SGQ.V · 2018-03-28

Southgobi Resources Announces Fourth Quarter and Full Year 2017 Financial and Operating Results

Production Results Financials

R E S O U R C E S March 28, 2018

SOUTHGOBI RESOURCES ANNOUNCES FOURTH QUARTER AND FULL YEAR 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 quarter and the year ended December 31, 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 year ended December 31, 2017 and the subsequent period to March 28, 2018 are as follows:

Operating Results – As a result of improved market conditions and prices for coal in China, the Company experienced an increase in the average selling price of coal from $16.44 per tonne in 2016 to $28.31 per tonne in 2017. The volume of coal sales has also increased from 3.91 million tonnes in 2016 to 4.65 million tonnes in 2017.
Financial Results – The Company recorded a gross profit of $15.1 million in 2017 compared to a gross loss of $28.6 million in 2016 while $16.8 million loss from operations was recorded in 2017 compared to a $38.1 million loss from operations in 2016. Revenue increased from $58.5 million in 2016 to $121.0 million in 2017. As a result of improved market conditions and prices for coal in China, the overall financial results improved when compared to 2016, which was principally attributable to increased coal sales as well as higher average selling price achieved during the year.
China Investment Corporation (“CIC”) Convertible Debenture (the “CIC Convertible Debenture”) – Pursuant to the terms of the deferral agreement dated June 12, 2017 (the “June 2017 Deferral Agreement”) with CIC in relation to a revised payment schedule on the $22.3 million of cash interest and associated costs originally due under the CIC Convertible Debenture on May 19, 2017 (the “May 2017 Interest Payable”), the Company was required to pay $9.7 million of cash interest and associated costs to CIC on November 19, 2017 (the “June 2017 Deferral Agreement Payment”). In addition, pursuant to the terms of the CIC Convertible Debenture, the Company was required to pay $8.1 million of anniversary cash interest to CIC on November 19, 2017 (the “November Interest Payment” and together with the June 2017 Deferral Agreement Payment, the “November 19^th Payments”). Pursuant to the CIC Convertible Debenture, the Company was also obliged to issue $4.0 million worth of PIK interest shares (the “November 2017 PIK Interest”) to CIC on November 19, 2017.
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As of the date of this press release, the Company: (i) has neither paid the November 19^th Payments nor issued the November 2017 PIK Interest shares to CIC within the cure period provided for under the CIC Convertible Debenture; and (ii) has not agreed upon a repayment plan for such amounts with CIC. Consequently, the Company is in default under the CIC Convertible Debenture and the June 2017 Deferral Agreement. Pursuant to the terms of the CIC Convertible Debenture and the June 2017 Deferral Agreement, CIC may, at its discretion, provide notice to the Company and declare all principal, interest and other amounts owing under the CIC Convertible Debenture and the June 2017 Deferral Agreement immediately due and payable, and take steps to enforce payment thereof, which would have a material adverse effect on the business and operations of the Company and may negatively affect the price and volatility of the Common Shares and any investment in such shares could suffer a significant decline or total loss in value. As of the date of this press release, the Company has received no indication from CIC of any intention to deliver a notice of default under the CIC Convertible Debenture and the June 2017 Deferral Agreement or to accelerate the amounts outstanding under the CIC Convertible Debenture and the June 2017 Deferral Agreement.

The Company is in discussions with CIC for a deferral of the November 19^th Payments and the November 2017 PIK Interest; however, there can be no assurance that a favorable outcome will be reached.

As a consequence of the Company not entering into a deferral agreement with CIC as at December 31, 2017, International Accounting Standard 1 (“IAS 1”) requires the Company to classify the entire balance of the CIC Convertible Debenture as a current liability as at December 31, 2017, notwithstanding the fact that CIC has not indicated any intention to deliver notice of default or accelerate the maturity of the CIC Convertible Debenture. The Company anticipates that both the debt host and the fair value of the embedded derivative will be classified as a non-current liability upon the execution of a deferral agreement, unless a future event of default occurs under the terms of the CIC Convertible Debenture.

