****UNITED STATES****SECURITIES AND EXCHANGE COMMISSION****Washington, DC 20549**
**FORM 10-QSB**
**(Mark One)**[ x ] Quarterly ReportPursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934for the quarterly period ended      September 30, 2001. or[   ] TransitionReport Pursuant to Section 13 or 15(d) of the Securities Exchange Act of1934 for the transition period from ______ to     ________.Commission FileNumber 2-93124
***SGI International***(Exact name of smallbusiness issuer as specified in its charter)**Utah**(State or other jurisdiction of incorporation or organization)  **33-0119035**(I.R.S. Employer Identification No.)
**1200 ProspectStreet, Suite 325, La Jolla, California 92037**(Address of principalexecutive offices)
**(858) 551-1090**(Issuer's telephonenumber) 
(Former name, formeraddress 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 theExchange Act during the past 12 months (or for such shorter period thatthe registrant was required to file such reports), and (2) has been subjectto such filing requirements for the past 90 days.
[ x ] Yes [  ]No
The number of sharesof common stock, no par value, outstanding as of November 6, 2001, was97,991,352.
Transitional SmallBusiness Disclosure Format (Check one): [   ] Yes [ x ] No  
 
**TABLE OF CONTENTS**
**FORM 10-QSB**
PARTI.FINANCIALINFORMATIONITEM1. FINANCIAL STATEMENTSCondensedConsolidated Balance Sheets3CondensedConsolidated Statements of Operations4CondensedConsolidated Statement of Stockholders' Deficiency5CondensedConsolidated Statements of Cash Flows6Notesto Condensed Consolidated Financial Statements7ITEM2. MANAGEMENT'S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITIONAND RESULTS OF OPERATIONSIntroductoryNote14Resultsof Operations14Liquidityand Capital Resources16AccountingPronouncements18ITEM3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKETRISK18PARTII.OTHERINFORMATIONITEM1. LEGAL PROCEEDINGS18ITEM2. CHANGES IN SECURITIES18ITEM3. DEFAULTS UPON SENIOR DEBT SECURITIES19ITEM4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS19ITEM5. OTHER INFORMATION19ITEM6. EXHIBITS AND REPORTS ON FORM 8-K20PARTIII.SIGNATURES21
  **SGI INTERNATIONAL AND SUBSIDIARIES****CONDENSEDCONSOLIDATED BALANCE SHEETS** **September 30,** December 31, **2001** 2000 -**(Unaudited)**  -ASSETS   Currentassets:   Cash$ 207,986 $ 410,352Restrictedcash deposit200,000 200,000Tradeaccounts receivable, less allowance for doubtful accounts of $48,026  and $47,989121,346 1,048,996Inventories413,926 414,268Costsand estimated earnings in excess of billings on contracts289,526 212,742Prepaidexpenses and other current assets47,681 78,826Totalcurrent assets1,280,465 2,365,184    LFCRoyalty rights, net392,813 628,500LFCProcess equipment, net135,979 230,225Investmentin LFC Investees191,399 225,608LFCcogeneration project, net26,321 105,284LFCrelated notes receivable, net150,000 150,000Property,plant and equipment, net of accumulated depreciation and amortization of $1,494,394and $1,363,4522,310,901 2,415,823Goodwill,net of accumulated amortization of $276,534 and $240,585203,710 239,659Interestreceivable on notes from stockholders65,863 37,680Otherassets, net27,770 26,337-$ 4,785,221 $ 6,424,300LIABILITIES AND STOCKHOLDERS'DEFICIENCY   Currentliabilities:   Accountspayable$ 1,288,783 $ 1,006,575Notespayable, net1,623,483 1,673,738Accruedsalaries, benefits and related taxes1,677,302 1,271,155Billingsin excess of costs and estimated earnings on contracts30,341 976,867Interestpayable596,924 298,893Otheraccrued expenses584,407 284,470Currentmaturities of long-term debt4,170,386 4,170,386Totalcurrent liabilities9,971,626 9,682,084Long-termdebt, less current maturities2,461,865 2,259,204Totalliabilities12,433,491 11,941,288COMMITMENTS AND CONTINGENCIES       Minorityinterest452,830 454,997    Stockholders'deficiency:   Convertiblepreferred stock605 605Commonstock56,035,115 53,885,499Paid-incapital8,698,383 7,929,297Accumulateddeficit(72,364,203) (67,316,386)Notesreceivable from stockholders(471,000) (471,000)Totalstockholders' deficiency(8,101,100) (5,971,985) $ 4,785,221 $ 6,424,300
*See notes to condensedconsolidated financial statements.*
 **SGI INTERNATIONAL AND SUBSIDIARIES****CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS****(Unaudited)**Three monthsNine monthsended September30,ended September30,2001200020012000REVENUES:Contractrevenues**734,055**$ 1,572,729**3,118,671**$ 3,954,131EXPENSES:Costof sales**541,775**1,216,592**2,169,116**3,028,770Researchand development**245,495**199,127**1,068,748**953,014Selling,general and administrative**823,821**996,798**2,546,844**2,824,505Losson LFC Investees**10,178**9,410**34,209**31,489Legaland accounting**90,393**100,352**307,033**283,309Depreciationand amortization**173,597**201,810**577,037**646,238Totalexpenses**1,885,259**2,724,089**6,702,987**7,767,325Lossfrom operations**(1,151,204)**(1,151,360)**(3,584,316)**(3,813,194)NON-OPERATINGINCOME (EXPENSES):Interestexpense**(525,033)**(380,963)**(1,585,622)**(794,679)Otherincome**13,865**21,591**119,954**63,063Lossbefore minority interest in consolidated subsidiary**(1,662,372)**(1,510,732)**(5,049,984)**(4,544,810)Minorityinterest in loss of consolidated subsidiary**497**3,146**2,167**12,384Netloss**$(1,661,875)**$ (1,507,586)**$(5,047,817)**$ (4,532,426)Netloss per common share basic**$(0.02)**$ (0.02)**$(0.06)**$ (0.07)Weightedaverage commonsharesoutstanding**92,452,095**68,229,474**85,698,137**62,518,327 
*See notes to condensedconsolidated financial statements*. 
