Syntroleum Earnings Conference Call Analysis

| About: Syntroleum Corporation (SYNM)
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Syntroleum (NASDAQ:SYNM) released earnings on Friday, May 3, and I wrote an article about the results on Sunday, May 5. The conference call was not held until Wednesday, May 8. Investors had almost five days to study the earnings, yet the stock was essentially unchanged from release date to the start of the conference call. SYNM closed at $4.00 on Friday, May 3, and hit a low of $4.06 on Wednesday, May 8 prior to the end of the conference call. The stock has since traded as high as $6.21, after the conference call, and the volume also surged. I think it is safe to say that the conference call made most of -- if not all -- the difference.

Date Open High Low Close Volume Adj Close*
May 9, 2013 5.54 6.21 5.54 5.96 348,900 5.96
May 8, 2013 4.11 5.75 4.06 5.51 493,700 5.51
May 7, 2013 4.12 4.21 4.03 4.16 12,100 4.16
May 6, 2013 4.05 4.23 3.96 4.05 37,800 4.05
May 3, 2013 4.20 4.20 3.99 4.00 68,500 4.00

While the earnings were strong, they didn't really move the stock when they were released. SYNM's main asset, the Dynamic Fuels plant, has been in stand-by status since late last year, so none of the income reported were generated from operations in 2013. What then happened in the conference call that got investors so excited? $4.06 to $6.21 is over a 50% gain in two days.

I would argue that the most important part of the conference call was the dramatic change in tone and style compared to past conference calls. This conference call was very informative, provided a great amount of detail, addressed a list of questions that had been submitted in advance and was so welcoming to callers that it afforded time for multiple follow-up questions. I have been a long time shareholder, and have often worried in the past that SYNM's approach to conference calls and their resistance to releasing information was more suited for a CIA operation at Area 51 than a publicly held company. Institutional investors, RIAs, pension and mutual funds have a fiduciary responsibility to their investors, and without critical information, it is hard to meet their fiduciary responsibilities.

Case in point is that SYNM previously released monthly production numbers, but inexplicably changed to releasing only quarterly numbers. That may not sound like a big deal, and wouldn't be, if SYNM's Dynamic Fuel plant was a well running plant with an established reliability record. The problem is one of, if not SYNM's major challenge is managing their cash, and their major use of cash is their Dynamic Fuels plant. Fiduciaries need to keep track of the status of their investments, and getting information on a quarterly basis on such a critical metric is very stressing to say the least. During this critical start-up time, I would argue more information is better, but in my opinion that has not been the case in the past, and has most likely scared away some potential institutional investors.

While this conference call didn't report monthly numbers, there was no need because the plant is in stand-by, it did provide plenty of information on other critical metrics and issues. In my opinion, if these kinds of conference calls continue, it will be much easier for SYNM to attract institutional investors, which should be a good thing for existing shareholders, especially now that there are 1/10th as many shares outstanding due to the recent reverse split.

Key information during the call was as follows:

Thanks, Karen. I am going to discuss the status of the Dynamic Fuels Geismar plant plus review of a few key highlights. We anticipate a restart of the Geismar plant in mid to late July.

Second only to the new format and tone of the conference call is that investors now have clarity as to when the Dynamic Fuels plant is expected to return to production. It will return to production in mid to late July. One would think that having a plant sit idle for over half a year during a high margin market would be disappointing to investors, but the stock performance serves as testament that transparency is key to investor confidence. Whether the news is good or bad isn't as important as transparency. Investors in SYNM appear to be very forgiving as long as they are given the information they need to forgive. Keeping investors in the dark simply leads to anxiety and creates uncertainty about the company. This kind of information goes a long way to resorting investor confidence, and I think the stock performance proves that.

Syntroleum's net income was $11 million and $1.15 per share for the three months ended March 31, 2013 compared to a net loss of $1.9 million or $0.20 per share million for the corresponding periods in 2012.

It is important to understand that none of the earnings were earned in 2013 from operations. More detail on the earnings can be found here.

Equity in earnings have dynamic fuels for the quarter ended March 31 2013 was 6.7 million which includes 12.6 million is gains from the $1 tax credit that is 5.9 million from dynamic fields operating losses for the first quarter ended December 31, 2012. We have accounted further retroactive restatement of $1 tax credit in the current quarter.

SYNM accounted for the full tax credit in Q1 2013, so future quarters will be more dependent upon operating earnings. More on this later when restart is discussed.

