LETTER FROM THE CEO TO SHARE HOLDERS
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September 10, 1998
Dear Shareholder:
I am writing to you because of the concern expressed by a number of our shareholders about SGI's recent stock price decline and the current status of the company. Management's primary goal is to increase the value of the company. I believe that we are accomplishing that objective, but unfortunately, the price of the stock does not presently reflect that. It is clear to me, by the failure of SGI's stock price to increase after we announced the Letter of Intent to form a joint venture with Mitsubishi Corporation, one of the larger companies in the world, that the benefits of the joint venture, as well as the accomplishments of SGI to date have not been properly perceived. Before describing the progress we have made on numerous fronts, the alliance with Mitsubishi warrants more explanation.
Mitsubishi
The Mitsubishi Group generated $370 billion in revenues in 1997. According to Forbes magazine's April 1998 issue, Mitsubishi accounts for 10% of Japan's gross national product. In my opinion, Mitsubishi represents the best avenue for commercializing and marketing the LFC Technology worldwide. The resources of Mitsubishi in engineering, heavy equipment, coal technology and its enormous international financial capabilities create the potential to develop the LFC process and plants to the point where they will have the same relationship to coal that integrated petroleum refineries have to crude oil.
The Letter of Intent between Mitsubishi Corporation and SGI was executed on August 6, 1998, and states that Mitsubishi will provide engineering to further improve the LFC Technology, to reduce the cost of commercial plants and to improve CDL upgrading. Mitsubishi will also market the Technology and products outside the United States through its 170 worldwide offices. These activities will dramatically reduce the costs that SGI has incurred for the past several years for these same activities. Further, Mitsubishi, applying its resources, has agreed to do much more than either SGI or Zeigler were capable of doing in these areas. In my opinion, this work by Mitsubishi will cost many millions of dollars and will directly benefit SGI. Mitsubishi will also pay SGI $500,000 each year for services provided to the new joint venture, which is basically a subsidy to SGI for U.S. LFC product and project marketing, and an additional $4,000,000 on the occurrence of certain milestones. While these milestones cannot occur immediately, they could occur in the near future. Finally, Mitsubishi will pick up all of the travel costs of SGI personnel whenever we travel overseas on LFC business.
Mitsubishi would not have committed to expend these substantial funds or the huge amount of employee time if it did not appreciate that the LFC Technology is a process of significant value. Further, all developments related to the LFC Technology, which are patented by the SGI/Mitsubishi joint venture, will be owned by SGI and Mitsubishi. Additional benefits can be derived by SGI since much of the work in developing the improved technology will be accomplished by Mitsubishi, which holds thousands of patents in coal technology. Mitsubishi has also offered, in an effort to expedite commercialization and as well improve communications, to provide for an exchange of personnel, which should result in an SGI representative in Tokyo and a Mitsubishi representative at our offices in the United States.
It is intended that the agreement to form the joint venture, in accordance with the Letter of Intent, be completed as soon as possible. In order to hasten the accomplishment of this objective, Mitsubishi has selected a California law firm, and drafting of the agreements has commenced.
Termination of TEK-KOL Partnership
On May 12, 1998, SGI served notice on Zeigler that it was terminating the TEK-KOL Partnership. That notice was served after we had endeavored, from November 1997 through May 1998, to put together a joint venture composed of Zeigler, Mitsubishi and SGI. That was a desirable objective because it would have joined the LFC demonstration plant, permits to build a commercial LFC plant at Zeigler's North Rochelle mine, and the engineering, financial and business capabilities of Mitsubishi, with the technical capabilities of SGI to develop and market LFC projects worldwide. Further, it could potentially have allowed the earliest possible construction of the first commercial LFC plant in the Powder River Basin in Wyoming. The demonstration plant could be used to produce samples to be tested by customers and long-term contracts could then be negotiated. Unfortunately, that effort failed because Zeigler would not agree to any of the proposals between SGI, Zeigler and Mitsubishi. These negotiations were further complicated by Zeigler's announced intent to sell its assets. Thus, the termination of the TEK-KOL Partnership in May was essential to take the steps necessary to establish a formal alliance with Mitsubishi. On September 2, 1998, AEI Resources, Inc.(Addington) completed its tender offer for all of the outstanding common stock of Zeigler. We are in discussions with Addington's management, now that the acquisition is complete, to determine if they are interested in developing the LFC technology with SGI and Mitsubishi, and if not, we will continue to negotiate with them for the acquisition of the ENCOAL demonstration plant and all of its LFC interests.
SGI and Zeigler recently held their first meeting relative to the termination and distribution of TEK-KOL's assets. The parties have reached a general consensus on the distribution of all assets. All TEK-KOL employees will become employees of SGI and provide services to the SGI/Mitsubishi joint venture.
OCET
The Company has already obtained two patents for OCET, and other patent applications are in process. We have built a first-rate research and development laboratory incorporating both process development and chemical analytical capabilities, supported by highly-qualified staff, including a number of chemists, engineers, and physicists with doctorate degrees, who have determined that there are additional potential applications for the process other than in the petroleum industry.
