<PAGE> 1
SGI INTERNATIONAL
[SGI INTERNATIONAL LOGO}
1995 ANNUAL REPORT
<PAGE> 2
[SGI INTERNATIONAL LOGO}
ON THE COVER SGI International is proud to introduce a new company logo
with this annual report. The logo is representative of SGI's
evolving corporate vision.
<PAGE> 3
SGI INTERNATIONAL'S GOAL IS TO DEVELOP
AND COMMERCIALIZE ENERGY TECHNOLOGIES
THAT ARE ENVIRONMENTALLY FRIENDLY,
AND THAT MORE EFFICIENTLY UTILIZE
THE NATURAL RESOURCES
OF AN ENERGY-HUNGRY EARTH.
1
<PAGE> 4
LETTER TO SHAREHOLDERS
[PHOTO OF JOSEPH A. SAVOCA]
I joined SGI as Chairman and Chief Executive Officer in June of 1995. Since that
time, there have been a number of noteworthy accomplishments. In general terms,
the Company's financial condition has improved and both the LFC and OCET
technologies have progressed toward commercialization and revenue generation.
The Liquids from Coal ("LFC") Technology was successfully demonstrated on a
commercial scale at the ENCOAL Plant. Remaining technical issues associated with
the Process were resolved in 1995 and product was shipped and successfully
utilized by customers. TEK-KOL, which owns and will license LFC, was reorganized
and repositioned to more effectively market LFC. TEK-KOL is the 50/50
partnership between SGI and a Zeigler Coal Holding Company subsidiary. In 1996,
TEK-KOL entered into agreements with Mitsubishi Heavy Industries and Mitsui SRC
that we believe may be the catalyst for transitioning the LFC Technology to
commercial use. Currently, TEK-KOL and Mitsubishi are financing and conducting a
feasibility study, which is nearing completion, for a potential plant in the
Powder River Basin.
The Opti-Crude Enhancement Technology ("OCET") is not yet ready for
commercialization. However, 1995 activities have moved OCET in that direction.
The Company expects that development of OCET will progress substantially during
1996. Further definition of economic and design parameters for OCET should lead
to future agreements with major oil companies, engineering firms, and others.
Also, the Company and the Department of Energy are discussing a cooperative
agreement to determine the efficacy and viability of the OCET Process.
The Company is proud of its accomplishments with respect to its ability to
discharge current obligations in a timely manner, and to eliminate long-standing
prior obligations. Certain debt has either been extended until September 30,
2
<PAGE> 5
1997, or converted to equity. Equity conversion represents about one-third of
SGI's former total debt.
SGI common stock is currently quoted over-the-counter on the NASD OTC Bulletin
Board. The Company's stock was quoted at an all-time low of $0.58 in December
1995, and reached a high of $13.00 in May 1996.
Until the Company achieves positive cash flow from operations, management
projects the sale of equity to be the most practical means to finance
commercialization, and to ultimately improve shareholder value. The working
capital generated by such transactions should satisfy the Company's cash flow
needs, accelerate commercialization and marketing of OCET, fund new development
projects, and assist in SGI's efforts to qualify for a more recognized exchange
than the OTC Bulletin Board, thereby improving the trading environment for the
Company's common stock.
Two prominent new candidates have been nominated for election to the Company's
Board of Directors. If elected at the annual meeting, I expect the Company will
benefit from the extensive business, scientific, and legal expertise of these
internationally recognized individuals.
SGI survived a year of financial turmoil, and is a leaner and more viable
version of its former self. By no means am I suggesting that SGI will not face
future challenges, but rather, that SGI has developed into the kind of company
that can successfully deal with challenge. SGI and its employees take great
pride in their accomplishments. We look forward to the rewards that the
international acceptance of our technologies will bring to SGI shareholders.
/s/ Joseph A. Savoca
JOSEPH A. SAVOCA
Chairman of the Board, Chief Executive Officer and President
3
<PAGE> 6
SGI INTERNATIONAL
ENERGY TECHNOLOGIES
SCOPE OF BUSINESS
SGI International's principal business is developing, commercializing, and
licensing new energy technologies. The Company developed the patented Liquids
from Coal Process ("LFC"), which economically upgrades low-rank coal into a
higher BTU coal called process derived fuel ("PDF"), and which concurrently
produces both coal derived liquids ("CDL") and coal gas ("CG"). The LFC
Technology is marketed, both in the United States and internationally, through
the TEK-KOL Partnership ("TEK-KOL"). SGI is also developing the Opti-Crude
Enhancement Technology ("OCET"), which is designed to deasphalt the residue
("Resid") from oil refining.
In 1995, SGI acquired Assembly & Manufacturing Systems, Inc. ("AMS"), a system
integrator of automated assembly equipment to large, established biomedical,
consumer, electronics, and computer companies in the United States.
THE LFC PROCESS
The LFC Process economically upgrades low-rank coal into PDF, and
produces CDL, which has characteristics similar to No. 6 Fuel Oil. The incentive
to upgrade low-rank sub-bituminous and lignite coal is attributable to a number
of related economic and environmental factors. Foremost among these factors is
the need to accommodate the increasing use of coal for electric power
generation, while simultaneously attempting to meet national and international
goals for environmental protection.
When PDF is used as a reductant for direct iron ore reduction, the steel
manufacturer is interested in the total carbon (which must be at least 75%); the
residual volatile matter (which must not exceed 15%); and the total sulphur
(which must not exceed 1%). An even lower sulfur content, on the order of .03%,
is desirable. Slightly more severe LFC processing enables the PDF to meet the
above carbon and volatile matter specifications.
The Company believes four key factors in the LFC Process differentiate it from
other coal cleaning, liquefaction, or gasification technologies. First, the
process simultaneously produces solids, liquids and gases. Second, the control
system regulates the coal heating rate and temperature level to control the
governing kinetics of gasification and stabilization reactions. Third, the PDF
is stabilized and does not self-ignite. Fourth, for the purpose of controlling
the gasification conditions (to obtain the desired co-products), computer models
of coal reaction kinetics, sensors, and servo-mechanisms have been incorporated
into the control system.
THE TEK-KOL PARTNERSHIP
The LFC Process is owned by the TEK-KOL Partnership. TEK-KOL was formed in 1989
by the Company and Shell Mining Company ("SMC") to further develop and
commercialize the LFC Process. In 1992, all of the assets of SMC were purchased
by Zeigler Coal Holding Company ("Zeigler"), the fifth largest coal producing
company in the United States.
The Company and TEK-KOL have progressed significantly in the last twelve months
to further refine and market the LFC Process. In conjunction with Mitsubishi
Heavy Indus-
4
<PAGE> 7
tries ("Mitsubishi" or "MHI"), comprehensive engineering plans, designs and
economic analyses have been prepared for a future LFC plant that could be built
in the Powder River Basin in the United States. The same engineering plans and
designs can be adapted for projects in Indonesia, Russia, China, Australia and
other locations. TEK-KOL, in collaboration with MHI and Mitsui SRC ("Mitsui"),
is currently marketing the LFC Process for future LFC plants in Indonesia and in
other areas of the Pacific Rim.
LFC MARKETS
DOMESTIC A marketing study completed for TEK-KOL indicated that there is a
current unsatisfied market for PDF, which should increase significantly in the
U.S. by the year 2000 because of concerns about acid rain and other
environmental pollutants. The U.S. Clean Air Act legislation, including
Amendments thereto, requires reductions in pollution, thereby creating a
challenge for industry and energy suppliers, which the Company believes is an
opportunity for marketing PDF.
INTERNATIONAL: THE ASIAN MARKET TEK-KOL is marketing LFC plants in Asia and
elsewhere. The developed areas of East Asia--Japan, Taiwan, South Korea, Hong
Kong-- currently import expensive high-grade bituminous coals. The Company
believes those imports can be replaced in many markets by upgraded coal produced
by LFC plants. TEK-KOL is focusing its Pacific Rim marketing efforts on
Indonesia as well as Russia and countries which have large reserves of low-grade
coal. Laboratory testing by SGI and TEK-KOL indicates that certain of these
coals are suitable for upgrading. The Company estimates that coal consumption in
Asia will increase and that LFC products from such coal could be profitably
sold. TEK-KOL has executed an agreement with Mitsui, which provides that Mitsui
undertake and complete a PDF and CDL market study for East Asia. The study could
provide the basis for a targeted marketing approach to many markets in Asia, as
well as on the Pacific Rim.
INDONESIA TEK-KOL is working to develop LFC plants in Indonesia. The Company has
signed a Letter of Intent with the government-owned coal company, P.T. Tambang
Batubara Bukit Asam, to discuss and work toward development of an LFC plant in
the Tanjung Enim area of South Sumatra. PTBA has received a $200,000 grant from
the Trade Development Agency of the U. S. Department of Commerce to be paid to
SGI for PTBA's one-half of SGI's costs in preparing a feasibility study for this
area. Another Letter of Intent has been signed with a private mining
concessionaire for a proposed project in the Musi Rawas region of South Sumatra.
Phase I Technical Feasibility Study Reports have been completed on fifteen coal
samples from four mining areas in Indonesia. Two Phase II Technical Feasibility
studies are being performed for PTBA and PT Berau. Additional opportunities are
being explored by TEK-KOL.
RUSSIA The Company has signed a Letter of Intent with ROSUGOL, a Russian state
entity, and has conducted a Phase I Technical Feasibility Study. Negotiations
are beginning for a Phase II Preliminary Engineering and Economic Assessment for
coal from the Kemerovo region of Siberia. TEK-KOL will continue to investigate
the potential to build LFC plants in Russia. Because of the lack of hard
currency in Russia, the involvement of Mitsubishi or some similar company will
likely be necessary for construction of LFC plants there.
