Arq - Q4 2022

Transcript

Operator (participant)

Welcome to the Advanced Emissions Solutions Q4 2022 Earnings Call. My name is Lauren. I'll be coordinating your call today. There'll be an opportunity for questions at the end of the presentation. If you would like to ask a question, please press star followed by one on your telephone keypad. I will now hand you over to your host, Ryan Coleman, with Investor Relations to begin. Ryan, please go ahead.

Ryan Coleman (Managing Director)

Thank you. Good morning, everyone. Thank you for joining us today for the Fourth Quarter and Full Year 2022 Earnings Results Call. With me on the call this morning are Greg Marken, Chief Executive Officer, President, and Treasurer, as well as Morgan Fields, Chief Accounting Officer. This call is being webcasted live within the investor 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 includes 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 two of today's slide presentation in our Form 10-K for the year ended December 31, 2022, 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 especially important to review the presentation and today's remarks in conjunction with the GAAP references in the financial statements. With that, I'll turn the call over to Greg.

Greg Marken (CEO and President)

Thank you, Ryan, and thanks to everyone for joining us this morning. This is our first earnings call since the closing of the Arq acquisition. As such, I'd like to extend a special welcome to our new team members from Arq, as well as any new shareholders who are joining on today's call. We are truly excited as we begin executing our new plan to transform and capitalize on the complementary nature of our combined assets and teams to become a diversified leading environmental technology company. I'll cover more on this transformative plan, which will begin in 2023, but first, I'd like to review our fourth quarter and full year 2022 results. We delivered a solid fourth quarter of consumable sales and production at Red River, which culminated in a record full-year revenue performance exceeding our original expectations for 2022.

Consumables revenue for the quarter was $23.4 million compared to $23.2 million in the prior year. Our fourth quarter production and sales revenue remained strong. The volumes were not as strong as what we had seen in prior quarters with the elevated average natural gas pricing experienced early in the year. The declining natural gas prices during much of the fourth quarter lowered demand from our power generation customers, which we have continued to see during the first quarter of 2023. Our full year total revenue of $103 million represents a year-over-year increase compared to the prior year despite $14 million of royalties from our Tinuum investments in 2021 that did not occur in 2022 due to the conclusion of the Section 45 tax credit generation period at the end of 2021.

Looking solely at our consumables revenues, they increased 20% year-over-year due to a combination of strong demand from power generation customers, pricing initiatives, and product mix improvements. For the quarter, we reported a net loss of $3.2 million compared to net income of $5.8 million in 2021. We recorded an adjusted EBITDA loss of $1.2 million compared to adjusted EBITDA of $9.1 million in 2021. The variance in year-over-year result is primarily the effect of the wind-down of our Tinuum investments in 2021 and additional costs in the current year related to our strategic process. Our Red River production volume during the quarter was lower than anticipated due to incremental unplanned downtime for maintenance.

However, our full year 2022 production volume, including the impact of blended carbons, exceeded our overall expectations. While our operations may continue to remain constrained at various points by tight manufacturing capacity, sourcing of product from third parties, and the overall inflationary environment, we continue to improve our inventory position, both from an overall volume and product mix perspective. We ended the year with a strong cash position of $76.4 million, which will facilitate our capital expenditure plans for 2023. Those efforts will be focused on growth projects related to the Arq acquisition, as well as ongoing organic investment in our manufacturing assets to continue to enable high production and operational rates from those assets. As a reminder, in September, we announced that we had reached an agreement to sell Marshall Mine to Caddo Creek Resources Company, subject to certain closing conditions.

This transaction will allow us to continue to de-risk our balance sheet as we focus on our future initiatives related to the Arq assets and integration. Upon closing, the asset retirement obligation and other liabilities, which total approximately $4.9 million as of year-end, will be removed from our balance sheet. We expect a portion of our restricted cash to be released as that asset retirement obligation goes away. We continue to expect that the Marshall Mine transaction will close during the first half of this year. Turning to our outlook for 2023, we expect a strong top line as we balance internal actions around pricing initiatives and a diverse sales and commercial pipeline. We acknowledge that persistently lower natural gas prices could hinder demand and revenue performance from our power generation customers, and therefore could also impact other markets.

