Summary of SYNTHESIS ENERGY SYSTEMS INC

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and the related notes and other financial information included elsewhere in this annual report. Some of the information contained in this discussion and analysis or set forth elsewhere in this annual report, including information with respect to our plans and strategy for our business and related financing, includes forward-looking statements that involve risks and uncertainties. You should review the "Risk Factors" section of this annual report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

Business Overview

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

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

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

Results of Operations

We are in our development stage and therefore have had limited operations. We have sustained net losses of $137.2 million from November 4, 2003, the date of our inception, to June 30, 2012.

Year Ended June 30, 2012 Compared to the Year Ended June 30, 2011

Revenue. Total revenue decreased by $7.1 million to $3.1 million for the year ended June 30, 2012 compared to $10.2 million for the year ended June 30, 2011.

Product sales decreased by $6.8 million to $2.1 million for the year ended June 30, 2012 compared to $8.9 million for the year ended June 30, 2011 and were derived from the sale of syngas and byproducts produced at the ZZ Joint Venture plant to Hai Hua. The decrease in product sales was due primarily to no capacity fee revenue being received during the year ended June 30, 2012 and the suspension of syngas production at the ZZ Joint Venture plant in late September 2011.

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In May 2011, Hai Hua notified the ZZ Joint Venture plant that it will not continue payment of capacity fees beyond April 2011. The unpaid amount totaled $4.7 million cumulatively as of June 30, 2012. The plant continued to operate and provide syngas to Hai Hua until operations were suspended in late September 2011, and Hai Hua has paid other contractual obligations such as the energy fees and by-product sales due under the contract. We are continuing to work with Hai Hua on alternatives to resolve this issue and recover these fees including restructuring the current business arrangement to create an integrated syngas to methanol operation. We did not recognize these capacity fee revenues during fiscal 2012 and we will not recognize any capacity fees until collection is reasonably assured.

Technology licensing and related services revenues decreased by $0.3 million to $0.9 million for the year ended June 30, 2012 compared to $1.2 million for the year ended June 30, 2011 and were generated from the testing of coal at the ZZ Joint Venture plant, and other coal testing, feasibility studies and other technical services provided in association with our technology licensing business.

Costs of sales and plant operating expenses. Costs of sales and plant operating expenses decreased by $4.3 million to $4.8 million for the year ended June 30, 2012 compared to $9.1 million for the year ended June 30, 2011. The decrease was due primarily to the suspension of syngas production at the ZZ Joint Venture plant in late September 2011.

General and administrative expenses. General and administrative expenses increased by $0.3 million to $13.2 million for the year ended June 30, 2012 compared to $12.9 million for the year ended June 30, 2011. The increase was due primarily to non-recurring consulting related costs of $0.8 million, including a $0.5 million charge to recognize the loss related to a matter with a consulting firm which was settled in May 2012 and fees associated with collecting a payment from Hai Hua, offset, in part, by a reduction in expenses of $0.5 million due principally to decreased compensation and other expenses. Recurring general and administrative expenses consist primarily of compensation, professional and consulting fees, travel, and other costs of our corporate, development and administrative functions in Houston and Shanghai, and project and technical development expenses.

Stock-based compensation expense. Stock-based compensation expense decreased by $0.3 million to $0.9 million for the year ended June 30, 2012 compared to $1.2 million for the year ended June 30, 2011 and related to the expensing of the estimated fair values of awarded stock options and restricted stock. The decrease was principally due to awarding fewer stock-based awards in 2012 compared to 2011.

Depreciation and amortization expense. Depreciation and amortization expense decreased by $0.1 million to $2.5 million for the year ended June 30, 2012 compared to $2.6 million for the year ended June 30, 2011 and was primarily related to depreciation of our ZZ Joint Venture plant's assets and our corporate assets.

Equity in losses of joint ventures. The equity in losses of joint ventures increased by $1.4 million to $1.9 million for the year ended June 30, 2012 compared to $0.4 million for the year ended June 30, 2011 and relates to our 25% share of the start-up losses incurred by the Yima Joint Ventures and our 50% share of the start-up losses incurred by SRS. The losses of the Yima Joint Ventures related to non-capitalizable costs incurred during the design, construction and start-up phases. The losses of SRS related to development costs including the value of Midas' contributed services, consulting and travel expenses.

Foreign currency gain. Foreign currency gains decreased $0.5 million to $0.5 million for the year ended June 30, 2012 compared to $1.0 million for the year ended June 30, 2011. The foreign currency gains have resulted from the appreciation of the Renminbi Yuan relative to the U.S. dollar and are generated on U.S. dollar denominated shareholder loans payable by our Chinese operations.

Interest income. Interest income was $90,000 for the year ended June 30, 2012 compared to $169,000 for the year ended June 30, 2011. The decrease was primarily due to lower cash equivalent investments.

