VeraSun Energy Corporation Q3 2007 Earnings Call Transcript

Vera Sun Energy Corporation (VSE)

Q3 2007 Earnings Call

November 15, 2007, 10:00 a.m. ET

Executives

Donald Endres, Chairman - President and Chief Executive Officer

Danny Herron - Senior Vice President and Chief Financial Officer

Analysts

Arjun Murti – Goldman Sachs

Eitan Bernstein – FBR

Chris Shaw – UBS

Brett Hundley - BB&T Capital Markets

Pavel Molchanov - Raymond James & Associates

Patrick Forkin - Tejas Securities Group

Nancy - Lehman Brothers

Cornell – Citigroup

Ian Horowitz - Soleil Securities

Gary - Lehman Brothers

Eric Larson – Piper Jaffray

Paul Cheng - Lehman Brothers

Ron Oster - Broadpoint Capital

Mark Miller - William Blair & Co.

Stewart Brown - West EBF & Associates

Gina Matsuyama- Post Advisory Group

Presentation

Operator

I would now like to turn you over to your host for today. Mr. Danny Herron, Senior Vice President and Chief Financial Officer. Please proceed.

Danny Herron

Good morning, everyone. Welcome to the VeraSun Energy conference call for the 3^rd quarter of 2007. Don Endres, our Chairman, and Chief Executive Officer, will also join me in the call this morning. If you would like to follow along with today’s presentation, please visit www.verasun.com, go to the “Investor” page and click the webcast.link. Today’s call will consist of prepared remarks regarding our financial and operational performance through the 3^rd quarter ended September 30, 2007. At the end of the remarks, we will open up the lines for questions from analysts.

Look at slide 2 on forward looking statements. Before we get started, I would like to remind everyone that today’s call will contain “forward-looking statements”. Certain statements in this presentation, and other written or oral statements made by or on behalf of us, are "forward-looking statements" within the meaning of the federal securities laws. Any forward-looking statements are not guarantees of our future performance, and are subject to risks and uncertainties that could cause actual results, developments and business decisions to differ materially from those contemplated by our forward-looking statements, including those risks and uncertainties described in our SEC reports, copies of which are available on our website. These actual results may differ materially from the expectations contained in the forward-looking statements. I would encourage each of you to seek independent investment advice.

At this time, I would like to turn the call over to our Chairman and Chief Executive Officer, Don Endres.

Don Endres

Thank you, Danny, and good morning everyone. Welcome to VeraSun’s 3^rd quarter 2007 earnings call. As you can see from our financial information release yesterday, VeraSun had a solid 3^rd quarter in 2007, particularly considering the change in market conditions for ethanols. We continue to execute on our strategy to be a.large scale, low cost producer. We significantly grew both our production gallons and revenues while at the same time reducing our fixed cost per gallon. Most importantly, we had a profitable quarter with solid cash flow from operations.

On slide 3, you can see VeraSun completed the quarter with diluted earnings per share of $0.09, net income of $7.8 million compared to $32 million in Q3 of 2006. The company generated revenues of $221.9 million, up 49.7% compared to Q3 2006, and EBITDA of $22.4 million or 10.1% of revenues. Cash on hand at the end of the quarter was$320.2 million.

If you turn to slide 4, I would like to just highlight our solid operations performance. First and most important, we continue to maintain an exceptional safety record. We also continue to operate with zero federal reportable spills or releases. This quarter, I am also pleased to report that we successfully completed the integration of our ASA acquisitions and we have completed the start-up of the Albion, Nebraska facility as scheduled. Production numbers continue to be very strong with production of 99.4 million gallons, a 77.4% increase over Q3 2006. Our fleet production averaged a 103.2% of nameplate capacity. Ethanol sales increased to 95.1 million gallons, a 69.0% increase over Q3 2006.

Our branded VE85 business continues to grow with approximately 150 stations under contract, which is about an 82% increase in stations overQ3 2006.

I know that you have heard of this before, but we have a very simple business strategy, which is to be large-scale and low-cost. As you can see in slide 5, we have significantly grown the company and planned for additional growth. In the last 5 years, we have grown from 100 million to 890 million gallons of capacity. We have dedicated teams that continue to focus and execute on our business strategy.

I want to take a moment on slide 6 to update you on improving economics we expect from our corn oil business. When we made the decision to invest in corn oil extraction, we assumed corn oil to be around $0.30 per pound, which at the time we estimated could add another $0.10 of EBITDA per ethanol gallon sold. Crude corn oil has moved up in value to approximately $0.45 per pound, which we estimate now would provide about $0.15 of EBITDA per ethanol gallon. We continue to remain on track to begin operations of the extraction system at Aurora in 2004 of next year, and Fort Dodge and Charles City by the end of 2009.

I’ll stop here and Danny will now walk us through the financials in more details.

Danny Herron

Please go to slide 7. Let’s review VeraSun’s financial and operational performance for the quarter. We ended our 3^rd quarter with diluted earnings per share of $0.09. Revenues were $221.9 million, up 49.7% compared to Q3 of 2006. EBITDA of 22.4 million or 10.1% of revenues. Net income of $7.8 million or 3.5% of revenues compared to $32 million in Q3 of 2006. Cash on Hand was $320.2 million at the end of the quarter. Our ethanol sales increased to 95.1 million gallons, a 69% improvement over Q3 of 2006.

We also had strong operational performance during the quarter. Production was 99.4 million gallons, a 77.4% increase over Q3 2006. More importantly, our production averaged 103.2% of capacity.. As Don mentioned, we also continued our exceptional safety record. We had zero federal reportable spills or releases during the quarter.

If you go to slide 8, you can see that our revenue growth continues. In fact, revenue is $221.9 million with an increase of 49.7% over the 3^rd quarter of 2006.

Now I just want to take you to slide 9 and show you once again our capacity increases that are currently under construction. By the end of the 2^nd quarter or the quarter ending June 30^th, 2008, we are going to average 25% per quarter growth over these six quarters.

On slide 10, we will see our operating metrics for Q3 compared to Q3 of 2006. Ethanol gallons sold increased by 69.0% over 2006. to 95.1 million gallons. Ethanol prices declined by an average of $0.40 per gallon from the 2006 prices. Our average corn cost increased by $1.27 per bushel over prices in 2006. Natural gas did decrease by 19.8% to an average price of $6.17 per MMBTU.

Before I go to the next slide, I would like to give you our view of the 4^th quarter volume, ethanol prices, and corn prices. I will remind you that these are based on current expectations in the market place. First, let us cover ethanol shipments in Q4. As you know, our fifth plant at Albion, NE started production in October. Based on our five plants, we expect ethanol sold to be approximately 135 million gallons during the quarter. That is an increase of 40 million gallons quarter over quarter. For ethanol prices, we have sold most of our production for the quarter on a spot index basis and we currently expect our average selling price for the quarter to be in the range of $1.80 to $1.90 per gallon, based on current market conditions. For corn, you will see in our 10-Q that we are currently unhedged as we continue to expect a drop in corn prices. Based on market conditions, we expect the corn price for the quarter to be in the range of $3.50 to $3.60 per bushel. Once again, those are based on the market as we see it today.

