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SouthGobi Resources announces second quarter 2019 financial and operating results

HONG KONG, Aug. 13, 2019 (GLOBE NEWSWIRE) -- 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 and six months ended June 30, 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 June 30, 2019 and the subsequent period up to August 13, 2019 are as follows:

  • Operating Results – The Company increased sales volume to 0.9 million tonnes for the second quarter of 2019 from 0.6 million tonnes for the second quarter of 2018. Given the improvement of the product mix, the average realized selling price increased from $32.8 per tonne in the second quarter of 2018 to $36.8 per tonne in the second quarter of 2019.
     
  • Financial Results – The Company recorded a gross profit of $10.4 million in the second quarter of 2019 compared to $2.3 million in the second quarter of 2018, while a $5.2 million profit from operations was recorded in the second quarter of 2019 compared to a $18.2 million loss from operations in the second 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 and the provision for doubtful trade and other receivables of $14.8 million during the second quarter of 2018.
     
  • 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) $27.9 million of 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 2019 Deferral Agreement was approved at the Company’s adjourned annual and special meeting of shareholders on June 13, 2019.

    The key repayment terms of the 2019 Deferral Agreement are: (i) the Company agreed to pay a total of $14.3 million over eight instalments from 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 the common shares (the “Common Shares”); and (iii) the Company agreed to pay the remaining balance of $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 fee payable to Fullbloom as a result of the Amended and Restated Cooperation Agreement, the Company agreed to pay to Fullbloom a deferral fee at the rate of 2.5% on the outstanding service fees. Pursuant to the Amended and Restated Cooperation Agreement, the Company agreed to pay Fullbloom the total outstanding service fee and related accrued deferral fee of $4.2 million over six instalments from June 2019 to November 2019. The Company executed the Amended and Restated Cooperation Agreement with Fullbloom on April 23, 2019.

    Pursuant to their terms, both the 2019 Deferral Agreement and the Amended and Restated Cooperation Agreement became effective on June 13, 2019, being the date on which the 2019 Deferral Agreement was approved by shareholders at the Company’s adjourned annual and special meeting of shareholders.

    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, 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.       
  • 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 June 30, 2019, the outstanding amount payable to First Concept amounted to $7.7 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 Company’s board of directors (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.

    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. Please refer to the Company’s Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) for the three months ended March 31, 2019 for a summary of the key findings of the Formal Investigation, a copy of which is available under the Company’s profile on SEDAR at www.sedar.com.

    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 December 31, 2016 and December 31, 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 and six months period ended June 30, 2018, the net effect of the Prior Restatement was a decrease in the net comprehensive loss of $1.6 million and $2.0 million for the respective periods. A summary of the requisite adjustments on the financial statements for the three and six months period ended June 30, 2018 is set forth in the table below:
                   
        Three months ended       Three months ended  
$ in thousands     June 30, 2018   Loss decrease/   June 30, 2018  
Statement of comprehensive income extract     (As previously reported)   (increase)   (Restated)  
                   
Other operating expenses     $   (18,091 )   $   1,579     $    (16,512 )  
Finance income         140         (132 )       8    
                   
Net loss attributable to equity holders of the Company     $   (26,603 )   $   1,447     $    (25,156 )  
Other comprehensive income for the period         898         135         1,033    
                   
Net comprehensive loss attributable to equity holders of the Company   $   (25,705 )   $   1,582     $    (24,123 )  
                   
                   
        Six months ended       Six months ended  
$ in thousands     June 30, 2018   Loss decrease/   June 30, 2018  
Statement of comprehensive income extract     (As previously reported)   (increase)   (Restated)  
                   
Other operating expenses     $   (19,429 )   $   2,160     $    (17,269 )  
Finance income         366         (290 )       76    
                   
Net loss attributable to equity holders of the Company     $   (30,063 )   $   1,870     $    (28,193 )  
Other comprehensive loss for the period         (2,430 )       135         (2,295 )  
                   
Net comprehensive loss attributable to equity holders of the Company   $   (32,493 )   $   2,005     $    (30,488 )  
  • Resumption of Trading on HKEX and TSX – On May 30, 2019, the Company announced the Company had fulfilled the trading resumption guidance to the satisfaction of the HKEX and the HKEX and the TSX had accepted the Company’s trading resumption application. Trading in the Common Shares on the TSX and the HKEX resumed on May 30, 2019 and May 31, 2019, respectively.
     