Interest expense. Interest expense was $0.6 million for the year ended June 30, 2012 compared to $0.7 million for the year ended June 30, 2011. Our interest expense relates primarily to the ZZ Joint Venture's outstanding principal balance on its loan with ICBC.

Net loss attributable to noncontrolling interests. Net loss attributable to noncontrolling interests was $176,000 for the year ended June 30, 2012 compared to $157,000 for the year ended June 30, 2011 and resulted from increased losses from the ZZ Joint Venture.

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Year Ended June 30, 2011 Compared to the Year Ended June 30, 2010

Revenue. Total revenue increased by $0.9 million to $10.2 million for the year ended June 30, 2011 compared to $9.3 million for the year ended June 30, 2010.

Product sales increased by $1.1 million to $8.9 million for the year ended June 30, 2011 compared to $7.8 million for the year ended June 30, 2010 and were derived from the sale of syngas and byproducts produced at the ZZ Joint Venture plant to Hai Hua. The increase in revenue was due to higher levels of syngas production during fiscal 2011 as compared to fiscal 2010. For the years ended June 30, 2011 and 2010, the plant operated for 65% and 61% of the period, respectively, and the plant's availability for production was 97% and 94% of the period, respectively.

During the three months ended June 30, 2011, Hai Hua notified the ZZ Joint Venture plant that it will not continue payment of capacity fees beyond April 2011 for commercial and contractual reasons. The unpaid amount totaled approximately $619,000 as of June 30, 2011. The plant has continued to operate and provide syngas to Hai Hua, and Hai Hua has paid other contractual obligations such as the energy fees and by-product sales due under the contract. We did not recognize these capacity fee revenues during fiscal 2011 and we will not recognize any capacity fees until collection is reasonably assured.

Technology licensing and related services revenues increased by $0.5 million to $1.2 million for the year ended June 30, 2011 compared to $0.7 million for the year ended June 30, 2010. The increase was due primarily to revenues generated from the recognition of previously deferred revenues received under a license agreement entered into in April 2010 which has since been terminated due to the licensee's inability to obtain financing for its project. Related services revenue for both years included testing of coal at the ZZ Joint Venture plant, and other coal testing, feasibility studies and other technical services provided in association with our technology licensing business.

Costs of sales and plant operating expenses. Costs of sales and plant operating expenses increased by $0.5 million to $9.1 million for the year ended June 30, 2011 compared to $8.6 million for the year ended June 30, 2010 and were comprised principally of coal consumption and electricity cost at the ZZ Joint Venture plant. The increase was due primarily to the increase in syngas production during the year ended June 30, 2011.

General and administrative expenses. General and administrative expenses decreased by $1.2 million to $13.0 million during the year ended June 30, 2011 compared to $14.2 million during the year ended June 30, 2010. Project and technical development expenses decreased by $1.7 due to reducing costs we incurred with third parties for development of our technology. Expenses for the year ended June 30, 2010 included a $0.9 million charge for a consulting fee related to the financial closing of the Yima project and other technical support and development costs of biomass gasification projects in the U.S. Other general and administrative expenses increases included travel and professional fees related to licensing, other business development activities, and increased annual royalty expense owed to GTI beginning in January 2010. These cost increases were offset, in part, by a reduction in corporate personnel expenses.

Stock-based compensation expense. Stock-based compensation expense decreased by $1.0 million to $1.2 million for the year ended June 30, 2011 compared to $2.2 million for the year ended June 30, 2010. The decrease was principally due to forfeitures of certain stock option awards and due to the fair values of recent stock option awards being lower than the fair values of certain prior awards as a result of the decrease in the price of our common stock.

Depreciation and amortization expense. Depreciation and amortization expense decreased by $0.1 million to $2.6 million for the year ended June 30, 2011 compared to $2.7 million for the year ended June 30, 2010 and was primarily related to depreciation of our ZZ Joint Venture plant's assets.

Asset impairment loss. The asset impairment loss of $6.6 million during the year ended June 30, 2010 was related to the write-off of the long-lived assets of the GC Joint Venture. We had no asset impairment loss during the year ended June 30, 2011.

Equity in losses of joint ventures. The equity in losses of joint ventures increased by $0.3 million to $0.4 million for the year ended June 30, 2011 compared to $39,000 for the year ended June 30, 2010 and relates to our 25% share of the losses incurred by the Yima Joint Ventures during the construction phase. The losses were comprised of non-capitalizable costs incurred during the design and construction phase, offset in part, by interest income earned on invested funds contributed by us and Yima. The losses for the year ended June 30, 2011 increased due to higher personnel and land lease related costs as portions of the project are nearing completion.

