10QSB 1 sgi_form10qsb93001.htm FORM 10-QSB 093001 10-Q.696
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-QSB

(Mark One)

[ x ] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended
       September 30, 2001.
  or [   ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ______ to     ________.
Commission File Number 2-93124

SGI International
(Exact name of small business issuer as specified in its charter)

Utah (State or other jurisdiction of incorporation or organization)  33-0119035 (I.R.S. Employer Identification No.)


1200 Prospect Street, Suite 325, La Jolla, California 92037
(Address of principal executive offices)

(858) 551-1090
(Issuer's telephone number)
 

(Former name, former address and former fiscal year, if changed since last report)




Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

[ x ] Yes [  ] No

The number of shares of common stock, no par value, outstanding as of November 6, 2001, was 97,991,352.

Transitional Small Business Disclosure Format (Check one): [   ] Yes [ x ] No
 
 


 

TABLE OF CONTENTS

FORM 10-QSB


PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets
3
Condensed Consolidated Statements of Operations
4
Condensed Consolidated Statement of Stockholders' Deficiency
5
Condensed Consolidated Statements of Cash Flows
6
Notes to Condensed Consolidated Financial Statements
7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Introductory Note
14
Results of Operations
14
Liquidity and Capital Resources
16
Accounting Pronouncements
18
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK
18
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
18
ITEM 2. CHANGES IN SECURITIES
18
ITEM 3. DEFAULTS UPON SENIOR DEBT SECURITIES
19
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
19
ITEM 5. OTHER INFORMATION
19
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
20
PART III. SIGNATURES
21


 
 
SGI INTERNATIONAL AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
 
September 30,
  
December 31,
 
2001
  
2000
 -
(Unaudited)
   -
ASSETS      
Current assets:      
Cash
$ 207,986
  
$ 410,352
Restricted cash deposit
200,000
  
200,000
Trade accounts receivable, less allowance for doubtful accounts of $48,026
  and $47,989
121,346
  
1,048,996
Inventories
413,926
  
414,268
Costs and estimated earnings in excess of billings on contracts
289,526
  
212,742
Prepaid expenses and other current assets
47,681
 
78,826
Total current assets
1,280,465
  
2,365,184
       
LFC Royalty rights, net
392,813
  
628,500
LFC Process equipment, net
135,979
  
230,225
Investment in LFC Investees
191,399
  
225,608
LFC cogeneration project, net
26,321
  
105,284
LFC related notes receivable, net
150,000
  
150,000
Property, plant and equipment, net of accumulated depreciation and 
amortization of $1,494,394 and $1,363,452
2,310,901
  
2,415,823
Goodwill, net of accumulated amortization of $276,534 and $240,585
203,710
  
239,659
Interest receivable on notes from stockholders
65,863
  
37,680
Other assets, net
27,770
 
26,337
-
$ 4,785,221
 
$ 6,424,300

LIABILITIES AND STOCKHOLDERS' DEFICIENCY		      
Current liabilities:      
Accounts payable
$ 1,288,783
  
$ 1,006,575
Notes payable, net
1,623,483
  
1,673,738
Accrued salaries, benefits and related taxes
1,677,302
  
1,271,155
Billings in excess of costs and estimated earnings on contracts
30,341
  
976,867
Interest payable
596,924
  
298,893
Other accrued expenses
584,407
  
284,470
Current maturities of long-term debt
4,170,386
 
4,170,386
Total current liabilities
9,971,626
  
9,682,084
Long-term debt, less current maturities
2,461,865
 
2,259,204
Total liabilities
12,433,491
 
11,941,288

COMMITMENTS AND CONTINGENCIES		      
       
Minority interest
452,830
 
454,997
       
Stockholders' deficiency:      
Convertible preferred stock
605
  
605
Common stock
56,035,115
  
53,885,499
Paid-in capital
8,698,383
  
7,929,297
Accumulated deficit
(72,364,203)
  
(67,316,386)
Notes receivable from stockholders
(471,000)
 
(471,000)
Total stockholders' deficiency
(8,101,100)
 
(5,971,985)
 
$ 4,785,221
 
$ 6,424,300

See notes to condensed consolidated financial statements.


 
SGI INTERNATIONAL AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three months
Nine months
ended September 30,
ended September 30,
2001
2000
2001
2000
REVENUES:
Contract revenues
734,055
$ 1,572,729
3,118,671
$ 3,954,131
EXPENSES:
Cost of sales
541,775
1,216,592
2,169,116
3,028,770
Research and development
245,495
199,127
1,068,748
953,014
Selling, general and administrative
823,821
996,798
2,546,844
2,824,505
Loss on LFC Investees
10,178
9,410
34,209
31,489
Legal and accounting
90,393
100,352
307,033
283,309
Depreciation and amortization
173,597
201,810
577,037
646,238
Total expenses
1,885,259
2,724,089
6,702,987
7,767,325
Loss from operations
(1,151,204)
(1,151,360)
(3,584,316)
(3,813,194)
NON-OPERATING INCOME (EXPENSES):
Interest expense
(525,033)
(380,963)
(1,585,622)
(794,679)
Other income
13,865
21,591
119,954
63,063
Loss before minority interest in consolidated subsidiary
(1,662,372)
(1,510,732)
(5,049,984)
(4,544,810)
Minority interest in loss of consolidated subsidiary
497
3,146
2,167
12,384
Net loss
$ (1,661,875)
$ (1,507,586)
$ (5,047,817)
$ (4,532,426)
Net loss per common share basic
$ (0.02)
$ (0.02)
$ (0.06)
$ (0.07)
Weighted average common
shares outstanding
92,452,095
68,229,474
85,698,137
62,518,327
 

See notes to condensed consolidated financial statements.
 


