U.S. Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
----- EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2006
TRANSITION REPORT PURSUANT TO 13 OR 15(d) OF THE EXCHANGE ACT OF 1934
-----
For the transition period from ________ to ________
Commission File Number: 000-50216
---------------------------------
ADA-ES, INC.
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(Exact name of registrant as specified in its charter)
Colorado 84-1457385
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
8100 SouthPark Way, B, Littleton, Colorado 80120
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(Address of principal executive offices) (Zip Code)
(303) 734-1727
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(Registrant's telephone number)
Not Applicable
--------------
(Former name, former address and former fiscal year,
if changed since last report)
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. Yes [X]; No [ ]
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act. (Check one):
Yes [ ]; No [X]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes[ ]; No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at July 28, 2006
-------------------------- ----------------------------
Common Stock, no par value 5,626,893
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1
PART I FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
ADA-ES, Inc. and Subsidiary
Consolidated Balance Sheets (Unaudited)
June 30, 2006
(amounts in thousands, except share amounts)
June 30, December 31,
2006 2005
-------- --------
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents $ 15,066 $ 14,026
Trade receivables, net of allowance for doubtful accounts of $4 2,906 3,014
Investments in securities 2,084 2,515
Prepaid expenses and other 931 283
-------- --------
Total current assets 20,987 19,838
-------- --------
PROPERTY AND EQUIPMENT, at cost 1,998 1,663
Less accumulated depreciation and amortization (1,128) (1,013)
-------- --------
Net property and equipment 870 650
-------- --------
GOODWILL, net of $1,556 in amortization 2,024 2,024
INTANGIBLE ASSETS, net of $50 and $44, respectively, in amortization 180 156
INVESTMENTS IN SECURITIES 5,392 5,663
OTHER ASSETS 279 385
-------- --------
TOTAL ASSETS $ 29,732 $ 28,716
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable $ 1,403 $ 1,706
Accrued payroll and related liabilities 477 516
Accrued expenses 601 138
Deferred revenue 659 460
-------- --------
Total current liabilities 3,140 2,820
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LONG-TERM LIABILITIES:
Deferred warranty and other 82 40
-------- --------
Total liabilities 3,222 2,860
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COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock; 50,000,000 shares authorized, none outstanding -- --
Common stock; no par value, 50,000,000 shares authorized,
5,626,893 and 5,610,267 shares issued and outstanding, respectively 26,704 26,318
Accumulated other comprehensive income 19 33
Accumulated deficit (213) (495)
-------- --------
Total stockholders' equity 26,510 25,856
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 29,732 $ 28,716
======== ========
See accompanying notes.
2
ADA-ES, Inc. and Subsidiary
Consolidated Statements of Operations (Unaudited)
Three and Six Months Ended June 30, 2006 and 2005
(amounts in thousands, except per share)
Three Months Ended Six Months Ended
June 30, June 30,
2006 2005 2006 2005
------- ------- ------- -------
REVENUE:
Mercury emission control $ 2,635 $ 1,952 $ 5,755 $ 3,559
Flue gas conditioning and other 671 522 1,200 1,087
------- ------- ------- -------
Total net revenues 3,306 2,474 6,955 4,646
COST OF REVENUES
Mercury emission control 1,734 1,334 3,753 2,346
Flue gas conditioning and other 428 216 680 469
------- ------- ------- -------
Total cost of revenues 2,162 1,550 4,433 2,815
------- ------- ------- -------
GROSS MARGIN 1,144 924 2,522 1,831
OTHER COSTS AND EXPENSES:
General and administrative 910 634 1,762 1,186
Research and development 310 188 614 446
Depreciation and amortization 64 40 122 82
------- ------- ------- -------
Total other costs and expenses 1,284 862 2,498 1,714
------- ------- ------- -------
OPERATING INCOME (LOSS) (140) 62 24 117
OTHER INCOME (EXPENSE):
Interest and other expense -- (1) -- (2)
Interest and other income 194 63 388 133
------- ------- ------- -------
Total other income 194 62 388 131
------- ------- ------- -------
INCOME BEFORE INCOME TAX PROVISION 54 124 412 248
DEFERRED INCOME TAX PROVISION (10) (17) (130) (46)
------- ------- ------- -------
NET INCOME 44 107 282 202
UNREALIZED GAINS AND (LOSSES) ON CERTAIN
INVESTMENTS IN DEBT AND EQUITY SECURITIES,
net of tax (31) 27 (14) 9
------- ------- ------- -------
COMPREHENSIVE INCOME $ 13 $ 134 $ 268 $ 211
======= ======= ======= =======
NET INCOME PER COMMON SHARE - BASIC AND DILUTED $ .01 $ .02 $ .05 $ .04
======= ======= ======= =======
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 5,624 4,822 5,620 4,820
======= ======= ======= =======
WEIGHTED AVERAGE DILUTED COMMON SHARES OUTSTANDING 5,875 4,939 5,818 4,997
======= ======= ======= =======
See accompanying notes.
