SouthGobi Resources' (OTC:SGQRF)
Q2 2014 Earnings Conference Call
August 11, 2014 7:00 p.m. ET
Ross Tromans - President and Chief Executive Officer
Bertrand Troiano - Chief Financial Officer
Benjamin Wang - Standard Chartered
Hello, my name is Rita 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 a 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 President and Chief Executive Officer of SouthGobi Resources, Ross Tromans. Please proceed sir.
Thank you, Rita. Good evening in North America and good morning in Hong Kong. And welcome to SouthGobi’s second quarter results conference call.
Before we start, please note that today’s discussion may contain forward-looking statements. Please refer to SouthGobi’s August 11, 2014 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.
On the line today with me in Hong Kong is Bertrand Troiano, SouthGobi’s Chief Financial Officer. I will now give you an overview of the key developments from the second quarter and Bertrand will take you through some of the detailed financial results. You may refer to Investor Presentation which is available on SouthGobi’s site. There will be time for questions at the end of the session.
Moving to Slide 4, I will, as always, start with Slide 3. I am happy to report that SouthGobi continues to maintain a strong safety record. At June 30, lost time injury frequency rate at SouthGobi was standing at 0.15 per 200,000 man-hours based on a rolling 12 months average.
Our operations continued to operate in difficult market conditions. Coal prices in China declined further in the second quarter compared to the first quarter of 2014 in response to excess seaborne supply. The decline in coal prices has been partially offset by the increase in the company’s sales volumes in the second quarter compared to the seasonally slow first quarter and also a lower royalty under the new royalty regime which became effective first of April 2014.
Seeking additional sources of financing order to re-establish appropriate liquidity levels remains one of our key priorities going forward and as we announced on May 25, the company obtained a US $10 million revolving credit facility from Turquoise Hill to meet our short term working capital requirements. Bertrand will provide further details on the facility and SouthGobi’s liquidity situation later.
On July 30, our major shareholder Turquoise Hill announced an agreement with National United Resources Holdings Limited to sell shares representing 29.95% of the company’s shareholding. The closing of this transaction is subject to certain conditions, including the approval of both the Hong Kong Stock Exchange as well as shareholders of National United Resources Holdings. Closing is expected to occur no later than November 30, 2014.
National United Resources is a company listed on the main board of the Hong Kong Stock Exchange and is principally engaged in coking coal trading, natural resource related logistics business, outdoor media advertising, and media related services. It entered the coking coal trading and natural resource related logistics business in the second half of 2013 and is actively building up networks and cost relationships in the industry.
Natural United Resources management believes that acquiring a stake in SouthGobi will allow them to further secure supplies of coking coal with our company, give them an opportunity to form a strategic alliance with the company and to continue to diversify and strengthen their natural resource business. NUR is one of the current customers of the company and had provided coal three times [ph] to us in the second quarter of 2014.
Following the closing of the transaction, as a significant owner of the company NUR will be appointing two new directors to the board of SouthGobi.
On Slide 5, I would like to take a few minutes to discuss with you the China coal market and also the landscape we are seeing in Mongolia. During the second quarter of 2014, the global metallurgical coal market remained over-supplied, further suppressing spot prices. Coal producers around the world continue to focus on efficiency and cost reduction with announcing production curtailments, closures and reductions in workforce, as well as delayed start-up or withdrawal from expansion projects. It has been similar position in Mongolia.
In China’s Shanxi province, rehabilitated coking coal production capacity is becoming more available after years of government mine consolidation programs. Outside of China, demand growth is healthy although prices are down, whereas in China coal imports are relatively flat year on year. Without the growth in Chinese demand, coal prices will remain suppressed with the rest of the world growth lower than supply capacity.
Moving to Slide 6, I would like to update you on the development in Mongolia. As we reported in the last quarter, the government of Mongolia changed the royalty regime whereby the royalty per ton per export coals out is calculated based on the actual contracted sales price per ton rather than a reference price set by the government in the previous regime. The change is a positive development for the company and resulted in a decrease in royalty per ton for SouthGobi in the second quarter, compared to the prior reference price system.
