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Synthesis Energy Systems, Inc. (NASDAQ:SYMX)

Q1 2012 Earnings Call

November 9, 2011 8:30 AM ET

Executives

Matt Haines – Managing Director

Robert Rigdon – President and CEO

Kevin Kelly – Chief Accounting Officer

Analysts

Robert Smith – Center for Performance Investing

Operator

Good morning. And welcome to the Synthesis Energy Systems Inc. First Quarter 2012 Financial Results Conference Call. All participants will be in listen-only mode. (Operator Instructions)

Please also note this event is being recorded. I would now like to turn the conference over to Matt Haines. Please go ahead.

Matt Haines

Thank you. Good morning. And thank you for joining Synthesis Energy Systems’ earnings conference call. Today management will discuss financial results for the fiscal 2012 first quarter ended September 30, 2011, and will provide an update on corporate developments. Following management’s prepared remarks, we will open the line for questions.

Before we begin, I would like to remind you that during this call, management will be making forward-looking statements within the meaning of Section 27(a) of the Securities Act of 1933, as amended, and Section 21(e) of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical fact 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 the company believes that in making such forward-looking statements its 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. There can be no assurances that the assumptions upon which these statements are based will prove to have been correct.

Please refer to the company’s annual report on Form 10-K for the year ended June 30, 2011 for a further discussion on risk factors. SES’ 10-K and other SEC filings are available on the Securities and Exchange Commission’s website at www.sec.gov or on the company’s website at www.synthesisenergy.com.

And now, I’ll turn the call over to Robert Rigdon, President and CEO. Robert?

Robert Rigdon

Good morning. And welcome to our first quarter fiscal year 2012 earnings call. I’m speaking to you from our offices in Shanghai and with me on the call today from our Houston office is Kevin Kelly, our Chief Accounting Officer.

It’s been seven weeks since our fiscal 2011 year end earnings call and in this short time we have continued to make good progress. After Kevin reviews our financial results for the first quarter, I will provide an update on our progress, regarding our three prong strategy, comprising technology licensing, equity partnerships and participation in low-cost coal resources. I will also provide an update on the strategic collaboration with ZJX and Yima, our progress resolving the capacity fee payment at the Zaozhuang joint venture.

However, before I turn the call over to Kevin, I’d like to take a moment to remember Michael Storey, Director of SES for the past six years, as well as a friend and colleague who recently past away.

Michael enjoyed a long and successful career, and his many contributions to the growth and success of SES during his tenure on the Board and as Chairman of the Compensation Committee and Member of both the Audit Committee and the Nominating in Corporate Governance Committee will be missed. We offer our sincere condolences to his family.

And in order to fill the roles left behind by Michael’s passing, our Board of Directors has named Harry Rubin, as Chairman of the Compensation Committee; Ziwang Xu, as a Member of the Audit Committee; and Lorenzo Lamadrid as Chairman of the Nominating and Corporate Governance Committee.

And now, I’ll turn the call over to Kevin to provide the quarterly financial update. Kevin?

Kevin Kelly

Thank you, Robert. For the first quarter of fiscal 2012 ended September 30, 2011, total revenues were $2.5 million, a 54% increase compared to the first fiscal quarter of 2011. Product sales from the ZZ joint venture plant increased 57% to $2.1 million, compared to $1.4 million for the prior year first quarter. The increase in revenue was primarily due to higher syngas production as a plant operated for 91% of the period, compared to 31% for the prior year first quarter.

During the quarter ended September 30, 2011, Hai Hua did not pay any of the capacity fees and SES did not recognize any capacity fee revenue for the period. As of September 30, the unpaid amount of capacity fees since April totaled approximately $1.5 million of which $0.9 million related to the quarter ended September 30, 2011. We will recognize these revenues in the period when collection of the capacity fees is assured. Robert will be providing more information about this in his update.

Technology licensing and related services revenue for the first fiscal quarter of 2012 increased 50% to $307,000 compared to $205,000 for the first quarter of fiscal 2011, and was generated primarily from coat testing services at the ZZ joint venture plant and from engineering studies for perspective technology licensed customers.

Cost of sales and plant operating expenses were $3.2 million for the fourth quarter versus $1.3 million in the first quarter of fiscal 2011, increase in the cost of sales and plant operating expenses was due to the ZZ plant increase syngas production level.

