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Synthesis Energy Systems, Inc. (NASDAQ:SYMX)

F3Q09 (Qtr End 03/31/09) Earnings Call

May 08, 2009 07:00 am ET

Executives

Ann Tanabe - Vice President of Investor Relations

Robert Rigdon - President and CEO

Kevin Kelly - Chief Accounting Officer

Donald Bunnell - President and Chief Executive Officer - Asia Pacific

Analysts

David Begleiter - Deutsche Bank

Pearce Hammond - Simmons & Company

Operator

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Synthesis Energy Systems third quarter financial results conference call. At this time all lines are in a listen-only mode. Later there will be a question-and-answer session and instructions will be given at that time. (Operator Instructions). As a reminder, today's call is being recorded. At this time and I would now like to turn the conference over to Ann Tanabe. Please go ahead.

Ann Tanabe

Good morning and thank you for joining Synthesis Energy Systems conference call. My name is Ann Tanabe and I'm the Vice President of Investor Relations for SES. Today we will discuss results for the quarter ended March 31st, 2009, and will provide an update on corporate development.

Following our prepared remarks, we will open the line for a brief question-and-answer session. Joining me on the call this morning is Mr. Robert Rigdon, our President and CEO, Mr. Kevin Kelly, our Chief Accounting Officer and Mr. John Biennial, our President of Asia Pacific.

Before we begin, I would like to remind you that during this call, we will be making forward-looking statements within the meaning of section 27A of the Securities Act and Section 21E of the Exchange Act. All statements other than statements of historical facts are forward-looking statements. Forward-looking statements are subject to certain risks, trends, and uncertainties that could cause actual results to differ materially from those projected.

Although we believe that in making such forward-looking statements, our expectations are based upon reasonable assumptions. Such statements may be influenced by factors that could cause actual outcomes and results to differ materially from those projected. We cannot assure you that the assumptions upon which these statements are based will prove to have been correct. Please refer to our most recent 10-K for the year ended June 30, 2008, and our 10-Q to be filed for the quarter ended March 31, 2009, for further discussion on risk factors. A copy of the 10-K and 10-Q can be found on the Securities and Exchange Commission website at www.sec.gov, on the company's website at www.synthesisenergy.com.

I would now like to turn the call over to Mr. Robert Rigdon, President and CEO of Synthesis Energy Systems. Robert.

Robert Rigdon

Thank you Ann, and welcome everybody to our third quarter conference call. For the very first time, we are hosting this call from our China office in Shanghai and hopeful that you are connection is clear and that will progress without any technical difficulties. As Ann just mentioned, Don Bunnell and Kevin Kelly are with me here in our office.

On March 31, we announced changes in management here at SES, since that time, I've been working with my senior management team, reviewing the operations at Hai Hua, the development progress of the YIMA project, and our steps for continued G&A reductions.

Business resulted in strong focus thought the organization on achieving our important goals and milestones, as well as our renewed enthusiasm of the team. I'll provide in more detail update in just a moment after Kevin gives us a brief overview of our third quarter financial results. Kevin?

Kevin Kelly

Thank you, Robert. For the third quarter of fiscal 2009, we reported revenue of $326,000 of which 76,000 was from the sale of syngas and byproducts produced at the Hai Hua joint venture plant. For the quarter, the plant operated about 13% of the time due to weak syngas demand and maintenance by both Hai Hua and the plant, which Robert will explain further.

Additionally, although the plant began to invoice Hai Hua for the energy and capacity fees after declaring commercial operation status in December 2008, Hai Hua did not pay the fees due to differing interpretations of the syngas quality component requirements.

As a result, the plant did not recognize these revenues. We believe that this issue has been resolved by entering into a supplemental agreement with Hai Hua, as Robert will discuss later on this call.

We are in $250,000 of revenue during the quarter from the North American coal company upon delivery of the pre-feasibility study for the Otter Creek project. We are not planning further development of Otter Creek at this time. Cost of sales and plant operating expenses were $906,000 for the quarter, which was approximately $2 million lower than the previous quarter. Operating cost increased due to lower utilities, pay roll, coal consumption and maintenance cost at the Hai Hua joint venture plant due its down time.

G&A expenses were 3.8 million for the quarter, down 19% from the previous quarter, due mainly to a reduction in Huston, personal as-well-as travel and other costs. We are expecting further reductions to G&A expenses in our fourth quarter due to personal reductions that occurred at end of March from our continuing cost savings initiatives and from lower professional fees and other overhead cost. Project and technical development expenses were $250,000 for the quarter and related primarily to the YIMA project.

