income was $0.4 million for the fourth quarter, while our full-year consolidated net loss was $20.3 million. That full-year net loss was mainly the result of a $26 million impairment charge that we incurred in the second quarter, as well as income tax expense, driven by an increase in the deferred tax asset valuation allowance. Our consolidated adjusted EBITDA was $23.4 million in the fourth quarter and $55.1 million in fiscal 2020 compared to 14.9 million and 66.5 million in the prior-year periods, respectively. Regarding our capital allocation, we continue to prioritize debt reduction and cash preservation.

We reduced our long-term loan balance to $16 million during the fourth quarter and we expect to pay off the remaining balance before Q4 of this year. We remain focused on cost containment, maintaining our pause on non-core capital spending, and we'll continue to evaluate our go-forward cost structure relative to business activities. Our focus was to prioritize liquidity and organic investment to ensure manufacturing capabilities, and we are pleased to say that we did not experience any significant business or manufacturing interruptions. During the year, we also restricted corporate travel, largely related to the pandemic and limited backfilling open positions, in addition to other measures.

Certain of these savings were offset by expenses we incurred throughout the year related to completing product testing and other matters related to securing the Cabot supply agreement. Irrespective of these impacts year over year, we reduced our other operating expenses by roughly 25% fourth quarter-over-fourth quarter and by 7% for the full year. Our focus on expense management helped us strengthen our balance sheet in 2020. Our year-end cash balances, including restricted cash, totaled $35.9 million, an increase of $18.9 million from the prior year.

However, working toward improvement in margins and EBITDA and a continued focus on cost structure will be key as we move into 2021. After the end of the fourth quarter, on February 4, we announced that we had entered into an agreement with Cabot to supply a Cabot European subsidiary with lignite activated carbon products and other ADES proprietary products used for mercury removal in utility and industrial coal-fired power plants in Europe, Turkey, the Middle East and Africa. This agreement is separate and incremental to the 15-year supply agreement we announced with Cabot back in September. The two supply agreements we have announced over the past six months are a testament to the Red River plant's competitive position in the market, as well as the opportunity we see for our product solutions going forward.

Upon signing the Cabot supply agreement at the end of September, we immediately began fulfilling our product commitments related to that agreement, and we are beginning to see the positive benefits of that deal. These collective agreements are an important step toward diversifying the revenue streams we will generate from the plant and capturing the value of the assets. We are fortunate to have an established and committed business partner in Cabot going forward. We expect the supply agreements 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 year, we expect that we will reduce our power generation exposure to less than 50% of our portfolio. While it's still too early to quantify the potential economic impact of the EMEA agreement we announced last month, mercury and other pollutant control regulations are coming online in the EU in 2021 and beyond. This creates a vital need for solutions like ours to ensure that industries are abiding by these new regulations. We expect to gain a clearer understanding of the financial impact as those regulations come online.

However, we are confident that the geographic expansion offered by the agreement is an important step to further diversify our revenue mix and further utilizing the plant's capacity while also providing downside protection related to the ongoing pressure on power generation in North America. In addition to the diversification provided by these agreements, we are simultaneously continuing to bid in non-power generation markets, but our current business and product portfolio remains very much tied to power. 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 has grown increasingly competitive in non-power generation markets like industrials and municipal water.

As a result of these efforts, we have more than doubled our water-related volumes on an annualized basis year over year. It remains a smaller portion of our overall portfolio, but it is encouraging progress. But as I said earlier, to ensure the longer-term profitability and viability of the assets moving forward, we need to continue to increase both the diversification of our product mix, as well as our customer mix. The addition of new applications, products and customers will provide us better balance in the segment and will improve our margins as we scale the business over time.

Overall, I am pleased with the strategic success we have achieved this year with our activated carbon assets and the groundwork we are laying for our post refined coal future. We expect the earnings profile of our APT segment to improve in 2021, and we have a solid line of sight to the 70 to 90 million of after-tax refined coal cash flows. I'll talk more about our strategy and outlook, but first I'd like to turn the call over to Chris to review our fourth-quarter and full-year financial performance.

