Sherritt International's CEO Discusses Q1 2014 Results - Earnings Call Transcript

| About: Sherritt International (SHERF)

Sherritt International Corp. (OTCPK:SHERF) Q1 2014 Earnings Conference Call April 30, 2014 2:00 PM ET


Paula Myson – Director, Investor Relations

David Pathe – President and CEO

Dean Chambers – EVP and CFO


Greg Barnes – TD Securities

Anoop Prihar – GMP Securities

Patrick Morton – RBC

Cliff Hale-Sanders - Cormark Securities

Alec Kodatsky – CIBC


Good afternoon, ladies and gentlemen. Thank you for standing-by. Welcome to the Sherritt International Corporation First Quarter 2014 Results Call. At this time, all participants are in listen-only mode. Following the presentation, we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions). I would like to remind everyone that this conference call is being recorded, today, Wednesday, April 30, 2014 at 2 PM Eastern Time. I will now turn the conference over to Ms. Paula Myson, Managing Director, Investor Relations and External Communications. Please go ahead.

Paula Myson

Thank you, Ron and good afternoon everyone. Our First Quarter Results were released this morning and a copy of the release along with the MD&A, the financials are available on our website. Today’s conference call is going to be webcast. So in addition to the people on the line, anyone may listen to the call by accessing our website and clicking on the webcast link. A replay will be posted later on this afternoon.

Before we begin our comments, I would like to remind everyone that today’s release and certain of our comments on the call will include forward-looking statements. We would like to refer everyone to the cautionary language in the press release and the risk factors in the SEDAR filings.

With us today is, David Pathe, our President and CEO and Dean Chambers, our Executive Vice President and Chief Financial Officer. We will begin with some prepared remarks and then we will open up the call to your questions. With that, I will turn the call over to David.

David Pathe

All right. Thank you Paula and thank you everybody for joining us this afternoon once again on what is I know a very busy day for earnings releases in our industry. So we won't take too much of your time here.

The first quarter was really continuation of the positive momentum that began in 2013. Tanks on large part to substantial progress Ambatovy and the implementation of our strategies to reduce costs and strengthen our balance sheet. And all of that is enhanced by strengthening of nickel prices in last few months. I am going to touch on few of the larger events during the quarter and few of the highlights from our operations but first I will just take a moment and address the current dissident campaign that we are dealing with and then I am going to move on and focus on earnings.

We are very pleased with the level of shareholders support we have seen to-date and I am equally pleased that throughout this process and despite all the distraction our employees have remained focused on moving the business forward and executing our plans.

While costly and distracting this proxy contest has highlighted the positive activities that are underway shares and the potential I believe we have to create this growing and sustainable value for our shareholders.

We have also had many valuable conversations with our shareholders throughout this process. We appreciate the support and constructive feedback that we have received. We will use what we have learned in those conversations to improve the execution of our plans going forward. I look forward to continuing these conversations in the future.

We have received strong endorsements from the leading independent corporate governance analysis and proxy firms, ISS and Glass Lewis. We welcomed their recommendations the shareholders vote only the blue proxy per shares direct to nominees. The deadline for shareholders to vote their proxies is this Friday at 5 o'clock normal time and our annual meeting takes place next Tuesday morning at 10 o'clock and we look forward to seeing many of you there.

So turning to some highlights from the quarter. Let's start with the closing of our previously announced coal transaction which occurred this past Monday. This transaction is consistent with our strategy of focusing on our medals in Cuban oil businesses. The completion of the transaction greatly enhances liquidity and provides the opportunity to prove the strengthened our balance sheet.

We used the significant amount of $800 million in cash proceeds to reduce our overall debt. In addition, Q1 marked the achievement of commercial production in Ambatovy. This was obviously a significant operational milestone and was important step in tangibly demonstrating Ambatovy to be the long life, low cost nickel and production facility we have longed to it believe will be.

And the timing of this commercial production coincided nicely with the favorable change in the nickel market. These events have been recognized by the market and the key elements in the momentum of our stock. So our operations, I will have quick look through.