 
SGI INTERNATIONAL AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIENCY
(Unaudited)
 
   
Convertible
                  
Total
   
Preferred Stock
 
Common Stock
 
Paid-In
  
Accumulated
  
Notes
  
Stockholders'
 -
 
Shares
Amount
 
Shares
 
Amount
 
Capital
 
Deficit
 
Receivable
 
Deficiency
                                 
Balances at December 31, 2000  
60,518
  
$ 605
  
77,049,377
  
$ 53,885,499
  
$ 7,929,297
  
$ (67,316,386)
  
$ (471,000)
  
$ (5,971,985)
Issuance of common stock for   services and operating activities          
954,783
  
159,100
              
159,100
Issuance of common stock for cash, net          
11,879,350
  
989,710
  
(44,108)
          
945,602
Issuance of common stock for notes payable and interest          
7,067,659
  
1,000,806
              
1,000,806
Imputed beneficial conversion feature related to convertible debt                  
813,194
          
813,194
Net loss                      
(5,047,817)
      
(5,047,817)
                                 
                                 
Balances at September 30, 2001
 
60,518
 
$ 605
 
96,951,169
 
$ 56,035,115
 
$ 8,698,383
 
$ (72,364,203)
 
$ (471,000)
 
$ (8,101,100)

See notes to condensed consolidated financial statements.

SGI INTERNATIONAL AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

Nine months ended September 30,
 
2001
 
2000
Operating activities:        
Net loss  
(5,047,817)
  
$ (4,532,426)
Adjustments to reconcile net loss to net        
    cash used in operating activities:        
  Depreciation and amortization  
577,037
  
646,238
  Common stock issued for services and operating activities  
95,781
  
168,581
  Common stock issued for interest  
32,202
  
-
  Notes payable issued for services  
15,000
  
-
  Non-employee compensation expense on issuance of warrants  
-
  
11,412
  Amortization of beneficial conversion feature on debt  
895,981
  
172,079
  Accrued long-term interest expense  
150,142
  
136,484
  Accrued interest income  
(28,183)
  
(28,286)
  Minority interest in loss of consolidated subsidiary  
(2,167)
  
(12,384)
  Equity in net loss of LFC Investees  
34,209
  
31,489
  Changes in operating assets and liabilities:        
     Restricted cash deposit  
-
  
402,500
    Trade accounts receivable  
850,866
  
(317,284)
    Inventories  
342
  
469
    Prepaid expenses and other current assets  
31,145
  
40,138
    Accounts payable  
282,208
  
62,829
    Billings in excess of costs and estimated        
      earnings on contracts  
(946,526)
  
(67,980)
  Accrued salaries, benefits and related taxes  
406,147
  
330,235
  Interest payable  
331,961
  
83,096
  Other accrued expenses
 
363,256
 
(16,915)
Net cash used in operating activities
 
(1,958,416)
 
(2,889,725)
Investing activities:        
  Additions to LFC Process equipment      
(482,399)
  Purchase of property and equipment  
(26,020)
  
(157,269)
  Other assets
 
(2,683)
 
(692)
Net cash used in investing activities
 
(28,703)
 
(640,360)
Financing activities:        
  Payments of notes payable  
0
  
(7,125)
  Payments on line-of-credit  
0
  
(400,000)
  Proceeds from issuance of debt  
839,150
  
1,384,040
  Proceeds from issuance of common stock,net
 
945,603
 
2,484,297
Net cash provided by financing activities
 
1,784,753
 
3,461,212
Net increase (decrease) in cash  
(202,366)
  
(68,873)
Cash at beginning of period
 
410,352
 
278,391
Cash at end of period
 
$ 207,986
 
$ 209,518
Supplemental disclosure of cash flow information:        
  Interest paid  
$ 161,664
  
$ 384,301
Supplemental disclosure of non-cash activities:        
  Conversion of preferred stock  
-
  
38,313
  Common stock issued for accrued liabilities  
63,319
  
68,225
  Common stock issued for debt and interest  
968,604
  
401,172
  Imputed beneficial conversion feature related to convertible debt
 
736,349
 
913,361
See notes to condensed consolidated financial statements.        

SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(1) BUSINESS

SGI International, a Utah corporation, (together with its subsidiaries, hereinafter referred to as the "Company"), has its principal office in La Jolla, California. The Company is primarily in the business of developing and marketing energy-related technologies, which at the present include the Liquids From Coal ("LFC") Process and, the Opti-Crude Enhancement Technology ("OCET") Process. The LFCÒ Process is designed to convert and upgrade low-rank coal into a higher Btu more efficient fuel and simultaneously produce a low temperature coal tar, which contains valuable chemicals. The OCET Process is designed to increase the efficiency of oil refineries by deasphalting crude oil as well as residual oil bottoms ("resid"), which is produced in oil refining. Through Assembly Manufacturing Systems, Inc. ("AMS"), a wholly owned subsidiary, the Company is in the business of designing and manufacturing custom precision automated assembly equipment. The Company is also attempting to develop the Level Sensor ("LS") and Asphaltenes Processing Technology. The LS technology is designed to overcome a number of limitations presented by existing "off-the-shelf" equipment and sensors. The Company's sensor is characterized by a high degree of sensitivity, electrical stability and its small size. The Asphaltenes Processing Technology is intended to convert the unwanted asphaltene by-products of the OCET Process, as well as the existing solvent deasphalting processes, into a coal-like fuel.

