Arq, Inc. (ARQ) Earnings Call Transcript & Summary

Today, I'm very pleased to welcome Bob Rasmus, who is the Chief Executive Officer of ARQ Incorporated, NASDAQ ticker ARQ. Arq is an environmental technology company producing activated carbon products, which are used to reduce reverse environmental liabilities, including things like forever chemicals from public drinking water systems. Arq is a high-growth company, and we at Water Tower Research forecast an 81% EBITDA CAGR through to 2028. Bob, thanks so much for joining us today.

Thank you, Peter. Happy to be here.

So before we dive into our conversation, I've got just a couple of housekeeping notes here. Our viewers today can submit questions directly via the platform, and we will do our best to incorporate as many questions as we can. I'd like to remind everyone that this is -- that this fireside chat is an open access platform for all investors. The fireside chat is being recorded as well. So for that recording, you'll be able to access this event using the same link for the rice registration should you choose to pass it on to someone else. I'd also encourage you to look at our Open Access website for disclosures and other research on ARQ, including our January initiation of coverage report on the company. You can find that at www.watertowerresearch.com, and also on research aggregators like [ Backset ]. Lastly, I'd like to point out that Arq's safe harbor statements can be found on the company's website. Now with that behind us, let's get started.

So Bob, let's please start with a bit of background on yourself, a bit of background in Arq. And It would be great if you could kind of share what attracted you to join the company.

Peter, there were multiple things that attracted me to join Arq. When I was approached about the company, I was asked, what do you know about activated carbon? And I said, quite frankly, nothing on that. But the more they described what the business was and the opportunity, the more intrigued I became. And I literally spent about 6 months doing due diligence on Arq's prospects, its asset base. including hiring IP counsel to evaluate separately the IP. So to move from kind of a macro to micro -- among the things that attracted me were the asset base. You'll hear me refer now, that I've been at the company almost 18 months about the foundational path business. But the plant that we have in Red River, Louisiana was in the existing powdered activated carbon business, was a business that was underperforming. I thought could use some basic blocking and tackling in terms of paying attention to what was going on with that business, paying attention to costs, paying attention to revenues, expand into adjacent markets. And fortunately, that has proved through, and we've really reversed the trends of that foundational pack business. The other was the expansion into the granular activated carbon business. The PAC business, I was confident we could turn around and have. But the reality was it was never going to be a turbocharged growth business. And so then you have the granular activated carbon business in the ability to use that Red River, Louisiana plant as the foundation to expand into granular activated carbon for $3, $3.25 a pound as opposed to, if you were going a greenfield site as opposed to brownfield, I think it would be close to $7 or $8 a pound. You combine that with what is happening and happened with the merger with the legacy Arq limited which had the IP, which I referred to in terms of the due diligence investigation, it's a very unique piece at turning bituminous coal waste into granular activated carbon. So for me, it was really two bites at the environmental Apple. You were taking waste. You were using that waste to create a product which remediated other waste, and it was going into a market which was undersupplied and growing. Most green energy is kind of relying or does rely on tax credits, in my opinion, or other non intrinsic value creation. But our product, given the demand isn't immediately profitable without the benefit of tax credit. So sorry for being so long-winded, but there was really a variety of factors that led me to believe that Arq was a great opportunity for a turnaround, and not just turnaround but growth and continued growth into the future.

Okay. And I understand you also have a bit of skin in the game, so to speak, in terms of your compensation structure. Is that right?

That's correct. One of the things I said was, one, I wanted to be aligned with shareholders. And two, I wanted to do it for the equity upside. I've always told my kids you make money really by owning equity. And so what I agreed to do to signal my belief in the company, it signal my belief in the company's future prospects is I agreed to a $50,000 salary. I bought 1 million shares of stock, I have subsequently added to that position as well. And the rest of my compensation is equity-based and equity linked including some options or shares that don't kick in until a $10 and/or $15 price target. So when I say I'm aligned with shareholders, I'm fully aligned with shareholders.

