SES Synthesis Energy Systems Inc

Item 1. Financial Statements

See accompanying notes to the condensed consolidated financial statements.

See accompanying notes to the condensed consolidated financial statements.

See accompanying notes to the condensed consolidated financial statements

See accompanying notes to the condensed consolidated financial statements.

See accompanying notes to the condensed consolidated financial statements.

Note 1 — Business and Liquidity

(a) Organization and Description of Business

Synthesis Energy Systems, Inc. (referred to herein as “we”, “us”, and “our”), together with its wholly-owned and majority-owned controlled subsidiaries, is a global clean energy company that owns proprietary technology, SES Gasification Technology (“SGT”), for the low-cost and environmentally responsible production of synthesis gas (referred to as “syngas”). Syngas is used to produce a wide variety of high-value clean energy and chemical products, such as synthetic natural gas, power, methanol, and fertilizer. Our focus has been on commercializing SGT both in China and globally through the regional business platforms we have created with partners in Australia, via Australia Future Energy Pty Ltd (“AFE”), in Poland, via SES EnCoal Energy sp. z o.o (“SEE”) and in China, via Tianwo-SES Clean Energy Technologies Limited (“TSEC Joint Venture”).

Over the past twelve years, we have successfully commercialized SGT primarily through our efforts in China where, between 2006 and 2016, we invested in and built two commercial scale gasification projects together with Chinese partners and sub-licensed the SGT into three additional projects in China. In the aggregate, we have completed five commercial scale industrial projects in China over a ten-year period, in which the projects utilize twelve proprietary SGT systems. We believe the completion of these projects in China propelled SGT into a globally recognized gasification technology.

In 2014, we undertook efforts to expand into other regions of the world and created AFE, a joint venture with partners Ambre Investments PTY Limited (“Ambre”) in Australia, and in 2017, created SEE in Poland, with its partners from EnInvestments sp. z o.o. These regions are ideal locations for industrial projects utilizing the SGT due to high energy prices and limited access to affordable natural gas, combined with an abundance of low-quality, low-cost coal resources, renewable biomass and municipal solid wastes.

Australia’s lack of both domestic gas and a uniform energy policy has created a shortage of reliable energy supply and rising consumer prices, creating a need and demand for more environmentally friendly and cleaner energy solutions. AFE was established for the purpose of building large-scale vertically integrated projects using SGT to produce syngas used in manufacturing fuel gas, synthetic natural gas, agricultural and other chemicals, transportation fuels, explosives and for power generation and also to secure ownership positions in local resources, such as coal and biomass. AFE is able to leverage the unique flexible feedstock capability of SGT to build industrial projects with low production costs that can also reduce carbon dioxide emissions and support Australian industry and regional growth.

Since its formation, AFE has made significant commercial progress, creating Batchfire Resources Pty Ltd (“BFR”), which acquired one of the largest operating coal mines in Queensland, acquiring a coal resource mine development lease near Pentland, Queensland, and advancing the development of its flagship Gladstone Energy and Ammonia Project (the “Gladstone Project”). The AFE business underpins the future value of the Company and, to that end, on October 10, 2019, we and AFE entered into a definitive agreement to merge the two entities, among other transactions, as described further in Note 4 – The Proposed Merger with AFE.

We operate our business from our headquarters located in Houston, Texas and our offices in Shanghai, China.

(b) Liquidity, Management’s Plan and Going Concern

As of December 31, 2019, we had $0.4 million in cash and cash equivalents and negative $1.4 million in working capital.

As of March 2, 2020, we had $269,000 in cash and cash equivalents. Of the $269,000 in cash and cash equivalents, $235,000 resides in the United States or easily accessed foreign countries and approximately $34,000 resides in China.

We have determined that we do not have adequate cash to continue the commercialization of SGT due primarily to our inability to realize financial results from our two investments into projects in China and three technology licensed projects in China as well as our inability to quickly develop alternative technology income sources in Australia, Poland or other global regions. As a result, we suspended our global SGT commercialization efforts, we undertook operating expense reductions, we ceased providing funds for project developments, we continue to explore the divesting of assets such as our Yima Joint Venture, as defined in Note 5 – Current Projects – Yima Joint Venture, and TSEC Joint Ventures and we formed a special committee of the board of directors to evaluate financing and restructuring alternatives.

As a result of our efforts evaluating financing and restructuring alternatives, on October 10, 2019 we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with AFE as described further in Note 4 – The Proposed Merger with AFE. Currently our focus is on completing the steps to complete the merger, which include but not limited to, (i) completion of all Company required filings, (ii) curing the Nasdaq listing requirement deficiencies, (iii) completion of the Form S-4, Form S-1 and Proxy related to the merger, (iv) completion of the Batchfire share exchange pre-emptive rights process and (v) all other tasks required to complete the merger

In connection with the entry into the Merger Agreement, we entered into a securities purchase and exchange agreements (each, a “New Purchase Agreements”) with each of the existing holders of our 11% senior secured debentures issued in October 2017 (the “Debentures”), whereby each of the holders agreed to exchange their Debentures and accompanying warrants (the “Debenture Warrants”) for new debentures (the “New Debentures”) and warrants (the “New Debenture Warrants”), and certain of the holders agreed to provide $2,000,000 of additional debt financing (the “Interim Financing”). Pursuant to the New Purchase Agreements, the Company also issued $2,000,000 of 11% senior secured debentures (the “Merger Debentures”) to certain accredited investors, along with warrants to purchase 1,333,338 shares of Common Stock, half of which were Series A Common Stock Purchase Warrants (the “Series A Merger Warrants”) and half of which were Series B Common Stock Purchase Warrants (the “Series B Merger Warrants” and, together with the Series A Merger Warrants, the “Merger Warrants”), as part of the Interim Financing. The Company shall receive the $2,000,000 pursuant to the Merger Debentures according to the following schedule: (i) $1,000,000 on or before October 14, 2019, (ii) $500,000 upon the filing of the proxy statement for the Company stockholders approval of the Merger, as defined in Note 4 – The Proposed Merger with AFE, and (iii) $500,000 within two business days of Company stockholders approval of the proposed merger . The terms of the Merger Debentures are the same as the New Debentures. The Merger Debentures are intended to assist the Company in financing its business through the closing of the Merger.

