UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-QSB (Mark One) / / Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended September 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. / / Yes / / No The number of shares of common stock, no par value, outstanding as of October 31, 2000, was 70,383,187. Transitional Small Business Disclosure Format (Check one): / / Yes / / 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 Statement of Cash FLows 6 Notes to Condensed Unaudited Consolidated Financial Statements 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANAYLSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Introductory Note 12 Results of Operations 12 Liquidity and Capital Resources 14 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 16 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS 16 ITEM 2. CHANGES IN SECURITIES 16 ITEM 3. DEFAULTS UPON SENIOR DEBT SECURITIES 18 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 18 ITEM 5. OTHER INFORMATION 18 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-k 18 PART III. SIGNATURES 19 2 SGI INTERNATIONAL AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS September 30, December 31, 2000 1999 (Unaudited) - ------------------------------------------------------------------------------------------------------------------------ ASSETS Current assets: Cash $ 209,518 $ 278,391 Restricted time deposit - 402,500 Trade accounts receivable, less allowance for doubtful accounts of $53,314 and $80,320 639,425 661,880 Costs and estimated earnings in excess of billings on contracts 439,319 99,580 Inventories 413,247 413,716 Prepaid expenses and other current assets 62,486 102,624 - ------------------------------------------------------------------------------------------------------------------------ Total current assets 1,763,995 1,958,691 - ------------------------------------------------------------------------------------------------------------------------ LFC royalty rights, net 707,063 942,750 LFC cogeneration project, net 131,605 210,568 Investment in LFC Investees 235,324 266,813 LFC related notes receivable, net 150,000 150,000 LFC process equipment, net 743,039 355,886 Other assets, net 25,940 26,757 Property, plant and equipment, net of accumulated depreciation of $ 1,311,034 and $1,340,622 2,472,980 2,514,595 Goodwill, net of accumulated amortization of $228,602 and $192,653 251,642 287,591 Interest receivable on notes from stockholders 28,286 - - ------------------------------------------------------------------------------------------------------------------------ $ 6,509,874 $ 6,713,651 - ------------------------------------------------------------------------------------------------------------------------ LIABILITIES AND STOCKHOLDERS' DEFICIENCY Current liabilities: Accounts payable $ 843,744 $ 849,140 Notes payable, net 1,194,607 881,408 Accrued salaries, benefits and related taxes 1,100,402 770,167 Billings in excess of costs and estimated earnings on contracts 432,427 500,407 Borrowings on line-of-credit - 400,000 Interest payable 250,121 182,492 Current maturities of long-term notes payable 4,170,386 7,125 Other accrued expenses 171,615 188,530 - ------------------------------------------------------------------------------------------------------------------------ Total current liabilities 8,163,302 3,779,269 Long-term debt, less current maturities 2,216,484 6,250,386 - ------------------------------------------------------------------------------------------------------------------------ Total liabilities 10,379,786 10,029,655 - ------------------------------------------------------------------------------------------------------------------------ Commitments and contingencies Minority interest 458,616 471,000 - ------------------------------------------------------------------------------------------------------------------------ Stockholders' deficiency: Convertible preferred stock 605 605 Common stock 52,982,986 49,890,623 Paid-in capital 7,920,418 7,021,879 Accumulated deficit (64,761,537) (60,229,111) Less notes receivable from stockholders (471,000) (471,000) - ------------------------------------------------------------------------------------------------------------------------ Total stockholders' deficiency (4,328,528) (3,787,004) - ------------------------------------------------------------------------------------------------------------------------ $ 6,509,874 $ 6,713,651 - ------------------------------------------------------------------------------------------------------------------------ See notes to condensed consolidated financial statements. 