An anonymous director reports
KATANGA MINING PROVIDES RESULTS OF INDEPENDENT DIRECTOR REVIEW OF CERTAIN PAST ACCOUNTING, FILES RESTATED FINANCIAL STATEMENTS AND SECOND AND THIRD QUARTER 2017 INTERIM FILINGS
Katanga Mining Ltd. has completed the previously announced internal review by the independent directors of the company of certain of the company's past accounting, completed the restatement of certain historical financial statements and related management's discussion and analysis (MD&A), filed its unaudited interim condensed consolidated financial statements for the three and six months ended June 30, 2017 (and accompanying MD&A), filed its unaudited interim condensed consolidated financial statements for the three and nine months ended Sept. 30, 2017 (and accompanying MD&A), made changes to its board and management, and has been co-operating with the Ontario Securities Commission (OSC) in the course of a continuing OSC enforcement staff investigation.
Background of the review
Following the end of the second quarter of fiscal 2017, in the course of the OSC investigation, information drawing into question the appropriateness of certain of the company's accounting practices came to the attention of the independent directors of the company. This information led the board of directors of the company to request the independent directors of the board, being Robert G. Wardell, Terry Robinson and Hugh Stoyell, to conduct a review of these practices. At the direction of the independent directors, an internal review was undertaken. The independent directors engaged Canadian legal counsel, and a multinational accounting firm, to assist the independent directors in conducting the review. The review identified accounting practices that, among other things, incorrectly recorded the total tonnage of finished copper cathode production which resulted in an overstatement of finished product inventories and incorrectly recorded the valuation of copper concentrate included in work in progress inventories, the valuation of ore in stockpile inventories and the amounts of property, plant and equipment during 2016, 2015 and prior periods, which practices were not appropriate and required adjustment.
All dollar amounts are in U.S. currency unless otherwise indicated.
Details of accounting restatements
The following is a more detailed description of the restatement adjustments.
Overstatement of copper cathode production in fiscal 2014
The review identified that in December, 2014, the company overstated copper cathode production by 6,650 tonnes. This material was provisionally invoiced to Glencore PLC for $41.9-million after a year-end marked-to-market adjustment of $1.0-million. In addition, over-reporting of cathode production in prior months in fiscal 2014 overstated cathode production by a further 1,266 tonnes resulting in a cumulative overstatement as at Dec. 31, 2014, of 7,916 tonnes. As a consequence of the cathode production overstatement, finished product inventories in the company's consolidated statement of financial position as at Dec. 31, 2014, were overstated by $41.8-million and costs of sales for the year ended Dec. 31, 2014, were understated by an equivalent amount. Furthermore, the review identified that the provisional invoicing to Glencore in December, 2014, resulted in an overstatement of receivables of $41.9-million in the company's consolidated statement of financial position as at Dec. 31, 2014. Since no revenue was recognized with respect to this invoicing, deferred revenue, which was reported in the amended loan facilities-related parties line item in the company's consolidated statement of financial position as at Dec. 31, 2014, was also overstated by $41.9-million.
The review found that the cathode inventory overstatement was written off through a series of journal entries in fiscal 2015, thereby eliminating the overstatement and charging 2015 cost of sales with the $41.8-million of costs that should have been recognized in 2014. The provisional invoicing was also reversed in 2015 via credit notes to eliminate the overstatement of receivable and amended loan facilities reported in the company's consolidated statement of financial position as at Dec. 31, 2014.
As a result of these 2015 entries, the December, 2014, and prior cathode production overstatement and resultant finished product inventory overstatement had no impact on the company's Dec. 31, 2015, and 2016 consolidated statements of financial position or the company's 2016 reported results of operations or cash flows.
