SYNTHESIS ENERGY SYSTEMS INC - Annual Report: 2009 (Form 10-K)
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
| þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended June 30, 2009
| 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: 01-33522
SYNTHESIS ENERGY SYSTEMS, INC.
(Exact Name of Registrant as specified in its Charter)
| Delaware (State or Other Jurisdiction of Incorporation or Organization) |
20-2110031 (I.R.S. Employer Identification No.) |
|
| Three Riverway, Suite 300, Houston, Texas (Address of Principal Executive Offices) |
77056 (Zip Code) |
Registrant’s telephone number, including area code (713) 579-0600
Securities registered pursuant to Section 12(b) of the Exchange Act:
| Common Stock, $.01 par value | NASDAQ Stock Market | |
| (Title of Class) | (Name of Exchange on Which Registered) |
Securities registered pursuant to Section 12(g) of the Exchange Act: None
Indicate by check mark whether the registrant is a well-known seasoned issuer as defined in
Rule 405 of the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section
13 of 15(d) of the Exchange Act. Yes o No þ
Indicate by check mark whether the registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 if there is disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be
contained, to the best of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. 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 þ | Smaller reporting company o |
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
The aggregate market value of the voting stock held by non-affiliates of the registrant was
$21.2 million on December 31, 2008. The registrant had 48,117,671 shares of common stock
outstanding on September 8, 2009.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information required to be disclosed in Part III of this report is incorporated by
reference from the registrant’s definitive Proxy Statement for the 2009 Annual Meeting of
Stockholders, which will be filed not later than 120 days after the end of the fiscal year covered
by this report.
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Forward-Looking Statements
This Annual Report on Form 10-K includes “forward-looking statements” within the meaning of
Section 27A of the Securities Act 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 raise
additional capital to fund cash requirements for future investments and operations, 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 Hai Hua joint venture, 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 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-K, 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,” “Management’s Discussion and Analysis of
Financial Condition and Results of Operations,” and elsewhere in this Form 10-K.
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-K 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-K after the date hereof.
PART I
| Item 1. | Description of Business |
We are in our development stage and therefore have had limited operations. We build, own and
operate 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 believe that we have several advantages over commercially available competing gasification
technologies, such as entrained flow and fixed bed, 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, which provide greater fuel
flexibility, and our ability to operate efficiently on a smaller scale, which enables us to
construct plants at a lower capital cost thus enabling us to be a lower cost producer of syngas for
energy products.
Our principal business activities are currently focused in China. Our first commercial scale
coal gasification plant is located in Shandong Province, China and has been in operation since the
three months ended March 31, 2008. We have additional projects in various stages of development in
Henan Province, China and in the Inner Mongolia Autonomous Region of China. During the year ended
June 30, 2009, we also investigated opportunities in Mississippi and North Dakota with North
American Coal, or NAC. However, based on current commodity prices and current financial market
conditions in the U.S., we do not expect projects in the U.S. will be a viable development option
for us in the near term.
Our gasification plants can produce synthesis gas, or syngas, a mixture of hydrogen, carbon
monoxide and other products. Depending on local market need and fuel sources, syngas can in turn be
used to produce many products including methanol, dimethyl ether, or DME, glycol, synthetic natural
gas, or SNG, ammonia, synthetic gasoline, steam, power and other byproducts (e.g., sulphur, carbon
dioxide or ash).
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Overview of U-GAS®
We have an exclusive license to the U-GAS® gasification technology from the Gas
Technology Institute, or GTI, a leading not-for-profit research and development organization
located near Chicago, Illinois. Over the past 30 years, GTI has developed a fluidized bed
gasification technology trademarked as U-GAS®. Our U-GAS® license grants
us the worldwide exclusive right to manufacture, make, use and sell both U-GAS® coal
gasification systems and coal and biomass mixture gasification systems and a non-exclusive right to
manufacture biomass exclusive gasification systems. Our license has an initial term expiring in
August 2016, with two additional 10-year extensions exercisable at our option. The primary
advantage of U-GAS® relative to other leading gasification technologies is its ability
to produce syngas from all ranks of coal (including low rank, high ash and high moisture coals),
many coal waste products and biomass feed stocks. This process is highly efficient at separating
carbon from waste ash, which allows for the efficient processing of certain low rank coal and many
coal waste products that cannot otherwise be utilized in the entrained flow and fixed bed gasifiers
offered by our competitors. The ability to gasify these lower quality fuels unlocks economic
advantages by allowing the use of lower cost feedstocks while maintaining high carbon conversion
and clean syngas outputs.
The U-GAS® gasification process is based on a single-stage, fluidized-bed
technology for production of low-to-medium heating value syngas from a wide array of biomass
feedstocks and coals (including low rank, high ash and high moisture coals). U-GAS®
technology was developed for gasification of all ranks of coal as well as coal and biomass blends.
In the U-GAS® gasification process, fuel is processed and conveyed into the
gasifier vessel. Within the fluidized bed, the fuel reacts with steam, air and/or oxygen and the
temperature is controlled to maintain high carbon conversion and non-slagging conditions for the
ash. The U-GAS® process accomplishes four important functions in a single-stage,
fluidized-bed gasifier: it decakes, devolatilizes and gasifies fuel, and if necessary, agglomerates
and separates ash from the reacting coal. The operating pressure of the gasifier depends on the end
use for the syngas and may vary from 3 to 30 bars (45 to 450 psia) or more. After cleaning, the
syngas can be used for many applications such as industrial fuel gas, power generation and
production of methanol, DME, glycol, SNG, ammonia, synthetic gasoline, steam, power and other
byproducts (e.g., sulphur, carbon dioxide or ash).
During operation, fuel is gasified rapidly within the fluidized bed and produces a gaseous
mixture of hydrogen, carbon monoxide, carbon dioxide, water vapor and methane, in addition to small
amounts of hydrogen sulfide and other trace impurities. The char material is removed from the
bottom of the gasifier.
Reactant gases, including steam, air, and/or oxygen are introduced into the gasifier. Ash is
removed by gravity from the fluidized bed and discharged into a system for depressurization and
disposal. The gasifier maintains a low level of carbon in the bottom ash discharge stream, making
overall carbon conversion of 90% or higher. Cold gas efficiencies of over 80% have been repeatedly
demonstrated.
Fines purified from the fluidized bed are typically separated from the product syngas. The
product syngas is essentially free of tars and oils due to the temperature and residence time of
the gases in the fluidized bed, simplifying downstream heat recovery and gas cleaning operations.
GTI Agreements
License Agreement
Pursuant to the our License Agreement with GTI, we have an exclusive worldwide license to
manufacture, make, use and sell both U-GAS® coal gasification systems and coal and
biomass mixture gasification systems that utilize coal and biomass blends having feedstock
materials containing no less than 60% coal and no more than 40% biomass. The License Agreement also
grants us a non-exclusive license to manufacture, make, use and sell worldwide biomass gasification
systems and coal and biomass mixture gasification systems that utilize coal and biomass blends
having feedstock materials containing up to 60% coal and no less than 40% biomass. The License
Agreement has a term of ten years, but may be extended for two additional ten-year periods at our
option.
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As consideration for the license, we paid $510,000 cash, and issued 190,500 shares of
restricted common stock, to GTI. We are also restricted from offering a competing gasification
technology during the term of the License Agreement. Additionally, for each U-GAS® unit
which we license, design, build or operate which uses coal or a coal and biomass mixture as the
feed stock, we must pay a royalty based upon a calculation using the thermal megawatt 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. 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. A failure to comply with any of the
above requirements could result in the termination of the License Agreement by GTI if not cured by
us within specified time periods.
In addition, we were required to (i) have a contract for the sale of a U-GAS®
system with a customer in the territory covered by the License Agreement no later than August 31,
2007 and (ii) fabricate and put into operation at least one U-GAS® system by July 31,
2008. We have a continuing obligation to fabricate and put into operation at least one
U-GAS® system for each calendar year of the License Agreement, beginning with the
calendar year 2009. We satisfied the obligation to have a contract for the sale of a
U-GAS® system no later than August 31, 2007 and fabricate and put into operation at least one
U-GAS® system by July 31, 2008 through our Hai Hua project described below. In June
2009, we agreed to pay GTI a non-refundable payment of $1.5 million toward future royalties due to
GTI for the proposed Yima project. In conjunction with this agreement, GTI agreed to waive our
next required obligation to put a U-GAS® system into operation until the earlier of a
renegotiated License Agreement or December 31, 2010. Additionally, we are required to disclose to
GTI any improvements related to the U-GAS® system that are developed and implemented by
us and the manner of using and applying such improvements. Failure to satisfy the requirements as
to these milestones could lead to the revocation of the license by GTI; provided, however, that GTI
is required to give a twelve-month notice of termination and we are able to cure the default and
continue the License Agreement prior to the expiration of such time period.
Without the prior written consent of GTI, we have no right to sublicense any U-GAS®
system other than to customers for which we have constructed a U-GAS® system. For a
period of ten years, we are restricted from disclosing any confidential information (as defined in
the License Agreement) to any person other than employees of our affiliates or contractors who are
required to deal with such information, and such persons will be bound by the confidentiality
provisions of the license. We have further indemnified GTI and its affiliates from any liability or
loss resulting from unauthorized disclosure or use of any confidential information that it
receives.
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.
Business Strategy
The key elements of our business strategy include:
| • | Improve the profitability and cash flows of the HH Joint Venture plant. We are in the
process of implementing operational measures and evaluating strategies to reduce the HH
Joint Venture’s losses and improve its financial performance, including the possible
expansion of the plant to produce other products and through the sharing of certain costs
with Hai Hua. |
| • | Execute on projects in China currently under development. We intend to leverage our
success to date at the HH Joint Venture in our ongoing business development efforts. Our
projects under development are also expected to have a significant impact on our business
development efforts and financial results once they are completed and producing. We also
believe that our Yima Joint Venture will help to demonstrate our ability to expand into
increasingly larger projects and new product markets. |
| • | Managing further project development in China based on available capital. Based on our
current focus on developing our projects in China, we plan to use our available cash for (i)
general and administrative expenses; (ii) working capital; (iii) debt service related to the
HH Joint Venture; (iv) project and technical development expenses; and (v) general corporate
purposes. However, we intend to minimize any further development on projects or move ahead
on any acquisitions 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. |
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| • | Leverage our proprietary technology. We intend to place increased focus on development of
licensing arrangements for our proprietary U-GAS® technology on a global basis
with a focus on China, India, the U.S. and Australia due to their large low rank coal
resources. We anticipate that we can generate revenues through 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. |
| • | Investigate acquisition opportunities. If we have the capital or financing is otherwise
available, we plan to evaluate acquisition opportunities, including existing plants,
facilities or coal mines, where we could enhance the economics with our U-GAS®
technology. |
| • | Expand our relationships with our strong strategic partners and new products. China is
presently our primary market, where our efforts have been focused primarily on facilities
producing syngas, methanol and DME. We plan to expand our relationships with our current
partners, develop new relationships with strategic partners and develop new downstream
coal-to-chemicals and coal-to-energy products. |
| • | 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. To date, we have
filed eight patent applications relating to improvements to the U-GAS®
technology. |
| • | Concentrate our efforts on opportunities where our U-GAS® technology provides
us with a clear competitive advantage. 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 fuel. |
Target Markets
China
We believe that China offers immediate opportunities to develop U-GAS®-based coal
gasification projects. Coal is China’s most abundant indigenous energy resource, including a ready
supply of low rank coal. According to the BP Statistical Review of World Energy report, as of year
end 2008, China’s recoverable coal reserves amounted to 114.5 billion tonnes, including 52 billion
tonnes of lower grade sub-bituminous and lignite coals. In addition, the Chinese government is
promoting the expansion of the domestic supply of chemical products and transportation fuels
derived from coal. Methanol derived from coal is used primarily as a commodity chemical used in
manufacturing a wide range of products from formaldehyde and acetic acid to pharmaceuticals and
plastics and is also used to a lesser extent as a natural gas substitute in power generation, to
further process into DME and as an automotive fuel through blending into gasoline. China’s methanol
consumption has grown from 2.6 million tonnes in 1999 to 13.4 million tonnes in 2008. DME
consumption in China was 2.2 million tones per year in 2008 and is expected to increase as DME
becomes more widely used as a fuel substitute for liquefied petroleum
gas, or LPG, and diesel. Today 95% of the DME produced in
China is used as LPG and less than 1% is used as diesel. The growth in the DME to diesel market is
expected to outpace DME in LPG and become the primary use of DME in the future due to DME’s
favorable physical properties. Due to the long-term growth prospects of the methanol and DME
markets in China, we plan to focus on projects in these markets.
The Chinese government has approved new standards for methanol to be used in methanol blended
with gasoline. Although these standards do not mandate the use of methanol, we expect that they
will act as a catalyst for further growth in the development of infrastructure, fuelling stations,
and vehicles in China which can accommodate higher proportion methanol blends. These recent
developments are positive for the long-term outlook for methanol demand, and with China
demonstrating the viability of methanol blending in gasoline, this should also increase the
potential for methanol blending to be adopted in other countries. We believe coal-to-natural gas
or SNG will grow in China due to China’s limited natural gas
resources. According to a 2007 report from the China Academy of
Social Sciences, it is estimated that
China’s natural gas shortage will reach 100 billion normal cubic meters by year 2020. Today coal to
SNG projects are beginning to progress and the Chinese government supports these types of coal to
energy projects. In addition to these applications, new technologies such as coal-to-glycol are
encouraged. Glycol is mainly used for making polyester and, to a lesser extent, coolant and
unsaturated polyester resins. China’s glycol demand was 6.6 million tonnes in 2008 and more than
70% of China’s glycol demand is satisfied through imports. We may develop projects that integrate
coal-to-glycol technology with our U-GAS® coal gasification systems.
United States
We believe that chemicals and fuels such as methanol, DME and SNG made from coal, biomass, and
coal/biomass blends can cleanly and economically supplement petroleum and natural gas based
products in the United States. For example, we are actively engaged with potential project partners
who have opportunities to apply the biomass capability of U-GAS® for generating carbon
neutral syngas that can be used for a variety of purposes. Concerns over greenhouse gas emissions,
such as carbon dioxide, have increased recently, particularly with respect to coal-based
consumption. For example, the U.S. House of Representatives recently approved adoption of the
American Clean Energy and Security Act of 2009, also known as the “Waxman-Markey cap-and-trade
legislation,” for the purposes of controlling and reducing emissions of greenhouse gases in the
United States by establishing an economy-wide cap on emissions of these gases in the United States
and requiring most sources of emissions to obtain emission “allowances” corresponding to their
annual emissions of such gases. We believe that coal gasification which enables the successful
utilization or sequestration of these gases and biomass gasification which could produce a carbon
neutral syngas that can be converted into chemicals, transportation fuels, and power generation
fuels could enable us to avoid incurring significant costs associated with new legislation, thereby
becoming a low cost producer.
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Business Development, Engineering and Project Management Staff
Business Development Staff
We currently employ a staff of eight experienced business development professionals in China.
Led by Don Bunnell, our President & Chief Executive Officer of Asia Pacific, and Foon Lee Leow,
Managing Director — China, the Chinese business development team is focused on the disciplined
development of gasification projects and licensing opportunities that maximize the advantages of
U-GAS® technology. Members of the team have either led or participated in the
development of multiple coal and natural gas power projects, coal gasification projects, chemical
and nuclear projects and gasification licensing transactions in China over the past two decades.
Engineering and Project Management Staff
Our operations in China have given us the opportunity to build a leading gasification
engineering team. Coal has been an important part of the Chinese economy for many decades. This
activity has spawned a large community of engineers with experience in coal gasification and
industrial process design and implementation. During the last few decades, China has developed an
entire university program dedicated to coal energy and process engineering, resulting in a ready
source of high quality, experienced engineers to work on advanced gasification projects such as
U-GAS®. Additionally, we have built an experienced project management team which
includes several members with international engineering, procurement and construction experience.
We intend to use this engineering and project management team to conceptualize, design and build
gasification projects in our target markets and to develop and protect the development of our
technology. We believe that this capability represents a key advantage for marketing to
multi-national firms throughout the project development cycle and enables pre-development
engineering work to be done with a faster cycle time and at a substantially lower cost.
Current Operations and Projects
Hai Hua Joint Venture
Joint Venture Agreement
Our first project is a joint venture with Shandong Hai Hua Coal & Chemical Company Ltd., or
Hai Hua. Through the joint venture, which we refer to as the HH Joint Venture, we developed,
constructed and are now operating a syngas production plant utilizing U-GAS® technology
in Zaozhuang City, Shandong Province, China designed to produce approximately 28,000 standard cubic
meters per hour of gross syngas. We recently received government approvals for the expansion of the
plant to a production capacity of approximately 45,000 standard cubic meters per hour. The plant is
producing and selling syngas and the various byproducts of the plant, including ash and elemental
sulphur. The plant produced initial syngas and syngas sales commenced during the three months ended
March 31, 2008. The plant was built on a site adjacent to the Hai Hua coke and methanol facility.
Hai Hua has granted rights of way for construction access and other ongoing operations of the
plant. The land for the construction of this plant was acquired from the Chinese government with
the assistance of the Shandong Xue Cheng Economic Development Zone.
For the first 20 years after the date that the plant became operational, 95% of all net
profits of the HH Joint Venture will be distributed to us. After the initial twenty years, the
profit distribution percentages will be changed, with us receiving 10% of the net profits of the HH
Joint Venture and Hai Hua receiving 90%. The contract has a term of 50 years, subject to earlier
termination if the HH Joint Venture either files for bankruptcy or becomes insolvent or if the
syngas purchase contract between the HH Joint Venture and Hai Hua (discussed in more detail below)
is terminated. Hai Hua has also agreed that the License Agreement is our sole property and that it
will not compete with us with respect to fluidized bed gasification technology for the term of the
HH Joint Venture.
We are in the process of implementing operational measures and evaluating strategies to reduce
the HH Joint Venture’s losses and improve its financial performance, including the possible
expansion of the plant to produce other products. We have tested our gasifier’s maximum capability
to have a better understanding of our gasification capacity for such an expansion. The local
government has expressed support for an expansion project and
acknowledged their willingness to allow a new local coal mine
to be used as the debt guarantee for the expansion project. They have
also indicated that discounted coal would be provided to the project. Currently we do not believe any additional equity
contributions by us would be required for an expansion, as we expect to contribute a portion of our
95% equity stake in the existing joint venture toward the expansion. The scope of the expansion is
still under evaluation and we expect to make a decision on moving forward during the first half of
calendar year 2010.
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If we are not successful in improving the HH Joint Venture’s profitability, or if our
estimated cash flow projections for these assets significantly decrease, or if Hai Hua does not
make its required payments, the plant’s assets could be impaired. As of June 30, 2009, we
determined that these assets were not impaired.
Syngas Purchase and Sale Agreement
We are also party to a purchase and sale contract with Hai Hua for syngas produced by the
plant, whereby Hai Hua will pay us an energy fee and capacity fee, as described below, based on the
syngas production. The syngas purchased by Hai Hua is subject to certain quality component
requirements set forth in the contract. Hai Hua (i) pays a monthly capacity fee, and subject to
delivery, a monthly energy fee; (ii) provides piping to the plant for the acceptance of steam and
coke oven gas from Hai Hua and for the delivery of syngas from the HH Joint Venture to Hai Hua; and
(iii) coordinates its operations and maintenance so as to ensure that it purchases as much syngas
as possible. The energy fee is a per Ncum of syngas fee calculated by 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 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 and exceptions for certain events
of force majeure. The agreement terminates 20 years from the date of the issuance of the business
license of the HH Joint Venture. Upon termination of the agreement for any reason other than the
expiration of the term, the HH Joint Venture will have the right to either produce syngas for other
customers in its current location or dismantle the plant and move the plant to another location.
The HH Joint Venture is contractually obligated to procure certain other necessary consumables
for operation of the plant, provided, the HH Joint Venture is entitled to reimbursement for these
costs through the payment of the energy fee. All byproducts of the gasification process are the
property of the HH Joint Venture and are sold to other parties. The HH Joint Venture is entitled to
provide services and sell products which it produces other than syngas to third parties, but Hai
Hua has a right of first refusal for any syngas sales.
Hai Hua is required to annually provide to the HH Joint Venture a preliminary syngas usage
plan for that year, provided, however, that in no event shall the usage plan require less than
19,000, or more than 22,000, Ncum per hour of syngas. In connection with this requirement, the HH
Joint Venture shall annually provide a generation plan to Hai Hua which sets forth the anticipated
syngas generation for that year, and it shall use its best efforts to match its generation plan
with Hai Hua’s usage plan. If the HH Joint Venture produces more syngas than the capacity that Hai
Hua is required to make capacity payments for under the contract, Hai Hua shall have a right of
first refusal to purchase such excess amount. It would be a default under the agreement if we fail
to materially perform these obligations. Due to recent worldwide reductions in methanol prices, Hai
Hua is operating at a reduced rate of syngas consumption. Hai Hua is forecasting the use of
approximately 35% to 45% of the syngas guarantee capacity for the remainder of calendar 2009.
Although the plant declared commercial operations in December 2008, Hai Hua did not begin
paying the HH Joint Venture for the energy and capacity fees until May 2009 due to differing
interpretations between Hai Hua and the HH Joint Venture regarding certain syngas quality
components requirements under the contract. During the three months ended March 31, 2009, the
plant was only operating for approximately 13% of the period. The downtime was due to an
unscheduled maintenance outage, repairs related to a power outage, a local area government
industrial inspection, and scheduled maintenance by Hai Hua. During the three months ended June
30, 2009, the plant operated for approximately 60% of the period, was available for production for
approximately 95% of the period, and met Hai Hua’s syngas demand and quality requirements for
approximately 98% of the time it was operating.
Based on these events, in April 2009, the HH Joint Venture entered into a Supplementary
Agreement, or the Supplementary Agreement, with Hai Hua, amending the terms of the purchase and
sales contract. 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 has been amended to provide more clarity as to the minor
constituents allowable in the syngas. For purposes of the contract, 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 adds a requirement for Hai Hua to pay
the HH 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 HH 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 HH
Joint Venture may be required to provide certain compensation to Hai Hua.
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In an effort to reduce operating costs, the HH Joint Venture entered into an additional
agreement with Hai Hua in May 2009 whereby the cost of operating the plant’s air separation unit,
or ASU, can be shared between the two parties based on the oxygen consumption of the respective
parties over the relevant period. The HH Joint Venture began to provide oxygen and nitrogen to Hai
Hua in September 2009. This cost sharing arrangement is expected to reduce operating costs of both
the HH Joint Venture and Hai Hua by allowing the parties to operate only one ASU instead of both
parties operating their respective ASU’s at low capacity.
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 are collectively
referred to as 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) if debt financing is not
available to the project, 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. As a result of these provisions,
we and Yima have contributed our remaining equity contributions of $29.3 million and $90.8 million,
respectively, to the Yima Joint Ventures.
In exchange for our 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.
When phase one of the project is completed, the plant is expected to have an annual capacity
of 300,000 tonnes per annum of refined methanol. The parties are planning two future phases of
coal gasification projects at this location. Phase two is expected to add additional capacity of
300,000 tonnes per annum of refined methanol or methanol equivalent products, and phase three is
expected to add additional capacity of 600,000 tonnes per annum of refined methanol or methanol
equivalent products. Refined methanol is the main feedstock for methanol protein and the approvals
to date have related to methanol protein production which has not yet been proven to be a
commercially viable technology. We intend to sell methanol as the primary product from the project
and sell methanol protein from a small scale demonstration unit in the project. We intend to
obtain the business license and related permits for both methanol and methanol protein production.
There may be delays in the project if we are unable to obtain these permits.
The joint venture companies have been established. Construction activities for site
preparation are currently underway and a Chinese design institute has been selected for the
project’s engineering work. The remaining construction and commissioning of phase one is expected
to take approximately three years. Based on the project’s current scope, the parties’ current
estimate of the total required capital of phase one of the project, which includes the downstream
facilities and infrastructure investment in support of phase two of the plant, is approximately
$250 million. The total investment for phase two is expected to be significantly lower.
Under the revised joint venture contracts, Yima has agreed to supply coal to the project at a
preferential price subject to a definitive agreement to be subsequently negotiated. Additionally,
we and the Yima Joint Ventures are continuing to investigate the possible acquisition of an
operating coal mine which would provide coal to the project.
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. 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. Yima’s loan would be repaid as soon as third-party debt financing is
available for the project. We have agreed to pledge to Yima our ownership interests in the joint
ventures as security for our obligations under any project guarantee or loan provided by Yima.
The Yima Joint Ventures will be governed by a board of directors consisting of eight
directors, two of whom will be appointed by us and six of whom will be appointed by Yima. The joint
ventures’ will also have officers that are appointed 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 the issuance of such business licenses.
