Arq Inc (ARQ) 2017 Q4 法說會逐字稿

Good morning. My name is Casey, and I will be your conference operator today. At this time, I would like to welcome everyone to the Advanced Emissions Solutions, Inc. Q4 and Year-end 2017 Earnings Conference Call. (Operator Instructions)

Mr. Ryan Coleman, you may begin your conference.

Thank you, Casey. Good morning, everyone, and thank you for joining us today for our fourth quarter and year-end 2017 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 within the Investors section of our website. 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 annual report on Form 10-K for the year ended December 31, 2017, 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's very important to review the presentation and today's remarks in conjunction with the Form 10-K and the GAAP references in the financial statements. So with that, I'll turn the call over to Heath Sampson. Heath?

Thanks, Ryan, and thanks to everyone for joining us this morning. Let's begin on Slide 3 and discuss some of our fourth quarter and full year highlights. Our capital allocation plan returned over $32 million to our shareholders last year through a combination of the company's first 3 recurring quarterly dividend payments and the successful Dutch tender offer, which we completed in June and a stock-repurchase program that our Board of Directors approved in December. Returning capital to shareholders and delivering shareholder value will continue to be a key focus moving forward.

Along those lines, we announced the first quarterly dividend of 2018 in February, which was paid to our shareholders last week. The cash generation power of the business remains strong and supports this capital allocation plan in full. In fact, year-over-year, we saw our cash position rise 132%, and we ended 2017 with $30.7 million of unrestricted cash and cash equivalents. This was a result of our continued commitment to reducing our indirect operating cost structure, coupled with further strong distributions from Tinuum. With respect to RC distributions, they were one of the highest in our history during the fourth quarter and totaled $16.5 million during the period and $53.5 million for the year, both solid increases from 2016. As previously announced, Tinuum Group completed the sale of 2 Refined Coal facilities to a third-party investor in November of last year. These sales are located at coal-burning power plants that have historically burned in excess of 3.5 million tons of coal per year and are royalty-bearing. This brings the total number of facilities invested to 17. Looking ahead, we continue to observe sustained strength in our tax equity investor pipeline. This strength has been further improved by the passage of the Tax Act this past December, which provided clarity on the treatment of Refined Coal tax credits and the new corporate tax rate, which we'll discuss in greater detail later in the call. Increases in invested RC facilities and more clarity on the tax front also allowed us to recently raise our expectations for future RC cash flows to ADES to be between $275 million to $300 million through the end of 2021, which was an increase of over 20% from our previously guided range.

Let's turn to Slide 4 and review the -- review our 2017 strategic priorities. At the beginning of last year, we outlined a set of actionable goals and priorities to focus on during 2017. These goals were as follows. First, helping Tinuum attain tax equity investors for as many of the remaining RC facilities as possible. Next was completing our remaining legacy equipment commitments on time, on schedule and on budget. We also aimed to expand our start-up chemical business focused on Mercury Control and to continue to test the viability of expanding and growing within this niche. Next, we examined the potential to provide investment or pursue in M&A opportunities in a dynamic and fragmented fossil fuel power market, primarily around our nascent consumable chemicals entry point. And finally, we sought to execute against our balanced capital allocation program to distribute a strong portion of our free cash flow and drive shareholder value. Looking back on our year, I'm very pleased with the progress we made toward nearly all these priorities.

So let's walk through each in a little more depth. First, we assisted Tinuum in leasing or selling 4 additional Refined Coal facilities throughout the year in the face of a very dynamic and uncertain market, given the lack of clarity related to tax equity from the IRS regarding the rumored tax advice memorandum and the prospect of an ultimate realization of federal tax reform through the passage of the Tax Act, both of which significantly impacted the tax equity investment market. This result was especially noteworthy considering that we know of just 1 small non-Tinuum transaction for our Refined Coal facility that was executed in 2017.

Second, we completed the remaining material obligations to our legacy equipment business on time, on schedule and on budget. This was done despite a reduced headcount and a lighter operating structure.

