Advanced Emissions Solutions, Inc. (ADES) CEO Greg Marken on Q3 2021 Results - Earnings Call Transcript

Nov. 10, 2021 2:09 PM ETAdvanced Emissions Solutions, Inc. (ADES)
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Advanced Emissions Solutions, Inc. (NASDAQ:ADES) Q3 2021 Earnings Conference Call November 10, 2021 9:00 AM ET

Company Participants

Greg Marken - President, Chief Executive Officer & Treasurer

Morgan Fields - Chief Accounting Officer

Ryan Coleman - Investor Relations

Conference Call Participants

Operator

Good day, and thank you for standing by. Welcome to the Advanced Emissions Solutions Third Quarter 2021 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers' presentation there will be a question-and-answer session. [Operator Instructions].

I would now like to hand the conference over to your first speaker today, Mr. Ryan Coleman, Investor Relations. Sir please go ahead.

Ryan Coleman

Thank you, and good morning, everyone, and thank you for joining us today for our third quarter 2021 earnings results call. With me on the call today are Greg Marken, who per the 8-K filed yesterday afternoon is now Chief Executive Officer, President and Treasurer; as well as Morgan Fields, our Chief Accounting Officer.

This conference call is being webcasted live within the Investor Section of the 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 Health IR through Investor Relations support at 312-445-2870.

Let me remind you that the presentation and remarks made today includes 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 and 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 two of today's slide presentation in our form 10-Q for the quarter ended September 30, 2021, 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 change circumstances or for any other reason. In addition, it is very important to review today's presentation and today's remarks in conjunction with GAAP references in the financial statements.

With that, I will turn the call over to Greg.

Greg Marken

Thank you, Ryan, and thanks to everyone for joining us this morning. Yesterday, after the close of markets, we reported our third quarter results, which are highlighted on Slide 3. Overall, our results were significantly improved over last year, and in line or ahead of our expectations going into the third quarter. Distributions from Tinuum remain strong as we approach the end of the tax credit generation period. And our APT segment delivered record quarterly revenue and strong gross margins.

Tinuum distributions to ADES totaled $22.9 million for the quarter, compared to $9.7 million in Q3 of 2020. Royalty earnings from Tinuum group also increased and were $4.2 million compared to $3.6 million in the prior year. In addition, both quarterly RC segment operating income and adjusted EBITDA more than doubled compared to the prior year. Similar to what we saw in the second quarter, the increased number of investment facilities as well as higher prices for alternative fuel sources such as natural gas have supported high demand for the RC customers. Of note we had six RC facilities reached the end of their scheduled expiration of their 10 year tax credit generation period. We now have 16 operational facilities, all of which will reach their expiration date for generating tax credits no later than December 31.

Our APT segment also benefited from higher natural gas prices and the year-over-year impact of the Cabot supply agreement, which contributed to a record quarter as revenue grew 56% compared to last year. The segment's operating income was $4.6 million, compared to an operating loss of $3.3 million in 2020. Segment adjusted EBITDA was $4.2 million, compared to a loss of $1.6 million in the prior year. The segment also demonstrated the inherent operating leverage it possesses as strong volumes drove our gross margins to 27% compared to 5% in 2020. It is important to keep in mind that Q3 is seasonally one of our strongest quarters. However, we do expect demand to remain strong due to high natural gas pricing, as well as the impact of colder months in the latter portion of Q4.

Due to inventory tightness, we continue to supplement our inventory through external sources in order to meet high customer demand. This means that our segment margins while better than the prior quarter, remain pressured by the higher cost per unit we are currently experiencing. We expect these pressures to persist well into 2022 despite that, we have proven our ability to navigate these tight supply conditions and expect high demand levels along with ongoing improvements to customer and product mix to help alleviate these cost pressures.

Although strong volumes are being driven by power generation customers, we also have experienced strong demand from industrial and water applications. We maintain a solid bid pipeline with potential customers in these markets, as they are important diversifying factors within our APT strategy. Our price increase initiatives for activated carbon products are progressing well. Of course, it takes time to step up pricing for an entire portfolio of product. But we are encouraged by our ability to negotiate better terms since our announcement earlier this year, and we are seeing our ASP improve accordingly. We also continue to make steady progress in developing new activated carbon products and technologies through our partnership with Cascade Environmental for the soil and groundwater remediation market. We are pleased with testing results achieved to-date and are excited about the potential of this emerging product offering.