As of March 31, 2013, Syntroleum's available cash position was $14.9 million. On April 12, 2013, we received $9.0 million in funds from the IRS related to the $1 tax credit resulting in total cash of approximately $23.9 million.

I would imagine the relatively low cash level relative to the demand on March 31st played into the decision not to restart the plant. The restart of the plant will cost $20 million in working capital, 50% or $10 million of which would need to be funded by SYNM. With only $14.9 million on March 31, SYNM would have reduced their cash down to $4.9 million had they funded the working capital at that time. Since March 31st, however, they received their tax credit and are now sitting on $23.9 million, and are in a much stronger position to fund the plant restart.

During the quarter ended March 31, 2013, Syntroleum and Tyson each made additional equity contributions of $1.7 million and working capital loans of $4.0 million to Dynamic Fuels to fund operations.

Together that sums to $11.4 million given to Dynamic Fuels in Q1. Dynamic Fuels will also receive a tax credit from the IRS that will be discussed later.

We ordered a new catalyst in February for which we have now confirmed delivery in late June. And we inspect an increase in our diesel yields from an average of 80% to 88%.

This is highly significant and will substantially increase the margin of their product.

Dynamic Fuels would have had revenues per gallon of $4.55 versus $4.09 resulting in 13 million in increased revenue. Rather than interrupt the Feedstock supply chain, we believe the better alternative is to defer operations until installation of the new catalyst.

The new catalyst results in an increase in the margin by $4.55 - $4.09 = $0.46. Had they been using the new catalyst in 2012 they would have had an additional $13 million in revenues. Dynamic Fuels is a 75 million gallon per year plant, so at full production that $0.46/gallon results in $34.5 million in new revenues to Dynamic Fuels, 50% of which is owned by SYNM, which only has a market cap of approximately $58 million. Additionally, SYNM typically has superior margins on their fuel, especially over Soy Bean Oil Methyl Esters (SME), so this is a nice boost to their competitiveness, and should allow them to continue producing at a profit while others are forced to shut down.

We believe the fundamentals of our renewable fuels industry to be attractive given the current process for refined products, winds and feedstock as well as our full year outlook for revalue.

"Winds" in the above quote should be RINs, but the key point is that the economics are sound today and looking forward. Economics was given as the reason for the plant shutdown last year, and the conditions for shutdown no longer exist, at least not from a macroeconomic perspective.

Thanks Gary in our view the simplest way to gauge the overall health of the biomass based diesel industry is to look at the margins for a soy biodiesel plant. When soy biodiesel is profitable, our industry is doing well and when they are negative our industry is not.

This is important for investors to understand because soy biodiesel or SME is the high cost feedstock, low cloud-point, high quality biodiesel. SYNM and other biofuels firms like Renewable Energy Group (NASDAQ:REGI) use the lower cost feedstocks like yellow grease, choice white grease and inedible corn oil to gain a competitive edge. SYNM has the advantage of producing a "drop-in" ultra low sulfur diesel fuel (ULSD) which gets a premium price to the lower quality biodiesels called fatty acid methyl esters or FAME that result from using the lower quality feedstocks.

They also get 1.7 x a D4 RIN per gallon vs. the 1.5 x biodiesel producers get, and SYNM acts as a "blender" so they get to keep the full $1.00/gallon tax credit per gallon of ULSD. Combine those advantages with the higher yield from the new catalyst and it is easy to see why the stock had such a nice run after the conference call. Key point is that SYNM is a low cost producer, and SME is the high cost but most abundant form of biodiesel. The regulatory requirements pretty much require SME to be produced, so if the high cost producers can survive, the low cost producers should thrive. SYNM is a low cost producer.

Soy margins turned positive in February of 2013 at $0.07 per gallon and $0.23 per gallon in March. Given dynamic feasibility the utilized lower cost feedstock, we calculate current cash margins using the new catalyst, yellow grease prices and petroleum and product and RIN prices as of May 6, 2013 to be approximately $0.78 per gallon.

This quote gives investors a rough way to estimate the margins of SYNM. The Iowa State University estimates SME margins for April to be $0.34/gallon. On May 6, SYNM's estimated margin was $0.78, or $0.44/gallon more than SME. That implies that during economic times when SME should shut down, SYNM can still be producing at a $0.44/gallon profit. I attempt to model SME and SYNM's margins throughout the quarter, and the $0.78/gallon is lower than my estimates, and is partially due to differing data sources discussed below.

