Arq, Inc. (ARQ) Q2 2019 Earnings Report, Transcript and Summary

Good morning. My name is Mariama, and I will be your conference operator today. At this time, I would like to welcome everyone to the Advanced Emissions Solutions Q2 Earnings Conference Call. [Operator Instructions]. Thank you. I would now like to turn the call over to Ryan Coleman, Investor Relations; you may begin your conference.

Thank you, Mariama. Good morning, everyone, and thank you for joining us this morning for our second quarter 2019 earnings results call. With me on the call today are Heath Sampson, President and Chief Executive Officer; and Greg Marken, Chief Financial Officer.This conference call is being webcast live in 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, and you can contact the Alpha IR Group for Investor Relations support at (312) 445-2870.Let me remind you 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, in our Form 10-Q for the quarter ended June 30, 2019, and other filings with the Securities and Exchange Commission.Except as expressly required by securities law, 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's very important to review the presentation and today's remarks in conjunction with 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 second quarter. Our focus during the second quarter was unchanged as we continued to assist Tinuum Group and securing third party tax equity investors for the remaining RC facility, and integrating our acquired assets with their existing solution control platform. As such and as previously announced in May, Tinuum was able to secure a tax equity investor for an additional RC facility. This marks the second closure during 2019 and brings the total number of invested facilities to 21.At the end of last year, we outlined a path to adding 12 million incremental tons in 2019 and so far we have added over half of that goal or 6.5 million tons. Based on current discussions with prospective investors, we maintain a line-of-sight towards adding the remaining 5.5 million to 6 million tons this month. We also have lined aside to additional closures in 2019.Additionally, equity earnings from Tinuum were significantly higher than one year ago as three facilities have been invested since the second quarter of last year. In our PGI segment we continue to be very pleased with the integration of the Carbon Solutions team and product as well as the execution and performance of the assets.Retention rates with existing customers remain at 89% and the feedback we are receiving from customers continue to be encouraging. The combination of our legacy technology, knowhow and industry relationships combined with our new activated carbon solutions are positioning us at the platform of choice.In fact, during the second quarter, we signed a large industrial customer that Carbon Solutions had lost prior to the acquisition. We have made investments in technology and team and had even begun to see traction with adjacent market penetration.The steps we have taken to align these newly acquired products with their existing platform are helping to position this world class, but once distressed asset for years of growth. Unfortunately our second quarter came in a bit softer than our expectations. The second quarter included our planned turnaround and is historically seasonal due to low coal fired power demand.This time of the year along with late in the third quarter, utilities were often had periods of downtime due to planned maintenance. Additionally, mild weather across the country coupled with cheap fuel sources that served as coal alternatives for electricity generation magnify the impact on coal dispatch during the period. This is shown in the recently updated forecast by the US Energy Information Administration in which we revised downward -- which was revised downward by 7%, its December 28, forecast of 2019, coal-fired electricity generated units.Lower coal dispatch affects the entirety of our business. But while we are happy with our execution we are not pleased that our customers did not operate and do not buy our products. June was the most challenging month for coal-fired dispatch across the country. But July has recovered.Consistent with previous years, the third quarter is off to a better start with the second quarter at this point. Additionally, we have more new contract opportunities in the second half of this year.The bottom line is that we remain every bit as excited about the potential for this business and amazing asset based as we were earlier this year. As I said, positive feedback from customers around our offerings, high retention rates and new customer wins have us encouraged.This general PTI and overall solution control market for coal-fired power market remains fragmented. And we will continue to evaluate key opportunities to capitalize on the platform that we have. No company is better positioned than us to take advantage of this disruption.The PGI platform remains uniquely strategic. Unrealized assets that provides multiple ways to drive future growth and shareholder value. I’ll discuss the longer-term vision for these new assets after Greg reviews our second quarter results. Greg?

