Scully Royalty Ltd. (SRL) Q2 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Second Quarter 2013 MFC Industrial Ltd. Earnings Conference Call. My name is Deborah, and I will be your operator today. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. And I would now like to turn the call over to Mr. Kevin McGrath of Cameron Associates. Please proceed, sir.

Thank you, and good morning. We appreciate your interest in joining us on MFC's conference call and webcast to discuss financial results for the 3- and 6-month period ended June 30, 2013. On the call with me today are Michael Smith, Chairman and CEO; and Rene Randall, Vice President. The company will make a presentation on the results announced this morning and then open the call to questions. Today's call is being webcast on our website at mfcindustrial.com. Simply click on the tab in the Webcasts section to access the webcast. The webcast will be posted at mfcindustrial.com for replay approximately 2 hours following the end of this call. The replay will stay on the site for on-demand review for the next 7 days. Certain statements in this conference call will be forward-looking statements, which reflects management's expectations regarding future growth, results of operation, performance and business prospects and opportunities. For detailed information about risks and uncertainties that could cause our actual results to differ materially from those expressed or implied, please refer to the disclaimer for forward-looking information contained in today's press release on file with the Canadian securities regulators and on Form 6-K with the SEC. And now, I'd like to turn the call over to Michael to begin the discussion.

Thank you very much, Kevin, and good morning, everybody. Let me first start by giving you an overview of the results for the first 6 months. And then let me see if we can talk a little bit about where we're going after I go through some of the various projects and what the status is of those projects and where they -- where we see them coming online. Revenues for the first 6 months were up considerably, $253 million, for the period ending December, to $376 million. I think what was important here, 2 things. One is the margins were up a bit, which was important, up to $60 million from $51 million in the prior period. But I think more important is the general administration expenses. Here, it is so important that we, number one, respect money; number two, when we spend it, we want to get it back, of course. But if we don't do that, we will not build this platform which we're attempting to do in quite a rapid manner. And our G&A expenses for 2012 was $20,700,000. For the 3 months this year it was $17.4 million, and for 6 months, was $33.3 million. As you can see, we're putting a lot of money in the G&A area and really, that is the key to our business. Because if we don't spend the money, well, we won't get the return and we won't be able to build the platform. So I think that's a key parameter for you to look to going forward, but also for us to control, but also to approve expenditures in that area. A couple of things that affected the results for the 6 months: Number one is our royalty for the Wabush mine. We -- I'll discuss Wabush entirely separately later. But from a bottom line perspective, we lost $4 million in net earnings there. Also, the last part of India last year gave us $12.3 million, and we had about another $6 million in miscellaneous bargain purchases when you compare the periods. This is not a good reason for me to say that the earnings were not up to par. We have to overcome these issues, and we will and get our margins up. The most positive thing, as I said before, is that we are seeing the gross margin increase. EBITDA for the 6 months was $37 million. And depletion, which to us is an important factor as it involves cash, was $13.4 million or $0.21 a share. For the 3 months ending also June 30, margins were also up on the comparable period from $26 million to $33 million. Touching on the balance sheet, which is, of course, so important to me, is that we had $281 million in cash in December and we have $330 million cash at June. So the company is still quite liquid. Our receivables at December were $72 million, and our receivables in June were $100 million. Current assets were $684 million at December versus $702 million in June. Working capital was up a little bit, $345 million in December to $373 million in June; our current ratio, 2.02 in December versus 2.13. Our acid test ratio at December was 1.2 versus 1.43 at June. Long-term debt to equity was 0.20. So the company is healthy. But we still have other items which I think we can help improve this balance sheet, and I want to point out a couple of them to you. When you look at our inventories at June 30, you'll see them down to $107 million from the period of December at $142 million. That is accountingly correct but practically not. But we do have a current liability and called deferred sales liability of $26 million, which disappeared in this 6-month period because the project it was involved with was closed down. We had a financial repo with Glencore, and that was expired in this period. So really, the inventories have not gone down. They're basically the same, and really, they shouldn't go down at this point. Of course, inventory is what we need to get some margins and to sell. I think another issue which is important is assets held for sale. The amount in December was $128 million as a current asset and as a current -- the current asset at June was $106 million. The 2 difference items there basically are the tail of the Indian operation and also some decommissioning obligations. And I'll explain that a little further as we go. If I can have you look at the long-term liabilities, and it's so important that we look at this decommissioning obligation. These are really long-term obligations. And one of our major projects is to eliminate this down to a more acceptable amount. And the ARO or the decommissioning expense there, as you can see, is down by $14 million in this period. And why it's down is because the different way it's classified and also part of it is from the current asset amount. But the decommission expenses is not a P&L gain when it goes down like this. It is a reduction of the interest in resource properties. So if you go back to the positive side of the balance sheet, you'll see that the resource properties have gone from $348 million from what they were at December, at $383 million. Of course, I bring your attention to the equity section, and you'll see accumulative income loss, which is the old translation adjustment of $14.9 million and that also is because of the resource property because, of course, our resource properties are primarily Canadian dollars, and, of course, we're reporting to you in U.S. dollars. So the balance sheet is okay, and it's fine to go forward. We do have areas to improve upon, and which we will try. One thing is very relevant before I get into the projects themselves is we had increased our lines of credit. As we see a requirement as we go forward now, as our revenues should increase and our margin should follow, we've increased those lines from $405 million to $463 million. Let me turn now to various projects which we're involved in. The first one is really what I call our natural gas and our midstream operation. We have more defined now what we're doing in the midstream operation and see a capital expenditure program in the maximum amount of $220 million. And we've also made a decision, and the decision is there. We will bring in a partner, a strategic partner for a small part of it. And I think that we've been going back and forth trying to understand if it was better to have a partner for the whole project or just for part of the project. And we've now made that decision to do it for part of the project, and that is underway. And I can give you further clarity as that now gets signed up and as we go forward. The natural gas wells which we have, doing fine, certain things we have done in that particular area. We have -- in the press release and in the 6-K, we have shown you a breakout of our sale price, and you can work out our actual costs there. But the price for gas, which we achieved through the 6 months was $3.57. We are looking at some of the gas wells which are very small, part of this group of gas wells. And we're looking to possibly go into as a separate business unit, a stripper well-type operation. But I'll give you more development -- more information on that and development as we go forward in the future. We have established a well-cycling policy. And I think it makes a lot of sense. Our attitude now is if a well isn't economic or the price of gas isn't as sufficient for us to make money from the well, we will shut in that well and bring it back. There's no sense dissipating the asset, leave the molecules in the ground. And as long as we do it right, we'll get it back at the right time, at the right price. Our land bank is fine. We have just under 300,000 acres. Our attitude is just to leave it as a bank. We're not getting any interest on it. But if we get lucky with gas prices, it will give us a great return. And I see very -- the costs as very minimal, so I -- and I see very, very, very little downside with the land bank. Let me now touch on Wabush. Wabush's last couple of years has gone up and down. Tonnage has been erratic, and our relationships with the mine owner there hasn't always been the best. But what the mine owner has done now, he has switched from making pellets to concentrates. This is the quarter which it actually occurred, and he starts to make concentrates this quarter. So the tonnage which you see that was produced, we don't believe you should look at that in any way except it's a changeover period. We think this is a good move for the mine. And iron ore prices themselves are only down by about 5%, 6% this year. Right now, the iron ore price is around $138 a ton. So our royalty rate should stay pretty constant and actually should go up. And so I think this is a positive for us. And in addition, Cliffs had said that they're going to produce 3 million tons of concentrates now, not of pellets, and they have some pellets in inventory which they will be shipping. Unfortunately, we do not get paid until they ship. And so the inventory on the ground there, we should benefit from it during this particular quarter. Pea Ridge. Pea Ridge has not been going as fast as we would like it to go, which is the development of iron ore project in the United States. So I think we've done 2 things. One, we've clarified now and are happy with the process which we're going through and the direction. And we are not unhappy with what is occurring. We're just not happy with the timing. So we have recently transferred a very senior man, who was with us in Africa for 11 years, to run this project full time. He's a very strong guy, a former lieutenant colonel in the South African Commandos, I guess. And he will now act as what I call the General of this project, and he will take daily responsibility and, in addition, beside the daily, he will make the decisions. I think we all know where we're going. We've just got to move it along faster. The actual project in Africa, the hydroelectric project, the conversion there, which he actually looked after as part of his prior duties and also, the refinery there, is on time, on budget and working out quite well. And we anticipate that to be in operation solely as a power producer before the end of the year. In the 6-K, you will see a picture of Mr. Steinbauer and of Mr. Peter Leibold. Somebody said to me never put pictures in any of your materials because you're wasting space for more acts, so people could see more acts of the company, and I think they're right there. But in this particular case, I think it's appropriate. And the point we're trying to make here is that in 2005, we started to do business with Peter Leibold and his company, German Pellets. And they had 1 facility in Germany. Now, they have 14 sites in Germany and Austria, and are the biggest producer of pellets in the world. In addition, they have 2 brand-new facilities, which they will commission this year in America. It's an example, I think, of here's a company that was a very, very small SME and needed financial help. And we also looked at them as a potential client. And we have worked very well together over these years, and we anticipate that to continue very much in the future. And I think we wanted to put Mr. Leibold's picture in here, number one, to congratulate him for his great success, but also to thank him and his shareholders and his people for working with MFC for all of these years. From the commodities business, we're seeing growth. We've just got to see more increase in margins and continue the growth. And we will work hard to that. So that's the end of my opening remarks and please, if I can invite questions now, it'd be appreciated.