As of March 31, 2009, the company at cash and cash equivalents had $98.6 million and working capital of $91.4 million. We used significantly less cash during our third quarter than previous quarters due to our G&A reductions, reduced capital expenditures, and lower operating cost at the higher volumes joining at the Hai Hua joint venture plant due its downtime.

I will now turn the call back over to Robert.

Robert Rigdon

Thanks, Kevin. As I mentioned on our previous call, our focus is on China and our strategy remains essentially the same, which is building owning and operating projects that realized the U-GAS technology, fuel advantage to be the low cost producer and the energy in chemical space.

As we execute on this strategy, we'll manage a low cost operation through the strength of our projects development in technical teams that are located here in China. In the near term, our focus is on operations at Hai Hua, the development of the YIMA project, as well as a continuing focus on reducing and managing operating cost.

As Kevin just mentioned, we are down 19% on our G&A cost from the previous quarter. And, we expect this trend to continue such that by the fourth quarter, we should be down approximately 30%, as compared to the first half of the fiscal year.

I would like to stress that we recognize, we are in a period of constraint capital. And therefore, we are really aggressively managing our cost. This includes development costs of our projects and related operational cost, so that we will have adequate cash for our project investments, and ultimately carry us through to a future point, where we can be cash positive.

Now, I would like to give you an update on the operations at the Hai Hua joint venture. As you read in the press release today the plant operated for about 30% of the quarter. Our partner Hai Hua has been operating at very low rates and took this opportunity to shutdown for maintenance for about one month during this quarter.

In addition to that Hai Hua's the maintenance period and weak syngas demand from Hai Hua early in the quarter, we experience some unscheduled maintenance downtime, as well as additional repairs related to a power outage. Also we held the plant down for area government, industrial inspection after which we chose not to start up and operate for some important reasons that I'll go ahead and describe.

First, I'd like to explain the energy fee we charge Hai Hua. The joint venture project was designed to run at or near full production rates. When the plant is turned down, meaning low production rates, the reduction in energy consumption is not linear. In other words, at low production rates, the energy cost for a single unit of syngas can be relatively high. Because the plant was intended to operate at full production rates, the original energy fee structure could not recover the real energy cost associated with the extended turndown operations. Because of this at very low production rates, there is no compelling reason to operate the plan due to the high energy cost.

Secondly, we began invoicing Hai Hua for the syngas capacity fee in the third quarter. The syngas from the plant must meet certain quality standards to be paid this capacity fee. Hai Hua became concerned about our mining constituent in the syngas for which the specifications in the contracts were unclear, and we disagree with Hai Hua on the contracts syngas quality requirements were recognized that both parties ultimately needed a solution here.

In addition to the currently low syngas demand, Hai Hua has projected this slow demand to extend throughout the calendar year and possibly beyond. So with this backdrop of low syngas demand by Hai Hua driving a high unit energy cost and syngas quality issue prohibiting the collection of the capacity fee, it was actually cheaper and the prudent thing for us to hold the plant down and work to resolve these issues, which is exactly what we did.

We took the first significant step by executing a supplementary agreement with Hai Hua to provide more clarity regarding this required syngas quality and volume to be delivered, as well as recovery of the energy fee during these turndown periods.

We took another significant step yesterday to solve the energy consumption issue that I previously noted by executing a related ASU sharing agreement with Hai Hua. The ASU or air separation unit generates oxygen for the plant and is the primary source of electricity consumption. Hai Hua also has an ASU that it uses as part of the process of converting coke oven gas for using this methanol plant.

Even at low production rates these ASUs continue to consume a lot of power, but have ample access capacity which creates inefficiency for both us and Hai Hua. The ASU sharing agreement provides a business structure for the plant to sell excess oxygen to Hai Hua thereby recovering the energy related and other variable cost. Under this agreement Hai Hua will shut down its ASU and purchase oxygen from the joint venture. This is clearly a win-win arrangement for the parties.

There is a small amount of hardware required for the ASU sharing and completion of installation is expected early summer. With these two agreements in place, we now have the ability to recovery energy cost even during extended turn down conditions, and provide clarity regarding the required syngas quality, such as the capacity fee payments can be collected as long as the plant meets the revised syngas quality specifications.

In addition, the supplementary agreement improves day-to-day operations, coordination and allows a structure for the joint venture to be paid for operating time related to Hai Hua on scheduled outages.

