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Synthesis Energy Systems Inc. (NASDAQ:SYMX)

F1Q10 Earnings Call

October 29, 2009; 8:00 am ET

Executives

Robert Rigdon - President & Chief Executive Officer

Kevin Kelly - Chief Accounting Officer

Donald Bunnell - President of Asia Pacific

Ann Tanabe - Vice President of Investor Relations

Analysts

Pearce Hammond - Simmons & company

Bill Burns - Johnson Rice

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Synthesis Energy Systems first quarter results conference call. (Operator Instructions)

At this time and I would now like to turn the conference over to our host today, Vice President of Investor Relations, Ms. Ann Tanabe. Please go a head.

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 September 30, 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 today is Mr. Robert Rigdon, our President and CEO; Mr. Kevin Kelly, our Chief Accounting Officer, Controller and Secretary; and Mr. Don Bunnell, 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 27-A of the Securities Act and Section 21-E 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 be materially different 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 10-K for the year ended June 30, 2009, for further discussion on risk factors. A copy of our filings can be found on the Securities and Exchange Commission’s website at www.sec.gov, or on our website at www.SynthesisEnergy.com.

I would now like to turn the call over to Mr. Robert Rigdon, our President and CEO. Robert?

Robert Rigdon - President and CEO

Thank you Ann. Welcome everybody to our conference call for the quarter ended September 30, 2009. It is only been about six weeks since our last update. We continue to make good progress and I’m looking forward to sharing our most recent accomplishments with you, but first what I would like to do is begin with Kevin, who will provide you an overview of our first quarter financial results. Kevin.

Kevin Kelly

Thank you, Robert. We are reporting continued improvement in our first quarter of fiscal 2010 financial results, with total revenue of $2.3 million, which is nearly double the revenue of $1.2 million for our fourth quarter of fiscal 2009. Our first quarter’s revenue was comprised of $1.6 million from product sales at the Hai Hua and joint venture plant, and $0.7 million of other revenue.

The Hai Hua joint venture plant was available for full capacity syngas production or 97% of the quarter. However, syngas was not required by our customer Hai Hua reporting to four days during the quarter due to maintenance on their methanol units. The plant’s byproduct revenues increased significantly due to the sale of oxygen that began in September under our ASU cost sharing arrangement with Hai Hua.

The combination of the plant’s availability for production and the additional oxygen sales grow a 40% increase in the plant’s revenue compared to the previous quarter. Our $0.7 million of other revenue during the quarter was primarily for engineering services related to the Yima project.

Cost of sales and plant operating expenses were $1.7 million for the quarter, a decrease of $0.5 million from the fourth fiscal quarter of 2009. As expected, the plant’s operating costs including coal, power and other materials improved on our per unit of syngas production basis. Due to increasing operating efficiencies and cost control.

Over the last two quarters, we have reported a reduction in our G&A expenses of about 30% compared to prior periods. Our G&A expenses were $3.1 million for the first quarter which is a reduction of $0.2 million compared to the fourth quarter of fiscal 2009. Project in technical development expenses for $1 million for the quarter and included $0.9 million charge for consulting fee related to the financial closings of the Yima project.

Our operating loss for the quarter was $4.9 million, this included a non-cash expense of $1.3 million and the nonrecurring expense of $0.9 million for the consulting fee related to Yima’s closing. These results reflect significant improvement from prior periods due to the improved performance of the Hai Hua joint venture plant’s operations. The additional revenues provided during the first quarter of our engineering services and our G&A reductions.

At September 30, we had cash and cash equivalents of $55 million and working capital of $45 million. As you know, we invested $29.3 million into the Yima project in August 2009. Overall, we are very pleased with our substantial revenue growth and the improving trend in our bottom-line results. Robert.

Robert Rigdon

Okay. Thanks Kevin. Clearly, our most significant milestone for the quarter was achieved in August when SES and Yima executed the revised joint venture agreements, and subsequently funded in September with Yima and SES funding their entire equity for the project accounting for approximately 50% of the project’s total investment cost.