3 SGI INTERNATIONAL AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) Three months Nine months ended September 30, ended September 30, 2000 1999 2000 1999 - ------------------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------------------- REVENUES: Contract revenues $ 1,572,729 $ 1,338,860 $ 3,954,131 $ 2,790,344 - ------------------------------------------------------------------------------------------------------------------------------- EXPENSES: Cost of revenues 1,216,592 795,396 3,028,770 1,710,233 Engineering, research and development 199,127 456,443 953,014 1,265,130 Selling, general and administrative 996,798 714,211 2,824,505 2,330,678 Loss on LFC Investees 9,410 (4,198) 31,489 (4,198) Legal and accounting 100,352 144,032 283,309 470,177 Depreciation and amortization 201,810 232,927 646,238 775,433 - ------------------------------------------------------------------------------------------------------------------------------- Total expenses 2,724,089 2,338,811 7,767,325 6,547,453 - ------------------------------------------------------------------------------------------------------------------------------- Loss from operations (1,151,360) (999,951) (3,813,194) (3,757,109) NON-OPERATING INCOME (EXPENSES): Interest expense (380,963) (162,440) (794,679) (474,788) Other income 21,591 122,375 63,063 153,264 - ------------------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------------------- Loss before minority interest in consolidated subsidiary (1,510,732) (1,040,016) (4,544,810) (4,078,633) Minority interest in loss of consolidated subsidiary 3,146 - 12,384 - - ------------------------------------------------------------------------------------------------------------------------------- Net loss $ (1,507,586) $(1,040,016) $(4,532,426) $(4,078,633) - ------------------------------------------------------------------------------------------------------------------------------- PREFERRED STOCK DIVIDENDS: Imputed preferred stock dividends and accretion on convertible and mandatorily redeemable preferred stock $ - $ 36,922 $ - $ 36,922 - ------------------------------------------------------------------------------------------------------------------------------- Net loss applicable to common stock $ (1,507,586) $(1,076,938) $(4,532,426) $(4,115,555) - ------------------------------------------------------------------------------------------------------------------------------- Net loss per common share - basic $ (0.02) $ (0.02) $ (0.07) $ (0.12) - ------------------------------------------------------------------------------------------------------------------------------- Weighted average common shares outstanding 68,229,474 44,402,990 62,518,327 34,781,806 - ------------------------------------------------------------------------------------------------------------------------------- See notes to condensed consolidated financial statements. 4 SGI INTERNATIONAL AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIENCY (Unaudited) Convertible Total Preferred Stock Common Stock 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 12,424,635 2,481,422 2,481,422 Exercise of warrants to purchase common stock for cash 23,000 2,875 2,875 Issuance of common stock for notes payable and interest 1,620,809 401,172 401,172 Issuance of common stock for services 877,269 168,581 168,581 Conversion of preferred stock (23) - 312,386 38,313 (38,313) - Imputed discount on convertible debt 925,440 925,440 Issuance of warrants to purchase common stock to non-employees 11,412 11,412 Net loss (4,532,426) (4,532,426) - ------------------------------------------------------------------------------------------------------------------------------------ Balances at September 30, 2000 60,518 $ 605 69,311,392 $52,982,986 $7,920,418 $(64,761,537)$(471,000) $(4,328,528) - ------------------------------------------------------------------------------------------------------------------------------------ See notes to condensed consolidated financial statements. 5 SGI INTERNATIONAL AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Nine months ended September 30, 2000 1999 - ----------------------------------------------------------------------------------------------------------------------- Operating activities: Net loss $(4,532,426) $(4,078,633) Adjustments to reconcile net loss to net cash used in operating activities: Equity in net (income) loss of LFC Investees 31,489 (4,213) Depreciation and amortization 646,238 775,433 Common stock issued for services 168,581 39,075 Non-employee compensation expense on issuance of warrants 11,412 24,166 Imputed and accrued interest on warrants issued to note holders - 21,107 Amortization of beneficial conversion feature on debt 172,079 - Accrued long-term interest expense 136,484 - Accrued interest income (28,286) - Minority interest in loss of consolidated subsidiary (12,384) - Changes in operating assets and liabilities: Restricted time deposit 402,500 - Trade accounts receivable (317,284) (67,228) Inventories 469 (749) Prepaid expenses and other current assets 40,138 49,714 Accounts payable 62,829 676,487 Billings in excess of costs and estimated earnings on contracts (67,980) 65,668 Accrued salaries, benefits and related taxes 330,235 532,931 Interest payable 83,096 39,304 Other accrued expenses (16,915) 228,909 - ----------------------------------------------------------------------------------------------------------------------- Net