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Enviva Partners LP (EVA) Q2 2019 Earnings Call Transcript

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Enviva Partners LP (NYSE: EVA)
Q2 2019 Earnings Call
Aug 8, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to the Enviva Second Quarter 2019 Earnings Conference Call. [Operator Instructions] Please note, today's event is being recorded. I would now like to turn the conference over to Ray Kaszuba, Treasurer. Please go ahead, sir.

Raymond J. Kaszuba -- Senior Vice President of Finance and Treasurer

Thank you. Good morning, and welcome to the Enviva Partners, LP Second Quarter 2019 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, our Chairman and CEO; and Shai Even, Chief Financial Officer. Our agenda will be for John and Shai to discuss our financial results released yesterday and provide an update on our current business outlook. Then we will open up the phone lines for questions. Before we get started, a few housekeeping items.

During the course of our remarks and the subsequent Q&A session, we will be making some forward-looking statements, which are subject to a variety of risks. Information concerning the risks and uncertainties that could cause our actual results to differ materially from those in our forward-looking statements can be found in our earnings release issued yesterday in the IR section of our website as well as in our most recent 10-K and our other filings with the SEC.

We assume no obligation to update any forward-looking statements to reflect new or changed events or circumstances. In addition to presenting our financial results in accordance with GAAP, we will also be discussing adjusted EBITDA and certain other non-GAAP measures pertaining to completed fiscal periods as well as our forecasts. Information concerning the reconciliations of these non-GAAP measures to the most directly comparable GAAP measures and other relevant disclosures are included in our press release issued yesterday.

I would now like to turn it over to John.

John Keppler -- President and Chief Executive Officer

Thank you, Ray. Good morning, everyone, and thanks for joining us today. As nations around the world continue to take major steps to combat climate change, Enviva is addressing the problem today helping reduce the life cycle of greenhouse gas emissions of major utilities. We are playing an increasingly important role mitigating the intermittency of solar and wind by enabling power generators to produce renewable baseload and dispatchable electricity and heat. Adoption rates continue to accelerate for biomass, as demonstrated by the additional 1.1 million metric tons per year of long-term, off-take contracts we and our sponsor just announced, some with duration into the mid-2040s. With these recently executed contracts, our sponsor not only extended its existing relationships with several major Japanese trading houses, but also brought on new long-term customers.

We are likewise very excited about the partnership's new contract with Albioma to deliver to the island of Guadeloupe, which is our second contract to a Caribbean island nation. While Europe and Asia are our 2 largest current markets, this new contract is proof that replacing fossil fuels with biomass for baseload power generation is a model that can be replicated in many different forms around the world. To be able to fulfill our long-term contracted demand, we and our sponsor continue to work on adding and developing new production internal capacity. To that end, within the partnership, expansions are under way at our Northampton and Southampton facilities. And the Hamlet plant, which we recently acquired, is now operating. Collectively, these projects are expected to increase the partnership's production capacity to about 4 million metric tons per year and balance the partnership's book through 2025.

The newly announced contracts, which our sponsor expects to become firm in the next few quarters, and the firm contracts previously signed by the sponsor and its development joint venture, total 3 million metric tons per year. To mine with our long-term contracted position of approximately 3.5 million tons per year today, we expect to supply approximately 6.5 million metric tons per year by 2025. This incremental long-term contracted demand underwrites not only the expanded production of the sponsor's currently operating Greenwood plant and the proposed new Lucedale plant you have heard us talk about, but also 2 additional build-and-copy plants around our sponsor's deep water terminal under development at the Port of Pascagoula. This brings the visible drop-in inventory of fully contracted assets of the sponsor to 4 plants and a port. It is our expectation that each of these will be made available to the partnership for acquisition.

With the preponderance of our growth coming from these accretive acquisitions from our sponsor, complemented by organic growth and expansions within the partnership, we believe will be able to stably and sustainably drive per unit distribution growth consistent with our past track record well into the future. On that point, Shai will to take some time to detail the financial results. But the quarter shaped up largely as we discussed on our last call with the second quarter being a step-up from the first quarter, and we continue to expect the second half of the year to be a step-up over the first half. With seasonal factors now largely behind us, we expect our performance for the remainder of the year to put us inside our previously announced guidance range of $140.7 million to $148.7 million of adjusted EBITDA.

