Arq Inc (ARQ) 2005 Q3 法說會逐字稿

Good day everyone, and welcome to the ADA-ES third quarter 2006 financial results conference call. At this time I'd like to inform you that this conference is being recorded and that all participants are in a listen-only mode. This conference call contains forward-looking statements within the meaning of Section 27(a) of the Securities Act of 1933 and Section 21(e) of the Securities Exchange Act of 1934, which provide a safe harbor for such statements in certain circumstances. These statements include the company's expectations regarding future revenues or other financial measures, anticipated projects, and new contracts, anticipated growth in the market, and similar items. Such statements involve significant 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, change in economy conditions and market demand for ADA-ES's products and services, changes in technology, failure to satisfy performance guarantees, federal funding, laws or regulations, results of demonstration of the companies and other license technologies, operational difficulties, availability of skilled personnel, and other factors discussed in the company's filings with the U.S. Securities and Exchange Commission.

I will now turn the conference over to Mark McKinnies, the senior VP and CFO of ADA-ES. Sir, you may begin.

Thanks, Judy. Good morning everyone, and thank you for joining us.

First, I want to discuss the company's financial performance for the third quarter and then our president, Mike Durham, will update you on the company's overall performance for the quarter and plans for future growth. After that, we will open the call for your questions.

Revenues increased 43% to $4.4 million for the third quarter due to increased sales in mercury emission control segment or MEC primarily from greater sales of commercial mercury systems. This market began in the second half of 2005 and generated $1.8 million for ADA-ES in this quarter. Work under our several DOE and industry-supported field demonstration projects during the third quarter continued at a pace somewhat above our expectations. These activities contributed approximately $1.9 million to MEC revenues recognized for the quarter, as compared to $1.4 million in the same period in 2005.

Our mercury measurement services and other consulting revenues totalled $462,000 for the quarter as compared to $525,000 in the same period last year due to several large consulting jobs in the second and third quarters of 2005.

FGC and other revenue decreased by 50% from $661,000 in the second quarter of 2005 to $328,000 in 2006 as fewer chemical deliveries were made during the current quarter. Based on contracts in hand and other expected work, we now anticipate total revenues for fiscal year 2006 to grow at a rate of about 35% over 2005.

The expected pace of work on our DOE programs has picked up for the fourth quarter and we'll offset lower revenues recognized in the first half of the year. We continue to hire personnel in response to realized and expected growth and sufficient human resources appear to be available. Our growth margin in the third quarter was 29% as compared to 40% for the third quarter last year. We expect activated carbon injection systems, times and materials related work, and fixed price consulting to continue to represent an increasingly greater portion of our revenues for which the anticipated growth margins are lower than our specially chemical sales. As a result, we expect the gross margins for the year 2006 to be lower than the margin realized in 2005.

Research and development expense in the third quarter increased $84,000 over the same period in 2005 reflecting increased activity in our mercury emission control and refined coal activities. We anticipate that our future direct R&D expenses will grow annually at about 20% for the next several years. General and administrative expenses increased by $287,000 to $974,000 in the third quarter primarily due to the implementation of stock option expensing for SFAS 123R of $95,000, as well as additions to our staff, increased cost of corporate governance and government compliance, and other general increases in costs.

During the quarter ended September 30, 2006, we determined that deferred charges amounting to approximately $412,00 related to our M&A activities incurred earlier in the year were no longer of future value and were therefore expensed. Due to those increased costs we recognize a net loss of $128,000 or $.02 per diluted share in the third quarter compared to net income of $248,000 or $.05 per diluted share for the same period in 2005.

Cash flow provided by operations increased to $667,000 for the quarter compared to $376,000 for the same period in 2005 primarily as a result of noncash charges for the stock compensation and an increase in accounts payable during the period. Our balance sheet of September 30th remain strong with working capital of $17.1 million and other investments and securities of $5.9 million. We have no long-term debt and shareholders' equity totalled over $26 million. With these funds in hand and our other available capital, we are aggressively pursuing internal and external opportunities in mercury emission control including consulting services, equipment supply, and the anticipated future need for expanded activated carbon production. We believe we are well positioned to capitalize on these opportunities as the mercury market continues to emerge in other areas that Mike will discuss further.

