SouthGobi Resources' CEO Discusses Q2 2013 Results - Earnings Call Transcript

 |  About: SouthGobi Resources Ltd. (SGQRF)
by: SA Transcripts

SouthGobi Resources Ltd. (OTC:SGQRF) Q2 2013 Earnings Conference Call August 12, 2013 7:00 PM ET


Ready to begin. Hello, my name is Jade and I’ll be your conference operator today. Thank you for participating in the Second Quarter Results Conference Call for SouthGobi Resources Limited. At this time, all participants are in a listen-only mode. After the call, we will conduct the question-and-answer session. Today’s conference call is being recorded and will be available for playback on the Company’s website.

I would now like to turn the call to Christina Pantin. Please proceed.

Christina Pantin - Investor Relations

Thank you Jade. Good evening North America and good morning in Hong Kong. And welcome to SouthGobi’s second quarter results conference call. On the line today and here with us in Hong Kong are Ross Tromans, SouthGobi’s President and Chief Executive Officer and Bertrand Troiano, SouthGobi’s Chief Financial Officer.

Before we start, please note that today’s discussion may contain forward-looking statements. Please refer to SouthGobi’s August 12, 2013 press release and management’s discussion and analysis relating to SouthGobi’s second quarter results for the risks associated with the forward-looking statements that may be made in today’s discussion.

Ross, will now give you an overview of the key developments from the second quarter and Bertrand will take us through some of the detailed financial results. For those of you who have joined this call via the webcast, you may refer to Investor Presentation which is available on the site. There will be time for questions at the end of the session. Please note that all amounts are in U.S. dollars unless stated otherwise.

And now, over to you Ross.

Ross Tromans - President and Chief Executive Officer

Hello everyone and thank you for joining us today for our second quarter results update. We are pleased to report that despite market conditions our second quarter ended on a promising note. Following on from the safety and success of reached out of the mine in the first quarter. As you know, management is relentless in ensuring safety reminds the priority in the way we operate. Now I'm pleased to report that production in the second quarter took place without incident. We have now operated for over 600 days without a loss time injury. And this is an achievement we can be proud of.

Throughout the second quarter we remain focused on sustainable operations and the mind produced a 170,000 tonnes of coal compared to 20,000 tonnes in the first quarter 2013. In addition to this we responded to the tough market environment by using the quarter to remove $2.71 million BCMs of waste material and exposing coal in the pit.

This is prepared as well for when the marketing grows and we start shipping tonnage under new contracts. We are particularly focused on our ongoing discussions with customers to put in place new sales contracts with the process that made the Company’s commercial objectives. I'm pleased to report that subject to June 30, we entered into a new coal supply agreement with Winsway, an integrated logistic service provider and key customer values, for the sale of 1.2 million tonnes of Standard product for the remainder of 2013. This agreement reaffirms a longstanding relationship with Winsway, and is a very positive step for us as we look to reestablish our operations on a sustainable basis going forward. We’re also having compensations with other potential customers and we will update you further once we have brighter clarity of the outcome of these compensations.

We continue to believe in the long-term potential of SouthGobi and we have made two new appointments in the management teams to support this. In July, we appointed Enkh-Amgalan Sengee as President and Executive Director of SouthGobi Sands LLC, and in August we appointed Brett Salt formerly a Non-Executive Director of the Company as Chief Commercial Officer. Enkh-Amgalan has a wealth of senior management experience and also in depth knowledge of a Mongolian mining in the energy industries. It will be focused on leading our operations in Mongolia as well as engaging with external share – stakeholders.

Brett joined us Turquoise Hill Resources., where he was Senior Vice President, Strategy and Development and at SouthGobi he will responsible for Strategy Development, Business development and overall South and marketing for the Company and based in Hong Kong. All of us at SouthGobi look forward to working with both Enkh-Amgalan and Brett and their extensive skill and experience will be a great asset as we continued to focus on strengthening the Company’s core business performance and realizing its production potentially.