G&A expenses were down 7% to $3 million for the first quarter of fiscal 2012 from $3.2 million for the first quarter of 2011, due to our ongoing focus on controlling these costs.

The operating loss for the first quarter was $4.4 million, compared to an operating loss of $3.9 million for the first quarter of fiscal 2011. Increase in operating loss was primarily attributable due to reduction in ZZ plant capacity fee revenues. At $0.9 million in capacity fee has been recognized during the quarter ended September 30, 2011, the operating loss would have been approximately $3.5 million or about 10% less in the first quarter of fiscal 2011.

The net loss attributable to stockholders for the first quarter of fiscal ‘12 was $4.5 million or $0.09 per share versus $3.7 million or $0.08 per share from the prior years first quarter. As of September 30, 2011, we had cash and cash equivalents of $27.7 million and working capital of $23.1 million.

And now, I’ll turn the call back over to Robert.

Robert Rigdon

Okay. Thanks Kevin. I would like to start by covering progress over the past few weeks on our China initiatives and focus items. The strategic collaboration was ZJX and Yima continues to progress. I want to give some insight into what has been completed and what steps remain to reach the financial closing of the share purchase agreement.

As a Chinese state-owned enterprise Yima has a series of steps to complete in order to satisfy their internal processes and government approvals required for them to complete the investment into China Energy and SES.

Shortly after the Yima committed to the investment in China Energy, they performed due diligence on SES and in late October this was completed. Yima is now reviewing the results of the due diligence with the leading body of the company.

Our team has been very closely involved in supporting the due diligence and although, Yima has not completed its internal review with their leading body, we have received encouraging preliminary feedback regarding the due diligence.

Once the due diligence review process is completed, documentation will finalized and submitted to the Henan State Asset Bureau and then to the Henan National Development and Reform Committee for key approvals.

There are also two other steps which we expect to be conducted in parallel after this first two key approvals are completed. This involved a Henan Ministry of Commerce and the Henan State Administration of Foreign Exchange. Together with ZJX, we’ve been highly engaged with this process and all parties are working diligently to close.

This week you may have also seen in the news that there was a coal mine accident in Henan Province, China, which involves one of the many mines owned and operated by Yima. As reported by China Daily News the accident was triggered by a small earthquake in the region and did involve some worker injuries and fatalities.

We’ve expressed our deepest sympathy to the Chairman of Yima and now we expect that this incident may consume some of the attention of Yima leadership for the period of time, and the impact of any on our timing to close the ZJX Yima financing remains to be determined.

Moving on to Zaozhuang, our joint venture project and progress related to recovering the unpaid capacity fees from Hai Hua reported on the last call. Our China team has put an enormous effort into developing a solution for the joint venture that could create an improved operation for both ZZ and the Hai Hua methanol production unit which buys our syngas.

There were series of technical workouts and joint financial analysis with Hai Hua. We believe we now have a viable to solution that does more than address the unpaid capacity fees. We already has potential to be a positive arrangement for both parties which could result in the ZZ joint venture achieving significantly improved profitability.

The arrangement involves a combination of technical improvements to the Hai Hua methanol unit operation that has been identified by the SES engineering team, combined with the restructuring the business agreements to create a technically and commercially integrated syngas to methanol operation for both Hai Hua and the ZZ joint venture, which share in the margins on methanol sales, which by the way have been increasing a price over the past year and have been currently selling between RMB2,900 and RMB3,100 per ton.

I want to be clear that we still have more negotiations remaining with Hai Hua to successfully complete the restructured deal agreements. However, we’ve been exchanging terms and both sides are actively pursuing this solution.

I’m encouraged that the prospect of this arrangement as it has a potential to transform the ZZ joint ventures financial such as ZZ to contribute meaningful earnings to our China business.

And in addition to this development, we are nearing completion on a syngas sales agreement between the ZZ joint venture and Zaozhuang mining group for the sale of syngas to an ethylene glycol pilot unit, which Zaozhuang mining group intense to build next year adjacent to our ZZ facility.