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Golden Concord Joint Venture
We are a party to a joint venture with Inner Mongolia Golden Concord (Xilinhot) Energy
Investment Co., Ltd., or Golden Concord. SES—GCL (Inner Mongolia) Coal Chemical Co., Ltd., 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 Xilinguole Economic and
Technology Development Zone, Inner Mongolia Autonomous Region, China and (ii) produce and sell
methanol, DME and the various byproducts of the plant, including fly ash, steam, sulphur, hydrogen,
xenon and argon. We agreed to contribute approximately $16.3 million in cash in exchange for a 51%
ownership interest in the GC Joint Venture, and Golden Concord has agreed to contribute
approximately $16 million in cash for a 49% ownership interest in the GC Joint Venture. We
consolidate the results of the GC Joint Venture in our consolidated financial statements. As of
June 30, 2009, we have funded a total of $3.3 million of our equity contribution and Golden Concord
has funded an additional approximately $3.1 million of its equity contribution. In the near term,
we anticipate additional funding to the GC Joint Venture of approximately $0.5 million to settle
outstanding design and construction related vendor payments. We do not anticipate funding any
further equity contributions to the GC Joint Venture until acceptable financing can be obtained for
the project. We believe that, given existing market conditions, debt financing is not currently
available on terms that are economically acceptable. However, we are continuing to evaluate
alternatives for financing with potential partners. We are maintaining some of our on-site staff
and related functions and are closely monitoring the relevant credit markets. Because of these factors, we do not believe that the assets of the GC Joint Venture were impaired as of June
30, 2009. If we are unable to develop alternatives for financing with other potential partners,
the assets of the GC Joint Venture may be deemed impaired.
In December 2007, the GC Joint Venture purchased 50-year land use rights from the Chinese
government for the construction of the plant. The $0.8 million cost to purchase these land use
rights has been capitalized on our balance sheet as a long-term asset which is being amortized to
rent expense over the term of the lease.
ExxonMobil License Rights Agreement
In September 2008, we entered into a License Rights Agreement with ExxonMobil Research and
Engineering Company, or ExxonMobil, pursuant to which we have the right to obtain up to 15 licenses
to use certain proprietary technical information of ExxonMobil in the development of our projects.
In September 2008 we entered into our first license agreement with ExxonMobil. Our rights to obtain
the additional licenses expire in September 2018, subject to earlier termination in limited
circumstances specified in the License Rights Agreement.
North American Coal
In July 2008, we entered into a joint development agreement with The North American Coal
Company, or NAC, a subsidiary of NACCO Industries, Inc., through which we and NAC would conduct a
pre-feasibility study to explore the development of a lignite coal-based gasification facility
utilizing our proprietary U-GAS® technology. The location for the study was NAC’s Red
Hills Mine operations near Ackerman, Mississippi. In addition, in September 2008, we commenced
another pre-feasibility study with NAC for the development of a coal-based gasification facility at
NAC’s proposed Otter Creek Mine in North Dakota. Although the additional pre-feasibility work for
the Otter Creek project was completed during our fiscal third quarter of 2009, based on current
commodity prices and current financial market conditions in the U.S., we do not expect these
projects to be viable development options for the Company in the near term.
Expiration of Development Agreement with CONSOL Energy
In October 2008, our joint development agreement with CONSOL Energy Inc. expired according to
its terms; therefore, funding of the front-end engineering design package for the Benwood, West
Virginia synthetic gasoline project ceased. Pursuant to terms and conditions thereof, the agreement
automatically expired because a formal joint venture agreement was not entered into within six
months of the completion of the pre-feasibility studies for potential projects in Ohio,
Pennsylvania and West Virginia. We allowed the agreement to expire due to its inability to develop
any projects as a result of existing market conditions.
U.S. Department of Energy
The National Energy Technology Laboratory of the U.S. Department of Energy, or the DOE, is
co-funding a series of studies to develop industrial coal-fueled hybrid gasification units. The
effort would focus on a large industrial-sized coal-stabilized gasification unit. It is expected
that the unit would produce pressurized syngas intended for the production of about 100,000 gallons
per week of Fischer-Tropsch liquids, and produce power. We have
entered into a contract with a U.S.
engineering company to supply a conceptual design report for the gasification system portion of the
hybrid gasification system. We believe that our experience in gasification equipment similar to
that needed by the hybrid gasification system envisioned by the DOE makes us well-positioned to
supply the gasifier.
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Business Concentration
Hai Hua is currently our sole customer for syngas. In addition, our operations in China
accounted for $42.8 million of the $43.8 million of our total long-lived assets, which consisted of
construction-in-progress and property, plant and equipment, net of accumulated depreciation.
Competition
In the world gasification market, the largest providers are General Electric, Shell, Lurgi and
Siemens. Some of these companies, such as Shell and General Electric, utilize entrained flow
gasification based technologies originally derived from liquid fuels processing (i.e. refining).
These technologies require the use of high grade bituminous or sub-bituminous coals as feedstocks
which result in a higher cost of operation. The other primary gasification technology in the
market is the Lurgi fixed bed slagging and non-slagging gasifiers which are currently used in
commercial operations. Lurgi gasifiers typically use lump-size non-caking coals such as lignite
for their feed. Because these are fixed bed gasifiers, they produce a large amount of tars and
oils that need to be removed and separated before the syngas can be used which results in a more
costly syngas cleaning operation compared to U-GAS®. There are also several Chinese
companies that utilize similar technologies. Additionally, several companies are developing other
gasification technologies which are still in the research and development phase.
Suppliers
We are in the process of developing an internal capability that allows for the cost effective
and timely sourcing of equipment for our current projects in China. China has rapidly expanded its
industrial manufacturing and construction capabilities which has reduced the cost and build time of
traditional sources of supply. We have been successful in locating and contracting with a number of
key suppliers of major equipment and services.
Research and Development
We may incur research and development costs primarily related to the advancement of our
U-GAS® technology. We plan to continue certain research and development that supports
our strategies and project development activities with a goal of offering our customers the best
and most efficient clean coal solutions. The costs are included in project and technical
development expenses on our consolidated statements of operations.
Governmental and Environmental Regulation
Our operations are subject to stringent federal, state and local laws and regulations
governing the discharge of materials into the environment or otherwise relating to environmental
protection. Numerous governmental agencies, such as the U.S. Environmental Protection Agency, or
the EPA, and various Chinese authorities, issue regulations to implement and enforce such laws,
which often require difficult and costly compliance measures that carry substantial administrative,
civil and criminal penalties or may result in injunctive relief for failure to comply. These laws
and regulations may require the acquisition of a permit before operations at a facility commence,
restrict the types, quantities and concentrations of various substances that can be released into
the environment in connection with such activities, limit or prohibit construction activities on
certain lands lying within wilderness, wetlands, ecologically sensitive and other protected areas,
and impose substantial liabilities for pollution resulting from our operations. We believe that we
are in substantial compliance with current applicable environmental laws and regulations and we
have not experienced any material adverse effect from compliance with these environmental
requirements.
China
In China, the development and construction of gasification facilities is highly regulated. In
the development stage of a project, the key government approvals relate to the project’s
environmental impact assessment report, feasibility study (also known as the project application
report) and, in the case of a Sino-foreign joint venture, approval of the joint venture company’s
joint venture contract and articles of association. Approvals in China are required at the
municipal, provincial and/or central government levels depending on the total investment in the
project and subject to industry specified criteria. Due to the global economic recession, China’s
State Council issued guidance related to the pace of new project approvals including wind power,
polysilicon, steel cement, glass and coal to methanol and DME. At the same time, the government
continues to encourage newer technologies for coal to substitute natural gas, or SNG, glycol,
polypropylene, olefins and liquid fuels. Although we do not believe that China’s project approval
requirements and slowing of approvals for new coal to methanol and DME projects will invalidate any
of our existing permits, our future joint ventures will have to abide by these guidelines.
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In April, 2009, the Chinese government approved a new national standard for methanol to be
used in motor vehicle fuel to become effective on November 1, 2009. The standard includes the
technical properties, testing methods, examination procedures as well as identification, packaging, transportation, storage and safety requirements for methanol that
is to be used in motor vehicle fuel. Further, in May 2009, the Chinese government approved a new
national standard, effective December 1, 2009, for M85 methanol gasoline, which specifies, amongst
others, the technical requirements, testing methods, examination procedures, identification,
packaging, transportation, storage and safety requirements for methanol gasoline that comprises
between 84%-86% of methanol and between 14%-16% of gasoline in terms of volume and other
performance enhancing additives, for use in motor vehicles. According to the China Petroleum and
Chemical Industry Association, it is likely that in 2010 national standards for M15 — 15% percent
methanol and 85% gasoline — will be promulgated. We are monitoring this development closely.
Although these standards do not mandate the use of methanol, we expect that they will act as a
catalyst for further growth in the development of infrastructure, fuelling stations, and vehicles
which can accommodate higher proportion methanol blends. These recent developments are positive for
the long term outlook for methanol demand, and with China demonstrating the viability of methanol
blending in gasoline, this should also increase the potential for methanol blending to be adopted
in other countries. This could lead to expanded syngas application in methanol production as well
as in the licensing business of coal gasification technologies, for which we believe that we are
uniquely positioned to benefit from.
United States
In the United States, carbon dioxide may be regulated in the future by the EPA as an air
pollutant requiring us to obtain additional permits, meet additional control requirements, and
install additional environmental mitigation equipment, which could adversely affect our financial
performance. The United States Supreme Court recently decided a case in which it ruled that carbon
dioxide is an air pollutant under the Clean Air Act for the purposes of motor vehicle emissions.
The lawsuit sought to require the EPA to regulate carbon dioxide in vehicle emissions. If the EPA
regulates carbon dioxide emissions by plants such as ours, we may have to apply for additional
permits or we may be required to install carbon dioxide mitigation equipment or take other as yet
unknown steps to comply with these potential regulations. Compliance with any future regulation of
carbon dioxide, if it occurs, could be costly and may delay our development of projects in the U.S.
Even if we obtain all of our necessary permits, the air quality standards or the interpretation of
those standards may change, thus requiring additional control equipment or more stringent
permitting requirements. Such requirements could significantly increase the operating costs and
capital costs associated with any future development, expansion or modification of a plant.
There is no assurance that a change in the law or regulations will not be adopted, such as the
imposition of a carbon tax, a cap and trade program requiring us to purchase carbon credits, or
measures that would require reductions in emissions, raw materials, fuel use or production rates.
In particular, the U.S. House of Representatives recently approved adoption of the American Clean
Energy and Security Act of 2009, also known as the “Waxman-Markey cap-and-trade legislation,” for
the purposes of controlling and reducing emissions of greenhouse gases in the United States by
establishing an economy-wide cap on emissions of these gases in the United States and requiring
most sources of emissions to obtain emission “allowances” corresponding to their annual emissions
of such gases, with the number of emission allowances issued each year would decline as necessary
to meet the overall emission reduction goals.
In addition, in the United States, certain environmental permits that are required for new
facilities must be issued prior to the commencement of construction, but issuance of these permits
is subject to unpredictable delays, contests and even, in some cases, denial. Our facilities will
require permits for air emissions and wastewater discharges, as well as other authorizations, some
which must be issued before construction commences. Although we believe that there will be public
support for our projects, the permitting process is complex and time consuming and the issuance of
permits is subject to the potential for contest and other regulatory uncertainties that may result
in unpredictable delays.
Although we have been successful in obtaining the permits that are required at a given stage
with respect to the HH Joint Venture, the GC Joint Venture and the Yima Joint Ventures, any
retroactive change in policy guidelines or regulations or an opinion that the approvals that have
been obtained are inadequate, either at the federal or state level in the United States, or the
municipal, provincial or central government levels in China, could require us to obtain additional
or new permits or spend considerable resources on complying with such regulations. Other
developments, such as the enactment of more stringent environmental requirements, changes in
enforcement policies or discovery of previously unknown conditions, could require us to incur
significant capital expenditures or suspend operations.
Employees
As of June 30, 2009, we had 224 employees, including 160 employees of the HH Joint Venture.
None of our employees are represented by any collective bargaining unit. We have not experienced
any work stoppages, work slowdowns or other labor unrest. We believe that our relations with our
employees are good.
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| Item 1A. | Risk Factors |
Risks Related to Our Business
We will require substantial additional funding, and our failure to raise additional capital
necessary to support and expand our operations could reduce our ability to compete and could harm
our business.
As of June 30, 2009, we had $90.4 million of cash and cash equivalents. We funded $29.3
million to the Yima Joint Ventures in August 2009. We expect to continue to have operating losses
until our Hai Hua plant and other projects under development produce significant revenues. We plan
to use our cash for:
| • | general and administrative expenses; |
| • | working capital; |
| • | debt service related to the HH Joint Venture; |
| • | project and technical development expenses; and |
| • | 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, including potential acquisitions of
existing plants, facilities or mines. Depending on the expenditures required for our joint
ventures, feasibility and engineering design work for these or other projects and any of the above
factors, our expenditures could exceed our current cash balance.
We will need to raise additional capital through equity and debt financing for any new
projects that are developed, to support our existing projects and any possible expansions thereof
and for our general and administrative expenses from our existing operations. We are also
continuing to work with Golden Concord and other potential partners on financing alternatives for
that project. We may also need to raise additional funds sooner than expected in order to fund more
rapid expansion, cover unexpected construction costs or delays, respond to competitive pressures or
acquire complementary energy related products, services, businesses and/or technologies. In
addition, we may attempt to secure project financing in order to construct additional plant
facilities. Such financing may be used to reduce the amount of equity capital required to complete
the project.
We cannot assure you that any financing will be available to us in the future on acceptable
terms or at all. 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)
negotiate and enter into new gasification plant development contracts; (iii) expand our operations;
(iv) hire and train new employees; or (v) respond to competitive pressures or unanticipated capital
requirements.
We are in an early stage of our development and our business strategies may not be accepted in
the marketplace and may not help us to achieve profitability.
We are in an early stage of our development and our lack of operating history or meaningful
revenue precludes us from forecasting operating results based on historical results. Our proposed
business strategies described in this annual report incorporate our senior management’s current
best analysis of potential markets, opportunities and difficulties that face us. No assurance can
be given that the underlying assumptions accurately reflect current trends in our industry or our
customers’ reaction to our products and services or that such products or services will be
successful. Our business strategies may and likely will change substantially from time to time as
our senior management reassesses its opportunities and reallocates its resources, and any such
strategies may be changed or abandoned at any time. If we are unable to develop or implement these
strategies through our projects and our U-GAS® technology, we may never achieve
profitability which could impair our ability to continue as a going concern. Even if we do achieve
profitability, it may not be sustainable, and we cannot predict the level of such profitability.
Our results of operations may fluctuate.
Our operating results may fluctuate significantly as a result of a variety of factors, many of
which are outside our control. Factors that may affect our operating results include: (i) our
ability to retain new customers; (ii) the cost of coal and electricity; (iii) the success and
acceptance of U-GAS® technology; (iv) the ability to obtain financing for our projects;
(v) shortages of equipment, raw materials or fuel; (vi) approvals by various government agencies;
(vii) the inability to obtain land use rights for our projects; and (viii) general economic
conditions as well as economic conditions specific to the energy industry. In addition, our results
of operation in the near future will be largely affected by syngas production levels at our Hai Hua
plant. Under the syngas purchase and sale contract, Hai Hua is only required to pay the energy and
capacity fee payments (described in “Description of Business — Current Operations and Projects —
Hai Hua — Syngas Purchase and Sale Agreement) if the syngas produced by the plant meets certain
minimum specifications once the plant is in commercial operation. Any failure of this plant to meet these
requirements would mean that Hai Hua would not be required to make the energy and capacity fee
payments which could in turn have a material adverse effect on our results of operations.
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Limited continuing rights of prior licensees of U-GAS® technology could limit the
exclusivity of our license and materially adversely affect our business and results of operations.
Prior to granting us an exclusive license, GTI licensed U-GAS® technology to five
other entities, all of which have been terminated. We rely on our exclusive license with GTI for
U-GAS® technology to negotiate, enter into and implement contracts with partners and
customers and to further develop our business and operations. Certain predecessor licensees may
have limited continuing rights under their license agreements with GTI or may have sublicensed the
technology. Although neither we nor GTI are aware of any continued use or development of
U-GAS® technology by any of these prior licensees or sublicensees, it is possible that
the exclusivity of our license of U-GAS® technology may be restricted in certain areas
of the world. If such rights do in fact exist, GTI does not intend to provide technical or any
other support to such licensees. Despite GTI’s intentions, any such limitations on the exclusivity
of the license could have a materially adverse effect on our business and results of operations.
We face the potential inability to protect our intellectual property rights which could have a
material adverse effect on our business.
We rely on proprietary technology licensed from GTI. Our license agreement with GTI for
U-GAS® technology (described under “Business—GTI Agreements—License Agreement”) is a
critical component of our business. All of the prior patents granted around U-GAS®
technology have expired. We are improving the technology and we plan to create new technologies
around the core U-GAS® technology and have applied for new patents for these
improvements and new technologies. Proprietary rights relating to U-GAS® technology are
protected from unauthorized use by third parties only to the extent that they are covered by valid
and enforceable patents, maintained within trade secrets or maintained in confidence through
legally binding agreements. There can be no assurance that patents will be issued from any pending
or future patent applications owned by or licensed to us or that the claims allowed under any
issued patents will be sufficiently broad to protect our technology. In addition, our ability to
obtain patent protection may be affected by the terms of the License Agreement. In the absence of
patent protection, we may be vulnerable to competitors who attempt to copy our technology or gain
access to our proprietary information and technical know-how. In addition, we rely on proprietary
information and technical know-how that we seek to protect, in part, by entering into
confidentiality agreements with our collaborators, employees, and consultants. We cannot assure you
that these agreements will not be breached, that we would have adequate remedies for any breach or
that our trade secrets will not otherwise become known or be independently developed by
competitors.
Proceedings initiated by us to protect our proprietary rights could result in substantial
costs to us. We cannot assure you that our competitors will not initiate litigation to challenge
the validity of our patents, or that they will not use their resources to design comparable
products that do not infringe upon our patents. Pending or issued patents held by parties not
affiliated with us may relate to our products or technologies. We may need to acquire licenses to,
or contest the validity of, any such patents. We cannot assure you that any license required under
any such patent would be made available on acceptable terms or that we would prevail in any such
contest. We could incur substantial costs in defending ourselves in suits brought against us or in
suits in which we may assert our patent rights against others. If the outcome of any such
litigation is unfavorable to us, our business and results of operations could be materially and
adversely affected.
Continued disruption in U.S. and international economic conditions and in the commodity and
credit markets may adversely affect our business, financial condition and results of operation.
The global economy is currently experiencing a significant contraction, with an almost
unprecedented lack of availability of business and consumer credit, which has seriously impeded our
ability to obtain financing for our projects. This current decrease and any future decrease in
economic activity in the United States, 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. Any decline in economic conditions may reduce the
demand or prices for the production from our plants. Our industry partners and potential customers
and suppliers may also experience insolvencies, bankruptcies or similar events. In particular, the
market for commodities such as methanol is under significant pressure and we are unsure of how much
longer this 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 may continue to be adversely
impacted. In addition, the increased currency volatility could significantly and adversely affect
our results of operations and financial condition. Any of the above factors could also adversely
affect our ability to access credit or raise capital even if the capital markets improve.
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The U.S. government’s current plans to address the financial crises may not be effective to
stabilize the financial markets or to increase the availability of credit.
In response to the financial crises affecting the banking system and financial markets and
going concern threats to investment banks and other financial institutions, legislation was enacted
that provides the U.S. Treasury the authority to, among other things, purchase mortgage-backed and
other securities from financial institutions for the purpose of stabilizing the financial markets,
and has discussed additional legislation that could expand this power. Despite these plans, the
capital markets have continued to experience extreme levels of volatility and the credit markets
have not yet shown any significant increase in the availability of credit. There can be no
assurance what impact these plans ultimately will have on the financial markets. If the actions
taken by the U.S. Treasury are not successful in stabilizing the financial markets and increasing
the availability of credit, it could have a material adverse effect on our business, financial
condition and results of operations or the trading price of our common stock.
The termination of our license agreement with GTI or any of our joint venture agreements would
materially adversely affect our business and results of operations.
The License Agreement and our joint ventures in China are essential to us and our future
development. The License Agreement terminates on August 31, 2016, but may be terminated by GTI upon
certain events of default if not cured by us within specified time periods. In June 2009, we
agreed to pay GTI a non-refundable payment of $1.5 million toward future royalties due to GTI for
the proposed Yima project. In conjunction with this agreement, GTI agreed to waive our next
required obligation to put a U-GAS® system into operation until the earlier of a
renegotiated license agreement or December 31, 2010. We cannot assure you that we will be
successful in renegotiating the License Agreement on terms commercially acceptable to us. In
addition, after the two ten year extension periods provided under the License Agreement, which are
exercisable at our option, we cannot assure you that we will succeed in obtaining an extension of
the term of the license at a royalty rate that we believe to be reasonable or at all. Our joint
venture agreements do not terminate for many years, but may be terminated earlier due to certain
events of bankruptcy or default, or, in the case of Hai Hua, if the purchase and sale contract for
syngas is terminated. Termination of any of our joint ventures would require us to seek another
collaborative relationship in that territory. We cannot assure you that a suitable alternative
third party would be identified, and even if identified, we cannot assure you that the terms of any
new relationship would be commercially acceptable to us.
We utilize a technology with a limited commercial history. If the U-GAS® technology
fails to gain or loses market acceptance, our business will suffer.
Although GTI is one of the world’s leading energy research and development organizations with
well-equipped research facilities, it does not have marketing resources to fully commercialize its
U-GAS® technology. To date, U-GAS® technology has not been used in a large
number of commercial facilities. U-GAS® technology may not meet reliability or
efficiency targets. If U-GAS® technology is not generally accepted as a low cost energy
alternative and we are unable to effectively manage the implementation of U-GAS®
technology, our business and operating results could be seriously harmed.
We are dependent on our relationships with our strategic partners for project development.
We are dependent on our relationships with our strategic partners to accelerate our expansion,
fund our development efforts, better understand market practices and regulatory issues and more
effectively handle challenges that may arise. Our future success will depend on these relationships
and any other strategic relationships that we may enter into. We cannot assure you that we will
satisfy the conditions required to maintain these relationships under existing agreements or that
we can prevent the termination of these agreements. We also cannot assure you that we will be able
to enter into relationships with future strategic partners on acceptable terms. The termination of
any relationship with an existing strategic partner or the inability to establish additional such
relationships may limit our ability to develop our U-GAS® projects and may have a
material adverse effect on our business and financial condition.
We may never be able to reach agreements regarding the completion of future projects.
Other than the HH Joint Venture, the Yima Joint Ventures and the GC Joint Venture, all of our
other potential development opportunities are in the early stages of development and/or contract
negotiations. Our joint ventures with Hai Hua, Yima and Golden Concord, discussed under
“Business—Current Operations and Projects,” are currently our only negotiated contracts. We are in
the process of developing alternative potential partners for our Golden Concord project. We must
undertake the time consuming and costly process of fulfilling the requirements of requests for
proposals and negotiating contracts before offering our services to industrial complexes. We are
unsure of when, if ever, many of these contracts will be negotiated, executed and implemented.
There are many reasons that we may fail in our efforts to negotiate, execute and implement
contracts with our target customers to provide cost efficient energy services, including the
possibilities that: (i) our products and services will be ineffective; (ii) our products and
services will be cost prohibitive or will not achieve broad market acceptance; (iii) competitors
will offer superior products and services; or (iv) competitors will offer their products and
services at a lower cost.
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Our projects are subject to an extensive governmental approval process which could delay the
implementation of our business strategy.
Selling syngas, methanol and other commodities is highly regulated in many markets around the
world. We believe our projects will be supported by the governmental agencies in the areas where
the projects will operate because coal-based technologies, which are less burdensome on the
environment, are generally encouraged by most governments. However, in China and other developing
markets, the regulatory environment is often uncertain and can change quickly, often with
contradictory regulations or policy guidelines being issued. In some cases, government officials
have different interpretations of such regulations and policy guidelines and project approvals that
are obtained by us could later be deemed to be inadequate. Furthermore, new policy guidelines or
regulations could alter applicable requirements or require that additional levels of approval be
obtained. If we are unable to effectively complete the government approval process in China and
other markets in which we intend to operate, our business prospects and operating results could be
seriously harmed.
Joint ventures that we enter into present a number of challenges that could have a material
adverse effect on our business and results of operations.
Our HH Joint Venture represents a substantial portion of our expected revenue in the near
future. In addition, as part of our business strategy, we plan to enter into other joint ventures
or similar transactions, some of which may be material. These transactions typically involve a
number of risks and present financial, managerial and operational challenges, including the
existence of unknown potential disputes, liabilities or contingencies that arise after entering
into the joint venture related to the counterparties to such joint ventures, with whom we share
control. We could experience financial or other setbacks if transactions encounter unanticipated
problems due to challenges, including problems related to execution or integration. Any of these
risks could reduce our revenues or increase our expenses, which could adversely affect our results
of operations.
Additionally, we are now a minority owner in the Yima Joint Ventures and we will be relying on
Yima to provide the management and operational support for the project. As a result, the success
and timing of development activities on the Yima project will depend upon a number of factors that
will be largely outside of our control. Dependence on Yima, and other owners of future projects in
which we have a minority interest, could delay or prevent the realization of targeted returns on
our capital invested in these projects.
We also include the financial statements of the HH Joint Venture and the GC Joint Venture in
our consolidated financial statements. We rely on personnel in China to compile this information
and deliver it to us in a timely fashion so that the information can be incorporated into our
consolidated financial statements prior to the due dates for our annual and quarterly reports. Any
difficulties or delays in receiving this information or incorporating it into our consolidated
financial statements could impair our ability to timely file our annual and quarterly reports.
