Mr. Joseph Lo reports
SOUTHGOBI RESOURCES ANNOUNCES FIRST QUARTER 2013 FINANCIAL AND OPERATING RESULTS
SouthGobi Resources Ltd. has released its financial and operating results for the quarter ended March 31, 2013 (all figures are in U.S. dollars unless otherwise stated).
Significant events
The company's significant events for the quarter ended March 31, 2013, and subsequent weeks are as follows:
- Received a premining agreement (PMA) pertaining to the Soumber
deposit;
- Provided an update on the continuing governmental, regulatory and internal
investigations;
- Announced the resumption of operations at its flagship Ovoot Tolgoi mine
on March 22, 2013. The company plans to produce 3.2 million tonnes of
semi-soft coking coal in 2013. Operations had been fully curtailed since
the end of June, 2012;
- Announced updated National Instrument 43-101-compliant resource estimates for the Soumber
and Zag Suuj deposits, which increased SouthGobi's total measured and
indicated resources to 533 million tonnes (8-per-cent increase) and inferred
resources to 302 million tonnes (24-per-cent increase);
- Announced the appointment of Bertrand Troiano as its chief financial
officer, effective April 8, 2013;
- First quarter coal sales volumes and revenue declined to 80,000 tonnes and $3.3-million, respectively, in 2013 compared with 840,000 tonnes and $40.2-million in 2012.
Review of quarterly operating results
The company's operating results for the previous eight quarters are summarized in the table.
REVIEW OF QUARTERLY OPERATING RESULTS
Q1 2013 Q4 2012 Q3 2012 Q2 2012 Q1 2012
Raw coal production
(millions of tonnes) 0.02 - - 0.27 1.07
Sales volumes and prices
SouthGobi premium
semi-soft coking coal
Coal sales (millions
of tonnes) 0.08 0.03 - 0.12 0.31
Average realized
selling price (per
tonne) $ 45.81 $ 47.86 $ - $ 67.17 $ 67.59
SouthGobi standard
semi-soft coking coal
Coal sales (millions
of tonnes) - - - 0.04 0.53
Average realized
selling price (per
tonne) $ - $ - $ - $ 49.91 $ 50.40
SouthGobi thermal coal
Coal sales (millions
of tonnes) 0.00 - 0.31 0.00 -
Average realized
selling price (per
tonne) $ 13.67 $ - $ 15.79 $ 38.80 $ -
Total
Coal sales (millions
of tonnes) 0.08 0.03 0.31 0.16 0.84
Average realized
selling price (per
tonne) $ 45.02 $ 47.86 $ 15.79 $ 62.56 $ 56.79
Costs
Direct cash costs of
product sold excluding
idled mine costs
(per tonne) $ 35.46 $ 33.11 $ 8.23 $ 22.57 $ 10.80
Total cash costs of
product sold excluding
idled mine costs
(per tonne) $ 40.52 $ 38.17 $ 12.12 $ 31.49 $ 15.04
Waste movement and
stripping ratio
Production waste
material moved
(millions of bank
cubic metres) 0.40 - - 1.16 2.20
Strip ratio (bank
cubic metres of waste
material per tonne of
coal produced) 26.21 - - 4.31 2.07
Preproduction waste
material moved
(millions of bank
cubic metres) - - - - -
Other operating capacity
statistics
Capacity
Number of mining
shovels/excavators
available at period-end 5 5 4 4 3
Total combined stated
mining
shovel/excavator
capacity at period
end (cubic metres) 113 113 98 98 64
Number of haul trucks
available at period-end 31 27 27 27 27
Total combined stated
haul truck capacity
at period-end
(tonnes) 5,615 4,743 4,743 4,743 4,743
Employees and safety
Employees at period-end 444 465 644 693 720
Lost-time injury
frequency rate - 0.1 0.2 0.2 0.3
Q4 2011 Q3 2011 Q2 2011
Raw coal production
(millions of tonnes) 1.34 1.25 0.87
Sales volumes and prices
SouthGobi premium
semi-soft coking coal
Coal sales (millions
of tonnes) 0.53 0.66 0.60
Average realized
selling price (per
tonne) $ 67.62 $ 66.83 $ 65.96
SouthGobi standard
semi-soft coking coal
Coal sales (millions
of tonnes) 0.37 0.20 -
Average realized
selling price (per
tonne) $ 48.59 $ 48.17 $ -
SouthGobi thermal coal
Coal sales (millions
of tonnes) 0.25 0.51 0.45
Average realized
selling price (per
tonne) $ 40.30 $ 39.74 $ 38.32
Total
Coal sales (millions
of tonnes) 1.15 1.37 1.05
Average realized
selling price (per
tonne) $ 55.51 $ 54.01 $ 54.06
Costs
Direct cash costs of
product sold excluding
idled mine costs
(per tonne) $ 22.14 $ 22.64 $ 26.77
Total cash costs of
product sold excluding
idled mine costs
(per tonne) $ 23.09 $ 23.17 $ 27.61
Waste movement and
stripping ratio
Production waste
material moved