Consolidated net income was $24.3 million for the quarter, or $1.31 per diluted share, compared to $5 or $0.27 per share in 2020. Our consolidated adjusted EBITDA was significantly higher at $28.5 million, compared to $8.7 million for Q3 of 2020. We continue to maintain a very strong balance sheet. Our cash balances including restricted cash totaled $82.1 million at the end of the quarter, an increase of $46.2 million compared to December 31, 2020.

From a capital allocation perspective, our number one priority remains the organic investment in our manufacturing assets to meet customer demand and ensuring that we are able to source sufficient inventory to serve our customers. We are updating our projected after tax cash flows from the RC segment to be between $12 million and $14 million with $8.5 million to be received during the fourth quarter.

We expect the additional cash flows to be disbursed to us during the first half of 2022 when Tinuum ultimately completes its wind down process. That cash flow guidance is inclusive of the associated wind down costs from Tinuum. I'd also like to state that many of these RC facilities will likely remain in place after the year end expiration date for the tax credit generation period.

These facilities or other application facilities can be utilized to apply the front end chemistry of feedstock coal as utilities currently leveraging the production tax credits will need to pivot to another method of meeting requisite emissions control standards. Some of these utilities will likely purchase our frontend technology or activated carbon instead, which will help replace a portion of the RC cash flows from Tinuum distributions that are going away.

As I mentioned, we expect our APT segments top line to remain very strong. Our margins are expected to remain under pressure due to tight inventory conditions as well as broader supply chain challenges that are putting upward pressure on the costs related to transportation and freight as well as other product inputs that may be necessary. We will seek to offset these pressures through continued price increases and product mix optimization.

Lastly, as it relates to our strategic review, we are pleased with ongoing progress to evaluate the opportunities available to us to maximize shareholder value. As a reminder, we have no timetable for the conclusion of this process. And we will provide updates when appropriate. In the meantime, we remain focused on continuing to improve the operating profile of our APT assets.

With that I'll turn the call over to Morgan to review our third quarter financial performance in greater detail.

Morgan Fields

Thank you, Greg. Slide 4 shows a snapshot of our third quarter and year-to-date financial performance. Third quarter earnings from equity method investments were $22.2 million compared to $9.5 million for the third quarter of 2020. The increase in earnings as a result of distributions from Tinuum group being in excess of the carrying value of the investment and therefore excess distributions are recognized as equity method earnings in the period in which the distributions occur.

In addition, Tinuum group had a higher number of RC facilities for majority of the current year due to three new RC facilities added during 2020. Third quarter revenues and cost of revenues were $28.9 million and $18 million respectively, compared to $19.5 million and $15 million for the third quarter of 2020. The increase in revenue was primarily the result of higher sales of consumables as well as higher royalty income. Third quarter net income was $24.3 million or $1.31 per diluted share, compared to $5 million or $0.27 per diluted share for the third quarter of 2020.

The increase was driven by higher earnings from equity method investments, as well as higher volumes and improved margins within the APT segment. Third quarter consolidated adjusted EBITDA was $28.5 million, compared to $8.7 million for 2020. The increase in adjusted EBITDA was driven by the increase in distributions from Tinuum as well as higher consumables revenue at more favorable margins.

Our cash balance, including restricted cash totaled $82.1 million, an increase of $46.2 million compared to December 31, 2020. The restricted cash stems from our surety bond and the requirement to post collateral of $10 million for the obligations due under the reclamation contract related to the mine in Marshall, Texas. With the full repayment of our term loan last quarter, the company's only debt outstanding, our finance lease obligations, totaling approximately $4.4 million as of quarter end. Through the first nine months of the year, capital expenditures totaled $5.4 million, compared to $4.9 million in 2020.

Our total obligations related to reclamation activities for the Marshall and Five Forks mines currently stand at $12.9 million. However, we also possess an offsetting receivable from Cabot for future reclamation reimbursements, which has a present value of $9 million at quarter end.