We or our joint venture partners will manage the design, procurement and construction of our
plants. If our management of these issues fails, our business and operating results could suffer.
For our HH Joint Venture and GC Joint Venture, and possibly for other projects we may work on
in the future, we have or expect to manage plant design, procurement of equipment and supervise
construction. Most of this work has been or will be subcontracted to third parties. We are and
will be coordinating and supervising these tasks. Although we believe that this is the most time
and cost effective way to build gasification plants in China and elsewhere, we bear the risk of
cost and schedule overruns and quality control. If we do not properly manage the design,
procurement and construction of our plants, our business and operating results could be seriously
harmed. Furthermore, as we continue to improve U-GAS® technology, we may decide to make
changes to our equipment that could further delay the construction of our plants.
Additionally, for certain of our projects, we will rely on joint venture partners to manage
the design, procurement and construction of the plant. The success and timing of work on these
projects by others will depend upon a number of factors that will be largely outside of our
control.
A portion of our revenues will be derived from the merchant sales of commodities and our
inability to obtain satisfactory prices could have a material adverse effect on our business.
In certain circumstances, we plan to sell methanol, DME, synthetic gasoline, SNG, ammonia,
hydrogen, nitrogen, elemental sulphur, ash and other commodities into the merchant market. These
sales may not be subject to long term offtake agreements and the price will be dictated by the then
prevailing market price. Revenues from such sales may fluctuate and may not be consistent or
predictable. In particular, the market for commodities such as methanol is currently under
significant pressure and we are unsure of how much longer this will continue. Our business and
financial condition would be materially adversely affected if we are unable to obtain satisfactory
prices for these commodities or if prospective buyers do not purchase these commodities.
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We are dependent on the availability and cost of low rank coal and coal waste and our
inability to obtain a low cost source could have an impact on our business.
The success of our projects will depend on the supply of low rank coal and coal waste. We
intend to locate projects in areas where low cost coal and coal waste is available or where it can
be moved to a project site easily without transportation issues. If we are unable to effectively
obtain a source of low cost coal or coal waste for our projects, our business and operating results
could be seriously affected.
We are dependent on key personnel who would be difficult to replace.
Our performance is substantially dependent on the continued services and on the performance of
our senior management and other key personnel. Our performance also depends on our ability to
retain and motivate our officers and key employees. The loss of the services of any of our
executive officers or other key employees could have a material adverse effect on our business,
results of operations and financial condition. Although we have employment agreements, which
include non-competition provisions, with Robert Rigdon, our President and Chief Executive Officer,
Kevin Kelly, our Controller and Chief Accounting Officer, and certain other members of senior
management, as a practical matter, those agreements will not assure the retention of our employees
and we may not be able to enforce all of the provisions in any such employment agreement, including
the non-competition provisions. Our future success also depends on our ability to identify,
attract, hire, train, retain and motivate other highly skilled technical, managerial, marketing and
customer service personnel. Competition for such personnel is intense, and we cannot assure you
that we will be able to successfully attract, integrate or retain sufficiently qualified personnel.
In addition, because substantially all of our operations are currently in China, we will be
required to retain personnel who reside in, or are willing to travel to, and who speak the language
and understand the customs of, China. Our inability to retain these types of individuals could have
a material adverse effect on our business, results of operations and financial condition.
Payment of severance benefits could strain our cash flow.
During the past six months, we have made significant workforce reductions and may continue to
do so in the future. Certain members of our senior management have employment agreements that
provide for substantial severance payments. In the event we terminate the employment of any of
these employees, or in certain cases, if such employees terminate their employment with us, such
employees will be entitled to receive certain severance and related payments. The need to pay
these severance payments could put a strain on our financial results.
Our success will depend in part on our ability to grow and diversify, which in turn will
require that we manage and control our growth effectively.
Our business strategy contemplates growth and diversification. As we add to our services, our
number of customers, and our marketing and sales efforts, operating expenses and capital
requirements will increase. Our ability to manage growth effectively will require that we continue
to expend funds to improve our operational, financial and management controls, as well as reporting
systems and procedures. In addition, we must effectively recruit new employees, and once hired,
train and manage them. From time to time, we may also have discussions with respect to potential
acquisitions, some of which may be material, in order to further grow and diversify our business.
However, acquisitions are subject to a number of risks and challenges, including difficulty of
integrating the businesses, adverse effects on our earnings, existence of unknown liabilities or
contingencies and potential disputes with counterparties. We will be unable to manage our business
effectively if we are unable to alleviate the strain on resources caused by growth in a timely and
successful manner. We cannot assure you that we will be able to manage our growth and a failure to
do so could have a material adverse effect on our business.
We face intense competition. If we cannot gain market share among our competition, we may not
earn revenues and our business may be harmed.
The business of providing energy is highly competitive. In the gasification market, large
multi-national industrial corporations that are better capitalized, such as General Electric,
Shell, ConocoPhillips and Siemens (with entrained flow technologies), and smaller Chinese firms
(with atmospheric pressure technologies) offer coal gasification equipment and services. Although
we do not directly compete with the multi-national industrial corporations, their activities in the
marketplace may negatively impact our operations and our ability to attract quality projects. In
addition, new competitors, some of whom may have extensive experience in related fields or greater
financial resources, may enter the market. Increased competition could result in a loss of
contracts and market share. Either of these results could seriously harm our business and operating
results. In addition, there are a number of gasification and conventional, non-gasification,
coal-based alternatives for producing heat and power that could compete with our technology in
specific situations. If we are unable to effectively compete with other sources of energy, our
business and operating results could be seriously harmed.
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In our areas of operation, the projects we intend to build are subject to rigorous
environmental regulations, review and approval. We cannot assure you that we will be able to obtain
such approvals, satisfy applicable requirements or maintain approvals once granted.
Our operations are subject to stringent laws and regulations governing the discharge of
materials into the environment, remediation of contaminated soil and groundwater, siting of
facilities or otherwise relating to environmental protection. Numerous governmental agencies, such
as the EPA and other state and local regulatory authorities in the United States, as well as
various Chinese authorities at the municipal, provincial or central government level, issue
regulations to implement and enforce such laws, which often require difficult and costly compliance
measures that carry substantial potential administrative, civil and criminal penalties or may
result in injunctive relief for failure to comply. These laws and regulations may require the
acquisition of a permit before construction and/or operations at a facility commence, restrict the
types, quantities and concentrations of various substances that can be released into the
environment in connection with such activities, limit or prohibit construction activities on
certain lands lying within wilderness, wetlands, ecologically sensitive and other protected areas
and impose substantial liabilities for pollution resulting from our operations. We believe that we
are in substantial compliance with current applicable environmental laws and regulations. Although
to date we have not experienced any material adverse effect from compliance with existing
environmental requirements, we cannot assure you that we will not suffer such effects in the
future.
In China, developing, constructing and operating gasification facilities is highly regulated.
In the development stage of a project, the key government approvals are the project’s environmental
impact assessment report, or EIA, feasibility study (also known as the project application report)
and, in the case of a Sino-foreign joint venture, approval of the joint venture company’s joint
venture contract and articles of association. Approvals in China are required at the municipal,
provincial and/or central government levels depending on the total size of the investment in the
project. Prior to commencing full commercial operations, we also need additional environmental
approvals to ensure that the facility will comply with standards adopted in the EIA.
Although we have been successful in obtaining the permits that are required at this stage of
our development, any retroactive change in policy guidelines or regulations or an opinion that the
approvals that have been obtained are inadequate could require us to obtain additional or new
permits or spend considerable resources on complying with such requirements or delay commencement
of construction. For example, China recently issued new project approval requirements for coal to
methanol and DME which could be applied to our existing permits. Other developments, such as the
enactment of more stringent environmental laws, regulations or policy guidelines or more rigorous
enforcement procedures, or newly discovered conditions, could require us to incur significant
capital expenditures.
We may incur substantial liabilities to comply with climate control legislation and regulatory
initiatives.
Recent scientific studies have suggested that emissions of certain gases, commonly referred to
as “greenhouse gases,” may be contributing to warming of the Earth’s atmosphere. Carbon dioxide, a
byproduct of burning fossil fuels such as coal, is an example of a greenhouse gas. Our plants using
U-GAS® technology may release a significant amount of carbon dioxide. In response to
such studies, many countries are actively considering legislation, and many states in the United
States have already taken legal measures, to reduce emissions of greenhouse gases. For example,
the U.S. House of Representatives recently approved adoption of the American Clean Energy and
Security Act of 2009, also known as the “Waxman-Markey cap-and-trade legislation,” for the purposes
of controlling and reducing emissions of greenhouse gases in the United States by establishing an
economy-wide cap on emissions of these gases in the United States and requiring most sources of
emissions to obtain emission “allowances” corresponding to their annual emissions of such gases,
with the number of emission allowances issued each year would decline as necessary to meet the
overall emission reduction goals. Although we plan to use advanced technologies to actively
utilize and sequester any greenhouse gas emission, new legislation or regulatory programs, such as
the Waxman-Markey cap-and-trade legislation, that restrict emissions of greenhouse gases in areas
in which we conduct business could have an adverse affect on our operations, costs and ability to
operate our plants.
In the United States, carbon dioxide may be regulated in the future by the EPA as an air
pollutant requiring us to obtain additional permits, meet additional control requirements, and
install additional environmental mitigation equipment, which could adversely affect our financial
performance. The United States Supreme Court recently decided a case in which it ruled that carbon
dioxide is an air pollutant under the Clean Air Act for the purposes of motor vehicle emissions.
The lawsuit sought to require the EPA to regulate carbon dioxide in vehicle emissions. If the EPA
regulates carbon dioxide emissions by plants such as ours, we may have to apply for additional
permits or we may be required to install carbon dioxide mitigation equipment or take other as yet
unknown steps to comply with these potential regulations. Compliance with any future regulation of
carbon dioxide, if it occurs, could be costly and may delay our development of projects in the U.S.
Even if we obtain all of our necessary permits, the air quality standards or the interpretation of
those standards may change, thus requiring additional control equipment or more stringent
permitting requirements. Such requirements could significantly increase the operating costs and
capital costs associated with any future development, expansion or modification of a plant.
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Our controls and procedures may fail or be circumvented.
Our management regularly reviews and updates our internal control over financial reporting,
disclosure controls and procedures, and corporate governance policies and procedures. Any system of
controls and procedures, however well designed and operated, is based in part on certain
assumptions and can provide only reasonable, not absolute, assurances that the objectives of the
system are met. Any failure or circumvention of our controls and procedures or failure to comply
with regulations related to controls and procedures could have a material adverse effect on our
business, results of operations and financial condition.
We are subject to the requirements of Section 404 of the Sarbanes-Oxley Act. If we are unable
to maintain compliance with Section 404 or if the costs related to compliance are significant, our
profitability, stock price and results of operations and financial condition could be materially
adversely affected.
We are required to comply with the provisions of Section 404 of the Sarbanes-Oxley Act of
2002. Section 404 and the related Securities and Exchange Commission’s implementing rules, require
that management disclose whether the CEO and CFO maintained internal control over financial
reporting that, among other things, provides reasonable assurance that material errors in our
external financial reports will be prevented or detected on a timely basis, and that we maintain
support for that disclosure that includes evidence of our evaluation of the design and operation of
our internal control. We are a small company with limited financial resources and our finance and
accounting staff is very limited.
Management has identified that our internal control over financial reporting was not effective
at ensuring that financial reporting risks arising from complex and non-routine transactions are
identified timely and that appropriate accounting policies for such transaction are selected and
applied. See “Item 9a. Controls and Procedures” for further discussion. We were not required to
obtain an auditor attestation of management’s report on internal control over financial reporting,
but we will be required to do so for the year ending June 30, 2010.
We cannot be certain that we will be able to successfully maintain the procedures,
certification and attestation requirements of Section 404 or that we or our auditors will not
identify material weaknesses in internal control over financial reporting in the future. If we are
unable to maintain compliance with Section 404, investors could lose confidence in our financial
statements, which in turn could harm our business and negatively impact the trading price of our
common stock.
Risks Related to Our Chinese Operations
Foreign laws may not afford us sufficient protections for our intellectual property, and we
may not be able to obtain patent protection outside of the United States.
Despite continuing international pressure on the Chinese government, intellectual property
rights protection continues to present significant challenges to foreign investors and,
increasingly, Chinese companies. Chinese commercial law is relatively undeveloped compared to the
commercial law in our other major markets and limited protection of intellectual property is
available in China as a practical matter. Although we have taken precautions in the operations of
our Chinese subsidiaries to protect our intellectual property, any local design or manufacture of
products that we undertake in China could subject us to an increased risk that unauthorized parties
will be able to copy or otherwise obtain or use our intellectual property, which could harm our
business. We may also have limited legal recourse in the event we encounter patent or trademark
infringement. Uncertainties with respect to the Chinese legal system may adversely affect the
operations of our Chinese subsidiaries. China has put in place a comprehensive system of
intellectual property laws; however, incidents of infringement are common and enforcement of rights
can, in practice, be difficult. If we are unable to manage our intellectual property rights, our
business and operating results may be seriously harmed.
Our operations in China may be adversely affected by evolving economic, political and social
conditions.
Our operations are subject to risks inherent in doing business internationally. Such risks
include the adverse effects on operations from war, international terrorism, civil disturbances,
political instability, governmental activities and deprivation of contract and property rights. In
particular, since 1978, the Chinese government has been reforming its economic and political
systems, and we expect this to continue. Although we believe that these reforms have had a positive
effect on the economic development of China and have improved our ability to do business in China,
we cannot assure you that these reforms will continue or that the Chinese government will not take
actions that impair our operations or assets in China. In addition, periods of international unrest
may impede our ability to do business in other countries and could have a material adverse effect
on our business and results of operations.
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Long term offtake agreements could be difficult to obtain and, if obtained, enforce because of
China’s underdeveloped legal system.
Historically, it has been difficult to enter into or otherwise obtain long term offtake
agreements in China. Even if we are able to enter into such agreements for syngas, power and other
commodities in the future, we may have difficulty seeking remedies under the agreements due to less certainty under China’s legal system, as compared to Western countries.
We will seek to mitigate this risk by (i) dealing with reliable partners, (ii) obtaining all
requisite government approvals, (iii) developing projects with good underlying economics, (iv)
developing modular plants that can be moved away in an extreme circumstance, (v) using local banks
to finance a majority of our project costs, and (vi) including enforceable arbitration provisions
in all project agreements. The success of our business depends in part on our ability to
successfully negotiate, implement and manage the offtake agreements. As a result, our business and
financial condition would be materially adversely affected if we are unable to enter into these
agreements, or if entered to, to mitigate the risks associated with these agreements.
Our results of operations would be negatively affected by potential currency fluctuations in
exchange rates with foreign countries.
Currency fluctuations, devaluations and exchange restrictions may adversely affect our
liquidity and results of operations. Exchange rates are influenced by political or economic
developments in China, the United States or elsewhere and by macroeconomic factors and speculative
actions. In some countries, local currencies may not be readily converted into U.S. dollars or
other hard currencies or may only be converted at government controlled rates, and, in some
countries, the transfer of hard currencies offshore has been restricted from time to time. Very
limited hedging transactions are available in China to reduce our exposure to exchange rate
fluctuations. To date, we have not entered into any hedging transactions in an effort to reduce our
exposure to foreign currency exchange risk. While we may decide to enter into hedging transactions
in the future, the availability and effectiveness of these hedges may be limited and we may not be
able to successfully hedge our exposure, if at all.
Fluctuations in exchange rates can have a material impact on our costs of construction, our
operating expenses and the realization of revenue from the sale of commodities. We cannot assure
you that we will be able to offset any such fluctuations and any failure to do so could have a
material adverse effect on our business, financial condition and results of operations. In
addition, our financial statements are expressed in U.S. dollars and will be negatively affected if
foreign currencies, such as the Chinese 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.
Chinese regulations of loans and direct investment by offshore entities to Chinese entities
may delay or prevent us from utilizing proceeds of funds to make loans or additional capital
contributions to our operations in China, which could materially and adversely affect our liquidity
and our ability to fund and expand our business.
We may make loans or additional capital contributions to our operations in China. Any loans to
our Chinese operations are subject to Chinese regulations and approvals. Such loans by us cannot
exceed statutory limits and must be registered with the Chinese State Administration of Foreign
Exchange or its local counterpart. We may also decide to finance our Chinese operations by means of
capital contributions. This capital contribution must be approved by the Chinese Ministry of
Commerce or its local counterpart. We cannot assure you that we will be able to obtain these
government registrations or approvals on a timely basis, if at all, with respect to future loans or
capital contributions by us to our Chinese operations or any of their subsidiaries. If we fail to
receive such registrations or approvals, our ability to use the proceeds of this offering and to
capitalize our Chinese operations may be negatively affected, which could adversely and materially
affect our liquidity and ability to fund and expand our business.
Risks Related to our Common Stock
We may have a contingent liability arising out of the issuance of shares by Tamborine.
In April 2005, we completed a merger with Tamborine Holdings, Inc., a shell company trading on
the Pink Sheets, or Tamborine. 6,000,000 shares of Tamborine common stock remained outstanding
after the merger and, through the merger and the related transactions, such shares became shares of
our common stock. Prior to the merger, Tamborine filed two broker-dealer diligence forms with the
Pink Sheets under Rule 15c2-11 of the Securities and Exchange Act of 1934, as amended, or the
Exchange Act, stating that 6,000,000 shares of Tamborine common stock had been sold in 2004
pursuant to an exemption from registration under Rule 504 of the Securities Act and that such
shares were freely tradable under U.S. securities laws. It is our belief that these forms were
filed to permit trading of the Tamborine common stock on the Pink Sheets.
We believe that the 6,000,000 shares that were represented to be “freely tradable” in
Tamborine’s filings, and which remained outstanding after the merger, were not in fact freely
tradable when issued. There are no available definitive records, other than Tamborine’s 15c2-11
filings, regarding the issuance of those shares or the possible exemptions from registration under
federal and state securities laws that were used to issue the shares or permit trading of the
shares on the Pink Sheets. We believe that the filings may have been based on an incorrect and
outdated interpretation of Rule 504. This means that resales of these shares on the Pink Sheets may
have been in violation of applicable securities laws because the shares were in fact restricted and
not freely tradable. Trading by subsequent holders may have been in accordance with applicable
securities laws based on other available exemptions, but we do not have any documentation to
confirm any such conclusions.
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We have taken a number of steps to mitigate these issues. In the spring of 2007, we conducted
a rescission offer to purchasers in our prior private placements and none of the purchasers elected
to accept the offer. We also filed a registration statement with the Securities and Exchange
Commission causing us to become a reporting company under the Exchange Act, which simplifies the
use of Rule 144 to trade our securities for eligible stockholders and provides more complete
information to stockholders. We also listed our common stock on The NASDAQ Stock Market to create a
more liquid market for our stockholders. Federal and state regulatory agencies could, however,
re-examine these events and commence proceedings against us, our officers and directors (former and
current) and the other individuals involved. Given the above facts, it is not possible at this time
to predict the likelihood that we will in fact have any liability arising out of these events or
the amount of such liability, if any.
Our historic stock price has been volatile and the future market price for our common stock is
likely to continue to be volatile.
The public market for our common stock has historically been very volatile. Any future market
price for our shares is likely to continue to be very volatile. Since we began trading on The
NASDAQ Stock Market on November 2, 2007, our common stock has traded at prices as low as $0.41 per
share and as high as $15.92 per share. This price volatility may make it more difficult for our
stockholders to sell shares when they want at prices that they find attractive. We do not know of
any one particular factor that has caused volatility in our stock price. However, the stock market
in general has experienced extreme price and volume fluctuations that have often been unrelated or
disproportionate to the operating performance of companies. Broad market factors and the investing
public’s negative perception of our business may reduce our stock price, regardless of our
operating performance.
If we do not meet the NASDAQ continued listing requirements, our common stock may be delisted.
As of September 8, 2009, the closing bid price of our common stock on the NASDAQ Stock Market
was $1.17, but has closed under $1.00 as recently as August 17, 2009. In accordance with NASDAQ
Marketplace Rule 4450(a)(5), if our stock price were to close below $1.00 for a period of 30
consecutive business days, NASDAQ would provide written notification that our securities may be
delisted unless the bid price of our common stock closes at $1.00 per share or more for a minimum
of 10 consecutive business days within 180 calendar days from such notification. Given the recent
market conditions, NASDAQ suspended the bid price requirement through July 31, 2009, but such
requirement was reinstated on August 3, 2009.
There can be no assurance that the market price per share of our common stock will remain
above $1.00. In addition, there can be no assurance that our common stock will not be delisted due
to a failure to meet other continued listing requirements even if the bid price of our common stock
remains in excess of $1.00 per share. Failure to maintain the listing of our common stock on the
NASDAQ Stock Market would have an adverse effect on a stockholder’s ability to sell its shares of
our common stock, which could result in the complete loss of their investment.
Our common stock is thinly traded on The NASDAQ Stock Market.
Although our common stock is traded on The NASDAQ Stock Market, the trading volume has been
low and we cannot assure investors that this will increase the trading volume or decrease the
volatility of the trading price of our common stock. We cannot assure investors that a more active
trading market will develop even if we issue more equity in the future.
The market valuation of our business may fluctuate due to factors beyond our control and the
value of the investment of our stockholders may fluctuate correspondingly.
The market valuation of energy companies, such as us, frequently fluctuate due to factors
unrelated to the past or present operating performance of such companies. Our market valuation may
fluctuate significantly in response to a number of factors, many of which are beyond our control,
including:
| • | Changes in securities analysts’ estimates of our financial performance; |
| • | Fluctuations in stock market prices and volumes, particularly among securities of energy
companies; |
| • | Changes in market valuations of similar companies; |
| • | Announcements by us or our competitors of significant contracts, new technologies,
acquisitions, commercial relationships, joint ventures or capital commitments; |
| • | Variations in our quarterly operating results; |
| • | Fluctuations in coal, oil, natural gas, methanol and ammonia prices;
|
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| • | Loss of a major customer of failure to complete significant commercial contracts; |
| • | Loss of a relationship with a partner; and |
| • | Additions or departures of key personnel. |
As a result, the value of your investment in us may fluctuate.
Investors should not look to dividends as a source of income.
In the interest of reinvesting initial profits back into our business, we do not intend to pay
cash dividends in the foreseeable future. Consequently, any economic return will initially be
derived, if at all, from appreciation in the fair market value of our stock, and not as a result of
dividend payments.
| Item 1B. | Unresolved Staff Comments |
None.
| Item 2. | Description of Property |
Our corporate office occupies approximately 10,000 square feet of leased office space in
Houston, Texas. We also lease approximately 6,000 square feet of office spaces in Shanghai, China.
The HH Joint Venture plant is constructed on approximately 375,000 square feet of land under
50-year land use rights acquired from the Chinese government. The plant buildings and related
structures occupy approximately 198,000 square feet. The GC Joint Venture has also purchased
50-year land use rights from the Chinese government for approximately 2,580,000 square feet of
land. Over time, additional properties may be required if we develop new projects and add personnel
to advance our commercial and technical efforts.
| Item 3. | 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 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
April 24, 2009, filed an amended complaint attempting to replead their securities fraud claims, and
have alleged a new claim for violation of the Uniform Commercial Code. The SES Defendants intend to
move to dismiss these claims, believe all claims alleged to be without merit, and intend to
continue to vigorously defend all claims which are allowed to proceed in the court.
| Item 4. | Submission of Matters to a Vote of Security Holders |
None.
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PART II
| Item 5. | Market for Registrant’s Common Equity and Related Stockholder Matters and Issuer Purchases
of Equity Securities |
Market Price for Common Stock and Stockholders
Our common stock was quoted on the Pink Sheets from March 29, 2005 until November 2, 2007 when
it began trading on The NASDAQ Capital Market under the symbol SYMX. On August 18, 2008, our common
stock commenced trading on The NASDAQ Global Market.
The following table sets forth the range of the high and low sale prices, as reported by the
respective exchanges, for our common stock for the periods indicated.
| Sales Price | ||||||||
| High | Low | |||||||
Year Ending June 30, 2009: |
||||||||
First Quarter |
$ | 11.05 | $ | 2.16 | ||||
Second Quarter |
$ | 4.92 | $ | 0.52 | ||||
Third Quarter |
$ | 0.80 | $ | 0.41 | ||||
Fourth Quarter |
$ | 1.69 | $ | 0.54 | ||||
Year Ending June 30, 2008: |
||||||||
First Quarter |
$ | 10.70 | $ | 5.05 | ||||
Second Quarter |
$ | 13.80 | $ | 9.35 | ||||
Third Quarter |
$ | 15.92 | $ | 6.56 | ||||
Fourth Quarter |
$ | 13.90 | $ | 7.75 | ||||
As of September 8, 2009, our authorized capital stock consisted of 100,000,000 shares of
common stock, of which 48,117,671 shares of common stock were issued and outstanding. As of such
date, there were approximately 194 holders of record of our common stock.
Dividend Policy
We have not paid dividends on our common stock and do not anticipate paying cash dividends in
the immediate future as we contemplate that our cash flows will be used for continued growth of our
operations. The payment of future dividends, if any, will be determined by our Board of Directors
in light of conditions then existing, including our earnings, financial condition, capital
requirements, and restrictions in financing agreements, business conditions and other factors.
