Synthesis Energy Systems, Inc.
SYNTHESIS ENERGY SYSTEMS INC (Form: 10-Q, Received: 05/14/2014 17:08:05)

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

________________

 

FORM 10-Q

 

(Mark One)

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2014

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from: ____________ to: ____________

 

Commission file number: 001-33522

________________

 

SYNTHESIS ENERGY SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

 

Delaware 20-2110031
(State of Incorporation) (I.R.S. Employer Identification No.)
   
Three Riverway, Suite 300, Houston, Texas 77056
(Address of principal executive offices) (Zip code)

________________

 

Registrant’s telephone number, including area code: (713) 579-0600

 

Former name, former address and former fiscal year, if changed since last report: N/A

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes þ No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

Yes þ No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company þ

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No þ

 

As of May 9, 2014 there were 72,811,830 shares of the registrant’s common stock, par value $.01 per share, outstanding.

 

 
 

 

TABLE OF CONTENTS

 

  Page
   
PART 1. Financial Information  
   
Item 1. Financial Statements 1
   
Consolidated Balance Sheets as of March 31, 2014 (unaudited) and June 30, 2013 1
   
Consolidated Statements of Operations for the Three Months Ended March 31, 2014 and 2013 (unaudited) 2
   
Consolidated Statements of Operations for the Nine Months Ended March 31, 2014 and 2013 and the period from November 4, 2003 (inception) to March 31, 2014 (unaudited) 3
   
Consolidated Statements of Comprehensive Loss for the Three and Nine Months ended March 31, 2014 and 2013 and the period from November 4, 2003 (inception) to March 31, 2014 (unaudited) 4
   
Consolidated Statements of Cash Flows for the Nine Months ended March 31, 2014 and 2013 and the period from November 4, 2003 (inception) to March 31, 2014 (unaudited) 5
   
Consolidated Statements of Stockholders’ Equity for the period from June 30, 2013 to March 31, 2014 (unaudited) 6
   
Notes to the Consolidated Financial Statements  (unaudited) 7
   
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 20
   
Item 3. Quantitative and Qualitative Disclosure about Market Risk 36
   
Item 4. Controls and Procedures 37
   
PART II. Other Information  
   
Item 1. Legal Proceedings 38
   
Item 1A. Risk Factors 38
   
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 41
   
Item 3. Defaults Upon Senior Securities 41
   
Item 4. Mine Safety Disclosures 41
   
Item 5. Other Information 41
   
Item 6. Exhibits 43

 

 
 

 

PART I

Item 1. Financial Statements

 

SYNTHESIS ENERGY SYSTEMS, INC.

(A Development Stage Enterprise)

 

Consolidated Balance Sheets

(In thousands, except per share amount)

 

    March 31,
2014
    June 30,
2013
 
    (Unaudited)        
             
ASSETS                
Current assets:                
Cash and cash equivalents   $ 21,721     $ 15,870  
Accounts receivable, net     2       2  
Accounts receivable-related party     674        
Prepaid expenses and other currents assets     1,859       2,636  
Inventory     994        
                 
Total current assets     25,250       18,508  
                 
Property, plant and equipment, net     31,886       32,641  
Intangible asset, net     963       1,060  
Investment in joint ventures     34,856       33,311  
Other long-term assets     2,476       2,844  
                 
Total assets   $ 95,431     $ 88,364  
                 
LIABILITIES AND EQUITY                
Current liabilities:                
Accrued expenses and accounts payable   $ 7,335     $ 7,632  
Short-term bank loan     3,251        
Current portion of long-term bank loan           2,428  
                 
Total current liabilities     10,586       10,060  
                 
Total liabilities     10,586       10,060  
                 
Commitment and contingencies                
                 
Common stock, $0.01 par value: 200,000 shares authorized: 72,711 and 63,583 shares issued and outstanding, respectively     727       636  
Additional paid-in capital     240,471       224,337  
Deficit accumulated during development stage     (161,489 )     (151,741 )
Accumulated other comprehensive income     6,064       5,958  
Total stockholders’ equity     85,773       79,190  
Noncontrolling interests in subsidiaries     (928 )     (886 )
                 
Total equity     84,845       78,304  
                 
Total liabilities and equity   $ 95,431     $ 88,364  

 

See accompanying notes to the consolidated financial statements.

 

1
 

 

SYNTHESIS ENERGY SYSTEMS, INC.

(A Development Stage Enterprise)

 

Consolidated Statements of Operations

(In thousands, except per share amounts)

(Unaudited)

 

    Three Months Ended  
    March 31,  
    2014     2013  
             
Revenue:                
Product sales   $ 4,600     $  
Technology licensing and related services           303  
Related party sale     2,635        
Total revenue     7,235       303  
                 
Costs and expenses:                
Costs of sales and plant operating expenses     7,806       275  
General and administrative expenses     2,536       3,331  
Stock-based compensation expense     336       1,195  
Depreciation and amortization     596       576  
                 
Total costs and expenses     11,274       5,377  
                 
Operating loss     (4,039 )     (5,074 )
                 
Non-operating (income) expense:                
Equity in losses of joint ventures     1       242  
Foreign currency losses     48       22  
Interest income     (6 )     (12 )
Interest expense     101       74  
                 
Net loss     (4,183 )     (5,400 )
                 
Less: net attributable to noncontrolling interests     33       20  
                 
Net loss attributable to stockholders   $ (4,150 )   $ (5,380 )
                 
Net loss per share:                
Basic and diluted   $ (0.06 )   $ (0.09 )
                 
Weighted average common shares outstanding:                
Basic and diluted     64,266       63,007  

 

See accompanying notes to the consolidated financial statements.

 

2
 

 

SYNTHESIS ENERGY SYSTEMS, INC.

(A Development Stage Enterprise)

 

Consolidated Statements of Operations

(In thousands, except per share amounts)

(Unaudited)

 

                November 4, 2003  
    Nine Months Ended     (inception) to  
    March 31,     March 31,  
    2014     2013     2014  
                   
Revenue:                        
Product sales   $ 10,514     $     $ 32,069  
Technology licensing and related services           387       3,367  
Related party sale     2,635             2,635  
Other                 607  
Total revenue     13,149       387       38,678  
                         
Costs and Expenses:                        
Costs of sales and plant operating expenses     11,933       538       45,034  
General and administrative expenses     7,141       9,552       107,359  
Asset impairment losses                 9,075  
Stock-based compensation expense     1,855       1,467       26,045  
Depreciation and amortization     1,727       1,722       16,135  
                         
Total costs and expenses     22,656       13,279       203,648  
                         
Operating loss     (9,507 )     (12,892 )     (164,970 )
                         
Non-operating (income) expense:                        
Equity in losses of joint ventures     2       1,159       3,659  
Foreign currency (gains) losses     5       (26 )     (2,428 )
Interest income     (22 )     (41 )     (3,209 )
Interest expense     292       249       3,874  
                         
Net loss     (9,784 )     (14,233 )     (166,866 )
                         
Less: net (income) loss attributable to noncontrolling interests     36       (32 )     5,377  
                         
Net loss attributable to stockholders   $ (9,748 )   $ (14,265 )   $ (161,489 )
                         
Net loss per share:                        
Basic and diluted   $ (0.15 )   $ (0.24 )   $ (3.83 )
                         
Weighted average common shares outstanding:                        
Basic and diluted     63,886       59,080       42,170  

 

See accompanying notes to the consolidated financial statements.

 

3
 

 

SYNTHESIS ENERGY SYSTEMS, INC.

(A Development Stage Enterprise)

 

Consolidated Statements of Comprehensive Loss

(In thousands)

(Unaudited)

 

                November 4,
2003
(Inception)
 
    Three Months Ended
March 31,
    Nine Months Ended
March 31,
    to
March 31,
 
    2014     2013     2014     2013     2014  
Net loss, as reported   $ (4,183 )   $ (5,400 )   $ (9,784 )   $ (14,233 )   $ (166,866 )
Unrealized foreign currency translation adjustment     (229 )     148       100       328       6,057  
Comprehensive loss     (4,412 )     (5,252 )     (9,684 )     (13,905 )     (160,809 )
Less comprehensive (income) loss attributable to noncontrolling interests     39       24       42       (34 )     5,384  
Comprehensive loss attributable to the Company   $ (4,373 )   $ (5,228 )   $ (9,642 )   $ (13,939 )   $ (155,425 )

 

See accompanying notes to the consolidated financial statements

 

4
 

 

SYNTHESIS ENERGY SYSTEMS, INC.

(A Development Stage Enterprise)

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

                November 4, 2003  
    Nine Months Ended     (inception) to  
    March 31,     March 31,  
    2014     2013     2014  
                   
Cash flows from operating activities:                        
Net loss   $ (9,784 )   $ (14,233 )   $ (166,866 )
Adjustments to reconcile net loss to net cash used in operating activities:                        
Stock-based compensation expense     1,855       1,467       26,045  
Depreciation of property, plant and equipment     1,532       1,561       14,434  
Amortization of intangible and other assets     195       161       1,701  
Equity in losses of joint ventures     2       1,159       3,659  
Foreign currency (gains) losses     5       (26 )     (2,428 )
Loss on disposal of property, plant and equipment           1       167  
Write-off of deferred financing costs                 1,004  
Asset impairment losses                 9,075  
Changes in operating assets and liabilities:                        
Accounts receivable     (675 )     245       (478 )
Prepaid expenses and other current assets     917       (421 )     (943 )
Inventory     (1,003 )     2       (1,539 )
Other long-term assets     283       (87 )     (1,183 )
Accrued expenses and payables     (479 )     (228 )     2,680  
Net cash used in operating activities     (7,152 )     (10,399 )     (114,672 )
Cash flows from investing activities:                        
Capital expenditures     (765 )     (12 )     (38,864 )
Equity investment in joint ventures     (1,547 )     (581 )     (33,771 )
Purchase of marketable securities                 (45,000 )
Redemption of marketable securities                 45,000  
GTI license royalty payments – Yima joint ventures                 (1,500 )
Other license royalty payments                 (1,250 )
Restricted cash – redemptions of certificates of deposit                 (50 )
Amendment to GTI license rights                 (500 )
Purchase of land use rights                 (1,896 )
Receipt of Chinese governmental grant                 556  
Project prepayments                 (3,210 )
Net cash used in investing activities     (2,312 )     (593 )     (80,485 )
Cash flows from financing activities:                        
Payments on long-term bank loan     (2,448 )     (2,443 )     (14,198 )
Proceeds from long-term bank loan                 12,081  
Refund of advance toward sale of common stock           (1,000 )      
Proceeds from short-term bank loan     3,253             3,253  
Proceeds from exercise of stock options, net     228             1,157  
Proceeds from issuance of common stock, net     14,261       14,877       209,107  
Prepaid interest                 (276 )
Financing costs                 (143 )
Contributions from noncontrolling interest partners                 4,456  
Loans from shareholders                 11  
Net cash provided by financing activities     15,294       11,434       215,448  
Net increase  in cash     5,830       442       20,291  
Cash and cash equivalents, beginning of period     15,870       18,035        
Effect of exchange rates on cash     21       (15 )     1,430  
Cash and cash equivalents, end of period   $ 21,721     $ 18,462     $ 21,721  

 

See accompanying notes to the consolidated financial statements.

 

5
 

 

SYNTHESIS ENERGY SYSTEMS, INC.

(A Development Stage Enterprise)

Consolidated Statement of Equity

(In thousands)

(Unaudited)

 

    Common Stock           Deficit
Accumulated
During the
    Accumulated
Other
    Non-        
   

 

Shares

   

 

Amount

   

Additional

Paid-in Capital

   

Development

Stage

   

Comprehensive

Income

   

controlling

Interest

   

 

Total

 
Balance at June 30, 2013     63,583     $ 636     $ 224,337     $ (151,741 )   $ 5,958     $ (886 )   $ 78,304  
Net loss                       (9,748 )           (36 )     (9,784 )
Currency translation adjustment                             106       (6 )     100  
Net proceeds from issuance of common stock     8,470       84       14,058                         14,142  
Exercise of stock options and warrants     658       7       221                         228  
Stock-based compensation expense                 1,855                         1,855  
Balance at March 31, 2014     72,711     $ 727     $ 240,471     $ (161,489 )   $ 6,064     $ (928 )   $ 84,845  

   

See accompanying notes to the consolidated financial statements.

 

6
 

 

SYNTHESIS ENERGY SYSTEMS, INC.

(A Development Stage Enterprise)

 

Notes to Consolidated Financial Statements

(Unaudited)

 

Note 1 — Summary of Significant Accounting Policies

 

(a) Organization and description of business

 

Synthesis Energy Systems, Inc. (“SES”), together with its wholly-owned and majority-owned controlled subsidiaries (collectively, the “Company”) is a development stage global energy and gasification technology company that provides products and solutions to the energy and chemical industries. The Company’s business is to create value by supplying its technology, equipment and services into global projects where lower cost low quality coals, coal wastes, municipal wastes, agricultural biomass, and other biomass feedstocks can be profitably converted through its proprietary gasification technology into clean synthesis gas, or syngas (a mixture of primarily hydrogen, carbon monoxide, and methane), which is then used to produce a variety of high value energy and chemical products. The Company’s initial operating projects to date convert high ash coal and coal wastes to chemical grade methanol, and the Company is pursuing a variety of additional global projects under development by customers who may use its technology platform to convert low quality coals such as lignite, coal wastes, municipal wastes and agricultural waste biomass to high value products such as electric power, transportation fuels, substitute natural gas fuel for direct reduction iron steel making and other products. The Company’s technology is originally based on the U-GAS ® process developed by the Gas Technology Institute and the Company has augmented and differentiated the technology through design, detailed engineering, constructing, starting up and operating two commercial plants in China. The Company’s headquarters are located in Houston, Texas.

(b) Basis of presentation and principles of consolidation

 

The consolidated financial statements for the periods presented are unaudited and reflect all adjustments, consisting of normal recurring items, which management considers necessary for a fair statement. Operating results for the three month and nine months periods ended March 31, 2014 are not necessarily indicative of results to be expected for the fiscal year ending June 30, 2014.

 

The consolidated financial statements are in U.S. dollars. Noncontrolling interests in consolidated subsidiaries in the consolidated balance sheets represents minority stockholders’ proportionate share of the equity in such subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto reported in the Company’s Annual Report on Form 10-K for the year ended June 30, 2013. Significant accounting policies that are new or updated from those presented in the Company’s Annual Report on Form 10-K for the year ended June 30, 2013 are included below. The consolidated financial statements have been prepared in accordance with the rules of the United States Securities and Exchange Commission (“SEC”) for interim financial statements and do not include all annual disclosures required by generally accepted accounting principles in the United States.

 

(c) Inventories

 

Inventories are stated at the lower of cost or market. Cost is determined using the average cost method. Inventories include finish goods (methanol) and raw materials which are expensed to cost of sales when sold or consumed.

 

 

7
 

 

(d) Accounting for Variable Interest Entities (“VIEs”) and Financial Statement Consolidation Criteria

 

The joint ventures which the Company enters into may be considered VIEs. The Company consolidates all VIEs where it is the primary beneficiary. This determination is made at the inception of the Company’s involvement with the VIE and is continuously assessed. The Company considers qualitative factors and forms a conclusion that the Company, or another interest holder, has a controlling financial interest in the VIE and, if so, whether it is the primary beneficiary. In order to determine the primary beneficiary, the Company considers who has the power to direct activities of the VIE that most significantly impacts the VIE’s performance and has an obligation to absorb losses from or the right to receive benefits of the VIE that could be significant to the VIE. The Company does not consolidate VIEs where it is not the primary beneficiary. The Company accounts for these unconsolidated VIEs using either the equity method of accounting or the cost method of accounting and includes its net investment on its consolidated balance sheets. Under the equity method, the Company’s equity interest in the net income or loss from its unconsolidated VIEs is recorded in non-operating (income) expense on a net basis on its consolidated statement of operations. Equity investments in which the Company exercises significant influence but does not control and is not the primary beneficiary are accounted for using the equity method. In the event of a change in ownership, any gain or loss resulting from an investee share issuance is recorded in earnings. Investments in which the Company is not able to exercise significant influence over the investee are accounted for under the cost method. Controlling interest is determined by majority ownership interest and the ability to unilaterally direct or cause the direction of management and policies of an entity after considering any third-party participatory rights.

 

The Company has determined that the ZZ Joint Venture is a VIE and has determined that the Company is the primary beneficiary. In making the initial determination, the Company considered, among other items, the change in profit distribution between the Company and Xuejiao after 20 years. The expected negative variability in the fair value of the ZZ Joint Venture’s net assets was considered to be greater during the first 20 years of the ZZ Joint Venture’s life, which coincided with our original 95% profit/loss allocation, versus the latter 30 years in which the Company’s profit/loss allocation would be reduced to 10%. As the result of an amendment to the ZZ Joint Venture agreement in 2010, the profit distribution percentages will remain in place after the first 20 years, providing further support to the determination that the Company is the primary beneficiary.

 

The following tables provide additional information on the ZZ Joint Venture’s assets and liabilities as of March 31, 2014 and June 30, 2013 which are consolidated within the Company’s consolidated balance sheets (in thousands):

 

    March 31, 2014  
    Consolidated     ZZ Joint Venture (1)     %(2)  
                   
Current assets   $ 25,250     $ 3,117       12 %
Long-term assets     70,181       33,582       48 %
Total assets   $ 95,431     $ 36,699       38 %
                         
Current liabilities   $ 10,586     $ 6,981       66 %
Equity     84,845       29,718       35 %
Total liabilities and equity   $ 95,431     $ 36,699       38 %

 

    June 30, 2013  
    Consolidated     ZZ Joint Venture (1)     %(2)  
                   
Current assets   $ 18,508     $ 523       3 %
Long-term assets     69,856       34,742       50 %
Total assets   $ 88,364     $ 35,265       40 %
                         
Current liabilities   $ 10,060     $ 4,529       45 %
Equity     78,304       30,736       39 %
Total liabilities and equity   $ 88,364     $ 35,265       40 %

 

(1) Amounts reflect information for the ZZ Joint Venture and exclude intercompany items.
(2) ZZ Joint Venture’s percentage of the amount on the Company’s consolidated balance sheets.

 

The Company has determined that the Yima Joint Ventures are VIEs and that Yima, the joint venture partner, is the primary beneficiary since Yima has a 75% ownership interest in the Yima Joint Ventures and has the power to direct the activities of the VIE that most significantly influence the VIE’s performance.

