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Syntroleum Corporation (NASDAQ:SYNM)

Q4 2012 Earnings Conference Call

March 18, 2013 15:00 ET

Executives

Karen Power - Senior Vice President and Principal Financial Officer

Gary Roth - President and Chief Executive Officer

Ron Stinebaugh - Senior Vice President, Finance

Analysts

Jerry McDonald - McDonald and McDonald

Operator

Good afternoon, and welcome to the Syntroleum’s 2012 Annual Results Conference Call. All participants will be in a listen-only mode. (Operator Instructions) After today’s presentation, there will be an opportunity to ask questions. (Operator Instructions) Please note this event is being recorded.

And I would now like to turn the conference over to Karen Power, Senior Vice President and Principal Financial Officer. Please go ahead.

Karen Power

Good afternoon and thank you for joining us today. Remarks for today’s call will be presented by Karen Power, Senior Vice President and Principal Financial Officer, Syntroleum’s President and Chief Executive Officer, Gary Roth, and Ron Stinebaugh, Senior Vice President of Finance.

Before we begin our remarks, I would like to remind everyone that during this call we will make certain forward-looking statements, as well as use historical information. Words such as believe, estimate, expect, intend, plan, anticipate, could, should or suggest are intended to identify forward-looking statements. Although Syntroleum believes that expectations reflected in these forward-looking statements are reasonable, these statements involve risks and uncertainties. Future results may differ materially from those projected in these forward-looking statements. You are encouraged to refer to our SEC filings, including our most recent Annual Report on Form 10-K for a full disclosure of these risks and uncertainties.

For the quarter ended December 31, 2012, company reported an operating loss of $797,000, resulting from revenues of $1.1 million and operating expenses of $1.9 million. For the year ended December 31, 2012, the company reported operating income of $9.2 million resulting from revenues of $17.5 million and operating expenses of $8.3 million.

For Dynamic Fuels quarter and year ended September 30, 2012, we reported a loss of $4.3 million and $10 million respectively compared to a loss of $2.8 million for the quarter ended June 30, 2012. During the quarter and year ended September 30, 2012, the plant sold 10.6 million and 35.2 million gallons of renewable fuels respectively.

We report Dynamic Fuels on a three-month lag and the loss reflected in our income statement is for the period ended September 30, 2012. Our 10-K filing included Dynamic Fuels’ annual financials.

Syntroleum’s net loss was $5.1 million and $1.1 million respectively for the three months and year ended December 31, 2012 compared with the loss of $3 million and $16.9 million respectively for the corresponding periods in 2011. As of December 31, 2012 Syntroleum’s available cash balance was $15.9 million.

On March 1, 2013, we received $5.7 million from the sale of our pilot plant to SASOL USA. Our current cash balance is $19 million. On December 6, 2012, we received a NASDAQ notification letter granting Syntroleum an additional 180 days to regain compliance relating to the $1 per share minimum bid price listing requirement expires on June 3, 2013. Except for the $1 per share minimum bid price, we meet listing requirements for the NASDAQ capital market.

Now, I will turn the call over to Gary Roth.

Gary Roth

Thanks, Karen. We began the turnaround on the [Geismar] [ph] plant on October 25, 2012. The turnaround was completed on December 10, 2012. At the time, our industry faced the following situation, (inaudible) that the 1 billion gallon 2012 biomass-based diesel mandate would be met as early as May, EMTS reported 121 million gallons or 1.45 billion gallons on an annualized basis. RIN prices which averaged $1.44 in April, fell 28%, averaging $1.03 for August, that’s 59% from $1 to a low of $0.42 over 17-day period in September to October 2012, $0.53 for December. Question of reinstatements for the dollar tax gallon, dollar per gallon tax credit, and the $0.50 per gallon alternative fuel mixture credit for 2013 whether or not they would be retroactive to 2012 had not been answered.

Currency was only partially resolved on January 3, 2012 when President Obama signed legislation [in anticipating] [ph] that these tax credits retroactive for 2012 and 2013. Once legislated, the filing mechanism remained undefined. IRS published procedures on January 31, 2013 it’s different from the procedures in 2011 leading to further delays as the industry internalized these regulations.