(2) BASIS OF PRESENTATION

The accompanying condensed consolidated financial statements of SGI International and subsidiaries for the three and nine month periods end September 30, 2001, and 2000, are unaudited and in the opinion of management have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the instructions to Form 10-QSB. Accordingly, they do not include all information and notes required by accounting principles generally accepted in the United States of America for complete financial statements. These financial statements reflect all adjustments, consisting of only normal recurring adjustments which, in the opinion of management, are necessary for a fair statement of the Company's consolidated financial position as of September 30, 2001, and its consolidated results of operations for the three and nine months ended September 30, 2001 and 2000, changes in stockholders' deficiency for the nine months ended September 30, 2001 and cash flows for the nine months ended September 30, 2001, and 2000. The results of operations for the three and nine months ended September 30, 2001, are not necessarily indicative of the results to be expected for the year ending December 31, 2001. For more complete financial information, these financial statements, and the notes thereto, should be read in conjunction with the consolidated audited financial statements for the year ended December 31, 2000, included in the Company's Form 10-KSB previously filed with the Securities and Exchange Commission.

The accompanying condensed consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America, which contemplates continuation of the Company as a going concern and realization of assets and settlement of liabilities and commitments in the normal course of business. The recovery of amounts invested in the Company's principal assets, the LFC and OCET Process assets are dependent upon the Company's ability to adequately fund its on-going development operations and any capital contributions that may be required for its joint venture "LFC Technologies, LLC" ("LFC Tech") with MLFC Corporation ("MLFC"), a wholly-owned subsidiary of Mitsubishi Corp. Furthermore, the ability to successfully bring both LFC and OCET Process technologies to commercialization will ultimately depend on the Company's ability to attract sufficient additional equity, debt or other third-party financing.

Success in commercialization of the LFC Process and OCET Process is dependent in large part upon the ability to enter into satisfactory arrangements with other partners, financiers or customers and upon the ability of these third parties to perform their responsibilities. The resources required to profitably develop, construct and operate a commercial LFC plant are likely to include hundreds of millions of dollars, and expertise in major plant development and operations. There can be no assurance any licenses, joint venture agreements or other arrangements will be available on acceptable terms, if at all; that any revenue will be derived from such arrangements; or that, if revenue is generated, any of said arrangements will be profitable to the Company. If the Company is unsuccessful in its attempts to license the LFC Process or OCET Process, or if such third parties are unsuccessful in profitably developing and operating LFC plants, the planned business and operations of the Company will likely not succeed and the Company would not be able to recover the carrying value of the long-lived assets related to either the LFC Process or OCET Process.

The Company had negative working capital of $8,691,161 and an accumulated deficit of $ 72,364,203 at September 30, 2001. These factors and the Company's recurring losses from continuing operations, among others, raise substantial doubt about the Company's ability to continue as a going concern. The Company is currently seeking additional financing through public or private sales of its securities to fund working capital requirements. The Company will also seek funding through additional strategic partnerships, joint ventures or similar arrangements to commercialize the technologies. There can be no assurance that any collaborative financing arrangements through a joint venture, and/or with strategic partners, will be available when needed, or on terms acceptable to the Company. If adequate funds are not available, the Company may be required to curtail or terminate one or more of its operating activities. The Company is engaged in continuing negotiations to secure additional capital and financing, and while management believes funds can be raised, there is no assurance that their efforts will be successful. The consolidated financial statements do not include any adjustments that might be necessary in the event the Company cannot continue in existence.

(3) FINANCING TRANSACTIONS

During the quarter ended March 31, 2001, the Company, upon maturity, exchanged three notes payable aggregating $226,192 in principal and interest for 1,585,939 shares of common stock.

In February 2001, the Board of Directors approved the 2001 Non-Qualified Stock Option Plan (the "2001 Stock Plan") pursuant to which a maximum aggregate of 4,000,000 shares was reserved for grant. Under the 2001 Stock Plan, employees may be granted as an incentive or bonus an opportunity to purchase common stock in the Company, by way of non-qualified (a) stock options or warrants, (b) stock purchase rights, (c) stock appreciation rights and (d) long term performance awards. The terms and conditions of each award are at the discretion of the Board of Directors or any duly authorized committee. During the quarter ended March 31, 2001, in accordance with the 2001 Stock Plan , the Company issued warrants at fair market value to employees of the Company. The exercise price was not lower than the closing bid price on the grant date. The warrants and incentive options are exercisable for a total of 1,215,000 shares of common stock at $0.26 per share, the closing bid prices on the grant dates. The warrants are exercisable one year from the date of grant and expire on December 31, 2005.

During the quarter ended March 31, 2001, the Company issued approximately 70,000 shares of restricted common stock valued at approximately $14,500. The shares were issued in full settlement of two contractual claims which arose in the ordinary course of business.

During the quarter ended June 30, 2001, in accordance with the 2001 Stock Plan, the Company issued warrants at fair market value to employees and directors of the Company. The warrants are exercisable for a total of 430,000 shares of common stock at $0.14 per share, the closing bid price on the grant date. The warrants are exercisable one year from the date of grant and expire on December 31, 2006.

During the six months ended June 30, 2001, the Company issued approximately 7,529,000 shares of restricted common stock to accredited investors for approximately $724,000 in cash. In connection therewith the Company paid $21,633 in cash and 98,572 shares of restricted stock valued at $9,500 for services rendered.

During the six months ended June 30, 2001, the Company, as provided in their related consulting agreements, issued approximately 607,000 restricted common shares to consultants for services rendered, valued at approximately $107,500.

During the quarter ended June 30, 2001, the Company, upon demand, exchanged $74,661 in principal of one 12% note payable for 439,254 shares of common stock.

During the six month period ended June 30, 2001, the Company sold nine notes payable aggregating $253,401 for cash. The notes bear interest at 9% per annum, mature one year from the sale date and are unsecured. The notes and accrued interest are payable in cash or upon maturity, at the Company's option, by issuing 3,419,699 shares of restricted common stock. In conjunction with the sale of these notes the Company recorded a beneficial conversion feature of $250,599.

