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Syntroleum Corporation (NASDAQ:SYNM)

Q2 2010 Earnings Call Transcript

August 16, 2010 9:00 am ET

Executives

Karen Gallagher – SVP and Principal Financial Officer

Jeff Bigger – SVP, Business Development

Ron Stinebaugh – SVP, Finance and Acquisitions

Analysts

Eric Wayne [ph] – Royal Investment Partners [ph]

Bob Weisman [ph]

Dan Fawcett [ph]

Frank Leonardo [ph]

Ervin Smith [ph]

John Smith [ph]

Bill Bright [ph]

Lloyd Crumrine [ph]

Operator

Greetings and welcome to the Syntroleum Corporation second quarter 2010 conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Karen Gallagher, Senior Vice President and Principal Financial Officer for Syntroleum. Thank you. Ms. Gallagher, you may begin.

Karen Gallagher

Good morning, and thank you for joining us today. Remarks for today’s call will be presented by Jeff Bigger, Senior Vice President of Business Development, who will provide an update on our Dynamic Fuels Geismar Plant. Gary Roth, our Chief Executive Officer, is away on business.

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 or should 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 these 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 such risks and uncertainties.

Let us begin by summarizing our results over the first half of the year and provide you with an update on activity at Dynamic Fuels, our joint venture with Tyson Foods.

The commissioning of the Geismar Plant is 40% complete and the project remains on budget. We expect full rate production in the third quarter. Jeff Bigger will provide more details in his update on Dynamic Fuels.

We have received the final payment from Sinopec for the relocation of the Catoosa Demonstration Facility to China. We have now received the full $20 million contract value.

The Department of Energy awarded us a $1 million demonstration contract to demonstrate the market potential for the phase change material and building envelopes such as wallboards and attic insulation. Phase change materials are compounds that melt at room temperature and are used to control the temperature inside a building and maybe sold at a substantial premium to our fuel products.

Oak Ridge National Laboratory has conducted a number of studies on phase material-enhanced building materials. These studies record a 35% to 40% reduction in building energy consumption. Our project will develop commercial applications for phase change materials that can be produced at our Geismar facility. The project is expected to be completed in the first quarter of 2012.

For the first six months ended June 30, 2010, the company reported operating income of $461,000 resulting from total revenues of $5.5 million and operating expenses of $5.1 million. This is compared to $12.3 million of operating income during the first six months of 2009 with $21.9 million of revenue and $9.6 million of operating expenses. Our total net loss for the six months ended June 30, 2010 was $622,000 compared to income of $7.4 million for the same period last year.

Finally, the company had a cash balance of $24.7 million at June 30th compared to $25 million at year-end 2009. We have a remaining commitment to Dynamic Fuels of $10 million.

I will now turn the call over to Jeff Bigger to update you on the status of Dynamic Fuels venture.

Jeff Bigger

Thank you, Karen. Today, I will update you on the status of the Geismar facility. Plant commissioning and startup is underway with commissioning 40% complete and on budget.

We have completed the following milestones in the commissioning process. The instrumentation and control has been commissioned. Feedstock has been delivered and is ready for processing. We commissioned all utility systems, including steam, water, nitrogen, and the flare. We commissioned the compression system. We have pressurized the reactor loop and are circulating hydrogen.

The major milestones left to complete include loading of some of the catalyst materials, processing of the feed, and commissioning of the fractionation system. We expect full rate production of fuels at the end of the third quarter 2010.

Let me now address our marketing activities. Regulatory mandates continue to be legislated around the world. These developments demonstrate increasing global demand for our products. For instance, the EPA recently confirmed the 800 million gallon requirement for biomass-based diesel for 2011. This is a substantial increase over the 490 million gallons of biodiesel that were produced in the U.S. in 2009, as reported by the EPA.

In July, Argentina increased the biodiesel mandate from B5 to B7, which has had the impact of reducing their exports to Europe. The B5 mandate had been in place since the beginning of 2010. Brazil instituted a B5 blend requirement at the beginning of 2010, up from a B4 in 2009. And the Canadian provinces of British Columbia, Alberta, and Manitoba have all recently implemented biodiesel mandates, which range from 2% to 5%.