JAPAN Japan is the largest importer of coal in the world, accounting for 30% of
the world's seaborne-traded coal. The Company expects continued growth in
Japan's imports of steam coal. TEK-KOL is working to develop strategic
relationships with Japanese coal
5
<PAGE> 8
SGI INTERNATIONAL
ENERGY TECHNOLOGIES
CONTINUED
and oil importers, equipment suppliers, and financial institutions that are
evaluating possible participation in the development of LFC plants. As stated
above and in Management's Discussion and Analysis, TEK-KOL has entered into
agreements with MHI and Mitsui, which will assist in marketing LFC plants.
CHINA Management believes that China represents a marketing opportunity for
programs to upgrade low-rank coal reserves for export and possible domestic use.
Proposed LFC plants in China could provide export of upgraded coal to Japan,
South Korea, Taiwan and other industrialized areas of East Asia. Specifically,
SGI has signed six Letters of Intent with coal officials in five provinces of
China to proceed with evaluation and development of LFC plants in Shandong,
Liaoning, the Yunan Province, and the Inner Mongolia Autonomous Area. Technical
feasibility studies have been completed on coals from three mining areas.
However, due to the political climate, all remaining studies have been delayed.
AUSTRALIA SGI's Australian subsidiary has the exclusive rights to market the LFC
Process in Australia and in New Zealand. SGI believes there are opportunities
for siting LFC plants in the region.
THE OCET PROCESS
Crude oil contains organic molecules ranging from light, straight-chain
hydrocarbons to heavy, multi-ring aromatics. Refinery processes convert most of
the crude oil into transportation fuels, chemicals and lubricants, leaving as a
byproduct, a tarry Residuum ("Resid"). Twenty-five to forty-five percent of the
crude oil processed at a refinery typically ends up as Resid.
The OCET Technology is designed to convert petroleum Resid into two products: a
liquid refinery feedstock, and a solid coker feedstock. The OCET Process is
designed to liberate the higher grade hydrogen-bearing liquids, which standard
petroleum refining processes do not release from the Resid, and return those
distillate liquids to the refinery's processing stream. The process is designed
to leave sufficient volatile content in the remaining solid material, so that it
would have combustibility characteristics similar to certain grades of high BTU
coal. Management believes that the OCET Process may significantly improve
refinery margins.
The present goals of the Company include further development of the OCET Process
and demonstration of its commercial viability. If the process is demonstrated,
the Company intends to license its use to owners or operators of domestic and
international crude oil refineries. In pursuit of these goals, the Company has
substantially upgraded its laboratory facilities, increased laboratory staff,
and filed for patents. A patent application for the OCET Process was filed in
September 1994 and is pending. A patent application was also filed and is
pending under the Patent Cooperation Treaty ("PCT") covering numerous foreign
countries. A specific patent application was also filed in Venezuela. The
Company believes that the OCET Process may also have commercial applications in
addition to, and substantially different from, the proposed initial application
to crude oil refinery Resid.
6
<PAGE> 9
SGI INTERNATIONAL
SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with the
consolidated financial statements and notes thereto. Information concerning
significant trends in the financial condition and results of operations is
contained in Management's Discussion and Analysis of Financial Condition and
Results of Operations. The realizability of certain assets is dependent upon the
success of future operations together with the adequate future financing
thereof.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, 1991 1992 1993 1994 1995
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenue $ 109,069 $ 693,118 $ 809,910 $ 552,503 $ 900,306 (1)
Net Loss (4,217,019) (4,915,472) (6,116,388) (5,844,121) (6,824,940)(1)
Net Loss Per Share (2.84) (3.14) (3.62) (3.02) (2.46)(1)
Weighted Average Shares Outstanding 1,485,066 1,564,124 1,691,675 1,933,032 2,774,084
Balance Sheet Data:
Current Assets $ 2,987,366 $ 1,727,940 $ 1,331,381 $ 717,406 $ 869,386
Working Capital Surplus (Deficit) 2,044,883 303,876 (917,979) (3,348,255) (2,369,079)
Total Assets 8,747,446 10,886,581 9,240,338 8,198,362 6,516,562
Long Term Debt
(Excluding Current Portion) 3,214,637 4,292,622 4,637,997 3,575,835 4,631,250
Stockholders' Equity (Deficit) 4,569,387 4,889,895 2,350,981 556,866 (1,629,578)
</TABLE>
Note: No dividends have been declared since inception.
(1) The Company acquired AMS effective October 30, 1995. AMS recorded revenue
of $867,000 and income from operations of $238,000 for the period October
31, 1995, through December 31, 1995.
7
<PAGE> 10
SGI INTERNATIONAL
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 set forth
herein are forward-looking statements and statements of management's belief:
thus, 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 plant construction actually begins, 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, which are made herein to reflect events or circumstances after the
date hereof, or to reflect the occurrence of unanticipated events.
OVERVIEW
The Company's 1995 results of operations reflect reduced expenditures to
commercialize the LFC Process, increased expenditures for research and
development of the OCET Process, and ongoing staff and overhead expenditures
related to managing and operating SGI.
The Company's method of operations related to development and commercialization
of the LFC Process was streamlined in 1995. These changes had the effect of
shifting certain responsibilities, including marketing (except in Australia and
New Zealand), to TEK-KOL and significantly reducing the Company's 1995 cash
expenditures. Other employee, consultant, and overhead requirements were
analyzed and reduced in 1995, further decreasing the Company's 1995 cash
expenditures. The Company's cash flows used by operations decreased
approximately $1.6 million as a result of these actions.
The Company restructured $5,591,500 of its debt by December 31, 1995. The
restructuring had the effect of converting notes payable of $1,557,500 into
equity and extending the maturity date of notes payable of $4,034,000 to
September 30, 1997. Interest obligations related to the restructured debt were
either converted into equity in 1995 or deferred through September 30, 1997. In
1996, management intends to restructure the remainder of its $1,200,000 current
debt. During the year, the Company was past due on certain debt and obligations,
but either cured or obtained waivers thereon.
The Company acquired AMS effective October 30, 1995. AMS recorded revenues and
income from operations of $867,000 and $238,000, respectively, for the period
October 30, 1995, through December 31, 1995. Management believes that AMS should
continue to generate positive results in the future.
The Company entered into an agreement in 1995 to test a series of crude oil and
Resid oil samples provided by Maraven, a Venezuelan state-owned oil company. The
OCET Process is designed to convert refinery Resid into higher value petroleum
distillate products and a synthetic coal. Favorable results could lead to
licensing and royalty agreements with Maraven and its affiliates. The Company
also entered into discussions with the Department of Energy regarding a
cooperative agreement and funding for OCET's research and development efforts.
8
<PAGE> 11
The Company is committed to pursuing these and other opportunities in order to
achieve its objectives of commercializing the LFC and OCET Processes and
increasing revenues from the operations of AMS.
As in prior years, the report of the Company's independent auditors for the year
ended December 31, 1995, contains an emphasis paragraph, concerning 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 primarily
dependent upon successful financing of its immediate working capital
requirements and successful commercialization of the LFC and OCET technologies.
The Company intends to rectify the short-term liquidity deficiency through
equity sales and collection of receivables. The Company intends to rectify the
long-term liquidity deficiency by commercializing both the LFC and OCET
technologies, increasing the cash flows from AMS's operations, and accelerating
collection of certain non-recourse notes receivable to SGI by the shareholders
of Rosebud Energy Corporation. 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.
Many events have occurred subsequent to December 31, 1995, which management
believes have had a positive impact. TEK-KOL recently entered into an agreement
with MHI pursuant to which MHI will pay a royalty to TEK-KOL based on the
revenue received by MHI from its sale of equipment and services to LFC plants,
if and when constructed. MHI will also assist in completing engineering for a
potential Powder River Basin LFC plant and adapt that engineering to specific
international projects. Further, MHI has an option during 1996 to obtain a four
year scope-of-supply exclusive in the Pacific Rim. If the option is exercised,
MHI will pay TEK-KOL $1 million per year during the exclusivity period, which is
subject to termination on written notice by either party. TEK-KOL
representatives have executed an agreement with Mitsui which provides for an LFC
product marketing study by Mitsui, an analysis of the opportunity for
development of LFC plants at several Mitsui mines, and assistance by Mitsui in
developing and optimizing an upgrading process for CDL. Expenditures for OCET
research and development have increased substantially during the first quarter
of 1996 in order to accelerate commercialization of the OCET Process. Lastly,
two outstanding candidates have been nominated for election to the Company's
Board of Directors. If elected at the annual meeting, the Company should benefit
from the significant business, scientific, and legal backgrounds of these
individuals.
The continued need to fund Company operations with equity-based financing is
causing significant dilution. Management is committed to accelerating
commercialization of the LFC and OCET technologies and increasing cash flows
from AMS's operations, rather than obtaining funds through the sale of equity.
However, equity sales will be required in the short-term.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994 As
previously noted, the Company acquired AMS effective October 30, 1995. AMS
recorded revenue and income from operations of $867,000 and $238,000,
respectively, for the period subsequent to October 30, 1995. The following
discussion does not include the effect of AMS's operations.
The Company's coal testing and analysis contract with the U.S. Department of
Energy was completed in June, 1995. The Company provided no contract engineering
services to
9
<PAGE> 12
SGI INTERNATIONAL
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CONTINUED
ENCOAL during 1995; therefore, revenues declined in 1995 compared to 1994. Also,
all deferred technology purchase payments were received prior to 1995;
therefore, no gain on sale of technology was recorded in 1995. Interest income
decreased in 1995 as the Company's average cash balances were lower than in
1994.
Engineering and research and development expenses in 1995 decreased 38% ($1.2
million) from 1994. Management curtailed certain engineering activities and
TEK-KOL assumed those responsibilities as well as all LFC Process marketing
activities, which contributed to the decrease.
General and administrative expense in 1995 increased 37% ($329,000) over 1994.
The 1995 expenses include non-recurring charges of $391,000 to reserve loans to
former officers, employees and consultants which may not be collectible. The
Company made loans to William M. Owens, former CEO, over a period of years.
