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SGQ.V ·

SouthGobi Resources announces second quarter 2017 financial and operating results

Production Results Financials

 August 14, 2017

SouthGobi Resources announces second quarter 2017 financial and operating results

HONG KONG – SouthGobi Resources Ltd. (TSX: SGQ, HK: 1878) (the “Company” or “SouthGobi”) today announces its financial and operating results for the three and six months ended June 30, 2017. All figures are in U.S. dollars (“USD”) unless otherwise stated.

SIGNIFICANT EVENTS AND HIGHLIGHTS

The Company’s significant events and highlights for the three months ended June 30, 2017 and the subsequent period to August 14, 2017 are as follows:

  • Operating Results – As a result of improved market conditions and prices for coal in the People’s Republic of China (“China”), the Company’s operating results for the quarter improved with an increase in the average selling price of coal as well as the volume of coal sales, as compared to the second quarter of 2016. The Company sold 1.48 million tonnes of coal product during the second quarter of 2017 as compared to 0.82 million tonnes for the second quarter of 2016. The average realized selling price increased from $13.65 per tonne for the second quarter of 2016 to $25.24 per tonne for the second quarter of 2017, which was mainly a result of improved market conditions as well as an improved product mix.
  • Financial Results – The Company recorded a gross profit of $7.3 million during the quarter compared to a gross loss of $12.7 million in the second quarter of 2016. The Company recorded a $0.9 million profit from operations during the second quarter of 2017, as compared to a $13.8 million loss from operations in the second quarter of 2016. Revenue was $34.7 million in the second quarter of 2017 as compared to $10.4 million in the second quarter of 2016. The operations during the second quarter of 2017 improved over the comparative 2016 quarter given the improved market conditions in China.
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  • China Investment Corporation (“CIC”) Convertible Debenture (“CIC Convertible Debenture”) – On June 12, 2017, the Company executed a deferral agreement (the “June 2017 Deferral Agreement”) with CIC in relation to a revised repayment schedule on the $22.3 million of cash interest and associated costs originally due on May 19, 2017 (the “May 2017 Interest Payable”). The key repayment terms of the June 2017 Deferral Agreement are: (i) the Company is required to repay on average $2.2 million of the cash interest and associated costs monthly during the period from May 2017 to October 2017; and (ii) the Company is required to repay $9.7 million of cash interest and associated costs on November 19, 2017. The Company will pay a deferral fee at a rate of 6.4% per annum in consideration of the deferral.
  • Settlement of Lawsuit Notice from a Former Fuel Supplier – On January 20, 2017, SouthGobi Sands LLC (“SGS”), a subsidiary of the Company, received a notice from the Khan-Uul District Civil Court of First Instance in Mongolia (the “DC Court”) in relation to a claim for damages from Magnai Trade LLC (“MTLLC”), a former fuel supplier of SGS, in the aggregate amount of MNT 22.2 billion (approximately $8.9 million) representing outstanding fuel supply payments and related penalties and interest costs. On January 25, 2017, the DC Court dismissed the litigation and the matter was referred to arbitration. The Company signed a settlement agreement with MTLLC on February 10, 2017, pursuant to which SGS would pay MTLLC $8.0 million in equal monthly installments from March 2017 to June 2017 in full satisfaction of the debt outstanding. The terms of the settlement agreement was subsequently acknowledged by the arbitrator in the arbitration award.

On June 30, 2017, the Company signed a triparty settlement agreement (the “Triparty Settlement Agreement”) with MTLLC and ICIC LLC (“ICIC”) (an independent fuel supplier of the Company), pursuant to which: (i) MTLLC transferred to ICIC its rights to receive payment from the Company for the outstanding balance of approximately $6.3 million owing under the settlement agreement (the “Outstanding Amount”) and its right to enforce the arbitration award against the Company; and (ii) the Company and ICIC agreed to a revised payment schedule for repayment of the Outstanding Amount. Pursuant to the Triparty Settlement Agreement, the Company shall pay interest on the Outstanding Amount which shall accrue at a monthly rate of 1.8% and will be settled on a monthly basis. The Company is required to repay on average $1.3 million monthly during the period from July 2017 to November 2017.

To date, the Company has made all payments due under the Triparty Settlement Agreement.

