Item 2. Management’s Discussion
and Analysis of Financial Condition and Results of Operations.
You should read the
following discussion and analysis of our financial condition and results of operations together with our consolidated financial
statements and the related notes and other financial information included elsewhere in this quarterly report. Some of the information
contained in this discussion and analysis or set forth elsewhere in this quarterly report, including information with respect to
our plans and strategy for our business and related financing, includes forward-looking statements that involve risks and uncertainties.
You should review the “Risk Factors” section of our Annual Report on Form 10-K for the fiscal year ended June 30, 2016
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.
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 and are subject to certain risks, trends and uncertainties that could cause actual results to differ materially from
those projected.
Among those risks, trends and uncertainties are the ability of our project
with Yima to produce earnings and pay dividends; our ability to develop and expand business of the TSEC joint venture in the joint
venture territory; our ability to successfully partner our technology business; our ability to develop our power business unit
and marketing arrangement with GE and our other business verticals, including DRI steel, through our marketing arrangement with
Midrex Technologies, and renewables; our ability to successfully develop the SES licensing business; the ability of the ZZ Joint
Venture to retire existing facilities and equipment and build another SGT facility; the ability of Batchfire management to successfully
grow and develop Callide operations; the economic conditions of countries where we are operating; events or circumstances which
result in an impairment of our assets; our ability to reduce operating costs; our ability to make distributions and repatriate
earnings from our Chinese operations; our ability to successfully commercialize our technology at a larger scale and higher pressures;
commodity prices, including in particular natural gas, crude oil, methanol and power, the availability and terms of financing;
our ability to obtain the necessary approvals and permits for future projects, our ability to raise additional capital, if any,
our ability to estimate the sufficiency of existing capital resources; the sufficiency of internal controls and procedures; and
our results of operations in countries outside of the U.S., where we are continuing to pursue and develop projects.
Although
we believes 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 by us.
We cannot assure you that the assumptions upon which these statements are based will prove to be 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, 2016, 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.
Business Overview
We are a global clean
energy company that develops, builds and owns clean energy projects and we own proprietary gasification technology which we utilize
to provide technology licenses and proprietary equipment to customers in the energy and chemical industries. Our Synthesis Energy
Systems Gasification Technology (“SGT”) is a flexible, efficient and economic technology for the production of synthesis
gas, or syngas, a mixture of primarily hydrogen, carbon monoxide and methane. Syngas is a versatile source of clean energy that
can be used to create a variety of valuable products. Through our unique SGT, we offer an attractive economic alternative to expensive
natural gas, imported LNG and crude oil for manufacturing many of the world’s energy and chemical products. We can do this
because our technology is uniquely capable of manufacturing clean syngas from a wide variety of energy resources including most
all existing forms of coal, biomass, municipal wastes and refuse derived fuels and petroleum coke. Our syngas can be efficiently
converted into a wide variety of energy and chemical products such as industrial fuel gas, substitute natural gas, electricity,
hydrogen, ammonia and methanol. Therefore, using our clean syngas enables a valuable alternative in many parts of the world where
natural gas, LNG and crude oil are expensive or unavailable. Our SGT is built on decades of research, development, demonstration
and we have deployed SGT in several commercial operating plants in China. At the present time, our technology is, or has been,
operating commercially on twelve gasification systems in five plant facilities.
Our business strategy
has focused upon generating growth and financial results from: i) forming value accretive partnerships with low cost equity and
debt financing capabilities which we use to build joint market segment and regional business platforms for developing, investing
into, owning and monetizing clean energy projects from our existing Chinese technology and gasification facilities joint ventures,
ii) licensing our gasification technology and selling our proprietary equipment and services and iii) our existing Chinese technology
and gasification facilities joint ventures. With these strategy components, we focus on leveraging our technology’s capability
to create value.
In implementing our
strategy, as we have shown with our investment in Australia, we intend to diversify our geographic concentration from China by
growing markets outside China where our unique technology capabilities can create value.
Our
technology license and equipment package is a very low-capital intensive offering and we believe it has potential to generate attractive
margins on license fees, equipment sales and services. We rely on a variety of regional, market segment and adjacent technology
partners to extend our global sales reach for commercializing our technology and equipment. We believe the largest contributor
to future earnings from our business strategy will be through our project investment partnerships and platforms. While this element
of our strategy is more capital intensive, we intend to manage and minimize our equity requirements, achieve project financing
debt support and minimize risk through the formation of joint business enterprises with partners which we call platforms. These
project investment platforms are intended to develop multiple projects, raise low cost capital and debt, and build projects using
SGT. We typically work with partners who have aligned business interest with SES related to value creation and who bring financial
capabilities, such as debt guarantees and equity financing as well as local project implementation and operating expertise. In
addition we anticipate that this element of our strategy will also grow our related technology license and equipment business as
these platform projects would utilize our SGT licensing, engineering and equipment systems.
Our business relies
on the unique capability of our SGT technology, which can convert the most challenging, and therefore lower cost, coal feedstocks,
such as high ash coal and coal wastes, into syngas. We believe our feedstock flexibility exceeds all other commercially available
gasification technologies. To demonstrate our technology capabilities, our initial joint venture operating projects were focused
on the demonstration of our technology’s robustness via a modest scale plant at our ZZ joint venture, then later on a larger
scale at our Yima Joint Ventures. Our three projects with the Aluminum Corporation of China (“CHALCO”), in connection
with our Tianwo-SES Joint Venture, have further enhanced the commercial validation of our technologies’ capabilities and
strengths. We believe these projects provide evidence of our technology’s capability to operate using coals with characteristics
that would not be offered by our competitors. We continue to pursue a variety of additional global projects under development internally
and by our customers who wish to use our proprietary gasification technology platform to convert low-cost, locally available feedstocks
to high value products.
