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, 2019 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 that our proposed merger transaction with Australian Future Energy Pty
Ltd may be unable to obtain stockholder approval or satisfy the other conditions
to closing; the ability to achieve the necessary consents to acquire the
additional share of Batchfire Resources Pty Ltd; the ability of Batchfire,
Australian Future Energy Pty Ltd, and Cape River Resources Pty Ltd management to
successfully grow and develop their Australian assets and operations, including
Callide, Pentland and the Gladstone Energy and Ammonia Project; the ability of
Batchfire to produce earnings and pay dividends; the ability of SES EnCoal
Energy sp. z o. o. management to successfully grow and develop projects, assets
and operations in Poland; our ability to raise additional capital; our
indebtedness and the amount of cash required to service our indebtedness; our
ability to find a partner for our technology business; our ability to develop
and expand business of the TSEC Joint Venture in the joint venture territory;
our ability to develop our business verticals, including DRI steel, through our
marketing arrangement with Midrex Technologies; our ability to successfully
develop our licensing business; our ability to continue as a going concern; the
ability of our project with Yima to produce earnings and pay dividends; 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 maintain our listing on the NASDAQ Stock
Market; 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
customers' and/or our ability to obtain the necessary approvals and permits for
future projects; 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 believe that in making such
forward-looking statements our expectations are based upon reasonable
assumptions, such statements may be influenced by factors that could cause
actual outcomes and results to be materially different from those projected 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," "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.
33
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
Synthesis Energy Systems, Inc. (referred to herein as "we", "us", and "our"),
together with its wholly-owned and majority-owned controlled subsidiaries, is a
global clean energy company that owns proprietary technology, SES Gasification
Technology ("SGT"), for the low-cost and environmentally responsible production
of synthesis gas (referred to as "syngas"). Syngas is used to produce a wide
variety of high-value clean energy and chemical products, such as synthetic
natural gas, power, methanol, and fertilizer. Our current focus has been on
commercializing our technology both in China and globally through the regional
business platforms we have created with partners in Australia, via Australian
Future Energy Pty Ltd ("AFE"), in Poland, via SES EnCoal Energy sp. z o.o
("SEE") and in China, via Tianwo-SES Clean Energy Technologies Limited ("TSEC
Joint Venture").
SGT produces syngas that can provide a competitive alternative to other forms of
energy such as natural gas, LNG, crude oil and the conventional utilization of
coal in boilers for power generation. Our syngas can provide a lower cost energy
source in markets where coal, low quality coal, coal wastes, biomass and
municipal wastes are available and where natural gas, LNG, and crude oil are
expensive or constrained due to lack of infrastructure such as distribution
pipelines or power transmission lines, such as Australia, Asia, Eastern Europe
and parts of South America. In addition to the economic advantages, we believe
our syngas also provides an environmentally responsible option for the
manufacturing of chemical, hydrogen, industrial fuel gas and a cleaner option
for the generation of power from coal. We believe that our technology is well
positioned to be an important solution that addresses the market needs of a
changing global energy landscape.
Over the past twelve years, we have successfully commercialized SGT, primarily
through our efforts in China where, between 2006 and 2016, we invested in and
built two commercial scale gasification projects together with Chinese partners
and sub-licensed the SGT into three additional projects in China. In the
aggregate, we have completed five commercial scale industrial projects in China
over a ten-year period, in which the projects utilize twelve SES proprietary SGT
systems. These projects represent a total project level investment of
approximately $450 million. We believe the completion of these projects in China
propelled SGT into a globally recognized gasification technology.
In 2014, we undertook efforts to expand into other regions of the world and
created AFE, a joint venture with partners Ambre Investments PTY Limited
("Ambre") in Australia, and in 2017, created SEE in Poland, with its partners
from EnInvestments sp. z o.o. These regions are ideal locations for industrial
projects utilizing the SGT due to high energy prices and limited access to
affordable natural gas, combined with an abundance of low-quality, low-cost coal
resources, renewable biomass and municipal solid wastes.
Australia's lack of both domestic gas and a uniform energy policy has created a
shortage of reliable energy supply and rising consumer prices, creating a need
and demand for more environmentally friendly and cleaner energy solutions. AFE
was established for the purpose of building large-scale vertically integrated
projects using SGT to produce syngas used in manufacturing fuel gas, synthetic
natural gas, agricultural and other chemicals, transportation fuels, explosives
and for power generation and also to secure ownership positions in local
resources, such as coal and biomass. AFE is able to leverage the unique flexible
feedstock capability of SGT to build industrial projects with low production
costs that can also reduce carbon dioxide emissions and support Australian
industry and regional growth.
Since its formation, AFE has made significant commercial progress, creating
Batchfire Resources Pty Ltd ("BFR"), which acquired one of the largest operating
coal mines in Queensland, acquiring a coal resource mine development lease near
Pentland, Queensland, and advancing the development of its flagship Gladstone
Energy and Ammonia Project (the "Gladstone Project"). The AFE business underpins
the future value of the Company and, to that end, on October 10, 2019, we and
AFE entered into a definitive agreement to merge the two entities, among other
transactions.
For a discussion on the proposed Merger with AFE and the related transactions,
see "Liquidity and Capital Resources."
34
We have determined that we did not have adequate cash to continue the
commercialization of SGT due primarily to our inability to realize financial
results from our two investments into projects in China and three technology
licensed projects in China as well as our inability to quickly develop
alternative technology income sources in Australia, Poland and other global
regions. As a result, we suspended our global SGT commercialization efforts, we
undertook operating expense reductions, we ceased providing funds to project
developments, we continue to explore the divesting of assets such as our Yima
and TSEC Joint Ventures and we formed a special committee of the board of
directors to evaluate financing and restructuring alternatives.
