We are seeking to develop and employ innovative technology to produce synthetic liquid hydrocarbons that are substantially free of contaminants normally found in conventional products made from crude oil. We are
focusing our efforts on projects that will allow us to use our proprietary processes for converting various feedstocks, including natural gas, or synthesis gas from coal or biomass or other materials into synthetic liquid hydrocarbons. The
Fischer-Tropsch process when used in converting natural gas to liquids is generally known as “GTL”; when used in converting coal to liquids as “CTL” and when used in converting biomass to liquids as “BTL.”
We also seek to form joint ventures for projects and acquire equity interests in these projects. We license our technologies, which we refer to as the
“Syntroleum Process” and the “Synfining Process,” to others. We believe that our use of air in the Syntroleum Process provides our GTL technology with a competitive advantage compared to other technologies that use pure oxygen,
thereby allowing us to deploy marine based facilities (“GTL Mobile Facility”), and avoid the operating risks associated with using pure oxygen.
We are currently investing a significant amount of our resources into potential international or domestic GTL or CTL projects that we believe offer the greatest potential to meet our objective of generating cash flow
and utilizing the advantages of our processes. We have projects ongoing and at varying stages of development with co-venturers and licensees in various geographical areas, including, Papua New Guinea, China, Egypt and the United States. We have
conducted testing that resulted in the production of research quantities of renewable fuels from a variety of liquid vegetable and animal fat feedstocks. We continue to evaluate this technology and possible future business opportunities.
We are incurring substantial operating and research and development costs with respect to developing and commercializing the Syntroleum Process, our
proprietary process of converting natural gas or gasified coal into synthetic liquid hydrocarbons, and the Synfining Process, our proprietary process for refining synthetic liquid hydrocarbons, and do not anticipate recognizing any significant
revenues from licensing our technology or from production from either a GTL or CTL plant in which we own an interest in the near future. As a result, we expect to continue to operate at a loss until sufficient revenues are recognized from licensing
activities, commercial operation of GTL or CTL plants or non-Fischer Tropsch projects we are developing. We may obtain funding through joint ventures, license arrangements and other strategic alliances, as well as various other financing
arrangements to meet our capital and operating needs for various projects. We are currently exploring alternatives for raising capital to commercialize our GTL and CTL business, including the development, and demonstration of effectiveness, of our
technology with coal-derived synthesis gas. Our longer-term survival will depend on our ability to obtain additional revenues or financing.
On January 25, 2007, we signed a non-binding memorandum of understanding (“MOU”) with the China Petrochemical Technology Company (“ST”) to establish a joint technology development effort to advance Fischer-Tropsch
technology in China based on Syntroleum’s nitrogen diluted synthesis gas conversion technology, and to determine the most advantageous alternatives to jointly market Fischer-Tropsch technology in China.
We began business as GTG, Inc. on November 15, 1984. On April 25, 1994, GTG, Inc. changed its name to Syntroleum Corporation. On August 7,
1998, Syntroleum Corporation merged into SLH Corporation. SLH Corporation was the surviving entity in the merger and was renamed Syntroleum Corporation. Syntroleum Corporation was later re-incorporated in Delaware on June 17, 1999 through its
merger into a Delaware corporation that was organized on April 23, 1999.
GTL and CTL Projects
The Syntroleum Process produces synthetic liquid hydrocarbons that are substantially free of contaminants normally found in conventional products made
from crude oil. These synthetic liquid hydrocarbons can be further processed into higher margin products through conventional refining processes and our Synfining Process. These products include:
•
Ultra-clean liquid fuels for use in internal combustion engines, jet/turbine engines (subject to certification), diesel engines and fuel cells; and
•
Specialty products , such as synthetic lubricants, process oils, high melting point waxes, liquid normal paraffins, and chemical feedstocks.
We believe the key advantages of our GTL technology over traditional GTL technologies are (1) the use of air in the
conversion process, which is inherently safer than the requirement for pure oxygen in other GTL technologies, and (2) the use of our proprietary catalysts, which we believe will provide operating cost efficiencies. We believe these advantages
will permit smaller plant sizes that could be mounted on barges and ocean-going vessels. Based on demonstrated research, including the advancement of our technology from the laboratory to pilot plant and demonstration facility scales, and current
market conditions, we believe that our single-train commercial design of 17,000 barrels per day (“b/d”) stand-alone facility can be economically developed. Economies of scale can be achieved with incremental trains. Additionally, we
believe that our single-train design could be increased to over 20,000 b/d. However, the economic application of our technology at any particular plant will depend on the cost of feedstock, plant operating conditions, including among other things,
the then-current market conditions and, in the case of GTL plants, the volume amount of oil, condensate and liquefied petroleum gas or propane that is produced along with the natural gas.
We believe the advantages afforded by the Syntroleum Process together with the large worldwide resource base of natural gas provide market opportunities
for the use of this technology by us and our licensees in the development of commercial GTL plants. These market opportunities include the application of our technology to undeveloped natural gas reserves, flared gas, recycled gas, and gas
constrained due to market limitations.
In addition to enabling monetization of natural gas, we believe that our Fischer-Tropsch
(“FT”) technology can be applied to coal. The largest coal reserves are located in the United States, Russia, India, China and Australia. Much of these reserves have not been developed because of environmental concerns and distance to
markets. By applying the Syntroleum Process, integrated with third party gasification and synthesis gas cleanup technology, undeveloped or underdeveloped coal resources could be converted to ultra-clean transportation fuels, thus providing a new
source of clean energy and reducing dependence on oil from politically unstable regions.
While we have not yet built a commercial-scale
GTL plant based on the Syntroleum Process, we have demonstrated numerous elements and variations of the major catalytic reactions that are part of the Syntroleum Process in a fully integrated demonstration facility. These major catalytic reactions
include the autothermal reforming of natural gas to Synthesis Gas, or Syngas, and the Fischer-Tropsch synthesis to convert the Syngas into paraffin-like synthetic crude. We have also demonstrated our Synfining Process, which involves the
hydro-processing of the synthetic crude to produce finished products. We have completed numerous tests and observations on each of these reactions in demonstration plant operations, pilot plant operations and laboratory tests, including:
•
operation of the demonstration plant located at the Tulsa Port of Catoosa (the “Catoosa Demonstration Facility” or “CDF”) since March 2004 as
part of the Department of Energy (“DOE”) Ultra-Clean Fuels Production and Demonstration Project ( the “DOE Catoosa Project”) with Marathon Oil Company (“Marathon”) which was completed in 2005;
•
operation of the CDF since the completion of the DOE Catoosa Project for the production of additional fuels, extension of our operating experience and for our own
research and development purposes and production of over 100,000 gallons of synthetic jet fuel (when certified) for the United States Department of Defense (“DOD”);
•
operation of the Cherry Point Refinery demonstration facility in Blaine, Washington with Atlantic Richfield Company (“ARCO”) for approximately one year;
•
several years of operations at our Tulsa-based pilot plant under various operating conditions; and
•
preparation and testing of various concepts and designs in our laboratories.
These reactions have produced synthetic liquid hydrocarbons in anticipated amounts. For a discussion of
our intellectual property rights, see “ – Intellectual Property”.
In September 2006, we completed the production of our
contract committed volume of fuels of approximately 104,000 gallons to the DOD. In addition, we also successfully completed the longest run of our catalyst testing activity at the Tulsa Pilot Plant. In line with the program completion of our
demonstration plants, we suspended operations at both facilities.
We currently have a number of licensing agreements with oil companies
plus the Commonwealth of Australia and have an active project under development with current licensee Ivanhoe Energy Inc. (“Ivanhoe”). This agreement is described under “ – Licensing Agreements”. In addition, we are pursuing
the development of various projects in Papua New Guinea, China and the United States. We also have strategic relationships with various companies in support of the Syntroleum Process, including AMEC Process and Energy Ltd., Mustang Engineering,
L.P., and Black and Veatch Corporation with which we have entered into agreements allowing access to our confidential engineering systems, technology and information.
We had previously been pursuing projects in which we intended to participate in the development, production and processing of hydrocarbons. In fourth quarter 2006, we exited our international oil and gas activities as
part of our strategy of focusing our efforts on specific goals and projects that have GTL and CTL potential. A similar decision related to our oil and gas activities in the United States was made in October 2005.
Business Strategy
Our objective is to be the leading
provider of Fischer-Tropsch and related technologies for the production of synthetic fuels. Our business strategy to achieve this objective involves the following key elements:
Participate in Development Projects. We intend to establish equity participation in projects involving monetization of natural gas and coal assets
and associated activities. We are actively pursuing such projects involving natural gas and coal development in Papua New Guinea, China and the United States. Under this strategy, we will provide our GTL, CTL and related technologies to work with
companies that have resources that can be economically monetized with our technology through individual site licenses.
License the
Syntroleum Process. We plan to support our existing and future licensees in their efforts to develop new GTL and CTL plants through both our process optimization and our commercial and engineering support activities. Our license agreements
obligate us to apprise licensees of upgrades and improvements in the Syntroleum Process. We believe that our research and development capabilities combined with our demonstration and pilot plant testing facilities provide advantages over competing
and alternative technologies. We also believe these advantages enable us to maintain strong relationships with existing licensees and gain project participation opportunities for us.
Expand and Develop Product Markets. We intend to continue developing markets for our synthetic fuels in order to promote construction of GTL and
CTL plants by us and our licensees, and to establish markets for GTL and CTL products from plants. Based on the results of our completed research and development activities, we believe that our technology can provide economic and environmentally
superior transportation fuels, including diesel and jet fuel when certified. These fuels when produced through the Syntroleum Process and Synfining Process are virtually free of sulfur and aromatics and can be transported to the end user through the
existing distribution infrastructure. We also believe that availability of these fuels will foster the development and economic application of existing diesel engines, fuel cells and other clean combustion technologies. Additionally, we are
exploring the applicability of our technologies to renewable energy. We have conducted testing that resulted in the production of research quantities of renewable fuels from a variety of liquid vegetable and animal fat feedstocks. We continue to
evaluate this technology and possible future business opportunities.
The Syntroleum Process
The Syntroleum Process involves two catalytic reactions: (1) conversion of natural gas into synthesis gas in our proprietary flameless autothermal reformer; and (2) conversion of the synthesis gas into
hydrocarbons over our proprietary Fischer-Tropsch catalyst. These reactions are expressed in the following equations:
Step 1
Conversion of Natural Gas to Synthesis Gas
Step 2
Fischer - Tropsch Synthesis
The flameless autothermal reformer (“ATR”) in the Syntroleum Process is similar to units used for
over 30 years in the ammonia industry. Different generations of our ATR design have operated since November 2003 in our Catoosa Demonstration Facility and have been operating since 1995 as the sole source of synthesis gas for our two b/d pilot plant
facility in Tulsa, Oklahoma. An earlier generation of this reformer design was also operated for over 6,500 hours at a 70 b/d demonstration facility with one of our licensees, ARCO, at its Cherry Point refinery in Washington State. The nitrogen in
the gas entering the autothermal reformer passes through the reactor essentially unchanged, although very low levels of other nitrogen compounds are produced. These trace contaminants may be removed from the process stream and are not incorporated
into the finished products in significant quantities.
In November 2005, Syntroleum engaged Eastman Chemical Company to provide
non-exclusive services and coal-derived syngas for use in a portable Fischer-Tropsch catalyst testing laboratory designed and built by us. The purpose of this $1+ million lab and testing program is to demonstrate performance of Syntroleum
cobalt-based FT catalyst using syngas produced from coal at a commercial gasification facility. The laboratory construction and installation was completed in November 2006 at Eastman’s coal gasification facility in Kingsport, Tennessee. The
testing program, funded 100% by Syntroleum, began in December and will continue through mid-2007 to gather catalyst performance data for use in development of reactor designs for future commercial coal-to-liquids plants using Syntroleum technology.
Initial production of FT waxes and light products was achieved in mid-December and the overall testing program is currently meeting Syntroleum expectations. A final analysis of the results of the program will be completed in mid-2007.
The Synfining Process
We have also developed
refining technology – the Synfining Process – for conversion of the Fischer-Tropsch products into a variety of products including diesel fuels, jet fuels subject to certification, lubricants, and other materials. The high purity and highly
paraffinic, or waxy, nature of the Fischer-Tropsch products generally require lower temperature processing conditions than conventional petroleum-derived feedstocks to obtain high yields of the desired products. This refining technology has been
used to produce fuels for testing by the DOE in its Ultra-Clean Fuels Program, automobile manufacturers in the United States and Japan as well as by the DOD and U.S. Department of Transportation (“DOT”). This refining technology will be
utilized in plants we construct and is available for license to our Syntroleum Process licensees and others. We are currently in the research and testing phase of our work with renewable fuels.
Syntroleum Technology Implementation
The Catoosa Demonstration Facility has produced ultra-clean diesel fuel and jet fuel (subject to certification) from natural gas using the Syntroleum Process and the Synfining Process. This is the first plant we have
built that incorporates our ATR, Fischer-Tropsch Process and Synfining Process on a single site. We completed the DOE Catoosa Project fuel production commitment during 2004. We completed delivery of ultra-clean diesel fuel to other project
participants during 2004 and 2005, including the Washington Metropolitan Area Transit Authority and the U.S. National Park Service at Denali National Park in Alaska for testing in bus fleets. We operated the Catoosa Demonstration Facility during
2005 to support additional fuel testing programs including those of the DOD and the DOT and to demonstrate GTL process technology and catalyst enhancements. In September 2006, we suspended operations at the Catoosa Demonstration Facility upon
completion of the testing activities.
Our goal in developing the Syntroleum Process and Synfining Process has been to reduce both the
capital and operating costs and the minimum economic size of a GTL or CTL plant. We have developed and continue to develop variations of our basic process design and make enhancements to our proprietary Fischer-Tropsch catalyst in an effort to lower
costs and increase the adaptability of the Syntroleum Process to a wide variety of potential applications. We are working with a number of engineering firms and manufacturers of catalysts with which we have entered into agreements allowing access to
our confidential engineering systems, technologies and information.
Although we believe that the Syntroleum Process can be utilized in
commercial-scale GTL and CTL plants, there can be no assurance that commercial-scale GTL or CTL plants based on the Syntroleum Process will be successfully constructed and operated or that these plants will yield the same results as those
demonstrated in a laboratory, pilot plant or demonstration plant. In addition, improvements to the Syntroleum Process currently under development may not prove to be commercially applicable. See “Item 1A. Risk Factors–Risks Relating to Our
Technology.”
Syntroleum Advantage
We believe that the Syntroleum Process and the Synfining Process will be an attractive solution for companies reviewing methods of producing their natural gas or coal reserves using non-traditional methods. We believe the Syntroleum Process
will enable owners of natural gas or coal reserves to monetize a portion of these resources by converting them into synthetic liquid hydrocarbons in the form of ultra-clean fuels, based on our belief that these products can be:
•
produced substantially free of undesirable products normally found in fuels and specialty products made from crude oil;
•
used as blending stock to upgrade conventional fuels and specialty products made from crude oil;
•
used unblended in traditional internal combustion engines to reduce emissions;
•
used in advanced internal combustion engines and fuel-cells that require sulfur-free fuels; and
•
transported through existing distribution infrastructures for crude oil and refined products.
Resource Base
Set forth below and elsewhere in this
Annual Report on Form 10-K are estimates of identified reserves of oil, natural gas and coal. These estimates do not constitute proved reserves in accordance with the regulations of the SEC. Under SEC regulations, proved oil and gas reserves are the
estimated quantities of crude oil, natural gas and natural gas liquids, which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating
conditions ( i.e. , prices and costs as of the date the estimate is made). Under SEC regulations, proven coal reserves are the reserves for which (a) the quantity is computed from dimensions revealed in outcrops, trenches, workings or
drill holes, and the grade and/or quality are computed from the results of detailed sampling, and (b) the sites for inspection, sampling and measurement are spaced so closely and the geologic character is so well defined that size, shape, depth
and mineral content of reserves are well-established. We compiled these estimates of identified reserves from the referenced
industry publications and other publicly available reports to identify the magnitude of the natural gas and coal resource base. We have not independently
verified this information. Accordingly, we cannot provide assurance as to the existence or recoverability of the estimates of identified reserves of oil, natural gas and coal set forth in this Annual Report on Form 10-K. References below and
elsewhere in this Annual Report on Form 10-K to the conversion of identified amounts of natural gas and coal into amounts of synthetic crude oil assume that all of the referenced natural gas and coal could be converted at anticipated conversion
rates. Actual amounts of synthetic crude oil produced will vary based on the ability of the producer to extract the natural gas and coal, the composition of the natural gas and coal and process conditions selected for the plant, and this variance
may be material.
Natural Gas
The
following table presents the 2005 worldwide identified natural gas reserves, consumption and ratio of reserves to consumption ( i.e. , reserve life) by region:
2005 Worldwide Natural Gas Reserves, Consumption and Reserve Life
Region
Reserves
Annual
Consumption
Reserve
Life
(TCF)
(TCF)
(years)
Central and South America
247.8
4.4
51.8
Africa and the Middle East
3,054.1
11.4
189.7
Asia Pacific
523.7
14.4
41.2
Europe and the Commonwealth of Independent States
2,259.4
39.6
60.3
North America
263.3
27.3
10.1
Total
6,348.3
97.1
65.3
Source:
Information derived from BP Statistical Review of World Energy 2006.
World natural gas reserves have increased in recent years. Identified gas reserves in 1993 were estimated to be approximately 4,981 trillion cubic feet (“TCF”), according to the BP Statistical Review of
World Energy 2006. However, by 2005, natural gas reserves were estimated to be approximately 6,348 TCF. This increase occurred while the demand for natural gas increased 25 percent over the same time period.
A significant amount of gas also exists that is not included in the natural gas reserves indicated above. The gas not identified as reserves has been
discovered but has no economic market or production with associated oil would be too prolific for the limited markets available. Typically this low value gas is managed by either not producing the reservoir, flaring, venting, or re-injecting the
natural gas into the geologic formation from which it is produced while producing the oil reserves.
We believe that energy companies will
be able to cost-effectively use our GTL technology to produce fuels that can be sold in well-developed global markets. As a result, we believe these companies would be able to generate a return on these already discovered reserves, which are
currently undeveloped.
Coal
In
addition to enabling monetization of stranded natural gas, we believe our Fischer-Tropsch technology can be applied to coal as well. According to BP Statistical Review of World Energy 2006, identified world coal reserves in 2005 were approximately
909,064 million tons. The largest coal reserves are located in the United States, Russia, China, India and Australia. Much of these reserves are difficult and expensive to utilize because of environmental concerns and distance to traditional
power markets. By applying the Syntroleum Process, these underused coal resources could be converted to ultra-clean transportation fuels, thus providing a new source of clean energy and reducing dependence on oil from politically unstable regions.
Market Demand
We believe significant market potential exists for the Syntroleum Process and products because of steadily increasing demand for transportation fuels, the anticipated increased demand for ultra-clean fuels for both internal combustion
engines and fuel cells, and the existing demand for high-quality specialty products—underpinned by the vast amounts of natural gas and coal worldwide.
We expect demand for products created via Syntroleum technologies to result from the following factors:
The Large Market for Transportation Fuels. According to the Energy Information Administration, diesel fuel demand is estimated to be growing at a faster rate than the total demand for refined products due to superior fuel efficiency
of the diesel engine. Based on a study completed by the National Energy Policy Development Group, oil consumption in the United States is expected to increase 32 percent by 2020 primarily due to the growth in consumption of transportation fuels.
Based on our belief that the Syntroleum Process can produce ultra-clean transportation fuels, we believe that a portion of the demand growth can be satisfied through our process, although the amount of this demand actually satisfied through our
process will depend on the number of products from any commercial plants that are constructed.
Increasing Demand for Ultra-Clean
Fuels. Market demand for ultra-clean fuels is increasing due to more stringent environmental standards in most of the world’s industrialized countries and the need for vehicle manufacturers to respond to the challenge of producing
fuel-efficient engines that meet these standards. The burden of producing cleaner fuels from conventional crude oil is expected to substantially increase refining costs. We believe these factors will promote the creation of markets for premium,
ultra-clean fuels produced by the Syntroleum Process. In addition, we believe that fuels produced by the Syntroleum Process, either alone or blended with conventional fuels, can be used in existing and new generation diesel engines on a
cost-effective basis to meet or exceed current and scheduled fuel specifications and emissions standards.
Increasingly Restrictive
Environmental Legislation. Key domestic and international environmental regulations and initiatives that affect the demand for ultra-clean fuels include the Clean Air Act of 1970, which establishes specific responsibilities for government and
private industry to reduce emissions from vehicles, factories and other pollution sources. In December 1999, the U.S. Environmental Protection Agency (“EPA”) issued rules mandating that sulfur levels in highway diesel fuel be lowered from
the then current level of 500 parts per million (“ppm”) to 15 ppm beginning in 2006.
Government Legislation. In 2005, the
U.S. government enacted two significant pieces of legislation, the “Energy Policy Act of 2005” (EPACT) and the “Safe, Accountable, Flexible, Efficient Transportation Equity Act: A Legacy for Users” (SAFETEA-LU), aimed at
addressing a new, comprehensive national energy policy to promote domestic energy security. Both laws included incentives in the form of tax credits to facilitate the use of coal and renewable sources of feedstock as a means of achieving more
domestic energy security, whether from clean coal power generation technology, motor vehicle fuels produced from a Fischer-Tropsch process or transportation fuels produced from renewable feedstock using alternative technology. While the U.S.
government did not advance any major Fischer-Tropsch legislative efforts in 2006 as were accomplished in 2005, we continue to monitor the actions of the U.S. government in the area of cleaner transportation fuels.
