Summary of ADA-ES INC - Yahoo! Finance

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

This Report contains forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934 that involve risks and uncertainties. Words or phrases such as "anticipate," "assume," "believe," "hope," "expect," "intend," "plan," 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 impact of the withdrawal of the appeal of the CAMR ruling, whether MACT-based mercury regulations (or any mercury regulations at all) will be promulgated and the timelines for effectiveness of such regulations on the nation's 1,100-plus coal-fired units;

(b) expected growth in the MEC market;

(d) the appropriation of funds by Congress for DOE projects and for CO2 technology;

(e) whether Clean Coal will succeed in obtaining approval for Section 45 Tax Credits;

(f) the timing of awarding of contracts and their value;

(g) the expected costs, funding of and timing for the commencement of operations at the AC Facility and the processing and logistics facility;

(h) possible changes in ADA's ownership of Carbon Solutions;

(i) Carbon Solutions' ability to enter into suitable long-term contracts or otherwise provide for the raw feedstock material necessary to supply the AC Facility;

(j) Carbon Solutions' ability to enter into suitable long-term contracts for the delivery of AC from the AC Facility and its ability to timely deliver the AC required by such contracts;

(k) Carbon Solutions' ability to meet a significant portion of the expected shortage in AC supply in 2009 and the first half of 2010 from interim sources and in the longer term from the AC Facility;

(l) Carbon Solutions' ability to obtain the desired long-term debt financing for the AC Facility;

(m) expected changes in revenues, margins, expenses and other financial measures and the timing of such changes;

(n) impact of litigation; the sufficiency of our working capital available to the non-AC Supply Business to continue pursuit of the MEC market; and

(o) the materiality of any future adjustments to previously received revenue as a result of DOE audits.

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: changes in the costs and timing of construction of the AC Facility; failure to raise additional equity financing; failure to satisfy funding or other conditions in our equity financing agreements; inability to sign or close acceptable debt financing, coal supply and/or off-take agreements with respect to the AC Facility in a timely manner; availability of raw materials and equipment; the government's failure

to enact regulations or appropriate funds that benefit our business; changes in laws and regulations, prices, economic conditions and market demand; impact of competition and litigation; availability, cost of and demand for alternative energy sources and other technologies; operational difficulties; loss of key personnel; availability of skilled personnel; failure to satisfy performance guaranties; results of demonstrations of our technologies, as well as other factors relating to our business, as described in our filings with the U.S. Securities and Exchange Commission, with particular emphasis on the risk factor disclosures contained in those filings and in Item 1A of our annual report on Form 10-K. You are cautioned not to place undue reliance on the forward-looking statements made in this release, 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.

Overview

We develop and implement proprietary environmental technology and provide specialty chemicals to the coal-burning electric utility industry. Revenues are generated through (1) the supply of powdered activated carbon injection ("ACI") systems, and related services for the growing mercury emission control ("MEC") market, including projects that are co-funded by government (Department of Energy - "DOE") and industry and (2) the sale of specialty chemicals and services for flue gas conditioning ("FGC") and other applications. We have also begun research and development efforts in CO2 capture and control from coal-fired boilers, and we recently signed and commenced work on our first significant contract for this work which is scheduled to continue over at least the next two years. In addition, through the Carbon Solutions joint venture with Energy Capital Partners I, LP and its affiliated funds ("ECP") we are constructing a "Greenfield" activated carbon ("AC") manufacturing facility in Coushatta, Red River Parish, Louisiana (the "AC Facility") for mercury control applications and are developing interim sources of AC to supply to utility customers until such time as the AC Facility is operational. We are also developing and marketing our refined coal technology through our Clean Coal joint venture with NexGen Refined Coal, LLC ("NexGen"), an affiliate of NexGen Resources Corporation.

