SGQ.V · 2018-11-13

SouthGobi Resources announces third quarter 2018 financial and operating results

Production Results Financials

R E S O U R C E S November 13, 2018

SouthGobi Resources announces third 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 and nine months ended September 30, 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 September 30, 2018 and the subsequent period up to November 13, 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 made through our Inner Mongolia subsidiary, the Company experienced an increase in the average selling price of coal from $26.5 per tonne in the third quarter of 2017 to $35.8 per tonne in the third quarter of 2018. The Company sold 0.7 million tonnes for the third quarter of 2018 as compared to 0.8 million tonnes for the third quarter of 2017.
Financial Results – The Company recorded a $1.7 million profit from operations in the third quarter of 2018 compared to a $4.7 million loss from operations in the third quarter of 2017. The overall financial results have improved when compared to the third quarter of 2017, which was principally attributable to the improved coal prices in China and the Company recording an impairment of coal stockpile inventories in the third quarter of 2017 (third quarter of 2018: nil; third quarter of 2017: $7.9 million). The improved financial performance in the third quarter was partially offset by the Company recognizing a provision for doubtful trade and other receivables during the quarter (third quarter of 2018: $5.3 million; third quarter of 2017: reversal of provision of $1.4 million).
Wash plant – The construction of the wash plant at the Ovoot Tolgoi mine was completed, and operations at the wash plant commenced in October 2018. The Company is in the process of making improvements to the wash plant in order to enhance the operational efficiency, as well as the output value. The Company expects to be in position to sell washed coal to the market in the fourth quarter of 2018. The expected annual wet washing capacity of the wash plant for 2019 is approximately 1.8 million tonnes of input coal. The Company is currently discussing an agreement regarding the operation of the wash plant with the wash plant operator; however, there can be no assurance that a favorable outcome will be reached.
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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”). Pursuant to the terms of the CIC Convertible Debenture, the Company was required to pay $8.1 million and $7.9 million of anniversary cash interest to CIC on November 19, 2017 and May 19, 2018, respectively (the “Anniversary Interest Payment” and together with the June 2017 Deferral Agreement Payment, the “November 19^th and May 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. The Company will also be required to pay $8.1 million of cash interest to CIC (the “November 2018 Payment”) and issue $4.0 million worth of PIK interest shares (the “November 2018 PIK Interest”) on November 19, 2018. As of the date of this press release, the Company expects that it will be unable to pay the November 2018 Payment to CIC on the due date.

As of the date of this press release, the Company: (i) has neither paid the November 19^th and May 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 discussion with CIC for a deferral of the November 19^th and May 19^th Payments and the November 2017 PIK Interest, the November 2018 Payment and the November 2018 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 September 30, 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 September 30, 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 Legal Proceedings from a Former Customer – On September 20, 2018, the Company announced that Inner Mongolia Southgobi Energy Co., Ltd. (“IMSGE”), a subsidiary of the Company, had received a court summons (the “Summons”) from the Ejinaqi People’s Court of Inner Mongolia Autonomous Region of China (the “Ejinaqi Court”) in relation to a dispute over certain coal sales contracts with Jiayuguan Xiyuan Trading Co., Ltd (“Xiyuan”), a former customer of IMSGE.

According to the Summons, Xiyuan has applied to the Ejinaqi Court claiming that IMSGE should repay a sum of RMB 19.4 million (approximately $2.8 million) to Xiyuan, comprised of RMB 19.1 million of coal prepayments and RMB 0.3 million of interest. Xiyuan also claimed Ejinaqi Fulemeng Energy Industry Co., Ltd. for joint liability of the above sums as it was alleged as an agent for IMSGE to receive coal prepayment and deliver coal on behalf of IMSGE.

Due to the complexity and monetary amount involved, the court hearing regarding this matter previously scheduled on October 10, 2018 was delayed and will be rescheduled for a future date.

The Company firmly believes that it has a strong defense on the merits and has retained independent Chinese litigation counsel to vigorously defend itself against these claims. However, due to the inherent uncertainties of litigation, it is not possible to predict whether IMSGE will be successful in defending itself in these proceedings.

Changes in Management and Director

Mr. Shougao Wang: Mr. Wang was appointed as an executive director on July 3, 2018.

Mr. Tao Zhang: Mr. Zhang was appointed as a vice president of the Company on July 3, 2018.

