SouthGobi Resources Limited
TSX : SGQ
HKSE : 1878

SouthGobi Resources Limited

August 13, 2015 07:32 ET

SouthGobi Resources Announces Second Quarter 2015 Financial and Operating Results

HONG KONG, CHINA--(Marketwired - Aug. 13, 2015) - SouthGobi Resources Ltd. (TSX:SGQ)(HKSE:1878) (the "Company" or "SouthGobi") today announced its financial and operating results for the three and six months ended June 30, 2015. 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, 2015 and subsequent period to August 13, 2015 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 2015. The impact of these conditions on the Company's operations continues to be exacerbated given the Company's liquidity constraints. The Company sold 0.19 million tonnes of its coal products during the quarter. After the resumption of mining operations on March 30, 2015, production for the second quarter of 2015 was 0.62 million tonnes, allowing the Company to position itself to meet its commitments under existing and expected new coal offtake contracts.

  • Tax investigation case in Mongolia - On January 30, 2015, the panel of appointed judges from the Second District Criminal Court of Justice found three of the Company's former employees guilty of tax evasion and gave sentences ranging from 5 years and 6 months to 5 years and 10 months of imprisonment in the correctional facilities of strict regimen in Mongolia. Although SouthGobi Sands LLC ("SGS"), the Company's wholly-owned subsidiary, was not a party to the criminal proceedings, the court declared it to be financially liable as a "civil defendant" for a penalty (the "Tax Penalty" ) of MNT 35.3 billion (approximately $18.0 million at June 30, 2015), the corresponding balance has been provided for in the second quarter of 2015.

    Subsequent to an unsuccessful appeal to the Second District Criminal Court of Justice, on April 22, 2015, SGS filed an appeal with the Supreme Court against the decision of the 10th Appeal Court for Criminal Case of Mongolia upholding the tax verdict against SGS (the "Tax Verdict"). SGS has been informed that the Supreme Court has refused to hear the tax case on appeal and as such the Tax Verdict has entered into force.

    The Tax Verdict is however not immediately payable and enforceable against SGS absent further actions prescribed by the laws of Mongolia. In particular, SGS has not received a copy of the bailiff's resolution on execution of the Tax Verdict, as required under the Law of Mongolia on Execution of Court Decisions in order for any judgment execution process to happen.

    The Company continues to believe that there is a lack of evidence to support the Tax Verdict and that the Tax Verdict and the subsequent decisions of the higher courts on appeal were substantively and procedurally in error under the laws of Mongolia.

    The Company has assessed other available judicial avenues to continue defending itself. However, it believes it can and is currently seeking to resolve amicably with the Mongolian authorities the dispute giving rise to the Tax Verdict in a manner that is both appropriate having regard to the Company's limited financial resources and supportive of a positive environment for foreign investment in Mongolia. There can be no assurance, however, that any such resolution can be successfully negotiated by the Company either at all or on favourable terms, or that the terms of any resolution to which the Government of Mongolia would be prepared to agree would not be materially adverse to the Company. In such case, this may result in an event of default under the China Investment Corporation ("CIC") convertible debenture (the "CIC Convertible Debenture") Convertible Debenture and CIC would have the right to declare the full principal and accrued interest owing thereunder immediately due and payable. Such an event of default under the CIC Convertible Debenture or the Company's inability to pay the penalty could result in voluntary or involuntary proceedings involving the Company (including bankruptcy) as discussed under the heading Risk Factors in the MD&A issued on March 30, 2015 and available on SEDAR at www.sedar.com.

  • Novel Sunrise Private Placement - On February 24, 2015, the Company announced it had entered into a private placement for proceeds of up to $7.5 million with Novel Sunrise Investments Limited ("Novel Sunrise") as a proposed new significant investor and strategic partner.

    On March 3, 2015, following the successful closing of the first tranche of the Novel Sunrise private placement, including the receipt of $3.5 million, the Company issued 10,131,113 Mandatory Convertible Units to Novel Sunrise and in accordance with the terms of the agreement Mr. Ted Chan was appointed as the Executive Director of the Company. On July 26, 2015, Mr. Ted Chan ceased to be the Executive Director of the Company. Refer to "Changes in Management and Directors" section below for more details.

    On April 23, 2015, the Company successfully closed the second and final tranche of the Novel Sunrise private placement generating approximately $4.0 million in gross proceeds through the issue of approximately 11.6 million Common Shares. In addition, Novel Sunrise converted their previously acquired Mandatory Convertible Units on a one for one basis into Common Shares.

  • CITIC Merchant and Swiss Life GP private placements - On June 22, 2015, the Company announced it had negotiated private placement agreements with sophisticated investors to provide additional capital resources into the Company. The terms of the subscription agreements for the private placements allowed for the issue of approximately 55 million Common Shares.

    On July 14, 2015, the Company announced it had obtained all the necessary regulatory approvals for the private placements and subsequently successfully closed the Swiss Life GP Private Placement, raising $2.9 million for the issuance of 5 million Common Shares.

    On July 14, 2015, the Company agreed to an extension of the closing date of the private placement agreement between the Company and CITIC Merchant until July 20, 2015. However, the conditions precedent to the agreement were not fulfilled and CITIC Merchant informed the Company that it would not be subscribing for Common Shares pursuant to the signed private placement agreement.

  • TSX remedial delisting review - As a result of relying on the financial hardship exemption to complete the Novel Sunrise private placement, the Company was placed on remedial delisting review as of February 25, 2015.

    The Company has received confirmation from the Continued Listing Committee of the TSX (the "TSX Committee") that it will further defer its scheduled meeting to consider whether the Company has met the listing requirements of the TSX until August 25, 2015. The TSX Committee has determined to defer its delisting decision until no later than August 28, 2015.

  • CIC Convertible Debenture - On May 20, 2015 under the terms of the CIC Convertible Debenture, CIC confirmed to the Company that subject to certain conditions and limitations, it would grant a deferral of payment of approximately $7.9 million in cash interest due by the Company to CIC on May 19, 2015 ("May 2015 cash interest installment") until July 22, 2015, subject to a three day cure period which expires on July 27, 2015.

    On July 27, 2015, CIC confirmed to the Company that, subject to certain conditions and limitations, it agreed to grant a further deferral of payment of the May 2015 cash interest installment until November 19, 2015 to allow the Company to execute its Proposed Funding Plan (as defined below in the section entitled "Going Concern").

  • Novel SPA - On February 24, 2015, the Company was advised by Turquoise Hill Resources Ltd. ("Turquoise Hill") that they had entered into a Sale and Purchase Agreement ("Novel SPA") with Novel Sunrise for the purchase of 48,705,155 Common Shares currently held by Turquoise Hill.

    On April 23, 2015, the Company was advised that the Novel SPA, as initially announced by the Company on February 24, 2015, had received all the necessary approvals and closed. Pursuant to the Novel SPA, Novel Sunrise has purchased approximately 48.7 million Common Shares from Turquoise Hill.

  • NUR SPA - On May 4, 2015, the Company announced it had been notified of the expiry of the Sale and Purchase agreement ("NUR SPA"), between Turquoise Hill and National United Resources Holdings Limited ("NUR") which provided for the sale of 56.1 million Common Shares held by Turquoise Hill.

  • Shareholder loan extension - On May 4, 2015, the Company received confirmation from Turquoise Hill of an extension to the limited deferral of amounts owing under the Turquoise Hill shareholder loan facility, subject to certain conditions and limitations.

  • Notice of arbitration - On June 29, 2015, the Company announced First Concept Logistics Limited ("First Concept"), a subsidiary of NUR, served a notice of arbitration (the "Notice") on SGS in respect of a coal supply agreement dated May 19, 2014 as amended on June 27, 2014 (the "Coal Supply Agreement").

    According to the Notice, First Concept alleges that SGS has breached the Coal Supply Agreement and seeks, among other items, the repayment of $11.5 million, representing the prepayment amount advanced by First Concept under such agreement. The Company firmly rejects the allegations of the First Concept in the Notice as lacking any merit and categorically denies First Concept's claim for repayment of the sum of $11.5 million as wholly misconceived and will vigorously defend itself throughout the arbitration proceedings. In addition, SouthGobi reserves the right to pursue legal action against NUR and its subsidiary for compensation for any damages that result from their actions.

  • Notice of claim - On July 2, 2015, the Company announced it had been served with a notice of claim by former President and Chief Executive Officer Alexander Molyneux. The claim relates to alleged breaches of Mr. Molyneux's employment agreement by the Company and is seeking damages of $1 million. The Company considers the claim has no merit and will vigorously defend the action.

  • Changes in Management and Directors
    Mr. Ted Chan: Mr. Chan was initially appointed as Executive Director of the Company on March 3, 2015. On July 26, 2015, following the appointment of Mr. Yulan Guo as Interim Chief Executive Officer, Mr. Chan is no longer Executive Director but remained as a Non-Executive Director of the Company until August 6, 2015, the date of the Company's Annual Meeting of Shareholders (the "AGM"), where Mr. Chan did not stand for election.

    Mr. Yulan Guo: Mr. Guo was initially appointed to the Board of Directors as a Non-Executive Director on May 15, 2015. On July 26, 2015 Mr. Guo was appointed as Interim Chief Executive Officer and Executive Director of the Company and was elected as a director of the Company at the AGM.

    Mr. Ningqiao Li: Mr. Li was appointed to the Board of Directors as a Non-Executive Director on May 15, 2015 and was elected as a director of the Company at the AGM.

    Mr. Aminbuhe, Mr. Zhu Liu and Ms. Jin Lan Quan: On August 6, 2015, Mr. Aminbuhe, Mr. Liu and Ms. Quan were elected to the Board of Directors as Non-Executive Directors following the conclusion of the AGM.

    Mr. Kelly Sanders: On August 6, 2015, Mr. Sanders did not stand for the election at the AGM and ceased to be a Non-Executive Director.

    Mr. Bertrand Troiano: Mr. Troiano has stepped down as Chief Financial Officer of the Company following a two-year secondment from Rio Tinto which ended on July 31, 2015.