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  • Settlement of Trade Receivable – During the year ended December 31, 2016, the Company entered into a settlement agreement with one of its major customers (the “Customer”) pursuant to which 200 residential units and 40 parking spaces (collectively, the “240 Units”) located in Ulaanbaatar, Mongolia, were transferred to the Company as partial consideration for settling outstanding trade receivables in the amount of $12.0 million owing by the Customer to the Company, with the balance of the receivable, totaling $7.5 million, payable in cash by the Customer to the Company. As of the date of this announcement, the entirety of the $7.5 million balance has been repaid by, and collected from, the Customer.
  • Changes in Directors

Mr. Yingbin Ian He: Mr. He was appointed as an independent non-executive director on May 16, 2017.

Mr. Wen Yao: Mr. Yao was appointed as a non-executive director on May 18, 2017.

Mr. Aminbuhe: Mr. Aminbuhe was appointed as Chairman of the Board immediately following the Company’s Annual General Meeting (the “AGM”) held on June 30, 2017.

Mr. Ningqiao Li: Mr. Li did not stand for the re-election at the AGM and ceased to be an executive director and the Executive Chairman of the Board on June 30, 2017.

Mr. Joseph Belan: Mr. Belan did not stand for the re-election at the AGM and ceased to be an independent non-executive director on June 30, 2017.

Mr. Huiyi Wang: Mr. Wang resigned as a non-executive director on July 24, 2017.

  • Strategic Advisory Board – In light of the reconstitution of the Board and appointment of new directors, the Company’s Strategic Advisory Board was dissolved on June 30, 2017.
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  • Going Concern – As at the date hereof, the Company has initiated a plan to change the existing product mix to higher value and higher margin outputs by washing certain grades of coal commencing in the second half of 2017 in order to produce more premium semi-soft coking coal and to initiate more processing of the lower grades of coal in order to reduce the ash content and improve the selling price and margins on its thermal coal product. The Company has also completed a new mine plan, which incorporates the coal washing and processing systems and contemplates significantly higher volumes of production in order to complement the Company’s new product mix and sales volume targets. Such plans will involve the need for a significant level of stripping activities over the next two years and require certain capital expenditures to achieve the designed production outputs. Such expenditures will require the Company to seek additional financing in the form of finance leases, debt or equity. The Company has entered into an agreement for a finance lease on the new wash plant facility but will need financing to complete the thermal coal processing facilities.

There is no guarantee that the Company will be able to successfully secure additional sources of financing. This could result in adjustments to the amounts and classifications of assets and liabilities in the Company’s condensed consolidated financial statements and such adjustments could be material. Unless the Company acquires additional sources of financing and/or funding in the short term, the ability of the Company to continue as a going concern is threatened. If the Company is unable to continue as a going concern, it may be forced to seek relief under applicable bankruptcy and insolvency legislation. See section “Liquidity and Capital Resources” for details. As at August 14, 2017, the Company had $2.5 million of cash.

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OVERVIEW OF OPERATIONAL DATA AND FINANCIAL RESULTS

Summary of Operational Data

Three months ended Six months ended June 30, June 30, 2017 2016 2017 2016

Sales Volumes, Prices and Costs

Premium semi-soft coking coal Coal sales (millions of tonnes) 0.18 – 0.37 0.06 Average realized selling price (per tonne) (i) $ 45.67 $ – $ 45.64 $ 21.38 Standard semi-soft coking coal Coal sales (millions of tonnes) 0.79 0.52 1.43 1.10 Average realized selling price $ 26.69 $ 16.27 $ 25.20 $ (per tonne) (i) 17.40 Thermal coal

0.51 0.79

Coal sales (millions of tonnes) 0.30 0.54 Average realized selling price (per tonne) (i) $ 15.79 $ 9.17 $ 14.85 $ 9.18 Total Coal sales (millions of tonnes) 1.48 0.82 2.59 1.70 Average realized selling price (per tonne) (i) $ 25.24 $ 13.65 $ 24.93 $ 14.92

1.89 3.40

Raw coal production (millions of tonnes) 0.67 1.04

Cost of sales of product sold (per tonne) $ 18.50 $ 28.01 $ 19.75 $ 24.71 Direct cash costs of product sold (per tonne) (ii) $ 7.84 $ 12.47 $ 8.52 $ 10.17 Mine administration cash costs of product sold (per tonne) (ii) $ 2.22 $ 2.32 $ 1.70 $ 1.76 Total cash costs of product sold (per tonne) (ii) $ 10.06 $ 14.79 $ 10.22 $ 11.93

Other Operational Data

Production waste material moved (millions of bank cubic meters) 6.36 1.82 9.66 2.54 Strip ratio (bank cubic meters of waste

3.37 2.84

material per tonne of coal produced) 2.71 2.43 Lost time injury frequency rate (iii) 0.04 0.00 0.03 0.00

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(i) Average realized selling price is presented before deduction of royalties and selling fees.

