Advanced Emissions Solutions, Inc. (NASDAQ:ADES)
2015 Financial Update Conference Call
April 20, 2016 09:00 AM ET
Nick Hughes - IR
Heath Sampson - President and CEO
Sean Hannan - Needham & Company
Rob Brown - Lake Street Capital Markets
Shantanu Agrawal - BlackRock
Kevin McKenna - Stifel
Greetings, and welcome to the ADES 2015 Financial Update Conference Call. At this time, all participants are in a listen-only mode, a question-and-answer session will follow the formal presentation. [Operator Instructions] And as a reminder, this conference is being recorded.
I would now like to turn the conference over to your host, Nick Hughes, Investor Relations for ADES. Thank you, Mr. Hughes. You may begin.
Thank you, Michelle. Good morning everyone, and thank you for joining us. With me on the call today is Heath Sampson, President and Chief Executive Office; Brad Gabbard, Chief Financial Officer; and Greg Marken, Director of SEC Reporting and Technical Accounting. This conference call is being webcast live within the investor relations section of our website. A webcast replay will also be available on our site and you can contact to Alpha IR Group for Investor Relations at 312-445-2870.
Let me remind you that the presentation and remarks made today, includes forward-looking statements as defined in Sector 21E of the Securities Exchange Act. These statements are based on information currently available to us and involve risks and uncertainties that could cause actual future results, performance and business prospects and opportunities to differ materially from those expressed in or implied by these statements.
These risks and uncertainties include, but are not limited to, those factors that implied on slide two of today’s slide presentation and our annual report on Form 10-K for the year ended December 31, 2015, which was filed yesterday, and other filings with the Securities and Exchange Commission. Except as expressly required by the Securities Laws, the Company undertakes no obligation to update those factors or any forward-looking statements to reflect future events, developments or changed circumstances or for any other reasons.
In addition, it is important to review the presentation and today’s remarks in conjunction with the Form 10-K and the GAAP references in the financial statements. Whenever the presentation or remarks refer to non-GAAP financial measures, they are intended to supplement but not substitute to the most directly comparable GAAP measures. The slide presentation which accompanies today’s call contains the financial and other quantitative information along with guidance on the reconciliation of the GAAP to non-GAAP measures.
So with that, I’d like to turn the call over to Heath Sampson. Heath?
Thanks Nick, and thanks to all of you for joining us today. We know it’s been a challenging number of quarters for our investors, which has been exacerbated by some significant challenges on the Company’s part to communicate as we navigated our financial statement review and transformation processes.
Today, I am happy to report that we are current with our financial filings and we hope that our communication today helps you understand that we are committed to improving the breadth, depth and consistency of our investor communications as we move forward.
While many of you have been holders for several years, our transformation really only started when I took over as CEO in mid-2015. At that time, our Company had a somewhat broken story with the below the cost structure, no real commercialization strategy for emission control or EC segment and unmet expectations related to our refined coal business. The good news is our Company also has and continues to have a wealth of refined coal and emission control solution assets experience, and intellectual property. However, as we evaluated all of our options in mid-2015, it was obvious that we needed to move quickly and execute against the number of strategic priorities simultaneously, to better position the Company for short-term and long-term success.
These initiatives are summarized for you on slide four and they include the realignment of both our organization and management team; the analysis, repositioning, and commercialization strategy within our EC business; the development of a plan to reinvigorate the identification and closing of tax equity investors for our refined coal business; and lastly, the formulation of a plan to reduce both our cash burn and organizational risk such that we can better preserve and reprioritize our free cash flow. Executing against so many initiatives was not an easy path and we’re grateful to a number of high quality people across our organization that worked hard to get our accounting in line, deliver on equipment [ph] commitment and execute on the numerous other concurrent work streams.
Today, I am going to spend a fair amount of time talking you through all these programs. Additionally, I’ll walk you through our new parallel path strategy to continue executing against all these existing opportunities while simultaneously evaluating the strategic alternatives we have for emission control business. The bottom line is we do not believe that the market is appropriately valuing our collection of assets and expertise. And in the interest of maximizing shareholder value, we believe that it’s appropriate to assess our value more directly with peers and other constituents at least within the EC business today.
Let’s begin our discussion today by walking through a few key takeaways and updates from our 2015 financial results, which we filed with our 10-K yesterday. Please turn to slide five of the presentation for a look at a few key financial items from 2015.
The first thing you’ll notice is that our revenues, which is primarily under the completed contract method, increased substantially in 2015 over 2014. As a reminder, our revenues only reflect the contribution of our EC business as a refined coal ventures are accounted for under the equity method, which you can see in the second line of this page.
The top line increase reflects the completion of sales of our ACI and DSI systems to a number of coal-fired utilities that needed to comply with the Mercury and Air Toxic Standards or MATS. As a reminder, many of these fixed price contracts required us to provide letters of credit which are secured with restricted cash and carry associated warranties and performance guarantees. Therefore, we mitigated a great deal of financial risk in 2015 by completing these contracts and on time within our revised expectation.