The amount of syngas contemplated in the agreement, ranges from about 15% to 30% of the full load capacity of the ZZ joint venture. We are nationally encouraged by this opportunity, not only because of the additional gas sales from ZZ, but the potential for expanding this first step into a larger opportunity with Zaozhuang mining group for a full scale glycol production facility in the future.

Some of the pricing terms for syngas sales in this agreement are interrelated with the final outcome of restructuring the business agreements between Zaozhuang joint venture and Hai Hau.

And therefore, our expectation is that this agreement could be completed at roughly the same time we complete the restructuring of the Zaozhuang joint venture business with Hai Hua. So I’m encouraged with progress we have made by our China team over the past few weeks to improve our Zaozhuang joint venture business.

Now, let me briefly cover our Yima joint venture project. The construction of the plant is on track for a mid-2012 completion of syngas generation and activity is ramping up on installing equipment as many of the equipment components are starting to arrive on site.

The civil work is now over 90% complete and we will soon be moving into the phase where major piping systems will be install. I visited the gasifier manufacturing facility earlier this week and was able to inspect the gasifier manufacturing process first hand.

All three gasifier are nearing completion now and will be shipped to the site for the final assembly and installation. I’m also planning to make a site visit while I’m in China over the next couple of weeks and take a look at the progress first hand at the project. We are hoping for a cooperative winter season this year, so we continue our progress uninterrupted.

Also for your reference we have posted some new photos on our website of the project construction status and the gasifier reactors in manufacturing.

Before, I move away from China, I would like to update everyone on other areas of progress we are making in the region. The ZJX has actually been engaged actively with our business team in China for the past several weeks beyond just the work required to complete the financial closing of the share purchase agreement.

Together we’ve been aggressively pursuing opportunities that are intended to define the launch of our strategic collaboration post closing. At this point, we are making progress particularly in the area of SNG producing projects.

We have recently signed a project investment and corporation agreement for a joint development of an SNG project in Inner Mongolia. This is an early stage project origination and development effort which includes the potential for SES to have a carried interest in the associated coal mine resource for that project. The project owners also have received the expression of intent from one of the major Chinese state-owned enterprises for SNG uptick.

We are also making good progress on completing a letter of intent for a second SNG project in China that would include an integrated coal resource as well and has a support by another one of the large Chinese state-owned enterprise for gas uptick.

Now, although, both of this projects are in the very early stages of project origination and commercial development, and significant amount of work remains for ZJX and SES to advance the projects to completion of definitive agreements we are encouraged with the potential of this opportunities.

Now, in addition to this, we continue to advance our technology position with the company called YYCC in China, who is a major ammonia producer for converting their old style fixed bed gasifier projects to advance U-GAS gasifier.

This opportunity has a potential to provide SES with licensing revenue equipment sales and participation in the improved cost position of that business. The economics on these gasifier convergent projects are driven very simply by coal price.

There are literally thousands of these fixed style bed gasifier operating across China making syngas for ammonia production and many of those projects must use very high grade, actually amphocyte coals priced today around $280 a ton.

With our U-GAS technology they would be able to access waste coals, high ash coals and coal discards in the $50 to $60 range, thereby making very meaningful improvements in the cost ammonia production.

In India, our work together with Zuari Industries continues to progress and we have identified opportunities where U-GAS technology can be integrated into industrial projects there.

We have also continued to work together incorporate the use of Zuari wholly-owned engineering company, Simon India for technical services related to the potential SES projects in India.

SES, Zuari and Simon have together developed an updated review of the potential for readily achievable projects based on our gasification technology there. The results of these review is being use as a basis for -- a value for establishing a business platform whereby we may realize the potential of our technology in that region.

As previously reported, we are engaged with Ambre Energy on a detail paid feasibility study for producing synthetic gasoline from low rank low cost Australian coal. Under the technical study agreement signed this past August, we’ve been developing a preliminary gasification design to support Ambre’s development on planned cold liquid project in Queensland, Australia, called Ambre CTL.

Ambre intends to integrate our technical study with its project development work on the overall Ambre CTL project. We’ve been working closely with Ambre and we believe they are progressing the development of their project quite well.

If Ambre continues on track with its current project development and funding efforts, then this project has a potential to generate near-term and meaningful licensing earnings for SES.

Lastly, I want to make a few comments about our joint venture SES Resource Solutions. The joint venture team has been very actively engaged in locating sources of low quality coals and originating the integrated project concepts that would utilize these coals.