As compensation for its services, the Company will pay to T.R. Winston & Company, LLC (the “Placement Agent”): (i) a cash fee of $140,000 (representing an aggregate fee equal to 7% of the face amount of the Merger Debentures, as defined below); and (ii) a warrant to purchase 100,000 shares of Common Stock (the “New Placement Agent Warrants”). We have also agreed to reimburse certain expenses of the Placement Agent.

The $1,000,000 scheduled payment on or before October 14, 2019 was subsequently received less certain legal costs and escrow fees in the amount of $966,000.

As part of the Interim Financing, we had also agreed to loan $350,000 of the proceeds from the Merger Debentures to AFE to assist AFE in financing its business through the closing of the Merger. On October 24, 2019, we entered into the loan agreement which is due in full on the later of March 31, 2020 or within five days following the closing of the Merger. If the Merger does not close, the loan will mature on March 31, 2020 or three months following the special stockholder meeting called to approve the merger transactions. The loan accrues interest at 11% per annum and is also due in full upon repayment, subject to an increased default interest in certain limited circumstances.

On February 19, 2020, we entered into a securities purchase agreement (the “Securities Purchase Agreement”) with certain holders of the Company’s 11% Senior Secured Convertible Debentures, pursuant to which, among other things, the holders purchased, in accordance with a private placement offering of the Company, $450,000 in principal amount of additional 11% Senior Secured Convertible Debentures (together, the “Additional Interim Debentures”) and warrants exercisable for up to 300,004 shares of common stock, half of which are Series A common stock purchase warrants and half of which are Series B common stock purchase warrants (together, the “Additional Interim Warrants”). The Additional Interim Debentures and Additional Interim Warrants are issued on substantially the same terms as the Merger Debentures and Merger Warrants issued in October 2019, provided that the Additional Interim Debentures include an adjustment to the conversion price in the event of certain dilutive equity issuances by the Company.

As compensation for its services, we paid to the Placement Agent: (i) a cash fee of $31,500 (representing an aggregate fee equal to 7% of the face amount of the Additional Interim Debentures); and (ii) a warrant to purchase 22,500 shares of Common Stock (the “Interim Placement Agent Warrant”). We have also agreed to reimburse certain expenses of the Placement Agent. The Interim Placement Agent Warrant has been issued on substantially the same terms as the Additional Interim Warrants.

On February 18, 2020, we entered into an amended loan agreement (the “Amended Loan Agreement”) with AFE, amending the Loan Agreement entered into with AFE in October 2019. The Loan Agreement contemplates that we would loan a portion of the $2,450,000 proceeds that we received under the New Purchase Agreements dated October 10, 2019 as well as under the Securities Purchase Agreement.

We had previously loaned $350,000 to AFE at the time of entering into the Loan Agreement, and on February 19, 2020, we have loaned an additional $100,000 out of the proceeds of the Additional Interim Debentures. An additional $115,000 will be loaned to AFE upon the receipt of the next tranche of funds under the New Purchase Agreements. These loaned amounts are due in full within five days following the closing of the transactions contemplated by the Merger Agreement dated October 10, 2019. If the Merger does not close, the loan will mature three months following the special meeting of the Company’s stockholders called to approve the Merger. The loan accrues interest at 11% per annum and is also due in full upon repayment, subject to an increased default interest rate in certain limited circumstances.

We can make no assurances that the proposed merger transaction will be completed on a timely basis or at all. We may also need to raise additional capital through equity and debt financing to complete the merger transaction or to otherwise strengthen our balance sheet for our corporate general and administrative expenses. We cannot provide any assurance that any financing will be available to us in the future on acceptable terms or at all. Any such financing could be dilutive to our existing stockholders. In addition, we may be forced to seek relief to avoid or end insolvency through other proceedings including bankruptcy. Based on the historical negative cash flows and the continued limited cash inflows in the period subsequent to year end there is substantial doubt about the Company’s ability to continue as a going concern.

Note 2 — Summary of Significant Accounting Policies

(a) Reverse Stock Split

On July 22, 2019, we enacted a 1 for 8 reverse stock split as approved by the shareholders at the Annual Meeting of Stockholders held in June 2019. All share and per share amounts in the condensed consolidated financial statements have been retroactively restated to reflect the reverse stock split.

(b) Basis of Presentation and Principles of Consolidation

The condensed consolidated financial statements for the periods presented are unaudited. Operating results for the three and six month periods ending December 31, 2019 are not necessarily indicative of results to be expected for the fiscal year ending June 30, 2020.

The condensed consolidated financial statements are in U.S. dollars. Non-controlling interests in consolidated subsidiaries in the consolidated balance sheets represents minority stockholders’ proportionate share of the equity including any contractual relationships in such subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto reported in the Company’s Annual Report on Form 10-K for the year ended June 30, 2019. Significant accounting policies that are new or updated from those presented in the Company’s Annual Report on Form 10-K for the year ended June 30, 2019 are included below. The condensed consolidated financial statements have been prepared in accordance with the rules of the United States Securities and Exchange Commission (“SEC”) for interim financial statements and do not include all annual disclosures required by generally accepted accounting principles in the United States.

The accompanying condensed consolidated interim financial statements have been prepared on the basis of a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. As such, conditions exist the may raise substantial doubt regarding the Company’s ability to continue as a going concern. These condensed consolidated interim financial statements do not give effect to any adjustment that would be necessary should the Company be unable to continue as a going concern and therefore need to realize its assets and liquidate its liabilities and commitments in other than the normal course of business and at amounts different from those in the accompanying condensed consolidated interim financial statements. In the opinion of management, all adjustments which are necessary for fair statements of the results for interim periods have been included.

(c) Accounting for Variable Interest Entities (“VIEs”) and Financial Statement Consolidation Criteria

We have equity investments in various privately held entities. We account for these equity investments either under the equity method or the cost method of accounting depending on our ownership interest and the level of our influence in each investment. Investments accounted for under the equity method are recorded based upon the amount of our investment and adjusted each period for our share of the investee’s income or loss. Cost method investments are recorded at cost less any impairments. All investments are reviewed for changes in circumstance or the occurrence of events that suggest an other-than-temporary event where our investment may not be recoverable.