  • Changes in Management and Directors

    Ms. Lan Cheng: Ms. Cheng did not stand for re-election at the Company’s annual and special meeting of shareholders (the “AGM”) held on May 30, 2019 and ceased to be a non-executive director following the conclusion of the AGM.

    Mr. Ben Liu: On May 30, 2019, Mr. Liu was elected as a non-executive director of the Company at the AGM.
  • Going ConcernIn 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 commissioning of the wash plant at the Ovoot Tolgoi mine was completed during the second quarter of 2019. 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 June 30, 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 August 13, 2019, the Company had $1.6 million of cash.

OVERVIEW OF OPERATIONAL DATA AND FINANCIAL RESULTS

Summary of Operational Data 

                     
      Three months ended   Six months ended  
      June 30,   June 30,  
        2019       2018       2019       2018    
  Sales Volumes, Prices and Costs                
                     
  Premium semi-soft coking coal                
  Coal sales (millions of tonnes)     0.12         0.07         0.23         0.10    
  Average realized selling price (per tonne)  $    32.72     $   59.98     $    39.72     $   62.54    
  Standard semi-soft coking coal/ premium thermal coal                
  Coal sales (millions of tonnes)     0.59         0.19         1.44         0.60    
  Average realized selling price (per tonne) $    35.67     $   33.80     $    34.29     $   42.32    
  Standard thermal coal                
  Coal sales (millions of tonnes)     -          0.32         0.09         0.44    
  Average realized selling price (per tonne) $    -      $   26.32     $    33.92     $   26.07    
  Washed coal                
  Coal sales (millions of tonnes)     0.17         -          0.18         -     
  Average realized selling price (per tonne) $    44.20     $   -      $    44.20     $   -     
  Total                
  Coal sales (millions of tonnes)     0.88         0.58         1.94         1.14    
  Average realized selling price (per tonne) $    36.80     $   32.81     $    35.77     $   37.83    
                     
  Raw coal production (millions of tonnes)     1.33         0.98         2.36         1.36    
                     
  Cost of sales of product sold (per tonne) $    25.04     $   29.27     $    23.42     $   30.44    
  Direct cash costs of product sold (per tonne) (i) $    17.18     $   10.12     $    13.71     $   13.43    
  Mine administration cash costs of product sold (per tonne) (i) $    1.39     $   1.00     $    1.40     $   1.12    
  Total cash costs of product sold (per tonne) (i) $    18.57     $   11.12     $    15.11     $   14.55    
                     
  Other Operational Data                
  Production waste material moved (millions of bank cubic     5.34       5.18         10.25       8.06    
   meters)                
  Strip ratio (bank cubic meters of waste material per tonne of     4.01       5.26         4.34       5.90    
  coal produced)                
  Lost time injury frequency rate (ii)     0.06       0.06         0.03       0.10    
                     

(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

For the three months ended June 30, 2019

For both the three months ended June 30, 2019 and June 30, 2018, the Company had a lost time injury frequency rate of 0.06 per 200,000 man hours based on a rolling 12 month average.

As a result of the improved product mix, the average realized selling price increased from $32.8 per tonne in the second quarter of 2018 to $36.8 per tonne in the second quarter of 2019.

The product mix for the second quarter of 2019 consisted of approximately 14% of premium semi-soft coking coal, 67% of standard semi-soft coking coal and 19% of washed coal compared to approximately 12% of premium semi-soft coking coal, 33% of standard semi-soft coking coal and 55% of thermal coal in the second quarter of 2018.