Thanks Heath. Let’s start on Slide 5 for our second quarter financial review. Earnings from equity method investments were sort of $20.9 million compared to $15.9 million in the prior year. The significant increase was driven by three additional invested RC facilities. Since the second quarter of 2018, with total equity earnings of $42.6 million compared to $28.1 million on a full year basis. Also contributing to the increase was Tinuum adoption of the new revenue and lease accounting rules that we mentioned on the first quarter call.We recorded a cumulative adjustment of $28.8 million related to the company’s percentage of Tinuum’s group cumulative account [ph] adjustment that increased Tinuum’s retained earnings. But those amounts as part of that adjustment will not impact our future earnings.We no longer have cumulative cash distributions in excess of our cumulative pro rata share of Tinuum Groups net income. Therefore we recognize equity earnings by recording our pro rata share of Tinuum’s net income rather than based upon cash distributions in the second quarter.I want you also to reiterate that this adjustment does not affect the timing of our total projected future cash flows for out RC segment from Tinuum. Second quarter consolidated revenue of $15.6 million was also significantly higher than $4.3 million one year ago, driven by the contribution from Carbon Solutions consumable and additional loyalty bearing RC facilities.Within that consolidated revenue second quarter consumables totaled $11.4 million. This was significantly higher than the prior year at $700,000 again driven by the Carbon Solutions contribution.Second quarter royalty earnings were higher year-over-year totaling $4.2 million versus $3.5 million in 2018. Royalty earnings in the first half of 2019 totaled $8.4 million compared to $6.8 million in the comparable period in 2018. This increase is a result of the additional royalty bearing facilities invested. Currently, there are 14 royalty bearing facilities that are operating compared to just 11 during the second quarter of 2018.The long term earnings expectation for royalties continues to be roughly $0.40 per ton and all future closures are expected to be royalty bearing to us.Our non-cost of revenue operating expenses were higher year-over-year. Second quarter other operating expenses were $7.5 million compared to $5.1 million in the second quarter of 2018. First half other operating expenses totaled $16.3 million compared to $2 [ph] million in the first half of 2018.The increase during the second quarter and first half of 2019 were driven by higher legal and professional and general administrative cost incurred as well as depreciation, amortization, depletion and accretion expenses resulting in 2.4 million and 5.8 million of the increase respectively related to the Carbon Solutions acquisition.Net income for the second quarter was $8.1 million, down from $15.3 million in the second quarter of 2018. Second quarter earnings were negatively impacted by $1.4 million swing related to the amortization of a step up in the basis of acquired finished goods inventory in connection with purchase accounting adjustments we discussed on our first quarter call. This step up in basis will have a total negative impact of earnings of $5 million during 2019, all of which impacted the financial metrics during the first and second quarters.Net income was also negatively impacted by a larger tax expense of $6.6 million compared to a tax benefit of $1.3 million in the second of 2018. This variance was largely a result of an increase in the valuation allowance against our deferred tax assets during the second quarter of 2019.Net income during the first six months totaled $22.5 million, a 2% decrease from $23 million during the first six months of 2018. The decrease in net income for the first six months of 2019 was primarily driven by higher interest expense, non-cost of revenue expenses and income taxes, which were largely offset by higher consumables revenue resulting from the contribution of the PGI segment, higher earnings from Tinuum resulting from additional refined coal facilities as well as higher royalty income from the refined coal business.Consolidated EBITDA for the second quarter was $17.4 million an increase of $3 million over the second quarter of 2018. The increase was driven by increased earnings before interest and taxes as well as higher expense related to interest and depreciation and amortization type expenses as well as income taxesOut total cash position as of June 30, 2019 was $20.4 million of which $5 million is restricted as a result of the term loan undertaken to acquire Carbon Solutions.Total cash was down from level seen at the end of 2018 for a few reasons. Most significantly, we have made $16 million of principal payments related to the term loan during 2019 of which $10 million occurred during the second quarter.Also the first and second quarter saw cash, cash usage from dividends and share repurchases that combine for more than $12 million. Back in November, the board authorized a $20 million share repurchase program on top of our previous repurchased authorization.Over the last two years, we have demonstrated our willingness to opportunistically repurchase stock in the open market having now reduced our share count to well under $19 million and we expect to continue to act opportunistically going forward.Lastly, as of June 30, 2019 the total current and long-term debt which is comprised of our term loan and finance leases totaled $58 million. We reduced the principal balance on our term loan from $70 million as of the end of the year to $54 million as of June 30, 2019.The senior term loan was used to finance our acquisition of Carbon Solutions and the subject to quarterly principal payments of $6 million that began on March 1st, 2019. During the quarter, we made over $10 million of principal payments and have previously expressed our expectation to pay off this loan in less than the stated three year term.I’ll now turn the call back over to Heath.

