United States
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________________
FORM 10-K
______________________________________
x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2017
or
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File Number: 001-37822
Advanced Emissions Solutions, Inc.
(Name of registrant as specified in its charter)
Delaware | 27-5472457 | |
(State of incorporation) | (IRS Employer Identification No.) | |
640 Plaza Drive, Suite 270, Highlands Ranch, CO, 80129
(Address of principal executive offices) (Zip Code)
(Registrant’s telephone number, including area code): (720) 598-3500
Securities registered under Section 12(b) of the Act:
Title of each class | Name of each exchange on which registered | |
Common Stock, $0.001 par value | NASDAQ Global Market | |
Securities registered under Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ¨ Yes x No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. ¨ Yes x No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes ¨ No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes ¨ No
Indicate by check mark if disclosure of delinquent filers in response to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ¨ | Accelerated filer | x |
Non-accelerated filer | ¨ | Smaller Reporting Company | ¨ |
Emerging growth company | ¨ | ||
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.) ¨ Yes x No
The aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $114.3 million based on the last reported bid price of the Common Stock on the NASDAQ Global Market on June 30, 2017. The number of shares outstanding of the registrant’s Common Stock, par value $0.001 per share, as of March 2, 2018 was 20,752,939.
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.
Documents Incorporated By Reference
Portions of Part III of this Form 10-K are incorporated by reference from the Registrant's definitive proxy statement to be filed with the Securities and Exchange Commission no later than 120 days after the end of the Registrant's fiscal year.
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ADVANCED EMISSIONS SOLUTIONS, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2017
TABLE OF CONTENTS
Page | ||||
PART I
Item 1. Business
General
ADA-ES, Inc. (“ADA”), a Colorado corporation, was incorporated in 1997. Pursuant to an Agreement and Plan of Merger ("Reorganization"), effective July 1, 2013, Advanced Emissions Solutions, Inc. (“ADES”), a Delaware company incorporated in 2011, replaced ADA as the publicly-held corporation and ADA became a wholly-owned subsidiary of ADES. Each outstanding share of ADA’s common stock automatically converted into one share of common stock of ADES and the shareholders of ADA became stockholders of ADES on a one-for-one basis, holding the same number of shares in and the same ownership percentage of ADES after the reorganization as they held in and of ADA prior to the reorganization. ADES’s common stock became listed on the NASDAQ Capital Market under the symbol, "ADES," ADA’s previous symbol, and ADA’s stock ceased trading on the NASDAQ Capital Market on July 1, 2013. From March 30, 2015 through July 6, 2016, ADES's common stock was traded on the OTC Pink® Marketplace - Limited Information Tier under the trading symbol "ADES." Effective, July 7, 2016 ADES's common stock began trading on the NASDAQ Global Market under the symbol, ADES. This Annual Report on Form 10-K is referred to as the "Form 10-K" or the "Report."
As this filing pertains to the year ended December 31, 2017, the terms the "Company," "we," "us" and "our" means ADA and its consolidated subsidiaries for the periods through and including the period ended June 30, 2013 and ADES and its consolidated subsidiaries for the dates or periods after July 1, 2013.
As of December 31, 2017 and 2016, we held equity interests of 42.50% and 50.00% in Tinuum Group, LLC ("Tinuum Group") and Tinuum Services, LLC ("Tinuum Services"), respectively, and each of their operations significantly impacted our financial position and results of operations for the years ended December 31, 2017, 2016 and 2015. We account for Tinuum Group and Tinuum Services under the equity method of accounting.
On July 27, 2017, the Company obtained a 50% membership interest in GWN Manager in exchange for a capital contribution of $0.1 million. GWN Manager subsequently purchased a 0.2% membership interest in a subsidiary of Tinuum Group.
Business Purpose and Strategy
We provide emissions solutions to customers in the coal-fired power generation and industrial boiler processes. We provide environmental control chemicals, equipment and technologies to our primary market that consists of approximately 650 coal-fired electrical generation units located in the United States.
Through our subsidiaries and joint ventures, we are a leader in emissions control ("EC") technologies and associated equipment, chemicals and services. Our proprietary environmental technologies enable our customers to reduce emissions of mercury and other pollutants, maximize utilization levels and improve operating efficiencies to meet the challenges of existing and pending EC regulations.
Our major activities include:
• | Development and sale of specialty chemicals, equipment, consulting services and other products designed to reduce emissions of mercury, acid gases, metals and other pollutants, and the providing of technology services in support of our customers' emissions compliance strategies; and |
• | Through Tinuum Group, an unconsolidated entity, reduction of mercury and nitrogen oxide ("NOX") emissions at select coal-fired power generators through the production and sale of Refined Coal ("RC") that qualifies for tax credits under the Internal Revenue Code ("IRC") Section 45 - Production Tax Credit ("Section 45 tax credits"). We benefit from Tinuum Group's production and sale of RC, which generates tax credits, as well as the revenue from selling or leasing RC facilities to tax equity investors. See the separately filed financial statements of Tinuum Group included in Item 15 - "Exhibits, Financial Statement Schedules" ("Item 15") of this Report. |
Markets for Our Products and Services
We expect that the share of coal-fired power generation as a percentage of U.S. electricity generation to be more stable compared to previous years when many coal-fired generating units were shut down in response to low gas prices and increasingly stringent environmental regulations. Further, we believe that coal-fired power generation will remain a significant component of the U.S. power generation mix for many years, given coal's abundance, affordability, reliability and availability as a domestic fuel source. Currently, the Energy Information Administration ("EIA") estimates coal makes up 30% of the
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United States electric generation. In its Annual Energy Outlook for 2017, the EIA projects that coal will provide between 24% and 33% of electricity generation in 2040 depending on whether the Clean Power Plan ("CPP") of the U.S. Environmental Protection Agency ("EPA"), which addresses limiting greenhouse gas emissions, is or is not implemented. The primary drivers for many of our products and services are environmental laws and regulations impacting the electric power generation industry and other coal users. These regulations include the Mercury and Air Toxics Standards ("MATS"), a U.S. federal regulation requiring all existing and any new coal-fired electric generating units to control mercury emissions, acid gases, and particulate matter, as well as various state regulations and permitting requirements for coal-fired electric generating units. In addition to the federal MATS rule, certain states have their own mercury rules that are similar to, or more stringent than, MATS, and many coal-fired electric generating units around the country have agreed to consent decrees, which require pollution controls that, in some cases, are more restrictive than the existing regulations. We continue to believe the MATS regulation as well as certain state regulations create a market for our RC and EC products.
In general, coal is a low cost, stable and reliable source of domestic energy that, unlike many other forms of energy, can be easily stored in large quantities. We believe coal is critical to ensuring the U.S. has a secure and stable source of energy. With current environmental regulations, we believe it is unlikely that any new coal-fired electric generating units will be financed or constructed, which suggests that the average coal-fired electric generating unit age in 2040 will be 64 years old. However, following the retirement of many of the less efficient and generally smaller coal-fired electric generating units over the past few years, and the announcement from the EPA on October 10, 2017 of their proposal to repeal the CPP, we believe that the amount of electricity generated from coal will remain relatively steady in the near term.
While the long-term future is uncertain, and as coal assets continue to age, we expect a continued purchasing trend towards variable cost products and integrated solutions with low capital expenditure requirements and away from large capital equipment and other fixed cost solutions that are less likely to have costs recovered.
We believe it is likely that many U.S. coal mines, coal-fired electric generating units, coal-centric large equipment providers and other coal-related businesses will have difficulty in adapting to industry changes expected in the coming years. However, we see opportunities for companies that can offer their customers creative and cost-effective solutions that help the U.S. coal-related businesses meet regulatory compliance, improve efficiency, lower costs and maintain reliability.
As of December 31, 2017, our primary products, services and RC technology licenses available to coal-fired electric generating units requiring solutions to assist with compliance with emissions standards included:
• | Chemicals: |
◦ | Our patented M-ProveTM ("M-Prove") technology, which is also incorporated in our RC technologies, that provides a cost effective alternative to other halogen-based, oxidation chemicals used to enhance removal of mercury emissions. M-Prove technology mitigates coal treatment corrosion risks to minimize maintenance and repair costs to enhance system reliability and risks associated with bromine discharge from plant wastewater; and |
◦ | Our RESPond® ("RESPond") liquid chemical additive that is a highly effective ash resistivity modifier for power plants operating cold-side electrostatic precipitators. Unlike Sulfur Trioxide ("SO3") solutions, the incumbent chemical being used to modify ash resistivity, the RESPond additive does not interfere with or reduce the effectiveness of activated carbon injected into the flue gas for purposes of reducing mercury emissions. |
• | RC technology licenses: |
◦ | Our patented CyCleanTM ("CyClean") technology, a pre-combustion coal treatment process that provides electric power generators the ability to enhance combustion and reduce emissions of NOX and mercury from coals burned in cyclone boilers; and |
◦ | Our patented M-45TM and patent pending M-45-PCTM technologies (collectively, the "M-45 Technology"), which are proprietary pre-combustion coal treatment technologies used to control emissions from circulating fluidized bed boilers and pulverized coal boilers, respectively. |
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• | Equipment: |
◦ | Low capital expenditure mercury control technologies and systems such as Activated Carbon Injection ("ACI") systems, that effectively reduce mercury emissions over a broad range of plant configurations and coal types; |
◦ | Dry Sorbent Injection systems ("DSI") that reduce emissions of Sulfur Dioxide ("SO2") and other acid gases such as SO3 and Hydrogen Chloride ("HC1"); and |
◦ | Other equipment that may be necessary for longer term storage for consumable additives as well as our patented ADAirTM Mixer in-duct technology that alters flue gas flow to improve mixing and optimize particle dispersion to reduce sorbent consumption for ACI and DSI systems. |
• | Consulting services and other: |
◦ | We provide general consulting services as requested by our customers related to emissions control. |
Additionally, we generate significant earnings from our investment in Tinuum Group. As of December 31, 2017, Tinuum Group, has built and placed into service a total of 28 RC facilities designed to produce RC for sale to coal-fired electric generating units. Coal-fired electric generating units use RC as one of a portfolio of tools to help comply with MATS and other environmental regulations. These RC facilities produce and sell RC that qualifies for Section 45 tax credits, including meeting the "placed in service" requirements (referred to as "placed in service"). The IRS has issued guidance regarding emissions reductions in the production of electricity by coal-fired electric generating units, including measurement and certification criteria necessary to qualify for the Section 45 tax credits. The ability to produce and sell RC, which generates Section 45 tax credits, expires 10 years after each RC facility is placed in service, but not later than December 31, 2021. Two of Tinuum Group's RC facilities were placed in service in 2009 and related Section 45 tax credits for these facilities substantially expire in December 2019. The Section 45 tax credits related to the remaining RC facilities expire in 2021.
Once an RC facility is in operation, Tinuum Group may lease or sell it to a tax equity investor, which we refer to as an "invested" RC facility. The tax equity investor subsequently operates the RC facility to produce and sell RC to a utility. It is financially advantageous for Tinuum Group to lease or sell an RC facility as the tax equity investor assumes the operating expenses for the RC facility and pays to Tinuum Group either an up-front payment to purchase or lease payments to lease the RC facility. We benefit from equity income and distributions accruing through our investment in Tinuum Group. Tax equity investors may benefit from their investment in RC facilities through the realization of tax assets and credits from the production and sale of RC.
RC facilities that are producing and selling RC and have not been leased or sold, are referred to as "retained" RC facilities, whereby the RC is produced and sold by Tinuum Group and, as an owner, we benefit from the related Section 45 tax benefits. As of December 31, 2017 and 2016, respectively, the Section 45 tax credits were $6.91 and $6.81 per ton of RC produced and sold to a utility. The value of the Section 45 tax credits is adjusted annually based on inflation adjustment factors published in the Federal Register. As of December 31, 2017, we have received, but have not been able to fully utilize, substantial tax credits and benefits from certain retained RC facilities that previously produced and sold RC for the benefit of Tinuum Group. See Note 12 to our Consolidated Financial Statements included in Item 8 - "Financial Statements and Supplementary Data" ("Item 8") of this Report for additional information regarding our net operating losses, tax credits and other deferred tax assets.
As of December 31, 2017, Tinuum Group had 17 invested RC facilities producing RC at utility sites and no retained RC facilities. The remaining 11 RC facilities, although placed in service, were either installed but not operating, awaiting site selection or in various other stages of contract negotiation or permanent installation.
The RC facilities producing and selling RC as of December 31, 2017 are generally operated by Tinuum Services under operating and maintenance agreements with the owners or lessees of the RC facilities.
Segment Information
As of December 31, 2017, our operations consisted of two reportable segments: (1) RC and (2) EC.
Financial information related to each of our reportable segments is set forth in Note 13 of the Consolidated Financial Statements included in Item 8 of this Report.
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(1) | RC Segment |
Our RC segment derives its earnings from equity method investments as well as royalty payment streams and other revenues related to reduced emissions of both NOX and mercury from coal treated with our proprietary chemicals and burned at coal-fired electric generating units. Our equity method investments related to the RC segment include Tinuum Group, Tinuum Services and GWN Manager.
Tinuum Group owns, leases or sells facilities used in the production of RC. The RC facilities are located at coal-fired generation stations owned by regulated utilities, cooperatives, government agencies and wholesale power generators (collectively, "Generators"). The RC produced by the RC facilities is used by the Generators as fuel in the coal-fired boilers to produce electricity. For invested RC facilities, Tinuum Group collects lease income from the lessee if leased, or sales proceeds from the buyer if sold. We benefit from these transactions through our equity method investment in Tinuum Group. RC facilities that are producing RC, but that Tinuum Group has not leased or sold, are referred to as retained RC facilities. Tinuum Group produces and sells RC to Generators and the owners of Tinuum Group, including us, may benefit to the extent Section 45 tax credits and other tax benefits are realized from the operation of retained RC facilities.
Tinuum Services operates and maintains RC facilities under operating and maintenance agreements with Tinuum Group and owners or lessees of RC facilities. Tinuum Group or the owners or lessees of the RC facilities pay Tinuum Services, subject to certain limitations, the costs of operating and maintaining the RC facilities plus various fees. Tinuum Services also arranges for the purchase and delivery of certain chemical additives under chemical agency agreements, which include the chemicals required for our CyClean, and M-45 Technologies, necessary for the production of RC. The term of each chemical agency agreement runs concurrently with the respective RC facility's sale or lease agreement.
We also earn royalties from the licensing of our M-45 Technology ("M-45 License") to Tinuum Group. Royalties are recognized based upon a percentage of the per-ton, pre-tax margin as defined in the M-45 License.
Key drivers to RC segment performance and cash distributions are the number of operating (leased or sold) versus retained RC facilities, production and sale of RC and royalty-bearing tonnage.
Refined Coal Data
The following table provides summary information related to the Company's investment in Tinuum Group and the related RC facilities as of December 31, 2017 and tons of RC produced and sold for the year ended December 31, 2017:
Operating | ||||||||||||
# of RC Facilities | Not Operating | Invested | Retained | |||||||||
RC Facilities | 28 | 11 | 17 | (1) | — | |||||||
RC tons produced and sold (000's) | 46,887 | 1,187 | ||||||||||
(1) One RC facility is approximately 50% invested with an independent third party. The remaining approximate 50% is retained by Tinuum Group and the Company.
Additional information related to RC facilities is included in Item 7 - "Management’s Discussion and Analysis of Financial Condition and Results of Operations" ("Item 7") of this Report.
(2) | EC Segment |
(a) | Systems & Equipment- Activated Carbon Injection, Dry Sorbent Injection System and Other Systems |
Historically, our EC segment included revenues and related expenses from the sale of ACI and DSI equipment systems, chemical sales, consulting services and other sales related to the reduction of emissions in the coal-fired electric generation process and the electric utility industry. Demand for ACI and DSI system contracts historically was driven by coal-fired power plant utilities that needed to comply with MATS and Maximum Achievable Control Technology Standards ("MACT"). As the deadline for these standards has passed, and customers have now implemented ACI, DSI and other large equipment systems as a component of their strategies to comply with applicable regulations, the Company does not anticipate entering into future long-term fixed price contracts for ACI or DSI systems. However, we may continue to provide smaller scale equipment products that may be needed by power generation units as part of their ongoing operations.
Currently, we are transforming ourselves into a consumable products-focused company to provide customers with emission reduction solutions within the mercury control consumables market.
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(b) | Chemicals |
Current mercury control options include consumables that utilize powdered activated carbon (“PAC”), halogen and re-emissions technologies. These options provide coal-powered utilities and industrial boilers with mercury control solutions working in conjunction with ACI and DSI systems and other pollution control equipment, generally without the requirement for significant ongoing capital outlays. Our current proprietary chemical portfolio generally provides customers with halogen and flue gas conditioning technology options, which include M-Prove and RESPond, respectively. Currently, sales of these products comprise a small piece of the consumables market. Our current and future focus is to increase our market share within the consumables market, both organically and through potential acquisition(s).
Our patented M-Prove pre-combustion coal treatment technology involves the application of chemicals to coal. This technology substantially reduces mercury emissions and also can reduce the amount of activated carbon or other sorbents used to meet regulatory mercury emission limits. The power industry is beginning to experience corrosion and wastewater issues in their plants that they attribute to the use of bromine to enhance the capture of mercury.
We believe the key benefits of the M-Prove additive are as follows:
• | effective at extremely low treatment rates; |
• | significantly reduces "balance-of-plant" risks attributed to other halogen-based coal treatments, including corrosion to air pre-heater baskets; |
• | minimizes ancillary halogen emissions in the stack as well as fly ash and wastewater; |
• | reduces sorbent consumption for ACI systems; |
• | facilitates enhanced mercury removal by downstream pollution control devices; |
• | supports fuel flexibility and potential for fuel cost savings. |
We experienced higher demand for our M-Prove Technology in 2017 and we believe that related revenues will continue to increase in 2018 as plants gain experience with their mercury control systems and begin to optimize their strategy to reduce operational impacts, especially as they relate to corrosion and wastewater. In October 2012, we were awarded the first in a family of patents designed to protect this technology in the U.S., and are pursuing similar patents in various other countries.
We license certain emissions control technologies, including the M-Prove additive, to Tinuum Group for the production of RC to reduce emissions of both mercury and NOX from coal-fired boilers. We licensed our patented CyClean technology to Tinuum Group upon formation of the entity in 2006 for use with cyclone boilers for the life of the patents. In July 2012, we executed the M-45 License with Tinuum Group, which is effective for the duration that Section 45 tax credits are available. We believe these licenses will leverage Tinuum Group’s operating expertise and allow it the ability to provide and use either the CyClean or M-Prove Technologies to produce RC. Later in 2012, we made a technological advancement in the M-Prove Technology, which was incorporated in the M-45 License and allows it to be effective in “pulverized coal” (“PC”) boilers. In addition to the royalty payments we receive from Tinuum Group, the use of M-Prove Technology in the production of RC provides valuable operating data and validates the effectiveness of the M-Prove Technology in a range of coal-fired boilers. We expect this information will help in our sales process for the M-Prove Technology. We are in the early stages of selling M-Prove into the EC market and a portion of our current revenues in this offering include application tests of M-Prove at customer sites.
