SYNTHESIS ENERGY SYSTEMS INC - Quarter Report: 2012 December (Form 10-Q)

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended December 31, 2012

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

For the transition period from: to:

Commission file number: 001-33522

SYNTHESIS ENERGY SYSTEMS, INC.

(Exact name of registrant as specified in its charter)


Delaware		20-2110031
(State of Incorporation)		(I.R.S. Employer Identification No.)

Three Riverway, Suite 300, Houston, Texas		77056
(Address of principal executive offices)		(Zip code)

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

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

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No x

As of February 8, 2013 there were 62,577,157 shares of the registrant’s common stock, par value $.01 per share, outstanding.

TABLE OF CONTENTS


	Page
PART 1. Financial Information

Item 1. Financial Statements		1

Consolidated Balance Sheets as of December 31, 2012 and June 30, 2012 (unaudited)		1

Consolidated Statements of Operations for the Three Months Ended December 31, 2012 and 2011 (unaudited)		2

Consolidated Statements of Operations for the Six Months Ended December 31, 2012 and 2011 and the period from November 4, 2003 (inception) to December 31, 2012 (unaudited)		3

Consolidated Statements of Comprehensive Loss for the Three and Six Months Ended December 31, 2012 and 2011 and the period from November 4, 2003 (inception) to December 31, 2012 (unaudited)		4

Consolidated Statements of Cash Flows for the Six Months Ended December 31, 2012 and 2011 and the period from November 4, 2003 (inception) to December 31, 2012 (unaudited)		5

Consolidated Statement of Equity for the period from November 4, 2003 (inception) to December 31, 2012 (unaudited)		6

Notes to the Consolidated Financial Statements (unaudited)		7

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		20

Item 3. Quantitative and Qualitative Disclosure about Market Risk		34

Item 4. Controls and Procedures		35

PART II. Other Information

Item 1. Legal Proceedings		35

Item 1A. Risk Factors		35

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		35

Item 3. Defaults Upon Senior Securities		35

Item 4. Mine Safety Disclosures		36

Item 5. Other Information		36

Item 6. Exhibits		37

PART I

Item 1. Financial Statements

SYNTHESIS ENERGY SYSTEMS, INC.

(A Development Stage Enterprise)

Consolidated Balance Sheets

(In thousands)

(Unaudited)


	December 31, 2012			June 30, 2012
ASSETS
Current assets:
Cash and cash equivalents	$	23,303		$	18,035
Accounts receivable		102			316
Prepaid expenses and other currents assets		2,449			2,015
Inventory		23			23

Total current assets		25,877			20,389

Property, plant and equipment, net		33,115			33,942
Intangible asset, net		1,060			1,126
Investment in joint ventures		33,164			33,340
Other long-term assets		3,830			4,050

Total assets	$	97,046		$	92,847

LIABILITIES AND EQUITY
Current liabilities:
Accrued expenses and accounts payable	$	7,780		$	8,080
Current portion of long-term bank loan		2,450			2,435

Total current liabilities		10,230			10,515
Long-term bank loan		1,161			2,372

Total liabilities		11,391			12,887

Commitments and contingencies

Equity:
Common stock, $0.01 par value: 200,000 shares authorized: 62,577 and 52,022 shares issued and outstanding, respectively		626			520
Additional paid-in capital		221,590			207,345
Deficit accumulated during development stage		(140,696	)		(131,808	)
Accumulated other comprehensive income		4,976			4,802

Total stockholders’ equity		86,496			80,859
Noncontrolling interests in subsidiaries		(841	)		(899	)

Total equity		85,655			79,960

Total liabilities and equity	$	97,046		$	92,847

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,
	2012			2011
Revenue:
Product sales and other — related parties	$	—		$	19
Technology licensing and related services		13			164

Total revenue		13			183

Costs and expenses:
Costs of sales and plant operating expenses		133			881
General and administrative expenses		3,141			3,174
Stock-based compensation expense		109			292
Depreciation and amortization		570			641

Total costs and expenses		3,953			4,988

Operating loss		(3,940	)		(4,805	)

Non-operating (income) expense:
Equity in losses of joint ventures		400			402
Foreign currency gains		(85	)		(202	)
Interest income		(15	)		(26	)
Interest expense		78			142

Net loss		(4,318	)		(5,121	)

Less: net (income) loss attributable to noncontrolling interests		(85	)		74

Net loss attributable to stockholders	$	(4,403	)	$	(5,047	)

Net loss per share:
Basic and diluted	$	(0.07	)	$	(0.10	)

Weighted average common shares outstanding:
Basic and diluted		61,899			50,862

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,
	2012			2011			2012
Revenue:
Product sales and other — related parties	$	—		$	2,121		$	21,511
Technology licensing and related services		84			471			2,917
Other		—			86			607

Total revenue		84			2,678			25,035

Costs and expenses:
Costs of sales and plant operating expenses		264			4,085			32,615
General and administrative expenses		6,223			6,199			92,843
Asset impairment losses		—			—			9,075
Stock-based compensation expense		272			359			22,145
Depreciation and amortization		1,146			1,281			13,263

Total costs and expenses		7,905			11,924			169,941

Operating loss		(7,821	)		(9,246	)		(144,906	)

Non-operating (income) expense:
Equity in losses of joint ventures		917			834			3,201
Foreign currency gains		(48	)		(615	)		(2,401	)
Interest income		(28	)		(63	)		(3,165	)
Interest expense		174			326			3,454

Net loss		(8,836	)		(9,728	)		(145,995	)

Less: net (income) loss attributable to noncontrolling interests		(52	)		141			5,299

Net loss attributable to stockholders	$	(8,888	)	$	(9,587	)	$	(140,696	)

Net loss per share:
Basic and diluted	$	(0.16	)	$	(0.19	)	$	(3.59	)

Weighted average common shares outstanding:
Basic and diluted		57,116			50,860			39,241

See accompanying notes to the consolidated financial statements.

SYNTHESIS ENERGY SYSTEMS, INC.

(A Development Stage Enterprise)

Consolidated Statements of Comprehensive Loss

(In thousands)

(Unaudited)


													November 4, 2003 (inception)
	Three Months Ended December 31,						Six Months Ended December 31,						to December 31
	2012			2011			2012			2011			2012
Net loss, as reported	$	(4,318	)	$	(5,121	)	$	(8,836	)	$	(9,728	)	$	(145,995	)
Unrealized foreign currency translation adjustment		299			347			180			1,117			4,978

Comprehensive loss		(4,019	)		(4,774	)		(8,656	)		(8,611	)		(141,017	)
Less comprehensive (income) loss attributable to noncontrolling interests		(90	)		77			(58	)		148			5,296

Comprehensive loss attributable to the Company	$	(4,109	)	$	(4,697	)	$	(8,714	)	$	(8,463	)	$	(135,721	)

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						(inception) to
	December 31,						December 31,
	2012			2011			2012
Cash flows from operating activites:
Net loss	$	(8,836	)	$	(9,728	)	$	(145,995	)
Adjustments to reconcile net loss to net cash used in operating activities:
Stock-based compensation expense		272			359			22,145
Depreciation of property, plant and equipment		1,041			1,170			11,869
Amortization of intangible and other assets		105			111			1,394
Equity in losses of joint ventures		917			834			3,201
Foreign currency gains		(48	)		(615	)		(2,401	)
(Gain) loss on disposal of property, plant and equipment		1			(12	)		167
Asset impairment losses		—			—			9,075
Changes in operating assets and liabilities:
Accounts receivable		215			1,943			98
Prepaid expenses and other current assets		(420	)		(977	)		(1,714	)
Inventory		2			(116	)		(560	)
Other long-term assets		(35	)		(317	)		(1,388	)
Accrued expenses and payables		271			1,198			3,096

Net cash used in operating activities		(6,515	)		(6,150	)		(101,013	)

Cash flows from investing activities:
Capital expenditures		(9	)		(50	)		(38,104	)
Equity investment in joint ventures		(481	)		(356	)		(32,109	)
Purchase of marketable securities		—			—			(45,000	)
Redemption of marketable securities		—			—			45,000
GTI license royalty – Yima joint ventures		—			—			(1,500	)
ExxonMobil license royalty		—			—			(1,250	)
Proceeds from sale of fixed assets		—			—			7
Restricted cash – redemptions of certificates of deposit		—			—			(50	)
Amendment to GTI license rights		—			—			(500	)
Purchase of land use rights		—			—			(1,896	)
Receipt of Chinese governmental grant		—			—			556
Project prepayments		—			—			(3,210	)

Net cash used in investing activities		(490	)		(406	)		(78,056	)

Cash flows from financing activities:
Payments on long-term bank loan		(1,214	)		(1,212	)		(10,521	)
Proceeds from long-term bank loan		—			—			12,081
Refund of advance toward sale of common stock		(1,000	)		—			—
Proceeds from exercise (repurchase) of stock options, net		—			(35	)		921
Proceeds from issuance of common stock, net		14,484			—			194,453
Prepaid interest		—			—			(276	)
Financing costs		—			—			(143	)
Contributions from noncontrolling interest partners		—			—			4,456
Loans from shareholders		—			—			11

Net cash provided by (used in) financing activities		12,270			(1,247	)		200,982

Net increase (decrease) in cash		5,265			(7,803	)		21,913
Cash and cash equivalents, beginning of period		18,035			32,176			—
Effect of exchange rates on cash		3			17			1,390

Cash and cash equivalents, end of period	$	23,303		$	24,390		$	23,303

See accompanying notes to the consolidated financial statements.

SYNTHESIS ENERGY SYSTEMS, INC.

(A Development Stage Enterprise)

Consolidated Statement of Equity

(In thousands)

(Unaudited)


								Deficit Accumulated			Accumulated
	Common Stock							During the			Other		Non-
	Shares		Common Stock		Additional Paid-in Capital			Development Stage			Comprehensive Income		controlling Interest			Total
Balance at June 30, 2012		52,022	$	520	$	207,345		$	(131,808	)	$	4,802	$	(899	)	$	79,960
Net income (loss)		—		—		—			(8,888	)		—		52			(8,836	)
Currency translation adjustment		—		—		—			—			174		6			180

Comprehensive loss		—		—		—			—			—		—			(8,656	)
Net proceeds from issuance of common stock		10,352		104		13,975			—			—		—			14,079
Stock-based compensation		—		—		272			—			—		—			272
Exercise of stock options		203		2		(2	)		—			—		—			—

Balance at December 31, 2012		62,577	$	626	$	221,590		$	(140,696	)	$	4,976	$	(841	)	$	85,655

See accompanying notes to the consolidated financial statements.

SYNTHESIS ENERGY SYSTEMS, INC.

(A Development Stage Enterprise)

Notes to Consolidated Financial Statements

(Unaudited)

Note 1 – Summary of Significant Accounting Policies

(a) Organization and description of business

Synthesis Energy Systems, Inc. (“SES”), together with its wholly-owned and majority-owned controlled subsidiaries (collectively, the “Company”) is a development stage enterprise. The Company is a global energy and gasification technology company that provides products and solutions to the energy and chemical industries. 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. The Company provides licenses, equipment components, engineering services and product offerings related to the U-GAS^® technology. The Company’s headquarters are located in Houston, Texas.

(b) Basis of presentation and principles of consolidation

The consolidated financial statements for the periods presented are unaudited and reflect all adjustments, consisting of normal recurring items, which management considers necessary for a fair statement. Operating results for the three month and six month periods ended December 31, 2012 are not necessarily indicative of results to be expected for the fiscal year ending June 30, 2013.