With these milestones behind us, we are now in the project implementation phase. I’d like to take just a moment here to remind you of the specifics of the Yima project. The project is strategically positioned as the first phase of a series of projects which will form the Mazhuang Coal Chemical Industrial Park, a plant $4.4 billion investment, which is located in the Hunan province area of China.

The Yima will supply coal to the project from a mine that is located in close proximity to this industrial park and based on the current estimates the total required capital for the project is approximately $250 million which includes all project facilities and some infrastructure facilities in support of a plant phase II expansion. When completed the project is expected to have an annual capacity of 300,000 tons of refined methanol.

There are also two future coal gasification projects planned for this location, the second project is expected to add another 300,000 tons of additional refined methanol or methanol equivalent capacity and then the third expansion is expected to add another 600,000 tons of methanol or equivalent capacity. And we have begun discussions with Yima now regarding the possible phase II products.

Moving on to Hai Hua, our Hai Hua joint venture project’s been operating very well for the past several months. We’ve experienced high owned string factors meeting Hai Hua syngas requirements over 98% of the time, and our overall plant availability has been approximately 95%, a little bit over that since May of this year.

We completed the installation of the ASU oxygen sharing hyping system during the last quarter and we had our first month of oxygen sales from this system in September. The combination of the high owned string factors combined with consistent syngas and oxygen sales is helping to show continuous improvement in these financial results from the Hai Hua joint venture.

Across the last quarter, the joint venture has produced a 40% increase in revenue compared to the prior quarter, while at the same time showing over 20% reduction in cost of sales and operating expenses, resulting in a nearly 1 million improvement in our Hai Hua operating results.

A lot of this has to do with the improvements we made in plant operations as well as technology refinements we’ve made. As I said, during our last call we are focusing heavily on becoming a more operationally capable company. We are now seeing the results of this with the improved operating results at the Hai Hua facility.

I would like to add also that over the past several month at Hai Hua at the joint venture there, we have demonstrated the U-GAS technology’s ability to operate on many different types of high ash bituminous coals, sub bituminous coals including, coal washing waste with 45% ash content and on Yima’s high ash sub bituminous coal, and now we recently completed a very successful demonstration of the plant operating on a typical lignite coal from the Inner Mongolia region of China.

Our value proposition has always been about using U-GAS as a platform to unlock the value of lowering feed stocks. Some of the lowest costs and most abundant energy resources available on the planet are these lignite and sub bituminous coals that are mined in open pit.

There are vast reserves of these coals in the U.S., China, Australia and other countries, but these coals have typically been of limited value and are often used in low value applications such as a boiler fuel. In China for example, the lignite coals can cost as much as 75% less on a thermal basis than more widely used bituminous coals, and this savings can be translated into compelling economics for coal based energy and chemical projects.

The result from our Hai Hua joint venture continues to be very encouraging. I’m very encouraged by our lignite pit, and I believed these demonstrate our growing operational capabilities as well as the reliability of the U-GAS technology.

Now I would like to turn the call over to Donald Bunnell who will provide a little more in detail update on our China operations. Don?

Donald Bunnell

Thanks Robert. Let me begin by updating you all on the progress we are making with the execution of the SES Yima project, then I will provide an update on our expansion plans for the Hai Hua JV and then such on our recent success and the strategic importance of our recent lignite demonstration. As Robert said before, the SES Yima JV is now focused on project execution.

So let’s take a couple of minutes to talk about the progress there. JV’s management organization has been established and is in the process of moving the project forward. The JV Company has contracted the East China Engineering Corporation or ECEC to carry out the basic and detailed engineering work for the project, and ECEC has already kicked of the projects engineering work.

ECEC is a subsidiary of the China National Chemical Engineering Company or CNCEC which is one of our strategic partners and China’s largest as well as one of its most respected chemical engineering companies. The JV team has also recently begun the process of soliciting bids for the projects, long need equipment and we expect long need equipment orders to be made during the current quarter.