We have deployed technologies for conditioning flue gas streams from coal-fired combustion sources and maybe used as an alternative to other mercury control products. Our flue gas conditioning chemicals, sold under the trade name RESPond®, allow existing air pollution control devices, such as electrostatic precipitators ("ESPs"), to operate more efficiently without the use of traditional SO3 additives, which have been shown to be detrimental to effective mercury control by partially negating the effectiveness of certain sorbents used to absorb mercury, including activated carbon. Such treatment of the flue gas stream allows for effective collection of fly ash particles that would otherwise escape into the atmosphere. The use of the proprietary chemical blends may help existing marginally sized ESPs continue to operate effectively when applied exclusively, or in combination with other chemicals such as hydrated lime, activated carbon products, or other high-resistivity materials.
(c) | Consulting Services |
Historically, we have provided consulting services to assist electric power generators, the electric utility industry and others in planning and implementing strategies to meet the new and increasing government emission standards requiring reductions in SO2, SO3, HC1, NOX, particulates, acid gases and mercury. We anticipate that consulting services revenue will continue to diminish as we shift our focus to selling in the emissions reduction consumables market.
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The following table shows the amount of total revenue by type:
Years Ended December 31, | ||||||||||||
(in thousands) | 2017 | 2016 | 2015 | |||||||||
Revenues: | ||||||||||||
Equipment sales | $ | 31,401 | $ | 46,949 | $ | 60,099 | ||||||
Chemicals | 4,246 | 3,025 | 888 | |||||||||
Consulting services and other | 45 | 648 | 1,752 | |||||||||
Total revenues | $ | 35,692 | $ | 50,622 | $ | 62,739 | ||||||
Legislation and Environmental Regulations
U.S. Federal Mercury and Air Toxic Standards (“MATS”) Affecting Electric Utility Steam Generating Units
On December 16, 2011, the U.S. EPA issued the final "MATS Rule," which took effect in April 2012. The EPA structured the MATS Rule as a MACT-based hazardous pollutant regulation applicable to coal and oil-fired Electric Utility Steam Generating Units (“EGU”), which generate electricity via steam turbines and have a capacity of 25 megawatts or greater, and provide for, among other provisions, control of mercury and particulate matter and control of acid gases such as HCl and other Hazardous Air Pollutants ("HAPs"). Approximately 1,260 units were coal-fired EGUs. According to our estimates, the standard sets a limit that we believe requires the capture of up to 80-90% of the mercury in the coal burned in electric power generation boilers as measured at the exhaust stack outlet for most plants. The MACT standards are also known as National Emission Standards for Hazardous Air Pollutants ("NESHAP"). Plants generally had four years to comply with the MATS Rule, and we estimate that, based on data reported to the EPA and conversations with plant operators, most plants were required to comply by April 2016 and implementation of the MATS Rule is largely complete. We estimate that 48% of the coal-fired EGUs that were operating in December 2011, when the MATS rule was finalized, have been permanently shut down, leaving approximately 650 EGUs in operation at the end of 2017.
In April 2017, a review by the U.S. Court of Appeals for the D.C. Circuit of a “supplemental finding” associated with the cost benefit analysis of the MATS Rule conducted by EPA was stayed at the request of the current Administration. The court case continues to be stayed indefinitely, but the MATS Rule is still in force until the issue is resolved. The EPA has not issued any further official proceedings regarding MATS Rule.
State Mercury and Air Toxics Regulations Affecting EGUs
In addition, certain states have their own mercury rules that are similar to or more stringent than the MATS Rule, and coal-fired electric generating units around the country are subject to consent decrees that require the control of acid gases and particulate matter, in addition to mercury emissions. Twenty-three states have mercury-specific rules that affect more than 283 generating units and more than 100 GW of generating capacity that were still operating at the end of 2017.
Effluent Limitation Guidelines
On September 30, 2015, the EPA set the first federal limits on the levels of toxic metals in wastewater that can be discharged from power plants. The final rule requires, among other things, zero discharge for fly ash transport water, and limits on mercury, arsenic, selenium, and nitrate from flue gas desulfurization ("FGD") wastewater (also known as "legacy wastewater"). In April 2017 the EPA Administrator announced his decision to reconsider the Effluent Limitations Guidelines ("ELG") Rule, and the U.S. Court of Appeals Fifth Circuit granted the motion to reconsider and placed the case in abeyance, which delayed the earliest compliance date from November 2018 to November 2020. In September 2017, the EPA indicated that plants would not need to comply before November 2020, with a possible extension of up to five years with state approval. Although halogens are not directly regulated in the effluent guidelines, some halogens may impact the effectiveness of biological wastewater treatment systems that are often used for the removal of selenium. We are evaluating whether the potential market opportunity supports our development of new products to help plants comply with these rules, as well as how these rules may affect our current product offerings.
Additional U.S. Legislation and Regulations
On August 3, 2015, the EPA finalized rules to reduced greenhouse gases ("GHGs") in the form of the CPP, which established guidelines for states to follow in developing plans to reduce GHG emissions. Under the CPP, states are required to prepare State Implementation Plans to meet state targets established based on emission reductions from affected sources. The CPP requires that the Best System of Emission Reduction ("BSER") be implemented and establishes three building blocks, which
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include heat rate improvements at affected coal-fired electric generating units, substituting coal-fired generation with less carbon-intensive EGUs such as natural gas combined cycle plants, and substituting renewable generation. The CPP has been challenged by multiple states in the U.S. Court of Appeals for the District of Columbia Circuit ("DC Circuit"). The CPP is currently stayed by the Supreme Court, and a panel of 10 judges on the DC Circuit are reviewing the CPP following a hearing in September 2016. On October 10, 2017, the EPA announced a proposal to repeal the CPP. The DC Circuit has been holding CPP litigation in abeyance since April 28, 2017.
International Regulations
There are various international regulations related to mercury control. In Canada, the Canada-Wide Standard ("CWS") was initially implemented in 2010, with increasingly stringent limits through 2020 and with varying mercury caps for each province. China and Germany both have limits for mercury emissions that are less stringent than U.S. limits, which are typically met using co-benefits from other installed air pollution control equipment designed to control other pollutants. In May 2017, the EU ratified the Minimata Convention on Mercury, triggering mercury control regulations with implementation starting in 2021. Specific emissions limits are currently being developed guided by the best available technologies reference ("BREF") document for limiting stack emissions and liquid effluents from industrial processes. The BREF conclusions for large coal-fired electric generating units were adopted by the European Commission in July 2017.
Based upon the existing and potential regulations, we believe the international market for mercury control products may expand in the coming years, and we are positioning our patent portfolio and existing commercial products accordingly to be prepared if an international market for our products develops.
Competition
In the EC consumables market, our mercury control chemicals primarily compete against the use of brominated PAC, as well as the use of bromine applied to the coal prior to combustion. Our primary competitors for our coal additives are Nalco Water, Ecolab Company, and Midwest Energy Emissions Corp ("MEEC"). As it relates to brominated PAC providers, our primary competitors include ADA Carbon Solutions, Cabot Corporation, and Calgon Carbon.
In the RC market, we believe Chem-Mod, LLC ("Chem-Mod") and licensees of the Chem-Mod technology are our principal competitors. Competition within the RC market is based primarily on price, the number of tons of coal burned at the coal-fired electric generating unit where the RC facilities are operating and the tax compliance facts associated with each RC facility. Additionally, competition for tax equity investors extends into other investment opportunities, including opportunities related to potential tax incentive transactions available to potential investors.
Patents
As of December 31, 2017, we held 38 U.S. patents and three international patents that were issued or allowed, 12 additional U.S. provisional patents or applications that were pending, and nine international patent applications that were either pending or filed relating to different aspects of our technology. Our existing patents generally have terms of 20 years from the date of filing, with our next patents expiring beginning in 2021. We consider many of our patents and pending patents to be critical to the ongoing conduct of our business.
Our Vendors and Supply of Materials
We purchase our proprietary chemicals through negotiated blending contracts that include confidentiality agreements with chemical suppliers. These arrangements attempt to assure continuous supply of our proprietary chemical blends. The manufacturing of our chemical products is dependent upon certain discrete chemicals that are subject to price fluctuations and supply constraints. In addition, the number of chemical suppliers who provide the necessary additives needed to manufacture our proprietary M-Prove and RESPond chemicals is limited. Supply agreements are generally renewed on an annual basis.
Seasonality of Activities
The sale of our chemical products and RC facility operation levels depend on the operations of the coal-fired electric generating units to which the applicable chemicals are provided and the location of the RC facilities, respectively. Coal-fired electric generating units routinely schedule maintenance outages in the spring and/or fall depending upon the operation of the boilers. During the period in which an outage may occur, which may range from one week to over a month, no chemicals are used or RC produced and sold, and our revenues can be correspondingly reduced. Additionally, power generation is weather dependent, with electricity and steam production varying in response to heating and cooling needs.
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Dependence on Major Customers
We depend on our customer relationships with owners and operators of coal-fired power electric generating units as well as general market demand for coal-fueled power generation. Additional information related to major customers is disclosed in Note 14 of the Consolidated Financial Statements included in Item 8 of this Report.
Through our investment in Tinuum Group, we depend on our relationships with owners and operators of coal-fired power generation facilities, including various electric utilities and tax equity investors. Tinuum Group is the exclusive licensee for purposes of producing RC using the CyClean and M-45 Technologies. Tinuum Group depends on tax equity investors, with significant concentration within affiliates of The Goldman Sachs Group, Inc. These investors could renegotiate or terminate their leases, or the utilities where the RC facilities are installed could materially reduce their use of RC.
Research and Development Activities
During 2017, we focused on pursuing the expansion of potential product offerings within the emissions reduction consumables market to complement our existing chemical solutions. Historically, we engaged in research and development activities that would bring the broader technologies to the EC market and expand our own offerings, including CO2 capture technology. This research and development was funded, in part, under contracts and/or cost reimbursement arrangements with the U.S. Department of Energy ("DOE") and other third parties.
Backlog
Backlog represents the dollar amount of revenues we expect to recognize in the future from fixed-price contracts, primarily for ACI and DSI systems as well as certain fixed-price chemical contracts that have been executed, but work has not commenced, and those that are currently in progress. A project is included within backlog when a contract is executed. Backlog amounts include anticipated revenues associated with the original contract amounts, executed change orders, and any claims that may be outstanding with customers. It does not include contracts that are in the bidding stage or have not been awarded. As a result, we believe the backlog figures are firm, subject to customer modifications, alterations or cancellation provisions contained in the various contracts.
Backlog may not be indicative of future operating results. Estimates of profitability could increase or decrease based on changes in direct materials, labor and subcontractor costs, and indirect costs related to contract performance, such as indirect labor, supplies, tools and repairs, and any claims with customers. Backlog is not a measure defined by accounting principles generally accepted in the United States and is not a measure of profitability. Our method for calculating backlog may not be comparable to methodologies used by other companies.
(in thousands) | ||||
Backlog as of December 31, 2016 | $ | 49,468 | ||
New contracts | 4,472 | |||
Change order and claims to existing contracts, net | (76 | ) | ||
Revenues recognized | (35,616 | ) | ||
Backlog as of December 31, 2017 | $ | 18,248 | ||
Based on our adoption of ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) ("ASU 2014-09") on January 1, 2018, all the equipment system contracts that are included in backlog as of December 31, 2017, and costs related thereto, will be recognized through a balance sheet adjustment on January 1, 2018, and will not impact our earnings in 2018. All material backlog will be recognized as a balance sheet adjustment on January 1, 2018.
Operating Locations
During the years ended December 31, 2017 and 2016, we had domestic operations located in Colorado. During 2015, we had domestic and international operations, in which the domestic operations were located in Colorado and Pennsylvania. The Pennsylvania location, used as a manufacturing facility, was closed at the end of 2015, with certain wind-down activities remaining through early 2016. The international operations, which were not material to our total revenues or long-lived assets, were closed at the end of 2015. As of December 31, 2017, Tinuum Group and Tinuum Services had operations in 12 and 10 states, respectively, in the United States.
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Employees
As of December 31, 2017 we employed 29 full-time and part-time personnel; all employees were employed at our offices in Colorado.
Available Information
Our periodic and current reports are filed with the SEC pursuant to Section 13(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") and are available free of charge within 24 hours after they are filed with, or furnished to, the SEC at the Company’s website at www.advancedemissionssolutions.com. The filings are also available through the SEC at the SEC's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549 or by calling 1-800- SEC-0330. Alternatively, these reports can be accessed at the SEC’s website at www.sec.gov. The information contained on our web site shall not be deemed incorporated by reference in any filing under the Securities Act of 1933, as amended (the "Securities Act") or the Exchange Act.
Copies of Corporate Governance Documents
The following Company corporate governance documents are available free of charge at our website at www.advancedemissionssolutions.com and such information is available in print to any stockholder who requests it by contacting the Secretary of the Company at 640 Plaza Drive, Suite 270, Highlands Ranch CO, 80129.
• | Certificate of Incorporation |
• | Bylaws |
• | Code of Ethics and Business Conduct |
• | Insider Trading Policy |
• | Whistleblower Protection Policy |
• | Board of Directors Responsibilities |
• | Audit Committee Charter |
• | Compensation Committee Charter |
• | Nominating and Governance Committee Charter |
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Forward-Looking Statements Found in this Report
This Report contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act that involve risks and uncertainties. In particular such forward-looking statements are found in this Part I and under the heading in Part II, Item 7 below. Words or phrases such as "anticipates," "believes," "expects," "intends," "plans," "estimates," "predicts," the negative expressions of such words, or similar expressions are used in this Report to identify forward-looking statements, and such forward-looking statements include, but are not limited to, statements or expectations regarding:
(a) | the scope and impact of mercury and other regulations or pollution control requirements, including the impact of the final MATS; |
(b) | the production and sale of RC by the RC facilities will qualify for Section 45 tax credits; |
(c) | expected growth or contraction in and potential size of our target markets; |
(d) | expected supply and demand for our products and services; |
(e) | increasing competition in the emission control market; |
(f) | our ability to satisfy warranty and performance guarantee provisions; |
(g) | expected dissolution and winding down of certain of our wholly-owned subsidiaries; |
(h) | future level of research and development activities; |
(i) | the effectiveness of our technologies and the benefits they provide; |
(j) | Tinuum Group’s ability to profitably sell and/or lease additional RC facilities and/or RC facilities that may be returned to Tinuum Group, or recognize the tax benefits from production and sale of RC on retained RC facilities; |
(k) | probability of any loss occurring with respect to certain guarantees made by Tinuum Group ("Party Guarantees"); |
(l) | the timing of awards of, and work and related testing under, our contracts and agreements and their value; |
(m) | the timing and amounts of or changes in future revenues, royalties earned, backlog, funding for our business and projects, margins, expenses, earnings, tax rate, cash flow, royalty payment obligations, working capital, liquidity and other financial and accounting measures; |
(n) | the outcome of current and pending legal proceedings; |
(o) | awards of patents designed to protect our proprietary technologies both in the U.S. and other countries; |
(p) | the materiality of any future adjustments to previously recorded reimbursements as a result of the DOE audits and the amount of contributions from the DOE and others towards planned project construction and demonstrations; and |
(q) | whether any legal challenges or EPA actions will have a material impact on the implementation of the MATS or other regulations and on our ongoing business. |
Our expectations are based on certain assumptions, including without limitation, that:
(a) | coal will continue to be a major source of fuel for electrical generation in the United States; |
(b) | the IRS will allow the production and sale of RC to qualify for Section 45 tax credits; |
(c) | we will continue as a key supplier of equipment, chemicals and services to the coal-fired power generation industry as it seeks to implement reduction of mercury emissions; |
(d) | current environmental laws and regulations requiring reduction of mercury from coal-fired boiler flue gases will not be materially weakened or repealed by courts or legislation in the future; |
(e) | we will be able to meet any performance guarantees we make and to continue to meet our other obligations under contracts; |
(f) | we will be able to obtain adequate capital and personnel resources to meet our operating needs and to fund anticipated growth and our indemnity obligations; |
(g) | we will be able to establish and retain key business relationships with other companies; |
(h) | orders we anticipate receiving will be received; |
(i) | governmental audits of our costs incurred under DOE contracts will not result in material adjustments to amounts we have previously received under those contracts; |
(j) | we will be able to formulate new chemicals and blends that will be useful to, and accepted by, the coal-fired boiler power generation business; |
(k) | we will be able to effectively compete against others; |
(l) | we will be able to meet any technical requirements of projects we undertake; |
(m) | Tinuum Group will be able to sell or lease additional RC facilities, including RC facilities that may be returned to Tinuum Group, to third party investors; and |
(n) | we will be able to utilize our portion of the Section 45 tax credits generated by production and sale of RC from retained facilities. |
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The forward-looking statements included in this Report involve risks and uncertainties. Actual events or results could differ materially from those discussed in the forward-looking statements as a result of various factors including, but not limited to, timing of new and pending regulations and any legal challenges to or extensions of compliance dates of them; the U.S. government’s failure to promulgate regulations or appropriate funds that benefit our business; changes in laws and regulations, accounting rules, prices, economic conditions and market demand; impact of competition; availability, cost of and demand for alternative energy sources and other technologies; technical, start up and operational difficulties; failure of the RC facilities to produce RC; termination of or amendments to the contracts for sale or lease of RC facilities; decreases in the production of RC; inability to commercialize our technologies on favorable terms; our inability to ramp up our operations to effectively address recent and expected growth in our business; loss of key personnel; potential claims from any terminated employees, customers or vendors; failure to satisfy performance guarantees; availability of materials and equipment for our businesses; intellectual property infringement claims from third parties; pending litigation; identification of additional material weaknesses or significant deficiencies; as well as other factors relating to our business, as described in our filings with the SEC, with particular emphasis on the risk factor disclosures contained in those filings and in Item 1A - "Risk Factors" of this Report. You are cautioned not to place undue reliance on the forward-looking statements made in this Report and to consult filings we have made and will make with the SEC for additional discussion concerning risks and uncertainties that may apply to our business and the ownership of our securities. The forward-looking statements contained in this Report are presented as of the date hereof, and we disclaim any duty to update such statements unless required by law to do so.
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Item 1A. Risk Factors
Risks relating to our business
The following risks relate to our business as of the date this Report is filed with the SEC, or any alternative date specified. This list of risks is not intended to be exhaustive, but reflects what we believe are the material risks inherent in our business and the ownership of our securities as of the specified dates. A statement to the effect that the occurrence of a specified event may have a negative impact on our business, results of operations, profitability, financial condition, or the like, is intended to reflect the fact that such an event would be likely to have a negative impact on your investment in the Company, but should not imply the likelihood of the occurrence of such specified event. The order in which the following risk factors are presented is not intended as an indication of the relative seriousness of any given risk.
Demand for our products and services depends significantly on environmental laws and regulations. Uncertainty as to the future of such laws and regulations, as well as changes to such laws and regulations, or granting of extensions of compliance deadlines has had, and will likely continue to have a material effect on our business.
