CHARAH SOLUTIONS, INC. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q)
The following discussion and analysis should be read in conjunction with the historical financial statements and related notes included in Part I, "Item 1. Financial Statements" of this Quarterly Report. This discussion contains "forwardlooking statements" reflecting our current expectations, estimates and assumptions concerning events and financial trends that may affect our future operating results or financial position. Actual results and the timing of events may differ materially from those contained in these forwardlooking statements due to a number of factors. Factors that could cause or contribute to such differences include, but are not limited to, public health threats or outbreaks of communicable diseases, such as the ongoing novel coronavirus "COVID-19" pandemic and its impact on our business, customers, employees or customers' facilities, capital expenditures, economic and competitive conditions, and regulatory changes and other uncertainties, as well as those factors discussed below and elsewhere in this Quarterly Report. Please read "Cautionary Note Regarding ForwardLooking Statements" included elsewhere in this Quarterly Report. Except as otherwise required by applicable law, we assume no obligation to update any of these forwardlooking statements.
Charah Solutions, Inc.(together with its subsidiaries, " Charah Solutions," the "Company," "we," "us" or "our") was incorporated in Delawarein 2018 in connection with our initial public offering in June 2018and, together with its predecessors, has been in business since 1987. Since our founding, we have continuously worked to anticipate our customers' evolving environmental needs, increasing the number of services we provide through our embedded presence at their power generation facilities. Our multi-service platform allows customers to gain efficiencies from sourcing multiple required offerings from a single, trusted partner compared to service providers with more limited scope.
We are a leading national service provider of mission-critical environmental services and byproduct recycling to the power generation industry. We offer a suite of remediation and compliance services, byproduct services, raw material sales and Environmental Risk Transfer ("ERT") services. We also design and implement solutions for complex environmental projects (such as coal ash pond closures) and facilitate coal ash recycling through byproduct marketing and other beneficial use services. We believe we are a partner of choice for the power generation industry due to our quality, safety, domain experience, and compliance record, all of which are key criteria for our customers. In 2021, we performed work at more than 40 coal-fired generation sites nationwide. We operate as a single operating segment, reflecting the suite of end-to-end services we offer our utility partners and how our chief operating decision maker reviews consolidated financial information to evaluate results of operations, assess performance and allocate resources for these services. We provide the following services through our one segment: remediation and compliance services, byproduct services, raw material sales and ERT services. Remediation and compliance services are associated with our customers' need for multi-year environmental improvement and sustainability initiatives, whether driven by regulatory requirements, power generation customer initiatives or consumer expectations and standards. Byproduct services consist of recurring and mission-critical coal ash management and operations for coal-fired power generation facilities while also supporting both our power generation customers' desire to recycle their recurring and legacy volumes of coal combustion residuals ("CCRs"), commonly known as coal ash, and our ultimate end customers' need for high-quality, cost-effective supplemental cementitious materials ("SCMs") that provide a sustainable, environmentally-friendly substitute for Portland cement in concrete. Our raw material sales provide customers with the raw materials that are essential to their business while also providing the sourcing, logistics, and management needed to facilitate these raw material transactions around the globe. ERT services represent an innovative solution designed to meet coal fired plant energy providers' evolving and increasingly complex plant closure and environmental remediation needs. These customers need to retire and decommission older or underutilized assets while maximizing the assets value and improving the environment. Our ERT services manage the sites' environmental remediation requirements, benefiting the communities and lowering the coal fired plant energy providers' costs.