Mercury has been identified as a toxic substance and, pursuant to a court order, the EPA issued regulations for its control in March 2005. A dozen states and several environmental groups had previously sued the EPA alleging that the process that resulted in the relatively lenient Clean Air Mercury Rule ("CAMR") violated the Clean Air Act and that CAMR was therefore invalid. In February 2008, the United States Court of Appeals for the District of Columbia Circuit ruled in favor of the plaintiffs in that case, holding that the EPA violated the Clean Air Act in the process it used to enact CAMR, and that CAMR was therefore invalid. The Court's ruling remanded the matter to the EPA for further proceedings; and the EPA filed an appeal of the ruling with the Court. In May 2008, the District of Columbia Circuit Court rejected the EPA's petition for an en banc rehearing on CAMR. In February 2009, EPA withdrew its appeal of the CAMR ruling, clearing the way to promulgate mercury standards under Section 112 of the Clean Air Act, which governs hazardous air pollutants from stationary sources, but has yet to set any defined timeline for such actions. In the interim, the lack of clear regulations has generated some short-term uncertainty among utilities as to what they will be required to do to reduce mercury emissions and is impacting their ability to include mercury control costs in their rate bases. However, we believe that the likely result will be that either the EPA will finalize a maximum achievable control technology ("MACT")-based mercury regulation and/or Congress will enact new legislation requiring stricter mercury emission control within the next year or two with implementation deadlines over the subsequent two to three years.

While federal regulation remains uncertain, the market remains strong in 16 states that have passed their own mercury control regulations for new power plants and several Canadian provinces. We believe that further substantial long-term growth of the MEC market for the electric utility industry will most likely depend on how industry chooses to respond to federal and state regulations. We anticipate this will create an even larger market for our mercury control products beyond 2010. As many as 1,100 existing coal-fired boilers may be affected by such regulations, if and when they are fully implemented. DOE's latest report issued in 2009 includes 87 existing and planned plant projects totaling 51 GW of capacity. Permitting of new coal-fired plants generally requires them to meet more stringent requirements that likely include MEC. For the near-term, our revenues from this market will be dependent on
(i) equipment sales of ACI systems, (ii) mercury testing and consulting services, and (iii) AC sales to new and existing plants affected by the implementation of enacted regulations. State regulations and increasing numbers of consent decrees, which were unaffected by the invalidation of CAMR, are the largest market driver for this part of our business. Although we expect this market to show steady growth over the next several years, we believe the most significant revenue growth will occur when final federal regulations or legislation impacts a significant portion of previously uncontrolled, existing boilers.

Thus far in 2009, we have signed contracts for six activated carbon injection ("ACI") systems to be delivered in 2009 and 2010, bringing the total number of ACI systems that we have installed to date or are in process of installing as of April 2009 to 42. Various consent decrees and state regulations are driving the current market in this growing portion of our business. We believe the eventual outcome of the invalidation of CAMR will accelerate and further expand the market for our MEC products and services. Because many of our current and potential customers would be affected by new federal regulations replacing CAMR, we are seeing some delays in the decision-making process on mercury control as a result of the invalidation of CAMR, which has postponed the award of some near-term projects as utilities revise their long-term plans for compliance. Revenue from ACI system contracts totaled $2.9 million for the quarter ended March 31, 2009. We had contracts in progress at quarter-end for supply of ACI systems totaling approximately $6.0 million.

We expect funding for mercury control evaluation and testing projects directly from utilities to increase as they strive to meet state and local regulations. In addition, we anticipate that DOE may fund other projects related to our business, including projects aimed at CO2 control. Revenue from DOE and industry demonstration contracts totaled $950,000 for the quarter ended March 31, 2009. We anticipate that DOE programs will continue to represent an important segment but a smaller overall percentage of revenues as other revenues increase over the next few years as we focus more on market growth for ACI systems for mercury emission control and the sale of AC to utility customers.

We are obligated to fund half of the operating costs of our 50% Clean Coal joint venture with NexGen. We expect our portion of these costs to average approximately $16,000 per month or approximately $193,000 total in 2009, which amount may increase if demonstrations currently in discussion move ahead. Our net operating loss for the quarter ended March 31, 2009 includes net costs of $59,000 related to our refined coal efforts and $23,000 from Clean Coal. The ability of Clean Coal to sell its planned refined coal product and qualify for the expected Section 45 Tax Credits depends on several conditions, including meeting the emission control requirements, finalizing necessary contractual agreements, and completing and making such facilities operational prior to January 1, 2010. In the Emergency Economic Stabilization Act of 2008, Congress included language on Section 45 which extended the qualification window for the Tax Credits to January 1, 2010 and eliminated the increased market value test for refined coal. We expect this legislation to positively impact Clean Coal's efforts to obtain approval for the Section 45 Tax Credits. If Clean Coal succeeds in obtaining approval for the Section 45 Tax Credits, NexGen has the right to maintain its 50% interest by paying us $4.0 million, in eight quarterly payments of $500,000 each, beginning in the quarter Clean Coal receives such qualification. NexGen is not obligated to make those payments, but if it does not do so once Clean Coal has qualified for the Section 45 Tax Credits, it will forfeit a part of its interest in Clean Coal in direct proportion to the amount of the $4.0 million that it elects not to pay, if any.