In the second quarter, we also continued to fully cooperate and proactively manage the government and regulatory investigations. And I will provide a further update on this shortly. And lastly, we continue to manage our liquidity, capital expenditure and overhead cost very tightly during the quarter. This is our particular importance as we did not see an improvement in the demand or price of coal in China.

Before I ask Bertrand to discuss the financial results for the period. I would like to take a few moments to discuss with you the China coal market and also the landscape we are seeing in Mongolia this time. When SouthGobi developed its objectives in early 2013 the market expected that economic activity posted China’s leadership transition would improve and the company responded to this by restarting its operations in March of this year.

Since then China’s economic growth has been slower than anticipated but China’s steel industry has been particularly affected and as a result demand and prices for coking coal as well as thermal coal have been negatively impacted. Certain coal prices indices in China have reached four year lows and coal consumption and production in regions close to the Mongolian border has dropped significantly year-on-year. There has been a 36% drop year-on-year to June 30th in Mongolian coal exports to China. Current market sentiment indicates that market conditions will remain challenging for the remainder of the year. The longer term outlook is more positive however, the timing of any recovery in 2014 remains uncertain and very much dependant on the Chinese economy.

Whilst we continue to actively seek new sales contracts in these uncertain conditions. The Company has decided to withdraw the production guidance of 3.2 million tons and to delay the use of the coal washing facilities. Hence we do not expect to be producing a washed coal product during the course of 2013 unless there is an improvement in market conditions and the margin for washed premium product. However we do plan to mine some premium semi-soft coking coal as raw coal later this year to place into this market.

On June 26, 2013 Mongolia held its presidential elections and we saw the democratic party nominate incumbent President Elbegdor reelected. Whilst we are yet to fully understand the impact of this reelection the continuity in leadership has been considered that potentially positive development for Mongolia.

In the second quarter we saw amendments to the 2012 enacted foreign investment law being passed under these amendments the requirement for parliamentary approval has been limited to circumstances where a state owned entity is to exceed 49% ownership of a strategy asset. These amendments have yet to be tested.

One challenge we continue to face relates to the royalty regime operating in Mongolia. As we’ve mentioned before in April of this year the government of Mongolia advised that the trial period of a royalty regime referencing contracted prices had not been extended and instead the royalties on coal are determined based on a referenced price per ton published monthly by the government.

The reference rates for April, May and June were US$66.60, US$73.53 and US$72.39 respectively. And SouthGobi’s effective royalty rates in the second quarter of 2013 were 34%. The 34% rate is due to the impact of actual prices achieved for the higher-ash coal sold as well as the reference price not being represented of the market in any event for coal traded at the Ceke border. This is significantly higher than the 6% effective royalty rate in the first quarter of 2013 when we were operating in the market based royalty regime trial period. SouthGobi together with other Mongolian mining companies continue discussions with the Government of Mongolia with the goal of reverting to a royalty regime determined using the contracted sales price per ton.

With regards to the ongoing rate increases we have seen a few development in relation to the investigations in Mongolia. Firstly the investigation by the Independent Authority Against Corruption into allegations of possible breaches of Mongolian Anticorruption Laws has been suspended by the prosecutor’s office. Although the company has not received noticed that the IAAC investigation is complete.

Today the IAAC has not formally accused any current or former SouthGobi employees of breach of Mongolia’s Anticorruption Laws. Secondly the company remains subject to continuing investigation by the state investigation office regarding allegations against SouthGobi and some of its former employees involving possible breaches of Mongolian laws relating to money laundering and taxation.

To-date the SIA has not accused any current or former SouthGobi employees at money laundering. However three former SouthGobi employees have been formed that they have been designated as accused in connection with the allegations of tax evasion, and are subject to a travel ban. The Company has been designated as a civil defendant in connection with these allegations. We have continued to show full cooperation with the investigations by providing relevant information. The authorities are yet to conclude on this information and such the likelihood or consequences for the Company of a judgment against its former employees is currently unclear.