(millions of bank
cubic metres) 4.58 4.10 4.08
Strip ratio (bank
cubic metres of waste
material per tonne of
coal produced) 3.42 3.28 4.74
Preproduction waste
material moved
(millions of bank
cubic metres) - 0.39 0.80
Other operating capacity
statistics
Capacity
Number of mining
shovels/excavators
available at period-end 3 3 4
Total combined stated
mining
shovel/excavator
capacity at period-end (cubic metres) 64 64 98
Number of haul trucks
available at period-end 25 16 16
Total combined stated
haul truck capacity
at period-end
(tonnes) 4,561 2,599 2,599
Employees and safety
Employees at period-end 720 695 658
Lost-time injury
frequency rate 0.2 0.2 0.1
On March 22, 2013, SouthGobi announced the resumption of operations at the Ovoot Tolgoi mine after having been fully curtailed since the end of the second quarter of 2012. The company plans to produce 3.2 million tonnes of semi-soft coking coal in 2013. The 2013 mine plan assumes a conservative resumption of operations, designed to achieve a cost-effective approach that will allow operations to continue on a sustainable basis and align production levels with forecast market conditions.
Moving forward, saleable products from the Ovoot Tolgoi mine will primarily be based on a two-product strategy and will consist of SouthGobi standard and SouthGobi premium semi-soft coking coal products. The standard and premium semi-soft coking coal products will be produced from raw semi-soft coking coals, together with raw medium and higher-ash coals, which can be washed and blended into the standard and premium semi-soft coking coal products. Some higher-ash product will be sold as a thermal coal product as required.
For the three months ended March 31, 2013, the company produced 20,000 tonnes of raw coal with a strip ratio of 26.21 compared with production of 1.07 million tonnes of raw coal with a strip ratio of 2.07 for the three months ended March 31, 2012. In the first quarter of 2013, the company's production was significantly impacted by the curtailment of mining operations until March 22, 2013. The company's strip ratio of 26.21 in the first quarter of 2013 is due to a higher proportion of waste material being mined over the limited operating period and is not indicative of the company's strip ratio moving forward.
For the three months ended March 31, 2013, SouthGobi recorded revenue of $3.3-million compared with $40.2-million in the first quarter of 2012. Revenue decreased primarily due to decreased sales volumes and a lower average realized selling price. The company sold 80,000 tonnes of coal at an average realized selling price of $45.02 per tonne in the first quarter of 2013 compared with sales of 840,000 tonnes of coal at an average realized selling price of $56.79 per tonne in the first quarter of 2012. In the first quarter of 2013, SouthGobi generated revenue through the sale of existing coal stockpiles. SouthGobi's sales volume and average realized selling price was negatively impacted by the continued softness of the inland China coking coal markets closest to SouthGobi's operations. The company's thermal coal product continued to be impacted more substantially than its other products. Market participants continue to deplete their existing stockpiles on the Mongolian and Chinese sides of the Shivee Khuren-Ceke crossing at the Mongolia-China border and this movement provides some indication of future sales once the remaining stockpiles are depleted in the second quarter of 2013. However, this has adversely impacted SouthGobi's ability to sign new contracts to date in the second quarter of 2013.
Direct cash costs of product sold excluding idled mine costs were $35.46 per tonne for the three months ended March 31, 2013, compared with $10.80 per tonne for the three months ended March 31, 2012. Direct cash costs of product sold excluding idled mine costs primarily increased in the first quarter of 2013 due to higher cost coal inventory being sold. In the first quarter of 2012, direct cash costs of product sold excluding idled mine costs were also lower due to a below-trend strip ratio.
Review of quarterly financial results
The company's financial results for the previous eight quarters are summarized in the table.