In summary, we remain optimistic about reporting ongoing revenue growth and profitability in 2006 and into the future.

Now I'd like to turn over the call to Mike.

Thank you, Mark. Our third quarter business developments and revenue growth continue to reflect the successful execution of our core strategy to be a leader in the emerging mercury control market. This market, which we at ADA predict will reach three to $10 billion per year as one of the two significant growth opportunities for the company.

Over the past year, our mercury control work began to reflect that the commercial market is well underway. During this time we have announced new contracts for 12 commercial mercury control systems for both existing power plants and new ones being developed. We expect initial revenues from commissions for carbon sales to begin once some of the systems are operational likely this quarter.

The market for mercury control systems continue to pick up momentum. As the impending regulations are becoming reality, we're beginning to receive requests for quotations from utilities for multiple control systems. We are encouraged by this new trend in the market in contrast to the market to date, which has been for single systems. It allows us to increase efficiency in the bid process and greatly improves our ability to implement plans for the rapidly developing market.

We expect several utilities to award multiple unit contracts in the next six months. These changes in the mercury control market are the result of a new power plant construction, which require a 90% mercury control and increase certain deregulations on existing plants. There has recently been a huge increase in new plant projects. DOE's latest report includes 153 new projects totaling 93 gigawatts of capacity.

As an example to this growth, TXU recently announced construction of 10 new large coal-fired units. State regulations are becoming the largest market driver for mercury control technology. In addition to laws already in place in eight states, significant progress has been made on mercury regulations in two key coal states, Pennsylvania and Illinois.

For example, last week Illinois announced approval of the governor's proposal to reduce mercury emissions from power plants by 90% by July 1, 2009. Power companies with more than one unit may average their emissions to meet the requirement, but each individual plant must achieve at least 75% reduction in that time frame.

In October, the Pennsylvania Environmental Quality Board voted in favor of the governor's proposal, proposed mercury emissions reduction rule that would cut mercury emissions from coal-fired plants by 80% by 2010 and 90% by 2015 and does not include any cap in trade provisions.

These regulations are significant, because of the near term business they will produce and the pressure they will create from meaningful federal regulations. Illinois has 58 power plants generating 16,000 megawatts and Pennsylvania has 77 power plants generating 24,000 megawatts, which could require over $100 million for capital equipment and $150 million per year of demand for activated carbon. These regulations also demonstrate that a thorough review of performance data on mercury control technology, the majority of which had been produced by ADA justifies an aggressive approach to mercury control.

This will also highlight the flaws in the current federal clean air mercury rule, which is based upon the assumption that no progress has been made since 1999 and that there is no commercial mercury control technology.

The commercial mercury revenues we recorded in this quarter were in addition to our work funded by DOE and power companies to develop and demonstrate mercury control technology. These programs which cost approximately $2 million per site have financed our growth, helped us establish our market position, and provided us a mechanism to be profitable before the commercial market commenced. To date we have performed participated in 23 full-scale demonstrations at different plants across the country providing us with the performance data on which to guarantee commercial mercury systems.

The same regulatory market drivers for the commercial market are also having a positive impact on this revenue source as utilities are beginning to directly fund new demonstrations. For example, in 2007 we expect more utility-funded demonstrations than DOE programs. This is significant for several reasons. The programs move from proposal funding in about a third of the time. Since DOE is not involved, we can charge full commercial rates with no cost sharing resulting in higher margins and it is a significant foot in the door for follow-on orders assistance.

We're also very excited about progress in our other near-term growth opportunity, which involves producing a refined coal product. Yesterday we announced the formation of a 50/50 joint venture with NexGen to market and produce refined coal.

NexGen paid ADA-ES $900,000 as a nonrefundable purchase for its interest in this venture following NexGen's initial payment of $100,000. NexGen has the right to maintain a 50% position in the JV by paying us an additional $4 million in eight quarterly payments of $500,000 each beginning in the fourth quarter 2007 and also paying 50% of the future costs of operating the JV.