3
ADA-ES, Inc. and Subsidiary
Consolidated Statements of Changes in Stockholders' Equity
Six Months Ended June 30, 2006 and 2005
(amounts in thousands)
(Unaudited)
ACCUMULATED
COMMON STOCK OTHER
---------------------- COMPREHENSIVE ACCUMULATED
SHARES AMOUNT INCOME DEFICIT TOTAL
-------- -------- -------- -------- --------
BALANCES, January 1, 2005 4,796 $ 13,134 $ 34 $ (1,158) $ 12,010
Issuance of stock on exercise of options 37 274 -- -- 274
Tax benefit of stock transactions -- 244 -- -- 244
Stock and options issued for services 4 62 -- -- 62
Return of shares from escrow (20) -- -- -- --
Unrealized gains on investments -- -- 9 -- 9
Net income -- -- -- 202 202
-------- -------- -------- -------- --------
BALANCES, June 30, 2005 4,817 $ 13,714 $ 43 $ (956) $ 12,801
======== ======== ======== ======== ========
BALANCES, January 1, 2006 5,610 $ 26,318 $ 33 $ (495) $ 25,856
Stock and stock options issued to
consultant and directors for services 7 153 -- -- 153
Issuance of stock on exercise of options 10 80 -- -- 80
Stock-based compensation -- 153 -- -- 153
Unrealized losses on investments -- -- (14) -- (14)
Net income -- -- -- 282 282
-------- -------- -------- -------- --------
BALANCES, June 30, 2006 5,627 $ 26,704 $ 19 $ (213) $ 26,510
======== ======== ======== ======== ========
See accompanying notes.
4
ADA-ES, Inc. and Subsidiary
Consolidated Statements of Cash Flows (Unaudited)
Six Months Ended June 30, 2006 and 2005
(amounts in thousands)
SIX MONTHS ENDED
JUNE 30,
--------------------
2006 2005
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 282 $ 202
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 122 82
Loss on asset dispositions and securities 53 50
Deferred tax expense 130 46
Expenses paid with stock and stock options 306 62
Changes in operating assets and liabilities:
Receivables 108 (165)
Prepaid expenses and other (718) (34)
Accounts payable (303) 118
Accrued expenses 479 (41)
Deferred revenue and other 241 19
-------- --------
Net cash provided by operating activities 700 339
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures for equipment and patents (365) (39)
Investment in securities (3,976) (5,362)
Proceeds from sale of securities 4,604 5,107
-------- --------
Net cash provided by (used in) investing activities 263 (294)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on debt and notes payable (3) (3)
Exercise of stock options 80 274
-------- --------
Net cash provided by financing activities 77 271
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INCREASE IN CASH AND CASH EQUIVALENTS 1,040 316
CASH AND CASH EQUIVALENTS, beginning of period 14,026 2,108
-------- --------
CASH AND CASH EQUIVALENTS, end of period $ 15,066 $ 2,424
======== ========
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION:
Cash payments for interest $ 1 $ 2
======== ========
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Tax effect of stock option exercises $ -- $ --
======== ========
Stock and options issued for services $ 306 $ 62
======== ========
See accompanying notes.
5
ADA-ES, Inc. and Subsidiary
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2006
(1) General
-----------
The accompanying consolidated financial statements were prepared in accordance
with U.S. generally accepted accounting principles and reflect all adjustments
which are, in the opinion of management, necessary for fair representation of
the financial results of ADA-ES, Inc. and subsidiary (the Company) for the
interim periods shown. Such statements should be considered in conjunction with
Registrant's Form 10-KSB, filed for the year ended December 31, 2005.
(2) Investments
---------------
Investments in available-for-sale securities consisting of certificates of
deposit, equities and corporate, government and municipal bonds maturing in the
next year are reported as current assets at their fair values in investments in
securities. Investments in available-for-sale securities not included in current
assets are reported at their fair values in non-current investments in
securities. Cumulative unrealized gains and losses on such securities are shown,
net of their tax effect, as a component of shareholders' equity and such gains
or losses related to the current period are shown in the determination of
comprehensive income as reported on the statement of operations.
(3) Stock Based Compensation
----------------------------
Effective January 1, 2006, the Company adopted Statement of Financial Accounting
Standards No. 123R (SFAS 123R), Share-Based Payment, which requires the Company
to record equity compensation to employees at fair value. Prior to January 1,
2006, the Company elected to use APB 25, which required expense to be recognized
only to the extent the exercise price of the stock-based compensation was below
the market price on the date of grant. The modified prospective approach was
used in adopting SFAS 123R; therefore, results prior to January 1, 2006 have not
been restated. For the three and six months ended June 30, 2006, $74,000 and
$154,000, respectively, were charged to expense for equity compensation, which
amounted to $52,000 and $105,000, respectively, after tax and ($0.01) and
($0.02), respectively, of basic and diluted earnings per share.
If compensation cost for the Company's stock-based compensation plans had been
determined based on the fair value at the grant dates for awards under those
plans consistent with the method of SFAS 123R during 2005, then the Company's
net income per share for the three and six months ended June 30, 2005 would have
been adjusted to the pro forma amounts indicated below:
Three Months Six Months
Ended Ended
June 30, 2005 June 30, 2005
------------- -------------
Net income as reported $ 107,000 $ 202,000
Deduct: Stock-based compensation cost under SFAS 123R (54,000) (98,000)
----------- -----------
Pro forma net income $ 53,000 $ 104,000
=========== ===========
Pro forma basic and diluted net income per share:
Pro forma shares used in the calculation of pro forma
net income per common share -
Basic 4,822,000 4,820,000
=========== ===========
Diluted 4,939,000 4,997,000
=========== ===========
Reported net income per common share -
Basic and Diluted $ 0.02 $ 0.04
=========== ===========
Pro forma net income per common share -
Basic and Diluted $ 0.01 $ 0.02
=========== ===========
(4) Stock Options
-----------------
During 2003 the Company adopted the 2002 ADA-ES, Inc. Stock Option Plan and
reserved 400,000 shares of common stock for issuance under the plan. In general,
all options granted under the plan expire ten years from the date of grant
unless otherwise specified by the Company's board of directors. The exercise
price of an option will be determined by the compensation committee of the board
of directors at the time the option is granted and will not be less than 100% of
the fair market value of a share of our common stock on the date the option is
granted. The compensation committee may provide in the option agreement that an
option may be exercised in whole immediately or is exercisable in increments
through a vesting schedule. During the first half of 2006, 19,900 options were
granted under this plan.
