SGQ.V · 2013-08-12

Southgobi Resources Announces Second Quarter 2013 Financial and Operating Results

Production Results Financials

August 12, 2013

SOUTHGOBI RESOURCES ANNOUNCES SECOND QUARTER 2013 FINANCIAL AND OPERATING RESULTS

HONG KONG – SouthGobi Resources Ltd. (TSX: SGQ, HK: 1878), (the “Company” or “SouthGobi”) today announced its financial and operating results for the three and six months ended June 30, 2013. All figures are in U.S. Dollars unless otherwise stated.

SIGNIFICANT EVENTS

The Company’s significant events for the quarter ended June 30, 2013 and subsequent weeks are as follows:

Entered into a coal supply agreement with Winsway Coking Coal Holdings Limited (“Winsway”) for the sale of 1.2 million tonnes of Standard semi-soft coking coal in 2013. Agreement reaffirms the Company’s longstanding relationship with Winsway, a key customer, as SouthGobi continues to focus on its 2013 commercial objectives;
Announced the appointment of Enkh-Amgalan Sengee as President and Executive Director of SouthGobi Sands LLC, the Company’s indirectly wholly-owned subsidiary, effective July 15, 2013;
Announced the appointment of Brett Salt as Chief Commercial Officer and his resignation as a non-executive director, effective August 1, 2013;
Second quarter sales volumes and revenue declined to 0.04 million tonnes and $0.4 million, respectively, in 2013 compared to 0.16 million tonnes and $8.4 million in 2012.

REVIEW OF QUARTERLY OPERATING RESULTS

The Company’s operating results for the previous eight quarters are summarized in the table below:

	2013		2012				2011
QUARTER ENDED	30-Jun	31-Mar	31-Dec	30-Sep	30-Jun	31-Mar	31-Dec	30-Sep
Raw coal production (millions of tonnes) Sales volumes and prices (i) SouthGobi premium semi-soft coking coal Coal sales (millions of tonnes) Average realized selling price (per tonne) SouthGobi standard semi-soft coking coal Coal sales (millions of tonnes) Average realized selling price (per tonne) SouthGobi thermal coal Coal sales (millions of tonnes) Average realized selling price (per tonne) Total Coal sales (millions of tonnes) Average realized selling price (per tonne) Costs Direct cash costs of product sold excluding idled mine asset costs (per tonne) (ii) Total cash costs of product sold excluding idled mine asset costs (per tonne) (ii) Waste movement and stripping ratio Production waste material moved (millions of bank cubic meters) Strip ratio (bank cubic meters of waste material per tonne of coal produced) Pre-production waste material moved (millions of bank cubic meters) Other operating capacity statistics Capacity of key mining fleet Number of mining shovels/excavators available at period end Total combined stated mining shovel/excavator capacity at period end (cubic meters) Number of haul trucks available at period end Total combined stated haul truck capacity at period end (tonnes) Employees and safety Employees at period end Lost time injury frequency rate (iii)	0.17 - $ - - $ - 0.04 $ 14.40 0.04 $ 14.40 $ 10.36 $ 70.14 2.71 15.55 - 5 113 24 4,978 449 -	0.02 0.08 $ 45.81 - $ - 0.00 $ 13.67 0.08 $ 45.02 $ 35.46 $ 40.52 0.40 26.21 - 5 113 31 5,615 444 -	- 0.03 $ 47.86 - $ - - $ - 0.03 $ 47.86 $ 33.11 $ 38.17 - - - 5 113 27 4,743 465 0.1	- - $ - - $ - 0.31 $ 15.79 0.31 $ 15.79 $ 8.23 $ 12.12 - - - 4 98 27 4,743 644 0.2	0.27 0.12 $ 67.17 0.04 $ 49.91 0.00 $ 38.80 0.16 $ 62.56 $ 22.57 $ 31.49 1.16 4.31 - 4 98 27 4,743 693 0.2	1.07 0.31 $ 67.59 0.53 $ 50.40 - $ - 0.84 $ 56.79 $ 10.80 $ 15.04 2.20 2.07 - 3 64 27 4,743 720 0.3	1.34 0.53 $ 67.62 0.37 $ 48.59 0.25 $ 40.30 1.15 $ 55.51 $ 22.14 $ 23.09 4.58 3.42 - 3 64 25 4,561 720 0.2	1.25 0.66 $ 66.83 0.20 $ 48.17 0.51 $ 39.74 1.37 $ 54.01 $ 22.64 $ 23.17 4.10 3.28 0.39 3 64 16 2,599 695 0.2