The ADA next coal JV will produce a product that we expect will qualify for the IRS tax credits established by the American Jobs Creation Act of 2004 for processing coal to reduce emissions of nitrogen oxide, sulfur dioxide and mercury. The ADA-ES refined coal technology combines ADA-ES patented chemical developed for slagging boilers with our expertise in sorbent-base mercury control technology. We believe that the technology is applicable to a target market of approximately 60 million tons of refined coal per year.

We believe that NexGen is an ideal partner for ADA to develop this exciting business opportunity. With over 30 years of experience in the coal business, NexGen is involved in many aspects of the mining, transportation, and delivery of coal to utilities. In addition to conventional coal since 1998, NexGen has been involved with the development and supply of coal-based synfuels. To date, the plants developed by NexGen synfuel project using their own technology have qualified for over $600 million in tax credits under Section 29 of the IRS Code.

ADA-ES began developing its refined coal product in early 2005. To prevent diluting our efforts in building our mercury control business, we brought in Dr. Nina French as an independent contractor to lead this effort. Over the past year and a half significant progress has been made on this business. Two successful full-scale tests were conducted and demonstrated ability to meet the emission control performance required to qualify for the Section 45 tax credit. This past month a patent application for the combined technology was submitted. There has also been several high-level discussions with the IRS and Treasury Department to help clarify key issues concerning the implementation of the new Section 45 tax credits.

We believe that this product will be highly marketable. We have had several meetings with customers who see this refined coal product, which avoids the need for large capital equipment as a means of keeping older plants running by meeting stricter environmental regulations. Our technology not only has shown the ability to meet the 20% reductions requirement of the tax credit, it can meet the strict mercury emissions requirement in states such as Illinois. We're also working with packaging it with other low capital technologies to provide utilities with a means to achieve 80 to 90% [nox] control.

In addition to emissions regulations, customers are also reporting other benefits of the product, such as increased operational performance of the boiler resulting in greater power generation and the ability to buy cheaper coal, both of which have significant cost implications.

Let me briefly present a financial model to explain why we're excited about the potential of this product. A typical 500 megawatt boiler burns two million tons of coal per year. Sale of refined coal to such a plant would result in a tax credit to the JV of approximately $6 per ton or $10 million per year.

In addition, there would be an additional sale of our license of the technology of $3 per ton or $6 million per year for a total potential of $18 million per year for a 500 megawatt plant. We expect that the JV will achieve 60 to 70% margins on this product through the use of monetizers who will license the technology to turn the tax credits into revenues for the JV.

The tax credits run for a ten-year period. We develop our technology for slagging boilers burning western coals, which we expect to represent a market of approximately 60 million tons per year. It is our aim to capture 30% of this potential market during the 2009 to 2019 time frame.

Let me now describe other corporate activities that stem from our decision to aggressively evaluate options for the growth through expansion in two key areas of our mercury control technology: Sorbent production and supply and equipment design and manufacture. In the near term, these efforts will generate expenses that will impact our bottom line as seen in the third quarter financials. In the long term, we expect these decisions to enhance the resources of the company, strengthen our market position, and broaden ADA's earnings potential. We're exploring the vertical integration of our business to establish an invested role in these areas of the mercury control market and increase our margin potential and the future sales of activated carbon.

Currently, activated carbon is manufactured primarily for the water treatment applications with a U.S. market of approximately $200 million per year. Our estimates indicate that the demand for activated carbon could increase to one to two billion per year as the result of the emerging market for mercury control. Having evaluated a number of options for investing in the production of activated carbon, we are very optimistic about the company's opportunities and accordingly are moving forward aggressively. We have made significant progress on plans for an approach that will help us maximize the earnings potential of our position in the mercury control area and we look forward to reporting details as soon as these plans are definitive.

In addition to our key growth areas, mercury control refined coal, we continue to demonstrate our position as a premiere developer of innovative clean energy technologies. We recently announced a project with hythane companies associated with the development of blended hydrogen methane fuels noted as hythane for motor vehicles. We have also begun plans to develop technology for the control of the greenhouse gas carbon dioxide, which we believe will be the next big opportunity for mission controls after mercury.

Since the commercial market is some years into the future, we will use the same model developed for the mercury control and refine coal products in which external funding sources are used to support activities in the premarket period. We also expect to announce progress on funding to support the development of carbon dioxide control technology in the near future.