  • Going Concern - As at the date hereof, the Company, together with its new strategic partner and significant shareholder, Novel Sunrise, has developed a funding plan (the "Proposed Funding Plan") in order to pay the interest due under the CIC Convertible Debenture, meet the Company's obligations as they fall due and achieve its business objectives in 2015 and beyond. However, there is no guarantee that the Company will be able to implement the Proposed Funding Plan or secure other sources of financing. As at August 13, 2015, the Company had cash of $2.0 million.
OVERVIEW OF OPERATIONAL DATA AND FINANCIAL RESULTS
Summary of Operational Data
Three months
ended June 30,
Six months
ended June 30,
2015 2014 2015 2014
Sales Volumes, Prices and Costs
Premium semi-soft coking coal
Coal sales (millions of tonnes) 0.02 - 0.02 -
Average realized selling price (per tonne) (i) $ 23.37 $ - $ 23.37 $ -
Standard semi-soft coking coal
Coal sales (millions of tonnes) 0.11 0.12 0.16 0.41
Average realized selling price (per tonne) (i) $ 19.97 $ 20.33 $ 19.31 $ 21.52
Thermal coal
Coal sales (millions of tonnes) 0.06 0.51 0.19 0.61
Average realized selling price (per tonne) (i) $ 10.47 $ 10.72 $ 10.46 $ 10.94
Total
Coal sales (millions of tonnes) 0.19 0.63 0.37 1.02
Average realized selling price (per tonne) (i) $ 17.42 $ 12.52 $ 15.15 $ 15.22
Raw coal production (millions of tonnes) 0.62 0.55 0.62 1.19
Direct cash costs of product sold (per tonne) (ii) $ 15.57 $ 8.23 $ 12.27 $ 9.08
Mine administration cash costs of product sold (per tonne) (ii) $ 7.90 $ 2.49 $ 5.13 $ 3.00
Total cash costs of product sold (per tonne) (ii) $ 23.47 $ 10.72 $ 17.40 $ 12.08
Other Operational Data
Production waste material moved (millions of bank 3.62 2.17 3.62 4.72
cubic meters)
Strip ratio (bank cubic meters of waste material per tonne of 5.87 3.97 5.87 4.00
coal produced)
Lost time injury frequency rate (iii) 0.00 0.15 0.00 0.15

(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

For the three months ended June 30, 2015

Market conditions and prices for coal remained weak in China through the second quarter of 2015. The Company sold 0.19 million tonnes of its coal products during the quarter. After the resumption of mining operations on March 30, 2015, production increased to 0.62 million tonnes for the quarter, allowing the Company to position itself to meet its commitments under existing and expected new coal offtake contracts.

The cash cost of product sold for the second quarter of 2015 $23.47 has significantly increased compared to the second quarter of 2014 $10.72. The reason for the increase is primarily related to the decrease in sales volumes over which the relatively fixed administration costs are allocated. The Mine administration cash costs per tonne of product sold in the second quarter of 2015 was $7.90 an increase of $5.41 compared to comparative period in 2014 of $2.49.

The Company ended the second quarter of 2015 without a lost time injury. As at June 30, 2015, the Company has a lost injury time frequency rate of nil per 200,000 man hours based on a rolling 12 month average.

For the six months ended June 30, 2015

During the first six months of 2015 market conditions and prices for coal remained weak in China.

The production in the first six months of 2015 was lower than the first six months of 2014 due to the curtailment of the Company's mining operations through to March 30, 2015. During the first quarter of 2015 the Company sold through its existing stockpiles to preserve the Company's liquidity and therefore mining operations were curtailed. On March 30, 2015, the Company resumed mining operations allowing the Company to position itself to meet its commitments under existing and expected new coal offtake contracts.

Total cash costs of product sold were $17.40 per tonne in the first six months of 2015 compared to $12.08 per tonne in the first six months of 2014. The reason for the increase is primarily related to the decrease in sales volumes over which the fixed and variable costs are allocated. At a gross level, the Mine administration cash costs of product sold in the first six months of 2015 is $1.9 million compared to $3.1 million a decrease of $1.2 million.

Summary of Financial Results
Three months
ended June 30,
Six months
ended June 30,
$ in thousands, except per share information 2015 2014 2015 2014
Revenue (i),(ii) $ 2,951 $ 6,691 $ 4,536 $ 11,828
Cost of sales (ii) (11,835 ) (20,086 ) (29,511 ) (38,452 )
Gross loss excluding idled mine asset costs (5,017 ) (8,497 ) (6,246 ) (18,699 )
Gross loss including idled mine asset costs (8,884 ) (13,395 ) (24,975 ) (26,624 )
Other operating expense (19,450 ) (1,776 ) (18,479 ) (2,849 )
Administration expenses (1,961 ) (2,253 ) (3,388 ) (4,490 )
Evaluation and exploration expenses 22 (107 ) (56 ) (279 )
Loss from operations (30,273 ) (17,531 ) (46,898 ) (34,242 )
Finance costs (5,222 ) (5,215 ) (11,605 ) (10,240 )
Finance income 273 127 16 1,134
Share of losses of joint venture 151 (3 ) 133 (29 )
Income tax expense (1 ) (546 ) (1 ) (546 )
Net loss (35,072 ) (23,168 ) (58,355 ) (43,923 )
Basic loss per share $ (0.15 ) $ (0.12 ) $ (0.25 ) $ (0.23 )
Diluted loss per share $ (0.15 ) $ (0.12 ) $ (0.25 ) $ (0.23 )

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

(ii) Revenue and cost of sales relate to the Company's Ovoot Tolgoi Mine within the Mongolian 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.

Royalty regime in Mongolia

The royalty regime in Mongolia is evolving and has been subject to change since 2012. The Government of Mongolia implemented a trial period from October 1, 2012 to March 31, 2013, during which the royalty imposed on coal sales was determined using the actual contracted sales price per tonne. Subsequently, from April 1, 2013 to March 31, 2014, the royalty on all coal sales exported out of Mongolia was based on a set reference price per tonne published monthly by the Government of Mongolia.

The Government of Mongolia implemented a new royalty regime effective April 1, 2014, referred to as the "flexible tariff" royalty regime. From April 1, 2014, the royalty per tonne for export coal sales has been calculated based on the actual contracted sales price per tonne, whereby the contracted sales price includes the costs of transporting the coal to the Mongolia-China border. If transportation costs are not included in the contracted sales price between a buyer and seller, the following costs are required to be included in the contracted sales price for purposes of calculating the royalty per tonne: transportation costs and costs associated with transportation such as customs documentation fees, insurance, loading and unloading costs. In the event the actual contracted sales price calculated as described above differs by more than 10% from the contracted sales price of coal products with the same classification and quality being exported by other legal entities in Mongolia through the same border crossing, the calculated contracted sales price is deemed non-market under Mongolian tax law and the royalty per tonne is calculated based on a reference price that will be determined by the Government of Mongolia.

The Company currently sells coal from the Ovoot Tolgoi Mine ex mine gate and the coal is exported through the Shivee Khuren Border Crossing. The Company's average realized selling price excludes transportation costs.

On July 4, 2014, the Government of Mongolia made further amendments to the royalty regime. From July 4, 2014 onwards, the royalty is initially calculated and paid monthly based on the Government reference price. On a quarterly basis the royalty amount is adjusted to reflect the contracted sales price and additional documentation needs to be submitted to the Mongolian Tax Authority. Once the quarterly statement has been approved by the Mongolian Tax Authority, any adjustments between the monthly payments for the quarter and the quarterly submission are adjusted in the next months' royalty calculation.

On January 1 2015, this "flexible tariff" royalty regime ended and royalty payments reverted to the previous regime which is based on a set reference price per tonne published monthly by the Government of Mongolia.

On March 16, 2015, the Government of Mongolia issued an amendment resolution to the "flexible tariff" regime changing the coal classification methodology from which to base the royalty calculation. The resolution is effective from May 1, 2015 and the Government of Mongolia has published reference price classifications subdivided into additional classifications since that date. According to the resolution, Company's coal is mainly divided into 2 classifications depending on coal quality under raw coal type.

The Company and other Mongolian coal producers are actively engaging the Mongolian authorities to seek the continuation of the "flexible tariff" regime. See "Risk Factors - Company's Projects in Mongolia" in the MD&A issued on March 30, 2015 and available on SEDAR at www.sedar.com.

Overview of Financial Results

For the three months ended June 30, 2015

The Company recorded a $30.3 million loss from operations in the second quarter of 2015 compared to a $17.5 million loss from operations in the second quarter of 2014. The operations for the three months ended June 30, 2015 were impacted by continuing difficult market conditions and weak coal prices in China. Whilst the Company resumed production on March 30, 2015 in anticipation of increased sales volumes, the results for the second quarter 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 three months ended June 30, 2015.

Revenue was $3.0 million in the second quarter of 2015 compared to $6.7 million in the second quarter of 2014. The Company sold 0.19 million tonnes of coal at an average realized selling price of $17.42 per tonne in the second quarter of 2015 compared to sales of 0.63 million tonnes at an average realized selling price of $12.52 per tonne in the second quarter of 2014. Despite the continued difficult market conditions there was an increase in the average realized selling price which is attributed to a change in sales mix. The product mix for the second quarter of 2015 consisted of approximately 69% of Premium and Standard semi-soft coking coal and 31% of Thermal coal compared to approximately 19% of Premium and Standard semi-soft coking coal and 81% of Thermal coal in the second quarter of 2014.

The Company's revenue is presented after deduction of royalties and selling fees. The Company's effective royalty rate for the second quarter of 2015, based on the Company's average realized selling price of $17.42 per tonne, was 10.7% or $1.86 per tonne compared to 8.1% or $1.00 per tonne based on the average realized selling price of $12.52 per tonne in the second quarter of 2014.

Cost of sales was $11.8 million in the second quarter of 2015 compared to $20.1 million in the second quarter of 2014. 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 "Non-IFRS Financial Measure" section for further analysis) during the period.

Three months ended June 30,
$ in thousands 2015 2014
Operating expenses $ 4,571 $ 6,754
Share-based compensation expense 4 127
Depreciation and depletion 832 2,061
Impairment of coal stockpile inventories 2,561 6,246
Cost of sales from mine operations 7,968 15,188
Cost of sales related to idled mine assets 3,867 4,898
Cost of sales $ 11,835 $ 20,086

Operating expenses in cost of sales were $4.6 million in the second quarter of 2015 compared to $6.8 million in the second quarter of 2014. The overall decrease in operating expenses is primarily the result of the impact of increasing the coal stockpile levels during the second quarter of 2015 to allow the Company to meet its existing and anticipated coal sales commitments compared to a reduction in the coal stockpile in the second quarter of 2014.

Cost of sales in the second quarter of 2015 and 2014 included coal stockpile impairments of $2.6 million and $6.2 million, respectively, to reduce the carrying value of the Company's coal stockpiles to their net realizable value. The coal stockpile impairments recorded in both the second quarter of 2015 and 2014 reflect the challenging coal market conditions and primarily related to the Company's higher-ash products.

Cost of sales related to idled mine asset costs primarily consisted of period costs, which were expensed as incurred and included mainly depreciation expense. Cost of sales related to idled mine assets in the second quarter of 2015 included $3.9 million related to depreciation expenses for idled equipment compared to $4.9 million in the second quarter of 2014.