Overvaluation of concentrate inventories
Due to large volumes, recurring spillages, the continual power interruptions and plant modifications between 2010 to 2013, operating conditions around the company's Kamoto concentrator facility (KTC) were not optimal. This resulted in unrecorded material containing copper being discharged at various stages of the KTC operations in varying qualities and some material ending up in locations other than those designated for concentrate storage. In July, 2017, the independent directors were advised by management that in April, 2014, management quantified the physical concentrate production in the concentrate storage locations. This quantification identified an overvaluation of sulphide and oxide concentrate inventories of $28-million and $79-million, respectively, due to the fact that concentrate reported as produced was not physically present in concentrate storage locations in which it had been recorded. The overstatement of concentrate arose from:
- Operating conditions experienced at KTC as described above;
- Inadequate plant housekeeping and material being transferred and not recorded;
- Improper measurement of historical concentrate production over a number of years due to inadequate controls, instrumentation and an ineffective metal accounting system.
The overstatement of concentrate was not detected on a timely basis due to:
- Failure to reconcile or resolve differences between tonnes of concentrate reported as produced by the KTC facility and tonnes reported as received by the Luilu processing facility;
- Improper adjustments to volume, density and moisture factors used to derive tonnage reported to be contained in the concentrate storage locations;
- Failure to adjust recorded amounts of concentrate on hand based on periodic quantity surveys and other measurement procedures.
Following quantification of the concentrate inventory overstatements, $28-million of the sulphide concentrate costs was written off over the remainder of fiscal 2014 and a portion of the oxide concentrate inventory overstatement was expensed. However, $66.5-million of the oxide concentrate costs were not written off but improperly transferred from inventories to property, plant and equipment in June, 2014, and depreciated using the unit of production method.
The restated consolidated statement of financial position as at Jan. 1, 2015, reflects the write-off of $66.5-million of costs improperly included in property, plant and equipment, net of depreciation recorded thereon of $1.4-million.
Valuation of ore in stockpiles
In July, 2017, the independent directors were advised by management that a review in April, 2014, of the valuation of ore in stockpiles identified that the recorded cost of such inventory exceeded its net realizable value. Subsequent movement in copper and cobalt prices reduced the initially identified shortfall to $55.7-million. This $55.7-million was improperly transferred to property, plant and equipment in June, 2014, and depreciated using the unit of production method.
The company's restated consolidated statement of financial position as at Jan. 1, 2015, reflects a reclassification of $55.7-million from property, plant and equipment back to the ore in stockpile inventories, net of depreciation recorded thereon of $2.6-million and also reflects a writedown of the cost of such inventories of $26.0-million, being the excess of cost over net realizable value on Jan. 1, 2015, based on prevailing metal prices at that date.
The company's restated consolidated statement of financial position as at Dec. 31, 2015, and the consolidated statement of loss and comprehensive loss for the year then ended reflect the reversal of the $26.0-million 2014 writedown due to subsequent further improvements in copper and cobalt prices in 2015 as well as expected improved recoveries when this material is processed using the whole ore leach (WOL) plant, such that $55.7-million of costs remain in the carrying value of the ore in stockpile inventories as at Dec. 31, 2015, and 2016.
Impairment of heap leach assets
The review determined that in 2015 the revised and optimized life-of-mine plan no longer included the use of the heap leach assets with a cost of $14.7-million and accumulated depreciation of $2.3-million. The assets were determined to be impaired and have been written off in the company's restated 2015 consolidated financial statements.
Other adjustments
As a result of the review, two additional adjustments were identified:
- Additional capital costs totalling $3.1-million relating to heap leach assets contained in property, plant and equipment were determined to be impaired and have been written off in the company's restated consolidated statement of loss for the year ended Dec. 31, 2015.
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An accrual with respect to the liability for the cost of concentrate purchased from a related party, Mutanda Mining SARL, in the amount of $10.4-million was incorrectly reversed in 2015 prior to finalization of the amount owing. Accordingly, in the consolidated statement of financial position as at Dec. 31, 2015, accounts payable and accrued liabilities have been increased by $10.4-million with a corresponding increase in cost of sales in 2015 and reduction of $10.4-million in operating costs in 2016, the year in which the purchase invoice from Mutanda Mining SARL was finalized.
