Enviva Inc (EVA) 2017 Q2 法說會逐字稿

Good day and welcome to the Enviva Second Quarter 2017 Conference Call and Webcast. (Operator Instructions). I would now like to turn the conference over to Ray Kaszuba. Please go ahead.

Thank you. Good morning and welcome to the Enviva Partners, LP Second Quarter 2017 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 released this morning and provide an update on our current business outlook. We will then open up 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 are 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 other 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 2016 amounts are as reported in our 10-Q filed today.

I would now like to turn it over to John.

Thank you, Ray. Good morning, everyone, and thanks for joining us today.

As we reported in our earnings release this morning for the second quarter, there are many great things going on in the business. We continued our track record of distribution increases with the eighth consecutive since our IPO, a trend we expect to continue as we progress down the path towards at least $2.36 per unit for 2017. Our adjusted gross margin is up and we are generating increased EBITDA year-over-year and quarter-over-quarter. There is strong growth in the markets we serve and, importantly, we, along with our sponsor, executed a memorandum of understanding to be the sole-source supplier to the largest dedicated biomass project in Japan yet announced.

But in the second quarter and carrying over for a bit of the third quarter, we are behind where we want to be on production volumes. This is principally driven by the decision we made to modify our process to further improve pellet quality to meet the handling requirements of the increasing variety of discharge systems of our customer set around the world. And it has taken us a bit longer than we initially expected to dial in our set points at some of our plants.

At this point in the year, we have good visibility into our shipping schedule and contract mix for the balance of 2017 including the commencement of deliveries to two new customers. So here's what we see going forward. The third quarter will likely look a lot like the second quarter, but the fourth quarter is shaping up to be stronger than anything we've seen in the past. This is because, although we've further improved and narrowed quality on the back end, we've been able to increase flexibility on the front end of our process. For the plants that are now through these improvements, we're seeing more tons and higher productivity, slightly on top of the 1% to 2% productivity increases we expect each year. This ultimately means greater cash flow going forward and, as a result, we expect, for the same set of assets and contracts, a run rate on volume and EBITDA that exceeds the expectations we set at the beginning of the year.

At the macro level, given the contract year delivery opportunities under our existing take-or-pay contracts, we will deliver all of the contracted volumes from own production as well as our broader sourcing activities, but as a result of the timing impact, we do not believe we will fully do so during the 2017 calendar year. Therefore, we are revising our full-year 2017 adjusted EBITDA and distributable cash flow guidance accordingly. Although we don't publish guidance beyond the calendar year, we do expect to make up some of that shift in 2018. Given the temporary nature of the production challenges, we are still expecting to distribute at least $2.36 per unit for the year.

I'll spend some time at the end of the call to discuss recent market developments and our increasing customer diversification that demonstrate the ongoing strong growth in demand that expected in the market, and also to provide and update on the investments in infrastructure occurring at the partnership and at our sponsor, which are needed to serve incremental offtake contracts. But first, I'd ask Steve to review our financial performance in some detail.

Thanks, John. As a reminder, in my comments, references to the prior year will be to the recast financials included in the press release that reflect the effects of the Sampson plant as though it was included for the full period. This is due to the common control nature of last year's drop transaction.

For the second quarter of 2017, we generated net revenue of $126.9 million, an increase of 6% or $7.2 million from the corresponding quarter of 2016. Included in that revenue were product sales of $121.7 million on volume of 628,000 metric tons of wood pellets. Product sales increased $5.4 million from the corresponding quarter of last year primarily due to favorable contract pricing mix and an increased number of shipments under CIF terms, which increased both revenue as well as cost of sales. Of course, with the drop of the Sampson plant and associated offtake contracts, we would have expected product sales revenue to have been higher in the quarter.

Other revenue was $5.3 million for the second quarter of 2017 compared to $3.5 million for the same period in 2016, an increase of $1.8 million mainly attributable to the margin on sales of wood pellets sourced from third-party producers. This partially offset the shortfalls in production that John mentioned. These are back-to-back transactions and are recorded on a net basis.