cash used in operating activities (2,889,725) (1,698,029) - ----------------------------------------------------------------------------------------------------------------------- Investing activities: Additions to LFC Process equipment (482,399) (85,419) Investment in LFC Investees - (985) Purchase of property and equipment (157,269) (36,643) Other assets (692) (9,247) - ----------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (640,360) (132,294) - ----------------------------------------------------------------------------------------------------------------------- Financing activities: Payments of notes payable (7,125) (7,125) Payments on line-of-credit (400,000) - Proceeds from issuance of debt 1,384,040 825,000 Proceeds from issuance of common stock 2,484,297 984,565 - ----------------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 3,461,212 1,802,440 - ----------------------------------------------------------------------------------------------------------------------- Net decrease in cash (68,873) (27,883) Cash at beginning of period 278,391 239,885 - ----------------------------------------------------------------------------------------------------------------------- Cash at end of period $ 209,518 $ 212,002 - ----------------------------------------------------------------------------------------------------------------------- Supplemental disclosure of cash flow information: Interest paid $ 384,301 $ 393,728 Supplemental disclosure of non-cash activities: Conversion of preferred stock 38,313 1,182,958 Common stock issued for convertible debentures - 68,107 Common stock issued for debt and interest 401,172 - Note Payable issued for current obligation 68,225 - Common stock issued for mandatorily redeemable preferred stock - 1,253,250 - ----------------------------------------------------------------------------------------------------------------------- See notes to condensed consolidated financial statements. 6 SGI INTERNATIONAL AND SUBSIDIARIES NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS September 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 includes the Liquids From Coal ("LFC") Process, the Opti-Crude Enhancement Technology ("OCET") Process and the Asphaltenes Processing technology. The LFC Process is designed to convert and upgrade low-rank coal to create a higher Btu more efficient fuel to produce power and simultaneously produce low temperature coal tars, which contain valuable specialty chemicals. The OCET Process is designed to increase the resulting product value of oil refineries by deasphalting crude oil as well as residual oil bottoms ("resid"), which is produced in oil refineries. The Asphaltenes Processing technology converts unwanted asphaltene by-products of the OCET Process, as well as the existing solvent deasphalting processes, into a coal-like fuel. 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") as of September 30, 2000, and for the three and nine month periods ended September 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 September 30, 2000, and the consolidated results of operations for the three and nine month periods ended September 30, 2000, and 1999, and cash flows for the nine month periods ended September 30, 2000, and 1999. The results of operations for the nine months ended September 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 7 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 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 $6.4 million and an accumulated deficit of $64.8 million at September 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 July 11, 2000, the Company in accordance with its related service agreements issued three warrants to purchase an aggregate of 225,000 common shares at $0.22 per share to three officer/directors of the Company. The exercise price was not lower than the closing bid price on the grant date. The warrants are exercisable one year from the date of grant and expire on December 31, 2005. 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. During the three month period ended September 30, 2000, the Company raised approximately $438,000 through the issuance of approximately 2,630,000 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 September 30, 2000, the Company in accordance with two agreements for consulting and private placement services, paid cash of approximately $28,000 and issued 417,552 shares of restricted common stock valued at approximately $73,000, for services rendered. The 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. Effective August 1, 2000, the Company exchanged for current obligations an unsecured 9% note payable with a face value of $68,225 due on demand after September 30, 2000, for equal value. Interest on the note accrues from April 1, 2000 and shall continue until paid in full. As of September 30, 2000 demand on the note had not been made. During the month of July, 2000, the Company issued for cash three unsecured 9% notes payable with an aggregate face value of $196,235. Both the principal