SYNTHESIS ENERGY SYSTEMS INC - Quarter Report: 2009 December (Form 10-Q)

TABLE OF CONTENTS

		Page
PART 1. Financial Information
Item 1. Financial Statements			2
Consolidated Balance Sheets as of December 31, 2009 and June 30, 2009 (unaudited)			2
Consolidated Statements of Operations for the Three Months Ended December 31, 2009 and 2008 (unaudited)			3
Consolidated Statements of Operations for the Six Months Ended December 31, 2009 and 2008 and the period from November 4, 2003 (inception) to December 31, 2009 (unaudited)			4
Consolidated Statements of Cash Flows for the Six Months Ended December 31, 2009 and 2008 and the period from November 4, 2003 (inception) to December 31, 2009 (unaudited)			5
Consolidated Statements of Stockholders Equity for the period from November 4, 2003 (inception) to December 31, 2009 (unaudited)			6
Notes to the Consolidated Financial Statements (unaudited)			7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			18
Item 3. Quantitative and Qualitative Disclosure about Market Risk			31
Item 4. Controls and Procedures			32
PART II. Other Information
Item 1. Legal Proceedings			33
Item 1A. Risk Factors			33
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			33
Item 3. Defaults Upon Senior Securities			33
Item 4. Submission of Matters to a Vote of Security Holders			34
Item 5. Other Information			34
Item 6. Exhibits			36
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

PART I

Item 1.		Financial Statements

SYNTHESIS ENERGY SYSTEMS, INC.
(A Development Stage Enterprise)

Consolidated Balance Sheets

(In thousands, except per share amounts)
(Unaudited)

		December 31,				June 30,
		2009				2009
ASSETS
Current assets:
Cash and cash equivalents		$	50,876			$	90,420
Accounts receivable			2,362				1,333
Prepaid expenses and other currents assets			942				689
Inventory			858				780
Total current assets			55,038				93,222
Construction-in-progress			572				6,078
Property, plant and equipment, net			36,846				37,713
Intangible asset, net			1,305				1,386
Investment in Yima joint ventures			32,238				1,500
Other long-term assets			3,284				6,237
Total assets		$	129,283			$	146,136
LIABILITIES AND EQUITY
Current liabilities:
Accrued expenses and accounts payable		$	7,573			$	8,828
Current portion of long-term bank loan			2,255				2,254
Total current liabilities			9,828				11,082
Long-term bank loan			7,835				8,958
Total liabilities			17,663				20,040
Equity:
Common stock, $0.01 par value: 200,000 and 100,000 shares authorized: 48,218 and 48,118 shares issued and outstanding, respectively			482				481
Additional paid-in capital			197,432				196,441
Deficit accumulated during development stage			(88,300	)			(74,701	)
Accumulated other comprehensive income			1,610				1,598
Total Synthesis Energy Systems, Inc. stockholders’ equity			111,224				123,819
Noncontrolling interests in subsidiaries			396				2,277
Total equity			111,620				126,096
Total liabilities and equity		$	129,283			$	146,136

See accompanying notes to the consolidated financial statements.

SYNTHESIS ENERGY SYSTEMS, INC.
(A Development Stage Enterprise)

Consolidated Statements of Operations

(In thousands, except per share amounts)
(Unaudited)

		Three Months Ended
		December 31,				December 31,
		2009				2008
Revenue:
Product sales		$	2,423			$	483
Other			184				—
Total revenue			2,607				483
Costs and Expenses:
Costs of product sales and plant operating expenses			2,609				2,915
General and administrative expenses			2,921				4,742
Project and technical development expenses			535				1,371
Stock-based compensation expense			366				1,252
Asset impairment loss			6,575				—
Depreciation and amortization			720				722
Total costs and expenses			13,726				11,002
Operating loss			(11,119	)			(10,519	)
Non-operating (income) expense:
Equity in losses of Yima joint ventures			50				—
Interest income			(13	)			(687	)
Interest expense			164				258
Net loss			(11,320	)			(10,090	)
Less: net loss attributable to noncontrolling interests			2,299				338
Net loss attributable to stockholders		$	(9,021	)		$	(9,752	)
Net loss per share:
Basic and diluted		$	(0.19	)		$	(0.20	)
Weighted average common shares outstanding
Basic and diluted			48,183				48,011

See accompanying notes to the consolidated financial statements.

SYNTHESIS ENERGY SYSTEMS, INC.
(A Development Stage Enterprise)

Consolidated Statements of Operations

(In thousands, except per share amounts)
(Unaudited)

										November 4,
										2003
		Six Months Ended								(inception) to
		December 31,				December 31,				December 31,
		2009				2008				2009
Revenue:
Product sales		$	4,067			$	608			$	6,122
Other			841				—				1,216
Total revenue			4,908				608				7,338
Costs and Expenses:
Costs of product sales and plant operating expenses			4,346				4,338				14,190
General and administrative expenses			6,004				9,301				42,435
Project and technical development expenses			1,555				1,941				13,237
Stock-based compensation expense			964				3,383				18,545
Asset impairment loss			6,575				—				6,575
Depreciation and amortization			1,442				1,502				5,779
Total costs and expenses			20,886				20,465				100,761
Operating loss			(15,978	)			(19,857	)			(93,423	)
Non-operating (income) expense:
Equity in losses of Yima joint ventures			50				—				50
Interest income			(52	)			(1,463	)			(2,796	)
Interest expense			344				536				1,693
Net loss			(16,320	)			(18,930	)			(92,370	)
Less: net loss attributable to noncontrolling interests			2,721				662				4,070
Net loss attributable to stockholders		$	(13,599	)		$	(18,268	)		$	(88,300	)
Net loss per share:
Basic and diluted		$	(0.28	)		$	(0.38	)		$	(2.63	)
Weighted average common shares outstanding
Basic and diluted			48,183				48,011				33,623

See accompanying notes to the consolidated financial statements.

SYNTHESIS ENERGY SYSTEMS, INC.
(A Development Stage Enterprise)

Consolidated Statements of Cash Flows

(In thousands)
(Unaudited)

										November 4, 2003
		Six Months Ended December 31,								(inception) to
		2009				2008				December 31, 2009
Cash flows from operating activities:
Net loss		$	(16,320	)		$	(18,930	)		$	(92,370	)
Adjustments to reconcile net loss to net cash used in operating activities:
Stock-based compensation expense			964				3,383				18,545
Depreciation of property, plant and equipment			1,323				1,385				5,043
Equity in losses of Yima joint ventures			50				—				50
Amortization of intangible and other assets			119				117				736
Loss on disposal of property, plant and equipment			6				7				139
Impairment loss on ExxonMobil license royalty			—				—				1,250
Asset impairment loss			6,575				—				6,575
Changes in operating assets and liabilities:
Accounts receivable			(1,029	)			(597	)			(2,362	)
Prepaid expenses and other current assets			(252	)			(16	)			424
Inventory			(78	)			(128	)			(855	)
Other long-term assets			61				(16	)			(74	)
Accrued expenses and other payables			(582	)			(3,777	)			908
Net cash used in operating activities			(9,163	)			(18,572	)			(61,991	)
Cash flows from investing activities:
Purchase of marketable securities			—				(45,000	)			(45,000	)
Redemption of marketable securities			—				—				45,000
Capital expenditures			(683	)			(3,347	)			(37,838	)
Equity investment in Yima joint ventures			(29,288	)			—				(30,788	)
GTI license royalty for Yima joint ventures			—				—				(1,500	)
ExxonMobil license royalty			—				—				(1,250	)
Proceeds from sale of fixed assets			—				3				6
Restricted cash –investments in long-term certificates of deposit			—				—				(429	)
Amendment of GTI license rights			—				—				(500	)
Purchase of land use rights			(181	)			—				(1,900	)
Receipt of Chinese governmental grant			—				—				556
Project prepayments			—				(88	)			(3,210	)
Net cash used in investing activities			(30,152	)			(48,432	)			(76,853	)
Cash flows from financing activities:
Proceeds (costs) from issuance of common stock, net			—				(63	)			174,981
Proceeds from long-term bank loan			—				—				12,081
Payments on long-term bank loan			(1,127	)			(1,129	)			(3,380	)
Prepaid interest			—				—				(276	)
Deferred financing costs			—				—				(143	)
Contribution from noncontrolling interest partners			840				—				4,456
Proceeds from exercise of stock options, net			63				—				691
Loans from shareholders			—				—				11
Net cash provided by (used in) financing activities			(224	)			(1,192	)			188,421
Net increase (decrease) in cash			(39,539	)			(68,196	)			49,577
Cash and cash equivalents, beginning of period			90,420				127,872				—
Effect of exchange rates on cash			(5	)			(46	)			1,299
Cash and cash equivalents, end of period		$	50,876			$	59,630			$	50,876

See accompanying notes to the consolidated financial statements.