(i) The sales volumes and prices that have been previously disclosed as raw semi-soft coking coal, raw medium-ash coal and raw higher-ash coal have now been reclassified as SouthGobi premium semi-soft coking coal, SouthGobi standard semi-soft coking coal and SouthGobi thermal coal, respectively, to reflect the Company’s new product strategy

(ii) A non-International Financial Reporting Standards (“IFRS”) financial measure, see Non-IFRS Financial Measures section

(iii) Per 200,000 man hours

On March 22, 2013, SouthGobi announced the resumption of operations at its flagship Ovoot Tolgoi Mine. The Company recognized revenue of $0.4 million in the second quarter of 2013 compared to $3.3 million in the first quarter of 2013 and $8.4 million in the second quarter of 2012. In the first half of 2013, the Company’s sales volume and average realized selling price continued to be negatively impacted by the softness of the inland China coking coal markets closest to SouthGobi’s operations. Economic activity post transition in China’s leadership has been slower than expected. The Chinese steel industry has been particularly affected and, as a result, demand and prices for coking coal have been negatively impacted. Subsequent to the end of the second quarter of 2013, SouthGobi entered into a coal supply agreement with Winsway, an integrated logistic service provider, for the sale of 1.2 million tonnes of Standard semi-soft coking coal in 2013.

For the three months ended June 30, 2013

For the three months ended June 30, 2013, the Company produced 0.17 million tonnes of raw coal with a strip ratio of 15.55 compared to production of 0.27 million tonnes of raw coal with a strip ratio of 4.31 for the three months ended June 30, 2012. In the second quarter of 2013, the Company primarily moved waste material (overburden) and exposed coal in the pit, aligning its operating activities to the significantly lower demand. The Company’s strip ratio of 15.55 for the three months ended June 30, 2013 is not indicative of the Company’s strip ratio moving forward.

For the three months ended June 30, 2013, SouthGobi recorded revenue of $0.4 million compared to $8.4 million in the second quarter of 2012. Revenue decreased primarily due to decreased sales volumes and a lower average realized selling price. The Company sold 0.04 million tonnes of coal at an average realized selling price of $14.40 per tonne in the second quarter of 2013 compared to sales of 0.16 million tonnes of coal at an average realized selling price of $62.56 per tonne in the second quarter of 2012. SouthGobi’s sales volume and average realized selling price was negatively impacted by the continued softness of the inland China coking coal markets closest to SouthGobi’s operations. SouthGobi’s average realized selling price was also negatively impacted by the Company’s sales mix in the second quarter of 2013, which consisted of thermal coal.

Direct cash costs of product sold excluding idled mine asset costs (a non-IFRS financial measure, see Non- IFRS Financial Measures section) were $10.36 per tonne for the three months ended June 30, 2013 compared to $22.57 per tonne for the three months ended June 30, 2012. Direct cash costs of product sold excluding idled mine asset costs primarily decreased in the second quarter of 2013 due to lower cost coal inventory being sold.

Mine administration cash costs of product sold excluding idled mine asset costs (a non-IFRS financial measure, see Non-IFRS Financial Measures section) increased to $59.78 per tonne for the three months ended June 30, 2013 from $8.92 per tonne for the three months ended June 30, 2012 primarily due to mine administration costs being allocated over lower sales volumes.

For the six months ended June 30, 2013

For the six months ended June 30, 2013, the Company produced 0.19 million tonnes of raw coal with a strip ratio of 16.40 compared to production of 1.33 million tonnes of raw coal with a strip ratio of 2.52 for the six months ended June 30, 2012. In the first quarter of 2013, the Company’s production was significantly impacted by the curtailment of mining operations until March 22, 2013. In the second quarter of 2013, the Company primarily moved waste material (overburden) and exposed coal in the pit, aligning its operating activities to the significantly lower demand. The Company’s strip ratio of 16.40 for the six months ended June 30, 2013 is not indicative of the Company’s strip ratio moving forward.