Okay. Thanks for that, Bob. So let's turn to the expansion strategy for the granular activated carbon. What is the backdrop for why Arq is expanding? And what do you see as Arq's competitive advantages? And also, on that, how are we tracking in terms of that Phase 1 expansion.

Sure. So I think there's about three or four questions embedded in there, Peter, and I'll try and take them in order. One, we have a great powdered activated carbon or pack business. We've been able to turn that around from a money-losing operation to a cash flow contributor. We've also been -- we have had and continue to have a leading market share and scrubbing mercury emissions from coal-fired power plants. That's great, but they're not building new power plants. And in fact, they're retiring. So one of the ways we've turned around that business is not only to paying attention to cost but expanding into adjacent markets, which have a higher average selling price, higher average margin like water for removing taste and odor or improving taste and odor cement and others. So we've turned that business around. But again, it's not going to be a super growth business. It's a nice business. The way I look at it is that business, the way we've turned it around and there's still room for some improvement is that it will generate sufficient cash flow to pay the maintenance CapEx of what I call the combined businesses, the GIC and the PAC business going forward. What really attracted us to the granular activated carbon business was two things: one, the unique feedstock and the unique patent-protected process we have for tuning that bituminous coal waste into granular activated carbon. And the fact that the market is currently undersupplied relative to excess demand and that gap between demand and supply is expected to grow even further. So again, very attractive market dynamics. And then you add what I'll call -- I'm old enough to say there are no barriers to entry anymore. There are speed bumps to entry. And it's just what's the size of the speed bump. And I think the size of the speed bump in terms of new entrants or expansion into the granular business is fairly steep. One, you have to get a permit, two, you have to build the assets. And three, it's a technical sale. So it's not just you show up and we say we're in business. So I think there's a minimum a 2- or 3-year head start for us in terms of some new entrants in terms of competitors in the granular business. And the pricing is a multiple of the PAC market. As I've said before, does it cost more to produce granular activated carbon. Yes, it does, but does it cost a multiple more? No, it doesn't. So it's very attractive return dynamics. As I say, the PAC business, that foundational business covers the CapEx, the cash flow, et cetera, from a maintenance standpoint. And then from going forward, it's pure cash flow to either reinvest in the business or to return to shareholders from the granular activated carbon business. You mentioned that first phase of expansion. It has cost more than we had originally anticipated. It costs more than we had anticipated at the end of November. It's not something I like. I realize that creates the potential for some poor market optics. But it is still an outstanding return in terms of investment in terms of slightly more than 3 years right now based on the current price on EBITDA. And based on the demand we're seeing, I think that once we get this Phase 1 expansion completely up and running and ramp to full run rate production, we would fairly quickly make the financial investment decision as to whether to invest in, and I think it's highly likely we would Phase 2. So I think I answered all the questions. If I didn't, I'm happy to revisit those.

You did, absolutely. Thanks, Bob. And so for the first phase, you've got to 25 million pounds of GAC, but you're also looking at the potential for some -- I don't know if you would call it debottlenecking, but there's potential where you could be producing, but sounds like significantly above that nameplate capacity. Is that correct?

That's correct. So we refer to it more as fine-tuning, we are absolutely comfortable we'll be able to achieve the full 25 million of run rate production. The real question is that additional production going to be 10%, 20% or even as much as 33% more. And when we refer to payback and financial investment decisions, we're only referring to the 25 million-pound of nameplate. Anything else we get as it relates to the additional production capability, which I'm confident we will get will just be land a or additive to our return profile on the investment.

Okay. And maybe we could talk a bit more about the customer engagement. I understand from your recent results briefing that you're having a lot of conversations now you're running some tests with quite a few customers. Could you please give an update how those conversations are progressing with different customer types? And what does this suggest about the prospects that we could have a future expansion of Phase 2.