In summary, we continue to advance our business strategy to provide environmental technology and especially chemicals to the power industry. We are very enthusiastic about the new commercial markets for mercury control technology, the recent successes of a refined coal project and other opportunities we are pursuing. We'll be discussing these topics tomorrow when we present at the Pacific Growth Equities Technology Conference in San Francisco. We thank you, our shareholders, for your continued support of ADA-ES and we remain enthusiastic about your company's future.

I'd now like to open up the call for questions.

(OPERATOR INSTRUCTIONS.) Your first question comes from the line of Mark Segal with Canaccord Adams. Please state your question.

Good morning, guys. I'm wondering if you're able to help quantify sort of RFG environment out there. Specifically I know that you guys stated that it seemed strong going forward. Curious as to the amount that you've responded and what's left for you to respond to going forward.

Well, the biggest change we're seeing I think last quarter we reported we had over $18 million in bids out and these were all pretty much for single units.

What is in the process of happening right now are these bids for multiple units. Some have recently been bid and we know there are two or three others are being developed to be put on the street within the next month or so. And these are on the order -- I think there's at least two or three that involve 10 to 15 systems each, so they haven't moved into a backlog of proposals, but you can imagine going from a total of essentially 15 to 18 total being bid as individual systems to seeing two, three or four bids going out for 10 to 15 systems. It's a very significant change in the RFG environment.

Okay. Great. And next, wondering the number of contracts to date that have actually been awarded versus and completed, sorry versus the number that are still in process.

I can give you some indication of that, Mark. We've announced 12 projects that we have been awarded to us. I would say given those we're about 50% complete on those in a general way. You'll see some numbers in the queue that will be released tomorrow that gives some further backlog information on the revenue numbers with that.

Okay. Great. And lastly, none of you mentioned that gross margins are going to, you know, be somewhat depressed to finish out the year here. Wondering at what rate do they bounce back going forward or where you see them sort of settling.

I think we'd expect to see them settling next year as we move more into these commercial markets. This year we've had a mix between our commercial chemical sales where those margins are higher and those sales were down this year which impacted that, but its decrease in margins is as we had expected because in the equipment sales that predominate our revenues now, those margins are just less and can be expected to be less, so we would expect them to even out this next year close to the rate that you'll see in the third and fourth quarters of this year.

Okay. So we're looking for somewhere in the low 30s range or somewhere around the 30% level?

They may average around the 30% level so that certainly is our goal, but if that's going to be dependent upon the mix of the equipment with the engineering services.

Okay. Thanks a lot.

(Operator instructions.) The next question comes from Louis [Arroar]. He's a private investor. Louis, your line is open.

Oh, okay. I was on the phone for just a minute. Yes. Can you tell us in any way how many contracts that you have without mentioning the company's names? I know you're restricted on that.

Louie, we've had a total of 12 contracts for ACI Systems. Some of those have been delivered already and we're in the process of delivering more and those contracts also stretch out in the deliveries into next year.

I guess that doesn't quite answer my question. I'm wondering if you have three or four contracts that you already have that you can't really announce the names on yet.

We announced contracts just as soon as they're awarded, so we know that we've got proposals out on several that we expect to be awarded here in the near term but we've announced everything that's been awarded.

Thanks, Mark.

The next question comes from Bill Burns with Johnson Rice. Please state your question.

Good morning, Mike and Mark. My question basically of the 12 projects you've got, did I hear you Mike, you said you'd start receiving maybe in the fourth quarter of this year, the current quarter, the first revenues on the activated carbon sales. And the question really is I'm trying to get a feeling of when these 12 projects start producing revenue from the carbon sales.

They're going to be spaced out over the next year to a year and a half as they go through various start-ups. In the fourth quarter there should be two units up and running and using carbon and generating revenue. We have a few others that have been delivered but they're on new power plants and so the new power plants haven't been started up and their start-up times are somewhere in the first three quarters.

Some of the other contracts are also on new plants that have longer start-up periods, but they wanted to get the drawings done, initial delivery, so it's really spread out probably over the next 12 to 18 months.

