SouthGobi Resources announces first quarter 2019 financial and operating results

HONG KONG, May 14, 2019 - SouthGobi Resources Ltd. (Toronto Stock Exchange (“TSX”): SGQ, Hong Kong Stock Exchange (“HKEX”): 1878) (the "Company" or “SouthGobi”) today announces its financial and operating results for the three months ended March 31, 2019. All figures are in U.S. dollars (“USD”) unless otherwise stated.

Significant Events and Highlights

The Company’s significant events and highlights for the three months ended March 31, 2019 and the subsequent period to May 14, 2019 are as follows:

• Operating Results – The Company increased sales volume to 1.1 million tonnes for the first quarter of 2019 from 0.6 million tonnes for the first quarter of 2018. Despite an improvement of the product mix, the average realized selling price decreased from $43.0 per tonne in the first quarter of 2018 to $34.9 per tonne in the first quarter of 2019 as a result of a higher portion of sales made at the mine gate instead of transporting the coal to the Company’s Inner Mongolia subsidiary and selling to third party customers within China.
  
• Financial Results – The Company recorded a gross profit of $13.4 million in the first quarter of 2019 compared to $6.7 million in the first quarter of 2018, while a $9.9 million profit from operations was recorded in the first quarter of 2019 compared to a $3.5 million profit from operations in the first quarter of 2018 (restated). The improvement of overall financial results were principally attributable to lower unit cost of sales of products sold during the quarter.
  
• China Investment Corporation (“CIC”) convertible debenture (“CIC Convertible Debenture”) – On April 23, 2019, the Company executed a deferral agreement (the “2019 Deferral Agreement”) with CIC in relation to a deferral and revised repayment schedule in respect of (i) $41.8 million of outstanding cash and payment in kind interest (“PIK Interest”) and associated costs due and payable to CIC on November 19, 2018 (the “Outstanding Interest Payable”) under the CIC Convertible Debenture and the deferral agreement dated June 12, 2017 (the “June 2017 Deferral Agreement”); and (ii) the cash and PIK Interest payments payable to CIC under the CIC Convertible Debenture from April 23, 2019 to and including May 19, 2020 (the “Deferral”). Pursuant to Section 501(c) of the TSX Company Manual, the Company will be seeking approval of the 2019 Deferral Agreement from disinterested shareholders at the Company’s upcoming annual and special meeting of shareholders (the “Meeting”) to be held on May 30, 2019. The effectiveness of the 2019 Deferral Agreement and the respective covenants, agreements and obligations of each party under the 2019 Deferral Agreement are subject to the Company obtaining the requisite approval from shareholders at the Meeting.

The key repayment terms of the 2019 Deferral Agreement are: (i) the Company agreed to pay $14.3 million by eight instalments during November 2019 to June 2020; (ii) the Company agreed to pay the PIK Interest covered by the Deferral by way of cash payments, rather than the issuance of Common Shares; and (iii) the Company agreed to pay $62.6 million on June 20, 2020. The Company agreed to pay a deferral fee at a rate of 6.4% per annum in consideration of the deferred amounts.

As a condition to agreeing to the Deferral, CIC required that the mutual co-operation agreement (the “Cooperation Agreement”) dated November 19, 2009 between SouthGobi Sands LLC (“SGS”), a subsidiary of the Company, and Fullbloom Investment Corporation (“Fullbloom”), an affiliate of CIC, be amended and restated (the “Amended and Restated Cooperation Agreement”) to clarify the manner in which the service fee payable to Fullbloom under the Cooperation Agreement is calculated, with effect as of January 1, 2017. Specifically, the service fee under the Amended and Restated Cooperation Agreement will be determined based on the net revenues realized by the Company and all of its subsidiaries derived from sales into China (rather than the net revenues realized by the Company and its Mongolian subsidiaries as currently contemplated under the Cooperation Agreement). As consideration for deferring payment of the additional service fees payable to Fullbloom as a result of the Amended and Restated Cooperation Agreement (the “Deferred Compensation”), the Company agreed to pay to Fullbloom a deferral fee at the rate of 2.5% on the outstanding amount of the Deferred Compensation. Pursuant to the Amended and Restated Cooperation Agreement, the Company agreed to pay Fullbloom the Deferred Compensation and related accrued deferral fee of $4.2 million in six instalments between June 2019 and November 2019. The effectiveness of the Amended and Restated Cooperation Agreement is subject to the Company obtaining the requisite approval of the 2019 Deferral Agreement from shareholders at the Meeting.

The Company also announced that it intends to discuss a potential debt restructuring plan with respect to amounts owing to Land Breeze II S.a.r.l., a wholly-owned subsidiary of CIC, which is mutually beneficial to the Company and CIC within the next 6 months, and to form a special committee comprised of independent directors to ensure that the interests of its minority shareholders are fairly considered in the negotiation and review of any such restructuring; however, there can be no assurance that a favorable outcome will be reached.

As of the date of this press release, the Company has neither: (i) paid the Outstanding Interest Payable within the cure period provided for under the CIC Convertible Debenture; nor (ii) obtained shareholders approval of the 2019 Deferral Agreement. Consequently, the Company is in default under the CIC Convertible Debenture and the June 2017 Deferral Agreement. Furthermore, the Common Shares have now been suspended from trading on the HKEX and TSX for a period of more than five trading days since December 17, 2018 (the “Trading Suspension”), which represents another event of default under the CIC Convertible Debenture. Pursuant to the terms of the CIC Convertible Debenture and the June 2017 Deferral Agreement, CIC may, at its discretion, provide notice to the Company and declare all principal, interest and other amounts owing under the CIC Convertible Debenture and the June 2017 Deferral Agreement immediately due and payable, and take steps to enforce payment thereof, which would have a material adverse effect on the business and operations of the Company and may negatively affect the price and volatility of the Common Shares and any investment in such shares could suffer a significant decline or total loss in value.

Because a deferral of the Outstanding Interest Payable was not in effect as at March 31, 2019, International Accounting Standard (“IAS”) 1 requires the Company to classify the entire balance of the CIC Convertible Debenture as a current liability as at March 31, 2019, notwithstanding the fact that CIC has not indicated any intention to deliver notice of default or accelerate the maturity of the CIC Convertible Debenture.

• Notice of Arbitration – As of the date hereof, the Company has not paid the November 2018 and January 2019 monthly payments due under a deed of settlement (the “Settlement Deed”). On March 5, 2019, SGS received a notice from First Concept Industrial Group Limited (“First Concept”) claiming that the Company is in default under the Settlement Deed and demanding payment of the full amount of the outstanding monthly payments due under the Settlement Deed, otherwise First Concept intends to commence legal action against SGS pursuant to the Settlement Deed. The Company is consulting with its independent litigation counsel regarding this matter; however, as a default is only triggered under the Settlement Deed where there has been a failure to pay two or more consecutive monthly instalment payments, the Company is of the view that SGS is not in default under the Settlement Deed. In the event that First Concept commences legal action against SGS regarding this matter, the Company intends to take appropriate steps to respond to such legal proceedings in the best interests of the Company through independent litigation counsel which has been retained by the Company for this purpose.
  
  As at March 31, 2019, the outstanding amount payable to First Concept amounted to $10.6 million (December 31, 2018: $12.5 million).
  
  
• Key Findings of Formal Investigation – On December 17, 2018, the Company announced that it had learned of certain information relating to past conduct engaged in by former senior executive officers and employees of the Company (“Former Management and Employees”) which raised suspicions of serious fraud, misappropriation of Company assets and other criminal acts by the Former Management and Employees relating to prior transactions (“Suspicious Transactions”) between 2016 and the first half of 2018 involving the Company, Inner Mongolia SouthGobi Energy Co. Ltd. (“IMSGE”), a subsidiary of the Company, and certain coal trading and transportation companies, some of which are allegedly related to or controlled by the Former Management and Employees or their related persons. The Company filed a report with local police authorities in China in respect of certain of the Suspicious Transactions and, on December 17, 2018, the Board expanded the mandate of its special committee of independent non-executive directors (the “Special Committee”), which was previously established to initiate a formal internal investigation into certain legal charges against Mr. Aminbuhe (the Company’s former Chairman and Chief Executive Officer), to include a formal investigation (the “Formal Investigation”) of the Suspicious Transactions, the implicated Former Management and Employees, and their impact, if any, on the business and affairs of the Company. The Special Committee engaged Blake, Cassels & Graydon LLP as independent Canadian legal counsel, Zhong Lun Law Firm, as independent Chinese legal counsel, and Ernst & Young (China) Advisory Limited (the “Forensic Accountant”), as forensic accountants, to assist in the formal investigation.
  