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Foreign currency gain. Foreign currency gains increased $0.9 million to $1.0 million for the year ended June 30, 2011 compared to $0.1 million for the year ended June 30, 2010. The foreign currency gains have resulted from the appreciation of the Renminbi Yuan relative to the U.S. dollar and are generated on U.S. dollar denominated shareholder loans payable by our Chinese operations.

Interest income. Interest income increased $0.1 million to $0.2 million for the year ended June 30, 2011 compared to $0.1 million for the year ended June 30, 2010. The increase was primarily due to higher yields earned on cash equivalent investments.

Interest expense. Interest expense was $0.7 million for both of the years ended June 30, 2011 and 2010. Our interest expense relates primarily to our long term debt comprised of the ZZ Joint Venture's outstanding principal balance on its loan with the Industrial and Commercial Bank of China, or ICBC. In addition, the ZZ Joint Venture has incurred additional interest expense of approximately $161,000 during 2011 due to incurring discounting costs on bank notes received from its customer in settlement of the ZZ Joint Venture's accounts receivable.

Net loss attributable to noncontrolling interests. Net loss attributable to noncontrolling interests decreased by $3.5 million to $0.2 million for the year ended June 30, 2011 compared to $3.7 million during the year ended June 30, 2010. Net loss attributable to noncontrolling interests for the year ended June 30, 2010 was principally from Golden Concord absorbing their interest in the asset impairment loss recognized by the GC Joint Venture.

Liquidity and Capital Resources

We are in our development stage and have financed our operations to date through private placements of our common stock in 2005 and 2006 and two public offerings, one in November 2007 and one in June 2008. We have used the proceeds of these offerings primarily for the development of and investments in our joint ventures in China, including our investments in the ZZ Joint Venture and the Yima Joint Ventures, and to pay other development and general and administrative expenses. In addition, we have entered into a loan agreement with ICBC to fund certain of the costs of the ZZ Joint Venture.

As of June 30, 2012, we had $18.0 million in cash and cash equivalents and $9.9 million of working capital available to us. During the year ended June 30, 2012, we used $11.8 million in operating activities compared to $13.5 million for the year ended June 30, 2011. The decrease in cash used in operating activities was due principally to the $1.0 million advance to the ZZ Joint Venture from Hai Hua. During fiscal 2012, we used $0.9 million in investing activities primarily to fund the start-up and development of SRS. During each of fiscal 2012 and 2011, we used $2.4 million in financing activities for the scheduled semi-annual principal payments on the ZZ Joint Venture's loan with ICBC. Other financing activities included the receipt of a $1.0 million deposit from Hongye towards the share purchase agreement with Hongye during fiscal 2012 (which is to be repaid to Hongye in connection with the funding described below) and the receipt of $5.0 million from the issuance of common stock to Zuari during fiscal 2011.

On September 21, 2012, we received gross proceeds of approximately $8.7 million from Hongye and issued 5,777,700 shares to Hongye. Hongye is expected to pay the remaining $596,090 of their aggregate purchase price for their shares, and receive their 397,393 share balance, at the closing of the Zhongmo transaction. The net proceeds received by us from these stock sales are to be fully applied to our operations and projects in China and are to be deposited into a bank account in China or Hong Kong controlled by our China-centric business platform, SES China.

Loan Agreement

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

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

Interest is adjusted annually based upon the standard rate announced each year by the People's Bank of China, and as of June 30, 2012, the applicable interest rate was 7.05% and is payable monthly;

Principal payments of RMB 7.7 million (approximately $1.2 million based on current currency exchange rates) are due in March and September of each year through March 2014;

Hai Hua is the guarantor of the entire loan;

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

Covenants include, among other things, prohibiting pre-payment without the consent of ICBC and permitting ICBC to be involved in the review and inspection of the ZZ Joint Venture plant; and

Subject to customary events of default which, should one or more of them occur and be continuing, would permit ICBC to declare all amounts owing under the contract to be due and payable immediately.

As of June 30, 2012, the ZZ Joint Venture was in compliance with all covenants and obligations under the Fixed Asset Loan Contract.

Share Purchase Agreements

Share Purchase Agreements with Hongye and Zhongmo

On June 18, 2012, we entered into a Share Purchase Agreement with Hongye International Investment Group Co., Ltd., or Hongye, pursuant to which Hongye will acquire 6,175,093 shares of our common stock for $1.50 per share, for an aggregate purchase price of approximately $9.3 million, and entered into a Share Purchase Agreement with Shanghai Zhongmo Investment Management Co., Ltd., or Zhongmo, pursuant to which Zhongmo will acquire 4,177,335 shares of the Common Stock for $1.50 per share, for an aggregate purchase price of approximately $6.3 million. The net proceeds received by us are to be fully applied to our operations and projects in China and are to be deposited into a bank account in China or Hong Kong controlled by our China-centric business platform, SES China. The terms and conditions of the Agreement are summarized in Note 12 to the consolidated financial statements included herein.