So a couple of comments on customers in the pace of contract negotiations. I'm a prisoner of my prior experience and background, and one of which is I started out in my career as a banker and going through a bank credit training program. And while it sounds boring, you're probably wondering why the heck is he bringing that up on that. But what really the takeaways I got from that is not just understanding credit but understanding risk mitigation and value is the value you're getting for the risk you're taking? What are the returns as it relates to that? And where I'm going with that digression is one of the things that originally attracted me to the business was, as I said, the excess demand versus supply. But what is also turbocharged investor interest and media awareness is the PFAS regulations promulgated by the EPA. That is great, and it has also served the turbocharged demand and interest in our product. We could contract 100% of the 25 million pounds right now in the municipal water market. But I don't think that's a good idea for several reasons. One, from a risk mitigation standpoint, I'd like to spread that contracting across various industries. Two, that as we look at other industries like the renewable natural gas marketplace, that carries a higher average selling price and consequently, a higher average margin. So again, it's not only risk mitigation from an industry concentration standpoint, but it's also diversifying the return profile and the value creation profile from our granular activated carbon. So we continue to have discussions with the municipal water, because some of the contracts that we've entered into already in that sector are -- but for a small percentage of their ended future demand we could see also entering into contracts with them for Phase 2 or Phase 3 or Phase 4 and also under renewable natural gas, that as opposed to certain other sectors being happy with lab testing or rapid small-scale column testing that they want in situ testing. They want to have the testing done in the field to ensure the efficacy. Now those tests take anywhere from 1 to 6 months. and that dovetails nicely with the production ramp-up that we expect to see from the granular activated carbon expansion at Red River in Phase if we had to, we could fall back and contract everything in the municipal water, but we think it makes sense for diversification and value creation to hold some of that back to match both the production profile and the testing profile of the renewable natural gas and some other sectors.

Okay. Thanks Bob. And it seems what you're saying here as well, you talk about the lab testing process and so forth that activated carbon really is a highly specialized product. So you've got the ability here to tailor this product depending on the unique demands of your customers. Is that fair to say?

That's absolutely fair to say. And one of the things, again, that attracted me is that we have a best-in-class technology team at Arq led by Jill Long. He's forgotten more than I'll ever know. And his team are also supremely qualified and extremely hard workers, and they've been an integral part of the team and helping to qualify and to contract this. But again, one of the things that we have shown in our initial testing is our product works as much as 8 to 9x better than the competition. as it relates to that. So we have a superior product. And that's what relates to the fine-tuning. The question is, as well, are we going to get paid for that 8 or 9x superior performance? Or should we fine-tune it to where it's 2 or 4, where we're still superior, but then we can also have additional product to sell. But it's clearly -- it's a technical sale. It's not a commodity product. And that technical sale, technical qualification also acts as a further speed bump to entry because even if somebody wants to get in the business, they have to prove the quality of their product. They have to prove the efficacy of their product, and that can take 6 months to a year if you're starting from scratch as well.

Okay. Great. Yes, in the future, we'd love to have your Chief Technology Officer, Jill on, again, for a chat. We can go deeper into that side of the business, the technical side. But with that...

He would love to be on and believe me, he can go deep into the technical side.

Okay. Great. Okay. That sounds great. So let's move on to the financing and capital strategy. You recently had a successful financing. Could you talk about that financing and what it suggests about the health of your cash flows? And also, how is the company positioned for financing future expansion phases?

Sure. So I think we're in a great position right now, both from a liquidity standpoint and a financial flexibility standpoint. The recent $30 million financing or overall financing was used to, one, repay an existing term loan, and we lowered our cost of capital by over 500 basis points on that. And we tripled the availability versus the previous line of credit on that. So one, it gives us flexibility to meet our financing needs and any potential liquidity needs that we might have going forward in the near term for the base business. But it also then serves because the company MidCap Financial also has the capability to expand significantly. This is kind of the low end of what they do. We also view it as getting in on the ground floor and getting them to know the company in detail vis-a-vis potentially Phase II or Phase III financing that with debt going forward. Again, when I look at the cash flow generation capabilities of the combined businesses, the PAC and the GAC. I see a Phase II that should be able to be financed on a traditional corporate cash flow basis going forward again to provide maximum value and returns for our shareholders.