The SIA also continues to enforce restrictions, initially imposed by the IAAC, on certain items of operating equipment, infrastructure and Mongolian bank accounts in connection with its continuing investigations. As previously discussed these restrictions do not limit the use of these items in the Company’s mining activities and SouthGobi does not expect these to have any material impact on the Company’s activities. It remains that the Company is taking these investigations extremely seriously and we continue to allocate time and resources to respond to the authorities and in conducting our own internal investigations which remain ongoing. I wanted to take some time to give you an update on the status of SouthGobi’s mining and exploration licenses. The Company currently holds three mining licenses and four exploration licenses which in total covered area of approximately 325,000 hectares.

The Company previously held six exploration licenses however on June 19, 2013 exploration licenses 9442X was canceled this June to a decision of the Supreme Court of Mongolia in relation to the case involving the former Chairman of the Mineral Resources Authority of Mongolia. The Company had no immovable assets located on this license and it did not contain any of SouthGobi’s NI 43-101 reserves or resources and as such this license is not considered material to the business.

In addition on August 8, 2013 MRAM notified the company that it has accepted the Company’s application to surrender exploration license 13916X. The company decided to surrender this license because it did not considered material or relevant to the Company’s present or future operations. Of the remaining four exploration licenses is held by the Company. One exploration license pertaining to the Soumber Deposit was issued at PMA in January 2013. While the remaining three exploration licenses has valid PMA applications lodged.

I would now like to turn over to Bertrand for more details on the financial results from the quarter before I discuss the outlook and objectives for the remainder of 2013.

Bertrand Troiano - Chief Financial Officer

Thank you, Ross. The financial results this quarter reflects the continued weakness in Chinese cold markets. SouthGobi reported an operating loss of $31.2 million in the second quarter of 2013 compared to an operating loss of $23 million in the first quarter of 2013 and an operating loss of $27.2 million in the second quarter of 2012.

Let me take you through the key elements that explains these results. I will start with revenues. SouthGobi recorded revenues of $0.4 million in the second quarter of 2013 this compared to $3.3 million in the first quarter of 2013 and $8.4 million in the second quarter of 2012 when our mine was operating in more favorable market conditions.

This quarter revenues were generated through the sale of thermal coal from existing stockpiles which explains the unfavorable product mix and lower average realized selling price compared to previous periods. As Ross mentioned earlier on the call China’s demand and prices for coal has remained low and this has impacted the prices we’ve been able to achieve for SouthGobi’s coal.

Cost of sales was $12.5 million in the second quarter compared to $21.9 million in the first quarter of 2013 and $22.2 million in the second quarter of 2012. Of that $12.5 million, $6.7 million related to mine operations and $5.8 million related to idled mine asset costs which were incurred due to the fact that some of our equipments was not operating at full capacity over the period.

Cost of sales for the quarter is therefore not reflected of the normal operating environments and as prices continue to weakened from the end of the first quarter to the second quarter the Company recorded an impairment loss of coal inventory of $4 million. Other operating expenses this quarter into the $3.1 million mark-to-market loss on our investment in Aspire.

The Company has also recorded $11.2 million in impairment and inventory, property, plant and equipment into surplus supplies materials and capital spares. These elements are not expected to be utilized with the Company’s existing mining fleets.

In anticipation of more favorable market conditions SouthGobi moved 2.7 billion BCM of waste material this quarter and increased volumes of the exposed or partially exposed thermal coal in pit. This explains an abnormally high strip ratio of 15.55 over the period. However, it also ensures that SouthGobi is well prepared for upcoming sales under the Winsway contract which commenced in July.

Overall, for 2013, we expect that the strip ratio will be inline with previous guidance. Managing our cost and cash flow remains a key priority especially in light of the continued strength we are seeing in the Chinese coal markets. The business continues to operate with a much leaner management structure and reduced workforce year-on-year and we remain committed to looking at ways to reduce our operational costs.