Tax adjustments
The restated consolidated financial statements also reflect the tax effects of the adjustments described above.
Restatement
As noted above, as a result of the review, the board is restating the following documents:
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Audited restated consolidated financial statements for the years ended Dec. 31, 2016, and 2015, and the audited restated consolidated statement of financial position as at Jan. 1, 2015, together with the related notes and audit report;
- MD&A (management's discussion and analysis) for the years ended Dec. 31, 2016, and 2015;
- Unaudited restated interim condensed consolidated financial statements for the three months ended March 31, 2017, and 2016, together with the related notes thereto;
- MD&A for the three months ended March 31, 2017, and 2016;
- Executed certifications of the chief executive officer and chief financial officer of the company in accordance with National Instrument 51-109 -- Certification of Disclosure in Issuers' Annual and Interim Filings -- for the foregoing filings.
The impact of the restatement adjustments on the company's previously reported consolidated financial statements as at and for the years ended Dec. 31, 2016, and 2015, as well as the impact on the restated consolidated statement of financial position as at Jan. 1, 2015, and the unaudited interim financial statements for the three months ended March 31, 2017, and 2016 are set forth in Schedule A on the company's website.
As disclosed in the company's Aug. 14, 2017, press release, the company's previously filed consolidated financial statements for the years ended Dec. 31, 2016, 2015 and 2014 and related MD&A and all interim consolidated financial statements and interim MD&A since Dec. 31, 2014, should not be relied upon.
Additional executive compensation
During the course of the review, it came to the attention of the independent directors that certain members of management of the company had received additional compensation not previously disclosed directly from the company's controlling shareholder, Glencore. The compensation was paid both in cash and in equity of Glencore. The review concluded that such payments should have been disclosed in the company's executive compensation disclosure in the company's management information circular for the affected years. As a result, the amounts included in the summary compensation table in the company's management information circular for the affected years and related disclosures were understated and should not be relied upon. Details of the additional compensation payments made by Glencore to members of Katanga's management who were, in the applicable years, named executive officers of the company as such term is defined in National Instrument 51-102 -- Continuous Disclosure Requirements -- are set out in Schedule B on the company's website. The company will include such payments in its executive compensation disclosure as required in future management information circulars.
Internal controls over financial reporting
The review concluded that the accounting practices that resulted in the restatements described above demonstrated the following material weaknesses in the company's internal control over financial reporting (ICFR):
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Control environment material weaknesses: The control environment is the responsibility of senior management, sets the tone of the organization, influences the control consciousness of its employees, and is the foundation of the other components of ICFR. The company has concluded that it did not adequately establish and enforce a strong culture of compliance and controls which includes the adherence to policies, procedures and controls necessary to present financial statements in accordance with IFRS (international financial reporting standards).
- Management override material weakness: The company did not maintain effective controls to prevent or detect the circumvention or override of controls. Certain of the accounting adjustments identified in the review are a result of senior management and executive directors in office at that time overriding the company's control processes.
- Monitoring material weaknesses: Monitoring ensures that the entire system of internal control is monitored continuously and problems are addressed timely. The company has determined that certain of the accounting adjustments identified in the review were not identified earlier due to inadequate monitoring controls, including inadequate controls and procedures to properly quantify and verify the value of in-process concentrate inventories, inadequate controls with respect to quarter-end and year-end sales cut-off procedures, insufficient involvement of internal audit in the testing of the accuracy of external financial reporting, and inadequate procedures to ensure the effective implementation of internal audit recommendations on high-risk areas, particularly with respect to metal accounting.
Each of these material weaknesses created a reasonable possibility that a material misstatement of the company's annual financial statements or interim financial reports would not be prevented or detected on a timely basis.