 

8
 

 

Until May 31, 2013, the Company accounted for its equity interest in the Yima Joint Ventures under the equity method of accounting. Under this method, the Company recorded its proportionate share of the Yima Joint Ventures’ net income or loss based on the Yima Joint Venture’s financial results. As of June 1, 2013, the Company changed to the cost method of accounting because the Company concluded that it is unable to exercise significant influence over the Yima Joint Ventures. The Company’s conclusion regarding its lack of significant influence is due to various circumstances including limited participation in operating and financial policymaking processes and the Company’s limited ability to influence technological decisions.

 

The Company has determined that SES Resource Solutions, Ltd. (“SRS”) which was formed in June 2011 is a VIE and that the Company is not the primary beneficiary since neither the Company nor Midas Resources AG control SRS since each have a 50% ownership interest in SRS and the control, risks and benefits of SRS are shared equally. SRS had no assets or liabilities as of March 31, 2014 and is inactive.

 

The Company has determined that the ZCM-SES is VIE and that ZCM, the joint venture partner, is the primary beneficiary since ZCM has a 65% ownership interest in the Joint Venture and has the power to direct the activities of the VIE that most significantly influence the VIE’s performance.

 

The Company has determined that the GC Joint Venture is a VIE and has determined that it is the primary beneficiary since the Company has a 51% ownership interest in the GC Joint Venture and since there are no qualitative factors that would preclude the Company from being deemed the primary beneficiary. There were no significant assets recorded within the GC Joint Venture as of March 31, 2014 or June 30, 2013. There were however, current liabilities of approximately $1.2 million as of March 31, 2014 and June 30, 2013 related to unpaid settlements of amounts due to various contractors from the initial construction work for the project. The GC Joint Venture project is not currently being developed and the Company is continuing to work to liquidate and ultimately dissolve the GC Joint Venture.

 

(e) Revenue Recognition

 

Revenue from sales of products, including the capacity fee and energy fee earned at the ZZ Joint Venture plant and sales of methanol under the ZZ Cooperation Agreement, and sales of equipment are recognized when the following elements are satisfied: (i) there are no uncertainties regarding customer acceptance; (ii) there is persuasive evidence that an agreement exists; (iii) delivery has occurred; (iv) the sales price is fixed or determinable; and (v) collectability is reasonably assured.

 

Technology licensing revenue is typically received over the course of a project’s development as milestones are met. The Company may receive upfront licensing fee payments when a license agreement is entered into. Typically, the majority of a license fee is due once project financing and equipment installation occur. The Company recognizes license fees as revenue when the license fees become due and payable under the license agreement, subject to the deferral of the amount of the performance guarantee. Fees earned for engineering services, such as services that relate to integrating our technology to a customer’s project, are recognized using the percentage-of-completion method.

 

(f) Fair value measurements

 

Accounting standards require that fair value measurements be classified and disclosed in one of the following categories:

 

Level 1 Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

 

Level 2 Quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability; and

 

Level 3 Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).

 

The Company’s financial assets and liabilities are classified based on the lowest level of input that is significant for the fair value measurement. The following table summarizes the valuation of the Company’s financial assets by pricing levels, as of March 31, 2014 and June 30, 2013 (in thousands):

 

9
 

 

    March 31, 2014  
    Level 1     Level 2     Level 3     Total  
Assets:                                
Certificates of Deposit   $       $   50 (1)     $     $ 50  
Money Market Funds           18,462 (2)             18,462  
                                 
Liabilities:                                
Short-term bank loan           3,251 (3)             3,251  

 

    June 30, 2013  
    Level 1     Level 2     Level 3     Total  
Assets:                                
Certificates of Deposit   $       $   50 (1)     $     $ 50  
Money Market Funds           8,752 (2)             8,752  
                                 
Liabilities:                                
Long-term bank loan           2,428 (4)             2,428  

 

(1) Amount included in current assets on the Company’s consolidated balance sheets.
(2) Amount included in cash and cash equivalents on the Company’s consolidated balance sheets.
(3) Amount included in current liabilities on the Company’s consolidated balance sheets.

(4) Amount comprised of current portion of bank loan on the Company’s consolidated balance sheets.

 

The carrying values of the certificates of deposit, money market funds, short-term and long-term debt approximate fair value, which was estimated using quoted market prices for those or similar investments. The carrying value of the Company’s other financial instruments, including accounts receivable and accounts payable, approximate their fair values.

 

Note 2 – Joint Ventures

 

Zao Zhuang Joint Venture

 

Joint Venture Agreement

 

On July 6, 2006, the Company entered into a cooperative joint venture contract with Shandong Hai Hua Coal & Chemical Company Ltd., or Hai Hua, which established Synthesis Energy Systems (Zao Zhuang) New Gas Company Ltd., or the ZZ Joint Venture, a joint venture company that has the primary purposes of (i) developing, constructing and operating a syngas production plant utilizing the U-GAS ® technology in Zao Zhuang City, Shandong Province, China and (ii) producing and selling syngas and the various byproducts of the plant. In August 2012, Hai Hua’s name was changed to Shandong Weijiao Group Xuecheng Energy Company Ltd., or Xuecheng Energy, after a change in control transaction. We own 97.6% of the ZZ Joint Venture and Xuecheng Energy owns the remaining 2.4%. We consolidate the results of the ZZ Joint Venture in our consolidated financial statements.

 

On July 24, 2013, the ZZ Joint Venture entered into a cooperation agreement (the “ZZ Cooperation Agreement”) with Xuecheng Energy and its parent company, Shandong Xuejiao Chemical Co., Ltd. (collectively referred to as “Xuejiao”), which serves to supersede the existing syngas purchase and sale agreement among the parties dated October 22, 2006 and supplemented previously in 2008. The ZZ Cooperation Agreement, which became effective on October 31, 2013, represents the basis for an integrated syngas to methanol operation and resolution of the nonpayment of the contractual capacity fees by Xuejiao. Under the terms of the ZZ Cooperation Agreement, Xuejiao will (i) provide the ZZ Joint Venture with use of their methanol plant for ten years at no cost to the ZZ Joint Venture, (ii) provide a bank loan guarantee of approximately $3.2 million for a majority of the financing necessary for the ZZ Joint Venture for the retrofit and related costs of the ZZ Joint Venture plant, (iii) waive certain advances previously made to the ZZ Joint Venture and (iv) supply discounted coke oven gas produced by its existing coke ovens to be used in combination with synthesis gas to produce refined methanol from the new ZZ Joint Venture integrated syngas methanol operation. The new integrated operation will be managed by the ZZ Joint Venture.

 

10
 

 

Effective October 31, 2013, the ZZ Joint Venture terminated and waived its claims to past due capacity fees owed by Xuejiao under the prior syngas purchase and sale agreement.  Pursuant to the ZZ Cooperation Agreement, prior payments of approximately $1.8 million were applied to settling the prior payments due under the syngas purchase and sale agreement. As a result, the ZZ Joint Venture recognized these related party advances as product sales of approximately $1.5 million, net of value-added taxes, during the three months ended December 31, 2013.

 

The ZZ Joint Venture began producing and selling methanol in November 2013 and sold 22,791 tonnes of methanol during the nine months ended March 31, 2014 generating approximately $9.0 million of revenue. The Company assumed operational control of the integrated methanol production facility in October 2013 under a restructured commercial arrangement. The ZZ Joint Venture has worked to complete the plant retrofits and equipment upgrades to enable increased methanol production from integrated syngas and coke oven gas feedstock. The ZZ Joint Venture is now operating an integrated plant which has two operating modes where it (i) converts coke oven gas directly to methanol and (ii) converts coal to syngas, then blends the syngas and coke oven gas at a specific ratio to produce additional quantities of methanol.  The ZZ Joint Venture began producing and selling methanol in November 2013 from coke oven gas. The ZZ Joint Venture restarted its syngas plant for approximately two weeks during December 2013. In January 2014, the ZZ Joint Venture produced methanol only from coke oven gas due to lower coke oven gas supplies during the cold weather. The ZZ Joint Venture intends to manage syngas production in order to optimize results. The syngas facility will generally operate when adequate coke oven gas supplies are available to achieve the correct syngas to coke oven gas blend ratio. The ZZ Joint Venture also recently executed agreements to secure an additional minimum 4,000 normal cubic meters per hour of coke oven gas from a local supplier, with a target of 5,000 normal cubic meters per hour, in order to increase methanol production and reduce supply risks. This additional coke oven gas represents approximately a 30% increase in feedstock supply for the ZZ Joint Venture Plant.

 

Additionally, the Company is also evaluating alternative products and partnership structures for a possible future expansion of the ZZ Joint Venture plant. In 2010, the ZZ Joint Venture received the necessary government approval for an expansion into monoethylene glycol production. This expansion project remains under evaluation by the Company. The Company is also evaluating certain new downstream technologies to produce high value products. 

 

Although the Company intends for the ZZ Joint Venture to sustain itself through its own earnings in the near term, the Company may need to make additional contributions to the ZZ Joint Venture in order for it to meet its obligations, including the ZZ Short-term Loan (defined below) due in September 2014 unless such loan can be refinanced.

 

Loan Agreement with ICBC

 

On March 22, 2007, the ZZ Joint Venture entered into a seven-year loan agreement and received approximately $12.6 million of loan proceeds pursuant to the terms of a Fixed Asset Loan Contract with the Industrial and Commercial Bank of China (“ICBC”) to complete the project financing for the ZZ Joint Venture. Interest was adjusted annually based upon the standard rate announced each year by the People’s Bank of China. The final principal payment of RMB 7.3 million (approximately $1.2 million) was repaid in January 2014.

 

Short-term Loan Agreement with Zaozhuang Bank Co., Ltd

 

On September 10, 2013, the ZZ Joint Venture entered into a short-term loan agreement with Zaozhuang Bank Co., Ltd., (the “ZZ Short-term Loan”), and received approximately $3.2 million of loan proceeds for the retrofit and related costs contemplated by the ZZ Cooperation Agreement. Key terms of the ZZ Short-term Loan are as follows:

 

Loan term is one year, due on September 9, 2014;

 

Interest is payable monthly at an annual rate of 10.8%;

 

Xuecheng Energy is the guarantor of the entire loan;

 

Certain assets of the ZZ Joint Venture, including land use rights and the administration building, are pledged as collateral; and

 

Subject to customary events of default which, should one or more of them occur and be continuing, would permit Zaozhuang Bank Co., Ltd. to declare all amounts owing under the agreement to be due and payable immediately.

 

11
 

 

Yima Joint Ventures

 

In August 2009, the Company entered into amended joint venture contracts with Yima Coal Industry (Group) Co., Ltd. (“Yima”), replacing the prior joint venture contracts entered into in October 2008 and April 2009. The joint ventures were formed for each of the gasification, methanol/methanol protein production, and utility island components of the plant (collectively, the “Yima Joint Ventures”). The amended joint venture contracts provide that: (i) the Company and Yima contribute equity of 25% and 75%, respectively, to the Yima Joint Ventures; (ii) Yima will guarantee the repayment of loans from third party lenders for 50% of the project’s cost and, if debt financing is not available, Yima is obligated to provide debt financing via shareholder loans to the project until the project is able to secure third-party debt financing; and (iii) Yima will supply coal to the project from a mine located in close proximity to the project at a preferential price subject to a definitive agreement to be subsequently negotiated. In connection with entering into the amended contracts, the Company and Yima contributed their remaining cash equity contributions of $29.3 million and $90.8 million, respectively, to the Yima Joint Ventures during the three months ended September 30, 2009. In exchange for their capital contributions, the Company owns a 25% interest in each joint venture and Yima owns a 75% interest.

  

The remaining capital for the project has been funded with project debt obtained by the Yima Joint Ventures. Yima agreed to guarantee the project debt in order to secure debt financing from domestic Chinese banking sources. The Company has agreed to pledge to Yima its ownership interests in the joint ventures as security for the Company’s obligations under any project guarantee. In the event that the necessary additional debt financing is not obtained, Yima has agreed to provide a loan to the joint ventures to satisfy the remaining capital needs of the project with terms comparable to current market rates at the time of the loan.

 

The Yima Joint Venture plant’s refined methanol section was fully commissioned in December 2013, and has operated at limited capacity since that date. Methanol production was approximately 27% of its capacity during the three months ended March 31, 2014. The plant is designed to produce 300,000 tonnes per year of methanol from operating two of its three available gasifiers and has achieved 100% peak syngas production levels and 80% peak methanol production levels. Yima has recently initiated an outage in March that should allow the plant to make improvements to the upstream and downstream units adjacent to the Company’s gasification systems at the Yima Joint Venture plant. Most of these are punch-list items, along with the improvements which have been learned from the past year’s operation at the plant. The improvements are currently scheduled to be completed in the next two to four months.

  

Under the terms of the joint venture agreements, the Yima Joint Ventures are to be governed by a board of directors consisting of eight directors, two of whom were appointed by the Company and six of whom were appointed by Yima. The joint ventures also have officers that are nominated by the Company, Yima and/or the board of directors pursuant to the terms of the joint venture contracts. The Company and Yima shall share the profits, and bear the risks and losses, of the joint ventures in proportion to their respective ownership interests. The term of the joint venture shall commence upon each joint venture company obtaining its business operating license and shall end 30 years after commercial operation of the plant.

 

The Company has included approximately $3.0 million of royalty costs due to GTI for the Yima Joint Ventures’ U-GAS ® license as part of its investment in joint ventures on its consolidated balance sheet, including a $1.5 million payment paid to GTI in June 2009 (when the amended joint venture contracts were signed), a $0.5 million payment in October 2013, and $1.0 million of payments in January 2014.

 

Until May 31, 2013, the Company accounted for its equity interest in the Yima Joint Ventures under the equity method of accounting. Under this method, the Company recorded its proportionate share of the Yima Joint Ventures’ net income or loss based on the Yima Joint Venture’s financial results. As of June 1, 2013, the Company changed to the cost method of accounting because the Company concluded that it is unable to exercise significant influence over the Yima Joint Ventures. The Company’s conclusion regarding its lack of significant influence is based on its interactions with the Yima Joint Ventures related to the start-up and operations and due to various other circumstances including limited participation in operating and financial policymaking processes and the Company’s limited ability to influence technological decisions. There was no equity in losses of the Yima Joint Ventures recognized for financial reporting purposes for the three months and nine months ended March 31, 2014 since the Company changed from the equity method to the cost method of accounting as of June 1, 2013. The Company’s equity in losses of the Yima Joint Ventures for the three months and nine months ended March 31, 2013 were $0.2 million and $0.6 million, respectively.

 

12
 

 

In January 2011, the Company signed gasifier sales agreements with the Yima Joint Ventures to sell gasifiers and gasifier related equipment for an aggregate contract price of $3.0 million. A portion of the equipment associated with these orders was ordered from ZCM (as defined under “Joint Venture with ZCM” in this Note 2). The gasifiers were completed and delivered in January 2012 to the Yima Joint Ventures. As of March 31, 2014, the Yima Joint Ventures had paid $2.4 million of the total contract price and still owed the remaining payment approximately of $0.67 million to the Company. The Company still owed $0.67 million to both ZCM and an additional vendor associated with the equipment purchase, which is accrued as a current liability on the Company’s consolidated balance sheet.

 

SES Resource Solutions

 

SRS is a joint venture owned 50% by us and 50% by Midas Resources AG, or Midas, that was formed in June 2011 to provide additional avenues of commercialization for the Company’s U-GAS® technology. Key objectives of the joint venture are to identify and procure low cost, low rank coal resources for which the Company’s technology represents the best route to commercialization; to provide investment opportunities in both gasification facilities and coal resources; and to facilitate the establishment of gasification projects globally based on the Company’s technology.

 

As of March 31, 2014, the Company had funded approximately $1.7 million to SRS. In December 2012, SRS suspended its activities due to the unavailability of financing for coal resources, therefore the Company’s contributions to SRS are expected to be minimal unless its activities resume.

 

The Company’s investment in SRS is accounted for using the equity method. SRS has no assets or liabilities as amounts are funded by the Company as costs are incurred. The following table presents summarized unconsolidated income statement data for SRS (in thousands):

 

    Three Months Ended     Nine Months Ended  
    March 31,     March 31,  
    2014     2013     2014     2013  
Income statement data:                                
                                 
Revenue   $     $     $     $  
Operating loss     (3 )     (77 )     (5 )     (1,163 )
Net loss     (3 )     (77 )     (5 )     (1,163 )

 

Joint Venture with ZCM

 

Joint Venture Contract

 

On February 14, 2014, SES Asia Technologies Limited, a wholly owned subsidiary of the Company entered into a Joint Venture Contract (the “JV Contract”) with Zhangjiagang Chemical Machinery Co., Ltd. (“ZCM”) to form SES-ZCM Clean Energy Technologies Limited (the “ZCM Joint Venture”). The purpose of the ZCM Joint Venture is to establish the Company’s gasification technology as the leading gasification technology in the ZCM Joint Venture territory (which is initially China, Indonesia, the Philippines, Vietnam, Mongolia and Malaysia) by becoming a leading provider of proprietary equipment for the technology. The scope of the ZCM Joint Venture is to market and license the Company’s gasification technology via project sublicenses; procurement and sale of proprietary equipment and services; coal testing; and engineering, procurement and research and development related to the technology. ZCM is contributing RMB 100,000,000 (approximately USD $16 million) in cash to the ZCM Joint Venture, and own approximately 65% of the ZCM Joint Venture, and the Company has contributed an exclusive license to use of its technology in the ZCM Joint Venture territory pursuant to the terms of a Technology Usage and Contribution Agreement entered into among the ZCM Joint Venture, ZCM and the Company (the “TUCA”) on the same date, and owns approximately 35% of the ZCM Joint Venture.

 

Under the JV Contract, neither party may transfer their interests in the ZCM Joint Venture without first offering such interests to the other party. Notwithstanding this, the Company has the right until 30 days after the first project sublicense is entered into by the ZCM Joint Venture to transfer 5% of its interest to a financial investor. If the Company elects not to transfer such 5% interest during that period, ZCM has the option to purchase such interest from the Company for RMB 10,000,000 (approximately USD$1.6 million).