Based on these things, we expect to see an increase in the percentage of operating time as-well-as a significant reduction in syngas production cost. This is a really important step forward for us towards meeting our goal for the plant to become financially sustainable and contribute positively to overall cash picture.

We are also continuing to improve the overall operations at the Hai Hua joint venture and we are putting a lot of energy into looking at all alternatives that can further reduce operating cost improve cash flows. I look forward to updating you regarding these initiatives on future calls.

Now, I'd like to move on to YIMA and we made a lot of progress on the project particularly over the last month. In late April, we executed several project related agreements with YIMA that now make it possible to formerly register the joint ventures to obtain our business license for the construction phase and complete the financing process, and Don has been spending most of his time focused on getting the YIMA project through financial closure and he is here to give you an update. Don?

Donald Bunnell

Thanks Robert. I want to echo Robert's earlier statement that the whole SES team is reenergized and I give him a lot of credit for that. I've worked with Robert now for a year and he has demonstrated excellent management leadership skills, and I'm very happy to have to see him in his new position.

Regarding the YIMA project, there has been a lot of progress since our last call, as Robert just mentioned. One significant step is that SES and YIMA have agreed on the scope of the project. We save at another 300,000 ton per year methanol plants, because the smaller plant translates into less equity for SES and because many plants of this scale have already been built and operated reliably in China.

A 300,000 ton projects scale gives SES confidence with respect to low technical risk and the accuracy of our project budget estimates. We are going to be designing the project to be a two by 300,000 ton facility. Phase I, a 300,000 tons of refine methanol, will include certain common facilities for our 300,000 ton Phase II expansion.

In addition to the 600,000 tons of methanol I just mentioned, YIMA and SES are now planning two future phases of this location and plan to add an additional 600,000 tons refined methanol or methanol equivalent products of the site. In addition to methanol, we will be taking a serious look at SNG and syngas based glycol production. We achieved another significant milestone with the execution of the projects key commercial agreements.

Last week, we executed the amended joint venture contracts with YIMA, replacing the joint venture contracts we had sign during the fourth quarter of calendar '08. The joint venture agreements are virtually identical except for the business scope of each JV company and the amount of required capital contributions. None of the materials terms from the 2008 joint venture agreements were changed, including the YIMA debt guarantee provision.

Last week, we also executed the U-GAS license agreement for the project, as well as the articles of associations for JV companies. The connection with entering into the updated joint venture contracts, we also agreed with YIMA that certain conditions precedent must be met before additional equity contributions required by us, and YIMA further clarified the timing of the required capital contributions and the amounts to be contributed to the project.

We also held our first JV board meeting, and both SES and YIMA nominated, and JVs board approved the projects senior management team. With the key document signed and senior management place at the JV, we are now in a process of formally establishing the JV companies in obtaining our business licenses.

A third major milestone last quarter was the approval of the projects environmental impact assessment or EIA. As we mentioned in our last quarter's call, we had already obtained the projects approval from the provincial government and the EIA approval from the local government. In March, we obtain the endorsement of the EIA from the prevention level environmental authority. EIA approval, along with the government approval for the projects FSR, and the key approvals we required to move ahead with the project.

As most of you know, YIMA has identified in operating coal mine that will supply coal to the project. We and YIMA are in discussions to acquire the coal mine and total cost of about $70 million to $90 million. Coal from this mine was successfully tested at our Zaozhuang U-GAS plan last November and the YIMA was very pleased with the results of that test. Our equity investment in the coal mine is expected to be proportional to our ownership interest in the joint ventures, and we expect that the acquisition of the coal mine will be financed with 50 to 70% debt.

The coal mine acquisition will require government approval, which would normally be expected to take 12 months after the establishment of the joint venture companies. We are also working on a long-term coal purchase contract to ensure that that for some reason the mine acquisition has not approved by the government. The project will have a low cost coal supply for the life of the deal.

So far SES and YIMA have each contributed $200,000 of equity to the projects preparation office. Our last week's contract closing, both companies authorized an additional equity contribution of $1.5 million from each party. The $3 million of the funds will be used for additional engineering work to cover the JVs G&A cost, site preparation work and other expenditures to move the project forward. Construction activities for site preparation are underway. Remaining construction work and the commissioning in the phase-I plant are expected to take about 3 years.

Based on the projects Otter Creek just ago, we estimate that the Phase-I total cost, which includes the downstream facilities and infrastructure investment, and support Phase-II will be about $250 million. We expect a much lower investment cost for phase-II because of the common facilities that we build now for both Phase-I and for Phase-II. We currently estimate the SESs equity investment from Phase-I to be approximately $60 million, excluding the coal mine, but we are actively pursuing alternative sources of equity which would reduce our equity obligation.