Our technology economically
extracts carbon and hydrogen from all types of coal, coal wastes, renewable forms of biomass and municipal wastes in an environmentally
friendly manner. The carbon and hydrogen are extracted by reacting the coal with oxygen, steam and utilize these energy building
blocks to form syngas. Syngas can be used as a substitute for natural gas in many industries such as energy, steel, aluminum, ceramics,
glass and others that combust natural gas to produce heat. In addition, syngas can be readily converted into a wide range of energy
and chemical products. These products include, but are not limited to, the following:
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hydrogen and its derivatives,
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substitute natural gas (“SNG”),
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transportation fuels such as gasoline, diesel and jet fuel,
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chemicals such as methanol, olefins, and glycols,
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fertilizers like ammonia and urea, and
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steel and direct reduction of iron (“DRI”).
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Our technology is
one of several which have been used successfully in these industrial applications for many years. However, our technology is meaningfully
differentiated over other forms of gasification primarily through its feedstock flexibility, its ability to economically convert
the lowest quality brown coals and lignites, high ash sub-bituminous coals, bituminous and anthracite coals as well as biomass
and other renewable waste materials.
Our most recent product
is the XL3000 gasification system introduced in October 2014. It is specifically targeted to provide high syngas capacity and delivery
pressure with low capital costs, while maintaining high syngas generation efficiencies on all types of coal feedstock. The XL3000
is targeted to deliver the efficiency and economy required to meet the needs of the world's syngas projects:
electricity,
steelmaking, industrial chemicals, fertilizers, SNG, and transportation fuels
. The XL3000 gasification system delivers approximately
250% syngas capacity (3,000 metric tons per day of coal feedstock) than our previous designs with syngas delivery pressures up
to 55 bar.
As discussed in “Current Operations and Projects” below, in August 2016, the Company
announced
that the Company and Shandong Hai Hua Xuecheng Energy Co., Ltd. (“Xuecheng Energy’) have entered into a Definitive
Agreement to restructure the ZZ Joint Venture. The agreement took full effect when the registration with the government was completed
on October 31, 2016. During the second quarter of fiscal 2017, the Company deconsolidated the ZZ Joint Venture and began accounting
for our investment under the cost method. For purposes of these financial statements, we have classified all operations related
to the ZZ Joint Venture as discontinued operations and have classified all assets and liabilities related to the ZZ Joint Venture
as assets/liabilities of discontinued operations. Prior period results have been adjusted to reflect the current presentation.
Outlook
We believe the ever
increasing industrialization of developing countries will drive the need for additional and cleaner energy sources and we anticipate
that there will be a preference to those companies who can provide these energy sources in an economical and environmentally efficient
manner. We own rights to proprietary gasification technology which is capable of converting most of the world’s coal, including
low-quality coal and coal waste and renewable sources such as biomass and municipal wastes, into a clean syngas. Because of our
technology capability, the clean syngas produced by our technology provides what we believe is a compelling low cost alternative
to using expensive natural gas and crude oil energy sources for the production of a wide variety of energy and chemical products.
While the current economic environment poses challenges in some regions of the world where growth is slow or where natural gas
and oil prices are very low, we believe the long-term outlook for our industry is quite strong.
To date our
operations have focused on China which has seen dramatic growth over the past few years. Over the past two years we have
successfully increased our installed base of gasifier systems from five to twelve, all of which are located in China. While
we have seen a recent slowing in the Chinese economy, we expect China will continue to provide a strong market and
proving ground for our technology. At the present time, we are attempting to limit further cash expenditures in the
Chinese market.
Globally, we have
seen a shifting of the competitive landscape of gasification over the past months from more commonly deployed gasification technologies
that rely on higher grade coals and utilize more water. This has generated an increasing global interest in our technology and
its capabilities to produce syngas cleanly, efficiently and with lower water consumption for most all qualities of coal as well
as biomass and municipal solid waste. We believe that our technology is well positioned to address the market needs of the changing
global energy landscape.
We view the technology
license, engineering and equipment business as the main driver to creating short-term revenue and cash generation. As we successfully
generate orders, and build our global presence, we believe we will have opportunities to strengthen our equity positions through
global project investment partnerships and platforms. We believe the largest long-term contributor to earnings from our business
strategy will be through our global project investment partnerships and platforms. While this element of our strategy is more capital
intensive, through partnering we intend to manage and minimize our equity requirements, achieve project financing debt support
and minimize risk through the formation of joint business enterprises which we call platforms. These project investment platforms
are intended to develop multiple projects, raise low cost capital and debt, and build projects using SGT. We typically work with
partners who have aligned business interest with us related to value creation and who bring financial capabilities, such as debt
guarantees and equity financing as well as local project implementation and operating expertise. The current global economic environment
does provide a number of risks to our business. Our ability to access both debt and equity funding, at commercially reasonable
returns, will be critical to achieving growth in the project investment side of our business.
We believe that this
is a critical time in shaping the future of our company. We have spent a number of years commercializing our technology and our
ZZ and Yima joint ventures combined with the latest licensed projects under our Tianwo-SES joint venture have provided the demonstration
of our technical capabilities at commercial scale. Building on the results from these projects we believe we will achieve increasingly
more reliable global opportunities which in turn will lead to better financial returns both to our shareholders and our joint venture
partners. We believe the AFE and Batchfire projects are examples of the type of potential projects that we will pursue in the future
as we seek to globalize our operations.
