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EX-31.1 - EXHIBIT 31.1 - SYNTHESIS ENERGY SYSTEMS INCc08414exv31w1.htm
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Table of Contents

 
 
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 September 30, 2010
     
o   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
(State of Incorporation)
  20-2110031
(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 o
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 o No o
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 o   Accelerated filer o   Non-accelerated filer o   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 o No þ
As of November 10, 2010 there were 48,386,512 shares of the registrant’s common stock, par value $.01 per share, outstanding.
Transitional Small Business Disclosure Format Yes o No þ
 
 

 

 


 

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 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2

 

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PART I
Item 1.  
Financial Statements
SYNTHESIS ENERGY SYSTEMS, INC.
(A Development Stage Enterprise)
Consolidated Balance Sheets
(In thousands)
                 
    September 30,     June 30,  
    2010     2010  
ASSETS
               
Current assets:
               
Cash and cash equivalents
  $ 37,654     $ 42,573  
Accounts receivable
    2,298       2,672  
Prepaid expenses and other currents assets
    1,759       1,875  
Inventory
    1,090       983  
 
           
 
               
Total current assets
    42,801       48,103  
 
               
Construction-in-progress
    508       565  
Property, plant and equipment, net
    35,249       35,316  
Intangible asset, net
    1,233       1,272  
Investment in Yima joint ventures
    32,734       32,430  
Other long-term assets
    2,845       2,895  
 
           
 
               
Total assets
  $ 115,370     $ 120,581  
 
           
 
               
LIABILITIES AND EQUITY
               
Current liabilities:
               
Accrued expenses and accounts payable
  $ 5,789     $ 7,008  
Deferred revenue
    497       522  
Current portion of long-term bank loan
    2,298       2,268  
 
           
 
               
Total current liabilities
    8,584       9,798  
Long-term bank loan
    5,686       6,744  
 
           
 
               
Total liabilities
    14,270       16,542  
Equity:
               
Common stock, $0.01 par value: 200,000 shares authorized: 48,429 and 48,337 shares issued and outstanding, respectively
    484       483  
Additional paid-in capital
    198,994       198,720  
Deficit accumulated during development stage
    (100,191 )     (96,449 )
Accumulated other comprehensive income
    2,391       1,836  
 
           
Total stockholders’ equity
    101,678       104,590  
Noncontrolling interests in subsidiaries
    (578 )     (551 )
 
           
 
               
Total equity
    101,100       104,039  
 
           
 
               
Total liabilities and equity
  $ 115,370     $ 120,581  
 
           
See accompanying notes to the consolidated financial statements.

 

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SYNTHESIS ENERGY SYSTEMS, INC.
(A Development Stage Enterprise)
Consolidated Statements of Operations
(In thousands, except per share amounts)
(Unaudited)
                         
                    November 4, 2003  
    Three Months Ended     (inception) to  
    September 30,     September 30,  
    2010     2009     2010  
 
Revenue:
                       
Product sales and other — related parties
  $ 1,417     $ 2,236     $ 11,895  
Technology licensing and related services
    205       65       936  
Other
                521  
 
                 
Total revenue
    1,622       2,301       13,352  
 
                       
Costs and Expenses:
                       
Costs of sales and plant operating expenses
    1,307       1,737       19,771  
General and administrative expenses
    3,186       3,081       52,641  
Project and technical development expenses
    85       1,020       11,140  
Asset impairment losses
                9,075  
Stock-based compensation expense
    227       598       19,987  
Depreciation and amortization
    680       722       7,690  
 
                 
 
                       
Total costs and expenses
    5,485       7,158       120,304  
 
                 
 
                       
Operating loss
    (3,863 )     (4,857 )     (106,952 )
 
                       
Non-operating (income) expense:
                       
Equity in losses of Yima joint ventures
    54             93  
Foreign currency gains
    (255 )           (1,056 )
Interest income
    (39 )     (38 )     (2,917 )
Interest expense
    146       180       2,163  
 
                 
 
                       
Net loss
    (3,769 )     (4,999 )     (105,235 )
 
                       
Less: net loss attributable to noncontrolling interests
    27       422       5,044  
 
                 
 
                       
Net loss attributable to stockholders
  $ (3,742 )   $ (4,577 )   $ (100,191 )
 
                 
 
                       
Net loss per share:
                       
Basic and diluted
  $ (0.08 )   $ (0.10 )   $ (2.84 )
 
                 
 
                       
Weighted average common shares outstanding:
                       
Basic and diluted
    48,352       48,148       35,218  
 
                 
See accompanying notes to the consolidated financial statements.

 

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SYNTHESIS ENERGY SYSTEMS, INC.
(A Development Stage Enterprise)
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
                         
                    November 4, 2003  
    Three Months Ended     (inception) to  
    September 30,     September 30,  
    2010     2009     2010  
 
Cash flows from operating activites:
                       
Net loss
  $ (3,769 )   $ (4,999 )   $ (105,235 )
Adjustments to reconcile net loss to net cash used in operating activities:
                       
Stock-based compensation expense
    227       598       19,987  
Depreciation of property, plant and equipment
    625       662       6,790  
Amortization of intangible and other assets
    55       60       900  
Equity in losses of Yima joint ventures
    54             15  
Foreign currency gains
    (255 )           (1,057 )
Loss on disposal of property, plant and equipment
          2       136  
Asset impairment losses
                9,075  
Changes in operating assets and liabilities:
                       
Accounts receivable
    407       (586 )     (2,256 )
Prepaid expenses and other current assets
    133       (354 )     (97 )
Inventory
    (93 )     69       (1,070 )
Other long-term assets
    128       5       (1,102 )
Deferred revenue
    (25 )           497  
Accrued expenses and payables
    (1,276 )     (961 )     (296 )
 
                 
Net cash used in operating activities
    (3,789 )     (5,504 )     (73,713 )
 
                 
Cash flows from investing activities:
                       
Capital expenditures
    (32 )     (258 )     (37,982 )
Equity investment in Yima joint ventures
          (29,288 )     (30,891 )
Purchase of marketable securities
                (45,000 )
Redemption of marketable securities
                45,000  
GTI license royalty — Yima joint ventures
                (1,500 )
ExxonMobil license royalty
                (1,250 )
Restricted cash — redemptions of certificates of deposit
                (379 )
Amendment to GTI license rights
                (500 )
Purchase of land use rights
          (181 )     (1,896 )
Receipt of Chinese governmental grant
                555  
Project prepayments
                (3,210 )
 
                 
Net cash used in investing activities
    (32 )     (29,727 )     (77,053 )
 
                 
Cash flows from financing activities:
                       
Payments on long-term bank loan
    (1,149 )     (1,127 )     (5,670 )
Proceeds from long-term bank loan
                12,081  
Proceeds (costs) from issuance of common stock, net
                174,981  
Financing costs
                (408 )
Contributions from noncontrolling interest partners
          840       4,456  
Proceeds from exercise of stock options, net
    47       63       813  
 
                 
Net cash provided by (used in) financing activities.
    (1,102 )     (224 )     186,253  
 
                 
Net increase (decrease) in cash
    (4,923 )     (35,455 )     35,487  
Cash and cash equivalents, beginning of period
    42,573       90,420        
Effect of exchange rates on cash
    4       (4 )     2,167  
 
                 
Cash and cash equivalents, end of period
  $ 37,654     $ 54,961     $ 37,654  
 
                 
See accompanying notes to the consolidated financial statements.

 

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SYNTHESIS ENERGY SYSTEMS, INC.
(A Development Stage Enterprise)
Consolidated Statement of Equity
(In thousands)
                                                         
                            Deficit                    
                            Accumulated     Accumulated              
    Common Stock             During the     Other     Non-        
            Common     Additional     Development     Comprehensive     controlling        
    Shares     Stock     Paid-in Capital     Stage     Income     Interest     Total  
 
                                                       
Balance at November 4, 2003 (inception)
    100,000     $     $     $     $     $     $  
Net loss for the period November 4, 2003 to June 30, 2004
                                         
 
                                         
Balance at June 30, 2004
    100,000                                      
 
                                         
Shares Forfeited in Merger
    (94,000 )                                    
Shares Issued in Merger
    21,000                                      
Net loss
                      (358 )                 (358 )
Investor contributions
          264       236                         500  
Conversion of debt to equity
          6       5                         11  
Net proceeds from private placement offering
    1,030       10       2,474                         2,484  
 
                                         
Balance at June 30, 2005
    28,030       280       2,715       (358 )                 2,637  
 
                                         
Net loss
                      (5,183 )                 (5,183 )
Net proceeds from private placement offering
    970       10       2,378                         2,388  
Stock-based compensation
                3,043                         3,043  
Adjustment related to return of shares
    (4,353 )     (44 )     44                          
 
                                         
Balance at June 30, 2006
    24,647       246       8,180       (5,541 )                 2,885  
 
                                         
Net loss
                      (13,142 )           (37 )     (13,179 )
Currency translation adjustment
                            175             175  
 
                                                     
Comprehensive loss
                                        (13,004 )
Contributions from noncontrolling interest partners
                                  492       492  
Net proceeds from private placement offering
    3,346       34       16,126                         16,160  
Stock-based compensation
                6,608                         6,608  
Shares issued for amended GTI license
    191       2       1,374                         1,376  
Shares issued upon option exercise by Union Charter Financial
    2,000       20       4,980                         5,000  
Stock grants to employees
    4             33                         33  
 
                                         
Balance at June 30, 2007
    30,188       302       37,301       (18,683 )     175       455       19,550  
 
                                         
Net loss
                      (27,442 )           (610 )     (28,052 )
Currency translation adjustment
                            1,390             1,390  
 
                                                     
Comprehensive loss
                                        (26,662 )
Contributions from noncontrolling interest partners
                                  3,124       3,124  
Stock-based compensation
                6,010                         6,010  
Exercise of stock options
    92       1       564                         565  
Shares issued for GTI reservation use fee
    278       3       2,497                         2,500  
Shares issued in public offerings
    17,451       174       148,226                         148,400  
Stock grants to employees
    2             19                         19  
 
                                         
Balance at June 30, 2008
    48,011       480       194,617       (46,125 )     1,565       2,969       153,506  
 
                                         
Net loss
                      (28,576 )           (703 )     (29,279 )
Currency translation adjustment
                            33       11       44  
 
                                                     
Comprehensive loss
                                        (29,235 )
Public offering costs
                (107 )                       (107 )
Stock-based compensation
                1,869                         1,869  
Exercise of stock options
    107       1       62                         63  
 
                                         
Balance at June 30, 2009
    48,118       481       196,441       (74,701 )     1,598       2,277       126,096  
 
                                         
Net loss
                      (21,748 )             (3,667 )     (25,415 )
Currency translation adjustment
                            238             238  
 
                                                     
Comprehensive loss
                                        (25,177 )
Contributions from noncontrolling interest partners
                                  839       839  
Stock-based compensation
                2,179                         2,179  
Exercise of stock options
    219       2       100                         102  
 
                                         
Balance at June 30, 2010
    48,337       483       198,720       (96,449 )     1,836       (551 )     104,039  
 
                                         
Net loss
                      (3,742 )             (27 )     (3,769 )
Currency translation adjustment
                              555             555  
 
                                                     
Comprehensive loss
                                          (3,214 )
Stock-based compensation
                227                         227  
Exercise of stock options
    92       1       47                         48  
 
                                         
Balance at September 30, 2010
    48,429     $ 484     $ 198,994     $ (100,191 )   $ 2,391     $ (578 )   $ 101,100  
 
                                         
See accompanying notes to the consolidated financial statements.