REVIEW OF QUARTERLY FINANCIAL RESULTS
(In thousands of U.S. dollars, except for per share)
Q1 2013 Q4 2012 Q3 2012 Q2 2012 Q1 2012
Revenue $ 3,259 $ 1,213 $ 3,337 $ 8,412 $ 40,153
Gross profit/(loss)
excluding idled mine
costs (2,187) (6,894) (8,601) 1,778 22,674
Gross profit margin
excluding idled
mine costs -67% -568% -258% 21% 56%
Gross profit/(loss)
including idled mine
costs (18,601) (25,336) (27,532) (13,809) 22,674
Other operating
(expenses) (383) (18,664) (29,301) (3,803) (2,578)
Administration
(expenses) (3,733) (6,079) (5,178) (7,497) (5,882)
Evaluation and
exploration (expenses) (273) (508) (958) (2,099) (5,033)
Income/(loss) from
operations (22,990) (50,586) (62,969) (27,208) 9,181
Net income/(loss) (24,901) (51,818) (54,564) 237 3,126
Basic income/(loss)
per share (0.14) (0.28) (0.30) 0.00 0.02
Diluted income/(loss)
per share (0.14) (0.28) (0.30) (0.12) 0.02
Q4 2011 Q3 2011 Q2 2011
Revenue $ 51,064 $ 60,491 $ 47,336
Gross profit/(loss)
excluding idled mine
costs 16,637 17,635 9,744
Gross profit margin
excluding idled
mine costs 33% 29% 21%
Gross profit/(loss)
including idled mine
costs 16,637 17,635 9,744
Other operating
(expenses) (24,644) (138) (3,024)
Administration
(expenses) (8,612) (7,993) (6,808)
Evaluation and
exploration (expenses) (14,513) (10,908) (4,356)
Income/(loss) from
operations (31,132) (1,404) (4,444)
Net income/(loss) (18,897) 55,921 67,323
Basic income/(loss)
per share (0.10) 0.31 0.37
Diluted income/(loss)
per share (0.14) (0.02) -
The company recorded a net loss of $24.9-million in the first quarter of 2013 compared with a net loss of $51.8-million in the fourth quarter of 2012 and a net income of $3.1-million in the first quarter of 2012.
Gross profit/(loss)
The company's gross profit/(loss) is composed of revenue (net of royalties and selling fees) and cost of sales, and relates solely to the Mongolian coal division. In the first quarter of 2013 and the fourth quarter of 2012, gross profit was negatively impacted by $16.4-million and $18.4-million of idled mine costs, respectively, contributing to a gross loss of $18.6-million in the first quarter of 2013 and $25.3-million in the fourth quarter of 2012. The company recorded a gross loss excluding idled mine costs of $2.2-million in the first quarter of 2013 compared with a gross loss excluding idled mine costs of $6.9-million in the fourth quarter of 2012 and a gross profit excluding idled mine costs of $22.7-million in the first quarter of 2012. Gross profit will vary by quarter depending on sales volumes, sales prices and unit costs.
The company recognized revenue of $3.3-million in the first quarter of 2013 compared with $1.2-million in the fourth quarter of 2012 and $40.2-million in the first quarter of 2012. The significant decrease in revenue in the first quarter of 2013 and the fourth quarter of 2012 compared with the first quarter of 2012 can be attributed to decreased sales volumes and a reduction in the company's average realized selling price. In the first quarter of 2013, the company's sales volumes and average realized selling price continued to be negatively impacted by the softness of the inland China coking coal markets closest to SouthGobi's operations. Although the company signed contracts with customers in the first quarter of 2013 to sell the majority of its remaining thermal coal stockpiles, customers did not collect contracted volumes.
SouthGobi's effective royalty rate in the first quarter of 2013 was 6 per cent. Effective Oct. 1, 2012 (for a six-month trial period), the royalty was determined using the contracted sales price per tonne, not the reference price per tonne published by the government of Mongolia. SouthGobi, together with other Mongolian mining companies, continued the dialogue with the appropriate government of Mongolia authorities with the goal of extending the trial period until the end of 2013. To date, this dialogue has not been successful and effective April 1, 2013, the royalty on all coal sales exported out of Mongolia will again be based on a set reference price per tonne published monthly by the government of Mongolia.
Cost of sales was $21.9-million in the first quarter of 2013 compared with $26.5-million in the fourth quarter of 2012 and $17.5-million in the first quarter of 2012. Cost of sales comprises the direct cash costs of product sold, mine administration cash costs of product sold, idled mine costs, inventory impairments, equipment depreciation, depletion of mineral properties and share-based compensation expense. Of the $21.9-million and $26.5-million recorded as cost of sales in the first quarter of 2013 and the fourth quarter of 2012, $5.4-million and $8.1-million related to mine operations, and $16.4-million and $18.4-million related to idled mine costs, respectively. Cost of sales related to mine operations decreased in the first quarter of 2013 compared with the fourth quarter of 2012 primarily due to reduced coal stockpile impairments, partially offset by higher sales volumes. Cost of sales related to mine operations decreased in the first quarter of 2013 compared with the first quarter of 2012 primarily due to lower sales volumes, partially offset by higher unit costs and coal stockpile impairments totalling $2.2-million. In the first quarter of 2013, the company recorded a coal stockpile impairment of $2.2-million to reduce the carrying value to its estimated net realizable value.