 **SGI INTERNATIONAL AND SUBSIDIARIES****CONDENSEDCONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIENCY****(Unaudited)**   Convertible         Total  Preferred Stock Common Stock Paid-In Accumulated Notes Stockholders' - SharesAmount Shares Amount Capital Deficit Receivable Deficiency                 Balancesat 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 commonstock for   services and operating activities     954,783 159,100       159,100Issuance of commonstock for cash, net     11,879,350 989,710 (44,108)     945,602Issuance of commonstock for notes payable and interest     7,067,659 1,000,806       1,000,806Imputed beneficialconversion feature related to convertible debt         813,194     813,194Net loss           (5,047,817)   (5,047,817)                                  Balancesat 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 condensedconsolidated financial statements*.

**SGI INTERNATIONAL AND SUBSIDIARIES****CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS****(Unaudited)****Ninemonths ended September 30,** **2001** 2000Operatingactivities:    Netloss **(5,047,817)** $ (4,532,426)Adjustmentsto 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)Netcash used in operating activities **(1,958,416)** (2,889,725)Investingactivities:     Additions to LFC Process equipment   (482,399) Purchase of property and equipment **(26,020)** (157,269) Other assets **(2,683)** (692)Netcash used in investing activities **(28,703)** (640,360)Financingactivities:     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** 2,484,297Netcash provided by financing activities **1,784,753** 3,461,212Netincrease (decrease) in cash **(202,366)** (68,873)Cashat beginning of period **410,352** 278,391Cashat end of period **$207,986** $ 209,518Supplementaldisclosure of cash flow information:     Interest paid **$161,664** $ 384,301Supplementaldisclosure 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*Seenotes to condensed consolidated financial statements.*    

**SGI INTERNATIONAL AND SUBSIDIARIES****NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS****(Unaudited)**
**(1) BUSINESS**
SGI International,a Utah corporation, (together with its subsidiaries, hereinafter referredto as the "Company"), has its principal office in La Jolla, California.The Company is primarily in the business of developing and marketing energy-relatedtechnologies, which at the present include the Liquids From Coal ("LFC")Process and, the Opti-Crude Enhancement Technology ("OCET") Process. TheLFCÒ Process is designed to convert and upgrade low-rank coal intoa higher Btu more efficient fuel and simultaneously produce a low temperaturecoal tar, which contains valuable chemicals. The OCET Process is designedto increase the efficiency of oil refineries by deasphalting crude oilas 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 precisionautomated assembly equipment. The Company is also attempting to developthe Level Sensor ("LS") and Asphaltenes Processing Technology. The LS technologyis designed to overcome a number of limitations presented by existing "off-the-shelf"equipment and sensors. The Company's sensor is characterized by a highdegree of sensitivity, electrical stability and its small size. The AsphaltenesProcessing Technology is intended to convert the unwanted asphaltene by-productsof the OCET Process, as well as the existing solvent deasphalting processes,into a coal-like fuel.
**(2) BASIS OF PRESENTATION**
The accompanying condensedconsolidated financial statements of SGI International and subsidiariesfor the three and nine month periods end September 30, 2001, and 2000,are unaudited and in the opinion of management have been prepared in accordancewith accounting principles generally accepted in the United States of Americafor interim financial information and the instructions to Form 10-QSB.Accordingly, they do not include all information and notes required byaccounting principles generally accepted in the United States of Americafor complete financial statements. These financial statements reflect alladjustments, consisting of only normal recurring adjustments which, inthe opinion of management, are necessary for a fair statement of the Company'sconsolidated financial position as of September 30, 2001, and its consolidatedresults of operations for the three and nine months ended September 30,2001 and 2000, changes in stockholders' deficiency for the nine monthsended September 30, 2001 and cash flows for the nine months ended September30, 2001, and 2000. The results of operations for the three and nine monthsended September 30, 2001, are not necessarily indicative of the resultsto be expected for the year ending December 31, 2001. For more completefinancial information, these financial statements, and the notes thereto,should be read in conjunction with the consolidated audited financial statementsfor the year ended December 31, 2000, included in the Company's Form 10-KSBpreviously filed with the Securities and Exchange Commission.
The accompanying condensedconsolidated financial statements are prepared in conformity with accountingprinciples generally accepted in the United States of America, which contemplatescontinuation of the Company as a going concern and realization of assetsand settlement of liabilities and commitments in the normal course of business.The recovery of amounts invested in the Company's principal assets, theLFC and OCET Process assets are dependent upon the Company's ability toadequately fund its on-going development operations and any capital contributionsthat may be required for its joint venture "LFC Technologies, LLC" ("LFCTech") with MLFC Corporation ("MLFC"), a wholly-owned subsidiary of MitsubishiCorp. Furthermore, the ability to successfully bring both LFC and OCETProcess technologies to commercialization will ultimately depend on theCompany's ability to attract sufficient additional equity, debt or otherthird-party financing.