 

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SYNTHESIS ENERGY SYSTEMS, INC.
(A Development Stage Enterprise)
Notes to Consolidated Financial Statements
(Unaudited)
Note 1 — Summary of Significant Accounting Policies
(a) Organization and description of business
Synthesis Energy Systems, Inc. (“SES”), together with its wholly-owned and majority-owned controlled subsidiaries (collectively, “the Company”) is a development stage enterprise. The Company is an alternative energy technology company that provides advanced technology products and solutions to the energy and chemical industries. The Company builds, owns and operates coal gasification plants that utilize our proprietary U-GAS® fluidized bed gasification technology to convert low rank coal and coal wastes into higher value energy products. We provide licenses, equipment components, engineering services and product offerings related to the U-GAS® technology. The Company’s headquarters are located in Houston, Texas.
(b) Basis of presentation and principles of consolidation
The consolidated financial statements for the periods presented are unaudited and reflect all adjustments, consisting of normal recurring items, which management considers necessary for a fair presentation. Operating results for the three months ended September 30, 2010 are not necessarily indicative of results to be expected for the fiscal year ending June 30, 2011.
The consolidated financial statements are in U.S. dollars and include SES and all of its wholly-owned and majority-owned controlled subsidiaries. Noncontrolling interests in consolidated subsidiaries in the consolidated balance sheets represents minority stockholders’ proportionate share of the equity in such subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto reported in the Company’s Annual Report on Form 10-K for the year ended June 30, 2010. 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, 2010 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. Certain reclassifications have been made in prior period financial statements to conform to current period presentation. These reclassifications had no effect on net loss.
(c) 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 both qualitative and quantitative factors and forms a conclusion that the Company, or another interest holder, absorbs a majority of the entity’s risk for expected losses, receive a majority of the entity’s potential for expected residual returns, or both. The Company does not consolidate VIEs where it is not the primary beneficiary. The Company accounts for these unconsolidated VIEs under the equity method of accounting and includes its net investment on its consolidated balance sheets. 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.

 

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The Company has determined that the ZZ Joint Venture is a VIE and has determined that it is the primary beneficiary. In making that determination, the Company considered, among other items, the change in profit distribution between the Company and Hai Hua 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 coincides with our original 95% profit/loss allocation, versus the latter 30 years in which the Company’s profit/loss allocation is reduced to 10%. In addition, the Company considered whether the terms of the syngas purchase and sale agreement with Hai Hua contained a lease. The factors considered included (i) the Company’s ability to operate and control the plant during the initial 20 years; and (ii) whether it was more than remote that one or more parties other than Hai Hua would purchase more than a minor amount (considered to be 10%) of the plant’s output during the term of the syngas purchase and sale agreement. Because the Company determined that the syngas purchase and sale agreement did not contain a lease, the Company accounts for the revenues from this agreement in accordance with the Company’s revenue recognition policy for product sales.
The following tables provide additional information on the ZZ Joint Venture’s assets and liabilities as of September 30, 2010 and June 30, 2010 which are consolidated within the Company’s consolidated balance sheets (in thousands):
                         
    September 30, 2010  
    Consolidated     ZZ Joint Venture (1)     % (2)  
 
Current assets
  $ 42,801     $ 4,218       10 %
Long-term assets
    72,569       38,170       53 %
 
                 
Total assets
  $ 115,370     $ 42,388       37 %
 
                 
 
                       
Current liabilities
  $ 8,584     $ 4,349       51 %
Long-term liabilities
    5,686       5,686       100 %
Equity
    101,100       32,353       32 %
 
                 
Total liabilities and equity
  $ 115,370     $ 42,388       37 %
 
                 
                         
    June 30, 2010  
    Consolidated     ZZ Joint Venture (1)     % (2)  
Current assets
  $ 48,103     $ 5,198       11 %
Long-term assets
    72,478       38,811       54 %
 
                 
Total assets
  $ 120,581     $ 44,009       36 %
 
                 
 
                       
Current liabilities
  $ 9,798     $ 5,852       60 %
Long-term liabilities
    6,744       6,744       100 %
Equity
    104,039       31,413       30 %
 
                 
Total liabilities and equity
  $ 120,581     $ 44,009       36 %
 
                 
     
(1)  
Amounts reflect information for ZZ Joint Venture and exclude intercompany items.
 
(2)  
ZZ Joint Venture’s percentage of the amount on the Company’s consolidated balance sheet.
The Company has determined that the Yima Joint Ventures are VIE’s and that Yima is the primary beneficiary since Yima has a 75% ownership interest in the Yima Joint Ventures.
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. As of June 30, 2010 and September 30, 2010, there were no significant assets or liabilities of the GC Joint Venture included in the Company’s consolidated balance sheets.

 

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(d) Revenue Recognition
Revenue from sales of products, which includes the capacity fee and energy fee earned at the ZZ Joint Venture plant, and byproducts 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 and earned over the course of a project’s development. The Company may receive upfront licensing fee payments in addition to fees for engineering services that are integral to the initial transfer of its technology to a customer’s project. Typically, the majority of a license fee is received once project financing and equipment installation occur. Recognition of upfront licensing fee payments is deferred and recognized as a percentage of completion of the engineering services associated with the initial technology transfer. Further, such revenues are deferred until performance guarantee provisions have been met. The Company recognizes revenue from engineering services under the percentage-of-completion method.
(e) Fair value measurements
Accounting standards require that fair value measurements be classified and disclosed in one of the following categories:
         
 
  Level 1   Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
 
 
  Level 2   Quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability; and
 
 
  Level 3   Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).
The carrying value of the Company’s non-financial items including accounts receivable, investment in the Yima Joint Ventures, accounts payable and long-term debt approximate their fair values.
The Company’s financial assets and liabilities are classified based on the lowest level of input that is significant for the fair value measurement. The following table summarizes the valuation of the Company’s financial assets and liabilities by pricing levels, as of September 30, 2010 and June 30, 2010 (in thousands):
                                 
    September 30, 2010  
    Level 1     Level 2     Level 3     Total  
Assets:
                               
Certificates of Deposit
  $     $ 379 (1)   $     $ 379  
Money Market Funds
          34,752 (2)           34,752  
                                 
    June 30, 2010  
    Level 1     Level 2     Level 3     Total  
Assets:
                               
Certificates of Deposit
  $     $ 379 (1)   $     $ 379  
Money Market Funds
          38,624 (2)           38,624  
     
(1)  
Amount included in current assets on the Company’s consolidated balance sheet.
 
(2)  
Amount included in cash and cash equivalents on the Company’s consolidated balance sheet.

 

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(f) Comprehensive income (loss)
The Company’s comprehensive income (loss) was as follows (in thousands):
                 
    Three Months Ended  
    September 30,  
    2010     2009  
Net loss, as reported
  $ (3,769 )   $ (4,999 )
Unrealized foreign currency translation adjustment
    555       10  
 
           
Comprehensive loss
    (3,214 )     (4,989 )
Less comprehensive loss attributable to noncontrolling interests
    27       422  
 
           
Comprehensive loss attributable to the Company
  $ (3,187 )   $ (4,567 )
 
           
Note 2 — Recently Issued Accounting Standards
In January 2010, the FASB issued an amendment to the disclosure requirement related to fair value measurements. The amendment requires new disclosures related to transfers in and out of Levels 1 and 2 and activity in Level 3 fair value measurements. A reporting entity is required to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers. Additionally, in the reconciliation for fair value measurements in Level 3, a reporting entity must present separately information about purchases, sales, issuances and settlements (on a gross basis rather than a net number). The new disclosures were effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The Company does not anticipate that its adoption of this amendment will have a material effect on its financial position, results of operations or cash flows.
In June 2009, the FASB also issued an amendment to the accounting and disclosure requirements for the consolidation of VIEs. This amendment requires an enterprise to perform a qualitative analysis when determining whether or not it must consolidate a VIE. The amendment also requires an enterprise to continuously reassess whether it must consolidate a VIE. Additionally, the amendment requires enhanced disclosures about an enterprise’s involvement with VIEs and any significant change in risk exposure due to that involvement, as well as how its involvement with VIEs impacts the enterprise’s financial statements. Finally, enterprises are required to disclose significant judgments and assumptions used to determine whether or not to consolidate a VIE. This amendment was adopted by the Company effective as of July 1, 2010 and adoption of the standard has not impacted the entities which are consolidated. The only impact is to the disclosure of financial statements. See Note 1 for disclosures regarding the Company’s involvement with VIEs.
In June 2009, the FASB issued an amendment to the accounting and disclosure requirements for transfers of financial assets. This amendment applies to the financial reporting of a transfer of financial assets; the effects of a transfer on an entity’s financial position, financial performance and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. It eliminates (1) the exceptions for qualifying special-purpose entities from the consolidation guidance and (2) the exception that permitted sale accounting for certain mortgage securitizations when a transferor has not surrendered control over the transferred financial assets. The requirements in the amendment must be applied to transfers occurring on or after the effective date. The Company’s adoption of these requirements as of July 1, 2010 had no effect on the Company’s financial statements.
In April 2010, the FASB issued accounting guidance for the milestone method of revenue recognition. This guidance allows entities to make a policy election to use the milestone method of revenue recognition and provides guidance on defining a milestone and the criteria that should be met for applying the milestone method. The scope of this guidance is limited to transactions involving milestones relating to research and development deliverables. The guidance includes enhanced disclosure requirements about each arrangement, individual milestones and related contingent consideration, information about substantive milestones and factors considered in the determination. The Company’s adoption of this guidance effective July 1, 2010 had no effect on the Company’s financial statements.

