Item 1B.
Unresolved Staff Comments
None.
We own 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 lease a corporate facility in Tulsa, Oklahoma. The lease expires in 2014 with an option to renew and provides for payments of approximately $85,500 annually, with escalation amounts occurring 2012 and 2013.
On August 17, 2007, we entered into a Resignation and Compromise Agreement (“Compromise Agreement”) with Mr. Ziad Ghandour, a former director, employee and consultant to Syntroleum. Under the Compromise Agreement, Mr. Ghandour has the right to receive additional compensation until December 31, 2011 for five potential commercial projects, as defined in the Compromise Agreement. Mr. Ghandour claims he is entitled to additional compensation as a result of a business transaction with SINOPEC. We determined that no additional compensation was warranted as a result of the transaction. The arbitration between Syntroleum Corporation and Ziad Ghandour’s styled Ziad Ghandour v. Syntroleum Corporation, Case No. 50 166 T 00048 10, pending before the American Arbitration Association, was settled on January 17, 2011, and the arbitration was dismissed with prejudice on January 18, 2011. The parties exchanged mutual releases. The settlement has been recorded in our year ended December 31, 2010 Statement of Operations.
Part II
Item 5.
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 NASDAQ Stock Market under the symbol “SYNM.” The table below reflects the high and low closing sales prices for our common stock for each quarter during 2010 and 2009.
Record Holders. The 81,901,346 shares of our common stock outstanding at March 11, 2011, were held by approximately 1,108 record holders (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.
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 as a result of internal and external events. This volatility has often been unrelated to the operating performance of the Company. 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 NASDAQ Stock Market, and we cannot assure you that we will be able to do so. We can make no assurance that we will be able to remain listed on the NASDAQ Stock Market.
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 6% percent of the outstanding shares of our common stock as of March 11, 2011. We cannot predict if future sales of our common stock, or the availability of our common stock for sale, will impact the market price for our common stock or our ability to raise capital by offering equity securities.
Issuer Repurchases of Equity Securities
Neither we nor anyone acting on our behalf or that of an affiliated purchaser purchased shares of our common stock during the three months ended December 31, 2010.
Equity Compensation Plans
The following table provides information concerning securities authorized for issuance under our equity compensation plans as of December 31, 2010.
Equity Compensation Plan Information
Use of Proceeds
The Company received total proceeds net of commission equal to $4.9 million from sales of 2,890,173 shares of its common stock at a price of $1.73 per share pursuant to an offering completed during December, 2010, under its shelf Registration Statement on Form S-3 (No. 333-157879). These sales were made to Energy Opportunity, Ltd., a statutory underwriter, under the terms of a common stock purchase agreement dated as of July 14, 2010. We currently intend to use the net proceeds from the sale of the securities for general corporate purposes. These general purposes may include capital expenditures and/or working capital for us or our joint ventures.
Performance Graph
The following performance graph compares the performance of our common stock during the period beginning on December 31, 2005 and ending on December 31, 2010 to the NASDAQ Stock Market index consisting of United States companies (the “NASDAQ Composite”) and an index consisting of all U.S. and Foreign publicly traded companies listed as non-financial stocks with Standard Industrial Codes 1100-5999, 7000-9999 for the same period. The graph assumes a $100 investment in our common stock and in each of the indexes at the beginning of the period and a reinvestment of dividends paid on such investments throughout the period.
VALUE OF $100 INVESTMENT
ASSUMING REINVESTMENT OF DIVIDENDS AT DECEMBER 31, 2005, AND AT THE END OF EVERY FISCAL
YEAR, AND THROUGH DECEMBER 31, 2010
The following selected financial information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operation” in Item 7
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operation
Overview
Our focus is the commercialization of our technologies to produce synthetic liquid hydrocarbons. Operations to date have consisted of activities related to the commercialization of a proprietary process (the “Syntroleum® Process”) and previously consisted of research and development of the Syntroleum® Process designed to convert carbonaceous material (biomass, coal, natural gas and petroleum coke) into synthetic liquid hydrocarbons. Synthetic hydrocarbons produced by the Syntroleum® Process can be further processed using the Syntroleum Synfining® Process into high quality liquid fuels, such as diesel, jet fuel (HRJ, subject to certification), kerosene, naphtha, propane and other renewable chemical products.
Our Bio-Synfining™ Technology is a renewable fuels application of our Synfining® Technology. This technology is applied commercially via our Dynamic Fuels, LLC joint venture with Tyson Foods, Inc. The technology processes renewable feedstocks such as triglycerides and/or fatty acids to make renewable synthetic products.
Operating Revenues
During the periods discussed below, our revenues were primarily generated from the sale or transfer of our technology, technical services revenue from engineering and sales of products for testing purposes. In the future, we expect to receive revenue from engineering technical services, royalties and other income from our jointly owned subsidiary Dynamic Fuels, sales and licensing of our technologies and product sales or royalties for the use of GTL, BTL and CTL plants in which we will own an equity interest.
Until the commencement of full rate commercial operation of Dynamic Fuels, we expect that cash flow relating to our Syntroleum® Technologies will consist primarily of revenues associated with technical services and sales and licensing of our technology. Upon full rate commercial operations of the Dynamic Fuels facility and adequate working capital, we may receive royalty fees based on the production of the facility. We expect to achieve full rate operations in the second quarter of 2011. We also expect to receive additional profits from the operations of the facility based on our proportionate equity ownership of the plant. We may receive revenues associated with the sale of the use of our technology to certain customers with limited rights in certain geographic areas. Our future operating revenues and investments in projects will depend on the successful commercial operation of the Dynamic Fuels facility or other GTL, BTL or CTL plants based on the Syntroleum® Process, the success of competing GTL technologies, and other competing uses for natural gas, biomass or coal. We expect our results of operations and cash flows to be affected by changing crude oil, natural gas, oils, animal fats, fuel and specialty product prices and trends in environmental regulations. If the price of these products increase (decrease), there could be a corresponding increase (decrease) in operating revenues.
We continue to incur operating expenses with respect to commercializing our Syntroleum® Technologies and do not anticipate recognizing any significant revenue production from the Dynamic Fuels Bio-Synfining™ facility until the second half of 2011.
Operating Expenses
Our operating expenses historically have consisted primarily of engineering, including third party engineering 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.
We have also recognized depreciation and amortization expense related to office and computer equipment, leasehold improvements and patents. We have reduced our costs and expenses over the past three years 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 plants, reducing our workforce and focusing on cost minimization. Our current workforce consists of engineers and general and administrative employees. The implementation of these cost saving measures had a significant favorable impact on our operating expenses.
We have incurred costs related specifically to the development and design of the Bio-Synfining™ and Syntroleum® Process. These costs, which relate primarily to engineers and outside contract services for initial engineering, design, and development, are included in engineering costs in our consolidated statements of operations.
We have invested $40.5 million of cash into our Dynamic Fuels Bio-Synfining™ plant in which we own an interest for our portion of start-up and capital expenditures, including working capital for our share of the engineering design, construction and start-up of the plant. We have incurred our share of initial working capital which includes expenses relating primarily to the cost of feedstocks for the plant and operating expenses relating to the plant, including labor, consumables and product marketing costs.
Commercial and Licensee Projects
On June 22, 2007, we entered into definitive agreements with Tyson to form Dynamic Fuels, to construct and operate facilities in the United States using our Bio-Synfining™ Technology. Dynamic Fuels is organized and operated pursuant to the provisions of its Limited Liability Company Agreement between the Company and Tyson (the “LLC Agreement”).
The LLC Agreement provides for management and control of Dynamic Fuels to be exercised jointly by representatives of the Company and Tyson equally with no LLC member exercising control. This entity is accounted for under the equity method and is not required to be consolidated in our financial statements; however, our share of the Dynamic Fuels net income or loss is reflected in the Consolidated Statements of Operations. Dynamic Fuels has a different fiscal year than us. The Dynamic Fuels fiscal year ends on September 30 and we report our share of Dynamic Fuels results of operations on a three month lag basis. Our carrying value in Dynamic Fuels is reflected in “Investment in and loans to Dynamic Fuels LLC” in our Consolidated Balance Sheets. As of December 31, 2010, Syntroleum’s total estimate of maximum exposure to loss as a result of its relationships with this entity was approximately $43,523,000, which represents our equity investment in and loans to this entity.
Dynamic Fuels was initially capitalized on July 13, 2007 with $4.25 million in capital contributions from Tyson and $4.25 million in capital contributions from us. Each member contributed an additional $36.25 million in capital contributions by December 31, 2010. Each member contributed an additional $5.0 million in the form of a working capital loan to the entity. The $5.0 loan will be repaid to each member upon Dynamic Fuels generating sufficient working capital from fuel sales.
Dynamic Fuels began commercial operations in November of 2010. The plant has achieved full rate production levels, but not on a continuous basis. As of February 28, 2011, the plant has produced and sold 3.1 million gallons of renewable diesel and 0.7 million gallons of renewable naphtha. The plant also produced 40,000 gallons of renewable jet fuel, which is being tested by the U.S. military. Full rate capacity for the plant is 5,000 barrels per day. We expect to achieve full rate capacity on a continuous basis in the second quarter of 2011.
Diesel is quality tested and meets ASTM D975 standards for diesel. The renewable products have low emissions and nearly no aromatics. Our jet fuel HRJ, meets all petroleum based jet fuel specifications. We are awaiting certification of HRJ jet fuel for a 50/50 blend for use in aviation. We expect it to occur in the first half of 2011, thus allowing us to market our jet fuel production capabilities to interested parties. The production of our fuel is eligible for the $1.00 tax credit per gallon of renewable diesel and $0.50 per gallon of renewable naphtha under the Energy Independence Act and Energy Policy Act of 2005. Our fuel also generates 1.7 RIN’s per gallon. RIN prices have increased in recent months due to the government mandated demand for 800 million gallons of biomass-based diesel to be consumed by refiners in 2011. As of March 1, 2011, RIN prices are $1.10 per gallon and therefore worth $1.87 per gallon with the 1.7 multiplier. Our fuel can be sold with the RIN premium included in our price of fuel. We have the ability to produce various renewable specialty chemical products with higher margins that are not dependent on government subsidies or mandates. We are actively researching and marketing to these specialty chemical markets.
On October 21, 2008, Dynamic Fuels issued tax exempt bonds through the Louisiana Public Facilities Authority in the amount of $100 million at an initial interest rate of 1.3% to fund construction of the plant. The Bonds required a letter of credit in the amount of $100 million as collateral for Dynamic Fuels’ obligations under the Bonds. Tyson agreed under the terms of the Warrant Agreement to provide credit support for the entire $100 million Bond issue. The interest rate for the Bonds is a daily floating interest rate and may change significantly from this amount. In the fourth quarter of 2008, Dynamic Fuels entered into an interest rate swap, which had the effect of locking in the interest rate at 2.19% for a period of 5 years with declining swap coverage. This debt funding is in addition to the equity contributions and loans provided by each member.
Discontinued Operations
Research and Development
In 2007, we determined we had completed the research and development activities necessary to validate our technology. All of these research and development expenses were associated with the development of our Syntroleum® Process. We decided to focus on the commercialization of our technologies to produce synthetic liquid hydrocarbons.
Results of Operations
Consolidated Results for the Years Ended December 31
Technology Revenue. Technology Revenue was $3,600,000 for the year ended December 31, 2010 and relates to the delivery of technology equipment related to our transfer of technology sale that occurred in 2009. Technology Agreements will be unique to individual customers. Revenue recognition will be determined on an individual contract basis. We are actively pursuing other agreements. Due to the complexity and due diligence requirements of these agreements, the business development requirements typically span current year timing.
Technical Services Revenue. Revenues from engineering services for Dynamic and other engineering services remained relatively the same in 2010 as compared to 2009. It increased in 2009 compared to 2008 revenues. This increase is attributable to increased technical services contracts related to certain Technology Revenue Agreements and continued work on the engineering design and project management of Dynamic Fuels. Revenue from Dynamic Fuels is expected to be significantly less in 2011 as the project is complete and the plant is operational and will need limited licensor work. We expect to continue to earn revenues for engineering services provided to other customers on an individual contract basis in 2011.