As of December 31,
2016, we had $9.3 million in cash and cash equivalents. We currently plan to use our available cash for: (i) commercializing our
technology and securing orders and associated tasks with developing our business with a prime focus on the markets of syngas for
direct replacement of natural gas, syngas for producing substitute natural gas and power; (ii) securing new partners for our technology
business; (iii) technology product advancement for power applications and industrial syngas; (iv) general and administrative expenses;
and (v) working capital and other general corporate purposes.
The current balance of cash on hand is not
expected to be sufficient to cover our obligations over the next twelve months based on current operating expenditure rates.
We have plans in anticipation of our current liquidity situation which may include: the issuance of additional equity
through our ATM program or other market raises or strategic investments, the issuance of debt or the sale of certain investments or
other assets. If we cannot accomplish these tasks on commercially reasonable terms, we will pursue an aggressive reduction
in operating expenses. We believe with one, or a combination of these approaches, we will be able to meet our needs
as they occur.
In addition, we may need to raise additional
capital through equity and debt financing for any new ventures that are developed, to support its existing projects and possible
expansions thereof and for its corporate general and administrative expenses. We are considering a full range of financing options
in order to create the most value in the context of the increasing interest we are witnessing in its proprietary technology. We
cannot provide any assurance that any financing will be available to it in the future on acceptable terms or at all. Any such
financing could be dilutive to its existing stockholders. If we cannot raise required funds on acceptable terms, it may not be
able to, among other things, (i) maintain its general and administrative expenses at current levels including retention of key
personnel and consultants; (ii) successfully develop its licensing and related service businesses; (iii) negotiate and enter into
new gasification plant development contracts and licensing agreements; (iv) make additional capital contributions to its joint
ventures; (v) fund certain obligations as they become due; or (vi) respond to competitive pressures or unanticipated capital requirements.
In addition we may elect to sell certain of its investments as a source of cash to develop additional projects or for its general
corporate purposes.
In addition, we do
not currently have all of the financial and human resources necessary to fully develop and execute on all of our business opportunities;
however, we intend to finance our development through paid services, technology access fees, equity and debt financings, earnings
from operations and by securing financial and strategic partners focused on the development of these opportunities. We can make
no assurances that our business operations will provide us with sufficient cash flows to continue our operations. We are also seeking
to raise capital through our strategic partnering activities. We may need to raise additional capital through equity and debt financing
for any new ventures that are developed, to support our existing projects and possible expansions thereof and for our corporate
general and administrative expenses. We may consider a full range of financing options in order to create the most value in the
context of the increasing interest we are seeing in our technology which could include the cooperation of a large strategic partner.
We cannot provide any assurance that any financing will be available to us in the future on acceptable terms or at all. Any such
financing could be dilutive to our existing stockholders. If we cannot raise required funds on acceptable terms, we may not be
able to, among other things, (i) maintain our general and administrative expenses at current levels including retention of key
personnel and consultants; (ii) successfully implement our business strategy; (iii) make additional capital contributions to our
joint ventures; (v) fund certain obligations as they become due; (vi) respond to competitive pressures or unanticipated capital
requirements; or (vii) repay our indebtedness. In addition, the Company may elect to sell certain of its investments as a source
of cash to develop additional projects or for its general corporate purposes.
Results of Operations
Three Months Ended December 31, 2016
(“Current Quarter”) Compared to the Three Months Ended December 31, 2015 (“Comparable Quarter”)
Unless noted below
the results of operations are comparing Current Quarter results of continuing operations with the Comparable Quarter results from
continuing operations.
Revenue
.
There were revenues of $5,000 for the Current Quarter. During the Comparable Quarter total revenues were $53,000, which resulted
from engineering feasibility studies and coal testing services for a customer
.
Costs of sales
and plant operating expenses.
There were $2,000 costs of sales during the Current Quarter. In the Comparable Quarter cost of
sales totaled $35,000, which related to the costs incurred for coal testing and engineering studies for a customer.
General and administrative
expenses.
General and administrative expenses were $2.4 million in the Current Quarter compared with $1.9 million for the Comparable
Quarter. The $0.5 million increase is due primarily to the engineering expenses and consulting fees incurred related to our engineering
feasibility studies and technology development.
Stock-based expense
.
Stock-based expense decreased by $0.7 million to $0.5 million for the Current Quarter, compared to $1.2 million for the Comparable
Quarter. This decrease is due primarily to a decrease in the number of stock warrants issued during the Current Quarter as compared
with the Comparable Quarter.
Depreciation and
amortization.
Depreciation and amortization expense for continuing operation was $9,000 for the Current Quarter compared with
$51,000 for the Comparable Quarter, which primarily related to the amortization of our exclusive worldwide GTI license fee.
Foreign currency
loss
. Foreign currency loss for continuing operation was $114,000 for the Current Quarter compared with a loss of $63,000 for
the Comparable Quarter. The $114,000 foreign currency loss for the Current Quarter primarily resulted from the 4% depreciation
of the yuan relative to the U.S. Dollar during the Current Quarter.
Gain (Loss) from
discontinued operations
. Gain from discontinued operations related to our ZZ Joint Venture was $2.3 million for the Current
Quarter compared with a total loss of $1.0 million for the Comparable Quarter. The gain of $2.3 million was due primarily to the
deconsolidation of the ZZ Joint Venture plant in the Current Quarter.
Six Months Ended December 31, 2016 (“Current
Period”) Compared to the Six Months Ended December 31, 2016 (“Comparable Period”)
Unless noted below
the results of operations are comparing Current Period results of continuing operations with the Comparable Period results from
continuing operations.
