Arq, Inc. quarterly report, Q2 FY2017

Business context and reporting period

Advanced Emissions Solutions, Inc. (ADES) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2017. The filing identifies Advanced Emissions Solutions, Inc. as the registrant, not Arq, Inc.; verify the company and filing match the request. ADES sells emissions-control equipment and chemicals and earns equity-method income and royalties through refined-coal businesses, principally Tinuum Group.

Financial performance and liquidity

Q2 equipment sales rose to $24.6 million from $8.2 million, while chemicals revenue was $0.8 million versus $0.6 million. For the first half, equipment revenue was nearly flat at $29.7 million; chemicals revenue increased to $3.1 million from $1.0 million. Six-month segment operating income was $26.2 million for Refined Coal and $2.2 million for Emissions Control, versus $22.1 million and $6.7 million, respectively, a year earlier.

Cash and cash equivalents were $26.4 million at June 30, 2017, plus $3.0 million of restricted cash; total liabilities were $20.5 million. Current assets were $34.9 million and current liabilities $17.2 million. No line-of-credit borrowings were outstanding, but $10.7 million of letters of credit reduced availability under the $15 million facility to $4.3 million. The facility matured September 30, 2017. Six-month operating cash flow was negative $6.1 million; investing cash flow was positive $22.1 million, including $22.3 million of Tinuum Group distributions classified as investing because ADES’s investment carrying value was zero. Financing cash flow was negative $13.5 million, including $13.0 million of share repurchases. ADES reported no long-term borrowings in the balance sheet.

Material changes versus prior period

• Q2 revenue increased 184%, primarily because four DSI equipment systems were completed versus one in Q2 2016; equipment sales cost rose faster than equipment revenue, and consolidated operating loss remained.
• First-half net income increased despite a higher tax burden: income tax expense was $9.0 million versus $0.2 million, following a partial release of the deferred-tax-asset valuation allowance at year-end 2016. The effective tax rate was 37% versus 1%.
• First-half equity-method earnings rose 24%, while Q2 earnings fell 26%. Tinuum Group distributions and their accounting treatment materially affect the timing and classification of reported earnings and cash flow.
• Operating expenses excluding cost of revenue fell 43% in the first half, reflecting lower headcount, restructuring, reduced restatement-related professional costs, and the office relocation.
• ADES repurchased 1,370,891 shares at $9.40 each for approximately $12.9 million before fees, and declared its first quarterly dividend of $0.25 per share, totaling $5.3 million.

Outlook, risks, contingencies, and unusual items

Management expected chemicals revenue to increase during 2017 as customer sales and the customer base expanded, but anticipated lower 2017 chemical gross margins than in 2016 because of field testing and contract mix; it expected longer-term margins to be more consistent with 2016. Increasing chemical sales was identified as the Emissions Control business’s primary focus. ADES did not expect further long-term fixed-price ACI or DSI system contracts after key regulatory deadlines passed and expected existing backlog to be completed by December 31, 2018. No quantified company-wide earnings or revenue guidance was provided.

Liquidity depends in part on Tinuum Group distributions and royalties, execution of equipment contracts, chemical growth, and Tinuum Group’s ability to preserve relationships and secure tax-equity investors for facilities not operating. The $5.4 million Royalty Award liability was reduced after lower forecast Red River Plant revenues; future payments remain dependent on actual adjusted sales. A $0.5 million SEC civil penalty was paid in Q1 2017. The securities class action and stockholder derivative matters were settled and no longer affected the June 30 balances. A Department of Labor investigation of the company retirement plan remained open; no loss was considered probable or estimable. Management reported disclosure controls effective and no material change in internal control during the quarter.

The board declared another $0.25-per-share dividend on August 7, payable September 7, 2017. The filing cautions that future dividends are not assured. The company also adopted a tax asset protection plan intended to preserve approximately $113 million of net operating losses and tax credits reported as of December 31, 2016; ownership changes could limit their use. Revenue recognition under the new standard could affect equipment sales timing, and the company was still assessing the impact.

Important facts for investors to verify

• Confirm the issuer identity: this filing is for Advanced Emissions Solutions, Inc., not Arq, Inc.
• Review Tinuum Group’s operating performance, distributions, facility activity, tax-credit eligibility, and the zero carrying value of ADES’s investment, which affects earnings and cash-flow classification.
• Check the sustainability and margins of chemical growth, the remaining equipment backlog, and the transition away from long-term ACI/DSI contracts.
• Verify liquidity and covenant compliance, availability under the line of credit, its September 30, 2017 maturity, and collateral needs for Royalty Award letters of credit.
• Assess the valuation and realizability of deferred tax assets, potential tax-rate changes, and the sensitivity of Royalty Award obligations to Red River Plant revenues.
• Evaluate whether dividends and repurchases remain affordable given negative operating cash flow and reliance on investee distributions.