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ADES > SEC Filings for ADES > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for ADA-ES INC

Form 10-Q for ADA-ES INC


9-Nov-2012

Quarterly Report


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 and Section 27A of the Securities Act of 1933 that involve risks and uncertainties. Words or phrases such as "anticipates," "believes," "hopes," "expects," "intends," "plans," 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) when mercury and other regulations or pollution control requirements will become effective and the scope and impact of such regulations, including the impact of the final Mercury and Air Toxics Standards ("MATS");

(b) expected growth in and potential size of our target markets;

(c) expected supply and demand for our products and services;

(d) the effectiveness of our technologies and the benefits they provide;

(e) expected timing of conducting additional demonstrations of our technology;

(f) the timing of awards of, and work under, our contracts and agreements and their value and their availability;

(g) expected production levels at our refined coal ("RC") facilities, when those RC facilities will be placed into permanent operation and expected use of the tax credits under Section 45 of the Internal Revenue Code ("Section 45 tax credits") generated by the RC facilities;

(h) our ability to profitably sell, lease and/or recognize the tax benefits from operating additional RC facilities;

(i) timing and amounts of or changes in future revenues, funding for our business and projects, margins, expenses, earnings, tax rate, cash flow, working capital, liquidity and other financial and accounting measures;

(j) the materiality of any future adjustments to previously recorded revenue as a result of Department of Energy ("DOE") audits; and

(k) whether any legal challenges or Environmental Protection Agency ("EPA") actions will have a material impact on the implementation of the MATS or other regulations.

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 them; the 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; inability to commercialize our technologies on favorable terms; our inability to ramp up our operations to effectively address expected growth in our target markets; loss of key personnel; failure to satisfy performance guaranties; the failure of the facilities leased by Clean Coal Solutions, LLC ("Clean Coal") to continue to produce coal that qualifies for Section 45 tax credits; termination of the leases of such facilities; rulings by the courts on, interpretations by the IRS of and other official pronouncements on tax credit regulations adverse to our RC business; decreases in the coal available for treatment at Clean Coal's RC facilities; plant outages; seasonality; failure to monetize the new CyCleanTM and M-45TMfacilities; inability to put into permanent operation our available RC facilities and obtain necessary agreements, permits and private letter rulings from the IRS; availability of raw materials and equipment for our businesses; intellectual property infringement claims from third parties; 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 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.

Restatement

The following Management Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") incorporates restated figures related to the following previously filed amended consolidated financial statements, data and related disclosures: Consolidated Balance Sheet as of December 31, 2011, Consolidated Statement of Operations for the three and nine months ended September 30, 2011 and Consolidated Statement of Changes in Stockholders' Deficit and Consolidated Statement of Cash Flows for the nine months ended September 30, 2011. For this reason, the following MD&A should be read in conjunction with the amended financial statements and notes thereto and the MD&A included in the Company's Amendment No. 1 to its Quarterly Report on Form 10-Q/A for the quarterly period ended September 30, 2011 and in the Company's Amendment No. 2 to its Annual Report on Form 10-K/A for the fiscal year ended December 31, 2011, which were both filed on October 19, 2012, as well as the Company's other filings with the SEC.


The restatement resulted from management's determination that the Company had not properly accounted for the interest held by an affiliate of the Goldman Sachs Group ("GS") in our joint venture, Clean Coal since May 2011 and that a full valuation allowance against the Company's deferred tax assets should have been recognized as of December 31, 2010 and all subsequent quarters thereafter.

Overview

We develop, offer and implement proprietary environmental technology and market specialty chemicals to the coal-burning electric utility steam generating units ("EGU") industry, to the Portland cement industry and to industrial boiler operators. We have three operating segments: RC (refined coal), EC (emission control) and CC (CO2 capture). The RC segment includes revenues from the leasing of RC facilities and RC sales which approximate the cost of raw coal acquired for RC facilities operated for our own account. The EC segment includes revenue from the supply of emissions control systems including powdered activated carbon injection ("ACI") systems, dry sorbent injection ("DSI") systems to control SO2, SO3 and HCl and flue gas conditioning ("FGC") systems, the licensing of certain technology and provision of consulting services. The CC segment includes revenue from projects relating to the CO2 capture and control market, including projects co-funded by government agencies, such as the DOE and industry supported contracts.

