Filing identity and reporting period
Important metadata discrepancy: The supplied filing is Advanced Emissions Solutions, Inc. (ADES), reporting results through its predecessor ADA-ES, Inc., not Arq, Inc. It is a Form 10-Q for the quarter and six months ended June 30, 2013, filed August 9, 2013. Effective July 1, 2013, ADES replaced ADA-ES as the publicly held parent; the business and management continued substantially unchanged.
The company provides refined-coal (RC) operations and facilities, emissions-control systems and services, and CO2-capture development, principally serving the coal-fired power industry. Unless otherwise indicated, financial amounts below are in millions of dollars.
Financial performance and position
| Metric | Q2 2013 | Q2 2012 | First half 2013 | First half 2012 |
|---|---|---|---|---|
| Revenue | $58.9 | $52.5 | $127.2 | $70.7 |
| Gross margin before depreciation and amortization | $10.6 (18%) | $7.4 (14%) | $20.0 (16%) | $11.4 (16%) |
| Operating income | $0.6 | $1.6 | $0.9 | $0.4 |
| Net income (loss) before non-controlling interests | $0.02 | $0.9 | $(0.3) | $(1.0) |
| Net loss attributable to ADA-ES | $(3.2) | $(1.3) | $(5.3) | $(3.7) |
| Loss per share, basic and diluted | $(0.32) | $(0.13) | $(0.53) | $(0.37) |
Revenue rose 12% in Q2 and 80% for the first half. The first-half increase reflected higher RC revenue and sharply increased emissions-control sales. Q2 operating income declined year over year as general and administrative expense more than doubled to $8.1 million. The company recorded no income-tax expense, and reported a full valuation allowance against deferred tax assets.
Cash flow: First-half operating cash flow was $11.8 million, versus cash used of $13.6 million in 2012. Investing used $3.2 million; financing used $6.1 million. Cash increased $2.6 million to $12.3 million. Operating cash flow benefited substantially from changes in deferred revenue and other liabilities, including facility-related receipts.
Liquidity and debt: Current assets were $36.9 million and current liabilities $54.9 million, a working-capital deficit of $18.0 million, improved from a $24.1 million deficit at year-end 2012. Cash excludes $3.1 million of certificates of deposit included in securities and generally supporting letters of credit. Notes payable totaled approximately $2.6 million; the $2.0 million revolving line had no balance at quarter-end. The balance sheet also included $60.0 million of redeemable temporary equity and a $42.3 million stockholders’ deficit. Current and long-term deferred revenue totaled $39.1 million.
Material changes and segment trends
- Refined coal: First-half revenue increased to $102.3 million from $63.5 million; Q2 revenue declined to $44.2 million from $48.4 million. Rental income increased, while coal sales fluctuate with facilities Clean Coal operates for its own account. Segment profit was $13.6 million for the first half, versus $6.6 million.
- Emission control: First-half revenue increased to $20.8 million from $6.7 million, mainly from ACI and DSI systems and the Bulk Conveyor assets acquired in 2012. The company reported $33.2 million of EC contracts in progress at quarter-end.
- CO2 capture: First-half revenue was $4.2 million, compared with $0.5 million. Segment margins fell as the work mix shifted toward subcontractors and equipment and third-party cost sharing was lower.
- Expense and margin detail: First-half G&A increased to $15.4 million from $7.7 million, including higher executive incentive compensation, sales and bid activity, occupancy, acquisition-related activity, and Clean Coal overhead. Reported gross margin was 16% for both first halves. Management’s adjusted gross margin, a non-GAAP measure excluding specified RC coal sales and operating costs, was 61% versus 79%.
Outlook, commentary and risks
- Management expected 2013 revenue and costs to be somewhat below 2012, while forecasting a higher full-year gross margin than 2012. It expected EC revenue to grow significantly in 2013 and EC gross margin to be about 20%.
- Management targeted placing remaining RC facilities into operation by the end of 2014, but acknowledged delays and difficulty forecasting timing. It stated that the seven RC facilities leased or sold were expected to generate more than $75 million of annual revenue through 2021. Longer-term RC revenue and income projections are management estimates, not guaranteed results.
- In July 2013, two additional facilities were leased, generating more than $14 million in prepaid rent; this occurred after the reporting date. Management said the leases would bring total facilities leased or sold to seven and reduce annual operating costs by more than $8 million for one facility.
- RC economics depend on continued facility operation, coal demand, Section 45 tax-credit eligibility and value, IRS interpretations or audits, permits, utility approvals, private letter rulings, and completion of third-party transactions. The placed-in-service deadline has passed, limiting new qualifying facilities absent legislative change.
- Emission-control demand depends on environmental rules and compliance timing. MATS extensions, legal challenges, less stringent rules, plant retirements, competition, and contract timing could delay or reduce sales. DOE contracts are subject to federal audit and annual funding; approximately $31 million of revenue recognized from 2005–2012 remained subject to audit.
- The company had performance guarantees and warranties; the performance-guarantee accrual was $0.9 million. It also had joint and several Clean Coal-related guarantees. The Norit settlement generated $1.4 million of royalty expense in the first half; a $3.2 million current liability was accrued, and management expected annual royalties of approximately $2–$4 million in the near term.
- GSFS’s $60 million Clean Coal investment is classified as temporary equity and may be redeemable, including a return of 15% in 2021 under the agreement and in certain limited circumstances. The company reported no off-balance-sheet arrangements and no updates to the risk factors in its prior annual report.
Important facts for investors to verify
- Confirm the issuer identity: this filing concerns ADES/ADA-ES, not Arq, Inc., and determine whether it is relevant to the intended company.
- Review subsequent results for actual RC lease and sale closings, facility operation, prepaid-rent recognition, and cash received versus management’s projections.
- Assess the sustainability and quality of operating cash flow, given the working-capital deficit and the contribution of deferred revenue, deposits, and other working-capital movements.
- Check progress on the $33.2 million EC contract backlog, expected delivery schedules, margins, and any MATS-related delays or extensions.
- Track Section 45 tax-credit eligibility, IRS audits and rulings, DOE contract audits and funding, Norit royalty obligations, performance guarantees, and the potential GSFS redemption obligation.