A significant market driver for our existing products and services, and those planned in the future, are present and expected environmental laws and regulations, particularly those addressing the reduction of mercury and other emissions from coal-fired electric generating units. If such laws and regulations are delayed, or are not enacted or are repealed or amended to be less strict, or include prolonged phase-in periods, or are not enforced, our business would be adversely affected by declining demand for such products and services. For example:
• | The implementation of environmental regulations regarding certain pollution control and permitting requirements has been delayed from time to time due to various lawsuits. The uncertainty created by litigation and reconsiderations of rule-making by the EPA has negatively impacted our business, results of operations and financial condition and will likely continue to do so. |
• | To the extent federal, state, and local legislation mandating that electric power generating companies serving a state or region purchase a minimum amount of power from renewable energy sources such as wind, hydroelectric, solar and geothermal, and such amount lessens demand for electricity from coal-fired plants, the demand for our products and services would likely decrease. |
Federal, state, and international laws or regulations addressing emissions from coal-fired electric generating units, climate change or other actions to limit emissions, including public opposition to new coal-fired electric generating units, has caused and could continue to cause electricity generators to transition from coal to other fuel and power sources, such as natural gas, nuclear, wind, hydroelectric and solar. The potential financial impact on us of future laws or regulations or public pressure will depend upon the degree to which electricity generators diminish their reliance on coal as a fuel source. That, in turn, will depend on a number of factors, including the specific requirements imposed by any such laws or regulations, the periods over which those laws or regulations are or will be phased in, the amount of public opposition, and the state and cost of commercial development of related technologies and processes. In addition, Public Utility Commissions ("PUCs") may not allow utilities to charge consumers for, and pass on the cost of, emission control technologies without federal or state mandate. We cannot reasonably predict the impact that any such future laws or regulations or public opposition may have on our results of operations, financial condition or cash flows.
Reduction of coal consumption by U.S. electric power generators could result in less demand for our products and services. If utilities significantly reduce the number of coal-fired electric generating units or the amount of coal burned, without a corresponding increase in the services required at the remaining units, this could reduce our revenues and materially and adversely affect our business, financial condition and results of operations.
The amount of coal consumed for U.S. electric power generation is affected by, among other things, (1) the location, availability, quality and price of alternative energy sources for power generation, such as natural gas, fuel oil, nuclear, hydroelectric, wind, biomass and solar power; and (2) technological developments, including those related to competing alternative energy sources.
Natural gas-fueled generation has been displacing and may continue to displace coal-fueled generation, particularly from older, less efficient coal-powered generators. We expect that many of the new power plants needed to meet increasing demand for electricity generation will be fueled by natural gas because the price of natural gas has remained at relatively low levels after a period of sharp decline, and use of natural gas is perceived as having a lower environmental impact than burning coal. Natural gas-fired plants are cheaper to construct, and permits to construct these plants are easier to obtain, and ongoing costs of natural
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gas-fired plants associated with meeting environmental compliance are lower. Possible advances in technologies and incentives, such as tax credits, to enhance the economics of renewable energy sources could make those sources more competitive with coal. Any reduction in the amount of coal consumed by domestic electric power generators, whether as a result of new power plants utilizing alternative energy sources or as a result of technological advances, could reduce the demand for our current products and services, thereby reducing our revenues and materially and adversely affecting our business and results of operations.
Additionally, long-term changes in environmental regulation that threaten or preclude the use of coal or other fossil fuels as a primary fuel source for electricity production, and result in the reduction or closure of a significant number of coal-fired electric generating units, may adversely affect our business, financial condition and results of operations.
The ability of Tinuum Group to generate revenues from the sale or lease of RC facilities to tax equity investors is not assured, and the inability to sell, lease or operate RC facilities to produce and sell RC and generate Section 45 production tax credits could adversely affect our future growth and profitability.
Except for RC facilities that Tinuum Group may retain and operate permanently for its own benefit, Tinuum Group is attempting to sell or lease the remaining RC facilities to third-party investors. The inability of Tinuum Group to successfully lease or sell additional RC facilities to third-party tax equity investors who may receive the benefit of the Section 45 tax credits that are expected to be generated from those RC facilities, as well as RC facilities that may be returned to Tinuum Group over time, would likely have an adverse effect on our future growth and profitability.
Furthermore, if, in the future, electric power generators decide to limit coal-fired generation for economic reasons and/or do not burn and use RC and instead switch to another power or fuel source, Tinuum Group would likely be unable to fully produce and sell the RC and the associated Section 45 production tax credits potentially available from RC facilities over the anticipated term of the Section 45 tax credit program.
The ability to generate Section 45 tax credits from existing operating RC facilities ends in 2021, which could eliminate the desire for investors to further lease RC facilities beyond this date, which would effectively eliminate Tinuum Group’s operations and significantly impact our financial condition and results of operations beyond 2021.
A substantial amount of our earnings and cash flows in 2017 are comprised of equity method and royalty earnings generated from Tinuum Group’s invested RC facilities. For the year ended December 31, 2017, our RC and EC segments generated segment operating income of $59.9 million and $0.4 million, respectively. As of December 31, 2017, Tinuum Group has 17 invested facilities and zero retained facilities. Of the 17 invested facilities, one is currently generating Section 45 tax credits that will no longer generate Section 45 tax credits beyond 2019 and the remaining 16 are generating Section 45 tax credits that will no longer generate Section 45 tax credits beyond 2021. As a result, we believe that substantially all of the invested RC facilities will be returned to Tinuum Group commensurate with the expiration of the Section 45 tax credit program. If Tinuum Group elects to continue operating these RC facilities, their earnings will be significantly reduced and accordingly, our pro rata share will also be substantially reduced.
Additionally, our EC segment is currently in its infancy and must grow substantially, either organically or acquisitively, in order to replace earnings from Tinuum Group that will substantially end during the 2020 to 2022-time frame. There can be no assurance that will be able to increase our EC segment earnings during this time frame to cover our current operating expenses or to provide a return to shareholders that is comparable to the return currently provided by our RC segment. If we are not able to cover operating expenses, we could be forced to raise additional capital, significantly reduce our operating expenses or take other alternative actions.
The recent change in income tax rates may make Section 45 production tax credits less attractive, which in turn could adversely affect our results of operations or financial condition.
On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (the “Tax Act”) became law. The Tax Act, among other things, lowered the federal income tax rate on corporations from 35% to 21%, effective for the year beginning January 1, 2018. This change to previous higher tax rates could negatively impact tax capacity of current or potential tax equity investors making Section 45 production tax credits less attractive. At this point, we are not fully certain how the tax credit investor market's reaction to the Tax Act’s rate changes and other changes could impact our businesses that produce and sell RC and generate Section 45 tax credits, which could have an adverse effect on our reported or future results of operations or financial condition.
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Market uncertainty created by the lack of guidance and rulings issued by courts and the IRS related to Section 45 tax credits could inhibit Tinuum Group's ability to lease or sell additional RC facilities or require a restructuring of, or result in the termination of, existing arrangements.
While the Tax Act did not change the provisions of Section 45, the availability of Section 45 tax credits related to the production and sale of RC to taxpayers investing in RC facilities depends upon a number of factors, including the risk assumed by the taxpayer in the RC facility investment transaction. The law addressing when a taxpayer may and may not be considered the producer and seller of RC and avail itself of Section 45 production tax credits is not fully developed and is subject to rulings by courts, interpretations by the IRS and other official pronouncements on tax credit regulations. If rulings, guidance or other pronouncements of courts or the IRS are not definitive or interpreted as allowing the IRS to restrict availability, increase the difficulty, or prohibit or limit the ability of taxpayers to be considered to be the producer and seller of RC and take advantage of Section 45 production tax credits, several aspects of our current and future RC business could be adversely affected. For example, current investors in RC facilities may decide to terminate their existing agreements, or potential investors may reduce the price they are willing to pay for an RC facility or change the structure of the investment to account for perceived risks associated with being considered the producer and seller of RC and the availability of the associated Section 45 production tax credits.
Presently, a group of related tax equity investors accounts for a substantial portion of our earnings from Tinuum Group and any lease renegotiation or termination by these investors or any failure to continue to produce and sell RC at the related investors' RC facilities would have a material adverse effect on our business.
As of December 31, 2017, 11 of Tinuum Group’s 28 RC facilities are leased to various affiliated entities. Significant components of our total cash flows come from Tinuum Group's distributions relating to payments received under these leases. These leases have an initial fixed period and then automatically renew, unless terminated at the option of the lessee, for successive one-year terms through 2019 or 2021. If these affiliated entities renegotiated or terminated their leases, or if the utilities where the RC facilities are installed materially reduce their use of RC, these events would have a material adverse effect on our business, results of operations or financial condition. Certain of these affiliated entities have amended their leases from time to time, with some of the amended leases including less favorable terms to Tinuum Group.
Our RC businesses are joint ventures and managed under operating agreements where we do not have sole control of the decision making process, and we cannot mandate decisions or ensure outcomes.
We oversee our joint ventures under the terms of their respective operating agreements by participating in the following activities: (1) representation on the respective governing boards of directors, (2) regular oversight of financial and operational performance and controls and establishing audit and reporting requirements, (3) hiring of management personnel, (4) technical support of RC facilities, and (5) other regular and routine involvement with our joint venture partners. Notwithstanding this regular participation and oversight, our joint venture partners also participate in the management of these businesses and they may have business or economic interests that divert their attention from the joint venture, or they may prefer to operate the business, make decisions or invest resources in a manner that is contrary to our preferences. Since material business decisions must be made jointly with our joint venture partners, we cannot mandate decisions or ensure outcomes.
The market for chemicals and other products that provide mercury emissions reduction is highly competitive and some of our competitors are significantly larger and more established than we are, which could adversely impede our growth opportunities and financial results.
We compete against certain significantly larger and/or more established companies in the market for chemicals and other products that provide mercury emissions reduction, including Norit America, Inc., a division of Cabot Corporation, Calgon Carbon, ADA Carbon Solutions and Nalco.
We are an early-stage company in the consumables mercury emissions reduction business and our chemicals products have been introduced later to the market than many of our competitors’ products. If we are not able to displace current providers of mercury emissions reduction products at coal-fired electric generating units, it would likely have a material adverse effect on our future growth opportunities and business, financial condition and results of operations.
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Our dependence on certain discrete chemicals that are both limited in supply and subject to significant price fluctuations used in the manufacturing of our chemical products that we sell to our customers may cause delays in products delivered to customers, delayed revenues, loss of customers and increased costs to us.
The manufacturing of our chemical products is dependent upon certain discrete chemicals that are prone to significant price fluctuations and supply constraints. Further, there are a limited number of suppliers that provide ingredients needed to manufacture our proprietary M-Prove and RESPond chemicals that are used at a customer's coal-fired electric generating unit. This makes us vulnerable to potential price increases from our suppliers that could negatively impact our gross margins if we are unable to increase the selling price to our customers. If suppliers are unable to procure discrete chemicals needed to manufacture our chemical products or elect not to continue to do business with us, we may be delayed in fulfilling customer orders and might not be able to fill orders at all. Delays in our ability to fulfill customer orders or the loss of any of our suppliers would have a material adverse effect on our EC business, results of operations and financial condition.
The quality and effectiveness of our technologies, products and services may not meet our customers’ expectations.
We utilize and rely on a limited number of suppliers to manufacture our proprietary M-Prove and RESPond chemicals. If these products are not manufactured to the standards and specifications that we have promised to our customers, we may suffer damage to our reputation and our customers may seek alternative products from competitors to fulfill their emissions reductions needs. In addition, if we have flaws in our service deliverables of delivery, installation, and performance testing and in our evaluation of our technologies, we could experience the loss of customers and resultant lower revenues. Historically, we have had minimal returns of chemicals sold to our customers due to non-compliance with agreed-upon specifications. While our suppliers are responsible and liable for any costs incurred to re-supply chemical products to our customers, including liability for liquidated damages, repair, replacement or service costs and for potential damage to our reputation, we have provided warranties and performance guarantees for certain ACI and DSI systems we have sold. Under those contractual arrangements, we are responsible for repair or replacement costs and certain operating costs within the limits provided by the contracts, if the agreed specifications are not met. Our efforts to monitor, develop, modify and implement acceptable chemicals and emissions reductions solutions may not be sufficient to avoid failures and meet performance criteria that may result in dissatisfied or lost customers, damage to our reputation, each of which could have a material adverse effect on our business, results of operations or financial condition.
Failure to protect our intellectual property or infringement of our intellectual property by a third party could have an adverse impact on our financial condition.
We rely on a combination of patent, copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions to protect our proprietary rights. Such means of protecting our proprietary rights may not be adequate because they provide only limited protection or such protection may be prohibitively expensive to enforce. We also enter into confidentiality and non-disclosure agreements with our employees, consultants, and many of our customers and vendors, and generally control access to and distribution of our proprietary information. Notwithstanding these measures, a third party could copy or otherwise obtain and use our proprietary information without authorization. We cannot provide assurance that the steps we have taken will prevent misappropriation of our technology and intellectual property, which could negatively impact our business and financial condition. In addition, such actions by third parties could divert the attention of our management from the operation of our business.
We may be subject to intellectual property infringement claims from third parties that are costly to defend and that may limit our ability to use the disputed technologies.
If our technologies are alleged to infringe the intellectual property rights of others, we may be prevented from continuing sales of existing products or services and from pursuing research, development or commercialization of new or complimentary products or services. Further, we may be required to obtain licenses to third-party intellectual property, or be forced to develop or obtain alternative technologies. Our failure to obtain a license to a technology that we may require, or the need to develop or obtain alternative technologies, could significantly and negatively affect our business.
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Agreements to indemnify third-party licensees of our technologies against intellectual property infringement claims concerning our licensed technology and our products could be significant to us.
We have agreed to indemnify licensees of our technologies (including Tinuum Group) and purchasers of our products and we may enter into additional agreements with others under which we agree to indemnify and hold them harmless from losses they may incur as a result of the infringement of third-party rights caused by the use of our technologies and products. Infringement claims, which are expensive and time-consuming to defend, could have a material adverse effect on our business, operating results and financial condition, even if we are successful in defending ourselves (and the indemnified parties) against them.
Our future success depends in part on our ongoing identification and development of intellectual property and our ability to invest in and deploy new products, services and technologies into the marketplace efficiently and cost effectively.
The process of identifying customer needs and developing and enhancing products, services and solutions for our business segments is complex, costly and uncertain. Any failure by us to identify and anticipate changing needs, emerging trends and new regulations could significantly harm our future market share and results of operations. Historically, our approach to technology development, implementation and commercialization of products has focused on quickly taking technology to full-scale testing and enhancing it under actual power plant operating conditions. We continue to review and adjust methods to deploy products, services and technologies to our customers. Our results are subject to risks related to our investments in new technologies, products and services, but if we are unable to develop and scale up new technologies, products or services to meet the needs of our customers, our business and financial results would be adversely affected.
The effects of Tinuum Group providing payment under performance guarantees of its RC facilities are largely unknown and could adversely affect our financial condition.
Tinuum Group indemnifies certain utilities and lessees of RC facilities for particular risks associated with the operations of those facilities. We have provided limited, joint and several guarantees of Tinuum Group’s obligations under those leases. Any substantial payments made under such guarantees could have a material adverse effect on our financial condition, results of operations and cash flows.
Material adjustments pursuant to DOE audits of our past performance could have a detrimental impact on our business.
Certain of our completed and current contracts awarded by the DOE and related industry participants remain subject to government audits. Our historical experience with these audits has not resulted in significant adverse adjustments to reimbursement amounts previously received; however audits for the years 2013 and later have not been finalized. If the results of future audits require us to repay material amounts, our results of operations and business would likely suffer material adverse impacts.
We may make future acquisitions or form partnerships and joint ventures that may involve numerous risks that could impact our financial condition, results of operations and cash flows.
Our strategy may include expanding our scope of products and services organically or through selective acquisitions, investments or creating partnerships and joint ventures. We have acquired, and may selectively acquire, other businesses, product or service lines, assets or technologies that are complementary to our business. We may be unable to find or consummate future acquisitions at acceptable prices and terms, or we may be unable to integrate existing or future acquisitions effectively and efficiently and may need to divest those acquisitions. We continually evaluate potential acquisition opportunities in the ordinary course of business. Acquisitions involve numerous risks, including among others:
• | integration difficulties, including challenges and costs associated with implementing systems and processes to comply with requirements of being part of a publicly-traded company; |
• | diverting management’s attention from normal daily operations of the business; |
• | entering markets in which we have no or limited direct prior experience and where competitors in such markets have stronger market positions; |
• | unanticipated costs and exposure to undisclosed or unforeseen liabilities or operating challenges; |
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• | potential loss of key employees and customers of the acquired businesses, product or service lines, assets or technologies; |
• | our ability to properly establish and maintain effective internal controls over an acquired company; and |
• | increasing demands on our operational and IT systems. |
The success of acquisitions of businesses, new technologies and products, or arrangements with third parties is not always predictable and we may not be successful in realizing our objectives as anticipated. We may not be able to integrate any acquired businesses successfully into our existing businesses, make such businesses profitable, or realize anticipated cost savings or synergies, if any, from these acquisitions, which could adversely affect our results of operations and financial condition. In addition, acquisitions of businesses may require additional debt or equity financing, resulting in additional leverage or dilution of equity ownership. Our loan agreements contain certain covenants that limit, or that may have the effect of limiting, among other things, acquisitions, capital expenditures, the sale of assets and the incurrence of additional indebtedness.
An “ownership change” could limit our ability to utilize tax loss and credit carryforwards to offset future taxable income.
We have certain general business credit tax credits (“Tax Attributes”). As of December 31, 2017, we had $100.4 million of Tax Attributes, equaling 88% of our total gross deferred tax assets. Our ability to use these Tax Attributes to offset future taxable income may be significantly limited if we experience an “ownership change” as discussed below.
On May 5, 2017, the Board of Directors ("Board") approved the Tax Asset Protection Plan (the “Protection Plan”) and declared a dividend of one preferred share purchase right (each, a “Right”) for each outstanding share of our common stock. The Protection Plan was adopted in an effort to protect stockholder value by attempting to diminish the risk that our ability to use the Tax Attributes to reduce potential future federal income tax obligations may become substantially limited. Under the IRC and regulations promulgated by the U.S. Treasury Department, we may carry forward or otherwise utilize the Tax Attributes in certain circumstances to offset any current and future taxable income and thus reduce our federal income tax liability, subject to certain requirements and restrictions. To the extent that the Tax Attributes do not otherwise become limited, we believe that we will have available a significant amount of Tax Attributes in future years, and therefore the Tax Attributes could be a substantial asset to us. However, if we experience an “ownership change,” as defined in Section 382 of the IRC, our ability to use the Tax Attributes may be substantially limited, and the timing of the usage of the Tax Attributes could be substantially delayed, which could therefore significantly impair the value of that asset.