For the six months ended June 30, 2013, SouthGobi recorded revenue of $3.6 million compared to $48.6 million for the six months ended June 30, 2012. The Company sold 0.12 million tonnes of coal at an average realized selling price of $34.62 per tonne for the six months ended June 30, 2013 compared to sales of 1.00 million tonnes of coal at an average realized selling price of $57.71 per tonne for the six months ended June 30, 2012. Revenue decreased primarily due to decreased sales volumes and a lower average realized selling price.

Direct cash costs of product sold excluding idled mine asset costs (a non-IFRS financial measure, see Non- IFRS Financial Measures section) were $26.94 per tonne for the six months ended June 30, 2013 compared to $12.67 per tonne for the six months ended June 30, 2012. In the first quarter of 2012, direct cash costs of product sold excluding idled mine asset costs were lower due to a below-trend strip ratio.

Mine administration cash costs of product sold excluding idled mine asset costs (a non-IFRS financial measure, see Non-IFRS Financial Measures section) increased to $23.63 per tonne for the six months ended June 30, 2013 from $4.98 per tonne for the six months ended June 30, 2012 primarily due to mine administration costs being allocated over lower sales volumes.

REVIEW OF QUARTERLY FINANCIAL RESULTS

The Company’s financial results for the previous eight quarters are summarized in the table below:

($ in thousands, except for per share information, unless otherwise indicated)

	2013		2012				2011
QUARTER ENDED	30-Jun	31-Mar	31-Dec	30-Sep	30-Jun	31-Mar	31-Dec	30-Sep
Revenue Gross profit/(loss) excluding idled mine asset costs Gross profit margin excluding idled mine asset costs Gross profit/(loss) including idled mine asset costs Other operating expenses Administration expenses Evaluation and exploration expenses Income/(loss) from operations Net income/(loss) Basic income/(loss) per share Diluted income/(loss) per share	$ 374 (6,337) -1694% (12,092) (14,877) (4,024) (221) (31,214) (33,662) (0.18) (0.18)	$ 3,259 (2,187) -67% (18,601) (383) (3,733) (273) (22,990) (24,901) (0.14) (0.14)	$ 1,213 (6,894) -568% (25,336) (18,664) (6,079) (508) (50,586) (51,818) (0.28) (0.28)	$ 3,337 (8,601) -258% (27,532) (29,301) (5,178) (958) (62,969) (54,564) (0.30) (0.30)	$ 8,412 1,778 21% (13,809) (3,803) (7,497) (2,099) (27,208) 237 0.00 (0.12)	$ 4 0,153 22,674 56% 22,674 (2,578) (5,882) (5,033) 9,181 3,126 0.02 0.02	$ 5 1,064 16,637 33% 16,637 (24,644) (8,612) (14,513) (31,132) (18,897) (0.10) (0.14)	$ 6 0,491 17,635 29% 17,635 (138) (7,993) (10,908) (1,404) 55,921 0.31 (0.02)

	2013		2012				2011
QUARTER ENDED	30-Jun	31-Mar	31-Dec	30-Sep	30-Jun	31-Mar	31-Dec	30-Sep
Net income/(loss) Income/(loss) adjustments, net of tax Idled mine asset costs Share-based compensation expense/(recovery) Net impairment loss/(recovery) on assets Unrealized foreign exchange losses/(gains) Unrealized loss/(gain) on embedded derivatives in CIC debenture Realized loss/(gain) on disposal of FVTPL investments (i) Unrealized loss/(gain) on FVTPL investments Adjusted net income/(loss) (ii)	$ (33,662) 4,316 (21) 18,269 12 (3,343) 43 473 (13,913)	$ (24,901) 12,312 154 1,621 (38) (748) - (5) (11,605)	$ (51,818) 14,474 (1,144) 22,814 750 (662) 15 664 (14,907)	$ (54,564) 13,572 1,490 34,299 179 (12,856) - 1,197 (16,683)	$ 237 10,966 4,383 2,583 (511) (26,770) 46 2,282 (6,784)	$ 3,126 - 3,799 - (950) 776 (85) 339 7,005	$ (18,897) - 4,050 23,818 34 (10,790) - 155 (1,630)	$ 55,921 - 4,296 (2,925) 103 (62,058) - 2,449 (2,214)

(i) FVTPL is defined as “fair value through profit or loss”

(ii) A non-IFRS financial measure, see Non-IFRS Financial Measures section

For the three months ended June 30, 2013

The Company recorded a net loss of $33.7 million in the second quarter of 2013 compared to a net loss of $24.9 million in the first quarter of 2013 and a net income of $0.2 million in the second quarter of 2012.