Half of the project will be funded from SES and YIMA equity contributions and the other half will come from commercial bank debt. Under the JV contracts, YIMA has agreed to provide a financing guarantee in order to ensure the project with secured debt on a timely basis. It might be helpful now to just take one minute to explain, how a typical project financing transaction works in China, because it differs from Western practices.

In china, non-recourse project financings are not common. It is much more common for banks to require a guarantee of repayment from one of the project sponsors, ideally a strong financial participant in the project, such as YIMA The lenders number one criteria for lending in China is the strength of the party guaranteeing the debt. Together this, we have a lot of confidence in our ability to close the financing further project as YIMA has recognized by the banks as a very credible financial partner.

Also a major part of China's recent stimulus package involves increase bank lending. There has been a significant increase in lending from State banks this year and we expect this trend to continue through the end of the year. The combination of the YIMA's financial strength and the excellent lending environment in China today give us confidence that we will close the financing on this project in the timely manner.

As we noted on previous calls, ICBC one of the big four state owned banks has already provided a letter certifying its intentions to loan to the project. ICBC has already reviewed the key project agreements, the feasibility study, BIA and the government approvals.

In addition to ICBC, the Bank of China and the China Construction Bank are also competing for the loan. Once the JV companies obtained our business licenses and it should take about two weeks, we will hand over the formal loan application documents to all three banks.

We expect the process to take three to seven months as the loans will have to be approved at different levels of the bank. It's possible that during this period, we and YIMA may make another equity injection for long leave procurement items.

Overall, I'm very pleased with the progress we have made on the YIMA projects since the last call and I want to thank my team for all of our hard work and dedication. Lastly, I would like to mention that we are developing alternative equity and debt options for our Golden Concord project.

Thank you all for your attention, and now I'm now going to turn the call back over to Robert.

Robert Rigdon

Okay. Thanks Don and also my thanks to Kevin and Ann, as that completes our third quarter update. So operator, I would like now to open the line for questions.

Question-and-Answer Session

Operator

Thank you very much. (Operator Instruction). And our first question today comes from the line of David Begleiter with Deutsche Bank. Please go ahead.

David Begleiter - Deutsche Bank

Good morning. Rob and Don, at the last call back in February, you said that you expected low approval in Q2, and YIMA still up in 2010. It's now been pushed for the back obviously, can you just give little more color as to why the delay in both the loan approval, as well as startup. Thank you.

Donald Bunnell

David, good morning and thanks for calling in. We obtain the preliminary commitment letter from ICBC last November. And, as I said, ICBC has already reviewed the key project documents and the approvals. But we can't submit a loan application until the JV companies are actually established. You needed to setup a legal entity in China to formally submit a bank loan application to the banks. So that's what's been holding us up. We needed to form the joint ventures. We had to get these other project documents executed, and really make sure that we had all the key documents nailed down before we move forward with the project.

I just want to emphasize that the key to the financing is the YIMA debt guarantee. That is the number one criteria for bank lending in China, YIMA is very strong and they have got great relationships with all this data on banks, so we are confident that we're going to move forward very quickly on the financing now.

Robert Rigdon

And I just like to add a follow-up to that to the second part of your question, David, regarding the time to build the project. These 300,000 ton methanol units are being built many times in China, and so there is kind of a well established track record of the construction schedule, and so now that's with the work has been done here in the last month, we now have a pretty good solid line aside to the schedule here and the three year time period to get the project up into full commercial operation.

David Begleiter - Deutsche Bank

Robert, right now what's your best guess startup for YIMA?

Robert Rigdon

Well, the startup will end-up probably being in the commissioning piece will start in probably late 11, but the startup would get into 2012 and it will go commercial sometime in 2012.

David Begleiter - Deutsche Bank

And last thing just on this coal mine acquisition, I was under the impression that YIMA is going to be supplying coal for the JV. At what point did it switch to SES making equity investment in a coal mine?

Donald Bunnell

The deal that we have with YIMA was, they are going to provide the financing guarantee and we were providing technology into the project. The deal on the coal has been that we would own the coal as part of the project, YIMA earns that coal mine today, and we have had discussions with them about valuation, and the valuation looks to be quite reasonable. But the idea as that the joint venture itself owns the coal mining assets and that the coal will be delivered into the project at coal mining cost.

David Begleiter - Deutsche Bank

Thank you.

Donald Bunnell

Sure.

