UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [ X ] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the period ended June 30, 1997 or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Commission File Number 2-93124 SGI International (Exact name of registrant 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) (619) 551-1090 Registrant's telephone number, including area code Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 July 31, 1997, was 7,378,000. TABLE OF CONTENTS FORM 10-Q PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Condensed Consolidated Balance Sheets 3 Condensed Consolidated Statements of Operations 4 Condensed Consolidated Statement of Stockholders' Equity 5 Condensed Consolidated Statements of Cash Flows 6 Notes to Condensed Consolidated Financial Statements 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview 8 Results of Operations 9 Liquidity and Capital Resources 10 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS 10 ITEM 5. OTHER INFORMATION 10 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 11 PART III. SIGNATURES 11 SGI INTERNATIONAL CONSOLIDATED BALANCE SHEETS June 30, December 31, 1997 1996 --------------------------------- (Unaudited) ASSETS Current assets: Cash $ 375,580 $ 740,018 Time deposit 402,500 402,500 Receivable from TEK-KOL Partnership 18,066 24,431 Trade accounts receivable 1,017,287 888,254 Costs and estimated earnings in excess of billings on contracts 331,917 113,130 Inventories 68,289 68,289 Prepaid expenses and other current assets 294,797 58,545 -------------------------------- Total current assets 2,508,436 2,295,167 LFC Process related assets: Notes receivable 304,903 304,903 Royalty rights, net 1,728,375 1,885,500 LFC Cogeneration project, net 473,779 526,421 Investment in TEK-KOL Partnership 582,414 464,163 Australia LFC project, net 137,410 144,795 Other technological assets 30,195 27,742 -------------------------------- 3,257,076 3,353,524 Property and equipment, net 681,148 548,601 Goodwill, net 407,420 431,386 -------------------------------- $ 6,854,080 $ 6,628,678 ================================ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 1,028,272 $ 444,436 Borrowings on line-of-credit 400,000 300,000 Billings in excess of costs and estimated earnings on contracts 60,228 387,892 Current maturities of long-term notes payable 4,204,500 4,216,500 Accrued salaries, benefits and related taxes 138,511 124,942 Payable to TEK-KOL Partnership - 83,252 Interest payable 533,183 529,183 Other accrued expenses 345,318 224,149 -------------------------------- Total current liabilities 6,710,012 6,310,354 Long-term notes payable, less current maturities 119,000 123,750 Commitments Stockholders' equity Convertible preferred stock 897 887 Common stock 37,639,272 36,118,231 Paid-in capital 7,168,777 6,494,585 Accumulated deficit (44,783,878) (42,419,129) -------------------------------- Total stockholders' equity 25,068 194,574 -------------------------------- $ 6,854,080 $ 6,628,678 ================================ See notes to condensed consolidated financial statements. SGI INTERNATIONAL CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) Three months Six months ended June 30, ended June 30, ------------------------- ------------------------- 1997 1996 1997 1996 ------------------------- ------------------------- Revenues: Net sales $ 1,479,892 $ 1,190,267 $ 2,584,152 $ 2,246,944 Other 9,859 80,584 19,514 222,520 ------------------------- ------------------------- 1,489,751 1,270,851 2,603,666 2,469,464 Income (loss) from investment in TEK-KOL (207,675) (23,125) (331,748) 52,978 Cost and expenses: Cost of sales 1,169,528 952,133 2,005,123 1,746,199 Research and development 249,420 102,560 551,301 257,334 Selling, general and administrative 623,092 407,325 1,154,546 997,704 Legal and accounting 152,279 157,951 305,073 613,165 Depreciation and amortization 174,928 143,318 351,681 309,052 Interest 134,033 91,607 268,943 243,385 ------------------------- ------------------------- 2,503,280 1,854,894 4,636,667 4,166,839 ------------------------- ------------------------- Net loss $(1,221,204) $ (607,168) $(2,364,749) $(1,644,397) ========================= ========================= Net loss per share $ (0.18) $ (0.12) $ (0.36) $ (0.35) ========================= ========================= Weighted average common shares 6,891,713 5,239,863 6,535,576 4,755,235 ========================= ========================= See notes to condensed consolidated financial statements. SGI INTERNATIONAL CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (Unaudited) Convertible preferred stock Common stock Shares Amount Shares Amount ----------------------------------------------- Balances at December 31, 1996 88,732 $ 887 6,094,605 $ 36,118,231 Issuance of common stock for cash - - 667,328 1,122,423 Issuance of common stock for services - - 162,506 172,820 Conversion of preferred stock (8) - 300,280 225,798 Issuance of preferred stock for cash 1,000 10 - - Net loss - - - - ----------------------------------------------- Balances at June 30, 1997 89,724 $ 897 7,224,719 $ 37,639,272 =============================================== Total Paid-in- Accumulated stockholders' capital deficit equity ----------------------------------------------- Balances at December 31, 1996 $ 6,494,585 $ (42,419,129) $ 194,574 Issuance of common stock for cash - - 1,122,423 Issuance of common stock for services - - 172,820 Conversion of preferred stock (225,798) - - Issuance of preferred stock for cash 