Carbon Solutions is continuing the process of specifying and sourcing key capital equipment, negotiating agreements to support facility operations, including feedstock supply, and negotiating long-term customer off-take contracts for the AC Supply Business. Many of the state mercury regulations already in place begin in 2010 and as such there are several utilities and independent power producers engaged in an AC procurement process this year. Given the current tight AC supply/demand situation in the U.S., we expect to be able to sell the majority of our AC output under three-to-five year contracts to owners of coal-fired power plants for the purpose of mercury emission mitigation. Carbon Solutions is currently bidding on many requests for proposal for AC with a contract value on the order of $500 million. We expect these potential customers will need AC supply beginning in 2009.

In order to supply early and interim quantities of AC to the utility mercury control market, we acquired from Winfield Industries, Inc. ("Winfield") the assets of an AC processing facility and entered into a take or pay Carbon Supply Agreement with Winfield to purchase AC beginning in 2008, with options to increase quantities during 2009 with additional amounts available for 2010. The AC processing facility and Carbon Supply Agreement were assigned to Crowfoot Supply in October 2008. From this facility, we produced our first batch of treated AC and performed a full scale power plant test that achieved greater than 90% mercury removal. A number of additional tests are under way and others are scheduled to allow clients to evaluate this product. Red River is currently selling AC on a continuous basis from this facility to meet delivery obligations under existing off-take agreements and expects to offer such supply to potential long-term customers who may become parties to off-take contracts for AC to be supplied from the AC Facility. Given the expected costs of the foreign carbons to be used for processing plus the transportation expenses in shipping AC from overseas, our AC Supply Business is expected to operate at significantly lower margins than the anticipated margins for the AC Facility. Crowfoot Supply is also developing a larger offsite processing and logistics facility that is expected to commence operations in the second quarter of 2009 and later operate in conjunction with the AC Facility. Crowfoot Supply is currently procuring additional AC processing equipment to enable it to expand capacity to over 30 million pounds of AC per year.

"All-in" capital costs for the AC Facility are anticipated to be approximately $363 million. Carbon Solutions' target is to secure approximately 60% of the financing for the AC Facility through debt financing. In order to support such financing, Carbon Solutions is working to obtain long-term take or pay off-take contracts for the AC that it is supplying from interim sources and expects to supply from the AC Facility. Red River, a subsidiary of Carbon Solutions, has already signed AC sales contracts that, subject to certain conditions, could contribute up to $160 million in revenues through 2016. In addition to the debt financing, Carbon Solutions is planning to fund the remaining 40% of the expected costs for the AC Facility through equity. Under the terms of the Limited Liability Agreement (the "LLC Agreement") of Carbon Solutions, ECP and ADA have funded the first two tranches of equity contributions to Carbon Solutions, with ADA having contributed $25.6 million in cash and other property and ECP having contributed cash of $25.6 million through March 31, 2009. ECP has committed to contribute the third tranche of capital up to 200% of the expected net proceeds of our sale of Series A and B Convertible Preferred Stock (the "Private Placement") to ECP under the Securities Purchase Agreement dated as of October 1, 2008, as amended ("SPA"), in exchange for non-voting preferred equity in Carbon Solutions, until the time that the Private Placement is completed. During the quarter ended March 31, 2009, ECP made preferred equity contributions of capital totaling $26.4 million. One-half of such preferred equity bears a preferred return of 12% per annum, and the other half does not bear a preferred return. If we consummate the sale of our Preferred Stock to ECP under the SPA, we will invest the net proceeds, expected to be $18.8 million, in Carbon Solutions for the AC Facility, and an equal amount of ECP's outstanding preferred equity bearing a 12% preferred return, plus the applicable 12% preferred return, would be redeemed and a matching amount of ECP's preferred equity that does not bear a preferred return would be converted into ordinary capital contributions. ADA does not have any further capital commitments to Carbon Solutions, and we expect that all future funding for the AC Facility will come from ECP and third-party debt financing.