The Company sold 0.9 million tonnes for the second quarter of 2019 as compared to 0.6 million tonnes for the second quarter of 2018.

The Company’s production in the second quarter of 2019 was higher than the second 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 1.3 million tonnes for the second quarter of 2019 as compared to 1.0 million tonnes for the second quarter of 2018.

The Company’s unit cost of sales of product sold decreased to $25.0 per tonne in the second quarter of 2019 from $29.3 per tonne in the second quarter of 2018. The decrease was mainly driven by increased sales and the related economies of scale.

For the six months ended June 30, 2019

The Company sold 1.9 million tonnes for the first six months of 2019 as compared to 1.1 million tonnes for the first six months of 2018. The average selling price decreased from $37.8 per tonne for the first six months of 2018 to $35.8 per tonne for the first six months of 2019.

The Company’s production in the first six months of 2019 was higher than the first six months of 2018 as a result of pacing the production to meet the expected sales, yielding 2.4 million tonnes for the six months of 2019 as compared to 1.4 million tonnes for the first six months of 2018.

The Company’s unit cost of sales of product sold decreased to $23.4 per tonne in the first six months of 2019 from $30.4 per tonne in the first six months of 2018. The decrease was mainly driven by increased sales and the related economies of scale.

Summary of Financial Results

                     
      Three months ended   Six months ended  
      June 30,   June 30,  
        2019     2018 (iii)     2019     2018 (iii)  
  $ in thousands, except per share information     (Restated)       (Restated)  
                     
  Revenue (i) $    32,479     $   19,278     $    69,290     $   43,713    
  Cost of sales (i)     (22,031 )       (16,979 )       (45,436 )       (34,698 )  
  Gross profit excluding idled mine asset costs (ii)     11,318         6,079         25,675         16,329    
  Gross profit     10,448         2,299         23,854         9,015    
                     
  Other operating expenses     (2,333 )       (16,512 )       (2,747 )       (17,269 )  
  Administration expenses     (2,878 )       (3,856 )       (5,987 )       (6,233 )  
  Evaluation and exploration expenses     (23 )       (156 )       (48 )       (280 )  
  Profit/(loss) from operations     5,214         (18,225 )       15,072         (14,767 )  
  Finance costs     (7,001 )       (5,958 )       (13,740 )       (11,932 )  
  Finance income     4,305         8         4,322         76    
  Share of earnings of a joint venture     375         628         827         968    
  Income tax expense     (801 )       (1,609 )       (2,240 )       (2,538 )  
  Net profit/(loss)     2,092         (25,156 )       4,241         (28,193 )  
  Basic and diluted earnings/(loss) per share  $    0.01     $   (0.09 )   $    0.02     $   (0.10 )  
                     

(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.
(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 and six months ended June 30, 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

For the three months ended June 30, 2019

The Company recorded a $5.2 million profit from operations in the second quarter of 2019 compared to a $18.2 million loss from operations in the second quarter of 2018 (restated). The improvement of overall financial results was principally attributable to lower unit cost of sales of products sold during the quarter and the provision for doubtful trade and other receivables of $14.8 million during the second quarter of 2018.

Revenue was $32.5 million in the second quarter of 2019 compared to $19.3 million in the second quarter of 2018. The Company’s effective royalty rate for the second quarter of 2019, based on the Company’s average realized selling price of $36.8 per tonne, was 7.2% or $2.6 per tonne, compared to 9.9% or $3.2 per tonne in the second quarter of 2018 (based on the average realized selling price of $32.8 per tonne in the second 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 $22.0 million in the second quarter of 2019 compared to $17.0 million in the second 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 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 measure” for further analysis) during the quarter. 