In general, an “ownership change” for tax purposes occurs if the percentage of stock owned by an entity’s 5% stockholders (as defined for tax purposes) increases by more than 50 percentage points over a rolling three-year period. An entity that experiences an ownership change generally will be subject to an annual limitation on its pre-ownership change tax loss and credit carryforwards equal to the equity value of the entity immediately before the ownership change, multiplied by the long-term, tax-exempt rate posted monthly by the IRS (subject to certain adjustments). The annual limitation would be increased each year to the extent that there is an unused limitation in a prior year. The limitation on our ability to utilize the Tax Attributes arising from an ownership change under Section 382 of the IRC would depend on the value of our equity at the time of any ownership change. If we were to experience an “ownership change,” it is possible that a significant portion of our tax loss and credit carryforwards could expire before we would be able to use them to offset future taxable income.
The Protection Plan is intended to act as a deterrent to any person acquiring beneficial ownership of 4.99% or more of our outstanding common stock without the approval of the Board. Stockholders who beneficially owned 4.99% or more of our outstanding common stock upon execution of the Plan will not trigger the Protection Plan so long as they do not acquire beneficial ownership of additional shares of Common Stock. The Board may, in its sole discretion, also exempt any person from triggering the Protection Plan.
Changes in taxation rules or financial accounting standards could adversely affect our results of operations or financial condition.
Changes in taxation rules and accounting pronouncements (and changes in interpretations of accounting pronouncements) have occurred and may occur in the future.
The Tax Act, among other things, reduced the U.S. federal corporate tax rate from 35 percent to 21 percent, beginning January 1, 2018. As a result, as of December 31, 2017, we reduced our net deferred tax assets for the reduction in the federal rate in the
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amount of $5.8 million, which increased our income tax expense by this amount for the year ended December 31, 2017. Our assessment and accounting for the income tax effects of the Tax Act affecting our consolidated financial statements is generally complete, subject to continued evaluation under the SEC Staff Accounting Bulletin 118 ("SAB 118"), which provides guidance on accounting for the tax effects of the Tax Act. We do not anticipate any other impacts to have a material adverse impact to our financial condition, results of operations and cash flows; however, our evaluation is ongoing and our conclusions are preliminary.
Information technology vulnerabilities and cyberattacks on our networks could have a material adverse impact on our business.
We rely upon information technology ("IT") to manage and conduct business, both internally and externally, with our customers, suppliers and other third parties. Internet transactions involve the transmission and storage of data including, in certain instances, customer and supplier business information. Therefore, maintaining the security of computers and other electronic devices, computer networks and data storage resources is a critical issue for us and our customers and suppliers because security breaches could result in reduced or lost ability to carry on our business and loss of and/or unauthorized access to confidential information. We have limited personnel and other resources to address information technology reliability and security of our computer networks and to respond to known security incidents to minimize potential adverse impact. Experienced hackers, cybercriminals and perpetrators of threats may be able to penetrate our network security and misappropriate or compromise our confidential information or that of third parties, create system disruptions or cause shutdowns. These perpetrators of cyberattacks also may be able to develop and deploy viruses, worms, malware and other malicious software programs that attack our information and networks or otherwise exploit any security vulnerabilities of our information and networks. Techniques used to obtain unauthorized access to or sabotage systems change frequently and often are not recognized until long after being launched against a target, and we may be unable to anticipate these techniques or to implement adequate preventative measures. A breach of our IT systems and security measures as a result of third-party action, malware, employee error, malfeasance or otherwise could materially adversely impact our business and results of operations and expose us to customer, supplier and other third-party liabilities.
Risks relating to our common stock
Our stock price is subject to volatility.
The market price of our common stock has experience substantial price volatility in the past and may continue to do so. The market price of our common stock may continue to be affected by numerous factors, including:
• | actual or anticipated fluctuations in our operating results and financial condition; |
• | changes in laws or regulations and court rulings and trends in our industry; |
• | Tinuum Group’s ability to lease or sell RC facilities; |
• | announcements of sales awards; |
• | changes in supply and demand of components and materials; |
• | adoption of new tax regulations or accounting standards affecting our industry; |
• | changes in financial estimates by securities analysts; |
• | perceptions of the value of corporate transactions; |
• | our ability to continue to be able to pay cash dividends |
• | the number of shares of common stock repurchased under stock repurchase programs |
• | the degree of trading liquidity in our common stock and general market conditions. |
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From January 1, 2016 to December 31, 2017, the closing price of our common stock ranged from $3.27 to $12.08 per share. In June 2017, we commenced a quarterly cash dividend program and paid out cash dividends in July, September and December 2017. In May 2017, we executed a modified Dutch Auction tender offer and repurchased 1,370,891 shares of our common stock. In December 2017, the Board authorized a stock repurchase program pursuant to which we may repurchase up to $10.0 million of our outstanding common stock from time to time. As of December 31, 2017, we had purchased 342,875 shares of our common stock under this stock repurchase program.
Stock price volatility over a given period may cause the average price at which we repurchase shares of our common stock to exceed the stock’s price at a given point in time. We believe our stock price should reflect expectations of future growth and profitability. Future dividends are subject to declaration by the Board, and under our current stock repurchase program, we are not obligated to acquire any specific number of shares. If we fail to meet expectations related to future growth, profitability, dividends, stock repurchases or other market expectations, our stock price may decline significantly, which could have a material adverse impact on our ability to obtain additional capital, investor confidence and employee retention, and could reduce the liquidity of our common stock.
There can be no assurance that we will continue to declare cash dividends at all or in any particular amounts.
The Board first approved a $0.25 per share of common stock quarterly dividend in June 2017. During 2017, we declared three quarterly dividends in the aggregate amount of $15.8 million. We intend to continue to pay quarterly dividends subject to capital availability and periodic determinations by our Board that cash dividends are in the best interest of our stockholders and are in compliance with all laws and agreements applicable to the declaration and payment of cash dividends by us. Future dividends may be affected by, among other factors: our views on potential future capital requirements for investments in acquisitions; legal risks; stock repurchase programs; changes in federal and state income tax laws or corporate laws; changes to our business model; and our increased interest and principal payments required by our outstanding indebtedness and any additional indebtedness that we may incur in the future. Our dividend payments may change from time to time, and we cannot provide assurance that we will continue to declare dividends at all or in any particular amounts. A reduction in our dividend payments could have a negative effect on our stock price.
Our certificate of incorporation and bylaws contain provisions that may delay or prevent an otherwise beneficial takeover attempt of us.
Certain provisions of our certificate of incorporation and bylaws could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. These include provisions that:
• | Limit the business at special meetings to the purpose stated in the notice of the meeting; |
• | Authorize the issuance of “blank check” preferred stock, which is preferred stock with voting or other rights or preferences that could impede a takeover attempt and that the Board can create and issue without prior stockholder approval; |
• | Establish advance notice requirements for submitting nominations for election to the Board and for proposing matters that can be acted upon by stockholders at a meeting; and |
• | Require the affirmative vote of the "disinterested" holders of a majority of our common stock to approve certain business combinations involving an "interested stockholder" or its affiliates, unless either minimum price criteria or procedural requirements are met, or the transaction is approved by a majority of our "continuing directors" (known as "fair price provisions"). |
These provisions, alone or in combination with each other, may discourage transactions involving actual or potential changes of control, including transactions that otherwise could involve payment of a premium over prevailing market prices to holders of our common stock, or could limit the ability of our stockholders to approve transactions that they may deem to be in their best interest.
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We may require additional funding for our growth plans, and such funding may require us to issue additional shares of our common stock, resulting in a dilution of your investment.
We estimate our funding requirements in order to implement our growth plans. If the funding requirements required to implement growth plans should exceed these estimates significantly or if we come across opportunities to grow through expansion plans which cannot be predicted at this time, and our funds generated from our operations prove insufficient for such purposes, we may need to raise additional funds to meet these funding requirements.
These additional funds may be raised by issuing equity or debt securities or by borrowing from banks or other resources. We cannot assure you that we will be able to obtain any additional financing on terms that are acceptable to us, or at all. If we fail to obtain additional financing on terms that are acceptable to us, we will not be able to implement such plans fully. Such financing even if obtained, may be accompanied by conditions that limit our ability to pay dividends or require us to seek lenders’ consent for payment of dividends, or restrict our freedom to operate our business by requiring lender’s consent for certain corporate actions. Further, if we raise additional funds through the issuance of new shares of our common stock, any shareholders who are unable or unwilling to participate in such an additional round of fund raising may suffer dilution of their investment.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
Office and Warehouse Leases
As of December 31, 2017, we lease approximately 9,785 square feet of office space in Highlands Ranch, Colorado, which serves as our corporate headquarters. This lease was effective February 28, 2017 and expires on May 31, 2020.
As of December 31, 2017, we lease approximately 7,559 square feet of warehouse space in Highlands Ranch, Colorado, which expires in February 2019 and contains an option to renew for two additional five-year periods.
Item 3. Legal Proceedings
From time to time, we are involved in various litigation matters arising in the ordinary course of our business. Information with respect to this item may be found in Note 4 “Commitments and Contingencies” to the consolidated financial statements included in Item 8 of this Report.
Item 4. Mine Safety Disclosures
Not applicable.
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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market for Our Common Stock
As of December 31, 2017, our common stock was quoted on the NASDAQ Global Market under the symbol "ADES." The table below sets forth the price range of our common stock for each quarter of 2017 and 2016, as well as dividends per common share declared in such quarter.
High | Low | Dividends | ||||||||||
2017 | ||||||||||||
First quarter | $ | 12.08 | $ | 9.19 | $ | — | ||||||
Second quarter | 9.99 | 8.19 | 0.25 | |||||||||
Third quarter | 11.21 | 9.02 | 0.25 | |||||||||
Fourth quarter | 12.01 | 8.02 | 0.25 | |||||||||
2016 | ||||||||||||
First quarter | $ | 8.18 | $ | 3.27 | $ | — | ||||||
Second quarter | 8.19 | 6.20 | — | |||||||||
Third quarter | 8.60 | 6.40 | — | |||||||||
Fourth quarter | 9.89 | 7.53 | — | |||||||||
For the period beginning February 3, 2015 through July 6, 2016, our common stock traded on the OTC Pink® Marketplace - Limited Information Tier ("OTC") under the symbol ADES. The OTC quotations for this period reflected inter-dealer prices, without retail mark-up, markdown or commissions, and, as such, were not necessarily representative of actual transactions or the value of our common stock.
The trading volume for our common stock is relatively limited. There is no assurance that an active trading market will provide adequate liquidity for our existing stockholders or for persons who may acquire our common stock in the future.
Dividends
Prior to June 2017, we had never paid dividends. In June 2017, we commenced a quarterly cash dividend program. Beginning in the June 2017 quarter, we declared quarterly cash dividends of $0.25 per common share, which were paid on July 17, 2017, September 7, 2017 and December 6, 2017. Our ability to pay dividends in the future will be dependent upon earnings, financial condition and other factors considered relevant by the Board of Directors ("Board") and will be subject to limitations imposed under Delaware law.
We intend to continue to declare and pay a cash dividend on shares of our common stock on a quarterly basis. Whether we do, however, and the timing and amounts of dividends will be subject to approval and declaration by our Board and will depend on a variety of factors including, but not limited to, our financial results, cash requirements, financial condition, contractual restrictions and other factors considered relevant by our Board.
Performance Graph
The following performance graph illustrates a five-year comparison of cumulative total return of our common stock, the Russell 3000 Index and a select industry peer group ("Peer Group") for the period beginning on December 31, 2012 and ending on December 31, 2017. The graph assumes an investment of $100 on December 31, 2012 and assumes the reinvestment of all dividends.
The performance graph is not intended to be indicative of future performance. The performance graph shall not be deemed "soliciting material" or to be "filed" with the SEC for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any of the Company’s filings under the Securities Act or the Exchange Act.
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Five Year Cumulative Total Shareholder Return Comparison
Advanced Emissions Solutions Return Relative to the Russell 3000 Index and Select Industry Peer Group
The select industry Peer group includes the following: American Vanguard Corp., Calgon Carbon Corporation, CECO Environmental Corp., Clean Energy Fuels Corp., FutureFuel Corp., Fuel-Tech, Inc., Flotek Industries Inc., Hawkins Inc., KMG Chemicals Inc., Lydall Inc., Rentech, Inc., and TerraVia Holdings, Inc.
Holders
The number of holders of record of our common stock as of March 2, 2018 was approximately 900. The approximate number of beneficial stockholders is estimated at 4,372.
Purchases of Equity Securities by the Company and Affiliated Purchasers
In December 2017, our Board authorized a program for us to repurchase up to $10.0 million of shares of our common stock through open market transactions at prevailing market prices. This stock repurchase program will remain in effect until December 31, 2018 unless otherwise modified by the Board. The following table summarizes the common stock repurchase activity for the three months ended December 31, 2017:
Period | (a) Total number of shares (or units) purchased | (b) Average price paid per share (or unit) | (c) Total number of shares (or units) purchased as part of publicly announced programs | (d) Maximum number (or approximate dollar value) of shares (or units) that may yet be purchased under the plans or programs (in thousands) | ||||||||||
October 1 to 31, 2017 | — | $ | — | — | $ | — | ||||||||
November 1 to 30, 2017 | — | — | — | — | ||||||||||
December 1 to 31, 2017 | 342,875 | 9.82 | 342,875 | 6,627 | ||||||||||
Total | 342,875 | $ | 9.82 | 342,875 | $ | 6,627 | ||||||||
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Item 6. Selected Financial Data
Five-year Summary of Selected Financial Data
The following selected financial data are derived from the audited Consolidated Financial Statements for the years ended December 31, 2017, 2016, 2015, 2014 and 2013 and should be read in conjunction with Item 1A, Item 7 and our Consolidated Financial Statements and the related notes included in Item 8 of this Report.
Years Ended December 31, | ||||||||||||||||||||
(in thousands, except per share amounts) | 2017 | 2016 | 2015 | 2014 | 2013 | |||||||||||||||
Statement of operations data: | ||||||||||||||||||||
Revenues | $ | 35,692 | $ | 50,622 | $ | 62,739 | $ | 16,923 | $ | 13,286 | ||||||||||
Earnings from equity method investments | $ | 53,843 | $ | 45,584 | $ | 8,921 | $ | 42,712 | $ | 15,502 | ||||||||||
Royalties, related party | $ | 9,672 | $ | 6,125 | $ | 10,642 | $ | 6,410 | $ | 2,505 | ||||||||||
Income tax (benefit) expense (1) | $ | 24,152 | $ | (60,938 | ) | $ | 20 | $ | 296 | $ | 463 | |||||||||
Net income (loss) (2) (3) | $ | 27,873 | $ | 97,678 | $ | (30,141 | ) | $ | 1,387 | $ | (15,987 | ) | ||||||||
Net income (loss), per common share, basic (4) | $ | 1.30 | $ | 4.40 | $ | (1.37 | ) | $ | 0.06 | $ | (0.78 | ) | ||||||||
Net income (loss), per common share, diluted (4) (5) | $ | 1.29 | $ | 4.34 | $ | (1.37 | ) | $ | 0.06 | $ | (0.78 | ) | ||||||||
Dividends declared per common share | $ | 0.75 | $ | — | $ | — | $ | — | $ | — | ||||||||||
As of December 31, | ||||||||||||||||||||
(in thousands) | 2017 | 2016 | 2015 | 2014 | 2013 | |||||||||||||||
Balance sheet data: | ||||||||||||||||||||
Total assets | $ | 82,618 | $ | 107,296 | $ | 60,775 | $ | 93,699 | $ | 73,524 | ||||||||||
Total debt | $ | — | $ | — | $ | 28,025 | $ | 15,910 | $ | — | ||||||||||
Stockholders’ equity (deficit) | $ | 73,455 | $ | 76,165 | $ | (24,978 | ) | $ | (697 | ) | $ | (6,167 | ) | |||||||
(1) As described in Note 12 of the Consolidated Financial Statements included in Item 8 of this Report, during the fourth quarter of 2016, the Company released $61.4 million of the valuation allowance related to the deferred tax assets, which resulted in an income tax benefit during 2016 of $60.9 million. During 2017, the Company recorded an income tax expense of $24.2 million, inclusive of the impact of the Tax Act, which increased the Company's income tax expense by $5.8 million.
(2) As described in Note 18 of the Consolidated Financial Statements included in Item 8 of this Report, during the years ended December 31, 2016 and 2015, we recorded restructuring charges of $1.6 million and $10.4 million, respectively. Additionally, during the year ended December 31, 2014, we recorded restructuring charges of $3.5 million. The restructuring charges were recorded in connection with a reduction in force, the departure of executive officers and management's further alignment of the business with strategic objectives.
(3) As described in Note 2 of the Consolidated Financial Statements included in Item 8 of this Report, on February 10, 2014, we purchased a 24.95% membership interest in RCM6, which owns a single RC facility that produces and sells RC that qualifies for Section 45 tax credits, from Tinuum Group through an up-front payment of $2.4 million and an initial note payable to Tinuum Group of $13.3 million. During the year ended December 31, 2016, the Company recognized equity method losses related to RCM6 of $0.6 million. On March 3, 2016, the Company sold its 24.95% membership interest in RCM6 for a cash payment of $1.8 million and assumption of the outstanding note payable made by the Company in connection with its purchase of RCM6 membership interests from Tinuum Group in February 2014, resulting in a $2.1 million gain being recognized during 2016.
(4) For the year ended December 31, 2013, the number of common shares and per common share amounts have been retroactively restated to reflect the two-for-one stock split of our common stock, which was effected in the form of a common stock dividend distributed on March 14, 2014.
(5) For the years ended December 31, 2015 and 2013, the computation of diluted net loss per common share was the same as basic net loss per common share as the inclusion of potentially dilutive securities for those years would have been anti-dilutive.
The Notes to the Consolidated Financial Statements included in Item 8 of this Report contain additional information about charges resulting from other operating expenses and other income (expense) which affects the comparability of information presented.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
This Form 10-K for the year ended December 31, 2017 is filed by Advanced Emissions Solutions, Inc. together with its consolidated subsidiaries (collectively, "ADES," the "Company," "we," "us," or "our" unless the context indicates otherwise).
We are a leader in emissions reductions technologies and associated specialty chemicals, primarily serving the coal-fired power generation and industrial boiler industries. Our proprietary environmental technologies and specialty chemicals enable our customers to reduce emissions of mercury and other pollutants, maximize utilization levels and improve operating efficiencies to meet the challenges of existing and potential emissions control ("EC") regulations. See further discussion of our business included in Item 1 - "Business" ("Item 1") of this Report. Discussion regarding segment information is included within the discussion of our consolidated results under this Item 7. Additionally, discussion related to our reportable segments is included in Item 1 and Note 13 of the Consolidated Financial Statements included in Item 8 of this Report.
Components of Revenue, Expenses and Equity Method Investees
The following briefly describes the components of revenues and expenses as presented in the Consolidated Statement of Operations. Descriptions of the revenue recognition policies are included in Note 1 to the Consolidated Financial Statements included in Item 8 of this Report.
Revenues and costs of revenue
Equipment sales
Equipment sales represent the sale of activated carbon injection ("ACI") systems to control mercury, dry sorbent injection ("DSI") systems to control SO2, SO3, and HCl and electrostatic precipitator ("ESP") liquid flue gas conditioning systems. Revenue from extended equipment contracts is recorded using the completed contract method of accounting.