Other operating expenses
Other operating expenses in the first quarter of 2013 decreased to $400,000 compared with $18.7-million in the fourth quarter of 2012 and $2.6-million in the first quarter of 2012. In the first quarter of 2013, other operating expenses primarily related to $300,000 of foreign exchange losses; whereas in the fourth quarter of 2012, other operating expenses primarily related to a $4.7-million loss provision for doubtful trade and other receivables, a $3.1-million impairment loss on available-for-sale financial assets, and $13.0-million of impairment charges related to property plant and equipment. In the first quarter of 2012, other operating expenses primarily related to $2.4-million of foreign exchange losses.
Administration expenses
Administration expenses in the first quarter of 2013 were $3.7-million compared with $6.1-million in the fourth quarter of 2012 and $5.9-million in the first quarter of 2012. Administration expenses decreased in the first quarter of 2013 compared with the fourth quarter of 2012, primarily due to decreased legal and professional fees, and salaries and benefits. Administration expenses decreased in the first quarter of 2013 compared with the first quarter of 2012 primarily due to decreased corporate administration, salaries and benefits, and share-based compensation expenses, partially offset by increased legal and professional fees.
Evaluation and exploration expenses
Exploration expenses in the first quarter of 2013 were $300,000 compared with $500,000 in the fourth quarter of 2012 and $5.0-million in the first quarter of 2012. Exploration expenses will vary from quarter to quarter depending on the number of projects and the related seasonality of the exploration programs. The company continues to minimize exploration expenditures to preserve the company's financial resources.
Finance income and finance costs
Finance costs in the first quarter of 2013 were $5.0-million compared with $1.5-million in the first quarter of 2012. Finance costs in the first quarter of 2013 primarily consisted of $5.0-million of interest expense on the China Investment Corp. (CIC) convertible debenture; whereas, finance costs in the first quarter of 2012 primarily consisted of an $800,000 unrealized loss on the fair value change of the embedded derivatives in the CIC convertible debenture, a $300,000 unrealized loss on FVTPL investments and $300,000 of interest expense on the CIC convertible debenture.
Finance income in the first quarter of 2013 was $800,000 compared with $200,000 in the first quarter of 2012. In the first quarter of 2013, finance income primarily consisted of a $700,000 unrealized gain on the fair value change of the embedded derivatives in the CIC convertible debenture; whereas, in the first quarter of 2012, finance income primarily consisted of $200,000 of interest income.
The company's investment in Aspire Mining Ltd. continues to be classified as an available-for-sale financial asset and for the three months ended March 31, 2013, the company recorded an aftertax mark-to-market gain of $900,000 related to Aspire that has been recorded in other comprehensive income. Other comprehensive income for the three months ended March 31, 2012, consists of an unrealized loss (net of tax) of $5.4-million related to the company's investment in Aspire.
Taxes
In the first quarter of 2013, the company recorded a current income tax expense of $1,000 related to its Mongolian operations compared with a current income tax expense of $4.9-million in the first quarter of 2012. The company has recorded a deferred income tax recovery related to deductible temporary differences and loss carry-forwards of $2.3-million in the first quarter of 2013 compared with a deferred income tax recovery related to deductible temporary differences of $100,000 in the first quarter of 2012.
Financial position and liquidity
Cash position and liquidity
As at March 31, 2013, the company had cash of $24.8-million compared with cash of $19.7-million and short-term money market investments of $15.0-million for a total of $34.7-million in cash and money market investments as at Dec. 31, 2012. Working capital (excess current assets over current liabilities) was $115.8-million as at March 31, 2013, compared with $127.2-million as at Dec. 31, 2012.
The company's total assets as at March 31, 2013, were $708.1-million compared with $729.4-million as at Dec. 31, 2012. The company's non-current liabilities as at March 31, 2013, were $103.1-million compared with $103.8-million as at Dec. 31, 2012.
Consistent with the company's capital risk management strategy, the company expects to have sufficient liquidity and capital resources to meet its continuing obligations and future contractual commitments for at least 12 months from the end of the March 31, 2013, reporting period. The company expects its liquidity to remain sufficient based on existing capital resources and estimated income from mining operations. Liquidity beyond the 12-month period is dependent on the success of the recommencement of operations, and continuing demand and prices in the coal market. On March 22, 2013, the company recommenced mining activities at the Ovoot Tolgoi mine. The company continues to minimize uncommitted capital expenditures and exploration expenditures in order to preserve the company's financial resources.