Gross Profit/(Loss):

The Company recorded a gross loss of $12.1 million in the second quarter of 2013, $18.6 million in the first quarter of 2013 and $13.8 million in the second quarter of 2012. SouthGobi’s gross loss in these periods was negatively impacted by idled mine asset costs. The Company recorded a gross loss excluding idled mine asset costs of $6.3 million in the second quarter of 2013 and $2.2 million in the first quarter of 2013 compared to a gross profit excluding idled mine asset costs of $1.8 million in the second quarter of 2012. Gross profit will vary by quarter depending on sales volumes, sales prices and unit costs.

The Company recognized revenue of $0.4 million in the second quarter of 2013 compared to $3.3 million in the first quarter of 2013 and $8.4 million in the second quarter of 2012. In the first half of 2013, the Company’s sales volume and average realized selling price continued to be negatively impacted by the softness of the inland China coking coal markets closest to SouthGobi’s operations.

Based on the reference prices for the second quarter of 2013, the Company was subject to an average 7% royalty based on a weighted average reference price of $70.83 per tonne. The Company’s effective royalty rate for the second quarter of 2013, based on the Company’s average realized selling price of $14.40 per tonne, was 34%. Effective October 1, 2012 (for a six month trial period) the royalty was determined using the contracted sales price per tonne, not the reference price per tonne published by the Government of Mongolia. Despite SouthGobi, together with other Mongolian mining companies, engaging the appropriate Government of Mongolia authorities, the six month trial period was not extended and effective April 1, 2013, the royalty on all coal sales exported out of Mongolia was once again based on a set reference price per tonne published monthly by the Government of Mongolia. Although discussions have not been successful to date, SouthGobi, together with other Mongolian mining companies, continue the dialog with the appropriate Government of Mongolia authorities with the goal of moving to a more equitable process for setting reference prices.

Cost of sales was $12.5 million in the second quarter of 2013 compared to $21.9 million in the first quarter of 2013 and $22.2 million in the second quarter of 2012. Cost of sales comprise the direct cash costs of product sold, mine administration cash costs of product sold, idled mine asset costs, inventory impairments, equipment depreciation, depletion of mineral properties and share-based compensation expense. Of the $12.5 million, $21.9 million and $22.2 million recorded as cost of sales in the second quarter of 2013, the first quarter of 2013 and the second quarter of 2012, $6.7 million, $5.4 million and $6.6 million related to mine operations and $5.8 million, $16.4 million and $15.6 million related to idled mine asset costs, respectively. Cost of sales from mine operations in the second quarter of 2013 and the first quarter of 2013 included coal stockpile impairments of $4.0 million and $2.2 million, respectively, to reduce the carrying value of the coal stockpiles to their estimated net realizable values. Cost of sales from mine operations, exclusive of impairments, decreased in the second quarter of 2013 compared to the second quarter of 2012 due to lower sales volumes, partially offset by higher unit costs.

Cost of sales from idled mine asset costs decreased in the second quarter of 2013 due to the recommencement of mining operations at the Ovoot Tolgoi Mine on March 22, 2013. However, the 2013 production plan does not fully utilize the Company’s existing mining fleet, therefore, idled mine asset costs will continue to be incurred moving forward.

Other Operating Expenses:

Other operating expenses in the second quarter of 2013 were $14.9 million compared to $0.4 million in the first quarter of 2013 and $3.8 million in the second quarter of 2012. In the second quarter of 2013, other operating expenses primarily related to the following:

Available-for-sale financial asset – the Company recognized an impairment loss of $3.1 million related to its investment in Aspire Mining Limited (“Aspire”).
Materials and supplies inventory – the Company recognized an impairment loss of $6.9 million related to surplus materials and supplies inventories not expected to be utilized with the Company’s existing mining fleet.
Property, plant and equipment – the Company recorded $4.3 million of impairment charges to reduce various items of property, plant and equipment to their recoverable amounts. The impairments relate to surplus capital spares not expected to be utilized with the Company’s existing mining fleet.