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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 washing certain grades of coal 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 construction of the wash plant at the Ovoot Tolgoi mine was completed, and operations at the wash plant commenced in October 2018. The Company is in the process making improvements to the wash plant in order to enhance the operational efficiency, as well as the output value. The Company expects to be in a position to sell washed coal to the market in the fourth 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 September 30, 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” for details. As at November 13, 2018, the Company had $5.4 million of cash.

OVERVIEW OF OPERATIONAL DATA AND FINANCIAL RESULTS

Summary of Operational Data

Three months ended Nine months ended September 30, September 30, 2018 2018

2017 2017

Sales Volumes, Prices and Costs

Premium semi-soft coking coal Coal sales (millions of tonnes) 0.25 0.12 0.35 0.49 $ 48.15 $ 46.81 $ 52.36 $ Average realized selling price (per tonne) ⁽ⁱ⁾ 45.93 Standard semi-soft coking coal/ premium thermal coal Coal sales (millions of tonnes) 0.26 0.41 0.86 1.84 Average realized selling price (per tonne) ⁽ⁱ⁾ $ 34.40 $ 28.32 $ 39.93 $ 25.89 Standard thermal coal Coal sales (millions of tonnes) 0.22 0.27 0.66 1.06 $ 23.49 $ 14.54 $ 25.21 $ Average realized selling price (per tonne) ⁽ⁱ⁾ 14.77 Total Coal sales (millions of tonnes) 0.73 0.80 1.87 3.39 $ 35.77 $ 26.47 $ 37.03 $ Average realized selling price (per tonne) ⁽ⁱ⁾ 25.29

1.11 2.47

Raw coal production (millions of tonnes) 2.47 5.87

Cost of sales of product sold (per tonne) $ 20.99 $ 31.31 $ 25.08 $ 22.48 $ 7.41 $ 10.98 $ 11.08 $ Direct cash costs of product sold (per tonne) ⁽ⁱⁱ⁾ 9.10 Mine administration cash costs of product sold $ 1.24 $ 2.98 $ 1.16 $ (per tonne) ⁽ⁱⁱ⁾ 2.00 Total cash costs of product sold (per tonne) ⁽ⁱⁱ⁾ $ 8.65 $ 13.96 $ 12.24 $ 11.10

Other Operational Data

Production waste material moved (millions of bank

4.56 12.62

cubic meters) 6.77 16.43 Strip ratio (bank cubic meters of waste material per tonne of coal produced) 4.11 2.74 5.08 2.80

0.00 0.06

Lost time injury frequency rate (iii) 0.23 0.18

(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

The Company ended the third quarter of 2018 without a lost time injury. For the three months ended September 30, 2018, the Company had a lost time injury frequency rate of nil per 200,000 man hours based on a rolling 12 month average as compared to 0.23 for the three months ended September 30, 2017.

For the three months ended September 30, 2018

As a result of improved market conditions and prices for coal in China as well as a higher portion of sales made through our Inner Mongolia subsidiary, the Company experienced an increase in the average selling price of coal from $26.5 per tonne in the third quarter of 2017 to $35.8 per tonne in the third quarter of 2018. The improvement in the product mix also contributed to the increase in the average price for the quarter. The product mix for the third quarter of 2018 consisted of approximately 34% of premium semi-soft coking coal, 36% of standard semi-soft coking coal/premium thermal coal and 30% of standard thermal coal compared to approximately 15% of premium semi-soft coking coal, 51% of standard semisoft coking coal/premium thermal coal and 34% of standard thermal coal in the third quarter of 2017.

The Company sold 0.7 million tonnes for the third quarter of 2018 as compared to 0.8 million tonnes for the third quarter of 2017.

The Company’s production in the third quarter of 2018 was lower than the third quarter of 2017 as a result of management’s decision to pace production to meet expected sales as well as a higher strip ratio achieved for the quarter, yielding 1.1 million tonnes for the third quarter of 2018 as compared to 2.5 million tonnes for the third quarter of 2017.

The Company’s unit cost of sales of product sold decreased to $21.0 per tonne in the third quarter of 2018 from $31.3 per tonne in the third quarter of 2017. The decrease was mainly driven by the Company recognizing coal stockpile impairments of $7.9 million for the third quarter of 2017 as compared to nil during this quarter.

For the nine months ended September 30, 2018

Due to the delays experienced in the custom clearance process at the Ceke border which the Company has been experiencing since July 2017, the Company sold 1.9 million tonnes for the first nine months of 2018 as compared to 3.4 million tonnes for the first nine months of 2017.