Gross margin decreased to $18.2 million in the second quarter of 2017 from $19.5 million in corresponding period in 2016 due to the non-cash charges related to loss on disposal of assets and depreciation. Operationally, higher production and demurrage costs due to lower plant utilization were largely offset by pricing increases and reduced wood fiber sourcing costs. Adjusted gross margin per metric ton improved to $46.41 during the second quarter of 2017 as compared to $43.11 for the same period of 2016 driven by the operational factors I just discussed.

On net income of $3.9 million, adjusted EBITDA improved to $24.5 million in the second quarter of 2017 from $21.3 million in the corresponding period last year, an increase of $3.2 million or 14.8% driven by the favorable contract pricing mix and the increase in other revenue. Net income for the second quarter of 2017 decreased by $6 million due to the non-cash charges that reduced gross margin and higher interest expense as the result of the issuance of the senior unsecured notes last year.

After maintenance capital expenditures of $1.6 million, interest expense, net of amortization of debt issuance costs and original issue discount of $7.3 million, and incentive distribution rights for our general partner of $669,000, distributable cash flow for the second quarter of 2017 was $14.9 million to our limited partners, which covers the $0.57 distribution announced yesterday at 1x.

While we fully expect the lower plant utilization to be rectified, we will not be able to fully ameliorate the financial effects during the calendar year. Accordingly, we are revising our full-year 2017 guidance. We now project to earn net income in the range of $18.5 million to $22.5 million with associated adjusted EBITDA of between $103 million and $107 million, which includes the impact of the acquisition of the Wilmington terminal. We expect maintenance capital expenditures of $4.5 million and interest less amortization of debt issuance costs and original issue discounts to be $30 million. As a result, the partnership expects to generate distributable cash flow of $68.5 million to $72.5 million for the year prior to any incentive distributions to our general partner. As John mentioned, we expect the third quarter to look a lot like the second quarter, but for the fourth quarter to be strong, which, if you do the math, works out to $30-plus million in adjusted EBITDA in Q4. This guidance reflects those expectations.

Since we believe that this is temporary reduction in plant utilization, we have the confidence to confirm our distribution guidance of at least $2.36 per unit for 2017 although on coverage that will be tighter than our long-term target. The business and industry fundamentals remain strong and we expect to maintain our track record of quarterly distribution growth through 2018. From a liquidity perspective, we continue to experience strong operating cash flow performance and we are undrawn on our $100 million revolving facility.

Now I would like to turn it back to John.

Thank you. Before we open the lines for Q&A, I would like to take a few minutes to provide an update on the market and our plans for the plants and ports needed to supply potential new offtake contracts, as there have been several noteworthy developments since last quarter.

Our strategy continues to be to fully contract the production capacity of the partnership and, as the market leader, to capitalize on short-term opportunities. Since our IPO, we have increased our weighted-average remaining contract term by more than 4 years to 9.8 years and grown our contracted revenue backlog by more than 3x to $5.5 billion. These robust tailwinds continue today as industry experts expect worldwide demand to increase 17% a year through 2021. The process improvements I mentioned earlier will help to ensure we maintain our position as the largest and preferred supplier in the market.

We are excited about the opportunity to further diversify our customer base with potential new customers and markets in Europe and Asia and we are negotiating definitive agreements with several new contracts across multiple jurisdictions. I'll start with an update on our current core market of Europe, as the expected demand continues to quickly grow to meet the binding 2020 renewable energy mandates.

In the Netherlands, the initial round of the 2017 renewable incentive program, called the SDE+, was completed successfully and biomass projects are expected to receive a portion of the EUR6 billion available. The awards are expected to be announced later this summer before the second round in October where an additional EUR6 billion in funding will be available. In addition, RWE has announced that it would like to fully convert to biomass 2 of its facilities, both of which received funding for co-firing in the 2016 SDE+ program and could represent more than 8 million tons of biomass demand if fully converted. DONG Energy, the largest power producer in Denmark and a customer of ours, received E.U. state aid approval to convert another combined heat and power facility to biomass, which was consistent with its ongoing efforts to completely eliminate coal from its fleet by 2023.

