UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ______.
COMMISSION FILE NO. 0-21911
SYNTROLEUM CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 73-1565725
(State or other jurisdiction of I.R.S. Employer
incorporation or organization) Identification No.)
1350 SOUTH BOULDER, SUITE 1100
TULSA, OKLAHOMA 74119-3295
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (918) 592-7900
NOT APPLICABLE
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO __.
--
At November 10, 1999, the number of outstanding shares of the issuer's common
stock was 26,900,052.
SYNTROLEUM CORPORATION
INDEX TO QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
Unaudited Consolidated Balance Sheets as of September 30, 1999 and
December 31, 1998. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Unaudited Consolidated Statements of Operations for the three month and nine month
periods ended September 30, 1999 and 1998. . . . . . . . . . . . . . . . . . . . 2
Unaudited Consolidated Statements of Stockholders' Equity for the nine
month period ended September 30, 1999. . . . . . . . . . . . . . . . . . . . . . 3
Unaudited Consolidated Statements of Cash Flows for the nine month
periods ended September 30, 1999 and 1998. . . . . . . . . . . . . . . . . . . . 4
Notes to Unaudited Consolidated Financial Statements . . . . . . . . . . . . . . . 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations. . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Item 3. Quantitative and Qualitative Disclosures About Market Risk. . . . . . . . 13
PART II - OTHER INFORMATION
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Item 2. Changes in Securities and Use of Proceeds . . . . . . . . . . . . . . . . 13
Item 3. Defaults Upon Senior Securities . . . . . . . . . . . . . . . . . . . . . 13
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . 14
Item 5. Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . . . . . . . . 14
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
INDEX TO EXHIBITS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q includes forward-looking statements as
well as historical facts. These forward-looking statements include statements
relating to the Syntroleum Process and related technologies, gas-to-liquids
plants based on the Syntroleum Process, anticipated costs to design, construct
and operate such plants, the timing of commencement and completion of the design
and construction of such plants, obtaining required financing for such plants,
the economic construction and operation of GTL plants, including the value,
markets and prices for and other characteristics of products produced by such
plants, the continued development of the Syntroleum Process (alone or with
partners), anticipated capital expenditures, anticipated revenues, the sale of
Syntroleum's real estate inventory and any other statements regarding future
growth, cash needs, operations, business plans and financial results. When used
in this document the words "anticipate," "believe," "estimate," "expect,"
"intend," "may," "plans," "project," "should" and similar expressions are
intended to be among the statements that identify forward-looking statements.
Although Syntroleum believes that the expectations reflected in these
forward-looking statements are reasonable, such statements involve risks and
uncertainties and actual results may not be consistent with these
forward-looking statements. Important factors that could cause actual results
to differ from these forward-looking statements include the potential that the
cost of designing and constructing commercial-scale GTL plants will exceed
current estimates, commercial-scale GTL plants will not achieve the same results
as those demonstrated on a laboratory or pilot basis or that such plants will
experience technological and mechanical problems, the potential that
improvements to the Syntroleum Process currently under development may not be
successful, the impact on plant economics of operating conditions (including
energy prices), competition, intellectual property risks, Syntroleum's ability
to obtain financing and other risks described in this Quarterly Report on Form
10-Q and Syntroleum's Annual Report on Form 10-K for the year ended December 31,
1998.
ii
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
SYNTROLEUM CORPORATION AND SUBSIDIARIES
UNAUDITED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
SEPTEMBER 30, DECEMBER 31,
1999 1998
-------------- ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents. . . . . . . . . . . . . . . $ 27,274 $ 34,981
Short-term investments . . . . . . . . . . . . . . . . 3,661 3,135
Accounts and notes receivable. . . . . . . . . . . . . 2,614 860
Other current assets . . . . . . . . . . . . . . . . . 182 498
--------- ---------
Total current assets. . . . . . . . . . . . . . . . 33,731 39,474
REAL ESTATE HELD FOR SALE. . . . . . . . . . . . . . . . 2,776 3,122
REAL ESTATE UNDER DEVELOPMENT. . . . . . . . . . . . . . 2,733 2,722
INVESTMENTS. . . . . . . . . . . . . . . . . . . . . . . 1,091 1,180
PROPERTY AND EQUIPMENT, net. . . . . . . . . . . . . . . 4,397 3,210
OTHER ASSETS, net. . . . . . . . . . . . . . . . . . . . 709 692
--------- ---------
$ 45,437 $ 50,400
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable . . . . . . . . . . . . . . . . . . . $ 1,617 $ 1,365
Accrued liabilities. . . . . . . . . . . . . . . . . . 741 633
Total current liabilities . . . . . . . . . . . . . 2,358 1,998
--------- ---------
OTHER NONCURRENT LIABILITIES . . . . . . . . . . . . . . 116 103
MINORITY INTERESTS . . . . . . . . . . . . . . . . . . . 1,344 1,337
DEFERRED REVENUE . . . . . . . . . . . . . . . . . . . . 11,000 11,000
Total liabilities . . . . . . . . . . . . . . . . . 14,818 14,438
--------- ---------
STOCKHOLDERS' EQUITY:
Preferred stock, $0.01 par value, 5,000,000 shares
authorized, no shares issued. . . . . . . . . . . . - -
Common stock, $0.01 par value, 150,000,000 shares
authorized, 34,574,957 shares issued in 1999 and
1998, respectively, including shares in treasury. . 346 346
Additional paid-in capital . . . . . . . . . . . . . . 68,905 62,908
Notes receivable from sale of common stock . . . . . . (699) (699)
Accumulated deficit (37,856) (26,516)
--------- ---------
30,696 36,039
Less-treasury stock, 7,674,905 shares in 1999 and 1998 (77) (77)
--------- ---------
Total stockholders' equity. . . . . . . . . . . . . 30,619 35,962
--------- ---------
$ 45,437 $ 50,400
========= =========
The accompanying notes are an integral part of these unaudited consolidated
balance sheets.
