Filing summary
Issuer and period: The supplied filing is Advanced Emissions Solutions, Inc. (ADES), not Arq, Inc.; the filing text does not identify Arq. It is an unaudited Form 10-Q for the quarter and six months ended June 30, 2016, filed August 9, 2016. Amounts below are in U.S. dollars.
Business context
ADES supplies emissions-control equipment, chemicals and services to coal-fired power and industrial boiler customers. Its Refined Coal business depends substantially on equity-method investees Clean Coal Solutions, LLC (CCS) and Clean Coal Solutions Services, LLC (CCSS), plus related royalty streams. The company had restructured operations, shut its BCSI manufacturing facility and wound down its analytics business.
Key financial metrics
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $9.0 million | $14.9 million | $31.3 million | $36.7 million |
| Operating loss | $4.6 million | $17.8 million | $7.9 million | $24.7 million |
| Net income (loss) | $7.9 million | ($12.4 million) | $12.2 million | ($18.6 million) |
| Diluted EPS | $0.35 | ($0.57) | $0.55 | ($0.85) |
| Cash from operating activities | Not stated by quarter | ($8.0 million) | ($13.8 million) |
- Equipment sales fell 42% in Q2 and 15% for the six-month period year over year. Chemicals revenue rose 79% and 70%, respectively; consulting and other revenue declined.
- Approximate gross margin, calculated from reported revenue less direct costs of revenue and excluding depreciation and amortization, was 35.5% in Q2 2016 versus 6.0% in Q2 2015, and 26.2% for the first half versus 18.9%.
- Profitability relied heavily on equity-method earnings: $13.8 million in Q2 and $19.3 million in the first half, compared with $4.9 million and $5.2 million a year earlier. In 2016, CCS-related income included distributions exceeding ADES’s investment carrying value; the CCS investment balance was zero at June 30.
- Cash and cash equivalents were $2.2 million at June 30, down from $9.3 million at year-end. Current assets were $19.1 million and current liabilities $30.3 million; working capital nevertheless improved by $14.2 million during the first half.
- ADES used $8.0 million in operating cash and generated $16.1 million in investing cash, including $14.9 million of CCS distributions classified as investing because they exceeded the investment basis. Financing used $15.2 million, including repayment of the credit agreement.
- Related-party borrowings and notes payable were zero at June 30, following repayment or settlement. Total liabilities were $47.1 million, including $23.1 million in legal settlements and accruals; stockholders’ deficit was $10.5 million.
Material changes and unusual items
- Net income improved substantially from the prior-year loss, despite lower revenue. Management attributed the improvement to higher refined-coal equity earnings and distributions, better emissions-control margins, and reduced payroll, legal, professional, and R&D costs.
- Operating expenses included $0.5 million of impairment charges for inventory and property and equipment. First-half results also included a $2.1 million gain on the sale of the RCM6 investment and approximately $0.9 million from settling a note payable; the company also recorded a gain related to terminating a Highview technology license.
- ADES paid $9.9 million on June 30 to settle and terminate its $15 million short-term credit agreement. The agreement had carried a 15% stated rate after amendment. Its separate bank line of credit had no borrowing availability because of historical covenant violations.
- Cash flows were pressured by contract delivery, debt service, restructuring and prior-period restatement expenses. Restricted cash and investments securing letters of credit totaled approximately $11.2 million at June 30; an additional $2.4 million was released in July after equipment performance requirements were met.
Outlook, risks and contingencies
- Management said liquidity pressure was expected to continue and that operating needs depend on contract execution, royalties, CCS/CCSS distributions, market share and operating efficiencies. Additional CCS distributions may depend on securing tax-equity investors for facilities not operating or retained by CCS. Management was seeking to restore borrowing capacity; absent financing or adequate cash generation, it could need further restructuring.
- Management expected remaining-2016 royalty income to approximate Q2 levels, given production and retained-facility conditions. It anticipated a significant decline in new long-term ACI/DSI equipment contracts as key regulatory compliance deadlines had passed, while citing potential upgrade and replacement demand and prospects for chemical products.
- In July, ADES initiated a workforce reduction affecting approximately 38% of employees, with estimated charges of $0.7–$0.9 million and cash costs of $0.5–$0.7 million. Additional restructuring charges were also expected.
- Legal contingencies included a proposed $4.0 million securities class-action settlement, subject to court approval and expected to be funded by insurers; a proposed derivative settlement with legal fees capped at $0.6 million, also subject to court approval; and a proposed $0.5 million SEC penalty, subject to SEC approval. The company accrued these amounts and corresponding insurance receivables where applicable. The separate Norit royalty obligation was accrued at $17.9 million, current and long-term combined.
- Disclosure controls were reported ineffective at June 30 because of previously disclosed material weaknesses. Remediation was ongoing, and management said the new controls had not been in place long enough to establish effectiveness.
- The board was reviewing strategic alternatives; ADES cautioned that the process might divert management attention, increase expenses, affect personnel or business relationships, and might not result in a transaction.
Most important facts for investors to verify
- Confirm the issuer identity: this filing is for Advanced Emissions Solutions, Inc., not Arq, Inc.
- Track cash generation and near-term liquidity, including the status and availability of the bank line of credit and the use of the $2.4 million released after quarter-end.
- Assess the sustainability and cash realization of CCS/CCSS earnings and distributions, including dependence on tax-equity investors and the zero carrying value of the CCS investment.
- Verify court and SEC approval, insurance funding, and final costs of the disclosed settlements and royalty obligations.
- Monitor remediation of material weaknesses, the effects of the July workforce reduction, and any developments in the strategic-alternatives review.