Third, we continued to test our patented technologies within the consumables chemical space and build out the viability of this segment. As a result, we saw annual chemical revenues higher year-over-year, as we navigated a dynamic and highly competitive environment. That said, this is the one goal we had last year that we would like to do better, and I'll talk about this market later in the call.

Fourth, we remained both diligent and approachable for strategic accretive M&A opportunities in a rapidly consolidated industry, including the addition of resources to expediate deal flow.

And lastly, we instituted the company's first ever recurring quarterly dividend as well as 2 successful buybacks of common stock in our ongoing effort to drive shareholder value.

Overall, I'm very pleased with the year that we had and the progress that was made. Our RC business continues to see strong momentum, and I am thrilled with the shareholder return initiatives we accomplished during the year.

On the EC front, the year was challenging and very competitive. Despite recent customer wins, we definitely did not make the progress we initially anticipated.

I want to thank our team as well as the broader Tinuum team for their efforts throughout the year on each of these fronts. I will now turn the call over to Greg Marken, who'll review our fourth quarter and full year financial results.

Thank you, Heath. Let's start on Slide 6 to review our financial results. Total revenue for the fourth quarter was $544,000 while the full year was $35.7 million. These results were lower than prior comparable period almost entirely due to the expected decrease in revenue from our legacy equipment sales business. Further, and as a reminder, the company adopted a new revenue recognition standard on January 1, 2018. As a result of this change, we anticipate that all remaining balances of material equipment sales revenue will be recognized through an opening balance sheet adjustment and not impact revenues or margins in 2018. Thus, we do not expect material equipment revenues in the future, as utilities have already purchased and installed ACI and DSI equipment systems to assist in achieving compliance with regulatory standards.

Revenue from our chemicals business for the quarter was $400,000 compared to $1.3 million in the fourth quarter of 2016. Full year chemical revenue, however, came in at $4.3 million, an increase of 40% compared to full year 2016. As we've talked about all year, this newer start-up business is expected to yield lumpy quarterly sales figures, as we continue to validate our proprietary chemical technology offerings and compete for market share against a fragmented and dynamic environment that has seen significant price decreases occur at the PAC and all other competing technologies over the last 12 to 18 months.

Distributions from Tinuum were $16.5 million during the fourth quarter and $53.5 million for the full year. These represent increases of 12% and 16%, respectively. Royalty earnings for the quarter and full year were $3.2 million and $9.7 million, increases of 47% and 58%, respectively. The increases in both distributions and royalty earnings are a result of the additional RC facilities being invested during the fourth quarter as well as the full year 2017, all of which are royalty bearing to the company. As another reminder, we expect all future RC facilities leased or sold to be royalty bearing.

Income before taxes for the fourth quarter was $18.5 million, a year-over-year increase of 31%. Full year income before taxes was $52 million, a 42% increase from the 2016 figure of $36.7 million. We also continue to focus on containment of our overall operating cost structure, which has helped bolster our cash position. Indirect operating expenses for the fourth quarter were $4.2 million, a decrease of 22% compared to the fourth quarter of the prior year. Full year indirect operating expenses for 2017 were $17.6 million, a decrease of 35% from 2016. Since 2014, we have reduced our indirect operating cost structure by over 60%. Additionally, we will continue to evaluate further SG&A optimization to align with the needs of our business and public company responsibilities.

All of our strategic actions in 2017 have resulted in significantly higher cash positions year-over-year. As of December 31, 2017, cash and cash equivalents were $30.7 million, an increase of 15% from the end of the prior quarter. Year-over-year, cash and cash equivalents have risen 132%. This increase in our cash position comes after paying 3 recurring quarterly dividend payments totaling $15.7 million, $13 million in funds to repurchase nearly 1.4 million shares of common stock in conjunction with the Dutch tender offer and an additional $3.4 million used to repurchase shares of common stock in December, under which, we generally attempted to repurchase the maximum number of shares based on valuation, volume limits and blackout restrictions. This liquidity position allows us to execute our capital allocation plan and shareholder return initiatives and evaluate opportunities to monetize tax assets and build on our existing platform. I'll now turn the call back over to Heath to walk through our go-forward strategy.