SYNTHESIS ENERGY SYSTEMS, INC.
(A Development Stage Enterprise)

Consolidated Statement of Equity

														Deficit
														Accumulated
		Common Stock												During the				Other				Non-
						Common				Additional				Development				Comprehensive				controlling
		Shares				Stock				Paid-in Capital				Stage				Income				Interest				Total
Balance at November 4, 2003 (inception)			100,000			$	—			$	—			$	—			$	—			$	—			$	—
Net loss for the period November 4, 2003 to June 30, 2004			—				—				—				—				—				—				—
Balance at June 30, 2004			100,000				—				—				—				—				—				—
Shares Forfeited in Merger			(94,000	)			—				—				—				—				—				—
Shares Issued in Merger			21,000				—				—				—				—				—				—
Net loss			—				—				—				(358	)			—				—				(358	)
Investor contributions			—				264				236				—				—				—				500
Conversion of debt to equity			—				6				5				—				—				—				11
Net proceeds from private placement offering			1,030				10				2,474				—				—				—				2,484
Balance at June 30, 2005			28,030				280				2,715				(358	)			—				—				2,637
Net loss			—				—				—				(5,183	)			—				—				(5,183	)
Net proceeds from private placement offering			970				10				2,378				—				—				—				2,388
Stock-based compensation			—				—				3,043				—				—				—				3,043
Adjustment related to return of shares			(4,353	)			(44	)			44				—				—				—				—
Balance at June 30, 2006			24,647				246				8,180				(5,541	)			—				—				2,885
Net loss			—				—				—				(13,142	)			—				(37	)			(13,179	)
Currency translation adjustment			—				—				—				—				175				—				175
Contribution from noncontrolling interest partners			—				—				—				—				—				492				492
Net proceeds from private placement offering			3,346				34				16,126				—				—				—				16,160
Stock-based compensation			—				—				6,608				—				—				—				6,608
Shares issued for amended GTI license			191				2				1,374				—				—				—				1,376
Shares issued upon 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				455				19,550
Net loss			—				—				—				(27,442	)			—				(610	)			(28,052	)
Currency translation adjustment			—				—				—				—				1,390				—				1,390
Contribution from noncontrolling interest partners			—				—				—				—				—				3,124				3,124
Stock-based compensation			—				—				6,010				—				—				—				6,010
Exercise of stock options			92				1				564				—				—				—				565
Shares issued for GTI reservation use fee			278				3				2,497				—				—				—				2,500
Shares issued in public offerings			17,451				174				148,226				—				—				—				148,400
Stock grants to employees			2				—				19				—				—				—				19
Balance at June 30, 2008			48,011				480				194,617				(46,125	)			1,565				2,969				153,506
Net loss			—				—				—				(28,576	)			—				(692	)			(29,268	)
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				2,277				126,096
Net loss			—				—				—				(13,599	)			—				(2,721	)			(16,320	)
Currency translation adjustment			—				—				—				—				12				—				12
Contribution from noncontrolling interest partners			—				—				—				—				—				840				840
Stock-based compensation			—				—				964				—				—				—				964
Exercise of stock options			100				1				27				—				—				—				28
Balance at December 31, 2009			48,218			$	482			$	197,432			$	(88,300	)		$	1,610			$	396			$	111,620

See accompanying notes to the consolidated financial statements.

SYNTHESIS ENERGY SYSTEMS, INC.
(A Development Stage Enterprise)

Notes to the Consolidated Financial Statements
(Unaudited)

Note 1 — Summary of Significant Accounting Policies

(a) Organization and description of business

Synthesis Energy Systems, Inc. (“SES”), together with its wholly-owned and majority-owned controlled subsidiaries (collectively, “the Company”) is a development stage enterprise. The Company builds, owns and operates coal gasification plants that utilize its proprietary U-GAS^® fluidized bed gasification technology to convert low rank coal and coal wastes into higher value energy 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 consolidated financial statements for the periods presented are unaudited and reflect all adjustments, consisting of normal recurring items, which management considers necessary for a fair presentation. Operating results for the three and six months ended December 31, 2009 are not necessarily indicative of results to be expected for the fiscal year ending June 30, 2010.

The consolidated financial statements are in U.S. dollars and include SES and all of its wholly-owned and majority-owned controlled subsidiaries. Noncontrolling interests in consolidated subsidiaries in the consolidated balance sheets represent minority stockholders’ proportionate share of the equity in such subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto reported in the Company’s Annual Report on Form 10-K for the year ended June 30, 2009. Significant accounting policies that are new or updated from those presented in the Company’s Annual Report on Form 10-K for the year ended June 30, 2009 are included below. The consolidated financial statements have been prepared in accordance with the rules of the United States Securities and Exchange Commission (“SEC”) for interim financial statements and do not include all annual disclosures required by generally accepted accounting principles in the United States.

(c) 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.

The Company recognizes revenue from engineering services and joint development activities under the percentage-of-completion method.

To date, substantially all of the Company’s revenues have been derived from its joint venture activities.

(d) Fair Value Measurements

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

Level 1		Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
Level 2		Quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability; and
Level 3		Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).

The Company’s financial assets and liabilities are classified based on the lowest level of input that is significant for the fair value measurement. The following table summarizes the valuation of the Company’s financial assets and liabilities by pricing levels, as of December 31, 2009 (in thousands):

		Level 1				Level 2				Level 3				Total
Assets:
Certificates of Deposit		$	—			$	429	(1)		$	—			$	429
Money Market Funds			—				49,327	(2)			—				49,327

On July 1, 2009, the Company adopted a newly issued accounting standard for fair value measurements of all nonfinancial assets and nonfinancial liabilities not recognized or disclosed at fair value in the financial statements on a recurring and nonrecurring basis. The accounting standard for those assets and liabilities did not have a material impact on the Company’s financial position, results of operations or liquidity.

The Company uses internally developed, unobservable inputs (Level 3 inputs in the fair value hierarchy of fair value accounting) to estimate cash flow projections used in its analysis to determine whether its long-lived assets are impaired.

(e) Comprehensive Income (Loss)

Our comprehensive income (loss) was as follows (in thousands):

		Three Months Ended								Six Months Ended
		December 31,								December 31,
		2009				2008				2009				2008
Net loss, as reported		$	(11,320	)		$	(10,090	)		$	(16,320	)		$	(18,930	)
Unrealized foreign currency translation adjustment			2				(33	)			12				40
Comprehensive loss			(11,318	)			(10,123	)			(16,308	)			(18,890	)
Comprehensive loss attributable to noncontrolling interests			1				(5	)			2				12
Comprehensive loss attributable to SES			(11,319	)			(10,118	)			(16,310	)			(18,902	)

Note 2 — Recently Issued Accounting Standards

In December 2007, the FASB issued authoritative guidance which established new accounting and reporting standards for the noncontrolling interest in a subsidiary (a “minority interest”) and for the deconsolidation of a subsidiary. The new guidance requires the recognition of a minority interest as equity in the consolidated financial statements and separate from the parent’s equity. The amount of net income attributable to the noncontrolling interest will be included in consolidated net income on the face of the income statement. This guidance clarifies that changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation are equity transactions if the parent retains its controlling financial interest. In addition, it requires that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated. Such gain or loss will be measured using the fair value of the noncontrolling equity investment on the deconsolidation date. Additionally, there are expanded disclosure requirements regarding the interests of the parent and its noncontrolling interest. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. The Company adopted the new guidance on July 1, 2009 and applied the provisions retroactively to all prior periods presented.

