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Executives

Karen Power - SVP & Principal Financial Officer

Gary Roth - President & CEO

Analysts

Shawn Severson - JMP Securities

Raphael Fong - JMP Securities

Jack Broadhurst - Broadhurst Investments

Syntroleum Corporation (SYNM) Q2 2012 Earnings Call August 10, 2012 11:00 AM ET

Operator

Good morning and welcome to the Syntroleum Corporation second quarter 2012 earnings 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 now 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 morning 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, who will report the financial results for the quarter ended June 30, 2012 followed by Syntroleum’s President and Chief Executive Officer, Gary Roth.

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 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 six months ended June 30, 2012, the company reported operating income of $8 million resulting from total revenues of $12.1 million and operating expenses of $4.1 million. Operating income include recognition of $6 million of unearned revenue due to the expiration of GTL license executed in 1997.

Net income for the six months ended June 30th, was $5 million which included a $2.9 million loss related to Dynamic Fuels operations for their six months ended March 31, 2012. As a result of this settlement on June 27, 2012 Syntroleum recognized $3.7 million in deferred revenue and a corresponding deferred expense of $1.45 million.

We report Dynamic Fuels using the equity method of accounting. Income or losses under this method are reported below operating income as income or loss in equity of Dynamic Fuels. As reported in our 10-Q for the six months ended March 31, 2012, Dynamic Fuels had revenues of $100.3 million, operating and general and administrative expenses of $102.1 million and other expense of $1.1 million resulting in a net loss of $2.9 million of which we report 50% in our financials.

During this time period, 19.9 million gallons of renewable fuels were sold and 20.1 million gallons were produced. As of June 30, 2012 Syntroleum’s cash balance was $18.3 million.

Now I’ll turn the call over to Gary Roth.

Gary Roth

Thank you, Karen. Dynamic Fuels produced 4.6 million gallons of renewable fuels during the month of July or 74% of capacity which is the highest production month in 2012 and the third highest since the Geismar plant began commercial operation in October 2010. Together with the 4 million gallons produced during June, this represents the second time that Dynamic Fuels plant has produced 4 million or greater in consecutive months.

The Geismar plant continues to experience improved reliability with hydrogen compressor and solvent recycle pump which were available at 90% and 84% respectively during the quarter ended June 30, 2012 and were available 100% and 92% during July 2012. This compares to 97% hydrogen compressor and 77% solvent recycle pump availability for the three months ended March 31st.

Downtime in June and July were related primarily to a hydrogen outage as well as for heat exchange repairs. The first unit of our feed pre-treatment system upgrading wasn’t started and has been operating as expected delivery of the second and third units have been delayed one month until October with installation and commissioning to begin in November.

For the three months ended June 30, 2012, Dynamic Fuels had an operating loss of $1 per gallon and operating cash loss of $0.72 per gallon on a produced 6.3 million gallons and sold 4.7 million gallons. This compares to three months ended March 31, 2012, where Dynamic Fuels had a net operating loss of $0.02 a gallon and a positive operating cash margin of $0.11 per gallon.

Dynamic Fuels’ financial performance for the quarter ended June 30 reflects down time of approximately 55 days due to our plan turnaround in April and the unplanned hydrogen containment in May.

Production averaged approximately 85% of design capacity during the operating days in the quarter ended June 30. For the quarter ended June 2012, diesel product delivery costs of discounts averaged $0.09 per gallon versus $0.14 per gallon in the first quarter of 2012. Net back diesel prices $4.89 compared to OPIS Gulf Coast SME of $4.45 and OPIS full RIN value of $4.98 during the quarter.

We defined full RIN value as US Gulf Coast ULSD price plus 1.7 times RIN price. Fleet sales were 75% and 26% of the quarter ended June 30 and March 31 respectively. Average blended revenue per gallon in the quarter ended June 30, 2012 was $5.13 a gallon compared to $5.23 a gallon in the quarter ended March 31, 2012.

Excluding military and jet fuel sales the blended revenue per gallon was $3.78 for the quarter ended June 30 versus $4.81 for the quarter ended March 31, 2012. Of the difference, 42% was due to lower diesel sales product mix as a result of the extended time line during the quarter and 58% was due to price variance.

Our weighted average feedstock cost for the three months ended June 30 and March 31 was $0.51 a pound. For the three months ended June 2012, approximately 92% of the feedstock secured was for third-party suppliers compared to 82% for the quarter ended March 2012.

For the EPA, for the first half of 2012, approximately 60% of the 1 billion gallons 2012 RFS2 biomass based diesel mandate has been produced. However, obligated parties can carryover 20% of the current year annual requirements from prior year.

EPA data indicated approximately a 170 million gallons of 2011 production can be carried over in to 2012.

Taking the carry over volumes into account, approximately 75% of the 2012 mandate was fulfilled through the first six months of 2012. Given that EPA approves the 1.2 billion gallon mandate for 2013, a maximum of 20% or 256 million gallons can be carried over from 2012 to 2013. Therefore, the expected range of second half 2012 production is somewhere between 245 million and 500 million gallons.

Let's look at the margin implications to the industry. RIN prices averaged $1.43 for the first five months of 2012, have fallen to an average of $1.15 since May and are about a $1.04 now.

During the same time frame, Gulf Coast petroleum diesel prices average 313 and 286 respectively.

Gulf Coast Index crude (medium-sour)[ph] for the first five months of 2012 averaged $0.55 a pound and averaged $0.53 a pound since May. The yellow grease and corn oil feedstock index price, both averaged $0.41 per pound for the first five months of 2012 and since May have averaged approximately $0.38 a pound.