Other operating expense was $19.5 million in the second quarter of 2015 compared to $1.8 million in the second quarter of 2014 as follows:

Three months ended June 30,
$ in thousands 2015 2014
Foreign exchange loss/ (gain) $ 1,196 $ (146 )
Impairment loss on prepaid expenses and deposits - 3,405
Impairment loss on property, plant and equipment - 277
Proceeds on disposal of mining license - (1,818 )
Provision for doubtful trade and other receivable 157 -
Provision for court case penalty 18,049 -
Other 48 58
Other operating expense $ 19,450 $ 1,776

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 on June 30, 2015).

The Company recognized an impairment loss of $3.4 million in the second quarter of 2014 related to prepaid toll washing fees under the contract with Ejinaqi Jinda Coal Industry Co. Ltd. ("Ejin Jinda"). The impairment charge was the result of the continued delay in starting the commercial operations at the wet washing facility and the continued soft coal market in China. No corresponding impairment charge was required in the second quarter of 2015.

In the second quarter of 2014, the Company completed the sale of the Tsagaan Tolgoi mining license. The gross proceeds of the sale were $2.0 million, indirect taxes and costs totaled $0.2 million and a withholding tax totaling $0.5 million was incurred. The net proceeds generated for the Company after taxes and costs were $1.3 million.

Administration expenses were $2.0 million in the second quarter of 2015 compared to $2.3 million in the second quarter of 2014 as follows:

Three months ended June 30,
$ in thousands 2015 2014
Corporate administration $ 512 $ 523
Legal and professional fees 890 779
Salaries and benefits 472 825
Share-based compensation expense 47 94
Depreciation 40 32
Administration expenses $ 1,961 $ 2,253

Administration expenses were lower for the second quarter of 2015 compared to the second quarter of 2014 primarily as a result of cost reduction measures.

Evaluation and exploration expenses were negligible in the second quarter of 2015 compared to $0.1 million in the second quarter of 2014. The Company continued to minimize evaluation and exploration expenditures in the second quarter of 2015 in order to preserve the Company's financial resources. Evaluation and exploration activities and expenditures in the second quarter of 2015 were limited to ensuring that the Company met the Mongolian Minerals Law requirements in respect of its mining and exploration licenses.

Finance costs were $5.2 million and $5.2 million respectively in the second quarter of 2015 and the second quarter of 2014. Finance costs primarily consisted of interest expense in respect of the $250.0 million CIC Convertible Debenture ($5.1 million for the second quarter of 2015 and $5.0 million for the second quarter of 2014).

Finance income was $0.3 million in the second quarter of 2015 compared to $0.1 million in the second quarter of 2014 which, primarily consists of an unrealized gain in respect of the embedded derivative in the CIC Convertible Debenture.

For the six months ended June 30, 2015

The Company recorded a $46.9 million loss from operations in the first six months of 2015 compared to a $34.2 million loss from operations in the first six months of 2014. The operations for the six months ended June 30, 2015 were impacted by continuing difficult market conditions and weak coal prices in China. Whilst the Company resumed production on March 30, 2015 in anticipation of increased sales volumes, 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 three months ended June 30, 2015.

Revenue was $4.5 million in the first six months of 2015 compared to $11.8 million in the first six months of 2014. The Company sold 0.37 million tonnes of coal at an average realized selling price of $15.15 per tonne in the first six months of 2015 compared to sales of 1.02 million tonnes at an average realized selling price of $15.22 per tonne in the first six months of 2014. The benefit of the improved product mix has been more than offset by continued declining prices for the first six months of 2015 when compared to the first six months of 2014.

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 2015, based on the Company's average realized selling price of $15.15 per tonne, was 18.0% or $2.73 per tonne compared to 16.2% or $2.46 per tonne based on the average realized selling price of $15.22 per tonne in the first six months of 2014.

Cost of sales was $29.5 million in the first six months of 2015 compared to $38.5 million in the first six months of 2014. 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 "Non-IFRS Financial Measure" section for further analysis) during the period.

Six months ended June 30,
$ in thousands 2015 2014
Operating expenses $ 6,498 $ 12,317
Share-based compensation expense 32 143
Depreciation and depletion 1,141 4,540
Impairment of coal stockpile inventories 3,111 13,527
Cost of sales from mine operations 10,782 30,527
Cost of sales related to idled mine assets 18,729 7,925
Cost of sales $ 29,511 $ 38,452

Operating expenses in cost of sales were $6.5 million in the first six months of 2015 compared to $12.3 million in the first six months of 2014. The overall decrease in operating expenses is the result of both (i) different production profiles, in the first six months of 2015 there was a period of curtailment until March 30, 2015 whilst in the first six months of 2014 production was impacted by a decision by the Company in June 2014 in response to market conditions to reduce production and place approximately half of its workforce on furlough; and (ii) a greater increase in coal stockpiles during the first six months of 2015 when compared to the first six months of 2014.

Cost of sales in the first six months of 2015 and the first six months of 2014 included coal stockpile impairments of $3.1 million and $13.5 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 2015 and 2014 reflect the challenging coal market conditions and primarily related to the Company's higher-ash products.

Cost of sales related to idled mine asset costs primarily consisted of period costs, which were expensed as incurred and primarily included depreciation expense. Cost of sales related to idled mine assets in the first six months of 2015 included $15.8 million related to depreciation expenses for idled equipment (2014: $7.9 million). Idled mine asset costs increased in the first six months of 2015 compared to the first six months of 2014 as a result of the period of curtailment until March 30, 2014 when mining operations recommenced. However, neither the production plan for the first six months of 2014 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.

Other operating expenses were $18.5 million in the first six months of 2015 compared to $2.8 million in the first six months of 2014.

Six months ended June 30,
$ in thousands 2015 2014
Foreign exchange loss/(gain) $ 138 $ (910 )
Impairment loss on available-for-sale financial asset - 1,766
Impairment loss on prepaid expenses and deposits - 3,405
Impairment loss on property, plant and equipment - 277
Proceeds on disposal of mining license - (1,818 )
Provision for doubtful trade and other receivable 157 -
Provision for court case penalty 18,049 -
Other 135 129
Other operating expense $ 18,479 $ 2,849

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).

The Company recognized an impairment loss of $3.4 million in the first six months of 2014 related to prepaid toll washing fees under the contract with Ejinaqi Jinda Coal Industry Co. Ltd. ("Ejin Jinda"). The impairment charge was the result of the continued delay in starting the commercial operations at the wet washing facility and the continued soft coal market in China. No corresponding impairment charge was required in the second quarter of 2015.

In the first six months of 2014, the Company completed the sale of the Tsagaan Tolgoi mining license. The gross proceeds of the sale were $2.0 million, indirect taxes and costs totaled $0.2 million and a withholding tax totaling $0.5 million was incurred. The net proceeds generated for the Company after taxes and costs were $1.3 million.

The Company's previous investment in Aspire Mining Limited ("Aspire") was accounted for as an available-for-sale financial asset and carried at its fair value. In the first six months of 2014, Aspire's market capitalization fluctuated, in the first quarter of 2014 the market capitalization decreased and an impairment charge of $1.8 million was initially recorded. In the second quarter of 2014 the gain of $0.4 million was recorded in other comprehensive income. The Company disposed all its investment in Aspire during 2014 and did not hold any Aspire shares as at December 31, 2014 or June 30, 2015.

Administration expenses were $3.4 million in the first six months of 2015 compared to $4.5 million in the first six months of 2014.

Six months ended June 30,
$ in thousands 2015 2014
Corporate administration $ 958 $ 1,183
Legal and professional fees 1,365 1,465
Salaries and benefits 852 1,553
Share-based compensation expense 147 225
Depreciation 66 64
Administration expenses $ 3,388 $ 4,490

Administration expenses were lower in the first six months of 2015 compared to the first six months of 2014 reflecting the continued cost-cutting initiatives.

Evaluation and exploration expenses were $0.1 million in the first six months of 2015 compared to $0.3 million in the first six months of 2014. The Company continued to minimize evaluation and exploration expenditures in the first six months of 2015 in order to preserve the Company's financial resources. Evaluation and exploration activities and expenditures in the first six months of 2015 were limited to ensuring that the Company met the Mongolian Minerals Law requirements in respect of its mining and exploration licenses.

Finance costs were $11.6 million and $10.2 million in the first six months of 2015 and 2014 respectively. This primarily consisted of interest expense on the CIC Convertible Debenture ($10.1 million for the first six months of 2015 and $10.0 million for the first six months of 2014).

Finance costs for the first six months of 2015, also includes $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 2014, the Company recorded within Finance income an unrealized fair value gain of the embedded derivative in the CIC Convertible Debenture ($1.1 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.

Finance income was negligible in the first six months of 2015 compared to $1.1 million in the first six months of 2014. Finance income primarily consists of unrealized gains on the fair value change of the embedded derivatives in the CIC Convertible Debenture (nil and $1.1 million respectively for the first six months of 2015 and the first six months of 2014).

Income tax expense was negligible in the first six months of 2015 compared to an expense of $0.5 million in the first six months of 2014. The $0.5 million recognized in the first six months of 2014 relates to taxes paid in respect of the sale of the Tsagaan Tolgoi mining license.

Summary of Quarterly Operational Data

2015 2014 2013
Quarter Ended 30-Jun 31-Mar 31-Dec 30-Sep 30-Jun 31-Mar 31-Dec 30-Sep
Sales Volumes, Prices and Costs
Premium semi-soft coking coal
Coal sales (millions of tonnes) 0.02 - 0.02 - - - 0.21 0.04
Average realized selling price (per tonne) (i) $ 23.37 $ - $ 26.77 $ - $ - $ - $ 37.54 $ 37.50
Standard semi-soft coking coal
Coal sales (millions of tonnes) 0.11 0.05 0.14 0.31 0.12 0.29 1.40 0.87
Average realized selling price (per tonne) (i) $ 19.97 $ 17.95 $ 18.32 $ 17.41 $ 20.33 $ 22.00 $ 24.49 $ 21.67
Thermal coal
Coal sales (millions of tonnes) 0.06 0.13 0.21 0.34 0.51 0.10 0.11 0.03
Average realized selling price (per tonne) (i) $ 10.47 $ 10.46 $ 11.69 $ 10.66 $ 10.72 $ 12.07 $ 12.60 $ 13.07
Total
Coal sales (millions of tonnes) 0.19 0.18 0.37 0.65 0.63 0.39 1.72 0.94
Average realized selling price (per tonne) (i) $ 17.42 $ 12.66 $ 15.04 $ 13.87 $ 12.52 $ 19.54 $ 25.30 $ 22.05
Raw coal production (millions of tonnes) 0.62 - 0.21 0.17 0.55 0.64 1.73 1.13
Direct cash costs of product sold (per tonne) (ii) $ 15.57 $ 8.68 $ 8.09 $ 7.38 $ 8.23 $ 10.43 $ 11.13 $ 9.41
Mine administration cash costs of product sold (per tonne) (ii) $ 7.90 $ 2.11 $ 2.44 $ 2.30 $ 2.49 $ 3.80 $ 1.39 $ 2.20
Total cash costs of product sold (per tonne) (ii) $ 23.47 $ 10.79 $ 10.53 $ 9.68 $ 10.72 $ 14.23 $ 12.52 $ 11.61
Other Operational Data
Production waste material moved (millions of bank 3.62 - 0.55 0.20 2.17 2.55 3.77 1.57
cubic meters)
Strip ratio (bank cubic meters of waste material per tonne of 5.87 - 2.61 1.20 3.97 4.02 2.18 1.39
coal produced)
Lost time injury frequency rate (iii) 0.00 0.25 0.21 0.17 0.15 0.00 0.00 0.00

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

(ii) A non-IFRS financial measure, refer to "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.