In May 2008, the FASB issued new authoritative guidance which establishes general standards of accounting and disclosure of events that occur after the balance sheet date but before the financial statements are issued. This guidance 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. Management has performed a review of our subsequent events and transactions through February 16, 2010, which is the date the financial statements are issued.

In June 2009, the FASB issued the FASB Accounting Standards Codification (“Codification”). The Codification became the single source for all authoritative GAAP recognized by the FASB to be applied for financial statements issued for periods ending after September 15, 2009. The Codification does not change GAAP and did not have an effect on our financial position, results of operations or cash flows.

In June 2009, the FASB issued a new standard that amends the accounting and disclosure requirements for the consolidation of variable interest entities. The new standard changed consolidation analysis for variable interest entities, and it is effective for fiscal years beginning after November 15, 2009. The adoption of this standard is not expected to have an impact on the Company’s financial statements.

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. (which was acquired by China National Offshore Oil Corporation in September 2009) (“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 $26.0 million in equity capital and Hai Hua has contributed approximately $1.3 million in equity capital. The remainder of the HH Joint Venture’s capital has been funded by intercompany loans from the Company. 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 sale agreement 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 worldwide reductions in methanol prices, Hai Hua has operated at a reduced rate of syngas consumption. Hai Hua forecasted the use of approximately 35% to 45% of the syngas guarantee capacity for calendar 2009 and has forecasted the same level of syngas consumption through June 2010.

In April 2009, the HH Joint Venture entered into the Supplementary Agreement with Hai Hua, amending the terms of the purchase and sale agreement. The Supplementary Agreement was entered into to provide more clarity regarding the required syngas quality and volume to be delivered, recovery of the energy fee during turndown periods and operations coordination during unscheduled outages. Under the Supplementary Agreement, the syngas quality specification was amended to provide more clarity as to the minor constituents allowable in the syngas. For purposes of the agreement, syngas that meets these specifications is deemed “compliant gas” and syngas that does not meet these specifications is deemed “non-compliant gas.” The Supplementary Agreement also added a requirement for Hai Hua to pay the 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 order to make up for the reduced energy fee, the HH Joint Venture entered into an additional agreement with Hai Hua 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 to Hai Hua in September 2009. This cost sharing arrangement has increased the HH Joint Venture’s byproduct revenues and has reduced the operating costs of Hai Hua by allowing the parties to operate only one ASU instead of both parties operating their respective ASU’s at low capacity.

The Company is evaluating alternative products and partnership structures for a possible expansion of the HH Joint Venture plant to produce products such as glycol. The Company does not believe any additional equity for an expansion would be required from the Company as it expects to contribute its 95% equity interest toward the expansion with third parties contributing all the additional required equity to expand the plant. In February 2010, the Company received the necessary government approval for the expansion. This approval, along with the previously received environmental approvals, are the key approvals required for the Company to commence execution of the expansion and also describe certain terms of the expansion project, including but not limited to, its use of land, the main additional facilities required and the use of the existing facilities. The scope of the expansion is still under evaluation and the Company expects to make a decision on moving forward with an expansion near the end of the first half of calendar 2010. The local government has expressed strong support for this expansion project and has executed a letter of intent allowing a new state-owned local coal mine to be used as a debt guarantee. The letter of intent also contemplates providing discounted coal to the project from this local coal mine.

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 December 31, 2009, the Company performed an analysis of this project and has determined that these assets were not impaired based upon management’s estimated cash flow projections for the project.

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, and as of December 31, 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
	•		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 December 31, 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) Yima will guarantee the repayment of loans from third party lenders for 50% of the project’s cost and, if debt financing is not available, Yima is obligated to provide debt financing via shareholder loans to the project until the project is able to secure third-party debt financing; and (iii) Yima will supply coal to the project from a mine located in close proximity to the project at a preferential price subject to a definitive agreement to be subsequently negotiated. In connection with entering into the amended contracts, the Company and Yima have contributed their remaining cash equity contributions of $29.3 million and $90.8 million, respectively, to the Yima Joint Ventures during the three months ended September 30, 2009. The Company will also be responsible for its share of any cost overruns on the project. During the three months ended September 30, 2009, the Company incurred a charge of $0.9 million relating to consulting fees paid in connection with the closing and funding of the Yima project.

In exchange for their capital contributions, the Company owns a 25% interest in each joint venture and Yima owns a 75% interest. Notwithstanding this, in connection with an expansion of the project, the Company has the option to contribute a greater percentage of capital for the expansion, such that as a result, the Company would have up to a 49% ownership interest in the Yima Joint Ventures. The investment in the Yima Joint Ventures is accounted for using the equity method.

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. Under the amended 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.

Construction activities for site preparation are currently underway and a Chinese engineering company has been selected for the project’s engineering work. The remaining construction and commissioning of 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.

The remaining capital for the project is to be provided by project debt to be obtained by the Yima Joint Ventures. Yima has agreed to guarantee the project debt and the Company expects this guarantee will allow debt financing to be obtained from domestic Chinese banking sources. The Company has agreed to pledge to Yima its ownership interests in the joint ventures as security for its obligations under any project guarantee. In the event that the debt financing is not obtained, Yima has agreed to provide a loan to the joint ventures to satisfy the remaining capital needs of the project with terms comparable to current market rates at the time of the loan.

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

During the six months ended December 31, 2009, the Company recognized $0.6 million of other revenue for engineering services provided to the Yima Joint Ventures.

The Company has included the $1.5 million payment paid to the Gas Technology Institute (“GTI”) in June 2009 toward future royalties due to GTI for the Yima Joint Ventures’ project as part of the Company’s investment in the Yima project. An additional future royalty payment of approximately $1.5 million will be due to GTI upon the commissioning of the gasifier equipment for the Yima project. See Note 4 — GTI License Agreement for more information on the royalty payments.

Golden Concord Joint Venture

The Company’s joint venture with Golden Concord was formed to (i) develop, construct and operate a coal gasification, methanol and dimethyl ether (“DME”) production plant utilizing U-GAS^® technology in the Xilinghote Economic and Technology Development Zone, Inner Mongolia Autonomous Region, China and (ii) produce and sell methanol, DME and the various byproducts of the plant, including fly ash, steam, sulphur, hydrogen, xenon and argon. At the time of the formation of the GC Joint Venture, 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 agreed to contribute approximately $16.0 million in cash for the remaining 49% ownership interest in the GC Joint Venture. The Company consolidates the results of the GC Joint Venture in its consolidated financial statements. The Company has funded a total of $3.4 million of its equity contribution and Golden Concord has additionally funded approximately $3.1 million of its equity contribution as of December 31, 2009. These funds were used for engineering and initial construction work for this project, land use rights, and for its development expenses. The GC Joint Venture has liabilities of approximately $1.1 million and has incurred losses of approximately $1.9 million prior to the impairment loss described below.

At this time, Golden Concord and other potential partners are not currently interested in the GC Joint Venture project’s investment as originally envisioned. However, since the formation of the GC Joint Venture, the Company has continued to make progress demonstrating the capability of its technology. This progress has attracted the interest of some of China’s coal to energy companies that are interested in using our technology for larger scale projects such as SNG. Due to the need to shift the project to a larger scale and higher value end product alternative such as SNG, development of the project will be delayed significantly. The Company believes that the GC Joint Venture project, as originally planned, will not be developed at this time. Due to these facts and circumstances, the Company determined that, as of December 31, 2009, it is improbable that the long-lived assets of the GC Joint Venture will be recovered. Therefore, the Company recognized an impairment loss of approximately $6.6 million during the three months ended December 31, 2009 to write-off the long-lived assets of the GC Joint Venture. The remaining noncontrolling interest of Golden Concord in the GC Joint Venture of approximately $2.2 million was recognized as a net loss attributable to noncontrolling interests due to Golden Concord absorbing their interest in the impairment loss. Golden Concord’s equity contributions of $3.1 million have been reduced by its 49% share of the operating losses of the GC Joint Venture to date.

The Company intends to continue to develop this project by shifting its focus to end products such as SNG that can be economically produced from local low rank coal when utilizing the U-GAS^® technology and which are of strategic interest to possible partners in China, including state owned, private and publicly traded gas companies.