During the three months ended March 31, 2013, the Mongolian Independent Authority Against Corruption (IAAC) informed the company that orders, placing restrictions on certain of its Mongolian assets, had been imposed in connection with its continuing investigation.
The orders placing restrictions on certain of the company's Mongolian assets could ultimately result in an event of default of the company's CIC convertible debenture. This matter remains under review by the company and its advisers, but to date, it is the company's view that this would not result in an event of default as defined under the CIC convertible debenture terms. However, in the event that the orders result in an event of default of the company's CIC convertible debenture that remains uncured for 10 business days, the principal amount owing, and all accrued and unpaid interest will become immediately due and payable upon notice to the company by CIC.
The orders relate to certain items of operating equipment and infrastructure and the company's Mongolian bank accounts. The orders related to the operating equipment and infrastructure restricts the sale of these items; however, the orders do not restrict the use of these items in the company's mining activities. The orders related to the company's Mongolian bank accounts restrict the use of in-country funds. While the orders restrict the use of in-country funds pending outcome of the investigation, they are not expected to have any material impact on the company's activities.
Impairment analysis
During the three months ended March 31, 2013, the company determined that an indicator of impairment existed for its property, plant and equipment related to the Ovoot Tolgoi mine. The impairment indicator was the continued weakness in the company's share price.
Therefore, the company conducted an impairment test whereby the carrying values of the company's property, plant and equipment, including mineral properties, related to the Ovoot Tolgoi mine were compared with their value in use using a discounted future cash flow valuation model as at March 31, 2013. The company's property, plant and equipment, including mineral properties, totalled $512.1-million as at March 31, 2013.
Key estimates and assumptions incorporated in the valuation model included the following:
- Inland Chinese coking coal market coal prices;
- Life-of-mine coal production and operating costs;
- A discount rate based on an analysis of market-, country- and company-specific factors.
The impairment analysis did not result in the identification of an impairment loss and no charge was required as at March 31, 2013. The company believes that the estimates and assumptions incorporated in the impairment analysis are reasonable; however, the estimates and assumptions are subject to significant uncertainties and judgments.
Processing infrastructure
On Feb. 13, 2012, the company announced the successful commissioning of the dry-coal-handling facility (DCHF) at the Ovoot Tolgoi mine. The DCHF has capacity to process nine million tonnes of run-of-mine (ROM) coal per year. The DCHF includes a 300-tonne-capacity dump hopper, which receives ROM coal from the Ovoot Tolgoi mine and feeds a coal rotary breaker that sizes coal to a maximum of 50 millimetres and rejects oversize ash. The DCHF is anticipated to reduce screening costs and improve yield recoveries.
The company has received all permits to operate the DCHF. However, the 2013 mine plan considers only limited utilization of the DCHF at the latter end of 2013 due to higher-quality coals being mined that likely will not require processing through the DCHF and can be sold raw or processed directly through the wet washing facility. The 2013 mine plan assumes a conservative resumption of operations, designed to achieve a cost-effective approach that will allow operations to continue on a sustainable basis.
The company has delayed construction to upgrade the DCHF to include dry air separation modules and covered load out conveyors with fan stackers to take processed coals to stockpiles and enable more efficient blending. Uncommitted capital expenditures have been minimized to preserve the company's financial resources.
To further enhance product value, in 2011, the company entered into an agreement with Ejinaqi Jinda Coal Industry Co. Ltd (Ejin Jinda), a subsidiary of China Mongolia Coal Co. Ltd. (CMC), to toll wash coals from the Ovoot Tolgoi mine. The agreement has a duration of five years from commencement and provides for an annual wet washing capacity of approximately 3.5 million tonnes of input coal. Pursuant to the terms of the agreement, the company prepaid $33.6-million of toll washing fees.
Ejin Jinda's wet washing facility is located approximately 10 kilometres inside China from the Shivee Khuren border crossing, approximately 50 km from the Ovoot Tolgoi mine. Primarily, medium and higher-ash coals with only basic processing through Ovoot Tolgoi's on-site DCHF will be transported from the Ovoot Tolgoi mine to the facility under a separate transport agreement. Based on preliminary studies, the company expects these coals can then be washed to produce coals with ash in the range of 8 per cent to 11 per cent at a yield of 85 per cent to 90 per cent. Ejin Jinda will charge the company a single toll washing fee which will cover its expenses, capital recovery and profit. Washed coal will generally meet semi-soft coking coal specifications.