The European Union currently requires that its road transport diesel fuel not exceed 50 ppm sulfur content, and the Commission of the European
Communities has provisionally stated that road transport diesel fuel with less than 10 ppm sulfur content must be made available on a broad geographic basis within each member state of the European Union by January 1, 2009. Most recently in
January 2007, the European Commission proposed new standards for transport fuels to include greater use of biofuels aimed at reducing their contribution to climate change and air pollution.
We believe that fuels produced by the Syntroleum Process are positioned to take advantage of the demand for ultra-clean fuels that we expect will develop
as a result of these stringent emission standards. This belief is based on the characteristics of fuels produced by the Syntroleum Process, which are substantially free of contaminants – sulfur and aromatics – and demonstrate high
operating efficiency. As a result, we believe that fuels produced by the Syntroleum Process, either alone or blended with conventional fuels, can be cost-effectively used to meet scheduled fuel specifications.
Increasing Demand for Fuel Cells. Fuel cells combine hydrogen – which can be derived from
natural gas, propane, methanol, gasoline or diesel – with oxygen from the air to produce electric power without combustion. Fuel cell systems have advantages over conventional power systems, which include low or no pollution, higher fuel
efficiency, greater flexibility in installation and operation, quiet operation, low vibration and potentially lower maintenance and capital costs. Fuel cells are being developed to support a variety of markets, including transportation and
continuous stationary (residential and commercial) power.
Because fuels produced by the Syntroleum Process are substantially free of
contaminants and have greater hydrogen content than other liquid fuels, we believe that fuels produced by the Syntroleum Process have the potential to become preferable fuel cell fuels and to significantly enhance commercial opportunities for many
fuel-cell applications. The absence of contaminants from fuels produced by the Syntroleum Process allows for simplified fuel cell processor design, construction and operation. As the storage and processing of the fuel for a fuel cell are simplified,
the physical size of a fuel-cell system can be reduced. Because fuels produced by the Syntroleum Process have almost twice the hydrogen content per volume of other commonly proposed fuel cell fuels, such as methanol, (a commonly proposed fuel cell
fuel) they enable greater utility and wider application of fuel-cell power for vehicles. We also believe that fuels produced by the Syntroleum Process have lower toxicity and similar solubility compared to conventional fuels, and can be distributed
via existing conventional fuel distribution infrastructure.
The Existing Market for High-Quality Specialty Products. Synthetic
crude oil produced by the Syntroleum Process can be further refined into specialty products using conventional refining processes that can be simplified to take advantage of the ultra-clean nature of the synthetic feedstock. We believe that
specialty products produced by the Syntroleum Process have environmental and performance characteristics that are superior to comparable conventional crude oil products.
Sales and Marketing
We intend to continue efforts to establish brand recognition for
“Syntroleum” through participation in conferences, press releases, providing fuels for testing with automobile and engine manufacturers, and our work with the DOE, DOD, DOT and other governmental agencies. “Syntroleum” is a
registered trademark and service mark in Argentina, Australia, Bolivia, Chile, the European Union, Japan, Peru, Brazil and the United States.
Licensing
Agreements
GTL Licenses. Traditionally, we have offered four categories of GTL license agreements, called master, volume,
regional and site.
•
Our master GTL license agreement generally grants to the licensee the non-exclusive, worldwide right to enter into an unlimited number of site license agreements to
construct GTL plants based on the Syntroleum Process to produce fuels.
•
Our volume GTL license agreement generally grants to the licensee the non-exclusive right to enter into an unlimited number of site license agreements to construct
GTL plants based on the Syntroleum Process, subject to specified aggregate production capacity limits.
•
Our regional GTL license agreement generally grants to the licensee the non-exclusive, limited right to enter into an unlimited number of site license agreements to
construct GTL plants based on the Syntroleum Process within a designated region.
•
Finally, our site GTL license agreement generally grants to the licensee the non-exclusive limited right to use the Syntroleum Process in a GTL plant at a single,
specified location for the life of the plant. This type of license may be granted under our master, regional or volume license agreements or may be granted to licensees for a specific site who have not otherwise entered into a master, regional or
volume license agreement.
Our licenses generally exclude the right to use the Syntroleum Process in areas of the world with which
we have intellectual property protection concerns and any countries prohibited by U.S. government commerce control laws; these areas may vary over time as countries change their laws and enforcement practices.
Under three different licensing programs that include prepaid deposits, a licensee receives pricing terms for future project site licenses and secures
(1) the right to use the Syntroleum Process, (2) the right to acquire catalysts from us for which we charge a fixed mark-up over our cost and (3) the right to future improvements in our GTL technology. Current GTL licensees include
BP, the Commonwealth of Australia, Ivanhoe, Kerr-McGee Corporation, Marathon, and Repsol-YPF, S.A. We have received an aggregate of $39.5 million in connection with our licensing agreements, which generally begin to expire in 2011.
In January 2007, we concluded our negotiations with Marathon to revise the prior master GTL license agreement. The new license agreement extends the term
of the license to 2017. For entering into this new agreement, Marathon agreed to terminate all of our obligations under the two promissory notes in the amount of $27.6 million (see “Non-current Debt Obligations” in Item 7). Under the
terms of the new master license agreement, Marathon retains the right to use the Syntroleum Process in its GTL projects, and, subject to Marathon paying us royalties for their improvements based upon the Syntroleum Process, they may conduct
independent research and development on FT reactions and catalysts. Furthermore, we have the obligation to make two payments of $3 million each to Marathon in December of 2008 and 2009, and we will no longer be obligated to disclose any further
improvements to the Syntroleum Process, provide process guarantees or indemnities for infringement to Marathon in GTL projects. Finally, the new master license agreement grants Marathon the right to access our CTL technology for use with coal and
petroleum coke, subject to then-current market rates at the time a CTL site license is requested.
CTL Licenses. We continue to
engage in discussions with potential CTL licensees, and, to date, only Marathon has obtained the right to access our CTL technology to construct CTL plants based on the Syntroleum Process. Outside of Marathon, we are focusing our efforts on CTL site
licenses where we would have the option to participate in the project as well as collect license fees. We have also considered exchanging license fees for equity in CTL projects. The license fee structure for our CTL licenses will be different than
our GTL licenses, reflecting increased market demand for the technology, as well as consideration for technology development support and options for equity participation by us.
Initial Deposits and CTL and GTL License Fees. Generally at the inception of a CTL or GTL license agreement, the licensee is required to make an
initial deposit to us, which is credited against future site-specific license fees. The amount of the initial deposit depends on market conditions, the size of the proposed plant, and geographic territory of the region covered. In some cases, we
have acquired technologies or commitments to provide funding for future development activities in lieu of initial cash deposits in cases where we viewed these technologies or commitments as being more valuable than the initial cash deposit.
The amount of our license fee is determined pursuant to a formula based on the discounted present value of the product of (1) the
annual maximum design capacity of the plant, (2) an assumed life of the plant and (3) an agreed royalty rate. Our license fees for new plants may change from time to time based on the size of the plant, improvements that reduce plant
capital cost and competitive market conditions. Our existing master and volume license agreements allow for the adjustment of fees for new site licenses under certain circumstances. We expect that license fees under existing GTL licensing agreements
will be paid in increments when certain milestones during the plant design and construction process are achieved.
Catalyst Sales and
Process Design Packages. Except for the new Marathon license, our existing license agreements grant the licensee the right to acquire from us or from vendors designated by us any proprietary catalyst used in either the synthesis gas reaction or
the Fischer-Tropsch reaction. We currently estimate that these catalysts will be required to be replaced every three to five years. Licensees also have the right to acquire proprietary reactors used in the Syntroleum Process. In addition, under our
license agreements, licensees are required to purchase from us or a designated engineering contractor a process design package for plants covered by the license on a time and material basis. We may develop the process design package with the
assistance of a third party engineering contractor. We are also required to provide certain technical support to licensees on a time and materials basis.
Other License Terms. As part of our network model for improving the Syntroleum Process, we
generally acquire a royalty-free, non-exclusive license to any invention or improvement to the Syntroleum Process that is developed by the licensee, together with the right to grant corresponding sublicenses to our other licensees who have granted
us similar rights. Licensees also generally acquire the right to use subsequent inventions or improvements to the Syntroleum Process that we acquire from other licensees. Licensees may, but are not required to, develop improvements to the Syntroleum
Process and may seek to obtain a patent on the improvements, either independently or jointly with us, and to license those improvements. Our license agreements may be terminated by the licensee, with or without cause, and without penalty, upon 90
days notice to us. For a further discussion of our license agreements and license fees, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Operating Revenues-License Revenues” in Item 7 of
this Annual Report on Form 10-K.
Agreement with ExxonMobil. In December 2004, we signed an agreement with ExxonMobil Research and
Engineering Company (“ExxonMobil”) whereby we were granted a worldwide license to use ExxonMobil's patented processes to produce and sell fuels from natural gas or other substances such as coal. In addition, we have the right to extend the
terms of this agreement to our licensees. The scope of this agreement includes the fields of syngas production, Fischer-Tropsch synthesis and product upgrading to make fuels and various processes that relate to these areas. It includes all existing
ExxonMobil patents (which number over 3,000 worldwide) and future improvement patents in these areas over the next several years. This agreement does not include patents covering certain specific catalyst formulations and manufacturing steps. We
have agreed that we will not enforce against ExxonMobil and its affiliates any patents that we obtain after the date of the license agreement, to the extent that those patents overlap with any of ExxonMobil’s patents. The ExxonMobil agreement
was amended in August 2006 to expand our rights to access the ExxonMobil technology into the areas of lubricating base oils and solvents.
Future License Agreements . As market conditions change, we consider the effects of those changes on the economic terms offered under license agreements. From time to time we may choose to change the terms of the license agreements
that we offer to the market. Prior terms may or may not reflect those we currently offer to third parties.
Research and Development
Our ongoing research and development strategy includes process documentation and improving the efficiency of the Syntroleum Process. Our expenditures for
research and development activities, including pilot plant, engineering and construction and operation of the Catoosa Demonstration Facility, totaled approximately $21.1 million, $22.4 million and $22.3 million in 2006, 2005, and 2004, respectively.
The current 2007 budget of $9.4 million for ongoing research and development efforts, including personnel costs, is focusing primarily on commercialization of the technology we previously have developed and to completing our FT technology
documentation. Additionally during 2006 we began exploring the applicability of our technologies to renewable energy. We have conducted testing that resulted in the production of research quantities of renewable fuels from a variety of liquid
vegetable and animal fat feedstocks.
Our research and development facilities include the following locations:
•
Catoosa Demonstration Facility —This facility houses a 70 b/d plant that initially produced products for the demonstration and testing under several
government contracts. This facility operated from March 2004 and completed fuel shipments in September 2006 to complete our commitments for the delivery of ultra-clean fuels as well as for our research and development demonstrations for licensees or
other potential customers.
•
Syntroleum Corporate Office and Technology Center —This facility houses our corporate offices and much of our research and development equipment,
including our Synfining Product Upgrading Unit. This unit manufactures finished fuels and specialty products to specifications for testing by our customers and us, which have included the DOD, DOE, and DOT, and a consortium of automobile
manufacturers from the U.S. and Japan. This facility is also home to our catalyst development and characterization, products, and gas chromatography laboratories.
•
Syntroleum Fischer-Tropsch Performance Laboratory —This laboratory houses and maintains the operational capacity to run four fixed bed reactors, two
horizontal shallow bed reactors, two U- tube de-waxing reactors and eleven continuously stirred-tank reactors (increasing to seventeen in 2007), as well as a particle size analysis instrument and supporting accessories.
•
Syntroleum Pilot Plant - The plant includes our Advanced Fischer-Tropsch Slurry Reactor Unit, which is utilized in demonstrating process performance such as
long term catalyst aging and conducting parametric studies requested by clients and engineering contractors involved in developing commercial GTL plants. In support of the Advanced Reactor Unit, we have a syngas generation process (ATR), steam
generation facilities, and a Fischer-Tropsch laboratory located at this facility that supports up to three continuous stirred tank reactors. Operations at this plant were suspended in September 2006 following successful completion of our longest run
of catalyst testing activities.
Intellectual Property
The success of our intellectual property portfolio depends on our ability to foster, invent and develop new ideas, to obtain, protect, and enforce our
intellectual property rights, to successfully avoid infringing the intellectual property rights of others and, if necessary, to defend against any alleged infringements. We regard the protection of our proprietary technologies as critical to our
future success, so we rely on a combination of patent, copyright, trademark and trade secret law and contractual restrictions to protect our proprietary rights. We protect the Syntroleum Process and the Synfining Process primarily through patents
and trade secrets. It is our policy to seek protection for our proprietary products and processes by filing patent applications, when appropriate, in the United States and selected foreign countries and to encourage or further the efforts of others
who have licensed technology to us to file patent applications. Our ability to protect and enforce these rights involves complex legal, scientific and factual questions and uncertainties. Our policy is to honor the valid, enforceable intellectual
property rights of others. While we have made efforts to avoid any such infringement, we acknowledge that commercialization of the Syntroleum Process may give rise to claims that the technologies infringe upon the patents or other proprietary rights
of others. We have not been notified of any claim that our GTL or CTL technologies infringes on the proprietary rights of any third party. However, we can provide no assurance that third parties will not claim infringement by us with respect to
past, present or future GTL or CTL technologies.
We currently own, or have licensed rights to, more than a combined 160 patents and patent
applications pending in the United States and various foreign countries that relate to one or more embodiments of Syntroleum technology. Our patents generally begin to expire in 2009 for the initial patents, which were issued in the late 1980s, and
in 2017 for most of our patents that have been issued since the late 1990s. Patent rights are granted for a term of years in the United States and foreign jurisdictions, subject to paying required fees to maintain the patent holder’s rights.
The cost of maintaining our patents in the United States and foreign jurisdictions is not material. In addition to patent protection, we also rely significantly on trade secrets, know-how and technological advances, which we seek to protect, in
part, through confidentiality agreements with our collaborators, licensees, employees and consultants. If these agreements are breached, we might not have adequate remedies for the breach. In addition, our trade secrets and proprietary know-how
might otherwise become known or be independently discovered by others.
In December 2004, we signed an agreement with ExxonMobil whereby we
were granted a worldwide license to use ExxonMobil's patented processes to produce and sell fuels from natural gas or other substances such as coal. In addition we have the right to extend the terms of this agreement to our licensees. The scope of
this agreement includes the fields of syngas production, Fischer-Tropsch synthesis, product upgrading to make fuels and various processes that relate to these areas. It includes all existing ExxonMobil patents (which number over 3,000 worldwide) and
future improvement patents in these areas over the next several years. This agreement does not include patents covering certain specific catalyst formulations and manufacturing steps. We have agreed that we will not enforce against ExxonMobil and
its affiliates any patents that we obtain after the date of the license agreement, to the extent that those patents overlap with any of ExxonMobil’s patents. The ExxonMobil agreement was amended in August 2006 to expand our rights to access the
ExxonMobil technology into the areas of lubricating base oils and solvents.
As part of our intellectual property program, we have reviewed
a large amount of Fischer-Tropsch patents and prior art literature. In conjunction with outside patent counsel, our technical staff and management have reviewed thousands of existing patents with respect to our own proprietary position and for
patent clearance related to specific projects. Together with licensees, we have spent more than $2.5 million to establish a strong patent position, and we do not believe our technology infringes on the valid enforceable patents of others. In
addition to
this effort, we have developed a large library of technical information related to the Fischer-Tropsch process and we are able to provide easy access to this
literature for the entire industry through our website, http://www.fischer-tropsch.org . This growing site now includes over 6,000 patents, 12,650 literature document references, 2,180 government reports, and approximately 225 of the U.S.
Technical Oil Mission microfilm reels. Recently, this website has had over 10,000 users and 100,000 hits per month from all parts of the world.
In any potential intellectual property dispute involving us, our licensees could also become the target of litigation. Generally, our license agreements require us to indemnify the licensees against specified losses, including the losses
resulting from patent and trade secret infringement claims, subject to a cap of 50 percent of the license fees received. Our indemnification and support obligations could result in substantial expenses and liabilities to us. These expenses or
liabilities could have a material adverse effect on our business, operating results and financial condition. See “Item 1A. Risk Factors-Risks Relating to Our Technology.”
Employees
As of March 1, 2007, we had 62 employees, none of which is represented by a labor
union. We have experienced no work stoppages.
Government Regulation
We are subject to extensive federal, state and local laws and regulations relating to the protection of the environment, including laws and regulations relating to the release, emission, use, storage, handling,
cleanup, transportation and disposal of hazardous materials, as well as to employee health and safety. Additionally, our GTL and CTL plants will be subject to environmental, health and safety laws and regulations of any foreign countries in which
these plants are located. Any GTL Mobile Facility may also be subject to the international treaties and laws relating to activities on the high seas. Violators of these laws and regulations may be subject to substantial fines, criminal sanctions or
third-party lawsuits. We may be required to install costly pollution control equipment or, in some extreme cases, curtail operations to comply with these laws. These laws and regulations may also limit or prohibit activities on lands lying within
wilderness areas, wetlands or other protected areas.
Our operations in the United States are also subject to the federal Comprehensive
Environmental Response, Compensation and Liability Act (“CERCLA”), also know as the “Superfund” law, and similar state laws, which can impose joint and several liability for site cleanup, regardless of fault, upon statutory
classes of persons, including our company, with respect to the release into the environment of substances designated under CERCLA as hazardous substances (“Hazardous Substances”). These classes of persons, or so-called potentially
responsible parties (“PRPs”), include the current and certain past owners and operators of a facility where there has been a release or threat of release of a Hazardous Substance and persons who disposed of or arranged for the disposal of
Hazardous Substances found at a site. CERCLA also authorizes the EPA and, in some cases, third parties to take actions in response to threats to the public health or the environment and to seek to recover from the PRPs the costs of such action. In
the course of our operations, we have generated and will generate wastes that may fall within CERCLA’s definition of Hazardous Substance. We may also be the owner or operator of sites on which Hazardous Substances have been released. To our
knowledge, neither we nor our predecessors have been designated as a PRP by the EPA under CERCLA. We also do not know of any prior owners or operators of our properties that are named as PRPs related to their ownership or operation of such
properties.
Environmental laws and regulations often require acquisition of a permit or other authorization before activities may be
conducted, and compliance with laws, regulations and any requisite permits can increase the costs of designing, installing and operating our GTL and CTL plants. GTL and CTL plants generally will be required to obtain permits under applicable
environmental laws of the country in which it is situated, as well as various permits for industrial siting and construction. Emissions from a GTL or CTL plant will contain nitrous oxides and may require the installation of abatement equipment in
order to meet applicable permit requirements. Additionally, GTL or CTL plants will be required to adhere to laws applicable to the disposal of byproducts produced, including waste water and spent catalyst.
Operation of our Tulsa-based pilot plant requires two annual permits regarding air emissions and industrial wastewater discharge to a sanitation sewer.
Operation of our Catoosa Demonstration Facility requires the following permits: air emissions; air
quality minor operating; industrial wastewater discharge; and storm water general. Each of these permits is renewed annually, with the exception of the storm water general permit, which expires on September 12, 2007. We do not expect the costs
to renew these permits to be material.
The following environmental regulations are applicable to the Catoosa Demonstration Facility: Clean
Air Act; Clean Water Act; Superfund Amendments and Reauthorization Act; Toxic Substance Control Agency; and Chemical Accident Prevention. We believe we are in substantial compliance with all of these regulations. We currently maintain a risk
management plan addressing these regulations. We do not expect the costs associated with this plan to be material.
Although we do not
believe that compliance with environmental and health and safety laws in connection with our current operations will have a material adverse effect on us, we cannot predict with certainty the future costs of complying with environmental laws and
regulations and containing or remediating contamination. In the future we could incur material liabilities or costs related to environmental matters, and these environmental liabilities or costs (including fines or other sanctions) could have a
material adverse effect on our business, operating results and financial condition. We currently carry environmental impairment liability insurance to protect us against these contingencies and may, in the future, seek to obtain additional insurance
in connection with our participation in the construction and operation of GTL and CTL plants, if coverage is available at reasonable cost and without unreasonably broad exclusions.
Our subsidiary, Scout Development Corporation (“Scout”), which owned our real estate assets sold in 2003, is subject to several U.S.
environmental laws, including the Clean Air Act, CERCLA, the Emergency Planning and Community Right-to-Know Act, the Federal Water Pollution Control Act, the Oil Pollution Act of 1990, the Resource Conservation and Recovery Act, the Safe Drinking
Water Act and the Toxic Substances Control Act. Scout is also subject to U.S. environmental regulations promulgated under these acts, as well as state and local environmental regulations that have their foundation in the foregoing U.S. environmental
laws. As is the case with many companies, Scout may face exposure to actual or potential claims and lawsuits involving environmental matters with respect to real estate that it has sold. However, no such claims are presently pending. Scout has not
suffered and does not anticipate that it will suffer a material adverse effect as a result of any past action by any governmental agency or other party, or as a result of noncompliance with such environmental laws and regulations.
Operating Hazards
Operations at our GTL and CTL
plants will involve a risk of incidents involving personal injury and property damage due to the operation of machinery in close proximity to individuals and the highly flammable nature of natural gas and the materials produced at these plants.
Depending on the frequency and severity of personal injury and property damage incidents, such incidents could affect our operating costs, insurability and relationships with customers, employees and regulators. Any significant frequency or severity
of these incidents, or the general level of compensation awards, could affect our ability to obtain insurance and could have a material adverse effect on our business, operating results and financial condition.