The advisers to the independent directors have recommended various remediation measures to strengthen the company's corporate governance, compliance and control processes. The board will consider these recommendations with a view to enhancing the company's internal control monitoring function to allow for a higher level of independent assurance from this function, increasing organizational awareness and understanding of the importance of internal controls to significantly decrease the risk of errors in the company's financial statements, and reinforcing related accounting policies through enhanced formalization of documentation requirements and additional training and procedures across the company to better ensure compliance with company standards by emphasizing adherence to these policies on a continuing basis.
The material weaknesses cannot be considered remediated until the applicable remedial controls are implemented and operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively. No assurance can be provided at this time that the actions and remediation efforts the company has taken or will implement will effectively remediate the material weaknesses described above or prevent the incidence of other significant deficiencies or material weaknesses in the company's ICFR in the future. The company does not expect that disclosure controls or ICFR will prevent all errors, even as the remediation measures are implemented and further improved to address the material weaknesses and significant deficiency. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving the company's stated goals under all potential future conditions.
Notwithstanding the material weaknesses outlined above, based on the work performed during the review by independent directors, management, external auditors, outside legal counsel and outside accounting advisers, management, and the board of directors have concluded that the restated consolidated financial statements are fairly stated in all material respects in accordance with international financial reporting standards.
Changes to the composition of the board and management
The independent directors, having received and considered the findings made in the review, have concluded that a recomposition of the board is in the best interests of the company. Liam Gallagher, Aristotelis Mistakidis and Tim Henderson have all co-operated fully with the review and have offered to step down from the board. Each of these directors has tendered his resignation from the board, effective immediately. The company is pleased to announce the appointment of Mike Ciricillo, Steve Kalmin and Tony Moser to the board. The biographies of each of these new directors are provided as Schedule C to this press release on the company's website.
In addition, the company's chief financial officer, Jacques Lubbe, who had previously indicated an intention to resign from the company but committed to stay in his current position until the restatement was completed, has tendered his resignation to the board, effective immediately. The board has appointed Grant Sboros as chief financial officer of the company, effective Nov. 20, 2017. The biography of Mr. Sboros is provided as Schedule C to this press release on the company's website.
Regulatory matters
Status update
This status update is provided pursuant to the alternative information guidelines in National Policy 12-203, which require the company to provide biweekly updates on its affairs until such time as the company is current with its filing obligations under Canadian securities laws. In accordance with those requirements, the company advises that: Except as previously disclosed and as disclosed herein, there have not been any material changes to the information contained in the company's July 31, Aug. 14, Aug. 16, Aug. 29, Sept. 12, Sept. 26, Oct. 11, Oct. 25, 2017, and Nov. 16, 2017, news releases; except for the delay in issuing its Nov. 8, 2017, default status report, there has not been any failure by the company to fulfill its publicly disclosed intentions with respect to satisfying the provisions of the alternative information guidelines of NP 12-203; except as previously disclosed, there are no subsequent specified defaults (actual or anticipated) within the meaning of NP 12-203; and there is no other material information concerning the company and its affairs that has not been generally disclosed as of the date of this update.
As previously disclosed, the OSC issued a management cease trade order (MCTO) on Aug. 16, 2017, that prohibits the directors and executive officers of the company from trading in or purchasing securities of the company, subject to certain limited circumstances. The MCTO has not and does not affect the ability of other persons to trade in the common shares of the company. The company is in discussions with staff of the OSC to have the MCTO revoked upon the completion of the restatement and the issuance of the company's second and third quarter interim filings.
OSC staff investigation
Katanga has been advised that OSC enforcement staff are investigating, among other things, whether Katanga's previously filed annual and interim financial statements, MD&A and/or annual information form contain statements that are misleading in a material respect. OSC enforcement staff are also investigating the adequacy of Katanga's corporate governance practices and compliance with those practices and the related conduct of certain directors and officers of Katanga. Katanga has also been advised that OSC enforcement staff are reviewing Katanga's risk disclosure in connection with applicable requirements under certain international bribery, government payment and anti-corruption laws.