Revenue
.
There were revenues of $5,000 for the Current Period. During the Comparable Period total revenues were $0.3 million, which resulted
from engineering feasibility studies and coal testing services for two customers
.
Costs of sales
and plant operating expenses.
There were $2,000 costs of sales during the Current Period. In the Comparable Period cost of
sales totaled $0.2 million, which related to the costs incurred for coal testing and engineering studies for two customers.
General and administrative
expenses.
General and administrative expenses were $4.8 million in the Current Period compared with $3.8 million for the Comparable
Period. The $1.0 million increase is due primarily to the engineering expenses and consulting fees incurred related to our engineering
feasibility studies and technology development.
Stock-based expense
.
Stock-based expense decreased by $1.6 million to $0.7 million for the Current Period, compared to $2.3 million for the Comparable
Period. This decrease is due primarily to fewer stock warrants issued during the Current Period as compared with the Comparative
Period and modification and replacement of certain warrants in the Comparable Period.
Depreciation and
amortization.
Depreciation and amortization expense for continuing operation was $48,000 for the Current Period compared with
$0.1 million for the Comparable Period. The decrease is primarily related to the amortization of our exclusive worldwide GTI license
fee in the Comparable Period.
Foreign currency
loss
. Foreign currency loss for continuing operation was $0.1 million for the Current Period compared with a loss of $0.2 million
for the Comparable Period. The $0.1 million foreign currency loss for the Current Period primarily resulted from the 5% depreciation
of the yuan relative to the U.S. Dollar from June to December 2016 as compared to a depreciation of the yuan relative to the U.S.
Dollar of 6% during the Comparable Period.
Gain (Loss) from
discontinued operations
. The gain from discontinued operations related to our ZZ Joint Venture was $1.9 million for the Current
Period compared with a total loss of $2.5 million for the Comparable Period. The gain of $1.9 million was due primarily to the
gain of $2.3 million recognized from deconsolidation of the ZZ Joint Venture plant in the Current Quarter, partially offset by
$0.4 million operating loss of ZZ Joint Venture during the Current Period.
Liquidity and Capital
Resources
As of December 31,
2016, we had $9.3 million in cash and cash equivalents. We currently plan to use our available cash for: (i) commercializing our
technology and securing orders and associated tasks with developing our business with a prime focus on the markets of syngas for
direct replacement of natural gas, syngas for producing substitute natural gas and power; (ii) securing new partners for our technology
business; (iii) technology product advancement for power applications and industrial syngas; (iv) general and administrative expenses;
and (v) working capital and other general corporate purposes.
The current balance of cash on hand is
not expected to be sufficient to cover our obligations over the next twelve months based on current operating expenditure
rates. We have plans in anticipation of our current liquidity situation which may include: the issuance of
additional equity through our ATM program or other market raises or strategic investments, the issuance of debt or the sale of certain
investments or other assets. If we cannot accomplish these tasks on commercially reasonable terms, we will pursue an
aggressive reduction in operating expenses. We believe with one, or a combination of these approaches, we will be able
to meet our needs as they occur.
In addition, we may need to raise additional
capital through equity and debt financing for any new ventures that are developed, to support its existing projects and possible
expansions thereof and for its corporate general and administrative expenses. We are considering a full range of financing options
in order to create the most value in the context of the increasing interest we are witnessing in its proprietary technology. We
cannot provide any assurance that any financing will be available to it in the future on acceptable terms or at all. Any such
financing could be dilutive to its existing stockholders. If we cannot raise required funds on acceptable terms, it may not be
able to, among other things, (i) maintain its general and administrative expenses at current levels including retention of key
personnel and consultants; (ii) successfully develop its licensing and related service businesses; (iii) negotiate and enter into
new gasification plant development contracts and licensing agreements; (iv) make additional capital contributions to its joint
ventures; (v) fund certain obligations as they become due; or (vi) respond to competitive pressures or unanticipated capital requirements.
In addition we may elect to sell certain of its investments as a source of cash to develop additional projects or for its general
corporate purposes.
We have financed our
operations to date through private placements and public offerings of our common stock and previously through lines of credit and
working capital loans in our ZZ Joint Venture. We currently do not have all of the financial resources necessary to fully develop
and execute on all of our business opportunities and may seek to raise additional capital through the issuance of equity or other
financing methods.
On
May 13, 2016, we entered into an At The Market Offering Agreement (the “Offering Agreement”) with T.R. Winston &
Company (“T.R. Winston”) to sell, from time to time, shares of our common stock having an aggregate sales price of
up to $20.0 million through an “at the marketing offering” program under which T.R. Winston would act as sales agent,
which we refer to as the ATM Offering. The shares that may be sold under the Offering Agreement, if any, would be issued and sold
pursuant to the Company’s $75.0 million universal shelf registration statement on Form S-3 that was declared effective by
the Securities and Exchange Commission on April 21, 2016. Through February 10, 2017, we have not sold any shares of our common
stock in the ATM Offering. We have no obligation to sell any of our common stock under the Offering Agreement.