Total principal and accrued interest at the time of Owen's resignation totaled
$268,000, of which $224,000 was reserved as uncollectible and $44,000 was offset
against Company obligations to Owens. In January 1996, the Company agreed to
forgive the loans made to Owens in accordance with his employment agreement and
a settlement agreement. The remainder of the amount reserved represents loans
made by the Company to two consultants and certain employees. The 1995 expenses
also reflect non-recurring charges of $289,000 paid in stock or warrants to
purchase common stock. The transactions resulting in the 1995 non-recurring
charges record commitments made by prior management. After adjusting for these
charges of $680,000, general and administrative expense in 1995 decreased 39%
($351,000) from 1994.
Legal and accounting expense in 1995 increased 12% ($61,000) over 1994 due to
increased business activities and corporate restructuring aimed at streamlining
the Company's activities.
Depreciation and amortization expense in 1995 increased 127% ($1.2 million) over
1994. Management evaluated the estimated net carrying value of certain LFC
process-related assets in September 1995 and recorded a write down. Management
revised the estimate in December 1995 and reversed a portion of the write down.
Accordingly, depreciation and amortization expense in 1995 includes a one time
charge of approximately $1.0 million to reflect management's estimates.
Interest expense is directly related to the amount of debt outstanding during
the period, the stated interest rate and note discounts, all as discussed in
Note 4 of Notes to the Consolidated Financial Statements.
The 1995 net loss increased 18% ($1.1 million) over 1994. After adjusting for
non-recurring charges in 1995 and 1994, the loss related to comparative on-going
activities decreased 30% ($1.7 million) from 1994.
YEAR ENDED DECEMBER 31, 1994 COMPARED TO YEAR ENDED DECEMBER 31, 1993 The net
loss for 1994 decreased 4% ($272,000) from 1993. Revenues for 1994 decreased 32%
10
<PAGE> 13
($257,000) from 1993 revenues primarily as a result of a lower amount of
engineering services being provided under contract to ENCOAL during 1994.
Engineering, research and consulting expenses for 1994 decreased 17% ($644,000)
from 1993. The amount of engineering and technical services provided in 1994 by
SGI in support of the ENCOAL/DOE commercial demonstration plant was
significantly less than in 1993 as the plant became "operational".
Legal and accounting expenses for 1994 decreased 22% ($143,000) from 1993. SGI
had certain non-recurring legal fees and costs in 1993. Legal and accounting
expense for 1994 ($519,000) is comparable to legal and accounting expense for
1992 ($534,000) when the Company had no unusual or non-recurring legal fees and
costs.
Interest expense is directly related to the amount of debt outstanding during
the period, the stated interest rate and note discounts, all as discussed in
Note 4 of Notes to the Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
The Company acquired AMS effective October 30, 1995. The discussion on Liquidity
and Capital Resources includes the effect of this transaction unless otherwise
indicated.
The Company had short-term liquidity deficiencies at December 31, 1995, and 1994
of $2.4 million and $3.3 million, respectively. The net improvement was achieved
primarily through the conversion of notes and interest payable totaling $1.7
million into equity. Current notes payable and accrued interest of $1.4 million
contribute to the Company's short-term deficiency at December 31, 1995. Based on
continuing interaction with the noteholders in 1996, management believes that
the Company should procure subscriptions to convert the remaining current notes
payable to preferred stock or secure agreements to extend the note due dates to
September 30, 1997. The Company and Dr. Esztergar have verbally agreed that the
Company's royalty obligation to Dr. Esztergar will not be satisfied currently.
The Company raised approximately $738,000 through the issuance of 678,306 common
shares to date in 1996. These funds have been used to fund current operations
and to satisfy a portion of the Company's short-term liquidity deficiency. The
Company plans to satisfy the remaining short-term liquidity deficiency through
the sale of equity securities and the collection of receivables.
The Company had long-term liquidity deficiencies at December 31, 1995, and 1994.
The Company expects the long-term liquidity deficiency to be satisfied by equity
sales, and increased positive cash flows from AMS's operations until such time
as the commercialization of the LFC and OCET Processes results in positive cash
flows.
The Company's 1995 cash flows used for operating activities decreased 36% ($1.6
million) from 1994. This decrease is attributable to TEK-KOL's assuming LFC
plant marketing activities, and the personnel and overhead cutbacks made in
1995. The Company's 1994 cash flows used for operating activities decreased 6%
($305,000) from 1993. If future financing activities are successful, the funds
will be used for operating expenditures; otherwise, certain operating
expenditures will be curtailed.
The Company's financing activities raised approximately $3.0 million, $7.5
million and $5.0 million during 1995, 1994 and 1993 respectively. These funds
were raised primarily through the private placement of debt and equity
securities. The amount of money raised during a given period is dependent upon
financial market conditions, technological progress, and the Company's projected
funding requirements. Funds raised in 1995
11
<PAGE> 14
SGI INTERNATIONAL
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CONTINUED
decreased significantly from 1994 due to unfavorable market conditions. 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.
At present, the Company has no commitments for future purchases of its
securities.
The Company invested approximately $0.2 million, $0.5 million and $0.5 million
in additions to certain LFC Process-related assets and other assets during 1995,
1994 and 1993 respectively. The amount of funds used for investing activities in
a given period is directly related to development requirements and fund
availability. The Company collected $0.2 million on the LFC Process related
notes receivable in 1995. No funds were collected in 1994 as the note makers
received no distributions from the Colstrip Project. The Company collected $0.7
million on the LFC Process-related notes receivable in 1993, which represents a
significant increase over collections in 1992. In 1993, Rosebud sold its
interest in a project which was originally acquired from the Company, and
thereafter paid off the related note and interest ($0.4 million) due to the
Company.
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 has recorded contributions payable to TEK-KOL of $412,000 at December
31, 1995. Management believes substantially all of the 1996 funding requirements
for TEK-KOL will be paid by third parties with whom TEK-KOL has or expects to
have agreements. The Company will be required to contribute approximately
$750,000 towards the 1996 TEK-KOL operating budget if none of these agreements
are consummated.
PATENTS
A United States patent was issued in 1983 for certain steps in the LFC Process.
The existing U.S. patent, which was assigned to TEK-KOL in 1989, will expire in
the year 2000. Currently, management does not anticipate any material adverse
impact on TEK-KOL caused by the expiration of the existing patent, based on the
Company's overall technical expertise, trade secrets and experience, in
comparison to the limited impact of the existing patent on the TEK-KOL marketing
programs. TEK-KOL has applied for nine U.S., as well as related foreign patents
in Japan, Indonesia and under the PCT, which covers a number of countries, for
improvements and updates to the LFC Process. Two U.S. patents have been issued
to TEK-KOL, the first on March 25, 1995, for a process to form char and the
second patent on December 13, 1994, for a process for igniting a burner in an
inert atmosphere.
The Company does not have material commitments for capital expenditures as of
December 31, 1995.
12
<PAGE> 15
SGI INTERNATIONAL
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, 1995 1994
- ---------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Current assets:
Cash $ 74,154 $ 551,299
Receivable from joint venture partner - 45,823
Trade accounts receivable 341,352 -
Costs and estimated earnings in excess of billings on
uncompleted contracts 271,448 -
Inventories 68,289 -
Prepaid expenses and other current assets 114,143 120,284
------------ -----------
Total current assets 869,386 717,406
Receivable from officers and directors - 396,961
LFC Process related assets:
Notes receivable, net 1,123,948 1,241,183
Royalty rights, net 2,199,750 2,514,000
LFC cogeneration project, net 631,705 736,989
Investment in TEK-KOL Partnership 596,276 412,276
Australia LFC project, net 173,754 202,714
Other technological assets, net 26,440 988,638
Process demonstration equipment, net 153,781 541,772
------------ -----------
4,905,654 6,637,572
Property and equipment, net 249,328 166,602
Other assets 12,876 279,821
Goodwill, net 479,318 -
------------ -----------
$ 6,516,562 $ 8,198,362
============ ===========
Liabilities and stockholders' equity (deficit)
Current liabilities:
Accounts payable $ 851,853 $ 306,632
Billings in excess of costs and estimated earnings
on uncompleted contracts 175,745
Current maturities of long-term obligations 909,016 3,251,530
Notes payable to Director 304,000
Accrued salaries, benefits and related taxes 139,103 84,630
Royalties payable to related party 141,790 229,854
Contributions payable to TEK-KOL Partnership 336,476 -
Interest payable 139,663 169,044
Other accrued expenses 240,819 23,971
------------ -----------
Total current liabilities 3,238,465 4,065,661
Interest payable 276,425 -
Long-term notes payable, less current maturities 4,631,250 3,575,835
Commitments and contingencies
Stockholders' equity (deficit):
Convertible preferred stock 1,037 1,071
Common stock 32,255,357 29,377,998
Paid-in capital 4,582,215 2,512,621
Accumulated deficit (38,159,764) (31,334,824)
Notes receivable from employees for common stock (308,423) -
------------ -----------
Total stockholders' equity (deficit) (1,629,578) 556,866
------------ -----------
$ 6,516,562 $ 8,198,362
============ ===========
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
13
<PAGE> 16
SGI INTERNATIONAL
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, 1995 1994 1993
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues:
Net sales $ 866,676 $ - $ -