  On March 30, 2019, the Company announced that the Special Committee concluded the Formal Investigation and delivered a final report summarizing its key findings to the Board, which was adopted and approved at a meeting held on March 30, 2019.
  
  The Formal Investigation concentrated on the following areas of focus (the “Areas of Focus”): (i) the arrangements of the Suspicious Transactions; (ii) the relationships between the Former Management and Employees and certain coal trading and transportation companies; (iii) any unidentified questionable transactions relating to the Former Management and Employees; and (iv) the potential impact of (i), (ii) and (iii) on the financial statements of the Company and its subsidiaries. During the course of the Formal Investigation, certain incomplete accounting/operational records of one of the Companies Under Investigation (as defined below) (“Company A”) were identified in Company’s employee computers. As a result, the Special Committee expanded the scope of the Area of Focus of the Formal Investigation to include: (i) a fund flow analysis of Company A; and (ii) a price analysis of the difference between Company A's purchase prices from the Company and selling prices to downstream customers.
  
  Based on the Areas of Focus, the Special Committee examined and made findings in respect of a number of matters in connection with the Formal Investigation, including the following: (i) allegations that Mr. Aminbuhe, the Company’s former Chairman and Chief Executive Officer, controlled certain companies the Company had business dealings (the “Companies Under Investigation”); (ii) uncollectable receivables from certain former customers and suppliers of the Company; (iii) the impact of the lawsuit filed by Jiayuguan Xiyuan Trading Co., Ltd, a former customer of IMSGE; and (iv) allegations of misconduct by the Former Management and Employees, including: (I) the grant of a Renminbi (“RMB”) 5 million loan; (II) embezzlement of bank acceptance bills of RMB12 million; (III) endorsement of commercial acceptance bills of RMB71 million which were not supported by genuine commercial transactions; (IV) prepayments of RMB8.5 million for coal transportation services which were never received by the Company; and (V) prepayment of RMB16.4 million for coal transportation services which were never received by the Company.
  
  Based on the information obtained from the Formal Investigation, the Special Committee concluded that four matters examined in connection with the Formal Investigation, having an aggregate value of approximately RMB41 million, involved improper conduct, fraud or misappropriation of assets (the “Fraudulent Transactions”) and that one matter examined in connection with the Formal Investigation, having an aggregate value of approximately RMB71 million, involved an accounting reclassification error. From an accounting perspective, the Company does not anticipate that the Fraudulent Transactions will have any impact on its financial statements in the future as the Company has already recorded the appropriate provisions in the financial statements as at December 31, 2018, 2017 and 2016 and for the years then ended.
  
  Based on the key findings of and information obtained from the Formal Investigation, the Company considered the resulting financial impact on its prior financial statements and restated certain items in the Company’s financial statements for the years ended 2016 and 2017 (the “Prior Restatement”), as disclosed in the Company’s audited annual consolidated financial statements and related management’s discussion and analysis for the year ended December 31, 2018, copies of which are available under the Company’s profile on SEDAR at www.sedar.com. The Prior Restatement reflects the impact of the misappropriation of assets as well as the reclassification of certain balances of assets in the prior years. With respect to the three month period ended March 31, 2018, the net effect of the Prior Restatement was a decrease in the net comprehensive loss of $0.4 million for the period. A summary of the requisite adjustments on the financial statements for the three month period ended March 31, 2018 is set forth in the table below:

• Trading Suspension on HKEX and TSX - Subsequent to the announcement made by the Company on December 17, 2018 in relation to the Suspicious Transactions, the Common Shares have been suspended from trading on the HKEX and TSX since December 17, 2018.
  
  On January 3, 2019, the HKEX provided the Company with certain resumption guidance, setting out the conditions which the Company must satisfy in order for trading of the Common Shares to resume on the HKEX. Pursuant to the resumption guidance, the Company is required to: (i) conduct a forensic investigation (the “Forensic Investigation”) of the Suspicious Transactions involving the Former Management and Employees; (ii) disclose the findings of the Forensic Investigation and take appropriate remedial actions; and (iii) inform the market of all material information in order for the Company’s shareholders and investors to appraise the Company’s position. The HKEX has advised that it may modify or supplement the trading resumption guidance if the Company’s situation changes. Pursuant to Rule 6.01A(1) of the HKEX’s Listing Rules, the HKEX may cancel the listing of any securities that have been suspended from trading for a continuous period of 18 months. In the case of the Company, this 18-month period expires on June 16, 2020. The HKEX has also advised that if the Company fails to remedy the issues causing the Trading Suspension, fully comply with the HKEX’s Listing Rules to the HKEX’s satisfaction and resume trading of the Common Shares on the HKEX by June 16, 2020, the Listing Department of the HKEX will recommend that the HKEX’s Listing Committee proceed with cancelling the Company’s listing on the HKEX. Pursuant to Rules 6.01 and 6.10 of the HKEX’s Listing Rules, the HKEX also has the right to impose a shorter specific remedial period, where appropriate. Pursuant to Rule 13.24A of the HKEX’s Listing Rules, the Company is required to announce quarterly updates on developments relating to its Trading Resumption Plan (as defined below), including details of the actions taken, or to be taken, in order to remedy the issues causing the Trading Suspension and fully comply with the HKEX’s Listing Rules, the progress of implementing the Trading Resumption Plan, details of any material change to the Trading Resumption Plan (including any delays thereof) and impact on the Company’s business operations. The Company made its first quarterly update on March 15, 2019 and is required to announce additional updates every three months thereafter until resumption of trading on the HKEX or cancellation of the Company’s listing on the HKEX (whichever is earlier).
  
  The action items set out below (the “Trading Resumption Plan”) were approved by the Board on March 30, 2019 in order to address the issues which caused the Trading Suspension, re-comply with the HKEX’s Listing Rules and allow trading of the Common Shares to resume trading on the HKEX:

The Trading Resumption Plan set forth above was approved by the Board based on the information and advice received as of March 30, 2019 and may be subject to change. In accordance with Rule 13.24A of the HKEX’s Listing Rules, the Company will announce details of any material changes to the Trading Resumption Plan (including any delays thereof) as and when necessary.

• Remedial Actions and Preventative Measures - On April 30, 2019, the Company announced that the Special Committee, with the assistance of the Forensic Accountant, completed its assessment of the potential remedial actions and preventative measures to improve and strengthen the Company’s commitment to a culture of honesty, integrity and accountability and compliance with the highest standards of professional and ethical conduct. The Special Committee delivered its report setting out a set of recommended remedial actions and preventative measures (the “Remedial Actions and Preventative Measures”) to the Board which was approved at a meeting of the Board held on April 28, 2019.
  
  The Remedial Actions and Preventative Measures, which are summarized below, are intended to remediate the incidents identified in the Formal Investigation and address deficiencies in the implementation of the Company’s existing practices and procedures. Issues identified of note for the purposes of such remediation include a lack of preventative measures to avoid conflicts of interests, the need for additional employee oversight and the need to enhance compliance with accounting protocols and documentation retention.
  
  The Company has already taken proactive steps to address some of the issues raised by the Formal Investigation, including but not limited to: ceasing business activities with companies allegedly controlled by the Company’s former management, taking steps to defend claims by third parties attempting to link the Company to the aforementioned companies, and considering whether legal recourse, such as collection actions, can be taken in respect of certain matters.
  
  The following is a summary of the Remedial Actions and Preventative Measures which were adopted and approved by the Board:

Management is committed to remediating the issues which caused the Trading Suspension in a timely manner and will begin implementing the Remedial Actions and Preventative Measures as soon as practicable. Once the Remedial Actions and Preventative Measures have been implemented, the Company will make a further announcement as to the results of the implementation of the Remedial Actions and Preventative Measures and the steps that the Company intends to take to apply for trading resumption on the HKEX and the TSX.