In June 2015, we entered
into an SPA with Rui Feng, whereby Rui Feng was to acquire a controlling interest in SESI, a wholly owned subsidiary of which we
owns our interest in the ZZ Joint Venture. Under the terms of the SPA, SESI will sell an approximately 61% equity interest
to Rui Feng in exchange for $10 million. Rui Feng’s second installment payment was due in December 2015 and the
third installment was due on or before May 1, 2016. Neither of these installment payments have been made. It is not certain when
or if Rui Feng will make any additional required installment payments under the SPA. Because Rui Feng has not made additional installment
payments, they have not acquired additional ownership interest in the ZZ Joint Venture. As a result of our agreement with Xuecheng
Energy discussed above, we do not anticipate additional installment payments from Rui Feng
We currently plan
to use our available cash for: (i) expanding our technology and securing orders and associated tasks with developing our business
with a prime focus on the markets of syngas for direct replacement of natural gas, syngas for producing substitute natural gas
and power; (ii) securing new partners for our technology business; (iii) technology product advancement for power applications
and industrial syngas; (iv) general and administrative expenses; and (v) working capital and other general corporate purposes.
In addition, we may elect to sell certain of its non-revenue generating investments as a source of cash to develop additional
projects or for its general corporate purposes.
The current balance of cash on hand is not
expected to be sufficient to cover our obligations over the next twelve months based on current operating expenditure rates. We
have plans in place in anticipation of our current liquidity situation which may include: the issuance of additional equity through
our ATM program or other market raises, the issuance of debt, or the sale of certain investments or other assets. If we cannot
accomplish these tasks on commercially reasonable terms, we will pursue an aggressive reduction in operating expenses. We believe
with one, or a combination of these strategies, we will be able to meet our obligations as they become due.
As of December 31,
2016, we had $9.3 million in cash and cash equivalents and $8.2 million of working capital. The following summarizes the sources
and uses of cash during the Current Period:
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Operating Activities: During the Current Period, we used $4.5 million
in cash for operating activities compared to $4.9 million during the Comparable Period. These funds were utilized to develop our
technical licensing and related services and for our general and administrative expenses.
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Investing Activities: During the Current Period, we used $5,000 in investing activities for capital expenditures and used $12,000 related to our ZZ Joint Venture restructuring. During the Comparable
Period, we used $15,000 for capital expenditures and $0.8 million for the certificate of deposit required by the renewal of a line
of credit associated with our ZZ Joint Venture.
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Financing Activities: For the Current Period, we had a net source of cash of approximately $26,000 as
compared to a net source of cash of $2.1 million in the Comparable Period. During the Current Period, we received proceeds of approximately
$26,000 from the exercise of stock options. During the Comparable Period, we received proceeds of $1.0 million from the exercise
of stock warrants from a warrant holder and $0.3 million from the exercise of stock options, we also used $3.1 million in financing
activities to repay a line of credit associated with our ZZ Joint Venture and received $3.9 million from a line of credit associated
with our ZZ Joint Venture.
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Current Operations and Projects
Yima Joint Ventures
In August 2009,
we entered into amended joint venture contracts with Yima Coal Industry Group Company (“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 amended joint venture contracts provide that:
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we and Yima contribute equity of 25% and 75%, respectively, to the Yima Joint Ventures;
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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
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Yima will supply coal to the project at a preferential price.
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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 could expand through contributions,
at our election, up to a 49% ownership interest in the Yima Joint Ventures.
The remaining capital
for the project construction has been funded with project debt obtained by the Yima Joint Ventures. Yima agreed to guarantee the
project debt in order to secure debt financing from domestic Chinese banking sources. We have agreed to pledge to Yima our ownership
interests in the joint ventures as security for our obligations under any project guarantee. In the event that the necessary additional
debt financing is not obtained, Yima has agreed to provide a loan to the joint ventures to satisfy the remaining capital needs
of the project with terms comparable to current market rates at the time of the loan.
Under the terms of
the joint venture agreements, the Yima Joint Ventures are to be governed by a board of directors consisting of eight directors,
two of whom were appointed by us and six of whom were appointed by Yima. The term of the joint venture shall commence upon each
joint venture company obtaining its business operating license and shall end 30 years after commercial operation of the business
license issue date, which occurred in July 2016.
We believe there is
a consistent pattern of the Yima Joint Venture management not demonstrating an understanding of the methanol facility operations
and not sourcing available expertise in China to improve the overall operations. We have witnessed operation of the gasifier systems
at Yima with design and operating parameter deviations from our existing technology recommendations. We continue to experience
a limited ability to influence the Yima Joint Ventures’ operating performance.
As a result of the
issues noted above, Yima’s parent company, Henan Energy Chemistry Group Company (“Henan Energy”) restructured
the management of the Yima Joint Ventures under the direction of the Henan Coal Gasification Company (“Henan Gasification”),
which is an affiliated company reporting directly to Henan Energy. Henan Gasification currently has full authority of day to day
operational and personnel decisions at the Yima Joint Venture. The ownership of the Yima Joint Ventures is unchanged.
Since 2014, we have
accounted for this joint venture under the cost method of accounting. Our conclusion to account for this joint venture
under this methodology is based upon our lack of significant influence in the Yima Joint Venture. The lack of significant
influence is determined based upon our interactions with the Yima Joint Ventures related to our limited participation in operating
and financial policymaking processes coupled with our limited ability to influence decisions which contribute to the financial
success of the Yima Joint Ventures.
Current Yima Plant Operating Description
Despite initiating
methanol production in December 2012, the Yima Joint Ventures’ plant continued its construction through the beginning of
2016. In March 2016, the Yima Joint Ventures completed the required performance testing of the SGT systems and successfully issued
its Performance Test Certificate. The plant has recently faced increasing regulatory scrutiny from the environmental and safety
bureaus as the plant was not built in full compliance with its original submitted designs.
In June 2016, the local environmental bureau requested that the plant temporarily halt operations to address
certain issues identified by the environmental bureau. After the plant shut down operations, the Yima plant experienced an accident
during maintenance activities that was unrelated to the gasification units. The Yima Joint Ventures worked closely with both the
environmental and safety bureaus and returned to resumed operating capacity in late November 2016.
