Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Thomas Edelman – Chairman

Scott Pearce – President and CEO

Dan Simon – EVP and COO

Kelly Maguire – VP of Finance and CFO

Analysts

David Driscoll – Citi Investment Research

Alan Walton [ph]

Cameron Wright – Jay A. Fishman Limited

BioFuel Energy Corporation (BIOF) Q3 2008 Earnings Call Transcript November 14, 2008 11:00 AM ET

Operator

Good morning, ladies and gentlemen. Welcome to BioFuel Energy third quarter results conference call. During the presentation all lines will be in a listen-only mode. A question-and-answer session will follow the presentation and instructions for asking questions will be given at that time. Thank you for your attention. I would now like to turn the conference over to your host, Mr. Thomas J. Edelman, the company’s Chairman.

Thomas Edelman

Thank you, operator, and good morning, ladies and gentlemen. Thank you for joining us. I am joined on the call this morning from our Denver headquarters by Scott Pearce, our President and CEO; Dan Simon, our Executive VP and COO; and Kelly Maguire, our Chief Financial Officer, who will help with various parts of the presentation. As you may or may not be able to hear in my voice I’ve managed to get a fairly extraordinary call, so if my voice, I will count on my friends in Denver to jump in and support me. But for the moment, I am sitting here with a large cup of tea.

Any case, what I would like to do is go through the results that we reported last evening for the third quarter, have Scott bring you up to date on the actual operating results of the company and his view of the plants and their completion. Dan Simon for a more hands-on view of his operating teams and the final steps of construction at the site and then we’ll come back to discuss overall industry conditions before opening this up for your questions and/or comments.

In terms of the quarter itself, I guess the most notable fact was that it was the first real quarter of operations by the company. As we indicated in the press release, our plants, which had been turned on late in June operated during the third quarter at an average of about 62% of their nameplate capacity. As you will remember, they are 115 million gallon a year facilities and obviously it is quite inefficient to run them at a 62% level in every respect from energy to enzymes on – down. Worse yet, when you are averaging 62% and you are in startup mode, as Dan and Scott may allude to in their comments, you are going up and down between shutdown, repair, starting back. So, it’s actually more challenging than if you were just running at a steady but a reduced rate. In any case, it was gratifying that the plants worked on a fairly steady, although still disappointing versus our expectations.

(inaudible) during the quarter we recorded $90 million of revenues, including as mentioned in the release, $77 million of ethanol sales and roughly $13 million from sales of distillers grain.

The result of that was an operating loss during the quarter of $17 million as laid out in the press release. It’s very simple – an excess of operating cost and inputs over the revenues and much of that difference, obviously it changes day-to-day based on the commodity prices, but much of that difference simply being that we were not operating on an efficient basis at capacity, meaning that that operating loss probably would have been at or very close to a break-even if we’d been running at capacity.

The only other peculiarity other than the hedging losses, which we’ll turn to in a moment was that during the quarter we did write off the final $1.1 million of site development cost that had been accumulated on the other sites that in more favorable conditions we contemplated building additional plants on. Obviously in the current climate that is not a realistic expectation, and so we wrote off that $1.1 million. Everything else, I think, was fairly straight forward.

Obviously, the draconian impact in the quarter was the hedging fiasco, is probably its best description based on input from our friends at Cargill and some of our larger shareholders we become convinced as we already described in our press release and cash flow call in August that the corn market was running away as it was in the spring just as we were getting ready to start the plants up.

We moved to try and protect ourselves from what was considered the greatest threat to the company’s viability by acquiring corn contracts that I think in aggregate covered about 38%-39% of our needs for the first year of operation and then everything went as wrong as we previously said as it could. It is not an excuse, it’s simply a fact that the corn market went from almost $8 to currently I guess about $3. (inaudible) the steepest drop in history in the corn markets just as we had acquired this position in corn. Couldn’t cover the margin calls. The position was sold out by Cargill, and it left us between the loss – actual loss during the third quarter of roughly $40 million and reversal of the $10 million gain that we reported because of the corn price very briefly at 50 – at June 30th, roughly $10 million with a total loss on futures of $50 million in the quarter. And I come back to – in the concluding remarks here the status of those losses.

There is still $17.5 million due at the parent company to Cargill on those losses; the rest of them have been paid and settle in cash and we’re trying to resolve that matter with Cargill, going forward.

In terms of the plants themselves, as Scott and Dan will talk to in greater detail, we did manage to reach 75% of capacity in October. Average run rates have improved on total as we speak. Both plants are operating at marginally above 90%, but we are continuing to struggle to bring these plants and the final problems with them through completion, although we do believe and hope that we will have these running at full capacity by calendar year-end.