Success in commercializationof the LFC Process and OCET Process is dependent in large part upon theability to enter into satisfactory arrangements with other partners, financiersor customers and upon the ability of these third parties to perform theirresponsibilities. The resources required to profitably develop, constructand operate a commercial LFC plant are likely to include hundreds of millionsof dollars, and expertise in major plant development and operations. Therecan be no assurance any licenses, joint venture agreements or other arrangementswill be available on acceptable terms, if at all; that any revenue willbe derived from such arrangements; or that, if revenue is generated, anyof said arrangements will be profitable to the Company. If the Companyis unsuccessful in its attempts to license the LFC Process or OCET Process,or if such third parties are unsuccessful in profitably developing andoperating LFC plants, the planned business and operations of the Companywill likely not succeed and the Company would not be able to recover thecarrying value of the long-lived assets related to either the LFC Processor OCET Process.
The Company had negativeworking capital of $8,691,161 and an accumulated deficit of $ 72,364,203at September 30, 2001. These factors and the Company's recurring lossesfrom continuing operations, among others, raise substantial doubt aboutthe Company's ability to continue as a going concern. The Company is currentlyseeking additional financing through public or private sales of its securitiesto fund working capital requirements. The Company will also seek fundingthrough additional strategic partnerships, joint ventures or similar arrangementsto commercialize the technologies. There can be no assurance that any collaborativefinancing arrangements through a joint venture, and/or with strategic partners,will be available when needed, or on terms acceptable to the Company. Ifadequate funds are not available, the Company may be required to curtailor terminate one or more of its operating activities. The Company is engagedin continuing negotiations to secure additional capital and financing,and while management believes funds can be raised, there is no assurancethat their efforts will be successful. The consolidated financial statementsdo not include any adjustments that might be necessary in the event theCompany cannot continue in existence.
**(3) FINANCING TRANSACTIONS**
During the quarterended March 31, 2001, the Company, upon maturity, exchanged three notespayable aggregating $226,192 in principal and interest for 1,585,939 sharesof common stock.
In February 2001, theBoard of Directors approved the 2001 Non-Qualified Stock Option Plan (the"2001 Stock Plan") pursuant to which a maximum aggregate of 4,000,000 shareswas reserved for grant. Under the 2001 Stock Plan, employees may be grantedas an incentive or bonus an opportunity to purchase common stock in theCompany, by way of non-qualified (a) stock options or warrants, (b) stockpurchase rights, (c) stock appreciation rights and (d) long term performanceawards. The terms and conditions of each award are at the discretion ofthe Board of Directors or any duly authorized committee. During the quarterended March 31, 2001, in accordance with the 2001 Stock Plan , the Companyissued warrants at fair market value to employees of the Company. The exerciseprice was not lower than the closing bid price on the grant date. The warrantsand incentive options are exercisable for a total of 1,215,000 shares ofcommon 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 expireon December 31, 2005.
During the quarterended March 31, 2001, the Company issued approximately 70,000 shares ofrestricted common stock valued at approximately $14,500. The shares wereissued in full settlement of two contractual claims which arose in theordinary course of business.
During the quarterended June 30, 2001, in accordance with the 2001 Stock Plan, the Companyissued warrants at fair market value to employees and directors of theCompany. The warrants are exercisable for a total of 430,000 shares ofcommon 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 expireon December 31, 2006.
During the six monthsended June 30, 2001, the Company issued approximately 7,529,000 sharesof restricted common stock to accredited investors for approximately $724,000in cash. In connection therewith the Company paid $21,633 in cash and 98,572shares of restricted stock valued at $9,500 for services rendered.
During the six monthsended June 30, 2001, the Company, as provided in their related consultingagreements, issued approximately 607,000 restricted common shares to consultantsfor services rendered, valued at approximately $107,500.
During the quarterended June 30, 2001, the Company, upon demand, exchanged $74,661 in principalof one 12% note payable for 439,254 shares of common stock.
During the six monthperiod ended June 30, 2001, the Company sold nine notes payable aggregating$253,401 for cash. The notes bear interest at 9% per annum, mature oneyear from the sale date and are unsecured. The notes and accrued interestare payable in cash or upon maturity, at the Company's option, by issuing3,419,699 shares of restricted common stock. In conjunction with the saleof these notes the Company recorded a beneficial conversion feature of$250,599.
During the quarterended June 30, 2001, the Company sold six notes payable aggregating $158,500for cash. The notes bear interest at 9% per annum, mature two years fromthe sale date and are unsecured. The notes and accrued interest are payablein cash or upon maturity, at the Company's option, by issuing 2,737,543shares of restricted common stock. In conjunction with the sale of thesenotes the Company recorded a beneficial conversion feature of $158,500.
During the quarterended September 30, 2001, in accordance with the 2001 Stock Plan, the Companyissued warrants at fair market value to employees of the Company. The exerciseprice was not lower than the closing bid price on the grant date. The warrantsare exercisable for a total of 760,000 shares of common stock at $0.136per share, the closing bid prices on the grant date. The warrants are exercisableone year from the date of grant and expire on December 31, 2006.
During the quarterended September 30, 2001, the Company issued approximately 4,350,075 sharesof restricted common stock to accredited investors for $265,300 in cash.In connection therewith the Company paid approximately $13,000 in cashfor services rendered.
