Arq, Inc. (ARQ) Q3 2019 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. And welcome to the Advanced Emissions Solutions Q3, 2019 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session [Operator Instructions]. Please be advised that today's conference is being recorded [Operator Instructions].I would now like to hand the conference over to your speaker today, Ryan Coleman, Investor Relations. Thank you. Please go ahead.

Thank you, Rob. Good morning, everyone. And thank you for joining us today for our third quarter 2019 earnings results call. With me on the call this morning are Heath Sampson, President and Chief Executive Officer and Greg Marken, Chief Financial Officer. This conference call is being webcast live in the Investor section of our Web site, 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 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, factors identified on Slide 2 of today's slide presentation, in our Form 10-Q for the quarter ended September 30, 2019 and other filings with the Securities and Exchange Commission. Except as expressly required by the securities laws, the Company undertakes no obligation to update those factors or any 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'd like to turn the call over to Heath Sampson. Heath?

Thanks, Ryan. And thanks everyone for joining us this morning. Let’s begin on Slide 3 and review our third quarter. RC distributions from Tinuum Group, as well as our RC segment operating income, were both strong and in line with our expectations during the quarter. Both were significantly higher than the prior year, driven primarily by the five additional invested RC facilities that we have added since then. During the third quarter alone, we added two facilities, bringing our year to date contracted tonnage to roughly 15 million and comfortably exceeding our previously guided 12 million incremental tons.In our PGI segment, our results were hampered by many of the same issues we outlined during the second quarter call. Coal dispatch has been weak and cheap fuel source alternatives to coal have had a significant impact on our core mercury capture for coal-fired power generation. This market is where we are best positioned today in the PGI segment and thus, these cheap alternative fuels have hurt our volumes.However, there are adjacent opportunities agnostic to coal burn that we have been aggressively pursuing and having success. For example, we have identified several industrial and municipal customers who have activated carbon need, and we are winning incremental volume in these areas. The widespread use and versatility of activated carbon as a purifying agent allows us the flexibility to not be reliant on a single market application. So we will continue to pursue customers and opportunities where we are competitive. Although, we do not yet have all the products, we have the most important competitive advantage, the largest and lowest cost manufacturing plant. And as a reminder, originally costs nearly $400 million to build. I'll talk about these new opportunities later in the call.We have executed in line with our expectations commercially, but the coal-fired power market hampered our third quarter results for our PGI segment. Although, we are disappointed with the short-term market impact, we remain excited about our long run expectations due to our unique competitive advantages. We are winning and renewing contracts well above historical levels. Our third quarter performance, coupled with our current and expected third quarter wins, will ensure we have a strong base of full-year volume going into 2020.In the meantime, we are continuing to generate strong net cash flows in our RC segment, which facilitates our organic investment in the business, as well as other capital allocation priorities. We are reducing our term loan balance and returning cash to shareholders through our quarterly dividend and opportunistic share buybacks.Looking ahead, the opportunity presented to us by a market-leading activated carbon asset continues to have significant long-term potential. Ongoing positive feedback from customers around our offerings, high retention rates and new customer wins, have us encouraged. The pollution control market for coal-fired power remains fragmented and most sub-scale providers are unable to gain market share or even survive. As such, we will continue to evaluate key opportunities to capitalize on the platform we have. The platform remains uniquely strategic underutilized assets that provide multiple ways to drive future growth and shareholder value.I'll discuss our forward vision in greater detail after Greg reviews our third quarter. Greg?

