UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-QSB (Mark One) [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended June 30, 2000 or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ______ to ________ Commission File Number 2-93124 SGI International (Exact name of small business issuer as specified in its charter) Utah 33-0119035 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1200 Prospect Street, Suite 325, La Jolla, California 92037 (Address of principal executive offices) (858) 551-1090 (Issuer's telephone number) (Former name, former address and former fiscal year, if changed since last report) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No The number of shares of common stock, no par value, outstanding as of August 11, 2000, was 67,646,849. Transitional Small Business Disclosure Format (Check one): [ ] Yes [X] No TABLE OF CONTENTS FORM 10-QSB PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Condensed Consolidated Balance Sheets 3 Condensed Consolidated Statements of Operations 4 Condensed Consolidated Statement of Stockholders' Deficiency 5 Condensed Consolidated Statements of Cash Flows 6 Notes to Condensed Unaudited Consolidated Financial Statements 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Introductory Note 11 Results of Operations 12 Liquidity and Capital Resources 13 Accounting Pronouncements 15 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 15 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS 15 ITEM 2. CHANGES IN SECURITIES 15 ITEM 3. DEFAULTS UPON SENIOR DEBT SECURITIES 16 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 16 ITEM 5. OTHER INFORMATION 17 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 17 PART III. SIGNATURES 18 SGI INTERNATIONAL 2 SGI INTERNATIONAL AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS June 30, December 31, 2000 1999 (Unaudited) ==================================================================================================================== ASSETS Current assets: Cash $ 308,737 $ 278,391 Restricted time deposit - 402,500 Trade accounts receivable, less allowance for doubtful accounts of $71,587 and $80,320 864,485 661,880 Costs and estimated earnings in excess of billings on contracts 117,746 99,580 Inventories 412,672 413,716 Prepaid expenses and other current assets 158,423 102,624 Total current assets 1,862,063 1,958,691 - -------------------------------------------------------------------------------------------------------------------- LFC royalty rights, net 785,625 942,750 LFC cogeneration project, net 157,926 210,568 Investment in LFC Investees 244,733 266,813 LFC related notes receivable, net 150,000 150,000 LFC process equipment, net 525,618 355,886 Other LFC assets, net 25,641 26,757 Property, plant and equipment, net of accumulated depreciation of $1,486,372 and $1,340,622 2,397,081 2,514,595 Goodwill, net of accumulated amortization of $216,619 and $192,653 263,625 287,591 Interest receivable on notes from stockholders 18,788 - - -------------------------------------------------------------------------------------------------------------------- $ 6,431,100 $ 6,713,651 ==================================================================================================================== LIABILITIES AND STOCKHOLDERS' DEFICIENCY Current liabilities: Accounts payable $ 925,609 $ 849,140 Notes payable 996,408 881,408 Accrued salaries, benefits and related taxes 958,419 770,167 Billings in excess of costs and estimated earnings on contracts 627,844 500,407 Borrowings on line-of-credit - 400,000 Interest payable 210,823 182,492 Current maturities of long-term notes payable 27,375 7,125 Other accrued expenses 161,276 188,530 - -------------------------------------------------------------------------------------------------------------------- Total current liabilities 3,907,754 3,779,269 Long-term debt, less current maturities 6,319,449 6,250,386 - -------------------------------------------------------------------------------------------------------------------- Total liabilities 10,227,203 10,029,655 - -------------------------------------------------------------------------------------------------------------------- Commitments and contingencies Minority interest 461,762 471,000 - -------------------------------------------------------------------------------------------------------------------- Stockholders' deficiency: Convertible preferred stock 605 605 Common stock 52,471,503 49,890,623 Paid-in capital 6,994,978 7,021,879 Accumulated deficit (63,253,951) (60,229,111) Less notes receivable from stockholders (471,000) (471,000) - -------------------------------------------------------------------------------------------------------------------- Total stockholders' deficiency (4,257,865) (3,787,004) - -------------------------------------------------------------------------------------------------------------------- $ 6,431,100 $ 6,713,651 ==================================================================================================================== See notes to condensed consolidated financial statements. SGI INTERNATIONAL 3 SGI INTERNATIONAL AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) Three months Six months ended June 30, ended June 30, 2000 1999 2000 1999 ================================================================================================================================ REVENUES: Contract revenues $ 1,325,691 $ 767,976 $ 2,381,402 $ 1,451,484 - -------------------------------------------------------------------------------------------------------------------------------- EXPENSES: Cost of sales 1,002,463 438,619 1,812,178 914,837 Engineering, research and development 385,157 525,962 753,887 808,687 Selling, general and administrative 992,122 867,843 1,827,706 1,616,467 Loss on LFC Investees 3,226 - 22,079 - Legal and accounting 85,482 167,474 182,957 326,145 Depreciation and amortization 218,320 231,028 444,429 542,506 - ------------------------------------------------------------------------------------------------------------------------------- Total expenses 2,686,770 2,230,926 5,043,236 4,208,642 - ------------------------------------------------------------------------------------------------------------------------------- Loss from operations (1,361,079) (1,462,950) (2,661,834) (2,757,158) NON-OPERATING INCOME (EXPENSES): Interest expense (203,489) (161,566) (413,716) (312,348) Other income 22,449 13,157 41,472 30,889 - -------------------------------------------------------------------------------------------------------------------------------- Loss before minority interest in consolidated subsidiary (1,542,119) (1,611,359) (3,034,078) (3,038,617) Minority interest in loss of consolidated subsidiary 4,074 - 9,238 - - -------------------------------------------------------------------------------------------------------------------------------- Net loss $ (1,538,045) $ (1,611,359) $ (3,024,840) $ (3,038,617) ================================================================================================================================ PREFERRED STOCK DIVIDENDS: Imputed preferred stock dividends and accretion on convertible and mandatorily redeemable preferred stock $ - $ 36,382 $ - $ 36,382 - -------------------------------------------------------------------------------------------------------------------------------- Net loss applicable to common stock $ (1,538,045) $ (1,647,741) $ (3,024,840) $ (3,074,999) - -------------------------------------------------------------------------------------------------------------------------------- Net loss per common share - basic $ (0.02) $ (0.05) $ (0.05) $ (0.10) ================================================================================================================================ Weighted average common shares outstanding 63,494,131 35,193,496 60,069,264 29,891,480 ================================================================================================================================ See notes to condensed consolidated financial statements. SGI INTERNATIONAL 4 SGI INTERNATIONAL AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIENCY (Unaudited) Convertible Preferred Stock Common Stock Total ----------------- ----------------------- Paid-In Accumulated Notes Stockholders' Shares Amount Shares Amount Capital Deficit Receivable Deficiency ==================================================================================================================================== Balances at December 31, 1999 60,541 $ 605 54,053,293 $49,890,623 $7,021,879 $(60,229,111) $(471,000) $(3,787,004) Issuance of common stock for cash, net 9,794,655 2,043,195 2,043,195 Exercise of warrants to purchase common stock for cash 20,000 2,500 2,500 Issuance of common stock for notes payable and interest 1,620,809 401,172 401,172 Issuance of common stock for services 459,717 95,700 95,700 Conversion of preferred stock (23) - 312,386 38,313 (38,313) - Issuance of warrants to purchase common stock to non-employees 11,412 11,412 Net loss (3,024,840) (3,024,840) - ------------------------------------------------------------------------------------------------------------------------------------ Balances at June 30, 2000 60,518 $ 605 66,260,860 $52,471,503 $6,994,978 $(63,253,951) $(471,000) $(4,257,865) ==================================================================================================================================== See notes to condensed consolidated financial statements. SGI INTERNATIONAL 5 SGI INTERNATIONAL AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Six months ended June 30, 2000 1999 ========================================================================================================== Operating activities: Net loss $ (3,024,840) $ (3,038,617) Adjustments to reconcile net loss to net cash used in operating activities: Equity in net loss of LFC Investees 22,080 - Depreciation and amortization 444,429 542,506 Common stock issued for services 95,700 39,075 Non-employee compensation expense on issuance of warrants 11,412 18,765 Imputed and accrued interest on warrants issued to note holders - 21,107 Accrued long-term interest expense 94,063 - Accrued interest income (18,788) - Minority interest in loss of consolidated subsidiary (9,238) - Changes in operating assets and liabilities: Restricted time deposit 402,500 - Trade accounts receivable (220,771) (49,786) Inventories 1,044 1,250 Prepaid expenses and other current assets (55,799) 15,264 Accounts payable 76,469 519,327 Billings in excess of costs and estimated earnings on contracts 127,437 298,427 Accrued salaries, benefits and related taxes 188,252 282,500 Interest payable 43,798 12,760 Other accrued expenses (27,254) 89,652 - ---------------------------------------------------------------------------------------------------------- Net cash used in operating activities (1,849,506) (1,247,770) - ---------------------------------------------------------------------------------------------------------- Investing activities: Additions to LFC Process equipment (233,562) (85,419) Investment in LFC Investees - (990) Purchase of property and equipment (28,236) (18,400) Other assets - (9,247) - ---------------------------------------------------------------------------------------------------------- Net cash used in investing activities (261,798) (114,056) - ---------------------------------------------------------------------------------------------------------- Financing activities: Payments of notes payable (4,750) (4,750) Payments on line-of-credit (400,000) - Proceeds from issuance of debt 500,705 825,000 Proceeds from issuance of common stock 2,045,695 645,500 - ---------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 2,141,650 1,465,750 - ---------------------------------------------------------------------------------------------------------- Net increase in cash 30,346 103,924 Cash at beginning of period 278,391 239,885 - ---------------------------------------------------------------------------------------------------------- Cash at end of period $ 308,737 $ 343,809 ========================================================================================================== Supplemental disclosure of cash flow information: Interest paid 261,873 $ 264,715 Supplemental disclosure of non-cash activities: Conversion of preferred stock 38,313 1,029,205 Common stock issued for convertible debentures - 68,107 Common stock issued for debt and interest 401,172 - Common stock issued for mandatorily redeemable preferred stock - 1,072,833 ========================================================================================================== See notes to condensed consolidated financial statements. SGI INTERNATIONAL 6 SGI INTERNATIONAL AND SUBSIDIARIES NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS June 30, 2000 (1) BUSINESS SGI International, a Utah corporation, (together with its