Arq, Inc. (ARQ) Q3 2018 Earnings Report, Transcript and Summary

Good morning. My name is Jamie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Advanced Emissions Solutions Q3 2018 Earnings Call. [Operator Instructions] Thank you. Ryan Coleman with Alpha IR, you may begin your conference.

Thank you, Jamie. Good morning, everyone, and thanks for joining us today for our third quarter earnings results call. With me on the call today are Heath Sampson, President and Chief Executive Officer; and Greg Marken, Chief Financial Officer. This call is being webcast live within the Investors section of our website, and a downloadable version of today’s presentation is available there as well. A webcast replay will also be available on our site. You can contact the Alpha IR Group for Investor Relations support at 312 445-2870. Let me remind you that the presentation and remarks made today include forward-looking statements as defined in Section 21E of the Securities Exchange Act. These statements are based on information currently available to us and involve risks and uncertainties that could cause actual future results, performance and business prospects and opportunities to differ materially from those expressed in or implied by these statements. These risks and uncertainties include, but are not limited to, those factors identified on Slide 2 of today’s slide presentation and our Form 10-Q for the quarter ended September 30, 2018, and other filings with the Securities and Exchange Commission. Except as expressly required by securities laws, the company undertakes no obligation to update those factors or any other forward-looking statements to reflect future events, developments or changed circumstances or for any other reason. In addition, it is very important to review the presentation and today’s remarks in conjunction with the Form 10-Q and the GAAP references in the financial statements. So with that, I’ll turn the call over to Heath Sampson. Heath?

Thanks, Ryan, and thanks to everyone for joining us this morning. Let’s begin on Slide 3 and review our third quarter. Our commitment to returning value to our stakeholders continued through the third quarter as we spent $7.1 million and $26.4 million during the three and nine month periods ending September 30, 2018, respectively, in the form of dividends and share repurchases. And today, we declare our fourth quarter dividend payable on December 6 to shareholders of record at business close on November 20. Distributions from Tinuum were slightly lower during the quarter compared to the prior year, resulting from engineering and installation costs for idle RC facilities. While these upfront costs lower distributable earnings to Tinuum equity members during the period that they were incurred, we continue to believe that it is a prudent step toward security in tax equity investors for the remaining units, which is our first priority. As we discussed on our previous earnings call, the third quarter included restructuring charges related to personnel reductions. Absent these onetime charges, operating expenses would have been lower compared to last year. Despite the deliberately lower distributions in the third quarter, our year-to-date distributions have remained strong and bolstered our cash position. As of September 30, our cash position exceeded $30 million, even after significant cash used for dividend and share buybacks. Our healthy liquidity position allows us the flexibility to evaluate our capital allocation plan as we continue to deploy capital in the most accretive manner for shareholders. Also, as previously announced, Tinuum attained a new tax equity investor for an additional RC facility previously in the installation phase during the month of October. This particular facility is located at a coal-burning power plant that historically burned in excess of 3 million tons of coal per year. The facility is royalty bearing and brings the number of invested units to 19. This closure provides further evidence as to why Tinuum continues to spend the capital necessary to install idle facilities, that maximizing RC cash flows with additional invested units ultimately facilitates our capital allocation plan. Now I’d like to turn the call over to Greg Marken, who will review our third quarter financial results.

Thank you, Heath. Let’s start on Slide 5 to review our financial results. Our cost containment efforts, coupled with strong year-to-date royalty earnings and distribution from Tinuum, continue to facilitate the steady increase in our cash levels. As of September 30, 2018, cash and cash equivalents totaled $31.9 million, which is a $1.2 million increase from December 31, 2017. This increase comes despite using another $26.4 million during the nine months ended September 30, 2018, to pay our third – our three quarterly dividends as well as repurchase common shares in accordance with our capital allocation plan. Total distributions from Tinuum were down slightly to $9.4 million during the third quarter of 2018 compared to $11.9 million in 2017. On a nine-month basis, total distributions from Tinuum were up slightly at $37 million versus $37 million in 2017. As Heath mentioned, the decrease in quarterly distributions and only slightly higher year-over-year distributions even though there was an increase in invested RC facilities is a result of costs incurred to Tinuum related to the engineering and the installation spending for RC facilities that are being put in place in anticipation of future tax equity investors. To date in 2018, these costs have totaled over $12 million in capital expenditures. We also expect continued expenditures in the fourth quarter, consistent with Tinuum’s operations during the first nine months of this year. Total revenues for the quarter were $5.1 million, a slight increase from the third quarter of 2017. Third quarter revenue was positively impacted by higher chemicals revenue and royalty earnings from Tinuum of $4.1 million, an increase of 46% compared with $2.8 million in the third quarter of 2017. Increased royalty revenue was driven by a higher number of RC facilities in place and earnings from their respective RC facilities. And as a reminder, we expect all future RC facilities to be royalty bearing. Year-to- date revenue totaled $13.3 million compared to $41.6 million for the first nine months of 2017. The year-to-date decline in revenue was primarily due to the completion of all material equipment contracts in the prior year. Operating costs during the third quarter, exclusive of cost of sales, were $4.2 million or flat compared in the third quarter of 2017. Restructuring charges of $1.1 million during the three months were driven by a reduction in force, including the departure of certain executive officers and management’s further alignment of the business with its strategic objectives. These restructuring costs were fully offset by lower legal and professional fees as well as lower general and administrative expenses. These changes, net of contributions from previous chemical wins, are allowing us to continue to progress towards our $8 million to $10 million annual cash cost goal. Consolidated pretax income and net income for the quarter were $9.4 million and $5.5 million, respectively. The slight decrease in net income represents year-over-year growth driven by higher distributions and royalties, offset by higher tax expense, driven by an increase in the valuation allowance during the third quarter. The slightly lower net income levels offset by a lower number of common shares outstanding resulted in fully diluted earnings per share of $0.28 in the quarter, which is flat compared to $0.28 in the third quarter of 2017. I’ll now turn the call back over to Heath to walk through our go-forward strategy.

