Arq, Inc. (ARQ) Q1 2023 Earnings Call Transcript

Good morning. Thank you for attending today's Advanced Emissions Solutions Q1 2023 Earnings Conference Call. My name is Alexis, and I will be your moderator for today's call.

Thank you, and good morning, everyone, and thank you for joining us today for our first quarter 2023 earnings results call. With me on the call are Greg Marken, Chief Executive Officer and President; as well as Morgan Fields, Chief Accounting Officer. This conference 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, 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, those factors identified on Slide 2 of today's slide presentation, in our Form 10-Q for the quarter ended March 31, 2023, 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 forward-looking statements to reflect future events, developments or changed circumstances or for any other reason. In addition, it is especially important to review the presentation and today's remarks in conjunction with the GAAP references in the financial statements. Please turn to Slide 3 of today's presentation, which provides our Q1 highlights. With that, I'd like to turn the call over to Greg.

Thank you, Ryan, and thanks to everyone for joining us this morning. I'd like to start by providing a high-level review of our first quarter, then discuss some of the initial steps we have taken to advance our business plan related to the ARQ transaction and related integration. Our first quarter Consumables Revenue was $20.8 million compared to $26.4 million in the prior year, which was below our expectations as significantly lower natural gas prices relative to the last 18 to 24 months impacted demand among our power generation customers. The potential for persistently lower natural gas prices could have an ongoing adverse impact on demand from our power generation customers and operations at Red River. However, more importantly, this economic environment underscores the importance of our acquisition of ARQ and our transformation strategy to begin producing new granular activated carbon or GAC products going forward, thus reducing our reliance on certain markets and industries over time, and broadening the addressable markets for our activated carbon technologies. Although this transition will take time due to the capital improvements required, we believe that we will be able to operate a highly utilized asset base during this transition period, and we'll be well positioned to diversify the end markets we sell to and capitalize on the broader, long-term growth opportunities available within the GAC markets. The near-term impact of lower sales volumes from Red River were partially offset by our ongoing price initiatives and commercial wins in water and industrial markets. As a reminder, we have focused our sales strategy on higher-value opportunities with improved economic and commercial terms. We expect that this approach, coupled with continued efforts in our pricing strategy will help offset portions of the softer volumes in our legacy markets. During 2023, we expect that our margins will continue to be pressured by the higher cost per unit of production, resulting from decreased power generation volumes compared to expectations. External sourcing of supplemental carbon, albeit at reduced volumes as well as inflationary impacts on a number of operational costs. In April, we completed our regularly scheduled plant turnaround event that occurs on a periodic basis, typically every 18 to 24 months and lasts for approximately 2 weeks. We were pleased with the planning and execution of the plant turnaround by our team, and we have returned to normal operations on our anticipated timeline. During the turnaround, we continued to meet all customer obligations with inventory on hand and did not encounter any commercial disruptions. In March, we completed the sale of Marshall Mine to Caddo Creek Resources Company and recognized a gain of $2.7 million. The removal of the asset retirement obligation associated with the Marshall Mine allows us to continue to derisk our balance sheet as we focus on our future initiatives related to the ARQ assets and integration, as well as freeing up approximately $2.3 million of restricted cash that was previously held as cash collateral pursuant to our bonding program. Upon the closing of the ARQ acquisition, we welcomed three new board members from the legacy ARQ business. Julian McIntyre, Jeremy Blank and Richard Campbell-Breeden. Each brings valuable experience that will be critical to the execution of our business plan. We also announced last month that Laurie Bergman will join our Board in June as an independent director and will serve as the Chair of our Audit Committee. Laurie is a proven financial executive with highly relevant industry experience, and we look forward to her leadership as we execute on the next phase of the business strategy. Turning to our capital plan and cost update. During Q1, we commenced the initial capital projects to upgrade the Corbin and Red River plants, which will facilitate our future ability to produce commercial scale GAC and leverage our new high-performance and vertically integrated bituminous-based feedstock. At Corbin, engineers, contractors and equipment have been selected related to the major components of the capital project, and purchasing of long lead items is underway. At Red River, where we anticipate spending the majority of the capital, we made progress related to equipment scoping and have completed engineering steps necessary to keep us on track to move forward with permitting at the applicable regulatory agencies during the second quarter. These collective initial capital projects are on track, and we believe these investments will ultimately lead to a more diversified commercial portfolio with a path towards improved and sustainable economic performance for our business on a long-term basis. Consistent with our plan, we expect that the aggregate growth CapEx related to these projects will be between $45 million and $50 million, of which, roughly $27 million to $30 million will be incurred in the current year. Our total CapEx spend for 2023 is expected to be between $40 million and $45 million, with the balance relating to our regularly scheduled plant turnaround and other capital projects. We've also begun to take actions to achieve the planned go-forward operating cost structure for the combined company, such as streamlining personnel and systems, optimizing overall operations as well as other items. We will continue to evaluate ways to simplify the overall organization and operations but are on track to achieving a go-forward cost structure consistent with our plans, while maintaining the ability to achieve the growth initiatives inherent in our business plan. In addition to commencing the initial capital improvements to the Red River and Corbin facilities, we are simultaneously focused on expanding the sales channels to identify and secure lead GAC customers once commercial production of GAC products utilizing ARQ powder begins. Part of that process involves engaging in a more visible and proactive marketing approach to increase awareness of our company and our overall suite of environmental technologies that we will bring to potential customers. During the first quarter, our Chief Technology Officer, Joe Wong; and our Vice President of Sales, Oscar Velasquez participated in multiple technical speaking engagements and conferences designed to strengthen our remediation market base, discuss our product applications and drive awareness around our suite of current and potential products, including GAC, PAC and Colloidal carbons. We expect to participate in future events in order to demonstrate the expanded joint product portfolio and capabilities of the combined company. And lastly, we remain focused on developing opportunities for emerging markets and applications for ARQ powder, which will continue to derisk the business by diversifying our revenue mix. We are pleased to have completed the acquisition of ARQ during the first quarter, which we believe is the right step in driving long-term growth and value creation. Our combined company will enjoy a diverse portfolio of products and customers in a much larger addressable market due to an enhanced feedstock portfolio and production capabilities, which will result in higher margin opportunities within the activated carbon market as well as providing access to additional potential revenue streams that would have been previously unattainable for our business as previously positioned. I'll talk a little bit more about our milestones for 2023. But first, I'd like to turn the call over to Morgan to review our first quarter results in greater detail.

