Gevo, Inc. (GEVO) Earnings Call Transcript & Summary

Hello, and good afternoon, everyone. My name is Shawn Severson, President and Co-Founder of Water Tower Research and Head of Sustainable Research. As a reminder, at Water Tower, you could access all of our information. It's open access for all investors to participate. You can do that at www.watertowerresearch.com, and on there, you'll also find information prior fireside chats and content on Gevo. Our guests today from Gevo is Lynn Smull, CFO. I remind people that this event is available on demand. You can use the same link from the original registration to view this on demand. And as a reminder, we will take a few questions at the end, and I try to keep these to half an hour at most. And before we start, Lynn, maybe just give us a little bit of background about yourself, I know some investors have probably heard you on conference calls, but we haven't done one of these in a while with you. So I think it'd be good to run through your background a little bit, and what brought you to Gevo.

Sure. Thanks, Shawn. Let's see, I have about 34 years now after business school in finance rules on investment banking, private equity and corporate platforms. The common thread through my career has been structured in project -- structured financings and project finance for energy infrastructure type of projects and power. And I've done everything from capital raising up and down the capital structure spectrum in public and private markets through to structured deals around mezz financing and different structured equity and common equity deals. So, yes, I think that background was something that the team here appreciated when they were looking for a CFO in 2019 because the nature of Gevo with our capital needs are so substantial and given our balance sheet and our cash position, which is meaningful and allows us to control our own destiny and developing our projects, but it doesn't allow the full build-out and the need for third-party capital and the need to do that on a structured basis was critical. So I brought that to the table and it was very appealing to be able to apply lessons learned over my career to Gevo's needs.

And so I guess from that, we take the experience of project finance. I think you touched on that a little bit about, about how Gevo develops its business, how it grows, what the financing capital structures look like.

Yes. As I said, we have enough capital to develop Net-Zero 1 and other projects, especially as we shifted towards a more capital-light developer role, technology developer, project developer and less of an investor position in the initial projects anyway, and we'll see how the future plays out on projects that followed Net-Zero 1. But the need for the third-party capital on a debt and equity basis drives you towards project finance, which is a very particular discipline in the world of finance, project financings, nonrecourse lenders don't have any other sources of cash or value to recover their debt positions and get paid on that, then the project itself because the recourse is limited to the project. So it requires a lot of upfront structuring to dot all the I's and cross all the T's before that capital can flow and equity is not far behind on their needs in a project deal because they're not looking at a portfolio of assets, they're looking at a single asset. So the structuring needs are critical. The development processes can be arduous but it results in a substantially improved risk return profile vis-a-vis a corporate financing oftentimes because of all of the work that was done upfront to determine -- to derisk the project and determine the cash flows to allow for a valuation of those flows.

So if we bring that to Gevo specifically, maybe differentiate between the corporate finance in this case and why project finance. I know we get investor questions all the time. I know you guys do on how this works, why the DOE loan, the project finance process. And I know it's frustrating for common equity investors because they wait for these big events to happen, right? And for these major pivot points. But let's spend a moment talking about what project finance is and the progress report that goes through in developing this because I think it creates a lot of confusion given the nature of project finance.

Sure. The development process is pinning down the commercial arrangements that essentially assure people or allow people to assess the risk return profile from a fundamental business perspective of EBITDA off of a project. And then beyond that, you go into the financial structuring to carve up that EBITDA between debt and other tranches equity [ mezz ] may be in between. And that development process is everything from site control, permitting, all of the engineering work, which we've completed FEL 3, and we're in detailed engineering now I'll comment on that to the offtake arrangements, O&M all has to be put together in a commercial structure that everyone can look to towards scope of obligations under a contract for different counterparties, and fees and cost of the scope and have it legally binding and able to be perfected under security laws. So all of this is a long process. When you're delivering a mega project, I understand how investors are frustrated, Gevo management, which is very much aggressive, passionate, driving management is -- wants to see this project in financial close and in construction as soon as possible. But that capital can't flow until all those I's are dotted and T's are crossed and that's what we do on a daily basis is address challenges, and we're knocking them down all the time. So we're quite happy about that. It's difficult to point to big milestones, like an FDA approval of a drug, for example, would be a good like extreme example of a binary milestone on a value of a particular opportunity. We have accomplishments every day. So it's very like hard to sort of pick a particular milestone because everything is important to get to financial close. So as we knock issues down and accomplish objectives, we're moving towards the ultimate milestone, which is financial close and then beyond that, operations -- commercial operations [ state ].

