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 Tianwo-SES 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 and AFE management to successfully grow and develop their Australian
assets and operations including Callide and Pentland; 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, owns, and operates clean energy and chemical
projects and we own proprietary technology for the production of synthesis gas (“syngas”) a mixture of primarily hydrogen,
carbon monoxide and methane. Additionally, we sell technology licenses which provide operating rights to our technology and we
sell our proprietary equipment and engineering services to third party customers in the energy and chemical industries. Our business
strategy is intended to deliver operating revenue, income, and dividend income from: i) our equity ownership interest in energy
and chemicals manufacturing facilities that utilize our technology, ii) the sales of technology, equipment and engineering services
to third party customers using our technology for their own facilities, iii) utilizing our technology via a variety of exclusive
arrangements to secure broader implementation capability in order to deliver our technology, proprietary equipment and services
into customers projects around the world and iv) our ownership in businesses related to the projects we build or license, such
as ownership in coal and biomass resources and engineering and technology related businesses, focusing on segments and regions
which enhance growth based on our capabilities along with the capabilities of our partners. We operate our business from our headquarters
located in Houston, Texas and our administrative offices in Shanghai, China. Additionally, we have additional operating resources
through operating joint ventures in Australia.
Our technology (“SGT”) is a unique,
flexible, efficient and economic technology for the production of syngas which is a versatile source of clean energy that can be
used to create a variety of valuable products. Production of syngas from our SGT provides a compelling and attractive economic
alternative to expensive natural gas, imported LNG and crude oil for manufacturing many of the world’s energy and chemical
products. Our technology is significantly differentiated by its capability to manufacture clean syngas from a wide variety of energy
resources including most all existing forms of coal, coal waste (also called unmarketable coal), biomass, municipal wastes, refuse
derived fuels and petroleum coke produced by refineries. The unique flexibility of SGT to use the lowest quality input resources
for producing syngas can provide meaningful cost savings for input feedstock into projects using our technology. Also, our syngas
is a versatile product which can be efficiently converted into a wide variety of energy and chemical products including but not
limited to industrial fuel gas, substitute natural gas, electricity, hydrogen, ammonia, and methanol. Therefore, using our technology
to produce clean syngas enables a lower cost alternative than natural gas, LNG, and crude oil and this lower input cost enabled
by our technology can translate into much lower operating costs for energy and chemicals production.
Our SGT technology is built on decades of research,
development, demonstration, and industrial scale commercial operating experience. In order 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 a larger scale application at our Yima Joint Venture. Our projects with the Aluminum
Corporation of China (“CHALCO”), in connection with our Tianwo-SES Joint Venture, have further enhanced the commercial
validation of our technology’s capabilities and strengths. We provide syngas generation technology and equipment systems
from a small scale of roughly 200 metric tons per day of input coal or biomass to very large scale based on the XL3000 syngas generating
system we introduced in October 2014 capable of utilizing approximately 3,000 metric tons per day of coal feedstock with syngas
delivery pressures up to 55 bar. Since 2007, we have deployed SGT into five industrial facilities in China which combined utilize
twelve of our syngas generation systems. We are currently developing new projects and bidding into multiple new third party projects
in a variety of locations in the world.
Although all our projects since 2007 have been
built in China we believe a meaningful part of our future growth will be derived from our non-China partnerships and business developments
now underway. In implementing our strategy, we intend to continue to diversify our geographic concentration beyond China to other
global regions. The process has already begun as evidenced by our growing Australian operations and new project development work
underway related to our Australian Future Energy Pty Ltd ("AFE”) partnership and our holdings in Batchfire Resources
Pty Ltd (“Batchfire”)– the owner and operator of the Callide coal mine in Queensland. In addition, we are bidding
and supporting project developments in South America, Eastern Europe, India and other locations. Our Company is rich in opportunities
in these areas and our partnering activities are enhancing our capabilities to pursue opportunities which we believe will provide
us with revenue and income growth.
As of March 31, 2017, we had $7.0 million in
cash and cash equivalents. 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 begun implementing significant cost cutting procedures
given our current liquidity situation and our change in operational focus away from China. In addition, we are aggressively pursuing
short-term revenue generation activities and a variety of capital raising options which can include: the issuance of additional
equity through our ATM program or other transactions, 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 additional reductions in operating expenses.
While we believe between our cost cutting strategies, short-term revenue generation and capital raising options, we will be able
to meet our needs as they occur, no assurances can be given that we will be successful. If we are not successful in short-term
revenue generation, or capital raising objectives in the future, it will cast substantial doubt on our ability to continue as a going concern. These financial statements do not include
any adjustments as a result of these uncertainties.