Given our confidence in the underlying business and our expectations for full year 2019 and beyond, our Board declared a quarterly distribution of $0.66 per unit for the second quarter of 2019, representing the partnership's 16th consecutive distribution increase and maintenance of a mid-teens distribution CAGR since our IPO. I will also note that the partnership continues to expect to distribute at least $2.65 per unit for full year 2019 and to distribute between $2.87 and $2.97 per unit for full year 2020. I will take some time at the end of the call to provide an update on the long-term market drivers and activities taking place at the partnership and our sponsor to meet the significant opportunities ahead of us,

But I would like to now hand it over to Shai to discuss our second quarter financial results.

Shai Even -- Executive Vice President and Chief Financial Officer

Thank you, John. For the second quarter of 2019, net revenue was $168.1 million, representing an increase of 24% over the second quarter of 2018. Product sales revenue was $167.2 million as compared to product sales revenue of $133.2 million for the second quarter of last year. For the quarter, we sold 869,000 metric tons of wood pellets as compared to 699,000 metric tons in the second quarter of 2018. The increase in product sales revenue was primarily attributable to a 24% increase in sales volume. Gross margin was $16.5 million for the second quarter of 2019 as compared to a gross margin of $19.8 million for the same period in 2018. Adjusted gross margin was $28 million for the second quarter of 2019 as compared to $25.6 million for the second quarter of 2018.

Adjusted gross margin per metric ton was $32.26 for the second quarter of 2019 as compared to $36.63 for the second quarter of 2018. Adjusted gross margin per metric ton decreased primarily due to increased costs attributable to seasonal factors that were more significant and longer-lasting than during the second quarter of 2018. But as of the end of the second quarter, these seasonal factors were largely behind us. Net loss for the second quarter of 2019 was $3.8 million as compared to net income of $3.5 million for the second quarter of 2018. Adjusted net income for the second quarter of 2019 was $7 million as compared to adjusted net income of $2.7 million for the second quarter of 2018. Adjusted EBITDA for the second quarter of 2019 was $27 million as compared to $21.1 million for the second quarter of 2018.

The increase in adjusted EBITDA was largely due to higher sales volume and $11 million of MSA Fee Waivers, which were primarily associated with the Hamlet drop-down transaction in April 2019. Distributable cash flow prior to any distribution of attributable to incentive distribution rights paid to our general partner was $17.2 million, which results in the second quarter of 2019 distribution coverage ratio of 0.65x. The coverage ratio for the second quarter of 2019 was negatively impacted by the units issued to prefund the Hamlet drop-down transaction and expansion projects at out Northampton and Southampton production plants.

We anticipate that the Hamlet production plant will benefit our operations starting with the third quarter of 2019, and the expansion project at the Northampton and Southampton production plants will benefit our operations beginning with the second half of 2020, subject to receiving the necessary payments. Similar to previous years, and as discussed in our last call, the partnership expects adjusted EBITDA and distributable cash flow for the second half of 2019 to be significantly higher than the first half of the year and, in particular, for the fourth quarter to be stronger than the third.

On a volume perspective, due to the expected benefit from the productivity initiatives at our plant and the production from the Hamlet plant, we expect to sell approximately $2 million metric tons during the second half of 2019. From a margin perspective, we expect the second half to be significantly stronger than the first half with wood costs reverting to historical levels, strong margins from the Hamlet plant, greater fixed cost absorption and improved pricing due to our customer offtake contract mix. As a result, the partnership reaffirms its full year 2019 adjusted EBITDA guidance range of $140.7 million to $148.7 million and full year 2019 distributable cash flow guidance range of $92 million to $100 million prior to any distribution attributable to incentive distribution rights paid to our general partners.