Summary of Quarterly Financial Results
$ in thousands, except per share information 2015 2014 2013
Quarter Ended 30-Jun 31-Mar 31-Dec 30-Sep 30-Jun 31-Mar 31-Dec 30-Sep
Financial Results
Revenue (i), (ii) $ 2,951 $ 1,587 $ 5,054 $ 7,611 $ 6,691 $ 5,137 $ 32,457 $ 15,652
Cost of sales (ii) (11,835 ) (17,678 ) (19,757 ) (23,922 ) (20,086 ) (18,366 ) (40,359 ) (33,486 )
Gross loss excluding idled mine asset costs (5,017 ) (1,230 ) (821 ) (2,178 ) (8,497 ) (10,202 ) (4,141 ) (13,323 )
Gross loss including idled mine asset costs (8,884 ) (16,091 ) (14,703 ) (16,311 ) (13,395 ) (13,229 ) (7,900 ) (17,834 )
Other operating income/(expenses) (19,450 ) 971 (11,989 ) (2 ) (1,776 ) (1,073 ) (109,682 ) (1,003 )
Administration expenses (1,961 ) (1,425 ) (1,924 ) (2,530 ) (2,253 ) (2,237 ) (3,668 ) (4,204 )
Evaluation and exploration expenses 22 (81 ) (911 ) (122 ) (107 ) (172 ) (489 ) (186 )
Loss from operations (30,273 ) (16,626 ) (29,527 ) (18,965 ) (17,531 ) (16,711 ) (121,740 ) (23,227 )
Finance costs (5,222 ) (6,648 ) (6,351 ) (5,257 ) (5,215 ) (5,025 ) (5,167 ) (5,382 )
Finance income 273 8 317 135 127 1,007 1,301 124
Share of earnings/(losses) of joint venture 151 (18 ) (40 ) (32 ) (3 ) (26 ) (15 ) (66 )
Income tax expense (1 ) - (40 ) - (546 ) - (13,109 ) (13,377 )
Net loss (35,072 ) (23,284 ) (35,641 ) (24,119 ) (23,168 ) (20,755 ) (138,730 ) (41,928 )
Basic loss per share $ (0.15 ) $ (0.11 ) $ (0.19 ) $ (0.13 ) $ (0.12 ) $ (0.11 ) $ (0.75 ) $ (0.23 )
Diluted loss per share $ (0.15 ) $ (0.11 ) $ (0.19 ) $ (0.13 ) $ (0.12 ) $ (0.11 ) $ (0.75 ) $ (0.23 )

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

(ii) Revenue and cost of sales relate to the Company's Ovoot Tolgoi Mine within the Mongolian 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.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity and Capital Management

The Company has in place a planning, budgeting and forecasting process to help determine the funds required to support the Company's normal operations on an ongoing basis and its expansionary plans.

Novel Sunrise private placement

On February 24, 2015, the Company announced it had entered into a private placement agreement with Novel Sunrise providing for the subscription of up to 21.75 million Common Shares for gross proceeds of up to approximately $7.5 million.

The initial tranche of the private placement consisting of approximately $3.5 million of Mandatory Convertible Units closed on March 3, 2015 having been subject to regulatory approvals and other customary closing conditions. On completion of the Novel SPA each Mandatory Convertible Unit was converted on a one for one basis into Common Shares.

On April 23, 2015, the Company successfully closed the second tranche of the Novel Sunrise private placement for gross proceeds of approximately $4.0 million through the issue of approximately 11.6 million Common Shares.

The issue price for both tranches of the private placement was set at CAD$0.432 ("Placing Price") and represented a discount of approximately 20% to the then 5-day volume-weighted average price per Common Share of approximately CAD$0.54, as of the date the Company received price protection from the TSX for the private placement. The Placing Price was determined with reference to the prevailing market price of the Common Shares and was negotiated on an arm's length basis between the Company's independent directors and Novel Sunrise.

The closing of the Novel Sunrise private placement and related transactions was subject to acceptance of notice of the placement by the TSX pursuant to the financial hardship exemption of the TSX Company Manual and the delisting review (For more information on the delisting review, refer to the heading "TSX Financial Hardship Exemption Application and Status of Listing on TSX").

In accordance with the terms of the Novel Sunrise private placement:

  • Following the closure of the initial tranche of the private placement, Mr. Chan was appointed as an Executive Director on March 3, 2015. Mr. Chan did not stand for election at the Company's AGM on August 6, 2015 and ceased to be an Executive Director of the Company as of that date.
  • Following the closure of the second and final tranche, Novel Sunrise holds the right to nominate three directors, to the Company's board of directors. In accordance with this provision, Novel Sunrise nominated Mr. Aminbuhe, Mr. Yulan Guo and Mr. Ningqiao Li to the Company's board of directors and such individuals were subsequently elected at the Company's AGM on August 6, 2015.

Novel SPA

On April 23, 2015, the Company was advised that the Novel SPA, as initially announced by the Company on February 24, 2015, had received all the necessary approvals and closed. Pursuant to the Novel SPA, Novel Sunrise has purchased 48.7 million Common Shares from Turquoise Hill.

Novel Sunrise change in ownership

The Company notes the announcement by Novel Sunrise, the largest shareholder of the Company, on July 20, 2015 which reported that China Cinda (HK) Investments Management Company Limited ("Cinda"), a wholly-owned subsidiary of China Cinda Asset Management Corporation Limited, acquired ownership and control of all of the outstanding voting (ordinary) shares of Novel Sunrise through Hope Rosy Limited, a wholly-owned subsidiary of Cinda.

CITIC Merchant and Swiss Life GP private placements

On June 22, 2015, the Company announced it had negotiated private placement agreements with sophisticated investors to provide additional capital resources into the Company. The terms of the subscription agreements for the private placements allowed for the issue of approximately 55 million Common Shares, priced at C$0.71 per share (a 20% discount to the five date volume weighted average price of the common shares on the TSX at June 19, 2015).

The closing of the private placements and related transactions were subject to necessary approvals, including by the TSX and the Stock Exchange of Hong Kong Limited, and in the case of CITIC Merchant was subject to the approval of their board.

On July 14, 2015, the Company announced it had obtained all the necessary regulatory approvals for the private placements and subsequently successfully closed a portion of the overall placement by placing 5 million Common Shares for approximately $2.9 million in proceeds.

On July 14, 2015, the Company agreed to an extension of the closing date of the private placement agreement between the Company and CITIC Merchant until July 20, 2015. However, the conditions precedent to the agreement were not fulfilled and CITIC Merchant informed the Company that it would not be subscribing for Common Shares pursuant to the signed private placement agreement.

Interim Funding Loan Commitment

On June 17, 2015, the Company negotiated an interim loan ("Interim Loan") for up to $8 million from Mr. Wilson Chen (a former principal of Novel Sunrise), with immediate availability, intended to address funding obligations pending the closing of the private placements between the Company and CITIC Merchant and Swiss Life GP. In accordance with the terms of the agreement the advances will be in a minimum amount of $2 million, with interest at LIBOR + 12% per annum, payable in cash on a quarterly basis in arrears, and maturing on June 18, 2016. The loan is unsecured and is subject to mandatory repayment upon completion of $30 million of equity or other debt financing.

As at June 30, 2015, the Company had not drawn down any funds under the Interim Loan. The Company has requested a funding drawdown on the Interim Loan multiple times; however, the Company has to date not received such funding.

Turquoise Hill Loan Facility

On May 25, 2014, the Company announced it had obtained a $10 million revolving credit facility from Turquoise Hill to meet its short term working capital requirements. The terms and conditions of this facility were filed on SEDAR (www.sedar.com) on June 2, 2014. The key commercial terms of the facility were as follows:

  • Original maturity date of August 30, 2014 (subsequently extended; refer below for details);
  • Interest rate of one month US dollar LIBOR Rate in effect plus 11% margin per annum;
  • Commitment fee of 35% of interest rate payable quarterly in arrears on undrawn principal amount of facility;
  • Front end fee of $0.1 million;
  • Draws subject to customary closing conditions and the Company's cash requirements in the ordinary course of business;
  • Facility is subject to certain mandatory prepayment and termination provisions; and
  • The Company to continue to seek other funding alternatives.

On August 30, 2014 and December 4, 2014, subject to certain conditions and limitations, Turquoise Hill agreed to grant deferrals of the payment of $3.8 million plus accrued interest thereon owing by the Company under the Turquoise Hill Loan Facility on the reduced revolving credit facility of $3.8 million. These deferrals of payment and repayment were granted to the Company without prejudice to Turquoise Hill's right and ability to assert and re-assert at any point in time to demand payment and repayment of all amounts owing to Turquoise Hill under the Turquoise Hill Loan Facility.

On May 4, 2015 following the expiry of the NUR SPA on April 30, 2015, Turquoise Hill agreed to a further limited deferral of repayment, subject to certain conditions and limitations, on the $3.8 million principal and accrued interest owing on the Turquoise Hill Loan Facility as follows:

  1. $1.9 million in principal and all interest that has accrued on and under the Turquoise Hill Loan Facility up to and including August 31, 2015 shall become due and payable on August 31, 2015; and
  2. $1.9 million in principal and all interest that has accrued on and under the Turquoise Hill Loan Facility from September 1, 2015 up to and including November 30, 2015 shall become due and payable on November 30, 2015.

At June 30, 2015 in addition to the principal of $3.8 million the Company owed accrued interest of $0.4 million under this facility (December 31, 2014 the Company had drawn $3.8 million and owed accrued interest of $0.1 million).

Revolving Loan Commitment

On June 22, 2015, the Company announced it had negotiated a revolving loan commitment (the "Revolving Loan") of RMB200 million (approximately $32 million) from a Chinese commercial bank, subject to the finalization of definitive documentation. The revolving loan commitment is intended to provide additional support to the Company in funding its operational objectives. The Company is negotiating with the bank to finalize the terms with a view to obtaining the Revolving Loan.

Going concern considerations

Notwithstanding the provision of the completed private placements, the coal prepayments received from customers and the Turquoise Hill Loan Facility, the Company continues to experience negative impacts on its margins and liquidity and there can be no assurance that the Company will have sufficient funding to be able to continue as a going concern.