The equity investments which we have entered into may be considered a variable interest entity (“VIE”). We consolidate all VIEs where we are the primary beneficiary. This determination is made at the inception of our involvement with the VIE and is continuously re-assessed. We consider qualitative factors and form a conclusion that we, or another interest holder, has a controlling financial interest in the VIE and, if so, whether it is the primary beneficiary. To determine the primary beneficiary, we consider who has the power to direct activities of the VIE that most significantly impacts the VIE’s performance and has the obligation to absorb losses from or the right to receive benefits of the VIE that could be significant to the VIE. We do not consolidate VIEs where we are not the primary beneficiary. As noted above, we account for these unconsolidated VIEs using either the equity method if we have significant influence but not control, or the cost method and include our net investment on our condensed consolidated balance sheet. Under the equity method, our equity interest in the net income or loss from our investments are recorded in non-operating income/expense on a net basis on our condensed consolidated statements of operations. In the event of a change in ownership, any gain or loss resulting from an investee share issuance is recorded in earnings. Controlling interest is determined by majority ownership interest and the ability to unilaterally direct or cause the direction of management and policies of an entity after considering any third-party participatory rights.

(d) Revenue Recognition

Technology licensing revenue is typically received over the course of a project’s development as milestones are met. We may receive upfront licensing fee payments when a license agreement is entered into. Typically, the majority of a license fee is due once project financing and equipment installation occur. We recognize license fees as revenue when the license fees become due and payable under the license agreement, subject to the deferral of the amount of the performance guarantee. Fees earned for engineering services, such as services that relate to integrating our technology to a customer’s project, are recognized using the percentage-of-completion method or as services are provided.

There were no license fee revenues was recorded in the three and six months ending December 31, 2019 or 2018. There were no revenues related to the sales of services or equipment in the three and six months ending December 31, 2019 or 2018.

(e) Use of estimates

The preparation of condensed consolidated financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates that affect the amounts reported in the financial statements and accompanying notes. Management considers many factors in selecting appropriate operational and financial accounting policies and controls, and in developing the assumptions that are used in the preparation of these consolidated financial statements. Management must apply significant judgment in this process. Among the factors, but not fully inclusive of all factors that may be considered by management in these processes are: the range of accounting policies permitted by accounting principles generally accepted in the United States; management’s understanding of the Company’s business for both historical results and expected future results; the extent to which operational controls exist that provide high degrees of assurance that all desired information to assist in the estimation is available and reliable or whether there is greater uncertainty in the information that is available upon which to base the estimate; expectations of the future performance of the economy, both domestically, and globally, within various areas that serve the Company’s principal customers and suppliers of goods and services; expected rates of exchange, sensitivity and volatility associated with the assumptions used in developing estimates; and whether historical trends are expected to be representative of future trends. The estimation process often times may yield a range of potentially reasonable estimates of the ultimate future outcomes and management must select an amount that lies within that range of reasonable estimates based upon the risks associated with the variability that might be expected from the future outcome and the factors considered in developing the estimate. Management attempts to use its business and financial accounting judgment in selecting the most appropriate estimate, however, actual amounts could and will differ from those estimates.

(f) Fair value measurements

Accounting standards require that fair value measurements be classified and disclosed in one of the following categories:

The Company’s financial assets and liabilities are classified based on the lowest level of input that is significant for the fair value measurement. The Company measures equity investments without readily determinable fair value on a non-recurring basis. The following table summarizes the assets of the Company measured at fair value as of December 31, 2019 and June 30, 2019 (in thousands):

The following table sets forth the changes in the estimated fair value for our Level 3 classified derivative liabilities (in thousands):

The carrying values of the certificates of deposit and money market funds approximate fair value, which was estimated using quoted market prices for those or similar investments. The carrying value of other financial instruments, including accounts receivable and accounts payable, approximate their fair values due to the short maturities on those instruments. The senior secured debenture at fair value and derivative liabilities were measured at fair value using a Monte Carlo simulation valuation methodology (See also Note 6 — Derivative Liabilities -Senior Secured Debentures & Debenture Warrants for more details related to the valuation and assumptions of the Company’s derivative liabilities).

Note 3 – Recently Issued Accounting Standards

In February 2016, the FASB issued ASU No. 2016-02, which creates ASC Topic 842, “Leases.” This update increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. This guidance is effective for interim and annual reporting periods beginning after December 15, 2018. We adopted ASC Topic 842. “Leases” beginning July 1, 2019. We currently do not have any leases for which this standard applies using the election to exclude leases for less than one year and therefore the standard had no effect on our financial condition, results of operations, cash flows or financial disclosures.

In July 2017, the FASB issued ASU 2017-11, “Earnings Per Share” ASC Topic 260, “Distinguishing Liabilities from Equity” ASC Topic 480, “Derivatives and Hedging” ASC Topic 815: (Part I) “Accounting for Certain Financial Instruments with Down Round Features.” These amendments simplify the accounting for certain financial instruments with down round features. The amendments require companies to disregard the down round feature when assessing whether the instrument is indexed to its own stock, for purposes of determining liability or equity classification. The Company adopted the guidance as of July 1, 2019. The adoption had no material effect on our financial condition, results of operations, cash flows or financial disclosures.

In June 2018, the FASB issued ASU No. 2018-07, which expands the scope of Topic 718, “Compensation – Stock Compensation”, to include share-based payment transactions for acquiring goods and services from non-employees. An entity should apply the requirements of Topic 718 to non-employee awards except for specific guidance on inputs to an option pricing model and the attribution of cost. This amendment specifies that Topic 718 applies to all share-based payment transactions in which a grantor acquires goods or services to be used or consumed in a grantor’s own operations by issuing share-based payment awards. This amendment also clarifies that Topic 718 does not apply to share-based payments used to effectively provide (1) financing to the issuer or (2) awards granted in conjunction with selling goods or services to customers as part of a contract accounted for under Topic 606, Revenue from Contracts with Customers. The standard is effective for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. We adopted ASC 718, “Compensation – Stock Compensation” beginning July 1, 2019. The adoption of the standard had no material effect on our financial condition, results of operations, cash flows or financial disclosures.