For full year 2019, the partnership continues to expect to distribute at least $2.65 per common unit. From a liquidity perspective, at the end of the second quarter of 2019, we had approximately $5 million of cash on hand with $166.5 million drawn on our $250 million revolving credit facility. The increase in revolving borrowings and decrease in cash on hand in the second quarter of 2019 are due primarily to funding of the first and second payments in connection with the Hamlet Transaction, the second payment for the Wilmington terminal as well as capital expenditures associated with the Hamlet plant and the expansion projects at our Southampton and Northampton production plants.

As John just mentioned, the 3 million metric tons per year of Japanese contracts we announced post the sign over these last 18 months will give the partnership the opportunity to acquire additional, fully contracted production in terminal facilities from our sponsor over the next few years. As we reposition the partnership to fund these activities, maintaining a balanced capital structure and conservative financial policy will remain a key focus. Therefore, we continue to target a 50-50 equity debt split for these activities and the distribution coverage ratio of 1 to 2x on a forward-looking annual basis, taking into account expectations for distributable cash flow for the next 4 quarters.

Now I would like to turn it back to John.

John Keppler -- President and Chief Executive Officer

Thank you, Shai. The new contracts we and our sponsor just announced significantly expanded our contracted position. With the newly executed Albioma contract, the weighted average remaining term of the partnership's offtake contracts now stands at 10.4 years. Our revenue backlog is $9.6 billion, and our current book is well balanced through at least 2025. Including volumes under the firm and contingent contracts held by our sponsor and its development joint venture, which we would expect to be made available to the partnership, our weighted average remaining contract term and product sales backlog would extend to 13.2 years and almost $18 billion, respectively. The scale of our offtake book is not surprising because time and time again, when policies related to biomass have been considered, regulators and other key government actors around the world have confirmed the environmental benefits of biomass, and the fact that Enviva and its customers are reducing the life cycle of greenhouse gas emissions of energy generation through the use of biomass.

The policy review process has been rigorous, taking into full account the perspectives of a broad range of stakeholders, including scientists, academics, environmental NGOs, forest owners, utilities and the broader voting electric. And the voice of the world has been clear, sustainable biomass is a carbon-neutral fuel source. That's what the U.S. EPA has concluded under both Republican and Democratic administrations. That's what the EU has included under both RED I and RED II. And that conclusion continues to be reflected in national policies in the U.K. and across Europe as well as in Japan and South Korea. Biomass is a key component in all pathways articulated by the United Nations' IPCC meaning to achieve the 1.5 degrees Celsius goal limiting climate change. Several additional policy developments around the world continue to support that conviction. In Japan, the cabinet approved the plan to reduce greenhouse gas emissions to 0 as part of its strategy to fight global warming.

In addition, the South Korean government recently adopted its third basic energy plant, which called for an increase in the share of renewable power generation to 30% to 35% by 2040, up from its previous goal of 20% by 2030. The government also confirmed its policy that would lead to the ultimate phase-out of coal and nuclear generation. In June, the United Kingdom became the first major economy in the world to pass along greenhouse gas emissions to net 0 by 2050. Meanwhile, the newly elected president of the EU Commission also announced the goal to make Europe the first climate-neutral continent by 2050. This enhanced EU climate goal further reinforces policymaking in countries like Germany, where the government recently announced that it expects to adopt into law by early 2020 the coal commission's recommendation to phase out coal by 2038. With the increased certainty around the timing of the expected end of coal, markets are responding.

For instance, EU carbon prices are up fivefold since 2017 with many forecasts suggesting a further doubling in price. We believe that in combination with the regulatory environment in Europe, the so-called cost of coal, evidenced by carbon pricing or taxes, creates additional economic incentive for customers to drive coal out of the system more quickly like we've seen in the United Kingdom and Denmark. With that, the need for dispatchable heat and power will accelerate biomass conversions in markets like Germany and Poland that have been particularly heavy coal users. Our continued growth in existing markets in Japan and Northwest Europe in the U.K. complemented by inbound sales inquiries from new geographies like Germany, Poland, Taiwan, South Korea and other island nations suggest robust long-term market demand for biomass that goes well beyond our existing contract backlog.