• Going Concern – In 2016, the Company started its program to build a coal washing plant to upgrade the low quality fractions of its run-of-mine coals to higher value and higher margin products. The construction of the wash plant at the Ovoot Tolgoi mine was completed, and commissioning was started in October 2018. As of the date hereof, the wash plant commissioning process remains in progress. The Company is currently in discussions with the wash plant operator concerning an agreement regarding the operation of the wash plant; however, there can be no assurance that a favorable outcome will be reached.
  
  The current operation plan contemplates significantly higher volumes of production in order to achieve the Company’s revenue and cash flow targets. Such plans will require a significant level of capital expenditure in waste rock stripping in 2019 and 2020. Such expenditures and other working capital requirements may require the Company to seek additional financing. There is no guarantee that the Company will be able to successfully execute the programs mentioned above and to secure other sources of financing. In addition, the current import restrictions on F-grade coal by Chinese authorities will further affect the short term cash inflow and may in turn undermine the execution of the operation plan. If the import restrictions on F-grade coal continue for an indefinite period, or if the Company fails to execute the aforementioned programs, or is unable to secure additional capital financing, or otherwise restructure or refinance its business in order to address its cash requirements through March 31, 2020, then the Company is unlikely to have sufficient cash flows from mining operations in order to satisfy its current ongoing obligations and future contractual commitments. This could result in adjustments to the amounts and classifications of assets and liabilities in the Company’s consolidated financial statements and such adjustments could be material.

Unless the Company acquires additional sources of financing and/or funding in the short term, the ability of the Company to continue as a going concern is threatened. If the Company is unable to continue as a going concern, it may be forced to seek relief under applicable bankruptcy and insolvency legislation. See section “Liquidity and Capital Resources” of this press release for details. As at May 14, 2019, the Company had $3.6 million of cash.

OVERVIEW OF OPERATIONAL DATA AND FINANCIAL RESULTS

Summary of Operational Data

(i) A Non-International Financial Reporting Standards (“IFRS”) financial measure, which does not have a standardized meaning according to IFRS. See “Non-IFRS Financial Measures” section. Cash costs of product sold exclude idled mine asset cash costs.
(ii) Per 200,000 man hours and calculated based on a rolling 12 month average.

Overview of Operational Data

The Company ended the first quarter of 2019 without a lost time injury. As at March 31, 2019, the Company has a lost time injury frequency rate of nil per 200,000 man hours based on a rolling 12 month average.

Despite an improvement of the product mix, the average realized selling price decreased from $43.0 per tonne in the first quarter of 2018 to $34.9 per tonne in the first quarter of 2019 as a result of a higher portion of sales made at the mine gate instead of transporting the coal to the Company’s Inner Mongolia subsidiary and selling to third party customers within China.

The product mix for the first quarter of 2019 consisted of approximately 10% of premium semi-soft coking coal, 80% of standard semi-soft coking coal, 9% of thermal coal and 1% of washed coal compared to approximately 6% of premium semi-soft coking coal, 72% of standard semi-soft coking coal and 22% of thermal coal in the first quarter of 2018.

The Company sold 1.1 million tonnes for the first quarter of 2019 as compared to 0.6 million tonnes for the first quarter of 2018.

The Company’s production in the first quarter of 2019 was higher than the first quarter of 2018 as a result of pacing production to meet the expected sales as well as a lower strip ratio achieved for the quarter, yielding 1.0 million tonnes for the first quarter of 2019 as compared to 0.4 million tonnes for the first quarter of 2018.

The Company’s unit cost of sales of product sold decreased to $22.1 per tonne in the first quarter of 2019 from $31.6 per tonne in the first quarter of 2018. The decrease was mainly driven by increased sales and the related economies of scale.

Summary of Financial Results

(i) Revenue and cost of sales related to the Company’s Ovoot Tolgoi Mine within the Mongolian Coal Division operating segment. Refer to note 3 of the condensed consolidated financial statements for further analysis regarding the Company’s reportable operating segments. Royalties have been reclassified from revenue to cost of sales.
(ii) A non-IFRS financial measure, idled mine asset costs represents the depreciation expense relates to the Company’s idled plant and equipment.
(iii) The financial results for the three months ended March 31, 2018 were restated. Refer to section “Significant Events and Highlights” of this press release under the heading entitled "Key Findings of Formal Investigation" for details.

Overview of Financial Results

The Company recorded a $9.9 million profit from operations in the first quarter of 2019 compared to a $3.5 million profit from operations in the first quarter of 2018 (restated). The improvement of overall financial results were principally attributable to lower unit cost of sales of products sold during the quarter.

Revenue was $36.8 million in the first quarter of 2019 compared to $24.4 million in the first quarter of 2018. The Company’s effective royalty rate for the first quarter of 2019, based on the Company’s average realized selling price of $34.9 per tonne, was 6.1% or $2.1 per tonne, compared to 5.0% or $2.1 per tonne in the first quarter of 2018 (based on the average realized selling price of $43.0 per tonne in the first quarter of 2018).

Royalty regime in Mongolia

The royalty regime in Mongolia is evolving and has been subject to change since 2012.

On February 1, 2016, the Government of Mongolia issued a resolution in connection with the royalty regime. From February 1, 2016 onwards, royalties are to be calculated based on the actual contract price including transportation costs to the Mongolia border. If such transportation costs have not been included in the contract, the relevant transportation costs, customs documentation fees, insurance and loading costs should be estimated for the calculation of royalties. In the event that the calculated sales price as described above differs from the contract sales price of other entities in Mongolia (same quality of coal and same border crossing) by more than 10%, the calculated sales price will be deemed to be “non-market” under Mongolian tax law and the royalty will then be calculated based on a reference price as determined by the Government of Mongolia. See the section entitled “Risk Factors - Company’s Projects in Mongolia” in the Company’s most recently filed Annual Information Form for the year ended December 31, 2018, a copy of which is available under the Company’s profile on SEDAR at www.sedar.com.

Cost of sales was $23.4 million in the first quarter of 2019 compared to $17.7 million in the first quarter of 2018. The increase in cost of sales was mainly due to the increased sales during the quarter. Cost of sales consists of operating expenses and royalties, share-based compensation expense, equipment depreciation, depletion of mineral properties, coal stockpile inventory impairments and idled mine asset costs. Operating expenses in cost of sales reflect the total cash costs of product sold (a Non-IFRS financial measure, see section “Non-IFRS Financial Measures” of this press release for further analysis) during the quarter.

Operating expenses in cost of sales were $13.0 million in the first quarter of 2019 compared to $10.1 million in the first quarter of 2018. The overall increase in operating expenses was primarily due to the net effect of: (i) increased sales volume from 0.6 million tonnes in the first quarter of 2018 to 1.1 million tonnes in the first quarter of 2019; and (ii) lower unit costs achieved through improvement of operational efficiency.

Cost of sales related to idled mine assets in the first quarter of 2019 included $1.0 million related to depreciation expenses for idled equipment (first quarter of 2018: $3.5 million).

Cost of sales in the first quarter of 2019 included coal stockpile impairments of $3.5 million to reduce the carrying value of the Company’s coal stockpiles to their net realizable value. The coal stockpile impairments recorded primarily related to the Company’s higher-ash content products.

Other operating expenses was $0.4 million in the first quarter of 2019 (first quarter of 2018: $0.8 million).

Administration expenses were $3.1 million in the first quarter of 2019 as compared to $2.4 million in the first quarter of 2018, as follows:

The increase was mainly due to the increase in professional fee incurred in connection with the Formal Investigation.

The Company continued to minimize evaluation and exploration expenditures in the first quarter of 2019 in order to preserve the Company’s financial resources. Evaluation and exploration activities and expenditures in the first quarter of 2019 were limited to ensuring that the Company met the Mongolian Minerals Law requirements in respect of its mining licenses.

Finance costs were $6.7 million and $6.0 million in the first quarter of 2019 and 2018 respectively, which primarily consisted of interest expense on the $250.0 million CIC Convertible Debenture.

Finance income was negligible for the first quarter of 2019 (first quarter of 2018: $0.1 million), which was primarily related to bank interest income.

Summary of Quarterly Operational Data

(i) A non-IFRS financial measure, which does not have a standardized meaning according to IFRS. See section “Non-IFRS Financial Measures”. Cash costs of product sold exclude idled mine asset cash costs.
(ii) Per 200,000 man hours and calculated based on a rolling 12 month average.

