SGQ.V · 2018-05-14

SouthGobi Resources announces first quarter 2018 financial and operating results

Production Results Financials

R E S O U R C E S May 14, 2018

SouthGobi Resources announces first quarter 2018 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, 2018. 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, 2018 and the subsequent period to May 14, 2018 are as follows:

Operating Results – As a result of improved market conditions and prices for coal in China as well as a higher portion of sales were made through our Inner Mongolia subsidiary, the Company experienced an increase in the average selling price of coal from $24.52 per tonne in the first quarter of 2017 to $43.02 per tonne in the first quarter of 2018. However, the volume of coal sales has decreased from 1.11 million tonnes in the first quarter of 2017 to 0.56 million tonnes in the first quarter of 2018 as a result of the delay in the customs clearance process at the Ceke border which the Company has been experiencing since July 2017.
Financial Results – The Company recorded a gross profit of $6.7 million in the first quarter of 2018 compared to $1.5 million in the first quarter of 2017 while $2.9 million profit from operations was recorded in the first quarter of 2018 compared to a $4.1 million loss from operations in the first quarter of 2017. As a result of improved market conditions and prices for coal in China, the overall financial results improved when compared to the first quarter of 2017, which was principally attributable to the higher average selling price achieved during the quarter.
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China Investment Corporation (“CIC”) convertible debenture (“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.

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. In addition, pursuant to the terms of the CIC Convertible Debenture, the Company is required to pay $7.9 million of cash interest to CIC on May 19, 2018 (the “May 2018 Payment”). As of the date of this press release, the Company expects that it will be unable to pay the May 2018 Payment to CIC on the due date. 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 discussion with CIC for a deferral of the November 19^th Payments, the November 2017 PIK Interest and the May 2018 Payment; 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 March 31, 2018, International Accounting Standard (“IAS”) 1 requires the Company to classify the entire balance of the CIC Convertible Debenture as a current liability as at March 31, 2018, 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.

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 (“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 March 31, 2018, the Company recorded a provision of $14.1 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. On May 10, 2018, SGS received a notice from First Concept advising that First Concept has obtained a court order dated April 27, 2018 from the High Court of Hong Kong granting leave to First Concept to enforce the Arbitration Award against SGS in Hong Kong. The Company is consulting with its independent litigation counsel regarding this matter. However, as SGS does not have any material assets, properties or place of business in Hong Kong, the Company is of the view that this court order will have little or no immediate impact on its ongoing operations.

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 any other jurisdiction in which SGS has assets or properties, the Company intends to take appropriate steps to respond to such enforcement proceedings in the best interests of the Company through independent litigation counsel which has been retained by the Company for this purpose.

Termination of Enforcement Procedures relating to Tax Verdict – Following the termination of enforcement procedures in relation to the previously disclosed judgment of the Mongolian Second Criminal Court rendered against SGS (the “Tax Verdict”) in January 2018, the dispute giving rise to the Tax Verdict has been fully resolved. The Company will continue to work closely with the Mongolian authorities to ensure compliance with all applicable Mongolian rules and regulations.
Changes in Directors

Mr. Zhiwei Chen: Mr. Chen was appointed as a non-executive director on April 13, 2018.

Mr. Xiaoxiao Li: Mr. Li was appointed as a non-executive director on April 13, 2018.

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.
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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 March 31, 2019, 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 condensed consolidated interim 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” of this press release for details. As at May 14, 2018, the Company had $2.1 million of cash.

OVERVIEW OF OPERATIONAL DATA AND FINANCIAL RESULTS

Summary of Operational Data

Three months ended March 31,

2018 2017

Sales Volumes, Prices and Costs

Premium semi-soft coking coal

0.03

Coal sales (millions of tonnes) 0.19 Average realized selling price (per tonne) ⁽ⁱ⁾ $ 67.94 $ 45.61 Standard semi-soft coking coal/premium thermal coal Coal sales (millions of tonnes) 0.64 Average realized selling price (per tonne) ⁽ⁱ⁾ $ 46.34 $ 23.36

Coal sales (millions of tonnes) 0.12 0.28 Average realized selling price (per tonne) ⁽ⁱ⁾ $ 25.40 $ 13.17

Coal sales (millions of tonnes) 0.56 1.11 Average realized selling price (per tonne) ⁽ⁱ⁾ 24.52

Raw coal production (millions of tonnes) 0.38 1.51

Cost of sales of product sold (per tonne) $ 29.48 $ 21.40 $ 16.86 $ Direct cash costs of product sold (per tonne)⁽ⁱⁱ⁾ 9.42 Mine administration cash costs of product sold (per tonne)⁽ⁱⁱ⁾ $ 1.23 $ 1.01 Total cash costs of product sold (per tonne)⁽ⁱⁱ⁾ $ 18.09 $ 10.43