Note 4 – The Proposed Merger with AFE

On October 10, 2019, we, SES Merger Sub, Inc., a Delaware corporation and a wholly-owned subsidiary of us (“Merger Subsidiary”), and AFE, entered into the Merger Agreement pursuant to which, among other things, AFE will, subject to the satisfaction or waiver of the conditions set forth in the Merger Agreement, merge with and into Merger Subsidiary (the “Merger”), the separate corporate existence of Merger Subsidiary shall cease and AFE shall be the successor or surviving corporation of the Merger and a wholly owned subsidiary of us. The Merger is intended to qualify for federal income tax purposes as a tax-free reorganization under the provisions of Section 368(a) of the Internal Revenue Code of 1986, as amended. Upon the consummation of the Merger, it is contemplated that we will also change our name.

Upon consummation of the Merger, and subject to the terms and conditions of the Merger Agreement, holders of AFE ordinary shares will receive, in exchange for such ordinary shares, 3,875,000 shares of our common stock. All outstanding stock options and restricted stock will remain outstanding post-Merger on the same terms and conditions as currently applicable to such awards, provided that outstanding awards for departing directors shall be amended to extend exercisability for the term of the award.

In connection with the entry into the Merger Agreement, the Company entered into Share Exchange Agreements (each, a “Share Exchange Agreement”) with certain of the shareholders of BFR, whereby such shareholders will exchange their shares of BFR for shares of the common stock at a ratio of 10 BFR shares for one share of common stock. As a result of these exchanges, the Company would own approximately 37% of the outstanding shares of BFR. The closing of the exchange is subject to certain conditions specified in the Share Exchange Agreements, including, without limitation, the consummation of the transactions contemplated by the Merger Agreement.

In connection with the entry into the Merger Agreement, the Company entered into New Purchase Agreements with each of the Purchasers of the Debentures, whereby each of the Purchasers agreed to exchange their Debentures and Debenture Warrants for New Debentures and New Debenture Warrants, and certain of the Purchasers agreed to provide $2,000,000 of Interim Financing.

As compensation for its services, the Company paid to the Placement Agent: (i) a cash fee of $140,000 (representing an aggregate fee equal to 7% of the face amount of the Merger Debentures; and (ii) New Placement Agent Warrants”). We have also agreed to reimburse certain expenses of the Placement Agent.

The New Debenture Warrants and the New Placement Agent Warrants are exercisable into shares of common stock at any time from and after the closing date at an exercise price of $3.00 or $6.00 per common share dependent upon their participation in the Interim Financing (subject to adjustment). The New Debenture Warrants and the New Placement Agent Warrants will terminate five years after they become exercisable. The New Debenture Warrants and the New Placement Agent Warrant contain provisions providing for the adjustment of the purchase price and number of shares into which the securities are exercisable.

The New Debentures and the New Debenture Warrants have substantially similar terms to the Debentures and Debenture Warrants, including as to maturity and security, except that the New Debentures, among other differences, (i) provide for the payment to certain Purchasers, at their election, of interest payments in shares of the common stock or in kind, and (ii) provide for certain optional conversion features. The New Debenture Warrants change the exercise price to $3.00 or $6.00 per share dependent upon their participation in the Interim Financing and makes certain other modifications to the Debenture Warrants. The New Debenture Warrants were issued upon the announcement of the Merger.

Pursuant to the New Purchase Agreements, each of the Purchasers (i) waived the events of default resulting from the failure by the Company to timely file its Annual Report on Form 10-K for the fiscal year ended June 30, 2018, its Annual Report on Form 10-K for the fiscal year ended June 30, 2019 and for this Quarterly Report, (ii) waived the event of default resulting from the failure by the Company to make interest payments due on July 1, 2019, October 1, 2019 and January 1, 2020, and (iii) consented to the consummation of the Merger and the issuance of the Merger Debentures and the Merger Warrants, notwithstanding any limitations in the Debentures to the contrary.

As mentioned above, pursuant to the New Purchase Agreements, the Company also issued Merger Debentures to certain accredited investors, half of which were Series A Merger Warrants and half of which were Series B Merger Warrants and, together with the Series A Merger Warrants, the Merger Warrants, as part of the Interim Financing. The Company shall receive the $2,000,000 pursuant to the Merger Debentures according to the following schedule: (i) $1,000,000 on or before October 14, 2019, (ii) $500,000 upon the filing of the proxy statement for the Company’s stockholders approval of the Merger, and (iii) $500,000 within two business days of Company’s stockholders approval of the Merger. The terms of the Merger Debentures are the same as the New Debentures. The Merger Debentures are intended to assist the Company in financing its business through the closing of the Merger.

The $1,000,000 scheduled payment on or before October 14, 2019 was subsequently received less certain legal costs and escrow fees in the amount of $966,000.

Interest on the Merger Debentures is payable quarterly in arrears, at the option of the holder, in the form of shares of common stock, to be issued at a price of the lower of $3.00 per share and the 10-day trailing VWAP for the period immediately prior to the due date of the interest payment, or in kind. The Merger Debentures are convertible at any time by the holders into shares of common stock at a price of $3.00 per share, and the Company can require conversion into shares of common stock at a price of $3.00 per share if the common stock trades at or above $10.00 per share for ten consecutive trading days.

The Merger Warrants are exercisable into shares of common stock at any time from and after the issue date (provided that the Company can only issue up to 19.99% of the outstanding shares as of the date the Merger was announced without shareholder approval) at an exercise price of $3.00 per share of common stock, in the case of the Series A Merger Warrants, or $6.00 per share of common stock, in the case of the Series B Merger Warrants. The Merger Warrants will terminate five years after they become exercisable. The Merger Warrants contain provisions providing for the adjustment of the purchase price and number of shares into which the securities are exercisable. The terms of the Merger Warrants are the same as the New Debenture Warrants. The New Placement Agent Warrants have the same terms as the Merger Warrants with an exercise price of $3.00 per share.

In connection with entering into the New Purchase Agreements, the Company also entered into a Registration Rights Agreement with the investors whereby the Company agreed to register the shares of common stock underlying the New Debentures, the New Purchase Agent Warrants, the Merger Debentures and the Merger Warrants.