Available Information
Our website address is
www.syntroleum.com . We make our website content available for information purposes only. It should not be relied upon for investment purposes, nor is it incorporated by reference in this Annual Report on Form 10-K. We make available on
this website under “Investor Relations-Financial Information –Filings,” free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports as soon as reasonably
practicable after we electronically file those materials with, or furnish those materials to, the SEC. The SEC also maintains a website at www.sec.gov that contains reports, proxy statements and other information regarding SEC
registrants, including us. Additionally, the public may read and copy any materials filed with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549.
Item 1
A. Risk Factors
You should carefully consider the risks described below. The risks and uncertainties described
below encompass many of the risks that could affect our company. If any of the following risks actually occur, our business, financial condition or results of operations could be materially and adversely affected. In that case, the trading price of
our common stock could decline and you may lose all or part of your investment in us.
Risks Relating to Our Technology
We might not successfully commercialize our technology, and commercial-scale FT plants based on the Syntroleum Process may never be successfully
constructed or operated.
We do not have significant experience managing the financing, design, construction or operation of
commercial-scale FT plants, and we may not be successful in doing so. No commercial-scale FT plant based on the Syntroleum Process has been constructed to date. A commercial-scale FT plant based on the Syntroleum Process may never be successfully
built either by us or by our licensees. Success depends on our ability and/or the ability of our licensees to economically design, construct and operate commercial-scale FT plants based on the Syntroleum Process. Successful commercial construction
and operation of an FT plant based on the Syntroleum Process depends on a variety of factors, many of which are outside our control.
Commercial-scale FT plants based on the Syntroleum Process might not produce results necessary for success, including results demonstrated on a laboratory, pilot plant and demonstration basis.
A variety of results necessary for successful operation of the Syntroleum Process could fail to occur at a commercial plant, including reactions
successfully tested on a laboratory, pilot plant and demonstration plant basis. Results that could cause commercial-scale FT plants to be unsuccessful include:
•
lower reaction activity than demonstrated in the pilot plant and demonstration plan operations which would decrease the conversion of natural gas into synthesis gas
and increase the amount of catalyst, and/or number of reactors required to produce the design synthesis gas rate;
•
lower reaction activity than that demonstrated in laboratory, pilot plant and demonstration plant operations, which would increase the amount of catalyst or number
of reactors required to convert synthesis gas into liquid hydrocarbons and increase capital and operating costs;
•
shorter than anticipated catalyst life, which would require more frequent catalyst regeneration, catalyst purchases, or both, thereby increasing operating costs;
•
excessive production of gaseous light hydrocarbons from the Fischer-Tropsch reaction compared to design conditions, which would lower the anticipated amount of
liquid hydrocarbons produced and would lower revenues and margins from plant operations;
•
lower reaction activity than that demonstrated in laboratory, pilot plant and demonstration plant operations, which would increase the amount of catalyst or number
of reactors required to convert Fischer-Tropsch products into finished, marketable fuels;
•
inability of the gas turbines or heaters integrated into the Syntroleum Process to burn the low-heating-value tail gas produced by the process, which would result
in the need to incorporate other methods to generate horsepower for the compression process that may increase capital and operating costs;
•
inability of third-party gasification and synthesis gas clean-up technology integrated into the Syntroleum Process to produce quantities of quality synthesis gas
adequate for economic operation of a CTL plant; and
•
higher than anticipated capital and operating costs to design, construct and operate an FT plant.
In addition, these plants could experience mechanical difficulties related or unrelated to elements of the Syntroleum Process.
Many of our competitors have significantly more resources than we do, and GTL and CTL technologies
developed by competitors could become more commercially successful than ours or render our technology obsolete.
Development of GTL and
CTL technology is highly competitive, and other GTL and CTL technologies could become more commercially successful than ours. The Syntroleum Process is based on chemistry that has been used by several companies in synthetic fuel projects over the
past 60 years. Our competitors include major integrated oil companies that have developed or are developing competing GTL and CTL technologies, including BP, ConocoPhillips, ExxonMobil, Sasol (including its participation in a joint venture with
Chevron) and Shell. Each of these companies has significantly more financial and other resources than we do to spend for research and development of their technologies and for funding construction and operation of commercial-scale FT plants. In
addition to using their own GTL technologies in competition with us, these competitors could also offer to license their technology to others. Additionally, several small companies have developed and are continuing to develop competing GTL and CTL
technologies. The DOE has also sponsored a number of research programs relating to GTL and CTL technology that could potentially lower the cost of competitive processes.
As our competitors continue to develop GTL and CTL technologies, one or more of our current technologies could become obsolete. Our ability to create and maintain technological advantages is critical to our future
success. As new technologies develop, we may be placed at a competitive disadvantage, and competitive pressures may force us to implement new technologies at a substantial cost. We may not be able to successfully develop or expend the financial
resources necessary to acquire new technology.
Our ability to protect our intellectual property rights involves complexities and
uncertainties and commercialization of the Syntroleum Process could give rise to claims that our technology infringes upon the rights of others.
Our success depends on our ability to protect our intellectual property rights, which involves complex legal, scientific and factual questions and uncertainties. We rely on a combination of patents, copyrights,
trademarks, trade secrets and contractual restrictions to protect our proprietary rights. Additional patents may not be granted, and our existing patents might not provide us with commercial benefit or might be infringed upon, invalidated or
circumvented by others. In addition, the availability of patents in foreign markets, and the nature of any protection against competition that may be afforded by those patents, are often difficult to predict and vary significantly from country to
country. We, our licensors, or our licensees may choose not to seek, or may be unable to obtain, patent protection in a country that could potentially be an important market for our GTL or CTL technology. The confidentiality agreements that are
designed to protect our trade secrets could be breached, and we might not have adequate remedies for the breach. Additionally, our trade secrets and proprietary know-how might otherwise become known or be independently discovered by others.
Commercialization of the Syntroleum Process may give rise to claims that our technologies infringe upon the patents or proprietary rights
of others. We may not become aware of patents or rights that may have applicability in the GTL or CTL industry until after we have made a substantial investment in the development and commercialization of those technologies. Third parties may claim
that we have infringed upon past, present or future GTL or CTL technologies. Legal actions could be brought against us, our co-venturers or our licensees claiming damages and seeking an injunction that would prevent us, our co-venturers or our
licensees from testing, marketing or commercializing the affected technologies. If an infringement action were successful, in addition to potential liability for damages, our co-venturers, our licensees or we could be required to obtain a license in
order to continue to test, market or commercialize the affected technologies. Any required license might not be made available or, if available, might not be available on acceptable terms, and we could be prevented entirely from testing, marketing
or commercializing the affected technology. We may have to expend substantial resources in litigation, either in enforcing our patents, defending against the infringement claims of others, or both. Many possible claimants, such as the major energy
companies that have or may be developing proprietary GTL or CTL technologies competitive with the Syntroleum Process, have significantly more resources to spend on litigation.
We could have potential indemnification liabilities to licensees relating to the operation of FT plants based on the Syntroleum Process or
intellectual property disputes.
Our indemnification obligations could result in substantial expenses and liabilities to us if
intellectual property rights claims were to be made against us or our licensees, or if FT plants based on the Syntroleum Process were to fail to operate as designed. Generally, our license agreements require us to indemnify the licensee, subject to
a cap of 50 percent of the license fees we receive, against specified losses relating to, among other things:
•
use of patent rights and technical information relating to the Syntroleum Process;
•
acts or omissions by us in connection with our preparation of process design packages for plants; and
•
performance guarantees that we may provide.
Industry rejection of our technology would make the construction of GTL and CTL plants based on the Syntroleum Process more difficult or impossible and would adversely affect our ability to receive future license fees.
Demand and industry acceptance for our GTL or CTL technology are subject to uncertainty. Failure by the industry to accept our technology would make
construction of our FT plants more difficult or impossible, adversely affecting our ability to receive future license fees and generate other revenue. If a high profile industry participant were to adopt the Syntroleum Process and fail to achieve
success, or if any commercial FT plant based on the Syntroleum Process were to fail to achieve success, other industry participants’ perception of the Syntroleum Process could be adversely affected.
If ongoing work to enhance project economics and improvements to the Syntroleum Process is not commercially viable, the design and construction of
lower-cost FT plants based on the Syntroleum Process could be delayed or prevented.
If improvements to the Syntroleum Process
currently under development do not become commercially viable on a timely basis, the total potential market for FT plants that could be built by us and our co-venturers and by our licensees could be significantly limited. Improvements to the
Syntroleum Process are in various stages of development. These improvements may require substantial additional investment, development and testing prior to their commercialization. We might not be successful in developing these improvements and, if
developed, they may not be capable of being utilized on a commercial basis.
Risks Relating to Our Business
We will need to obtain funds from additional financings or other sources for our business activities. If we do not receive these funds, we would need
to reduce, delay or eliminate some of our expenditures.
We have sustained recurring losses and negative cash flows from operations.
Over the periods presented in the accompanying financial statements, our growth has been funded through a combination of equity and convertible debt financings and the sale of certain assets. As of December 31, 2006, we had approximately
$33,469,000 of cash and cash equivalents available to fund operations. We review cash flow forecasts and budgets periodically. We believe that we currently have sufficient cash and financing capabilities to meet our funding requirements until the
end of 2008. However, we have experienced , and continue to experience, negative operating margins and negative cash flows from operations, as well as an ongoing requirement for substantial additional capital investment related to construction of
GTL and CTL plants, research and development programs in which we participate and other activities.
We expect that we will need to raise
substantial additional capital to accomplish our business plan over the next several years. In addition, we may wish to selectively pursue equity partnerships in certain gas or coal monetization projects in order to achieve operating efficiencies.
We expect to seek to obtain additional funding through debt or equity financing in the capital markets, joint ventures, license agreements and other strategic alliances, as well as various other financing arrangements. If we obtain additional funds
by issuing equity securities, dilution to stockholders may occur. In addition, preferred stock could be issued in the future without stockholder approval, and the terms of our preferred stock could include dividend, liquidation, conversion, voting
and other rights that are more favorable than the rights of the holders of our common stock. There can be no assurance as to the availability or terms upon which such financing and capital might be available.
If adequate funds are not available, we may be required to reduce, delay or eliminate expenditures for
our GTL and CTL plant development and other activities, as well as our research and development and other activities, or seek to enter into a business combination transaction with or sell assets to another company. We could also be forced to license
to third parties the rights to commercialize additional products or technologies that we would otherwise seek to develop ourselves. The transactions outlined above may not be available to us when needed or on terms acceptable or favorable to us.
Construction of GTL or CTL plants based on the Syntroleum Process will be subject to risks of delay and cost overruns.
The construction of GTL or CTL plants based on the Syntroleum Process will be subject to the risks of delay or cost overruns resulting from numerous
factors, including the following:
•
shortages of equipment, materials or skilled labor;
•
unscheduled delays in the delivery of ordered materials and equipment;
•
engineering problems, including those relating to the commissioning of newly designed equipment;
•
work stoppages;
•
weather interference;
•
unanticipated cost increases; and
•
difficulty in obtaining necessary permits or approvals.
We have incurred losses and anticipate continued losses.
As of December 31, 2006, we had an
accumulated deficit of $338 million. We have not yet achieved profitability and we expect to continue incurring net losses until we recognize sufficient revenues from licensing activities, GTL or CTL plants or other sources. Because we do not have
an operating history upon which an evaluation of our prospects can be based, our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by small companies seeking to develop new and rapidly evolving
technologies. To address these risks we must, among other things, continue to attract investment capital, respond to competitive factors, continue to attract, retain and motivate qualified personnel and commercialize and continue to upgrade the
Syntroleum Process technologies. We may not be successful in addressing these risks, and we may not achieve or sustain profitability.
Our
anticipated expense levels are based in part on our expectations as to future operating activities and not on historical financial data. We plan to continue funding research and development and project development activities. Capital expenditures
will depend on progress we make in developing various projects on which we are currently working. Increased revenues or cash flows may not result from these expenses.
If prices for crude oil, natural gas, coal and other commodities are unfavorable, GTL and CTL plants based on the Syntroleum Process may not be economical.
Because the synthetic crude oil, liquid fuels and specialty products that Syntroleum Process-based GTL and CTL plants are expected to produce will
compete in markets with oil and refined petroleum products, and because natural gas or coal will be used as the feedstock for these plants, an increase in prices relative to prices for oil, natural gas, and coal, or a decrease in prices for oil and
refined products, could adversely affect the operating results of these plants. Higher than anticipated costs for the catalysts and other materials used in these plants could also adversely affect operating results. Prices for natural gas are
subject to wide fluctuation in response to relatively minor changes in the supply of and demand for natural gas, market uncertainty and a variety of additional factors that are beyond our control. Coal prices are also subject to variation due to
supply and demand forces beyond our control. Factors that could cause changes in the prices and availability of oil, natural gas, coal and refined products include:
•
level of consumer product demand;
•
weather conditions;
•
domestic and foreign government regulation;
•
actions of the Organization of Petroleum Exporting Countries;
•
political conditions in oil and natural gas producing countries;
•
supply of foreign crude oil and natural gas;
•
location of GTL plants relative to natural gas reserves and pipelines;
•
location of CTL plants relative to coal reserves and transportation systems;
•
capacities of pipelines;
•
fluctuations in seasonal demand;
•
price and availability of alternative fuels; and
•
overall economic conditions.
We
cannot predict the future markets and prices for oil, natural gas, coal or other materials used in the Syntroleum Process or refined products.
We believe that the Syntroleum Process can be cost effective for GTL plants with capacities from 17,000 to over 100,000 b/d depending upon the amount of oil, condensate, and LPG that is produced along with the natural gas. We believe that
the Syntroleum process can be economic for both GTL and CTL plants given the current world crude oil prices. However, the markets for oil and natural gas have historically been volatile and are likely to continue to be volatile in the future.
Although world crude oil prices were approximately $62 per barrel in December 2006, crude oil prices fell for a period of time during 1998 to historically low levels below $10 per barrel and could return to such low levels in the future.
Adverse operating conditions could prevent GTL and CTL plants based on the Syntroleum Process from operating economically.
The economic application of GTL and CTL technologies depends on favorable plant operating conditions. Among operating conditions that impact plant
economics are the site location, infrastructure, weather conditions, size of equipment, quality of the feedstock, type of plant products and, in the case of GTL plants, whether the natural gas converted by the plant is associated with oil reserves.
For example, if a plant were located in an area that requires construction of substantial infrastructure, plant economics would be adversely affected. Additionally, GTL plants that are not designed to produce specialty products or other high margin
products, and plants that are not used to convert natural gas that is associated with oil reserves, will be more dependent on favorable natural gas and oil prices than plants designed for those uses.
GTL and CTL plants will depend on the availability of natural gas or coal at economic prices, and alternative uses of natural gas or coal could be
preferred in many circumstances.
Operation of GTL plants will depend on availability of natural gas at economic prices. The market for
natural gas is highly competitive in many areas of the world and, in many circumstances, the sale of natural gas for use as a feedstock in a GTL plant will not be the highest value market for the owner of the natural gas. Cryogenic conversion of
natural gas to liquefied natural gas may compete with our GTL plants for use of natural gas as feedstocks in many locations. Local commercial, residential and industrial consumer markets, power generation, ammonia, methanol and petrochemicals are
also alternative markets for natural gas. Unlike us, many of our competitors also produce or have access to large volumes of natural gas, which may be used in connection with their GTL operations. The availability of natural gas at economic prices
for use as a feedstock for GTL plants may also depend on the production costs for the gas and whether natural gas pipelines are located in the areas where these plants are located. New pipelines may be built or existing pipelines may be expanded
into areas where GTL plants are built, and this may affect operating margins of these plants as other markets compete for available natural gas.
Construction and operation of CTL plants will depend on the availability of coal or other carbon-based materials such as pet-coke or vacuum resin at economic prices. The cost of coal varies depending upon the energy value per ton of
different types of coal and the type of mining operations. The markets for these feedstocks are highly dependent upon the source, location and availability of transportation systems that are generally tied to the power generation sector. Higher coal
prices are generally found closer to major population centers where power plants may have a competitive advantage in converting coal to power for transmission in the local region.
Our receipt of license fees depends on substantial efforts by our licensees, and our licensees could choose not to construct a GTL or CTL plant based
on the Syntroleum Process or to pursue alternative GTL or CTL technologies.
Our licensees will determine whether we issue any plant
site licenses to them and, as a result, whether we receive any additional license fees under our license agreements. To date, no licensee of the Syntroleum Process has exercised its right to obtain a site license. Under most circumstances, a
licensee will need to undertake substantial activities and investments before we issue any plant site licenses and receive license fees. These activities may include performing feasibility studies, obtaining regulatory approvals and permits,
obtaining preliminary cost estimates and final design and engineering for the plant, obtaining a sufficient dedicated supply of feedstock, obtaining adequate commitments for the purchase of the plant’s products and obtaining financing for
construction of the plant. A licensee will control the amount and timing of resources devoted to these activities. Whether licensees are willing to expend the resources necessary to construct GTL or CTL plants will depend on a variety of factors
outside our control, including the prevailing view of price outlook for crude oil, natural gas, coal and refined products. In addition, our license agreements may be terminated by the licensee, with or without cause and without penalty, upon 90
days’ notice to us. If we do not receive payments under our license agreements, we may not have sufficient resources to implement our business strategy. Our licensees are not restricted from pursuing alternative GTL or CTL technologies on their
own or in collaboration with others, including our competitors.
Our success depends on the performance of our executive officers, the
loss of whom would disrupt our business operations.
We depend to a large extent on the performance of our executive officers,
including Kenneth L. Agee, our founder, Chairman of the Board and inventor with respect to many of our patents and patent applications, John B. Holmes, Jr., our Chief Executive Officer, and Edward G. Roth, our President and Chief Operating Officer.
Given the technological nature of our business, we also depend on our scientific and technical personnel. Our efforts to develop and commercialize our technology have placed a significant strain on our scientific and technical personnel, as well as
our operational and administrative resources. Our ability to implement our business strategy may be constrained and the timing of implementation may be impacted if we are unable to attract and retain sufficient personnel. As such, retention
agreements with key employees were put in place in December 2006. At March 1, 2007, we had 62 full-time employees. Except for a $500,000 life insurance policy that we hold on the life of Kenneth L. Agee, we do not maintain “key
person” life insurance policies on any of our employees. We have entered into employment agreements with several key employees.
We
depend on strategic relationships with manufacturing and engineering companies. If these companies fail to provide necessary components or services, this could negatively impact our business.
We intend to, and believe our licensees will, utilize third-party component manufacturers in the design and construction of GTL and CTL plants based on
the Syntroleum Process. If any third-party manufacturer is unable to
acquire raw materials or provide components of GTL or CTL plants based on the Syntroleum Process in commercial quantities in a timely manner and within
specifications, we or our licensees could experience material delays or construction or development plans could be canceled while alternative suppliers or manufacturers are identified. We have no experience in manufacturing and do not have any
manufacturing facilities. Consequently, we will depend on third parties to manufacture components for GTL and CTL plants based on the Syntroleum Process. We have conducted development activities with third parties for our proprietary catalysts and
other equipment, including turbines that may be used in the Syntroleum Process, and other manufacturing companies may not have the same expertise as these companies.
We also intend to utilize third parties to provide engineering services in connection with our efforts to commercialize the Syntroleum Process. If these engineering firms are unable to provide requisite services or
performance guarantees, we or our licensees could experience material delays or construction plans could be canceled while alternative engineering firms are identified and become familiar with the Syntroleum Process. We have limited experience in
providing engineering services and have a limited engineering staff. Consequently, we will depend on third parties to provide necessary engineering services, and these firms may be asked by licensees or financial participants in plants to provide
performance guarantees in connection with the design and construction of GTL or CTL plants based on the Syntroleum Process.
Our
operating results may be volatile due to a variety of factors and are not a meaningful indicator of future performance.
We expect to
experience significant fluctuations in future annual and quarterly operating results because of the unpredictability of many factors that impact our business. These factors include:
•
timing of any construction by us or our licensees of GTL and CTL plants;
•
demand for licenses of the Syntroleum Process and receipt and revenue recognition of license fees;
•
oil and gas prices;
•
coal prices;
•
timing and amount of research and development expenditures;
•
demand for synthetic fuels and specialty products;
•
introduction or enhancement of GTL or CTL technologies by us and our competitors;
•
availability of insurance;
•
market acceptance of new technologies; and
•
general economic conditions.
As a
result, we believe that period-to-period comparisons of our results of operations are not meaningful and should not be relied upon as any indication of future performance. Due to all of the foregoing factors, it may be that in some future year or
quarter our operating results will be below the expectations of public market analysts and investors. In that event, the price of our common stock would likely be materially adversely affected.
We are subject to extensive laws relating to the protection of the environment, and these laws may increase the cost of designing, constructing and
operating our GTL and CTL plants.
If we violate any of the laws and regulations relating to the protection of the environment, we may
be subject to substantial fines, criminal sanctions or third party lawsuits and may be required to install costly pollution
control equipment or, in some extreme cases, curtail operations. Our GTL or CTL plants will generally be required to obtain permits under applicable
environmental laws and various permits for industrial siting and construction. Compliance with environmental laws and regulations, as well as with any requisite environmental or construction permits, may increase the costs of designing, constructing
and operating our GTL or CTL plants. We may also face exposure to actual or potential claims and lawsuits involving environmental matters with respect to our previously owned real estate.
Terrorist threats and U.S. military actions could result in a material adverse effect on our business.