In the U.K., Drax has announced its progress on converting its fourth unit. In addition to 3 of 6 units, which already have been converted to biomass, Drax has been running the fourth unit on biomass on a trial basis. If operated at full capacity on biomass, this unit would represent an incremental 2 million metric tons per year of wood pellet demand.

While Europe continues to adopt renewables over fossil fuels for power generation, policymakers are beginning to focus on thermal and heat requirements to meet the binding de-carbonization objectives. In particular, the Head of the European Commission's Renewable Energy Unit stated that the level of penetration of renewables into Europe's heating and cooling sector, which represents more than half of the energy used in Europe, is, and I quote, "unacceptable." In the U.K., the Climate Change Committee, the body responsible for implementation of the Climate Change Act, has also called for incremental policies to support heat from renewable sources to meet the U.K.'s 2032 de-carbonization goals.

Beyond Europe, demand continues to materialize in Asia as well. In Japan, submissions from biomass projects for the 2017 feed-in tariff were significantly higher than expectations as applications represented more than 15 gigawatts of biomass-fired capacity as compared to the 6 to 7.5 gigawatts Japan is targeting as part of its energy mix by 2030.

I am also pleased to announce that we and our sponsor have executed a memorandum of understanding with the premier trading house and sponsor of the largest dedicated biomass development to date in Japan for the sole-source supply of the required 650,000 metric tons per year. Subject to documentation of the definitive agreement and satisfaction of a series of CPs, volumes are expected to commence in 2022 and run for at least 15 years, which would add significantly to our revenue backlog and weighted-average remaining contract term.

We remain in detailed discussions with other major utilities, trading houses and power plant developers seeking to build more than 1,700 megawatts of biomass-fired generation. Although not all of these projects will ultimately be constructed, the more than 7 million tons of annual wood pellet supply required to support just this demand is consistent with our expectations of growth for this stage of the market's development. And I'll tell you that we're in a unique position in the Japanese market, which places a premium on long-term supply that can grow alongside expected demand, with the reliability Enviva affords through a portfolio of plants and ports that benefit from a robust, scalable raw material basin. Naturally, more to come over the course of the next few quarters. As you would expect for long-term agreements like this, the contracting process is quite diligent.

South Korea also continues to progress towards significant renewables adoption as well. The new president has announced a phase-out of coal and a restriction on new nuclear plants and a proposal that at least 20% of the country's power will be from renewable sources by 2030. As a case in point, Korea South-East Power, or KOEN, just yesterday announced a tender seeking 1.5 million tons of wood pellets over a 2-year period for its 125 megawatt facility it has converted biomass fuel; the largest tender in Asia to date.

Shifting gears to our capacity development activities, as we announced last quarter, we are on track to purchase the Wilmington terminal early in the fourth quarter of this year from our sponsor. The terminal is contracted under a long-term terminal services agreement to receive, store and load wood pellets from a third-party production plant as well as our Sampson plant. In addition, pellets produced at the plant our sponsor is currently constructing in Hamlet, North Carolina, which is expected to be operational late in 2018, will also move through the Wilmington terminal. You will recall that the Hamlet plant is being built to supply the Macquarie-backed MGT Teesside project in the U.K.

In the broader context, we're now in our third year following our IPO. We have increased our distribution for 8 straight quarters, representing an 18% annualized growth rate since our IPO. We've continued to sign new offtake contracts and re-contract our existing ones, which further extends our growing contracted cash flow profile. We've also continued to make significant progress for additional contracts based on our position as the preferred supplier in an industry experiencing continued strong tailwinds for long-term demand of wood pellets not only in our current core market of Europe, but in Asia as well.

We've successfully completed 2 drop-downs with our third expected to occur before our next quarter's earnings call with clear visibility for additional drops needed to fulfill that long-term demand. Our sponsor continues to evaluate sites in the Southeastern United States for production facilities and the utilization of untapped capacity at the partnership's existing terminals.

Those accomplishments and the long-term fundamentals underpinning significant demand are a strong platform to generate stable, growing cash flows that enable us to increase per-unit distributions each quarter. As you've heard me say in the past, we are just getting started and that's certainly still the case. I'm as encouraged as ever about where Enviva is heading. As we close, I would like to thank all the great people at Enviva for their dedication and hard work keeping our plants, our ports and, most importantly, each other safe each and every day.