In the first quarter of 2013, other operating expenses primarily related to $0.3 million of foreign exchange losses. In the second quarter of 2012, other operating expenses primarily related to a $2.6 million provision for doubtful trade and other receivables.

Administration Expenses:

Administration expenses in the second quarter of 2013 were $4.0 million compared to $3.7 million in the first quarter of 2013 and $7.5 million in the second quarter of 2012. The increase in administration expenses in the second quarter of 2013 compared to the first quarter of 2013 primarily related to increased legal expenses due to the ongoing governmental, regulatory and internal investigations. The decrease in administration expenses in the second quarter of 2013 compared to the second quarter of 2012 primarily related to decreased corporate administration, salaries and benefits and share-based compensation expenses, partially offset by increased legal and professional fees due to the ongoing governmental, regulatory and internal investigations.

Evaluation and Exploration Expenses:

Exploration expenses in the second quarter of 2013 were $0.2 million compared to $0.3 million in the first quarter of 2013 and $2.1 million in the second quarter of 2012. Exploration expenses will vary from quarter to quarter depending on the number of projects and the related seasonality of the exploration programs. The Company continues to minimize exploration expenditures to preserve the Company’s financial resources.

Finance Income & Finance Costs:

Finance costs in the second quarter of 2013 were $5.6 million compared to $4.0 million in the second quarter of 2012. Finance costs in the second quarter of 2013 primarily consisted of $5.1 million of interest expense on the China Investment Corporation (“CIC”) convertible debenture; whereas, finance costs in the second quarter of 2012 primarily consisted of a $2.3 million unrealized loss on FVTPL investments and $1.6 million of interest expense on the CIC convertible debenture.

Finance income in the second quarter of 2013 was $3.4 million compared to $26.9 million in the second quarter of 2012. In the second quarter of 2013 and 2012, finance income primarily consisted of a $3.3 million and $26.8 million unrealized gain on the fair value change of the embedded derivatives in the CIC convertible debenture, respectively. The fair value of the embedded derivatives in the CIC convertible debenture is driven by many factors including: the Company’s share price, foreign exchange rates and share price volatility.

Taxes:

In the second quarter of 2013, the Company recorded $nil current income tax expense related to its Mongolian operations compared to a current income tax recovery of $3.7 million in the second quarter of 2012. The Company has recorded a deferred income tax expense related to deductible temporary differences and loss carry-forwards of $0.2 million in the second quarter of 2013 compared to a deferred income tax recovery related to deductible temporary differences of $0.6 million in the second quarter of 2012.

For the six months ended June 30, 2013

The Company recorded a net loss of $58.6 million for the six months ended June 30, 2013 compared to net income of $3.4 million for the six months ended June 30, 2012.

Gross Profit/(Loss):

The Company recorded a gross loss of $30.7 million for the six months ended June 30, 2013 compared to a gross profit of $8.9 million for the six months ended June 30, 2012. SouthGobi’s gross profit/(loss) in these periods was negatively impacted by idled mine asset costs. The Company recorded a gross loss excluding idled mine asset costs of $8.5 million for the six months ended June 30, 2013 compared to a gross profit excluding idled mine asset costs of $24.5 million for the six months ended June 30, 2012. Gross profit will vary by quarter depending on sales volumes, sales prices and unit costs.

Revenues are presented net of royalties and selling fees. Based on the reference prices for the six months ended June 30, 2013, the Company was subject to an average 6% royalty based on a weighted average reference price of $53.76 per tonne. The Company’s effective royalty rate for the six months ended June 30, 2013, based on the Company’s average realized selling price of $34.62 per tonne, was 10%.

Cost of sales was $34.3 million for the six months ended June 30, 2013 compared to $39.7 million for the six months ended June 30, 2012. Cost of sales comprise the direct cash costs of product sold, mine administration cash costs of product sold, idled mine asset costs, inventory impairments, equipment depreciation, depletion of mineral properties and share-based compensation expense. Of the $34.3 million (1H 2012: $39.7 million) recorded as cost of sales for the six months ended June 30, 2013, $12.2 million (1H 2012: $24.1 million) related to mine operations and $22.2 million (1H 2012: $15.6 million) related to idled mine asset costs. Cost of sales related to mine operations decreased for the six months ended June 30, 2013 compared to the six months ended June 30, 2012 primarily due to lower sales volumes, partially offset by higher unit costs and coal stockpile impairments totaling $6.1 million. Cost of sales related to idled mine asset costs primarily consist of period costs, which are expensed as incurred and primarily include depreciation expense. The depreciation expense relates to the Company’s idled plant and equipment.