Subsequent to the September 11, 2001 terrorist attacks on the World Trade Center and the Pentagon, the United States commenced military actions in
response to these attacks. On March 19, 2003, the United States and a coalition of other countries initiated military action in Iraq for the stated purpose of removing that country’s government and destroying its ability to use or produce
weapons of mass destruction. Further acts of terrorism in the United States or elsewhere could occur. In addition, recent world political events have resulted in increasing tension involving Iran, North Korea and Syria. These developments and
similar future events may cause instability in the world’s financial and insurance markets and could significantly increase political and economic instability in the geographic areas in which we may wish to operate. These developments could
also lead to increased volatility in prices for crude oil and natural gas. In addition, these developments could adversely affect our ability to access capital and to successfully implement projects currently under development.
Following the terrorist attacks on September 11, 2001, insurance underwriters increased insurance premiums charged for many coverages and issued
general notices of cancellations to their customers for war risk, terrorism and political risk insurance with respect to a variety of insurance coverages. Insurance premiums could be increased further or coverages may be unavailable in the future.
United States government regulations effectively preclude us from actively engaging in business activities in certain countries. These
regulations could be amended to cover countries where we may wish to operate in the future. These developments could subject the operations of our company to increased risks and, depending on their magnitude, could have a material adverse effect on
our business.
Sufficient markets for the synthetic products of the Syntroleum Process or products that utilize these synthetic
products, including fuel cells, may never develop or may take longer to develop than we anticipate.
Sufficient markets may never
develop for the synthetic products of the Syntroleum Process, or may develop more slowly than we anticipate. The development of sufficient markets for the synthetic products of the Syntroleum Process may be affected by many factors, some of which
are out of our control, including:
•
cost competitiveness of the synthetic products of the Syntroleum Process;
•
consumer reluctance to try a new product;
•
environmental, safety and regulatory requirements; and
•
emergence of more competitive products.
In addition, a new market may fail to develop for products that utilize our synthetic products. For example, the establishment of a market for the use of these products as fuel for fuel cells is uncertain, in part because fuel cells
represent an emerging market and we do not know if distributors will want to sell them or if end-users will want to use them.
If
sufficient markets fail to develop or develop more slowly than we anticipate, we may be unable to recover the losses we will have incurred in the development of our technology and may never achieve profitability.
We may not have enough insurance to cover all of the risks we face.
In accordance with customary industry practices, we maintain insurance coverage against some, but not all,
potential losses in order to protect against the risks we face. We do not carry a significant amount of business interruption insurance. We may elect not to
carry insurance if our management believes that the cost of available insurance is excessive relative to the risks presented. In addition, we cannot insure fully against pollution and environmental risks. The occurrence of an event not fully covered
by insurance could have a material adverse effect on our financial condition and results of operations.
Item 1B.
Unreso
lved Staff Comments
None.
It
em 2.
Properties
We own and operate a nominal two b/d
pilot plant located on approximately three acres leased in Tulsa, Oklahoma. This lease expires in May 2022, and annual lease payments total approximately $9,000. We also lease 4,500 square feet of laboratory space, which expires in June 2011 and has
lease payments of approximately $45,000 per year. We expect to be able to renew this under similar terms. We own a 24,000 square-foot corporate office and technology center located on approximately 25 acres in Tulsa. We also lease office space in
Houston, Texas, under a lease that expires in November 2007 and provides for payments of approximately $68,000 per year.
We lease
approximately 10 acres of land at the Port of Catoosa near Tulsa, on which we have constructed a nominal 70 b/d GTL demonstration plant as part of our clean fuels project with the DOE known as the “DOE Catoosa Project.” We added additional
equipment to the project for our own work outside of the scope of the DOE Catoosa Project. We refer to the entire project, including the additional equipment, as the “Catoosa Demonstration Facility.” This lease runs through May 2011 and
the rent expense is approximately $47,000 annually.
Scout is subject to contingent obligations under leases and other instruments incurred
in connection with real estate activities and other operations. See Note 11 to our consolidated financial statements included in Item 8 of this Annual Report on Form 10-K.
Item 3.
Legal Proceedings
In February 2000, we sold our parking garage in Reno, Nevada to
Fitzgerald’s Reno, Inc. ("FRI"), a Nevada corporation doing business as Fitzgerald’s Hotel & Casino Reno, for $3.0 million. FRI paid $750,000 in cash and executed a promissory note in the original principal amount of $2.3 million
and interest rate of 10 percent per year (based on a twenty-year amortization). The note was payable in monthly installments of principal and interest, with the entire unpaid balance due on February 1, 2010. The note was secured by a deed of
trust, assignment of rents and security interest in favor of us on the parking garage. FRI also executed an Assumption and Assignment of Ground Lease dated February 1, 2000, under which FRI agreed to make the lease payments due under the ground
lease. FRI’s obligations under the Assumption and Assignment of Ground Lease are secured by the deed of trust, assignment of rents and security interest in the parking garage and the ground lease.
In December 2000, FRI, along with several affiliates, filed voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code
in the United States Bankruptcy Court, District of Nevada. Since the date of its bankruptcy petition, FRI has continued to make the monthly payments due on the note and the payment obligations due under the ground lease.
On August 28, 2003, the bankruptcy plan filed by FRI went into effect and FRI agreed to pay us $50,000 to be applied towards the outstanding
principal balance of the promissory note. FRI then issued a new note in the amount of $2.1 million, which was the balance outstanding on the original note at that time, under the same terms and conditions as the original promissory note, except that
the maturity date was accelerated to August 28, 2006 and the interest rate was reduced to 5 percent with a 16-year amortization. FRI executed an amended and restated deed of trust under the same terms and conditions as the previous deed of
trust. FRI is required to continue to make the lease payments due under the ground lease under the same terms as originally agreed in the Assumption and Assignment of Ground Lease dated February 1, 2000.
The Company received payment from FRI under the note in 2006 and was officially released from the ground lease on February 2, 2007.
We are not a party to, nor are any of our properties the subject of, any pending legal proceedings that,
in the opinion of management, are expected to have a material adverse effect on our consolidated results of operations or financial position.
Item 4.
Su
bmission of Matters to a Vote of Security Holders
None.
Executive Officers of the
Registrant
The following table sets forth certain information concerning our executive officers as of March 16, 2007.
Name
Age
Position
Kenneth L. Agee
50
Chairman of the Board and Chief Research Officer
John B. Holmes, Jr.
59
Chief Executive Officer and Director
Edward G. Roth
50
Chief Operating Officer, President and Director
Greg G. Jenkins
49
Executive Vice President of Finance and Business Development and Chief Financial Officer
Carla S. Covey
34
Senior Vice President of Finance and Chief Accounting Officer
Richard L. Edmonson
55
Senior Vice President, General Counsel and Corporate Secretary
Ronald E. Stinebaugh
42
Senior Vice President of Finance & Acquisitions
Our board of directors has adopted an executive succession policy that requires our Chief
Executive Officer to identify for the board's approval an executive succession plan prior to the Chief Executive Officer's 60th birthday. Pursuant to this plan, on March 16, 2007, our board of directors appointed Edward G. Roth as President and
Chief Operating Officer and as a member of our board of directors. John B. (Jack) Holmes, Jr. remains Chief Executive Officer and a director. Also pursuant to this plan, after Mr. Holmes' 60th birthday (which will occur on March 27, 2007),
he will be eligible to retire and receive a retirement benefits package approved by the board.
We are currently pursuing a transition in
the office of Chief Financial Officer. We are negotiating a retirement agreement with Greg G. Jenkins, our current Executive Vice President of Finance and Business Development and Chief Financial Officer, including resolution of incentive
compensation arrangements, and are seeking to identify candidates to replace his position as Chief Financial Officer.
Effective
February 14, 2007, Jeffrey M. Bigger, Senior Vice President of Business Development, Kenneth R. Roberts, Senior Vice President of Business Development and Larry J. Weick, Senior Vice President of Business Development, retired from the Company.
Kenneth L. Agee is Chairman of the Board and Chief Research Officer. Mr. Agee founded our company in 1984 and initially served
as President and a director. He served as Chief Executive Officer from February 1996 until January 2005. He became Chairman of the Board in November 1995. He also served as President from June 2002 to September 2002. He became the Chief Technology
Officer in April 2005. Mr. Agee became Chief Research Officer in April, 2006. He is a graduate of Oklahoma State University with a degree in Chemical Engineering. He has over 20 years of experience in the energy industry and is listed as
Inventor on several U.S. and foreign patents, with several more patent applications pending, all of which he has assigned to us.
John
B. (Jack) Holmes, Jr. is Chief Executive Officer and a Director. Mr. Holmes has been Chief Executive Officer since January 3, 2005 and was also President from January 3, 2005 until March 16, 2007. From October 2002 until January
2005, Mr. Holmes was President and Chief Operating Officer. Mr. Holmes became a director upon joining Syntroleum in October 2002. Prior to joining Syntroleum, Mr. Holmes was Chief Operating Officer of El Paso Merchant Energy Company
beginning in January 2001, where he had operating responsibility for all assets, including power generation, refining and chemical terminals and marine assets throughout the U.S. and overseas. Before becoming the Chief Operating Officer of El Paso,
Mr. Holmes was the President of Oil and Gas Operations from 1999 to 2001. Prior to joining El Paso in 1999, he was President and Chief Operating Officer of Zilkha Energy Company from 1986 to 1998 and, upon its merger with Sonat, Inc. in 1998,
he served as President and Chief Executive Officer of Sonat Exploration until 1999. He holds a B.S. in Chemical Engineering from the University of Mississippi.
Greg G. Jenkins is Executive Vice President of Finance and Business Development and Chief
Financial Officer. Prior to joining Syntroleum in January 2005, Mr. Jenkins served in several executive roles at the El Paso Corporation from December 1996 to June 2003, including: President, El Paso Merchant Energy from December 1996 to August
2000; President, El Paso Global Networks from August 2000 to December 2001; and President, Global Petroleum and LNG from January 2002 to June 2003. From June 2003 to January 2005, Mr. Jenkins was a private investor. Previously, he was President
of Entergy Power from May 1996 to December 1996, President and CEO of Hadson Corporation from 1993 to 1996, and served in various senior management positions at Santa Fe Energy Company between 1982 and 1993. He holds a B.A. in Business Management
and Economics from Western State College.
Carla S. Covey is Senior Vice President of Finance and Chief Accounting Officer.
Ms. Covey became Director of Accounting in June 1997. She had been Controller since January 1999 and Vice President of Finance since September 2002 and was promoted to Senior Vice President of Finance and Chief Accounting Officer in March 2005.
Prior to joining Syntroleum, she served as Accounting Manager/Human Resource Manager and Manager, Facility Operations for AGC Manufacturing Services, Inc., a global energy company in Tulsa, Oklahoma, from 1995 to 1997. Ms. Covey received her
B.A. degree in Business Administration from Drury University and her M.S. degree in Management from Southern Nazarene University. She has also completed the Harvard Business School’s Executive Management Program in Finance and is a certified
public accountant.
Richard L. Edmonson is Senior Vice President, General Counsel and Corporate Secretary. Mr. Edmonson became
our Vice President, General Counsel and Corporate Secretary in August 2003 and was promoted to Senior Vice President in July 2004. Prior to assuming that position, he served as a contract attorney for us since April 2003. Prior to joining
Syntroleum, Mr. Edmonson spent 26 years in the energy industry in various legal and management positions, including seven years as a Senior Vice President of various subsidiaries of Pennzoil Company until January 1999. From January 1999 to
August 1999, he was a senior vice president of PennzEnergy Company. From August 1999 to July 2000, Mr. Edmonson was in private practice. In July 2000, Mr. Edmonson joined EEX Corporation as Senior Vice President, General Counsel and
Corporate Secretary where he remained until the sale of that company in November 2002. From December 2002 to April 2003, Mr. Edmonson was in private practice. Mr. Edmonson received his B.A. degree from Oklahoma State University and his
juris doctor degree from the University of Texas School of Law.
Edward G. (Gary) Roth is Chief Operating Officer, President and a
Director. He was appointed to these positions on March 16, 2007. Previously, he had served as Executive Vice President of Engineering and Chief Technology Officer since April 2006. Previously Mr. Roth served as Senior Vice President of Projects
from July 2004 to April 2005. Prior to joining Syntroleum in July 2004, Mr. Roth served from December 1997 to July 2004 with Petrofac Resources International in varying positions, and in July 2003 was appointed President and Chief Operating
Officer of Petrofac LLC, a company involved in all facets of turnkey engineering, procurement and construction in refining and gas processing. From February 1994 to December 1997, Mr. Roth was Vice President of Engineering & Operations
at Zilkha Energy. From December 1979 to February 1994, he worked at ARCO in various capacities, including drilling production operations and business development both domestically and internationally. Mr. Roth has a B.S. in Petroleum
Engineering from Texas A&M University and a M.B.A. in Finance from the University of Chicago.
Ronald E. Stinebaugh is Senior
Vice President of Finance & Acquisitions. He joined our company in February 2003 and served as Director of Corporate Finance & Acquisitions. In April 2003, he was promoted to Vice President of Corporate Finance and Acquisitions and
served in that position until January 2005, when he assumed his current position. He has 12 years of investment banking-related experience, primarily focused on the energy industry. Prior to joining Syntroleum, Mr. Stinebaugh held the position
of Director, Investment Banking for The Integrated Energy Group at ABN AMRO Incorporated from August 2000 to March 2002 and Vice President, Investment Banking, Energy Group at Prudential Securities in Houston from February 1997 to August 2000.
Mr. Stinebaugh was an independent consultant between March 2002 and joining Syntroleum in February 2003. He also held investment banking-related positions with Trivest, Inc., a private equity firm, NationsBanc Capital Markets, Inc. and Kidder,
Peabody & Co., Incorporated. Mr. Stinebaugh holds a B.A. from Rice University and an M.B.A. from Harvard Business School.
There are no family relations, of first cousin or closer, among our executive officers, by blood,
marriage or adoption.
Par
t II
Item 5
.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Stock Prices . Our common stock is traded on the National Market System of the Nasdaq Stock Market under the symbol “SYNM.” The table
below reflects the high and low sales prices for our common stock for each quarter during 2006 and 2005.
Sales Price
High
Low
Year Ended December 31, 2006:
First Quarter
$
11.85
$
7.83
Second Quarter
$
8.30
$
4.82
Third Quarter
$
6.05
$
3.96
Fourth Quarter
$
4.91
$
2.45
Year Ended December 31, 2005:
First Quarter
$
12.47
$
7.71
Second Quarter
$
14.45
$
7.41
Third Quarter
$
16.50
$
9.81
Fourth Quarter
$
12.32
$
6.54
Record Holders. As of March 1, 2007, we had approximately 1,200 record holders of our
common stock (including brokerage firms and other nominees).
Dividends. Cash dividends have not been paid since our inception. We
currently intend to retain any earnings for the future operation and development of our business and do not currently anticipate paying any dividends in the foreseeable future. Any future determination as to dividend policy will be made, subject to
Delaware law, at the discretion of our board of directors and will depend on a number of factors, including our future earnings, capital requirements, financial condition, business prospects and other factors that our board of directors may deem
relevant. Although we are not currently a party to any agreement that restricts dividend payments, future dividends may be restricted by our then-existing financing arrangements. See “ Management’s Discussion and Analysis of Financial
Condition and Results of Operations—Liquidity and Capital Resources” in Item 7 of this Annual Report on Form 10-K.
Our
stock price may continue to be volatile and could decline in the future. Historically, the market price of our common stock has been very volatile. The trading price of our common stock is expected to continue to be subject to substantial
volatility in response to numerous factors, including publicity regarding actual or potential results with respect to development of the Syntroleum Process and design, construction and commercial operation of plants using our process, announcements
of technological innovations by others with competing GTL processes, developments concerning intellectual property rights, including claims of infringement, annual and quarterly variances in operating results, changes in energy prices, competition,
changes in financial estimates by securities analysts, any differences in actual results and results expected by investors and analysts, investor perception of our favorable or unfavorable prospects and other events or factors. In addition, the
stock market has experienced and continues to experience significant price and volume volatility that has affected the market price of equity securities of many companies. This volatility has often been unrelated to the operating performance of
those companies. These broad market fluctuations may adversely affect the market price of our common stock. We are required to maintain standards for listing of our common stock on the National Market System of the Nasdaq Stock Market, and we cannot
assure you that we will be able to do so. There is no guarantee that an active public market for our common stock will be sustained.
Future sales of our common stock could adversely affect our stock price. Substantial sales of our
common stock in the public market, or the perception by the market that those sales could occur, could lower our stock price or make it difficult for us to raise additional equity capital in the future. These sales could include sales of shares of
our common stock by our directors and officers, who beneficially owned approximately 15 percent of the outstanding shares of our common stock as of March 1, 2007. We cannot predict if future sales of our common stock, or the availability of our
common stock for sale, will harm the market price for our common stock or our ability to raise capital by offering equity securities.
Equity
Compensation Plans
The following table provides information concerning securities authorized for issuance under our equity compensation
plans as of December 31, 2006.
Equity Compensation Plan Information
Plan Category
Number of Securities to be Issued
Upon Exercise of
Outstanding
Options, Warrants and Rights
(a)
Weighted-average Exercise Price of
Outstanding Options,
Warrants
and Rights
(b)
Number of Securities Remaining
Available for Future Issuance
Under
Equity Compensation Plans
(excluding securities reflected in
column (a))
(c)
Equity Compensation Plans Approved by Security Holders (1)(2)(3)(4)
7,935,471
$6.84
4,381,375
Equity Compensation Plans Not Approved by Security Holders (4)(5)(6)(7)
1,025,198
$1.72
2,203,371
Total
8,960,669
$6.25
6,584,746
(1)
Includes the 1993 Stock Option and Incentive Plan, the 1997 Stock Incentive Plan, the 2005 Stock Incentive Plan and the Stock Option Plan for Outside Directors.
(2)
Includes 346,253 shares to be issued upon exercise of options with a weighted average exercise price of $12.45 that were granted under our 1993 Stock Option and Incentive Plan and
our Stock Option Plan for Outside Directors assumed by us in connection with the merger of Syntroleum Corporation and SLH Corporation on August 7, 1998, which were approved by our stockholders.
(3)
Includes up to 970,000 shares to be issued upon exercise of warrants granted to Mr. Ziad Ghandour, one of our directors, at exercise prices ranging from $4.50 per share to
$5.25 per share, which were approved by our stockholders. An additional 1,000,000 warrants to purchase shares of common stock at an exercise price of $11.21 per share may be issued to Mr. Ghandour upon the achievement of certain performance
objectives. These warrants were approved by our stockholders in April 2005.
(4)
Includes up to 141,250 shares to be issued upon exercise of warrants issued to Sovereign Oil & Gas Company II, LLC (“Sovereign”), a consulting
firm that we have retained to assist us in acquiring stranded natural gas fields worldwide using the Syntroleum Process as a feedstock for our GTL Mobile Facility, which were approved by our stockholders. The warrants are issuable in varying amounts
upon the acquisition of properties of the achievement of third-party participation in a project, and have an exercise price of between $6. 40 and $7.98 per share for warrants issued since March 1, 2004. The exercise price per share for any
additional warrants issued is to be determined based on the price for our common stock on December 1 prior to the contract year for the contract under which warrants are issued. Under the joint development agreement, we have agreed to issue to
Sovereign warrants to purchase up to an aggregate of 2,000,000 shares of our
common stock in varying amounts upon the acquisition of properties or the achievement of third-party participation in a project. The issuance of warrants to
purchase up to 500,000 shares of our common stock has been approved by our stockholders.
(5)
On August 31, 2002, we granted options to purchase 1,000,000 shares of our common stock at an exercise price of $1.55 to our Chief Executive Officer, John B. Holmes, Jr., as an
inducement to his employment with Syntroleum. The rights to exercise the options and purchase 333,334 shares vested on October 1, 2002, the rights to exercise the options and purchase an additional 333,333 shares vested on October 1, 2003,
and the rights to exercise the options and purchase an additional 333,333 shares vested on October 1, 2004. The ability to exercise the options will terminate upon the earliest of: (a) the tenth anniversary of the date of the grant;
(b) 12 months after the date of the termination of Mr. Holmes’ employment by reason of death or disability; (c) the third annual anniversary of Mr. Holmes’ retirement; or (d) the date 12 months following the date
upon which Mr. Holmes’ employment terminates for any reason other than those described in (b) or (c) above.
(6)
On June 30, 1997, and on February 3, 1999, we granted options to purchase 17,198 and 8,000 shares of common stock at exercise prices of $9.30 and $6.88, respectively, to a
Business Development Consultant. The rights to exercise the options and purchase shares vest in three equal installments each year on the anniversary of each grant.
(7)
The Company has registered via S-8 750,000 shares of common stock issuable as matching pursuant to the terms of the Syntroleum 401 (k) Plan. As of December 31, 2006, the
Company had issued 46,629 shares under this Plan.
Issuer Repurchases of Equity Securities
Neither we nor anyone acting on our behalf of an affiliated purchaser purchased shares of our common stock during the three months ended December 31,
2006.
Item 6.
Selected Financ
ial Data
The following selected financial information should be read in conjunction with
“Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of this Annual Report on Form 10-K and our consolidated financial statements and the related notes thereto included in Item 8
of this Annual Report on Form 10-K.
