SGQ.V · 2017-05-12

SouthGobi Resources announces first quarter 2017 financial and operating results

Production Results Financials

May 12, 2017

SouthGobi Resources announces first 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 months ended March 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 three months ended March 31, 2017 and the subsequent period to May 12, 2017 are as follows:

Operating Results – As a result of improved market conditions and prices for coal in 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 first quarter of 2016. The Company sold 1.11 million tonnes of its coal product during the first quarter of 2017 as compared to 0.88 million tonnes for the first quarter of 2016. The average realized selling price increased from $16.11 per tonne for the first quarter of 2016 to $24.52 per tonne for the first quarter of 2017, which was mainly a result of improved market conditions as well as improved product mix.
Financial Results – The Company recorded a gross profit of $1.5 million during the quarter compared to gross loss of $6.4 million in the first quarter of 2016. The Company recorded a $4.1 million loss from operations during the first quarter of 2017, as compared to a $9.8 million loss from operations in the first quarter of 2016. Revenue was $25.3 million in the first quarter of 2017 as compared to $12.7 million in the first quarter of 2016. The operations during the first quarter of 2017 improved over the comparative 2016 quarter given the improved market conditions in China.
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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, are to be transferred to the Company as partial consideration for settling an 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 by March 31, 2017 (subsequently extended to June 30, 2017). As the transfers of title to the 240 Units were substantially completed during the first quarter of 2017, the 240 Units have been recorded in the Company’s accounts accordingly. The settlement agreement includes an option for the Company to return any unsold units back to the Customer, until September 30, 2017, at the same price per unit for immediate payment of the balance in cash. The Company anticipates that the sales of the 240 Units will commence during the second quarter of 2017. As of the date of this announcement, the Company has collected $5.8 million from the Customer to settle the amount of trade receivables outstanding and, on May 9, 2017, the Company agreed with the Customer to extend the payment due date on the remaining uncollected balance to June 30, 2017.
Tax Investigation Case in Mongolia – In May 2016, Resolution No. 258 of the Government of Mongolia (“Resolution 258”) was issued, which approved the Company’s proposal to settle the Tax Penalty (as defined and described in this announcement under the heading entitled “Regulatory Issues and Contingencies – Governmental and Regulatory Investigations”) by making a series of cash payments and by performing mining operations at the Tavan Tolgoi deposit in Southern Mongolia on behalf of Erdenes Tavan Tolgoi JSC (“Erdenes”), a company owned by the Government of Mongolia. During 2016, the Company made cash payments of $2.4 million as a partial settlement of the Tax Penalty.

In compliance with Resolution 258, in November 2016, the Company entered into an agreement with Erdenes under which the Company agreed to perform certain mining operations equivalent to MNT 20.3 billion (approximately $8.1 million) in the West Tsankhi section of the Tavan Tolgoi deposit during the period from November 2016 to February 2017. As at March 31, 2017, the Company had completed the mining operations at the Tavan Tolgoi deposit equivalent to MNT 20.3 billion (approximately $8.1 million).

As at March 31, 2017, the provision for the Tax Verdict (as defined below in this announcement under the heading entitled “Regulatory Issues and Contingencies – Governmental and Regulatory Investigations”) was reduced to $3.1 million. The Company is required to make further cash payments of $3.1 million in 2017 to complete repayment of the balance of the penalty owing.

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Settlement of Lawsuit Notice from a Former Fuel Supplier – On January 20, 2017, the Company announced that 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 of $2.0 million each 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.

As a result of the Company failing to honor the repayment schedule set out in the settlement agreement, the Company received on May 1, 2017 a judicial order issued by the DC Court which stated that, subject to MTLLC filing the requisite notice with the DC Court, the arbitration award will be executed by the Court Decision Implementation Agency of Mongolia (“CDIA”) and taken to bailiff service for further action. The Company is currently in discussion with MTLLC to revise the repayment schedule. As of May 12, 2017, the Company has made payments in the aggregate of $2.0 million to MTLLC pursuant to the settlement agreement. See section “Regulatory Issues and Contingencies” of this announcement under the heading entitled “Settlement of Lawsuit Notice from a Former Supplier” for more information.

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.
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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 May 12, 2017, the Company had $1.2 million of cash.