Okay. Well, like I say, I'm just trying to get my hands around that, but so much of it you just have to wait till these plans to get finished, I guess.

Yes.

And then talking about the growing activated carbon market, you're willing to participate in that. Can you give me any like details how you are leaning towards participating in that?

Not at this time, Bill. We should be able to in the next quarter or so as our plans firm up and we can announce some very definitive forward movement there.

Okay. Well, we're keeping an eye out at watching Pennsylvania and Illinois. Got my fingers crossed for you guys.

Yes, thanks.

Yeah, thanks.

Our next question comes from Steve Santos with RBC. Please state your question.

Good morning, Mark, Mike. Just a real quick couple of questions, Mike, regarding the joint venture with NexGen. Could you go over you had explained a hypothetical 500 megawatt plant and the kinds of cash that it would generate. Could you kind of give us an idea how many of these units might be approachable with a 30% market share, what kind of timing you might be able to anticipate given that it's something of a short time horizon with the 12-31-08 deadline, and I guess also the amount of resources at ADA that this will be requiring as we go forward to manage this process?

Okay. Thanks for the question, Steve. The model I gave you was for a 500 megawatt plant which will burn two million tons per year of coal and pointed out we'd get $6 a ton on the tax credit and $3 a ton on the chemical.

Well, so rather than talk about number of plants, the model let's extend that model to tons of coal we expect. And as I mentioned that we I think this applies to about 60 million tons and we're going to shoot to try to get a third of that market, so we're talking about a 20-million-ton market, so we're talking about ten times that particular model. So let's stick to dollars per ton and looking at 20 million tons per year.

As far as the timing, these systems have to be put in by the end of 2008, and that's one of the advantages of our business model in that we have a very low capital equipment technology, which allows us to implement the technology very similar and very quickly in order to meet this requirement. And so the process we've developed can be implemented, relatively low capital cost probably on the order of a million dollars per plant, and it's probably something that could be implemented to a six to nine-month period. So as far as resources, this could be applied to 10 to 20 plants and it would take a similar amount of resources of our other mercury control technology on a plant-by-plant basis.

So the capital equipment is relatively low, it's relatively fast, and so we don't see any problem in implementing the technology to meet this 20-ton-per-year market.

And so you don't think the resources necessary to address this market will detract from your ability to address the MUC market obviously.

No, actually it's two different groups we've got working on it. Through this JV we will probably use a lot more outside resources to do the engineering and installation of these activities. NexGen is going to provide support in the marketing and pretty much take the lead on the more regulatory side of the issue dealing with the IRS in Washington and also in putting some of the business infrastructure in. There's some complications in how this has to be applied to qualify for the tax credits and involving companies that will monetize the tax credits that turns it into revenues for the JV. This is something that NexGen has successfully done for the past ten years in the Section 29, so they're going to be able to handle all of those issues and so we don't see it as a dilution of our other business.

Okay. Excellent. And just backing up just a bit, I just want to try to get my arms around this joint venture, because it sounds like it could really be generating an enormous amount of cash over the intermediate time frame here, but so if you're collecting upwards of $9 per ton and the 20 million tons per year, six of which is coming from the tax credits and the balance from equipment and chemical sales, is that correct?

Yeah, three from the $6, essentially around $6 on the tax credit, $3 on the chemicals.

And Mike had mentioned that you anticipate seeing roughly a 60% margin on those revenues.

Yes. And that'll come from the 60%. Seventy percent is about the margin we would expect on the chemical. And by using these monetizers to turn the tax credits into revenues, they keep a percentage of that, so that's where the only expenditures are going to be, because it's a rather modest business structure. Once it's in place, the equipment runs with very little maintenance and after the marketing is over in two years there's very little marketing so it's a business that will operate for ten years where the primary expenses to it that go from 100% margin to a 60, 70% are the fee the monetizers charge and the cost of the chemicals, both of which will end up being around a 70% margin.

Okay. And in the refined coal arena are there any other affordable choices that some of these boilers might be able to evaluate that you're aware of at this point?

It's a very difficult rule to meet, because it was passed in the late 2004. The technology has to be developed, built, and implemented by the end of 2008 so, you know, a four-year period to get it done. So any technology that involves large cap equipment, it's going to have a hard time getting designed and built in that time frame.