Thanks, Greg. I'd like to take a moment to review our go-forward strategy in each of our business segments before taking your questions.

Let's turn to Slide 8 and discuss some changes within the Refined Coal environment. As I briefly mentioned earlier, the Refined Coal environment has undergone some favorable changes in the last year. For starters, the IRS's publication of the technical advice memorandum, or TAM, in the spring, provided validation of our tax equity model and brought both new and legacy investors to the negotiating table. Since the memorandum's publication, Tinuum has completed deals for 3 Refined Coal facilities and a fourth total in 2017. I think it's important to repeat that while Tinuum has obtained third-party tax equity investors for 4 facilities this year, we know of only 1 small non-Tinuum Refined Coal transaction in 2017. In fact, in the last 2 full calendar years, Tinuum has executed 8 of the 10 known Refined Coal transactions, which really is a testament to the combined hard work that our 2 organizations put forth over the time period. In addition, as a result of the industry's efforts, including Tinuum, the IRS just released guidance on Refined Coal commercial structures to its IRS field offices. This guidance is not safe harbor, however, it is helpful that it does set boundaries and standards that will help investors better understand the commercial structures that will be respected by the IRS. We view this as positive for Tinuum and the Refined Coal industry.

In addition to the IRS commercial structure transparency, the passage of the Tax Act in late December has provided much needed clarity for many of our prospective tax equity investors. Prior to passage, impending corporate tax reform was a major hurdle. The lack of clarity surrounding the final bill would include -- and where the corporate rate would ultimately land caused many potential investors within Tinuum's pipeline to simply remain on the sidelines. Thus, the clarity now provided by the passage of the Tax Act removes a major hindrance for Tinuum's marketing efforts. Within the bill itself, we view the removal of the corporate alternative minimum tax, or AMT, as a net positive for Tinuum's business. The removal of this effective tax floor for many corporations could theoretically make the investment and deployment of tax equity investment an economically sound venture. Whereas before the AMT, it would effectively have capped the benefit of those credits.

Again, for the most part, we do not view a lower corporate tax rate as having a material impact in the funnel of prospective investors. While lower corporate tax rates do reduce the total project margins available in Refined Coal transactions, as the expenses of those projects are worth less in tax benefits, the prospective and current investor Tinuum is engaged with are significant taxpayers. Therefore, we do not anticipate any material reductions in the appetite for these tax credits from our pipeline of potential investors, and the pipeline remains strong. Also included within the tax bill was the base erosion anti-abuse tax, or BEAT. This is one area of the tax reform that still needs additional clarity, and we expect that develop as the year progresses. Entities that are currently subject to BEAT, primarily more global entities, are allowed to offset up to 80% of this tax with production tax credits. But the ambiguity lies in the treatment of the remaining 20% and the timing of if or when that portion of the tax credit may be applied. Impacted taxpayers will continue to seek clarity from regulators and lawmakers as the year progresses, and we and Tinuum are continuing to work with regulators as well as our investors subject to BEAT to obtain the final clarity. However, despite this ambiguity in the BEAT provisions, discussions from current investors have confirmed their continued conviction of their investment in Refined Coal. Investors that are impacted by BEAT are still able to appropriately use Refined Coal tax credits. However, their margin related to those credits may be impacted.

Lastly, and most importantly, we are ultimately pleased with the final Tax Act and its reinforcement of the tax credit derived from the production and sale of Refined Coal, which is critical to our equity investment in Tinuum. The reaffirmation of these tax credits is an acknowledgment of the critical role they play in advancing our country's cleaner energy initiative. These factors, combined with a more favorable overall political environment, give us ample reason to be excited about our RC business moving into 2018 and a constructed landscape that is further conducive to further RC closures.

Reflective of this confidence, due to increases in RC facilities in our recently raised cash flow guidance from Tinuum to ADES, which we now expect to be between $275 million and $300 million through the end of 2021, an increase of more than 20% from our previous range.

