Filed pursuant to Rule 424(b)(1)

Registration No. 333-151035

 

Prospectus

 

10,000,000 shares

 

 

Synthesis Energy Systems, Inc.

 

Common stock

 

We are offering 10,000,000 shares of our common stock.

 

Our common stock is traded on The NASDAQ Capital Market under the symbol “SYMX.” On June 19, 2008, the last reported sale price of our common stock on The NASDAQ Capital Market was $9.54 per share.

 

Investing in our common stock involves significant risks that are described in the “Risk factors” section beginning on page 9 of this prospectus.

 

 

We have granted the underwriters a 30-day option to purchase up to an additional 1,500,000 shares of common stock from us at the public offering price, less the underwriting discounts and commissions, to cover over-allotments, if any.

 

The underwriters expect to deliver the shares against payment in New York, New York on June 25, 2008.

 

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

 

June 19, 2008

 

 

You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with different information. We are not making an offer of our common stock in any jurisdiction where the offer is not permitted. You should not assume that the information contained in this prospectus is accurate as of any date other than the date on the front of this prospectus.

 

An investment in our common stock involves a high degree of risk. You should consider carefully the risks and uncertainties described below and the other information included in this prospectus, including our financial statements and related notes, before deciding to invest in our common stock. If any of the following risks or uncertainties actually occur, our business, financial condition and operating results would likely suffer. In that event, the market price of the offered securities could decline and you could lose all or part of the money you paid to buy our common stock.

 

 

We are in an early stage of our development and our business strategies may not be accepted in the marketplace and may not help us to achieve profitability.

 

We are in an early stage of our development and our lack of operating history or meaningful revenue precludes us from forecasting operating results based on historical results. Our proposed business strategies described in this prospectus incorporate our senior management’s current best analysis of potential markets, opportunities and difficulties that face us. No assurance can be given that the underlying assumptions accurately reflect current trends in our industry or our customers’ reaction to our products and services or that such products or services will be successful. Our business strategies may and likely will change substantially from time to time as our senior management reassesses its opportunities and reallocates its resources, and any such strategies may be changed or abandoned at any time. If we are unable to develop or implement these strategies through our projects and our U-GAS^® technology, we may never achieve profitability. Even if we do achieve profitability, it may not be sustainable, and we cannot predict the level of such profitability.

 

We utilize a technology with a limited commercial history. If the U-GAS^® technology fails to gain or loses market acceptance, our business will suffer.

 

Although GTI is one of the world’s leading energy research and development organizations with well-equipped research facilities, it does not have marketing resources to fully commercialize its U-GAS^® technology. To date, U-GAS^® technology has not been used in a large number of commercial facilities. U-GAS^® technology may not meet reliability or efficiency targets. If U-GAS^® technology is not generally accepted as a low cost energy alternative and we are unable to effectively manage the implementation of U-GAS^® technology, our business and operating results could be seriously harmed.

 

We will require substantial additional funding, and our failure to raise additional capital necessary to support and expand our operations could reduce our ability to compete and could harm our business.

 

As of March 31, 2008, we had $39.1 million of cash and cash equivalents. We also expect to continue to have operating losses until our Hai Hua plant and other projects under development produce significant revenues. We plan to use the net proceeds of this offering for equity contributions to our Golden Concord project, and, if approved, our YIMA project, the proposed expansion of our Hai Hua project, when and if agreed to, feasibility and engineering design work for our CONSOL project and any future North American projects, and working capital and general corporate purposes. Other than our required capital contributions to our Golden

Concord project, and if approved, our YIMA project, we are not currently able to estimate the approximate amount of the net proceeds that will be used for the other purposes noted above. The actual allocation of the net proceeds for these purposes and the timing of the 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, including potential acquisitions of existing plants, facilities or mines. Depending on the expenditures required for the proposed expansion of our Hai Hua project, when and if agreed to, feasibility and engineering design work for our North American projects and any of the above factors, our expenditures could exceed the net proceeds of this offering.

 

We may need to raise additional capital in calendar year 2008 through equity and debt financing for any new projects that are developed, to support possible additional expansion of our existing operations and for our general and administrative expenses from our existing operations. We are also continuing to work with Golden Concord on financing alternatives for that project. We may also need to raise additional funds sooner than expected in order to fund more rapid expansion, cover unexpected construction costs or delays, respond to competitive pressures or acquire complementary energy related products, services, businesses and/or technologies. In addition, we may attempt to secure project financing in order to construct additional plant facilities. Such financing may be used to reduce the amount of equity capital required to complete the project.

 

We cannot assure you that any financing will be available to us in the future on acceptable terms or at all. If we cannot raise required funds on acceptable terms, we may not be able to, among other things, (i) maintain our general and administrative expenses at current levels; (ii) negotiate and enter into new gasification plant development contracts; (iii) expand our operations; (iv) hire and train new employees; or (v) respond to competitive pressures or unanticipated capital requirements.

 

The termination of our license agreement with GTI or any of our joint venture agreements would materially adversely affect our business and results of operations.

 

Our license agreement with GTI for U-GAS^® technology and our joint ventures in China and the United States are essential to us and our future development. The license agreement terminates on August 31, 2016, but may be terminated by GTI upon certain events of default if not cured by us within specified time periods. In addition, after the two ten year extension periods provided under the license agreement, which are exercisable at our option, we cannot assure you that we will succeed in obtaining an extension of the term of the license at a royalty rate that we believe to be reasonable or at all. Our joint venture agreements do not terminate for many years, but may be terminated earlier due to certain events of bankruptcy or default, or, in the case of Hai Hua, if the purchase and sale contract for syngas is terminated. Termination of any of our joint ventures would require us to seek another collaborative relationship in that territory. We cannot assure you that a suitable alternative third party would be identified, and even if identified, we cannot assure you that the terms of any new relationship would be commercially acceptable to us.

 

We are dependent on our relationships with our strategic partners for project development.

 

We are dependent on our relationships with our strategic partners to accelerate our expansion, fund our development efforts, better understand market practices and regulatory issues and more effectively handle challenges that may arise. Our future success will depend on these

relationships and any other strategic relationships that we may enter into. We cannot assure you that we will satisfy the conditions required to maintain these relationships under existing agreements or that we can prevent the termination of these agreements. We also cannot assure you that we will be able to enter into relationships with future strategic partners on acceptable terms. The termination of any relationship with an existing strategic partner or the inability to establish additional such relationships may limit our ability to develop our U-GAS^® projects and may have a material adverse effect on our business and financial condition.

 

We may never be able to reach agreements regarding the completion of future projects.

 

Other than Hai Hua, all of our other potential development opportunities are in the early stages of development and/or contract negotiations. Our joint ventures with Hai Hua and Golden Concord, discussed under “Business—Current operations and projects,” are currently our only negotiated contracts. We must undertake the time consuming and costly process of fulfilling the requirements of requests for proposals and negotiating contracts before offering our services to industrial complexes. We are unsure of when, if ever, many of these contracts will be negotiated, executed and implemented. There are many reasons that we may fail in our efforts to negotiate, execute and implement contracts with our target customers to provide cost efficient energy services, including the possibilities that: (i) our products and services will be ineffective; (ii) our products and services will be cost prohibitive or will not achieve broad market acceptance; (iii) competitors will offer superior products and services; or (iv) competitors will offer their products and services at a lower cost.

 

Our projects are subject to an extensive governmental approval process which could delay the implementation of our business strategy.

 

Selling syngas, methanol and other commodities is highly regulated in many markets around the world. We believe our projects will be supported by the governmental agencies in the areas where the projects will operate because coal-based technologies, which are less burdensome on the environment, are generally encouraged by most governments. However, in China and other developing markets, the regulatory environment is often uncertain and can change quickly, often with contradictory regulations or policy guidelines being issued. In some cases, government officials have different interpretations of such regulations and policy guidelines and project approvals that are obtained by us could later be deemed to be inadequate. Furthermore, new policy guidelines or regulations could alter applicable requirements or require that additional levels of approval be obtained. If we are unable to effectively complete the government approval process in China and other markets in which we intend to operate, our business prospects and operating results could be seriously harmed.

 

Joint ventures that we enter into present a number of challenges that could have a material adverse effect on our business and results of operations.

 

Our joint venture with Hai Hua represents a substantial portion of our expected revenue in the near future. In addition, as part of our business strategy, we will enter into other joint ventures or similar transactions, some of which may be material. These transactions typically involve a number of risks and present financial, managerial and operational challenges, including the existence of unknown potential disputes, liabilities or contingencies that arise after entering into the joint venture related to the counterparties to such joint ventures, with whom we share control. We could experience financial or other setbacks if transactions encounter unanticipated

problems due to challenges, including problems related to execution or integration. Any of these risks could reduce our revenues or increase our expenses, which could adversely affect our results of operations. In addition, Hai Hua will, and Golden Concord, as well as any other joint ventures that we enter into (including YIMA and CONSOL), could, be included in our consolidated financial statements. We will rely on personnel in China and the United States to compile this information and deliver it to us in a timely fashion so that the information can be incorporated into our consolidated financial statements prior to the due dates for our annual and quarterly reports. Any difficulties or delays in receiving this information or incorporating it into our consolidated financial statements could impair our ability to file these annual and quarterly reports.

 

We will manage the design, procurement and construction of our plants. If our management of these issues fails, our business and operating results could suffer.

 

For our joint ventures with Hai Hua and Golden Concord, and possibly for other projects we may work on in the future (including YIMA and CONSOL), we are managing plant design, procurement of equipment and are supervising construction. Most of this work has been or will be subcontracted to third parties. We are coordinating and supervising these tasks. Although we believe that this is the most time and cost effective way to build gasification plants in China and elsewhere, we bear the risk of cost and schedule overruns and quality control. If we do not properly manage the design, procurement and construction of our plants, our business and operating results could be seriously harmed. Furthermore, as we continue to improve U-GAS^® technology, we may decide to make changes to our equipment that could further delay the construction of our plants.

 

A portion of our revenues will be derived from the merchant sales of commodities and our inability to obtain satisfactory prices could have a material adverse effect on our business.

 

In certain circumstances, we plan to sell methanol, DME, synthetic gasoline, SNG, ammonia, hydrogen, nitrogen, elemental sulfur, ash and other commodities into the merchant market. These sales may not be subject to long term offtake agreements and the price will be dictated by the then prevailing market price. Revenues from such sales may fluctuate and may not be consistent or predictable. Our business and financial condition would be materially adversely affected if we are unable to obtain satisfactory prices for these commodities or if prospective buyers do not purchase these commodities.

 

Our results of operations may fluctuate.

 

Our operating results may fluctuate significantly as a result of a variety of factors, many of which are outside our control. Factors that may affect our operating results include: (i) our ability to retain new customers; (ii) the cost of coal in China and the United States; (iii) the success and acceptance of U-GAS^® technology; (iv) the ability to obtain financing for our projects; (v) shortages of equipment, raw materials or fuel; (vi) approvals by various government agencies; (vii) the inability to obtain land use rights for our projects; and (viii) general economic conditions as well as economic conditions specific to the energy industry. In addition, our results of operation in the near future will be largely affected by our Hai Hua plant. As of June 5, 2008, the plant was running at approximately 30% of its design capacity. Any failure of this plant to run at its design capacity could have a material adverse effect on our results of operations.

We are dependent on the availability and cost of low rank coal and coal waste and our inability to obtain a low cost source could have an impact on our business.

 

The success of our projects will depend on the supply of low rank coal and coal waste. We intend to locate projects in areas where low cost coal and coal waste is available or where it can be moved to a project site easily without transportation issues. If we are unable to effectively obtain a source of low cost coal or coal waste for our projects, our business and operating results could be seriously affected.

 

We are dependent on key personnel who would be difficult to replace.

 

Our performance is substantially dependent on the continued services and on the performance of our senior management and other key personnel. Our performance also depends on our ability to retain and motivate our officers and key employees. The loss of the services of any of our executive officers or other key employees could have a material adverse effect on our business, results of operations and financial condition. Although we have employment agreements, which include non-competition provisions, with Timothy Vail, our President and Chief Executive Officer, David Eichinger, our Chief Financial Officer, and certain other of our key employees, as a practical matter, those agreements will not assure the retention of our employees and we may not be able to enforce all of the provisions in any such employment agreement, including the non-competition provisions. Our future success also depends on our ability to identify, attract, hire, train, retain and motivate other highly skilled technical, managerial, marketing and customer service personnel. Competition for such personnel is intense, and we cannot assure you that we will be able to successfully attract, integrate or retain sufficiently qualified personnel. In addition, because substantially all of our operations are currently in China, we will be required to retain personnel who reside in, or are willing to travel to, and who speak the language and understand the customs of, China. Our inability to retain these types of individuals could have a material adverse effect on our business, results of operations and financial condition.

 

Our success will depend in part on our ability to grow and diversify, which in turn will require that we manage and control our growth effectively.

 

Our business strategy contemplates growth and diversification. As we add to our services, our number of customers, and our marketing and sales efforts, operating expenses and capital requirements will increase. Our ability to manage growth effectively will require that we continue to expend funds to improve our operational, financial and management controls, as well as reporting systems and procedures. In addition, we must effectively recruit new employees, and once hired, train and manage them. From time to time, we may also have discussions with respect to potential acquisitions, some of which may be material, in order to further grow and diversify our business. However, acquisitions are subject to a number of risks and challenges, including difficulty of integrating the businesses, adverse effects on our earnings, existence of unknown liabilities or contingencies and potential disputes with counterparties. We will be unable to manage our business effectively if we are unable to alleviate the strain on resources caused by growth in a timely and successful manner. We cannot assure you that we will be able to manage our growth and a failure to do so could have a material adverse effect on our business.

We face intense competition. If we cannot gain market share among our competition, we may not earn revenues and our business may be harmed.

 

The business of providing energy is highly competitive. In the gasification market, large multi-national industrial corporations, such as General Electric, Shell, ConocoPhillips and Siemens (with entrained flow technologies), and smaller Chinese firms (with low pressure, fixed bed technologies) offer coal gasification equipment and services. Although we do not directly compete with the multi-national industrial corporations, their activities in the marketplace may negatively impact our operations and our ability to attract quality projects. In addition, new competitors, some of whom may have extensive experience in related fields or greater financial resources, may enter the market. Increased competition could result in a loss of contracts and market share. Either of these results could seriously harm our business and operating results. In addition, there are a number of gasification and conventional, non-gasification, coal-based alternatives for producing heat and power that could compete with our technology in specific situations. If we are unable to effectively compete with other sources of energy, our business and operating results could be seriously harmed.

 

In our areas of operation, the projects we intend to build are subject to rigorous environmental regulations, review and approval. We cannot assure you that we will be able to obtain such approvals, satisfy applicable requirements or maintain approvals once granted.

 

Our operations are subject to stringent laws and regulations governing the discharge of materials into the environment, remediation of contaminated soil and groundwater or otherwise relating to environmental protection. Numerous governmental agencies, such as the U.S. Environmental Protection Agency and various Chinese authorities at the municipal, provincial or central government level, issue regulations to implement and enforce such laws, which often require difficult and costly compliance measures that carry substantial potential administrative, civil and criminal penalties or may result in injunctive relief for failure to comply. These laws and regulations may require the acquisition of a permit before construction and/or operations at a facility commence, restrict the types, quantities and concentrations of various substances that can be released into the environment in connection with such activities, limit or prohibit construction activities on certain lands lying within wilderness, wetlands, ecologically sensitive and other protected areas and impose substantial liabilities for pollution resulting from our operations. We believe that we are in substantial compliance with current applicable environmental laws and regulations. Although to date we have not experienced any material adverse effect from compliance with existing environmental requirements, we cannot assure you that we will not suffer such effects in the future.

 

In China, developing, constructing and operating gasification facilities is highly regulated. In the development stage of a project, the key government approvals are the project’s environmental impact assessment report, or EIA, feasibility study (also known as the project application report) and, in the case of a Sino-foreign joint venture, approval of the joint venture company’s joint venture contract and articles of association. Approvals in China are required at the municipal, provincial and/or central government levels depending on the total size of the investment in the project. Prior to commencing full commercial operations, we also need additional environmental approvals to ensure that the facility will comply with standards adopted in the EIA.