and interest on the notes are due one year from the date of issuance and may only be paid off through the issuance of 1,195,043 shares of restricted common stock. The underlying shares of common stock do not have any registration rights. These securities were 8 issued pursuant to the exemptions provided by Section 4(2) of the Securities Act and Regulation D. Investment representations were obtained from the accredited investors. On August 16, 2000, the Company issued for cash an unsecured 9% note payable with a face value of $136,000. Both the principal and interest on the note are due on February 16, 2001 and may only be paid off through the issuance of 967,457 shares of restricted common stock. Pursuant to the terms of the note, the Company granted the investor piggy back registration rights for the underlying common shares. These securities were 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 late July and September of 2000, the Company issued for cash three unsecured 9% notes payable with an aggregate face value of $270,100. Both the principal and interest on the notes are due one year from the date of issuance and may only be paid off through the issuance of 2,153,464 shares of restricted common stock. Pursuant to the terms of the note the Company granted the investors piggy back registration rights for the underlying common shares. These securities were issued pursuant to the exemptions provided by Section 4(2) of the Securities Act and Regulation D. Investment representations were obtained from the accredited investors. During the three month period ended September 30, 2000, the Company issued for cash three unsecured 9% notes payable with an aggregate face value of $256,000 to one accredited investor. The notes are payable upon 30 days written demand beginning one year following their issuance date. Both the principal and accrued interest thereon may be paid in cash or, at the option of the Company, on the first anniversary by issuing 2,728,097 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. In conjunction with the issuance of the various convertible notes issued during the three months ended September 30, 2000, the Company recorded the issuance of the notes payable net of a $913,512 beneficial conversion feature (see note 5). This beneficial conversion feature will be amortized over the life of each note and result in a non-cash interest charge. As of September 30, 2000, the Company had amortized approximately $160,000 of the beneficial conversion feature. (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. 9 Property and Equipment September 30, December 31, 2000 1999 - ------------------------------------------------------------------------------------- ENCOAL LFC Plant $ 2,121,000 $ 2,121,000 Laboratory equipment 1,032,000 1,020,000 Machinery and equipment 140,000 136,000 Computer equipment 254,000 400,000 ENCOAL projects under construction 113,000 - Office furniture and fixtures 70,000 125,000 Leasehold improvements 54,000 54,000 - ------------------------------------------------------------------------------------- 3,784,000 3,856,000 Less accumulated depreciation (1,311,000) (1,341,000) - ------------------------------------------------------------------------------------- Net property and equipment $ 2,473,000 $ 2,515,000 - ------------------------------------------------------------------------------------- Notes Payable During the period ended September 30, 2000, the Company issued various notes payable (as more fully described in Note 3) which contained a beneficial conversion feature. The Company in accordance with generally accepted accounting principles has recognized this beneficial conversion feature by allocating a portion of the proceeds to additional-paid-in-capital and as an offset to the notes payable. Furthermore, the recorded beneficial conversion feature resulting from the allocation of the proceeds, will be recognized by the Company as interest expense over the period ending on the note's earliest conversion date, which in this case is primarily over a one year period. The beneficial conversion feature on these notes represents the aggregate difference between the conversion price and the fair market value of the common stock as of the date of issuance of the notes payable. During the three month period ended September 30, 2000, the Company amortized approximately $160,000 of the beneficial conversion feature. The Company also recorded an additional $12,000 of interest expense related to the beneficial conversion feature associated with the payment of the stated interest on the notes payable. September 30, December 31, 2000 1999 - ----------------------------------------------------------------------------- Notes payable $ 1,947,968 $ 881,408 Beneficial coversion feature (753,361) - - ----------------------------------------------------------------------------- Notes payable, net $1,194,607 $ 881,408 - ----------------------------------------------------------------------------- (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 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 located 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. 