Summary of Quarterly Financial Results

The Company’s consolidated financial statements are reported under IFRS issued by the International Accounting Standards Board (“IASB”). The following table provides highlights from the Company’s consolidated financial statements of quarterly results for the past eight quarters.

(i) Revenue and cost of sales relate to the Company’s Ovoot Tolgoi Mine within the Coal Division operating segment. Refer to note 3 of the condensed consolidated financial statements for further analysis regarding the Company’s reportable operating segments. Royalties have been reclassified from revenue to cost of sales.

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.

Turquoise Hill Resources Ltd. (“Turquoise Hill”) Loan Facility (“TRQ Loan”)

On May 25, 2014, the Company announced it obtained the TRQ Loan in the form of a $10 million revolving credit facility 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: an original maturity date of August 30, 2014 (subsequently extended as described below); an interest rate of one-month US dollar London Interbank Offered Rate (“LIBOR”) in effect plus 11% per annum; a commitment fee of 35% of the interest rate payable quarterly in arrears on undrawn principal amount of facility and a front end fee of $0.1 million.

During 2014 to 2016, the due date of the TRQ Loan, was extended several times and the maximum amount of the facility was reduced to $3.8 million.

On August 29, 2018, the Company and Turquoise Hill entered into a deferral agreement (the “August 2018 Deferral Agreement”), whereby Turquoise Hill agreed to a limited deferral of repayment of all remaining amounts and obligations owing under the TRQ Loan to February 28, 2019 in accordance with the schedule of repayments set out below:

• The Company agreed to effect monthly repayments on the last business day of each month in an amount of (i) $0.1 million per month from August 2018 to September 2018; (ii) $0.2 million per month from October 2018 to January 2019; and (iii) the remaining balance on February 28, 2019 (the payments in (i), (ii) and (iii), the "Repayments"); and
• Interest shall continue to accrue on all outstanding obligations at the 12-month US dollar LIBOR.

Unless otherwise agreed by Turquoise Hill, under certain circumstances, including the non-payment of interest amounts as the same become due, amounts outstanding under the TRQ Loan may be accelerated. Bankruptcy and insolvency events with respect to the Company or its material subsidiaries will result in an automatic acceleration of the indebtedness under the TRQ Loan. Subject to notice and cure periods, certain events of default under the TRQ Loan will result in acceleration of the indebtedness under such loan at the option of Turquoise Hill.

As of the date hereof, the Company has not paid a portion of the payment due in February 2019. Pursuant to the terms of the TRQ Loan and the August 2018 Deferral Agreement, the Company is, as of the date of this press release, in default of its obligations under the TRQ Loan and the August 2018 Deferral Agreement as a result of the Company failing to make the Repayments in its entirety on or before the dates set out above. Consequently, all of the outstanding obligations under the TRQ Loan and the August 2018 Deferral Agreement are immediately due and payable to Turquoise Hill as of the date hereof. As of the date of this press release, the Company has received no indication from Turquoise Hill of any intention to demand payment of the amounts outstanding under the TRQ Loan and the August 2018 Deferral Agreement.

As at March 31, 2019, the outstanding principal and accrued interest under this facility amounted to $nil and $0.2 million, respectively (December 31, 2018: the outstanding principal and accrued interest under this facility amounted to $nil and $0.7 million, respectively).

Bank Loan

On May 6, 2016, SGS obtained a bank loan (the “Bank Loan”) in the principal amount of $2.0 million from a Mongolian bank (the “Bank”). The principal terms of the Bank Loan include, among other things, an interest rate of 15.8% per annum, a maturity date of May 6, 2017 (subsequently extended as described below) and SGS being required to pledge certain of its mobile equipment in favour of the Bank as collateral for the Bank Loan.

On July 6, 2017, SGS and the Bank entered into a supplementary agreement with the key commercial terms of the Bank Loan modified as follows:

• Principal amount increased to $3.0 million;
• $2.3 million of the principal amount matured on May 6, 2018 while the remaining balance of the principal amount of $0.7 million matured on January 4, 2019;
• Interest rate of 15.8% per annum applies to the $2.3 million portion of the principal amount, while an interest rate of 15.0% per annum applies to the remaining $0.7 million portion of the principal amount; in each case, interest is payable monthly; and
• Certain items of property, plant and equipment were pledged as security (subsequently released upon repayment of loan principal of $2.3 million).

$2.3 million and $0.7 million of the loan principal was repaid to the Bank by the Company in May 2018 and January 2019, respectively, and the loan balance was fully settled.

On May 15, 2018, SGS and the Bank entered into another loan agreement with the key commercial terms as follows:

• Principal amount of the loan (the “2018 Bank Loan”) of $2.8 million;
• Maturity date set at 24 months from drawdown;
• Interest rate of 15% per annum and interest is payable monthly; and
• Certain items of property, plant and equipment were pledged as security for both the Bank Loan and the 2018 Bank Loan. As at March 31, 2019, the net book value of the pledged items of property, plant and equipment was $1.6 million (December 31, 2018: $2.6 million).

As at March 31, 2019, the outstanding principal balance of the Bank Loan, together with the 2018 Bank Loan, was $2.8 million (December 31, 2018: $3.5 million) and the accrued interest owed by the Company was negligible (December 31, 2018: negligible).

Costs reimbursable to Turquoise Hill

Prior to the completion of a private placement with Novel Sunrise Investments Limited on April 23, 2015, Rio Tinto Plc (“Rio Tinto”) was the Company’s ultimate parent company. In the past, Rio Tinto sought reimbursement from the Company for the salaries and benefits of certain Rio Tinto employees who were assigned by Rio Tinto to work for the Company, as well as certain legal and professional fees incurred by Rio Tinto in relation to the Company’s prior internal investigation and Rio Tinto’s participation in the tripartite committee. Subsequently Rio Tinto transferred and assigned to Turquoise Hill its right to seek reimbursement for these costs and fees from the Company.

As at March 31, 2019, the amount of reimbursable costs and fees claimed by Turquoise Hill (the “TRQ Reimbursable Amount”) amounted to $8.1 million (such amount is included in the aging profile of trade and other payables set out below). On October 12, 2016, the Company received a letter from Turquoise Hill, which proposed an arrangement for regular payments of the outstanding TRQ Reimbursable Amount although no agreement has been reached between the Company and Turquoise Hill as of the date of this press release. As of the date of this press release, the Company has received no indication from Turquoise Hill of any intention to demand payment of the TRQ Reimbursable Amount.

Going concern considerations

The Company’s condensed consolidated interim financial statements have been prepared on a going concern basis which assumes that the Company will continue operating until at least March 31, 2020 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 transactions to provide it with additional liquidity.

Several adverse conditions and material uncertainties cast significant doubt upon the going concern assumption. The Company had a deficiency in assets of $46.1 million as at March 31, 2019 compared to a deficiency in assets of $48.1 million as at December 31, 2018 while the working capital deficiency (excess current liabilities over current assets) reached $202.9 million as at March 31, 2019 compared to a working capital deficiency of $203.1 million as at December 31, 2018. Included in the working capital deficiency at March 31, 2019 are significant obligations, which include the obligation to pay CIC under the June 2017 Deferral Agreement in which the Company was required to pay $9.7 million of cash interest and associated costs on November 19, 2017. Pursuant to the terms of CIC Convertible Debenture, the Company was required to: (i) pay $8.1 million, $7.9 million and $8.1 million of anniversary cash interest on November 19, 2017, May 19, 2018 and November 19, 2018, respectively; and (ii) issue to CIC $4.0 million worth of PIK Interest shares on November 19, 2017 and $4.0 million worth of PIK Interest shares on November 19, 2018, respectively.

The Company has executed the 2019 Deferral Agreement with CIC in relation to a deferral and revised repayment schedule in respect of the Outstanding Interest Payable and the cash and PIK Interest payments payable to CIC under the CIC Convertible Debenture from April 23, 2019 to and including May 19, 2020; however, the effectiveness of the 2019 Deferral Agreement and the respective covenants, agreements and obligations of each party under the 2019 Deferral Agreement are subject to the Company obtaining the requisite approval from shareholders at the Meeting. Until such time as the 2019 Deferral Agreement becomes effective, the principal amount outstanding and all accrued and unpaid interest and other amounts owing under the CIC Convertible Debenture and the June 2017 Deferral Agreement would immediately become due and payable in the event that CIC provides notice to the Company.

