SGQ.V · 2016-08-15

SouthGobi Resources announces second quarter 2016 financial and operating results

Production Results Financials

August 15, 2016

SouthGobi Resources announces second quarter 2016 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, 2016. All figures are in U.S. Dollars unless otherwise stated.

SIGNIFICANT EVENTS AND HIGHLIGHTS

The Company’s significant events and highlights for the three months ended June 30, 2016 and subsequent period to August 15, 2016 are as follows:

Operating results – The Company continues to operate under difficult market conditions as prices for coal remained weak in China through the second quarter of 2016. The impact of these conditions on the Company’s operations continues to be exacerbated given the Company’s liquidity constraints. The Company sold 0.82 million tonnes of its coal products during the quarter compared to 0.19 million tonnes in the second quarter of 2015. The production for the second quarter of 2016 was 0.67 million tonnes compared to 0.62 million tonnes for the second quarter of 2015.
Shareholder loan – On May 16, 2016, Turquoise Hill Resources Limited (“Turquoise Hill”) signed a deferral letter agreement with the Company (“May 2016 Deferral Letter Agreement”), in which Turquoise Hill agreed to a limited and circumscribed deferral of repayment of all remaining amounts and obligations now and hereafter owing under the Turquoise Hill shareholder loan (“TRQ Loan”) to December 29, 2017. The Company has agreed to repay $0.15 million per month starting on May 31, 2016 and ending on April 28, 2017; $0.2 million per month starting on May 31, 2017 and ending on December 29, 2017, at which time all remaining obligations will become due. Interest shall continue to accrue on all outstanding obligations at 12-month US dollar LIBOR rate. The amount due in May to July 2016 has been paid as at August 15, 2016.
Class Action Lawsuit – On May 24, 2016, the Ontario Superior Court of Justice granted the Company leave to appeal the decision made on November 5, 2015, which granted the plaintiff permission to commence an action claiming damages under the Ontario Securities Act with respect to the Company’s restatement of financial statements as previously disclosed in the Company’s public filings.
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The plaintiff has also appealed. The Ontario Court of Appeal granted an adjournment of the plaintiff’s original hearing date of June 27, 2016, pending the expected consolidation of the Divisional Court appeal brought on behalf of the Company. The parties have consented to a consolidation of the appeals in principle and are negotiating the terms of the Consent Order. It is expected that the Motion seeking consolidation on consent will be filed with the Court‎ in August and the Court of Appeal will deal with the consolidation quickly. Assuming that the Court of Appeal will grant the consent order, the appeals will be perfected in September and heard together in the spring of 2017.

China Investment Corporation (“CIC”) convertible debenture(the “CIC Convertible Debenture”) – On July 13, 2016, the Company executed deferral agreement with CIC which covers outstanding deferred cash interest obligations and associated costs of $18.8 million as of July 13, 2016 and the next Issue Date Anniversary Cash Interest payment of $8.1 million due on November 19, 2016. Pursuant to the deferral agreement, the Company has agreed to repay $1.3 to $1.4 million monthly from July to November 2016 and repay $20.7 million on December 19, 2016. In consideration for the deferred payments of $18.8 million, the Company will pay a deferral fee at a rate of 6.4% per annum to CIC. The interest due in July 2016 has been paid as at August 15, 2016.

Although CIC and the Company had finalized the terms of a deferral of CIC interest payments at the end of the second quarter, a formal written agreement had not been executed as at June 30, 2016. As a consequence, International Accounting Standard 1 (“IAS 1”) required the Company to classify the entire balance of the CIC Convertible Debenture as a current liability as at June 30, 2016, notwithstanding the fact that CIC had agreed to the terms of the deferral and had not indicated any intention to deliver notice of default or accelerate the maturity of the debenture. Following the execution of the deferral agreement on July 13, 2016, the CIC Convertible Debenture met the requirements of IAS 1. The Company anticipates that both the debt host and the fair value of the embedded derivative will be classified as a non-current liability going forward, unless a future event of default occurs under the terms of the CIC Convertible Debenture.

Short-term bridge loan – The Company repaid the first tranche of the short-term bridge loan of $4.9 million on July 26, 2016. During June and July 2016, the Company drew the second tranche of $5.0 million. $1.5 million and $3.5 million will mature in March and April 2017, respectively.
Retirement of a Director – Mr. Pierre Lebel retired as Lead Director and Independent Non-Executive Director on June 30, 2016.
Going Concern – As at the date hereof, the Company is focused on securing additional sources of financing and continues to minimize uncommitted capital expenditures in order to pay the interest due under the CIC Convertible Debenture, the short-term bridge loan, the TRQ Loan and the bank loan, meet the Company’s obligations as they fall due and achieve its business objectives in 2016. However,
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there is no guarantee that the Company will be able to successfully secure additional sources of financing. 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 August 15, 2016, the Company had cash of $0.8 million.