Let us move to slide 11 and recap the financial performance for the quarter. Revenues increased by $73.6 million up to $221.9 million, a 49.7% improvement. Net income for the quarter, $7.8 million, was down from last year’s almost record quarter. EBITDA was $22.4 million or 10.1% of revenues, and fully diluted EPS was $0.09 per share. Now given the market conditions that existed during the 3^rd quarter, I believe we had a very solid quarter.

Now I turn the call back over to Don for some additional thoughts before we open the phone lines for your questions.

Don Endres

I would like to now spend some time on the current state of the ethanol market, and how we are seeing positive signs for improving ethanol prices. First on slide 12, let us take a look at ethanol prices since August 1. In August and September, we saw a decrease in ethanol prices over $0.60 per gallon. However, since the end of September, we have experienced a steady increases as ethanol prices have climbed, we believe, due to increased discretionary blending of ethanol. Now why is discretionary blending increasing? Economics, it is very pure and simple.

Let us look at slide 13. Slide 13 overlays the price of unleaded gasoline to the price of ethanol. The golden egg on the left shows that in early August, margins in blending ethanol were approximately $0.70 per gallon. The $0.70 is made up of the difference in the price of ethanol versus unleaded gasoline plus a $0.51 blender’s credit. The golden egg on the right shows that margins have continued to increase and are in the range of $1.10 per gallon. That represents a margin of over $46 per barrel just from blending ethanols.

So how much additional ethanol is being blended today? Slide 14 shows an increase in ethanol blending since August 1. These are annualized weekly blending numbers published by the DOE. Ethanol blending is running at an annualized rate of approximately 6.7 billion gallons at the beginning of August. Based on last week’s numbers, ethanol blending has increased to an annualized rate of approximately 7.4 billion gallons, an increase of over 700 million gallons annually over 4 months, in only 4 months. The bar on the right hand shows, according to the RFA, a current ethanol capacity is only about 7 billion gallons. Every gallon of ethanol produced is fairly finding its way into the fuel stream.

Let us turn to slide 15. It illustrates when economics are compelling as they are today, people will find ways to participate, such as by trans-loading ethanol from rail cars directly into trucks.

Let us take a look at the potential for additional blending over the next several quarters, based upon what we know to date. On slide 16 is a map of the Southeast US, which we estimate represents approximately 2.9 billion gallons of additional ethanol demand. As you may know, Tennessee, Kentucky and South Carolina have all recently changed their regulations to allow up to 10% ethanol blending. Georgia is expected to implement the same change in December, and we expect Florida to follow shortly thereafter. This potential of 2.9 billion gallons of demand should help to continue to firm the market.

On slide 17, I just wanted to show you how much runway is left for additional blending over the next 24 months. Based on the gasoline usage of approximately 147 billion gallons, we still have potential demand for over 7 billon gallons of additional blending.

Finally on slide 18, if you look down the road, it appears that demand opportunities are large and continue to grow. The EIA projects that by 2015, gasoline demand in the US will reach 163 billion gallons. At a 10% blend, that equates to 16.3 billion gallons of ethanol demand. In addition, the auto industry has stepped up and committed to producing additional flexible fuel vehicles. Based on the estimate that autos will double FFV production, potential demand could grow to 11 billion gallons by 2015. Therefore, the combined potential demand could be as much as 27.3 billion gallons by 2015.

I also want to make a comment regarding the international opportunity for ethanol. Last week, I spoke at the World Ethanol Conference in Amsterdam and met with a few groups developing their international ethanol blending plan. It was interesting to understand that some countries are looking for clean blend components to reduce their air emission and produce octane to extend their refining capacities.

If oil and gasoline values remain strong at this time, then it could create export opportunities for Brazil and potentially the US product. That concludes our formal comments. If you will now open up the lines, we would be happy to answer questions.

Question and Answer Session

Operator

Your first question comes from the line of Arjun Murti with Goldman Sachs. Please proceed.

Arjun Murti – Goldman Sachs

Thank you. Your 10-Q highlights the remaining capex for this year, I think $125 to $150 million. Can you comment on how much additional capex we should expect in ’08 to get to the 890 million gallon capacity number? Then I see you still have the bar out there for the billion for Reynolds. I was not quite sure of the status of whether you were moving forward with that plant or not. Thank you.

Danny Herron

Yes. In 2008, we will have to complete about three months’ worth of work on Welcome and Hartley; a couple of months of Bloomingburg; and then as you know, we are implementing oil extraction in Aurora in 2008 and in Charles City and Fort Dodge in 2009. We would estimate somewhere between 100 and 150 million for those projects in 2008 in addition to what we are going to spend in the fourth quarter of 2007. I would highlight, however, remember the construction cost for the Bloomingburg facility will come out of the debt facility that we had in place for the ASA plants when we acquired those. That would not be a reduction of our current cash balance of $320 million.

Arjun Murti – Goldman Sachs

That is great, and then there is typically some additional amount of maintenance type capex, $10 or $20 million on top of the $100 to $150?

Danny Herron

No, probably $10. It all depends on where margins are. As you know, plants are brand new, so our maintenance capital, while we give a number that is about $2.5 million for plants, with brand new plants covered under warranty. That is a discretionary number if you really think through it.

Arjun Murti – Goldman Sachs

That is great. One final question just on general market conditions. I give you guys credit. You had positive EBITDA in the quarter. It does not look like everybody else did. I would imagine, looking through the fourth quarter, many companies in the industry will have trouble having positive EBITDA. Can you just talk about what you are seeing in terms of, especially some of the smaller companies out there, their ability or desire to keep running with challenged EBITDA conditions? Actually, I am not so much talking about yourself as some of the other companies out there, whether that creates consolidation opportunities or how you think people are thinking about that right now?

Don Endres

Well, sure. There are a couple of dynamics. First of all, there is obviously net income and that you could see some of the small producers get that challenge upfront But if you look at the variable cost continue to run, these plants will continue to generate cash towards their fixed cost and interest and so. They clearly will keep operating. So we do not see a case where plants quit running. In fact, ethanol values have improved significantly and their economics are improving as well. I do not see that.

In terms of consolidation, I think it is more of a liquidity issue for some of their facilities. Many of them are private and they kind of trade these shares in a kind of an inefficient fashion; and so I think liquidity may be more of a driver for their desire to consolidate and an understanding that being with larger groups can be beneficial. but that, I am sure, will take time to pan out.

Arjun Murti - Goldman Sachs

That is great. Thank you very much for your thoughts. I appreciate it.

Operator

Your next question comes from the line of Eitan Bernstein with FBR. Please proceed.

