2023-06-15 02:32:44 ET
Summary
- The company reported weak first quarter results as lower natural gas prices impacted demand from its power generation customers with no improvement expected anytime soon.
- Elevated capex commitments in combination with losses from operating activities are likely to put severe pressure on cash flows and liquidity going forward.
- As a result, I would expect cash usage of up to $65 million until the end of 2023 which would leave the company with insufficient liquidity going into next year.
- Even if actual cash usage turns out to be somewhat lower, I would expect the company to raise additional capital in Q4 at the latest point in order to avoid going concern language in the company's 2023 annual report.
- Considering ongoing execution risks and the high likelihood of near-term dilution, investors should continue to avoid the shares or even consider selling existing positions.
Note:
I have covered Advanced Emissions Solutions Inc. ( ADES ) previously, so investors should view this as an update to my earlier articles on the company.
Last month, Advanced Emissions Solutions reported its first quarter of operations following the recent combination with Arq Limited or "Arq" - an emerging environmental technology company that converts coal mining waste into a micro-fine carbon powder ("Arq Powder") for use in environmentally sustainable products:
Company Presentation
While Arq has constructed a $80 million processing plant in Kentucky with the ability to process over 100,000 tons of mining waste per year and received investments from Peabody Energy ( BTU ), Vitol and Mitsubishi (MSBHF), the company has not generated any revenue to date.
In fact, the combined business requires substantial, additional capital expenditures to position the company for growth.
Until the end of next year, ADES expects to invest $95 million to upgrade existing infrastructure at its Red River activated carbon plant and Arq's production plant in Corbin, Kentucky.
Last month, the company reported disappointing first quarter results with revenue and profitability down meaningfully both on a sequential and year-over year basis.
On the conference call , management blamed the poor performance on lower natural gas prices and warned of persistent weakness in customer demand:
Our first quarter consumables revenue was $20.8 million compared to $26.4 million in the prior year, which was below our expectations as significantly lower natural gas prices relative to the last 18 months to 24 months impacted demand among our power generation customers. The potential for persistently lower natural gas prices could have an ongoing adverse impact on demand from our power generation customers and operations at Red River.
That said, results were impacted by $4.4 million in " transaction and integration costs " related to the recent Arq merger.
ADES reported a whopping $17.7 million in negative cash flow from operations and another $3.5 million in capital expenditures for the quarter.
The company's quarterly report on form 10-Q states " a decrease in accounts payable and accrued expenses of $10.8 million, primarily from payments of Arq assumed liabilities comprised of accrued employee-related compensation and accrued transaction costs associated with the Arq Acquisition " as one of the main reasons behind the large cash outflow.
Negative free cash flow was offset by an aggregate $23.7 million in net proceeds from the recent PIPE investment and an expensive $10 million related-party term loan with truly ugly conditions:
- The loan has a term of 48 months and bears interest at a rate equal to either (a) Adjusted Term SOFR (subject to a 1.00% floor and a 2.00% cap) plus a margin of 9.00% paid in cash and 5.00% paid in kind or (b) Base Rate (subject to a 2.00% floor and a 3.00% cap) plus a margin of 8.00% paid in cash and 5.00% paid in kind.
- Net proceeds amounted to just $8.5 million after deducting $1.3 million in debt issuance costs and $0.2 million in original issue discount.
- The company will be subject to a $5 million minimum liquidity covenant and required to achieve certain minimum annual revenue and EBITDA levels.
- The lender managed to extract 325,457 immediately exercisable penny warrants.
Just recently, the company was required to amend the terms of a $10 million term loan originally provided to subsidiaries of Arq Limited by Kentucky-based Community Trust Bank Inc. after violating a number of debt covenants.
In order to get covenant relief, ADES was required to deposit $0.73 million into a so-called " Interest Reserve Account " which will be sufficient to pay all regularly scheduled payments of principal and interest on the loan for a period of one year.
On the Q1 conference call , management provided an update on capital expenditures anticipated for this year (emphasis added by author):
During Q1, we commenced the initial capital projects to upgrade the Corbin and Red River plants, which will facilitate our future ability to produce commercial scale GAC and leverage our new high performance and vertically integrated bituminous based feedstock. At Corbin, engineers, contractors and equipment have been selected related to the major components of the capital project and purchasing of long lead items is underway.
At Red River, where we anticipate spending the majority of the capital, we made progress related to equipment scoping and have completed engineering steps necessary to keep us on track to move forward with permitting at the applicable regulatory agencies during the second quarter. (...)
Consistent with our plan, we expect that the aggregate growth CapEx related to these projects will be between $45 million and $50 million, of which roughly $27 million to $30 million will be incurred in the current year. Our total CapEx spend for 2023 is expected to be between $40 million and $45 million with the balance relating to our regularly scheduled plant turnaround and other capital projects.
Considering limited spending in Q1, cash outflows related to capital expenditures might exceed $40 million for the remainder of the year.
In addition, weak customer demand is likely to weigh on sales and margins for the time being thus putting further pressure on operating cash flow.
As a result, I would expect cash usage of up to $65 million until the end of 2023 which would leave ADES with insufficient liquidity going into next year.
Keep in mind that unrestricted cash was $68.0 million at the end of Q1. Adjusted for the $5 million minimum liquidity covenant governing the related-party term loan, liquidity at quarter-end calculated to just $63 million.
Even if actual cash usage turns out to be somewhat lower, I would expect ADES to raise additional capital in Q4 at the latest point in order to avoid going concern language in the company's 2023 annual report on form 10-K.
Bottom Line
Advanced Emissions Solutions Inc. reported weak first quarter results as lower natural gas prices have impacted demand from the company's power generation customers with no improvement expected anytime soon.
The company recorded negative free cash of $21.2 million for the quarter with elevated cash usage likely to continue given anticipated capital expenditures of up to $45 million this year and ongoing pressure on operating cash flow from weaker-than-expected customer demand.
In aggregate, I would expect additional cash usage of up to $65 million until the end of 2023 which would leave ADES with insufficient liquidity going into next year.
Given this issue, I wouldn't be surprised to see Advanced Emissions Solutions Inc. raising new capital before the end of this year.
Considering ongoing execution risks and high likelihood of near-term dilution, investors should continue to avoid the shares or even consider selling existing positions.
For further details see:
Advanced Emissions Solutions: Weak Q1 Results Increase Risk Of Near-Term Dilution - Sell