The Company also has other current liabilities, which require settlement in the short-term, including: the $10.6 million owing to First Concept under the Settlement Deed and $26.1 million of unpaid taxes payable by SGS to the Mongolian government.

Further, the trade and other payables of the Company continue to accumulate due to liquidity constraints. The aging profile of the trade and other payables as at March 31, 2019 as compared to that as at December 31, 2018, is as follows:

The Company may not be able to settle all trade and other payables on a timely basis, while continuing postponement in settling the trade payables may impact the mining operations of the Company and result in potential lawsuits and/or bankruptcy proceedings being filed against the Company. Except as disclosed elsewhere in this press release, no such lawsuits or proceedings are pending as at May 14, 2019.

In 2016, the Company started its program to build a coal washing plant to upgrade the low quality fractions of its run-of-mine coals to higher value and higher margin products. The construction of the wash plant at the Ovoot Tolgoi mine was completed, and commissioning was started in October 2018. As of the date hereof, the wash plant commissioning process remains in progress. The Company is currently in discussions with the wash plant operator concerning an agreement regarding the operation of the wash plant; however, there can be no assurance that a favorable outcome will be reached.

The current operation plan contemplates significantly higher volumes of production in order to achieve the Company’s revenue and cash flow targets. Such plans will require a significant level of capital expenditure in waste rock stripping in 2019 and 2020. Such expenditures and other working capital requirements may require the Company to seek additional financing. There is no guarantee that the Company will be able to successfully execute the programs mentioned above and to secure other sources of financing. In addition, the current import restrictions on F-grade coal by Chinese authorities will further affect the short term cash inflow and may in turn undermine the execution of the operation plan. If the import restrictions on F-grade coal continue for an indefinite period, or if the Company fails to execute the aforementioned programs, or is unable to secure additional capital financing, or otherwise restructure or refinance its business in order to address its cash requirements through March 31, 2020, then the Company is unlikely to have sufficient cash flows from mining operations in order to satisfy its current ongoing obligations and future contractual commitments. This could result in adjustments to the amounts and classifications of assets and liabilities in the Company’s consolidated financial statements and such adjustments could be material.

Unless the Company acquires additional sources of financing and/or funding in the short term, the ability of the Company to continue as a going concern is threatened. If the Company is unable to continue as a going concern, it may be forced to seek relief under applicable bankruptcy and insolvency legislation.

As of the date of this press release, the Company is in default under the CIC Convertible Debenture, the June 2017 Deferral Agreement and the TRQ Loan. Pursuant to the terms of the CIC Convertible Debenture and the June 2017 Deferral Agreement, CIC may, at its discretion, provide notice to the Company and declare all principal, interest and other amounts owing under the CIC Convertible Debenture and the June 2017 Deferral Agreement immediately due and payable, and take steps to enforce payment thereof. Pursuant to the terms of the TRQ Loan and the August 2018 Deferral Agreement, all of the outstanding obligations under the TRQ Loan are immediately due and payable to Turquoise Hill as of the date hereof. If the 2019 Deferral Agreement is not approved by shareholders at the Meeting and CIC takes steps to enforce payment under the CIC Convertible Debenture and the June 2017 Deferral Agreement, this would have a material adverse effect on the business and operations of the Company and may negatively affect the price and volatility of the Common Shares and any investment in such shares could suffer a significant decline or total loss in value. As of the date of this press release, the Company has: (i) received no indication from CIC of any intention to deliver a notice of default under the CIC Convertible Debenture and the June 2017 Deferral Agreement or to accelerate the payment of amounts outstanding under the CIC Convertible Debenture and the June 2017 Deferral Agreement; and (ii) has received no indication from Turquoise Hill of any intention to deliver a notice of default under the TRQ Loan.

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.

As at March 31, 2019 and December 31, 2018, the Company was not subject to any externally imposed capital requirements.

As at May 14, 2019, the Company had $3.6 million of cash.

CIC Convertible Debenture

In November 2009, the Company entered into a financing agreement with a wholly owned subsidiary of CIC for $500 million in the form of a secured, convertible debenture bearing interest at 8.0% (6.4% payable semi-annually in cash and 1.6% payable annually in the Company’s shares) with a maximum term of 30 years. The CIC Convertible Debenture is secured by a first ranking charge over the Company’s assets and certain subsidiaries. The financing was used primarily to support the accelerated investment program in Mongolia and for working capital, repayment of debt, general and administrative expenses and other general corporate purposes.

On March 29, 2010, the Company exercised its right to call for the conversion of up to $250.0 million of the CIC Convertible Debenture into approximately 21.5 million shares at a conversion price of $11.64 (CAD$11.88). As at March 31, 2019, CIC owned, through its indirect wholly owned subsidiary, approximately 23.8% of the issued and outstanding Common Shares of the Company.

On June 12, 2017, the Company executed the June 2017 Deferral Agreement with CIC for a revised repayment schedule on the May 2017 Interest Payable. The key repayment terms of the June 2017 Deferral Agreement are: (i) the Company was required to repay on average $2.2 million of the cash interest and associated costs monthly during the period from May 2017 to October 2017; and (ii) the Company was required to repay $9.7 million of cash interest and associated costs on November 19, 2017.

At any time before the payment under the terms of the June 2017 Deferral Agreement is fully repaid, the Company is required to consult with and obtain written consent from CIC prior to effecting a replacement or termination of either or both of its Chief Executive Officer and its Chief Financial Officer, otherwise this will constitute an event of default under the CIC Convertible Debenture, but CIC shall not withhold its consent if the Board proposes to replace either or both such officers with nominees selected by the Board, provided that the Board acted honestly and in good faith with a view to the best interests of the Company in the selection of the applicable replacements.

In addition, pursuant to the terms of the CIC Convertible Debenture, the Company was required to pay $8.1 million, $7.9 million and $8.1 million of anniversary cash interest to CIC on November 19, 2017, May 19, 2018 and November 19, 2018, respectively. Pursuant to the CIC Convertible Debenture, the Company was also obligated to issue to CIC $4.0 million worth of PIK Interest shares on November 19, 2017 and $4.0 million worth of PIK Interest shares on November 19, 2018.

On April 23, 2019, the Company executed the 2019 Deferral Agreement with CIC in relation to a deferral and revised repayment schedule in respect of (i) $41.8 million of Outstanding Interest Payable under the CIC Convertible Debenture and the June 2017 Deferral Agreement; and (ii) the cash and PIK Interest payments payable to Land Breeze II S.a.r.l. under the CIC Convertible Debenture from April 23, 2019 to and including May 19, 2020. Pursuant to Section 501(c) of the TSX Company Manual, the Company will be seeking approval of the 2019 Deferral Agreement from disinterested shareholders at the Meeting. The effectiveness of the 2019 Deferral Agreement and the respective covenants, agreements and obligations of each party under the 2019 Deferral Agreement are subject to the Company obtaining the requisite approval from shareholders at the Meeting.

The key repayment terms of the 2019 Deferral Agreement are: (i) the Company agreed to pay $14.3 million, by eight instalments during November 2019 to June 2020; (ii) the Company agreed to pay the PIK Interest covered by the Deferral by way of cash payments, rather than the issuance of Common Shares; and (iii) the Company agreed to pay $62.6 million on June 20, 2020. The Company agreed to pay a deferral fee at a rate of 6.4% per annum in consideration of the Deferral.

As a condition to agreeing to the Deferral, CIC required that the Cooperation Agreement between SGS and Fullbloom, an affiliate of CIC, be amended and restated to clarify the manner in which the service fee payable to Fullbloom under the Cooperation Agreement is calculated, with effect as of January 1, 2017. Specifically, the service fee under the Amended and Restated Cooperation Agreement will be determined based on the net revenues realized by the Company and all of its subsidiaries derived from sales into China (rather than the net revenues realized by the Company and its Mongolian subsidiaries as currently contemplated under the Cooperation Agreement). As consideration for deferring payment of the Deferred Compensation, the Company agreed to pay to Fullbloom a deferral fee at the rate of 2.5% on the outstanding amount of the Deferred Compensation. Pursuant to the Amended and Restated Cooperation Agreement, the Company agreed to pay Fullbloom the Deferred Compensation and related accrued deferral fee of $4.2 million in six instalments between June 2019 and November 2019.

