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SYMX > SEC Filings for SYMX > Form 10-Q on 13-Nov-2012All Recent SEC Filings

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Form 10-Q for SYNTHESIS ENERGY SYSTEMS INC


13-Nov-2012

Quarterly Report


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

You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and the related notes and other financial information included elsewhere in this quarterly report. Some of the information contained in this discussion and analysis or set forth elsewhere in this quarterly report, including information with respect to our plans and strategy for our business and related financing, include forward-looking statements that involve risks and uncertainties. You should review the "Risk Factors" section of our Annual Report on Form 10-K for the fiscal year ended June 30, 2012 for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

Business Overview

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


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

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

The key elements of our business strategy include:

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

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

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


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• Expanding our relationships with strong strategic partners. Our efforts have been initially focused on facilities producing syngas, methanol and DME in China. We are expanding our relationships with our current partners and developing new relationships, including through our potential transaction with ZJX and China Energy, through our engagement of Crystal Vision Energy and through strategic joint venture initiatives in specific markets that will enable us to expand our business. Such strategic relationships may include an investment in projects either directly by us or through an investment partner where our gasification technology plants may supply syngas to strategic customers via long-term off take agreements. For example, through our joint venture SES Resource Solutions, we are working with Midas Resource Partners AG, a coal resource consulting and project development firm, to collaborate on project origination and project development activities for integrated coal resource-gasification projects to incentivize third party investors to commit to providing financing for such projects. We are exploring new markets for entry such as India, Australia, and other parts of Asia and Europe.

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

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

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

Results of Operations

We are in our development stage and therefore have had limited operations. We have sustained net losses of approximately $141.7 million from November 4, 2003, the date of our inception, to September 30, 2012.

Three Months Ended September 30, 2012 Compared to the Three Months Ended September 30, 2011

Revenue. Total revenue decreased to $71,000 for the three months ended September 30, 2012 compared to $2.5 million for the three months ended September 30, 2011.


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There was no product sales revenues for the three months ended September 2012 due primarily to no capacity fee revenue being received during the three months ended September 30, 2012 and the suspension of syngas production at the ZZ Joint Venture plant in late September 2011. Product sales were $2.1 million for the three months ended September 30, 2011 and were derived from the sale of syngas and byproducts produced at the ZZ Joint Venture plant to Xuecheng Energy before the suspension of syngas production at the ZZ Joint Venture.

In May 2011, Shangdong Xuecheng Energy Group Xuecheng Energy Company Ltd., or Xuecheng Energy (previously Hai Hua), notified the ZZ Joint Venture plant that it will not continue payment of capacity fees beyond April 2011. The unpaid amount totaled approximately $5.7 million cumulatively as of September 30, 2012. The plant continued to operate and provide syngas to Xuecheng Energy until operations were suspended in late September 2011, and Xuecheng Energy has paid other contractual obligations such as the energy fees and by-product sales due under the contract. We are continuing to work with Xuecheng Energy on alternatives to resolve this issue and recover these fees including restructuring the current business arrangement to create an integrated syngas to methanol operation. We did not recognize these capacity fee revenues during fiscal 2012 and the three months ended September 30, 2012 and we will not recognize any capacity fees until collection is reasonably assured.

Technology licensing and related services revenues were $71,000 for the three months ended September 30, 2012 compared to $0.3 million for the three months ended September 30, 2012, and resulted primarily from coal testing services for customers who are actively developing projects and may license and build plants using our technology.

Costs of sales and plant operating expenses. Costs of sales and plant operating expenses decreased by $3.2 million to $0.1 million for the three months ended September 30, 2012 compared to $3.2 million for the three months ended September 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 $0.1 million to $3.1 million during the three months ended September 30, 2012 compared to $3.0 million during the three months ended September 30, 2011. The increase was due primarily to non-recurring fees of approximately $0.2 million associated with collecting an advance of approximately $0.8 million from Xuecheng Energy. 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 increased by $97,000 to $164,000 for the three months ended September 30, 2012 compared to $67,000 for the three months ended September 30, 2011 and related to the expensing of the estimated fair values of awarded stock options and restricted stock. The lower stock based compensation expense for the three months ended September 30, 2011 was due to forfeitures of certain stock option awards in September 2011.