subsidiaries, hereinafter referred to as the "Company"), has its corporate office in La Jolla, California. The Company is primarily in the business of developing and marketing energy-related technologies, which at the present include the Liquids From Coal ("LFC") Process and the Opti-Crude Enhancement Technology ("OCET") Process. The LFC Process is designed to convert and upgrade low-rank coal to create a higher Btu more efficient and less environmentally polluting fuel to produce power and simultaneously produce low temperature coal tars, which contain valuable specialty chemicals. The OCET Process is designed to increase the efficiency of oil refineries by deasphalting crude oil as well as residual oil bottoms ("resid"), which is produced in oil refining. Through Assembly & Manufacturing Systems, Inc. ("AMS"), a wholly-owned subsidiary, the Company is also in the business of supplying custom precision automated assembly equipment. (2) BASIS OF PRESENTATION The accompanying condensed consolidated financial statements of SGI International and subsidiaries (the "Company") for the three and six month periods ended June 30, 2000, and 1999, are unaudited and have been prepared in accordance with generally accepted accounting principles for interim financial information and the instructions to Form 10-QSB. Accordingly, they do not include all information and footnotes required by generally accepted accounting principles for complete financial statements. These financial statements reflect all adjustments, consisting of only normal recurring adjustments which, in the opinion of management, are necessary for a fair statement of the consolidated financial position as of June 30, 2000, and the consolidated results of operations for the three and six month periods ended June 30, 2000, and 1999, and cash flows for the six month periods ended June 30, 2000, and 1999. The results of operations for the six months ended June 30, 2000, are not necessarily indicative of the results to be expected for the year ending December 31, 2000. For more complete financial information, these financial statements, and the notes thereto, should be read in conjunction with the consolidated audited financial statements for the year ended December 31, 1999, included in the Company's Form 10-KSB filed with the Securities and Exchange Commission. The accompanying consolidated financial statements are prepared on a going concern basis and in conformity with generally accepted accounting principles, which contemplates continuation of the Company as a going concern and realization of assets and settlement of liabilities and commitments in the normal course of business. The recovery of amounts invested in the Company's principal assets, the LFC Process and OCET Process assets, is dependent upon the Company's ability to adequately fund its on-going development operations and eventual commercialization of these technologies. Furthermore, the ability to successfully bring both the LFC Process and OCET Process technologies to commercialization will ultimately depend on the Company's ability to attract sufficient additional equity, debt or other third-party financing. Success in commercialization of the LFC Process and OCET Process is dependent in large part upon the ability to enter into satisfactory arrangements with other partners, financiers or customers and upon the ability of these third parties to perform their responsibilities. The resources required to profitably develop, construct and operate an LFC plant are likely to include hundreds of millions of dollars, and expertise in major plant development and operations. There can be no assurance any licenses, joint venture agreements or other arrangements will be available on acceptable terms, if at all; that any revenue will be derived from such arrangements; or that, if revenue is generated, any of said arrangements will be profitable to the Company. If the Company is unsuccessful in its attempts to license the LFC Process or SGI INTERNATIONAL 7 OCET Process, or if such third parties are unsuccessful in profitably developing and operating LFC plants, the planned business and operations of the Company will likely not succeed and the Company would not be able to recover the carrying value of the long-lived assets related to either the LFC Process or OCET Process. The Company had negative working capital of approximately $2.0 million and an accumulated deficit of $63.3 million at June 30, 2000. These factors and the Company's recurring losses from continuing operations, among others, raise substantial doubt about the Company's ability to continue as a going concern. The Company is currently seeking additional financing through public or private sales of its securities to fund working capital requirements. The Company will also seek funding through additional strategic partnerships, joint ventures or similar arrangements to commercialize the technologies. There can be no assurance that any collaborative financing arrangements through a joint venture, and/or with strategic partners, will be available when needed, or on terms acceptable to the Company. If adequate funds are not available, the Company may be required to curtail or terminate one or more of its operating activities. The Company is engaged in continuing negotiation to secure additional capital and financing, and while management believes funds can be raised, there is no assurance that their efforts will be successful. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. (3) FINANCING TRANSACTIONS On June 8, 2000, the Company as provided in a related consulting agreement, granted one warrant to purchase an aggregate of 48,000 common shares, to one consultant for services rendered. The warrants were issued pursuant to the exemptions provided by Section 4(2) of the Securities Act and Regulation D and investment representations were obtained and legends were placed on the certificate. In connection therewith, the Company recorded compensation expense of approximately $7,000. The exercise price was not lower than the closing bid price on the grant date. The warrant is exercisable one year from the grant date at $0.225 per share and expires on December 31, 2005. During the three month period ended June 30, 2000, the Company raised approximately $834,000 through the issuance of approximately 4,457,000 restricted common shares to accredited investors. These securities were issued pursuant to the exemptions provided by Section 