10 Three months ended Automated LFC OCET September 30 Assembly Process Process Corporate Total - ----------------------------------------------------------------------------------------------------------------------- 2000 Revenues $ 1,572,000 $ - $ 1,000 $ - $ 1,573,000 Net income (loss) 131,000 (608,000) (105,000) (926,000) (1,508,000) Equity in operations of investee - (9,000) - - (9,000) Depreciation & Amortization 22,000 136,000 39,000 5,000 202,000 Engineering, research and consulting expenditures - 106,000 79,000 14,000 199,000 Interest expense - - - 381,000 381,000 - ----------------------------------------------------------------------------------------------------------------------- 1999 Revenues $ 1,086,000 $ 250,000 $ 1,000 $ 2,000 $ 1,339,000 Net income (loss) (87,000) (322,000) (792,000) (1,040,000) Equity in operations of investee - 4,000 - - 4,000 Depreciation & Amortization 29,000 112,000 88,000 3,000 232,000 Engineering, research and consulting expenditures - 224,000 232,000 - 456,000 Interest expense - - - 162,000 162,000 - ----------------------------------------------------------------------------------------------------------------------- Nine months ended Automated LFC OCET September 30 Assembly Process Process Corporate Total - ----------------------------------------------------------------------------------------------------------------------- 2000 Revenues $3,949,000 $ - $ 5,000 $ - $3,954,000 Net income (loss) 288,000 (1,963,000) (413,000) (2,444,000) (4,532,000) Equity in operations of investee - (31,000) - - (31,000) Depreciation & Amortization 85,000 411,000 138,000 12,000 646,000 Engineering, research and consulting expenditures - 583,000 316,000 54,000 953,000 Interest expense 1,000 - - 794,000 795,000 - ----------------------------------------------------------------------------------------------------------------------- 1999 Revenues $2,019,000 $ 750,000 $ 21,000 $ - $ 2,790,000 Net loss (328,000) (181,000) (999,000) (2,571,000) (4,079,000) Equity in operations of investee - 4,000 - - 4,000 Depreciation & Amortization 87,000 415,000 262,000 11,000 775,000 Engineering, research and consulting expenditures - 515,000 750,000 - 1,265,000 Interest expense 1,000 - - 474,000 475,000 - ----------------------------------------------------------------------------------------------------------------------- September 30, December 31, Total Assets by Segment 2000 1999 - ----------------------------- ---------- ---------------- --- ----------------- Identifiable assets, net Automated Assembly $ 1,649,000 $1,414,000 LFC Process 4,552,000 4,425,000 OCET Process 165,000 281,000 Corporate 144,000 594,000 - ----------------------------- ---------- ---------------- --- ----------------- Total $ 6,510,000 $6,714,000 - ----------------------------- ---------- ---------------- --- ----------------- 11 (7) RELATED PARTY TRANSACTIONS On July 14, 2000, the Company issued for cash a $25,000 unsecured 9% note payable to one outside director. The note is payable upon 30 days written demand after January 14, 2001. Both the principal and accrued interest thereon may be paid in cash or at the option of the Company, on January 14, 2001, by issuing 147,059 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. (8) 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." 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 technologies, 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 nine month periods ended September 30, 2000, remained the same and decreased approximately $0.05 per share, respectively, over the same prior year periods. The decrease in basic net loss per share for the nine month period ended September 30, 2000 is primarily attributable to an increase in the weighted average number of common shares outstanding as the net loss for both the three and nine month periods increased. The net loss for the three and nine month periods ended September 30, 2000, increased approximately 45% and 11%, respectively, over the same prior year periods. 12 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 nine month periods ended September 30, 2000, increased 45% and 96% respectively over the same prior year periods. Gross margin as a percentage of sales for both the three and nine month periods ended September 30, 2000, remained near 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 September 30, 2000, was 23%, compared to 27% over the same prior year period. Gross margins for the nine month period ended September 30, 2000, was 23% compared to 16% 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 anticipates that sales to the high-tech industry (electronics and communications) sector will continue to be approximately equal to the prior year. AMS tries to maintain a steady growth in revenues by marketing to at least three different industries, specifically, medical, automotive and high-tech. However, it cannot guarantee securing