Looking at operations in the first quarter we saw strong operating performance delivered by our coal, metals and oil and gas businesses. Ambatovy delivered in terms of our expectations in the advance from the ramp up. With the achievement of commercial production in the quarter, this is the first time we have provided the net direct cash cost number for Ambatovy. The cost delivered in the first two months for the commercial production were at the low end of our guidance. We are seeing steady gains and autoclave availability, solid density and volumetric flows to the autoclaves. All this evidence supports our expectations of the operation is becoming cash flow neutral in early 2015.

Besides to our Ambatovy, we hosted the end of March highlighted our success in Madagascar. And more, we continue to address the challenges of moving into new mining area that was the transition to begin in the fourth quarter of 2013. Production was impacted somewhat by this issue but over the course of the quarter, we made modifications to our mine plant and by the end of the quarter we have seen significant improvement.

We also had implant maintenance in one of the five leads trends in Moa. We completed repairs to the autoclave during the quarter and the train was returned to service by the end of the quarter, because of the multiple train design of the operation, the production impact was such instantly minimized however the cost do go into our mining and processing cost in our net direct cash cost.

Despite the additional cash cost of this maintenance, the net direct cash cost from Moa was down from Q4 and down from Q1 in the prior year.

Oil and gas, during the quarter, we achieved higher production, both gross and nets and lower unit cost in our Cuban oil business. This reflects our ongoing concentrated focus on costs, currently around 12 bucks a barrel and our ongoing success in drilling activities to offset the natural decline rates in the reservoir.

We also concluded our negotiations with Cuba regarding four new exploratory production sharing contracts and a 10 year extension to one of our existing PLCs. The contracts are now being reviewed by the relevant ministries and we are hoping that we have our final approvals in the second quarter.

On the power side, we completed the (inaudible) term by an addition of our Boca site. It was tested and put into operations nearly February. The expansion assets are expected to run at 55% to 60% of their capacity until the gas supply constrains so that's alleviated and that’s one of the things we have been working on.

So our production has increased significantly during the quarter because of the new turbine coming online. We are looking to increase that further as we realize more success in our gas strategy. We plan to capture some additional gas, which is currently being flared. Two of our mostly completed wells are now producing quantities of associated gas that makes it worthwhile to capture that gas and we are intending to do that in the second quarter. We are also in the process of moving the drilling rate to drill well to evaluate the gas potential of one of our current oil producing sectors in this quarter. We should have cleared up picture of that opportunity in time for our second quarter discussion.

Just to touch briefly on the markets, oil prices have obviously continued to be strong but the real story of the quarter from the market perspective is nickel. When we spoke in February, we talked about nickel market since 2013 being depressed, marked by declining prices and rising inventories.

We also mentioned that we still believe to fundamentally in the medium to long-term outlook that was very strong. Sentiment now appears to change quite dramatically in the nickel market. Nickel has gone from being the worse performing base metal in the London Metal Exchange in 2013 to being the best performer thus far in 2014.

We started the quarter around 6 bucks, just over $6 and by the end of March pricing was $7.14. This continue to strengthen in April and it is now trading around $8.25, I think it is today. So with noting there are reference price for the quarter was 664, so I am releasing the benefits of that improving market flow through to our results here.

Lot of the movement price thus far has been attributable to Indonesian ore band and the effects that's having on NPI production in China as well as raw oil prices have shot up significantly since the position of the ore band from Indonesia. The Indonesian ore impact was also, is in addition to the strengthening the stainless steel market which we would consumes about two-thirds of primary nickel production and as we have seen decent decreases in base stainless steel pricing this year as well.

As a result, we have seen nickel prices rise about 30% since at the beginning of the year without any real production cost to response and the response to that we haven’t really seen that flow through our operations yet. Those are the things I wanted to highlight for you today and Dean is going to talk through a few more specific accounting implications of some of this quarter's events and then will come back and take your questions.

Dean Chambers

Thanks David, and good afternoon. I want to focus on some of the items as how the material impact in the quarter or could in the future and those are unique to our financial reporting.

The biggest change in our financial reporting of course is related to Ambatovy. This is the first quarter Ambatovy financial results have been included in shares, before shadow the impact of this accounting change in our year-end call.