We operate our business from our headquarters located in Houston, Texas and our
offices in Shanghai, China.
Outlook
As a result of our efforts evaluating financing and strategic options, on
October 10, 2019, we entered into an Agreement and Plan of Merger (the "Merger
Agreement") with AFE as previously discussed and also described in Note 4 - The
Proposed Merger with AFE. Currently our focus is on completing the steps
required to complete the merger, which include but not limited to, (i)
completion of all Company required filings, (ii) curing the Nasdaq listing
requirement deficiencies, (iii) completion of the Form S-4, Form S-1 and Proxy
related to the merger, (iv) completion of the Batchfire share exchange
pre-emptive rights process and (v) all other tasks required to complete the
merger transaction.
We can make no assurances that the proposed merger transaction will be completed
on a timely basis or at all. We may also need to raise additional capital
through equity and debt financing to complete the merger transaction or to
otherwise strengthen our balance sheet for our corporate general and
administrative expenses. We cannot provide any assurance that any financing will
be available to us in the future on acceptable terms or at all. Any such
financing could be dilutive to our existing stockholders. In addition, we may be
forced to seek relief to avoid or end insolvency through other proceedings
including bankruptcy. Based on the historical negative cash flows and the
continued limited cash inflows in the period subsequent to year end there is
substantial doubt about the Company's ability to continue as a going concern.
Results of Operations
Three Months Ended December 31, 2019 ("Current Quarter") Compared to the Three
Months Ended December 31, 2018 ("Comparable Quarter")
Revenue. Total revenues were zero for both the Current Quarter and the
Comparable Quarter.
Costs of sales expenses. There were no costs of sales expenses for both the
Current Quarter and the Comparable Quarter.
General and administrative expenses. General and administrative expenses were
$1.3 million in the Current Quarter compared with $1.8 million for the
Comparable Quarter. The decrease of $0.5 million was due primarily to the
reduction of employee related compensation costs, professional fees, and other
general and administrative expenses.
Stock-based expense. Stock-based expense was approximately $0.6 million for the
Current Quarter compared with $0.1 million for the Comparable Quarter, which
primarily related to the stock warrants issued to our investor relations advisor
during the Current Quarter and the Comparable Quarter.
Depreciation and amortization. Depreciation and amortization expense was $14,000
for the Current Quarter compared with $8,000 for the Comparable Quarter, which
relates to the amortization of our global patents.
Equity in income of joint ventures. The equity losses of joint ventures was
approximately $0.3 million during the Current Quarter as compared to $0.1
million for the Comparable Quarter, which primarily relates to our share of
losses in AFE and the recognition of past losses due to additional support in
the form of the loan to AFE.
35
Loss on fair value adjustments of derivative liabilities. The loss on fair value
adjustments of derivative liabilities was approximately $0.9 million for the
Current Quarter compared with net gain of $0.7 million for the Comparable
Quarter, which resulted from the change of fair market value for the Merger
Debenture and Merger Warrants accounted for as liabilities, the change in the
fair value was primarily due to movements in our stock price with minor
movements related to the passage of time, interest rate fluctuations and stock
market volatility.
Loss on Extinguishment of Debentures. The loss on extinguishment of the
debentures was $17.9 million for the Current Quarter compared with zero for the
Comparable Quarter which was related to write-off of approximately $2.1 million
of unamortized debt discount and issuance costs, and $15.8 million fair value
adjustment to the Merger Debenture and Merger Warrants for the quarter ended
December 31, 2019.
Interest expenses: Interest expenses were $0.3 million for both the Current
Quarter and the Comparable Quarter, which was related to the interest payments
for the Debentures and the amortization of debenture discount and issuance
costs,
Foreign currency gain losses. Foreign currency losses were approximately $1,000
for the Current Quarter compared with a gain of $31,000 for the Comparable
Quarter, which resulted from the lower value and volume of transactions in
China.
Six Months Ended December 31, 2019 ("Current Period") Compared to the Six Months
Ended December 31, 2018 ("Comparable Period")
Revenue. The total revenues were zero for both the Current Period and the
Comparable Period.
Costs of sales expenses. There were no costs of sales expenses for both the
Current Period and the Comparable Period.
General and administrative expenses. General and administrative expenses were
$1.9 million in the Current Period compared with $3.3 million for the Comparable
Period. The $1.4 million decrease was primarily due to the reduction of employee
related compensation costs, professional fees, and other general and
administrative expenses.
Stock-based expense. Stock-based expense was $0.5 million for the Current Period
as compared to $0.3 million for the Comparable Period. The increase of $0.2
million was due primarily to common shares issued to our investor relations
advisor in October 2019.
Depreciation and amortization. Depreciation and amortization expense was $27,000
for the Current Period compared with $19,000 for the Comparable Period, which
primarily related to the amortization of our global patents.
Equity in losses of joint ventures. The equity losses of joint ventures was
$322,000 during the Current Period as compared to $24,000 for the Comparable
Period, which primarily relates to our share of losses in AFE and the
recognition of past losses due to additional support in the form of the loan to
AFE.
Loss on fair value adjustments of derivative liabilities. The loss on fair value
adjustments of derivative liabilities was approximately $0.9 million for the
Current Period compared with net gain of $1.5 million for the Comparable Period,
which resulted from the change of fair market value for the Merger Debenture and
Merger Warrants accounted for as liabilities, the change in the fair value was
primarily due to movements in our stock price with minor movements related to
the passage of time, interest rate fluctuations and stock market volatility.