Of note, our regularly scheduled plant maintenance activity that occurs every two years is scheduled to take place in April. The associated downtime is expected to last approximately two weeks, which is normal for a maintenance exercise of this nature. As we have planned for this downtime, we will ensure that we have sufficient inventory on hand to continue to meet customer demand and minimize any disruption during this period. During 2023, we expect that our margins will continue to be pressured by the higher cost per unit of production as a result of the routine plant turnaround, external sourcing of supplemental carbon, albeit at reduced volumes, as well as inflationary aspects on a number of operational costs.

We are attempting to alleviate these manufacturing cost pressures through increased average selling price and positive changes in our product mix, as well as targeting markets and end-use customers with improved economics. We continue to be encouraged by our ability to realign contracts with current market conditions when possible, and as a result, our ASP continues to trend higher. As mentioned, we are also commencing capital projects to modify the Red River and Corbin sites in order to enable commercial scale GAC and Arq Powder production. In addition, we are taking other technical and commercial steps to position the combined business for success when production and sales of GAC products derived from Arq Powder ultimately begin. We believe these ongoing investments and efforts will lead to a more diversified commercial portfolio with a path towards improved and sustainable economic performance for our business on a long-term basis.

I'll discuss these initiatives in more detail later on the call. Finally, for the full year, we are forecasting approximately $106 million in revenue and an EBITDA loss of roughly $6 million, excluding one-time acquisition costs. With that, I will turn the call over to Morgan to review our financial performance in greater detail.

Morgan Fields (Chief Accounting Officer)

Thank you, Greg. Slide four provides a snapshot of our fourth quarter and full year financial performance. Fourth quarter revenue and cost of revenue were $23.4 million and $17.5 million respectively, compared to $25.8 million and $16.9 million in 2021. Revenues and cost of revenues for the full year were $103 million and $80.5 million respectively, compared to $100.3 million and $65.6 million in 2021. The increase in revenue was primarily driven by higher sales of consumable products as well as successful pricing initiatives, which were partially offset by the non-recurrence of royalty earnings from Tinuum investments that we recognized in 2021.

Product volumes in 2022 were higher in power generation, primarily due to higher natural gas prices compared to the prior year, which contributed to increased demand for our products. That benefit faded in the fourth quarter as natural gas prices began to decline. Fourth quarter other operating expenses were $9.3 million compared to $8.1 million for the fourth quarter of 2021. Other operating expenses for the total year totaled $34.6 million compared to $29.9 million in the prior year. The increase was mainly the result of higher legal and professional fees associated with the company's strategic review process as well as the gain on the change in estimate for the asset retirement obligation that occurred in 2021. This was partially offset by the lower payroll and benefits expense.

Fourth quarter earnings from equity method investments totaled $3 million compared to $6.8 million in the prior year. For the full year, earnings from equity method investments totaled $3.5 million compared to $68.7 million in 2021. The decline was the result of all remaining invested refined coal facilities reaching the end of their tax credit generation period as of December 31st, 2021. The company does not expect any material distributions from its Tinuum investments going forward. The company recognized $0.2 million of income tax expense for the fourth quarter and full year 2022 compared to income tax expense of $1.7 million for the fourth quarter of 2021 and income tax expense of $15.7 million in the full year 2021.

Fourth quarter net loss was $3.2 million or $0.17 per diluted share compared to positive net income of $5.8 million or $0.31 per diluted share in the prior year. The company recorded a net loss of $8.9 million or $0.48 per diluted share during the full year compared to a positive net income of $60.4 million or $3.27 per diluted share in 2021. Fourth quarter adjusted EBITDA was a loss of $1.2 million compared to a positive $9.1 million in the prior year, while full year adjusted EBITDA was $1.3 million compared to $84.9 million in the prior year.