In 2009, the project
was approved as three separate joint ventures. The approval for the original joint ventures was for the production of methanol
protein, and methanol by-product. This has impacted the ability of the plant to sell pure methanol on the open market and has been
an impediment to receive the permanent safety operating permit.
To resolve these issues,
during the quarter ended June 30, 2016, the Yima Joint Ventures commenced an organizational restructuring to better streamline
the operations of the Joint Ventures which received the local government’s support. This restructuring effort was a multi-step
process which included combining the three joint ventures into a single operating entity and obtaining a business operating license.
After completing these steps the new joint venture would obtain the permanent safety and environmental permits. The Yima Joint
Ventures received the business license in July 2016, merged the Yima Joint Ventures into one joint venture in November 2016 and
is making continued progress on completing the remaining items.
The Yima Joint Ventures
have experienced certain liquidity concerns with a series of third party bank notes due during calendar year 2016. Yima, the 75%
shareholder of the Yima Joint Ventures, has been routinely providing liquidity to the Yima Joint Ventures in the form of shareholder
loans and in October 2016, Yima successfully refinanced, for one full year through October 2017, certain amounts which were to
become due in October 2016. In addition to these refinancings, Yima is in the process of an internal restructuring of its debts
and has converted a number of outstanding third party notes into shareholder loans primarily due to Yima and its related parent
companies. As of January 31, 2017, the Yima Joint Ventures had approximately $7.2 million of third party debt which is due in the
latter half of 2017.
Because of the situations
detailed above, our management evaluated the conditions of the Yima Joint Ventures to determine whether an other than temporary
decrease in value had occurred for the year ended June 30, 2016. Management determined that the decrease in value due to the then
present shutdown and liquidity situation were other than temporary in nature and therefore management conducted an impairment analysis
utilizing a discounted cash flow fair market valuation with the assistance of a third party valuation expert. In this valuation,
significant unobservable inputs were used to calculate the fair value of the investment. The valuation led to the conclusion that
the investment in the Yima Joint Ventures was impaired as of June 30, 2016, and accordingly, we recorded an $8.6 million impairment
for the fiscal year ended June 30, 2016.
With the return to
operations in late November 2016 and the internal refinancing of certain third party debt, management determined that there was
not an other than temporary impairment of value of our Yima investment during the six months ended December 31, 2016. The carrying
value of our Yima investment was approximately $26.2 million as of both December 31, 2016 and June 30, 2016. We continue to monitor
the Yima Joint Ventures and could take an additional impairment in the future if operating conditions do not meet our current expectations,
or if the liquidity situation worsens.
Tianwo-SES Clean Energy Technologies Limited (the “Tianwo-SES
Joint Venture”)
Joint Venture Contract
In
February 2014, SES Asia Technologies Limited, one of our wholly owned subsidiaries, entered into a Joint Venture Contract (the
“JV Contract”) with Zhangjiagang Chemical Machinery Co., Ltd., which subsequently changed its legal name to Suzhou
Thvow Technology Co. Ltd. (“STT”), to form the Tianwo-SES Joint Venture. The purpose of the Tianwo-SES Joint Venture
is to establish the Company’s gasification technology as the leading gasification technology in the Tianwo-SES Joint Venture
territory (which is China, Indonesia, the Philippines, Vietnam, Mongolia and Malaysia) by becoming a leading provider of proprietary
equipment and engineering services for the technology. The scope of the Tianwo-SES Joint Venture is to market and license our gasification
technology via project sublicenses; procurement and sale of proprietary equipment and services; coal testing; and engineering,
procurement and research and development related to the technology. STT contributed 53.8 million yuan in April 2014 and was required
to contribute an additional 46.2 million yuan within two years of such date for a total contribution of 100 million yuan (approximately
$14.4 million) in cash to the Tianwo-SES Joint Venture, and owns 65% of the Tianwo-SES Joint Venture.
We
have contributed certain exclusive technology sub-licensing rights into the Tianwo-SES Joint Venture for the territory pursuant
to the terms of a Technology Usage and Contribution Agreement (the “TUCA”) entered into among the Tianwo-SES Joint
Venture, STT and us on the same date and further described in more detail below. We own 35% of the Tianwo-SES Joint Venture. Under
the JV Contract, neither party may transfer their interests in the Tianwo-SES Joint Venture without first offering such interests
to the other party.
The JV Contract also
includes a non-competition provision which requires that the Tianwo-SES Joint Venture be the exclusive legal entity within the
Tianwo-SES Joint Venture territory for the marketing and sale of any gasification technology or related equipment that utilizes
low quality coal feedstock. Notwithstanding this, STT has the right to manufacture and sell gasification equipment outside the
scope of the Tianwo-SES Joint Venture within the Tianwo-SES Joint Venture territory. In addition, we have the right to develop
and invest equity in projects outside of the Tianwo-SES Joint Venture within the Tianwo-SES Joint Venture territory. After the
termination of the Tianwo-SES Joint Venture, STT must obtain written consent from us to market development of any gasification
technology that utilizes low quality coal feedstock in the Tianwo-SES Joint Venture territory.
The JV Contract may
be terminated upon, among other things: (i) a material breach of the JV Contract which is not cured, (ii) a violation of the TUCA,
(iii) the failure to obtain positive net income within 24 months of establishing the Tianwo-SES Joint Venture or (iv) mutual agreement
of the parties.