Our RC segment generates revenues through the lease or sale of RC facilities, which qualify for Section 45 tax credits, to third party financial institutions or others, as well as operating RC facilities and keeping the tax credits for our own and our partners' accounts. To date, 28 RC facilities that qualify for the Section 45 tax credits have been "placed in service" through Clean Coal, our RC joint venture with NexGen Refined Coal, LLC ("NexGen"), an affiliate of NexGen Resources Corporation, and with an affiliate of The Goldman Sachs Group, Inc. ("GS").

The primary drivers for many of our EC products and services are environmental laws and regulations impacting the electric power generation industry. Environmental regulations, such as the 1990 Clean Air Act Amendments, the MATS regulations, various Maximum-Achievable Control Technology ("MACT") standards including the Industrial Boiler MACT ("IBMACT") regulations, Cement MACT (as defined below) regulations, various state regulations and permitting requirements for coal-fired power plants are requiring electric power generators to reduce emissions of pollutants, such as particulate matter, SO2, NOx, mercury, and acid gases. We are a key supplier of mercury control equipment and services, which include ACI systems, to the EC market whose commercial equipment component first began in 2005 when several individual states began to require limits on mercury emissions. We also offer DSI systems to control SO2 and acid gases such as HCl and SO3.

We conduct research and development efforts in CO2 capture and control from coal-fired boilers. In September 2010, we signed our second significant contract related to CO2 capture with the DOE, for a project that is expected to continue through the end of 2014.

Refined Coal

We are marketing our CyClean and M-45 technologies, services and equipment through our joint venture in Clean Coal. Since its inception, ADA has been considered the primary economic beneficiary of Clean Coal and has consolidated its accounts.

Environmental Legislation and Regulations

Clean Coal's primary opportunity is based on Section 45 tax credits, established by the American Jobs Creation Act of 2004, and as amended by the Emergency Economic Stabilization Act of 2008, the American Recovery and Reinvestment Act of 2009, and the Tax Relief and Job Creation Act of 2010, the last of which extended the placed in service deadline for the Section 45 tax credits from its original date to January 1, 2012. The 2012 tax credit amounts to $6.47 per ton of RC, and is expected to escalate annually through 2021. In December 2009, the IRS issued the initial guidance as to the specifics concerning how the emissions reductions are to be measured and certified to demonstrate compliance necessary to qualify for the Section 45 tax credits. The IRS provided subsequent guidance on October 4, 2010 to address various issues that had arisen. Additionally, the IRS has published a number of Private Letter Rulings ("PLRs) that provide approval to taxpayers on matters related to specific Section 45 tax credit issues. Although the approval in each PLR only applies to the taxpayer and the specific project mentioned in the PLR, other taxpayers can gain an understanding on how the IRS interprets certain matters based on the conclusions reached in the PLR.

Use of the tax credits is also subject to audits of the entity that claims the credit on its tax return and rulings by the United States Tax Court (the "Tax Court"), each of which can impact several aspects of the RC business including the viability of the market for Section 45 tax credits in general, the perceived risk involved in obtaining Section 45 Tax Credits and thus the price a third party would be willing to pay for them and the structure of contracts that we enter into to monetize our RC facilities.


Technology License Agreements and Operating Agreement

ADA licensed to Clean Coal, on an exclusive basis, the CyClean technology in November 2006. On July 27, 2012 ADA licensed the M-45 technology (the "M-45 License") to Clean Coal in order to leverage Clean Coal's operating expertise and take advantage of the other synergies that can be obtained by Clean Coal having the ability to provide and use either the CyClean or M-45 technology.

In addition, the M-45 License gives Clean Coal, on a limited, non-exclusive, non-transferable, royalty-bearing basis, with the right to sublicense (under specified terms to be approved by ADA prior to the sublicense being granted) to limited utilities that burn or have burned RC produced using the M-45 technology the right to continue to use the M-45 technology under certain circumstances for the purpose of "Mercury Only Emission Control".