As I mentioned earlier on the call, we and our sponsor will have the opportunity to invest into new production and terminaling capacity in order to fulfill our combined long-term contracted demand of approximately 6.5 million tons per year by 2025, up from 3.5 million tons per year today. The partnership is progressing the expansion projects at our existing Northampton and Southampton production facilities as detailed engineering is in process, major pieces of equipment are being delivered and site preparation work is advancing. The partnership expects to complete the construction of the expansion activities in the first half of 2020, with start-up thereafter subject to receiving our final permits. Projects like these are expected to be highly accretive, and our operations and development teams continue to evaluate new opportunities to drive organic growth and capacity expansions. The U.S. Department of Commerce recently announced a $10 million grant to build a biomass storage dome in addition to the current warehouse at Port Panama City.

This would increase throughput capacity for Enviva at the port and potentially allow the partnership to consider production expansions in that region. With respect to development at the sponsor level, where the preponderance of our capacity growth has occurred historically, our sponsor has received the final permits from both the terminal at the Port of Pascagoula and the Lucedale production plant. In addition, the sponsor continues to evaluate the potential for build and copy wood pellet production plants in Epes, Alabama and in other sites in Alabama and Mississippi that would export wood pellets through the Pascagoula terminal. These are, of course, complemented by additional activities, evaluating potential production sites around the partnership's existing terminal facilities in Wilmington, North Carolina and Chesapeake, Virginia. By design, the expectation is that all of the assets developed by the sponsor and its joint venture as well as the relating contract backlog, will be made available to the partnership for drop-down acquisitions.

As we continue to grow, sustainability remains the foundation of our business and the core of our value proposition. Our industry leadership is not defined solely by the size and scale of our global operations, but also by our unparalleled sustainability practices. You may have seen that we and our sponsor recently announced our revised responsible sourcing policy as part of our long-standing pledge to continuously improve environmental performance. The revised policy was developed in conjunction with independent organizations, including environmental NGOs, state wildlife agencies, foresters and other community stakeholders. Ongoing collaboration with these independent organizations has resulted in tangible specific goals and implementation plans that will be reviewed twice annually to track progress. I would also point out the latest data from our Track & Trace system.

This is a proprietary and unique system in the broader wood products industry that provides unmatched transparency into our fiber procurement. With Track & Trace, we track every ton of wood fiber we procure on a primary basis from the land owner all the way through to our customers and publish all the characteristics of the tracks from which we procure, including the source of the wood fiber, the forest track details, age classes and species mix. We also monitor how much of a harvest came to Enviva as low-grade fiber and, just as importantly, how much went to others in the wood products industry. It's pretty rare, if not unique, for a company to be able to identify not only what raw material it buys, but also understand what happens to the material it didn't buy. This level of transparency gives our customers and regulators around the world comfort in the sustainability of our activities and our ability to reduce life cycle greenhouse gas emissions.

Since we began deliveries of wood pellets in 2011, in markets like the United Kingdom, coal consumption has decreased from 51 million tons in 2011 to just 13 million tons last year. Meanwhile, forest acreage and forest inventory grew substantially. As our Track & Trace data highlights, there are 262,000 more acres of forest land and 270 million metric tons more standing wood fiber in the areas in which we operate over just the same short period from 2011 to 2018. At Enviva, our purpose is to displace coal and grow more trees, and it's clear we're making a difference sustainably. In sum, the second quarter is now on the books with results largely as expected.

We believe we will end the year with strong operational and financial performance and continue our track record of increased distributions. Longer term, with the new contracts announced by our sponsor, we are aligned on growing and extending the runway for sustainable, durable cash flow generation. The level of growth and stability that we were able to achieve as an enterprise is made possible by the dedication and hard work of the great people at Enviva through achieving our plans, goals and, most importantly, each other 24 hours a day, 365 days a year.

Thank you. Operator, can you please open the line for questions?

Questions and Answers:

Operator

[Operator Instructions] Today's first question comes from Brian Maguire of Goldman Sachs. Please go ahead

Brian Maguire -- Goldman Sachs -- Analyst

Hey good morning everyone and Congratulations on the new contract wins.

John Keppler -- President and Chief Executive Officer

Thank you very much. It's a really important step forward for us.

