Synthesis Energy Systems, Inc.
SYNTHESIS ENERGY SYSTEMS INC (Form: 10-Q, Received: 02/13/2015 17:14:34)

 

 

 

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 December 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 February 10, 2014 there were 73,224,330 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 December 31, 2014 (unaudited) and June 30, 2014 1
   
Consolidated Statements of Operations for the Three Months ended December 31, 2014 and 2013 (unaudited) 2
   
Consolidated Statements of Operations for the Six Months ended December 31, 2014 and 2013 (unaudited) 3
   
Consolidated Statements of Comprehensive Loss for the Three and Six Months ended December 31, 2014, and 2013 (unaudited) 4
   
Consolidated Statements of Cash Flows for the Six Months ended December 31, 2014 and 2013 (unaudited) 5
   
Consolidated Statements of Equity for the period from June 30, 2014 to December 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 22
   
Item 3. Quantitative and Qualitative Disclosure about Market Risk 39
   
Item 4. Controls and Procedures 40
   
PART II. Other Information  
   
Item 1. Legal Proceedings 41
   
Item 1A. Risk Factors 41
   
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 43
   
Item 3. Defaults Upon Senior Securities 43
   
Item 4. Mine Safety Disclosures 43
   
Item 5. Other Information 43
   
Item 6. Exhibits 45

 

 
 

 

PART I

Item 1. Financial Statements

 

SYNTHESIS ENERGY SYSTEMS, INC.

Consolidated Balance Sheets

(In thousands, except per share amounts)

 

    December 31,
2014
    June 30,
2014
 
    (Unaudited)        
ASSETS                
Current assets:                
Cash and cash equivalents   $ 13,728     $ 19,407  
Certificate of deposit- restricted     1,634        
Accounts receivable-related party, net     679       676  
Prepaid expenses and other currents assets     1,485       873  
Inventory     556       865  
Total current assets     18,082       21,821  
                 
Property, plant and equipment, net     10,666       31,499  
Intangible asset, net     973       1,049  
Investment in joint ventures     34,813       34,856  
Other long-term assets     1,976       2,481  
                 
Total assets   $ 66,510     $ 91,706  
                 
LIABILITIES AND EQUITY                
Current liabilities:                
Accrued expenses and accounts payable   $ 7,982     $ 7,167  
Line of credit     3,269        
Short-term bank loan     3,269       3,251  
                 
Total current liabilities     14,520       10,418  
                 
Commitment and contingencies                
                 
Stockholder’s Equity:                
Common stock, $0.01 par value: 200,000 shares authorized: 73,224 and 73,107 shares issued and outstanding, respectively     732       731  
Additional paid-in capital     242,413       241,125  
Accumulated deficit     (196,093 )     (165,984 )
Accumulated other comprehensive income     6,170       6,062  
Total stockholders’ equity     53,222       81,934  
Noncontrolling interests in subsidiaries     (1,232 )     (646 )
                 
Total stockholder’s equity     51,990       81,288  
                 
Total liabilities and stockholder’s equity   $ 66,510     $ 91,706  

 

See accompanying notes to the consolidated financial statements.

 

1
 

 

SYNTHESIS ENERGY SYSTEMS, INC.

Consolidated Statements of Operations

(In thousands, except per share amounts)

(Unaudited)

 

    Three Months Ended  
    December 31,  
    2014     2013  
             
Revenue:                
Product sales and other — related parties   $ 3,731     $ 5,914  
Technology licensing and related services     151        
Total revenue     3,882       5,914  
                 
Costs and Expenses:                
Costs of sales and plant operating expenses     5,261       4,030  
General and administrative expenses     2,299       2,183  
Stock-based compensation expense     949       472  
Depreciation and amortization     572       565  
Impairment of long-lived assets     20,914        
                 
Total costs and expenses     29,995       7,250  
                 
Operating loss     (26,113 )     (1,336 )
                 
Non-operating (income) expense:                
Foreign currency gains, net     (36 )     (31 )
Interest income     (10 )     (11 )
Interest expense     74       122  
                 
Net loss     (26,141 )     (1,416 )
                 
Less: Net income (loss) attributable to noncontrolling interests     (548 )     19  
                 
Net loss attributable to stockholders   $ (25,593 )   $ (1,435 )
                 
Net loss per share:                
Basic and diluted   $ (0.35 )   $ (0.02 )
                 
Weighted average common shares outstanding:                
Basic and diluted     73,224       63,720  

 

See accompanying notes to the consolidated financial statements.

 

2
 

 

SYNTHESIS ENERGY SYSTEMS, INC.

Consolidated Statements of Operations

(In thousands, except per share amounts)

(Unaudited)

 

    Six Months Ended  
    December 31,  
    2014     2013  
             
Revenue:                
Product sales and other — related parties   $ 7,945     $ 5,914  
Technology licensing and related services     151        
                 
Total revenue     8,096       5,914  
                 
Costs and Expenses:                
Costs of sales and plant operating expenses     11,042       4,127  
General and administrative expenses     4,368       4,605  
Stock-based compensation expense     1,234       1,518  
Depreciation and amortization     1,145       1,130  
Impairment of long-lived assets     20,914        
                 
Total costs and expenses     38,703       11,380  
                 
Operating loss     (30,607 )     (5,466 )
                 
Non-operating (income) expense:                
Equity in losses of joint ventures           1  
Foreign currency gains, net     (27 )     (43 )
Interest income     (20 )     (16 )
Interest expense     138       192  
                 
Net loss     (30,698 )     (5,600 )
                 
Less: Net income (loss) attributable to noncontrolling interests     (589 )     (3 )
                 
Net loss attributable to stockholders   $ (30,109 )   $ (5,597 )
                 
Net loss per share:                
Basic and diluted   $ (0.41 )   $ (0.09 )
                 
Weighted average common shares outstanding:                
Basic and diluted     73,211       63,695  

 

See accompanying notes to the consolidated financial statements.

 

3
 

 

SYNTHESIS ENERGY SYSTEMS, INC.

Consolidated Statements of Comprehensive Loss

(In thousands)

(Unaudited)

 

    Three Months Ended
December 31,
    Six Months Ended
December 31,
 
    2014     2013     2014     2013  
                         
Net loss, as reported   $ (26,141 )   $ (1,416 )   $ (30,698 )   $ (5,600 )
Unrealized foreign currency translation adjustment     111       207       111       329  
Comprehensive loss     (26,030 )     (1,209 )     (30,587 )     (5,271 )
Less comprehensive income (loss) attributable to noncontrolling interests     (545 )     16       (586 )     (3 )
Comprehensive loss attributable to the Company   $ (25,485 )   $ (1,225 )   $ (30,001 )   $ (5,268 )

 

See accompanying notes to the consolidated financial statements

 

4
 

 

SYNTHESIS ENERGY SYSTEMS, INC.

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

    Six Months Ended  
    December 31,  
    2014     2013  
             
Cash flows from operating activities:                
Net loss   $ (30,698 )   $ (5,600 )
Adjustments to reconcile net loss to net cash used in operating activities:                
Stock-based compensation expense     1,234       1,518  
Depreciation of property, plant and equipment     1,029       1,018  
Amortization of intangible and other assets     116       112  
Impairment of long-lived assets     20,914        
Equity in losses of joint ventures           1  
Foreign currency gains     (27 )     (43 )
Changes in operating assets and liabilities:                
Accounts receivable     15       (89 )
Prepaid expenses and other current assets     (599 )     (1,963 )
Inventory     312       (542 )
Other long-term assets     (213 )     331  
Accrued expenses and payables     780       920  
Net cash used in operating activities     (7,137 )     (4,337 )
                 
Cash flows from investing activities:                
Certificate of deposit- restricted     (1,627 )      
Capital expenditures     (253 )     (695 )
Equity investment in joint ventures           (516 )
Net cash used in investing activities     (1,880 )     (1,211 )
                 
Cash flows from financing activities:                
Payments on long-term bank loan           (1,252 )
Payments on short-term bank loan     (3,251 )      
Proceeds from short-term bank loan     3,254       3,253  
Proceeds from Line of Credit     3,254        
Proceeds from exercise of stock options, net     55        
Proceeds from issuance of common stock, net           100  
Net cash provided by financing activities     3,312       2,101  
                 
Net decrease in cash     (5,705 )     (3,447 )
                 
Cash and cash equivalents, beginning of period     19,407       15,870  
Effect of exchange rates on cash     26       5  
Cash and cash equivalents, end of period   $ 13,728     $ 12,428  

 

See accompanying notes to the consolidated financial statements.

 

5
 

 

SYNTHESIS ENERGY SYSTEMS, INC.

Consolidated Statement of Equity

(In thousands)

(Unaudited)

 

    Common Stock                 Accumulated
Other
    Non-        
    Shares    

Common

Stock

   

Additional

Paid-in Capital

   

Deficit

Accumulated

   

Comprehensive

Income

   

controlling

Interest

    Total  
                                           
Balance at June 30, 2014     73,107     $ 731     $ 241,125     $ (165,984 )   $ 6,062     $ (646 )   $ 81,288  
Net loss                       (30,109 )           (589 )     (30,698 )
Currency translation adjustment                             108       3       111  
Comprehensive loss                                         (30,587 )
Net proceeds from issuance of common stock     117       1       54                         55  
Stock-based compensation expense                 1,234                         1,234  
Balance at December 31, 2014     73,224     $ 732     $ 242,413     $ (196,093 )   $ 6,170     $ (1,232 )   $ 51,990  

 

See accompanying notes to the consolidated financial statements.

 

6
 

 

SYNTHESIS ENERGY SYSTEMS, INC.

 

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 an 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. Operating results for the three month and six months periods ended December 31, 2014 are not necessarily indicative of results to be expected for the fiscal year ending June 30, 2015.