4(2) of the Securities Act and Regulation D. Investment representations were obtained and legends placed on the certificates. During the three month period ended June 30, 2000, the Company in conjunction with its private placements, paid cash of approximately $16,000, issued 182,271 shares of restricted common stock valued at $46,000 and accrued a liability of approximately $27,000 to be paid through the issuance of approximately 144,000 shares of restricted common stock, as compensation for placement agent services. On June 30, 2000, the Company exchanged one unsecured 9% note payable with a face value of $31,000 due on demand but no sooner than June 15, 2000, for a new note payable of equal value. The new note is payable upon 30 days written demand but no sooner than January 25, 2001. Both the principal and accrued interest thereon may be paid in cash or at the option of the Company on January 25, 2001, by issuing 366,482 shares of restricted common stock. The security was issued pursuant to the exemptions provided by Section 4(2) of the Securities Act and Regulation D. Investment representations were obtained from the accredited investor. On June 30, 2000, the Company exchanged one unsecured 9% note payable with a face value of $9,000 due on demand but no sooner than June 15, 2000, for a new note payable of equal value. The new note is payable upon 30 days written demand but no sooner than November 30, 2000. Both the principal and accrued interest thereon may be paid in cash or at the option of the Company on November 30, 2000, by SGI INTERNATIONAL 8 issuing 94,737 shares of restricted common stock. The security was issued pursuant to the exemptions provided by Section 4(2) of the Securities Act and Regulation D. Investment representations were obtained from the accredited investor. On June 30, 2000, the Company issued for cash a $75,000 unsecured 9% note payable to one accredited investor. The note is payable upon 30 days written demand but no sooner than December 15, 2000. Both the principal and accrued interest thereon may be paid in cash or at the option of the Company, on December 15, 2000, by issuing 882,331 shares of restricted common stock. The security was issued pursuant to the exemptions provided by Section 4(2) of the Securities Act and Regulation D. Investment representations were obtained from the accredited investor. During the three month period ended June 30, 2000, the Company as provided in their related consulting agreements issued approximately 50,000 restricted common shares to two consultants for services rendered, valued by the parties at approximately $10,000. These securities were issued pursuant to the exemptions provided by Section 4(2) of the Securities Act and Regulation D. Investment representations were obtained and legends were placed on the certificates. (4) NET LOSS PER SHARE Basic net loss per share is computed based on the weighted average number of common shares outstanding and includes preferred stock dividends. Diluted net loss per share is not presented since the effect of shares issuable upon the assumed conversion of preferred stock and convertible debentures and the assumed exercise of outstanding stock options and warrants would be anti-dilutive. For purposes of computing net loss per share, preferred stock dividends include "imputed dividends" for preferred stock issued with a non-detachable beneficial conversion feature near the date of issuance. Imputed dividends represent the aggregate difference between conversion price and the fair market value of the common stock as of the date of issuance of the preferred stock. (5) COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS Inventories Inventories are stated at the lower of cost or market, using the first-in, first-out cost method. Substantially, all inventories represent finished goods held for use in operations. Property and Equipment June 30, December 31, 2000 1999 ==================================================================== ENCOAL LFC Plant $ 2,121,000 $ 2,121,000 Laboratory equipment 1,030,000 1,020,000 Machinery and equipment 137,000 136,000 Computer equipment 416,000 400,000 Office furniture and fixtures 125,000 125,000 Leasehold improvements 54,000 54,000 - -------------------------------------------------------------------- 3,883,000 3,856,000 Less accumulated depreciation (1,486,000) (1,341,000) - -------------------------------------------------------------------- Net property and equipment $ 2,397,000 $ 2,515,000 ==================================================================== (6) SEGMENT REPORTING The Company manages its segments based on strategic business units that are in turn based along technological lines. These strategic business units offer products and services to different markets in SGI INTERNATIONAL 9 accordance with their underlying technology. Accordingly, the Company's three business segments are centered on the operations associated with the LFC Process, the OCET Process and automated assembly and manufacturing systems. The Company's operations are primarily centered in the United States, however, through its joint venture with MLFC, a subsidiary of Mitsubishi Corp., the Company's LFC Process technology will continue to be marketed on an international basis. The Company evaluates performance of each segment based on profit or loss from operations before income taxes. The Company has no significant intersegment sales. Reclassification of certain items has been made to the 1999 schedule to conform to the 2000 presentation. Three months ended Automated LFC OCET June 30 Assembly Process Process Corporate Total ================================================================================================================ 2000 Revenues $ 1,322,000 $ - $ 4,000 $ - $ 1,326,000 Net income (loss) 122,000 (676,000) (136,000) (848,000) (1,538,000) Equity in operations of investee - (3,000) - - (3,000) Depreciation & Amortization 32,000 137,000 46,000 3,000 218,000 Engineering, research and consulting expenditures - 242,000 103,000 40,000 385,000 Interest expense - - - 203,000 203,000 - ---------------------------------------------------------------------------------------------------------------- 1999 Revenues $ 374,000 $ 375,000 $ 19,000 $ - $ 768,000 Net loss (322,000) (4,000) (330,000) (955,000) (1,611,000) Equity in operations of investee - - - - - Depreciation & Amortization 29,000 112,000 87,000 3,000 231,000 Engineering, research and consulting