During the quarter ended June 30, 2001, the Company sold six notes payable aggregating $158,500 for cash. The notes bear interest at 9% per annum, mature two years from the sale date and are unsecured. The notes and accrued interest are payable in cash or upon maturity, at the Company's option, by issuing 2,737,543 shares of restricted common stock. In conjunction with the sale of these notes the Company recorded a beneficial conversion feature of $158,500.

During the quarter ended September 30, 2001, in accordance with the 2001 Stock Plan, the Company issued warrants at fair market value to employees of the Company. The exercise price was not lower than the closing bid price on the grant date. The warrants are exercisable for a total of 760,000 shares of common stock at $0.136 per share, the closing bid prices on the grant date. The warrants are exercisable one year from the date of grant and expire on December 31, 2006.

During the quarter ended September 30, 2001, the Company issued approximately 4,350,075 shares of restricted common stock to accredited investors for $265,300 in cash. In connection therewith the Company paid approximately $13,000 in cash for services rendered.

During the quarter ended September 30, 2001, the Company, as provided in their related consulting agreements, issued approximately 130,000 restricted common shares to consultants for services rendered, valued at approximately $17,544.

During the quarter ended September 30, 2001, the Company, upon demand and or maturity, exchanged $603,447 in principal and accrued interest on convertible note payable for 4,582,912 shares of common stock.

During the quarter ended September 30, 2001, the Company sold one note payable aggregating $30,000 for cash. The note bears interest at 9% per annum, matures one year from the sale date and is unsecured. The note and accrued interest is payable in cash or upon maturity, at the Company's option, by issuing 654,000 shares of restricted common stock.

During the quarter ended September 30, 2001, the Company sold ten notes payable aggregating $297,250 for cash. The notes bear interest at 9% per annum, mature two years from the sale date and are unsecured. The notes and accrued interest are payable in cash or upon maturity, at the Company's option, by issuing 7,015,100 shares of restricted common stock.

(4) COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS

Inventories

Inventories are stated at the lower of cost or market, using the first-in, first-out cost method. Substantially, all inventories represent finished goods held for use in operations.

Property and Equipment

 
September 30, 
December 31,
-
2001
2000
     
ENCOAL Demonstration Plant $ 2,121,000 $ 2,121,000
Laboratory equipment 1,036,000 1,036,000
Machinery and equipment 206,000 196,000
Computer equipment 268,000 266,000
Office furniture and fixtures 73,000 72,000
Leasehold improvements 54,000 54,000
Projects under construction
47,000
34,000
  3,805,000 3,779,000 
Less accumulated depreciation
(1,494,000)
(1,363,000)
                  Net property and equipment
$ 2,311,000
$ 2,416,000

Notes Payable

The Company from time to time issues various notes payable which contain a beneficial conversion feature. The Company in accordance with accounting principles generally accepted in the United States of America has recognized this beneficial conversion feature by allocating a portion of the proceeds to additional paid-in capital and as an offset to the notes payable. During the three and nine month periods ended September 30, 2001, the Company amortized approximately $ 292,000 and $896,000, respectively, of the beneficial conversion feature. Short-term notes payable and bank lines of credit are shown below net of the unamortized portion of the beneficial conversion feature.
 

 
September 30,
December 31,
-
2001
2000
     
Short-term notes payable $1,671,194 $ 2,307,468
Line of credit 100,000 -
Beneficial conversion feature
(147,711)
(633,730) 
Notes payable, net
$1,623,483
$ 1,673,738

Long-Term Debt

 
September 30,
December 31,
-
2001
2000
     
Long-term debt $7,035,482 $ 6,429,590
Current maturities of long-term debt (4,170,386) (4,170,386)
Beneficial conversion feature
(403,231)
- 
Notes payable, net
$2,461,865
$ 2,259,204

(5) SEGMENT REPORTING

The Company in the past has managed its segments based on business units that are in turn based along technological lines. These business units offer products and services to different markets in accordance with their underlying technology. Accordingly, the Company's three business segments were centered on the operations associated with the LFC Process, the OCET Process and the manufacturing of custom automated assembly systems.

During 2000, the Company's focus of its OCET lab and technical facilities slowly shifted from being primarily devoted to the OCET Process, to more of a general research and development facility capable of assisting the Company on its various research and development projects. These various research and development projects include (a) enhancing the value of the various CDL by-products, (b) advancing the Level Sensor Technology, (c) further developing the Asphaltenes to Coal Process and (d) advancing the development of the OCET Process. In keeping with this changing focus the Company effective February 28, 2001, combined the OCET lab and the SGI Technical Center ("SGITC") into one corporate wide research facility which will now be known solely as SGITC. Accordingly, all assets not solely devoted to the OCET Process and the OCET lab's lease have been transferred to SGITC, a division of SGI International. This combination will not result in any change in business segment reporting as the Company will continue to report the operations of its technical facilities as one segment by combining OCET's operations and those of SGITC.

The Company evaluates performance of each segment based on profit or loss from operations before income taxes. The Company has no significant inter-segment sales and inter-segment transfers are done at cost.
 