In addition, the site work has commenced and is moving forward. Today, the project site has been cleared and other site preparation works such as earth cutting and back drilling and site work construction have all started. The JV is currently in the process of evaluating construction contractors and we anticipate that piling and foundation work will begin late this year.

This month the SES Engineering team completed the final review of the U-GAS process design package or PDP with the projects engineering contractor and the JV team. Overall, the work is going ahead as planned and as we said on the past two quarterly calls, we expect to reach mechanical completion in the first half of 2012 with commercial operations estimated to begin about 6 months later.

Moving on to Hua Hai; as we discussed during the last call, in order to strengthen the financial performance of the Hai Hua plant, we are actively exploring the possibility of expanding the plant. An expansion of the plant was always part of the project’s initial concept, and we are currently narrowing down the alternative products and partnership structures.

We did not believe that any additional equity will be required from us for an expansion, and as we expect to contribute on 95% equities taken phase I towards the phase II expansion with third parties contributing all of the required equity to expand the project. The scale for the expansion is still under evaluation and we hope to make a decision on moving forward with phase II in the end of the first quarter of calendar 2010.

The government has expressed strong support for the expansion project and sees this as a strategically important to the area. As evidence of the government support this July we executed a letter of intent with the local government allowing a local coal mine to be used as collateral to raise debt financing for the expansion project. The letter of intent also contemplates providing discounted coal to the project.

As Robert said, we’ve been very pleased with the performance of the plant over the past several months, during the current quarter of our planning continued operation of the Hai Hua JV on local high ash coals, and we are planning systems maintenance outage of about three weeks during this period.

I would like to take a minute now to expand on the lignite coal demonstration at the Hai Hua JV which Robert has already talked about. Because lignite is such an abundant and easy to mine fuel and in response to the significant interest that we’ve received from various parties in China, Australia and India, we are looking to build coal energy project utilizing lower cost, low rank and high ash coals for their projects, we decided to conduct this two week demonstration using lignite coal from inner Mongolia.

We’ve always had confidence in the U-GAS technology’s ability to process lignite, because U-GAS is an inherently flexible gasification technology, but also because there has been significant pilot unit experience operating lignite at TTI Chicago facilities.

With that said, the successful demonstration of lignite on the commercial scale gasfier really is the major milestone for the technology, and has real strategic implications for us. This is because fuel cost is typically the largest cost over the life of the coal to energy or coal to chemical project and open cast lignite mining is generally the lowest cost coal to recover. So, lignite based coals energy projects have a lower cost of production for products ranging from substitute natural gas, methanol to gasoline, power, hydrogen generation and steam for industrial applications.

We hosted multiple companies for the plant during the demonstration run. These companies are all keenly interested in the gasification system that can process lignite and high ash coals for the reasons I just unmentioned. One half of the operating demonstration was Francis Lau, our Chief Technology Officer and Foon Lee Leow, our Managing Director for China.

They received positive feedback from all the visitors and what to seem to impress the visitors the most, was a very stable operations and the high conversion efficiency about 96% achieved on the lignite fuel.

I think it’s important to note that these high efficiencies and reliable operations were achieved on the U-GAS plant that was not even specifically designed to gasified lignite. Also significant and encouraging is how well the plat transitions seamlessly from the local high ash bituminous coal to the lignite fuel. During the entire demonstration our plant continues to supply quality syngas to our customer Hai Hua without any interruptions.

Multiple Chinese companies, two Australian companies and one Indian company sent technical experts and senior executives to observe the lignite demonstration. As a result, one of the Australian companies entered into a coal testing arrangement with SES last week to test low rank Australian coal and determine its suitability for application in U-GAS for a coal to liquids project.

Also one of China’s largest gas distribution companies observed the test and as a result of the test, we have been able to advance our ongoing discussions with them regarding a lignite SNG project in Inner Mongolia. Overall, I think this test really demonstrates that U-GAS as a uniquely flexible and robust coal gasification system which gives project owners confidence and good economics and reliable U-GAS operations over the life of their projects.