             
          Three months ended 
June 30,
 
  $ in thousands      2019      2018   
                 
  Operating expenses     $    16,341     $   6,444    
  Share-based compensation expense         3         -     
  Depreciation and depletion         2,479         4,853    
  Royalties         2,338         1,902    
  Cost of sales from mine operations         21,161         13,199    
  Cost of sales related to idled mine assets         870         3,780    
  Cost of sales     $    22,031     $   16,979    
                       

Operating expenses in cost of sales were $16.3 million in the second quarter of 2019 compared to $6.4 million in the second quarter of 2018. The overall increase in operating expenses was primarily due to the effect of: (i) increased sales volume from 0.6 million tonnes in the second quarter of 2018 to 0.9 million tonnes in the second quarter of 2019; and (ii) higher inventory carrying costs given less deferred stripping cost was capitalized for the second quarter of 2019. 

Cost of sales related to idled mine assets in the second quarter of 2019 included $0.9 million related to depreciation expenses for idled equipment (second quarter of 2018: $3.8 million).

Other operating expenses was $2.3 million in the second quarter of 2019 (second quarter of 2018: $16.5 million). 

                 
          Three months ended 
June 30,
 
            2019       2018    
  $ in thousands         (Restated)  
                 
  Provision for doubtful trade and other receivables     $    (46 )   $   (14,834 )  
  CIC service fee         (1,422 )       (395 )  
  Foreign exchange loss         (528 )       (742 )  
  Provision for prepaid expenses and deposits         (260 )       -     
  Provision for commercial arbitration         (92 )       (230 )  
  Gain on disposal of property, plant and equipment          29       39    
  Loss on disposal of properties for resale         (14 )       -     
  Penalty on late settlement of trade payables         -          (323 )  
  Other         -          (27 )  
  Other operating expenses     $    (2,333 )   $   (16,512 )  
                 

During the second quarter of 2018, the Company made a provision for doubtful trade and other receivables of $14.8 million (second quarter of 2019: negligible) for certain long aged receivables based on expected credit loss model.

Administration expenses were $2.9 million in the second quarter of 2019 as compared to $3.9 million in the second quarter of 2018, as follows: 

                 
          Three months ended
June 30,
 
  $ in thousands       2019       2018    
                 
  Corporate administration     $    677     $   704    
  Professional fees         856         1,748    
  Salaries and benefits         1,162         1,344    
  Share-based compensation expense         11         21    
  Depreciation         172         39    
  Administration expenses     $    2,878     $   3,856    
                 

The decrease was mainly due to the decrease in professional fees incurred during the second quarter of 2019.

The Company continued to minimize evaluation and exploration expenditures in the second quarter of 2019 in order to preserve the Company’s financial resources. Evaluation and exploration activities and expenditures in the second 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 $7.0 million and $6.0 million in the second quarter of 2019 and 2018 respectively, which primarily consisted of interest expense on the $250.0 million CIC Convertible Debenture.

Finance income was $4.3 million for the second quarter of 2019 (second quarter of 2018: negligible), which primarily related to the modification of the terms of the CIC Convertible Debenture as a result of signing of the 2019 Deferral Agreement with CIC. 

For the six months ended June 30, 2019

The Company recorded a $15.1 million profit from operations in the first six months of 2019 compared to a $14.8 million loss from operations in the first six months of 2018 (restated). The improvement of overall financial results was principally attributable to lower unit cost of sales of products sold during the first six months of 2019 and the provision for doubtful trade and other receivables of $15.4 million during the first six months of 2018.

Revenue was $69.3 million in the first six months of 2019 compared to $43.7 million in the first six months of 2018. The Company sold 1.9 million tonnes of coal at an average realized selling price of $35.8 per tonne in the first six months of 2019 compared to sales of 1.1 million tonnes at an average realized selling price of $37.8 per tonne in the first six months of 2018.

The Company’s effective royalty rate for the first six months of 2019, based on the Company’s average realized selling price of $35.8 per tonne, was 6.6% or $2.4 per tonne compared to 7.1% or $2.7 per tonne based on the average realized selling price of $37.8 per tonne in the first six months of 2018.