So since February 1st, we began including the impact of Ambatovy in our income statements nearing how we have been reporting the Moa joint venture for the last year.

Share of Ambatovy earnings or loss now appears in the line earnings a lot from an associate on our income statement. For the quarter, there was a loss of $40 million or 80% of the corporation's total loss.

As we have discussed before, the largest driver of this loss is and will continue to be the level of depreciation and amortization at Ambatovy. To illustrate, in the first two months as a commercial operations, Ambatovy on 100% basis, recorded a loss before tax of $110 million.

Of that loss, almost two-thirds or $69 million was attributable to depreciation and amortization. So despite the strong operational gains and cost deliberate at the low band of the expected range, significant depreciation and interest expense will likely keep Ambatovy at a loss for 2014.

We estimate the depreciation at Ambatovy to be approximately $170 million that share is 40% share and for the 11 months of commercial operations in 2014. On the same basis, net interest expense would be about $110 million.

Now net interest expense on shared balance sheet will probably be about $70 million because as a result of consolidation, elimination of interest on subordinated debt provided by the shareholders takes place.

Last quarter, we indicated that we expected Sherritt share of Ambatovy funding for 2014 to be around $200 million, $125 million for operations and $75 million for senior debt service and even though the nickel price has remained weak for most of the first quarter, there has been a significant change in the nickel price increasing over 25% since our last call. And as we have talked about many times, one of the biggest factors in determining cash flows and neutrality at Ambatovy is the market price for nickel and cobalt.

We would expect our funding obligations to decline as Ambatovy ramps up and receives more of the benefit of a higher market price for its products. A quick way to estimate the impact of the change in nickel price from our disclosure could be as follows; again with the 2014 outlook for finished metal production say 45,000 times for the year which is about 99 million pounds. It's also assumed that sales and production are match each other.

In the first quarter, Ambatovy produced about 19 million pounds and sold 14 million pounds in two months. For using that 19 million pound number that leaves about 80 million pounds to be sold in the last nine months of this year.

So if the price increases by a dollar, it could reduce the total required part of the funding by $80 million or $32 million on Sherritt’s share. Now of course there will be many factors that will influence the actual funding for Ambatovy, ramp up into commodity prices, cobalt prices et cetera and this assumes everything remains the same, we gives you some estimate the benefit of nickel price change on our requirements going forward.

The second item of course is the significant financially is the closing of the coal sale transaction and as Dave mentioned this call is on Monday of this week.

Sherritt sold the assets for total consideration of $946 million including $793 million of cash received on closing.

The operating assets were sold to Westmoreland Coal Company for total consideration of $465 million, $312 million in cash and their function of capital leases valued at $153 million. The corporation's wealthy portfolio and interest in coal development assets were sold to a group led by Altius Minerals for cash consideration of $481 million.

Post-closing adjustments, for among other things, changes to capital leases, working capital and coal inventories, are expected to be finalized in the second quarter 2014. I also expect a small gain related to the disposition of the royalty portfolio.

Sherritt had a $525 million revolving credit facility used primarily for letters of credit and short-term funding for the Coal business. The $300 million that we have drawn on this facility was repaid from Sherritt's existing cash balances immediately prior to closing of the Coal transaction and this facility has subsequently been terminated.

There were two unusual items in our earnings during the quarter that related to the coal business being classified as the discontinued operation during the period. First, accounting standards do no permit us to record depreciation on assets categorized as discontinued. Therefore, you will see that the coal results in the coal results, there is no depreciation recognized. We also adjusted the carrying value of the discontinued assets to fair value.

Moving on to tax, last quarter we spoke of the complexities of our tax calculation and we encouraged you to think of this in three main elements. First: because we are now equity account for Ambatovy and Moa, earnings and loss of these two operations come into our income statements in a single line that is already after tax.

Second, and as the result of the metal business accounting, essentially the income tax line on our income statement reflects the income tax on our oil and gas business with the tax rate of 30% and then if you look Sherritt International the corporate parent, typically we will have significant losses because that's where we do most of our financing and where most of the financing expense has contained.

