U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
Commission File Number: 000-50216
ADA-ES, Inc.
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(Name of small business issuer in its charter)
Colorado 84-1457385
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(State of incorporation) (IRS Employer Identification No.)
8100 SouthPark Way, Unit B, Littleton, Colorado 80120-4525
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(Address of principal executive offices, including Zip Code)
(Issuer's telephone number, including area code): (303) 734-1727
Securities registered under Section 12(g) of the Exchange Act:
Title of class
Common Stock, no par value
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Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. [X] Yes [ ] No
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [ X ]
State issuer's revenues for its most recent fiscal year. $ 5,863,000
State the aggregate market value of the voting and non-voting common equity held
by nonaffiliates computed by reference to the price at which the common equity
was sold, or the average bid and asked prices of such common equity, as of a
specified date within the past 60 days. As of March 19, 2004 was $20,938,000.
Number of shares outstanding of registrant's Common Stock, no par value as of
March 19, 2004 - 3,689,800.
DOCUMENTS INCORPORATED BY REFERENCE:
None
Transitional Small Business Disclosure Format: Yes __ No X
PART I
Item 1. Description of Business
This Annual Report may contain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933. In particular, such forward-looking
statements may be found in this section under "Description of Business," and
below in Item 6. under "Management's Discussion and Analysis or Plan of
Operation ." Actual events or results could differ materially from those
discussed in the forward-looking statements as a result of various factors
including those set forth below or under the heading "Management's Discussion
and Analysis or Plan of Operation."
(a) Business Development.
ADA-ES, Inc. ("ADA-ES" or "Registrant" or "Company", which term includes its
wholly-owned subsidiary unless otherwise indicated) is an environmental
technology and specialty chemicals company helping electric utility companies
remain competitive while meeting environmental regulations. The major activities
of the Company include the sale of flue gas conditioning ("FGC") and other
chemicals and technologies for electric generating coal-fired boilers, and
testing and services related to the emerging market for mercury emission control
("MEC") for such boilers. ADA-ES was incorporated under the laws of the State of
Colorado in 1997 to serve as the holding company for ADA-ES, LLC. In May 1997,
Earth Sciences, Inc. ("ESI" or "Earth Sciences") acquired a 51% equity position
in ADA-ES, LLC through a combination of stock and cash. The acquisition
agreement provided for payments of cash and notes and included an option for
Earth Sciences to acquire the remaining equity interests in ADA-ES, LLC from the
ADA-ES shareholders. In May 1998, Earth Sciences exercised that option,
acquiring a 100% interest in ADA-ES, LLC by issuance of 1,716,000 shares of
stock to the shareholders of ADA-ES in exchange for all their shares in ADA-ES.
As of January 1, 2003, Earth Sciences transferred all of its ownership in
ADA-ES, LLC into ADA-ES. In March 2003 ADA-ES and ESI entered into an agreement
for the pro rata distribution of all the common stock of ADA-ES to the
shareholders of ESI. The distribution occurred on September 12, 2003 based on a
record date of August 29, 2003 as set by the ESI Board of Directors. The
distribution resulted in ADA-ES being a separate company operated apart from
ESI.
During 2003, ADA-ES (a) maintained its FGC business through continued chemical
sales and service on four full-time units, one temporary unit and a
government-funded research and development contract for development of new FGC
products; (b) continued limited sales and further demonstrated a new
anti-slagging product through a joint venture with Arch Coal, Inc. ("Arch")
formed to co-market that product; and (c) substantially increased its MEC
business through government and industry funded contract work including existing
and new contracts and a growing number of commercial activities.
Thus far in 2004, ADA-ES is in the final phases of long-term testing of a
mercury emission control system at the Southern Company's Gaston plant in
Alabama under a contract awarded in the fall of 2002 and is actively making
preparations to participate in (1) a new 5-year government- and
industry-supported contract for permanent installation and evaluation of mercury
removal and related activities at another utility, and (2) a new 3-year
government and industry supported contract for testing of mercury emission
control systems at four different plants. Through the co-marketing agreement
with Arch, preparations are being made for a sixth utility demonstration of its
new anti-slagging chemical. These activities and those in the preceding
paragraph are described in the succeeding paragraphs below in Item 1(b).
ADA-ES currently has four operating FGC units at coal-fired utilities in Iowa,
Louisiana, Oregon, and Wisconsin. Revenues from sales of equipment and chemicals
to FGC customers in 2003 and other FGC contract work totaled $2,037,000.
Assuming the continuation of the historical levels of FGC chemical purchases
over the last four years by its existing customers, ADA-ES expects to recognize
revenues of approximately $2.0 million in 2004 from sales to those customers. In
addition, ADA-ES is in discussions with several utilities where it is believed
that the use of its FGC can aid operations and expects to add one more FGC
customer by 2005. There can be no assurances that either of those expectations
will be met.
Early in 2000, ADA-ES received the signed Department of Energy ("DOE")
cooperative agreement awarded to develop a broader spectrum of FGC chemicals
(the "DOE FGC Contract") and commenced research activities thereunder. In the
fall of 2000, ADA-ES received the award of an additional DOE cooperative
agreement to test mercury control technology (the "DOE Mercury Contract")
totaling up to $6.8 million over the life of the contract, which amount includes
industry cost-share, and commenced research activities thereunder. In the fall
of 2002 ADA-ES received the award of a further DOE cooperative agreement and
commenced activities thereunder for the long-term test of mercury control
technology totaling $2.4 million, which amount includes industry cost share.
During 2003 ADA-ES commenced limited work on the permanent installation, testing
and related activities of a mercury control system for We Energies Presque Isle
plant in northern Michigan. The contract for that work is expected to be signed
soon and will cover $10 million of work over a 5-year period. In the fall of
2003 ADA-ES received the award of a further DOE cooperative agreement and
commenced activities thereunder for the testing of mercury control technology at
four plant sites over the next 3 years totaling $8.8 million, which amount
includes industry cost share. Revenues recognized in 2003 from these
government/industry contracts totaled $2.7 million. ADA-ES retains the right to
commercialize any products developed under the activities of these contracts.
Assuming continued funding, ADA-ES expects to recognize revenues of
approximately $4.8 million from these contracts in 2004. The government commits
funds for these contracts on an annual basis and although continued funding
under the awarded contracts is considered highly probable, there can be no
assurances that the government will continue to approve such funding in its
future budgets.
In July 2001, ADA-ES entered an agreement with Arch, the second largest U.S.
coal producer, to jointly market ADA-249 to cyclone-fired power plants. The
agreement was modified and restated as of January 1, 2002. ADA-249 has been
demonstrated to improve the combustion performance of cost-efficient, low-sulfur
coals from the Powder River Basin (PRB) in cyclone boilers. When added prior to
combustion, this patent-pending product increases PRB coal's burning efficiency,
allowing it to perform more like bituminous coal. Utility companies using
ADA-249 may thus realize significant savings from reduced fuel costs, enhanced
operational flexibility and improved marketability of combustion byproducts.
Continuous feeding at one small unit, seasonal feeding at another unit and
demonstrations at three utilities took place during 2003 with positive results.
A larger scale test where ADA-249 will be blended with coal from Arch is
scheduled for the first quarter of 2004. We expect to add at least one
continuous user of ADA-249 in 2004. However, the election to install a system
for addition of ADA-249 and use it on a continuous basis is complex and involves
fuel buying and plant operating decisions, and there can be no assurances that
such expectation will be met.
The Spin-Off
In March 2003, ESI and ADA-ES entered into an agreement to provide for the
distribution of the ADA-ES stock to the shareholders of ESI. In an effort to
maximize stockholder value, the ESI Board of Directors decided to separate its
significant operations into two separate businesses. Since ESI no longer
produces the chemicals needed for the ADA-ES proprietary environmental products,
there is no longer a necessary business connection between the two companies.
The separation allows ESI to focus on its mineral exploration business, while
ADA-ES focuses on its environmental technology/specialty chemical business. The
distribution has resulted in two independent public companies.
The separation of the two businesses was accomplished through a spin-off of
ADA-ES, Inc. In the spin-off, 100% of the outstanding shares of ADA-ES common
stock held by ESI were distributed to the ESI shareholders on September 12,
2003. In the distribution, the ESI shareholders received one share of ADA-ES
common stock for every ten shares of ESI common stock they held on the close of
business on August 29,2003, the record date for the spin-off.
Sale of Stock and Debenture to Arch Coal, Inc.
The Company executed a Securities Subscription and Investment Agreement with
Arch Coal, Inc. ("Arch") in July 2003. The agreement provided for an investment
by Arch, which was subject to completion of the spin-off and certain other
conditions precedent, and could have been rescinded if the spin-off did not
occur.
Pursuant to the investment agreement, Arch purchased, in September 2003, a
$300,000 convertible debenture from the Company (the "Debenture"), with a term
of five years that bears a variable interest rate, currently 6%, based upon the
Wall Street Journal prime rate plus 1.75%. Interest accrues quarterly and is
payable with principle at the end of term. The Debenture is convertible into
shares of Common Stock of the Company after 2 years at the lower of a rate of
$20, $30, and $40 per share in the 3rd, 4th and 5th years, or 150% of the then
current market price. The Debenture is convertible solely at the discretion of
Arch. Collateral for the Debenture is the patent pending for the Company's
ADA-249 product and the Company's interest in the agreement with Arch to jointly
market the ADA-249 product discussed below under the heading "ADA-249."
In addition to the Debenture, and pursuant to the investment agreement, Arch
also purchased in September 2003, 137,741 shares of the Company's common stock,
for an aggregate purchase price of $1 million or $7.26 per share. The price per
share paid and the number of shares issued was based on a formula of ten times
200% of the 20 day average price of the Earth Sciences common stock before
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closing or $10 per share whatever was less. Of those issued, 37,741 shares have
been placed in escrow and a portion of those shares may be returned to the
Company at the end of one year depending on the future market price for the
Company's shares. If the market price per share for a 20-day period in the
following year is above $15, then all the shares in escrow will be returned to
the Company. At market prices per share between $9.08 and $15.00 per share a pro
rata portion of the stock placed in escrow will be returned to the Company. If
market prices above $9.08 per share are not reached for any 20-day period, all
of the shares placed in escrow will be released to Arch. As a part of the
purchase Arch was also granted an option to purchase 50,000 shares for $10.00
per share. The option expires in five years. Under the option, Arch may purchase
one third of the shares after one year, another one third of the shares after a
second year, and another one third of the shares after three years.
Arch has agreed not to sell or solicit the sale of any of the shares issued in
the above transactions for a one-year period. The Company has granted Arch
certain "piggyback" rights in the event the Company registers certain other
equity securities and certain demand registration rights as part of the
transaction. A designee of Arch has been appointed a seat on the Company's Board
of Directors and management of the Company has agreed in the future to nominate
and to vote all proxies and other shares of stock in the Company which they are
entitled to vote in favor of that designee so long as Arch holds no less 100,000
shares of the Company's common stock. Assuming (1) any shares placed in escrow
are released to Arch, (2) Arch converts the Debenture at a rate of $10.65 per
share (150% of the market price at 12/31/03), and (3) Arch exercises its option
to purchase 50,000 shares, Arch would own a total of 215,910 shares or approx.
5.9% of all outstanding shares of the Company.
(b) Business of Issuer.
BUSINESS
Market for Our Products and Services
The primary drivers for many of our services are new environmental regulations
and the deregulation of the utility industry. Environmental regulations, such as
the 1990 Clean Air Act Amendments, various State regulations and permitting
requirements for new plants, are requiring utilities to reduce emission of
pollutants, such as sulfur dioxide and nitrogen dioxide, and toxic particles.
The Environmental Protection Agency and numerous state regulatory bodies are
developing regulations that are expected to require large mercury reductions at
the nation's 1,100-plus coal units by 2008. Early DOE studies indicate that the
cost to control these emissions will be $2-$5 billion annually. We are
positioning ourselves to be a key supplier of services to the market that is
anticipated to be established by these regulations. The markets that will be
affected by new regulations are the same ones that we currently operate within.
In addition, the systems and products that are required for mercury controls fit
well with our existing products and capabilities.
In addition to environmental regulations, the coal burning electric power
generation industry is also impacted by the ongoing deregulation of the utility
business. Historically, public utilities have been able to pass capital and
operating costs onto customers through rate adjustments. However with
deregulation, utility companies face competitive challenges requiring them to
better control capital spending and operating costs. These changes increase the
need for cost-effective retrofit technologies that can be used to enhance
existing plant equipment to meet the more stringent emission limits while
burning less expensive coals. We have entered this market with (1)our
proprietary non-toxic chemical conditioner that offers both technical and
economic advantages over the hazardous chemicals that have been in use, (2)
mercury control technology that has been demonstrated to effectively reduce
mercury emission over a broad range of plant configurations and coal types, and
(3) products, such as ADA-249, that provide utilities flexibility in choosing
the fuel they plan to burn.