Cost of sales was $45.4 million in the first six months of 2019 compared to $34.7 million in the first six months of 2018 as follows: 

             
          Six months ended 
June 30,
 
  $ in thousands       2019       2018    
                 
  Operating expenses     $    29,309     $   16,576    
  Share-based compensation expense         5         -     
  Depreciation and depletion         6,258         7,694    
  Royalties         4,577         3,114    
  Impairment of coal stockpile inventories         3,466         -     
  Cost of sales from mine operations         43,615         27,384    
  Cost of sales related to idled mine assets         1,821         7,314    
  Cost of sales     $    45,436     $   34,698    
                 

Operating expenses in cost of sales were $29.3 million in the first six months of 2019 compared to $16.6 million in the first six months of 2018. The increase in operating expenses was primarily related to the increase in sales volume from 1.1 million tonnes in the first six months of 2018 to 1.9 million tonnes in the first six months of 2019.

Cost of sales in the first six months 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 products.

Cost of sales related to idled mine asset costs primarily consisted of period costs, which were expensed as incurred and primarily included depreciation expense. Cost of sales related to idled mine assets in the first six months of 2019 included $1.8 million related to depreciation expenses for idled equipment (first six months of 2018: $7.3 million).

Other operating expenses were $2.7 million in the first six months of 2019 compared to $17.3 million in the first six months of 2018 as follows: 

             
          Six months ended 
June 30,
 
            2019       2018    
  $ in thousands         (Restated)  
                 
  Provision for doubtful trade and other receivables      $    (97 )   $   (15,356 )  
  CIC service fee         (2,180 )       (978 )  
  Provision for commercial arbitration         (226 )       (454 )  
  Provision for prepaid expenses and deposits         (260 )       -     
  Penalty on late settlement of trade payables         -          (427 )  
  Loss on disposal of properties for resale         (14 )       -     
  Gain/(loss) on disposal of property, plant and equipment         29         (28 )  
  Foreign exchange gain         1         37    
  Other         -          (63 )  
  Other operating expenses     $    (2,747 )   $   (17,269 )  
                 

During the first six months of 2018, the Company made a provision for doubtful trade and other receivables of $15.4 million (first six months of 2019: negligible) for certain long aged receivables based on expected credit loss model.

Administration expenses were $6.0 million in the first six months of 2019 compared to $6.2 million in the first six months of 2018 as follows:

                 
             
          Six months ended 
June 30,
 
  $ in thousands       2019       2018    
                 
  Corporate administration     $    1,098     $   1,372    
  Professional fees         2,303         2,263    
  Salaries and benefits         2,231         2,478    
  Share-based compensation expense         23         37    
  Depreciation         332         83    
  Administration expenses     $    5,987     $   6,233    
                 

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

Finance costs were $13.7 million and $11.9 million in the first six months of 2019 and 2018 respectively. This primarily consisted of interest expense on the CIC Convertible Debenture.

Finance income was $4.3 million for the first six month of 2019 (first six months of 2018: negligible), which primarily related to the modification of the terms of the CIC Convertible Debenture as a result of signing of the 2019 Deferral Agreement with CIC.

Summary of Quarterly Operational Data 

                           
      2019       2018       2017      
Quarter Ended 30-Jun 31-Mar   31-Dec 30-Sep 30-Jun 31-Mar   31-Dec 30-Sep    
                           