 

The consolidated financial statements are in U.S. dollars. Non-controlling 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, 2014. 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, 2014 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) Certificate of deposit- restricted

 

The Company had approximately $1.6 million in restricted certificates of deposit at December 31, 2014. These amounts represent deposits made to Zaoahuang Bank Co, Ltd. and are used to secure the ZZ Line of Credit Agreement (as defined in Note 2)with Zaozhuang Bank Co., Ltd. These amounts are not available to the Company, unless the line of credit is paid down proportionately.

 

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 December 31, 2014 and June 30, 2014 which are consolidated within the Company’s consolidated balance sheets (in thousands ):

 

    December 31, 2014  
    Consolidated     ZZ Joint Venture
(1)
    %(2)  
                   
Current assets   $ 18,082     $ 4,546       25 %
Long-term assets (3)     48,428       11,871       25 %
Total assets   $ 66,510     $ 16,417       25 %
                         
Current liabilities   $ 14,520     $ 11,702       81 %
Equity     51,990       4,715       9 %
Total liabilities and equity   $ 66,510     $ 16,417       25 %

 

    June 30, 2014  
    Consolidated     ZZ Joint Venture
(1)
    %(2)  
                   
Current assets   $ 21,821     $ 2,256       10 %
Long-term assets     69,885       33,193       48 %
Total assets   $ 91,706     $ 35,449       39 %
                         
Current liabilities   $ 10,418     $ 7,462       72 %
Equity     81,288       27,987       34 %
Total liabilities and equity   $ 91,706     $ 35,449       39 %

 

(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.
(3) Includes the effect of impairment of long-lived assets related to our ZZ Joint Venture facility.

 

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 of 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 December 31, 2014 and was dissolved on January 9, 2015.

 

The Company has determined that the TSEC Joint Venture (as defined in Note 2 – Joint Ventures – TSEC Joint Venture) is a VIE and that TST, the joint venture partner, is the primary beneficiary since TST has a 65% ownership interest in the TSEC Joint Venture and has the power to direct the activities of the TSEC Joint Venture that most significantly influence its 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 December 31, 2014. There were however, current liabilities of approximately $0.6 million as of December 31, 2014 and $1.2 million as of December 31, 2013, related to unpaid settlements of amounts due to various contractors from the initial construction work for the project. In June 2014, the Company wrote off approximately $0.6 million of these unpaid settlements according to current local business contract law. 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, which has included the capacity fee and energy fee earned at the ZZ Joint Venture plant and is expected to include sale 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. The Company records revenue net of any applicable value-added taxes.

 

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).

  

9
 

  

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 assets and liabilities of the Company measured at fair value on a recurring basis as of December 31, 2014 and June 30, 2014 (in thousands):

 

    December 31, 2014  
    Level 1     Level 2     Level 3     Total  
Assets:                                
Certificates of Deposit   $     $ 50 (1)   $     $ 50  
Certificates of Deposit-restricted           1,634 (1)           ,1,634  
Money Market Funds           11,474 (2)           11,474  
                                 
Liabilities:                                
Line of credit           3,269 (3)           3,269  
Short-term bank loan           3,269 (3)           3,269  

 

    June 30, 2014  
    Level 1     Level 2     Level 3     Total  
Assets:                                
Certificates of Deposit   $     $ 50 (1)   $     $ 50  
Money Market Funds           16,971 (2)           16,971  
                                 
Liabilities:                                
Short-term bank loan            3,251 (3)           3,251  

 

(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.

 

The carrying values of the certificates of deposit, money market funds, short-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.

 

The following table summarizes the assets of the Company measured at fair value on a non-recurring basis as of December 31, 2014 and June 30, 2014 (in thousands):

 

    December 31, 2014  
    Level 1     Level 2     Level 3     Total  
Assets:                                
Assets held and used   $     $     $ 10,906 (1)   $ 10,906  

 

    June 30, 2014  
    Level 1     Level 2     Level 3     Total  
Assets:                                 
Assets held and used   $     $     $     $  

 

(1)  Amount included in long-term assets on the Company’s consolidated balance sheets, and represents the estimated fair value of our ZZ Joint Venture plant.

 

The Company’s Level 3 asset fair values are determined using a pricing model and discounted cash flow methodology, as well as significant management judgment and estimation for our ZZ Joint Venture.

 

The losses recorded during the three months and six months ended December 31, 2014, which were a result of the ZZ Joint Venture plant impairment, were as follows (in thousands):

 

10
 

 

    Three Months Ended
December 31,
2014
    Six Months Ended
December 31,
2014
 
             
Impairment of long-lived assets designated as held and used   $ 20,914     $ 20,914  
Total losses recorded   $ 20,914     $ 20,914  

 

(g) Recently Issued Accounting Standards

 

The Financial Accounting Standards Board issued Accounting Standards Update (ASU) 2014-15, Presentation of Financial Statements – Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going concern . ASU 2014-15 is intended to define management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and provide related footnote disclosures. This ASU is effective for interim periods within annual periods beginning after December 15, 2016. The Company is currently evaluating the impact of the adoption of this ASU on its consolidated financial statements.

 

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 $3.3 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 year ended June 30, 2014.

 

 The ZZ Joint Venture began producing and selling methanol in November 2013 and sold 12,268 tonnes of methanol during the three months ended December 31, 2014 generating approximately $3.7 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 completed 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 is managing 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.

 

11
 

 

Additionally, the Company is also evaluating alternative products and partnership structures in an effort to repurpose 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 us. The Company is also evaluating certain new downstream technologies to produce high value products and options for maximizing site asset value. The Company is also considering other options for the gasifiers at the plant, including repurposing by moving to a new location, since methanol prices are in decline. 

  

Although the Company intends for the ZZ Joint Venture to sustain itself through its own earnings, the Company may need to make additional contributions to the ZZ Joint Venture in order for it to meet its obligations. For example, in September 2014, we made a capital contribution of $1.5 million to the ZZ Joint Venture. This capital contribution was used to pay a portion of the ZZ Short-term Loan, which was due on September 9, 2014.

 

During the three months ended December 31, 2014, there was a significant decline in methanol prices in the China commodity market, which put significant pressure on our methanol production margins at the ZZ Joint Venture plant. Accordingly, the Company evaluated the ongoing value of the ZZ Joint Venture facility and based on this evaluation, the Company determined that the $32 million carrying value of the ZZ Joint Venture facility was no longer entirely recoverable. Due to this impairment, the Company wrote down the value of the facility to its estimated fair value of $11 millon and incurred an impairment expenses of $20.9 million. Fair value was based on expected future cash flows using Level 3 inputs under ASC 820. While changes in market conditions for methanol in China may increase the Company’s operating margins, any further degradation in methanol prices, as well as changes in assumptions used to test for recoverability and to determine fair value, could result in additional impairment charges in the future for the ZZ Joint Venture facility.

 

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 $3.3 million of loan proceeds for the retrofit and related costs contemplated by the ZZ Cooperation Agreement, the principal was repaid on the due date, September 9, 2014.

 

Working Capital Loan Agreement with Zaozhuang Bank Co., Ltd

 

On October 2, 2014, the ZZ Joint Venture replaced the above ZZ Short-term Loan with a new working capital loan agreement with Zaozhuang Bank Co., Ltd. (the “ZZ Working Capital Loan”), and received approximately $3.3 million of loan proceeds.

 

Key terms of the ZZ Working Capital Loan are as follows:

 

Term of the loan is one year, due on September 23, 2015;

 

Interest is payable monthly at an annual rate of 9%;

 

Xuecheng Energy is the guarantor of the loan;

 

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

 

Line of Credit (Deposit Secured Loan) with Zaozhuang Bank Co., Ltd

 

On October 8, 2014, the ZZ Joint Venture entered a Line of Credit Agreement with Zaozhuang Bank Co., Ltd. (the “ZZ Line of Credit Agreement”), and received a line of credit of approximately $2.5 million. On October 9, 2014, the ZZ Joint Venture entered an additional Line of Credit Agreement with Zaozhuang Bank Co., Ltd. and received a line of credit of approximately $0.8 million.

 

12
 

 

Key terms of the two lines of credit are as follows:

 

The ZZ Joint Venture is required to deposit 50% of the total face amount, or approximately $1.6 million, to Zaozhuang Bank for the line of credit as a security deposit, and the Company has recorded this amount as certificates of deposit – restricted on its balance sheet as of December 31, 2014;

 

Term of the lines of credit is six months, due on April 8 and April 9, 2015 respectively, and can be renewed for another six month term with bank approval;

 

Service fee is 0.05% of the face amount for each renewal.

 

Xuecheng Energy is the guarantor of each line of credit;

 

Certain assets of the ZZ Joint Venture, including land use rights and the administration building, are pledged as collateral for the lines of credit; 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 agreements to be due and payable immediately.

 

Xuecheng Energy’s combined guarantee for both the ZZ Working Capital Loan and the ZZ Line of Credit Agreement is limited to approximately $3.3 million.

 

Yima Joint Ventures

 

In August 2009, the Company entered into amended joint venture contracts with 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) 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 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. 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.

  

In exchange for such capital contributions, the Company owns a 25% interest in each joint venture and Yima owns a 75% interest. Notwithstanding this, in connection with an expansion of the project, the Company has the option to contribute a greater percentage of capital for the expansion, such that as a result, the Company 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. 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.

 

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 term of the joint venture shall commence upon each joint venture company obtaining its operating license and shall end 30 years after commercial operation of the plant.

  

13
 

 

The Yima Joint Venture plant generated its first methanol production in December 2012. The Yima Joint Venture plant’s refined methanol section was 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 intended to provide a commercial demonstration of the Company’s technology as deployed on a much larger scale than the ZZ Joint Venture plant.

 

The Yima Joint Venture initiated an outage in March 2014 intended to allow the plant to make broad and miscellaneous improvements to many areas of the entire methanol producing facility which had not been completed or properly installed.  Many of these improvements were punch-list items left over from construction, along with improvements which have been learned from the past year’s operation at the plant. Additionally, it was identified during this time that the Yima Joint Venture has not installed all the required units related to removal of sulfur compounds from syngas. A portion of these repairs were completed and the facility was restarted in late June 2014. The plant continues to run at approximately 30% to 50% of design capacity as data is gathered and as repairs and construction continue to be made to the facility.