OVERVIEW OF OPERATIONAL DATA AND FINANCIAL RESULTS

Summary of Operational Data

Three months ended March 31,

2017 2016

Sales Volumes, Prices and Costs

Premium semi-soft coking coal

0.19

Coal sales (millions of tonnes) 0.06 Average realized selling price (per tonne) ⁽ⁱ⁾ $ 45.61 $ 21.38 Standard semi-soft coking coal

0.64

Coal sales (millions of tonnes) 0.58 Average realized selling price (per tonne) ⁽ⁱ⁾ $ 23.36 $ 18.42 Thermal coal Coal sales (millions of tonnes) 0.28 0.24 Average realized selling price (per tonne) ⁽ⁱ⁾ $ 13.17 $ 9.19 Total Coal sales (millions of tonnes) 1.11 0.88 $ 24.52 $ Average realized selling price (per tonne) ⁽ⁱ⁾ 16.11

Raw coal production (millions of tonnes) 1.51 0.37

Cost of sales of product sold (per tonne) $ 21.40 $ 21.62 Direct cash costs of product sold (per tonne) ⁽ⁱⁱ⁾ 7.88 Mine administration cash costs of product sold (per tonne) ⁽ⁱⁱ⁾ $ 1.01 $ 1.24 Total cash costs of product sold (per tonne) ⁽ⁱⁱ⁾ $ 10.43 $ 9.12

Other Operational Data

Production waste material moved (millions of bank cubic meters) 3.30 0.72

Strip ratio (bank cubic meters of waste material per tonne of coal produced) 1.94 Lost time injury frequency rate (iii) 0.02 0.00

(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.

Overview of Operational Data

As at March 31, 2017, the Company had a lost time injury frequency rate of 0.02 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’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 first quarter of 2016.

The Company sold 1.11 million tonnes of its coal product during the first quarter of 2017 as compared to 0.88 million tonnes for the first quarter of 2016. The average realized selling price increased from $16.11 per tonne for the first quarter of 2016 to $24.52 per tonne for the first quarter of 2017, which was mainly a result of improved market conditions as well as improved product mix. The product mix for the first quarter of 2017 consisted of approximately 17% of Premium semi-soft coking coal, 58% of Standard semi-soft coking coal and 25% of thermal coal compared to approximately 7% of Premium semi-soft coking coal, 66% of Standard semi-soft coking coal and 27% of thermal coal for the first quarter of 2016.

The Company also improved the pacing of production to meet demand, such that production was 1.51 million tonnes for the first quarter of 2017 as compared to 0.37 million tonnes for the first quarter of 2016.

The Company’s unit cost of sales of product sold decreased to $21.40 per tonne in the first quarter of 2017 from $21.62 per tonne in the first quarter of 2016. The decrease was mainly driven by increased sales and the related economies of scale.

Summary of Financial Results

Three months ended March 31, 2017

$ in thousands, except per share information 2016

Revenue (i),(ii) $ 25,254 $ 12,727

(23,759)

Cost of sales ⁽ⁱⁱ⁾ (19,080) Gross profit/(loss) excluding idled mine asset costs 4,714 (1,049)

1,495

Gross profit/(loss) including idled mine asset costs (6,353)

Other operating expenses (3,208) (1,711)

(2,385)

Administration expenses (1,642) Evaluation and exploration expenses (29) (47)

(4,127)

Loss from operations (9,753)

Finance costs (5,715) (5,497) Finance income 1 Share of earnings of a joint venture 266 83

(45)

Income tax expense (235)

Net loss (9,617) (15,401) $ (0.04)$ Basic and diluted loss per share (0.06)

(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.

Overview of Financial Results

The Company recorded a gross profit $1.5 million during the quarter compared to a gross loss of $6.4 million in the first quarter of 2016. The Company recorded a $4.1 million loss from operations in the first quarter of 2017 compared to a $9.8 million loss from operations in the first quarter of 2016. The operations for the three months ended March 31, 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 $25.3 million in the first quarter of 2017 compared to $12.7 million in the first quarter of 2016.

The Company’s revenue is presented after deduction of royalties and selling fees. The Company’s effective royalty rate for the first quarter of 2017, based on the Company’s average realized selling price of $24.52 per tonne, was 5.9% or $1.44 per tonne compared to 7.1% or $1.14 per tonne based on the average realized selling price of $16.11 per tonne in 2016.

Royalty regime in Mongolia

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

On January 1, 2015, the “flexible tariff” royalty regime ended and royalty payments reverted to the previous regime which is based on a set reference price per tonne published monthly by the Government of Mongolia. The Company and other Mongolian coal producers are actively engaging the Mongolian authorities to seek the continuation of the “flexible tariff” regime.