The next item you’ll see in line two on the table, on slide five, is the contribution from our refined coal venture, which is again accounted for under the equity method. Actively [ph] comparing contributions from refined coal business in 2015 against 2014 is somewhat complex. So, I’ll try to avoid accounting one-o-one and will offer a few quick clarifiers. In 2014 and 2015, our refined coal business had a number of tax equity investors who maintained in the $3 to $4 per ton range. However, we chose to operate or retain five RC facilities with the tax equity investor as their financial return for using these tax credits to offset future earnings even considering leverage within our long-term best interest.
As a reminder, when there is a tax equity investor, simplistically three things happen: One, they pay CCS a purchase release payment; two, they cover the cost of operating the RC facility which includes paying an ADES [ph] royalty if the M-45 technology reviews; and three, the production of refined coal by the RC facility creates tax benefit that the tax equity investor can use to make a very good return, when CCA operates and CCS operates an RC facility, without a tax equity investor and again they ran five facilities in 2015 but immediate cash available for distribution was significantly reduced in 2015.
Three other items reduced our distributions from CCS and CCSS in 2015, including the installations of eight RC facilities to prepare them for future tax equity investor, and the cost of securing key additives for future operations. Excluding the obvious disappointing of not pivoting to the new tax equity investor sales approach fast enough, our refined coal business actually performed quite well in 2015 as it produced more refined coal at higher net income and drove significantly more tax credits year-over-year.
I’ll talk further later in the presentation about 2016’s outlook and strategy on the RC side. But I wanted to make sure we explain that the reduction in earnings showed on the equity method line do not reflect the loss contribution from our RC facilities that have tax equity investors.
Next, you’ll see the royalties received from CCS for the use of technology in IP increased commensurate with the 35% increase that CCS showed in the production of refined coal.
Moving to the net income and earnings line. You will see that on a GAAP basis, we lost $30.1 million. However, this loss included a number of unique items, non-cash entries and impact from activities that have not been -- that have been reduced and/or stopped.
If you turn to page six of the presentation, I’ll walk you through a quick summary of the major components of the net loss to provide better context. First, net loss included roughly $13.9 million of non-cash items including items such as depreciation, amortization of debt, PP&E impairments, share based comps, et cetera. Please see the Appendix A for more detailed explanation. While our net income will always include components of non-cash items, 2015 included a number of unusual items, such as the acceleration of vesting stock awards related to our restructuring and a number of impairments and other write-offs.
In addition, in 2015, we exited various historical business or products, our manufacturing and fabrication operations in Pennsylvania; our Israeli based ADA analytics business; and various other R&D products and ventures. These costs impacted our financial statements by roughly $10 million in 2015 and are now behind us. Finalizing the walk down this table, we also saw significant accounting restatement expenses of $9.5 million and net restructuring expenses of $5.4 million. When we take all these items together and net out the refined coal positive impact from this earning, [ph] you can see a large portion of our net loss in 2015 is comprised of items guidance that we feel [indiscernible] call out, many of which will not be continued expenses in the future.
Said another way, our 2015 performance would have substantially improved had we taken many of these strategic actions in 2014 rather than 2015, even after covering all of our normalized expenses associated with being a public Company and supporting the operations of CCS. As we look forward, it’s also worth noting that we’ve recently taken new cost reduction actions that I’ll discuss in depth later in the presentation.
Before we go too much further, I think we need to discuss the big strategic news that we hired an investment banker to help evaluate strategic alternatives for emission control portfolio products and associated intellectual property. Given our path the last few years, I know our investors are frustrated with our valuation today, but the simple answer is we are too. Although we acknowledge we have some credibility going back as we move forward.
If you turn to slide seven, you will see a graphic that highlights the value of our installed RC facilities today. Our most important is remain -- our refined coal joint venture, which I know is the primary reason many of you are investing in our stock. While the achievement of tax equity investor in 2015 was clearly below the pace we had hoped for, the RC facilities that are in place today, assuming consistent renewals, are expected to generate almost $650 million in cumulative tax equity investor payments to CCS from 2016 through the end of 2021.
If we remove the cumulative SG&A costs associated with CCS, then apply the 42.5% ownership that we have in them, you will see that an undiscounted and simple pretax review these expected future cash flows exceeds our current market cap by over $100 million. Additionally, our current valuation reflects almost no value for the assets we list on slide eight.
First, we have 16 other RC facilities that don’t have tax equity investors yet. If we’re able to lease the remaining facilities, the refined coal assets could significantly increase the aforementioned potential cash flow, and obviously this remains our top priority. Beyond those un-leased facilities, our interest in CCSS and the royalty we receive from the RC business also have significant future value.
Next, the EC business, which may currently have a negative impact on our valuation of stock has untapped value. As a reminder, there is no question that ADES is the technical leader regarding low cost solutions for mercury emissions control in North America. Many of our current and former employees have been building this expertise and reputation for over 20 years. As a Company, we celebrated the final long-term long time coming April 15, 2016 MATS compliance date last week. While these EC businesses have historically had lumpy revenue streams and burn cash, we believe that we’ve made the right strategic decisions in the second half of 2015 to commercialize and identify value within the core portfolio.
