Business context and reporting period
This is Advanced Emissions Solutions, Inc. (ADES)’s unaudited Form 10-Q for the quarter ended March 31, 2017—not a filing identified as Arq, Inc. ADES supplies emissions-control equipment, chemicals and services to the coal-fired power industry and earns income and royalties through refined-coal investments and technology licenses. Its two reportable segments are Refined Coal (RC) and Emissions Control (EC).
Financial results and liquidity
Unless otherwise indicated, amounts are in millions of dollars; comparisons are with Q1 2016.
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Revenue | $7.4 | $22.4 |
| Operating loss | $(3.7) | $(3.3) |
| Income from equity-method investments | $13.8 | $5.6 |
| Net income | $8.7 | $4.4 |
| Diluted EPS | $0.39 | $0.20 |
| Operating cash flow | $(2.8) | $(1.9) |
- Equipment sales fell 76% to $5.1 million; chemical revenue increased to $2.3 million from $0.4 million. Approximate gross margin on equipment was 18.9% versus 21.6%; on chemicals it was 22.9% versus 67.3%.
- Reported net income included $13.8 million of equity-method earnings, $1.8 million of related-party royalties, and a $2.9 million reduction in the estimated royalty-indemnity liability. Equity earnings included $13.2 million of Tinuum Group cash distributions recognized as earnings because ADES’s investment carrying value was zero.
- Income-tax expense was $5.4 million, with a 38% effective rate, versus $0.1 million and 1%. The balance sheet reported deferred tax assets of $56.0 million, down from $61.4 million at year-end.
- Cash and cash equivalents were $28.4 million and restricted cash was $8.5 million at quarter-end. Cash plus restricted cash increased $10.0 million during the quarter. Investing cash flow of $13.0 million included $13.2 million in Tinuum Group distributions in excess of investment basis.
- Total assets were $104.8 million and total liabilities $19.5 million. Current assets were $42.4 million against current liabilities of $14.9 million. No line-of-credit borrowings were outstanding; $11.2 million of letters of credit left $3.8 million of borrowing availability. The $15 million line matures September 30, 2017 and carries financial covenants, including minimum trailing-twelve-month EBITDA of $24 million.
Material changes versus the prior period
- Net income rose despite a 67% decline in reported revenue, primarily reflecting higher Tinuum Group distributions and equity earnings, lower expenses, and the royalty-liability estimate revision.
- RC segment operating income increased to $15.0 million from $7.9 million; EC segment operating income declined to $0.3 million from $4.6 million, mainly as equipment-system completions and sales fell.
- Operating expenses excluding cost of revenue declined 38% to $5.2 million. Lower payroll and professional fees reflected reduced headcount, restructuring, and the completion of most restatement work; general and administrative expense increased.
- Royalty-indemnity and legal-settlement liabilities fell to $7.0 million from $16.1 million, reflecting settlement-related releases and the revised Royalty Award estimate. The Denver securities class action and shareholder derivative cases were dismissed after settlement.
Outlook, risks and unusual items
- Management expects chemical revenue to increase in 2017 as existing customers contribute for a full year and the customer base expands, but expects 2017 chemical margins below 2016 levels because of customer field testing and contract terms. It expects longer-term margins to be consistent with 2016 performance.
- Management expects substantially fewer long-term equipment contracts following the MATS compliance deadline and does not expect consulting revenue to be material in the near term. It expects royalty income per ton to move closer to historical levels during the remainder of 2017.
- Future liquidity depends in part on Tinuum Group distributions and royalties, preservation of contractual relationships, additional tax-equity investors for facilities not operating, and growth in emissions-control chemicals. Management cautions that operating results and cash flows may vary and are not necessarily indicative of full-year results.
- ADES paid a $0.5 million SEC civil penalty in Q1 under a settlement reached without admitting or denying the allegations; the penalty had been reserved previously. ADES is contesting a $0.8 million customer draw on an equipment letter of credit and pursuing recovery.
- In April 2017, $5.5 million of restricted cash was released and transferred to the bank account held with the line-of-credit lender. Subsequent to quarter-end, the board adopted a tax-asset protection plan related to approximately $113 million of tax attributes reported at December 31, 2016. ADES also commenced a tender offer to buy up to 925,000 shares for up to $10 million.
- Key risks include declining coal-related equipment demand, the dependence of earnings and liquidity on investee distributions and RC operations, tax-credit qualification and utilization, legal and contractual obligations, and compliance with credit-facility covenants. Management reported disclosure controls effective as of March 31, 2017 and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Confirm the issuer: the supplied filing is for Advanced Emissions Solutions, Inc., although the request metadata names Arq, Inc.
- Review the sustainability and source of Tinuum Group distributions, including the zero carrying value of ADES’s investment and the effect on reported equity earnings and cash-flow classification.
- Check line-of-credit covenant compliance, borrowing availability, letter-of-credit collateral and maturity; assess the effect of the April restricted-cash release.
- Evaluate the assumptions behind the $2.9 million Royalty Award liability reduction and the remaining estimated settlement obligations.
- Assess whether projected chemical growth and margins, reduced equipment demand, tax attributes and the proposed tender offer support future liquidity and earnings.