expenditures - 268,000 258,000 - 526,000 Interest expense - - - 162,000 162,000 ================================================================================================================ Six months ended Automated LFC OCET June 30 Assembly Process Process Corporate Total ================================================================================================================ 2000 Revenues $ 2,376,000 $ - $ 5,000 $ - $ 2,381,000 Net income (loss) 157,000 (1,355,000) (308,000) (1,519,000) (3,025,000) Equity in operations of investee - (22,000) - - (22,000) Depreciation & Amortization 63,000 275,000 99,000 7,000 444,000 Engineering, research and consulting expenditures - 477,000 237,000 40,000 754,000 Interest expense 1,000 - - 413,000 414,000 - ---------------------------------------------------------------------------------------------------------------- 1999 Revenues $ 933,000 $ 500,000 $ 18,000 $ - $ 1,451,000 Net loss (489,000) (94,000) (677,000) (1,779,000) (3,039,000) Equity in operations of investee - - - - - Depreciation & Amortization 58,000 303,000 174,000 8,000 543,000 Engineering, research and consulting expenditures - 291,000 518,000 - 809,000 Interest expense 1,000 - - 311,000 312,000 ================================================================================================================ SGI INTERNATIONAL 10 June 30, December 31, Total Assets by Segment 2000 1999 ============================================================ Identifiable assets, net Automated Assembly $ 1,684,000 $ 1,414,000 LFC Process 4,373,000 4,425,000 OCET Process 192,000 281,000 Corporate 182,000 594,000 - ------------------------------------------------------------ Total $ 6,431,000 $ 6,714,000 ============================================================ (7) LINE-OF-CREDIT In May 2000 the Company, upon maturity of a $402,500 certificate of deposit securing its borrowings under a $400,000 line-of-credit, used the proceeds to pay-off the borrowing and closed the line. (8) LEASES During the period ended June 30, 2000, the Company renewed its operating leases for its corporate offices and its OCET facilities. The Company leases its corporate offices under an operating lease agreement which provides for annual escalation of rental payments which now expires in December 2005. The Company's OCET subsidiary leases its laboratory facilities under an operating lease agreement which expires in May 2003. AMS leases its manufacturing facility under an operating lease agreement which expired in October 1998 and is currently on a monthly basis. Under the terms of these lease agreements, the lessee pays taxes, maintenance and insurance. As of June 30, 2000, the Company had no other significant commitments under capital or operating leases. Future minimum annual operating lease commitments, by fiscal year and in the aggregate, under noncancelable operating leases with initial or remaining terms of one year or more, consisted of the following as of June 30, 2000. Fiscal Year End Amount =============================== 2000 $ 254,000 2001 307,000 2002 314,000 2003 252,000 2004 189,000 Thereafter 192,000 - ------------------------------- $ 1,508,000 =============================== (9) RECLASSIFICATION Certain prior period amounts have been reclassified to conform to the current period presentation. These changes had no impact on previously reported results of operations, cash flows or stockholders' deficiency. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INTRODUCTORY NOTE This Quarterly Report on Form 10-QSB contains statements relative to (i) projections, (ii) estimates, (iii) future research plans and expenditures, (iv) potential collaborative arrangements, (v) opinions of management and (vi) the need for and availability of additional financing which may be considered "forward looking statements." SGI INTERNATIONAL 11 The forward-looking statements included herein are based on current expectations that involve a number of risks and uncertainties. These forward-looking statements are based on assumptions regarding the Company's business and technology, which involve judgments with respect to, among other things, future scientific, economic and competitive conditions, and future business decisions, as well as risk factors detailed from time to time in the Company's Securities and Exchange Commission reports (including this Form 10-QSB) and are difficult or impossible to predict accurately and many of which are beyond the control of the Company. Although the Company believes that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate and, therefore, there can be no assurance that the results contemplated will be realized and actual results may differ materially. Readers are urged to carefully review and consider the various disclosures made by the Company in this report and in the Company's other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks and factors that may affect the Company's business. Therefore, historical results and percentage relationships will not necessarily be indicative of the operating results of any future period. RESULTS OF OPERATIONS Net Loss per Common Share. Basic net loss per common share for the three and six month periods ended June 30, 2000, decreased approximately $0.03 per share and $0.05 per share, respectively, over the same prior year periods. The decrease in basic net loss per share for both the three and six month periods is primarily attributable to an increase in the weighted average number of common shares outstanding. The net loss for the three and six month periods ended June 30, 2000 declined approximately 5% and remained essentially unchanged, respectively, over the same prior year periods. Revenues and Gross Margin. Revenues and cost of sales are primarily attributable to Assembly and Manufacturing Systems, Inc. (AMS) and are recorded using the percentage of completion method. Revenues at AMS for the three and six month periods ended June 30, 2000, increased 253% and 155% respectively over the same prior year periods. Gross margin as a percentage of sales for both the three and six month periods ended June 30, 2000 returned to normal operating levels and are anticipated to remain at these levels throughout the remainder of the fiscal year. Gross margin as a percentage of sales for the three month period ended June 30, 2000 was 24%, compared to a negative 16% over the same prior year period. Gross margins for the six month period ended June 30, 2000, was 