For example, within the next week, we expect to announce the significant chemical sale for M-Prove technology and see that has a great initial validated for some of the hard work that we’ve done. Our product portfolio is backed by more than 30 patents and multiple pending patents. For example, our M-Prove technology is protected by a family of U.S. patents, which we are also pursuing internationally. I want to explicitly state that our patent claims cover such activities as the combined use of halogens and coals with carbon injection that we’ve got and halogen plus metal such as iron, [indiscernible] all of which are tested and proven emission control solutions for coal-fired customers.
Frankly, this Company did not completely understand the potential value of its patent portfolio until the last few months. The bottom line is we believe we have developed a strong commercialization strategy in this business, and we have a goal to get the business to breakeven within the next four to six quarters.
Lastly, we also continued to carry over $121 million in tax affected net operating losses and tax credits as of December 31, 2015. Additionally, under various change of control scenarios, these credits and NOLs could be used to offset earnings from our current refined coal lease or sale payment. In terms of liabilities offset by some of these assets, we did a great job in 2015 executing against our goals and have mitigated potential liabilities, which would have resulted from not meeting our contractual obligations to a great extent.
Moving to slide nine, you will see that we’ve already begun our strategic alternatives review. We have a banker who is exploring the potential value of our EC business today. We believe this step is critical to take in serving our obligations to shareholders. If our assets have more value to other organizations that might be able to leverage them faster and more appropriately than we can, then the prudent thing to do is to collect that value. That said, we will not slow down the progress that we’ve made in transforming our business in 2015, and we will continue remain disciplined and aggressive in our standalone strategy to drive value as an independent entity. Most importantly, we will not let this process dried out as we expect to complete the analysis no later than the end of the fiscal year. We will do our best to report on progress as we move forward. But please understand that these strategic alternative reviews are very fluid processes.
With that, I’d like to walk you through some of the cost containment, risk mitigation, and cash preservation efforts. Please turn to slide 10. As I discussed early, as an organization, we undertook a number of high profile strategic reviews in mid-2015 to inform our decision making and go forward strategy. The focus of many of our activities was on ways we can mitigate our risk, reduce our cash burn, and significantly change our operating structure. We quickly realized that there were places where we could improve operations and eliminate cost and risk in other areas that we needed more time and ongoing investment to better positioning for the success in the future.
On the cost and operations side, we acted decisively and outlined and find to exit businesses as I mentioned earlier. With regard to BCSI manufacturing, our subsidiary here in Denver has taken over responsibility for finalizing the BCSI equipment contract more cost effectively and with less risk. All of the employees of the closed operations including over 100 staff members at our BCSI manufacturing location completed their assignment by the end of December 2015 and the leases for these facilities were terminated. Therefore, our expenses going forward will be more manageable.
Again, from a risk perspective, we also needed to manage several potential contingent liabilities related to our contractual obligations of our equipment contracts. As you know, many of these were executed on a fixed fee basis and required us to provide letters of credit, which we had to secure with cash until they were completed. In addition to those letters of credit being a risk, failure to comply with our contracts would have triggered significant financial penalties or forced us to incur certain make right cost. Our teams worked hard and completed 41 systems in 2015 compared to 22 in 2014; and to-date, we have not had any material customer claims.
Moving to a number of new initiatives for 2016 we’re putting in place to reduce cost and risk and increase cash flow. Our EC team worked diligently through the second half of 2015. But as we entered 2016, many tasks have been completed and many of those positions have become unnecessary and thus we have announced a further reduction of approximately 30% of our headcount. It’s important to understand that these reductions are natural part of the strategic plan we laid out in mid-2015 and they do not impact our ability to sell or market products, deliver on customer commitments, or ensure effective financial and regulatory processes.
Lastly, our financial statements are now current. And as a reminder, the SEC inquiry that we have disclosed is focused on the restated financial statements and related internal controls. But it’s hard to predict the definite conclusion of the SEC inquiry. Now that our financial statements are current and with our plan to remain current and deliver Q1 2016 results on time by May 10th, we hope we can put these legacy issues behind us.
Moving to slide 11, I want to summarize our historical cost and all the strategic changes we’ve executed, on the one page. We still have a little work to do on the handful of these strategic actions but this slide provides you with the sense of the structure that we believe we’ll have in place later this year or worst case by the beginning of fiscal year 2017. This slide really shows you how much we’ve accomplished, particularly in terms of the scale of activity and its associated impact. Starting with 2014’s operating cost basis and removing the business operations we executed, the headcount we’ve reduced and the excess costs associated with our restatement and realignments of the business, we forecast our go forward cost basis will range between $12 million to $14 million per year. To quantify that, it will be a reduction of over 70% of our SG&A and payroll expense compared to 2014. This should allow our EC business to succeed in the future without the support of cash from the refined coal business as long as we execute against our sales and marketing goals.
Our refined coal production and its long-term potential are outlined on slide 12. Our 12 RC facilities with tax equity investors produced 37.7 million tons of refined coal. Although we ended the year with two retained facilities, we operated more during the year, resulting in 11.7 million tons. Today we have 14 RC facilities that do not have tax equity investors, 9 of which are installed and 5 of which are yet to be installed at our identified locations. So the last part on the right gives you a long-term view of our potential, which historically we target 24 facilities with tax equity investors and 4 facilities retained, which would provide the ability to produce 75 million to 100 million tons of refined coal per year.
