SouthGobi Resources Announces First Quarter 2014 Financial and Operating Results

HONG KONG, CHINA--(Marketwired - May 12, 2014) - SouthGobi Resources Ltd. (TSX:SGQ)(HKSE:1878) (the "Company"). The Company today announced its financial and operating results for the three months ended March 31, 2014. 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 March 31, 2014 and subsequent period to May 12, 2014 are as follows:

• Coal prices in China continue to adversely affect the Company's margins and liquidity. As at the date hereof, the Company expects to be able to pay the interest due under the China Investment Corporation ("CIC") convertible debenture on May 19, 2014. The Company is actively seeking additional sources of financing to maintain liquidity to fund its operations and meet its obligations. See section "Liquidity and Capital Resources" of this announcement and section 11 "Risk Factors" of the Company's Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") for the three months ended March 31, 2014 which is available at www.sedar.com.
  
  
• Production increased to 0.64 million tonnes of raw coal in the first quarter of 2014 compared to production of 0.02 million tonnes of raw coal in the first quarter of 2013. The increase in production primarily related to the operations at the Ovoot Tolgoi Mine being fully curtailed for most of the first quarter of 2013. Operations at the Ovoot Tolgoi Mine resumed on March 22, 2013 after having been fully curtailed since the end of the second quarter of 2012.
  
  
• Sales volumes increased to 0.39 million tonnes in the first quarter of 2014 compared to 0.28 million tonnes in the first quarter of 2013. Revenue increased to $5.1 million in the first quarter of 2014 compared to $4.4 million in the first quarter of 2013 primarily due to higher sales volumes.
  
  
• Government of Mongolia changed the royalty regime effective April 1, 2014. Under the new "flexible tariff" royalty regime, the royalty per tonne for export coal sales will be 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. The Company expects that its royalty per tonne calculated under the new "flexible tariff" royalty regime will decrease compared to the prior reference price royalty regime.
  
  

Overview of Operational Data

Raw coal production was 0.64 million tonnes in the first quarter of 2014 with a strip ratio of 4.02 compared to raw coal production of 0.02 million tonnes in the first quarter of 2013 with a strip ratio of 26.21. Raw coal production decreased in the first quarter of 2014 compared to the fourth quarter of 2013 (1.73 million tonnes) as first quarter 2014 contracted sales tonnages were lower than the fourth quarter of 2013.

The Company resumed operations at the Ovoot Tolgoi Mine on March 22, 2013 after having been fully curtailed since the end of the second quarter of 2012. Therefore, there was only limited production of 0.02 million tonnes in the first quarter of 2013 with a strip ratio of 26.21. The Company's strip ratio of 26.21 in the first quarter of 2013 is due to a higher proportion of waste material being mined over the limited operating period and is not indicative of the Company's strip ratio moving forward.

Mining activities continued in a safe and cost effective manner in the first quarter of 2014. The Company ended the first quarter of 2014 without a lost time injury.

Overview of Financial Results

The Company recorded a $16.7 million loss from operations in the first quarter of 2014 compared to a $21.3 million loss from operations in the first quarter of 2013 and a $20.8 million net loss in the first quarter of 2014 compared to a $23.7 million net loss in the first quarter of 2013. The first quarter 2014 loss from operations was negatively impacted by $7.3 million of coal stockpile impairments (2013: $1.1 million) and $3.0 million of idled mine asset costs (2013: $16.4 million). The Company's loss from operations was $6.4 million in the first quarter of 2014 excluding the impact of the above noted items (2013: $3.8 million).

Revenue was $5.1 million in the first quarter of 2014 compared to $4.4 million in the first quarter of 2013. The Company sold 0.39 million tonnes of coal in the first quarter of 2014 at an average realized selling price of $19.54 per tonne compared to sales of 0.28 million tonnes from stockpile in the first quarter of 2013 at an average realized selling price of $22.75. Revenue increased in the first quarter of 2014 compared to the first quarter of 2013 primarily due to higher sales volumes. The average realized selling price was impacted by the product mix in the first quarter of 2014. The first quarter of 2014 product mix primarily included Standard semi-soft coking coal and thermal coal compared to a mix of Premium semi- soft coking coal and thermal coal in the first quarter of 2013.

Sales volume is generally lower in the first quarter of each year due to the seasonal holidays of Mongolian Tsagaan Sar and Chinese New Year, which result in border closures at the Shivee Khuren-Ceke crossing at the Mongolia-China border ("Shivee Khuren Border Crossing") and a general decrease in the level of economic activity at the Shivee Khuren Border Crossing. Coal prices in China declined in the first quarter of 2014 after slightly improving in the fourth quarter of 2013.