6
During 2004, the Company adopted the 2004 Executive Stock Option Plan. This plan
authorized the grant of up to 200,000 options to purchase shares of the
Company's Common Stock to executive officers of the Company, all of which were
granted in 2004. The option exercise price of $8.60 per share was the market
price on the date of the grant. The options are exercisable over a 10-year
period based on a vesting schedule that may be accelerated based on performance
of the individual recipients as determined by the Board of Directors. In January
2006, the Board of Directors authorized the vesting of 38,428 options under this
plan with a fair value of $77,000. Such options were exercisable at June 30,
2006.
During 2004, the Company adopted a plan (the "2004 Plan") for the issuance of
shares and the grant of options to purchase shares of the Company's Common Stock
to the Company's non-management directors. The 2004 Plan provided for the award
of stock of 603 shares per individual non-management director or 4,221 shares in
total, and the grant of options of 5,000 per individual non-management director
or 35,000 in total, all of which were formally granted and issued in 2005 after
approval of the 2004 Plan by the stockholders. The option exercise price of
$13.80 per share for the stock options granted on November 4, 2004 was the
market price on the date of the grant. The options are exercisable over a period
of five years and will vest over a three-year period, one-third each year for
continued service on the Board. If such service is terminated, the non-vested
portion of the option will be forfeited. During the first half of 2006, 15,000
of such options were forfeited after the resignation of two directors. As of
June 30, 2006, one-third of the remaining outstanding options, or a total of
6,668 options had vested and were exercisable.
During 2005 the Company adopted the 2005 Directors' Compensation Plan (the "2005
Plan"), which authorized the issuance of shares of Common Stock and the grant of
options to purchase shares of the Company's Common Stock to non-management
directors. The 2005 Plan provides a portion of the annual compensation to
non-management directors of the Company in the form of awards of shares of
Common Stock and vesting of options to purchase Common Stock of the Company for
services performed for the Company. Under the 2005 Plan, the award of stock is
limited to not more than 1,000 shares per individual per year, and the grant of
options is limited to 5,000 per individual in total. The aggregate number of
shares of Common Stock reserved for issuance under the 2005 Plan totals 90,000
shares (50,000 in the form of stock awards and 40,000 in the form of options).
The exercise price will be the market price on the date of grant, the shares of
Stock underlying the option will vest for exercise at a rate of no more than
1,667 shares per annual period per individual, and any unvested shares of Stock
that are outstanding at the date the individual is no longer a director will be
forfeited. The 2005 Plan, if not terminated earlier by the Board, will terminate
ten years after the date of its adoption. In January 2006, the Board of
Directors authorized the issuance of 1,000 shares of Common Stock each, or a
total of 7,000 shares, to the non-management directors of the Company. No
options have been granted under the 2005 Plan.
Following is a table of options activity for the six months ended June 30, 2006:
Weighted
Average
Employee Non-Employee Exercise
Options Options Price
--------- ------------ ---------
OPTIONS OUTSTANDING, January 1, 2006 351,483 80,000 $10.99
Options granted 19,900 - $20.20
Options expired (15,000) - $13.80
Options exercised (9,626) - $ 8.36
--------- --------- ---------
OPTIONS OUTSTANDING, June 30, 2006 346,757 80,000 $11.38
========= ========= =========
The weighted average remaining contractual life for all options as of June 30,
2006 was approximately 8.0 years. At June 30, 2006, 140,249 options with a
weighted average exercise price of $10.83 were fully vested and exercisable. Of
the remaining 286,508 options, 60,700 options with a weighted average exercise
price of $13.16 vest in 2006, 47,567 options with a weighted average exercise
price of $16.88 vest in 2007, 4,975 options with a weighted average exercise
price of $20.20 vest in 2008, and 149,267 options with an exercise price of
$8.60 vest at the discretion of the board of directors based on specific
achievements of individual employees, with minimum annual vesting of 10,000 and
maximum vesting of 20,000. Additionally, 24,000 options with an exercise price
of $14.60 vest at the discretion of the board of directors upon achievement of
performance objectives.
7
The average fair value of each employee option granted in 2006 was approximately
$4.90 and was estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted average assumptions.