 

The JV Contract also includes a non-competition provision which requires that the JV be the exclusive legal entity within the ZCM Joint Venture territory for the marketing and sale of any gasification technology or related equipment that utilizes low quality coal feedstock. Notwithstanding this, ZCM has the right to manufacture and sell gasification equipment outside the scope of the ZCM Joint Venture within the ZCM Joint Venture territory. In addition, the Company has the right to develop and invest equity in projects outside of the ZCM Joint Venture within the ZCM Joint Venture territory. After the termination of the ZCM Joint Venture, ZCM must obtain written consent from the Company for the market development of any gasification technology that utilizes feedstock in the ZCM Joint Venture territory.

 

13
 

 

The JV Contract may be terminated upon, among other things, (i) a material breach of the JV Contract which is not cured, (ii) a violation of the TUCA, (iii) the failure to obtain positive net income within 24 months of establishing the ZCM Joint Venture or (iv) mutual agreement of the parties.

 

On March 18, 2014, the ZCM Joint Venture received the required 20-year business license from the State Administration for Industry & Commerce of the People’s Republic of China (SAIC) in Zhangjiagang. On April 8, 2014, the transactions were completed and the ZCM Joint Venture began operations.

 

Technology Usage and Contribution Agreement

 

Pursuant to the TUCA, the Company has contributed to the ZCM Joint Venture the exclusive right to the Company’s gasification technology in the ZCM Joint Venture territory, including the right to: (i) grant site specific project sub-licenses to third parties; (ii) use the Company’s marks for proprietary equipment and services; (iii) engineer and/or design processes that utilize the Company’s technology or other Company intellectual property; (iv) provide engineering and design services for joint venture projects and (v) take over the development of projects in the ZCM Joint Venture territory that have previously been developed by the Company and its affiliates.

 

The ZCM Joint Venture will be the exclusive operational entity for business relating to the Company’s technology in the ZCM Joint Venture Territory. If the ZCM Joint Venture loses exclusivity due to a Company breach, ZCM is to be compensated for direct losses and all lost project profits. The Company will also provide training for technical personnel of the ZCM Joint Venture through the second anniversary of the establishment of the ZCM Joint Venture. The Company will also provide a review of engineering works for the ZCM Joint Venture. If modifications are suggested by the Company and not made, the ZCM Joint Venture bears the liability resulting from such failure. If the Company suggests modifications and there is still liability resulting from the engineering work, it is the liability of the Company.

 

Any party making, whether patentable or not, improvements relating to the Company technology after the establishment of the ZCM Joint Venture, grants to the other Party an irrevocable, non-exclusive, royalty free right to use or license such improvements and agrees to make such improvements available to the Company free of charge. All such improvements shall become part of the Company’s technology and both parties shall have the same rights, licenses and obligations with respect to the improvement as contemplated by the TUCA.

 

The ZCM Joint Venture will establish an Intellectual Property Committee, with two representatives from the ZCM Joint Venture and two from the Company. The Committee is expected to be established within the next fiscal quarter. This Committee shall review all improvements and protection measures and recommend actions to be taken by the ZCM Joint Venture in furtherance thereof. Notwithstanding this, each party is entitled to take actions on its own to protect intellectual property rights.

 

Any breach of or default under the TUCA which is not cured on notice entitles the non-breaching party to terminate. The parties can suspend performance of the TUCA in the event of a dispute if the dispute poses a significant adverse impact on performance. The ZCM Joint Venture indemnifies the Company for misuse of the Company’s technology or infringement of the Company’s technology upon rights of any third party.

 

Note 3 – GTI License Agreement

 

On November 5, 2009, the Company entered into an Amended and Restated License Agreement (the “GTI Agreement”) with GTI, replacing the Amended and Restated License Agreement between the Company and GTI dated August 31, 2006, as amended. Under the GTI Agreement, the Company maintains its exclusive worldwide right to license the U-GAS ® technology for all types of coals and coal/biomass mixtures with coal content exceeding 60%, as well as the non-exclusive right to license the original U-GAS ® technology for 100% biomass and coal/biomass blends exceeding 40% biomass.  

 

14
 

 

In order to sublicense any U-GAS ® system, the Company is required to comply with certain requirements set forth in the GTI Agreement. In the preliminary stage of developing a potential sublicense, the Company is required to provide notice and certain information regarding the potential sublicense to GTI and GTI is required to provide notice of approval or non-approval within ten business days of the date of the notice from the Company, provided that GTI is required to not unreasonably withhold their approval. If GTI does not respond within that ten business day period, they are deemed to have approved of the sublicense. The Company is required to provide updates on any potential sublicenses once every three months during the term of the GTI Agreement. The Company is also restricted from offering a competing gasification technology during the term of the GTI Agreement.

 

For each U-GAS ® unit which the Company licenses, designs, builds or operates for itself or for a party other than a sublicensee and which uses coal or a coal and biomass mixture or biomass as the feed stock, the Company must pay a royalty based upon a calculation using the MMBtu per hour of dry syngas production of a rated design capacity, payable in installments at the beginning and at the completion of the construction of a project (the “Standard Royalty”). If the Company invests, or has the option to invest, in a specified percentage of the equity of a third party, and the royalty payable by such third party for their sublicense exceeds the Standard Royalty, the Company is required to pay to GTI, an agreed percentage split of third party licensing fees (the “Agreed Percentage”) of such royalty payable by such third party. However, if the royalty payable by such third party for their sublicense is less than the Standard Royalty, the Company is required to pay to GTI, in addition to the Agreed Percentage of such royalty payable by such third party, the Agreed Percentage of its dividends and liquidation proceeds from its equity investment in the third party. In addition, if the Company receives a carried interest in a third party, and the carried interest is less than a specified percentage of the equity of such third party, the Company is required to pay to GTI, in its sole discretion, either (i) the Standard Royalty or (ii) the Agreed Percentage of the royalty payable to such third party for their sublicense, as well as the Agreed Percentage of the carried interest. The Company will be required to pay the Standard Royalty to GTI if the percentage of the equity of a third party that the Company (a) invests in, (b) has an option to invest in, or (c) receives a carried interest in, exceeds the percentage of the third party specified in the preceding sentence.

 

The Company is required to make an annual payment to GTI for each year of the term, with such annual payment due by the last day of January of the following year; provided, however, that the Company is entitled to deduct all royalties paid to GTI in a given year under the GTI Agreement from this amount, and if such royalties exceed the annual payment amount in a given year, the Company is not required to make the annual payment. The Company accrues the annual royalty expense ratably over the calendar year as adjusted for any royalties paid during year as applicable. The Company must also provide GTI with a copy of each contract that it enters into relating to a U-GAS® system and report to GTI with its progress on development of the technology every six months.

 

For a period of ten years, the Company and GTI are restricted from disclosing any confidential information (as defined in the GTI Agreement) to any person other than employees of affiliates or contractors who are required to deal with such information, and such persons will be bound by the confidentiality provisions of the GTI Agreement. The Company has further indemnified GTI and its affiliates from any liability or loss resulting from unauthorized disclosure or use of any confidential information that the Company receives.

 

The GTI Agreement expires on August 31, 2016, but may be extended for two additional ten-year periods at the Company’s option.

 

Note 4 – Stockholders’ Equity and Stock-Based Compensation

 

As of August 31, 2013, the Company had issued 279,480 shares of common stock to Crystal Vision Energy Limited (“CVE”) as part of CVE’s monthly compensation payable in common stock under CVE’s consulting agreement with the Company which was terminated effective as of August 31, 2013. On August 1, 2013, CVE made a $100,000 investment in the Company’s common stock and received 136,986 shares and warrants to purchase 136,986 shares of the Company common stock. The shares of the Company’s common stock were issued at a price of $0.73. The associated warrants have an exercise price of $0.91. The fair values of the August 1, 2013 transaction, including the shares and warrants, was estimated to be approximately $0.1 million. Under the consulting agreement, CVE was also entitled to nonforfeitable incentive warrants upon signing. A warrant to purchase up to 1,200,000 shares of the Company’s common stock with an exercise price of $1.50 was granted in February 2013, became vested and fully exercisable on December 31, 2013 and has a term of five years.

 

On November 1, 2013, the Company entered into a management consulting agreement (the “MDC Agreement”) with Market Development Consulting Group, Inc. d/b/a MDC Group (“MDC”) for communications and investor relations advisory services. As part of MDC’s consideration, MDC received an initial warrant to acquire 750,000 shares of common stock on November 1, 2013 at an exercise price of $.70 per share. The fair value of these warrants was estimated to be approximately $0.4 million. MDC will receive additional warrants (“Anniversary Warrants”) to acquire 1% of the then fully diluted common stock on each annual anniversary prior to termination of the MDC Agreement. The exercise price of each such Anniversary Warrant shall be equal to the average closing price over the twenty consecutive trading days immediately preceding the anniversary. MDC is prohibited from exercising the initial warrant until the first anniversary of the date of the Agreement, other than in connection with a change of control of the Company.

 

15
 

 

On March 24, 2014, the Company raised gross proceeds of approximately $15 million through the sale of 8,333,341 shares of common stock plus warrants to acquire 4,166,667 shares of common stock. The aggregate fair value of these warrants was approximately $3.97 million. The warrants have an exercise price of $2.16 per share and a three-year term from the date of issuance. In connection with this offering, the Company paid commissions and other offering-related expenses of approximately $1.0 million in cash and also issued warrants to the placement agent to acquire 500,000 shares of common stock. The aggregate fair value of these warrants was approximately $0.6 million. The warrants have an exercise price of $2.25 per share and a five-year term from the date of issuance.

 

As of March 31, 2014, the Company had outstanding stock option and restricted stock awards granted under the Company’s Amended and Restated 2005 Incentive Plan, as amended (the “Incentive Plan”), under which the Company’s stockholders have authorized a total of 9,800,000 shares of common stock for awards under the Incentive Plan. As of March 31, 2014, there were 69,879 shares authorized for future issuance pursuant to the Incentive Plan. Under the Incentive Plan, the Company may grant incentive and non-qualified stock options, stock appreciation rights, restricted stock units and other stock-based awards to officers, directors, employees and non-employees. Stock option awards generally vest ratably over a one to four year period and expire ten years after the date of grant.

 

Stock option activity during the nine months ended March 31, 2014 was as follows:

 

    Shares of Common
Stock Underlying
 
    Stock Options  
       
Outstanding at June 30, 2013     7,404,692  
Granted     899,687  
Exercised     (408,250 )
Forfeited/Canceled     (46,250 )
Outstanding at March 31, 2014     7,849,879  
Exercisable at March 31, 2014     6,788,894  

 

The fair values for the stock options granted during the nine months ended March 31, 2014 were estimated at the date of grant using a Black-Scholes-Morton option-pricing model with the following weighted-average assumptions:

 

Risk-free rate of return     1.6 %
Expected life of award     5.2 years  
Expected dividend yield     0.0 %
Expected volatility of stock     99 %
Weighted-average grant date fair value   $ 0.97  

 

Stock warrant activity during the nine months ended March 31, 2014 was as follows:

 

    Shares of Common
Stock Underlying
 
    Stock Warrants  
       
Outstanding at June 30, 2013     1,649,438  
Warrants issued     5,553,653  
Exercised     (586,424 )
Forfeited      
Outstanding at March 31, 2014     6,616,667  

 

The fair values of the warrants issued during the nine months ended March 31, 2014 were estimated using a Black-Scholes-Morton option-pricing model with the following weighted-average assumptions:

 

16
 

 

Risk-free rate of return     1.3 %
Expected life of award     4.2 years  
Expected dividend yield     0.0 %
Expected volatility of stock     88 %
Weighted-average grant date fair value   $ 0.92  

 

The following table presents stock based compensation expense attributable to stock option awards issued under the Incentive Plan and attributable to warrants and stock issued or sold to consultants (in thousands):

 

    Three Months Ended     Nine Months Ended  
    March 31,     March 31,  
    2014     2013     2014     2013  
                         
Incentive Plan   $ 336     $ 372     $ 822     $ 644  
Consultants           823       1,033       823  
Total stock-based compensation expense   $ 336     $ 1,195     $ 1,855     $ 1,467  

 

Note 5 – Net Loss Per Share

 

Historical net loss per share of common stock is computed using the weighted average number of shares of common stock outstanding. Basic loss per share excludes dilution and is computed by dividing net loss available to common stockholders by the weighted average number of shares of common stock outstanding for the period. Stock options, warrants and unvested restricted stock are the only potential dilutive share equivalents the Company has outstanding for the periods presented. For the three months and nine months ended March 31, 2014 and 2013 and the period from November 4, 2003 (inception) to March 31, 2014, options and warrants to purchase common stock were excluded from the computation of diluted earnings per share as their effect would have been antidilutive as the Company incurred net losses during those periods.

 

Note 6 – Risks and Uncertainties

 

Any future decrease in economic activity in China, India or in other regions of the world, in which the Company may in the future do business, could significantly and adversely affect its results of operations and financial condition in a number of other ways. Any decline in economic conditions may reduce the demand for prices from the products from our plants, thus the Company’s ability to finance and develop its existing projects, commence any new projects and sell its products could be adversely impacted.

 

The ZZ Joint Venture began producing and selling methanol in November 2013 and sold 12,664 tonnes of methanol during the three months ended March 31, 2014. The ZZ Joint Venture has worked to complete the plant retrofits and equipment upgrades to enable increased methanol production from integrated syngas and coke oven gas feedstock. Although the ZZ Joint Venture restarted its syngas plant for approximately two weeks during December 2013, it has since stopped syngas production and is currently only using coke oven gas only as feedstock. The ZZ Joint Venture plans to manage syngas production rates to optimize its operation and has secured additional sources of coke oven gas from a local supplier in order to increase methanol production. There can be no assurances that the methanol production operations contemplated by the ZZ Cooperation Agreement will be profitable. Profitability will be dependent on, among other things, our management of the operations of the plant, pricing of methanol, coal and power, and maintaining necessary government approvals.

 

The Yima Joint Venture plant’s refined methanol section was fully commissioned in December 2013, and has operated at limited capacity since that date. Methanol production was approximately 27% of its capacity during the three months ended March 31, 2014. The plant is designed to produce 300,000 tonnes per year of methanol from operating two of its three available gasifiers and has achieved 100% peak syngas production levels and 80% peak methanol production levels. Yima has recently initiated an outage in March that should allow the plant to make improvements to the upstream and downstream units adjacent to the Company’s gasification systems at the Yima Joint Venture plant. Most of these are punch-list items, along with the improvements which have been learned from the past year’s operation at the plant. The improvements are currently scheduled to be completed in the next two to four months. The Company has limited influence on the operating and financial policymaking of the Yima Joint Ventures. There can be no assurances that the Yima Joint Ventures’ operations will be profitable or that dividends will be paid to the Company. There have been a variety of minor construction related shutdowns which are normally seen in the startup of these types of facilities, but the shutdowns have generally not been related to the gasifier systems . In addition, the Yima Joint Ventures still owe the Company approximately $0.67 million for certain gasifiers and gasifier related equipment delivered in 2012, a portion of which is due from the Company to ZCM and the balance to a second vendor for providing equipment associated with the gasifiers. It is unclear when or if the balance of this money will be paid to the Company from the Yima Joint Venture.

 

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Although the Company has made significant progress recently on partnering its China business, the Company expects to continue for a period of time to have negative operating cash flows until it can generate sufficient cash flows from its technology, equipment and services business and SES China (including the ZZ Joint Venture, the Yima Joint Ventures and the ZCM Joint Venture) to cover its general and administrative expenses and other operating costs. In addition, the Company may need to aggressively pursue additional partners in China and may need to seek other equity financing or reduce its operating expenses. The Company will also limit the development of any further projects until it has assurances that acceptable financing is available to complete the project.

 

The Company currently plans to use its available cash for (i) general and administrative expenses; (ii) executing our strategy to develop market based business verticals, (iii) if we are unable to refinance the loan, debt service for the $3.2 million of principal due in September 2014 under the ZZ Short-term Loan; (iv) securing orders and other associated tasks associated with our distributed power initiatives such as in Pakistan with General Electric; and (v) working capital and other general corporate purposes. Although the Company intends for the ZZ Joint Venture to sustain itself through its own earnings in the near term, the Company may also need to make additional contributions to the ZZ Joint Venture in order for it to meet its obligations until the ZZ Joint Venture generates sufficient cash flows to cover its operating costs and debt service. The actual allocation and timing of these expenditures will be dependent on various factors, including changes in the Company’s strategic relationships, commodity prices and industry conditions, and other factors that the Company cannot currently predict. In particular, any future decrease in economic activity in China or in other regions of the world in which the Company may in the future do business could significantly and adversely affect its operating results and financial condition. Operating cash flows from joint venture operating projects can be positively or negatively impacted by changes in coal, power and methanol prices. These are commodities where market pricing is often cyclical in nature and can be volatile.

 

The Company does not currently have all of the financial and human resources to fully develop and execute on all of its other business opportunities; however, the Company intends to finance their development through paid services, technology access fees, equity and debt financings and by securing financial and strategic partners focused on development of these opportunities. The Company can make no assurances that its business operations will provide it with sufficient cash flows to continue its operations. The Company may need to raise additional capital through equity and debt financing for any new ventures that are developed, to support its existing projects and possible expansions thereof and for its corporate general and administrative expenses. The Company is considering a full range of financing options in order to create the most value in the context of the increasing interest the Company is witnessing in its proprietary technology. The Company cannot provide any assurance that any financing will be available to it in the future on acceptable terms or at all. Any such financing could be dilutive to its existing stockholders. If the Company cannot raise required funds on acceptable terms, it may not be able to, among other things, (i) maintain its general and administrative expenses at current levels including retention of key personnel and consultants; (ii) successfully develop its licensing and related service businesses; (iii) negotiate and enter into new gasification plant development contracts and licensing agreements; (iv) make additional capital contributions to its joint ventures; (v) fund certain obligations as they become due; and (vi) respond to competitive pressures or unanticipated capital requirements.

 

Note 7 – Segment Information

 

The Company’s reportable operating segments have been determined in accordance with the Company’s internal management reporting structure and include SES China, Technology Licensing and Related Services, and Corporate. The SES China reporting segment includes all of the assets and operations and related administrative costs for China including initial closing costs relating to the ZCM Joint Venture and the investment in the Yima Joint Ventures. The Technology Licensing and Related Services reporting segment includes all of the Company’s current operating activities outside of China. The Corporate reporting segment includes the executive and administrative expenses of the corporate office in Houston. The Company evaluates performance based upon several factors, of which a primary financial measure is segment operating income or loss.