The respective boards of directors of the Company, Merger Subsidiary and AFE have determined that the Merger Agreement and the transactions contemplated by the Merger Agreement are fair to, advisable and in the best interests of their respective stockholders and have approved the Merger and the Merger Agreement. The transactions contemplated by the Merger Agreement are subject to the approval of the Company’s and AFE’s respective shareholders at shareholders’ meetings to be called and held by the Company and AFE, respectively, and other closing conditions, including, among other things, the filing and effectiveness of a registration statement on Form S-4 with the SEC, and the consummation of the transactions contemplated by the Share Exchange Agreements and the New Purchase Agreements.

The Merger Agreement contains representations and warranties by the Company and Merger Subsidiary, on the one hand, and by AFE, on the other hand, made solely for the benefit of the other. The assertions embodied in those representations and warranties are qualified by information in confidential disclosure schedules that the parties have exchanged in connection with signing the Merger Agreement. The disclosure schedules contain information that modifies, qualifies and creates exceptions to the representations and warranties set forth in the Merger Agreement. Moreover, certain representations and warranties in the Merger Agreement were made as of a specified date, may be subject to a contractual standard of materiality different from what might be viewed as material to shareholders, or may have been used for the purpose of allocating risk between the Company and Merger Subsidiary, on the one hand, and AFE, on the other hand. Accordingly, the representations and warranties and other disclosures in the Merger Agreement should not be relied on by any persons as characterizations of the actual state of facts about the Company, Merger Subsidiary or AFE at the time they were made or otherwise.

The Merger Agreement contains certain termination rights for both the Company and AFE, including, among other things, if the Merger is not consummated on or before April 15, 2020.

As part of the Interim Financing, we had also agreed to loan $350,000 of the proceeds from the Merger Debentures to AFE to assist AFE in financing its business through the closing of the Merger. On October 24, 2019, we entered into the loan agreement which is due in full on the later of March 31, 2020 or within five days following the closing of the Merger. If the Merger does not close, the loan will mature on March 31, 2020 or three months following the special stockholder meeting called to approve the Merger. The loan accrues interest at 11% per annum and is also due in full upon repayment, subject to an increased default interest in certain limited circumstances.

Note 5 – Current Projects

Australian Future Energy Pty Ltd

In February 2014, we established AFE together with an Australian company, Ambre. AFE is an independently managed Australian business platform established for the purpose of building a large-scale, vertically integrated business in Australia based on developing, building and owning equity interests in financially attractive and environmentally responsible projects that produce low-cost syngas as a competitive alternative to expensive local natural gas and LNG.

On May 10, 2017, we entered into a project technology license agreement with AFE in connection with a project being developed by AFE in Queensland, Australia. AFE intends to form a subsidiary project company and assign the project technology license agreement to that company which will assume all of the obligations of AFE thereunder. Pursuant to the project technology license agreement, we granted a non-exclusive license to use our technology at the project to manufacture syngas and to use our technology in the design of the facility. In consideration, the project technology license agreement calls for a license fee to be finalized based on the designed plant capacity and a separate fee of $2.0 million for the delivery of a process design package. License fees shall be paid as project milestones are reached throughout the planning, construction and first five years of plant operations. The success and timing of the project being developed by AFE will affect if and/or when we will be able to receive all the payments related to this technology license agreement. However, there can be no assurance that AFE will be successful in developing this or any other project.

In September 2018, AFE’s Gladstone Project was formally announced in Queensland Parliament by Minister for State Development, Manufacturing, Innovation and Planning, Mr. Cameron Dick and was declared by the Queensland Co-Ordinator General as a Co-Ordinated Project.

On April 4, 2019, we entered into a Technology Purchase Option Agreement (the “Option Agreement”) with AFE providing AFE has an exclusive option through July 31, 2019 to purchase 100% ownership of Synthesis Energy Systems Technology, LLC, our wholly-owned subsidiary which owns our interest in the SGT. In addition, ownership rights to SGT are carved out of the transaction and retained by us for China and we have a three-year option period post-closing to monetize SGT for India, Brazil, Poland and for the DRI technology market segment. On July 31, 2019, we entered into an Amendment to the Option Agreement with AFE extending the exclusive option provided in the Option Agreement through August 31, 2019. On August 31, 2019, we mutually agreed with AFE to allow the Option Agreement to terminate pursuant to its terms and no penalties or payments were due as a result of the termination of the agreement.

AFE issued one million shares to us in connection with the execution of the Option Agreement. AFE would also pay (i) an additional $2.0 million in three equal installments, with the first installment paid at closing and the remainder over the subsequent twelve months, and (ii) $3.8 million on the earlier of the closing of a construction financing by AFE or five years from closing. The closing of the transaction was subject to the negotiation of definitive agreements and other conditions specified in the Option Agreement. In addition to the payment schedule above, AFE issued an additional one million shares with the execution of the Option Agreement and would also pay an additional $100,000 with the first installment paid at closing as full and final settlement of outstanding invoices owing AFE to us at the date of this Option Agreement. As a result of the termination of the Option Agreement, we retained the two million shares AFE issued in connection with the Option Agreement. We accounted for the first million shares as an additional investment in AFE for $70,000 and a reduction of receivable amounts due from AFE with a fair value of $100,000 with a write-off for the remaining $30,000. The second million shares were accounted for as an additional investment in AFE and a deferred liability in the amount of $70,000 as a down payment on the purchase of our subsidiary. In the quarter ending September 30, 2019, we recognized the $70,000 down payment as an other gain due to the termination of the Option Agreement.

On October 24, 2019 we entered into a loan agreement with AFE in connection with the proposed Merger where we loaned $350,000 to AFE as mentioned above in Note 4 – The Proposed Merger with AFE.

For our ownership interest in AFE, we have been contributing cash, engineering support and most recently made a loan mentioned above, for AFE’s business development while Ambre contributed cash and services. Additional ownership in AFE has been granted to the AFE management team and staff individuals providing services to AFE. In April 2019, we were issued two million shares in connection with the Option Agreement and its subsequent termination.

We account for our investment in AFE under the equity method. Our ownership interest of approximately 35% makes us the second largest shareholder. We also maintain a seat on the board of directors which allows us to have significant influence on the operations and financial decisions, but not control, of AFE. Our carrying value of our AFE investment as of both December 31, 2019 and June 30, 2019 was zero.