Expected volatility 38%
Risk-free interest rate 4.0%
Expected life of options (in years) 4.0
Expected dividends 0
Following is information related to options outstanding/exercisable at June 30,
2006:
Shares Outstanding Shares Exercisable
------------------ ------------------
Weighted
Weighted Weighted Average
Average Average Contractual
Range Number of Exercise Number of Exercise Life
Shares Price Shares Price (in years)
------ ----- ------ ----- ----------
$2.80 11,665 $ 2.80 11,665 $2.80 7.3
$8.60 - $10.00 248,617 $ 8.88 73,279 $9.24 8.0
$13.80 - $18.61 146,575 $15.09 55,305 $14.64 8.0
$20.20 19,900 $20.20 0 n/a 9.6
------- ------ ------- ------ ---
426,757 $11.38 140,249 $10.83 8.0
======= ====== ======= ====== ===
The aggregate intrinsic value of options exercised in the six months ended June
30, 2006 and 2005, based on a market price of $17.15 and $15.10, respectively,
was $85,000 and $207,000, respectively. The aggregate intrinsic value of options
exercisable at June 30, 2006 was $886,000 based on a market price of $17.15.
As of June 30, 2006, total compensation costs related to non-vested options,
which had not yet been recognized was $496,000. The weighted average period over
which such expense is expected to be recognized is 2.0 years.
(5) Business Segment Information
--------------------------------
The Company has two reportable segments: mercury emission control (MEC) and flue
gas conditioning and other (FGC). All assets are located in the US and are not
evaluated by management on a segment basis. All significant customers are US
companies.
Three Months Ended June 30, 2006 (amounts in thousands)
MEC FGC Total
--- --- -----
Total revenue $2,635 $671 $3,306
Segment profit $519 $214 $733
Three Months Ended June, 2005 (amounts in thousands)
MEC FGC Total
--- --- -----
Total revenue $1,952 $522 $2,474
Segment profit $348 $218 $566
Six Months Ended June 30, 2006 (amounts in thousands)
MEC FGC Total
--- --- -----
Total revenue $5,755 $1,200 $6,955
Segment profit $1,205 $379 $1,584
8
Six Months Ended June 30, 2005 (amounts in thousands)
MEC FGC Total
--- --- -----
Total revenue $3,559 $1,087 $4,646
Segment profit $607 $491 $1,098
A reconciliation of reported total segment profit to Net Income for the periods
shown above is as follows (amounts in thousands). Non-allocated general and
administrative expenses include costs that benefit the business as a whole and
are not directly related to one of our segments. Such costs include but are not
limited to accounting and human resources staff, information systems costs,
facility costs, audit fees and corporate governance expenses.
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2006 2005 2006 2005
------- ------- ------- -------
Total segment profit $ 733 $ 566 $ 1,584 $ 1,098
Non-allocated general & admin
expenses (809) (464) (1,438) (899)
Depreciation and amortization (64) (40) (122) (82)
Interest, other income and taxes 184 45 258 85
------- ------- ------- -------
Net Income $ 44 $ 107 $ 282 $ 202
======= ======= ======= =======
----------------------------------------------------
Item 2. Management's Discussion and Analysis or Plan of Operation.
------------------------------------------------------------------
This Quarterly Report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934 that involve risks and uncertainties. The following
discussion and analysis of our financial condition and results of operations
should be read in conjunction with the audited consolidated financial statements
and related notes thereto included in our Annual Report on Form 10-KSB for the
year ended December 31, 2005. Words or phrases such as "will," "hope," "expect,"
"anticipate," "intend," "plan" or similar expressions are generally intended to
identify forward-looking statements. Forward-looking statements in this report
include statements regarding our expectations for market growth and continued
positive cash flow; the impact of governmental regulations and the outcome of
pending litigation contesting them; timing of performance of services under
existing contracts and associated revenue recognition; expected increase in
merger and acquisition activities; payments expected from NexGen; expected
growth in MEC revenues, operating cash flow and research and development
expenses; sources of MEC revenue growth; anticipated declines in the market for
FGC chemicals and services and revenues from such market, and gross margins;
expenses under our defined contribution and 401(k) plan; our ability to satisfy
performance guaranties; sufficiency of working capital; future capital
expenditures; realization of net deferred tax assets; outcome of any
governmental audits of our contracts; availability of skilled labor; and no
material effect on our internal controls. Forward-looking statements involve
risks and uncertainties that could cause actual results to differ materially
from the results discussed herein.
The principal risks and uncertainties that may affect our actual performance and
results of operations include the following: general economic conditions;
adverse weather; changes in federal income tax laws and federal funding for
environmental technology/specialty chemicals programs; changes in federal and
state governmental regulations; clarification of "market value" requirements by
Congress or the Internal Revenue Service impacting our joint venture with
NexGen; changes in governmental and public policy; the outcome of pending
litigation regarding EPA regulations; permitting requirements; changes in market
demand and cost/benefit analysis of our products and services; results of
demonstrations of our technologies; construction of new coal-fueled power plants
and significant retrofitting of existing plants; availability and pricing of
coal compared to other energy sources; changes in relationships with key
business partners; intellectual property protection of our technologies and
availablity of additional intellectual property necessary for our business;
dependence on key employees; availability of skilled personnel; changes in
economic conditions specific to one or more of our markets and businesses;
competition; availability of raw materials; and unexpected operations
difficulties. Other risks and uncertainties may also affect the outcome of our
actual performance and results of operations. You are cautioned not to place
undue reliance on the forward-looking statements made in this Management's
Discussion and Analysis of Financial Condition and Results of Operations.
Overview
We provide environmental technologies and specialty chemicals to the
coal-burning electric utility industry. Revenues are generated through (1) time
and materials and fixed-price contracts for the emerging mercury emission
control (MEC) market, several of which 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.