The consolidated financial statements are in U.S. dollars. Noncontrolling interests in consolidated subsidiaries in the consolidated balance sheets represents minority stockholders’ proportionate share of the equity in such subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications have been made in prior period financial statements to conform to current period presentation. These reclassifications had no effect on net loss. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto reported in the Company’s Annual Report on Form 10-K for the year ended June 30, 2012. 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, 2012 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) Accounting for Variable Interest Entities (“VIEs”) and Financial Statement Consolidation Criteria

The joint ventures which the Company enters into may be considered VIEs. The Company consolidates all VIEs where it is the primary beneficiary. This determination is made at the inception of the Company’s involvement with the VIE and is continuously assessed. The Company considers qualitative factors and forms a conclusion that the Company, or another interest holder, has a controlling financial interest in the VIE and, if so, whether it is the primary beneficiary. In order to determine the primary beneficiary, the Company considers who has the power to direct activities of the VIE that most significantly impacts the VIE’s performance and has an obligation to absorb losses from or the right to receive benefits of the VIE that could be significant to the VIE. The Company does not consolidate VIEs where it is not the primary beneficiary. The Company accounts for these unconsolidated VIEs under the equity method of accounting and includes its net investment on its consolidated balance sheets. The Company’s equity interest in the net income or loss from its unconsolidated VIEs is recorded in non-operating (income) expense on a net basis on its consolidated statement of operations.

The Company has determined that the ZZ Joint Venture is a VIE and has determined that the Company is the primary beneficiary. In making the initial determination, the Company considered, among other items, the change in profit distribution between the Company and Shandong Weijiao Group Xuecheng Energy Company Ltd., (“ Xuecheng Energy”) (previously Hai Hua), after 20 years. The expected negative variability in the fair value of the ZZ Joint Venture’s net assets was considered to be greater during the first 20 years of the ZZ Joint Venture’s life, which coincided with our original 95% profit/loss allocation, versus the latter 30 years in which the Company’s profit/loss allocation would be reduced to 10%. As the result of an amendment to the ZZ Joint Venture agreement in 2010, the profit distribution percentages will remain in place after the first 20 years, providing further support to the determination that the Company is the primary beneficiary. In addition, the Company considered whether the terms of the syngas purchase and sale agreement with Xuecheng Energy contained a lease. The factors considered included (i) the Company’s ability to operate and control the plant during the initial 20 years; and (ii) whether it was more than remote that one or more parties other than Xuecheng Energy would purchase more than a minor amount (considered to be 10%) of the plant’s output during the term of the syngas purchase and sale agreement. Because the Company determined that the syngas purchase and sale agreement did not contain a lease, the Company accounts for the revenues from that agreement in accordance with the Company’s revenue recognition policy for product sales.

The following tables provide additional information on the ZZ Joint Venture’s assets and liabilities as of December 31, 2012 and June 30, 2012 which are consolidated within the Company’s consolidated balance sheets (in thousands):


	December 31, 2012
	Consolidated		ZZ Joint Venture (1)		% (2)
Current assets	$	25,877	$	532		2	%
Long-term assets		71,169		35,167		49	%

Total assets	$	97,046	$	35,699		37	%

Current liabilities	$	10,230	$	4,500		44	%
Long-term liabilities		1,161		1,161		100	%
Equity		85,655		30,038		35	%

Total liabilities and equity	$	97,046	$	35,699		37	%


	June 30, 2012
	Consolidated		ZZ Joint Venture (1)		% (2)
Current assets	$	20,389	$	575		3	%
Long-term assets		72,458		36,937		50	%

Total assets	$	92,847	$	37,512		40	%

Current liabilities	$	10,515	$	3,793		36	%
Long-term liabilities		2,372		2,372		100	%
Equity		79,960		31,347		39	%

Total liabilities and equity	$	92,847	$	37,512		40	%

(1)	Amounts reflect information for ZZ Joint Venture and exclude intercompany items.

(2)	ZZ Joint Venture’s percentage of the amount on the Company’s consolidated balance sheets.

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

The Company has determined that SES Resource Solutions, Ltd. (“SRS”) that was formed in June 2011 is a VIE and that the Company is not the primary beneficiary since neither the Company nor Midas Resources AG control SRS due to each having 50% ownership interest in SRS and each sharing control, risks and benefits of SRS equally. SRS had no assets or liabilities as of December 31, 2012.

The Company’s joint venture with Golden Concord (“GC Joint Venture”) was formed to (i) develop, construct and operate a coal gasification, methanol and dimethyl either (“DME”) production plant utilizing U-GAS^®. The GC Joint Venture project is not currently being developed. The Company has determined that the GC Joint Venture is a VIE and has determined that it is the primary beneficiary since the Company has a 51% ownership interest in the GC Joint Venture and since there are no qualitative factors that would preclude the Company from being deemed the primary beneficiary. Although the Company includes the financial statements of the GC Joint Venture in its consolidated financial statements, there are no significant assets within the GC Joint Venture. There were however current liabilities of approximately $1.1 million as of December 31, 2012 and June 30, 2012 related to unpaid settlements of amounts due to various contractors from the initial construction work for the project.

(d) Revenue Recognition

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

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

(e) Fair value measurements

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

Level 1

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

Level 2

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

Level 3

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

The Company’s financial assets and liabilities are classified based on the lowest level of input that is significant for the fair value measurement. The following table summarizes the valuation of the Company’s financial assets by pricing levels, as of December 31, 2012 and June 30, 2012 (in thousands):


	December 31, 2012
	Level 1		Level 2			Level 3		Total
Assets:
Certificates of Deposit	$	—	$	50	(1)	$	—	$	50
Money Market Funds		—		22,231	(2)		—		22,231

	June 30, 2012
	Level 1		Level 2			Level 3		Total
Assets:
Certificates of Deposit	$	—	$	50	(1)	$	—	$	50
Money Market Funds		—		15,957	(2)		—		15,957

(1)	Amount included in current assets on the Company’s consolidated balance sheets.

(2)	Amount included in cash and cash equivalents on the Company’s consolidated balance sheets.

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

Note 2 – Recently Issued Accounting Standards

In June 2011, the the Financial Accounting Standards Board (“FASB”) issued new guidance on the presentation of comprehensive income. The new guidance allows an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The new guidance eliminates the current option to report other comprehensive income and its components in the statement of changes in stockholders equity. This new guidance is effective for fiscal years beginning after December 15, 2011, however the provision of the new guidance which requires reclassifications out of comprehensive income be shown separately in the financial statements has been deferred to allow the FASB to reconsider alternatives. The Company adopted these requirements as of July 1, 2012.

In July 2012 the FASB issued ASU 2012-02: Intangibles: Goodwill and Other: Testing Indefinite-Lived Intangible Assets for Impairment (Topic 350) which is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. This update is intended to reduce cost and complexity by providing an entity with the option to make a qualitative assessment about the likelihood that an indefinite-lived intangible asset is impaired to determine whether it should perform a quantitative impairment test. The Company does not expect the adoption of this guidance to have a significant impact on its consolidated financial statements.

Note 3 – Current Projects

Zao Zhuang Joint Venture

Joint Venture Agreement

On July 6, 2006, the Company entered into a cooperative joint venture contract with Shandong Hai Hua Coal & Chemical Company Ltd. (“Hai Hua”), which established Synthesis Energy Systems (Zao Zhuang) New Gas Company Ltd., (“ ZZ Joint Venture”), a joint venture company that has the primary purposes of (i) developing, constructing and operating a syngas production plant utilizing the U-GAS ^® technology in Zao Zhuang City, Shandong Province, China and (ii) producing and selling syngas and the various byproducts of the plant, including ash and elemental sulphur. In August 2012, Hai Hua’s name was changed to Xuecheng Energy, after a change in control transaction. The Company owns 97.5% of the ZZ Joint Venture and Xuecheng Energy owns the remaining 2.5%. The Company consolidates the results of the ZZ Joint Venture in its consolidated financial statements.

Syngas Purchase and Sale Agreement

The ZZ Joint Venture is also party to a purchase and sale agreement with Xuecheng Energy for syngas produced by the plant, whereby Xuecheng Energy will pay the ZZ Joint Venture an energy fee and capacity fee, as described below, based on the syngas production. The syngas to be purchased by Xuecheng Energy is subject to certain quality component requirements set forth in the contract. In late December 2008, the plant declared commercial operations status for purposes of the purchase and sale agreement. The energy fee is a per normal cubic meters, or Ncum, of syngas calculation based on a formula which factors in the monthly averages of the prices of design base coal, coke, coke oven gas, power, steam and water, all of which are components used in the production of syngas. The capacity fee is paid based on the capacity of the plant to produce syngas, factoring in the number of hours (i) of production and (ii) of capability of production as compared to the guaranteed capacity of the plant, which for purposes of the contract is 22,000 Ncum per hour of net syngas. Xuecheng Energy 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, as well as reliability issues with respect to Xuecheng Energy’s plant, Xuecheng Energy has operated at a reduced rate of syngas consumption. Xuecheng Energy has used approximately 35% to 45% of the syngas guarantee capacity since 2009.

In April 2009, the ZZ Joint Venture entered into a Supplementary Agreement with Xuecheng Energy, amending the terms of the purchase and sale agreement. The Supplementary Agreement was entered into to provide more clarity regarding the required syngas quality and volume to be delivered, recovery of the energy fee during turndown periods and operations coordination during unscheduled outages. Under the Supplementary Agreement, the syngas quality specification was amended to provide more clarity as to the minor constituents allowable in the syngas. For purposes of the Supplemental Agreement, syngas that meets these specifications is deemed “compliant gas” and syngas that does not meet these specifications is deemed “non-compliant gas.” The Supplementary Agreement also added a requirement for Xuecheng Energy to pay the ZZ Joint Venture the capacity fee and 70% of the energy fee for all non-compliant gas which is taken by Xuecheng Energy. However, if more than 50% of the syngas taken by Xuecheng Energy 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 Xuecheng Energy 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 Xuecheng Energy has an unscheduled shutdown, and the plant continues to operate on standby during such period, Xuecheng Energy is still required to pay the energy fee to the ZZ Joint Venture. In the event that the plant has an unscheduled shutdown and does not provide at least three hours prior notice to Xuecheng Energy, the ZZ Joint Venture may be required to provide certain compensation to Xuecheng Energy.

Since April 2011, Xuecheng Energy has not paid the capacity fees owed to the ZZ Joint Venture. The unpaid amount totaled approximately $6.8 million as of December 31, 2012. The plant continued to operate and provide syngas to Xuecheng Energy through September 2011 with the expectation that Xuecheng Energy would pay the capacity fee. Xuecheng Energy has paid other contractual obligations such as the energy fees and by-product sales due under the contract. Since April 2011, the Company has not recognized these capacity fee revenues and will not recognize any capacity fees until collection is reasonably assured. In late September 2011, both the Xuecheng Energy methanol plant and the ZZ Joint Venture plant were shut down for scheduled maintenance and the ZZ Joint Venture plant has been kept idle while the ZZ Joint Venture develops its revised commercial arrangement with Xuecheng Energy. In March 2012, Xuecheng Energy advanced approximately $1.0 million to the ZZ Joint Venture. In September 2012, Xuecheng Energy advanced an additional approximately $0.8 million to the ZZ Joint Venture.

To date, Xuecheng Energy has been unable to off take the volume of syngas originally expected for the original plant design and as a result the plant has incurred operating losses. Because of these circumstances, the ZZ Joint Venture is working on various arrangements to increase the syngas off take volume. Such arrangements involve a combination of technical improvements to Xuecheng Energy’s methanol unit, as well as restructuring the current business arrangement to create an integrated syngas to methanol operation. In December 2011, the Company entered into a framework agreement with Xuecheng Energy pursuant to which the Company and Xuecheng Energy are working collaboratively to complete a definitive agreement that will provide the basis for a fully integrated syngas to methanol operation and to resolve the commercial issues. Discussions regarding the nonpayment of the contractual capacity fees and the restructuring of the joint venture are ongoing. In the event that the Company is not successful reaching agreement with Xuecheng Energy, the Company will seek to recover the outstanding capacity fees through binding arbitration.

