Arq, Inc. annual report, FY2014

Full document

Filing identity and reporting period

Important identity discrepancy: The request identifies Arq, Inc., but the supplied filing is Advanced Emissions Solutions, Inc. (ADES), Form 10-K for the fiscal year ended December 31, 2014. This summary covers ADES; the filing does not provide Arq-specific information. The report was filed February 29, 2016, and includes later developments where noted.

ADES provides emissions-control equipment, chemicals, engineering and services to coal-fired power and industrial customers. Its results also depend heavily on equity-method investments and royalties tied to refined-coal production and related tax-credit arrangements.

Financial performance and liquidity

  • Revenue: $16.9 million in 2014, up 27% from $13.3 million in 2013. Equipment sales rose to $12.0 million from $5.7 million, while consulting revenue fell to $4.5 million from $6.8 million.
  • Operating result: Operating loss widened to $41.8 million from $32.3 million. Operating expenses increased 29% to $58.7 million; legal and professional fees reached $14.4 million, reflecting the re-audit, restatement and SEC inquiry.
  • Net result: Net income was $1.4 million ($0.06 per diluted share), versus a $16.0 million net loss in 2013. The 2014 result included $42.7 million of equity-method earnings and $6.4 million of related-party royalties, offset in part by $5.7 million of interest expense. CCS distributions exceeded ADES’s investment carrying value, so accounting earnings are not a simple measure of recurring operating profitability.
  • Cash flow: Operating cash outflow was $42.5 million, compared with $10.2 million in 2013. Investing activities provided $31.4 million, substantially including $43.6 million of CCS distributions classified as distributions in excess of cumulative earnings; financing used $1.6 million. Cash and cash equivalents declined $12.7 million to $25.2 million.
  • Balance sheet and liquidity: At year-end, assets were $93.7 million, liabilities $94.4 million and stockholders’ deficit $0.7 million. Current assets were $54.4 million against current liabilities of $47.2 million, including $2.5 million of restricted cash. Notes payable were $15.9 million, primarily related-party obligations; the balance sheet also carried $24.0 million of settlement and royalty indemnification obligations.
  • Subsequent borrowing: In October 2015, ADES obtained a $15.0 million short-term loan at 10.5% annual interest, receiving $13.5 million net. It was due April 22, 2016, subject to a conditional extension, and secured by substantially all company assets. The filing describes repayment and refinancing as dependent on cash generation and distributions from investees.
  • Backlog: $144.1 million at December 31, 2014, versus $109.4 million a year earlier. Backlog is not a GAAP measure and may be delayed, changed or cancelled.

Changes versus comparable periods

  • Revenue increased as more ACI equipment projects were completed; consulting and chemical sales declined. The company recorded $0.4 million of DSI contract loss provisions in 2014, versus $4.9 million in 2013.
  • Equity-method earnings rose to $42.7 million from $15.5 million, principally reflecting CCS distributions and more invested refined-coal facilities. Management expected 2015 equity-method earnings to decrease substantially, citing fewer new investments and cash used for retained-facility operations and installation.
  • Operating cash use worsened materially, driven by project costs and working capital, higher professional expenses, settlement payments and investment outlays.
  • ADES restated prior-period financial information. It deconsolidated CCS effective January 1, 2010 and corrected equity-method accounting, equipment revenue recognition, settlement and royalty-indemnity accounting, and other items. The filing says investors should rely on the restated information here rather than prior reports for affected periods.

Outlook, risks and unusual items

  • Business and regulatory outlook: Management viewed emissions rules as a market opportunity but noted uncertainty from litigation, extensions, regulatory changes and declining U.S. coal generation. The Supreme Court required EPA reconsideration of MATS costs; the Clean Power Plan was stayed pending court review. No quantified company revenue or earnings guidance is provided.
  • Business restructuring: After year-end, the company wound down its ADA Analytics operations and closed BCSI’s Pennsylvania manufacturing operations at the end of 2015, shifting toward engineering and third-party manufacturing. Employee count fell from 231 at December 31, 2014 to 69 at December 31, 2015.
  • Refined-coal exposure: Results depend on CCS, in which ADES held 42.5%, and on Section 45 tax credits, coal-plant operations, tax-equity investors and leases. CCS reported a $45.5 million unrecovered GSFS investment balance, including its preferred return, at year-end 2014. One tax-equity investor notified CCS it would terminate an investment effective April 2016.
  • Accounting and controls: The financial-statement audit opinion was unqualified, but management and the auditor concluded internal control over financial reporting was ineffective at December 31, 2014. Material weaknesses included control environment and oversight, technical accounting resources and procedures, and IT general controls. Remediation was ongoing.
  • Reporting and market status: ADES did not file a 2013 Form 10-K or 2014 quarterly reports, and the filing states it did not intend to file them. Its shares were delisted from Nasdaq in March 2015 and traded on OTC Pink, with associated liquidity and capital-market access risks.
  • Legal and contingencies: A securities class action, stayed derivative actions and a formal SEC investigation related to financial reporting were pending; potential loss was not estimable and no loss accrual was recorded. DOE contract audits for 2010–2014 were unfinished. The company also reported two 2015 equipment performance-guarantee issues, which it did not expect to have a material adverse effect.
  • Other notable matters: A $0.5 million note receivable was fully reserved at year-end 2014 after repayment concerns emerged. The company recorded a $3.5 million restructuring charge in 2014. It had full valuation allowances against deferred tax assets, despite substantial tax-credit and net operating loss carryforwards.

Investor verification priorities

  1. Confirm the issuer: the supplied document is ADES, not Arq, Inc.
  2. Review the restated statements and notes, especially CCS deconsolidation, completed-contract revenue recognition and royalty-indemnity accounting.
  3. Assess the sustainability and cash conversion of equity-method earnings, including CCS distributions, lease changes, tax-credit qualification and investor concentration.
  4. Verify current debt, refinancing or repayment status, collateral and covenant compliance; the filing’s $15 million short-term borrowing was a post-2014 event.
  5. Track remediation of material weaknesses, SEC reporting compliance and the outcomes of the SEC inquiry and investor litigation.
  6. Evaluate backlog conversion, customer concentration, equipment guarantees and the effects of the manufacturing and analytics wind-downs.