Let's move on to Slide 9. This slide shows the current invested and operational facilities versus the noninvested facilities that are not operating. As of December 31, Tinuum has leased or sold 17 facilities, with the remaining 11 facilities either installed and awaiting a tax equity investor or waiting for a utility and a tax equity investor. But the big -- biggest challenge here, again, does not necessarily lie within identifying the utilities but rather in identifying and securing tax equity investors to invest in idle units. As shown on the right side of this slide, there is still sufficient potential for Tinuum to substantially increase production, provided the remaining facilities can be leased or sold.

Slide 10 provides the quarter-by-quarter breakdown of Tinuum operating volumes and retained tonnage. As a reminder, retained tonnage is tonnage we operate on our own behalf. We pay the operating expenses but also receive the tax benefit. You'll see that the sequential tonnage has increased, as it was positively impacted by the increased number of invested facilities. These increases and related increases in cash payments from Tinuum will continue to allow us to execute our capital allocation initiatives as we collect future cash flows. Our top priority is to obtain more investors as fast as possible and build the cash payments we receive through 2021.

Slide 11 shows the royalty versus nonroyalty schedule. This schedule has been updated to reflect the addition of 2 Refined Coal facilities during November 2017. As a reminder, the number of royalty-bearing facilities is greater than nonroyalty-bearing facilities, a change that occurred during the middle of 2017. Again, all future RC closures are expected to be at power utilities that are royalty bearing to the company.

Let's continue to Slide 13, which outlines the current opportunity and environment within our Emissions Control segment. As briefly alluded to earlier in the call, the last few quarters have seen an increasingly competitive environment within the Mercury Control market, as numerous industry players continue to jockey for market share. The rapidly changing market dynamics have required a nimble and proactive approach to remain competitive and win customers in what has appeared to be a race to a bottom -- to the bottom type environment.

The size of this market is considerably smaller than we, along with many other participants, originally projected on these new competitive developments. Before mercury regulations were enacted, the Mercury Control consumable space was previously estimated to be roughly a $1 billion annual market. That original estimate proved to be overambitious, and there was a subsequent reduction in the estimated market opportunity. Significantly impacting this reduction was the emergence of abundant cheap natural gas that led to coal to natural gas switching. Moving through the coming years, utilities began to optimize operations related to Mercury Control, which, along with the better-than-expected performance of equipment systems, continued to apply downward pressure to the potential market.

Finally, during the 12-month period that has displayed significant competitive pricing changes and shifting landscapes, the market size is currently closer to $3 million -- $300 million. And we expect that when market pricing stabilizes, it will settle closer to $200 million moving forward. All these competitive changes within the industry, coupled with the decreased overall market opportunity, has led to our reevaluation of our strategic priorities for the chemical business.

Despite recent contract wins, strong patents and a healthy number of RFPs currently in the market, the growth and ultimate potential for existing product offerings in power plants Emissions Control is not large enough as a stand-alone set of products due to the smaller-than-estimated North American market and the undeveloped international market. Therefore, we are updating our priorities to focus on supporting Tinuum and RC, while maintaining the longer-term option to monetize our tax assets and public platform.

Our chemicals technologies and knowledge are important to the future of Refined Coal. Many of the relationships we have in this industry are critical to our RC side of the business, as many of these facilities currently use our chemical technologies on-site. We've had some successes in this market, and believe we will have more in the future, and those successes will help cover a portion of our corporate costs. As such, we will opportunistically evaluate ways to reduce expenses, but appropriately resource EC and corporate to be more focused on supporting Refined Coal. Moving forward, we will be strategic in our pursuit of deployment of chemical revenues to cover a portion of our expenses and maintain the assets for potential other strategic alternatives.

The net cash flow usage from corporate, offset by EC segment contributions, is estimated to be in the range of $8 million to $10 million annually. Of note, we have reviewed a number of M&A opportunities within the consumables space over the last year. We've seen a few interesting ideas and have pursued opportunities in a few circumstances. But given the uncertain state of the market and our commitment to our overall capital allocation strategies, we have remained very disciplined with those pursuits. We have said for some time that we will not -- we are not going to do a deal for a deal's sake and that any opportunity must be accretive, at a reasonable price tag. We will continue to scan the market opportunistically, but again have placed it as a lower priority.