Loss on Extinguishment of Debentures. The loss on extinguishment of debentures
was $17.9 million for the Current Period compared with zero for the Comparable
Period which was related to write-off of approximately $2.1 million of
unamortized debt discount and issuance costs, and $15.8 million fair value
adjustment to the Merger Debenture and Merger Warrants for the quarter ended
December 31, 2019.
36
Interest expenses. Interest expense was $0.6 million for the Current Period
compared with $0.7 million for the Comparable Period, which was primarily due to
the interest payments to the purchasers of debentures and the amortization of
debt discount and issuance cost for the Debentures issued in October 2017.
Foreign currency gain / loss. Foreign currency loss was $11,000 for the Current
Period as compared to $91,000 for the Comparable Period which resulted from the
lower value and volume of transaction in China.
Liquidity and Capital Resources
As of December 31, 2019, we had $0.4 million in cash and cash equivalents and
negative $1.4 million in working capital. As of March 2, 2020, we had $269,000
in cash and cash equivalents. Of the $269,000 in cash and cash equivalents,
$235,000 resides in the United States or easily accessed foreign countries and
approximately $34,000 resides in China.
In connection with the entry into the Merger Agreement, the Company entered into
a securities purchase and exchange agreements (each, a "New Purchase
Agreements") with each of the existing holders of its 11% senior secured
debentures issued in October 2017 (the "Debentures"), whereby each of the
holders agreed to exchange their Debentures and accompanying warrants (the
"Debenture Warrants") for new debentures (the "New Debentures") and warrants
(the "New Debenture Warrants"), and certain of the holders agreed to provide
$2,000,000 of additional debt financing (the "Interim Financing"). Pursuant to
the New Purchase Agreements, the Company also issued $2,000,000 of 11% senior
secured debentures (the "Merger Debentures") to certain accredited investors,
along with warrants to purchase 1,333,338 of shares of Common Stock, half of
which were Series A Common Stock Purchase Warrants (the "Series A Merger
Warrants") and half of which were Series B Common Stock Purchase Warrants (the
"Series B Merger Warrants" and, together with the Series A Merger Warrants, the
"Merger Warrants"), as part of the Interim Financing. The Company shall receive
the $2,000,000 pursuant to the Merger Debentures according to the following
schedule: (i) $1,000,000 on or before October 14, 2019, (ii) $500,000 upon the
filing of the proxy statement for the Company stockholders approval of the
proposed merger, and (iii) $500,000 within two business days of Company
stockholders approval of the proposed merger transaction. The terms of the
Merger Debentures are the same as the New Debentures. The Merger Debentures are
intended to assist the Company in financing its business through the closing of
the proposed merger transaction.
As compensation for its services, the Company will pay to T.R. Winston &
Company, LLC (the "Placement Agent"): (i) a cash fee of $140,000 (representing
an aggregate fee equal to 7% of the face amount of the Merger Debentures, as
defined below); and (ii) a warrant to purchase 100,000 shares of Common Stock
(the "New Placement Agent Warrants"). We have also agreed to reimburse certain
expenses of the Placement Agent.
The $1,000,000 scheduled payment on or before October 14, 2019 was subsequently
received less certain legal costs and escrow fees in the amount of $966,000.
As part of the Interim Financing, we had also agreed to loan $350,000 of the
proceeds from the Merger Debentures to AFE to assist AFE in financing its
business through the closing of the proposed merger transaction. On October 24,
2019, we entered into the loan agreement which is due in full on the later of
March 31, 2020 or within five days following the closing of the proposed merger
transaction. If the merger does not close, the loan will mature on March 31,
2020 or three months following the special stockholder meeting called to approve
the merger. The loan accrues interest at 11% per annum and is also due in full
upon repayment, subject to an increased default interest in certain limited
circumstances.
On February 19, 2020, we entered into the Securities Purchase Agreement with
certain holders of the Company's 11% Senior Secured Convertible Debentures,
pursuant to which, among other things, the holders purchased, in accordance with
a private placement offering of the Company, $450,000 in principal amount of
Additional Interim Debentures and Additional Interim Warrants exercisable for up
to 300,004 shares of common stock. The Additional Interim Debentures and
Additional Interim Warrants are issued on substantially the same terms as the
debentures and warrants issued in October 2019, provided that the debentures
include an adjustment to the conversion price in the event of certain dilutive
equity issuances by the Company.
37
As compensation for its services, we paid to the Placement Agent: (i) a cash fee
of $31,500 (representing an aggregate fee equal to 7% of the face amount of the
Additional Interim Debentures); and (ii) an Interim Placement Agent Warrant to
purchase 22,500 shares of Common Stock. We have also agreed to reimburse certain
expenses of the Placement Agent. The Interim Placement Agent Warrant has been
issued on substantially the same terms as the Additional Interim Warrants.
On February 18, 2020, we entered into an Amended Loan Agreement with AFE,
amending the Loan Agreement entered into with AFE in October 2019. The Amended
Loan Agreement contemplates that we would loan a portion of the $2,450,000
proceeds that we received under the New Purchase Agreements dated October 10,
2019 as well as under the Securities Purchase Agreement.