The Company anticipates that coal prices in China will remain under pressure in 2015, which will continue to impact the Company's margins and liquidity. Therefore the Company is actively seeking prepaid coal offtake agreements and other additional sources of financing to continue operating and meet its business objectives, while continuing to be focused on minimizing uncommitted capital expenditures and preserving the Company's growth options. The Company, together with its new strategic partner, Novel Sunrise, has developed the Proposed Funding Plan in order to pay the interest due under the CIC Convertible Debenture, meet its obligations as they fall due and achieve its business objectives in 2015 and beyond. These obligations include the Tax Penalty ($18.0 million). However, there is no guarantee that the Company will be able to implement this Proposed Funding Plan or 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 June 30, 2016, then the Company is unlikely to have sufficient capital resources or cash flows from mining operations in order to satisfy its ongoing obligations and future contractual commitments, including cash interest payments due on the CIC Convertible Debenture (approximately $16.3 million on November 19, 2015). Refer to section 11 "Risk Factors". Therefore, the Company is actively seeking additional sources of financing to continue operating and meet its objectives.

The Company's consolidated financial statements have been prepared on a going concern basis which assumes that the Company will continue operating until at least June 30, 2016 and will be able to realize its assets and discharge its liabilities in the normal course of operations as they come due; however, in order to continue as a going concern, the Company must generate sufficient operating cash flows, secure additional capital or otherwise pursue a strategic restructuring, refinancing or other transaction to provide it with additional liquidity. 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 June 30, 2016, then the Company is unlikely to have sufficient capital resources or cash flows from mining operations in order to satisfy its ongoing obligations and future contractual commitments, including cash interest payments due on the CIC Convertible Debenture, it may not be able to continue as a going concern.

If for any reason, the Company is unable to secure the additional sources of financing and continue as a going concern, then this could result in adjustments to the amounts and classifications of assets and liabilities in the Company's consolidated financial statements and such adjustments could be material.

While the Company intends to secure additional sources of financing as soon as possible, a continued delay in securing additional financing could ultimately result in an event of default of the CIC Convertible Debenture, which if not cured within applicable cure periods in accordance with the terms of such debenture, may result in the principal amount owing and all accrued and unpaid interest becoming immediately due and payable upon notice to the Company by CIC.

The Company is also subject to a remedial delisting review by the TSX in connection with its reliance on the financial hardship exemption from approval by its shareholders of the private placement with Novel Sunrise as announced on February 24, 2015. Refer to the below section "TSX Financial Hardship Exemption Application and Status of Listing on TSX" for details. The failure by the Company to clear the TSX delisting review may result in the delisting of the Common Shares from the TSX which may result in an event of default under the CIC Convertible Debenture. An event of default may result in the principal amount owing and all accrued and unpaid interest becoming immediately due and payable upon notice to the Company by CIC.

Factors that impact the Company's liquidity are being closely monitored and include, but are not limited to, Chinese economic growth, market prices of coal, production levels, operating cash costs, capital costs, exchange rates of currencies of countries where the Company operates and exploration and discretionary expenditures.

Cash Position and Liquidity

At June 30, 2015, the Company had cash of $0.9 million compared to cash of $3.8 million at December 31, 2014. Working capital (excess current assets over current liabilities) was negative $31.3 million at June 30, 2015 compared to positive $3.4 million at December 31, 2014. At August 13, 2015, the Company had cash of $2.0 million.

At June 30, 2015, the Company's gearing ratio was 0.24 (December 31, 2014: 0.23), which was calculated based on the Company's long term liabilities to total assets. At June 30, 2015, the Company is not subject to any externally imposed capital requirements.

Proposed Funding Plan

The Company has commenced the implementation of the Proposed Funding Plan intended to improve cash flow for the Company and support its business strategy and operations in a difficult market, with the goal of positioning the Company with a strong future as a coal producer.

On June 22, 2015, the Company announced a progress update with respect to the Proposed Funding Plan. This included the CITIC Merchant and Swiss Life GP private placements, the Interim Loan, the Revolving Loan all of which are described above and an offtake agreement with a China-based buyer for the sale of 1.8 million tonnes of coal from July 2015 to July 2016.

Subsequent to the change in ownership of Novel Sunrise the Company held discussions with Cinda who confirmed to the Company its continuing support for the Proposed Funding Plan. Therefore the Company will continue with the implementation of the Proposed Funding Plan which includes expanding its customer base further inland in China, securing longer-term coal offtake arrangements, thereby allowing the Company to ramp up production to capacity and obtaining additional loans as required to meet existing obligations and expected further working capital requirements.

At present the Company has decided to pursue the Proposed Funding Plan described above rather than additional equity placements.

While it is the Company's intention to continue to implement the Proposed Funding Plan as soon as possible, the Proposed Funding Plan is indicative only and the Company's ability to implement it successfully is dependent on a number of factors beyond its control. Such factors include but not limited to, China's economic growth and coal demand growth, market prices of coal, the availability of credit and market interest rates, and exchange rates of currencies of countries where the Company operates. There can be no assurance that the Company will be able to implement the Proposed Funding Plan, or that it will be able to do so in sufficient time to satisfy the TSX's delisting review or to continue as a going concern. In such event, the Company is likely to be unable to meet its obligations, which could result in voluntary or involuntary insolvency proceedings involving the Company (including bankruptcy) as discussed under the heading "Risk Factors" in the December 31, 2014 MD&A issued on March 30, 2015 and available on SEDAR at www.sedar.com.

TSX Financial Hardship Exemption Application and Status of Listing on TSX

On February 25, 2015, the TSX confirmed that the Company had been placed on remedial delisting review in connection with its reliance on the financial hardship exemption from approval by its shareholders of the private placement with Novel Sunrise. A delisting review is customary practice under TSX policies when a listed company relies on the financial hardship exemption; refer to the Company's MD&A for the year ended December 31, 2014 available on SEDAR at www.sedar.com for additional detail.

Following extension requests by the Company to address delays in the implementation of its Proposed Funding Plan, a meeting of the TSX Committee has been deferred until August 25, 2015 to consider whether the Company has met the listing requirements of the exchange or delist the Common Shares. The TSX Committee has determined to defer its delisting decision until no later than August 28, 2015.

The Company believes the extension will provide sufficient time for the implementation of the next stage of the Proposed Funding Plan, which will allow it to meet its short term financing needs, and that it will be compliant with the continued listing requirements of the TSX; however, no assurance can be provided that the Proposed Funding Plan will be successfully implemented or to the outcome of the remedial delisting review when it occurs and the Common Shares may become subject to delisting from the TSX.

Mongolian IAAC Investigation

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 and were continued to be enforced by the Mongolian State Investigation Office (the "SIA"). The restrictions on the assets were reaffirmed in the Tax Verdict and form part of the tax penalty payable by the Company.

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.

Following a review by the Company and its advisers, it is the Company's view that the orders placing restrictions on certain of the Company's Mongolian assets did not result in an event of default as defined under the terms of the CIC Convertible Debenture. However, the enforcement of the orders could ultimately result in an event of default of the Company's CIC Convertible Debenture, which if remains uncured for ten business days, would result in the principal amount owing and all accrued and unpaid interest will become immediately due and payable upon notice to the Company by CIC.

Ovoot Tolgoi Mine Impairment Analysis

Unchanged from the assessment made as at each quarter end in 2014 and the first quarter end of 2015, the Company determined that an indicator of impairment existed for its Ovoot Tolgoi Mine cash generating unit as at June 30, 2015. The impairment indicator was the continued weakness in the Company's share price during the second quarter of 2015 and the fact that the market capitalization of the Company, as at June 30, 2015, was less than the carrying value of its net assets.

Therefore, the Company conducted an impairment test whereby the carrying value of the Company's Ovoot Tolgoi Mine cash generating unit was compared to its "value in use" using a discounted future cash flow valuation model. The Company's cash flow valuation model has been updated to take into consideration the latest available information to the Company, including but not limited to, sales price, sales volumes and washing assumptions, operating cost assumptions and life of mine coal production assumptions as at June 30, 2015. The Company's Ovoot Tolgoi Mine cash generating unit carrying value was $340.6 million as at June 30, 2015.

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

  • Long term price estimates from an independent market consulting firm;
  • Forecasted sales volumes in line with production levels as per the updated mine plan;
  • Updated life-of-mine coal production, strip ratio, capital costs and operating costs;
  • A pre-tax discount rate of 17.3% based on an analysis of market, country and the Company specific factors; and
  • Coal processing yield of 75%.

Key sensitivities in the valuation model are as follows:

  • For each 1% increase/(decrease) in the long term price estimates, the calculated fair value of the cash generating unit increases/(decreases) by approximately $22.2/($22.2) million;
  • For each 1% increase/(decrease) in the discount rate, the calculated fair value of the cash generating unit (decreases)/increases by approximately ($23.4)/$25.8 million; and
  • For each 1% increase/(decrease) in the cash mining cost estimates, the calculated fair value of the cash generating unit (decreases)/increases by approximately ($13.2)/$13.2 million.

The impairment analysis did not result in the identification of an impairment loss and no charge was required as at June 30, 2015. A decline of more than 2% in the long term price estimates, an increase of more than 2% in the pre-tax discount rate or an increase of more than 3% in the cash mining cost estimates may trigger an impairment charge on the cash generating unit. 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.

The Company is currently reviewing its mine plan for the Ovoot Tolgoi project. Changes to the mine plan may have an impact on the quantities of measured and/or indicated resources and reserves of the Ovoot Tolgoi project.

REGULATORY ISSUES AND CONTINGENCIES

Governmental and Regulatory Investigations

The Company was subject to investigations by the IAAC regarding allegations of breaches of Mongolia's anti-corruption laws (the "Anti-Corruption Case"), tax evasion and money laundering (the "Tax Evasion Case"). On March 18, 2013 the Prosecutor's Office decided to split the Tax Evasion Case from the Anti- Corruption Case and on April 12, 2013, the Public Prosecutor of Capital city Prosecutor's Office issued a resolution that the jurisdiction to conduct the investigation on Tax Evasion Case was with the SIA and not the IAAC, and the Tax Evasion Case was transferred to SIA.

While the IAAC has not made any formal accusations against any current or former employee of the Company or the Company under the Anti-Corruption Case, administrative penalties were imposed on certain of the Company's Mongolian assets in connection with the investigation, including a restriction of the use of $1.2 million (the "Restricted Funds") held in bank accounts in Mongolia to spending in Mongolia. The Company has been informed that the Anti-Corruption Case has been suspended; however, it has not received formal notice that the investigation is completed and the restriction on the Restricted Funds remains in place. The Restricted Funds are included within the prepaid expenses and deposits balance in the Company's financial statements. This restriction may have a material impact on the Company's activities in light of the Tax Penalty (MNT 35.3 billion as declared by the Tax Verdict).

