Dr. Michael D. Durham
TWST: Please begin with a brief historical sketch of the company and a picture of what you're doing now.
Dr. Durham: ADA - the "ES" stands for "environmental solutions" - we provide emission control technology to the coal-fired power industry. I've been working in this area for about 35 years with the group I have here. In 1997 we were sold to a public company called Earth Sciences, and then in 2003 we spun out as a separate public entity and started trading on Nasdaq in 2004.
TWST: What are you up to at the present time?
Dr. Durham: As you know, there is a lot of pressure on burning coal cleaner. Coal represents 50% of electrical power generation in the U.S., but there are mandates to burn it cleaner and cleaner. We are working on three areas that are related to new regulations. Mercury is being regulated for the first time ever from coal-fired power plants. We have been working in mercury control for over a decade and the market is coming in two phases, the first of which occurred in 2006 through 2010, resulting from mercury regulations in 19 states. In this initial phase, ADA was the market leader in providing mercury control technology for power plants. The technology that we provide is based around activated carbon injection, and what this represents is somewhat of a razor and razor-blade model. We sell a piece of hardware to a power plant that represents about a $1 million capital equipment sale to them. But once that equipment is in, it will require approximately $1 million to $2 million per year in activated carbon. We have started construction of a new activated carbon plant in Louisiana in 2008 that is in the process of starting up as we speak, that will produce about 150 million pounds per year of activated carbon. The next wave of activity is occurring as a result of a court-ordered mandate for EPA to create a federal mercury control regulation that will create a market on the equipment side about five times bigger - about $800 million - five times bigger than the current market for activated carbon equipment. But it will also generate markets for about close to a billion pounds of activated carbon starting in 2014. So we have permitted a number of new plants to produce activated carbon at as many as six total production lines that would be required for this market. That's the mercury control area.
Another area that's growing for us is our refined coal segment. Refined coal is basically a chemical treatment of coal that reduces mercury as well nitrogen oxides. This product qualifies for a Section 45 tax credit of about $6 per ton of coal. We were able to get two systems up and running by the December 31 IRS deadline. These two systems, which are about to start up now, meet all the requirements for the tax credit. They'll be generating about 6.5 million tons per year of coal, so that will generate about $40 million a year in tax credits for 10 years. We are finalizing an agreement with a monetizers, who will turn those tax credits into revenues for us. We'll announce the details of those contracts once they're finalized shortly.
The third area is the capture of carbon dioxide in response to potential climate change legislation. We have been developing carbon capture technology for the power industry, and currently we are working on a $3 million program from the Department of Energy that's co-founded by several large utilities, such as AEP, Southern Company, Luminant and Xcel. We are waiting to hear about a $14 million extension of funding that we submitted to the DOE, which we expect to hear on in the next couple of weeks. This funding will allow us to scale up our technology.
TWST: Tell me about your own background and about those of the key members of your team.
Dr. Durham: As I mentioned, I've been in this over 35 years, and I have a Ph.D. in environmental engineering. I've focused my entire career on developing emission control technology for the power industry. I started the original ADA company in 1985 and then spun it out in 1997, at which time I earned an MBA. Shortly after that, I took the company public. The rest of my executive team has worked together for one to two decades, at least in this field, and we have positioned ourselves for this major increase in the number of regulations that is finally coming to the forefront of the coal-fired power industry.
TWST: You've been looking forward to these regulatory changes for a while, correct?
Dr. Durham: Just for example, there is a worldwide concern surrounding mercury emissions. We performed the first pilot plant test in 1990; we completed the first full-scale demonstration in the year 2000, which was in anticipation of what was supposed to be a rule that was to come out in late 2004. In all, we conducted about 50 full-scale demonstrations with the technology, and that provided a database on which they based the regulations. However, the administration at that time tried to circumvent the rule. This motivated 19 states to develop their own strict rules. The weak federal rule was thrown out by the courts and now mandated that EPA put in a new rule that's based around maximum achievable control technology, or MACT. Our technology fits that description of maximum achievable control technology.
TWST: How would you describe the outlook for the industry in general and for your company in particular?
Dr. Durham: You see the public opinion of coal come and go, but the reality of it is we're going to continue to depend upon it for the next several decades for approximately 50% of the power. When you look at the alternatives, oil obviously has its own problems, as we are seeing in the Gulf. We have more BTUs in coal in the U.S. than all the BTUs in the world in oil and gas, so it's a very plentiful supply. Even as we're seeing more and more renewables start to increase, that's only a few percent of U.S. electricity demand, so we can't depend upon those for a reliable supply. Renewables can only supplement some supply. Nuclear makes sense, but it's a long way away. So the coal industry is solid, and we believe it will be solid for decades. It's the cheapest, safest fuel we have, but there are these current mandates that are being implemented by EPA and by Congress to burn it cleaner. So that's just creating tremendous market for us.