 

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 six months period ended December 31, 2014 and 2013 since the Company changed from the equity method to the cost method of accounting as of June 1, 2013.

 

Additionally, 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 TST (as defined under “TSEC Joint Venture” in this Note 2). The gasifiers were completed and delivered in January 2012 to the Yima Joint Ventures. As of December 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 owes a combined $0.67 million to both TST and an additional vendor associated with the equipment purchase, which is accrued as a current liability on the Company’s consolidated balance sheet.

 

During the three months ended December 31, 2014, there was a significant decline in methanol price in China commodity market, which put pressure on our Yima Joint Venture plant methanol production margins. Accordingly, the Company performed a fair value analysis based on expected future cash flows using Level 3 inputs under ASC 820. The results of the test indicated that the estimated current fair value of the Yima investment exceeded its book value, and as a result, no impairment is required.

 

14
 

 

TSEC Joint Venture

 

Joint Venture Contract

 

On February 14, 2014, SES Asia Technologies Limited, one of the Company’s wholly owned subsidiaries, entered into a Joint Venture Contract (the “JV Contract”) with Zhangjiagang Chemical Machinery Co., Ltd., which subsequently changed its legal name to Suzhou Tianwo Science and Technology Co. Ltd. (“TST”), to form Jangsu Tianwo-SES Clean Energy Technologies Limited (the “TSEC Joint Venture”). The purpose of the TSEC Joint Venture is to establish the Company’s gasification technology as the leading gasification technology in the TSEC 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 TSEC 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. TST contributed RMB 53,800,000 in April 2014 and is required to contribute an additional RMB 46,200,000 within two years of contract execution for a total contribution of RMB 100,000,000 (approximately USD $16 million) in cash to the TSEC Joint Venture, and owns 65% of the TSEC Joint Venture. The Company has contributed an exclusive license to use of its technology in the TSEC Joint Venture territory pursuant to the terms of a Technology Usage and Contribution Agreement entered into among the TSEC Joint Venture, TST and the Company (the “TUCA”) on the same date. The Company owns 35% of the TSEC Joint Venture.

 

Under the JV Contract, neither party may transfer their interests in the TSEC 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 TSEC 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, TST 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 TSEC Joint Venture territory for the marketing and sale of any gasification technology or related equipment that utilizes low quality coal feedstock. Notwithstanding this, TST has the right to manufacture and sell gasification equipment outside the scope of the TSEC Joint Venture within the TSEC Joint Venture territory. In addition, the Company has the right to develop and invest equity in projects outside of the TSEC Joint Venture within the TSEC Joint Venture territory. After the termination of the TSEC Joint Venture, TST must obtain written consent from the Company for the market development of any gasification technology that utilizes feedstock in the TSEC 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 TSEC Joint Venture or (iv) mutual agreement of the parties.

 

On March 18, 2014, the TSEC 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 TSEC Joint Venture began operations.

 

Technology Usage and Contribution Agreement

 

Pursuant to the TUCA, the Company has contributed to the TSEC Joint Venture the exclusive right to the Company’s gasification technology in the TSEC 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 TSEC Joint Venture territory that have previously been developed by the Company and its affiliates.

 

The TSEC Joint Venture will be the exclusive operational entity for business relating to the Company’s technology in the TSEC Joint Venture Territory. If the TSEC Joint Venture loses exclusivity due to a Company breach, TST is to be compensated for direct losses and all lost project profits. The Company will also provide training for technical personnel of the TSEC Joint Venture through the second anniversary of the establishment of the TSEC Joint Venture. The Company will also provide a review of engineering works for the TSEC Joint Venture. If modifications are suggested by the Company and not made, the TSEC 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 TSEC 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.

 

15
 

 

The TSEC Joint Venture will establish an Intellectual Property Committee, with two representatives from the TSEC Joint Venture and two from the Company. This Committee shall review all improvements and protection measures and recommend actions to be taken by the TSEC 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 TSEC 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.

 

The following table presents summarized unconsolidated financial information for the TSEC Venture (in thousands):

 

Income Statement data:   Three months
Ended
December 31,
2014
    Six months
Ended
December 31,
2014
 
Revenue   $     $  
Operating loss     (742 )     (1,417 )
Net loss     (742 )     (1,418 )

 

Balance sheet data:   December 31,
2014
    June 30,
2014
 
Current assets   $ 7,793     $ 8,573  
Noncurrent assets     8,067       8,458  
Current liabilities     164       3  
Noncurrent liabilities            
Equity     15,696       17,028  

 

SES Resource Solutions

 

SES Resource Solutions, Ltd., or 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 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. In December 2012, SRS suspended its activities due to the unavailability of financing for coal resources, as of January 9, 2015, SRS was dissolved.

 

The Company’s investment in SRS is accounted for using the equity method. At December 31, 2014, SRS had no assets or liabilities as amounts are funded by the Company as costs are incurred.

 

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.  

 

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.

 

16
 

 

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 – Stock-Based Compensation

 

As of December 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 12,000,000 shares of common stock for awards under the Incentive Plan. As of December 31, 2014, there were 1,535,683 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 six months ended December 31, 2014 was as follows:

 

    Shares of Common
Stock Underlying
 
    Stock Options  
         
Outstanding at June 30, 2014     7,702,550  
Granted     506,025  
Exercised     (117,500 )
[Forfeited     (20,000 )
Outstanding at December 31, 2014     8,071,075  
Exercisable at December 31, 2014     7,294,769  

 

17
 

 

The fair values for the stock options granted during the six months ended December 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     1.61 %
Expected life of award     5.1 years  
Expected dividend yield     0.00 %
Expected volatility of stock     85 %
Weighted-average grant date fair value   $ 0.80  

 

Stock warrants activity during the six months ended December 31, 2014 were as follows:

 

    Shares of Common
Stock Underlying
 
    Stock Warrants  
       
Outstanding at June 30, 2014     6,616,667  
Granted     782,551  
Exercised      
Outstanding at December 31, 2014     7,399,218  

 

The Company recognizes the stock-based compensation expense related to the Incentive Plan awards and warrants over the requisite service period. The following table presents stock based compensation expense attributable to stock option awards issued under the Incentive Plan and attributable to warrants issued to consulting firms as compensation (in thousands):

 

    Three Months Ended     Six Months Ended  
    December 31,     December 31,  
    2014     2013     2014     2013  
                         
Incentive Plan   $ 229,160     $ 152     $ 514,312     $ 485  
Consultants     719,946       320       719,946       1,033  
Total stock-based compensation expense   $ 949,106     $ 472     $ 1,234,258     $ 1,518  

 

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. An Anniversary Warrant to acquire 782,551 shares at an exercise price of $1.00 per share was issued to MDC in November 2014

 

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 six months ended December 31, 2014 and 2013, 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.

 

18
 

 

During the three months ended December 31, 2014, there was a significant decline in methanol prices in the China commodity market, which put significant pressure on our ZZ and Yima Joint Venture plant methanol production margins. As a result, the Company evaluated both operating assets for potential impairment as of December 31, 2014. Based on this evaluation, the Company determined that the $32 million carrying value of the ZZ Joint Venture facility was no longer entirely recoverable. Due to this impairment, the Company wrote down the value of the facility to its estimated fair value of $11 millon and incurred an impairment expenses of $20.9 million. Fair value was based on expected future cash flows using Level 3 inputs under ASC 820. The ZZ Joint Venture is currently not paying all of its vendor payables, which is a breach of contract under the ZZ Cooperation Agreement. In addition, there are payments due under the ZZ Line of Credit Agreement on April 8 and 9, 2015 for a combined total of $3.3 million, and payments due under the ZZ Working Capital Loan on September 13, 2015 of $3.3 million. If the ZZ Joint Venture is unable to make these payments, it could forfeit the plant and the restricted certificate of deposit amount of $1.6 million to the lenders. With respect to the Company’s investment in the Yima Joint Venture, the Company performed a fair value analysis based on expected future cash flow, and concluded that fair value exceeded the current book value of the Company’s investment in the Yima Joint Venture. While changes in market conditions for methanol in China may increase the Company’s operating margins, any further degradation in methanol prices, as well as changes in assumptions used to test for recoverability and to determine fair value, could result in additional impairment charges in the future for the ZZ Joint Venture facility or an impairment related to the Yima investment.

 

The Yima Joint Venture plant’s refined methanol section was commissioned in December 2013, and has operated at limited capacity since that date. Methanol production was approximately 31% of its capacity during the three months ended December 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. The Yima Joint Venture initiated an outage in March 2014 intended to allow the plant to make broad and miscellaneous improvements to many areas of the entire methanol producing facility which had not been completed or properly installed. Many of these improvements were punch-list items left over from construction, along with improvements which have been learned from the past year’s operation at the plant. Additionally, it was identified during this time that the Yima Joint Venture has not installed all the required units related to removal of sulfur compounds from syngas. A portion of these repairs were completed and the facility was restarted in late June 2014. After three weeks of operation the plant was shut down again due to improper repair techniques on its Heat Recovery System Generator. 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 TST 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. 

 

The Company has made significant progress recently on partnering its China business through the TSEC Joint Venture, including through the recently announced projects with Innovative Coal Chemical Design Insitute, ICCDI, a subsidiary of TST, and Aluminum Corporation of China for an industrial syngas project, as well as with Dengfeng Power Group Co., Ltd. for a planned 160 MW distributed power generation program initially in Henan Province, China. However, the Company expects to continue 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 TSEC 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.