Other Operating Expenses:

Other operating expenses for the six months ended June 30, 2013 were $15.3 million compared to $6.4 million for the six months ended June 30, 2012. For the six months ended June 30, 2013, other operating expenses primarily related to the following:

Available-for-sale financial asset – the Company recognized an impairment loss of $3.1 million related to its investment in Aspire.
Materials and supplies inventory – the Company recognized an impairment loss of $6.9 million related to surplus materials and supplies inventories not expected to be utilized with the Company’s existing mining fleet.
Property, plant and equipment – the Company recorded $4.3 million of impairment charges to reduce various items of property, plant and equipment to their recoverable amounts. The impairments relate to surplus capital spares not expected to be utilized with the Company’s existing mining fleet.

For the six months ended June 30, 2012, other operating expenses primarily related to a $2.6 million provision for doubtful trade and other receivables and a $2.0 million foreign exchange loss.

Administration Expenses:

Administration expenses for the six months ended June 30, 2013 were $7.8 million compared to $13.4 million for the six months ended June 30, 2012. The decrease in administration expenses primarily relates to decreased corporate administration, salaries and benefits and share-based compensation expenses, partially offset by increased legal and professional fees due to the ongoing governmental, regulatory and internal investigations.

Evaluation and Exploration Expenses:

Exploration expenses for the six months ended June 30, 2013 were $0.5 million compared to $7.1 million for the six months ended June 30, 2012. Exploration expenses will vary from period to period depending on the number of projects and the related seasonality of the exploration programs. The Company continues to minimize exploration expenditures to preserve the Company’s financial resources.

Finance Income & Finance Costs:

Finance costs for the six months ended June 30, 2013 were $10.6 million compared to $4.7 million for the six months ended June 30, 2012. Finance costs for the six months ended June 30, 2013 primarily consisted of $10.0 million of interest expense on the CIC convertible debenture; whereas, finance costs for the six months ended June 30, 2012 primarily consisted of a $2.6 million unrealized loss on FVTPL investments and $1.8 million of interest expense on the CIC convertible debenture.

Finance income for the six months ended June 30, 2013 was $4.1 million compared to $26.2 million for the six months ended June 30, 2012. For the six months ended June 30, 2013 and June 30, 2012, finance income primarily consisted of a $4.1 million and $26.0 million unrealized gain on the fair value change of the embedded derivatives in the CIC convertible debenture, respectively. The fair value of the embedded derivatives in the CIC convertible debenture is driven by many factors including: the Company’s share price, foreign exchange rates and share price volatility.

Taxes:

For the six months ended June 30, 2013, the Company recorded a $1 thousand current income tax expense related to its Mongolian operations compared to a current income tax expense of $1.1 million for the six months ended June 30, 2012. The Company has recorded a deferred income tax recovery related to deductible temporary differences and loss carry-forwards of $2.1 million for the six months ended June 30, 2013 compared to a deferred income tax recovery related to deductible temporary differences of $0.7 million for the six months ended June 30, 2012.

FINANCIAL POSITION AND LIQUIDITY

Cash Position and Liquidity

As at June 30, 2013, the Company had cash of $19.2 million compared to cash of $19.7 million and short term money market investments of $15.0 million for a total of $34.7 million in cash and money market investments as at December 31, 2012. Working capital (excess current assets over current liabilities) was $78.0 million as at June 30, 2013 compared to $127.2 million as at December 31, 2012.

Consistent with the Company’s capital risk management strategy, the Company expects to have sufficient liquidity and capital resources to meet its ongoing obligations and future contractual commitments, including interest payments due on the CIC convertible debenture, for at least twelve months from the end of the June 30, 2013 reporting period. The Company expects its liquidity to remain sufficient based on existing capital resources and estimated income from mining operations. Estimated income from mining operations is subject to a number of external market factors including supply and demand and pricing in the coal industry. The Company continues to minimize uncommitted capital expenditures and exploration expenditures in order to preserve the Company’s financial resources.