When we go back and we look at, I think investors remember kind of what was happening with the groundbreaking, for example, at NZ1, and we talked originally about Citigroup financing, but things have shifted toward people and those public information. They talked about that. Now clearly, in the sites of the DOE and that process has started. Could you spend a minute maybe helping us understand what happened over that year, why the DOE is now viewed as the best option? And also, the things that have happened that since there was the shovel -- the first shovel in the ground symbolically, so to speak.

Sure. So back to that comment about carving up the cash flows between debt and equity. The question for such a large project and such a large capital investment is what type of debt, what format, there are multiple formats. There's the syndicated bank loan market for project finance. They're different private placement markets and credit funds. And then there's the DOE. And the DOE's mandate is to support staff. And they come to the party with an attitude of bringing this project to fruition and supporting it and they bring, I think, much more attractive terms that we could get in the commercial markets today. That's their job is to support technology. So we did gravitate away from the syndicated bank loan or credit fund markets, the commercial markets towards the DOE and that took time to get through the Part 1 application and to be formally invited into due diligence, which has occurred a couple of months ago. They are in the process of fully engaging in "due diligence", but that encompasses so much more than that. It's hiring of their consultants to advise them on the credit quality and the credit structuring and terms and conditions. It's negotiating terms and conditions with us, and we expect to have soft terms and conditions circled by the end of the year and advancing the project delivery, the EPC contracts in simultaneously so that we can close in on a financing next year with the DOE, and it will be, I think, more attractive debt terms than we'd see in the commercial markets.

So if we go back to that, I think addressing why EPCs are important in this because it's a critical part of project finance. Maybe if you could spend a moment.

Yes. I mean this is my world is project risk mitigation. So for completion risk and we define that in the world of project finances cost, schedule and performance. Nobody wants to take that. And so where do you place that risk? Do you place it with a party who is best able to manage it and price it. And those are EPC contractors, very technical-oriented, engineering, procurement of all the equipment and the actual construction, that's their world. They live in it and they manage those risks all the time. So theoretically and practically, they're the ones who can price that risk the lowest. So we work with contractors to nail them down on lump sum turnkey provisions or terms and conditions. That's fixed price turnkey meaning bringing the whole project to fruition and into commercial operations, everything from the upfront engineering, detailed engineering, procurement of the equipment and on the ground construction to commissioning and start-up. And those terms and conditions have certain features in them that are "bankable", i.e., support debt structures and equity as well because equity looks to this as well. We're going to need third-party equity to build this alongside of the debt. And those features really boil down to what happens if there's a cost overrun. Well, it's a fixed price. So there shouldn't be a cost overrun. There may be the potential for change orders, but there's a requirement by lenders for certain contingent equity to handle change orders. What happens if there's a delay? Well, the package of liquidated damages in that contract have to support the interest expense and fixed operations during the hopefully short delay, but if there is a delay, during the delayed period, those costs have to be supported by the lump sum turnkey contractor. What happens if the project doesn't perform to the guaranteed specs that the contractors signed up for? Well, they have to pay certain liquidated damages that buy the debt down to keep the debt sort of credit quality constant. And those features are critical, and we're succeeding in getting those features in place in the negotiations now with the contractors. I think we've publicly said that our preferred contractor, the lead horse for the ETJ portion is McDermott. We're delighted to be working with them. They are in detailed engineering. We hope to arrive at a lump sum price in the contract terms that are already done by beginning of Q2 next year. And on the ethanol side, we're working with a major contractor negotiating EPC terms, but we're delighted to have worked with Fluid Quip, who is an excellent technology provider and also developing proprietary technology around energy platform footprint because our objective is to deliver the lowest CI fuels out there. Mother Nature does a large part of that with photosynthesis and delivering a corn kernels with -- that have both food and carbohydrates and the carbohydrates are raw material for fuel. But we do need process energy and to lower that process energy need the better off we are. So our engineers have done an excellent job of getting very creative on reducing the energy needs. And we're working with a world-class ethanol contractor that will disclose in the coming months here to deliver that project. So those names are very important, too, for third-party capital, debt and equity. The quality of the names matter a lot. They're wherewithal credibility and capabilities in both of the names we're working with are absolutely capable of delivering a mega project like ours.