Construction of Ejin Jinda's wet washing facility is now complete and it has been connected to utility supply. The company plans to commence wet washing coals in the second half of 2013. As at March 31, 2013, the delay in commencing wet washing coals has had no impact on the carrying value of the company's prepaid toll washing fees of $33.6-million.
Regional transportation infrastructure
On Aug. 2, 2011, the State Property Committee of Mongolia awarded the tender to construct a paved highway from the Ovoot Tolgoi complex to the Shivee Khuren border crossing to consortium partners NTB LLC and SouthGobi Sands LLC (together referred to as RDCC). SouthGobi Sands holds a 40-per-cent interest in RDCC. On Oct. 26, 2011, RDCC signed a concession agreement with the State Property Committee of Mongolia. RDCC has the right to conclude a 17-year build, operate and transfer agreement under the Mongolian law on concessions. Construction on the paved highway has recommenced in the second quarter of 2013 after a scheduled demobilization in the fourth quarter of 2012 due to winter weather conditions. Completion of the paved highway is expected in late 2013. The paved highway will have an intended carrying capacity upon completion in excess of 20 million tonnes of coal per year.
Regulatory issues
Governmental, regulatory and internal investigations
The company is subject to continuing investigations by the IAAC and the State Investigation Office (SIA) in Mongolia regarding allegations against SouthGobi and some of its employees involving possible breaches of Mongolian laws, including anti-corruption and taxation laws. Certain of those allegations (including allegations of bribery, money laundering and tax evasion) have been the subject of public statements and Mongolian media reports, both prior to and in connection with the recent trial and conviction of the former chairman and the former director of the geology, mining and cadastral department of the MRAM, and others. SouthGobi was not a party to that case. The company understands that the court's decision is the subject of an appeal.
A number of the media reports referred to above suggest that, in its decision, the court in the above-mentioned case referred to two matters specifically involving SouthGobi Sands.
In respect of the first matter, being an alleged failure to meet minimum expenditure requirements under the Mongolian minerals law in relation to four exploration licences, the company is investigating these allegations, but advises that three of the four licences were considered to be non-material and allowed to lapse between November, 2009, and December, 2011. Activities historically carried out on the fourth (and the only currently held) licence include drilling, trenching and geological reconnaissance. The company has no immovable assets located on this licence and it does not contain any of SouthGobi's NI 43-101 reserves or resources. This licence does not relate to the company's Ovoot Tolgoi mine and SouthGobi does not consider this licence to be material to its business.
The second matter referred to by the court was an alleged impropriety in the transfer of licence 5261X by SouthGobi Sands to a third party in March, 2010, in violation of Mongolian anti-corruption laws. The company understands, based on media reports, that the court has invalidated the transfer of this licence, and so the licence's current status is unclear.
In addition, the IAAC and SIA have advised the company that they continue to investigate other alleged improprieties by SouthGobi Sands as described above. Neither SouthGobi nor any of its employees have been charged in connection with the IAAC or SIA investigations, but certain former employees have been advised that they are suspects. The IAAC has imposed orders placing a travel ban on those employees and administrative restrictions on certain of the company's Mongolian assets, including local bank accounts, in connection with its continuing investigation of those allegations. While the orders restrict the use of in-country funds pending the outcome of the investigation, they are not expected to have a material impact on the company's activities in the short term, although they could create potential difficulties for the company in the medium to long term. SouthGobi is taking and intends to take all necessary steps to protect its ability to continue to conduct its business activities in the ordinary course.
Through its audit committee (comprising solely independent directors), SouthGobi is conducting an internal investigation into possible breaches of law, internal corporate policies and codes of conduct arising from the allegations that have been raised. The audit committee has the assistance of independent legal counsel in connection with its investigation. The chair of the audit committee is also participating in a tripartite committee, comprising the audit committee chairs of the company and Turquoise Hill, and a representative of Rio Tinto, which is focused on the investigation of those allegations, including possible violations of anti-corruption laws. Independent legal counsel and forensic accountants have been engaged by this committee to assist it with its investigation. All of these investigations are continuing but are not yet complete. Information that has been provided to the IAAC by the company has also been provided by the tripartite committee to Canadian and United States regulatory authorities that are monitoring the Mongolian investigations. The company continues to co-operate with all relevant regulatory agencies in respect of the continuing investigations.