In August 2016, the Company
announced that the Company and Shandong Weijiao
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 syngas generation technology which can convert 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’s capability,
the clean syngas we produce provides what we believe is a compelling low cost alternative to expensive natural gas and crude oil
energy sources for production of a wide variety of energy and chemical products. While the economic prospects of our technology
are not as strong in regions of the world where growth is slow or where natural gas and oil prices are very low, we believe our
prospects in the many regions of the world that have expensive natural gas, LNG and crude oil or have inadequate infrastructure
to deliver natural gas and LNG provide an attractive long-term outlook for us.
Historically, our operations have focused on China which has seen dramatic growth in our industry over
the past twenty years and over the past ten years we have successfully grown our installed base of syngas generation systems there
to a total of twelve across five projects. Today, we believe the Chinese market for syngas is shifting from rapid growth to a moderated
growth rate with much more focus from the Chinese government for industrial consolidation and increasing efficiency of projects.
In addition, we are seeing emerging opportunities in China for utilization of syngas in energy projects such as industrial fuel
gas, SNG and electric power in addition to the traditional chemicals market. We expect China, over the long term, will remain a
key market for syngas projects however we believe achieving financial results from syngas projects built in China will continue
to be difficult as lower rates of returns have historically been acceptable to Chinese state owned companies and the ability for
western companies like ourselves to influence outcomes in China is limited. We believe financial success in China will require
unique partnerships with Chinese companies that align interests such that foreign companies like ourselves have more influence
over outcomes and better aligned interest related to expected financial results. At the present time, we are de-emphasizing our
China business activities as compared to our past efforts and we expect to realize reduced expenditures related to our China operations
as a result. Our near-term objective is to make our Chinese operations self-sufficient either through delivering financial operating
results or through asset sales in a manner that maximizes value to our shareholders.
In implementing our strategy, we intend to
continue to diversify our geographic concentration beyond China to other global regions. This process has already begun as evidenced
by our growing Australian operations and our project development work underway related to our Australian Future Energy (“AFE”)
investment and our equity interest in Batchfire Resources Pty Ltd
("
Batchfire
”)
, the owner and operator
of the Callide coal mine in Queensland. In addition, we are bidding and supporting project developments in South America, Eastern
Europe, India and other locations.
Operationally we have seen an acceleration
of activities in Australia. Our partnership with AFE has allowed us entry to the Australian market with a pipeline of projects
that may serve to benefit the Company both in the short-term and the long-term. We intend to place more operational focus onto
working with our AFE partnership to drive business results from the Australian market.
Globally, we have seen a steady shifting of
the competitive landscape of syngas generation from more commonly deployed technologies that rely on expensive higher grade coals
and utilize more water to technologies than can tap into the globally abundant lower quality, lower cost coals. This has generated
increasing interest in our technology and its capabilities to produce syngas cleanly, efficiently and with lower water consumption
for most all qualities of coal wastes 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.
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 equity holdings in partnerships, projects and related business platforms. 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 or can help bring financial capabilities, such as debt guarantees and equity financing as well as local
project implementation and operating expertise. Our AFE investment is an example of such a platform established to serve the Australian
market. Developing business and projects entails a number of risks we must manage with our partners and our ability to access both
debt and equity funding, at commercially reasonable returns, will be critical to achieving growth in the equity project development
side of our business.
We believe that this is a critical time in shaping
the future of our company. We have spent the past ten years commercializing our technology in China beginning at our ZZ and Yima
joint ventures culminating with the latest licensed projects completed in conjunction with our Tianwo-SES joint venture for a total
of five projects completed which utilize twelve of our syngas generating systems. This significant accomplishment has provided
a robust demonstration of our technical capabilities at commercial scale. Building on the results from our first ten years in China,
we believe we are positioned to secure new projects and related operations which in turn will lead to improved financial returns
to the Company. We believe the AFE and Batchfire investments are examples of the type of undertakings that will generate financial
results for the Company both in the near and long-term.
As of March 31, 2017, we had $7.0 million
in cash and cash equivalents. 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 begun implementing significant cost cutting
procedures given our current liquidity situation and our change in operational focus away from China. In addition, we are
aggressively pursuing strategic alternatives variety of capital raising options which can include: the issuance of additional
equity through our ATM program or other open market and private placements, 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 additional
reductions in operating expenses. While we believe between our cost cutting strategies and strategic alternative capital
raising options, we will be able to meet our needs as they occur, no assurances can be given that we will be successful. If
we are not successful in short-term revenue generation, or strategic alternative capital raising objectives in the future, it will cast
substantial doubt to continue as a going concern. These financial statements do not include any adjustments as a result of
these uncertainties.
In addition, we may choose 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 general corporate purposes. 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 our 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 March 31, 2017 (“Current Quarter”)
Compared to the Three Months Ended March 31, 2016 (“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 $22,000 for the Current Quarter which is a result of engineering studies for a customer. During the Comparable
Quarter total revenues were $51,000, which resulted from engineering feasibility studies and coal testing services for a customer
.