Other Revenue. There were no other revenues in the year ended December 31, 2010. The revenue in 2008 consisted of GTL fuel sales and recognition of revenue for the completion of the second and third milestone for our work with testing 600 gallons of renewable jet fuel with the DOD in the amount of $1,012,000 in 2008. We do not expect to recognize future revenues from this revenue source.
Engineering Expense. The decrease in expenditures in 2010 compared to 2009 and 2008 is a result of decreased engineering headcount and increased bonus compensation granted and expensed in 2009 for the execution and delivery of technology document agreements.
Non-Cash Equity Compensation. Equity compensation expense for the vesting of stock compensation awards to employees decreased in 2010 compared to 2009 and 2008. These changes in expense primarily relate to the vesting schedule of performance based awards granted to all employees in 2008. The vesting of these awards is based on achieving certain milestones associated with the Bio-Synfining™ Technology project. A majority of the expense associated with these awards was recognized in 2009 and we expect to recognize the remaining amount of equity compensation for the milestone based awards in 2011, but we do not expect such additional equity compensation expense to be significant and will not have significant equity compensation expense for the remainder of 2011, unless new awards are granted.
General and Administrative and Other. General and administrative expenses decreased significantly in 2010 compared to 2009 and 2008. The decrease primarily relates to bonus compensation granted in 2009 for the execution and delivery of technology document agreements and decreased legal fees due to settlement of litigation, offset by the non-cash expense of legal fees from prior years on abandoned patents and cash settlements. In 2008 expenses were higher due to legal fees associated with litigation.
Interest Income. The decrease in interest income over the years is due to declining interest rates on money market funds. A majority of interest income is generated from money market accounts with our current cash balances.
Loss in equity of Dynamic Fuels, LLC. Our 50% share of Dynamic Fuels’ loss for its year ended September 30, 2010 increased due to initial start-up operating expenditures. Expenditures incurred for Dynamic’s year ended September 30, 2010 includes site rent, project development, equipment evaluation and labor expenditures for operations staff for 12 months. In anticipation of plant operation in 2010, operating expenditures incurred for Dynamic Fuels total approximately $12,042,000 for the twelve months ended September 30, 2010. We expect to see income from this investment in 2011 upon full rate commercial operations. We report our 50 percent share of Dynamic Fuels results of operations on a three month lag basis.
Foreign Currency Exchange. Changes in the foreign currency exchange are due to fluctuation in the value of the Australian dollar compared to the U.S. Dollar. The foreign currency changes result from translation adjustments from our license with the Commonwealth of Australia which is denominated in Australian dollars. These changes have no current cash impact on us.
Income (Loss) from Discontinued Operations. Changes in income from discontinued operation primarily resulted from lower than expected dismantlement costs in 2010 resulting in a gain from reducing our asset retirement liability associated with the Catoosa Demonstration Facility to $0. The increase in 2008 results from proceeds received in the amount of $1,500,000 from the settlement of future payments associated with our international oil and gas assets in 2008.
We will not incur further expenses related to our oil and gas activities in the future.
Liquidity and Capital Resources
General
As of December 31, 2010, we had $12,513,000 in cash and cash equivalents. At December 31, 2010 we had $1,285,000 in accounts receivable outstanding relating to our Technical Services Revenue, $729,000 of which is due from Dynamic Fuels. We believe that all of the receivables currently outstanding will be collected and have not established a reserve for bad debts.
Our current liabilities totaled $1,693,000 as of December 31, 2010.
Our business plan over the next several years includes potential investments in additional plants and we will need to raise capital to accomplish this plan. We expect to obtain funding through debt or equity financing, joint ventures, license agreements and other strategic alliances. If we obtain additional funds by issuing equity, dilution to stockholders may occur. In addition, preferred stock could be issued 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 might be available.
If we are unable to generate funds from operations, our need to obtain funds through financing activities will be increased.
Cash Flows
2010 vs. 2009
Cash flows used in operations was $1,112,000 during the year ended December 31, 2010 compared to cash flows provided by operations of $12,646,000 during the year ended December 31, 2009. The increase in cash flows provided by operations in 2009 primarily results from the collection of revenues from technology transfer agreements of $19,000,000 and engineering technical services.
Cash flows used in investing activities were $21,264,000 during the year ended December 31, 2010 compared to $6,218,000 during the year ended December 31, 2009. We invested $16,250,000 in and loaned $5,000,000 to Dynamic Fuels in 2010. We have no further commitments to fund Dynamic Fuels, but additional commitments could arise based on the cash flow needs of the entity. The cash used in investing activities in 2009 included a $6,000,000 investment into Dynamic Fuels.
Cash flows provided by financing activities during the year ended December 31, 2010 was $9,877,000 compared to $8,483,000 in 2009. The cash flows provided by financing activities are primarily due to net proceeds received from our Stock Purchase Agreement with Fletcher and Energy Opportunity Ltd (“Energy”). Fletcher purchased a total of 4,541,497 shares of our common stock at a stock price of approximately $2.64 in 2009 and 2010. Energy purchased a total of 3,948,374 shares of our common stock at a stock price of approximately $1.77 in 2010.
2009 vs. 2008
Cash flows provided by operations was $12,646,000 during the year ended December 31, 2009 compared to cash flows used in operations of $2,772,000 during the year ended December 31, 2008. The increase in cash flows provided by operations primarily results from the collection of revenues from technology transfer agreements of $19,000,000 and engineering technical services.
Cash flows used in investing activities were $6,218,000 during the year ended December 31, 2009 compared to $5,532,000 during the year ended December 31, 2008. We invested $6,000,000 in Dynamic Fuels in April of 2009. The cash used in investing activities in 2008 included a $14,000,000 investment into Dynamic Fuels. This investment was offset by the sale of assets associated with our discontinued operations such as, receipt of payments from AAERL of $7,266,000 and the proceeds from the sale of the Technology Center of $1,100,000.
Cash flows provided by financing activities during the year ended December 31, 2009 was $8,483,000 compared to $0 in 2008. The increase in cash flows provided by financing activities is primarily due to net proceeds received from our Stock Purchase Agreement with Fletcher. Fletcher purchased 3,406,123 shares of our common stock at a stock price of approximately $2.64 in the fourth quarter of 2009.
Contractual Obligations
The following table sets forth our contractual obligations as of December 31, 2010:
Our operating leases include leases for corporate headquarters, demonstration plants and software.
We have entered into employment agreements, which provide severance cash benefits to several key employees. Commitments under these agreements totaled approximately $2,139,000 at December 31, 2010. Expense is not recognized until an employee is severed.
We entered into a Bio-Synfining Master License Agreement on June 22, 2007 with Dynamic Fuels, LLC. Under this license agreement, we at the request of the licensee must execute a Site License Agreement in favor of licensee for licensee’s use of our Bio-Synfining™ Technology. The form of the Site License Agreement is included in the agreement as Exhibit B. The form of the Site License Agreement includes process guarantees if the plant fails to pass a performance test as defined in the Site License Agreement. If the plant fails to meet the Process Guarantee during the Performance Test and such failure is due in whole or in part to the Process Design Package, then we and Dynamic Fuels shall mutually agree whether or not remedial measures are reasonably likely to cause the plant to satisfy the Process Guarantee. The actual cost of the remedial measures will be reimbursed to licensee through application of any future royalties owed to us, not to exceed $9,800,000. If the remedial measures are not effective, we shall pay to Dynamic Fuels an additional amount for liquidated damages in an amount not to exceed $9,800,000. As of the date of this filing the Site License Agreement has not been executed by Dynamic Fuels and we cannot be certain the document that will be executed will have this same language and amounts. Dynamic Fuels has not met all conditions required for the Performance Test to occur in order to pass the Performance Guarantee at this time.
We may need to fund future short-term working capital needs of Dynamic Fuels on an as needed basis.
Equity Issuances
We and Fletcher entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”) dated October 14, 2009 whereby Fletcher could purchase up to $12,000,000 of our common stock at a price of approximately $2.6423 per share. With each common stock purchase, Fletcher also received a warrant, exercisable for a period of six years, to purchase the number of shares of our common stock equal to the product of 1.25 times the number of shares of our common stock purchased, with an exercise price of $3.30. On October 14, 2009, December 30, 2009 and April 20, 2010 Fletcher purchased a total of 4,541,497 shares of our common stock. Warrants were issued with each stock purchase to purchase a total of 5,676,871 shares of our common stock at an exercise price of $3.3029 per share. The warrants expire between October 14, 2015 and April 20, 2016. The warrants were deemed to have a fair value of approximately $10.1 million at the date of issuance and were recorded as additional paid-in capital. The Company received net proceeds of approximately $11.6 million, after deducting fees and expenses of the offering payable by us.
Fletcher is subject to an ownership limitation of 4.95% of the outstanding shares of common stock (“Ownership Limitation”), under which Fletcher is prohibited from consummating any subsequent closing or exercising any warrant where such closing or exercise would cause Fletcher to exceed the Ownership Limitation, or from otherwise exceeding the Ownership Limitation through other avenues, including the purchase of shares in the public market.
On July 14, 2010, we entered into a Common Stock Purchase Agreement with Energy that provides that Energy is committed at our option to purchase up to $10,000,000 of our common stock over the 24-month term of the agreement. On August 5, 2010 we sold 1,058,201 shares of our common stock under the Purchase Agreement at a negotiated purchase price of $1.89 per share, based on current market prices. On December 29, 2010, we sold 2,890,173 shares of our common stock under the Purchase Agreement at a negotiated purchase price of $1.73 per share, based on current market prices. We have received $6,900,000 in net proceeds from this Purchase Agreement. An additional $3,000,000 remains under the Purchase Agreement.
As an incentive to Tyson for entering into the Dynamic Fuels Limited Liability Company Agreement, Tyson received warrants to buy our common stock. The warrants are allocated in three tranches. The first tranche of 4.25 million shares was awarded upon signing of the LLC Agreement, Feedstock and Master License Agreements in June 2007. The Warrant Agreement provides that the second tranche of 2.5 million shares will be issued upon sanctioning of the second plant and the third tranche of 1.5 million shares will be issued upon sanctioning of the third plant, provided that Tyson has at least a 10% interest in Dynamic Fuels. The exercise price of the first tranche of 4.25 million warrants is $2.87 per share, which was the ten-day average closing price prior to the signing of the above referenced agreements on June 22, 2007. The exercise price of the second and third tranches of warrants will be the ten-day average closing price prior to the sanctioning of plants 2 or 3. Vesting requires that Tyson remain at least a 10% equity owner in Dynamic Fuels (in the case of the first tranche) and in the applicable plant (in the case of the second and third tranches), and that each plant has commenced commercial operation. Maturity of each tranche of warrants will be on the third anniversary of each respective plant’s start-up date of commercial operations. If 25% or more of the project cost for the third plant is debt financed, then the third warrant tranche will not vest. In the event that Tyson owns a 90% or greater interest in Dynamic Fuels the number of shares subject to the second and third warrant tranche doubles subject to a limitation that Tyson will not receive pursuant to all tranches, warrants for stock equal to or more than 20% of the outstanding shares of Syntroleum common stock. In the event Tyson defaults by not paying its capital contributions to the plant, Tyson loses the warrants for such plant.
On June 30, 2008, we and Tyson entered into a Warrant Agreement providing for the issuance of warrants to Tyson to purchase shares of our common stock in exchange for credit support relating to the obligations of Dynamic Fuels under the Gulf Opportunity Zone Tax Exempt Bonds, (“GO Zone Bonds”). Tyson agreed under the terms of the Warrant Agreement to provide credit support for our 50% share of the letter of credit required under the GO Zone Bonds. Tyson received 8.0 million fully vested warrants to purchase the Company’s common stock at an exercise price of $0.01 on October 21, 2008 upon providing the credit support upon the issuance of the GO Zone Bonds. The warrants were exercised on April 16, 2009.
Pursuant to two registration rights agreements, we have granted Tyson demand and piggyback registration rights with respect to the shares of common stock issuable pursuant to the warrants.