Okay. Great. Maybe with that, it's probably a good point in our discussion to kind of open up for questions, because there are a few that are coming through on our feet here. I just want to say to our audience as well. Please feel free to keep submitting questions. We might not -- we probably won't get to all of them, but we will take note of those, and we'll make sure that the Arq team gets back to you directly on some of those questions. So let's just start off here. So this question was already a little bit addressed, but maybe the second part could elaborate a bit more. So last month, Arq disclosed the company's Phase 1 GAC expansion. CapEx was slightly above expectations, which you already talked about. Could you please address this and whether this has any implications for the cost of future expansions?

Sure. Absolutely. And if you look at, I think it's Page 9 of our earnings presentation, we talk about how we're going to save that and bring that down from -- by at least $10 million going forward on Phases 2 or 3. There is no doubt that I share the investors' disappointment in terms of the cost overrun on that. It's not something that makes me happy. And I want to ensure that it's not something that occurs again. And it's really broken down that $10 million overage into several areas. One, about $4 million to $5 million of engineering costs that we incurred to finish the project, which we won't have going forward. The second is about $3 million to $4 million of acceleration cost to bring the project forward from where it was, with the engineering firm and others so that we could make the first quarter deadline in terms of first production. And then there's another $1 million to $3 million of savings that we expect to be able to occur from efficiencies and more proficient procurement practices going forward. So I'm very confident that $85 million is not the new norm, but $75 million will be the normal going forward or hopefully less.

Okay. Great. That's good to hear. Next question here is going to your foundational pack business, the powder activated carbon business. When we think about 2025 and beyond, how much additional performance do you think you can squeeze out of the PAC business?

So I think there's still room for improvement. We had $7.7 million of EBITDA. This year, we were negative $2 million or $3 million the year before. So again, we've had a $10 million-plus turnaround. I still think there's areas where the business can be optimized. And those two areas are: one, continuing to focus on cost I think SG&A for a company of our size is still too high, and we've taken steps already in the first quarter of this year to address that and bring that down. The other is operating cost. I'm confident that once we get fully up and running on the GAC line, we'll also be able to optimize the path costs, and we'll also have further fixed cost absorption by the additional volumes from granular activated carbon. And the third component of that besides the cost, the two cost items I mentioned, is we continue to expand into new markets that have a higher average selling price and consequently higher margin. And so I think those three things combined still lead me to say with confidence that there's continued room for performance improvement in terms of the results and the foundational pack business versus what we achieved this year -- or I should say, 2024.

Okay. Great. Next question here is about your competitors. How do you see your competitors' positioning for the GAC, the granular activated carbon market expansion?

So I think the largest is Calgons who is owned by Kuraray, the Japanese company. They are the largest. They completed a $50-million-plus expansion of their GAC business the prior year. That is -- our understanding is that is fully sold out right now. We're seeing that in terms of market dynamics now in terms of just increased customer demand for wanting to contract, wanting to expand with GAC. Some people have heard me say, I worship out the alternative capitalism on that. And so when you have these types of returns available you have to assume that new capital is going to flow into the business, whether it is from existing players or from new entrants. I think versus the new entrants, we have a 3- to 5-year head start versus the existing in terms of existing players expanding. I think it's a 2- or 3-year head start because there is permitting that's required, then it's building it. So it's at least 2 years. And one of the benefits we have is our Phase 2 is already permitted. So again, do I expect new entrants, you have to assume the returns are too strong to expect that there wouldn't be. But I think there are significant hurdles that allow us to have a significant head start to be able to maintain the projected margins going forward.

Okay. Great. Okay. I think we've got time for one more question here. Let's take this on policy, very topical recently with the changes in D.C. So do envision any policy risk is activated carbon imported to the U.S., good imported products come in the crosshairs of tariffs.

So I'm going to answer that question, and I'm going to be a politician and answer another question, but I'm going to tell you I'm answering another question, too, as it relates to that. So on activated carbon, there are already tariffs in place, particularly on Chinese imports. And those have been raised recently. And one of the things that we benefit at Arq and again, another item that attracted me to the company, is that we have the only fully vertically integrated, fully domestic supply chain so that we qualify for both all the Built in America by America, which a lot of our competitors and most of our competitors do not. And also, we have an outstanding reputation for product quality, product availability and customer service. So we don't have to worry about and our customers don't have to worry about supply disruptions, as it relates to imported product or increased costs. So that's one. The question I'm also answering is on the policy relating to PFAS. I think there was some concern with the new administration under President Trump that would -- the PFAS drinking regulations be rolled back. And my answer to that is, one, Lees Elden, who is the new Head of the EPA, voted for regulations or the legislation empowering the EPA to come up with the regulations. And both President Trump and Lees Eldon have been on record as saying the U.S. wants to have the cleanest and safest water. And we've seen not only no dimunition or expectation of rolling that back we've seen an increase in emphasis on the part of our water customers looking to comply with those regulations now in advance of them formally being going into existence in terms of the deadline because they -- their customers are demanding it. And they also say the deal that securing supply now helps ensure that they have it in the future because they share the same supply demand outlook that we do.

Okay. Great. Thank you. So I think we got time. We'll do one more question here. Let's see. So how volatile do you expect pricing for GAC to be over time? Also, what are the key hurdles to get over related to getting to nameplate production capacity for the new facility?

So in terms of -- I'll take the latter first. The key hurdles is we have to be able to consistently produce and have reliably produce granular activated carbon. We produce granular activated carbon we haven't done it in a repeatable format so that I feel comfortable saying we're in full-scale commercial production. I expect that shortly. And then as we start ramping up as with anything, new line, new commissioning there's going to be some things that go wrong and we have to fine-tune in terms of production. So it's really just basic blocking and tackling, but we already have produced granular-activated carbon that meet all of our specifications. It's just being efficient and repeatable in terms of doing that. on the pace of pricing or what happens in pricing. Everything I see in the marketplace right now says that pricing is going to continue to go up or at the worst case basis maintain current levels, and that's very attractive. And I think there's an excellent case for pricing continuing to rise because demand is continuing to rise. We're seeing that from our conversations with customers and potential customers, and it's very difficult to bring new supply online. So I think there are definitely tailwinds on our sales.

Okay. Great. So we'll have to wrap it up there in terms of the Q&A. But as I mentioned earlier, we will make sure to get back. There's a couple more questions outstanding. But we're just afraid we're running out of time here. So Bob, this has been a great discussion. I would just like you to provide any concluding remarks for investors.

One, thanks, Peter. And to thanks to everyone, as I say, I really like the way we're positioned as a company right now. We've turned around the PAC business. We are getting ready to -- we have full scale, full commercial production of the GAC and it's entering into a marketplace that is undersupplied with excess demand. And I think we can still have opportunity to expand our PAC business results. So I really like where we are as a company.

Great. Thanks, Bob. So I just want to remind everybody that you can access this online as well as other fireside chats and research on ARQ Incorporated at www.watertowerresearch.com, also the views expressed in this fireside chat may not necessarily reflect the use of Water Tower Research and are provided for informational purposes only. This fireside chat may not be distributed or reproduced without the written consent of Water Tower Research and should not be considered research recommendations. WTR is an IR firm, not a licensed broker, broker dealer, market maker, investment banker, underwriter or investment adviser. Additional disclaimers can be found at our website. So thank you again to our guests, Bob Rasmus, CEO of Arq Incorporated. We look forward to following developments to your company very closely and to future conversations with you and other on the Arq management team. So thank you very much, and have a great day.

Thanks, Peter. And thank you, everyone.