 

Although we have been successful in obtaining the permits that are required at this stage of our development, any retroactive change in policy guidelines or regulations or an opinion that the approvals that have been obtained are inadequate, either at the federal or state level in the

United States or the municipal, provincial or central government level in China, could require us to obtain additional or new permits or spend considerable resources on complying with such requirements. Other developments, such as the enactment of more stringent environmental laws, regulations or policy guidelines or more rigorous enforcement procedures, or newly discovered conditions, could require us to incur significant capital expenditures.

 

We may incur substantial liabilities to comply with climate control legislation and regulatory initiatives.

 

Recent scientific studies have suggested that emissions of certain gases, commonly referred to as “greenhouse gases,” may be contributing to warming of the Earth’s atmosphere. Carbon dioxide, a byproduct of burning fossil fuels such as coal, is an example of a greenhouse gas. Our plants using U-GAS^® technology will release a significant amount of carbon dioxide. In response to such studies, many countries are actively considering legislation, and many states in the United States have already taken legal measures, to reduce emissions of greenhouse gases. New legislation or regulatory programs that restrict emissions of greenhouse gases in areas in which we conduct business could have an adverse affect on our operations, costs and ability to operate our plants.

 

Limited continuing rights of prior licensees of U-GAS^® technology could limit the exclusivity of our license and materially adversely affect our business and results of operations.

 

Prior to granting us an exclusive license to manufacture, make, use and sell worldwide both U-GAS^® coal gasification systems and coal and biomass mixture gasification systems that utilize coal and biomass blends having feedstock materials containing up to 60% coal and no more than 40% biomass, GTI licensed U-GAS^® technology to five other entities, all of which have been terminated. We rely on our exclusive license with GTI for U-GAS^® technology to negotiate, enter into and implement contracts with partners and customers and to further develop our business and operations. Certain predecessor licensees may have limited continuing rights under their license agreements with GTI or may have sublicensed the technology. Although neither we nor GTI are aware of any continued use or development of U-GAS^® technology by any of these prior licensees or sublicensees, it is possible that the exclusivity of our license of U-GAS^® technology may be restricted in certain areas of the world. If such rights do in fact exist, GTI does not intend to provide technical or any other support to such licensees. Despite this, any such limitations on the exclusivity of the license could have a materially adverse effect on our business and results of operations.

 

We face the potential inability to protect our intellectual property rights which could have a material adverse effect on our business.

 

We rely on proprietary technology licensed from GTI. Our license agreement with GTI for U-GAS^® technology (described under “Business—GTI agreements—License agreement”) is a critical component of our business. GTI’s proprietary technical know-how is critical to the use of the technology and all of the prior patents granted around U-GAS^® technology have expired. We are improving the technology and we plan to create new technologies around the core U-GAS^® technology and seek patent protections for these improvements and new technologies. Proprietary rights relating to U-GAS^® technology are protected from unauthorized use by third parties only to the extent that they are covered by valid and enforceable patents or are maintained in confidence. There can be no assurance that patents will be issued from any

pending or future patent applications owned by or licensed to us or that the claims allowed under any issued patents will be sufficiently broad to protect our technology. In addition, our ability to obtain patent protection may be affected by the terms of our license agreement with GTI for U-GAS^® technology. In the absence of patent protection, we may be vulnerable to competitors who attempt to copy our technology or gain access to our proprietary information and technical know-how. In addition, we rely on proprietary information and technical know-how that we seek to protect, in part, by entering into confidentiality agreements with our collaborators, employees, and consultants. We cannot assure you that these agreements will not be breached, that we would have adequate remedies for any breach or that our trade secrets will not otherwise become known or be independently developed by competitors.

 

Proceedings initiated by us to protect our proprietary rights could result in substantial costs to us. We cannot assure you that our competitors will not initiate litigation to challenge the validity of our patents, or that they will not use their resources to design comparable products that do not infringe upon our patents. Pending or issued patents held by parties not affiliated with us may relate to our products or technologies. We may need to acquire licenses to, or contest the validity of, any such patents. We cannot assure you that any license required under any such patent would be made available on acceptable terms or that we would prevail in any such contest. We could incur substantial costs in defending ourselves in suits brought against us or in suits in which we may assert our patent rights against others. If the outcome of any such litigation is unfavorable to us, our business and results of operations could be materially and adversely affected.

 

We have found material weaknesses in our internal accounting controls and our inability to correct these weaknesses could reduce confidence in our financial statements.

 

In November 2007, we paid an invoice for $940,040 on behalf of a 5% or greater stockholder. The stockholder represented to us that the invoice was for work performed by a third party engineering firm for engineering and other related services performed by that firm on behalf of the stockholder. In the course of its review of our condensed consolidated interim financial statements for the period ending December 31, 2007, KPMG LLP, our independent registered public accounting firm, or KPMG, inquired about the payment and questioned whether the payment should be accounted for as an offering cost incurred in connection with our 2007 public offering, rather than as an operating expense. As a result of KPMG’s inquiry, the audit committee of our board of directors initiated a review of the payment and later engaged independent counsel to further investigate the matter. The independent counsel found no evidence of misconduct by our management. However, the results of the investigation led to a material adjustment to our condensed consolidated interim financial statements that was not otherwise detected by our internal accounting controls, and we concluded that the control deficiencies represented material weaknesses in our internal accounting controls.

 

Specifically, management identified the following material weaknesses: (1) ineffective policies and procedures to ensure that sufficient written agreements describing the terms of payments exist before a disbursement is made; (2) ineffective controls to prevent or detect payments being processed without adequate backup or support to identify the amount being paid, the services rendered and the associated costs of each service, and the identity of the vendor; and (3) ineffective internal controls to ensure that disbursements to related parties are approved by appropriate individuals, and that our public filings include the appropriate disclosure of related party transactions.

Management implemented new policies and procedures in late March, early April 2008 through (1) increasing the level of supporting documentation required for management to pay invoices; (2) requiring Audit Committee approval for all related party transactions regardless of dollar amount; and (3) requiring all new vendors to be formally approved prior to payments. Although we believe we have implemented changes to our policies and procedures that mitigate these material weaknesses, an insufficient amount of time has passed to ensure that the actions implemented are operating as intended.

 

It is possible that all or a part of the above described payment should have been disclosed in connection with our public offering in November 2007. If so, and if material, we could face liability under the Securities Act of 1933, as amended, or the Securities Act, for failing to disclose it in the related prospectus. However, given the above facts, it is not possible at this time to predict with any exactness the likelihood that we will in fact have any liability arising out of these events or the amount of such liability, if any.

 

For the period ended March 31, 2008, management has identified an additional material weakness related to our period-end financial reporting process. Specifically, we did not have a sufficient number of accounting professionals who have familiarity with our operations and the requisite knowledge of generally accepted accounting principles to prepare our financial statements and related disclosures on a timely basis, which resulted in our inability to complete our period-end close procedures as designed and also resulted in us recording adjustments to our financial statements that were not detected by our internal accounting controls. Because of these issues, we also performed additional procedures that were designed to provide management with reasonable assurance regarding the reliability of our financial reporting and the preparation of the condensed consolidated interim financial statements for the quarter ended March 31, 2008. Subsequent to March 31, 2008, we have hired, and will continue to hire, additional experienced supervisory and staff accounting professionals to provide the resources necessary to remediate this material weakness. In addition, when necessary, we will engage external accounting resources to supplement our current staff to support our growing business.

 

Although our management and the audit committee intend for the new policies and procedures to provide sufficient assurance of future compliance, we are unable to determine at this time whether the new policies and procedures will be fully effective in correcting these weaknesses. In addition, we are still in the process of completing the procedures, certification and attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002 for the fiscal year ending June 30, 2008, and additional changes may arise from the process. Despite this, a control system, no matter how well conceived and operated, can provide only reasonable assurance that the objectives of the control system are met. Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or internal accounting controls will prevent all errors and fraud, even after instituting the changes described above. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues have been detected and further misstatements due to error or fraud may occur and not be detected.

 

We will be subject to the requirements of Section 404 of the Sarbanes-Oxley Act. If we are unable to timely comply with Section 404 or if the costs related to compliance are significant, our profitability, stock price and results of operations and financial condition could be materially adversely affected.

 

As noted in the above risk factor, we will be required to comply with the provisions of Section 404 of the Sarbanes-Oxley Act of 2002 for the fiscal year ending June 30, 2008.

Section 404 requires that we document and test our internal control over financial reporting and issue management’s assessment of our internal control over financial reporting. We are a small company with limited financial resources and our finance and accounting staff is very limited.

 

We believe that the out-of-pocket and other additional costs, the diversion of management’s attention from running the day-to-day operations and operational changes caused by the need to comply with the requirements of Section 404 could be significant. If the time and costs associated with such compliance exceed our current expectations, our results of operations could be affected. During the quarter ended March 31, 2008, management has also identified that we have insufficient finance and accounting resources with an appropriate level of accounting knowledge, experience and training in the application of generally accepted accounting principles commensurate with our financial reporting requirements and our operations. We are actively searching for additional finance and accounting personnel to assist in compliance with our financial reporting obligations.

 

We cannot be certain that we will be able to successfully complete the procedures, certification and attestation requirements of Section 404 or that we or our auditors will not identify material weaknesses in internal control over financial reporting. If we fail to satisfy the requirements of Section 404 on a timely basis, investors could lose confidence in our financial statements, which in turn could harm our business and negatively impact the trading price of our common stock.

 

 

Our results of operations would be negatively affected by potential currency fluctuations in exchange rates with foreign countries.

 

Currency fluctuations, devaluations and exchange restrictions may adversely affect our liquidity and results of operations. Exchange rates are influenced by political or economic developments in China, the United States or elsewhere and by macroeconomic factors and speculative actions. In some countries, local currencies may not be readily converted into U.S. dollars or other hard currencies or may only be converted at government controlled rates, and, in some countries, the transfer of hard currencies offshore has been restricted from time to time. Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may decide to enter into hedging transactions in the future, the availability and effectiveness of these hedges may be limited and we may not be able to successfully hedge our exposure, if at all.

 

Fluctuations in exchange rates can have a material impact on our costs of construction, our operating expenses and the realization of revenue from the sale of commodities. We cannot assure you that we will be able to offset any such fluctuations and any failure to do so could have a material adverse effect on our business, financial condition and results of operations. In addition, our financial statements are expressed in U.S. dollars and will be negatively affected if foreign currencies, such as the Chinese Renminbi Yuan, depreciate relative to the U.S. dollar. In addition, our currency exchange losses may be magnified by exchange control regulations in China or other countries that restrict our ability to convert into U.S. dollars.

Our operations in China may be adversely affected by evolving economic, political and social conditions.

 

Our operations are subject to risks inherent in doing business internationally. Such risks include the adverse effects on operations from war, international terrorism, civil disturbances, political instability, governmental activities and deprivation of contract and property rights. In particular, since 1978, the Chinese government has been reforming its economic and political systems, and we expect this to continue. Although we believe that these reforms have had a positive effect on the economic development of China and have improved our ability to do business in China, we cannot assure you that these reforms will continue or that the Chinese government will not take actions that impair our operations or assets in China. In addition, periods of international unrest may impede our ability to do business in other countries and could have a material adverse effect on our business and results of operations.

 

Long term offtake agreements could be difficult to obtain and, if obtained, enforce because of China’s underdeveloped legal system.

 

Historically, it has been difficult to enter into or otherwise obtain long term offtake agreements in China. Even if we are able to enter into such agreements for syngas, power and other commodities in the future, we may have difficulty seeking remedies under the agreements due to less certainty under China’s legal system, as compared to Western countries. We will seek to mitigate this risk by (i) dealing with reliable partners, (ii) obtaining all requisite government approvals, (iii) developing projects with good underlying economics, (iv) developing modular plants that can be moved away in an extreme circumstance, (v) using local banks to finance a majority of our project costs, and (vi) including enforceable arbitration provisions in all project agreements. The success of our business depends in part on our ability to successfully negotiate, implement and manage the offtake agreements. As a result, our business and financial condition would be materially adversely affected if we are unable to enter into these agreements, or if entered to, to mitigate the risks associated with these agreements.

 

New regulations relating to minimum production requirements for coal-to-methanol plants recently promulgated by the Chinese government could materially adversely affect our project development.

 

The Chinese government has recently promulgated new project approval requirements for infra-structure projects related to coal-to-methanol plants. China’s National Development and Reform Commission, or NDRC, or its provincial or municipal counterparts, must approve new projects based on a minimum production requirement of 1,000,000 tonnes or greater capacity per year for coal-to-methanol plants. Although we do not believe that this would invalidate any of our existing permits, we will be required to comply with these requirements for our future joint ventures in China. Any delays in obtaining or failure to obtain these required approvals, if any, for future coal-to-methanol plants could materially adversely affect our ability to develop additional projects of these types in China.

 

Foreign laws may not afford us sufficient protections for our intellectual property, and we may not be able to obtain patent protection outside of the United States.

 

Despite continuing international pressure on the Chinese government, intellectual property rights protection continues to present significant challenges to foreign investors and, increasingly, Chinese companies. Chinese commercial law is relatively undeveloped compared to the

commercial law in our other major markets and limited protection of intellectual property is available in China as a practical matter. Although we have taken precautions in the operations of our Chinese subsidiaries to protect our intellectual property, any local design or manufacture of products that we undertake in China could subject us to an increased risk that unauthorized parties will be able to copy or otherwise obtain or use our intellectual property, which could harm our business. We may also have limited legal recourse in the event we encounter patent or trademark infringement. Uncertainties with respect to the Chinese legal system may adversely affect the operations of our Chinese subsidiaries. China has put in place a comprehensive system of intellectual property laws; however, incidents of infringement are common and enforcement of rights can, in practice, be difficult. If we are unable to manage our intellectual property rights, our business and operating results may be seriously harmed.

 

Chinese regulations of loans and direct investment by offshore entities to Chinese entities may delay or prevent us from utilizing proceeds of funds to make loans or additional capital contributions to our operations in China, which could materially and adversely affect our liquidity and our ability to fund and expand our business.

 

We may make loans or additional capital contributions to our operations in China. Any loans to our Chinese operations are subject to Chinese regulations and approvals. For example, in fulfilling our guarantee to the project debt to the GC Joint Venture, we may make loans directly to GC Joint Venture which is a foreign-invested enterprise regarded as a Chinese domestic entity. Such loans by us cannot exceed statutory limits and must be registered with the Chinese State Administration of Foreign Exchange or its local counterpart. We may also decide to finance our Chinese operations by means of capital contributions. This capital contribution must be approved by the Chinese Ministry of Commerce or its local counterpart. We cannot assure you that we will be able to obtain these government registrations or approvals on a timely basis, if at all, with respect to future loans or capital contributions by us to our Chinese operations or any of their subsidiaries. If we fail to receive such registrations or approvals, our ability to use the proceeds of this offering and to capitalize our Chinese operations may be negatively affected, which could adversely and materially affect our liquidity and ability to fund and expand our business.

 

 

Our management and board of directors have broad discretion to determine the specific use of the net proceeds of this offering.

 

As of the date of this prospectus, we have broadly characterized the amount of the net proceeds of this offering that will be used for the various purposes described under “Use of proceeds.” Other than with respect to our required capital contributions, our management and board of directors will have considerable discretion in the specific application of the net proceeds, may apply the net proceeds in ways other than those we currently expect, and may apply the net proceeds in ways that may not increase our revenues or our market value. As a result, you will not have the opportunity, as part of your investment decision, to assess whether the proceeds of this offering are being used appropriately.

 

We may have a contingent liability arising out of the issuance of shares by Tamborine.