Eitan Bernstein - FBR

Good morning, gentlemen. Congratulations on managing, just a tough environment, very well in my view. Question on the incremental demand, can you put some color on that? Obviously the Southeast is a huge opportunity budgets in terms of timing orders. What are you seeing currently going on? I am trying to get a sense of what the pace is going to be for increasing demand from the 7.5 billion gallon, or the level indicated on the slide, up to 8, 9 billion gallons?

Danny Herron

Interesting dynamic. Actually, we see the market relatively tighten in those yesterday, Chicago market straightened significantly. These gallons are bleeding contracts. Blend economics that are provided to all blenders throughout the country, so you see a lot of interesting activity. But honestly, we do have a few more quarters of additional blend capacities to enter the market. Again, it feels like the market whirled over the last six to eight months; blending infrastructures will be put in place and the market responds. It is hard to know how this ultimately works over time. It is probably not a straight line, it is probably a little choppy. But we see the markets responding, and at this pace, it continues pretty strong.

Eitan Bernstein - FBR

Okay. Great! Just a quick one for Danny, any thoughts or guidance regarding the 4^th quarter tax rate might be?

Danny Herron

You know, we adjusted our year-to-date tax rate to approximately 20%. I think it is 19.7% to be precise. We would expect that for the fourth quarter given the mix of tax deferred interest we have and our earnings outlook. So I would say up to 20% for the fourth quarter.

Eitan Bernstein - FBR

Excellent. Thank you very much.

Operator

Your next question comes from the line of Chris Shaw with UBS. Please proceed.

Chris Shaw – UBS

Seriously, what are your impressions in California now that they blend the ethanol in terms of incremental demand? Do you see their guys out there blend that immediately, given the economics? Or is it a slow ramp up? What are you seeing out there?

Don Endres

We see that some of them are able to move to a 7.7% blend and they are in the process of doing that. Our view would be again, based on economics, that there will be work underway to try to move to 10% sometime in 2008. It is hard to know exactly when this comes together because of the very large market that tends to move for the most part together. But again it feels like it is some time in 2008 when that market will develop to 10%.

Chris Shaw – UBS

I would think of all markets, they already have the infrastructure there, I mean I thought they would blend up to the maximum as quickly as possible, right?

Don Endres

That is right. They do have the CARB, California Resources Board, has not changed the predictive model to allow 10% blending. But they are wanting to reduce sulphur at the same time, since some of their hires are working on ways that they can reduce sulphur. They do have an ability to basically pay into a fund and actually take ethanol, the economics would show they should do that. The question is whether or not they will. But again, by 2010, they need to be running at 10%. We see it developing over time, and again, the economics are so great. Octane tends to be tight and we think that move is sooner rather than later.

Chris Shaw – UBS

The prices have been moving above the bottom. Is there any of that seasonality that you can interpret?

Don Endres

Actually, this tends to be a relatively slow time for demand so it is interesting that demand is picking up in light of all the new gallons coming on. So again, I think it is just the function of gasoline values have stayed high, therefore, blend economics are very high. Blenders are figuring out a way to get into the fuel stream. So sit tight.

Danny Herron

Let me just put that in perspective. For every semi-truck you see going down the road, it holds about 9000 gallons of gasoline. You would be making a little over $900 extra profit on every one of those trucks with today’s economics.

Chris Shaw – UBS

Right, right. Building off that statement. The slide you had about going directly from the train to the truck. What is going on there exactly? How are they blending them after that?

Don Endres

That truck would typically go to a terminal or a small tank farm. It will be then blended with gasoline to go to the stations. That is how it works. Some of the terminals that do not yet have their rail infrastructure in place to bring the tanker right up to the terminal, we see that happening over time. But again, this is a way for them to put ethanol in the market almost immediately, once they have a tank at the terminal that they can place their products into.

Chris Shaw – UBS

In what kind of geographical markets is that happening right now? Do you know?

Don Endres

I am sorry?

Chris Shaw – UBS

What sort of markets is that in now? In what geographies is that happening? [Voice Overlap]

Don Endres

Okay. In 2006, they actually started this sort of trans-loading in Texas. But we see it now taking place in Florida. We think it will take place in some areas of the Northeast as well. It varies. As you can see, this can really take place about anywhere. You can pull up a train on a side lane then there is a road to offer a truck.

Chris Shaw – UBS

Okay great, thanks.

Operator

Your next question comes from the line of Heather Jones with BB&T Capital Markets. Please proceed.

Brett Hundley - BB&T Capital Markets

This is actually Brett Hundley. I will be speaking on behalf of Heather this morning. First question is, you are all kind of aware of domestically, what markets are opening up for ethanol. Don, you alluded, at the end of your prepared remarks, of international opportunities for ethanol? Internationally, do you see kind of the work Brazil is doing in signing all these different accords? My question is, are we kind of limited in our ethanol exports due to rules that we have for certain, you know, barging certain chemicals? Can you talk about the opportunities that exist for putting some of these excess ethanol maybe out into the global market?

Don Endres

Yes, that is a good point. I think you are alluding to the fact that we denature our products periodically in our plants, and the export market tends to be an un-denatured market. We understand there is actually a product that has moved from the US, and that companies can gain a permit in order to ship an un-denatured product. And so if economics hold over time, that will very likely become a method to gain ethanol volume.

There are opportunities to back oil products into Europe. China looks interesting, India looks interesting. They are still relatively small in terms of what they are blending today. But again, the economics of octane, as well as the need of some of these countries to reduce their air emissions, I think will continue to drive potentially blending into those markets.

Now the question is, how much product does Brazil have to ship? We understand that Brazil is relatively tight with all the new flexible fuel vehicles that are being sold there. It looks like their demand for their product domestically will be strong.

Brett Hundley - BB&T Capital Markets

Okay great, thanks. Also your DDG pricing came in a little bit later than we had expected for the quarter. We are just wondering, have you locked in some of that via contracts? Or do the regions that you operate in have typically lower DDG pricing. The reason I ask is we have seen some of your competitors’ pricing around the 120 to 140 range. I was just wondering if you could speak about that a little bit?

Don Endres

Right, right. So there are two different issues there. One is you are looking back at a historical number that was probably priced sometime in the summer time. Corn values were lower as well. We do contract in advance a portion of our products. So there is a delay, they indirectly track corn. We are seeing soft values clearly at the levels that you have mentioned. It seems to maintain its rate.

Brett Hundley - BB&T Capital Markets

Okay thank you. Then there was a question alluded to earlier, obviously ethanol pricing has increased. We have seen a significant basis strengthening in northeast Iowa, Illinois, Nebraska, but mainly in northeast Iowa. I was wondering if you could give some reasoning behind this and where do you see this going?

Don Endres

Well you know, there is always a traditional tightening of basis from fall to winter. In fact all the way into spring, it seems to tighten. So there is a natural kind of process that takes place, you know, the additional storage in those belts. I think the perspective maybe was there would not be enough storage in those basis and would remain wider than lower.

But we see tightening up, we see the export sales remain somewhat strong. So that is another reason why the basis would tighten.