We also enter into other non-extended equipment contracts for which we generally recognize revenues on a time and material basis as services to build equipment systems are performed or as equipment is delivered.
Chemicals
We sell proprietary chemical blends to coal-fired utilities that allow the respective utilities to comply with the regulatory emissions standards. Revenue is generally recorded upon delivery of the chemicals.
Certain chemicals customer contracts are comprised of evaluation tests of the Company's chemicals' effectiveness and efficiency in reducing emissions and entail the delivery of chemicals to the customer and the Company evaluating results of emissions reduction over the term of the contract. The Company generally recognizes revenue from these types of contracts over the duration of the contract based on the cost of chemicals consumed by the customer.
Consulting services and other
We provide consulting services to assist electric power generators and others in planning and implementing strategies to meet the new and increasingly stringent government emission standards requiring reductions in SO2, NOx, particulates, acid gases and mercury.
Other Operating Expenses
Payroll and benefits
Payroll and benefits costs include personnel related fringe benefits, sales and administrative staff labor costs and stock compensation expenses.
Rent and occupancy
Rent and occupancy costs include rent, insurance, and other occupancy-related expenses.
Legal and professional fees
Legal and professional costs include external legal, audit and consulting expenses.
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General and administrative
General and administrative costs include director fees and expenses, bad debt expense and other general costs of conducting business.
Research and development, net
Research and development expense consists of research relating to continued product development for our ongoing business and various other projects. Historically, we have entered into reimbursement contracts with the Department of Energy ("DOE") related to certain of our research and development contracts. These contracts were best-effort-basis contracts. We have often included and continued to include industry cost-share partners to offset the costs incurred in excess of funded amounts from the DOE or from our own research and development project budgets. We recognize amounts funded by the DOE and industry partners under research-and-development-cost-sharing arrangements as an offset to our aggregate research and development expenses within the Research and development, net line in the Consolidated Statements of Operations included in Item 8 of this Report.
Depreciation and amortization
Depreciation and amortization expense consists of depreciation expense related to property and equipment and the amortization of long lived intangibles.
Other Income (Expense), net
Earnings from equity method investments
Earnings from equity method investments relates to our share of earnings (losses) related to our equity method investments.
Our equity method earnings in Tinuum Group, LLC ("Tinuum Group"), a related party in which we own a 42.5% equity interest and a 50% voting interest, are positively impacted when Tinuum Group obtains an investor in a refined coal ("RC") facility and receives lease payments from the lessee, or purchase payments from the sale, of the RC facility. If Tinuum Group operates a retained RC facility, the Company's equity method earnings will be negatively impacted as operating retained RC facilities generate operating losses. However, we benefit on an after-tax basis if we are able to utilize tax credits associated with the production and sale of RC from operation of retained RC facilities by Tinuum Group. These benefits, if utilized, will increase our consolidated net income as a result of a reduction in income tax expense. In addition, our equity method earnings in Tinuum Group are negatively impacted due to an annual preferred return to which one of Tinuum Group's equity owners, GSFS, is entitled. Therefore, Tinuum Group's equity earnings available to its common members are equal to Tinuum Group's net income less the preferred return due to GSFS. In February 2018, the unrecovered investment balance associated with the preferred return was repaid in full.
Tinuum Services, LLC ("Tinuum Services"), a related party in which we own both a 50% equity and voting interest, operates and maintains RC facilities under operating and maintenance agreements. Tinuum Group or the lessee/owner of the RC facilities pays Tinuum Services, subject to certain limitations, the costs of operating and maintaining the RC facilities plus certain fees. Tinuum Services also arranges for the purchase and delivery of certain chemical additives under chemical agency agreements necessary for the production of refined coal. Tinuum Services consolidates certain RC facilities leased or owned by tax equity investors that are deemed to be VIE's. All net income (loss) associated with these VIE's is allocated to the noncontrolling equity holders of Tinuum Services and therefore does not impact our equity earnings (loss) from Tinuum Services.
On July 27, 2017, we obtained a 50% membership interest in GWN Manager, LLC ("GWN Manager") in exchange for a capital contribution of $0.1 million. GWN Manager subsequently purchased a 0.2% membership interest in a subsidiary of Tinuum Group, which owns a single RC facility that produces RC that qualifies for Section 45 tax credits. Tinuum Group sold 49.9% of the subsidiary that owns the RC facility to an unrelated third party and retained ownership of the remaining 49.9%. GWN Manager is subject to monthly capital calls based on estimated working capital needs.
Through March 3, 2016, we owned a 24.95% equity interest in RCM6, LLC ("RCM6"), a related party, which owned a single RC facility that was managed by Tinuum Group. The economics to us were consistent with an invested facility discussed above except that we were subject to funding our share of RCM6's operating costs during 2014 and 2015 and through March 3, 2016.
Royalties, related party
We license our M-45TM and M-45-PCTM emission control technologies ("M-45 License") to Tinuum Group and realize royalty income based upon a percentage of the per-ton, pre-tax margin as defined in the M-45 License.
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Other income (expense)
The remaining components of other income (expense) include interest income, interest expense and other miscellaneous items. For 2017, miscellaneous items included various items related to litigation accruals and settlement with a third-party service provider. For 2016, miscellaneous items included an adjustment to a litigation loss accrual and change in estimate related to royalty indemnity expense.
We record interest expense due to our share of Tinuum Group's equity method earnings for RC facility leases or sales that are treated as installment sales for tax purposes. IRS Section 453A requires taxpayers using the installment method to pay an interest charge on the portion of the tax liability that was deferred under the installment method. We refer to this as "453A interest."
Results of Operations
For comparison purposes, the following tables set forth our results of operations for the years presented in the Consolidated Financial Statements included in Item 8 of this Report. The year-to-year comparison of financial results is not necessarily indicative of financial results that may be achieved in future years.
Year ended December 31, 2017 Compared to Year ended December 31, 2016
Total Revenue and Cost of Revenue
A summary of the components of revenues and cost of revenue for the years ended December 31, 2017 and 2016 is as follows:
Years Ended December 31, | Change | ||||||||||||||
(Amounts in thousands except percentages) | 2017 | 2016 | ($) | (%) | |||||||||||
Revenues: | |||||||||||||||
Equipment sales | $ | 31,401 | $ | 46,949 | $ | (15,548 | ) | (33 | )% | ||||||
Chemicals | 4,246 | 3,025 | 1,221 | 40 | % | ||||||||||
Consulting services and other | 45 | 648 | (603 | ) | (93 | )% | |||||||||
Total revenues | 35,692 | 50,622 | (14,930 | ) | (29 | )% | |||||||||
Operating expenses: | |||||||||||||||
Equipment sales cost of revenue, exclusive of depreciation and amortization | 28,438 | 37,741 | (9,303 | ) | (25 | )% | |||||||||
Chemicals cost of revenue, exclusive of depreciation and amortization | 3,434 | 1,700 | 1,734 | 102 | % | ||||||||||
Consulting services and other cost of revenue, exclusive of depreciation and amortization | 13 | 376 | (363 | ) | (97 | )% | |||||||||
Equipment sales and Equipment sales cost of revenue
During the years ended December 31, 2017 and 2016, we entered into zero and five long-term (6 months or longer) fixed price contracts to supply ACI systems with aggregate contract values, net of change orders of $0.1 million and $2.9 million, respectively. During the years ended December 31, 2017 and 2016, we completed four and 17 ACI systems, recognizing revenues of $3.4 million and $26.9 million and cost of revenue of $2.4 million and $20.5 million, respectively. We recognized zero and $0.5 million in loss provisions related to ACI system contracts during the years ended December 31, 2017 and 2016, respectively. As of December 31, 2017, all ACI system contracts are complete.
During the years ended December 31, 2017 and 2016, we did not enter into any long term (6 months or longer) fixed price contracts to supply DSI systems and other material handling equipment with contract values including associated change orders of zero and $1.5 million, respectively. During the years ended December 31, 2017 and 2016, we completed five and 11 DSI systems, recognizing revenues of $27.8 million and $15.8 million and cost of revenue of $26.0 million and $14.8 million, respectively. During the year ended December 31, 2017, we recognized zero in loss provisions related to DSI system contracts. During the year ended December 31, 2016, we recorded a reduction of $0.1 million in previously recognized loss provisions included in cost of revenue related to DSI system contracts.
Additionally, in 2016, we executed sales-type lease agreements related to ACI and DSI systems and recognized revenue of $3.4 million and cost of revenue of $1.2 million during the year ended December 31, 2016.
The remaining changes were due to other equipment sales.
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As a result of using the completed contract method for revenue recognition on long-term equipment contracts, our revenue and cost of revenue information may not be comparable to the information of our competitors who do not use the completed contract method. For example, due to the long-term revenue recognition period on certain contracts, we may recognize less revenue and related cost of revenue during a particular period, but record significant deferred revenue and deferred project costs. This impacts our outstanding backlog as is discussed in more detail in Item 1 of this Report.
Demand for ACI and DSI system contracts during 2015 and 2016 was driven by coal-fired power plant utilities that need to comply with the Mercury and Air Toxics Standards ("MATS") and the Maximum Achievable Control Technology ("MACT") standards by 2016. Revenues related to ACI and DSI system contracts have historically fluctuated due to changes in the number of contracts entered into as well as the long duration of completing certain contracts, which involve long-lead time requirements for manufacturing, installation and testing of the equipment. As the deadline for these standards has now passed, we do not anticipate entering into long-term fixed price contracts for ACI or DSI systems in the future.
Chemicals and Chemical cost of revenue
During the years ended December 31, 2017 and 2016, revenues increased year over year primarily due to an overall increase in pounds of our chemicals sold. Gross margins on sales of chemicals for the year ended December 31, 2017 were lower than 2016 due to price compression in the EC consumables market and increased field testing of our M-ProveTM ("M-Prove") consumable, which results in significantly lower gross margins compared to recurring sales. Future period revenues are expected to be negatively impacted by a major customer who is not expected to purchase chemicals going forward, as well as the effects of continued price compression compared to historical periods. As we continue to expand our customer base and attempt to increase the volume, size and duration of chemical sale arrangements, we are faced with the challenge of a competitive market with a long lead-to-sale cycle. Increasing future sales of chemicals is our primary focus of the EC business at this time.
Consulting services and other and Consulting services cost of revenue
We reported minimal revenue related to consulting services for the year ended December 31, 2017. Due to diminishing market demand related to historical services provided, we do not believe this revenue component will be material in the near term. We also provide consulting services related to emissions regulations.
Additional information related to revenue concentrations and contributions by class and reportable segment can be found within the segment discussion below and in Note 14 to the Consolidated Financial Statements included in Item 8 of this Report.
Other Operating Expenses
A summary of the components of our operating expenses, exclusive of cost of revenue items (presented above), for the years ended December 31, 2017 and 2016 is as follows:
Years Ended December 31, | Change | ||||||||||||||
(in thousands, except percentages) | 2017 | 2016 | ($) | (%) | |||||||||||
Operating expenses: | |||||||||||||||
Payroll and benefits | $ | 7,669 | $ | 12,390 | $ | (4,721 | ) | (38 | )% | ||||||
Rent and occupancy | 795 | 2,168 | (1,373 | ) | (63 | )% | |||||||||
Legal and professional fees | 4,354 | 8,293 | (3,939 | ) | (47 | )% | |||||||||
General and administrative | 3,857 | 3,721 | 136 | 4 | % | ||||||||||
Research and development, net | 157 | (648 | ) | 805 | (124 | )% | |||||||||
Depreciation and amortization | 789 | 979 | (190 | ) | (19 | )% | |||||||||
$ | 17,621 | $ | 26,903 | $ | (9,282 | ) | (35 | )% | |||||||
Payroll and benefits
Payroll and benefits expenses decreased in 2017 compared to 2016 primarily due to a decrease in average headcount of approximately 40% during 2017. Additionally, restructuring expenses decreased during the year ended December 31, 2017 compared to 2016 in connection with the departure of certain executive officers and management's alignment of the business with strategic objectives in 2016. During the years ended December 31, 2017 and December 31, 2016, we recorded net restructuring charges of zero and $1.6 million, respectively. In addition, bonuses and stock-based compensation decreased by $1.4 million in 2017 compared to 2016.
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Rent and occupancy
Rent and occupancy expenses decreased in 2017 compared to 2016 primarily due to lower rent and occupancy expense in 2017 as a result of the relocation of our corporate headquarters in the first quarter of 2017 and the acceleration of deferred rent and tenant improvement allowances recorded in 2017 associated with the termination of the lease agreement of our former corporate headquarters.
Legal and professional fees
Legal and professional fees expenses decreased in 2017 compared to 2016 as a result of a reduction in the professional resources deployed to address the restatement of our consolidated financial statements, including litigation associated with such restatement. Expenses related to the restatement during the year ended December 31, 2017 and 2016 were zero and $2.0 million, respectively. Additional decreases during the year ended December 31, 2017 were driven by a decrease in costs related to outsourced shared service costs, including accounting consultants, legal fees and audit fees.
General and administrative
General and administrative expenses remained relatively flat in 2017 compared to 2016 as we began to experience normalization of our operating expenses in most categories following our cost-containment initiatives implemented in 2016. During the year ended December 31, 2017, we incurred expenses related to the implementation of a new enterprise resource planning ("ERP") system and a $0.4 million reserve on an asset related to a letter of credit asset draw made by a former customer that we are contesting and pursing legal actions. These increases were offset by decreases in travel and professional expenses. During the year ended December 31, 2016, we recognized impairment charges on property and equipment and inventory of $0.5 million, as projected future cash flows from operations related to such property and equipment and inventory did not support the carrying value of these assets.
Research and development, net
Research and development expense increased in 2017 compared to 2016 primarily due to the reimbursements of research and development expense recognized in 2016 from final billings to the DOE on one research and development contract, which resulted in negative research and development expense for 2016, and an increase in research and development activities during 2017 incurred in pursuit of the expansion of potential product offerings within the emissions reduction consumables market to complement our existing chemicals solutions. The net increase in 2017 was offset by a decrease in our asset retirement obligation estimate, which was primarily driven by a reduction in the scope of the obligation.
Depreciation and amortization
Depreciation and amortization expense decreased in 2017 compared to 2016 primarily due to higher depreciation recorded in 2016 as a result of the acceleration of depreciation on certain fixed assets that were disposed of in 2016 in connection with our corporate office relocation, which resulted in a lower depreciable base in 2017. Additionally, during 2016, we terminated a technology license arrangement, which resulted in approximately $0.1 million decrease in the related amortization expense. in 2017.
Other Income (Expense), net
A summary of the components of our other income (expense), net for the years ended December 31, 2017 and 2016 is as follows:
Years Ended December 31, | Change | ||||||||||||||
(Amounts in thousands, except percentages) | 2017 | 2016 | ($) | (%) | |||||||||||
Other income (expense): | |||||||||||||||
Earnings from equity method investments | $ | 53,843 | $ | 45,584 | $ | 8,259 | 18 | % | |||||||
Royalties, related party | 9,672 | 6,125 | 3,547 | 58 | % | ||||||||||
Interest income | 54 | 268 | (214 | ) | (80 | )% | |||||||||
Interest expense | (3,024 | ) | (5,066 | ) | 2,042 | (40 | )% | ||||||||
Litigation settlement and royalty indemnity expense, net | 3,269 | 3,464 | (195 | ) | (6 | )% | |||||||||
Other | 2,025 | 2,463 | (438 | ) | (18 | )% | |||||||||
Total other income | $ | 65,839 | $ | 52,838 | $ | 13,001 | 25 | % | |||||||
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Earnings in equity method investments
The following table presents the equity method earnings, by investee, for the years ended December 31, 2017 and 2016:
Years Ended December 31, | Change | ||||||||||||||
(in thousands) | 2017 | 2016 | ($) | (%) | |||||||||||
Earnings from Tinuum Group | $ | 48,875 | $ | 41,650 | $ | 7,225 | 17 | % | |||||||
Earnings from Tinuum Services | 4,963 | 4,491 | 472 | 11 | % | ||||||||||
Earnings (losses) from other | 5 | (557 | ) | 562 | (101 | )% | |||||||||
Earnings from equity method investments | $ | 53,843 | $ | 45,584 | $ | 8,259 | 18 | % | |||||||
Earnings from equity method investments, and changes related thereto, are impacted by our most significant equity method investees: Tinuum Group and Tinuum Services. Earnings from equity method investments increased during the year ended December 31, 2017 compared to 2016 primarily as a result of an increase in cash distributions due to the addition of four invested facilities, three of which were fully invested by third parties during 2017. See the discussion below regarding the accounting of earnings from Tinuum Group.
During the year ended December 31, 2017, we recognized $48.9 million in equity earnings from Tinuum Group compared to our proportionate share of Tinuum Group's net income of $46.6 million for the year. During the year ended December 31, 2016, we recognized $41.7 million in equity earnings from Tinuum Group compared to our proportionate share of Tinuum Group's net income of $35.0 million for the year. The difference between our pro-rata share of Tinuum Group's net income and our earnings from our Tinuum Group equity method investment as reported on the Condensed Consolidated Statements of Operations relates to us receiving cumulative distributions in excess of the carrying value of the investment, and therefore recognizing such excess distributions as equity method earnings in the period the distributions occur, as discussed in more detail below.
As a result of cash flows from invested RC facilities, Tinuum Group distributions to us during the year ended December 31, 2017 were $48.9 million, which exceeded our pro-rata share of Tinuum Group's net income, resulting in us having cumulative cash distributions that exceeded our cumulative pro-rata share of Tinuum Group's net income as of December 31, 2017.
The following table for Tinuum Group presents our investment balance, equity earnings, cash distributions received and cash distributions in excess of the investment balance for the years ended December 31, 2017 and 2016 (in thousands).
Description | Date(s) | Investment balance | ADES equity earnings (loss) | Cash distributions | Memorandum Account: Cash distributions and equity loss in (excess) of investment balance | |||||||||||||
Total investment balance, equity earnings (loss) and cash distributions | 12/31/2015 | $ | — | $ | — | $ | — | $ | (3,263 | ) | ||||||||
ADES proportionate share of net income from Tinuum Group (1) | 2016 activity | 35,019 | 35,019 | — | — | |||||||||||||
Recovery of cash distributions in excess of investment balance (prior to cash distributions) | 2016 activity | (3,263 | ) | (3,263 | ) | — | 3,263 | |||||||||||
Cash distributions from Tinuum Group | 2016 activity | (41,650 | ) | — | 41,650 | — | ||||||||||||
Adjustment for current year cash distributions in excess of investment balance | 2016 activity | 9,894 | 9,894 | — | (9,894 | ) | ||||||||||||
Total investment balance, equity earnings (loss) and cash distributions | 12/31/2016 | — | 41,650 | 41,650 | (9,894 | ) | ||||||||||||
ADES proportionate share of net income from Tinuum Group (1) | 2017 activity | 46,551 | 46,551 | — | — | |||||||||||||
Recovery of cash distributions in excess of investment balance (prior to cash distributions) | 2017 activity | (9,894 | ) | (9,894 | ) | — | 9,894 | |||||||||||
Cash distributions from Tinuum Group | 2017 activity | (48,875 | ) | — | 48,875 | — | ||||||||||||
Adjustment for current year cash distributions in excess of investment balance | 2017 activity | 12,218 | 12,218 | — | (12,218 | ) | ||||||||||||
Total investment balance, equity earnings and cash distributions | 12/31/2017 | $ | — | $ | 48,875 | $ | 48,875 | $ | (12,218 | ) | ||||||||
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(1) The amounts of our 42.5% proportionate share of net income as shown in the table above differ from mathematical calculations of the Company’s 42.5% equity interest in Tinuum Group multiplied by the amounts of Net Income available to Class A members as shown in the table above of Tinuum Group results of operations due to adjustments related to the Class B preferred return and the elimination of Tinuum Group's earnings attributable to RCM6, of which we owned 24.95%, for the period from January 1 to March 3, 2016.