1
SYNTROLEUM CORPORATION AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------- -------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
REVENUES:
Joint development revenue. . . . . . . . . $ 792 $ 635 $ 1,942 $ 1,486
Real estate sales. . . . . . . . . . . . . 590 1,560 1,110 1,560
Other. . . . . . . . . . . . . . . . . . . 166 119 491 119
------------ ------------ ------------ ------------
Total revenues . . . . . . . . . . . . . 1,548 2,314 3,543 3,165
------------ ------------ ------------ ------------
COST AND EXPENSES:
Cost of real estate sales. . . . . . . . . 345 1,538 749 1,538
Real estate operating expense. . . . . . . 192 145 581 145
Pilot plant, engineering and research and
development. . . . . . . . . . . . . . . 3,199 1,231 7,736 3,509
General and administrative . . . . . . . . 2,676 2,843 7,355 7,269
------------ ------------ ------------ ------------
INCOME (LOSS) FROM OPERATIONS. . . . . . . . (4,864) (3,443) (12,878) (9,296)
INVESTMENT AND INTEREST INCOME . . . . . . . 436 396 1,551 587
OTHER INCOME (EXPENSE) . . . . . . . . . . . (8) 11 (5) 11
------------ ------------ ------------ ------------
INCOME (LOSS) BEFORE MINORITY
INTERESTS. . . . . . . . . . . . . . . . . (4,436) (3,036) (11,332) (8,698)
MINORITY INTERESTS . . . . . . . . . . . . . (41) 18 (8) 32
------------ ------------ ------------ ------------
NET INCOME (LOSS). . . . . . . . . . . . . . $ (4,477) $ (3,018) $ (11,340) $ (8,666)
============ ============ ============ ============
NET INCOME (LOSS) PER SHARE -
Basic and diluted. . . . . . . . . . . . . $ (0.17) $ (0.12) $ (0.42) $ (0.35)
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING. . . . . . . . . . . . . . . . 26,900,052 25,934,909 26,900,052 24,983,715
============ ============ ============ ============
The accompanying notes are an integral part of these unaudited consolidated
statements.
2
SYNTROLEUM CORPORATION AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
COMMON STOCK NOTES
-----------------ADDITIONAL RECEIVABLE TOTAL
NUMBER PAID-IN FROM SALE OF ACCUMULATED TREASURY STOCKHOLDERS'
OF SHARES AMOUNT CAPITAL COMMON STOCK DEFICIT STOCK EQUITY
--------- ------ --------- -------------- --------- -------- -------------
BALANCE, December 31, 1998 . 34,575 $346 $62,908 $ (699) $(26,516) $(77) $ 35,962
SETTLEMENT OF MERGER
CONTINGENCY . . . . . . - - 5,997 - - - 5,997
NET INCOME (LOSS). . . . . - - - - (11,340) - (11,340)
BALANCE, September 30, 1999. 34,575 $346 $68,905 $ (699) $(37,856) $(77) $ 30,619
========== ====== ========= ============== ========== ======= ============
The accompanying notes are an integral part of these unaudited consolidated
statements.
3
SYNTROLEUM CORPORATION AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
-------------------
1999 1998
--------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) . . . . . . . . . . . . . . . . . $(11,340) $(8,666)
Adjustments to reconcile net income (loss)
to net cash provided by (used in) operations:
Minority interest in loss of subsidiary. . . . . 8 (32)
Depreciation and amortization. . . . . . . . . . 450 199
Equity in earnings of affiliates . . . . . . . . (127) 16
Changes in real estate held for sale and
under development . . . . . . . . . . . . . . 336 1,275
Changes in assets and liabilities--
Accounts receivable. . . . . . . . . . . . . (1,754) 285
Prepaids and other . . . . . . . . . . . . . 299 -
Other assets . . . . . . . . . . . . . . . . (316) (542)
Accounts payable . . . . . . . . . . . . . . 251 554
Accrued liabilities and other. . . . . . . . 72 (1,998)
--------- --------
Net cash provided by (used in)
operating activities . . . . . . . . . . (12,121) (8,909)
--------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (1,525) (1,967)
Distribution from venture capital investment funds. - 71
Maturity of SLH investments held to maturity. . . . (16) 26,774
Net cash provided by (used in)
investing activities. . . . . . . . . . (1,541) 24,878
--------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Settlement of merger contingency. . . . . . . . . . 5,997 -
Cash acquired in SLH merger . . . . . . . . . . . . - 713
Payments under capital lease (42) (11)
Minority interest investment in subsidiary. . . . . - 1,000
--------- --------
Net cash provided by (used in)
financing activities. . . . . . . . . . 5,955 1,702
--------- --------
NET INCREASE (DECREASE) IN CASH . . . . . . . . . . . (7,707) 17,671
CASH AND CASH EQUIVALENTS,
beginning of period . . . . . . . . . . . . . . . . 34,981 10,158
--------- --------
CASH AND CASH EQUIVALENTS, end of period. . . . . . . $ 27,274 $27,829
========= ========
The accompanying notes are an integral part of these unaudited consolidated
statements.