In the unprecedented event that existing and expected environmental laws were
rescinded or substantially changed, our business would be adversely affected by
declining demand for such products and services. Demand for the Company's FGC
and ADA-249 products is primarily two-fold. Customers purchase these products to
mitigate operating problems and/or to help comply with environmental regulations
such as the Clean Air Act Amendments of 1990. Although the Company's existing
customers and those expected in the near-term are believed to desire the
Company's products for mitigation of operating problems, we would anticipate
that any softening of existing air pollution control requirements would slow
expected growth for these products. Demand for the Company's mercury emission
control technology is being driven almost exclusively by legislation requiring
such control. Although several states have passed, or are expected to pass,
legislation requiring such control (Connecticut, Massachusetts, New Hampshire,
New Jersey, North Carolina and Wisconsin), federal legislation mandating mercury
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control is expected to be debated this year as part of EPA's Proposed National
Emission Standards for Hazardous Air Pollutants (proposed rule published in the
Federal Register 1/30/04). EPA has stated in the rulemaking activity that it
intends to require reduction in the emission of mercury. Delays in, or
derailment of, the passage of federal mercury control legislation will
significantly impede the expected growth of the Company.
The environmental technology/specialty chemicals industry is generally subject
to seasonal trends. These trends reflect the general pattern of electricity use
and generation, which typically peak during the spring and summer months and
decline from October through March. Our quarterly results can be expected to
fluctuate in the future, reflecting this seasonality. These and other factors
may make it difficult to predict our results of operations. If our results of
operations do not meet the expectations of our stockholders and financial
analysts, then our common stock price may be adversely impacted.
Government and Industry Supported Contracts
In 2003, 2002 and 2001, 45%, 47% and 46%, respectively of the Company's revenues
were derived from or related to DOE and industry-supported programs. Our
revenues from government and industry-supported contracts would be adversely
impacted by any material decrease in funding for the projects in which we are
involved. In addition, we look to the DOE funding as a significant means to
further develop our technology and intellectual property in the area of mercury
emissions control covered by that funding. Any material decrease in funding for
the projects in which we are involved would hamper the development of our
technology and intellectual property as it does not appear that we could
currently fund the same level of development work apart from the support
provided by DOE and industry.
The DOE issues solicitations from time to time for various development and
demonstration projects. The DOE solicitations range in subject matter, and the
Company submits bids for topics that fit the Company's mission and strategic
plan. The bids involve a proposed statement of work, and contracts are
negotiated with successful bidders to perform the specified work. The contracts
with the DOE are known as Cooperative Agreements and are considered financial
assistance awards. The Company currently has three such agreements. Generally,
the agreements cover the development and/or demonstration of air pollution
control technologies for coal-fired power generating plants. Our agreements
cover the testing of mercury control systems at power plants. The work may
involve designing and fabricating equipment, installing the equipment at power
plants, testing the equipment, preparing economic studies, and preparing various
reports. The deliverables required by the agreements include various technical
and financial reports that are submitted by the Company on a prescribed
schedule. The agreements require that the negotiated scope of work be performed,
which includes testing/demonstrating various air pollution control technologies.
The agreements with the DOE provide that any intellectual property that results
from the work become the property of the Company.
The agreements with DOE generally require industry cost share, which is
considered a key component to the viability of the project and which may take
the form of cash contributions and/or in-kind contributions of material and
services. The cost share percentages on the mercury projects in which we are
involved range from 32% to 50%. Typically, the utility host site for the
demonstration project provides a considerable amount of the cost share with
other interested industry partners also providing funding, either individually
or through EPRI (the Electric Power Research Institute). To the extent that the
required cost share is not provided by industry partners or EPRI, ADA-ES
provides the balance by reducing the revenues it would otherwise recognize on
the work performed. We expect the power industry's interest in these and future
projects to continue and grow as the nation moves closer to enactment of mercury
control regulations.
Key Business Relationships
We have developed key industry relationships with companies much larger than
ourselves (e.g. NORIT Americas, Inc., ALSTOM Power, Inc., and Arch Coal, Inc.).
Subject to the terms of those agreements, the relationships may be terminated by
the passage of time, through notification from the other party or failure of the
Company to obtain a certain market share of activated carbon sales. Those
relationships are expected to bolster the premier position we believe we hold
that will allow participation in the large market projected to emerge from the
anticipated forthcoming regulations to limit mercury emissions from coal burning
power plants. The loss of those key relationships would impede our ability to
secure the highest achievable amount of business from that emerging mercury
control market. (See the discussion below under the caption "ADA-249" and
"Commercial Mercury Emissions Control.)
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ADA-ES' Technology and Services - FGC
We have developed a technology for conditioning flue gas streams from combustion
sources that allows existing air pollution control devices to operate more
efficiently. Through various suppliers and contractors, we may manufacture
engineered units for each individual application. The units mix, pump and
monitor the feed of proprietary chemical blends. The chemical blends are applied
to the flue gas streams by a pressurized system of specially designed lances and
nozzles. Such treatment of the flue gas stream alters the physical properties of
the fly ash particles contained therein primarily by decreasing particle
resistivity. This alteration allows the existing electrostatic precipitator
("ESP") to more effectively collect such fly ash particles that would otherwise
escape into the atmosphere. ADA-ES' technology also has application in the
cement and petroleum refining industries where particulate emissions are being
or need to be controlled. The non-utility markets are not being aggressively
pursued since the profit margin potential for such customers is considered to be
less since chemical usage is lower.
DOE FGC Contract
In September 1999, ADA-ES was awarded a $1 million DOE cooperative agreement to
develop an expanded line of flue gas conditioning agents. This project was
initiated in January 2000 with an objective of developing a new family of flue
gas conditioning products. These products are targeted for use at coal-fired
power stations that are equipped with older and smaller cold-side electrostatic
precipitators. Efforts during the first year helped to establish laboratory
methodologies for evaluating trial formulations of chemical additives, preparing
and evaluating trial quantities of additives, and beginning full-scale field
trials of the most promising formulations. Three of the best performing
conditioning agents were tested at full scale at the City of Ames power plant,
and one showed improved performance when compared to the product currently being
used at the plant. Refinements were made to the conditioning agents during 2001
and field trials began late in the year at a PacifiCorp plant. The testing at
PacifiCorp was successfully completed during 2002 showing opacity reductions. In
addition, no detrimental impacts on ash quality were observed. A third test
series was begun later in the year at the AEP Conesville Plant. Initial results
showed positive performance of the product in terms of opacity reductions. The
testing continued during 2003. A final series of tests were completed at the We
Energies Presque Isle plant in 2003 and the cooperative agreement with DOE was
completed late in the year. Commercial flue gas conditioning products may result
from this work that will serve a new market segment of power plants for ADA-ES.
Under terms of the cooperative agreement with the Department of Energy, ADA-ES
will own the proprietary rights to any commercial products that are developed as
a result of this work. ADA-ES has provided the 20% cost share for this project.
ADA-249
In 2000, we introduced a new specialty chemical, ADA-249, a product designed to
save utility companies with cyclone furnaces significant costs each year through
reduced fuel costs, enhanced operational flexibility and improved marketability
of combustion by-products. Cyclone furnaces were designed as an efficient,
compact way to burn high-ash, high-sulfur coals to produce steam for power
generation. The coals for which these units were designed typically produce a
thick molten slag layer on the walls of each cyclone barrel. The slag coating
catches the incoming coal and holds it until combustion is completed. When
switching to Powder River Basin ("PRB") coal, however, the slag layer is usually
too thin and watery to capture the coal, so the coal must burn in flight. Even
though PRB coal burns faster than bituminous coal, there is just not enough time
for combustion to be completed within the main furnace firebox. The result is
usually unacceptable amounts of unburned carbon in the flyash as well as
increased ash deposition, increased air emissions, and an unfavorable unit heat
rate. Another problem with PRB coal slag in a cyclone furnace is that it
solidifies (freezes) abruptly during low-load operation when the cyclone
temperature drops.
Since these boilers rely on keeping the slag molten all the way to the slag tap
(a drain on the furnace floor) in order to operate, the freezing problem can
cause unplanned shutdowns and lost revenues. In order to keep the PRB coal slag
molten, these units must be operated at high loads even during periods of low
demand, which adversely affects power revenues. Finally, bottom ash is a more
valuable commodity for sale to ash brokers than flyash. Many cyclone boilers
that have converted to PRB coal have lost significant revenues from ash sales
compared to the old days of burning high-ash coals.
ADA-249 is a patent-pending product designed to modify slag viscosity. ADA-249
is a blend of iron oxides, mineralizers, and flow enhancers, that is added to
the PRB coal prior to combustion in order to create the proper slag layer for
combustion within the cyclone barrel. In application at the utility, ADA-249 is
conveyed mechanically from a supply delivered via dump truck to a hopper. From
there ADA-249 is fed by screw and belt conveyors to the coal feeders. The
addition of ADA-249 to the coal results in more coal burning in the cyclone,
less carbon in the flyash, better precipitator performance, reliable slag
tapping, and more bottom ash to sell. We design and sell the delivery system and
the continuing supply of chemical.
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In May 2001, we entered into an agreement with Arch Coal Inc., the second
largest U.S. coal producer, to jointly market ADA-249 to cyclone-fired power
plants. The agreement was modified and restated as of January 1, 2002. Pursuant
to the agreement, the Company has granted a non-exclusive, non-transferable
license to the joint venture ("JV") to use ADA-249 in connection with the JV
activities. The JV is controlled by a five-member management committee, three of
whose members are selected by Arch and the remaining members by the Company. The
JV will pay the Company from the commercial price less a discount of
approximately $15 per ton for all ADA-249 material supplied and commercial rates
for any technical services. The Company and Arch each will bear their own costs
and expenses related to any ADA-249 marketing efforts. Arch will fund the JV
activities, including equipment needs and will retain any net profits. Either
party may terminate the JV upon 60-days written notice after non-approval of the
annually required business plan.
Together, we and Arch anticipate providing to Arch customers a long-term package
of PRB coal, the ADA-249 chemical and, if needed, the required injection
equipment. This package is intended to enable boiler operators to achieve the
benefits of the ADA-249 fuel additive without making a significant capital
investment. The companies will also handle the logistics of supply and system
maintenance. During 2003, in addition to continual sales to one customer and
seasonal sales to another, (the revenues from whom amounted to less than 10% of
the Company's total revenues), ADA-249 was demonstrated at three sites, for
which we are in various stages of negotiation to supply ADA-249 on a continual
basis. The DOE does not participate with the Company in any of its activities
related to ADA-249.
DOE Mercury Contract
ADA-ES began work on a cooperative agreement with the Department of Energy in
October, 2000 to demonstrate full-scale mercury control systems at coal-fired
power plants. During the three-year, $6.8 million project, integrated control
systems were installed and tested at four power plants. The mercury control
system involves injecting powdered activated carbon (PAC) into the power plant
flue gas where it ties up the mercury. The existing particle control equipment
at the power plant then collects the PAC. ADA-ES was responsible for managing
the project including engineering, testing, economic analysis, and information
dissemination functions. Power generating companies that entered into contracts
with ADA-ES are Alabama Power Company, We Energies, and PG&E National Energy
Group. During 2001 ADA-ES completed demonstration tests at two of the plants,
and the remaining two plants were tested during 2002. The first test site was
Alabama Power's Gaston plant, which uses fabric filters to reduce particulate
matter emissions. Tests using PAC at this site showed that 80-85 percent of the
mercury was removed, with as much as 90 percent being removed at the highest
performing periods during two weeks of testing. The We Energies Pleasant Prairie
Power Plant was the second site to be tested. This site is equipped with
electrostatic precipitators for particle collection. Mercury-removal rates at
this site using PAC ranged from 40 to 60 percent, with short-term peak removal
rates being 60-70 percent. Testing at the PG&E Brayton Point Station showed that
mercury removals of 90 percent could be achieved using PAC. Test data from Salem
Harbor were still being evaluated at the end of 2003 and were not available for
release. The Cooperative Agreement with DOE is scheduled to be completed in
mid-2004. Overall industry cost share on this project is 33% and ADA-ES has
provided cost share of approximately 13% of the total project.
DOE Long-Term Test of Mercury Controls
ADA-ES was awarded a $2.4 million cooperative agreement from the Department of
Energy in September 2002 to install a mercury control system and evaluate its
operation over an extended period of time. The project location is Alabama Power
Company's Plant Gaston where PAC has been injected into the flue gas stream
between an existing electrostatic precipitator and COHPAC baghouse. A limited
test of this configuration was performed under the DOE project described above
with good results. The extended test will mature the technology and provide
information that is needed to assure reliable long-term continuous operation in
these systems. Work on the project in 2003 involved installation and several
test regimes. Further testing and final reporting on results of the project is
expected in mid-2004. Overall industry cost share on this project is 43% and
ADA-ES has provided cost share of approximately 18% of the total project.
CCPI Program at We Energies
The Company has been selected to provide mercury control technology and services
for a major project at the We Energies Presque Isle Power Plant. The U.S.
Department of Energy announced in January 2003 that it will award a grant to We
Energies, located in Milwaukee, Wis., to demonstrate an integrated mercury and
particulate matter emissions control system on three generating units at the
facility located in Marquette, Mich. The demonstration project, named TOXECON,
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will also investigate the capabilities of the proposed system to control sulfur
dioxide and nitrogen oxide emissions. The primary attribute of TOXECON, an EPRI
(Electric Power Research Institute) patented process, is that it potentially
represents the best option for control of greater than 80 percent of mercury
from coal-fired plants. TOXECON may also prove to be the primary mercury control
choice for western coals, and the only choice for units with hot-side
electrostatic precipitators. TOXECON will make use of only one "baghouse," or
emissions collection structure, for three small boilers, increasing the
cost-effectiveness of the integrated system. TOXECON would also allow for
separate treatment or disposal of the ash collected in the primary particulate
control device, and would be applicable to a significant number of existing
coal-fired plants in the U.S. Specific objectives of the project are to achieve
at least 90 percent mercury removal; determine viability of sorbent injection
for up to 70 percent sulfur dioxide control; minimize waste disposal with a
target of 100 percent utilization; and recover at least 90 percent of the
mercury captured in the ash. DOE will provide $25 million of the project's $50
million total cost. We Energies will host the project as well as serve as the
prime contractor with the DOE. The Company is expected to provide on-site
engineering support, mercury control and measurement technologies, and project
reporting services under a $10 million contract with We Energies. Cummins &
Barnard will provide design construction management resources to the project.