 

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The FASB issued new guidance relating to revenue recognition for contractual arrangements with multiple revenue-generating activities. The ASC Topic for revenue recognition includes identification of a unit of accounting and how arrangement consideration should be allocated to separate the units of accounting, when applicable. The Company’s adoption of this guidance effective July 1, 2010 had no effect on the Company’s financial statements.
Note 3 — Current Projects
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., which was acquired by China National Offshore Oil Corporation in September 2009, (“Hai Hua”), which established Synthesis Energy Systems (Zao Zhuang) New Gas Company Ltd. (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, including ash and elemental sulphur. We own 95.5% of the ZZ Joint Venture and Hai Hua owns the remaining 4.5%. For the first 20 years after the commercial operation date of the plant, the net profits and losses of the ZZ Joint Venture will be distributed to the Company and to Hai Hua based on the parties’ ownership interest. After the initial 20 years, the profit distribution percentages will be changed, with the Company receiving 10% of the net profits/losses of the ZZ Joint Venture and Hai Hua receiving 90%. The Company consolidates the results of the ZZ Joint Venture in its consolidated financial statements.
Syngas Purchase and Sale Agreement
The ZZ Joint Venture is also party to a purchase and sale agreement with Hai Hua for syngas produced by the plant, whereby Hai Hua will pay the ZZ Joint Venture an energy fee and capacity fee, as described below, based on the syngas production. The syngas to be purchased by Hai Hua is subject to certain quality component requirements set forth in the contract. In late December 2008, the plant declared commercial operations status for purposes of the purchase and sale agreement. The energy fee is a per normal cubic meters, or Ncum, of syngas calculation based on a formula which factors in the monthly averages of the prices of design base coal, coke, coke oven gas, power, steam and water, all of which are components used in the production of syngas. The capacity fee is paid based on the capacity of the plant to produce syngas, factoring in the number of hours (i) of production and (ii) of capability of production as compared to the guaranteed capacity of the plant, which for purposes of the contract is 22,000 Ncum per hour of net syngas. Hai Hua is obligated to pay the capacity fee regardless of whether they use the gasification capacity, subject only to availability of the plant, quality of the syngas and exceptions for certain events of force majeure. Due to worldwide reductions in methanol prices, Hai Hua has operated at a reduced rate of syngas consumption. Hai Hua used approximately 35% to 45% of the syngas guarantee capacity during 2009 and has forecasted the same level of syngas consumption through December 2010.

 

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In April 2009, the ZZ Joint Venture entered into a Supplementary Agreement with Hai Hua, amending the terms of the purchase and sale agreement. The Supplementary Agreement was entered into to provide more clarity regarding the required syngas quality and volume to be delivered, recovery of the energy fee during turndown periods and operations coordination during unscheduled outages. Under the Supplementary Agreement, the syngas quality specification was amended to provide more clarity as to the minor constituents allowable in the syngas. For purposes of the Supplemental Agreement, syngas that meets these specifications is deemed “compliant gas” and syngas that does not meet these specifications is deemed “non-compliant gas.” The Supplementary Agreement also added a requirement for Hai Hua to pay the ZZ Joint Venture the capacity fee and 70% of the energy fee for all non-compliant gas which is taken by Hai Hua. However, if more than 50% of the syngas taken by Hai Hua during any operating day is non-compliant gas, all of the syngas for that day is deemed to be non-compliant gas for purposes of calculating the energy fee. In addition, the Supplementary Agreement accommodates periods of turndown operation by Hai Hua by establishing a minimum threshold gas off take volume of 7,500 Ncum per hour of net syngas for the purpose of calculating the energy fee during such periods. The Supplementary Agreement also provides that, to the extent Hai Hua has an unscheduled shutdown, and the plant continues to operate on standby during such period, Hai Hua is still required to pay the energy fee to the ZZ Joint Venture. In the event that the plant has an unscheduled shutdown and does not provide at least three hours prior notice to Hai Hua, the ZZ Joint Venture may be required to provide certain compensation to Hai Hua.
To date, Hai Hua has been unable to offtake the volume of syngas originally expected for the original plant design and the plant has incurred operating losses. The Company does not foresee Hai Hua’s volume offtake changing significantly in the near term. In an effort to improve the return on its investment in this plant, the company is evaluating alternative products and partnership structures for a possible expansion of the ZZ Joint Venture plant to produce products such as glycol. The Company does not expect any additional equity for an expansion would be required from the Company as it continues to expect to contribute its 95.5% equity interest toward the expansion with third parties contributing all the additional required equity to expand the plant. In February 2010, the Company received the necessary government approval for the expansion. This approval, along with the previously received environmental approvals, are the key approvals required to commence execution of the expansion and also describe certain terms of the expansion project, including but not limited to, its use of land, the main additional facilities required and the use of the existing facilities. The scope of the expansion is still under evaluation. The local government has expressed strong support for this expansion project and has executed a letter of intent allowing a new state-owned local coal mine to be used as a debt guarantee. The letter of intent also contemplates providing discounted coal to the project from this local coal mine. The Company is in discussions with a provincial level coal company that has expressed interest in becoming our partner on this expansion. Earlier work to structure a partnership with a local Zao Zhuang area coal mining company has not progressed due to investment constraints with that company. The Company is working with local government entities and prospective partners to develop the partnership and project structure.
Due to the business climate, the recessionary trends that have significantly affected commodity prices including methanol, and the ZZ Joint Venture plant’s operating losses to-date, the Company believed an impairment assessment of the plant’s assets was warranted. As of September 30, 2010, the Company performed an analysis of this project and has determined that these assets were not impaired based upon management’s estimated cash flow projections for the project. If the Company is not successful in improving the ZZ Joint Venture’s profitability, or if management’s estimated cash flow projections for these assets decrease, or if Hai Hua does not make its required payments, the plant’s assets could be impaired.
Loan Agreement
On March 22, 2007, the ZZ Joint Venture entered into a seven-year loan agreement and received $12.6 million of loan proceeds pursuant to the terms of a Fixed Asset Loan Contract with the Industrial and Commercial Bank of China (“ICBC”) to complete the project financing for the ZZ Joint Venture. Key terms of the Fixed Asset Loan Contract with ICBC are as follows:
   
Term of the loan is seven years from the commencement date (March 22, 2007) of the loan;
   
Interest is adjusted annually based upon the standard rate announced each year by the People’s Bank of China, and as of September 30, 2010, the applicable interest rate was 5.94% and is payable monthly;
   
Principal payments of $1.1 million are due in March and September of each year beginning on September 22, 2008 and ending on March 31, 2014;
   
Hai Hua is the guarantor of the entire loan;

 

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Assets of the ZZ Joint Venture are pledged as collateral for the loan;
   
Covenants include, among other things, prohibiting pre-payment without the consent of ICBC and permitting ICBC to be involved in the review and inspection of the Zao Zhuang plant; and
   
Subject to customary events of default which, should one or more of them occur and be continuing, would permit ICBC to declare all amounts owing under the contract to be due and payable immediately.
As of September 30, 2010, the ZZ Joint Venture was in compliance with all covenants and obligations under the Fixed Asset Loan Contract.
Yima Joint Ventures
In August 2009, the Company entered into amended joint venture contracts with Yima Coal Industry (Group) Co., Ltd. (“Yima”), replacing the prior joint venture contracts entered into in October 2008 and April 2009. The joint ventures were formed for each of the gasification, methanol/methanol protein production, and utility island components of the plant (collectively, the “Yima Joint Ventures”). The parties obtained government approvals for the project’s feasibility study during the three months ended December 31, 2008 and for the project’s environmental impact assessment during the three months ended March 31, 2009, which were the two key approvals required to proceed with the project. The amended joint venture contracts provide that: (i) the Company and Yima contribute equity of 25% and 75%, respectively, to the Yima Joint Ventures; (ii) Yima will guarantee the repayment of loans from third party lenders for 50% of the project’s cost and, if debt financing is not available, Yima is obligated to provide debt financing via shareholder loans to the project until the project is able to secure third-party debt financing; and (iii) Yima will supply coal to the project from a mine located in close proximity to the project at a preferential price subject to a definitive agreement to be subsequently negotiated. In connection with entering into the amended contracts, the Company and Yima contributed their remaining cash equity contributions of $29.3 million and $90.8 million, respectively, to the Yima Joint Ventures during the three months ended September 30, 2009. The Company will also be responsible for its share of any cost overruns on the project. During the three months ended September 30, 2009, the Company incurred a charge of $0.9 million relating to consulting fees paid in connection with the closing and funding of the Yima project.
In exchange for their 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 investment in the Yima Joint Ventures is accounted for using the equity method.
During this quarter, Yima expressed their intent to convert the existing project from methanol production to glycol production. Yima has communicated their belief that the prospect for strong economic performance of the plant can be improved by modifying the backend of the project to make glycol. In addition, Yima has recently acquired a nearby coal to methanol facility and is looking to diversify and sees glycol as a potentially more profitable alternative. The Company has indicated to Yima that it would be willing to support this scope change if both parties can agree upon appropriate modifications to the joint venture contracts that can improve the Company’s overall risk and return without requiring any additional capital investment from the Company. Yima’s project management team believes that this change can be executed without delaying the original schedule for commercial operation. The Company has agreed to work diligently with Yima to restructure the agreements as necessary to achieve these goals.

 

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Construction activities for site preparation are currently underway and a Chinese engineering company has been selected for the project’s engineering work. The remaining construction and commissioning of the project is expected to take approximately two years. Yima is the project management leader for the project and has indicated their belief that the change in the scope of the project would not delay this schedule; however, the construction of the methanol portion of the plant is on hold pending the revisions for the possible glycol production. Based on the project’s current scope of methanol only, the current estimate of the total required capital of the project is approximately $250 million. The remaining capital for the project is to be provided by project debt to be obtained by the Yima Joint Ventures. Yima has agreed to guarantee the project debt and the Company expects this guarantee will allow debt financing to be obtained from domestic Chinese banking sources. The Company has agreed to pledge to Yima its ownership interests in the joint ventures as security for its obligations under any project guarantee. In the event that the debt financing is not obtained, Yima has agreed to provide a loan to the joint ventures to satisfy the remaining capital needs of the project with terms comparable to current market rates at the time of the loan.
The Yima Joint Ventures are governed by a board of directors consisting of eight directors, two of whom were appointed by the Company and six of whom were appointed by Yima. The joint ventures also have officers that are nominated by the Company, Yima and/or the board of directors pursuant to the terms of the joint venture contracts. The Company and Yima shall share the profits, and bear the risks and losses, of the joint ventures in proportion to our respective ownership interests. The term of the joint venture shall commence upon each joint venture company obtaining its business license and shall end 30 years after commercial operation of the plant.
The Company has included the $1.5 million payment paid to the Gas Technology Institute (“GTI”) in June 2009 toward future royalties due to GTI for the Yima Joint Ventures’ project as part of the Company’s investment in the Yima project. An additional future royalty payment of approximately $1.5 million will be due to GTI upon the commissioning of the gasifier equipment for the Yima project.
The Company’s equity in losses of the Yima Joint Ventures for the three months ended September 30, 2010 was $54,000. There was no equity in losses reported for the three months ended September 30, 2009 as the joint venture was newly formed during that period. The following table presents summarized unconsolidated financial information for the Yima Joint Ventures (in thousands):
         
    September 30,  
Income statement data:   2010  
 
       
Revenue
  $  
Operating loss
    (272 )
Net loss
    (216 )
                 
    September 30,     June 30,  
Balance sheet data:   2010     2010  
 
               
Current assets
  $ 109,999     $ 118,073  
Noncurrent assets
    20,306       11,694  
Current liabilities
    5,147       6,046  
Noncurrent liabilities
           
Golden Concord Joint Venture
The Company’s joint venture with Golden Concord (“GC Joint Venture”) was formed to (i) develop, construct and operate a coal gasification, methanol and dimethyl either (“DME”) production plant utilizing U-GAS® technology in the Xilinghote Economic and Technology Development Zone, Inner Mongolia Autonomous Region, China and (ii) produce and sell methanol, DME and the various byproducts of the plant. The Company has a 51% ownership interest in the GC Joint Venture and consolidates the results of the GC Joint Venture in its consolidated financial statements.