The declines in net income and adjusted EBITDA were again due to lower earnings from equity method investments as a result of the wind down of the Tinuum investments. Cash balances as of December 31, including restricted cash totaled $76.4 million compared to $88.8 million as of December 31, 2021. As of December 31, 2022, the company's only debt outstanding were finance lease obligations, which totaled $4.6 million. Full year CapEx was $9.5 million compared to $7.5 million in 2021. We anticipate an elevated level of CapEx in 2023 between $40 million-$45 million, driven by enhanced capabilities to enable future GAAP production and amounts for the planned plant turnaround, as well as the completion of certain planned projects that were started in 2022 and are scheduled to be completed during the turnaround.

As Greg mentioned, we expect the sale of Marshall Mine to close during the first half of the year. As previously discussed, we anticipate paying roughly $2.4 million to Caddo Creek, subject to certain adjustments, which will eliminate the asset retirement obligation from our balance sheet and remove all future cash outflows associated with the reclamation of the mine. We also expect a portion of our restricted cash to be released upon closing of the transaction. Upon the completion of the Arq acquisition, we expect to retain approximately $86 million of our existing federal tax credits, which may be utilized to offset future federal tax payments that we may owe as the business grows in the coming years. I'll now turn the call back to Greg.

Greg Marken (CEO and President)

Thanks, Morgan. Slide five again highlights the synergistic nature of the combined ADES and Arq businesses. Pre-acquisition, ADES was a top three producer of activated carbon products in North America, with the ability to potentially serve an estimated 35% of the activated carbon market with our lignite-based portfolio of products. Post-acquisition, utilizing both ADES's existing lignite-based feedstock and Arq Powder as a bituminous-based feedstock, the combined company will be well-positioned to provide activated carbon products that serve more than 80% of the North American activated carbon markets and will do so through an expanded focus in granular activated carbon or GAC products, which will generally provide higher value and higher margin opportunities. We will benefit from our strong existing customer base, and we will be able to pursue new, diverse, and high growth end markets served by both powder and GAC products.

This diversification of our product offering will mitigate longer-term headwinds that our existing lignite-focused business would otherwise encounter, specifically within the declining coal-fired power generation market. This acquisition provides us with a longer-term sustainable and diversified product mix and facilitates participation in higher margin activated carbon products and end markets. In addition, we expect the acquisition to yield a competitive advantage via product performance, longer-term sustainable product cost, and environmental benefits compared to other activated carbon producers. The competitive value of securing a high-quality, domestically sourced feedstock that is cost-competitive and vertically integrated into the combined operations and that has been shown to create high-performance products is significant. We will be the only North American activated carbon manufacturer that controls 100% of its primary feedstock needs, both through our existing resource operations as well as through the access to Arq Powder.

Further providing a platform for long-term success is the fact that Arq's composition and processes for converting coal waste into Arq Powder are patent protected. We believe that the combination of our existing technical, operating, and sales capabilities presents reduced execution risk as we enhance the production capabilities of the business and transition to producing a broader range of products. Our proven manufacturing assets, product technology, applications expertise, sales channels, and customers within the activated carbon markets when combined with Arq's patented feedstock, Corbin facility, and access to non-activated carbon markets provide a platform to transform our existing business as we know it today. Finally, slide six provides our outlook and key milestones for 2023. First and foremost, we will continue to operate our Red River plant as we have historically while simultaneously looking to continue to grow and improve our existing business.

We are focused on maintaining high renewal rates with existing PAC customers being selected within our bidding process and aligning renewed contracts with market conditions to maximize our top-line opportunities. As it relates to our acquisition of 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 teams to begin executing our combined transformative business plan. Operationally, our key focus will be on commencing the capital work to optimize both the Corbin and Red River facilities for industrial scale production of Arq Powder and GAC products and developing the customer and sales channels entry into the GAC market.