Tinuum Group's consolidated financial statements as of December 31, 2017 and 2016, and for the years ended December 31, 2017, 2016 and 2015 are included in Item 15 of this Report.
Equity earnings from our interest in Tinuum Services increased by $0.5 million in 2017 compared to 2016. As of December 31, 2017 and 2016, Tinuum Services provided operating and maintenance services to 16 and 13 RC facilities, respectively. However, the weighted-average number of RC facilities for which Tinuum Services provided operating and maintenance services, based upon the number of months each facility was operated during the respective years, did not change year over year. Tinuum Services derives earnings from both fixed-fee arrangements as well as fees that are tied to actual RC production, depending upon the specific RC facility operating and maintenance agreement.
On March 3, 2016, we sold our 24.95% membership interest in RCM6 for a cash payment of $1.8 million and assumption of a note payable (the "RCM6 Note Payable") made by us in connection with our purchase of the RCM6 membership interest from Tinuum Group in February 2014. Through March 3, 2016, we recognized equity losses related to our investment in RCM6 of $0.6 million.
On July 27, 2017, we obtained a 50% membership interest in GWN Manager in exchange for a capital contribution of $0.1 million. GWN Manager subsequently purchased a 0.2% membership interest in a subsidiary of Tinuum Group, which owns a single RC facility that produces RC that qualifies for Section 45 tax credits. Tinuum Group sold 49.9% of the subsidiary that owns the RC facility to an unrelated third party and retained ownership of the remaining 49.9%. We are subject to monthly capital calls to GWN Manager based on estimated working capital needs. Our investment in GWN Manager as of December 31, 2017, was $0.1 million. Equity earnings from our interest in GWN Manager included our share of net income from inception to December 31, 2017.
Additional information related to equity method investments can be found in Note 2 to the Consolidated Financial Statements included in Item 8 of this Report.
Tax Credits
We earned the following tax credits that may be available for future benefit related to the production of RC from the operation of retained RC facilities under the Internal Revenue Code ("IRC") Section 45 - Production Tax Credit ("Section 45 tax credits"):
Years Ended December 31, | ||||||||
(in thousands) | 2017 | 2016 | ||||||
Section 45 tax credits earned | $ | 3,496 | $ | 2,956 | ||||
The increase in the Section 45 tax credits earned during the year ended December 31, 2017 compared to December 31, 2016 was collectively due to our membership interest in GWN Manager and Tinuum Group's ownership in the single RC facility that is generating tax credits.
As discussed in Item 1 of this Report, Tinuum Group operates and leases or sells facilities used in the production and sale of RC to third party tax equity investors. All dispositions of such facilities are treated as sales for federal income tax purposes at Tinuum Group. The resulting gain from these sales is reported by Tinuum Group pursuant to the installment method under IRC Section 453. Under IRC Section 453A ("453A"), taxpayers using the installment method for income tax purposes are required to pay interest ("453A interest") calculated on the portion of the tax liability that is deferred under the installment method. As of December 31, 2017, ADES’s allocable share of the gross deferred installment gain from Tinuum Group to be recognized in future years was approximately $202 million.
Due to the production and sale of RC from the operation of retained RC facilities, Tinuum Group has generated production tax credits ("PTCs") that qualify as General Business Credits ("GBCs"). These GBC's are allocated to the owners of Tinuum Group, including us, who may benefit to the extent that the GBC's are realized from the operation of retained RC facilities. As of December 31, 2017, we had approximately $100.2 million in GBC carryforwards.
In the hypothetical event of an ownership change, as defined by IRC Section 382, utilization of the GBC's generated prior to the change would be subject to an annual limitation imposed by IRC Section 383 for GBC's. The results of a recent analysis indicated that we had not experienced an ownership change as of December 31, 2017, as defined by IRC Section 382. Such analysis for the period from January 1, 2018 through the date of this Report has not been completed. Therefore, it is possible that we experienced an ownership change between January 1, 2018 and the date of this filing, thus subjecting our GBC
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carryforwards to limitation. Should a limitation exist, however, we would likely be in a position to substantially increase the limitation amount by virtue of our approximately $202 million deferred installment sale gain at Tinuum Group.
Specifically, IRC Section 382 provides that a corporation with a net unrealized built-in gain ("NUBIG") immediately before an ownership change may increase its limitation by the amount of recognized built-in gain ("RBIG") arising from the sale of a built-in gain asset during a recognition period, which is generally the five-year period immediately following an ownership change. Built-in gain reported on the installment sale method that is attributable to assets sold by the corporation before or during the recognition period may increase the corporation’s limitation during and after the recognition period. Therefore, it is likely that any IRC Section 382 limitation imposed upon an ownership change may be increased by our share of RBIG from Tinuum Group’s installment sale gain attributable to RC facilities sold before or during the period in which the change in ownership occurred.
There are numerous assumptions that must be considered in calculating the RBIG related to Tinuum Group and the increase to our IRC Section 383 limitation. Assuming the following assumptions below, we may be able to increase the total limitation by approximately $202 million over the duration of the installment sale. As of December 31, 2017, after increasing the total hypothetical limitation, we would likely not have been able to utilize approximately $41.0 million of tax credits.
• | The Tinuum Group RBIG is a result of the sale of RC facilities by Tinuum Group and its election to utilize the installment sale method for tax purposes; |
• | Investors in RC facilities will not terminate existing contracts as completion of an installment sale transaction is necessary to realize RBIG; |
• | We have no net unrealized built-in loss to offset the NUBIG from Tinuum Group; |
• | Our RBIG is equal to the deferred gain allocated from Tinuum Group or, approximately $202 million; |
• | We will have a NUBIG immediately before a hypothetical ownership change such that the Tinuum Group RBIG is available to increase the IRC Section 382 limitation; |
• | We will continue our historic business operations for at least two years following a hypothetical ownership change; and |
• | A second ownership change does not occur. |
The annual limitation will be increased by the amount of RBIG that is included in taxable income each year.
Royalties, related party
Royalty income increased in 2017 compared to 2016 primarily due to obtaining additional tax equity investors for four incremental new facilities during 2017 compared to 2016, all of which use our M-45 License. The total facilities that use our M-45 License increased from six facilities in 2016 to 10 facilities in 2017. The increase in facilities resulted in an increase in rental and sales payments to Tinuum Group and an increase in the related tons produced and sold subject to the M-45 License. During the years ended December 31, 2017 and 2016, there were 22.6 million tons and 16.2 million tons, respectively, of RC produced using the M-45 License.
Interest expense
Interest expense decreased in 2017 compared to 2016 primarily due to interest expense incurred in 2016 related to a credit agreement for a $15.0 million short-term loan with a related party (the "Credit Agreement"), which was terminated in June 2016 and resulted in a decrease of $2.1 million. In addition, interest expense decreased in 2017 compared to 2016 by $0.3 million related to the RCM6 Note Payable, which was eliminated in March 2016.
Offsetting these decreases in interest expense was an increase of $0.1 million related to 453A, which was primarily due to an increase in 2017 in the aggregate deferred tax liability, which was primarily driven by an increase in invested RC facilities in which Tinuum Group recognized as installment sales for tax purposes from 13 as of December 31, 2016 to 17 as of December 31, 2017.
The following table shows the balance of the tax liability that has been deferred and the applicable interest rate to calculate 453A interest:
As of December 31, | ||||||||
(in thousands) | 2017 | 2016 | ||||||
Tax liability deferred on installment sales (1) | $ | 70,739 | $ | 71,559 | ||||
Interest rate | 4.00 | % | 4.00 | % | ||||
(1) Represents the approximate tax effected liability utilizing the federal tax rate in effect for the applicable years ended related to the deferred gain on installment sales (approximately $202 million as of December 31, 2017).
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Based on the interest rate in effect as of the date of this filing, the 453A interest rate for the year ended December 31, 2018 is expected to be 5%.
Revision of estimated litigation settlement and royalty indemnity expense, net
During the years ended December 31, 2017 and 2016, management revised its estimate for future Royalty Award (as defined in Note 4 to the Consolidated Financial Statements included in Item 8 of this Report) payments based in part on updated forecasts provided to us by ADA Carbon Solutions, LLC ("Carbon Solutions"). As discussed in Note 4 to the Consolidated Financial Statements, we were required to pay additional damages related to certain future revenues generated from Carbon Solutions. These forecasts provided in 2017 and 2016 included a material reduction in estimated future revenues generated at the specific activated carbon plant from which the royalties are generated.
In December 2017, we, Carbon Solutions and the parent company of Carbon Solutions agreed to terminate certain provisions of the Indemnity Settlement Agreement (the " Indemnity Termination Agreement"). Pursuant to an agreement executed concurrently with the Indemnity Termination Agreement, the Company, Norit and an affiliate of Norit (collectively referred to as “Norit”) agreed to a final payment in the amount of $3.3 million (the "Settlement Payment") to settle all outstanding royalty obligations owed under the terms of the Norit Settlement Agreement. This amount was paid by the Company on December 29, 2017. As a result of changes in estimates and the final Settlement Payment, the Litigation settlement and royalty indemnity expense, net line item was positively impacted by $3.3 million and $3.5 million during the years ended December 31, 2017 and 2016, respectively.
Other
The components of Other income (expense) include the following significant items:
Settlement with service provider
In November 2017, we entered into a settlement agreement with a former third-party service provider and as part of the settlement we received cash in the amount of $3.5 million. Cash from this settlement was received in December 2017.
Advanced Emission Solutions, Inc. Profit Sharing Retirement Plan
The Advanced Emissions Solutions, Inc. Profit Sharing Retirement Plan (the “401(k) Plan”) is subject to the jurisdiction of the Internal Revenue Service ("IRS") and the Department of Labor ("DOL"). The DOL opened an investigation into the 401(k) Plan, and we are responding to all requests for documents and information from the DOL. The DOL has not issued any formal findings as of the date of this Report. Although we believe there has been no breach of fiduciary duty with respect to the 401(k) Plan, we believe a liability for contributions to the 401(k) Plan is probable and estimable and, as such, should be accrued for in the amount of $1.0 million as of December 31, 2017. The liability is recorded in the Other current liabilities line item on the Consolidated Balance Sheets. The expense recognized related to this accrual is included in the Other line item in the Consolidated Statements of Operations for the year ended December 31, 2017.
Impairment of cost method investment
In November 2014, we acquired an 8% ownership interest in the common stock of Highview ("Highview"), a London, England based development stage company specializing in power storage. We accounted for our investment in Highview (the "Highview Investment") under the cost method. As of September 30, 2017, we recorded an impairment charge of $0.5 million for the Highview Investment based on an estimated fair value of £1.00 compared to the estimated carrying value prior to the impairment charge of £2.00 per share. As of December 31, 2017, the estimated fair value of the Highview Investment was based on an equity raise that commenced during the third quarter of 2017 at a price of £1.00 per share. The impairment charge is included in the Other line item in the Consolidated Statements of Operations for the year ended December 31, 2017.
As of December 31, 2016, we recorded an impairment charge of $1.8 million for the Highview Investment based on an estimated fair value of £2.00 per share compared to the estimated carrying value prior to the impairment charge of £4.25 per share. The impairment charge is included in the Other line item in the Consolidated Statements of Operations for the year ended December 31, 2016.
Gain on sale of equity method investment
On March 3, 2016, we sold our 24.95% membership interest in RCM6 for a cash payment of $1.8 million and the assumption, by the buyer, of the RCM6 Note Payable. The outstanding balance on the RCM6 Note Payable at the time of the sale was $13.2 million. With the sale of our membership interest in RCM6, we recognized a gain on the sale of $2.1 million, which is included within the Other line item in the Consolidated Statements of Operations for the year ended December 31, 2016.
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Gain on settlement of note payable
During the first quarter of 2016, we entered into an agreement to settle the remaining amounts owed to the former owner of the DSI equipment assets that we acquired in 2014 (the "DSI Business Owner"), resulting in a gain of approximately $0.9 million, which is included in the Other line item in the Consolidated Statements of Operations for the year ended December 31, 2016.
Gain on settlement of licensed technology obligation
On June 15, 2016, we entered into an agreement with Highview to terminate a license agreement (the "Highview License") in exchange for a one-time payment by us of £0.2 million (approximately $0.2 million). According to the agreement, this payment will only be made upon the sale of our shares in Highview to satisfy the liability. As a result of terminating the Highview License, we eliminated the licensed technology asset, reduced the corresponding long-term liability to the amount of the one-time payment, and recognized a gain of approximately $0.2 million, which is included in the Other line item in the Consolidated Statements of Operations for the year ended December 31, 2016.
Gain on lease termination
On September 30, 2016, we and the lessee terminated a sale-type lease, and we recorded a lease termination fee of $3.6 million, which was in excess of the carrying value of the net investment in sales-type lease of $2.7 million. As a result of this lease termination, we recognized a gain of $0.9 million, which is included in the Other line item in the Consolidated Statements of Operations for the year ended December 31, 2016.
Income tax expense (benefit)
New Tax Legislation
On December 22, 2017 (the "Enactment Date"), the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the "Tax Act"). The Tax Act makes broad and complex changes to the U.S. tax code and key provisions applicable, or that may be applicable, to us or certain of Tinuum Group's existing or potential customers for 2018 include the following: (1) reduction of the U.S. federal corporate tax rate from 35 percent to 21 percent; (2) elimination of the corporate alternative minimum tax (AMT); (3) a new limitation on deductible interest expense; (4) limitations on the deductibility of certain executive compensation; (5) limitations on the use of foreign tax credits ("FTCs") to reduce the U.S. income tax liability; (6) limitations on net operating losses (“NOL’s”) generated after December 31, 2017 to 80 percent of taxable income; and (7) the introduction of the Base Erosion Anti-Abuse Tax (“BEAT”) for tax years beginning after December 31, 2017.
Concurrent with the enactment of the Tax Act, in December 2017, the SEC staff issued Staff Accounting Bulletin 118 ("SAB 118"), which provides guidance on accounting for the tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the Enactment Date for companies to complete the accounting under Accounting Standards Codification 740 - Income Taxes ("ASC 740"). In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Tax Act for which the accounting under ASC 740 is complete. To the extent that an entity's accounting for certain income tax effects of the Tax Act is incomplete but it is able to determine a reasonable estimate, it must record a provisional estimate in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Tax Act.
Our assessment and accounting for the income tax effects of the Tax Act affecting our consolidated financial statements is generally complete, subject to continued evaluation under SAB 118, and as such, we recorded an adjustment to our recorded deferred tax assets and deferred tax liabilities as of the Enactment Date from 35 percent to 21 percent. Accordingly, we have recorded a reduction of $5.8 million to our net deferred tax assets as of December 22, 2017 with a corresponding entry to deferred tax expense for the year ended December 31, 2017 for those temporary differences expected to reverse after the Enactment Date. This adjustment is reflected in our income tax expense for the year ended December 31, 2017 and was the primary factor that increased our effective income tax rate to 46% for 2017. We do not anticipate any other accounting impacts of the Tax Act during the period within one year from the Enactment Date, however, we will continue to assess any potential impact from the Tax Act through this period.
Beginning January 1, 2018, our effective income tax rate for 2018 and future years will be substantially lower as a result of the lowering of the U.S. federal corporate tax rate to 21%, however, this decrease in tax rate may also result in decreased utilization of deferred tax assets prior to their expiration.
For the year ended December 31, 2017, we recorded income tax expense of $24.2 million compared to an income tax benefit of $60.9 million for 2016. The federal income tax expense for the year ended December 31, 2017 includes $5.8 million associated with the reduction of our net deferred tax asset as of the Enactment Date of the Tax Act. Excluding the impact of the Tax Act,
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we would have recorded a tax benefit of approximately $14.0 million during the fourth quarter of 2017 due to a reduction in the valuation allowance recorded against our deferred tax assets. However, after the impact of the Tax Act, we recorded tax expense of $11.5 million. The income tax benefit for 2016 primarily reflects a $61.4 million reversal of the valuation allowance of our deferred tax assets. As of December 31, 2017 and 2016, we had a valuation allowance recorded of $75.4 million and $75.9 million, respectively, against our deferred tax assets.
Accounting for income taxes requires that companies assess whether a valuation allowance should be recorded against their deferred tax asset based on an assessment of the amount of the deferred tax asset that is “more likely than not” to be realized. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount that is more likely than not to be realized.
We assess the valuation allowance recorded against deferred tax assets at each reporting date. The determination of whether a valuation allowance for deferred tax assets is appropriate requires the evaluation of positive and negative evidence that can be objectively verified. Consideration must be given to all sources of taxable income available to realize the deferred tax asset, including, as applicable, the future reversal of existing temporary differences, future taxable income forecasts exclusive of the reversal of temporary differences and carryforwards, taxable income in carryback years and tax planning strategies. In estimating taxes, we assess the relative merits and risks of the appropriate tax treatment of transactions taking into account statutory, judicial, and regulatory guidance.
As of December 31, 2017, we concluded it is more likely than not we will generate sufficient taxable income within the applicable NOL and tax credit carry-forward periods to realize $38.7 million of our net deferred tax assets, and therefore, reversed $0.5 million of the valuation allowance. In reaching this conclusion, we most significantly considered: (1) forecasts of continued future taxable income, (2) changes to the current deferred tax asset ("DTA") balances related to the effects of the Tax Act, (3) changes to forecasts of future utilization of DTA's related to the effects of the Tax Act, and (4) impacts of additional RC invested facilities during 2017.
Prior to 2016, we had recorded a valuation allowance for all of our deferred tax assets, primarily due to our historical three-year cumulative loss position. However, as of December 31, 2016, we concluded it was more likely than not that we would generate sufficient taxable income within the applicable NOL and tax credit carry-forward periods to realize $61.4 of our net deferred tax assets, and therefore, reversed $61.4 million of the valuation allowance, after utilizing $11.0 million during 2016. This conclusion was reached after weighing all of the evidence and determining that the positive evidence outweighed the negative evidence. The positive evidence considered by management in arriving at its conclusion to partially reverse the valuation allowance includes factors such as: (1) emergence from the previous three-year cumulative loss position during the fourth quarter of 2016, (2) completion of four consecutive quarters of profitability and (3) forecasts of continued future profitability.