  

19
 

 

The majority of our revenues are derived from the sale of methanol in China. We do not have long term offtake agreements for these sales, so revenues fluctuate based on local market spot prices, which have been under significant pressure and are generally not consistent or predictable. We remain unsure of how much longer this downward market pressure will continue or where methanol prices will eventually stabilize. Our liquidity and capital resources will be materially adversely affected if markets remain under pressure, and we are unable to obtain satisfactory process for these commodities or if prospective buyers do not purchase these commodities

 

The Company currently plans to use its available cash for (i) securing a partner for its technology business vertical; (ii) securing orders and other associated tasks associated with the Company’s distributed power initiatives such as in China with Dengfeng Power and in Pakistan with General Electric; (iii) executing the Company’s strategy to develop market based business verticals; (iv) general and administrative expenses; (v) repaying the ZZ Short-term Loan and the ZZ Workign Capital Loan; and (vi) working capital and other general corporate purposes. Although the Company intends for the ZZ Joint Venture to sustain itself through its own earnings, 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 our results of operations and financial condition. Operating cash flows from the Company’s 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 volatile in nature.

  

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; or (vi) respond to competitive pressures or unanticipated capital requirements.

 

The Company is subject to concentration of credit risk with respect to our cash and cash equivalents, which it attempts to minimize by maintaining cash and cash equivalents with major high credit quality financial institutions. At times, the Company’s cash balances in a particular financial institution may exceed limits that are insured by the U.S. Federal Deposit Insurance Corporation or equivalent agencies in foreign countries such as Hong Kong.

 

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 our 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.

 

20
 

 

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

 

    Three Months Ended     Six Months Ended  
    December 31,     December 31,  
    2014     2013     2014     2013  
Revenue:                                
SES China   $ 3,882     $ 5,914     $ 8,096     $ 5,914  
Technology licensing and related services                        
Total revenue   $ 3,882     $ 5,914     $ 8,096     $ 5,914  
                                 
Depreciation and amortization:                                
SES China   $ 521     $ 516     $ 1,042     $ 1,031  
Technology licensing and related services     50       47       100       94  
Corporate & other     1       2       3       5  
Total depreciation and amortization   $ 572     $ 565     $ 1,145     $ 1,130  
                                 
Operating income (loss):                                
SES China   $ (23,525 )   $ 402     $ (26,162 )   $ (2,262 )
Technology licensing and related services     (643 )     (256 )     (1,240 )     (346 )
Corporate & other     (1,945 )     (1,482 )     (3,205 )     (2,858 )
Total operating loss   $ (26,113 )   $ (1,336 )   $ (30,607 )   $ (5,466 )
                                 
Interest expense:                                
SES China   $ 74     $ 122     $ 138     $ 192  
Total interest expense   $ 74     $ 122     $ 138     $ 192  
                                 
Equity in losses of joint ventures:                                
SES China   $     $     $     $  
Corporate & other                       1  
Total equity in losses of joint venture   $     $     $     $ 1  

 

    December 31,
2014
    June 30,
2014
 
Assets:                
SES China   $ 50,021     $ 76,316  
Technology licensing and related services     932       943  
Corporate & other     15,557       14,447  
Total assets   $ 66,510     $ 91,706  

 

21
 

 

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, 2014 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 global energy and gasification technology company that provides proprietary gasification technology systems and solutions to the energy and chemical industries.

 

Our business strategy 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.

 

Our technology can cleanly and economically extract carbon and hydrogen from most types of coal resources, coal wastes and renewable forms of biomass and municipal wastes. This carbon and hydrogen is extracted in the form of synthesis gas, called syngas. Our syngas is then readily converted into a wide range of fundamental energy and chemical products. These products include, but are not limited to, electric power, natural gas (methane), transportation fuels such as gasoline, diesel and jet fuel, chemicals such as methanol, olefins, and glycols, ammonia and urea for agricultural fertilizers and feedstocks for steel making. Our technology is part of a family of gasification technologies which have been used successfully in industrial applications for many years. However, our technology is meaningfully differentiated over these older forms of gasification primarily through its ability to create clean and economical syngas from most forms of coal resources—from the lowest quality brown coals and lignites , high ash sub-bituminous coals and including the highest quality bituminous and anthracite coals—as well as biomass and other renewable waste materials. Our most recent development is the SES XL3000 gasification system introduced in October 2014. It is specifically targeted to provide higher syngas capacity and delivery pressure with lower specific capital costs, while maintaining high carbon to syngas conversion ratios with high syngas generation efficiency on both high and low quality coals. The XL3000 is targeted to deliver efficiency and economy in performance required to meet the needs of the wide range of the world's syngas projects: distributed power, direct reduced iron, or DRI, steelmaking, industrial chemicals, fertilizers, synthetic natural gas, and transportation fuels . The XL3000 gasification system delivers approximately 250% higher syngas capacity than our previous designs with delivery pressures up to 55 bar pressure, driving lower specific capital costs per unit.

 

We intend to further commercialize our technology through supplying our gasification systems, which consist of technology, equipment and services to projects globally via value accretive partnerships and collaborations with other companies operating in the energy and chemical market segments in which 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. 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.

 

22
 

 

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 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 which 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 “Note 2 –Joint Ventures– Zao Zhuang Joint Venture” to our consolidated financial statements. During the quarter ended December 31, 2014, and as discussed further under “Current Operations and Projects – Zao Zhoang Joint Venture,” we incurred impairment expense associated with the write down of the value of the ZZ Joint Venture facility to its fair value.

 

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 “Note 2 –Joint Ventures-Yima Joint Venture” to our consolidated financial statements. 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 31% of its capacity during the three months ended December 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.

 

We also recently completed the formation of the TSEC Joint Venture, our China joint venture with TST. The purpose of the TSEC Joint Venture is to establish our gasification technology as the leading gasification technology in the TSEC 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 TSEC 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. As discussed further below under “-Current Operations and Projects – TSEC Joint Venture,” we have seen the first potential projects emerge with Innovative Coal Chemical Design Insitute and Dengfeng Power Group.

 

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. In addition, as mentioned above, in December 2014, we and TSEC signed a Framework Agreement with Dengfeng Power Group for a series of engineering and evaluation steps for a 160MW distributed power generation plant intended to utilize the combineation of our gasification technology and GE LM2500+G4 technology platforms with the gasification equipment provided by TSEC. We believe the distributed power segment offers opportunity over time to provide meaningful sales opportunities for our gasification technology and equipment systems, and 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.

 

23
 

 

We have also entered into an exclusive agreement with TSEC and Midrex for the joint marketing of coal gasification-based DRI facilities in China. These facilities will combine our gasification technology with the Direct Reduction Process of Midrex to create syngas from low quality coals in order to convert iron ore into high-purity DRI. TSEC will aid in the marketing of these DRI facilities in China and will supply the gasification equipment and licensing of the technology.

 

We are also actively seeking a partner for our technology vertical with existing businesses and vested interest in the growth of the global energy and chemicals projects who also has financial strength, a strong global sales force and demonstrated experience in process or power industry engineering and technology deployment are target candidates for this cooperation with us.

   

Business Strategy

 

The key elements of our business strategy include:

 

Generate financial results from our existing joint venture assets in China.

 

ZZ Joint Venture

 

Our ZZ Joint Venture plant produces clean syngas which is blended with coke oven gas, or COG, to produce chemical-grade methanol, or MeOH. This methanol is sold into the local methanol market in Shandong Province, China.  The history of the ZZ Joint Venture and the commercially restructured facility is described in more detail under “Current Operations and Projects– Zao Zhuang Joint Venture. Key elements of our business strategy for the plant are:

 

a) Operating at the highest possible production rates, based on market conditions, to maximize the financial results from the facility.
b) Maximizing the operation of our gasification systems at the ZZ Joint Venture within local market constraints and continue to demonstrate the robustness and efficient capability of our technology.
c) Evaluating, advancing and closing new partnering and/or expansion alternatives for improving the financial results of the ZZ Joint Venture, which may include additional downstream technologies to produce high value products at the site.
d) Secure alternative and increased sources of COG to aid increased production rates and lower production costs, as well as to seek to restructure the existing Cooperation Agreement to reflect the current methanol market situation.
e) Selective testing of new inventions at the ZZ Joint Venture that will benefit the joint venture and our future gasification projects.
f) Continuously improving and innovating at the ZZ Joint Venture to lower production costs and improve operating margins.
g) Considering other options for gasifiers at the plant, including repurposing by moving to another location.

 

Yima Joint Venture

 

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 intended to provide a commercial demonstration of our technology as deployed on a much larger scale than the ZZ Joint Venture plant.

 

We own 25% of the Yima Joint Ventures and Yima Coal Industry (Group) Co., Ltd., or Yima, owns 75%. Yima controls the construction, startup and operation of the plant. Recently, Yima put in place a new facility management structure, which we believe will significantly improve the operations of the facility. We believe the fundamental value of the Yima Joint Ventures is sound due to (1) the preferential coal pricing Yima can provide to the facility, (2) our technology’s capability to efficiently gasify this low quality coal and (3) the benefits derived from the plant’s large scale. More detail is available under “Current Operations and Projects – Yima Joint Ventures”. Key elements of our business strategy for the Yima plant are:

 

a) Achieving formal commercial acceptance of the entire facility including documented acceptance of the performance of our technology at Yima.
b) Explore ways to monetize our investment in Yima.
c) Achievement of safe, compliant, full-design annual methanol production rates and overall profitable operation which can lead to dividend distributions to the shareholders of the joint venture.
d) Increase the scrutiny of results from onsite JV management via cooperation with Yima and Henan Energy and Chemical Industry Group Co., Ltd., parent company of Yima, or HNECGC, senior leadership, maintaining our onsite staff, regular joint venture board meetings and related shareholder meetings.

 

24
 

  

e) Continually assess long-term approach for us in the Yima Joint Ventures to maximize our financial return through achieving eventual dividends, restructuring alternatives and/or exit strategies.