OVERVIEW OF OPERATIONAL DATA AND FINANCIAL RESULTS

Summary of Operational Data

Three months ended Six months ended June 30, June 30, 2016 2016

2015 2015

Sales Volumes, Prices and Costs

Premium semi-soft coking coal Coal sales (millions of tonnes) – 0.02 0.06 0.02 Average realized selling price (per tonne)⁽ⁱ⁾ $ – $ 23.37 $ 21.38 $ 23.37 Standard semi-soft coking coal

0.52 1.10

Coal sales (millions of tonnes) 0.11 0.16 Average realized selling price (per tonne)⁽ⁱ⁾ $ 16.27 $ 19.97 $ 17.40 $ 19.31 Thermal coal Coal sales (millions of tonnes) 0.30 0.06 0.54 0.19 Average realized selling price (per tonne)⁽ⁱ⁾ $ 9.17 $ 10.47 $ 9.18 $ 10.46 Total

Coal sales(millions of tonnes)		0.82		0.19		1.70		0.37
Average realized selling price(per tonne)(i)			$	17.42			$	15.15
	$	13.65			$	14.92
Raw coal production(millions of tonnes)		0.67		0.62		1.04		0.62
Direct cash costs of product sold(per tonne)(ii)	$	12.47	$	15.57	$	10.17	$	12.27

Mine administration cash costs of product sold (per tonne)⁽ⁱⁱ⁾ $ 2.32 $ 7.90 $ 1.76 $ 5.13 Total cash costs of product sold (per tonne)⁽ⁱⁱ⁾ $ 14.79 $ 23.47 $ 11.93 $ 17.40

Other Operational Data

Production waste material moved (millions of bank cubic meters) 1.82 3.62 2.54 3.62 Strip ratio (bank cubic meters of waste material per tonne of coal produced) 2.71 5.87 2.43 5.87

0.00 0.00

Lost time injury frequency rate(iii) 0.00 0.00

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

(ii) A non-IFRS financial measure, see “Non-IFRS Financial Measure” 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 second quarter of 2016 without a lost time injury. As at June 30, 2016, the Company has a lost time injury frequency rate of nil per 200,000 man hours based on a rolling 12 month average.

For the three months ended June 30, 2016

Market conditions and prices for coal remained weak in China through the second quarter of 2016. The impact of these conditions was exacerbated given the depreciation of Renminbi against USD. The Company sold 0.82 million tonnes of its coal products during the second quarter of 2016 compared to 0.19 million tonnes for the second quarter of 2015. The Company is pacing production with current and expected demand, production was 0.67 million tonnes for the quarter as compared to 0.62 million tonnes for the second quarter of 2015.

For the six months ended June 30, 2016

During the first six months of 2016 market conditions and prices for coal remained weak in China. The Company sold 1.70 million tonnes of its coal products during the first six months of 2016 compared to 0.37 million tonnes for the first six months of 2015.

The production in the first six months of 2016 was higher than the first six months of 2015 as a result of pacing production with the current and expected demand.

Summary of Financial Results

Three months ended Six months ended June 30, June 30, $ in thousands, except per share information 2016 2015 2016 2015

$ 10,361 $ 23,088

Revenue (i),(ii) $ 2,951 $ 4,536 Cost of sales ⁽ⁱⁱ⁾ (23,105) (11,835) (42,185) (29,511)

(9,926) (10,975)

Gross loss excluding idled mine asset costs (5,017) (6,246) Gross loss including idled mine asset costs (12,744) (8,884) (19,097) (24,975)

812 (899)

Other operating income/(expenses) (19,450) (18,479) Administration expenses (1,826) (1,961) (3,468) (3,388)

(52) (99)

Evaluation and exploration expenses 22 (56) Loss from operations (13,810) (30,273) (23,563) (46,898)

(5,377) (10,845)

Finance costs (5,222) (11,605)

Finance income	324	273	296	16
Share of earnings of a joint venture	256	151	339	133
Income tax expense	(23)	(1)	(258)	(1)
Net loss		(35,072)		(58,355)

(18,630) (34,031)

Basic and diluted loss per share $ (0.07) $ (0.15) $ (0.13) $ (0.25)

(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 interim financial statements for further analysis regarding the Company’s reportable operating segments.

Overview of Financial Results

For the three months ended June 30, 2016

The Company recorded an $13.8 million loss from operations in the second quarter of 2016 compared to a $30.3 million loss from operations in the second quarter of 2015. The operations for the three months ended June 30, 2016 were impacted by continuing difficult market conditions and weaker coal prices experienced by the Company.