TWST: What's the competitive landscape like? Tell us what you see as your competitive advantages.
Dr. Durham: Entering the activated carbon production market was a vertical integration for the company. There were really only two primary competitors in that field. It's basically a duopoly, Calgon Carbon and Norit. Norit is a private Dutch company that had about 90% market share between them, but they had never sold to the power industry before. We saw that they weren't expanding their production to meet this new market. We went forward and started permitting the six plants and financed the first plant at $400 million. As I mentioned earlier, it's in startup right now and will be in full operating capacity by August. We plan to build a number more. One of our competitive advantages is the fact that we are very much involved in the policy development. Congress is looking at developing a new regulation for mercury on the federal level, and I've testified a number of times to the Senate on this issue. We are very much aware of the technology and the policy side of things, so we can look at the size of the market that's going to develop and, as we looked to build our plants, we analyzed the market and we started the process for permitting all six of these.
Another competitive advantage we have in the activated carbon market is we planned ahead to build our AC plants in places near cheap sources of the feedstock that's used to make activated carbon, which is a low-quality coal. So therefore we have a long-term supply of our material adjacent to the plants, and that's going to make us a low-cost producer. The other advantage is that it's very difficult to get permits for new facilities like this because it's very similar to a new coal-fired power plant, and so that process can take up to three or four years to get a permit. But we have our permits in place. Just a couple of weeks ago, EPA proposed a new mercury regulation for industrial boilers, and one for utility boilers is coming up next March. Because of our existing permits, we can be producing a product within two years. So we've positioned ourselves for this big wave of a new market for the product.
TWST: How was the company affected by the recession and the economic slowdown?
Dr. Durham: A couple of things have happened. Right when we started financing this new plant, we started to see the economic downturn have an negative effect on our stock price - not because of our performance, but because we had a couple of hedge funds with liquidity problems sell a significant amount of our shares, which brought our stock price down to a level lower than it was two years ago - before we were involved in building this plant. Now we've successfully completed it. That was the primary problem for us due to the recession. Other than that, we have grown this new activated carbon company that we built through our joint venture to about 90 people. We have brought on several key people to operate this new chemical plant, and what we found was that the recession actually helped us there because there were some pretty good people that were available for us to hire. So we're really pleased at the level of talent we were able to bring in at that time.
TWST: I was going to ask you about the joint venture with NexGen Resources. Clean Coal Solutions is part of NexGen, correct?
Dr. Durham: That's correct. That's our 50-50 joint venture with NexGen, in which we sell our refined coal technology. This technology allows us to treat coal and qualify for tax credits. Once we get our two systems that were qualified up and running, we should generate pretty significant cash flows. The guidance we've given is that the joint venture should receive about $9 million in cash right away from the sale/lease of the equipment. Then as the tax credits are monetized, we will receive somewhat of a royalty payment that will represent about $12 million in operating income per year to the joint venture for 10 years. During the first year of operation, ADA will receive about $10 million and then split income 50-50 for the next nine years. We've got an opportunity to grow that business further if we can get an extension of placed-in service requirement for the tax credit. We've been working with Congress, and it's been in a bill passed by the Senate and being modified in the House. So hopefully once Congress comes back next week, we might see a bill passing that could allow us to double or triple that business if we get that tax extension.
TWST: How does your business break down between those three different technologies? Where do you see the growth coming from as we go forward?
Dr. Durham: The best way to look at those is by their time frames. As I mentioned, we expect the two refined coal projects to start up this month. And so that's going to start generating about $9 million a year in operating income to the joint venture after tax for 10 years. And so that's increasing from zero today and, hopefully by the end of the month, it will be up to that level - pretty flat for the next 10 years. The next time frame is related to the federal mandate, and our activated carbon plants and the activated carbon systems. This ruling will create a market for our activated carbon systems of about $800 million between 2012 and 2014. Right now, with the 19 states that have regulations in place we have achieved about 30% market share on the equipment side. Once the federal regulation is implemented, it will create a market for close to a billion dollars a year for activated carbon, and that will be starting in 2014. So we'll be building plants for that market. The next time frame is based upon commercialization of technology for CO2 capture. That's probably not commercial until 2020, but we get our early revenues prior to it being a commercial product, through funding from the Department of Energy and our customers. So as with our current $3 million program, that's all revenue for us. We're expecting another $14 million to scale up the technology. So instead of us having R&D expenses, we actually have R&D revenues, as we develop new growth technologies for future regulations.
TWST: We've touched on different regulatory affairs. Are there others that you keep an eye on? Obviously CO2 could be a big deal for you.