Through March 2012 total RINs reported by the EPA for the entire RFS2 pool was 22% of the 2013 mandate compared to 25% of the 2012 mandate. If we project the March RIN generation rate for the balance of 2013, 94% of the 2013 mandate will be met. As I move into 2014, if EPA affirms the 2014 RIN mandate, the March 2013 run rate for a full year would be 84% of the 2014 mandate therefore we do not expect a return to the negative margins that the industry witnessed last year due to a sharp fall in RIN prices.

I wrote about this observation in a recent article. Being below quote is very positive for RIN prices and the profit outlook by itself, but the regulations allow 20% of production to be carried over into the next year, so we are substantially off the target needed to reach the likely production for 2013, which could be 120% of the quota. A surge in production late in the year, however, would be expected to weaken margins, so it is important for SYNM to get producing as soon as possible to lock in the high margins that currently exist in the market.

We are focusing significant management time on advancing a concept of a project integrating a 4,000 to 5,000 barrel per day GTL plant to a natural gas field in an integrated project the cost of the gas is the cost of drilling and operating the wells typically but depending on the play acreage and drilling costs for dry gas are about $1 per mcf and operating costs are another dollar per mcf. Therefore at an 11 mcf per barrel conversion ratio, synthetic hydrocarbons would be produced at about a $22 per barrel feedstock cost. We believe an integrated project is financeable for the following reasons.

While Dynamic Fuels is SYNM's main operational asset, in my opinion, it is SYNM's Fischer Tropsch assets that offer the real promise for SYNM. Supplies of yellow grease and other low cost waste oils are of limited supplies. The market is finite, relatively small and subject to wild price swings. Natural gas is virtually unlimited and cheap, as is coal. As noted in the quote above, SYNM can buy $22 worth of natural gas, tack on about $15 for operating expenses, and they can produce a barrel of fuel for about $37. I don't have the product mix, but assuming 80% is ULSD, a 42 gallon barrel would contain 34 gallons of ULSD. ULSD currently goes for around $3.00/gallon wholesale, so SYNM would make over $100/barrel just on the ULSD production, or a profit of $100 - $37 = $63/barrel. That, in my opinion, is where SYNM really stands to make substantial profits -- if they can get a plant built and running efficiently.

Field testing of our PCM pellet product was completed at Oakridge National Laboratory, economic modeling work was conducted by Fraunhofer CSE, and based on this analysis a payback period of 8-16 years is expected for retrofit projects involving addition of PCM pellets to attic insulation. With a typical payoff expected in the building industry. We have also produced prototypes of our PCM in sheet form. For example PCM sheets can be placed between wall board and as power components or as part of thermal energy storage modules.

SYNM also has what is called a "phase change material" or PCM that can be used as insulation. It is an innovative new insulation that utilizes the endo/exothermic reaction's heat absorption and release properties similar to the process orange growers rely on when they spray their crops in advance of a freeze. The product appears to be nearing the commercialization phase.

We have regained listing compliance on the NASDAQ.

Regaining compliance, as well as trading above the psychologically critical $1 and $5 levels, should also greatly help with SYNM's appeal to institutional investors that may have restrictions or be hesitant about buying low priced or restricted stocks. SYNM also had a portion of the conference call reserved to answer questions that they had received prior to and during the conference call. Some key comments were:

1) "We believe market conditions favor restarting the plant."

2) "Syntroleum has received its $9 million (tax credit). Dynamic Fuels has applied for its $7 million and is awaiting payment from the IRS."

SYNM and Tyson (NYSE:TSN) gave Dynamic Fuels a combined total of $11.4 million in the first quarter as mentioned above and they will be receiving an additional $7 million for a total of $18.4 million. Dynamic Fuels burns about $2 million per month in cash while in stand-by mode, so by July they should be down to about $6.4 million, and in need of about another $13.6 million to fund the $20 million in working capital to get the plant restarted and running. After funding their share of the working capital should still leave SYNM with over $15 million in cash in July.

3) "What has been the monthly cost of keeping the plant in standby mode? Approximately $2 million per month or $1 million to Syntroleum's interest."

If my math above is correct, Dynamic Fuels should have enough cash on hand to fund their operations up to restart, and partially fund the restart.

4) "According to the Jacobson, as of May 7th, yellow grease was $0.40, edible tallow $0.43, inedible tallow $0.415, inedible corn oil $0.3625, and poultry fat was $0.38 per pound."

(Note: This helps explain why my estimates are off. I use a different source, the USDA, which has yellow grease at $0.35/lb. That $0.05 difference impacts the margin by 7.2lbs x $0.05 = $0.36. This highlights the difficulties in estimating the margins in this industry.)