The formal contract is expected to be executed in the first quarter of 2004.
Overall industry cost share on this project is 50% and ADA-ES is not providing
any cost share to the total project.
Work under the contract will cover five phases over a five-year period , with
design and construction expected to begin during 2004. As a result of the
project, it's expected that there will be (i) a significant reduction in the
rate of air emissions from the Presque Isle units and (ii) mercury control
retrofit technologies and emissions control improvements applicable throughout
the U.S.
CCPI Program at Sunflower, AEP, Ameren UE and Ontario Power
During 2003 the Company was awarded an $8.8 million cooperative agreement with
the U.S. Department of Energy's National Energy Technology Laboratory
(DOE/NETL). The agreement is to perform longer-term sorbent-based mercury
control technology testing for coal-fired power plants. The project will be
executed together with ADA-ES' partner, ALSTOM Environmental Control Systems
("ALSTOM"), one of the largest suppliers of air pollution control equipment to
power plants in North America. The program will be carried out over 3 years.
Under the new program, ADA-ES and ALSTOM will test the mercury control
technology for much longer periods of time at four power plants. These will
cover a combination of coals and pollution control equipment configurations
typically used in over 900 plants, and more than 75% of the U.S. coal-fired
generating capacity. ADA-ES and ALSTOM will be working in partnership with
Sunflower Electric, American Electric Power, AmerenUE, and Ontario Power, which
are providing host sites. These companies, along with EPRI and ADA-ES, are
contributing $2.8 million in cash and cost share to the project. The DOE will
contribute $6 million of the $8.8 million in funding for the project. Overall
industry cost share on this project is 32% and ADA-ES has provided cost share of
approximately 16% of the total project.
The four new test sites were specifically selected to provide key operating data
that will be complementary to our earlier demonstrations. The data from this
program should generate widespread interest in the power industry, and these
tests should significantly improve our ability to provide effective and reliable
mercury control systems that minimize the costs and impact on power generation.
Over the 3-year period, ADA-ES expects to recognize $7.4 million in revenue from
the project. Two sites are expected to be tested during 2004.
The project is expected to help promote the marketing arrangement between ADA-ES
and ALSTOM, discussed below, as the premier integrated solutions provider for
the control of mercury emissions from coal-fired power plants.
Commercial Mercury Emissions Control
In December 2002 we entered into an exclusive relationship with ALSTOM
Environmental Control Systems ("ALSTOM"), the largest supplier of equipment to
power plants in North America, to market systems for mercury removal from power
plants and other facilities. In response to pending State and Federal
legislation for mercury emission control, ALSTOM and ADA-ES intend to provide
overall turnkey solutions for mercury control including guaranteed performance.
Such solutions may include all equipment required including carbon storage and
injection equipment, particulate collection equipment or
redesign/rebuild/conversion of existing equipment, monitoring equipment, and
even guaranteed supply of powdered activated carbon (PAC). The partnership will
focus on providing the required equipment and modifications to achieve up to 90%
removal of mercury meeting all applicable standards. The partnership will
7
combine our leading technology position in PAC-based mercury removal, acquired
through our years of development including the DOE sponsored projects, with
ALSTOM's technology in particulate collection (Electrostatic Precipitators and
Fabric Filters) and ALSTOM's experience in mercury removal in the
waste-to-energy business.
Under the terms of the agreement with ALSTOM:
o the parties will jointly develop marketing plans and sales objectives;
o the parties will grant one another exclusive marketing licenses to
exploit their respective intellectual property for mercury emission
control;
o the parties will grant one another limited, royalty-free licenses to
use their respective intellectual property for mercury emission
control;
o the parties will make joint commercial offerings for mercury emission
control;
o ADA-ES and ALSTOM will each pay for their respective costs of
marketing and development of their mercury control technologies; and
o the agreement may be terminated by mutual agreement of ADA-ES and
ALSTOM, for an uncured breach of a material provision, and/or after
one year upon three months written notice to the other party.
In 2001 Earth Sciences and NORIT Americas Inc. ("NORIT") entered into a Market
Development Agreement to jointly pursue the market for equipment and sorbents to
remove mercury from coal-fired boilers. Earth Sciences has assigned all of its
rights under that agreement to us as part of the distribution agreement with the
consent of NORIT. The agreement joins us with NORIT, the country's leading
supplier of powdered activated carbon. The goal of the agreement is to jointly
develop mercury control sorbents designed to maximize removal efficiency and
minimize costs. NORIT provides PAC and dosing systems for removing mercury from
flue gas generated from the combustion of municipal and medical solid waste and
hazardous waste. The agreement provides a long-term means for both us and NORIT
to benefit from potential sales of equipment and to participate in the
development of sorbents for this emerging mercury control market.
Under the terms of the agreement with NORIT:
o the target market is defined as North American coal-fired utilities;
o ADA-ES is responsible for
o sorbent identification, technical and economic ranking and
demonstration testing
o market development and sales coverage
o equipment contract negotiation, project execution and
installation supervision
o NORIT is responsible for manufacture and/or supply of sorbents and the
equipment dosing systems;
o subject to performance requirements, ADA-ES will represent NORIT
exclusively in the defined market;
o in order for ADA-ES to maintain its exclusive representation of NORIT,
at least 50% of the market users during the 2004 to 2007 period must
be supplied by NORIT, in periods beyond those dates, annual minimum
sales targets will be mutually agreed upon;
o for NORIT to maintain exclusivity, it must supply sorbents at prices
and in quantities to meet the market demand and the ADA-ES sales
targets;
o ADA-ES will earn a commission of 10% on sorbent sales and 5% on
equipment sales, which commissions continue even if ADA-ES fails to
maintain its exclusivity through failure to meet its performance
requirements; and
o the parties agree to renew or renegotiate the agreement in good faith
during the period when regulations requiring mercury emission controls
are being reviewed which the parties estimate will be in mid-2005.
Other Consulting Services
ADA-ES also offers consulting services to assist utilities in planning and
implementing strategies to meet new government emission standards requiring
reductions in both sulfur dioxide and nitrogen dioxide. ADA-ES is also
developing and testing new chemical blends expected to aid coal-burning
utilities in the variety of problems that may be encountered in switching to
lower cost coals.
Competition
Our primary competition is the conventional FGC technology using either sulfur
trioxide or a combination of sulfur trioxide and ammonia. This technology has
been available commercially since the 1970's and is offered by Chemithon
8
Engineers Ltd., Wahlco, Inc. and Benetech in a variety of forms. Conditioning of
fly ash by injecting small amounts of sulfur trioxide into the flue gas is a
well-proven technique for improving performance of the ESP. Such sulfur trioxide
conditioning loses its effectiveness in application with temperatures over 350
degrees F. The capital costs of conventional FGC technology are in excess of $1
million. Injection of water mist into the flue gas stream is also a known
technique for improving performance of the ESP in certain applications and is
offered by EnviroCare, Inc. The capital cost of a water injection system are
typically $200-300,000. A typical ADA-ES system can cost between
$300,000-600,000. The Company has also introduced a product shown to be
effective in the 300-750 degree range that is suitable for intermittent
application and can augment a sulfur trioxide system and help to avoid use of
ammonia. The competitive advantages of our FGC technology include an effective
temperature range of 300 degrees F to 900 degrees F; a simple injection system;
a non-toxic conditioner that will not become a secondary pollutant; and
chemicals that are safer and easier to handle on site. The variety of products
in the industry to aid ESP performance primarily compete on the basis of
performance and price. The Company usually arranges for a full-scale
demonstration of its products to its potential customers prior to selling its
systems and chemicals for use on a continual basis.
There are no major barriers to entry of our products in the market, however,
utility companies are generally slow to embrace new technologies when they
perceive any potential for disruption in the production of electricity. The
market for ADA-249 is just starting to emerge and no significant competition yet
exists. The market for mercury emission control of coal-fired utilities is
considered an emerging industry driven by regulations that are expected to be
promulgated by the U.S. EPA, state legislatures and/ or the U.S. Congress. See
the discussion above under the caption "Market for Our Products and Services."
Patents
We have received five patents related to different aspects of our technology.
The Company's patents have terms of 20 years measured from the application date,
the earliest of which was in 1995. The patent related to ADA-249 has been
approved for issuance and the related fee has been paid. We expect issuance of
that patent in the near future. The application for the ADA-249 patent was filed
in 2000. We continue to improve our products, and patents applications for
additional products have been submitted. Although important to protect our
continuing business, we do not consider any of such patents to be critical to
the ongoing conduct of our business.
Supply of Chemical for Our Customers
We typically negotiate blending contracts that include secrecy agreements with
chemical suppliers located near major customers. These arrangements minimize
transportation costs while assuring continuous supply of ADA-ES proprietary
chemical blends. Such arrangements have been in place since the spring of 1999
and are generally renewed on an annual basis.
Raw Materials
We purchase equipment from a variety of vendors for the engineered units we
manufacture. Such equipment is available from numerous sources. We purchase our
proprietary chemicals through negotiated blending contracts with chemical
suppliers generally located near each major customer. The chemicals used are
readily available, and several such chemical suppliers can perform to our
requirements.
Seasonality of Activities
The sale of FGC chemicals is dependent on the operations of the utilities to
which such chemicals are provided. Our FGC customers routinely schedule
maintenance outages in the spring of each year. During the period of such
outages, which may range from two weeks to over a month, no FGC chemicals are
used and purchases from us are correspondingly reduced.
Dependence on Major Customers
In 2003 we supplied chemical, equipment and services to 5 FGC customers. We
recognized 12% of our revenue from MidAmerican Energy Co. in Iowa, 8% from
Alliant Power in Wisconsin, and 11% from Cleco Utility Group, Inc. in Louisiana.
ADA-ES' own sales staff markets our technology through trade shows, mailings and
direct contact with potential customers. During 2003 we recognized 45% of our
revenue from services provided under contracts to the U.S. government as
discussed above under Government and Industry Supported Contracts. (See also
Notes 4 and 8 to the Consolidated Financial Statement included elsewhere in this
report).
9
Research and Development Activities
The Company is involved in several R&D contracts funded by DOE and industry
groups primarily directed toward the control of mercury emissions. The Company
cost shares in many of those contracts. For 2003 we estimate that our direct
cost share of R&D in our contracts amounted to approximately $250,000. In
addition, we spent approximately $170,000 and $93,000 directly on research and
development activities related to further development of our technology during
2003 and 2002, respectively.
Employees
As of December 31, 2003 we employed a total of 21 full-time personnel. Included
in this number are 18 people employed at our offices in Littleton, Colorado and
3 in Alabama. In addition, other personnel were employed on a contract basis for
specific project tasks.
Item 2. Description of Property.
Office Lease
ADA-ES leases approx. 12,000 square feet of combined office and warehouse space
in Littleton, Colorado a suburb of Denver. The term of the lease runs through
2009 and the lease agreement has an option to extend the term. We believe the
facilities are sufficient for our needs in to the foreseeable future. We do not
own any real property, but lease all of our office facilities. Annual lease
costs on this space amount to approximately $100,000.
Item 3. Legal Proceedings.
Registrant knows of no reportable pending legal matters involving Registrant or
its subsidiary.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
PART II
Item 5. Market for Common Equity, Related Stockholder Matters and Small Business
Issuer Purchases of Equity Securities.
(a) Market Information.
Registrant's common stock currently trades on the OTCBB market under the symbol
ADES. Trading commenced on October 22, 2003 after the spin off from ESI noted
above. For the period from October 22, 2003 through December 31, 2003, the
Company's common stock traded in the price ranges of $3.00 to $7.50 (high and
low closing prices). The price range shown is based on OTCBB quotations. The
sale prices may reflect inter-dealer prices, without retail mark-up, markdown or
commission and may not represent actual transactions.
(b) Holders.
The number of record holders of common stock, one-cent par value, of Registrant
as of March 14, 2003 was approximately 1,735; the approximate number of
beneficial shareholders is estimated at 8,000.
(c) Dividends.
Registrant has not paid dividends since its inception and there are no plans for
paying dividends in the foreseeable future. The provisions of the term loan with
the Colorado Business Bank prohibit the payment of dividends without obtaining a
written waiver.
Item 6. Management's Discussion and Analysis or Plan of Operation.
This Annual Report may contain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 that involve risks and uncertainties.
In particular such forward-looking statements may be found in this section and
under the heading "Description of Business." The following discussion and
analysis of the financial condition and results of operations of the Company
should be read in conjunction with the consolidated financial statements and
related notes thereto included elsewhere in this report. Words or phrases such
as "will," "hope," "expect," "intend," "plan" or similar expressions are
generally intended to identify forward-looking statements. Those statements
10
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 the Company's 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; governmental regulation; changes in
governmental and public policy; changes in economic conditions specific to one
or more of the Company's markets and businesses; competition; availability of
raw materials; and unexpected operations difficulties. Other risks and
uncertainties may also affect the outcome of the Company's 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.