SECOND QUARTER FINANCIAL RESULTS
(in thousands)
Three months ended Six months ended
June 30 March 31 June 30 June 30
2017 2017 2016 2017 2016
Financial
Total sales (loss) $11,723 ($2) ($615) $11,721 ($28,498)
Including repricing (loss) 5 (2) (615) 3 (29,224)
EBITDA (loss) (73,604) (52,466) (42,919) (126,070) (119,064)
Net (loss) attributable to shareholders (126,555) (100,923) (96,058) (227,478) (207,168)
Cash flows (used) in operating activities (26,569) (17,330) (42,007) (43,899) (120,849)
THIRD QUARTER FINANCIAL RESULTS
(in thousands)
Three months ended Nine months ended
Sept. 30 June 30 Sept. 30 Sept. 30
2017 2017 2016 2017 2016
Financial
Total sales* $5,875 $11,723 ($1,632) $17,596 ($30,130)
Including repricing* (169) 5 (1,632) (166) (30,856)
EBITDA** (loss) (69,091) (73,604) (55,213) (195,161)(174,277)
Net (loss) attributable to shareholders (115,362)(126,555) (99,499) (342,840)(306,667)
Cash flows (used) in operating activities (56,745) (26,569) (33,141) (100,643)(153,990)
KITD reserve and resource estimate
Due to the continual power interruptions, recurring spillages and plant modifications completed over the period of 2010 to 2013, concentrate-quality material containing valuable amounts of copper and cobalt was discharged along with the operational waste to the Kamoto interim tailings dam (KITD), a large tailings facility located in proximity to the KTC facility. The material was not stored in the concentrate stockpiles due to quantities and operational issues. For this reason, the KITD extraction plant was approved in 2012, installed in 2013 and an initial drilling program was undertaken in late 2014 and early 2015. In August, 2017, the company resumed an exploration drilling program to profile the mineral contents of KITD.
This drilling activity identified anticipated mineralization in KITD. Though, as a tailings facility, KITD does not have a geological profile and its mineral deposits are technogenetic in nature as they are the product of previous mining activities, the company has been aware of the potential for a significant copper resource within KITD since waste and material were discharged into the facility until 2013. The mineralization contained in KITD is the end product of KTC which processed the original ore from the mines. The company began hydraulic mining of KITD in January, 2017.
Following the completion of the exploration drilling program and related work on profiling the KITD described above, the company commissioned a prefeasibility study. The results of these efforts were newly defined mineral reserve and mineral resource estimates at KITD, which estimates have been independently peer reviewed and signed off by Golder Associates Africa Pty. Ltd.
The KITD mineral resource and mineral reserve estimates are set out in the associated table.
KITD MINERAL RESOURCES ESTIMATE AS AT SEPT. 30, 2017
Classification Mt TCu TCo
(%) (%)
Measured 0.0 0.00 0.00
Indicated 8.34 1.48 0.16
Measured and indicated 8.34 1.48 0.16
Inferred 0.0 0.00 0.00
KITD MINERAL RESERVE ESTIMATE AS AT SEPT. 30, 2017
Mining operation Proven Probable Total
Mt TCu TCo Mt TCu TCo Mt TCu TCo
(%) (%) (%) (%) (%) (%)
KITD 0 0 0 7.9 1.48 0.16 7.9 1.48 0.16
Total 0 0 0 7.9 1.48 0.16 7.9 1.48 0.16
The summary noted above of the KITD mineral reserve and mineral resource estimates was prepared under the supervision of Tim Henderson, technical consultant and director of Katanga, and a qualified person as such term is defined in NI 43-101.
About Katanga Mining Ltd.
Katanga Mining operates a major mine complex in the Democratic Republic of the Congo producing refined copper and cobalt. The company has the potential to become Africa's largest copper producer and the world's largest cobalt producer.
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