Thank you, Greg. I’d like to take a moment to discuss our future outlook. Turning to slide 7 you can see our usual representation of the number of invested facilities versus the number waiting for our tax equity investor waiting to be installed.As of today, we have 21 invested facilities and seven uninvested. To maximize this refined coal opportunity and secure additional investors for the remaining units, Tinuum has been proactively installing facilities in preparation for investments, and two are currently in the installation phase.During 2018, Tinuum spent roughly $17 million related to capital expenditures, nearly all of which was engineering and installation costs.Tinuum and its members, including us, would certainly not be incurring these costs if we were not confident that they would translate into future invested RC facilities. We expect 2019 to be similar from a CapEx perspective.We have active, ongoing conversations with potential tax equity investors for a handful of facilities. We expect to add an additional $5.5 million to $6 million in annual times to Tinuum total this month, fulfilling our commitment to adding incremental tonnage of approximately $12 million on an annual run rate basis.Let's turn to Slide 9 for an update of our expected future RC cash flows. As of June 30, 2019, and inclusive of 21 refined coal facilities invested with third party investors, we are updating our expected net RC cash flows to range between $175 million and $200 million to ADES through the end of 2021. This has been our number one priority and our commitment to leasing or selling the idle units is unaffected by our integration and scaling of our PGI segment.Also recall, that the refined coal business is run by an experienced management team with involvement from its owners including us for oversight and strategic guidance. This structure will allow us to continue, execute and refine coal, while devoting the necessary resources to simultaneously integrate and grow our new assets.Let's flip to Slide 10 and review the growth opportunities for our new assets. This slide shows our roadmap for the new ADES and how we plan to leverage our new assets to become the North American leader and Mercury control and activated carbon within multiple, diversified industries.As we briefly discussed, the entire coal fired power market, which includes very large utilities and mining companies were surprised by the unusually poor coal fired dispatch in Q2. This directly and negatively impacted our consumable product sales. However, with a broader view, our discussions with both existing and potential future customers are leaving us encouraged about our position in the market that we are winning in.We have executed better than our competitors as represented by our high renewal rates and new wins, which validates that our combined offer -- offering provide new value as a combined platform. These are the type of wins we expect to replicate moving forward to drive volumes into 2020.As a reminder, these contracts typically are longer than one year and we must wait to compete as these contracts come up for bid. The second half of this year have more bids than the first half of 2019. And we look forward to updating you as we progress through the year.We are already attractively positioned for long term profitable growth due to the completion of our leading position in the segment. The Mercury control market in North America is competitive, and has seen more than a few changes over the past years, as Coal burned has shifted to natural gas.As a result, many coal-fired power generators have dramatically reduced headcount and are continuously looking for cost savings. They simply do not have the bandwidth or resources anymore to compete at significant scale. They are now looking for fewer strategic vendors that can provide more for less. With our combined offerings, we are best positioned to be the supplier of choice for this changing power market.Gaining incremental share within the North American mercury control market by driving performance, either by pricing power or premium service for products is a top priority.As a reminder, the mercury market is expected to expand 20% to 35% in 2021 and 2022 as refined coal expires. We are thankful to the developers and utilities who have invested time and money to develop refined coal many years ago as their efforts created the platform for many pollution control technologies used today.Like any tax incentive program that benefits society, like refined coal does, the industry deserves the benefits from the tax incentive program. Currently, refined coal is the solution for many facilities, and many need the benefits to continue. However, when the incentive expires, we are best positioned to service them.Next, we are also position today to achieve further penetration into the municipal water treatment market. This market provides an immediately addressable adjacent market to grow within. It is also highly fragmented space comprised of many producers and sellers. To better position ourselves in this space, we have made incremental capital investments to invent the product performance and have a focus and have focused some of our existing personnel here and believe this will lead to positive long term results, within water activated carbon.Longer term, we aim to grow our share in industries that command premium products and thus, premium pricing and margins. We see a significant opportunity in the broader, consumer, and commercial water market. As everyone has seen over the years in the press, clean water is increasingly in demand, both here and across the globe. This market commands higher margins by approximately 20% to 25% compared