The effectiveness of the Amended and Restated Cooperation Agreement is subject to the Company obtaining the requisite approval of the 2019 Deferral Agreement from shareholders at the Meeting.

As of the date of this press release, the Company: (i) has neither paid the Outstanding Interest Payable within the cure period provided for under the CIC Convertible Debenture; and (ii) has not obtained the requisite approval at the Meeting to put the 2019 Deferral Agreement in effect. Consequently, the Company is in default under the CIC Convertible Debenture and the June 2017 Deferral Agreement. Furthermore, the Common Shares have now been in the Trading Suspension, which represents another event of default under the CIC Convertible Debenture. Pursuant to the terms of the CIC Convertible Debenture and the June 2017 Deferral Agreement, CIC may, at its discretion, provide notice to the Company and declare all principal, interest and other amounts owing under the CIC Convertible Debenture and the June 2017 Deferral Agreement immediately due and payable, and take steps to enforce payment thereof, which would have a material adverse effect on the business and operations of the Company and may negatively affect the price and volatility of the Common Shares and any investment in such shares could suffer a significant decline or total loss in value.

Under certain conditions, including the non-payment of interest amounts as the same become due or the Common Shares being suspended or halted from trading on any stock exchange for a period of longer than five trading days, amounts outstanding under the CIC Convertible Debenture may be accelerated. Bankruptcy and insolvency events with respect to the Company or its material subsidiaries will result in an automatic acceleration of the indebtedness under the CIC Convertible Debenture. Subject to notice and cure periods, certain events of default under the CIC Convertible Debenture will result in acceleration of the indebtedness under such debenture at the option of CIC. Such other events of default include, but are not limited to, non-payment, breach of warranty, non-performance of obligations under the CIC Convertible Debenture, default on other indebtedness and certain adverse judgments.

Because a deferral of the Outstanding Interest Payable was not in effect as of March 31, 2019, IAS 1 requires the Company to classify the entire balance of the CIC Convertible Debenture as a current liability as at March 31, 2019, notwithstanding the fact that CIC has not indicated any intention to deliver notice of default or accelerate the maturity of the CIC Convertible Debenture.

Commercial Arbitration in Hong Kong

On June 24, 2015, First Concept 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") for a total consideration of $11.5 million.

On January 10, 2018, the Company received a confidential partial award (final except as to costs) with respect to the commercial arbitration. Pursuant to the Arbitration Award, SGS was ordered to repay the sum of $11.5 million (which SGS had received as a prepayment for the purchase of coal) to First Concept, together with accrued interest at a simple interest rate of 6% per annum from the date which the prepayment was made until the date of the Arbitration Award, and then at a simple interest rate of 8% per annum until full payment. The Arbitration Award is final, except as to costs which were reserved for a future award.

On November 14, 2018, the Company executed the Settlement Deed with First Concept in respect of the Arbitration Award. The Settlement Deed provides for the full and final satisfaction of the Arbitration Award as well as the settlement of the issue of costs relating to the Arbitration and any other disputes arising out of the Coal Supply Agreement. Pursuant to the Settlement Deed, which provides for the full and final satisfaction of the Arbitration Award as well as the settlement of the issue of costs relating to the Arbitration and any other disputes arising out of the Coal Supply Agreement, SGS agreed to pay to First Concept the sum of $13.9 million, together with simple interest thereon at the rate of 6% per annum from November 1, 2018 until full payment, in 12 monthly installments commencing in November 2018. Provided that SGS complies with the terms of the Settlement Deed, First Concept agreed to waive its costs in connection with the Arbitration and Arbitration Award and interest for the period from January 4, 2018 to October 31, 2018.

As of the date hereof, the Company has not paid the November 2018 and January 2019 monthly payments due under the Settlement Deed. On March 5, 2019, SGS received a notice from First Concept claiming that the Company is default under the Settlement Deed and demanding payment of the full amount of the outstanding monthly payments due under the Settlement Deed by no later than March 11, 2019, otherwise First Concept intends to commence legal action against SGS pursuant to the Settlement Deed. The Company is consulting with its independent litigation counsel regarding this matter; however, as a default is only triggered under the Settlement Deed where there has been a failure to pay two or more consecutive monthly instalment payments, the Company is of the view that SGS is not in default under the Settlement Deed. In the event that First Concept commences legal action against SGS regarding this matter, the Company intends to take appropriate steps to respond to such legal proceedings in the best interests of the Company through independent litigation counsel which has been retained by the Company for this purpose.

As at March 31, 2019, the outstanding payables to First Concept amounted to $10.6 million (December 31, 2018: $12.5 million).

Ovoot Tolgoi Mine Impairment Analysis

The Company determined that an indicator of impairment existed for its Ovoot Tolgoi Mine cash generating unit as at March 31, 2019. The impairment indicators were the uncertainty of future coal prices in China and the lower than budgeted production.

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 “fair value less costs of disposal” (“FVLCTD”) using a discounted future cash flow valuation model. The Company’s cash flow valuation model takes into consideration the latest available information to the Company, including but not limited to, sales prices, sales volumes, coal washing capacity, operating costs and life of mine coal production estimates as at March 31, 2019. The resulting FVLCTD was $155.9 million as at March 31, 2019 while the cash generating unit carrying value of the Company’s Ovoot Tolgoi Mine was $139.5 million, resulting in a headroom of $16.4 million.

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

• Coal resources and reserves as estimated by an independent third party engineering firm;
• Sales price estimates from an independent market consulting firm;
• Forecasted sales volumes in line with production levels as reference to the mine plan;
• Life-of-mine coal production, strip ratio, capital costs and operating costs; and
• A post-tax discount rate of 11% based on an analysis of the market, country and asset specific factors.

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 $16.9/(16.9) million;
• For each 1% increase/(decrease) in the post-tax discount rate, the calculated fair value of the cash generating unit (decreases)/increases by approximately $(9.8)/10.9 million;
• For each 1% increase/(decrease) in the cash mining cost estimates, the calculated fair value of the cash generating unit (decreases)/increases by approximately $(13.3)/13.3 million; and
• For each 1% increase/(decrease) in Mongolian inflation rate, the calculated fair value of the cash generating unit (decreases)/increases by approximately $(76.8)/66.2 million.

The impairment analysis did not result in the identification of an impairment loss or an impairment reversal and no charge or reversal was required as at March 31, 2019. A decline of 1% in the long term price estimates, an increase of more than 2% in the post-tax discount rate, an increase of 1% in the cash mining cost estimates or an increase of 1% in Mongolian inflation rate 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.

REGULATORY ISSUES AND CONTINGENCIES

Class Action Lawsuit

In January 2014, Siskinds LLP, a Canadian law firm, filed a class action (the “Class Action”) against the Company, certain of its former senior officers and directors, and its former auditors, Deloitte LLP, in the Ontario Court in relation to the Company’s restatement of certain financial statements previously disclosed in the Company’s public fillings (the “Restatement”).

To commence and proceed with the Class Action, the plaintiff was required to bring a preliminary leave motion and to certify the Class Action as a class proceeding (the “Leave Motion”). The Ontario Court rendered its decision on the Leave Motion on November 5, 2015 (the “November 5, 2015 Ontario Court Decision”) and dismissed the plaintiff’s Leave Motion as against each of the former senior officers and directors of the Company named in the Class Action on the basis that the “large volume of compelling evidence” proved the defense of reasonable investigation on the balance of probabilities and provided the basis for dismissing the Leave Motion as against them.

However, the Ontario Court allowed the Class Action to proceed under Part XXIII.1 of the Ontario Securities Act, permitting the plaintiff to commence and proceed with an action against the Company in respect of alleged misrepresentations affecting trades in the secondary market for the Company’s securities arising from the Restatement. The Company appealed this portion of the decision of the Ontario Court (the “Corporation Appeal”).

The plaintiff appealed that part of the November 5, 2015 Ontario Court Decision dismissing the action against former officers and directors of the Company (the “Individual’s Appeal”). The Individual's Appeal was brought as of right to the Ontario Court of Appeal.

On September 18, 2017, the Ontario Court of Appeal dismissed the Corporation Appeal of the original Ontario lower court decision to permit the plaintiff to commence and proceed with the Class Action. Concurrently, the Ontario Court of Appeal allowed the Individual’s Appeal of the original Ontario lower court decision to dismiss the plaintiff’s leave motion against certain of the Company’s former officers and directors and made an order granting leave for the plaintiff to proceed against such former officers and directors of the Company in relation to the Restatement. As a result, the plaintiff is now permitted to proceed with the Class Action against both the Company and the former officers and directors.