A good deal of early stage business planning work has now been completing by the joint venture team and we expect the joint venture to move into aggressive business development of select integrated coal resource project opportunities. And to this point, the JV has identified SNG in Asian markets is one of the primary focus segments for the early projects.

Based on our business planning work we are expecting to see substantive progress in 2012 and I look forward to providing those updates as the business develops. Securing and integrating low quality coal resources through implementation of our technology is a key value driver for SES in this segment of coal gasification.

We believe this approach has the potential to generate shorter term license earnings while creating a long-term value through unlocking the potential and very low cost coal resources.

Overall, SES is becoming increasingly well-position to generate operational success from our projects, as well as creating much larger value through our partnerships.

Based on our accomplishments to date and the many positive customer and partner discussions we are having throughout the various parts of our business, our team believes that our technology is developing a strong and growing reputation as a technology of choice for the convergent of low rate low cost coals into high value products.

In closing, we continue to make good progress executing on our three prong strategy comprising licensing, equity partnerships and participation in low cost coal resources. We are also working smartly to build near-term revenue streams via the restructured Zaozhuang joint venture plant, the Yima plant syngas production coming online in mid 2012 and the licensing opportunities currently under development.

In addition to the near-term revenue and earnings focus, the big value creation opportunities are gaining momentum as well via our ZJX Yima collaboration, which helps accelerate our business in China and our India initiatives and the SES Resource Solutions activity. So we look forward to providing additional details of our accomplishments as we move through a fiscal 2012.

At this point, this concludes our management update for the first quarter 2012. Operator, you can open the call for questions now.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Robert Smith of Center for Performance Investing. Please go ahead.

Robert Smith – Center for Performance Investing

Hi. I don’t know what time it is showing here, but it’s about 8:30 here. Good morning.

Robert Rigdon

Good morning, Bob. Its late here, it’s almost 10 o’clock by the way.

Robert Smith – Center for Performance Investing

So my question is can you give us some order of possible closings, I mean when you expect to close first and some kind of a reasonable timeline, I mean, lets not get two exact thing, but just kind of a feel for that. And also, do you expect any change in the burn rate?

Robert Rigdon

Okay. Let me, just making some notes here. Look, yeah, on the timelines, on the closing we’ve not changed our target for what we have been doing on our big focus side in here for the ZJX Yima transaction and so we’re working very diligently to get that deal done.

The other activities that are underway here, that I mentioned, that I’m very encouraged about regarding Zaozhuang are also actively being discussed in pursed and we are expecting those to be done in a very timely manner Bob, probably in parallel with what’s going on here with the ZJX. So these are not long-term things, these are things that are right at hand for us.

Regarding the burn rate the, we are -- we’ve continue to manage our burn rate and as we progress here, I’m not anticipating a large change at all in our G&A rate. As we go through closing the deal with ZJX, we’ve got quite a bit of work to get underway here in China, but at this point, we’re going to keep things the way they are for the forceable future.

Robert Smith – Center for Performance Investing

Robert, if I’m correct that you are kind of targeting a closing around the end of the year is that, so when you say, you’re still on that kind of timeline is that…

Robert Rigdon

Right. We’ve not change that target Bob and that’s been our target, since we brought Yima into this activity, this past summer.

Robert Smith – Center for Performance Investing

Okay. Just from what you suggested earlier, I mean, the different things that still had to be tied up, it seems that, for me that might take somewhat longer, but I’m glad to hear what you say?

Robert Rigdon

Yeah. We’re monitoring very closely and this -- when this gets into the approval process, certainly, I’m sure, we’ll have little more information, but we have no reason to believe that the approvals process will not move forward in a timely way.

Robert Smith – Center for Performance Investing

How closely should I try and monitor the price movements in coal as an indicator of future projects?

Robert Rigdon

Well, that’s a very good question actually. I -- what we see here and this is the key differentiator for SES in the space is that coal prices, as they go up are driving interest into, certainly to go and find lower cost coals and the challenge with the lower cost coals is that they just not has -- has not been a sort of technologies available that can cleanly deal with these.