Costs of sales and plant operating expenses.
There were $20,000 costs of sales during the Current Quarter, which related to the costs incurred for engineering studies for
a customer. There was no cost of sales in the Comparable Quarter.
General and administrative expenses.
General
and administrative expenses were $2.2 million in the Current Quarter compared with $2.3 million for the Comparable Quarter. The
$0.1 million decrease is the result of a reduction of employee related compensation costs from a reduction in headcount.
Stock-based expense
. Stock-based expense
was $0.6 million in the Current Quarter compared with $0.5 million for the Comparable Quarter. The $0.1 million increase is due
primarily to an increase in the number of stock options 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,
the $42,000 decrease is primarily due to our exclusive worldwide GTI license fee was fully amortized in August 2016.
Equity in loss of joint venture.
The
equity loss of joint venture was $40,000 in the Current Quarter, which related to our 39% share of the start-up losses incurred
by AFE in the current period. There was no equity loss of joint venture for the Comparable Quarter.
Foreign currency gain
. Foreign currency
gain from continuing operation was $16,000 for the Current Quarter compared with a gain of $15,000 for the Comparable Quarter.
Nine Months Ended March 31, 2017 (“Current Period”)
Compared to the Nine Months Ended March 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 $27,000 for the Current Period resulting from engineering services revenue from a customer. During the Comparable
Period total revenues were $0.4 million, which resulted from engineering feasibility studies and coal testing services for two
customers
.
Costs of sales and plant operating expenses.
There were $22,000 costs of sales during the Current Period resulting from costs incurred for engineering services for a customer.
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 $6.9 million in the Current Period compared with $6.2 million for the Comparable Period. The $0.7
million increase is due primarily to engineering expenses and consulting fees incurred related to increased project development
activities in China during the early portion of the current fiscal year.
Stock-based expense
. Stock-based expense
decreased by $1.5 million to $1.3 million for the Current Period, compared to $2.8 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 $57,000 for the Current Period compared with $0.2 million for the Comparable
Period. The decrease is primarily related to our exclusive worldwide GTI license fee was fully amortized in August 2016.
Equity in loss of joint venture.
The
equity in loss of joint venture were $40,000 in the Current Period, which related to our 39% share of the start-up losses incurred
by AFE. There was no equity in loss of joint venture for 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 approximately $0.1 million foreign currency loss for the Current Period primarily resulted from the 6.8% depreciation of the
yuan relative to the U.S. Dollar from June to March 2017 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 $2.8 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 Period, partially offset by $0.4 million operating loss of ZZ
Joint Venture during the Current Period.
Liquidity and Capital Resources
As of March 31, 2017, we had $7.0 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 begun
implementing significant cost cutting procedures given our current liquidity situation and our change in operational focus away
from China. In addition, we are aggressively pursuing short-term revenue generation activities and a variety of capital raising
options which can include: the issuance of additional equity through our ATM program or other transactions, 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 additional reductions in operating expenses. While we believe between our cost cutting strategies, short-term revenue generation
and capital raising options, we will be able to meet our needs as they occur, no assurances can be provided that we will be successful.
If we are not successful in short-term revenue generation, or capital raising objectives in the future, it will cast substantial doubt on our ability to continue as a going concern. These
financial statements do not include any adjustments as a result of these uncertainties.
In addition, we may choose 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 general corporate purposes. 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 our 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 May 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.
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 our non-revenue generating investments as a source of cash to develop additional projects or for general corporate purposes.
As of March 31, 2017, we had $7.0 million in
cash and cash equivalents and $5.7 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 $6.5 million in cash for operating activities in the Current Period compared to
$6.6 million for the Comparable Period. These funds were utilized to develop our technical licensing and related services and
for our general and administrative expenses.
|
|
•
|
Investing
Activities: During the Current Period, we used $0.4 million in investing activities for investing in Australian Future Energy
Pty Ltd.; used $5,000 for capital expenditures; and used $12,000 related to our ZZ Joint Venture restructuring. During the Comparable
Period, we used $20,000 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.
|
|
•
|
Financing
Activities: For the Current Period, we had a net source of cash of approximately $82,000 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 $82,000 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.
|
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:
|
·
|
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
|
|
·
|
Yima will supply coal to the project at a preferential price.
|
As discussed below in November 2016, as part
of an overall corporate restructuring plan, these joint ventures were combined into a single joint venture.
We own a 25% interest in the 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 Venture.
The remaining capital for the project construction
has been funded with project debt obtained by the Yima Joint Venture. 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 agreement,
the Yima Joint Venture is 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 Venture’s 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
Venture 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 Venture 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 Venture 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 Venture.
With the changes in management, we continue to evaluate our level of influence over the Yima Joint Venture, which could result
in us recording the Yima Joint Venture under the equity method of accounting in the future.