New Accounting Pronouncements
In October of 2009 the FASB issued guidance that addresses the accounting for multiple-deliverable arrangements (complex contract or related contracts that require the separate delivery of multiple goods and/or services) by expanding the circumstances in which vendors may account for deliverables separately rather than as a combined unit. This update clarifies the guidance on how to separate such deliverables and how to measure and allocate consideration for these arrangements to one or more units of accounting. The existing guidance requires a vendor to use vendor-specific objective evidence or third-party evidence of selling price to separate deliverables in multiple-deliverable arrangements. In addition to retaining this guidance, in situations where vendor-specific objective evidence or third-party evidence is not available, the guidance will require a vendor to allocate arrangement consideration to each deliverable in multiple-deliverable arrangements based on each deliverable’s relative selling price. This update also expands disclosure requirements for multiple deliverable arrangements, can be applied either prospectively or retrospectively, and is effective for fiscal years beginning on or after June 15, 2010, with early adoption permitted. We do not expect the adoption of this guidance to have a material impact on our financial position and results of operations.
In July of 2009 the FASB issued guidance that addresses additional required disclosures about recurring and nonrecurring fair value measurements under Topic 820, Fair Value Measurements. The ASU requires certain new disclosures and clarifies two existing disclosure requirements. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. We do not expect the adoption of this guidance to have a material impact on our financial positions and results of operations.
In April of 2010 the FASB issued guidance on defining a milestone under Topic 605 and determining when it may be appropriate to apply the milestone method of revenue recognition for research and development transactions. Consideration that is contingent on achievement of a milestone in its entirety may be recognized as revenue in the period in which the milestone is achieved only if the milestone is judged to meet certain criteria to be considered substantive. Milestones should be considered substantive in their entirety and may not be bifurcated. This update is effective on a prospective basis for milestones achieved in fiscal years beginning on or after June 15, 2010, with early adoption permitted. We do not expect the adoption of this guidance to have a material impact on our financial position and results of operations.
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 technical services provided as time and expenses for services or support associated with a contract or license as incurred. The license agreements require us to develop a technology design and other technical services in accordance with licensee specifications; this design package is called the Process Design Package, or “PDP.” The preparation of our PDP includes engineering labor and necessary materials for completion of the package.
We recognized revenues from the transfer of technology documentation to customers or through licensing structures. Any deposits or advance payments for the technology documentation is recorded as deferred revenue in the consolidated balance sheets until recognized as revenue in the consolidated statement of operations. The Company recognizes revenue on the transfer of technology documentation upon the physical transfer of the technology documentation by the Company to the customer pursuant to the terms of the specific agreement.
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) delivery to the licensee the PDP for the licensee’s initial plant. Since 50 percent of the license fee deposit is subject to 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 statement 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 use our own engineering staff or to work with outside engineering contractors to develop a site specific plant design in accordance with licensee specifications; this design package is called the PDP. To date, we have not delivered any PDP’s for initial licensed plants, except for the Dynamic Fuels Plant, which we are part owner of and no initial license fee deposits are required. 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 2012 and the initial deposits will be recognized as licensing revenue as the licenses expire should the licensee not purchase a site license and begin construction of a plant prior to expiration of the license. We have not received additional funds under these license agreements during the license period and do not expect to receive additional funds under these license agreements. We are currently pursuing different avenues for the sale of technology rights, via equity ownership or sale or transfer of technology, and have not entered into this type of license agreement since 2007.
Preparation of the PDP can take varying amounts of time depending on the size of the project and could take a period of time; ranging six months to two years from notice to proceed. Construction time will depend on the size of the project, site location conditions and the availability of construction services, necessary materials and labor. Current estimates for construction times for large capital projects in excess of one billion dollars in costs are from three to five years from completion of the front end engineering design.
We expect to recognize revenue for royalty fees associated with our licensees’ plants or our own equity owned plants. The royalties, if applicable, will be recognized upon production of finished product by the licensee.
Stock-Based Compensation. We account for stock-based compensation in accordance with FASB ASC Topic 718, Compensation - Stock Compensation. Under the fair value recognition provisions of this statement, share-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the applicable vesting period of the stock award (generally three years) using the straight line method.
Non-Employee Stock-Based Compensation. We also grant stock-based incentives to certain non-employees. These stock based incentives are accounted for in accordance with FASB ASC Topic 718, Compensation - Stock Compensation. Stock awards that are tied to performance criteria are expensed at the time the performance goals are met.
Asset Retirement Obligations. We follow FASB ASC Topic 410, Asset Retirement and Environmental Obligations, which requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred and a corresponding increase in the carrying amount of the related long-lived asset. The standard requires that we record the discounted fair value of the retirement obligation as a liability at the time the plants are constructed. The asset retirement obligations consist primarily of costs associated with the future plant dismantlement of our pilot plants. As the pilot plants are directly related to research and development activities and have been expensed accordingly, no corresponding amount is capitalized as part of the related property’s carrying amount. The liability accretes over time with a charge to accretion expense.
Critical Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Some of the more significant estimates made by management include, but are not limited to, the valuation of stock-based compensation, estimates for accrued liabilities and estimates for asset retirement obligations. Actual results could differ from these estimates.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk.
Margins for crude oil, natural gas, coal, vegetable oils and fats and other commodities create a market risk for economics associated with our Syntroleum® Technologies. Because the synthetic crude oil, liquid fuels and specialty products that plants utilizing the Syntroleum® Technologies are expected to produce will compete in markets with oil and refined petroleum products, and because natural gas, coal, biomass, fats or vegetable oils will be used as the feedstock for these plants, an increase in feedstock prices relative to prices for oil or refined products, or a decrease in prices for oil or refined products relative to feedstock prices, 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 oil, natural gas, coal, biomass, fats, greases, vegetable oils and refined products are subject to wide fluctuation in response to relatively minor changes in the supply and demand, market uncertainty and a variety of additional factors that are beyond our control.
We expect that we will need to raise substantial additional capital to accomplish our business plan over the next several years. We expect to obtain additional funding through debt or equity financing in the capital markets, joint ventures, license agreements, sale of assets 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.
Foreign exchange risk currently relates to deferred revenue, a portion of which is denominated in Australian dollars. Financial statement assets and liabilities may be translated at prevailing exchange rate and may result in gains or losses in current income. 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. The portion of deferred revenue denominated in Australian currency was U.S. $15,245,000 at December 31, 2010. 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 $1.02 and $0.89 at December 31, 2010 and December 31, 2009, 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.
Item 8.
Financial Statements and Supplementary Data
Our consolidated financial statements, together with the report thereon of HoganTaylor LLP dated March 15, 2011, are set forth on pages through hereof. See Item 15 for an index to our consolidated financial statements.
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A.
Controls 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 Principal 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 Principal Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2010 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, 2010 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 Principal Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2010 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, 2010.
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.
HoganTaylor 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 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 Syntroleum Corporation’s (a Delaware Corporation) internal control over financial reporting as of December 31, 2010, 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, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on Syntroleum Corporation’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, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
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 (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (b) 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 (c) 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, Syntroleum Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control-Integrated Framework issued by 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, 2010 and 2009, 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, 2010 and our report dated March 15, 2011, expressed an unqualified opinion.
/s/ HOGANTAYLOR LLP
Tulsa, Oklahoma
March 15, 2011
None.
PART III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance
Our certificate of incorporation divides the board of directors into three classes with the number of directors in each class to be fixed as provided in our bylaws. Our bylaws provide for a board of not less than three and no more than 11 directors with the exact number of directors in each class to be fixed by our board. Our board has determined that the total number of directors on the board at this time shall be six and that two directors shall be in each of Class A, Class B and Class C. Directors hold office for staggered terms of three years (or less if they were appointed to the board between annual meetings to fill a vacancy). One of three classes is elected at each year’s annual meeting to succeed the directors of that class whose terms are expiring. The terms for the directors of Classes C, A and B expire at the annual meeting of stockholders in 2011, 2012 and 2013, respectively. The 2011 annual meeting of stockholders is expected to be held in the third quarter of 2011.
2011 - Class C Directors
2012 - Class A Directors
2013 Class B Directors
There are no family relationships, of first cousin or closer, among our directors and executive officers, by blood, marriage or adoption.
Director Meetings and Compensation
During 2010, the board of directors held a total of 12 regular meetings and four special meetings and took action by unanimous written consent on six occasions. No director attended fewer than 75 percent of the aggregate of board meetings and meetings of any committee on which he served in 2010.
We do not pay our directors a cash retainer. All directors are reimbursed for their travel and other expenses involved in attendance at board and committee meetings.
Under the 2005 Stock Incentive Plan, non-employee directors are eligible to receive grants of options to purchase shares of our common stock or awards of common stock or restricted stock. On January 1 of each year, non-employee directors received annual grants of a number of shares of our common stock determined by dividing $50,000 by the closing price of our common stock on the last trading day of the previous year. We granted 18,797 shares to each of our directors on January 1, 2010 at a grant date stock price of $2.66 and expect to continue the annual grant of common stock to non-employee directors as part of their compensation for service on the board. Mr. Robert B. Rosene, Jr., Chairman of the board, received an additional grant of 35,088 shares of common stock at a grant date price of $2.85 in recognition of his additional services as Chairman of the board.
Employees who are directors are not paid any fees or additional remuneration for their services as members of the board or any committee of the board.
At December 31, 2010 our non-employee directors held unexercised options to purchase common stock as follows: Alvin R. Albe, Jr.-20,406; Frank M. Bumstead-20,406; P. Anthony Jacobs-10,002; Robert B. Rosene, Jr.-20,406; James R. Seward-3,301.
Stock Ownership Guidelines for Directors
We do not have a set guideline for director stock ownership. We do, however, encourage stock ownership by our directors and all compensation for services as a director is paid by us in shares of our common stock. As of December 31, 2010 board members beneficially owned approximately 5.3% of our issued and outstanding common stock.
Corporate Governance
We have adopted a written Code of Ethics that is applicable to our directors, chief executive officer, principal financial officer, controller and other executive officers. A copy of our Code of Ethics, Audit Committee Charter, and Nominating and Compensation Committee Charters is available on our website at www.syntroleum.com. Investors may request a copy of any of these documents at no charge by writing to Karen L. Gallagher, Senior Vice President, Principal Financial Officer and Corporate Secretary, Syntroleum Corporation, 5416 S. Yale, Suite 400, Tulsa, OK 74135. 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.
Executive Officers of the Company
The following are our executive officers as of March 11, 2011.
For biographical information on Mr. Roth, please see, “Class C Directors”.
Karen L. Gallagher is a Senior Vice President and our Principal Financial Officer, having joined our company in June 2007. Ms. Gallagher was previously Executive Vice President, Chief Financial Officer and Cashier for Summit Bank from 2001 to 2007, Senior Vice President, Chief Financial Officer and Cashier for Federal BankCentre from 1998-2001, Vice President and Chief Financial Officer for Community Care HMO, Inc. from 1994-1997, and Senior Vice President and Chief Financial Officer for Western National Bank from 1984-1994. Prior to 1984 Ms. Gallagher served in various tax positions with Arthur Andersen & Co., GRA, Inc. and Commerce Bank. Ms. Gallagher is a certified public accountant and received her Bachelor of Science in Business Administration from the University of Missouri-Kansas City, Missouri.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires our directors, executive officers and owners of 10% or more of our common stock to file with the SEC and the Nasdaq Stock Market initial reports of ownership and reports of changes in ownership of common stock. Based solely on a review of the copies of reports furnished to us and representations that no other reports were required, we believe that all of our directors, executive officers and 10% or more stockholders during the fiscal year ended December 31, 2010 complied on a timely basis with all applicable filing requirements under Section 16(a) of the Exchange Act.
Audit Committee Expert
Mr. Albe is the “audit committee financial expert” under SEC rules and meets the Nasdaq’s professional experience requirements.
Each other member of the Audit Committee believes that he also meets the requirements for being considered an “Audit Committee financial expert” under applicable rules and regulations.
COMPENSATION DISCUSSION AND ANALYSIS
Executive Compensation Philosophy and Objectives
The objective of Syntroleum’s executive compensation policy is to attract, retain and motivate highly qualified individuals and to align their interests with our shareholders. We do this by offering competitive, interrelated compensation components that are designed to reward them for results that have been identified as important factors in enhancing shareholder value. The tables that you find in this Annual Report on Form 10-K contain specific information about the compensation earned or paid in 2010, 2009 and 2008 to Edward G. Roth and Karen L. Gallagher, whom we refer to as our “named executive officers” as of December 31, 2010.