Sales Volumes, Prices and Costs                        
                           
Premium semi-soft coking coal                        
Coal sales (millions of tonnes)     0.12       0.11         0.24       0.25       0.07       0.03         0.37       0.12      
Average realized selling price (per tonne)  $    32.72   $   47.34     $   47.37   $   48.15   $   59.98   $   67.94     $   50.47   $   46.55      
Standard semi-soft coking coal/ premium thermal coal                        
Coal sales (millions of tonnes)     0.59       0.85         0.40       0.26       0.19       0.41         0.60       0.41      
Average realized selling price (per tonne)  $    35.67   $   33.34     $   32.60   $   34.40   $   33.80   $   46.34     $   37.49   $   28.32      
Standard thermal coal                        
Coal sales (millions of tonnes)     -        0.09         0.12       0.22       0.32       0.12         0.29       0.27      
Average realized selling price (per tonne)  $    -    $   34.88     $   24.26   $   23.49   $   26.32   $   25.40     $   16.98   $   14.48      
Washed coal                        
Coal sales (millions of tonnes)     0.17       0.01         0.15       -        -        -          -        -       
Average realized selling price (per tonne)  $    44.20   $   45.07     $   44.02   $   -    $   -    $   -      $   -    $   -       
Total                        
Coal sales (millions of tonnes)     0.88       1.06         0.91       0.73       0.58       0.56         1.26       0.80      
Average realized selling price (per tonne)  $    36.80   $   34.91     $   37.32   $   35.77   $   32.81   $   43.02     $   36.54   $   26.41      
                           
Raw coal production (millions of tonnes)     1.33       1.03         1.87       1.11       0.98       0.38         0.51       2.47      
                           
Cost of sales of product sold (per tonne) $    25.04   $   22.08     $   30.80   $   23.44   $   29.27   $   31.64     $   23.54   $   31.31      
Direct cash costs of product sold (per tonne) (i) $    17.18   $   10.82     $   8.73   $   7.41   $   10.12   $   16.86     $   9.91   $   10.98      
Mine administration cash costs of product sold (per tonne) (i) $    1.39   $   1.41     $   2.19   $   1.24   $   1.00   $   1.23     $   4.92   $   2.98      
Total cash costs of product sold (per tonne) (i) $    18.57   $   12.23     $   10.92   $   8.65   $   11.12   $   18.09     $   14.83   $   13.96      
                           
Other Operational Data                        
                           
Production waste material moved (millions of bank     5.34       4.91         5.54       4.56       5.18       2.88         4.36       6.77      
cubic meters)                        
Strip ratio (bank cubic meters of waste material per tonne of     4.01       4.76         2.97       4.11       5.26       7.55         8.59       2.74      
coal produced)                        
Lost time injury frequency rate (ii)     0.06       0.00         0.00       0.00       0.06       0.13         0.20       0.23      
                           

(i) A Non-IFRS financial measure. 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.

Summary of Quarterly Financial Results

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

                           
$ in thousands, except per share information   2019       2018       2017      
    30-Jun 31-Mar   31-Dec 30-Sep 30-Jun 31-Mar   31-Dec 30-Sep    
Quarter Ended         (Restated) (Restated) (Restated)   (Restated) (Restated)    
Financial Results                        
Revenue (i) $    32,479   $   36,811     $   33,814   $   26,277   $   19,278   $   24,435     $   41,698   $   19,356      
Cost of sales (i)     (22,031 )     (23,405 )       (28,027 )     (17,110 )     (16,979 )     (17,719 )       (29,665 )     (25,049 )    
Gross profit/(loss) excluding idled mine asset costs     11,318       14,357         7,305       13,195       6,079       10,250         15,682       (2,094 )    
Gross profit/(loss) including idled mine asset costs     10,448       13,406         5,787       9,167       2,299       6,716         12,033       (5,693 )    
                           
Other operating income/(expenses)     (2,333 )     (414 )       (2,921 )     (3,417 )     (16,512 )     (757 )       (4,971 )     3,097      
Administration expenses     (2,878 )     (3,109 )       (1,583 )     (2,724 )     (3,856 )     (2,377 )       (2,111 )     (2,451 )    
Evaluation and exploration expenses     (23 )     (25 )       (36 )     (40 )     (156 )     (124 )       (52 )     (48 )    
Impairment of property, plant and equipment     -        -          -        -        -        -          (11,171 )     -       
Profit/(loss) from operations     5,214       9,858         1,247       2,986       (18,225 )     3,458         (6,272 )     (5,095 )    
                           