On slide 13 and 14, I want to cover how view our refined coal business segment and why our earnings from equity investments were so significantly reduced from 2014. On slide 13, you can see the components of the refined coal business segment. Note, the segment income component includes our income or loss from equity investment entities, CCS, CCSS and RCM6 and our royalties. Expenses associated with the refined coal business segment include RCM6 note payable interest expense and 453A interest expense. There are two significant takeaways from this slide. First, RC segment income is down by $30 million, primarily as result of a $35 million reduction in income from CCS but offset by $4 million increase in royalties; second, our 2015 RC segment loss included a $7 million and loss was contributed by our investment in RCM6 in the form an equity loss and imputed interest expense.
RCM6 was sold in March of 2016, so we will not see significant losses related to this investment in 2016. The reduction in income from CCS is a bit more complex to explain but we have attempted to do so in the next slide, slide 14.
CCS is a bit of an unusual situation, in that it has on a cumulative basis distributed more cash with equity owners including us than it has recorded in cumulative equity earnings. As a result, we basically recognized earnings equal to our distribution, and we will continue to do the cumulative distributions and cumulative CSS earnings until they reach equilibrium. Please see our 10-K for more detailed information.
CCS distributed to us $43.5 million in 2014 and $8 million in 2015. This is the basic reason for the reduction in our segment earnings in 2015. However, on our CCS’s book, CCS actually had higher net income in 2015 than 2014. So, why were distributions less? Slide 14 explains this disconnect. As show, CCS’ earnings were $87.3 million. If CCS distributed all of those earnings, our share of the distribution would have been $35.3 million, roughly equal to our equity interest of 42.5% and our segment income would have been $38.7 million or much closer to the 2014 amount. That did not happen, why? There are three primary reasons that CCS was not able to make distribution close to its earnings: Capital expenditures; working capital needs; and prepaid lease amortization derived from prepayments made in conjunction with new investor leases in 2013 and 2014.
Slide 14 shows that $30.1 million was expanded on capital items, principally to install facilities on coal plan sites. We installed clean coal facilities on eight new sites in 2015 at an installation cost of approximately $3.5 million per site. We also used $13.7 million of working capital as a prepayment related to chemical supply agreement to assure future supply of our key emission control chemical. Lastly, $43.2 million of 2015 earnings relate to amortization of lease prepayments that were principally -- that were from 2013 and 2014 payments. As a reminder, many tax equity investors prepay one year of lease payments upon contract sign. This item represents real accrual base of earnings, but the cash was paid to CCS in a prior year and CCS also distributed this cash out to equity owners including us immediately upon the receipt of these payments. You can look at our 2014 CCS allocable earnings of $26.6 million compared to our 2014 distribution of $43.6 million and see that we had exactly the opposite situation in 2014. I refer to you note seven of our financial statements for more details on this matter.
One other note, CCS’s net income was substantially reduced in 2015 as a result of operating several facilities as retained facilities. No tax equity investor was involved in any of these facilities and CCS retained the benefit of tax credit and tax losses generated and passed these through to equity owners including ADES. The flip side is that CCS also had to pay the operating costs associated with these operations. Total operating costs funded by CCS were approximately $40 million. This reduced CCS’s net income dollar per dollar, as well as reduced the potential cash available for distribution to CCS equity owners. Incenting this operating capital, CCS processed 11.7 million tons of clean coal and generated tax credits of 78.8 million. While we have a full evaluation allowance against our share lease tax benefit, we do expect that we will be able to use these credits to shelter future taxable income flowing from CCS. While we can discuss the merits of this decision, particularly at a time when we could have used the additional distribution, this was a strategic decision made by the partners of CCS to produce tax credits in 2015 and particularly the specified tax credit.
Let’s move to slide 15, and talk about where we go here with our RC business. That is very exciting but as you know we hadn’t had this success we would have liked in securing additional tax equity investors. Therefore, in mid-2015, we reassessed our sales efforts and approach. The reality is our refined coal investor pipeline was thin and efforts were much more reactive than proactive. Therefore, we built out the new broker network and supported with marketing materials and collaterals. Additionally, we identified a broad potential set of investors and began systematically approach -- and we began to systematically approach those organizations at multiple levels. Historically, we had a few individuals talk to the tax group within these organizations and often got stonewalls [ph] when they got to the primary gatekeepers. Today we are taking a more top down approach where we are not only talking to the leaders within the tax group, but also to the CC, the finance function, the reputation committee and many other people within these organizations.
The result has been a complete transformation of our pipeline, which has grown in depth, breadth and qualification. Said more simply, our pipeline has never been this real and deep. Refined coal deals continue to be executed in the market at strong economics. We also have the ability to move facilities proactively to mitigate coal to gas switching. So to sum it up, while the RC process is not a simple one, nor a predictable one as all of you know, we feel as confident as ever that we can accelerate our pace and secure more equity investors for many of our open facilities. While we don’t want to provide specific short-term projections, we hope to make substantial progress on many of these facilities in 2016.