Investigations under the Tax Evasion Case included investigations of three of the Company's former employees (the "Former Employees"). On December 30, 2014, the Capital City Prosecutor's Office (Ulaanbaatar, Mongolia) dismissed the allegations of money laundering as not having been proven during the investigation. The Former Employees were indicted for tax evasion by the Prosecutor General on March 14, 2014. The case was sent to the First Instance Second District Criminal Court of Justice (the "District Court"). The Company was advised on May 12, 2014 that the appointed judge of the District Court concluded that the investigation of the Tax Evasion Case initiated by IAAC and continued by SIA was incomplete and ordered the case to be returned to the Prosecutor General for additional investigation. The additional investigation was subsequently completed and the case was sent to the District Court again on June 4, 2014. The trial took place on August 25 and 26, 2014. A panel of three judges appointed to the case returned the case to the Prosecutor General once again for further investigation due to insufficient evidence presented by the prosecutor.

On October 7, 2014, based on the District Court verdict, the SIA ordered a re-investigation (the "Fourth Investigation") into allegations of violations of Mongolian tax laws by the Former Employees. Following the completion of the Fourth Investigation, the Former Employees were indicted again on December 31, 2014 and were subsequently tried in the District Court. On January 30, 2015, the panel of appointed judges from the District Court found the Former Employees guilty of tax evasion and imposed sentences on the Former Employees ranging from 5 years and 6 months to 5 years and 10 months of imprisonment in the correctional facilities of strict regimen in Mongolia. The Former Employees were immediately imprisoned. The Company was informed that, following the receipt of the Tax Verdict, the Former Employees requested pardons from the President of Mongolia and waived their right of appeal. On February 26, 2015 the President of Mongolia issued a decree to pardon to the Former Employees. The Former Employees were released from imprisonment following the decree and departed Mongolia.

The Tax Verdict declared SGS to be financially liable as a "civil defendant" the Tax Penalty of MNT35.3 billion (approximately $18.0 million on June 30, 2015). The Company firmly rejects this conclusion.

On February 18, 2015, the Company appealed the Tax Verdict (the "Tax Verdict Appeal") on the grounds that it has prepared its financial statements, including those of SGS, in compliance with IFRS, and lodged all its tax returns in the required format under Mongolian tax law. The hearing of the Tax Penalty Appeal took place on March 25, 2015 at the 10th Appeal Court for Criminal Case of Mongolia (the "Court of Appeal") and a panel of three appointed judges decided to uphold the Tax Verdict and dismissed the Tax Verdict Appeal by the Company. It is the view of the Company that there is a lack of evidence to support both the Tax Verdict and the Appeal Verdict. The Company received the written version of the Appeal Court's verdict ("Appeal Verdict") on April 10, 2015. The Company lodged a final appeal with the Supreme Court of Mongolia on April 22, 2015. In accordance with Mongolia's criminal procedure law, SGS filed the appeal with the Supreme Court of Mongolia through the Second District Criminal Court of Justice.

On April 29, 2015 the Second District Criminal Court refused to advance SGS's appeal to the Supreme Court. Following an immediate protest by SGS, the Second District Criminal Court delivered SGS's appeal to the Supreme Court of Mongolia.

On May 20, 2015, SGS was informed that the Supreme Court had refused to hear the appeal and had returned the appeal to the Second Criminal Court of Justice. The Supreme Court based its decision on a restrictive reading of Article 342 of the Criminal Procedure Law of Mongolia which stipulates that "the defendant, person acquitted, the victim, and their respective defense counsel have the right to lodge a complaint to the Supreme Court". The Supreme Court concluded that the omission of a specific reference to a civil defendant in Article 342, in and of itself denies SGS, in such capacity, the right to lodge an appeal to the Supreme Court.

In its decision, the Supreme Court did not address other provisions of the Criminal Procedure Law and the Law on Courts of Mongolia, which provide that civil defendants have standing to appeal to the Supreme Court and that no judicial proceedings or decisions in Mongolia are outside of the scope of supervision by the Supreme Court.

On May 21, 2015, SGS sent an official letter of protest to the Presiding Justice of the Criminal Chamber of the Supreme Court (the "Presiding Justice"), challenging the decision to refuse to hear the tax case on appeal. On June 2, 2015, SGS received a formal response from the Presiding Justice, confirming the Supreme Court's refusal to hear the tax case. In the letter, the Presiding Justice reaffirmed the restrictive interpretation of Article 342 of the Criminal Procedure Law.

With the refusal by the Supreme Court to hear the case on appeal, the Tax Verdict has entered into force. The Tax Verdict is, however, not immediately payable and enforceable against SGS absent further actions prescribed by the laws of Mongolia. In particular, SGS has not received a copy of the bailiff's resolution on execution of the Tax Verdict, as required under the Law of Mongolia on Execution of Court Decisions in order for any judgment execution process to happen. However, the Company made a corresponding provision for the court case penalty of $18.0 million as at June 30, 2015 given the Tax Verdict has entered into force.

The Company continues to believe that there is a lack of evidence to support the Tax Verdict and that the Tax Verdict and the subsequent decisions of the higher courts on appeal were substantively and procedurally in error under the laws of Mongolia.

While the Company had various additional legal avenues available to it to continue defending itself, it has decided to and is currently seeking to resolve amicably the dispute giving rise to the Tax Verdict in a manner that is both appropriate having regard to the Company's limited financial resources and supportive of a positive environment for foreign investment in Mongolia. There can be no assurance, however, that any such resolution can be successfully negotiated by the Company either at all or on favourable terms, or that the terms of any resolution to which the Government would be prepared to agree would not be materially adverse to the Company. In such case, this may result in an event of default under the Debenture held by CIC and CIC would have the right to declare the full principal and accrued interest owing thereunder immediately due and payable. Such an event of default under the Debenture or the Company's inability to pay the penalty could result in voluntary or involuntary proceedings involving the Company (including bankruptcy) as discussed under the heading Risk Factors in the MD&A issued on March 30, 2015 and available on SEDAR at www.sedar.com. However, with the Presiding Justice having upheld the decision to refuse to hear the case on appeal, this exhausts the legal appeals available to the Company in Mongolia.

Internal Investigations

Commencing in September 2012, through its Audit Committee (comprised solely of independent directors), the Company has conducted an internal investigation into possible breaches of law, internal corporate policies and codes of conduct arising from the allegations which have been raised through the investigations in Mongolia. The Chair of the Audit Committee has also participated in a tripartite committee, comprised of the Audit Committee Chairs of the Company and Turquoise Hill and a representative of Rio Tinto, which focused on the investigation of a number of those allegations, including possible violations of anti-corruption laws. The tripartite committee substantially completed the investigative phase of its activities during the third quarter of 2013. There have been no significant developments in respect of the internal investigations since the completion of the investigative phase during the third quarter of 2013.

The investigations referred to above could result in one or more Mongolian, Canadian, United States or other governmental or regulatory agencies taking civil or criminal action against the Company, its affiliates or its current or former employees. The likelihood or consequences of such an outcome are unclear at this time but could include financial or other penalties, which could be material, and which could have a material adverse effect on the Company. Refer to the Company's MD&A for the year ended December 31, 2014, which is available on SEDAR at www.sedar.com, section 14 risk factors, "the Company is subject to continuing governmental, regulatory and internal investigations, the outcome of which is unclear at this time but could have a material adverse effect on the Company".

Mining Prohibition in Specified Areas Law

In July 2009, Mongolia promulgated the Law on Prohibiting Mineral Exploration and Extraction Near Water Sources, Protected Areas and Forests (the "Mining Prohibition in Specified Areas Law"). Pursuant to the Mining Prohibition in Specified Areas Law, the Government of Mongolia has defined the boundaries of certain areas in which exploration and mining is purportedly prohibited. A list of licenses has been prepared that overlap with the prohibited areas described in the law based on information submitted by water authority agencies, forest authority agencies and local authorities for submission to the Government of Mongolia.

Portions of the Company's Ovoot Tolgoi mining license and exploration licenses pertaining to the Zag Suuj Deposit and the South Biluut and Jargalant Fields within the Soumber Deposit are included on the list of licenses published by the Government of Mongolia, potentially affecting the status of those licenses under the Mining Prohibition in Specified Areas Law.

In regard to the Ovoot Tolgoi mining license, the potential area which may be affected is a relatively small area which represents approximately 3% of the entire area of the mining license and does not contain any of the Company's NI 43-101 reserves or resources or immovable assets. Accordingly, the loss of the potentially affected area would not materially and adversely affect the existing operations.

Activities historically carried out on the other licenses referred to above include drilling, trenching and geological reconnaissance. The Company has no immovable assets located in any of the potentially affected areas of these licenses and the loss of any or all of these potentially affected properties would not materially and adversely affect the existing operations.

The Mining Prohibition in Specified Areas Law has not been adequately enforced mainly due to compensation issues due to the license holders.

In order to address the issues facing its implementation, in February, 2015 the Parliament of Mongolia adopted an amendment to the Law on Implementation of the Mining Prohibition in Specified Areas Law (the "Amended Law on Implementation"). The Amended Law on Implementation provides an opportunity for license holders covered within the scope of application of the Mining Prohibition in Specified Areas Law to continue their mining operations subject to advance placement of funds to cover 100% of the future environmental rehabilitation costs. A model contract and a specific Government regulation on this requirement will be adopted by the Government. The licence holders must also apply within 3 months after the amendment to the Law on Implementation comes into effect for permission to the Mineral Resource Authority of Mongolia (the "MRAM") to resume activities. The Company submitted its application with respect to its mining licenses before the deadline set on June 16, 2015 and hasn't yet received any communication from the MRAM on the status of its application.

The potential impact of the Mining Prohibition in Specified Areas Law on the Company's operations is unclear pending the adoption by the Government of the relevant regulations pursuant to the Amended Law on implementation. The Company will continue to monitor the developments and ensure that it follows the necessary steps in the Amended Law on Implementation to secure its operations and licenses and is fully compliant with Mongolian law.

Special Needs Territory in Umnugobi

On February 13, 2015, the whole of the Soumber mining license and a portion of SGS' exploration license No.9443 X (the "License Areas") were included into a special protected area (to be further referred as Special Needs Territory "SNT") newly set up by the Umnugobi Aimag's Civil Representatives Khural (the "CRKh") to establish a strict regime on the protection of natural environment and prohibit mining activities in the territory of the SNT.

In March 2015, SGS filed a complaint with the 12th Court for Administrative Cases of First Instance (the "Administrative Court") seeking the annulment of CRKh's decision to the extent it impacted the License Areas. In parallel, SGS initiated negotiations with the CRKh in order to reach an acceptable solution.