For the Year Ended December 31,
2006
2005
2004
2003
2002
(in thousands, except per share data)
Statement of Operations Data:
Revenues:
Joint development revenue
$
1,089
$
7,444
$
923
$
14,183
$
9,621
Catalyst materials revenue
—
—
5,674
4,966
—
Other revenues
2,700
464
9
91
25
Total revenues
3,789
7,908
6,606
19,240
9,646
Costs and expenses:
Cost of catalyst materials sales and impairment
—
—
3,033
7,886
—
Catoosa Demonstration Facility
8,429
10,710
12,994
21,843
12,606
Write down of Sweetwater Project
—
—
—
—
30,855
Pilot plant, engineering and research and development
12,700
11,734
9,260
8,135
15,558
Depreciation, depletion, amortization and impairment
816
686
602
639
835
General and administrative and other
27,225
22,423
19,613
15,390
16,040
Total operating expenses
49,170
45,553
45,502
53,893
75,894
Operating income (loss)
(45,381
)
(37,645
)
(38,896
)
(34,653
)
(66,248
)
Investment, interest, other income (expense), foreign currency, taxes and minority interest
(1,282
)
1,769
(1,603
)
(1,188
)
711
Loss from discontinued oil and gas operations
(7,962
)
(5,518
)
(2,051
)
—
—
Income from discontinued real estate business
—
—
—
1,203
357
Net income (loss)
$
(54,625
)
$
(41,394
)
$
(42,550
)
$
(34,638
)
$
(65,180
)
Basic and diluted per share amounts -
Income (loss) from continuing operations
$
(0.84
)
$
(0.67
)
$
(0.93
)
$
(1.04
)
$
(1.99
)
Income from discontinued operations
$
(0.14
)
$
(0.10
)
$
(0.05
)
$
0.04
$
0.01
Net income (loss)
$
(0.98
)
$
(0.77
)
$
(0.98
)
$
(1.00
)
$
(1.98
)
As of December 31,
2006
2005
2004
2003
2002
(in thousands)
Balance Sheet Data:
Working capital
$
29,199
$
46,095
$
22,625
$
10,795
$
13,626
Oil and gas properties and equipment held for sale
2,360
6,490
5,353
—
—
Property and equipment, net
2,596
2,910
2,380
1,985
12,673
Total assets
43,937
89,795
44,751
67,235
57,140
Long-term debt and deferred credit
—
—
—
13,546
11,261
Convertible debt
27,641
25,925
24,221
21,842
4,466
Deferred revenue
21,840
20,952
27,575
38,273
35,875
Stockholders’ equity (deficit)
(14,558
)
32,413
(13,324
)
(12,830
)
(3,990
)
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
We began business as GTG, Inc. on November 15, 1984. On April 25, 1994, GTG, Inc. changed its name to Syntroleum Corporation.
On August 7, 1998, Syntroleum Corporation merged into SLH Corporation. SLH Corporation was the surviving entity in the merger and was renamed Syntroleum Corporation. Syntroleum Corporation was later re-incorporated in Delaware on June 17,
1999 through its merger into a Delaware corporation that was organized on April 23, 1999.
We are incurring substantial operating and
research and development costs with respect to developing and commercializing the Syntroleum Process and the Synfining Process and do not anticipate recognizing any significant revenues from production from either a GTL or CTL fuel or specialty
plant or from licensing our technology in the near future. As a result, we expect to continue to operate at a loss until sufficient revenues are recognized from licensing activities or commercial operations of GTL and CTL plants. Generally, any
reference to GTL is also applicable to CTL unless the context indicates otherwise.
Operating Revenues
During the periods discussed below, our revenues were primarily generated from reimbursement for research and development activities associated with the
Syntroleum Process and catalyst sales. In the future, we expect to receive revenue from sales of products or fees for the use of GTL and CTL plants in which we will own an equity interest, demonstration plant product sales, licensing, catalyst
sales, and research and development activities carried out with industry participants.
Until the commencement of commercial operation of
GTL or CTL plants in which we own an interest, we expect that cash flow relating to the Syntroleum Process will consist primarily of revenues associated with joint development activities. We will not receive any cash flow from GTL or CTL plants in
which we own an equity interest until the first of these plants is constructed and will not receive additional license fees until we enter into additional license agreements or existing licensees develop commercial plants. Our future operating
revenues will depend on the successful commercial construction and operation of GTL or CTL plants based on the Syntroleum Process, the success of competing GTL technologies, the success of our non-GTL projects, and other competing uses for natural
gas or coal. We expect our results of operations and cash flows to be affected by changing crude oil, natural gas, fuel and specialty product prices and trends in environmental regulations. If the price of these products increases (decreases), there
could be a corresponding increase (decrease) in operating revenues. Additionally during 2006 we began exploring the applicability of our technologies to renewable energy. We have conducted testing that resulted in the production of research
quantities of renewable fuels from a variety of liquid vegetable and animal fat feedstocks. We continue to evaluate this technology and possible future business opportunities.
GTL/CTL Plant Revenues. We intend to develop GTL or CTL plants and to retain equity interests in these plants. These plants will enable us to gain
experience with the commercial operation of the Syntroleum Process and, if successful, are expected to provide ongoing revenues. Some of the anticipated products of these plants ( i.e. , synthetic crude oil, Fischer-Tropsch waxes, synthetic
diesel iso-paraffinic kerosene and other fuels, naphtha, lube base oils, process oils, and/or liquid normal paraffins) have historically been sold at premium prices and may result in relatively high sales margins. We anticipate forming joint
ventures with energy industry and financial participants in order to finance and operate these plants. We anticipate that our GTL or CTL plants will include co-venturers who have low-cost gas or coal reserves in strategic locations and/or have
distribution networks in place for the synthetic products to be made in each plant as well as engineering, procurement and construction contractors and Floating, Production, Storage and Offloading vessel (“FPSO”) operators.
License Revenues . We expect to generate revenue earned from licensing the Syntroleum Process through four types of 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 or CTL
plants. A master license agreement grants broad geographic and volume rights, while volume license agreements limit the total production capacity of all GTL plants constructed under the agreement to specified amounts, and regional license agreements
limit the geographical rights of the licensee. Master, volume and regional license agreements signed in the past have required an up-front cash deposit
that may offset or partially offset license fees for future plants payable under site licenses. In the past, we have acquired technologies or commitments of
funds for joint development activities, services or other consideration in lieu of the initial cash deposit in cases where we believed the technologies or commitments had a greater value.
Our site license agreements currently require fees to be paid in increments when milestones during the plant design and construction process are
achieved. The amount of the license fee under our existing master and volume license agreements is currently 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) an agreed royalty rate. 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 existing
master and volume license agreements allow for the adjustment of fees for new site licenses under certain circumstances.
Our accounting
policy is to defer all up-front deposits under master, volume and regional license agreements and license fees under site license agreements and recognize 50 percent of the deposits and fees as revenue in the period in which the engineering process
design package (“PDP”) for a plant licensed under the agreement is delivered and recognize the other 50 percent of the deposits and fees when the plant has passed applicable performance tests. The amount of license revenue we earn will be
dependent on the construction of plants by licensees, as well as the number of licenses we sell in the future. To date we have received $39.5 million in cash as initial deposits and option fees under our existing license agreements. Except for $2.0
million recorded as revenue in connection with option expirations, $8.8 million of license credits returned by the Commonwealth of Australia as part of the settlement for the Sweetwater project and $10.0 million recorded as revenue as a result of
the release of license credits and indemnifications, these amounts have been recorded in deferred revenue. Our obligations under these license agreements are to allow the use of the technology, provide access to engineering services to generate a
PDP at an additional cost, and to refund 50 percent of the advances should the licensee build a plant that does not pass all process performance testing. These licenses generally begin to expire in 2011 and the initial deposits will be recognized as
licensing revenue as the licenses expire should a licensee not purchase a site license and begin construction of a plant prior to expiration of the license.
Catalyst Revenues. We expect to earn revenue from the sale of our proprietary catalysts to some of our licensees. Our license agreements currently require our catalyst to be used in the initial loading of the
catalyst into the Fischer-Tropsch reactor for the licensee to receive a 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 pursuant
to license agreements 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.
Joint Development Revenues. We continually conduct research and development activities in order to improve the conversion efficiency and reduce
the capital and operating costs of GTL and CTL plants based on the Syntroleum Process. We receive joint development revenues primarily through two initiatives: (1) prospect assessment and feasibility studies and (2) formal joint
development arrangements with our licensees and others. Through these joint development arrangements, we may receive revenue as reimbursement for specified portions of our research and development or engineering expenses. Under some of these
agreements, the joint development participant may receive credits against future license fees for monies expended on joint research and development. During the periods presented, joint development revenues consisted primarily of amounts received
from Marathon, the DOE, DOD, Sasol, and Ivanhoe. These projects require us to deliver results from development activities such as non-proprietary analysis of plant processes, flow diagrams, chemical analysis and fuel production plans that will be
jointly shared by each party. The customers benefit from paying for these development activities as they are obtaining access to information pertaining to the Syntroleum Process. Revenue is recognized when final delivery of the shared technology has
occurred. Under some of these agreements, the joint development participant may receive credits against future license fees for monies expended on joint development. The value of these credits is a fixed amount stated in the contract and reflected
as deferred revenue until the credit is utilized. The revenues recognized in the future from these contracts are deemed to be fixed and determinable under the criteria specified in Staff Accounting bulletin, Topic 13 and SOP 97-2, Software
Revenue Recognition . To date, our revenues and costs have been related to certain projects and are wholly dependent upon the nature of our projects. The various sizes and timing of these projects, including the demonstration plant (the
“Catoosa Demonstration Facility”) used as part of the DOE Ultra-Clean Fuels Production and Demonstration Project with Marathon affect the comparability of the periods presented.
Demonstration Plant Product Sales Revenues. We expect to provide synthetic ultra-clean diesel
fuel, such as our S-2 diesel fuel and S-8 iso-parafinnic kerosene (jet fuel subject to certification), and FC-1 naphtha fuels to various customers for their use in further research and testing upon their request. Our ultra-clean S-2 diesel fuel and
S-8 iso-paraffinic kerosene (jet fuel subject to certification) is a paraffinic, high-cetane distillate fuel that is essentially free of sulfur, olefins, metals, aromatics and alcohols. The fuels have been produced at our Catoosa Demonstration
Facility. Revenues are recognized upon delivery of the requested fuels.
Operating Expenses
Our operating expenses historically have consisted primarily of the construction and operation of the Catoosa Demonstration Facility, pilot plant,
engineering, including third party engineering, research and development expenses and general and administrative expenses, which include costs associated with general corporate overhead, compensation expense, legal and accounting expenses and
expenses associated with other related administrative functions.
Our policy is to expense costs associated with the Catoosa Demonstration
Facility and pilot plant, engineering and research and development costs as incurred in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 2, Accounting for Research and Development Costs . All of these
research and development expenses are associated with our development of the Syntroleum Process. The Catoosa Demonstration Facility expenses include costs to construct, maintain, and operate the facility for further research and development as well
as for demonstrations for licensees and other customers. Research and development expenses include costs to operate both our laboratory and technology center, salaries and wages associated with these operations, research and development services
performed by universities, consultants and third parties and additional supplies and equipment for these facilities. Our policy is to expense costs associated with the development of GTL plants or other projects until we begin our front-end
engineering and design program on the respective projects. We also capitalize any costs associated with a project that would have economic value for future projects. We have incurred costs related specifically to the development of the Syntroleum
Process including our GTL Mobile Facility project. These costs, which relate primarily to outside contract services for initial engineering, design, and development are included in pilot plant, engineering and research and development costs in our
consolidated statements of operations.
We commenced operations at the Catoosa Demonstration Facility in the first quarter of 2004, with
production of the initial finished fuels occurring on March 4, 2004. We have produced all of our contractual commitments to the DOE and have delivered all of the required fuels to a fuels testing facility in Detroit, Michigan, Denali National
Park in Alaska, the University of Alaska in Fairbanks and the Washington D.C. Area Metropolitan Transit Authority. In September 2006, the Company completed the production of our contract committed volume of fuels to the United States Department of
Defense. In addition, we also successfully completed the longest run of our catalyst testing activity at the Tulsa Pilot Plant. In line with the program completion of our demonstration plans, we suspended operations at both facilities.
We have also recognized depreciation, depletion and amortization expense related to office and computer equipment, buildings and leasehold
improvements and patents. We have incurred significant costs and expenses over the last several years as we have expanded our research and development, engineering and commercial activities, including staffing levels. In the third quarter of 2006
with the completion of our research and development efforts related to running the CDF and Pilot Plant, operating costs declined as a result of suspending operations at both plants, reducing our workforce and focusing on cost minimization. This
workforce reduction amounted to 46 employees. We anticipate these cost saving measures implemented in the third quarter of 2006 to have a significant favorable impact on operating expenses on a go-forward basis. We do not expect to rehire any of the
employees included in the reductions if we accelerate the development of a commercial project. We paid in full a significant portion of the severance payments related to our staff reduction by the end of 2006. We plan to continue to monitor our
expenditures with regards to general and administrative expense throughout 2007 as well. Our operating expenses could increase further if we accelerate our development of commercial projects.
If we are successful in developing a GTL or CTL plant in which we own an interest, we expect to incur significant expenses in connection with our share
of the engineering design, construction and start-up of the plant. Upon the commencement of commercial operations of a plant, we will incur our share of cost of sales expenses relating primarily to the cost of natural gas or coal feedstocks for the
plant and operating expenses relating to the
plant, including labor, consumables and product marketing costs. Due to the substantial capital expenditures associated with the construction of GTL or CTL
plants, we expect to incur significant depreciation and amortization expense in the future.
Discontinued Operations
International Oil and Gas
Our international oil and
gas activities have primarily included the leasehold acquisition, geological and geophysical work covering various areas in Nigeria, and drilling costs for the Aje-3 discovery well (“Aje-3”) in Oil Mining Lease (“OML”) 113
offshore Nigeria. In fourth quarter 2006, we decided to exit our international oil and gas activities as part of our strategy of focusing our efforts on specific goals and projects that have GTL and CTL potential. On January 19, 2007, we sold
all of the stock of various subsidiaries, including Syntroleum Nigeria Limited, which held our interests in the Ajapa and Aje fields offshore Nigeria to African Energy Equity Resources Limited (“AEERL”), a direct wholly owned subsidiary of
Energy Equity Resources (Norway) Limited (“EERNL”). The sale was effectuated through a sale share and purchase agreement which was entered into pursuant to a letter of intent dated November 30, 2006. As consideration for the sale,
AEERL paid us a $2 million nonrefundable deposit on December 12, 2006 and will pay up to an additional $23,172,000 subject to the occurrence of certain financial and commercial milestones. Among these milestones, AEERL will pay us $10,172,000
on the earlier to occur of April 1, 2007 or the date AEERL raises additional capital, $5 million from the first gross revenues AEERL receives from each of the Ajapa and Aje interests, and $3 million if third party farmees enter into an
agreement to fund at least half of the cost of drilling the proposed Aje-4 well. Net international oil and gas properties classified as held for sale is $1,750,000 for the year ended December 31, 2006.
Domestic Oil and Gas
We were pursuing gas
monetization projects in which we were directly involved in gas field development using available gas processing technologies from third parties. We completed an evaluation of potential reserves related to drilled properties in the United States and
decided to discontinue further expenditures in the Central Kansas Uplift area based on management’s decision to focus efforts with company specific goals and projects that have GTL and CTL potential. We recorded depreciation, depletion,
amortization and impairment expense of $3,783,000 related to these properties and the associated gas processing plant and equipment during the year ended December 31, 2005. We successfully sold certain leasehold acres during 2005 for
$1,000,000. The remaining leasehold acreage, including the wells and equipment, sold for $522,000 in January 2006. We are actively seeking prospects for sale of our gas processing plant and related equipment and expect to complete the sale in 2007.
Net domestic oil and gas properties and equipment classified as held for sale is $610,000 for the year ended December 31, 2006.
Significant
Developments During 2006 and Early 2007
Commercial and Licensee Projects
Stranded Gas Venture. On April 11, 2005, we entered into a Participation Agreement with Dorset Group Corporation
(“Dorset”) pursuant to which Dorset committed to provide approximately $40,000,000 to us to be used to evaluate investment opportunities, conduct oil and gas project development activities, and acquire interests in oil and gas properties
(“Venture”). Mr. Ziad Ghandour, a member of the board of directors and a consultant of the Company was a participant in Dorset Group Corporation. Subsequently, Ernest Williams II Q-TIP TUA dated 01/25/02 (“Williams”) and
Selim K. Zilkha Trust (“Zilkha)” joined the Participation Agreement as venture participants and agreed to provide an additional capital commitment of $10,000,000 each, making the total commitment amount $60,000,000. Effective
September 30, 2006, Williams transferred its interest in the Participation Agreement to Jerry B. Williams (“J. Williams”).
On September 22, 2006, we delivered written notice of default to Dorset for breach of the Participation Agreement due to Dorset’s failure to remit the funds necessary to meet its pro rata share of each capital call within ten
business days of its notice of the capital call. On November 22, 2006, Syntroleum and Dorset entered into a Cancellation, Termination and Release Agreement which terminated Dorset’s participation in the venture, released Dorset and
Syntroleum from any claims against the other and Dorset relinquished any future interest under the
Participation Agreement. On December 20, 2006, Syntroleum, J. Williams and Zilkha agreed to terminate the remainder of the Participation Agreement. We
will repay 100 percent of the contributions previously made by J. Williams and Zilkha in amount of $1,193,386 each. Of this amount, $360,000 was paid to each remaining participant on December 20, 2006 and $833,386 will be paid to each remaining
participant on or before May 1, 2007.
As a result of entering into the participation agreements with respect to the Stranded Gas
Venture, we have issued 103,627 shares of common stock and paid $600,000 in cash to TI Capital Management (“TI Capital”), whose principal owner is Mr. Ziad Ghandour, in accordance with its amended consulting agreement.
Sinopec . On January 25, 2007, we signed a non- binding MOU with China Petroleum Technology Company (“ST”) which calls for the
following:
•
The establishment of a joint research and development effort by us and ST to advance GTL and CTL technologies in China;
•
The establishment of a joint marketing effort by us and ST to market the joint ST and Syntroleum GTL and CTL technologies in China;
•
ST using its utmost efforts to construct a GTL plant in China using the Syntroleum Process;
•
ST using its utmost efforts to construct a CTL pilot plant in China using the Syntroleum Process;
•
The Company providing ST access to our complete set of proprietary GTL and CTL technologies, including catalyst technology and Fischer-Tropsch technology for use in
China; and
•
ST paying us $20 million per year over the next five years, subject to applicable taxes, to support the development of our technologies
The MOU is non-binding and will not become binding until the parties have executed a definitive agreement which more
clearly defines each party’s rights, duties and obligations.
Mobile GTL Facility. In August 2003, we announced our plan to
commercialize a GTL Barge. The GTL Barge is designed to develop offshore and near-shore coastal natural gas fields in the one to three trillion cubic feet (“TCF”) range where there is currently no infrastructure to produce and transport
the natural gas. These fields are generally considered to be too small to support a liquefied natural gas facility. The GTL Barge builds on the strengths and advantages of the Syntroleum Process, which utilizes air instead of oxygen. The GTL Barge
is also designed to have equipment to process natural gas liquids.
In February 2005, we executed an agreement with Bluewater Energy
Services B.V. (“Bluewater”) to conduct a feasibility study and engineering study for placing a small GTL plant on an FPSO. In February 2006, we executed a Letter of Intent with Bluewater to memorialize the intentions of the formation of a
joint venture to develop, construct, own and operate a FPSO vessel equipped with gas-to-liquids conversion capability. We and Bluewater will each bear 50 percent of the costs associated with the formation of the joint venture. The Letter of Intent
will terminate on the first date to occur of an executed and mutually signed definitive agreement with respect to the joint venture or December 31, 2007.
Papua New Guinea . During 2004, we completed a feasibility study with Oil Search Limited (“Oil Search”) for a Barge in Papua New Guinea. We worked with Oil Search to develop cost estimates for upstream
gas and liquids development and pipeline transportation in addition to the GTL facility. We recognized revenue of $100,000 related to this project in joint development revenue for the year ended December 31, 2004.
In November 2005, we entered into a Memorandum of Understanding with the government of Papua New Guinea
to examine the development of an approximately 50,000 b/d GTL plant as part of an industrial complex dedicated to gas-based industries near the capital city of Port Moresby. We have worked with the government of Papua New Guinea Ministry of Planning
and Development to study the feasibility of a large GTL plant that would share natural gas pipeline infrastructure facilities with various other possible gas conversion participants, including ammonia, methanol and power plant developers. The
feasibility study was completed in 2006 and in November 2006 the Papua New Guinea government stated that the Syntroleum GTL facility was granted priority status and designated as a lead project in PNG’s effort to create a domestic gas
monetization industry utilizing a portion of its significant resources.
On November 15, 2006 we entered into a Joint Development
Agreement with Kuwait Foreign Petroleum Exploration Company, K.S.C. (“KUFPEC”) to join in the development of a 50,000 barrel per day GTL facility in Papua New Guinea. While the project is still in development, the plant under consideration
would produce 50,000 barrels per day of Syntroleum ultra-clean S-2 Diesel and other high valued ultra clean fuels. The plant is anticipated to be located near the capital city Port Moresby, in the Konebada Petroleum Park.
Ivanhoe Energy. Ivanhoe Energy Inc. (“Ivanhoe”) and Egyptian Natural Gas Holding Company (“EGAS”), the state organization
charged with the management of Egypt’s natural gas resources, signed a memorandum of understanding to enable Ivanhoe to conduct and prepare a feasibility study to construct and operate a GTL plant in Egypt. Ivanhoe holds a master
unlimited-volume license with us. Ivanhoe has announced that, if the results of the feasibility study are positive, EGAS has agreed to commit up to 4.2 TCF of natural gas for the anticipated 20-year operating life of the proposed project.