(ii) A Non-International Financial Reporting Standards (“IFRS”) financial measure, which does not have a standardized meaning according to IFRS. See “Non-IFRS Financial Measures” section. Cash costs of product sold exclude idled mine asset cash costs.

(iii) Per 200,000 man hours and calculated based on a rolling 12 month average.

Overview of Operational Data

For the second quarter of 2017, the Company had a lost time injury frequency rate of 0.04 per 200,000 man hours based on a rolling 12 month average.

For the three months ended June 30, 2017

As a result of improved market conditions and prices for coal in China, the Company’s operational results for the quarter improved with an increase in the average selling price of coal as well as the volume of coal sales, as compared to the second quarter of 2016.

The Company sold 1.48 million tonnes of coal product during the second quarter of 2017 as compared to 0.82 million tonnes for the second quarter of 2016. The average realized selling price increased from $13.65 per tonne for the second quarter of 2016 to $25.24 per tonne for the second quarter of 2017, which was mainly a result of improved market conditions as well as improved product mix. The product mix for the second quarter of 2017 consisted of approximately 12% of premium semi-soft coking coal, 53% of standard semi-soft coking coal and 35% of thermal coal compared to approximately 63% of standard semi-soft coking coal and 37% of thermal coal for the second quarter of 2016.

The Company also improved the pacing of production to meet demand, such that production was 1.89 million tonnes for the second quarter of 2017 as compared to 0.67 million tonnes for the second quarter of 2016.

The Company’s unit cost of sales of product sold decreased to $18.50 per tonne in the second quarter of 2017 from $28.01 per tonne in the second quarter of 2016. The decrease was mainly driven by economies of scale resulted from the increased productions and sales.

For the six months ended June 30, 2017

Given the improved market conditions and prices for coal in China, the Company experienced an increase in the tonnage of coal product sold from 1.70 million tonnes during the first six months of 2016 to 2.59 million tonnes for the first six months of 2017. The average selling price also increased from $14.92 per tonne for the first six months of 2016 to $24.93 per tonne for the first six months of 2017, which was mainly a result of improved market conditions as well as improved product mix.

The production in the first six months of 2017 was higher than the first six months of 2016 as a result of pacing production with the current and expected demand.

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The Company’s unit cost of sales of product sold decreased to $19.75 per tonne in the first six months of 2017 from $24.71 per tonne in the first six months of 2016. The decrease was mainly driven by economies of scale resulted from the increased productions and sales.

Summary of Financial Results

Three months ended Six months ended

June 30,

$ in thousands, except per share June 30,

information2017201620172016
Revenue(i),(ii)$ 34,665 $10,361 $59,919 $23,088
Cost of sales(ii)(27,385)(23,105)(51,144)(42,185)

Gross profit/(loss) excluding idled mine asset costs 9,445 (9,926) 14,159 (10,975) Gross profit/(loss) including idled mine asset costs 7,280 (12,744) 8,775 (19,097)

(4,045) (7,253)

Other operating income/(expenses) 812 (899) Administration expenses (2,234) (1,826) (4,619) (3,468)

(144) (173)

Evaluation and exploration expenses (52) (99) Profit/(loss) from operations 857 (13,810) (3,270) (23,563)

(5,494) (11,169)

Finance costs (5,377) (10,845) Finance income 50 324 14 296

388 654

Share of earnings of a joint venture 256 339 Income tax expense (2,714) (23) (2,759) (258)

(6,913) (16,530)

Net loss (18,630) (34,031) Basic and diluted loss per share $ (0.03)$ (0.07)$ (0.06)$ (0.13)

(i) Revenue is presented after the deduction of royalties and selling fees.

(ii) Revenue and cost of sales relate to the Company’s Ovoot Tolgoi Mine within the Coal Division operating segment. Refer to note 3 of the condensed consolidated financial statements for further analysis regarding the Company’s reportable operating segments.