Current Yima Plant Operating Description
Despite initiating methanol production in December
2012, the Yima Joint Venture’s plant continued its construction through the beginning of 2016. In March 2016, the Yima Joint
Venture completed the required performance testing of the SGT systems and successfully issued its Performance Test Certificate,
which is the point that we considered the plant to be completed. 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 Venture returned to operations 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. 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 Venture 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 Venture 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 March 31,
2017, the Yima Joint Venture had approximately $68.7 million of third party debt which is due starting in September 2017.
Because of the situations detailed above, our
management evaluated the conditions of the Yima Joint Venture 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 Venture was impaired as of June 30, 2016, and accordingly, we recorded an $8.6 million impairment for the fiscal year
ended June 30, 2016.
In November 2016, the plant returned to operations.
While the plant’s operations were initially in line with our expectations, due to recent operational issues, production has
fallen below our expectations over the past two months. Yima’s management has plans in place to increase the operational
efficiency of the plant. If Yima management is not able to increase its operational effectiveness over the next quarter, we anticipate
further impairments of our investment in the future. However given, the return to operations, a favorable market environment for
methanol, and the internal refinancing of certain third party debt, management determined that there has not been an other than
temporary impairment in the value of our Yima investment during the nine months ended March 31, 2017. The carrying value of our
Yima investment was approximately $26.2 million as of both March 31, 2017 and June 30, 2016. We continue to monitor the Yima Joint
Venture and could record an additional impairment in the future if operating conditions improve to meet our 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 $14.5 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 March 31, 2017 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 was not completed by March 23, 2017. CESI has not completed any development work on any projects and therefore
the contract may be terminated by either party. At this point in time, neither party has exercised their right to terminate the
agreement.
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 given our
shift away from the China market, 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 ($290 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 ($79.7
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. Given our current strategic focus away from China operations, we may elect to not go forward with this project.
AFE
In May 2015, we established AFE together
with an Australian company, Ambre Investments PTY Limited (“Ambre”). AFE is an independently managed Australian
business platform established for the purpose of developing, building and owning equity interests in chemical and energy
manufacturing facilities in Australia utilizing resources such as waste coals, renewable biomass and municipal wastes.
Additionally, AFE is acquiring ownership positions in these Australian resources in order to secure a long-term source of
feedstock for its projects and has completed the creation and spin-out of Batchfire (as discussed below), which now owns the
large operating Callide coal mine in Queensland. Also, in April 2017 AFE completed the acquisition of the mine development
lease related to the 270 million ton resource near Pentland, Queensland.
In forming AFE, we contributed conditional
exclusive access to SGT in Australia via a Master Technology Agreement and we received our ownership interest in AFE. The Master
Technology Agreement also states SES will share a portion of its earned license fee with AFE, and AFE will exclusively use SES
technology while SES will exclusively use AFE as its channel to the Australian market.
In addition to the initial technology transfer,
we have been contributing engineering support for AFE’s business development while Ambre has contributed cash. In fiscal
year 2016, we recognized approximately $0.2 million in related party consulting services provided to AFE. In January 2017, the
Company elected to increase its ownership interest in AFE by contributing approximately $0.4 million of cash in additional equity.
At March 31, 2017, we owned approximately 39% of AFE and the carrying value of AFE was $0.3 million as of March 31, 2017.
Because of the early stage business development
expenses incurred by AFE, the carrying value of AFE was zero as of June 30, 2016. Under the equity method of accounting, losses
in the venture are not recorded if the losses cause the carrying value to be negative and there is no requirement of the Company
to contribute additional capital. Had the Company recognized its share of the losses related to the venture, the Company would
have recognized additional losses of approximately $0.4 million from inception to date.
AFE is currently evaluating project opportunities that would use
SGT and recently signed agreements with SES to provide certain license and engineering services, as they begin the initial scoping
of potential projects. AFE plans to utilize the unmarketable coal from the Callide mine discussed below to responsibly manufacture
energy or chemical products.
Batchfire
Because of AFE’s early stage business development efforts associated with the Callide coal mine
in Central Queensland, Australia, AFE created Batchfire. Batchfire was a spin-off company for which ownership interest was distributed
to the existing shareholders of AFE and to the new Batchfire management team 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”).
The acquisition of the Callide thermal coal mine from Anglo American was completed in October 2016. 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 contributions in AFE, the carrying value of our investment in Batchfire was zero as
of March 31, 2017 and June 30, 2016.
Batchfire has implemented its mining plan at
the Callide mine which has resulted in increased output from the mine while continuing to lower per unit mining costs. We believe
that this plan will continue to improve the overall financial results of the mine.
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. . During the current year, GTI agreed to defer $0.4 million of its 2016 payment
until May 15, 2017. 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.