Brian Maguire -- Goldman Sachs -- Analyst

I just had a question on the -- some of the seasonal costs in the quarter. I understand if the year is it's still sort of playing out relatively how you expected. If you like the gross margin per time, you'd probably time it a little bit lower. Just wondering if you could explain some of the seasonal costs that you're experiencing? Maybe how much of it was related to the Hamlet ramp-up versus higher fiber costs? And considering, I think, a lot of your contracts are cost pass-through in nature, should -- is this something that we should sort of expect from time-to-time?

John Keppler -- President and Chief Executive Officer

No. Great question. I think as we articulated on our call for Q1, given the very intense rainfall and wetter weather season that we experienced coming through the first part of the year, that did drive up the costs of delivered fiber. As we described in both our prepared remarks and our release, as we kind of came through the second quarter, that is now largely behind us. And again, I would suggest that this channel of 2018 to 2019 was certainly much more significant and much lengthier than we've seen historically. That's now behind us.

And certainly, I think as we described on our call in -- with respect to Q1, Q2 was going to be an important step-up. I think we just demonstrated that. And certainly, with the addition of the Hamlet plant and the larger sales volume that we expect in the second half of the year, we'll be continuing fairly strongly into the big step-up in 2H over first half of this year. I think Shai can provide some better visibility and do an AGM walk as well.

Shai Even -- Executive Vice President and Chief Financial Officer

And thanks, John. So as John mentioned, for the rest of the year, we expect to see improvements coming from -- generally from 4 buckets, if you will. We expect to bring the AGM better on for the full year back to its normal range. The first is we mentioned already on the call, but there is -- we're expecting much greater fixed cost absorption with the expectation that we were going to sell and produce around 2 million tons during the second half of the year. So that's a significant uplift compared to the first half of the year. We are expecting wood fiber costs for the second half of 2019 to revert back to historical levels. So we're expecting roughly $4 to $5 per metric ton improvement over the first half. We're expecting call pricing to customer offtake contract mix.

And then as John just mentioned, we also are, of course, expecting the benefits from the Hamlet plant that will start benefiting the operations during the second half of the year. I haven't seen that during the first half of the year, and it's the first quarter or the first quarter that we just acquired the Hamlet production plant. And combined, and taking into account the SG&A, we expect these factors to put us in a range of between $90 million to $100 million of adjusted EBITDA and getting us back to the guidance that we just provided.

Brian Maguire -- Goldman Sachs -- Analyst

Okay. So it sounds like you're sort of on track to exit the year with a fourth quarter EBITDA that implies a run rate close to $200 million or so of EBITDA. I understand that some seasonality in 4Q is usually a little bit better than expected. And then next year, you've got the Mid-Atlantic expansions and a full year of Hamlet ramping. I think in the past, you talked about a 2020 EBITDA number that's north of $200 million of EBITDA. Is that still your expectation? And should we still be targeting that?

John Keppler -- President and Chief Executive Officer

Yes. For clarity, we -- the guidance we've previously provided indicated that we would be exiting 2020 at a run rate of $200 million.

Brian Maguire -- Goldman Sachs -- Analyst

Got it. And then one last one for me. Obviously, there's a lot of growth in the pipeline. A lot of growth capital is sort of going to be needed. Now that the IDRs are sort of in the high splits, you have a relatively high cost of capital, equity. Just wondering if you or the partnership have had any discussions around restructuring the IDRs either changing the split terms or maybe potentially buying them out considering how expensive they sort of are at this point?

John Keppler -- President and Chief Executive Officer

The -- I mean, look, the -- we're certainly mindful that others in the broader industry sector have undertaken IDR restructuring or simplification transactions. I think as we continue to look at it, it's an evaluation of what problem you're trying to solve. And what I'd suggest is that, historically, including for the 5 quarters now that we've been in the high splits, we've been able to demonstrate a mid-teens distribution CAGR, and that's one that, given that now 4 plants and a port, they're upstairs at the sponsor, one that we would expect to be able to continue.