Securities Authorized For Issuance Under Equity Compensation Plans
The following table sets forth information regarding our existing equity compensation plans as
of June 30, 2009.
| Equity Compensation Plan Information | ||||||||||||
| Number of securities to be issued upon exercise of outstanding options, warrants and rights | Weighted average exercise price of outstanding options, warrants and rights | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) | ||||||||||
| Plan Category | (a) | (b) | (c) | |||||||||
Equity compensation
plans approved by
security holders (1) |
5,099,538 | (2) | $ | 0.67 | 2,695,912 | (2) | ||||||
Equity compensation
plans not approved by
security holders |
— | — | — | |||||||||
Total as of June 30, 2009 |
5,099,538 | $ | 0.67 | 2,695,912 | ||||||||
| (1) | Consists of the Amended and Restated 2005 Incentive Plan, as amended, or the Plan. |
|
| (2) | Of the total 8,000,000 shares under the Plan, options to acquire 5,099,538 shares of commons
stock were outstanding at June 30, 2009 and 5,800 shares of restricted stock had been granted
under the Plan. The shares issued for the restricted stock grants were vested immediately upon
grant. |
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Performance Graph
The following performance graph and related information shall not be deemed “soliciting
material” or to be “filed” with the Securities and Exchange Commission, nor shall such information
be incorporated by reference into any future filing under the Securities Act of 1933 or Securities
Exchange Act of 1934, each as amended, except to the extent that we specifically incorporate it by
reference into such filing.
The following graph compares, for the period from June 13, 2007 to June 30, 2009, the
cumulative stockholder return on our common stock with the cumulative total return on the NASDAQ
Stock Market Index and a peer group selected by us. The comparison assumes that $100 was invested
on June 13, 2007: (i) in our common stock, (ii) the NASDAQ Stock Market Index and (iii) the peer
group, and further assumes all dividends were reinvested. The stock price performance reflected on
the following graph is not necessarily indicative of future stock price performance.
Comparison of Cumulative Total Return Among Synthesis Energy Systems, Inc.,
NASDAQ Stock Market Index and Peer Group
NASDAQ Stock Market Index and Peer Group
Our peer group is comprised of the following companies: Evergreen Energy, Inc., Rentech, Inc.,
Syntroleum Corp. and Alter NRG Corp. We are excluded from the peer group for purposes of the
comparative performance graph.
22
Table of Contents
| Item 6. | Selected Financial Data |
The following table presents selected consolidated financial data as of the dates and for the
periods indicated. Such consolidated financial data has been derived from our audited consolidated
financial statements for such periods. The historical results are not necessarily indicative of the
operating results to be expected in the future. The selected financial data should be read in
conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of
Operations” and the consolidated financial statements and the accompanying notes included elsewhere
in this annual report. Among other things, those financial statements include more detailed
information regarding the basis of presentation for the following consolidated financial data.
Statements of Operations Data
(in thousands, except per share amounts)
(in thousands, except per share amounts)
| November 4, 2003 | ||||||||||||||||||||||||
| Years Ended June 30, | (inception) | |||||||||||||||||||||||
| 2009 | 2008 | 2007 | 2006 | 2005 | to June 30, 2009 | |||||||||||||||||||
Revenue: |
||||||||||||||||||||||||
Product sales |
$ | 1,852 | $ | 203 | $ | — | $ | — | $ | — | $ | 2,055 | ||||||||||||
Project development fees |
250 | 125 | — | — | — | 375 | ||||||||||||||||||
Total revenue |
2,102 | 328 | — | — | — | 2,430 | ||||||||||||||||||
Costs and Expenses: |
||||||||||||||||||||||||
Costs of sales and plant operating expenses |
7,449 | 2,396 | — | — | — | 9,845 | ||||||||||||||||||
General and administrative expenses |
16,395 | 13,147 | 5,644 | 1,018 | 237 | 36,431 | ||||||||||||||||||
Project and technical development expenses |
3,546 | 5,615 | 1,136 | 1,245 | 132 | 11,682 | ||||||||||||||||||
Stock-based compensation expense |
1,869 | 6,029 | 6,640 | 3,043 | — | 17,581 | ||||||||||||||||||
Depreciation and amortization |
2,905 | 1,202 | 222 | 5 | — | 4,337 | ||||||||||||||||||
Total costs and expenses |
32,164 | 28,389 | 13,642 | 5,311 | 369 | 79,876 | ||||||||||||||||||
Operating loss |
(30,062 | ) | (28,061 | ) | (13,642 | ) | (5,311 | ) | (369 | ) | (77,446 | ) | ||||||||||||
Non-operating (income) expense: |
||||||||||||||||||||||||
Interest income |
(1,742 | ) | (397 | ) | (463 | ) | (129 | ) | (13 | ) | (2,744 | ) | ||||||||||||
Interest expense |
959 | 388 | — | — | 2 | 1,349 | ||||||||||||||||||
Net loss before minority interest |
(29,279 | ) | (28,052 | ) | (13,179 | ) | (5,182 | ) | (358 | ) | (76,051 | ) | ||||||||||||
Minority interest |
703 | 610 | 37 | — | — | 1,350 | ||||||||||||||||||
Net loss |
$ | (28,576 | ) | $ | (27,442 | ) | $ | (13,142 | ) | $ | (5,182 | ) | $ | (358 | ) | $ | (74,701 | ) | ||||||
Net loss per share: |
||||||||||||||||||||||||
Basic and diluted |
$ | (0.60 | ) | $ | (0.80 | ) | $ | (0.47 | ) | $ | (0.19 | ) | $ | (0.01 | ) | $ | (2.31 | ) | ||||||
Weighted average common shares outstanding |
||||||||||||||||||||||||
Basic and diluted |
48,017 | 34,385 | 27,852 | 27,754 | 27,180 | 32,336 | ||||||||||||||||||
Balance Sheet Data
(in thousands)
(in thousands)
| June 30, | ||||||||||||||||||||
| 2009 | 2008 | 2007 | 2006 | 2005 | ||||||||||||||||
Total working capital |
$ | 82,140 | $ | 117,646 | $ | (54 | ) | $ | 2,868 | $ | 2,622 | |||||||||
Total assets |
146,136 | 177,747 | 38,472 | 3,213 | 2,752 | |||||||||||||||
Total liabilities |
20,040 | 24,241 | 18,922 | 328 | 115 | |||||||||||||||
Total stockholders’ equity |
123,819 | 150,537 | 19,095 | 2,885 | 2,637 | |||||||||||||||
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| Item 7. | 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 annual report. Some of the information contained
in this discussion and analysis or set forth elsewhere in this annual report, including information
with respect to our plans and strategy for our business and related financing, includes
forward-looking statements that involve risks and uncertainties. You should review the “Risk
Factors” section of this annual report 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 in our development stage and therefore have had limited operations. We build, own and
operate 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 believe that we have several advantages over commercially available competing gasification
technologies, such as entrained flow and fixed bed, 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, which provide greater fuel
flexibility, and our ability to operate efficiently on a smaller scale, which enables us to
construct plants at a lower capital cost thus enabling us to be a lower cost producer of syngas for
energy products.
Our principal business activities are currently focused in China. Our first commercial scale
coal gasification plant is located in Shandong Province, China and has been in operation since the
three months ended March 31, 2008. We have additional projects in various stages of development in
Henan Province, China and in the Inner Mongolia Autonomous Region of China. During the year ended
June 30, 2009, we also investigated opportunities in Mississippi and North Dakota with North
American Coal, or NAC. However, based on current commodity prices and current financial market
conditions in the U.S., we do not expect projects in the U.S. will be a viable development option
for us in the near term.
Our gasification plants can produce synthesis gas, or syngas, a mixture of hydrogen, carbon
monoxide and other products. Depending on local market need and fuel sources, syngas can in turn be
used to produce many products including methanol, dimethyl ether, or DME, glycol, synthetic natural
gas, or SNG, ammonia, synthetic gasoline, steam, power and other byproducts (e.g., sulphur, carbon
dioxide or ash).
Our business strategy includes the following elements:
| • | Improve the profitability and cash flows of the HH Joint Venture plant. We are in the
process of implementing operational measures and evaluating strategies to reduce the HH
Joint Venture’s losses and improve its financial performance, including the possible
expansion of the plant to produce other products and through the sharing of certain costs
with Hai Hua. |
| • | Execute on projects in China currently under development. We intend to leverage our
success to date at the HH Joint Venture in our ongoing business development efforts. Our
projects under development are also expected to have a significant impact on our business
development efforts and financial results once they are completed and producing. We also
believe that our Yima Joint Venture will help to demonstrate our ability to expand into
increasingly larger projects and new product markets. |
| • | Managing further project development in China based on available capital. Based on our
current focus on developing our projects in China, we plan to use our available cash for (i)
general and administrative expenses; (ii) project and technical development expenses; (iii)
debt service related to the HH Joint Venture; and (iv) working capital and general corporate
purposes. However, we intend to minimize any further development on projects or move ahead
on any acquisitions 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. |
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| • | Leverage our proprietary technology. We intend to place increased focus on development of
licensing arrangements for our proprietary U-GAS® technology on a global basis
with a focus on China, India, the U.S. and Australia due to their large low rank coal
resources. We anticipate that we can generate revenues through 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. |
| • | Investigate acquisition opportunities. If we have the capital or financing is otherwise
available, we plan to evaluate acquisition opportunities, including existing plants,
facilities or coal mines, where we could enhance the economics with our U-GAS®
technology. |
| • | Expand our relationships with our strong strategic partners and new products. China is
presently our primary market, where our efforts have been focused primarily on facilities
producing syngas, methanol and DME. We plan to expand our relationships with our current
partners, develop new relationships with strategic partners and develop new downstream
coal-to-chemicals and coal-to-energy products. |
| • | 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. To date, we have
filed eight patent applications relating to improvements to the U-GAS®
technology. |
| • | Concentrate our efforts on opportunities where our U-GAS® technology provides
us with a clear competitive advantage. 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 fuel. |
Results of Operations
We are in our development stage and therefore have had limited operations. We have sustained
net losses of approximately $74.7 million from November 4, 2003, the date of our inception, to June
30, 2009. We have primarily financed our operations to date through private placements and two
public offerings of our common stock.
Year Ended June 30, 2009 Compared to Year Ended June 30, 2008
Revenue. Product sales increased by $1.7 million to $1.9 million for the year ended June 30,
2009 compared to $0.2 million for the year ended June 30, 2008 and were derived from the sale of
syngas and byproducts produced at the HH Joint Venture plant. The plant’s initial syngas sales
commenced during the three months ended March 31, 2008. Product sales of $1.2 million were
recognized during the three months ended June 30, 2009 as the plant operated for approximately 60%
of the period and was available for production for approximately 95% of the period. Although the
plant declared commercial operations in December 2008, Hai Hua did not begin paying the HH Joint
Venture for the energy and capacity fees until May 2009 due to differing interpretations between
Hai Hua and the HH Joint Venture regarding certain syngas quality components requirements under the
contract. During the three months ended March 31, 2009, the plant was only operating for
approximately 13% of the period due to an unscheduled maintenance outage, repairs related to a
power outage, a local area government industrial inspection, and scheduled maintenance by Hai Hua.
Project development fees were $0.3 million for the year ended June 30, 2009 and were earned
upon completion of the Otter Creek project pre-feasibility study for NAC.
Cost of sales and plant operating expenses. Cost of sales and plant operating expenses
increased by $5.0 million to $7.4 million for the year ended June 30, 2009 compared to $2.4 million
for the year ended June 30, 2008 and were comprised principally of coal consumption, electricity,
maintenance and other operating costs at the HH Joint Venture plant. The plant’s initial
operations commenced during the three months ended March 31, 2008. Costs were higher during the
year ended June 30, 2009 due to the plant operating for a longer period of time and due to costs
incurred to enable the plant to declare commercial operations status in December 2008.
General and administrative expenses. General and administrative expenses increased by $3.3
million to $16.4 million for the year ended June 30, 2009 compared to $13.1 million for the year
ended June 30, 2008. The increase was primarily due to an increase in employee compensation as a
result of increased staffing levels during the first half of fiscal 2009, professional fees, travel
and other expenses. During the second half of fiscal 2009, we made significant workforce and other
cost reductions which reduced general and administrative expenses by 24% as compared to the first
half of fiscal 2009. General and administrative expenses included our internal project development
and engineering staffing costs which have supported development of our Yima project and other
projects.
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Project and technical development expenses. Project and technical development expenses
decreased by $2.1 million to $3.5 million for the year ended June 30, 2009 compared to $5.6 million
for the year ended June 30, 2008. The 2009 period included a $1.25 million impairment loss on a
royalty deposit paid to ExxonMobil during the three months ended December 31, 2008 and a non-cash
charge to write-off the $1.25 million remaining carrying value of the reservation and use fee paid
to GTI. The GTI reservation and use fee was paid for with shares of our common stock during fiscal
2008 to reserve the facility for calendar 2008 and 2009. Based on current commodity prices and
current financial market conditions in the U.S., we have not utilized, and do not anticipate
utilizing, GTI’s facility during calendar year 2009. Excluding the effect of these charges, project
and technical development expenses decreased by approximately $4.6 million due primarily to a
reduction in U.S project and technical development activities and a $0.6 million reimbursement from
CONSOL in full settlement of its cost-sharing arrangement under our joint development agreement
with CONSOL. Project and technical development expenses incurred during the period related
principally to the Yima project, the feasibility study with NAC for the development of a coal-based
gasification facility at NAC’s proposed Otter Creek Mine in North Dakota which has been suspended
and our project with CONSOL, which will not continue due to the expiration of the joint development
agreement.
Stock-based compensation expense. Stock-based compensation expense decreased by $4.1 million
to $1.9 million for the year ended June 30, 2009 compared to $6.0 million for the year ended June
30, 2008. For the year ended June 30, 2009, stock-based compensation expense included a reduction
of approximately $4.8 million due to the reversal of previously recognized expense due to
forfeitures related to cancellations of terminated employees’ stock option awards. This decrease
was offset, in part, with incremental compensation cost related to modifications resulting from the
stock option exchange program and additional stock option awards granted during 2009.
Depreciation and amortization. Depreciation and amortization increased by $1.7 million to $2.9
million for the year ended June 30, 2009 compared to $1.2 million for the year ended June 30, 2008.
The increase was due principally to commencing depreciation of the HH Joint Venture plant during
the quarter ended March 31, 2008.
Interest income. Interest income increased by $1.3 million to $1.7 million for the year ended
June 30, 2009 compared to $0.4 million for the year ended June 30, 2008. The increase was primarily
due to interest income from higher cash balances due to investment of the proceeds from an equity
offering completed in June 2008. The yields earned on our investments have decreased significantly
over fiscal 2009 due to market conditions.
Interest expense. Interest expense increased by $0.6 million to $1.0 million for the year
ended June 30, 2009 compared to $0.4 million for the year ended June 30, 2008. Prior to the
commissioning of the HH Joint Venture plant in January 2008, the interest expense for the HH Joint
Venture loan was capitalized.
Minority interest. Minority interest increased by $0.1 million to $0.7 million for the year
ended June 30, 2009 compared to $0.6 million for the year ended June 30, 2008. The increase was due
to recognizing our joint venture partners’ interests in the operating losses of the GC Joint
Venture and the HH Joint Venture during the period.
Year Ended June 30, 2008 Compared to Year Ended June 30, 2007
Revenue. We had $0.3 million in revenue during the year ended June 30, 2008 and none during
the year ended June 30, 2007. Revenue during the year ended June 30, 2008 was comprised of $0.2
million of syngas sales produced at the HH Joint Venture plant in China and $0.1 million of revenue
from project development fees.
Cost of sales and plant operating expenses. There were $2.4 million of costs of sales and
plant operating expenses the year ended June 30, 2008 and none during the year ended June 30, 2007.
Cost of sales and plant operating expenses during the year ended June 30, 2008 were comprised
principally of coal consumption, electricity, maintenance and other operating costs at the HH Joint
Venture plant.
General and administrative expenses. General and administrative expenses increased by $7.5
million to $13.1 million for the year ended June 30, 2008 compared to $5.6 million for the year
ended June 30, 2007. The increase was primarily due to an increase in salaries and incentive wages
as a result of increased staffing levels, and to a lesser extent, an increase in travel expenses
associated with activities in China, investor relations expenses, outside consulting and accounting
fees incurred in connection with Sarbanes-Oxley Act compliance requirements and legal fees.
Project and technical development expenses. Project and technical development expenses
increased by $4.5 million to $5.6 million during the year ended June 30, 2008 compared to $1.1
million during the year ended June 30, 2007 due to expenditures related to our projects with
CONSOL, Hai Hua and Golden Concord and the amortization of $1.25 million of the GTI facility
reservation and use fee for calendar year 2008.
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Stock-based compensation expense. Stock-based compensation expense decreased by $0.6 million
to $6.0 million during the year ended June 30, 2008 compared to $6.6 million during the year ended
June 30, 2007. The decrease was due to the partial immediate vesting of options granted to certain
members of senior management in prior periods.
Depreciation and amortization. Depreciation and amortization increased by $1.0 million to
$1.2 million for the year ended June 30, 2008 compared to $0.2 million for the year ended June 30,
2007. The increase was due principally to commencing depreciation of the HH Joint Venture plant
during the quarter ended March 31, 2008.
Interest income. Interest income decreased by $0.1 million to $0.4 million during the year
ended June 30, 2008 from $0.5 million during the year ended June 30, 2007. The decrease was
primarily due to lower effective interest rates partially offset by higher interest income from
higher cash balances due to investment of the proceeds from equity offerings during the year.
Interest expense. Interest expense was $0.4 million for the year ended June 30, 2008 and none
for the year ended June 30, 2007. Prior to the HH Joint Venture plant being placed into service,
interest expense related to the HH Joint Venture’s outstanding loan with the Industrial and
Commercial Bank of China, or ICBC, was capitalized. The Hai Hua plant was commissioned in January
2008. Interest on the ICBC loan has been expensed from that point forward.
Minority interest. Minority interest increased by $0.6 million to $0.6 million for the year
ended June 30, 2008 compared to $37,000 for the year ended June 30, 2007. The increase was due to
recognizing our joint venture partners’ interests in the operating losses of the GC Joint Venture
and the HH Joint Venture during the period.
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 HH
Joint Venture.
As of June 30, 2009, we had $90.4 million in cash and cash equivalents and $82.1 million of
working capital available to us. During the year ended June 30, 2009, cash flows used in operating
activities were $26.7 million. In August 2009, we invested $29.3 million of our cash into the Yima
Joint Ventures. At current levels, we expect to incur general and administrative expenses of
approximately $10.0 to $11.0 million during fiscal 2010. We are also funding the working capital,
operating losses and debt service of the HH Joint Venture. The following summarizes the uses of
equity capital and debt with respect to our projects.
HH Joint Venture
Our first project is the HH Joint Venture, through which we and Hai Hua developed, constructed
and are now operating a syngas production plant utilizing U-GAS® technology in Zaozhuang
City, Shandong Province, China designed to produce approximately 28,000 standard cubic meters per
hour of gross syngas. The plant produces and sells syngas and the various byproducts of the plant,
including ash and elemental sulphur. Hai Hua, an independent producer of coke and coke oven gas,
owns a subsidiary engaged in methanol production. We have contributed $22.6 million in equity
capital and Hai Hua has contributed $0.5 million in equity capital. The plant produced initial
syngas and syngas sales commenced during the three months ended March 31, 2008. The plant was built
on a site adjacent to the Hai Hua coke and methanol facility. Hai Hua has granted rights of way for
construction access and other ongoing operations of the plant. The land for the construction of
this plant was acquired from the Chinese government with the assistance of the Shandong Xue Cheng
Economic Development Zone.
For the first 20 years after the date that the plant became operational, 95% of all net
profits of the HH Joint Venture will be distributed to us. After the initial twenty years, the
profit distribution percentages will be changed, with us receiving 10% of the net profits of the HH
Joint Venture and Hai Hua receiving 90%. The contract has a term of 50 years, subject to earlier
termination if the HH Joint Venture either files for bankruptcy or becomes insolvent or if the
syngas purchase contract between the HH Joint Venture and Hai Hua (discussed in more detail below)
is terminated. Hai Hua has also agreed that the License Agreement is our sole property and that it
will not compete with us with respect to fluidized bed gasification technology for the term of the
HH Joint Venture.
The HH Joint Venture plant operated at limited capacity for a significant part of fiscal 2009
and is expected to continue operating at reduced capacity due to the depressed methanol market.
The reduced capacity at the HH Joint Venture plant has contributed to the plant’s operating losses.
In addition to funding these operating losses, we are funding the working capital and debt service
for the HH Joint Venture. We are in the process of implementing operational measures, pursuing
additional customers and evaluating strategies to reduce the HH 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 HH Joint Venture plant were to be developed, we would expect to contribute
our interest in the HH Joint Venture to the project without significant additional cash investment
by us. If we are not successful in improving the HH Joint Venture’s profitability, or if management’s estimated cash flow
projections for these assets significantly decrease, or if Hai Hua does not make its required
payments, the plant’s assets could be impaired. As of June 30, 2009, we estimated projected cash
flows for the plant and based on this we have determined that these assets were not impaired.
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On March 22, 2007, the HH 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 ICBC to
complete the project financing for the HH 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. As of June 30, 2009, 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 21, 2014; |
| • | Hai Hua is the guarantor of the entire loan; |
| • | Assets of the HH Joint Venture are pledged as collateral for the loan; |
| • | Covenants include, among other things, prohibiting pre-payment without the consent of
ICBC and permiting ICBC to be involved in the review and inspection of the Hai Hua plant;
and |
| • | Loan is 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 June 30, 2009, the HH Joint Venture is in compliance with all covenants and obligations
under the Fixed Asset Loan Contract.
The plant produced initial syngas, and syngas sales commenced, during the three months ended
March 31, 2008. Due to recent worldwide reductions in methanol prices, Hai Hua is operating at a
reduced rate of syngas consumption. Hai Hua is forecasting the use of approximately 35% to 45% of
the syngas guarantee capacity for the remainder of calendar 2009.
Although the plant declared commercial operations in December 2008, Hai Hua did not begin
paying the HH Joint Venture for the energy and capacity fees until May 2009 due to differing
interpretations between Hai Hua and the HH Joint Venture regarding certain syngas quality
components requirements under the contract. During the three months ended March 31, 2009, the
plant was only operating for approximately 13% of the period. The downtime was due to an
unscheduled maintenance outage, repairs related to a power outage, a local area government
industrial inspection, and scheduled maintenance by Hai Hua. During the three months ended June
30, 2009, the plant operated for approximately 60% of the period, was available for production for
approximately 95% of the period, and met Hai Hua’s syngas demand and quality requirements for
approximately 98% of the time it was operating.
Based on these events, in April 2009, the HH Joint Venture entered into the Supplementary
Agreement with Hai Hua, amending the terms of the purchase and sales contract. 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
has been amended to provide more clarity as to the minor constituents allowable in the syngas. For
purposes of the contract, 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 adds a requirement for Hai Hua to pay the HH 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 HH 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 HH Joint Venture may be required to provide certain compensation to
Hai Hua.
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In an effort to reduce operating costs, the HH Joint Venture entered into an additional
agreement with Hai Hua in May 2009 whereby the cost of operating the plant’s air separation unit,
or ASU, can be shared between the two parties based on the oxygen consumption of the respective
parties over the relevant period. The HH Joint Venture began to provide oxygen and nitrogen to Hai Hua in September 2009. This cost sharing arrangement is expected to reduce operating costs of
both the HH Joint Venture and Hai Hua by allowing the parties to operate only one ASU instead of
both parties operating their respective ASU’s at low capacity.
Yima Joint Ventures
In August 2009, we entered into amended joint venture contracts with Yima, replacing the prior
joint venture contracts entered into in October 2008 and April 2009. The Yima Joint Ventures were
formed for each of the gasification, methanol/methanol protein production, and utility island
components of the plant. 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) if debt financing
is not available to the project, 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. As a result of these
provisions, we and Yima have contributed our remaining equity contributions of $29.3 million and
$90.8 million, respectively, to the Yima Joint Ventures. In the first fiscal quarter of 2010, we
will incur 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 our 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.
When phase one of the project is completed, the plant is expected to have an annual capacity
of 300,000 tonnes per annum of refined methanol. The parties are planning two future phases of
coal gasification projects at this location. Phase two is expected to add additional capacity of
300,000 tonnes per annum of refined methanol or methanol equivalent products, and phase three is
expected to add additional capacity of 600,000 tonnes per annum of refined methanol or methanol
equivalent products. Refined methanol is the main feedstock for methanol protein and the approvals
to date have related to methanol protein production which has not yet been proven to be a
commercially viable technology. We intend to sell methanol as the primary product from the project
and sell methanol protein from a small scale demonstration unit in the project. We intend to
obtain the business license and related permits for both methanol and methanol protein production.
There may be delays in the project if we are unable to obtain these permits.
The joint venture companies have been established. Construction activities for site
preparation are currently underway and a Chinese design institute has been selected for the
project’s engineering work. The remaining construction and commissioning of phase one is expected
to take approximately three years. Based on the project’s current scope, the parties’ current
estimate of the total required capital of phase one of the project, which includes the downstream
facilities and infrastructure investment in support of phase two of the plant, is approximately
$250 million. The total investment for phase two is expected to be significantly lower.