The investigations referred to above could result in one or more Mongolian, Canadian, United States, or other governmental or regulatory agencies taking civil or criminal action against the company, its affiliates or its current or former employees. The likelihood or consequences of such an outcome are unclear at this time but could include financial or other penalties, which could be material, and which could have a material adverse effect on the company.
Pending the completion of the investigations, the company, through its board of directors and new management, has taken a number of steps to focus continuing compliance by employees with all applicable laws, internal corporate policies and codes of conduct, and with the company's disclosure controls and procedures, and internal controls over financial reporting.
Notice of investment dispute
On July 11, 2012, SouthGobi announced that SGQ Coal Investment Pte. Ltd., a wholly owned subsidiary of SouthGobi Resources Ltd. that owns 100 per cent of the company's Mongolian operating subsidiary SouthGobi Sands, filed a notice of investment dispute on the government of Mongolia pursuant to the bilateral investment treaty between Singapore and Mongolia. The company filed the notice of investment dispute following a determination by management that it had exhausted all other possible means to resolve a continuing investment dispute between SouthGobi Sands and the Mongolian authorities.
The notice of investment dispute consists of, but is not limited to, the failure by MRAM to execute the PMAs associated with certain exploration licences of the company pursuant to which valid PMA applications had been lodged in 2011. The areas covered by the valid PMA applications include the Zag Suuj deposit and certain areas associated with the Soumber deposit outside the existing mining licence.
The notice of investment dispute triggers the dispute resolution process under the bilateral investment treaty whereby the government of Mongolia has a six-month cure period from the date of receipt of the notice to satisfactorily resolve the dispute through negotiations. If the negotiations are not successful, the company will be entitled to commence conciliation/arbitration proceedings under the auspices of the International Centre for Settlement of Investment Disputes (ICSID) pursuant to the bilateral investment treaty. However, in the event that the government of Mongolia fails to negotiate, ICSID arbitration proceedings may be accelerated before the six months have expired. The company continues to have the right to commence conciliation/arbitration proceedings under the auspices of the ICSID pursuant to the bilateral investment treaty. On Jan. 18, 2013, MRAM issued the company a PMA pertaining to the Soumber deposit; however, four valid PMA applications remain outstanding.
Activities historically carried out on the exploration licences with valid PMA applications include drilling, trenching and geological reconnaissance. The company has no immovable assets located on these licences and the loss of any or all of these licences would not materially and adversely affect the existing operations.
Outlook
Economic activity posttransition in China's leadership has been slower than expected. The Chinese steel industry has been particularly affected and, as a result, demand and prices for coking coal have been negatively impacted. Nevertheless, market sentiment remains that demand in the second half of 2013 should improve; albeit, more slowly than anticipated at the beginning of this year. Looking forward, the more positive market position, as previously outlined, endures.
The company resumed operations at the Ovoot Tolgoi mine on March 22, 2013, after having been fully curtailed since the end of the second quarter of 2012. Full safety inductions and retraining were undertaken as part of the ramp-up which has taken place without incident. The company has been producing at conservative levels reflecting lower demand, and managing quality and stockpiles. The rate of production is expected to pick up as demand improves and the company continues to target production of 3.2 million tonnes of semi-soft coking coal in 2013. Once toll washing commences, it will enable SouthGobi to develop a predominantly two-product strategy of a premium and standard semi-soft coking coal product from the Ovoot Tolgoi mine. The premium product will be washed and the standard product will be a predominantly unwashed product. The capability to begin supplying a washed semi-soft coking coal product in the second half of the year is another important step in improving both the company's market position and access to end-customers.
The company continues to minimize uncommitted capital expenditures, exploration and operational expenditures in order to preserve its financial resources. For at least 12 months from the end of the March 31, 2013, reporting period, the company expects its liquidity to remain sufficient based on existing capital resources and estimated income from mining operations. Liquidity beyond the 12-month period is dependent on the success of the recommencement of operations, and continuing demand and prices in the coal market.
To date, the company has not signed any semi-soft coking coal sales contracts for the second quarter of 2013. However, discussions are actively continuing in order to meet the company's commercial objectives. Market participants at the Ceke border have been selling coal from existing stockpiles rather than contracting new volumes as they deal with current market uncertainty. A request from the Ceke Coal Import Association received April 1, 2013, and indirectly supported by the Ejina Qi banner government in China for coal to be bought through the association has exacerbated this uncertainty. As a result, customers have been reluctant to purchase coal under individual contracts.