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 $23.8 million in the first quarter of 2017 compared to $19.1 million in the first quarter of 2016. 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 announcement for further analysis) during the period.

Three months ended March 31, 2017

$ in thousands 2016

Operating expenses $ 10,700 $ 8,045 Share-based compensation expense/(recovery) (5) Depreciation and depletion 7,486 3,579

2,331

Impairment of coal stockpile inventories 2,157

20,540

Cost of sales from mine operations 13,776 Cost of sales related to idled mine assets 3,219 5,304

Cost of sales $ 23,759 $ 19,080

Operating expenses in cost of sales were $10.7 million in the first quarter of 2017 compared to $8.0 million in the first quarter of 2016. The increase in operating expenses is primarily related to the increase in sales volume from 0.88 million tonnes in the first quarter of 2016 to 1.11 million tonnes in the first quarter of 2017.

Cost of sales in the first quarter of 2017 and 2016 included coal stockpile impairments of $2.3 million and $2.2 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 first 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 first quarter of 2017 included $3.2 million of depreciation expenses for idled equipment compared to $5.3 million in the first quarter of 2016. The decrease is due to more of our mining fleet being engaged in active mining operations.

Other operating expenses were $3.2 million in the first quarter of 2017 compared to $1.7 million in the first quarter of 2016 as follows:

Three months ended March 31, $ in thousands 2016

2017

Foreign exchange gain/(loss) $ (510) $ 272

(2,395)

Mining services, net – Provision for doubtful trade and other receivables – (1,911) Penalty on late settlement of trade payables (268) –

(35)

Other (72)

Other operating expenses $ (3,208) $ (1,711)

Mining services at the Tavan Tolgoi deposit were provided by the Company to Erdenes in connection with settlement of the Tax Penalty at a net cost of $2.4 million in the first quarter 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” of this announcement under the heading entitled “Governmental and Regulatory Investigations” for more details), with no similar amount incurred in the first quarter of 2016.

For the three months ended March 31, 2016, the Company made a provision for doubtful trade and other receivables of $1.9 million (2017: nil) for certain long aged receivables.

Administration expenses were $2.4 million in the first quarter of 2017 compared to $1.6 million in the first quarter of 2016 as follows:

Three months ended March 31, $ in thousands 2017 2016

$ 470 $ Corporate administration 465 Legal and professional fees 918 504 Salaries and benefits 643

Share-based compensation expense/(recovery)	11	(7)
Depreciation	143	37
Administration expenses	$ 2,385 $	1,642

The increase in salaries and benefits was mainly due to the operations of the new subsidiary in China, which was incorporated in June 2016 to expand the sales channels of coal in China.

Evaluation and exploration expenses were negligible in the first quarter of 2017 and the first quarter of 2016. The Company continued to minimize evaluation and exploration expenditures in the first quarter of 2017 in order to preserve the Company’s financial resources. Evaluation and exploration activities and expenditures in the first quarter of 2017 were limited to ensuring that the Company met the Mongolian Minerals Law requirements in respect of its mining licenses.

Finance costs were $5.7 million and $5.5 million respectively in the first quarter of 2017 and the first quarter of 2016. Finance costs primarily consisted of interest expense in respect of the $250.0 million China Investment Corporation (“CIC”) convertible debenture (“CIC Convertible Debenture”) ($5.3 million for the first quarter of 2017 and $5.2 million for the first quarter of 2016).

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Summary of Quarterly Operational Data

2017

2016 2015 Quarter Ended 31-Mar 31-Dec 30-Sep 30-Jun 31-Mar 31-Dec 30-Sep 30-Jun

Sales Volumes, Prices and Costs

Premium semi-soft coking coal Coal sales (millions of tonnes) 0.19 0.15 0.07 – 0.06 0.04 0.16 0.02

$ 45.61

Average realized selling price (per tonne)⁽ⁱ⁾ $ 40.49 $ 21.04 $ – $ 21.38 $ 21.72 $ 22.32 $ 23.37 Standard semi-soft coking coal Coal sales (millions of tonnes) 0.64 0.65 0.77 0.52 0.58 0.12 0.31 0.11

$ 23.36

Average realized selling price (per tonne)⁽ⁱ⁾ $ 16.79 $ 15.66 $ 16.27 $ 18.42 $ 18.91 $ 19.10 $ 19.97 Thermal coal