In terms of the financial side of the company, at quarter-end, we’ve spent a total of $320 million on the construction of the two facilities excluding capitalized interest. Of that, $272 million, the great majority had been incurred under our turnkey contracts with TIC, who despite some struggles has continued to do a terrific job in trying to bring these plants, which we think will be exceptional once they are shaken down to successful conclusion.

In addition, $48 million has been spent by the company, directly in terms of our part of the construction, and we are still doing a modest amount of work on the sites as my partners will discuss. The final piece of this is the $13.5 million or 5% of the total expended on the TIC contract is being held as retainage until the plants are successfully completed.

In any event, it’s moving fast, but subsequent to September 30, we estimate that between $6 million and $8 million will need to be expended in final loose ends with TIC, and on final construction that we are doing, but we would expect all or the overwhelming majority of that to be done and behind us by year-end at which point we will fund the working capital reserve pay whatever the agreed amount of retainage over and be up and running on a fully completed basis.

That leaves us, as we noted in the release, with borrowings gradually approaching the $210 million, which will be fully drawn by the time we have finished this construction, funded the debt service reserve and paid the retainage. And we had drawn, as of quarter-end, I guess about $10 million under our working capital facility, $20 million facility. I think as we speak it’s probably about $17 million.

But there is more than adequate liquidity, particularly given prices have come down and at the operating subs the only real financial challenge we face we are not in a comfortable position certainly given those hedging losses, but the only real challenges we financially at the moment is some resolution of the amounts due to Cargill. But the operating subs were that claim is up in the parent company, the operating subs seem to us to be more than adequately funded given current market conditions for the moment.

With that, if I could, I’d like to turn this over to Scott to give you a review on our operations and bringing the company to full functioning form.

Scott Pearce

Thanks, Tom. Since we last spoke we’ve made a lot of progress in stabilizing our operations and completing the plants. As Tom noted, none of this has gone as quickly as we would like, but we have successfully made the transition from essentially running a construction to full operation.

If you were to visit either of our plants, you’ll see a much different environment with a steady flow of trucks delivering corn, plant is live with the various emissions, and outbound shipments of ethanol and distillers grain. There is still about 30 TIC personnel on site working beside our operational teams to finish the plants, and I will talks about that in a minute.

What I want to cover are just some key events of the quarter, share the things that are still not going well and then touch on our credit risk management program, and how things are working with Cargill.

During the quarter, TIC, as you’ll recall, our turnkey construction contractor, was able to complete the first of three major performance tests, provisional acceptance. This is a seven-day test where the facility was required to run continuous 100% designed capacity over a seven-day period, although it was not required to meet all of the efficiency guarantees on that first test. Tom hit on a couple of the production statistics, but we ran at an average of 62.5% during the quarter. This is part was due to several extended shutdowns where were in fact check (inaudible) plants and they were completing repairs on the facility. During that time we produced 37 million gallons of ethanol and approximately $160 ton of wet and dry distillers grain.

We, after the first test, based on the contract, we took control and from this September now and it will continue in the future, our operators are running the plants. We have since that time put a major focus on operational reliability and also, as noted previously, have been able to demonstrate progress in obtaining sustained production, especially with 75% average in October.

While this was still less than expected, we had a number of unplanned shutdowns caused mostly by mechanical failures and some operational issues, which I will walk through now. The main areas that have (inaudible) us from producing 100% on a sustained basis include the dyer and related systems, which I will talk about in more detail in a second, and several areas of bottleneck relating to heat exchangers at the plant.

The dryers remain a big area of focus. This is a system that we have a major supplier (inaudible) that is part of a large German engineering conglomerate that probably has about a third of the dry-mill ethanol plants in the U.S. These are large engineered systems and it’s not just the dryer that’s been a challenge for us but the centrifuge and conveyor systems that actually feed the wed distillery grain to the dryers to be dried. And then as well on the outlet there is thermal oxidizers that regulate the emissions. Getting these systems to work well together that we have not yet achieved the success we had hoped and specifically TIC has not been able to yet accomplish that.

As to what is going well, the front-end of the plant’s fermentation and despite some challenges with distillation operationally, we still like both of these major systems are pretty well aligned out at this point.

All the major infrastructure and utilities work that we did this included electric, water, natural gas, rail, all complete and running well. Our boilers are also running pretty well and have been aligned out.

Finally, we have demonstrated environmental compliance with our (inaudible). However, there are still some state certifications that remain that will be closed out through the end of the year.

As we look to the balance of the year, we are focused on finishing the plants, as Tom noted. TIC is largely complete with construction, and in fact the only thing they’re doing are repairs at this point. We have at each site small projects ongoing though neither are directly related to plant reliability. We expect that TIC will be able to pass its final performance test during this remainder of the year and as noted will be able to realize design capacity on a regular basis in 2009.