The Company's revenue is presented net of royalties and selling fees. The Company is subject to a base royalty in Mongolia of 5% on all export coal sales. In addition, effective January 1, 2011, the Company is subject to an additional sliding scale royalty of up to 5%. During the first quarter of 2014, the royalty was calculated using a set reference price per tonne published by the Government of Mongolia.

Based on the reference prices for the first quarter of 2014, the Company was subject to an average 7% royalty based on a weighted average reference price of $68.76 per tonne. The Company's effective royalty rate for the first quarter of 2014, based on the Company's average realized selling price of $19.54 per tonne, was 25% or $4.81 per tonne compared to 6% or $1.37 per tonne in the first quarter of 2013. During a trial period from October 1, 2012 to March 31, 2013, the royalty was determined using the actual contracted sales price per tonne, not the reference price. Therefore, the Company's first quarter 2013 royalty per tonne was lower than the royalty per tonne in the first quarter of 2014.

The Government of Mongolia changed the royalty regime effective April 1, 2014. Under the new "flexible tariff" royalty regime, the royalty per tonne for export coal sales will be 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 shall be deemed non-market under Mongolian tax law and the royalty per tonne will be 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 at the mine-gate and the coal is exported through the Shivee Khuren Border Crossing. The Company's average realized selling price excludes transportation costs. The Company expects that its royalty per tonne calculated under the new "flexible tariff" royalty regime will decrease compared to the prior reference price royalty regime.

Cost of sales was $18.4 million in the first quarter of 2014 compared to $21.3 million in the first quarter of 2013. 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 Measures section) during the period.

Operating expenses in cost of sales were $5.6 million in the first quarter of 2014 compared to $3.2 million in the first quarter of 2013. Operating expenses were higher in the first quarter of 2014 compared to the first quarter of 2013 primarily due to higher sales volumes.

Total cash costs of product sold were $14.23 per tonne in the first quarter of 2014 compared to $11.68 per tonne in the first quarter of 2013. The increase in total cash costs per tonne sold primarily relates to increased mine administration cash costs per tonne sold. Mine administration cash costs per tonne sold were $3.80 per tonne in the first quarter of 2014 compared to $1.46 per tonne in the first quarter of 2013. The increase in mine administration cash costs per tonne sold primarily related to the majority of these costs being allocated to costs of sales related to idled mine assets, rather than operating expenses, during the first quarter of 2013 prior to the recommencement of mining operations at the Ovoot Tolgoi Mine on March 22, 2013.

Cost of sales in the first quarter of 2014 and 2013 included coal stockpile impairments of $7.3 million and $1.1 million, respectively, to reduce the carrying value of the Company's coal stockpiles to their net realizable value. The coal stockpile impairments recorded in both the first quarter of 2014 and 2013 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 quarter of 2014 included $3.0 million related to depreciation expenses for idled equipment (2013: $11.2 million). Idled mine asset costs decreased in the first quarter of 2014 compared to the first quarter of 2013 as a result of the recommencement of mining operations at the Ovoot Tolgoi Mine on March 22, 2013. However, the first quarter 2014 production plan did not fully utilize the Company's existing mining fleet, therefore, idled mine asset costs continued to be incurred throughout the first quarter of 2014.

Other operating expenses were $1.1 million in the first quarter of 2014 compared to $0.4 million in the first quarter of 2013.

The Company recognized an impairment loss of $1.8 million in the first quarter of 2014 related to its investment in Aspire Mining Ltd. ("Aspire") (2013: $0.9 million unrealized gain recorded in other comprehensive income). The Company's investment in Aspire is accounted for as an available-for-sale financial asset. In 2012, the Company determined that objective evidence of impairment in the Company's investment in Aspire existed. Therefore, the Company recorded an impairment loss in the first quarter of 2014 as a result of declines in the fair value of the Company's investment in Aspire during the first quarter of 2014.

Administration expenses were $2.2 million in the first quarter of 2014 compared to $3.7 million in the first quarter of 2013.

Administration expenses were lower in the first quarter of 2014 compared to the first quarter of 2013 primarily due to lower legal and professional fees. Legal and professional fees in the first quarter of 2013 included $0.9 million of fees related to the internal and tripartite committees referred to in section "Regulatory Issues and Contingencies". The tripartite committee substantially completed the investigative phase of its activities during 2013, therefore additional legal and professional fees were not incurred in the first quarter of 2014. Refer to section "Regulatory Issues and Contingencies" for further analysis.

