Arq, Inc. quarterly report, Q3 FY2022

Business context and reporting period

This is Advanced Emissions Solutions, Inc. (ADES)’s unaudited Form 10-Q for the quarter and nine months ended September 30, 2022—not a filing by Arq, Inc. The filing describes a proposed combination with Arq Limited, which ADES had agreed to acquire. ADES sells activated-carbon and other consumable air- and water-treatment products, and operates the Five Forks lignite mine. Its former refined-coal affiliates, Tinuum Group and Tinuum Services, ceased material operations after the Section 45 tax-credit program expired at year-end 2021.

Financial performance and position

Amounts below are in millions of dollars, except per-share data and percentages.

Consumables gross profit before depreciation and amortization was $6.9 million in Q3 2022, about 24% of consumables revenue, versus $6.7 million, about 25%, a year earlier. For the first nine months, it was $16.6 million, about 21%, compared with $14.0 million, about 22%. These percentages are calculated from reported consumables revenue and cost of revenue.

At September 30, 2022, cash was $75.8 million, restricted cash was $10.0 million, and current assets and current liabilities were $112.6 million and $25.2 million, respectively. Total liabilities were $42.8 million, including $4.9 million of finance-lease obligations; the filing reports no term-loan balance. Cash and restricted cash together declined $3.0 million from year-end 2021 to $85.8 million. Stockholders’ equity was $142.6 million.

Material changes versus the prior comparable periods

• Q3 consumables revenue rose 7% to $28.4 million, driven by higher volumes and pricing, but total revenue fell 8% because there were no license royalties from Tinuum Group. For nine months, consumables revenue rose 27%, lifting total revenue 7% despite the loss of royalties.
• Higher raw-material, transportation, fuel, and other operating costs pressured consumables margins. Management said Q3 consumables gross margin was flat year over year; the nine-month margin declined.
• Equity-method earnings fell to zero in Q3 and to $3.2 million for nine months, from $22.2 million and $61.9 million, respectively, in 2021. The 2021 comparisons included substantial earnings from Tinuum; 2021 also included a $3.3 million gain from forgiveness of a PPP loan.
• Legal and professional fees rose, principally due to merger-related work. Nine-month operating expenses also included a $1.9 million ARO estimate gain in 2021, versus a $0.03 million loss in 2022.
• Operating cash flow fell to $0.4 million for the first nine months, reflecting lower earnings and equity-investee distributions and higher working-capital needs. Investing cash flow was a $2.0 million use, versus $38.9 million provided in 2021, largely because distributions exceeding investment basis declined.

Outlook, risks, contingencies and unusual items

• Management expected September-end cash to fund operations for the next 12 months. It forecast $11.4 million of 2022 capital expenditures, primarily for Red River Plant improvements and maintenance, funded from cash on hand.
• ADES expected product-price increases and efforts to shift toward higher-margin products to help offset inflation and third-party carbon purchases. It also anticipated scheduled maintenance outages in Q2 2023 would weigh on cost of revenue and gross margin. Demand remains sensitive to electricity demand, seasonal weather, coal dispatch, and competing natural gas and renewable-energy prices.
• The proposed transaction would combine ADES and Arq Limited under New ADES. ADES shareholders could elect 1.11 New ADES shares plus $0.52 cash per share, or 1.22 shares; non-electing holders would receive the all-stock alternative. Arq shareholders were to receive 19,729,235 shares, with a $20 million PIPE investment and $10 million term-debt financing also contemplated. Completion depended on shareholder, regulatory, listing, court and other conditions; the agreement allowed termination if not completed by April 30, 2023, subject to extensions. Failure could entail transaction costs, possible termination fees or expense reimbursement, and business disruption.
• ADES agreed to sell Marshall Mine for an estimated $2.4 million cash payment to the buyer and assumption of certain liabilities. Closing depended, among other things, on Texas permit approval and replacement of the seller’s surety support. The mine had about $5.1 million of liabilities; closing timing and the period for recognizing the sale were uncertain.
• ADES had $24.1 million of mine-related surety bonds and $10.0 million of restricted cash collateral. A call on a bond could require reimbursement to the surety provider. The company also disclosed limited contingent guarantees relating to Tinuum Group, with no provision recorded because management considered a loss not probable. No significant legal proceedings were reported.
• Management reported disclosure controls were not effective at September 30, 2022 because of previously identified material weaknesses involving freight accounting under ASC 606, monitoring of accounting guidance, and review of policies for material accounts. Remediation procedures were underway; management said the financial statements nevertheless fairly presented the company’s position and results in all material respects.
• ADES recorded no income-tax benefit on its 2022 losses because of a valuation allowance. It intended to adopt the expected-credit-loss standard on January 1, 2023 and did not expect a material impact.

Important facts for investors to verify

• Confirm the registrant and transaction status: this filing is ADES’s 10-Q, and Arq is the proposed acquisition target, not the filing company.
• Review subsequent filings for merger approvals, financing, closing conditions, termination rights, and the final consideration and share dilution.
• Assess whether consumables pricing, volume, product mix, and input-cost trends support margins as Tinuum-related earnings and distributions run off.
• Track operating cash generation, working-capital and inventory needs, capital spending, and liquidity available excluding restricted cash.
• Verify Marshall Mine sale completion, actual proceeds and liabilities assumed, and any resulting changes to reclamation obligations, surety bonds, and collateral.
• Monitor remediation and testing of the disclosed control weaknesses, as well as potential costs and obligations related to the merger and mine reclamation.