Our renewable diesel has greater ability to penetrate a broader range of markets at lower handling and transportation costs compared to biodiesel, because of its ability to utilize existing infrastructure. We are in the process of qualifying renewable diesel for shipment on pipelines, first in segregated batches and ultimately, as a blend with petroleum diesel. We expect approval for shipment on certain key pipelines in segregated batches by the end of this year and approval for shipments of blended batches in early 2011.

Our long-term marketing plan includes niche markets that value cold-flow properties and reduce tailpipe emissions. Cold-flow markets include Northern states such as Minnesota and Illinois and export markets such as Canada and Europe. We are also exploring markets with severe emission restrictions such as underground mines.

We are pursuing high-end specialty product markets for various fractions of our renewable diesel fuel. Products sold to these markets currently sell for prices greater than fuel. These include isoparaffins, which are typically used as solvents, drilling fluids, and propellants in industrial applications.

Congress has not yet acted to reinstate the $1 per gallon tax credit for renewable diesel and biodiesel. The latest news on the extensions of $1 tax credit is that on August 10th, Senator Kerry of Massachusetts proposed the Clean Energy Technology Leadership Act of 2010. Among its provisions is an extension of the renewable diesel and biodiesel tax credits through 2012, retroactive to 2010. The ultimate fate of the tax credit is uncertain, as is the timing for a decision by Congress.

As you know, Dynamic Fuels made its investment decision with respect to constructing the Geismar Plant on the expectation that the $1 per gallon tax credit would remain in effect. Unfortunately, the failure of Congress to reinstate the tax credit has resulted in a great deal of uncertainty in the renewable fuels industry.

The tax credit has been caught up in the legislative limbo on the one hand. But on the other hand, the EPA has confirmed the 2011 mandate for 800 million gallons of biomass-based diesel. During the past few months, there has been upward pressure on RIN prices. RINs or Renewable Identification Numbers are very volatile, but we believe that there will be strong demand in the coming months as obligated parties seek to meet their demand obligations by purchasing renewable diesel and renewable diesel RINs.

Currently, RINs are reported to be selling at approximately $0.50 each; and since each gallon of our renewable diesel creates 1.7 RINs, we see a current RIN value of approximately $0.85 for each gallon we produce. These RIN values are close to making up for the not-yet-approved $1 per gallon tax credit.

The Geismar Plant is impacted as the rest of the industry with current regulatory uncertainty. However, we believe the Geismar Plant is better positioned than any competing facility to deal with this uncertainty due to our ability to process lower-cost feedstocks and to create products with excellent cold-flow properties for target markets, generating the best netback values in the industry.

Now, I will turn the call over to Karen.

Karen Gallagher

Thanks, Jeff. Thank you for your attendance today. We will now open up the call for questions.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions). One moment please while we poll for questions. Our first question is from Eric Wayne [ph] with Royal Investment Partners [ph]. Please proceed with your question.

Eric Wayne – Royal Investment Partners

My question is relating to the marketing of your renewable diesel. You mentioned a couple of general macro forces. I was just wondering if there is anything specific you can add, like who would be buying the fuel later this year.

Jeff Bigger

Yes, Eric, this is Jeff Bigger. We have off-take contracts on fuel that will take it into the fuel market and those are primarily being driven by obligated parties that are required to either sell renewable diesel or biodiesel or to basically retire RINs by the EPA. So, primarily, our focus is on selling the fuel products to obligated parties.

Eric Wayne – Royal Investment Partners

And you have it contracted for the next couple of quarters then?

Jeff Bigger

We have contract for off-take of fuel that will be used in the diesel market, yes.

Eric Wayne – Royal Investment Partners

Okay. Thanks.

Operator

Our next question is from Bob Weisman [ph], who is a private investor. Please proceed with your question.

Bob Weisman

Yes. I was wondering, you keep talking about the $1 tax or tax credit you receive from the government. I'm a little confused. Is not the product profitable without having a $1 surcharge?