The average selling price increased from $25.3 per tonne for the first nine months of 2017 to $37.0 per tonne for the first nine months of 2018, which was mainly due to the improved market conditions and prices for coal in China as well as a higher portion of sales made through our Inner Mongolia subsidiary.

The Company’s production in the first nine months of 2018 was lower than the first nine months of 2017 as a result of management’s decision to pace production to meet expected sales as well as a higher strip ratio achieved for the period, yielding 2.5 million tonnes for the nine months of 2018 as compared to 5.9 million tonnes for the first nine months of 2017.

The Company’s unit cost of sales of product sold increased to $25.1 per tonne in the first nine months of 2018 from $22.5 per tonne in the first nine months of 2017. The increase was principally attributable to the diseconomies of scale driven by decreased sales volume.

Summary of Financial Results

Three months ended Nine months ended September 30, September 30, 2018 2018

$ in thousands, except per share information 2017 2017

Revenue (i),(ii) $ 24,487 $ 19,356 $ 65,087 $ 79,275

(15,320) (46,905)

Cost of sales ⁽ⁱⁱ⁾ (25,049) (76,193) Gross profit/(loss) excluding idled mine asset costs 13,195 (2,094) 29,524 12,065

9,167 18,182

Gross profit/(loss) including idled mine asset costs (5,693) 3,082

Other operating income/(expenses) (4,721) 3,477 (24,150) (3,776)

(2,724) (8,957)

Administration expenses (2,451) (7,070) Evaluation and exploration expenses (40) (48) (320) (221)

1,682 (15,245)

Profit/(loss) from operations (4,715) (7,985)

Finance costs (5,758) (5,674) (17,690) (16,708)

106 472

Finance income 142 21

Share of earnings of a joint venture	247	265	1,215	919
Income tax credit/(expense)	(267)	238	(2,805)	(2,521)
Net loss	(3,990)	(9,744)	(34,053)	(26,274)

$ (0.01) $ (0.04) $ (0.12) $ Basic and diluted loss per share (0.10)

(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

For the three months ended September 30, 2018

The Company recorded a $1.7 million profit from operations in the third quarter of 2018 compared to a $4.7 million loss from operations in the third quarter of 2017. The overall financial results have improved when compared to the third quarter of 2017, which was principally attributable to the improved coal prices in China and the Company recording an impairment of coal stockpile inventories in the third quarter of 2017 (third quarter of 2018: nil; third quarter of 2017: $7.9 million). The improved financial performance in the third quarter was partially offset by the Company recognizing a provision for doubtful trade and other receivables during the period (third quarter of 2018: $5.3 million; third quarter of 2017: reversal of provision of $1.4 million).

The provision for certain long aged doubtful notes receivables and trade and other receivables is recognized based on the expected credit loss model that the Company has been applying. The Company will continue to explore different options to recover the balance of these doubtful trade and notes receivables.

Revenue was $24.5 million in the third quarter of 2018 compared to $19.4 million in the third quarter of 2017. The Company’s revenue is presented after deduction of royalties. Royalty for the quarter was $1.8 million, compared to $1.3 million for the third quarter of 2017. The increase was mainly due to increase in the average price for the coal exported to China during the quarter.

Cost of sales was $15.3 million in the third quarter of 2018 compared to $25.0 million in the third quarter of 2017. The decrease in cost of sales was mainly due to the Company recognizing coal stockpile impairments of $7.9 million for the third quarter of 2017 as compared to nil 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 (a Non-IFRS financial measure, see section “Non-IFRS financial measure” for further analysis) during the quarter.

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.

Three months ended September 30, $ in thousands 2018 2017

Operating expenses $ 6,318 $ 11,165 Share-based compensation expense 2

Depreciation and depletion	4,973	2,350
Impairment of coal stockpile inventories	–	7,933
Cost of sales from mine operations	11,292	21,450

4,028

Cost of sales related to idled mine assets 3,599

$ 15,320

Cost of sales $ 25,049

Operating expenses in cost of sales were $6.3 million in the third quarter of 2018 compared to $11.2 million in the third quarter of 2017. The overall decrease in operating expenses was primarily due to the effect of: (i) lower unit costs achieved through improvement of operational efficiency and (ii) decreased sales volume from 0.8 million tonnes in the third quarter of 2017 to 0.7 million tonnes in the third quarter of 2018.

There was no impairment of coal stockpiles for the third quarter of 2018 (third quarter of 2017: $7.9 million). The coal stockpile impairments recorded in the third 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 third quarter of 2018 included $4.0 million related to depreciation expenses for idled equipment (third quarter of 2017: $3.6 million).