That’s where we come in. And China is sort of the ground zero for this whole coal price. We’re trying to catch so much coal activity. Coal has become very expensive here. And now with technologies like ourselves coming into China, we can open up coals that have not been mined or utilized in the past such as the lignite coal.

So, I think from our perspective the more that we see pressure on coal prices going up, this is -- this drives business toward SES and it drives business towards company who wanting to get into this low quality coal resources and it’s actually, one of the fundamental reasons why we decided to move forward with this SES resources joint venture is to be able to act on this opportunity.

Robert Smith – Center for Performance Investing

Yeah. I was more trying to reference the possibility of coal prices weakening?

Robert Rigdon

Frankly, I mean, I guess, you got always -- got at look at both size of the equation, but frankly, if you had study markets here in Asia and the growth in demand that’s continuing, coal is going to be a very, very big part of it for the long-term future.

Robert Smith – Center for Performance Investing

No. Yeah. I got it that, but I was just wondering about the sensitivity of possible weakening coal prices having an effect on the projects going forward or the negotiations?

Robert Rigdon

What’s happening and they can move on from a sort of spot prices or short-term, I would say, perspective would really have any impact. I think the companies that we do business with have a long-term view of where things are going with coal. And that’s what drives the value creation here in the projects for us.

Robert Smith – Center for Performance Investing

And could you contrast a little -- doing business in China and India, one versus the other?

Robert Rigdon

Well, there are certain, there are some similarities and some differences, I think the similarities that we see is that, there is just a huge opportunity really in both areas for growth.

India like China, I like it’s probably not exactly active, but I like to sort of characterized India is in the position that China was in may be 15 years ago in terms of building out energy, infrastructure and so coal gasification space. And because of that there’s a tremendous amount of opportunity in India.

I do think that, so the opportunity is large and similar. I think the way the Indians and Chinese approach the project decision are little different with the central government approach there in China versus the Indian companies are sort of more autonomous to be able to move forward with their on decisions that way.

So, but in China things tends to move very fast Bob, with it’s decision and when it decides to build projects and move forward like the project that I was just mentioning here on the call, such as SNG projects. China has a track record of undertaking these developments and completing them and getting them build pretty quickly.

India is a little bit a emerging into this space, so we’ll see how fast India will move. But we do absolutely see India come into coal gasification now and it’s something that in the time I have been involve with gasification, India had not been that aggressive in this space but that has changed in the last couple of years.

Robert Smith – Center for Performance Investing

Robert, I think you mentioned an upstream modification move of the technology, I mean how much does that change the economic model as far as making it more profitable.

Robert Rigdon

Could you repeat an upstream modification, I didn’t quite catch?

Robert Smith – Center for Performance Investing

Well, I though earlier in the discussion, you said that there had been some improvement in the technology, which might change the profitability parameters or lead to me…

Robert Rigdon

I think maybe you are referring to my comments around the Zaozhuang plant and what we’re doing there Bob is, there -- the way these projects have been operated in the past, as we sort of head our projects sitting and generating syngas and it sold over the fence to Hai Hua who is operating a separate unit to manufacture methanol.

We work together with Hai Hua to go in and look at, how do we improve that operation by more tightly integrating this and actually also our technical team and this is what I think you may be referring to.

We did a very deep study of their methanol unit and we found several areas, where we can improve the overall sort of integrated efficiency of our unit with the methanol unit, thus creating the potential for both companies to get more value out of that operation.

And in that become the basis of what we were doing with try working to restructure this business agreement now, which is turning out to be as it looks today turning out to be a classic sort of win win approach here for both Hai Hua and our Zaozhuang joint venture project. But that’s what I was referring to, the integration of the two technologies in the more efficient way ours and the methanol unit at Hai Hua.

Robert Smith – Center for Performance Investing

Okay. Thank you. It seems -- certainly seems like that you have on the cost of an exciting future, so lets keep our figures cross. Thanks so much. Good luck.

Robert Rigdon

Yeah. Thanks.

Operator

(Operator Instructions) This concludes our question-and-answer session. I would like to turn the conference back over to Robert Rigdon for any closing remarks.

Robert Rigdon

Okay. Well, thank you everybody for joining us on the call today. And thank you for your questions. Please feel free to contact us, if you have any additional questions. And now, I’ll turn the call back over to the Operator to close it. Thank you.

Operator

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

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