4
SYNTROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
1. BASIS OF REPORTING
The primary operations of Syntroleum Corporation (together with its
predecessors and subsidiaries, the "Company" or "Syntroleum") to date have
consisted of the research and development of a proprietary process (the
"Syntroleum Process") designed to convert natural gas into synthetic liquid
hydrocarbons. Synthetic liquid hydrocarbons produced by the Syntroleum Process
can be further processed into high quality liquid fuels such as diesel, kerosene
and naphtha, or high quality specialty products such as synthetic lubricants,
synthetic drilling fluid, waxes, liquid normal paraffins and certain chemical
feedstocks.
The consolidated financial statements included in this report have been
prepared by Syntroleum without audit pursuant to the rules and regulations of
the Securities and Exchange Commission ("SEC"). Accordingly, these statements
reflect all adjustments (consisting of normal recurring entries) which are, in
the opinion of management, necessary for a fair presentation of the financial
results for the interim periods presented. These financial statements should be
read in conjunction with the financial statements and the notes thereto included
in the Company's Annual Report on Form 10-K for the year ended December 31, 1998
filed with the SEC under the Securities Exchange Act of 1934, as amended, on
March 31, 1999.
Effective June 17, 1999, the Company completed its reincorporation as a
Delaware corporation. In the reincorporation, the Company merged (the
"Reincorporation Merger") with the Company's predecessor, Syntroleum
Corporation, a Kansas corporation ("Syntroleum-Kansas"), with the Company being
the surviving corporation and the successor to Syntroleum-Kansas. The
Reincorporation Merger has been accounted for as a combination of entities
under common control using the historical cost basis of the combining companies
as if it were a pooling of interests.
On August 7, 1998, the Company's predecessor, Syntroleum Corporation, an
Oklahoma corporation, merged with SLH Corporation, a Kansas corporation ("SLH").
This merger was accounted for as a reverse acquisition. The results of
operations of SLH have been included in the results of Syntroleum since
completion of the merger with SLH. Unaudited pro forma results of operations
for the nine months ended September 30, 1998, as though the merger with SLH had
occurred at January 1, 1998, are presented below. The proforma results of
operations are not necessarily indicative of the actual operating results had
the transaction been consummated at the beginning of the period presented below
or in future operating results of the combined operations:
FOR THE NINE MONTHS
ENDED SEPTEMBER 30, 1998
------------------------
Revenues. . . . . . . . . . . . . $ 10,703
Net income (loss) . . . . . . . . (4,727)
Basic and diluted earnings (loss)
per share. . . . . . . . . . . $ (.19)
The preparation of financial statements in conformity with generally
accepted accounting principals requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
2. EARNINGS PER SHARE
The Company applies the provisions of SFAS No. 128, "Earnings Per Share."
Basic and diluted earnings (losses) per common share were computed by dividing
net income (loss) by the weighted average number of shares of common stock
outstanding during the reporting period. Options to purchase 2,798,619 shares
of common stock at an average exercise price of $7.21 were not included in the
computation of diluted earnings per share as inclusion of such options would be
anti-dilutive.
5
3. FOOTNOTES INCORPORATED BY REFERENCE
Certain footnotes are applicable to the financial statements, but
would be substantially unchanged from the footnotes presented in the Company's
December 31, 1998 audited financial statements included in the Company's Annual
Report on Form 10-K for the year ended December 31, 1998 as filed with the SEC,
and are incorporated herein by reference as follows:
NOTE DESCRIPTION
- ---- ------------------------------------------
1. Summary of Significant Accounting Policies
2. Investments
3. Property and Equipment
4. Notes Receivable from Sale of Common Stock
5. Accrued Liabilities
6. Income Taxes
7. Supplemental Cash Flow Information
9. Lease Commitments
10. Fair Value of Financial Instruments
11. Cash Equivalents and Short-Term Investments
12. Stock Options
13. Significant Customers
14. Stockholder Rights Plan
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
You should read the following information in conjunction with the
information presented elsewhere in this Quarterly Report on Form 10-Q and with
the information presented in our Annual Report on Form 10-K for the year ended
December 31, 1998 (including our audited financial statements and the
accompanying notes).