Thanks, Heath. Let's start on Slide 4 for our third quarter financial results. Earnings from equity method investments totaled $14.4 million compared to $9.7 million in the prior year. The significant increase was driven by five incremental RC facilities invested since the third quarter of 2018 with total equity earnings of $57.1 million compared to $37.9 million on a full year basis.As a reminder, Tinuum's adoption of the new revenue and lease accounting rules also impacted this increase. We recorded a cumulative adjustment of $28.8 million related to the company's percentage of Tinuum Group's cumulative effect adjustment that increased Tinuum's retained earnings, but those amounts now will not impact our future earnings. We no longer have cumulative cash distributions in excess of our cumulative pro-rata share of Tinuum Group's net income. Therefore, we recognized equity earnings by recording our pro-rata share of Tinuum's net income rather than based on cash distributions during 2019. I want to also reiterate that this accounting standard adoption does not affect the timing or total potential future cash flows from our RC segment from Tinuum.Third quarter consolidated revenue of $19.1 million was also significantly higher than $5.1 million one year ago, driven by the meaningful contribution from Carbon Solutions consumables and additional royalty-bearing RC facilities. Revenue in the nine month period ended September 30, 2019 totaled $54 million compared to $13.3 million in the comparable period in 2018. Within that consolidated revenue, third quarter consumables revenue totaled $14.8 million. This was significantly higher than the prior year, again driven by the Carbon Solutions contributions.Third quarter royalty earnings were also higher year-over-year, totaling $4.4 million versus $4.1 million in 2018. Royalty earnings in the nine months ended September 30, 2019 totaled $12.8 million compared to $10.9 million in 2018. This increase is a result of the additional royalty-bearing facilities invested. As of September 30, 2019, there were 16 royalty bearing facilities operating compared to just 11 during the third quarter of 2018.Our non-cost of revenue operating expense was higher year-over-year, driven by greater SG&A costs, which are largely related to the combined personnel of both entities, as well as the integration efforts related to the acquisition of Carbon Solutions, net of personnel synergies achieved earlier this year. More specifically, third quarter other operating expenses were $9.6 million compared to $4.2 million in third quarter of 2018. On a year-to-date basis, other operating expenses totaled $25.9 million compared to $14.3 million in the third quarter of 2018. Depreciation expense contributed $2 million and $4.6 million of these increases in the respective periods.Pre-tax income for the third quarter was $10.5 million versus $9.4 million in the third quarter of 2018. Net income for the third quarter was $3.9 million compared to net income of $5.5 million in the third quarter of 2018. The decrease was driven by substantially higher income tax expense compared to prior year, driven by an increase in the valuation allowance for deferred tax assets. On a year-to-date basis, earnings were negatively impacted by $5 million, but none of this impact was in the quarter related to the amortization of a step-up in basis of acquired finished goods inventory in connection with purchase accounting adjustments.Net income during the first nine months totaled $26.4 million, a 7% decrease from $28.5 million during the first nine months 2018. The changes in net income during the third quarter and first nine months were primarily driven by higher interest expense and tax expense during the current year periods, partially offset by higher equity earnings from Tinuum compared to the same periods in 2018.Consolidated EBITDA for the third quarter was $14.2 million, an increase of $4.4 million over the third quarter of 2018. Consolidated EBITDA for the nine-month period ended September 30, 2019 totaled $52 million compared to $34.9 million in the comparable period in 2018. Our total cash position as of September 30, 2019 was $20.2 million, of which $5 million is restricted as a result of the term loan undertaken to acquire Carbon Solutions.Total cash was down from levels seen at the end of 2018 for a few reasons; drivers include dividend payments, debt repayment, CapEx and year-to-date cash usage from share repurchases of $2.9 million. In November 2018, the Board authorized $20 million share repurchase program on top of our previous repurchase 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. To this point, as announced yesterday, the Board authorized an increase in the amount available in this stock repurchase program to $10 million and the program will remain in effect until all amounts are utilized or the program is otherwise modified by the Board.Lastly, as of September 30, 2019, the outstanding principal balance of the senior term loan was $46 million. The senior term loan was used to finance our acquisition of Carbon Solutions and is subject to quarterly principal payments of $6 million that began on March 1st of this year. During the third quarter, we made an $8 million principal payment 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.