Brett Hundley - BB&T Capital Markets

Okay excellent, thank you. My last question, as far as interest expense goes, we understand that some of your finances are in these constructions in progress. What should we be using going forward to sort of model this?

Danny Herron

[Weak volume of audio] Our interest expense, obviously our cash interest is our bond debt and the coupon, as well as the 8.5 to 9% we have on the construction financing. However, we are required to capitalize interest for the projects that we have. Currently we have 3 plants under construction, so we will probably have a CIP balance close to $300 to $350 million or more. About half of our interest as it stands right now gets capitalized.

So that changes every quarter as we complete a plant and put it on as a fixed asset, then of course our CIP balance goes down. But I think that in the past, I have suggested somewhere between $30 thousand. 50% of our interest currently will probably be capitalized.

Brett Hundley - BB&T Capital Markets

Okay great. Thank you, that is all I have.

Operator

Your next question comes from the line of Pavel Molchanov with Raymond James. Please proceed.

Pavel Molchanov - Raymond James & Associates

Question on the co-ops space. Obviously that is about half the current production capacity in the industry. Since you guys are very in tune with the market overall, can you talk about any, either pricing delays or production shut ins or cancellations that you have seen among the co-ops?

Don Endres

It is a good question. We clearly see delays. It is very interesting actually, we have tracked this pretty close. 50% of the projects have been delayed at least by one quarter. Those are from projections just 6 months ago. So we see delays.

For those projects that are clearly under construction, we believe they get bailed, we understand they are moving forward. There are a few projects that have been announced, for some others, removed. But the fact that they have declared these under construction, but they are really not moving forward because they do not have, in most cases, their equity financing finalized. So they are really not moving forward. There is probably still a relatively small number in the under construction category.

Pavel Molchanov - Raymond James & Associates

Got it. Do you see, if current ethanol, let us say, depressed pricing environment continues for the next 6 to 12 months, do you think that there could actually be a significant amount of bankruptcies or exits from the market of capacity that is already in place?

Don Endres

I really do not. Again, our view is that corn has shown significant resistance as you get to $4 of that, we kind of think that is on the top side of things. It looks like gasoline values are going to stay stronger; for the blending, economics should be there and blending will continue. So I do not see a case where we are going to see a large shutdown of capacity. We just do not see it. These plants are currently running above their variable cost. They should keep running above variable cost and that stuff will change. I just think they will continue to operate. Many of the banks are actually, you know, real banks and so I do not think they will be too quick to move to try to stop the project.

Pavel Molchanov - Raymond James & Associates

Okay got it. Thanks very much.

Operator

Your next question comes from the line of Patrick Forkin with Tejas Securities. Please proceed.

Patrick Forkin - Tejas Securities Group

Congratulations on putting out really good operating metrics in a very challenging market. Don, it sounds like you guys feel like corn prices maybe have peaked here and you talked about it a little bit. But could you give us some more color on what your thoughts are on corn over the next 6 months or so? You mentioned some strong exports as well, I assume that’s because of the weak dollar. If you could give us some color on your thoughts there as well, I would appreciate it.

Don Endres

Sure. I would be happy to. First, it looks like the, market seems driven by a large open interest from fund speculators. It does not appear that commercials are driving the market right now. Clearly the export sales, it looks like some buyers are securing their products early based on net prices adjusted for the value of the dollar. That is part of the impact.

I believe that the market, I believe it continues to maintain the acres. But with the 1.8 billion bushel carry out, it looks like it could give up 6 to 7 million acres and still end up with a billion plus carry out at the end of next year.

The market seems to be waiting to see the number of bean acres planted in South America. The market is also considering the number of bean acres that will come from double cropping wheat and beans in the US.

The carry out number today is predicted to be about 1.9 billion bushels. It is interesting, last year’s carry out at this time was projected to be about 750 million bushels. The actual carry out in the November USDA report was 1.3 billion bushels. So they significantly underestimated the actual carry out.

Also keep in mind, as I have mentioned, these ethanol plant startups are delayed at least one quarter. That is going to have a significant impact on how many bushels of demand comes from ethanol. So you do the math on it; it really adds up that you are not grinding up for the quarter. And so it proves that there is plenty of products out there with a record yield of 13 plus billion bushel crop.

Also we talked about how the corn acre today has about $25 dollar advantage per acre compared to beans. So it still looks like the sentiments there will continue to maintain corn acres.

So again, we think that the market will work long term, and that we are going to see prices moderate.

Patrick Forkin - Tejas Securities Group

Okay, that is very helpful. Thank you. Don, with respect to, I would like to get your assessment on the energy bill, where you think it stands right now, what moving parts are important to you guys that we should be keeping an eye on?

Don Endres

Yes well, actually we have 5 different answers. But we are a bit more optimistic. There is a lot of activity taking place today on both sides. The House and senators are actively working on pushing forward the energy bill, maybe kind of an energy light version of the bill. With nearly $100 crude, there is call for action by policy makers. .It may be that it is kind of an energy light version where the controversial items may be removed, and leadership will get together and push forward a policy to continue to support good energy policy specifically on biofuels. So we are somewhat optimistic about it, but we are realistic as well. Things change. But it is possible, yes, that we could see an energy bill by the end of the year.

Patrick Forkin - Tejas Securities Group

Okay, very good. Thanks guys.

Operator

Your next question comes from the line of Nancy Steinel with Lehman Brothers. Please proceed.

Nancy - Lehman Brothers

That was a good quarter. It is Nancy from Lehman Brothers. I just have a question. Now that you are marketing your ethanol, could you give us a flavor of the market, like the new contracts you are signing? Are those more with majors or with independents? Who are the buyers in the market right now? Do you have any contract to sell ethanol for the 1^st quarter of 08’?

Don Endres

Yes, there are a couple of questions there. First of all, we do business with the largest blenders or the majors. But we have also seen a large amount of increased activity from some of the large independent marketers. They are clearly stepping out, wanting to, purchasing products and blending products. So we do you see that dynamic changing over time, especially as you get into these discretionary markets. In the Midwest for example, stations are largely independently held.

Danny Herron

I would just add for 2008, we currently have contracts for over a quarter of a billion gallons already on hand. Most of that is primarily all evidence that index prices, the dynamic that has changed in the marketplace, since there are very little fixed contracts, are being led at this point on a fixed price. Because as you saw on Don’s earlier slides, we are seeing an upside on pricing. We probably all have seen presentations that talk about octane value of ethanol being the north of $3 when you have a $75 crude. So now $95.00 crude will have a very advantageous opportunity for blenders. So I think most producers would be reluctant to lock in prices as we see this upward price pressure.

Nancy - Lehman Brothers

Do you anticipate in 2008 selling any amount of ethanol in the spot market? Or are you kind of just looking towards getting 100% contracted out?

Danny Herron

We always reserve some products for the spot market. We like to be able to service our customers. Our strategy has been large scale, and by having product in reserve, we can always take care of our customer demands when they run short of product from time to time. So we would see a certain percentage of our product being sold in the spot market, primarily though to our customers so that we maintain excellent customer service.