Thanks, Greg. I’d like to take a moment to discuss the refined coal environment. Let’s turn to Slide 7 and discuss the refined coal backdrop. As validated by the recent contract closure with a third-party tax equity investor, we, along with Tinuum, continued to maintain the thesis that the refined coal environment is conducive to obtaining additional tax equity investors. While the timing of the closures are difficult to determine at times, we do feel good about the prospects of securing an additional unit by the time we discuss our fourth quarter results. Slide 8 shows the current invested and operational facilities versus the non-invested facilities that are not operating. As of September 30, Tinuum has leased or sold 18 facilities, with the remaining 10 facilities either installed and awaiting a tax equity investor or waiting for a utility and a tax equity investor. As of September 30, Tinuum had two idle refined coal facilities in the engineering and installation phase. Year-to-date, Tinuum has spent over $12 million in engineering and installation costs primarily related to five facilities. While each facility requires between $4 million and $6 million to prepare for a tax equity investor and does lower near-term distributed earnings, we believe this is a necessary step toward securing investors and maximizing our projected cash flows from the remaining units. Since September 30, Tinuum has added an additional refined coal facility with a third current tax equity investor and now has four refined coal facilities in the engineering and installation phase. The remaining five units are either installed and awaiting investor or awaiting for a utility location. Additionally, as shown on the right side of the slide, there is still sufficient potential capacity for Tinuum to substantially increase production, provided a substantial number of the remaining units can be leased or sold as is our expectation. As a reminder, two of the 28 facilities tax credit generation period ends during 2019. One of the two facilities is currently operating and invested. Slide 9 provides a quarter-by-quarter breakdown of Tinuum invested and retained tonnage volumes. As a reminder, retained tonnage is tonnage Tinuum operates on its members' behalf. Tinuum pays the operating expenses, but its members also receive the tax benefits. You’ll see that the sequential tonnage had increased as it was positively impacted by the increased number of invested facilities. These increases and related increases in cash payments from Tinuum will continue to allow us to execute on our capital allocation initiative as we collect future cash flows. Our top priority again is to assist Tinuum in obtaining more investors as fast as possible and build on the cash payments we receive through 2021. Slide 10 shows the royalty versus non-royalty schedule. As a reminder, the number of royalty-bearing facilities is greater than non-royalty-bearing facilities, a change that occurred during the middle of 2017. As Greg mentioned, all future RC facilities are expected to be at power utilities that are royalty bearing to the company. Let’s continue to Slide 12, where you’ll see our updated expectations for future cash flows through 2021. As of September 30, 2018, we are expecting between $225 million and $250 million in cash flows, net of taxes and interest expense from Tinuum through 2021. The quarterly distributions were offset by the quarterly invested facility. This figure is based on the 18 invested facilities as of that date and does not reflect the additional facility invested during October2018 nor the expectation of additional future facilities becoming operational and invested by a third party. Any future invested facilities, which is the main focus of ours, would add to these current expectations. Flipping to Slide 13. This shows capital returned to shareholders. Since we initiated our capital return program during the second quarter of 2017, we have paid out over $30 million in common dividends and utilized an additional $27.6 million to repurchase outstanding shares. This equates to approximately $2.65 per share returned to shareholders since March 31, 2017. Lastly, I’d like to mention a pending revision to existing MATS legislation by the current administration. We’re aware of the EPA’s proposed rule changes to mercury and other air toxin emission standards. However, the administration has yet to issue a formal response to their proposals. Consensus among interested parties believe it will come up before the end of the year, but it may be later. The important component here that I’d like to mention is that we are confident that any proposed changes to existing MATS legislation will not impact our projected RC cash flow to 2021 as MATS did not impact the Section 45 tax credit rule. As a sidenote, the vast majority of the power generators, coal mining companies, states and, of course, environmental groups want MATS to remain in place. Let me conclude today by again discussing our 28 goals and priorities on Slide 14. We remain focused on: helping Tinuum obtain tax equity investors for its remaining RC facilities; helping Tinuum ensure operational performance to allow production and the sale of refined coal tax equity investors while also helping to ensure stickiness of RC investors through strong customer relationships; streamlining and optimizing the deployment of EC chemical revenues to support RC efforts and public platform; executing against our balanced capital allocation program to distribute and create value for our shareholders; and finally, evaluating alternative options to monetize tax assets and build upon our existing platform. With that, we’ll open the line for questions. Operator?