 
Three months ended
Automated
LFC
September 30
Assembly
Process
SGITC
Corporate
Total
2001
Revenues
$734,000
$-
$-
$-
$734,000
Income (loss) before income taxes
(6,000)
(526,000)
(159,000)
(971,000)
(1,662,000)
Equity in operations of investee
-
(10,000)
-
-
(10,000)
Depreciation and amortization
23,000
136,000
11,000
4,000
174,000
Research and development
-
86,000
159,000
1,000
246,000
Interest expense
-
-
-
525,000
525,000

2000
Revenues
$ 1,572,000
$ -
$ 1,000
$ -
$ 1,573,000
Income (loss) before income taxes
131,000
(608,000)
(105,000)
(926,000)
(1,508,000)
Equity in operations of investee
-
(9,000)
-
-
(9,000)
Depreciation and amortization
22,000
136,000
39,000
5,000
202,000
Research and development
-
106,000
79,000
14,000
199,000
Interest expense
-
-
-
381,000
381,000
Nine months ended
Automated
LFC
September 30
Assembly
Process
SGITC
Corporate
Total
2001
Revenues
$3,119,000
$-
$-
$-
$3,119,000
Income (loss) before income taxes
301,000
(1,877,000)
(495,000)
(2,977,000)
5,048,000
Equity in operations of investee
-
(34,000)
-
-
(34,000)
Depreciation and amortization
409,000
72,000
11,000
577,000
Research and Development
-
558,000
454,000
57,000
1,069,000
Interest expense
-
-
-
1,586,000
1,586,000
-
2000
Revenues
$ 3,949,000
$ -
$ 5,000
$ -
$3,954,000
Income (loss) before income taxes
288,000
(1,963,000)
(413,000)
(2,444,000)
(4,532,000)
Equity in operations of investee
-
(31,000)
-
-
(31,000)
Depreciation and amortization
85,000
411,000
138,000
12,000
646,000
Research and development
-
583,000
316,000
54,000
953,000
Interest expense
1,000
-
-
794,000
795,000

 
Total Assets by Segment
September 30, 2001
December 31, 2000
Identifiable assets, net        
Automated Assembly  
$ 1,024,000
  
$ 2,062,000
LFC Process  
3,414,000
  
3,844,000
SGITC   
97,000
  
153,000
Corporate
 
250,000
 
365,000
Total
 
$ 4,785,000
 
$ 6,424,000

(6) RELATED PARTY TRANSACTIONS

During the quarter ended March 31, 2001, two outside directors of the Company, upon maturity, exchanged their notes payable aggregating $96,506 in principal and interest for 459,554 shares of restricted common stock. On the day of the exchange the bid price of the Company's common stock was $0.21.

On December 10, 2000, as a condition for obtaining a $100,000 line-of-credit for AMS with a financial institution, an entity controlled by an outside director guaranteed the payment of the line-of-credit which expires on December 31, 2001. In return for this guarantee the Company during the quarter ended March 31, 2001, paid this entity 50,000 shares of restricted common stock valued at $10,000.

Effective March 23, 2001, the Company amended the terms of a $25,000 note payable to an outside director of the Company. Pursuant to the amendment the note is now due five days after the Company receives written notice of demand and may be paid by mutual consent in cash or restricted stock.

(7) NEW ACCOUNTING PRONOUNCEMENT

In June, 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets", which requires that goodwill and certain intangibles assets, including those recorded in past business combinations, no longer be amortized to earnings, but instead be tested for impairment at least annually. SFAS No. 142 will become effective for fiscal years beginning after December 15, 2001. The Company is required to adopt SFAS No. 142 on January 1, 2002 and has not determined the impact that this statement will have on its consolidated financial statements.

(8) SUBSEQUENT EVENTS

Debt. On September 14, 2001, the Company issued to holders of $3,422,000 of 99-D Amended Debentures and $724,000 of Amended Notes Payable (the Debentures and Notes are collectively hereafter referred to as the "Debt") an offering (the "2001 Exchange Offering") to extend the due dates of those instruments from September 30, 2001 to September 30, 2004. Essentially all of the holders of the Debt have accepted the offering terms, which will become effective once the Company officially 'closes' the transaction, by paying all interest in arrears. The terms of the extension accepted by the holders allows the Company to prepay the debt in whole or in part. Further, the Notes were amended to allow the holder to convert their notes into restricted stock of the Company after the passage of one year and in accordance with rule 144, at the greater of the average closing bid price of the Company's common stock for the ten business days prior to the receipt of notice of conversion or $0.80 per share. In the same way, the Debenture holders whose debentures had a similar conversion feature provided the stock price was at least $1.00, accepted the offering and accordingly the conversion price was reduced to $.80. In consideration for the reduction in the conversion price and the provision of a conversion feature to Note holders, the holders of the Debt agreed to waive all defaults on the Debt, if any, and extend the payment date to September 30, 2004. Interest under the Debt continues, after closing, to be due and payable quarterly in cash. The 2001 Exchange Offering was made only to existing Debt holders pursuant to exemptions provided by Sections 3(a)(9) and Section 4(2) of the Securities Act and Regulation D. No registration rights were granted to any of the securities amended under the 2001 Exchange Offering.

ENCOAL Transaction. Over the last sixteen months the Company has been in negotiations with a large U.S. utility that wished to acquire the ENCOAL LFC plant. This transaction would not only have provided the Company with much needed working capital but would have required this utility to make certain specified improvements to the plant and enter into other ancillary agreements. On September 25 the Company was informed that this utility did not wish to close this transaction. Subsequently the Company's stock price declined precipitously and it has had an extremely difficult time raising funding for its operations. While the Company continues to seek short and long term financing both for operations and for the start-up of the ENCOAL demonstration plant, it has reduced its work force. If the Company can obtain funding for the demonstration plant it believes it can re-employ personnel on either a full time basis or on a consulting basis.
 

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

INTRODUCTORY NOTE

This Quarterly Report on Form 10-QSB contains statements relative to (i) projections, (ii) estimates, (iii) future research plans and expenditures, (iv) potential collaborative arrangements, (v) opinions of management and (vi) the need for and availability of additional financing which may be considered "forward looking statements."