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Notice of Arbitration – On January 10, 2018, the Company received a confidential partial award (final except as to costs) (the “Arbitration Award”) with respect to an arbitration proceeding in Hong Kong related to a dispute concerning a coal supply agreement between SouthGobi Sands LLC (“SGS”), a subsidiary of the Company, and First Concept Industrial Group Limited (formerly known as First Concept Logistics Limited) (“First Concept”).

Pursuant to the Arbitration Award, SGS has been ordered to repay the sum of $11.5 million (which SGS had received as a prepayment for the purchase of coal) to First Concept, together with accrued interest at a simple interest rate of 6% per annum from the date which the prepayment was made until the date of the Arbitration Award, and then at a simple interest rate of 8% per annum until full payment. The Arbitration Award is final, except as to costs which have been reserved for a future award. As at December 31, 2017, the Company recorded a provision of $13.9 million for the commercial arbitration.

On March 23, 2018, SGS received a notice from First Concept demanding payment of the full amount of the Arbitration Award, together with the accrued interest thereon, by no later than March 30, 2018, otherwise First Concept intends to commence enforcement proceedings against SGS in respect of the Arbitration Award. The Company is currently considering and reviewing its options with respect to the Arbitration Award, including exploring ways to work together with First Concept on payment arrangements that are practical to and are in best interests of both parties; however, there can be no assurance that a favorable outcome will be reached. In the event that First Concept applies to enforce the Arbitration Award against SGS through judicial measures in courts of Mongolia or in other applicable jurisdiction(s), the Company intends to defend itself against such enforcement proceedings through independent litigation counsel retained by the Company for this purpose. However, due to the inherent uncertainties of litigation, it is not possible to predict whether the Company will be successful in defending itself against any such enforcement proceedings.

Tax Investigation Case in Mongolia – On January 10, 2018, SGS was informed by the Court Decision Implementation Agency of Capital City in Mongolia that the enforcement procedure in relation to the previously disclosed judgment of the Mongolian Second Criminal Court (the “Tax Verdict”) rendered against SGS in January 2015 has been terminated and no party shall have any right to make any further claims in connection with the Tax Verdict. As of the date hereof, SGS has fulfilled its obligations under the Tax Verdict.
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Settlement of Lawsuit Notice from a Former Fuel Supplier – On January 20, 2017, SGS 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 right to receive payment from the Company for the outstanding balance of approximately $8.0 million owing under the settlement agreement dated February 10, 2017 (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 agreed to pay interest on the Outstanding Amount, which accrues at a monthly rate of 1.8% and will be settled on a monthly basis. The Company was required to repay on average $1.3 million monthly during the period from July 2017 to November 2017.

As of the date of this press release, the Company has fulfilled its obligations under the Triparty Settlement Agreement and has fully repaid the Outstanding Amount.

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Class Action Lawsuit – On September 18, 2017, the Ontario Court of Appeal dismissed the Company’s appeal of the original Ontario lower court decision to permit the plaintiff to commence and proceed with a class action (the “Class Action”) against the Company claiming damages under the Ontario Securities Act in connection with the Company’s restatement of certain financial statements previously disclosed in the Company’s public fillings (the “Restatement”). Concurrently, the Ontario Court of Appeal allowed the plaintiff’s appeal of the original Ontario lower court decision to dismiss the plaintiff’s leave motion against certain of the Company’s former officers and directors and made an order granting leave for the plaintiff to proceed against such former officers and directors of the Company in relation to the Restatement. As a result, the plaintiff is now permitted to proceed with the Class Action against both the Company and the former officers and directors of the Company.

The Company has filed an application for leave to appeal to the Supreme Court of Canada in November 2017. Leave to appeal is expected to be decided by May 2018. If leave to appeal is granted, the appeal would likely be scheduled to be heard in early 2019.