We are going after a very particular niche. I mentioned 20 million tons. That's 20 to 30 plants out of 1100. They're very, very specific, and within that specific niche that we're going after we have very, very solid intellectual property and patents that we already have. We've applied for new patents and so we've got very solid protection that nobody could be using to take away from this area for us, so we feel very comfortable. And really the competition is other choices, the large capital equipment, potential fixes for knocks, socks and mercury, and that's what we're really competing against, rather than other refined coal companies.

But it sounds just like a wonderful intermediate project to engage in. I guess as long as it doesn't dilute your efforts in mercury emissions, but the way it sounded it's somewhat complimentary to --

It's very complementary, Steve.

Excellent. Just one other issue, just a side issue. The FGC business, IU know it's a lower priority for you, but it's really kind of fallen off the boards here this quarter. Could you pay a little bit of attention to that, explain what took place and the revenues to margins?

Well, there's a couple trends there. One is that the solution that we are the original FGC market for was for these hot side precipitators. And over time, those are going to disappear with other options, and so we're going to be losing some revenues in the flue gas conditioning.

Now, on the positive side what we're seeing is that there is a very strong interference between the conventional flue gas conditioning technology, which involves sulfuric acid injection, sulfur trioxide, and the ability to capture mercury. So the mercury control new arena is actually creating some new markets for our flue gas conditioning.

And so what this does means there's a potential increased market for us in that we can sell both a combined mercury control and an alternative flue gas conditioning. It allows us to maybe provide more of a proprietary combination that other companies can't, so we think that even though we will lose over the next two to three years the hot side sales, we see sales picking up on the cold side, electro-side (phonetic) precipitators because of this interference with the ability to control mercury.

Okay. So your previously-stated 10% growth rate in the FGC business is still a viable outlook for that business over the long term?

I think so. We're seeing new markets. We've got a couple of test programs to evaluate this, and this part could be a very key part of our mercury control offering which enforces that, so it's there's the synergism between the mercury control flue gas conditioning is very interesting to us.

Okay. Excellent. Well, thank you very much, Mike.

Okay, Steve.

Our next question comes from the line of [Bryant Demuth] with Mazama Capital. Please state your question.

Hi, Mike. Quick question on the second 45s. Do you have a sense of when the IRS will make clarifications? And then kind of as a tangential question does the 12-31-08 mandate get pushed out if IRS does not clarify the value-add question.

The first part is it probably won't get pushed out because of that, but there's a couple mechanisms that we are dealing with. This could be a correction that the IRS does or the Treasury Department performs or it may have to go back to Congress for a technical correction. We're looking at all of those options. There was no bills moving through Congress during the election year so the Congressional change would have to be postponed to the first session of next year, so this is an issue on how it's enforced, how it's looked at. I think the feedback we're getting is they recognize it is a legitimate issue. We feel it will be resolved in our favor, but it will probably be something that will take another six to nine months to resolve it.

Okay. And then on the vertical integration and the acidic carbon space any more clarity on the timing should is that something we could expect by year end or is that more of an '07?

Probably first quarter '07.

That you'll make the announcement?

Yes.

Okay, guys. Thanks.

Okay.

Thank you.

(Operator instructions.) At this time there are no further questions. I will now turn the conference back to management.

All right. Thank you for your attention and interest in the company. This is a very exciting time for the company as we're implementing this plan. Got two very, very significant growth opportunities that are coming to fruition. The mercury control market we're seeing in these key regulations. We know some changes. No matter how the elections come out within key committees that there's going to be a fertile environment for a multi-pluton federal regulation that could create even a larger national market for mercury control.

The refined coal product we've got a great business model there. We've got a very interesting technology. The market seems interested in it and it could turn into something as big or bigger than our mercury control markets. We've had a couple excellent opportunities here. You'll see progress over the next quarter. We'll be reporting additional backlog, potential sales, and hopefully in the very near future the results of these vertical integrations activities. So again, thank you for your interest in the company and we will keep you informed of progress. Thank you. Goodbye.

Ladies and gentlemen, that concludes your conference call for today. Thank you all for participating and have a nice day. All parties may now disconnect.