Research and LFC consulting fees - - 2,831
Engineering services revenue from related party - 123,117 299,448
Contract revenue 8,722 - 23,657
Net gain from related party for sale of technology - 360,000 400,000
Other 24,908 69,386 83,974
------------ ------------ ------------
900,306 552,503 809,910
Expense:
Cost of sales 628,506 - -
Engineering, research and consulting 1,599,826 3,089,078 3,732,637
Loss on investment in TEK-KOL 288,000 - -
Selling, general and administrative 1,377,172 891,400 898,928
Legal and accounting 579,630 518,738 661,667
Depreciation and amortization 2,142,957 944,656 957,699
Interest 1,109,155 952,752 675,367
------------ ------------ ------------
7,725,246 6,396,624 6,926,298
------------ ------------ ------------
Net loss $ (6,824,940) $ (5,844,121) $ (6,116,388)
============ ============ ============
Net loss per share $ (2.46) $ (3.02) $ (3.62)
------------ ------------ ------------
Weighted average shares outstanding 2,774,084 1,933,032 1,691,675
============ ============ ============
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
14
<PAGE> 17
SGI INTERNATIONAL
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, 1995 1994 1993
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Operating activities
Net loss $ (6,824,940) $ (5,844,121) $(6,116,388)
Adjustments to reconcile net loss to net cash flows used for
operating activities:
Depreciation and amortization 1,164,157 944,656 957,699
Write down and write off of LFC related assets 978,800 - 179,046
Write off of receivables from officers and directors 396,961 - -
Amortization of note discounts 269,064 271,715 150,633
Common stock and warrants for common stock issued in lieu of
compensation and interest 603,160 28,333 10,850
Amortization of deferred compensation - - 95,993
Changes in assets and liabilities:
Receivable from joint venture partner 45,823 (16,262) (29,561)
Trade accounts receivable (59,162) - -
Inventories 500 - -
Receivable from officers and directors - (56,125) (22,890)
Prepaid expenses and other current assets 5,266 17,837 (102,668)
Accounts payable (65,664) (7,384) 63,977
Billings in excess of costs and estimated earnings on uncompleted contracts 77,188 - -
Accrued salaries, benefits and related taxes 54,473 14,073 12,178
Royalty payable to related party (88,064) 54,166 49,496
Contributions payable to TEK-KOL Partnership 336,476 - -
Interest payable 247,044 169,044
Other accrued expenses 20,849 553 23,418
------------ ----------- -----------
Net cash flows used for operating activities (2,838,069) (4,423,515) (4,728,217)
Investing activities
Cash acquired from AMS 21,184 - -
LFC process related assets:
Collection of notes receivable and related interest 189,147 - 702,805
Payments to former MOP partners (71,912) - (242,868)
Additions to other technological assets (33,183) (130,020) (241,577)
Additions to process demonstration equipment (31,511) (72,729) (91,156)
Contributions to TEK-KOL (184,000) - -
Purchase of property and equipment (45,469) (36,623) (60,305)
Other assets 63,274 (223,158) 50,366
------------ ----------- -----------
Net cash flows provided by (used for) investing activities (92,470) (462,530) 117,265
Financing activities
Proceeds from issuance of notes payable 830,362 3,467,580 1,604,941
Payment of notes payable (525,025) (2,857,608) (202,756)
Proceeds from issuance of convertible preferred stock 1,113,976 303,424 238,310
Proceeds from issuance of common stock 1,034,081 3,718,249 3,135,036
------------ ----------- -----------
Net cash flows provided by financing activities 2,453,394 4,631,645 4,775,531
------------ ----------- -----------
Net increase (decrease) in cash (477,145) (254,400) 164,579
Cash and cash equivalents at beginning of the year 551,299 805,699 641,120
------------ ----------- -----------
Cash and cash equivalents at end of the year $ 74,154 $ 551,299 $ 805,699
============ =========== ===========
Supplemental disclosure of cash flow information:
Cash paid for interest $ 294,000 $ 515,000 $ 498,000
============ =========== ===========
Supplemental disclosure of non-cash activities:
Series 95 convertible preferred stock issued to acquire AMS, Inc. $ 330,000 $ - $ -
------------ ----------- -----------
Series 95 convertible preferred stock issued for notes payable $ 1,557,500 $ - $ -
------------ ----------- -----------
Exercise of warrants for common stock for notes receivable $ 308,000 $ - $ -
------------ ----------- -----------
Issuance of common stock or warrants for services and accrued interest $ 482,000 $ 28,000 $ 11,000
------------ ----------- -----------
Conversion of preferred stock to common stock $ 1,051,000 $ 3,540,000 $5,878,000
------------ ----------- -----------
Issuance of common stock for minority interest $ - $ - $ 47,000
============ =========== ===========
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
15
<PAGE> 18
SGI INTERNATIONAL
CONSOLIDATED STATEMENTS OF
STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
CONVERTIBLE
PREFERRED STOCK
SHARES AMOUNT
- -----------------------------------------------------------------------------------------------------
<S> <C> <C>
Balances at December 31, 1992 1,583,001 $ 15,830
Issuance of common stock for services - -
Issuance of common stock for acquisition of minority interest - -
Issuance of common stock at $36 to $42 per share for cash -
Exercise of warrants to purchase common stock for cash
and reduction of notes payable and related interest - -
Issuance of convertible preferred stock for cash 183 2
Conversion of convertible preferred stock into common stock (1,441,088) (14,411)
Amortization of deferred compensation - -
Net loss - -
----------- --------
Balances at December 31, 1993 142,096 1,421
Issuance of common stock for services - -
Warrants to purchase common stock issued for services - -
Issuance of common stock at $14 to $40 per share for cash - -
Exercise of warrants to purchase common stock for cash - -
Issuance of convertible preferred stock for cash 355 4
Conversion of convertible preferred stock into common stock (35,350) (354)
Net loss
----------- --------
Balances at December 31, 1994 107,101 1,071
Issuance of common stock for services and interest - -
Issuance of common stock at $.48 to $10 per share for cash
net of issuance costs of $47,671 - -
Exercise of warrants to purchase common stock for cash and notes - -
Issuance of convertible preferred stock for cash, net 125,002 1,250
Conversion of convertible preferred stock into common stock (128,533) (1,286)
Issuance of convertible preferred stock for notes payable and interest 156 2
Issuance of convertible preferred stock issued to acquire AMS, Inc. 3 -
Net loss -
----------- --------
Balances at December 31, 1995 103,729 $ 1,037
=========== ========
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
16
<PAGE> 19
SGI INTERNATIONAL
CONSOLIDATED STATEMENTS OF
STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
COMMON STOCK
SHARES AMOUNT
- -----------------------------------------------------------------------------------------------------
<S> <C> <C>
Balances at December 31, 1992 1,597,467 $12,970,332
Issuance of common stock for services 250 10,850
Issuance of common stock for acquisition of minority interest 1,110 47,410
Issuance of common stock at $36 to $42 per share for cash 75,342 2,784,283
Exercise of warrants to purchase common stock for cash
and reduction of notes payable and related interest 33,193 400,628
Issuance of convertible preferred stock for cash - -
Conversion of convertible preferred stock into common stock 126,065 5,892,769
Amortization of deferred compensation - -
Net loss - -
--------- -----------
Balances at December 31, 1993 1,833,427 22,106,272
Issuance of common stock for services 500 13,333
Warrants to purchase common stock issued for services - -
Issuance of common stock at $14 to $40 per share for cash 198,806 3,678,027
Exercise of warrants to purchase common stock for cash 2,275 40,222
Issuance of convertible preferred stock for cash - -
Conversion of convertible preferred stock into common stock 69,439 3,540,144
Net loss
--------- -----------
Balances at December 31, 1994 2,104,447 29,377,998
Issuance of common stock for services and interest 389,103 482,166
Issuance of common stock at $.48 to $10 per share for cash
net of issuance costs of $47,671 963,035 1,023,956
Exercise of warrants to purchase common stock for cash and notes 274,829 318,548
Issuance of convertible preferred stock for cash, net - -
Conversion of convertible preferred stock into common stock 128,257 1,052,689
Issuance of convertible preferred stock for notes payable and interest - -
Issuance of convertible preferred stock issued to acquire AMS, Inc. - -
Net loss - -
--------- ------------
Balances at December 31, 1995 3,859,671 $ 32,255,357
========= ============
</TABLE>
<TABLE>
<CAPTION>
ACCUMULATED
PAID-IN-CAPITAL DEFICIT
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Balances at December 31, 1992 $ 11,374,041 $(19,374,315)
Issuance of common stock for services - -
Issuance of common stock for acquisition of minority interest - -
Issuance of common stock at $36 to $42 per share for cash - -
Exercise of warrants to purchase common stock for cash
and reduction of notes payable and related interest - -
Issuance of convertible preferred stock for cash 238,308 -
Conversion of convertible preferred stock into common stock (5,878,358) -
Amortization of deferred compensation - -
Net loss - (6,116,388)
------------ ------------
Balances at December 31, 1993 5,733,991 (25,490,703)
Issuance of common stock for services - -
Warrants to purchase common stock issued for services 15,000 -
Issuance of common stock at $14 to $40 per share for cash - -
Exercise of warrants to purchase common stock for cash - -
Issuance of convertible preferred stock for cash 303,420 -
Conversion of convertible preferred stock into common stock (3,539,790) -
Net loss (5,844,121)
------------ ------------
Balances at December 31, 1994 2,512,621 (31,334,824)
Issuance of common stock for services and interest - -
Issuance of common stock at $.48 to $10 per share for cash
net of issuance costs of $47,671 - -
Exercise of warrants to purchase common stock for cash and notes - -
Issuance of convertible preferred stock for cash, net 1,112,726 -
Conversion of convertible preferred stock into common stock (1,051,403) -
Issuance of convertible preferred stock for notes payable and interest 1,678,492 -
Issuance of convertible preferred stock issued to acquire AMS, Inc. 329,779 -
Net loss - (6,824,940)
Balances at December 31, 1995 ------------ ------------
$ 4,582,215 $(38,159,764)
============ ============
</TABLE>
See notes to consolidated financial statements.