On July 8, 2015, SGS and the Chairman of the CRKh, in his capacity as the respondent's representative, reached an agreement (the "Amicable Resolution Agreement") to exclude the License Areas from the territory of the SNT in full, subject to confirmation of the Amicable Resolution Agreement by the session of the CRKh. The parties formally submitted the Amicable Resolution Agreement to the appointed judge of the Administrative Court for her approval and requested a dismissal of the case in accordance with the Law of Mongolia on Administrative Court Procedure. On July 10, 2015, the judge issued her order approving the Amicable Resolution Agreement and dismissing the case, while reaffirming the obligation of CRKh to take necessary actions at its next session to exclude the License Areas from the SNT and register the new map of the SNT with the relevant authorities. The Company has not yet received any indication on the timing of the next session of the CRKh.

Commercial arbitration in Hong Kong

On June 24, 2015, First Concept served the Notice on SGS in respect of the Coal Supply Agreement. The arbitral proceedings (the "Arbitration") are deemed to have commenced on June 24, 2015 as the date when the respondent received the Notice.

According to the Notice, First Concept: alleged, inter alia, (i) that SGS had failed and/or wrongfully refused to sell any coal to First Concept; (ii) expressed its wish to have the dispute settled in an arbitration to be administered by the Hong Kong International Arbitration Centre; and (iii) sought the repayment of the prepayment, in the sum of $11.5 million, it made to SGS under the Coal Supply Agreement, as well as any and all damages that may be due to it.

Under the Coal Supply Agreement, SGS agreed to sell coal to First Concept between May 22, 2014 and May 31, 2015 for a total consideration of $11.5 million. It was also agreed that that First Concept would pre-pay the $11.5 million. While First Concept fulfilled its payment obligation under the contract, it totally failed to fulfill its obligation to collect and transport the coal. Pursuant to the Coal Supply Agreement that obligation fell squarely on First Concept, while SGS was only obliged to make the coal available at its stockpile. The sole reason for the lack of coal sales to First Concept was the continued failure of First Concept to complete the necessary legal requirements for collection and transportation of coal and to provide a pickup schedule in accordance with industry practice. Contrary to the allegation by First Concept that SGS "wrongfully refused" to sell the coal, SGS has repeatedly advised First Concept of its willingness, ability and readiness to make available the coal for collection at its stockpile. In fact, SGS, at all times during the term of the Coal Supply Agreement, had more than sufficient coal at its stockpile to meet its obligations.

The Company, therefore, firmly rejects the allegations of First Concept in the Notice as lacking any merit and will vigorously defend itself in the Arbitration, including claiming the relevant fees and damages from First Concept.

There can be no assurance, however, that the Company will prevail in the Arbitration. Should SGS be unsuccessful in the Arbitration, the Company may not be able to re-pay the sum of $11.5 million. In such case, this may result in an event of default under the Debenture held by CIC and CIC would have the right to declare the full principal and accrued interest owing thereunder immediately due and payable. Such an event of default under the Debenture or the Company's inability to re-pay the $11.5 million to First Concept could result in voluntary or involuntary proceedings involving the Company.

Class Action Lawsuit

On or about January 6, 2014, Siskinds LLP, a Canadian law firm, filed a proposed securities class action (the "Ontario Action") against the Company, certain of its former senior officers and current directors, and its former auditors, Deloitte LLP, in the Ontario Superior Court of Justice in relation to the Company's restatement of financial statements as previously disclosed in the Company's public filings.

There have been no significant developments in respect of the class action lawsuit since the first quarter ended March 31, 2014. For more details, refer to the Company's Management Discussion and Analysis for the quarter ended March 31, 2014 available on SEDAR at www.sedar.com, and, in particular, the sub- section on "Contingencies - Class Action Lawsuit" of the "Regulatory Issues and Contingencies".

The Company disputes and will vigorously defend itself against these claims through independent Canadian litigation counsel retained by the Company and the other defendants for this purpose. Due to the inherent uncertainties of litigation, it is not possible to predict the final outcome of the Ontario Action or determine the amount of any potential losses, if any. However, the Company has judged a provision for this matter at June 30, 2015 is not required.

Notice of claim by former Chief Executive Officer

On June 30, 2015, the Company was served with a Notice of Civil Claim filed by the Company's former President and Chief Executive Officer, Alexander Molyneux, in the British Columbia Supreme Court. The claim relates to alleged breaches of Mr. Molyneux's employment agreement by the Company. In addition to the Company, Turquoise Hill Resources Ltd., the Company's largest shareholder at the time of Mr. Molyneux's employment, was also named in the claim.

Mr. Molyneux acted as the Company's President (from April 2009) and Chief Executive Officer (from October 2009) until September 2012, when the Company terminated his employment.

Mr. Molyneux is seeking damages in excess of $1 million in his Notice of Claim. The Company considers the action is without merit. SouthGobi intends to vigorously defend the action and reserves its right to pursue all legal rights and remedies available to it in connection with the proceedings.

PROCESSING INFRASTRUCTURE

Dry Coal Processing

The use of mobile screens at stockpile areas closer to the pits has enabled the Company to realize a cost benefit compared to hauling the coal to the central DCHF and operating the rotary breaker. This provides a lower cost solution without adversely impacting the coal quality of the coal planned to be mined over the next year.

Assuming the Proposed Funding Plan is successfully implemented, coal markets improve and the mine plan review does not materially impact the existing mine plan, the Company expects to increase production from the Ovoot Tolgoi Mine in line with its anticipated annual capacity of 9 million tonnes run- of-mine production. At such time the Company will review the use of the DCHF as part of its existing assets and continue developing beneficiation capabilities to maximize value from its product.

Wet Washing Facility

In 2011, the Company entered into an agreement with 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 of the contract and provides for an annual wet washing capacity of approximately 3.5 million tonnes of input coal.

In 2011, the Company made an initial payment of $33.6 million in respect of prepaid toll washing fees. The Company recorded a $30.2 million impairment loss on the $33.6 million of prepaid toll washing fees during the year ended December 31, 2013 and in the quarter ended June 30, 2014, the Company recorded an additional impairment of $3.4 million to fully impair the deposit. As at June 30, 2015 the Company has reassessed the carrying value of this prepayment and continues to believe it is appropriate for the balance to be fully impaired. This impairment continues to be recognized due to the continued delay in starting the commercial operations at the wet washing facility and the continued soft coal market in China.

Under the original agreement which required the commercial operation of the wet washing facility to commence on October 1, 2011 the additional fees payable by the Company under wet washing contract would be $18.5 million. The Company assesses on a continuous basis the agreement with Ejin Jinda and has determined it is not probable the $18.5 million will be required to be paid as part of the initial contract.

The Company's objective continues to be the implementation of an effective and profitable wet washing solution, and the Company is cooperating with Ejin Jinda in reviewing the utilization of the wet washing facility.

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 (the "Paved Highway") to consortium partners NTB LLC and SGS (together referred to as "RDCC LLC"). The Company has an indirect 40% shareholding in RDCC LLC through its Mongolian subsidiary SGS.

On October 26, 2011, RDCC LLC signed a concession agreement with the State Property Committee of Mongolia. RDCC LLC has the right to conclude a 17 year build, operate and transfer agreement under the Mongolian Law on Concessions.

On May 8, 2015, the commercial operation of the Paved Highway commenced and subsequently the unpaved highway which was previously used to transport coal through the Shivee Khuren Border Crossing has been closed. The Paved Highway is expected to significantly increase the safety of coal transportation, reduce environmental impacts and improve efficiency and capacity of coal transportation. For the three and six months ended June 30, 2015, RDCC LLC recognized toll fee revenue of $0.5 million (2014: nil).

The paved highway is expected to have a carrying capacity in excess of 20 million tonnes of coal per year.

OUTLOOK

The outlook for Mongolian coal exports remains dependent on the Chinese economy. Market conditions and prices for coal remained weak in China during the first half of 2015.

The Company anticipates that coal prices in China will remain under pressure through the remainder of 2015, which will continue to impact the Company's margins and liquidity. The Company continues to strive for further cost reductions and where possible will delay expenditures. In addition, the Company entered into the transaction with Novel Sunrise as a new significant shareholder and strategic partner intending to bring its operational and marketing expertise to the Company. Novel Sunrise has agreed to assist the Company in implementing the Proposed Funding Plan intended to improve cash flow for the Company and support its business strategy and operations in a difficult market, with the goal of positioning the Company with a strong future as a coal producer. The Proposed Funding Plan includes introducing potential customers in China to the Company to allow the Company to expand its customer base further inland in China, and helping the Company to secure longer-term coal offtake arrangements, thereby allowing the Company to ramp up production to capacity. Novel Sunrise also intends to help the Company to establish relationships with commercial banks in China and Hong Kong to help the Company to secure short term bridge loans, trading credit facilities and other types of financing.

The Company's consolidated financial statements have been prepared on a going concern basis which assumes that the Company will continue operating until at least June 30, 2016 and will be able to realize its assets and discharge its liabilities in the normal course of operations as they come due. While the Company is actively seeking additional sources of financing to continue operating and meet its objectives, there can be no assurance that such financing will be available on terms acceptable to the Company. If for any reason, the Company is unable to implement the Proposed Funding Plan or is not able to secure additional sources of financing to continue as a going concern, adjustments to the amounts and classifications of assets and liabilities in the Company's consolidated financial statements may be required and such adjustments could be material.

A continued delay in securing additional financing could ultimately result in an event of default of the Convertible Debenture, which if not cured within applicable cure periods in accordance with the terms of such debenture, may result in the principal amount owing and all accrued and unpaid interest becoming immediately due and payable upon notice to the Company by CIC.

The Company remains well positioned in the market, with a number of key competitive strengths, including:

  • Strategic location - The Ovoot Tolgoi Mine is located approximately 40km from China, which represents the main coal market. The Company has an infrastructure advantage, being approximately 50km from a major Chinese coal distribution terminal with rail connections to key coal markets in China.
  • Large resource base - The Company's aggregate coal resources include measured and indicated resources of 497 million tonnes and inferred resources of 293 million tonnes. These numbers have been aggregated from the Ovoot Tolgoi Technical Report, the Soumber Technical Report and the Zag Suuj Technical Report. The Measured and Indicated Coal Resources are inclusive of those Coal Resources modified to produce the Coal Reserves.
  • Several growth options - Assuming the Company is able to manage its liquidity issues, successfully implement the Proposed Funding Plan and there are no material changes to the Company's mine plan resulting from the mine plan review currently underway, the Company has several potential growth options, including an anticipated increase to 9 million tonnes annual run-of-mine capacity at the Ovoot Tolgoi Mine as well as greenfield options with the Soumber Deposit and Zag Suuj Deposit, located approximately 20km east and approximately 150km east of the Ovoot Tolgoi Mine, respectively.
  • Flexible product offering - Most of the Company's coal resources have coking properties, including a mixture of semi-soft coking coals and hard coking coals. The Company is currently studying options to supply washed coal to the market to further improve its market position and access to end customers.