[In moving] [ph] through the tax credit process the total effective value of these credits is estimated at $25 million with $8.9 million in direct tax credits to each owner, Syntroleum electronically filed its tax return and received receipt of confirmation on March 15, 2012. Feedstock prices remained high in late 2012 relative to the combined value of fiscal fuel prices in RIN partially due to the uncertainty of the dollar per gallon tax credit (inaudible). Past three months, we have seen resolution to the uncertainties we have outlined above. Biodiesel margins, which are a primary indicator of health in our industry, reached breakeven levels in February. (Technical Difficulty) RIN prices are currently $0.80 having been as high as $1.09 when we combine with (inaudible) tax credit (inaudible) distributed margins. Question remains how long will these margins exist?

Let me turn the call over to Ron Stinebaugh for a more in-depth review of this question.

Ron Stinebaugh

Thanks, Gary. Let’s start by reviewing RIN codes which are commercially available today. RINs are the currency by which the EPA measures compliance with RFS2. System is built around ethanol energy equivalent gallons, where one gallon of ethanol is equal to one RIN, where fuel types are assigned RIN values per gallon based on energy content relative to ethanol. D4 RINs are for biomass-based diesel, which includes biodiesel and renewable diesel, biodiesel receives 1.5 RINs per gallon and renewable diesel receives 1.7 RINs per gallon.

D5 RINs are for advanced biofuels, which typically includes biomass-based diesel (inaudible) naphtha and carbon intensity sugarcane ethanol and D6 RINs are for other renewable fuels, which is typically corn ethanol. What can D4 RINs be used for? The answer is that D4 RINs can not only be used for D4 compliance, but also D5 and D6 compliance. However, D5 and D6 RINs cannot be used for D4 compliance. This makes D4 RINs the most flexible RINs.

There are several factors that are positively impacting the value of D4 RINs, factors relate to E10 blending, a growing advanced biofuel mandate, and an abundant global palm oil supplies. D6 corn ethanol RINs began the year at $0.07. D6 RINs increased to $0.30 level in late January and remained there most of February. Then over 11 trading days beginning on February 20 advanced $0.72 to $1.06 on March 11. Same time period D4 biomass-based diesel RINs increased $0.52 to $1.09, D5 advanced biofuel RINs increased $0.59 to $1.11. In other words, the commercially available RIN complex all increased to parity, and have essentially remained that way since.

Key question is what is driving the price of D6 RINs and how does this impact D4 biomass-based diesel RINs? RFS2 mandates corn ethanol usage growing from 13.8 billion gallons in 2013 to 15 billion gallons in 2015. 2013, The United States Energy Information Agency also known as EIA projects 2013 U.S. gasoline demand of 134 billion gallons trending flat to down. This suggests that 2013 fiscal ethanol demand of 13 billion gallons at E10 blending levels. This results in a current year statutory shortfall of approximately 400 million gallons to meet the 13.8 billion gallon mandate, excluding carryover D6 RINs. The same methodology for 2014 and 2015 suggests deficit of 1 billion gallons in 2014 and 1.9 billion gallons in 2015.

In ‘13, the advanced biofuel mandate is proposed at 2.75 billion RINs, which consist of 1.92 billion RINs from 1.28 billion gallons of biomass-based diesel. This results in a D5 RIN requirement of 830 million RINs using the same methodology that D5 RIN requirement in 2014 grows to 1.83 billion RINs and 3.58 billion RINs in 2015 holding biomass-based diesel constant at 1.28 billion gallons.

In summary, given current RFS2 legislation, E10 blending infrastructure and a 1.28 billion gallon biomass-based diesel requirement, we see D4 RIN potential in excess of the current 1.28 billion gallon RIN equivalent requirement of 860 million gallons, 1.9 billion gallons, and 3.6 billion gallons in 2013, 2014, 2015 respectively. EIA projects diesel consumption at 53 billion, 56 billion, and 58 billion gallons in 2013, 2014, and 2015. If RIN distribution shifted 100% to D4 biomass-based diesel for compliance, this would result in B4, B5.7, and B8.4 levels consistent with the B5 to B20 typically sold by the fuel industry. Note diesel produced by Dynamic Fuels has no blend limitations. And the biomass-based diesel industry produced these volumes.

According to the EIA, installed biodiesel annual capacity is 2.1 gallons year end 2012. (Inaudible) renewable diesel facility annual capacity is approximately 225 million gallons for a total of 2.3 billion gallons as per EMTS the maximum recorded biomass-based diesel gallon supplied was 165 million gallons December 2011, which translates to an annualized 2 billion. As per Howard Energy, year end 2010 global annual biodiesel capacity was 15 billion gallons.

