By Steven Ralston, CFA
READ THE FULL MEEC RESEARCH REPORT
Despite the challenges of the 2018 transitional year, Midwest Energy Emissions (MEEC) remains well positioned to benefit from the reduction of mercury emissions initiatives in the U.S, Canada and Europe. The recently reported financial results appear to indicate 1) that the company has turned the corner and 2) that in 2019 Midwest Energy’s top-line will return to growth. It is important to remember that:
• Midwest Energy Emissions continues to generate revenues from its operationally-effective and cost-effective mercury emissions technology.
• The recently reported financial results for the first quarter of 2019 indicate that the company is benefiting from cost cutting initiatives which have lower the costs of its sorbent products.
• The company announced two new contracts covering three additional EGUs since October 2018.
• Despite recent challenges, Midwest Energy Emissions has not issued any common shares to fund the company since early 2017, and currently management has no plans to seek capital through the issuance of equity.
• The company has meaningful potential in Europe beginning in the fall of 2019 as a result of mercury control standards at coal-fired EGUs being fully enforced across Europe by mid-2021 with initiation of testing starting in the summer of 2019. In Europe, the barriers to entry should be significantly reduced since Cabot Corp. (with its established relationships) will be the sales point contact.
• The licensing model being pursued under management’s patent strategy could provide top-line and/or licensing revenues, both of which would enhance the company’s profitability.
2018 was a transitional year for Midwest Energy Emissions. During 2018, product (sorbent) deliveries declined due to a variety of factors, including lower product usage by the company’s customer base and the shutdown of some client EGUs as a result of competitive disadvantages versus other EGUs in their service areas. The lower product (sorbent) usage by the company’s customer base was both due to some customers lowering capacity factors and also due to Midwest Energy’s own optimization efforts at each client EGU in order to improve operating efficiencies, both of which resulted in lower and less-than-expected product (sorbent) usage.
Despite the pipeline of prospective customer opportunities, the anticipated closing of new contracts during the summer of 2018 did not materialize due to an unexpected pricing response by incumbent suppliers of sorbent. It was necessary for Midwest Energy Emissions to offer competitive pricing; however, management subsequently initiated a cost cutting initiative, which has lowered the costs of its sorbent products.
Management also discerned that many non-client EGUs implemented aspects of the Midwest Energy’s patented process as these non-client EGUs sought out solutions to achieve compliance with MATS. As a result, management initiated a licensing program during November 2018 in an effort to capture revenues from the unauthorized use of the company’s patented SEA® technologies. An IP (Intellectual Property) law firm (Caldwell Cassady & Curry P.C.) was engaged to seek fair compensation from the many coal-fired EGUs (which management believes to be over 100) that have adopted aspects of the patented methods of SEA® technologies. Potential resolutions include a licensing program with Midwest Energy Emissions or a supply contract by which Midwest would become the provider of the sorbent. Already one EGU has opted to sign a supply contract with Midwest Energy Emissions as a result of this effort.
View Exhibit I
Currently, Midwest Energy Emissions has supply contracts for 15 Electric Generating Units (EGUs) in the United States, including the initial contracts on three EGU’s announced in March 2019. Given the year-over-year growth in the number of EGUs being served and the seasonal increase of demand for electricity from coal-fired EGUs during the warmer months, Midwest Energy Emissions should show strong double-digit top-line growth in the 2nd and 3rd quarters of 2019.
In 2018, Midwest Energy Emissions began supplying product to the front-end of an EGU located in Canada. Initially a $700,000 purchase order was secured. In April 2018, Midwest Energy Emissions secured another order from the same Canadian customer, this time to supply product to an EGU in Alberta. Currently, Midwest Energy is supplying sorbent product to these two EGUs in Canada with the potential to expand the relationship to a total of eight EGUs for this particular Canadian customer.
Financial Results for the First Quarter of 2019
On May 15, 2019, Midwest Energy Emissions reported results for the first quarter of 2019 ending March 31, 2019. Total revenues increased 31.4% to $2,787,321 from $2,121,112 reported in the comparable quarter last year as revenue from product (sorbent) deliveries increased 33.9%. Sorbent sales increased primarily from the addition of several new EGU’s to the company’s customer base. Other revenues declined from $52,147 to $29,000, primarily due to a decrease in demonstration revenues.
Total operating expenses decreased 5.2% to $3.31 million versus $3.49 million, primarily attributable to SG&A decreasing 36.0% due to decreases in stock-based compensation and sales compensation. The gross margin expanded to 21.5% versus 17.1% in the first quarter of 2018 due to lower overhead costs per sales dollar (aka the cost of goods sold increased at a rate less than the increase in sorbent product revenues). Interest expense declined 37.7% to $320,000 versus $513,501 million in the comparable quarter last year, primarily attributable to the decrease in secured debt and the new interest rates associated with the debt, which was restructured in February 2019.
The company reported a gain of $2.36 million (or $0.03 per diluted share) versus a reported loss of $1.91 million (or $0.03 per diluted share) in the first quarter of 2018, primarily due to the non-cash, one-time $3.41 million gain on debt restructuring and secondarily, to increased sales with an improved gross margin and cost-cutting efforts that decreased SG&A costs. Operating earnings (aka earnings before non-recurring items, specifically the gain on debt restructuring) were a loss of $1,048,407 (or $0.01 per diluted share). Adjusted EBITDA improved to a negative $257,000 versus a negative $847,000 in the first quarter of 2018. As of March 31, 2019, the company had $611,547 in cash on hand and working capital deficit of $1.1 million. Shares outstanding have remained stable at 76,246,113 shares since the end of the second quarter of 2017. Subsequently, 235,184 shares were issued to a Director who resigned from the Board.
On the May 15th conference call, management reconfirmed prior guidance that EDITDA is anticipated to be positive in 2019. In addition, due to existing contract renewals, further penetration of current customer fleets and the addition of new customers through the company’s patent strategy/licensing program, management anticipates the top-line to grow in the mid-20% range in 2019. The company should also benefit from the sorbent product cost cutting measures implemented in 2018 and from new products being introduced in order to further enhance the company’s product line.
Over the last eight months, the news flow from Midwest Energy Emissions has been significant and positive, both regarding North American contracts and concerning corporate initiatives. In terms of contracts, three additional EGUs are under supply contracts, one of which is a new customer brought on board through the Patent Strategy. The European initiative (through the licensing agreement with Cabot) is expected to gain traction during the summer months of 2019, and management anticipates that some European contracts may be announced in the fall. The Licensing initiative continues to be pursued and has already led to a new customer contract. Moreover, the company’s secured and unsecured debt held by AC Midwest Energy LLC was restructured in February 2019 with maturities being extended and the interest rate being reduced. Finally, despite the challenging industry dynamics, Midwest Energy Emissions has not issued any common shares to fund the company since early 2017.
Management expects to continue securing additional contracts for USA-based EGUs during 2019 and for European EGUs beginning in the fall of 2019. The licensing strategy, spearheaded by Caldwell Cassady & Curry’s efforts, has already led to one contract, which was announced on March 5, 2019.
Our indicated share price target is based on market-based comparative analysis that utilizes the valuation metric of Price/Sales. Utilizing a second quartile industry average P/S ratio of 3.36 on TTM sales through 1Q-2019 of $13.0 million, our share price target is $0.57.
We remain optimistic the ultimate success of Midwest Energy Emissions. The company should experience increases in revenues over the next few years as more coal-fired plants (both in North America and Europe) utilize Midwest Energy’s SEA Technology to control mercury emissions.
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By Steven Ralston, CFA