The market for our FGC chemicals and services has been declining over the last couple of years, and this is not expected to change until the uncertainty caused by the CAMR ruling has been eliminated. We are responding to inquiries about our product meeting the needs of the changing regulations in combination for mercury control. With a defined mercury rule or legislation, there will be opportunities to combine FGC with AC, as FGC can enhance the performance of AC in specific applications. Margins on these products are typically higher than what we recognize for our present MEC sales and represent an important, but decreasing, contribution to our overall revenue and profit potential.

Results of Operations - 1st Quarter 2009 versus 1st Quarter 2008

Revenues totaled $4.9 million for 2009 versus $4.0 million in 2008, representing an increase of 22%. Revenues in our MEC segment for 2009 increased by $890,000 (23%), and revenues from FGC and other activities decreased by $26,000 (25%).

Revenues in 2009 from the MEC segment were comprised of sales of ACI systems (60%), government and industry-supported contracts (20%), consulting services (12%), and activated carbon sales (8%) compared to 62%, 37%, 2% and 0%, respectively, in 2008. For the quarter, our ACI systems sales contributed approximately $2.9 million to MEC revenues, increasing19% from the 2008 contribution to revenue of $2.4 million. We had contracts in progress at quarter-end for supply of ACI systems with remaining revenue of approximately $6.0 million, $4.4 million of which we expect to complete and realize in the last three quarters of 2009, with the balance to be completed and realized in 2010. The most significant growth occurred in the sales and installations of ACI systems, which increased $456,000 in the quarter and is the result of an increasing number of system sales as noted above. We expect growth in 2009 in the MEC segment to result primarily from an increasing number of retrofit ACI systems sold in response to existing mercury emission control regulations.

Our DOE and industry demonstration contract revenues totaled $950,000, representing a decrease of $486,000 or 34% from 2008 revenues. The remaining unearned amount of these contracts was $2.7 million as of March 31, 2009, of which $1.2 million is expected to be recognized in 2009 (including cash contributions by other industry partners). We expect the DOE funding for mercury related projects to continue to decline or be eliminated, however, increased funding for CO2 capture technology from government and industry supported contracts will began to replace that source of revenue for us in 2009, and we expect this to continue. We are also seeing increased funding for clean coal technology through the American Recovery and Reinvestment Act which allocated $3.4 billion to support development and demonstration of technology to capture and store CO2 from coal-fired power plants.

Our contracts with the government are subject to audit by the federal government, which could result in adjustment(s) to previously recognized revenue. We believe, however, that we have complied with all requirements of the contracts and future adjustments, if any, will not be material. In addition, the federal government must appropriate funds on an annual basis to support DOE contracts, and funding is always subject to unknown and uncontrollable contingencies.

Revenues from consulting services included in the MEC segment increased approximately $529,000 from 2008 first quarter revenues, due to different demonstrations of milling applications, AC tests and ACI systems tests for mercury control.

Our AC sales for the first quarter of 2009 contributed approximately $390,000 to MEC revenues, compared to no sales in the first quarter of 2008 as our AC Supply Business had not yet commenced sales. In 2009, we expect significant growth to occur in the sales of AC. Carbon Solutions is expanding the supply of AC with the development of a larger off site AC processing and logistics facility scheduled to commence operations in the second quarter of 2009.

FGC and other revenues decreased by $26,000 or 25% from the year-ago quarter due to fewer shipments of chemicals to continuing customers. We expect FGC and other revenues in 2009 to be lower than 2008. Sales related to our ADA-249M product are recorded in the FGC and other segments and were $17,000 and $18,000 for the quarters ended March 31, 2009 and 2008, respectively.

Cost of revenues increased by $139,000 or 5% in 2009 from 2008, primarily as a result of increased volume and changes in our business mix as discussed below. Gross margins were 42% for the first quarter as compared to 33% in 2008. The increase reflects increased margins in MEC, offset by decreased margins in FGC and other segments. For the near term, we expect the sales of ACI systems and activated carbon to continue to represent an increasing source of revenues, for which the anticipated gross margins are lower than for our specialty chemical sales and DOE demonstration work that involves industry cost-sharing. We expect the amount of fixed price and time and materials work in the MEC segment for the near term to represent an increasing source of revenue. As a result, we expect overall gross margins for fiscal year 2009 to be consistent with the levels achieved in fiscal year 2008.