Additionally, the Company is also evaluating alternative products and partnership structures for a possible expansion of the ZZ Joint Venture plant for its longer term use. In 2010, the Company received the necessary government approval for an expansion and this project is under evaluation by the Company. The Company is also evaluating certain new downstream technologies to produce high value products. The local government has expressed interest in supplying biomass to the project if the Company decides to convert the feedstock from coal to biomass.

Loan Agreement

On March 22, 2007, the ZZ Joint Venture entered into a seven-year loan agreement and received $12.6 million of loan proceeds pursuant to the terms of a Fixed Asset Loan Contract with the Industrial and Commercial Bank of China (“ICBC”) to complete the project financing for the ZZ Joint Venture. Key terms of the Fixed Asset Loan Contract with ICBC are as follows:

•

Term of the loan is seven years from the commencement date (March 22, 2007) of the loan;

•

Interest is adjusted annually based upon the standard rate announced each year by the People’s Bank of China, and as of December 31, 2012, the applicable interest rate was 7.05% and is payable monthly;

•

Principal payments of RMB 7.7 million (approximately $1.2 million based on current currency exchange rates) are due in March and September of each year beginning on September 22, 2008 and ending on March 31, 2014;

•

Xuecheng Energy is the guarantor of the entire loan;

•

Assets of the ZZ Joint Venture are pledged as collateral for the loan;

•

Covenants include, among other things, prohibiting pre-payment without the consent of ICBC and permitting ICBC to be involved in the review and inspection of the ZZ Joint Venture 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, 2012, the ZZ Joint Venture was in compliance with all covenants and obligations under the Fixed Asset Loan Contract.

Impairment Assessment

Due to the economic trends that have significantly affected commodity prices including methanol, Xuecheng Energy’s refusal to pay capacity fees owed to the ZZ Joint Venture and the ZZ Joint Venture plant’s operating losses, the Company believed an impairment assessment of the ZZ Joint Venture plant was warranted as of June 30, 2012. The Company performed an analysis of the ZZ Joint Venture plant and determined that these assets were not impaired based upon management’s estimated cash flow projections for the plant. Such estimated cash flow projections included a case based on the completion of the ongoing negotiations between the Company and Xuecheng Energy to restructure the current business arrangement to create an integrated syngas to methanol operation. This restructuring would include a combination of technical improvements being made to Xuecheng Energy’s methanol unit allowing for increased syngas off-take and other repairs and improvements being made to the plant enabling more efficient joint production of methanol. An alternative case was based on developing an additional downstream facility to produce glycol. This case assumes the additional capital investment is made by a strategic partner and that we retain a minority interest in the combined project. If the Company is not successful in restructuring the joint venture or otherwise improving the ZZ Joint Venture’s profitability, or if management’s estimated cash flow projections for these assets decrease, the ZZ Joint Venture plant could become impaired which could have a material effect on the Company’s consolidated financial statements. As no significant changes occurred during the six months ended December 31, 2012, an updated impairment assessment was not necessary as of December 31, 2012.

Yima Joint Ventures

In August 2009, the Company entered into amended joint venture contracts with Yima Coal Industry (Group) Co., Ltd. (“Yima”), replacing the prior joint venture contracts entered into in October 2008 and April 2009. The joint ventures were formed for each of the gasification, methanol/methanol protein production, and utility island components of the plant (collectively, the “Yima Joint Ventures”). The parties obtained government approvals for the project’s feasibility study during the three months ended December 31, 2008 and for the project’s environmental impact assessment during the three months ended March 31, 2009, which were the two key approvals required to proceed with the project. The amended joint venture contracts provide that: (i) the Company and Yima contribute equity of 25% and 75%, respectively, to the Yima Joint Ventures; (ii) Yima will guarantee the repayment of loans from third party lenders for 50% of the project’s cost and, if debt financing is not available, Yima is obligated to provide debt financing via shareholder loans to the project until the project is able to secure third-party debt financing; and (iii) Yima will supply coal to the project from a mine located in close proximity to the project at a preferential price subject to a definitive agreement to be subsequently negotiated. In connection with entering into the amended contracts, the Company and Yima contributed their remaining cash equity contributions of $29.3 million and $90.8 million, respectively, to the Yima Joint Ventures during the three months ended September 30, 2009. The Company will also be responsible for its share of any cost overruns on the project.

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.

The Yima Joint Venture plant’s final stages of construction and its commissioning are progressing well and most sections of the plant are either complete or more than 90% complete. In December 2012, the plant produced its first methanol and expects to be ramping up methanol production to annual production of 210,000 tonnes, or about 70% of the plant’s capacity, as it completes all the remaining commissioning and start-up steps throughout the first half of calendar year 2013. The plant is designed to produce 300,000 tonnes per year of methanol from two operating gasifiers. Any delays in the final work on construction or commissioning could cause delays in methanol production.

Based on the project’s current scope of methanol only, the current estimate of the total required capital of the project is approximately $250 million. The remaining capital for the project is to be provided by project debt to be obtained by the Yima Joint Ventures. Yima has agreed to guarantee the project debt in order to secure debt financing from domestic Chinese banking sources. The Company has agreed to pledge to Yima its ownership interests in the joint ventures as security for its obligations under any project guarantee. In the event that the necessary additional debt financing is not obtained, Yima has agreed to provide a loan to the joint ventures to satisfy the remaining capital needs of the project with terms comparable to current market rates at the time of the loan.

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

The Company has included the $1.5 million payment paid to the 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 which is expected in fiscal 2013.

The Company’s equity in losses of the Yima Joint Ventures for the three-month and six-month periods ended December 31, 2012 and 2011 were $0.1 million, $0.2 million, $0.4 million and $0.4 million, respectively. The following table presents summarized unconsolidated financial information for the Yima Joint Ventures (in thousands):


	Three Months Ended						Six Months Ended
	December 31,						December 31,
	2012			2011			2012			2011
Income statement data:

Revenue	$	—		$	—		$	—		$	—
Operating loss		(1,127	)		(1,080	)		(2,120	)		(2,073	)
Net loss		(510	)		(872	)		(1,495	)		(1,711	)


	December 31, 2012		June 30, 2012
Balance sheet data:

Current assets	$	42,235	$	74,154
Noncurrent assets		209,185		174,165
Current liabilities		33,701		29,247
Noncurrent liabilities		90,843		91,491

SES Resource Solutions

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

•

SRS has the exclusive right to promote our gasification technology for the purpose of securing low-cost coal resources in projects worldwide that have been approved by the board of directors of SRS;

•

Midas provides expertise to originate and execute the above projects;

•

the Company provides SRS with technology licenses and engineering development support for use in developing the joint integrated coal resource projects;

•

SRS being managed by a four person board of directors, two of which are appointed by the Company and two of which are appointed by Midas;

•

the Company agreeing to provide up to $2.0 million in funding to SRS, although it has the ability to discontinue funding at any point in time; and

•

revenue and profits are equally divided between the joint venture partners.

As of December 31, 2012, the Company had funded approximately $1.7 million to SRS including. In December 2012, SRS suspended a majority of its expenses until the financial markets for coal resources improve.

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


	Three Months Ended						Six Months Ended
	December 31,						December 31,
	2012			2011			2012			2011
Income statement data:

Revenue	$	—		$	—		$	—		$	—
Operating loss		(544	)		(368	)		(1,085	)		(817	)
Net loss		(544	)		(368	)		(1,085	)		(817	)

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 original U-GAS ^® technology for 100% biomass and coal/biomass blends exceeding 40% biomass. The New Agreement differs from the Original Agreement most critically by allowing the Company to sublicense U-GAS ^® to third parties for coal, coal and biomass mixtures or 100% biomass projects (subject to the approval of GTI, which approval shall not be unreasonably withheld), with GTI to share the revenue from such third party licensing fees based on an agreed percentage split (the “Agreed Percentage”). In addition, the prior obligation to fabricate and put into operation at least one U-GAS ^® system for each calendar year of the Original Agreement in order to maintain the license has been eliminated in the New Agreement.

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

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

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

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

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

Note 5 – Stock-Based Compensation

As of December 31, 2012, the Company had outstanding stock option and restricted stock awards granted under the Company’s Amended and Restated 2005 Incentive Plan, as amended (the “Plan”). On December 21, 2012, the Company’s stockholders authorized an additional 1,800,000 shares of common stock for future awards under the Plan. As of December 31, 2012, there were 2,136,533 shares authorized for future issuance pursuant to the Plan. Under the Plan, the Company may grant both incentive and non-qualified stock options, stock appreciation rights, restricted stock units and other stock-based awards to officers, directors, employees and non-employees. Stock option awards generally vest ratably over a one to four year period and expire ten years after the date of grant.

In March 2012, the Compensation Committee of the Company’s Board of Directors authorized the issuance of 146,668 shares of restricted stock to the Company’s independent non-employee directors as consideration for director fees. The restricted stock vested quarterly over calendar year 2012 and the fair value of the restricted stock was based on the market value as of the date of the awards.

The amount of unvested restricted stock outstanding was as follows:


	Shares of
	Restricted Stock
Nonvested at June 30, 2012		73,336
Granted		—
Vested		(73,336	)

Nonvested at December 31, 2012		—

Stock option activity during the six months ended December 31, 2012 was as follows:


	Shares of Common Stock Underlying
	Stock Options
Outstanding at June 30, 2012		6,750,201
Granted		50,000
Exercised		(541,226	)
Forfeited		(50,000	)

Outstanding at December 31, 2012		6,208,975

Exercisable at December 31, 2012		5,279,863

The fair values for the stock options granted during the six months ended December 31, 2012 were estimated at the date of grant using a Black-Scholes-Morton option-pricing model with the following weighted-average assumptions.


Risk-free rate of return		0.80	%
Expected life of award		5.75	years
Expected dividend yield		0.00	%
Expected volatility of stock		96	%
Weighted-average grant date fair value	$	1.05

In February 2013, the Company issued warrants to Crystal Vision Energy Limited (“CVE”) for the right to acquire up to 1.2 million shares of the Company’s common stock. CVE was entitled to the warrants under the terms of the consulting agreement entered into with CVE effective as of January 1, 2013. The warrants have an exercise price of $1.50 per share and have a term of 5 years. Warrants to acquire an additional 1.2 million shares on the same terms are due to CVE in February 2014 if the consulting agreement is still in effect.

Note 6 – Net Loss Per Share

Historical net loss per share of common stock is computed using the weighted average number of shares of common stock outstanding. Basic loss per share excludes dilution and is computed by dividing net loss available to common stockholders by the weighted average number of shares of common stock outstanding for the period. Stock options and unvested restricted stock are the only potential dilutive share equivalents the Company has outstanding for the periods presented. For the six months ended December 31, 2012 and 2011 and the period from November 4, 2003 (inception) to December 31, 2012, options to purchase common stock were excluded from the computation of diluted earnings per share as their effect would have been antidilutive as the Company incurred net losses during those periods.

Note 7 – Risks and Uncertainties

Any future decrease in economic activity in China, India or in other regions of the world, in which the Company may in the future do business, could significantly and adversely affect its results of operations and financial condition in a number of other ways. Any decline in economic conditions may reduce the demand for prices from the products from our plants. 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.