I’ll now turn the call back over to Robert

Robert Rigdon

Thanks Don. So with a brilliant track record of stable and efficient operations at the Hai Hua joint venture, along with confidence that Yima has demonstrated by investing with us in a U-GAS base project, and now our very successful lignite demonstration, we are seeing growing interest in the technology, not only in China but other markets, such as India, Australia, Vietnam and the U.S.

Our plan is to capitalize from this momentum, further develop third party licensing opportunities with the potential U-GAS customers who observed the lignite test as well of course as other potential customers we are cultivating.

In addition to our China and Asian opportunities, we are seeing a growing interest in the US regarding the U-GAS technology’s capability of processing biomass feed stocks. Biomass feed stocks processed by our U-GAS system result in a carbon neural syngas which can be further processed in the fuels, power or even chemicals. This results in a renewable energy and chemical products.

Driven by the renewable fuel standards of the Energy Policy Act of 2005 and the Energy Independence and Security Act of 2007, we believe that the stage is set for advanced biofuels and cellulostic biofuels to grow. We also believe that our U-GAS system can play an important role in this growth due to the significant past experience with the technology processing biomass fuels and the syngas.

In fact, our Hai Hua joint venture plant utilizes essentially the same gas biotechnology as would be required to process biomass feed stocks. And our experience at Hai Hua is transferable to the renewable fuel space. In addition, over the years, TTI has piloted as well as operated U-GAS based biomass demonstration facilities in the U.S. as well as Europe.

Today, we’re engaged in discussions with prospective customers in the US regarding licensing our technology for this purpose. And as you can see, we’ve had a busy quarter, we’re making progress on our key initiatives. In our third quarter 2009 call, we stated that we would be reducing G&A cost, targeting at 30% reduction. And there we would be focusing on the development of the Yima project. And that we would be improving the operations at our Hai Hua joint venture.

Today, we have achieved the targeted 30% reduction in our G&A cost. We successfully completed the financial close of the Yima, SES joint venture project during this past quarter and have now moved that project into the implementation phase.

At Hai Hua, we’ve demonstrated over 95% plant availabilities since May of this year, and we implemented our ASU sharing project which combined have produced approximately $1 million improvement in our Hai Hua joint venture operating results. Our team is consistently meeting the goals that we set up for the business earlier this year and overall, I’m pleased and encouraged by our results.

And this concludes the management update and now I’d like to give the callers a chance to ask questions. Tom, could you please open the line?

Question-And-Answer Session

Operator

(Operator Instructions) Your first question comes from Pearce Hammond - Simmons & Co.

Pearce Hammond - Simmons & Co

The first question I had was, if you look at the Chinese government in the past quarter had made an announcement that they were concerned about over capacity in some basic industries, and I was curious if that particular announcement impacted SES in any way?

Robert Rigdon

Okay, thanks for the question. I think I will let Don handle that question since he is there on the ground in China.

Donald Bunnell

Let me just start out specifically, we don’t believe it’s going to impact the Yima project, you have to remember that the Yima project was approved last February before these regulations came out. Typically, the way these regulations work as they are not retrospective, they are forward-looking.

We’ve thought about it, we’ve looked at these and our conclusion is this is not going to impact the Yima project. I talked about the Phase II expansion of Dudlong, those approvals are not in place yet, but we don’t believe it’s going to impact the approval of that expansion. The product that we are looking at there is not methanol, it’s not one of the products that’s been outlined by the Chinese government for possible over capacity.

So we’re not too concerned that it’s going to impact that approval either. I can’t say that one of the nice things about gasification are there - there is lots of downstream applications that are not covered by government’s current focus on some of these commodities. So I think there are still lot of opportunity in China and other areas.

Pearce Hammond - Simmons & Co

Then as a follow up, can you provide an update on the bank financing status there at Yima?

Donald Bunnell

Yes, from our perspective we have a binding commitment from Yima to provide the debt. The baseline is still Chinese commercial lending to the project and we’re moving forward with that. But from our perspective we have a binding long commitment from a very credible partner.