 

As discussed elsewhere herein, Synthesis Energy Systems, Inc., a corporation formed under the laws of the British Virgin Islands, or Synthesis BVI, and Synthesis Energy Systems, LLC, a West

Virginia limited liability company, or Synthesis LLC, were formed as sister companies in November 2003 to engage in the business of development and commercialization of U-GAS^® technology. The founders of Synthesis BVI believed that it was important to be a publicly traded company in order to obtain the capital necessary to engage in this business. Tamborine Holdings, Inc., or Tamborine, a shell company trading on the Pink Sheets, a centralized quotation service that collects and publishes market maker quotes for securities traded in the over-the-counter market, was receptive to a combination transaction with Synthesis BVI. As such, on April 18, 2005, pursuant to the terms of an Agreement and Plan of Merger, or the Agreement, SES Acquisition Corporation, a wholly-owned subsidiary of Tamborine, merged with and into Synthesis Energy Holdings, Inc., a Florida corporation, or Synthesis Florida, whereby the holders of common stock of Synthesis Florida became shareholders of, and Synthesis Florida became a wholly-owned subsidiary of, Tamborine. As a condition of the above merger, Synthesis Florida completed a restructuring whereby each of Synthesis BVI and Synthesis LLC became wholly owned subsidiaries of Synthesis Florida. On April 27, 2005, Tamborine changed its name to “Synthesis Energy Systems, Inc.” and on June 27, 2005, reincorporated in the state of Delaware. At the time of the merger, there were 100,000,000 shares of Tamborine common stock outstanding, 94,000,000 of which were cancelled in connection with the merger. The remaining 6,000,000 shares became shares of our common stock as a result of the name change and the reincorporation. An additional 21,000,000 “restricted” shares were issued as consideration in the merger to former shareholders of Synthesis Florida, all of whom were accredited investors.

 

Tamborine made numerous representations and warranties in the Agreement, including a representation that all prior offers and sales of its common stock were duly registered or exempt from the registration requirements of the Securities Act or any applicable state securities laws. As noted above, one of the principal reasons that Synthesis Florida completed the merger was to have access to a public trading market, and Tamborine had represented that its shares were eligible for trading, and in fact were trading, on the Pink Sheets. Our current management team, which took office beginning in May 2006, re-examined the facts surrounding the Tamborine issuances prior to the merger and now believes that Tamborine’s representation in the Agreement as to its compliance with federal and state securities laws was incorrect. Although our current management has not been able to locate any definitive records regarding the prior issuances of Tamborine, they have been able to determine the following details.

 

Tamborine was formed in May 2004, and in connection with its formation, issued 100,000,000 shares of its common stock to its three founders, including IFG Investment Services, Inc., or IFG. The certificates issued to two of the three founders contained the appropriate restrictive legend limiting transfer of the shares as is customary in an unregistered private placement. However, the certificate issued to IFG for 7,500,000 shares was apparently issued without such restrictive legends. In June 2004, IFG delivered its certificate to Transfer Online, which thereafter began acting as the transfer agent for Tamborine’s common stock. Subsequently, on December 2, 2004, IFG sold these shares to Ford Allen, Inc., and 1,500,000 of these shares were subsequently cancelled by us. In January 2005, a broker-dealer diligence form was filed by Tamborine with the Pink Sheets under Rule 15c2-11 of the Securities and Exchange Act of 1934, as amended, or the Exchange Act, stating that 6,000,000 shares of Tamborine common stock had been sold in 2004 pursuant to an exemption from registration under Rule 504 of the Securities Act. It is our belief that this Rule 15c2-11 form was filed to permit trading of the common stock of Tamborine on the Pink Sheets. On March 29, 2005, a second Rule 15c2-11 filing was made by Tamborine which stated that there were 7,500,000 freely tradable shares in the

“float,” meaning that those shares could be traded on the Pink Sheets, and also stating that 6,000,000 shares had been sold in 2004 to three investors in Texas under Rule 504.

 

It is our belief that 6,000,000 shares of the 7,500,000 shares that were represented to be “freely tradable” in Tamborine’s second Rule 15c2-11 filing, and which remained outstanding after the merger, were not in fact freely tradable when issued. As noted above, there are no available definitive records, other than the two Rule 15c2-11 filings, regarding the issuance of those shares or the possible exemptions from registration under federal and state securities laws that were used to issue the shares or permit trading of the shares on the Pink Sheets. IFG has not provided an opinion of counsel confirming that these shares were issued, and subsequently transferred, subject to an available exemption. Moreover, the representation in the 15c2-11 filing that issuing these shares under Rule 504 permits those shares to become “freely tradable” is likely not correct. Under Rule 504, any shares sold thereunder are “restricted” shares and may not be sold in the public markets without the use of an exemption from registration. We believe that IFG may have based its view on an incorrect and outdated interpretation of Rule 504. This means that resales of these shares by IFG and subsequently Ford Allen, Inc. on the Pink Sheets may have been in violation of applicable securities laws because the shares were in fact restricted. Trading by subsequent holders may have been in accordance with applicable securities laws based on other available exemptions, but we do not have any documentation to confirm any such conclusions.

 

We have taken a number of steps to deal with these issues. We contacted all stockholders who purchased shares of common stock in our May 2005 and August 2006 private placements to inform them of these issues and gave them the opportunity to have the aggregate purchase price that they paid returned, plus interest. The offer period expired on March 20, 2007, and none of the stockholders elected to accept the offer. We also filed a registration statement on Form SB-2 to (a) cause us to become a reporting company under the Exchange Act, which simplified the use of Rule 144 to trade our securities for eligible stockholders and provided information that is more complete to stockholders, and (b) register resales of shares held by certain of our stockholders, which provided them with an opportunity to dispose of shares using the registration statement without any limitations on volume or concerns about the issues noted above. Tamborine’s ”promoters” or their ”affiliates” and their transferees, within the meaning of the Securities Act, both before and after the merger (as described in “Business—General”), are deemed to be ”underwriters” within the meaning of the Securities Act. Any commissions or discounts given to any such broker-dealer may be regarded as underwriting commissions or discounts under the Securities Act. As such, regardless of technical compliance with Rule 144 under the Securities Act, because Tamborine was a shell company prior to the merger, Rule 144 will be unavailable to its promoters and affiliates and their transferees.

 

As noted above, many aspects of these events cannot be corroborated by documentary evidence or otherwise. In addition, there is not sufficient evidence relating to the trading history of our common stock to analyze the range of potential damages, if any, arising out of these events. In fact, the trading price for our stock has generally increased since we began trading on the Pink Sheets, and we have made progress in executing our business strategy, so it is possible that these events have not generated significant liabilities. Of course, federal and state regulatory agencies could also examine these events and commence proceedings against us, our officers and directors (former and current) and the other individuals involved. We do maintain officer and director liability insurance, and would of course utilize that coverage, if it is available under the terms of the policy, in the event any liabilities are assessed against officers and directors.

Given the above facts, it is not possible at this time to predict the likelihood that we will in fact have any liability arising out of these events or the amount of such liability, if any.

 

Our historic stock price has been volatile and the future market price for our common stock is likely to continue to be volatile. Furthermore, the limited market for our shares could make our price more volatile. This may make it difficult for you to sell our common stock for a positive return on your investment.

 

The public market for our common stock has historically been very volatile. Any future market price for our shares is likely to continue to be very volatile. Since we began trading on The NASDAQ Capital Market on November 2, 2007, our common stock has traded at prices as low as $6.56 per share and as high as $15.92 per share. This price volatility may make it more difficult for you to sell shares when you want at prices you find attractive. We do not know of any one particular factor that has caused volatility in our stock price. However, the stock market in general has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of companies. Broad market factors and the investing public’s negative perception of our business may reduce our stock price, regardless of our operating performance.

 

Further, the market for our common stock is limited and we cannot assure you that a larger market will ever be developed or maintained. The average daily trading volume of our common stock has historically been insignificant and on some trading days, we have had no volume in our common stock. Market fluctuations and volatility, as well as general economic, market and political conditions, could reduce our market price. Should additional equity be issued by us in the future, we cannot assure you that a more active trading market will develop. As a result, this may make it difficult or impossible for you to sell our common stock or to sell our common stock for a positive return on your investment.

 

Our common stock was thinly traded on the Pink Sheets and has continued to be thinly traded on The NASDAQ Capital Market.

 

Prior to trading on The NASDAQ Capital Market, our common stock was quoted on the Pink Sheets. Our stock was usually thinly traded and the trading price was highly volatile. Although our common stock is now traded on The NASDAQ Capital Market, the trading volume has been low and we cannot assure you that this change will increase the trading volume or decrease the volatility of the trading price of our common stock.

 

Substantial sales of our common stock could cause our stock price to decline and issuances by us may dilute your ownership interest in us.

 

The 10,000,000 shares covered by this prospectus represent approximately 23% of our outstanding common stock on a fully diluted basis. Any sales of substantial amounts of our common stock in the public market, or the perception that these sales might occur, could lower the market price of our common stock. In addition, if we issue additional equity securities to raise additional capital in the future, your ownership interest in us may be diluted and the value of your investment may be reduced.

Purchasers in this offering will experience immediate dilution and will experience further dilution with the future exercise of stock options.

 

If you purchase common stock in this offering, you will pay more for your shares than the amount paid by stockholders who purchased their shares from us prior to this offering. As a result, you will experience immediate and substantial dilution of approximately $6.14 per share, representing the difference between our net tangible book value per share as of March 31, 2008 and after giving effect to this offering. Additionally, you will experience further dilution as holders of certain of our stock options exercise those options. As of March 31, 2008, we had 8,000,000 shares of our common stock available under our stock incentive plan, of which 6,708,500 shares are reserved for issuance upon the exercise of outstanding options with a weighted average exercise price of $4.59 per share. See “Dilution” for more.

 

The market valuation of our business may fluctuate due to factors beyond our control and the value of your investment may fluctuate correspondingly.

 

The market valuation of energy companies, such as us, frequently fluctuate due to factors unrelated to the past or present operating performance of such companies. Our market valuation may fluctuate significantly in response to a number of factors, many of which are beyond our control, including:

 

 

As a result, the value of your investment in us may fluctuate.

 

Investors should not look to dividends as a source of income.

 

In the interest of reinvesting initial profits back into our business, we do not intend to pay cash dividends in the foreseeable future. Consequently, any economic return will initially be derived, if at all, from appreciation in the fair market value of our stock, and not as a result of dividend payments.

 

This prospectus includes “forward-looking statements” within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. All statements other than statements of historical fact are forward-looking statements. Forward-looking statements 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 our early stage of development, our estimate of the sufficiency of existing capital sources, our ability to raise additional capital to fund cash requirements for future operations, the limited history and viability of our technology, our results of operations in foreign countries and our ability to diversify, our ability to maintain production from our first plant in the Hai Hua project and the sufficiency of internal controls and procedures. 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. We cannot assure you that the assumptions upon which these statements are based will prove to have been correct.

 

When used in this prospectus, 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 prospectus.

 

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. Before you invest in our common stock, you should be aware that the occurrence of certain of the events described in this prospectus could substantially harm our business, results of operations and financial condition and that upon the occurrence of any of these events, the trading price of our common stock could decline, and you could lose all or part of your investment.

 

We cannot guarantee any future results, levels of activity, performance or achievements. Except as required by law, we undertake no obligation to update any of the forward-looking statements in this prospectus after the date hereof.

 

 

The industry and market data contained in this prospectus are based either on our management’s own estimates or, where indicated, independent industry publications, reports by governmental agencies or market research firms or other published independent sources and, in each case, are believed by our management to be reasonable estimates. However, industry and market data is subject to change and cannot always be verified with complete certainty due to limits on the availability and reliability of raw data, the voluntary nature of the data gathering process and other limitations and uncertainties inherent in any statistical survey of market shares. We have not independently verified market and industry data from third-party sources. In addition, consumption patterns and customer preferences can and do change. As a result you should be aware that market share, ranking and other similar data set forth herein, and estimates and beliefs based on such data, may not be verifiable or reliable.

 

Our common stock has been quoted on The NASDAQ Capital Market since November 2, 2007 under the symbol “SYMX.” From March 29, 2005 until that date, our common stock was quoted in the Pink Sheets.

 

The following table sets forth the range of the high and low sale prices, as reported by the Pink Sheets or The NASDAQ Capital Market, as applicable, of our common stock for the periods indicated.

 

 

Our authorized capital stock consists of 100,000,000 shares of common stock, of which 36,510,921 shares of common stock were issued and outstanding as of June 19, 2008. As of such date, there were approximately 203 holders of record of our common stock.

 

We have not paid dividends on our common stock and do not anticipate paying cash dividends in the immediate future as we contemplate that our cash flows will be used for continued growth of our operations. The payment of future dividends, if any, will be determined by our board of directors in light of conditions then existing, including our earnings, financial condition, capital requirements, and restrictions in financing agreements, business conditions and other factors.

 

We estimate that our net proceeds from this offering will be approximately $85,950,000 after deducting underwriting discounts and commissions and estimated offering expenses. We expect to use the net proceeds of this offering for:

 

 

Other than our required capital contributions to our Golden Concord project, and if approved, our YIMA project, we are not currently able to estimate the approximate amount of the net proceeds that will be used for the other purposes noted above. The actual allocation of the net proceeds for these purposes and the timing of the 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, including potential acquisitions of existing plants, facilities or mines. Depending on the expenditures required for our YIMA project, the proposed expansion of our Hai Hua project, when and if agreed to, feasibility and engineering design work for our North American projects and any of the above factors, our expenditures could exceed the net proceeds of this offering.

 

Pending ultimate use, the net proceeds from this offering will be invested with other funds that we have on hand in cash equivalents and short-term investments, including United States government securities and high-grade corporate investments, commercial paper and bankers acceptances.

 

The following table sets forth our capitalization as of March 31, 2008:

 

 

This table should be read in conjunction with the information under “Use of proceeds” and “Management’s discussion and analysis of financial condition and results of operations,” our unaudited interim consolidated financial statements for the nine months ended March 31, 2008, our audited consolidated financial statements for the year ended June 30, 2007 and related notes and other financial information included in this prospectus.

 

 

Our reported net tangible book value as of March 31, 2008 was $58,563,481, or $1.61 per share of common stock, based upon 36,418,921 shares outstanding as of that date. Net tangible book value per share is determined by dividing such number of outstanding shares of common stock into our net tangible book value, which is our total tangible assets less total liabilities and minority interest. After giving effect to the sale by us of 10,000,000 shares of common stock offered in this offering and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us, our net tangible book value as of March 31, 2008 would have been approximately $144,513,481, or $3.11 per share. This represents an immediate increase in net tangible book value of $1.50 per share to our existing stockholders and an immediate dilution of $6.14 per share to new investors purchasing shares at the public offering price.

 

The following table illustrates the per share dilution:

 

 

The following table sets forth, as of March 31, 2008, after giving pro forma effect to the offering, the number of shares of common stock purchased from us by our existing stockholders and by the new investors, together with the total consideration paid and average price per share paid by each of these groups, before deducting underwriting discounts and commissions and estimated offering expenses.

 

 

If the underwriters’ over-allotment option is exercised in full, the number of shares held by new investors will be increased to 11,500,000, or approximately 24% of the total number of shares of common stock.

 

The data in the table above excludes 6,708,500 shares of our common stock reserved for issuance upon the exercise of options granted under our stock incentive plan with a weighted average exercise price of $4.59 per share.

 

 

We build, own and operate coal gasification plants that utilize our proprietary U-GAS^® fluidized bed gasification technology to convert low rank coal and coal wastes into higher value energy products, such as transportation fuels and ammonia. We believe that we have several advantages over commercially available competing technologies, such as entrained flow and fixed bed, 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, which provide greater fuel flexibility, and our ability to operate efficiently on a smaller scale, which enables us to construct plants more quickly, at a lower capital cost and, in many cases, in closer proximity to coal sources.

 

Our principal business activities are currently focused in China and the United States, areas which are estimated by the U.S. Department of Energy to represent a combined 40% of total global coal reserves. Our first commercial scale coal gasification plant is located in Shandong Province, China, and has been in operation since January 2008. We have a second plant under construction in the Inner Mongolia Autonomous Region of China and plants under development in Henan Province, China and in West Virginia. See “—Current operations and projects” and “—Other industry partners” for more on our first plant and our other projects.

 

The target size of our plants is 100 MW (equivalent) to 400 MW (equivalent) costing from approximately $100 million to several hundred million dollars to build. Our plants can produce synthesis gas, or syngas, a mixture of hydrogen, carbon monoxide and other products. Depending on local market need and fuel sources, syngas can in turn be used to produce methanol, dimethyl ether, or DME, synthetic natural gas, or SNG, ammonia, synthetic gasoline, steam, power and other byproducts (e.g., sulfur, carbon dioxide or ash).