sufficient contracts from the industries to maintain its growth. Consequently, AMS may experience significant fluctuations in its future annual and quarterly operating results. For the three and nine month periods ended September 30, 1999, the Company received net revenues of $250,000 and $750,000, 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, thereby offsetting the increase in revenues from AMS. Engineering, Research and Development Expenses. Engineering, research and development expenses for the three and nine month periods ended September 30, 2000, decreased 56% and 25%, respectively, over the same prior year periods. The decrease for both the three and nine month periods is primarily attributable to a decrease of 66% and 58% respectively, 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 the remainder of the year. Selling, General and Administrative Expenses. Selling, general and administrative expenses for the three and nine month periods ended September 30, 2000, increased 40% and 21%, 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 for both the three and nine month periods remained relatively unchanged over the same prior year periods. Loss on Investment in LFC Investee. The Company's share of the losses for its joint venture in LFC Technologies (LFC Tech) for the three and nine months ended September 30, 2000, increased over the same prior year period. The increase is primarily attributable to the amortization of assets which LFC Tech acquired in late 1999. 13 Legal and Accounting Expenses. Legal and accounting expenses for the three and nine month periods ended September 30, 2000, decreased 30% and 40%, respectively, over the same prior year periods. The decrease for both the three and nine month periods 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 in 1999. Depreciation and Amortization Expenses. Depreciation and amortization expense for the three and nine month periods ended September 30, 2000, decreased 13% and 17%, respectively over the same prior year periods due primarily to a non-recurring charge of approximately $80,000 which occurred in the first quarter of 1999 and a significant portion of OCET Corporation's fixed assets becoming fully depreciated. Partially offsetting this decrease is the Company's acquisition of various LFC related assets late in 1999. AMS' depreciation expense for both the three and nine month periods remained relatively unchanged over the same prior year periods. Interest Expense. Interest expense for the three and nine month periods ended September 30, 2000, increased 135% and 67%, respectively, over the same prior year periods. The increase is 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 and a non-cash interest charge of approximately $172,000 related to the beneficial conversion feature of various convertible notes payable primarily issued during the three month period ended September 30, 2000. Other Income. Other income for the three and nine month periods ended September 30, 2000, decreased 82% and 59% respectively, over the same prior year periods. The decrease for both the three and nine month periods is related to the receipt of a payment in 1999 in settlement of a lawsuit. LIQUIDITY AND CAPITAL RESOURCES As of September 30, 2000, the Company had assets totaling $6.5 million and a working capital deficiency of $6.4 million. This is compared to total assets of $6.7 million and a working capital deficiency of $1.8 million as of December 31, 1999. The current maturities of long-term debt of approximately $4.2 million due September 30, 2001 and current notes payable primarily contribute to the change in the working capital deficiency between September 30, 2000 and December 31, 1999. The Company anticipates continued operating losses over the next twelve months and has both short-term and long-term liquidity deficiencies as of September 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 September 30, 2000. Over the long-term, the Company will require substantial additional funds to maintain and expand its research and development activities 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 Company's technologies result in positive cash flows. The Company is seeking additional funds through the financing, sale and operations of the ENCOAL LFC plant and through 14 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. The use of cash from operating activities is essentially attributable to the Company's net loss of approximately $4.5 million and $4.1 million for the nine month periods ended September 30, 2000, and 1999, respectively. These losses were incurred primarily as a result of the Company's administrative and technology development activities. Cash used in operating activities for the nine month period ended September 30, 2000, increased 70% over the same prior year period. The Company's activities associated with the holding costs of the ENCOAL LFC Plant are the primary reason for this increase. In the fourth quarter of 1999 the Company acquired various LFC related assets, including the ENCOAL LFC 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 September 30, 2000, the Company had incurred approximately $650,000 of expenses and anticipates incurring an additional $100,000 of expenses each month until it concludes a financing/sale as described below. The Company's investing activities amounted to a use of funds of approximately $640,000 a 384% increase over the same prior year period. This use of funds is primarily related to the acquisition of LFC Process related equipment and equipment under construction which is required for the ENCOAL LFC Plant to resume operations once an investor, if any, is obtained. 