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Midwest Energy Emissions (MEEC) reports 1Q; Revenue Guidance Lowered

By Steven Ralston,CFA


• Midwest Energy Emissions (MEEC) reported 1Q results. 
o The top line was in line with our expectations. 
o The gross margin on sorbent product sales improved by 897 basis points to 28.4%.
o Cost reduction efforts in SG&A expenses masked by expenses related to stock-based compensation (aka stock options). 
• Management adjusted 2017 revenue guidance down to the $40-to-$45 million range, which still  represents a 23%-to-39% increase over 2016’s revenues of $32.3 million.
o The short list of EGUs anticipated to sign contracts this year remain about 20 in number but is fluid with some prospects opting to take advantage of uneconomic pricing of legacy sorbent from a desperate competitor. 
o The signing of new contracts has been delayed to some extent due to the competitive dynamics within the MATS compliance space.
o Management believes that the adoption of SEA Technology is merely being pushed out in time by this irrational competitive response.
• Our indicated share price target is $1.20, which is based on market-based comparative analysis that utilizes the valuation metric of Price/Sales and targeting the industry (value-added specialty chemical companies) mean multiple of 2.6 times TTM revenues. With the company expected to continue growing the top line in the double-digit range and also expected to become profitable later this year, the price decline related to the lowering of 2017 revenue guidance appears to present an opportunity. 

First Quarter 2017 Results

Midwest Energy Emissions reported results for the first quarter ending March 31, 2017. The company reported revenues of $ 5,427,394, up 60.9% from $3,373,311, reported in comparable quarter last year. Revenue growth was primarily driven by product (sorbent) deliveries (+86.2% to $5.28 million) while revenues from demonstration & consulting services ($136,000) also contributed to the top-line. The increased use of sorbent is associated with many customer sites not implementing for full MATS compliance until April last year.

Total operating expenses increased 77.2% to $6.48 million versus $3.66 million in the first quarter of 2016, primarily attributable to $954,621 in expenses related to stock-based compensation (option grants) recorded under SG&A. Cost of goods sold increased only 48.6% to $3.79 million, less than rate of increase in revenues demonstrating the positive effects of economies of scale and cost saving initiatives. The direct product gross margin improved 382 basis points (bps) from 38.3% to 47.6%. Midwest Energy has a $500,000 net operating loss carry forward.

The company reported a net loss of $1,445,285 (or $0.02 per diluted share) versus net income of $908,294 (or $0.02 per diluted share) in the first quarter of 2016. The net loss in the first quarter of 2017 was primarily due to higher SG&A expenses, particularly $954,621 related to stock-based compensation. The profitable quarter last year was a result of the $3,309,400 positive change in value of warrant liability. Without the change in value of warrant liability, the company would have reported a loss of approximately $2.4 million (or $0.05 per diluted share).

Adjusted EBITDA improved over 800% to $145,000 compared to $16,000 in the first quarter of 2016 as again most of Midwest’s customer has not yet committed to full compliance to MATS in the comparable quarter last year. As of March 31, 2017, working capital was a healthy $4.3 million, though down $1.3 million sequentially.

2017 Revenue Guidance

Management adjusted revenue guidance for the 2017 year down to the range of $40 million-to-$45 million, representing a 23% and 39% increase from 2016 revenue $32.3 million but below prior guidance of $60 million-to-$70 million. Guidance appears to have been lowered due to a slower than expected closing rate of new contracts primarily from an unexpected competitive response from a particular large chemical company discounting the price of sorbent to its break-even point (and possibly below) in order to maintain customer relationships, to preserve accounts and to create a situation whereby production capacity can be expanded. 

Despite the lower guidance for the year, Midwest Energy Emissions has maintained a sales pipeline of over 20 EGUs, which are in various stages of testing, demonstration and contract negotiation. Management firmly believes that the ownership of the patent portfolio will aid in the conversion of high quality prospects to long-term, recurring revenue contracts. On April 24, 2017, Midwest Energy closed the acquisition of 42 patents, patents-pending and applications (both domestic and foreign) patents from the Energy & Environmental Research Center (EERCF) at University of North Dakota. Consideration for the patent portfolio was $2.5 million in cash and 925,000 shares of MEEC.

Midwest Energy Emissions is well-positioned to benefit from the implementation of Mercury and Air Toxics Standards (MATS). The company has exclusive rights to Sorbent Enhancement Additive (SEA™) Technology for the reduction of mercury emissions by coal-fired electric generating units. The technology has been commercially deployed and provides many advantages, including low cost of operation, flexibility for optimization and preservation of fly ash marketability. 

Midwest Energy is unique in that it has a singular focus (the mercury emissions control market), holds exclusive rights to patented processes, has achieved market penetration through the commercialization of SEA Technology and is positioned to take advantage of further growth opportunities afforded by the implementation of MATS. We continue to be optimistic about Midwest Energy Emissions. The company should experience a dramatic increase in revenues over the next few years as the coal-fired plants (which have contracted for Midwest Energy’s SEA Technology) ramp up their mercury emissions control efforts to become MATS-compliant.

Comparable pollution control and value-added specialty chemical companies trade in a wide P/S valuation range between 4.5 and 0.8. Utilizing market-based comparative analysis that utilizes the valuation metric of Price/Sales and that targets the industry (value-added specialty chemical companies) mean multiple of 2.6 times TTM (Trailing 12 Month) revenues, a share price target of $1.20 is indicated.

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