As described under Note 3, Xuecheng Energy has not made the capacity fee payments to the ZZ Joint Venture since April 2011. The unpaid amount totals approximately $6.8 million as of December 31, 2012. Although the Company is continuing to work with Xuecheng Energy on alternatives to resolve the issue, there can be no assurances that the Company will collect these amounts or that the joint venture will be restructured. The Company’s revenue and results of operations have been and would continue to be adversely affected if Xuecheng Energy continues to not pay the capacity fee or if it is unable to retain Xuecheng Energy as a customer or secure new customers. The Company has shut down the ZZ Joint Venture plant since late September 2011 and expects the plant to remain idle until it is able to restructure the joint venture with Xuecheng Energy to jointly produce methanol, as contemplated by the framework agreement executed in December 2011 as described under Note 3, or find an alternative purchaser of its production or a different use for the plant. Discussions regarding the nonpayment of the contractual capacity fees and the restructuring of the joint venture are ongoing. In the event that the Company is not successful reaching agreement with Xuecheng Energy, the Company will seek to recover the outstanding capacity fees through binding arbitration.

The Yima Joint Venture plant’s final stages of construction and its commissioning are progressing well and most sections of the plant are either complete or more than 90% complete. In December 2012, the plant produced its first methanol and expects to be ramping up methanol production to full capacity as it completes all the remaining commissioning and start-up steps throughout the first half of calendar year 2013. The plant is designed to produce 300,000 tonnes per year of methanol from two operating gasifiers.Any delays in the final work on construction or commissioning could cause that methanol production is delayed.

The Company will limit the development of any further projects until worldwide capital and debt markets improve and it has assurances that acceptable financing is available to complete such projects. 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 could lead to, among other things, the impairment of the Company’s significant assets, including its assets in the ZZ Joint Venture and its investment in the Yima Joint Ventures, and an inability to develop any further projects.

The Company expects to continue for a period of time to have negative operating cash flows until it can generate sufficient cash flows from SES China (including the ZZ Joint Venture and the Yima Joint Ventures) or its licensing and related service projects, as well as from other projects which are under development, to cover its general and administrative expenses and other operating costs. In addition, the Company may need to aggressively pursue additional partners in China and may need to seek other equity financing or reduce its operating expenses. The Company will also limit the development of any further projects until it has assurances that acceptable financing is available to complete the project. Despite this, the Company will continue to pursue the development of selective projects with strong and credible partners or off-takers where the Company believes equity and debt can be raised from third parties or where the Company believes it can attract a financial partner to participate in the project.

The Company can make no assurances that its business operations will develop and provide it with significant cash to continue operations. 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.

Note 8 – Share Purchase Agreements

Share Purchase Agreements with Hongye and Zhongmo

On June 18, 2012, the Company entered into a Share Purchase Agreement (the “Hongye Agreement”) with Hongye International Investment Group Co., Ltd. (“Hongye”), pursuant to which Hongye will acquire 6,175,093 shares (the “Hongye Shares”) of the Company’s common stock for $1.50 per share, for an aggregate purchase price of $9,262,639, and entered into a Share Purchase Agreement (the “Zhongmo Agreement”) with Shanghai Zhongmo Investment Management Co., Ltd. (“Zhongmo”), pursuant to which Zhongmo will acquire 4,177,335 shares (the “Zhongmo Shares,” and together with the Hongye Shares, the “Shares”) of common stock for $1.50 per share, for an aggregate purchase price of $6,266,002. In June 2012, the Company received a $1.0 million advance from Hongye towards the Share Purchase Agreement (which was repaid to Hongye in connection with the funding described below).

On September 21, 2012, the Company received gross proceeds of approximately $8.7 million from Hongye and issued 5,777,700 of the Hongye Shares to Hongye. On October 10, 2012, the Company received gross proceeds of approximately $6.3 million from Zhongmo and issued the Zhongmo Shares to Zhongmo. Also, on October 16, 2012, the Company received gross proceeds of approximately $0.6 million from Hongye and issued the remaining 397,393 of the Hongye Shares to Hongye. The Company incurred transaction costs of approximately $1.3 million related to closing the Hongye Agreement of which approximately $0.3 million was paid with shares of the Company’s common stock in January 2013.

The Hongye Agreement and the Zhongmo Agreement include several post-closing covenants and agreements:

•

Neither Hongye nor Zhongmo shall sell, assign or transfer any Shares until the twelve month anniversary of the closing date.

•

For so long as either Hongye or Zhongmo owns at least 5% of the total issued and outstanding shares of Common Stock at any meeting of stockholders of the Company or at any adjournment thereof or in any other circumstances upon which a vote, consent or other approval (including by written consent) is sought, they shall, including by executing a written consent if requested by the Company, vote (or cause to be voted) the Shares in favor of each director nominated by the board of directors of the Company (the “Board”).

•

Until the third anniversary of the closing date, neither Hongye, Zhongmo nor any of their affiliates, shall, without the prior written consent of the Board, directly or indirectly, (i) effect or seek, offer or propose (whether publicly or otherwise) to effect, or cause or participate in or in any way assist any other person to effect or seek, offer or propose (whether publicly or otherwise) to effect or participate in, (A) any acquisition of any securities or rights to acquire any securities (or any other beneficial ownership thereof) or assets of the Company or any of its subsidiaries (provided that the foregoing shall not apply to any acquisition of securities under the terms hereof); (B) any merger or other business combination or tender or exchange offer involving the Company or any of its subsidiaries; or (C) any “solicitation” of “proxies” (as such terms are used in the proxy rules of the SEC) or consents to vote with respect to any voting securities of the Company, or any communication exempted from the definition of “solicitation” by Rule 14a-1(l)(2)(iv) under the Exchange Act); (ii) form, join or in any way participate in a “group” (as defined under the Exchange Act) with respect to the Company; (iii) have any discussions or enter into any arrangements, understandings or agreements (oral or written) with, or advise, finance, assist or actively encourage, any third party with respect to any of the matters set forth above, or make any investment in any other person that engages, or offers or proposes to engage, in any of such matters; (iv) take any action which might cause or require the Company, Hongye and/or their affiliates to make a public announcement regarding any of the types of matters set forth above; or (v) disclose any intention, plan or arrangement relating to any of the foregoing.

•

The net proceeds received by the Company shall be fully applied to its operations and projects in China and shall be deposited into a bank account in China or Hong Kong controlled by the Company’s China-centric business platform, SES China.

In addition, under the Hongye Agreement, the Company has agreed to certain additional post-closing covenants and agreements:

•

After the closing date, the Company will increase the size of the Board by two (2) and the Board agrees to appoint two (2) individuals identified by Hongye for service as directors on the Board (one of which will be appointed Vice Chairman of the Board) and to annually nominate such individuals for continued service on the Board; provided, however, that if Hongye owns less than 9%, but more than 5%, of the total issued and outstanding shares of Common Stock at any point after the closing date, the Board agrees to appoint one (1) individual identified by Hongye for service as director on the Board and to annually nominate such individual for continued service on the Board, while if Hongye owns less than 5% of the total issued and outstanding shares of Common Stock at any point after the closing date, the Board shall have no further obligation to appoint or nominate any individual identified by Hongye for service as a director. Any person appointed or elected to the Board must meet minimum criteria for service on the Board under applicable Company guidelines, U.S. securities laws and the rules and regulations of the NASDAQ, as determined in the reasonable discretion of the Board, and shall follow all applicable policies and procedures of the Company. In September 2012, Mr. Gao Feng was appointed to the Board as a designee of Hongye and, in October 2012, Mr. Yang Guang was appointed to the Board as a designee of Hongye.

•

After the closing date, and as long as Hongye owns more than 9% of the total issued and outstanding shares of common stock, Hongye shall have the right to appoint one Vice President and a Deputy Financial Director in the Company’s China business. Such Vice President and Deputy Financial Director shall report to the Company’s China Managing Director and China Financial Director, respectively. The qualification and employment terms and conditions of such positions will be subject to the approval of the China Managing Director and the appointees to such positions shall agree to follow all applicable policies and procedures of the Company.

Share Purchase Agreements with ZJX

On March 31, 2011, the Company entered into a Share Purchase Agreement (the “Agreement”) with China Energy Industry Holdings Group Co, Ltd. (“China Energy”) and Zhongjixuan Investment Management Company Ltd. (“ZJX”). For a summary description of the terms of this Agreement, see the Company’s Current Report on Form 8-K filed on March 31, 2011.

Closing of the transaction with China Energy and ZJX is subject to approval by the Company’s stockholders and other customary closing conditions. Although the Agreement was not extended at March 31, 2012, the Company and ZJX have continued to keep the Agreement in effect. Although the Company believes that ZJX remains active in securing the funding for China Energy with various investor groups, the Company cannot predict the likelihood of ZJX’s success with this effort or the amount of time it could take to close the transaction. The Company also expects than a transaction, if any, which is ultimately entered into with ZJX is likely to be on different terms than previously disclosed.

Note 9 – Segment Information

The Company’s reportable operating segments have been determined in accordance with the Company’s internal management reporting structure. The segment reporting has been revised during fiscal 2013 to include SES China, Technology Licensing and Related Services, and Corporate. The SES China reporting segment includes all of the assets and operations and related administrative costs for China including the investment in the Yima Joint Ventures. The Technology Licensing and Related Services reporting segment includes all of the Company’s current operating activities outside of China. The Corporate reporting segment includes the executive and administrative expenses of the corporate office in Houston. The Company evaluates performance based upon several factors, of which a primary financial measure is segment operating income or loss. Reclassifications have been made in the prior period financial statements to conform to the current period presentation.

The following table presents the revenue, operating loss and total assets by segment (in thousands):


	Three Months Ended						Six Months Ended
	December 31,						December 31,
	2012			2011			2012			2011
Revenue:
SES China	$	3		$	19		$	8		$	2,121
Technology licensing and related services		10			164			76			557
Corporate & other		—			—			—			—

Total revenue	$	13		$	183		$	84		$	2,678

Operating loss:
SES China	$	(2,190	)	$	(2,650	)	$	(4,625	)	$	(5,444	)
Technology licensing and related services		(579	)		(769	)		(1,064	)		(1,102	)
Corporate & other		(1,171	)		(1,386	)		(2,132	)		(2,700	)

Total operating loss	$	(3,940	)	$	(4,805	)	$	(7,821	)	$	(9,246	)


	December 31, 2012		June 30, 2012
Assets:
SES China, excluding investment in Yima joint ventures	$	37,709	$	39,012
Investment in Yima joint ventures		33,164		33,340

Total SES China		70,873		72,352
Technology licensing and related services		1,022		1,089
Corporate & other		25,151		19,406

Total assets	$	97,046	$	92,847

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, 2012 for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

Business Overview

We are a global energy and gasification technology company that provides products and solutions to the energy and chemical industries. Our strategy is to create value by providing technology and equipment in regions where low rank coals and biomass feedstocks can be profitably converted into high value products through our proprietary fluidized bed gasification technology, which technology is based on the U-GAS ^® process developed by the Gas Technology Institute, but is augmented and differentiated by our own intellectual property gained by owning and operating one commercial plant and partnering in a second that is currently in commissioning. We do this through providing a proprietary technology package whereby we license technology rights to third parties, deliver an engineered technology package and provide proprietary equipment components to customers who have contracted to own and operate projects. In addition, we may (i) integrate our technology package with downstream technologies to provide a fully integrated offering where we may invest in projects either directly or through an investment partner, (ii) partner with engineering, equipment and technology companies to provide our technology package into an integrated modular product offering, (iii) provide technology to enable coal resources to be integrated together with our technology where the coal resources may be of little value without our conversion technology, or (iv) acquire or partner with owners of these coal resources to create more value and opportunity for us through the integration of our technology with the coal resources.