 

The following table presents statements of operations data and assets by segment (in thousands):

 

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    Three Months Ended     Nine Months Ended  
    March 31,     March 31,  
    2014     2013     2014     2013  
Revenue:                                
SES China   $ 7,235     $     $ 13,149     $ 8  
Technology licensing and related services           303             379  
Total revenue   $ 7,235     $ 303     $ 13,149     $ 387  
                                 
Depreciation and amortization:                                
SES China   $ 520     $ 516     $ 1,552     $ 1,538  
Technology licensing and related services     75       47       169       141  
Corporate & other     1       13       6       43  
Total depreciation and amortization   $ 596     $ 576     $ 1,727     $ 1,722  
                                 
Operating loss:                                
SES China   $ (2,106 )   $ (2,960 )   $ (4,370 )   $ (7,586 )
Technology licensing and related services     (414 )     (343 )     (760 )     (1,491 )
Corporate & other     (1,519 )     (1,771 )     (4,377 )     (3,815 )
Total operating loss   $ (4,039 )   $ (5,074 )   $ (9,507 )   $ (12,892 )
                                 
Interest expense:                                
SES China   $ 101     $ 74     $ 292     $ 249  
Total interest expense   $ 101     $ 74     $ 292     $ 249  
                                 
Equity in losses of joint ventures:                                
SES China   $     $ 204     $     $ 579  
Corporate & other     1       38       2       580  
Total equity in losses of joint ventures   $ 1     $ 242     $ 2     $ 1,159  

 

    March 31,
2014
    June 30,
2013
 
Assets:                
SES China   $ 72,231     $ 76,316  
Technology licensing and related services     924       1,030  
Corporate & other     22,276       11,018  
Total assets   $ 95,431     $ 88,364  

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and the related notes and other financial information included elsewhere in this quarterly report. Some of the information contained in this discussion and analysis or set forth elsewhere in this quarterly report, including information with respect to our plans and strategy for our business and related financing, includes forward-looking statements that involve risks and uncertainties. You should review the “Risk Factors” section of our Annual Report on Form 10-K for the fiscal year ended June 30, 2013 for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

 

Business Overview

 

We are a development stage global energy and gasification technology company that provides proprietary gasification technology systems and solutions to the energy and chemical industries. Our business is to create value by supplying our technology, equipment and services into global projects where lower cost low quality coals, coal wastes, municipal wastes, agricultural biomass, and other biomass feedstocks can be profitably converted through our proprietary gasification technology into clean synthesis gas, or syngas (a mixture of primarily hydrogen, carbon monoxide, and methane), which is then used to produce a variety of high value energy and chemical products. Our initial operating projects to date convert high ash coal and coal wastes to chemical grade methanol, and we are pursuing a variety of additional global projects under development by customers who may use our technology platform to convert low quality coals such as lignite, coal wastes, municipal wastes and agricultural waste biomass to high value products such as electric power, transportation fuels, substitute natural gas, or SNG, fuel for direct reduction iron, or DRI, steel making and other products. Our technology is originally based on the U-GAS ® process developed by the Gas Technology Institute and we have augmented and differentiated the technology through newly developed intellectual property related to design, detailed engineering, constructing, starting up and operating our two commercial joint venture plants in China.

 

We intend to commercialize our technology through supplying our gasification systems consisting of technology, equipment and services to projects globally and to accomplish this largely via value accretive partnerships and collaborations with other companies which operate in the energy and chemical market segments where we believe our technology is highly advantaged. This is a low capital intensity business approach which we believe can generate attractive margins for us through providing our technology differentiated equipment and services in multiple market segments globally with a potential to build meaningful sales opportunities over time. However, to date our principal operating activities have focused in China where we have invested and built two commercial projects and recently entered into a joint venture designed to establish our gasification technology as the leading gasification technology in China and other territories in Asia. We made these investments to fully demonstrate our technology and our capabilities to build and operate, but with this step of commercializing our technology successfully completed, we no longer intend to make such extensive capital investments in the foreseeable future.

 

Our ZZ Joint Venture project is our first commercial scale coal gasification plant and is located in Shandong Province, China. It achieved commercial operation in December 2008. The ZZ Joint Venture is designed to produce clean syngas for sale to an immediately adjacent industrial company who manufactures methanol from the syngas. Under the new commercial structure completed effective October 31, 2013, we assumed control of XE’s methanol facilities and the ZZ Joint Venture plant is operating as an integrated plant which converts coal to syngas and then converts syngas and coke oven gas into methanol, as described in more detail under “Current Operations and Projects – Zao Zhuang Joint Venture.”

 

The Yima Joint Venture project in Henan Province, China generated its first methanol production in December 2012, and is currently in its start-up phase as described in more detail under “Current Operations and Projects.” The Yima Joint Venture plant’s refined methanol section was fully commissioned in December 2013, and has operated at limited capacity since that date. Methanol production was approximately 27% of its capacity during the three months ended March 31, 2014. The plant is designed to produce 300,000 tonnes per year of methanol from operating two of its three available gasifiers and has achieved 100% peak syngas production levels and 80% peak methanol production levels.

 

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We also recently completed the formation of SES-ZCM Clean Energy Technologies Limited (the “ZCM Joint Venture”), our China joint venture with Zhangjiagang Chemical Machinery Co., Ltd. (“ZCM”). The purpose of the ZCM Joint Venture is to establish our gasification technology as the leading gasification technology in the ZCM Joint Venture territory (which is initially China, Indonesia, the Philippines, Vietnam, Mongolia and Malaysia) by becoming a leading provider of proprietary equipment for the technology. The scope of the ZCM Joint Venture is to market and license our gasification technology via project sublicenses; procurement and sale of proprietary equipment and services; coal testing; and engineering, procurement and research and development related to the technology.

 

Our business model is to deploy our technology on a global basis via supplying a technology package, containing license rights to operate a project using our technology, gasification system equipment, and technology related services. As part of our overall strategy we intend to form strategic regional and market-based partnerships or business verticals where our technology offers advantages and through cooperating with these partners grow an installed base of projects. Through collaborative partnering arrangements we believe we will commercialize our technology much faster than entering these markets alone. In addition to regional business units, we are continuing to evaluate and develop our business in markets such as power, steel, fuels, substitute natural gas, chemicals and renewables which can benefit from deploying our technology offering to create these products from low cost coal and renewable feedstocks. We are developing these market-based business vertical opportunities together with strategic partners which have established businesses or interests in these markets with the goal of growing and expanding these businesses by partnering with us and deployment of our technology offering.

 

Our collaboration with GE Packaged Power, Inc., a subsidiary of GE, which began in early 2013 to jointly evaluate and market a small scale power generation unit combining our gasification technology with GE’s aeroderivative gas turbines, is an ongoing example of our market-based business vertical developments underway. We, along with our distributed power collaborators, GE, ISTROENERGO GROUP, Inc. and TUTEN Ltd, have signed our first letter of intent, or LOI, with K-Electric (formerly known as Karachi Electric Supply Company), or KESC. KESC is a large electric utility company in Karachi, Pakistan with over 2.3 GW of installed electric generating capacity. The exclusive LOI calls for a feasibility engineering and financial evaluation of a coal gasification power generation project with a capacity between 90 and 200 MW to be constructed near Karachi. The completed feasibility study will serve as the basis for further discussions and negotiations for a syngas power plant contract. We believe the distributed power segment offers opportunity over time to provide meaningful sales opportunities for our gasification technology and equipment systems. We intend to focus on the continued development of this business vertical. We are also advancing developments via technology integration studies with potential partners for business verticals in DRI steel and “green” chemicals derived from municipal wastes. We have also formalized agreements with Simon India Ltd., a subsidiary of the Adventz Group, for marketing our technology in India which we believe is an important growth region for which our technology is uniquely well suited.

 

We believe our existing operating projects in China have clearly demonstrated that we have several advantages which differentiate our technology over other commercially available gasification technologies, such as entrained flow, fixed bed, and moving bed gasification technologies. The first of these advantages is our ability to use a wide range of feedstocks (including low rank, high ash and high moisture coals, which are significantly cheaper than higher grade coals), coal wastes, municipal wastes, agricultural wastes, and other biomass feedstocks to make clean syngas. Our feedstock advantage opens up many of these global resources for use to manufacture energy and chemical products which otherwise could not be done with other currently available commercial gasification technologies.  Secondly, our technology’s advanced fluidized bed design is extremely tolerant to a wide range changes in feedstock during operation, which allows for flexible fuel purchasing for our customers. Additionally, our technology can use much less water and its simple design leads to more favorable fabrication costs and resulting plant costs being lower compared to other commercially available technologies. We believe these important cost, feedstock flexibility, and water consumption factors position our technology for future deployment of gasification worldwide because our technology can enable projects to become a lower cost producer of products. Depending on local market needs and fuel sources, our syngas can be used to produce many valuable products including electric power, SNG, chemicals such as methanol, dimethyl ether, or DME, and glycol, ammonia for fertilizer production, reducing gas for DRI processes, and transportation fuels such as gasoline and diesel.

 

The key elements of our business strategy include:

 

Grow our China business platform. On February 14, 2014, SES Asia Technologies Limited, a wholly owned subsidiary of the Company entered into a Joint Venture Contract (the “JV Contract”) with Zhangjiagang Chemical Machinery Co., Ltd. (“ZCM”) to form SES-ZCM Clean Energy Technologies Limited (the “ZCM Joint Venture”). The purpose of the ZCM Joint Venture is to establish the Company’s gasification technology as the leading gasification technology in the ZCM Joint Venture territory (which is initially China, Indonesia, the Philippines, Vietnam, Mongolia and Malaysia) by becoming a leading provider of proprietary equipment for the technology. The scope of the ZCM Joint Venture is to market and license our gasification technology via project sublicenses; procurement and sale of proprietary equipment and services; coal testing; and engineering, procurement and research and development related to the technology. ZCM is contributing RMB 100,000,000 (approximately USD $16 million) in cash to the ZCM Joint Venture, and owns approximately 65% of the ZCM Joint Venture, and we have contributed an exclusive license to use of its technology in the ZCM Joint Venture territory pursuant to the terms of a Technology Usage and Contribution Agreement entered into among the ZCM Joint Venture, ZCM and us (the “TUCA”) on the same date, and owns approximately 35% of the ZCM Joint Venture.

 

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We have partnered a significant portion of SES China with ZCM, a financially strong and highly skilled Chinese company which desires to invest into the growth of China’s clean energy space and which recognizes the opportunity afforded by our technology capability and business model.  We believe partnering with ZCM can accelerate the commercialization of our technology on a global basis and will enable us to reduce our capital requirements to achieve this acceleration. In addition, our SES China business will not only support the growth of our ZCM Joint Venture but we believe will also build new partnerships in China within market segments such as DRI steel, power, transportation fuels and for longer term value creation, larger scale SNG projects utilizing low rank coal resources and biomass where our technology brings. We intend to form business verticals where we can secure ownership positions in these market vertical partnerships that both help build value for the ZCM Joint Venture and for our SES China business.

 

Operation of existing plants. The ZZ Joint Venture plant was designed to produce clean syngas for sale to an immediately adjacent industrial company which manufactured methanol from coke oven gas and syngas.  We successfully operated the ZZ Joint Venture’s syngas plant for over three years through September 2011, and since then held it idle while an expanded commercial structure was negotiated with Hai Hua, the former syngas buyer.  Under the new commercial structure completed effective October 31, 2013, we assumed control of XE’s methanol facilities and the ZZ Joint Venture plant is operating as an integrated plant which converts coal to syngas and then converts syngas and coke oven gas into methanol, as described in more detail under “Current Operations and Projects – Zao Zhuang Joint Venture.” The ZZ Joint Venture expects to resume syngas production in the near term and is also working to secure additional sources of coke oven gas from a local supplier in order to increase methanol production. The Yima Joint Venture plant generated its first methanol production in December 2012. The Yima Joint Venture plant’s refined methanol section was fully commissioned in December 2013, and has operated at limited capacity since that date. The plant is designed to produce 300,000 tonnes per year of methanol from operating two of its three available gasifiers and has achieved 100% peak syngas production levels and 80% peak methanol production levels. This plant is providing a commercial demonstration of our technology as deployed on a much larger scale than the ZZ Joint Venture plant.

 

Strategic partnerships and collaborations in key market segments through new business verticals. We intend to commercialize our technology through supplying our gasification systems consisting of technology, equipment and services to projects globally and to accomplish this largely via value accretive partnerships and collaborations with other companies which operate in the energy and chemical market segments where we believe our technology has strong competitive advantages.  This is a low capital intensity business approach which we believe can generate attractive margins for us through providing our technology differentiated equipment and services in multiple market segments globally with a potential to build meaningful sales opportunities over time.  As part of our overall strategy we intend to form strategic regional and market-based partnerships or business verticals where our technology offers advantages and through cooperating with these partners grow an installed base of projects. This includes our transactions with Hongye and Zhongmo for SES China and strategic collaborations in specific markets that will enable us to expand our business. Building on our success in China, we have formalized other early stage business vertical relationships through marketing agreements including with GE’s Packaged Power Inc. for global distributed power generation projects and with Simon India Ltd, an Adventz Group company, to exclusively market our technology in India. The most modern and environmentally friendly types of new steel plants include an iron ore processing step called DRI that replaces dirty blast furnaces.   Syngas produced by our technology has a composition that is especially well-suited for use in DRI, and our process’ ability to utilize low-cost coal and coal wastes makes it especially economical in this application.   In addition, we are also developing additional business vertical opportunities to integrate our technology with DRI steel making technology for a coal-to-steel solution and for evaluating projects that can make methanol and other commodities from refuse derived fuels from our technology.  Our most recent example of a partnering initiative is the ZCM Joint Venture to establish our gasification technology as the leading gasification technology in the ZCM Joint Venture territory (which is initially China, Indonesia, the Philippines, Vietnam, Mongolia and Malaysia) by becoming a leading provider of proprietary equipment for the technology. The scope of the ZCM Joint Venture is to market and license our gasification technology via project sublicenses; procurement and sale of proprietary equipment and services; coal testing; and engineering, procurement and research and development related to the technology.

 

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Leveraging our proprietary technology through licensing, equipment sales and related services to increase revenues and position us for future growth .  We provide a proprietary technology package whereby we license our technology rights to third parties, deliver an engineered technology package and sell proprietary equipment components to customers who have contracted to own and operate projects using our technology. We intend to focus on developing opportunities for our proprietary technology package whereby we may (i) integrate our gasification process technology package with downstream technologies to provide a fully integrated offering where we may invest in projects either directly or through an investment partner or (ii) may partner with engineering, equipment and technology companies to provide our gasification process technology package into an integrated and modular product offering. We anticipate that we can increase revenues through collecting technology licensing fees and royalties, engineering and technical service fees, as well as equipment product sales to customers who have contracted to own and operate projects which incorporate our proprietary technology. We also believe that our licensing activities will provide insight into project development activities, which may allow us to make selective equity investments in such projects in the future, or take options in projects for which we provide a license.

 

Developing value where we have a competitive advantage and have access rights to feedstock resources. We believe that we have the greatest competitive advantage using our gasification technology in situations where there is a ready source of low quality coal, coal waste or biomass to utilize as a feedstock. We are focusing our efforts globally together with our partners in countries with large low rank coal resources, but our principal operating activities to-date have focused on China and India. In the U.S. and certain other countries, we believe there may be opportunities for us to leverage the capability of our technology to efficiently and cleanly gasify coal wastes or biomass material to make renewable fuels or “green chemicals”. Today’s regulatory environment in the U.S. is favorable for these types of projects because increased environmental concerns are creating a market demand for renewable fuels and companies are under increasing pressure to reduce their carbon footprint. In addition, existing coal fired power generating assets that are facing costly air emission control upgrades or else being retired are a potential market to convert to syngas fired gas turbine generating stations using the existing coal handling infrastructure and our technology.

 

Continue to develop and improve our technology. We are continually seeking to improve the overall plant availability, plant efficiency and fuel handling capabilities of our gasification technology. We are continuing to work with our prospective customers to determine the suitability of their low rank coals for our technology through proprietary coal characterization testing and bench scale gasification tests. Additionally, we are growing our technology base through (i) continued development of know-how with our engineering and technical staff, (ii) growing and protecting our trade secrets as a result of patenting improvements tested at our ZZ and Yima Joint Venture plants, (iii) developing improvements resulting from integration of our technology with downstream processes, and (iv) developing improvements resulting from scaling up the design of our technology in pressure and capacity. Examples of our technology development include our Fines Management System and Ash Management System which increase overall efficiency. We have several patent applications pending relating to these technology improvements in addition to a number of other improvements to increase the gasifier availability and to lower the costs of the gasifier installation and subsequent operations.

 

Grow earnings through increased revenues, joint venture projects and control of expenses. We remain intently focused on control of our expenses while we grow revenues from our technology business and operating projects. We believe our strategy will allow us to develop revenues and operating cash flows necessary for sustainable long term growth. We anticipate that we can generate revenues through equipment supply, engineering and technical service fees, licensing fees and royalties on products sold by our licensees that incorporate our proprietary technology without incurring the significant capital costs required to develop and construct a plant. We also believe that our licensing activities will provide additional insight into project development activities, which may provide us opportunities to make selective equity investments in such infrastructure projects in the future and also the development of integrated, modular product offerings. We have initiated discussions with companies that have expressed interest in partnering with us on a strategic basis to accelerate our business and in some cases who are willing to pay us to bring our technology into an industry-specific joint venture. We intend to minimize project development expense until we have assurances that acceptable financing is available to complete our projects. Until we have such assurances, our strategy will be to operate using our current capital resources and to leverage the resources of strategic relationships or financing partners. We have taken and may take additional steps to significantly reduce expenses, particularly in China, to align our development efforts with available cash resources until we can execute arrangements with a suitable partner.

 

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Results of Operations

 

We are in our development stage and therefore have had limited operations. We have sustained cumulative net losses of approximately $167 million from November 4, 2003, the date of our inception, to March 31, 2014.

 

Three Months Ended March 31, 2014 Compared to the Three Months Ended March 31, 2013

 

Revenue . Total revenue increased to $7.2 million for the three months ended March 31, 2014 compared to $0.3 million for the three months ended March 31, 2013.