OVERVIEW
We are the developer and owner of a proprietary process (the "Syntroleum
Process") designed to catalytically convert natural gas into synthetic liquid
hydrocarbons ("gas to liquids" or "GTL"). The Syntroleum Process is a
simplification of traditional GTL technologies aimed at substantially reducing
both the capital cost and the minimum economical size of a GTL plant, as well as
plant operating costs. A unique characteristic and primary advantage of the
Syntroleum Process over competing processes is its use of air, rather than pure
oxygen, in the conversion process. Although no commercial-scale GTL plant based
on the Syntroleum Process has yet been built, we operate a nominal two barrel
per day pilot plant in Tulsa, Oklahoma which has successfully demonstrated
certain elements and variations of the Syntroleum Process. We have also
participated with Atlantic Richfield Company ("ARCO"), a licensee of our GTL
technology, in the successful design, construction, start-up, and on-going
operation of a 70 barrel-per-day pilot plant located at ARCO's refinery at
Cherry Point, Washington. We believe that a significant opportunity exists for
the construction of cost-effective GTL plants due to the large volumes of
natural gas reserves worldwide that are currently not marketable because
distance to market makes use of those reserves uneconomical. Additionally, we
believe that increasingly strict environmental regulations will increase demand
for GTL products and, as a result, demand for the Syntroleum Process.
Our strategy for commercializing the Syntroleum Process involves the
following key elements: (1) entering into agreements with oil and gas industry
participants to license the Syntroleum Process for use in GTL plants designed to
produce synthetic crude oil and liquid fuels; (2) establishing joint ventures
with oil and gas industry partners and/or financial partners to construct and
operate GTL plants designed to produce specialty products; (3) making available
mobile GTL plants to customers on a contract basis through efforts with industry
partners and others; and (4) continuing to reduce plant costs and develop
process improvements through research and development activities and
acquisitions. To date, we have entered into master license agreements with
Texaco, Inc. ("Texaco"), ARCO, and Marathon Oil Company ("Marathon"), and we
have entered into volume license agreements with YPF International, Ltd., an
affiliate of Argentina-based Yacimientos Petroliferos Fiscales, S.A. ("YPF"),
Enron Capital & Trade Resources Corp. ("Enron"), and Kerr-McGee Corporation
("Kerr-McGee"). We received an aggregate of $11 million and rights to certain
6
technologies in exchange for entering into these license agreements. We are
currently in discussions with several oil and gas companies and others with
respect to joint ventures to develop specialty product GTL plants. We have
formed a joint venture with Enron with respect to the development of a specialty
products plant and we are currently evaluating different potential international
sites for this plant, including possible sites in Australia and Trinidad and
Tabago. The schedule for construction of this proposed plant has not yet been
finally determined.
We have entered into joint development arrangements with Texaco, ARCO, Marathon,
Bateman Engineering, Inc. ("Bateman"), AGC Manufacturing Services, Inc. ("AGC"),
GE Power Systems ("GE Power Systems"), DaimlerChrysler AG ("DaimlerChrysler"),
Catalytica Combustion Systems, Inc. ("Catalytica Combustion Systems"), and AMEC
Process and Energy Limited ("AMEC"). These agreements provide us access to the
resources and technology of our development partners to enhance our efforts to
commercialize the Syntroleum Process.
Because we continue to incur costs with respect to developing and
commercializing the Syntroleum Process and we do not anticipate recognizing any
revenues from licensing our technology in the near future, we expect to continue
to operate at a loss unless and until sufficient revenues are recognized from
licensing activities or specialty product GTL plants.
OPERATING REVENUES
General. During the periods discussed below, our revenues were generated
from (1) sales of real estate holdings we received as a result of our merger
with SLH, (2) reimbursement from our joint development partners for research and
development activities associated with the Syntroleum Process and (3) other
sources, including rent generated by real estate holdings owned by SLH prior to
our merger with SLH. Because SLH had substantially reduced its real estate
inventory prior to our merger with SLH, and we have sold several properties
since the merger, we expect to receive lower levels of revenues from these
sources in the future. In the future, we expect to receive revenue relating to
the Syntroleum Process from five sources: licensing; catalyst sales; sales of
products from specialty product GTL plants in which we own an equity interest;
revenues from providing mobile GTL plants on a contract basis; and revenues from
research and development activities carried out with industry partners. Until
the commencement of commercial operation of GTL plants in which we own an
interest, we expect that cash flow relating to the Syntroleum Process will
consist primarily of license fee deposits, site license fees, catalysts sales
and revenues associated with joint development activities. We will not receive
any cash flow from GTL plants in which we own an equity interest until the first
such plant is constructed and begins commercial operation. Our future operating
revenues will depend on the successful commercial construction and operation of
GTL plants based on the Syntroleum Process, the success of competing GTL
technologies and other competing uses for natural gas. Our results of
operations and cash flows are expected to be affected by changing natural gas,
crude oil, fuel and specialty product prices. If the price of these products
increases (decreases), there could be a corresponding increase (decrease) in our
operating revenues.
License Revenues. The revenue earned from licensing the Syntroleum Process
is expected to be generated through four types of license contracts: master
license agreements, volume license agreements, regional license agreements and
site license agreements. Master, volume and regional license agreements provide
the licensee with the right to enter into site license agreements for individual
GTL plants. A master license agreement grants broad geographic and volume
rights. Volume license agreements limit the total production capacity of all
GTL plants constructed under the agreement to specified amounts. Regional
license agreements limit the geographical rights of the licensee. Master,
volume and regional license agreements require an up-front cash deposit that may
offset or partially offset license fees for future plants payable under site
licenses. In some cases, we have acquired technology, commitment of funds for
joint development activities, services or other consideration in lieu of the
initial cash deposit required in exchange for entering into a license agreement.