During the quarterended September 30, 2001, the Company, as provided in their related consultingagreements, issued approximately 130,000 restricted common shares to consultantsfor services rendered, valued at approximately $17,544.
During the quarterended September 30, 2001, the Company, upon demand and or maturity, exchanged$603,447 in principal and accrued interest on convertible note payablefor 4,582,912 shares of common stock.
During the quarterended September 30, 2001, the Company sold one note payable aggregating$30,000 for cash. The note bears interest at 9% per annum, matures oneyear from the sale date and is unsecured. The note and accrued interestis payable in cash or upon maturity, at the Company's option, by issuing654,000 shares of restricted common stock.
During the quarterended September 30, 2001, the Company sold ten notes payable aggregating$297,250 for cash. The notes bear interest at 9% per annum, mature twoyears from the sale date and are unsecured. The notes and accrued interestare payable in cash or upon maturity, at the Company's option, by issuing7,015,100 shares of restricted common stock.
**(4) COMPOSITIONOF CERTAIN FINANCIAL STATEMENT CAPTIONS**
Inventories
Inventories are statedat the lower of cost or market, using the first-in, first-out cost method.Substantially, all inventories represent finished goods held for use inoperations.
Property and Equipment September 30, December 31,-20012000   ENCOALDemonstration Plant$2,121,000$2,121,000Laboratoryequipment1,036,0001,036,000Machineryand equipment206,000196,000Computerequipment268,000266,000Officefurniture and fixtures73,00072,000Leaseholdimprovements54,00054,000Projectsunder construction47,00034,000 3,805,0003,779,000 Lessaccumulated depreciation(1,494,000)(1,363,000)                 Net property and equipment$2,311,000$2,416,000
Notes Payable
The Company from timeto time issues various notes payable which contain a beneficial conversionfeature. The Company in accordance with accounting principles generallyaccepted in the United States of America has recognized this beneficialconversion feature by allocating a portion of the proceeds to additionalpaid-in capital and as an offset to the notes payable. During the threeand nine month periods ended September 30, 2001, the Company amortizedapproximately $ 292,000 and $896,000, respectively, of the beneficial conversionfeature. Short-term notes payable and bank lines of credit are shown belownet of the unamortized portion of the beneficial conversion feature.  September 30,December 31,-20012000   Short-termnotes payable$1,671,194$2,307,468Lineof credit100,000-Beneficialconversion feature(147,711)(633,730) Notespayable, net$1,623,483$1,673,738
Long-Term Debt September 30,December 31,-20012000   Long-termdebt$7,035,482$6,429,590Currentmaturities of long-term debt(4,170,386)(4,170,386)Beneficialconversion feature(403,231)- Notespayable, net$2,461,865$2,259,204
**(5) SEGMENT REPORTING**
The Company in thepast has managed its segments based on business units that are in turnbased along technological lines. These business units offer products andservices to different markets in accordance with their underlying technology.Accordingly, the Company's three business segments were centered on theoperations associated with the LFC Process, the OCET Process and the manufacturingof custom automated assembly systems.
During 2000, the Company'sfocus of its OCET lab and technical facilities slowly shifted from beingprimarily devoted to the OCET Process, to more of a general research anddevelopment facility capable of assisting the Company on its various researchand development projects. These various research and development projectsinclude (a) enhancing the value of the various CDL by-products, (b) advancingthe Level Sensor Technology, (c) further developing the Asphaltenes toCoal Process and (d) advancing the development of the OCET Process. Inkeeping with this changing focus the Company effective February 28, 2001,combined the OCET lab and the SGI Technical Center ("SGITC") into one corporatewide 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 leasehave been transferred to SGITC, a division of SGI International. This combinationwill not result in any change in business segment reporting as the Companywill continue to report the operations of its technical facilities as onesegment by combining OCET's operations and those of SGITC.
The Company evaluatesperformance of each segment based on profit or loss from operations beforeincome taxes. The Company has no significant inter-segment sales and inter-segmenttransfers are done at cost.  Threemonths endedAutomatedLFCSeptember30AssemblyProcessSGITCCorporateTotal2001Revenues$734,000$-$-$-$734,000Income(loss) before income taxes(6,000)(526,000)(159,000)(971,000)(1,662,000)Equityin operations of investee-(10,000)--(10,000)Depreciationand amortization23,000136,00011,0004,000174,000Researchand development-86,000159,0001,000246,000Interestexpense---525,000525,0002000Revenues$ 1,572,000$ -$ 1,000$ -$ 1,573,000Income(loss) before income taxes131,000(608,000)(105,000)(926,000)(1,508,000)Equityin operations of investee-(9,000)--(9,000)Depreciationand amortization22,000136,00039,0005,000202,000Researchand development-106,00079,00014,000199,000Interestexpense---381,000381,000Ninemonths endedAutomatedLFCSeptember30AssemblyProcessSGITCCorporateTotal2001Revenues$3,119,000$-$-$-$3,119,000Income(loss) before income taxes301,000(1,877,000)(495,000)(2,977,000)5,048,000Equityin operations of investee-(34,000)--(34,000)Depreciationand amortization409,00072,00011,000577,000Researchand Development-558,000454,00057,0001,069,000Interestexpense---1,586,0001,586,000-2000Revenues$ 3,949,000$ -$ 5,000$ -$3,954,000Income(loss) before income taxes288,000(1,963,000)(413,000)(2,444,000)(4,532,000)Equityin operations of investee-(31,000)--(31,000)Depreciationand amortization85,000411,000138,00012,000646,000Researchand development-583,000316,00054,000953,000Interestexpense1,000--794,000795,000 **TotalAssets by Segment**September 30,2001December 31, 2000Identifiableassets, net    AutomatedAssembly $ 1,024,000 $ 2,062,000LFCProcess 3,414,000 3,844,000SGITC  97,000 153,000Corporate 250,000 365,000Total $ 4,785,000 $ 6,424,000
**(6) RELATED PARTYTRANSACTIONS**
During the quarterended March 31, 2001, two outside directors of the Company, upon maturity,exchanged their notes payable aggregating $96,506 in principal and interestfor 459,554 shares of restricted common stock. On the day of the exchangethe 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 financialinstitution, an entity controlled by an outside director guaranteed thepayment of the line-of-credit which expires on December 31, 2001. In returnfor 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 outsidedirector of the Company. Pursuant to the amendment the note is now duefive days after the Company receives written notice of demand and may bepaid by mutual consent in cash or restricted stock.