Finance costs     (7,001 )     (6,739 )       (10,899 )     (5,758 )     (5,958 )     (6,006 )       (5,960 )     (5,674 )    
Finance income     4,305       17         13       106       8       100         143       142      
Share of earnings of a joint venture     375       452         416       247       628       340         368       265      
Income tax credit/(expense)     (801 )     (1,439 )       (1,023 )     (267 )     (1,609 )     (929 )       781       238      
                           
Net profit/(loss)     2,092       2,149         (10,246 )     (2,686 )     (25,156 )     (3,037 )       (10,940 )     (10,124 )    
Basic and diluted earnings/(loss) per share  $    0.01   $   0.01     $   (0.04 ) $   (0.01 ) $   (0.09 ) $   (0.01 )   $   (0.04 ) $   (0.04 )    
                           

(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 Limited (“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 LIBOR Rate in effect plus 11% per annum; a commitment fee of 35% of interest rate payable quarterly in arrears on undrawn principal amount of facility and a front end fee of $0.1 million.

The Company repaid $0.2 million during the second quarter of 2019 and, as of the date hereof, the principal and accrued interest of the Turquoise Hill Loan Facility has been fully repaid.

Bank Loan

On May 15, 2018, SGS obtained a bank loan (the “2018 Bank Loan”) in the principal amount of $2.8 million from a Mongolian bank (the “Bank”) with the key commercial terms as follows:

  • Principal amount 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 the 2018 Bank Loan. As at June 30, 2019, the net book value of the pledged items of property, plant and equipment was $1.0 million (December 31, 2018: $2.6 million).

As at June 30, 2019, the outstanding principal balance of the 2018 Bank Loan was $2.8 million (December 31, 2018: $2.8 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 the private placement with Novel Sunrise Investments Limited (“Novel Sunrise”) on April 23, 2015, Rio Tinto plc (“Rio Tinto”) was the Company’s ultimate parent company. In the past, Rio Tinto has 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 June 30, 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. 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 June 30, 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 $44.8 million as at June 30, 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 $118.2 million as at June 30, 2019 compared to a working capital deficiency of $203.1 million as at December 31, 2018.

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, pursuant to which the Company agreed to pay a total of $14.3 million over eight instalments from November 2019 to June 2020 and the remaining balance of $62.6 million on June 20, 2020.

The Company also has other current liabilities, which require settlement in the short-term, including: the $7.7 million owing to First Concept under the Settlement Deed and $30.3 million of unpaid taxes payable by SGS to the Mongolian government.

Further, the trade and other payables of the Company remain high due to liquidity constraints. The aging profile of the trade and other payables as at June 30, 2019 as compared to that as at December 31, 2018, is as follows: 

             
        As at  
        June 30,   December 31,  
$ in thousands        2019    2018  
               
Less than 1 month     $    28,295   $   34,927  
1 to 3 months         13,261       16,336  
3 to 6 months         11,757       5,446  
Over 6 months         35,851       42,867  
Total trade and other payables     $    89,164   $   99,576  
               

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 August 13, 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 commissioning of the wash plant at the Ovoot Tolgoi mine was completed during the second quarter of 2019. 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 June 30, 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.

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 June 30, 2019 and December 31, 2018, the Company was not subject to any externally imposed capital requirements.

As at August 13, 2019, the Company had $1.6 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 June 30, 2019, CIC owned, through its indirect wholly-owned subsidiary, approximately 23.8% of the issued and outstanding Common Shares.

On June 12, 2017, the Company executed the June 2017 Deferral Agreement with CIC for a revised repayment schedule on the $22.3 million of cash interest and associated costs originally due under the CIC Convertible Debenture on May 19, 2017. The key repayment terms of the June 2017 Deferral Agreement are: (i) the Company is 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 is required to repay $9.7 million of cash interest and associated costs on November 19, 2017.

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) $27.9 million of 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 2019 Deferral Agreement was approved at the Company’s adjourned annual and special meeting of shareholders on June 13, 2019.

The key repayment terms of the 2019 Deferral Agreement are: (i) the Company agreed to pay a total of $14.3 million over eight instalments from 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 the remaining balance of $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.

