KiOR: No Revenue, No Problem ... For Now

| About: KiOR, Inc. (KIOR)

Introduction

KiOR (NASDAQ:KIOR) investors were taken for a wild ride immediately prior to and following the company's release of its Q2 2012 earnings on Tuesday morning (see chart). After spiking by nearly 25% (from $7.15 to $8.98) in the last eight minutes of trading on Monday and first eight minutes of trading on Tuesday, shares promptly proceeded to fall back below $7 shortly after noon. The catalyst for this action was a combination of bad short-term and good long-term news in the earning results.

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First, the good news. KiOR's 454 metric ton per day Columbus facility is scheduled to commence operations next month; furthermore, the facility's capital costs came in about 4% below expectations ($213 million actual versus $222 million expected), which is a relatively rare event in the annals of alternative fuels commercialization efforts.

Finally, and potentially most importantly for its long-term prognosis, KiOR reported that it has developed a new catalyst capable of significantly reducing pathway coke yields. I've expressed skepticism in the past over the company's ability to coax high fuel yields from biomass via catalytic pyrolysis, primarily because of the pathway's noted tendency to produce very large quantities of coke and char relative to fast pyrolysis, which generally come at the expense of liquid hydrocarbon yields [1-3]. Reduced coke yields are important for a couple of reasons. First, KiOR apparently scaled its Columbus facility on the basis of expected coke output and President and CEO Fred Cannon said in the earnings conference call that this reduction in coke yields will result in an automatic 20% increase in biomass capacity for each facility. Increased capacity without increased capital costs will improve the project's overall rate of return.

Second, the reduced coke yields could translate into increased gasoline and diesel fuel yields via greater bio-oil yields. A word of caution is important here, however: the other possible co-product via catalytic pyrolysis is syngas, which is like coke in that it only has value in the pathway as a low-quality boiler feedstock. Mr Cannon stated that the company doesn't yet know whether the coke reduction is due to increased production of liquids or gases and therefore isn't willing to say that the new catalyst will increase fuel yields. This has the potential to be a very valuable development for the company but it isn't just yet; more information is needed before this can be determined.

Now the bad news: According to the earnings press release, KiOR had no revenue in the second quarter and is running low on cash. The company reported for the quarter a net loss of $23 million and, just as importantly, a reduction in cash and cash-equivalents of $45 million, leaving it with $107 million on its balance sheet at the end of the quarter. KiOR's cash shortage has been an issue since at least June, but at this rate the company will run out of cash sometime in early 2013. CFO John Karnes stated during the conference call Q&A session that KiOR does expect to bring in new revenue and additional financing following the collection of operating data from the Columbus facility. This schedule will be cutting it close, however, and therein lies the greatest risk to investors. Based on the company's balance sheet at the end of Q2 and the reduction in cash and cash-equivalents during the quarter, KiOR only has cash on hand for about seven more months of operations at the current rate of use. Any delays, serious accidents, or unexpectedly low fuel yields at the facility during this time period could place the company in dire financial straits. Four months of revenues resulting from the production of cellulosic gasoline and diesel fuel produced at the Columbus facility could attract additional investment by the end of the year; on the other hand, two more quarters of zero revenue will send investors running.

The future isn't entirely bleak for KiOR, however. The company is currently going through the most difficult stage of the commercialization process, having expended hundreds of millions of dollars on the construction of a facility that isn't yet operational and able to generate revenue. Indeed, investors shouldn't be surprised that the company isn't pulling in any revenue at this stage of the commercialization process. While a delay could cause the company to run out of cash before the Columbus facility begins to yield high-value fuel products, a successful start-up would make KiOR the winner of the marathon race to become the first commercial-scale producer of cellulosic gasoline and diesel fuel. The winner of this race earns more than just bragging rights and a section in the renewable energy history books; it also begins to receive the fabled D3 RINs under the revised Renewable Fuel Standard. While there is currently no market for this category of RINs due to a complete lack of production (and therefore no market value), their value will initially be at least high enough to cover the Columbus facility's operating costs, and probably higher as the EPA tries to encourage additional production, which, even with the Columbus facility operational, will only be a tiny fraction of the volume initially mandated by the RFS2. RINs for the biomass-based diesel category, which has been produced on a commercial scale for years, peaked at nearly $2/gal in September 2011. The revenue derived from the combination of fuel market prices and RIN values for the company's expected output of 500,000-1 million gallons in Q4 would give KiOR additional time to acquire further financing for the completion of its much larger Natchez facility.

It should be noted that KiOR's ability to acquire cellulosic biofuel RINs this year isn't entirely within its control. The EPA is under legal and political pressure to rescind its original decision to enforce the cellulosic biofuels portion of the mandate in 2012, which critics have labeled the "Phantom Fuels" mandate. That said, successful cellulosic biofuels production at the Columbus facility in Q4 2012 would reduce pressure on the EPA and thereby encourage an expansion in production, whereas any delay would increase the odds of yet another waiver of the cellulosic biofuels mandate by the EPA. No pressure, KiOR.

Conclusion

KiOR investors should be prepared for significant volatility in coming months, particularly during Q4 of this year. To use the common industry analogy, KiOR has just enough water to make it to the next oasis in the Valley of Death if all goes according to plan, but that's a rather large "if." This could very well be an all-or-nothing scenario for the company, with substantial profits to be made and a renewed lease on life to be had if the Columbus facility becomes fully operational during Q4, or corporate demise if it does not. The company's shares are a speculative play for those with a significant tolerance for risk, as this week's price movements in the stock suitably demonstrated.

References

[1] Agblevor FA, Beis S, Mante O, Abdoulmoumine N. Fractional Catalytic Pyrolysis of Hybrid Poplar Wood. Industrial & Engineering Chemistry Research 49:3533-8.

[2] Compton DL, Jackson MA, Mihalcik DJ, Mullen CA, Boateng AA. Catalytic pyrolysis of oak via pyroprobe and bench scale, packed bed pyrolysis reactors. Journal of Analytical and Applied Pyrolysis 90:174-81.

[3] Mullen CA, Boateng AA, Mihalcik DJ, Goldberg NM. Catalytic Fast Pyrolysis of White Oak Wood in a Bubbling Fluidized Bed. Energy & Fuels 25:5444-51.

Disclosure: I am long KIOR.