For example, in the second quarter our administration costs were $4 million, compared to $7.5 million in the second quarter of 2012. Despite the impact of legal fees linked to the ongoing internal and external investigations for the fir six months ended June 30, 2013 administration expenses were $7.8 million, down from $13.4 million with the six months ended June 30, 2012.

We’re also continuing to minimize our exploration expenditures. In the second quarter these amounted to $220,000, down from $2.1 million for the same period in 2012. Throughout the rest of our 2013 our exploration expenditures were continued to be limited to what is required our Mongolian Minerals Law to maintain our licenses.

Our capital expenditures for the second quarter were $7.5 million, down from $48.3 million in Q3 2012, and were primarily related to stripping activities. As part of the Company’s cash mitigation measures new projects will be paced to market conditions and as it results we’ve decided to delay a pre-feasibility study for the Soumber Deposit to the first half of 2014.

We made great strides to limit our capital commitments to what is actually necessary to protect the Company’s assets. As of June 30, 2013 our capital commitments for the next 12 months were $14.5 million compared to $36.3 million for 12 months as of June 30, 2012. in addition to capital spend on critical project SouthGobi is also investing a construction of the pave roads from the Ovoot Tolgoi mine to the Chevy current board crossing. We expect the road to be completed by the end of this year.

As a result of continued attention to liquidity, our quarterly cash out lay has significant slowdown compared to this time last year. We continue to mange our cost and balance sheet prudently, we’re focusing on generating free cash flow to new sales, rigorous collection or receivables, reduction of our inventory and selling non-core assets. We’re also drawing down on a prepaid credits in co-joining previous financial reporting periods.

In addition, the Company has engaged in mutually agreed with CIC, a three month deferral of the convertible debenture semi-annual $8 million cash interest payments. This payment is now due on August 19, 2013. As part of the normal course of business we continue to examine additional funding options for the Company.

As of June 30, 2013, SouthGobi had cash of $19.2 million and working capital of $78 million. SouthGobi expect to have sufficient liquidity and capital resources to meet its ongoing obligations and future contractual commitments including interest payments due to the CIC debenture for at least 12 months from the end of June 30, 2013. Estimated income from mining operations is obviously subject to a number of factors including supply and demand and pricing in the coal markets.

I will now turn back to Ross who will run through our outlook and objectives for 2013 before we take your questions.

Ross Tromans - President and Chief Executive Officer

Thank you, Bertrand. So looking forward as mentioned already, in July SouthGobi entered into a coal supply agreement with Winsway for the purchase of 1.2 million tonnes of Standard products in 2013. Pricing for the coal sold under this agreement will be based on a floating monthly index, and this inline with our previously stated intention to restructure our contractual agreement to minimize the risk of non-performance in the event of coal price move against us. This is an encouraging development that reaffirms the Company’s longstanding relationship with Winsway and marked a promising staff for the third quarter. In addition, two small spot market sales we concluded in July and early August and we are engaged in active discussions with other potential customers.

As we start to provide tonnage under the Winsway agreement and made further sales, the rate of production in the second half of 2013 is expected to increase. For example, in July we produced 216,000 tons of saleable product. However, as Chinese coking coal market is expected to remain challenging in the short-term and we still not yet seen a rising demand and prices for coal we have decided to withdraw our production guidance of 3.2 million tonnes for the year. We will provide you with more guidance on our production levels once we have some greater visibility on demand.

In the meantime, we are focused on updating the mine plant to optimize cash generation and adapting to current market demand dynamics as demonstrated by the decision to push back the plans for the washing facility. Despite the near-term challenges, longer-term our flexible product offer substantial resource by its favorable cost structure and strategically advantageous location makes us confident that demand for our two products strategy remains in tact.

Before I take questions, let me sum up by adding despite the persistent challenges in market condition, management remains totally committed to our 6-K objectives. At our core production, safety, environmental protection and operational excellence is fundamental for enabling sustainable production. We have continued to operate safely throughout the second quarter and ensure the mine is well positioned to respond to new contractual agreements and any improvement in market conditions. For the remainder of 2013, where we are continuing to focus on how we can build on sustainable production in improving sales, whilst being vigilant on cash out flow.