The ability to recognize the remaining deferred tax assets that continue to be subject to a valuation allowance is evaluated on a quarterly basis to determine if there are any significant events that would affect the ability to utilize those deferred tax assets.
Our estimate of future taxable income is based on internal projections which consider historical performance, multiple internal scenarios and assumptions, as well as external data that we believe is reasonable. If events are identified that affect our ability to utilize our deferred tax assets, or if additional deferred tax assets are generated, the analysis will be updated to determine if any adjustments to the valuation allowance are required. If actual results differ negatively from the current estimates of future taxable income, even if caused by adverse macro-economic conditions, the remaining valuation allowance may need to be increased. Such an increase could have a material adverse effect on our financial condition and results of operations. Conversely, better than expected results and continued positive results and trends could result in further releases to the deferred tax valuation allowance, and any such decreases could have a material positive effect on our financial condition and results of operations.
See additional discussion in Note 12 of the Consolidated Financial Statements included in Item 8 of this Report.
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Year ended December 31, 2016 Compared to Year ended December 31, 2015
Total Revenue and Cost of Revenue
A summary of the components of revenues and costs of revenue for the years ended December 31, 2016 and 2015 is as follows:
Years Ended December 31, | Change | ||||||||||||||
(in thousands except percentages) | 2016 | 2015 | ($) | (%) | |||||||||||
Revenues: | |||||||||||||||
Equipment sales | $ | 46,949 | $ | 60,099 | $ | (13,150 | ) | (22 | )% | ||||||
Chemicals | 3,025 | 888 | 2,137 | 241 | % | ||||||||||
Consulting services and other | 648 | 1,752 | (1,104 | ) | (63 | )% | |||||||||
Total revenues | 50,622 | 62,739 | (12,117 | ) | (19 | )% | |||||||||
Operating expenses: | |||||||||||||||
Equipment sales cost of revenue, exclusive of depreciation and amortization | 37,741 | 45,433 | (7,692 | ) | (17 | )% | |||||||||
Chemicals cost of revenue, exclusive of depreciation and amortization | 1,700 | 601 | 1,099 | 183 | % | ||||||||||
Consulting services and other cost of revenue, exclusive of depreciation and amortization | 376 | 1,518 | (1,142 | ) | (75 | )% | |||||||||
Equipment sales and Equipment sales cost of revenue
During the years ended December 31, 2016 and 2015, we entered into five and four long-term (six months or longer) fixed price contracts to supply ACI systems with aggregate contract values including change orders of $2.9 million and $5.5 million, respectively. During the years ended December 31, 2016 and 2015, we completed 17 and 32 ACI systems, recognizing revenues of $26.9 million and $51.7 million and cost of revenue of $20.5 million and $38.4 million, respectively. We recognized $0.5 million and $0.1 million in loss provisions related to ACI system contracts during the years ended December 31, 2016 and 2015, respectively.
During the years ended December 31, 2016 and 2015, we entered into zero and one long-term (6 months or longer) fixed price contracts to supply DSI systems and other material handling equipment with contract values including associated change orders of $1.5 million and $2.4 million, respectively. During the years ended December 31, 2016 and 2015, we completed 11 and seven DSI systems and zero and two other material handling equipment systems, recognizing revenues of $15.8 million and $7.2 million and cost of revenue of $14.8 million and $5.9 million, respectively. During the year ended December 31, 2016, we recognized a reduction of $0.1 million in previously recognized loss provisions included in cost of revenue related to DSI system contracts. During the year ended December 31, 2015, we recognized $0.2 million in loss provisions included in costs of revenue related to DSI systems contracts.
Additionally, in 2016, we executed sales-type lease agreements related to ACI and DSI systems and recognized revenue of $3.4 million and cost of revenue of $1.2 million during the year ended December 31, 2016
The remaining changes were due to other equipment projects.
Demand for ACI and DSI system contracts during 2016 and 2015 was driven by coal-fired electric generating units that needed to comply with MATS and MACT standards by 2016. Revenues related to ACI and DSI system contracts in these years fluctuated due to changes in the number of contracts entered into as well as the long duration of completing certain contracts, which involved long-lead time requirements for manufacturing, installation and testing of the equipment.
Chemicals and Chemicals cost of revenue
During the years ended December 31, 2016 and 2015, revenues increased year over year primarily due to an overall increase in pounds of our chemicals sold, most significantly driven by higher sales of our M-Prove consumable during the second half of 2016. The increase in revenue was largely due to our increased focus on selling these products to coal-fired power plants to be in compliance with applicable regulations.
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Consulting services and other and Consulting services cost of revenue
During the years ended December 31, 2016 and 2015, revenues decreased year over year due to a decrease in the number of consulting service engagements performed. The decrease in the number of consulting services engagements was due in part to us no longer performing consulting services engagements for one customer.
Additional information related to revenue concentrations and contributions by class and reportable segment can be found within the segment discussion below and in Note 13 to the Consolidated Financial Statements included in Item 8 of this Report.
Other Operating Expenses
A summary of the components of our operating expenses, exclusive of cost of revenue items (presented above), for the years ended December 31, 2016 and 2015 is as follows:
Years Ended December 31, | Change | ||||||||||||||
(in thousands, except percentages) | 2016 | 2015 | ($) | (%) | |||||||||||
Operating expenses: | |||||||||||||||
Payroll and benefits | $ | 12,390 | $ | 23,589 | $ | (11,199 | ) | (47 | )% | ||||||
Rent and occupancy | 2,168 | 3,309 | (1,141 | ) | (34 | )% | |||||||||
Legal and professional fees | 8,293 | 16,604 | (8,311 | ) | (50 | )% | |||||||||
General and administrative | 3,721 | 6,104 | (2,383 | ) | (39 | )% | |||||||||
Research and development, net | (648 | ) | 5,362 | (6,010 | ) | (112 | )% | ||||||||
Depreciation and amortization | 979 | 2,019 | (1,040 | ) | (52 | )% | |||||||||
Total operating expenses | $ | 26,903 | $ | 56,987 | $ | (30,084 | ) | (53 | )% | ||||||
Payroll and benefits
Payroll and benefits expenses decreased in 2016 compared to 2015 primarily due to a decrease in restructuring expenses in connection with the departure of certain executive officers and management's alignment of the business with strategic objectives. During the years ended December 31, 2016 and December 31, 2015, we recorded net restructuring charges of $1.6 million and $10.4 million, respectively, including the modification and acceleration of equity awards of $0.4 million and $3.4 million, respectively. Additionally, we had a decrease in headcount of approximately 70% during 2016 compared to 2015 in connection with employees impacted by management's alignment of the business with strategic objectives.
Rent and occupancy
Rent and occupancy expenses decreased in 2016 compared to 2015 primarily due to the shutdown of our office and fabrication facilities located in Pennsylvania in the fourth quarter of 2015. During the first quarter of 2016, we entered into an agreement to terminate various lease agreements covering approximately 207 thousand square feet of manufacturing, warehouse and office space in Pennsylvania. As consideration for terminating the leases, we agreed to pay the lessor a termination fee of $0.3 million in April 2016 and the same amount in April 2017. During the first quarter of 2016, we recorded a gain of $0.2 million related to the difference between the amount accrued as of the cease-use date of December 31, 2015 and the settlement amount. In December 2016, we entered into an agreement to terminate approximately 37 thousand square feet of office space and relocate our corporate office in Colorado. In exchange for terminating the lease, we agreed to pay the lessor a termination fee of $0.3 million. The amount was paid in full in December 2016.
Legal and professional fees
Legal and professional fees expenses decreased in 2016 compared to 2015 as a result of a reduction in the professional resources deployed to address the restatement of our consolidated financial statements, including litigation associated with such restatement. Expenses related to the restatement during the year ended December 31, 2016 and 2015 were $2.0 million and $9.5 million, respectively. In addition, legal and professional fees decreased as a result of a reduction in other consulting fees during 2016.
General and administrative
General and administrative expenses decreased in 2016 compared to 2015 due to a $0.5 million allowance recorded during 2015 against the entire principal balance of a note receivable. Additionally, during the year ended December 31, 2016, there was a decrease in expenses of $1.6 million due to the shutdown of our Pennsylvania office and fabrication facilities in the fourth quarter of 2015. Other decreases during the year ended December 31, 2016 were due to decreases in general operating expenses, including travel and professional expenses. These decreases were partially offset by impairment charges recognized
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during the year ended December 31, 2016 on property and equipment and inventory of $0.5 million, as projected future cash flows from operations related to such property and equipment and inventory did not support the carrying value of these assets.
Research and development, net
Research and development expense decreased in 2016 compared to 2015 primarily due to a decrease in research and development activities in 2016, as we concluded all material research and development activities except for continued product development necessary to our ongoing business. We also reduced research and development expense by $0.8 million during the year ended December 31, 2016 due to final billings made during this period to the DOE for one research and development contract, which resulted in negative expense during 2016. Additional decreases in research and development expense were due to expenses incurred during 2015 related to our investment in ADA Analytics of $2.6 million, of which $1.9 million related to an impairment charge we recognized in 2015.
Depreciation and amortization
Depreciation and amortization expense decreased in 2016 compared to 2015 by approximately $0.8 million due to the shutdown of our Pennsylvania office and fabrication facility in 2015 and by approximately $0.2 million due to the termination of the Highview License.
Other Income (Expense), net
A summary of the components of our other income (expense), net for the years ended December 31, 2016 and 2015 is as follows:
Years Ended December 31, | Change | ||||||||||||||
(in thousands, except percentages) | 2016 | 2015 | ($) | (%) | |||||||||||
Other income (expense): | |||||||||||||||
Earnings from equity method investments | $ | 45,584 | $ | 8,921 | $ | 36,663 | 411 | % | |||||||
Royalties, related party | 6,125 | 10,642 | (4,517 | ) | (42 | )% | |||||||||
Interest income | 268 | 24 | 244 | * | |||||||||||
Interest expense | (5,066 | ) | (8,402 | ) | 3,336 | (40 | )% | ||||||||
Litigation settlement and royalty indemnity expense, net | 3,464 | — | 3,464 | * | |||||||||||
Other | 2,463 | 494 | 1,969 | 399 | % | ||||||||||
Total other income | $ | 52,838 | $ | 11,679 | $ | 41,159 | 352 | % | |||||||
Earnings in equity method investments
The following table shows the equity method earnings, by investee, for the years ended December 31, 2016 and 2015:
Years Ended December 31, | Change | ||||||||||||||
(in thousands) | 2016 | 2015 | ($) | (%) | |||||||||||
Earnings from Tinuum Group | $ | 41,650 | $ | 8,651 | $ | 32,999 | 381 | % | |||||||
Earnings from Tinuum Services | 4,491 | 4,838 | (347 | ) | (7 | )% | |||||||||
Earnings (losses) from other | (557 | ) | (4,568 | ) | 4,011 | (88 | )% | ||||||||
Earnings from equity method investments | $ | 45,584 | $ | 8,921 | $ | 36,663 | 411 | % | |||||||
Earnings from equity method investments, and changes related thereto, were impacted by our equity method investees: Tinuum Group, Tinuum Services and RCM6 (through the date of the sale of our interest in RCM6 on March 3, 2016). Earnings from equity method investments increased during the year ended December 31, 2016 compared to 2015 primarily as a result of an increase in cash distributions, as Tinuum Group did not invest significant capital expenditures related to the installation of RC facilities or incur significant costs to operate retained RC facilities during 2016 as they had done during 2015. See discussion below regarding the accounting of earnings from Tinuum Group.
During the year ended December 31, 2016, we recognized $41.7 million in equity earnings from Tinuum Group compared to our proportionate share of Tinuum Group's net income of $35.0 million for the year. During the year ended December 31, 2015, we recognized $8.7 million in equity earnings from Tinuum Group compared to our proportionate share of Tinuum Group's net income of $35.3 million for the year. The difference between our pro-rata share of Tinuum Group's net income and our earnings recognized from our Tinuum Group equity method investment as reported on the Condensed Consolidated Statements of Operations relates to us receiving cumulative distributions in excess of the carrying value of the investment, and therefore
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recognizing such excess distributions as equity method earnings in the period the distributions occur, as discussed in more detail below.
The following table for Tinuum Group shows our investment balance, equity earnings, cash distributions received and cash distributions in excess of the investment balance for the years ended December 31, 2016 and 2015 (in thousands):
Description | Date(s) | Investment balance | ADES equity earnings (loss) | Cash distributions | Memorandum Account: Cash distributions and equity loss in (excess) of investment balance | |||||||||||||
Beginning balance | 12/31/2014 | $ | — | $ | — | $ | — | $ | (29,877 | ) | ||||||||
ADES proportionate share of net income from Tinuum Group (1) | 2015 activity | 35,265 | 35,265 | — | — | |||||||||||||
Recovery of cash distributions in excess of investment balance (prior to cash distributions) | 2015 activity | (29,877 | ) | (29,877 | ) | — | 29,877 | |||||||||||
Cash distributions from Tinuum Group | 2015 activity | (8,651 | ) | — | 8,651 | — | ||||||||||||
Adjustment for current year cash distributions in excess of investment balance | 2015 activity | 3,263 | 3,263 | — | (3,263 | ) | ||||||||||||
Total investment balance, equity earnings (loss) and cash distributions | 12/31/2015 | $ | — | $ | 8,651 | $ | 8,651 | $ | (3,263 | ) | ||||||||
ADES proportionate share of net income from Tinuum Group (1) | 2016 activity | 35,019 | 35,019 | — | — | |||||||||||||
Recovery of cash distributions in excess of investment balance (prior to cash distributions) | 2016 activity | (3,263 | ) | (3,263 | ) | — | 3,263 | |||||||||||
Cash distributions from Tinuum Group | 2016 activity | (41,650 | ) | — | 41,650 | — | ||||||||||||
Adjustment for current year cash distributions in excess of investment balance | 2016 activity | 9,894 | 9,894 | — | (9,894 | ) | ||||||||||||
Total investment balance, equity earnings (loss) and cash distributions | 12/31/2016 | $ | — | $ | 41,650 | $ | 41,650 | $ | (9,894 | ) | ||||||||
(1) The amounts of our 42.5% proportionate share of net income as shown in the table above differ from mathematical calculations of the Company’s 42.5% equity interest in Tinuum Group multiplied by the amounts of Net Income available to Class A members as shown in the table above of Tinuum Group results of operations due to adjustments related to the Class B preferred return and the elimination of Tinuum Group earnings attributable to RCM6, of which we owned 24.95%, for the period from January 1 to March 3, 2016 and for the year ended December 31, 2015.
Equity earnings from our interest in Tinuum Services decreased by $0.3 million in 2016 compared to 2015 primarily due to a decrease in the number of RC facilities being operated by Tinuum Services throughout the year. The weighted-average number of RC facilities for which Tinuum Services provided operating and maintenance services, based upon the number of months each facility was operated during the respective years, decreased year over year. As of December 31, 2016 and 2015, Tinuum Services provided operating and maintenance services to 13 and 14 RC facilities, respectively. Tinuum Services derives earnings from both fixed-fee arrangements as well as fees that are tied to actual RC production, depending upon the specific RC facility operating and maintenance agreement. The reduction in operating facilities during the year ended December 31, 2016 compared to the year ended December 31, 2015 was due to suspending operations on retained facilities to reduce operating expenses.
Equity losses from our interest in RCM6 decreased during the year ended December 31, 2016 compared to the year ended December 31, 2015 due to the sale of our 24.95% membership interest in RCM6 on March 3, 2016.
Tax credits
We earned the following tax credits that may be available for future benefit related to the production of RC from the operation of retained RC facilities:
Years Ended December 31, | ||||||||
(in thousands) | 2016 | 2015 | ||||||
Section 45 tax credits earned | $ | 2,956 | $ | 38,998 | ||||
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The decrease in production and sale of RC, and the related tax credits earned during the year ended December 31, 2016 compared to December 31, 2015 was due to the suspension of retained RC facilities, as described above.
Royalties, related party
Royalty income decreased in 2016 compared to 2015 primarily due to a decrease from 2015 to 2016 in the number of RC facilities and related tons of RC produced using the M-45 License, which resulted in 16.2 million and 22.0 tons produced during 2016 and 2015, respectively. The decrease in tonnage was primarily due to the suspension of retained operations at facilities during the fourth quarter of 2015 and the first quarter of 2016 to reduce operating expenses. The decrease in royalties we earned in 2016 was also the result of higher Tinuum Group operating expenses in 2016 due to higher payments made to secure the location for an RC facility in advance of securing a lease or a sale with a tax equity investor.
Interest expense
Interest expense decreased in 2016 compared to 2015 due to a decrease in 453A interest and the elimination of the RCM6 Note Payable. These decreases were $2.1 million and $2.2 million, respectively, for the year ended December 31, 2016 compared to 2015. These decreases were offset by an increase in interest expense in 2016 of $0.7 million related to the Credit Agreement, which was entered into during the fourth quarter of 2015 and was paid off as of June 30, 2016.
During the year ended December 31, 2016 compared to 2015, there was an increase in RC facilities from 12 to 13 in which Tinuum Group recognized installment sales for tax purposes and are therefore subject to 453A interest.
The following table shows the balance of the tax liability that has been deferred and the applicable interest rate to calculate section 453A interest:
As of December 31, | ||||||||
(in thousands) | 2016 | 2015 | ||||||
Tax liability deferred on installment sales (1) | $ | 71,559 | $ | 111,905 | ||||
Interest rate | 4.00 | % | 4.00 | % | ||||
(1) Represents the approximate tax effected liability utilizing the federal tax rate in effect for the applicable years ended related to the deferred gain on installment sales (approximately $204 million as of December 31, 2016).
Revision of estimated litigation settlement and royalty indemnity expense, net
During the fourth quarter of 2016, management revised its estimate for future Royalty Award payments based on an updated forecast provided to the Company by a former equity method investment for which we are required to pay additional damages related to certain future revenues generated from the former equity method investment. This forecast included a material reduction in estimated future revenues generated at the specific activated carbon plant from which the royalties are generated. Based primarily on the updated forecast, management recorded a $4.0 million reduction to its Royalty Award accrual as of December 31, 2016.
During the year ended December 31, 2016, we recorded an expense for the estimated payment of monetary penalties in connection with litigation in the amount of $0.5 million.
Other
Gain on sale of equity method investment
On March 3, 2016, we sold our 24.95% membership interest in RCM6 for a cash payment of $1.8 million and the assumption, by the buyer, of the RCM6 Note Payable. The outstanding balance on the RCM6 Note Payable at the time of the sale was $13.2 million. With the sale of our membership interest in RCM6, we recognized a gain on the sale of $2.1 million, which is included within the Other line item in the Consolidated Statements of Operations for the year ended December 31, 2016.
Gain on settlement of note payable
In February 2016, we entered into an agreement with the DSI Business Owner to settle the remaining amounts owed (the "DSI Business Owner Note Payable") of approximately $1.1 million for a one-time payment of $0.3 million. The one-time payment was made during the first quarter of 2016, and we recognized a gain of approximately $0.9 million, which is included in the Other line item in the Consolidated Statements of Operations for the year ended December 31, 2016.