Our site license agreements require fees to be paid in increments when
certain milestones are achieved relating to plant design and construction. The
amount of the license fee under our existing master and volume license
agreements is determined pursuant to a formula based on the present value of the
product of (1) the yearly maximum design capacity of the plant, (2) an assumed
life of the plant, and (3) our per barrel rate, which currently is approximately
$.50 per barrel of daily capacity, regardless of plant capacity. Our licensee
fees may change from time to time based on the size of the plant, improvements
that reduce plant capital cost and competitive market conditions. Our
accounting policy is to defer all up-front deposits under master, volume and
7
regional license agreements and license fees under site license agreements
(which are applied against any related up front deposits) and recognize 50% of
license deposits and fees as revenue in the period during which the engineering
process design package for a plant licensed under the agreement is delivered and
the remaining 50% of the deposits and fees when the plant has passed agreed
performance tests. The amount of license revenue we earn will depend on the
construction of plants by licensees, as well as the number of licenses we sell
in the future.
Catalyst Revenues. We expect to earn revenue from the sale of our
proprietary catalysts to our licensees. Our license agreements require our
catalyst to be used in the initial fill for the licensee to receive our process
guarantee. After the initial fill, the licensee may use other catalyst vendors
if appropriate catalysts are available. The price for catalysts purchased from
us is equal to our cost plus a specified margin. We will receive revenue from
catalyst sales if and when our licensees purchase catalysts. We expect that
catalysts will need to be replaced every three to five years.
Specialty Product GTL Plant Revenues. We intend to develop several
specialty product GTL plants in which we intend to retain significant equity
interests. These plants will enable us to gain experience with the commercial
operation of the Syntroleum Process and, if successful, are expected to provide
us ongoing revenues. The anticipated specialty products of these plants (i.e.,
synthetic lube base oils, synthetic drilling fluid, waxes and liquid normal
paraffins) have historically been sold at premium prices and are expected to
result in relatively high margins. We anticipate forming several joint ventures
with oil and gas industry and financial partners in order to finance and operate
these plants.
Revenues from Providing GTL Plants on a Contract Basis. Through joint
efforts with industry partners and others, we may make mobile GTL plants
available to customers on a contract basis. We believe that there is a market
for users who need GTL plants for applications that do not justify the capital
investment of a dedicated GTL plant. We are currently doing preliminary design
work for these types of plants.
Joint Development Revenue. We continually conduct research and development
activities in order to reduce the capital and operating costs of GTL plants
based on the Syntroleum Process. We conduct our research and development
activities primarily through two initiatives: (1) independent development
utilizing our own resources and (2) formal joint development arrangements with
our licensee partners and others. Through these joint development agreements,
we may receive revenue as reimbursement for certain research and development
expenses. Under some agreements, the joint development partner may receive
credits against future license fees for monies expended on joint research and
development.
Real Estate Sales Revenues. As of September 30, 1999, our real estate
inventory consisted of (1) a seven-story parking garage in Reno, Nevada; (2) a
49.9% interest in a community shopping center in Gillette, Wyoming; (3) land
under development in Houston, Texas (336 acres comprising the "Houston Project")
and nine acres in Corinth, Texas, and (4) an equity investment in a hotel
located in Tulsa, Oklahoma. This real estate inventory was owned by SLH prior
to our merger with SLH and reflects the remaining assets of a real estate
development business that was conducted by SLH. The total real estate inventory
had an aggregate carrying value at September 30, 1999 of approximately $5.6
million. All of our real estate inventory is held for sale except for the
investment in the hotel located in Tulsa, Oklahoma. The Houston Project is
being developed for commercial and residential use and we have recently begun
selling residential lots to home builders. Subsequent to the end of the third
quarter, we entered into an agreement to sell our Reno, Nevada parking garage to
a casino operator in Reno for a purchase price of $3,000,000. Closing of the
transaction is subject to satisfaction of several conditions. If the
transaction closes, we expect to finance a portion of the purchase price.
Closing expected to occur late in the first quarter of 2000.
The timing of real estate sales will create variances in our period-to-period
earnings recognition. We do not intend to acquire additional real estate
holdings for development and/or sale other than as necessary for our core
business, and real estate sales revenues should decrease as the current real
estate inventory is liquidated.
8
OPERATING EXPENSES
Our operating expenses historically have consisted primarily of pilot
plant, engineering and research and development expenses and general and
administrative expenses, which include costs associated with general corporate
overhead, compensation expense, legal and accounting expense and other related
administrative functions. Our policy is to expense pilot plant, engineering and
research and development costs as incurred. All of these research and
development expenses are associated with our development of the Syntroleum
Process. We have also recognized depreciation and amortization expense
primarily related to office and computer equipment. Following our merger with
SLH, our operating expenses have also included costs of real estate sold and
real estate development expense. Our operating expenses have increased as we
have expanded our research and development, engineering and commercial
operations, and these expenses are expected to continue to increase. We also
expect to continue to incur higher pilot plant, engineering and research and
development expenses as we continue to develop and improve our GTL technology.
RESULTS OF OPERATIONS
OVERVIEW
During the third quarter of 1999, we continued our efforts on several
fronts to commercialize our GTL technology. Construction of the pilot plant
facility jointly developed by us with ARCO at ARCO's refinery located in Cherry
Point, Washington was completed and the plant was successfully started up in
July. The plant is currently being operated and we continue to gather data and
experience from plant operations which will be useful in our efforts to apply
this version of our GTL technology on a commercial basis.