Note 4 — GTI License Agreement

On November 5, 2009, the Company entered into an Amended and Restated License Agreement (the “New Agreement”) with GTI, replacing the Amended and Restated License Agreement between the Company and GTI dated August 31, 2006, as amended (the “Original Agreement”). Under the New Agreement, the Company maintains its exclusive worldwide right to license the U-GAS^® technology for all types of coals and coal/biomass mixtures with coal content exceeding 60%, as well as the non-exclusive right to license the U-GAS^® technology for 100% biomass and coal/biomass blends exceeding 40% biomass. The New Agreement differs from the Old Agreement most critically by allowing the Company to sublicense U-GAS^® to third parties for coal, coal and biomass mixtures or 100% biomass projects (subject to the approval of GTI, which approval shall not be unreasonably withheld), with the Company and GTI to share the revenue from such third party licensing fees based on an agreed percentage split (the “Agreed Percentage”). In addition, the prior obligation to fabricate and put into operation at least one U-GAS^® system for each calendar year of the Original Agreement in order to maintain the license has been eliminated in the New Agreement.

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

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

The Company is required to make an annual payment to GTI for each year of the term beginning with the year ended December 31, 2010, with such annual payment due by the last day of January of the following year; provided, however, that the Company is entitled to deduct all royalties paid to GTI in a given year under the New Agreement from this amount, and if such royalties exceed the annual payment amount in a given year, the Company is not required to make the annual payment. The Company must also provide GTI with a copy of each contract that it enters into relating to a U-GAS^® system and report to GTI with its progress on development of the technology every six months.

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

The term of the New Agreement is the same as the Original Agreement, expiring on August 31, 2016, but may be extended for two additional ten-year periods at the option of the Company.

In June 2009, the Company agreed to pay GTI a non-refundable payment of $1.5 million toward future royalties due to GTI under the Original Agreement for the proposed Yima Joint Ventures project.

Note 5 — Stock-Based Compensation

As of December 31, 2009, the Company had outstanding stock options granted under the Company’s Amended and Restated 2005 Incentive Plan, as amended (the “Plan”). As of December 31, 2009, 2,379,465 shares were authorized for future issuance pursuant to the Plan and $1.98 million of estimated expense with respect to non-vested stock-based awards has yet to be recognized.

Stock option activity during the six months ended December 31, 2009 was as follows:

		Number of
		Stock Options
Outstanding at June 30, 2009			5,099,538
Granted			353,947
Exercised			(137,500	)
Forfeited			(37,500	)
Outstanding at December 31, 2009			5,278,485
Exercisable at December 31, 2009			3,642,099

Note 6 — Detail of Selected Balance Sheet Accounts

Inventory consisted of the following (in thousands):

		December 31,				June 30,
		2009				2009
Raw materials		$	275			$	192
Parts and assemblies			583				588
Total		$	858			$	780

Construction-in-progress related to the following projects (in thousands):

		December 31,				June 30,
		2009				2009
Golden Concord JV		$	—			$	4,821
HH Joint Venture			572				1,257
Total		$	572			$	6,078

Note 7 — Net Loss Per Share

Historical net loss per share of common stock is computed using the weighted average number of shares of common stock outstanding. Basic loss per share excludes dilution and is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding for the period. Stock options are the only potential dilutive share equivalents the Company has outstanding for the periods presented. For the three month and six month periods ended December 31, 2009 and 2008 and the period from November 4, 2003 (inception) to December 31, 2009, options to purchase common stock were excluded from the computation of diluted earnings per share as their effect would have been antidilutive as the Company incurred net losses during those periods.

Note 8 — Litigation

In September 2008, the Company was named as one of a number of defendants in a lawsuit filed in the U.S. District Court for the Central District of California, Southern Division, by Igor Olenicoff, one of the Company’s former stockholders, and a company he controls. Also named were Timothy E. Vail (the Company’s former CEO and one of its directors), David Eichinger (the Company’s former CFO), and another one of the Company’s directors (collectively, the Company, Mr. Vail, Mr. Eichinger and the director are referred to as the “SES Defendants”), as well as UBS AG, Union Charter Ltd., and other persons who allegedly managed Mr. Olenicoff’s investments outside the U.S. The SES Defendants have been named in this lawsuit based primarily upon allegations that one of 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 August 24, 2009, filed an amended complaint attempting to replead their securities fraud claims, and alleged a new claim for violation of the Uniform Commercial Code (the “UCC”). In response, on September 23, 2009, the SES Defendants filed a motion to dismiss the securities fraud and UCC claims. The court heard oral argument on the SES Defendants’ motion to dismiss, and on various other defendants’ motions to dismiss, on November 9, 2009. No final order has yet been issued by the court on these motions. The SES Defendants believe the claims alleged against them to be without merit and intend to continue to vigorously defend all claims which are allowed to proceed in the court.

Note 9 — Risks and Uncertainties

Since mid-2008, the global economy has experienced a significant contraction, with an almost unprecedented lack of availability of business and consumer credit, which has impeded, and could continue to impede, the Company’s ability to obtain financing for its projects. Although the Company is seeing early signs of improved economic activity, this decrease and any future decrease in economic activity in China or in other regions of the world, in which the Company may in the future do business, could significantly and adversely affect its results of operations and financial condition in a number of other ways. Any decline in economic conditions may reduce the demand or prices from the products from our plants. In addition, the market for commodities such as methanol has been under significant pressure and the Company is unsure of how much longer this pressure will continue. As a direct result of these trends, the Company’s ability to finance and develop its existing projects, commence any new projects and sell its products could be adversely impacted.

The Company will limit the development of any further projects until worldwide capital and debt markets improve and it has assurances that acceptable financing is available to complete the project. The Company’s strategy will be to grow its licensing business and create selective investment opportunities primarily through its China based operations and using its current capital resources combined with leveraging its technology and success at Hai Hua. However, there have also been recent announcements of a constricting credit market in China. Even if the Company does obtain the necessary capital for its projects, the Company could face other delays in its projects due to additional approval requirements or due to unanticipated issues in the commissioning of such a project. These factors have led to the impairment of the GC Joint Venture’s assets and could lead to, among other things, the impairment of the Company’s significant assets, including its investments in the HH Joint Venture and the Yima Joint Ventures, and an inability to develop any further projects.

The Company may need to raise additional capital through equity and debt financing for any new projects that are developed, to support its existing projects and possible expansions thereof and for its corporate general and administrative expenses. The Company cannot provide any assurance that any financing will be available to the Company in the future on acceptable terms or at all. Any such financing could be dilutive to the Company’s existing stockholders. If the Company cannot raise required funds on acceptable terms, it may not be able to, among other things, (i) maintain its general and administrative expenses at current levels; (ii) negotiate and enter into new gasification plant development contracts; (iii) expand its operations; (iv) hire and train new employees; or (v) respond to competitive pressures or unanticipated capital requirements.

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

You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and the related notes and other financial information included elsewhere in this quarterly report. Some of the information contained in this discussion and analysis or set forth elsewhere in this quarterly report, including information with respect to our plans and strategy for our business and related financing, include forward-looking statements that involve risks and uncertainties. You should review the “Risk Factors” section of our Annual Report on Form 10-K for the fiscal year ended June 30, 2009 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 are developing opportunities to provide licenses, equipment components and engineering services related to the U-GAS^® technology. We believe that we have several advantages over commercially available competing gasification technologies, such as entrained flow and fixed bed technologies, including our ability to use all ranks of coals (including low rank, high ash and high moisture coals, which are usually 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 operating activities are currently in China, however, we are developing opportunities in other countries including the U.S., Australia and India to provide licenses, equipment components and engineering services. Our first commercial scale coal gasification plant is located in Shandong Province, China and has been in operation since February 2008. We have additional projects in various stages of development in Henan Province, China and in the Inner Mongolia Autonomous Region of China.

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 be used as a fuel gas in industrial applications or can 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 continuing to implement 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.
	•		Execute on projects in China. We are currently executing on our Yima project and intend to leverage our success to date at the HH Joint Venture in our ongoing business development efforts. We also believe that our Yima Joint Venture will help to demonstrate our ability to expand into increasingly larger projects and new product markets.