Corporate administration and salaries and benefits were also lower in the first quarter of 2014 compared to the first quarter of 2013 which reflects the Company's cost-cutting initiatives and workforce reductions throughout 2013.

Evaluation and exploration expenses were $0.2 million in the first quarter of 2014 compared to $0.3 million in the first quarter of 2013. The Company continued to minimize evaluation and exploration expenditures in the first quarter of 2014 in order to preserve the Company's financial resources. Evaluation and exploration activities and expenditures in the first quarter of 2014 were limited to ensuring that the Company met the Mongolian Minerals Law requirements in respect of its mining and exploration licenses.

Finance costs were $5.0 million in both the first quarter of 2014 and 2013. Finance costs in the first quarter of 2014 and 2013 primarily consisted of $4.9 million of interest expense on the $250.0 million CIC convertible debenture.

Finance income was $1.0 million in the first quarter of 2014 compared to $0.8 million in the first quarter of 2013. Finance income for the first quarter of 2014 and 2013 primarily consisted of $1.0 million and $0.7 million of unrealized gains on the fair value change of the embedded derivatives in the CIC convertible debenture, respectively. The fair value of the embedded derivatives in the CIC convertible debenture is driven by many factors including: the Company's common share price, U.S. Dollar and Canadian Dollar exchange rates and share price volatility.

Income tax expense was $nil in the first quarter of 2014 compared to a recovery of $1.9 million in the first quarter of 2013. As at December 31, 2013, the Company's deferred income tax asset was derecognized. The income tax recovery in the first quarter of 2013 related to the Company's Mongolian tax loss carry forwards and deductible temporary differences.

FINANCIAL POSITION AND LIQUIDITY

Liquidity and Capital Resources

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.

The Company anticipates that coal prices in China will remain under pressure in 2014, which will continue to impact the Company's margins and liquidity. The Company is in discussions with various parties regarding a potential loan; however, there is no guarantee that an agreement will be reached. As of the date hereof, the Company expects to be able to secure such funding in order to pay the interest due under the CIC convertible debenture on May 19, 2014. If it does not do so, or if it fails to secure additional capital or otherwise restructure or refinance its business in order to address its cash requirements through March 31, 2015, 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. As a result, the Company may not be able to continue as a going concern. Therefore, the Company is actively seeking additional sources of financing to continue operating and meet its objectives.

Several adverse conditions and material uncertainties cast significant doubt upon the going concern assumption. The Company had cash of $9.9 million and working capital of $28.9 million at March 31, 2014. 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 March 31, 2015 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 the Company fails to generate sufficient operating cash flows, secure additional capital or otherwise restructure or refinance its business in order to pay the interest due under the CIC convertible debenture on May 19, 2014, or if it fails to generate sufficient operating cash flows, secure additional capital or otherwise restructure or refinance its business in order to address its cash requirements through March 31, 2015, it will not have adequate liquidity to fund its operations and meet its obligations (including its debt payment obligations), it may not be able to continue as a going concern. Refer to section 11 "Risk Factors" of the Company's MD&A for the three months ended March 31, 2014 which is available at www.sedar.com for further analysis. 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 $250.0 million 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 focused on securing additional sources of financing and continues to minimize uncommitted capital expenditures while preserving the Company's growth options. 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

As at March 31, 2014, the Company had cash of $9.9 million compared to cash of $21.8 million as at December 31, 2013. Working capital (excess current assets over current liabilities) was $28.9 million as at March 31, 2014 compared to $41.7 million as at December 31, 2013. As at May 12, 2014, the Company had cash of $10.8 million.

As at March 31, 2014, the Company's gearing ratio was 0.20 (December 31, 2013: 0.19), which was calculated based on the Company's long term liabilities to total assets. As at March 31, 2014, the Company is not subject to any externally imposed capital requirements.

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. The Mongolian State Investigation Office (the "SIA") also continues to enforce the orders on the Company.

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

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

Ovoot Tolgoi Mine Impairment Analysis

Unchanged from the assessment made as at December 31, 2013, the Company determined that an indicator of impairment existed for its Ovoot Tolgoi Mine cash generating unit as at March 31, 2014. The impairment indicator was the continued weakness in the Company's share price during the first quarter of 2014 and the fact that the market capitalization of the Company, as at March 31, 2014, 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 Ovoot Tolgoi Mine cash generating unit carrying value was $414.6 million as at March 31, 2014.