Cost of revenues for the MEC segment increased by $173,000 or 7% in 2009, as compared to 2008, primarily as a result of the increased revenue-generating activities from our ACI system sales, offset by increased costs in our AC Supply Business. Gross margins for the MEC segment were 42% for the first quarter as compared to 33% for 2008. The increase in gross margins from the prior year resulted from an increase in margins on ACI systems sold due to improvements in design and internal efficiencies. Looking further ahead, we expect ACI system sales, government and industry-supported demonstration work and sales of AC to maintain MEC margins consistent with prior years.

Cost of revenues for the FGC and other segment decreased by $34,000 or 38% in 2009, as compared to 2008. Gross margins for this segment were 29% for 2009 as compared to 14% in 2008. The increase in gross margins from 2009 to 2008 is attributed to higher sales prices and is offset by direct costs related to the current joint venture activities of Clean Coal. FGC and other revenues comprised 2% of total revenues in 2009, compared to 3% in 2008.

General and administrative expenses increased by $1.7 million or 114% to $3.2 million in 2009. The dollar increase in 2009 resulted primarily from increased costs directly related to our AC Supply Business ($1.1 million) and legal costs ($426,000) related to our litigation with Norit Americas, Inc. ("Norit") and Calgon Carbon Corporation ("Calgon") described in Part II, Item 1 of this Report.

We incur R&D expenses not only on direct activities we conduct but also by sharing a portion of the costs in the government and industry programs in which we participate. Direct research and development expenses decreased by $16,000 or 7% in 2009 as compared to 2008 as a result of a decrease in DOE contract activities. We anticipate that our future R&D expenses will grow in direct proportion to DOE-funded CO2 work we perform for the next several years.

MEC segment profits increased by $764,000, or 85%, to $1.7 million as compared to 2008. The increase was primarily a result of increased revenues and margins from our ACI systems sales. FGC and other segment loss was $39,000 as compared to a loss of $67,000 in the first quarter of 2008. The decrease in loss was primarily the result of higher margin chemical sales somewhat offset by decreasing segment revenues.

We had net interest and other income of $33,000 in 2009, as compared to $169,000 for 2008. Interest and other income decreased in 2009 due to our liquidation of investments in order to make contributions of capital to Carbon Solutions, which resulted in lower invested balances. In addition, interest rates were at record lows resulting in lower earnings on interest-bearing accounts.

Our net operating loss for the period ended March 31, 2009 includes net costs of $59,000 related to our refined coal efforts and $23,000 loss of the Clean Coal joint venture as well as a loss of $1.2 million related to Carbon Solutions, our AC Supply Business.

The deferred income tax benefit for 2009 represents our expected effective tax benefit of approximately 21% for 2009, which is less than the rate of 50% we recognized for the first quarter of 2008.

Liquidity and Capital Resources

We had cash and cash equivalents of $28.4 million and positive working capital of $9.0 million at March 31, 2009, compared to cash and cash equivalents of $28.2 million and working capital of $18.6 million at December 31, 2008. Approximately two-thirds of these amounts relate to Carbon Solutions. The decrease in working capital results primarily from our funding of the development and construction activities of Carbon Solutions relating to the AC Facility and interim AC processing and logistics facility. We believe that our existing and expected future working capital available to the non-AC Supply Business of the Company will be sufficient to meet the anticipated operating needs of such business for at least the next twelve months. We believe that we have sufficient resources on hand to continue pursuit of the rapidly-growing MEC market.

Our principal source of liquidity is our existing working capital and equity contributions from ECP to Carbon Solutions. In 2009, we may not be able to achieve positive operating cash flow, primarily due to the start-up nature of the AC Supply Business and anticipated legal fees we expect to expend in the litigation with Norit and Calgon. We recently settled certain aspects of litigation with our insurer regarding whether our insurance policies provide coverage of defense costs and indemnification for legal fees and other costs we are incurring in connection with the Norit litigation for an expected payment to ADA of $1.25 million. For additional information, see Part II, Item 1 of this Report. We have recently instituted programs to conserve cash and working capital related to the non-AC Supply Business, including a reduction in cash compensation to our directors and senior officers and payments with shares of our Common Stock in lieu of cash to certain consultants. We may need to institute further short-term cash conservation programs, such as a reduction in non-core business activities. Our plans for the future include continuing to construct the AC facilities and provide AC to our customers on an interim basis, which will require additional funding from ECP or other sources and debt financing.

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