So to summarize our forecast and expectations for 2015 and beyond with regard to our refined coal business, I’ll walk you through slide 16. First, we have 12 facilities with investors and we also expect to renew many of these facilities at economics that are comparable and in line with our expectations. Thus, our historical cash flows from CCS and CCSS remain stable. Further, our top down sales approach will provide future competition for these facilities which will hopefully increase our cash flow opportunities and mitigate risks in future renewal discussions.
As we talked about last quarter, we assume the economics of the 12 facilities with investors renewed as planned and we close no new tax equity investor, and assuming no new tax equity investors, our refined coal JVs will have in excess $650 million in cumulative tax equity investor payment before CCS SG&A over the next six years. Further, the opportunity in our RC facility do not yet have investors remain compelling as each should generate the following: $8 million to $10 million before CCS SG&A which ADES gets 42.5%; $400,000 to $800,000 from CCS which ADES gets 50%; and $1 million to $2 million from our M-45 royalty and it is expected that majority of the remaining facilities will be royalty bearing. So, the bottom line here is the RC opportunity remains compelling and we’re going to aggressively pursue new tax equity investors in the near-term.
Moving on to our EC business, please turn to slide 17. Even though the equipment market has peaked, we believe there’s value in equipment upgrade and significant recurring revenue opportunities in chemicals and services. Coal-fired power generation will be necessary for many years to come and we have the technology, IP and experience to ensure customers stay in regulatory compliance in cost effective manner. Let me further tell you I think we have the opportunity to hear to cost effectively and efficiently explore organic opportunities in the EC businesses. Historically, our EC business was really a collection of assets and quite honestly, some very interesting and potentially valued IP. However, there was no commercialization strategy on any level for the group.
So, over the last 6 to 9 months, our team has built out highly functional and efficient sales and marketing function. I understand some skepticism is warranted from investors as it relates to our efforts within the EC segment, but we believe we have some solid wins coming in the next few weeks and we believe that we’re doing the right thing to develop value here. In fact, our pipeline for the M group of technology continues to grow and we have numerous customers committee testing our products. Again, we expect chemical sales to increase substantially as we progress through 2016. Through these sales and marketing efforts and when coupled with our streamlined cost structure, our goal is to get our core EC business to breakeven within 4 to 6 quarters. Again that will allow our EC business to succeed in the future without the support of cash from our refined coal business.
Turning to last slide, page 18, I would like wrap up by walking through our priorities for the next 8 months. First, we will remain compliant with our financial statement and we’ve already started the process of the NASDAQ relisting. We hope to resolve the associated SEC increase and private litigation as well and would like to accomplish everything by the end of the year. We will remain diligent in our pursuit of new tax equity investors and expect to report incremental progress along those lines as the year progresses. Again, I don’t want to provide a specific number that we expect to close in 2016, given the complexity of finalizing the deal but our goal is to make substantial progress in 2016.
We also expect to prove that our EC products are selling as we continue to aggressively and efficiently execute against our commercialization strategy. We believe there are significant IP within this unit as well as we’ll continue to evaluate ways to monetize that IP as we move forward. Our EC efforts will be supported by a leaner cost structure as we work to complete our cost containment efforts in mid this year.
If we are only partially successful in these efforts, we believe that we will enhance both our cash flow and liquidity profile, and we’d like to reduce or eliminate our debt as soon as possible. And we will complement all these activities by actively pursuing strategic alternatives to make sure that we’re maximizing value to our stakeholders and shareholders. The process will be complete in no later than the end of the year and could include a variety of partial or full divestures.
Lastly, another one of our goal is to ensure we’re communicating and interacting more consistently and effectively with all of our investors as we move forward. We will be moving to a more traditional pattern of hosting quarterly conference calls with the release of our Q1 numbers and in-time we hope to get more visible with the street through conference participation.
We want to thank all of you for your support. And we’d like now to offer a chance for a few questions. As a reminder, we’ve got Brad Gabbard, our Chief Financial Officer; and Greg Marken, our Director of SEC Reporting and Technical Accounting with me to support this Q&A session. Operator?
Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Sean Hannan with Needham & Company. Please proceed with your question.
Good morning, folks. Congratulations on getting current. A number of questions here; you’ve certainly talked a bit about the opportunities as well as the confidence in getting on the RC side more of these facilities installed; we’ve got progress that we’re looking to get accomplished this year. Just really need to see if we can get some more clarity around this, because we certainly hear this verbally from you folks quite a bit and there just has been really little progress. And just want to better understand how this actually materializes and really what’s truly that confidence level behind it?
Well, first before we get into what we are doing, just the market itself on RC, it’s been around for a number of years, and that’s continuing to mature. Many of the companies that have RC have been through numerous IRS audits and are passing successfully. So that has been helpful for the market, coupled with our competitors are continuing to execute on the RC business as well. So, in general, the market is maturing; it’s becoming more comfortable with passing the IRS audits. So, the market itself is improving. With us ourselves, we’ve recognized that this is a complicated sale. And many of the targets that we have to go to are Fortune 50 or 250 companies, and many of these companies are not as sophisticated or understand tax credits.
So, we know that the approach now is not what it historically has been to go through the tax group; it needs to be a more holistic approach from the top down. And with that approach, we’re seeing that we are making a lot of progress because when you can explain this asset class and really understand the economic to the company and then also explain why this is important from a refined coal perspective to have coal-fired power plants producing power, we’re able to get through these levels at these Fortune 50 or Fortune 250 companies, so they are interested in tax equity. And so that’s really why I feel confident in our ability to get these closed. And then really, it’s supported by what we’re seeing in our pipeline, like I said earlier. It is full and it’s full with companies that we are far along in the due diligence process. So, 2016 is going to be a good year for us to close on many of these facilities.
How many are in the stage of dotting the i’s and crossing the t’s at this point?
Yes. So, the stages are that you move in and out of these stages, which is pretty complex when you have many lawyers and many consultants involved. But we have -- we’re continuously talking with 10 plus that are far along and then we have numerous below that. So, I think the best thing for us is in the next couple of months, as we progress through here, show some closings and then you will really see that this pipeline has taken hold and we are moving far along.
I am just not sure what far along means. I mean are there -- of that 10, are there three, four, five of them that are really at the very final stages of getting hammered out and announced here? I mean help me to understand that 10.
Yes. There are more -- not all 10 are in that -- those final stages but there are a few in those final stages. And let me explain what those final stages are and really what this process is. So, when you get through the first gate that this company should consider refined coal, the due diligence process, which involves various attorneys and various other consultants, needs to go into these utilities, these specific facilities and do a bunch of due diligence work from site visits to engineering reports to legal opinion. So, many of these 10 facilities or a few of these 10 facilities are in those stages right now.
But you’d like to say it’s never done until it’s done because these ultimate approvals still needs to go through the executive committee and the board. So, we feel good about where the process is and we feel good about the efforts that all of these companies are committed to but it’s never done until it’s done. Just give you a little bit of an example why I am hedging till it finally gets done. We were close a couple of months ago with a large entity that went all the way through their due diligence and in fact even obtained insurance in the market for this product. But in the 11th hour, it got put to the side burner and the main reason for that there is a large strategic issue that popped up for that company and they put on the side burner. So, it’s never done until it’s done. But again we have numerous of these companies that are in those -- that are spending a lot of money, doing a lot of due diligence, have been approved through their historical reputation type committee. So, we are encouraged about closing a number of these facilities in the next couple of months.
So, when you think about the scenario that we can be in very, very final stages and some of these don’t actually get across the finish line, what do you folks think about in terms of success rate; I mean is this 50%, 70%; how do we think about those that are final stages and where you are today versus historically, what actually gets done?
Yes. Historically, we only have one or two of these in these stages. So, now we have numerous in these stages. So, the history has been, there hasn’t been a lot that have been in this stage, so we’re -- it’s tough to say what the percentage is because there is a handful of that were closed that went away but now we have more than handful and we’re further along. And beyond the fact through talking to the CEO and talking to the CFO, so the hit rate is I wouldn’t say -- it’s hard for me to put a percentage on it, but because of now we have more than just one or two that are further along, we have multiple of these, and multiple of these -- let me back up a little bit. Because we’re going to 50, Fortune 50 or Fortune 250 companies, they’re just not looking at one facility. They’re looking at three, four facilities. So, if one or two of these hit, which we expect to, it’s going to be more than just one facility. So, I understand the questions and I appreciate the potential about the confidence but really what we have done and what the CCS team and management team have done have really built the right processes and structure to ensure that we’re going to close on a number of these in 2016.
Okay. And then, in terms of tonnage process last year, it looks like at least on average, you guys did about 3.53 when including the retained facilities, 3.1 million on the lease side. If I would get the implied range, when you get the 75 million to 100 million accomplished, that gives me kind of mid 2s to about 3.57, so really not all that different from what you would accomplish last year. Can you talk about, number one, what you’re chasing for the mix, what to be accomplished on the belts that you would get into for incremental facility side, the impression that you want to try and mix up. Number two, can we talk about how perhaps last year’s winter, the weather, the impacts of nat gas may have impacted your tonnage, and does that imply either kind of stay or upside, how to think about that? But I’d focus on those two in response. Thanks.
So, the facilities that we have installed, facilities and we expect to install are hope to be at higher tonnage. The reason for my maybe conservatism in the future tonnage is because there is a lot happening in this market as it relates to gas prices and coal. So, we are optimistic on this plant that we have that we’re planning to go through and they are higher than what we have now, but I think it’s prudent for us to stay conservative as we move through this coal to gas challenge that we’re in. So, we’ll update as these quarters go by, and we’re hopeful that the tonnage will be higher for these facilities that we get installed and monetized, but right now, it makes sense to stay with what the guidance of that that we have now.
It is a little concerning that if you look at that downside number, even with conservatism; I mean you’ll be really getting on some very small doubts…
The rationale for that conservatism is not -- if you are looking at all 28 and multiplying by that all that, I’m hedging for all the 28 as well. So, it’s a combination of number of facilities and the tonnages into those facilities. So, just simply put that 75 million would assume less than 28.
You know there is a lot of power plants and that burn well in excess of 4 million tons; those are the power plants that we want to go after and we want to get installed.
Okay, last question here; I’ll jump back in queue; sorry for so many. The costs, it seems that those really should have come down far earlier, I think if there is a fair amount that you’ve explained well during the course of the presentation, help us to understand a little bit better for why we weren’t able to be a little bit more aggressive? Thanks.
So, I assume you’re meaning to our Company here and specifically…
Yes. So, the real simple answer is we have a lot of commitment that we needed to deliver on for our equipment products, and also ensure that we have the necessary accounting consulting people to ensure that we get through this restatement process. So, those two reasons are the main reasons why the costs were at the levels that they’re at. Everywhere else, we reduced. And as we also noted just recently, last week we reduced even more because we’ve been through a lot of these contracts. So, I can tell you we’re not spending money on anything that does impact value to this Company and we’ve significantly reduced costs. But the reason for maybe the perceived lack of speed was because we needed to deliver on our contract commitments.
Our next question comes from the line of Rob Brown with Lake Street Capital Markets. Please proceed with your question.
On the RC and the 12 that you have operating, could you just -- you gave a good view of 2014 and 2015 changes. But what’s the future pro forma cash flow to ADA from those 12 units under current conditions that you see annually starting in 2016?
Yes. That’s a good question. We attempted to talk about in our script and in our financial statements what happened in 2015. I’ll revisit that again because it’s a little unusual when we try to estimate what the go forward cash is from our current facility. And again, the main reason for 2015 that the distributions were less or earnings weren’t as much, it’s primarily because we operated retained facilities, and operating five facilities at a cost between $3 to $3.5 has a lot of cash. We do not expect to operate that many in 2016. So, that expense should not be there. Additionally, in 2015, we installed eight new facilities at utility and again that cost is about 3.5 per facility. We don’t expect many additional costs on that as well. So those two items together we do not expect in 2016. We do as you know, we have other facilities that we need to install at the five remaining, so there maybe some costs around that but we don’t expect it to be the same extent that it was in 2015. So, from a macro perspective how you should think about and maybe how you model what the cash flow should be for 2016, think about that $3 to $4 range of lease payments that we expect to get plus the SG&A from CCS. That’s the right way to think about how you model that because a lot of the -- again those costs that we needed to incur in 2015 we will not do in 2016.
And so, the SG&A at CCS is what…
It’s around, $9 million right now as of 2015. As the year progress, especially we get always up and running and may come down a bit, but…
Okay, good. And then switching to the improved business, you said that you’re close to customer there. And just remind us the economics outline of that business? And then how many tons or facilities or how we want to characterize this, how many of those do you need to get to breakeven in your commentary while getting to breakeven?
Yes. So, we’ll give more guidance as we go through the year on this. But it’s -- from a macro perspective, the market for refined coal and our opportunities to get after that market, we don’t have to get a large market share to hit our revenue target and be breakeven. So, we do have to execute and we do have to close on many deals, but the market opportunity is much larger for us. So, the margin on that equipment is around 40%, and I expect that to improve as we go through that.
So, though we have new revenue that we need to get at for improvement in chemical sales, I think we have reasonable revenue targets that we are well on track to hit and therefore allow us to meet our goals of getting breakeven in the next four to six quarters. So, I look forward to updating. We’re excited about the market opportunity that we’re just in beginning. So, as each quarter goes by, I look forward to sharing the successes that we expect.
Our next question comes from the line of Shantanu Agrawal with BlackRock. Please proceed with your questions.
Just a follow-up on that prior thread, talking about the cash flow changes at CCS on a go forward. When I look at the 2015 numbers, I can see that CCS, despite a large top line and a large EBITDA number, didn’t really generate much free cash flow and you highlighted some of those reasons for why. Just to quantify, to make sure that I am thinking about it correctly. If we look out to say 2017, so a clean year and assuming you haven’t monetized any new facilities which I know you folk -- like you’ve closed a couple but just looking at status quo basis. It sounds like CapEx was elevated in 2015 and was $30 million. Is that the -- on a go forward basis sub $5 million or even close to zero on a status quo basis? So, if you look to 2017 CapEx alone, do you have $30 million cash flow swing?
Yes. Again, the majority of the CapEx is used to install the facilities and we installed eight of those facilities. There is other CapEx that we expect to have on the business but that’s relatively small as each year goes by. So, I wouldn’t say zero but it’s significantly less than we have now. And again, Shantanu, we have now five facilities that we have not installed but as we’re going to install those, that’s a good thing because we either have a tax equity investor in place, so we want those tax credits. But you’re thinking of it right. So, you simply model that $30 million would be much, much in a go forward basis in the single digit number.
And then by 2017, I assume that remained deferred revenue liability would have been caught up, so that could be another $40 million swing on the cash flow basis in 2017 versus 2016?
That is correct.
And then working capital, it’s been a use of cash; it sounds like kind of onetime building up inventories, assuming you folks have done building up inventories or actually say CCS has done building inventories, that could be another call it $10 million positive swing in on a run rate basis going forward?
Yes, that’s correct. We did build upon the critical chemical that we needed to secure, which is in that $13 million range for this year, correct.
So, between deferred revenue, CapEx and working capital, you would on those threads and kind of an $18 million annual swing on positive on cash flow on a forward basis?
And then just on the expense side at CCS, I see this line of sight in production fees that’s gone from 5 million to 20 million, are those the -- that were run for your own account which were shut down so that’s another 20 millionish of cost that would come out of the system on a go forward basis?
No, those fees are primarily the fees that we paid to the utility when we produced refined coal.
Okay, got it.
Those I think we’ve given a range between a buck, buck and half per ton; as each facility comes and installs, we will continue to pay those.
Got it. So, assuming EBITDA is kind of constant, you’d have that kind of almost $80 million pick up on a cash flow side and that should and then you’ll get you pro rata share of that through 2021?
Yes, exactly. And again, said another way, the simply way, if you take the tonnage that we expect between $3 and $4 and then take out CCS SG&A that’s another way to back into the number that you just articulated.
Correct, because the cash flow charges should just fall away for the most part?
Exactly, you don’t have a lot of those operating costs that are needed for retained facilities. So again, the simple way, and this is really simple macro is the SG&A is really the cost that we will have in that CCS business when all the facilities are up and running.
And then, I guess we’ll wait till that new deal gets announced and then we can talk about that. Third bucket of value that you highlighted is IP. You mentioned some patents that you folks have. Can you elaborate more on why those patents are meaningful or how we can quantify the impact or how important those trends maybe?
Yes. So, like I said, and I did this on purpose in the script, which you maybe galloped over, I got specific on the types of combination patents we have, primarily within mercury control. And why I did that is because many mercury control and the expenses that many of the utilities have to expand each year use many of these types of technologies and even combination, those substitute combinations. So, I am not just talking about our based patent improved. We have various other patents that are we think have value in the market because we know that those combinations are being used in the market. So, we’re in these beginning stages. This is one of the primary reasons why we’re thinking we need to continue to sell our products but also look for other potential companies that have used these patents to expand their abilities in the market. So, just ensure the work and the patents that have been developed over the last 20 years are well beyond just our improved products. So, we’re evaluating how best to monetize those current patents, continue to sell our current products and continue to sell new products or are these valuable to another companies that could really capitalize the market that’s out there. So that’s what we’re evaluating. And I really look forward to these next number of months as we progress through that evaluation process.
Are these patents potentially being used by other players today, or is the value really just helping other people use these patents to the extent…
Well, that’s we’re evaluating right now. Let me say differently. We deeply understand what each utility does in controlling mercury. So, we can make extrapolations and guesses around all this, but it makes sense for us to just move through these next couple of months and understand what all this means and then figure out what’s the best strategy for us to monetize the value of that. So, we’ll update you as the months go by.
Ladies and gentlemen, we have time for one more question. And our final question comes from the line of Kevin McKenna with Stifel. Please proceed with your question.
Good morning; I’ll make it quick. So, when we look at the tax credits on page eight that we’ve generated the NOLs on, it comes out to 120 million. How does that get monetized to ADA’s bottom line, both on an operating basis that would be from sales of -- on a taxable profits, but if the company was sold how would they get monetized, or could it?
Yes, this is a good question. So, the 121 of tax affected credits, really to take a step back, the money that we expect to get from lease payments or sale payments from CCS that we articulated that 650 and then our portion after that, that’s what we would use a good portion of those tax credits for and we expect that continue. And again, that’s just the current lease payments that we expect on our current customers. We can use those credits to offset that income. We could also use the credits to offset income that we generate for our business itself. But the unique item that I think you’re asking in this question, because of the nature of these contracts that we have with CCS, these had a hypothetical change of control, we would basically lock in those payments that we expect to get in that 650. And in essence, even if there was a change in control, we wouldn’t be -- we wouldn’t have those normal limitations against that income. And again, it has to be specific to that RC income or that 650 that we’ve been articulating on its own. So, it’s a great opportunity, if there was a change in control that really we could utilize all of that 121 million with that 650. But it is specific; it’s a bit nuance. It is specific to those payments that we expect on that 650.
I guess as long as I am last, if I could just ask, so we’re operating 11.10 million or 7 million ton, if that goes to lease, what’s the swing in cash flow from negative to positive on that?
So, the simple way to think about the math from a cash flow perspective for retained, it costs us, specifically CCS -- and this is from a CCS perspective, costs between 3 to 3.50 per ton produced, so that’s a negative cash burn. If we lease, you no longer have those costs and you switch between $3 and $4 per ton. So, the swing is $6 to $7 of cash flow when you move through a monetized facility.
Okay, great. Thanks for the questions.
There are no more questions at this time. I would like to turn the floor back over to management for closing comments.
Again, thank you again for your time today. And we look forward to reporting back to you more regularly as we move forward and continue to execute our strategic plan. Have a great day. And we’ll talk to you all again when we report our first quarter numbers on May 10th. Thank you.
This concludes today’s teleconference.
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