The M-45 License runs from July 27, 2012, through the later of the expiration of
(i) the Section 45 tax credits, (ii) any similar tax credit subsequently enacted, after the effective date of the agreement up to within one year of the expiration of the Section 45 tax credits, which tax credit provides for the production of a coal-based fuel (pre-combustion) that emits, when combusted, a lower level of both NOx and mercury emissions, or (iii) the date on which Clean Coal and all sublicensees have permanently ceased to provide Mercury Only Emission Control.

Pursuant to the M-45 License, we will receive royalties equal to (i) a percent of the per-ton, pre-tax margin from RC produced with the M-45 technology from leased or sold RC facilities, (ii) a percentage of the Section 45 tax credits claimed by Clean Coal (or a Clean Coal affiliate), or their respective owners, on RC produced by a facility that Clean Coal does not monetize with a third party and instead opts to retain the Section 45 tax credits from that facility for its (or an affiliate's) own benefit, net of all directly allocable operating expenses and all utility payments incurred by Clean Coal (or an affiliate) in connection with the production and sale of such RC, and (iii) a percent of the revenue, net of all direct expenses, received by Clean Coal as a direct result of Clean Coal's exercise of the license for Mercury Only Emission Control described above. ADA is entitled to receive up to $10 million in prepaid royalty deposits upon the attainment by Clean Coal of certain milestones, which amount includes the initial payment of $2 million made upon signing of the non-binding term sheet for the M-45 License Agreement in November, 2011. We have certain obligations to provide technical assistance to Clean Coal and its sublicensees during the term of the M-45 License, as well as certain obligations to protect and maintain the patents that underlie the M-45 technology and to indemnify Clean Coal against certain claims related to the technology.

Leased and Operating RC Facilities

On June 29, 2010, Clean Coal executed contracts pursuant to which two RC facilities were leased by Clean Coal's wholly owned subsidiaries (the "Lessors") to GS RC Investment, LLC (the "Lessee"). The two facilities were installed at two different power plants in the Midwest each of which operates two cyclone boilers burning Powder River Basin ("PRB") coal from Wyoming. On November 21 and December 15, 2011, Clean Coal, the Lessors and the Lessee entered into two Exchange Agreements pursuant to which the parties exchanged the leased RC facilities at each power plant with newly constructed, redesigned RC facilities which resulted in termination of the original leases and entry into new lease agreements. The new leases carry over most of the substantive terms and conditions of the initial leases and have annual terms that automatically renew through December 31, 2021.

As a result of the extension of the Section 45 tax credit placed in service deadline, Clean Coal built and qualified an additional 26 RC facilities that met the extended placed in service date. These facilities use a combination of our CyClean technology, which is limited to cyclone boilers, and M-45 technology, which can be used in non-cyclone boilers.


Based on the ten year term of the current Section 45 tax credits, we expect Clean Coal to generate revenues from leasing or selling RC facilities to financial parties and by generating tax credits by retaining and operating certain of the 28 RC facilities that met the placed in service deadline through December 31, 2021. Upon expiration of the tax credits on December 31, 2021, the leases of our RC facilities to financial parties will terminate. Clean Coal may then lease or sell the RC facilities directly to the utilities that own and operate the power plants at which the RC facilities are located or operate the facilities on behalf of utility customers given the significant benefit of the mercury reductions such facilities provide. After December 31, 2021, Section 45 tax credits would no longer be available absent further extension by Congress.