Linc Energy, Ltd. On August 15, 2005, we entered into a Memorandum of Agreement with Australian- based Linc Energy, Ltd.
(“Linc Energy”) to pursue the development of a CTL project using the Syntroleum Process in Queensland, Australia. The agreement, which would enable our technology to benefit from Linc Energy’s underground coal gasification
(“UCG”) expertise, is part of Linc Energy’s ongoing Chinchilla Project. The terms of the agreement included cooperation on the Chinchilla Project and future UCG-CTL projects to be pursued by Linc Energy under a CTL license from us,
and provided us with an option to invest in the equity of these projects. We and Linc Energy had agreed to jointly fund a series of technology demonstration programs in advance of developing engineering designs for the CTL projects. This Memorandum
of Agreement expired on December 31, 2006, and no further definitive agreements or technology license were executed.
Sustec AG.
Sustec AG. On January 31, 2006, we entered into a Memorandum of Understanding (the “MOU”) with Sustec AG (“Sustec”), a private company based in Basel, Switzerland and parent company of Future Energy of Freiberg, Germany
that provides for exclusive joint business development of projects that will integrate Future Energy’s GSP gasification technology with our Fischer-Tropsch technology. The purpose of the joint venture is to develop projects for the conversion
of coal and other carbonaceous materials such as pet-coke, reside and biomass into ultra-clean fuels. Subsequent to the execution of this MOU, Sustec completed a transaction with Siemens whereby ownership of the GSP gasification technology and
certain other assets were transferred to Siemens. Sustec retained access rights to the GSP gasification technology and has a license to utilize the GSP technology with certain Syntroleum Fischer-Tropsch projects at market rates.
Qatar. In the Middle East, Qatar has one of the world’s largest single gas fields, the North Field, with recoverable reserves that are
sufficient to support multiple GTL projects. In April 2005, the Minister of Energy of Qatar announced that the Marathon GTL project in Qatar, along with ConocoPhillips, Chevron and others, are being delayed for approximately three years. Marathon
has announced that it remains interested in pursuing the project in Qatar, notwithstanding the delay, as well as other GTL projects around the world.
Demonstration Activities
DOE Catoosa Project . The DOE awarded a contract in 2001 to Integrated Concepts and Research
Corporation to provide funding for the DOE Ultra Clean Transportation Fuels Project for which we provided the ultra clean fuels (“Doe Catoosa Project”). In May 2002, we signed a participation agreement with Marathon in connection with this
project that included the relocation of certain modules from our Cherry Point GTL facility at ARCO's refinery in Washington State to the Tulsa Port of Catoosa near Tulsa, Oklahoma. These modules formed the basis of our Catoosa Demonstration
Facility, a demonstration facility designed to produce up to approximately
70 b/d of synthetic products and demonstrate commercial scale-up of the Syntroleum and Synfining Processes. The facility was mechanically completed and dedicated on October 3, 2003, and we achieved startup and commenced fuel deliveries in
the first quarter of 2004. The fuels from this facility have been tested by others in advanced power train and emission control technologies, and the fuels were also tested in bus fleets by the Washington Metropolitan Area Transit Authority and the
U.S. National Park Service at Denali National Park in Alaska. Outside the scope of the DOE Catoosa Project and at our own cost, we installed additional facilities at the Catoosa Demonstration Facility for the purpose of further demonstrating our
technology and operational capabilities.
Since this project is not for commercial operations, the costs associated with it have been
expensed in accordance with SFAS No. 2, Accounting for Research and Development Costs. The project has been funded by us and the other project participants, including $12.0 million from the DOE for the relocation, engineering, and
re-installation of the Cherry Point equipment, labor and cash contributions of $9.3 million by Marathon, and $21.3 million from us provided by a loan agreement between Marathon and us. We completed our fuel production and delivery commitments in
connection with the DOE Catoosa Project during 2005 and as a result, we recognized $5,798,000 in joint development revenues for the year ended December 31, 2005.
DOD Projects . In January 2002, Congress appropriated $3.5 million for a proposed Flexible JP-8 (“single battlefield fuel”) Pilot Plant program under the Department of Defense Appropriation Bill, 2002.
In September 2002, we signed a $2.2 million contract with the DOD to participate in the program, to provide for the design of a small footprint plant for fuels-production for land-based and marine applications, as well as testing of synthetically
made GTL JP-8 fuel in military diesel and turbine engine applications. Phase I of this program is now complete, and all the work done to date has validated our beliefs in the performance of the single battlefield fuel product.
Congress appropriated $2.0 million for Phase II development of our proposed Flexible JP-8 single battlefield fuel Pilot Plant Program under fiscal year
2004 DOD appropriations legislation. We received approximately $950,000 under the appropriation. Phase II included expanded engineering and design work for fuel production systems and further single battlefield fuel characterization and
demonstration work. Finalization of our contracts occurred in the fourth quarter of 2004 and we began work at that time. We recognized joint development revenue from this project of $250,000, $435,000 and $95,000 for the years ended
December 31, 2006, 2005 and 2004, respectively. The project was completed in September 30, 2006.
In August 2004, Congress
appropriated $4.5 million for Phase III development of our Flexible JP-8 single battlefield fuel Pilot Plant Program under the DOD fiscal 2005 appropriations legislation. We received approximately $2.8 million under the appropriation. Phase III of
this program includes expanded engineering and design work for single battlefield fuel production systems for a marine environment and further single battlefield fuel characterization and demonstration work for all branches of the military.
Finalization of the contracts for this phase occurred in the second quarter of 2005. We recognized joint development revenue from this project of $740,000 and $747,000 for the years ended December 31, 2006 and 2005 respectively. We expect to
complete the contract in 2007.
In June 2006, we signed a contract to deliver an initial 100,000 gallons of aviation grade FT research
fluid (S-8) to the DOD for evaluation and flight testing. This marked the commencement of the DOD’s larger program aimed at long-term in-flight evaluation of FT aviation fuel, and their examination of the prospects for the domestic manufacture
and supply of synthetic aviation fuels from FT plants. We completed production and shipment of approximately 104,000 gallons of our FT aviation fuel commitment in early September 2006. On September 19, 2006, our ultra-clean iso-paraffinic
kerosene (“jet fuel”) was successfully tested in a United States Air Force B-52 Stratofortress bomber aircraft. The plane lifted off from Edwards Air Force Base with a 50/50 blend of our FT jet fuel and traditional JP-8 jet fuel which was
burned in two of the eight engines on the plane. This marks the first time that FT jet fuel has been tested in a military flight demo, and is the first of several planned test flights. A second successful flight test was performed on
December 15, 2006 at Edwards Air Force Base in California. This test used a 50/50 blend of our jet fuel and conventional JP-8 in all eight engines. This marks the first time that a B-52 has flown using a synfuel blend as the only fuel on board.
We recognized approximately $2,300,000 in revenue from the sale of jet fuel and labor associated with this contract. The government announced plans to seek up to an additional 200 million gallons of alternative synthetic aviation fuel in 2008
and we anticipate submitting one or more proposals to aid in this effort.
Following delivery of our S-8 jet fuel to the DOD for the flight test in September 2006, we had completed
the production requirements of our contract committed volumes of fuels to the United States Departments of Defense, Energy and Transportation. Fuel deliveries to the DOT from prior production are ongoing. Also, we successfully completed the longest
run of our catalyst testing activity at the Tulsa Pilot Plant. Thereafter, we suspended our research and fuels production activities at both facilities, but we maintain them in a standby mode for future commissioning, research on our technology and
use to produce additional quantities of ultra clean fuels.
DOE Coal-to-Liquids Project . In March 2005, Congress authorized funding
of $4.5 million to evaluate commercially available coal gasification and synthesis gas cleanup technologies and the integration of these processes with a cobalt catalyst based Fischer-Tropsch (“FT”) technology. Integrated Concepts and
Research Corporation (“ICRC”) was awarded a contract from the DOE. We anticipate that the results of this work may provide a foundation for the development of a coal-to-liquids plant based on a cobalt catalyst FT technology. Additionally,
the study would require engineering and economic analysis to be utilized to evaluate the commercial feasibility of a plant in a coal-producing state. In 2006, ICRC offered a subcontract to us to participate in this effort, which we have not accepted
to date because we have been independently pursuing our own efforts to evaluate our cobalt FT catalyst with Eastman Chemical Company. Syntroleum and ICRC continue discussions of how the parties can work together to achieve the ICRC program
requirements.
DOT Fuel Evaluation Program. In November 2005, the DOT awarded an agreement with ICRC to provide funding for
demonstration of the operating performance benefits and development of the market acceptance of Ultra-Clean Fischer-Tropsch diesel fuels in transit bus fleet covering a range of climates. Oklahoma and Alabama transit bus fleets were provided with
awards to purchase, demonstrate and test our S-2 FT diesel fuel. The Alaskan transit bus fleet was also given an award to purchase, demonstrate and test our S-1 arctic-grade FT diesel fuel. We expect to receive approximately $1.0 million in revenue
related to fuel sales and labor for this program. We recognized revenues related to this project of $334,000 and $364,000 for the years ended December 31, 2006 and 2005, respectively.
Coal Derived Synthesis Gas . In November 2005, we announced that we had entered into an agreement with another company to conduct laboratory-scale
demonstration of our Fischer-Tropsch (FT) catalyst with coal-derived synthesis gas produced at an established gasification facility. Syntroleum intends that this testing program with Eastman Chemical Company will demonstrate the effectiveness of the
Syntroleum FT catalysts with proven coal-derived synthesis gas clean-up and treatment processes for use in a CTL application. The testing program, funded 100% by Syntroleum began in December and will continue through mid-2007 to gather catalyst
performance data for use in development of reactor designs for future commercial coal-to-liquids plants using Syntroleum technology. Initial production of FT waxes and light products was achieved in mid-December and the overall testing program is
currently meeting Syntroleum expectations.
Research and Development Projects
Our primary research and development projects during the year ended December 31, 2006 related to our GTL technologies for use in GTL plants,
including catalyst performance evaluation and enhanced reactor designs. Expenses for pilot plant, engineering and research and development incurred during the year ended December 31, 2006 totaled $12,700,000. These expenses related to salaries
and wages, outside contract services, lab equipment and improvements and laboratory operating expenses, which primarily supported work on technology we plan to use in fuels plants and our GTL Mobile Facility. We operated our Catoosa Demonstration
Facility for the first three quarters of 2006 for further research and development, fuel production, and additional testing. Upon successful completion of our delivery commitments to the DOD in September 2006 and our longest run of catalyst testing
activity at the Tulsa Pilot Plant, we suspended operations at both facilities. Expenses incurred for the operations and modifications to our Catoosa Demonstration Facility during the year ended December 31, 2006 totaled $8,429,000.
Other Activities
Agreement with ExxonMobil.
In December 2004, we signed an agreement with ExxonMobil Research and Engineering Company (“ExxonMobil”) pursuant to which we received a worldwide license to use ExxonMobil's patented processes to produce and sell fuels from natural
gas or substances such as coal. In addition, we have the right to extend the terms of this agreement to our licensees. The scope of this agreement includes the fields of synthesis gas production, Fischer-Tropsch synthesis, product upgrading to make
fuels and various processes that
relate to these areas. The agreement includes all existing ExxonMobil patents (which number over 3,000 worldwide) and future improvements to patents in these
areas over the next several years. This agreement does not include patents covering certain specific catalyst formulations and manufacturing steps. We have agreed that we will not enforce against ExxonMobil and its affiliates any patents that we
obtain after the date of the license agreement, to the extent that those patents overlap with any of ExxonMobil’s patents. We intend to continue to develop and commercialize our process; however, we recognize a potential to utilize some
ExxonMobil patents in our process. The Exxonmobil agreement was amended in August 2006 to expand our rights to access the ExxonMobil technology into the areas of lubricating base oils and solvents.
Results of Operations
Consolidated Results for the Years Ended
December 31,
Revenues
2006
2005
2004
(in thousands)
Joint Development Revenue
$
1,089
$
7,444
$
923
Catalyst Materials Revenue
—
—
5,674
Other
2,700
464
9
Total Revenues
$
3,789
$
7,908
$
6,606
2006 vs. 2005
Joint Development Revenue. Revenues from our joint research and development and demonstration operations were $1,089,000 in 2006, compared with $7,444,000 in 2005. The decreased revenues in 2006 primarily were due to:
•
revenue recognition in 2005 of previously deferred revenue related to fuel delivery commitments associated with the DOE Ultra Clean Fuels Demonstration project in
the amount of $5,798,000, and
•
completion of a DOD contract in September 2006.
Other Revenue. Other revenues were $2,700,000 in 2006 compared to $464,000 in 2005. The increase was primarily due to:
•
delivery of 104,000 gallons of S-8 synthetic diesel to the DOD for testing in aircraft and vehicle engines in 2006 related to a DOD fuel delivery contract completed
in 2006 in the amount of $2,300,000.
•
GTL fuel sales to the Tulsa Transit Authority in Oklahoma and Alaska in accordance with our sub-agreement with the Department of Transportation of approximately
$364,000 in 2005, and
•
approximately $100,000 of GTL fuel sales were recognized for shipments to various customers for further research on fuel capabilities in 2005.
2005 vs. 2004
Joint
Development Revenue. Revenues from our joint research and development and demonstration operations were $7,444,000 in 2005, compared with $923,000 in 2004. The increase in revenue in 2005 primarily resulted from:.
•
increased funding for research and development activities by licensees, the U.S. government and other third parties, and
•
revenue recognition of previously deferred revenue related to fuel delivery commitments associated with the DOE Ultra Clean Fuels Demonstration project in the
amount of $5,798,000.
Catalyst Materials Revenue. Revenues from catalyst materials sales was $0 in 2005 compared to $5,674,000 in
2004. The decrease in catalyst revenue in 2005 resulted from:
•
liquidation of catalyst materials from our suspended Sweetwater project in 2004, with no comparable activity in 2005.
Other Revenue. Other revenues were $464,000 in 2005 compared to $9,000 in 2004. The increase was primarily due to:
•
GTL fuel sales to the Tulsa Transit Authority in Oklahoma and Alaska in accordance with our sub-agreement with the Department of Transportation of approximately
$364,000 in 2005,
•
approximately $100,000 of GTL fuel sales were recognized for shipments to various customers for further research on fuel capabilities in 2005, and
•
smaller quantities of sales of GTL fuel recognized in 2004.
Operating Costs and Expenses
2006
2005
2004
(in thousands)
Cost of catalyst materials sales and impairment
$
—
$
—
$
3,033
Catoosa Demonstration Facility
8,429
10,710
12,994
Pilot plant, engineering and research and development
12,700
11,734
9,260
Depreciation, depletion, amortization and impairment
816
686
602
Non-cash equity compensation
7,859
4,686
4,341
General and administrative and other
19,366
17,737
15,272
Total Operating Costs and Expenses
$
49,170
$
45,553
$
45,502
2006 vs. 2005
Catoosa Demonstration Facility. Expenses related to the Catoosa Demonstration Facility totaled $8,429,000 during 2006 compared to $10,710,000 during 2005. The decrease resulted primarily from:
•
the suspension of operations at the plant in September, 2006 significantly reduced our expenses in the fourth quarter of 2006
Pilot Plant, Engineering and R&D Expense. Expenses from pilot plant, engineering and research and development activities were $12,700,000 in 2006 compared to
$11,734,000 in 2005. The increase in expenditures resulted primarily from:
•
increased salaries and wages for the technical and engineering group related to the operations of both the pilot plant during the first nine months of 2006 and the
lab for the full year 2006 on continuous running shifts,
•
studies and documentation for the process design of a GTL plant,
•
increased catalyst performance testing in 2006, and
•
the suspension of operations at the plant in September, 2006 reduced our expenses in the fourth quarter of 2006.
Depreciation, Depletion and Amortization. Depreciation, depletion and amortization expenses were $816,000 in 2006 compared to $686,000 in 2005. The increase
resulted primarily from:
•
purchases of computers in the ordinary course of business.
Non-Cash Equity Compensation . Equity compensation expense for the vesting of stock compensation awards to employees and consultants totaled $7,859,000 in 2006 and $4,686,000 in 2005. The increase resulted primarily from:
•
the adoption of SFAS 123(R) and the continuing effects of SFAS 123(R) for new employee grants, which changes the valuation technique for all share based
compensation for employees and requires that value of the shares to be expensed, and
•
higher restricted stock-based compensation in 2006 when compared to 2005.
General and Administrative and Other. General and administrative expenses for 2006 were $19,366,000 compared to $17,737,000 in 2005. The increase resulted primarily from:
•
increased expenses in 2006 related to business development professional consultants and higher insurance premiums in 2006, and
•
settlement of dispute with a vendor in 2005 that resulted in the reversal of a $680,000 contingency accrual.
2005 vs. 2004
Cost of Sales and Impairment of Catalyst Materials. Costs of catalyst material sales during 2005 were $0 as compared to $3,033,000 in 2004. The decrease resulted primarily from:
•
the full liquidation of catalyst materials held at market value in 2004 with no comparable activity in 2005.
Catoosa Demonstration Facility. Expenses related to the Catoosa Demonstration Facility totaled $10,710,000 during 2005 compared to $12,994,000 during 2004. The
decrease resulted primarily from:
•
the installation of major equipment modules during 2004, and
•
continuous operations with smaller modifications and maintenance for 2005.
Pilot Plant, Engineering and R&D Expense. Expenses from pilot plant, engineering and research and development activities were $11,734,000 in 2005 compared to $9,260,000 in 2004. The increase in expenditures
resulted primarily from:
•
increased salaries and wages for technical and engineering group,
•
studies and documentation for the process design of a GTL plant, and
•
modifications to the Tulsa Pilot Plant and start up operations with modifications in place in 2005 compared to 2004.
Depreciation, Depletion and Amortization. Depreciation, depletion and amortization expenses were $686,000 in 2005 compared to $602,000 in 2004. The increase
resulted primarily from:
•
increased depreciation expense in 2005 related primarily to purchases of computers in the ordinary course of business.
Non-Cash Equity Compensation . Equity compensation expense for the vesting of stock compensation awards to employees and consultants totaled $4,686,000 in 2005 and
$4,341,000 in 2004. The increase resulted primarily from:
•
vesting of warrants issued to consultants for the achievement of goals under agreements with these consultants for 2004 and 2005, and
•
increased consultant stock compensation and stock compensation bonus structure for employees in 2005.
General and Administrative and Other. General and administrative expenses for 2005 were $17,737,000 compared to $15,272,000 in 2004. The increase resulted
primarily from:
•
increased general and administrative staffing resulting in higher salaries and wages and other components directly correlated with increased staffing, and
•
increased insurance premiums in 2005.
Other Income and Expenses
2006
2005
2004
(in thousands)
Investment and Interest Income
$
2,527
$
2,554
$
891
Interest Expense
(1,717
)
(1,704
)
(1,697
)
Other Income (Expense)
(1,200
)
174
(418
)
Foreign Currency Exchange
(892
)
745
(367
)
Income Taxes
—
—
(12
)
Income from discontinued oil and gas businesses
(7,962
)
(5,518
)
(2,051
)
2006 vs. 2005
Investment and Interest Income. Investment and interest income was $2,527,000 in 2006, which was comparable to $2,554,000 in 2005.
Interest Expense. Interest expense was $1,717,000 during 2006, which was comparable to interest expense of $1,704,000 in 2005.
Other Income (Expense) and Foreign Exchange. Other income (expense), including foreign exchange loss, was expense
of $2,092,000 in 2006, compared to income of $919,000 during 2005. The increase in expense resulted primarily from:
•
other expense of $1,200,000 related to financing costs previously capitalized that were expensed in 2006, and
•
foreign currency losses recorded in 2006 compared to foreign currency gains recorded in 2005 due to the fluctuation in the value of the Australian dollar compared
to the U.S. Dollar between periods.
Loss from Discontinued Operations. Loss from discontinued operations was $7,962,000 in
2006 and $5,518,000 in 2005. The increase resulted from:
•
the absence of $3,556,000 gain recognized in 2005 from conveyance of a portion of our participating interest in the Aje field,
•
amortization expense of $1,457,000 related to the termination of the stranded gas venture in 2006 compared to $165,000 in 2005, and
•
higher impairment in 2005 due to impairment of domestic oil and gas assets that were sold in January 2006.
2005 vs. 2004
Investment and Interest Income.
Investment and interest income was $2,554,000 in 2005 compared to $891,000 in 2004. The increase resulted from:
•
increased cash balance resulting in higher interest received on cash held in money market accounts in 2005.
Interest Expense. Interest expense was $1,704,000 during 2005, which was comparable to interest expense of $1,697,000 in 2004.
Other Income (Expense) and Foreign Exchange. Other income (expense), including foreign exchange loss, was income of $919,000 in 2005, compared to expense of
$785,000 during 2004. The increase resulted primarily from:
•
foreign currency gains recorded in 2005 compared to foreign currency losses recorded in 2004 due to the fluctuation in the value of the Australian dollar compared
to the U.S. Dollar between periods.
Provision for Income Taxes. Income tax expense was $0 and $12,000 in 2005 and 2004,
respectively. The decrease resulted from:
•
the Australian withholding tax imposed during 2004 on interest earned on funds held in Australian bank accounts, and
•
no remaining funds in Australian escrow bank accounts in 2005, thus resulting in no income tax expense in 2005.