As we account for AFE under the equity method and currently AFE’s losses exceed our investment carrying value, therefore we have not been recording our equity loss pickup related to AFE’s losses. Due to the loan mentioned above, we are required, under ASC 323-10 to record our share of losses related to the additional support to AFE which includes the loan. Additional equity loss of $350,000 was recorded in the quarter ended December 31, 2019 due to the execution of the loan agreement with AFE and creating a liability in excess of basis of equity method investment.

The following summarizes unaudited condensed financial information of AFE for the three and six months ended December 31, 2019 and 2018 and as of December 31, 2019 and June 30, 2019 (in thousands):

For more on the Merger and related transactions, see Note 4 – The Proposed Merger with AFE above.

Cape River Resources Pty Ltd

In October 2018, AFE formed a separate unrelated company, Cape River Resources Pty Ltd (“CRR”) for the purpose of developing the Pentland resource into an operating thermal coal mine. Ownership in CRR was distributed proportionately to the shareholders of AFE with additional shares issued to the management team. Our ownership in CRR was approximately 38% upon the formation of CRR through our ownership interest in AFE.

We accounted for our investment in CRR under the equity method. Our ownership interest of approximately 38% made us the second largest shareholder. We may have appointed one board director for each 15% ownership interest we held in CRR which allowed us to have significant influence on the operations and financial decisions, but not control, of CRR. Our carrying value of our CRR investment as of June 30, 2019 was zero.

In September 2019, AFE repurchased all of the shares in CRR in exchange for AFE shares. The CRR shareholders received one share of AFE for every ten shares of CRR. As a result of the transaction, CRR is a wholly-owned subsidiary of AFE.

Batchfire Resources Pty Ltd

As a result of AFE’s early stage business development efforts associated with the Callide coal mine in Central Queensland, Australia, AFE created BFR. BFR was a spin-off company for which ownership interest was distributed to the existing shareholders of AFE and to the new BFR management team in December 2015. BFR is registered in Australia and was formed for the purpose of purchasing the Callide thermal coal mine from Anglo-American plc (“Anglo-American”). The Callide mine is one of the largest thermal coal mines in Australia and has been in operation for more than 40 years.

In October 2016, BFR stated that it had received investment support for the acquisition from Singapore-based Lindenfels Pte, Ltd, a subsidiary of commodity traders Avra Commodities, and as a result the acquisition of the Callide thermal coal mine from Anglo-American was completed in October 2016.

On April 29, 2019, BFR issued additional shares as part of a rights offering. We did not execute our rights in this offering and therefore after the completion of the offering process and the issuance of the additional shares, our ownership interest was diluted from approximately 11% to approximately 7%.

We account for our investment in BFR under the cost method. Our limited ownership interest in BFR was approximately 7% and we do not have significant influence over the operation or financial decisions made by the company. At the time of the spin-off, the carrying amount of our investment in AFE was reduced to zero through equity losses. As such, the value of the investment in BFR post spin-off was also zero. As of December 31, 2019, our ownership interest in BFR was approximately 7% and the carrying value of our investment in BFR as of both December 31, 2019 and June 30, 2019 was zero.

For additional information on our investment in BFR and the Share Exchange Agreements, please see Note 4 – The Proposed Merger with AFE.

Townsville Metals Infrastructure Pty Ltd

In August 2018, AFE formed a separate unrelated company, Townsville Metals Infrastructure Pty Ltd (“TMI”) for the purpose of completing the development of the required infrastructure such as rail and port modifications related to the transport of mined products including coal from the Pentland resource to the Townsville port. Ownership in TMI was distributed proportionately to the shareholders of AFE. Our ownership in TMI is approximately 38% upon the formation of TMI through our ownership interest in AFE.

We account for our investment in TMI under the equity method. Our ownership interest of approximately 38% makes us the second largest shareholder. We may appoint one board director for each 15% ownership interest we hold in TMI which allows us to have significant influence on the operations and financial decisions, but not control, of TMI. Our carrying value of our TMI investment as of both December 31, 2019 and June 30, 2019 was zero.

SES EnCoal Energy sp. z o. o.

In October 2017, we entered into agreements with Warsaw-based EnInvestments sp. z o.o. Under the terms of the agreements, we and EnInvestments are equal shareholders of SEE and SEE will exclusively market, develop, and commercialize projects in Poland which utilize our technology, services and proprietary equipment and we share with SEE a portion of the technology license payments, net of fees, we receive from Poland. The goal of SEE is to establish efficient clean energy projects that provide Polish industries superior economic benefits as compared to the use of expensive, imported natural gas and LNG, while providing energy independence through our technological capabilities to convert the wide range of Poland’s indigenous coals, coal waste, biomass and municipal waste to valuable syngas products. SEE has developed a pipeline of projects and together we are actively working with Polish customers and partners to complete necessary project feasibility, permitting, and SGT technology agreement steps required prior to starting construction on the projects.

For our ownership interest in SEE, we have been contributing cash and assisting in the development of SEE. In August 2018 we contributed additional cash of approximately $11,000.

We account for our investment in SEE under the equity method. Our ownership interest of 50% makes us an equal shareholder and we also maintain two of the four seats on the board of directors which allows us to have significant influence on the operations and financial decisions, but not control, of SEE. On December 31, 2019, as an equal shareholder, our ownership was 50% of SEE and our carrying value of our investment in SEE as of December 31, 2019 and June 30, 2019 was approximately $17,000 and $19,000 respectively.

Midrex Technologies

In July 2015, we entered into a Project Alliance Agreement that expands our exclusive relationship with Midrex Technologies for integration and optimization of DRI technology using coal gasification. Midrex has taken the lead in marketing, sales, proposal development, and project execution for coal gasification DRI projects as part of the new project alliance. Midrex may also lead the construction of the fully integrated solution for customers who desire such an execution strategy. We will provide the DRI gasification technology for each project including engineering, key equipment, and technical services. The agreement includes finalization of an engineering package for the optimized coal gasification DRI solution. Prior to the Project Alliance Agreement, we also entered into an exclusive agreement with the TSEC Joint Venture and Midrex for the joint marketing of coal gasification-based DRI facilities in China. These facilities will combine our gasification technology with the Direct Reduction Process of Midrex to create syngas from low quality coals in order to convert iron ore into high-purity DRI. The TSEC Joint Venture will aid in the marketing of these DRI facilities in China and will supply the gasification equipment and licensing of the technology.