Under the revised joint venture contracts, Yima has agreed to supply coal to the project at a
preferential price subject to a definitive agreement to be subsequently negotiated. Additionally,
we and the Yima Joint Ventures are continuing to investigate the possible acquisition of an
operating coal mine which would provide coal to the project.
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. 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. Yima’s loan would be repaid as soon as third-party debt financing is
available for the project. We have agreed to pledge to Yima our ownership interests in the joint
ventures as security for our obligations under any project guarantee or loan provided by Yima.
The Yima Joint Ventures will be governed by a board of directors consisting of eight
directors, two of whom will be appointed by us and six of whom will be appointed by Yima. The joint
ventures’ will also have officers that are appointed 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 the issuance of such business licenses.
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Golden Concord Joint Venture
Our joint venture with Golden Concord was formed to (i) develop, construct and operate a coal
gasification, methanol and DME production plant utilizing U-GAS® technology in the
Xilinguole Economic and Technology Development Zone, Inner Mongolia Autonomous Region, China and
(ii) produce and sell methanol, DME and the various byproducts of the plant, including fly ash,
steam, sulphur, hydrogen, xenon and argon. We agreed to contribute approximately $16.3 million in
cash in exchange for a 51% ownership interest in the GC Joint Venture, and Golden Concord has
agreed to contribute approximately $16 million in cash for a 49% ownership interest in the GC Joint Venture. We consolidate the results of the GC Joint
Venture in our consolidated financial statements. As of June 30, 2009, we have funded a total of
$3.3 million of our equity contribution and Golden Concord has funded an additional approximately
$3.1 million of its equity contribution. In the near term, we anticipate additional funding to the
GC Joint Venture of approximately $0.5 million to settle outstanding design and construction
related vendor payments. We do not anticipate funding any further equity contributions to the GC
Joint Venture until acceptable financing can be obtained for the project. We believe that, given
existing market conditions, debt financing is not currently available on terms that are
economically acceptable. However, we are continuing to evaluate alternatives for financing with
potential partners. We are maintaining some of our on-site staff and related functions and are
closely monitoring the relevant credit markets. Because of these factors, we do not
believe that the assets of the GC Joint Venture were impaired as of June 30, 2009. If we are unable
to develop alternatives for financing with potential partners, the assets of the GC Joint Venture
may be deemed impaired.
In December 2007, the GC Joint Venture purchased 50-year land use rights from the Chinese
government for the construction of the plant. The $0.8 million cost to purchase these land use
rights has been capitalized on our balance sheet as a long-term asset which is being amortized to
rent expense over the term of the lease.
U.S. Department of Energy
The National Energy Technology Laboratory of the U.S. Department of Energy, or the DOE, is
co-funding a series of studies to develop industrial coal-fueled hybrid gasification units. The
effort would focus on a large industrial-sized coal-stabilized gasification unit. It is expected
that the unit would produce pressurized syngas intended for the production of about 100,000 gallons
per week of Fischer-Tropsch liquids, and produce power. We have been contracted by a U.S.
engineering company to supply a conceptual design report for the gasification system portion of the
hybrid gasification system. We believe that our experience in gasification equipment similar to
that needed by the hybrid gasification system envisioned by the DOE makes us well-positioned to
supply the gasifier.
GTI
Pursuant to the terms and conditions of the License Agreement, we were required to (i) have a
contract for the sale of a U-GAS® system with a customer in the territory covered by the
License Agreement no later than August 31, 2007 and (ii) fabricate and put into operation at least
one U-GAS® system by July 31, 2008. We have a continuing obligation to fabricate and
put into operation at least one U-GAS® system for each calendar year of the License
Agreement, beginning with the calendar year 2009. We satisfied the obligation to have a contract
for the sale of a U-GAS® system no later than August 31, 2007 and fabricate and put into
operation at least one U-GAS® system by July 31, 2008 through our HH Joint Venture
project. In June 2009, we agreed to pay GTI a non-refundable payment of $1.5 million toward future
royalties due to GTI for the proposed Yima Joint Ventures project. In conjunction with this
agreement, GTI agreed to waive our next required obligation to put a U-GAS® system into
operation until the earlier of the renegotiated License Agreement or December 31, 2010.
Additionally, we are required to disclose to GTI any improvements related to the U-GAS®
system that are developed and implemented by us and the manner of using and applying such
improvements. Failure to satisfy the requirements as to these milestones could lead to the
revocation of the license by GTI; provided, however, that GTI is required to give a twelve-month
notice of termination and we are able to cure the default and continue the License Agreement prior
to the expiration of such time period.
Outlook
We expect to continue to have negative cash flows until we can generate sufficient revenues
from the HH Joint Venture and other projects and licenses under development, including Yima, 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) working capital; (iii) debt service related to the HH Joint Venture; (iv) project 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, the global economy has experienced a significant contraction,
with an almost unprecedented lack of availability of business and consumer credit, which has
impeded our ability to obtain financing for our projects. 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 is under
significant pressure and we are unsure of how much longer this 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 believe that improving the financial performance and reducing the operating costs of the HH
Joint Venture plant are critical to improving our financial performance and we believe this can be
accomplished through the expansion of the plant and the sale of our excess oxygen capacity to Hai
Hua. Currently, we do not believe any additional equity contributions by us would be required for
an expansion, as we expect to contribute a portion of our 95% equity stake in the existing joint
venture toward the expansion. The scope of the expansion is still under evaluation and we expect to make a decision on moving forward
during the first half of calendar year 2010. The HH Joint Venture began to provide oxygen and
nitrogen to Hai Hua in September 2009 under a cost sharing arrangement that we believe will reduce
our operating costs in the near term.
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We are also actively pursuing project partners to invest in our projects’ development
including for the GC Joint Venture and for the possible expansion of the HH Joint Venture plant.
In addition, we have a variety of cooperation agreements in place with regional governments, coal
companies and downstream off-takers for potential projects in China that would utilize U-GAS as a
platform for products such as SNG, chemicals such as glycol, and fuels such as methanol and DME. As
discussed in “Business-Target Markets-China,” the Chinese government has approved new standards for
methanol to be used in methanol blended with gasoline, and although these standards do not mandate
the use of methanol, we believe this is a positive development for the long term outlook of
methanol demand. As these projects develop, they may include combinations of equity and debt
financing from third parties, selective equity investments by us, retention of a carried interest
by us, or technology licenses.
We are also considering possible scenarios for U-GAS® licensing allowing us to
build on our experience at the HH Joint Venture and our technology and engineering capability. We
believe that we may generate revenues through licensing fees and royalties without incurring all of
the capital costs required to develop a project. However, we cannot predict the timing of, or
revenues to be generated by, any such licensing opportunity.
Our
development of any further projects will be limited until worldwide capital and debt markets
improve and we have assurances that acceptable financing is available to complete the project.
Until these markets improve, our strategy will be to operate in China using our current capital
resources. Even if we do obtain the necessary capital for our projects, we could face other delays
in our projects due to additional approval requirements or due to unanticipated issues in the
commissioning of such a project. These factors could lead to, among other things, the impairment
of several of our significant assets, including our investments in the HH Joint Venture, the GC
Joint Venture and the Yima Joint Ventures, and an inability to develop any further projects.
We will 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 assure 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 shareholders. 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) negotiate and enter into new gasification plant development contracts; (iii) expand
our operations; (iv) hire and train new employees; or (v) 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.
We believe the following describes significant judgments and estimates used in the preparation
of our consolidated financial statements:
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.
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The following summarizes some of the most significant estimates and assumptions used in
evaluating if we have an impairment charge.
Undiscounted Expected Future Cash Flows. In order to estimate future cash flows, we
consider historical cash flows and changes in the market environment and other factors that may
affect future cash flows. To the extent applicable, the assumptions we use are consistent with
forecasts that we are otherwise required to make (for example, in preparing our other earnings
forecasts). The use of this method involves inherent uncertainty. We use our best estimates in
making these evaluations and consider various factors, including forward price curves for energy,
fuel costs, and operating costs. However, actual future market prices and project costs could vary
from the assumptions used in our estimates, and the impact of such variations could be material.
Fair Value. Generally, fair value will be determined using valuation techniques such
as the present value of expected future cash flows. We will also discount the estimated future cash
flows associated with the asset using a single interest rate representative of the risk involved
with such an investment. We may also consider prices of similar assets, consult with brokers, or
employ other valuation techniques. We use our best estimates in making these evaluations; however,
actual future market prices and project costs could vary from the assumptions used in our
estimates, and the impact of such variations could be material.
The evaluation and measurement of impairments for 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.
HH Joint Venture Plant Impairment Analysis
We assessed the HH Joint Venture’s plant assets for impairment as of June 30, 2009 due to its
operating at reduced capacity and its operating losses to date. Significant assumptions we made in
determination of the projected cash flows for purposes of this impairment analysis included the
plant’s availability for production of compliant syngas and expected cost reductions from the
sharing of our ASU costs with Hai Hua. Variances in these assumptions could result in projected
cash flows that do not support the assets’ carrying values. For example, if the plant’s
availability to produce compliant syngas was reduced from 100% to 80%, or if the assumed cost
reductions from the ASU cost sharing arrangement with Hai Hua were 50% less, the projected cash
flows would have been less than the assets’ carrying values resulting in an impairment of the
assets.
The HH Joint Venture plant operated at limited capacity for a significant part of fiscal 2009
and is expected to continue operating at reduced capacity due to the depressed methanol market.
The reduced capacity at the HH Joint Venture plant has contributed to the plant’s operating losses.
In addition to funding these operating losses, we are funding the working capital and debt service
for the HH Joint Venture. We are in the process of implementing operational measures, pursuing
additional customers and evaluating strategies to reduce the HH 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 HH Joint Venture plant were to be developed, we would expect to contribute
our interest in the HH Joint Venture to the project without significant additional cash investment
by us. If we are not successful in improving the HH Joint Venture’s profitability, or if
management’s estimated cash flow projections for these assets significantly decrease, or if Hai Hua
does not make its required payments, the plant’s assets could be impaired. As of June 30, 2009, 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 HH 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 HH Joint Venture’s net assets was considered to be greater during the first
20 years of the HH Joint Venture’s life, which coincides with our 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.
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Off Balance Sheet Arrangements
In January 2008, we entered into a 63 month lease agreement, with a 60 month optional renewal,
for our corporate offices in Houston, Texas. The lease commenced on March 27, 2008 with rental
payments of $20,308 per month for the first year and escalating thereafter annually. Our
obligations under the lease are secured by a letter of credit for $328,900, which is payable to the
landlord in the event of any uncured default by us under the lease. The letter of credit remains in
place until the third anniversary of the lease, but is reduced to $219,266 after the second
anniversary of the lease. We have a certificate of deposit pledged as collateral for this letter
of credit and pay an annual fee of 1.0% on this letter of credit.
Contractual Obligations
Our material contractual obligations at June 30, 2009 were as follows (in thousands):
| Less than 1 | 1–3 | 4–5 | After 5 | |||||||||||||||||
| Contractual Obligations | Total | Year | Years | Years | Years | |||||||||||||||
Long-term bank loan, including interest |
$ | 12,877 | $ | 2,859 | $ | 5,310 | $ | 4,708 | $ | — | ||||||||||
Operating leases |
1,132 | 352 | 515 | 265 | — | |||||||||||||||
Total |
$ | 14,009 | $ | 3,211 | $ | 5,825 | $ | 4,973 | $ | — | ||||||||||
Recently Issued Accounting Standards
Effective July 1, 2008, we adopted Statement of Financial Accounting Standards, or SFAS No.
157, “Fair Value Measurements” as it relates to financial assets and financial liabilities. In
February 2008, the Financial Accounting Standards Board, or FASB, issued Staff Position No. FAS
157-2, “Effective Date of FASB Statement No. 157,” which defers the effective date of SFAS No. 157
by a year for nonfinancial assets and liabilities, except for items that are recognized or
disclosed at fair value in the financial statements on a recurring basis (at least annually).
Accordingly, we deferred the adoption of SFAS No. 157 for its nonfinancial assets and nonfinancial
liabilities until July 1, 2009. The adoption of SFAS No. 157 is not currently expected to have a
material impact on our financial statements.
In December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated
Financial Statements — an amendment to ARB No. 51.” SFAS No. 160 requires non-controlling interests
(previously referred to as minority interests) to be reported as a component of equity.
Additionally, we will be required to present net income attributable to us and the minority
partners’ ownership interest separately on the consolidated statements of operations. SFAS No. 160
is effective for financial statements issued for fiscal years beginning on or after December 15,
2008 and we adopted this standard as of July 1, 2009. SFAS No. 160 will be applied prospectively to
all non-controlling interests, including any that arose before the effective date.
In May 2008, the FASB issued SFAS No. 165, “Subsequent Events”. SFAS No. 165 establishes
general standards of accounting and disclosure of events that occur after the balance sheet date
but before the financial statements are issued. SFAS No. 165 sets forth (1) the period after the
balance sheet date during which management should evaluate events or transactions that may occur
for potential recognition or disclosure in the financial statements, (2) the circumstances under
which an entity should recognize events or transactions occurring after the balance sheet date and
(3) the disclosures an entity should make about such events or transactions. SFAS No. 165 is
applicable to both interim and annual financial statements ending after June 15, 2009. Management
has performed a review of our subsequent events and transactions through September 21, 2009, which
is the date the financial statements are issued.
In April 2009, FASB issued FSP No. FAS 107-1 and APB 28-1, “Interim Disclosures about Fair
Value of Financial Instruments.” FSP No. FAS 107-1 and APB 28-1 amends FASB Statement No. 107,
“Disclosures about Fair Value of Financial Instruments,” as well as APB Opinion No. 28, “Interim
Financial Reporting,” to require disclosures about fair value of financial instruments in interim
financial statements as well as in annual financial statements. FSP No. FAS 107-1 and APB 28-1 is
effective for interim periods ending after June 15, 2009, therefore we will adopt this standard as
of September 30, 2009. Adoption of this standard is expected to result in the addition of interim
disclosures of the fair values of our financial instruments, which previously had only been
required annually. Adoption of this standard is expected to have no effect on our financial
statements.
In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)”.
SFAS No. 167 changes the consolidation analysis for variable interest entities. SFAS No. 167 is
effective for fiscal years ending after November 15, 2009. We are currently evaluating this
standard but have not yet determined the impact that the adoption of SFAS No. 167 will have on our
financial statements.
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In June 2009, the FASB issued SFAS No. 168, “The ‘FASB Accounting Standards Codification’ and
the Hierarchy of Generally Accepted Accounting Principles”. SFAS No. 168 establishes the FASB
Accounting Standards Codification (“Codification”), which officially commenced July 1, 2009, to
become the source of authoritative U.S. GAAP recognized by the FASB to be applied by
nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commision
under authority of federal securities laws are also sources of authoritative U.S. GAAP for registrants. The subsequent
issuances of new standards will be in the form of Accounting Standards Updates that will be
included in the Codification. Generally, the Codification is not expected to change U.S. GAAP.
All other accounting literature excluded from the Codification will be considered
nonauthoritative. SFAS No. 168 is effective for financial statements issued for interim and annual
periods ending after September 15, 2009, therefore we will adopt SFAS No. 168 for our quarter
ending September 30, 2009. We are currently evaluating the effect on our financial statement
disclosures as all future references to authoritative accounting literature will be referenced in
accordance with the Codification.
| Item 7A. | Quantitative and Qualitative Disclosure About Market Risk |
Qualitative disclosure about market risk
We are exposed to certain 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 sales and in order to mitigate coal price fluctuation risk for future projects, we expect
to enter into long-term contracts for coal supply or to acquire coal assets. For the sale of
commodities from our projects, fixed price contracts will not be available to us in certain
markets, such as China, which will require us to purchase some portion of our coal and other
consumable needs, or sell some portion of our production, into spot commodity markets or under
short term supply agreements. Hedging transactions may be available to reduce our exposure to these
commodity price risks, but availability may be limited and we may not be able to successfully hedge
this exposure at all. To date, we have not entered into any hedging transactions.
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 June 30, 2009, Hai Hua is our only customer for syngas sales and as such,
we are exposed to significant customer credit risk due to this concentration. Unless we are able to
retain our customers, or secure new customers if we lose one or more of our significant customers,
our revenue and results of operations would be adversely affected.
34
Table of Contents
| Item 8. | Financial Statements and Supplementary Data |
INDEX TO FINANCIAL STATEMENTS
| 36 | ||||
| 38 | ||||
| 39 | ||||
| 40 | ||||
| 41 | ||||
| 42 |
35
Table of Contents
Report of Independent Registered Public Accounting Firm
To Board of Directors and Stockholders
Synthesis Energy Systems, Inc.
Synthesis Energy Systems, Inc.
In our opinion, the accompanying consolidated balance sheet and the related consolidated
statements of operations, of stockholders’ equity, and of cash flows present fairly, in all
material respects, the financial position of Synthesis Energy Systems Inc. and its subsidiaries (a
development stage enterprise) (the “Company”) at June 30, 2009, and the results of their operations
and their cash flows for the year then ended and for the period from July 1, 2008 to June 30, 2009
in conformity with accounting principles generally accepted in the United States of America. We
did not audit the cumulative totals of the Company for the period from November 4, 2003 (date of
inception) to June 30, 2008, which totals reflect a deficit of $46,124,646 accumulated during the
development stage. Those cumulative totals were audited by other auditors whose report, dated
September 12, 2008, expressed an unqualified opinion on the cumulative amounts. These financial statements are the responsibility of the Company’s management; our responsibility
is to express an opinion on these financial statements based on our audit. We conducted our audit
of these statements in accordance with the standards of the Public Company Accounting Oversight
Board (United States), which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We believe that our audit
provides a reasonable basis for our opinion.
As explained in Note 13, the Company entered into amended joint venture contracts with Yima in
August 2009.
/s/ PricewaterhouseCoopers LLP
September 21, 2009
September 21, 2009
36
Table of Contents
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Synthesis Energy Systems, Inc.:
Synthesis Energy Systems, Inc.:
We have audited the accompanying consolidated balance sheet of Synthesis Energy Systems, Inc.
and subsidiaries (a development stage enterprise) (the Company) as of June 30, 2008, and the
related consolidated statements of operations, stockholders’ equity, and cash flows for each of the
years in the two-year period ended June 30, 2008 and for the period from November 4, 2003
(inception) to June 30, 2008. These consolidated financial statements are the responsibility of
the Company’s management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Synthesis Energy Systems, Inc. and subsidiaries as of
June 30, 2008, and the results of their operations and their cash flows for each of the years in
the two-year period ended June 30, 2008 and for the period from November 4, 2003 (inception) to
June 30, 2008, in conformity with U.S. generally accepted accounting principles.
/s/ KPMG LLP
Houston, Texas
September 12, 2008
September 12, 2008
37
Table of Contents
SYNTHESIS ENERGY SYSTEMS, INC.
(A Development Stage Enterprise)
(A Development Stage Enterprise)
Consolidated Balance Sheets
(In thousands)
| June 30, | June 30, | |||||||
| 2009 | 2008 | |||||||
ASSETS |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 90,420 | $ | 127,872 | ||||
Accounts receivable |
1,333 | 169 | ||||||
Prepaid expenses and other currents assets |
689 | 2,162 | ||||||
Inventory |
780 | 516 | ||||||
Total current assets |
93,222 | 130,719 | ||||||
Construction-in-progress |
6,078 | 2,408 | ||||||
Property, plant and equipment, net |
37,713 | 37,570 | ||||||
Intangible asset, net |
1,386 | 1,546 | ||||||
Other long-term assets |
7,737 | 5,504 | ||||||
Total assets |
$ | 146,136 | $ | 177,747 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY |
||||||||
Current liabilities: |
||||||||
Accrued expenses and accounts payable |
$ | 8,828 | $ | 10,828 | ||||
Current portion of long-term bank loan |
2,254 | 2,245 | ||||||
Total current liabilities |
11,082 | 13,073 | ||||||
Long-term bank loan |
8,958 | 11,168 | ||||||
Total liabilities |
20,040 | 24,241 | ||||||
Commitments and contingencies (note 10) |
||||||||
Minority interest |
2,277 | 2,969 | ||||||
Stockholders’ Equity: |
||||||||
Common stock, $0.01 par value: 100,000 shares authorized:48,118
and 48,011 shares issued and outstanding, respectively |
481 | 480 | ||||||
Additional paid-in capital |
196,441 | 194,617 | ||||||
Deficit accumulated during development stage |
(74,701 | ) | (46,125 | ) | ||||
Accumulated other comprehensive income |
1,598 | 1,565 | ||||||
Total stockholders’ equity |
123,819 | 150,537 | ||||||
Total liabilities and stockholders’ equity |
$ | 146,136 | $ | 177,747 | ||||
See accompanying notes to the consolidated financial statements.
38
Table of Contents
SYNTHESIS ENERGY SYSTEMS, INC.
(A Development Stage Enterprise)
(A Development Stage Enterprise)
Consolidated Statements of Operations
(In thousands, except per share amounts)
| November 4, 2003 | ||||||||||||||||
| Year Ended June 30, | (inception) | |||||||||||||||
| 2009 | 2008 | 2007 | to June 30, 2009 | |||||||||||||
Revenue: |
||||||||||||||||
Product sales |
$ | 1,852 | $ | 203 | $ | — | $ | 2,055 | ||||||||
Product development fees |
250 | 125 | — | 375 | ||||||||||||
Total revenue |
2,102 | 328 | — | 2,430 | ||||||||||||
Costs and Expenses: |
||||||||||||||||
Costs of sales and plant operating expenses |
7,449 | 2,396 | — | 9,845 | ||||||||||||
General and administrative expenses |
16,395 | 13,147 | 5,644 | 36,431 | ||||||||||||
Project and technical development expenses |
3,546 | 5,615 | 1,136 | 11,682 | ||||||||||||
Stock-based compensation expense |
1,869 | 6,029 | 6,640 | 17,581 | ||||||||||||
Depreciation and amortization |
2,905 | 1,202 | 222 | 4,337 | ||||||||||||
Total costs and expenses |
32,164 | 28,389 | 13,642 | 79,876 | ||||||||||||
Operating loss |
(30,062 | ) | (28,061 | ) | ( 13,642 | ) | (77,446 | ) | ||||||||
Non-operating (income) expense: |
||||||||||||||||
Interest income |
(1,742 | ) | (397 | ) | (463 | ) | (2,744 | ) | ||||||||
Interest expense |
959 | 388 | — | 1,349 | ||||||||||||
Net loss before minority interest |
(29,279 | ) | (28,052 | ) | (13,179 | ) | (76,051 | ) | ||||||||
Minority interest |
703 | 610 | 37 | 1,350 | ||||||||||||
Net loss |
$ | (28,576 | ) | $ | (27,442 | ) | $ | (13,142 | ) | $ | (74,701 | ) | ||||
Net loss per share: |
||||||||||||||||
Basic and diluted |
$ | (0.60 | ) | $ | (0.80 | ) | $ | (0.47 | ) | $ | (2.31 | ) | ||||
Weighted average common shares outstanding |
||||||||||||||||
Basic and diluted |
48,017 | 34,385 | 27,852 | 32,336 | ||||||||||||
See accompanying notes to the consolidated financial statements.
39
Table of Contents
SYNTHESIS ENERGY SYSTEMS, INC.
(A Development Stage Enterprise)
(A Development Stage Enterprise)
Condensed Consolidated Statement of Stockholders’ Equity
(In thousands)
| Deficit | ||||||||||||||||||||||||
| Accumulated | ||||||||||||||||||||||||
| Common Stock | During the | Other | ||||||||||||||||||||||
| Common | Additional | Development | Comprehensive | |||||||||||||||||||||
| Shares | Stock | Paid-in Capital | Stage | Income | 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 | ) | — | (13,142 | ) | ||||||||||||||||
Currency translation
adjustment |
— | — | — | — | 175 | 175 | ||||||||||||||||||
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 UCF
option exercise |
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 | 19,095 | |||||||||||||||||
Net loss |
— | — | — | (27,442 | ) | — | (27,442 | ) | ||||||||||||||||
Currency translation
adjustment |
— | — | — | — | 1,390 | 1,390 | ||||||||||||||||||
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 | 150,537 | |||||||||||||||||
Net loss |
— | — | — | ( 28,576 | ) | — | (28,576 | ) | ||||||||||||||||
Currency translation
adjustment |
— | — | — | — | 33 | 33 | ||||||||||||||||||
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 | $ | 123,819 | ||||||||||||
See accompanying notes to the consolidated financial statements.
40
Table of Contents
SYNTHESIS ENERGY SYSTEMS, INC.