In summary, D4 RINs are a mechanism for obligated parties to meet their RIN requirements now and over near-term. There is sufficient domestic and global production capacity, that generate these RINs and these biomass-based diesel volumes can be blended within industry standard levels. According to the Malaysian Palm Oil Board, Malaysian palm oil stocks at the beginning of 2013 were an all-time high of 2.6 million metric tons. RBD palm oil differential to soy at the West Gulf Coast has widened $0.183 from a $0.29 per pound premium in August of 2010 to a $0.154 per pound discount in February 2013. Given the significant plantings of palm in the past few years, we believe that the additional supply could persist we expect the global supply of palm oil to temper feedstock prices. Another impact of palm supply is the importation of palm biodisel. Palm biodiesel qualifies for the dollar blenders’ tax credit, but does not generate D4 RINs. According to RIN less palm biodiesel, we will use some of the domestic biodiesel blending capacity that generates RINs and could result in fewer RINs created.

Now, I will turn the call back to Gary Roth.

Gary Roth

Thank you, Ron, for that detailed analysis. We understand that our business is complicated. However, it is critical for us to understanding inner workings of the RFS2 compliant systems. Have any additional questions and I am sure you will, please feel free to call Ron or myself.

Ron’s analysis suggest that the downside RIN uncertainty we saw in the second half of 2012 will likely be mitigated as a result of increased deeper RIN demand in addition to the 28% increase in biomass-based diesel mandated year-on-year. Prices for feedstock to be buffered by excess global palm supply. As a result, we have anticipated mutual decision between the owners to restart the Geismar facility. Our optimism related to natural gas to liquids business continued to grow.

Recently, we have seen gas suppliers linked to price of natural gas to end product prices. Price bottle significantly lowers the differential commodity price risk inherent to a gas to liquids project. We see this as an indication gas prices will remain competitive for the foreseeable future (Technical Difficulty) pricing models. In conjunction with gas producers, we have developed geologic basin-specific economic modeling allowing us to focus our business development efforts. Coming months, we expect to further now our evaluation to a fully integrated development concept, including drilling (Technical Difficulty) conversion and product marketing.

With respect to our patent dispute with Neste, let me review the status. May 2012 Neste sued Syntoleum for alleged infringement of their 344 patent (Technical Difficulty) 344 patent. January 31, 2013, the United States District Court for the District of Delaware grant Syntroleum’s motion to abstain Neste’s lawsuit (Technical Difficulty) orders consistent with a prior finding on March 22 (Technical Difficulty) affirming the Examiner’s rejection of Neste’s 018 patent claims. December 20, 2012, (Technical Difficulty) March 8, 2013, Syntoleum filed an (indiscernible) review with the U.S. patent office in relation to the 094 patent.

On March 13, 2012 Syntroleum filed a motion to stay with the United State District Court of Delaware. On February 7, 2013, Syntroleum filed suit against Neste in Singapore asserting its Singapore patent number 172045 by manufacturing the same. Syntroleum has invested substantial time and resources in its proprietary Biofining technology, of course, our intellectual property rights in venues domestically. Thank you for your attendance today. We will now open the call for questions. Thank you.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. (Operator Instructions) And our first question will come from Jerry McDonald with McDonald and McDonald. Please go ahead.

Jerry McDonald - McDonald and McDonald

Yeah, this is Jerry McDonald. I appreciate you talking my call. We are not a real big firm, we are a small firm, but we do have an investment in this company of 160,000 shares. Some people might think that’s big, some people might think that’s small, but which is just a small part of our investment firm. My question involves Tyson’s part of this joint venture. I wonder and probably many other people wondered if Tyson is really putting forth a real 100% care it doesn’t take a business major to figure out that the main part of a business is the more you sell you sell it for cheaper.

Okay, now my question is even you guys have said that Tyson feedstock is not the best of quality. So, why is it that they are trying to get top dollar if it’s $0.35 a pound and why would they not try and sell it as they partner to you for cheaper. Business 101 tells you the more you sell for cheap. Now, you buy a Coke, it’s $0.65 you buy a case, its $5 or a candy bars or anything anybody that’s a main multi-billion dollar company sells quality for less – quantity for less I should say and don’t they have 8 or 9 million shares. So, my question comes back to if they are going to – if they were to sell you this stuff for cheaper, wouldn’t your increase in the price per share earnings go up and their stock go up, I mean, if you guys were making $0.15 a share or $0.20 a share per quarter and you made $0.50 or $0.60 a share for the year, you take a multiple of that and your stock would be $5 or $6 and Tyson’s 8 or 9 million shares would be worth a lot more money than at $0.40. So, is there any chance that Tyson is going to breakdown and see a business one-on-one quality for less as a proposition.