INTRODUCTION
The Company provides environmental technologies and specialty chemicals to the
coal-burning electric utility industry. Revenues are generated through (1) time
and materials contracts for the emerging mercury emission control (MEC) market,
several of which are co-funded by government and industry, (2) the sale of
specialty chemicals and services for flue gas conditioning (FGC), and (3) the
sale of combustion aid (CA) chemicals and services, primarily ADA-249 through a
joint venture with Arch Coal.
Mercury has been identified as a toxic substance and the EPA is under court
order to issue regulations for its control. The growth of the MEC market for the
electric utility industry will most likely be dependent on federal and/or state
regulations, which are in various stages of enactment. As many as 1,100 existing
coal-fired boilers may be affected by such regulations, if and when they are
enacted. 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 discussed above, (ii) mercury testing services and (iii) equipment
sales and commissions on sorbents sold to new plants and existing plants
affected by enacted regulations. Although we expect this market to show steady
growth over the next several years, significant revenue growth is anticipated
when federal regulations impact the existing boilers.
The market for our FGC chemicals and services is relatively flat and is expected
to only show modest growth, if any, 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.
In spite of several successful demonstrations, market acceptance for our CA
products has not grown as previously expected. Commencement of continuing sales
to a significant customer in 2004 is important, and is expected, if such occurs,
to help promote additional sales.
Liquidity and Capital Resources
The Company had a positive working capital of $1.3 million at 12/31/03. The
amount represents an increase of $745,000 during the year. Management believes
that existing and expected improving working capital, through continued and
improved cash flow from ongoing operations, will be sufficient to meet the
anticipated needs of the Company in 2004. However, there can be no assurances
that the positive cash flow that has been achieved will continue. The Company
also has a $250,000 line-of-credit arrangement with a bank to help with its
working capital needs. No amounts were outstanding under the line as of
12/31/03.
As required under the Distribution Agreement with ESI, in September 2003 the
Company assumed notes payable to Tectonic Construction Co. totaling $1,150,000.
Of that amount $300,000 was paid off with proceed of a convertible debenture
sold to Arch in a like amount as noted below. Also in September, Tectonic
converted $210,000 of the remaining debt into 100,000 shares of the Company's
stock pursuant to the terms of the debt assumed from ESI. The remaining $640,000
was paid off in September with the proceeds from a term loan of the same amount
described below. The Company also assumed other indebtedness from ESI in the
amount of $130,000 related to prior service obligations for certain ESI
employees now employees of the Company, which is expected to be paid off on a
monthly basis over the next three years.
The Company executed a Securities Subscription and Investment Agreement with
Arch in July 2003. Pursuant to the investment agreement, in September 2003 Arch
purchased a $300,000 convertible debenture from the Company (the "Debenture"),
with a term of five years that bears a variable interest rate, currently 6%,
based upon the Wall Street Journal prime rate plus 1.75%. Interest accrues
11
quarterly and is payable with principal at the end of term. Arch also purchased
137,741 shares of the Company's Common stock, for an aggregate purchase price of
$1 million or $7.26 per share. Of the shares issued, 37,741 have been placed in
escrow and a portion those shares may be returned to the Company at the end of
one year depending on the future market price for the Company's shares. As a
part of the purchase Arch was also granted an option to purchase 50,000 shares
for $10.00 per share.
In September the Company borrowed $640,000 from the Colorado Business Bank
("CBB") in the form of a term loan with interest and principal payable in equal
monthly installments of approximately $13,500 over a 4 and one-half year period.
The interest on the term loan is a fixed 7.17% per annum. The proceeds from the
loan were used to pay off the remaining balance of the Tectonic debt assumed
from ESI as part of the spin-off.
The Company's principal source of liquidity is its existing working capital and
operating cash flows as supplemented by its line-of-credit noted above. 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 Wisconsin, Louisiana and Iowa, each of which provide an
average monthly cash flow of approximately $20,000. Unsatisfactory results,
which could be caused by a combination or single factor such as changes in coal,
mechanical difficulties (whether in the FGC unit or otherwise), and/or overall
cost/benefit analysis, at any of those units may decrease or end the sale of
chemicals for such units. The Company is also performing services under three
DOE and industry co-funded contracts, which overall are expected to produce an
estimated $5.1 million in revenues in 2004. Of that amount approximately 15%
represents cost share amounts from industry partners, and 50% represents
reimbursement from DOE for costs that pass through the Company. Currently
funding has been approved by the DOE for approximately $4.1 million of its share
of those contracts. 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.
Debt service obligations in 2004 total approximately $145,000. Planned capital
expenditures for ADA-ES to sustain and improve ongoing operations for 2004 are
estimated at $347,000. The Company expects to fund these requirements out of
existing working capital and cash flow from operations.
The Company assumed a defined contribution and 401(k) plan covering all eligible
employees from ESI as of January 1, 2003. The Company matches up to 5% of salary
amounts deferred by employees in the Plan. During 2003, the Company recognized
$71,000 of matching expense; this expense is expected to amount to approximately
$86,000 in 2004. In the past the Company has also made discretionary
contributions to the Plan amounting to approximately 10% of salaries, which
amounts were paid in stock. At December 31, 2003, the Company had authorized a
discretionary contribution of $146,000. In 2004 such discretionary amounts may
be paid as bonuses and based on budget figures may total approximately $206,000.
The Company has recorded net deferred tax assets of $93,000. Based on existing
R&D contracts supported by the DOE and industry, the Company has determined that
it is more probable than not that those deferred tax assets will be realized in
the future.
Cash flow provided from operations totaled $183,000 for 2003 compared to
$279,000 for 2002. Cash flow from operations in 2002 was higher than 2003 as the
result of significant decreases in accounts payable and other liabilities, both
of which changes improved the Company's working capital as of the end of the
year. Cash flow provided from operations in 2003 resulted primarily from the
operating income less non-cash charges for depreciation and amortization plus
and minus other components of working capital. Cash flow from net investing
activities for 2003 includes a use for capital expenditures of $348,000. Cash
flow from financing activities in 2003 consisted of advances to ESI of
$(355,000) and payments on notes payable and debt assumed in the spin-off of
$(968,000), proceeds from the Arch debenture and a new term loan of $940,000 and
proceeds from the sale of stock to Arch of $1million. Cash flow provided from
operations in 2002 also resulted primarily from the operating income plus
non-cash charges for depreciation and amortization and changes in other assets
and liabilities. Cash flow from investing activities for 2002 includes a use for
capital expenditures of $69,000. Cash flow from financing activities in 2002
consisted of advances to ESI of $372,000 and payments on long-term liabilities
of $6,000.
Results of Operations
Revenues totaled $5,863,000 in 2003 versus $5,700,000 in 2002. Revenues for 2003
increased $960,000 due to increased sales in MEC activities and $129,000 from CA
activities, whereas FGC revenues declined by $926,000. The decline in FGC
revenues is a result of a large non-recurring equipment sale in 2002 and
chemical sales in 2002 for a temporary user in 2002 that were not repeated in
2003. The Company sold FGC chemicals and services to five utilities during 2003,
all of which were continuing customers as of year-end. We expect FGC revenues in
2004 to show only modest growth, if any. The Company's government contracts are
subject to audit by the federal government, which could result in adjustment(s)
to previously recognized revenue. The Company believes, however, it has complied
with all the requirements of the contracts and future adjustments, if any, will
not be material. Based on contracts in hand and those expected to be executed in
the near future, total revenues for 2004 are anticipated to grow by
approximately 30% from the 2003 level.
Operating expenses increased by $53,000 in 2003 as a result of increased
activities associated with revenue generating activities. ADA-ES experienced
positive gross margins in 2003 and 2002 of 47% and 46%, respectively. As noted
above, management expects the amount of time and materials work to represent an
12
increasing source of revenues wherein the anticipated gross margins are less
than for our specialty chemical sales. Gross margins for 2004 are expected to
decline from the levels achieved in 2002 and 2003.
Consolidated research and development increased in 2003 by $77,000 to $170,000
as compared to $93,000 in 2002. 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 grow at about 10% per year for the
next several years.
General and administrative expenses increased by $189,000 to $2,130,000 in 2003.
The increases result primarily from increases in staff and our office space as
the Company prepares for the anticipated growth in the mercury control market,
other general increases in costs, such as insurance, and costs to comply with
new internal control and reporting standards.
The Company's interest expense totaled approximately $27,000 for 2003 and
$26,000 for 2002. As a result of the transaction related to the spin-off and the
new term loan discussed above we expect interest expense in 2004 to total around
$40,000.
Critical Accounting Policies and Estimates
Significant estimates are used in preparation of the financial statements and
include the Company's allowance for doubtful accounts, which is based on
historical experience. However, a significant amount of the Company's accounts
receivable ($241,000 and $397,000 at December 31, 2003 and 2002, respectively)
is from the federal government. Amounts invoiced for government contracts are
subject to change based on the results of future audits by the federal
government. The Company has not experienced significant adjustments in the past,
and as a we do not expect that a significant adjustment will be made in the
future. The Company uses its judgment to support the current fair value of
goodwill and other intangible assets of $2.1 million on the consolidated balance
sheet. Although the Company has had an independent valuation prepared, which
support its recorded value and, management believes the fair value of other
recorded intangibles are not impaired, market demand for the Company's product
and services could change in the future requiring a write-down in recorded
values. As with all estimates, the amounts described above are subject to change
as additional information becomes available.
New Accounting Policies
In May 2003, the Financial Accounting Standards Board ("FASB") issued Statements
of Financial Accounting Standards No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity." SFAS No. 150
requires issuers to classify as liabilities (or assets in some circumstances)
three classes of freestanding financial instruments that embody obligations for
the issuer. SFAS No. 150 is effective for financial instruments entered into or
modified after May 31, 2003 and is otherwise effective at the beginning of the
first interim period beginning after June 15, 2003. The adoption of SFAS No. 150
has had no immediate impact on the Company's financial position or results of
operations.
Item 7. Financial Statements. (see pages F-1 through F-22)
Index to Financial Statements
Independent Auditor's Report
Financial Statements:
ADA-ES, Inc. and Subsidiary
Consolidated Balance Sheet, December 31, 2003
Consolidated Statements of Operations, For the Years Ended December 31,
2003 and 2002
Consolidated Statement of Stockholders' Equity, For the Period from January
1, 2002 to December 31, 2003
Consolidated Statements of Cash Flows, For the Years Ended December 31,
2003 and 2002
Notes to Consolidated Financial Statements
Item 8. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure.
None.
Item 8A. Controls and Procedures.
Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures designed to ensure that
it is able to collect the information it is required to disclose in the reports
it files with the Securities and Exchange Commission (SEC), and to process,
summarize and disclose this information within the time periods specified in the
rules of the SEC. Based on their evaluation of the Company's disclosure controls
13
and procedures which took place as of a date within 90 days of the filing date
of this report, the Chief Executive and Financial Officer believes that these
controls and procedures are effective to ensure that the Company is able to
collect, process and disclose the information it is required to disclose in the
reports it files with the SEC within the required time periods.
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.
Since the date of the most recent evaluation of the Company's internal controls
by the Chief Executive and Financial Officer, there have been no significant
changes in such controls or in other factors that could have significantly
affected those controls, including any corrective actions with regard to
significant deficiencies and material weaknesses.
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance
With Section 16(a) of the Exchange Act.
Our directors and executive officers were appointed by Earth Sciences prior to
the spin-off. Our Directors will serve until the first annual meeting of
stockholders, which is expected to occur in 2005. Directors are expected to be
elected annually. Information concerning our directors and our key executive
officers is provided below.
Name Age Position and Offices
---- --- ---------------------------
Ramon E. Bisque 72 Chairman of the Board of Directors
Duane N. Bloom 70 Director
C. Jean Bustard 46 Executive Vice President
Michael D. Durham 54 Director, President
John W. Eaves 46 Director, Member of the Audit Committee
Ronald B. Johnson 72 Director, Chairman of the Audit Committee
Robert H. Lowdermilk 67 Director
Mark H. McKinnies 52 Director, Chief Financial Officer
Rollie J. Peterson 56 Director, Member of the Audit Committee
Richard J. Schlager 52 Vice President Contract R&D
Jeffrey C. Smith 51 Director, Member of Audit Committee
John F. Wurster 56 Vice President Sales and Marketing
The appointment of John Eaves to the Board of Directors of Registrant (the
"Board") was made pursuant to the investment agreement with Arch Coal, Inc.
whereby the management of the Company has agreed to make available one seat on
the Board so long as Arch continues to hold no less than 100,000 shares. There
are no other arrangements or understandings between any directors or executive
officers and any other person or persons pursuant to which they were selected as
director or executive officer.
14
Each of the officers named above serves from year to year at the pleasure of the
Board of Directors. Drs. Bisque and Bloom and Mr. McKinnies are all Directors of
Earth Sciences, Inc. Dr. Durham and Messrs. Johnson, Lowdermilk, and Peterson
have tendered their resignations as directors to Earth Sciences effective upon
completion of the spin-off.
Dr. Bisque is Professor Emeritus at the Colorado School of Mines, Golden,
Colorado and was a co-founder of Earth Sciences, Inc. in 1963. Dr. Bisque has
been Chairman of the Board of Directors and a full or part time employee of
Earth Sciences since 1974.