Dr. Durham: Absolutely, the 2020 time frame was based upon the Waxman-Markey Bill that was passed in the House last summer. The bill has been struggling to get support in the Senate. So we don't know what the actual time frame will be. In the meantime, the concern over climate change has generated a significant increase in funding from the government for technology to meet a future carbon-capture technology. For example, in contrast to last year, I think DOE had about $40 million to spend on carbon capture, whereas this year they have about $3.5 billion set aside in the Stimulus Bill to fund carbon capture and sequestration technology. So it's a great deal of funding. Even though we don't yet have the bill that creates a commercial market, it at least creates the funding for scale-up and full-scale demonstration of this technology over the next number of years.
TWST: How far off do you think profitability is? What will it take to get there?
Dr. Durham: I think we're on the verge of it. We've obviously had a lot of capital expenditures building this new $400 million plant through a joint venture. We've hired about 70, 80 people to operate the plant ,which create expenses prior to producing and selling product. So once the plant is up and running at full capacity and we bring new CyClean systems on line, I think that will take us a long way toward profitability.
TWST: How is the company's capital structure? Do you have areas that need to be improved?
Dr. Durham: We have pretty much spent most of the balance sheet on these new capital projects. We have a couple of million dollars in cash. We have announced that we're negotiating a license of our technology with Arch Coal on another technology that will bring in a couple of million dollars. We have these two Refined Coal systems that once monetized, that will bring into the joint venture about $9 million. But as we look to expand and build another five production lines for activated carbon, we think to maintain a 50% ownership will require about $30 million to $35 million a piece. But they end up generating very large EBITDA margins for us. With the product pricing where we expected it to be, the plants could generate 60%, 70% EBITDA margin. So we will be raising money after the federal mercury bill is passed, and we will need to start building. We put into our annual proxy an approval for sale of 3.5 million shares. We only have about 7 million shares out right now.
TWST: Does the company pay a great deal of attention to investor relations?
Dr. Durham: We schedule about six or eight investor road shows a year - two to three in San Francisco, two to three in New York and then a couple others. So we're on the road quite a bit. In addition, we also present at numerous small-cap and industry specific conferences throughout the year.
TWST: Looking ahead, what are some year-by-year milestones or indicators that investors should keep an eye on when looking at ADA-ES?
Dr. Durham: There's a number of things that will happen in the next few months that are going to be key to us. We expect to hear about this $14 million program on CO2 capture; we expect to finalize a licensing agreement on a new technology with Arch Coal that we would expect to bring in about $2 million upfront and then a royalty based on success of applying the technology. We're expecting to get these first two CyClean systems up and running in the next few weeks, and then there is the possibility of an extension on the tax credit. So a number of things are happening over the summer that are going to have a pretty significant impact on the company.
TWST: Over the longer haul, are there regulatory issues that investors might be watching?
Dr. Durham: Yes, there are three key regulations to follow. The EPA is putting out three of these MACT regulations, Maximum Achievable Control Technology regulations. The first one came out in draft a few weeks ago for industrial boilers, and it should be final by the court-ordered December date. The second one will be a MACT regulation for mercury from cement plants. That is expected in the next few weeks, and again it will be final by the end of the year. And finally the court-ordered MACT for utility boilers, which is the big one. That draft is scheduled for next March and set to be final by November 2011.
TWST: The CO2 regulations could be good news, no?
Dr. Durham: That just sets the date for when the commercial market is established. What is key for us over the next five years or so is the availability of funding to support the development of technology. The utilities follow the regulations, but they need the regulation to drive their interest. So once they are starting to see even a threat of a regulation or a draft of a bill, we start seeing business pick up in anticipation of that regulation.
TWST: Are you confident about what will happen?
Dr. Durham: We have an idea of what the challenges are. And as long as there is funding over the next five to six years to continue supporting our development of the technology, that's our near-term focus.
TWST: What would be the two or three best reasons for a long-term investor to look closely at ADA-ES?
Dr. Durham: It's the perfect time because we have been developing these technologies for quite a while, and they are just starting to come into play, with the first activated carbon plant starting up, the CyClean systems about to start generating money. And so you're going to start to see an increase in revenues. These revenues are based on our business model, which include a continuous revenue source. So as each new business starts up, it creates a bump in revenues and profitability that we believe will be maintained for a long period of time.
TWST: Anything else you wanted to let folks know about the company?
Dr. Durham: That's pretty much our story and we plan to put out information as some of these catalysts come into play over the next month or so to keep everybody informed.
TWST: Thank you. (MJW)
Dr. MICHAEL D. DURHAM, PH.D.
ADA-ES, Inc. (ADES)
8100 Southpark Way
Littleton, CO 80120
(303) 734-0330 - FAX