 

Market drivers

 

Over the past decade, developing economies such as China and India, as well as established economies such as the United States, have experienced increased demand for energy. As a result global prices of crude oil and natural gas have risen, particularly relative to coal prices.

 

The following chart shows the average prices per MMBtu of the 12 month forward New York Mercantile Exchange (“NYMEX”) strip for crude oil and natural gas in comparison to the price per MMBtu of Powder River Basin 8800 BTU / lb coal spot prices.

 

 

Markets

 

China and the United States are two of the most well suited markets for utilizing coal gasification technology. Both have an abundant indigenous supply of coal. Coal reserves in the two countries make up approximately 40% of the total global coal reserves. China and the United States are also two of the largest importers of petroleum in the world.

 

According to the U.S. Department of Energy, at the end of 2006, China’s recoverable coal reserves ranked third in the world with 115 billion tonnes, of which 52 billion tonnes were sub-bituminous and lignite coals. In addition, the Chinese government is interested in promoting the expansion of the domestic supply of transportation fuels derived from coal. This is expected to be primarily accomplished through the blending of methanol into gasoline supplies. As of 2006, the recoverable coal reserves of the United States were 246 billion tonnes, of which 132 billion tonnes were lower grade sub-bituminous and lignite coals. Capitalizing on these abundant supplies, we believe that gasification technology can cleanly provide for the production of synthetic gasoline via methanol, at a significantly lower price than other energy alternatives.

 

 

Current end use markets of coal gasification products

 

Coal gasification can be used to produce syngas which can then be converted into many different higher valued products for use in the transportation and chemicals industries.

 

Transportation fuels

 

Syngas can be converted into many different transportation fuels including methanol, DME and synthetic gasoline. Methanol is currently used in China directly as a transportation fuel or as a gasoline blend stock in 15% and 85% ratios. DME, a derivative of methanol, can be used as a substitute for liquefied petroleum gas, or LPG, and with some modifications as a replacement for diesel fuel. Synthetic gasoline can be created after the gasification process by processing methanol into synthetic gasoline and other hydrocarbon products.

 

Chemicals

 

Syngas can be used as a feedstock for producing many chemicals including methanol, formaldehyde for use in the construction industry and acetic acid for use in producing plastics. Other methanol derivatives are used to manufacture a wide range of products including plywood, particleboard, foams, resins and silicon. The chemical uses of methanol are somewhat mature with growth rates typically tied to gross domestic product and construction activity. Our initial projects, other than Hai Hua, are targeted to produce methanol (and methanol derivatives) as our primary product. In 2006, China and the United States together accounted for over 42% of worldwide methanol consumption (China 26%, U.S. 16%) according to PCI—Ockerbloom & Co.

 

Methanol demand

 

Worldwide methanol consumption has grown from 28.8 to 40.3 million tonnes between 1999 and 2007 according to PCI—Ockerbloom & Co., with China contributing the largest portion of this growth. Chinese methanol consumption has grown at a compound annual growth rate of 19%, from approximately 2.6 to 10.6 million tonnes between 1999 and 2007.

 

In China, methanol derived from syngas, is increasingly being used as a fuel blending stock as priority is being placed on domestically sourced energy. More than 4,000 cars are being added daily to China’s existing fleet of 92.3 million vehicles in registration and we anticipate the demand for transportation fuels to increase dramatically. In July 2007, the Chinese central government issued preliminary standards for the blending at ratios of 15% and 85% of methanol to gasoline. The National Development and Reform Commission, China’s main economic decision-making body, is in the process of considering legislation supporting nationwide use of methanol in gasoline blends. We expect mandatory blending levels to be instituted on a national basis, as many regional mandates have already been issued. Mandatory blending of 15% methanol into gasoline in China alone would represent an approximately 70% increase (on a Btu basis) in the global methanol market based on current consumption rates. During 2007, China led the world in using methanol as a transportation fuel by using between three and five million tonnes. The following chart shows the growth in methanol consumption in China between 1999 and 2007.

 

In 2007 the United States consumed 6.5 million tonnes of methanol, of which imports made up 89% due to high natural gas feedstock costs in the United States. The following chart shows methanol import growth in the United States from 1999 and 2007.

 

 

 

Methanol capacity

 

According to Jim Jordan & Associates, China will add approximately 6.5 million tonnes of new methanol capacity by the end of 2010. We also believe that most of this new capacity will be coal-based production that will meet Chinese derivative and energy market demand for methanol.

 

Carbon dioxide capture

 

The cost of capturing the carbon dioxide stream is relatively low in a U-GAS^® plant, as the carbon dioxide is pure as compared to power plants, and is estimated to add only a small percentage to the overall capital expense of a U-GAS^® plant. The cost of transport and disposal of the carbon dioxide is also relatively low.

 

There are a variety of options for disposing of captured carbon dioxide. Enhanced oil recovery (EOR) and enhanced coal bed methane recovery (ECBMR) provide storage opportunities that can create positive economic value for the project. Injecting carbon dioxide into depleting oil and natural gas fields enhances the ability to recover reserves that would be otherwise be unrecovered. Storage in underground aquifers and other geologic structures offers additional storage capacity in many diverse locations in our target markets. Storage in geologic structures does not, however, provide the economic benefits typically associated with EOR.

 

 

According to the Global Energy Technology Strategy Program (GTSP), a research organization sponsored by the U.S. Department of Energy and the Battelle Memorial Institute, there is potential geological capacity to store more than 11,000 gigatonnes of carbon dioxide around the world, which we believe is significantly more than would be required in response to even the most strict sequestration policies.

 

Our longer term opportunities

 

Agriculture/fertilizer

 

Syngas can be converted into many different products used in the agriculture industry such as ammonia and ammonia based fertilizers including urea, ammonium nitrate and urea ammonium nitrate. World population and economic growth, combined with changing dietary trends in many nations, has significantly increased demand for agricultural production, which has increased demand for nitrogen-based fertilizers. Corn is an example of a high-yield crop, which on average requires 100-160 pounds of nitrogen for each acre of plantings. According to the United States Department of Agriculture, U.S. farmers planted approximately 92.9 million acres of corn in 2007, exceeding the 2006 planted area by 19%. In recent years, the price of ammonia has increased over 250%, as the demand for corn-based ethanol has increased corn demand.

 

Synthetic natural gas

 

Due to increasing costs of natural gas produced from traditional sources, and in turn, certain commodities requiring natural gas as a feedstock, there is a market for lower cost, alternative sources for natural gas. Pipeline quality SNG can be synthesized through a catalytic processing of syngas. Natural gas is typically used for power generation or home heating. While we believe that this is an attractive long term market for us, liquids, such as methanol, ammonia or synthetic gasoline, are higher value outputs for us to produce at this time.

 

Power generation

 

Syngas can be utilized to produce electricity when burned in a gas turbine. All of the major turbine manufacturers offer syngas capable equipment. In the production of power, the carbon dioxide created through the U-GAS^® gasification process can be economically removed, and in

most cases, sequestered. We view power generation, particularly the repowering of existing coal-fired facilities, as an important future opportunity for us.

 

 

We have an exclusive license to the U-GAS^® gasification technology from the Gas Technology Institute, or GTI, a leading non-profit research and development organization located near Chicago, Illinois. Over the past 30 years, GTI has developed a fluidized bed gasification technology trademarked as U-GAS^®. Our U-GAS^® license grants us the worldwide exclusive right to manufacture, make, use and sell both U-GAS^® coal gasification systems and coal and biomass mixture gasification systems and has an initial term expiring in August 2016, with two additional 10-year extensions exercisable at our option. The primary advantage of U-GAS^® relative to other leading gasification technologies is the ability to produce syngas from all ranks of coal (including low rank, high ash and high moisture coals), many coal waste products and biomass feed stocks. This process is highly efficient at separating carbon from waste ash, which allows for the efficient processing of certain low rank coal and many coal waste products that cannot otherwise be utilized in the entrained flow and fixed bed gasifiers offered by our competitors. The ability to gasify these lower quality fuels unlocks economic advantages by allowing the use of lower quality feedstocks while maintaining high carbon conversion and clean syngas outputs.

 

The U-GAS^® gasification process is based on a single-stage, fluidized-bed technology for production of low-to-medium heating value syngas from a wide array of biomass feedstocks and coals (including low rank, high ash and high moisture coals). U-GAS^® technology was developed for gasification of all ranks of coal as well as coal and biomass blends.

 

 

In the U-GAS^® gasification process, fuel is processed and conveyed into the gasifier vessel. Within the fluidized bed, the fuel reacts with steam, air and/or oxygen at a temperature of between 1,550°F to 2,000°F. The temperature for gasification depends on the type of fuel used and is controlled to maintain high carbon conversion and non-slagging conditions for the ash. The U-GAS^® process accomplishes four important functions in a single-stage, fluidized-bed gasifier: it decakes, devolatilizes and gasifies fuel, and if necessary, agglomerates and separates ash from the reacting coal. The operating pressure of the gasifier depends on the end use for the syngas and may vary from 3 to 30 bars (40 to 435 psia) or more. After cleaning, the syngas can be used as industrial fuel gas, for power generation and for production of produce methanol, DME, SNG, ammonia, synthetic gasoline, steam, power and other products (e.g., sulfur, carbon dioxide or ash).

 

During operation, fuel is gasified rapidly within the fluidized bed and produces a gaseous mixture of hydrogen, carbon monoxide, carbon dioxide, water vapor and methane, in addition to small amounts of hydrogen sulfide and other trace impurities. If the operating temperature

required to achieve acceptable carbon conversion exceeds the fuel ash softening temperature, the ash concentration of the fluidized bed is allowed to increase until a condition is reached that allows the ash particles to agglomerate into larger particles. The agglomerated particles are denser than the surrounding bed material and can thus be selectively removed from the bottom of the bed.

 

Reactant gases, including steam, air, and/or oxygen are introduced into the gasifier in two areas: (i) through a sloping distribution grid at the bottom of the bed and (ii) through a terminal velocity-controlled ash discharge port at the center of the distribution grid. In both agglomerating and non-agglomerating operating modes, ash is removed by gravity from the fluidized bed and discharged into a lockhopper system for depressurization and disposal. In both operating modes, the gasifier maintains a low level of carbon in the bottom ash discharge stream, making overall carbon conversion of 90% or higher. Cold gas efficiencies of over 80% have been repeatedly demonstrated.

 

Fines purified from the fluidized bed are typically separated from the product syngas by up to three stages of external cyclone separators, one or two of which return the fines to the fluidized bed for increased carbon conversion. The product syngas is essentially free of tars and oils due to the temperature and residence time of the gases in the fluidized bed, simplifying downstream heat recovery and gas cleaning operations.

 

When used to gasify biomass or highly reactive wastes, an inert material such as sand, limestone or dolomite is used to maintain the fluidized bed. In this case, most of the ash from the fuel leaves the fluidized bed with the product syngas, with the bottom ash discharge serving primarily to discharge tramp material entering with the biomass or waste feed.

Example installations

 

 

License agreement

 

Pursuant to the Amended and Restated License Agreement dated as of August 31, 2006, as amended on June 14, 2007, between us and GTI, or the License Agreement, we have an exclusive worldwide license to manufacture, make, use and sell both U-GAS^® coal gasification systems and coal and biomass mixture gasification systems that utilize coal and biomass blends having feedstock materials containing no less than 60% coal and no more than 40% biomass. The License Agreement also grants us a non-exclusive license to manufacture, make, use and sell worldwide biomass gasification systems and coal and biomass mixture gasification systems that utilize coal and biomass blends having feedstock materials containing up to 60% coal and no less than 40% biomass. The License Agreement has a term of ten years, but may be extended for two additional ten-year periods at our option.

 

As consideration for the license, we paid $500,000 cash, and issued 190,500 shares of restricted common stock, to GTI. We are also restricted from offering a competing gasification technology during the term of the License Agreement. Additionally, for each U-GAS^® unit which we license, design, build or operate which uses coal or a coal and biomass mixture as the feed stock, we must pay a royalty based upon a calculation using the per thermal megawatt/hr 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. 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. A failure to comply with any of the above requirements could result in the termination of the License Agreement by GTI if not cured by us within specified time periods.

 

In addition, we were required to (i) have a contract for the sale of a U-GAS^® system with a customer in the territory covered by the License Agreement no later than August 31, 2007, (ii) fabricate and put into operation at least one U-GAS^® system by July 31, 2008 and (iii) fabricate and put into operation at least one U-GAS^® system for each calendar year of the License Agreement, beginning with the calendar year 2009. We have satisfied the obligation to have a contract for the sale of a U-GAS^® system no later than August 31, 2007 and fabricate and put into operation at least one U-GAS^® system by July 31, 2008 through our Hai Hua project described below. Additionally, we are required to disclose to GTI any improvements related to the U-GAS^® system that are developed and implemented by us and the manner of using and applying such improvements. Failure to satisfy the requirements as to these milestones could lead to the revocation of the license by GTI; provided, however, that GTI is required to give a twelve-month notice of termination and we are able to cure the default and continue the License Agreement prior to the expiration of such time period.

 

During the term of the License Agreement, we have granted to GTI a royalty-free, non-exclusive, irrevocable license to make, manufacture, use, market, import, offer for sale and sell U-GAS^® systems that incorporate our improvements. Such license only applies outside of the exclusive rights granted to us under the License Agreement. Without the prior written consent of GTI, we have no right to sublicense any U-GAS^® system other than to customers for which we have constructed a U-GAS^® system. For a period of ten years, we are restricted from disclosing any confidential information (as defined in the License Agreement) to any person other than employees of our affiliates or contractors who are required to deal with such information, and such persons will be bound by the confidentiality provisions of the license. We have further

indemnified GTI and its affiliates from any liability or loss resulting from unauthorized disclosure or use of any confidential information that it receives.

 

Other services

 

GTI also offers various technical services including but not limited to laboratory testing of coal samples and plant design review. While we have no obligations to do so, we have requested GTI to provide various services including: (i) developing an industry-standard process model for performance and cost evaluations of U-GAS^®, (ii) replenishing and enlarging the intellectual property portfolio for U-GAS^® technology and (iii) assisting us with appropriate design support for gasification opportunities that would include fuel feeder, gasifier, solids separation and solids handling systems sizing and configuration.

 

 

We believe that the key strengths of our business include the following:

 

 

 

 

 

 

 

 

The key elements of our business strategy include:

 

 

 

 

China

 

We believe that China offers immediate opportunities to develop U-GAS^®-based coal gasification projects, has coal as its most abundant indigenous energy resource and, in particular, has a ready supply of low rank coal. According to the U.S. Department of Energy, as of year end 2006, China’s recoverable coal reserves amounted to 115 billion tonnes, including 52 billion tonnes of lower grade sub-bituminous and lignite coals. In addition, the Chinese government is promoting the expansion of the domestic supply of chemical products and transportation fuels derived from coal. Recently promulgated legislation is expected to mandate methanol blending into gasoline supplies. More than 4,000 cars are being added daily to China’s existing fleet of 92.3 million vehicles in registration and we anticipate the demand for transportation fuels to increase dramatically. In addition, methanol and DME are both experiencing strong consumption growth. Methanol is used as a natural gas substitute in power generation and as an automotive fuel additive. DME, a methanol derivative, is presently used as a clean-burning substitute for liquefied petroleum gas, or LPG, and is used in China as an automotive fuel as a replacement for diesel fuel. China’s methanol consumption has grown from 2.6 million tonnes in 1999 to 10.6 million tonnes in 2007. Due to the strength and growth prospects of the methanol and DME markets in China, we plan to focus on projects in these markets.