 

TSEC Joint Venture

 

The purpose of the TSEC Joint Venture is to establish our gasification technology as the leading gasification technology in the TSEC Joint Venture territory (which is China, Indonesia, the Philippines, Vietnam, Mongolia and Malaysia) by becoming a leading provider of proprietary equipment for the technology. The scope of the TSEC 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. In addition, we believe our TSEC Joint Venture will also help build new partnerships 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, and accelerate the commercialization of our technology on a global basis enabling us to reduce the capital requirements to achieve this acceleration. We own a 35% interest in the TSEC Joint Venture. More detail is available under “Current Operations and Projects – TSEC Joint Venture” . Key elements of our business strategy for TSEC are:

 

a) Achieve initial orders for new project license and equipment supply.
b) Secure first customers for our higher pressure 40bar gasification platform, with a focus on brown field projects which could move quickly to install and operate the 40 bar system.
c) Expand the scope of supply of the TSEC joint venture to grow from licenses and proprietary equipment supply into supply of non-proprietary process equipment into TSEC projects.
d) Expand the TSEC engineering and construction capability together with TST to provide fully constructed fixed priced gasification systems in the territory.
e) Endeavor to form collaborations and partnerships in market segments with known leaders in those markets to help advance our technology, such as our exclusive marketing agreement with the TSEC Joint Venture and Midrex Technologies for coal gasification-based DRI and our framework agreement with Dengfeng Power for a planned 160 MW power generation plant.
f) Build implementation capability with TSEC to supply high quality, low cost equipment into our global projects outside the territory.

 

Partnering with proven project development companies .

 

We believe that compatible and strategic partners will help us grow and accelerate deployment of our technology, engineering, equipment and services into global projects much faster and with better overall market penetration capability and value generation than if we were to continue on our own. As a result, we are actively seeking such a partner and intend to complete this undertaking within the next two to three quarters. Potential partners with existing businesses and vested interest in the growth of the global energy and chemicals projects who also has financial strength, a strong global sales force and demonstrated experience in process or power industry engineering and technology deployment are target candidates for this cooperation with us.

 

We believe that partnering to enable the development of gasification projects, which can benefit from our technology’s capability regarding low cost feedstock flexibility, lower capital cost and reduce water usage footprint, can provide value through creating a channel for us to secure new orders and the ability to share in project development fees and/or achieve carried interests in projects. We believe that we have the greatest competitive advantage by 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. In many cases such low cost resources are not a viable energy source without our technology’s capability to convert the resource into syngas and resulting energy and chemical products.

  

Increase our organizational and financial capability to deliver our technology, equipment and services .

 

As our business verticals and other business initiatives develop and we secure new technology orders, we believe we may need to add significant implementation capability to follow through with fulfillment and implementation and increase our ability to provide the necessary financial and performance guarantees required by project customers and equity and debt financiers. We intend to seek new and impactful partnering opportunities to provide this needed capability in similar fashion to our TSEC Joint Venture in China.

 

25
 

 

Continue to develop and improve our technology .

 

We are continually seeking to advance and improve our gasification technology, such as through our new XL3000 gasification system. 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. We are advancing our higher pressure 40bar to 60bar gasification system designs which can further enhance our capital and operating expenses effectiveness and allow our system to achieve much higher syngas output from a smaller sized gasifier. 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 High Pressure Gasifier, 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.

 

Results of Operations

 

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

 

Revenue . Total revenue was $3.9 million for the three months ended December 31, 2014 compared to $5.9 million for the three months ended December 31, 2013.

 

Our ZZ Joint Venture began producing and selling methanol in November 2013 and sold 12,268 tonnes of methanol and generated approximately $3.7 million of revenue during the three months ended December 31, 2014 compared with 10,127 tonnes of methanol sold and generated approximately $4.4 million of revenue during the three months ended December 31, 2013. The decrease in revenue was primarily due to a 30 % decrease in methanol prices during the three months ended December 31, 2014 when compared to the three months ended December 31, 2013. 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, during the three months ended December 31, 2013.

 

Technology licensing and related services revenue was $0.2 million for the three months ended December 31, 2014, which resulted from technical consulting and engineering services provided to our TSEC Joint Venture. There was no technology licensing and related services revenue for the three months ended December 31, 2013.

  

Costs of sales and plant operating expenses. Costs of sales and plant operating expenses increased to $5.3 million for the three months ended December 31, 2014 compared to $4.0 million for the three months ended December 31, 2013. The increase was primarily due to the costs incurred for the ZZ Joint Venture’s production of methanol from coke oven gas purchased from Xuecheng Energy, including electricity, coke oven gas, labor and other operating costs.

  

 

General and administrative expenses. General and administrative expenses increased by $0.1 million to $2.3 million for the three months ended December 31, 2014 compared to $2.2 million for the three months ended December 31, 2013. The increase was due primarily to the loss of approximately $0.1 million incurred to write down our ZZ Joint Venture’s inventory to the current fair market value resulting from the decline of methanol price in China market. 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 by $0.4 million to $0.9 million for the three months ended December 31, 2014 compared to $0.5 million for the three months ended December 31, 2013. The increase was due primarily to the expensing of approximately $0.7 million for the fair value of warrants issued in connection with our consulting agreement with MDC in November 2014 compared to the expensing of only approximately $0.4 million for the fair value of warrants issued to MDC in November 2013.

  

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

  

Impairment of ZZ Joint Venture Plant. Impairment of the ZZ Joint Venture Plant was recognized for the three months ended December 31, 2014 of approximately $20.9 million (see “-Current Operations and Projects – Zao Zhuang Joint Venture”).

 

26
 

  

Foreign currency gains . Foreign currency gain was $36,000 for the three months ended December 31, 2014 compared to $31,000 for the three months ended December 31, 2013. These amounts resulted from the appreciation of the Renminbi Yuan relative to the U.S. dollar.

  

Interest expense. Interest expense decreased to $74,000 for the three months ended December 31, 2014 compared to $0.1 million for the three months ended December 31, 2013. For the three months ended December 31, 2014, our interest expense relates to the ZZ Working Capital Loan (as defined under “–Liquidity and Capital Resources”) with the ZaoZhuang Bank Co. Ltd., or ZZ Bank. For the three months ended December 31, 2013, our interest expense related to ZZ Joint Venture’s loans with Industrial and Commercial Bank of China, or ICBC, and the ZZ Short-term Loan (as defined under “–Liquidity and Capital Resources”) with ZZ Bank. The ZZ Joint Venture repaid its final principal payment of RMB 7.3 million (approximately $1.2 million) to ICBC in January 2014 and repaid its principal of approximately $3.3 million for the ZZ Short-term Loan in September 2014. The decrease in interest expense was due primarily to the lower principal outstanding as of December 31, 2014.

 

Six Months Ended December 31, 2014 Compared to the Six Months Ended December 31, 2013

 

Revenue . Total revenue increased to $8.1 million for the six months ended December 31, 2014 compared to $5.9 million for the six months ended December 31, 2013.

 

Our ZZ Joint Venture began producing and selling methanol in November 2013 and sold 25,117 tonnes of methanol and generated approximately $7.9 million of revenue during the six months ended December 31, 2014 compared with 10,127 tonnes of methanol sold and generated approximately $4.4 million of revenue during the six months ended December 31, 2013. 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, during the three months ended December 31, 2013.

 

Technology licensing and related services revenue was $0.2 million for the six months ended December 31, 2014, which resulted from technical consulting and engineering services provided to our TSEC Joint Venture. There was no technology licensing and related services revenue for the six months ended December 31, 2013.

 

Costs of sales and plant operating expenses. Costs of sales and plant operating expenses increased by $6.9 million to $11.0 million for the six months ended December 31, 2014 compared to $4.1 million for the six months ended December 31, 2013. The increase was due principally to the ZZ Joint Venture producing and selling methanol until November 2013, the cost incurred for production of methanol from coke oven gas purchased from Xuecheng Energy, those costs include electricity, coke oven gas, labor and other operating costs. In addition, the ZZ Joint Venture incurred costs of approximately $0.4 million during the six months ended December 31, 2013 for non-routine repairs and retrofit expenses incurred for the new operations and restart of its syngas plant.

  

General and administrative expenses. General and administrative expenses decreased by $0.2 million to $4.4 million for the six months ended December 31, 2014 compared to $4.6 million for the six months ended December 31, 2013. The decrease was due primarily to a reduction of consulting expenses resulted from the termination of our consulting agreement with Crystal Vision Energy Limited, or CVE, as of August 31, 2013 and reductions in employee related compensation cost resulted from reducing headcount in China. 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 $0.3 million to $1.2 million for the six months ended December 31, 2014 compared to $1.5 million for the six months ended December 31, 2013. The decrease was due primarily to the reduction of 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 due to the termination of the consulting agreement with CVE as of August 31, 2013 and offset, in part, by higher fair values of warrants issued to MDC in November 2014 compared to the fair values of warrants issued to MDC in November 2013.

  

Depreciation and amortization expense. Depreciation and amortization expense was $1.1 million for both of the six months ended December 31, 2014 and 2013 and was primarily related to depreciation of our ZZ Joint Venture’s syngas plant assets.

  

27
 

 

Impairment of ZZ Joint Venture Plant. Impairment of the ZZ Joint Venture Plant was recognized for the six months ended December 31, 2014 of approximnately $21 million. (See “–Current Operations and Projects – Zao Zhuang Joint Venture”).

  

Foreign currency gain . Foreign currency gain was $27,000 for the six months ended December 31, 2014 and $43,000 for the six months ended December 31, 2013. These amounts resulted from the appreciation of the Renminbi Yuan relative to the U.S. dollar.

  

Interest expense. Interest expense was $0.1 million for the six months ended December 31, 2014 compared to $0.2 million for the six months ended December 31, 2013. For the six months ended December 31, 2014, our interest expense relates to the ZZ Working Capital Loan and the ZZ Short-term Loan with ZZ Bank. For the six months ended December 31, 2013, our interest expense related to ZZ Joint Venture’s loans with ICBC, and the ZZ Short-term Loan with ZZ Bank. The ZZ Joint Venture repaid its final principal payment of RMB 7.3 million (approximately $1.2 million) to ICBC in January 2014 and repaid its principal of approximately $3.3 million for the ZZ Short-term Loan in September 2014. The decrease in interest expense was due primarily to the lower principal outstanding as of December 31, 2014.