Flipping to Slide 15, you'll see our updated expectations for future cash flows through 2021. As of December 31, 2017, we're expected -- expecting between $275 million to $300 million in cash flows, net of interest, taxes from Tinuum through 2021. As a reminder, this does not include the reduced cost of $8 million to $10 million annually at ADES. This figure is based on the 17 currently invested facilities and does not reflect expectations of future RC closures. Any future RC closures which is a key focus of ours would add to these levels. Again, this range was recently raised by more than 20% last month to reflect the 2 additional facilities through November as well as the effects of corporate tax reform.

Let me conclude today by discussing our 2018 goals and priorities on Slide 16. We remain focused on helping Tinuum obtain tax equity investors for its remaining RC facilities; helping Tinuum ensure operational performance to allow production and sale of Refined Coal by tax equity investors, by also helping ensure stickiness of RC investors through strong customer relationships; streamlining and optimizing the deployment of EC chemical revenues to support our RC efforts in public platform; executing against our balanced capital allocation program to distribute and create value for our shareholders; and finally, evaluating alternative options to monetize tax assets and build upon our existing platform in an opportunistic manner.

Let me extend my many thanks to both our team and the extended Tinuum team for their efforts this year. We are carrying more momentum into a new year, and I'm extremely excited to continue to execute on our strategy and provide near-term and long-term shareholder value. Lastly, I'd like to, once again, thank our shareholders for your ongoing support. With that, we'll open the line for questions. Operator?

(Operator Instructions) Your first question comes from the line of Amit Dayal with H.C. Wainwright.

Just in terms of the backlog or the work you're doing towards trying to close additional RC facilities, could you provide what the pipeline looks like? We did 4 closings last year, should we expect a similar rate this year, given the tax clarity? Just any granularity on this front would be helpful.

Yes. So we have 11 remaining facilities, and our goal is to close those as fast as possible. Our pipeline is primarily made up of very large tax players that could take more than 1 facility. So we're really encouraged about 2018. Though '17 was successful, we're hoping for even more success for 2018. So consistent with what I've done before, I'm not really predicting the exact number and timing, but like I said before, because of the clarity around what the IRS has done with their publications -- in recent publications as recent as last week coupled with the tax reform, there's more interest than we've ever had. So I'm looking forward to a great 2018 and getting more closures in RC.

Great. So how should we look at period beyond 2018, given that these expire by 2021? Does the probability of new tax investors taking this drop quite a bit after 2018? Would be really interested to hear your view on that front?

Yes. So as a reminder, if you are an investor in refined coals, you get to carry forward the tax credits for 20 years and back for 1 year. So the majority of the investors that we have view that in -- using the cash in the year they have. And then if they can, they can carry forward. So though we are getting closer to the 2021 guideline, for where we are right now, it has not been an issue for us to obtain tax equity investors. And I don't expect that for the next couple of years. We'll see how that plays out after 2019, call it. But the way to view this is that they can use these tax credits and invest in this all the way to the last day in 2021, because they can use those credits at year-end, carrying forward.

And just one clarification, Heath. Does the amount of coal burned also have an impact on Tinuum revenues? Or are these like sort of fixed-price contracts?

So it's both, depending on who the customer is. So a good chunk of our portfolio are fixed. But those fixed are based on what is expected to burn in those -- in those specific facilities, and there are others that are truly production tax credits on that side. So it's a mix, but a good proxy for looking at what our revenue would be is what is actually burned and it matches to that. So hopefully that answers your question. So said a different way, we feel really good about a good chunk of our fixed payments that we expect through 2021. They are less susceptible to those fluctuations. But that's just a portion of our portfolio. Also as a reminder, the places that we have these facilities paced are at utilities that are expected to burn well past 2021. So regardless of whether it's fixed or less fixed or variable, we feel good about our forecast and the future through 2021.