(A Development Stage Enterprise)
(A Development Stage Enterprise)
Consolidated Statements of Cash Flows
(In thousands)
| November 4, 2003 | ||||||||||||||||
| Year Ended June 30, | (inception) | |||||||||||||||
| 2009 | 2008 | 2007 | to June 30, 2009 | |||||||||||||
Cash flows from operating activities: |
||||||||||||||||
Net loss |
$ | (28,576 | ) | $ | (27,442 | ) | $ | (13,142 | ) | $ | (74,701 | ) | ||||
Adjustments to reconcile net loss to net cash
used in operating activities: |
||||||||||||||||
Stock-based compensation expense |
1,869 | 6,029 | 6,640 | 17,581 | ||||||||||||
Depreciation of property, plant and equipment |
2,671 | 986 | 58 | 3,720 | ||||||||||||
Amortization of intangible and other assets |
234 | 215 | 165 | 617 | ||||||||||||
Loss on disposal of property, plant and equipment |
37 | 93 | 2 | 132 | ||||||||||||
Impairment loss on ExxonMobil license royalty |
1,250 | — | — | 1,250 | ||||||||||||
Minority Interest |
(703 | ) | (610 | ) | (37 | ) | (1,350 | ) | ||||||||
Changes in operating assets and liabilities: |
||||||||||||||||
Accounts receivable |
(1,164 | ) | (168 | ) | — | (1,332 | ) | |||||||||
Prepaid expenses and other current assets |
1,578 | (462 | ) | (398 | ) | 676 | ||||||||||
Inventory |
(261 | ) | (516 | ) | — | (777 | ) | |||||||||
Other long-term assets |
(103 | ) | (31 | ) | — | (134 | ) | |||||||||
Accrued expenses and payables |
(3,581 | ) | 3,065 | 1,680 | 1,490 | |||||||||||
Net cash used in operating activities |
(26,749 | ) | (18,841 | ) | (5,032 | ) | (52,828 | ) | ||||||||
Cash flows from investing activities: |
||||||||||||||||
Purchase of marketable securities |
(45,000 | ) | — | — | (45,000 | ) | ||||||||||
Redemption of marketable securities |
45,000 | — | — | 45,000 | ||||||||||||
Capital expenditures |
(4,155 | ) | (22,268 | ) | (10,707 | ) | (37,155 | ) | ||||||||
Equity investment in Yima Joint Ventures |
(1,500 | ) | — | — | (1,500 | ) | ||||||||||
GTI license royalty — Yima Joint Ventures |
(1,500 | ) | — | — | (1,500 | ) | ||||||||||
ExxonMobil license royalty |
(1,250 | ) | — | — | (1,250 | ) | ||||||||||
Proceeds from sale of fixed assets |
7 | — | — | 7 | ||||||||||||
Loan proceeds transferred from (to) restricted cash |
— | 11,101 | (11,101 | ) | — | |||||||||||
Restricted cash — redemptions from (investments
in) long-term certificates of deposit |
150 | (579 | ) | — | (429 | ) | ||||||||||
Amendment to GTI license rights |
— | (500 | ) | (500 | ) | |||||||||||
Purchase of land use rights |
— | (833 | ) | (887 | ) | (1,720 | ) | |||||||||
Receipt of Chinese governmental grant |
— | 556 | — | 556 | ||||||||||||
Project prepayments |
(102 | ) | (895 | ) | (2,213 | ) | (3,210 | ) | ||||||||
Net cash used in investing activities |
(8,350 | ) | (12,918 | ) | (25,408 | ) | (46,701 | ) | ||||||||
Cash flows from financing activities: |
||||||||||||||||
Proceeds (costs) from issuance of common stock,
net |
(107 | ) | 148,556 | 21,160 | 174,982 | |||||||||||
Proceeds from long-term bank loan |
— | — | 12,080 | 12,080 | ||||||||||||
Payments on long-term bank loan |
(2,253 | ) | — | — | (2,253 | ) | ||||||||||
Prepaid interest |
— | — | (276 | ) | (276 | ) | ||||||||||
Deferred financing costs |
— | — | (143 | ) | (143 | ) | ||||||||||
Contribution from minority interest partner |
— | 3,124 | 492 | 3,616 | ||||||||||||
Proceeds from exercise of stock options, net |
63 | 565 | — | 628 | ||||||||||||
Loans from shareholders |
— | — | — | 11 | ||||||||||||
Net cash provided by (used in) financing
activities |
(2,297 | ) | 152,245 | 33,313 | 188,645 | |||||||||||
Net increase (decrease) in cash |
(37,396 | ) | 120,486 | 2,873 | 89,116 | |||||||||||
Cash and cash equivalents, beginning of period |
127,872 | 6,202 | 3,154 | — | ||||||||||||
Effect of exchange rates on cash |
(56 | ) | 1,184 | 175 | 1,304 | |||||||||||
Cash and cash equivalents, end of period |
$ | 90,420 | $ | 127,872 | $ | 6,202 | $ | 90,420 | ||||||||
See accompanying notes to the consolidated financial statements.
41
Table of Contents
SYNTHESIS ENERGY SYSTEMS, INC.
(A Development Stage Enterprise)
(A Development Stage Enterprise)
Notes to the Consolidated Financial Statements
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 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 products, such as syngas, transportation fuels and ammonia. The Company’s
headquarters are located in Houston, Texas.
(b) Basis of presentation and principles of consolidation
The accompanying consolidated financial statements are in U.S. dollars. As a result of
consolidation, we record minority interest on our balance sheet to reflect minority stockholders’
proportionate share of the equity in such subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation. 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) Use of estimates
The preparation of financial statements in conformity with generally accepted accounting
principles requires management to make estimates that affect the amounts reported in the financial
statements and accompanying notes. Management considers many factors in selecting appropriate
operational and financial accounting policies and controls, and in developing the assumptions that
are used in the preparation of these financial statements. Management must apply significant
judgment in this process. Among the factors, but not fully inclusive of all factors that may be
considered by management in these processes are: the range of accounting policies permitted by
accounting principles generally accepted in the United States of America; management’s
understanding of the Company’s business for both historical results and expected future results;
the extent to which operational controls exist that provide high degrees of assurance that all
desired information to assist in the estimation is available and reliable or whether there is
greater uncertainty in the information that is available upon which to base the estimate;
expectations of the future performance of the economy, both domestically, and globally, within
various areas that serve the Company’s principal customers and suppliers of goods and services;
expected rates of exchange, sensitivity and volatility associated with the assumptions used in
developing estimates; and whether historical trends are expected to be representative of future
trends. The estimation process often times may yield a range of potentially reasonable estimates of
the ultimate future outcomes and management must select an amount that lies within that range of
reasonable estimates based upon the quantity, quality and risks associated with the variability
that might be expected from the future outcome and the factors considered in developing the
estimate. Management attempts to use its business and financial accounting judgment in selecting
the most appropriate estimate, however, actual amounts could and will differ from those estimates.
(d) Cash and cash equivalents
The Company considers all highly liquid investments with original maturities of three months
or less to be cash equivalents. Cash equivalents are carried at cost, which approximates market
value.
(e) Supplemental disclosures of cash flow information (in thousands):
| November 4, 2003 | ||||||||||||||||
| Years Ended June 30, | (inception) | |||||||||||||||
| 2009 | 2008 | 2007 | to June 30, 2009 | |||||||||||||
Interest paid |
$ | 950 | $ | 918 | $ | 440 | $ | 2,311 | ||||||||
Interest received |
1,746 | 416 | 413 | 2,717 | ||||||||||||
Non-cash transactions: |
||||||||||||||||
Accrued construction-in-progress |
1,556 | 367 | — | 1,556 | ||||||||||||
Stock issued to employees |
— | 19 | 33 | 52 | ||||||||||||
Fair value of stock issued to GTI |
— | 2,500 | 1,376 | 3,876 | ||||||||||||
Conversion of debt to equity |
— | — | — | 11 | ||||||||||||
42
Table of Contents
| (f) | Restricted cash |
Restricted cash consists of cash and cash equivalents that are to be used for a specific
purpose. At June 30, 2009 restricted cash was comprised of a $100,000 certificate of deposit which
collateralizes a company credit card program with a financial institution.
Additionally, included in other long-term assets was a $328,900 investment in a long-term
certificate of deposit pledged as collateral for a letter of credit issued in connection with the
lease agreement for the Company’s corporate office in Houston, Texas.
(g) Inventories
Inventories are stated at the lower of cost or market. Cost is determined using the average
cost method. Inventories include raw materials (primarily coal which is processed into syngas) and
replacement parts for plant equipment which are expensed to cost of goods sold when consumed.
(h) Fair value of financial instruments
The carrying value of the Company’s financial instruments including cash and cash equivalents,
accounts receivable and accounts payable approximates their fair values.
(i) Construction-in-progress
Construction-in-progress consists primarily of coal gasification plants under construction
(engineering and construction costs, cost of machinery and equipment, installation costs and any
interest charges arising from borrowings used to finance these assets during the period of
construction or installation).
(j) Property, plant, and equipment
Property, plant and equipment are stated at cost, net of accumulated depreciation.
Depreciation is computed by using the straight-line method at rates based on the estimated useful
lives of the various classes of property, plant and equipment. Estimates of useful lives are based
upon a variety of factors including durability of the asset, the amount of usage that is expected
from the asset, the rate of technological change and the Company’s business plans for the asset.
Leasehold improvements are amortized on a straight-line basis over the shorter of the lease term or
estimated useful life of the asset. Should the Company change its plans with respect to the use and
productivity of property, plant and equipment, it may require a change in the useful life of the
asset or incur a charge to reflect the difference between the carrying value of the asset and the
proceeds expected to be realized upon the asset’s sale or abandonment. Expenditures for
maintenance and repairs are expensed as incurred and significant major improvements are capitalized
and depreciated over the estimated useful life of the asset.
Effective as of October 1, 2008, the Company changed its estimated useful life of the
production equipment at the HH Joint Venture’s syngas production plant from a period of 15 years to
20 years. Based upon information obtained from operating the plant during its commissioning phase
in 2008, the Company now believes that a 20-year life reflects a better estimate of these assets’
useful life. The plant’s production equipment was designed and constructed to operate for at least
20 years with normal maintenance. This period is consistent with the Company’s business plans,
expected use and productivity of these assets. The carrying value of the affected assets was
approximately $29.0 million as of June 30, 2009. Depreciation of these assets commenced during the
three months ended March 31, 2008. This change in estimated useful life was applied prospectively.
The effect of the change in estimated useful life from 15 to 20 years resulted in a decrease to
depreciation expense and operating loss of approximately $0.4 million for the year ended June 30,
2009.
(k) Intangible assets
The Company accounts for intangible assets in accordance with SFAS No. 142, “Goodwill and
Other Intangible Assets.” This statement requires that goodwill and other intangible assets with
indefinite useful lives not be amortized but instead tested annually for impairment, or immediately
if conditions indicate that impairment could exist. Intangible assets with definite useful lives
are amortized over their estimated useful lives and reviewed for impairment in accordance with SFAS
No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets.” Substantial judgment is
necessary in the determination as to whether an event or circumstance has occurred that may trigger
an impairment analysis and in the determination of the related cash flows from the asset.
Estimating cash flows related to long-lived assets is a difficult and subjective process that
applies historical experience and future business expectations to revenues and related operating
costs of assets. Should impairment appear to be necessary, subjective judgment must be applied to
estimate the fair value of the asset, for which there may be no ready market, which oftentimes
results in the use of discounted cash flow analysis and judgmental selection of discount rates to
be used in the discounting process. If the Company determines an asset has been impaired based on
the projected undiscounted cash flows of the related asset or the business unit, and if the cash
flow analysis indicates that the carrying amount of an asset exceeds related undiscounted cash
flows, the carrying value is reduced to the estimated fair value of the asset or the present value of the expected
future cash flows. There were no events or circumstances that triggered an impairment analysis of
intangible assets during the year ended June 30, 2009.
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(l) Impairment of long-lived assets
The Company evaluates its 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 the Company believes an impairment condition may have occurred, it is 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. The Company evaluates its 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 the Company determines that the undiscounted cash flows from an asset to be
held and used are less than the carrying amount of the asset, or if the Company has classified an
asset as held for sale, it estimates fair value to determine the amount of any impairment charge.
Due to the worldwide business climate, the recessionary trends that have significantly
affected commodity prices including methanol, and the HH Joint Venture plant’s operating losses
during the year ended June 30, 2009, the Company believed an impairment analysis of the plant’s
assets was warranted. As of June 30, 2009, the Company has determined that these assets were not
impaired.
(m) Income taxes
The Company accounts for income taxes using the asset and liability method. Deferred tax
liabilities and assets are determined based on temporary differences between the basis of assets
and liabilities for income tax and financial reporting purposes. The deferred tax assets and
liabilities are classified according to the financial statement classification of the assets and
liabilities generating the differences. Valuation allowances are established when necessary based
upon the judgment of management to reduce deferred tax assets to the amount expected to be realized
and could be necessary based upon estimates of future profitability and expenditure levels over
specific time horizons in particular tax jurisdictions.
The Company adopted the provisions of Financial Accounting Standards Board Interpretation No.
48, Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109 (“FIN
48”). FIN 48 addresses the determination of whether tax benefits claimed, or expected to be
claimed, on a tax return should be recorded in the financial statements. The Company recognizes
the tax benefit from an uncertain tax position when, based on technical merits, it is more likely
than not the position will be sustained on examination by the taxing authorities.
(n) Debt issuance costs
The Company capitalizes direct costs incurred to issue debt or modify debt agreements. These
costs, which are included in other long-term assets on the Company’s consolidated balance sheet,
are deferred and amortized to interest expense over the term of the related debt agreement.
(o) Land use rights
Prepayments for land use rights are amortized on a straight-line basis over the term of the
leases and are included in long-term assets on the Company’s consolidated balance sheet.
(p) Foreign currency translation
Assets and liabilities of the Company’s foreign subsidiaries are translated into U.S. dollars
at period-end rates of exchange, and income and expenses are translated at average exchange rates
during the period. For the years ended June 30, 2009, 2008 and 2007, adjustments resulting from
translating financial statements into U.S. dollars are reported as cumulative translation
adjustments and are shown as a separate component of other comprehensive income. Gains and losses
from foreign currency transactions are included in the calculation of net loss.
(q) Revenue recognition
Revenue from sales of products, which includes the capacity fee and energy fee earned at the
HH 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.
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The Company recognizes revenue from engineering consulting and joint development activities
when contract deliverables are completed. Proceeds received prior to the completion of contractual
obligations are deferred with revenue recognized upon the Company’s completion of its obligations
specified under the contract.
(r) Stock-based compensation
The Company has a stock-based compensation plan under which stock-based awards have been
granted to employees and non-employees. Stock-based compensation is accounted for in accordance
with SFAS No. 123 (Revised) “Share-Based Payment” (“SFAS 123(R)”). The Company establishes fair
values for its equity awards to determine its cost and recognizes the related expense over the
appropriate vesting period. The Company recognizes expense for stock options and restricted stock
awards. For stock-based awards vesting based on service period, the value of the portion of the
award that is ultimately expected to vest is recognized as expense over the requisite service
period on a straight-line basis for each separately vesting portion of the award as if the award
was, in substance, multiple awards. See Note 12 for additional information related to stock-based
compensation expense.
(s) Accounting for Variable Interest Entities (VIEs) and financial statement consolidation
criteria
The Company’s primary VIEs are entered into as part of joint ventures. The Company
consolidates all VIEs where the Company is the primary beneficiary. This determination is made at
the inception of the Company’s involvement with the VIE. 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, receives a majority of the entity’s
potential for expected residual returns, or both.
The Company does not consolidate VIE’s where the Company is not the primary beneficiary. The
Company accounts for unconsolidated VIEs under the equity method of accounting and includes the
Company’s net investments on the Company’s consolidated balance sheets. The Company’s equity
interest in the net income from unconsolidated VIEs is recorded in non- operating (income) expense
on a net basis on the Company’s consolidated statements of operations.
Note 2 — Recently Issued Accounting Standards
Effective July 1, 2008, the Company adopted Statement of Financial Accounting Standards
(“SFAS”) No. 157, “Fair Value Measurements” (“SFAS No. 157”) as it relates to financial assets and
financial liabilities. In February 2008, the Financial Accounting Standards Board (“FASB”) issued
Staff Position No. FAS 157-2, “Effective Date of FASB Statement No. 157,” which defers the
effective date of SFAS No. 157 by a year for nonfinancial assets and liabilities, except for items
that are recognized or disclosed at fair value in the financial statements on a recurring basis (at
least annually). Accordingly, the Company deferred the adoption of SFAS No. 157 for its
nonfinancial assets and nonfinancial liabilities until July 1, 2009. The adoption of SFAS No. 157
is not currently expected to have a material impact on the Company’s financial statements.
As defined in SFAS No. 157, fair value is the price that would be received to sell an asset or
paid to transfer a liability in an orderly transaction between market participants at the
measurement date (“exit price”). SFAS No. 157 requires disclosure that establishes a framework for
measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 requires
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). |
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As required by SFAS No. 157, 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
defined by the provisions of SFAS No. 157, as of June 30, 2009 (in thousands):
| Level 1 | Level 2 | Level 3 | Total | |||||||||||||
Assets: |
||||||||||||||||
Certificates of Deposit |
$ | — | $ | 679 | (1) | $ | — | $ | 679 | |||||||
Money Market Funds |
— | 89,035 | (2) | — | 89,035 | |||||||||||
| (1) | Amount comprised of $0.3 million included in cash and cash equivalents, $0.1 million
included in other current assets, and $0.3 million included in other long-term assets on the
Company’s consolidated balance sheet. |
|
| (2) | Amount included in cash and cash equivalents on the Company’s consolidated balance sheet. |
Effective July 1, 2008, the Company adopted SFAS No. 159, “The Fair Value Option for Financial
Assets and Financial Liabilities — including an amendment of FASB Statement No. 115.” SFAS No. 159
permits entities to choose to measure most financial instruments and certain other items at fair
value on an instrument-by-instrument basis (the fair value option) with changes in fair value
reported in earnings. The adoption of SFAS No. 159 did not have a material impact on the Company’s
financial statements.
In December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated
Financial Statements — an amendment to ARB No. 51.” SFAS No. 160 requires non-controlling interests
(previously referred to as minority interests) to be reported as a component of equity.
Additionally, the Company will be required to present net income attributable to the Company and
the minority partners’ ownership interest separately on the consolidated statements of operations.
SFAS No. 160 is effective for financial statements issued for fiscal years beginning on or after
December 15, 2008 and the Company adopted this standard as of July 1, 2009. SFAS No. 160 will be
applied prospectively to all non-controlling interests, including any that arose before the
effective date.
In May 2008, the FASB issued SFAS No. 165, “Subsequent Events”. SFAS No. 165 establishes
general standards of accounting and disclosure of events that occur after the balance sheet date
but before the financial statements are issued. SFAS No. 165 sets forth (1) the period after the
balance sheet date during which management should evaluate events or transactions that may occur
for potential recognition or disclosure in the financial statements, (2) the circumstances under
which an entity should recognize events or transactions occurring after the balance sheet date and
(3) the disclosures an entity should make about such events or transactions. SFAS No. 165 is
applicable to both interim and annual financial statements ending after June 15, 2009. Management
has performed a review of the Company’s subsequent events and transactions through September 21,
2009, which is the date the financial statements are issued.
In April 2009, FASB issued FSP No. FAS 107-1 and APB 28-1, “Interim Disclosures about Fair
Value of Financial Instruments.” FSP No. FAS 107-1 and APB 28-1 amends FASB Statement No. 107,
“Disclosures about Fair Value of Financial Instruments,” as well as APB Opinion No. 28, “Interim
Financial Reporting,” to require disclosures about fair value of financial instruments in interim
financial statements as well as in annual financial statements. FSP No. FAS 107-1 and APB 28-1 is
effective for interim periods ending after June 15, 2009, therefore the Company will adopt this
standard as of September 30, 2009. Adoption of this standard is expected to result in the addition
of interim disclosures of the fair values of the Company’s financial instruments, which previously
had only been required annually. Adoption of this standard is expected to have no effect on the
Company’s financial statements.
In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)”.
SFAS No. 167 changes the consolidation analysis for variable interest entities. SFAS No. 167 is
effective for fiscal years ending after November 15, 2009. The Company is currently evaluating this
standard but has not yet determined the impact that the adoption of SFAS No. 167 will have on its
financial statements.
In June 2009, the FASB issued SFAS No. 168, “The ‘FASB Accounting Standards Codification’ and
the Hierarchy of Generally Accepted Accounting Principles”. SFAS No. 168 establishes the FASB
Accounting Standards Codification (“Codification”), which officially commenced July 1, 2009, to
become the source of authoritative U.S. GAAP recognized by the FASB to be applied by
nongovernmental entities. Rules and interpretive releases of the Securities and Exchange
Commission (‘SEC”) under authority of federal securities laws are also sources of authoritative
U.S. GAAP for SEC registrants. The subsequent issuances of new standards will be in the form of
Accounting Standards Updates that will be included in the Codification. Generally, the
Codification is not expected to change U.S. GAAP. All other accounting literature excluded from
the Codification will be considered nonauthoritative. SFAS No. 168 is effective for financial
statements issued for interim and annual periods ending after September 15, 2009, therefore the
Company will adopt SFAS No. 168 for its quarter ending September 30, 2009. The Company is
currently evaluating the effect on its financial statement disclosures as all future references to
authoritative accounting literature will be referenced in accordance with the Codification.
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Note 3 — Current Projects
Hai Hua 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. (“Hai Hua”) which established Synthesis Energy Systems
(Zaozhuang) New Gas Company Ltd. (the “HH Joint Venture”), a joint venture company that has the
primary purposes of (i) developing, constructing and operating a synthesis gas (“syngas”)
production plant utilizing the U-GAS® technology in Zaozhuang City, Shandong Province,
China and (ii) producing and selling syngas and the various byproducts of the plant, including ash
and elemental sulphur. The Company owns 95% of the HH Joint Venture and Hai Hua owns the remaining
5%. The Company has contributed approximately $22.6 million in equity capital and Hai Hua has
contributed approximately $0.5 million in equity capital. For the first 20 years after the
commercial operation date of the plant, 95% of all net profits and losses of the HH Joint Venture
will be distributed to the Company and 5% to Hai Hua. After the initial 20 years, the profit
distribution percentages will be changed, with the Company receiving 10% of the net profits/losses
of the HH Joint Venture and Hai Hua receiving 90%. The Company consolidates the results of the HH
Joint Venture in its consolidated financial statements.
Syngas Purchase and Sale Agreement
The HH Joint Venture is also party to a purchase and sales contract with Hai Hua for syngas
produced by the plant, whereby Hai Hua will pay the HH 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 (“Ncum”) of syngas calculated by 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 recent worldwide reductions in methanol prices, Hai Hua is operating at a reduced
rate of syngas consumption. Hai Hua is forecasting the use of approximately 35% to 45% of the
syngas guarantee capacity for the remainder of calendar 2009.
Although the plant declared commercial operations in December 2008, Hai Hua did not begin
paying the HH Joint Venture for the energy and capacity fees until May 2009 due to differing
interpretations between Hai Hua and the HH Joint Venture regarding certain syngas quality
components requirements under the contract. During the three months ended March 31, 2009, the
plant was only operating for approximately 13% of the period. The downtime was due to an
unscheduled maintenance outage, repairs related to a power outage, a local area government
industrial inspection, and scheduled maintenance by Hai Hua. During the three months ended June
30, 2009, the plant operated for approximately 60% of the period, was available for production for
approximately 95% of the period, and met Hai Hua’s syngas demand and quality requirements for
approximately 98% of the time it was operating.
Based on these events, in April 2009, the HH Joint Venture entered into the Supplementary
Agreement with Hai Hua, amending the terms of the purchase and sales contract. 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
has been amended to provide more clarity as to the minor constituents allowable in the syngas. For
purposes of the contract, 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 adds a requirement for Hai Hua to pay the HH 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 HH 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 HH Joint Venture may be required to provide certain compensation to
Hai Hua.
In an effort to reduce operating costs, the HH Joint Venture entered into an additional
agreement with Hai Hua in May 2009 whereby the cost of operating the plant’s air separation unit,
or ASU, can be shared between the two parties based on the oxygen consumption of the respective parties over the relevant period. The HH Joint Venture began to
provide oxygen and nitrogen to Hai Hua in September 2009. This cost sharing arrangement is
expected to reduce operating costs of both the HH Joint Venture and Hai Hua by allowing the parties
to operate only one ASU instead of both parties operating their respective ASU’s at low capacity.
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The Company is in the process of implementing operational measures, pursuing additional syngas
customers and evaluating strategies to reduce the HH Joint Venture’s losses and improve its
financial performance including the possible expansion of the plant to produce other products. If
the Company is not successful in improving the HH Joint Venture’s profitability, or if management’s
estimated cash flow projections for these assets significantly decrease, or if Hai Hua does not
make its required payments, the plant’s assets could be impaired. As of June 30, 2009, the Company
estimated projected cash flows for the plant and based on this has determined that these assets
were not impaired.
Loan agreement
On March 22, 2007, the HH 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 HH 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. As of June 30, 2009, 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 21, 2014; |
| • | Hai Hua is the guarantor of the entire loan; |
| • | Assets of the HH 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 Hai Hua plant;
and |
| • | Loan is 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 June 30, 2009, the HH 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 Company 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) if debt
financing is not available to the project, 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.
As a result of these provisions, the Company and Yima have contributed our remaining equity
contributions of $29.3 million and $90.8 million, respectively, to the Yima Joint Ventures. In the
first fiscal quarter of 2010, the Company will incur 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 its 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.