During the quarter we received formal notice that our PPP loan was forgiven. This is presented as a $3.3 million gain on the extinguishment of debt in our financial statements for the forgiveness of both the debt and the accrued interest. Third quarter other operating expenses was $7.6 million compared to $7.3 million in the third quarter of 2020. The increase was primarily driven by higher payroll expense and higher depreciation and amortization, partially offset by lower legal and professional fees, as well as lower general and administrative costs. To reiterate, we do not expect a significant reduction in our run rate operating expenses upon the wind down of the RC business as that business is run by a separate management team. And we had previously reduced resources that were specific to Tinuum over the past couple of years.

Given the visibility of the year end date of the expiration of the production tax credit Tinuum has already taken the necessary steps to right size their cost structure over the past several quarters and our estimates of future RC cash flows include the impact of those actions.

Overall, our capital allocation approach will remain unchanged. We expect to continue to focus on near term liquidity, ensuring that our manufacturing capabilities and manufacturing shareholder value. Our RC segment will deliver between $12 million and $14 million, with $8.5 million being received in the fourth quarter, and the remaining received in the first half of next year. We expect our top line performance in our APT segment to remain strong as we manage inventory tightness to protect our margins.

I'll now turn the call back to Greg.

Greg Marken

Thank you Morgan. Turning to slide 5, you can see our expected future RC cash flows. During the third quarter six invested RC facilities reached the end of their scheduled expiration of their 10 year tax credit generation life. As such Tinuum now has the 16 invested RC facilities that we have just discussed in the updated cash flow guidance. As we discussed earlier, the remaining 16 invested facilities tax credit generation periods are scheduled to expire by the end of this year.

As I mentioned some of the expired facilities will likely remain in place utility customers to apply our front end technologies to assist them in meeting emissions control requirements. As such, we expect there to be a small but stable revenue opportunity from these customers after the wind down of Tinuum. Of the previously invested facilities that have reached the end of their tax credit generation period we are also seeing some transitioning to our front end chemical technology. We believe our front end technologies and our activated carbon products offer viable and sustainable options for these utilities bound by Mercury Air Toxic Standards.

Slide 6 reflects the APT segment growth channels that we have been discussing where we are either currently active or have identified future opportunities. We're approaching three years since our acquisition of carbon solutions in December of 2018. At that time, we immediately became the go to provider of activated carbon solutions for coal fired power plants that needed to adhere to Mercury Air Toxic Standards. Since that time, coal fired power generation in general has declined faster than forecast predicted, largely driven by abundant and competitively priced natural gas.

Today, we possess a much more diversified commercial in market mix after considerable time and effort building out our internal sales team and conducting product tests with the new potential customers in the water industrial channels. Well, this year has marked a significant rebound in the power generation market as alternative fuel source pricing has provided tailwinds to coal fire dispatch, we continue to build upon our progress in these adjacent markets; industries such as manufacturing and waste management, that are also subject to emissions restrictions.

We're also continuing to see strong customer interest in other growing market opportunities utilizing both existing and developing product technologies and capabilities that may provide opportunities in areas where the legacy carbon solutions business had not competed.

We remain on track to begin several site field demonstrations for these new products by the end of the year. As a result of our internal actions in addition to our supply agreements with Cabot, the APT segment is yielding substantially better volumes and operating leverage, while also expanding our commercial end markets to create a more balanced mix of applications. We continue to see increased demand within these end market applications we are supporting, which is also contributing to high plant utilization rates on a go forward basis.

Our supply and inventory situation remains tight as high levels of demand have persisted and are expected to remain for the foreseeable future. The requirements base provisions of many of our contracts with customers provide significant benefits. These contracts make us an exclusive provider of activated carbon products to each of our customers. However, it simultaneously means that when demand rises, we must fulfill that incremental demand.

This coupled with the scheduled turnaround activity in Q2 of 2021, as well as the plants incident in April have created tight inventory conditions. With this as a backdrop, as well as much higher natural gas prices leading to gas to coal switching, there continues to be pressure on our inventory levels and meeting customer demand, requiring us to procure inventory from third parties.