However on July 4, the government of Mongolia made a further amendment to the royalty regime whereby the royalty is to be initially calculated and paid monthly based on the government reference price. At the end of each quarter, the royalty amount will then be adjusted to reflect the contracted sales price. Once the quarterly statement has been approved by the Mongolian tax authorities and the adjustments between the monthly payments for the quarter and the quarterly submission are to be adjusted in the next month’s royalty payment.
The company is still subject to investigation by the Mongolian authorities regarding allegations against the company and some of its employees. The trial date for the tax investigation case against the company’s subsidiary SouthGobi Sands and the three of its former employees has been set for the August 25 this year. As we have previously stated, the company has prepared its financial statements in compliance with IFRS and lodged all its tax returns in the required format under Mongolian tax law
Now let me take you through key operating highlights for the second quarter on Slide 7. In light of the current market, we continue to pace our production with the market demand. As a result, we operated significantly below our operating capacity in the second quarter with a total production of 550,000 tons and drawing from stockpiles. In June 2014, following the review of operations in response to the market conditions, we further reduced production and placed approximately half of the company’s workforce on furlough. This is expected to remain like this until the end of August.
The average realized selling price in the second quarter was also impacted by decreasing prices and by the product mix, which primarily consisted of thermal coal with limited sales of standard semi-soft coking coal. In late June, and then again in early July, the Ovoot Tolgoi Mine site region experienced torrential rain and flooding which temporarily interrupted mining operations. The impact on the company’s operations, however, is not expected to be material.
I would now like to turn over to Bertrand for more details on the financial results from the second quarter.
Thank you, Ross. Today I will describe our second quarter results, including our disciplined approach to cost of capital management. I will then conclude with some comments on liquidity.
Financial results for the second quarter of 2014 reflect continuing difficult coal market conditions. Compared to the first quarter, lower sales prices have been offset by higher sales volumes and lower royalty expenses. As a result of these challenging market conditions, SouthGobi recorded a $17.5 million loss from operations in the second quarter compared to a $16.7 million loss from operations in the first quarter 2014.
I will now take you through the key elements that explain these results outlined on Slide 9. I will start with revenues. We recorded revenues of $6.7 million in the second quarter compared to $5.1 million in the first quarter of 2014. This increase in revenue was driven by higher sales volumes in the second quarter following seasonally low sales in the first quarter. As indicated earlier, the average realized selling price was impacted by the product mix in the second quarter which consisted of thermal coal with limited Standard semi-soft coking coal.
The company’s revenue is presented net of royalties and selling fees. Following the change in the Mongolia’s royalty regime starting April 1, the company’s effective royalty has dropped from 24.6% or $4.80 per ton in the first quarter to 8.1% or $1.00 per ton for the second quarter of 2014.
SouthGobi’s operating expenses, including cost of sales, were $6.8 million in the second quarter compared to $5.6 million in the first quarter of 2014. The increase in operating expenses is in line with the increase in volumes sold, partially offset by a lower cash cost of product sold. Cost of sales in the second and first quarter of 2014 included coal stockpile impairments of $6.2 million and $7.3 million respectively to reduce the carrying value of the company’s coal stockpiles to their net realizable value.
The coal stockpile impairments recorded in both quarters reflected challenging coal market conditions that I highlighted earlier. Cost of sales in the second and first quarters of 2014 also included idled mine asset costs of $4.9 million and $3 million respectively. The production plan in both quarters did not fully utilize the company’s existing mining fleet, therefore, idled mine asset costs continued to be incurred throughout the first half of the year.
Finally, the company recognized an impairment loss of $3.4 million in the second quarter of 2014 related to prepaid toll washing fees under the Ejinaqi Jinda 2011. This impairment charge is due to the further delay in starting the commercial operations at the wet washing facility and the continued soft coal market in China.
Moving on to Slide 7, managing our costs remains a key priority. We have further reduced direct cash costs of product sold from $10.40 per ton in the first quarter of 2014 down to $8.20 per ton in the second quarter of 2014, as a result of the ongoing efforts to reduce production costs and improve operating efficiencies. We also continued to minimize our administration expenses. Administration expenses were 45% lower in the first half of 2014 compared to the same period in 2013, primarily due to the lower legal and professional fees.
Meanwhile we continue to limit our capital expenditures to essential equipment maintenance and critical projects, with $0.8 million spent in CapEx this quarter and $3.2 million spent in the first quarter of 2014. We also limited our evaluation and exploration expenditures to ensuring compliance requirement with the Mongolian Minerals law.