On April 8, 2013, the government of Mongolia advised that the royalty regime trial period had not been extended beyond April 1, 2013. Under the trial period, royalties on all coal sales exported out of Mongolia were determined using the contracted sales price per tonne. However, effective April 1, 2013, royalties on all coal sales exported out of Mongolia will be based on the reference price per tonne published by the government of Mongolia. The reference price applied does not adequately reflect the price applicable to the range of products of varying quality and prices sold ex-mine in Mongolia. This can result in effective royalty rates being far in excess of the prescribed royalty rates and will impact Mongolian producers' margins going forward if it is not changed. The current monthly royalty reference price system is not supported by any of the Mongolian coal producers and collectively these companies, including SouthGobi, continue to engage with the government of Mongolia to resolve this matter in the interests of all parties.
Longer term, SouthGobi remains well positioned, with a number of key competitive strengths, including:
- Strategic location -- SouthGobi is the closest major coking coal producer
in the world to China. The Ovoot Tolgoi mine is approximately 40 km from
China, which is approximately 190 km closer than Tavan Tolgoi coal
producers in Mongolia, and 7,000 to 10,000 km closer than Australian and
North American coking coal producers. The company has an infrastructure
advantage, being approximately 50 km from existing railway
infrastructure, which is approximately one-10th the distance to rail of
Tavan Tolgoi coal producers in Mongolia.
- Premium quality coals -- Most of the company's coal resources have coking
properties, including a mixture of semi-soft coking coals and hard
coking coals. SouthGobi is also completing its investment in
infrastructure to capture more of the value from the products it sells.
- Favourable cost structure -- The long-term cost structure of SouthGobi
provides a strong base for sustainable growth when access to end-user
markets is obtained even though competition from other Chinese and
Mongolian semi-soft coals indicate that capturing margins relative to
other international coals is difficult.
- Substantial resource base -- The company's aggregate coal resources
(including reserves) include measured and indicated resources of 533
million tonnes and inferred resources of 302 million tonnes.
Objectives
The company's objectives for 2013 are as follows:
-
Resume production at the Ovoot Tolgoi mine -- The company has reviewed
the overall structure of its work force and market conditions, and has
recommenced mining activities at the Ovoot Tolgoi mine in March, 2013,
with plans to produce 3.2 million tonnes in 2013. The focus is to do
this in a safe manner that provides a sustainable long-term operating
base.
- Continue to develop regional infrastructure -- The company's priority is
to complete the construction of the paved highway from the Ovoot Tolgoi
mine to the Shivee Khuren border crossing as part of the existing
consortium that was awarded the tender by the end of 2013.
- Advance the Soumber deposit -- The company intends to substantially
advance the feasibility, planning and physical preparation for a mine at
Soumber by 2014.
- Value adding/upgrading coal -- The company intends to implement an effective and profitable
utilization of the wet washing facility contracted with Ejin Jinda to
toll wash coal from the Ovoot Tolgoi mine, further develop the
company's marketing plans on product mix and seek to expand the
company's customer base.
- Re-establish the company's reputation -- The company's vision is to be a
respected and profitable Mongolian coal company. This will require re-establishing good working relationships with all its external
stakeholders.
- Operations -- The company plans to continue to focus on production safety, environmental
protection, operational excellence and community relations.
CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(In thousands of U.S. dollars, except per share)
Three months ended March 31,
2013 2012
Revenue $ 3,259 $ 40,153
Cost of sales (21,860) (17,479)
Gross profit/(loss) (18,601) 22,674
Other operating (expenses) (383) (2,578)
Administration (expenses) (3,733) (5,882)
Evaluation and exploration (expenses) (273) (5,033)
Income/(loss) from operations (22,990) 9,181
Finance costs (4,996) (1,497)
Finance income 775 236
Share of (loss) of joint venture (17) -
Income/(loss) before tax (27,228) 7,920
Current income tax (expense) (1) (4,874)
Deferred income tax recovery 2,328 80
Net income/(loss) attributable to
equity holders of the company (24,901) 3,126
Other comprehensive income/(loss)
Item that may be reclassified to profit or
(loss)
Gain/(loss) on available-for-sale financial
asset, net of tax 930 (5,422)
Net comprehensive (loss) attributable to
equityholders of the company $ (23,971) $ (2,296)
Basic income/(loss) per share $ (0.14) $ 0.02
Diluted income/(loss) per share $ (0.14) $ 0.02
Review of interim results
The condensed consolidated interim financial statements for the company for the three months ended March 31, 2013, were reviewed by the audit committee of the company.
SouthGobi's results for the quarter ended March 31, 2013, are contained in the unaudited condensed consolidated interim financial statements, and management's discussion and analysis of financial condition and results of operations, available on SEDAR and SouthGobi's website.
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