The Company filed an application for leave to appeal to the Supreme Court of Canada in November 2017. The leave to appeal to the Supreme Court of Canada was dismissed in June 2018.

Counsel for the parties has appeared in a case conference before the motions judge. A procedure to fix the process and timing leading up to the trial of the action has been settled in broad terms including the favourable prospect of an early trial based to a large extent on the existing record. The details of the final process are being negotiated between counsel.

The Company firmly believes that it has a strong defense on the merits and will continue to vigorously defend itself against the Class Action through independent Canadian litigation counsel retained by the Company for this purpose. Due to the inherent uncertainties of litigation, it is not possible to predict the final outcome of the Class Action or determine the amount of potential losses, if any. However, the Company has judged a provision for this matter as at March 31, 2019 was not required.

Toll Wash Plant Agreement with Ejin Jinda

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 had a duration of five years from commencement of the contract and provided for an annual wet washing capacity of approximately 3.5 million tonnes of input coal.

Under the original agreement with Ejin Jinda, which required the commercial operation of the wet washing facility to commence on October 1, 2011, the additional fees payable by the Company under the wet washing contract would have been $18.5 million. At each reporting date, the Company assesses the agreement with Ejin Jinda and has determined it is not probable that these $18.5 million will be required to be paid. Accordingly, the Company has determined a provision for this matter at March 31, 2019 is not required.

Special Needs Territory in Umnugobi

On February 13, 2015, the entire Soumber mining license and a portion of SGS' exploration license 9443X (9443X was converted to mining license MV-020436 in January 2016) (the “License Areas”) were included into a special protected area (to be further referred as Special Needs Territory, the “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.

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. Mining activities at the Soumber property cannot proceed until the License Areas are removed from the SNT.

On June 29, 2016, the Mongolian Parliament and CRKh election was held. As a result, the Company was aware that additional action may be taken in respect of the SNT; however, the Company has not yet received any indication on the timing of the next session of the CRKh.

Mongolian royalties

During 2017, the Company was ordered by the Mongolian tax authority to apply the “reference price” determined by the Government of Mongolia, as opposed to calculated sales price that is derived based on the actual contract price, in calculating the royalties payable to the Government of Mongolia. Although no official letter has been received by the Company in respect of this matter as of the date hereof, there can be no assurance that the Government of Mongolia will not disagree with the methodology employed by the Company in determining the calculated sales price and deem such price “non-market” under Mongolian tax law. Management believes that its interpretation of the relevant legislation is appropriate and the Company’s positions related to the royalty will be sustained.

Restrictions on Importing F-Grade Coal into China

As a result of import restrictions established by Chinese authorities at the Ceke border, the Company has been barred from transporting its F-grade coal products into China for sale since December 15, 2018. The Company, together with other Mongolian coal companies, have been in discussions with Chinese authorities regarding a potential amendment or withdrawal of these import restrictions to allow for the importation of F-grade coal into China; however, there can be no assurance that a favorable outcome will be reached.

TRANSPORTATION INFRASTRUCTURE

On August 2, 2011, the State Property Committee of Mongolia awarded the tender to construct a paved highway from the Ovoot Tolgoi Mine 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% interest 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. The Paved Highway has significantly increased the safety of coal transportation, reduced environmental impacts and improved efficiency and capacity of coal transportation. The toll rate was set at Mongolian Tugrik (“MNT”) 900 per tonne of coal (subsequently increased) as compared to MNT 1,500 as stated in the signed concession agreement between RDCC LLC and the State Property Committee of Mongolia.

On September 17, 2015, the Invest Mongolia Agency signed an amendment to the concession agreement with RDCC LLC to extend the exclusive right of ownership to 30 years.

On February 4, 2017, the Board of RDCC LLC increased the toll rate from MNT 900 per tonne of coal to MNT 1,200, effective from March 1, 2017.

On April 26, 2018, the Board of RDCC LLC increased the toll rate from MNT 1,200 per tonne of coal to MNT 1,500, effective from June 1, 2018.

The Paved Highway has a carrying capacity in excess of 20 million tonnes of coal per year.

For the three months ended March 31, 2019, RDCC LLC recognized toll fee revenue of $1.8 million (2018: $1.6 million).

OUTLOOK

The Company believes that coal will continue to be the primary energy source which China will rely on in the foreseeable future, as coal has supported more than half of China’s total energy consumption in recent years. However, growth in the demand for coal in China is expected to decline gradually in the long run for the following reasons: (i) increased adoption and utilization of clean energy; (ii) the implementation of stricter safety and environmental rules and regulations; and (iii) total energy consumption growth rates are expected to decrease over time.

The Company believes that the future trend of the coal industry in China will involve coal companies placing an increased emphasis on improving the quality of their coal products through enhanced screening and washing procedures and mine management.

Looking forward to 2019, the Company remains cautiously optimistic regarding the Chinese coal market. The expected benefit from the reduced supply of low quality coal and increased railway transportation capacity in China are anticipated to be offset by the uncertain Chinese macroeconomic environment.

The Company’s objectives for 2019 and the medium term are as follows:

• Enhance product mix – The Company will focus on improving the product mix and increase production of higher quality coal by: (i) washing lower quality coal in the Company’s coal wash plant; and (ii) improving mining operations and employing better mining technique and equipment.
  
• Expand customer base – The Company will endeavor to increase sales volume, expand its sales network, strengthen its sales and logistics capabilities and diversify its customer base.
  
• Increase production and optimize cost structure – The Company will aim to increase coal production volume to take advantage of economies of scale. The Company will also focus on reducing its production cost and optimizing its cost structure through innovation, training and productivity enhancement.
  
• Progress growth options – Subject to available financial resources, the Company plans to further the development of the Soumber Deposit in the medium term, while complying with all government requirements in relation to its licenses and agreements.
  
• Operate in a socially responsible manner – The Company will continue to maintain the highest standards in health, safety and environmental performance in a corporate socially responsible manner.

Going forward, the Company will continue to focus on creating shareholders value by leveraging its key competitive strengths, including:

• Strategic location – The Ovoot Tolgoi Mine is located approximately 40km from China, which represents the Company’s 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.
  
• A large resources and reserves base – The Ovoot Tolgoi Deposit has mineral reserves of 114.1 million tonnes, while the aggregate coal resources include measured and indicated mineral resources of 194.6 million tonnes and inferred resources of 32.1 million tonnes.
  
• Several growth options – The Company has several growth options including the Soumber Deposit and Zag Suuj Deposit, located approximately 20km east and approximately 150km east of the Ovoot Tolgoi Mine, respectively.
  
• Bridge between Mongolia and China – The Company is well positioned to capture the resulting business opportunities between China and Mongolia under the “One Belt, One Road” program. The Company will seek potential strategic support from its two largest shareholders (i.e., CIC and Cinda), which are both state-owned-enterprises in China, and its strong operational record for the past twelve years in Mongolia, being one of the largest enterprises and taxpayers in Mongolia.

NON-IFRS FINANCIAL MEASURES

Cash Costs

The Company uses cash costs to describe its cash production and associated cash costs incurred in bringing the inventories to their present locations and conditions. 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 property, plant and equipment and 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.

Summarized Comprehensive Income Information
(Expressed in thousands of USD, except for share and per share amounts)

Summarized Financial Position Information
(Expressed in thousands of USD)

REVIEW OF INTERIM RESULTS

The condensed consolidated interim financial statements for the Company for the three months ended March 31, 2019, were reviewed by the Audit Committee of the Company.

The Company’s results for the quarter ended March 31, 2019, are contained in the unaudited Condensed Consolidated Interim Financial Statements and Management Discussion and Analysis of Financial Condition and Results of Operations (“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, owns and operates its flagship Ovoot Tolgoi coal mine in Mongolia. It also holds the mining licences of its other metallurgical and thermal coal deposits in South Gobi Region of Mongolia. SouthGobi produces and sells coal to customers in China.