Turning now to cash and financing on Slide 11. Coal prices in China continues to adversely affect SouthGobi’s margins and liquidity. In the second quarter of 2014, we generated a positive cash flow, excluding interest paid and financing of $3.2 million, supported by pre-payments on coal sales. During the second quarter, SouthGobi paid $8 million of interest under the CIC convertible debenture and obtained a $10 million loan revolving credit facility from Turquoise Hill to meet its short term working capital requirements. As at June 30, and as of today, the company has drawn down $3.8 million under that facility.
The company’s cash balance as at August 11 stands at $6.2 million. Looking forward, we anticipate the challenging market conditions will continue to impact SouthGobi’s margins and liquidity. Therefore we remain focused on securing prepaid coal sales and minimizing working capital. The company is also seeking additional sources of financing to continue operating and meet its objectives.
I will now turn back to Ross who will run through our outlook and objectives for 2014 and beyond before we take your questions.
Thank you, Bertrand. Turning to Slide 13, as I have already stated, the outlook for Mongolian coal exports remain very dependent on China and the overall coal market balance. We anticipate that coal prices in China will remain under pressure through to the end of 2014. And this will continue to impact the company’s margins and liquidity.
Our production will continue to be paced to market demand and we will continue to maintain our focus on productivity enhancement and cost reduction going forward.
The company’s objectives for 2014 and the medium term remain as previous. We are seeking to secure additional and immediate sources of financing. The company is focused on securing this principally through prepayments of coal and continues to minimize uncommitted capital expenditures while preserving the company’s growth options,
Drive operational excellence. The company is focused on further improving operational efficiency in production and to further reduce operating and administrative costs.
Target to complete the road projects by the end of 2014. The company’s priority is to complete the construction of the paved highway from the mine area to the Shivee Khuren Border Crossing subject to the company having available financial resources to fund its force [ph] and construction costs. Construction of the paved highway was substantially completed by the end of 2013 and the remaining construction work is currently underway and is expected to be completed within 2014.
Deliver value through marketing by improving the company’s access to market and end customers and the overall quality of its product by beneficiation process based on wet washing.
Progress growth options – subject to available financial resources, the company plans to further the development of the Soumber Deposit, while staying compliant with the government regulations in relation to its licenses and agreements.
Operating in a socially responsible manner – the Company is focused on maintaining its vigilance on health, safety and environmental performance.
Re-establish the company’s reputation – the company’s vision is to be a respected and profitable Mongolian coal company. To achieve this, the company continues to work on re-establishing good working relationships with all external stakeholders.
Despite the current challenging market conditions, in the longer term, our product offer, substantial resource base, favourable cost structure and locations make us well positioned to create value for our shareholders.
Thank you for your attention and this concludes our second quarter results discussion. We will be happy to take your questions. Rita, please start the Q&A session.
(Operator Instructions) There are no questions registered at this time sir. I would now like to turn the meeting over to Mr. Tromans. Please proceed sir.
Rita, could we just leave it just a little bit longer just --
We had a problem in the past where getting the connections – just another 30 seconds. And if there is no further questions, then we will conclude the conference call.
Okay, Rita, it seems that there is no questions. So let’s conclude this call. Thank you participants for listening.
Thank you very much for joining this conference. You may disconnect your lines at this time. And again we thank you for your participation. Oh, I am sorry, Mr. Tromans, we do have a call – question from Mr. Benjamin Wang of Standard Chartered. Are you available to take the questions sir.
Thank you. Your line is open Mr. Wang. Please mention your organization before proceeding with your question.
Benjamin Wang - Standard Chartered
This is Benjamin Wang from Standard Chartered. I would like to ask management – with one question. So I understand that it has been a slight change in the shareholder structure recently and I was just wondering if the new management has any new plans for the company.
Well, there have been announcements, as I mentioned in the presentation where Turquoise Hill has provisionally sold 29.95% of the company to NUR. That transaction is still underway and has not closed. So strictly speaking it’s not been changed yet. We have talked to NUR because they are customer of ours and we are aware of that, but it’s too early to discuss, the change of direction of the organization.
Thank you. There are no further questions registered at this time. Once again we thank you for your participation. Please disconnect your lines at this time.
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