 

Our ZZ Joint Venture began producing and selling methanol in November 2013 and sold 12,664 tonnes of methanol during the three months ended March 31, 2014, generating approximately $4.6 million of revenue. There was no product sales revenue for the three months ended March 31, 2013.

 

In January 2011, we signed gasifier sales agreements with the Yima Joint Ventures to sell gasifiers and gasifier related equipment for an aggregate contract price of $3.0 million. A portion of the equipment associated with these orders was ordered from ZCM. The gasifiers were completed and delivered in January 2012 to the Yima Joint Ventures. As of March 31, 2014, the Yima Joint Ventures had paid $2.4 million of the total contract price and still owed the remaining payment approximately of $0.67 million to us. We still owed $0.67 million to both ZCM and an additional vendor associated with the equipment purchase, which is accrued as a current liability on our consolidated balance sheet.

 

There was no technology licensing and related services revenues for the three months ended March 31, 2014, compared to $0.3 million of technology licensing and related services revenues for the three months ended March 31, 2013 which resulted from engineering feasibility studies and coal testing services for two customers.

 

Costs of sales and plant operating expenses. Costs of sales and plant operating expenses increased by $7.5 million to $7.8 million for the three months ended March 31, 2014 compared to $0.3 million for the three months ended March 31, 2013. The increase was primarily related to the costs of $2.6 million incurred for building the gasifiers for our Yima Joint Ventures, $5.0 million incurred for ZZ Joint Venture’s production of methanol from coke oven gas purchased from Xuecheng Energy and from syngas produced by the ZZ Joint Venture’s syngas plant, those costs include electricity, coke oven gas feedstock, coal feedstock to produce syngas, labor and other operating costs. In addition, the ZZ Joint Venture incurred approximately $0.2 million during the three months ended March 31, 2014 for non-routine repairs and retrofit expenses incurred for the new operations and restart of its syngas plant (need get number from China). Although the ZZ Joint Venture restarted its syngas plant for approximately two weeks during December 2013, it has since stopped syngas production and is currently only using coke oven gas as feedstock. The ZZ Joint Venture plans to resume syngas production in the near term and is also working to secure additional sources of coke oven gas from a local supplier in order to increase methanol production.

 

General and administrative expenses. General and administrative expenses decreased by $0.8 million to $2.5 million for the three months ended March 31, 2014 compared to $3.3 million for the three months ended March 31, 2013. The decrease was due primarily to a reduction of consulting fees resulting from the termination of the consulting agreement with CVE as of August 31, 2013 and reductions in employee related compensation cost resulting from reducing headcount in China during fiscal 2014. Recurring general and administrative expenses consist primarily of compensation, professional and consulting fees, travel, and other costs of our corporate, development and administrative functions in Houston and Shanghai, and project and technical development expenses.

 

Stock-based compensation expense. Stock-based compensation expense decreased by $0.9 million to $0.3 million for the three months ended March 31, 2014 compared to $1.2 million for the three months ended March 31, 2013. The decrease was due primarily to expensing of approximately $0.5 million for the excess of the fair value over the consideration paid for shares of common stock and warrants issued to CVE under the unit purchase agreement closed in February 2013, and $0.4 million expenses for shares and warrants issued in connection with CVE’s consulting agreement for the three months ended March 31, 2013, and expensing the estimated fair values of stock options awarded to directors and employees during the period.

 

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Depreciation and amortization. Depreciation and amortization expense was $0.6 million for both of the three months ended March 31, 2014 and 2013 and was primarily related to depreciation of our ZZ Joint Venture’s syngas plant assets.

 

Equity in losses of joint ventures. Equity in losses of joint ventures was $1,000 for the three months ended March 31, 2014 compared with $0.2 million for the three months ended March 31, 2013 which related to our 25% share of the start-up losses incurred by the Yima Joint Ventures and our 50% share of the start-up losses incurred by SES Resource Solutions, Ltd., or SRS. The losses of the Yima Joint Ventures related to non-capitalizable costs incurred during the design, construction, commissioning and start-up phases. The SRS losses related to development costs including the value of Midas’ contributed services, consulting and travel expenses. We suspended SRS joint ventures activities in December 2012, and changed from the equity method to the cost method of accounting for Yima Joint Ventures as of June 1, 2013.

 

Foreign currency gain . Foreign currency gain was $6,000 for the three months ended March 31, 2014 and $12,000 for the three months ended March 31, 2013. These amounts resulted from the appreciation of the Renminbi Yuan relative to the U.S. dollar.

 

Interest expense. Interest expense increased by $27,000 to $101,000 for the three months ended March 31, 2014 compared to $74,000 for the three months ended March 31, 2013. Our interest expense relates to the ZZ Joint Venture’s short-term loan with Zaozhuang Bank Co. Ltd., or the ZZ Short-term Loan and its loan with Industrial and Commercial Bank of China, or ICBC. The ZZ Joint Venture repaid its final principal payment of RMB 7.3 million (approximately $1.2 million) to ICBC in January 2014. The increase in interest expense was due primarily to the higher interest rate and higher remaining balance on the ZZ Short-term Loan borrowed in September 2013.

 

Nine Months Ended March 31, 2014 Compared to the Nine Months Ended March 31, 2013

 

Revenue . Total revenue increased to $13.1 million for the nine months ended March 31, 2014 compared to $0.4 million for the nine months ended March 31, 2013.

 

Our ZZ Joint Venture began producing and selling methanol in November 2013 and sold over 22,791 tonnes of methanol during the nine months ended March 31, 2014 generating approximately $9.0 million of revenue. Pursuant to the ZZ Cooperation Agreement, prior payments of approximately $1.8 million from Xuejiao were applied to settling the prior payments due under the syngas purchase and sale agreement. As a result, the ZZ Joint Venture recognized these related party advances as product sales of approximately $1.5 million, net of value-added taxes as of December 31, 2013. There was no product sales revenue for the nine months ended March 31, 2013.

 

In January 2011, we signed gasifier sales agreements with the Yima Joint Ventures to sell gasifiers and gasifier related equipment for an aggregate contract price of $3.0 million. A portion of the equipment associated with these orders was ordered from ZCM. The gasifiers were completed and delivered in January 2012 to the Yima Joint Ventures. As of March 31, 2014, the Yima Joint Ventures had paid $2.4 million of the total contract price and still owed the remaining payment approximately of $0.67 million to us. We still owed $0.67 million to both ZCM and an additional vendor associated with the equipment purchase, which is accrued as a current liability on our consolidated balance sheet.

 

There were no technology licensing and related services revenues for the nine months ended March 31, 2014, compared to $0.4 million of technology licensing and related services revenues for the nine months ended March 31, 2013 which resulted from engineering feasibility studies and coal testing services for primarily two customers.

 

Costs of product sales and plant operating expenses. Costs of sales and plant operating expenses increased by $11.5 million to $12 million for the nine months ended March 31, 2014 compared to $0.5 million for the nine months ended March 31, 2013. The increase was primarily related to the costs of $2.6 million incurred for building the gasifiers for our Yima Joint Ventures, $8.8 million incurred for ZZ Joint Venture’s production of methanol from coke oven gas purchased from Xuecheng Energy and from syngas produced by the ZZ Joint Venture’s syngas plant, those costs include electricity, coke oven gas feedstock, coal feedstock to produce syngas, labor and other operating costs. In addition, the ZZ Joint Venture incurred approximately $0.6 million during the nine months ended March 31, 2014 for non-routine repairs and retrofit expenses incurred for the new operations and restart of its syngas plant (need get number from China). Although the ZZ Joint Venture restarted its syngas plant for approximately two weeks during December 2013, it has since stopped syngas production and is using coke oven gas only as its feedstock until additional coke oven gas supply is available. The ZZ Joint Venture plans to resume syngas production in the near term and is also working to secure additional sources of coke oven gas from a local supplier in order to increase its methanol production capability.

 

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General and administrative expenses. General and administrative expenses decreased $2.5 million to $7.1 million for the nine months ended March 31, 2014 compared with $9.6 million for the nine months ended March 31, 2013. The decrease was due primarily to a reduction of consulting fees resulting from the termination of our consulting agreement with CVE as of August 31, 2013, a reduction in royalty expense due under our licensing agreement with GTI, and other reductions in employee related compensation cost resulting from reducing headcount in China during fiscal 2014. Recurring general and administrative expenses consist primarily of compensation, professional and consulting fees, travel, and other costs of our corporate, development and administrative functions in Houston and Shanghai, and project and technical development expenses

 

Stock-based compensation expense. Stock-based compensation expense increased $0.4 million to $1.9 million for the nine months ended March 31, 2014 compared to $1.5 million for the nine months ended March 31, 2013. The increase was due primarily to the expensing of the fair values of shares and warrants issued in connection with our consulting agreements with MDC, expensing the excess of the fair value over the consideration paid for shares of common stock and warrants issued to CVE under a unit purchase agreement in August 2013 and expensing the estimated fair values of stock options awarded to officers, employees and directors during the period.

 

Depreciation and amortization. Depreciation and amortization expense was $1.7 million for both the nine months ended March 31, 2014 and March 31, 2013 and was primarily related to depreciation of our ZZ Joint Venture plant’s assets.

 

Equity in losses of joint ventures. The equity in losses of joint ventures was $2,000 for the nine months ended March 31, 2014 compared with $1.2 million for the nine months ended March 31, 2013 and relates to our 25% share of the start-up losses incurred by the Yima Joint Ventures and our 50% share of the start-up losses incurred by SRS. The losses of the Yima Joint Ventures related to non-capitalizable costs incurred during the design, construction, commissioning and start-up phases. The losses of SRS related to development costs including the value of Midas’ contributed services, consulting and travel expenses. The decrease in equity in losses of joint ventures was due primarily to the suspension of the SRS joint ventures activities since December 2012 and due to our change from the equity method to the cost method of accounting for Yima Joint Ventures as of June 1, 2013.

 

Foreign currency (gain) loss . Foreign currency loss was $5,000 for the nine months ended March 31, 2014 and foreign currency gain was $26,000 for the nine months ended March 31, 2013. These amounts resulted from the appreciation and depreciation, as applicable, of the Renminbi Yuan relative to the U.S. dollar.

 

Interest expense. Interest expense was $0.3 million and $0.2 million for the nine months ended March 31, 2014 and 2013, respectively. Our interest expense relates to the ZZ Short-term Loan and its loan with ICBC. The ZZ Joint Venture repaid its final principal payment of RMB 7.3 million (approximately $1.2 million) to ICBC in January 2014. The increase in interest expense was due primarily to the higher interest rate and higher remaining balance on the ZZ Short-term Loan borrowed in September 2013.

   

Liquidity and Capital Resources

 

We are in our development stage and have financed our operations to date through private placements of our common stock in and three public offerings, one in November 2007, one in June 2008 and one in March 2014. We have used the proceeds of these offerings primarily for the development of our technology including the investments in the ZZ Joint Venture and the Yima Joint Ventures, and to pay other business development and general and administrative expenses. In addition, (as described below) the ZZ Joint Venture had a loan agreement with ICBC which funded certain of its plant’s construction costs, and the ZZ Short-term Loan funded in September 2013 to finance costs related to the ZZ Cooperation Agreement.

 

As of March 31, 2014, we had $21.7 million in cash and cash equivalents, and $14.7 million of working capital available to us. During the nine months ended March 31, 2014, we used $7.2 million in operating activities compared to $10.4 million for the nine months ended March 31, 2013. We used $2.3 million in investing activities for the nine months ended March 31, 2014 including $0.8 million for capital expenditures related to the ZZ Cooperation Agreement and $1.5 million for royalties due to GTI for the Yima Joint Venture’s license accounted for as part of our investment in the Yima Joint Ventures.

 

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For both the nine months ended March 31, 2014 and 2013, we used $2.4 million in financing activities for the scheduled semi-annual principal payments on the ZZ Joint Venture’s loan with ICBC. On September 10, 2013, the ZZ Joint Venture received proceeds of approximately $3.3 million under a short-term bank loan with ZaoZhuang Bank which is due and payable on September 9, 2014. On March 24, 2014, we received $15 million of gross proceeds from the sale of 8,333,341 shares of our common stock plus warrants to acquire 4,166,667 shares of common stock in a registered direct offering. On August 1, 2013, we received proceeds of $100,000 and issued 136,986 shares of our common stock and issued warrants to acquire 136,986 shares of our common stock under a Unit Purchase Agreement with CVE. In September and October 2012, we received $9.2 million of gross proceeds from sales of our common stock to Hongye. In October 2012, we received approximately $6.3 million of gross proceeds from sales of our common stock to Zhongmo.

 

We currently plan to use our available cash for (i) general and administrative expenses; (ii) executing our strategy to develop market based business verticals, (iii) if we are unable to refinance the loan, debt service for the $3.2 million of principal due in September 2014 under the ZZ Short-term Loan; (iv) securing orders and other associated tasks associated with our distributed power initiatives such as in Pakistan with General Electric; and (v) working capital and other general corporate purposes. Although we intend for the ZZ Joint Venture to sustain itself through its own earnings in the near term, we may also need to make additional contributions to the ZZ Joint Venture in order for it to meet its obligations until the ZZ Joint Venture generates sufficient cash flows to cover its operating costs and debt service.

 

Loan Agreement with ICBC

 

On March 22, 2007, the ZZ Joint Venture entered into a seven-year loan agreement and received approximately $12.6 million of loan proceeds pursuant to the terms of a Fixed Asset Loan Contract with ICBC to complete the project financing for the ZZ Joint Venture. Interest was adjusted annually based upon the standard rate announced each year by the People’s Bank of China. The final principal payment of RMB 7.3 million (approximately $1.2 million) was repaid in January 2014.

 

Short-term Loan Agreement with Zaozhuang Bank Co., Ltd

 

On September 10, 2013, the ZZ Joint Venture entered into the ZZ Short-term Loan and received approximately $3.2 million of loan proceeds for the retrofit and related costs contemplated by the ZZ Cooperation Agreement. Key terms of the ZZ Short-term Loan are as follows:

 

Loan term is one year, due on September 9, 2014;

 

Interest is payable monthly at an annual rate of 10.8%;

 

Certain assets of the ZZ Joint Venture, including land use rights and the administration building, are pledged as collateral; and

 

Subject to customary events of default which, should one or more of them occur and be continuing, would permit Zaozhuang Bank Co., Ltd. to declare all amounts owing under the agreement to be due and payable immediately.

 

Current Operations and Projects

 

Zao Zhuang Joint Venture

 

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Joint Venture Agreement

 

On July 6, 2006, the ZZ Joint Venture entered into a cooperative joint venture contract with Shandong Hai Hua Coal & Chemical Company Ltd., or Hai Hua, which established Synthesis Energy Systems (Zao Zhuang) New Gas Company Ltd., or the ZZ Joint Venture, a joint venture company that has the primary purposes of (i) developing, constructing and operating a syngas production plant utilizing the U-GAS ® technology in Zao Zhuang City, Shandong Province, China and (ii) producing and selling syngas and the various byproducts of the plant. In August 2012, Hai Hua’s name was changed to Shandong Weijiao Group Xuecheng Energy Company Ltd., or Xuecheng Energy, after a change in control transaction. We own 97.6% of the ZZ Joint Venture and Xuecheng Energy owns the remaining 2.4%. We consolidate the results of the ZZ Joint Venture in our consolidated financial statements.

 

We successfully operated the ZZ Joint Venture’s syngas plant for over three years through September 2011, and since then held it idle while an expanded commercial structure was negotiated with Hai Hua.  During this operating period, the plant demonstrated the ability to process a wide range of coals, coal washery wastes and lignite coals from Inner Mongolia China and Australia.

 

On July 24, 2013, the ZZ Joint Venture entered into a cooperation agreement (the “ZZ Cooperation Agreement”) with Xuecheng Energy and its parent company, Shandong Xuejiao Chemical Co., Ltd. (collectively referred to as “Xuejiao”), which serves to supersede the existing syngas purchase and sale agreement among the parties dated October 22, 2006 and supplemented previously in 2008. The ZZ Cooperation Agreement, which became effective on October 31, 2013, represents the basis for an integrated syngas to methanol operation and resolution of the nonpayment of the contractual capacity fees by Xuejiao.  Under the terms of the ZZ Cooperation Agreement, Xuejiao will (i) provide the ZZ Joint Venture with use of their methanol plant for ten years at no cost to the ZZ Joint Venture, (ii) provide a bank loan guarantee of approximately $3.2 million for a majority of the financing necessary for the ZZ Joint Venture for the retrofit and related costs of the ZZ Joint Venture plant, (iii) waive certain advances previously made to the ZZ Joint Venture and (iv) supply discounted coke oven gas produced by its existing coke ovens to be used in combination with synthesis gas to produce refined methanol from the new ZZ Joint Venture integrated syngas methanol operation. The new integrated operation will be managed by the ZZ Joint Venture.

 

Effective October 31, 2013, the ZZ Joint Venture terminated and waived its claims to past due capacity fees owed by Xuejiao under the prior syngas purchase and sale agreement. Pursuant to the ZZ Cooperation Agreement, prior payments of approximately $1.8 million were applied to settling the prior payments due under the syngas purchase and sale agreement. As a result, the ZZ Joint Venture recognized these related party advances as product sales of approximately $1.5 million, net of value-added taxes, during the three months ended December 31, 2013.

 

The ZZ Joint Venture began producing and selling methanol in November 2013 and sold 22,791 tonnes of methanol during the nine months ended March 31, 2014 generating approximately $9.0 million of revenue. We assumed operational control of the integrated methanol production facility in October 2013 under a restructured commercial arrangement. The ZZ Joint Venture has worked to complete the plant retrofits and equipment upgrades to enable increased methanol production from integrated syngas and coke oven gas feedstock. The ZZ Joint Venture is now operating an integrated plant which has two operating modes where it (i) converts coke oven gas directly to methanol and (ii) converts coal to syngas, then blends the syngas and coke oven gas at a specific ratio to produce additional quantities of methanol.  The ZZ Joint Venture began producing and selling methanol in November 2013 from coke oven gas. The ZZ Joint Venture restarted its syngas plant for approximately two weeks during December 2013. In January 2014, the ZZ Joint Venture produced methanol only from coke oven gas due to lower coke oven gas supplies during the cold weather. The ZZ Joint Venture intends to manage syngas production in order to optimize results. The syngas facility will generally operate when adequate coke oven gas supplies are available to achieve the correct syngas to coke oven gas blend ratio. The ZZ Joint Venture also recently executed agreements to secure an additional minimum 4,000 normal cubic meters per hour of coke oven gas from a local supplier, with a target of 5,000 normal cubic meters per hour, in order to increase methanol production and reduce supply risks. This additional coke oven gas represents approximately a 30% increase in feedstock supply for the ZZ Joint Venture Plant.