Eight of the 28 total RC facilities are currently in routine operations on 15 coal-fired boilers. Once the final utility site and financing party have been determined, it takes an average of approximately six to twelve months to obtain environmental permits for full-time operation, secure necessary approvals from state Public Utility Commissions, and negotiate and complete all necessary contracts. Since the IRS did not provide explicit guidance on the blending of coal to qualify for Section 45 tax credits, PLRs may be needed from the IRS if requested by the applicable utility or financing party, which may take an additional two to four months to obtain after formal contracts are completed. We expect that the requesting party will eventually be able to obtain all required PLRs necessary for operating the RC facilities. We expect that the transactions for the new RC facilities may be either leases or sales transactions with the purchase price payable over time, but that regardless of their form the final transaction structures will provide long-term economic benefits substantially similar to those provided by the prior lease transactions. However, the economics of each facility will be somewhat unique as the revenue and expected margins will differ from one RC facility to another depending upon: size of the power plant being served, the annual RC burned at each plant, the cost of chemicals, labor costs, negotiated payments to the utility, upfront prepaid rent payments, royalty payments for certain technologies, and the payment structure for the tax credits. As is generally the case in these transactions, the sale or lease of the RC facilities and the monetization of the Section 45 tax credits involve a relationship between the utility, a financial party and Clean Coal. By buying or leasing the RC facility and producing RC, the financial institution or other party becomes the producer of RC, receives the benefit of the annually escalating per ton Section 45 tax credit and is able to deduct depreciation and/or a portion or all of the lease payments. In return it pays, and may also deduct, a fee to the utility for coal handling and land use to site the RC facility and operational costs. In addition, the financial party pays a mutually agreed combination of fixed and contingent rents to Clean Coal for the lease of the RC facility or, in the case of a sale, payments that are substantially similar to fixed and contingent rents. In addition to the site and coal handling payments, the utility receives the benefit of the resulting mercury reductions which have an estimated value of between $1.00- $4.00 per ton.

In connection with the Exclusive Right to Lease Agreement ("Lease Agreement") among ADA, NexGen and Clean Coal as discussed in prior filings, Clean Coal granted GS the exclusive right (but not the obligation) to lease facilities that will produce up to approximately 12 million tons (+/- 10%) (the "Target Tons") of RC per year on pre-established lease terms similar to those currently in effect for Clean Coal's two then-existing leased facilities, but which are more economically favorable to Clean Coal than the rates in the leases for the existing RC facilities that Clean Coal leased to another GS affiliate in June 2010. Under this arrangement, Clean Coal is required to submit a package to GS with respect to each RC facility it proposes that GS consider for leasing (being all RC facilities developed by Clean Coal until the Target Tons are met), and upon certification and acceptance of the certification for a given RC facility by GS, GS is required to pay Clean Coal, as a deposit, an agreed amount for each 1 million tons of projected annual RC production. Upon closing of such a lease of an RC facility from Clean Coal, GS is required to pay Clean Coal an additional amount per 1 million tons of projected annual RC production. These payments will be paid as advance rent, and actual amounts due under the leases (with true-ups) will be paid in accordance with the operative lease and related agreements. If GS determines that it will not lease a RC facility after it has paid the deposit, it can provide notice requesting the return of the deposit paid for that RC facility, and the deposit must be paid within 30 days of the end of the quarter in which the notice is given . The amount of any deposit will earn interest from the date of the notice until the deposit is paid. Clean Coal received $14.9 million from GS in 2011 as initial deposits for more than the Target Tons, which according to the Lease Agreement reserves GS's right to negotiate for specific RC facilities. In October 2012, GS determined that it would not pursue leases on two particular RC facilities on which it had paid deposits totaling $4.7 million and concurrently gave notice for the return of the related deposits. While Clean Coal has not yet returned the deposit, it plans to do so by January 30, 2013 as required by the Lease Agreement unless GS selects other facilities in which to participate for which deposits could be applied. We are currently in discussions with a number of other major financial institutions, corporations and other investors with respect to a number of the remaining facilities.

Pursuant to the Lease Agreement, Clean Coal leased a third RC facility to GS in the first quarter of 2012 and leased a fourth RC facility to another financial party during the third quarter. All agreements included substantially similar terms and conditions as those applicable to the first two leased RC facilities. With progress to date, currently a total of eight RC facilities are operating at full time status treating fifteen boilers that, in the aggregate, average more than twenty-one million tons of RC per year.

In addition to the four leased RC facilities, Clean Coal currently operates four additional RC facilities for its own account, resulting in its right to claim the Section 45 tax credits for the RC produced during those operations. Clean Coal plans to retain and operate one or two of these RC facilities permanently for its own account (with an ultimate goal of one of every five tons of RC produced) going forward and to lease or sell the other RC facilities currently in full time operation to financial institutions or others pending completion of definitive agreements. During the third quarter, the RC facilities operated for Clean Coal's account generated $16.1 million in Section 45 tax credits that can be used to offset future tax expenses and $59 million in revenues from RC sales which are offset by $59 million in raw coal costs. Clean Coal has finalized monetization contracts for a ninth RC facility and the monetizer is waiting for a PLR and other approvals before full time operation can commence, which is expected in the


next few months. When these nine RC facilities are operating, Clean Coal will be producing about 25 million tons of RC per year based upon historical coal usage at these plants. Clean Coal is in negotiations to lease or sell several additional RC facilities and has the potential to be producing up to 60 million tons of RC by the end of 2014 utilizing the CyClean and M-45 technologies.