We had previously loaned $350,000 to AFE at the time of entering into the Loan
Agreement, and on February 19, 2020, we have loaned an additional $100,000 out
of the proceeds of the Additional Interim Debentures. An additional $115,000
will be loaned to AFE upon the receipt of the next tranche of funds under the
New Purchase Agreements. These loaned amounts are due in full within five days
following the closing of the transactions contemplated by the Merger Agreement
dated October 10, 2019. If the Merger does not close, the loan will mature three
months following the special meeting of the Company's stockholders called to
approve the Merger. The loan accrues interest at 11% per annum and is also due
in full upon repayment, subject to an increased default interest rate in certain
limited circumstances.
We can make no assurances that the proposed merger with AFE will be completed on
a timely basis or at all. We may also need to raise additional capital through
equity and debt financing to complete the merger transaction or to otherwise
strengthen our balance for our corporate general and administrative expenses. We
cannot provide any assurance that any financing will be available to us in the
future on acceptable terms or at all. Any such financing could be dilutive to
our existing stockholders. In addition, we may be forced to seek relief to avoid
or end insolvency through other proceedings including bankruptcy. Based on the
historical negative cash flows and the continued limited cash inflows in the
period subsequent to year end there is substantial doubt about the Company's
ability to continue as a going concern.
The following summarizes the sources and uses of cash during the Current
Quarter:
? Operating Activities: During the Current Period, we used $1.4 million in cash
for operating activities compared to $3.6 million during the Comparable
Period. The decrease was primarily due to our reduced employee related
compensation costs; other general and administrative expenses; and zero
payment of interest expense on the Debentures as compared with the Comparable
Period.
? Investing Activities: During the Current Period, we loaned $350,000 of the
proceeds from the Merger Debentures to AFE joint venture to assist AFE in
financing its business through the closing of the Merger. During the
Comparable Period, we used approximately $11,000 to invest in our SEE joint
venture.
? Financing Activities: During the Current Period, we received gross proceeds of
$1 million related to the issuance of the Merger Debentures, and approximately
proceeds of $0.3 million for exercise of stock warrants related to the New
Debenture Warrants and the Placement Agent Warrants. There were no financing
activities for the Comparable Period.
Current Operations and Projects
The Proposed Merger with AFE
On October 10, 2019, we, SES Merger Sub, Inc., a Delaware corporation and a
wholly-owned subsidiary of us ("Merger Subsidiary"), and AFE, entered into the
Merger Agreement pursuant to which, among other things, AFE will, subject to the
satisfaction or waiver of the conditions set forth in the Merger Agreement,
merge with and into Merger Subsidiary (the "Merger"), the separate corporate
existence of Merger Subsidiary shall cease and AFE shall be the successor or
surviving corporation of the Merger and a wholly owned subsidiary of us. The
Merger is intended to qualify for federal income tax purposes as a tax-free
reorganization under the provisions of Section 368(a) of the Internal Revenue
Code of 1986, as amended. Upon the consummation of the Merger, it is
contemplated that we will also change our name.
38
Upon consummation of the Merger, and subject to the terms and conditions of the
Merger Agreement, holders of AFE ordinary shares will receive, in exchange for
such ordinary shares, 3,875,000 shares of our common stock. All outstanding
stock options and restricted stock will remain outstanding post-Merger on the
same terms and conditions as currently applicable to such awards, provided that
outstanding awards for departing directors shall be amended to extend
exercisability for the term of the award.
In connection with the entry into the Merger Agreement, the Company entered into
Share Exchange Agreements (each, a "Share Exchange Agreement") with certain of
the shareholders of BFR, whereby such shareholders will exchange their shares of
BFR for shares of the common stock at a ratio of 10 BFR shares for one share of
common stock. As a result of these exchanges, the Company would own
approximately 37% of the outstanding shares of BFR. The closing of the exchange
is subject to certain conditions specified in the Share Exchange Agreements,
including, without limitation, the consummation of the transactions contemplated
by the Merger Agreement.
In connection with the entry into the Merger Agreement, the Company entered into
New Purchase Agreements with each of the Purchasers of the Debentures, whereby
each of the Purchasers agreed to exchange their Debentures and Debenture
Warrants for New Debentures and New Debenture Warrants, and certain of the
Purchasers agreed to provide $2,000,000 of Interim Financing.
As compensation for its services, the Company paid to the Placement Agent: (i) a
cash fee of $140,000 (representing an aggregate fee equal to 7% of the face
amount of the Merger Debentures); and (ii) New Placement Agent Warrants". We
have also agreed to reimburse certain expenses of the Placement Agent.
The New Debenture Warrants and the New Placement Agent Warrants are exercisable
into shares of common stock at any time from and after the closing date at an
exercise price of $3.00 or $6.00 per common share dependent upon their
participation in the Interim Financing (subject to adjustment). The New
Debenture Warrants and the New Placement Agent Warrants will terminate five
years after they become exercisable. The New Debenture Warrants and the New
Placement Agent Warrant contain provisions providing for the adjustment of the
purchase price and number of shares into which the securities are exercisable.
The New Debentures and the New Debenture Warrants have substantially similar
terms to the Debentures and Debenture Warrants, including as to maturity and
security, except that the New Debentures, among other differences, (i) provide
for the payment to certain Purchasers, at their election, of interest payments
in shares of the common stock or in kind, and (ii) provide for certain optional
conversion features. The New Debenture Warrants change the exercise price to
$3.00 or $6.00 per share dependent upon their participation in the Interim
Financing and makes certain other modifications to the Debenture Warrants. The
New Debenture Warrants were issued upon the announcement of the Merger.