The most significant of these modifications relates to the Red River plant and includes the installation of shaping and heat treatment processes, enabling the processing of bituminous-based feedstock to manufacture new and higher value GAC products. We estimate that these 2023 growth focused CapEx related to the initial phase of the business plan will be approximately $25 million-$30 million. It is important to note that PAC production at Red River and our deliveries to existing customers will not be interrupted by these capital improvements. Our focus will also be on securing lead customers and building our sales channels within the North American market for both GAC and other emerging products. We expect to undertake further product testing in all of these areas, which we believe will provide an opportunity to capitalize on the expanded capabilities in 2024 when the initial capital improvements are completed.

Financially, for the full year 2023, we expect to generate roughly $106 million of revenue and an EBITDA loss of roughly $6 million, excluding one-time costs associated with the acquisition. To wrap up, we are very excited about the combined company and the opportunities ahead of us to meet the growing demands of the North American activated carbon market. The combined company will be able to pursue end markets served by both powder and granular activated carbon products and will be only completely vertically integrated activated carbon provider from feedstock to distribution. The diversification within our activated carbon markets and the ability to compete in other markets where our environmentally beneficial products can be used in a variety of critical markets will yield a diversified and materially stronger integrated business platform going forward.

The result is a truly differentiated environmental technology company with new growth avenues and a path towards long-term sustainable profitability. With that, I'll turn the call back over to our operator to move us to Q&A.

Operator (participant)

Thank you. If you would like to ask a question, then please press star followed by 1 on your telephone keypad and remember to unmute locally. As a reminder, that is star followed by 1 to ask a question. Our first question comes from Gerry Sweeney from Roth Capital. Gerry, please go ahead.

Gerry Sweeney (Managing Director of Senior Research Analyst)

Hey, Greg. Thanks for the detailed update. I appreciate it.

Greg Marken (CEO and President)

Thanks, Gerry.

Gerry Sweeney (Managing Director of Senior Research Analyst)

You touched upon this a little bit, but just I'm curious about pricing and contracts. Could you give a little bit more detail on, maybe the contracts, how often they roll, and do you have any contracts that were maybe longer dated, maybe 1 to 2 years that maybe you'll have under market pricing that you could see improvement across in, if possible?

Greg Marken (CEO and President)

Yeah. You know, generally, Gerry, the contracts within our portfolio are about three to four years in duration. You know, on an average basis, I would say we'd always have about 25% of the portfolio turning just based on kind of those numbers. When we think about the portfolio, you know, and looking at what we think might be current market pricing for the various products and those sort of things, I'd estimate that we probably have about 15% of our overall portfolio that may be below, you know, today's existing market pricing. That, you know, as those contracts come up, we'll definitely work to renew, you know, towards the market environment that we're operating in.

Gerry Sweeney (Managing Director of Senior Research Analyst)

Gotcha. Do all 15% of those contracts renew this year or some of it this year, next year, et cetera?

Greg Marken (CEO and President)

I would say some of those are a little further out, but there's a good portion of those that will be this year, Gerry.

Gerry Sweeney (Managing Director of Senior Research Analyst)

Gotcha. Okay. Switching gears, the Marshall Mine, I think you had about $10 million of unrestricted cash, or I'm sorry, restricted cash on the balance sheet associated with. I'm not sure if all of that $10 million is Marshall Mine, but I'm curious as to how much could come unlocked this year and if there's other sort of gates or milestones that unlock more in the future.

Morgan Fields (Chief Accounting Officer)

Yeah, Gerry, we estimate that probably 50%-70% of that restricted cash will come off as that restriction will be freed up when we close this transaction. You know, to get to that point, we're still going through all the regulatory approvals for that transaction. We still think that's gonna close in the first half of 2023.