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When phase one of the project is completed, the plant is expected to have an annual capacity
of 300,000 tonnes per annum of refined methanol. The parties are planning two future phases of
coal gasification projects at this location. Phase two is expected to add additional capacity of 300,000 tonnes per annum of refined methanol or methanol equivalent
products, and phase three is expected to add additional capacity of 600,000 tonnes per annum of
refined methanol or methanol equivalent products. Refined methanol is the main feedstock for
methanol protein and the approvals to date have related to methanol protein production which has
not yet been proven to be a commercially viable technology. The Company intends to sell methanol as
the primary product from the project and sell methanol protein from a small scale demonstration
unit in the project. The Company intends to obtain the business license and related permits for
both methanol and methanol protein production. There may be delays in the project if it is unable
to obtain these permits.
The joint venture companies have been established. Construction activities for site
preparation are currently underway and a Chinese design institute has been selected for the
project’s engineering work. The remaining construction and commissioning of phase one is expected
to take approximately three years. Based on the project’s current scope, the parties’ current
estimate of the total required capital of phase one of the project, which includes the downstream
facilities and infrastructure investment in support of phase two of the plant, is approximately
$250 million. The total investment for phase two is expected to be significantly lower.
Under the revised joint venture contracts, Yima has agreed to supply coal to the project at a
preferential price subject to a definitive agreement to be subsequently negotiated. Additionally,
the Yima Joint Ventures and the Company are continuing to investigate the possible acquisition of
an operating coal mine which would provide coal to the project.
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. Yima’s loan
would be repaid as soon as third-party debt financing is available for the project.
The Yima Joint Ventures will be governed by a board of directors consisting of eight
directors, two of whom will be appointed by the Company and six of whom will be appointed by Yima.
The joint ventures’ will also have officers that are appointed 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.
Golden Concord Joint Venture
Joint venture contract
The Company is party to a joint venture with Inner Mongolia Golden Concord (Xilinhot) Energy
Investment Co., Ltd. (“Golden Concord”). SES—GCL (Inner Mongolia) Coal Chemical Co., Ltd. (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 Xilinguole Economic and
Technology Development Zone, Inner Mongolia Autonomous Region, China and (ii) produce and sell
methanol, DME and the various byproducts of the plant, including fly ash, steam, sulphur, hydrogen,
xenon and argon. The Company agreed to contribute approximately $16.3 million in cash in exchange
for a 51% ownership interest in the GC Joint Venture, and Golden Concord has agreed to contribute
approximately $16.0 million in cash for a 49% ownership interest in the GC Joint Venture. The
contributions of each of the Company and Golden Concord are payable in installments, with the first
20% due within 90 days of the date of the issuance of the GC Joint Venture’s business license. As
of June 30, 2009, the Company had funded a total of approximately $3.3 million of its equity
contribution and Golden Concord had funded approximately $3.1 million of its equity contribution.
Within the next three months the Company anticipates additional funding to the GC Joint Venture of
approximately $0.8 million to settle outstanding construction related vendor payments. Other than
this amount, the Company does not anticipate funding any further equity contributions to the GC
Joint Venture until acceptable financing can be obtained for the project. The Company consolidates
the results of the GC Joint Venture in its consolidated financial statements. The Company believes
that, given existing market conditions, debt financing is not currently available on terms that are
economically acceptable. However, the Company is continuing to evaluate alternatives for financing
with potential partners. The Company is maintaining some of its on-site staff and related
functions and is closely monitoring the relevant credit markets. Because of these factors, the
Company does not believe that the assets of the GC Joint Venture were impaired as of June 30, 2009.
If the Company is unable to develop alternatives for financing with other potential partners, the
assets of the GC Joint Venture may be deemed impaired.
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Purchase of land use rights
In December 2007, the GC Joint Venture purchased 50-year land use rights from the Chinese
government for the construction of the plant. The $0.8 million cost to purchase these land use
rights has been capitalized on the Company’s balance sheet as a long-term asset which is being
amortized to rent expense over the term of the lease.
ExxonMobil License Rights Agreement
In September 2008, the Company entered into a License Rights Agreement with ExxonMobil
Research and Engineering Company, or ExxonMobil, pursuant to which the Company has the right to
obtain up to 15 licenses to use certain proprietary technical information of ExxonMobil in the
development of the Company’s projects. In September 2008, the Company entered into its first
license agreement with ExxonMobil. The Company’s rights to obtain the additional licenses expire in
September 2018, subject to earlier termination in limited circumstances specified in the License
Rights Agreement. During the three months ended June 30, 2009, the Company wrote-off a $1.25
million royalty paid in September 2008 related to the first license agreement as an impairment loss
due to the slowdown of project development in the U.S.
North American Coal
In July 2008, the Company entered into a joint development agreement with The North American
Coal Company, or NAC, a subsidiary of NACCO Industries, Inc., through which the Company and NAC
would conduct a pre-feasibility study to explore the development of a lignite coal-based
gasification facility utilizing our proprietary U-GAS® technology. The location for the
study was NAC’s Red Hills Mine operations near Ackerman, Mississippi. In addition, in September
2008, the Company commenced another pre-feasibility study with NAC for the development of a
coal-based gasification facility at NAC’s proposed Otter Creek Mine in North Dakota. Although the
additional pre-feasibility work for the Otter Creek project was completed during our fiscal third
quarter, based on current commodity prices and current financial market conditions in the U.S., the
Company does not expect this project will be a viable development option for the Company in the
near term. Project development fees of $0.3 million were earned during 2009 upon completion of the
Otter Creek project pre-feasibility study for NAC.
CONSOL Energy
In October 2008, the Company’s joint development agreement with CONSOL Energy Inc. expired
according to its terms; therefore, funding of the front-end engineering design package for the
Benwood, West Virginia synthetic gasoline project will cease. Pursuant to terms and conditions
thereof, the agreement automatically expired because a formal joint venture agreement was not
entered into within six months of the completion of the pre-feasibility studies for potential
projects in Ohio, Pennsylvania and West Virginia. The Company allowed the agreement to expire due
to its inability to develop any projects as a result of existing market conditions. During the
three months ended December 31, 2008, CONSOL Energy Inc. paid the Company $0.6 million in full
settlement of its cost-sharing arrangement under the joint development agreement. This receipt of
$0.6 million was reported as a reduction to project and technical development expenses.
Note 4 — Risks and Uncertainties
As a development stage company with limited operations, the Company’s financial performance
and future rate of growth are substantially dependent on its ability to: (1) increase the operating
rates of the HH Joint Venture plant and provide Hai Hua with syngas that meets contract
specifications on a sustainable basis, (2) construct and place in operation the Yima project, and
(3) successfully renegotiate the license agreement with GTI before December 31, 2010.
The Company’s revenues are almost exclusively from its HH Joint Venture plant and Hai Hua is
currently the Company’s sole customer for syngas. During the fiscal year ended June 30, 2009, the
plant was operating at limited capacity due to the depressed methanol prices and reduced demand
from Hai Hua. Although the plant declared commercial operation in December 2008, there were
differing interpretations regarding certain quality component requirements under the syngas
purchase and sale agreement until the Company signed a supplementary agreement in April 2009 which
clarified these terms. Under the supplementary agreement, as discussed in Note 3, non-compliant
syngas may impact the amount of revenue to be received under the contract.
The Company’s operations are concentrated in China accounting for $42.8 million of the
Company’s $43.8 million of long-lived assets, which consisted of construction-in-progress and
property, plant and equipment, net of accumulated depreciation. This concentration will continue
with its Yima project.
Because the Company’s revenues are generated primarily from a customer who has similar
economic interests, and is concentrated in one geographic region, its operations are also
susceptible to market volatility resulting from economic, cyclical, or other factors related to the energy industry in China. Further decreases in methanol prices or changes in
industry perceptions about the future of coal, methanol or syngas could materially decrease the
demand for the Company’s production, adversely affecting its financial position and results of
operations.
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The Company expects to continue to have operating losses until the HH Joint Venture plant and
other projects under development produce significant revenues. The Company believes that it will
be able to reduce operating losses at the HH Joint Venture through the expansion of the plant and
the sales of excess oxygen to Hai Hua, each as discussed under Note 3 — Current Projects — Hai Hua
Joint Venture.”
The Company’s cash balance, after the funding of its commitments related to the Yima project
will be used for:
| • | general and administrative expenses; |
| • | working capital; |
| • | debt service related to the HH Joint Venture; |
| • | project and technical development expenses, and |
| • | general corporate purposes. |
We
believe our available cash is sufficient to meet our cash
requirements for the foreseeable future, however, the facts described
above create uncertainty. The Company’s cash flow forecasts contain certain estimates and assumptions including
sustainable production of compliant syngas, production and sale of byproducts, cost sharing with
Hai Hua as well as operating and general and administrative expenses, which could prove to be
inaccurate. A material deviation from one or more of these estimates or assumptions could result
in a material impact to the Company’s results of operations and cash flows and there can be no
assurance that the Company will be able to raise additional debt or equity capital.
Note 5 — Property, Plant and Equipment
Property, plant and equipment consisted of the following (in thousands):
| Estimated | June 30, | |||||||||
| useful lives | 2009 | 2008 | ||||||||
Furniture and fixtures |
2 to 3 years | $ | 384 | $ | 407 | |||||
Production equipment |
20 years | 31,295 | 30,091 | |||||||
Building — plant and office |
30 years | 7,736 | 7,009 | |||||||
Leasehold improvements |
Lease term | 131 | 122 | |||||||
Computer hardware |
3 years | 397 | 230 | |||||||
Computer software |
3 years | 897 | 254 | |||||||
Office equipment |
3 years | 240 | 357 | |||||||
Motor vehicle |
5 years | 211 | 145 | |||||||
| $ | 41,291 | $ | 38,615 | |||||||
Less: Accumulated depreciation |
(3,578 | ) | (1,045 | ) | ||||||
Net carrying value |
$ | 37,713 | $ | 37,570 | ||||||
Depreciation expense for the years ended June 30, 2009, 2008, 2007 was $2.7 million, $1.0
million, and $0.1 million, respectively.
Note 6 — Detail of Selected Balance Sheet Accounts
Inventory consisted of the following (in thousands):
| June 30, | ||||||||
| 2009 | 2008 | |||||||
Raw materials |
$ | 192 | $ | 150 | ||||
Parts and assemblies |
588 | 366 | ||||||
| $ | 780 | $ | 516 | |||||
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Construction-in-progress related to the following projects (in thousands):
| June 30, | ||||||||
| 2009 | 2008 | |||||||
Golden Concord JV |
$ | 4,821 | $ | 2,189 | ||||
HH Joint Venture |
1,257 | 48 | ||||||
Other |
— | 171 | ||||||
| $ | 6,078 | $ | 2,408 | |||||
Other long-term assets consisted of the following (in thousands):
| June 30, | ||||||||
| 2009 | 2008 | |||||||
Equity investment in Yima Joint Ventures |
$ | 1,500 | $ | — | ||||
GTI license royalty — Yima Joint Ventures (a) |
1,500 | — | ||||||
Land use rights |
1,448 | 1,473 | ||||||
Project prepayments |
666 | 1,221 | ||||||
GTI reservation and use fee |
— | 1,250 | ||||||
GTI license royalty, net — HH Joint Venture |
744 | 756 | ||||||
Restricted cash |
329 | 579 | ||||||
Value added tax receivable — HH Joint Venture |
1,368 | — | ||||||
Other |
182 | 225 | ||||||
| $ | 7,737 | $ | 5,504 | |||||
| (a) | In June 2009, the Company agreed to pay GTI a non-refundable payment of $1.5 million
toward future royalties due to GTI for the Yima Joint Ventures’ project. |
Accrued expenses and other payables consisted of the following (in thousands):
| As of June 30, | ||||||||
| 2009 | 2008 | |||||||
Construction and equipment costs |
$ | 4,880 | $ | 4,500 | ||||
Accounts payable — trade |
562 | 2,287 | ||||||
Accrued payroll, vacation and bonuses |
1,025 | 1,558 | ||||||
Technical consulting, engineering and design services |
423 | 1,586 | ||||||
Book overdrafts |
1,003 | — | ||||||
Other |
935 | 897 | ||||||
| $ | 8,828 | $ | 10,828 | |||||
Note 7 — Intangible assets
The Company has a license with the Gas Technology Institute (“GTI”), a U.S. based non-profit
research organization, for U-GAS® technology.
Pursuant to the Amended and Restated License Agreement dated as of August 31, 2006, as amended
on June 14, 2007, between the Company and GTI, or the License Agreement, the Company has an
exclusive worldwide license to manufacture, make, use and sell both U-GAS® coal
gasification systems and coal and biomass mixture gasification systems that utilize coal and
biomass blends having feedstock materials containing no less than 60% coal and no more than 40%
biomass. The License Agreement also grants the Company a non-exclusive license to manufacture,
make, use and sell worldwide biomass gasification systems and coal and biomass mixture gasification
systems that utilize coal and biomass blends having feedstock materials containing up to 60% coal
and no less than 40% biomass. The License Agreement has a term of ten years, but may be extended
for two additional ten-year periods at our option.
As consideration for the license, the Company paid $500,000 cash, and issued 190,500 shares of
restricted common stock, to GTI. The Company is also restricted from offering a competing
gasification technology during the term of the License Agreement. Additionally, for each
U-GAS® unit which the Company licenses, designs, builds or operates which uses coal or a
coal and biomass mixture as the feed stock, the Company must pay a royalty based upon a calculation
using the per thermal megawatt/hr 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 Company
must also provide GTI with a copy of each contract that the Company enters into relating to a
U-GAS® system and report to GTI with the Company’s progress on development of the
technology every six months. A failure to comply with any of the above requirements could result in the termination of the License Agreement by GTI if not
cured by the Company within specified time periods.
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In addition, the Company was required to (i) have a contract for the sale of a
U-GAS® system with a customer in the territory covered by the License Agreement no later
than August 31, 2007 and (ii) fabricate and put into operation at least one U-GAS®
system by July 31, 2008. The Company has a continuing obligation to fabricate and put into
operation at least one U-GAS® system for each calendar year of the License Agreement,
beginning with the calendar year 2009. The Company satisfied the obligation to have a contract for
the sale of a U-GAS® system no later than August 31, 2007 and fabricate and put into
operation at least one U-GAS® system by July 31, 2008 through the HH Joint Venture
described below. In June 2009, the Company agreed to pay GTI a non-refundable payment of $1.5
million toward future royalties due to GTI for the proposed Yima project. In conjunction with this
agreement, GTI agreed to waive the Company’s next required obligation to put a U-GAS®
system into operation until the earlier of the renegotiated License Agreement or December 31, 2010.
Additionally, the Company is required to disclose to GTI any improvements related to the
U-GAS® system that are developed and implemented by the Company and the manner of using
and applying such improvements. Failure to satisfy the requirements as to these milestones could
lead to the revocation of the license by GTI; provided, however, that GTI is required to give a
twelve-month notice of termination and the Company is able to cure the default and continue the
License Agreement prior to the expiration of such time period.
Without the prior written consent of GTI, the Company has no right to sublicense any
U-GAS® system other than to customers for which we have constructed a U-GAS®
system. For a period of ten years, the Company is restricted from disclosing any confidential
information (as defined in the License Agreement) to any person other than employees of the
Company’s affiliates or contractors who are required to deal with such information, and such
persons will be bound by the confidentiality provisions of the license. 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 it receives.
The cost and accumulated amortization of intangible assets were as follows (in thousands):
| As of June 30, 2009 | As of June 30, 2008 | |||||||||||||||||||||||
| Gross | Gross | |||||||||||||||||||||||
| Carrying | Accumulated | Carrying | Accumulated | |||||||||||||||||||||
| Amount | Amortization | Net | Amount | Amortization | Net | |||||||||||||||||||
Use rights of U-GAS® |
$ | 1,886 | $ | 537 | $ | 1,349 | $ | 1,886 | $ | 348 | $ | 1,538 | ||||||||||||
Other intangible assets |
37 | — | 37 | 8 | — | 8 | ||||||||||||||||||
Total |
$ | 1,923 | $ | 537 | $ | 1,386 | $ | 1,894 | $ | 348 | $ | 1,546 | ||||||||||||
The use rights of U-GAS® have an amortization period of ten years. Amortization
expense was $0.2 million for each of the years ended June 30, 2009, 2008 and 2007 and is recorded
in depreciation and amortization expense. Estimated amortization expense for each of the five
subsequent fiscal years is expected to be $0.2 million.
Note 8 — Income taxes
For financial reporting purposes, net loss before income taxes and minority interest showing
domestic and foreign sources was as follows (in thousands):
| Year Ended June 30, | ||||||||||||
| 2009 | 2008 | 2007 | ||||||||||
Domestic |
$ | (9,992 | ) | $ | (18,969 | ) | $ | (9,399 | ) | |||
Foreign |
(19,287 | ) | (9,083 | ) | (3,780 | ) | ||||||
Net loss before minority interest |
$ | (29,279 | ) | $ | (28,052 | ) | $ | (13,179 | ) | |||
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Provision for income taxes
The following is a reconciliation of income taxes at the statutory federal income tax rate of
35% to the income tax provision (benefit) recorded (in thousands):
| Year Ended June 30, | ||||||||||||
| 2009 | 2008 | 2007 | ||||||||||
Net loss before minority interest |
$ | (29,279 | ) | $ | (28,052 | ) | $ | (13,179 | ) | |||
Computed tax benefit at statutory rate |
(10,247 | ) | (9,818 | ) | (4,613 | ) | ||||||
Other |
463 | 88 | 2 | |||||||||
Tax on income (losses) from foreign operations |
4,400 | 1,822 | 1,049 | |||||||||
Valuation allowance |
5,384 | 7,908 | 3,562 | |||||||||
| $ | — | $ | — | $ | — | |||||||
Deferred tax assets (liabilities)
Net deferred asset (liabilities) consisted of the following (in thousands):
| Year Ended June 30, | ||||||||
| 2009 | 2008 | |||||||
Deferred tax assets (liabilities): |
||||||||
Net operating loss carry forward |
$ | 12,833 | $ | 6,818 | ||||
Depreciation and amortization |
(32 | ) | (72 | ) | ||||
Stock-based compensation |
4,613 | 5,003 | ||||||
Accrued vacation |
23 | 26 | ||||||
Accrued bonus |
97 | 94 | ||||||
Other accruals |
529 | 809 | ||||||
Subtotal |
18,063 | 12,678 | ||||||
Valuation allowance |
(18,063 | ) | (12,678 | ) | ||||
Net deferred assets (liabilities) |
$ | — | $ | — | ||||
At June 30, 2009 we had approximately $25.5 million of U.S. federal net operating loss (“NOL”)
carryforwards, and $15.6 million of China NOL carryforwards. The U.S. federal NOL carryforwards
have expiration dates through the year 2028. The China NOL carry forwards have expiration dates
through 2013. The utilization of U.S. federal NOLs and other tax attributes may be limited due to
changes in ownership from equity offerings that occurred during the year and any future equity
offerings.
The Company’s tax returns are subject to periodic audit by the various taxing jurisdictions in
which the Company operates, which can result in adjustments to its NOLs. There are no significant
audits underway at this time.
In assessing the realizability of deferred tax assets, management considers whether it is more
likely than not that some portion or all of the deferred tax assets will not be realized. Based on
the level of historical taxable income and projections for future taxable income over the periods
in which the deferred tax assets are deductible, management believes it is more likely than not
that the Company will not realize the benefits of these deductible differences. Future changes in
estimates of taxable income or in tax laws may change the need for the valuation allowance.
The Company and one of its subsidiaries files income tax returns in the U.S. federal
jurisdiction, and various states and foreign jurisdictions. The Company has been subject to U.S.
federal, state, and local, or non-U.S. income tax examinations by tax authorities for all tax years
since its operations began in 2003. As of June 30, 2009, the Internal Revenue Service (“IRS”) has
not proposed any adjustments to the Company’s material tax positions. The Company establishes
reserves for positions taken on tax matters which, although considered appropriate under the
regulations, could potentially be successfully challenged by authorities during a tax audit or
review. The Company did not have any liability for uncertain tax positions as of June 30, 2009 or
2008.
Note 9 — Net Loss Per Share Data
Historical net loss per share of common stock is computed using the weighted average number of
shares of common stock outstanding. Basic loss per share excludes dilution and is computed by
dividing net loss available to common stockholders by the weighted average number of shares of
common stock outstanding for the period. Stock options are the only potential dilutive share
equivalents the Company has outstanding for the periods presented. For the years ended June 30,
2009, 2008 and 2007 and the period from November 4, 2003 (inception) to June 30, 2009, options to purchase shares of 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 the periods.
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Note 10 — Commitments and Contingencies
Letters of credit
On January 14, 2008, the Company entered into a 63 month lease agreement, with a 60 month
optional renewal, for its new corporate office in Houston, Texas. The lease commenced on March 27,
2008 with rental payments of $20,308 per month for the first year and escalating thereafter
annually. The obligations of the Company under the lease are secured by a letter of credit for
$328,900, which will be paid to the landlord if the Company commits any default under the lease
which is not cured. The letter of credit remains in place until the third anniversary of the lease,
but is reduced to $219,266 after the second anniversary of the lease. The company has a $328,900
investment in a long-term certificate of deposit pledged as collateral for this letter of credit
and also pays an annual fee of 1.0% on this letter of credit.
Operating leases
The Company occupies approximately 10,000 square feet of leased office space in Houston,
Texas. The Company also leases approximately 6,000 square feet of office space in Shanghai, China.
Rental expenses incurred under operating leases for the years ended June 30, 2009, 2008, 2007 and
the period from November 4, 2003 (inception) to June 30, 2009 were approximately $0.3 million, $0.3
million $0.1 million and $0.7 million, respectively. Future minimum lease payments under
non-cancelable operating leases (with initial or remaining lease terms in excess of one year) as of
June 30, 2009 are as follows (in thousands):
| Years Ending June 30, | Total | |||
2010 |
$ | 352 | ||
2011 |
256 | |||
2012 |
259 | |||
2013 |
265 | |||
Thereafter |
— | |||
Total lease commitments |
$ | 1,132 | ||
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 the Company’s 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 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 one of the Company’s 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 the Company, 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 April 24, 2009, filed an amended complaint attempting to replead their
securities fraud claims, and have alleged a new claim for violation of the Uniform Commercial Code.
The SES Defendants intend to move to dismiss these claims, believe all claims alleged to be without
merit, and intend to continue to vigorously defend all claims which are allowed to proceed in the
court.
Note 11 — Stockholders’ Equity
NASDAQ listing
On November 2, 2007, the Company’s common stock began trading on The NASDAQ Stock Market under
the symbol “SYMX.”
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Public offering
In November 2007, the Company received $49.2 million in net proceeds from a public offering in
which the Company sold 5,951,406 shares of its common stock at $9.00 per share. Gross proceeds from
this offering were $53.6 million. In the offering and in connection with entering into the joint
development agreement, AEI purchased 1,750,000 shares of the Company’s stock at $9.00 per share.
In June 2008, the Company received $99.2 million in net proceeds from a public offering in
which the Company sold 11,500,000 shares, including 1,500,000 shares upon the underwriters’
exercise of their over-allotment option, of its common stock at $9.25 per share. Gross proceeds
from this offering were $106.4 million.
Issuance to GTI
GTI provides the Company with various technical services including but not limited to
laboratory testing of coal samples and plant design review. On August 31, 2006, the Company issued
190,500 shares of common stock to GTI as consideration for the issuance of the U-GAS®
license, as described in more detail in Note 8 above. In addition, on September 25, 2007, the
Company entered into a Reservation and Use Agreement with GTI for the reservation of time to use
GTI’s Flex-Fuel Test Facility in Des Plaines, Illinois to perform pilot-scale evaluations to verify
and validate process design information for effects of fuel variability on syngas (volume and
quality) with prospective fuels. The tests conducted in the facility allow for a mass balance
analysis on specific coal sources to be used in the design of commercial U-GAS® plants.
The agreement reserves the facility for 3 months in the calendar year 2008 and 2009. During fiscal
year 2008, the Company issued 278,000 unregistered shares of common stock in satisfaction of the
$2.5 million reservation and use fee for the facility.
Note 12 — Stock-Based Compensation
As of June 30, 2009, 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”). As
of June 30, 3009, 2,695,912 shares were authorized for future issuance pursuant to the Plan. Under
the Plan, the Company may grant both incentive and non-qualified stock options, stock appreciation
rights, restricted stock units and other stock-based awards to officers, directors, employees and
non-employees. Stock option awards generally vest ratably over a one to four year period and expire
ten years after the date of grant.
During the three months ended March 31, 2009, the Compensation Committee of the board of
directors of the Company authorized a stock option exchange program to its employees and directors.
Optionholders could elect to surrender for cancellation any amount of currently held options, but
were required to surrender the entire amount of any individual award that they have received. All
options that were not surrendered remain exercisable in accordance with the terms of the original
option award. Upon receipt of the optionholder’s election to exchange, the Company issued to each
participating optionholder a new stock option grant (the “New Option”) representing one share for
each two shares under the existing stock option surrendered. The New Options are subject to the
same vesting schedule as the options which were surrendered, including as to any portion of the
option which had already vested. The New Options were granted under, and are subject to, the terms
of the Plan. The New Options have an exercise price equal to the closing price of the Company’s
common stock on The NASDAQ Stock Market on the date that the optionholder accepted the offer. Upon
exchange of the stock options, additional compensation cost was recognized for the difference
between the fair value of the modified award and the fair value of the original award on the
modification date. This incremental compensation cost and the remaining unrecognized compensation
cost for the original award will be recognized over the remaining requisite service period.