Pursuant to the New Purchase Agreements, each of the Purchasers (i) waived the
events of default resulting from the failure by the Company to timely file its
Annual Report on Form 10-K for the fiscal year ended June 30, 2018, its Annual
Report on Form 10-K for the fiscal year ended June 30, 2019 and for this
Quarterly Report, (ii) waived the event of default resulting from the failure by
the Company to make interest payments due on July 1, 2019, October 1, 2019 and
January 1, 2020, and (iii) consented to the consummation of the Merger and the
issuance of the Merger Debentures and the Merger Warrants, notwithstanding any
limitations in the Debentures to the contrary.
As mentioned above, pursuant to the New Purchase Agreements, the Company also
issued Merger Debentures to certain accredited investors, half of which were
Series A Merger Warrants and half of which were Series B Merger Warrants and,
together with the Series A Merger Warrants, the Merger Warrants, as part of the
Interim Financing. The Company shall receive the $2,000,000 pursuant to the
Merger Debentures according to the following schedule: (i) $1,000,000 on or
before October 14, 2019, (ii) $500,000 upon the filing of the proxy statement
for the Company stockholders approval of the Merger, and (iii) $500,000 within
two business days of Company stockholders approval of the Merger. The terms of
the Merger Debentures are the same as the New Debentures. The Merger Debentures
are intended to assist the Company in financing its business through the closing
of the Merger.
39
The $1,000,000 scheduled payment on or before October 14, 2019 was subsequently
received less certain legal costs and escrow fees in the amount of $966,000.
Interest on the Merger Debentures is payable quarterly in arrears, at the option
of the holder, in the form of shares of common stock, to be issued at a price of
the lower of $3.00 per share and the 10-day trailing VWAP for the period
immediately prior to the due date of the interest payment, or in kind. The
Merger Debentures are convertible at any time by the holders into shares of
common stock at a price of $3.00 per share, and the Company can require
conversion into shares of common stock at a price of $3.00 per share if the
common stock trades at or above $10.00 per share for ten consecutive trading
days.
The Merger Warrants are exercisable into shares of common stock at any time from
and after the issue date (provided that the Company can only issue up to 19.99%
of the outstanding shares as of the date the Merger was announced without
shareholder approval) at an exercise price of $3.00 per share of common stock,
in the case of the Series A Merger Warrants, or $6.00 per share of common stock,
in the case of the Series B Merger Warrants. The Merger Warrants will terminate
five years after they become exercisable. The Merger Warrants contain provisions
providing for the adjustment of the purchase price and number of shares into
which the securities are exercisable. The terms of the Merger Warrants are the
same as the New Debenture Warrants. The New Placement Agent Warrants have the
same terms as the Merger Warrants with an exercise price of $3.00 per share.
In connection with entering into the New Purchase Agreements, the Company also
entered into a Registration Rights Agreement with the investors whereby the
Company agreed to register the shares of common stock underlying the New
Debentures, the Merger Debentures, the New Placement Agent Warrants and the
Merger Warrants.
The respective boards of directors of the Company, Merger Subsidiary and AFE
have determined that the Merger Agreement and the transactions contemplated by
the Merger Agreement are fair to, advisable and in the best interests of their
respective stockholders and have approved the Merger and the Merger Agreement.
The transactions contemplated by the Merger Agreement are subject to the
approval of the Company's and AFE's respective shareholders at shareholders'
meetings to be called and held by the Company and AFE, respectively, and other
closing conditions, including, among other things, the filing and effectiveness
of a registration statement on Form S-4 with the SEC, and the consummation of
the transactions contemplated by the Share Exchange Agreements and the New
Purchase Agreements.
The Merger Agreement contains representations and warranties by the Company and
Merger Subsidiary, on the one hand, and by AFE, on the other hand, made solely
for the benefit of the other. The assertions embodied in those representations
and warranties are qualified by information in confidential disclosure schedules
that the parties have exchanged in connection with signing the Merger Agreement.
The disclosure schedules contain information that modifies, qualifies and
creates exceptions to the representations and warranties set forth in the Merger
Agreement. Moreover, certain representations and warranties in the Merger
Agreement were made as of a specified date, may be subject to a contractual
standard of materiality different from what might be viewed as material to
shareholders, or may have been used for the purpose of allocating risk between
the Company and Merger Subsidiary, on the one hand, and AFE, on the other hand.
Accordingly, the representations and warranties and other disclosures in the
Merger Agreement should not be relied on by any persons as characterizations of
the actual state of facts about the Company, Merger Subsidiary or AFE at the
time they were made or otherwise.
The Merger Agreement contains certain termination rights for both the Company
and AFE, including, among other things, if the Merger is not consummated on or
before April 15, 2020.
As part of the Interim Financing, we had also agreed to loan $350,000 of the
proceeds from the Merger Debentures to AFE to assist AFE in financing its
business through the closing of the Merger. On October 24, 2019, we entered into
the loan agreement which is due in full on the later of March 31, 2020 or within
five days following the closing of the Merger. If the Merger does not close, the
loan will mature on March 31, 2020 or three months following the special
stockholder meeting called to approve the Merger. The loan accrues interest at
11% per annum and is also due in full upon repayment, subject to an increased
default interest in certain limited circumstances.
40
Australian Future Energy Pty Ltd
In February 2014, we established AFE together with an Australian company, Ambre.
AFE is an independently managed Australian business platform established for the
purpose of building a large-scale, vertically integrated business in Australia
based on developing, building and owning equity interests in financially
attractive and environmentally responsible projects that produce low-cost syngas
as a competitive alternative to expensive local natural gas and LNG.
