SYNTROLEUM: Second Quarter 2011 Conference Call

August 9, 2011/11:00 a.m. EDT

SPEAKERS

Karen Gallagher – Senior Vice President and Principal Financial Officer
Gary Roth – President and Chief Executive Officer
Jeff Bigger – Senior Vice President of Business Development
Ron Stinebaugh – Senior Vice President of Finance & Acquisitions

ANALYSTS

John Smith – Private Investor
Joel Stanton – Private Investor
Tony Chin – ALC Capital
Ezra Burn – Private Investor
Thomas Victor – Private Investor
Jack Bean – Private Investor
Tom Davis – Private Investor
Gary Rumble – Private Investor
Charles Nelson – Private Investor
Jonathan Art – Kaufmann Fund
Julie Kim – Private Investor
David Ciruli – JMP Securities
Michael Prouty – 10K Capital
John Anderson – Private Investor
Jim Burken – Private Investor
Nick Biassi – Omebit
Mike Walker – Private Investor

Before we begin our remarks, I would like to remind everyone that during this call, we will make certain forward-looking statements as well as use historical information. Words such as believe, estimate, expect, intend, plan, anticipate, could or should are intended to identify forward-looking statements. Although Syntroleum believes that expectations reflected in these forward-looking statements are reasonable, these statements involve risks and uncertainties. Future results may differ materially from those projected in these forward-looking statements. You are encouraged to refer to our SEC filings, including our most recent Annual Report on Form 10-K for a full disclosure of these risks and uncertainties.

Now, I’ll turn the call over to Mr. Gary Roth for opening remarks.

Let us review the performance for the last 10 months. We’ll focus on three items: Feedstock cost, revenues and operating expense. For the prior 10 months, our average feedstock costs have been $3.68/gallon, and our blended revenue was $4.98/gallon, resulting in a gross margin of $1.30. This compares to weighted average soy based biodiesel gross margin of $.76/gallon for the same time period. Our average operating expense was $2.96/gallon, which equates to the net loss of $1.66/gallon through June. The $2.96/gallon occurred during our commissioning and startup period where we averaged 25% of design capacity. Based on preliminary costs in July, we believe our original operating expense of $.50-.55/gallon is attainable. This is especially true given our budget originally included $.19/gallon of hydrogen cost. Due to improved plant performance and favorable natural gas costs, we achieved $.14/gallon hydrogen cost in July.

In summary, we’ve averaged $1.30/gallon gross margin and with a projected operating expense of $.55/gallon, Dynamic Fuels would achieve a cash margin of $.75/gallon or $56 million a year at design capacity.

There remains considerable revenue upside. Our diesel price during commissioning and startup averaged $5.55/gallon. During the same period, the average full value of renewable diesel, which is calculated to be the sum of ULSD diesel price plus RINs plus a dollar subsidy was $6.01/gallon. As we continue to improve plant reliability, we would expect to close a differential between our current sales price and full value of renewable diesel.

During the 10 months of operation, our non-diesel price component of production averaged $1.68/gallon versus a petroleum-equivalent of $2.03. This discount again was primarily due to commissioning volatilities.

Finally, we expect to receive 1.5 advance biofuel or D5 RINs per gallon for renewal naphtha. Advanced biofuel RINs has averaged $.61/RIN for the first six months of this year, and currently trade at $.84/RIN. We have applied to the EPA for advanced biofuel naphtha RINs and expect approval in the fourth quarter. If we had received full market value for our products and naphtha RINs during the prior 10 months, our average revenue per gallon would have been $5.48 versus $4.98, or an improvement of $.50.

The fundamentals of the renewable diesel market remain strong. Renewable fuel standard or RFS was created by Congress in 2007 to simulate the adoption of renewable fuels in the United States. In 2010, EPA adopted the second generation of RFS known as RFS2, which was implemented in July 2010. Since its introduction, RFS2 remains the primary tool to create biofuel’s demand in the U.S. Last year, EPA set domestic-based diesel volumes at 800 million gallons for 2011, and on June 28^th of this year, EPA formally recommended the RFS2 mandate for biomass-based diesel at one billion gallons for 2012 and 1.3 billion gallons for 2013. EPA typically sets its final rule making in November.