Revenue was $10.4 million in the second quarter of 2016 compared to $3.0 million in the second quarter of 2015. The Company sold 0.82 million tonnes of coal at an average realized selling price of $13.65 per tonne in the second quarter of 2016 compared to sales of 0.19 million tonnes at an average realized selling price of $17.42 per tonne in the second quarter of 2015. The decrease in the average realized selling price mainly resulted from continued difficult market conditions as well as the depreciation of Renminbi against USD. The product mix for the second quarter of 2016 consisted of approximately 63% of standard semi-soft coking coal and 37% of thermal coal compared to approximately 69% of premium and standard semi-soft coking coal and 31% of thermal coal in the second quarter of 2015.

The Company’s revenue is presented after the deduction of royalties and selling fees. The Company’s effective royalty rate for the second quarter of 2016, based on the Company’s average realized selling price of $13.65 per tonne, was 6.9% or $0.95 per tonne compared to 10.7% or $1.86 per tonne based on the average realized selling price of $17.42 per tonne in the second quarter of 2015.

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 to the royalty regime. From February 1, 2016 onwards, royalties are 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 “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.

Cost of sales was $23.1 million in the second quarter of 2016 compared to $11.8 million in the second quarter of 2015. 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” for further analysis) during the period.

Three months ended

Operating expenses $ 10,488 $ 4,571

(3)

Share-based compensation expense/(recovery) 4

Depreciation and depletion	6,253	832
Impairment of coal stockpile inventories	3,549	2,561
Cost of sales from mine operations	20,287	7,968

2,818

Cost of sales related to idled mine assets 3,867

$ 23,105

Cost of sales $ 11,835

Operating expenses in cost of sales were $10.5 million in the second quarter of 2016 compared to $4.6 million in the second quarter of 2015. The increase in operating expenses is primarily related to the increase in sales volume from 0.19 million tonnes in the second quarter of 2015 to 0.82 million tonnes in the second quarter of 2016.

Cost of sales in the second quarter of 2016 and 2015 included coal stockpile impairments of $3.5 million and $2.6 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 second quarter of 2016 and 2015 reflected the challenging coal market conditions

were expensed as incurred and included mainly depreciation expense. Cost of sales related to idled mine assets in the second quarter of 2016 included $2.8 million of depreciation expenses for idled equipment compared to $3.9 million in the second quarter of 2015.

Other operating income was $0.8 million in the second quarter of 2016 compared to other operating expenses of $19.5 million in the second quarter of 2015 as follows:

Three months ended

$ in thousands 2016 2015

Foreign exchange loss $ 1,786 $ 1,196 Provision/(reverse of provision) for doubtful trade and other receivables (1,909) 157 Provision for court case penalty – 18,049

(1,009)

Discount on settlement of trade payables – Others 320 48

Other operating expenses/(income) $ (812) $ 19,450

For the three months ended June 30, 2016, the Company reversed a provision for doubtful trade and other receivables of $1.9 million (2015: provision of $0.2 million was made) as a result of collecting long aged receivables in the second quarter of 2016. In addition, a settlement plan with a supplier of machinery was reached in the second quarter of 2016 and a discount on settlement of $1.0 million was recorded accordingly.

Administration expenses were $1.8 million in the second quarter of 2016 compared to $2.0 million in the second quarter of 2015 as follows:

Three months ended June 30,

$ in thousands 2016 2015

$ 693

Corporate administration $ 512

Legal and professional fees	391	890
Salaries and benefits	677	472
Share-based compensation expense	12	47
Depreciation	53	40
Administration expenses	$ 1,826 $	1,961

Administration expenses were lower for the second quarter of 2016 compared to the second quarter of 2015 primarily due to lower legal and professional fees were incurred in the second quarter of 2016.

Evaluation and exploration expenses were $0.1 million in the second quarter of 2016. The Company continued to minimize evaluation and exploration expenditures in the second quarter of 2016 in order to preserve the Company’s financial resources.

Finance costs were $5.4 million and $5.2 million respectively in the second quarter of 2016 and the second quarter of 2015. Finance costs primarily consisted of interest expense in respect of the $250.0 million CIC Convertible Debenture ($5.3 million for the second quarter of 2016 and $5.1 million for the second quarter of 2015).

For the six months ended June 30, 2016

The Company recorded an $23.6 million loss from operations in the first six months of 2016 compared to a $46.9 million loss from operations in the first six months of 2015. The operations for the six months ended June 30, 2016 were impacted by continuing difficult market conditions and weak coal prices in China. Whilst the Company resumed production on March 30, 2015, the results for the first six months of 2015 were primarily impacted as a consequence of the tax investigation case in Mongolia as a provision of $18.0 million was recorded in respect of the Tax Penalty during the six months ended June 30, 2015.