On May 10, 2017, we entered into a project technology license agreement with AFE
in connection with a project being developed by AFE in Queensland Australia. AFE
intends to form a subsidiary project company and assign the project technology
license agreement to that company which will assume all of the obligations of
AFE thereunder. Pursuant to the project technology license agreement, we granted
a non-exclusive license to use our technology at the project to manufacture
syngas and to use the technology in the design of the facility. In
consideration, the project technology license agreement calls for a license fee
to be finalized based on the designed plant capacity and a separate fee of $2.0
million for the delivery of a process design package. License fees shall be paid
as project milestones are reached throughout the planning, construction and
first five years of plant operations. The success and timing of the project
being developed by AFE will affect if and/or when we will be able to receive all
of the payments related to this technology license agreement. However, there can
be no assurance that AFE will be successful in developing this or any other
project.
In September 2018, AFE's Gladstone Project was formally announced in Queensland
Parliament by Minister for State Development, Manufacturing, Innovation and
Planning, Mr. Cameron Dick and was declared by the Queensland Co-Ordinator
General as a Co-Ordinated Project. A coordinated project approach also means
that all the potential impacts and benefits of the project are considered in an
integrated and comprehensive manner and the Coordinator-General's decision to
declare this project a Coordinated Project is expected to help streamline
approvals and fast-track delivery of the project.
The project will be located in the State Development Area in Gladstone,
Queensland and is planned to process 1.5 million mtpa of low-quality coal using
SGT, to produce up to 330,000 mtpa of ammonia product, and up to 8 petajoules of
pipeline quality gas for the east coast domestic gas market. In addition, the
proposed project will generate approximately 90 MW of electrical power, with
approximately 25 MW of this being available for export to the local domestic
grid. The ammonia and gas produced is to be used by major industrial users,
including those focusing on agriculture, the mining industry and advanced
manufacturing. The project is estimated by AFE to commence construction by
early-2021, with the first ammonia production proposed in early-2023.
On April 4, 2019, we entered into a Technology Purchase Option Agreement (the
"Option Agreement") with AFE providing AFE has an exclusive option through July
31, 2019 to purchase 100% ownership of Synthesis Energy Systems Technology, LLC,
our wholly-owned subsidiary which owns our interest in the SGT. In addition,
ownership rights to SGT are carved out of the transaction and retained by us for
China and we have a three-year option period post-closing to monetize SGT for
India, Brazil, Poland and for the DRI technology market segment. On July 31,
2019, we entered into an Amendment to the Option Agreement with AFE extending
the exclusive option provided in the Option Agreement through August 31, 2019.
On August 31, 2019, we mutually agreed with AFE to allow the Option Agreement to
terminate pursuant to its terms and no penalties or payments were due as a
result of the termination of the agreement.
AFE issued one million shares to us in connection with the execution of the
Option Agreement. AFE would also pay (i) an additional $2.0 million in three
equal installments, with the first installment paid at closing and the remainder
over the subsequent twelve months, and (ii) $3.8 million on the earlier of the
closing of a construction financing by AFE or five years from closing. The
closing of the transaction was subject to the negotiation of definitive
agreements and other conditions specified in the Option Agreement. In addition
to the payment schedule above, AFE issued an additional one million shares with
the execution of the Option Agreement and would also pay an additional $100,000
with the first installment paid at closing as full and final settlement of
outstanding invoices owing AFE to us at the date of this Option Agreement. As a
result of the termination of the Option Agreement, we retained the two million
shares AFE issued in connection with the Option Agreement. We accounted for the
first million shares as an additional investment in AFE for $70,000 and a
reduction of the receivable amounts due from AFE with a fair value of $100,000
with a write-off for the remaining $30,000. The second million shares were
accounted for as an additional investment in AFE and a deferred liability in the
amount of $70,000 as a down payment on the purchase of our subsidiary. In the
quarter ending September 30, 2019, we recognized the $70,000 down payment as an
other gain due to the termination of the Option Agreement.
41
On October 24, 2019 we entered into a loan agreement with AFE in connection with
the proposed Merger where we loaned $350,000 to AFE as mentioned above in
"Liquidity and Capital Resources."
For our ownership interest in AFE, we have been contributing cash, engineering
support and most recently a loan mentioned above for AFE's business development
while Ambre contributed cash and services. Additional ownership in AFE has been
granted to the AFE management team and staff individuals providing services to
AFE. In April 2019, we were issued two million shares in connection with the
Option Agreement and its subsequent termination.
We account for our investment in AFE under the equity method. Our ownership
interest of approximately 35% makes us the second largest shareholder. We also
maintain a seat on the board of directors, which allows us to have significant
influence on the operations and financial decisions, but not control, of AFE.
Our carrying value of our AFE investment as of both September 30, 2019 and June
30, 2019 was zero.
As we account for AFE under the equity method and currently AFE's losses exceed
our investment carrying value, therefore we have not been recording our equity
loss pickup related to AFE's losses. Due to the loan mentioned above, we are
required, under ASC 323-10 to record our share of losses related to the
additional support to AFE which includes the loan. Additional equity loss of
$350,000 was recorded in the quarter ended December 31, 2019 due to the
execution of the loan agreement with AFE.
Cape River Resources Pty Ltd
In October 2018, AFE formed a separate unrelated company, Cape River Resources
('CRR") for the purpose of developing the Pentland resource into an operating
thermal coal mine. Ownership in CRR was distributed proportionately to the
shareholders of AFE with additional shares issued to the management team. Our
ownership in CRR was approximately 38% upon the formation of CRR through our
ownership interest in AFE.