Other operating expenses was $4.7 million in the third quarter of 2018 (third quarter of 2017: other operating income of $3.5 million).

Three months ended September 30, $ in thousands 2018 2017

Reversal of provision/(provision) for doubtful trade

$ (5,251)

and other receivables $ 1,389 Impairment of properties for resale (1,372) – Loss on disposal of property, plant and equipment (1,145) –

(358)

CIC management fee –

Provision for commerial arbitration	(232)		–
Gain on settlement of trade payables	2,956		–
Foreign exchange gain	693	2,128
Other	(12)		(40)
Other operating income/(expenses)	$ (4,721) $	3,477

The Company made a provision for doubtful trade and other receivables of $5.3 million in the third quarter of 2018 (third quarter of 2017: reversal of provision of $1.4 million) for certain long aged receivables based on expected credit loss model. An impairment of $1.4 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.

Administration expenses were $2.7 million in the third quarter of 2018 (third quarter of 2017: $2.5 million).

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Three months ended September 30,

$ in thousands	2018	2017
Corporate administration	$ 616 $	919
Professional fees	713	508

1,342

Salaries and benefits 952

Share-based compensation expense	10	32
Depreciation	43	40
Administration expenses	$ 2,724 $	2,451

Administration expenses were higher for the third quarter of 2018 compared to the third quarter of 2017 primarily due to higher legal and professional fees and salaries incurred in the quarter.

Evaluation and exploration expenses were negligible for the third quarter of 2018 (third 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 third 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 $5.8 million and $5.7 million in the third quarter of 2018 and 2017 respectively, which primarily consisted of interest expense on the $250.0 million CIC Convertible Debenture.

Finance income was $0.1 million for both the third quarter of 2018 and 2017, which primarily related to unrealized gain on the change in fair value of the embedded derivatives in the CIC Convertible Debenture.

For the nine months ended September 30, 2018

The Company recorded a $15.2 million loss from operations in the first nine months of 2018 compared to an $8.0 million loss from operations in the first nine months of 2017. The operations for the nine months ended September 30, 2018 were impacted by the following factors: (i) improved coal prices in China; (ii) diseconomies of scale driven by decreased sales;

(iii) provision for doubtful trade and other receivables of $14.5 million; and (iv) provision for doubtful notes receivables of $7.7 million. The recognition of a provision for doubtful notes receivables and trade and other receivables follows after a credit reassessment exercise carried out during the second quarter of 2018 which concluded with the Company only continuing coal deliveries to customers with above-standard credit ratings in order to preserve the capital of the Company and discontinuing coal deliveries to certain other customers. The provision recognized relates to receivables from those customers that the Company has ceased coal shipments to. The Company will continue to explore different options to recover the balance of these doubtful trade and notes receivables.

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Revenue was $65.1 million in the first nine months of 2018 compared to $79.3 million in the first nine months of 2017. The Company sold 1.9 million tonnes of coal at an average realized selling price of $37.0 per tonne in the first nine months of 2018 compared to sales of 3.4 million tonnes at an average realized selling price of $25.3 per tonne in the first nine months of 2017.

The Company’s revenue is presented net of royalties. Royalty for the first nine months of 2018 was $4.9 million, compared to $5.0 million for the first nine months of 2017, the decrease was mainly due to less coal being exported to China during the period.

Cost of sales was $46.9 million in the first nine months of 2018 compared to $76.2 million in the first nine months of 2017 as follows:

Nine months ended September 30,

$ in thousands	2018		2017
Operating expenses	$ 22,895 $		36,756
Share-based compensation expense		1	30
Depreciation and depletion	12,667		17,290
Impairment of coal stockpile inventories		–	13,134
Cost of sales from mine operations	35,563		67,210

11,342

Cost of sales related to idled mine assets 8,983

$ 46,905

Cost of sales $ 76,193

Operating expenses in cost of sales were $22.9 million in the first nine months of 2018 compared to $36.8 million in the first nine months of 2017. The decrease in operating expenses was primarily related to the decrease in sales volume from 3.4 million tonnes in the first nine months of 2017 to 1.9 million tonnes in the first nine months of 2018.

Cost of sales in the first nine months of 2017 included coal stockpile impairments of $13.1 million, to reduce the carrying value of the Company’s coal stockpiles to their net realizable value. The coal stockpile impairments recorded in 2017 primarily related to the Company’s higher-ash products.

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