Dr. Bloom was a co-founder of Earth Sciences, Inc. in 1963. Dr. Bloom was
employed full time by Earth Sciences since that time through 1999. Dr. Bloom has
been retired since that time. Dr. Bloom also remains a director of Earth
Sciences.
Ms. Bustard has been Executive Vice President of ADA-ES, LLC since its formation
in 1996. Ms. Bustard was employed by ADA Technologies from 1988 through 1996.
Ms. Bustard holds a B.S. in Physics Education from Indiana University and a 1979
M.A. in Physics from Indiana State University.
Dr. Durham was a co-founder in 1985 of ADA Technologies, Inc., an Englewood,
Colorado private company which contracts to the Federal government and others
for development of emission technologies. Dr. Durham has been president of
ADA-ES LLC, since 1996.
Mr. Johnson has been the Chairman of Twin Kem International, Inc., a distributor
of agricultural and industrial chemicals, since 1984.
Mr. Lowdermilk has been president of Tectonic Construction Company, a producer
of washed aggregates and specialty sands since 1986. Mr. Lowdermilk has a long
history in construction and engineering projects.
Mr. McKinnies is a CPA and worked for Peat, Marwick, Mitchell & Co. before
commencing employment at Earth Sciences in 1978. Mr. McKinnies has been
President of Earth Sciences since 1983 and remains a director of Earth Sciences.
Mr. Peterson is a self-employed businessman and president and co-owner of
Cobblestone Development Co., a commercial land development company in Minnesota
that he helped found in 1987.
Mr. Schlager has been employed by the Company since 2000 and was employed by ADA
Technologies from 1989 until that time. Mr. Schlager holds a BS in Chemistry and
a M.S. in Metallurgical Engineering from the Colorado School of Mines.
Mr. Smith was appointed a director of the Company in August 2003 and is a
self-employed lawyer in the Law Office of Jeffrey C. Smith. Mr. Smith is the
past Executive Director of the Institute of Clean Air Companies where he served
for 17 years.
Mr. Wurster has been a Vice President of ADA-ES, LLC since its formation in
1996. Prior to 1996, Mr. Wurster was employed by ADA Technologies, Inc. as VP of
Sales.
No family relationship exists between any individuals named in this Item 9.
Audit Committee
The Board of Directors has an Audit Committee consisting of Messrs. Eaves,
Johnson, Peterson and Smith. Mr. Johnson serves as the chairman of the Audit
Committee. The Board has not yet secured a member who is willing to act as the
Audit Committee Financial Expert, but is in the process of seeking one who will
be added as soon as practical.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires Registrant's
officers and directors, and persons who own more than ten percent of a
registered class of the Company's equity securities, to file reports of
ownership with the Securities and Exchange Commission (the "SEC"). Officers,
directors and greater than ten percent shareholders are required by SEC
regulation to furnish the Company with copies of all Section 16(a) forms they
file.
15
Based solely on its review of the copies of such forms received by it, or
written representations from certain reporting persons, Registrant believes that
during the fiscal year ended December 31, 2003, all filing requirements
applicable to its officers, directors and greater than ten percent beneficial
owners were met.
Code of Ethics
The Company has adopted a Code of Ethics for Senior Financial Officers that is
applicable to our principal executive officer, principal financial officer,
principal accounting officer or controller, or persons performing similar
functions. A copy of our Code of Ethics for Senior Financial Officers is filed
as an exhibit to this annual report on Form 10KSB.
Item 10. Executive Compensation.
The following tables show compensation during the fiscal years ended December
31, 2003, 2002 and 2001, and option grants and option exercises during the
fiscal year ended December 31, 2003, of those persons who were, at December 31,
2003 the five most highly compensated executive officers of ADA-ES whose total
compensation exceeded $100,000.
Summary Compensation Table
Long Term
Compensation Awards
-------------------
Annual Compensation Securities Underlying
Name of Individual and ---------------------- Options
Principal Position Year Salary (1) Other (2) (#) (3)
------------------ ---- ---------- --------- -------
C. Jean Bustard 2003 $107,244 $28,885 -
Executive Vice President of 2002 $97,170 $26,633 -
ADA-ES 2001 $88,086 $24,180 -
Michael D. Durham 2003 $155,137 $38,351 -
President and 2002 $150,652 $35,742 -
Director 2001 $142,911 $34,270 -
Mark H. McKinnies 2003 $156,468 $36,351 14,500
Director and Chief 2002 $149,156 $35,628 -
Financial Officer 2001 $137,989 $33,698 -
Richard J. Schlager 2003 $104,328 $30,827 -
Vice President of Contract 2002 $92,041 $25,335 -
Research & Development 2001 $86,934 $24,007 -
John F. Wurster 2003 $206,208 $36,387 -
Vice President of 2002 $196,811 $34,043 -
Sales and Marketing 2001 $298,844 $32,279 -
(1) The salary amount for Mr. Wurster includes $170,438, $61,799 and
$64,631 paid to Orion Issues Management, Inc. ("OINI") on his behalf
in 2001, 2002 and 2003, respectively. Mr. Wurster performs a portion
of his services to the Company through OIMI. The Company has no other
relationship with OIMI.
(2) Amounts represent discretionary pension contributions, 401(k)
deferrals and matching payments made or accruing to a qualified plan
by the Company for the benefit of the named individual. In 2001 and
2002 such amounts include stock issued by Earth Sciences, Inc. for the
discretionary pension contribution portion of such payments. Amounts
paid by stock average 40% of the amounts shown.
(3) The securities shown represent options to acquire shares granted
pursuant to the Company's ISO Plan.
Options/SAR Grants in Last Fiscal Year
Individual Grants
Number of Securities % of Total Options
Underlying Options Granted to Employees Exercise or Base Expiration
Name Granted (#) in Fiscal Year Price ($/Sh) Date
-----------------------------------------------------------------------------------------------
Mark H. McKinnies 14,500 7.7% $ 2.50 2/23/2013
16
Aggregated Option Exercises in Last Fiscal Year and FY-End Option Values
Number of securities
Shares underlying unexercised Value of unexercised
acquired on Value options at FY-end(#) (1) options at FY-End
Name exercise (#) realized ($) exercisable/not exercisable exercisable/not exercisable
---- ------------ ------------ --------------------------- ---------------------------
C. Jean Bustard -0- $-0- 9,386/ -0- $43,176/ -0-
Michael D. Durham -0- $-0- 14,548/ -0- $66,921/ -0-
Mark H. McKinnies 14,079 -$-0- 14,500/ -0- $66,700/ -0-
Richard J. Schlager -0- $-0- 9,386/ -0- $43,176/ -0-
John F. Wurster -0- -$-0- 40,000/ -0- $184,000/ -0-
(1) With the exception of the shares shown for Mr. McKinnies, the
securities and options shown represent the duplication of shares of
Earth Sciences issued in December 2000 adjusted to reflect the
underlying shares in the Company (1 share for each 10 shares of Earth
Sciences). On the completion of the Distribution, options were granted
by the Company to duplicate the purchase rights afforded by any
options that were outstanding in Earth Sciences. For purposes of the
foregoing tables, these options were deemed to be granted on the dates
of the original grants to acquire shares of Earth Sciences.
DIRECTOR COMPENSATION
The compensation plan for our non-employee directors is reviewed annually. Under
the existing compensation plan, each non-employee director will receive $5,000
per year, which amount may be payable in common stock of the Company, and such
directors will also receive a fee of $600 per regular meeting, $300 per
committee meeting and/or $500 per committee meeting for serving as chairman of
the committee.
EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL
ARRANGEMENTS
The Company has executed employment agreements with every fulltime employee,
including executive officers, that contain the following standard provisions:
1. Automatic extensions for one-year periods.
2. Three month written notice of intent to terminate by either the
Company of the employee.
3. Description of position, duties, authority, compensation, benefits and
obligation of the employee to devote fulltime to the fulfillment of
his/her obligations under the agreement
4. Disclosure/ownership of inventions and confidential subject matter.
5. Assignment of inventions and confidential subject
matter/documentation/commercialization.
6. Copyright works and written records.
7. Restrictive obligations relating to confidential subject matter.
8. Conflicting obligations and obligations upon termination of
employment.
The employment agreement with John F. Wurster varies from the above provisions
as shown below. Mr. Wurster was given notice of termination of his employment
contract on January 19, 2004 in order to implement a Board recommended policy to
end commissions on sales, to be replaced by a bonus/incentive program currently
being developed by the Board.
1. Six months notice of termination rather than three.
2. Mr. Wurster is obligated to devote a minimum of 32 hours per week in
the fulfillment of his obligations under the agreement.
3. In addition to salary, Mr. Wurster receives a commission on certain
sales representing 5% of revenues from new sales and 2% of revenues
from continuing sales. Sales from government and co-funded industry
contracts are excluded from commissions. All commissions stop 30 days
after termination of employment.
The compensation amounts included in the employment agreements are subject to
annual adjustment and the current compensation levels are shown in the tables
above. None of the Company's employment contracts nor other agreements contain
any provisions for the payment of any amounts that result from or will result
from the resignation, retirement or any other termination of any executive
17
officer's employment with the Company or from a change-in-control of the Company
or a change in the named executive officer's responsibilities following a
change-in-control.
Item 11. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.
The following table provides information with respect to the beneficial
ownership of the Company's common stock by (1) each of our stockholders whom we
believe are beneficial owners of more than 5% of our outstanding common stock,
(2) each of our directors and executive officers and (3) all of our directors
and executive officers as a group. We base the share amounts shown on each
person's beneficial ownership as of March 19, 2004, unless we indicate some
other basis for the share amounts. With the exception of Mr. Lowdermilk, each of
the individuals named below has sole voting and investment power for the
respective shares.
Amount and Nature of
Name and Address Beneficial Ownership Percent of Class
---------------- -------------------- ----------------
Ramon E. Bisque (Chairman of the Board of Directors) 70,747 (1) 1.9%
9113 Fern WayGolden, CO
Duane N. Bloom (Director) 53,163 (2) 1.4%
5565 Pine Ridge Rd.
Golden, CO
C. Jean Bustard (Executive Vice President) 25,320 (3) *
9193 Buffalo Drive
Littleton, CO
Michael D. Durham (Director and President) 180,395 (4) 4.9%
5252 Lariat Drive
Castle Rock, CO
John W. Eaves (Director) 1,000 *
1 CityPlace One, Suite 300
St. Louis, MO
Hummingbird Value Funds 249,679 7.0%
153 East 53rd Street, 55th Floor.
New York, NY
Ronald B. Johnson (Director) 7,998 (5) *
4220 S. Allison St.
Littleton, CO
Robert H. Lowdermilk (Director) 174,432 (6) 4.7%
100 Cherry St.
Denver, CO
Mark H. McKinnies (Director, Secretary and CFO) 71,595 (7) 1.9%
27638 Pine Grove Trail
Conifer, CO
Rollie J. Peterson (Director) 31,961 *
22486 County Road 73
Big Lake, MN
Richard J. Schlager (VP of Contract R&D) 21,473 (8) *
8100 SouthPark Way, B
Littleton, CO
Jeffrey C. Smith (Director) 3,597 *
7272 Wisconsin Avenue, Suite 300
Bethesda, MD
John F. Wurster (VP of Sales and Marketing) 2,293 (9) *
3815 Spring Valley Trail
Evergreen, CO
Directors and Officers as a Group (12 individuals) 643,974 (10) 17.3%
* Less than 1%.
18
Notes:
(1) Included in the amount shown are 100 shares registered in the name of Dr.
Bisque's wife and 16,281 shares held in Dr. Bisque's pension fund account.
(2) Included in the amount shown are 773 shares registered in the name of Dr.
Bloom's wife and 20,416 shares held in Dr. Bloom's pension fund account.
(3) Included in the amount shown are 9,386 shares to which Ms. Bustard has the
right to acquire beneficial ownership through stock options and 15,934
shares held in Ms. Bustard's pension fund account.
(4) Included in the amount shown are 14,548 shares to which Dr. Durham has the
right to acquire beneficial ownership through stock options and 41,842
shares held in Dr. Durham's pension fund account.
(5) Included in the amount shown are 6,069 shares registered in the name of
Twin Kem International of which Mr. Johnson is the CEO.
(6) Included in the amount shown are 13,000 shares registered in the name of
Mr. Lowdermilk's wife, and 101,000 shares held by Tectonic Construction Co.
("TCC"). Mr. Lowdermilk is the president and majority shareholder of TCC.
(7) Included in the amount shown are 32,976 shares held in Mr. McKinnies'
pension fund account.
(8) Included in the amount shown are 12,087 shares to which Mr. Schlager has
the right to acquire beneficial ownership through stock options and 10,339
shares held in Mr. Schlager's pension fund account.
(9) Included in the amount shown are 2,293 shares held in Mr. Wurster's pension
fund account.
(10) The amount shown includes 33,320 shares to which individuals in the group
have the right to acquire beneficial ownership through convertible debt and
stock options.
Equity Compensation Plan Information
------------------------------------
Number of securities remaining
Number of securities to Weighted-average available for future issuance
be issued upon exercise exercise price of under equity compensation plans
of outstanding options, outstanding options, (excluding securities reflected
Plan category warrants and rights warrants and rights in column (a))
------------- ----------------------- -------------------- -------------------------------
(a) (b) (c)
Equity compensation plans
approved by security holders 187,310 $2.55 212,690
Equity compensation plans not
approved by security holders 0 n/a 0
------- ----- -------
Total 187,310 $2.55 212,690
======= ===== =======
DIRECTOR COMPENSATION
As noted above, under the existing compensation plan, each non-employee director
will receive $5,000 per year, which amount may be payable in common stock of the
Company. This payment plan has not been approved by the shareholders.