0.28

Coal sales (millions of tonnes) 0.28 0.29 0.30 0.24 0.05 0.02 0.06 Average realized selling price (per tonne)⁽ⁱ⁾ $ 13.17 $ 15.26 $ 14.79 $ 9.17 $ 9.19 $ 9.26 $ 10.48 $ 10.47 Total

1.11

Coal sales (millions of tonnes) 1.08 1.13 0.82 0.88 0.21 0.49 0.19

Average realized selling price(per tonne)(i) $ 24.52	$ 19.55	$ 15.79	$ 13.65	$ 16.11	$ 17.19	$ 19.76	$ 17.42
Raw coal production(millions of tonnes)	1.51 1.21	1.13	0.67	0.37	0.62	0.71	0.62
Cost of sales of product sold(per tonne)	$ 21.15	$ 19.53	$ 28.01	$ 21.62	$ 56.59	$ 44.86	$ 60.75

$ 21.40

Direct cash costs of product sold (per tonne)⁽ⁱⁱ⁾ $ 7.97 $ 7.13 $ 12.47 $ 7.88 $ 6.55 $ 17.46 $ 15.57 Mine administration cash costs of product sold (per tonne)⁽ⁱⁱ⁾ $ 1.01 $ 3.23 $ 2.26 $ 2.32 $ 1.24 $ 1.78 $ 2.81 $ 7.90

$ 10.43

Total cash costs of product sold (per tonne)⁽ⁱⁱ⁾ $ 11.20 $ 9.39 $ 14.79 $ 9.12 $ 8.33 $ 20.27 $ 23.47

Other Operational Data

Production waste material moved

3.30

(millions of bank cubic meters) 2.62 2.22 1.82 0.72 1.08 2.33 3.62 Strip ratio (bank cubic meters of waste material per tonne of coal produced) 2.16 1.96 2.71 1.94 1.75 3.25 5.87 Lost time injury frequency rate(iii) 0.02 0.00 0.00 0.00 0.00 0.00 0.00 0.00

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

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Summary of Quarterly Financial Results

The Company’s consolidated financial statements are reported under IFRS issued by the International Accounting Standards Board (“IASB”). The following table provides highlights from the Company’s consolidated financial statements of quarterly results for the past eight quarters.

2017

$ in thousands, except per share information 2016 2015 Quarter Ended 31-Mar 31-Dec 30-Sep 30-Jun 31-Mar 31-Dec 30-Sep 30-Jun

Financial Results

$ 25,254

Revenue(i), (ii) $ 18,983 $ 16,379 $ 10,361 $ 12,727 $ 2,873 $ 8,620 $ 2,949 Cost of sales⁽ⁱⁱ⁾ (23,759) (22,842) (22,018) (23,105) (19,080) (12,072) (22,108) (11,833) Gross profit/(loss) excluding idled mine asset costs 4,714 (2,353) (3,162) (9,926) (1,049) (5,338) (10,642) (5,017) Gross profit/(loss) including idled mine

1,495

asset costs (3,859) (5,639) (12,744) (6,353) (9,199) (13,488) (8,884)

(3,208)

Other operating income/(expenses) (3,782) 4,631 812 (1,711) (1,093) 621 (19,450)

Administration expenses	(2,385)	(2,378)	(2,042)	(1,826)	(1,642)	(2,154)	(1,967)	(1,963)
Evaluation and exploration expenses	(29)	(222)	(101)	(52)	(47)	(46)	(40)	22
Impairment of property, plant and equipment		(1,152)	–	–	–	(92,651)	–	–

–

Loss from operations	(4,127)	(11,393)	(3,151)		(13,810)	(9,753)		(105,143)	(14,873)	(30,275)
Finance costs	(5,715)	(5,645)	(6,358)		(5,377)	(5,497)		(5,694)	(5,351)	(5,222)
Finance income	4	472		5	324		1	580	1,984	274
Share of earnings/(losses) of a joint venture		378		89	256		83	(7)	99	151

Income tax credit/(expense)	(45)	(1,294)	82	(23)	(235)	(2)	(1)	(1)
Net loss	(9,617)	(17,482)	(9,333)	(18,630)	(15,401)	(110,266)	(18,142)	(35,073)
Basic and dilute loss per share	$ (0.04) $	(0.07) $	(0.04) $	(0.07) $	(0.06) $	(0.44) $	(0.07) $	(0.15)

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

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