to Mercury control and its higher expected growth rates. However, entering this market would require upgrades to the existing facility or combination of feedstock’s and the associated capital investment. So these opportunities we envision for the future.In addition to positioning ourselves as the leader for North American mercury capture and activated carbon, and pursuing adjacent markets opportunity such as water, we will also evaluate international markets as mercury control regulations outside the U.S. mature, like they currently are in Europe, as well as adjacent segments like oil and gas, food and beverage, industrial and consumer markets.The broader water market and other specialized adjacent markets have higher growth rates and higher margins. As I previously mentioned, this general PGI and overall activated carbon market remains fragmented, and we will continue to evaluate key opportunities to capitalize on the platform that we have, whether they be near in term or longer term opportunities.One note regarding our activated carbon assets that most significantly impact the PGI segment and the Q2 results is that we had a period of schedule downtime for planned maintenance during the second quarter. These scheduled downtimes are planned for and occur every 18 to 24 months for a period of two to three weeks.The efforts of our people to complete this work during the second quarter with incredible quality allows this asset to remain the best-in-class.I'd like to take a moment to review what we have seen since the acquisition of carbon solutions and how we think the second half of the year will come together. As we reflect on the past seven to eight months since the acquisition, the RC landscape, integration of new assets and the go-to-market approach of the activated carbon opportunities have exceeded our expectations. The momentum in the RC business has fostered two closures this year, and as I said, we expect to meet our 12 million ton commitment this month. I am also encouraged about Tinuum’ pipeline and the prospect of additional closures in 2019.Turning to PGI, the $2.5 million of operating synergies we outlined when we purchased carbon solutions have been achieved, and with the combination of our existing platform the business is yielding attractive opportunities for both our legacy technology as well as the activated carbon platform. Although we are pleased with our execution, the downward revision for expected coal fired generation released by the EIA is a key input we look at when forecasting future expectations internally. So we have been assessing that change and the ultimate effect it has on short term outlook for our specialty chemical business.Revenues have been fairly flat thus far, but we still maintain the conviction that we have an opportunity to grow this business in 2020 and beyond as we outlined for you earlier. Carbon solutions for the business through the market downturn was generated between $5 million to $6 million in EBITDA at the time in the acquisition, and we have long believed that this asset given its underutilized capacity and efficient nature is capable of far better performance.That said, we're still evaluating volumes and production costs, which have ultimately led to margins below what we have seen as the long term potential of this business. However, we have tremendous leverage as a combined entity to drive volumes higher and be competitive across different markets.As we look to the remainder this year, we continue to expect to have new customers starting in the second half of the year, which will allow our activated carbon assets to yield results with higher revenue and margin than the first half of 2019. And we'll look to expand that profitability into 2020, and beyond.In the meantime, our strong projected future cash flows in excess of our -- of our term loan balance offers us incredible flexibility as we position ourselves for future and scale -- for the future and scale this operation.Moving to Slide 11 let's review our capital allocation approach. Since the start of the capital allocation program in the second quarter of 2017, the company has paid $45 million in dividends and utilized capital of over $44 million to repurchase shares. We paid our second quarter dividend on June 7th and our third quarter dividend declared yesterday will be paid on September 6.As Greg mentioned, we made roughly $10 million in principal payments this quarter on our term loan, and we expect to continue to continue aggressively pay down our debt, while maintaining our commitment to dividend and opportunistic share repurchases. These initiatives remain a key focus of ours and we believe we generate sufficient cash flows to both honor our capital return commitments and invest in the new business.Finally, let's review our 2019 priorities on slide 12. As always, our ongoing commitment to leasing additional RC facilities and supporting Tinuum in their efforts to secure tax equity investors is unchanged. Maximizing RC cash flows will continue to be our first focus, as the cash flows from this partnership are utilized to honor our capital allocation commitments.Our second strategic goal will be the integration of our newly acquired assets, people and operations to immediately capture share in the North American Mercury control and municipal water activated carbon market. We will also evaluate and pursue the adjacent attractive opportunities and other verticals, which we are beginning to do now.And finally, we will continue to return capital to our shareholders through our continued commitment to our dividend program as well as the opportunistic repurchasing of outstanding shares.So with that, we'll take questions.