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 $750,000 of net revenues through the nine month period ended September 30, 1999. This agreement was amended subsequent to October 1999, and the Company will not receive any additional funds pursuant thereto in 2000. The Company does not anticipate that any significant contributions to LFC Tech will be required in 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. In addition, the Company is now anticipating that it will additionally expend approximately $200,000 in LFC Process related equipment through the end of 2000. Further, the Company intends to obtain financing for the ENCOAL LFC Plant currently estimated at $13.7 million. The financing is for capital improvements and start-up expenditures 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 capital improvements previously discussed, the Company as of September 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. The Company's net financing activities raised approximately $3.5 million and $1.8 million for the nine month period ended September 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 15 during the nine month period was the pay-off and termination of the Company's $400,000 line-of-credit which was collateralized 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 financing related to the ENCOAL LFC Plant estimated at $13.7 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. Due to the tax laws surrounding the realization of these tax credits the financing of the ENCOAL LFC Plant's required improvements will mostly likely require that the Company sell the ENCOAL LFC Plant directly to the financier in order facilitate the transaction. Following any such transaction the Company expects it will continue to be involved with various aspects of the project, including in the supervision of the improvements. In this case the Company will not be required to make any of the improvements discussed earlier or assume the repayment of the financing associated with the improvements. 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. 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. On August 23, 2000, the Company filed a lawsuit against Earthco in San Diego County Superior Court. The lawsuit seeks as yet to be determined damages for breach of an agreement by which the Company acted as a finder for 10% of Earthco's interest in a coal fines briquetting project. The Company alleges that it fulfilled its obligation under the agreement and Earthco failed to compensate the Company for services rendered pursuant thereto. Earthco has denied all allegations and the parties are proceeding towards discovery. ITEM 2. CHANGES IN SECURITIES On July 11, 2000, the Company in accordance with its related service agreements issued three warrant to purchase an aggregate of 225,000 common shares at $0.22 per share to three officer/directors of the Company. The exercise price was not lower than the closing bid price on the grant date. The warrants are exercisable one year from the date of grant and expire on December 31, 2005. 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. During the three month period ended September 30, 2000, the Company raised approximately $438,000 through the issuance of approximately 2,630,000 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. 16 During the three month period ended September 30, 2000, the Company in accordance with two agreements for consulting and private placement services, paid cash of approximately $28,000 and issued 417,552 shares of restricted common stock valued at approximately $73,000, for services rendered. The 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. Effective August 1, 2000, the Company exchanged for current obligations an unsecured 9% note payable with a face value of $68,225 due on demand after September 30, 2000, for equal value. Interest on the note accrues from April 1, 2000 and shall continue until paid in full. As of September 30, 2000 demand on the note had not been made. During the month of July, 2000, the Company issued for cash three unsecured 9% notes payable with an aggregate face value of $196,235. Both the principal and interest on the notes are due one year from the date of issuance and may only be paid off through the issuance of 1,195,043 shares of restricted common stock. The underlying shares of common stock do not have any registration