We accounted for our investment in CRR under the equity method. Our ownership
interest of approximately 38% makes us the second largest shareholder. We may
appointed one board director for each 15% ownership interest we hold in CRR
which allows us to have significant influence on the operations and financial
decisions, but not control, of CRR. Our carrying value of our CRR investment as
of June 30, 2019 was zero.
In September 2019, AFE repurchased all of the shares in CRR in exchange for AFE
shares. The CRR shareholders received one share of AFE for every ten shares of
CRR. As a result of the transaction, CRR is a wholly-owned subsidiary of AFE.
Batchfire Resources Pty Ltd
As a result of AFE's early stage business development efforts associated with
the Callide coal mine in Central Queensland, Australia, AFE created BFR. BFR was
a spin-off company for which ownership interest was distributed to the existing
shareholders of AFE and to the new BFR management team in December 2015. BFR is
registered in Australia and was formed for the purpose of purchasing the Callide
thermal coal mine from Anglo-American plc ("Anglo-American"). The Callide mine
is one of the largest thermal coal mines in Australia and has been in operation
for more than 20 years. As reported by BFR at the time of the acquisition,
Callide has approximately 230 million metric tons of recoverable reserves and an
additional 850 million metric tons of proven resources.
In October 2016, BFR stated that it had received investment support for the
acquisition from Singapore-based Lindenfels Pte, Ltd, a subsidiary of commodity
traders Avra Commodities, and as a result the acquisition of the Callide thermal
coal mine from Anglo-American was completed in October 2016. Since then, BFR has
been implementing its plan at Callide intended to lower the per unit mining
costs and deliver profitable financial results.
42
In January 2018, the Minister of Natural Resources, Mines and Energy approved
BFR's mining lease application through to 2043 for Callide's Boundary Hill South
Project. The Callide mining tenure extends across 180 square kilometers and
contains an estimated coal resource of up to 1.7 billion metric tons and
saleable coal production averages 10 million metric tons per year. BFR is
implementing its mining plan at Callide intended to lower the per unit mining
costs and deliver profitable financial results.
On April 29, 2019, BFR issued additional shares as part of a rights offering. We
did not execute our rights in this offering and therefore after the completion
of the offering process and the issuance of the additional shares, our ownership
interest was diluted from approximately 11% to approximately 7%.
We account for our investment in BFR under the cost method. Our limited
ownership interest in BFR was approximately 7% and we do not have significant
influence over the operation or financial decisions made by the company. At the
time of the spin-off, the carrying amount of our investment in AFE was reduced
to zero through equity losses. As such, the value of the investment in BFR post
spin-off was also zero. As of December 31, 2019, our ownership interest in BFR
was approximately 7% and the carrying value of our investment in BFR as of both
December 31, 2019 and June 30, 2019 was zero.
For additional information on our investment in BFR and the Share Exchange
Agreements, please see The Proposed Merger with AFE above.
Townsville Metals Infrastructure Pty Ltd
In August 2018, AFE formed a separate unrelated company, Townsville Metals
Infrastructure Pty Ltd ("TMI") for the purpose of completing the development of
the required infrastructure such as rail and port modifications related to the
transport of mined products including coal from the Pentland resource to the
Townsville port. Ownership in TMI was distributed proportionately to the
shareholders of AFE. Our ownership in TMI is approximately 38% upon the
formation of TMI through our ownership interest in AFE.
We account for our investment in TMI under the equity method. Our ownership
interest of approximately 38% makes us the second largest shareholder. We may
appoint one board director for each 15% ownership interest we hold in TMI which
allows us to have significant influence on the operations and financial
decisions, but not control, of TMI. Our carrying value of our TMI investment as
of both December 31, 2019 and June 30, 2019 was zero.
SES EnCoal Energy sp. z o.o
In October 2017, we entered into agreements with Warsaw-based EnInvestments sp.
z o.o. Under the terms of the agreements, we and EnInvestments are equal
shareholders of SEE and SEE will exclusively market, develop, and commercialize
projects in Poland which utilize our technology, services and proprietary
equipment and we share with SEE a portion of the technology license payments,
net of fees, we receive from Poland. The goal of SEE is to establish efficient
clean energy projects that provide Polish industries superior economic benefits
as compared to the use of expensive, imported natural gas and LNG, while
providing energy independence through our technological capabilities to convert
the wide range of Poland's indigenous coals, coal waste, biomass and municipal
waste to valuable syngas products. SEE has developed a pipeline of projects and
together we are actively working with Polish customers and partners to complete
the necessary project feasibility, permitting and SGT technology agreement steps
required prior to starting construction on the projects.
Tauron Wytwarzanie S.A., ("Tauron"), has contracted Poland's Institute of Coal
Chemistry ("IChPW") to complete a detailed preliminary design assessment and
economic study for the conversion of its 200MW conventional power boilers to
clean syngas which would be Poland's first SGT facility. The project feasibility
study concluded in March 2018 with positive results. The results presented by
IChPW to Tauron have shown that the conversion of Tauron's 200 MW power boiler
utilizing SGT can be both economically attractive and environmentally
beneficial. We believe that SGT power boiler conversions are an ideal solution
capable of meeting EU and IED targets.
43
For our ownership interest in SEE, we have been contributing cash and assisting
in the development of SEE. In August 2018, we contributed additional cash of
approximately $11,000.
We account for our investment in SEE under the equity method. Our ownership
interest of 50% makes us an equal shareholder and we also maintain two of the
four seats on the board of directors which allows us to have significant
influence on the operations and financial decisions, but not control, of the
company. On December31, 2019, as an equal shareholder, our ownership was 50% of
SEE and the carrying value of our investment in SEE as of both December 31, 2019
and June 30, 2019 was approximately $17,000 and $19,000 respectively.