Other Operational Data

Production waste material moved (millions of bank cubic meters) 2.88 3.30

Strip ratio (bank cubic meters of waste material per tonne

7.55

of coal produced) 2.18 Lost time injury frequency rate (iii) 0.13 0.11

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

(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

As at March 31, 2018, the Company had a lost time injury frequency rate of 0.13 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 as well as a higher portion of sales were made through our Inner Mongolia subsidiary, the average realized selling price increased from $24.52 per tonne in the first quarter of 2017 to $43.02 per tonne in the first quarter of 2018. The product mix for the first quarter of 2018 consisted of approximately 6% of premium semi-soft coking coal, 72% of standard semi-soft coking coal/premium thermal coal and 22% of standard thermal coal compared to approximately 17% of premium semisoft coking coal, 58% of standard semi-soft coking coal/premium thermal coal and 25% of standard thermal coal in the first quarter of 2017.

The Company sold 0.56 million tonnes for the first quarter of 2018 as compared to 1.11 million tonnes for the first quarter of 2017, as a result of the delay in the customs clearance process at the Ceke border which the Company has been experiencing since July 2017.

The Company’s production in the first quarter of 2018 was lower than the first quarter of 2017 as a result of pacing the production to meet the expected sales, yielding 0.38 million tonnes for the first quarter of 2018 as compared to 1.51 million tonnes for the first quarter of 2017.

The Company’s unit cost of sales of product sold increased to $29.48 per tonne in the first quarter of 2018 from $21.40 per tonne in the first quarter of 2017. The increase was mainly driven by decreased sales and the related diseconomies of scale.

Summary of Financial Results

Three months ended March 31, 2018

$ in thousands, except per share information 2017

Revenue (i),(ii) $ 23,223 $ 25,254

(16,507)

Cost of sales ⁽ⁱⁱ⁾ (23,759) Gross profit excluding idled mine asset costs 10,250 4,714

6,716

Gross profit including idled mine asset costs 1,495

Other operating expenses (1,338) (3,208)

(2,377)

Administration expenses (2,385) Evaluation and exploration expenses (124) (29)

2,877

Profit/(loss) from operations (4,127)

Finance costs (6,006) (5,715) Finance income 4 Share of earnings of a joint venture 340 266

(929)

Income tax expense (45)

Net loss (3,460) (9,617) $ (0.01)$ Basic and diluted loss per share (0.04)

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

(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 $2.9 million profit from operations in the first quarter of 2018 compared to a $4.1 million loss from operations in the first quarter of 2017. As a result of improved market conditions and prices for coal in China, the overall financial results improved when compared to the first quarter of 2017, which were principally attributable to higher average selling price achieved during the quarter.

Revenue was $23.2 million in the first quarter of 2018 compared to $25.3 million in the first quarter of 2017. The Company’s revenue is presented after deduction of royalties. The Company’s effective royalty rate for the first quarter of 2018, based on the Company’s average realized selling price of $43.02 per tonne, was 5.0% or $2.13 per tonne compared to 5.9% or $1.44 per tonne based on the average realized selling price of $24.52 per tonne in the first quarter of 2017.

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, customs 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 “non-market” under Mongolian tax law and the royalty will then be calculated based on a reference price as determined by the Government of Mongolia. See the section entitled “Risk Factors – Company’s Projects in Mongolia” in the Company’s most recently filed Annual Information Form for the year ended December 31, 2017, a copy of which is available under the Company’s profile on SEDAR at www.sedar.com.

Cost of sales was $16.5 million in the first quarter of 2018 compared to $23.8 million in the first quarter of 2017. The decrease in cost of sales was mainly due to the decreased sales during the quarter. 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 (see section “Non-IFRS financial measure” of this press release for further analysis) during the quarter.

Three months ended March 31,

$ in thousands	2018	2017
Operating expenses	$ 10,132 $	10,700
Share-based compensation expense	–	23

2,841

Depreciation and depletion 7,486 Impairment of coal stockpile inventories – 2,331

Cost of sales from mine operations 12,973 20,540

3,534

Cost of sales related to idled mine assets 3,219

$ 16,507 $ Cost of sales 23,759

Operating expenses in cost of sales were $10.1 million in the first quarter of 2018 compared to $10.7 million in the first quarter of 2017. The overall decrease in operating expenses was primarily due to the net effect of: (i) decreased sales volume from 1.11 million tonnes in the first quarter of 2017 to 0.56 million tonnes in the first quarter of 2018 and (ii) less coal stockpile inventories were impaired during the quarter which increased the inventory cost.

There was no impairment of coal stockpiles for the first quarter of 2018 (first quarter of 2017: $2.3 million). The coal stockpile impairments recorded in the first quarter of 2017 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 the first quarter of 2018 included $3.5 million related to depreciation expenses for idled equipment (first quarter of 2017: $3.2 million).

Other operating expenses was $1.3 million in 2018 (first quarter of 2017: $3.2 million).