9
Mercury has been identified as a toxic substance and, pursuant to a court order,
the EPA issued regulations for its control in March 2005. The 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, which are in
various stages of enactment and challenge in the courts. As many as 1,100
existing coal-fired boilers may be affected by such regulations, if and when
they are fully implemented. We have recently seen a significant increase in new
plant projects. DOE's latest report includes 153 new projects totaling 93GW 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) DOE- and industry-funded
contracts mentioned above, (ii) mercury testing services and (iii) equipment
sales and commissions on sorbents sold to new plants and existing plants
affected by the implementation of enacted regulations. State regulations and
increasing numbers of consent decrees are becoming the largest market driver for
this part of our business. Although we expect this market to show steady growth
over the next several years, more significant revenue growth is anticipated when
federal regulations impact a significant portion of existing boilers.
The market for our FGC chemicals and services is relatively flat and is expected
to decline in the near-term. Margins on these products are typically higher than
what we recognize for our present MEC sales and represent an important
contribution to the overall profitability of the Company.
Thus far in 2006, we have signed contracts for seven ACI systems to be delivered
in 2006 and 2007, bringing our total number of ACI systems installed or
currently in process to nine. In addition, one system was installed in
partnership with a third party for whom we provided design services through a
DOE contract. We are entitled to royalties on future sorbent sales to the
utility industry in North America purchased from a vendor we have a relationship
with. Revenue from ACI system contracts totaled $2.4 million for the six months
ended June 30, 2006 and $4.4 million is remaining to be recognized.
Thus far in 2006, we have also signed two development and testing contracts with
DOE with revenues totaling approximately $7.5 million, including industry cost
share amounts, the services for which are expected to be performed over the
period from contract signing through the fall of 2008. We were also awarded a
$100,000 research grant from DOE in 2006 to develop an improved activated carbon
manufacturing process, which activities are expected to be conducted over the
next six months.
Assuming no changes in government funding, we expect to recognize over the next
several years the remaining revenue on the in-progress and new awards totaling
$18.0 million as of June 30, 2006. We recognized $2.7 million related to DOE and
industry co-funded contracts in the first half of 2006. We expect to recognize
revenue from these contracts of approximately $5.5 million in total for 2006,
including the revenue recognized in the first half. If further funding were not
approved, the Company would decrease or cease activities on those contracts and
would expect to maintain a positive cash flow but at a reduced level. We expect
DOE programs to represent a decreasing percentage of revenues over the next few
years as we focus more on market growth for ACI systems.
In June 2006, we signed a Letter of Intent (LOI) to form a 50/50 joint venture
with NexGen Resources Corporation ("NexGen") to pursue opportunities based upon
our refined coal technology. The joint venture is structured to generate tax
credits with a current value of approximately $5.60 per ton of refined coal
under Section 45 under the American Jobs Creation Act of 2004. The tax credits
can be earned for a period of ten years ending in or before 2019. Pursuant to
the LOI, NexGen paid us a nonrefundable fee of $100,000 upon signing, and is
expected to pay $900,000 upon signing of a definitive agreement and completion
of certain testing, and two additional payments of $2 million each on the first
and second anniversary of the signing of the definitive agreement, if NexGen
opts to continue its participation in the joint venture. The $100,000 payment
received has been recorded as deferred revenue. The LOI also calls for NexGen to
pay 50% of future development costs for the rights to one-half of any tax
credits generated from future sales of refined coal.
As part of our strategy to address the growing MEC market, we are not only
pursuing internal, organic growth, but we have also been and expect to be
engaged in merger and acquisition (M&A) activities, particularly with respect to
the vertical integration of our business to establish an invested role in the
production and supply of activated carbon. The major revenue sources from the
growing MEC market are expected to include engineering services, equipment sales
and activated carbon supply. Our M&A activities have been and will likely be
focused on candidates engaged in those businesses. The costs we incur in our M&A
activities may be significant. Such costs are generally deferred and either (a)
expensed when it has been determined they are no longer of future value, or (b)
capitalized as part of an acquisition and then subject to future impairment
evaluations. Included in other long-term assets as of June 30, 2006 are deferred
charges amounting to approximately $412,000 related to our M&A activities
incurred during the first half of 2006, which may be expensed in future periods
based on the above criteria.
Liquidity and Capital Resources
We had a positive working capital of $17.8 million at June 30, 2006, compared to
working capital of $17.0 million at December 31, 2005. The increase resulted
from an increase in cash, offset by a decrease in short-term investments due to
liquidation of certificate of deposits and fluctuations in operating assets and
liabilities in the normal course of business. In addition to working capital, we
had long-term investments in securities, accounted for as "available-for-sale"
investments, of approximately $5.4 million and $5.7 million at June 30, 2006 and
December 31, 2005, respectively. We intend to retain a portion of these
investments to demonstrate strength in our financial position to support
performance guarantees we have been and may continue to provide on sales of ACI
systems. We may also use a portion of such investments and cash on hand to fund
growth of the Company, which may include expansion of product offerings and
10
strategic acquisitions. We believe that existing and expected future working
capital, which we expect to come from positive cash flow, will be sufficient to
meet the anticipated operating needs of the Company in 2006. However, we cannot
be certain that positive cash flow that we have achieved historically will
continue, and it is possible that we could be required to expend some of our
current working capital to fund operations, although we consider this unlikely.