[Operator Instructions] And your first question comes from the line of Joe Pratt of Wells Fargo Advisors.

Could you just tell us a little bit about, with your commodity trading acquisitions, when you acquired them in December or during last year, what you thought the margins would be by this time this year, let's say, the June quarter? And what are those actual margins? What have those margins turned out to be as they -- as those businesses were combined with your prior commodity trading operations?

Joe, it's difficult to segregate because the businesses are entirely different. And we are now putting microfactory products, which were sold in the past out of New Jersey, they are now being sold in Argentina and also into Europe. That particular industry, those margins have come down because they're steel oriented. And in some cases, they have come down by 30%. In other cases, other products, which they have now gone into, have increased. So you're seeing a change of mix. And I think it's so important, and I'm not disappointed in those margins. I'm actually quite happy because what it's done is given us a more global footprint, but it's also given us more products. And the real key to this is China, and we've always had a presence in China. And we've now integrated those operations in China. And that's the key to the one word called sourcing at a reasonable price. Long as we can source at a reasonable price and finance at a very reasonable price, we then have -- we should have stronger margins everywhere. And that's what we're working out very, very much.

Okay. And second, when you talk about the G&A going up substantially, what businesses is the G&A getting invested in?

Well, for instance, we're getting lots of younger people, Joe, in the business. We should have been hiring lots of younger people a long time ago and transferring them throughout our system. We're doing that now and it's predominately being involved in rationalizing the natural gas business, it's being done also in the trading and the purchasing of commodities. So it's overall. We're encouraging hiring everywhere. And also, Joe, we're also transferring; we're taking people from Argentina and we want those people from Mexico to go to New Jersey; we want those people in China to be transferred to Vienna. We're trying to integrate, to communicate, to get better margins. And I'm very impressed with a couple of them who have just become good stars, and that, I think, is an area of weakness for us from the past.

Okay. And thirdly, with regard to the German Pellet company, did you ever assist them financially in the past? And do you own any part of them?

We've been assisting them since 2005. And we anticipate assisting them for years to come, including their operations in America, their new operations. They have 2 new phenomenal facilities that they are commissioning as we speak. And it's been a good client, and we anticipate more of that.

But do you own any part of the company?

Oh, I'm sorry, Joe. We don't own any part of that, no.

And your next question comes from the line of Emmett Wright of Milwaukee Private Wealth Management.

Just to clarify, when you talked about comps and then the need for $220 million in CapEx and in the same sentence talked about a strategic partner for a small percentage, is that $220 million, will it accrue to MFC? Or is that -- and you'll slap some of that off on your partner?

We will slap a reasonable and fair amount off on our partner.

So the $220 million is gross?

Gross. Gross, yes. Sorry.

Yes. How much could we assume you'll slap -- how will you allocate that $220 million to partner versus yourself?

We would sooner not get into that and I tell you the reason why so you could understand it. The assets which we have, midstream assets that exist today, will be sold to a structure. And the selling price to the structure will help them determine what our final contribution is. And, of course, that will be an issue of negotiations. All I can say, it will be fair and everybody has to make money with it. But I can't give you a final number at this time. In the future, we can get more transparent as we get clarity on the values.

I appreciate that. Follow-up to that, with regard to some of these wells that you might idle given the economics, will this impact your bargain price accounting retrospectively?

Not at all, because the molecules will still be in the ground. I just don't like it when the molecules come out of the ground and you sell them, right. If you don't sell them for a proper price, why produce them? Turn them off, right?

Yes, yes, most definitely. And back to Joe's question earlier, my final comment here. With regard to the transactions that occurred at year end, and you talked a little bit about how that's working, but how has that working related to your expectation at the time you made that transaction?

Not as well as my expectation. I believe we could do it much faster, but you have -- we had cultures, right. And it took a while to break down cultures and barriers. I think moving and integrating people together help break down those barriers, but it could have been done faster.