**(7) NEW ACCOUNTINGPRONOUNCEMENT**
In June, 2001, theFASB issued SFAS No. 142, "Goodwill and Other Intangible Assets", whichrequires that goodwill and certain intangibles assets, including thoserecorded in past business combinations, no longer be amortized to earnings,but instead be tested for impairment at least annually. SFAS No. 142 willbecome effective for fiscal years beginning after December 15, 2001. TheCompany is required to adopt SFAS No. 142 on January 1, 2002 and has notdetermined the impact that this statement will have on its consolidatedfinancial statements.
**(8) SUBSEQUENT EVENTS**
Debt. On September14, 2001, the Company issued to holders of $3,422,000 of 99-D Amended Debenturesand $724,000 of Amended Notes Payable (the Debentures and Notes are collectivelyhereafter referred to as the "Debt") an offering (the "2001 Exchange Offering")to extend the due dates of those instruments from September 30, 2001 toSeptember 30, 2004. Essentially all of the holders of the Debt have acceptedthe offering terms, which will become effective once the Company officially'closes' the transaction, by paying all interest in arrears. The termsof the extension accepted by the holders allows the Company to prepay thedebt in whole or in part. Further, the Notes were amended to allow theholder to convert their notes into restricted stock of the Company afterthe passage of one year and in accordance with rule 144, at the greaterof the average closing bid price of the Company's common stock for theten business days prior to the receipt of notice of conversion or $0.80per share. In the same way, the Debenture holders whose debentures hada similar conversion feature provided the stock price was at least $1.00,accepted the offering and accordingly the conversion price was reducedto $.80. In consideration for the reduction in the conversion price andthe provision of a conversion feature to Note holders, the holders of theDebt agreed to waive all defaults on the Debt, if any, and extend the paymentdate to September 30, 2004. Interest under the Debt continues, after closing,to be due and payable quarterly in cash. The 2001 Exchange Offering wasmade only to existing Debt holders pursuant to exemptions provided by Sections3(a)(9) and Section 4(2) of the Securities Act and Regulation D. No registrationrights were granted to any of the securities amended under the 2001 ExchangeOffering.
ENCOAL Transaction.Over the last sixteen months the Company has been in negotiations witha large U.S. utility that wished to acquire the ENCOAL LFC plant. Thistransaction would not only have provided the Company with much needed workingcapital but would have required this utility to make certain specifiedimprovements to the plant and enter into other ancillary agreements. OnSeptember 25 the Company was informed that this utility did not wish toclose this transaction. Subsequently the Company's stock price declinedprecipitously and it has had an extremely difficult time raising fundingfor its operations. While the Company continues to seek short and longterm financing both for operations and for the start-up of the ENCOAL demonstrationplant, it has reduced its work force. If the Company can obtain fundingfor the demonstration plant it believes it can re-employ personnel on eithera full time basis or on a consulting basis. 
**ITEM 2. MANAGEMENT'SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**
**INTRODUCTORYNOTE**
This Quarterly Reporton Form 10-QSB contains statements relative to (i) projections, (ii) estimates,(iii) future research plans and expenditures, (iv) potential collaborativearrangements, (v) opinions of management and (vi) the need for and availabilityof additional financing which may be considered "forward looking statements."
The forward-lookingstatements included herein are based on current expectations that involvea number of risks and uncertainties. These forward-looking statements arebased on assumptions regarding the Company's business and technology, whichinvolve judgments with respect to, among other things, future scientific,economic and competitive conditions, and future business decisions, aswell as risk factors detailed from time to time in the Company's Securitiesand Exchange Commission reports (including this Form 10-QSB) and are difficultor impossible to predict accurately and many of which are beyond the controlof the Company. Although the Company believes that the assumptions underlyingthe forward-looking statements are reasonable, any of the assumptions couldprove inaccurate and, therefore, there can be no assurance that the resultscontemplated will be realized and actual results may differ materially.
Readers are urged tocarefully review and consider the various disclosures made by the Companyin this report and in the Company's other reports filed with the Securitiesand Exchange Commission that attempt to advise interested parties of therisks and factors that may affect the Company's business. Therefore, historicalresults and percentage relationships will not necessarily be indicativeof the operating results of any future period.
**RESULTSOF OPERATIONS**
***Net Loss perCommon Share*.**Basic net loss per common share for the three and nine month periods endedSeptember 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 monthperiods ended September 30, 2001, increased approximately 10% and 11%,respectively, over the same prior year periods. The decrease in basic netloss per share for the nine month period ended September 30, 2001 is primarilyattributable to an increase in the weighted average number of common sharesoutstanding..