  

Liquidity and Capital Resources

 

We have financed our operations to date through private placements of our common stock and in 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, the ZZ Joint Venture had a loan agreement with ICBC which funded certain of its plant’s construction costs, the ZZ Short-term Loan funded in September 2013 to finance costs related to the ZZ Cooperation Agreement, and the ZZ Working Capital Loan funded in October 2014 for purchase of raw material. We do not currently have all of the financial resources necessary to fully develop and execute on all of our business opportunities and, as discussed further under “–Outlook,” 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.

 

As of December 31, 2014, we had $13.7 million in cash and cash equivalents and $3.6 million of working capital available to us. During the six months ended December 31, 2014, we used $7.1 million in operating activities compared to $4.3 million for the six months ended December 31, 2013. We used $1.6 million in investing activities for the certificate of deposit required by ZZ Bank for securing the ZZ Line of Credit Agreement and $0.3 million for capital expenditures related to the ZZ Cooperation Agreement for the six months ended December 31, 2014 compared with $1.2 million for the six months ended December 31 2013. For the six months ended December 31, 2014, we used $3.3 million in financing activities to repay the ZZ Short-term bank loan with ZZ Bank, and we used $1.2 million for the scheduled semi-annual principal payments on the ZZ Joint Venture’s loan with ICBC for the six months ended December 31, 2013. On October 2, 2014, the ZZ Joint Venture received approximately $3.3 million of working capital loan proceeds from ZZ Bank under the ZZ Working Capital Loan. On October 8, 2014, the ZZ Joint Venture received a line of credit of approximately $2.5 million from ZaoZhuang Bank and on October 9, 2014, the ZZ Joint Venture received an additional Line of credit of approximately $0.8 million from ZZ Bank. Amounts owed to ZZ Bank are $3.3 million in April 2015 and $3.3 million in September 2015. It is expected that these amounts will be paid out of ZZ Joint Venture funds.

 

We currently plan to use our available cash for (i) securing a partner for our technology business vertical; (ii) securing orders and other associated tasks associated with our distributed power initiatives such as in China with Dengfeng Power and in Pakistan with General Electric; (iii) executing our strategy to develop market based business verticals, (iv) general and administrative expenses (v) repaying the ZZ Short-term Loan and the ZZ Working Capital Loan and (vi) working capital and other general corporate purposes. Although we intend for the ZZ Joint Venture to sustain itself through its own earnings, 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.

 

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 ZZ Bank (the “ZZ Short-term Loan”), and received approximately $3.3 million of loan proceeds for the retrofit and related costs contemplated by the ZZ Cooperation Agreement. The ZZ Joint Venture paid off the ZZ Short-term Loan in September 2014.

 

Working Capital Loan Agreement with Zaozhuang Bank Co., Ltd

 

On October 2, 2014, the ZZ Joint Venture replaced the above ZZ Short-term Loan with a new working capital loan agreement with the ZZ Bank (the “ZZ Working Capital Loan”), and received approximately $3.3 million of loan proceeds.

 

28
 

 

Key terms of the ZZ Working Capital Loan are as follows:

 

Term of the loan is one year, due on September 23, 2015;

 

Interest is payable monthly at an annual rate of 9%;

 

Xuecheng Energy is the guarantor of the loan;

 

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

  

Line of Credit (Deposit Secured Loan) with Zaozhuang Bank Co., Ltd

 

On October 8, 2014, the ZZ Joint Venture entered a Line of Credit Agreement with the ZZ Bank (the “ZZ Line of Credit Agreement”), and received a line of credit of approximately $2.5 million. On October 9, 2014, the ZZ Joint Venture entered an additional Line of Credit Agreement with ZZ Bank and received a line of credit of approximately $0.8 million.

 

Key terms of the two lines of credit are as follows:

 

The ZZ Joint Venture is required to deposit 50% of the total face amount, or approximately $1.6 million, to the ZZ Bank for the line of credit as a security deposit;

 

Term of the lines of credit is six months, due on April 8 and April 9, 2015 respectively, and can be renewed for another six months term with bank approval;

 

Service fee is 0.05% of the face amount for each renewal.

 

Xuecheng Energy is the guarantor of the line of credit;

 

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

 

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

 

Xuecheng Energy’s combined guarantee for both the ZZ Working Capital Loan and the ZZ Line of Credit Agreement is limited to approximately $3.3 million.

 

ZZ Joint Venture liquidity

 

Due to the low methanol prices in China, the ZZ Joint Venture is currently not paying all of its vendor payables. In addition, there are payments due under the ZZ Line of Credit Agreement on April 8 and 9 of 2015 for a combined total of $3.3 million, and payments due under the ZZ Working Capital Loan on September 13, 2015 of $3.3 million. If the ZZ Joint Venture is unable to make these payments, it could forfeit the plant and the restricted certificate of deposit amount of $1.6 million to the lenders.

 

Current Operations and Projects

   

Zao Zhuang Joint Venture

  

Joint Venture Agreement

 

On July 6, 2006, we 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.

 

29
 

 

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 $3.3 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 year ended June 30, 2014.

 

The ZZ Joint Venture began producing and selling methanol in November 2013 and sold 12,268 tonnes of methanol during the three months ended December 31, 2014 generating approximately $3.7 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 completed 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. 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. In addition, the Company is focused on lowering our operating costs, as well as reducing forced outages at the facility.

 

Additionally, we are also evaluating alternative products and partnership structures for a possible repurpose 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 us. We are also evaluating certain new downstream technologies to produce high value products and options for maximizing site asset value. We are also considering other options for the gasifiers at the plant, including repurposing by moving to a new location, since methanol prices are in decline.

   

Current ZZ Operating Description and Capability

 

As described above, we assumed operational control of the integrated methanol production facility in October 2013 under a restructured commercial arrangement pursuant to the ZZ Cooperation Agreement. The ZZ Joint Venture completed plant retrofits and equipment upgrades to enable increased methanol production from integrated syngas and COG feedstock. The ZZ Joint Venture began producing and selling methanol in November 2013 and sold 12,268 tonnes of methanol during the three months ended December 31, 2014 generating approximately $3.7 million of revenue. The ZZ Joint Venture restarted its syngas plant for approximately two weeks during December 2013. In January 2014, the facility produced methanol from coke oven gas only due to coke oven gas supplies disruptions during the cold weather when COG was diverted to the city gas loop for residential heating needs. We expect such diversions of COG into residential heating during the winter months to be reduced or eliminated in the future due to local town gas system being upgraded to use pipeline natural gas.

 

30
 

 

We are experiencing methanol prices in China and at our ZZ facility at near historic lows. Under these conditions the facility has operated primarily in the COG only mode. We believe methanol prices have been at these recent low levels primarily related to both the general economic conditions in China as demonstrated by China’s current low PMI and due to a correlation between methanol prices and oil prices.

 

Other non-market based factors affect economic expectations at the ZZ Joint Venture facility such as but not limited to unscheduled maintenance, forced outages, catalyst degradation and performance in both the COG reformer and methanol synthesis loop and third party coke oven outages which can curtail available COG feedstock. The ZZ facility is limited to approximately 24 hours of COG storage.

 

Although we intend for the ZZ Joint Venture to sustain itself through its own earnings, we may need to make additional contributions to the ZZ Joint Venture in order for it to meet its obligations. In September 2014, we made a capital contribution of $1.5 million to the ZZ Joint Venture. This capital contribution was used to pay a portion of the ZZ Short-term Loan, which was due on September 9, 2014.

 

During meetings with the local government at Xuecheng in June 2014 and separate meetings with Xuejiao, the ZZ Joint Venture has been advised that the existing Xuejiao coke oven facility may be permanently shutdown in the future. A definitive timeline has not been established for this shutdown and the ZZ Joint Venture was informed that it may occur in the next 3 to 4 years. Xuejiao has constructed a new coking coal facility about 20 kilometers away from the current facility and this new facility is intended to eventually replace the current facility which has come under scrutiny for pollution from its old generation coking coal technology used. Because of this the ZZ Joint Venture intends to develop its alternatives for continued production of methanol and other products from the facility. The ZZ Joint Venture is expected to qualify as a clean industrial producer of chemicals such as methanol which can be expanded into a clean industrial park once the existing coke ovens are removed. We are evaluating alternative products and partnership structures for partnering and/or expansion of the ZZ Joint Venture plant. In 2010, the ZZ Joint Venture received the necessary government approval for an expansion into mono-ethylene glycol production. This expansion project remains under evaluation by us. We are also evaluating new downstream technologies to produce high value products at the site. 

 

Impairment

 

During the three months ended December 31, 2014, there was a significant decline in methanol prices in China. By December 31, 2014, methanol prices were below 1,900 Rmb per tonne, which was a level not seen since November 2009. This significant decline in methanol prices generally corresponded to the significant decline in global oil prices for the same quarter. Due to this reduction in methanol prices, the ZZ Joint Venture’s gasification portion of the facility is no longer able to make a positive financial contribution to the facility and has been turned off since December 2014 until such time as methanol prices increase.

 

The ZZ Joint Venture plant is contractually obligated to take coke oven gas from Xuecheng Energy and Xuecheng Energy is under extreme financial pressure because their coke oven gas operations are running at a loss in the current low steel price environment in China. Xuecheng Energy is unable to shut down this operation and wait for improved steel prices. As a result, the ZZ Joint Venture is currently taking the coke oven gas feedstock and managing the operation with cash and revenues coming solely from methanol sales which have been adequate to pay fixed costs and third-party costs, except for the coke oven gas. As a result the ZZ Joint Venture is accruing a payable for coke oven gas, which was $3.0 million as of December 31, 2014, and the ZZ Joint Venture anticipates negotiating a settlement for this payable with Xuecheng Energy in the future.