 

United States

 

We have also targeted the United States market for development of U-GAS^®-based coal gasification projects. The United States has the most abundant coal reserves in the world and a ready supply of low rank coal. We believe that synthetic gasoline made from coal-derived methanol can cleanly supplement transportation fuel requirements with domestically produced gasoline. Concerns over greenhouse gas emissions, such as carbon dioxide, have increased recently, particularly with respect to coal-based consumption. Coal gasification enables the successful utilization or sequestration of these gases from our U-GAS^®-based plants. Gasoline produced utilizing lower cost feedstocks, such as low rank coal and coal waste products, is expected to cost significantly less than other alternatives. As of year end 2006, the United States had over 246 billion tonnes of coal, including 132 billion tonnes of lower grade sub-bituminous and lignite coals. In the United States, coal has a significant cost advantage over natural gas on a BTU basis. As of May 9, 2008, Powder River Basin coal (an example of a lower rank coal) costs approximately $0.58 per MMBtu, as compared to the twelve month NYMEX strip price of $11.76 per MMBtu for natural gas. This difference in feedstock prices has created a cost advantage for us, which we believe will allow us to become a low-cost producer of methanol, synthetic gasoline and ammonia. Between 2003 and 2008, the price of methanol has increased 114% and the price of ammonia has increased 263%. These price increases have enhanced the attractiveness of projects where the price of the end product is derived from or based on the cost of natural gas. In addition, recent federal legislation has mandated the use of alternatives fuels, such as corn-based ethanol, as fuel additives. We believe that synthetic gasoline derived from coal-based methanol will gain support as a low cost alternative to other domestically produced

alternative fuels. To take advantage of this trend, we believe that our projects in the United States will focus on the production of methanol, synthetic gasoline and ammonia.

 

 

Business development staff

 

We currently employ a staff of five experienced business development professionals in China. Led by Don Bunnell, our President & Chief Executive Officer of Asia Pacific, the Chinese business development team is focused on the disciplined development of gasification projects that maximize the advantages of U-GAS^® technology. The team has combined experience of over 80 years of energy infrastructure project development in China. Members of the team have either led or assisted in the development of multiple coal and natural gas power projects, chemical and nuclear projects in mainland China over the past two decades. We intend to strengthen this staff with the addition of at least four individuals within the next twelve months.

 

Our development effort in the United States consists of four experienced individuals focused on the development of gasification projects in the United States as well as structured transactions with select multi-national industrial corporations. Led by David Eichinger, our Chief Financial Officer and Senior Vice President of Business Development, the team is executing on coal-to-transportation fuel opportunities in areas where low rank coals are available as feedstocks. The team is also working with select multi-national industrial corporations to deploy U-GAS^® technology to replace traditional higher cost energy supplies around the world. We intend to augment this capability with the addition of three individuals within the next twelve months.

 

Engineering staff

 

Operations in China have given us the opportunity to build a leading gasification engineering team at a time when process engineering resources are in short supply in the western world. Coal has been an important part of the Chinese economy for many decades. This activity has spawned a large community of engineers with experience in coal gasification and industrial process design and implementation. During the last few decades, China has developed an entire university program dedicated to coal energy and process engineering, resulting in a ready source of high quality, experienced engineers to work on advanced gasification projects such as U-GAS^®. We currently employ a staff of 38 engineers in our Shanghai office and at our Hai Hua plant, many of whom have graduated from the university programs and together have an average of more than 15 years of gasification experience each. Core members of the team were the original engineering team that built the world’s largest U-GAS^® facility at Shanghai Coking and Chemical in 1994. We have also recently added two engineers in the United States with extensive experience in the gasification industry through their work with Fluor Corporation and General Electric.

 

We intend to use this engineering team to conceptualize, design and build gasification projects in our target markets. We believe that this capability represents a key advantage for marketing to U.S. companies and multi-national firms throughout the project development cycle and enables pre-development engineering work to be done with a faster cycle time and at a substantially lower cost.

 

The target size of our plants is 100 MW (equivalent) to 400 MW (equivalent) costing from approximately $100 million to several hundred million dollars to build. Our plants can produce synthesis gas, or syngas, a mixture of hydrogen, carbon monoxide and other products. Depending on local market need and fuel sources, syngas can in turn be used to produce methanol, dimethyl ether, or DME, synthetic natural gas, or SNG, ammonia, synthetic gasoline, steam, power and other byproducts (e.g., sulfur, carbon dioxide or ash).

 

Hai Hua

 

Our first project is a joint venture with Shandong Hai Hua Coal & Chemical Company Ltd., or Hai Hua. Through the joint venture, which we refer to as the HH Joint Venture, we developed, constructed and are now operating a syngas production plant utilizing U-GAS^® technology in Zaozhuang City, Shandong Province, China designed to produce approximately 28,000 standard cubic meters per hour of gross syngas. The plant is producing and selling syngas and the various byproducts of the plant, including ash, elemental sulphur, hydrogen and argon. Hai Hua, an independent producer of coke and coke oven gas, owns a subsidiary engaged in methanol production. This coal washing process produces a byproduct which is used as the design fuel for the HH Joint Venture’s U-GAS^® gasification plant. Construction of the plant has been completed for a total cost of approximately $36.3 million. The plant produced initial syngas in January 2008 and syngas sales commenced in February 2008. As of June 5, 2008, the plant is running at approximately 30% of its design capacity. The plant was built on a site adjacent to the Hai Hua coke and methanol facility. Hai Hua has granted rights of way for construction access and other ongoing operations of the plant. The land for the construction of this plant was acquired from the Chinese government with the assistance of the Shandong Xue Cheng Economic Development Zone.

 

A Chinese supplier of air separation equipment supplied the oxygen production equipment for the plant. By utilizing this supplier, we were able to source this piece of equipment on an acceptable schedule and at a cost significantly below alternative prices. A leading supplier of pressure vessel and heat exchanger equipment in China was contracted to build the gasifier vessels and heat recovery units for the plant. This supplier has built major thermal equipment for industries ranging from coal power generation to nuclear energy and successfully met our quality, schedule and pricing demands. An international industrial construction firm was contracted to build the plant. This firm has built large scale industrial facilities throughout China and the world and was able to deploy a large dedicated skilled labor force for our project.

 

According to the joint venture agreement of the HH Joint Venture, if either we or Hai Hua desires to invest in another coal gasification project within Zaozhuang City, the other company has a right to participate in up to 25% of the investment. For the first 20 years after the date that the plant became operational, 95% of all net profits of the HH Joint Venture will be distributed to us. After the initial twenty years, the profit distribution percentages will be changed, with us receiving 10% of the net profits of the HH Joint Venture and Hai Hua receiving 90%. The contract has a term of 50 years, subject to earlier termination if the HH Joint Venture either files for bankruptcy or becomes insolvent or if the syngas purchase contract between the HH Joint Venture and Hai Hua (discussed in more detail below) is terminated. Hai Hua has also agreed that the License Agreement is our sole property and that it will not compete with us with respect to fluidized bed gasification technology for the term of the HH Joint Venture.

In addition, Hai Hua has agreed to certain capacity and energy payments with respect to syngas purchased from the HH Joint Venture pursuant to the terms and conditions of a purchase and sale contract. Hai Hua will (i) pay a monthly capacity fee and, subject to delivery, a monthly energy fee; (ii) provide piping to the plant for the acceptance of steam and coke oven gas from Hai Hua and for the delivery of syngas from the HH Joint Venture to Hai Hua; and (iii) coordinate its operations and maintenance so as to ensure Hai Hua purchases as much syngas as possible. The energy fee is a per Ncum of syngas fee calculated by 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 syngas.

 

The HH Joint Venture is contractually obligated to procure certain other necessary consumables for operation of the plant, provided, the HH Joint Venture is entitled to reimbursement for these costs through the payment of the energy fee. As part of its registered capital contribution to the HH Joint Venture, Hai Hua contributed approximately $480,000 in cash. Hai Hua is also required to provide up to 100,000 Ncum of coke oven gas and up to 600 tonnes of coke free to the HH Joint Venture during the first year of operation as start-up fuels for the gasifiers. Any requirements for coke or coke oven gas above these amounts shall be paid for by the HH Joint Venture. If Hai Hua is unable or unwilling to provide the required coke or coke oven gas, the plant will be deemed to be able to produce for purposes of calculating the capacity fee and Hai Hua will not be relieved of its payment obligations. Pursuant to the terms of the contract, the value of the items provided by Hai Hua to the HH Joint Venture (including the coke, coke oven gas, piping and acreage for the storage facilities) shall not exceed 5% of the equity of the HH Joint Venture.

 

Hai Hua is required to annually provide to the HH Joint Venture a preliminary syngas usage plan for that year, provided, however, that in no event shall the usage plan require less than 19,000, or more than 22,000 Ncum per hour of syngas. In connection with this, the HH Joint Venture shall annually provide a generation plan to Hai Hua which sets forth the anticipated syngas generation for that year, and it shall use its best efforts to match its generation plan with Hai Hua’s usage plan. If the HH Joint Venture produces more syngas than the capacity that Hai Hua is required to make capacity payments for under the contract, Hai Hua shall have a right of first refusal to purchase such excess amount. It would be a default under the agreement if we fail to materially perform these obligations.

 

The syngas to be purchased by Hai Hua is subject to certain quality component requirements set forth in the contract. All byproducts of the gasification process are the property of the HH Joint Venture. The HH Joint Venture is entitled to provide services and sell products which it produces other than syngas to third parties, but Hai Hua has a right of first refusal for any such sales. Hai Hua is obligated to pay the capacity fee regardless of whether they use the gasification capacity, subject only to availability of the plant and exceptions for certain events of force majeure.

 

The agreement terminates 20 years from the date of the issuance of the business license of the HH Joint Venture. Upon termination of the agreement for any reason other than the expiration of the term, the HH Joint Venture will have the right to either produce syngas for other customers in its current location or dismantle the plant and move the plant to another location. Within two years of October 22, 2006, the date of the contract, Hai Hua could request that the HH Joint Venture expand its syngas production in order to assist in the production of methanol by a subsidiary of Hai Hua, and the HH Joint Venture is required to negotiate such increased

production in good faith. Hai Hua has made such a request and as of the date hereof, the HH Joint Venture is in negotiations regarding the details and pricing of the expansion project. The HH Joint Venture is also considering possible acquisitions of interests in coal mines near the plant.

 

Golden Concord

 

We are a party to a joint venture with China Coal Chemical (Xilin) Company Limited, or Golden Concord. SES—GCL (Inner Mongolia) Coal Chemical Co., Ltd., or the GC Joint Venture was formed to (i) develop, construct and operate a coal gasification, methanol and DME production plant utilizing U-GAS^® technology in the Xilinguole Economic and Technology Development Zone, Inner Mongolia Autonomous Region, China and (ii) produce and sell methanol, DME and the various byproducts of the plant, including fly ash, steam, sulphur, hydrogen, xenon and argon. Golden Concord is a subsidiary of one of China’s largest independent private power producers. The facility is expected to produce syngas which will be used as a feedstock for a 225,000 tonne per year methanol plant. The project is currently moving through the approval process and we broke ground in June 2007 with operations scheduled to begin by the second quarter of 2010. We agreed to contribute approximately $16.3 million in cash in exchange for a 51% ownership interest in the GC Joint Venture, and Golden Concord has agreed to contribute approximately $16 million in cash for a 49% ownership interest in the GC Joint Venture. The contributions of each of SES Investments and Golden Concord are payable in installments, with the first 20% due within 90 days of the date of the issuance of the GC Joint Venture’s business license. We are continuing to work with Golden Concord on financing alternatives for the project.

 

As of March 31, 2008, we have funded a total of $3.3 million of our equity contribution and Golden Concord has funded an additional approximately $3.1 million of its equity contribution. We are also required to fund an additional approximately $13.0 million, representing the remainder of our equity contribution, no later than September 3, 2009. The parties’ preliminary estimate of the total required capital of the GC Joint Venture is approximately $110.0 -$130.0 million, including the approximately $32.3 million in cash to be contributed by us and Golden Concord.

 

The remaining capital is expected to be provided by project debt to be obtained by the GC Joint Venture. We and Golden Concord have each agreed to guarantee any such project debt incurred by the GC Joint Venture, with our requirement being to guarantee no less than 55% and no more than 60% of its debt, based on the percentage of the debt which relates to the gasification processes of the plant, and Golden Concord is required to guarantee the remainder. If either we or Golden Concord is unable to perform its guarantee obligations, the other party shall be required to use its best efforts to provide such guarantee and shall be entitled to a guarantee fee of 5.5% of the amount of the guarantee from the other party. If the other party is unable to provide such guarantee, it shall be deemed a material breach of the contract by the party that was originally unable to provide the guarantee and the ownership interests of such party shall be subject to the call rights described below.

 

We and Golden Concord are in the process of assisting the GC Joint Venture in obtaining approval of its feasibility study and environmental impact assessment, the issuance of its business license and any other consents or approvals which will be required to construct the plant. Golden Concord is also assisting the GC Joint Venture in negotiating the construction contract for the plant. Once operational, the plant will supply methanol to the merchant market, and may enter into long term offtake agreements. The GC Joint Venture will also sell the byproducts of the plant in either the open market or pursuant to long term offtake

agreements to be negotiated. Upon the completion of the construction of Golden Concord’s coal mine in Baoyanbaolige, Inner Mongolia Autonomous Region, China, the GC Joint Venture will be required to purchase its coal requirements from Golden Concord unless the price for such coal is greater than the price from suitable alternatives that can be purchased by the GC Joint Venture in the open market.

 

The GC Joint Venture will be governed by a board of directors consisting of eight directors, four of whom will be appointed by us and four of whom will be appointed by Golden Concord. The right to appoint directors can be reduced or increased if the ownership interests of either party changes by 12.5%. The GC Joint Venture will also have officers that are appointed by us, Golden Concord and/or the board of directors pursuant to the terms of the GC Joint Venture contract. We and Golden Concord shall share the profits, and bear the risks and losses, of the GC Joint Venture in proportion to their respective ownership interests. The contract has a term of 30 years, subject to earlier termination if either us or Golden Concord files for bankruptcy or otherwise becomes insolvent.

 

We and Golden Concord have agreed to certain rights of first refusal and call rights with respect to their ownership interests in the GC Joint Venture. If either party desires to transfer all or any portion of its interest in the GC Joint Venture, other than to an affiliate, the other party shall have a right of first refusal to acquire such interest. In addition, Golden Concord has an option, in its sole discretion and for 30 months from the date that plant begins commercial operation, to acquire two percent (2%) of the registered capital of the GC Joint Venture from us. Each of us and Golden Concord also has an option to acquire all (but not a part of) the interest of the other party in the registered capital of the GC Joint Venture in the event of a material breach of the contract by such party which is not resolved pursuant to the terms of the contract.

 

We and Golden Concord have also agreed to certain penalties if certain milestones for the GC Joint Venture are not achieved. Golden Concord would be required to transfer a portion of its registered capital in the GC Joint Venture to us if certain water and power interconnections are not connected within a period of time after the start-up of the plant. The amount to be transferred is based on the percentage ownership interest held, costs incurred and capital invested. We would be required to pay liquidated damages to the GC Joint Venture if the gas capacity for the plant is not within a certain percentage of the target capacity for the plant. If the problem cannot be remedied pursuant to the requirements of the contract, we would have to transfer a portion of its registered capital in the GC Joint Venture to Golden Concord based on their percentage ownership interest held, costs incurred and capital invested.

 

YIMA

 

We have also entered into a non-binding preliminary co-operative agreement with YIMA Coal Industry Group Co. Ltd., a company owned by the Chinese government. Phase one of the project deals with the construction of an approximately $250-$350 million integrated coal-to-methanol (ultimately into DME) plant in Henan Province, China. In March 2008, we established a joint project office responsible for developing the plant. When phase one is completed, the plant is expected to have an hourly capacity of approximately 180,000 standard cubic meters of gross syngas and an annual capacity of 500,000 tonnes of methanol. The estimated total cost represents the estimated capital expenditures for both the gasification and methanol portions of the plant. We are currently negotiating various documents related to this project, including operations and management agreements for the plant, coal purchase agreements, offtake

agreements and other related agreements. We are waiting for final government approvals before this project commences.

 

CONSOL

 

We are party to an agreement with CONSOL Energy Inc., the largest producer of bituminous coal in the United States, or CONSOL, to investigate the development of coal-based gasification facilities to replace domestic production of various industrial chemicals that has been shut down due to the high cost of natural gas. CONSOL produces over 20 million tons per year of coal preparation plant tailings that could be used to make valuable liquid and gas products instead of land-filling the coal trapped in this material as waste. In April 2008, we completed the feasibility and initial engineering studies analyzing potential projects in Ohio, Pennsylvania and West Virginia that would use our U-GAS^® technology to convert coal from CONSOL’s eastern coal mining complexes into higher value products including methanol, synthetic gasoline, ammonia and SNG. We have also secured an option for a project site located near one of CONSOL’s West Virginia mines and we are currently working on the front-end engineering design package and negotiating the terms of a joint venture agreement. This particular project is expected to have an annual capacity of 500,000 tonnes of methanol, although we may consider increasing the size of the project.

