Arq, Inc. quarterly report, Q1 FY2018

Business context and reporting period

The supplied filing is Advanced Emissions Solutions, Inc. (ADES) Form 10-Q for the quarter ended March 31, 2018; it does not identify Arq, Inc. Investors should verify that this is the intended filing. ADES operates in emissions-control products and services and refined-coal (RC) technologies, with substantial earnings and cash distributions tied to equity-method investees, particularly Tinuum Group.

Financial results and position

Net income was primarily supported by equity-method earnings and $3.2 million of related-party license royalties, while consolidated operations recorded a loss. Cash provided by investing activities was $11.0 million, including $11.1 million of Tinuum Group distributions in excess of investment basis. Financing cash use was $7.1 million, including $5.1 million of dividends and $1.6 million of share repurchases. The filing does not provide a consolidated gross-margin percentage.

At quarter-end, current assets were $41.2 million and current liabilities $5.3 million; total liabilities were $5.5 million and stockholders’ equity was $77.3 million. Deferred tax assets were $36.2 million. The company declared a $0.25-per-share dividend for the quarter.

Material changes versus the prior comparable period

• Revenue fell mainly because equipment sales declined to $0.05 million from $5.1 million and chemical sales declined 73% to $0.6 million. Management said the major chemical customer from Q1 2017 was not expected to resume purchasing.
• License royalties rose 84% to $3.2 million; licensed RC production increased to 7.7 million tons from 3.4 million, reflecting additional invested facilities.
• Equipment sales cost of revenue was a $0.15 million credit, versus $4.1 million of expense in Q1 2017, including a $0.3 million reduction from settlement of a prior customer commitment.
• RC segment operating income was $14.7 million versus $15.0 million. Emissions Control segment results shifted to a $0.9 million operating loss from $0.3 million of income.
• Income tax expense declined to $2.6 million from $5.4 million; the effective rate fell to 25% from 38%, mainly reflecting the federal corporate tax-rate reduction and lower pretax income.
• ADES adopted ASC 606 using the modified-retrospective method, increasing opening accumulated earnings by $3.0 million. License royalties were presented as revenue rather than non-operating income; this reclassification did not affect net income.

Outlook, risks, contingencies and unusual items

• Management did not provide quantified financial guidance. It said it did not expect future long-term fixed-price ACI or DSI equipment contracts, as the related regulatory compliance deadlines had passed. Cash generation depends materially on Tinuum distributions and royalties, RC facility performance and investor participation, and recovery of emissions-control chemical sales.
• Tinuum Group’s investment carrying value was zero because cumulative distributions exceeded ADES’s cumulative share of earnings. While it remains zero, ADES recognizes earnings from Tinuum Group only to the extent distributions are received. The filing notes that 11 of Tinuum Group’s 17 invested RC facilities were leased to one customer; loss of that customer could materially harm results and cash flows.
• The company had a $1.0 million accrual for a potential Department of Labor restorative payment related to its 401(k) plan investigation. Management considered a loss probable and estimable, but actual payment could exceed the accrual. Tinuum-related limited guarantees were disclosed, with no liability recorded because a loss was not considered probable.
• After quarter-end, the company announced a workforce reduction affecting approximately 43% of employees, including two named executive officers. It expected $1.9–$2.1 million of charges in Q2 and Q3 2018, with $1.1–$1.3 million of cash expenditures.
• After quarter-end, the board declared another $0.25-per-share dividend, payable June 8, 2018. ADES also repurchased approximately 392,000 shares for $4.3 million after March 31.
• Management reported disclosure controls were effective and no material risk-factor updates. It cautioned that RC production and Section 45 tax-credit qualification, customer and investor relationships, competition, regulation, litigation, and execution could affect results.

Important facts for investors to verify

• Confirm the filing identity: the supplied 10-Q is for Advanced Emissions Solutions, Inc., not Arq, Inc.
• Assess the sustainability and cash convertibility of equity-method earnings, particularly given Tinuum Group’s zero carrying value and dependence on distributions.
• Verify Tinuum’s customer concentration, RC facility operating status, renewals, and ability to attract tax-equity investors.
• Track the decline in chemical sales and margins, the absence of expected long-term equipment contracts, and the impact of the workforce reduction.
• Review the 401(k) investigation, the $1.0 million accrual, and any updates to contingent guarantees or other legal matters.
• Confirm the credit-line renewal or replacement before its September 30, 2018 maturity and evaluate planned dividends and share repurchases against recurring cash generation.