 

Due to this significant shift in the market for methanol, we were required to evaluate the ongoing value of the ZZ Joint Venture facility and, based on this evaluation, we determined that the ZZ Joint Venture asset value is no longer entirely recoverable as of December 31, 2014. Becasue of this, we have incurred an impairment expense of $20.9 million, reducing the value of the facility to a fair value of $11 millon. Fair value was based on expected future cash flows using Level 3 inputs under ASC 820. While changes in market conditions for methanol in China may increase operating margins, any further reduction in methanol prices, as well as changes in assumptions used to test for recoverability and to determine fair value, could result in additional impairment charges in the future for the ZZ Joint Venture facility.

 

The primary reasons that we recorded an impairment on the ZZ Joint Venture plant and not on Yima are (1) the Yima facility is significantly larger than the ZZ Joint Venture plant, thus spreading our fixed costs over more units, (2) the Yima project is newer than the ZZ Joint Venture plant, therefore has a longer remaining life, (3) Yima is less expensive to operate, since the coal at Yima is generally purchased at a lower cost and (4) the ZZ Joint Venture plant operates primarily on COG, whereas Yima operates solely on syngas.

  

31
 

 

Yima Joint Ventures

 

In August 2009, we entered into amended joint venture contracts with 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 and Yima shall share the profits, and bear the risks and losses, of the joint ventures in proportion to our respective ownership interests..

   

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.

 

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. 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 Yima Joint Venture plant generated its first methanol production in December 2012. The Yima Joint Venture plant’s refined methanol section was 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 intended to provide a commercial demonstration of our technology as deployed on a much larger scale than the ZZ Joint Venture plant.

 

The Yima Joint Venture initiated an outage in March 2014 that was intended to allow the plant to make broad and miscellaneous improvements to many areas of the entire methanol producing facility which had not been completed or properly installed. Many of these improvements were punch-list items left over from construction, along with improvements which have been learned from the past year’s operation at the plant. Additionally, it was identified during this time that the Yima Joint Venture has not installed all the required units related to removal of sulfur compounds from syngas. A portion of these repairs were completed and the facility was restarted in late June 2014. After three weeks of operation the plant was shut down again due to improper repair techniques on its Heat Recovery System Generator. The plant continues to run at approximately 30% to 50% of design capacity as data is gathered and as repairs and construction continue to be made to the facility.

 

We believe there is a consistent pattern of the Yima Joint Venture management not demonstrating an understanding of the methanol facility operations and not sourcing available expertise in China to improve the overall operations. We have witnessed operation of its gasifier systems at Yima with design and operating parameter deviations from our existing technology recommendations. We have previously experienced limited ability to influence the Yima Joint Ventures’ operating performance. 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.

 

As a result of these issues, HNECGC restructured the management of the Yima Joint Ventures under the direction of the Henan Coal Gasification Company or Henan, which is an affiliated company reporting directly to HNEGC. The ownership of the Yima Joint Ventures is unchanged. Henan currently has full authority of day to day operational and personnel decisions at the Yima Joint Venture. The goal of the management restructuring is to provide for a more experienced and efficient operations management system. The management team at Henan is experienced at running and optimizing coal gasification facilities, and they currently operate other coal gasification facilities. We currently plan to rely upon and assist Henan's management to achieve optimized operations and will continue to attempt to improve our influence on the Yima Joint Ventures. Despite this, we believe the fundamental value of the Yima Joint Ventures remains sound due to (1) the preferential coal pricing Yima can provide to the facility, (2) our technology’s capability to efficiently gasify this low quality coal and (3) the benefits derived from the plant’s large scale.

 

32
 

 

During the three months ended December 31, 2014, there was a significant decline in methanol price in China commodity market, which put pressure on our Yima Joint Venture plant methanol production margins. Accordingly, the Company performed a fair value analysis based on expected future cash flows. The results of the test indicated that the current estimated fair value of the Yima investment exceeded its book value, and as a result, no impairment is required.

 

TSEC Joint Venture

 

Joint Venture Summary

 

On February 14, 2014, SES Asia Technologies Limited, one of our wholly owned subsidiaries, entered into a Joint Venture Contract (the “JV Contract”) with Zhangjiagang Chemical Machinery Co., Ltd., which subsequently changed its name to Suzhou Tianwo Science and Technology Co. Ltd. (“TST”), to form Jiangsu Tianwo-SES Clean Energy Technologies Limited (the “TSEC Joint Venture”). The purpose of the TSEC Joint Venture is to establish our gasification technology as the leading gasification technology in the TSEC 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 TSEC 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. TST contributed RMB 53,800,000 in April 2014 and is required to contribute an additional RMB 46,200,000 within two years of contract execution for a total contribution of RMB 100,000,000 (approximately USD $16 million) in cash to the TSEC Joint Venture, and owns 65% of the TSEC Joint Venture, and we have contributed an exclusive license to use of our technology in the TSEC Joint Venture territory pursuant to the terms of a Technology Usage and Contribution Agreement entered into among the TSEC Joint Venture, TST and us (the “TUCA”) on the same date, and own 35% of the TSEC Joint Venture. Under the JV Contract, neither party may transfer their interests in the TSEC 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 TSEC Joint Venture to transfer 5% of its interest to a financial investor. If we elect not to transfer such 5% interest during that period, TST has the option to purchase such interest from us for RMB 10,000,000 (approximately USD$1.6 million).

 

Through the TSEC Joint Venture, we have partnered a significant portion of our China business with TST, a financially strong and highly skilled Chinese chemical equipment manufacturing company which desired to invest into the growth of China’s clean energy space and which recognized the opportunity afforded by our technology capability and business model.  We believe partnering with TST 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 China business will not only support the growth of our TSEC 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 which 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 TSEC Joint Venture and for our China business.

 

TSEC Projects

 

In December 2014, Innovative Coal Chemical Design Insitute, ICCDI, a subsidiary of TST, was awarded three projects from Aluminum Corporation of China, Shandong Branch. The award calls for ICCDI to serve as the general contractor providing all engineering and construction of the three projects. ICCDI has finalized two of the three definitive agreements for the projects and expects to finalize the third and final definitive agreement by the end of our fiscal year. The Company’s technology systems are to be supplied by TSEC to ICCDI and will be used to produce an expected combined total of approximately 175,000 normal cubic meters per hour of industrial syngas as a clean energy fuel for three existing aluminum manufacturing plants, located in the Shandong, Henan and Shanxi provinces. TSEC is is also undertaking the required engineering work now while also developing the required contracts with ICCDI for completion of the three projects.

 

33
 

 

In December 2014, we and TSEC entered into an agreement with Dengfeng Power Group Co., Ltd., or DFPG, for a distributed power generation program initially in Henan Province, China. The first phase of the program will be a pre-feasibility study for the first of several planned 160 MW distributed power plants designed to utilize two state-of-the-art SES XL3000 advanced fluidized bed gasification systems; gasification equipment provided by TSEC, and four GE model LM2500+G4 aero-derivative gas turbines and related power generation equipment. Upon the completion and successful results of the feasibility studies, and requisite government approvals, the first cleaner distributed power plant is expected to be built in Dengfeng. It is intended to serve as a model for additional cleaner coal distributed power generation projects in Dengfeng (up to 600 MW total), as well as elsewhere in Henan Province and in other regions of China. DFPG, an industrial conglomerate specializing in thermal power generation whose products include aluminum, other non-ferrous metals and cement, and who operates power generation plants and coal mines in Henan Province, is funding the program and will serve as the owner and operator of the first project.

 

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 sub-licensee 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 accrue the annual royalty expense ratably over the calendar year as adjusted for any royalties paid during year as applicable. 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.

 

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.

 

34
 

   

Outlook

 

Our strategies are focused on securing a partner for our technology business vertical, 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 TSEC Joint Venture, sourcing suitable partners for our other business verticals and advancing and improving our gasification technology, such as through our new XL3000 gasification system. 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.

 

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. The energy and chemicals landscape has been evolving rapidly with upward pressure on demand and increasing pressure to deliver improved environmental performance while simultaneously delivering economics that will attract investment capital. World energy consumption is expected to increase significantly over the next two decades and demand is heavily driven by non-OECD nations where developing economies require ever increasing access to more energy products to establish healthy economies that improve the living conditions of those populations. Our market research indicates that coal will be required as a major source of energy for decades to come and growth in coal usage is expected to be led by the non-OECD nations. Because of these market dynamics, we believe our gasification technology has strategic importance to countries and regions with developing economies which have their own low cost domestic coal resources and need access to low cost clean energy and chemical products to grow. We believe this also applies to developed nations in the west such as Australia, Europe and US which possess significant low cost coal resources and which have a strategic need and desire to produce clean and affordable energy and chemicals from their own domestic resources and to existing operating companies which deploy their own technologies for energy and/or chemicals production. We believe that our technology is well positioned to address the market needs of the changing global energy landscape and we believe we are well positioned in Asia where we have two operating projects using five of our gasification systems. In addition, the TSEC Joint Venture provides us with a strong Chinese partner already specialized in the manufacturing and design of processing industry equipment and projects.

 

During the three months ended December 31, 2014, there was a significant decline in methanol prices in China during the quarter ending December 31, 2014, which caused an operating loss from our methanol production at the ZZ Joint Venture plant. Methanol prices at the end of December 2014 were below 1,900 Rmb per tonne, which was a level not seen since November 2009. This significant decline in methanol prices generally corresponded to the significant decline in global oil prices for the same quarter. Due to this significant shift in the market for methanol, we were required to evaluate the ongoing value of the ZZ Joint Venture facility and, based on this evaluation, we determined that the ZZ Joint Venture asset value is no longer entirely recoverable as of December 31, 2014. Becasue of this, we have incurred an impairment expense of $20.9 million, reducing the value of the facility to a fair value of $11 millon. While changes in market conditions for methanol in China may increase operating margins, any further reduction in methanol prices, as well as changes in assumptions used to test for recoverability and to determine fair value, could result in additional impairment charges in the future for the ZZ Joint Venture facility.