Thank you, Greg. Slide 4 presents an overview of our financial results for the first quarter. Our first quarter revenues and costs were $20.8 million and $17.2 million, respectively, down from $26.4 million and $21.5 million in the same quarter of 2022. This revenue drop was primarily due to decreased sales of consumable products linked to lower natural gas prices, which reduced demand from our power generation customers. However, this decline was somewhat mitigated by higher average selling prices for consumables. Other operating expenses for the first quarter reached $11.5 million, compared to $8.2 million in the same quarter of the previous year. The increase stemmed mainly from higher legal and professional fees related to the company's strategic review and the closing of the ARQ acquisition, along with additional payroll and benefits costs and operating expenses from ARQ activities post-acquisition. This rise in expenses was partially offset by a $2.7 million gain from the sale of Marshall Mine. As Greg mentioned, we are already implementing measures to achieve our anticipated ongoing operating cost structure for the merged company by integrating the organizations to realize cost synergies and efficiencies. The operating loss for the first quarter was $7.8 million, compared to $3.3 million the previous year, largely due to lower consumables revenue influenced by the factors mentioned earlier and the added transaction and integration costs of $3.6 million associated with acquiring ARQ. First quarter interest expense amounted to $0.5 million, up from $0.1 million last year, driven by $0.3 million of additional interest from the company's new $10 million term loan, along with interest from ARQ's existing term loan. We recorded a modest income tax benefit for the first quarter of 2023, unlike the previous year when there was no income tax expense. The first quarter net loss was $7.5 million or $0.32 per diluted share, compared to a net loss of $3 million or $0.17 per share last year. This decline was attributed to lower operating earnings resulting from decreased consumable sales. The consolidated adjusted EBITDA for the first quarter was a loss of $7.7 million, compared to a positive adjusted EBITDA of $0.9 million in 2022. The drop in consolidated adjusted EBITDA was primarily due to the larger year-over-year net loss, which included $4.4 million in transaction and integration costs related to the ARQ acquisition versus $0.8 million in the previous year. The current year also accounts for $0.9 million in additional ARQ payroll and benefit costs since the acquisition date compared to the prior year. Cash balances as of March 31, 2023, which includes restricted cash, totaled $79.1 million, up from $76.4 million as of December 31, 2022. Total debt, including financing leases, stood at $21.7 million as of March 31, 2023, compared to $4.6 million as of December 31, 2022. This increase was largely due to the term loan related to the acquisition and the assumption of ARQ's existing term loan. As Greg stated, the sale of the Marshall Mine was finalized in March, leading to the removal of the asset retirement obligation from our balance sheet and the transfer of future cash outflows associated with mine reclamation to the buyer. In April, we received the release of approximately $2.3 million in restricted cash that was previously held in escrow as collateral for our surety bond portfolio. First quarter capital expenditures were $3.6 million, up from $1.5 million last year. This increase resulted from initial costs related to capital growth projects and higher spending in preparation for our periodic plant turnaround. As Greg mentioned, we anticipate capital expenditures between $40 million and $45 million in 2023, driven by improvements to ensure GAC production and the plant turnaround, as well as the completion of other capital projects, including those initiated in 2022 that will be finalized in the first half of 2023.