Taken together industry margins have compressed anywhere from $0.45 to $0.55 a gallon. In this lower margin environment, Dynamic Fuels continues to work to improve plant reliability and is also working to reduce operating expense. In addition, EPA approval of D5 RINs for renewable naptha sit at approximately $0.70 to the value of each gallon of naptha which equates to approximately $0.10 per gallon of incremental blended margin. The Senate Finance Committee has approved reinstatement of the dollar per gallon for the 2013 retroactive to January 1, 2012 as part of the Family and Business Tax Cut Certainty Act of 2012. It must still pass the full Senate and House and be signed by the President to become law.

Thank you for attendance, we will now open the call up for questions.

Question-and-Answer Session

Operator

Thank you. We will begin the question-and-answer session. (Operator Instructions) The first question comes from Shawn Severson of JMP Securities.

Shawn Severson - JMP Securities

Gary, I was wondering what do you think will happen to the RIN market assuming we do get the EPA mandate for $1.28, do you think that we see a fairly rapid snap back in RIN prices in the second half or I guess late this year when that takes place?

Gary Roth

Yeah, that would be our expectation is we would have a normalization back where RIN values were in the earlier part of the year.

Shawn Severson - JMP Securities

So kind of that $40-ish range you know once we got the $1.28 billion mandate from the EPA?

Gary Roth

That would be our expectation.

Shawn Severson - JMP Securities

Okay. And in the quarter what was your actual feedstock blend in terms of, I don’t know, yellow grease and others?

Gary Roth

The majority was yellow grease and corn oil. We had a lot of carryover, that's why we didn't see a pricing movement. Because our logistics trains cleaned up in the second quarter but it was primarily yellow grease and corn oil and there was beef tallow.

Shawn Severson - JMP Securities

And I was wondering could you just detail and maybe talk a little bit about the some of the efforts that you are taking at this point to streamline and get the higher up times. I mean I know we were talking about the feedstock issues before, but what are you doing I guess today and what should we look for over the next couple of months as you work through the plant at this point?

Gary Roth

We have one exchanger left to change out metallurgy, all the other exchangers we have that we've had problems with, that would be the last major item. Compressor has run extremely well. Solvent recycle pump is running better, but we are still out 10 months on the replacement of that pump. We did average since the turnaround, we've averaged about 85% of production capacity last month on the up day. So when we are up and running we had good run times. The new centrifuge is running extremely well. We've gone through the commissioning and debugging. So that's helping us quite a bit and stabilizing. So the main thing right now is just run.

Operator

Our next question comes from Raphael Fong of JMP Securities.

Raphael Fong - JMP Securities

Your operating expenses were $2.19 in the quarter. What was the fixed cost portion and what was the variable cost portion?

Gary Roth

The $2.19 includes part of the turnaround during that period. So it's really not comparable to what we typically think of our fixed and variable cost. So we typically look at our fixed cost of around 2 million to 2.5 million a month and the balance is variable cost. But once again in that quarter there was cost associated with the turnaround.

Operator

The next question comes from Jack Broadhurst of Broadhurst Investments. Please go ahead.

Jack Broadhurst - Broadhurst Investments

Basically you received authorization by stockholder vote to do a reverse split by next June and you provided a rather detailed explanation in the annual report to why this might be necessary and it's potential advantages. Are there any circumstances under which you would not do such a split, and if so what are they?

Gary Roth

We would likely not do the split if we come back in to NASDAQ compliance which is we’re above the dollar share price.

Jack Broadhurst - Broadhurst Investments

That’s the only requirement?

Gary Roth

That’s the only requirement outstanding today.

Operator

Our next question comes from (Ron Wagner of Advanced Assets)[ph]. Please go ahead.

Ron Wagner - Advanced Assets

A large amount of your revenues came from recognizing some deferred revenues and I see that you have about 18 million in deferred revenues left. Is there a time line or are there other events that may occur that you will be able to recognize those and also would you make a comment on the naphtha RINs and explain the difference between your average feed cost and for what the feed cost is going for in the market. You mentioned $0.51 versus the yellow grease trading for like 35. What's the difference between those costs?

Karen Power

This is Karen Power. I will answer the one on the deferred revenue. We will be recognizing another $3 million in this next quarter of deferred revenue for another license that will have expired from 1997. Then the remainder which will be about 15 million will remain there till I believe it’s 2019. At this time we don’t have anything moving on that license. So if it expires we will take it to income, but it won’t be till 2019.

Gary Roth

This is Gary, on the feedstock, last quarter what you do is you see the logistics train clearing out?

I So, it depends on the feedstock. Rail feedstock can actually be anywhere from six to eight weeks out from pricing to delivery. So that’s what you have seen in the prior quarter. The current quarter month will also have some logistics feed out because we have been in a falling market in terms of feedstock and to keep the plant running, you buy week to week or in some cases month to month. And in some cases with the rail loading I can say that it can be seven or eight weeks out. So that’s what you are seeing in the pricing

Ron Wagner - Advanced Assets

Did you get most of your feedstock delivered through rail versus truck?

Gary Roth

It’s typically we try to do 50:50. Currently, we try to move more towards truck because the pricing is typically shorter term, but we have our own railcars now moving in more and more toward corn oil and pricing seems to be more stable.

Ron Wagner - Advanced Assets

Any progress on the naphtha RINs?

Gary Roth

We keep hearing from EPA. We are into that every month. It’s next month mode with EPA, so in our experience that means it's generally pretty close. Haven’t had any other enquiries or request for info, so typically that is a good sign from EPA.

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. Again we would like to thank you all for your attendance today and your interest in Syntroleum. Thank you.

Operator

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

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