899,990 - 900,000 Net loss - (2,364,749) (2,364,749) ----------------------------------------------- Balances at June 30, 1997 $ 7,168,777 $ (44,783,878) $ 25,068 =============================================== See notes to condensed consolidated financial statements. SGI INTERNATIONAL CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Six months ended June 30, ----------------------------- 1997 1996 ----------------------------- Operating activities Net loss $ (2,364,749) $ (1,644,397) Adjustments to reconcile net loss to net cash flows used for operating activities: Depreciation and amortization 365,068 349,525 Stock and warrants issued for interest, services, and notes receivable 172,820 633,954 Changes in assets and liabilities: Receivable from TEK-KOL Partnership 6,365 - Trade accounts receivable (347,820) (110,603) Inventories - (5,879) Other current assets (236,252) (14,379) Accounts payable 583,836 (199,871) Billings in excess of costs and estimated earnings on contracts (327,664) (681) Accrued salaries, benefits and related taxes 13,569 (4,353) Royalty payable to related party - (141,790) Payable to TEK-KOL Partnership (83,252) (137,367) Interest payable 4,000 24,280 Other accrued expenses 121,169 14,001 ----------------------------- Net cash flows used for operating activities (2,092,910) (1,237,560) Investing activities LFC Process related assets: Collection of notes receivable and interest - 144,030 Investment in TEK-KOL Partnership (118,251) (183,478) Purchase of property and equipment (256,497) (149,176) Other assets (2,453) 12,876 ----------------------------- Net cash flows used for investing activities (377,201) (175,748) Financing activities Borrowings on line-of-credit 100,000 - Proceeds from issuance of notes payable - 50,000 Payments of notes payable (16,750) (79,000) Proceeds from issuance of common stock 1,122,423 2,103,935 Proceeds from issuance of preferred stock 900,000 - Collection of notes receivable - 47,000 ----------------------------- Net cash flows provided by financing activities 2,105,673 2,121,935 ----------------------------- Net increase (decrease) in cash (364,438) 708,627 Cash at beginning of period 740,018 74,154 ----------------------------- Cash at end of period $ 375,580 $ 782,781 ============================= See notes to condensed consolidated financial statements. SGI INTERNATIONAL NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1997 (Unaudited) (1) Basis of Presentation The accompanying condensed consolidated financial statements of SGI International (the "Company") for the three and six months ended June 30, 1997, and 1996 are unaudited. 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, 1997, and the consolidated results of operations for the three and six months ended June 30, 1997, and 1996. The results of operations for the three and six months ended June 30, 1997, are not necessarily indicative of the results to be expected for the year ending December 31, 1997. 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, 1996, included in the Company's Form 10-K filed with the Securities and Exchange Commission. (2) Organization and Business The principal businesses of the Company are developing, commercializing, and licensing new energy technologies; and manufacturing automated assembly equipment. The recovery of amounts invested in the Company's principal assets, the LFC Process related assets, is dependent upon the Company's ability to adequately fund its capital contributions to the TEK-KOL Partnership and TEK-KOL's ability to successfully attract sufficient additional equity, debt or other third party financing to complete the commercialization of the LFC Process technology. The Company is engaged in continuing negotiations to secure additional capital and financing, and while management believes these negotiations will be successful, there is no assurance thereof. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Projections and Estimates The projections, estimates and opinions of management contained herein relative to the LFC and OCET Processes and to the business of the Company are forward looking statements of management's belief. There can be no assurance that these projections, estimates, or opinions of management will ultimately be correct or that actual results or events will not differ materially from those discussed herein. Further, until agreements are actually executed, LFC plants actually begin construction, the OCET Process is actually commercialized and operating revenues are actually earned, there can be no assurance that such events will occur. The Company undertakes no obligation to publicly release the results of any revisions to these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Overview Development of the first commercial LFC Plant in the Powder River Basin of Wyoming continues to progress as previously reported. The $460,000,000 Engineering, Procurement, and Construction contract was signed on December 30, 1996. A Memorandum of Understanding ("MOU") between TEK-KOL (a partnership between the Company and a unit of Zeigler Coal Holding Company) and a group of Russian private and public entities has been executed. The Russian Central government and the regional government in Kemerovo have approved a Phase II study to determine the economic and technical feasibility of an LFC project in Russia's Kuzbass Region. This study is currently underway and is anticipated to be completed prior to year end. Under the protocol established, should the Phase II feasibility