Operator, can you please open the line for questions?

(Operator Instructions). Our first question comes from Brian Maguire, Goldman Sachs.

This is Derrick Laton on for Brian. Just curious if we could get a little bit more color on some of the process improvement projects that you had completed in the quarter. And then, maybe to the extent that you can comment, any potential upside in 2018 from your base case, given some of the, maybe, the productivity improvements there.

Look, that's a great question and let me put this in some additional context. What we're really talking about here is a growing industry and efficiency across the entire industry supply chain. As our customer set expands and we think about the variety of discharge systems that are being put in place around the world, what we see is, as you would expect, an increased focus on safety and efficiency. If you look back to where the industry started, you had clamshell discharges, relatively slow, but easy to manage. And now you've got a much higher product volume flow through our customers' existing ports as well as through new ports and customers around the world. This is in Asia. This is in Europe. Our customer set now is far wider. We've got Drax, DONG, NG, Lynemouth, MGT, RWE, Uniper, the emerging Japanese customer set as well as a host of smaller entrants to the market that are getting into the power business based on biomass.

And with that, efficiency is very important and safety is more important than ever. And so what we've made some decisions around is shrinking the process window to increase 2 attributes of our product spec: durability, which is how hard a pellet is, and fines, which is the amount of material that comes along with it. And though the spec itself in the industry is quite wide, what we've done is we've narrowed that to make a harder, less fine pellet. This increases efficient handling not only for our existing customers, as well as the emerging ones around the globe. And we took the opportunity to get ahead of this.

And so while we narrowed the process window on the back end, what we did on the front end is increased the flexibility of our raw material furnished. And so what we've seen coming out of this is productivity increases that are on top of the 1% to 2% that we would target each and every year. So we do think that there is material upside to this. I think as Steve pointed out in his remarks, as we get through this, we're looking at a very strong fourth quarter. And so what we would look at is, frankly, coming through this, exiting the year on a run rate on volume and EBITDA that's better than we thought at the beginning of the year.

Great. That's helpful. And just curious if there's plans going forward to implement these process improvements at all the other facilities there. I guess maybe if you could just kind of give us an idea of kind of your progress to date across your asset base there.

What I'd say is that this is largely in the rearview mirror. We've undertaken this across the entire portfolio. At our sponsor level, these are already put in place for the new facilities as well. And what we see is that roll through, through Q3 and, frankly, having this fully behind us during the quarter and as we exit the year very strong.

Our next question comes from Ryan Levine from Citi.

Thanks for that explanation. Just to follow up, so would you be able to explain why now and what prompted it in the second quarter of this year in terms of your planned production facility implemented process enhancements?

Absolutely. Again we're serving an increasing customer set. We started the year serving 3 customers in addition to some smaller single-contract deliveries. But we're exiting the year with 5 or 6 new customers and we took the opportunity to get ahead of it. It certainly took us a bit longer at some of our facilities than we had originally expected, but we took the opportunity because this is important to maintaining our market leadership.

And again, this didn't occur in a vacuum. This was widely communicated to our customer set. They understood the opportunity that we were seeking to take advantage of, as well as it's no surprise that we can maintain the type of positioning that can result in sole-source supply contracts, given the demonstration of process capabilities like this. This is a market that's growing very rapidly, increasingly wide adoption of discharge systems, of applications of biomass around the world, and they're looking for a partner that can make these modifications, that can engineer these solutions. And frankly, that's what we're good at. This is about continuing to maintain our market leadership and we took the opportunity to do so and fortunately that's now bearing fruit.

What's the CapEx associated with it and what's the EBITDA impact for 2017? And what type of payback period do you foresee in realizing a return on this investment?

Sure. It's very, very capital-light, to be honest with you. This is about process set points and tool and die work that you would see expensed in our P&L on an annual basis anyway. What you're seeing is an adjustment on a facility to facility level, in some cases shortening die lengths, in other cases lengthening it to optimize the process, and then optimizing the front end of that with greater flexibility. So coming out of it, light capital expense, productivity in excess of the 1% to 2% that we target each year. And I think Steve could provide a bit of guidance on how good Q4 looks and what we would expect going forward.