19
STOCK OPTION PLAN
During 2003 the Company adopted the 2002 ADA-ES, Inc. Stock Option Plan. One
purpose of the plan was to duplicate the options previously awarded by Earth
Sciences that have been cancelled. Otherwise, the plan is intended to serve to
encourage our key employees, through their individual efforts, to improve our
overall performance and to promote profitability by providing them an
opportunity to participate in the increased value they help create. Options
granted under the plan may be in the form of "incentive stock options" as
defined under section 422 of the Internal Revenue Code of 1986, as amended, or
options that are not incentive stock options. The plan is administered by the
compensation committee of the board of directors. The plan was approved by ESI
as the sole shareholder of ADAES prior to the spin-off distribution of ADA-ES
shares. We reserved 400,000 shares of our common stock for issuance under the
plan. In general, all options granted under the plan will lapse ten years from
the date of grant (five years in the case of a 10% stockholder of our company,
our parent or one of our subsidiaries). In general, 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 2003, 187,310 options were granted under the
plan of which 133,710 represented the duplication of options previously granted
by ESI which were cancelled.
Item 12. Certain Relationships and Related Transactions.
In 2000, Earth Sciences re-negotiated a convertible debenture in the amount of
$1,000,000 (the "Debenture") with Tectonic Construction Co. ("TCC") and a note
in the amount of $250,000 (the "Note") from TCC to extend the due dates and
clarify certain collateral. Mr. Lowdermilk, a director of Registrant, is the
president and majority shareholder of TCC. The Debenture and the Note bore
interest at the greater of prime plus two points or 10% which interest was
payable quarterly. As required under the Distribution Agreement with Earth
Sciences, in September 2003 the Company assumed remaining balance of the notes
payable to Tectonic Construction Co. totaling $1,150,000. Of that amount
$300,000 was paid off with proceeds of a convertible debenture sold to Arch in a
like amount as noted below. Also in September 2003, Tectonic converted $210,000
of the remaining debt into 100,000 shares of the Company's stock pursuant to the
terms of the debt assumed from Earth Sciences. The remaining $640,000 was also
paid-off in September 2003 with the proceeds from a term loan of the same amount
obtained from a commercial bank. The Company also assumed other indebtedness
from ESI in the amount of $130,000 related to past service obligations ($77,000
payable for the benefit of Mr. McKinnies and $44,200 payable for the benefit of
Dr. Bisque, both Directors of the Company).
As discussed above, the Company executed a Securities Subscription and
Investment Agreement with Arch Coal, Inc. in July 2003. Pursuant to the
investment agreement, in September 2003 Arch purchased a $300,000 convertible
debenture from the Company, purchased 137,741 shares of the Company's Common
stock and was also granted an option to purchase 50,000 shares. The Company also
co-markets its ADA-249 product under an agreement with Arch as described above.
Under that arrangement, the Company has recorded revenue of $60,000 and $150,000
in 2002 and 2003, respectively. The Company also granted Arch certain
"piggyback" rights in the event the Company registers certain other equity
securities and certain demand registration rights as part of the transaction. A
designee of Arch, John W. Eaves, has been appointed a seat on the Company's
Board of Directors and management of the Company has agreed in the future to
nominate and to vote all proxies and other shares of stock in the Company which
they are entitled to vote in favor of that designee so long as Arch holds no
less 100,000 shares of the Company's common stock.
Item 13. Exhibits and Reports on Form 8-K.
(a) Exhibits and Index of Exhibits (all exhibits except as otherwise noted are
incorporated by reference; Exhibit 3.1 through Exhibit 10.12 were filed as
exhibits to Registrant's Form 10SB, as amended, filed March 23, 2003; Exhibit
10.13 was filed as an exhibit to Registrant's Form S-8 filed November 13, 2003
and Exhibit 10.14 was filed as an exhibit to Registrant's Form S-8 filed
February 6, 2004 ).
No. Description
--- -----------
Index to Exhibits.
3.1 Amended and Restated Articles of Incorporation of ADA-ES
3.2 Amended and Restated Bylaws of ADA-ES
4.1 Form of Specimen Stock Certificate
10.1 Distribution Agreement
20
10.2 2002 ADA-ES, Inc. Stock Option Plan
10.3 Market Development Agreement between NORIT Americas Inc. and Earth
Sciences, Inc. dated June 29, 2001
10.4 Assignment and Assumption Agreement between NORIT Americas Inc. and
ADA-Environmental Solutions, LLC dated August 4, 2003
10.5 Joint Venture and Co-Marketing Agreement by and between Arch Coal
Sales Company and ADA- Environmental Solutions, LLC as of January 1,
2002
10.6 Securities Subscription and Investment Agreement between ADA-ES, Inc.
and Arch Coal, Inc. dated July 7, 2003
10.7 U.S. Department of Energy Cooperative Agreement No. DE-FC26-00NT40755
"Advanced Flue Gas Conditioning as a Retrofit Upgrade to Enhance PM
collection from Coal-Fired Electric Utility Boilers"
10.8 U.S. Department of Energy Cooperative Agreement No. DE-FC26-00NT41005
"Field Test Program to Develop Comprehensive Design, Operating, and
Cost Data for Mercury Control Systems"
10.9 Joint Product Exploitation and Marketing Agreement dated October 2,
2002, by and between ALSTOM Power Inc. ADA Environmental Solutions LLC
10.10 Tax Sharing Agreement between ADA-ES, Inc. and Earth Sciences, Inc.
dated March 17, 2003
10.11 U.S. Department of Energy Cooperative Agreement No. DE-FC26-02NT41591
"Long-Term Operation of a COHPAC System for Removing Mercury from
Coal-Fired Flue Gas"
10.12 Amendment No. 1 to Distribution Agreement by and between ADA-ES, Inc.
and Earth Sciences, Inc. dated August 15, 2003
10.13 2003 Stock Compensation Plan #1
10.14 2003 Stock Compensation Plan #2
10.15* U.S. Department of Energy Cooperative Agreement No. DE-FC26-03NT41986
"Evaluation of Sorbent Injection for Mercury Control".
14* Code of Ethics for Senior Financial Officers
21.1 Subsidiaries of ADA-ES
23.1* Consent of Hein + Associates LLP
31.1* Certification of Chief Executive and Chief Financial Officer of
ADA-ES, Inc. Pursuant to 17 CFR 240.13a-14(a) or 17 CFR 240.15d-14(a)
32.1* Certifications Pursuant to 18 U.S.C. Section 1350
(*) - filed herewith.
(b) Reports on Form 8-K.
On November 7 2003 Registrant filed a Form 8K reporting Item 5. Other Events and
Regulation FD Disclosures, which included Exhibit 99.1 November 7, 2003 Press
Release announcing Third Quarter Financial Results.
Item 14. Principal Accountant Fees and Services.
Fiscal Year
--------------------------
2002 2003
------- -------
Audit Fees $54,095 $66,267
Audit-Related Fees -- --
Tax Fees -- --
All Other Fees (1) $ 2,980 $19,021
The above amounts include combined services provided for Registrant and Earth
Sciences for 2002 and a portion of 2003, where such services could not be
divided into their components.
(1) Registrant's principal accountant provided review and consulting services
related to the filing of a Form 10SB with the SEC to effect the spin-off from
Earth Sciences.
21
Audit Committee Approval of Services
It is the policy of the Audit Committee of the Company to approve the engagement
to render audit or non-audit services before the accountant is engaged by the
Company. The Audit Committee approved of 100% of the services provided by the
independent accountant in 2003.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
ADA-ES, Inc.
------------
(Registrant)
By /s/ Mark H. McKinnies /s/ Michael D. Durham
------------------------ ---------------------
Mark H. McKinnies, Treasurer Michael D. Durham
and Principal Financial Officer President
Date: March 26, 2004 March 26, 2004
--------------------- --------------
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the Registrant and in the capacities and on the
dates indicated.
/s/ Ramon E. Bisque /s/ Robert H. Lowdermilk
------------------- -------------------------
Ramon E. Bisque Robert H. Lowdermilk
Chairman of The Board of Directors Director
March 26, 2004 March 26, 2004
-------------- --------------
Date Date
/s/ Duane N. Bloom /s/ Michael D. Durham
------------------ ---------------------
Duane N. Bloom, Director Michael D. Durham, Director
March 26, 2004 March 26, 2004
-------------- --------------
Date Date
/s/ Mark H. McKinnies /s/ Ronald B. Johnson
--------------------- ---------------------
Mark H. McKinnies, Director Ronald B. Johnson, Director
March 26, 2004 March 26, 2004
-------------- --------------
Date Date
22
INDEX TO FINANCIAL STATEMENTS
PAGE
----
Independent Auditor's Report............................................ F-2
Consolidated Balance Sheet - December 31, 2003.......................... F-3
Consolidated Statements of Operations - For the Years Ended
December 31, 2003 and 2002......................................... F-4
Consolidated Statements of Changes in Stockholders' Equity
- For the Years Ended
December 31, 2003 and 2002......................................... F-5
Consolidated Statements of Cash Flows - For the Years Ended
December 31, 2003 and 2002......................................... F-6
Notes to Consolidated Financial Statements.............................. F-7
F-1
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Stockholders
ADA-ES, Inc. and Subsidiary
Littleton, Colorado
We have audited the accompanying consolidated balance sheet of ADA-ES, Inc. and
Subsidiary as of December 31, 2003, and the related consolidated statements of
operations, and accumulated deficit and cash flows for the years ended December
31, 2003 and 2002. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of ADA-ES,
Inc. and Subsidiary as of December 31, 2003, and the results of their operations
and their cash flows for the years ended December 31, 2003 and 2002, in
conformity with accounting principles generally accepted in the United States of
America.
/s/ HEIN & ASSOCIATES LLP
-------------------------
HEIN & ASSOCIATES LLP
February 20, 2004
Denver, Colorado
F-2
ADA-ES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 2003
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents $ 777,000
Trade receivables, net of allowance for doubtful accounts of $4,000 1,065,000
Inventories 82,000
Prepaid expenses and other 117,000
-----------
Total current assets 2,041,000
-----------
PROPERTY AND EQUIPMENT, at cost 1,251,000
Less accumulated depreciation and amortization (791,000)
-----------
Net property, plant and equipment 460,000
-----------
GOODWILL, net of $1,556,000 in amortization 2,024,000
INTANGIBLE ASSETS, net of $23,000 in amortization 112,000
DEFERRED TAX BENEFIT AND OTHER ASSETS 63,000
-----------
TOTAL ASSETS $ 4,700,000
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable $ 162,000
Accrued payroll and related 183,000
Accrued expenses 31,000
Current portion-long-term debt 122,000
Deferred revenue 185,000
-----------
Total current liabilities 683,000
-----------
LONG-TERM LIABILITIES:
Note and accrued interest payable to related party 305,000
Note payable, net of current portion 491,000
Accrued profit-sharing 146,000
Deferred compensation and other 102,000
-----------
Total long-term liabilities 1,044,000
-----------
COMMITMENTS AND CONTINGENCIES (Notes 4 and 7)
STOCKHOLDERS' EQUITY:
Preferred stock; 50,000,000 shares authorized, none outstanding --
Common stock; no par value, 50,000,000 shares authorized,
3,582,230 shares issued and outstanding 4,467,000
Accumulated deficit (1,494,000)
-----------
Total stockholders' equity 2,973,000
-----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 4,700,000
===========
See accompanying notes to these financial statements.
F-3
ADA-ES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED
DECEMBER 31,
------------------------------------
2003 2002
----------- -----------
REVENUE:
Mercury emission control $ 3,437,000 $ 2,477,000
Flue gas conditioning 2,037,000 2,963,000
Combustion aids and others 389,000 260,000
----------- -----------
Total net revenues 5,863,000 5,700,000
COST AND EXPENSES:
Operating 3,113,000 3,060,000
General and administrative 2,130,000 1,941,000
Research and development 170,000 93,000
Depreciation and amortization 130,000 113,000
----------- -----------
Total expenses 5,543,000 5,207,000
----------- -----------
OPERATING INCOME 320,000 493,000
OTHER INCOME (EXPENSE):
Interest expense (27,000) (26,000)
Other, net 23,000 3,000
----------- -----------
Total other income (expense) (4,000) (23,000)
----------- -----------
NET INCOME BEFORE TAXES 316,000 470,000
PROVISION FOR TAX BENEFIT 93,000 --
----------- -----------
NET INCOME $ 409,000 $ 470,000
=========== ===========
NET INCOME PER COMMON SHARE - BASIC AND DILUTED $ .12 $ .14
=========== ===========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING, AS ADJUSTED 3,412,000 3,344,000
=========== ===========
See accompanying notes to these financial statements.