TUCA
Pursuant to the TUCA,
we have contributed to the Tianwo-SES Joint Venture certain exclusive rights to our gasification technology in the Tianwo-SES Joint
Venture territory, including the right to: (i) grant site specific project sub-licenses to third parties; (ii) use our marks for
proprietary equipment and services; (iii) engineer and/or design processes that utilize our technology or our other intellectual
property; (iv) provide engineering and design services for joint venture projects and (v) take over the development of projects
in the Tianwo-SES Joint Venture territory that have previously been developed by us and our affiliates.
The Tianwo-SES Joint
Venture will be the exclusive operational entity for business relating to our technology in the Tianwo-SES Joint Venture territory.
If the Tianwo-SES Joint Venture loses exclusivity due to a breach by us, STT is to be compensated for direct losses and all lost
project profits. We will also provide training for technical personnel of the Tianwo-SES Joint Venture through the second anniversary
of the establishment of the Tianwo-SES Joint Venture. We will also provide a review of engineering works for the Tianwo-SES Joint
Venture. If modifications are suggested by us and not made, the Tianwo-SES Joint Venture bears the liability resulting from such
failure. If we suggest modifications and there is still liability resulting from the engineering work, it is our liability.
Any party making,
whether patentable or not, improvements relating to our technology after the establishment of the Tianwo-SES Joint Venture, grants
to the other party an irrevocable, non-exclusive, royalty free right to use or license such improvements and agrees to make such
improvements available to us free of charge. All such improvements shall become part of our technology and both parties shall have
the same rights, licenses and obligations with respect to the improvement as contemplated by the TUCA.
The Tianwo-SES Joint
Venture is required to establish an Intellectual Property Committee, with two representatives from the Tianwo-SES Joint Venture
and two from SES. This Committee shall review all improvements and protection measures and recommend actions to be taken by the
Tianwo-SES Joint Venture in furtherance thereof. Notwithstanding this, each party is entitled to take actions on its own to protect
intellectual property rights. As of December 31, 2016 that committee was yet to be formed.
Any breach of or default
under the TUCA which is not cured on notice entitles the non-breaching party to terminate. The Tianwo-SES Joint Venture indemnifies
us for misuse of our technology or infringement of our technology upon rights of any third party.
Current relationship with STT
The second capital
contribution from STT of 46.2 million yuan (approximately $6.7 million) was not paid in April 2016 as required by our initial JV
Contract and currently remains outstanding. We notified STT in writing to determine the status of the payment, and other contractual
breaches related to the TUCA, and the JV Contract, and have continued to work with our joint venture partner to resolve these issues.
Should the payment or the other breaches of the TUCA not be cured, we will consider any and all legal actions to resolve these
issues.
CESI-SES Investment Platform
In March 2016, we
entered a strategic Joint Project Development and Investment Agreement with China Environment State Investment Co., Ltd. (“CESI”).
CESI is a state-owned enterprise established in Beijing under the China Ministry of Environmental Protection that is charged with,
and funded to, develop and invest in the energy conservation and environmental protection industry. We and CESI have agreed to
develop, jointly invest, and build a total of no less than 20 projects using our gasification technology over the next five years.
Further, we and CESI are targeting to bring a minimum of two projects through development within 12 months. Equity in the projects
for investment by us and CESI is expected to be 51% owned by CESI, and 49% by us through our wholly owned Hong Kong subsidiary,
SES Clean Energy Investment Holdings Limited. We and CESI have initially identified a pipeline of potential projects.
In July 2016, CESI’s
executive management changed after a restructuring agreement and the entrance of a new shareholders. We have been in contact with
the new management team and we have been told that CESI will evaluate the economics of the projects discussed above and will make
its decision to continue in the projects based upon their views of the projects’ economics. The agreement may be terminated
by either party if development work has not been completed by March 23, 2017. At the present time, no development work has been
completed on any projects.
If CESI were to not
continue to participate in these projects, it could cause delays as we seek replacement partners and alternative funding sources.
Alternatively we may decide to discontinue the Dongying Projects mentioned below. We can provide no assurances as to the level
of involvement which CESI will have in the projects in the future but if we decide to continue the project, we believe that we
will be able to find a replacement partner should CESI decide not to participate.
Dongying Projects
In May 2016, we announced
the first of our projects on the platform discussed above. The project will use SGT to produce lower-cost hydrogen in the Lijin
County Binhai New District industrial park in Dongying, Shandong Province. The build-out consists of three projects completed in
phases with an estimated preliminary total investment to be approximately 2 billion yuan ($287.9 million). In June 2016, we signed
an investment and cooperation agreement with Shandong Dongying Hekou District Government. The project will use SGT to produce lower-cost
hydrogen needed for clean fuels production by refineries at the Hekou Blue Economy Industrial Park Project in Dongying City, Shandong
Province. The build-out consists of multiple phases with an estimated preliminary total investment to be approximately 550 million
yuan ($79.2 million).
At the present time,
we have not substantially completed the work necessary to commence these projects and may be unable to secure the exclusive offtake
agreements contemplated in these contracts.
Australian Future Energy Pty Ltd ("AFE”)
& Batchfire Resources Pty Ltd ("Batchfire”)
In May 2015, we established
AFE together with Australian company Ambre Investments PTY Limited (“Ambre”). AFE is a development stage Australian
company which is seeking to deploy SGT into projects in Australia where AFE or its affiliates would own equity and to secure ownership
positions in low quality, low cost, coal resources such as unmarketable coal generally produced from coal mining operations in
order to secure a long-term source of feedstock for the projects that would utilize SGT.