Forward-Looking Statements: Except for statements of fact relating to SouthGobi Resources Ltd. and its subsidiaries (collectively, 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 relate to management’s future outlook and anticipated events or results and are based on the opinions and estimates of management at the time the statements are made. Forward-looking statements in this press release include, but are not limited to, statements regarding:

• 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 consolidated financial statements and the impact thereof;
• the Company’s expectations of sufficient liquidity and capital resources to meet its ongoing obligations and future contractual commitments, including the Company’s ability to settle its trade payables, to secure additional funding and to meet its obligations under each of the CIC Convertible Debenture, the June 2017 Deferral Agreement, the TRQ Loan, the Bank Loan and 2018 Bank Loan, and the Settlement Deed with First Concept, as the same become due;
• the Company's anticipated financing needs, development plans and future production levels;
• the Company successfully obtaining shareholder approval of the 2019 Deferral Agreement at the Meeting;
• the Company entering into discussions with CIC regarding a potential debt restructuring plan;
• the ability of the Company to successfully respond to any enforcement proceeding brought by First Concept in respect of the Arbitration Award and Settlement Deed;
• the results and impact of the Ontario class action (as described under section “Regulatory Issues and Contingencies” of this press release under the heading entitled "Class Action Lawsuit");
• the impact of the Suspicious Transactions engaged in by Former Management and Employees and the results of the investigation conducted by the Special Committee;
• the Company successfully implementing the Remedial Actions and Preventative Measures to address the issues which caused the Trading Suspension;
• the ability of the Company to successfully satisfy the conditions necessary to resume trading of the Common Shares on the HKEX and TSX;
• the expected timing to complete the actions set out in the Trading Resumption Plan and to resume trading of the Common Shares on the HKEX and TSX;
• the estimates and assumptions included in the Company’s impairment analysis and the possible impact of changes thereof;
• the agreement with Ejin Jinda and the payments thereunder (as described under section “Regulatory Issues and Contingencies” of this press release under the heading entitled "Toll Wash Plant Agreement with Ejin Jinda”);
• the ability of the Company to successfully negotiate a new agreement with the third party contractor relating to the operation of the wash plant at the Ovoot Tolgoi mine site;
• the ability of the Company to successfully recover the balance of its doubtful trade and notes receivables;
• the ability to enhance the operational efficiency and the output throughput of the of the washing facilities at Ovoot Tolgoi;
• the estimated annual wet washing capacity of the washing facilities at Ovoot Tolgoi;
• the ability to enhance the product value by conducting coal processing and coal washing;
• 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 impact of the delays in the custom clearance process at the Ceke border on the Company’s operations and the restrictions established by Chinese authorities on the import of F-grade coal into China;
• the future demand for coal in China;
• future trends in the Chinese coal industry;
• the Company’s outlook and objectives for 2019 and beyond (as more particularly described under section “Outlook” of this press release); and
• other statements that are not historical facts.

Forward-looking information is based on certain factors and assumptions described below and elsewhere in this press release, including, among other things: the current mine plan for the Ovoot Tolgoi mine; mining, production, construction and exploration activities at the Company’s mineral properties; the costs relating to anticipated capital expenditures; the capacity and future toll rate of the Paved Highway; plans for the progress of mining license application processes; mining methods; the Company's anticipated business activities, planned expenditures and corporate strategies; management’s business outlook, including the outlook for 2019 and beyond; the Company obtaining shareholder approval of the 2019 Deferral Agreement at the Meeting; the Company’s ability to implement the Remedial Actions and Preventative Measures successfully; the Company’s ability to satisfy the HKEX’s resumption guidance conditions; the HKEX and the TSX accepting the Company’s application for trading resumption; currency exchange rates; operating, labour and fuel costs; the ability of the Company to raise additional financing; the anticipated royalties payable under Mongolia’s royalty regime; the future coal market conditions in China and the related impact on the Company’s margins and liquidity; future coal prices, and the level of worldwide coal production. While the Company considers these assumptions to be reasonable based on the information currently available to it, they may prove to be incorrect. Forward-looking statements 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 risks and uncertainties include, among other things: the uncertain nature of mining activities, actual capital and operating costs exceeding management’s estimates; variations in mineral resource and mineral reserve estimates; failure of plant, equipment or processes to operate as anticipated; the possible impacts of changes in mine life, useful life or depreciation rates on depreciation expenses; risks associated with, or changes to regulatory requirements (including environmental regulations) and the ability to obtain all necessary regulatory approvals; the potential expansion of the list of licenses published by the Government of Mongolia covering areas in which exploration and mining are purportedly prohibited on certain of the Company's mining licenses; the Government of Mongolia designating any one or more of the Company’s mineral projects in Mongolia as a Mineral Deposit of Strategic Importance; continued delays in the custom clearance process at the Ceke border; the restrictions established by Chinese authorities on the import of F-grade coal into China; the Company being in default under the CIC Convertible Debenture, the June 2017 Deferral Agreement and the TRQ Loan, including the risk of CIC accelerating all amounts outstanding under the CIC Convertible Debenture and enforcing payment thereof, and the risk of Turquoise Hill demanding immediate payment of all amounts outstanding under the TRQ Loan, respectively; the risk of the Company failing to obtain shareholder approval of the 2019 Deferral Agreement at the Meeting; the possible impact of changes to the inputs to the valuation model used to value the embedded derivatives in the CIC Convertible Debenture; the risk of the Company failing to successfully negotiate favorable repayment terms on the TRQ Reimbursable Amount (as described under section “Liquidity and Capital Management” of this press release under the heading entitled “Costs Reimbursable to Turquoise Hill”) ; the risk of the Company or its subsidiaries defaulting under its existing debt obligations, including the Bank Loan and 2018 Bank Loan, and the Settlement Deed; the impact of amendments to, or the application of, the laws of Mongolia, China and other countries in which the Company carries on business; modifications to existing practices so as to comply with any future permit conditions that may be imposed by regulators; delays in obtaining approvals and lease renewals; the risk of fluctuations in coal prices and changes in China and world economic conditions; the risk that First Concept initiates legal proceedings against SGS pursuant to the Settlement Deed (as described under section “Liquidity and Capital Management” of this press release under the heading entitled "Commercial Arbitration in Hong Kong"); the outcome of the Class Action (as described under section “Regulatory Issues and Contingencies” of this press release under the heading entitled "Class Action Lawsuit") and any damages payable by the Company as a result; the result of the internal investigation conducted by the Special Committee and the impact thereon on the Company; the risk that the Company fails to properly implement the Remedial Actions and Preventative Measures to address the issues which caused the Trading Suspension; the risk that the Remedial Actions and Preventative Measures fail to successfully address the issues which caused the Trading Suspension; the risk that the Company is unable to satisfy the conditions required to resume trading of the Common Shares on the TSX and the HKEX, including the risk that the Company fails to properly complete its Trading Resumption Plan; the risk that the Common Shares are delisted from trading on the TSX and the HKEX; the risk that the Company is unable to successfully negotiate a debt restructuring plan with CIC; the risk that the calculated sales price determined by the Company for the purposes determining of the amount of royalties payable to the Mongolian government is deemed as being “non-market” under Mongolian tax law; customer credit risk; cash flow and liquidity risks; the risk of continued delays in the custom clearance process at the Ceke border; risks relating to the Company’s decision to suspend activities relating to the development of the Ceke Logistics Park project, including the risk that its investment partner may initiate legal action against the Company for failing to comply with the underlying agreements governing project development; risks relating to the ability of the Company to enhance the operational efficiency and the output throughput of the washing facilities at Ovoot Tolgoi; the risk that the Company is unable to successfully negotiate a new agreement with the third party contractor relating to the operation of the wash plant; risks relating to the Company’s ability to raise additional financing and to continue as a going concern. This list is not exhaustive of the factors that may affect any of the Company’s forward-looking statements.

Due to assumptions, risks and uncertainties, including the assumptions, risks and uncertainties identified above and elsewhere in this press release, actual events may differ materially from current expectations. The Company uses forward-looking statements because it believes such statements provide useful information with respect to the currently expected future operations and financial performance of the Company, and cautions readers that the information may not be appropriate for other purposes. 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 the forward-looking statements, which speak only as of the date of this press release; they should not rely upon this information as of any other date.

The English text of this press release shall prevail over the Chinese text in case of inconsistencies.

Contact:

Investor Relations
Kino Fu
Office: +852 2156 7030
Email: kino.fu@southgobi.com

Website: www.southgobi.com