 

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The Company is continuing to develop this project and has shifted its focus to include end products such as SNG, glycol, olefins, methanol and DME that can be economically produced from local low rank coal when utilizing the U-GAS® technology and which are of strategic interest to possible partners in China, including state owned, private and publicly traded gas companies. The Company has entered into a cooperation agreement with a local Chinese company who is assisting with obtaining certain necessary government approvals and who may desire to continue the development of the project.
Note 4 — GTI License Agreement
On November 5, 2009, the Company entered into an Amended and Restated License Agreement (the “New Agreement”) with GTI, replacing the Amended and Restated License Agreement between the Company and GTI dated August 31, 2006, as amended, or the Original Agreement. Under the New 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 U-GAS® technology for 100% biomass and coal/biomass blends exceeding 40% biomass. The New Agreement differs from the Old Agreement most critically by allowing the Company to sublicense U-GAS® to third parties for coal, coal and biomass mixtures or 100% biomass projects (subject to the approval of GTI, which approval shall not be unreasonably withheld), with GTI to share the revenue from such third party licensing fees based on an agreed percentage split (the “Agreed Percentage”). In addition, the prior obligation to fabricate and put into operation at least one U-GAS® system for each calendar year of the Original Agreement in order to maintain the license has been eliminated in the New Agreement.
In order to sublicense any U-GAS® system, the Company is required to comply with certain requirements set forth in the New 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 New Agreement. The Company is also restricted from offering a competing gasification technology during the term of the New Agreement.
For each U-GAS® unit which the Company licenses, designs, builds or operates for itself or for a party other than a sublicensee and which uses coal or a coal and biomass mixture or biomass as the feed stock, the Company must pay a royalty based upon a calculation using the MMBtu per hour of dry syngas production of a rated design capacity, payable in installments at the beginning and at the completion of the construction of a project (the “Standard Royalty”). Although it is calculated using a different unit of measurement, the Standard Royalty is effectively the same as the royalty payable to GTI under the Original Agreement. 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 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.

 

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The Company is required to make an annual payment to GTI for each year of the term beginning with the year ended December 31, 2010, 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 New 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. 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 New 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 New 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 term of the New Agreement is the same as the Original Agreement, expiring on August 31, 2016, but may be extended for two additional ten-year periods at the Company’s option.
Other Services
GTI also offers various technical services including but not limited to laboratory testing of coal samples and plant design review. While the Company has no obligations to do so, the Company has requested GTI to provide various services including: (i) developing an industry-standard process model for performance and cost evaluations of U-GAS®, (ii) replenishing and enlarging the intellectual property portfolio for U-GAS® technology and (iii) assisting the Company with appropriate design support for gasification opportunities that would include fuel feeder, gasifier, solids separation and solids handling systems sizing and configuration.
Note 5 — Stock-Based Compensation
As of September 30, 2010, the Company had outstanding stock option and restricted stock awards granted under the Company’s Amended and Restated 2005 Incentive Plan, as amended (the “Plan”) exercisable for 5,608,959 shares of common stock. As of September 30, 2010, 1,843,991 shares were authorized for future issuance pursuant to the Plan and $0.9 million of estimated expense with respect to non-vested stock-based awards has yet to be recognized.
Stock option activity during the three months ended September 30, 2010 was as follows:
         
    Shares of Common  
    Stock Underlying  
    Stock Options  
 
       
Outstanding at June 30, 2010
    6,037,573  
Granted
    75,000  
Exercised
    (92,250 )
Forfeited
    (411,364 )
 
     
Outstanding at September 30, 2010
    5,608,959  
 
     
Exercisable at September 30, 2010
    4,217,113  
 
     

 

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The fair values for the stock options granted during the three months ended September 30, 2010 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
    2.18 %
Expected life of award
  6.25 years
Expected dividend yield
    0.00 %
Expected volatility of stock
    93.43 %
Weighted-average grant date fair value
  $ 0.86  
Note 6 — 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 common shares outstanding for the period. Stock options are the only potential dilutive share equivalents the Company has outstanding for the periods presented. For the three months ended September 30, 2010 and 2009 and the period from November 4, 2003 (inception) to September 30, 2010, options 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 7 — Risks and Uncertainties
Since mid-2008, the global economy has experienced a significant contraction, with an almost unprecedented lack of availability of business and consumer credit, which has impeded, and could continue to impede, the Company’s ability to obtain financing for its projects. Although the Company is seeing signs of improved economic activity, this decrease and any future decrease in economic activity in China or in other regions of the world, in which the Company may in the future do business, could significantly and adversely affect its results of operations and financial condition in a number of other ways. Any decline in economic conditions may reduce the demand or prices from the products from our plants. In addition, the market for commodities such as methanol has been under significant pressure and the Company is unsure of how much longer this pressure will continue. As a direct result of these trends, the Company’s ability to finance and develop its existing projects, commence any new projects and sell its products could be adversely impacted.
The Company will limit the development of any further projects until worldwide capital and debt markets improve and it has assurances that acceptable financing is available to complete such projects. In addition, as of September 30, 2010, Hai Hua is the Company’s only customer for syngas sales and as such, it is exposed to significant customer credit risk due to this concentration. The Company’s revenue and results of operations would be adversely affected if it is unable to retain Hai Hua as a customer or secure new customers. There have also been recent announcements of a constricting credit market in China. Even if the Company does obtain the necessary capital for its projects, the Company could face other delays in its projects due to additional approval requirements or due to unanticipated issues in the commissioning of such a project. These factors have led to the impairment of the GC Joint Venture’s assets and could lead to, among other things, the impairment of the Company’s significant assets, including its assets in the ZZ Joint Venture and its investment in the Yima Joint Ventures, and an inability to develop any further projects.
The Company may need to raise additional capital through equity and debt financing for any new projects that are developed, to support its existing projects and possible expansions thereof and for its corporate general and administrative expenses. The Company cannot provide any assurance that any financing will be available to the Company in the future on acceptable terms or at all. Any such financing could be dilutive to the Company’s 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; (ii) negotiate and enter into new gasification plant development contracts; (iii) expand its operations; (iv) hire and train new employees; or (v) respond to competitive pressures or unanticipated capital requirements.

 

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On October 28, 2010, the Company received a notification indicating that the minimum bid price of the Company’s common stock is not in compliance with the minimum bid price requirement for continued listing on the NASDAQ Stock Market (the “NASDAQ”). The Company has a grace period until April 26, 2011 in which to regain compliance with the minimum bid price rule. To regain compliance, the closing bid price of the common stock must meet or exceed $1.00 per share for a minimum of ten consecutive business days during this grace period. If the Company does not regain compliance before April 26, 2011, the NASDAQ stated that it will provide the Company with written notice that its securities are subject to delisting, although the Company may be able to appeal this decision. The Company actively monitors the price of its common stock and will consider all available options to regain compliance with the continued listing standards of the NASDAQ.
Note 8 — Litigation
In September 2008, the Company was named as one of a number of defendants in a lawsuit filed in the U.S. District Court for the Central District of California, Southern Division, by Igor Olenicoff, one of its former stockholders, and a company he controls. Also named were Timothy E. Vail (our former CEO and one of the Company’s directors), David Eichinger (the Company’s former CFO), and another one of the Company’s directors (collectively, the Company, Mr. Vail, Mr. Eichinger and the director are referred to as the “SES Defendants”), as well as UBS AG, Union Charter Ltd., and other persons who allegedly managed Mr. Olenicoff’s investments outside the U.S. The SES Defendants have been named in this lawsuit based primarily upon allegations that one of our former stockholders, Teflomi Trade & Trust, Inc., was a shell company formed for the purposes of holding Mr. Olenicoff’s assets overseas, and that the SES Defendants allegedly had knowledge of this arrangement. The claims initially asserted against the SES Defendants included, among others, securities fraud in violation of Rule 10b-5 under the Securities Act and the California state law equivalent, violations of the Racketeer Influenced and Corrupt Organizations Act, or RICO, common law fraud and negligent misrepresentation, breach of fiduciary duty, conspiracy and unfair business practices. On the SES Defendants’ motion, on July 31, 2009, the court issued an order dismissing the securities fraud claims as to each of the SES Defendants and the common law fraud, negligent misrepresentation claim and breach of fiduciary duty claims as to us, Mr. Vail and Mr. Eichinger. The court determined that certain other claims, including RICO, conspiracy and unfair business practices, were sufficiently pled and could proceed at this stage. Plaintiffs were given leave to amend and, on August 24, 2009, filed an amended complaint attempting to replead their securities fraud claims, and alleged a new claim for violation of the Uniform Commercial Code (the “UCC”). In response, on September 23, 2009, the SES Defendants filed a motion to dismiss the securities fraud and UCC claims. The court heard oral argument on the SES Defendants’ motion to dismiss, and on various other defendants’ motions to dismiss, on November 9, 2009. On March 16, 2010, the court issued an order on the pending motions to dismiss, dismissing the securities fraud and UCC claims as to each of the SES Defendants. Thus, the claims that remain as to the SES Defendants collectively include violations of RICO, RICO conspiracy, unfair business practices, conversion and civil conspiracy; the claims that remain as to the individually named director include fraudulent misrepresentation, constructive fraud, negligent misrepresentation and breach of fiduciary duty. The SES Defendants filed their answer to these claims on April 22, 2010. With the pleadings now resolved, the case is moving forward with respect to those claims the court has allowed to remain in the case. The court has set a trial date of February 7, 2012. The SES Defendants believe the claims alleged against them to be without merit and intend to continue to vigorously defend all claims which are allowed to proceed in the court.