 

Additionally, we are also evaluating alternative products and partnership structures for a possible expansion of the ZZ Joint Venture plant. In 2010, the ZZ Joint Venture received the necessary government approval for an expansion into monnethylene glycol production. This expansion project remains under evaluation by us. We are also evaluating certain new downstream technologies to produce high value products. 

 

Although we intend for the ZZ Joint Venture to sustain itself through its own earnings in the near term, we may need to make additional contributions to the ZZ Joint Venture in order for it to meet its obligations, including the ZZ Short-term Loan due in September 2014 unless such loan can be refinanced.

 

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Yima Joint Ventures

 

In August 2009, we entered into amended joint venture contracts with Yima Coal Industry (Group) Co., Ltd., or Yima, replacing the prior joint venture contracts entered into in October 2008 and April 2009. The joint ventures were formed for each of the gasification, methanol/methanol protein production, and utility island components of the plant, or collectively, the Yima Joint Ventures. The amended joint venture contracts provide that: (i) we and Yima contribute equity of 25% and 75%, respectively, to the Yima Joint Ventures; (ii) Yima will guarantee the repayment of loans from third party lenders for 50% of the project’s cost and, if debt financing is not available, Yima is obligated to provide debt financing via shareholder loans to the project until the project is able to secure third-party debt financing; and (iii) Yima will supply coal to the project from a mine located in close proximity to the project at a preferential price subject to a definitive agreement to be subsequently negotiated. In connection with entering into the amended contracts, we and Yima contributed remaining cash equity contributions of $29.3 million and $90.8 million, respectively, to the Yima Joint Ventures during the three months ended September 30, 2009. We will also be responsible for our share of any cost overruns on the project.

   

In exchange for such capital contributions, we own a 25% interest in each joint venture and Yima owns a 75% interest. Notwithstanding this, in connection with an expansion of the project, we have the option to contribute a greater percentage of capital for the expansion, such that as a result, we would have up to a 49% ownership interest in the Yima Joint Ventures.

 

The remaining capital for the project has been funded with project debt obtained by the Yima Joint Ventures. Yima agreed to guarantee the project debt in order to secure debt financing from domestic Chinese banking sources. We have agreed to pledge to Yima our ownership interests in the joint ventures as security for our obligations under any project guarantee. In the event that the necessary additional debt financing is not obtained, Yima has agreed to provide a loan to the joint ventures to satisfy the remaining capital needs of the project with terms comparable to current market rates at the time of the loan.

 

The Yima Joint Venture plant’s refined methanol section was fully commissioned in December 2013, and has operated at limited capacity since that date. Methanol production was approximately 27% of its capacity during the three months ended March 31, 2014. The plant is designed to produce 300,000 tonnes per year of methanol from operating two of its three available gasifiers and has achieved 100% peak syngas production levels and 80% peak methanol production levels. Yima has recently initiated an outage in March that should allow the plant to make improvements to the upstream and downstream units adjacent to our gasification systems at the Yima Joint Venture plant. Most of these are punch-list items, along with the improvements which have been learned from the past year’s operation at the plant. The improvements are currently scheduled to be completed in the next two to four months.

   

Under the terms of the joint venture agreements, the Yima Joint Ventures are to be governed by a board of directors consisting of eight directors, two of whom were appointed by us and six of whom were appointed by Yima. The joint ventures also have officers that are nominated by us, Yima and/or the board of directors pursuant to the terms of the joint venture contracts. We and Yima shall share the profits, and bear the risks and losses, of the joint ventures in proportion to our respective ownership interests. The term of the joint venture shall commence upon each joint venture company obtaining its business operating license and shall end 30 years after commercial operation of the plant.

   

We have experienced little ability to influence the Yima Joint Ventures’ operating performance and we are relying on Yima's management to achieve an efficient ramp up to full operations. As of June 1, 2013, we concluded that we are unable to exercise significant influence over the Yima Joint Ventures, resulting in certain accounting changes described in “Note 2 – Joint Ventures - Yima Joint Ventures.”  Our conclusion regarding our lack of significant influence is based on our interactions with the Yima Joint Ventures related to the start-up and operations and due to various other circumstances including limited participation in operating and financial policymaking processes and our limited ability to influence technological decisions. We are continuing to attempt to improve our influence on the Yima Joint Ventures.

 

We have included approximately $3.0 million of royalty costs due to GTI for the Yima Joint Ventures’ U-GAS ® license as part of our investment in joint ventures on our consolidated balance sheet including a $1.5 million payment paid to GTI in June 2009 (when the amended joint venture contracts were signed), a $0.5 million payment in October 2013, and $1.0 million of payments in January 2014.

 

In January 2011, we signed gasifier sales agreements with the Yima Joint Ventures to sell gasifiers and gasifier related equipment for an aggregate contract price of $3.0 million. A portion of the equipment associated with these orders was ordered from ZCM. The gasifiers were completed and delivered in January 2012 to the Yima Joint Ventures. As of March 31, 2014, the Yima Joint Ventures had paid $2.4 million of the total contract price and still owed us the remaining payment of approximately $0.67 million. We still owe $0.67 million to both ZCM and an additional vendor associated with the equipment purchase, which is accrued as a current liability on our consolidated balance sheet.

 

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Joint Venture with ZCM

 

Joint Venture Contract

 

On February 14, 2014, SES Asia Technologies Limited, one of our wholly owned subsidiaries entered into a Joint Venture Contract with ZCM to form the ZCM Joint Venture. The purpose of the ZCM Joint Venture is to establish our gasification technology as the leading gasification technology in the ZCM Joint Venture territory (which is initially China, Indonesia, the Philippines, Vietnam, Mongolia and Malaysia) by becoming a leading provider of proprietary equipment for the technology. The scope of the ZCM Joint Venture is to market and license our gasification technology via project sublicenses; procurement and sale of proprietary equipment and services; coal testing; and engineering, procurement and research and development related to the technology. ZCM is contributing RMB 100,000,000 (approximately USD$16 million) in cash to the ZCM Joint Venture, and owns approximately 65% of the ZCM Joint Venture, and we have contributed an exclusive license to use of its technology in the ZCM Joint Venture territory pursuant to the terms of a Technology Usage and Contribution Agreement entered into among the ZCM Joint Venture, ZCM and us (the “TUCA”) on the same date, and owns approximately 35% of the ZCM Joint Venture.

 

Under the JV Contract, neither party may transfer their interests in the ZCM Joint Venture without first offering such interests to the other party. Notwithstanding this, we have the right until 30 days after the first project sublicense is entered into by the ZCM Joint Venture to transfer 5% of its interest to a financial investor. If we elect not to transfer such 5% interest during that period, ZCM has the option to purchase such interest from us for RMB 10,000,000 (approximately USD$16 million).

 

The JV Contract also includes a non-competition provision which requires that the JV be the exclusive legal entity within the ZCM Joint Venture territory for the marketing and sale of any gasification technology or related equipment that utilizes low quality coal feedstock. Notwithstanding this, ZCM has the right to manufacture and sell gasification equipment outside the scope of the ZCM Joint Venture within the ZCM Joint Venture territory. In addition, we have the right to develop and invest equity in projects outside of the ZCM Joint Venture within the ZCM Joint Venture territory. After the termination of the ZCM Joint Venture, ZCM must obtain written consent from us for the market development of any gasification technology that utilizes feedstock in the ZCM Joint Venture territory.

 

The JV Contract may be terminated upon, among other things, (i) a material breach of the JV Contract which is not cured, (ii) a violation of the TUCA, (iii) the failure to obtain positive net income within 24 months of establishing the ZCM Joint Venture or (iv) mutual agreement of the parties.

 

On March 18, 2014, the ZCM Joint Venture received the required 20-year business license from the State Administration for Industry & Commerce of the People’s Republic of China (SAIC) in Zhangjiagang. On April 8, 2014, the transactions were completed and the ZCM Joint Venture began operations.

 

Technology Usage and Contribution Agreement

 

Pursuant to the TUCA, we contributed to the ZCM Joint Venture the exclusive right to our gasification technology in the ZCM Joint Venture territory, including the right to: (i) grant site specific project sub-licenses to third parties; (ii) use our marks for proprietary equipment and services; (iii) engineer and/or design processes that utilize our technology or other intellectual property; (iv) provide engineering and design services for joint venture projects and (v) take over the development of projects in the ZCM Joint Venture territory that have previously been developed by us and our affiliates.

 

The ZCM Joint Venture will be the exclusive operational entity for business relating to our technology in the ZCM Joint Venture Territory. If the ZCM Joint Venture loses exclusivity due to breach by us, ZCM is to be compensated for direct losses and all lost project profits. We will also provide training for technical personnel of the ZCM Joint Venture through the second anniversary of the establishment of the ZCM Joint Venture. We will also provide a review of engineering works for the ZCM Joint Venture. If modifications are suggested by us and not made, the ZCM Joint Venture bears the liability resulting from such failure. If we suggest modifications and there is still liability resulting from the engineering work, it is our liability.

 

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Any party making, whether patentable or not, improvements relating to our technology after the establishment of the ZCM Joint Venture, grants to the other party an irrevocable, non-exclusive, royalty free right to use or license such improvements and agrees to make such improvements available to us free of charge. All such improvements shall become part of our technology and both parties shall have the same rights, licenses and obligations with respect to the improvement as contemplated by the TUCA.

 

The ZCM Joint Venture will establish an Intellectual Property Committee, with two representatives from the ZCM Joint Venture and two from us. The Committee is expected to be established within the next fiscal quarter. The Committee shall review all improvements and protection measures and recommend actions to be taken by the ZCM Joint Venture in furtherance thereof. Notwithstanding this, each party is entitled to take actions on its own to protect intellectual property rights.

 

Any breach of or default under the TUCA which is not cured on notice entitles the non-breaching party to terminate. The parties can suspend performance of the TUCA in the event of a dispute if the dispute poses a significant adverse impact on performance. The ZCM Joint Venture indemnifies us for misuse of our technology or infringement of our technology upon rights of any third party.

   

GTI Agreement

 

On November 5, 2009, we entered into an Amended and Restated License Agreement, or the GTI Agreement, with GTI, replacing the Amended and Restated License Agreement between us and GTI dated August 31, 2006, as amended. Under the GTI Agreement, we maintain our exclusive worldwide right to license the U-GAS ® technology for all types of coals and coal/biomass mixtures with coal content exceeding 60%, as well as the non-exclusive right to license the U-GAS ® technology for 100% biomass and coal/biomass blends exceeding 40% biomass.

 

In order to sublicense any U-GAS ® system, we are required to comply with certain requirements set forth in the GTI Agreement. In the preliminary stage of developing a potential sublicense, we are required to provide notice and certain information regarding the potential sublicense to GTI and GTI is required to provide notice of approval or non-approval within ten business days of the date of the notice from us, provided that GTI is required to not unreasonably withhold their approval. If GTI does not respond within that ten business day period, they are deemed to have approved of the sublicense. We are required to provide updates on any potential sublicenses once every three months during the term of the GTI Agreement. We are also restricted from offering a competing gasification technology during the term of the GTI Agreement.

   

For each U-GAS ® unit which we license, design, build or operate for ourselves or for a party other than a sublicensee and which uses coal or a coal and biomass mixture or biomass as the feed stock, we must pay a royalty based upon a calculation using the MMBtu per hour of dry syngas production of a rated design capacity, payable in installments at the beginning and at the completion of the construction of a project, or the Standard Royalty. If we invest, or have the option to invest, in a specified percentage of the equity of a third party, and the royalty payable by such third party for their sublicense exceeds the Standard Royalty, we are required to pay to GTI an agreed percentage split of third party licensing fees, or the Agreed Percentage, of such royalty payable by such third party. However, if the royalty payable by such third party for their sublicense is less than the Standard Royalty, we are required to pay to GTI, in addition to the Agreed Percentage of such royalty payable by such third party, the Agreed Percentage of our dividends and liquidation proceeds from our equity investment in the third party. In addition, if we receive a carried interest in a third party, and the carried interest is less than a specified percentage of the equity of such third party, we are required to pay to GTI, in our sole discretion, either (i) the Standard Royalty or (ii) the Agreed Percentage of the royalty payable to such third party for their sublicense, as well as the Agreed Percentage of the carried interest. We will be required to pay the Standard Royalty to GTI if the percentage of the equity of a third party that we (a) invest in, (b) have an option to invest in, or (c) receive a carried interest in, exceeds the percentage of the third party specified in the preceding sentence.

 

We are required to make an annual payment to GTI for each year of the term, with such annual payment due by the last day of January of the following year; provided, however, that we are entitled to deduct all royalties paid to GTI in a given year under the GTI Agreement from this amount, and if such royalties exceed the annual payment amount in a given year, we are not required to make the annual payment. We must also provide GTI with a copy of each contract that we enter into relating to a U-GAS ® system and report to GTI with our progress on development of the technology every six months.

 

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For a period of ten years, we and GTI are restricted from disclosing any confidential information (as defined in the GTI Agreement) to any person other than employees of affiliates or contractors who are required to deal with such information, and such persons will be bound by the confidentiality provisions of the GTI Agreement. We have further indemnified GTI and its affiliates from any liability or loss resulting from unauthorized disclosure or use of any confidential information that we receive.

 

The GTI Agreement expires on August 31, 2016, but may be extended for two additional ten-year periods at our option.

 

Outlook

 

Our strategies are focused on the continuing progress of the ZZ Joint Venture’s methanol production and commercial sales including the syngas plant’s restart, improving operations at the Yima Joint Venture, developing our ZCM Joint Venture and sourcing suitable partners for our other business verticals. Our business is to create value by supplying our technology, equipment and services into global projects where lower cost low quality coals, coal wastes, municipal wastes, agricultural biomass, and other biomass feedstocks can be profitably converted through our proprietary gasification technology into clean synthesis gas, or syngas (a mixture of primarily hydrogen, carbon monoxide, and methane), which is then used to produce a variety of high value energy, power, and chemical products.

 

Our business model is to deploy our technology on a global basis via supplying a technology package, containing license rights to operate a project using our technology, gasification system equipment, and technology related services. As part of our overall strategy we intend to form strategic regional and market-based partnerships or business verticals where our technology offers advantages and through cooperating with these partners grow an installed base of projects. Through collaborative partnering arrangements we believe we will commercialize our technology much faster than entering these markets alone.  This is a low capital intensity business approach which we believe can generate attractive margins for us through providing our technology differentiated equipment and services in multiple market segments globally with a potential to build meaningful sales opportunities over time. We also believe that our technology business activities will help advance our capabilities and provide opportunities which may allow us to selectively participate as equity partners in such projects in the future. Additionally, we are continuing to improve our technology in ways we believe will enhance our competitive position. We are pursuing other possible technology licensing opportunities with third parties allowing us to build on our capability as demonstrated at both the ZZ Joint Venture and the Yima Joint Venture. We are focusing our efforts globally with our partners in countries with large low rank coal resources, but our principal operating activities to-date have focused on China and India.

 

The focus on China has resulted in the successful conclusion in April 2014, for SES Asia Technologies Limited, one of our wholly owned subsidiaries to form the ZCM Joint Venture. The purpose of the ZCM Joint Venture is to establish our gasification technology as the leading gasification technology in the ZCM Joint Venture territory (which is initially China, Indonesia, the Philippines, Vietnam, Mongolia and Malaysia) by becoming a leading provider of proprietary equipment for the technology. The scope of the ZCM Joint Venture is to market and license our gasification technology via project sublicenses; procurement and sale of proprietary equipment and services; coal testing; and engineering, procurement and research and development related to the technology. ZCM is contributing RMB 100,000,000 (approximately USD$16 million) in cash to the ZCM Joint Venture, and will own approximately 65% of the ZCM Joint Venture, and SES is contributing an exclusive license to use of its technology in the ZCM Joint Venture territory pursuant to the terms of a Technology Usage and Contribution Agreement entered into among the ZCM Joint Venture, ZCM and us on the same date, and will own approximately 35% of the ZCM Joint Venture.

 

We and GE Packaged Power, Inc., a subsidiary of GE, have agreed to jointly evaluate and market a distributed power generation unit combining our gasification technology with GE’s aeroderivative gas turbines. This application marketing arrangement will focus on regions of the world where conversion of non-conventional feedstock sources such as lignite and coal wastes into synthesis gas fuel via our technology may be highly price advantaged over conventional gas turbine fuel sources such as natural gas and fuel oil.  Together with GE, we have completed a preliminary evaluation of this application of our combined technologies. Under the terms of this agreement, the two businesses on a non-exclusive basis will complete the market evaluation and seek initial customers for this small scale power product. We, along with our distributed power collaborators, GE, ISTROENERGO GROUP, Inc. and TUTEN Ltd, have signed our first LOI with KESC. KESC is a large electric utility company in Karachi, Pakistan with over 2.3 GW of installed electric generating capacity. The exclusive LOI calls for a feasibility engineering and financial evaluation of a coal gasification power generation project with a capacity between 90 and 200 MW to be constructed near Karachi. The completed feasibility study will serve as the basis for further discussions and negotiations for a syngas power plant contract. We believe the distributed power segment offers opportunity over time to provide meaningful sales opportunities for our gasification technology and equipment systems. We intend to focus on the continued development of this business vertical.

 

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We are working on licensing opportunities and other business arrangements with high-profile steel companies who are active in the DRI industry. In addition, we are also developing additional business vertical opportunities to integrate our technology with DRI steel making technology for a coal-to-steel solution and for evaluating projects that can make methanol and derivatives from refuse derived fuels from our technology. We have completed two paid studies during fiscal 2013 with potential partners to assess integrating our technology into these applications and the results of these studies indicated a very cost effective solution with highly efficient integrations. Our goal for these two business verticals is to find strategic partnering to provide a complete technology and equipment package offering.