With very little offset in Canadian income or very simply the interest expense of this debt is not getting a tax benefit. Tax benefits of these losses were recognized in prior periods but we are no longer recognizing the benefit of these losses. But for the quarter, our income tax expense has $30 million relates almost entirely to our oil operations and there is about $11 million higher than the comparable period last year.

Due to depreciation of the Canadian dollar, there has been a significant foreign exchange impact on our results this period. Our net financial expense was approximately $14 million higher than in the prior year period due to unrealized foreign exchange losses on U.S. denominated debt, higher interest and accretion expense offset partially the higher interest income.

If you look at foreign exchange on continuing operations, in fact last quarter – first quarter of last year we had a gain and this past quarter we had a loss of almost $10 million. So the differential in foreign exchange is about $16 million after tax.

Adjusted operating cash flow was 44% higher in the first quarter this year compared to the first quarter of last year or $0.08 a share. I do want to remind you that the operating cash flow only includes Moa and Ambatovy cash flows if there are distributions in the quarter from the joint venture.

David has talked about the operations in the quarter and that was relatively good quarter and this has been reflected in our unit cost. I want to take a few minutes to talk about the net direct cash cost that we reports in our metal businesses.

Net direct cash cost is comprised of fixed cost and variable cost. And variable costs are primarily related to input commodities and the price of those commodities and by-product credit. The variable cost typically represent the majority of our total net direct cash cost.

At metals, net direct cash cost are down about $0.04 per pound from the prior year quarter despite lower production. The majority of that decline has occurred in mining, processing and refining cost and higher cobalt by-product credits offset by lower net fertilizer by-product credits.

The decline in the mining process and refinery cost is primarily driven by declines in input commodity prices, primarily sulphur and sulphuric acid.

With respect to our fixed and controllable cost, we have managed to keep those stable for years despite decrease in cost relating to the equipment and labor. The net direct cash cost at metal has consistently been in the lower half of the public figures published by independent analyst.

The one of the real values of net direct cash cost is to allow comparisons across many operations and in that light we have made a change the way we calculate net direct cash cost for our metal business. We now include a by-product credit from the four site operations, effectively utilities and fertilizer operations that are integral to the refinery in Fort Saskatchewan and our previously reported net direct cash cost was conservative by not including this credit. The incorporation with this change makes the metal net direct cash cost completely comparable to the Ambatovy net direct cash cost and other global operations.

As Dave mentioned Ambatovy delivered net direct cash cost of $6.83 per pound well within guidance for production at this stage of the ramp up and below the current cash price for nickel. We expect the Ambatovy net direct cash cost to continue to drop as the ramp-up progresses, allowing the company to further benefit from the strengthening of the nickel market and the rise in prices.

In our Cuban oil operations, unit costs were down almost $1.50 per barrel from Q4 and was the lowest in the last eight quarters. This is partly due to the fact that there were fewer work-overs in the quarter. We do expect an increase in the number of work-overs in the second quarter which will have some impact on the unit cost.

Turing to cash and liquidity, our cash balance at the end of March was just over $600 million, a decrease of approximately $50 million from our yearend balance. This decrease was due to our investment in Ambatovy as well as capital spending across our businesses.

Clearly, the closing of our coal transaction is having two impacts on our cash. As I spoke, earlier we have used $300 million of our existing cash to repay the outstanding balance on the coal revolving credit facility.

Second, our cash balance has increased by almost $800 million upon receipt of the cash proceeds from the sales of the coal business.

Looking at adjusted EBITDA, with $55 million for the quarter versus $61 million in the comparable quarter a year ago, this was attributable mainly to the lower nickel prices in the first quarter and the continued ramp-up of Ambatovy.

As I look forward to the second quarter, a couple of things I do expect our cash balance to be – to have improved significantly as a result of sales of the coal business, less any funds that we have used to repay debts and as I mentioned earlier, there will be some post-closing adjustments that will have an impact on second quarter results.

This concludes the remarks I would like to make and operator we can now open the line for questions.

Question-and-Answer session


Thank you. Ladies and gentlemen we will now conduct the Question-and-Answer session. (Operator Instructions). And your first question comes from (inaudible). Please go ahead.