Nancy - Lehman Brothers

Great, and just a quick modeling question. The $1.7 million out of expense that we saw in the quarter, should we a similar one in the 4^th quarter, given Albion and Linden ?

Danny Herron

Yes, there will be additional start up expense in the 4^th quarter. As you know, you hire plant managers prior to start up of plants and you hire some of your people so that they get trained. I would suggest probably in the 4^th quarter, that number would probably be in the range of $600 to $800 thousand for the 4^th quarter

Operator

Your next question comes from the line of David Driscoll.

Cornell - Citigroup

This is Cornell actually calling on behalf of David Driscoll. I just have a few quick questions. The first was you guys have talked about strong amounts of discretionary blending that are currently taking place and the markets heightening. With more and more customers switching their infrastructure over to receiving and blending ethanol, is there a play, maybe over the next couple of quarters, where you would expect to see basically better pricing fundamentals for ethanol versus gasoline? In other words seeing the spread begin to narrow a bit?

Don Endres

[Weak volume of audio] Sure, that is absolutely possible. We would see that even though the spread has widened, it is somewhat tightening because gasoline has moved up so much. But we do see that that could happen. We actually see, the traditional buyers have been slow to come to market, because they have settled potential links in the market. But the new buyers have stepped in and purchased a fair amount of products. So I think that is why you see tightness. It is possible but the market is not perfect and so you could see some variability between now and once we bring on the traditional crops to it. We should keep in mind as you get through 2008 especially in the first three quarters, the amount of new capacities coming on, we need to slow down and we get to kind of a much slower growth scenario as we get into ‘09.

Cornell - Citigroup

Okay, great. Then on the DDG side, you have mentioned earlier that you have contracted a bit of that stuff forward. Typically how far ahead can you contract the DDG business out?

Don Endres

It tends to be six months at a time. That is what most feed buyers are looking at. But it varies though.

Cornell - Citigroup

Okay, so what I can deduct is that we continue to see prices hold in the current areas that they are at about $120 per ton. At some point, you should start to realize that.

Don Endres

Absolutely.

Cornell - Citigroup

Okay, then the last question would be, just any preliminary guidance on what you believe the current tax rate will be for 2008?

Danny Herron

I believe it will migrate back up, probably to the 35% range or so, based on what we know today.

Cornell - Citigroup

Okay, thanks a lot.

Operator

Your next question comes from line of Ian Horowitz with Soleil Securities. Please proceed.

Ian Horowitz - Soleil Securities

A lot of questions have been answered, but I just have a couple of questions. Arjun asked about capex and I think you mentioned that Bloomingburg will not be coming out of the cash balance. How much of the total ’08 capex are you allocating to Bloomingburg?

Danny Herron

I believe there is roughly in our credit facility at the end of the quarter, I believe there is a little over $50 million still left in that credit facility. That would have completed the Albion post-startup spending plus Bloomingburg.

Ian Horowitz - Soleil Securities

Okay. You were unhedged on your corn position as of the 10-Q. Are you still unhedged as of today?

Danny Herron

Oh yes. Our view is that the market has a waste to go on corn. We think that corn will drop in price in the future. As Don mentioned, we had a record harvest, I think the largest harvest ever on record. We have a 1.9 billion bushel carry-out that is publicized; and as Don mentioned, last year the publicized number was 700 million and the real number came in about 1.3. So when the real number is known in 6 months, we could well have an excess of a 2-billion bushel carry-out. So we think that corn will decline in price in the future.

Ian Horowitz - Soleil Securities

This is not really financially impactful, but I was wondering what the $600,000 in the bio-diesel breakdown [Voice Overlap]?

Danny Herron

If you recall about a year ago when we first announced corn oil extraction, we announced that we would extract the corn oil and build a bio-diesel plant. So we have done some preliminary design engineering for a bio-diesel plant. As you well know, the market has moved such that we get the same revenue stream without investing the capital on bio-diesel. So we chose to not go forward with bio-diesel plants, and as Don showed you, the returns on the oil extraction are tremendous. And we went ahead and wrote off the pre-engineering that had been done on the bio-diesel plant.

Ian Horowitz - Soleil Securities

Okay. One last question, I think. Besides your corn opportunity, is there any way that you can see to easily reduce the cost of goods sold? Transportation or taking out some of per gallon basis?

Danny Herron

Your biggest opportunity in cost of goods sold is that about 80% of that is variable cost. When you think about it, corn ranges from 50 to 60 % of cost of good sold depending on the price of corn.

Your second highest item is transportation. And we choose to have a high transportation cost because we access the coastal market to give us a better net back. On a net back basis, we feel we are a lot better off shipping unit trains for the coastal markets.

The other big one is natural gas. When you get past those three, you capture a little over 80% of your cost. So really, volume leverage only applies about 15% of your volume So if we continue to run really well in our plants and push that envelope, you will see our cost come down slightly. Also as our volume grows, as I mentioned, we are going to be up 40 million gallons in the 4^th quarter versus the 3^rd,, our G&A costs will remain constant in that $9 to $10 million per quarter, and now we are going to leverage it by another 40 million gallons. If you figure G&A was somewhere in the $0.09 to $0.10 per gallon range in quarter 3, in quarter 4 it will be down in the $0.075 to $0.08 per gallon range But we still have upside as we grow raw our company.

Ian Horowitz - Soleil Securities

[Some fadeouts in audio] Right, I guess I am just trying to do some equity and calculations. There is about $0.26 .a gallon on transportation. We have been hearing increasing freight rates for both corn driven to the coast or ethanol I suppose. I am just wondering if that market is actually $26. that amount, is that a real season kind of range to be using on a per gallon basis, or should we be [Voice Overlap]?

Danny Herron

Yes. One thing I have just mentioned, in the future, is our new plants coming on line. I will use as example our Linden, Indiana plant. That plant is shipping a lot of products into the local truck market. So its distribution cost is significantly lower than when we ship unit trains. The net back is reasonable. So you will see a blending downward of our transportation rate in the future.

Another point to mention is that $0.25 includes distillers’ rates. We do some unit train shipments to Mexico and other places that give us good net backs. Also our Albion Nebraska plant will also sell a lot of products in the local markets a year, surrounded by significant feed yards for beef cattle and a lot of their modified wet distillers would be sold locally. So you will see a blending of that transportation rate coming down in the future, I believe.

Ian Horowitz, Soleil Securities Corp.

Okay, excellent.

Don Endres

Just one comment. We heard that transportation comment as well in the-- if you look on a single car manifest rate, there is probably slightly ethanol increase versus corn. But if you look at it on a unit train basis, the ethanol rate has stayed consistent with the corn unit train rates. So there has been about a $200 increase this year; $2 for corn unit rates as well as ethanol unit train rates. It just depends upon how you are set up. If you cannot ship unit trains, then that would be a fair comment.

Ian Horowitz - Soleil Securities Corp.

Okay. I think, given on East bound, that is still the same and both the rates are going up fairly well on a unit train basis?