	•		Leverage our proprietary technology and success at Hai Hua through licensing. We intend to place increased focus on development of licensing opportunities for our proprietary U-GAS® technology on a global basis with a focus on China, India, the U.S. and Australia due to their large low rank coal resources. In the U.S., the focus will primarily be on biomass to biofuel opportunities. We anticipate that we can generate revenues through engineering and technical service fees, as well as licensing fees and royalties on products sold by our licensees that incorporate our proprietary technology without incurring the significant capital costs required to develop a plant. We also believe that our licensing activities will provide additional insight into project development activities, which may allow us to make selective equity investments in such projects in the future.
	•		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.
	•		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 generated revenues of $4.9 million for the six months ended December 31, 2009. We have sustained net losses of approximately $88.3 million from November 4, 2003, the date of our inception, to December 31, 2009. We have primarily financed our operations to date through private placements and two public offerings of our common stock.

Three Months Ended December 31, 2009 Compared to Three Months Ended December 31, 2008

Revenue. Total revenue increased $2.1 million to $2.6 million for the three months ended December 31, 2009 compared to $0.5 million for the three months ended December 31, 2008.

Product sales were $2.4 million for the three months ended December 31, 2009 compared to $0.5 million for the three months ended December 31, 2008 and were derived from the sale of syngas and other byproducts produced at the HH Joint Venture plant in China. Product revenues have increased at the plant due to the plant’s increased availability for production, increased syngas volume offtake by our customer, Hai Hua, and increased byproduct sales including sales of our excess oxygen to Hai Hua under our ASU cost-sharing arrangement which began in September 2009. The HH Joint Venture plant was in its commissioning phase prior to achieving commercial operations status in December 2008.

Other revenues were $0.2 million for the three months ended December 31, 2009 and were primarily for a sponsorship grant related to lignite testing at the HH Joint Venture plant.

Costs of product sales and plant operating expenses. Costs of product sales and plant operating expenses decreased by $0.3 million to $2.6 million for the three months ended December 31, 2009 compared to $2.9 million for the three months ended December 31, 2008, and were comprised principally of coal consumption, electricity, and other operating costs at the HH Joint Venture plant in China. The costs for the three months ended December 31, 2008 were higher in relation to revenues due to commissioning costs incurred prior to the plant achieving commercial operations status.

General and administrative expenses. General and administrative expenses decreased by $1.8 million to $2.9 million during the three months ended December 31, 2009 compared to $4.7 million during the three months ended December 31, 2008. The decrease of $1.8 million was primarily due to a decrease in compensation costs as a result of reduced staffing levels, and a decrease in consulting and professional fees.

Project and technical development expenses. Project and technical development expenses decreased by $0.9 million to $0.5 million for the three months ended December 31, 2009 compared to $1.4 million for the three months ended December 31, 2008. Costs during the three months ended December 31, 2009 related to development of our U-GAS^® technology and product feasibility studies for a possible expansion of the HH Joint Venture plant. During the three months ended December 31, 2008, we had a non-cash charge to write-off the $1.3 million remaining carrying value of the reservation and use fee for GTI’s Flex-Fuel Test Facility in Des Plaines, Illinois.

Stock-based compensation expense. Stock-based compensation expense decreased by $0.9 million to $0.4 million for the three months ended December 31, 2009 compared to $1.3 million for the three months ended December 31, 2008. The decrease was principally due to fewer stock option awards outstanding and due to the reversal of previously recognized expense due to forfeitures. Additionally, the amount of stock-based compensation expense associated with recent grants of stock option awards is lower than certain prior awards due to the decrease in the price of our common stock.

Asset impairment loss. The asset impairment loss of $6.6 million during the three months ended December 31, 2009 related to the write-off of the long-lived assets of the GC Joint Venture.

Depreciation and amortization. Depreciation and amortization expense was $0.7 million for the three months ended December 31, 2009 and 2008.

Equity in losses of Yima Joint Ventures. The equity in losses of the Yima Joint Ventures for the three months ended December 31, 2009 relates to our 25% share of the loss incurred by the Yima Joint Ventures. The loss is comprised of non-capitalizable costs incurred during the design and construction phase, offset in part, by interest income earned on invested funds contributed by the joint ventures’ partners.

Interest income. Interest income decreased to $13,000 for the three months ended December 31, 2009 compared to $0.7 million for the three months ended December 31, 2008. The decrease was primarily due to lower effective yields on money market investments and lower invested principal balances.

Interest expense. Interest expense decreased by $0.1 million to $0.2 million for the three months ended December 31, 2009 compared to $0.3 million during the three months ended December 31, 2008. The decrease was primarily due to the HH Joint Venture’s lower outstanding principal balance on its loan with the Industrial and Commercial Bank of China and a lower interest rate based on the annual adjustment in March 2009 to 5.94%.

Net loss attributable to noncontrolling interests. Net loss attributable to noncontrolling interests increased by $2.0 million to $2.3 million for the three months ended December 31, 2009 compared to $0.3 million during the three months ended December 31, 2008. The increase resulted from the GC Joint Venture partner absorbing their interest in the impairment loss.

Six Months Ended December 31, 2009 Compared to Six Months Ended December 31, 2008

Revenue. Total revenue increased $4.3 million to $4.9 million for the six months ended December 31, 2009 compared to $0.6 million for the six months ended December 31, 2008.

Product sales were $4.1 million for the six months ended December 31, 2009 compared to $0.6 million for the six months ended December 31, 2008 and were derived from the sale of syngas and other byproducts produced at the HH Joint Venture plant in China. Product revenues have increased at the plant due to the plant’s increased availability for production; increased syngas volume offtake by our customer, Hai Hua; and increased byproduct sales, including sales of our excess oxygen to Hai Hua under our ASU cost-sharing arrangement, which began in September 2009. The HH Joint Venture plant was in its commissioning phase prior to achieving commercial operations status in December 2008.

Other revenues were $0.8 million for the six months ended December 31, 2009 and were primarily for engineering services provided to the Yima Joint Ventures and a sponsorship grant related to lignite testing at the HH Joint Venture plant.

Costs of product sales and plant operating expenses. Costs of product sales and plant operating expenses were $4.3 million for the both of the six month periods ended December 31, 2009 and 2008, and were comprised principally of coal consumption, electricity, and other operating costs at the HH Joint Venture plant in China. The costs for the six months ended December 31, 2008 were incurred prior to the plant achieving commercial operations status.

General and administrative expenses. General and administrative expenses decreased by $3.3 million to $6.0 million during the six months ended December 31, 2009 compared to $9.3 million during the six months ended December 31, 2008. The decrease of $3.3 million was primarily due to a decrease in compensation costs as a result of reduced staffing levels, and a decrease in consulting and professional fees.

Project and technical development expenses. Project and technical development expenses decreased by $0.3 million to $1.6 million for the six months ended December 31, 2009 compared to $1.9 million for the six months ended December 31, 2008. Project development expenses for the six months ended December 31, 2009 included a $0.9 million charge for a consulting fee related to the financial closing of the Yima project. During the six months ended December 31, 2008, we had a non-cash charge to write-off the $1.3 million remaining carrying value of the reservation and use fee for GTI’s Flex-Fuel Test Facility in Des Plaines, Illinois.

Stock-based compensation expense. Stock-based compensation expense decreased by $2.4 million to $1.0 million for the six months ended December 31, 2009 compared to $3.4 million for the six months ended December 31, 2008. The decrease was principally due to fewer stock option awards outstanding and due to the reversal of previously recognized expense due to forfeitures. Additionally, the amount of stock-based compensation expense associated with recent grants of stock option awards is lower than certain prior awards due to the decrease in the price of our common stock.

Asset impairment loss. The asset impairment loss of $6.6 million during the six months ended December 31, 2009 related to the write-off of the long-lived assets of the Golden Concord joint venture.

Depreciation and amortization. Depreciation and amortization decreased by $0.1 million to $1.4 million during the six months ended December 31, 2009 compared to $1.5 million during the six months ended December 31, 2008. The decrease was due principally to the change in the estimated useful live of the production equipment at the HH Joint Venture plant from a period of 15 years to 20 years effective October 1, 2008.

Equity in losses of Yima joint ventures. The equity in losses of the Yima joint ventures for the six months ended December 31, 2009 relates to our 25% share of the loss incurred by the Yima joint ventures. The loss is comprised of non-capitalizable costs incurred during the design and construction phase, offset in part, by interest income earned on invested funds contributed by the joint ventures’ partners.