Unidentified Analyst

Hi. Good afternoon. I wanted to focus on SG&A cost and given your cost reduction initiatives in regards to SG&A, what can we expect, when these are fully implemented, what can we expect your quarterly run rate to be for admin expenses. I mean this quarter was $16.8 million and curious sort of where that is going or where you think it can get you by the end of the year? Thank you.

Dean Chambers

Hi (inaudible) this is Dean. Yes it's a good question. There is lot of ins and outs in our SG&A cost and even as we implement some of those improvements things like severance cost as along show up. But we do expect, it's hard to see some significant reduction in SG&A also obviously we no longer have coal, it just discontinued but no longer be part of our number. To give you a run rate is a little bit hard but I would start to expect to see significant reduction in the quarters going forward.

Unidentified Analyst

Okay. So the 16.8, you can't offer some kind of guidance on how or so what you are targeting on it?

Dean Chambers

Well we are seeing some decline obviously in compensation, outside services, travel those sorts of expenses. It is being offset by some cost related to the coal transaction and our upcoming shareholders meetings so those are running through admin cost. So I could see if we take that out there is like – you could see like a million and half dollar that would be different this quarter.

Unidentified Analyst

Okay and does that reflect the current number? Does that reflect a full quarter of Ambatovy, actually but it’s not even in that number because of the JV, never mind that part of the question. Thank you.

Unidentified Analyst

Yes, you are right.


Your next question comes from Greg Barnes with TD Securities. Please go ahead.

Greg Barnes – TD Securities

Yes thank you. David or Dean I guess the obvious question is how has Ambatovy done during April?

David Pathe

Yes we have carried on the ramp that we have had pretty good months down there again we have got couple of challenges in March. When you guys were down there, we saw the issues with the cylinder at your preparation plant and in March that in fact but that is what brought us down a bit from the 17% for the quarter. Through April, I think we are probably in high 60s again in April where we did period there we have got five autoclaves going but we did a trip on the hydrogen plant, which took us down for a couple of days but overall we are still seeing a sustained levels of throughputs up in the high 60s and when we get good runs with four and five autoclaves going, we are seeing production up in the 85% - 90% range. So we are pleased with the way it's going. The other thing we did is connection with the issue or at our preps facilities.

We took down, we accelerated a scheduled maintenance run on one of the autoclave, autoclave four I believe it was, that was originally scheduled for June and that impacted our production a bit in March and then in the first part of April but that does set us up for now and we think we have got stretch now for several months here but we don't have scheduled maintenance on any of the five autoclave trains. So the short answer to your question, we have had a pretty good month in April and I think we are looking to sustain that and then pick it up over the course of the rest of the quarter.

Greg Barnes – TD Securities

Okay. Good. Thank you. Dean it was helpful to give us the potential impact on I guess the burn rate for Ambatovy for this year 200 million in debt funding and ops funding. So how much of the 200 million was spent in Q1?

Dean Chambers

I think we spent – we contributed about $36 million in the quarter.

Greg Barnes – TD Securities

Okay. So if we take the 200 minus 36 and use that up as sensitivity, we should be in got a good idea where you break even the nickel prices then for this year.

Dean Chambers

It's the good estimate. If all the other things remain relatively constant.

Greg Barnes – TD Securities

Okay. And David just one final question. When you opened up the discussion you talked about your core nickel and oil and gas operations. Where does power sit?

David Pathe

Power sits with the oil and gas business, it's a smaller business, obviously in our metals and our oil and gas business but it's an important piece of it as well. I don't see undertaking a lot of expansion or seeing much happening in the power business as until we can more comprehensively address our gas issues there and it's certainly never going to be the contributed to our EBITDA the way metals and oil business is but it's a business that we are happy to be in and the Cuba in terms of its solid cash flowing business and important part of our relationship in Cuba.

Greg Barnes – TD Securities

Okay. Thank you.


You next question comes from Anoop Prihar with GMP Securities. Please go ahead.

Anoop Prihar – GMP Securities

Good afternoon. Just with respect to the covenant issues that we discussed in the MD&A, am I correct to saying and understanding that there were two covenant that you are in breach of one really into your debt equity and the other one liberating you in debtness of 40% of total assets and then how do you – how do these issues get resolved? Does the coal seal clean them both up or is there something more to it than that?