Depreciation and amortization. Depreciation and amortization expense was $0.6 million for both of the three months ended September 30, 2012 and 2011 and was primarily related to depreciation of our ZZ Joint Venture plant's assets.

Equity in losses of joint ventures. The equity in losses of joint ventures increased by $0.1 million to $0.5 million for the three months ended September 30, 2012 compared to $0.4 million for the three months ended September 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 SES Resource Solutions, Ltd., or 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. There was a foreign currency loss of $38,000 for the three months ended September 30, 2012 compared to $0.4 million foreign currency gain for the three months ended September 30, 2011. These amounts result from the depreciation or appreciation of the Renminbi Yuan relative to the U.S. dollar and are generated on U.S. dollar denominated shareholder loans payable by our Chinese operations.

Interest expense. Interest expense was $96,000 for the three months ended September 30, 2012 compared to $184,000 for the three months ended September 30, 2011. Our interest expense relates primarily to the ZZ Joint Venture's outstanding principal balance on its loan with ICBC.


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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 September 30, 2012, we had $22.7 million in cash and cash equivalents and $13.1 million of working capital available to us. During the three months ended September 30, 2012, we used $2.6 million in operating activities compared to $3.1 million for the three months ended September 30, 2011. During the three months ended September 30, 2012, we used $0.1 million in investing activities compared to $0.2 million for the three months ended September 30, 2011 due primarily to fund the start-up and development of SRS. For both the three months ended September 30, 2012 and 2011, we used $1.2 million in financing activities for the scheduled semi-annual principal payments on the ZZ Joint Venture's loan with ICBC. On September 21, 2012, we received gross proceeds of approximately $8.7 million from Hongye International Investment Group Co., Ltd., or Hongye, and issued 5,777,700 of the Hongye Shares to Hongye. On October 10, 2012, we received gross proceeds of approximately $6.3 million from Shanghai Zhongmo Investment Management Co., Ltd., or Zhongmo, and issued the Zhongmo Shares to Zhongmo. Also, on October 16, 2012, we received gross proceeds of approximately $596,000 from Hongye and issued the remaining 397,393 of the Hongye Shares to Hongye. The net proceeds received by us from Hongye and Zhongmo are to be fully applied to our operations and projects in China and are to be deposited into a bank account in China or Hong Kong controlled by the SES China, our China-centric business platform.

Share Purchase Agreements

Share Purchase Agreements with Hongye and Zhongmo

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

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

Share Purchase Agreement with ZJX

On March 31, 2011, we entered into a Share Purchase Agreement, or the Agreement, with China Energy Industry Holdings Group Co, Ltd., or China Energy, and Zhongjixuan Investment Management Company Ltd., or ZJX, pursuant to which we will issue on the closing date to China Energy 37,254,475 shares of our common stock, in exchange for approximately $83.8 million, or the Consideration. Within 20 business days after the accomplishment of the Milestone, as defined, we shall further issue directly to China Energy an amount of shares of common stock which, when combined with the shares issued on the closing date, equals 60.0% of the outstanding common stock on a fully-diluted basis. 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. Although we believe that ZJX remains active in securing the funding for China Energy with various investor groups, we cannot predict the likelihood of ZJX's success with this effort or the amount of time it could take to close the transaction.


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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.

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.

Zao Zhuang Joint Venture

Joint Venture Agreement

On July 6, 2006, we entered into a cooperative joint venture contract with Shandong Hai Hua Coal & Chemical Company Ltd., or Hai Hua, which established Synthesis Energy Systems (Zao Zhuang) New Gas Company Ltd., or the ZZ Joint Venture, a joint venture company that has the primary purposes of
(i) developing, constructing and operating a syngas production plant utilizing the U-GAS ® technology in Zao Zhuang City, Shandong Province, China and
(ii) producing and selling syngas and the various byproducts of the plant, including ash and elemental sulphur. In August 2012, Hai Hua's name was changed to Shandong Weijiao Group Xuecheng Energy Company Ltd., or Xuecheng Energy, after a change in control transaction. We own 96.9% of the ZZ Joint Venture and Xuecheng Energy owns the remaining 3.1%. We consolidate the results of the ZZ Joint Venture in our consolidated financial statements.

Syngas Purchase and Sale Agreement

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


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