We believe that we have several advantages over commercially available competing gasification technologies, such as entrained flow, fixed and moving bed gasification technologies, including our ability to use all ranks of coals (including low rank, high ash and high moisture coals, which are significantly cheaper than higher grade coals), many coal waste products and biomass feed stocks. In addition, our technology’s advanced fluidized bed design is tolerant to changes in feedstock. These factors enable us to be a lower cost producer of synthesis gas, or syngas, a mixture of primarily hydrogen and carbon monoxide, which can then be used to produce other products. Depending on local market need and fuel sources, syngas can be used as a fuel gas in industrial applications or can be used to produce many products including power, synthetic natural gas, or SNG, methanol, dimethyl ether, or DME, glycol, ammonia, direct reduction iron, or DRI, gasoline and other transportation fuels, steam, and other byproducts (e.g., sulphur, carbon dioxide or ash).

Our principal operating activities are currently in China. However, we are developing opportunities in other countries including India, the U.S. and Australia, as well as other parts of Asia, southern Africa and Europe. Our ZZ Joint Venture project is our first commercial scale coal gasification plant and is located in Shandong Province, China. It started up in February 2008 and was in commercial operation from December 2008 until late September 2011 when it was shut down as described below under “Business –Current Operations and Projects – Zao Zhuang Joint Venture.” Our Yima project in Henan Province, China is currently in its final stages of construction and plant commissioning.

The key elements of our business strategy include:

•

Develop China business platform. We have developed a new, China-centric business platform, or SES China, which is intended to be a stand-alone, self-funding business platform that will encompass all of our current and future business activities and initiatives in China, including our Yima Joint Venture. We have also engaged Crystal Vision Energy Limited to provide management support functions to SES China. We believe that the creation of SES China will better enable us to raise capital in China, work effectively with our existing partners to advance our current projects, make strategic investments in assets together with strategic partners, as well as efficiently develop large business verticals including clean coal-to-chemicals projects, clean renewable fuels and power businesses, DRI for the steel industry, and for longer term value creation, larger scale SNG projects utilizing our low rank coal resources and biomass.

•

Executing on existing projects. We are continuing to implement operational measures to improve the financial performance of our ZZ Joint Venture plant in the near term, while also continuing to evaluate alternatives to better position the project to be commercially and financially successful in the future including the possible expansion of the plant to produce other products for other customers. We also intend to continue to leverage our technological success to date at the ZZ Joint Venture in our ongoing business development efforts. Additionally, the Yima Joint Ventures plant has produced its first methanol and is in process of commissioning. This plant will provide commercial demonstration of our technology on a much larger scale.

•

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

•

Expanding our relationships with strong strategic partners. Our efforts have been initially focused on facilities producing syngas, methanol and DME in China. We are expanding our relationships with our current partners and developing new relationships, including through our recent transactions with Hongye and Zhongmo, SES Resource Solutions Joint Venture, through our engagement of Crystal Vision Energy and through strategic joint venture initiatives in specific markets that will enable us to expand our business. Such strategic relationships may include an investment in projects either directly by us or through an investment partner where our gasification technology plants may supply syngas to strategic customers via long-term off take agreements.

•

Developing value where we have a competitive advantage and have access of rights to feedstock resources. We believe that we have the greatest competitive advantage using our gasification technology in situations where there is a ready source of low cost coal, coal waste or biomass to utilize as a feedstock. We are focusing our efforts in countries with large low rank coal resources such as China, India, Australia and South Africa. We are working to develop transactions that include securing options to these feedstock resources. For example, we are currently in discussions regarding development opportunities in Inner Mongolia, China where provincial authorities are willing to make available coal resources to the project owners, which adds protection from future coal cost increases, and can potentially lead to increased project revenue. In these cases, we may provide technology to add value to coal resources which may be of little value without our gasification conversion technology, or may acquire or partner with owners of these resources to create more value and opportunity for us through the integration of our technology with the resources. Additionally, where strategic relationships and capital and/or financing is available, we may acquire an interest in such resources, including existing facilities or coal mines, where we could create value with our gasification technology by securing direct access to feedstock. We are also actively pursuing business verticals in the segments of transportation fuels, steel and fertilizers where our technology is specifically well suited and developing new downstream coal-to-chemicals and coal-to-energy projects which may expand our initial focus to include facilities producing SNG, MTG, glycol, and power and reducing gas for the steel industry.

•

Continue to develop and improve our technology. We are continually seeking to improve overall plant availability, plant efficiency rates and fuel handling capabilities of our gasification technology. We are continuing to work with our prospective customers to determine the suitability of their low rank coals for our technology through proprietary coal characterization testing and bench scale gasification tests. Additionally, we are growing our technology base through continued development of know-how with our engineering and technical staff, growing and protecting our trade secrets as a result of patenting improvements tested at our ZZ and Yima Joint Venture plants, and improvements resulting from integration of our technology with downstream processes. One example includes the development of our Fines Management System, or FMS, which we believe can maximize the utilization of low rank coal in our gasifiers, resulting in improved cost advantages. We have filed several patent applications relating to our improvements to the technology.

•

Grow earnings through increased revenues, joint venture projects and control of expenses. We remain intently focused on control of our expenses while we grow revenues from our technology business and develop our projects. We believe our strategy will allow us to grow near term revenues to position us for sustainable long term growth. We intend to minimize project development expense until we have assurances that acceptable financing is available to complete our projects. Until we have such assurances, our strategy will be to operate using our current capital resources and to leverage the resources of strategic relationships or financing partners.

Results of Operations

We are in our development stage and therefore have had limited operations. We have sustained cumulative net losses of approximately $146 million from November 4, 2003, the date of our inception, to December 31, 2012.

Three Months Ended December 31, 2012 Compared to the Three Months Ended December 31, 2011

Revenue. Total revenue decreased to $13,000 for the three months ended December 31, 2012 compared to $183,000 for the three months ended December 31, 2011.

There was no product sales revenues for the three months ended December 31, 2012 and product sales were $19,000 for the three months ended December 31, 2011 due primarily to no capacity fee revenue being received for both the three months ended December 31, 2012 and 2011, and the suspension of syngas production at the ZZ Joint Venture plant in late September 2011.

In May 2011, Shangdong Xuecheng Energy Group Xuecheng Energy Company Ltd., or Xuecheng Energy (previously Hai Hua), notified the ZZ Joint Venture plant that it will would not continue payment of capacity fees beyond April 2011. The unpaid amount totaled approximately $6.8 million cumulatively as of December 31, 2012. The plant continued to operate and provide syngas to Xuecheng Energy until operations were suspended in late September 2011, and Xuecheng Energy has paid other contractual obligations such as the energy fees and by-product sales due under the contract. We are continuing to work with Xuecheng Energy on alternatives to resolve this issue and recover these fees including restructuring the current business arrangement to create an integrated syngas to methanol operation. We did not recognize these capacity fee revenues during fiscal 2012 or the six months ended December 31, 2012 and we will not recognize any capacity fees unless collection is reasonably assured.

Technology licensing and related services revenues were $13,000 for the three months ended December 31, 2012 compared to $164,000 for the three months ended December 31, 2011, and resulted primarily from coal testing services for customers who are actively developing projects and may license and build plants using our technology.

Costs of sales and plant operating expenses. Costs of sales and plant operating expenses decreased by $0.8 million to $0.1 million for the three months ended December 31, 2012 compared to $0.9 million for the three months ended December 31, 2011. The decrease was due primarily to the suspension of syngas production at the ZZ Joint Venture plant in late September 2011 and ongoing repairs and maintenance costs incurred during the three months ended December 31, 2011.

General and administrative expenses. General and administrative expenses were $3.1 million for the three months ended December 31, 2012 compared to $3.2 million for the three months ended December 31, 2011. Recurring general and administrative expenses consist primarily of compensation, professional and consulting fees, travel, and other costs of our corporate, development and administrative functions in Houston and Shanghai, and project and technical development expenses.

Stock-based compensation expense. Stock-based compensation expense was $109,000 for the three months ended December 31, 2012 compared to $292,000 for the three months ended December 31, 2011 and related to the expensing of the estimated fair values of awarded stock options and restricted stock.

Depreciation and amortization. Depreciation and amortization expense was $0.6 million for both of the three month periods ended December 31, 2012 and 2011 and was primarily related to depreciation of our ZZ Joint Venture plant’s assets.

Equity in losses of joint ventures. The equity in losses of joint ventures were $0.4 million for both of the three month periods ended December 31, 2012 and 2011 and relates to our 25% share of the start-up losses incurred by the Yima Joint Ventures and our 50% share of the start-up losses incurred by SES Resource Solutions, Ltd., or SRS. The losses of the Yima Joint Ventures related to non-capitalizable costs incurred during the design, construction, commissioning and start-up phases. The losses of SRS related to development costs including the value of Midas’ contributed services, consulting and travel expenses. We expect the SRS expenses to decrease significantly as SRS has suspended its activities until the financial markets for coal resources improves.

Foreign currency gains. Foreign currency gains were $85,000 for the three months ended December 31, 2012 and $202,000 for the three months ended December 31, 2011. These amounts result from the appreciation of the Renminbi Yuan relative to the U.S. dollar and are generated on U.S. dollar denominated shareholder loans payable by our Chinese operations.

Interest expense. Interest expense was $78,000 for the three months ended December 31, 2012 compared to $142,000 for the three months ended December 31, 2011. Our interest expense relates primarily to the ZZ Joint Venture’s outstanding principal balance on its loan with the Industrial and Commercial Bank of China, or ICBC.

Six Months Ended December 31, 2012 Compared to the Six Months Ended December 31, 2011

Revenue. Total revenue was $84,000 for the six months ended December 31, 2012 compared to $2.7 million for the six months ended December 31, 2011.

There was no product sales revenues for the six months ended December 31, 2012 due primarily to no capacity fee revenue being received for the six months ended December 31, 2012 and the suspension of syngas production at the ZZ Joint Venture plant in late September 2011. Product sales were $2.1 million for the six months ended December 31, 2011 and were derived from the sale of syngas and byproducts produced at the ZZ Joint Venture plant to Xuecheng Energy before the suspension of syngas production at the ZZ Joint Venture plant.

In May 2011, Xuecheng Energy notified the ZZ Joint Venture plant that it would not continue payment of capacity fees beyond April 2011. The unpaid amount totaled approximately $6.8 million cumulatively as of December 31, 2012. The plant continued to operate and provide syngas to Xuecheng Energy until operations were suspended in late September 2011, and Xuecheng Energy has paid other contractual obligations such as the energy fees and by-product sales due under the contract. We are continuing to work with Xuecheng Energy on alternatives to resolve this issue and recover these fees including restructuring the current business arrangement to create an integrated syngas to methanol operation. We did not recognize these capacity fee revenues during fiscal 2012 or the six months ended December 31, 2012 and we will not recognize any capacity fees unless collection is reasonably assured.

Technology licensing and related services revenues were $84,000 for the six months ended December 31, 2012 compared to $471,000 for the six months ended December 31, 2011 and resulted primarily from coal testing services for customers who are actively developing projects and may license and build plants using our technology.

Costs of product sales and plant operating expenses. Costs of product sales and plant operating expenses were $0.3 million for the six months ended December 31, 2012 compared to $4.1 million for the six months ended December 31, 2011. The decrease was due primarily to the suspension of syngas production at the ZZ Joint Venture plant in late September 2011 and ongoing repairs and maintenance costs incurred through December 2011.