In addition, we may need to raise additional capital to fund strategic
acquisitions.
Our principal source of liquidity is our existing working capital and positive
operating cash flow. The continuation of positive cash flow is somewhat
dependent upon the continuation of chemical sales and operations of the flue gas
conditioning (FGC) units currently in-place in Illinois, Louisiana and Iowa.
Each of these units provided an average monthly cash flow of approximately
$30,000 in 2005. One of these customers is performing a process upgrade expected
to be completed in 2006 that may reduce or eliminate the requirement for FGC.
Since the beginning of 2006, we performed a successful demonstration project at
one plant that has resulted in continued chemical sales, although at a lower
level and with a lower gross margin than existing customers. While we have been
awarded a contract to perform a demonstration project at another plant beginning
in the first half of 2006, we are not certain that this demonstration will be
successful or will result in future sales of FGC equipment and chemicals.
Unsatisfactory results for any of our FGC customers, which could be caused by a
single factor (or some combination of factors) such as changes in coal,
mechanical difficulties (whether in the FGC unit or otherwise), changes in
regulations, and/or overall cost/benefit analysis, at any of those units, are
likely to result in a decrease or termination of the sale of chemicals for such
units and a reduction in the cash flow we have historically received, thereby
reducing that portion of our liquidity that has been provided by positive cash
flow.
We have planned capital expenditures to sustain and improve ongoing operations
for 2006 estimated at $415,000, which include planned expenditures for build out
of space and office equipment to accommodate new employees, replacement of
obsolete computers and office equipment and field equipment. We expect to fund
these requirements out of existing working capital and cash flow from
operations.
Under our defined contribution and 401(k) pension plan, we match up to 5% of
salary amounts deferred by employees in the Plan and contribute certain amounts
based on the profits of the Company, which amounts are determined annually by
our Board of Directors. During the six months ended June 30, 2006 and 2005, we
recognized $55,000 and $41,000, respectively, of matching expense; this expense
is expected to amount to approximately $123,000 in 2006. In the past, the
Company has also made discretionary contributions to the Plan and employees.
Based on results for 2005, the amount paid to the plan totaled $108,000 and was
paid in the form of cash to the accounts of all eligible employees in February
2006. During the first halves of 2006 and 2005, the Company accrued
approximately $58,000 and $26,000, respectively, for such payments based on
results for the respective periods.
We recorded net deferred tax assets of $217,000 and $340,000 as of June 30, 2006
and December 31, 2005, respectively. Based on existing R&D contracts supported
by the DOE, the current industry and regulatory environment and other
expectations of continuing work, the Company has determined that it is more
probable than not that deferred tax assets will be realized in the future.
Cash flow from operations totaled $700,000 for the first half of 2006 compared
to $339,000 for the same period of 2005. Cash flow from operations in 2006
increased from 2005 primarily as a result of increases in net income, expenses
paid with stock and stock options, and deferred income taxes, offset by
variations in operating asset and liability accounts due to fluctuations in the
normal course of business. The 2006 operating cash flow was reduced by
additional prepaid expenses and other current assets totaling ($718,000) as a
result of increases in prepaid insurance, deferred project costs and interest
receivable. The 2006 operating cash flow was increased as a result of increased
accrued expenses in the net amount of $479,000 and other current liabilities,
which net to $241,000 but include a $529,000 overpayment by a customer that was
refunded in July 2006 and is shown by us as a current liability as of June 30,
2006.
Net cash provided by investing activities was $263,000 for the first half of
2006 compared to cash used in investing activities of ($294,000) in the first
half of 2005. In 2006, certificates of deposit were liquidated and held as cash,
whereby proceeds from sales of securities exceeded purchases of securities. Such
11
excess was offset somewhat by trading activity on investments to maintain a
targeted portfolio balance and maximize earnings, as well as re-investment of
gains that occurred during the period. The net increase in cash from investment
activity was offset by a use of cash for purchases of property and equipment for
the build-out of additional space in our current headquarters location to
accommodate new employees and field equipment.
Cash provided by financing activities was $77,000 and $271,000 in the first half
of 2006 and 2005, respectively. The decrease was due to the exercise of fewer
stock options in 2006. We may require additional debt or equity financing to
support future growth, including potential acquisitions.
Results of Operations
Revenues totaled $3,306,000 and $6,955,000 for the quarter and six months ended
June 30, 2006, respectively, versus $2,474,000 and $4,646,000 for the same
periods in 2005, representing increases of 34% for the quarter and 50% for the
first six months of 2006. Revenues in the MEC segment for 2006 increased for the
second quarter by $683,000 (35%), and FGC and other activities increased by
$149,000 (29%). For the six-month period, revenues in the MEC segment for 2006
increased by $2,196,000 (62%), and FGC and other activities increased by
$113,000 (10%). Based on contracts in hand and other anticipated projects, we
anticipate that total revenues for 2006 will grow by approximately 30% from the
2005 level, a decrease from our original forecast of 35% due to slight delays in
timing of equipment deliveries and for conducting certain projects as discussed
below. We have been hiring personnel in response to the growth we have realized
in the past and expect to achieve in 2006, and adequate resources of skilled
labor appear to be available to meet anticipated needs.