 

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Item 2.  
Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and the related notes and other financial information included elsewhere in this quarterly report. Some of the information contained in this discussion and analysis or set forth elsewhere in this quarterly report, including information with respect to our plans and strategy for our business and related financing, include 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, 2010 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 an alternative energy technology company that provides technology, equipment and engineering services for the conversion of low rank, low cost coal and biomass feedstocks into energy and chemical products. Our strategy is to create value through providing technology and equipment in regions where low rank coals and biomass feedstocks can be profitably converted into high value products through our proprietary U-GAS® fluidized bed gasification technology. We do this through providing a proprietary technology package whereby we license U-GAS® technology rights to third parties, deliver an engineered technology transfer package and provide proprietary equipment components to customers who plan to own and operate projects. In addition, we may (i) integrate our U-GAS® technology package with downstream technologies to provide a fully integrated offering where we may invest in projects either directly or through an investment partner, (ii) partner with engineering, equipment and technology companies to provide our U-GAS® technology package into an integrated modular product offering, (iii) provide technology to enable coal resources to be integrated together with our U-GAS® technology where the coal resources may be of little value without our U-GAS® conversion technology, or (iv) acquire or partner with owners of these coal resources to create more value and opportunity for us through the integration of our technology with the coal resources.
We believe that we have several advantages over commercially available competing gasification technologies, such as entrained flow, fixed and moving bed gasification technologies, including our ability to use all ranks of coals (including low rank, high ash and high moisture coals, which are significantly cheaper than higher grade coals), many coal waste products and biomass feed stocks. In addition, U-GAS® technology’s advanced fluidized bed design is tolerant to changes in feedstock. These factors enable us to be a lower cost producer of synthesis gas, or syngas, a mixture of primarily hydrogen and carbon monoxide, which can then be used to produce other products. Depending on local market need and fuel sources, syngas can be used as a fuel gas in industrial applications or can be used to produce many products including power, synthetic natural gas, or SNG, methanol, dimethyl ether, or DME, glycol, ammonia, direct reduction iron, or DRI, synthetic gasoline, steam, and other byproducts (e.g., sulphur, carbon dioxide or ash).
Our principal operating activities are currently in China, however, we are developing opportunities in other countries including the U.S., India, Europe, Australia and Vietnam, as well as other parts of Europe and Asia to provide our U-GAS® technology package. Our ZZ Joint Venture project is our first commercial scale coal gasification plant located in Shandong Province, China and has been in operation since February 2008 and in commercial operation since December 2008. Our Yima project is currently under construction in Henan Province, China.
The key elements of our business strategy include:
   
Executing on existing projects in China. We are continuing to implement operational measures to improve the financial performance of our ZZ Joint Venture plant in the near term, while also continuing to evaluate alternatives to better position the project to be commercially and financially successful in the future. These alternatives include the possible expansion of the plant to produce other products for other customers. We also intend to continue to leverage our success to date at the ZZ Joint Venture in our ongoing business development efforts, including through further visits from senior executives of possible customers and partners, as well as government officials, from China, India, Australia, Vietnam and the United States. We are also continuing the ongoing construction of our Yima project, and are working to restructure our joint venture agreements to change the scope of the project from methanol to glycol production.

 

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Leveraging our proprietary technology through licensing, equipment sales and related services to increase revenues and position us for future growth. We provide a proprietary technology package whereby we license U-GAS® technology rights to third parties, deliver an engineered technology transfer package and provide proprietary equipment components to customers who plan to own and operate projects. We intend to focus on developing opportunities for our proprietary technology package whereby we may (i) integrate our U-GAS® technology package with downstream technologies to provide a fully integrated offering where we may invest in projects either directly or through an investment partner or (ii) may partner with engineering, equipment and technology companies to provide our U-GAS® technology package into an integrated modular product offering, which may include coal or biomass feedstocks for units producing power and fuels such as SNG, MTG, diesel and ethanol as well as methanol for gasoline blending. We anticipate that we can increase revenues through collecting technology licensing fees and royalties, engineering and technical service fees, as well as equipment product sales sold to customers who plan to own and operate projects and desire to incorporate our proprietary technology. We also believe that our licensing activities will provide additional insight into project development activities, which may allow us to make selective equity investments in such projects in the future, develop integrated, modular product offerings, or take options in projects for which we provide a license.
   
Expanding our relationships with strong strategic partners. Our efforts have been initially focused on facilities producing syngas, methanol and DME in China. We are expanding our relationships with our current partners, developing new relationships with strategic partners and developing new downstream coal-to-chemicals and coal-to-energy products which may expand our initial focus to include facilities producing SNG, methanol to gasoline, or MTG, glycol, power and reducing gas for the steel industry. We are exploring new markets for entry such as the U.S., India, Australia, Vietnam, and other parts of Europe and Asia. Such strategic relationships may include an investment in projects either directly by us or through an investment partner where U-GAS® plants may supply syngas to strategic customers via long-term offtake agreements.
   
Developing value where we have a competitive advantage and have access of rights to feedstock resources. We believe that we have the greatest competitive advantage using our U-GAS® technology in situations where there is a ready source of low rank, low cost coal, coal waste or biomass to utilize as a feedstock. We are focusing our efforts in countries with large low rank coal resources such as India, the U.S., China, Turkey and Australia. We are working to develop structured transactions that include securing options to these feedstock resources. For example, we are currently in discussions regarding several projects in Inner Mongolia, China where the provincial government is making coal resources available to the project owners which adds protection for the project from future coal cost increases, as well as potentially increasing project revenues. In these cases, we may provide technology to add value to coal resources which may be of little value without our U-GAS® conversion technology or may acquire or partner with owners of these resources to create more value and opportunity for us through the integration of our technology with the resources. Additionally, where capital and/or financing is available, we may acquire an interest in such resources, including existing facilities or coal mines, where we could create value with our U-GAS® technology through securing greater access to feedstock.

 

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Continue to develop and improve U-GAS® technology. We are continually seeking to improve the overall plant availability, plant efficiency rates and fuel handling capabilities of the existing U-GAS® gasification technology. We are continuing to work with our prospective customers to determine the suitability of their low rank coals for our U-GAS® technology through our proprietary coal characterization testing as well as selective commercial scale testing in our ZZ Joint Venture plant. In addition, we are growing our technology base through continued development of know-how with our engineering and technical staff, growing and protecting our trade secrets as well as through patenting improvements tested at our ZZ Joint Venture plant, and improvements resulting from integration of our technology with downstream processes. To date, we have filed 13 patent applications relating to our improvements to the U-GAS® technology.
   
Grow earnings through increased revenues and control of expenses. We remain intently focused on control of our expenses while we grow revenues from our technology business. We believe our strategy will allow us to grow near term revenues to position us for sustainable long term growth. We intend to minimize project development expense on projects until we have assurances that acceptable financing is available to complete the project. Until the capital markets improve, our strategy will be to operate using our current capital resources and to leverage the resources of financing partners.
Results of Operations
We are in our development stage and therefore have had limited operations. We generated revenues of $1.6 million for the three months ended September 30, 2010 and $9.3 million during the fiscal year ended June 30, 2010. We have sustained net losses of approximately $100.2 million from November 4, 2003, the date of our inception, to September 30, 2010. We have primarily financed our operations to date through private placements and two public offerings of our common stock.
Three Months Ended September 30, 2010 Compared to the Three Months Ended September 30, 2009
Revenue. Total revenue decreased $0.7 million to $1.6 million for the three months ended September 30, 2010 compared to $2.3 million for the three months ended September 30, 2009.
Product sales were $1.4 million for the three months ended September 30, 2010 compared to $1.6 million for the three months ended September 30, 2009 and were derived from the sale of syngas and byproducts produced at the ZZ Joint Venture plant. Product sales decreased due to reduced syngas production and oxygen sales as a result of Hai Hua’s extended shut down during the period. For the three months ended September 30, 2010 and 2009, the plant operated for 31% and 54% of the period, respectively. For the three months ended September 30, 2010 and 2009, the plant’s availability for production was 100% and 98%, respectively, resulting in capacity fee revenue of $0.9 million and $0.7 million, respectively.
Other related party revenues for the three months ended September 30, 2010 and 2009 were $0 and $0.6 million, respectively. The 2009 period’s related party revenue was generated from engineering services provided to the Yima Joint Ventures.
Technology licensing and related services revenues for the three months ended September 30, 2010 and 2009 were $0.2 million and $0.1 million, respectively, and were generated from coal testing, feasibility studies and other technical services provided in association with our technology licensing business.
Costs of product sales and plant operating expenses. Costs of product sales and plant operating expenses decreased by $0.4 million to $1.3 million for the for the three months ended September 30, 2010 compared to $1.7 million for the three months ended September 30, 2009 due primarily to the decrease in production at the ZZ Joint Venture plant.

 

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General and administrative expenses. General and administrative expenses increased by $0.1 million to $3.2 million during the three months ended September 30, 2010 compared to $3.1 million during the three months ended September 30, 2009. The increase of $0.1 million was primarily due to royalties due to GTI during calendar year 2010 and increased travel and professional fees related to licensing and other business development activities, offset in part by a reduction in corporate personnel costs.
Project and technical development expenses. Project and technical development expenses decreased by $0.9 million to $0.1 million for the three months ended September 30, 2010 compared to $1.0 million for the three months ended September 30, 2009. Project development expenses for the three months ended September 30, 2009 included a $0.9 million charge for a consulting fee related to the financial closing of the Yima project.
Stock-based compensation expense. Stock-based compensation expense decreased by $0.4 million to $0.2 million for the three months ended September 30, 2010 compared to $0.6 million for the three months ended September 30, 2009. The decrease was principally due to forfeitures of certain awards and the fact that the fair values of recent stock option awards is lower than the fair values of certain prior awards due to the decrease in the price of our common stock.
Depreciation and amortization. Depreciation and amortization expense was $0.7 million for the three months ended September 30, 2010 and 2009 and was primarily depreciation of our ZZ Joint Venture plant’s assets.
Equity in losses of Yima Joint Ventures. The equity in losses of the Yima Joint Ventures for the three months ended September 30, 2010 relates to our 25% share of the loss incurred by the Yima Joint Ventures. The loss is comprised of non-capitalizable costs incurred during the design and construction phase, offset in part, by interest income earned on invested funds contributed by us and Yima.
Foreign currency gain. During the three months ended September 30, 2010, we recognized a foreign currency gain of $0.3 million due to the appreciation of the Renminbi Yuan relative to the U.S. dollar.
Interest expense. Interest expense decreased by $0.1 million to $0.1 million for the three months ended September 30, 2010 compared to $0.2 million during the three months ended September 30, 2009. The decrease was primarily due to the ZZ Joint Venture’s lower outstanding principal balance on its loan with the Industrial and Commercial Bank of China, or ICBC.
Liquidity and Capital Resources
We are in our development stage and have financed our operations to date through private placements of our common stock in 2005 and 2006 and two public offerings, one in November 2007 and one in June 2008. We have used the proceeds of these offerings for the development of our joint ventures in China and to pay other development and general and administrative expenses. In addition, we have entered into a loan agreement with ICBC to fund certain of the costs of the ZZ Joint Venture.
As of September 30, 2010, we had $37.7 million in cash and cash equivalents and $34.2 million of working capital available to us. During the three months ended September 30, 2010, cash flows used in operating activities were $3.8 million. Additionally, we made the scheduled semi-annual principal payment of $1.1 million on the ICBC loan during the three months ended September 30, 2010.