5) "The pump is on schedule for delivery in October."

It was mentioned that this install should not require any additional downtime, and should not cost Dynamic Fuels any production time.

6) "Are there any plant process issues that could prevent restart? Not that we are aware of."

That is very good news and implies that the feedstock processing, the hydrogen issues and just about every other issue that had plagued the plant have been resolved. The remaining issue, the resolvent pump was discussed above, but is currently in running condition.

7) "What do you expect plant up time to be going forward? We believe we have implemented or are implementing solutions to address the major issues we have learned by running the plant, while we do not give guidance, we are optimistic about the future uptime of the plant."

This supports No. 6 above. Dynamic Fuels is a 75 million gallon a year plant at full capacity. If the plant runs at 80%, it will be producing around 5 million gallons per month, half of which go to SYNM. Also prior to shut-down last year, the plant had a period of over 50 consecutive days of production. A solid production run during this high margin time would go a long way to solving the cash burn issue.

8) "What is the impact of Dynamic Fuels on the CME group beginning RIN's futures contracts."

Assuming there is a RIN integrity program associated with the futures contracts, this should go a long way to establishing a market for RINs, instilling confidence in market participants and allowing for greater risk control of the production process. What would really be beneficial to SYNM and other biofuels firms would be the ability to trade futures on their feedstocks.

9) "First taking Sinopec; Sinopec continues to run our facility and gather data, in China. We have annual conferences in which we exchange data; they continue to manufacture our catalyst and work on those and we get those learning's back and forth."

SYNM has a working relationship with Sinopec, one of China's largest oil companies. While a significant deal has yet to be signed, the very fact that a company as small as SYNM is working with Sinopec offers some hope. You can only win if you play the game, and SYNM is in the game and fishing in a pond with some very big fish such as Sasol, the U.S. Navy, and Sinopec.

10) "A dynamic fuel; what we have is we have three basic thesis to gas to liquids. One is conversion of natural gas, with the creation of same gas. The second piece is the FT reactor in which we convert synthesis gas to FT wax; candle wax. And the third piece is the conversion of the FT wax to finished products... Syngas generation is a commodity; if I were right, currently there is about 38 plants in the United States that convert natural gas to Syngas so you can buy that readily."

There are three main parts of the Fischer Tropshe process, and it appears that SYNM would only need to build out two of them, and purchase the synthesis gas on the open market. I would imagine this would reduce the cost on building a new plant. This may be a topic for more discussion in the next conference call.

11) "Our current pump works, it just doesn't have the stability and the reliability that we would like and that justifies the replacement with the new solvent recycle pump."

This pump referred to above that will be replaced later in the year.

12) "PCM, some of our analysis looks like peek and you talked peek energy savings are about 42% that would be an expectation related to roofing installation where we use our pallet... In terms of the costs savings of PCM, we've seen anywhere between 8 and 16% savings that doesn't include savings associated with peak, power costs, data empower versus off peak lifetime power costs."

Hopefully in future conference calls metrics like payback period will be discussed regarding the PCM.

In conclusion, the new tone, format and information provided in the most recent conference call not only serves shareholders well, but as the recent price actions demonstrate, is good for SYNM as well. Transparency and frequent communication on critical metrics and issues is essentially in attracting institutional investors. This last conference call should go a long way in alleviating the fears some institutions may have had in investing in SYNM. One conference call, however, does not make a trend, so investors should pay attention to any shifts in their conference call approach. I would expect that reverting back to the old style would not be good for SYNM shareholders. Uncertainty, secrecy and confusion are rarely good for a stock price.

The information provided in this conference call should help alleviate some of the anxiety shareholders may have been feeling, I know it did for me. SYNM seems to be making progress on all major fronts from the Dynamic Fuels plant, GTL/CTL and PCM. With the date of restart set for mid to late July, shareholders now have a better way to track their progress. Investors also know the cash position, the cash burn rate and estimated margins, all of which should help investors better understand the firm and feel more comfortable with their investment. If the transparency and open communication continues, and the Dynamic Fuels plants can resume production at or near full capacity, it should bode well for shareholders. Last, I would recommend that anyone interested in investing in SYNM should listen to the conference call. It is available on the SYNM website.

Disclosure: I am long SYNM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: This article is not an investment recommendation. Any analysis presented in this article is illustrative in nature, is based on an incomplete set of information and has limitations to its accuracy, and is not meant to be relied upon for investment decisions. Please consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.