Revenues in the first half of 2006 from the MEC segment were comprised of
government and industry-supported contracts (47%), sales and installation of
activated carbon injection (ACI) systems (42%) and consulting services (10%),
compared to 67%, 3% and 30%, respectively, in the first half of 2005. While
revenues from both the government and industry-supported contracts and the ACI
systems sales increased from the first half of 2005 to the first half of 2006,
the most significant growth occurred in the sales and installations of ACI
systems, which increased $2.4 million. We expect growth in 2006 in the MEC
segment to result primarily from sales of ACI systems in response to mercury
emission control legislation and from existing and recently awarded government
and industry-supported contracts. Activities in two of our DOE contracts are
behind the original planned schedule due to the unavailability of one of the
host sites and test results that did not meet project goals. Discussions are
underway with DOE as to reallocating a portion of the remaining contract amounts
to other activities. 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 these DOE contracts, and funding is always subject to
unknown and uncontrollable contingencies.
FGC and other revenues increased due to increased shipments of chemical and
revenues related to two demonstration projects. We expect FGC and other revenues
in 2006 to be somewhat lower than 2005, as we believe that planned customer
purchases for 2006 will be less than such purchases made in 2005.
Cost of revenues increased by $612,000 and $1,618,000, respectively, in the
second quarter and first six months of 2006 as compared to the same periods in
2005 as a result of increased revenue generating activities. Gross margins were
35% and 36% for the quarter and six months ended June 30, 2006, respectively, as
compared to 37% and 39%, respectively, for the same periods in 2005. The
decrease is a result of decreased margins in the FGC and other segment as
discussed below.
Cost of revenues for the MEC segment increased by $400,000 and $1,407,000,
respectively, in the second quarter and first six months of 2006, as compared to
the same periods in 2005 as a result of the increased revenue generating
activities noted above. Gross margins for this segment were 34% and 35% for the
quarter and six months ended June 30, 2006, respectively, as compared to 32% and
34%, respectively, for the same periods in 2005. The increase in gross margins
from the prior periods resulted from greater amounts of industry cost share that
improve our margins on our government and industry-supported contracts. The
changes in MEC segment profits for periods under review are a result of the same
factors.
Cost of revenues for the FGC and other segment increased by $212,000 and
$211,000, respectively, in the second quarter and first six months of 2006, as
compared to the same periods in 2005 also as a result of the increased revenue
generating activities noted above. Gross margins for this segment were 36% and
43% for the quarter and six months ended June 30, 2006, respectively, as
compared to 59% and 57%, respectively, for the same periods in 2005. The
decrease in gross margins from 2005 to 2006 is a result of increased FGC sales
that include sales of a product we license from ARKAY Technologies, which carry
a lower margin than historical FGC sales, and lower margins typically recognized
on the demonstration projects we carried out in 2006. FGC revenues primarily
include chemical sales, which carry a higher margin than the fixed price and
time and materials MEC revenues. FGC and other revenues comprised 17% of total
revenues thus far in 2006, compared to 23% in 2005. The changes in the FGC
segment profits for the periods under review are a result of the same factors.
12
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. Overall
gross margins for 2006 are therefore expected to decline further from the levels
achieved in 2005, as a result of an increasing proportion of fixed price and
time and materials work, our assumption of an increasing share of costs in the
field demonstration projects in which we have elected to participate and pricing
pressure caused by increased competition.
General and administrative expenses increased by $276,000 or 43%, from $634,000
to $910,000, and by $576,000 or 49% to $1,762,000 in the second quarter and the
first half of 2006, respectively. The dollar increase in 2006 resulted primarily
from compensation expenses related to the implementation of SFAS 123R ($80,000
for the quarter and $153,000 for the six months ended June 30, 2006); legal and
increased director fees and expenses incurred to maintain compliance with public
company regulations (approximately $50,000 for the quarter and $100,000 for the
six months); facilities, benefits and other overhead expenses resulting from
increases in number of employees(approximately $80,000 for the quarter and
$150,000 for the six months); and expenses related to our M&A activities noted
above ($79,000 for the quarter and six months).
Research and development expenses increased by $122,000 or 65% in the second
quarter of 2006, and $168,000 or 38% in the first half of 2006 as compared to
the same periods in 2005. 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. Future consolidated research and
development expenses, except for those anticipated to be funded by the DOE
contracts and others that may be awarded, are expected to continue to grow at a
rate of about 10% annually for the next several years, with an expected increase
of about 40% in total for 2006 compared to 2005.
The Company had net interest and other income of $194,000 for the second quarter
and $388,000 in the first half of 2006, as compared to $63,000 and $133,000 for
the same periods in 2005. Interest and other income increased in 2006 due to an
increase in invested balances and increasing interest rates.
Unrealized losses on investments in debt and equity securities amounted to
($31,000) and ($14,000), respectively, for the second quarter and first six
months of 2006 as compared to gains of $27,000 and $9,000 for the same periods
in 2005. The losses incurred in 2006 were primarily the result of increasing
interest rates, which correspondingly tend to decrease the market value of our
investments in longer-term fixed-rate debt securities.
The deferred income tax provision for the first half of 2006 represents an
effective tax rate of approximately 32% as compared to a rate of approximately
19% for the same period in 2005. The 2005 rate was lower due to the favorable
tax impact of employee stock options exercised during the first half of 2005.