It’s not going to be an easy challenge to accomplish and TIC and ourselves both need to execute very well. I have already covered the areas that we are having the most challenges with respect to the overall dryer system and a couple of these bottleneck areas. The fact is that TIC has done an exceptional job with their technology partner Delta-T at working hard to get these plants to the finish line. They still have the final performance test ahead with the plants, have another seven days at 100% with the dryers running continuously, and meeting all efficiency targets. But the fact is – and I think Dan will touch on this – they are out there with the people they have working very aggressively to get to the finish line.

As to the balance of our operations, we have been focused on getting our (inaudible) risk management, and accounting systems in full, operation integrated between Denver, the plants, and Cargill’s headquarters. So, you can understand the magnitude. The corn alone we had 100 – 25,000 trucks that have delivered corn during the quarter and through which we’ve managed all of those receipts and invoices, et cetera.

We’ve been able to manage our working capital well during the time, keeping ethanol and distillers receivables flowing in a timely manner consistent with the – and then we’ve been in an industry from pretty favorable payment terms under our Cargill agreements.

Finally, also as reported during the quarter or previously we were able to complete an amendment to our bank facility at the – right at the end of August and gave us full access to $20 million of working capital. We also closed out all of our prior hedging arrangements. We have updated our risk management program, and for the time being are staying very close to home, not taking any wrong positions on corn, and are carefully monitoring the ethanol distiller sales with Cargill’s help.

Finally, with respect to Cargill, they are performing well under service agreements and during times like this we believe it’s a distinct benefit to have them as a counter-party for both our corn purchases plus our ethanol and distillery sales. We are optimistic that the benefits we’ve previously articulated about working with them will show through in our results as we get our plants into steady and reliable operations.

Against all of this, many of you are, I am sure, very aware we are in a very challenging industry environment for the ethanol market against the overall challenges of our financial system, and Tom, I will turn it back to you unless you want Dan to make the comments first.

Thomas Edelman

Sure, well why don’t we do this – I think that’s a good overall look because it is so critical in the next 45 days really to wrap op this construction phase and have the reliable facilities that are essential, if I could, Dan – if you could just give us a couple of minutes on what is happening day-to-day at the plants as you shuttle back and forth between Denver, Fairmont, and Wood River.

Dan Simon

Well, thanks, Tom and Scott. I think Scott gave a lot of good detail there, so really all I would say is, from an action standpoint, for our construction we’ve gone from 3500 (inaudible) items at both sites, we are down to about 20 at both sites right now. So, between June and now we’ve been able to work through hand-in-hand with TIC as well as other subcontractors on site through thousands of (inaudible) items and some are I consider standard in the 20 left, proving to be the most difficult. They are related to the dryer and the conveyors. We will work through the reliability issues, we think within the next two month. Everybody is confident. We’re making progress everyday. We are working 24 hours on it.

The only other item I’d add for the Wood River site is we are doubling our – the size of our wet cake pad. The wet cake market in Wood River is turning out to be better than we had expected, so we’ve doubled the size of that and that is also in process.

On the production side, we’ve got everybody working. About 55 people at each site working 12-hour shifts. It’s becoming pretty routine there at this point except for, as we said, the dryer and the conveyor reliability items.

Beyond that, all I can say is people are laser focused on getting us through the final (inaudible) items, and we are going to be at 100% reliable production by the end of the year. And if you would ask anybody on site, whether it would be TIC, BioFuel Energy, from a production or construction side, everybody is on the same focused effort.

Thomas Edelman

Thank you, Dan. Appreciate it. And as Dan said, this is not without its challenges. At least the scope of what is being addressed is narrowing down and there is still some hard weeks ahead, but we think we’re in sight of the finish line. It’s hard to remember given what’s happened to the overall ethanol industry as well as what happened to us in the hedging fiasco of the third quarter, but our original objective was to build and operate the most cost-effective plants in the ethanol business.

We still think that we have a good chance to achieve that once we get these plants up and running and we are past shakedown mode and could be working each day and months to improve the efficiency in terms of yield, use of energy, use of enzymes and other ingredients here. We haven’t had the luxury of focusing on that, but that is what we hope and expect to be focusing on come the first quarter when these plants are done and behind us. And it seems like at least we are close to that objective.

As I mentioned, the company is in relatively strong financial position given what’s going and given the hedging fiasco that took place. We have the peculiarity or may be the good fortuned perhaps that the liability to Cargill through their error [ph] as well as ours is in the parent company whereas the functioning of these plants, the buying and selling of corn and ethanol is in the operating subs where all these final pieces are coming together, and those operating subs have more than adequate, certainly in current market conditions, although it could change that to finish out their work and job and make the purchases corn, natural gas, et cetera, that they need.