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Overview of Financial Results

For the three months ended June 30, 2017

The Company recorded a gross profit of $7.3 million during the quarter compared to a gross loss of $12.7 million in the second quarter of 2016. The Company recorded a $0.9 million profit from operations during the quarter compared to a $13.8 million loss from operations in the second quarter of 2016. The operations for the three months ended June 30, 2017 were positively impacted by improved market conditions resulting in higher sales volumes and a better sales mix of the Company’s products as well as the improved coal prices in China.

The Company earned revenue of $34.7 million in the second quarter of 2017 compared to $10.4 million in the second quarter of 2016.

The Company’s revenue is presented after deduction of royalties and selling fees. The Company’s effective royalty rate for the second quarter of 2017, based on the Company’s average realized selling price of $25.24 per tonne, was 5.5% or $1.38 per tonne compared to 6.9% or $0.95 per tonne based on the average realized selling price of $13.65 per tonne in the second quarter of 2016.

Royalty regime in Mongolia

The royalty regime in Mongolia is evolving and has been subject to change since 2012.

On February 1, 2016, the Government of Mongolia issued a resolution in connection with the royalty regime. From February 1, 2016 onwards, royalties are to be calculated based on the actual contract price in which transportation cost to the Mongolia border should have been included. If such transportation cost was not included in the contract, the relevant transportation costs, custom documentation fees, insurance and loading costs should be estimated for the calculation of royalties. In the event that the calculated sales price as described above differs from the contract sales price of other entities in Mongolia (same quality of coal and same border crossing) by more than 10%, the calculated sales price will be deemed to be “nonmarket” under Mongolian tax law and the royalty will then be calculated based on a reference price as determined by the Government of Mongolia.

Cost of sales was $27.4 million in the second quarter of 2017 compared to $23.1 million in the second quarter of 2016, the increase was mainly due to the higher sales volume. Cost of sales comprises operating expenses, share-based compensation expense, equipment depreciation, depletion of mineral properties, coal stockpile inventory impairments and idled mine asset costs. Operating expenses in cost of sales reflect the total cash costs of product sold (a non-IFRS financial measure, see section “Non-IFRS Financial Measures” for further analysis) during the period.

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Three months ended June 30,

$ in thousands20172016
Operating expenses$ 14,891 $10,488
Share-based compensation expense/(recovery)5(3)

7,454

Depreciation and depletion 6,253

Impairment of coal stockpile inventories2,8703,549
Cost of sales from mine operations25,22020,287
Cost of sales related to idled mine assets2,1652,818
Cost of sales$ 27,385 $23,105

Operating expenses in cost of sales were $14.9 million in the second quarter of 2017 compared to $10.5 million in the second quarter of 2016. The increase in operating expenses was primarily related to the increase in sales volume from 0.82 million tonnes in the second quarter of 2016 to 1.48 million tonnes in the second quarter of 2017.

Cost of sales in the second quarter of 2017 and 2016 included coal stockpile impairments of $2.9 million and $3.5 million, respectively, to reduce the carrying value of the Company’s coal stockpiles to their net realizable value. The coal stockpile impairments recorded in both the second quarter of 2017 and 2016 primarily related to the Company’s higher-ash products.

Cost of sales related to idled mine asset costs primarily consisted of period costs, which were expensed as incurred and included mainly depreciation expense. Cost of sales related to idled mine assets in the second quarter of 2017 included $2.2 million of depreciation expenses for idled equipment compared to $2.8 million in the second quarter of 2016.

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Other operating expenses was $4.0 million in the second quarter of 2017 compared to other operating income of $0.8 million in the second quarter of 2016 as follows:

Three months ended June 30,

$ in thousands 2017 2016

$ (1,607) $ Foreign exchange loss (1,786) Discount on settlement of trade payables – 1,009

(1,075)

Impairment of properties held for sale – Reverse of provision/(provision) for doubtful trade and other receivables (1,335) 1,909

(28)

Other (320)

$ (4,045) $ Other operating income/(expenses) 812

For the three months ended June 30, 2017, the Company made a provision for doubtful trade and other receivables of $1.3 million (2016: reversal of provision of $1.9 million was made) for certain long aged receivables. In addition, due to the delay in commencing the sales of the properties held for sale, an impairment of $1.1 million was recorded accordingly.

Administration expenses were $2.2 million in the second quarter of 2017 compared to $1.8 million in the second quarter of 2016 as follows:

Three months ended June 30,

$ in thousands 2017 2016

$ 566 $ Corporate administration 693

Legal and professional fees533391
Salaries and benefits1,040677
Share-based compensation expense2412
Depreciation7153
Administration expenses$ 2,234 $1,826

The increase in salaries and benefits was mainly due to the operations of the new subsidiary in China, which was incorporated to expand the sales channels of coal in China.