 

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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. (which was acquired by China National Offshore Oil Corporation in September 2009), 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, including ash and elemental sulphur. We own 95.5% of the ZZ Joint Venture and Hai Hua owns the remaining 4.5%. For the first 20 years after the commercial operation date of the plant, the net profits and losses of the ZZ Joint Venture will be distributed to us and to Hai Hua based on our ownership interest. After the initial 20 years, the profit distribution percentages will be changed, with us receiving 10% of the net profits/losses of the ZZ Joint Venture and Hai Hua receiving 90%. We consolidate the results of the ZZ Joint Venture in our consolidated financial statements.
Syngas Purchase and Sale Agreement.
The ZZ Joint Venture is also party to a purchase and sale agreement with Hai Hua for syngas produced by the plant, whereby Hai Hua will pay the ZZ Joint Venture an energy fee and capacity fee, as described below, based on the syngas production. The syngas to be purchased by Hai Hua is subject to certain quality component requirements set forth in the contract. In late December 2008, the plant declared commercial operations status for purposes of the purchase and sale agreement. The energy fee is a per normal cubic meters, or Ncum, of syngas calculation based on a formula which factors in the monthly averages of the prices of design base coal, coke, coke oven gas, power, steam and water, all of which are components used in the production of syngas. The capacity fee is paid based on the capacity of the plant to produce syngas, factoring in the number of hours (i) of production and (ii) of capability of production as compared to the guaranteed capacity of the plant, which for purposes of the contract is 22,000 Ncum per hour of net syngas. Hai Hua is obligated to pay the capacity fee regardless of whether they use the gasification capacity, subject only to availability of the plant, quality of the syngas and exceptions for certain events of force majeure. Due to worldwide reductions in methanol prices, Hai Hua has operated at a reduced rate of syngas consumption. Hai Hua used approximately 35% to 45% of the syngas guarantee capacity during 2009 and has forecasted the same level of syngas consumption through December 2010.
In April 2009, the ZZ Joint Venture entered into a Supplementary Agreement with Hai Hua, amending the terms of the purchase and sale agreement. The Supplementary Agreement was entered into to provide more clarity regarding the required syngas quality and volume to be delivered, recovery of the energy fee during turndown periods and operations coordination during unscheduled outages. Under the Supplementary Agreement, the syngas quality specification was amended to provide more clarity as to the minor constituents allowable in the syngas. For purposes of the Supplementary Agreement, syngas that meets these specifications is deemed “compliant gas” and syngas that does not meet these specifications is deemed “non-compliant gas.” The Supplementary Agreement also added a requirement for Hai Hua to pay the ZZ Joint Venture the capacity fee and 70% of the energy fee for all non-compliant gas which is taken by Hai Hua. However, if more than 50% of the syngas taken by Hai Hua during any operating day is non-compliant gas, all of the syngas for that day is deemed to be non-compliant gas for purposes of calculating the energy fee. In addition, the Supplementary Agreement accommodates periods of turndown operation by Hai Hua by establishing a minimum threshold gas off take volume of 7,500 Ncum per hour of net syngas for the purpose of calculating the energy fee during such periods. The Supplementary Agreement also provides that, to the extent Hai Hua has an unscheduled shutdown, and the plant continues to operate on standby during such period, Hai Hua is still required to pay the energy fee to the ZZ Joint Venture. In the event that the plant has an unscheduled shutdown and does not provide at least three hours prior notice to Hai Hua, the ZZ Joint Venture may be required to provide certain compensation to Hai Hua.

 

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To date, Hai Hua has been unable to offtake the volume of syngas originally expected for the original plant design and the plant has incurred operating losses. We do not foresee Hai Hua’s volume offtake changing significantly in the near term. In an effort to improve the return on our investment in this plant, we are evaluating alternative products and partnership structures for a possible expansion of the ZZ Joint Venture plant to produce products such as glycol. We do not expect any additional equity for an expansion would be required from us as we continue to expect to contribute our 95.5% equity interest toward the expansion with third parties contributing all the additional required equity to expand the plant. In February 2010, we received the necessary government approval for the expansion. This approval, along with the previously received environmental approvals, are the key approvals required for us to commence execution of the expansion and also describe certain terms of the expansion project, including but not limited to, its use of land, the main additional facilities required and the use of the existing facilities. The scope of the expansion is still under evaluation. We are also continuing to evaluate alternatives to improve the financial performance of the ZZ Joint Venture. The local government has expressed strong support for this expansion project and has executed a letter of intent allowing a new state-owned local coal mine to be used as a debt guarantee. The letter of intent also contemplates providing discounted coal to the project from this local coal mine. We are in discussions with a provincial level coal company that has expressed interest in becoming our partner on this expansion. Earlier work to structure a partnership with a local Zao Zhuang area coal mining company has not progressed due to investment constraints with that company. We are working with local government entities and prospective partners to develop a partnership and project structure.
Yima Joint Ventures
In August 2009, we entered into amended joint venture contracts with Yima Coal Industry (Group) Co., Ltd., or Yima, replacing the prior joint venture contracts entered into in October 2008 and April 2009. The joint ventures were formed for each of the gasification, methanol/methanol protein production, and utility island components of the plant, or collectively, the Yima Joint Ventures. We obtained government approvals for the project’s feasibility study during the three months ended December 31, 2008 and for the project’s environmental impact assessment during the three months ended March 31, 2009, which were the two key approvals required to proceed with the project. 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 have contributed our remaining cash equity contributions of $29.3 million and $90.8 million, respectively, to the Yima Joint Ventures during the three months ended September 30, 2009. We will also be responsible for our share of any cost overruns on the project. During the three months ended September 30, 2009, we incurred a charge of $0.9 million relating to consulting fees paid in connection with the closing and funding of the Yima project.
In exchange for the 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 investment in the Yima Joint Ventures is accounted for using the equity method.
During this quarter, Yima expressed their intent to convert the existing project from methanol production to glycol production. Yima has communicated their belief that the prospect for strong economic performance of the plant can be improved by modifying the backend of the project to make glycol. In addition, Yima has recently acquired a nearby coal to methanol facility and is looking to diversify and sees glycol as a potentially more profitable alternative. We have indicated to Yima that we would be willing to support this scope change if both parties can agree upon appropriate modifications to the joint venture contracts that can improve our overall risk and return without requiring any additional capital investment from us. Yima’s project management team believes that this change can be executed without delaying the original schedule for commercial operation. We have agreed to work diligently with Yima to restructure the agreements as necessary to achieve these goals.

 

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Construction activities for site preparation are currently underway and a Chinese engineering company has been selected for the project’s engineering work. The remaining construction and commissioning of the project is expected to take approximately two years. Yima is the project management leader for the project and has indicated their belief that the change in the scope of the project would not delay this schedule; however, the construction of the methanol portion of the plant is on hold pending the revisions for the possible glycol production. Based on the project’s current scope of methanol only, the current estimate of the total required capital of the project is approximately $250 million. The remaining capital for the project is to be provided by project debt to be obtained by the Yima Joint Ventures. Yima has agreed to guarantee the project debt and we expect this guarantee will allow debt financing to be obtained from domestic Chinese banking sources. We have agreed to pledge to Yima our ownership interests in the joint ventures as security for its obligations under any project guarantee. In the event that the debt financing is not obtained, Yima has agreed to provide a loan to the joint ventures to satisfy the remaining capital needs of the project with terms comparable to current market rates at the time of the loan.
The Yima Joint Ventures are governed by a board of directors consisting of eight directors, two of whom were appointed by us and six of whom were appointed by Yima. The joint ventures also have officers that are nominated by us, Yima and/or the board of directors pursuant to the terms of the joint venture contracts. We and Yima shall share the profits, and bear the risks and losses, of the joint ventures in proportion to our respective ownership interests. The term of the joint venture shall commence upon each joint venture company obtaining its business license and shall end 30 years after commercial operation of the plant.
Golden Concord Joint Venture
Our joint venture with Golden Concord, or the GC Joint Venture, was formed to (i) develop, construct and operate a coal gasification, methanol and DME production plant utilizing U-GAS® technology in the Xilinghote Economic and Technology Development Zone, Inner Mongolia Autonomous Region, China and (ii) produce and sell methanol, DME and the various byproducts of the plant. We have a 51% ownership interest in the GC Joint Venture and we consolidate the results of the GC Joint Venture in our consolidated financial statements. We have funded a total of $3.4 million of our required equity contribution and Golden Concord has additionally funded approximately $3.1 million of its equity contribution as of June 30, 2010. These funds were used for engineering and initial construction work for this project, land use rights, and for its development expenses.
We are continuing to develop this project and have shifted our focus to include end products such as SNG, glycol, olefins, methanol and DME that can be economically produced from local low rank coal when utilizing the U-GAS® technology and which are of strategic interest to possible partners in China, including state owned, private and publicly traded gas companies. We have entered into a cooperation agreement with a local Chinese company who is assisting with obtaining certain necessary government approvals and who may desire to continue the development of the project.
GTI Agreements
License Agreement
On November 5, 2009, we entered into an Amended and Restated License Agreement, or the New Agreement, with GTI, replacing the Amended and Restated License Agreement between us and GTI dated August 31, 2006, as amended, or the Original Agreement. Under the New 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. The New Agreement differs from the Old Agreement most critically by allowing us to sublicense U-GAS® to third parties for coal, coal and biomass mixtures or 100% biomass projects (subject to the approval of GTI, which approval shall not be unreasonably withheld), with GTI to share the revenue from such third party licensing fees based on an agreed percentage split, or the Agreed Percentage. In addition, the prior obligation to fabricate and put into operation at least one U-GAS® system for each calendar year of the Original Agreement in order to maintain the license has been eliminated in the New Agreement.

 

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In order to sublicense any U-GAS® system, we are required to comply with certain requirements set forth in the New 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 New Agreement. We are also restricted from offering a competing gasification technology during the term of the New Agreement.
For each U-GAS® unit which we license, design, build or operate for ourself or for a party other than a sublicensee and which uses coal or a coal and biomass mixture or biomass as the feed stock, we must pay a royalty based upon a calculation using the MMBtu per hour of dry syngas production of a rated design capacity, payable in installments at the beginning and at the completion of the construction of a project, or the Standard Royalty. Although it is calculated using a different unit of measurement, the Standard Royalty is effectively the same as the royalty payable to GTI under the Original Agreement. 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 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 beginning with the year ended December 31, 2010, 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 New Agreement from this amount, and if such royalties exceed the annual payment amount in a given year, we are not required to make the annual payment. We must also provide GTI with a copy of each contract that we enter into relating to a U-GAS® system and report to GTI with our progress on development of the technology every six months.
For a period of ten years, we and GTI are restricted from disclosing any confidential information (as defined in the New 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 New 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 term of the New Agreement is the same as the Original Agreement, expiring on August 31, 2016, but may be extended for two additional ten-year periods at our option.