Thanks, Morgan. Slide 5 shows the strong foundation we continue to build upon to become a leading environmental solutions provider. We are currently a top 3 producer of activated carbon products in North America with a market share of approximately 17%. However, we are currently able to only serve an estimated 30% to 35% of the activated carbon market with our lignite-based portfolio of products. Post-acquisition, utilizing both our existing lignite-based feedstock and ARQ powder as a bituminous-based feedstock we will be well positioned to provide activated carbon products that could serve more than 80% of the North American activated carbon market. This will inherently reduce our exposure to certain end markets and leave us less susceptible to headwinds that we are currently experiencing in our existing business. Additionally, as we complete the growth capital projects to integrate ARQ powder, we will reposition, utilization capabilities of our existing assets towards GAC products that generally provide higher value and higher-margin opportunities in markets that are expected to continue to have growth in demand for years to come. We have proven sales channels and more than 100 current customers, many of which provide potential entry points for the expanded markets we will enter as we look to accelerate our sales of GAC products when the capital improvements at our facilities are completed. Our commercial and technical teams have a proven track record of success in new markets. We expect our historical track record to continue to drive accelerated market acceptance of our new GAC and overall suite of activated carbon products and ultimately enhance our ability to win new business in these emerging market segments. We will be the only vertically integrated activated carbon producer in North America for our primary feedstock needs, from material sourcing to manufacturing to distribution. We expect this integration to yield sustainable long-term cost advantages and provide a distinct competitive advantage when the production of GAC products from ARQ powder begins in 2024. And lastly, we are well positioned to benefit from a changing regulatory landscape as the need to control and remediate the release of harmful chemicals into our air and water evolves. We continue to develop products to be potential solutions to emerging soil and groundwater regulations focused on forever chemicals such as PFOS. We expect to further expand upon and utilize our improved ESG profile to support and contribute to our customers' sustainability goals in a world increasingly focused on the preservation of its natural resources. Overall, the new combined company provides us with a longer-term, sustainable and diversified product mix and facilitates participation in higher-margin activated carbon products and end markets. Finally, Slide 6 lists our areas of focus for 2023. First and foremost, we will continue to operate our Red River plant as we have while looking to continue to grow and improve our existing business. We are focused on maintaining high renewal rates with existing customers and being focused in our bidding process in order to align new and renewed contracts to maximize our top line opportunities. As it relates to ARQ, our first priority will be the integration of the ARQ team, assets and operations. We are pleased with the integration efforts to date and are encouraged by the enthusiasm of our collective teams to begin executing our combined transformative business plan. Operationally, our key focus will be on progressing the capital work to optimize both the Corbin and Red River facilities for industrial scale production of ARQ powder and GAC products. The most significant of these modifications relate to the Red River plant and include the installation of new shaping and heat treatment processes to enable the processing of bituminous-based feedstock to manufacture new and higher-value GAC products. The capital projects will not interrupt our ongoing manufacturing operations or sales opportunities. Our focus will also be on securing lead customers and building our sales channels within the North American market for GAC and other emerging products. We expect to undertake further product testing with potential customers for GAC and other activated carbon products, which we believe will provide an opportunity to capitalize on the expanded capabilities in 2024 when the initial growth capital improvements are completed. Additionally, we will continue to progress the technical feasibility of other potential products for emerging markets during 2023 and beyond. To conclude, while our first quarter results were down compared to our prior year, it underscores the importance of securing a bituminous-based feedstock in acquiring ARQ. The combined company will be able to pursue end markets served by both powder and granular activated carbon products, greatly expanding our market breadth and reducing our reliance on power generation and when complete, will position the business to be the only completely vertically integrated, activated carbon provider for our primary feedstock needs from primary material to distribution. This market expansion, and diversification of our product portfolio and cost-competitive position of the new company are all expected to create a materially improved earnings profile and a more resilient company. With that, I will turn the call back over to our operator to move us to Q&A.