Okay. Would you be able to provide that financial impact for the year and what type of return or over what period you think you'll see that return?

Sure. So what I think, if you were to reconcile the change in guidance, going through this process change, there's lots of puts and takes, but it's largely a volume -- it was a volume challenge here in mid-year. So we're probably going through the year about 150,000 tons light on production, which is roughly 3 ships, just to put it in total perspective. As we work through this challenge and for which, as John mentioned, we're going to be able to increase throughput and the run rate coming out of A4 at $30 million EBITDA, I think, is testament to kind of the benefit we'll achieve going forward.

Okay. And then shifting gears to Japan, this MOU is clearly favorable. Do you foresee additional opportunities beyond this MOU reaching contract in this calendar year? And any more color you can provide around the potential opportunity near term before the feed-in tariff changes?

Yes, Ryan. Listen, great question. And what we've tried to do is, given that this is a new market for the industry, this is a new market for Enviva, we've tried to provide some incremental transparency and updates on our progress serving that market.

For those who are familiar with the Japanese contracting approach, an MOU is a pretty significant milestone. This is a material agreement, as we mentioned. It's a sole-source. It's U.S. dollar-denominated. It is a robust long-term contract.

And what we see in the market generally is, beyond this largest, largest announced to date biomass supply project, we do see material opportunities and we are in direct negotiations with a host of other major trading houses, major utilities and independent power producers for fuel supply into those agreements. Some of them will also be sole-source. Some will be as part of a portfolio of suppliers, just depending upon the contracting disposition of our counterparty. But those are well on track.

And you're right, there's an important milestone in late September, October of this year for the FIT submissions. All of these projects are in front of that. Some of them have been previously approved. And so we believe that we are in great shape in the market, as I mentioned, and continue on track for material volumes to be delivered into the Japanese market, potentially with incremental announcements during the course of this calendar year.

The next question comes from Elvira Scotto, RBC Capital Markets.

Just some clarifications. So the revised guidance is solely based on this process enhancement program that you undertook? There's nothing else that caused that change in guidance?

No, Elvira. That's the total impact.

Okay, great. And then, was this something that you decided to undertake after you provided guidance last quarter? Or were you planning this early on in the year, but just didn't realize the impact that it would have to volumes?

I think we're trying to -- we were contemplating it, of course. We felt that we could execute it faster than we did. And that's on us to learn from those issues. We're trying to be transparent on that fact; that we thought we could execute this a little faster than what it transpired. The different facilities took different lengths of time to get through it. So it's a learning for us. I can't put it any other way.

Got it. And then, coming out on the other side of this, the 1% to 2% annual productivity increases, which is kind of where you were previously guiding to, now you think you can do better than that? Is that 2% to 3%? Or how do we think about that?

Well, I think perhaps maybe another way to look at it is I think we're going to still strive for the 1% to 2%, but off of a higher base as we come out of the fourth quarter here. This is more of a step change in terms of our productive capabilities.

Got it. And then, just remind me, the run rate EBITDA, the previous guidance had already included the Wilmington drop-down. Is that correct?

That's correct. And so does this, yes.

(Operator Instructions). The next question comes from Michael Byron, Raymond James.

This is Michael in for Pavel. Am I allowed to ask what needs to happen before the MOU in Japan becomes binding, like what moving pieces? And I know a time table might be tough, but maybe a ballpark for when it could be all finalized.

No, sure. Entirely fair questions and we'll do our best to answer it within the boundaries of some of the confidentiality provisions with our counterparty. But, look, as I mentioned in our prepared remarks for this morning, subject to execution of the definitive agreement and their final investment decision, this will be a binding agreement for delivery on a sole-source basis, 650,000 tons a year for 15 years.

(Operator Instructions). There are no further questions at the moment and this concludes our question and answer session. I would like to turn the conference back over to the company for any closing remarks.

Thank you again, everyone, for joining us on today's call. Obviously, much to look forward to as we approach our next discussion later this year. And thank you again for your time and attention.

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