Objectives

The Company's objectives for 2015 and the medium term are as follows.

  • Execute step change improvement in the Company's sales, marketing and logistics capabilities and expand the Company's customer base further inland in China - Subject to available financial resources and in cooperation with the Company's new strategic partner, Novel Sunrise, implement an effective business structure and production profile that is capable of delivering a profitable product mix to the Chinese market.
  • Drive operational excellence - The Company is focused on further improving productivity and operational efficiency in delivering production to meet market requirements.
  • Progress growth options - Subject to available financial resources, the Company plans to further the development of the Soumber Deposit, while staying compliant with all government requirements in relation to its licenses and agreements.
  • Operate in a socially responsible manner - The Company is focused on maintaining the highest standards in health, safety and environmental performance.
  • Enhance the Company's reputation - The Company is committed to contributing to the long term development and prosperity of Mongolia and its local communities.

NON-IFRS FINANCIAL MEASURES

Cash Costs

The Company uses cash costs to describe its cash production costs. Cash costs incorporate all cash production costs, which include direct and indirect costs of production, with the exception of idled mine asset costs and non-cash expenses which are excluded. Non-cash expenses include share-based compensation expense, impairments of coal stockpile inventories, depreciation and depletion of mineral properties.

The Company uses this performance measure to monitor its operating cash costs internally and believes this measure provides investors and analysts with useful information about the Company's underlying cash costs of operations. The Company believes that conventional measures of performance prepared in accordance with IFRS do not fully illustrate the ability of its mining operations to generate cash flows. The Company reports cash costs on a sales basis. This performance measure is commonly utilized in the mining industry.

The cash costs per tonne of product sold presented below may differ from cash costs per tonne of product produced depending on the timing of coal stockpile inventory turnover and impairments of coal stockpile inventories from prior periods.

Summarized Comprehensive Income Information
(Unaudited)
(Expressed in thousands of U.S. Dollars, except for share and per share amounts)
Three months ended June 30, Six months ended June 30,
2015 2014 2015 2014
Revenue $ 2,951 $ 6,691 $ 4,536 $ 11,828
Cost of sales (11,835 ) (20,086 ) (29,511 ) (38,452 )
Gross loss (8,884 ) (13,395 ) (24,975 ) (26,624 )
Other operating expenses (19,450 ) (1,776 ) (18,479 ) (2,849 )
Administration expenses (1,961 ) (2,253 ) (3,388 ) (4,490 )
Evaluation and exploration expenses 22 (107 ) (56 ) (279 )
Loss from operations (30,273 ) (17,531 ) (46,898 ) (34,242 )
Finance costs (5,222 ) (5,215 ) (11,605 ) (10,240 )
Finance income 273 127 16 1,134
Share of earnings/(losses) of joint venture 151 (3 ) 133 (29 )
Loss before tax (35,071 ) (22,622 ) (58,354 ) (43,377 )
Current income tax expense (1 ) (546 ) (1 ) (546 )
Net loss attributable to equity holders of the Company (35,072 ) (23,168 ) (58,355 ) (43,923 )
Other comprehensive income/(loss) to be reclassified to
profit or loss in subsequent periods
Change in value of available-for-sale financial asset, net of tax - 414 - (100 )
Net comprehensive loss attributable to equity holders of
the Company $ (35,072 ) $ (22,754 ) $ (58,355 ) $ (44,023 )
Basic loss per share $ (0.15 ) $ (0.12 ) $ (0.25 ) $ (0.23 )
Diluted loss per share $ (0.15 ) $ (0.12 ) $ (0.25 ) $ (0.23 )

Summarized Financial Position Information
(Unaudited)
(Expressed in thousands of U.S. Dollars)
As at
June 30, 2015 December 31, 2014
Assets
Current assets
Cash $ 901 $ 3,789
Trade and other receivables 3,327 462
Inventories 31,001 31,255
Prepaid expenses and deposits 3,951 4,192
Total current assets 39,180 39,698
Non-current assets
Property, plant and equipment 334,967 349,867
Long term investments 26,840 26,574
Total non-current assets 361,807 376,441
Total assets $ 400,987 $ 416,139
Equity and liabilities
Current liabilities
Trade and other payables $ 24,466 $ 18,124
Provision for court case penalty 18,049 -
Deferred revenue 11,506 11,898
Interest-bearing borrowings 4,158 3,945
Current portion of convertible debenture 12,278 2,301
Total current liabilities 70,457 36,268
Non-current liabilities
Convertible debenture 94,249 92,886
Decommissioning liability 2,830 2,704
Total non-current liabilities 97,079 95,590
Total liabilities 167,536 131,858
Equity
Common shares 1,087,759 1,080,417
Share option reserve 52,224 52,041
Accumulated deficit (906,532 ) (848,177 )
Total equity 233,451 284,281
Total equity and liabilities $ 400,987 $ 416,139
Net current assets $ (31,277 ) $ 3,430
Total assets less current liabilities $ 330,530 $ 379,871

REVIEW OF INTERIM RESULTS

The condensed consolidated interim financial statements for the Company for the three and six months ended June 30, 2015, were reviewed by the Audit Committee of the Company.

The Company's results for the quarter ended June 30, 2015, are contained in the unaudited Condensed Consolidated Interim Financial Statements and MD&A, available on the SEDAR website at www.sedar.com and the Company's website at www.southgobi.com.

About SouthGobi

SouthGobi, listed on the Toronto and Hong Kong stock exchanges, is focused on exploration and development of its metallurgical and thermal coal deposits in Mongolia's South Gobi Region. It has a 100% shareholding in SouthGobi Sands LLC, Mongolian registered company that holds the mining and exploration licences in Mongolia and operates the flagship Ovoot Tolgoi coal mine. Ovoot Tolgoi produces and sells coal to customers in China.

Forward-Looking Statements: Except for statements of fact relating to the Company, certain information contained herein constitutes forward-looking statements. Forward-looking statements are frequently characterized by words such as "plan", "expect", "project", "intend", "believe", "anticipate", "could", "should", "seek", "likely", "estimate" and other similar words or statements that certain events or conditions "may" or "will" occur. Forward-looking statements are based on the opinions and estimates of management at the times the statements are made, and are subject to a variety of risks and uncertainties and other factors that could cause actual events or results to differ materially from those projected in the forward-looking statements. These statements include, but are not limited to, statements regarding:

  • anticipated stock market conditions, the future prices of the Company's common shares (the "Common Shares") and ownership thereof;
  • the Company's anticipated business activities, planned expenditures and corporate strategies;
  • the Company's intention to develop markets for its semi-soft coking coal brands and to pursue long-term supply offtake agreements with end users in the People's Republic of China ("China");
  • costs relating to anticipated capital expenditures and the 2015 exploration program;
  • the Company's anticipated financing needs, development plans and future production levels;
  • expected impacts of the administrative restrictions on certain of the Company's Mongolian assets and the anticipated impact on the Company's activities;
  • the impact of future disclosure of the results of the internal investigations being conducted by the Company's Audit Committee;
  • the results and impact of the Ontario Action;
  • the ability of the Company to pay the Tax Penalty and the possible consequences to the Company of the Tax Verdict and Appeal Verdict;
  • the potential effect of the list of licenses published by the Government of Mongolia covering areas in which exploration and mining is purportedly prohibited on the Company's mining licenses;
  • the Company's expectations of sufficient liquidity and capital resources to meets its ongoing obligations and future contractual commitments, including the Company's ability to secure additional funding and to meet its obligations under the China Investment Corporation ("CIC") convertible debenture (the "CIC Convertible Debenture") as the same become due;
  • the possible impact of changes to the inputs to valuation model used to value the embedded derivatives in the CIC Convertible Debenture;
  • the estimates and assumptions included in the Company's impairment analysis and the possible impact of changes thereof;
  • the possible impacts of changes in useful life or depreciation rates on depreciation expenses;
  • the potential effects of a difference between future cash flows and profits from estimates;
  • estimates of the Company's mineral reserves and resources; the possible impact of the review of the geology type at the Ovoot Tolgoi Mine and the as yet uncompleted revisions to Ovoot Tolgoi mine plan on quantities of measured and/or indicated resources and reserves of the Ovoot Tolgoi project; the impact of the completion of the paved highway;
  • the ability for higher-ash product to be sold as a thermal coal product; the type of coal products being produced; the ability to preserve liquidity and continue on a sustainable basis; the ability of the Company to meet the targeted annual capacity of run-of-mine production; the anticipated increase of production from the Ovoot Tolgoi Mine to anticipated annual capacity of 9 million tonnes run-of-mine production;
  • the ability of the Company to successfully review the utilization of the wet washing facility and enhance the quality of its coal products through a beneficiation process based on wet washing;
  • the agreement with Ejin Jinda and payments thereunder;
  • the Company's review of the use of the dry coal handling facility ("DCHF") and plans regarding the use of the DCHF;
  • the future mining operations at the Soumber Deposit being allowed to share the existing infrastructure with the Ovoot Tolgoi Mine;
  • plans for the progress of mining license application processes;
  • future coal market conditions in China and the related impact on the Company's margins and liquidity;
  • the outcome of the issues described under the heading "REGULATORY ISSUES AND CONTINGENCIES";
  • business outlook, including the outlook for the remainder of 2015 and beyond;
  • the implementation and impact of the Proposed Funding Plan and actions to be taken under the Proposed Funding Plan;
  • the outcome and results of the TSX's remedial delisting review of the Company;
  • the Company continuing as a going concern and its ability to realize its assets and discharge its liabilities in the normal course of operations as they become due; adjustments to the amounts and classifications of assets and liabilities in the Company's financial statements and the impact thereof; the Company's objectives for the remainder of 2015 and beyond, including plans regarding the 2015 exploration program;
  • expected production at the Ovoot Tolgoi Mine;
  • the capacity of the paved highway;
  • the impact of amendments to, or the application of the laws of Mongolia and other countries in which the Company carries on business;
  • the impact of the Company's activities on the environment and actions taken for the purpose of mitigation of potential environmental impacts and planned focus on health, safety and environmental performance;
  • the outcome of legal proceedings involving the Company and its former Chief Executive Officer, Mr. Alexander Molyneux;
  • the outcome of arbitration proceedings involving the Company and First Concept Logistics Limited with respect a coal supply agreement and payments thereunder;
  • greenfield development options with the Soumber Deposit and Zag Suuj Deposit; and
  • other statements that are not historical facts.

This list is not exhaustive of the factors that may affect any of the Company's forward-looking statements. Except as required by law, the Company undertakes no obligation to update forward-looking statements if circumstances or management's estimates or opinions should change. The reader is cautioned not to place undue reliance on forward-looking statements.

Contact Information