study results prove positive, the protocol agreement states that the project will be included in the Central Government's Coal Renovation Program for the Kuzbass Region. A MOU has been executed between TEK-KOL and PTBA (the Indonesian state owned coal company) to perform additional tasks necessary to develop and finance an LFC project at PTBA's mine in the Tanjung Enim area of South Sumatra. The United States Trade and Development Agency (the "USTDA") provided funding for the Phase II study, and the USTDA has completed its due diligence relative to another grant for the additional tasks necessary to develop and finance an LFC project. A grant funding decision by the USTDA is expected during the fourth quarter of this year. OCET process effectiveness to remove asphaltenes and substantially reduce catalyst-fouling nickel and vanadium metal content from a variety of oil field crudes has been successfully demonstrated using bench-scale continuous processing equipment. Samples of several types of heavy crudes and resids have been processed to produce high yields of deasphalted oil and substantial reductions of catalyst-fouling metals. Based on these results and progress in developing methods to monitor, control process yields and product quality, in response to continually changing feedstocks, OCET has commenced construction of the second generation, continuous process, stainless steel Process Development Unit (the "PDU"), which is expected to be operational prior to year end. A Cooperative Research and Development Agreement has been executed with the U.S. Department of Energy in support of the OCET development program. Additionally, contacts have been made with several potential strategic partners capable of further accelerating the Company's commercialization efforts. Additional resources are being deployed to increase sales at Assembly and Manufacturing Systems, Inc. ("AMS"), SGI's automated assembly subsidiary. Sales for 1997 are expected to exceed 1996 levels. AMS assisted in designing and constructing certain portions of OCET's second generation PDU. The continuing need to fund Company operations with equity-based financing is causing dilution. Management is committed to accelerating commercialization of the LFC and OCET technologies and increasing cash flows from AMS's operations so that equity-based financing can be minimized. The report of the Company's independent auditors for the year ended December 31, 1996, contains an emphasis paragraph as to the Company's ability to continue as a going concern. As discussed in Liquidity and Capital Resources, the Company has short-term and long-term liquidity deficiencies. The Company's ability to continue as a going concern is dependent upon successful financing of its immediate working capital requirements and successful commercialization of the LFC and OCET technologies. The Company is engaged in license marketing activities and negotiations to secure additional financing. If immediate working capital requirements are not successfully financed and/or the LFC and OCET technologies cannot be successfully commercialized, then the adverse impact on the business and operations of the Company could be material. Results of Operations Three months ended June 30, 1997, compared to Three months ended June 30, 1996. The Company's net loss for the three months ended June 30, 1997, increased 101% ($614,000) over the same prior year period. Components of the increase in net loss are discussed below. Sales and cost of sales for the three months ended June 30, 1997, increased 24% ($290,000) and 23% ($217,000), respectively, over the same prior year period. Sales and cost of sales are recorded using the percentage of completion method, and vary based upon activity during the quarter. Other income for the three months ended June 30, 1997, decreased 88% ($71,000) from the same prior year period. The prior year period included the reversal of certain accrued expenses totaling $75,000. The Company's share of the TEK-KOL loss for the three months ended June 30, 1997, increased 798% ($185,000) over the same prior year period. TEK-KOL received certain non-recurring payments under an agreement with Mitsubishi Heavy Industries during the prior year period. The results of TEK-KOL's operations are influenced by the number and timing of feasibility studies prepared for third parties. Research and development expenses for the three months ended June 30, 1997, increased 143% ($147,000) over the same prior year period. The increase relates to the Company's heightened efforts to develop the OCET process. Selling, general and administrative expense for the three months ended June 30, 1997, increased 53% ($216,000) from the same prior year period. The increase relates to the addition of sales and marketing personnel at AMS, public relation fees, and financial consulting fees. Interest expense for the three months ended June 30, 1997, increased 46% ($42,000) over the same prior year period. The prior year period included the reversal of accrued interest payable totaling $43,000. Six months ended June 30, 1997, compared to Six months ended June 30, 1996. The Company's net loss for the six months ended June 30, 1997, increased 44% ($720,000) from the same prior year period. Components of the increase in net loss are discussed below. Sales and cost of sales for the six months ended June 30, 1997, increased 15% ($337,000) and 15% ($259,000), respectively, over the same prior year period. Sales and cost of sales are recorded using the