rights. These securities were issued pursuant to the exemptions provided by Section 4(2) of the Securities Act and Regulation D. Investment representations were obtained from the accredited investors. On August 16, 2000, the Company issued for cash an unsecured 9% note payable with a face value of $136,000. Both the principal and interest on the note are due on February 16, 2001 and may only be paid off through the issuance of 967,457 shares of restricted common stock. Pursuant to the terms of the note, the Company granted the investor piggy back registration rights for the underlying common shares. These securities were 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 late July and September of 2000, the Company issued for cash three unsecured 9% notes payable with an aggregate face value of $270,100. Both the principal and interest on the notes are due one year from the date of issuance and may only be paid off through the issuance of 2,153,464 shares of restricted common stock. Pursuant to the terms of the note the Company granted the investors piggy back registration rights for the underlying common shares. These securities were issued pursuant to the exemptions provided by Section 4(2) of the Securities Act and Regulation D. Investment representations were obtained from the accredited investors. During the three month period ended September 30, 2000, the Company issued for cash three unsecured 9% notes payable with an aggregate face value of $256,000 to one accredited investor. The notes are payable upon 30 days written demand beginning one year following their issuance date. Both the principal and accrued interest thereon may be paid in cash or, at the option of the Company, on the first anniversary by issuing 2,728,097 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. In conjunction with the issuance of the various convertible notes issued during the three months ended September 30, 2000, the Company recorded the issuance of the notes payable net of a $913,512 beneficial conversion feature (see note 5). This beneficial conversion feature will be amortized over the life of each note and result in a non-cash interest charge. As of September 30, 2000, the Company had amortized approximately $160,000 of the beneficial conversion feature. ITEM 3. DEFAULTS UPON SENIOR DEBT SECURITIES [NONE] 17 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. A Special Meeting of Stockholders was held on September 18, 2000. At the Special Meeting stockholders of SGI International were asked to vote on an amendment to the Articles of Incorporation to increase the number of authorized shares from 75,000,000 to 125,000,000. The vote on the amendment to the Articles of Incorporation was as follows: Voting Results ---------------------------------------------------------- Votes Percent -------------- ------ -------------- ------- ------------- For 53,581,309 97% Against 1,376,393 3% Abstain 47,487 *% -------------- ------ -------------- ------- ------------- * Less than 1% ITEM 5. OTHER INFORMATION SGI International ("SGI") and subsidiaries of AEI Resources, specifically, Bluegrass Coal Development Company and Americoal Development Company have amended effective October 31, 2000, (the "Fifth Amendment") certain terms and conditions of the Amended and Restated Acquisition Agreement (the "Acquisition Agreement") between the parties, dated December 9, 1999. The Fifth Amendment essentially provides SGI with an extension of the October 31, 2000, date to November 30, 2000, in which to satisfy various terms and conditions more fully described in the Acquisition Agreement. All other terms and conditions of the Acquisition Agreement remain in full force and effect. A copy of the Fifth Amendment is attached hereto as Exhibit 4.6 and is incorporated herein by reference. 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 with Registration Rights (2) 4.3 Form of Promissory Note without Registration Rights(2) 4.4 Form of Promissory Note payble in cash or stock(2) 4.5 Form of July 2000 Warrant(2) 4.6 Fifth Amendment to Amended and Restated Acquisition Agreement Among SGI etal.(2) 27.1 Financial Data Schedule (2) (1) Incorporated by reference to report on Form 10-Q (File No. 2-93124) ending September 30, 1999. (2) Filed herewith. (b) Reports on 8-K On October 10, 2000, the Company reported on its Current Report on form 8-K, filed with the Securities and Exchange Commission, that it had amended effective September 30, 2000 (the "Fourth 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 Fourth Amendment essentially provides SGI with an extension of the September 30, 2000, date to October 31, 2000, in which to satisfy various terms and conditions more fully described in the Acquisition Agreement. 18 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 November 10, 2000 - ------------------------------------ Michael L. Rose, President and Chief Executive Officer /s/ GEORGE E. DONLOU November 10, 2000 - ------------------------------------ George E. Donlou Vice President Finance and Controller 19