So, subject to working out a mutually satisfactory arrangement with Cargill, which we continue to discuss, we think we all have a vested interest in this company being successful, having started it with aid and assistance. We are confident that we’ll be successful, but we certainly have nothing that we can announce on the subject at this point in time.

Putting that aside for a moment, and taking the liberty of jumping ahead to year-end and the assumption that Dan and his operating guys and TIC will bring this to successful conclusion on time at year-end for this construction project, we will be relatively good position within the industry. We’ll have approximately $0.91 per gallon of operating capacity in senior debt. If you include the working capital debt and the $20 million of subordinated debt outstanding, we’ll have about $1.09 in total of debt per gallon. It’s certainly not a comfortable position in terms of our working capital or even our debt-to-equity ratios, nothing like what we would have hoped or aspired to when we started this or went public 15 months ago, but one of the better positions in the business.

Now the business itself is a lot cover question. As most of you will recall, when we started this project roughly three years ago today the margins in the ethanol business was such that these plants on an unleveraged basis had exceptional rates of return. We thought we were forecasting conservatively by jumping corn from roughly I think $2.20 a bushel price to a conservative case of $3 corn, as I mentioned earlier. We managed to jump to almost $8 in June. We are now back down to about $3.60 Chicago price as we speak. But the ethanol price is up as well.

What has happened, however, is that the movement, lot’s of erratic steps along the way, but the movement of the commodity prices as at the present time basically taken the margin of these and virtually all the ethanol plants in the country to or very close to zero. Based on the spot price and movement on any given day, a modern ethanol plant running at capacity such as the ones we own and are completing, it is somewhere in the range of negative $0.05 or $0.06 a gallon to a positive $0.05 or $0.06 a gallon, and it literally – that changes day to day. It’s averaging right around a breakeven point.

Now, the good news from our perspective is if we can get to full completion by year-end. If the commodity markets become at least no more unfavorable, they don’t deteriorate further, and we can begin to get enhancements to efficiency and cost, we should at least be able to begin chipping away at this debt burden, while we work and hope for a better day in terms of margins in the ethanol business. Obviously, should it go the other way and the commodity spread between the corn and the ethanol could widen to the negative, in that case, we along with the rest of the industry if it lasts for a considerable period of time are in serious trouble.

But there at least for the first time as we approach completion, looking at the market there is a reasonable shot that sometime in the first half of 2009 that we can be running these plants and the company in a sufficiently cash flow positive, and be chipping away, as I said, at our debt.

So, it’s certainly too early to be optimistic, it certainly is an unfriendly climate as illustrated by the bankruptcy filing of VeraSun. I don’t think anyone in the industry is enjoying in the present, but is some ways the prospect looks at least marginally better to me as we look forward and very rapidly approach full completion.

Thank you. At this point, operator, let’s open this up for questions.

Question-and-Answer Session

Operator

Thank you, Mr. Edelman. At this time, we’ll begin the question-and-answer session. (Operator instructions) The first question comes from David Driscoll of Citi Investment Research. Please go ahead.

David Driscoll – Citi Investment Research

Great, thank you. Good morning, everyone.

Thomas Edelman

Good morning, David.

Scott Pearce

Good morning, David.

David Driscoll – Citi Investment Research

Could you guys just walk me through the sources and uses of cash here on our consolidated basis? I think you made the comment, Tom, that on the operating subsidiaries that you saw that the cash positions were sufficient to continue to fund those operations, but I am – I want to understand the fully consolidated basis when we look at where your – where are the positions that are out here and I also – please correct me if I am wrong on this, but upon completion of these plants, you will have additional access to working capital lines that’s not currently available. I believe that’s something you had mentioned on the last call, but again, could you guys just start off with the macro here on the fully consolidated basis, sources and uses? What’s going to happen over time here? Do we have enough liquidity that – to keep this thing running properly?

Thomas Edelman

Well, I think the difficulty is you can't look at it on a fully consolidated basis. The fully consolidated basis is what is sitting in front of you in terms of the 10-Q and the press release, David. The peculiarity is that we are under, as you know, very complicated project finance borrowing arrangements under which these plants were financed and built. And when in the second quarter of this year we had not yet started production at the plant, but were being urged strongly by certain of our shareholders and Cargill to protect ourselves on the corn price, there was no ability to enter into any contracts yet because we weren’t operational at the operating subs. As a result, all the hedging that was done with Cargill was done at the parent company level. And that parent company, at the time, because of proceeds remaining from the public offering, was perfectly able to do that and only as a result of the $50 million in losses that it run out of the ability to cover first its margin calls and then ultimately once the contracts were closed out the announced due to Cargill relating to those contracts. So the net result is that as we speak at the parent company there is $17.5 million of unsatisfied (inaudible) related to the hedging due to Cargill. There is about $5 million of cash that we consider close to at least a comfortable amount to be sitting in that company. And there is some restricted cash relating to the natural gas and other utility LCs and guarantees that have been put up. So, the parent company cannot, either with regard to Cargill or with regard to the sub debt, cannot currently cover its full obligations. And we need to resolve that problem.