Midrex Technologies
In July 2015, we entered into a Project Alliance Agreement that expands our
exclusive relationship with Midrex Technologies for integration and optimization
of DRI technology using coal gasification. Midrex has taken the lead in
marketing, sales, proposal development, and project execution for coal
gasification DRI projects as part of the new project alliance. Midrex may also
lead the construction of the fully integrated solution for customers who desire
such an execution strategy. We will provide the DRI gasification technology for
each project including engineering, key equipment, and technical services. The
agreement includes finalization of an engineering package for the optimized coal
gasification DRI solution. Prior to the Project Alliance Agreement, we also
entered into an exclusive agreement with the TSEC Joint Venture and Midrex for
the joint marketing of coal gasification-based DRI facilities in China. These
facilities will combine our gasification technology with the Direct Reduction
Process of Midrex to create syngas from low quality coals in order to convert
iron ore into high-purity DRI. The TSEC Joint Venture will aid in the marketing
of these DRI facilities in China and will supply the gasification equipment and
licensing of the technology.
Yima Joint Venture
In August 2009, we entered into joint venture contracts and related agreements
with Yima Coal Industry Group Company ("Yima"). We continue to own a 25%
interest in the Yima Joint Venture and Yima owns a 75% interest.
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 historical lack of significant influence in the
Yima Joint Venture. The lack of significant influence was 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. We continue to evaluate our level of influence over
the Yima Joint Venture.
The carrying value of our Yima Joint Venture investment as of both December 31,
2019 and June 30, 2019 was zero.
Tianwo-SES Clean Energy Technologies Limited
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 TSEC Joint
Venture. In August 2017, we entered into a restructuring agreement which changed
the share ownership in the TSEC Joint Venture, reduced the registered capital
and brought an additional party, The Innovative Coal Chemical Design Institute
("ICCDI"), into the JV Contract. Current ownership interests of the TSEC Joint
Venture are STT owning 50%, ICCDI owning 25% and we own the remaining 25%. The
purpose of the TSEC Joint Venture is to establish SGT as the leading
gasification technology in the TSEC 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 TSEC Joint Venture is to market and license SGT via
project sublicenses; procurement and sale of proprietary equipment and services;
coal testing; and engineering, procurement and research and development related
to SGT.
44
The TSEC Joint Venture is accounted for under the equity method. Our initial
capital contribution in the formation of the venture was the TUCA, which is an
intangible asset. As such, we did not record a carrying value at the inception
of the venture. The carrying value of our investment in the TSEC Joint Venture
as of both December 31, 2019 and June 30, 2019 was zero.
TUCA
Pursuant to the TUCA, we have contributed to the TSEC Joint Venture certain
exclusive rights to our SGT in the TSEC 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 TSEC Joint Venture territory that
have previously been developed by us and our affiliates. As a result of the
Restructuring Agreement, ICCDI was added as a party to the TUCA, but all other
material terms remained the same.
GTI Agreement
In November 2009, we entered into an Amended and Restated License Agreement (the
"GTI Agreement") with the Gas Technology Institute ("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 the ten-business day
period, they are deemed to have approved of the sublicense. We are required to
provide updates on any potential sublicenses once every three months during the
term of the GTI Agreement. We are also restricted from offering a competing
gasification technology during the term of the GTI Agreement.
For each U-GAS® unit which we license, design, build or operate for ourselves or
for a party other than a sub-licensee and which uses coal or a coal and biomass
mixture or biomass as the feedstock, we must pay a royalty based upon a
calculation using the MMBtu per hour of dry syngas production of a rated design
capacity, payable in installments at the beginning and at the completion of the
construction of a project, or the Standard Royalty. If we invest, or have the
option to invest, in a specified percentage of the equity of a third party, and
the royalty payable by such third party for their sublicense exceeds the
Standard Royalty, we are required to pay to GTI an agreed percentage split of
third party licensing fees, or the Agreed Percentage, of such royalty payable by
such third party. However, if the royalty payable by such third party for their
sublicense is less than the Standard Royalty, we are required to pay to GTI, in
addition to the Agreed Percentage of such royalty payable by such third party,
the Agreed Percentage of our dividends and liquidation proceeds from our equity
investment in the third party. In addition, if we receive a carried interest in
a third party, and the carried interest is less than a specified percentage of
the equity of such third party, we are required to pay to GTI, in our sole
discretion, either (i) the Standard Royalty or (ii) the Agreed Percentage of the
royalty payable to such third party for their sublicense, as well as the Agreed
Percentage of the carried interest. We will be required to pay the Standard
Royalty to GTI if the percentage of the equity of a third party that we (a)
invest in, (b) have an option to invest in, or (c) receive a carried interest
in, exceeds the percentage of the third party specified in the preceding
sentence.
We are required to make an annual payment to GTI for each year of the term, with
such annual payment due by the last day of January of the following year;
provided, however, that we are entitled to deduct all royalties paid to GTI in a
given year under the GTI Agreement from this amount, and if such royalties
exceed the annual payment amount in a given year, we are not required to make
the annual payment. We must also provide GTI with a copy of each contract that
we enter into relating to a U-GAS®system and report to GTI with our progress on
development of the technology every six months.
45
For a period of ten years, beginning in May 2016, 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.
We continue to innovate and modify the SGT 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. In
relation to the Merger with AFE, AFE and GTI have agreed upon new terms which,
subject to a definitive agreement being completed prior to the Merger closing,
would replace the current GTI Agreement.
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