The infrastructure will be an important component of how we support the business going forward and we continue to develop our regional infrastructure with the construction of the paved highway. Our focus on product development is also vital as we seek to expand our customer base and adjust product mix inline with market conditions. The advancement Soumber deposit remains central to potential future growth but it is critical that subsequent growth is based to market demand and market conditions. We continue to be focused on our vision to be respected and profitable Mongolian coal company with excellent working relationships with all our stakeholders and we remain firmly committed to demonstrating the long-term sustainability of this business.

Thank you for your attention and this concludes our second quarter results discussion. We would be happy to take your questions. Let me first turn it back to Christina for some instructions.

Christina Pantin - Investor Relations

Thank you Ross. We appreciate that there may be many questions out there and to maximize participation could you please keep with two questions. If you have follow-ups we will put you back in the queue. Jade, please start the Q&A session.

Question-and-Answer Session


Thank you. We will now take questions from the telephone lines (Operator Instructions) There will be a brief pause while participants register. Thank you for your patience. We have a question from Oscar Cabrera from Merrill Lynch. Please go ahead.

Oscar Cabrera - Merrill Lynch

Good morning and/or afternoon everyone. Just wanted a clarification on your notes on the convertible debentures, there is a note here that alludes to the fact that might be because of the restriction of the new legislation in Mongolia, there could be an issue with full thing on the on the securities. Can you just clarify that because I don’t think that was mentioned during your statements at the beginning of the call?

Ross Tromans

Bertrand, can you answer that one or you want me to take it? Well you will recall that back in I think how (indiscernible) and I talked about November of 2012 where this issue first came up. We decided in the end to not test the legislation that was currently in place at that time and we paid cash instead of the convertible as part of the interest. We have continued to have discussions with the CIC and the government and we are on, and those discussions are ongoing. There is changes in the current amendment to the legislation which suggests that we should be able to progress on that but we are in discussions at this moment.

Oscar Cabrera - Merrill Lynch

I mean CIC?

Bertrand Troiano

I’m sorry Oscar and in our view that there is no fault under this reading the documentation and we’ve had legal opinion that there is no default.

Oscar Cabrera - Merrill Lynch

Great, okay. That’s very helpful. Thank you. And then my second question is with regards to the stripping ratio and during the second quarter assuming that you move ways to be able to release more production. What can you remain me what’s the life of mine strip ratio and where do you expected to be if you presume production on a normal basis in 2014?

Bertrand Troiano

Okay. 2013 obviously we moved our strip ratios went up in the last quarter because we are moving material and increasing our impaired inventory. So over the year we are expecting a pretty forecast a strip ratio around about the three level 3.1. The given we’ve already moved in the last quarter then we are expecting the strip ratio in the next quarter will be slightly lower to make up for that. Going forward we’ve been doing a review of our whole operations and we’ve looked at different opportunities and we believe that we can bring down the strip ratio. For 2014 again still preliminary we haven’t finalized our plant and stuff but we are looking at our rate that’s around the four level.

Oscar Cabrera - Merrill Lynch

Okay. Thank you. I’ll get back on queue.


Thank you. (Operator Instructions). We have a question from Mike Plaster from Salman Partners. Please go ahead.

Mike Plaster - Salman Partners

Hi. Thanks very much. Ross I wonder if you could just expand a little bit more on your views and what you are seeing on the local market in China in terms of demand and pricing. I think in your opening remarks you sort of said no improvement so far but you are seeing things is being fairly static or there is some signs of improvement sort of going into the back there the later half of the year?

Ross Tromans

Thank, Mike. I think it’s a question of who you talk to. There is certainly some people who are seeing signs that things are slightly improving. However from where we are seeing, we are seeing that the response by the Chinese coal market to the current position and it is that they are still producing tons and they’ve noticed that even today that there has been talk of reduction in taxes in some of the provinces to in China to then encourage more production to get the guys through. From a market perspective I think it’s still going to be tough for the rest of this year and we are still a little bit uncertain for 2014. However market, the market will improve over time it is at a very low level any sign of improvement in China will be reflected pick up and demand whether that mean to substantial rise in prices is less likely but I think there will be a rise and to a level that’s better for the coal producer.