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

Good morning, Greg. Thanks for taking my call -- questions. Just a clarification on the write-up versus the commentary, in the write-up you mentioned plant turnaround. Is that the same as the plant maintenance, the 2 to 3-week plant maintenance you mentioned?

Yes it's synonymous in the industry that you’ve turned around. And I just clarify the disclosures, so both are synonymous.

Okay. Got it. Thanks. On the RC front or rather on Tinuum front, has there been any change in the cost structure of -- in terms of operating costs and distributions? Also, you mentioned there was CapEx of $17 million last year and do you expect similar levels this year? What portion of that CapEx has already been spent?

So, yes, that's Greg -- for the $17 million -- yes, so it's going to be consistent with last year because of the facilities that we have in place. Greg is flipping through that. What was the -- what, was the first part of your question again?

Yes. The other question was about just the cross -- operating cost structure there. Are there any costs that are different than say a year ago?

So on the on the first part, there's no -- no material change to their cost structure and what they're doing. And then the second part of your question, related to CapEx. It's a little over $9 million has already been spent on a year-to-date basis and that's included in the liquidity disclosure within the 10-Q as well.

Right. And so they're -- in conjunction with that you also mentioned that an additional facility will be like you will reach 12 million ton this month. So that takes into account this as well?

It does.

Okay.

That CapEx for something that's going to close this month has already been incurred. That's within that 9 million.

Right. Right, understood. And then on the EBITDA front towards the end of your presentation, you mentioned around $5 million to $6 million EBITDA from carbon solutions. Was that -- was this at the time of acquisition or was this the annualized first year expectation for you?

That was at the time of the acquisition. You know the market was going through the downturn and all those things. That's where they were performing.

And so what is the target for this year, or it has not been disclosed?

Yes, we’re not disclosing what the target is going to be this year, mainly because of the refined coal business trying to get the refined coal business predicted for 2019 is challenging such large dollar amounts, and the timing really matters, coupled that with what we're seeing in the business, it didn't make sense to give that that broader kind of 2019 guidance. We think it would be unproductive. We can -- we as you see we still give the cash forecast for Tinuum. I mean, we are we still do that. But the broader market I think it makes sense to really understand the longer term strategy, and couple that with the guidance.So that's why we've decided not to kind of give some type 19 guidance. We didn't think it was productive right now. But like I said ago, we set up the cost with the asset in the acquisition and our ability to execute I feel the same if not better than when we made the acquisition. So as we get through that bumpy time to do with coal dispatch, we look forward to coming up the latter part of this year and especially in the 2020 to be well positioned like we said when we initially made this acquisition.

Understood. And then the last one, sort of a complex question or compound question. Looking forward at the industries that you targeting -- or markets that you're targeting, the broader auto market and international mercury controlled markets. Can you give us an idea of the size of these markets, and what is your expected share of that market? And what is the timeline you're targeting to achieve that?

Yes. So the first the markets that we're looking at specifically International and the municipal water market, why we are in -- excited about those? Because our current capabilities and our current products can service those markets. So that makes sense to go into those places first.The international side, it's primarily in Europe. And those are just beginning. They actually don't have to start being in compliance till 2021. So we are -- we're pursuing what we're going to be there. That market is fairly broad. It's about a third of what the U.S. market is from a Mercury control perspective, but that's continuing to mature. So it's significant and it would be meaningful as we move through the next number of months and quarters, we'll get tighter and what we think the expectation is there. But it is significant and it will will drive value if we can get into that market.The water market specifically, the municipal water market you know depends how you segment it. We've disclosed in the past that it's around £200 million to £300 million per year. Our segment is smaller than that, and that's the segment we are attacking. So our obviously international we don't have any volume.Our Mercury volume, I mean our water market is really low as well. So we will see strong growth rates in both of those markets as they begin to mature. As we get into them, and we see success, we'll give more updates on what the size and the opportunity for us to get into them are. The purpose of us talking about them is because there are areas that we haven't looked at, and our current capabilities can get into those.So we wanted to make sure we are transparent but there is broader opportunity. And again, we'll update on what the what the size, and our addressable component are going to be in later quarters.

Understood. So it is a mid-to-longer term target market.

Yes, it's -- there's some-there's near-term right now in the municipal side. We're selling into that and we are winning contracts within that. But we when -- so and we expect this year to be good. But really, this is new for us. So I'd like to articulate, sometime when we -- when we can say OK here's what our revenue is now and here's what the future is going to be. So we just need some time to make sure we can execute and then provide a key tight guidelines for what we think the expectations are further. So it's not mid or even long-term. I mean, it's for water, it's happening today.

What's happened. Understood. I know, I said it was the last question, but just one more clarification. In addition to the 12 million target that you will achieve this month, are there any, should we expect additional installs or deployments over the next two quarters?

Yes. We're -- in and I'm going to sound like a broken record but I feel really good about additional closures. Like I said in the script, the when and the timing with refined coal we're -- unless it's really tight, like we -- like we were just announcing that we feel good about one that's going to close this month, for us to really get tight on when the timing is going to be and our conviction around it. We'll just update you when we get close. But we are spending money. We have a lot of discussions. So we feel good about the prospect of additional closures in 2019. But we'll give an update on timing as we as we get closer.

Great. Thanks a lot. Thanks for taking my…

Thank you.

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

Well thanks to everybody for your time today. We really appreciate you joining and we look forward to updating you next quarter. Take care.

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