F-4
ADA-ES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2003 AND 2002
COMMON STOCK RECEIVABLE
--------------------------- FROM ACCUMULATED
SHARES AMOUNT PARENT DEFICIT TOTAL
----------- ----------- ----------- ----------- -----------
BALANCES, January 1, 2002 10,000 $ 5,326,000 $ (251,000) $(2,373,000) $ 2,702,000
Cash distributions to Parent -- -- (356,000) -- (356,000)
Stock issued to employees by Parent
for expenses -- -- 134,000 -- 134,000
Net income -- -- -- 470,000 470,000
----------- ----------- ----------- ----------- -----------
BALANCES, December 31, 2002 10,000 5,326,000 (473,000) (1,903,000) 2,950,000
Cash distributions to Parent (355,000) -- (355,000) -- (355,000)
Stock issued to employees by Parent
for expenses -- -- 20,000 -- 20,000
Stock option issued to third party for
services -- 19,000 -- -- 19,000
Assumption of debt on spin-off -- -- (1,280,000) -- (1,280,000)
Constructive dividend to Parent to
complete spin-off 3,334,489 (2,088,000) 2,088,000 -- --
Issuance of stock for cash 137,741 1,000,000 -- -- 1,000,000
Issuance of stock on conversion of debt 100,000 210,000 -- -- 210,000
Net income -- -- -- 409,000 409,000
----------- ----------- ----------- ----------- -----------
BALANCES, December 31, 2003 3,582,230 $ 4,467,000 $ -- $(1,494,000) $ 2,973,000
=========== =========== =========== =========== ===========
See accompanying notes to these financial statements.
F-5
ADA-ES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED
DECEMBER 31,
---------------------------------
2003 2002
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 409,000 $ 470,000
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 130,000 113,000
Loss on asset dispostions 6,000 --
Expenses paid with stock of Parent and stock options 39,000 134,000
Provision for tax benefit (93,000) --
Changes in operating assets and liabilities:
(Increase) decrease in:
Receivables 16,000 (444,000)
Inventories (1,000) 240,000
Other assets 16,000 (33,000)
Increase (decrease) in:
Accounts payable (292,000) 171,000
Accrued expenses 183,000 39,000
Other liabilities (230,000) (411,000)
----------- -----------
Net cash provided by operating activities 183,000 279,000
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (372,000) (69,000)
Proceeds from asset dispostions 24,000 --
----------- -----------
Net cash used in investing activities (348,000) (69,000)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from notes payable 940,000 --
Payments on assumed debt and notes payable (968,000) --
Advances to Parent (355,000) (372,000)
Sale of stock 1,000,000 --
Decrease in long-term liabilities -- (6,000)
----------- -----------
Net cash provided (used) in financing activities 617,000 (378,000)
----------- -----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 452,000 (168,000)
CASH AND CASH EQUIVALENTS, beginning of year 325,000 493,000
----------- -----------
CASH AND CASH EQUIVALENTS, end of year $ 777,000 $ 325,000
=========== ===========
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION:
Cash payments for interest $ 26,000 $ 26,000
=========== ===========
Stock of Parent and options issued for services $ 39,000 $ 134,000
=========== ===========
Stock issued in conversion of debt $ 210,000 $ --
=========== ===========
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Assumption of debt and accrued liabilities at spin-off $ 1,280,000 $ --
=========== ===========
Constructive dividend to Parent at Spin-off $ 2,088,000 $ --
=========== ===========
See accompanying notes to these financial statements.
F-6
ADA-ES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES:
-------------------------------------------------------------------
Nature of Operations - The accompanying consolidated financial statements
include the accounts of ADA-ES, Inc. (ADA-ES) and its wholly-owned
subsidiary, ADA Environment Solutions, LLC (ADA). ADA-ES was a wholly-owned
subsidiary of Earth Sciences, Inc. ("ESI" or the "Parent") until September
2003 when ESI distributed all of the then outstanding stock of ADA-ES to
its stockholders. ADA-ES' only asset is its investment in its wholly-owned
subsidiary, ADA. All significant intercompany transactions have been
eliminated. Collectively, ADA and ADA-ES are referred to as the Company.
The Company is principally engaged in providing environmental technologies
and specialty chemicals to the coal-burning utility industry. The Company
also generates substantial revenue from contracts co-funded by the
government and industry. The Company sales occur principally throughout the
United States.
Cash Equivalents - For purposes of the statement of cash flows, the Company
considers all highly liquid debt instruments with original maturities of
three months or less to be cash equivalents.
Receivables and Credit Policies - Trade receivable are uncollateralized
customer obligations due under normal trade terms requiring payment within
30 days from the invoice date. Management reviews trade receivables
periodically and reduces the carrying amount by a valuation allowance that
reflects management's best estimate of the amount that may not be
collectible.
Inventories - Inventories are stated at the lower of cost or market,
determined by the first-in, first-out method and consist of supplies.
Percentage of Completion - ADA follows the percentage of completion method
of accounting for all significant long-term contracts excluding government
contracts. The Company recognizes revenue on government contracts based on
the time and expenses incurred to date. The percentage of completion method
of reporting income from contracts takes into account the cost and revenue
to date on contracts not yet completed. Except for the government contracts
(discussed in Note 4), the Company had no material long-term contracts in
progress at December 31, 2003.
Revenue Recognition - ADA chemical sales are recognized when products are
shipped to customers. A reserve is established for any returns, based on
historical trends. Chemical products are shipped FOB shipping point and
title passes to the customer when the chemicals are shipped. The Company's
sales agreements do no contain right of inspection or acceptance provision
and products are generally received by customers within one day of
shipment. The Company has had no significant history of non-acceptance, nor
of replacing goods damaged or lost in transit. ADA equipment sales are
recognized when the equipment is delivered and installed and all return or
buy back privileges have expired. Consulting revenue is recognized as
services are performed and collection is assured.
F-7
ADA-ES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Property and Equipment - Property and equipment is stated at cost.
Depreciation on assets is provided using the straight-line method based on
estimated useful lives ranging from 3 to 10 years. Maintenance and repairs
are charged to operations as incurred. When assets are retired, or
otherwise disposed of, the property accounts are relieved of costs and
accumulated depreciation and any resulting gain or loss is credited or
charged to income.
Intangible Assets - Intangible assets principally consist of patents.
Acquired patents are being amortized over a 7-year period using the
straight-line method, which is less than the remaining legal life of the
patents. Patents obtained by the Company directly are being amortized over
a 17-year life.
Intangible assets consist of:
Accumulated
Cost Amortization Net
------------ ------------ ------------
Patents $ 135,000 $ (23,000) $ 112,000
============ ============ ============
Goodwill - Goodwill consists of the excess of the aggregate purchase price
over the fair value of net assets of businesses acquired. Goodwill was
amortized over a 10-year period through December 31, 2001. As of January 1,
2002, the Company adopted FAS 142, Goodwill and Other Intangible Assets.
Under FAS 142, Goodwill is no longer amortized, but subject to an
impairment evaluation, which is performed in the fourth quarter of each
year. During fiscal 2002, the Company engaged an investment banking firm to
perform a valuation of the Company. As a result of this evaluation, which
was reviewed and updated for 2003, the Company concluded that no impairment
of its goodwill was required.
Receivable from Parent - As discussed above, ADA was a wholly-owned
subsidiary of ESI. The net of intercompany transactions between ADA and ESI
were set forth in the Receivable from Parent and shown in the accompanying
Consolidated Statement of Stockholder's Equity. The intercompany
transactions consisted of cash distributions from ADA to the Parent and the
payment of certain ADA pension expenses (see Note 7) by the Parent using
its stock.
Operating Costs - Operating costs include all labor, fringe, subcontract
labor, chemical costs, materials, equipment, supplies and travel costs
directly related to ADA's production of revenue.
General and Administrative - General and administrative costs include
personnel related fringe benefits, sales and administrative staff labor
costs, facility costs and other general cost of conducting business.
F-8
ADA-ES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Net Income Per Share - Net income per share is presented in accordance with
the provisions of Statement of Financial Accounting Standards (SFAS) No.
128, Earnings Per Share. Basic EPS is calculated by dividing the income or
loss available to common shareholders by the weighted average number of
common shares outstanding for the period. Diluted EPS reflects the
potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock. As the
Company did not have any options outstanding as of December 31, 2002
diluted EPS is not presented for that period. For 2003 and 2002, the
weighted average number of common shares outstanding for the periods shown
have been adjusted to reflect the spin-off as if it occurred on January 1,
2002. As of December 31, 2003, the Company has 267,310 options outstanding
that can be converted into common stock (see Note 6).
Impairment of Long-Lived Assets - The Company follows Statement of
Financial Accounting Standards (SFAS) No. 144, Impairment of Long-Lived
Assets. In the event that facts and circumstances indicate that the cost of
assets or intangible assets may be impaired, an evaluation of
recoverability would be performed.
Income Taxes - The Company accounts for income taxes under the liability
method of SFAS No. 109, whereby current and deferred tax assets and
liabilities are determined based on tax rates and laws enacted as of the
balance sheet date. Income taxes for financial reporting purposes for the
Company for 2002 and the period through September 11, 2003 are based as if
the Company filed a separate return, even though the Company files a
consolidated income tax return with ESI for those periods.
Research and Development Costs - Research and development costs are charged
to operations in the period incurred.
Stock-Based Compensation - The Company records expense for stock options
granted to employees by using APB 25, which requires expense to be
recognized only to the extent the exercise price of the stock-based
compensation is below the market price on the date of grant. Transactions
in equity instruments with non-employees for goods or services are
accounted for on the fair value method. Because the Company has elected not
to adopt the fair value accounting described in SFAS No. 123 for employees,
it is subject only to the disclosure requirements described in SFAS No.
123.
F-9
ADA-ES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Had compensation cost been determined based on an estimate of the fair
value consistent with the method of SFAS No. 123 at the grant dates for
awards under those plans, the Company's net income and EPS would have been
reduced to the pro forma amounts indicated below.
Year Ended December 31,
---------------------------
2003 2002
------------ -----------
Net income applicable to other stockholders:
As reported $ 409,000 $ 470,000
Stock based compensation included in net income -- --
Fair value of stock based compensation (62,000) --
----------- -----------
Pro forma $ 347,000 $ 470,000
=========== ===========
Net income per share applicable to other shareholders
- basic and diluted:
As reported $ .13 $ .14
Fair value of net income per share (.03) --
----------- -----------
Pro forma - basic and diluted $ .10 $ .14
=========== ===========
There were no options granted in 2002 and options granted in 2003 had an
exercise price equal to the market price on the date of the grant. The
average fair value of each employee option granted in 2003 was
approximately $2.32 and was estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted average
assumptions:
Years Ended December 31,
-------------------------
2003 2002
-------- --------
Expected volatility 50% N/A
Risk-free interest rate 2% N/A
Expected dividends 0 N/A
Use of Estimates - The preparation of the Company's consolidated financial
statements in conformity with generally accepted accounting principles
requires the Company's management to make estimates and assumptions that
affect the amounts reported in these financial statements and accompanying
notes. Actual results could differ from those estimates. The Company makes
significant assumptions concerning the impairment of and the remaining
realizability of its intangibles. In addition, the Company enters into
significant research contracts with the U.S. Government, which are subject
to future audits. Pursuant to the contracts, the Company makes estimates of
certain overhead and other rates, which may be adjusted as a result of such
audits. At this time, the Company does not believe any future government
audit will result in material adjustment to previously recorded revenues.
F-10
ADA-ES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Comprehensive Income/Loss - SFAS No. 130 establishes standards for
reporting and display of comprehensive income/loss, its components and
accumulated balances. Comprehensive income/loss is defined to include all
changes in equity except those resulting from investments by owners and
distributions to owners. Comprehensive income was the same as net income in
2003 and 2002.
Segment Information - The Company follows SFAS No. 131, Disclosure About
Segments of an Enterprise and Related Information. SFAS No. 131 establishes
standards on the way that public companies report financial information
about operating segments in annual financial statements and requires
reporting of selected information about operating segments in interim
financial statements issued to the public. It also establishes standards
for disclosures regarding products and services, geographic areas, and
major customers. SFAS No. 131 defines operating segments as components of a
company about which discrete financial information is available that is
evaluated regularly by the chief operating decision maker in deciding how
to allocate resources and in assessing performance. The Company has three
reportable segments even though it derives its revenues primarily from
specialty chemicals and government contracts.
Recently Issued Accounting Pronouncements - In May 2003, the Financial
Accounting Standards Board ("FASB") issued Statements of Financial
Accounting Standards No. 150, Accounting for Certain Financial Instruments
with Characteristics of Both Liabilities and Equity. SFAS No. 150 requires
issuers to classify as liabilities (or assets in some circumstances) three
classes of freestanding financial instruments that embody obligations for
the issuer. SFAS No. 150 is effective for financial instruments entered
into or modified after May 31, 2003 and is otherwise effective at the
beginning of the first interim period beginning after June 15, 2003. The
adoption of SFAS No. 150 has had no immediate impact on the Company's
financial position or results of operations.
2. SPIN-OFF OF ADA-ES:
------------------
In March 2003, the Company and ESI entered into an agreement (the
"Distribution Agreement") for the pro rata distribution of all the common
stock of the Company to the stockholders of ESI based on a record date of
August 29, 2003 and thereby formed a separate public company. The
Distribution Agreement required certain allocations of cash and liabilities
among ESI and the Company prior to the distribution of the Company's common
stock.
Based on the Distribution Agreement, ESI issued one share of ADA-ES for
each ten shares currently owned by the stockholders of ESI. Approximately
3,344,000 shares of ADA-ES were issued to the shareholders of ESI in
September 2003 to effect the spin-off.