Interest income. Interest income decreased to $0.1 million for the six months ended December 31, 2009 compared to $1.5 million for the six months ended December 31, 2008. The decrease was primarily due to lower effective yields on money market investments and lower invested principal balances.

Interest expense. Interest expense decreased by $0.2 million to $0.3 million for the six months ended December 31, 2009 compared to $0.5 million during the six months ended December 31, 2008. The decrease was primarily due to the HH Joint Venture’s lower outstanding principal balance on its loan with the Industrial and Commercial Bank of China and to a lower interest rate based on the annual adjustment in March 2009 to 5.94%.

Net loss attributable to noncontrolling interests. Net loss attributable to noncontrolling interests increased by $2.0 million to $2.7 million for the six months ended December 31, 2009 compared to $0.7 million during the six months ended December 31, 2008. The increase resulted principally from the GC Joint Venture partner absorbing their interest in the impairment loss.

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 December 31, 2009, we had $50.9 million in cash and cash equivalents and $45.2 million of working capital available to us. During the six months ended December 31, 2009, cash flows used in operating activities were $9.2 million. Additionally, we invested $29.3 million of our cash into the Yima Joint Ventures and repaid $1.1 million of principal on the HH Joint Venture loan during the six months ended December 31, 2009. At current levels, we expect to incur corporate general and administrative expenses of approximately $11 million during the year ending June 30, 2010. We are also funding our share of 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 $26.0 million in equity capital and Hai Hua has contributed $1.3 million in equity capital. The remainder of the HH Joint Venture’s capital has been funded by intercompany loans from us. 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 and sale agreement between the HH Joint Venture and Hai Hua 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.

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 December 31, 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 December 31, 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 has operated at a reduced rate of syngas consumption. Hai Hua forecasted the use of approximately 35% to 45% of the syngas guarantee capacity for calendar 2009 and has forecasted the same level of syngas consumption through June 2010. The HH Joint Venture plant 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 evaluating alternative products and partnership structures for a possible expansion of the HH Joint Venture plant to produce products such as glycol. We do not believe any additional equity would be required from us for an expansion as we expect to contribute our 95% equity interest toward the expansion with third parties contributing all the additional required equity to expand the plant. In February 2010, we received the necessary government approval for the expansion. This approval, along with the previously received environmental approvals, are the key approvals required for us to commence execution of the expansion and also describe certain terms of the expansion project, including but not limiting to, its use of land, the main additional facilities required and the use of the existing facilities. The scope of the expansion is still under evaluation and we expect to make a decision on moving forward with an expansion near the end of the first half of calendar 2010. The local government has expressed strong support for this expansion project and has executed a letter of intent allowing a new state-owned local coal mine to be used as a debt guarantee. The letter of intent also contemplates providing discounted coal to the project from this local coal mine.

In April 2009, the HH Joint Venture entered into the Supplementary Agreement with Hai Hua, amending the terms of the purchase and sale agreement. The Supplementary Agreement was entered into to provide more clarity regarding the required syngas quality and volume to be delivered, recovery of the energy fee during turndown periods and operations coordination during unscheduled outages. Under the Supplementary Agreement, the syngas quality specification has been amended to provide more clarity as to the minor constituents allowable in the syngas. For purposes of the agreement, syngas that meets these specifications is deemed “compliant gas” and syngas that does not meet these specifications is deemed “non-compliant gas.” The Supplementary Agreement also 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 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 to Hai Hua in September 2009. This cost sharing arrangement has increased the HH Joint Venture’s byproduct revenues and has reduced operating costs of Hai Hua by allowing the parties to operate only one ASU instead of both parties operating their respective ASU’s at low capacity.

During the six months ended December 31, 2009, the plant operated for approximately 69% of the period, was available for production for approximately 97% of the period, and met Hai Hua’s syngas demand and quality requirements for approximately 98% of the time that it was operating. 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 December 31, 2009, we performed an analysis of the project and determined that these assets were not impaired based upon our estimated cash flow projections for the project.

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) Yima will guarantee the repayment of loans from third party lenders for 50% of the project cost and, if debt financing is not available, Yima is obligated to provide debt financing via shareholder loans to the project until the project is able to secure third-party debt financing; and (iii) Yima will supply coal to the project from a mine located in close proximity to the project at a preferential price subject to a definitive agreement to be subsequently negotiated. In connection with entering into the amended contracts, we and Yima have contributed our respective remaining cash equity contributions of $29.3 million and $90.8 million, respectively, to the Yima Joint Ventures during the three months ended September 30, 2008. We will also be responsible for our share of any cost overruns on the project. During the three months ended September 30, 2009, we incurred a charge of $0.9 million relating to consulting fees paid in connection with the closing and funding of the Yima project.

In exchange for 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. Our investment in the Yima Joint Ventures is accounted for using the equity method.

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. Under the amended 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.

Construction activities for site preparation are currently underway and East China Engineering Corporation (“ECEC”), a subsidiary of China National Chemical Engineering Corp., China’s largest chemical engineering group, has been contracted for the project’s engineering work. ECEC has completed the basic design package and is now working on the detailed engineering design phase. Foundation work is expected to start next month. 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.

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. Yima has filed the appropriate documentation for the loan and the approvals have advanced through the provincial level on to the national level. 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. 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 are governed by a board of directors consisting of eight directors, two of whom were appointed by us and six of whom were appointed by Yima. The joint ventures also have officers that are nominated by us, Yima and/or the board of directors pursuant to the terms of the joint venture contracts. We and Yima shall share the profits, and bear the risks and losses, of the joint ventures in proportion to our respective ownership interests. The term of the joint venture shall commence upon each joint venture company obtaining its business license and shall end 30 years after the issuance of such business licenses.

During the six months ended December 31, 2009, we recognized $0.6 million of other revenue for engineering services provided to the Yima Joint Ventures.

We have included the $1.5 million payment paid to the Gas Technology Institute, or GTI, in June 2009 toward future royalties due to GTI for the Yima Joint Ventures’ project as part of our investment in the Yima project. An additional future royalty payment of approximately $1.5 million will be due to GTI upon the commissioning of the gasifier equipment for the Yima project.

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 Xilinghote Economic and Technology Development Zone, Inner Mongolia Autonomous Region, China and (ii) produce and sell methanol, DME and the various byproducts of the plant, including fly ash, steam, sulphur, hydrogen, xenon and argon. At the time of the formation of the GC Joint Venture, 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 agreed to contribute approximately $16.0 million in cash for the remaining 49% ownership interest in the GC Joint Venture. We consolidate the results of the GC Joint Venture in our consolidated financial statements. We have funded a total of $3.4 million of our equity contribution and Golden Concord has additionally funded approximately $3.1 million of its equity contribution as of December 31, 2009. These funds were used for engineering and initial construction work for this project, land use rights, and for its development expenses. The GC Joint Venture has liabilities of approximately $1.1 million and has incurred losses of approximately $1.9 million prior to the impairment loss described below.

At this time, Golden Concord and other potential partners are not currently interested in the GC Joint Venture project’s investment as originally envisioned. However, since the formation of the GC Joint Venture, we have continued to make progress demonstrating the capability of our technology. This progress has attracted the interest of some of China’s coal to energy companies that are interested in using our technology for larger scale projects such as SNG. Due to the need to shift the project to a larger scale and higher value end product alternative such as SNG and large scale chemicals such as olefins, development of the project will be delayed significantly. We believe that the GC Joint Venture project, as originally planned, will not be developed at this time. Due to these facts and circumstances, we have determined that, as of December 31, 2009, it is improbable that the long-lived assets of the GC Joint Venture will be recovered. Therefore, we have recognized an impairment loss of approximately $6.6 million during the three months ended December 31, 2009 to write-off the long-lived assets of the GC Joint Venture. The remaining noncontrolling interest of Golden Concord in the GC Joint Venture of approximately $2.2 million was recognized as a net loss attributable to noncontrolling interests interests due to Golden Concord absorbing their interest in the impairment loss. Golden Concord’s equity contributions of $3.1 million had been reduced by its 49% share of the operating losses of the GC Joint Venture to date.

We intend to continue to develop this project by shifting our focus to end products such as SNG and olefins that can be economically produced from local low rank coal when utilizing the U-GAS^® technology and which are of strategic interest to possible partners in China, including state owned, private and publicly traded gas companies.