Jeff Bigger

Our basic economics included the $1 a gallon tax credit as part of the economics for the plant.

Bob Weisman

Without the $1 tax credit, is the production of the diesel profitable?

Jeff Bigger

No, it's about break-even at that point.

Bob Weisman

And at what point at the cost per barrel of oil is the production of the Syntroleum product – what is the break-even point? In other words, how many dollars per barrel do we have to spend to make the product Syntroleum produces equal to the product that somebody else – that standard diesel is produced with fossil fuel?

Jeff Bigger

Ron, you want to answer that question?

Ron Stinebaugh

Yes. This is Ron Stinebaugh. It really depends on the feedstock price and the feedstock price moves around. So it's really hard to take a $1 per barrel of oil that's break-even, because those prices sometimes they move together, sometimes they don't move together, so – and it's a margin-based business. So usually the feedstock prices are moving sometimes up as the oil price is moving up. So we tend to look at the margin.

And to just to reiterate what Jeff said earlier, we are a fuels business that's based on alternative fuels like wind and solar and other alternative fuels businesses. We require some form of subsidy or a mandate in order for the economics to be attractive. We are a low-cost producer in a sense that our feedstocks that we are pursuing in this industry are the lowest cost, but compared to the price of oil, they are still more expensive.

Bob Weisman

So as – and the bottom line is as an individual investor –

Operator

Thank you. Our next question is from Dan Fawcett [ph], who is a private investor. Please proceed with your question.

Dan Fawcett

Yes, thank you. I understood that the government – there was a possibility of the government contract to use this fuel in government vehicles. Is that happening or when would they make that decision or when do you anticipate that that decision might be made or –?

Jeff Bigger

Dan, we have been in conversation with certainly the government about procuring our fuels and we have active conversation with them, but they are – we are not in a position to disclose where that stands at this moment.

Dan Fawcett

Okay.

Operator

(Operator Instructions). Our next question is from Frank Leonardo [ph], who is a private investor. Please proceed with your question.

Frank Leonardo

Hi, guys. Thanks for the conference call. I realize we are still working on Geismar, the first plant. I was wondering about any forward-looking plants, Geismar, maybe, number two and how would you procure capital for that?

Jeff Bigger

Frank, this is Jeff Bigger. Thanks for the question. We focused primarily at this point on getting Geismar up and running and stabilized. We continue to have our options for the second – let's say additional plants that we have been pursuing, but we put those on the back burner until we get Geismar up and running as our primary goal.

Frank Leonardo

Do you – if it came to pass – when you – when it comes to pass for your second plant, how would you consider getting capital for that?

Jeff Bigger

Ron, would you answer that please?

Ron Stinebaugh

Yes. Frank, the government has a couple of programs, the USDA and the DOE, for loan guarantees. We continue to monitor those programs. We are a – we will hopefully be a cash flowing business and that will hopefully open up financing alternatives for us as well. And as with any project, there always is an equity component and we would presumably raise that – need to raise some equity as well for a second plant. But it's really premature for us to discuss those opportunities in any greater detail.

Frank Leonardo

Can I ask one more question? You got over $1 million from the government on this phase change building situation. Can you just elaborate on that just a little more?

Jeff Bigger

Yes. Frank, this is Jeff Bigger. In the product that we make at Geismar, there is a number of compounds including a normal paraffin of about 17 or 18 carbon chain length and those materials – particularly, the 18 carbon material melts at about 78 degrees Fahrenheit, which is not a bad temperature for maintaining building temperature.

So we are working a program with Oak Ridge on how to capture those materials and convert them into commercial building products that could then be used to build the building envelopes and commercial and residential applications. So this is something Oak Ridge has studied a lot; it has a lot of commercial attractiveness to it. And so we are pursuing that program with them through funding from the DOE.

Operator

Thank you. Our next question is from Ervin Smith [ph], who is a private investor. Please proceed with your question.

Ervin Smith

Yes. Can you – am I available? Hello?

Operator

Yes, sir – (Multiple Speakers)

Jeff Bigger

Yes, you are on.