And to clarify, so investors and everybody is clear, you really can't -- you can't get project finance funded until you have an EPC rep because there's de-risking of the project. So let's spend a second talking about that because in your developer role is also a derisking, correct? And then the EPC. And maybe just explain what -- where -- what your role was in that and clarified no EPC contract, you really can't get -- you can't get funding on project finance, the risk mitigation isn't there.

That's exactly right, Shawn. The -- we don't have the capacity on our balance sheet to guarantee completion. We need a capable, credible counterparty. EPC contractors are the best positioned to do that because they're the ones who actually have to do the detailed engineering, procurement and construction. So that's all gone very well. I think there's also something that needs to be said about the benefit of project financing to Gevo corporate to Gevo equity, the more we derisk a project, the better the risk-adjusted returns are for the distributions that we expect off of the project for our proportionate equity position that we will have an equity position in Net-Zero 1, and we will be receiving distributions. The more risk mitigated the project is, the better those -- the higher value those distributions have because they have lower risk.

Right. So again, I think that's going back to how this flows through and why it's important to the common equity holders is it's, again, Gevo able to participate at the plant level, both as a developer and an investor, right? But going back to majority...

And technology provider, too.

Yes, technology provider, of course, right. And then going back to no EPC wrap, no funding. And I'm just trying to make sure that we're on the same page and investors understand this, too, that these are all critical things that have to happen that are part of this process. And everybody wants to put a shovel in the ground and start digging and develop in NZ1 but all of this, I think, project finance gets lost in this. So I'm just hoping that some of this will explain to investors what's going on and help them understand and better track the progress best we can because that's we were all looking for as progress report. So that's key.

Right. And the other key element to risk mitigation for project financing is the sale of your products. And of course, our offtake agreements, our portfolio of offtake agreements is very helpful for that. I think that we all are waiting for some guidance and rumor has it that we'll hear that in December, and that it will be favorable to our view of the world, which is a scientific databased accounting of carbon from field to tailpipe that relies on the Argonne GREET model and we're hearing that some version of that will be implemented and defined by the U.S. Treasury, which we're very -- we're just anticipating it with a lot of excitement because that will help ourselves, Gevo, our investors and counterparties on the offtake to value the contracts, and we think it will bolster the cash flow value once that's better defined.

And I don't want to, I guess, dilute the focus on NZ1 but really looking at Gevo, there are some other things going on, too, you got NZ1. You've got the opportunity of wind and hydrogen optionality in RNG. And I don't want to get too distracted by this, but I think it's important to look at the portfolio, let's say, the platform that Gevo has and talk about that for a moment.

Sure. Just as an overarching comment, I'd say we're all about carbohydrates to fuels and chemical feedstocks and renewable carbohydrates. So that's our fundamental common theme. But we have a number of technologies, as I think our investors know we have isobutanol, a proprietary IP position there. That has long-term value. We continue to nurture that. But it doesn't take a lot of capital, but to continue to advance the R&D around it, we think that will have legs in the future. We have some other intermediate technologies or they actually are in game technologies for some parties like the LG Chem, ETO work on ethanol to olefins to get to chemicals. But that doesn't take a lot of our capital or even our time because that's largely LG Chem taking what we had as foreground technology and further developing it. We get the benefit off of that deal of the fuels that come out of that, whereas they take most of the benefits off of chemicals. And then we have RNG and our Northwest Iowa RNG project started at 355,000 MMBtu. The expansion to 400,000 MMBtu started up, I think, last month, it's going well. On an annualized basis, it'd be 400,000-plus MMBtu per annum. And it's currently generating EBITDA roughly breakeven because it's on the [ old 355 ], but that was at a negative [ 3.5 ] temporary CI score, which we expect carb will grant us the permanent score at a negative 350 in the first half of next year. So that will substantially increase our cash flows off of Northwest Iowa. We look at RNG as a fundamental business. We ask ourselves the question as to whether it has merit on pursuing as a business on its own, but we haven't really answered that question. We do know that it has merits to pursue as an augmentation to use as a tool in our renewable fuels production or liquid transportation fuels and staff production. So RNG is an important piece of our puzzle, and we know how to do it well. Northwest Iowa came off really well. We executed it well and we continue to improve it and I think that could leverage into a lot more activity there, but we're going to be very careful where we deploy dollars and resources. We're very selective on what we do. The other big part of Gevo is Verity. And I think investors are aware of Paul Bloom and what he's done there to build that undertaking its field to tailpipe measurement reporting and validation. It's transparent, credible, auditable and it creates real value in the compliance markets and voluntary markets around carbon abatement or carbon credits. And that undertaking is going well. It's live in production at facilities now, for example, SIRE, which we announced. It's working, and we're really excited. Other people see that value. And I think I'd love to say more, but we're going to provide guidance on that by the end of the year, and it should be pretty exciting as what it could be even on its own, let alone functioning as a critical tool to weave together what Net-Zero 1, Net-Zero program and anything else we do, which all centers around carbon abatement and value on that.