Ceke Logistics Park Project – On October 10, 2017, the Company entered into an investment agreement (the “Investment Agreement”) with Beijing De Rong Tai Investment Co., Ltd. (“BDRT”) in connection with the Company’s development of the Ceke Port Eco-friendly Bonded Logistics Park project (the “Ceke Logistics Park”). Pursuant to the Investment Agreement, BDRT has agreed, subject to fulfilment of certain conditions, to invest RMB231 million in installments by July 30, 2018 in return for a 30% interest in Inner Mongolia SouthGobi Enterprise Co. Ltd. (“IMSE”), while the Company will hold the remaining 70% interest in IMSE. Proceeds from BDRT’s equity investment will be used by IMSE for the construction of the Ceke Logistics Park. IMSE is the project company which holds a 100% interest in the Ceke Logistics Park. As of the date of this press release, IMSE has received RMB15 million from BDRT pursuant to the Investment Agreement.
Novel Sunrise Investments Limited (“Novel Sunrise”) Sold 25.8 million Shares to a Company Owned by Members of Management – On January 11, 2017, Novel Sunrise, the Company’s largest shareholder at the time, reported that it had sold 25.8 million Common Shares of the Company effective December 31, 2016 to Voyage Wisdom Limited (“Voyage Wisdom”), a company owned by three members of the Company’s management team, for consideration of $24 million.
Equipment Loan – Inner Mongolia SouthGobi Energy Ltd., a subsidiary of the Company executed a $10.4 million loan agreement on August 31, 2017 with Beijing Jin Rui Tian Chen Asset Management Co Ltd. (the “Equipment Loan”) for the purpose of financing the purchase of mining equipment to increase the production capacity of the Company. As at December 31, 2017, the outstanding principal and accrued interest for the Equipment Loan amounted to $2.3 million and $0.1 million, respectively (December 31, 2016: nil).
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Changes in Management and 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. Joseph Belan: Mr. Belan did not stand for the re-election at the Company’s Annual General Meeting (the “AGM”) and ceased to be an independent non-executive director 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 of Directors of the Company (the “Board”) on June 30, 2017.

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

Mr. Aminbuhe: Mr. Aminbuhe commenced a leave from his role as the Chief Executive Officer of the Company effective as of November 13, 2017. The Board subsequently terminated the employment of Mr. Aminbuhe due to his incapability to fulfil his daily duties and responsibilities as the Chief Executive Officer of the Company effective as of November 22, 2017. Mr. Aminbuhe was also removed as the Chairman of the Board, but remains on the Board as a non-executive director of the Company.

The Company learned that Mr. Aminbuhe was arrested on October 11, 2017 and is being detained at Rizhao City Detention Center in China as a suspect in a fraudulent loan case. The Board has formed a special committee of independent non-executive directors (the “Special Committee”) to initiate a formal internal investigation into the charges against Mr. Aminbuhe and the connection, if any, between those charges and the Company and his conduct as Chairman and Chief Executive Officer of the Company, which includes engaging external advisors to assist in the investigation. The Special Committee is required to report to the Board from time to time with respect to the results and status of its investigation and the potential impact of these matters, if any, on the business and affairs of the Company.

Mr. Bing Wang: Mr. Wang was appointed as interim Chief Executive Officer of the Company, effective as of November 13, 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 – In the fourth quarter of 2016, the Company initiated a plan to change the existing product mix to higher value and higher margin outputs by commencing the washing of certain grades of coal in order to produce more premium semi-soft coking coal upon the successful commissioning of the coal washing facility under construction at the mine 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 construction of the wash plant was substantially completed in 2017, however, the commencement of washing has been delayed to the second quarter of 2018. The current mine plan 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 require a significant level of stripping activities over the next two years and certain capital expenditures to achieve the designed production outputs. Such expenditures and other working capital requirements will require the Company to seek additional financing in the form of finance leases, debt or equity.

