Filing identity and reporting period
The supplied filing is Advanced Emissions Solutions, Inc. (ADES), Form 10-K for the fiscal year ended December 31, 2015—not Arq, Inc. or a 2014 fourth-quarter filing. The filing was signed April 19, 2016. ADES provides emissions-control equipment, chemicals and services to coal-fired power and industrial customers, and earns additional income through refined-coal investments and technology royalties.
Financial performance and liquidity
Unless otherwise noted, amounts are in millions of dollars. The audited financial statements received an unqualified opinion; however, the auditor reported material weaknesses in internal control over financial reporting.
| Metric | FY 2015 | FY 2014 |
|---|---|---|
| Revenue | $62.7 | $16.9 |
| Gross profit and margin | $15.2; 24.2% | $3.3; 19.5% |
| Operating loss | $(41.8) | $(41.8) |
| Equity-method earnings | $8.9 | $42.7 |
| Related-party royalties | $10.6 | $6.4 |
| Net income (loss) | $(30.1) | $1.4 |
| Basic and diluted EPS | $(1.37) | $0.06 |
| Cash from operations | $(28.2) | $(42.5) |
| Cash and cash equivalents at year-end | $9.3 | $25.2 |
| Total assets | $60.8 | $93.7 |
| Total debt | $28.0 | $15.9 |
Revenue rose 271%, chiefly as ACI and DSI equipment contracts were completed and recognized. Equipment revenue increased to $60.1 million from $12.0 million, while consulting revenue fell 61% to $1.8 million. Direct costs of revenue were approximately $47.6 million, producing a 24.2% gross margin. Despite the revenue increase, the operating loss remained about $41.8 million; higher revenue was offset by operating costs, restructuring and professional expenses.
Net loss widened from 2014 largely because equity-method earnings fell 79% to $8.9 million. CCS-related distributions recognized as equity-method earnings were $8.7 million, versus $43.6 million in 2014; total cash distributions from equity-method investees were $13.7 million. The company’s share of CCS earnings and cash distributions differ materially, so reported equity income should not be treated as cash received.
Year-end current assets were $24.7 million against current liabilities of $48.9 million, implying negative working capital of approximately $24.2 million and a current ratio of about 0.5. Cash declined by $15.9 million during the year. Restricted cash and restricted investments totaled approximately $12.0 million and were pledged principally to support letters of credit, limiting available liquidity. The company reported stockholders’ deficit of $25.0 million.
Material changes and unusual items
- ADES reorganized reporting segments in the fourth quarter into Refined Coal and Emissions Control. Segment operating income was $12.1 million for Refined Coal and a $7.6 million loss for Emissions Control; corporate costs and other items contributed to the consolidated net loss.
- The company recorded $10.4 million of net restructuring charges in 2015, including workforce and executive departures, closure of the McKeesport fabrication facility, and the wind-down of ADA Analytics. It recorded a $1.9 million impairment associated with ADA Analytics and further reduced operations and staffing.
- Legal and professional fees were $16.6 million, including $9.5 million of restatement-related expenses. R&D expense, net of reimbursements, rose to $5.4 million; management expected future R&D spending to be significantly lower.
- Management used the completed-contract method for extended equipment contracts because it lacked sufficient information to estimate contract progress. Two 2015 emissions-control contracts had unresolved performance-guarantee issues; revenue on those contracts was deferred pending resolution. Loss provisions were recorded for certain DSI contracts.
- ADES sold its 24.95% RCM6 interest in March 2016 for approximately $1.8 million in cash, with the buyer assuming the related note payable. The sale removes future RCM6 capital calls and note obligations, but does not eliminate the company’s exposure to coal-market or CCS-related performance.
Outlook, risks and contingencies
- Management anticipated increased chemical revenue in 2016 and expected CCS distributions to increase, contingent on securing tax-equity investors for facilities not operating or retained by CCS. It expected royalties to fall to approximately 2014 levels until investors are secured and production at certain idled facilities resumes. Management also expected lower R&D spending and reduced Emissions Control losses. These are expectations, not firm financial guidance.
- ADES’s $15 million short-term loan was amended in March 2016: maturity was extended to July 8, 2016, the stated interest rate increased from 10.5% to 15%, and the minimum cash requirement rose from $3.0 million to $3.5 million. The company said it might need refinancing or alternative capital; the debt is secured by substantially all company assets. Failure to repay could expose collateral to enforcement.
- Coal-market contraction, regulatory or court changes, and uncertainty around IRC Section 45 tax credits could reduce demand for emissions products or the value and monetization of refined-coal facilities. Ten CCS facilities were leased to entities related to Goldman Sachs; lease renegotiation, termination or reduced coal use could materially affect cash flows. A CCS investor’s unrecovered balance, including its preferred return, was $30.4 million at year-end.
- The company had approximately $97 million of general business tax-credit carryforwards and $59 million of federal NOL carryforwards, but recorded a full valuation allowance against deferred tax assets. Utilization may be limited by future taxable income, tax-credit eligibility or a potential ownership change.
- A securities class action, stayed while the parties mediate, derivative litigation, and an SEC investigation relating to prior financial statements and controls remained unresolved. No loss was recorded because management said potential losses were not probable or reasonably estimable. DOE contract audits for 2010–2015 were also unfinished.
- ADES was delisted from Nasdaq in March 2015 and traded on the OTC market. Its disclosure controls and internal controls were ineffective at year-end, with material weaknesses in the control environment, monitoring and IT controls. Remediation was ongoing. The filing also notes late periodic filings and an ongoing SEC inquiry.
Key facts investors should verify
- Confirm the filing identity and period: this is ADES’s FY 2015 10-K, not an Arq, Inc. 2014 Q4 filing.
- Review cash availability, restricted balances, debt covenants and the status of refinancing or repayment of the loan due July 8, 2016.
- Track actual CCS cash distributions, tax-equity placements and operating status of retained or idled refined-coal facilities; distinguish distributions from equity-method earnings.
- Assess whether the two performance-guarantee matters were resolved and whether equipment-contract backlog converted into revenue and cash. Year-end Emissions Control backlog was $92.6 million, down from $144.1 million.
- Check progress on internal-control remediation, SEC reporting timeliness, the SEC investigation, securities litigation and DOE audits.
- Evaluate exposure to coal-sector decline, changes to MATS and other environmental rules, Section 45 tax-credit eligibility, tax-attribute limitations and major customer or investor concentration.