***Revenues andGross Margin***. Revenues and cost of sales are primarily attributableto Assembly and Manufacturing Systems, Inc. (AMS) and are recorded usingthe percentage of completion method. Revenues at AMS for the three andnine month periods ended September 30, 2001, decreased 53% and 21%, respectively,over the same prior year periods. The Company attributes the decrease inrevenues for both the three and nine months period to be associated withthe decline in the U.S. economy. Future sales to all sectors for the remainderof 2001 are anticipated to be below prior year levels.
Gross margin as a percentageof 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 normaloperating levels. Gross margin for the nine months period ended September30, 2001, was 30% compared to 23% over the same prior year period. Grossmargins are anticipated to remain at or below normal operating levels throughoutthe remainder of the fiscal year due to declining order activity. Grossmargin may vary in any given period as a result of the variations in profitabilityof contracts for large orders of automated production systems or specialtymachines, as well as efficiencies related to the overall utilization ofAMS' manufacturing resources.
***Research andDevelopment Expenses***. Research and development expenses for thethree and nine month periods ended September 30, 2001, increased 23% and12%, respectively, over the same prior year periods. Research and developmentexpenses are primarily related to the LFC Process as the Company has focusedits efforts and limited resources on commercializing the LFC Process. Researchand development of the Company's other technologies will resume at suchtime as more financial resources become available.
The increase in researchand development expenses for both the three and nine month periods endedSeptember 30, 2001 is primarily attributable to the Company capitalizingcertain engineering costs in the prior year related to the ENCOAL LFC plant.Research and development expenses are anticipated to decline over the remainderof the year due to lack of resources.
***Selling, Generaland Administrative Expenses*.**Selling,general and administrative expense for the three and nine month periodsended September 30, 2001, decreased 17% and 10%, respectively, over thesame prior year periods. The decrease for both the three and nine monthperiods is primarily attributable to a reduction in financing related expendituresthat includes costs for financial consultants.
Selling, general andadministrative expenses for AMS for both the three and nine month periodsended September 30, 2001, decreased 4% respectively, over the same prioryear periods. The decrease for both periods ended September 30, 2001 isprimarily the result of decreased sales/order activity due to a slowingof the U.S. economy.
***Loss on Investmentin LFC Investee*.**TheCompany's share of the losses for its LFC joint venture (LFC Tech) forthe three and nine months ended September 30, 2001, increased 8% and 9%,respectively, over the same prior year periods. The results of LFC Tech'soperations are largely influenced by the timing of legal and accountingexpenses associated with maintaining the various LFC Process patents. Allother costs associated with the licensing and marketing of the LFC Processare being borne separately by the joint venture members.
***Legal and AccountingExpenses.***Legaland accounting expenses for the three and nine month periods ended September30, 2001, decreased 10% and increased 9%, respectively, over the same prioryear periods. The 10% decrease in legal expense for the three months periodis essentially related to a decrease in legal activity such as lawsuitsand contract negotiations. The increase of 9% for the nine months periodis related primarily to the one-time recovery of certain legal expensesin the prior year, resulting from the settlement of various lawsuits towhich the Company and AMS were parties.
***Depreciationand Amortization Expenses*.**Depreciationand amortization expense for the three and nine month periods ended September30, 2001, decreased 14% and 11%, respectively, over the same prior yearperiods. The decrease for both periods is due primarily to a significantportion of the Company's laboratory assets becoming fully depreciated.
***Interest Expense.***Interestexpense 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 September30, 2001, is primarily due to non-cash interest charges of related to theamortization of the imputed beneficial conversion feature of various convertiblenotes payable, primarily issued during the last half of 2000.
***Other Income.***Otherincome for the three and nine month periods ended September 30, 2001, decreased36% and increased 90%, respectively over the same prior year periods. Thedecrease in other income for the three months period is essentially dueto income related to the settlement of lawsuit in the prior year. The increasein other income for the nine months ended September 30, 2001, is due tothe Company's receipt of $75,000 in the first quarter of the year in settlementof a lawsuit.
**LIQUIDITYAND CAPITAL RESOURCES**
As of September 30,2001, the Company had assets totaling $4,785,000, including restrictedcash of $200,000, and a working capital deficiency of $8,691,000. Currentmaturities of approximately $4,170,000 of long-term debt, along with currentnotes payable, accounts payable and accrued salaries primarily contributeto the working capital deficiency at September 30, 2001. This is comparedto assets of approximately $6,509,000 and a $6,399,000 working capitaldeficiency as of September 30, 2000. The Company anticipates continuedoperating losses over the next twelve months and has both short-term andlong-term liquidity deficiencies as of September 30, 2001.