The pandemic caused by a novel coronavirus ("COVID-19") has impacted many aspects of our operations, directly and indirectly, including our employees, the services we provide at our customers' power generation facilities, our suppliers and the overall market. We, along with our utility partners, have implemented the precautionary health and safety measures recommended by the
Centers for Disease Control and Prevention(the "CDC") in response to the COVID-19 pandemic, including, but not limited to: an employee health status questionnaire, taking daily temperatures, enhanced sanitation practices and cleaning surfaces throughout each shift, and increasing the number of hand sanitizing stations. We have also implemented social distancing measures such as staggering shift start and stop times and break times with additional break spaces to support social distancing as well as holding safety meetings outside of the site trailer. Furthermore, we have implemented work-from-home measures for the majority of office employees. Understanding that the COVID-19 challenge is evolving, based on new information and feedback, we continue to monitor the situation and update our proactive measures in coordination with our customers. We continue to work closely with our utility partners and concrete producer customers to meet their needs and monitor any potential slowdowns of byproduct recycling and marketing services if there is decreased demand for construction materials. The COVID-19 pandemic presents potential new risks to the Company's business, including logistical, supply chain and other challenges that may continue to affect demand for services, which are driven by construction activity, and the timing of our remediation and compliance services projects, due to delays in new contract awards and increasing costs and declining availability for certain machinery and equipment. 20 --------------------------------------------------------------------------------
How we evaluate our operations
We use a variety of financial and operational measures to assess the performance of our operations, including:
•Revenue; •Gross Profit; •Operating Income; •Adjusted EBITDA; and •Adjusted EBITDA Margin. Revenue We analyze our revenue by comparing actual revenue to our internal projections for a given period and to prior periods to assess our performance. We believe that revenue is a meaningful indicator of the demand and pricing for our services.
We analyze our gross profit, which we define as revenue less cost of sales, to measure our financial performance. We believe that gross profit is a meaningful metric because it provides insight on financial performance of our revenue streams without consideration of company overhead. When analyzing gross profit, we compare actual gross profit to our internal projections for a given period and to prior periods to assess our performance.
We analyze our operating income, which we define as revenue less cost of sales and general and administrative expenses, to measure our financial performance. We believe that operating income is a meaningful metric because it provides insight on profitability and true operating performance based on the historical cost basis of our assets. Additionally, due to the nature of the accounting requirements relating to our ERT services, the gains from the sales of fixed assets and the costs associated with ERT fixed asset sales are recorded as a component of operating income. When analyzing operating income, we compare actual operating income to our internal projections for a given period and to prior periods to assess our performance.
Adjusted EBITDA and Adjusted EBITDA margin
We view Adjusted EBITDA and Adjusted EBITDA margin, which are non-GAAP financial measures, as important indicators of performance because they allow for an effective evaluation of our operating performance when compared to our peers, without regard to our financing methods or capital structure. We define Adjusted EBITDA as net loss attributable to
Charah Solutions, Inc.before income from discontinued operations, net of tax, interest expense, net, loss on extinguishment of debt, income taxes, depreciation and amortization, equity-based compensation, impairment expense (including inventory reserves), gain on change in contingent payment liability and transaction-related expenses and other items. Adjusted EBITDA margin represents the ratio of Adjusted EBITDA to total revenue. See "-Non-GAAP Financial Measures" below for more information and a reconciliation of Adjusted EBITDA to net loss attributable to Charah Solutions, Inc., the most directly comparable financial measure calculated and presented in accordance with GAAP.
Key Factors Affecting Our Business and Financial Statements
Ability to seize new contracts and opportunities
Our ability to grow revenue and earnings is dependent on maintaining and increasing our market share, renewing existing contracts, and obtaining additional contracts from proactive bidding on contracts with new and existing customers. We proactively work with existing customers ahead of contract end dates to attempt to secure contract renewals. We also leverage the embedded long-term nature of our customer relationships to obtain insight and capture new business opportunities across our platform.
Based on historical trends, we expect our operating results to vary seasonally. Variations in normal weather patterns can also cause changes in energy consumption which may influence the demand and timing of associated services for our byproduct services offerings. Our byproduct services and raw material sales are also negatively affected during winter months when the use of cement and cement products is generally lower. Inclement weather can impact construction-related activities associated with pond and landfill remediation, which affects the timing of revenue generation for our remediation and compliance services.
Nature of project-based environmental remediation mandates
We believe there is a significant pipeline of coal ash ponds and landfills that will require remediation and/or closure in the future. Due to their scale and complexity, these environmental remediation projects are typically completed over longer periods. As a result, our revenue from these projects can fluctuate over time. Some of our revenue from projects is recognized over time using the cost-to-cost input method of accounting for GAAP purposes, based primarily on contract costs incurred to date compared to total estimated contract costs. This method is the most accurate measure of our contract performance because it depicts the company's performance in transferring control of goods or services promised to customers according to a reasonable measure of progress toward complete satisfaction of the performance obligation. The timing of revenue recorded for financial reporting purposes may differ from actual billings to customers, sometimes resulting 21 --------------------------------------------------------------------------------
costs and billings exceeding actual revenues. Due to the risks associated with estimating gross profit margins for long-term employment, actual results may differ from these estimates.