General and administrative expenses. General and administrative expenses were $6.2 million for both of the six month periods ended December 31, 2012 and 2011. Recurring general and administrative expenses consist primarily of compensation, professional and consulting fees, travel, and other costs of our corporate, development and administrative functions in Houston and Shanghai, and project and technical development expenses.

Stock-based compensation expense. Stock-based compensation expense was $272,000 for the six months ended December 31, 2012 compared to $359,000 for the six months ended December 31, 2011 and related to the expensing of the estimated fair values of awarded stock options and restricted stock.

Depreciation and amortization. Depreciation and amortization expense was $1.1 million for the six month ended December 31, 2012 compared to $1.3 million for the six months ended December 31, 2011 and was primarily related to depreciation of our ZZ Joint Venture plant’s assets.

Equity in losses of joint ventures. The equity in losses of joint ventures were $0.9 million for the six months ended December 31, 2012 compared to $0.8 million for the six months ended December 31, 2011 and relates to our 25% share of the start-up losses incurred by the Yima Joint Ventures and our 50% share of the start-up losses incurred by SES Resource Solutions, Ltd., or SRS. The losses of the Yima Joint Ventures related to non-capitalizable costs incurred during the design, construction, commissioning and start-up phases. The losses of SRS related to development costs including the value of Midas’ contributed services, consulting and travel expenses.

Foreign currency gains. Foreign currency gains were $48,000 for the six months ended December 31, 2012 compared to $615,000 for the six months ended December 31, 2011. These amounts result from the appreciation of the Renminbi Yuan relative to the U.S. dollar and are generated on U.S. dollar denominated shareholder loans payable by our Chinese operations.

Interest expense. Interest expense was $174,000 and $326,000 for the six month periods ended December 31, 2012 and 2011, respectively. Our interest expense relates primarily to the ZZ Joint Venture’s outstanding principal balance on its loan with ICBC.

Liquidity and Capital Resources

We are in our development stage and have financed our operations to date through private placements of our common stock and public offerings of our common stock in November 2007 and in June 2008. We have used the proceeds of these offerings primarily for the development of and investments in our joint ventures in China, including our investments in the ZZ Joint Venture and the Yima Joint Ventures, and to pay other development and general and administrative expenses. In addition, we entered into a loan agreement with ICBC to fund certain of the costs of the ZZ Joint Venture under which we owed $3.6 million as of December 31, 2012.

As of December 31, 2012, we had $23.3 million in cash and cash equivalents and $15.6 million of working capital available to us. During the six months ended December 31, 2012, we used $6.5 million in operating activities compared to $6.2 million for the six months ended December 31, 2011. During the six months ended December 31, 2012, we used $0.5 million in investing activities compared to $0.4 million for the six months ended December 31, 2011 due primarily to fund the start-up and development of SRS. For both the six months ended December 31, 2012 and 2011, we used $1.2 million in financing activities for the scheduled semi-annual principal payments on the ZZ Joint Venture’s loan with ICBC. On September 21, 2012, we received gross proceeds of approximately $8.7 million from Hongye International Investment Group Co., Ltd., or Hongye, and issued 5,777,700 of the Hongye Shares to Hongye. On October 10, 2012, we received gross proceeds of approximately $6.3 million from Shanghai Zhongmo Investment Management Co., Ltd., or Zhongmo, and issued the Zhongmo Shares to Zhongmo. Also, on October 16, 2012, we received gross proceeds of approximately $596,000 from Hongye and issued the remaining 397,393 of the Hongye Shares to Hongye. Upon completion of the Hongye and Zhongmo transactions, we refunded the $1.0 million advance that Hongye paid to us in June 2012. The net proceeds received by us from Hongye and Zhongmo are to be fully applied to our operations and projects in China and are to be deposited into a bank account in China or Hong Kong controlled by SES China, our China-centric business platform.

Share Purchase Agreements

Share Purchase Agreements with Hongye and Zhongmo

On June 18, 2012, we entered into a Share Purchase Agreement with Hongye pursuant to which Hongye will acquire 6,175,093 shares of our common stock for $1.50 per share, for an aggregate purchase price of approximately $9.3 million, and entered into a Share Purchase Agreement with Zhongmo pursuant to which Zhongmo will acquire 4,177,335 shares of the Common Stock for $1.50 per share, for an aggregate purchase price of approximately $6.3 million. The net proceeds received by us are to be fully applied to our operations and projects in China and are to be deposited into a bank account in China or Hong Kong controlled by our China-centric business platform, SES China. The terms and conditions of the Agreement are summarized in Note 8 to the consolidated financial statements included herein.

On September 21, 2012, we received gross proceeds of approximately $8.7 million from Hongye and issued 5,777,700 of the Hongye Shares to Hongye. On October 10, 2012, we received gross proceeds of approximately $6.3 million from Zhongmo and issued the Zhongmo Shares to Zhongmo. Also, on October 16, 2012, we received gross proceeds of approximately $596,000 from Hongye and issued the remaining 397,393 of the Hongye Shares to Hongye.

Share Purchase Agreement with ZJX

On March 31, 2011, we entered into a Share Purchase Agreement, or the Agreement, with China Energy Industry Holdings Group Co, Ltd., or China Energy, and Zhongjixuan Investment Management Company Ltd., or ZJX, pursuant to which we will issue on the closing date to China Energy 37,254,475 shares of our common stock, in exchange for approximately $83.8 million, or the Consideration. Within 20 business days after the accomplishment of the Milestone, as defined, we shall further issue directly to China Energy an amount of shares of common stock which, when combined with the shares issued on the closing date, equals 60.0% of the outstanding common stock on a fully-diluted basis.

Closing of the transaction with China Energy and ZJX is subject to approval by our stockholders and other customary closing conditions. Although the Agreement was not extended at March 31, 2012, we and ZJX have continued to keep the Agreement in effect. Although we believe that ZJX remains active in securing the funding for China Energy with various investor groups, we cannot predict the likelihood of ZJX’s success with this effort or the amount of time it could take to close the transaction. We also expect than a transaction, if any, which is untimately entered into with ZJX is likely to be on different terms than previously disclosed.

Zao Zhuang Joint Venture

Joint Venture Agreement

On July 6, 2006, we entered into a cooperative joint venture contract with Shandong Hai Hua Coal & Chemical Company Ltd., or Hai Hua, which established Synthesis Energy Systems (Zao Zhuang) New Gas Company Ltd., or the ZZ Joint Venture, a joint venture company that has the primary purposes of (i) developing, constructing and operating a syngas production plant utilizing the U-GAS ^® technology in Zao Zhuang City, Shandong Province, China and (ii) producing and selling syngas and the various byproducts of the plant, including ash and elemental sulphur. In August 2012, Hai Hua’s name was changed to Shandong Weijiao Group Xuecheng Energy Company Ltd., or Xuecheng Energy, after a change in control transaction We own 97.5% of the ZZ Joint Venture and Xuecheng Energy owns the remaining 2.5%. We consolidate the results of the ZZ Joint Venture in our consolidated financial statements.

Syngas Purchase and Sale Agreement

The ZZ Joint Venture is also party to a purchase and sale agreement with Xuecheng Energy for syngas produced by the plant, whereby Xuecheng Energy will pay the ZZ Joint Venture an energy fee and capacity fee, as described below, based on the syngas production. The syngas to be purchased by Xuecheng Energy is subject to certain quality component requirements set forth in the contract. In late December 2008, the plant declared commercial operations status for purposes of the purchase and sale agreement. The energy fee is a per normal cubic meters, or Ncum, of syngas calculation based on a formula which factors in the monthly averages of the prices of design base coal, coke, coke oven gas, power, steam and water, all of which are components used in the production of syngas. The capacity fee is paid based on the capacity of the plant to produce syngas, factoring in the number of hours (i) of production and (ii) of capability of production as compared to the guaranteed capacity of the plant, which for purposes of the contract is 22,000 Ncum per hour of net syngas. Xuecheng Energy 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, as well as reliability issues with respect to Xuecheng Energy’s plant, Xuecheng Energy has operated at a reduced rate of syngas consumption. Xuecheng Energy used approximately 35% to 45% of the syngas guarantee capacity from 2009 until September 2011 when the plant was shut down.

Since April 2011, Xuecheng Energy has not paid the capacity fees owed to the ZZ Joint Venture. The unpaid amount totaled approximately $6.8 million as of December 31, 2012. The plant continued to operate and provide syngas to Xuecheng Energy through September 2011 with the expectation that Xuecheng Energy would pay the capacity fee. Xuecheng Energy has paid other contractual obligations such as the energy fees and by-product sales due under the contract. Since April 2011, we have not recognized these capacity fee revenues and will not recognize any capacity fees until collection is reasonably assured. In late September 2011, both the Xuecheng Energy methanol plant and the ZZ Joint Venture plant were shut down for scheduled maintenance and the ZZ Joint Venture plant has been kept idle while the ZZ Joint Venture develops its revised commercial arrangement with Xuecheng Energy. In March 2012, Xuecheng Energy advanced approximately $1.0 million to the ZZ Joint Venture. In September 2012, Xuecheng Energy advanced an additional approximately $0.8 million to the ZZ Joint Venture.

To date, Xuecheng Energy has been unable to off take the volume of syngas originally expected for the original plant design and as a result the plant has incurred operating losses. Because of these circumstances, the ZZ Joint Venture is working on various arrangements to increase the syngas off take volume. Such arrangements involve a combination of technical improvements to Xuecheng Energy’s methanol unit, as well as restructuring the current business arrangement to create an integrated syngas to methanol operation. In December 2011, we entered into a framework agreement with Xuecheng Energy pursuant to which we and Xuecheng Energy are working collaboratively to complete a definitive agreement that will provide the basis for a fully integrated syngas to methanol operation and to resolve the commercial issues. Discussions regarding the nonpayment of the contractual capacity fees and the restructuring of the joint venture are ongoing. In the event that we are not successful reaching agreement with Xuecheng Energy, we will seek to recover the outstanding capacity fees through binding arbitration.

Additionally, we are also evaluating alternative products and partnership structures for a possible expansion of the ZZ Joint Venture plant for its longer term use. In 2010, the ZZ Joint Venture received the necessary government approval for an expansion and this project is under evaluation by us. We are also evaluating certain new downstream technologies to produce high value products. The local government has expressed interest in supplying biomass to the project if we decide to convert the feedstock from coal to biomass.

Yima Joint Ventures

In August 2009, we entered into amended joint venture contracts with Yima Coal Industry (Group) Co., Ltd., or Yima, replacing the prior joint venture contracts entered into in October 2008 and April 2009. The joint ventures were formed for each of the gasification, methanol/methanol protein production, and utility island components of the plant, or collectively, the Yima Joint Ventures. The parties obtained government approvals for the project’s feasibility study during the three months ended December 31, 2008 and for the project’s environmental impact assessment during the three months ended March 31, 2009, which were the two key approvals required to proceed with the project. The amended joint venture contracts provide that: (i) we and Yima contribute equity of 25% and 75%, respectively, to the Yima Joint Ventures; (ii) Yima will guarantee the repayment of loans from third party lenders for 50% of the project’s cost and, if debt financing is not available, Yima is obligated to provide debt financing via shareholder loans to the project until the project is able to secure third-party debt financing; and (iii) Yima will supply coal to the project from a mine located in close proximity to the project at a preferential price subject to a definitive agreement to be subsequently negotiated. In connection with entering into the amended contracts, we and Yima contributed 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. We will also be responsible for its share of any cost overruns on the project.