percentage of completion method, and vary based upon activity during the quarter. Other income for the six months ended June 30, 1997, decreased 91% ($203,000) from the same prior year period. The decrease is related to the forgiveness of certain royalty obligations by a related party totaling $142,000 and the reversal of certain accrued expenses totaling $75,000, in the prior year. The Company's share of the TEK-KOL loss for the six months ended June 30, 1997, was $332,000 compared to income from operations of $53,000 for the same prior year period. TEK-KOL received certain non-recurring payments under an agreement with Mitsubishi Heavy Industries during the prior year period. The results of TEK-KOL's operations are influenced by the number and timing of feasibility studies prepared for third parties. Research and development expenses for the six months ended June 30, 1997, increased 114% ($294,000) from the same prior year period. The increase relates to the Company's heightened efforts to develop the OCET process. Selling, general and administrative expense for the six months ended June 30, 1997, increased 37% ($315,000) from the same prior year period after adjusting for non-recurring charges of $158,000. The increase relates to the addition of sales and marketing personnel at AMS, public relation fees, and financial consulting fees. Legal and accounting expense for the six months ended June 30, 1997, increased 2% ($8,000) over the same prior year period after adjusting for non-recurring charges of $316,000. Liquidity and Capital Resources As of June 30, 1997, the Company had current assets totaling $6.8 million, including cash of $376,000, and a working capital deficit of $4.2 million. 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, 1997. Short-term liquidity requirements are expected to be satisfied from existing cash balances and proceeds from the sale of equity securities. In the event that the Company is unable to finance operations at the current level, various administrative activities would be curtailed and certain research 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's Form 10-K for the year ended December 31, 1996, disclosed the execution of two funding agreements in April 1997 which provided gross proceeds of $2 million through the sale of equity securities. As previously reported, funding for an additional $2 million was subject to certain minimum levels of price and trading volume of the Company's common stock. The contingencies were not met and the additional funding did not close. The Company's investing activities increased during the six months ended June 30, 1997, as lab equipment was purchased and built for the OCET lab. The Company's financing activities raised approximately $2.1 million and $2.2 million during the six months ended June 30, 1997, and 1996, respectively. These funds were raised primarily through the private placement of equity securities and borrowings on the line-of-credit. 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. The Company is engaged in continuing negotiations to secure additional capital and financing, and while management believes these negotiations will be successful, there is no assurance thereof. Additional capital contributions to the TEK-KOL Partnership are expected to be required from time to time prior to profitable operations. The Company is required to contribute one-half of any such required capital contributions. The Company does not have material commitments for capital expenditures as of June 30, 1997. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In the ordinary course of business, various claims are asserted against the Company and its subsidiaries. However, except for a cross complaint asserted in a lawsuit filed by the Company for Declaratory Relief, no claims asserted against the Company have resulted in litigation. Management's opinion is that the ultimate resolution of any and all claims, including the cross complaint against the Company, will not have material effect on the Company's financial position, results of operations or liquidity. ITEM 5. OTHER INFORMATION During April 1997, the Company raised $29,735, net of discounts aggregating $24,329, through the issuance of 15,008 restricted common shares. These shares were sold to one employee pursuant to Regulation D of the Securities Act of 1933, as amended ("Reg. D"). In April 1997, the Company issued 4,388 restricted common shares to two domestic individuals and one domestic entity pursuant to Reg. D for services rendered. In May 1997, the Company issued 112,000 restricted common shares to a domestic entity pursuant to Reg. D for services rendered. As provided in related service agreements, the Company granted warrants to purchase 325,250 common shares to thirty-four employees, three Board of Director members, and one consultant in May 1997 pursuant to Reg. D. The exercise prices were not lower than the closing bid price on the grant date. The warrants are exercisable one year from the grant date at $2.00 per share, and expire on December 31, 2001. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 1. Exhibits - None 2. Reports on Form 8-K - None PART III. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SGI INTERNATIONAL /s/ ______________________ August 13, 1997 Joseph A. Savoca, Chief Executive Officer and Chairman of the Board 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. /s/ _____________________ August 13, 1997 Joseph A. Savoca, Chief Executive Officer and Chairman of the Board