Chris Bellino -- Chief Accounting Officer

Thank you, Greg. Let's turn to slide four for our financial review. Fourth-quarter earnings from equity method investments were 5 million compared to 12.1 million for the fourth quarter of 2019. Full-year earnings from equity method investments were 31 million compared to 69.2 million in 2019.

The decline in earnings from equity method investments during the fourth quarter and full year was due to lower earnings from Tinuum Group, primarily driven by higher depreciation on all Tinuum Group RC facilities as a result of the reduction in the estimated useful lives during the third quarter of 2019, as well as Tinuum Group restructuring RC facility leases with its largest customer, which decreased net lease payments and equity earnings beginning in the three months ended September 30 of 2019. Fourth-quarter revenue totaled 18.4 million compared to 16 million in the fourth quarter of 2019. The increase in revenue was primarily the result of higher consumables revenue driven by increased volumes at our Red River plant compared to the fourth quarter of 2019. Full-year revenue totaled 61.6 million compared to 70.1 million in 2019.

The decline in the year in revenue was the result of lower royalty income and lower consumables revenue due to product and customer mix, partially offset by the fourth-quarter impact of increased volume from the Cabot supply agreement. Fourth-quarter royalty earnings from Tinuum Group was 3.5 million compared to 4.1 million in the fourth quarter of 2019. Full-year royalty earnings totaled 13.4 million compared to 16.9 million in 2019. Royalty income is based upon a percentage of per ton pre-tax margin, inclusive of impacts related to depreciation expense and other allocable expenses.

The lower royalty earnings in the fourth quarter and full year 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 2021. After the two refined coal transactions we announced during the fourth quarter, we now have 23 refined coal facilities invested with 17 that are generating royalty. Fourth-quarter 2020 net income was 0.4 million compared to 9.1 million in 2019.

The decline in net income was primarily driven by lower earnings from equity method investments, as well as changes impacts expense. Full-year 2020 net loss was 20.3 million compared to net income of 35.5 million in 2019. The decline in net income for the year was driven by an impairment charge of 26.1 million, which the company incurred in the second quarter of 2020. Excluding these impairment charges, 2020 pre-tax income would have been approximately 12.4 million versus a 13.8 million loss.

Fourth-quarter 2020 consolidated adjusted EBITDA was 23.4 million compared to 14.9 million in 2019. The increase was driven by increased revenues in our APT segment and higher depreciation and amortization expense within our RC segment. Full-year 2020 consolidated adjusted EBITDA was 55.1 million compared to 66.5 million in 2019. The decrease in full-year consolidated adjusted EBITDA was largely driven by lower cash distributions for Tinuum, lower royalty income and lower net revenue from consumables.

We ended the year with a cash balance inclusive of restricted cash of 35.9 million, an increase of $10.9 million compared to the end of 2019. We have also continued to pay down the balance of our term loan and made a 6 million principal payment to reduce the principal balance, which includes the current portion down to 16 million. Total borrowings now stand at $24 million compared to 44 million at the end of 2019. That 24 million is comprised of 16 million term loans, 3.3 million of funds that we secured from the SBA potentially forgivable loan program, while the remainder comprised of finance leases.

Overall, we are pleased with our financial position. As we continue to build our cash balance, we expect to pay off the remaining $16 million term loan balance before Q4 2021 maturity. We are confident that our future forecasted net after tax RC cash flows will be in the range of 70 to $90 million. We also expect our financial performance to improve, particularly within our consumables business as we fulfill our production commitments related to the supply agreement we have signed with Cabot and optimize our product mix.

And with that, I will now turn it back to Greg for his closing remarks.

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

Thank you, Chris. Turning to slide five, you can see the expected future RC cash flows. Based on the 23 invested facilities as of quarter end and cash distributions received during the fourth quarter, we are updating our expectation of future after tax RC cash flows to ADES to be between 70 million and 90 million. Absent an unexpected change to the duration of the Section 45 tax credit, Tinuum does not expect to obtain additional tax equity investors for any incremental facilities.