At any time before the payment under the terms of the 2019 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.

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 additional service fees payable to Fullbloom as a result of the Amended and Restated Cooperation Agreement, the Company agreed to pay to Fullbloom a deferral fee at the rate of 2.5% on the outstanding service fee. Pursuant to the Amended and Restated Cooperation Agreement, the Company agreed to pay Fullbloom the total outstanding service fee and related accrued deferral fee of $4.2 million over six instalments from June 2019 to November 2019. The Company executed the Amended and Restated Cooperation Agreement with Fullbloom on April 23, 2019.

Pursuant to their terms, both the 2019 Deferral Agreement and the Amended and Restated Cooperation Agreement became effective on June 13, 2019, being the date on which the 2019 Deferral Agreement was approved by shareholders at the Company’s adjourned annual and special meeting of shareholders
       
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, 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.

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.

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 ruling (final except as to costs) with respect to the commercial arbitration (the “Arbitration Award”). 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 June 30, 2019, the outstanding payables to First Concept amounted to $7.7 million (December 31, 2018: $12.5 million).

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. 

On consent of the plaintiff, the former senior officers and directors, originally sued as defendants, were withdrawn from the Class Action in December 2018.   

Counsel for the parties have appeared in two case conferences 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.  A third case conference may be necessary.

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 June 30, 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 coal 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 this $18.5 million will be required to be paid. Accordingly, the Company has determined a provision for this matter at June 30, 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”) with an exclusive right of ownership of the Paved Highway for 30 years. The Company has an indirect 40% interest in RDCC LLC through its Mongolian subsidiary SGS. The toll rate is MNT 1,500 per tonne.

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

For the three and six months ended June 30, 2019, RDCC LLC recognized toll fee revenue of $1.8 million (2018: $2.5 million) and $3.7 million (2018: $4.1 million), respectively.

PLEDGE OF ASSETS

As at June 30, 2019, certain of the Company’s property, plant and equipment of $1.0 million (December 31, 2018: $2.6 million) were pledged as security for a bank loan granted to the Company.

PURCHASE, SALE OR REDEMPTION OF LISTED SECURITIES OF THE COMPANY

The Company did not redeem its listed securities, nor did the Company or any of its subsidiaries purchase or sell such securities during the six months ended June 30, 2019.

COMPLIANCE WITH CORPORATE GOVERNANCE

The Company has, throughout the six months ended June 30, 2019, applied the principles and complied with the requirements of its corporate governance practices as defined by the Board and all applicable statutory, regulatory and stock exchange listings standards, which include the code provisions set out in the Corporate Governance Code (the “Corporate Governance Code”) contained in Appendix 14 to the Rules Governing the Listing of Securities on the Hong Kong Stock Exchange (the “Hong Kong Listing Rules”), except for the following:

Pursuant to code provision A.2.7 of the Corporate Governance Code, the chairman of the board should at least annually hold meetings with the non-executive directors (including independent non-executive directors) without the executive directors present. The Company does not have a Chairman since the conclusion of the AGM held on June 30, 2017. During the period of January 1, 2019 to June 30, 2019 there were no meetings between the Independent Lead Director, who is fulfilling the duties of the Chairman, and the non-executive directors without the presence of other executive directors. The opportunity for such communication channel is offered at the end of each Board meeting.

SECURITIES TRANSACTIONS BY DIRECTORS

The Company has adopted policies regarding Directors’ securities transactions in its Corporate Disclosure, Confidentiality and Securities Trading Policy that have terms that are no less exacting than those set out in the Model Code for Securities Transactions by Directors of Listed Issuers contained in Appendix 10 to the Hong Kong Listing Rules.

In response to a specific enquiry made by the Company on each of the directors, all directors confirmed that they had complied with the required standards as set out in the Model Code and the Company’s Corporate Disclosure, Confidentiality and Securities Trading Policy throughout the six months ended June 30, 2019.

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, 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)

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