The forward-looking statements included herein are based on current expectations that involve a number of risks and uncertainties. These forward-looking statements are based on assumptions regarding the Company's business and technology, which involve judgments with respect to, among other things, future scientific, economic and competitive conditions, and future business decisions, as well as risk factors detailed from time to time in the Company's Securities and Exchange Commission reports (including this Form 10-QSB) and are difficult or impossible to predict accurately and many of which are beyond the control of the Company. Although the Company believes that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate and, therefore, there can be no assurance that the results contemplated will be realized and actual results may differ materially.

Readers are urged to carefully review and consider the various disclosures made by the Company in this report and in the Company's other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks and factors that may affect the Company's business. Therefore, historical results and percentage relationships will not necessarily be indicative of the operating results of any future period.

RESULTS OF OPERATIONS

Net Loss per Common Share. Basic net loss per common share for the three and nine month periods ended September 30, 2001, remained the same and decreased $0.01 per share, respectively, over the same prior year periods. The net loss for the three and nine month periods ended September 30, 2001, increased approximately 10% and 11%, respectively, over the same prior year periods. The decrease in basic net loss per share for the nine month period ended September 30, 2001 is primarily attributable to an increase in the weighted average number of common shares outstanding..

Revenues and Gross Margin. Revenues and cost of sales are primarily attributable to Assembly and Manufacturing Systems, Inc. (AMS) and are recorded using the percentage of completion method. Revenues at AMS for the three and nine month periods ended September 30, 2001, decreased 53% and 21%, respectively, over the same prior year periods. The Company attributes the decrease in revenues for both the three and nine months period to be associated with the decline in the U.S. economy. Future sales to all sectors for the remainder of 2001 are anticipated to be below prior year levels.

Gross margin as a percentage of sales for the three months period ended September 30, 2001, was 26%, compared to 23% over the same prior year period which is a return to normal operating levels. Gross margin for the nine months period ended September 30, 2001, was 30% compared to 23% over the same prior year period. Gross margins are anticipated to remain at or below normal operating levels throughout the remainder of the fiscal year due to declining order activity. Gross margin may vary in any given period as a result of the variations in profitability of contracts for large orders of automated production systems or specialty machines, as well as efficiencies related to the overall utilization of AMS' manufacturing resources.

Research and Development Expenses. Research and development expenses for the three and nine month periods ended September 30, 2001, increased 23% and 12%, respectively, over the same prior year periods. Research and development expenses are primarily related to the LFC Process as the Company has focused its efforts and limited resources on commercializing the LFC Process. Research and development of the Company's other technologies will resume at such time as more financial resources become available.

The increase in research and development expenses for both the three and nine month periods ended September 30, 2001 is primarily attributable to the Company capitalizing certain engineering costs in the prior year related to the ENCOAL LFC plant. Research and development expenses are anticipated to decline over the remainder of the year due to lack of resources.

Selling, General and Administrative Expenses. Selling, general and administrative expense for the three and nine month periods ended September 30, 2001, decreased 17% and 10%, respectively, over the same prior year periods. The decrease for both the three and nine month periods is primarily attributable to a reduction in financing related expenditures that includes costs for financial consultants.

Selling, general and administrative expenses for AMS for both the three and nine month periods ended September 30, 2001, decreased 4% respectively, over the same prior year periods. The decrease for both periods ended September 30, 2001 is primarily the result of decreased sales/order activity due to a slowing of the U.S. economy.

Loss on Investment in LFC Investee. The Company's share of the losses for its LFC joint venture (LFC Tech) for the three and nine months ended September 30, 2001, increased 8% and 9%, respectively, over the same prior year periods. The results of LFC Tech's operations are largely influenced by the timing of legal and accounting expenses associated with maintaining the various LFC Process patents. All other costs associated with the licensing and marketing of the LFC Process are being borne separately by the joint venture members.

Legal and Accounting Expenses. Legal and accounting expenses for the three and nine month periods ended September 30, 2001, decreased 10% and increased 9%, respectively, over the same prior year periods. The 10% decrease in legal expense for the three months period is essentially related to a decrease in legal activity such as lawsuits and contract negotiations. The increase of 9% for the nine months period is related primarily to the one-time recovery of certain legal expenses in the prior year, resulting from the settlement of various lawsuits to which the Company and AMS were parties.

Depreciation and Amortization Expenses. Depreciation and amortization expense for the three and nine month periods ended September 30, 2001, decreased 14% and 11%, respectively, over the same prior year periods. The decrease for both periods is due primarily to a significant portion of the Company's laboratory assets becoming fully depreciated.

Interest Expense.Interest expense for the three and nine months periods ended September 30, 2001, increased 38% and 100%, respectively, over the same prior year periods. The increase for both the three and nine month periods ended September 30, 2001, is primarily due to non-cash interest charges of related to the amortization of the imputed beneficial conversion feature of various convertible notes payable, primarily issued during the last half of 2000.

Other Income.Other income for the three and nine month periods ended September 30, 2001, decreased 36% and increased 90%, respectively over the same prior year periods. The decrease in other income for the three months period is essentially due to income related to the settlement of lawsuit in the prior year. The increase in other income for the nine months ended September 30, 2001, is due to the Company's receipt of $75,000 in the first quarter of the year in settlement of a lawsuit.

LIQUIDITY AND CAPITAL RESOURCES

As of September 30, 2001, the Company had assets totaling $4,785,000, including restricted cash of $200,000, and a working capital deficiency of $8,691,000. Current maturities of approximately $4,170,000 of long-term debt, along with current notes payable, accounts payable and accrued salaries primarily contribute to the working capital deficiency at September 30, 2001. This is compared to assets of approximately $6,509,000 and a $6,399,000 working capital deficiency as of September 30, 2000. The Company anticipates continued operating losses over the next twelve months and has both short-term and long-term liquidity deficiencies as of September 30, 2001.