Dean Chambers

Yes, I know you are right. We brief the covenant in our corporate credit facility as well as the fund to as debtness to total asset covenant in public debentures and yes the coal transaction we did have a waiver from our banks, so I think through the end of the second quarter on that relevant covenant, to that facility but the coal transaction should fix that as well as the fund and debtness to total asset. So I mean we would expect there are some scenarios, commodity price scenario and so on that could lead us to future difficulties but right now that should be fine.

Anoop Prihar – GMP Securities

I am assuming those even on the back of the sale as the coal assets closing and paying off debt and your cash balance increasing. You are not going to be much below 40% on that one test, are you?

Dean Chambers

No, that’s correct. We will be in the high 30s.

Anoop Prihar – GMP Securities

Thank you.


(Operator Instructions). Your next question comes from Patrick Morton with RBC. Please go ahead.

Patrick Morton – RBC

Hi guys what’s the status of the negotiations for potentially refinancing existing high yield bonds?

David Pathe

So we have had some discussions, they are still relatively preliminary, we have been talking to some banks as well in terms of what may be possible. The realty as we probably are not as far ahead on that as we would be but with all the preparation that we had going on for our AGM next week but as we get through that, then it will become the focus and we are still looking to be doing something there in the second quarter.

Patrick Morton – RBC

Great. Thanks.


Your next question comes from Cliff Hale-Sanders with Cormark Securities. Please go ahead.

Cliff Hale-Sanders – Cormark Securities

Hi good afternoon everyone, a bit of a nitpicky question for Dean on the Ambatovy financials. Just curious on the depreciation obviously you (inaudible) the numbers that you have given us here talking about $400 millionish, sort of number for the year on a 100% basis. I am just wondering if you give us a little color on what method of depreciation is being used because it seems a little bit higher than we have been effectively trying to calculate. So if you just give us a color that would be useful.

Dean Chambers

Well as you know, in IF or S you have to componentized things and that different depreciation rates for different assets so we have gone through the various assets and put the (inaudible) and depreciation on the various components of the project. We could probably offline give you some help with that.

Cliff Hale-Sanders –- Cormark Securities

Okay. Yes, it just seems little bit higher, just wanted that’s a good run rate we introduced for the next couple of years.

Dean Chambers

I would expect that's a probably a good run rate but we can help you to look what you have got and what we are showing.

Cliff Hale-Sanders – Cormark Securities



Your next question comes from Alec Kodatsky with CIBC. Please go ahead.

Alec Kodatsky – CIBC

Yes, thanks. I just had a question on the oil and gas contracts, on the earlier call you were talking about that was submitted for review, just sort of curious if you can provide a bit of color around that process sort of what can we expect and are there specific risk to the time line and things we can watch out further?

Dean Chambers

Yes it's difficult for me to put a specific time line Alec for you. Alec, I mean it's obviously something we have been working on and pushing forward with our Cuban partners for quite some time. The progress we did make in the quarter was that we now seen have agreed forms of the contracts, the new PSCs for the blocks, (inaudible) blocks, so we are trying to get and have those signed off with CUPET –the state owned royal company down there.

So it does go to a number of different ministries for approval in terms of the ministries of foreign investment as well as some of the economic ministries. It's difficult for me to handicap with great certainty of how long that process is going to take. But I am down there regularly and so as (inaudible) pushing that as soon as we have got some news there we will be keen to share.

Alec Kodatsky – CIBC

Okay so we will keep our eyes open. That's all I have. So thanks very much.

Dean Chambers

Thanks Alec.


There are no further questions at this time. I will turn the call over to Paula Myson for any additional comments or closing remarks.

Paula Myson

Thanks, Ron. As Dave mentioned earlier, our Annual General Meeting is coming up on Tuesday May 6th in Toronto. The specific details are on the website under the event’s page so you can refer to that for the details. For those of you that we won’t see at the AGM, we look forward to speaking with you again at the end of July with our second quarter results and thank you very much for participating in the call today and please feel free to contact us with any further questions.


Ladies and gentlemen this concludes the conference call for today. Thanks for participating. Please disconnect your line.

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