<TABLE>
<CAPTION>
TOTAL
STOCKHOLDERS'
NOTES DEFERRED EQUITY
RECEIVABLE COMPENSATION (DEFICIT)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balances at December 31, 1992 $ - $ (95,993) $ 4,889,895
Issuance of common stock for services - - 10,850
Issuance of common stock for acquisition of minority interest - - 47,410
Issuance of common stock at $36 to $42 per share for cash - - 2,784,283
Exercise of warrants to purchase common stock for cash
and reduction of notes payable and related interest - - 400,628
Issuance of convertible preferred stock for cash - - 238,310
Conversion of convertible preferred stock into common stock - - -
Amortization of deferred compensation - 95,993 95,993
Net loss - - (6,116,388)
--------- --------- ------------
Balances at December 31, 1993 - - 2,350,981
Issuance of common stock for services - - 13,333
Warrants to purchase common stock issued for services - - 15,000
Issuance of common stock at $14 to $40 per share for cash - - 3,678,027
Exercise of warrants to purchase common stock for cash - - 40,222
Issuance of convertible preferred stock for cash - - 303,424
Conversion of convertible preferred stock into common stock - - -
Net loss (5,844,121)
--------- --------- ------------
Balances at December 31, 1994 - - 556,866
Issuance of common stock for services and interest - - 482,166
Issuance of common stock at $.48 to $10 per share for cash
net of issuance costs of $47,671 - - 1,023,956
Exercise of warrants to purchase common stock for cash and notes (308,423) - 10,125
Issuance of convertible preferred stock for cash, net - - 1,113,976
Conversion of convertible preferred stock into common stock - - -
Issuance of convertible preferred stock for notes payable and interest - - 1,678,494
Issuance of convertible preferred stock issued to acquire AMS, Inc. - - 329,779
Net loss - - (6,824,940)
--------- ------- ------------
Balances at December 31, 1995 $(308,423) $ - $ (1,629,578)
========= ======= ============
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
17
<PAGE> 20
SGI INTERNATIONAL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1995
1. BUSINESS, ORGANIZATION AND PRINCIPLES OF CONSOLIDATION
SGI International (the "Company") was organized in 1985 as the successor to
certain other businesses. Through 1994, the principal business of the Company
was to license the Liquids from Coal ("LFC") Process technology as exclusive
licensing agent for the TEK-KOL Partnership, to provide expert technical
services to all LFC Process related activities and projects and to develop Clean
Coal Refineries worldwide. During 1995, the Company commenced development of the
Opti-Crude Enhancement Technology Process ("OCET") which is designed to increase
the ratio of high quality fuels refined from residual oil bottoms, and the
Company acquired a manufacturing business that fabricates and sells automated
assembly equipment. Since inception, the Company has financed its research and
development of the LFC and OCET processes by private placement of debt and
equity securities and to a lesser extent through research and development
contracts. The Company was considered a development stage company through
December 31, 1994. Since the acquisition of its AMS subsidiary in October 1995,
the Company has generated operating revenues from sales.
The Company is a partner in the TEK-KOL Partnership ("TEK-KOL"), which was
formed in 1989 to own and license the LFC Process technology. TEK-KOL's
formation is discussed in Note 4.
The Company has the following wholly owned subsidiaries at December 31, 1995:
Assembly & Manufacturing Systems, Inc. ("AMS"); OCET Corporation ("OCET"); U.S.
Clean Coal Refineries, Inc. ("USCCR"); and SGI Australia Pty. Ltd. ("SGIA"). The
Company dissolved the following wholly owned inactive subsidiaries during 1995:
SG Technology, Inc. , SGI Development Corp. and SGI Fuels, Inc.
AMS designs, manufactures, and installs automated assembly equipment, and was
acquired in October 1995 (Note 6). OCET was organized in February 1995 to
research and develop the Opti-Crude Enhancement Technology, a process for
further refining residual oil bottoms. USCCR was organized in October 1994 to
market clean coal refinery project development programs. SGIA was organized in
1985 and became a wholly owned subsidiary in 1993. SGIA was established to
commercialize the LFC Process technology in Australia and New Zealand.
The consolidated financial statements include the accounts of the Company and
its subsidiaries. All significant intercompany transactions have been eliminated
in consolidation.
2. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION The accompanying consolidated financial statements are
prepared on a going concern basis; however, the recovery of amounts invested in
the Company's principal assets, which are 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. Amounts
capitalized by the Company through December 31, 1995 related to the OCET Process
are not significant.
Success in commercialization of both the LFC and OCET Processes 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 require hundreds of millions of
dollars, several years of construction, 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 and TEK-KOL are unsuccessful in their attempts to license the LFC
Process, or if such third parties are unsuccessful in profitably developing and
operating LFC plants, it will likely have a material adverse impact on the
business and operations of the Company.
The Company has no established bank financing arrangements. It is likely the
Company will continue to need to seek additional financing through future public
or private sales of its securities including equity and debt securities. It is
likely the Company will also seek funding through additional strategic
partnerships, joint ventures or similar arrangements. 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 negotiations 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.
18
<PAGE> 21
USE OF ESTIMATES The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
disclosures made in the accompanying notes to the consolidated financial
statements. Actual results could differ from those estimates.
CONCENTRATION OF CREDIT RISK The Company invests its excess cash in interest
bearing deposits with major banks, commercial paper and money market funds.
Although certain of the cash accounts may exceed the federally insured deposit
amount, management does not anticipate non-performance by the other parties.
Management reviews the stability of these institutions on a periodic basis.
INVENTORIES Inventories are valued at the lower of cost (first-in, first-out)
method or market.
ACCOUNTING FOR LONG-LIVED ASSETS The LFC Process related assets and other long
lived assets are continually evaluated by management for recoverability and/or
impairment and are stated at the lower of cost or net realizable value. In
performing its evaluation, management considers such factors as competing
technologies, current market for products generated from the LFC Process
technology, viability of projects or assets and progress of related projects
such as the Colstrip Project and the TEK-KOL Partnership.
The Company previously capitalized software costs related to the proprietary
process control system and virtual plant model related to the LFC process. These
assets were fully amortized in 1995 based on management's evaluation of
recoverability. Amortization expense of $760,000, $89,000 and $85,000 of the
capitalized software costs was recorded during 1995, 1994 and 1993,
respectively.
In March 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," effective for
fiscal years beginning after December 15, 1995. SFAS 121 requires impairment
losses to be recorded on long-lived assets used in operations when indicators of
impairment are present and the undiscounted cash flows estimated to be generated
by those assets are less than the assets' carrying amount. SFAS 121 also
addresses the accounting for long-lived assets that are expected to be disposed
of. The Company has not evaluated the effect of adoption of SFAS 121.
DEPRECIATION AND AMORTIZATION Royalty rights and the Australian LFC project are
stated at cost and are being amortized over ten years. Process demonstration
equipment is stated at cost and is being depreciated over five years. Property
and equipment is stated at cost and is being amortized over three to five years.
Goodwill related to the AMS acquisition is being amortized over ten years.
Depreciation and amortization on the LFC Process related assets and other
long-lived assets is calculated using the straight-line method and the
depreciation and amortization periods are based on management's estimates of the
useful lives of the respective assets.
WARRANTS FOR COMMON STOCK GRANTED TO EMPLOYEES The Company has elected to follow
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25"), and related Interpretations, in accounting for its
warrants for common stock granted to employees. Under APB 25, because the
exercise price of the Company's warrants for common stock granted to employees
is not less than the fair market value of the underlying stock on the date of
grant, no compensation expense is recognized.
COMMON SHARES ISSUED FOR SERVICES The values assigned to the restricted common
shares issued for services have been determined by the Board of Directors and
are intended to reflect the estimated fair value of the services rendered.
REVENUE RECOGNITION Revenues from engineering and consulting services are
recorded as the services are performed and earned in accordance with the
contracts to perform such services. Revenues from manufacturing contracts are
recorded using the percentage-of-completion method of accounting, based upon the
ratio of costs incurred to total estimated costs. Estimated losses are recorded
in their entirety when loss contracts are identified. Since contracts may extend
over one or more accounting periods, revisions in estimated costs and revenue
recognition during the course of the work are reflected during the accounting
period in which the facts that require such revisions become known. Other income
consists primarily of interest income and is recorded as earned.
INCOME TAXES Income taxes are provided for in accordance with the provisions of
SFAS No. 109. Under this method, the Company recognizes deferred tax assets and
liabilities for the expected future tax effects of temporary differences between
the carrying amounts of assets and liabilities used for financial reporting and
income tax purposes, as well as operating loss carryforwards.
NET LOSS PER SHARE Net loss per share is computed using the weighted average
number of common shares outstanding during the periods presented.
RECLASSIFICATION Certain prior year balances have been reclassified to conform
to the current year presentation.
19
<PAGE> 22
3. BALANCE SHEET DETAIL
Costs and estimated earnings in excess of billings on uncompleted contracts are
summarized as follows:
<TABLE>
<CAPTION>
1995
- -----------------------------------------------------------------------------------------
<S> <C>
Costs incurred and estimated earnings on uncompleted contracts $3,005,186
Less billings to date 2,909,483
----------
$ 95,703
==========
Included in accompanying balance sheets under the following captions:
Costs and estimated earnings in excess of billings on uncompleted contracts $ 271,448
Billings in excess of costs and estimated earnings on uncompleted contracts (175,745)
----------
$ 95,703
==========
</TABLE>
4. LFC PROCESS RELATED ASSETS
NOTES RECEIVABLE In June 1985, Montana One Partners ("MOP") was formed to
develop an LFC-CoGen Plant in Colstrip, Montana. The Company was the sole
general partner. Originally, the limited partners purchased a 5.93% preferred
interest in the Partnership for $1,462,000; 84.07% was acquired by the Company
and 10% by an affiliate, AEM Corp.
Pursuant to agreements executed in 1988 (the Colstrip Sale Agreements), MOP sold
its interest in the Colstrip Project and the Company sold its interest in
certain other projects to four individuals who formed Rosebud Energy Corp.