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

• Long term real selling price of $109 per tonne for semi-soft coking coal FOB Australia;
• Life-of-mine coal production and operating costs; and
• A discount rate of 12.8% based on an analysis of market, country and company specific factors.

Key sensitivities in the valuation model are as follows:

• For each 1% increase/(decrease) in the long term real selling price of semi-soft coking coal FOB Australia, the calculated fair value of the cash generating unit increases/(decreases) by approximately $34.0/($34.0) million; and
• For each 1% increase/(decrease) in the discount rate, the calculated fair value of the cash generating unit (decreases)/increases by approximately ($41.0)/$46.0 million.

The impairment analysis did not result in the identification of an impairment loss and no charge was required as at March 31, 2014. 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.

REGULATORY ISSUES AND CONTINGENCIES

Regulatory Issues

Governmental and Regulatory Investigations

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

While the IAAC investigation into allegations of possible breaches of Mongolian anti-corruption laws has been suspended, the Company has not received formal notice that the IAAC investigation is completed. The IAAC has not formally accused any current or former Company employees of breach of Mongolia's anti-corruption laws.

A report issued by the experts appointed by the SIA on June 30, 2013 and again in January 2014 has recommended that the accusations of money laundering as alleged against the Company's three former employees be withdrawn. However, to date, the Company has not received notice or legal document confirming such withdrawal as recommended by the experts appointed by the SIA.

A third investigation ordered by the SIA and conducted by the National Forensic Center ("NFC") into alleged violations of Mongolian taxation law was concluded at the end of January 2014. The Company has received notice that the report with conclusions of the investigations by the NFC have been provided to the Prosecutor General of Mongolia. The Company has been advised that the Prosecutor General has issued criminal charges against the three former employees and the Company's Mongolian subsidiary SouthGobi Sands LLC may be held liable as "civil defendant" for alleged violations of Mongolian taxation law. The case was transferred to a Court of Justice for review by a judge in April 2014. On May 12, 2014, the Company was advised that the appointed judge has concluded that the investigation on the case was incomplete and has ordered to return the case to the General Prosecutor for additional investigation.

The likelihood or consequences of an outcome or any action taken against SouthGobi Sands LLC as "civil defendant" are uncertain and 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.

The Company, including its Mongolian subsidiary SouthGobi Sands LLC, has prepared its financial statements in compliance with IFRS, and lodged all its tax returns in the required format under Mongolian tax law. During the investigative period, which has been ongoing since May 2012, the Company devoted considerable internal resources in reviewing and responding to the allegations raised through the investigations by the relevant authorities. The Company views these allegations as unfounded and will vigorously defend itself against any potential claim.

At this point, the three former employees remain designated as "accused" in connection with the allegations of tax evasion, and continue to be subject to a travel ban. SouthGobi Sands LLC remains designated as a "civil defendant" in connection with the tax evasion allegations, and may potentially be held financially liable for the alleged criminal misconduct of its former employees under Mongolian Law.

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

Internal Investigations

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.

Contingencies

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.

The plaintiff seeks leave to bring a claim under applicable Canadian securities legislation and seeks certification of a class action with respect to a class of persons who purchased shares of the Company between March 30, 2011 and November 7, 2013, alleging that the financial reporting of the Company during that period contained misrepresentations giving rise to liability at common law and under applicable Canadian securities legislation. The Ontario Action also seeks general damages against all defendants in the sum of Cdn$30 million, without particulars as to how such amount was determined, or such other amount that the Court deems appropriate. Assuming that leave is granted, the action is certified as a class proceeding, and there is a finding of liability, the actual quantum of damages will depend upon the evidence which is adduced in the court proceedings.

Named in the Ontario Action as individual defendants are the Company's former Chief Executive Officer, Alexander Molyneux, the Company's former Chief Financial Officers, Messrs. Terry Krepiakevich and Matthew O'Kane, and the members of its Audit Committee, Messrs. Andre Deepwell, Pierre Lebel and Gordon Lancaster, each of whom held those positions during the period at issue.

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, in the opinion of management of the Company, at March 31, 2014 a provision for this matter is not required.