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.

Coalworks

In December 2009, we entered into a strategic alliance agreement with Coalworks Limited, an emerging Australian energy developer, to develop the first coal gasification and liquefaction plant for Coalworks at Oaklands, New South Wales, Australia utilizing our U-GAS^® technology. Pursuant to the strategic alliance agreement, Coalworks has engaged us to conduct a feasibility study for the plant. Pending successful results from the feasibility study, Coalworks would enter into a license agreement with us for the U-GAS^® technology for the Oaklands project. The study also contemplates that Coalworks will license commercially proven methanol to gasoline technology. We would also provide expertise, designs, plans and cost reduction techniques such as modularization to assist Coalworks with the construction and operation of the plant.

GTI

On November 5, 2009, we entered into an Amended and Restated License Agreement, which we refer to as the New Agreement, with GTI, replacing the Amended and Restated License Agreement between us and GTI dated August 31, 2006, as amended, which we refer to as the Original Agreement. Under the New Agreement, we maintain our exclusive worldwide right to license the U-GAS^® technology for all types of coals and coal/biomass mixtures with coal content exceeding 60%, as well as the non-exclusive right to license the U-GAS^® technology for 100% biomass and coal/biomass blends exceeding 40% biomass. The New Agreement differs from the Old Agreement most critically by allowing us to sublicense U-GAS^® to third parties for coal, coal and biomass mixtures or 100% biomass projects (subject to the approval of GTI, which approval shall not be unreasonably withheld), with us and GTI to share the revenue from such third party licensing fees based on an agreed percentage split, which we refer to as the Agreed Percentage. In addition, the prior obligation to fabricate and put into operation at least one U-GAS^® system for each calendar year of the Original Agreement in order to maintain the license has been eliminated in the New Agreement.

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

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

We are required to make an annual payment to GTI for each year of the term beginning with the year ended December 31, 2010, with such annual payment due by the last day of January of the following year; provided, however, that we are entitled to deduct all royalties paid to GTI in a given year under the New Agreement from this amount, and if such royalties exceed the annual payment amount in a given year, we are not required to make the annual payment. We must also provide GTI with a copy of each contract that we enter into relating to a U-GAS^® system and report to GTI with our progress on development of the technology every six months.

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

The term of the New Agreement is the same as the Original Agreement, expiring on August 31, 2016, but may be extended for two additional ten-year periods at our option.

In June 2009, we agreed to pay GTI a non-refundable payment of $1.5 million toward future royalties due to GTI under the Original Agreement for the proposed Yima Joint Ventures project

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 the Yima Joint Ventures, to cover our general and administrative expenses and other operating costs.

We currently plan to use our available cash for (i) our general and administrative expenses; (ii) debt service related to the HH Joint Venture; (iii) working capital; (iv) project, third-party licensing and technical development expenses; and (v) general corporate purposes. The actual allocation of and the timing of the expenditures will be dependent on various factors, including changes in our strategic relationships, commodity prices and industry conditions, and other factors that we cannot currently predict. In particular, since mid-2008, the global economy has experienced a significant contraction, with an almost unprecedented lack of availability of business and consumer credit, which has impeded, and could continue to impede, our ability to obtain financing for our projects. Although we are seeing early signs of improved economic activity, this decrease and any future decrease in economic activity in China or in other regions of the world in which we may in the future do business could significantly and adversely affect our results of operations and financial condition in a number of other ways. In addition, the market for commodities such as methanol has been under significant pressure and we are unsure of how much longer this pressure will continue. As a direct result of these trends, our ability to finance and develop our existing projects, commence any new projects and sell our products could be adversely impacted.

We 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 improvement can be accomplished through the expansion of the plant to produce products such as glycol and the sale of our excess oxygen capacity to Hai Hua. Currently, we do not believe any additional equity contributions for an expansion would be required by us, as we expect to contribute a portion of our 95% equity stake in the existing joint venture toward the expansion. In February 2010, we received the necessary government approval for the expansion. This approval, along with the previously received environmental approvals, are the key approvals required for us to commence execution of the expansion and also describe certain terms of the expansion project, including but not limiting to, its use of land, the main additional facilities required and the use of the existing facilities. The scope of the expansion is still under evaluation and we expect to make a decision on moving forward near the end of the first half of calendar year 2010. The HH Joint Venture began to provide oxygen to Hai Hua in September 2009 under a cost sharing arrangement that has increased our byproduct revenues. In addition, our successful commercial-scale demonstration at the Hai Hua plant using lignite coal from the Inner Mongolia region of China was a significant milestone for us and our U-GAS^® technology as it demonstrated our ability to efficiently process lignite coal. As a result of the lignite demonstration, we have seen a large increase in visits to our Hai Hua plant from potential customers and partners.

Although we have recognized an impairment loss on the assets of the GC Joint Venture, we are actively pursuing project partners to invest in our projects’ development, including a different project scope and end product for the GC Joint Venture and for the possible expansion of the HH Joint Venture plant and further development of the YIMA Joint Venture project. 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. The Chinese government has recently 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 pursuing possible U-GAS^® licensing opportunities with third parties allowing us to build on our experience at the HH Joint Venture and our technology and engineering capability. We intend to place increased focus on development of licensing opportunities for our proprietary U-GAS^® technology on a global basis with a focus on China, India, the U.S. and Australia due to their large low rank coal resources. In the U.S., we believe there may be a significant near-term opportunity for us by leveraging the capability of U-GAS^® to efficiently gasify biomass to make renewable fuels. Today’s regulatory environment in the U.S. is favorable for these types of projects because increased environmental concerns are creating a market demand for renewable fuels and companies are under increasing pressure to reduce their carbon footprint. We anticipate that we can generate revenues through engineering and technical service fees, as well as licensing fees and royalties on products sold by our licensees that incorporate our proprietary technology without incurring the significant capital costs required to develop a plant. We also believe that our licensing activities will provide additional insight into project development activities, which may allow us to make selective equity investments in such projects in the future.

We will limit the development of any further projects until worldwide capital and debt markets improve and we have assurances that acceptable financing is available to complete the project. Our strategy will be to grow our licensing business and create selective investment opportunities primarily through our China based operations and using our current capital resources combined with leveraging our technology and success at Hai Hua. The financial performance of our HH Joint Venture project will be affected by its ability to sell syngas to Hai Hua combined with our ability to successfully expand the project. Further, development of our Yima Joint Ventures may be impacted by delays related to additional permits, implementation and commissioning delays and market conditions during operations.

As of December 31, 2009, we had $50.9 million in cash and cash equivalents and $45.2 million of working capital available to us. During the six months ended December 31, 2009, cash flows used in operating activities were $9.2 million. Additionally, we invested $29.3 million of our cash into the Yima Joint Ventures and repaid $1.1 million of principal on the HH Joint Venture loan during the six months ended December 31, 2009. At current levels, we expect to incur corporate general and administrative expenses of approximately $11 million during fiscal 2010. We are also funding the working capital, operating losses and debt service of the HH Joint Venture. As a result, we may need to raise additional capital through equity and debt financing for any new projects that are developed, to support our existing projects and possible expansions thereof and for our corporate general and administrative expenses. We cannot provide any assurance that any financing will be available to us in the future on acceptable terms or at all. Any such financing could be dilutive to our existing stockholders. If we cannot raise required funds on acceptable terms, we may not be able to, among other things, (i) maintain our general and administrative expenses at current levels; (ii) 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.

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.

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.

Item 3.		Quantitative and Qualitative Disclosure About Market Risk

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

Foreign currency risk

We conduct operations in China and the functional currency in China is the Renminbi Yuan. Our financial statements are expressed in U.S. dollars and will be negatively affected if foreign currencies, such as the Renminbi Yuan, depreciate relative to the U.S. dollar. In addition, our currency exchange losses may be magnified by exchange control regulations in China or other countries that restrict our ability to convert into U.S. dollars.

Commodity price risk

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

Interest rate risk

We are exposed to interest rate risk through our loan with ICBC. Interest under this loan is adjusted annually based upon the standard rate announced each year by the People’s Bank of China. As of December 31, 2009, the applicable interest rate was 5.94%. We could also be exposed to the risk of rising interest rates through our future borrowing activities. This is an inherent risk as borrowings mature and are renewed at then current market rates. The extent of this risk as to our ICBC loan, or any future borrowings, is not quantifiable or predictable because of the variability of future interest rates.