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

Based on the project’s current scope of methanol production, the current estimate of the total required capital of the project is approximately $250 million. The remaining capital for the project is to be provided by project debt to be obtained by the Yima Joint Ventures. Yima has agreed to guarantee the project debt in order to secure debt financing from domestic Chinese banking sources. We have 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 necessary additional debt financing is not obtained, Yima has agreed to provide a loan to the joint ventures to satisfy the remaining capital needs of the project with terms comparable to current market rates at the time of the loan.

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

We have included the $1.5 million payment paid to GTI in June 2009 (when the amended joint venture contracts were signed) 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 which is expected in fiscal 2013.

SES Resource Solutions

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

Terms of the SRS joint venture agreement include:

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SRS has the exclusive right to promote our gasification technology for the purpose of securing low-cost coal resources in projects worldwide that have been approved by the board of directors of SRS;

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Midas provides expertise to originate and execute the above projects;

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we provide SRS with technology licenses and engineering development support for use in developing the joint integrated coal resource projects;

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SRS being managed by a four person board of directors, two of which are appointed by us and two of which are appointed by Midas;

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our agreement to provide up to $2.0 million in funding to SRS, although it has the ability to discontinue funding at any point in time; and

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revenue and profits are equally divided between the joint venture partners.

As of December 31, 2012, we had funded approximately $1.7 million to SRS. In December 2012, SRS suspended a majority of its expenses until the financial markets for coal resources improve.

GTI Agreement

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

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

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

We are required to make an annual payment to GTI for each year of the term, 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.

Outlook

Our strategy is to create value by providing technology and equipment in regions where low rank coals and biomass feedstocks can be profitably converted into high value products through our proprietary fluidized bed gasification technology, which is technology is based on the U-GAS ^® process developed by GTI, but is augmented and differentiated by our own intellectual property gained by owning and operating one commercial plant and partnering in a second that is currently in commissioning. We do this by providing a proprietary technology package whereby we license our technology rights to third parties, deliver an engineered technology package and provide proprietary equipment components to customers who have contracted to own and operate projects. 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 help advance our project development activities, which may allow us to make selective equity investments in such projects in the future and afford opportunities to develop integrated, modular product offerings. Additionally, we are continuing to improve our technology in ways we believe will enhance our ability to further develop our licensing activities.

We currently plan to use our available cash for (i) general and administrative expenses, including relating to the SES China business platform; (ii) debt service related to the ZZ Joint Venture; (iii) working capital; (iv) project, third party licensing and technical development expenses; (v) operating expenses of SRS; and (vi) general corporate purposes. The actual allocation and timing of these expenditures will be dependent on various factors, including changes in our strategic relationships, commodity prices and industry conditions, and other factors that we cannot currently predict. In particular, any future decrease in economic activity in China or in other regions of the world in which we may in the future do business could significantly and adversely affect our results of operations and financial condition. Although demand for methanol is increasing is some regions, markets for commodities such as methanol have been under significant pressure and we are unsure of how much longer methanol prices may remain depressed. Accordingly, our ability to finance and develop our existing projects, commence any new projects and sell products from our current operations could be adversely impacted.

We are pursuing possible technology licensing opportunities with third parties allowing us to build on our experience at the ZZ Joint Venture and the Yima Joint Venture and our overall technological and engineering capabilities. We are placing increased focus on development of licensing opportunities for our proprietary gasification technology on a global basis with a focus on India, China, Eastern Europe, the U.S., Australia, as well as other parts of Asia and southern Africa, due to their large low rank coal resources. Our prospects are growing globally in numbers and quality. In particular, in India, we believe the market for coal gasification plants is now developing due to large infrastructure growth demands and an increasing need for a variety of basic chemical and energy products. Notably, we are in advanced discussions with a large Indian industrial company and we are hopeful that we will soon close on our first licensing transaction. We have also been evaluated in two separate and thorough technology comparisons for prospective Indian customers where our technology was evaluated for their projects which would operate on high ash Indian coal. Having access to resources in these regions may lead to new commercial opportunities and greater cost and operating efficiencies in existing or planned projects.

We may (i) integrate our technology package with downstream technologies to provide a fully integrated offering where we may invest in projects either directly or through an investment partner, (ii) partner with engineering, equipment and technology companies to provide our technology package into an integrated modular product offering, (iii) provide technology to enable coal resources to be integrated together with our technology where the coal resources may be of little commercial value without our conversion technology, or (iv) acquire or partner with owners of these coal resources to create more value and opportunity for us through the integration of our technology with the coal resource. We understand the need to partner in certain markets, and plan to do so with companies that we believe can help us accelerate our business. Our partnering approach in some cases is country specific and in some cases is industry or segment specific. Additionally, where strategic relationships and capital and/or financing is available, we may acquire an interest in such resources, including existing facilities or coal mines, where we could create value with our gasification technology by securing direct access to feedstock. We are also actively pursuing business verticals in the segments of transportation fuels, steel and fertilizers where our technology is specifically well suited and developing new downstream coal-to-chemicals and coal-to-energy projects which may expand our initial focus to include facilities producing SNG, MTG, glycol, and power and reducing gas for the steel industry.

We are currently advancing business vertical opportunities for waste and renewable feedstocks for fuels and chemicals and separate power and steel market verticals. In December 2012, we announced an agreement with a global leader in iron ore processing and steel production to fund our study of the integration of our technology with this steel production technology. We believe that the study will result in a highly feedstock flexible means of producing steel in developing areas with attractive economics and environmental characteristics. Positive results from this funded study could lead to a joint venture business that would be a first of its kind in this industry. We have targeted this market segment as a key global business vertical growth platform for our technology. Additionally, in January 2013 we announced a similar agreement with a confidential customer to study the optimal use of renewable feedstock combinations for the production of “green chemicals”. These feedstocks may include auto shredder residue, refuse-derived fuels and other waste materials that can be efficiently and cost-effectively used to produce valuable chemicals. The plants being contemplated are expected to have an attractive environmental footprint as they would process these waste streams with an exceptionally low emissions profile. In addition, these plants have the potential to include carbon capture capability. Recently, we have also been evaluating small scale power applications to validate the potential market and seek initial customers for small scale power plants using our technology in combination with small scale gas turbine engines. We have had increasing interest in using our technology for small scale power generation in regions where conventional fuels are scarce or expensive.

Our China-centric business platform (“SES China”) is intended to be a stand-alone, self-funding business platform that will encompass all current and future SES business activities and initiatives in China, including our Yima Joint Venture. We also entered into a consulting services agreement with Crystal Vision Energy Limited (“CVE”), pursuant to which CVE will provide executive leadership and management services focused upon delivering key objectives for SES China over the next 12 months, including (i) restructuring of the ZZ plant; (ii) development of methanol sales from the Yima Joint Venture plant; and (iii) delivering SES China subsidiary level funding and financing required for acquisition initiatives currently under development by SES China. In addition, CVE will assist SES China to secure a full time chief executive officer with significant experience in both managing an infrastructure business in China, as well as successfully executing and integrating mergers and acquisitions. We have established a senior level executive steering committee for SES China, led by Colin Tam of CVE, which reports to our chief executive officer. As part of the services provided by CVE, Stephen Chow, a representative of CVE, will act as the Managing Director of SES China. We believe the formation of SES China will enable us to attract financially strong and highly skilled Chinese partners which desire to invest into the growth of China’s clean energy space and who recognize the opportunity afforded by our technology capability and business model. Business verticals that we can address through SES China include ammonia retrofit projects, clean coal-to-chemicals projects, clean renewable fuels and power businesses, direct reduced iron for the steel industry, and for longer term value creation, larger scale SNG projects utilizing our low rank coal resources and biomass.

We are also actively pursuing new project partners to invest in our ongoing development efforts and may possibly be expanding both the size and scope of our ZZ Joint Venture plant. The Yima Joint Venture plant’s final stages of construction and its commissioning are progressing well and most sections of the plant are either complete or more than 90% complete. In December 2012, the plant produced its first methanol and expects to be ramping up methanol production to annual production of 210,000 tonnes, or about 70% of the plant’s capacity, as it completes all the remaining commissioning and start-up steps throughout the first half of calendar year 2013. The plant is designed to produce 300,000 tonnes per year of methanol from two operating gasifiers. Any delays in the final work on construction or commissioning could cause delays in methanol production. The Yima Joint Venture plant is being closely watched by our potential customers and partners in China and globally, and we expect the Yima project to be a major catalyst for securing much of the new business we have been developing.

We believe that the ZZ Joint Venture plant has achieved significant success demonstrating our technology as well as our technical and operating capabilities. We are of the view that by improving financial performance and reducing operating costs at the ZZ Joint Venture plant our overall financial performance can be improved. To date, Xuecheng Energy has been unable to off take the volume of syngas originally expected for the original plant design and as a result the plant has incurred operating losses. We do not foresee this situation changing significantly in the near term. Because of this, the ZZ Joint Venture is working on various arrangements to increase the syngas off take volume. Such arrangements involve a combination of technical improvement to Xuecheng Energy’s methanol unit, as well as restructuring the current business arrangement to create an integrated syngas to methanol operation. In December 2011, we entered into a framework agreement with Xuecheng Energy pursuant to which we and Xuecheng Energy are working collaboratively to complete a definitive agreement that will provide the basis for a fully integrated syngas to methanol operation and to resolve the commercial issues. Discussions regarding the nonpayment of the contractual capacity fees and the restructuring of the joint venture are ongoing. In the event that we are not successful reaching agreement with Xuecheng Energy, we will seek to recover the outstanding capacity fees through binding arbitration.

Despite our work with Xuecheng Energy on improving financial performance and reducing costs, Xuecheng Energy has not made the capacity fee payments to the ZZ Joint Venture since April 2011 as described under “—Results of Operation.” The unpaid amount totals approximately $6.8 million as of December 31, 2012. Although we are continuing to work with Xuecheng Energy on alternatives to resolve the issue, there can be no assurances that we will collect these amounts. In late September 2011, both the Xuecheng Energy methanol plant and the ZZ Joint Venture plant were shut down for scheduled maintenance and, as noted above, the ZZ Joint Venture plant has been kept idle while we develop a revised commercial arrangement with Xuecheng Energy. In March 2012, Xuecheng Energy advanced approximately $1.0 million towards future costs of the revised commercial arrangement. In September 2012, Xuecheng Energy advanced an additional $0.8 million to the ZZ Joint Venture.

We believe that there is currently a shift in the coal gasification business toward the use of low quality, and therefore low cost, coals for coal-to-energy and chemicals projects and we believe that China is a good example of this new direction in coal gasification. According to the 2011 International Energy Outlook from the U.S. Energy Information Administration, China’s natural gas consumption is estimated to reach 6.8 trillion cubic feet in 2020 but domestic production of natural gas in China is estimated to be 3.7 trillion cubic feet in 2020. Today, coal to SNG projects are beginning to progress and the Chinese government supports these types of coal to energy projects. Due to this estimated shortfall in natural gas, combined with the current encouragement from the Chinese government for these projects, we believe there is potential in China for several of these SNG projects which are anticipated to be very large scale as compared to previous coal-to-chemical projects that have been built in China. In addition, we believe many of these projects will be located in regions such as Inner Mongolia where very low cost lignite coals can be made available and are necessary to reduce the production cost of SNG. Our technology is well suited for this location due to its ability to process these low quality coals and to meet local requirements for clean production of syngas, without tars and oils produced by other technologies, and very low water usage for the overall process. In addition, Inner Mongolia government regulations permit higher quality coals to be made available to those companies that can cleanly gasify the low quality lignite coals. This creates the potential to sell the high quality coals directly to the market while operating the project on low cost lignite, further enhancing the overall financial performance and value created by the project.