Operator

Great, thanks a lot. And our next question comes from the line of Pearce Hammond with Simmons & Company. Please go ahead.

Pearce Hammond - Simmons & Company

Yes. Good evening there. My first question is what should we think about cash burn for the company at the operating level, as we move forward given the significant reductions to G&A that you have made?

Robert Rigdon

Okay. Thanks for the question Pearce. We've made some big steps in terms of cash burn certainly on the G&A side, as I mentioned. We have got a good line of sigh to achieving the 30% over where we were first half of the fiscal year.

In addition to that, Don just mentioned here, we are looking very aggressively looking at alternative ways that we can reduce the equity contribution to the YIMA project, and that's a critical piece on the overall cash picture.

Our goal here getting through this, and we feel that we've got a good plan in place is to preserve cash and get through all OEM to the COD of YIMA until we start getting project returns from the YIMA project.

Pearce Hammond - Simmons & Company

Well I guess what I'm trying to ask is, if we have got essentially $98 million in cash right now, and I was trying to put it absent of the $60 million likely contribution for Phase I, as well as whatever the contribution is on the coal mine. But, I was just trying to see what sort of SES is just cash burn that I could expect to kind of dial in for the next few years, because I'm trying to get to the point at which you're going to need to raise some capital.

Kevin Kelly

Pearce this is Kevin. Based to our forecast, we think we are going to, particularly since we are pursuing other equity investment in YIMA to minimize our contribution. We think that we have got sufficient cash at expected levels to be able to make that investment and get through to YIMA startup.

Pearce Hammond - Simmons & Company

Okay.

Robert Rigdon

I was just going to add to that that I went through kind of to explain what's been happening at the Hai Hua joint venture, and our goal for at least to make sometime during this year, certainly by the end of the year, is to get that that joint venture project where it is at least had a cash neutral position, so that we will not continue to see the large cash burn drain from that project.

Pearce Hammond - Simmons & Company

And I guess the one that are following up on the prior question, but from the other analyst. I don't understand that the coal mine acquisition, it seems like that's an easy place to save capital, and if you could just buy the coal from some other producer there in China, rather than have to outlay the capital now, because, if you take $98 million or $99 billion of cash and again you've got a three year period here through what's left the 2009, '10 and then late '11 before you get the commissioning on the facility and then the 60 million plus the coal mine, it seems like cash is going to get very tight?

Robert Rigdon

That's a good comment. But the idea is that we buy the coal from the mine at cost. If you don't contribute equity, if we don't own the mine, YIMA is not going to just give the coal away to us without any profit. They are state owned company, and I would essentially be giving state owned assets away to foreign company. So, the strategy is to buy into the coal mine. We don't expect it to be a large amount of equity, but one of the things that we may look at the end of the day is deferring that investment in the coal mine for a little while.

Pearce Hammond - Simmons & Company

Okay.

Robert Rigdon

All around, we're getting cheap coal into the project.

Pearce Hammond - Simmons & Company

And then Don, can you provide an update on the methanol market in China right now, both pricing and supply demand?

Robert Rigdon

I think, about three months ago in last quarters call, the pricing in China was about 1600 or 1800 renminbi a ton, I apologies, I think in terms of renminbi ton, not in US dollars. Today it's selling at 2000 to 2200. So, looks like we sell the bottom two or three months ago and prices have been trending up since then.

Pearce Hammond - Simmons & Company

Great, and..

Robert Rigdon

The demand obviously isn't as strong as it was a few months ago, but we see demand coming back a bit as well.

Pearce Hammond - Simmons & Company

Do you see other projects similar to SESs as that maybe on the drawing boards here in China?

Robert Rigdon

There are some large projects that will be commissioned and go into operation this year, next year.

Pearce Hammond - Simmons & Company

Okay. well, thank you very much.

Robert Rigdon

Sure.

Operator

Great, thanks. (Operator Instructions). And at this time and I'm showing no further questions in queue. And would you like me then to conclude the call?

Robert Rigdon

Yes, if there is no further questions operator, we can go ahead and conclude the call.

Operator

Great. Sure, well. Thank you, and ladies and gentlemen this conference will be available for replay and that starting today May 8, Friday at 8:45 AM central US time and it will be available through Friday, May 15 at midnight central time. And you may access the AT&T Executive Playback Service by dialing 320-365-3844, and then enter the access code of 998-340. That number once again, is 320-365-3844, and again enter the access code of 998-340.

And that does conclude our conference for today. Thank you for your participation and for using AT&Ts executive teleconference. You may now disconnect.

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