Dynamics of the by-product recycling market
There is a growing demand for recycled coal ash across various applications driven by market forces and governmental regulations creating the need to dispose of coal ash in an environmentally sensitive manner. Pricing of byproduct services and raw material sales are driven by supply and demand market dynamics as well as the chemical and physical properties of the ash. As demand increases for the end-products that use CCRs (i.e., concrete for construction and infrastructure projects), the demand for recycled coal ash also typically rises. These fluctuations affect the relative demand for our raw material sales. In recessionary periods, construction and infrastructure spending and the corresponding need for concrete may decline. However, this unfavorable effect may be partially offset by an increase in the demand for recycled coal ash during recessionary periods, given that coal ash is more cost-effective than other alternatives.
Power generation industry expenditures for environmental liability management and regulatory requirements
The power generation industry has increased annual spending on environmental liability management. We believe this results from regulatory requirements and consumer pressure, and the industry's increasing focus on environmental stewardship. Continued increases in spending on environmental liability management by our customers should result in increased demand for services across our platform. Many power generation entities are experiencing an increased need to retire and decommission older or less economically viable generating assets while minimizing costs and maximizing the value of the assets and improving the environment. Our ERT services allow these partners to remove the environmental risk and insurance obligations and place control and oversight with a company specializing in these complex remediation and reclamation projects. We believe our broad set of service capabilities, track record of quality service and safety, exacting environmental standards, and a dependable and experienced labor force is a significant competitive advantage. Our work, mission and culture are directly aligned with meeting environmental, sustainability, and governance ("ESG") standards and providing innovative services to solve our coal fired plant energy providers' most complex environmental challenges.
Cost management and capital investment efficiency
Our principal operating costs consist of labor, material and equipment costs and equipment maintenance. We focus on cost management and efficiency, including monitoring labor costs, both in terms of wage rates and headcount, along with other costs such as materials and equipment. We believe we maintain a disciplined approach to capital expenditure decisions, typically associated with specific contract requirements. Furthermore, we strive to extend our equipment's useful life through a well-planned routine maintenance program.
How we generate revenue
Our remediation and compliance services primarily consist of the design, construction, management, remediation and closure of ash ponds and landfills at client-owned sites.
Our byproduct services include recycling recurring and contracted volumes of coal-fired power generation waste byproducts, such as fly ash, bottom ash, IGCC slag and gypsum byproducts, each of which can be used for various industrial purposes. Byproduct services also include the management of coal ash which is mission-critical to power plants' daily operations including silo management, on-site ash transportation and capture, and disposal of combustion byproducts from coal-power operations. More than 90% of our services work is time and materials based, cost reimbursable or unit price contracts, which significantly reduces the risk of loss on contracts and provides gross margin visibility. Revenue from management contracts is recognized when the ash is hauled to the landfill or the management services are provided. Revenue from the sale of ash is recognized when it is delivered to the customer. Revenue from construction contracts is recognized using the cost-to-cost input method.
Our commodity sales provide customers with the critical raw materials for their business while providing the sourcing, logistics and management necessary to facilitate these commodity transactions around the world.