We are actively managing our product mix to optimize production at the Red River Plant. And we have instituted price increases on activated carbon products where we are able. These actions are helping to mitigate the cost pressures we are seeing, but also constrained the full earnings potential of the segment. While we expect these conditions to persist well into 2022, the best in class nature of our assets allows us to manage these conditions better than most producers. We expect to be a leading provider of choice for these activated carbon technologies and believe our strong financial position and assets leave us well-positioned going forward.

And finally, slide 7 reiterates our priorities for the remainder of the year. Our first priority is to continue to protect our net RC cash flows and optimize the remaining cash flows we expect between today and 10 years line down. We will continue to leverage our vertically integrated APT segment and its best in class Red River plans to optimize our product mix to generate improved operating leverage. While near term margin pressures will persist we are focused on fulfilling our agreements with customers, identifying opportunities to improve earnings potential through customer and product mix and maintaining the focus on our cost structure relative to go forward business activities.

Lastly, we are reiterating our near term capital allocation focused on cash preservation as well as necessary organic investment in our activated carbon business as we approach the end of the RC business and progress through our strategic review. We aim to complete the strategic alternatives review process in a timely manner, while ensuring we continue to run our business efficiently.

With that, I'll turn the call back over to Ryan to move us to Q&A.

Question-and-Answer Session

A - Ryan Coleman

Thanks, Greg. As many of you have seen similar to past quarters, we included invitation to submit questions ahead of time at the bottom of the conference call announcement press release as well as yesterday afternoon’s earnings press release. Thanks for those of you who continue to send your questions. We'll continue this practice going forward and we invite you to submit your questions ahead of future calls as well. The first question we received is there anything in the currently proposed bill back better legislation that could either extend the life of the Tinuum business or benefit the carbon solutions business.

Greg Marken

Ryan, there is currently nothing in the bill back better bill that relates to extending the life of the refined coal production tax credits. While it's difficult to predict outcomes in D.C., we in Tinuum consider such an extension unlikely. Also the window for Tinuum to continue even a portion of its operation is closing. Tinuum closed multiple units during Q3 and continues down that path in Q4 as they are planning for the end of that business. As it relates to our APT segments, there are multiple sections related to the recently passed bipartisan infrastructure bill and ADES could possibly qualify for certain of these provisions included in that bill. However, actual funding and probability of qualifying is unknown. So we can't truly predict any benefit are tailwind at this point.

Ryan Coleman

The second question was last quarter your commentary identified that the margin headwinds in the AAPT segment would persist into 2022. But this quarter that is changed to well into 2022. What has changed?

Greg Marken

The primary driver continues to be higher natural gas prices. It's clear as we move into the colder months, that high natural gas prices are not likely to subside anytime soon, at least not to a level that would lead to call the gas switching. As a result, we expect demand to remain high and for our top line to be very strong, which is going to require us to continue to source inventory from third parties. The other factor is the broader inflationary pressures we are seeing across the economy in general, from transportation and freight costs, commodity prices and input prices for certain additives that we use. We are certainly not immune to those price pressures, which do not seem to be easing. So those will create a bit of headwind as well.

Ryan Coleman

And our last question that we received, are you able to quantify the revenue opportunity from switching current RC customers to utilizing activated carbon and other of your front end technologies to meet emissions regulations?

Greg Marken

It's difficult to quantify at this stage because it will be highly dependent on the individual utility and the technology that they choose to adopt. It also depends on whether we have the capacity to serve those customers. Thus, it is still too early to identify an annualized run rate revenue opportunity at this point. However, we know that our front end technology combined with our activated carbon technologies are a competitive and viable solution, especially in a post defined coal world. So we intend to provide this option for customers going forward.

Operator

Thanks, Greg. And thanks again to everyone that submitted questions. I'll turn the call back over to Greg for closing remarks.

Greg Marken

Thanks, Ryan, and thanks to everyone for joining the call this morning. And for your continued support. We look forward to updating everyone next quarter.

Operator

This concludes today's conference call. Thank you all for participating. You may now disconnect.

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