In the short-term the Company has approximately $4,170,000 of unsecured notes payable and convertible debentures which matured on September 30, 2001 and must be paid or have the due date extended prior to October 31, 2001. On September 14, 2001 the Company initiated and exchange offering for the holders of these notes and debentures in which the due date of these instruments would be extended until September 30, 2004 and all defaults if any would be waived. As of October 31, 2001essentially all of the holders of these notes and debentures have accepted the offering terms, which will become effective once the Company officially 'closes' the transaction, by paying all interest in arrears (refer to Notes 7 to the Condensed Consolidated Financial Statements included in this Form 10-QSB for the terms of the offering.) At the current time, due to various events the Company has been unable to make the required interest payments. The rights to receive payments for both principal and interest of both the debenture holders and note holders are essentially similar with interest being payable quarterly in cash and the principal being due on September 30, 2001 as stated earlier. However, in the event the Company fails to make either a scheduled principal payment or interest payment on time, the rights for the two classes of debt holders are different. For the debenture holders, in the event the Company does not make either a scheduled principal or interest payment ten days after written notice of such non-payment from the debenture holder, then the debenture shall become immediately due and payable without presentment, demand, protest or further notice. For the note holders, in the event the Company does not make either a scheduled principal or interest payment on the due date then the note shall become immediately due and payable without presentment, demand, protest or notice of any other kind. As of September 30, 2001 the Company was in arrears on two quarter's interest payment to debenture and note holders. As of September 30, 2001 no written demands, from either class, for payment had been received by the Company. The Company believes that the reason for this is due to the ongoing dialogue with the debt holders the Company's diligent efforts to bring these obligations current.

Other short-term liquidity requirements are expected to be satisfied from existing cash balances, proceeds from the sale of equity securities in the future or other collaborative arrangements. Negotiations are on-going for the public and private placement of equity securities, the proceeds of which are intended to be used to satisfy the short-term liquidity deficiency. As a result of the slowing U.S. economy and the events of September 11 on the nation's financial markets the Company is currently finding that the raising of short term working capital is becoming more difficult. Consequently, the Company has found that it is unable to finance operations at the current level and has cutback on various administrative activities, curtailed all research and development efforts and severely reduced its workforce. If the Company is unsuccessful in securing sufficient short-term financing quickly and/or generating other revenues it will not be able to sustain operations.

The Company had long-term liquidity deficiencies at September 30, 2001. Over the long-term, the Company will require substantial additional funds to maintain and expand its research and development activities and ultimately to commercialize, with or without the assistance of corporate partners, any of its proposed technologies. Although there are no commitments, the Company believes the long-term liquidity deficiency will be satisfied through a combination of future equity sales, increased positive cash flows from operations, and research or other collaborative agreements, until such time as the commercialization of the LFC and OCET Processes result in positive cash flows. The Company is continuing to seek additional funds through the financing, sale and operation of the ENCOAL Demonstration plant and through collaborative or other arrangements with larger well capitalized companies, under which such companies may provide additional capital to the Company in exchange for exclusive or non-exclusive licenses or other rights to certain commercial projects, technologies and products the Company is developing. Although the Company is presently engaged in discussions with a number of suitable candidates, there can be no assurance that an agreement or agreements will arise from these discussions in a timely manner, or at all, or that revenues that may be generated thereby will offset operating expenses sufficiently to reduce the Company's short-term or long-term funding requirements.

The use of cash in operating activities of approximately $1,958,000 and $2,890,000 for the nine months ended September 30, 2001, and 2000, respectively, is primarily related to the Company's general operating expenses and R&D activities. The major components of cash flows used in operating activities are a net loss of approximately $5,048,000 offset by the net change in current assets and liabilities totaling $1,319,000 and other non-cash charges of $1,771,000. The net change in current assets and liabilities is primarily the result of increasing liabilities.

The Company's investing activities amounted to a use of cash of approximately $29,000 and $640,000 for the nine months ended September 30, 2001, and 2000, respectively. The use of cash in investing activities for the current year is significantly lower than in the past due to funds availability.

In 2001, the Company is projecting no significant capital expenditures at OCET and AMS will delay its approximately $300,000 capital improvements project which it started in 2000. Further, the Company, through collaboration with another larger and better capitalized company, intends to obtain financing estimated at approximately $16,000,000 for the ENCOAL Demonstration plant. The financing is for capital improvements, working capital and start-up expenditures which are necessary to set the plant on more of a commercial footing and to position it as a reference plant for potential future commercial LFC facilities. Other than the improvements intended to be made to the ENCOAL Demonstration plant, the Company as of September 30, 2001, does not have any material requirements or commitments for capital expenditures. The amount of cash used for investing activities in a given period is directly related to development requirements and cash availability.

The Company's net financing activities raised approximately $1,785,000 and $3,461,000 for the nine months ended September 30, 2001, and 2000, respectively. These funds were raised primarily through the private placement of debt and equity securities for both periods. See Note 3 "Financing Transactions" to the Notes to the Condensed Consolidated Financial Statements included in this Form 10-QSB. The Company believes that the slowing of the nations economy and its effects on the financial is partially responsible for the reduction in its financing activities.

During the fourth quarter of 2000, the Company was successful in obtaining a new line-of-credit to provide short term working capital to AMS. The line allows maximum borrowings of $100,000 and bears interest at prime plus 1%. At September 30, 2001, AMS had borrowings of $100,000 on this line of credit. The agreement expires November 5, 2001.