Thanks, Greg. I'd like to take a moment to discuss our outlook. Turning to Slide 5, you can see the update to our expected future RC cash flows. As of September 30, 2019, we are updating our expected net RC cash flows to a range between $150 million to $175 million to ADES through the end of 2021. This range is after $23 million of RC distributions collected during the third quarter and inclusive of the two units added during this period.Unlike most quarters where changes to our forward RC cash flow guidance is typically related to netting the amount of distributions collected versus incremental tonnage added, the third quarter saw few different moving parts. All-in-all, they amounted to an approximate 6% contraction to our contracted cash flows. Before I summarize the puts and takes, I want to remind everyone that this reduction is for contracted amounts as of September 30th, as we do not increase these cash flows for anything we may expect to add.First, throughout the current year, there has been a broad-based reduction in coal consumption, largely due to lower natural gas prices, as well as unusually lower temperatures during the first half of 2019. As a result of the reduction in coal consumption, during the third quarter, Tinuum Group restructured RC facility contract leases with its largest customer, which will decrease lease payments beginning in the third quarter of 2019.Second, there were two plant closures that were announced by utilities during the third quarter where Tinuum had an invested RC facility on site. One particular closure in Illinois was spun by our regulatory settlement that required a large power company to quickly shut down two gigawatts of coal-fired power by the end of this year. While the closure was not expected, Tinuum is proactively working to relocate some of this particular tax equity investment at a new utility site, and retain a portion of the previously expected cash flows. However, as these potential cash flows from relocation are not yet contracted, they are not included within our future RC cash flow estimates. We look forward to updating you all on our progress here.Finally, during the third quarter, Tinuum updated its estimate for asset utilized related to RC facilities. The impact the amount of -- this impacts the amount of depreciation expense during the period of Q3, 2019 through the end of 2021, and decreases royalty earnings as the royalties are based upon refined coal payments less expenses, inclusive of depreciation. As a result of the higher depreciation, we expect our future royalty earnings to be approximately $0.35 per ton as opposed to the previous $0.40 ton estimate. As always, future incremental invested RC facilities will positively impact our expectation of future earnings and distributions.To this point, Tinuum had active ongoing conversations with potential tax equity investors for additional facilities. Should these deals be finalized, they have the potential to add an additional 69 million in annual tons. In addition to these more profitable opportunities, Tinuum has installed or partially installed facilities totaling another 5 million to 8 million tons that need to have clear specific near term milestones passed. Before we can handicap the likelihood of closure, these milestones need to be passed.Lastly, there are other willing investors that are in the early stages with that they provide future incremental tonnage. As such, we continue to be optimistic related to Tinuum's ability to obtain incremental cash flows through additional RC facility closures, as well as the potential to relocate the RC facilities that were closed at utilities that were announced earlier.Let's flip to Slide 6 and review the growth opportunities for our new asset. This slide shows our roadmap for the new ADES and how we plan to leverage our new assets to become the North American leader in 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 hindered by the poor coal-fired power dispatch in both the quarter and this entire year. This directly negatively impacted our consumable product sales in the PGI segment.However, with a broader view, our discussions with both existing and potential future customers are leaving us excited about our position to market that we are winning in. With the wins we have had in 2019, our run rate volume is already 15% to 20% higher going into 2020. The mercury control market in North America is competitive and has more than a few changes over the past years. Many coal-fired power generators are increasingly cost conscious, and no longer have the bandwidth or resources to compete at a significant scale. They are now looking for a fewer strategic vendors who can provide more for less.With our combined offerings, we are best positioned to be the supplier of choice for this changing power market. While the coal-fired power market has been pressured in recent years, we see our total addressable mercury control market expanded by approximately 25% in 2021 and '22 as refined coal expires, and utilities seek alternative cleansing mechanisms for coal currently treated by refined coal.Also, as I briefly mentioned, industrial markets while competitive are not impacted by coal burn, and must also comply with applicable emission regulations. We have been expanding our customer base here and have realigned more sales and product personnel to this area. Earlier this year, we have talked about a significant win of a customer, and our commercial team continues to identify opportunities in this area that we believe our existing products can address.We also expect additional diversification as we grow the municipal water business, and look forward to updating you all on our progress after the fourth quarter as we have many opportunities in November and December. These are the type of wins we expect to replicate moving forward to drive volumes into 2020. Additionally, our high renewal rates and new wins are validating that our combined offerings provide new volume as a combined platform. As a reminder, these contracts are typically longer than one year, and we must wait to compete as these contracts come up for bid.That being said, the second half of this year had more bids than the first half of 2019, and we expect those to translate to better volumes as well. Just recently, we were able to obtain multiple wins in both the power generation and industrial markets that will be significant to setting the stage to improved volumes and performance in 2020. Again, just with the wins we had today, our base is 15% to 20% higher.Next, we are also positioned 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 resellers. To better position ourselves in this space, we have made incremental capital investments to advanced product performance and have focused some of existing personnel here.We have already seen these investments pay off and believe this will lead to positive longer-term results within the municipal water activated carbon market. Longer term and consistent with our belief in the purchase of the Carbon Solution assets as the low cost manufacturer, coupled with our commercial and R&D expertise, we will work to optimize the portfolio that drives higher growth across the broader spectrum of the activated carbon market.In summary, we're encouraged by the momentum of bids and opportunities here in the second half of the year, and expect to capitalize them as we progress through 2020. In the meantime, our strong projected future cash flows in excess of the term loan balance, offers us incredible flexibility as we position ourselves for the future of this operation.Moving to Slide 7, reviews our capital allocation program. Since the start of the capital allocation program in the second quarter of 2017, the company has paid nearly $50 million in dividends and utilized capital of over $44 million to repurchase shares. We paid our third quarter dividend on September 6th and the fourth quarter dividend, declared yesterday will be paid on December 13th. As Greg mentioned, we made another $8 million payment this quarter against the principal of our term loan, bringing our year-to-date debt reduction to $24 million and our remaining debt balance to $46 million. We expect to continue to pay down our debt, while paying our quarterly dividend and opportunistic share repurchases. These initiatives remain a key focus of ours, and we believe we generate cash flows to both honor our capital return commitments and invest in the business.Finally, let's close with the 2019 priorities on Slide 8. As always, our ongoing commitment to leasing additional RC facilities and supporting Tinuum in these 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 ongoing integration and expansion of our newly acquired assets, people and operations to immediately capture share in the North American mercury control market and municipal water activated carbon market. We will also evaluate and pursue the adjacent attractive opportunities in other verticals, which we are beginning to do now. And finally, we will continue to return capital to our shareholders through our dividend program, as well as the opportunistic repurchasing of outstanding shares.So with that, we will take questions.