Yima Joint Venture

In August 2009, we entered into joint venture contracts and related agreements with Yima Coal Industry Group Company (“Yima”). We continue to own a 25% interest in the Yima Joint Venture and Yima owns a 75% interest.

Since 2014, we have accounted for this joint venture under the cost method of accounting. Our conclusion to account for this joint venture under this methodology is based upon our historical lack of significant influence in the Yima Joint Venture. The lack of significant influence was determined based upon our interactions with the Yima Joint Venture related to our limited participation in operating and financial policymaking processes coupled with our limited ability to influence decisions which contribute to the financial success of the Yima Joint Venture. We continue to evaluate our level of influence over the Yima Joint Venture.

The carrying value of our Yima Joint Venture investment as of both December 31, 2019 and June 30, 2019 was zero.

Tianwo-SES Clean Energy Technologies Limited

Joint Venture Contract

In February 2014, SES Asia Technologies Limited, one of our wholly owned subsidiaries, entered into a Joint Venture Contract (the “JV Contract”) with Zhangjiagang Chemical Machinery Co., Ltd., which subsequently changed its legal name to Suzhou Thvow Technology Co. Ltd. (“STT”), to form the TSEC Joint Venture. In August 2017, we entered into a restructuring agreement which changed the share ownership in the TSEC Joint Venture, reduced the registered capital and brought an additional party, The Innovative Coal Chemical Design Institute (“ICCDI”), into the JV Contract. Current ownership interests of the TSEC Joint Venture are STT owning 50%, ICCDI owning 25% and we own the remaining 25%. The purpose of the TSEC Joint Venture is to establish SGT as the leading gasification technology in the TSEC Joint Venture territory (which is China, Indonesia, the Philippines, Vietnam, Mongolia and Malaysia) by becoming a leading provider of proprietary equipment and engineering services for the technology. The scope of the TSEC Joint Venture is to market and license SGT via project sublicenses; procurement and sale of proprietary equipment and services; coal testing; and engineering, procurement and research and development related to SGT.

TSEC Joint Venture financial data

The following summarizes unaudited condensed financial information of TSEC Joint Venture for the three and six months ended December 31, 2019 and 2018 and as of December 31, 2019 and June 30, 2019 (in thousands):

The TSEC Joint Venture is accounted for under the equity method. Our initial capital contribution in the formation of the venture was the Technology Usage and Contribution Agreement (“TUCA”), which is an intangible asset. As such, we did not record a carrying value at the inception of the venture. The carrying value of our investment in the TSEC Joint Venture as of both December 31, 2019 and June 30, 2019 was zero.

Under the equity method of accounting, losses in the venture are not recorded if the losses cause the carrying value to be negative and there is no requirement to contribute additional capital. As we are not required to contribute additional capital, we have not recognized losses in the venture, as this would cause the carrying value to be negative.

TUCA

Pursuant to the TUCA, we have contributed to the TSEC Joint Venture certain exclusive rights to our SGT in the TSEC Joint Venture territory, including the right to: (i) grant site specific project sub-licenses to third parties; (ii) use our marks for proprietary equipment and services; (iii) engineer and/or design processes that utilize our technology or our other intellectual property; (iv) provide engineering and design services for joint venture projects and (v) take over the development of projects in the TSEC Joint Venture territory that have previously been developed by us and our affiliates. As a result of the Restructuring Agreement, ICCDI was added as a party to the TUCA, but all other material terms remained the same.

Note 6 — Derivative Liabilities - Senior Secured Debentures & Debenture Warrants

On October 24, 2017, we entered into a securities purchase agreement (the “Purchase Agreement”) with certain accredited investors (the “Purchasers”) for the purchase of $8.0 million in principal amount of Debentures. The Debentures have a term of 5 years with an interest rate of 11% that adjusts to 18% in the event the Company defaults on an interest payment. The Debentures require that dividends received from BFR are used to pay down the principal amounts of outstanding Debentures. Additionally, we issued Debenture Warrants to purchase 125,006 shares of common stock at $32.00 per common share. The Purchase Agreement and the Debentures contain certain customary representations, warranties and covenants. There are no financial metric covenants related to the Debentures. The transaction was approved by a special committee of our board of directors due to the fact that certain board members were Purchasers. Interest on the outstanding balance of Debentures is payable quarterly and commenced on January 2, 2018. All unpaid principal and interests on the Debentures will be due on October 23, 2022.

The net offering proceeds to us from the sale of the Debentures and the Debenture Warrants, after deducting the Placement Agent’s fee and associated costs and expenses, was approximately $7.4 million, not including the proceeds, if any, from the exercise of the warrants issued in this offering. As compensation for their services, we paid the Placement Agent: (i) a cash fee of $0.56 million (representing an aggregate fee equal to 7% of the face amount of the Debentures); and (ii) a warrant to purchase 8,750 shares of common stock, representing 7% of the Debenture Warrants issued to the Purchasers (the “Placement Agent Warrant”). We also reimbursed certain expenses of the Placement Agent. The fair market value of the warrants was approximately $137,000 at the time of issuance and recorded as debt issuance cost. A total of approximately $1.0 million debt issuance cost was recorded as a result and was being amortized to interest expense over the term of the Debentures by using effective interest method beginning in October 2017.

The Debenture Warrants and Placement Agent Warrant contain provisions providing for the adjustment of the purchase price and number of shares into which the securities are exercisable in certain events. Also, under certain events, we shall, at the holder’s option, purchase the warrants from the holder by paying the holder an amount in cash based on a Black Scholes Option Pricing Model for remaining unexercised warrants. Under U.S. GAAP, this potential cash transaction requires us to record the fair market value of the warrants as a liability as opposed to equity.

The Company recorded $8.0 million as the face value of the Debentures and a total of $2.0 million as discount of Debentures and $0.1 million as debt issuance cost for warrants issued to the Purchasers and Placement Agent, which was be amortized to interest expense over the term of the Debenture.