 

 

AEI

 

We are party to a joint development agreement with AEI, pursuant to which we will seek to identify and jointly develop, finance and operate various projects involving the conversion of coal, or coal and biomass mixtures, into syngas using the U-GAS^® technology (or other alternative technology). The agreement will be for all projects in emerging markets, which includes markets other than in North America, certain countries in the European Union, Japan, Australia and New Zealand. Our current projects with Hai Hua, Golden Concord and, if approved, YIMA, and any future expansion of such projects, are specifically excluded from the agreement. In addition, we may continue to independently pursue equipment sales and licensing opportunities with customers who will use syngas predominately for their own internal consumption.

 

The types of projects subject to the agreement include:

 

 

We and AEI shall seek to identify these types of projects and will then provide an exclusive offer to the other party to co-develop such projects. Both parties have the right, but not the obligation, to invest in up to 50% of the required equity in any project utilizing the U-GAS^® technology originated by the other party. For any project that does not utilize the U-GAS^® technology, the investment percentage to be offered to the non-originating party ranges from 0% to 35% depending on the type of project. As to any project, either party has the option to withdraw from development of the project at any time prior to a decision to proceed with the project by the board of directors by the applicable project joint venture company. Such decision

may be evidenced by, among other things, funding the equity to develop a project, issuing notice to proceed under a construction contract, executing and performing under any other project contracts or executing and delivering any documents related to the financing of any project.

 

The “lead developer” will be agreed to by the parties on a case-by-case basis for each project and in that capacity will be responsible for, among other things, obtaining government approvals, negotiating construction contracts and other agreements and acquiring any necessary financing or real estate to develop the project. For each project, we will provide engineering support, equipment and training, all at 110% of the direct cost of such support. We will make the U-GAS^® technology available for all projects in the markets listed above, even if we are not invested in the project. To facilitate this, and as agreed to by GTI, the joint venture or AEI, as applicable, will be granted a license to use the U-GAS^® technology for each project. We will receive a one-time installation fee of $10 per Thermal MegaWatt/hr of dry syngas production for each project that utilizes the U-GAS^® technology. For projects that we co-develop with AEI, the royalty rate shall be negotiated at the time of the development of such project, but the royalty shall not exceed $0.50 per MMBtu.

 

We will form project company joint ventures with AEI for each project that we co-develop. The required capital investments of the parties will be determined based on the percentage ownership in that joint venture. The joint ventures will be managed by a board of directors, with representation split between AEI and us based on the percentage ownership in that joint venture, and will include standard supermajority voting ownership for material decisions. The joint ventures will also have officers that are appointed by AEI and us, with the general manager and chief financial officer being appointed by AEI and the deputy general manager and operations manager being appointed by us.

 

The agreement with AEI has a term of five years, subject to the rights of either party to terminate upon a default, subject to applicable cure periods. Although we are required to continue to provide the support services for any continuing projects, such obligation will cease on the second anniversary of the termination of the agreement. We have the right to terminate the agreement if AEI has not identified and presented, in accordance with defined procedures, at least four prospective projects (as such term is defined in the agreement), within the first twelve months, to the project committee, comprised of two representatives from each party.

 

China National Chemical Engineering Company

 

We recently entered into an agreement with China National Chemical Engineering Company, or CNCEC, under which CNCEC will provide project support in China and other areas where CNCEC does business. CNCEC is China’s leading and largest chemical engineering group, operating six chemical engineering companies and thirteen construction companies and employing over 60,000 employees. CNCEC is China’s leader in both coal gasification and methanol plant construction with knowledge, and experience in, designing such plants in china and in other countries. We believe that CNCEC will have the ability to recommend U-GAS^® technology in projects where it has been engaged by others.

 

Multinational chemical company

 

We are party to a project development agreement with a major multinational chemical company to perform feasibility studies and devise plans for the potential development of a coal-

to-methanol gasification plant in China. The plant would support the chemical company’s facilities in China, and address the region’s increased demand for clean petrochemical feedstocks. The planned plant will use the U-GAS^® technology to convert coal reserves into syngas and to further refine the syngas into methanol. The capacity of this plant is intended to be similar in size to our Golden Concord project. The agreement covers a number of project development phases. During phase one, we will conduct feasibility studies to identify the optimum site for the construction of the proposed plant in order to ensure adequate coal supply, coal and methanol transport costs and the permitting process. Subject to a successful plant-site designation, we will conduct additional scoping work that will include further definition of project design, schedules and costs. The agreement requires the successful completion of these project development phases, at which point further negotiation of a definitive agreement by both parties would be undertaken before initiating any projects. Either we or the chemical company may terminate the agreement prior to the completion of the feasibility and other studies related to the proposed plant.

 

 

In the world gasification market, the largest providers are General Electric, Shell, Siemens and ConocoPhillips. These companies utilize entrained flow gasification based technologies originally derived from liquid fuels processing (i.e. refining). These technologies require the use of high grade bituminous or sub-bituminous coals as feedstocks which result in a higher cost of operation. The Siemens technology (recently acquired from Future Energy), while still an entrained flow design, has the potential to operate on low rank coals. However, to date, the Siemens technology has not been commercially deployed. There are also several Chinese companies that use low pressure, fixed bed technologies, which utilize high cost coals and are relatively immature, with low capital costs being their primary basis for competition. Additionally, several companies are developing other gasification technologies which are still in the research and development phase.

 

 

We believe that we have developed an internal capability that allows for the cost effective and timely sourcing of equipment for our current projects in China. China has rapidly expanded its industrial manufacturing and construction capabilities which has reduced the cost and build time of traditional sources of supply. We have been successful in locating and contracting with a number of key suppliers of major equipment and services. We also intend to utilize Chinese sourced major equipment in projects located in the United States and elsewhere.

 

 

During the fiscal years ended June 30, 2007 and 2006, we expensed $304,086 and $373,282, respectively, for research and development primarily related to the development and fuel testing of coal. During the fiscal years ended June 30, 2007 and 2006, we expensed $198,040 and $158,406, respectively, on engineering salaries. We plan to continue increasing internal research and development with a goal of offering our customers the best and most efficient clean coal solutions.

 

Our operations are subject to stringent federal, state and local laws and regulations governing the discharge of materials into the environment or otherwise relating to environmental protection. Numerous governmental agencies, such as the U.S. Environmental Protection Agency and various Chinese authorities, issue regulations to implement and enforce such laws, which often require difficult and costly compliance measures that carry substantial administrative, civil and criminal penalties or may result in injunctive relief for failure to comply. These laws and regulations may require the acquisition of a permit before operations at a facility commence, restrict the types, quantities and concentrations of various substances that can be released into the environment in connection with such activities, limit or prohibit construction activities on certain lands lying within wilderness, wetlands, ecologically sensitive and other protected areas, and impose substantial liabilities for pollution resulting from our operations. We believe that we are in substantial compliance with current applicable environmental laws and regulations and we have not experienced any material adverse effect from compliance with these environmental requirements.

 

In China, the development and construction of gasification facilities is highly regulated. In the development stage of a project, the key government approvals relate to the project’s environmental impact assessment report, feasibility study (also known as the project application report) and, in the case of a Sino-foreign joint venture, approval of the joint venture company’s joint venture contract and articles of association. Approvals in China are required at the municipal, provincial and/or central government levels depending on the total investment in the project and subject to industry specified criteria. For example, the Chinese government has recently promulgated new project approval requirements for infra-structure projects related to coal-to-methanol plants. China’s NDRC, or its provincial or municipal counterparts, must approve new projects based on a minimum production requirement of 1,000,000 tonnes or greater capacity per year for coal-to-methanol plants.

 

Although we do not believe that this would invalidate any of our existing permits, our future joint ventures in China relating to coal-to-methanol plants will have to abide by these guidelines.

 

Although we have been successful in obtaining the permits that are required at a given stage with respect to the HH Joint Venture and the GC Joint Venture, any retroactive change in policy guidelines or regulations or an opinion that the approvals that have been obtained are inadequate, either at the federal or state level in the United States, or the municipal, provincial or central government levels in China, could require us to obtain additional or new permits or spend considerable resources on complying with such regulations. Other developments, such as the enactment of more stringent environmental requirements, changes in enforcement policies or discovery of previously unknown conditions, could require us to incur significant capital expenditures.

 

 

As of June 5, 2008, we had 206 employees. None of our employees are represented by any collective bargaining unit. We have not experienced any work stoppages, work slowdowns or other labor unrest. We believe that our relations with our employees are good.

 

 

As of June 5, 2008, we had no pending legal proceedings.

 

Our corporate office occupies approximately 10,000 square feet of leased office space in Houston, Texas. We also lease approximately 5,000 square feet of office space in Shanghai, China and we also lease a small office in Beijing, China. Over time, additional facilities may be required as we add personnel to advance our commercial and technical efforts.

 

The following table presents selected consolidated financial data as of the dates and for the periods indicated. The selected consolidated balance sheet data as of June 30, 2007 and June 30, 2006 and the selected consolidated statement of operations data and other financial data for the period from November 4, 2003 (inception) through June 30, 2007 and for each of the years in the two year period ended June 30, 2007 have been derived from our audited consolidated financial statements included elsewhere in this prospectus. The selected consolidated historical financial information as of and for the nine months ended March 31, 2008 has been derived from the unaudited condensed consolidated financial statements included elsewhere in this prospectus. The unaudited condensed consolidated financial statements include all adjustments which we consider necessary for a fair presentation of our financial position, results of operations and cash flows for the interim periods presented. Results for the nine months ended March 31, 2008 are not necessarily indicative of the results that may be expected for the full year. You should read the following table in conjunction with “Use of proceeds” and “Management’s discussion and analysis of financial condition and results of operations” and the consolidated financial statements and the accompanying notes included elsewhere in this prospectus. Among other things, those financial statements include more detained information regarding the basis of presentation for the following consolidated financial data.

 

 

 

 

 

 

We build, own and operate coal gasification plants that utilize our proprietary U-GAS^® fluidized bed gasification technology to convert low rank coal and coal wastes into higher value energy products, such as transportation fuels and ammonia. We believe that we have several advantages over commercially available competing technologies, such as entrained flow and fixed bed, 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, which provide greater fuel flexibility, and our ability to operate efficiently on a smaller scale, which enables us to construct plants more quickly, at a lower capital cost and in many cases closer proximity to coal sources.

 

Our principal business activities are currently focused in China and the United States, areas which are estimated by the U.S. Department of Energy to represent a combined 40% of total global coal reserves. Our first commercial scale coal gasification plant is located in Shandong Province, China and has been in operation since January 2008. We have a second plant under construction in the Inner Mongolia Autonomous Region of China and have plants under development in Henan Province, China and in West Virginia.

 

The target size of our plants is 100 MW (equivalent) to 400 MW (equivalent) costing from approximately $100 million to several hundred million dollars to build. Our gasification plants can produce synthesis gas, or syngas, a mixture of hydrogen, carbon monoxide and other products. Depending on local market need and fuel sources, syngas can in turn be used to produce methanol, DME, SNG, ammonia, synthetic gasoline, steam, power and other byproducts (e.g., sulfur, carbon dioxide or ash).

 

Our business strategy includes the following elements:

 

 

 

 

We are in our development stage and therefore have had limited operations. We generated our first revenues of $39,879 during the three months ended March 31, 2008. We have sustained net losses of $34.2 million from November 4, 2003, the date of our inception, to March 31, 2008. We have primarily financed our operations to date through private placements and a public offering of our common stock. As discussed in “Liquidity and capital resources” below, we will need to raise additional capital through equity and debt financing for any new projects that we develop and to support possible expansion of our existing operations. In particular, we may attempt to secure non-recourse debt financing in order to construct additional plants. Such financing may be used on a project basis to reduce the amount of equity capital required to complete the project.

 

Nine months ended March 31, 2007 compared to nine months ended March 31, 2008

 

Revenue and cost of goods sold

 

We had no revenue in the nine months ended March 31, 2007 compared to $39,879 in the nine months ended March 31, 2008. Revenue in the nine months ended March 31, 2008 was predominately from the sale of syngas produced at the HH Joint Venture plant in China.

 

There were no cost of goods sold for the nine months ended March 31, 2007 compared to $376,033 for the nine months ended March 31, 2008. The $376,033 in cost of goods sold primarily includes materials, direct labor costs and plant depreciation expense.

 

General and administrative expenses

 

General and administrative expenses increased 194.7% from $3.0 million for the nine months ended March 31, 2007 to $8.8 million for the nine months ended March 31, 2008. The increase of $5.8 million was primarily due to an increase in salaries and incentive wages as a result of increased staffing levels, and to a lesser extent, an increase in travel expenses associated with activities in China, investor relations expenses, outside consulting and accounting fees incurred in connection with Sarbanes-Oxley Act compliance requirements and legal fees.

 

Stock-based compensation expenses

 

Stock-based compensation decreased 23.9% from $5.1 million for the nine months ended March 31, 2007 to $3.9 million for the nine months ended March 31, 2008. The decrease was

due to the full vesting of options granted to certain members of senior management in prior periods.

 

Project and technical development expenses

 

Project and technical development expenses increased 178.9% from $1.0 million for the nine months ended March 31, 2007 to $2.9 million for the nine months ended March 31, 2008. The increase was primarily due to increased expenditures related to our projects with CONSOL, Hai Hua and Golden Concord and expenses associated with the GTI facility reservation and use fee for calendar year 2008.

 

Interest income

 

Interest income decreased from $0.4 million for the nine months ended March 31, 2007 to $0.2 million for the nine months ended March 31, 2008. The decrease was primarily due to lower effective interest rates.

 

Interest expense

 

There was no interest expense recorded in the nine months ended March 31, 2007 compared to $0.1 million recorded in the nine months ended March 31, 2008. Prior to the Hai Hua plant being placed into service, interest expense related to the HH Joint Venture’s outstanding loan with the Industrial and Commercial Bank of China, or ICBC, was capitalized. The Hai Hua plant was commissioned in January 2008. Interest on the ICBC loan has been expensed from that point forward.

 

Net loss

 

Net loss for the nine months ended March 31, 2007 was $8.7 million, or $0.32 per share compared to a net loss of $15.5 million, or $0.46 per share, for the nine months ended March 31, 2008.

 

 

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 a public offering in November 2007. In calendar year 2005, we issued 2,000,000 shares of common stock in a private placement for net proceeds of $4.9 million. In August 2006, we issued 3,345,715 shares of common stock in a private placement for net proceeds of $16.2 million. In addition, in November 2007, we received net proceeds of $49.2 million from a public offering of 5,951,406 shares of our common stock at a price to the public of $9.00 per share. We have used the proceeds of these offerings for the development of our joint ventures in China and to pay other development expenses and general and administrative expenses. In addition, we have entered into a loan agreement to fund certain of the expenses of the HH Joint Venture. The following summarizes the uses of equity capital and debt as of March 31, 2008 with respect to our projects.

 

Hai Hua joint venture

 

Our first project is the HH Joint Venture, through which we and Hai Hua developed, constructed and are now operating a syngas production plant utilizing U-GAS^® technology in Zaozhuang

City, Shandong Province, China designed to produce approximately 28,000 standard cubic meters per hour of gross syngas. The plant produces and sells syngas and the various by-products of the plant, including ash, elemental sulphur, hydrogen and argon. Hai Hua, an independent producer of coke and coke oven gas, owns a subsidiary engaged in methanol production. In exchange for their respective ownership shares in the HH Joint Venture, SES Investments contributed $9.1 million in equity capital, and Hai Hua contributed $480,000 in equity capital.

 

On March 22, 2007, the HH 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 the ICBC to complete the project financing for the HH Joint Venture. Key terms of the Fixed Asset Loan Contract with ICBC are as follows:

 

 

Additionally, in March and October 2007, the HH Joint Venture entered into loan agreements with SES Investments. As of March 31, 2008, $12.4 million was outstanding related to these loans. The SES loans bear interest per annum at a rate of 6% and are due and payable on March 20, 2016 and October 18, 2016 and March 3, 2017, respectively. In addition, the SES loans are unsecured and are subordinated to the above described ICBC loan, and any other subsequent ICBC loans. The HH Joint Venture may not prepay the SES loans until the ICBC loan is either paid in full or is fully replaced by another loan. Proceeds of the SES loans may only be used for the purpose of developing, constructing, owning, operating and managing the Hai Hua plant.