There are two products that can satisfy the biomass-based diesel RFS2 mandates, biodiesel and renewable diesel. Our renewable diesel enjoys significant competitive advantages. First, it is a true drop-in fuel that is certified to ASTM D975 standard, the same standard as petroleum diesel. As such, there are no infrastructure requirements to blend renewable diesel and therefore it can be shipped on any pipeline. Further, the cold flow properties of renewable diesel are not feedstock dependent. We can make renewable diesel with cold flow properties ranging from summer grade diesel to arctic grade diesel and jet fuel.

Lastly, our renewable diesel has virtually the same energy content as petroleum diesel. As such, renewable diesel receives 1.7 RINs/gallon compared to 1.5 RINs/gallon of biodiesel. Because of renewable diesel superior properties, we have realized more revenue per gallon compared to soy based biodiesel.

For the prior 10 months, our diesel revenue per gallon averaged 5.55 compared to 5.22 for soy-based biodiesel. Dynamic Fuels currently has contractual arrangements for 100% of the plant renewable diesel production. Such contractual arrangements have provided Dynamic Fuels assurance for reliable off-take during the startup and commissioning phase of the Geismar plant. We sell our non-diesel products on a spot basis.

RFS2 has been implemented by creating a trading compliance commodity known as a Renewable Identification Number or RIN. Each obligated party must purchase sufficient RINs to satisfy its annual biomass-based diesel quota. RINs are meant to be a market pricing mechanism to stimulate production to meet RFS2 demands. Since the beginning of the year, RIN prices have increased from $.74 to $1.40 currently. For the second quarter, RINs averaged $1.32. U.S. biodiesel production was 297 million gallons for the first five months of 2011 compared to 311 million gallons produced for all of 2010. We believe that the demand for RINs and correspondingly biomass-based diesel, exceeds supply and therefore RIN prices must remain at current levels or increase further in order to stimulate the production required to meet RFS2 mandates.

The renewable diesel price consists of two components. The first is the underlying petroleum diesel price and the second is a regulatory premium that enables producers to compete with petroleum diesel. This regulatory premium currently consists of a dollar subsidy and the RIN values. For renewable diesel, RIN values equate to 1.7 times the RIN price. Given the U.S. budget debate, we are frequently asked the status of the dollar subsidy. Should the dollar not be renewed, we believe the regulatory premium required would remain the same and therefore RIN values would increase.

On June 30, Dynamic Fuels made aviation history when it supplied fuel to KLM Royal Dutch Airlines to fly the first commercial flight from Amsterdam to Paris using renewable jet fuel. Our fuel was part of extensive jet fuel testing and certification work conducted by the Air Force research laboratory, Rolls Royce Group and Cessna Aircraft Company. In addition to meeting rigorous technical specifications, Dynamic Fuels’ jet fuel met KLM’s sustainability requirements including reduction in CO2 emissions and minimum negative impact on biodiversity and food supply.

In July I had the pleasure of seeing our former Catoosa Demonstration Facility producing in China. The Sinopec Syntroleum Demonstration Facility, also known as SPF, is located in Zhenhai, China. The SPF is an 80-barrel-a-day facility utilizing the Syntroleum FT technology for this conversion of syngas produced from coal, asphalt and petroleum coke into synthetic petrochemical feedstocks. Our agreement states that Sinopec must run the plant for six months non-continuously. Sinopec is now in the long term testing phase. Sinopec has stated, based on the results of this run, they intend to build a commercial scale coal-to-liquids plant. The production from a commercial scale CTL plant will provide validation of our technology from the fifth largest company in the world, according to the Fortune Global 500.