Don Endres

Right, compared to shipping corn, that is correct. Now you realize to your shipping, there is a lot more volume when you ship corn. You know, if you were shipping a third of the volume with ethanol, that should be corn, and have the same car rate increase.

Ian Horowitz - Soleil Securities Corp.

One last question. What are you going to be looking at? There is a bunch of different variables. But what is going to make you come back to turning Reynolds back on over the next 6 to 9 months?

Don Endres

We simply want to see a sustained margin environment. Our view would be as we get into the spring and summer time frame, we will get a much better forward view on the market, but good, a sustained view that margins will be there.

Ian Horowitz - Soleil Securities Corp.

Okay, thanks guys.

Operator

Your next question comes from the line of Gary Stromder with Lehman Brothers. Please proceed.

Gary - Lehman Brothers

A couple of questions. Corn oil extraction, can you just remind me what the capital costs are there? I seem to recall at $0.25 plus or minus per gallon, is that still fair?

Danny Herron

It is around $30 million per installation. Our first one will be probably $35 as you do the initial engineering work. Then the others still have to repeat that engineering work. So for 3 facilities, we earmarked $100 million.

Gary - Lehman Brothers

Okay. So that is pretty good, pretty good return. If you are getting $0.15 per gallon, I think a 2-year payback current margin for that, right?

Danny Herron

Yes that is correct.

Gary - Lehman Brothers

Okay. Secondly, you talked in the past about building terminals and maybe extending some real estate opportunities? Is that in the $100 to $150 million capex guidance for 2008?

Danny Herron

A small piece of it would be, we have earmarked some funds for terminal infrastructure, and we are getting close to pulling the trigger on some of those. It is not significant capital, but it is included in that range I gave.

Don Endres

What is interesting is that capital being invested is on its own as well. We thought we would have larger amount of capital going on the terminal side. But it appears that infrastructure will be put in place.

Gary - Lehman Brothers

A final question, back to Danny. Working capital is a pretty good source of cash in the 3^rd quarter. Looks like accrued expense eats a lot of that. Can you just give us an outlook for the 4^th quarter that sees some of that turn around and then in 2008 as you put the three facilities on line? I assume. I believe you need to invest in some working capital.

Danny Herron

Yes, some of that will turn around. Part of that is part of our acquisitions of ASA. There were some accrued expenses for basically a retainage in our contracts with our design builder that are in that accrued numbers, and they will be paid out as the plants come up and pass substantial completion hurdles that have to be met. So that will be a little bit of a reversal in the 4^th quarter.

As far as the build-up in 2008, for our plant in Bloomingburg, it will have very little working capital needs just because of the nature of how those contracts work, and that’s the same thing for Albion and Linden. We will see some working capital build-up for Welcome and Hartley that will probably be in the range of $15-20 million in total. That will be shown in spare parts, it will be shown in corn inventory, and receivables will run about ten days. Expect those plants on a daily basis produce over 300 thousand gallons;. 10 days is 3 million gallons per plant. So that is 6 million gallons of receivables, just at those two facilities in Welcome and Hartley. So you can see a $15-20 million increase in working capital on the way.

Gary - Lehman Brothers

I know I said that that was my last question, but I do have one more. You mentioned the ASA credit facility converting to a term loan from a construction facility. What affects that change? Is there any risk to that not happening and that construction facility coming due early next year?

Danny Herron

The condition is completing the construction of those plants. I think that the end date is a March 15 completion date of construction at Bloomingburg. At this point, we don’t see any risk to that. Obviously, I guess there is always a potential for a tornado or something to go through. But you know, we don’t see that happening, so effectively, fairly little risk at this point.

Operator

Your next question comes from the line of Eric Larson with Piper Jaffray. Please proceed.

Eric Larson – Piper Jaffray

I want to go back to something you alluded to a little bit earlier. I was a little surprised that you may not have gotten as much ethanol-pricing translation in the quarter as what you reported. Several of your competitors actually had higher pricing, and I know that you have a much higher exposure to the higher value coastal markets. My question is, did you have some , are you cycling through some adverse contracts, maybe on the coast, that you had to get through in the quarter? Or was the market difficult enough , which we know it was difficult , where the premium actually went out of the coastal markets so that you were not able to capture the premium that you normally do capture?

Danny Herron

You know, Eric, that is a good question. I think the majority of it is just the timing of when the contract is put on place. We did not start marketing our ethanol, as you know, until April of this year. A year ago, you could have put contracts in place that were above plus $0.35 a gallon. We were not marketing our product for ourselves at those times, so I believe some of that higher pricing that you saw would have been the result of that. There is also, some of the pricing reflects heavy truck shipments and it is a deliberate price that gets mentioned. So when you have heavy truck shipments and larger freight rates, that will show up in your pricing also. What is most important to look at, and obviously do these for our public competitors, is take the gross price minus the transportation, look at the net back. And our net backs perform very well when you compare against them.

Eric Larson – Piper Jaffray

Okay, the transportation cost in the quarter, we have always sort of used $0.23. But if I just kind of back through some numbers, it looks like it was about $0.26 in this quarter. Is that correct? Is that the right number or no?

Danny Herron

You are using the total transportation cost which would also include distillers. One thing that did occur in the quarter is that we probably got more distillers sold out of Linden than we did on a percentage basis, than we did ethanol for the quarter, just because of the nature of how the plant came up here in the start-up.

Eric Larson – Piper Jaffray

Okay. Have you ever disclosed what cost per gallon distillers’ transportation would be in that number?

Danny Herron

We generally look at our transportation for ethanol to be in the $0.17 to $0.18 per gallon range, and distillers is somewhere between $0.05 to $0.08, depending on the mix of products and where it is going to that quarter. As we mentioned in the past, we export some products to Mexico via unit train. While it has a very high transportation cost, it also has a very good net back.

Eric Larson – Piper Jaffray

Okay. Thank you. I appreciate it.

Operator

Your next question comes from the line of Paul Cheng with Verasun. Please proceed.

Paul Cheng - Lehman Brothers

I did not realize I joined the family.

Don Endres and Danny Herron

Well, welcome aboard, Paul! [Laughter]

Paul Cheng - Lehman Brothers

But anyway, that would be great. In California, have you guys been able to sign any actual contract of high ethanol shipment with California refiners?

Don Endres

Yes, Paul. We do not release, you know, the specifics of what we are selling to each customer, but the market remains strong. There are really customers in the California market that are looking to increase funding.

Paul Cheng - Lehman Brothers

No, I am not looking for a specific name, just curious that have you been able to sign any largely incremental contracts with anyone in California? What I mean, how quickly should we assume that, I mean if they are going to blend more, I mean they have to start mining up supply, I presume?

Don Endres

No, actually the East Coast markets have been really more aggressive than California to date. But realize, too, that a number of these new facilities are located on the D & S, FL, UP railroads and so they are satisfying that market. So we have the ability to go either direction at most of our plants, and it sure looks like the East Coast demand has been more aggressive.