Share Purchase Agreement with ZJX

On March 31, 2011, we entered into a Share Purchase Agreement, or the Agreement, with China Energy Industry Holdings Group Co, Ltd., or China Energy, and Zhongjixuan Investment Management Company Ltd., or ZJX, pursuant to which we will issue on the closing date to China Energy 37,254,475 shares of our common stock, in exchange for approximately $83.8 million, or the Consideration. Within 20 business days after the accomplishment of the Milestone, as defined, we shall further issue directly to China Energy an amount of shares of common stock which, when combined with the shares issued on the closing date, equals 60.0% of the outstanding common stock on a fully-diluted basis. The terms and conditions of the Agreement are summarized in Note 12 to the consolidated financial statements included herein.

Closing of the transaction with China Energy and ZJX is subject to approval by our stockholders and other customary closing conditions. Although the Agreement was not extended at March 31, 2012, we agreed with ZJX to keep the Agreement in effect as long as the parties are making good progress toward meeting the objective of completing the Agreement in a reasonable amount of time.

Use of Proceeds

Subject to the discretion and approval of the Board, the Consideration, net of costs and expenses, is required to be applied to the following:
(i) incorporation of a Company headquarters in China to consolidate the ownership of our investment projects in China and enhance our presence in China;
(ii) investing in the expansion of our ZZ Joint Venture; (iii) investing in Phase I of our Yima Joint Ventures; (iv) acquiring an ownership interest in a coal mine that will provide coal to the Yima Joint Venture project;
(v) investing in our Golden Concord Joint Venture; (vi) other Chinese projects that may be recommended to the Board from time to time; and (vii) other expenses of the operation and business of us in China.

ZJX will use reasonable endeavours to assist us to obtain third party funding (third party direct equity investment in projects or debt financing to the projects) to (a) cover funding needs of the above projects; (b) provide funding for us to invest in future phases of the Yima Joint Venture project; (c) invest in strategic coal resources in China connected to our projects; and (d) provide funding for us to invest in other projects in China not listed above and assist us to obtain third party investment in any of our other projects.

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Project Development

ZJX is required to use reasonable endeavours to create at least four project joint ventures, or the MJVs, in the areas of synthetic natural gas, methanol to gasoline; fertilizer; and electric power. Funding for each MJV is expected to be approximately RMB20 billion (approximately $3.2 billion based on the exchange rate as of December 31, 2011). Each MJV is expected to be funded with equity from a strategic investor plus project debt. We are anticipated to be part owner of each MJV through a targeted 35% carry provided by the strategic investor as part of our development of and provision of technology for the particular projects. ZJX will help us work with the strategic investors to obtain long term purchase commitments for each of the MJVs prior to the start of construction of each such project.

Other

We have included the $1.5 million payment paid to GTI in June 2009 toward future royalties due to GTI for the Yima Joint Ventures' project as part of our investment in the Yima project. An additional future royalty payment of approximately $1.5 million will be due to GTI upon the commissioning of the gasifier equipment for the Yima project which is expected during fiscal 2013.

Outlook

Our strategy is to create value by providing technology and equipment in regions where low rank coals and biomass feedstocks can be profitably converted into high value products through our proprietary fluidized bed gasification technology, which is technology is based on the U-GASŽ process developed by GTI, but is augmented and differentiated by our own intellectual property gained by owning and operating one commercial plant and partnering in a second that is currently in commissioning. We do this by providing a proprietary technology package whereby we license our technology rights to third parties, deliver an engineered technology package and provide proprietary equipment components to customers who have contracted to own and operate projects. We anticipate that we can generate revenues through engineering and technical service fees, as well as licensing fees and royalties on products sold by our licensees that incorporate our proprietary technology without incurring the significant capital costs required to develop a plant. We also believe that our licensing activities will help advance our project development activities, which may allow us to make selective equity investments in such projects in the future and afford opportunities to develop integrated, modular product offerings. Additionally, we are continuing to improve our technology in ways we believe will enhance our ability to further develop our licensing activities.

We currently plan to use our available cash for (i) general and administrative expenses, including the SES China business platform; (ii) debt service related to the ZZ Joint Venture; (iii) working capital; (iv) project, third party licensing and technical development expenses; (v) operating expenses of SRS; and
(vi) general corporate purposes. The actual allocation and timing of these expenditures will be dependent on various factors, including changes in our strategic relationships, commodity prices and industry conditions, and other factors that we cannot currently predict. In particular, any future decrease in economic activity in China or in other regions of the world in which we may in the future do business could significantly and adversely affect our results of operations and financial condition. Although demand for methanol is increasing . . .