So if the banks don’t come through, Yima will enter the project and we’re very, very comfortable with that, is that enough cash in the joint venture, remember that we put in all our equity, Yima’s put in all their equity which equals 50% of the project cost. So we have plenty of cash to move the project forward and we’re really focused on execution right now.

Yima having 75% of the joint venture, they have to see the CFO and the joint venture so they are moving the financing forward, I think with the debt guarantee it’s very doable with the Chinese banks, but again if for some reason that doesn’t happen, Yima has got a binding commitment and we’re comfortable with that.

Pearce Hammond - Simmons & Co

Sure and then one final question I’ll jump back in queue. We have talked in the past or you have talked in the past about making a coal mine acquisition there around Yima is that still the case?

Donald Bunnell

As part of the closing we signed an MOU and we are kicking off the due diligence to look at the mine, at the end of the day it’s going to be a function how that due diligence looks, and whether or not we think an acquisition like that would be accretive to SES.

Operator

Your next question comes from Bill Burns - Johnson Rice.

Bill Burns - Johnson Rice

Have you all stated what kind of CapEx you would be looking at for the Hai Hua expansion and if you have remind me?

Robert Rigdon

Sure Bill. With the Hai Hua expansion, we are 95% owner of the current Hai Hua facility, and our plan is to contribute that asset into the restructured expansion project. So with that contribution, we do not anticipate any additional capital being required from SES for the expansion into alternative products there.

Bill Burns - Johnson Rice

Then you have to look for debt of third party equity and what kind of size would you be looking at?

Robert Rigdon

Well, the size of the project is still under evaluation. I will let Don give you some more color on in details here around this, but essentially we would be taking our position down, we would have a smaller position in the overall expanded project. And Don maybe you would want to add something to this?

Donald Bunnell

Yes, I think the idea is that a third party would come in and we are in discussions with a few parties who are interested in the expansion. They would supply 100% of the capital required for the expansion and remember that we also have this coal mine that the government will let us pledge its collateral for debt financing.

So we’ve got a plan on debt financing and any third party would require would bring in all the capitals. So we don’t plan to put any more dollars into that project for an expansion. At the end of the day, we will just end up being diluted depending on what the debt equity ratio for the project is and what the final capital cost is.

Bill Burns - Johnson Rice

Then Don, I apologize, I missed that you said you said timing 2010?

Donald Bunnell

We love to make a final decision on the Mazhuang Phase II expansion by the end of the next quarter if not sooner.

Operator

(Operator Instruction) Your next question comes from Pearce Hammond - Simmons & Co.

Pearce Hammond - Simmons & Co

Yes Robert, as we think about the current quarter that we’re in. Is there anything we need to be aware of this as far as Hai Hua availability operations or should we see a very similar performance to last quarter.

Robert Rigdon

Pearce what we are expecting is to see similar performance to the last quarter now, Don did mention that we are going to take about a, probably about a three week maintenance outage at some point here, during the current quarter to do some maintenance on some downstream units that are downstream of our gasifiers, but that’s being planned. So I do anticipate that, but other than that, I think we should anticipate pretty much continued performance the way we’ve seen over the last two quarters.

Pearce Hammond - Simmons & Co

Then one final question; abstinent capital investment obviously in projects, if we look at the companies burn rate at the corporate level, you’ve done a great job to reducing the G&. How should we think about burn rate on a per annum basis again abstinent capital investments of projects?

Donald Bunnell

Pearce, we’ve got about $3 million a year for debt service at the Hai Hua plant and beyond that it’s really our G&A, and then results of the Hai Hua joint venture which we expect that to move closer to EBITDA break even levels has been doing. So, you can sort of figure that number out.

Operator

There are no other questions queuing up at this time.

Robert Rigdon

Okay, well thanks everybody for tying into our earnings call update here, and at this time we will go ahead and conclude the call. Thank you.

Operator

Ladies and gentlemen, that concludes our conference for today. Thank you for your participation and for using the AT&T executive teleconference. You may now disconnect.

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