Role of the Nominating and Compensation Committee and Management
The Nominating and Compensation Committee determines cash bonuses and stock option and restricted stock awards and changes in remuneration to our executive officers. Bonuses and grants of stock options and restricted stock are individually determined and administered by the nominating and compensation committee. The Chief Executive Officer works with the Nominating and Compensation Committee in the design of the plans and makes recommendations to the committee regarding the salaries and bonuses of executive officers that report directly to him as well as the salaries and bonuses and the award of options and restricted stock to other employees.
Our executive compensation guidelines, as established by the Nominating and Compensation Committee, are designed to pay a base salary generally measured below the 50th percentile of base salaries paid by other peer group companies, as adjusted to take into account differences in revenue size and for individual performance. Our peer group companies have similar low current sales with high market to sales ratios. This is an indicator that the peer group is in a similar pre-commercialization stage in their business life cycle. The Nominating and Compensation Committee has determined Syntroleum’s peer group to include Andersons Inc., Aventine Renewable Energy Holdings, Inc., Ballard Power Systems, Inc., BioFuel Energy Corporations, Evergreen Energy, Inc., FuelCell Energy Inc., Fuel-Tech, Inc., Global Energy Holdings Group, Headwaters Inc., Pacific Ethanol, Rentech Inc., Synthesis Energy Systems, and Verenium Corporations. As the Company is in the pre-commercialization stage of business life and cash is a key performance indicator to the Company, the Nominating and Compensation Committee deems it appropriate to pay a base salary below average at this point in the Company’s business life. Based on compensation data for 2008, the chief executive officer was paid in the 11th percentile compared to the peer group listed above. Mr. Roth’s salary is paid under the terms of an employment agreement described below.
Incentive compensation takes the form of equity and cash. As part of this process, the Nominating and Compensation Committee recommends the Chief Executive Officer’s incentive compensation award to the board for approval and reviews and approves the awards recommended by the Chief Executive Officer with respect to the other executive officer. Such awards reward participants for achieving established cost targets and prosecuting the business of the company, reward execution of the business plan and success in execution beyond budgeted or expected values, and reward performance related to specific commercialization projects. These awards can take the form of cash or Syntroleum Corporation restricted stock or options with performance vesting schedules. In 2009 and 2010, these awards took the form of cash and in 2008 Syntroleum Corporation restricted stock or options with vesting aligned with certain company based performance objectives. All cash or equity grants to named executive officers are approved by the Nominating and Compensation Committee.
Typically, increases in base compensation occur upon significant changes in job responsibility or notable changes in the job market. Normally, previous compensation actions do not influence current year’s awards or grants except in the case of awards intended to cover multi-year periods.
Elements of Compensation Plan
Our compensation plan for key executives includes long-term milestone based incentives. We believe that by making milestone based incentives the basis for incentive awards provides the board with a means to emphasize and monitor management’s progress towards our key strategic goals. Based on the Nominating and Compensation Committee’s reviews of executive compensation, it was determined that the plan would be primarily comprised of base pay, incentive compensation and long-term incentive compensation. Base pay would be comprised of an executive’s salary, while incentive compensation consists of cash bonuses or immediately vested stock awards and would reward the executive for cost target performance during the year as measured against individual performance and reward execution of the business plan. Long-term incentive compensation is meant to reward multi-year achievements with awards given in stock options and restricted stock with vesting based on the occurrence of Company project related intermediate milestones. Long-term incentive compensation will take the form of stock and be performance based. By providing these three pieces of compensation it was determined that incentives would be in place to achieve strategic short-term milestones, while the long-term incentive compensation would be used to reinforce the sense of shared purpose, overall shareholder returns and focus executives on key longer term strategic and financial milestones. From time to time, individual or corporate achievements or market pressures may merit additional discretionary grants being given throughout the year. It is not our practice to time these grants prior to the release of material information but rather to provide these grants during the normal course of business. These would be granted at the Nominating and Compensation Committees’ discretion.
The allocation among these compensation elements depends on performance objectives and market pressures. Generally more emphasis is placed on incentive compensation than base salary. Grants of incentive and long-term incentive compensation were generally at least 50% of the named executive compensation package.
Base Pay
Base salary is generally measured below the 50th percentile of base salaries paid by other peer group companies, as adjusted to take into account differences in market capitalization and for individual performance. Base pay is designed to be competitive with salary levels for comparable executive positions at other peer group companies engaged in the development of new technologies. The Nominating and Compensation Committee reviews such comparable salary information as one factor to be considered in determining the base pay for our executive officers. The Nominating and Compensation Committee also considers other factors, including that officer’s responsibilities, experience, leadership, potential future contribution and demonstrated individual performance measured against strategic business objectives. As the Company is in the pre-commercialization stage of business, the Nominating and Compensation Committee considers the liquidity of the Company when factoring base pay into management salaries and therefore pays base salaries below average for named executive officers. Our philosophy and practice is to place a significant emphasis on incentive and long-term incentive compensation. The Nominating and Compensation Committee also considers internal pay equity among the executive officers and employees generally. The types and relative importance of the strategic business objectives and financial objectives vary among our executives depending on their positions and the particular operations and functions for which they are responsible. The compensation committee reviews base salaries annually. These salaries are reviewed at the first board meeting of each year and were not increased in 2010. Annual base salaries for Edward G. Roth and Karen L. Gallagher are currently $260,000 and $175,000, respectively.
Incentive Compensation
Incentive compensation takes the form of annual cash or equity bonuses paid at specific targets ranging from 25% to 50% of salary for key executives based on our compensation plan structure. These payouts are based on the Nominating and Compensation Committee’s review of individual performance related to cost targets and prosecution of the business of the Company. The annual bonus is not typically dependent on macroeconomic conditions. Annual bonuses are paid to our executive officers pursuant to our Syntroleum Incentive Compensation Plan, which provides for cash bonuses based on achievement over the course of the year of performance objectives. The amount each executive officer receives is determined by the Nominating and Compensation Committee and the board of directors and depends on the individual’s performance and level of responsibility. Typically executive officers may receive cash bonuses of 25% to 50% of their annual salary depending on the achievement of individual and company goals during the year. There is no limitation on the annual bonus if individual achievement and company goals are exceeded during the year. Competitive market factors for employee retention are taken into account as well as corporate performance when making these determinations. Successful achievement of all goals and objectives is not required for bonuses to be paid out. However, the amount of bonus paid is significantly impacted by lack of goal achievement. A minimum bonus threshold is included in Edward G. Roth’s employment agreement requiring bonuses of at least 50% of annual salary each year. Increases to this amount are based on the factors described above.
Incentive compensation may also take the form of a performance cash bonus paid at specific targets. These payouts are based on the Nominating and Compensation Committee’s review of execution of the business plan and success in that execution beyond budgeted or expected values. These bonuses are dependent on project related profitability and collections of profits. All business development, legal and final execution costs of a project are considered when determining profitability of a project. The amount each executive officer receives is determined by the Nominating and Compensation Committee and the board of directors and depends on the individual’s performance and level of responsibility related to the execution of the business plan and individual project.
In March of 2009, upon the successful execution of technology transfer revenue contracts, the Nominating and Compensation Committee approved performance cash bonuses to be paid out upon collection of receivables from these contracts. In 2009, the Company paid $1,144,456 and $240,625 to Edward G. Roth and Karen L. Gallagher, respectively for the execution and collection of funds from the revenue contracts and for the return of certain equity awards. At the time of such payment, Mr. Roth forfeited his rights to stock options granting him the right to purchase 785,000 shares of common stock.
At the end of 2010 individual performance ratings were determined for executives and it was determined that individual performance was in line with expectations, cash bonuses related to 2010 individual performance were paid on December 24, 2010 to Edward G. Roth and Karen L. Gallagher in the amounts of $200,000 and $35,000, respectively. These bonuses were 77% and 20% of 2010 annual salaries, respectively.
The nomination and compensation committee expectations for 2010 included fiscal responsibility, expansion or engineering services, and execution of key projects, including collection of receivables from these projects. The Company was under budget on all capital expenditures and expenses and exceeded budgeted revenues. The engineering team performed engineering work and provided licensor assistance throughout 2010 on the Dynamic Fuels Plant as well as worked on additional studies for other clients. Key projects for the Company for 2010 included, leased pilot plant operations for a client with successful data collected, dismantlement of our Catoosa Demonstration Facility for shipment to China to be reconstructed and operated by our client and licensor assistance and construction activities for our Dynamic Fuels Plant. Ms. Gallagher and Mr. Roth played key roles in leading all of these activities for the Company and managing the staff and Company funds to achieve each of these goals. Given the committee’s view of their contributions to key roles in the Company the decision was made to make these payments in cash.
Performance Based Long-Term Equity Incentive Compensation
Long-term incentive compensation is tied directly to Company project related milestones that if achieved, are expected to increase stockholder return. Long-term incentive compensation consists of stock options and restricted stock, which generally vest based on specified performance measures such as company milestones. The specific milestones are listed below. The vesting amounts differ upon each milestone. Vesting of 60% or more of the award occurs upon the final milestone, successful project completion and operation. The exercise price of stock options is generally equal to the fair market value of the common stock on the date of grant. Accordingly, executives receiving stock options and restricted stock are rewarded only if the market price of the common stock appreciates. Stock options and restricted stock are thus designed to align the interests of our executive officers and other employees with those of our stockholders by encouraging executives to enhance our value and, hence, the price of the common stock and stockholder return. In determining whether to grant stock options or restricted stock to executive officers, the Nominating and Compensation Committee considers a variety of factors, including that executive’s current ownership stake in our company, the degree to which increasing that ownership stake would provide the executive with additional incentives for future performance, the likelihood that the grant of those options or restricted stock would encourage the executive to remain with our company, prior option grants (including the size of previous grants and the number of options and shares of restricted stock held), peer group analysis of similar positions and the value of the executive’s service to our company. Historical grants of long-term incentive compensation have been in line with peer group analysis. The compensation committee also considers these factors when determining whether to grant stock options or restricted stock to other employees. Stock option grants were previously granted annually with time vesting. Performance based grants are given out less frequently and timed to changes in our long-term performance measures.
In November of 2008, the board approved performance based grants of stock or option awards to all employees, including officers. These grants pertain to milestones listed below and additional grants will not be granted annually. The Nominating and Compensation Committee reviewed the amount of awards to each officer and employee and considered contributions to company milestones and comparable compensation packages for officers within the same industry. Upon completion of this analysis the Nominating and Compensation Committee granted an additional award of restricted stock to Mr. Roth of 1,000,000 shares. Ms. Gallagher received options in the amount of 485,000 at an exercise price of $0.66. In exchange for this award, Ms. Gallagher turned back her previous unvested stock award of 150,000 shares. These awards vest as follows:
•
Approximately 12% total vesting, upon the date of closing of the financing for the construction of a commercial Bio-Synfining Plant (the “Plant”); and
•
Approximately 12% total vesting, upon the date of the groundbreaking of the above Plant’s construction; and
•
Approximately 15% total vesting, upon the date of completion start-up operations and commencement of the Plant’s commercial operations; and
•
Approximately 61% total vesting, upon the successful completion of the performance testing on the Plant.
These awards were granted pursuant to the Company’s 2005 Stock Incentive Plan. The first three milestones have been achieved and the corresponding options and shares have vested. The Awards also vest upon death, disability, retirement, resignation for good reason and a change in control.
Benefits
Benefits are part of the overall competitive compensation program designed to attract and retain employees including executive officers. The named executive officers participate in the same benefit programs as our general employee population.
Severance and Retirement
We have severance agreements with all of our named executive officers who remained employed by us following the 2007 restructure of our work force. Our severance agreements provide for the payment of salary for periods after the date of termination of employment that vary depending primarily upon the position held by the employee and the event giving rise to the termination of employment. The payment of severance is intended to provide financial security to the executive at competitive levels to attract and retain executive officers.
Stock Ownership Guidelines
Syntroleum does not have specific equity or other security ownership requirements or guidelines for management. However, management is encouraged to take an ownership stake in the company and is specifically compensated with a trend towards equity compensation for both cash conservancy and long-term growth opportunities. Margin accounts of our common stock held by executive officers and trading in derivatives of our common stock by executive officers are discouraged but not specifically disallowed by corporate policy. Under our Code of Ethics and Conduct all insiders are bound by the rules of insider trading and speculation in Syntroleum stock is discouraged.