[Operator Instructions] Your first question comes from the line of Amit Dayal from H. C. Wainwright. Your line is open.

So Heath, just looking at the RC and Tinuum side of the business, with all of these drivers in play right now, including weather, competitive factors, et cetera, when we look at 4Q '19, your expectations for that quarter versus what you saw in the third quarter. I mean, should we anticipate similar performance in the fourth quarter relative to the third quarter?

So just to backup a little bit. When we were entering really this year and the end of last year, we thought that the refined coal investments would decline, because there is around two years left. We were right in some sense. But in the other side of things, we were surprised by how there are additional investors that want to take advantage of refined coal, even for these last two years. So we guided to 12 million tons a few quarters ago, we over achieved that and then we thought we would be done.However, we're not. And then we gave the numbers that we were in current discussions with now that we expect to close. And even beyond that, there is a few other that we expect to close beyond that. So we're pleasantly surprised that our pipeline is full and we should have more closures beyond what we are disclosing today. So we'll have those cash flows that we just talked about here, the $150 million to $175 million and we hope to add on those based on the tonnage that we talked about a little bit earlier.

And these two RC units that are expiring in the fourth quarter. Are these available to maybe new investors or are these done, is there tenure over basically…

Yes, they're done. And only one of those was installed, the other 2019 was not in our cash flows, nor installed. And we've always had that in our cash flow projections and it's in the $150 million to $175 million that we talked about. So yes, they're expired at the end of this year.

And then in the prior quarter you talked about plant maintenance impacting some performance, are those efforts out of the way now, and are you kind of functioning at the levels you were looking to?

As expected, we knew we had to make some investments to ensure that our manufacturing assets were where we wanted to be. So we made those one-time investments to get to the plant to where we wanted to. So we expect a more normal run rate going forward.

And then on the PGI side of things. Right now, we're still sort of in the mercury as our key product line, mercury related offerings. In terms of your product roadmap, can we look for in terms of new products or solutions you're working on and the timeline for maybe introducing these?

So in mercury, though it's hurt this year by just coal-fired power going down, we are still well positioned to gain market share. In addition, what we talked about, as refined coal rolls off, that market is going to expand. Right now, we estimate it's about approximately 25% expansion. So we are in a really good position to capitalize on that. So, though it may seem that the mercury control market is under pressure and it is, because of our capabilities, because of our asset that will continue to be a strategic part for us and we will continue to see growth opportunity within that.That being said and we talked about this it does make sense for us to diversify. One , because we have the asset and we have the availability to expand coupled with our technical expertise, we are able to move into adjacent market. Already we've been doing that, whether that's the industrial market or in the municipal water market. That is our current focus right now, but there is a lot of opportunities beyond that. So we are taking it as fast as we can, but still be very deliberate to ensure that we protect our current business and make sure that when we're grabbing this new business that is sticky for us. So again, as you may or may not know the activated carbon market is very large and we're excited about the future and we'll continue to execute as we articulated in our strategy outlook.

[Operator Instructions] And we have no further questions at this time. I'll turn the call back to our presenters.

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

Ladies and gentlemen, thank you for your participation. This concludes today's conference call. And you may now disconnect.