We continued our activities to confirm catalyst performance and reactor
designs for our proposed Sweetwater project. These activities included
completion of the erection and operation of new pilot scale Fischer-Tropsch
reactors. Operation of these reactors will allow us to complete a battery of
confirmation tests and begin detailed engineering of our proposed Sweetwater
plant during the fourth quarter of 1999 or early in the first quarter of 2000.
We also continued our efforts to advance numerous other aspects of the
Sweetwater project. We have identified Australia and Trinidad and Tobago as
potential sites for the proposed Sweetwater plant. We are now engaged in
advanced negotiations regarding site location and related infrastructure and gas
supply. We are also in final negotiations with an engineering, procurement and
construction contractor to provide a fixed price for the design and construction
of the plant. While we are encouraged by our progress, there remain a number of
issues, including financing, to be addressed over the next several months in
order to successfully complete engineering and begin construction of this
proposed plant.
THREE MONTHS ENDED JUNE 30, 1999 COMPARED TO THREE MONTHS ENDED JUNE 30,
1998
Joint Development Revenue. Revenues from joint research and development
and pilot plant operations were $792,000 in the third quarter of 1999, up
$157,000 from the third quarter of 1998 when they were $635,000. The increase
was primarily due to revenue from ARCO in connection with research and
development activities related to the construction and preparation for start-up
of a GTL pilot plant at ARCO's Cherry Point, Washington refinery under a joint
development agreement with ARCO. This increase is partially offset by the
completion during 1998 of construction of the hybrid, multiphase (HMX) reactor
at our pilot plant that was funded by Texaco under our joint development
agreement.
Real Estate Sales. Real estate sales were $590,000 in the third quarter of
1999, down from $1,560,000 in the third quarter of 1998, when we sold our
remaining real estate in New Mexico. Real estate sales in the third quarter of
1999 reflect the sale of 32 lots of the Houston Project.
Other Revenues. Other revenues were $166,000 in the third quarter of 1999,
up from $119,000 in the third quarter of 1998. The increase resulted primarily
from parking and retail rentals at our parking garage in Reno, Nevada.
Cost of Real Estate Sales and Real Estate Operating Expense. The cost of
real estate sales was $345,000 in the third quarter of 1999, down from
$1,538,000 in the third quarter of 1998. The decrease resulted from reduced
real estate sales in 1999 compared to 1998. Real estate operating expenses were
$192,000 in the third quarter of 1999 compared to $145,000 in the third quarter
of 1998. These expenses include operating expenses relating to the development
or disposal of the remaining SLH real estate.
Pilot Plant, Engineering and R&D. Expenses from pilot plant, engineering
and research and development activities were $3,199,000 in the third quarter of
1999, up $1,968,000 from the third quarter of 1998 when these expenses were
$1,231,000. The increase occurred as a result of ongoing expansion of our
pilot plant facility and the purchase of equipment for our recently acquired
technology center, both in Tulsa, Oklahoma.
9
General and Administrative Expenses. General and administrative expenses
were $2,676,000 in the third quarter of 1999, down $167,000 from the third
quarter of 1998 when these expenses were $2,843,000. The decrease is
attributable to decreased outside professional fees as a result of higher
staffing levels, partially offset by higher rent expense.
Investment, Interest and Other Income (Expense). Investment, interest and
other income decreased to $387,000 in the third quarter of 1999, down $38,000
from the third quarter of 1998 when this income was $425,000. The decrease was
primarily attributable to minority interest expense incurred with respect to the
Houston Project in the third quarter of 1999.
Provision for Income Taxes. We incurred a loss in both the third quarter
of 1999 and the third quarter of 1998 and did not recognize an income tax
benefit for such loss.
Net Income (loss). In the third quarter of 1999, we experienced a loss of
$4,477,000. The loss was $1,459,000 higher than the third quarter of 1998 when
we experienced a loss of $3,018,000. The increase in the loss is a result of
the factors described above.
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 1998
Joint Development Revenue. Revenues from joint research and development
and pilot plant operations were $1,942,000 in the first nine months of 1999, up
$456,000 from the first nine months of 1998 when they were $1,486,000. The
increase was primarily due to revenue from ARCO in connection with research and
development activities related to the construction and preparation for start-up
of a GTL pilot plant at ARCO's Cherry Point, Washington refinery under a joint
development agreement with ARCO. This increase is partially offset by the
completion during 1998 of construction of the hybrid, multiphase (HMX) reactor
at our pilot plant that was funded by Texaco under the joint development
agreement with Texaco.
Real Estate Sales. Real estate sales were $1,110,000 in the first nine
months of 1999, down from $1,560,000 in the first nine months of 1998, when we
sold our remaining real estate in New Mexico. Real estate sales in the first
nine months of 1999 reflect the sale of two acres in the Kansas City
metropolitan area and 32 lots of the Houston Project.
Other Revenues. Other revenues were $491,000 in the first nine months of
1999, up from $119,000 in the first nine months of 1998. The increase resulted
primarily from higher parking and retail rentals at our parking garage in Reno,
Nevada.