I have a couple of questions. I want to start on the capital project side. We have Corbin and Red River and want to ask about them independently. So one of the risks that we're watching is just timeline of investments and sort of what are the gating factors or key milestones to make sure those projects stay on time for completion production, et cetera. So could you maybe just outline each for Corbin and separately for Red River, what are some of the key areas that we should be looking at for investments in and meeting those milestones? Obviously, I think Red River is going to be a little bit more, I don't want to say challenging, but there is probably a little more risk or a little bit more challenge around Red River than Corbin.

Yes. Let me start with Corbin. I agree that this project is relatively straightforward. We're aiming to complete all related projects by the end of the first quarter of 2024. We're on track, having initiated three major capital projects immediately after the acquisition. The first area involves upgrading equipment to enhance water processing capabilities, which is essential for throughput and ongoing operations. It requires a significant water inflow, even though it's a closed-loop system, so we need to boost those capabilities. The second focus is on automating the plant further for more dependable and efficient operations. When ARQ built it, automation was only partial, and we're working to complete that to align it more closely with Red River's operations. Lastly, we need to improve equipment for handling the finished product, whether it goes to Red River or other customers. We're adhering to the detailed project plan and have selected the engineers, contractors, and equipment for Corbin, with long lead items already purchased or in the buying process. I'm satisfied with our progress on Corbin. Regarding Red River, you’re correct that it is the larger and more complex project of the two, involving more financial investment and complications. The technology and equipment for shaping and heating processes to produce GAC products, along with our existing furnace capabilities, are well underway. A key milestone in the first quarter was completing the detailed engineering and additional testing to support the permit filing with regulatory agencies in the second quarter. We're still on schedule to complete that by the end of the third quarter of 2024. Overall, I'm very pleased with our progress. We’ve started strong, but it's crucial that we continue to execute consistently throughout these projects.

Got it. Let's talk about engaging lead customers. You're getting Red River and Corbin up and running, but at the same time, Joe and Oscar are actively promoting the granular activated carbon product. Can you provide more details about the process of seeding the market? Are municipalities or end customers testing the materials to understand how you’re making them comfortable with the product and preparing them for its arrival?

I’ll break it down into a couple of components, Gerry. From what we're doing actively in the marketplace, attending and speaking at conferences, the development of relationships is really critical. We'll invest time and energy in that until we come online, making sure we establish the right relationships, which are key. In addition, we are engaging with both municipal water customers and other early adopters. We're conducting pilot scale and larger quantity testing to validate product performance based on what we observed during the diligence process. We're having these customers perform testing, and we'll do this across multiple end markets with various customers. The process in municipal water is a bit more transparent, while the relationships with lead adopters will be longer-term. All of this involves testing, and we're currently undertaking it.

Got it. Any initial feedback or still too early?

Yes. The feedback has been very, very consistent, Gerry, with what we kind of put out in some previous presentations, product performs really, really well. It's very high quality. And so we're seeing some very, very good results across multiple industries, which we're very excited about.

Got it. Switching to ARQ powder, you mentioned in your prepared remarks that there is also an opportunity there. We've discussed aspects like fuel and asphalt. How does that fit into the opportunity chain as we assess it?

Yes. So a final outlet for ARQ powder, it is important, Gerry. But if I would order it in relative timing and ability to get to market, I think the known one for sure is activated carbon. ARQ powder can definitively serve as a feedstock to allow us to do that. We need to continue to go through the technical and commercial development related to other ARQ powder outlets. I think ARQ has done a lot of really good work, but there are still additional hurdles and a little bit more proving out of the potential outlets. I think it's important because ultimately, it will result in full utilization of the Corbin facility if we're able to do that. But there's additional technical and commercial work that needs to be done to get over those hurdles. And that timing is probably a little more uncertain.

Okay. That's fair. And then just one thing I wanted to confirm, right? So I think in the quarter, if I heard it right, there was about $4.4 million of professional fees, merger costs, etc. And this was not backed out of the $7.7 million EBITDA loss, is that correct?

That's correct, Gerry. There is a footnote below it, where it does give that information, but that is correct.

Okay. Got it. That's it for me, I appreciate it, thanks for all the answers, Greg.

Yes. Thanks for jumping on, Gerry, appreciate it.

There are currently no further questions in the queue. I will now pass the line back to the management team for closing or additional remarks.

Thank you, and thanks to everyone for joining the call this morning. Our business plan for the new Advanced Emissions Solutions is underway, and we are excited about the company's prospects of becoming an environmental technology leader. We look forward to speaking with everyone soon and updating everyone on our next call.

That concludes the Advanced Emission Solutions Q1 2023 Earnings Conference Call. Thank you for your participation. You may now disconnect your lines.