During the preparation of its effective tax rate, the Company uses an annualized
estimate of pre-tax earnings or loss. Throughout the year, this annualized
estimate may change based on actual results and annual earnings or loss estimate
revisions. Because the Company's permanent tax benefits expected for 2006 are
relatively constant, changes in the annualized estimate may have a significant
impact on the effective tax rate in future periods.
Critical Accounting Policies and Estimates
Significant estimates are used in preparation of our financial statements and
include (1) our allowance for doubtful accounts, which is based on historical
experience; (2) our valuation and classification of investments as
"available-for-sale" securities, which is based on estimated fair market value;
(3) our percentage of completion method of accounting for significant long-term
contracts, which is based on estimates of gross margins and of the costs to
complete such contracts; and (4) warranty reserves related to sales of ACI
systems to cover performance guarantees that we provided on certain contracts.
In addition, amounts invoiced for government contracts are subject to change
based on the results of future audits by the federal government. We have not
experienced significant adjustments in the past from such audits, and we do not
expect significant adjustments will be required in the future. We also use our
judgment to support the current fair value of goodwill and other intangible
assets of $2.2 million on the consolidated balance sheet. Although we have
performed an evaluation of the goodwill and intangible asset values which
supports the recorded value, market demand for our products and services could
change in the future, which would require a write-down in recorded values. As
with all estimates, the amounts described above are subject to change as
additional information becomes available, although we are not aware of anything
that would cause us to believe that any material changes will be required in the
near term.
Recently Issued Accounting Policies
Effective January 1, 2006, we adopted SFAS 123R using the modified prospective
approach. See Note 3 to the consolidated financial statements for further
details.
13
Item 4. CONTROLS AND PROCEDURES
-------------------------------
Disclosure Controls and Procedures
We maintain disclosure controls and procedures designed to ensure that the
information required to be disclosed by us in the reports we file with the
Securities and Exchange Commission (SEC), is recorded, processed, summarized and
disclosed within the time periods specified in the rules of the SEC. Based on
their evaluation of our disclosure controls and procedures which took place as
of June 30, 2006, the end of the period covered by this report, the Chief
Executive and Financial Officers believe that these controls and procedures are
effective to ensure that (i) we are able to record, process, summarize and
disclose the information we are required to disclose in the reports we file with
the SEC within the required time periods and (ii) information required to be
disclosed by us in such reports is accumulated and communicated to our
management, including our principal executive and financial officers, or persons
performing similar functions, as appropriate to allow timely decisions regarding
required disclosures.
Internal Control Over Financial Reporting
The Company also maintains a system of internal controls designed to provide
reasonable assurance that: transactions are executed in accordance with
management's general or specific authorization; transactions are recorded as
necessary (1) to permit preparation of financial statements in conformity with
generally accepted accounting principles, and (2) to maintain accountability for
assets; access to assets is permitted only in accordance with management's
general or specific authorization; and the recorded accountability for assets is
compared with the existing assets at reasonable intervals and appropriate action
is taken with respect to any differences.
During the Company's last fiscal quarter, we evaluated our disclosure controls
and procedures and our internal controls over financial reporting and concluded
that (i) our disclosure controls and procedures were effective as of June 30,
2006, and (ii) there have been no changes in such controls or in other factors
that have materially affected, or are reasonably likely to materially affect,
those controls.
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders.
The annual meeting of our shareholders was held on May 10, 2006. At the meeting,
at which a quorum of the requisite number of shares under our bylaws for the
conduct of business was present in person or by proxy, management's slate of
nominees was voted on by the shareholders with the following results:
Election of Directors For Withheld
-------------------------------------------------------------
Robert N. Caruso 3,277,281 12,240
Michael D. Durham 3,271,546 17,975
John W. Eaves 3,273,051 16,470
Derek C. Johnson 3,270,968 18,553
Ronald B. Johnson 3,285,084 4,437
Mark H. McKinnies 3,271,221 18,300
Rollie J. Peterson 3,279,199 10,322
Jeffrey C. Smith 3,278,011 11,510
Item 6. Exhibits
----------------
31.1* Certification of Chief Executive Officer of ADA-ES, Inc. Pursuant to
17 CFR 240.13a-14(a)or 17 CFR 240.15d-14(a)
31.2* Certification of Chief Financial Officer of ADA-ES, Inc. Pursuant to
17 CFR 240.13a-14(a)or 17 CFR 240.15d-14(a)
32* Certification Pursuant to 18 U.S.C. Section 1350
* These certifications are "furnished" and shall not be deemed filed for
purposes of Section 18 of the Securities Exchange Act of 1934, as amended.
14
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934,
the Registrant caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
ADA-ES, Inc.
------------
Registrant
Date: August 7, 2006 /s/ Michael D. Durham
---------------------
Michael D. Durham
President and Chief Executive Officer
Date: August 7, 2006 /s/ Mark H. McKinnies
---------------------
Mark H. McKinnies
Chief Financial Officer
EXHIBIT INDEX
31.1* Certification of Chief Executive Officer of ADA-ES, Inc. Pursuant to
17 CFR 240.13a-14(a)or 17 CFR 240.15d-14(a)
31.2* Certification of Chief Financial Officer of ADA-ES, Inc. Pursuant to
17 CFR 240.13a-14(a)or 17 CFR 240.15d-14(a)
32* Certification Pursuant to 18 U.S.C. Section 1350
*These certifications are "furnished" and shall not be deemed filed for purposes
of Section 18 of the Securities Exchange Act of 1934, as amended.
15