Revenue was $23.1 million in the first six months of 2016 compared to $4.5 million in the first six months of 2015. The Company sold 1.70 million tonnes of coal at an average realized selling price of $14.92 per tonne in the first six months of 2016 compared to sales of 0.37 million tonnes at an average realized selling price of $15.15 per tonne in the first six months of 2015. The benefit of the improved product mix has been more than offset by continued declining prices for the first six months of 2016 when compared to the first six months of 2015.

The Company’s revenue is presented net of royalties and selling fees. With the changes affecting the royalty regime in Mongolia, the Company’s effective royalty rate for the first six months of 2016, based on the Company’s average realized selling price of $14.92 per tonne, was 7.0% or $1.05 per tonne compared to 18.0% or $2.73 per tonne based on the average realized selling price of $15.15 per tonne in the first six months of 2015.

Cost of sales was $42.2 million in the first six months of 2016 compared to $29.5 million in the first six months of 2015.

Six months ended

Operating expenses $ 18,533 $ 6,498

(8)

Share-based compensation expense/(recovery) 32

Depreciation and depletion	9,832	1,141
Impairment of coal stockpile inventories	5,706	3,111
Cost of sales from mine operations	34,063	10,782

8,122

Cost of sales related to idled mine assets 18,729

$ 42,185

Cost of sales $ 29,511

Operating expenses in cost of sales were $18.5 million in the first six months of 2016 compared to $6.5 million in the first six months of 2015. The increase in operating expenses is primarily related to the increase in sales volume from 0.37 million tonnes in the first six months of 2015 to 1.70 million tonnes in the first six months of 2016.

Cost of sales in the first six months of 2016 and the first six months of 2015 included coal stockpile impairments of $5.7 million and $3.1 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 2016 and 2015 reflect the challenging coal market conditions

were expensed as incurred and primarily included depreciation expense. Cost of sales related to idled mine assets in the first six months of 2016 included $8.1 million related to depreciation expenses for idled equipment (2015: $15.8 million). Idled mine asset costs decreased in the first six months of 2016 compared to the first six months of 2015 as a result of the period of curtailment until March 30, 2015 when mining operations recommenced. However, neither the production plan for the first six months of 2016 nor for the period from March 30, 2015 until June 30, 2015 fully utilized the Company’s existing mining fleet, therefore, idled mine asset costs continued to be incurred.

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Other operating expenses were $0.9 million in the first six months of 2016 compared to $18.5 million in the first six months of 2015.

Six months ended

$ in thousands	2016		2015
Foreign exchange loss	$ 1,514 $		138
Provision for doubtful trade and other receivables		2	157
Provision for court case penalty		–	18,049
Discount on settlement of trade payables	(1,009)		–

Others 135

$ 899

Other operating expenses $ 18,479

The Company recognized an expense for the provision of the Tax Penalty in respect of the tax investigation case in Mongolia. The Tax Penalty amounts to MNT35.3 billion (approximately $18.0 million at June 30, 2015).

Administration expenses were $3.5 million for the first six months of 2016 compared to $3.4 million in the first six months of 2015.

Six months ended June 30, 2016

$ in thousands 2015

Corporate administration	$ 1,158 $	958
Legal and professional fees	895	1,365
Salaries and benefits	1,320	852

Share-based compensation expense 147 Depreciation 90 66

Administration expenses $ 3,468 $ 3,388

Evaluation and exploration expenses were $0.1 million in both the first six months of 2016 and the first six months of 2015. The Company continued to minimize evaluation and exploration expenditures in the first six months of 2016 in order to preserve the Company’s financial resources. Evaluation and exploration activities and expenditures in the first six months of 2016 were limited to ensuring that the Company met the Mongolian Minerals Law requirements in respect of its mining and exploration licenses.

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Finance costs were $10.8 million and $11.6 million in the first six months of 2016 and 2015 respectively. This primarily consisted of interest expense on the CIC Convertible Debenture ($10.5 million for the first six months of 2016 and $10.1 million for the first six months of 2015).

Finance costs for the first six months of 2015 also included $1.3 million in respect of the unrealized fair value loss of the embedded derivative in the CIC Convertible Debenture. In comparison, in the first six months of 2016, the Company recorded within finance income an unrealized fair value gain of the embedded derivative in the CIC Convertible Debenture ($0.3 million). The fair value of the embedded derivatives in the CIC Convertible Debenture is driven by many factors including: the Common Share price, U.S. Dollar and Canadian Dollar exchange rates and share price volatility.

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