 

As of March 31, 2008, the HH Joint Venture had spent all of the remaining restricted cash from the proceeds of the ICBC loan on construction and equipment costs of the plant.

 

Construction of the plant has been completed and, as of March 31, 2008, we have capitalized a total of $36.3 million to property, plant and equipment. The increase in cost from our previous estimate of $29.0 million was primarily due to (i) several design improvements, (ii) changes in exchange rates between the U.S. dollar and the Chinese Renminbi Yuan, (iii) increases in material costs and (iv) equipment redundancies built in our plant processes. The plant produced its first syngas in December 2007 and initial syngas sales commenced in February 2008.

Golden Concord joint venture

 

The GC Joint Venture was established for the primary purposes of (i) developing, constructing and operating a coal gasification, methanol and DME production plant utilizing U-GAS^® technology in the Xilinguole Economic and Technology Development Zone, Inner Mongolia Autonomous Region, China and (ii) producing and selling methanol, DME and the various byproducts of the plant, including fly ash, steam, sulphur, hydrogen, xenon and argon. In exchange for their respective ownership shares in the GC Joint Venture, SES Investments agreed to contribute $16.3 million in cash, and Golden Concord agreed to contribute $16.0 million in cash.

 

The current estimate of total required capital of the GC Joint Venture is approximately $110.0 to $130.0 million, including the $32.0 million in cash to be contributed by SES Investments and Golden Concord. The remaining capital is expected to be provided by project debt to be obtained by the GC Joint Venture. SES Investments and Golden Concord have each agreed to guarantee any such project debt incurred by the GC Joint Venture, with SES Investments required to guarantee no less than 55% and no more than 60% of its debt, based on the percentage of the debt which relates to the gasification processes of the plant, and Golden Concord is required to guarantee the remainder. Each party is subject to penalties under the GC Joint Venture contract if they are unable to perform their guarantee obligations. We are continuing to work with Golden Concord on financing alternatives for the project.

 

As of March 31, 2008, we have funded a total of $3.3 million of our equity contribution and Golden Concord has funded an additional $3.1 million of their equity contribution. We are also required to fund $13.0 million, representing the remainder of our equity contribution, no later than September 3, 2009.

 

CONSOL Energy joint venture

 

In September 2007, we entered into a joint development agreement with CONSOL to investigate the development of coal-based gasification facilities to produce liquid fuel, chemical feedstocks and/or substitute natural gas. Under the agreement, we and CONSOL agreed to perform engineering, environmental and marketing activities to analyze the feasibility of projects that would use coal gasification technology to convert coal from CONSOL’s eastern coal mining complexes into products including methanol, mixed alcohols, ammonia, SNG and synthetic gasoline. In April 2008, we completed the feasibility and initial engineering studies analyzing potential projects in Ohio, Pennsylvania and West Virginia that would use our U-GAS^® technology to convert coal from preparation plant tailings provided by CONSOL’s eastern coal mining complexes into higher value products including methanol, synthetic gasoline, ammonia and SNG. We have also secured an option for a project site located near one of CONSOL’s West Virginia mines and we are currently working on the front-end engineering design, or FEED, study and negotiating the terms of a joint venture agreement. This particular project is expected to have an annual capacity of 500,000 tonnes of methanol, although we may consider increasing the size of the project. As of March 31, 2008 we had incurred $1.3 million in project and development expenditures to analyze these projects, representing a majority of the expenditures envisioned in our original agreement with CONSOL. We believe that our portion of the FEED study will be approximately $10.0 million, and that most of the FEED study will be complete by March 31, 2009.

Outlook

 

As of March 31, 2008, we had $39.1 million of cash and cash equivalents. We expect to continue to have operating losses until our Hai Hua plant and other projects under development produce significant revenues. We plan to use the net proceeds of this offering for equity contributions to our Golden Concord project, and, if approved, our YIMA project, the proposed expansion of our Hai Hua project, when and if agreed to, feasibility and engineering design work for our CONSOL project and any future North American projects, and working capital and general corporate purposes. Other than our required capital contributions to our Golden Concord project, and if approved, our YIMA project, we are not currently able to estimate the approximate amount of the net proceeds that will be used for the other purposes noted above. The actual allocation of the net proceeds for these purposes and the timing of the 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, including potential acquisitions of existing plants, facilities or mines. Depending on the expenditures required for the proposed expansion of our Hai Hua project, when and if agreed to, feasibility and engineering design work for our North American projects and any of the above factors, our expenditures could exceed the net proceeds of this offering.

 

We may need to raise additional capital in calendar year 2008 through equity and debt financing for any new projects that are developed, to support possible additional expansion of our existing operations and for our general and administrative expenses from our existing operations. As noted above, we are also continuing to work with Golden Concord on financing alternatives for that project. We may also need to raise additional funds sooner than expected in order to fund more rapid expansion, cover unexpected construction costs or delays, respond to competitive pressures or acquire complementary energy related products, services, businesses and/or technologies. In addition, we may attempt to secure project financing in order to construct additional plant facilities. Such financing may be used to reduce the amount of equity capital required to complete the project.

 

We cannot assure you that any financing will be available to us in the future on acceptable terms or at all. If we cannot raise required funds on acceptable terms, we may not be able to, among other things, (i) maintain our general and administrative expenses at current levels; (ii) negotiate and enter into new gasification plant development contracts; (iii) expand our operations; (iv) hire and train new employees; or (v) respond to competitive pressures or unanticipated capital requirements.

 

 

On January 14, 2008, we entered into a 63 month lease agreement, with a 60 month optional renewal, for our new corporate offices in Houston, Texas. The lease commenced on March 27, 2008 with rental payments of $20,308 per month for the first year and escalating thereafter annually.

 

Our obligations under the lease are secured by a letter of credit for $328,900, which is payable to the landlord in the event of any uncured default by us under the lease. The letter of credit remains in place until the third anniversary of the lease, but is reduced to $219,266 after the second anniversary of the lease.

 

Our material contractual obligations at March 31, 2008 were as follows:

 

 

 

In September 2006, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards, or SFAS, No. 157, “Fair Value Measurements,” or SFAS 157, which established a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. We are required to adopt the provisions of SFAS 157, as applicable, as of July 1, 2008. We are currently evaluating this standard but have not yet determined the impact, if any, that the adoption of SFAS 157 will have on our financial statements.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115,” or SFAS 159. SFAS 159 permits entities to measure eligible assets and liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007. We are currently evaluating this standard but have not yet determined the impact, if any, that the adoption of SFAS 159 will have on our financial statements.

 

In December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements—an amendment to ARB No. 51,” or SFAS 160. SFAS 160 requires non-controlling interests (previously referred to as minority interests) to be reported as a component of equity, which changes the accounting for transactions with non-controlling interest holders. SFAS 160 is effective for periods beginning on or after December 15, 2008 and earlier adoption is prohibited and will be applied prospectively to all non-controlling interests, including any that arose before the effective date. We are currently evaluating this standard but have not yet determined the impact, if any, that the adoption of SFAS 160 will have on our financial statements.

 

 

We are exposed to certain market risks as part of our ongoing business operations, including risks from changes in foreign currency exchange rates and commodity prices that could impact our financial position, results of operations and cash flows. We manage our exposure to these risks through regular operating and financing activities, and may, in the future, use derivative financial instruments to manage this risk. As of the date of this report, we have not conducted

any sensitivity analysis with respect to how these risks could affect our financial statements. We have not entered into any derivative contracts to date.

 

Foreign currency risk

 

We conduct operations in China and the functional currency in China is the Renminbi Yuan. Our financial statements are expressed in U.S. dollars and will be negatively affected if foreign currencies, such as Renminbi Yuan, depreciate relative to the U.S. dollar. In addition, our currency exchange losses may be magnified by exchange control regulations in China or other countries that restrict our ability to convert into U.S. dollars.

 

Commodity price risk

 

Our strategy is to sell commodities, such as methanol. We do not expect to enter into long-term contracts with customers for all of our projected production, which would reduce our exposure to changes in commodity prices. We may mitigate some of our exposure by entering into fixed price contracts. However, fixed price contracts will not be available to us in certain markets, such as China. We would then have to sell some portion of our production into spot commodity markets or under short term supply agreements, where we will be exposed to fluctuations in the commodity prices. Hedging transactions may be available to reduce our exposure to these fluctuations, but such availability may be limited and we may not be able to successfully hedge this exposure at all.

 

The following table sets forth information concerning our directors, executive officers and key employees as of June 5, 2008:

 

 

Timothy Vail. Mr. Vail is our President and Chief Executive Officer and is also a Director. Mr. Vail joined us as a Director in September 2005, and accepted the President and Chief Executive Officer position in May 2006. Prior to joining us, beginning in 2002, Mr. Vail served as the Director of Commercialization for Fuel Cell Development for General Motors Corporation. At GM, Mr. Vail’s duties included the development of GM’s Shanghai fuel cell office as well as coordination of engineering facilities in the United States, Germany, Japan and China. Prior to his position at GM, Mr. Vail was the Vice President of product development for The New Power Company, a start-up subsidiary of Enron Corporation, where he was responsible for the development of new products and services to be delivered to New Power’s customer bases. From 1995 until starting work for The New Power Company, Mr. Vail was a Vice President at Enron Energy Services. Mr. Vail was also a securities lawyer with Andrews Kurth, LLP from 1990 to 1993. Mr. Vail holds a J.D. from the University of Houston Law Center and a B.A. in Economics from The University of Texas at Austin.

 

David Eichinger. Mr. Eichinger has served as our Chief Financial Officer and Senior Vice President of Corporate Development since May 2006. Prior to joining us as an executive officer, Mr. Eichinger was a consultant to us since November 2005, in which capacity he advised us on technology license negotiations and global expansion beyond the Chinese market. From 1991 to 1996, Mr. Eichinger spent five years in the Corporate Treasury section as an analyst in Corporate Finance and Tax at Exxon Corporation and Exxon Chemicals. From 1996 to 2000, Mr. Eichinger led merger and acquisition teams for Enron Corporation in the deregulation wholesale and retail markets in North and South America. In addition, Mr. Eichinger led the spin off of The New Power Company and served as an executive officer in charge of corporate development. From 2003 to mid-2005, Mr. Eichinger ran the fuel cell distributed generation group at General Motors. Mr. Eichinger has also advised a number of energy related firms including CAM Energy, a New York based hedge fund, and General Hydrogen. Mr. Eichinger holds both a B.S. and an M.S. in Chemistry from The College of William and Mary, and an M.B.A. from Carnegie Mellon.

 

Donald Bunnell. Mr. Bunnell is our President and Chief Executive Officer—Asia Pacific, a Director and a co-founder of our company. From 2001 until our founding in 2003, Mr. Bunnell was the Asia Business Development Vice President for BHP Billiton’s aluminum group. Between 1997 and

2001, Mr. Bunnell served in various capacities, including Vice President in charge of Enron China’s power group, and Country Manager, with the power development team of Enron Corporation. During this time, Mr. Bunnell spent three years leading the Enron/Messer/Texaco consortium for the Nanjing BASF Project. From 1995 to 1997, Mr. Bunnell was a manager with Coastal Power Corporation (now part of El Paso Corporation) in Beijing, where he was involved in development of gas turbine power plants and other power projects. Mr. Bunnell is an attorney licensed to practice in the United States and has practiced law in Hong Kong, advising clients on China investments, prior to entering the power business. Mr. Bunnell is fluent in Mandarin Chinese, has lived in China for over 11 years, and has 10 years of experience in the China power industry developing projects and managing joint ventures. Mr. Bunnell graduated from Miami University with a B.A. and from the William & Mary School of Law with a J.D.

 

Robert Rigdon. Mr. Rigdon has served as our Senior Vice President of Global Development since May 2008 and is responsible for overseeing all aspects of our current and future coal gasification projects worldwide. From June 2004 until joining us, Mr. Rigdon worked for GE Energy in a variety of capacities, including Manager—Gasification Engineering, Director—IGCC Commercialization, and Director—Gasification Industrials and Chemicals Business. For the 20 years previous to this, Mr. Rigdon worked for Texaco, and later ChevronTexaco, as an engineer and in the Worldwide Power & Gasification group, where he ultimately became Vice President—Gasification Technology for the group. Mr. Rigdon is a mechanical engineer with a B.S. from Lamar University.

 

Lorenzo Lamadrid. Mr. Lamadrid has been our Chairman since April 2005. Since 2001, Mr. Lamadrid has been the Managing Director of Globe Development Group, LLC, a firm that specializes in the development of large scale energy, power generation, transportation and infrastructure projects in China and provides business advisory services and investments with a particular focus on China. Mr. Lamadrid has also been a Director of Flow International Corporation since January 2006. Mr. Lamadrid has been a member of the International Advisory Board of Sirocco Aerospace, an international aircraft manufacturer and marketer, since mid-2001. He previously served as President and Chief Executive Officer of Arthur D. Little, a management and consulting company, from 1999 to 2001, as President of Western Resources International, Inc. from 1996 through 1999 and as Managing Director of The Wing Group from 1993 through 1999. The Wing Group was a leading international electric power project-development company that was sold to Western Resources in 1999. Prior to that, he was with General Electric from 1984 to 1993 serving as corporate officer, Vice President and General Manager at GE Aerospace for Marketing and International Operations, and as General Manager of Strategic Planning and Business Development or GE’s International Sector. Prior to joining GE, Mr. Lamadrid was a senior Manager at the Boston Consulting Group where he worked from 1975 to 1984. Mr. Lamadrid holds a dual bachelor’s degree in Chemical Engineering and Administrative Sciences from Yale University, an M.S. in Chemical Engineering from the Massachusetts Institute of Technology and an M.B.A. in Marketing and International Business from the Harvard Business School.

 

Michael Storey. Mr. Storey has served as one of our directors since November 2005. From June 2002 through November 2005, he was a partner with Union Charter Financial. From 2000 to 2004, he has served as President and CEO of Inmarsat Ventures, a global communications company. He resigned in March 2004, but continued as an advisor until March 2006. From 1993 to 1999, Mr. Storey ran several telecommunications businesses during European deregulation that became MCI Europe and is now Verizon Communications. In 1984, Mr. Storey and a partner established City Centre Communications, a business in the cable television and telecommunications industry. The business was grown through several acquisitions of franchises before the

business was sold in 1992 to Videotron and Bell Canada. He served as a Director and later as Chairman of the Cable Communications Association from 1983 to 1990, representing all the investors in the U.K. cable industry. Starting in 1972, Mr. Storey served for 10 years as a Vice President and Partner of Booze Allen Hamilton International Management Consultants. He is also currently the non-executive Chairman of Impello Plc, an independent utility company in the United Kingdom. Mr. Storey is a graduate of King’s Fund Administrative Staff College and has an M.B.A. from the University of Chicago. From 1958 to 1968, he worked in the healthcare industry, operating hospitals in the U.K., Middle East and North America. He also holds two professional certifications: Professionally Qualified Hospital Administrator and Professionally Qualified Personnel Manager.

 

Denis Slavich. Mr. Slavich has served as a director since November 2005 and currently serves as the Chairman of our Audit Committee. Mr. Slavich has over 35 years of experience in large scale power generation development. He is currently an international consultant to a number of U.S. and China-based companies engaged in cross border transactions, as well as an advisor and board member for a number of additional firms. From 1998 to 2000 Mr. Slavich was the CFO and director of KMR Power Corporation and was responsible for the development of an international IPP company that developed projects in Columbia as well as other areas. From 2000 until 2002, he served as Vice President and CFO of BigMachines Inc., a software company, and from 2001 until the present, he has served as Chairman of Leading Edge Technologies, a desalination technology company, and has recently served as its CEO. Mr. Slavich also served as acting President for Kellogg Development Corporation, a division of M.W. Kellogg, during 1997. From 1991 to 1995, Mr. Slavich was also a Vice President of Marketing for Flour Daniel. From 1971 to 1991, Mr. Slavich served in various executive positions at Bechtel Corporation including Sr. VP, CFO, and director and Sr. VP and manager of the International Power Division. Mr. Slavich received his Ph.D. from Massachusetts Institute of Technology, his M.B.A. from the University of Pittsburgh and his B.S. in Electrical Engineering from the University of California at Berkeley.