("Rosebud"). The sales price of $6,769,000 included $3,500,000 of 8% notes
payable, liabilities aggregating $2,519,000 which were assumed by Rosebud and
liabilities of $750,000 which were forgiven. The basis of the assets sold was
$5,317,000. The Company recognized the immediate reduction of accounts payable
and deferred the remaining gain of $702,000. The notes are non-recourse and as
such collectibility of these notes is contingent on profitable operations of the
Colstrip Project or future refinancing of the Colstrip Project. The transaction
was recorded as a non monetary exchange and because of the contingencies on the
note payments, no gain or interest income will be recognized until the proceeds
received are in excess of the basis of assets sold. By December 31, 1991, the
Company had acquired the limited partners' 5.93% preferred interest and AEM's
10% interest in MOP in exchange for cash ($727,000), contingent notes payable
($1,124,500) and warrants to purchase 28,688 common shares at $10 per share.
The notes payable to former MOP limited partners are contingent upon collection
of the notes receivable from Rosebud. As of December 31, 1995, the Company has
received principal payments of $375,000, interest payments of $739,000 and has
written off notes receivable with a face value of $425,000. The components of
the net carrying value of the notes receivable on the accompanying consolidated
balance sheets are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1995 1994
- -------------------------------------------------------------------------------------------
<C> <C> <C>
8% notes receivable $ 2,700,000 $ 2,700,000
Interest receivable 1,532,095 1,390,220
----------- -----------
4,232,095 4,090,220
Deferred gain and interest income (1,494,030) (1,289,227)
8% notes contingently payable to former MOP limited partners (1,614,117) (1,559,810)
----------- -----------
Net carrying value $ 1,123,948 $ 1,241,183
=========== ===========
</TABLE>
Future collections on these notes receivable collateralize notes payable to LFC
Process Technology Partners in the amount of $230,000 at December 31, 1995.
ROYALTY RIGHTS LFC Technology Partners ("LFCTP") originally financed research
and development of the LFC Process technology under certain research agreements
entered into with the Company from 1982 to 1986. As provided under the research
agreements, LFCTP provided cash and issued notes to the Company in exchange for
all rights in the LFC Process technology. On October 1, 1987, the Company and
LFCTP entered into an Amended Technology Transfer Agreement (the "transfer
agreement"), which provided for the transfer of all rights in the LFC Process
technology to the Company in exchange for three levels of royalty payments. The
first level of royalty payments was satisfied during 1992.
In 1992, the Company and LFCTP entered into a Settlement Agreement which
provided for modifications of the second and third level royalty payments. In
exchange for 12,500 shares of Series 92-C convertible preferred stock, LFCTP's
third level royalty under the transfer agreement was reduced from 12.5% of the
Company's future net
20
<PAGE> 23
cash receipts (as defined) to zero and LFCTP's second level royalty under the
transfer agreement was reduced from approximately $9 million at December 1992 to
$10,000 per month plus 25% of net cash receipts generated by the Colstrip
Project.
Royalty rights aggregating $3,142,500 were recorded in 1992 based upon the value
of the underlying common shares. Royalty expense will be recognized as would
have been required under the transfer agreement or evenly over 10 years,
whichever is greater. Amortization expense of $314,250 was recorded during 1995,
1994 and 1993, and accumulated amortization totals $942,750 and $628,500 at
December 31, 1995, and 1994, respectively.
Payment obligations under the reduced second level royalty terminated once the
common stock underlying the Series 92-C preferred stock was registered in August
1994. LFCTP converted the 12,500 shares of Series 92-C preferred stock into
62,500 common shares in September 1994.
LFC COGENERATION PROJECT The Company has substantially completed the design and
engineering of an LFC facility intended to be used in conjunction with an
electric cogeneration plant. Amounts capitalized at December 31, 1995 relate
primarily to plans and drawings for the design of such a facility. Amortization
expense of $105,000 was recorded during 1995, 1994 and 1993, and accumulated
amortization totaled $421,000 and $316,000 at December 31, 1995, and 1994,
respectively. Pursuant to the Colstrip Sale Agreements, the Company granted
Rosebud a non-exclusive license for LFC Process cogeneration plants with an
aggregate capacity of 350 megawatts which provides for SGI to receive royalties
of up to $1,000,000 from future plant financings and operations. The Company is
continuing its efforts to enter into additional licenses which utilize the LFC
Cogeneration technology.
INVESTMENT IN TEK-KOL PARTNERSHIP The Company entered into a Technology Purchase
Agreement (the Agreement) with Shell Mining Company ("SMC") on September 28,
1989. Under the Agreement, SMC acquired a one-half interest in the LFC Process
technology, related stand-alone assets and patents in exchange for $650,000 in
cash, a $550,000 note, and forgiveness of $350,000 of current debt. SMC also
agreed to pay additional consideration totaling $1,000,000 when the first LFC
plant became operational or $40,000 per month, up to an aggregate of $1,000,000
beginning July, 1992. Because of the time period involved over which the
proceeds were collected, the Company recognized the revenue as the consideration
was received. During 1994, $360,000, the final increment on the $1,000,000, was
recognized as revenue. During 1993, the Company recognized $400,000 of revenue
under the Agreement.
The Company and SMC formed the TEK-KOL Partnership ("TEK-KOL") on September 30,
1989, and each partner contributed its respective one-half interest in the LFC
Process technology, related LFC stand-alone assets and patents to the
partnership. TEK-KOL was formed to own and license the LFC Process technology.
As a result of the Agreement and subsequent partnership formation, the Company
recovered $1,202,000 of costs resulting in a net gain of $348,000 and recorded
the book value of its one-half interest in the assets contributed, $412,000 as
its investment in TEK-KOL. The Company accounts for its investment in TEK-KOL
using the equity method. TEK-KOL was inactive through December, 1994. TEK-KOL
became operational in 1995 and the Company has recorded $288,000 as its share of
TEK-KOL's 1995 net loss.
Capital contributions to the TEK-KOL Partnership are expected to be required
from time to time. The partnership agreement requires the Company to contribute
one-half of any required capital contributions. The Company has recorded a
liability to TEK-KOL for a portion of its 1995 contribution totaling
approximately $412,000 at December 31, 1995. The partners have verbally agreed
that the Company is not in default of the partnership agreement provision
regarding payment of required capital contributions. If the Company is unable to
fund the capital contribution, its investment in the TEK-KOL Partnership could
be adversely impacted. Management believes substantially all of the 1996 funding
requirements for TEK-KOL will be paid by third parties with whom TEK-KOL has, or
will have, agreements. Management estimates the Company will be required to
contribute approximately $750,000 in 1996 if none of these agreements are
consummated.
The partnership agreement designates the Company as licensing contractor. To
date, the Company has not been reimbursed for past licensing related
expenditures. The partnership agreement was amended effective May 1, 1995 so
that the Company will now receive 75% of all royalties, fees, and other monies
paid to TEK-KOL by third parties until such time that the Company has received
$2.0 million. After the Company receives $2.0 million, all royalties, fees, and
other monies paid to TEK-KOL will be shared evenly. Ongoing license activities
by the Company will be compensated as determined by TEK-KOL. The Company will
record licensing revenues as these monies are received.
TEK-KOL granted the Company a royalty-free LFC Process license for cogeneration
plants with an aggregate capacity of 350 megawatts and a royalty-bearing LFC
Process license which requires the Company to pay royalties of approximately
12.5% of the net proceeds from the sale of liquids produced by its first two
sole LFC Projects. Royalties to TEK-KOL for all products produced by additional
SGI sole projects are subject to negotiation based on prevailing industry
practices.
TEK-KOL granted an LFC Process license to SMC through which TEK-KOL will receive
royalties of approximately 12.5% of the net proceeds from the sale of liquids
produced by the first Level I and Level II plants. Royalties to TEK-KOL for all
products produced by any subsequent SMC plants are subject to royalties
negotiated based on prevailing industry practices.
21
<PAGE> 24
SGI INTERNATIONAL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
continued
AUSTRALIA LFC PROJECT The Company has capitalized certain costs associated with
preliminary site reviews and engineering studies relative to Australian coals as
part of an effort to market the LFC Process technology. The capitalized costs
are being amortized over a ten year estimated life and amortization expense of
$29,000 was recorded during 1995, 1994 and 1993. Accumulated amortization at
December 31, 1995 and 1994 is $87,000 and $58,000, respectively.
5. NOTES PAYABLE
Notes payable consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, 1995 1994
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
12% notes, due through September 2000, unsecured $ 47,500 $ 54,625
10-12% notes, due at various dates through September 2000, unsecured 5,796,766 6,772,740
----------- -----------
5,844,266 6,827,365
Less current portion 1,213,016 3,251,530
----------- -----------
$ 4,631,250 $ 3,575,835
=========== ===========
</TABLE>
The Company sold investment units in 1986 and 1987 which included 12% notes
payable. Principal payments of $2,375 and 12% interest payments are due
quarterly through maturity. The 12% notes payable also include contingent
interest ranging from 6% to 24%. The contingent interest begins accruing
quarterly upon completion of construction, start-up and testing of a commercial
LFC Plant. No commercial LFC Plants have been built and no interest expense
related to this contingency has been recorded to date. The notes are convertible
into restricted common stock at the rate of .075 shares per $1 of outstanding
principal. Prepayment of the principal results in the payment of an amount which
would cause the annual return from the original note date to become 18% to 24%,
compounded annually. An additional payment equal to 25% of the outstanding
principal is also required upon prepayment. The balance outstanding under these
notes totaled $47,500 at December 31, 1995.
During 1995 and 1994, the Company sold Investment Units ("Units") through
private placement offerings to qualified investors for $10,100 per unit. Such
Units consist of a $10,000 note payable, bearing interest at rates ranging from
10%-12% per annum and one convertible preferred share. The notes payable
generally have twelve to thirty-six month terms and interest is payable
quarterly. The preferred shares are convertible into common stock as described
in Note 7. The proceeds from the Units were allocated to the notes payable and
preferred shares based on their relative fair values which resulted in recording
discounts to the notes payable. The note discounts of $269,000 at December 31,
1994, were fully amortized in 1995 and discounts aggregating $272,000 and
$151,000 were amortized to interest expense during 1994 and 1993, respectively.