At the subsidiary level, the operating subs where the bank debt is and where the corn is bought and ethanol is sold now that we are operational, we have – and Kelly, help me here – but we now, I believe, have access to a full $20 million working capital line.

Kelly Maguire

Correct.

Thomas Edelman

We asked for it to be expanded, but I don’t think the banks really want to talk to us about it until we are finished construction, but we’ve got access to the full $20 million we originally planned. And I think at least based on current corn and ethanol prices, which have shrunk the need from that earlier peak, for working capital back, our feeling is unless there are material ongoing losses, which obviously could happen if these commodity markets move the wrong way, at these prices that we have more than adequate liquidity to run the business at the operating company level. Is that a fair statement, Kelly? Am I leaving something out?

Kelly Maguire

No, that’s a fair assessment, Tom.

Thomas Edelman

What is the cash position in both the operating subs and undrawn – combination of cash and undrawn amounts under the working capital line at present, excluding money in the holding company?

Kelly Maguire

Yes, the cash amount at present in the operating subs is $17.5 million and the undrawn working capital is $3 million.

Thomas Edelman

So, there is $20 million of available liquidity there and I think there is working capital in the subs, which includes corn on site, ethanol and distillers grain waiting to be sold, and then including this cash already drawn. What’s total working capital in those subs at the current time, Kelly?

Kelly Maguire

The total working capital in those subs at the current time is around $12 million.

Thomas Edelman

Okay. So after all the receivables and payables, there is roughly $12 million in those subs plus the available to withdraw. It’s not wildly comfortable, but based on everything we see, we can finish up these plants if we do it on time and based on current margins run at roughly a breakeven level. We do need a resolution with Cargill and the parent company.

Is that sort of on point what you were looking for? Do you want a more detailed cash flow? We may (inaudible) to it offline with you talking to Kelly directly.

David Driscoll – Citi Investment Research

I probably will take you up on that. If I can just maybe try one more time I think with the total credit [ph] lines, I think you said you owe $13.5 million to TIC. You’ve got $8 million more that you have to pay to complete the plant. And then you owe Cargill $17.5 million. That’s something like $39 million. If I look on the consolidated balance sheet, I see cash –

Thomas Edelman

It won't – you can't do it that way, David, I apologize. You are heading for a point where the numbers won't solve because the amount we owe to TIC, right, and the amount for the working capital reserve is set aside in borrowing the rest of the construction loan. They’ve stayed down at the operating subs first. Okay?

David Driscoll – Citi Investment Research

Okay.

Thomas Edelman

Those will be paid with draws under our construction loan, both of those amounts. And there will be a bit more along with some of the cash to make up the lose ends of the construction beyond those two pieces. So that will all be taken care of in the operating subs. Nothing to do with the parent.

David Driscoll – Citi Investment Research

Alright. So the only numbers in there that are comparable are the $17.5 million and you look at that relative to that cash number and that’s why you are saying it’s that–

Thomas Edelman

That’s the problem that we need to address with Cargill. We have now – normally the source of cash for the holding company would be profits from the operating subs. For one, we don’t have them fully operating yet, and two, in current market conditions although there is hope for the future, there is no current expectation based on existing prices of profits. So we need to work out something with Cargill that stabilizes this situation and at least in part satisfy their claims. We have no such resolution. I don’t want to promise you one, but logic suggest we will find one.

David Driscoll – Citi Investment Research

Great. Thank you very much.

Operator

Thank you. (Operator instructions) And the next question comes from Alan Walton [ph], a private investor, and please go ahead.

Alan Walton

Yes, Hi, Tom, Good morning.

Thomas Edelman

Good morning, sir.

Alan Walton

I have – you know I’ve been owning a lot of the stock in the company. I got into it in the beginning and I have been watching things as they have transpired and you – my interest is in this Cargill thing. I don’t quite understand it in terms of the fact what is in the best interest of Cargill or why is it in their interest for BioFuel not to work this out? Do they have any interest on their part in perhaps getting involved as the parent company and it producing if you will ethanol on their own?

Thomas Edelman

Sure. While I want to be careful and make sure you understand I am neither entitled nor capable of speaking for Cargill. So all I can do is give you my judgment. We are in this business because Cargill did not wish to directly on these plants. They certainly could have, on their adjacent sites, built these plants, if they’ve chosen to. And at least based on my understanding – and Scott, please correct me if you have any different understanding – they have no desire that has ever been indicated in anyway to us to own these plants. So, we had no reason to believe they would like to move in on these things.