 

Harry Rubin. Mr. Rubin has been a Director since August 2006. Mr. Rubin is currently Chairman of Henmead Enterprises, in which capacity he advises various companies regarding strategy, acquisitions and divestitures. He currently serves as a Director of Image-Metrics Plc, and has held board positions at a number of private and public companies such as the A&E Network, RCA/Columbia Pictures Home Video and the Genisco Technology Corporation. He was a founding partner of the Boston Beer Company. In the 12 years prior to 2006, Mr. Rubin held various senior management roles in the computer software industry, including Senior Executive Vice President and Chief Operating Officer of Atari, and President of International Operations and Chief Financial Officer for GT Interactive Software. Mr. Rubin entered the computer software business in 1993 when he became Executive VP for GT Interactive Software as a start-up company, and played a leadership role in GT’s progression as the company went public in 1995 and became one of the largest industry players. Prior to 1993, he held various senior financial and general management positions at RCA, GE and NBC. He is a graduate of Stanford University and Harvard Business School.

 

 

Our Board of Directors, or the Board, has six directors and has established the Audit, Compensation, and Nominating and Governance Committees as its standing committees. The Board does not have an executive committee or any committees performing a similar function. Our common stock is currently listed on The NASDAQ Capital Market which requires that a majority of the board of directors be independent. The Board has determined that all members of the Board, other than Timothy Vail, our President and Chief Executive Officer, and Donald Bunnell, our President and Chief Executive Officer—Asia Pacific, are “independent” under the definition set forth in the listing standards of The NASDAQ Capital Market. In addition, the Board has determined that all members of its Audit Committee, in addition to meeting the above standards, also meet the criteria for independence for audit committee members which are set out in the Exchange Act. The Board considered Mr. Storey’s previous relationship with Union Charter Financial, one of our 5% or greater stockholders, when determining his independence, but determined that it did not disqualify him as an independent director on the Board.

 

 

No current member of the Compensation Committee of the Board is or formerly was an officer or employee of us. Lorenzo Lamadrid, a former employee, served as a member of the compensation committee until May 16, 2007. During the year ended June 30, 2007, none of our executive officers served on the compensation committee (or equivalent), or the board of directors, of another entity whose executive officer or officers served on our compensation committee.

 

The following table sets forth information with respect to the beneficial ownership of our common stock as of June 5, 2008, by:

 

 

Beneficial ownership is determined in accordance with the rules of the SEC. To our knowledge, each of the holders of capital stock listed below has sole voting and investment power as to the capital stock owned unless otherwise noted.

 

 

 

 

 

The following table provides information concerning compensation paid or accrued during the fiscal years ended June 30, 2007 and 2006 to our principal executive officer, our principal financial officer and our other most highly paid executive officer whose salary and bonus exceeded $100,000, collectively referred to as the Named Executive Officers, determined at the end of the last fiscal year:

 

 

 

 

 

 

Compensation philosophy and objectives. Our philosophy in establishing executive compensation policies and practices is to align each element of compensation with our short-term and long-term strategic objectives, while providing competitive compensation that enables us to attract and retain top-quality executive talent.

 

The primary objectives of our compensation policies and practices for our named executive officers (Timothy Vail, our President and Chief Executive Officer, David Eichinger, our Chief Financial Officer and Senior Vice President of Corporate Development, and Donald Bunnell, our President and Chief Executive Officer—Asia Pacific) for the fiscal year ended June 30, 2007, were to:

 

 

 

 

We have adopted this philosophy because we believe that it is critical to our continued success and the achievement of our short-term and long-term goals and objectives as a company for our stockholders.

 

Administration. Our executive compensation program is administered by the Compensation Committee of the Board in accordance with the committee’s charter and other corporate governance requirements of the SEC and The NASDAQ Capital Market.

 

The committee has directly engaged, and may in the future engage, compensation consultants familiar with our industry to advise the committee regarding certain compensation issues. The assignments of the consultants are determined by the committee, although management may have input into these assignments.

 

The committee determines the total compensation of Mr. Vail, as our President and Chief Executive Officer, and the nature and amount of each element of his compensation. Mr. Vail plays a key role in determining executive compensation for the other named executive officers. Mr. Vail attends the meeting of the committee regarding executive compensation and discusses his recommendations with the committee, including his evaluation of the performance of the other named executive officers in arriving at his recommendations, which are based on his direct evaluation of such executives, after receiving input from the peers of such executives and others, if necessary. These recommendations are considered by the committee, along with other relevant data, in determining the base salary, annual cash incentives, long-term equity incentives, and benefits and perquisites for such executives.

 

Compensation program. Based on and consistent with the philosophy and objectives stated above, our current executive compensation program and its historical programs and practices consist of the following elements:

 

 

We have chosen these elements to remain competitive in attracting and retaining executive talent and to provide strong incentives for consistent high performance with current and potential financial rewards. The compensation packages of Messrs. Vail and Eichinger are more heavily weighted towards long-term equity incentive awards, as opposed to base salary or annual incentive awards. The goal of this policy is to attract and retain the executives to ensure our long term success. Mr. Bunnell’s compensation package is more heavily weighted towards annual cash incentive awards, which are tied to the performance of the business. We also provide employee benefits such as health, dental and life insurance at no cost to the named executive officers pursuant to plans that are generally available to our employees. We think our mix of compensation instills in our executives the importance of achieving our short-term and long-term business goals and objectives and thereby increasing stockholder value.

 

In evaluating the data assimilated from peer companies, the committee takes into account differences in the size of individual peer companies. In 2007, Korn/Ferry International, the

independent compensation consultant engaged by the committee, provided the committee with executive compensation data as part of its comparative process. The committee used the data as a basis to include both smaller and larger companies in the peer group similar to the method used by the investment community in comparing the company to peer companies. The committee will continue to monitor the appropriateness of the peer group and the relative measures drawn from the process with the primary objective of utilizing a peer group that provides the most appropriate comparison to the company as part of the committee’s competitiveness evaluation.

 

Consistent with our total executive compensation philosophy set forth above, in setting executive compensation the committee considers the total compensation payable to a named executive officer and each form of compensation. The committee seeks to achieve a balance between immediate cash rewards for the achievement of annual company-wide objectives and individual objectives, and long-term incentives that vest over time and that are designed to align the interests of our named executive officers with those of our stockholders.

 

As mentioned above, the percentage of compensation that is equity based compensation typically increases in relation to an executive’s responsibilities within the company, with contingent incentive compensation for more senior executives being a greater percentage of total compensation than for less senior executives. The committee believes that making a significant portion of an executive’s incentive compensation contingent on long-term stock price performance more closely aligns the executive’s interests with those of our stockholders.

 

Additional details regarding each element of our executive compensation program are as follows:

 

 

 

 

Our Amended and Restated 2005 Incentive Plan, as amended, is maintained with the objectives of (i) attracting and retaining selected key employees, consultants and outside directors; (ii) encouraging their commitment; (iii) motivating superior performance; (iv) facilitating attainment of ownership interests in us; (v) aligning personal interests with those of our stockholders; and (vi) enabling grantees to share in our long-term growth and success.

 

The committee exercises its discretion in determining the mix between and among awards of incentive stock options, non-qualified stock options and restricted stock. To date, the only incentive awards granted to the named executive officers by the committee have been stock options. The exercise price of stock options is based on the fair market value of a share of our common stock on the date of grant, which, under our Amended and Restated 2005 Incentive Plan, as amended, is the closing sales price on that date of a share of our common stock as reported on The NASDAQ Capital Market.

 

Currently, stock options granted under our Amended and Restated 2005 Incentive Plan, as amended, vest ratably on the first, second, third and fourth anniversaries of the grant date so that the options are fully vested after four years, although certain of the initial option grants under our Amended and Restated 2005 Incentive Plan, as amended, had five year vesting. Stock option grants are available for exercise for ten years from the date of grant. Since stock options are priced at fair market value, the options will only have value to the grantee if the market price of our common stock increases after the grant of the option.

 

Post-Employment Benefits. We have entered into employment agreements with our executive officers which provide for the payment of severance and other post-termination benefits depending on the nature of the termination, including, severance payments in the event of a termination following a “change in control.” The committee believes that the terms and conditions of these agreements are reasonable and assist us in retaining the executive talent needed to achieve our objectives. In particular, the termination agreements, in the event of a “change in control,” help executives focus their attention on the performance of their duties in the best interests of the stockholders without being concerned about the consequences to them of a change in control and help promote continuity of senior management. Information regarding the specific payments that are applicable to each termination event, as well as the effect on unvested equity awards, is provided under the heading “—Potential payments upon termination or change of control” below.

 

Benefits and Executive Perquisites. As our executives and employees, the named executive officers are eligible to participate in the health, dental, short-term disability and long-term disability insurance plans and programs provided to all company employees. Named executive officers are also eligible to participate in our 401(k) plan, which is generally available to all of our employees. Mr. Vail’s employment agreement also requires us to reimburse Mr. Vail if he uses his personal aircraft for our business. He is entitled to receive the lesser of (i) the cost of a comparable commercial airline fare or (ii) the actual operating costs of the flight on his aircraft, including fuel costs, pilot expenses and engine reserves.

 

Impact of Accounting and Tax Treatments. Section 162(m) of the Internal Revenue Code limits tax deductions for certain executive compensation over $1 million. Certain types of compensation are deductible only if performance criteria are specified in detail, and stockholders have approved the compensation arrangements. The committee remains aware of these provisions and may in the future determine to make grants whereby all or any of such awards may qualify for deductibility, but the committee has not yet adopted a formal policy with respect to

qualifying compensation paid to the named executive officers for an exemption from this limitation on deductibility imposed by this section.

 

On October 22, 2004, the American Jobs Creation Act of 2004 was signed into law, changing the tax rules applicable to nonqualified deferred compensation arrangements. While the final regulations have not yet become effective, we believe that we are operating in good faith compliance with the statutory provisions which were effective January 1, 2005.

 

 

We have entered into employment agreements with Timothy Vail, as our President and Chief Executive Officer, David Eichinger, as our Chief Financial Officer and Senior Vice President of Corporate Development and Donald Bunnell, as our President and Chief Executive Officer—Asia Pacific.

 

Our agreement with Mr. Vail became effective May 30, 2006 and has a term of four-years. He receives an annual base salary of up to $180,000, bonuses as may be awarded from time to time by the Board or any compensation committee thereof, including a performance bonus, and reimbursement of no more than $1,500 per month for all reasonable and customary medical and health insurance premiums incurred by Mr. Vail if he is not covered by insurance. Mr. Vail’s salary as of June 30, 2006 was $10,000 per month and was subject to increase upon the achievement of certain performance milestones. Mr. Vail met two of these milestones, one in August 2006 and his salary was increased to $12,500 per month, and the second in March 2007 and his salary was increased to $15,000 per month. The compensation committee of the Board also evaluates Mr. Vail’s salary on an annual basis and will determine if any additional increases are warranted. Pursuant to the terms of the employment agreement, we have also granted Mr. Vail options to purchase 2,350,000 shares of common stock. The options have an exercise price of $3.00 and vest in five equal annual installments, with the first installment vesting on the effective date of the employment agreement. The options are subject to the terms and conditions outlined in our Amended and Restated 2005 Incentive Plan, as amended.

 

The employment agreement prohibits Mr. Vail from competing with us during his employment and for a period of 18 months thereafter. The agreement also requires us to reimburse Mr. Vail if he uses his personal aircraft for our business. He is entitled to receive the lesser of (i) the costs of a comparable commercial airline fare or (ii) the actual operating costs of the flight on his aircraft, including fuel costs, pilot expenses and engine reserves.

 

Mr. Vail was also granted an option to purchase 50,000 shares of common stock pursuant to the terms of a nonstatutory stock option agreement dated effective November 7, 2005. The option has an exercise price of $2.50 and vests in four equal annual installments, with the first installment vesting on the effective date of the grant. The option expires on November 7, 2010 and the option is subject to the terms and conditions outlined in the Amended and Restated 2005 Incentive Plan, as amended.

 

Our agreement with Mr. Eichinger became effective May 30, 2006 and has a term of four-years. He receives an annual base salary of up to $180,000, bonuses as may be awarded from time to time by the Board or any compensation committee thereof, including a performance bonus, and reimbursement of no more than $1,500 per month for all reasonable and customary medical and health insurance premiums incurred by Mr. Eichinger if he is not covered by insurance. Mr. Eichinger’s current salary is $15,000 per month and is subject to increase upon the achievement of certain performance milestones. The compensation committee of the Board evaluates

Mr. Eichinger’s salary on an annual basis and will determine if any additional increases are warranted. We have also granted Mr. Eichinger options to purchase 1,750,000 shares of common stock. The options have an exercise price of $3.00 and vest in five equal annual installments, with the first installment vesting on the date of the option grant. The options are subject to the terms and conditions outlined in our Amended and Restated 2005 Incentive Plan. The employment agreement prohibits Mr. Eichinger from competing with us during his employment and for a period of 18 months thereafter.

 

Our agreement with Mr. Bunnell was amended and restated effective July 14, 2006 and has a term ending on April 18, 2009. Mr. Bunnell receives an annual base salary of $120,000, bonuses as may be awarded from time to time by the Board or any compensation committee thereof, including a performance bonus, and reimbursement of no more than $1,500 per month for all reasonable and customary medical and health insurance premiums incurred by Mr. Bunnell if he is not covered by insurance. Mr. Bunnell’s salary is subject to increase upon the achievement of certain performance milestones. The compensation committee of the Board evaluates Mr. Bunnell’s salary on an annual basis and will determine if any additional increases are warranted. The employment agreement prohibits Mr. Bunnell from competing with us during his employment and for a period of 18 months thereafter.

 

 

Pursuant to the terms of their employment agreements, upon a termination without cause or a voluntary termination for good reason, Messrs. Vail and Eichinger are entitled to receive (i) all payments of their base salary (as of the date of termination) for the remainder of the term of their agreements and in accordance with the terms thereof, (ii) payment of any bonus that they would have been otherwise entitled to received under their agreement as of the date of their termination, and (iii) all unvested options shall automatically vest as of the termination date. In addition, pursuant to the terms of his employment agreement, upon a termination without cause or a voluntary termination for good reason, Mr. Bunnell is entitled to receive all payments of his base salary (as of the date of termination) for the remainder of the term of his agreement and in accordance with the terms thereof. Upon a voluntary termination, termination for cause, death or disability, Messrs. Vail, Eichinger and Bunnell would not be entitled to receive benefits from us. Assuming that the effective date of termination is June 30, 2007, the total of such benefits would be as follows: (i) $3,100,361 for Mr. Vail (including $525,000 in base salary, $262,500 in bonus and $2,312,861 as the value of accelerated options), (ii) $2,487,040 for Mr. Eichinger (including $525,000 in base salary, $262,500 in bonus and $1,699,540 as the value of accelerated options) and (iii) $220,000 in base salary for Mr. Bunnell. All vested options must be exercised within six months of the termination date, regardless of the reason for termination.

 

Upon a change of control (as defined in their employment agreements), all unvested options of Messrs. Vail and Eichinger would automatically vest on the effective date of the change of control, even if their employment is not terminated. In addition, the employment agreements of Messrs. Vail and Eichinger also contain tax gross-up provisions which are applicable in the event that they received payments or benefits under their employment agreement in connection with a change of control. If the officer incurs any excise tax by reason of his or her receipt of such payments, he or she will receive a gross-up payment in an amount that would place them in the same after-tax position that he or she would have been in if no excise tax had applied.

Outstanding equity awards for year ended June 30, 2007. The following table shows the number of shares covered by exercisable and unexercisable options held by our named executive officers on June 30, 2007.

 

 

 

The description of the terms of the employment agreements of Messrs. Vail and Eichinger also includes a summary description of the terms of their May 30, 2006 option grants.

 

Option exercises and stock vested table. The table below shows the number of shares of our common stock acquired by our named executive officers during the year ended June 30, 2007 upon the exercise of options.