Gerry Sweeney (Managing Director of Senior Research Analyst)

Okay. Gotcha. Maybe final question. You know, Arq, you know, I think it's great acquisition. You know, vertically integrates you, opens up a larger addressable market, higher value market, et cetera. One question, but maybe really two in actuality. Just curious as to when you can maybe start seeing some revenue from some of the Arq products. Now granted, you know, this isn't all, you know, activated carbon related as we've talked about in the past, but just wanted to get an idea when some revenue may start to hit the income statement from Arq related production of, you know, the Arq Powder. Thanks.

Greg Marken (CEO and President)

Right. You know, I think the plan, Gerry, is to materially complete most of the CapEx to enable us to start producing some product very early in the year, next year out of the Corbin facility. The Red River CapEx is going to take longer. You know, the first thing that we're gonna do this year is really work on the additional testing opportunities that we have to bring some Arq Additives based products to market. The desire would be to do that in the early portion of 2024. Then, you know, later in 2024, you know, probably around the fourth quarter time period, as long as all the capital expenditures at Red River go according to the timelines that we anticipate.

That's gonna be impacted, you know, by permitting and those sort of things that are out there. That's when we would expect to start generating some revenue from the GAC-related products.

Gerry Sweeney (Managing Director of Senior Research Analyst)

Got it. I appreciate it. That's it for me for now. I'll follow up with you later today.

Greg Marken (CEO and President)

Okay.

Gerry Sweeney (Managing Director of Senior Research Analyst)

I appreciate your time. Thank you.

Greg Marken (CEO and President)

Gerry, I appreciate it. Thanks for jumping on.

Ryan Coleman (Managing Director)

Thanks, Greg and Gerry. We've also continued to include an invitation to submit questions ahead of time at the bottom of the conference call announcement press release, and in yesterday afternoon's earnings press release. Thank you to those of you who sent in questions, and we continue to invite listeners to submit questions in future quarters. One question that we received was about power generation customers and natural gas. What are your expectations for power generation customers and the overall PAC business if natural gas pricing remains low, and how much exposure do you have related to this market?

Greg Marken (CEO and President)

You know, Ryan, as we're aware, natural gas pricing has the potential to materially impact the demand and products that are needed by our power generation customers. Contrary to the expectations from various third parties as well as our own expectations during the third and fourth quarters of last year, natural gas pricing has not remained at the anticipated pricing levels. You know, additionally, we've seen further declines here in the first quarter. This kind of goes back to exactly why we did the Arq transaction. This provides a bituminous-based feedstock that allows us to diversify, you know, into markets in general, also to transition to more of a GAC-focused business on a longer term basis, which will help us have a broader earnings profile and more sustainability.

You know, as we think about the current year, if natural gas does remain low, it will impact demand just as it positively impacted demand really for the last year and a half in those power generation customers.

Ryan Coleman (Managing Director)

Then a final question. Can you talk a bit about the combined R&D efforts for the company? Where do development efforts stand for the Colloidal Carbon Product for soil and groundwater remediation?

Greg Marken (CEO and President)

Okay. I'll take both of those, Ryan. On a combined basis, we've begun the integration of our technology teams and have been very pleased with the power of combining the strengths of the respective company's technology efforts. The culture of tackling technology opportunities from idea to lab prototyping to customer engagement by both groups is very similar and focused. Specifically related to the development of our colloidal carbon, we have completed the development of our generation one product and have secured a manufacturing partner to produce commercial scale quantities. On a market front, we've also engaged various entities that are active within the marketplace, and we are prepared to provide them, you know, product that has been produced to meet their testing and treatment schedules.

Ryan Coleman (Managing Director)

Thanks, Greg. Thanks again to everybody who submitted questions. I'll turn the call back to Greg for any closing remarks here.

Greg Marken (CEO and President)

Thank you. Thanks to everyone for joining the call this morning. We are eager to begin executing on our key actions for 2023 and plan to provide updates on these initiatives along the way. We look forward to speaking with everyone soon. Thanks.

Operator (participant)

This concludes today's call. Thank you for joining. You may now disconnect.