Revenue from construction contracts is recognized using the cost-to-cost input method. Revenue from management contracts is recognized when the ash is hauled to the landfill or the management services are provided. Revenue from the sale of ash is recognized when it is delivered to the customer. This combination of one-stop related services deepens customer connectivity and drives long-term relationships, which we believe are critical for renewing existing contracts, winning incremental business from existing customers at new sites and adding new customers. 22
Three Months Ended
March 31, 2022Compared to Three Months Ended March 31, 2021Three Months Ended March 31, Change 2022 2021 $ % (dollars in thousands) Revenue $ 66,051 $ 52,107 $ 13,94426.8 % Cost of sales (69,818) (46,522) (23,296) 50.1 % Gross profit (3,767) 5,585 (9,352) (167.4) % General and administrative expenses (8,952) (9,432) 480 (5.1) % Gain on sales-type lease - 5,568 (5,568) (100.0) %
Gains on sale of real estate, property, plant and equipment, net
3,543 547 2,996 547.7 % Gain on ARO settlement 2,451 - 2,451 100.0 % Other operating expenses from ERT services (667) (290) (377) 130.0 % Operating (loss) income (7,392) 1,978 (9,370) 473.7 % Interest expense, net (4,573) (3,235) (1,338) (41.4) % Income from equity method investment - 202 (202) (100.0) % Loss before income taxes (11,965) (1,055) (10,910) 1,034.1 % Income tax expense 78 157 (79) (50.3) % Net loss (12,043) (1,212) (10,831) (893.6) %
Less (loss) income attributable to non-controlling interests
(3) 75 (78) 104.0 %
Net loss attributable to
(835.5) % Revenue. Revenue increased
$13.9 million, or 26.8%, to $66.1 millionfor the three months ended March 31, 2022as compared to $52.1 millionfor the three months ended March 31, 2021, primarily driven by increases in remediation and compliance services revenue of $10.9 millionfrom the net commencements of new project work and in raw material sales of $5.5 millionfrom an increase in shipments. This increase was partially offset by lower byproduct services revenue of $2.5 millionprimarily due to net completions of operations work. Gross Profit. Gross profit decreased $9.4 million, or 167.4%, to $(3.8) millionfor the three months ended March 31, 2022as compared to $5.6 millionfor the three months ended March 31, 2021. As a percentage of revenue, gross profit was (5.7)% and 10.7% for the three months ended March 31, 2022and 2021, respectively. The decrease in gross profit and gross profit margin was directly affected by several factors, most notably supply chain and logistics issues, which impacted the expected ramp of two long-term beneficial use projects, and significant weather challenges, which delayed the completion of three projects during the quarter, resulting in cost overruns. Delays in receiving material and obtaining necessary rail and trucking resources resulted in a delay to the start of one large project and have pushed the expected ramp of the second. The Company is taking steps to address these issues, and it is not expected that the long-term profitability of the projects will be materially impacted. Additionally, significant rain events at three construction projects extended the final completion dates for those projects and resulted in cost overruns. The projects had originally been scheduled for completion in the Fall of 2021. The Company has now demobilized at the largest of these projects and expects to complete the remaining two projects during the second quarter. General and Administrative Expenses. General and administrative expenses decreased $0.5 million, or 5.1%, for the three months ended March 31, 2022to $9.0 millionas compared to $9.4 millionfor the three months ended March 31, 2021, primarily attributable to improved expense management. Gain on sales-type lease. Gain on sales-type lease decreased $5.6 millionfor the three months ended March 31, 2022due to the absence of the recognition of a parcel transferred under a sales-type lease at an ERT project as discussed in Note 5, Balance Sheet Items, to the accompanying unaudited condensed consolidated financial statements. Gains on Sales of Real Estate, Property and Equipment, Net. Gains on sales of real estate, property and equipment, net increased $3.0 million, or 547.7%, to $3.5 millionfor the three months ended March 31, 2022as compared to $0.5 millionfor the three months ended March 31, 2021, primarily due to increased scrap sales from the demolition of the Gibbons Creekpower plant. Gain on ARO settlement. Gain on ARO settlement increased $2.5 millionfor the three months ended March 31, 2022due to differences between the estimated costs used in the measurement of the fair value of the Company's AROs and the actual costs incurred for specific remediation tasks recognized on a proportionate basis. Other Operating Expenses from ERT Services. Other operating expenses from ERT services increased $0.4 million, or 130.0%,to $0.7 millionfor the three months ended March 31, 2022as compared to $0.3 millionfor the three months ended March 31, 2021, primarily driven by a complete quarter of expenses associated with operations on the Gibbons Creek ERT project in 2022. Interest Expense, Net. Interest expense, net increased $1.3 million, or 41.4%, to $4.6 millionfor the three months ended March 31, 2022as compared to $3.2 millionfor the three months ended March 31, 2021, primarily due to higher debt balances, a higher weighted-average cost of capital associated with equipment financing and an increase in amortization of debt issuance costs. 23 --------------------------------------------------------------------------------
Income Tax Expense. Income tax expense decreased
$0.1 million, or 50.3%, for the three months ended March 31, 2022to $0.1 millionas compared to $0.2 millionfor the three months ended March 31, 2021, primarily due to limitations of the utilization of deferred tax assets against the reversal of deferred tax liabilities.
Net loss. Net loss increased
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