The Company made limited principal and interest payments in 1995 on the notes
payable issued through the Unit sales and in November and December 1995 the
Company proposed to the noteholders to restructure their notes. Under this
restructuring, noteholders extended the due dates on notes payable with a
carrying value of $4,034,000. The original maturity dates through June 1997 were
extended to September 30, 1997. Other noteholders converted their notes with a
carrying value of $1,557,500 into 155.75 shares of Series 95 convertible
preferred stock with a $10,000 per preferred share liquidation preference. Of
the preferred shares issued, 135.25 preferred shares are convertible into
1,805,875 common shares on November 1, 1997 and 20.5 preferred shares are
convertible into a predetermined market value of common stock on November 1,
1997. At December 31, 1995, these preferred shares would have been convertible
into 529,094 common shares based on the closing bid price of $.6875 per share at
December 29, 1995.
Accrued interest through December 31, 1995 relating to the restructured notes
was either extended to September 30, 1997 ($276,000), satisfied through the
issuance of the 155.75 preferred shares ($121,000), or satisfied through the
issuance of 88,838 restricted common shares ($99,000). The Company also prepaid
interest of $94,000 on certain notes by issuing 84,177 restricted common shares.
Interest obligations on these notes subsequent to September 30, 1996 either will
be paid quarterly in cash (through maturity in September, 1997) or will be
prepaid on September 30, 1996 through the issuance of restricted common stock
with the number of shares issued based on the closing common stock bid price on
that date.
Certain of the noteholders who converted their notes into Series 95 preferred
stock were granted warrants to purchase 39,250 shares of common stock at $1.25
per share under the terms of the restructuring.
22
<PAGE> 25
Scheduled principal payments of notes payable are as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
- ------------------------------------------------------------------------------
<S> <C>
1996 $ 1,213,016
1997 4,377,500
1998 9,500
1999 9,500
2000 234,750
-----------
Total Payments $ 5,844,266
===========
</TABLE>
The Company borrowed a total of $304,000 from a Director in 1995 in exchange for
10% notes payable which mature on December 31, 1996. In 1995 the Company also
borrowed a total of $460,000 from certain related parties in exchange for 10%
notes that mature through 2000 and include $230,000 of notes which are
collateralized by the Rosebud notes receivable (Note 4). In connection with the
collateralized borrowing of $230,000, the Company issued warrants to purchase
230,000 shares of common stock at $1.00 per share that expire in 2000.
6. ACQUISITION OF AMS
On October 30, 1995, the Company acquired AMS, a designer and manufacturer of
automated assembly equipment. The Company issued three Series 95 convertible
preferred shares valued at $330,000 in exchange for 100% of the outstanding
common stock of AMS. The acquisition has been accounted for as a purchase and
resulting goodwill of $479,000 is being amortized over ten years.
Pro forma results of the Company's operations, assuming the acquisition had
occurred as of January 1, 1994, are presented below.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, 1995 1994
- --------------------------------------------------------------------------------
<S> <C> <C>
Net revenue $ 4,865,000 $ 6,184,000
Net loss 7,258,000 6,093,000
Net loss per share 2.64 3.15
</TABLE>
The results give effect to pro forma adjustments for amortization of goodwill
and income taxes. The pro forma information is not necessarily indicative of the
actual results that would have been achieved had AMS been acquired on January 1,
1994, nor is it necessarily indicative of future results.
7. STOCKHOLDERS'EQUITY (DEFICIT)
CONVERTIBLE PREFERRED STOCK A summary of the issued and outstanding convertible
preferred stock at December 31, 1995, is as follows:
<TABLE>
<CAPTION>
COMMON
SHARES SHARES
ISSUED AND PREFERENCE IN ISSUABLE ON
OUTSTANDING LIQUIDATION CONVERSION
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Series P-90 Preferred Stock 400 $ 40,000 100,000
Series 90 Preferred Stock 6 640 561
Series PS90 Preferred Stock 20 5,000 2,500
Series 91 Preferred Stock 85,157 351,540 7,545
Series 92 Preferred Stock 30 2,960 215
Series 93 Preferred Stock 100 9,950 3,677
Series 94 Preferred Stock 357 35,655 15,109
Series 95 Preferred Stock 17,659 2,153,056 2,915,655
------- ----------- ---------
103,729 $ 2,598,801 3,045,262
======= =========== =========
</TABLE>
The Series 95 convertible preferred shares are non-voting and were issued in
connection with private placements, the note restructuring discussed in Note 5
and the AMS acquisition discussed in Note 6.
In 1995, the Company raised $1,114,000, net of offering costs of $137,500,
through the issuance of 125,000 Series 95 convertible preferred shares and the
issuance of two Series 94 convertible preferred shares. The Series 95 preferred
shares were convertible after forty one days into common shares based on the
closing bid price of SGI common shares at various dates in 1995. As of December
31, 1995, 107,500 Series 95 preferred shares had been converted into 126,241
common shares.
The Series 94, 93, 92 and 91 convertible preferred shares were issued in
connection with the sale of Investment Units which were sold through private
placement offerings to qualified investors. At December 31, 1995, the Series 94
preferred shares are convertible into restricted common shares after certain
dates in 1996. The Series 94, 93 and 92 preferred shares outstanding are
non-voting and are callable at $100 per share.
23
<PAGE> 26
SGI INTERNATIONAL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CONTINUED
The Series 91 convertible preferred shares are non-voting and have a preference
in liquidation ranging from $2 to $10,000 per share. In addition, certain of the
Series 91 preferred shares provide cumulative dividends ranging from $8 to $800
per share and are callable at $100 per preferred share plus any unpaid
cumulative dividends.
The Series P-90 convertible preferred shares were issued in 1990 to two members
of the Board of Directors who were also officers of the Company and are
convertible into restricted common shares, subject to an additional payment of
$1.375 per common share. The Series P-90 preferred shares are non-voting and
provide an $8 cumulative dividend per share. In addition, the Series P-90
preferred shares are callable after January 1, 1996, at $100 per share plus any
unpaid cumulative dividends.
The Series 90 preferred shares are non-voting, provide an $8 cumulative dividend
per share and are callable at $100 per share plus any unpaid cumulative
dividends.
The Series PS90 convertible preferred shares were issued in 1990 to employees of
the Company and are convertible into restricted common shares, subject to an
additional payment of $1.375 per common share. The Series PS90 preferred shares
are non-voting, have a preference in liquidation of $250 per share and provide a
$20 cumulative dividend per share.
Dividends on all preferred shares are only payable when the Company has
sufficient accumulated earnings and at December 31, 1995, cumulative dividends
of $78,000 were in arrears under the Series 91, P-90, 90 and PS90 preferred
share agreements.
WARRANTS During 1995, the Company granted warrants to employees, consultants,
and noteholders for the purchase of 1,768,815 shares of restricted common stock
at exercise prices ranging from $0.875 to $20.00 per share. The exercise prices
of the warrants granted equaled or exceeded the closing bid price of the
Company's common stock on the grant date. The Company changed the exercise price
of warrants for 1,458,433 common shares from exercise prices ranging from $0.875
to $20.00 to exercise prices ranging from $0.60 to $1.375. The repricings
changed the exercise price to the then current closing bid price of the
Company's common stock. The Company also issued warrants to purchase 39,250
common shares at $1.25 per share in connection with the note restructurings
(Note 5).
As of December 31, 1995, approximately 1.1 million common shares underlying
warrants have been registered with the Securities and Exchange Commission.
The following table summarizes outstanding warrants all of which are currently
exercisable:
<TABLE>
<CAPTION>
COMMON SHARES
UNDER WARRANT
EXERCISE PRICE EXPIRATION DATE DECEMBER 31, 1995
- --------------------------------------------------------------------------------
<S> <C>
$ .20 December 31, 1999 5,000
.60 December 31, 1999 768,534
.60 December 31, 2000 383,750
.875 December 31, 1999 4,199
1.00 September 30, 2000 230,000
1.25 December 31, 1999 39,250
1.25 December 31, 2000 50,000
1.375 December 31, 1999 87,796
9.50 Various 87,645
10.00 Various 4,295
18.00 December 31, 1999 2,500
20.00 December 31, 1999 11,765
25.00 December 31, 1998 7,615
30.00 December 31, 1998 250
34.00 December 31, 1998 3,560
40.00 December 31, 1997 3,325
40.00 December 31, 1998 1,750
45.00 December 31, 1998 500
47.50 December 31, 1998 1,000
50.00 December 31, 1996 3,450
54.00 December 31, 1997 3,086
---------
1,699,270
=========
</TABLE>
24
<PAGE> 27
Also during 1995, the Company granted warrants to employees for the purchase of
3,530,000 shares of OCET common stock at $1.00 per share. There is no current
market for OCET common stock. At December 31, 1995, warrants for the purchase of
1,205,000 OCET common shares are exercisable; warrants for the remaining OCET
common shares become exercisable at various dates from September 30, 1996,
through June 1998. All warrants to purchase OCET common shares expire December
31, 1999. In January 1996, warrants to purchase 850,000 OCET common shares were
cancelled.
COMMON STOCK During 1995, the Company raised $1,024,000, net of offering costs
of $48,000, through the issuance of 963,035 common shares. The Company issued
216,088 common shares for services and recorded compensation expense of $289,000
in 1995. As discussed in Note 5, the Company also issued 173,015 common shares
for accrued interest and future interest obligations under the note
restructuring agreements with certain noteholders. During 1994, the Company
issued 500 restricted common shares to a consultant and recorded $13,000 of
compensation expense. During 1993, the Company issued 250 restricted common
shares to a consultant and recorded $11,000 of compensation expense. Also during
1993, the Company issued 1,110 restricted common shares to acquire the minority
interest in SGIA and promised to issue another 1,050 restricted common shares if
certain Australian project development requirements are satisfied.
At December 31, 1995, the Company has reserved 6,000,000 common shares for the
conversion of preferred stock into common stock and the exercise of outstanding
warrants.