24% compared to 3% over the same prior year period. Gross margins may vary in any given period as a result of the variations in profitability of contracts for large orders of automated production systems or specialty machines, as well as efficiencies related to the overall utilization of AMS' manufacturing resources. The Company attributes the increase in revenues and improved gross margins primarily to strong sales to the medical industry which continues from the prior year and renewed sales to the automotive industry. The Company anticipates sales to both these industries to exceed prior year levels based on current order activity. The Company is continuing to experience weak sales to the high-tech industry (electronics and communications) which negatively impacted overall revenues in the prior year. The Company anticipates that sales to this sector will continue to be slow throughout 2000. The projected length and severity of the slowdown to this sector is unknown at this time. For the three and six month periods ended June 30, 1999, the Company received net revenues of $375,000 and $500,000, respectively, from its services agreement with LFC Tech, it's joint venture with MLFC. No additional revenues are anticipated from the services agreement in 2000 offsetting the increase in revenues from AMS. Engineering, Research and Development Expenses. Engineering, research and development expenses for the three and six month periods ended June 30, 2000, decreased 27% and 7%, respectively, over the SGI INTERNATIONAL 12 same prior year periods. The decrease for both the three and six month periods is primarily attributable to a 60% decrease in expenses on the OCET Process as the Company has shifted its laboratory resources towards increasing the value of CDL produced from the LFC Process. Work on increasing the value of CDL is expected to continue throughout most of the year. Selling, General and Administrative Expenses. Selling, general and administrative expense for the three and six month periods ended June 30, 2000, increased 14% and 13%, respectively, over the same prior year periods. The increase is primarily attributable to the carrying costs associated with the ENCOAL LFC plant which the Company acquired in late 1999. Selling, general and administrative expenses for AMS remained relatively unchanged over the same prior year periods. Loss on Investment in LFC Investee. The Company's share of the losses for its LFC joint venture (LFC Tech) for the three and six months ended June 30, 2000, increased 100% over the same prior year period. The increase is primarily attributable to the amortization of assets which LFC Tech acquired in late 1999. Legal and Accounting Expenses. Legal and accounting expenses for the three and six month periods ended June 30, 2000, decreased 49% and 44%, respectively, over the same prior year periods. The decrease is related primarily to a reduction in legal and accounting salaries and the settlement of various lawsuits to which the Company and AMS were parties. Depreciation and Amortization Expenses. Depreciation and amortization expense for the three and six month periods ended June 30, 2000, decreased 6% and 18%, respectively over the same prior year periods due primarily to a non-recurring charge of approximately $80,000 related primarily to the write-off of the Company's Australian LFC project costs in 1999 which occurred in the first quarter of the year. Partially offsetting this decrease is the Company's acquisition of various LFC related assets late in 1999. Interest Expense. Interest expense for the three and six month periods ended June 30, 2000, increased 26% and 32%, respectively, over the same prior year periods. The increase is primarily due to the addition of approximately $2.0 million in long-term debt associated with the purchase of the ENCOAL LFC plant and various LFC assets in late 1999. Other Income. Other income for the three and six month periods ended June 30, 2000, remained substantially unchanged over the same prior year periods. LIQUIDITY AND CAPITAL RESOURCES As of June 30, 2000, the Company had assets totaling $6.4 and a working capital deficiency of $2.0 million. This is compared to assets of $4.6 million and a $6.1 million working capital deficiency as of June 30, 1999. Current notes payable, accounts payable and accrued salaries primarily contribute to the working capital deficiency at June 30, 2000. The Company anticipates continued operating losses over the next twelve months and has both short-term and long-term liquidity deficiencies as of June 30, 2000. Other short-term liquidity requirements are expected to be satisfied from existing cash balances, proceeds from the sale of future equity securities or other collaborative arrangements. Negotiations are on-going for the public and private placement of equity securities, the proceeds of which are intended to be used to satisfy the short-term liquidity deficiency. In the event that the Company is unable to finance operations at the current level, various administrative activities would be curtailed and certain research and development efforts would be reduced. The Company will not be able to sustain operations if it is unsuccessful in securing sufficient financing and/or generating revenues from operations. The Company had long-term liquidity deficiencies at June 30, 2000. Over the long-term, the Company will require substantial additional funds to maintain and expand its research and development activities SGI INTERNATIONAL 13 and ultimately to commercialize, with or without the assistance of corporate partners, any of its proposed technologies. Although there are no commitments, the Company believes the long-term liquidity deficiency will be satisfied through a combination of future equity sales, increased positive cash flows from operations, and research or other collaborative agreements, until such time, if ever, as the commercialization of the LFC and OCET Processes result in positive cash flows. The Company is seeking additional funds through the financing, sale and operations of the ENCOAL LFC plant and through collaborative or other arrangements with larger well capitalized companies, under which such companies may provide additional capital to the Company in exchange for exclusive or non-exclusive licenses or other rights to certain commercial projects, technologies and products the Company is developing. Although the Company is presently engaged in discussions with a number