[Operator Instructions] Your first question comes from Sameer Joshi with H.C. Wainwright. Your line is open.

So the first question relates to this drop in distributions. Was the bulk of this because of the expenses incurred for engineering and solution to the tune of $4 million to $6 million? Or can you give us some more color on that?

Yes. So that is absolutely – and that’s – again, that’s $4 million to $6 million per facility. And through September 30, we incurred $12 million of that, and we expect to incur additional costs as we install the remaining units that we talked about. So distributions would have grown if we did not spend those costs. But again, spending those costs allow us to have a facility installed and ready for an investor. So it might be short term in having lower distributions, the long- term investment will ensure we have more in the future.

So the four remaining out of the nine total remaining facilities that you have to spend on engineering and installation, do you have interest – I know you don’t have signed tax equity investors, but are there investors who are saying that you – if you have – get this prepared, we will invest for these four remaining facilities?

Yes. Yes, consistent with what – especially recently, we do not build specs facilities. We would only be building because of our confidence in obtaining the investors that we are currently talking to. So that’s consistent with what I’ve said in the past, and that’s the reason why we are installing these current facilities because we have investors that we think we’re going to be able to get into those units.

And then the one that you mentioned you will be very – or will be installed before your fourth quarter call, will – does that need any additional CapEx or engineering spend?

The majority of that CapEx has already been spent. But we are still incurring other CapEx and installation costs for those other four remaining

Four additional facilities.

Yes. So you should expect to continue at the similar run rate that we’ve had in the past for the next number of months.

Got it, thanks for that clarity. The other thing we observe is that the operating tonnage historically peaks in the third quarter and then accounting for changes in the number of units deployed and then slightly going down in the fourth quarter. Is that a seasonality you expect to see this fourth quarter as well?

Yes, if you’re normalizing out the additional facilities that have come on, that is an expected seasonality trend.

Okay. And then are there any additional facilities? I know you wouldn’t give guidance, but additional facilities that may be ready by the time of your next quarter call in addition to the one that you already feel confident about?

Yes, we’re working on that, right. The reason why I can’t talk about that one because we’re close on it, and there are other ones that we have far along. And I hope to have more closed in the next number of months, but we’re not going to say we’re committing to any more beyond the one that I talked about.

Okay. Just two more on the operating expenses. You incurred some researching costs. Going forward, what level of OpEx do you expect at the corporate level?

So from a cash perspective, again, we expect net of the revenue coming from our emissions business to be in that $8 million to $10 million range, where our current – so when you take out the severance amounts right now, and it’s pretty similar from a cost perspective that you see now. That’s the right way to think about it as you’re modeling it out.

So the 3Q levels are fairly flat going forward?

Yes.

And then last one for me. The stock repurchase during Q3 was – that slowed down compared to Q2. Do you have any like plans how you would do it over the next few quarters?

Yes, we absolutely – again, buying back stock because of our cash flow and our commitments to doing it will still be something we do. And you can do that in two ways. You can do purchases in the open market, which we have done. And then like we’ve done in the past, you can do a broader tender offer. Both are absolutely on the table for us going forward.

Okay. I know I said that was my last, but one more for me, if I may. How is the – like are there any additional – you mentioned on Slide 14 alternative options. Do you have any more color on that, any thoughts, any progress on that plan?

Oh, so on Slide 14, the evaluate alternative options? Is that your question?

Yes.

Yes, no, that’s still an important priority for us. As we move through this, we want to ensure that we’re evaluating all the options and what’s the best thing for shareholder value. So that still remains a 2018 and 2019 priority.

But there is no – nothing concrete you can say you’re working on right now?

Well, we’ll update accordingly based on when we get something. So that’s where we are right now, if we get it.

Fair enough, thanks for that Heath. And good luck.

There are no further questions. At this time, I will turn the call back over to Heath Sampson for closing remarks.

Great. Thank you again to everyone for your time today and your continued support. I look forward to updating you all next quarter. Have a great day, everyone.

This concludes today’s conference call. You may now disconnect.