There is no guarantee that the Company will be able to successfully execute the measures mentioned above and secure other sources of financing. If it fails to do so, or is unable to secure additional capital or otherwise restructure or refinance its business in order to address its cash requirements through December 31, 2018, then the Company is unlikely to have sufficient capital resources or cash flows from mining operations in order to satisfy its current ongoing obligations and future contractual commitments. This could result in adjustments to the amounts and classifications of assets and liabilities in the Company’s 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”. As at March 28, 2018, the Company had $7.1 million of cash.

OVERVIEW OF OPERATIONAL DATA AND FINANCIAL RESULTS

Summary of Annual Operational Data

Year ended December 31, 2017 2016

Sales Volumes, Prices and Costs

Premium semi-soft coking coal

0.86

Coal sales (millions of tonnes) 0.28 Average realized selling price (per tonne) ⁽ⁱ⁾ $ 47.84 $ 31.14 Standard semi-soft coking coal

2.44

Coal sales (millions of tonnes) 2.52 Average realized selling price (per tonne) ⁽ⁱ⁾ $ 28.72 $ 16.71 Thermal coal Coal sales (millions of tonnes) 1.35 1.11 Average realized selling price (per tonne) ⁽ⁱ⁾ $ 15.24 $ 12.16 Total Coal sales (millions of tonnes) 4.65 3.91 $ 28.31 $ Average realized selling price (per tonne) ⁽ⁱ⁾ 16.44

Raw coal production (millions of tonnes) 6.38 3.38

Cost of sales of product sold (per tonne) $ 22.77 $ 22.26 $ 9.32 $ Direct cash costs of product sold (per tonne) ⁽ⁱⁱ⁾ 8.66 Mine administration cash costs of product sold (per tonne) ⁽ⁱⁱ⁾ $ 2.80 $ 2.32 Total cash costs of product sold (per tonne) ⁽ⁱⁱ⁾ $ 12.12 $ 10.98

Other Operational Data

Production waste material moved (millions of bank cubic meters) 20.79 7.38 Strip ratio (bank cubic meters of waste material per tonne of coal produced) 3.26 2.18

0.03

Lost time injury frequency rate (iii) 0.00

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

(ii) A Non-International Financial Reporting Standards (“IFRS”) financial measure, 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 Annual Operational Data

As at December 31, 2017, the Company had a lost time injury frequency rate of 0.03 per 200,000 man hours based on a rolling 12 month average.

As a result of improved market conditions and prices for coal in China, the Company experienced an increase in the average selling price of coal as compared to 2016. The Company increased its sales volume from 3.91 million tonnes in 2016 to 4.65 million tonnes in 2017. The average realized selling price increased from $16.44 per tonne in 2016 to $28.31 per tonne in 2017, which was mainly a result of improved market conditions as well as an improved product mix. The product mix for 2017 consisted of approximately 19% of premium semi-soft coking coal, 52% of standard semi-soft coking coal and 29% of thermal coal compared to approximately 7% of premium semi-soft coking coal, 64% of standard semi-soft coking coal and 29% of thermal coal in 2016.

The Company’s production in 2017 was higher than 2016 as a result of ramping up production to meet the expected increase in sales, yielding 6.38 million tonnes for 2017 as compared to 3.38 million tonnes for 2016.

The Company’s unit cost of sales of product sold remained similar to 2016 (2017: $22.77 per tonne; 2016: $22.26 per tonne).