Loss from Discontinued Operations. Loss from discontinued operations in 2005 was $5,518,000 and $2,051,000 in 2004. The increase resulted from:
•
depreciation, depletion, amortization, and impairment in 2005 of approximately $8,162,000 compared to $480,000 in 2004,
•
a gain of $3,556,000 related to the conveyance of a portion of our interest in the Aje Field recorded in 2005, and
•
a decrease in general, administrative and other costs related to professional fees between years of $938,000
Net Income (Loss)
2006
2005
2004
(in thousands)
Net Income (Loss)
$
(54,625
)
$
(41,394
)
$
(42,550
)
2006 vs. 2005
In 2006, we experienced a loss of $54,625,000 compared to a loss of $41,394,000 in 2005. The increase in net loss relates primarily to factors stated
above, including lower joint development revenues coupled with increased general and administrative expenses, other income (expense), and foreign currency when compared to 2005.
2005 vs. 2004
In 2005, we experienced a loss of $41,394,000 compared to a loss of $42,550,000
in 2004. The decrease in the net loss primarily relates to greater total revenues in 2005 when compared to 2004 as well as other factors stated in the explanations above.
Liquidity and Capital Resources
General
As of December 31, 2006, we had $33,469,000 in cash and short-term investments. Our current liabilities from continuing operations totaled $4,530,000
as of December 31, 2006.
At December 31, 2006, we had $500,000 in accounts receivable outstanding relating to our GTL fuel sales
and joint development activities. We believe that all of the receivables currently outstanding will be collected and therefore we have not established a reserve for bad debts.
Cash flows used in operations were $35,807,000 during the year ended December 31, 2006, compared to $38,470,000 during the year ended
December 31, 2005. The decrease primarily results from lower cash used in discontinued operations in 2006 when compared to 2005 and lower costs related to the CDF. This was partially offset by increased research, development, and engineering
costs in 2006 when compared to 2005.
Cash flows used in investing activities were $419,000 during the year ended December 31, 2006,
compared to cash flows used in investing activities of $7,942,000 during the year ended December 31, 2005. The decrease in cash used in investing activities is primarily related to the receipt in 2006 of $1,802,000 for a note receivable
previously held, receipt of a non-refundable deposit of $2,000,000 from AEERL and lower capital expenditures for international oil and gas assets which have been included in cash used in discontinued operations.
Cash flows provided by financing activities were $34,000 during the year ended December 31, 2006, compared to $84,507,000 provided by financing
activities during the year ended December 31, 2005. The decrease in cash flows provided by financing activities relates to the proceeds received from the sale of stock and option exercises totaling $426,000 during the year ended
December 31, 2006 compared to $81,792,000 during the same period in 2005.
We have expended and will continue to expend a substantial
amount of funds to continue the research and development of the Syntroleum Process, to market the Syntroleum Process, to design and construct GTL and CTL plants, and to develop our other commercial projects. We intend to obtain additional funds
through collaborative or other arrangements with strategic partners and others and through debt (including debt which is convertible into our common or preferred stock) and equity financing. We also intend to obtain additional funding through joint
ventures, license agreements and other strategic alliances, as well as various other financing arrangements to meet our capital and operating cost needs for various projects.
We had an effective registration statement at December 31, 2006 for the proposed offering from time to time of shares of our common stock, preferred
stock, debt securities, depository shares or warrants for an aggregate offering price of approximately $102 million. As discussed below, we had an equity transaction subsequent to December 31, 2006 which reduced the amount available in our
effective registration statement to $97 million. If we obtain additional funds by issuing equity securities, dilution to stockholders may occur. In addition, preferred stock could be issued in the future without stockholder approval, and the terms
of our preferred stock could include dividend, liquidation, conversion, voting and other rights that are more favorable than the rights of the holders of our common stock. We can give no assurance that any of the transactions outlined above will be
available to us when needed or on terms acceptable or favorable to us.
On January 19, 2007, we sold all of the stock of the
subsidiaries that held our interests in the Ajapa and Aje fields to AEERL. As previously discussed, AEERL is obligated to pay us $10,172,000 on the earlier to occur of April 1, 2007, or the date AEERL raises additional capital.
We are currently exploring alternatives for raising capital to commercialize the growth of our GTL and
CTL businesses, including the formation of joint ventures and other strategic alliances. If adequate funds are not available, or if we are not successful in establishing a strategic alliance, we may be required to reduce, delay or eliminate
expenditures for our GTL and CTL plant development and other activities, as well as our research and development and other activities, or may seek to enter into a business combination transaction with or sell assets to another company. We could also
be forced to license to third parties the rights to commercialize additional products or technologies that we would otherwise seek to develop ourselves. The transactions we outlined above may not be available to us when needed or on terms acceptable
or favorable to us.
Assuming the commercial success of the plants based on the Syntroleum Process, we expect that license fees, catalyst
sales and sales of products from GTL or CTL plants in which we own an interest will be a source of revenues. In addition, we could receive revenues from other commercial projects we are pursuing. However, we may not receive any of these revenues,
and these revenues may not be sufficient for capital expenditures or operations and may not be received within the expected time frame. If we are unable to generate funds from operations, our need to obtain funds through financing activities will be
increased.
We have sought and intend to continue to temporarily invest our assets, pending their use, so as to avoid becoming subject to
the registration requirements of the Investment Company Act of 1940. These investments are likely to result in lower yields on the funds invested than might be available in the securities market generally. If we were required to register as an
investment company under the Investment Company Act, we would become subject to substantial regulation that could materially and adversely affect us.
Contractual Obligations
The following table sets forth our contractual obligations as of December 31, 2006:
Contractual Obligations
Payments Due by Period
Total
Less than
1 year
1-3 years
4-5 years
After 5
years
Noncurrent Debt Obligations
$
27,641
$
27,641
$
—
$
—
$
—
Purchase Obligations
6,000
6,000
—
—
—
Capital (Finance) Lease Obligations
114
79
35
—
—
Operating Lease Obligations
7,445
1,070
2,021
800
3,554
Other Current Liabilities from discontinued operations
1,667
1,667
—
—
—
Total
$
42,867
$
36,457
$
2,056
$
800
$
3,554
Noncurrent debt obligations represent our convertible loan agreement with Marathon related to our
DOE Catoosa Project. This agreement provides project funding pursuant to advances under two secured promissory notes totaling $21.3 million between Marathon and us for costs relating to the DOE Catoosa Project. At December 31, 2006, we had
received advances of $21.3 million under the loan and we had accrued interest of $6.3 million. On January 16, 2007, we entered into a Consolidation and License Agreement which grants Marathon the non-exclusive right to use our FT process to
produce synthetic crude. As part of this agreement, Marathon eliminated all of its rights under the promissory notes in the amount of $27.6 million. In exchange, we agreed to pay Marathon $3 million in both December 2008 and 2009 as well as
providing an enhanced licensing agreement to them.
As of December 31, 2006, we were obligated to spend up to $6 million to drill,
evaluate, test and either complete or plug and abandon one well in the Ajapa Field in OML 90, offshore Nigeria. This obligation was terminated upon our sale of the subsidiaries holding the interest in the Ajapa field on January 19, 2007.
Our operating leases include leases for corporate equipment such as copiers, printers and vehicles. We have leases on our laboratory, our
Houston office and had a lease on an office in Bolivia. Because the ground lessor did not remove us from the lease as of December 31, 2006, we also remain the lessee of a parking garage in Reno,
Nevada that we sold to Fitzgerald’s Casino in 2001. This lease is currently paid by Fitzgerald’s Casino and is part of the sale agreement executed
in 2001; however, it is included in our schedule of contractual obligations above. We were officially released from the ground lease on February 2, 2007.
The Stranded Gas Venture was established in April, 2005 to evaluate investment opportunities, conduct oil and gas project development activities, and acquire interests in oil and gas properties. On November 22,
2006, we entered into a Cancellation, Termination and Release Agreement which terminated one participants’ involvement in the venture. On December 20, 2006 we agreed to terminate the remaining two participants’ involvement in the
venture in exchange for a $360,000 payment to each remaining participant in December 2006 and a payment of $833,386 to each remaining participant by May 1, 2007. This obligation is reflected in the table above as other current liabilities of
discontinued operations.
We have entered into employment agreements, which provide severance benefits to several key employees.
Commitments under these agreements totaled approximately $7,300,000 at December 31, 2006. Expense is not recognized until an employee is severed. Additionally, we have a commitment to pay $671,000 on June 29, 2007 and $1,092,600 on
June 29, 2008 for retention bonus agreements. We have the option to grant shares of restricted stock for the 2008 commitment in lieu of making a cash payment.
On February 14, 2007, we entered into retirement agreements with four officers. Pursuant to the terms of the agreements, we made one time payments to the retirees on the effective retirement date totaling
$400,000 and will make monthly cash payments for a total of $670,000 through February 2009 and entered into consulting agreements for the next four to six months for a total of $376,000.
We are also in discussions with various parties regarding joint venture projects. If these discussions progress, we could enter into additional
commercial commitments. These discussions currently relate to projects to be located in the United States and various other countries.
Notes Receivable
from Related Parties
In June 1995, Larry J. Weick, previously our Senior Vice President of Business Development, purchased 200,000
shares of common stock of a predecessor of Syntroleum for a purchase price of $0.50 per share, paid by delivery of promissory notes totaling $100,000, the amount of the aggregate purchase price. In September 1997, our predecessor company loaned
Mr. Weick approximately $117,000, the proceeds of which were used to repay his previously outstanding note and accrued interest. To secure his note, Mr. Weick pledged to our predecessor shares of our predecessor’s common stock with a
market value equal to no less than two times the indebtedness under the note. The note was full recourse, bore interest at the rate of 6.1 percent per year and matured in May 2004. The amount outstanding, including accrued interest was approximately
$169,000 at December 31, 2003. In May 2004, Mr. Weick paid us for the entire outstanding balance of the loan, including accrued interest. As a result of this transaction, we have no additional loans outstanding with any directors or
officers of the Company.
Equity Line of Credit
On November 20, 2006, we entered into a Common Stock Purchase Agreement (sometimes termed an equity line of credit agreement) with Azimuth Opportunity Ltd (“Azimuth”). The Common Stock Purchase Agreement provides that, upon
the terms and subject to the conditions set forth in the agreement, Azimuth is committed to purchase up to $40,000,000 of our common stock, or the number of shares that is one less than 20 percent of the issued and outstanding shares of our common
stock as of November 20, 2006, whichever occurs first, over the twenty four month term of the agreement. No shares of stock were issued in connection with the execution of the Purchase Agreement as of December 31, 2006. At our discretion,
we may present Azimuth with draw-down notices requiring Azimuth to purchase our common stock over eleven consecutive trading days or such other period mutually agreed upon by us and Azimuth, with each draw-down subject to limitations based on the
price of our common stock and a limit of 2.5% of our market capitalization at the time of such draw-down, and further subject to the satisfaction of customary closing conditions. We can present Azimuth up to 24 draw-down notices during the term of
the Purchase Agreement, with a minimum of five trading days required between each draw-down period. Once presented with a draw-down notice, Azimuth is required to purchase a pro- rata portion of the shares on each trading day on which the daily
volume weighted average price of our common stock exceeds a threshold price determined by us for such draw-down, which will not be less than $1.37 per share. The per share purchase price for
these shares equals the daily volume weighted average price of our common stock on each date during the draw-down period on which shares are purchased, less
a discount ranging from 3.125% to 6.25%, based on the threshold price. If the daily volume weighted average price of our stock falls below the threshold price on any trading day during a draw-down period, Azimuth is not required to purchase the
pro-rata portion of shares of common stock allocated to that day. However, at its election, Azimuth can buy the pro- rata portion of shares allocated to that day at the threshold price less the discount.
The Purchase Agreement also provides that at our sole discretion, we may grant Azimuth the right to exercise one or more options to purchase additional
shares of our common stock during each draw-down pricing period for an amount that we specify. Upon Azimuth’s exercise of the option, we can sell to Azimuth the shares of our common stock subject to the option at a price equal to the greater of
the daily volume weighted average price of our common stock on the day Azimuth notifies us of its election to exercise its option or the threshold price for the option determined by us in each case, less a discount ranging from 3.125% to 6.25%,
based on the volume weighted average price of our common stock. Our ability to draw-down on equity could be reduced or eliminated by material, adverse changes to our business.
As of December 31, 2006, no amounts were outstanding under this agreement. On March 1, 2007, a draw-down of $5 million was consummated at an
average stock price of $3.23 per share. As allowed in the agreement, we authorized Azimuth to purchase an additional 614,000 shares during the draw-down period.
Equity Issuances
In May 2004, we completed the sale of 5,916,000 shares of common stock and warrants to purchase 887,400
shares of common stock pursuant to a public offering at a price to the public of $5.60 per share and 15 percent of a warrant. Each warrant is initially exercisable at a price of $7.60 per share of common stock beginning on the date of issuance and
ending on May 26, 2008. The warrants were deemed to have a fair market value of approximately $1.9 million at the date of issuance and were recorded as additional paid-in-capital. We received net proceeds of approximately $31.1 million after
underwriting discount and offering expenses.
In March 2005, we completed the sale of 7,000,000 shares of common stock at a price of $10.00
per share. We sold all of these shares directly to Legg Mason Opportunity Trust, a series of Legg Mason Investment Trust, Inc., a registered investment company. The sale resulted in net proceeds to us of approximately $69,950,000.
In April 2005 we completed the sale of 1,000,000 shares of our common stock at a price of $10.00 per share directly to Dorset Group Corporation. The
sales resulted in net proceeds to us of approximately $9,968,000.
As of December 31, 2006, we had not issued any shares under our
equity line of credit agreement with Azimuth. On March 1, 2007, a draw-down of $5 million was completed at an average stock price of $3.23 per share resulting in our issuance of approximately 614,000 shares.
TI Capital Management. During October 2003, we consummated the private issuance and sale to Mr. Ziad Ghandour a total of 400,000 shares of
our common stock for an aggregate purchase price of $1.8 million and entered into a consulting agreement granting Mr.Ghandour with 600,000 options. Mr. Ghandour is one of our directors and also serves as a consultant to us. Mr. Ghandour
became an employee of our Company in October of 2005. In February 2004, we issued warrants to purchase up to 1,170,000 shares of our common stock to TI Capital Management (“TI Capital”), a consulting firm owned by Mr. Ziad Ghandour,
pursuant to an amended and restated consulting agreement. These warrants replace the 600,000 options that were granted to Mr. Ghandour in October 2003. The warrants to purchase 170,000 shares at an exercise price of $5.00 per share are
exercisable from the date of stockholder approval, which was received on April 26, 2004. The vesting period for these warrants did not begin until they were approved by stockholders, at which time we recognized expense totaling $636,000 with
respect to these warrants during the year ended December 31, 2005. The warrants to purchase 500,000 shares at an exercise price of $5.25 per share became exercisable upon the execution of the agreement with Bluewater in February 2005. Warrants
to purchase 500,000 shares at an exercise price of $4.50 per share vested in September 2004 in relation to work completed with Dragados. Related to the vesting of these warrants for the year ended December 31, 2005, we recognized expense of
$2,759,000. All warrants will expire on November 4, 2007. This transaction was exempt from the registration requirements of the Securities Act of 1933, as amended, by virtue of Section 4(2) thereof as a transaction not involving any public
offering.
In October 2004, we amended our consulting agreement with TI Capital to provide that in connection with
the closing of a financing with a company introduced to us by TI Capital, we will pay TI Capital, a number of shares of our common stock equal to one percent of the net proceeds that we receive in connection with such financing divided by $5.79 per
share, provided that the closing occurs by February 2006, or such later date as we, in our sole discretion, may designate. The cash payment was made promptly after the meeting of stockholders at which the proposal to approve the issuance of the
shares was approved. As a result of the Stranded Gas Venture, we have issued TI Capital 103,627 shares of common stock and paid cash bonuses totaling $600,000 in accordance with this agreement. TI Capital and Mr. Ghandour collectively own
207,658 shares of our common stock at December 31, 2006.
In February 2006, we amended this agreement to provide that in connection
with the closing of a financing with a company introduced to Syntroleum by TI Capital, we will make a payment to TI Capital equal to 1.5 percent of the total equity and debt financing provided by parties other than us for each of the first two GTL
plants, provided that the cumulative amount of the two payments does not exceed $50,000,000.
Sovereign Oil and Gas Company II,LLC.
In March 2004, we entered into a joint development agreement with Sovereign Oil & Gas Company II, LLC (“Sovereign”), a consulting firm that we have retained to assist us in acquiring stranded natural gas fields worldwide. Under
the agreement, we agreed to issue warrants to purchase 50,000 shares of our common stock at an exercise price of $6.40 upon stockholder approval of the agreement. These warrants are exercisable for five years beginning on the date of stockholder
approval, which was received on April 26, 2004. The vesting period for these warrants did not begin until they were approved by stockholders, at which time we recognized expense totaling $165,000 with respect to these warrants for the period
ended December 31, 2005.
In addition, under the agreement we are required to issue warrants to purchase 25,000 shares upon our
acquisition of an interest in a property proposed by Sovereign, the acquisition from us by another company of such property or the execution of an agreement by us and another company regarding joint participation in the project involving such a
property, exercisable five years from the acquisition or agreement date. If we and Sovereign do not receive a cash bonus or overriding royalty interest in connection with the acquisition from us by another company of such property or the execution
of an agreement by us and another company regarding our joint participation in the project involving such a property, we will issue an additional 25,000 warrants exercisable for five years from the acquisition or agreement date plus an additional
50,000 warrants exercisable for five years from the date of first production of hydrocarbons from the property. We are required under the agreement to issue warrants to purchase 12,500 shares upon our acquisition of an interest in a property
proposed by us and accepted by Sovereign or for which we initiated negotiations, the acquisition from us by another company of such property or the execution of an agreement by us and another company regarding participation in the project involving
such a property, exercisable for five years from the acquisition or agreement date.
Warrants issued in connection with properties acquired
or third party participation achieved between March 1, 2004 and March 1, 2005 had an exercise price of $6.40. Warrants issued in connection with properties acquired or third party participation achieved after March 1, 2005 will have
exercise prices per share to be determined based on the price of our common stock on March 1 of the contract year stated in the agreement during which the project commences. No more than 2,000,000 shares of our common stock are issuable upon
exercise of the warrants issued pursuant to the agreement.
As a result of our agreements on OML 113 offshore Nigeria, we issued Sovereign
warrants to purchase a total of 50,000 shares of our common stock at an exercise price of $6.40 per share. Sovereign has also earned warrants to purchase 25,000 shares of our common stock in relation to our agreement on OML 90. On January 28,
2005, Sovereign exercised warrants to purchase 8,750 shares of our common stock at an exercise price of $6.40 per share, resulting in proceeds of approximately $56,000. On July 26, 2006, Sovereign earned warrants to purchase 25,000 shares of
our common stock at an exercise price of $7.98 per share.
Our shareholders approved an amendment to the joint development agreement with
Sovereign at the annual shareholders meeting in April 2006 to change the exercise price of warrants issued to the closing per share sale price of our common stock as of December 1 prior to a contract year in which the warrants are issued. This
amendment was made because this is the date that we must give notice to Sovereign of continuation or termination of the joint
development agreement for the next contract year. For the 2005 and 2006 contract years, the exercise price for all warrants issued, after shareholder
approval, is $6.94 and $7.98 per share, respectively. The exercise price for the 25,000 warrants to purchase shares of common stock issued for OML 90 changed from $11.16 to $6.94 per share due to the approval by the shareholder’s of the
amendment mentioned above.
We notified Sovereign on November 15, 2006 that we did not intend to renew the JDA at the conclusion of
the current contract year. The JDA terminates in March 2007.
In January 2005, we granted an aggregate of 84,081 shares of common stock to
certain employees under our existing stock option and incentive plans related to service performed in 2004. These shares were fully vested on the date of grant. We recognized compensation expense of $774,000 during the year ended December 31,
2004 for the stock awards that were granted to employees in 2005 related to this plan based on the value of our common stock on January 24, 2005. In connection with the vesting of restricted shares we repurchased and subsequently cancelled a
total of 17,282 shares of common stock as settlement for the employees’ payroll taxes.
On April 25, 2005, our stockholders
approved the adoption of the Syntroleum Corporation 2005 Stock Incentive Plan (the “Plan”), which provides for the issuance of up to 6,600,000 shares of our common stock pursuant to the grant of stock options, stock appreciation rights,
stock awards (including restricted stock and stock units) and performance awards. Awards will be available for grant to our employees, independent contractors and non-employee directors, except that non-employee directors may only be granted awards
of stock appreciation rights, stock options or restricted stock under the Plan. The Board of Directors has established an annual incentive plan under which employees are eligible to receive a certain number of shares of common stock based on the
achievement of certain company-wide objectives and the individual’s performance rating for the year. The Board of Directors has established objectives on which we will be measured which determines a number of shares to be issued to employees
based on a rating system. In January 2006, we granted an aggregate of 91,707 shares of common stock to certain employees under our existing stock option and incentive plans related to service performed in 2005. These shares were fully vested on the
date of grant. We recognized compensation expense of $877,000 during the year ended December 31, 2005 for the stock awards that were granted to employees in 2006 related to this plan based on the value of our common stock on January 23,
2006. We recognized compensation expense of $1,086,000 during the year ended December 31, 2006 for the stock awards that were granted to employees in 2007 related to this plan based on the value of our common stock on January 24, 2007 and
February 6, 2007.