 

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Other Services
GTI also offers various technical services including but not limited to laboratory testing of coal samples and plant design review. While we have no obligations to do so, we have requested GTI to provide various services including: (i) developing an industry-standard process model for performance and cost evaluations of U-GAS®, (ii) replenishing and enlarging the intellectual property portfolio for U-GAS® technology and (iii) assisting us with appropriate design support for gasification opportunities that would include fuel feeder, gasifier, solids separation and solids handling systems sizing and configuration.
Outlook
We expect to continue to have negative cash flows until we can generate sufficient revenues from our licensing and related service projects, as well as from the ZZ Joint Venture, the Yima Joint Ventures and other projects which are under development, to cover our general and administrative expenses and other operating costs.
We currently plan to use our available cash for (i) our general and administrative expenses; (ii) debt service related to the ZZ Joint Venture; (iii) working capital; (iv) project, third-party licensing and technical development expenses; and (v) general corporate purposes. The actual allocation of and the timing of the 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, since mid-2008, the global economy has experienced a significant contraction, with an almost unprecedented lack of availability of business and consumer credit, which has impeded, and could continue to impede, our ability to obtain financing for our projects. Although we are seeing signs of improved economic activity, this decrease and 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 in a number of other ways. In addition, the market for commodities such as methanol has been under significant pressure and we are unsure of how much longer this pressure will continue. As a direct result of these trends, our ability to finance and develop our existing projects, commence any new projects and sell our products could be adversely impacted.
We are pursuing possible U-GAS® licensing opportunities with third parties allowing us to build on our experience at the ZZ Joint Venture and our technology and engineering capability. In April 2010, we executed our first third party technology licensing agreement. Under this agreement, we are providing U-GAS® technology for a commercial scale biomass to biofuels project in the U.S. In addition we and the licensee entered into a separate multi-site agreement whereby the licensee has the option to license our biomass gasification technology for five additional commercial scale biomass to biofuels projects within North America. As part of the license agreement, we are providing the biomass gasification process design package, and may provide some key proprietary gasification system equipment components and technical services. We intend to place increased focus on development of licensing opportunities for our proprietary U-GAS® technology on a global basis with a focus on India, China, Turkey, the U.S., Australia and Vietnam, as well as other parts of Europe and Asia, due to their large low rank coal resources. We have recently signed an agreement with an Australian company that is in the process of shipping coal to our Zao Zhuang facility for testing.
Our strategy is to create value by providing technology and equipment in regions where low rank coals and biomass feedstocks can be profitably converted into high value products through our proprietary U-GAS® fluidized bed gasification technology. We do this through providing a proprietary technology package whereby we license U-GAS® technology rights to third parties, deliver an engineered technology transfer package and provide proprietary equipment components to customers who plan to own and operate projects. In the U.S., we believe there may be a significant near-term opportunity for us to leverage the capability of U-GAS® to efficiently gasify biomass to make renewable fuels. Today’s regulatory environment in the U.S. is favorable for these types of projects because increased environmental concerns are creating a market demand for renewable fuels and companies are under increasing pressure to reduce their carbon footprint. We anticipate that we can generate revenues through engineering and technical service fees, as well as licensing fees and royalties on products sold by our licensees that incorporate our proprietary technology without incurring the significant capital costs required to develop a plant. We also believe that our licensing activities will provide additional insight into project development activities, which may allow us to make selective equity investments in such projects in the future and also the development of integrated, modular product offerings.

 

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We may (i) integrate our U-GAS® technology package with downstream technologies to provide a fully integrated offering where we may invest in projects either directly or through an investment partner, (ii) partner with engineering, equipment and technology companies to provide our U-GAS® technology package into an integrated modular product offering, (iii) provide technology to enable coal resources to be integrated together with our U-GAS® technology where the coal resources may be of little value without our U-GAS® conversion technology, or (iv) acquire or partner with owners of these coal resources to create more value and opportunity for us through the integration of our technology with the coal resource. We understand the need to partner in certain markets, and plan to do so with companies that we believe can help us accelerate our business. Our partnering approach in some cases is country specific and in some cases is industry or segment specific. Additionally, where capital and/or financing is available, we may acquire an interest in such resources, including existing facilities or coal mines, where we could create value with our U-GAS® technology through securing greater access to feedstock.
We are actively pursuing project partners to invest in our projects’ development, including a different project scope and end product for the GC Joint Venture and the YIMA Joint Ventures and for the possible expansion of the ZZ Joint Venture plant. Our Yima project is under construction and Yima is the project management leader for the project. During this quarter, Yima indicated their intent to convert the existing project from methanol production to glycol production. Yima has expressed their belief that the prospect for strong economic performance of the plant can be improved by modifying the backend of the project to make glycol. In addition, Yima has recently acquired a nearby coal to methanol facility and is looking to diversify and sees glycol as a potentially more profitable alternative. We have indicated to Yima that we would be willing to support this scope change if both parties can agree upon appropriate modifications to the joint venture contracts that can improve our overall risk and return without requiring any additional capital investment from us. Yima’s project management team believes that this change can be executed without delaying the original schedule for commercial operation; however, the construction of the methanol portion of the plant is on hold pending the revisions for the possible glycol production. We have agreed to work diligently with Yima to restructure the agreements as necessary to achieve these goals.
We believe that improving the financial performance and reducing the operating costs of the ZZ Joint Venture plant are critical to improving our financial performance and we believe one method to achieve this improvement is through the expansion of the plant to produce products such as glycol. To date, Hai Hua has been unable to offtake the volume of syngas originally expected for the original plant design and the plant has incurred operating losses. We do not foresee this situation changing significantly in the near term. In an effort to improve the return on our investment in this plant, we are evaluating alternative products and partnership structures for a possible expansion of the ZZ Joint Venture plant to produce products such as glycol. We do not expect any additional equity for an expansion would be required from us as we continue to expect to contribute our 95.5% equity interest toward the expansion with third parties contributing all the additional required equity to expand the plant. We are in discussions with a provincial level coal company that has also expressed an interest in becoming our partner on this expansion. Earlier work to structure a partnership with a local Zao Zhuang coal mining company has not progressed due to investment constraints with that company. In February 2010, we received the necessary government approval for the expansion. This approval, along with the previously received environmental approvals, are the key approvals required for us to commence execution of the expansion and also describe certain terms of the expansion project, including but not limiting to, its use of land, the main additional facilities required and the use of the existing facilities. The scope of the expansion is still under evaluation. In addition, our successful commercial-scale demonstration at the Zao Zhuang plant using lignite coal from the Inner Mongolia region of China was a significant milestone for us and our U-GAS® technology as it demonstrated our ability to efficiently process lignite coal. As a result of the lignite demonstration, we have seen a large increase in visits to our Zao Zhuang plant from potential customers and partners. We intend to continue to leverage our success to date at the ZZ Joint Venture in our ongoing business development efforts, including through further visits from senior executives of possible customers and partners, as well as government officials, from China, India, Australia, Vietnam and the United States.

 

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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 and we believe that China is a good example of this new direction in coal gasification. In China, coal prices for high quality coals has risen dramatically over the past few years and the high coal prices have a very negative impact on the margins of its coal gasification projects. Today, China is moving toward even larger coal based projects to fuel the country’s energy needs, which includes several large scale coal to methane or SNG projects, as compared to previous coal-to-chemical projects that have been build in China. Due to the current encouragement from the Chinese government for these projects, we believe there is potential in China for several of these projects, some of which are in various stages of planning. In addition, we believe many of these projects will be located in regions where very low cost lignite coals can be made available and are necessary to reduce the production cost of SNG and should make these projects more profitable. As we have found with the tests at our Zao Zhuang plant, our technology has the unique ability to be efficiently process this lignite and thus we believe it is very desirable for these projects. As evidence of this, we are in discussions regarding several projects in Inner Mongolia where the provincial government is making coal resources available to the project owners which adds protection for the project from future coal cost increases, as well as potentially increasing project revenues. In these types of projects, we believe that we have the opportunity to create more value from the U-GAS technology than licensing alone could bring us.
We will limit the development of any further projects until worldwide capital and debt markets improve and we have assurances that acceptable financing is available to complete the project. However, we will 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. As of September 30, 2010, we had $37.7 million in cash and cash equivalents and $34.2 million of working capital available to us. During the three months ended September 30, 2010, cash flows used in operating activities were $3.8 million. Additionally, we made the scheduled semi-annual principal payment of $1.1 million on the ICBC loan during the three months ended September 30, 2010. We may need to raise additional capital through equity and debt financing for any new projects that are developed, to support our existing projects and possible expansions thereof and for our corporate general and administrative expenses. 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; (ii) successfully develop our licensing and related service business; (iii) negotiate and enter into new gasification plant development contracts and licensing agreements; (iv) expand our operations; (v) hire and train new employees; or (vi) respond to competitive pressures or unanticipated capital requirements.
Critical Accounting Policies
The preparation of financial statements in accordance with U.S. 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.

 

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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 includes the capacity fee and energy fee earned at the ZZ Joint Venture plant, and byproducts 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 and earned over the course of a project’s development. We may receive upfront licensing fee payments in addition to fees for engineering services that are integral to the initial transfer of our technology to a customer’s project. Typically, the majority of a license fee is received once project financing and equipment installation occur. Recognition of upfront licensing fee payments is deferred and recognized as a percentage of completion of the engineering services associated with the initial technology transfer. Further, such revenues are deferred until performance guarantee terms under the licensing agreement are met. We recognize revenue from engineering services under 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, fuel costs, and operating costs. However, actual future market prices and project costs could vary from the assumptions used in our estimates, and the impact of such variations could be material.

 

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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 equity method investments such as our equity 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
The ZZ Joint Venture plant has operated at limited capacity and is expected to continue operating at reduced capacity due to the depressed methanol market. The reduced capacity at the ZZ Joint Venture plant has contributed to the plant’s operating losses. In addition to funding these operating losses, we are funding the debt service for the ZZ Joint Venture. We are in the process of implementing operational measures, pursuing additional customers and evaluating strategies to reduce the ZZ Joint Venture’s losses and improve its financial performance including the possible expansion of the plant to produce other products. If an expansion of the ZZ Joint Venture plant were to be developed, we would expect to contribute our interest in the ZZ Joint Venture to the project without significant additional cash investment by us. If we are not successful in improving the ZZ Joint Venture’s profitability, or if management’s estimated cash flow projections for these assets decrease, or if Hai Hua does not make its required payments, the plant’s assets could be impaired. As of September 30, 2010, we have determined that these assets were not impaired.
Accounting for Variable Interest Entities (“VIEs”) and Financial Statement Consolidation Criteria
The joint ventures which we enter into may be considered 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 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 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 we have determined that we are the primary beneficiary. In making that determination, we considered, among other items, the change in profit distribution between us and Hai Hua 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 coincides with our original 95% profit/loss allocation, versus the latter 30 years in which our profit/loss allocation is reduced to 10%. In addition, we considered whether the terms of the syngas purchase and sale agreement with Hai Hua contained a lease. The factors considered included (i) our ability to operate and control the plant during the initial 20 years; and (ii) whether it was more than remote that one or more parties other than Hai Hua would purchase more than a minor amount (considered to be 10%) of the plant’s output during the term of the syngas purchase and sale agreement. Because we determined that the syngas purchase and sale agreement did not contain a lease, we account for the revenues from this agreement in accordance with our revenue recognition policy for product sales.
We have determined that the Yima Joint Ventures are VIE’s and that Yima is the primary beneficiary since Yima has a 75% ownership interest in the Yima Joint Ventures.