For the years ended June 30, 2009, 2008 and 2007, the Company recorded stock-based
compensation expense of approximately $1.9 million, $6.0 million and $6.6 million, respectively.
During the year ended June 30, 2009, credits of approximately $4.8 million were recognized to
stock-based compensation expense due to the reversal of previously recognized expense due to
forfeitures related to cancellations of terminated employees’ stock option awards.
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Assumptions
The fair values for the stock options granted during the years ended June 30, 2009, 2008 and
2007 were estimated at the date of grant using a Black-Scholes-Morton option-pricing model with the
following weighted-average assumptions.
| Year Ended June 30, | ||||||||||||
| 2009 | 2008 | 2007 | ||||||||||
Risk-free rate of return |
1.80 | % | 3.47 | % | 4.76 | % | ||||||
Expected life of award |
5.6 years | 6.1 years | 3.5 years | |||||||||
Expected dividend yield |
0.00 | % | 0.00 | % | 0.00 | % | ||||||
Expected volatility of stock |
87 | % | 73 | % | 69 | % | ||||||
Weighted-average grant date fair value |
$ | 0.46 | $ | 6.72 | $ | 3.47 | ||||||
The expected volatility of stock assumption was derived by referring to changes in the
historical volatility of comparable companies. In accordance with SAB 107, we used the
“simplified” method for “plain vanilla” options to estimate the expected term of options granted
during 2009, 2008 and 2007.
Stock option activity during the three years ended June 30, 2009 was as follows:
| Weighted | ||||||||||||||||
| Weighted | Average | Aggregate | ||||||||||||||
| Average | Remaining | Intrinsic | ||||||||||||||
| Number of | Exercise | Contractual | Value | |||||||||||||
| Stock Options | Price | Term (years) | (in millions) | |||||||||||||
Outstanding at June 30, 2006 |
4,802,500 | $ | 2.97 | |||||||||||||
Granted |
860,000 | 6.45 | ||||||||||||||
Exercised |
— | — | ||||||||||||||
Cancelled/forfeited |
— | — | ||||||||||||||
Outstanding at June 30, 2007 |
5,662,500 | 3.50 | ||||||||||||||
Granted |
1,852,500 | 9.65 | ||||||||||||||
Exercised |
(92,000 | ) | 6.20 | |||||||||||||
Cancelled/forfeited |
(287,000 | ) | 7.89 | |||||||||||||
Outstanding at June 30, 2008 |
7,136,000 | 4.90 | ||||||||||||||
Granted |
6,082,538 | 1.08 | ||||||||||||||
Exercised |
(106,750 | ) | 0.59 | $ | 0.1 | |||||||||||
Cancelled/forfeited |
(8,012,250 | ) | 4.83 | |||||||||||||
Outstanding at June 30, 2009 |
5,099,538 | 0.67 | 9.6 | $ | 2.6 | |||||||||||
Exercisable at June 30, 2009 |
3,208,511 | 0.63 | 9.6 | $ | 1.7 | |||||||||||
As of June 30, 2009, approximately $2.9 million of estimated expense with respect to
non-vested stock-based awards has yet to be recognized and will be recognized in expense over the
remaining weighted average period of approximately 1.7 years.
The following table summarizes information with respect to stock options outstanding and
exercisable at June 30, 2009:
| Weighted | ||||||||||||||||||||
| Average | ||||||||||||||||||||
| Remaining | Weighted | Weighted | ||||||||||||||||||
| Contractual | Average | Average | ||||||||||||||||||
| Number | Term | Exercise | Number | Exercise | ||||||||||||||||
| Range of Exercise Prices | Outstanding | (Years) | Price | Exercisable | Price | |||||||||||||||
| $0.43 to $0.66 | 4,697,038 | 9.7 | $ | 0.61 | 3,208,511 | $ | 0.63 | |||||||||||||
| $0.67 to $1.00 | 242,500 | 9.6 | 0.73 | — | — | |||||||||||||||
| $1.01 to $2.00 | 110,000 | 9.3 | 1.92 | — | — | |||||||||||||||
| $2.01 to $3.00 | 50,000 | 9.3 | 2.59 | — | — | |||||||||||||||
| Total | 5,099,538 | 9.6 | 0.67 | 3,208,511 | 0.63 | |||||||||||||||
Restricted Stock Grants to Employees
During the year ended June 30, 2008 and 2007, the Company issued 1,900 and 3,900 shares,
respectively, of restricted stock to employees. The shares issued for the stock grants were
immediately vested upon grant.
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Note 13 — Subsequent Event
In August 2009, the Company entered into amended joint venture contracts with Yima and
contributed its remaining equity contributions of $29.3 million to the Yima Joint Ventures. See
Note 3 for additional information.
Note 14 — Quarterly Results of Operations (Unaudited) (in thousands, except per share amounts)
| 1st Quarter | 2nd Quarter | 3rd Quarter | 4th Quarter | Year | ||||||||||||||||
2009: |
||||||||||||||||||||
Revenues |
$ | 125 | $ | 483 | $ | 326 | $ | 1,168 | $ | 2,102 | ||||||||||
Operating loss (a) |
(9,337 | ) | (10,519 | ) | (3,559 | ) | (6,647 | ) | (30,062 | ) | ||||||||||
Net loss (a) |
(8,516 | ) | (9,752 | ) | (3,615 | ) | (6,693 | ) | (28,576 | ) | ||||||||||
Net loss per
share — basic and
diluted (a)
|
(0.18 | ) | (0.20 | ) | (0.08 | ) | (0.14 | ) | (0.60 | ) | ||||||||||
2008: |
||||||||||||||||||||
Revenues |
— | — | 40 | 288 | 328 | |||||||||||||||
Operating loss |
(3,818 | ) | (4,438 | ) | (7,627 | ) | (12,178 | ) | (28,061 | ) | ||||||||||
Net loss |
(3,766 | ) | (4,328 | ) | (7,438 | ) | (11,910 | ) | (27,442 | ) | ||||||||||
Net loss per share
— basic and
diluted |
(0.12 | ) | (0.13 | ) | (0.20 | ) | (0.32 | ) | (0.80 | ) | ||||||||||
| (a) | The operating results for the third quarter of 2009 included credits of approximately
$3.4 million that were recognized to stock-based compensation expense due to the reversal
of previously recognized expense due to forfeitures related to cancellations of terminated
employees’ stock option awards. |
| Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosures |
None.
| Item 9A. | Controls and Procedures |
(a) Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures designed to ensure that information required
to be disclosed in our annual and periodic reports is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange Commission’s rules and
forms. In addition, we designed these disclosure controls and procedures to ensure that this
information is accumulated and communicated to our management, including the Chief Executive
Officer and Chief Accounting Officer, to allow timely decisions regarding required disclosures.
Our management, with the participation of the Chief Executive Officer and the Chief
Accounting Officer, assessed the effectiveness of our disclosure controls and procedures as
defined in Rules 13a-15(e) and 15d-15(e) of the Securities and Exchange Act of 1934, as amended
(the “Exchange Act”), as of June 30, 2009. Based upon that evaluation, including consideration
of the material weaknesses in our internal control over financial reporting discussed below, our
Chief Executive Officer and Chief Accounting Officer have concluded that our disclosure controls
and procedures were not effective as of June 30, 2009.
(b) Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control
over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our
internal control over financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles. Our internal
control over financial reporting includes those policies and procedures that (i) pertain to the
maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that our receipts and expenditures are being made
only in accordance with authorizations of our management and directors; and, (iii) provide
reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use,
or disposition of our assets that could have a material effect on the financial statements.
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Because
of the inherent limitations of internal control over financial
reporting, including the possibility of collusion or improper
management override of controls, material misstatements due to error
or fraud may not be prevented or detected on a timely basis.
In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
Our management, with the participation of the Chief Executive Officer and the Chief
Accounting Officer, evaluated the effectiveness of our internal control over financial reporting
as of June 30, 2009 based on criteria set forth in Internal Control — Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on
our evaluation, management has concluded that we did not maintain effective internal control
over financial reporting as of June 30, 2009 due to the material weakness in internal control
over financial reporting described below. A material weakness is a control deficiency, or a
combination of control deficiencies, in internal control over financial reporting such that
there is a reasonable possibility that a material misstatement to the annual or interim
financial statements could occur and not be prevented or detected on a timely basis.
Management
concluded that a previously identified and reported material weakness
in internal control over financial reporting still existed as
of June 30, 2009. Specifically, our internal control over financial reporting was
not effective at ensuring that financial reporting risks arising from complex and non-routine
transactions are identified timely and that appropriate accounting policies for such
transactions are selected and applied. This material weakness 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.
This
annual report on Form 10-K does not include an attestation report of our
independent registered public accounting firm regarding internal control over financial
reporting. Management’s report was not subject to attestation by
our independent
registered public accounting firm pursuant to temporary rules of the Securities and Exchange
Commission that permit us to provide only management’s report in this annual report on
Form 10-K.
(c) Remediation Plans for Material Weakness in Internal Control over Financial Reporting
Related to Complex and Non-Routine Transactions
During
fiscal year 2009, we designed and implemented enhanced procedures to address the material weakness identified in management’s assessment
of our disclosure controls and procedures which included ensuring that the
relevant personnel involved in the accounting for complex and non-routine transactions fully
understand and apply the proper accounting for such transactions. In
addition, we are fully
prepared to engage external accounting resources, when necessary, to augment our consideration
and resolution of accounting matters especially those involving complex and non-routine
transactions. We will not consider this material weakness fully
remediated until we can evidence effectiveness of these procedures for a
sufficient period of time.
(d) Remediation of Material Weakness in Internal Control over Financial Reporting Related to
Monitoring the Operation of Internal Controls within our Period-end Close Process on a Timely
Basis
Our management previously identified and disclosed a material weakness in our internal
control over financial reporting. Specifically, we reported that we did not maintain a
sufficient number of accounting professionals with familiarity with our operations and the
requisite knowledge of U.S. generally accepted accounting principles, or U.S. GAAP. As a
result, our internal control over financial reporting was not effective at monitoring the
operation of internal controls within our period-end close process on a timely basis. This
material weakness resulted in errors in our interim and year-end
preliminary consolidated financial statements during fiscal year 2008 that were not prevented or detected by our internal control over
financial reporting.
We implemented a remediation plan of enhanced monthly and quarterly controls and procedures
to address this material weakness. These new controls and procedures have materially affected
the Company’s internal control over financial reporting and primarily consisted of the
following:
| 1) | Hired a full-time Chief Accounting Officer with appropriate U.S. GAAP and public
company financial reporting experience. This assured that previously designed
period-end close procedures and controls were being performed by accounting personnel
with appropriate experience and judgment. |
| 2) | Changed the frequency of several period-end close procedures and controls from
quarterly to monthly. |
| 3) | Implemented enhancements of existing internal controls in order to strengthen the
control over the monthly and/or quarterly period-end close and financial reporting
processes. |
Management has concluded that the remedial actions as described above have remediated this
material weakness as of June 30, 2009.
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(e) Changes in Internal Control Over Financial Reporting
As described above, in the paragraph titled Remediation of Material Weakness in Internal
Control over Financial Reporting Related to Monitoring the Operation of Internal Controls within
our Period-end Close Process, there were changes in our internal control over
financial reporting during the quarter ended June 30, 2009 that have materially affected, or are reasonably likely
to materially affect, our internal control over financial reporting. As a result of these
changes, as stated above, management has concluded that the previously reported material weakness relating
to the period-end close process has been remediated. There have been no other changes in our internal control over
financial reporting during the quarter ended June 30, 2009 that have materially affected, or
that are reasonably likely to materially affect, our internal control over financial reporting
except for those changes described above.
| Item 9B. | Other Information |
None.
PART III
| Item 10. | Directors, Executive Officers and Corporate Governance |
The information required by this item is incorporated in this Annual Report by reference to
our definitive proxy statement to be filed with the Securities and Exchange Commission not later
than 120 days after the close of our fiscal year ended June 30, 2009.
| Item 11. | Executive Compensation |
The information required by this item is incorporated in this Annual Report by reference to
our definitive proxy statement to be filed with the Securities and Exchange Commission not later
than 120 days after the close of our fiscal year ended June 30, 2009.
| Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters |
The information required by this item is incorporated in this Annual Report by reference to
our definitive proxy statement to be filed with the Securities and Exchange Commission not later
than 120 days after the close of our fiscal year ended June 30, 2009.
| Item 13. | Certain Relationships and Related Transactions, and Director Independence |
The information required by this item is incorporated in this Annual Report by reference to
our definitive proxy statement to be filed with the Securities and Exchange Commission not later
than 120 days after the close of our fiscal year ended June 30, 2009.
| Item 14. | Principal Accountant Fees and Services |
The information required by this item is incorporated in this Annual Report by reference to
our definitive proxy statement to be filed with the Securities and Exchange Commission not later
than 120 days after the close of our fiscal year ended June 30, 2009.
60
Table of Contents
| Item 15. | Exhibits and Financial Statement Schedules |
| 1. | Financial Statements. Reference is made to the Index to Consolidated Financial Statements
at Item 8 of this Annual Report. |
| 2. | Financial Statement Schedules. All schedules are omitted because they are not applicable
or the required information is shown in the financial statements or the notes to the
financial statements. |
| 3. | Exhibits. |
| Number | Description of Exhibits | |||
| 3.1 | Certificate of Incorporation of the Company (incorporated
by reference to Exhibit 3.1 to the Company’s Registration
Statement (Registration No. 333-140367) on Form SB-2 filed
on January 31, 2007). |
|||
| 3.2 | Amended and Restated Bylaws of the Company (incorporated by
reference to Exhibit 3.2 to Amendment No. 2 to the
Company’s Registration Statement (Registration No.
333-140367) on Form SB-2 filed on March 30, 2007). |
|||
| 4.1 | Specimen Stock Certificate (incorporated by reference to
Exhibit 4.1 to the Company’s Registration Statement
(Registration No. 333-140367) on Form SB-2 filed on January
31, 2007). |
|||
| 10.1 | ** | Amended and Restated License Agreement by and between
Synthesis Energy Systems, Inc. and Gas Technology Institute
dated August 31, 2006 (incorporated by reference to Exhibit
10.3 to Amendment No. 4 to the Company’s Registration
Statement (Registration No. 333-140367) on Form SB-2 filed
on May 23, 2007). |
||
| 10.2 | Cooperative Joint Venture Contract of SES (Zaozhuang) New
Gas Company Ltd. between Shandong Hai Hua Coal & Chemical
Company Ltd. and Synthesis Energy Systems Investments, Inc.
dated July 6, 2006 — English translation from original
Chinese document (incorporated by reference to Exhibit 10.4
to the Company’s Registration Statement (Registration No.
333-140367) on Form SB-2 filed on January 31, 2007). |
|||
| 10.3 | Amendment to Cooperative Joint Venture Contract of SES
(Zaozhuang) New Gas Company Ltd. between Shandong Hai Hua
Coal & Chemical Company Ltd. and Synthesis Energy Systems
Investments, Inc. dated November 8, 2006 — English
translation from original Chinese document (incorporated by
reference to Exhibit 10.5 to the Company’s Registration
Statement (Registration No. 333-140367) on Form SB-2 filed
on January 31, 2007). |
|||
| 10.4 | ** | Contract for Synthesis Gas Purchase and Sales by and
between Shandong Hai Hua Coal & Chemical Company Ltd. and
Synthesis Energy Systems (Zaozhuang) New Gas Company Ltd.
dated October 22, 2006 — English translation from original
Chinese document (incorporated by reference to Exhibit 10.6
to Amendment No. 4 to the Company’s Registration Statement
(Registration No. 333-140367) on Form SB-2 filed on May 23,
2007). |
||
| 10.5 | + | Amended and Restated Employment Agreement between the
Company and Donald P. Bunnell dated July 14, 2006
(incorporated by reference to Exhibit 10.10 to the
Company’s Registration Statement (Registration No.
333-140367) on Form SB-2 filed on January 31, 2007). |
||
| 10.6 | + | Consulting Agreement between the Company and Lorenzo
Lamadrid dated May 30, 2006 (incorporated by reference to
Exhibit 10.11 to the Company’s Registration Statement
(Registration No. 333-140367) on Form SB-2 filed on January
31, 2007). |
||
| 10.7 | + | Amended and Restated 2005 Incentive Plan (incorporated by
reference to Exhibit 10.13 to Amendment No. 3 to the
Company’s Registration Statement (Registration No.
333-140367) on Form SB-2 filed on May 1, 2007). |
||
| 10.8 | Shareholder’s Loan Agreement by and between Synthesis
Energy Systems Investments, Inc. and Synthesis Energy
Systems (Zaozhuang) dated March 20, 2007 (incorporated by
reference to Exhibit 10.15 to Amendment No. 2 to the
Company’s Registration Statement (Registration No.
333-140367) on Form SB-2 filed on March 30, 2007). |
|||
| 10.9 | Fixed Assets Loan Contract between Synthesis Energy Systems
(Zaozhuang) New Gas Company Ltd. and Industrial and
Commercial Bank of China dated March 27, 2007 — English
translation from original Chinese document (incorporated by
reference to Exhibit 10.16 to Amendment No. 2 to the
Company’s Registration Statement (Registration No.
333-140367) on Form SB-2 filed on March 30, 2007). |
|||
61
Table of Contents
| Number | Description of Exhibits | |||
| 10.10 | Second Amendment to Cooperative Joint Venture Contract of
SES (Zaozhuang) New Gas Company Ltd., between Shandong Hai
Hua Coal & Chemical Company Ltd. and Synthesis Energy
Systems Investments, Inc., dated February 12, 2007 —
English translation from original Chinese document
(incorporated by reference to Exhibit 10.6 to Amendment No.
3 to the Company’s Registration Statement (Registration No.
333-140367) on Form SB-2 filed on May 1, 2007). |
|||
| 10.11 | Co-Operative Joint Venture Contract of SES — GCL (Inner
Mongolia) Coal Chemical Co., Ltd. between Inner Mongolia
Golden Concord (Xilinhot) Energy Investment Co., Ltd. and
Synthesis Energy Systems Investments, Inc. dated May 25,
2007 — English translation from original Chinese document
(incorporated by reference to Exhibit 10.21 to Amendment
No. 5 to the Company’s Registration Statement (Registration
No. 333-140367) on Form SB-2 filed on June 6, 2007). |
|||
| 10.12 | Amendment No. 1 to Amended and Restated License Agreement
by and between Synthesis Energy Systems, Inc. and Gas
Technology Institute dated June 14, 2007 (incorporated by
reference to Exhibit 10.22 to the Company’s Registration
Statement (Registration No. 333-143817) on Form SB-2 filed
on June 15, 2007). |
|||
| 10.13 | Joint Development Agreement by and between Synthesis Energy
Systems, Inc. and AEI dated July 11, 2007 (incorporated by
reference to Exhibit 10.24 to Amendment No. 1 to the
Company’s Registration Statement (Registration No.
333-143817) on Form SB-2 filed on July 16, 2007). |
|||
| 10.14 | Form of Indemnification Agreement between the Company and
its officers and directors (incorporated by reference to
Exhibit 10.25 to the Company’s Annual Report on Form 10-KSB
for the year ended June 30, 2007). |
|||
| 10.15 | Reservation and Use Agreement dated September 25, 2007
between the Company and the Gas Technology Institute
(incorporated by reference to Exhibit 10.26 to Amendment
No. 4 to the Company’s Registration Statement (Registration
No. 333-143817) on Form SB-2 filed on September 26, 2007). |
|||
| 10.16 | First Amendment to Joint Development Agreement by and
between the Company and AEI dated September 26, 2007
(incorporated by reference to Exhibit 10.1 to the Company’s
Current Report on Form 8-K filed on October 2, 2007). |
|||
| 10.17 | Lease Agreement between Synthesis Energy Systems, Inc. and
AVPF Riverway Ltd. dated January 14, 2008 (incorporated by
reference to Exhibit 10.1 to the Company’s Current Report
on Form 8-K filed on January 31, 2008). |
|||
| 10.18 | Severance Agreement and Release between Synthesis Energy
Systems, Inc. and Carol Pearson dated effective April 12,
2008 (incorporated by reference to Exhibit 10.1 to the
Company’s Current Report on Form 8-K filed on April 17,
2008). |
|||
| 10.19 | + | First Amendment to the Amended and Restated 2005 Incentive
Plan (incorporated by reference to Annex B to the Company’s
Proxy Statement on Schedule 14A filed on November 15,
2007). |
||
| 10.20 | Equity Joint Venture Contract of Yima-SES New Energy
Company Ltd. between Yima Coal Industry (Group) Co., Ltd.
and Synthesis Energy Systems Investment, Inc. dated October
11, 2008 — English translation from original Chinese
document (incorporated by reference to Exhibit 10.1 to the
Company’s Current Report on Form 8-K filed on October 23,
2008).] |
|||
| 10.21 | Employment Agreement between the Company and Robert Rigdon
dated March 14, 2008 (incorporated by reference to Exhibit
10.1 to the Company’s Current Report on Form 8-K filed on
November 12, 2008). |
|||
| 10.22 | Employment Agreement between the Company and Kevin Kelly
dated October 16, 2008 (incorporated by reference to
Exhibit 10.2 to the Company’s Current Report on Form 8-K
filed on November 12, 2008). |
|||
| 10.23 | Letter Agreement between the Company and Kevin Kelly dated
January 9, 2009 (incorporated by reference to Exhibit 10.2
to the Company’s Current Report on Form 8-K filed on
January 14, 2009). |
|||
| 10.24 | Separation Agreement and Release between the Company and
Timothy E. Vail dated effective March 31, 2009
(incorporated by reference herein to Exhibit 10.6 to the
Company’s Current Report on Form 8-K dated April 2, 2009). |
|||
62
Table of Contents
| Number | Description of Exhibits | |||
| 10.25 | Separation Agreement and Release between the Company and
David Eichinger dated effective March 31, 2009
(incorporated by reference herein to Exhibit 10.7 to the
Company’s Current Report on Form 8-K dated April 2, 2009). |
|||
| 10.26 | Form of Nonstatutory Stock Option Agreement (incorporated
by reference herein to Exhibit 10.8 to the Company’s
Current Report on Form 8-K dated April 2, 2009). |
|||
| 10.27 | Form of Equity Joint Venture Contract between Yima Coal
Industry (Group) Co., Ltd. and Synthesis Energy Investment
Holdings, Inc. dated April 30, 2009 — English translation
from original Chinese document (incorporated by reference
to Exhibit 10.7 to the Company’s Quarterly Report on Form
10-Q filed on May 11, 2009).] |
|||
| 10.28 | Letter Agreement between the Company and Don Bunnell dated
August 13, 2009 (incorporated by reference to Exhibit 10.2
to the Company’s Current Report on Form 8-K filed on August
13, 2009). |
|||
| 10.29 | Form of Equity Joint Venture Contract between Yima Coal
Industry (Group) Co., Ltd. and Synthesis Energy Investment
Holdings, Inc. dated August 27, 2009 — English translation
from original Chinese document. (incorporated by reference
to Exhibit 10.1 to the Company’s Current Report on Form 8-K
filed on September 2, 2009). |
|||
| 21.1 | * | Subsidiaries of the Company. |
||
| 23.1 | * | Consent of PricewaterhouseCoopers LLP. |
||
| 23.2 | * | Consent of KPMG LLP. |
||
| 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 Accounting 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 Accounting 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. |
|
| ** | Portions of this exhibit have been omitted pursuant to a request for confidential treatment
accepted by the Securities and Exchange Commission and this exhibit has been filed separately
with the Securities and Exchange Commission in connection with such request. |
|
| + | Management contract or compensatory plan or arrangement. |
63
Table of Contents
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: September 21, 2009 | By: | /s/ Robert Rigdon | ||
| Robert Rigdon, President | ||||
| and Chief Executive Officer | ||||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the capacities and on the
dates indicated.
| Signature | Capacity In Which Signed | Date | ||
/s/ Robert Rigdon
|
President and Chief
Executive Officer and Director (Principal Executive Officer) |
September 21, 2009 | ||
/s/ Kevin Kelly
|
Chief Accounting Officer, Controller
and Secretary (Principal Financial and Accounting Officer) |
September 21, 2009 | ||
/s/ Donald Bunnell
|
President, Chief Executive Officer — Asia Pacific and Director |
September 21, 2009 | ||
/s/ Lorenzo Lamadrid
|
Director | September 21, 2009 | ||
Lorenzo Lamadrid |
||||
/s/ Michael Storey
|
Director | September 21, 2009 | ||
Michael Storey |
||||
/s/ Denis Slavich
|
Director | September 21, 2009 | ||
Denis Slavich |
||||
/s/ Harry Rubin
|
Director | September 21, 2009 | ||
Harry Rubin |
||||
/s/ Timothy Vail
|
Director | September 21, 2009 | ||
Timothy Vail |
64
Table of Contents
EXHIBIT INDEX
| Number | Description of Exhibits | |
21.1* |
Subsidiaries of the Company. | |
23.1* |
Consent of PricewaterhouseCoopers LLP. | |
23.2* |
Consent of KPMG LLP. | |
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 Accounting 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 Accounting 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. |
65