Cost of Real Estate Sales and Real Estate Operating Expense. The cost of
real estate sales was $749,000 in the first nine months of 1999, down from
$1,538,000 in the first nine months of 1998. The decrease resulted from reduced
real estate sales during the 1999 period compared to the 1998 period. Real
estate operating expenses were $581,000 in the first nine months of 1999
compared to $145,000 in the first nine months of 1998. These expenses include
operating expenses relating to the development or disposal of our remaining real
estate.
Pilot Plant, Engineering and R&D. Expenses from pilot plant, engineering
and research and development activities were $7,736,000 in the first nine months
of 1999, up $4,227,000 from the first nine months of 1998 when these expenses
were $3,509,000. The increase occurred as a result of ongoing expansion at the
pilot plant facility and the purchase of equipment for our recently acquired
technology center, both in Tulsa, Oklahoma.
General and Administrative Expenses. General and administrative expenses
were $7,355,000 in the first nine months of 1999, up $86,000 from the first nine
months of 1998 when these expenses were $7,269,000. The increase is
attributable to higher wages, salaries and other overhead costs resulting from
higher staffing levels as well as higher rent expense.
Investment, Interest and Other Income (Expense). Investment, interest and
other income increased to $1,538,000 in the first nine months of 1999, up
$908,000 from the first nine months of 1998 when this income was $630,000. The
increase was primarily attributable to interest income from higher cash balances
following the merger with SLH.
10
Provision for Income Taxes. We incurred a loss in both the first nine
months of 1999 and the first nine months of 1998 and did not recognize an income
tax benefit for such loss.
Net Income (loss). In the first nine months of 1999, we experienced a loss
of $11,340,000. The loss was $2,674,000 greater than the first nine months of
1998 when we experienced a loss of $8,666,000. The increase in the loss is a
result of the factors described above.
LIQUIDITY AND CAPITAL RESOURCES
GENERAL
As of September 30, 1999, we had $30,935,000 in cash and short-term
investments and $2,358,000 in current liabilities. We do not currently have any
material outstanding debt or lines of credit. Prior to our merger with SLH, our
primary sources of liquidity were equity capital contributions and prepaid
license fees and our principal liquidity needs were to fund expenditures
relating to research and development and pilot plant activities and to fund
working capital. At September 30, 1999, we had $2,614,000 in accounts and notes
receivable outstanding which are primarily related to joint development
activities with our joint development partners.
Cash flows used in operations were $12,121,000 in the first nine months of
1999 compared to $8,909,000 during the first nine months of 1998. The increase
in cash flows used in operations during the first nine months of 1999 compared
to the first nine months of 1998 was primarily the result of an increase in
expenditures on real estate under development in Houston, Texas, and continued
expenditures on pilot plant, engineering and research and development
activities. The increase was partially offset by our sale of the remaining two
acres of real estate in Kansas City and the sale of 32 lots of the Houston
Project.
Cash flows provided by (used in) investment activities were $(1,541,000) in
the first nine months of 1999 compared to $24,878,000 in the first nine months
of 1998. The increase in cash flows used in investing activities in the first
nine months of 1999 compared to the first nine months of 1998 resulted from the
maturity of SLH investments and lower spending on property and equipment.
Cash flows provided by financing activities were $5,955,000 in the first
nine months of 1999 compared to $1,702,000 in the first nine months of 1998.
The increase was primarily due to the receipt of approximately $6.0 million in
satisfaction of a judgment in our favor which was a contingency of the merger
with SLH. These funds have been recorded as additional paid in capital. Cash
flows in 1998 primarily reflected the investment by Enron in
Syntroleum/Sweetwater Company, LLC.
The construction of our specialty product GTL plants will require
significant capital expenditures. Our other efforts to commercialize the
Syntroleum Process will also involve significant expenditures. We intend to
seek additional funding through joint ventures, partnerships, license agreements
and other strategic alliances, as well as various other financing arrangements.
We may also seek debt or equity financing in the capital markets. In the event
necessary capital resources are not available to us, our GTL plant development
and other activities may be curtailed.
INITIAL SPECIALTY PRODUCT GTL PLANT
In May 1997, we formed a joint venture to develop, own and operate an 8,000
to 10,000 barrel-per-day specialty product GTL plant which is known as the
"Sweetwater project". We have issued a site license and contributed a total of
$2 million to the joint venture. The original structure of the joint venture
provided for our contribution of an additional $15 million at the closing of the
financing for the plant and we would retain a majority interest. In January
1998, Enron contributed $1 million in exchange for a four percent interest in
the joint venture and agreed to contribute an additional approximately $14
million in exchange for an additional seven percent interest upon the
satisfaction of certain conditions, including the execution of agreements which
provide for the remaining equity and debt financing for construction of the
plant, the execution of fixed price engineering and construction contracts, and
the execution of acceptable agreements for the sale of products produced at the
plant.
11
The Sweetwater project originally anticipated that the plant would be located in
the United States. However, because of the availability of large quantities of
foreign gas at prices significantly below prices for gas available in this
country and the resulting favorable impact on the economics of the project, we
have been actively pursuing various foreign sites for the plant's location. As
a result, we anticipate that the structure and terms of the original Sweetwater
project joint venture will be modified if, and when, a foreign site is finally
selected.
