Business context and reporting period
The supplied filing is Advanced Emissions Solutions, Inc. (ADES) Form 10-Q for the quarter ended June 30, 2019; it is not a filing for Arq, Inc. ADES operates in Refined Coal (RC) and Power Generation and Industrials (PGI). Its business includes equity-method investments and royalties tied to refined-coal facilities, and activated-carbon products for emissions control. Carbon Solutions, an activated-carbon manufacturer and lignite-mine operator, was acquired in December 2018, so 2019 PGI comparisons include its operations while 2018 reported results generally do not.
Financial results and liquidity
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Reported revenue | $15.6 million | $4.3 million | $34.9 million | $8.2 million |
| Operating loss | $4.3 million | $1.6 million | $7.8 million | $3.3 million |
| Earnings from equity-method investments | $20.9 million | $15.9 million | $42.6 million | $28.1 million |
| Net income | $8.1 million | $15.3 million | $22.5 million | $23.0 million |
| Diluted EPS | $0.44 | $0.75 | $1.22 | $1.12 |
| Operating cash flow | — | — | $30.6 million | $(3.4) million |
Q2 reported revenue rose 265%, mainly because of Carbon Solutions; six-month revenue rose 327%. These revenue figures exclude equity-method earnings, which were a major contributor to pretax income. Net income fell in Q2 despite higher revenue and equity earnings, reflecting higher tax expense, interest and operating costs. The six-month effective tax rate was 27%, versus 5% in 2018; the Q2 rate was 45%, versus a tax benefit in the prior-year quarter. ADES cited changes in forecasts of future taxable income and deferred-tax valuation allowances.
Consumables revenue was $11.4 million in Q2, while related cost of revenue was $12.3 million; that cost included $1.4 million of acquisition-related inventory fair-value step-up. The company said the step-up was fully expensed by June 30. PGI reported an operating loss of $3.9 million in Q2 and $7.3 million for the first half. RC segment operating income was $24.6 million in Q2 and $50.0 million for the first half.
At June 30, cash, cash equivalents and restricted cash totaled $20.4 million, including $5.0 million of long-term restricted cash; unrestricted current cash was $15.4 million. Six-month cash flow was $30.6 million from operations, $(5.0) million from investing and $(28.9) million from financing. Operating cash flow benefited from $38.1 million of distributions from equity investees, while reported earnings included $42.6 million of non-cash equity-method earnings. Total current assets were $48.6 million and current liabilities $39.7 million.
Debt and finance-lease obligations totaled $58.2 million carrying value, including a $54.0 million Senior Term Loan principal balance and $7.4 million of finance leases. ADES repaid $16.0 million of term-loan principal during the first half. The loan matures in December 2021, bears interest at three-month LIBOR (subject to a 1.5% floor) plus 4.75%, and requires $6.0 million quarterly principal payments. The $5.0 million line of credit had no outstanding borrowings; availability was $5.0 million.
Material changes versus the prior comparable period
- The Carbon Solutions acquisition materially expanded PGI sales, assets, costs and capital needs; the company paid $75.0 million in stated purchase price and funded the acquisition partly with the Senior Term Loan.
- Equity-method earnings increased, principally from Tinuum Group. The company attributed the increase in part to sales of RC facilities to third-party investors; adoption of revenue and lease accounting standards at Tinuum Group also changed the timing and recognition of earnings. A Q2 facility sale contributed earnings recognized at a point in time.
- License royalties rose 19% in Q2 and 25% for the first half. Royalty-bearing RC production using ADES’s licensed technology increased to 9.6 million tons in Q2 and 20.5 million tons in the first half.
- Interest expense increased to $2.0 million in Q2 and $4.1 million for the first half, primarily due to acquisition financing. Depreciation, amortization, depletion and accretion also increased with acquired assets.
- Cash from operations improved substantially year over year, but the prior-year comparison included $25.5 million of Tinuum distributions classified as investing cash flow. Following an accounting adjustment that increased the Tinuum investment carrying value, 2019 distributions were classified as operating cash flow.
Outlook, commentary and risks
ADES estimated future cash flows from Tinuum through 2021 at $175 million to $200 million, including distributions and royalties and net of estimated taxes and 453A interest. This is an assumption-dependent estimate, not formal earnings guidance. Assumptions include no material unexpected costs, no termination or repricing of tax-equity leases, no operation of retained facilities, and coal-fired generation remaining consistent. The filing provides no clear consolidated revenue or earnings guidance.
Management said mild weather and low coal-fired power dispatch, alongside generation from natural gas and renewable sources, pressured PGI consumables revenue and margins. The company cited an EIA forecast reduction of 7% in 2019 coal-fired electricity generation versus its December 2018 forecast. It also expects increased capital needs following the Carbon Solutions acquisition, including manufacturing-facility maintenance and mine development.
Key exposures include coal demand and competing energy sources; lease renewals and facility economics at Tinuum; and customer concentration, as 11 of Tinuum Group’s 21 invested facilities were leased to one customer. Loss of that customer or materially changed lease terms could adversely affect Tinuum and ADES. The Senior Term Loan requires at least $5.0 million cash and specified future refined-coal cash-flow coverage; dividends and share repurchases are subject to loan conditions and an aggregate annual limit. ADES reported no significant legal proceedings and no material updates to its previously disclosed risk factors. It recorded no liability for limited Tinuum-related guarantees because management did not consider a loss probable.
The board declared a $0.25-per-share quarterly dividend in August 2019, payable September 6 to shareholders of record August 19. ADES also reported that disclosure controls were effective as of June 30, 2019.
Important facts for investors to verify
- Confirm issuer identity: the supplied filing is for Advanced Emissions Solutions (ADES), not Arq, Inc.
- Assess the assumptions behind the $175–$200 million Tinuum cash-flow estimate, including customer concentration, lease renewals, coal dispatch and facility sales.
- Reconcile equity-method earnings with cash distributions and distinguish recurring performance from facility-sale timing and accounting-adoption effects.
- Track Carbon Solutions’ PGI margins, the effect of acquisition-related inventory charges, and required plant and mine capital spending.
- Review loan covenants, scheduled repayments, restricted cash and the conditions governing dividends and share repurchases.
- Monitor deferred-tax valuation allowances and the realizability of deferred tax assets as taxable-income forecasts change.