Compliance with Internal Revenue Code Section 162(m)
Section 162(m) of the Internal Revenue Code generally disallows a deduction to public companies to the extent of excess annual compensation over one million dollars paid to the chief executive officer or to any of the four other most highly compensated executive officers, except for qualified performance-based compensation. While the board considers all compensation paid to the Chief Executive Officer and the named executive officers to be performance-based, it does not meet all the definitions of “performance based” compensation in Section 162(m). The compensation committee strongly believes that retaining discretion in determining awards within the parameters of the performance goals is essential for long-term success. In the past, the effect of the amounts paid in excess of the deductibility amount has been immaterial to our tax return. We plan to review executive compensation as appropriate and take action as may be necessary to preserve the deductibility of compensation payments to the extent reasonably practical and consistent with our compensation objectives.
EXECUTIVE COMPENSATION
The following Summary Compensation Table provides information regarding the compensation awarded to or earned during the years ended December 31, 2010, 2009 and 2008 by the persons named in the table, who we refer to in this Annual Report on Form 10-K as our “named executive officers”. The tables following the Summary Compensation Table provide additional detail with respect to grants of plan-based awards, the value of outstanding equity awards as of December 31, 2010, the value of options exercised and stock awards that vested during 2010 and estimates of changes of control and post-employment benefits.
Summary Compensation Table
(1)
The amounts in columns (e) and (f) reflect the grant date fair value of awards during the covered year. Grant date fair value is determined in accordance with the applicable Accounting Standard Codification 718, Stock Compensation. These amounts do not reflect whether the named executive officers have actually realized a financial benefit from the awards. For information on the assumptions used to calculate the value of the awards, refer to Note 8 to our consolidated financial statements in this Annual Report on Form 10-K for the fiscal year ended December 31, 2010. The awards listed above are all performance based awards. The grant date fair value listed is based on the probable outcome of the performance conditions. The Company has disclosed the maximum performance value based on the probability of achieving these goals.
(2)
The amounts in column (g) reflect the cash awards to the named executive officers under the Syntroleum compensation plan, which is discussed in further detail under “Compensation Discussion and Analysis-Incentive Compensation”.
(3)
Amounts shown in column (i) represent a Company match of 401(k) contributions paid in the form of Company stock.
We have entered into employment agreements with our two executive officers and 10 of our employees. These agreements provide for annual base salaries that we may increase from time to time. In addition, each employment agreement entitles the employee to participate in employee benefit plans that we may offer to our employees from time to time.
Under each agreement, employment may be terminated as follows: by us upon the employee’s death, disability or retirement; by us upon the dissolution and liquidation of our company (unless our business is thereafter continued); by us for just cause; by the mutual agreement of the employee and us; and by either us or the employee upon 15 days’ written notice.
For a description of our severance and change of control arrangements with the named executive officers see “2010 Potential Payments upon Termination or a Change in Control Table.”
All agreements prohibit the employee from disclosing to third parties, directly or indirectly, our trade secrets, either during or after the employee’s employment with our company, other than as required in the performance of the employee’s duties. The agreement also provides that the employee will not have or claim any right, title or interest in any trademark, service mark or trade name that we own or use. The employee agrees to irrevocably assign to us all of the employee’s right, title and interest in and to any and all inventions and works of authorship made, generated or conceived by the employee during his or her period of employment with us and which related to our business or which were not developed on the employee’s own time. Each employee further agrees that during the period of employment with us and for a period of two years following the termination of employment, the employee will not engage in certain activities related to our business.
Mr. Roth’s employment agreement, dated as of April 24, 2007, has a 48 month initial term and is automatically renewed for successive 12 month terms. The agreement provides for a $260,000 annual salary and a minimum annual bonus equal to 50% of base salary. Our board may in its discretion increase these amounts.
Mr. Gallagher’s employment agreement, dated as of June 13, 2007, has an initial term of 12 months and is automatically renewed for successive 12 month terms. The agreement provides for a $175,000 annual salary subject to increase in our discretion.
2010 Grants of Plan-Based Awards
The following table provides information regarding the individual grants of plan-based awards during the last completed fiscal year to the named executive officers.
(1)
The amounts in column (l) reflect the fair value on the date of grant for options and stock issued during 2010 that fall within the scope of guidance issued on Stock Based Compensation by the financial accounting standards board. Assumptions used in the calculation of these amounts are included in note 8 to the our audited financial statements for the fiscal year ended December 31, 2010, included in this Annual Report on Form 10-K.
(2)
The amounts in column (d) reflect the cash awards to the named executive officers, which is discussed in further detail under “Compensation Discussion and Analysis-Incentive Compensation”.
2010 Outstanding Equity Awards at Fiscal Year-End
The following table provides information on the current holdings of stock options and stock awards by the named executive officers which includes unexercised and unvested stock options and unvested restricted stock as of December 31, 2010.
(1)
The amounts in column (i) reflect performance based restricted stock awards granted during 2008 for Mr. Roth. For detailed information on these grants refer to “Compensation Discussion and Analysis-Performance Based Long-Term Equity Incentive Compensation”.
(2)
The amounts in column (j) reflect the fair value on December 31, 2010 based on a closing market price of $1.85 per share.
(3)
The amounts in column (d) reflect performance based options granted during 2008 for Ms. Gallagher. For detailed information on these grants refer to “Compensation Discussion and Analysis-Performance Based Long-Term Equity Incentive Compensation”.
2010 Option Exercises and Stock Vested
The following table provides information on the exercise of stock options and the vesting of restricted stock for the named executive officers during 2010.
(1)
The value realized in column (e) is equal to the number of vesting shares multiplied by the closing stock price on the vest date.
Post Employment Benefits/Change of Control Arrangement
Each of our employment agreements with our executive officers and key employees may be terminated as follows: (i) by us upon the employee’s death, disability or retirement; (ii) by us upon the dissolution and liquidation of our company (unless our business is thereafter continued); (iii) by us for just cause; (iv) by the mutual agreement of the employee and us; and (v) by either us or the employee upon 15 days’ written notice.
If we terminate Mr. Roth’s employment for any reason other than as noted in (i) or (iii) above, Mr. Roth is entitled to receive the greater of (a) an amount equal to 300% of his annual salary payable over 24 months or (b) an amount equal to 150% of his monthly salary for the number of months remaining in the stated term of his agreement. As of December 31, 2010, three months remained in the term of Mr. Roth’s agreement. The employment agreement of Ms. Gallagher provides for severance equal to three months of her full base salary as in effect on the date of her termination of employment.
In the event of a change in control of our company and a termination in the executive’s employment within one year period immediately following the change of control, the employee is entitled to receive substantially the same amounts as the severance amounts provided above payable over the same periods as described above and will receive a vested right to all shares and options outstanding.
2010 POTENTIAL PAYMENTS UPON TERMINATION OR CHANGE IN CONTROL TABLE
Our executives are entitled to receive payments upon termination of their employment as described below. The following table summarizes these payments under different termination of employment scenarios and reflects the estimated value of those payments had the termination occurred effective December 31, 2010.
The plans and agreements under which the payments summarized in the following table would be made are described above.
Compensation Committee Report
The Nominating and Compensation Committee has reviewed and discussed the compensation discussion and analysis with management and has recommended to the board that the Compensation Discussion and Analysis be included in this Annual Report on Form 10-K for the year ended December 31, 2010.
Nominating and Compensation Committee
Alvin R. Albe, Jr.
Frank M. Bumstead
P. Anthony Jacobs
Robert B. Rosene, Jr. (Chairman)
James R. Seward
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Unless otherwise stated, the following table sets forth the number of shares of our common stock beneficially owned as of March 11, 2011, by (1) each director and nominee for director, (2) each of the executive officers named in the Summary Compensation Table in this proxy statement, (3) all directors and executive officers as a group; and (4) all persons known by us to be the beneficial owners of at least five percent (5%) of our outstanding common stock. As of March 11, 2011, there were 81,901,346 shares of our common stock issued and outstanding.
(5)
Includes 10,200 shares of common stock owned by trusts the beneficiaries of which are Mr. Rosene’s children, as to which Mr. Rosene disclaims beneficial ownership.
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence
Affirmative Determinations Regarding Director Independence and Other Matters
Our board of directors has determined that each of the following directors is an “independent director” as such term is defined in Rule 5605(a)(2) of the Nasdaq Stock Market (“Nasdaq”) Listing Rules: Alvin R. Albe, Jr., Frank M. Bumstead, P. Anthony Jacobs, Robert B. Rosene, Jr. and James R. Seward.
These five directors are each referred to individually as an “independent director” and collectively as the “independent directors.”
The board of directors has also determined that each member of the two committees of the board meets the independence requirements applicable to those committees prescribed by Nasdaq, the Securities and Exchange Commission (“SEC”) and the Internal Revenue Service.
The Nominating and Compensation Committee reviewed the applicable legal standards for board member and board committee independence. On the basis of this review, the Nominating and Compensation Committee disclosed no change to the full board of directors and the board made its “independent director” determinations based upon the Nominating and Compensation Committee’s disclosure and each director’s review of the information made available to the Nominating and Compensation Committee.
Certain Relationships and Related Person Transactions and Code of Ethics
We have a written Code of Ethics and Conduct pursuant to which we evaluate all transactions required to be reported under Item 404 of Regulation S-K promulgated under the Securities Act and the Exchange Act. The Code of Ethics is accessible on our website, www.syntroleum.com. This policy provides for the transaction to be brought to the attention of the CEO, PFO or Audit Committee for approval. If approval is obtained, our practice is to take the matter to our board of directors and, in certain circumstances involving equity transactions, to our stockholders.
Tyson Foods, a greater than 9% shareholder, is our partner in the Dynamic Fuels venture which is discussed at length in our SEC filings. We provide technical engineering, licensing and other services to Dynamic Fuels and Tyson will provide feedstock.
Item 14.
Item 14.
Principal Accountant Fees and Services
Independent Registered Public Accounting Firm’s Fees
HoganTaylor LLP billed us fees in fiscal year 2010 and 2009 as set forth in the table below for (i) the audit of our annual financial statements, the audit of effectiveness of internal controls over financial reporting, the reviews of our quarterly financial statements and services related to certain SEC registration statements, (ii) assurance and related services that are reasonably related to the performance of the audit or review of financial statements not included in (i), (iii) professional services relating to tax compliance and preparation, tax advice and tax planning, and (iv) all other services rendered.
The Audit Committee has considered whether the provision of services rendered in 2010, other than the audit of our financial statements, the 2010 audit of effectiveness of internal controls over financial reporting, and the reviews of our quarterly financial statements, was compatible with maintaining the independence of HoganTaylor LLP and determined that the provision of such services was compatible with maintaining such independence.
The Audit Committee is responsible for appointing, setting compensation for and overseeing the work of the independent auditor. The Audit Committee’s amended and restated charter allows the Audit Committee to delegate to subcommittees consisting of one or more members the authority to grant pre-approvals of audit and permitted non-audit services between Audit Committee meetings, provided that the subcommittee reports any pre-approval decisions to the full Audit Committee at the committee’s next scheduled meeting. The Audit Committee has adopted policies and procedures for pre-approving all audit and non-audit services performed by the independent registered public accounting firm. The policy requires advance approval by the Audit Committee of all audit and non-audit work. Unless the specific service has been previously pre-approved with respect to the 12-month period following the advance approval, the Audit Committee must approve a service before the independent registered public accounting firm is engaged to perform the service. The Audit Committee has given advance approval for specified audit, audit-related and tax services for 2011. Requests for services that have received this pre-approval are subject to specified fee or budget restrictions as well as internal management controls. All of the 2010 audit and non-audit services described above were pre-approved by the Audit Committee in accordance with its charter, its policies and procedures, and pursuant to applicable rules of the SEC.
PART IV
Item 15.
Item 15.
Exhibits and Financial Statement Schedules
(a)(1) Financial Statements
Consolidated Financial Statements for the Three Years Ended December 31, 2010:
(a)(2) Financial Statement Schedules
All schedules and other statements for which provision is made in the applicable regulations of the SEC have been omitted because they are not required under the relevant instructions or are inapplicable.