In the first quarter of 2013, the Company was subject to orders imposed by Mongolia’s Independent Authority against Corruption (the “IAAC”) which placed restrictions on certain of the Company’s Mongolian assets. The orders were imposed on the Company in connection with the IAAC’s investigation of the Company. The Mongolian State Investigation Office (the “SIA”) also continues to enforce the orders on the Company.

The orders placing restrictions on certain of the Company’s Mongolian assets could ultimately result in an event of default of the Company’s CIC convertible debenture. This matter remains under review by the Company and its advisers but to date, it is the Company's view that this would not result in an event of default as defined under the CIC convertible debenture terms. However, in the event that the orders result in an event of default of the Company’s CIC convertible debenture that remains uncured for ten business days, the principal amount owing and all accrued and unpaid interest will become immediately due and payable upon notice to the Company by CIC.

The orders relate to certain items of operating equipment and infrastructure and the Company’s Mongolian bank accounts. The orders related to the operating equipment and infrastructure restricts the sale of these items; however, the orders do not restrict the use of these items in the Company’s mining activities. The orders related to the Company’s Mongolian bank accounts restrict the use of in-country funds. While the orders restrict the use of in-country funds pending outcome of the investigation, they are not expected to have any material impact on the Company’s activities.

Impairment Analysis

During the three months ended June 30, 2013, the Company determined that an indicator of impairment existed for its property, plant and equipment related to the Ovoot Tolgoi Mine. The impairment indicator was the continued weakness in the Company’s share price.

Therefore, the Company conducted an impairment test whereby the carrying values of the Company’s property, plant and equipment, including mineral properties, related to the Ovoot Tolgoi Mine were compared to their “value-in-use” using a discounted future cash flow valuation model as at June 30, 2013. The Company’s property, plant and equipment, including mineral properties, totaled $508.7 million as at June 30, 2013.

Key estimates and assumptions incorporated in the valuation model included the following:

Inland Chinese coking coal market coal prices;
Life-of-mine coal production and operating costs; and
A discount rate based on an analysis of market, country and company specific factors.

The impairment analysis did not result in the identification of an impairment loss and no charge was required as at June 30, 2013. The Company believes that the estimates and assumptions incorporated in the impairment analysis are reasonable; however, the estimates and assumptions are subject to significant uncertainties and judgments.

PROCESSING INFRASTRUCTURE

On February 13, 2012, the Company announced the successful commissioning of the dry coal handling facility (“DCHF”) at the Ovoot Tolgoi Mine. The DCHF has capacity to process nine million tonnes of run-ofmine (“ROM”) coal per year. The DCHF includes a 300-tonne-capacity dump hopper, which receives ROM coal from the Ovoot Tolgoi Mine and feeds a coal rotary breaker that sizes coal to a maximum of 50mm and rejects oversize ash. The DCHF is anticipated to reduce screening costs and improve yield recoveries.

The Company has received all permits to operate the DCHF. However, the 2013 mine plan considers limited utilization of the DCHF at the latter end of 2013 due to higher quality coals being mined that likely will not require processing through the DCHF. The 2013 mine plan assumes a conservative resumption of operations, designed to achieve a cost effective approach that will allow operations to continue on a sustainable basis.

The Company has delayed construction to upgrade the DCHF to include dry air separation modules and covered load out conveyors with fan stackers to take processed coals to stockpiles and enable more efficient blending. Uncommitted capital expenditures have been minimized to preserve the Company’s financial resources.

To further enhance product value, in 2011, the Company entered into an agreement with Ejinaqi Jinda Coal Industry Co. Ltd (“Ejin Jinda”), a subsidiary of China Mongolia Coal Co. Ltd to toll-wash coals from the Ovoot Tolgoi Mine. The agreement has a duration of five years from commencement and provides for an annual wet washing capacity of approximately 3.5 million tonnes of input coal. Pursuant to the terms of the agreement, the Company prepaid $33.6 million of toll washing fees.