Two, we have pretty extensive commercial relationships with Cargill. They have some very profitable contracts with this company in terms of leasing us their silos and sites in terms of supplying us corn and in terms of marketing our ethanol and distillers grain. At least to my knowledge we had every reason to believe and they have as much as said so that they might very much want to continue those commercial relationships, which is not to say that they have any desire to lose money any more than any one else does. So, our feeling is that all logic suggest that we will need to find a mutually acceptable solution to BioFuel and its shareholders and Cargill on the other hand, but I can tell you we’ve done so yet.

Alan Walton

Now, let me just ask a basic question here. I remember when I listened in – when the other conference call – believe it was in either May or June – why has it taken such a long time for Cargill to work out a resolution on this? And I know this has been going on for two or three months, they are talking sort of what’s going on I mean they are bright people. I don’t know what their cash position is, but it would seem to me that in order to stabilize all the things that you guys are going, they could very quickly do that by coming to some kind of an agreement with you on this debt.

Thomas Edelman

Yes, I mean I don’t think any of us ought to assume that there is any cash issue with Cargill. I can't remember what the numbers was, but they announced the highest profits in their history, I believe in the third quarter in the billions of dollars. So I don’t think that this is any type of a threat to Cargill by any stretch of the imagination. The difficulty with all of this, in my opinion – and again, be careful that you understand, I can't speak of Cargill, I can simply give you my impression – all of us I think got caught by wild surprise at the total collapse in the corn market. There really was a consensus. I don’t particularly have a view on corn markets up or down, but there seemed to be a pretty strong consensus among Cargill, the big brokerage firms, hedge funds, et cetera, that this corn was sort of heading to the moon, and there was going to be food riots around the world, et cetera as of last June. It melted down very fast in about a 25-day period. These losses we’re talking about were incurred. And in the process we and Cargill and our banks were all caught completely by surprise, not just by the market losses – we were certainly surprised by those – but we were surprised by this arbitrage that none of us had frankly fully thought through between having the operating subs that had not been up and running when we entered into the hedges. If they’ve been up and running, the hedges would have been at the operating company level. And all of these might have been painful, but I think would have probably worked out. As it was, the banks had full control of all assets and cash flow, access to debt at the operating sub level, and Cargill, and we were left with these contract obligation and an inability to fund them and pay them in the parent company and we’ve had a number of meetings and discussions on the subject since August. There is plan for s next discussion next week. Could they resolve this if they wanted? Absolutely, in about an hour. And we are not nearly as flexible as them because we don’t have the same degree of resources, but as I say I think it will get resolved. I will tell you that from both our and their point of view as much we’d like it resolved it would be a hell of a lot easier to resolve if our plants were finished, up running, the bank debt was fully drawn, every one was just focused on efficiency as opposed to construction and retainage and TIC, and the 500 parts of this that are in constant motion, although we are getting close to the end.

So, on the one hand I’d love it settled, on the other hand this whole company will be a hell of a lot easier to run and to finance and arrange things by January 1. So, I hope it’s done very quickly, but it should be getting easier to resolve not harder with the passage of time.

Alan Walton

I hear you, Tom, and unfortunate for you guys, and I know what you’ve been through is just mind-boggling because someone on the outside of this and looking at a company like Cargill where $17 million is petty cash or something like that in their size, I mean it’s just amazing to me that this continues not be made easier by them, looking at the long term.

Thomas Edelman

Well, I am hoping they will. This is a very good, rich, wisely [ph] run company. I think mistakes were made by probably everyone involved here. Along the way we all got caught at the perfect wrong moment in this commodity and financial storm. I think it will get resolved. I don’t think any of us are going to walk away smiling or doing hi-five’s [ph] but I think this will be successfully resolved. There are some very smart people around the table and there is no reason to bring this house down.

Alan Walton

I appreciate it, Tom. Thank you for your answers.

Thomas Edelman

Yes, sir.

Operator

Thank you. The next question comes from David Driscoll of Citi Investment Research. Please go ahead.

David Driscoll – Citi Investment Research

Great. Thanks for taking the call up guys.

Thomas Edelman

Sure.

David Driscoll – Citi Investment Research

Tom, can you – tell me a little bit here about fourth quarter. Did I hear you correct in that there are no – all the hedges, everything related to the $50 million that you’ve acknowledges that’s the conclusion of that event, there is no carryover into the fourth quarter. Is that correct?