Gary Roth

Yeah, I am not sure, there is a questions in there. Tyson sells us feedstock and procures feedstock on market. Those markets have indices, and we follow those indices and that’s the joint venture. It was the way it set up, the way it will be. In terms of the volume sold one always has to remember that we have a mandated or a quota system. So, when we hit the quotas, we are going to hit a wall and that’s what we did last year. In terms of feedstock pricing quality, in terms of feedstock quality, we had some issues early on, they were startup related issues. We think we went through those issues. We have put in and made upgrades to the plant and are continuing to make upgrades to the plant to address what we can believe is market available feedstocks.

Operator

Our next question will come from [John Dempsey, from Dempsey Inc,] [ph]. Please go ahead.

Unidentified Analyst

Yes, hello. I could barely hear most of what you had said on this call, I don’t know if it were just me or not, but if you hit this wall, I guess my question is that you speak up and you have had issues with performance, are you guys still cycling through, wouldn’t you be creating some inventory to make sure you are continuing to work out the bugs on this process, so that you can when the proverbial wall is lifted, and you are able to go with it, you have more confidence that the machinery will work as expected. And I guess my other follow up here is how can you continue to go with the overhead - are the employees just sitting around, how do we get a feel for what training, I mean what goes on when the plant is not operational, because it appears between gas availability and some other issues, it feels like that plant is never very operational for long?

Gary Roth

Well, the plant operation has improved fairly dramatically from the start of the operations till we work through our feedstock related issues, till we made the modifications to the plant; we have talked about the compressor, we’ve resolved those issues. We have the new solvent recycling purchase. We have changed out the exchanger bundles. When we hit the blending wall, when you are producing at 1.5 billion a year gallon rate on 1 billion gallon mandate, some things going to give and that’s what we saw last year when the margins turned negative.

Unidentified Analyst

But if you have some customers who are like expecting, let’s say, they were expecting to buy that, do they have one or two issues, where often it’s not available from you guys and then often they are left wondering if they are going to have a consistency and supply issue? And my next question as a follow-up to that would be with our…

Gary Roth

Well, our Mansfield relationship allows Mansfield with the clients to supply either renewable diesel or petroleum-based diesel, because they are interchangeable, but as we have suggested on numerous occasions, clients will not pay a premium for renewable products. So, when we have disproportionate commodities, fats, oils, and greases that are not linked to oil prices except through the RIN mechanism and when the RIN mechanism hits the mandate level, those commodities disconnect and that’s what we saw.

Unidentified Analyst

Okay. Well, my last question would really be, it sounds like there is a process, I agree it’s complicated, and I mean there is struggling going on, whether it’s fixing some of the equipment and getting up and going or some of the RIN issues, but how come it feels like overall communication is I have not been following this company for so many years that the overall communication level is almost nonexistent. I would think like how you read – you opened the post and you read about like the Mazda thing a few weeks ago with the race cars or some planes that are utilizing Louisiana oil grease to fly or some of that, but it never appears that there is every kind of releases from you guys just sort of get people to feel that hey, we are out there, we are in this business, we are one of the first out there. This should be a something that is a pat on the back for this country as far as trying to use renewable fuels, and as much as it feels like it should be a something that we pat ourselves on the back over and you guys as well. It just appears it’s like almost like a secret that nobody should know about it. I always have thought the communication is stunningly poor, and I just would love to hear, because I have seen companies that have huge losses out there, and they are out there every time they can get any better press to try to get their name and some recognition out there. Do you have any comment on that I was just very curious about that?

Gary Roth

Well, we supply press release informations, for example, for the Great Green Fleet we supplied the 450,000 gallons for which the United States military flew the F-18s and ran its offshore fleet. So, I think that’s pretty compelling. We did do the Mazda work. We have had other relationships with Sky Energy that we reported developmental volumes with clients. So, can we do a better job? We always think we can do a better job, but we think we get our fair share of developmental production within the country.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Ms. Power for any closing remarks.

Karen Power

Thank you for your participation today. We appreciate your interest in Syntroleum. Good afternoon.

Operator

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

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