Ejin Jinda’s wet washing facility is located approximately 10km inside China from the Shivee Khuren Border Crossing, approximately 50km from the Ovoot Tolgoi Mine. Primarily, medium and higher-ash coals with only basic processing through Ovoot Tolgoi’s on-site DCHF will be transported from the Ovoot Tolgoi Mine to Ejin Jinda’s wet washing facility under a separate transportation agreement. Based on preliminary studies, the Company expected coals processed through Ovoot Tolgoi’s on-site DCHF to then be washed to produce coals with ash in the range of 8% to 11% at a yield of 85% to 90%. However, the Company is currently reassessing these preliminary studies. The Company continues to expect that washed coals will generally meet semi-soft coking coal specifications. Ejin Jinda will charge the Company a single toll washing fee which will cover their expenses, capital recovery and profit.

Construction of Ejin Jinda’s wet washing facility is now complete and it has been connected to utility supply. The Company has delayed plans to commence wet washing coals due to the current market conditions. The commencement of wet washing coals will be aligned with improvements in market conditions. As at June 30, 2013, the delay in commencing wet washing coals has had no impact on the carrying value of the Company’s prepaid toll washing fees of $33.6 million.

REGIONAL TRANSPORTATION INFRASTRUCTURE

On August 2, 2011, the State Property Committee of Mongolia awarded the tender to construct a paved highway from the Ovoot Tolgoi Complex to the Shivee Khuren Border Crossing to consortium partners NTB LLC and SouthGobi Sands LLC (together referred to as “RDCC”). SouthGobi Sands LLC holds a 40% interest in RDCC. On October 26, 2011, RDCC signed a concession agreement with the State Property Committee of Mongolia. RDCC has the right to conclude a 17 year build, operate and transfer agreement under the Mongolian Law on Concessions. Construction on the paved highway re-commenced in the second quarter of 2013 after a scheduled demobilization in the fourth quarter of 2012 due to winter weather conditions. Completion of the paved highway is expected in late 2013. The paved highway will have an intended carrying capacity upon completion in excess of 20 million tonnes of coal per year.

REGULATORY ISSUES

Governmental, Regulatory and Internal Investigations

The Company is subject to investigations by the IAAC and the SIA regarding allegations against SouthGobi and some of its former employees and one current employee. The IAAC investigation concerns possible breaches of Mongolia’s anti-corruption laws, while the SIA investigation concerns possible breaches of Mongolia’s money laundering and taxation laws.

While the IAAC investigation into allegations of possible breaches of Mongolian anti-corruption laws has been suspended, the Company has not received notice that the IAAC investigation is complete. To date, three former SouthGobi employees and one current SouthGobi employee have been named as suspects in the IAAC investigation and are subject to a continuing travel ban imposed by the IAAC. The IAAC has not formally accused any current or former SouthGobi employees of breach of Mongolia’s anti-corruption laws.

The SIA has not accused any current or former SouthGobi employees of money laundering. However, three former SouthGobi employees have been informed that they have each been designated as “accused” in connection with the allegations of tax evasion, and are subject to a travel ban. The Company has been designated as a “civil defendant” in connection with the tax evasion allegations, and it may potentially be held financially liable for the criminal misconduct of its former employees, under Mongolian Law. The Company has shown full cooperation with the investigation by providing relevant information. The relevant authorities are yet to conclude on this information. Accordingly, the likelihood or consequences for the Company of a judgment against its former employees is unclear at this time.

The SIA also continues to enforce administrative restrictions, which were initially imposed by the IAAC investigation, on certain of the Company’s Mongolian assets, including local bank accounts, in connection with its continuing investigation of these allegations. While the orders restrict the use of in-country funds pending the outcome of the investigation, they are not expected to have a material impact on the Company’s activities in the short term, although they could create potential difficulties for the Company in the medium to long term. SouthGobi is taking and intends to take all necessary steps to protect its ability to continue to conduct its business activities in the ordinary course.

Certain of the allegations raised by the SIA and IAAC against SouthGobi (concerning allegations of bribery, money laundering and tax evasion) have been the subject of public statements and Mongolian media reports, both prior to and in connection with the recent trial, conviction, and appeal of the former Chairman and the former director of the Geology, Mining and Cadastral Department of the MRAM, and others. SouthGobi was not a party to this case. The Company understands that the court process is now concluded following the decision of the Supreme Court of Mongolia to uphold the convictions.

A number of the media reports referred to above suggest that, in its decision, the Supreme Court in the above-mentioned case referred to two matters specifically involving SouthGobi Sands LLC.

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