 

We intend to focus on developing new opportunities for our proprietary technology whereby we may (i) integrate our technology package with downstream technologies to provide a fully integrated offering, (ii) partner with engineering, equipment and technology companies to provide our technology package into an integrated modular product offering, (iii) provide technology to enable coal resources to be integrated together with our technology where the coal resources may be of little commercial value without our conversion technology, or (iv) acquire or partner with owners of these coal resources to create more value and opportunity for us through the integration of our technology with the coal resource. We understand the need to partner in certain markets, and plan to do so with companies that we believe can help us accelerate our business. For example, we have entered into an agreement with Simon India Ltd, a subsidiary of Zuari Global Ltd, to exclusively market our technology in India where we believe the market for coal gasification plants is now developing due to large infrastructure growth demands and an increasing need for a variety of basic chemical and energy products. Our partnering approach in some cases is country specific and in some cases is industry or market segment specific. Additionally, where strategic relationships and capital and/or financing is available, we may acquire operating assets with potential to generate near term earnings and provide us with advantages in deploying our technology. Examples of such assets include methanol fuel-blending facilities, compressed natural gas fuel operations and operating coal mines. We are also actively pursuing business verticals in the diversified segments of transportation fuels, steel and fertilizers where our technology is specifically well suited and developing new downstream coal-to-chemicals and coal-to-energy projects which may expand our initial focus to include facilities producing SNG, MTG, glycol, and power and reducing gas for the steel industry.

 

SES China is intended to be a stand-alone business platform that encompasses all of our current and future business activities and initiatives in China. We believe that SES China will better enable us to grow faster in China than otherwise possible and to better protect our intellectual property and technology in China.  In addition, we expect to work more effectively with our existing partners such as ZCM to efficiently leverage the other business verticals we are developing including clean renewable fuels and power businesses, direct reduction iron for the steel industry, clean coal-to-chemicals projects, and for longer term value creation, larger scale SNG projects utilizing low rank coal resources and biomass. We have completed a significant business objective by partnering a significant portion of SES China with ZCM, a financially strong and highly skilled Chinese company which desires to invest into the growth of China’s clean energy space and who recognizes the opportunity afforded by our technology capability and business model.  We believe partnering with ZCM is the proper direction to accelerate the commercialization of our technology on a global basis and will enable us to reduce our capital requirements to achieve this acceleration. We are also actively pursuing potential project partners to invest in our ongoing development efforts at Yima, the ZZ Joint Venture plant, power projects such as the current initiative with GE in Pakistan, and other industrial facilities seeking to deploy our technology both through our ZCM Joint Venture as well as through projects working directly with us. 

 

Our Yima Joint Venture plant is being closely watched by our potential customers and partners in China and globally. We expect the Yima project to be a major catalyst for securing much of the new business we have been developing. The Yima Joint Venture plant’s refined methanol section was fully commissioned in December 2013, and has operated at limited capacity since that date. Methanol production was approximately 27% of its capacity during the three months ended March 31, 2014. The plant is designed to produce 300,000 tonnes per year of methanol from operating two of its three available gasifiers and has achieved 100% peak syngas production levels and 80% peak methanol production levels, and is providing a commercial demonstration of our technology on a much larger scale than the ZZ Joint Venture plant.  Yima has recently initiated an outage in March that should allow the plant to make improvements to the upstream and downstream units adjacent to our gasification systems at the Yima Joint Venture plant. Most of these are punch-list items, along with the improvements which have been learned from the past year’s operation at the plant. The improvements are currently scheduled to be completed in the next two to four months. The Yima Joint Ventures still owe us approximately $0.67 million for gasifiers and gasifier related equipment delivered in 2012, a portion of which is due from us to ZCM and an additional vendor for providing equipment associated with the gasifiers. It is unclear when or if the balance of this money will be paid to us.

 

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We believe that the ZZ Joint Venture plant has achieved significant success demonstrating our technology as well as our technical and operating capabilities. We are of the view that by improving financial performance and reducing operating costs at the ZZ Joint Venture plant our overall financial performance can be improved. On July 24, 2013, the ZZ Joint Venture entered into the ZZ Cooperation Agreement with Xuejiao, which serves to supersede the existing syngas purchase and sale agreement among the parties dated October 22, 2006 and supplemented in 2008. The ZZ Cooperation Agreement represents the basis for an integrated syngas to methanol operation and resolution of the nonpayment of the contractual capacity fees by Xuejiao. Under the terms of the Agreement, Xuejiao will (i) provide the ZZ Joint Venture with use of their methanol plant for ten years at no cost to the ZZ Joint Venture, (ii) has provided a bank loan guarantee of approximately $3.2 million for a majority of the financing necessary for the ZZ Joint Venture for the retrofit and related costs of the ZZ Joint Venture plant, (iii) waive certain advances previously made to the ZZ Joint Venture and (iv) supply discounted coke oven gas produced by its existing coke ovens to be used in combination with synthesis gas to produce refined methanol from the new ZZ Joint Venture integrated syngas to methanol operation. The new integrated operation is being managed by us effective October 31, 2013.  The ZZ Joint Venture plans to manage syngas production rates to optimize its operation and has secured additional sources of coke oven gas from a local supplier in order to increase methanol production. There can be no assurances that the methanol production operations contemplated by the ZZ Cooperation Agreement will be profitable. Profitability will be dependent on, among other things, our management of the operations of the plant, pricing of methanol, coal and power, and maintaining necessary government approvals.

 

 We believe that there is currently a shift in the coal gasification business toward the use of low quality, and therefore low cost, coals for coal-to-energy and chemicals projects. We believe China is a good example of this new direction in coal gasification. According to the International Energy Outlook 2013 from the U.S. Energy Information Administration, China’s natural gas consumption is estimated to reach 7.8 trillion cubic feet in 2020 but domestic production of natural gas in China is estimated to be 4.2 trillion cubic feet in 2020. Today, coal to SNG projects are beginning to progress and the Chinese government supports these types of coal to energy projects. Due to this estimated shortfall in natural gas, combined with the current encouragement from the Chinese government for these projects, we believe there is potential in China for several of these SNG projects which are anticipated to be very large scale as compared to previous coal-to-chemical projects that have been built in China. In addition, we believe many of these projects will be located in regions such as Inner Mongolia where very low cost lignite coals can be made available and are necessary to reduce the production cost of SNG. Our technology is well suited for this location due to its ability to process these low quality coals and to meet local requirements for clean production of syngas, without tars and oils produced by other technologies, and very low water usage for the overall process. In addition, Inner Mongolia government regulations permit higher quality coals to be made available to those companies that can cleanly gasify the low quality lignite coals. This creates the potential to sell the high quality coals directly to the market while operating the project on low cost lignite, further enhancing the overall financial performance and value created by the project.

 

Although we have made significant progress recently on partnering our China business, we expect to continue for a period of time to have negative operating cash flows until we are generating sufficient cash flows from our technology, equipment and services business and SES China (including our ZZ Joint Venture, the Yima Joint Ventures and ZCM-SES Joint Venture) to cover our general and administrative expenses and other operating costs. We will also limit the development of any further projects until we have assurances that acceptable financing is available to complete the project. We may pursue the development of selective projects with strong and credible partners or off-takers where we believe equity and debt can be raised or where we believe we can attract a financial partner to participate in the project and where the project would utilize our technology, equipment and services.

 

We currently plan to use our available cash for (i) general and administrative expenses; (ii) executing our strategy to develop market based business verticals, (iii) if we are unable to refinance the loan, debt service for the $3.2 million of principal due in September 2014 under the ZZ Short-term Loan; (iv) securing orders and other associated tasks associated with our distributed power initiatives such as in Pakistan with General Electric; and (v) working capital and other general corporate purposes. Although we intend for the ZZ Joint Venture to sustain itself through its own earnings in the near term, we may also need to make additional contributions to the ZZ Joint Venture in order for it to meet its obligations until the ZZ Joint Venture generates sufficient cash flows to cover its operating costs and debt service. The actual allocation and timing of these expenditures will be dependent on various factors, including changes in our strategic relationships, commodity prices and industry conditions, and other factors that we cannot currently predict. In particular, any future decrease in economic activity in China or in other regions of the world in which we may in the future do business could significantly and adversely affect our results of operations and financial condition. Operating cash flows from our joint venture operating projects can be positively or negatively impacted by changes in coal and methanol prices. These are commodities where market pricing is often cyclical in nature.

 

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We do not currently have all of the financial and human resources to fully develop and execute on all of our other business opportunities; however, we intend to finance our development through paid services, technology access fees, equity and debt financings and by securing financial and strategic partners focused on development of these opportunities. We can make no assurances that our business operations will provide us with sufficient cash flows to continue our operations. We may need to raise additional capital through equity and debt financing for any new ventures that are developed, to support our existing projects and possible expansions thereof and for our corporate general and administrative expenses. We may consider a full range of financing options in order to create the most value in the context of the increasing interest we are seeing in our technology. We cannot provide any assurance that any financing will be available to us in the future on acceptable terms or at all. Any such financing could be dilutive to our existing stockholders. If we cannot raise required funds on acceptable terms, we may not be able to, among other things, (i) maintain our general and administrative expenses at current levels including retention of key personnel and consultants; (ii) successfully develop our licensing and related service businesses; (iii) negotiate and enter into new gasification plant development contracts and licensing agreements; (iv) make additional capital contributions to our joint ventures; (v) fund certain obligations as they become due; and (vi) respond to competitive pressures or unanticipated capital requirements.

 

Critical Accounting Policies

 

The preparation of financial statements in accordance with U.S. generally accepted accounting principles, or GAAP, requires our management to make certain estimates and assumptions which are inherently imprecise and may differ significantly from actual results achieved. We believe the following are our critical accounting policies due to the significance, subjectivity and judgment involved in determining our estimates used in preparing our consolidated financial statements. We evaluate our estimates and assumptions used in preparing our consolidated financial statements on an ongoing basis utilizing historic experience, anticipated future events or trends and on various other assumptions that are believed to be reasonable under the circumstances. The resulting effects of changes in our estimates are recorded in our consolidated financial statements in the period in which the facts and circumstances that give rise to the change in estimate become known.

 

We believe the following describes significant judgments and estimates used in the preparation of our consolidated financial statements:

 

Revenue Recognition

 

Revenue from sales of products, including the sales of methanol under the ZZ Cooperation Agreement, and sales of equipment are recognized when the following elements are satisfied: (i) there are no uncertainties regarding customer acceptance; (ii) there is persuasive evidence that an agreement exists; (iii) delivery has occurred; (iv) the sales price is fixed or determinable; and (v) collectability is reasonably assured.

 

Technology licensing revenue is typically received over the course of a project’s development as milestones are met. We may receive upfront licensing fee payments when a license agreement is entered into. Typically, the majority of a license fee is due once project financing and equipment installation occur. We recognize license fees as revenue when the license fees become due and payable under the license agreement, subject to the deferral of the amount of the performance guarantee. Fees earned for engineering services, such as services that relate to integrating our technology to a customer’s project, are recognized using the percentage-of-completion method.

 

Impairment Evaluation of Long-Lived Assets

 

We evaluate our long-lived assets, including property, plant and equipment, equity investments in joint ventures and specifically identified intangibles, when events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. When we believe an impairment condition may have occurred, we are required to estimate the undiscounted future cash flows associated with a long-lived asset or group of long-lived assets at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities for long-lived assets that are expected to be held and used. We evaluate our operating plants as a whole. Production equipment at each plant is not evaluated for impairment separately, as it is integral to the assumed future operations of the plant. All construction and development projects are reviewed for impairment whenever there is an indication of potential reduction in fair value. If it is determined that it is no longer probable that the projects will be completed and all capitalized costs recovered through future operations, the carrying values of the projects would be written down to the recoverable value. If we determine that the undiscounted cash flows from an asset to be held and used are less than the carrying amount of the asset, or if we have classified an asset as held for sale, we estimate fair value to determine the amount of any impairment charge.

 

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The following summarizes some of the most significant estimates and assumptions used in evaluating if we have an impairment charge.

 

Undiscounted Expected Future Cash Flows . In order to estimate future cash flows, we consider historical cash flows and changes in the market environment and other factors that may affect future cash flows. To the extent applicable, the assumptions we use are consistent with forecasts that we are otherwise required to make (for example, in preparing our other earnings forecasts). The use of this method involves inherent uncertainty. We use our best estimates in making these evaluations and consider various factors, including forward price curves for energy, fuel costs, and operating costs. However, actual future market prices and project costs could vary from the assumptions used in our estimates, and the impact of such variations could be material.

 

Fair Value . Generally, fair value will be determined using valuation techniques such as the present value of expected future cash flows. We will also discount the estimated future cash flows associated with the asset using a single interest rate representative of the risk involved with such an investment. We may also consider prices of similar assets, consult with brokers, or employ other valuation techniques. We use our best estimates in making these evaluations; however, actual future market prices and project costs could vary from the assumptions used in our estimates, and the impact of such variations could be material.

 

The evaluation and measurement of impairments for investments such as our investment in the Yima Joint Ventures involve the same uncertainties as described for long-lived assets that we own directly. Similarly, our estimates that we make with respect to our equity and cost-method investments are subjective, and the impact of variations in these estimates could be material.

 

Accounting for Variable Interest Entities and Financial Statement Consolidation Criteria

 

The joint ventures which we enter into may be considered variable interest entities, or VIEs. We consolidate all VIEs where we are the primary beneficiary. This determination is made at the inception of our involvement with the VIE. We consider both qualitative and quantitative factors and form a conclusion that we, or another interest holder, absorb a majority of the entity’s risk for expected losses, receive a majority of the entity’s potential for expected residual returns, or both. We do not consolidate VIEs where we are not the primary beneficiary. We account for these unconsolidated VIEs under the equity method or cost method of accounting and include our net investment in investments on our consolidated balance sheets. Our equity interest in the net income or loss from our unconsolidated VIEs under the equity method of accounting is recorded in non-operating (income) expense on a net basis on our consolidated statement of operations.

 

We have determined that the ZZ Joint Venture is a VIE and that we are the primary beneficiary. We have determined that the Yima Joint Ventures are VIEs and that Yima is the primary beneficiary since Yima has a 75% ownership interest in the Yima Joint Ventures. We have determined that ZCM-SES is a VIE and that ZCM is the primary beneficiary since ZCM has a 65% ownership interest in the Joint Venture. We have determined that SRS is a VIE and that we are not the primary beneficiary since we and Midas each have a 50% ownership interest in SRS and the control, risks and benefits of SRS are shared equally. We have determined that the GC Joint Venture is a VIE and that we are the primary beneficiary since we have a 51% ownership interest in the GC Joint Venture and since there are no qualitative factors that would preclude us from being deemed the primary beneficiary.

 

Item 3. Quantitative and Qualitative Disclosure About Market Risk

 

Qualitative disclosure about market risk

 

We are exposed to certain qualitative market risks as part of our ongoing business operations, including risks from changes in foreign currency exchange rates and commodity prices that could impact our financial position, results of operations and cash flows. We manage our exposure to these risks through regular operating and financing activities, and may, in the future, use derivative financial instruments to manage this risk. We have not entered into any derivative financial instruments to date.

 

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Foreign currency risk

 

We conduct operations in China and our functional currency in China is the Renminbi Yuan. Our financial statements are expressed in U.S. dollars and will be negatively affected if foreign currencies, such as the Renminbi Yuan, depreciate relative to the U.S. dollar. In addition, our currency exchange losses may be magnified by exchange control regulations in China or other countries that restrict our ability to convert into U.S. dollars. The People’s Bank of China, the monetary authority in China, sets the spot rate of the Renminbi Yuan, and may also use a variety of techniques, such as intervention by its central bank or imposition of regulatory controls or taxes, to affect the exchange rate relative to the U.S. dollar. In the future, the Chinese government may also issue a new currency to replace its existing currency or alter the exchange rate or relative exchange characteristics by devaluation or revaluation of the Renminbi Yuan in ways that may be adverse to our interests.

 

Commodity price risk

 

Our business plan is to purchase coal and other consumables from suppliers and to sell commodities, such as syngas, methanol and other products. Coal is the largest component of our costs of product sales and in order to mitigate coal price fluctuation risk for future projects, we expect to enter into long-term contracts for coal supply or to acquire coal assets. For the sale of commodities from our projects, fixed price contracts will not be available to us in certain markets, such as China, which will require us to purchase some portion of our coal and other consumable needs, or sell some portion of our production, into spot commodity markets or under short term supply agreements. Hedging transactions may be available to reduce our exposure to these commodity price risks, but availability may be limited and we may not be able to successfully hedge this exposure at all. To date, we have not entered into any hedging transactions.

 

Interest rate risk

 

We are exposed to interest rate risk through our ZZ Joint Venture’s loans. Interest under these loans is adjusted annually based upon the standard rate announced each year by the People’s Bank of China. As of March 31, 2014, the applicable interest rate on the ZZ Joint Venture’s short-term bank loan with Zaozhuang Bank was 10.8%. We could also be exposed to the risk of rising interest rates through our future borrowing activities or refinancings. This is an inherent risk as borrowings mature and are renewed at then current market rates. The extent of this risk as to these loans, or any future borrowings, is not quantifiable or predictable because of the variability of future interest rates. 

 

Customer credit risk

 

As our projects, including the ZZ Joint Venture plant’s methanol operations, progress to commercial operation, we may be exposed to the risk of financial non-performance by customers. To manage customer credit risk, we intend to monitor credit ratings of customers and seek to minimize exposure to any one customer where other customers are readily available.

 

Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Our internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements. Because of inherent limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

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Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our internal control over financial reporting as of March 31, 2014 based on criteria set forth in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our evaluation, management has concluded that we did maintain effective internal control over financial reporting as of March 31, 2014.

 

Changes in Internal Control Over Financial Reporting

 

There have been no changes in our internal control over financial reporting during the quarter ended March 31, 2014 that have materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II

 

Item 1. Legal Proceedings.

 

None.

 

Item 1A. Risk Factors.

 

We will require substantial additional funding, and our failure to raise additional capital necessary to support and expand our operations could reduce our ability to compete and could harm our business.

 

As of March 31, 2014, we had $21.7 million in cash and cash equivalents. We currently plan to use our available cash for (i) general and administrative expenses; (ii) executing our strategy to develop market based business verticals, (iii) if we are unable to refinance the loan, debt service for the $3.2 million of principal due in September 2014 under the ZZ Short-term Loan; (iv) securing orders and other associated tasks associated with our distributed power initiatives such as in Pakistan with General Electric; and (v) working capital and other general corporate purposes. We may also need to make additional contributions to the ZZ Joint Venture in order for it to meet its obligations until the ZZ Joint Venture generates sufficient cash flows to cover its operating costs and debt service. The actual allocation and timing of these expenditures will be dependent on various factors, including changes in our strategic relationships, commodity prices and industry conditions, and other factors that we cannot currently predict. In particular, any future decrease in economic activity in China or in other regions of the world in which we may in the future do business could significantly and adversely affect our results of operations and financial condition. Operating cash flows from our joint venture operating projects can be positively or negatively impacted by changes in coal and methanol prices. These are commodities where market pricing is often cyclical in nature.