Paul Cheng - Lehman Brothers

Okay. On a strategic standpoint, once that we get through the middle of next year, you get your $890 million gallon, you have I think 9 plants that is up, no, 6 plants that is up and running. On a further expansion of capacity, should we look at the focus that is going to be at that point shift to debottleneck? Or that will be new plant or acquisition? I mean how you pilotize those three?

Don Endres

Sure. De-bottlenecking falls always front and center. So we continue to do that both to run it in the best of best within our fleets, but also to take the bar to a higher level. Those are our lowest cost gallons. And as our team continues to take those steps, then it, of course, is just a process of allocating capital, so we are going to do that wisely. Corn oil extraction is a very good return in investment and there would be a park station there, as well.

Paul Cheng - Lehman Brothers

When you bought the ASAlliance, I think the price you paid is a little bit higher than the then-construction clauses, $1, $2, and you pay about $2.20. The argument is that you are going to get the cash flow upfront. Wondering that, over the last several months, have you been looking out in any pretense, saw M&A opportunity, is there any change in your view of how you are looking at the market today?

Don Endres

No, we just continue to look at buy versus build, and it is not a complicated process. That is really what it is. We are pooling capital, and we will try to do that as efficiently as we can.

Paul Cheng - Lehman Brothers

Then maybe let me ask you then in another way. Do you believe that the future M&A activities are at the purchase point and may actually be above their development cost? Or do you think that because of some mom and pop shops see the potential value to be part of a larger enterprise, that they will be willing more than you think is being forced to them, that the transition cost is going to be lower than the development cost?

Don Endres

Gosh, that is a hard, there is a lot of, depending upon the groups, that could vary a lot. But I think that they are all run by smart business people that are going to do the right thing for their shareholders and there will be lots of dynamics. But I think if you look at some of these stand-alone, single plants, they could be more motivated again by net back and liquidity than cost per gallon.

Paul Cheng - Lehman Brothers

Just one final question. Don, if we assume that on January 1, the rest of Southeast is all legislation wise that opened up, how quickly do you think the infrastructure that we need to build out to be sufficient, so we can get the entire region being supplied?

Don Endres

I am sorry. I did not hear the first part of it.

Paul Cheng - Lehman Brothers

If you assume by January 1, that all the rest of Southeast order legislation condition is being matched that we can now plan for ethanol. How quickly, or based on your understanding of infrastructure data, how quickly do you think that we would be able to move into an ethanol on that market?

Don Endres

It is a very good question. In fact, we see a great amount of work going on today to put infrastructure in place. So we think it would come quite quickly after regulation change will be made.

Paul Cheng - Lehman Brothers

So, you think six months, a year, two years, any idea?

Don Endres

No, we are anticipating that that product is available. We think it could go early the next year.

Danny Herron

Paul, it is to our understanding that there are two ethanol terminals ready to receive ethanol in Port Everglade. There is one in Tampa. There is a receiving location in Jacksonville, Florida. There is one in Bainbridge, Georgia to service the Talahassee market and there is one in Pensacola. So the refiners have been putting up the infrastructure in place. Remember the Florida market was anticipated really to open up mid 2007 and because of this legislative issue, it has been challenged a little bit. But people went ahead and put in their infrastructure. So we should very quickly see Florida taking substantial amounts of ethanol.

Don Endres

Reported today as taking products, there are some independents that are now blending products, the same with Georgia and Atlanta. We actually have products that are sold into that market.

Paul Cheng - Lehman Brothers

So you guys do not foresee the infrastructure hurt, or would it be hurt if there were a foreign ramp up in the ethanol sales in that part of the region?

Danny Herron

No.

Paul Cheng - Lehman Brothers

Very good, thank you.

Operator

Your next question comes from the line of Ron Oster with Broadpoint Capital. Please proceed.

Ron Oster - Broadpoint Capital

Good morning guys. I have a few that I don’t think have been asked. But first on some of the operating metrics. If I back into your conversion yields, your gallons per bushel, it seems to have averaged over the last four quarters or so at around 2.7 gallons per bushel, below that 2.8 benchmark. Is there any noise in that number? Is that kind of what we should be modeling going forward. Can you just comment on that?

Don Endres

Well, the yield for the 3^rd quarter is right at about 2.8. You are right, there is some noise in that the denatured levels have been reduced because the cause of denature is higher than the price of ethanol. So I think you will see that with other producers as well. That was then in the mid-quarter. But going forward, we should expect the denatured levels, if prices stay where they are today, to be in that 2% to 2.5% area.

Danny Herron

Ron, the other thing, just a note on yield, we did run 103.2% of capacity in the quarter. We have had quarters where it is 105% It is a fine line between running more gallons, when there is good margin in this business, and maximizing yield. And, if you do the math, it generally applies to get more gallons out and focus on the last 2 or 3% of the yield point.

Ron Oster - Broadpoint Capital

Okay. Then on some of the other per gallon costs, the transportation has been touched on. But Danny, I am more surprised you mentioned that you expected a trend down with most of the new demand centers coming from the Southeast and the California markets. What is kind of going to drive that downward trend there?

Danny Herron

Well, what I was referring to is the geographic mix of where our plants were going to be located. As you know, we have a diversity coming on line here; with Linden, Indiana, which is primarily a truck market, serving Indianapolis and Chicago. Then you have Albion, Nebraska which will get a reduced rate on distillers’ rate because most of that product will be truck products. It is a modified distiller into the local feed yards. So it is really a mixed issue of where our plants are that will drive the costs down. I did not mean to imply that we will see transportation rates per mile go down, because I do not think we will see that. But I think the geographic mix of our plants where they will serve the market will allow us to see reduced freight cost.

Just for instance, Bloomingburg, Ohio is a lot closer to the Northeast than Aurora, South Dakota or Fort Dodge, Iowa. So it is significantly less in distance so we will see rate reductions.

Ron Oster - Broadpoint Capital

Okay thanks, that is helpful. And then if you back into the labor manufacturing overhead cost per gallon, should we expect that to trend down over the next several quarters? I assume there may have been some one-off related items to the merger?

Danny Herron

You will certainly see it trend down as plants come online. Obviously you quit charging the start up costs when you saw the plants up. But when they start up, they are running at 50%, then 75%, then 100%. We have made sure we have adequate staff in our plants to maximize the gallons coming out. As you develop your plate infrastructure and your training programs and all over time, you will probably be able to scale that up without a loss in the gallons per plant.

Ron Oster - Broadpoint Capital

Okay. Last one on the slide regarding the improved corn oil economics. I was just wondering if the new, the $0.15 per gallon you cited, does that assume a higher corn cost? Or is it more driven by operating efficiencies?

Danny Herron

It is really just the market dynamics of what corn oil is selling for today. Because you are cost is really just your distillers, in that you are losing about 8% of your volume out.

Ron Oster - Broadpoint Capital

Okay. Is the corn oil correlated to the corn plays? The per bushel corn plays?