Thomas Edelman

Kelly, Scott, please, given this topic, if you think there is even a (inaudible) gap jump in and correct me incidentally. We closed out and that Cargill closed out under their contracts the last of those agreements in September. Now, understand you can never be 100% insulated from the market, but there is no futures position, meaning that there is corn, as Scott mentioned, being dropped off this afternoon at the plant. I believe it is priced – and Scott jump in here and help me – I believe it’s priced when I took – sit on the scales – let’s take a silly example, but it crosses the scales and corn is $3.60 a bushel, and the next morning it drops to $2. We can lose money on corn because the corn is in our possession, being ground, running through the plant. It’s now instantaneous in and out. But we have no futures position. Conversely, if corn gets delivered at $3.60 and it goes to $4, we can have a gain on corn. But there is no futures position of any magnitude at this point in time open. Is that correct, Kelly?

Kelly Maguire

Right.

Scott Pearce

That’s correct.

Kelly Maguire

It’s right, Tom.

David Driscoll – Citi Investment Research

Okay. So, then if I just follow-up on this, so the logic then for the fourth quarter will be that your average corn cost will be simply the average of the spot prices on a daily basis throughout the fourth quarter and current prices are as good as any for a proxy on what that number would be. Would you agree with that?

Thomas Edelman

Well, I would if markets weren't moving 5% a day. So I mean do I think it's as good a proxy as you and I know as we speak today? Yes. But given what we've all been through in the last 100 days, could corn be $7 or $2 tomorrow? Unfortunately, it could.

David Driscoll – Citigroup

Okay. On the ethanol price realization in the quarter, I think you guys said in the press release it was $2.20. When I look at the New York Harbor average price over the third quarter, I come up with a value of about $2.50, and I'm just trying to understand, what's the nature of the delta here? Because of the low utilization, did you guys sell a lot of this material much closer in the Midwest, i.e., and that would result in lower prices than what we see on New York Harbor?

Thomas Edelman

Well, Scott, help me here. I think to move ethanol on an average day – and I'm not sure that these commodity markets have many average days, at least recently – but on an average day, I think our cost to move to New York Harbor was about $0.17.

Scott Pearce

It’s more than that, Tom. It's probably closer to $0.23 to $0.25.

Thomas Edelman

Okay. And I think that is in rough terms the arbitrage, meaning our ethanol is really not ending up in New York Harbor. Our ethanol is being sold all over the Midwest and to some degrees being shipped out West or to the Eastern Midwest. It's not going to New York Harbor. But I think the price relationships come off the Chicago Board. But the trading is so thin, David. It's hard for me at least to follow this with any published number, meaning, you get an announcement at the end of the day that ethanol barge is traded at X and you receive $0.10 or $0.12, sometimes more, sometimes less, on the exact same day. It's just a very thin market, so–

David Driscoll – Citigroup

Okay–

Thomas Edelman

It's not efficient. But I think basically the arbitrage is the transportation cost to New York Harbor and/or LA.

David Driscoll – Citigroup

One final question. In the release you indicated that you did not pay your scheduled interest payment on the subordinated debt–

Thomas Edelman

Correct.

David DriscollCitigroup

I don't often see this. So tell me what's the effect of this to you guys? What happens when you fail to pay? You indicated that there was an increase in the interest rate.

Thomas Edelman

The interest rate went from an obscene 15 to a slightly more obscene 17, other than that at least so far nothing, as you probably know. Our subordinated debt are held by our two largest stockholders, Greenlight Capital and Third Point Partners. Again, I need to be careful. I cannot speak for them. But I think it's in everyone's interest that this along with the Cargill situation gets resolved. At least my opinion was that while we are working out – since that is in the same entity, that while we were working out or trying to work out our arrangement with Cargill that it was prudent for no material amount of monies to be flowing in or out of that entity until we had a meeting of the minds. And that's all it is. I hope it is just a temporary situation, but it really is part and parcel of the resolution at the parent company with Cargill.

David Driscoll – Citigroup

Understood. Good luck with completing the plants. Thank you.

Thomas Edelman

Thank you, sir.

Scott Pearce

Thanks, David.

Operator

The next question comes from Cameron Wright of Jay A. Fishman Limited. Please go ahead.

Cameron Wright – Jay A. Fishman Limited

Hi, Tom. Thanks for taking my call. Just – I mean just a question on your business. You can't control your input costs. You can't really control the price that you sell your product at. So, I mean, what needs to happen for you guys have sustainable profitability in this business? Or is that something that you may never get?

Thomas Edelman

Well, never is a long time. Again, I guess, I'm limited given where we are in this process to giving you my opinion. The view that Scott and I and Dan and Cargill, along with our investors, all had back when we started this was really quite simple and straightforward, which was that ethanol represented a fully domestic, farm-friendly, environmentally friendly, source of vehicle fuel for the United States. Never was going to replace gasoline, but it should rise to provide on average 10% of the amount of gasoline we needed. And that between the cost to produce it and the tax credit benefit, that there should be a profit per gallon of between $0.30 and $0.60 a gallon on ethanol, which would make building and owning these plants a very valuable proposition.