(a)(3) Index of Exhibits
*
Incorporated by reference as indicated.
**
Filed herewith
+
Compensatory plan or arrangement.
***
CERTAIN PORTIONS OF THIS EXHIBIT AND THE ANNEXES THERE TO WHICH ARE INDICATED BY “XXX” HAVE BEEN OMITTED BASED UPON A REQUEST FOR CONFIDENTIAL TREATMENT WHICH HAS BEEN GRANTED BY THE SECURITIES AND EXCHANGE COMMISSION. SUCH OMITTED PORTIONS HAVE BEEN FILED SEPARATELY WITH THE COMMISSION PURSUANT TO RULE 24B-2 OF THE SECURITIES AND EXCHANGE ACT OF 1934.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Index to Exhibits
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Syntroleum Corporation
We have audited the accompanying consolidated balance sheets of Syntroleum Corporation (a Delaware corporation) and subsidiaries as of December 31, 2010 and 2009, 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, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits 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 the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Syntroleum Corporation and subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Syntroleum Corporation’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 15, 2011 expressed an unqualified opinion on the effectiveness of Syntroleum Corporation’s internal control over financial reporting.
/s/ HOGANTAYLOR LLP
Tulsa, Oklahoma
March 15, 2011
SYNTROLEUM CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
SYNTROLEUM CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
SYNTROLEUM CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
(in thousands)
The accompanying notes are an integral part of these consolidated statements.
SYNTROLEUM CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
SYNTROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Nature of Operations
The focus of Syntroleum Corporation and subsidiaries is the commercialization of our technologies to produce synthetic liquid hydrocarbons. Operations to date have consisted of activities related to the commercialization of a proprietary process (the “Syntroleum® Process”) and previously consisted of research and development of the Syntroleum® Process designed to convert carbonaceous material (biomass, coal, natural gas and petroleum coke) into synthetic liquid hydrocarbons. Synthetic hydrocarbons produced by the Syntroleum® Process can be further processed using the Syntroleum Synfining® Process into high quality liquid fuels, such as diesel, jet fuel (HRJ subject to certification), kerosene, naphtha, propane and other renewable chemical products.
Our Bio-Synfining™ Technology is a renewable fuels application of our Synfining® Technology. This technology is applied commercially via our Dynamic Fuels, LLC joint venture with Tyson Foods, Inc. The technology processes renewable feedstocks such as triglycerides and/or fatty acids to make renewable synthetic products.
Consolidation
The consolidated financial statements include the accounts of Syntroleum Corporation and our majority-owned subsidiaries. All significant inter-company accounts and transactions have been eliminated. Companies in which we own a 20 percent to 50 percent interest, but in which we do not have a controlling interest are accounted for by the equity method. We own 50 percent and have a non-controlling interest in Dynamic Fuels, LLC (“Dynamic Fuels”). The entity is accounted for under the equity method and is not required to be consolidated in our financial statements; however, our share of the Dynamic Fuels results of operations activities is reflected in the Consolidated Statements of Operations and the subsidiary’s summarized financial information is reported in Note 4, “Investment in and Loans to Dynamic”. The carrying value of our investment in Dynamic Fuels is reflected in “Investment in and Loans to Dynamic Fuels, LLC” in our Consolidated Balance Sheets.
Revenue Recognition
We recognize revenues from technical services provided as time and expenses for services or support associated with a contract or license as incurred. The license agreements require us to develop a technology design and other technical services in accordance with licensee specifications; this design package is called the Process Design Package, or “PDP.” Technical service revenues primarily resulted from the preparation of our PDP to Dynamic Fuels in 2009 and 2008. The preparation of our PDP includes engineering labor and necessary materials for completion of the package.
We recognized revenues from the transfer of technology documentation to customers or through licensing structures. Any deposits or advance payments for the technology documentation is recorded as deferred revenue in the consolidated balance sheets until recognized as revenue in the consolidated statement of operations. The Company recognizes revenue on the transfer of technology documentation upon the physical transfer of the technology documentation by the Company to the customer pursuant to the terms of the specific agreement.
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) delivery to the licensee the PDP for the licensee’s initial plant. Since 50 percent of the license fee deposit is subject to 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 statement 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 use our own engineering staff or to work with outside engineering contractors to develop a site specific plant design in accordance with licensee specifications; this design package is called the PDP. To date, we have not delivered any PDP’s for initial licensed plants, except for the Dynamic Fuels Plant, which we are part owner of and no initial license fee deposits are required. 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 2012 and the initial deposits will be recognized as licensing revenue as the licenses expire should the licensee not purchase a site license and begin construction of a plant prior to expiration of the license. We have not received additional funds under these license agreements during the license period and do not expect to receive additional funds under these license agreements. We are currently pursuing different avenues for the sale of technology rights, via equity ownership or sale or transfer of technology, and have not entered into this type of license agreement since 2007.
Preparation of the PDP can take varying amounts of time depending on the size of the project and could take a period of time; ranging six months to two years from notice to proceed. Construction time will depend on the size of the project, site location conditions and the availability of construction services, necessary materials and labor. Current estimates for construction times for large capital projects in excess of one billion dollars in costs are from three to five years from completion of the front end engineering design.
We expect to recognize revenue for royalty fees associated with our licensees’ plants or our own equity owned plants. The royalties, if applicable, will be recognized upon production of finished product by the licensee.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and highly liquid investments with an original maturity of three months or less, primarily in the form of money market instruments. The Company places its temporary cash investments with high credit quality financial institutions. At times such investments may be in excess of the Federal Deposit Insurance Corporation (FDIC) insurance limit.
Restricted Cash
Restricted cash consists of cash held in an escrow account for the prepayment of operations and invoices for an ongoing contractual project. The account has also been recorded as a liability in current deposits on the consolidated balance sheet at December 31, 2010 and 2009.
Accounts Receivable
The majority of our accounts receivable is due from technical service agreements. These accounts are typically due within 30 days and are stated as amounts due from customers. Accounts outstanding longer than the contractual payment terms are considered past due. We write off accounts receivable when they become uncollectible. Management determines accounts to be uncollectible when we have used all reasonable means of collection and settlement. Management believes that all amounts included in accounts receivable at December 31, 2010 and 2009 will be collected and therefore no allowance for uncollectible accounts has been recorded.
Property and Equipment
Property and equipment is stated at cost less accumulated depreciation. Maintenance, repairs and replacement of minor items are expensed and major additions, expansions and betterments to physical properties are capitalized. When assets are sold or retired, the cost and accumulated depreciation related to those assets are removed from the accounts and any gain or loss is recognized. Depreciation of property and equipment is computed on the straight-line method over the estimated useful lives of three to seven years. Property and equipment consists of the following (in thousands):
Income Taxes
Income taxes are accounted for using the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and of net operating loss carry-forwards. Deferred tax assets and liabilities are measured using the enacted tax rates and laws in effect or that will be in effect when the differences are expected to reverse. The Company records a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized.
Asset Retirement Obligations
We follow FASB ASC Topic 410, Asset Retirement and Environmental Obligations, which requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred and a corresponding increase in the carrying amount of the related long-lived asset. The standard requires that we record the discounted fair value of the retirement obligation as a liability at the time the plants are constructed. The asset retirement obligations consist primarily of costs associated with the future plant dismantlement of our pilot plants. As the pilot plants are directly related to research and development activities and have been expensed accordingly, no corresponding amount is capitalized as part of the related property’s carrying amount. The liability accretes over time with a charge to accretion expense. Our Catoosa Demonstration Facility was fully dismantled in 2010. We reduced our liability with expenditures incurred with the dismantlement and no longer have a liability associated with this plant. Below is a reconciliation of the changes in our asset retirement obligation for the years ended December 31, 2010 and 2009 (in thousands).
Other Assets
Other assets include costs associated with patents and are amortized using the straight-line method over their estimated period of benefit, ranging from fifteen to seventeen years. All costs are capitalized and amortization begins upon initial costs incurred. Amortization expense for the years ended December 31, 2010, 2009 and 2008 was $147,000, $175,000 and $159,000, respectively. We periodically evaluate the recoverability of intangible assets and take into account events or circumstances that warrant revised estimates of useful lives or that indicate that impairment exists. Future amortization expense for patents as of December 31, 2011 is estimated to be $142,000 per year through 2019. Patent costs consist of the following (in thousands):
Impairment of Assets
We follow the provisions of FASB ASC Topic 360, Property, Plant and Equipment, for assets. Management reviews assets for impairment when certain events have occurred or changes in circumstances 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.
Accounting for Guarantees
We follow the provisions of FASB ASC Topic 460, Guarantees for any guarantees entered into after December 2002. Under ASC Topic 460, we are required to record a liability for the fair value of the obligation undertaken in issuing the guarantees.
Stock-Based Compensation
Employee Stock-Based Compensation. We account for stock-based compensation in accordance with FASB ASC Topic 718, Compensation - Stock Based. Under the fair value recognition provisions of this statement, share-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the applicable vesting period of the stock award (generally three years) using the straight line method.
Non-Employee Stock-Based Compensation. We also grant stock-based incentives to certain non-employees. These stock based incentives are accounted for in accordance with FASB ASC Topic 718, Compensation - Stock Based. Stock awards that are tied to performance criteria are expensed at the time the performance goals are met.
Earnings Per Share
Basic earnings (losses) per common share were computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the reporting period. Diluted earnings per common share for each of the three years ended December 31, 2010 are calculated by dividing net income by weighted-average common shares outstanding during the period plus dilutive potential common shares, which are determined as follows:
The table below includes information related to stock options, warrants and restricted stock that were outstanding at December 31 of each respective year, but have been excluded from the computation of weighted-average stock options due to (i) the option exercise price exceeding the twelve-month weighted-average market price of our common shares or (ii) their inclusion would have been anti-dilutive to our earnings/(loss) per share.
Defined Contribution Plan - 401(k)
We sponsor a defined contribution plan, named the Syntroleum 401(k) Plan (the “401(k) Plan”), covering virtually all of our employees who have met the eligibility requirements. Our employees may participate in the 401(k) Plan upon employment. Participants become eligible for matching and profit sharing contributions upon employment on the last day of the 401(k) Plan quarter.
We contribute a matching contribution equal to 50 percent of employees’ contributions quarterly in the form of shares of our common stock. No employee purchase of our stock is permitted. We recorded expense of $136,000, $141,000 and $143,000 from issuing 74,960, 90,529 and 163,576 shares of Syntroleum Stock for the years ended December 31, 2010, 2009 and 2008, respectively, of which 22,044 shares were issued in January 2011.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Some of the more significant estimates made by management include, but are not limited to, the valuation of stock-based compensation, estimates for accrued liabilities and estimates for asset retirement obligations. Actual results could differ from these estimates.
Foreign Currency Transactions
All of our subsidiaries use the U.S. dollar for their functional currency. Assets and liabilities denominated in other currencies are translated into U.S. 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 U.S. dollar are included in the consolidated results of operations as incurred.
New Accounting Pronouncements
In October of 2009 the FASB issued guidance that addresses the accounting for multiple-deliverable arrangements (complex contract or related contracts that require the separate delivery of multiple goods and/or services) by expanding the circumstances in which vendors may account for deliverables separately rather than as a combined unit. This update clarifies the guidance on how to separate such deliverables and how to measure and allocate consideration for these arrangements to one or more units of accounting. The existing guidance requires a vendor to use vendor-specific objective evidence or third-party evidence of selling price to separate deliverables in multiple-deliverable arrangements. In addition to retaining this guidance, in situations where vendor-specific objective evidence or third-party evidence is not available, the guidance will require a vendor to allocate arrangement consideration to each deliverable in multiple-deliverable arrangements based on each deliverable’s relative selling price. This update also expands disclosure requirements for multiple deliverable arrangements, can be applied either prospectively or retrospectively, and is effective for fiscal years beginning on or after June 15, 2010, with early adoption permitted. We do not expect the adoption of this guidance to have a material impact on our financial position and results of operations.