PROCESSING INFRASTRUCTURE

Dry Coal Handling Facility

Following an extensive review that commenced in the fourth quarter of 2013, the Company concluded in the first quarter of 2014 that it does not plan to either complete or use the dry coal handling facility ("DCHF") at the Ovoot Tolgoi Mine in the foreseeable future. As a result of the review and subsequent impairment assessment, the Company recorded a $66.9 million non-cash impairment in the fourth quarter of 2013 to reduce the carrying value of the DCHF to its recoverable amount. The DCHF had a carrying value of $11.2 million at March 31, 2014. The Company continues to use mobile screens for initial dry processing of its higher-ash coals. 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.

As coal markets improve and production from the Ovoot Tolgoi Mine increases in line with its anticipated annual capacity of 9 million tonnes run-of-mine production, 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 Ejinaqi Jinda Coal Industry Co. Ltd. ("Ejin Jinda"), a subsidiary of China Mongolia Coal Co. Ltd. to toll-wash coals from the Ovoot Tolgoi Mine. The agreement has a duration of five years from commencement of the contract and provides for an annual wet washing capacity of approximately 3.5 million tonnes of input coal. The facility is located approximately 10km inside China from the Shivee Khuren Border Crossing, approximately 50km from the Ovoot Tolgoi Mine. Ejin Jinda will charge the Company a single toll washing fee which will cover their expenses, capital recovery and profit. Ejin Jinda will also transport coal from the Ovoot Tolgoi Mine to the wet washing facility under a separate transportation agreement.

To date, commercial operations at the wet washing facility have not commenced. Pursuant to the terms of the agreement, the Company prepaid $33.6 million of toll washing fees in 2011. As at March 31, 2014, the prepaid toll washing fees have a carrying value of $3.4 million following an impairment loss recorded in the fourth quarter of 2013. The Company identified the results of a trial sample from the wet washing facility and the delay in starting the commercial operations at the wet washing facility as indicators of impairment for the prepaid toll washing fees.

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 to consortium partners NTB LLC and SouthGobi Sands LLC (together referred to as "RDCC LLC"). SouthGobi Sands LLC holds a 40% interest in RDCC LLC.

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. Construction of the paved highway was substantially complete by the end of 2013. The 2014 construction program commenced in the second quarter of 2014. Subject to the Company having available financial resources to fund its portion of the remaining construction costs, the remaining construction work and commissioning of the paved highway is expected to be completed by the end of the third quarter of 2014. RDCC LLC is presently in discussions with the relevant Mongolian authorities to postpone the July 2014 deadline for commissioning of the paved highway in accordance with the concession agreement and facilitate the planned commissioning of the paved highway by the end of the third quarter of 2014.

The paved highway will have an intended carrying capacity upon completion in excess of 20 million tonnes of coal per year.

OUTLOOK

Excess supply within the coking coal markets in first quarter of 2014 continued with further erosion of spot coking coal prices in the international market. Chinese domestic coal prices declined due to weaker market conditions in the Chinese steel sector, the impact of the Chinese Lunar New Year on demand and the supply overhang in the international market. The Mongolian coal industry continues to face strong competition from seaborne and domestic Chinese coal producers.

The outlook for Mongolian coal exports remains dependent on China. Demand at the beginning of 2014 has been seasonally weak with the impact of the Chinese New Year lasting longer than expected and prices have again declined after rising in the fourth quarter of 2013. Mongolian exports in the first quarter of 2014 were down 3.3 million tonnes (53%) compared to the fourth quarter of 2013 and down 0.4 million tonnes (12%) compared to the first quarter of 2013. Price declines were approximately 15-20% depending on quality compared to the fourth quarter of 2013. The demand for coal however in the first month of the second quarter of 2014 has improved albeit from a very low base. Coal production in the second quarter of 2014 will be paced to meet contracted sales volumes.

The Company anticipates that coal prices in China will remain under pressure in 2014, which will continue to impact the Company's margins and liquidity. The Company continues to strive for further cost reductions and where possible delay expenditures. As at the date hereof, the Company expects to be able to make the $7.9 million cash interest payment on the CIC convertible debenture on May 19, 2014. However, in the event a loan or other financing arrangement is not secured by May 19, 2014, and even if such loan is secured, if the Company does not secure additional funding to address its cash requirements through March 31, 2015, the Company is unlikely to have sufficient capital resources and does not expect to generate sufficient cash flows from mining operations in order to satisfy its ongoing obligations and future contractual commitments. 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 March 31, 2015 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 the Company fails to generate sufficient operating cash flows, secure additional capital or otherwise restructure or refinance its business as described above, it will not have adequate liquidity to fund its operations and meet its obligations (including its debt payment obligations) and it may not be able to continue as a going concern. Refer to section "Liquidity and Capital Resources".