As stated earlier the Company intends to obtain financing primarily related to improvements for the ENCOAL Demonstration plant estimated at $16,000,000. The Company believes, due to the plant's special nature, that financing for these improvements will not likely be obtained through conventional methods and that a strategic partner or financier capable of utilizing Internal Revenue Code Section 29 tax credits will be required. Due to the tax laws surrounding the realization of these tax credits the financing of the ENCOAL Demonstration plant's improvements will require that the Company sell or lease the plant directly to the financier in order to facilitate the transaction. Following any such transaction the Company expects it will continue to be involved with various aspects of the project, including the supervision of the improvements. In this case the Company will most likely not be required to make any expenditures for the improvements discussed earlier or assume the repayment of the financing associated with the improvements. There is no assurance that the Company will be able to obtain this financing, or if available, that its terms will be acceptable.

The amount of money raised during a given period is dependent upon financial market conditions, technological progress and the Company's projected funding requirements. The Company anticipates that future financing activities will be influenced by the aforementioned factors. Significant future financing activities will be required to fund future operating and investing activities and to maintain debt service. While the Company is engaged in continuing negotiations to secure additional capital and financing, there is no assurance such funding will be available or if received will be adequate.

ACCOUNTING PRONOUNCEMENTS

In June, 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets", which requires that goodwill and certain intangibles assets, including those recorded in past business combinations, no longer be amortized to earnings, but instead be tested for impairment at least annually. SFAS No. 142 will become effective for fiscal years beginning after December 15, 2001. The Company is required to adopt SFAS No. 142 on January 1, 2002 and has not determined the impact that this statement will have on its consolidated financial statements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

[NONE]

Part II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Company and its subsidiaries are from time to time involved in litigation arising in the ordinary course of their respective businesses. As of September 30, 2001, the Company was not party to any material legal proceeding.

ITEM 2. CHANGES IN SECURITIES

During the quarter ended September 30, 2001, in accordance with the 2001 Stock Plan , the Company issued warrants at fair market value to employees of the Company. The exercise price was not lower than the closing bid price on the grant date. The warrants are exercisable for a total of 760,000 shares of common stock at $0.136 per share, the closing bid prices on the grant date. The warrants were granted in reliance upon exemptions from registration pursuant to Section 4(2) of the Securities Act and Regulation D. Investment representations were obtained from each of the employees. The warrants are exercisable one year from the date of grant and expire on December 31, 2006.

During the quarter ended September 30, 2001, the Company issued approximately 4,350,075 shares of restricted common stock to accredited investors for $265,300 in cash. In connection therewith the Company paid approximately $13,000 in cash for services rendered. These securities were issued pursuant to the exemptions provided by Section 4(2) of the Securities Act and Regulation D. Investment representations were obtained from the accredited investors and legends were placed on the certificates.

During the quarter ended September 30, 2001, the Company, as provided in their related consulting agreements, issued approximately 130,000 restricted common shares to consultants for services rendered, valued at approximately $17,544. These securities were issued pursuant to the exemptions provided by Section 4(2) of the Securities Act and Regulation D. Investment representations were obtained and legends were placed on the certificates.

During the quarter ended September 30, 2001, the Company, upon demand and or maturity, exchanged $603,447 in principal and accrued interest on convertible note payable for 4,582,912 shares of common stock. The securities were issued pursuant to the exemptions provided by Section 4(2) of the Securities Act and Regulation D. Investment representations were obtained from the accredited investor involved and restrictive legends were placed on the certificates.

During the quarter ended September 30, 2001, the Company sold one note payable aggregating $30,000 for cash. The note bears interest at 9% per annum, matures one year from the sale date and is unsecured. The note and accrued interest is payable in cash or upon maturity, at the Company's option, by issuing 654,000 shares of restricted common stock. The securities were issued pursuant to the exemptions provided by Section 4(2) of the Securities Act and Regulation D. Investment representations were obtained from the accredited investors.

During the quarter ended September 30, 2001, the Company sold ten notes payable aggregating $297,250 for cash. The notes bear interest at 9% per annum, mature two years from the sale date and are unsecured. The notes and accrued interest are payable in cash or upon maturity, at the Company's option, by issuing 7,015,100 shares of restricted common stock. The securities were issued pursuant to the exemptions provided by Section 4(2) of the Securities Act and Regulation D. Investment representations were obtained from the accredited investors.

ITEM 3. DEFAULTS UPON SENIOR DEBT SECURITIES

[NONE]

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

[NONE]

ITEM 5. OTHER INFORMATION

SGI International ("SGI") and subsidiaries of AEI Resources (collectively "AEI"), specifically, Bluegrass Coal Development Company and Americoal Development Company have verbally agreed to extend the term within which compliance must occur pursuant to the Amended and Restated Acquisition Agreement (the "Acquisition Agreement) originally dated December 9, 1999.  This agreement essentially provides SGI an undetermined extension.  All other terms and conditions of the Acquisition Agreement remain in full force and effect.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

4.1 Form of Warrant (1)
4.2 Form of Restricted Stock Subscription Agreement (2)
4.3 Form of Promissory Note payable in cash or stock (3)
_____________________________________
(1) Incorporated by reference to Registrants report on Form 10KSB ending June 30, 2001.
(2) Incorporated by reference to Registrants report on Form 10KSB ending December 31, 2000.
(2) Incorporated by reference to Registrants report on Form 10QSB ending March 31, 2001.

(b) Reports on 8-K. None
 

Part III. SIGNATURES
 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
 

SGI INTERNATIONAL
 

/s/ MICHAEL L. ROSE                          November 19, 2001
Michael L. Rose,
President and Chief Executive Officer

/s/ GEORGE E. DONLOU                       November 19, 2001
George E. Donlou,
Controller