Well, a series of things have changed since that happened. One, as you know, there was at least for a while the question as to whether corn was going to run short and whether the ethanol producers were principal cause for a food crisis around the world. I think it was a Red Herring, but there was at least the assertion.

The second is we now have gasoline demand for the first time I believe in my life time heading downward in the United States. And finally, there were plants, ethanol plants, not just ours, but others, coming on-stream at a rate faster than the infrastructure could distribute it around the United States. I think for a long time there was a problem getting any of it into the whole Southeastern quadrant of the United States. That's now been broken through, but it took a long time to have it. We had a simple supply-and-demand problem. Too much supply, too little demand, all the margin transferred over to the refiners. They were making, Scott, I think $1 a gallon for a while–

Scott Pearce

Yes.

Thomas Edelman

– on ethanol? And they were leaving none for the ethanol producers, which because of supply-and-demand they were able to do. Longer term – when is a tougher question – longer term I still believe in most if not all of that thesis. I still believe we ought to produce – it’s humanly possible – at least 10% of our domestic vehicle fuel in the form of ethanol. Like everyone else in the world, I'd much prefer to produce it with cellulosic waste or scruffy crops than I would with corn that has other uses for animal feed. It's really not human food for most of the world, only Americans do eat corn in corn form. But I think what we've done is we collectively – very expensively so far might be – but collectively have built an industry that can make and distribute and blend with gasoline very large quantities, 15 billion gallons by the time this thing is going to – a year of ethanol. And I believe that some point, hopefully, including at our plants, at some point we will make this partially or largely from substances other than food. No, we've got plans to do that. Are we going to make money in the short term, cooking corn and making ethanol? It doesn't look it. It looks like if you freeze today spot prices, we, in the best case, will be running these plants at roughly breakeven, and I mean breakeven after all interest and overhead and maybe a little bit of debt service. But certainly nothing good in terms of profitability. I think the margins will return and I think the industry is going to work out. But I cannot, for the life of me, find a reason it's going to happen tomorrow.

Cameron Wright – Jay A. Fishman Limited

Do you think the tax credit is going to find its way back to the producers or is it going to stay at the blenders?

Thomas Edelman

I think it's supply and demand. I mean, look, the blenders had the power in Los Angeles – there wasn't enough final demand that they had to get every gallon of ethanol, and they made the ethanol producers fight with each other in an effect in a Dutch auction until they took them to breakeven. So they were able to capture 100% of it. If next year, and obviously it would a lot better if the economy was not shrinking and gasoline demand was at least flat so that you didn't have that fighting against you, if these plants stopped coming on-stream, which is definitely going to happen within the next six months to nine months, no new ones anyone's crazy enough to think about. New ones stop coming on and that demand gradually rises. Eventually, supply and demand will change the negotiating posture between the blenders and the producers. In fact, you look at the numbers today; it's already happened a little bit as the oil prices collapsed. Their blending margins have shrunk. Now, it hasn't so far gone to us, but they are no longer getting the dollar. So I'm not sure that's a good solution to the problem from a business perspective. But I think it's going to right itself, I just don't know when.

Cameron Wright – Jay A. Fishman Limited

Okay. Just one final question. In retrospect, do you regret getting into the business or –?

Thomas Edelman

Oh my God! As much as anything in my life I've never taken a set of public shareholders. Forget my own money, I'm the largest individual investor in this thing and I'm perfectly prepared to lose money, but I really hate losing other people's money. And to take the public into a company that along with the rest of this industry has now lost between, I believe, at the best 87%, and at the worst I guess in the case of VeraSun, it's 100% of our investors money, I've never been more disgusted with myself or disappointed. We were dead wrong. We have a lot of company, but we were dead wrong in about four or five different material ways, and I regret every minute of them.

Cameron Wright – Jay A. Fishman Limited

Thank you very much, Tom.

Thomas Edelman

Yes, sir.

Operator

Thank you. (Operator instructions) Mr. Edelman, it appears there are no questions at this time.

Thomas Edelman

Alright. Well, thank you all for joining us. I wish it was happier news. It was obviously a revolting third quarter. The fourth will certainly be better, although not in this market good, and hopefully by the first quarter we will simply be facing the challenges of efficiently running and operating business still in a tough market, but without some of this horror show that we've all faced together over the last 12 months. My thanks for your time.

Operator

This concludes today's conference call. All participants may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: BioFuel Energy Corporation Q3 2008 Earnings Call Transcript
This Transcript
All Transcripts