In the short-term theCompany has approximately $4,170,000 of unsecured notes payable and convertibledebentures which matured on September 30, 2001 and must be paid or havethe due date extended prior to October 31, 2001. On September 14, 2001the Company initiated and exchange offering for the holders of these notesand debentures in which the due date of these instruments would be extendeduntil September 30, 2004 and all defaults if any would be waived. As ofOctober 31, 2001essentially all of the holders of these notes and debentureshave accepted the offering terms, which will become effective once theCompany officially 'closes' the transaction, by paying all interest inarrears (refer to Notes 7 to the Condensed Consolidated Financial Statementsincluded in this Form 10-QSB for the terms of the offering.) At the currenttime, due to various events the Company has been unable to make the requiredinterest payments. The rights to receive payments for both principal andinterest of both the debenture holders and note holders are essentiallysimilar with interest being payable quarterly in cash and the principalbeing due on September 30, 2001 as stated earlier. However, in the eventthe Company fails to make either a scheduled principal payment or interestpayment 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 eithera scheduled principal or interest payment ten days after written noticeof such non-payment from the debenture holder, then the debenture shallbecome immediately due and payable without presentment, demand, protestor further notice. For the note holders, in the event the Company doesnot make either a scheduled principal or interest payment on the due datethen the note shall become immediately due and payable without presentment,demand, protest or notice of any other kind. As of September 30, 2001 theCompany was in arrears on two quarter's interest payment to debenture andnote holders. As of September 30, 2001 no written demands, from eitherclass, for payment had been received by the Company. The Company believesthat the reason for this is due to the ongoing dialogue with the debt holdersthe Company's diligent efforts to bring these obligations current.
Other short-term liquidityrequirements are expected to be satisfied from existing cash balances,proceeds from the sale of equity securities in the future or other collaborativearrangements. Negotiations are on-going for the public and private placementof equity securities, the proceeds of which are intended to be used tosatisfy the short-term liquidity deficiency. As a result of the slowingU.S. economy and the events of September 11 on the nation's financial marketsthe Company is currently finding that the raising of short term workingcapital is becoming more difficult. Consequently, the Company has foundthat it is unable to finance operations at the current level and has cutbackon various administrative activities, curtailed all research and developmentefforts and severely reduced its workforce. If the Company is unsuccessfulin securing sufficient short-term financing quickly and/or generating otherrevenues it will not be able to sustain operations.
The Company had long-termliquidity deficiencies at September 30, 2001. Over the long-term, the Companywill require substantial additional funds to maintain and expand its researchand development activities and ultimately to commercialize, with or withoutthe assistance of corporate partners, any of its proposed technologies.Although there are no commitments, the Company believes the long-term liquiditydeficiency will be satisfied through a combination of future equity sales,increased positive cash flows from operations, and research or other collaborativeagreements, until such time as the commercialization of the LFC and OCETProcesses result in positive cash flows. The Company is continuing to seekadditional funds through the financing, sale and operation of the ENCOALDemonstration plant and through collaborative or other arrangements withlarger well capitalized companies, under which such companies may provideadditional capital to the Company in exchange for exclusive or non-exclusivelicenses or other rights to certain commercial projects, technologies andproducts the Company is developing. Although the Company is presently engagedin discussions with a number of suitable candidates, there can be no assurancethat an agreement or agreements will arise from these discussions in atimely manner, or at all, or that revenues that may be generated therebywill offset operating expenses sufficiently to reduce the Company's short-termor long-term funding requirements.
The use of cash inoperating activities of approximately $1,958,000 and $2,890,000 for thenine months ended September 30, 2001, and 2000, respectively, is primarilyrelated to the Company's general operating expenses and R&D activities.The major components of cash flows used in operating activities are a netloss of approximately $5,048,000 offset by the net change in current assetsand 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 resultof increasing liabilities.
The Company's investingactivities amounted to a use of cash of approximately $29,000 and $640,000for the nine months ended September 30, 2001, and 2000, respectively. Theuse of cash in investing activities for the current year is significantlylower than in the past due to funds availability.
In 2001, the Companyis projecting no significant capital expenditures at OCET and AMS willdelay its approximately $300,000 capital improvements project which itstarted in 2000. Further, the Company, through collaboration with anotherlarger and better capitalized company, intends to obtain financing estimatedat approximately $16,000,000 for the ENCOAL Demonstration plant. The financingis for capital improvements, working capital and start-up expenditureswhich are necessary to set the plant on more of a commercial footing andto position it as a reference plant for potential future commercial LFCfacilities. Other than the improvements intended to be made to the ENCOALDemonstration plant, the Company as of September 30, 2001, does not haveany material requirements or commitments for capital expenditures. Theamount of cash used for investing activities in a given period is directlyrelated to development requirements and cash availability.
The Company's net financingactivities raised approximately $1,785,000 and $3,461,000 for the ninemonths ended September 30, 2001, and 2000, respectively. These funds wereraised primarily through the private placement of debt and equity securitiesfor both periods. See Note 3 "Financing Transactions" to the Notes to theCondensed Consolidated Financial Statements included in this Form 10-QSB.The Company believes that the slowing of the nations economy and its effectson the financial is partially responsible for the reduction in its financingactivities.
During the fourth quarterof 2000, the Company was successful in obtaining a new line-of-credit toprovide short term working capital to AMS. The line allows maximum borrowingsof $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 expiresNovember 5, 2001.
As stated earlier theCompany intends to obtain financing primarily related to improvements forthe ENCOAL Demonstration plant estimated at $16,000,000. The Company believes,due to the plant's special nature, that financing for these improvementswill not likely be obtained through conventional methods and that a strategicpartner or financier capable of utilizing Internal Revenue Code Section29 tax credits will be required. Due to the tax laws surrounding the realizationof these tax credits the financing of the ENCOAL Demonstration plant'simprovements will require that the Company sell or lease the plant directlyto the financier in order to facilitate the transaction. Following anysuch transaction the Company expects it will continue to be involved withvarious aspects of the project, including the supervision of the improvements.In this case the Company will most likely not be required to make any expendituresfor the improvements discussed earlier or assume the repayment of the financingassociated with the improvements. There is no assurance that the Companywill be able to obtain this financing, or if available, that its termswill be acceptable.