 

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We have determined that the GC Joint Venture is a VIE and has determined that we are the primary beneficiary since we have a 51% ownership interest in the GC Joint Venture and since there are no qualitative factors that would preclude us from being deemed the primary beneficiary.
Item 3.  
Quantitative and Qualitative Disclosure About Market Risk
Qualitative disclosure about market risk.
We are exposed to certain qualitative market risks as part of our ongoing business operations, including risks from changes in foreign currency exchange rates and commodity prices that could impact our financial position, results of operations and cash flows. We manage our exposure to these risks through regular operating and financing activities, and may, in the future, use derivative financial instruments to manage this risk. We have not entered into any derivative financial instruments to date.
Foreign currency risk
We conduct operations in China and the functional currency in China is the Renminbi Yuan. Our financial statements are expressed in U.S. dollars and will be negatively affected if foreign currencies, such as the Renminbi Yuan, depreciate relative to the U.S. dollar. In addition, our currency exchange losses may be magnified by exchange control regulations in China or other countries that restrict our ability to convert into U.S. dollars.
Commodity price risk
Our business plan is to purchase coal and other consumables from suppliers and to sell commodities, such as syngas, methanol and other products. Coal is the largest component of our costs of product sales and in order to mitigate coal price fluctuation risk for future projects, we expect to enter into long-term contracts for coal supply or to acquire coal assets. For the sale of commodities from our projects, fixed price contracts will not be available to us in certain markets, such as China, which will require us to purchase some portion of our coal and other consumable needs, or sell some portion of our production, into spot commodity markets or under short term supply agreements. Hedging transactions may be available to reduce our exposure to these commodity price risks, but availability may be limited and we may not be able to successfully hedge this exposure at all. To date, we have not entered into any hedging transations.
Interest rate risk
We are exposed to interest rate risk through our loan with ICBC. Interest under this loan is adjusted annually based upon the standard rate announced each year by the People’s Bank of China. As of September 30, 2010, the applicable interest rate was 5.94%. We could also be exposed to the risk of rising interest rates through our future borrowing activities. This is an inherent risk as borrowings mature and are renewed at then current market rates. The extent of this risk as to our ICBC loan, or any future borrowings, is not quantifiable or predictable because of the variability of future interest rates.
Customer credit risk
When our projects progress to commercial production, 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. As of September 30, 2010, Hai Hua, a related party, is our only customer for syngas sales and as such, we are exposed to significant customer credit risk due to this concentration. Our revenue and results of operations would be adversely affected if we are unable to retain Hai Hua as a customer and secure new customers.

 

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Item 4.  
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 Accounting Officer, to allow timely decisions regarding required disclosures.
We do not expect that our disclosure controls and procedures will prevent all errors or fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitation in a cost-effective control system, misstatements due to error or fraud could occur and not be detected.
Our management, with the participation of the Chief Executive Officer and the Chief Accounting Officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2010 pursuant to Rule 13a-15 (b) of the Securities and Exchange Act of 1934, as amended, or the Exchange Act. Based upon this evaluation, the Chief Executive Officer and Chief Accounting Officer concluded that our disclosure controls and procedures were not effective as of September 30, 2010 due to a previously disclosed material weakness in our internal accounting controls. Specifically, our internal control over financial reporting was not effective at ensuring that financial reporting risks arising from complex and non-routine transactions were identified timely and that appropriate accounting policies for such transactions were selected and applied. This material weakness has resulted in adjustments to our interim preliminary consolidated financial statements that were not identified by us. These errors were not prevented or detected by our internal control over financial reporting which could have resulted in a material misstatement of our interim or year-end consolidated financial statements and disclosures.
During our fiscal year ended June 30, 2009, we designed and implemented enhanced procedures to address this material weakness which included 1) the hiring of a full-time Chief Accounting Officer with appropriate U.S. GAAP and public company financial reporting experience, 2) ensuring that relevant personnel involved in the accounting for complex and non-routine transactions fully understand and apply the proper accounting for such transactions, and 3) engaging external accounting resources, when necessary, to augment our consideration and resolution of accounting matters especially those involving complex and non-routine transactions. However, we will not consider this material weakness fully remediated until we can evidence effectiveness of these procedures for a sufficient period of time.
There have been no changes in internal control over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, internal control over financial reporting.
PART II
Item 1.  
Legal Proceedings.
In September 2008, we were named as one of a number of defendants in a lawsuit filed in the U.S. District Court for the Central District of California, Southern Division, by Igor Olenicoff, one of our former stockholders, and a company he controls. Also named were Timothy E. Vail (our former CEO and one of our directors), David Eichinger (our former CFO), and another one of our directors (collectively, we, Mr. Vail, Mr. Eichinger and the director are referred to as the “SES Defendants”), as well as UBS AG, Union Charter Ltd., and other persons who allegedly managed Mr. Olenicoff’s investments outside the U.S. The SES Defendants have been named in this lawsuit based primarily upon allegations that one of our former stockholders, Teflomi Trade & Trust, Inc., was a shell company formed for the purposes of holding Mr. Olenicoff’s assets overseas, and that the SES Defendants allegedly had knowledge of

 

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this arrangement. The claims initially asserted against the SES Defendants included, among others, securities fraud in violation of Rule 10b-5 under the Securities Act and the California state law equivalent, violations of the Racketeer Influenced and Corrupt Organizations Act, or RICO, common law fraud and negligent misrepresentation, breach of fiduciary duty, conspiracy and unfair business practices. On the SES Defendants’ motion, on July 31, 2009, the court issued an order dismissing the securities fraud claims as to each of the SES Defendants and the common law fraud, negligent misrepresentation claim and breach of fiduciary duty claims as to us, Mr. Vail and Mr. Eichinger. The court determined that certain other claims, including RICO, conspiracy and unfair business practices, were sufficiently pled and could proceed at this stage. Plaintiffs were given leave to amend and, on August 24, 2009, filed an amended complaint attempting to replead their securities fraud claims, and alleged a new claim for violation of the Uniform Commercial Code, or the UCC. In response, on September 23, 2009, the SES Defendants filed a motion to dismiss the securities fraud and UCC claims. The court heard oral argument on the SES Defendants’ motion to dismiss, and on various other defendants’ motions to dismiss, on November 9, 2009. On March 16, 2010, the court issued an order on the pending motions to dismiss, dismissing the securities fraud and UCC claims as to each of the SES Defendants. Thus, the claims that remain as to the SES Defendants collectively include violations of RICO, RICO conspiracy, unfair business practices, conversion and civil conspiracy; the claims that remain as to the individually named director include fraudulent misrepresentation, constructive fraud, negligent misrepresentation and breach of fiduciary duty. The SES Defendants filed their answer to these claims on April 22, 2010. With the pleadings now resolved, the case is moving forward with respect to those claims the court has allowed to remain in the case. The court has set a trial date of February 7, 2012. The SES Defendants believe the claims alleged against them to be without merit and intend to continue to vigorously defend all claims which are allowed to proceed in the court.
Item 1A.  
Risk Factors.
Our common stock may be subject to delisting from the NASDAQ Stock Market.
On October 28, 2010, we a notification indicating that the minimum bid price of our common stock is not in compliance with the minimum bid price requirement for continued listing on the NASDAQ Stock Market (the “NASDAQ”). We have a grace period until April 26, 2011 in which to regain compliance with the minimum bid price rule. To regain compliance, the closing bid price of our common stock must meet or exceed $1.00 per share for a minimum of ten consecutive business days during this grace period. If we do not regain compliance before April 26, 2011, the NASDAQ stated that it will provide us with written notice that our securities are subject to delisting, although we may be able to appeal this decision. We actively monitor the price of our common stock and will consider all available options to regain compliance with the continued listing standards of the NASDAQ.
Item 2.  
Unregistered Sales of Equity Securities and Use of Proceeds.
None.
Item 3.  
Defaults Upon Senior Securities.
None.
Item 4.  
[Removed and Reserved.]
Item 5.  
Other Information.
None.

 

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Forward-Looking Statements.
This Quarterly Report on Form 10-Q includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act. All statements other than statements of historical fact are forward-looking statements. Forward-looking statements are subject to certain risks, trends and uncertainties that could cause actual results to differ materially from those projected. Among those risks, trends and uncertainties are our early stage of development, our estimate of the sufficiency of existing capital sources, our ability to successfully develop our licensing business, our ability to raise additional capital to fund cash requirements for future investments and operations, our ability to reduce operating costs, the limited history and viability of our technology, the effect of the current international financial crisis on our business, commodity prices and the availability and terms of financing opportunities, our results of operations in foreign countries and our ability to diversify, our ability to maintain production from our first plant in the ZZ Joint Venture, our ability to complete the expansion of the Zao Zhuang project, our ability to obtain the necessary approvals and permits for our Yima project and other future projects, our estimated timetables for achieving mechanical completion and commencing commercial operations for the Yima project, our ability to negotiate the terms of the conversion of the Yima project from methanol to glycol and the sufficiency of internal controls and procedures. 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, 2010, as well as in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and elsewhere in this Form 10-Q.
You should read these statements carefully because they discuss our expectations about our future performance, contain projections of our future operating results or our future financial condition, or state other “forward-looking” information. You should be aware that the occurrence of certain of the events described in this Form 10-Q could substantially harm our business, results of operations and financial condition and that upon the occurrence of any of these events, the trading price of our common stock could decline, and you could lose all or part of your investment.
We cannot guarantee any future results, levels of activity, performance or achievements. Except as required by law, we undertake no obligation to update any of the forward-looking statements in this Form 10-Q after the date hereof.

 

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Item 6.  
Exhibits
         
Number   Description of Exhibits
       
 
  10.1    
Letter Agreement between the Company and Don Bunnell dated October 15, 2010 (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on October 15, 2010).
       
 
  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.
 
     
*  
Filed herewith.

 

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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: November 12, 2010  By:   /s/ Robert Rigdon    
    Robert Rigdon   
    President and Chief Executive Officer   
     
Date: November 12, 2010  By:   /s/ Kevin Kelly    
    Kevin Kelly   
    Chief Accounting Officer, Controller and Secretary   

 

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