In July of 2009 the FASB issued guidance that addresses additional required disclosures about recurring and nonrecurring fair value measurements under Topic 820, Fair Value Measurements. The ASU requires certain new disclosures and clarifies two existing disclosure requirements. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. We do not expect the adoption of this guidance to have a material impact on our financial positions and results of operations.
In April of 2010 the FASB issued guidance on defining a milestone under Topic 605 and determining when it may be appropriate to apply the milestone method of revenue recognition for research and development transactions. Consideration that is contingent on achievement of a milestone in its entirety may be recognized as revenue in the period in which the milestone is achieved only if the milestone is judged to meet certain criteria to be considered substantive. Milestones should be considered substantive in their entirety and may not be bifurcated. This update is effective on a prospective basis for milestones achieved in fiscal years beginning on or after June 15, 2010, with early adoption permitted. We do not expect the adoption of this guidance to have a material impact on our financial position and results of operations.
2. OPERATIONS AND LIQUIDITY
In the past we have sustained recurring losses and negative cash flows from operations. As of December 31, 2010, we had approximately $12.5 million of cash and cash equivalents and $1.3 million of accounts receivable available to fund operations and investing activities. We review cash flow forecasts and budgets periodically. Upon successful full rate operations of our Dynamic Fuels plant and based on working capital and capital expenditures requirements for the plant, we expect to receive partner distributions from the entity in 2011.
3. DISCONTINUED OPERATIONS AND ASSETS HELD FOR SALE
International Oil and Gas
We were pursuing international oil and gas activities, which primarily included the leasehold acquisition, geological and geophysical work covering various areas in Nigeria. In the fourth quarter of 2006, we exited our international oil and gas activities due to capital restraints. We sold all the stock of various subsidiaries to African Energy Equity Resources Limited (“AEERL”), a direct wholly owned subsidiary of Energy Equity Resources (Norway) Limited (“EERNL”). We received $14,266,000 in total from the sale of these interests. Collection of this amount occurred between 2006 and 2008. The results of international oil and gas operations are presented as discontinued operations in the accompanying consolidated financial statements and prior periods have been reclassified for comparability in accordance with FASB ASC Topic 360, Property, Plant and Equipment.
Based on the total proceeds received, we recognized a gain on the sale of these entities for the year ended December 31, 2008 of $1,500,000 which is reflected in “Income (loss) on discontinued operations” in the Consolidated Statement of Operations for the year ended December 31, 2008. The entity incurred additional costs of $80,000 in legal fees and closing costs. These costs are netted against the total gain in the Consolidated Statement of Operations. As of December 31, 2010 and 2009 there were no assets associated with the activities and all obligations associated with the international oil and gas operations have been fulfilled.
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 sold our gas processing plant and related equipment in February 2008 for $95,000. The results of operations of the domestic oil and gas segment are presented as discontinued operations in the financial statements for the year ended December 31, 2008 in accordance with FASB ASC Topic 360, Property, Plant and Equipment. As of December 31, 2010 and 2009 there were no assets associated with the activities and all obligations associated with the international oil and gas operations have been fulfilled.
Research and Development
We have completed the necessary testing and demonstration associated with our pilot plants as well as completion of catalyst formulation and deactivation studies. Analytical testing of finished fuels has supported conclusions with regards to lower emissions and higher cetane ratings. We have documented the conclusions from all of these activities and do not intend to further fund other research and development activities. All revenues and costs associated with these activities such as; facilities, dismantlement of facilities, overhead associated with the facilities, personnel, equipment and outside testing and analytical work have been reported in “Income (Loss) from Discontinued Operations” in the Consolidated Statement of Operations. The total income or (loss) of research and development activities totaled $97,000, ($122,000) and ($326,000) for the years ended December 31, 2010, 2009 and 2008, respectively. The gain in 2010 resulted from lower actual dismantlement costs than estimated for the asset retirement obligation associated with the Catoosa Demonstration Facility.
A summary of the research and development segment recorded in discontinued operations is as follows for the three-year period ended December 31, 2010 (in thousands):
4. INVESTMENT IN AND LOANS TO DYNAMIC FUELS
On June 22, 2007, we entered into definitive agreements with Tyson to form Dynamic Fuels, to construct and operate facilities in the United States using our Bio-Synfining™ Technology. Dynamic Fuels is organized and operated pursuant to the provisions of its Limited Liability Company Agreement between the Company and Tyson (the “LLC Agreement”).
The LLC Agreement provides for management and control of Dynamic Fuels to be exercised jointly by representatives of the Company and Tyson equally with no LLC member exercising control. This entity is accounted for under the equity method and is not required to be consolidated in our financial statements; however, our share of the Dynamic Fuels net income or loss is reflected in the Consolidated Statements of Operations. Dynamic Fuels has a different fiscal year than us. The Dynamic Fuels fiscal year ends on September 30 and we report our share of Dynamic Fuels results of operations on a three month lag basis. Our carrying value in Dynamic Fuels is reflected in “Investment in and Loans to Dynamic Fuels LLC” in our Consolidated Balance Sheets. As of December 31, 2010, Syntroleum’s total estimate of maximum exposure to loss as a result of its relationships with this entity was approximately $43,523,000, which represents our equity investment in and loans to this entity.
Dynamic Fuels was initially capitalized on July 13, 2007 with $4.25 million in capital contributions from Tyson and $4.25 million in capital contributions from us. Each member contributed an additional $36.25 million in capital contributions by December 31, 2010. Each member contributed an additional $5.0 million in the form of a working capital loan to the entity. The $5.0 will be returned to each partner upon Dynamic Fuels generating sufficient working capital from fuel sales. We may need to fund future short-term working capital needs of Dynamic Fuels on an as needed basis.
Dynamic Fuels began commercial operations in November of 2010. The plant has been in start-up mode since commercial operations began in November of 2010. As of February 28, 2011, the plant has produced and sold, 3.1 million gallons of renewable diesel and 0.7 million gallons of renewable naphtha. The plant also produced 40,000 gallons of renewable jet fuel, which is being tested by the U.S. military. Full rate capacity for the plant is 5,000 barrels per day. We expect to achieve full rate capacity on a continuous basis in the second quarter of 2011.
Diesel is quality tested and meets ASTM D975 standards for diesel. The renewable products have low emissions and nearly no aromatics. Our jet fuel HRJ, meets all petroleum based jet fuel specifications. We are awaiting certification of HRJ jet fuel for a 50/50 blend for use in aviation. We expect it to occur in the first half of 2011, thus allowing us to market our jet fuel production capabilities to interested parties.
On October 21, 2008, Dynamic Fuels issued tax exempt bonds through the Louisiana Public Facilities Authority in the amount of $100 million at an initial interest rate of 1.3% to fund construction of the plant. The Bonds required a letter of credit in the amount of $100 million as collateral for Dynamic Fuels’ obligations under the Bonds. Tyson agreed under the terms of the Warrant Agreement to provide credit support for the entire $100 million Bond issue, see Note 7 “Stockholders’ Equity - Tyson”. The interest rate for the Bonds is a daily floating interest rate and may change significantly from this amount. In the fourth quarter of 2008, Dynamic Fuels entered into an interest rate swap which had the effect of locking in the interest rate at 2.19% for a period of 5 years with declining swap coverage. This debt funding is in addition to the equity contributions provided by each member.
Dynamic Fuels, LLC (A Development Stage Company) 2010 and 2009 Audited Financials (in thousands):
During 2010, 2009 and 2008, we prepared a PDP for Dynamic Fuels in accordance with the technical services agreement between us and Dynamic Fuels and provided additional licensor services. We recognized revenue associated with this work in the amount of $2,005,000, $2,767,000 and $2,592,000 for the years ended December 31, 2010, 2009 and 2008. This revenue is reported in “Technical services revenue from Dynamic Fuels, LLC” in the Consolidated Statement of Operations. We had a receivable from Dynamic of $729,000 and $150,000 as of December 31, 2010 and 2009, respectively.
5. DEFERRED REVENUE
License fees received for which the criteria for revenue recognition have not been met totaled $24,300,000 and $22,452,000 at December 31, 2010 and 2009, respectively.
In August 2000, we signed a non-exclusive license agreement with the Commonwealth of Australia, granting the Commonwealth the right to utilize the Syntroleum® Process. As of December 31, 2010 and 2009, we had a remaining license agreement with the Commonwealth of Australia that includes credits against future license fees earned in Australia in the amount of AUD $15,000,000. This license has been recorded as deferred revenue of US $15,245,000 and US $13,400,000 as of December 31, 2010 and 2009, respectively. This license expires in 2019. The license agreement is denominated in Australian dollars and is subject to changes in foreign currency. During the years ended December 31, 2010, 2009 and 2008, the foreign currency effect on our deferred revenues was a change of $(1,848,000), $(3,036,000) and $2,790,000, respectively, as a result of changes in the exchange rate between the United States and Australian dollars.
6. COMMON STOCK PURCHASE AGREEMENTS
Fletcher International Ltd. We and Fletcher entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”) dated October 14, 2009 whereby Fletcher could purchase up to $12,000,000 of our common stock at a price of approximately $2.6423 per share. With each common stock purchase, Fletcher also received a warrant, exercisable for a period of six years, to purchase the number of shares of our common stock equal to the product of 1.25 times the number of shares of our common stock purchased, with an exercise price of $3.30. On October 14, 2009, December 30, 2009 and April 20, 2010 Fletcher purchased a total of 4,541,497 shares of our common stock. Warrants were issued with each stock purchase to purchase a total of 5,676,871 shares of our common stock at an exercise price of $3.3029 per share. The warrants expire between October 14, 2015 and April 20, 2016. The warrants were deemed to have a fair value of approximately $10.2 million at the date of issuance and were recorded as additional paid-in capital. The Company received net proceeds of approximately $11.6 million, after deducting fees and expenses of the offering payable by us.
Fletcher is subject to an ownership limitation of 4.95% of the outstanding shares of common stock (“Ownership Limitation”), under which Fletcher is prohibited from consummating any subsequent closing or exercising any warrant where such closing or exercise would cause Fletcher to exceed the Ownership Limitation, or from otherwise exceeding the Ownership Limitation through other avenues, including the purchase of shares in the public market.
On July 14, 2010, we entered into a Common Stock Purchase Agreement with Energy Opportunity Ltd. (“Energy”) that provides that Energy is committed at our option to purchase up to $10,000,000 of our common stock over the 24-month term of the agreement. On August 5, 2010 we sold 1,058,201 shares of our common stock under the Purchase Agreement at a negotiated purchase price of $1.89 per share, based on current market prices. On December 29, 2010, we sold 2,890,173 shares of our common stock under the Purchase Agreement at a negotiated purchase price of $1.73 per share, based on current market prices. We have received $6,900,000 in net proceeds from this Purchase Agreement. An additional $3,000,000 remains under the Purchase Agreement.
7. STOCKHOLDERS’ EQUITY
Tyson. As an incentive to Tyson for entering into the Dynamic Fuels joint venture, Tyson received warrants to buy the Company’s common stock. The warrants are allocated in three tranches. The first tranche of 4.25 million shares was awarded upon signing of the LLC Agreement, Feedstock and Master License Agreements in June 2007. The Warrant Agreement provides that the second tranche of 2.5 million shares will be issued upon sanctioning of the second plant and the third tranche of 1.5 million shares will be issued upon sanctioning of the third plant, provided that Tyson has at least a 10% interest in Dynamic Fuels. The exercise price of the first tranche of 4.25 million warrants is $2.87 per share, which was the ten-day average closing price prior to the signing of the above referenced agreements on June 22, 2007. The exercise price of the second and third tranches of warrants will be the ten-day average closing price prior to the sanctioning of plants 2 or 3. Vesting requires that Tyson remain at least a 10% equity owner in Dynamic Fuels (in the case of the first tranche) and in the applicable plant (in the case of the second and third tranches), and that each plant has commenced commercial operation. Maturity of each tranche of warrants will be on the third anniversary of each respective plant’s start-up date of commercial operations. If 25% or more of the project cost for the third plant is debt financed, then the third warrant tranche will not vest. In the event that Tyson owns a 90% or greater interest in Dynamic Fuels the number of shares subject to the second and third warrant tranche doubles subject to a limitation that Tyson will not receive pursuant to all tranches warrants for stock equal to or more than 20% of the outstanding shares of Syntroleum common stock. In the event Tyson defaults by not paying its capital contributions to the plant, Tyson loses the warrants for such plant. These warrants are accounted for in accordance with FASB ASC Topic 718 Compensation - Stock Compensation. Warrants that are granted to non-employees that are tied to performance criteria are expensed at the time the performance goals are met.