Ervin Smith

Sorry, guys. Just a quick follow-up or a quick question. I've got bad cell service. But just wondering, do you guys ever foresee this product being available to the consumer, either in a straight Dynamic Fuels form or a blend?

Jeff Bigger

Well, Ervin, this is Jeff Bigger. We will be selling the product to obligated parties, which tend to be refineries, who will then move it into the normal fuel distribution chain. We don't currently have any plans to have a Dynamic Fuels branded gas station. That's will (inaudible) be far, far in the future.

Ervin Smith

Okay. And just a quick – just one follow-up. Are you – do you plan on having an official plant's grand opening and will there be any public figures there, such as the Louisiana Governor or the chosen one, such as President Obama?

Jeff Bigger

Well, Ervin, thank you for your question. We most definitely will have a plant dedication ceremony at the right time. It will be sometime out in the next several months or possibly after the first of the year. And we most certainly will invite the appropriate political figures to that. Governor Jindal has been a great friend to our cause down there. We would love to have his participation, as well as others – political figures that would basically put the spotlight on our facility.

Ervin Smith

Thanks very much, guys.

Jeff Bigger

Thank you.

Operator

Our next question is from John Smith [ph], who is a private investor. Please proceed with your question.

John Smith

Yes, hi. My question dovetails in with an earlier question concerning the economics at Geismar without the $1 tax credit. Your break-even price, does that include the RIN or does it not include the RIN?

Jeff Bigger

Yes, John, this is Jeff Bigger. That does include the RIN.

John Smith

All right. Thank you.

Operator

Our next question is from Bill Bright [ph], who is a private investor. Please proceed with your question.

Bill Bright

Hi, thanks for all the information today. I appreciate the call. I have a question related to a comment that was made at the last conference call. You indicated that you were negotiating off-take agreements for about 50% of your product output at that time, and you expected to have those contracts inked by June time frame. Did that happen?

Jeff Bigger

Bill, this is Jeff Bigger. We did indeed sign contract on off-take, and that has been done, and it did happen back in the June time frame. So that's behind us.

Bill Bright

Okay. But you are keeping the customer quiet, right?

Jeff Bigger

Our customers have requested that the agreement and its terms be held confidential and we are keeping with their request on that.

Bill Bright

Okay. Thank you, Jeff.

Jeff Bigger

Thank you.

Operator

Our next question is from Lloyd Crumrine [ph] with – who is a private investor. Please proceed with your question.

Lloyd Crumrine

Good morning and thank you for the conference call today. I first heard about Syntroleum through testing with the Air Force for alternative fuels. From everything I hear today, that is not a direction that Syntroleum appears to go in because of the economics. Is that correct?

Jeff Bigger

Lloyd, this is Jeff Bigger. We have a great relationship with the Air Force and continue to work with them on the demonstration of synthetic and renewable fuels for flight operations. So we maintain that relationship. The fact is the economics are better for diesel today than they are for jet fuel. And at the moment, the Air Force doesn't really have a mechanism to pay, let's say, a premium above commodity prices for jet fuel. So, therefore, we are focusing on the premium markets, which are diesel.

Lloyd Crumrine

Okay. The Air Force's policy is to be completely biofuels by 2015. Has that changed any of the marketing or direction of construction for Syntroleum?

Jeff Bigger

Lloyd, we continue to work with the Air Force and if they get to where the pricing that they can offer for renewable versions of jet fuel are competitive with diesel fuel, then we will most certainly work with them to provide that fuel.

Lloyd Crumrine

Thank you.

Jeff Bigger

Okay.

Operator

There are no further questions at this time. I would like to turn the floor back over to Ms. Gallagher for any closing remarks.

Karen Gallagher

Thank you for joining us on today's conference call. In the spring, we have a site visit of our Geismar facility for interested investors. Please e-mail Ron Stinebaugh at rstinebaugh@Syntroleum.com if you are interested in visiting the completed facility. If you have any additional questions, please e-mail or call Mr. Stinebaugh at 918-764-3406. As always, we appreciate your interest in Syntroleum. Thank you.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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