In forming AFE, we
contributed access to SGT limited to Australia through a master technology agreement in return for an ownership interest in AFE.
In addition, we contributed certain early stage engineering support for AFE’s business development through an engineering
consulting agreement while Ambre contributed cash for the early stage business development. In connection with this agreement,
in fiscal year 2016, we recognized approximately $0.2 million in related party consulting services. At December 31, 2016, we owned
approximately 37% of AFE. Because of the early stage business development expenses incurred by AFE, the carrying value of AFE was
zero as of both December 31, 2016 and June 30, 2016.
In January 2017, the
Company elected to increase its interest in AFE by contributing approximately $0.4 million in additional equity. This additional
contribution raised our ownership in the AFE joint Venture to approximately 41%.
Because of its early
stage business development efforts associated with the Callide coal mine in Central Queensland, Australia, AFE created Batchfire.
Batchfire was a spin-off company which was distributed to the shareholders of AFE in December 2015. Batchfire is registered in
Australia and was formed for the purpose of purchasing the Callide thermal coal mine from Anglo-American plc (“Anglo-American”).
On October 31, 2016, Batchfire announced that it had completed its acquisition of the Callide thermal coal mine from Anglo American.
The Callide mine is a mature and significantly sized coal producer with substantial recoverable thermal coal reserves. After the
transaction on October 31, 2016, which included the infusion of additional capital by certain shareholders, the Company owns an
approximately 11% interest in Batchfire. Because of the nature of our contribution in AFE, the carrying value of our investment
in Batchfire was zero as of December 31, 2016 and June 30, 2016.
Batchfire intends
to operate the Callide mine and implement its planned improvements to increase output from the mine and lower the mining costs.
AFE is currently evaluating project opportunities that would use SGT and utilize the unmarketable coal from the Callide mine to
responsibly manufacture energy or chemical products.
GTI Agreement
In November 2009, we
entered into an Amended and Restated License Agreement, or the GTI Agreement, with GTI, replacing the Amended and Restated License
Agreement between us and GTI dated August 31, 2006, as amended. Under the GTI Agreement, we maintain our exclusive worldwide
right to license the U-GAS
®
technology for all types of coals and coal/biomass mixtures with coal content exceeding
60%, as well as the non-exclusive right to license the U-GAS
®
technology for 100% biomass and coal/biomass blends
exceeding 40% biomass.
In order to sublicense
any U-GAS
®
system, we are required to comply with certain requirements set forth in the GTI Agreement. In the preliminary
stage of developing a potential sublicense, we are required to provide notice and certain information regarding the potential sublicense
to GTI and GTI is required to provide notice of approval or non-approval within ten business days of the date of the notice from
us, provided that GTI is required to not unreasonably withhold their approval. If GTI does not respond within that ten business
day period, they are deemed to have approved of the sublicense. We are required to provide updates on any potential sublicenses
once every three months during the term of the GTI Agreement. We are also restricted from offering a competing gasification technology
during the term of the GTI Agreement.
For each U-GAS
®
unit which we license, design, build or operate for ourselves or for a party other than a sub-licensee and which uses coal or a
coal and biomass mixture or biomass as the feedstock, we must pay a royalty based upon a calculation using the MMBtu per hour of
dry syngas production of a rated design capacity, payable in installments at the beginning and at the completion of the construction
of a project, or the Standard Royalty. If we invest, or have the option to invest, in a specified percentage of the equity
of a third party, and the royalty payable by such third party for their sublicense exceeds the Standard Royalty, we are required
to pay to GTI an agreed percentage split of third party licensing fees, or the Agreed Percentage, of such royalty payable by such
third party. However, if the royalty payable by such third party for their sublicense is less than the Standard Royalty, we are
required to pay to GTI, in addition to the Agreed Percentage of such royalty payable by such third party, the Agreed Percentage
of our dividends and liquidation proceeds from our equity investment in the third party. In addition, if we receive a carried interest
in a third party, and the carried interest is less than a specified percentage of the equity of such third party, we are required
to pay to GTI, in our sole discretion, either (i) the Standard Royalty or (ii) the Agreed Percentage of the royalty payable
to such third party for their sublicense, as well as the Agreed Percentage of the carried interest. We will be required to pay
the Standard Royalty to GTI if the percentage of the equity of a third party that we (a) invest in, (b) have an option
to invest in, or (c) receive a carried interest in, exceeds the percentage of the third party specified in the preceding sentence.
We are required to
make an annual payment to GTI for each year of the term, with such annual payment due by the last day of January of the following
year; provided, however, that we are entitled to deduct all royalties paid to GTI in a given year under the GTI Agreement from
this amount, and if such royalties exceed the annual payment amount in a given year, we are not required to make the annual payment.
We must also provide GTI with a copy of each contract that we enter into relating to a U-GAS
®
system and report
to GTI with our progress on development of the technology every six months.
For a period of ten
years, we and GTI are restricted from disclosing any confidential information (as defined in the GTI Agreement) to any person other
than employees of affiliates or contractors who are required to deal with such information, and such persons will be bound by the
confidentiality provisions of the GTI Agreement. We have further indemnified GTI and its affiliates from any liability or loss
resulting from unauthorized disclosure or use of any confidential information that we receive.
While the core of our
technology is the U-GAS
®
system, we have continued to innovate and modify the process to a point where we maintain
certain intellectual property rights over SGT. Since the original licensing in 2004, we have maintained a strong relationship with
GTI and continue to benefit from the resources and collaborative work environment that GTI provides us. It is in part for that
reason, in May 2016, we exercised the first of our 10-year extensions and now maintain the exclusive license described above through
2026.