Gain on settlement of licensed technology obligation
On June 15, 2016, we entered into an agreement with Highview to terminate the Highview License in exchange for a one-time payment by us of £0.2 million (approximately $0.2 million). According to the agreement, this amount is only payable upon the
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sale of our shares in Highview to satisfy the liability. As a result of terminating this license agreement, we eliminated the licensed technology asset, reduced the corresponding long-term liability to the amount of the one-time payment, and recognized a gain of approximately $0.2 million, which is included in the Other line item in the Consolidated Statements of Operations for the year ended December 31, 2016.
Impairment of cost method investment
As of December 31, 2016, we estimated the fair value of the Highview Investment based upon an anticipated equity raise by Highview at a price of £2.00 per share, which was less than our cost per share of £4.25. As a result, we recorded an impairment charge of $1.8 million, which is included in the Other line item in the Consolidated Statements of Operations for the year ended December 31, 2016.
Gain on lease termination
In 2016, we and the lessee terminated a sale-type lease, and we recorded a lease termination fee of $3.6 million, which was in excess of the carrying value of the net investment in sales-type lease of $2.7 million. As a result of this lease termination, we recognized a gain of $0.9 million, which is included in the Other line item in the Consolidated Statements of Operations for the year ended December 31, 2016.
Income tax expense (benefit)
As of December 31, 2016 and 2015, we had a valuation allowance recorded of $75.9 million and $148.3 million, respectively, against our deferred tax assets. During 2016, we recorded an income tax benefit of $60.9 million compared to income tax expense of zero for 2015. The income tax benefit for 2016 primarily reflects a $61.4 million reversal of the valuation allowance of our deferred tax assets. Historically, we had recorded a valuation allowance for all of our deferred tax assets primarily due to a historical three-year cumulative loss position. However, as of December 31, 2016, we concluded that it was more likely than we will generate sufficient taxable income within the applicable NOL and tax credit carry-forward periods to realize $61.4 million of our net deferred tax assets and, therefore, reversed the valuation allowance by this amount. This conclusion was reached after weighing all of the evidence and determining that the positive evidence outweighed the negative evidence. The positive evidence considered by management in arriving at its conclusion to partially reverse the valuation allowance included factors such as the emergence from the previous three-year cumulative loss position during the fourth quarter of 2016, achievement of four consecutive quarters of profitability and forecasts of continued future profitability under several potential scenarios derived from currently contracted business within the RC segment. We believed these factors supported the partial utilization of deferred tax assets attributable to temporary differences that do not expire and NOL's and tax credits prior to their expiration between 2031 through 2036.
Business Segments
As of December 31, 2017, we have two reportable segments: (1) RC; and (2) EC.
The business segment measurements provided to and evaluated by our chief operating decision maker ("CODM") are computed in accordance with the principles listed below:
• | The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies except as described below. |
• | Segment revenues include equity method earnings and losses from our equity method investments. Segment revenue also includes royalty earnings from Tinuum Group and income related to sales-type leases. |
• | Segment operating income (loss) includes segment revenues, gains related to sales of equity method investments and allocation of certain "Corporate general and administrative expenses," which include Payroll and benefits, Rent and occupancy, Legal and professional fees, and General and administrative. |
• | RC segment operating income includes interest expense directly attributable to the RC segment. |
The principal products and services of our segments are:
1. | RC - Our RC segment derives its earnings from equity method investments as well as royalty payment streams and other revenues related to enhanced combustion of and reduced emissions of both NOX and mercury from the burning of RC. Our equity method investments related to the RC segment include Tinuum Group, Tinuum Services as well as other immaterial equity method investments. Segment revenues include equity method earnings (losses) from our equity method investments and royalty earnings from Tinuum Group. These earnings are included within the Earnings from equity method investments and Royalties, related party line items in the Consolidated Statements of Operations included in Item 8 of this Report. Key drivers to RC segment performance are operating and retained produced and |
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sold RC, royalty-bearing tonnage, and the number of operating (leased or sold) and retained RC facilities. These key drivers impact our earnings and cash distributions from equity method investments.
2. | EC - Our EC segment includes revenues and related expenses from the sale of ACI and DSI equipment systems, chemical sales, consulting services and other sales related to the reduction of emissions in the coal-fired power generation and industrial boiler industries. These amounts are included within the respective revenue and cost of revenue line items in the Consolidated Statements of Operations included in Item 8 of this Report. |
Management uses segment operating income (loss) to measure profitability and performance at the segment level. Management believes segment operating income (loss) provides investors with a useful measure of our operating performance and underlying trends of the businesses. Segment operating income (loss) may not be indicative of our overall consolidated performance and therefore, should be read in conjunction with our Consolidated Results of Operations.
The following table presents our operating segment results for the years ended December 31, 2017, 2016 and 2015:
Years Ended December 31, | Change | |||||||||||||||||||
(in thousands) | 2017 | 2016 | 2015 | ($) | ($) | |||||||||||||||
Revenues: | ||||||||||||||||||||
Refined Coal: | ||||||||||||||||||||
Earnings in equity method investments | $ | 53,843 | $ | 45,584 | $ | 8,921 | $ | 8,259 | $ | 36,663 | ||||||||||
Consulting services | — | — | 55 | — | (55 | ) | ||||||||||||||
Royalties, related party | 9,672 | 6,125 | 10,642 | 3,547 | (4,517 | ) | ||||||||||||||
63,515 | 51,709 | 19,618 | 11,806 | 32,091 | ||||||||||||||||
Emissions Control: | ||||||||||||||||||||
Equipment sales | 31,401 | 46,949 | 60,099 | (15,548 | ) | (13,150 | ) | |||||||||||||
Chemicals | 4,246 | 3,025 | 888 | 1,221 | 2,137 | |||||||||||||||
Consulting services | 45 | 648 | 1,697 | (603 | ) | (1,049 | ) | |||||||||||||
35,692 | 50,622 | 62,684 | (14,930 | ) | (12,062 | ) | ||||||||||||||
Total segment reporting revenues | $ | 99,207 | $ | 102,331 | $ | 82,302 | $ | (3,124 | ) | $ | 20,029 | |||||||||
Adjustments to reconcile to reported revenues: | ||||||||||||||||||||
Refined Coal: | ||||||||||||||||||||
Earnings in equity method investments | $ | (53,843 | ) | $ | (45,584 | ) | $ | (8,921 | ) | (8,259 | ) | (36,663 | ) | |||||||
Royalties, related party | (9,672 | ) | (6,125 | ) | (10,642 | ) | (3,547 | ) | 4,517 | |||||||||||
(63,515 | ) | (51,709 | ) | (19,563 | ) | (11,806 | ) | (32,146 | ) | |||||||||||
Total reported revenues | 35,692 | 50,622 | 62,739 | (14,930 | ) | (12,117 | ) | |||||||||||||
Segment operating income (loss) | ||||||||||||||||||||
Refined Coal (1) | $ | 59,908 | $ | 51,264 | $ | 12,131 | $ | 8,644 | $ | 39,133 | ||||||||||
Emissions Control (2) | 379 | 7,334 | (7,583 | ) | (6,955 | ) | 14,917 | |||||||||||||
Total segment operating income | $ | 60,287 | $ | 58,598 | $ | 4,548 | $ | 1,689 | $ | 54,050 | ||||||||||
(1) Included within the RC segment operating income for the year ended December 31, 2016 is a $2.1 million gain on the sale of RCM6 and for the years ended December 31, 2017, 2016 and 2015 453A interest expense of $2.6 million, $2.5 million and $4.6 million, respectively, and interest expense related to the RCM6 Note Payable of zero, $0.3 million, and $2.5 million, respectively.
(2) Included within the EC segment operating income for the year ended December 31, 2016 is a $0.9 million gain related to a termination of a sales-type lease.
A reconciliation of segment operating income to consolidated net income (loss) is included in Note 13 of the Consolidated Financial Statements included in Item 8 of this Report.
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RC
The following table details the segment revenues of our respective equity method investments for the years ended December 31, 2017, 2016 and 2015:
Year ended December 31, | ||||||||||||
(in thousands) | 2017 | 2016 | 2015 | |||||||||
Earnings from Tinuum Group | $ | 48,875 | $ | 41,650 | $ | 8,651 | ||||||
Earnings from Tinuum Services | 4,963 | 4,491 | 4,838 | |||||||||
Earnings (losses) from other | 5 | (557 | ) | (4,568 | ) | |||||||
Earnings from equity method investments | $ | 53,843 | $ | 45,584 | $ | 8,921 | ||||||
RC earnings increased primarily due to increased equity earnings from Tinuum Group during the year ended December 31, 2017 compared to the year ended December 31, 2016, as presented above. Our equity earnings increased primarily due to an increase in cash distributions from Tinuum Group due to the addition of four invested facilities, three of which were fully invested by third parties, as discussed in the consolidated results above. For the year ended December 31, 2017, Tinuum Group's consolidated earnings increased $26.6 million from the comparable December 31, 2016 period due to an increase in lease revenues driven by significant sales of facilities to third-party investors.
As discussed above and in Note 2 of the Consolidated Financial Statements included in Item 8 of this Report, our earnings in Tinuum Group may not equal our pro-rata share due to the accounting related to our equity method investment. As such, our earnings in Tinuum Group increased by $7.2 million during the year ended December 31, 2017 compared to the year ended December 31, 2016 in part due to $48.9 million of cash distributions received that were in excess of our pro-rata share of cumulative earnings in Tinuum Group.
RC operating income in 2017 was also positively impacted for the following:
• | The sale of RCM6 in 2016, which had incurred losses from inception; |
• | An increase in earnings from Tinuum Services, which was primarily due to an increase in the number of RC facilities operated by Tinuum Services during 2017; |
• | An increase in M-45 royalties earned as a result of increased tonnage; and |
• | A decrease in 453A interest expense as a result of the declining deferred tax liability. |
EC
Discussion of revenues derived from our EC segment and costs related thereto are included within our consolidated results in Item 8 of this Report.
EC segment operating income decreased during the year ended December 31, 2017 compared to 2016 primarily due to the decrease in revenues year over year, as discussed within the consolidated results. The decrease in EC segment operating income was offset by decreases in segment operating expenses. Specifically, Payroll and benefits decreased year over year by $1.2 million, primarily due to a decrease in severance expense of $1.0 million. Additional decreases in segment operating expenses were primarily due to a decrease in impairment charges of $1.3 million related to the Highview investment. Offsetting the net decrease in segment operating expenses was the $0.9 million gain on settlement recognized in 2016 of the DSI Business Owner Note Payable as well as a $0.4 million reserve recorded in 2017 on an asset related to a letter of credit asset draw made by a former customer that we are contesting and pursing legal actions.
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Liquidity and Capital Resources
Overview of Factors Affecting Our Liquidity
During 2017, our liquidity position was positively affected primarily due to distributions from Tinuum Group and Tinuum Services and borrowing availability under our bank ("Lender") line of credit (the "Line of Credit"). As a result, our working capital position as of December 31, 2017 improved by $14.8 million compared to December 31, 2016.
Our principal sources of liquidity currently include:
• | cash on hand; |
• | distributions from Tinuum Group and Tinuum Services; |
• | royalty payments from Tinuum Group; and |
• | the Line of Credit. |
Our principal uses of liquidity during the year ended December 31, 2017 included:
• | payment of dividends; |
• | repurchases of shares of common stock pursuant to a modified Dutch Auction tender offer ("Tender Offer"); |
• | repurchases of shares of common stock pursuant to a stock repurchase program by which the Company may repurchase up to $10.0 million of the Company's outstanding common stock, from time to time; |
• | our business operating expenses, including federal and state tax payments; |
• | delivering on our existing contracts and customer commitments; and |
• | repayments on the Line of Credit. |
The following table summarizes the cash distributions from our equity method investments, which most significantly impact our consolidated cash flow results, for the years ended December 31, 2017, 2016 and 2015:
Year ended December 31, | ||||||||||||
(in thousands) | 2017 | 2016 | 2015 | |||||||||
Tinuum Group | $ | 48,875 | $ | 41,650 | $ | 8,651 | ||||||
Tinuum Services | 4,638 | 4,500 | 5,019 | |||||||||
Other | — | — | — | |||||||||
Distributions from equity method investees | $ | 53,513 | $ | 46,150 | $ | 13,670 | ||||||
On May 5, 2017, our Board authorized the commencement of the Tender Offer to purchase for cash up to 925,000 shares of our common stock at a price per share of not less than $9.40 nor greater than $10.80, for a maximum aggregate purchase price of $10.0 million, with an option to purchase an additional 2% of the outstanding shares of common stock if the Tender Offer was oversubscribed. The Tender Offer expired on June 6, 2017 and a total of 2,858,425 shares were validly tendered and not properly withdrawn at or below the final purchase price of $9.40 per share.
Because the Tender Offer was oversubscribed, we purchased a prorated portion of the shares properly tendered by each tendering stockholder (other than "odd lot" holders whose shares were purchased on a priority basis) at the final per share purchase price. Accordingly, we acquired 1,370,891 shares of our common stock ("Tendered Shares") at a price of $9.40 per share, for a total cost of approximately $12.9 million, excluding fees and other expenses related to the Tender Offer. The Tendered Shares represented approximately 6.2% of our outstanding shares of our common stock prior to the Tender Offer. The Tendered Shares include the 925,000 shares we initially offered to purchase and 445,891 additional shares that we elected to purchase pursuant to our right to purchase up to an additional 2% of our outstanding shares of common stock.
During December 2017, our Board authorized the repurchase of up to $10.0 million of outstanding common stock in open market transactions. As of December 31, 2017, we had purchased 342,875 shares of common stock for cash payments of $3.4 million, inclusive of commissions and fees.
Our Board declared quarterly cash dividends of $0.25 per share on the outstanding shares of our common stock on each of June 14, 2017, August 7, 2017, and November 6, 2017, payable to stockholders of record as of the close of business on June 28, 2017, August 21, 2017, and November 17, 2017, respectively. The payments of $5.2 million, $5.3 million and $5.2 million were subsequently made in July, September, and December 2017, respectively. The total amount of dividends paid by the Company during the twelve months ended December 31, 2017 was $15.7 million. Dividends in the amount of $0.1 million
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have been accrued and represent dividends accumulated on nonvested shares of our common stock held by our employees and directors that contain dividend rights that are forfeitable and not payable until the underlying shares vest.
During the third quarter of 2017, we amended the Line of Credit ("Eleventh Amendment") with the Lender. The Eleventh Amendment decreased the Line of Credit to $10.0 million due to decreased collateral requirements for the Company's outstanding letters of credit ("LC's"), extended the maturity date of the Line of Credit to September 30, 2018, and permitted the Line of Credit to be used as collateral (in place of restricted cash) for LC's up to $8.0 million related to equipment projects, the remaining estimated payments due under the Royalty Award and certain other agreements. Additionally, under the Eleventh Amendment there is no minimum balance requirement based on the Company meeting certain conditions and maintaining minimum trailing twelve-month EBITDA (earnings before interest, taxes, depreciation and amortization as defined in the Eleventh Amendment) of $24.0 million.
As of December 31, 2017, there were no outstanding borrowings under the Line of Credit, however, LC's in the aggregate amount of $3.5 million related to obligations due under the Royalty Award ("Royalty Award LC's") were secured under the Line of Credit, resulting in borrowing availability of $6.5 million. On December 29, 2017, pursuant to the execution of the Indemnity Termination Agreement on December 29, 2017, we settled all remaining obligations due under the Royalty Award in exchange for the Settlement Payment of $3.3 million resulting in remaining LC availability of $4.5 million. Pursuant to the Indemnity Settlement Agreement, the LC’s were terminated in January 2018.
As of December 31, 2016, we had Royalty Award LC's totaling $7.2 million outstanding that were collateralized by restricted cash.
During March 2017, a customer drew on an LC related to an equipment system in the amount of $0.8 million, which was funded by borrowing availability under the Line of Credit. We subsequently repaid this amount to the Lender during the three months ended March 31, 2017. We are contesting the draw on this LC and are pursuing actions to recover this amount from the customer.
Our ability to continue to generate sufficient cash flow required to meet ongoing operational needs and obligations, as well as future expected dividend payments and potential future share repurchases, depends upon several factors, including executing on our contracts and initiatives, receiving royalty payments from Tinuum Group and distributions from Tinuum Group and Tinuum Services, and increasing our share of the market for EC products, and, in particular EC chemicals sales. Increased distributions from Tinuum Group will likely be dependent upon both preserving existing contractual relationships and the securing of additional tax equity investors for those Tinuum Group facilities that are currently not operating.
Sources and Uses of Cash
Year ended December 31, 2017 Compared to Year ended December 31, 2016
Cash, cash equivalents and restricted cash increased from $26.9 million as of December 31, 2016 to $30.7 million as of December 31, 2017, an increase of $3.7 million. The following table summarizes our cash flows for the years ended December 31, 2017 and 2016, respectively.
Years Ended December 31, | ||||||||||||
(in thousands) | 2017 | 2016 | Change | |||||||||
Cash provided by (used in): | ||||||||||||
Operating activities | $ | (11,748 | ) | $ | (18,257 | ) | $ | 6,509 | ||||
Investing activities | 48,386 | 39,899 | 8,487 | |||||||||
Financing activities | (32,889 | ) | (15,671 | ) | (17,218 | ) | ||||||
Net change in Cash and Cash Equivalents and Restricted Cash | $ | 3,749 | $ | 5,971 | $ | (2,222 | ) | |||||
Cash flows from operating activities
Cash flows from operating activities for the year ended December 31, 2017 increased by $6.5 million compared to the year ended December 31, 2016 and were positively impacted primarily by the following: (1) a decrease in deferred tax benefit of $60.9 million, which was recorded in 2016 as a result of the release of a portion of our valuation allowance on our deferred tax assets; (2) a decrease in deferred tax assets during 2017 of $23.2 million as a result of utilization in 2017 as we generated taxable income; (3) net changes in working capital and other liabilities of $10.6 million, primarily due to significant reductions to Accounts payable, Accrued payroll, Other current liabilities and Other long-term liabilities that occurred in 2016 as a result of the Company becoming current on, or settling, significant amounts related to these liabilities. Offsetting these increases to operating cash flows were primarily the following: (1) a decrease in net income of $69.8 million, which was primarily due to
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the deferred tax benefit recorded in 2016; (2) an increase in earnings from equity method investees of $8.3 million; (3) a net decrease in the Royalty Award of $7.6 million in 2017 as a result of the final payments and settlement of all remaining royalties due; and (4) a decrease in cash distributions from equity method investees, return on investment of $3.3 million, primarily from a decrease in cash distributions received from Tinuum Group, as all of its cash distributions for 2017 were reported as distributions in excess of cumulative earnings within Investing cash flows.
Cash flows from investing activities
Distributions from equity method investees
Our cash flows from investing activities are significantly impacted by cash distributions from equity method investees that represent a return in excess of cumulative earnings, which increased from $38.3 million in 2016 to $48.9 million