 

35
 

 

We have made significant progress recently on partnering our China business through the TSEC Joint Venture, including through the recently announced projects with ICCDI, and Aluminum Corporation of China for an industrial syngas project, as well as with Dengfeng for a planned 160 MW distributed power generation program initially in Henan Province, China. However, we expect to continue to have negative operating cash flows until we can generate sufficient cash flows from our technology, equipment and services business and SES China (including the ZZ Joint Venture, the Yima Joint Ventures and the TSEC 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 are also actively seeking a partner for our technology vertical with existing businesses and vested interest in the growth of the global energy and chemicals projects who also has financial strength, a strong global sales force and demonstrated experience in process or power industry engineering and technology deployment are target candidates for this cooperation with us.

 

We currently plan to use our available cash for (i) securing a partner for our technology business vertical; (ii) securing orders and other associated tasks associated with our distributed power initiatives such as in China with Dengfeng Power and in Pakistan with General Electric; (iii) executing our strategy to develop market based business verticals, (iv) general and administrative expenses (v) repaying the ZZ Short-term Loan and the ZZ Working Capital Loan and (vi) working capital and other general corporate purposes. Although we intend for the ZZ Joint Venture to sustain itself through its own earnings, 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 volatile in nature.

 

We do not currently have all of the financial and human resources necessary to fully develop and execute on all of our 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 the 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 are also seeking to raise capital by partnering our technology vertical. 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.

  

36
 

 

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, which has included the capacity fee and energy fee earned at the ZZ Joint Venture plant and is expected to include sale 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, such as property, plant and equipment, construction-in-progress, equity method investments 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.

  

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, feedstock costs, and other 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.

  

ZZ Joint Venture Plant Impairment Analysis

 

During the three months ended December 31, 2014, there was a significant decline in methanol prices in the China commodity market, which put significant pressure on our ZZ Joint Venture facility methanol production margins. Accordingly, we evaluated the ongoing value of the ZZ Joint Venture facility. Based on this evaluation, we determined that the $32 million carrying value of the ZZ Joint Venture facility was no longer entirely recoverable. Due to this impairment, the Company wrote down the value of the facility to its estimated fair value of $11 million. Fair value was based on expected future cash flows using Level 3 inputs under ASC 820. Changes in market conditions for methanol in China, as well as changes in assumptions used to test for recoverability and to determine fair value, could result in additional impairment charges in the future for our ZZ Joint Venture facility.

 

37
 

  

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 TSEC is a VIE and that TST is the primary beneficiary since TST has a 65% ownership interest in the Joint Venture. 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. 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, SRS was dissolved on January 9, 2015.

  

38
 

 

Item 3. Quantitative and Qualitative Disclosures 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.

  

Foreign currency risk 

 

We conduct operations in China and our functional currency in China is the Renminbi Yuan. Our consolidated 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.

  

The majority of our revenues are derived from the sale of methanol in China. We do not have long term offtake agreements for these sales, so revenues fluctuate based on local market spot prices, which have been under significant pressure, and we are unsure of how much longer this will continue. Our liquidity and capital resources will be materially adversely affected if markets remain under pressure, and we are unable to obtain satisfactory prices for these commodities or if prospective buyers do not purchase these commodities.

  

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.

  

Customer credit risk

 

When our projects, including the ZZ Joint Venture plant’s methanol production, progress to commercial operation, we will 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.  

 

39
 

 

Item 4. Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in our annual and periodic reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. In addition, we designed these disclosure controls and procedures to ensure that this information is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures.

 

Our management, with the participation of the Chief Executive Officer and the Chief Financial Officer, assessed the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Securities and Exchange Act of 1934, as amended, or the Exchange Act, as of December 31, 2014. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of December 31, 2014.

 

Notwithstanding the foregoing, there can be no assurance that the Company’s disclosure controls and procedures will detect or uncover all failures of persons within the Company and its consolidated subsidiaries to disclose material information otherwise required to be set forth in the Company’s periodic reports. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures.

 

Changes in Internal Control Over Financial Reporting

 

There have been no changes in our internal control over financial reporting during the three months and six months ended December 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 December 31, 2014, we had $13.7 million in cash and cash equivalents. We currently plan to use our available cash for (i) securing a partner for our technology business vertical; (ii) securing orders and other associated tasks associated with our distributed power initiatives such as in China with Dengfeng Power and in Pakistan with General Electric; (iii) executing our strategy to develop market based business verticals, (iv) general and administrative expenses; (v) repaying the ZZ Short-term Loan and the ZZ Working Capital Loan and (vi) working capital and other general corporate purposes. Although we intend for the ZZ Joint Venture to sustain itself through its own earnings, 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 volatile in nature.

 

We have made significant progress recently on partnering our China business through the TSEC Joint Venture, including through the recently announced projects with ICCDI, and Aluminum Corporation of China for an industrial syngas project, as well as with Dengfeng for a planned 160 MW distributed power generation program initially in Henan Province, China. However, we expect to continue to have negative operating cash flows until we can generate sufficient cash flows from our technology, equipment and services business and SES China (including the ZZ Joint Venture, the Yima Joint Ventures and the TSEC 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.

 

40
 

 

We do not currently have all of the financial 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.

 

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.

 

Our liquidity and capital resources are highly dependent on Chinese methanol prices.

 

The majority of our current revenues are derived from the sale of methanol in China. We do not have long term offtake agreements for these sales, so revenues fluctuate based on local market spot prices, which have been under significant pressure, and we are unsure of how much longer this will continue. During the quarter ended December 31, 2014, we incurred an impairment loss associated with the impact of reduced methanol prices on our ZZ Joint Venture plant. While changes in market conditions for methanol in China may increase our operating margins, any further degradation in methanol prices, as well as changes in assumptions used to test for recoverability and to determine fair value, could result in additional impairment charges in the future for the ZZ Joint Venture facility or an impairment related to the Yima investment. Our liquidity is also negatively effected if the ZZ Joint Venture plant does not operate due to the reduced methanol pricing. Although we are considering various options for these gasifiers due to the pricing of methanol, including repurposing by moving them to a new location, there can be no assurances that we will be able to generate more than limited revenues until methanol prices recover. Our revenues, liquidity and capital resources will be materially adversely affected if markets remain under pressure, and we are unable to obtain satisfactory prices for these commodities or if prospective buyers do not purchase these commodities.

 

We may be subject to future impairment losses due to potential declines in the fair value of our assets .

 

During the three months ended December 31, 2014, there was a significant decline in methanol prices in the China commodity market, which put significant pressure on our ZZ Joint Venture plant methanol production margins. As a result, we evaluated both operating assets for potential impairment as of December 31, 2014. Based on this evaluation, we determined that the $32 million carrying value of the ZZ Joint Venture facility was no longer entirely recoverable. Due to this impairment, we wrote down the value of the facility to its estimated fair value of $11 millon and incurred an impairment expenses of $20.9 million. The potential for future impairment at the ZZ Joint Venture plant or for other of our assets is increased during a period of economic uncertainty, including with respect to the current reduced pricing of methanol. Should general economic, market or business conditions decline further, and continue to have a negative impact on our stock price or revenues, we may be required to record additional impairment charges in the future, which could materially and adversely affect financial condition and results of operation.

 

 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 TSEC 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.

 

41
 

 

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 TSEC 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 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. Through the TSEC Joint Venture, we have partnered a significant portion of our China business with TST, 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 TST can 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 seeking a partner for our technology vertical. 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, including partnering our technology vertical. The termination of any relationship with an existing strategic partner, our failure to successfully partner our technology vertical, or the inability to establish additional strategic relationships may limit our ability to develop the TSEC Joint Venture, our projects, including the ZZ Joint Venture and Yima Joint Ventures and our marketing arrangement with GE and Midrex, and may have a material adverse effect on our business and financial condition.

 

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 TSEC Joint Venture.  Although we have begun to develop our power vertical through our relationship with GE and our DRI steel vertical with Midrex, we are still in the early stages of developing these verticals and many of the relationships with potential partners are still being cultivated. We are also seeking a partner for our technology vertical. We cannot provide assurance that we will be able to successfully develop our business verticals or to successfully grow the TSEC 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 TSEC 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; (ix) the volatility of local Chinese methanol markets; and (x) general economic conditions as well as economic conditions specific to the energy industry.

 

42
 

  

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.

  

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 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 and pay dividends; our ability to develop and expand business of the TSEC joint venture in the joint venture territory; our ability to successfully partner our technology business; our ability to develop our power business unit and marketing arrangement with GE and our other business verticals, including DRI steel, through our marketing arrangement with Midrex Technologies, and renewables; our ability to successfully develop the SES licensing business; events or circumstances which result in an impairment of assets, including, but not lmited to, at our ZZ Joint Venture; our ability to reduce operating costs; our ability to make distributions and repatriate earnings from our Chinese operations; our limited history, and viability of our technology; commodity prices, including in particular methanol, 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, 2014, as well as in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and elsewhere in this Form 10-Q.

 

43
 

  

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.

  

44
 

 

Item 6. Exhibits  

 

Number Description of Exhibits
   
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.

 

 

* Filed herewith.

 

45
 

   

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:  February 13, 2015 By:   /s/ Robert Rigdon
     

Robert Rigdon

      President and Chief Executive Officer
       
     
     
Date:  February 13, 2015 By:   /s/ Roger Ondreko
     

Roger Ondreko

Chief Financial Officer 

       
       

   

46

 

 

 

 

 

 

 

 

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: February 13, 2015

 

/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, Roger Ondreko, 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: February 13, 2015

 

/s/Roger Ondreko  
Roger Ondreko  
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 December 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  

 

February 13, 2015

 

 

 

 

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 December 31, 2014 (the “Report”), as filed with the Securities and Exchange Commission on the date hereof, I, Roger Ondreko, 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/ Roger Ondreko  
Roger Ondreko  
Chief Financial Officer  

 

February 13, 2015