Evaluation and exploration expenses were $0.1 million in the second quarter of 2017 (2016: $0.1 million). The Company continued to minimize evaluation and exploration expenditures in the second quarter of 2017 in order to preserve the Company’s financial resources.

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Finance costs were $5.5 million and $5.4 million respectively in the second quarter of 2017 and the second quarter of 2016. Finance costs primarily consisted of interest expense in respect of the $250.0 million CIC Convertible Debenture ($5.3 million for the second quarter of 2017 and $5.3 million for the second quarter of 2016).

For the six months ended June 30, 2017

The Company recorded a $3.3 million loss from operations in the first six months of 2017 compared to a $23.6 million loss from operations in the first six months of 2016. The operations for the six months ended June 30, 2017 were positively impacted by improved market conditions resulting in higher sales volumes and a better sales mix of the Company’s products as well as the improved coal prices in China.

Revenue was $59.9 million in the first six months of 2017 compared to $23.1 million in the first six months of 2016. The Company sold 2.59 million tonnes of coal at an average realized selling price of $24.93 per tonne in the first six months of 2017 compared to sales of 1.70 million tonnes at an average realized selling price of $14.92 per tonne in the first six months of 2016, which was mainly a result of improved market conditions as well as improved product mix.

The Company’s revenue is presented net of royalties and selling fees. The Company’s effective royalty rate for the first six months of 2017, based on the Company’s average realized selling price of $24.93 per tonne, was 5.6% or $1.41 per tonne compared to 7.0% or $1.05 per tonne based on the average realized selling price of $14.92 per tonne in the first six months of 2016.

Cost of sales was $51.1 million in the first six months of 2017 compared to $42.2 million in the first six months of 2016 as follows:

Six months ended June 30,

$ in thousands 2017 2016

$ 25,591 $ Operating expenses 18,533 Share-based compensation expense/(recovery) 28 (8)

14,940

Depreciation and depletion 9,832

Impairment of coal stockpile inventories5,2015,706
Cost of sales from mine operations45,76034,063
Cost of sales related to idled mine assets5,3848,122
Cost of sales$ 51,144 $42,185
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Operating expenses in cost of sales were $25.6 million in the first six months of 2017 compared to $18.5 million in the first six months of 2016. The increase in operating expenses was primarily related to the increase in sales volume from 1.70 million tonnes in the first six months of 2016 to 2.59 million tonnes in the first six months of 2017.

Cost of sales in the first six months of 2017 and the first six months of 2016 included coal stockpile impairments of $5.2 million and $5.7 million, respectively, to reduce the carrying value of the Company’s coal stockpiles to their net realizable value. The coal stockpile impairments recorded in both 2017 and 2016 primarily related to the Company’s higher-ash products.

Cost of sales related to idled mine asset costs primarily consisted of period costs, which were expensed as incurred and primarily included depreciation expense. Cost of sales related to idled mine assets in the first six months of 2017 included $5.4 million related to depreciation expenses for idled equipment (2016: $8.1 million).

Other operating expenses were $7.3 million in the first six months of 2017 compared to $0.9 million in the first six months of 2016 as follows:

Six months ended June 30,

$ in thousands 2017 2016

$ (2,105) $ Foreign exchange loss (1,514) Impairment of properties held for sale (1,075) –

(2,395)

Mining services, net – Provision for doubtful trade and other receivables (1,335) (2) Penalty on late settlement of trade payables (280) –

–

Discount on settlement of trade payables 1,009 Other (63) (392)

Other operating expenses $ (7,253) $ (899)

For the six months ended June 30, 2017, the Company made a provision for doubtful trade and other receivables of $1.3 million (2016: negligible) for certain long aged receivables. In addition, due to the delay in commencing the sales of the properties held for sale, an impairment of $1.1 million was recorded accordingly.

Mining services at the Tavan Tolgoi deposit were provided by the Company to Erdenes Tavan Tolgoi JSC (“Erdenes”) in connection with settlement of the Tax Penalty (as defined below) at a net cost of $2.4 million in the first six months of 2017 (direct mining costs and depreciation totaling $8.0 million, net of service revenue of $5.6 million) (see section “Regulatory Issues and Contingencies – Governmental and Regulatory Investigations” for more details).

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