Customer credit risk

When our projects progress to commercial production, we will be exposed to the risk of financial non-performance by customers. To manage customer credit risk, we intend to monitor credit ratings of customers and seek to minimize exposure to any one customer where other customers are readily available. As of December 31, 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 Hai Hua and secure new customers, our revenue and results of operations would be adversely affected.

Item 4.		Controls and Procedures

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

We do not expect that our disclosure controls and procedures will prevent all errors or fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitation in a cost-effective control system, misstatements due to error or fraud could occur and not be detected.

Our management, with the participation of the Chief Executive Officer and the Chief Accounting Officer, evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2009 pursuant to Rule 13a-15 (b) of the Securities and Exchange Act of 1934, as amended. Based upon this evaluation, the Chief Executive Officer and Chief Accounting Officer concluded that our disclosure controls and procedures were not effective as of December 31, 2009 due to a material weakness in our internal accounting controls. Specifically, our internal control over financial reporting was not effective at ensuring that financial reporting risks arising from complex and non-routine transactions were identified timely and that appropriate accounting policies for such transactions were selected and applied. This material weakness has resulted in adjustments to our interim preliminary consolidated financial statements that were not identified by us. These errors were not prevented or detected by our internal control over financial reporting which could have resulted in a material misstatement of our interim or year-end consolidated financial statements and disclosures.

During our fiscal year ended June 30, 2009, we designed and implemented enhanced procedures to address this material weakness which included 1) the hiring of a full-time Chief Accounting Officer with appropriate U.S. GAAP and public company financial reporting experience, 2) ensuring that relevant personnel involved in the accounting for complex and non-routine transactions fully understand and apply the proper accounting for such transactions, and 3) engaging external accounting resources, when necessary, to augment our consideration and resolution of accounting matters especially those involving complex and non-routine transactions. However, we will not consider this material weakness fully remediated until we can evidence effectiveness of these procedures for a sufficient period of time.

There have been no changes in internal control over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

PART II

Item 1.		Legal Proceedings

In September 2008, we were named as one of a number of defendants in a lawsuit filed in the U.S. District Court for the Central District of California, Southern Division, by Igor Olenicoff, one of our former stockholders, and a company he controls. Also named were Timothy E. Vail (our former CEO and one of our directors), David Eichinger (our former CFO), and another one of our directors (collectively, we, Mr. Vail, Mr. Eichinger and the director are referred to as the “SES Defendants”), as well as UBS AG, Union Charter Ltd., and other persons who allegedly managed Mr. Olenicoff’s investments outside the U.S. The SES Defendants have been named in this lawsuit based primarily upon allegations that one of our former stockholders, Teflomi Trade & Trust, Inc., was a shell company formed for the purposes of holding Mr. Olenicoff’s assets overseas, and that the SES Defendants allegedly had knowledge of this arrangement. The claims initially asserted against the SES Defendants included, among others, securities fraud in violation of Rule 10b-5 under the Securities Act and the California state law equivalent, violations of the Racketeer Influenced and Corrupt Organizations Act, or RICO, common law fraud and negligent misrepresentation, breach of fiduciary duty, conspiracy and unfair business practices. On the SES Defendants’ motion, on July 31, 2009, the court issued an order dismissing the securities fraud claims as to each of the SES Defendants and the common law fraud, negligent misrepresentation claim and breach of fiduciary duty claims as to us, Mr. Vail and Mr. Eichinger. The court determined that certain other claims, including RICO, conspiracy and unfair business practices, were sufficiently pled and could proceed at this stage. Plaintiffs were given leave to amend and, on August 24, 2009, filed an amended complaint attempting to replead their securities fraud claims, and alleged a new claim for violation of the Uniform Commercial Code (the “UCC”). In response, on September 23, 2009, the SES Defendants filed a motion to dismiss the securities fraud and UCC claims. The court heard oral argument on the SES Defendants’ motion to dismiss, and on various other defendants’ motions to dismiss, on November 9, 2009. No final order has yet been issued by the court on these motions. The SES Defendants believe the claims alleged against them to be without merit and intend to continue to vigorously defend all claims which are allowed to proceed in the court.

Item 1A.		Risk Factors

None.

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

None.

Item 3.		Defaults Upon Senior Securities

None.

Item 4.		Submission of Matters to a Vote of Security Holders

At our Annual Meeting of Stockholders on December 16, 2009, six directors were elected for one-year terms expiring on the date of the annual meeting for the year ended June 30, 2010. As to each nominee for director, the results of the voting were as follows:

		For				Withheld
Lorenzo Lamadrid			32,758,821				3,757,191
Robert Rigdon			33,741,564				2,774,448
Donald Bunnell			33,764,255				2,751,757
Michael Storey			32,715,213				3,800,799
Denis Slavich			33,088,286				3,427,726
Harry Rubin			31,986,892				4,529,120

The results of voting to approve an amendment to our Certificate of Incorporation to increase the number of authorized shares of common stock, par value $.01 per share, from 100,000,000 to 200,000,000 were as follows:

										Broker non-
For		Against				Abstain				votes
25,104,755			9,563,433				1,847,818				—

The results of voting to approve the amendment to our Certificate of Incorporation to authorize a class of preferred stock, consisting of 20,000,000 authorized shares, which may be issued in one or more series, with such rights, preferences, privileges and restrictions as shall be fixed by our Board of Directors were as follows:

										Broker non-
For		Against				Abstain				votes
17,390,818			8,339,358				1,826,843				8,958,994

The results of voting to ratify the appointment of PricewaterhouseCoopers LLC as our independent registered public accounting firm for the fiscal year ending June 30, 2010, was as follows:

										Broker non-
For		Against				Abstain				votes
34,481,263			124,136				1,910,611				—

Item 5.		Other Information

None.

Forward Looking Statements

This Quarterly Report on Form 10-Q includes “forward-looking statements” within the meaning of Section 27A of the Securities Act, as amended, and Section 21E of the Exchange Act, as amended. All statements other than statements of historical fact are forward-looking statements. Forward-looking statements are subject to certain risks, trends and uncertainties that could cause actual results to differ materially from those projected. 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 operations, our ability to reduce operating costs, the limited history and viability of our technology, the impact of regulatory changes in China and elsewhere on our business, 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 HH Joint Venture, our ability to obtain the necessary approvals and permits for our Yima Joint Ventures and other future projects, our estimated timetables for achieving mechanical completion and commencing commercial operations for the Yima project and the sufficiency of our internal controls and procedures. Although we believe that in making such forward-looking statements our expectations are based upon reasonable assumptions, such statements may be influenced by factors that could cause actual outcomes and results to be materially different from those projected. We cannot assure you that the assumptions upon which these statements are based will prove to have been correct.

When used in this Form 10-Q, the words “expect,” “anticipate,” “intend,” “plan,” “believe,” “seek,” “estimate” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. Because these forward-looking statements involve risks and uncertainties, actual results could differ materially from those expressed or implied by these forward-looking statements for a number of important reasons, including those discussed under “Risk Factors” in our Annual Report on Form 10-K for the year ended June 30, 2009, as well as in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and elsewhere in this Form 10-Q.

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

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

Item 6.		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			Certificate of Amendment to the Certificate of Incorporation of the Company dated effective December 16, 2009 (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on December 17, 2009).
	31.1*			Certification of Chief Executive Officer of Synthesis Energy Systems, Inc. pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934, as amended.
	31.2*			Certification of Chief Financial Officer of Synthesis Energy Systems, Inc. pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934, as amended.
	32.1*			Certification of Chief Executive Officer of Synthesis Energy Systems, Inc. pursuant to Rule 13a-14(b) promulgated under the Securities Exchange Act of 1934, as amended, and Section 1350 of Chapter 63 of Title 18 of the United States Code.
	32.2*			Certification of Chief Financial Officer of Synthesis Energy Systems, Inc. pursuant to Rule 13a-14(b) promulgated under the Securities Exchange Act of 1934, as amended, and Section 1350 of Chapter 63 of Title 18 of the United States Code.

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.