Slide six reflects the growth channels we have been discussing, where we are either currently active or have identified as future opportunities. When we acquired Carbon Solutions in December of 2018, we immediately became the go-to provider of activated carbon solutions for coal-fired power plants that needed to meet mercury air toxic standards. Since that time, coal-fired power generation has declined faster than ours and even the EIA's initial expectations. Cheap and abundant alternative fuel sources led to coal-to-gas switching, and we responded by engaging more aggressive diversification efforts to lower our reliance on power generation.

We were very aggressive in an effort to obtain new volume wins and increase the capacity utilization of the plant. We since have generated solid traction in other markets, industries such as manufacturing and waste management that are bound by emissions caps. We are also seeing better-than-expected share gains in water purification and we have an active and robust funnel of bids currently in place. We are now producing activated carbon more efficiently as we are capitalizing on the low-cost nature of the asset and seeing important improvements to our margin profile.

Unfortunately, our total volume has remained under pressure as these adjacent markets have not been able to fully offset the decline in power generation. However, the two announcements we have made with Cabot are important steps toward building our total volumes, raising the plant's capacity utilization and generating better results in our APT segment. We are also seeing early successes in other growing market opportunities, utilizing product technologies and capabilities that may provide additional volumes in areas where the historical carbon solutions business has not competed. The two Cabot deals allow us to scale our production and fully realize the low-cost nature of the plant, which, in turn, makes us more competitive in markets we pursue and opens doors to new markets altogether.

The customer and market diversification will be a main priority in 2021 to lay the foundation for this business for years to come. The agreement is also an example of some of the rationalization we have discussed and expect to continue to see in the activated carbon space. We continue to believe that additional opportunities will present themselves, and we stand well positioned to be a participant given the sophistication and flexibility offered by our Red River plant. Slide seven provides a quick recap of the terms and the impact of the supply agreements we have reached with Cabot.

In September, 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 market, product portfolio beyond our current suite of products and capabilities and will allow us to enter through Cabot's customer relationships and end market users a broader range of PAC and GAC opportunities.

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. We have begun fulfilling our commitments outlined within the agreement, and we expect to cycle through existing inventory balances that were produced at much lower overall volumes relative to the largely fixed cost manufacturing base before the end of 2021. Ultimately, as a result of this agreement, we expect to see incremental annual revenue growth of 30to 40%, incremental annual EBITDA growth of 10 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 began immediately, and outside of a brief pause last month due to the Texas weather events, those activities have proceeded as planned. We still expect that 70% of the reclamation costs will be completed in the first 24 months, and Cabot will share in the cost to complete these activities. As I mentioned, subsequent to that agreement, we announced last month that we have entered into a five-year supply agreement with Cabot's EMEA subsidiary.

As part of that agreement, Cabot will be the exclusive and sole reseller of the products within EMEA. The expansion of our products and technologies to international markets and applications is an important milestone for ADES and furthers our belief for the further -- future potential of the business. The broadened relationship with a trusted and global partner like Cabot is also a testament to the asset's quality, as well as the product portfolio. As the world need for sophisticated pollution control solutions grow, we expect to be a provider of choice for these technologies given our expertise and the quality of our plant.

Looking ahead, we believe additional opportunities will present themselves and our competitive position we have in the industry leaves us in a good position to capitalize on them. 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 also paid down 54 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 expect to pay off the balance of the loan prior to its Q4 2021 maturity. And finally, slide nine reiterates our priorities for the remainder of the year. Our first priority is to continue to protect our net RC cash flows.

Tinuum is taking actions to ensure they continue to produce product while also updating their organization and cost structure for the upcoming winding down of operations. We will simultaneously leverage our Red River plant and its best-in-class characteristics to optimize our capacity to generate improved operating leverage. Part of this will be accelerating production to meet our commitments to our supply agreements with Cabot, identifying opportunities to improve earnings potential through customer and product mix and maintaining a focus on our cost structure relative to go-forward business activities. Lastly, we are reiterating our near-term capital allocation focused on risk mitigation, cash preservation, as well as necessary organic investment in our activated carbon business.

We will continue to deleverage, but the shareholder return component of our capital allocation plan remains on hold to preserve liquidity and ensure we are investing behind our strategic initiatives. 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

[Operator signoff]

Duration: 28 minutes

Call participants:

Wyatt Turk -- Investor Relations

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

Chris Bellino -- Chief Accounting Officer

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