On a lab-scale we have demonstrated that the Technology can substantially reduce asphaltene content in residual fuel oil as well as crude oil, simultaneously reducing metal content. After a year of development, engineering and design, the construction of a Process Demonstration Unit ("PDU") was completed. The PDU is currently generating data, which should enable us to determine the commercial efficacy of the OCET and related technologies in the petroleum industry as well as in other industries. The PDU was partly made possible because of the purchase (for approximately $40,000) of almost $1,500,000 in state-of-the-art equipment from UNOCAL's Brea, California Research and Development Center, which was being phased out. SGI offered its services to dismantle and transport this equipment, which allowed for the construction of the PDU at something considerably less than the original estimated cost of $250,000 and has also increased the capabilities of the SGI Development Center.
AMS
Since 1995, AMS has continued to improve in profitability and capability. It has become respected in the automation industry and has received numerous written commendations from its customers for its on-time, on-budget projects. AMS is a profitable company that continues to improve and generate additional net revenues. The year 1998 continues to be better for AMS than was 1997. Both the backlog and volume of sales have increased close to plan.
Progress to Date
Since I took office in June of 1995, I have focused on bringing the LFC Technology to market as quickly as possible in order to earn revenues and also to continue the development of OCET. Since 1995 engineering drawings and specifications for a 15,000 ton-per-day commercial LFC plant were prepared and used to estimate a $460,000,000 plant cost. This cost, as a result of continuing plant and process optimization programs, has been reduced to an estimated $350,000,000. Further, significant cost reductions are achievable along with a capacity increase of up to 21,000 tons-per-day. We have also examined methods to economically refine the coal liquids into chemical components. We have determined markets and prices for these components, as well as having examined methods to economically refine the coal liquids into those chemicals. All of this effort has taken several years, thousands of man hours, and millions of dollars expended by SGI, Zeigler, Mitsubishi, and other companies with whom we have forged alliances. I believe that we are close to optimizing CDL upgrading as a prerequisite to building the first several LFC plants. We have also determined four separate locations in the Powder River Basin where LFC plants could be located and we continue our efforts to develop those sites as well as working on additional ones.
While TEK-KOL, before the dissolution with Zeigler, had made numerous contacts with steel companies, chemical companies in the United States and overseas and coal companies overseas, few contacts were made with any coal companies in the United States. That is not surprising since Zeigler, as a coal holder, at one time viewed the LFC technology as a competitive advantage. Other coal holders in the Powder River Basin were also convinced that, as a consequence of being a partner in TEK-KOL, Zeigler had opportunities that were not available to them. With the termination of the TEK-KOL Partnership and the announcement of the formation of a joint venture with Mitsubishi, a number of coal companies and other interested parties have therefore contacted SGI to discuss the possible implementation of the LFC Technology. These companies include some of the largest U.S. coal companies. We are commencing or are in discussion with each of these companies as potential customers and/or strategic partners. SGI also intends to attempt to put together an alliance with a large transportation company that has shown real interest in the Technology. The Company is also in discussions to create business transactions with three separate chemical companies that use coal tars as their basic manufacturing feedstocks.
In addition, SGI has opened a Denver office and hired John Hart to market the LFC Technology and products in the United States. Mr. Hart, who has over 20 years of experience in the coal industry, is the former marketing manager for ARCO Coal. SGI has had several meetings with the DOE regarding upgrading coal liquids and is also making presentations to the DOE and other government agencies later this month for capital assistance to purchase ENCOAL and related LFC interests.
The SGI Development Center has recently established a new relationship with the Energy Institute at Pennsylvania State University, to further the development of fuels and chemicals from CDL. The Institute has agreed in principle to enter into a joint development program, which will explore new commercial applications for certain unique compounds found in CDL, and to explore together possible avenues of funding from government and private agencies. The initial work, which will be funded by Penn State and certain major oil companies, will focus on the application of the middle distillate of CDL as a high performance jet fuel.
The Department of Energy, Federal Energy Technology Center, (FETC), in Pittsburgh, PA has shown a renewed interest in the LFC process. Discussions are underway between FETC and the SGI Development Center to define how LFC fits in the FETC program matrix and particularly, their Vision 21 Program, which is designed to integrate fuel production with power generation and chemical processing, all of which are potential features of an integrated LFC plant. These discussions are preliminary, but program opportunities are scheduled to arise within four to eight weeks. OCET is also in continuing discussions with FETC to develop an additional Cooperative Research and Development Agreement related to electroprocessing.
OCET, along with a number of national corporations in cooperation with the DOE, is performing a joint study with Western Research Institute to develop a new technology for characterizing the way that asphaltenes interact with oil to stay in solution. This new method may lead to a "road map" of how asphaltenes may be caused to precipitate, and therefore further enhance the capability of the OCET process. When this process is in place, we may also have a new way to characterize resid feedstocks and predict OCET performance.
We continue discussions with domestic as well as international oil companies as part of our objective to commercialize OCET in the petroleum industry as well as other applications.
In the course of pursuing other business interests, SGI has acquired, by way of settlement or as a result of providing services, certain minority interests in other businesses. Those interests do not presently have a defined value, but include a 12% interest in a cogeneration plant that could be built to provide electricity to Golden Valley Electric in Alaska in the next few years and 10% of the interest of the developer in an Alabama coal fine recovery project. The potential revenue to SGI includes Section 29C tax credits. As SGI cannot use the tax credits we are evaluating how to monetize this interest.
I am delighted to have this opportunity to bring our shareholders up-to-date on the status of SGI. I very much appreciate the cooperation of those loyal shareholders and noteholders who continuously motivate me to achieve our corporate objectives, not the least of which is to substantially improve shareholder value. Thank you.
Best regards,
Joseph A. Savoca
Chairman/CEO
JAS/ncp
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