Largely, that's driven by the underlying, both cost of development and cost of acquisition being it fundamentally different in lower transaction multiples than you see elsewhere in the world. We don't see anything today standing in the way of our ability to continue to grow our distributions at our historic rates.

As and when that changes or where certainly the dynamics of investment and acquisition change, that would be something to consider. But with the robust pipeline and the alignment of interests, given the tremendous amount of investment that does need to occur, that alignment is part of the key driver of what will drive continued per unit increases in our distribution.

Brian Maguire -- Goldman Sachs -- Analyst

Okay thanks very much

Operator

[Operator Instructions] Today's next question comes from Pavel Molchanov of Raymond James.please go ahead.

Pavel S. Molchanov -- Raymond James & Associates, Inc. -- Analyst

Thanks for taking the question taking kind of a high-level perspective on Japan and Germany. So the 2 countries have very similar levels of coal generation, about 40 gigawatts each. Germany has the official phaseout, Japan does not, and yet you've signed 3 million tons of offtakes in Japan by, I think, at this point, none or very little in Germany, and I'm curious what accounts for that gap.

John Keppler -- President and Chief Executive Officer

Pavel, that's a great question. What I think we see happening in Germany today is much the same that happened in the United Kingdom and other parts of Europe. First is RED I came into effect and now with the tailwinds of Red II and the IPCC's continued emphasis on the importance of baseload dispatchable energy principally driven by biomass. And, ultimately, of course, Germany has elected also to shut down its nukes. I think that Japan's current industry policy would expect some of those to return, but Germany, I think, is now facing a fairly significant and steep hurdle to mitigate the implications of reducing their coal fleet at the same time as their fuel alternatives exist for the generation of dispatchable electricity and heat.

And so what we see is probably the next 18 to 24 months, as the coal commission's recommendations now become legislated into law, which I think the expectation is the early 2020 on that, that the customers and the -- certainly the reverse inbound that we get associated with utilities have a mind to exercise conversions or newbuilds of biomass generation capacity, we'd expect to be entering into contracts in that same 18- to 24-month period. As we've kind of sized the market in the past, we would suggest that that's a 5 million to 10 million ton market, and we expect to be getting after that pretty quickly here.

Pavel S. Molchanov -- Raymond James & Associates, Inc. -- Analyst

If I look at the backlog, the existing offtake agreements that you have, Japan obviously being the centerpiece, but you have others as well, I know, beyond the -- your existing production facilities, how many plants would you need to have in total? Is it -- the number close to 15 accurate?

John Keppler -- President and Chief Executive Officer

That -- what I think we've described here is that we've -- with the contract backlog that we have now created at both the sponsor as well as the partnership, we've underwritten now an incremental 4 plants and a port upstairs at the sponsor. And with the tremendous pipeline that we have ahead, which has kind of done a little bit of a walk on the waterfront between whether it's Germany, Taiwan, South Korea, incremental Japan, broader Northwest Europe, Poland, etc, you could see very clearly a very long runway to incremental plant development, which is why as we continue to communicate the opportunities for new plants and newbuilds, we will continue to be expanding our operations throughout the Southeast U.S. with incremental plants and ports potentially built to supply that demand and, again, focus on in and around our existing terminal infrastructure as well as our recently announced Pascagoula terminal and potentially beyond that.

Pavel S. Molchanov -- Raymond James & Associates, Inc. -- Analyst

Appreciate it.

Operator

And ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the conference back over to John Keppler for any final remarks.

John Keppler -- President and Chief Executive Officer

Well, I want to thank everybody for joining us again today. As you know, I am very fond of saying we're just getting started. Certainly, this quarter's financial results, this tremendous backlog we've built, it's absolutely still the case. We're looking forward to telling you about our continued progress, and thanks for being a part of Enviva.

Operator

[Operator Closing Remarks]

Duration: 34 minutes

Call participants:

Raymond J. Kaszuba -- Senior Vice President of Finance and Treasurer

John Keppler -- President and Chief Executive Officer

Shai Even -- Executive Vice President and Chief Financial Officer

Brian Maguire -- Goldman Sachs -- Analyst

Pavel S. Molchanov -- Raymond James & Associates, Inc. -- Analyst

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