Summary of Annual Financial Results

Year ended December 31, $ in thousands, except per share information 2017 2016

$ 120,973 $ Revenue (i),(ii) 58,450

Cost of sales(ii)	(105,858)	(87,045)
Gross profit/(loss) excluding idled mine asset costs	27,747	(16,490)
Gross profit/(loss) including idled mine asset costs	15,115	(28,595)

(11,264)

Other operating expenses (50)

Administration expenses	(9,181)	(7,888)
Evaluation and exploration expenses	(273)	(422)
Impairment of property, plant and equipment	(11,171)	(1,152)

(16,774)

Loss from operations (38,107)

Finance costs	(22,958)	(22,314)
Finance income	164	239
Share of earnings of a joint venture	1,287	806

(1,740)

Income tax expense (1,470)

Net loss (40,021) (60,846) Basic and diluted loss per share $ (0.15)$ (0.24)

(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 2 of the selected information from the notes to the consolidated financial statements for further analysis regarding the Company’s reportable operating segments.

Overview of Annual Financial Results

The Company recorded a $16.8 million loss from operations in 2017 compared to a $38.1 million loss from operations in 2016. As a result of improved market conditions and prices for coal in China, the overall financial results improved when compared to 2016, which were principally attributable to increased coal sales as well as higher average selling price achieved during the year.

Revenue was $121.0 million in 2017 compared to $58.5 million in 2016. The Company’s revenue is presented after deduction of royalties and selling fees. The Company’s effective royalty rate for 2017, based on the Company’s average realized selling price of $28.31 per tonne, was 5.8% or $1.65 per tonne compared to 7.0% or $1.14 per tonne based on the average realized selling price of $16.44 per tonne in 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 cost 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 $105.9 million in 2017 compared to $87.0 million in 2016. The increase in cost of sales in 2017 was mainly due to the increased sales during the year. 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” of this press release for further analysis) during the year.

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Year ended December 31, 2017

$ in thousands 2016

Operating expenses	$ 55,451 $	41,452
Share-based compensation expense/(recovery)	30	(8)
Depreciation and depletion	20,719	26,142

17,026

Impairment of coal stockpile inventories 7,354

93,226

Cost of sales from mine operations 74,940 Cost of sales related to idled mine assets 12,632 12,105

Cost of sales $ 105,858 $ 87,045

Operating expenses in cost of sales were $55.5 million in 2017 compared to $41.5 million in 2016. The overall increase in operating expenses was primarily due to the increased sales volume from 3.91 million tonnes in 2016 to 4.65 million tonnes in 2017.

Cost of sales in 2017 and 2016 included coal stockpile impairments of $17.0 million and $7.4 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 years primarily related to the Company’s higher-ash content products.

Cost of sales related to idled mine asset costs primarily consisted of periodic costs, which were expensed as incurred and included mainly depreciation expense. Cost of sales related to idled mine assets in 2017 included $12.6 million related to depreciation expenses for idled equipment (2016: $12.1 million).

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Other operating expenses was $11.3 million in 2017 (2016: negligible).

Year ended December 31,

$ in thousands	2017	2016
Mining services, net	$ (2,395)$	(1,006)
Provision of commercial arbitration	(2,384)	–

(1,718)

Impairment of properties for resale – Impairment of prepaid expenses and deposits (2,517) –

(1,421)

Underprovision of miscellaneous taxes – Foreign exchange gain/(loss) (1,116) 5,423 Reversal of provision/(provision) for doubtful trade and other receivables (2,641) Discount on settlement of trade payables – 1,009

–

Settlement of civil claims (2,652) Other (395) (183)

Other operating expenses $ (11,264)$ (50)

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 hereinafter defined) at a net cost of $2.4 million in 2017 (direct mining costs and depreciation totaling $8.0 million, net of service revenue of $5.6 million) (2016: net cost of $1.0 million (direct mining costs and depreciation totaling of $3.1 million, net of service revenue of $2.1 million) (see section “Regulatory Issues and Contingencies – Governmental and Regulatory Investigations” for more details).

In connection with the Arbitration Award involving First Concept, the Company recorded a provision for this commercial arbitration in the amount of $2.4 million in 2017.

An impairment of $1.7 million was recorded for certain properties for resale by the Company that were obtained by the Company pursuant to a settlement agreement with one of its major customers in connection with outstanding trade receivables, which reflects the drop in market value.

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