And maybe just one last one for me, in regards to the Mercury Control business, should we assume you're trying to, sort of, unload this by the end of this year and focus on other M&A opportunities? How do we sort of prioritize between trying to keep this business around versus trying to find something new that we apply our resources towards?

Yes. So I think there is -- it's a second priority right now. As we noted, and if you look at the market size and how dramatically that has changed, and I expect it to change through the end of 20 -- till this year. I think it'll stabilize at the end of this year, if you look at the different substitute products, [one was in] Mercury Control. I think we've hit close to rock-bottom on these potential prices that people can charge. So within that market, we're going to wait and see what happens. We have strong patents, strong technologies and some contributing revenue. So we're going to continue to get that revenue and close on deals that we need to close on, and then we'll evaluate where we are in 2018. So I'm not saying we're going to sell or not. It's a second priority, and we're going to evaluate options as the year progresses.

And your next question comes from the line of Shantanu Agrawal from BlackRock.

Can you please talk about the new IRS guidance that came out, sounds like, last week? Was this a new TAM? Was this a follow-up to last year's TAM? What exactly did the IRS say? And what clarity does it provide to the market today?

Yes. No. That's a very good question. So it really is providing clarity to the TAM that came out last year. It's a detailed -- more detailed description of what is acceptable for commercial structures within this space. So when the TAM came out last year though we viewed it as very positive, it was relatively short and ambiguous. So for some investors and some of our competitors, they were still uncertain of the structures that would be respected by the IRS. However, what came out last week was detailed, and it provided much needed clarity. So for the market as a whole, we're extremely excited about that clarity and many of the investors that we are -- that we have or talking to are excited about this clarity as well. So it's really good for us and the industry as a whole, to get that much needed clarity from the TAM that was released last year and just recent released update last week.

And your next question comes from the line of Patrick Wolff with Grandmaster.

I have 2 questions. One is just if you could provide a little more clarity on the potential future cash flows for the 11 RC facilities that are installed, not operating, not invested. I mean, are they roughly comparable, so are they roughly sort of in proportion to the 17 that are currently leased? Like how should we think about that?

Yes. In general, when you look across the average of those 11 facilities, they should be larger than the historical ones. A lot of the earlier facilities that were installed at plants were at lower burning facilities. So the average of those 11 should be higher, on average. Some will be smaller, some will be larger. So that's the right way to think about it. What we've done in the past, just so you have context on how to model this, is assume about 4 million tons per those -- per each facility. Again, that could -- that would be probably up or down around that. But that's a good proxy. We hope to be higher than that. But I think that again -- that's a good proxy to use going forward on average across all 11.

Okay, great. And then I guess the second question, and I think I brought this up before but just in terms of the aggressiveness with which you are buying back stock. I mean, if I sit here, you have, wherever you are, roughly, let's call it a $240 million market cap today and $30 million of cash, pretty much no liabilities. You think you have pure line of sight to $275 million to $300 million undiscounted over the next 3 years or so, with the potential to grow that somewhat meaningfully. I mean, it sure looks like you have a cheap stock, and you've been very good about returning cash to shareholders which is terrific. But every time you pay $1 out in dividends, and you don't use that $1 to buy back stock, it's a net loss of potential -- so a net loss of gain, if that's a way to put it, for shareholders. And you've bought back some stock during the year which was great, but it seems like you really could've been more aggressive, so I'd really love to hear your thoughts on that.

Yes. Well, so it was on purpose that Greg and I said it maybe 4 or 5 times that the capital allocation plan and specifically buying back stock is a critical part of our strategy, especially because we are in a great spot with cash and do expect that cash to continue and increase. It is a major part of our strategy to continue to evaluate and buy back stock and for all the reasons that you just talked about. For last year, when we announced, we bought as much back as we could within the blackout period. So we're looking now -- what -- how do we increase that? How do we do better with that? So it's an important part of our strategy, top priority for us, and we will continue to do it as aggressively as possible.

And ladies and gentlemen, that is all the time we have for Q&A. I will turn the call back over to Mr. Heath Sampson for closing remarks.

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

And ladies and gentlemen, this concludes today's conference call. You may now disconnect.