 

Although we made significant progress recently on partnering our China business, we expect to continue for a period of time to have negative operating cash flows until we are generating sufficient cash flows from our technology, equipment and services business and SES China (including the ZZ Joint Venture, the Yima Joint Ventures and ZCM-SES Joint Venture) to cover our general and administrative expenses and other operating costs. We will also limit the development of any further projects until we have assurances that acceptable financing is available to complete the project. We may pursue the development of selective projects with strong and credible partners or off-takers where we believe equity and debt can be raised or where we believe we can attract a financial partner to participate in the project and where the project would utilize our technology, equipment and services.

 

 We do not currently have all of the financial and human resources to fully develop and execute on all of our other business opportunities; however, we intend to finance our development through paid services, technology access fees, equity financings and by securing financial and strategic partners focused on development of these opportunities. We can make no assurances that our business operations will provide us with sufficient cash flows to continue our operations. We will need to raise additional capital through equity and debt financing for any new ventures that are developed, to support our existing projects and possible expansions thereof and for our corporate general and administrative expenses. We may consider a full range of financing options in order to create the most value in the context of the increasing interest we are witnessing in our proprietary technology.

 

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We cannot provide any assurance that any financing will be available to us in the future on acceptable terms or at all. Any such financing could be dilutive to our existing stockholders. If we cannot raise required funds on acceptable terms, we may not be able to, among other things, (i) maintain our general and administrative expenses at current levels including retention of key personnel and consultants; (ii) successfully develop our licensing and related service businesses; (iii) negotiate and enter into new gasification plant development contracts and licensing agreements; (iv) make additional capital contributions to our joint ventures; (v) fund certain obligations as they become due; and (vi) respond to competitive pressures or unanticipated capital requirements.

 

We may not be successful developing our business strategies.

 

In addition to the completion of the Yima Joint Venture plant and the restart of the ZZ Joint Venture plant, we intend to focus on developing our business verticals and focus on the development of our recently formed ZCM Joint Venture.  Although we have begun to develop our power vertical through our relationship with GE, we are still in the early stages of developing these verticals and many of the relationships with potential partners are still being cultivated. We cannot provide assurance that we will be able to successfully develop our business verticals or to successfully develop the ZCM Joint Venture, which depends upon several factors, including the strength of global energy and chemical markets, commodity prices and the continued success of our ZZ Joint Venture Plant and Yima Joint Venture plant.  There can be no assurances that we will be able to succeed in these strategies and our inability to do so could have a material adverse effect on our business and results of operation.

 

Our results of operations and cash flows may fluctuate.

 

Our operating results and cash flows may fluctuate significantly as a result of a variety of factors, many of which are outside our control. Factors that may affect our operating results and cash flows include: (i) the success of the ZCM Joint Venture, the Yima Joint Ventures and our ZZ Joint Venture; (ii) our ability to obtain new customers and retain existing customers; (iii) the cost of coal and electricity; (iv) the success and acceptance of our technology; (v) our ability to successfully develop our licensing business verticals for power, steel and renewables, as well as execute on our projects; (vi) the ability to obtain financing for our projects; (vii) shortages of equipment, raw materials or feedstock; (viii) approvals by various government agencies; and (ix) general economic conditions as well as economic conditions specific to the energy industry.

 

We are dependent on our relationships with our strategic partners for project development.

 

     We are dependent on our relationships with our strategic partners to accelerate our expansion, fund our development efforts, better understand market practices and regulatory issues and more effectively handle challenges that may arise. Our future success will depend on these relationships and any other strategic relationships that we may enter into. We cannot assure you that we will satisfy the conditions required to maintain these relationships under existing agreements or that we can prevent the termination of these agreements. We also cannot assure you that we will be able to enter into relationships with future strategic partners on acceptable terms. The termination of any relationship with an existing strategic partner or the inability to establish additional strategic relationships may limit our ability to develop the ZCM Joint Venture, our projects, including the ZZ Joint Venture and Yima Joint Ventures and our marketing arrangement with GE Power, and may have a material adverse effect on our business and financial condition.

 

     We face the potential inability to protect our intellectual property rights which could have a material adverse effect on our business.

 

We rely on proprietary technology licensed from GTI. Our license agreement with GTI for U-GAS ®  technology (described under “Description of Business—GTI Agreements”) is a critical component of our business. All of the prior patents granted around U-GAS ®  technology have expired. We are improving the technology and we plan to create new technologies around the core U-GAS ®  technology and have applied for new patents for these improvements and new technologies. Proprietary rights relating to U-GAS ®  technology are protected from unauthorized use by third parties only to the extent that they are covered by valid and enforceable patents, maintained within trade secrets or maintained in confidence through legally binding agreements. There can be no assurance that patents will be issued from any pending or future patent applications owned by or licensed to us or that the claims allowed under any issued patents will be sufficiently broad to protect our technology. In addition, our ability to obtain patent protection may be affected by the terms of the GTI Agreement. In the absence of patent protection, we may be vulnerable to competitors who attempt to copy our technology or gain access to our proprietary information and technical know-how. In addition, we rely on proprietary information and technical know-how that we seek to protect, in part, by entering into confidentiality agreements with our collaborators, employees, and consultants. In the case of the ZCM Joint Venture, to which we have transferred the exclusive right to our technology within the joint venture territory, we are relying on the covenants and protections included in the TUCA. We cannot assure you that these agreements will not be breached, that we would have adequate remedies for any breach or that our trade secrets will not otherwise become known or be independently developed by competitors.

 

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Proceedings initiated by us to protect our proprietary rights could result in substantial costs to us. We cannot assure you that our competitors will not initiate litigation to challenge the validity of our patents, or that they will not use their resources to design comparable products that do not infringe upon our patents. Pending or issued patents held by parties not affiliated with us may relate to our products or technologies. We may need to acquire licenses to, or contest the validity of, any such patents. We cannot assure you that any license required under any such patent would be made available on acceptable terms or that we would prevail in any such contest. We could incur substantial costs in defending ourselves in suits brought against us or in suits in which we may assert our patent rights against others. If the outcome of any such litigation is unfavorable to us, our business and results of operations could be materially and adversely affected.

 

     Foreign laws may not afford us sufficient protections for our intellectual property, and we may not be able to obtain patent protection outside of the United States.

 

Despite continuing international pressure on the Chinese government, intellectual property rights protection continues to present significant challenges to foreign investors and, increasingly, Chinese companies. Chinese commercial law is relatively undeveloped compared to the commercial law in our other major markets and only limited protection of intellectual property is available in China as a practical matter. Although we have taken precautions in the operations of our Chinese subsidiaries and in our joint venture agreements (including as to the ZCM Joint Venture to which we have transferred the exclusive right to our technology within the joint venture territory) to protect our intellectual property, any local design or manufacture of products that we undertake in China could subject us to an increased risk that unauthorized parties will be able to copy or otherwise obtain or use our intellectual property, which could harm our business. We may also have limited legal recourse in the event we encounter patent or trademark infringement. Uncertainties with respect to the Chinese legal system may adversely affect the operations of our Chinese subsidiaries. China has put in place a comprehensive system of intellectual property laws; however, incidents of infringement are common and enforcement of rights can, in practice, be difficult. If we are unable to manage our intellectual property rights, our business and operating results may be seriously harmed.

 

     The termination of our license agreement with GTI or any of our joint venture agreements or licensing agreements would materially adversely affect our business and results of operations.

 

The GTI Agreement, our joint ventures in China, our licensing and related service business and our business verticals for power, steel and renewables, including our marketing arrangement with GE Power, are essential to us and our future development. The GTI Agreement terminates on August 31, 2016, but may be terminated by GTI upon certain events of default if not cured by us within specified time periods. In addition, after the two ten year extension periods provided under the GTI Agreement, which are exercisable at our option, we cannot assure you that we will succeed in obtaining an extension of the term of the license at a royalty rate that we believe to be reasonable or at all. Our joint venture agreements do not terminate for many years, but may be terminated earlier due to certain events of bankruptcy or default, or, in the case of the ZZ Joint Venture, if the purchase and sale contract for syngas or the methanol cooperation agreement is terminated, and, in the case of the ZCM Joint Venture, if the joint venture does not establish positive net income within 24 months of formation. Termination of any of our joint ventures or other key business relationships would require us to seek another collaborative relationship in that territory. We cannot assure you that a suitable alternative third party would be identified, and even if identified, we cannot assure you that the terms of any new relationship would be commercially acceptable to us. In addition, any of our license agreements could be terminated by our customer if we default under the terms of the agreement and any such termination could have a material adverse effect on our business and results of operations.

 

     Joint ventures that we enter into present a number of challenges that could have a material adverse effect on our business and results of operations and cash flows.

 

We have developed two projects in China, the ZZ Joint Venture and the Yima Joint Ventures, and have recently entered into our ZCM Joint Venture. In addition, as part of our business strategy, we plan to enter into other joint ventures or similar transactions, including as part of our business verticals for power, steel and renewables, some of which may be material. These transactions typically involve a number of risks and present financial, managerial and operational challenges, including the existence of unknown potential disputes, liabilities or contingencies that arise after entering into the joint venture related to the counterparties to such joint ventures, with whom we share control. We could experience financial or other setbacks if transactions encounter unanticipated problems due to challenges, including problems related to execution or integration. Any of these risks could reduce our revenues or increase our expenses, which could adversely affect our results of operations and cash flows.

 

40
 

 

Additionally, we are a minority owner in the Yima Joint Ventures and we are relying on Yima to provide the management and operational support for the project. As a result, the success and timing of the Yima project will depend upon a number of factors that will be largely outside of our control and influence. As of June 1, 2013, we changed from the equity method of accounting for our investment in the Yima Joint Ventures to the cost method of accounting because we concluded that we are unable to exercise significant influence over the Yima Joint Ventures. Our conclusion regarding our lack of significant influence is based on our interactions with the Yima Joint Ventures related to the start-up and operations and due to various other circumstances including limited participation in operating and financial policymaking processes and our limited ability to influence technological decisions. Dependence on Yima, and other owners of future projects in which we have a minority interest, or extended negotiations regarding the scope of the projects, could delay or prevent the realization of targeted returns on our capital invested in these projects.

 

We also include the condensed financial information of the ZZ Joint Venture in our consolidated financial statements. We rely on personnel in China to compile this information and deliver it to us in a timely fashion so that the information can be incorporated into our consolidated financial statements prior to the due dates for our annual and quarterly reports. Any difficulties or delays in receiving this information or incorporating it into our consolidated financial statements could impair our ability to timely file our annual and quarterly reports.

 

   We may have difficulty establishing adequate management, legal and financial controls in China.

 

China historically has been deficient in Western style management and financial reporting concepts and practices, as well as in modern banking, computer and other control systems. For example, we recently changed from the equity method of accounting for our investment in the Yima Joint Ventures to the cost method of accounting because we concluded that we are unable to exercise significant influence over the Yima Joint Ventures due to, among other things, our limited participation in operating and financial policymaking processes and our limited ability to influence technological decisions. In addition, we have recently entered into our ZCM Joint Venture, in which ZCM may own up to a 65% interest, and although certain decisions require unanimous approval of its board of directors, and we have representatives in management of the joint venture, we have more limited influence in decision making. We may have difficulty in hiring and retaining a sufficient number of employees who are qualified to assist us in application of such concepts and practices to work in China. As a result of these factors, we may experience difficulty in establishing management, legal and financial controls, collecting financial data and preparing financial statements, books of account and corporate records and instituting business practices that meet Western standards.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

 

None.

 

Item 3. Defaults Upon Senior Securities.

 

None.

 

Item 4. Mine Safety Disclosures

 

Not Applicable.

 

Item 5. Other Information.

 

None.

 

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Forward-Looking Statements

 

This Quarterly Report on Form 10-Q includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act. 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. Among those risks, trends and uncertainties are: the development stage of our operating assets; the ability of our ZZ joint venture to effectively operate XE's methanol plant and produce methanol; the ability of our project with Yima to produce earnings, pay dividends and collect the remaining receivable from the Yima Joint Venture; our ability to develop and expand business of the ZCM joint venture in the joint venture territory; our ability to develop our power business unit and marketing arrangement with GE and our other business verticals, steel and renewables; our ability to successfully develop our licensing business; to reduce operating costs; our limited history, and viability of our technology; commodity prices, and the availability and terms of financing; our ability to obtain the necessary approvals and permits for future projects; our ability to raise additional capital, if any, and our ability to estimate the sufficiency of existing capital resources; the sufficiency of internal controls and procedures; and our results of operations in countries outside of the U.S., where we are continuing to pursue and develop projects. 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.

 

When used in this Form 10-Q, the words “expect,” “anticipate,” “intend,” “plan,” “believe,” “seek,” “estimate” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. Because these forward-looking statements involve risks and uncertainties, actual results could differ materially from those expressed or implied by these forward-looking statements for a number of important reasons, including those discussed under “Risk Factors” in our Annual Report on Form 10-K for the year ended June 30, 2013, as well as in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and elsewhere in this Form 10-Q.

 

You should read these statements carefully because they discuss our expectations about our future performance, contain projections of our future operating results or our future financial condition, or state other “forward-looking” information. You should be aware that the occurrence of certain of the events described in this Form 10-Q could substantially harm our business, results of operations and financial condition and that upon the occurrence of any of these events, the trading price of our common stock could decline, and you could lose all or part of your investment.

 

We cannot guarantee any future results, levels of activity, performance or achievements. Except as required by law, we undertake no obligation to update any of the forward-looking statements in this Form 10-Q after the date hereof.

 

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Item 6. Exhibits

 

Number   Description of Exhibits
     
4.1   Form of Warrant (incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on March 25, 2014).
10.1   Joint Venture Contract between Zhangjiagang Chemical Machinery Co., Ltd. and SES Asia Technologies, Ltd., dated February 14, 2014 – English translation from Chinese document (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on February 14, 2014). ++
10.2   Technology Usage and Contribution Agreement among SES-ZCM Clean Energy Technologies Limited, Zhangjiagang Chemical Machinery Co., Ltd. and SES Asia Technologies, Ltd., dated February 14, 2014 – English translation from Chinese document (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on February 14, 2014). ++
10.3   Form of Securities Purchase Agreement among the Company and the purchasers identified therein (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on March 25, 2014).
31.1*   Certification of Chief Executive Officer of Synthesis Energy Systems, Inc. pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934, as amended.
31.2*   Certification of Chief Financial Officer of Synthesis Energy Systems, Inc. pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934, as amended.
32.1*   Certification of Chief Executive Officer of Synthesis Energy Systems, Inc. pursuant to Rule 13a-14(b) promulgated under the Securities Exchange Act of 1934, as amended, and Section 1350 of Chapter 63 of Title 18 of the United States Code.
32.2*   Certification of Chief Financial Officer of Synthesis Energy Systems, Inc. pursuant to Rule 13a-14(b) promulgated under the Securities Exchange Act of 1934, as amended, and Section 1350 of Chapter 63 of Title 18 of the United States Code.
101.INS   XBRL Instance Document.**
101.SCH   XBRL Taxonomy Extension Schema Document.**
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document.**
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document.**
101.LAB   XBRL Taxonomy Extension Label Linkbase Document.**
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document.**

_____________________________

+ Management contract or compensatory plan or arrangement.

 

++ Portions of this exhibit have been omitted pursuant to a confidential treatment order granted by the Securities and Exchange Commission.

 

* Filed herewith.

 

** In accordance with Rule 406T of Regulation S-T, the XBRL information in Exhibit 101 to this quarterly report on Form 10-Q shall not be deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (“Exchange Act”), or otherwise subject to the liability of that section, and shall not be incorporated by reference into any registration statement or other document filed under the Securities Act of 1933, as amended, or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.

 

43
 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

    SYNTHESIS ENERGY SYSTEMS, INC.
     
Date:  May 14, 2014 By:   /s/ Robert Rigdon
      Robert Rigdon
      President and Chief Executive Officer
     
Date:  May 14, 2014 By:   /s/ Charles Costenbader
      Charles Costenbader
      Chief Financial Officer

 

44

 

Exhibit 31.1

 

CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER PURSUANT TO RULE 13a-14(a)/15d-14(a) PROMULGATED UNDER THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED

 

I, Robert Rigdon, certify that:

 

1. I have reviewed this quarterly report on Form 10-Q of Synthesis Energy Systems, Inc.;

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date:  May 14, 2014  
   
/s/ Robert Rigdon  
Robert Rigdon  
President and Chief Executive Officer  

 

 

 

Exhibit 31.2

 

CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER PURSUANT TO RULE 13a-14(a) PROMULGATED UNDER THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED

 

I, Charles Costenbader, certify that:

 

1. I have reviewed this quarterly report on Form 10-Q of Synthesis Energy Systems, Inc.;

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date:  May 14, 2014  
   
/s/ Charles Costenbader  
Charles Costenbader  
Chief Financial Officer  

 

 

 

Exhibit 32.1

 

CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER

PURSUANT TO 18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO SECTION 906

OF THE SARBANES-OXLEY ACT OF 2002

 

In connection with the Quarterly Report of Synthesis Energy Systems, Inc. (the “Company”) on Form 10-Q for the period ended March 31, 2014 (the “Report”), as filed with the Securities and Exchange Commission on the date hereof, I, Robert Rigdon, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:

 

1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

 

2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

/s/ Robert Rigdon  
Robert Rigdon  
President and Chief Executive Officer  
   
May 14, 2014  

 

 

 

Exhibit 32.2

 

CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER

PURSUANT TO 18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO SECTION 906

OF THE SARBANES-OXLEY ACT OF 2002

 

In connection with the Quarterly Report of Synthesis Energy Systems, Inc. (the “Company”) on Form 10-Q for the period ended March 31, 2014 (the “Report”), as filed with the Securities and Exchange Commission on the date hereof, I, Charles Costenbader, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:

 

1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

 

2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

/s/ Charles Costenbader  
Charles Costenbader  
Chief Financial Officer  
   
May 14, 2014