In those cases where Clean Coal chooses to operate an RC facility for its own account, either on an interim basis or for the long-term, it receives the benefit of the Section 45 tax credits from the RC produced at the facility. As part of those operations Clean Coal purchases raw coal from the utility, refines the raw coal into RC and then sells the RC back to the utility, generally at the same price per ton, recognizing revenue from the RC sale and costs of revenue for the raw coal purchased. These amounts may be significant as the average per ton price for the raw coal purchased and RC sold has historically ranged from $20 to $40 per ton. In those operations Clean Coal also pays, recognizing an expense, and may also deduct for tax purposes, operational costs, a fee to the utility for coal handling and a fee for the land used to site the RC facility.

Closings of several deals with utilities and tax equity partners for our RC facilities were delayed in the second and third quarters of 2012 for various reasons, including: permitting, regulatory approval, corporate financial restructuring of third parties involved in some aspect of the transaction, changes in plant ownership, changes and retirements of personnel involved in the negotiations, involvement of additional parties in the transactions, and uncertainties in the tax credit community. As our previous disclosures have indicated, because of the complexities of each RC deal and the number of externalities that are outside our direct control and involvement, there was potential for and we are experiencing delays beyond our initial estimates of six to nine months to close the transactions.

Status of Remaining RC Facilities

Our goal is to place into full time operations the majority of the remaining facilities as soon as possible with an expectation that all will be in operation in 2014. For the remaining facilities, there are a number of possible locations all with different sizes and characteristics. As a result, it is difficult to provide explicit guidance at this time for their permanent placement. For example, we are holding five facilities in reserve for placement at five very large potential RC production sites. Each of these sites has its own unique set of circumstances and issues that will likely require some change in operations at the utility or other changes such as technology improvements, switch in coal rank, or a PLR, in order for those facilities to begin full time operation. In this regard we have made significant progress in expanding the potential target market by extending the RC technologies beyond PRB coals. Clean Coal is currently operating two RC facilities using the M-45 technology at plants burning Gulf Coast lignite and one CyClean facility at a plant burning North Dakota lignite. In addition, tests have demonstrated the potential to apply the RC technologies to bituminous coals. Clean Coal is also conducting tests on an improvement to the M-45 technology that would potentially make it available for use on different types of pulverized coal ("PC") boilers. This would significantly increase the potential market for where the RC facilities could be located as PC boilers represent over 80% of the 1,200 electricity generating boilers in the U.S. and there are over 50 plants where it may be possible to treat five to ten million tons of coal per year with a single RC facility. The tax credit rules further ease the transition by allowing us to change the process and use the RC facilities at plants other than those at which they were originally placed into service.

We are also in the process of increasing the number of potential financial parties and others that we are negotiating with to monetize the Section 45 tax credits. By the end of the year we expect that we will have leased or sold another RC facility to a new financial party bringing the total to three RC facilities monetized in 2012. As more of the RC facilities become operational and operate for longer periods, we believe the technical and tax credit risks are reduced. As a result, we expect the financial terms around future lease and/or sale transactions to generally improve for Clean Coal and result in higher per-ton profits over time. In addition, our RC business opportunities do not depend upon any new environmental or tax regulations. The current ten year term of the tax credits do not require any additional approval by Congress, which provides us with a high degree of confidence that the CyClean and M-45 technologies will generate long-term cash flows.

Despite the recent delays in closings, we do not expect any changes that may result from variables outside our control to have a material impact on the expected size of our market or the future long term economics for our RC business segment. ADA expects to generate pre-tax income of greater than $1.60 per ton of RC produced per year for facilities leased or sold to others after payments to its joint venture partners, over the remaining nine-year life of the . . .

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