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 $250.0 million 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.

Longer term and assuming the Company's immediate liquidity challenges are resolved, the Company remains well positioned, 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 (including reserves) include measured and indicated resources of 533 million tonnes and inferred resources of 302 million tonnes.
  
  
• Several growth options - The Company has several 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 2014 and the medium term are as follows.

• Secure additional and immediate sources of financing - The Company is focused on securing additional and immediate sources of financing and continues to minimize uncommitted capital expenditures while preserving the Company's growth options.
  
  
• Drive operational excellence - The Company is focused on further improving operational efficiency in delivering production to meet market requirements and to further reduce operating and administrative costs.
  
  
• Continue to develop regional infrastructure - Subject to the Company having available financial resources to fund its portion of the construction costs, the Company's priority is to complete the construction of the paved highway from the Ovoot Tolgoi Mine to the Shivee Khuren Border Crossing as part of the existing consortium. Construction of the paved highway was substantially complete by the end of 2013 with the remaining construction work and commissioning expected to be completed by the third quarter of 2014.
  
  
• Deliver value through marketing by improving the Company's access to market and end customers and the overall quality of its product - Subject to available financial resources, implement an effective business structure and beneficiation process based on wet washing that is capable of delivering a sustainable and profitable product mix to the Chinese market and expand the Company's customer base further inland in China.
  
  
• 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.

• Operating in a socially responsible manner - The Company is focused on maintaining its vigilance on health, safety and environmental performance.
  
  
• Re-establish the Company's reputation - The Company's vision is to be a respected and profitable Mongolian coal company. To achieve this, the Company will continue to work on re-establishing good working relationships with all external stakeholders.
  
  

NON-IFRS FINANCIAL MEASURES

Cash Costs

The Company uses cash costs to describe its cash production costs. Cash costs incorporate all 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 of product sold may differ from cash costs of product produced depending on the timing of coal stockpile inventory turnover and impairments of coal stockpile inventories from prior periods.

CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS

REVIEW OF INTERIM RESULTS

The condensed consolidated interim financial statements for the Company for the three months ended March 31, 2014, were reviewed by the Audit Committee of the Company.

The Company's results for the quarter ended March 31, 2014, 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 RESOURCES

SouthGobi Resources is listed on the Toronto and Hong Kong stock exchanges, in which Turquoise Hill Resources Ltd., also publicly listed in Toronto and New York, has a 56% shareholding. Turquoise Hill took management control of SouthGobi in September 2012 and made changes to the board and senior management. Rio Tinto has a majority shareholding in Turquoise Hill.

SouthGobi Resources 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, the Mongolian registered company that holds the mining and exploration licenses in Mongolia and operates the flagship Ovoot Tolgoi coal mine. Ovoot Tolgoi produces and sells coal to customers in China.

Forward-Looking Statements: This document includes forward-looking statements. Forward-looking statements include, but are not limited to: 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 and immediate funding, to meet its obligations under the CIC convertible debenture as the same become due, the estimates and assumptions included in the Company's impairment analysis; the ability to preserve liquidity and continue on a sustainable basis; the Company's expectation that its royalty per tonne calculated under the new "flexible tariff" royalty regime will decrease compared to the prior reference price royalty regime; the ability of the Company to meet the targeted annual capacity of 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 wet washing; the possibility of the CIC convertible debenture and all accrued and unpaid interest becoming immediately due; the continued pressure on the coal prices in China, and the related impact on the Company's margins and liquidity; the outcome of the issues described in the section "Regulatory Issues and Contingencies"; statements regarding the outlook for 2014; statements regarding the Company's objectives for 2014 and beyond; the statement that completion of the paved highway is expected by the end of the third quarter of 2014; the statement that the capacity of the paved highway is in excess of 20 million tonnes of coal per year; and other statements that are not historical facts. When used in this document, the words such as "plan", "estimate", "expect", "intend", "may", and similar expressions are forward-looking statements. Although the Company believes that the expectations reflected in these forward-looking statements are reasonable, such statements involve risks and uncertainties and no assurance can be given that actual results will be consistent with these forward-looking statements. Important factors that could cause actual results to differ from these forward-looking statements are disclosed under the heading "Risk Factors" in the Company's MD&A for the year ended December 31, 2013 and the three months ended March 31, 2014 which are available at www.sedar.com.