With the progress of Sinopec and discoveries of shale gas in the U.S., we receive many technical inquiries on a potential domestic GTL plant. It is reported there is over 1,600 trillion cubic feet of gas reserves in North America. To put that in perspective, one TCF of gas is approximately 100 million barrels of GTL fuel. The economics of GTL are compelling. With natural gas costs of $4.00-$5.00 per thousand cubic feet, and a conversion ratio of 10 units of natural gas per barrel of product, we see an equivalent refined feedstock cost of $40-50/barrel. This compares favorably to long-run expected petroleum product prices.

Because we are an independent FT technology provider, we see numerous GTL opportunities and are in a position to evaluate and high grade those projects on which we devote our resources. We are in active discussion with gas suppliers, off-takers, project developers and project financiers.

One final note on technology; for the first six months of 2011, we were granted two patents by the U.S. patent office and given notice of allowance on a third patent. We were granted one patent in China and one in Australia, as well as we filed three patent applications in the first half of 2011.

I will now turn the call over to Karen.

We also recorded revenues for royalties from the Dynamic Fuels commercial production which began in November. The total net loss for the six months ended June 30, 2011 was $9.4 million. Of this loss, $6.9 million relates to Dynamic Fuels’ operations for their six months ended March 31, 2011. The loss reflected in our income statement represents the loss incurred for Dynamic from October 1, 2010 to March 31, 2011. Our 10-Q filing includes Dynamic financials for their six months ended March 31, 2011 in the footnotes to our financial statement.

We do not consolidate Dynamic Fuels; instead, we report using the equity method of accounting. Income or losses under the equity method are reported below operating income as income or loss and equity of Dynamic Fuels. Per generally accepted accounting principles, we are not able to record gross revenues associated from Dynamic Fuels because the entity is not consolidated. We will only report our share of the total net income or net loss.

As reported in our 10-Q, Dynamic Fuels had revenues of $28.1 million and operating expenses of $41.8 million, resulting in a net loss of $13.7 million for the six months ended March 31, of which we report 50% in our Syntroleum financials. During this time period, 5.7 million gallons of renewable fuel were sold and 6.5 million gallons were produced. Our limited production level during the startup and commissioning period resulted in losses at Dynamic Fuels. As we have discussed with you throughout this call, we are achieving better reliability on our equipment and reducing costs associated with operating activity. In July, we expect revenues of $28.1 million on sales of 5.3 million gallons for an average sales price of $5.26/gallon. Therefore, we anticipate Dynamic Fuels to significantly improve its profitability in their quarter ended September 30, 2011.

On July 6, we raised $23.6 million net of operating expenses from the sale of 15.9 million shares of common stock. The use of proceeds is to fund working capital requirements at Dynamic Fuels and project development capital for a potential GTL plant. At the time of the offering, we expected that approximately $7-10 million would be required for additional working capital for Dynamic Fuels, and the balance would be used for general corporate purposes and if prudent, project development costs for a gas-to-liquid plant. Our current cash balance is approximately $29.3 million.

Thank you for your attendance today. We will now open up the call for questions.

The second question was cash flow positive; we’re right on the verge in July. We’ve got the revenues booked and we need to finish up the accounting on the cost side, but we’re doing a very good job this last month reducing our costs and get the standard operating conditions. We can report hydrogen costs at about $.14/gallon. We had budgeted about $.19 so we are favorable there due to reduced consumption of hydrogen and also due to lower natural gas prices than budgeted.

In terms of the offering, the offering was to institutional investors and that was the method of delivery that we chose. There are offerings where you can make a broader offering to retail investors, but given the circumstances of our raise, we chose the institutional route.

As far as the second Geismar plant, typically expansions are done based on the de-bottleneck design. And so we would expect expansions to be looked at at the same time as we would be looking at the de-bottlenecking. We think Geismar continues to be an excellent site for a second plant. Economics in this business remain fairly strong, so that would be our basic plan.