Three months ended March 31, $ in thousands 2017

2018

Provision for doubtful trade and other receivables $ (1,103) $ – Foreign exchange gain/(loss) (510) CIC management fee (583) –

(104)

Penalty on late settlement of trade payables (268) Loss on disposal of property, plant and equipment (67) – Provision for commercial arbitration (224) –

–

Mining services, net (2,395) Other (36) (35)

Other operating expenses $ (1,338) $ (3,208)

The Company made a provision for doubtful trade and other receivables of $1.1 million in the first quarter of 2018 (first quarter of 2017: nil) for certain long aged receivables based on expected credit loss model upon the adoption of the IFRS 9.

A foreign exchange gain of $0.8 million was recorded during the first quarter of 2018 (first quarter of 2017: a foreign exchange loss of $0.5 million) as a result of the significant appreciation of RMB against USD. The key underlying driver of the forex gain are that most trade receivables are denominated in RMB.

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Administration expenses were $2.4 million for both the first quarter of 2018 and first quarter of 2017.

Three months ended March 31, $ in thousands 2018 2017

$ 668 $ Corporate administration 470 Professional fees 515 918

1,134

Salaries and benefits 843

Share-based compensation expense	16	11
Depreciation	44	143
Administration expenses	$ 2,377 $	2,385

The increase in salaries and benefits was mainly due to the increase of headcount, which is to support the expansion of the sales channel in China.

Evaluation and exploration expenses were $0.1 million in the first quarter of 2018 (first quarter of 2017: negligible). The Company continued to minimize evaluation and exploration expenditures in 2018 in order to preserve the Company’s financial resources. Evaluation and exploration activities and expenditures in the first quarter of 2018 were limited to ensuring that the Company met the Mongolian Minerals Law requirements in respect of its mining licenses.

Finance costs were $6.0 million and $5.7 million in the first quarter of 2018 and 2017 respectively, which primarily consisted of interest expense on the $250.0 million CIC Convertible Debenture.

Finance income was $0.3 million for the first quarter of 2018 (first quarter of 2017: negligible), which primarily related to fair value gain on notes receivable upon redemption.

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Summary of Quarterly Operational Data

2018

2017 2016 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) 0.03 0.37 0.12 0.18 0.19 0.15 0.07 –

$ 67.94

Average realized selling price (per tonne)⁽ⁱ⁾ $ 50.47 $ 46.55 $ 45.67 $ 45.61 $ 40.49 $ 21.04 $ – Standard semi-soft coking coal/ premium thermal coal Coal sales (millions of tonnes) 0.60 0.41 0.79 0.64 0.65 0.77 0.52 Average realized selling price (per tonne)⁽ⁱ⁾ $ 46.34 $ 37.49 $ 28.32 $ 26.69 $ 23.36 $ 16.79 $ 15.66 $ 16.27

Coal sales (millions of tonnes) 0.12 0.29 0.27 0.51 0.28 0.28 0.29 0.30 Average realized selling price (per tonne)⁽ⁱ⁾ $ 25.40 $ 16.98 $ 14.48 $ 15.79 $ 13.17 $ 15.26 $ 14.79 $ 9.17

Coal sales (millions of tonnes) 0.56 1.26 0.80 1.48 1.11 1.08 1.13 0.82 Average realized selling price (per tonne)⁽ⁱ⁾ $ 36.54 $ 26.41 $ 25.24 $ 24.52 $ 19.55 $ 15.79 $ 13.65

Raw coal production (millions of tonnes) 0.38 0.51 2.47 1.89 1.51 1.21 1.13 0.67

Cost of sales of product sold (per tonne) $ 29.48 $ 23.54 $ 31.31 $ 18.50 $ 21.40 $ 21.15 $ 19.53 $ 28.01 Direct cash costs of product sold (per tonne)⁽ⁱⁱ⁾ $ 16.86 $ 9.91 $ 10.98 $ 7.84 $ 9.42 $ 7.97 $ 7.13 $ 12.47 Mine administration cash costs of

$ 1.23

product sold (per tonne)⁽ⁱⁱ⁾ $ 4.92 $ 2.98 $ 2.22 $ 1.01 $ 3.23 $ 2.26 $ 2.32 Total cash costs of product sold (per tonne)⁽ⁱⁱ⁾ $ 18.09 $ 14.83 $ 13.96 $ 10.06 $ 10.43 $ 11.20 $ 9.39 $ 14.79

Other Operational Data

Production waste material moved (millions of bank cubic meters) 2.88 4.36 6.77 6.36 3.30 2.62 2.22 1.82 Strip ratio (bank cubic meters of waste material per tonne of coal produced) 7.55 8.59 2.74 3.37 2.18 2.16 1.96 2.71 Lost time injury frequency rate(iii) 0.13 0.20 0.23 0.18 0.11 0.00 0.00 0.00

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

(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.

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

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