On June 30, 2005, we entered into stock option award agreements with certain of our officers under our 2005
Stock Incentive Plan. The agreements granted the officers options to purchase up to 2,000,000 shares of our common stock at an exercise price of $10.52 per share. Depending on the sustained stock price of our common stock and the net present value
of future cash flows, a percentage of the options will vest as determined in a performance vesting schedule with respect to the period commencing on the date of grant and ending on December 31, 2010 (the “Performance Period”). The
term of each option is ten years from the date of grant. “Sustained stock price” means the average fair market value of a share of our common stock during any six-month period commencing on or after the first day of the Performance Period
and ending on or before the last day of the Performance Period. “Net present value of future cash flows” means the net present value of estimated future cash flows from executed agreements (such as a contract to supply natural gas), proven
reserves or any other source of future cash flows with analogous certainty to the aforementioned sources as estimated by an independent auditor designated by our Board of Directors. For this purpose, an annual discount rate of 10 percent is used to
calculate net present value.
In July 2005, we entered into a stock option award agreements with certain of our officers under our 2005
Stock Incentive Plan similar to those described above. The agreements granted the officers options to purchase up to 600,000 shares of our common stock at an exercise prices of $10.14 per share. The term of each option is ten years from the date of
grant. Depending on the sustained stock prices of our common stock and the net present value of future cash flows, a percentage of options will vest as according to the Performance Period.
During 2005, we granted an aggregate of 250,000 restricted common stock units to certain employees under the 2005 Stock Incentive Plan. These restricted
common stock units vest over various periods through 2010. We recognized $238,000 in compensation expense for the year ending December 31, 2005. Throughout the remainder of the vesting period we expect to recognize $2,297,000 in compensation
expense relating to the vesting of these restricted common stock units. We recorded deferred compensation for these units totaling $2,535,000 at the time of grant based on the market prices of our common stock on that date.
During 2006, we granted an aggregate of 261,500 options to purchase shares of common stock to employees
at a weighted average exercise price of $9.59 per share. We also issued 119,998 shares of common stock as a result of the vesting of restricted common stock units. We granted 45,230 restricted common stock units to employees and issued 38,759 shares
of common stock to our directors for services to be provided in the future. In connection with the vesting of restricted shares we repurchased and subsequently cancelled a total of 77,716 shares of common stock as settlement for the employee’s
payroll taxes.
On May 22, 2006, we registered via an S-8, 750,000 shares of common stock issuable as matching pursuant to the terms of our
401K Plan. As of December 31, 2006, we had issued 46,629 shares under this Plan.
We implemented a retention incentive agreement plan on
December 8, 2006 where certain employees were granted stock options, restricted shares and/or cash awards. The agreements granted the executive officers the option to purchase up to 600,000 shares of our common stock at an exercise price of
$2.89 per share. One-third of the options vest and become exercisable on June 29, 2007 and the remaining two-third of the options vest and become exercisable on June 29, 2008. In addition, 200,000 restricted common stock units were granted
to the executives with a vesting date of June 29, 2007. Additional retention agreements were entered into with other key employees. If the employee remains employed through the date specified under the terms of the agreement, we have a
commitment to pay $671,000 on June 29, 2007 and $1,092,600 on June 29, 2008. The Company has no obligation if the employee leaves before the date specified in the agreement. We have the option to grant shares of restricted stock units of
the 2008 commitment in lieu of making a cash payment with the number of shares
Commonwealth of Australia Settlement
In April 2004, we reached an agreement with the Commonwealth of Australia to resolve all issues between the two parties regarding the suspension of our
nominal 11,500 b/d specialty product GTL plant in Western Australia (known as the Sweetwater project). Under this agreement, funds held in escrow accounts in Australia related to previous loan advances and a license agreement, plus all interest
earned on these funds since the suspension of the project, and other associated costs were returned to the Commonwealth of Australia in September 2004. The Commonwealth retained its license for the Syntroleum Process; however, rather than retaining
the right to receive AUD $30 million in credits against future license fees per the original agreement, the Commonwealth received AUD $15 million in credits. The income statement impact of this transaction was a charge against earnings of $610,000
for interest and other associated costs since the suspension of the project and included in other income (expense) on our consolidated statement of operations for the year ended December 31, 2004. We have no plans to re-start the Sweetwater
Project.
New Accounting Pronouncements
In July 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”) Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement 10 9 . FIN 48 clarifies that an entity’s tax benefits
recognized in tax returns must be more likely than not of being sustained prior to recording the related tax benefit in the financial statements. As required by FIN 48, the Company will adopt this new accounting standard effective January 1,
2007. The adoption of FIN 48 is not expected to have a material impact on the Company’s consolidated results of operations and financial condition.
In September 2006, the FASB issued SFAS No. 157 (“SFAS No. 157”), Fair Value Measurements . This statement defines fair value, establishes a framework for measuring fair value, and expands
disclosures about fair value measurements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company will adopt SFAS No. 157 effective January 1, 2007. The adoption of
SFAS No. 157 is not expected to have a material impact on the Company’s consolidated results of operations and financial condition.
In September, 2006, the SEC Staff issued SAB 108, Financial Statements – Considering the Effects of Prior Years Misstatements When Quantifying Misstatements in Current Year Financial Statements . This statement provides guidance
on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. Based on this guidance, the SEC staff believes that registrants should quantify errors using both a balance
sheet and an income statement approach and evaluate whether either approach results in quantifying a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. The application of SAB 108 is encouraged for
an interim period of the first fiscal year ending after November 15, 2006. SAB 108 became effective for Syntroleum in the fourth quarter of 2006 and did not have a material impact on the Company’s consolidated financial statements.
In November 2006, the FASB ratified a consensus opinion reached by the EITF on EITF Issue 06-6 Debtor’s Accounting for a
Modification (or Exchange) of Convertible Debt Instruments , which supersedes EITF Issue 05-7, Accounting for Modifications to Conversion Options Embedded in Debt Instruments and Related Issue s , and amends EITF Issue 96-19,
Debtor’s Accounting for a Modification or Exchange of Debt Instruments . Under the guidance in EITF Issue 06-6, when the Company modifies or exchanges debt instruments that affect the terms of an embedded conversion option, debt
extinguishment accounting would apply under certain conditions. Guidance is also provided for modifications or exchanges that are not treated as extinguishments. The consensus in EITF Issue 06-6 is effective for modifications and exchanges of debt
instruments that occur in interim or annual reporting periods beginning after November 29, 2006. The Company intends to adopt EITF Issue 06-6 effective January 1, 2007 and does not believe that the adoption will have a significant effect on its
financial statements.
In December, 2006, the FASB issued FASB Staff Position (FSP) EITF 00-19-2, Accounting for Registration
Payment Arrangements . The FSP specifies the contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement, whether issued as a separate agreement or included as a provision of a
financial instrument or other agreement should be recognized and measured separately in accordance with FASB No. 5, Accounting for Contingencies . FSP EITF 00-19-2 further clarifies that a financial instrument subject to a registration
payment arrangement should be accounted for in accordance with other applicable generally accepted accounting principles without regard to the contingent obligation to transfer consideration. The FSP is effective immediately for registration payment
arrangements that are entered into or modified subsequent to December 21, 2006. We will adopt the provisions of FSP EITF 00-19-2 beginning in January 2007 and expect no impact on the Company’s consolidated financial statements.
Critical Accounting Policies and Estimates
The
preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and use assumptions that affect reported amounts. We believe that the following items represent our critical
accounting policies and estimates:
Revenue Recognition . We recognize revenues from joint development activities when contract deliverables
are completed. Proceeds received prior to the completion of contractual obligations are deferred with revenues recognized upon completion of our obligations specified under the contract.
Substantially all of our joint development revenues during the periods presented have been from joint development activities with several major oil
companies (see Note 13), the DOE and the DOD. All such joint development activities were pursuant to joint research and development agreements where we expense our research and development costs as incurred. These projects require us to deliver
results from development activities such as non-proprietary analysis of plant processes, flow diagrams, chemical analysis and fuel production plans that will be jointly shared by each party. The customers benefit from paying for these development
activities as they are obtaining access to information pertaining to the Syntroleum Process. Revenue is recognized when final delivery of the shared technology has occurred. Under some of these agreements, the joint development participant may
receive credits against future license fees for monies expended on joint research and development. The value of these credits is a fixed amount stated in the contract and reflected as deferred revenue until the credit is utilized. The revenues to be
recognized in the future from these contracts are deemed to be fixed and determinable under the criteria specified in Staff Accounting Bulletin, Topic 13 and SOP 97-2 Software Revenue Recognition.
License fee deposits received as cash upon the sale of master volume or regional license agreements are recorded as deferred revenue in the consolidated
balance sheets until recognized as revenue in the consolidated statements of operations. We recognize revenue on the sale of license agreements by recording 50 percent of the license fee deposit as revenue when: (1) a site license agreement has
been formally executed, (2) the license fee deposit has been paid in cash and (3) we have delivered to the licensee the process design package for the licensee’s initial licensed plant. Since 50 percent of the license fee deposit is
subject to the our indemnity obligation with respect to the performance guarantee on the related plant, the remaining license fee deposit will be recognized as revenue in the consolidated statements of operations after the related plant has passed
certain performance tests. Option fees, which provide licensees the right to include additional geographic areas in its license agreement territory, are deferred until the earlier of the option being exercised or lapsing. The license agreements
currently allow us to work with outside engineering contractors to develop a site-specific plant design in accordance with licensee specifications; this design package is called the Process Design Package, or “PDP,” and allows for a 100
percent cost recovery plus a 10 percent mark-up from the licensee. To date, we have not delivered any PDP’s for initial licensed plants. We are under no obligation to return these deferred revenues except in the case when a licensee builds a
plant and the plant does not pass certain performance tests. In this situation, the licensee would be able to receive a refund of 50 percent of the license fees paid. The license agreements have a 15-year life and, after this time, the deferred
revenue will be recorded as license revenue in the statements of operations unless a site license has been executed. Our current licenses generally begin to expire in 2011 and the initial deposits will be recognized as licensing revenue as the
licenses expire should a licensee not purchase a site license and begin construction of a plant prior to expiration of the license.
We
sold a certain amount of the catalyst materials we had on-hand during the years ended December 31,
2004. Any revenues and costs of sales related to the sale of these materials are recorded in the statement of operations in the period in which the materials
are sold. We fully liquidated all of these catalyst materials during the year ended December 31, 2004.
We expect to earn revenue from
the sale of proprietary catalysts to licensees. Our license agreements currently require catalyst to be used in the initial loading of the catalyst into the Fischer-Tropsch reactor for the licensee to receive a 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 pursuant to license agreements is equal to cost plus a specified margin. We will receive revenue from catalyst sales
if and when the licensees purchase catalysts. We expect that catalysts will need to be replaced every three to five years.
We provide
synthetic ultra-clean diesel fuel, such as our S-2 diesel fuel and S-8 jet fuel (subject to certification), produced from natural gas and FC-1 naphtha fuels to various customers for their use in further research and testing upon their request. The
ultra-clean S-2 diesel fuel and S-8 jet fuel (subject to certification) is a paraffinic, high-cetane distillate fuel that is essentially free of sulfur, olefins, metals, aromatics or alcohols. The fuels have been produced at the Catoosa
Demonstration Facility. Revenues are recognized upon delivery of the requested fuels and are recorded as other revenue.
Research and
Development. We incur significant costs for research, development and engineering programs. Expenses classified as research and development include salaries and wages, rent, utilities, equipment, engineering and outside testing and analytical
work associated with our research, development and engineering programs. Since these costs are for research and development purposes, and not commercial or revenue producing, they are charged to expense when incurred in accordance with SFAS
No. 2, Accounting for Research and Development Costs .
Stock-Based Compensation. Prior to January 1, 2006, we
accounted for share-based compensation to employees in accordance with the Accounting Principles Board Opinion No. 25 (“APB 25”), Accounting for Stock Issued to Employees and related interpretations. We also followed the
disclosure requirements of SFAS No. 123, Accounting for Stock-Based Compensation . Effective January 1, 2006, we adopted the provisions of SFAS No. 123(R) Share-Based Payment , which requires that we measure the cost of
employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized in the consolidated statement of operations over the period during which an employee is required to
provide service in exchange for the award.
We adopted the modified prospective transition method as provided by SFAS No. 123(R).
Accordingly, the financial statement amounts for the prior periods have not been restated to reflect the fair value method of expensing share-based compensation. In accordance with the modified prospective transition method, all outstanding deferred
compensation at the time of adoption was reclassified to additional paid-in capital. For the year ended December 31, 2006, we recorded a total of $7,859,000 or ($0.14) per basic and diluted share of share-based compensation expense. At
January 1, 2006, we had no cumulative effect associated with adopting SFAS 123 (R).
Non-Employee Stock-Based Compensation. The
Company also grants stock-based incentives to certain non-employees. These stock based incentives are accounted for in accordance with Emerging Issues Task Forces Issue 96-18, Accounting for Equity Instruments That Are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services . Any stock options granted to non-employees that are not related to specific performance criteria are expensed over the period of vesting. Stock options that are tied to
performance criteria are expensed at the time the performance goals are met.
Oil and Gas Properties. We follow the full cost method
of accounting for exploration, development, and acquisition of gas and oil reserves. Under this method, all such costs (productive and nonproductive) including salaries, benefits, and other internal costs directly attributable to these activities
are capitalized and amortized on an aggregate basis over the estimated lives of the properties using the units-of-production method. We exclude all costs of unevaluated properties from immediate amortization. Our unamortized costs of oil and gas
properties are limited to the sum of the future net revenues attributable to proved oil and gas reserves discounted at 10 percent plus the lower of cost or market value of any unproved properties. If our unamortized costs in oil and gas properties
exceed this ceiling amount, a provision for additional depreciation, depletion and amortization is required.
Discontinued Operations and Impairment of Assets . We follow the provisions of SFAS
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets for assets, other than oil and gas properties, including for the presentation and disclosure of discontinued operations . We make assessments of impairment on
a project-by-project basis. Management reviews assets for impairment when certain events have occurred that indicate that the asset may be impaired. An asset is considered to be impaired when the estimated undiscounted future cash flows are less
than the carrying value of the asset. The impairment provision is based on the excess of carrying value over fair value. Fair value is defined as the present value of the estimated future cash flows of a project.
We follow the full cost method of accounting for the exploration, development and acquisition of oil and reserves as stated above. All unamortized costs
of oil and gas properties are limited to the sum of future net revenues attributable to proved oil and gas reserves discounted at 10 percent plus the lower of cost or market value of any unproved properties. We completed an evaluation of the
potential reserves and the economics related to our domestic oil and gas properties in 2005 and decided to focus our efforts on aligning the Company with specific goals and projects that have GTL and CTL potential. As a result, we discontinued
further expenditures in the Central Kansas Uplift area and began disposing of these properties. We disposed of the majority of these properties in 2005. The final transaction occurred in January 2006. In December 2006, we entered into an agreement
to sell the common stock of the subsidiary that holds our interest in our international oil and gas projects. The transaction closed in January 2007 with the execution of a common stock purchase agreement. Accordingly, we have also classified our
international oil and gas activities in discontinued operations for the years ended December 31, 2006, 2005 and 2004. The net effect of the United States oil and gas activities, including the related gas processing plant and equipment, and
international oil and gas activities, are presented in discontinued operations in the financial statements for the years ended December 31, 2006 and 2005 in accordance with SFAS No. 144.
Critical Estimates. Some of the more significant estimates made by management include, but are not limited to, valuation of stock-based
compensation, estimates for accrued liabilities and impairment of property and equipment. Actual results have not been materially different than the estimates made by management in the past. Management bases these estimates on the most current
information available. These estimates are subject to change in the future as a result of changes in the fair values of the assets.
Item 7A.
Quantitative and Qualitative Disclosures about Mark
et Risk
We had approximately $33,469,000 in cash and cash equivalents in the form of money
market instruments and short-term certificates of deposit at December 31, 2006. This compares to approximately $69,663,000 in cash and cash equivalents at December 31, 2005. Our cash and cash equivalents balances are subject to
fluctuations in interest rates and we are restricted in our options for investment by our short-term cash flow requirements. Our cash and cash equivalents are held in a few financial institutions; however, we believe that our counter-party risks are
minimal based on the reputation and history of the institutions selected.
We expect to conduct a portion of our business in currencies
other than the United States dollar. We may attempt to minimize our currency exchange risk by seeking international contracts payable in local currency or we may choose to convert our currency position into United States dollars. In the future, we
may also have significant investments in countries other than the United States. The functional currency of these foreign operations may be the local currency; accordingly, financial statement assets and liabilities may be translated at prevailing
exchange rates and may result in gains or losses in current income. Currently, all of our subsidiaries use the United States dollar as their functional currency. Monetary assets and liabilities are translated into United States dollars at the rate
of exchange in effect at the balance sheet date. Transaction gains and losses that arise from exchange rate fluctuations applicable to transactions denominated in a currency other than the United States dollar are included in the results of
operations as incurred.
Foreign exchange risk currently relates to deferred revenue, a portion of which is denominated in Australian
dollars. The portion of deferred revenue denominated in Australian currency was U.S. $11,840,000 at December 31, 2006. The deferred revenue is converted to U.S. dollars for financial reporting purposes at the end of every reporting period. To
the extent that conversion results in gains or losses, such gains or losses will be reflected in our statements of operations. The exchange rate of the Australian dollar to the United States dollar was $0.79 and $0.73 at December 31, 2006 and
December 31, 2005, respectively.
We do not have any purchased futures contracts or any derivative financial instruments, other than
warrants issued to purchase common stock at a fixed price in connection with consulting agreements, private placements and other equity offerings.
Item 8.
Financial Statements and
Supplementary Data
Our consolidated financial statements, together with the report thereon of
Grant Thornton LLP dated March 13, 2007, are set forth on pages F-1 through F-29 hereof. See Item 15 for an index to our consolidated financial statements.
Item 9.
Cha
nges in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Contr
ols and Procedures
Evaluation of Disclosure Controls and Procedures. In accordance with
Exchange Act Rules 13a-15 and 15d-15, we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls
and procedures as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2006 to
provide reasonable assurance that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms.
Changes in Internal Controls. There has been no change in our internal control over financial reporting that occurred during the three months
ended December 31, 2006 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
Management’s Report on Internal Control Over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined
in Exchange Act Rules 13a-15(f) and 15(d)-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal
control over financial reporting as of December 31, 2006 based on the framework in “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under
the criteria set forth in “Internal Control-Integrated Framework”, our management believes that our internal control over financial reporting was effective as of December 31, 2006.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Grant Thornton LLP, an independent registered public accounting firm that audited our financial statements included in this Annual Report on Form 10-K,
has issued an attestation report on management’s assessment of our internal control over financial reporting. Such attestation is included below.
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
Syntroleum Corporation
We have audited management's assessment, included in
the accompanying “Management’s Report on Internal Control Over Financial Reporting” referenced under Item 9A, that Syntroleum Corporation (a Delaware Corporation) maintained effective internal control over financial reporting as
of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Syntroleum Corporation’s management is
responsible for
maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our
responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about
whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and
evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the
maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation
of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and
(3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management's assessment that Syntroleum Corporation maintained effective internal control over financial reporting as of December 31, 2006, is
fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) . Also in our opinion, Syntroleum
Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO) .
We also have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of Syntroleum Corporation and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of operations, stockholders' equity (deficit) and cash flows
for each of the three years in the period ended December 31, 2006 and our report dated March 13, 2007 expressed an unqualified opinion on those financial statements.
GRANT THORNTON LLP
Tulsa, Oklahoma
March 13, 2007
Item 9B
.
Other Information
None.
PAR
T III
Item 10.
Directors, Exec
utive Officers and Corporate Governance of the Registrant
The information required by
Item 10 is incorporated herein by reference to the section entitled “Proposal 1—Election of Directors” in our definitive proxy statement for our 2007 annual meeting of stockholders, which will be filed with the SEC pursuant to
Regulation 14A under the Securities Exchange Act of 1934 within 120 days of December 31, 2006. Certain information with respect to our executive officers is set forth at the end of Part I of this Annual Report on Form 10-K under the caption
“Executive Officers of the Registrant.”
We have adopted a written Code of Ethics that is applicable to our directors, chief
executive officer, chief financial officer, chief accounting officer, controller and other executive officers. A copy of our Code of Ethics is available on our website at www.syntroleum.com and was included as Exhibit 14 to our Annual Report
on Form 10-K for the year ended December 31, 2003 filed with the SEC on March 23, 2004. Investors may request a copy of our Code of Ethics at no charge by writing to Richard L. Edmonson, Senior Vice President, General Counsel and Corporate
Secretary, Syntroleum Corporation, 4322 South 49th West Avenue, Tulsa, Oklahoma 74107. We will disclose any amendments to the Code of Ethics and any waivers to the Code of Ethics for directors and executive officers by posting such information on
our website or in a current report on Form 8-K filed with the SEC.
Item
11.
Executive Compensation
The information required by
Item 11 is incorporated herein by reference to the section entitled “Executive Compensation” in our definitive proxy statement for our 2007 annual meeting of stockholders, which will be filed with the SEC pursuant to Regulation 14A
under the Securities Exchange Act of 1934 within 120 days of December 31, 2006. Certain information with respect to our executive officers is set forth in Item 4 of this Annual Report on Form 10-K under the caption “Executive Officers
of the Registrant.”
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by Item 12 is incorporated herein by reference to the section entitled “Security Ownership of Management and Certain
Beneficial Owners” in our definitive proxy statement for our 2007 annual meeting of stockholders, which will be filed with the SEC pursuant to Regulation 14A under the Securities Exchange Act of 1934 within 120 days of December 31, 2006.
Information required by
Syntroleum Corp (SYNM) - Description of business
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