And just an extension of that too. It's certainly an interesting area because carbon is becoming an asset and a liability, right? So at some point, it has to have an audit trail and accountability. People are putting on balance sheet that markets are opening up for trading -- trading those assets and liabilities. So really, Verity is a way. And I think, obviously, where it fits with you guys is it goes right back to the farmer, right? I mean this is where this starts. And I want to spend a moment talking about CI and carbon, but you're getting to what's the carbon -- what's the CI score of a bushel of corn is really where you [indiscernible] process into the ethanol, the energy used, everything that goes through the process into the SAF part of the process as well.

That's right. I think that this also relates to treasury guidance on the inflation Reduction Act 45Z, which is the Clean Fuel Production Credit. And it relates to even carb and the LCFS credits and other LCFS markets as to how they count carbon. It's our strong view, and we can back it up with data and science, and we continue to develop more. For example, the Verity growers program. We're working with I'm drawing a blank on the acreage, but a lot of farms in the South Dakota area near Lake Preston. That's where it was a natural for us to start there on developing programs with the farmers to track the soil carbon sequestration that naturally occurs and their corn CI that results from both sequestration and the process inputs that they use in their farming operations and the efficiencies around that. And so that's part of what Verity is doing live with SIRE as well as in South Dakota is to track the carbon that is sequestered in soil, the carbon emissions that are needed to grow and farm and then ultimately through to the end of our own processes at the Net-Zero 1 plant, when our fuels leave the gate, they're substantially negative. And then when they are burned at the tailpipe it puts the carbon back in the atmosphere closing the loop at a zero net CI score. So it's not adding anything to the atmosphere. And you're able to travel without adding carbon as opposed to the fossil world where you do.

I have one more question, then I'll take a few from the audience. And my question is focused on project economics, but I want to ask it a little different way. So I'm a common equity holder in Gevo and the share volatility up and down, but I'm waiting for something to happen, right? And we're talking about happening is how does it -- what is the pot of gold let's say, for the average shareholder at the end of this. So NZ1, you get the funding that goes through, how do the economics work down to the shareholder in this case, assuming you're taking the project finance out and through the DOE.

Sure. It's a combination of factors. The development work that we've done, cost and capital, we have resources to do it, thank goodness. And we're using those to design, acquire the site, get the permitting and make equipment purchases to mitigate price risk and locking and equipment. The -- we've been faced with a lot of challenges over the last few years from COVID to the Ukrainian war and all the impacts on in addition to people's lives, but what we see is supply chain disruptions, escalation and concern about actually being able to procure equipment and materials in time for your construction. So we have to mitigate some of those risks to get to financial close under a project finance structure. So that means equipment deposits. And we've spent a fair bit of capital advancing the project to date. We don't have that much more to go until we get to financial close. But that risk reduction is critical to the development process. We expect to recover all of that capital plus fee at financial close. It's common in project financings for the developers to get their capital back plus fee. Now they may roll that back in as an equity position or they may not or some combination of the two, plus we expect to have certain license fees for the technology we're bringing to the project. And then, of course, on the back end, after completion, a stream of cash flows associated with whatever equity investment we leave in plus some carried interest. So it's all a number of sources of cash flow to Gevo. It's hard to define that today because we need to further mature the project that I think debt normally doesn't have as much to say about the structure of that cash flow -- those cash flow components to Gevo, but our equity partners will have a lot to say about it. So we'll have to have that better defined before we can talk about specifics on the types and timing of different cash flows. But that's an example of the combination we fully expect to see.