8. RELATED PARTY TRANSACTIONS
SGI has entered into the following transactions with related parties:
(a) The Company sold 200 Series P-90 preferred shares for $22,000 to two
officers in 1990. Each preferred share is convertible into 250 restricted common
shares upon payment of a price that was reduced from $15.00 per share to $1.375
per share in 1995.
(b) The Company granted warrants to purchase 568,500 common shares to officers
and directors in 1995, 1994, and 1993 at exercise prices ranging from $0.875 to
$54.00 per share. The exercise prices equaled or exceeded the closing bid price
on the grant dates. During 1995, the exercise prices of warrants to purchase
498,500 and 70,000 common shares were changed to $0.60 and $1.375, respectively
(Note 7).
(c) During 1995, the Company issued 10% notes payable totaling $304,000 to a
Board member. An additional 10% note payable for $50,000 was issued to the same
Board member in January 1996. The notes and accrued interest were converted into
283,200 restricted common shares in March, 1996. Also during 1995, an officer
advanced the Company a total of $52,000 and was repaid.
(d) At December 31, 1994, the Company had receivables from its TEK-KOL partner's
subsidiary aggregating $45,283. During 1994 and 1993, the Company recorded
revenues for engineering services of $123,000 and $299,000 from its partner's
subsidiary.
(e) The Company had receivables from two officers of $397,961 at December 31,
1994. A portion of this receivable was offset by obligations of the Company to
both of the officers and the remaining $224,000 was reserved at December 31,
1995. In January 1996, the Company agreed to forgive the loans made to a former
officer.
(f) The Company has an agreement with an officer/shareholder for the assignment
of his patent to the Company. The agreement provides for a royalty equal to the
greater of (i) $50,000 per calendar year or (ii) one-tenth of one percent (.1%)
of royalty revenues received by the Company (or any joint venture of which the
Company is a partner) through December 31, 2000, conditioned only upon the
continued practice of the LFC Process technology during such period by the
Company and/or any such joint venture. The Company recognized royalty expense of
$50,000 in each of the years ended December 31, 1995, 1994, and 1993. As of
December 31, 1995, royalties payable of $141,790 were recorded on the balance
sheet.
(g) Three employees exercised warrants in August 1995 for 274,154 common shares
in exchange for notes receivable of $308,423. The notes are non-recourse, bear
interest at 8%, and are payable August 23, 1999, only if the bid price for the
Company's common stock is in excess of $3.00 per share on that date. As of
January, 1996, the employees had pledged 321,341 restricted common shares as
collateral for the notes receivable. The notes are reflected in the accompanying
balance sheet as a component of stockholders' equity.
9. COMMITMENTS AND CONTINGENCIES
(a) The Company leases its corporate offices under an operating lease agreement
which provides for annual escalation of rental payments and expires in December
2000. The Company's OCET subsidiary leases its laboratory facilities under an
operating lease agreement which expires in May 2000. AMS leases its
manufacturing facility under an operating lease agreement which expires in
October 1997. Under the terms of the lease agreements, the lessee pays taxes,
maintenance and insurance. As of December 31, 1995, the Company had no other
significant commitments under
25
<PAGE> 28
SGI INTERNATIONAL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CONTINUED
capital or operating leases. Total rent expense relating to leased facilities
was $226,000, $170,000 and $163,000 in 1995, 1994 and 1993, respectively.
Future minimum annual operating lease commitments are as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31:
- --------------------------------------------------------------------------------
<S> <C>
1996 $ 317,000
1997 301,000
1998 178,000
1999 180,000
2000 149,000
-------
$1,125,000
==========
</TABLE>
(b) As discussed in Note 4, the Company is required to make contributions to the
TEK-KOL Partnership.
10. INCOME TAXES
The significant components of the Company's deferred tax assets and liabilities
are:
<TABLE>
<CAPTION>
1995 1994
- -------------------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $ 16,878,000 $ 14,420,000
Depreciation and amortization 553,000 336,000
Research and development credits 350,000 320,000
Other 377,000 140,000
------------ ------------
18,158,000 15,216,000
Deferred tax liabilities:
Other (625,000) (18,000)
Net deferred tax assets 17,533,000 15,198,000
Deferred tax assets valuation allowance (17,533,000) (15,198,000)
------------ ------------
$ - $ -
============ ============
</TABLE>
At December 31, 1995, the Company had net operating losses available for
carryforward for federal and state tax purposes of approximately $44,010,000 and
$24,575,000 respectively. The federal and state loss carryforwards will begin
expiring in 1996, unless previously utilized. The difference between federal and
state loss carryforwards is primarily attributable to the 50% limitation of
California loss carryforwards. The Company also has federal research credit
carryforwards of approximately $350,000 which will begin to expire in 2004
unless previously utilized. The Company has determined that the future annual
use of net operating loss carryforwards and research and development tax credits
will be materially limited under Internal Revenue Code Sections 382 and 383 due
to a 50% ownership change that occurred during 1995.
Approximately $1,600,000 of the valuation allowance for deferred tax assets
relates to stock warrant deductions which, when recognized, will be allocated
directly to contributed capital.
11. INFORMATION ON INDUSTRY SEGMENTS
AMS's revenue and income from operations in the period from October 31, 1995, to
December 31, 1995, totaled $867,000 and $238,000, respectively. Revenues were
derived primarily from contracts to manufacture assembly equipment for two
customers. Revenue from sales of automated assembly equipment accounted for 96%
of the Company's 1995 revenues. AMS's total assets and aggregate depreciation
and amortization were $1,297,000 and $12,000, respectively at December 31, 1995.
12. EVENTS SUBSEQUENT TO DECEMBER 31, 1995
In the normal course of its capital formation efforts from January 1, 1996,
through March 19, 1996, the Company raised $738,000 through the issuance of
678,306 common shares to qualified investors.
26
<PAGE> 29
SGI INTERNATIONAL
REPORT OF ERNST & YOUNG LLP
INDEPENDENT AUDITORS
THE BOARD OF DIRECTORS AND STOCKHOLDERS
SGI INTERNATIONAL
We have audited the accompanying consolidated balance sheets of SGI
International as of December 31, 1995, and 1994, and the related consolidated
statements of operations, stockholders' equity (deficit), and cash flows for
each of the three years in the period ended December 31, 1995. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of SGI International
at December 31, 1995, and 1994, and the consolidated results of its operations
and its cash flows for each of the three years in the period ended December 31,
1995.
As discussed in the notes to the consolidated financial statements, the Company
has material transactions with related parties.
As discussed in Note 2 of the notes to consolidated financial statements, the
Company's principal assets are related to the LFC (Liquid from Coal) Process.
The recovery of these assets is dependent upon future events, including the
Company's ability to attract sufficient additional equity and/or financing
needed to fund its portion of the TEK-KOL Partnership, that is responsible for
completion and commercialization of the LFC Process. These factors and the
Company's working and net capital deficiencies and recurring losses from
operations raise substantial doubt about its ability to continue as a going
concern. The consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
Ernst & Young LLP
SAN DIEGO, CALIFORNIA
MARCH 11, 1996
27
<PAGE> 30
SGI INTERNATIONAL
MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED SHAREHOLDER MATTERS
The Common Stock of the Company is currently traded and prices are quoted on the
NASD OTC Bulletin Board under the symbol SGII.
The following table sets forth the high and low bid prices for SGI Common Stock
during the periods indicated. The prices represent bid quotations and do not
include retail mark-ups, mark-downs or fees, nor do they necessarily represent
actual trades.
As of December 31, 1995, the Company had approximately 2,500 stockholders of
record, and believes it has beneficial owners in excess of that number. The
Company has not declared any cash dividends on the Common Stock and does not
currently intend to pay any cash dividends on the Common Stock in the
foreseeable future.
Except as otherwise indicated, all information contained in this filing has been
adjusted to give effect to a 1-for-20 reduction of the outstanding SGI common
shares which became effective March 22, 1995.
<TABLE>
<CAPTION>
QUARTER ENDED HIGH LOW
- -----------------------------------------------------------------------------
<S> <C> <C>
Fiscal 1996
March 31 $ 3.43 $ 0.62
Fiscal 1995
December 31 $ 1.28 $ 0.58
September 30 $ 1.78 $ 0.78
June 30 $ 4.94 $ 0.93
March 31 $ 25.60 $ 3.75
Fiscal 1994
December 31 $ 21.26 $ 11.88
September 30 $ 37.50 $ 19.38
June 30 $ 55.00 $ 33.76
March 31 $ 61.26 $ 45.00
Fiscal 1993
December 31 $ 70.00 $ 33.76
September 30 $ 62.50 $ 36.26
June 30 $ 81.26 $ 62.50
March 31 $ 90.00 $ 52.50
</TABLE>
28
<PAGE> 31
Directors
JOSEPH A. SAVOCA
Chairman, President and Chief Executive Officer
ERNEST P. ESZTERGAR
Technical Director
WILLIAM A. KERR
Director
NORMAN A. GRANT
Director
Officers
JOSEPH A. SAVOCA
Chairman, President and Chief Executive Officer
JOHN R. TAYLOR
Secretary
Corporate Headquarters
SGI International
1200 Prospect Street
Suite 325
La Jolla, California
Tel: 619/551-1090
Fax: 619/551-0247
Investor Relations
Corporate Communications
Tel. 619/551-1090
Independent Auditors
Ernst & Young LLP, Independent Auditoors
San Diego, California
Outside Counsel
Fisher Thurber LLP
La Jolla, California
Transfer Agent
Atlas Stock Transfer Corporation
3899 South State Street
Salt Lake City, Utah 54107
801/266-7151
Annual Meeting
July 18, 1996
Radisson Hotel
3299 Holiday Court
La Jolla, California 92067
<PAGE> 32
[SGI INTERNATIONAL LOGO]
SGI INTERNATIONAL
1200 PROSPECT STREET
SUITE 325
LA JOLLA, CALIFORNIA 92037
TEL: 619/551-1090
FAX: 619/551-0247