of suitable candidate companies, there can be no assurance that an agreement or agreements will arise from these discussions in a timely manner, or at all, or that revenues that may be generated thereby will offset operating expenses sufficiently to reduce the Company's short-term or long-term funding requirements. Cash used in operating activities for the six month period ended June 30, 2000, increased 48% over the same prior year period. This increase is primarily attributable to an increase in accounts receivable and decrease in billings in excess of costs and estimated earnings at AMS, due to a significant increase in sales. The use of funds from operating activities is essentially attributable to the Company's net loss of approximately $3.0 million for both the six month periods ended June 30, 2000, and 1999, respectively. These losses were incurred primarily as a result of the Company's administrative and technology development activities. In the fourth quarter of 1999 the Company acquired various LFC related assets, including the ENCOAL Demonstration Plant. As a result of this acquisition, the Company originally anticipated operating expenses associated with maintaining the ENCOAL LFC plant in idle condition at approximately $350,000 in 2000. As of June 30, 2000, the Company had incurred approximately $360,000 and anticipates incurring an additional $100,000 each month until an investor for the facility is obtained. The Company's investing activities amounted to a use of funds of approximately $262,000 a 130% increase over the same prior year period. This use of funds is primarily related to the acquisition of LFC Process related equipment. In January of 1999 the Company and MLFC a wholly-owned subsidiary of Mitsubishi Corporation formed LFC Technologies, LLC ("LFC Tech"). Accordingly, the Company may be required from time to time to make capital contributions to LFC Tech. The Company is required to contribute one-half of any such required capital contributions. In the prior year, in accordance with the Amended Services Agreement between the Company and LFC Tech, the Company received approximately $500,000 of net revenues under this agreement through the six month period ended June 30. This agreement was amended subsequent to October 1999, and the Company will not be receiving any additional funds pursuant thereto through the year 2000. In 2000 the Company is projecting capital expenditures for equipment at OCET to remain consistent with the prior year and an increase in capital expenditures at AMS of approximately $300,000 to improve manufacturing capabilities and efficiencies. Further, the Company intends to obtain project financing for the ENCOAL LFC plant estimated at $10.1 million. The financing is for improvements which are necessary to set the plant on more of a commercial footing and to position it as a reference plant for potential future commercial LFC facilities. Other than the improvements to the ENCOAL LFC plant, the Company as of June 30, 2000, does not have any material requirements or commitments for capital expenditures. The amount of funds used for investing activities in a given period are directly related to development requirements of the Company's technologies and funds availability. SGI INTERNATIONAL 14 The Company's net financing activities raised approximately $2.1 million and $1.5 million for the six month period ended June 30, 2000, and 1999, respectively. These funds were raised primarily through the private placement of debt and equity securities. Offsetting the $2.5 million of funds raised during the six month period was the pay-off and termination of the Company's $400,000 line-of-credit which was secured by a $402,500 certificate of deposit which matured in May 2000. The Company is actively seeking a new line-of-credit to provide working capital to AMS and support its current and anticipated growth in business activity. As stated earlier the Company intends to obtain project financing related to the ENCOAL LFC plant estimated at $10.1 million. The Company believes, due to the plant's special nature, that financing for these improvements will not likely be obtained through conventional methods and that a strategic partner or financier capable of utilizing Internal Revenue Code section 29 tax credits will be required. There is no assurance that the Company will be able to obtain this financing, or if available, the terms will be acceptable. The amount of money raised during a given period is dependent upon financial market conditions, technological progress and the Company's projected funding requirements. The Company anticipates that future financing activities will be influenced by the aforementioned factors. Significant future financing activities will be required to fund future operating and investing activities and to maintain debt service. While the Company is engaged in continuing negotiations to secure additional capital and financing, there is no assurance such funding will be available or if received will be adequate. ACCOUNTING PRONOUNCEMENTS In March 2000, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 44 ("FIN 44"), Accounting For Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25. FIN 44 clarifies the application of Opinion 25 for (a) the definition of employee for purposes of applying Opinion 25, (b) the criteria for determining whether a plan qualifies as a noncompensatory plan, (c) the accounting consequence of various modifications to the terms of a previously fixed stock option or award, and (d) the accounting for an exchange of stock compensation awards in a business combination. FIN 44 is effective July 1, 2000, but certain conclusions cover specific events that occur after either December 15, 1998, or January 12, 2000. Management believes that the impact of FIN 44 will not have a material effect on the financial position or results of operations of the Company. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK [NONE] PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company and its subsidiaries are from time to time involved in litigation arising in the ordinary course of their respective businesses. As of June 30, 2000, the Company is not party to any pending legal proceeding. ITEM 2. CHANGES IN SECURITIES On June 8, 2000, the Company as provided in a related consulting agreement, granted one warrant to purchase an aggregate of 48,000 common shares, to one consultant for services rendered. The warrants were issued pursuant to the exemptions provided by Section 4(2) of the Securities Act and Regulation D and investment representations were obtained and legends were placed on the certificate. In connection SGI INTERNATIONAL 15 therewith, the Company recorded compensation expense of approximately $7,000. The exercise price was not lower than the closing bid price on the grant date. The warrant is exercisable one year from the grant date at $0.225 per share and expires on December 31, 2005. During the three month period ended June 30, 2000, the Company raised approximately $834,000 through the issuance of approximately 4,457,000 restricted common shares to accredited investors. These securities were issued pursuant to the exemptions provided by Section 4(2) of the Securities Act and Regulation D. Investment representations were obtained and legends placed on the certificates. During the three month period ended June 30, 2000, the Company in conjunction with its private placements, paid cash of approximately $16,000, issued 182,271 shares of restricted common stock valued at $46,000 and accrued a liability of approximately $27,000 to be paid through the issuance of approximately 144,000 shares of restricted common stock, as compensation for placement agent services. On June 30, 2000, the Company exchanged one unsecured 9% note payable with a face value of $31,000 due on demand but no sooner than June 15, 2000, for a new note payable of equal value. The new note is payable upon 30 days written demand but no sooner than January 25, 2001. Both the principal and accrued interest thereon may be paid in cash or at the option of the Company on January 25, 2001, by issuing 366,482 shares of restricted common stock. The security was issued pursuant to the exemptions provided by Section 4(2) of the Securities Act and Regulation D. Investment representations were obtained from the accredited investor. On June 30, 2000, the Company exchanged one unsecured 9% note payable with a face value of $9,000 due on demand but no sooner than June 15, 2000, for a new note payable of equal value. The new note is payable upon 30 days written demand but no sooner than November 30, 2000. Both the principal and accrued interest thereon may be paid in cash or at the option of the Company on November 30, 2000, by issuing 94,737 shares of restricted common stock. The security was issued pursuant to the exemptions provided by Section 4(2) of the Securities Act and Regulation D. Investment representations were obtained from the accredited investor. On June 30, 2000, the Company issued for cash a $75,000 unsecured 9% note payable to one accredited investor. The note is payable upon 30 days written demand but no sooner than December 15, 2000. Both the principal and accrued interest thereon may be paid in cash or at the option of the Company, on December 15, 2000, by issuing 882,331 shares of restricted common stock. The security was issued pursuant to the exemptions provided by Section 4(2) of the Securities Act and Regulation D. Investment representations were obtained from the accredited investor. During the three month period ended June 30, 2000, the Company as provided in their related consulting agreements issued approximately 50,000 restricted common shares to two consultants for services rendered, valued by the parties at approximately $10,000. These securities were issued pursuant to the exemptions provided by Section 4(2) of the Securities Act and Regulation D. Investment representations were obtained and legends were placed on the certificates. ITEM 3. DEFAULTS UPON SENIOR DEBT SECURITIES [NONE] ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. The Annual Meeting of Stockholders was held on June 2, 2000. At that meeting the following matters were submitted to a vote of the stockholders of SGI International: 2000 SGI International Annual Meeting Final Voting Results SGI INTERNATIONAL 16 Proposal Item No. 1 Election of Directors The following nominees for director received the number of votes set opposite their respective names: Voting Results - ---------------------------------------------------------- Votes Percent ========================================================== Richard B. Bein For 42,220,275 99% Withhold 282,209 1% Edward D. Doherty For 42,220,285 99% Withhold 282,199 1% William A. Kerr For 42,219,037 99% Withhold 283,447 1% Ben W. Reppond For 42,219,428 99% Withhold 283,056 1% ========================================================== Directors: Michael L. Rose, James W. Mahler, Dr. Ernest P. Esztergar, Jeffrey L. Smith and John R. Taylor whose terms of office had not expired, continued in their respective capacities as directors. Item No. 2 Ratification of Selection of J.H. Cohn LLP, as Independent Public Accountants Voting Results - ---------------------------------- Votes Percent ================================== For 42,100,694 98% Against 230,343 1% Abstain 171,448 1% ================================== ITEM 5. OTHER INFORMATION NONE ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 4.1 Form of Restricted Stock Subscription Agreement (1) 4.2 Form of Promissory Note (2) 10.1 Lease agreement between OCET Corporation and Sorrento Square dated May 10, 2000 (2) 10.2 Second Amendment to Lease between Registrant and La Jolla Financial dated June 19, 2000 (2) 27.1 Financial Data Schedule (2) - ------------ (1) Incorporated by reference to report on Form 10-Q (File No. 2-93124) ending June 30, 1999. (2) Filed herewith. (b) Reports on 8-K On July 14, 2000, the Company reported on its Current Report on form 8-K, filed with the Securities and Exchange Commission, that it had amended effective June 30, 2000 (the "Second Amendment"), certain terms and conditions of the Amended and Restated Acquisition Agreement (the "Acquisition Agreement") between itself and certain subsidiaries of AEI Resources, dated December 9, 1999. The Second Amendment essentially provides SGI with an extension of the June 30, 2000, date to September 30, 2000, in which to satisfy various terms and conditions more fully described in the Acquisition Agreement. SGI INTERNATIONAL 17 PART III. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. SGI INTERNATIONAL /s/ MICHAEL L. ROSE August 11, 2000 - ------------------------------------ Michael L. Rose, President and Chief Executive Officer /s/ GEORGE E. DONLOU August 11, 2000 - ------------------------------------ George E. Donlou Vice President Finance and Controller SGI INTERNATIONAL 18