The effective annual interest rate of the Debentures was approximately 18% after considering this $2.0 million discount related to the Debentures.

The Debentures are guaranteed by the U.S. subsidiaries of the Company, as well as the Company’s British Virgin Islands subsidiary, pursuant to a Subsidiary Guarantee, in favor of the holders of the Debentures by the subsidiary guarantors, party thereto, as well as any future subsidiaries which the Company forms or acquires. The Debentures are secured by a lien on substantially all of the assets of the Company and the subsidiary guarantors, other than their equity ownership interest in the Company’s foreign subsidiaries, pursuant to the terms of the Purchase Agreement among the Company, the subsidiary guarantors and the holders of the Debentures.

In connection with the entry into the Merger Agreement, the Company entered into New Purchase Agreements with each of the Purchasers of the Debentures, whereby each of the Purchasers agreed to exchange their Debentures and Debenture Warrants for New Debentures and New Debenture Warrants, and certain of the Purchasers agreed to provide $2,000,000 of Interim Financing. The certain holders that provided the Interim Financing received Merger Warrants with a fair value total of approximately $6,113,000, see calculation below for Series A Warrants and Series B Warrants.

As compensation for its services, the Company paid to the Placement Agent: (i) a cash fee of $140,000 (representing an aggregate fee equal to 7% of the face amount of the Merger Debentures); and (ii) New Placement Agent Warrants”. We have also agreed to reimburse certain expenses of the Placement Agent.

The New Debenture Warrants and the New Placement Agent Warrants are exercisable into shares of common stock at any time from and after the closing date (provided that the Company can only issue up to 19.99% of the outstanding shares as of the date the Merger was announced without shareholder approval) at an exercise price of $3.00 or $6.00 per common share dependent upon their participation in the Interim Financing (subject to adjustment). The New Debenture Warrants and the New Placement Agent Warrants will terminate five years after they become exercisable. The New Debenture Warrants and the New Placement Agent Warrants contain provisions providing for the adjustment of the purchase price and number of shares into which the securities are exercisable.

The New Debentures and the New Debenture Warrants have similar terms to the Debentures and Debenture Warrants, including as to maturity and security, except that the New Debentures, among other differences, (i) provide for the payment to certain Purchasers, at their election, of interest payments in shares of the common stock or in kind, and (ii) provide for certain optional conversion features. The New Debenture Warrants change the exercise price to $3.00 or $6.00 per share dependent upon their participation in the Interim Financing and makes certain other modifications to the Debenture Warrants. The New Debenture Warrants were issued upon the announcement of the Merger.

Pursuant to the New Purchase Agreements, each of the Purchasers (i) waived the events of default resulting from the failure by the Company to timely file its Annual Report on Form 10-K for the fiscal year ended June 30, 2018, its Annual Report on Form 10-K for the fiscal year ended June 30, 2019 and for this Quarterly Report, (ii) waived the event of default resulting from the failure by the Company to make interest payments due on July 1, 2019, October 1, 2019 and January 1, 2020, and (iii) consented to the consummation of the Merger and the issuance of the Merger Debentures and the Merger Warrants, notwithstanding any limitations in the Debentures to the contrary.

As mentioned above, pursuant to the New Purchase Agreements, the Company also issued Merger Warrants to certain accredited investors, half of which were Series A Merger Warrants and half of which were Series B Merger Warrants and, together with the Series A Merger Warrants, the Merger Warrants, as part of the Interim Financing. The Company shall receive the $2,000,000 pursuant to the Merger Debentures according to the following schedule: (i) $1,000,000 on or before October 14, 2019, (ii) $500,000 upon the filing of the proxy statement for the Company’s stockholders approval of the Merger, and (iii) $500,000 within two business days of Company’s stockholders approval of the Merger. The terms of the Merger Debentures are the same as the New Debentures. The Merger Debentures are intended to assist the Company in financing its business through the closing of the Merger.

The $1,000,000 scheduled payment on or before October 14, 2019 was subsequently received less certain legal costs and escrow fees in the amount of $966,000.

Interest on the Merger Debentures is payable quarterly in arrears, at the option of the holder, in the form of shares of common stock, to be issued at a price of the lower of $3.00 per share and the 10-day trailing VWAP for the period immediately prior to the due date of the interest payment, or in kind. The Merger Debentures are convertible at any time by the holders into shares of common stock at a price of $3.00 per share, and the Company can require conversion into shares of common stock at a price of $3.00 per share if the common stock trades at or above $10.00 per share for ten consecutive trading days.

The Merger Warrants are exercisable into shares of common stock at any time from and after the issue date (provided that the Company can only issue up to 19.99% of the outstanding shares as of the date the Merger was announced without shareholder approval) at an exercise price of $3.00 per share of common stock, in the case of the Series A Merger Warrants, or $6.00 per share of common stock, in the case of the Series B Merger Warrants. The Merger Warrants will terminate five years after they become exercisable. The Merger Warrants contain provisions providing for the adjustment of the purchase price and number of shares into which the securities are exercisable. The terms of the Merger Warrants are the same as the New Debenture Warrants. The New Placement Agent Warrants have the same terms as the Merger Warrants with an exercise price of $3.00 per share.

The Merger Debentures and Merger Warrants also include a fundamental transaction clause, under certain circumstances, including the merger or consolidation of the Company or disposition of all or substantially all of the Company’s assets, then upon subsequent conversion, the holder shall have the right to receive an equivalent number of shares of common stock of the successor and any additional consideration receivable as a result of such a transaction. The Merger Warrants are required to be recorded as liability awarded the fair market value as a derivative liability. Upon the modification of the debentures that are required to be treated as an extinguishment, management has elected the fair value for the debentures. Management, with the assistance of a third-party valuation expert, used a Monte Carlo Simulation method to value both the Merger Debenture and the Merger Warrants with Anti-Dilution Protection.

To execute the model and value the face value of the $9.0 million of Merger Debentures, certain assumptions were needed as noted below:

To execute the model and value the Merger Series A Warrants, certain assumptions were needed as noted below:

To execute the model and value the Merger Series B Warrants, certain assumptions were needed as noted below: