Good afternoon, everyone, and thank you for joining us today. Welcome to this WTR Insights conference session with Arq, Inc. I am Peter Gastreich, Managing Director of Energy Transition and Sustainable Investing at Water Tower Research. Joining me today is Bob Rasmus, who is the Chief Executive Officer of Arq. Bob, welcome today, and thanks so much for spending some time with us today.
Thank you, Peter. We are delighted to be here and delighted to participate.
Okay, fantastic. Just a couple of quick housekeeping items before we begin. Arq's safe harbor statements can be found on the investor tab of the company's website, and I would encourage investors to take a look at those. Investor questions are, of course, welcome. Please put them in the chat box and we will make sure that those are delivered to Bob and his team to address during the chat or later. If you would like to request a meeting with Arq management's team, you can also register that interest through the conference portal. With that formality out of the way, let us get into it here. Bob, maybe we will just start from the top. As always with these kind of calls, there could be some investors listening who are new to the story.
With that in mind, could you walk us through from a high level, what does the company do, what markets does Arq serve, and how would you characterize the strategy that you are executing right now?
Sure. We're an environmental technology company whose products, principally activated carbon, reduce and even reverse harmful environmental liabilities and pollutants such as PFAS or forever chemicals, scrubbing mercury emissions from coal-fired power plants, remediating groundwater or soil in terms of pollutants, as well as improving the taste and odor of municipal water supply on that. Our markets, as I mentioned, are utilities, water utilities, coal-fired power plants, and other industrial generators, as well as a wide variety of pollution remediation activities.
Why don't we start with PFAS here. The compliance clock for U.S. water utilities is now running. Where are the utilities in their planning today, and how exactly will your activated carbon help them to achieve that objective, in terms of their water systems?
Sure. Where utilities are as it relates to PFAS varies by municipality, by state, by region, and by utility. I think all of them are keenly aware of the need to stay on top of and be proactive as it relates to the upcoming compliance as mandated by the EPA. I'd say people are focused on characterizing the problem in terms of expanding or confirming their existing PFAS sampling, mapping concentrations by well or by source, evaluating seasonal variabilities, and if they're not in compliance, starting to focus on how are we going to get in compliance. If they are in compliance, focusing on contingency, what happens if they go out of compliance?
I think all are keenly aware of the cost of compliance, especially as it relates to if the decision is made to install a granular activated as a solution, that the timing and the considerable expense that would be associated with that. Where we are is that we've looked to take advantage of our core competency in terms of our best-in-class research and technology, and developed our PAC for PFAS product. It's not a one size fits all. It's designed for those who are close to being in compliance or those. The quick definition is what's close to being in compliance is a logical question to ask. We know that you have to be four parts per trillion or less to comply with the new EPA regulations. We know that 20 or 30 parts per trillion, that our PAC for PFAS product will allow people to get into compliance.
Now, we could go much higher, but at some point, the volume of PAC that would be required would offset the cost of capital in terms of GAC. It is a selective portion of the market, but it is a very large portion of the market, and it allows our customers to be in compliance proactively with the upcoming EPA regulations, and also avoid the capital expense required in terms of installing GAC systems to be able to combat PFAS.
You have said before that the PAC for PFAS trials are ongoing and looking very encouraging, with a meaningful contribution starting from next year. What has to go right in a trial to turn that into a contract, and how much of that demand do you think you can serve from your existing asset base, whether that means displacing lower margin volume or by raising your utilization?
Sure. We know PAC for PFAS works. We know it from our trials, we know it from third party trials, we know it from independent third party trials. Where we are now is with a beta group of water utilities who we have our PAC for PFAS product out who are currently testing and confirming the results that we have, and again, that the third party testing. Based on that, we expect those utilities to enter into contracts for us for PAC for PFAS. In terms of the overall market, it is quite significant. As I say, it is not the entire market in terms of PFAS remediation, but it is a significant portion, and we think it will provide very meaningful opportunity to expand our EBITDA and our cash flow. As it relates to cannibalizing potentially existing business.
One of the initiatives we have is increasing our efficiency, increasing our capacity, lowering costs, and that goes hand in hand, is interrelated with our PAC for PFAS initiative. That will allow us to not only serve our existing customers, but also to expand volumes and sales capabilities to be able to handle PAC for PFAS. If it ever becomes a constraint, it would be a very advantageous problem to have, because what we would do is then we would cut off the lower margin and lowest margin product, and continue to expand PAC for PFAS.
Okay. Thanks for that. Let's turn over to the granular activated carbon strategy. This recent quarter, you put a CapEx range on phase one for the first time, and you're equally clear at the same time that just publishing that number is not necessarily a decision either way. Could you walk investors inside that framework and what are you looking for on cost, on design, and on returns before you would sanction that opportunity?
Sure. W e constructed and did a debrief and lesson learned on our initiative into GAC, and one of the lessons learned was that the business is not GAC, the business is PFAS remediation. That led to a dual pronged strategy in terms of emphasizing PAC for PFAS, creating that as a product which takes advantage of our core capabilities, our strong R&D team, our strong technical relationships without the need for additional CapEx. When we look at the granular activated carbon, it is still a very viable alternative and solution, but it's all about what's the best vehicle for creating maximum shareholder value as it relates to that. Can we achieve maximum returns with PAC for PFAS without getting into the GAC business? Or as time evolves, do we look into getting into the GAC business and getting rid of some of the lower margin existing PAC business?
What's the return on that investment? What maximizes shareholder values? We know pretty much, in fact, with a high degree of certainty what the design is. We know with a high degree of certainty what the cost is. The key question is what's in the best interest of our shareholders, and that's how we'll behave. We're constantly analyzing that, and it's great to have that option value for our shareholders.
Well, investors really paid attention recently when Calgon announced that up to 25% increase, and I know you don't want to comment on a competitor's rationale, but really maybe more from an industry angle, would you view that tightness related to cost inflation? Is it imports or is it all of the above?
Right. From a micro factor, as you're right, I don't want to comment on our competitor. From a macro, happy to comment. I think it's reflective of the underlying strength of the activated carbon market, particularly as it relates to PFAS remediation. I think there is a component of cost inflation. I think you see it all across the board, but it's also most reflective, in my opinion, of the significant excess demand versus supply, and that there's very little supply that one can foresee coming on board in the next two, three, four years for activated carbon to solve the PFAS situation. So I think it's really a fundamental supply-demand imbalance in favor of excess demand versus the supply than anything else.
Should we have any read-throughs for Arq's own pricing? Also given that you've already had a campaign the last two years of raising the prices for PAC.
I think what we're focused on overall is improving shareholder returns. We're always looking for opportunities where we can increase price or pass along price increases, but we're also very focused on increasing efficiency, increasing throughput, as I mentioned, and reducing our costs and further absorption of our fixed cost overhead. So that's where we're looking to expand our margins. It's not necessarily through price increases, but it's paying attention to the basic business, increase throughput, increase efficiency, reduce cost. Going back to your question on pricing on granular activated carbon, the pricing increases further give credence to a shareholder value in terms of the optionality we have in the PAC for PFAS business, as well as potentially getting into the granular activated carbon component of the PFAS remediation business.
The PAC business in the second quarter delivered against analyst expectations, again, meaning beating analyst expectations yet again. Had quite a few quarters like that in the past, and that was even during a low season with the turnaround. Meanwhile, you've been deliberately reducing the exposure to that coal-fired power while growing water. How do you balance that kind of legacy demand against the diversification that you've been driving?
I think a couple things. One, we have transformed the foundational PAC business from one that lost $15 million three years ago to at the high end of the guidance range we provided this year is $20 million of adjusted EBITDA. That is a $35 million turnaround, and we think we can do better, and in fact, much better. As we have talked about, our target for exiting next year is a $30 million annual EBITDA run rate. What it is, again, I am hating to be redundant, but it is focusing on our core business, our core strength. It is continuing to serve our base customers, our base business, continuing to expand that business, but also expanding into new products. That is products plural, not just PAC for PFAS.
That goes hand in hand with our ability and desire to increase our capacity, increase our capacity utilization, increase the efficiency. That will allow us to continue to serve our existing customer base while continuing to expand into new products and markets with even higher average selling price and higher margin.
I think one of the great aspects of the story is that Arq really has a lot of levers that you can potentially pull. We have already been through PAC and GAC, but you have Corbin and the coal waste purification technology are other value levers that you flagged. Your asphalt partner is now cleared an important validation step, and you have mentioned unsolicited third-party interest in some other applications. How do you weigh the options that are in front of you, whether that is operating Corbin as a feedstock supplier, licensing, an outright sale, or a joint venture?
It is all about maximizing shareholder return as it relates to that. On the asphalt side, we talked about on the most recent earnings call, the testing. It continues to advance in numerous other testing areas on the asphalt side, including looking at some of these roofing applications as it relates to that. We are very encouraged there. We are also talking to third parties who have expressed interest in either acquiring or investing in and having us operate that for various business opportunities as it relates to rare earth minerals, critical elements, or other as coal, high-quality coal as a feedstock.
We just continue to evaluate those in terms of what is the best opportunity for our shareholders, as well as how do we minimize that option cost or option premium in terms of that by winterizing the product, reducing staffing, reducing the cost of heating and things like that, so that we maintain that optionality, but at the lowest potential cost.
Okay, great. Let us take a look at the financial position and your funding strategy. You reaffirmed your guidance this quarter and set out an ambition to lift the core PAC adjusted EBITDA by 50%. If not GAC, what is going to drive that growth into next year, and what does that suggest for the balance sheet and the funding prospects as well?
A couple things in terms of the avenues to achieve that 50% growth above the top end of the guidance range that we provided this year. I would say about 30% of that is cost related in terms of increased efficiency, finding alternative sources to some of the feedstocks that we use and some of the additives that we utilize, and increase fixed cost absorption as we produce additional volumes. The remainder, 60%-70%, is roughly from increasing our average selling price, expanding and diversifying into new markets, particularly the PAC for PFAS, which is at a much higher pricing and much higher margin. We think those are readily achievable goals in terms of being able to do that.
We might not have addressed this a bit earlier, but when we talk about the GAC opportunity, can you give investors an idea of what you are looking at in terms of scale of the new facility?
If we go forward, it would be a minimum of 25 million pounds of granular activated carbon. Again, in terms of production capability, there seems to be a cost trade-off that once you cover your fixed cost at a certain volume, that it all virtually falls to the bottom line. We think 25 million pounds of granular activated carbon is the right amount, or I should say more precisely, the minimum amount to be able to, if we decided to expand in going forward. Of course, we want to do that in terms of without diluting the existing shareholder base. I think one of the things that has retarded our stock price in the past is people have thought with the uncertainty regarding GAC expansion that we were going to issue massive amounts of stock, which would then dilute existing shareholders.
But when you look at the $20 million of EBITDA, that is our high-end target this year, $30 million for next year, you look at a business that has existing $30 million of debt, and if we monetize Corbin, it would go down by about $8 million or $9 million and increase EBITDA. You're talking a business that's levered one times or one and a half times. If there was a need for a chunk of CapEx to, let's say, expand into granular activated carbon production capability, we should be able to easily finance that in the debt markets without having to dilute shareholders, because that is absolutely our goal.
Yeah. Bob, you, as well as your management team, do have significant skin in the game, right, in terms of shareholding for the company.
Absolutely. I only take a $50,000 salary. I own well over a million shares, have exposure to well over a couple million shares beyond that. In between myself, management, and the board, it's almost 25% ownership in the company. So we're aligned with shareholders. When people talk about alignment, we're living and breathing icon of shareholder alignment on management and board.
How about, investors are always interested in knowing what they should sort of, suggestions anyway from the management, what they might be focusing on at the company. What would be some of the key signposts that investors should be watching in the coming quarters or into next year to kind of give them evidence that the company's executing on its strategy?
I think a couple things. One obviously is EBITDA, as it relates to that, what type of cash are we producing? Two, how is our gross margin progressing? Are we continuing to increase our gross margin? Is it stabilizing at a higher level? Is it a consistent level? Because in the past, given some of our troubles trying to get into the granular activated carbon portion of the PFAS remediation business, we've been uneven both in our financial performance and our gross margin performance. It's also looking at if we isolate it, what new product volume do we get from the PAC for PFAS? Those would be the three main in terms of gross margin, EBITDA, and new product penetration.
Okay. We have a little bit more time before we get to the closing remarks. I just want to ask you about, over the past year, you've made some notable changes in terms of your management team. Would just like to get your thoughts on what's been happening there.
Sure. No, we're always on the outlook to how do we improve the business. There are no sacred cows in the business in terms of what we do. So what we've done is we brought a new operating team at Red River in Louisiana. The previous team had done an okay job, but okay isn't good enough. Average isn't good enough in my world, on that we want to be the best performing company. Our goal has always been to be the safest, lowest cost, and best returning company in the activated carbon business, and we needed a new outlook in terms of how we view our operations, how do we increase efficiency? How do we increase capacity? How do we increase throughput? How do we lower costs? The answer, "We've always done it this way," isn't good enough. It clearly hasn't been good enough.
And we've seen some of the effects on that in the margin enhancement in the second quarter. On the sales side, we brought in Jeanette McQueeney to help us expand strategically into new products and markets, and we're encouraged by that. PAC for PFAS has been one of those. On the finance side, we also brought in a more seasoned finance veteran who's been a great partner for me in terms of Shimon Steinmetz in helping drive the business forward and being more proactive.
Yeah. Just to highlight to investors that a couple of months ago, we invited your leadership for operations and technology in together, and it was really a fantastic podcast, had a lot of interest, but would definitely recommend that investors take a look at that on our website if you get a chance. But, Bob, with that, I'm afraid we are getting close to the end of our time here. But is there anything that we missed today or any closing remarks that you'd like to provide?
No. I appreciate your interest today, Peter, and from an investor standpoint. I think the key is that we've transformed the foundational PAC business from, as I said before, from a money-losing business into a growth business. And there's the opportunity to do much, much better, going forward in terms of shareholder returns and the ability to expand the profitability of that business. You stack that on top of our best-in-class R&D capabilities, which has allowed us to expand into the PAC for PFAS business and allow us to participate in the PFAS remediation market without any significant or meaningful additional capital expenditure. When you look at that and the opportunities, I think we're quite undervalued, in terms of our equity price.
Okay, that's great. Well, Bob, thank you very much. It's always a pleasure to have you in with us to share your thoughts with investors, and really appreciate you joining us, and we'll look forward to having you back at a future event.
Thank you, Peter, and thank you at all.
Thank you to everyone who joined us for this session. Additional research and content on Arq is available at www.watertowerresearch.com. If you have any questions that we didn't get to or you'd like to arrange a meeting with Arq's management, please indicate that through the conference portal. We do have another session starting shortly, so please stay tuned for that. Thank you very much.