The amount of moneyraised 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 influencedby the aforementioned factors. Significant future financing activitieswill be required to fund future operating and investing activities andto maintain debt service. While the Company is engaged in continuing negotiationsto secure additional capital and financing, there is no assurance suchfunding will be available or if received will be adequate.
**ACCOUNTING PRONOUNCEMENTS**
In June, 2001, theFASB issued SFAS No. 142, "Goodwill and Other Intangible Assets", whichrequires that goodwill and certain intangibles assets, including thoserecorded in past business combinations, no longer be amortized to earnings,but instead be tested for impairment at least annually. SFAS No. 142 willbecome effective for fiscal years beginning after December 15, 2001. TheCompany is required to adopt SFAS No. 142 on January 1, 2002 and has notdetermined the impact that this statement will have on its consolidatedfinancial statements.
**ITEM3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**
[NONE]
**Part II. OTHER INFORMATION**
**ITEM1. LEGAL PROCEEDINGS**
The Company and itssubsidiaries are from time to time involved in litigation arising in theordinary course of their respective businesses. As of September 30, 2001,the Company was not party to any material legal proceeding.
**ITEM2. CHANGES IN SECURITIES**
During the quarterended September 30, 2001, in accordance with the 2001 Stock Plan , theCompany issued warrants at fair market value to employees of the Company.The exercise price was not lower than the closing bid price on the grantdate. The warrants are exercisable for a total of 760,000 shares of commonstock at $0.136 per share, the closing bid prices on the grant date. Thewarrants were granted in reliance upon exemptions from registration pursuantto Section 4(2) of the Securities Act and Regulation D. Investment representationswere obtained from each of the employees. The warrants are exercisableone year from the date of grant and expire on December 31, 2006.
During the quarterended September 30, 2001, the Company issued approximately 4,350,075 sharesof restricted common stock to accredited investors for $265,300 in cash.In connection therewith the Company paid approximately $13,000 in cashfor services rendered. These securities were issued pursuant to the exemptionsprovided by Section 4(2) of the Securities Act and Regulation D. Investmentrepresentations were obtained from the accredited investors and legendswere placed on the certificates.
During the quarterended September 30, 2001, the Company, as provided in their related consultingagreements, issued approximately 130,000 restricted common shares to consultantsfor services rendered, valued at approximately $17,544. These securitieswere issued pursuant to the exemptions provided by Section 4(2) of theSecurities Act and Regulation D. Investment representations were obtainedand legends were placed on the certificates.
During the quarterended September 30, 2001, the Company, upon demand and or maturity, exchanged$603,447 in principal and accrued interest on convertible note payablefor 4,582,912 shares of common stock. The securities were issued pursuantto the exemptions provided by Section 4(2) of the Securities Act and RegulationD. Investment representations were obtained from the accredited investorinvolved and restrictive legends were placed on the certificates.
During the quarterended September 30, 2001, the Company sold one note payable aggregating$30,000 for cash. The note bears interest at 9% per annum, matures oneyear from the sale date and is unsecured. The note and accrued interestis payable in cash or upon maturity, at the Company's option, by issuing654,000 shares of restricted common stock. The securities were issued pursuantto the exemptions provided by Section 4(2) of the Securities Act and RegulationD. Investment representations were obtained from the accredited investors.
During the quarterended September 30, 2001, the Company sold ten notes payable aggregating$297,250 for cash. The notes bear interest at 9% per annum, mature twoyears from the sale date and are unsecured. The notes and accrued interestare payable in cash or upon maturity, at the Company's option, by issuing7,015,100 shares of restricted common stock. The securities were issuedpursuant to the exemptions provided by Section 4(2) of the Securities Actand Regulation D. Investment representations were obtained from the accreditedinvestors.
**ITEM3. DEFAULTS UPON SENIOR DEBT SECURITIES**
[NONE]
**ITEM4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.**
[NONE]
**ITEM5. OTHER INFORMATION**
SGI International ("SGI")and subsidiaries of AEI Resources (collectively "AEI"), specifically, BluegrassCoal Development Company and Americoal Development Company have verballyagreed to extend the term within which compliance must occur pursuant tothe Amended and Restated Acquisition Agreement (the "Acquisition Agreement)originally dated December 9, 1999.  This agreement essentially providesSGI an undetermined extension.  All other terms and conditions ofthe Acquisition Agreement remain in full force and effect.
**ITEM6. EXHIBITS AND REPORTS ON FORM 8-K**
(a) Exhibits
4.1 Form of Warrant(1)4.2 Form of RestrictedStock Subscription Agreement (2)4.3 Form of PromissoryNote payable in cash or stock (3)_____________________________________(1) Incorporatedby reference to Registrants report on Form 10KSB ending June 30, 2001.(2) Incorporatedby reference to Registrants report on Form 10KSB ending December 31, 2000.(2) Incorporatedby reference to Registrants report on Form 10QSB ending March 31, 2001.
(b) Reports on 8-K.None **PartIII. SIGNATURES**Pursuant to the requirementsof the Securities Exchange Act of 1934, this report has been signed belowby the following persons on behalf of the Registrant and in the capacitiesand on the dates indicated. 
**SGI INTERNATIONAL** 
/s/ MICHAEL L. ROSE                        November 19, 2001Michael L. Rose,President and ChiefExecutive Officer
/s/ GEORGE E. DONLOU                      November 19, 2001George E. Donlou,Controller      

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