Don Endres

No it tends not to be correlated. It tends to be driven by demand.

Ron Oster - Broadpoint Capital

Okay great, thanks very much for your time.

Operator

Your next question comes from the line of Mark Miller with William Blair. Please proceed.

Mark Miller - William Blair & Co.

Hi good morning. I wanted to understand your perspective on what you think we should look at as being the key leading indicators for this ethanol versus gasoline price spread. The information you have, the trends you show in discretionary blending are encouraging. But that seems to have been concurrent with actually a widening in that spread. Is that the key driver to the spread narrowing? Or how important do you think the level of purchases via contract relative to the spot market driving that? What do those discussions look like?

Don Endres

It appears, quite honestly that the blend economics for ethanol are actually much wider than if you look at the refiners economics. It is so, I had a great slide that showed ethanol blend value as an active component that is at $3.25 a gallon. So it is a pretty significant value.

Whether it is $0.70 or $1, the economics are so great. We think it is a kind of maximum blending, and all gallons are being blended. No gallons are sitting out there. So that will be my view. I do not believe that it is really going to be driven necessarily by how companies deserve a contract. It could very well be that the market starts to look at the forward curve on ethanol productions, sees it flattening out, they could want to go more on a contract basis.

Mark Miller - William Blair & Co.

But I mean, the question was asked earlier, but to follow up on it. With the wave of supply coming on, do you think that is going to be tough for that spread to narrow in advance of that, or do you think that could occur as people anticipate coming on later in the year?

Don Endres

I think the market already has a pretty clear view. In fact, just the physical availability of the product is now strengthening prices. But it is pretty transparent when these plants come on. So I think that is the driver of prices and so therefore, we do not have a view that we are going to get back to $50 over at the gas lane, which is where the market ends historically. So we clearly see it getting back to a more of a value closer to gasoline than what it is today.

Mark Miller - William Blair & Co.

I also want to ask about the corn cost in the quarter. I might have missed it, but can you describe what your hedging activities were and the impact on the reported corn cost? Because I guess I think of VeraSun as typically having a more favorable basis on corn relative to CBOT and what I have seen in the quarter. So is that a fair observation, and what are the factors that impacted in the quarter?

Don Endres

We do have a favorable basis relative to CBOT. So I am not sure how you are looking at the basis. Keep in mind when we book our physical bushels, we also put a hedge against those bushels. So you see a benefit back on our hedging. So that ultimately reduced our effective corn costs.

But basis is a strange thing. It depends upon when the bushels are booked. So we had some corn ground in the 3^rd quarter that is actually sold over a year ago at favorable pricing. A lot of bushels obviously, they were purchased in a very, in the current quarter. We see producers out now booking bushels forward as well. So the basis, you just cannot look at the basis and say, today‘s bid basis is what you will see in the quarter. Because it depends upon on when those bushels were actually contracted. I think that is where the noise is coming from.

Mark Miller - William Blair & Co.

Can you say what the net impact was of hedging in the quarter?

Danny Herron

In our 10-Q, it is a little over $13 million. So Don’s point, what that is, when we buy corn in the future for delivery 12 months from now, we sell it short on the board. That is an offset to our corn cost, so that shows up as a derivative gain.

Mark Miller - William Blair & Co.

Okay, thanks.

Operator

Your next question comes from the line of Stewart Brown, West EBF & Associates

Stewart Brown, West EBF & Associates

Just two quick questions regarding costs. The first is , you gave some guidance as to your 4^th quarter corn cost. What is your assumption with respect to c bond during that period?

Danny Herron

It is based on what the current market is, as we look here today. So if the market stayed where it is today, that number would be right in this week’s spot where we would end up in the market Obviously, since we are unhedged, if the market runs up or down, you will see a move to that.

Stewart Brown, West EBF & Associates

Okay, so that is relative to today’s spot [Voice Overlap] price.

Danny Herron

Yes.

Stewart Brown, West EBF & Associates

Your cost of goods sold, your break out of your corn expense, your natural gas, your transportation, and your labor and your manufacturing overhead, and then some of those is less than the total cost of goods sold, even excluding depreciation and the various impairments. There is about a $16 million difference. Can you describe what is in that number?

Danny Herron

Well, there are several things in there. In our E85 volume of gasoline that we buy would be called out separately. So when we make E85, we are buying 15% gasoline and then we charge the 85% of ethanol that is used there. Probably the other one that is in the numbers but is hard to get to is other inputs, which is primarily the denaturant that we use to denature the 200 proof alcohol. And then in the quarter, we probably were somewhere north of 3% on an average blend rate. Denaturing is, generally, we use a natural gasoline, so it generally runs $0.15 to $0.20 per gallon under the cost of unleaded gasoline. So that is the other big part.

Stewart Brown, West EBF & Associates

Okay, so they are largely variable. Thank you.

Operator

Your final question comes from the line of Ron Oster with Broadpoint Capital, Inc. Please proceed.

Ron Oster - Broadpoint Capital, Inc.

I would just like to follow up very quickly on the conversion yield. As I back into your bushels processed using your total corn cost and using your per-bushel price, and divide that by the ethanol production, I am coming up with a conversion yield closer to 2.7 gallons per bushel. Am I missing something in that calculation?

Danny Herron

Ron, I have to do the math. If you want to can call me off line, we can go through that. I do not know for sure that you are missing anything but there are factors in there on the denaturant rate that will affect your yield number, because you are dividing bushels by the final gallons that you produce, but yet the corn you use is really to produce 200 proof ethanol. So you are blending at a 5% rate, you only have 95% of the product that is true 200-proof ethanol. If you are blending at a 2% rate, you have got 98%, so it is going to take more corn to do that. But you are going to divide by the same number. So if you don’t mind, if we take it off line, I will get the right answer for you.

Ron Oster - Broadpoint Capital, Inc.

Sounds good.

Operator

The next question comes from the line of Gina Matsuyama with Post Advisory Group. Please proceed.

Gina Matsuyama- Post Advisory Group

I have a quick question regarding the construction loans. If they turn out, will there be maintenance covenants on them, like leverage or interest covenants?

Danny Herron

Always, there are some covenants on that, and of course there are public documents so you can see what those are. But it is only to those three plants, not to the rest of the plants in the company.

Gina Matsuyama- Post Advisory Group

Okay, could you tell me what the covenants are?

Danny Herron

If you want to call me off line, I will fill up the contracts and look at them. I just do not recall them just like that.

Gina Matsuyama - Post Advisory Group

Okay alright.

Danny Herron

Operator, I think now we can probably turn over the call to Don for his closing comments.

Operator

Please proceed, Sir.

Don Endres

As you heard, we remain excited regarding the future of the industry. The VeraSun team has confidence in our strategy and in our ability to execute on the opportunity, and we appreciate your participation in the call today. We look forward to your call next quarter. Have a great day.

Operator

Thank you for your participation. This concludes today’s conference. We do appreciate your participation. You may now disconnect. Have a good day.

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