Mike Plaster - Salman Partners

Okay. That helps. And just on the toll washing and the delaying I assuming that happens into 2014. Are there any penalties that could be incurred if you do not put any coal through that plant this year?

Ross Tromans

We don’t believe so we’ve been in discussions with some over it I mean that the fee structure in the way this is set up in the current market there needs to be some readjustment and we’ve been having discussions with them to make it more worthwhile for both parties.

Mike Plaster - Salman Partners

Okay. Thanks. That’s my two questions. I’ll get back in the queue.

Ross Tromans



Thank you. The next question is from Oscar Cabrera from Merrill Lynch. Please go ahead.

Oscar Cabrera - Merrill Lynch

Thank you for taking my follow-up. We’ve been very good with the questions two at a time. This is just on your dry plant. You talk about improvements there and I was wondering if you can just remind me what, what’s the CapEx outstanding to get it to where you want it to be once operations (erect) into normal production?

Ross Tromans

Yeah, in the current market that facility is just – the cost of running it versus the gain that you’re going to get from it is not working for us. So we haven’t planned on bringing it back at this point in time, we’ll be using a bit of this training that’s all but not the facility. So we really haven’t progressed anything on the capital cost of finishing that given the current market conditions and how we just try and control the CapEx. So we’re not really giving guidance at this point in time, it’s not timing, have a immediate radar screen.

Oscar Cabrera - Merrill Lynch

Right. I feel I can ask it this way, if – so based on market conditions, right now basically you are selling raw coal for the balance of the year. Where would you need to see pricing so that this on a sustainable level obviously so that these operations are worth putting back into operation?

Ross Tromans

It’s a good question. It’s – we need to make sure that the toll washing and the dry coal handling facility are integrated and in some instances they’re slightly mutually exclusive because they both achieved the same result. So we’re doing some work on understanding that better. The preference obviously first off I think would be the washing facility because it’s a more efficient way of doing it and produces a better consistent quality, so that will be our main priority.

Oscar Cabrera - Merrill Lynch

Okay, great. Thank you very much.

Ross Tromans

In terms – sorry – I didn’t answer question, I apologize. The margin is an ongoing discussion because it really depends on your cost as such. So we certainly need to see a better improvement in the coke and coal prices to make up for any yield differentiation that you may lose as a consequence of washing and then how that plays into the market. So it’s very (indiscernible).

Oscar Cabrera - Merrill Lynch

Right. No, I listen the qualitative health as much as a quantitative a lot of times, so thank you.


Thank you. (Operator Instructions) The next question is from Mike Plaster from Salman Partners. Please go ahead.

Mike Plaster - Salman Partners

Hi, thanks, I appreciate you taken the follow-up. Just one last one actually from me, in terms of CapEx in your remarks you talked about $14.5 million over the next 12 months. Is it reasonable to assume that’s roughly split between the last half of 2013 and the first half of 2014 or can you give us a bit more of a breakdown of that?

Ross Tromans

I’ll set to Bertrand.

Bertrand Troiano

Yeah, I think it’s a fair assessment, but probably 50:50, three quarters perhaps in 2013 depending on market conditions and how our cash flows shape up. So I would say you are correct on this one. We’ll be using of - so prepaid as much of course as we can depending on the sequencing of our projects. So and again minimizing the cash outlay from the – for CapEx as much as we can in 2013.

Mike Plaster - Salman Partners

Okay. Thanks very much.


Thank you. (Operator Instructions) If there are no questions that concludes SouthGobi’s second quarter investor call. Thank you. And have a good day.

Ross Tromans

Thank you everyone.

Christina Pantin - Investor Relations

Thank you.


The conference has ended. Please disconnect your lines at this time. And we thank you for your participation.

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