The capital costs of the Sweetwater project are currently expected to be
funded by a combination of project senior and subordinated debt and equity
financing. Our actual ownership percentage and the ownership percentage of any
other equity investors will depend on the terms of the debt and equity
financings.
During the first nine months of 1999, we continued to pursue development of
the Sweetwater project. We are currently reviewing preliminary design and cost
estimates for the plant and exploring sources of debt and equity capital to fund
final design and construction. However, there can be no assurance that the
necessary capital for this project will be obtained. The site and schedule for
construction of this plant has not yet been finally determined.
YEAR 2000 COMPLIANCE
Historically, certain computerized systems have used two digits rather than
four digits to define the applicable year, causing them to not properly
recognize a year that does not begin with "19." This could result in major
failures or miscalculations and is generally referred to as the "Year 2000
issue." We recognize that the impact of the Year 2000 issue extends beyond
traditional computer hardware and software to automated systems and
instrumentation, as well as to third party vendors, suppliers, customers, banks
and to the securities markets.
Our computer hardware and software and automated systems and
instrumentation were acquired during the past two years. Based on the recent
date of purchase and assertions made by the vendors of these systems, we believe
these systems are Year 2000 compliant.
With respect to external parties, we are in the process of completing our
assessment of the level of risk to us of non-compliance by the external parties
and, to the extent we deem necessary, we contacted those external parties deemed
to be significant to our operations. Based on assertions made by these external
parties, we do not believe that a material uncertainty exists of noncompliance
by an external party which would significantly affect our operations.
Because of the number of external risks involved, we believe there is
likely to be some disruption in our business as a result of noncompliance by
third parties. Of all the external risks, we believe that the most reasonably
likely worse case scenario would be a business disruption resulting from lack of
utilities such as electric power, gas and water service as well as failure of
telephone service. Based on our information regarding the readiness of third
parties, we expect that any Year 2000 disruption would be of short duration.
However, we are unable to determine the potential business interruption costs
that might be incurred as a result of Year 2000 disruptions.
We are currently exploring contingency plans in the event of possible business
interruptions. We intend to address possible emergency situations such as the
need for security, power outages and telecommunications failures. In
particular, on December 31, 1999, we intend to shut down most of our computer
based systems in order to guard against possible damage to those systems or loss
of data as a result of such failures. We expect that our contingency planning
will continue to the end of 1999 and the beginning of 2000.
The total cost of Year 2000 activities to date has not been, and future costs
are not expected to be, material to our operations, liquidity or capital
resources. Despite our assessment to date, there can be no assurance as to the
ultimate effect that the Year 2000 issues will have on us.
Our assessment of Year 2000 issues involves many assumptions, and our
assumptions may prove to be inaccurate and actual results could differ
significantly from these assumptions. In conducting our Year 2000 compliance
efforts, we have relied primarily on seller representations with respect to our
internal computerized systems and representations from third parties with which
we have business relationships and have not independently verified these
representations. These representations might not prove to be accurate. We
could be adversely affected by business disruptions of a greater magnitude than
anticipated or from a failure of our contingency plans to adequately address
problems. We are also continuing to monitor Year 2000 risks and compliance and
expect this work to continue through 2000.
12
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities. SFAS No.
133 establishes accounting and reporting standards requiring that every
derivative instrument (including certain derivative instruments embedded in
other contracts) be recorded in the balance sheet as either an asset or
liability measured at its fair value. SFAS No. 133 requires that changes in
the derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's gains and losses to offset related results on the hedged
item in the income statement. Companies must formally document, designate and
assess the effectiveness of transactions that receive hedge accounting. SFAS
No. 133, as amended by SFAS No. 137, is effective for fiscal years beginning
after June 15, 2000. However, companies may elect to adopt SFAS No. 133 prior
to that date. SFAS No. 133 cannot be applied retroactively and must be applied
to (a) derivative instruments and (b) certain derivative instruments embedded in
hybrid contracts that were issued, acquired, or substantively modified after
December 31, 1997. We have not yet determined the timing or effect of adopting
SFAS No. 133.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We had short-term investments in the form of U.S. Treasury securities as of
September 30, 1999. The majority of these securities mature in less than 90
days. Our policy is to hold short-term securities to maturity which minimizes
interest rate risk. The average interest rate on these investments at September
30, 1999 was approximately 5.3%.
We do not currently conduct any material operations in foreign markets.
Accordingly, we do not have material market risk related to foreign exchange
rates.
We do not purchase futures contracts nor do we purchase or hold any
derivative financial instruments.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Not applicable.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
13
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
ITEM 5. OTHER INFORMATION.
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
Reports on Form 8-K. Not applicable.
Exhibits. The following exhibits are filed as part of this quarterly
report:
27 Financial Data Schedule.
____________________
* Incorporated by reference as indicated.
14
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SYNTROLEUM CORPORATION, a Delaware
corporation (Registrant)
Date: November 11, 1999 By: /s/ Mark A. Agee
----------------
Mark A. Agee
President and Chief Operating
Officer
Date: November 11, 1999 By: /s/ Randall M. Thompson
-----------------------
Randall M. Thompson
Chief Financial Officer
(Principal Financial
Officer)
15
INDEX TO EXHIBITS
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
- ------- ---------------------------------------------------------------
27 Financial Data Schedule.
____________________
* Incorporated by reference as indicated.
16