In a related transaction, ADA-ES entered into an investment agreement with
Arch Coal, Inc. (Arch). The Arch Coal Agreement was subject to the spin-off
of ADA-ES from ESI. The agreement provided for $300,000 of additional debt
(the proceeds of which were used to pay down debt assumed in the spin-off)
and $1,000,000 of equity for the issuance of shares of common stock. The
price of the stock of $7.26 per share was based on a multiple of the market
price for the ESI common stock at the time of the spin-off.
F-11
3. PROPERTY AND EQUIPMENT:
----------------------
Property and equipment as of December 31, 2003 is summarized as follows:
Estimated Useful
Lives
----------------
Machinery and equipment $ 916,000 3-10
Leasehold improvements 195,000 7
Furniture and fixtures 140,000 5
-------------
$ 1,251,000
=============
Depreciation and amortization of property and equipment for the years ended
December 31, 2003 and 2002 was $123,000 and $107,000, respectively.
4. GOVERNMENT AND INDUSTRY FUNDED CONTRACTS:
----------------------------------------
ADA has performed activities under four contracts awarded by the Department
of Energy (the "DOE") that contributed a total of $2,164,000 and $2,650,000
to revenues in 2003 and 2002, respectively. These amounts are included in
Mercury emission control revenues of $1,956,000 and $2,327,000, and Flue
gas conditioning revenues of $208,000 and $323,000, in 2003 and 2002,
respectively. ADA typically invoices the DOE monthly for estimated labor
and expenditures plus overhead factors, less cost share amounts. The total
approved DOE budgets amount to $18 million, of which the Company's and
industry partners' cost-share portion is $6 million. The remaining unearned
amount of the contracts expected to be recognized by the Company in 2004
(including cash contributions by other industry partners) is $4.8 million.
The Company is in the process of working with DOE on a new contract in
which the Company will be a subcontractor and primary technology provider
for 2003 through 2008. These contracts are subject to audit and future
appropriation of funds by Congress. The Company's historical experience has
not resulted in significant adverse adjustments to the Company, however the
government audits for years ended 2003 and 2002 have not yet been
finalized.
5. DEBT:
----
Note Payable to Related Party - ADA-ES has a debenture to Arch with a total
balance including accrued interest of $305,000 at December 31, 2003.
Payment of the debenture and related interest are due at maturity on
September 30, 2008. The note bears interest at the greater of the Wall
Street Journal prime rate plus 1% or 6% (6% at December 31, 2003). The note
is convertible into shares of the Company's common stock on or after March
31, 2005 as explained below in Note 6. Interest expense recognized on this
note in 2003 was $5,000.
F-12
ADA-ES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Term Loan and Line of Credit - In 2003, ADA negotiated a revolving $250,000
line of credit and a $640,000 term loan with a financial institution. No
amounts were outstanding under the line of credit at December 31, 2003,
which bears interest at bank prime plus 1.75% (6% at December 31, 2003),
payable monthly. The term loan is due in monthly installments of principal
and interest of $13,551 through May 2008 and bears interest at 7.17%.
Covenants of the line and term loan require the Company to meet certain
borrowing base requirements and other financial covenants. The line and
term loan are secured by inventory, accounts receivable, equipment and
intangibles of the Company and are guaranteed by certain officers of the
Company. Future maturities of the term loan are as follows:
2004 $ 122,000 (shown as current portion)
2005 131,000
2005 141,000
2007 152,000
2008 67,000
-----------
$ 613,000
===========
6. STOCKHOLDERS' EQUITY:
--------------------
Shares Issued for Pension Expenses - ESI issued shares of its common stock
in 2003 and 2002, respectively, for the payments of approximately $20,000
and $134,000 of ADA pension related expenses (see Note 7), based upon the
per share value of unrestricted common stock of ESI at the time of
exchanges. This amount was recorded as an additional payable of the Company
to ESI. These amounts were recorded in the Receivable from Parent and shown
in the accompanying financial statements in the Stockholder's Equity
section.
Sale of Stock, Convertible Debenture and Grant of Option to Arch - In
September 2003, the Company sold 137,741 shares to Arch Coal for $1 million
and sold a convertible debenture for $300,000 both pursuant to an
investment agreement. Of the shares sold, 37,741 have been placed in escrow
and a portion or all may be returned to the Company if the market price of
the Company's shares exceeds a minimum of $9.08 for a twenty-day continuous
period during the one-year period from the date of their issuance. The
Debenture is convertible into shares after August 2005 at the lower of $20,
$30, and $40 per share in the years expiring March 2006, 2007, and 2008,
respectively, or 150% of the then current market price. The Debenture is
convertible solely at the discretion of Arch. As a part of the share
purchase Arch was also granted an option to purchase 50,000 shares for
$10.00 per share. The option expires in five years. Under the option, Arch
may purchase 16,667 shares after August 2004, another 16,667 shares after
August 2005, and the remaining shares after August 2006.
Conversion of Debt to Shares - The Company assumed convertible debt to a
related party as part of the spin-off transaction (see Note 10), which
debt, to the extent allowable, was converted to stock in September 2003.
Upon such conversion, the Company issued 100,000 shares of its common stock
in exchange for $210,000 of such debt.
F-13
ADA-ES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock Options - The Company did not issue any options during 2002. However,
as a result of the spin-off (Note 2), options outstanding at ESI were
exchanged for options of ADA-ES based on the effective share exchange of
one option share for each ten options outstanding at ESI based on the price
and terms the options were originally issued. If this exchange had occurred
at December 31, 2002, pro forma options outstanding would have been
133,710, with a weighted average exercise price of $2.50. The following is
a table of options issued during 2003:
Weighted
Average
Employees Non-Employee Exercise
Options Options Price
------- ------- -----
OPTIONS OUTSTANDING, January 1, 2003 -- -- $ --
Options granted resulting from spin-off 133,710 -- 2.50
Other options granted 53,600 80,000 5.38
-------------- ------------ -----------
OPTIONS OUTSTANDING, December 31, 2003 187,310 80,000 $ 3.94
============== ============ ===========
The weighted average remaining contractual life for all options as of
December 31, 2003 was approximately 4 years. At December 31, 2003, 187,210
options with a weighted average exercise price of $2.50 were fully vested
and exercisable. Of the remaining 80,100 options, 30,100 options with a
weighted average exercise price of $2.80 vest based on the earlier of
specific achievements of individual employees or 5 years and the remaining
50,000 option with an exercise price of $10.00 vest one third after one
year, another one third after a second year, and another one third after
three years.
If not previously exercised, options outstanding at December 31, 2003, will
expire as follows:
Weighted
Range Average
----------------------- Number of Exercise
Year Low High Options Price
---- ---------- ----------- -------------- -------------
2005 2.50 2.50 133,710 $ 2.50
2008 2.50 10.00 133,600 $ 5.38
---------
267,310
=========
Change in Shares Authorized - During 2003, the Company changed its
authorized shares to 50,000,000 of preferred stock and 50,000,000 of common
stock. Preferred shares may be issued in the future in such series and with
preferences as determined by the Company's Board of Directors.
F-14
ADA-ES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. COMMITMENTS AND CONTINGENCIES:
-----------------------------
Pension Expense and Retirement Plan - The Company assumed a defined
contribution and 401(k) plan covering all eligible employees from ESI as of
January 1, 2003. The Company recognized contribution expense of $217,000
and $159,000 for 2003 and 2002, respectively, based on a percentage of the
eligible employees' annual compensation. A portion of those expenses were
paid for with stock of ESI (see Note 6).
Office Lease - The Company leases office space under a noncancellable
operating lease. Total rental expense was $135,000 and $73,000 for the
years ending December 31, 2003 and 2002, respectively. The total minimum
rental commitments at December 31, 2003 was $723,000 for lease payments due
in 2003 through 2010 as follows:
Year Amount
---- ----------
2004 $ 113,000
2005 116,000
2006 119,000
2007 122,000
2008 125,000
Thereafter 128,000
----------
$ 723,000
==========
Equipment Purchase - During 2003, the Company entered into an agreement to
subsequently purchase equipment previously sold to a customer for $235,000.
The Company anticipates it will fully recover its cost in the equipment by
using it in a future project.
8. MAJOR CUSTOMERS:
---------------
Sales to unaffiliated customers which represent 10% or more of the
Company's sales for the year ended December 31, 2003 and 2002 were as
follows (as a percentage of each entity's sales):
Customer 2003 2002
-------------------------- -------------- --------------
A (Governmental Contracts) 26% 41%
B 12% 12%
C 11% 10%
D - 14%
At December 31, 2003, approximately 80% of the Company's trade receivables
were from six customers.
A significant portion of ADA's revenue is derived from contracts with
Department of Energy and chemical and equipment sales to coal-burning
electric power plants.
F-15
ADA-ES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. INCOME TAXES:
------------
Prior to September 2003, the Company was a wholly owned subsidiary of ESI.
The Company's tax attributes were passed through to its Parent and any
taxable income was offset by the Parent's tax loss carryforwards. In
connection with the spin-off, the Company retained its tax loss
carryforward generated in the current year returns. The Company's tax basis
of its assets and liabilities carry forward after the spin-off. The
following lists the Company's deferred tax assets and liabilities as of
December 31, 2003:
Current assets (liabilities):
Prepaid expenses $ (23,000)
Deferred revenues and compensation 69,000
----------
46,000
Non-current assets (liabilities)
Property and intangible asset differences (2,000)
Net loss carryforward 15,000
Tax credits 34,000
----------
47,000
Net tax assets 93,000
Net valuation allowances -
----------
$ 93,000
==========
As of December 31, 2003, the Company had approximately $40,000 of tax loss
carryforwards. The Company's valuation allowance as of December 31, 2003
and 2002 was $0 and $80,000, respectively, and as such, the valuation
allowance was reduced by $80,000 in 2003. During the years ended December
31, 2003 and 2002, the Company's deferred tax valuation allowance increased
by approximately $80,000 in 2003 and reduced by approximately $174,000 in
2002 (2002 calculated on a "stand-alone" basis). The following is a
reconciliation of the actual income tax rate - expense (benefit) to the
expected combined Federal and State tax rate of approximately 37%:
2003 2002
---- ----
Expected income tax rate - expense
(benefit) 37% 37%
Permanent differences 1% -
Change in the deferred tax
valuation allowance (decrease) (67%) (37%)
---- ----
Actual income tax rate (29%) 0%
==== ====
During 2003, the Company determined that it was more probable than not that
the Company's net deferred tax asset would be realized in the future and
accordingly, the Company eliminated the related valuation allowance.
F-16
ADA-ES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. RELATED PARTY TRANSACTIONS:
--------------------------
In 2003, pursuant to the Distribution Agreement with ESI (see Note 2) the
Company assumed a convertible debenture in the amount of $1,000,000 (the
"Debenture") with Tectonic Construction Co. ("TCC") and a note in the
amount of $150,000 (the "Note"). A director of the Company is the president
and majority shareholder of TCC. The Debenture and the Note bore interest
at the greater of prime plus two points or 10% which interest was payable
quarterly. Of that amount $300,000 was paid off with proceeds of a
convertible debenture sold to Arch in a like amount. Also, in September of
2003, TCC converted $210,000 of the remaining debt into 100,000 shares of
the Company's stock pursuant to the terms of the debt assumed from ESI. The
remaining $640,000 was also paid off in September with the proceeds from a
term loan of the same amount obtained from a commercial bank.
As discussed above in Note 2, the Company executed a Securities
Subscription and Investment Agreement with Arch Coal, Inc. in July 2003.
Pursuant to the investment agreement, in September 2003 Arch purchased a
$300,000 convertible debenture from the Company, purchased 137,741 shares
of the Company's Common stock and was also granted an option to purchase
50,000 shares. The Company also co-markets its ADA-249 product under an
agreement with Arch as described above. Under that arrangement, the Company
has recorded revenue of $150,000 and $60,000 in 2003 and 2002,
respectively. The Company also granted Arch certain "piggyback" rights in
the event the Company registers certain other equity securities and certain
demand registration rights as part of the transaction. A designee of Arch
has been appointed a seat on the Company's Board of Directors and
management of the Company has agreed in the future to nominate and to vote
all proxies and other shares of stock in the Company which they are
entitled to vote in favor of that designee so long as Arch holds no less
than 100,000 shares of the Company's common stock.
11. BUSINESS SEGMENT INFORMATION:
----------------------------
The Company has three reportable segments: mercury emission controls (MEC),
flue gas conditioning and consulting (FGC), and combustion aids and
consulting (CA). All assets are located in the U.S. and are not evaluated
by management on a segment basis. All significant customers are U.S.
companies.
Year Ended December 31, 2003:
----------------------------
MEC FGC CA Total
--- --- -- -----
Total revenue $3,437,000 $2,037,000 $389,000 $5,863,000
Segment profit (loss) $890,000 $1,104,000 $(84,000) $1,910,000
F-17
ADA-ES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Year Ended December 31, 2002:
----------------------------
MEC FGC CA Total
--- --- -- -----
Total revenue $2,477,000 $2,963,000 $260,000 $5,700,000
Segment profit (loss) $272,000 $1,493,000 $(127,000) $1,638,000
A reconciliation of the reported total segment profit (loss) to Net Income
for the periods shown above is as follows:
2003 2002
------------ ------------
Total segment profit (loss) $ 1,910,000 $ 1,638,000
Non-allocated general & administrative expenses (1,460,000) (1,032,000)
Depreciation and amortization (130,000) (113,000)
Interest, other expenses and tax benefit 89,000 (23,000)
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Net income $ 409,000 $ 470,000
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F-18