In addition, we have continued to work with Midas in identifying other sources of low quality coals around the world, primarily in Asia, to develop additional projects for SRS utilizing our technology. Our primary focus for SRS is to acquire ownership positions in low quality coal resources that can then be used as fuel feedstock for high value products such as SNG, in projects using our technology, and to facilitate the development of these projects with industry partners in regions where gas prices are based on expensive LNG. In December 2012, SRS suspended a majority of its expenses until the financial markets for coal resources improve.

Although the agreement with ZJX and China Energy was not extended at March 31, 2012, we and ZJX have continued to keep the Agreement in effect. Although we believe that ZJX remains active in securing the funding for China Energy with various investor groups, we cannot predict the likelihood of ZJX’s success with this effort or the amount of time it could take to close the transaction. We also expect than a transaction, if any, which is untimately entered into with ZJX may be on different terms than previously disclosed.

We expect to continue for a period of time to have negative operating cash flows until we can generate sufficient cash flows from SES China (including the ZZ Joint Venture and the Yima Joint Ventures) or our licensing and related service projects, as well as from other projects which are under development, to cover our general and administrative expenses and other operating costs. In addition, if we are not able to complete the ZJX/China Energy transaction, we will need to aggressively pursue additional partners in China and may need to seek other equity financing or reduce our operating expenses. We will also limit the development of any further projects until we have assurances that acceptable financing is available to complete the project. Despite this, we will continue to pursue the development of selective projects with strong and credible partners or off-takers where we believe equity and debt can be raised or where we believe we can attract a financial partner to participate in the project.

We can make no assurances that our business operations will develop and provide us with sufficient cash flows to continue our operations. We may need to raise additional capital through equity and debt financing for any new projects that are developed, to support our existing projects and possible expansions, and to meet corporate general and administrative expenses. We cannot provide any assurance that any financing will be available to us in the future on acceptable terms or at all. Any such financing could be dilutive to our existing stockholders. If we cannot raise required funds on acceptable terms, we may not be able to, among other things, (i) maintain our general and administrative expenses at current levels; (ii) successfully develop our licensing and related service businesses; (iii) negotiate and enter into new gasification plant development contracts and licensing agreements; (iv) expand our operations; (v) hire and train new employees; or (vi) respond to competitive pressures or unanticipated capital requirements.

Critical Accounting Policies

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

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

Revenue Recognition

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

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

Impairment Evaluation of Long-Lived Assets

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

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

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

ZZ Joint Venture Plant Impairment Analysis

Due to the economic trends that have significantly affected commodity prices including methanol, Xuecheng Energy’s refusal to pay capacity fees owed to the ZZ Joint Venture and the ZZ Joint Venture plant’s operating losses to-date, we believed an impairment assessment of the ZZ Joint Venture plant was warranted as of June 30, 2012. We performed an analysis of the ZZ Joint Venture plant and determined that these assets were not impaired based upon management’s estimated cash flow projections for the plant. Such estimated cash flow projections included a case based on the completion of the ongoing negotiations between us and Xuecheng Energy to restructure the current business arrangement to create an integrated syngas to methanol operation. This restructuring would include a combination of technical improvements being made to Xuecheng Energy’s methanol unit allowing for increased syngas off-take and other repairs and improvements being made to the plant enabling more efficient joint production of methanol. An alternative case was based on developing an additional downstream facility to produce glycol. This case assumes the additional capital investment is made by a strategic partner and that we retain a minority interest in the combined project. If we are not successful in restructuring the joint venture or otherwise improving the ZZ Joint Venture’s profitability, or if management’s estimated cash flow projections for these assets decrease, the ZZ Joint Venture plant could become impaired which could have a material effect on our consolidated financial statements. As no significant changes occurred during the six months ended December 31, 2012, an updated impairment assessment was not necessary as of December 31, 2012.

Accounting for Variable Interest Entities and Financial Statement Consolidation Criteria

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

We have determined that the ZZ Joint Venture is a VIE and that we are the primary beneficiary. In addition, we considered whether the terms of the syngas purchase and sale agreement with Xuecheng Energy contained a lease. The factors considered included (i) our ability to operate and control the plant during the initial 20 years; and (ii) whether it was more than remote that one or more parties other than Xuecheng Energy would purchase more than a minor amount (considered to be 10%) of the plant’s output during the term of the syngas purchase and sale agreement. Because we determined that the syngas purchase and sale agreement did not contain a lease, we account for the revenues from this agreement in accordance with our revenue recognition policy for product sales.

We have determined that the Yima Joint Ventures are VIEs and that Yima is the primary beneficiary since Yima has a 75% ownership interest in the Yima Joint Ventures.

We have determined that SRS is a VIE and that we are not the primary beneficiary since we and Midas each have a 50% ownership interest in SRS and the control, risks and benefits of SRS are shared equally.

We have determined that the GC Joint Venture is a VIE and have determined that we are the primary beneficiary since we have a 51% ownership interest in the GC Joint Venture and since there are no qualitative factors that would preclude us from being deemed the primary beneficiary.

Recently Issued Accounting Standards

In June 2011, the FASB issued new guidance on the presentation of comprehensive income. The new guidance allows an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The new guidance eliminates the current option to report other comprehensive income and its components in the statement of changes in stockholders equity. This new guidance is effective for fiscal years beginning after December 15, 2011, however the provision of the new guidance which requires reclassifications out of comprehensive income be shown separately in the financial statements was deferred to allow the FASB to reconsider alternatives. We adopted these requirements as of July 1, 2012.

In July 2012 the FASB issued ASU 2012-02: Intangibles: Goodwill and Other: Testing Indefinite-Lived Intangible Assets for Impairment (Topic 350) which is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. This update is intended to reduce cost and complexity by providing an entity with the option to make a qualitative assessment about the likelihood that an indefinite-lived intangible asset is impaired to determine whether it should perform a quantitative impairment test. We do not expect the adoption of this guidance to have a significant impact on our consolidated financial statements.

Item 3. Quantitative and Qualitative Disclosure About Market Risk

Qualitative disclosure about market risk.

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

Foreign currency risk

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

Commodity price risk

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

Interest rate risk

We are exposed to interest rate risk through our 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, 2012, the applicable interest rate was 7.05%. 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 other than the ZZ Joint Venture plant 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, 2012, Xuecheng Energy, a related party, is our only customer for syngas sales and as such, we are exposed to significant customer credit risk due to this concentration. In addition, as described under “–Results of Operation,” Xuecheng Energy has not made the capacity fee payments to the ZZ Joint Venture since April 2011. The unpaid amount totals approximately $6.8 million as of December 31, 2012. Although we are continuing to work with Xuecheng Energy on alternatives to resolve the issue, there can be no assurances that we will collect these amounts. Our revenue and results of operations would be adversely affected if Xuecheng Energy continues to not pay the capacity fee or if we are otherwise unable to retain Xuecheng Energy as a customer and secure new customers and we may need to shut down the ZZ Joint Venture plant for a period of time until we are able to either find an alternative purchaser of our production or a different use for the plant.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

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

Our management, with the participation of the Chief Executive Officer and the Chief Accounting Officer, assessed the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Securities and Exchange Act of 1934, as amended, or the Exchange Act, as of December 31, 2012. Based upon that evaluation, our Chief Executive Officer and Chief Accounting Officer have concluded that our disclosure controls and procedures were effective as of December 31, 2012.

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting during the quarter ended December 31, 2012 that have materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting.

PART II

Item 1. Legal Proceedings.

None.

Item 1A. Risk Factors.

None.

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

On June 18, 2012, we entered into a Share Purchase Agreement, or the Hongye Agreement with Hongye International Investment Group Co., Ltd., or Hongye, pursuant to which Hongye would acquire 6,175,093 shares, or the Hongye Shares, of our common stock for $1.50 per share, for an aggregate purchase price of $9,262,639, and entered into a Share Purchase Agreement, or the Zhongmo Agreement, and together with the Hongye Agreement, the Agreements, with Shanghai Zhongmo Investment Management Co., Ltd., or Zhongmo, pursuant to which Zhongmo would acquire 4,177,335 shares, or the Zhongmo Shares, and together with the Hongye Shares, the Shares of our common stock for $1.50 per share, for an aggregate purchase price of $6,266,002. On September 21, 2012, we received gross proceeds of approximately $8.7 million from Hongye and issued 5,777,700 of the Hongye Shares to Hongye. On October 10, 2012, we received gross proceeds of approximately $6.3 million from Zhongmo and issued the Zhongmo Shares to Zhongmo. Also, on October 16, 2012, we received gross proceeds of approximately $596,000 from Hongye and issued the remaining 397,393 of the Hongye Shares to Hongye. The securities were sold pursuant to exemptions under the Securities Act and the rules and regulations promulgated thereunder, including pursuant to Section 4(2) of the Securities Act.

On January 7, 2013, we issued 259,079 shares of common stock to Crystal Vision Energy as compensation pursuant to the terms of our consulting agreement with them. The securities were sold pursuant to exemptions under the Securities Act and the rules and regulations promulgated thereunder, including pursuant to Section 4(2) of the Securities Act.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures

Not Applicable.

Item 5. Other Information.

None.

Forward-Looking Statements

This Quarterly Report on Form 10-Q includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act. All statements other than statements of historical fact are forward-looking statements. Forward-looking statements are subject to certain risks, trends and uncertainties that could cause actual results to differ materially from those projected. Among those risks, trends and uncertainties are the development stage of our operations, our estimate of the sufficiency of existing capital sources, our ability to successfully develop our licensing business, our ability to raise additional capital to fund cash requirements for future investments and operations including our China platform initiative, our ability to reduce operating costs, the limited history and viability of our technology, commodity prices and the availability and terms of financing opportunities, our results of operations in foreign countries, our ability to diversify, our ability to complete the restructuring of the ZZ joint venture, our ability to obtain the necessary approvals and permits for our future projects, the estimated timetables for achieving mechanical completion and commencing commercial operations for the Yima project as well as the ability of the Yima project to produce revenues and earnings, the sufficiency of internal controls and procedures and our ability to grow our business as a result of our proposed china platform initiative and our relationship with Crystal Vision Energy, as well as our joint venture with Midas Resource Partners. 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, 2012, 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

10.1		Consulting Services Agreement between the Company and Crystal Vision Energy Limited dated effective January 1, 2013 (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on December 27, 2012).

31.1*		Certification of Chief Executive Officer of Synthesis Energy Systems, Inc. pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934, as amended.

31.2*		Certification of Chief Financial Officer of Synthesis Energy Systems, Inc. pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934, as amended.

32.1*		Certification of Chief Executive Officer of Synthesis Energy Systems, Inc. pursuant to Rule 13a-14(b) promulgated under the Securities Exchange Act of 1934, as amended, and Section 1350 of Chapter 63 of Title 18 of the United States Code.

32.2*		Certification of Chief Financial Officer of Synthesis Energy Systems, Inc. pursuant to Rule 13a-14(b) promulgated under the Securities Exchange Act of 1934, as amended, and Section 1350 of Chapter 63 of Title 18 of the United States Code.

101.INS		XBRL Instance Document.**

101.SCH		XBRL Taxonomy Extension Schema Document.**

101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document.**

101.DEF		XBRL Taxonomy Extension Definition Linkbase Document.**

101.LAB		XBRL Taxonomy Extension Label Linkbase Document.**

101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document.**

*	Filed herewith.

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

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.


Date: February 12, 2013	SYNTHESIS ENERGY SYSTEMS, INC.

	By:	/s/ Robert Rigdon
		Robert Rigdon
		President and Chief Executive Officer

Date: February 12, 2013	By:	/s/ Kevin Kelly
		Kevin Kelly
		Chief Accounting Officer,
		Controller and Secretary