On June 30, 2008, the Company and Tyson entered into a Warrant Agreement providing for the issuance of warrants to Tyson to purchase shares of the Company’s common stock in exchange for credit support relating to the obligations of Dynamic Fuels. Dynamic Fuels received approval from the Louisiana State Bond Commission to issue up to $100 million of certain Gulf Opportunity Tax Exempt Bonds originated by the Louisiana Public Facilities Authority (the “Bonds”). On October 21, 2008 the issuance of the Bonds occurred and required a letter of credit in the amount of $100 million as collateral for Dynamic Fuels’ obligations under the Bonds. Tyson agreed under the terms of the Warrant Agreement to provide credit support for the entire $100 million Bond issue. Tyson received 8.0 million warrants to purchase the Company’s common stock. The warrants are 100% vested upon issuance. The exercise price of the warrants is $0.01 per share. The warrants were exercised on April 16, 2009. These warrants are accounted for in accordance with FASB ASC Topic 718 Compensation - Stock Compensation. The measurement date is the date of issuance, October 21, 2008. We valued the warrants at $8.6 million and have recorded them as an additional cost of our Investment in and Loans to Dynamic Fuels on our Consolidated Balance Sheets. This additional cost in our investment results in a difference between our cost and our share of the underlying equity of Dynamic Fuels. We amortize the basis difference to Earnings or Loss From Dynamic Investment in our Consolidated Statement of Operations over the life of the Bonds, 25 years.
Pursuant to two registration rights agreements, we have granted Tyson demand and piggyback registration rights with respect to the shares of common stock issuable pursuant to the warrants.
8. STOCK-BASED COMPENSATION
Our share-based incentive plans permit us to grant restricted stock units, restricted stock, incentive or non-qualified stock options, and certain other instruments to employees, directors, consultants and advisors of the Company. Certain stock options and restricted stock units vest in accordance with the achievement of specific company objectives. The exercise price of options granted under the plan must be at least equal to the fair value of our common stock on the date of grant. All options granted vest at a rate determined by the Nominating and Compensation Committee of our Board of Directors and are exercisable for varying periods, not to exceed ten years. Shares issued under the plans upon option exercise or stock unit conversion are generally issued from authorized, but previously unissued shares.
As of December 31, 2010, approximately 4,637,846 shares of common stock were available for grant under our current plan. We are authorized to issue up to approximately 12,941,444 plan equivalent shares of common stock in relation to stock options or restricted shares outstanding or available for grant under the plans.
Stock Options
The number and weighted average exercise price of stock options outstanding are as follows:
The following table summarizes information about stock options outstanding at December 31, 2010:
A total of 3,657,950, 4,952,450 and 6,586,701 stock options with a weighted average exercise price of $0.66, $2.23 and $2.55 were outstanding at December 31, 2010, 2009 and 2008, respectively, which had not vested.
The fair value of options granted during the years ended December 31, 2010, 2009 and 2008 was estimated on the grant date using the Black-Scholes option pricing model. The model utilizes certain information, such as the interest rate on a risk-free security maturing generally at the same time as the option being valued, and requires certain assumptions, such as the expected amount of time an option will be outstanding until it is exercised or it expires and the volatility associated with the price of the underlying shares of common stock, to calculate the fair value of stock options granted. Expected volatilities are based on historical stock prices. We use historical data to estimate option exercise and employee termination within the valuation model; separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. A forfeiture rate of five percent has been estimated to reduce the expense for awards expected to not be exercised because of termination or expiration. We believe that this valuation technique and the approach utilized to develop the underlying assumptions are appropriate in calculating the fair values of our stock options granted in the years ended December 31, 2010, 2009 and 2008. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by persons who receive equity awards.
There were no stock options granted for the years ended December 31, 2010 and 2009. During 2010, an award granted in 2008 was reinstated based on an arbitration ruling. The weighted average grant date fair value of stock options granted during the year ended December 31, 2008 was approximately $0.49 per stock option (total grant date fair value of $3,265,458). The fair value of these options was estimated with the following weighted average assumptions:
Non-cash compensation cost related to stock and stock options and restricted stock recognized during the years ended December 31, 2010, 2009 and 2008 was $1,719,000, $4,180,000 and $2,418,000, respectively.
The total intrinsic value of options exercised (i.e. the difference between the market price on the exercicse date and the price paid by the employee to exercise the options) during the years ended December 31, 2010, 2009 and 2008 was $476,000, $645,000 and $0, respectively. The total amount of cash received in 2010, 2009 and 2008 by the Company from the exercise of these options was $232,000, $347,000, and $0, respectively. As of December 31, 2010 there was $6,323,000 in aggregrate intrinisic value of stock options that were fully vested or were expected to vest. The remaining weighted average contractual term for options exercisable is approximately 4.47 years. In addition, as of December 31, 2010, unrecognized compensation cost related to non-vested stock options was $77,000 which will be fully amortized using the straight-line basis over the vesting period of the options, which is expected to occur in 2011.
Restricted Stock
We also grant common stock and restricted common stock units to employees. These awards are recorded at their fair values on the date of grant and compensation cost is recorded using graded vesting over the expected term. The weighted average grant date fair value of common stock and restricted stock units granted during the years ended December 31, 2010, 2009, and 2008 was $2.59 per share (total grant date fair value of $379,000), $0.84 per share (total grant date fair value of $253,000) and $0.66 per share (total grant date fair value of $759,000), respectively. As of December 31, 2010, the aggregrate intrinsic value of restricted stock units that are expected to vest was approximately $1,854,000. In addition, as of December 31, 2010, unrecognized compensation cost related to non-vested restricted stock units was $29,000, which is expected to be recognized in 2011. The total fair value of restricted stock units vested during December 31, 2010, 2009 and 2008 was $1,584,000, $1,274,000 and $390,150, respectively. The following summary reflects restricted stock unit activity and related information.
9. INCOME TAXES
We had federal income tax net operating loss (“NOL”) carry-forwards of approximately $315 million at December 31, 2010. Our NOLs generally begin to expire as follows:
We recognize the tax benefit of NOL carry-forwards as assets to the extent that management concludes that the realization of the NOL carry-forwards is “more likely than not.” Realization of the future tax benefits is dependent on the Company’s ability to generate taxable income within the carry-forward period. The Company’s management has concluded that, based on the historical results of the Company, a valuation allowance should be provided for the entire balance of the net deferred tax asset.
We have not recorded an income tax provision for the year ended December 31, 2010. The limitation on the net operating loss deduction in 2009 resulted in an alternative minimum tax liability of $281,000 for the year ended December 31, 2009. We did not record an income tax provision or benefit for the year ended December 31, 2008. This differs from the amount of income tax benefit that would result from applying the 35 percent statutory federal income tax rate to the pretax loss due to the increase in the valuation allowance in each period. The valuation allowance increased (decreased) by approximately $3,411,000 ($5,568,000) and $250,000 for the years ended December 31, 2010, 2009 and 2008, respectively. Deferred taxes arise primarily from NOL carry-forwards and the recognition of revenues and expenses in different periods for financial and tax purposes.
Deferred taxes consist of the following (in thousands):
Open tax years are December 31, 2007 forward for both federal and state jurisdictions, except for years in which net operating losses originated and are subsequently utilized.
10. COMMITMENTS AND CONTINGENCIES:
We have entered into various, non-cancelable operating leases for office space, equipment, land and buildings that expire between 2011 and 2023. Rental expense was $325,000, in 2010, $308,000 in 2009 and $405,000 in 2008. Total future minimum lease payments under these agreements as of December 31, 2010 are as follows:
Dynamic Fuels received approval from the Louisiana State Bond Commission to sell $100 million in Gulf Opportunity Zone Tax Exempt Bonds to partially finance the plant. These bonds were sold on October 21, 2008, in the amount of $100 million. The interest rate for the bonds is a daily floating interest rate and may change significantly from this amount. The interest rate as of December 31, 2010 was 0.30%. In the fourth quarter of 2008, Dynamic Fuels entered into an interest rate swap of 2.19% for a period of 5 years with declining swap coverage. The bond indenture requires that the bond principal be backed by a stand-by letter of credit. Tyson provided a letter of credit guaranteeing the full amount of bonds for Dynamic Fuels. We granted Tyson warrants for our portion of the letter of credit. Monthly fees for this letter of credit are paid by Tyson. Dynamic Fuels reimburses Tyson for these monthly fees and are an additional financing cost to Dynamic.
We entered into a Bio-Synfining Master License Agreement on June 22, 2007 with Dynamic Fuels, LLC. Under this license agreement, we at the request of the licensee must execute a Site License Agreement in favor of licensee for licensee’s use of our Bio-Synfining™ Technology. The form of the Site License Agreement is included in the agreement as Exhibit B. The form of the Site License Agreement includes process guarantees if the plant fails to pass a performance test as defined in the Site License Agreement. If the plant fails to meet the Process Guarantee during the Performance Test and such failure is due in whole or in part to the PDP, then we and Dynamic Fuels shall mutually agree whether or not remedial measures are reasonably likely to cause the plant to satisfy the Process Guarantee. The actual cost of the remedial measures will be reimbursed to licensee through application of any future royalties owed to us, not to exceed $9,800,000. If the remedial measures are not effective, we shall pay to Dynamic Fuels an additional amount in liquidated damages in an amount not to exceed $9,800,000. As of the date of this filing the Site License Agreement has not been executed by Dynamic Fuels and we cannot be certain the document that will be executed will have this same language and amounts. Dynamic Fuels has not met all conditions required for the Performance Test to occur in order to pass the Performance Guarantee at this time, therefore no liability has been recorded at this time.
We have entered into employment agreements, which provide severance benefits to several key employees. Commitments under these agreements totaled approximately $2,139,000 at December 31, 2010. Expense is not recognized until an employee is severed.
On August 17, 2007, we entered into a Resignation and Compromise Agreement (“Compromise Agreement”) with Mr. Ziad Ghandour, a former director, employee and consultant to Syntroleum. Under the Compromise Agreement, Mr. Ghandour has the right to receive additional compensation until December 31, 2011 for five potential commercial projects, as defined in the Compromise Agreement. Mr. Ghandour claims he is entitled to additional compensation as a result of a business transaction with SINOPEC. We determined that no additional compensation was warranted as a result of the transaction. The arbitration between Syntroleum Corporation and Ziad Ghandour’s styled Ziad Ghandour v. Syntroleum Corporation, Case No. 50 166 T 00048 10, pending before the American Arbitration Association, was settled on January 17, 2011, and the arbitration was dismissed with prejudice on January 18, 2011. The parties exchanged mutual releases. The settlement has been recorded in our year ended December 31, 2010 Statement of Operations.
11. SIGNIFICANT CUSTOMERS
The Company’s revenue is derived from significant customers. Three customers made up 93%, 96% and 84% of revenues in 2010, 2009 and 2008, respectively. See Note 4, “Investment in and Loans to Dynamic Fuels” and Note 5, “Deferred Revenue” for further information regarding revenue transactions with specific customers.
12. FAIR VALUE DISCLOSURES
The Company’s short-term financial instruments consist of cash, accounts receivable, accounts payable and accrued expenses. The carrying amounts of these financial instruments approximate fair value because of their short-term maturities. The Company does not hold or issue financial instruments for trading purposes nor does it hold or issue interest rate or leveraged derivative financial instruments.
13. SEGMENT INFORMATION
We apply FASB ASC Topic 280, Segment Reporting. Previously, our reportable business segments have been identified based on the differences in products or services provided. Segments previously identified were Technology, General, Administrative and Other; Domestic Oil and Gas and International Oil and Gas. As discussed in Note 3, we classified the Domestic and International Oil and Gas segments and research and development component as discontinued operations for the years ended December 31, 2010, 2009 and 2008. We now operate only one reportable segment.
14. QUARTERLY DATA
(UNAUDITED)
Our revenues and costs are the result of projects described in these financial statements and are not from a mature, more predictable business. These projects may affect the comparability of the periods presented.