And anecdotally, in reading your releases and understanding a guy from Mexico is going up to Jersey or something like that, it struck me that, that was a pretty, pretty good sell that you'd have to make to the guy in Mexico or Argentina or somewhere to move to another area. Is that effectively what's happened? And how do you mitigate that in the future?

That is what has happened, and I find that you don't say "Move to America forever." Right. You say, "Move to America for a year." You got to go at least a year, or "Move to Shanghai for a year." It's been well received and it's been encouraged. And these people are college graduates, CFAs. They're may -- maybe they've been there 5, 6, 7 years in sales, and you could see some complementary items. So they have -- it's just not moving there and becoming an American. It's moving there and assisting with communication with Mexico and New Jersey. Both those companies buy products from China. They should buy those products for the most reasonable price possible, but especially for the most reasonable price from a freight perspective. Freight is a big driver. And so it may seem silly, but communication is so important. And by having these people who know how to get it done and know how to speak the languages and know that yesterday was a holiday is important, and it's working now. I'm pleased with that.

And your next question is from the line of Graham Tanaka of Tanaka Capital.

Yes. Just if you could give us a little help on timing, a little bit more maybe specifics on timing of Compton, Pea Ridge, the power gen facility in Africa. And then I have some other questions about trading. But just when might you be doing/making/consummating deals on Compton, for example? And what -- will you be pulling cash out, or will you be basically transferring assets and owning a smaller part of a better funded opportunity?

Yeah. So on Compton, I guess, just to simplistically say, we viewed it, first, it had a large tax loss carryforward. And so we've created a partnership there for some of our other assets to be joined, to help us be physically responsible tax-wise. Two, we are taking the midstream operation and developing that. And we're in the engineering and the purchasing cycle of that and we've agreed to now take in a partner for part of it. Now, the timing for that is -- goes in phases. But the first phase will, let's just say, middle of next year and then 3 years for the final. And that's a well laid out plan. The next part of that natural gas program, really is the development of the stripper wells, and I think that will be very shortly. When I say shortly, 2 or 3 months.

I'm sorry, shortly will be when?

2 or 3 months.

Okay. So 2 or 3 months, you'd be starting development, drilling developmental wells, or stripping...

No, no, no. Just taking our sales and other low-volume wells, from our sales and from other people and running them in a more efficient way, you could call it -- you shouldn't call it that. You should call it -- we shouldn't call it the junk part of the business. But most people don't like that part of the business. And to me, it's okay if you run it on a basis that it is not an oil company or a gas company. It's just a company trying to turn cash and make some money. And I find that there's ways you can cut costs when you have lots of things. And we see some people who have the same need, to put some of their shallow wells, low-volume wells and our wells, and we commit a much, much more substantial company outside of comp. And that's just a business opportunity to help us rationalize the assets of that…

What are we talking about is potential either cash flow, revenues or profits that you can get once you develop more efficient stripper wells?

We should not give that out at this particular point, Graham. But all I can say to you is that there's a lot of them are out there, and a lot of them have a great need to be run more efficiently and can be. And we see that, and the numbers to us are interesting enough. And the numbers also, from a capitals perspective, are not great. So, to us, that's one we must push to pursue rapidly.

So you're going to be working with other companies to actually pool their low-volume wells into this pool?

Yes. Our people don't have -- our people don't mind doing more menial type work, right. And so, we say, let us -- give us your less economic wells, and let's put them together into a different unit. And I think that's been well received at this particular point. In reference to the hydroelectric plant in Uganda, where I think that will be on stream with the proper tariff in October. We're ahead of schedule. So that's working out quite well.

Well, what might that produce in revenues and/or cash flow profits?

I'd sooner wait until we've got the license. We have the license now, but not in effect before I say anything to you and to anybody in Uganda.

That should be producing revenues beginning in October or later after that?

I think we're okay for October at this particular point. We did have a natural disaster there recently, but our people did a great job and solved that quite quickly.

So that should help the fourth quarter then?

Yes.

And then, how about Pea Ridge; the timing on that? That has been slower. I don't know if that's -- is that because of problems with dewatering or just some management problems?

I don't know if it's management problems. I think it's really -- it's -- maybe the bus hasn't been driven hard enough, and we've -- this is really getting the process done correctly. And so, by taking a real strong manager who we have, and putting him in it full time, I think it's a move we should have made several months ago. And his job now is to move it along quite rapidly. And I think that he would definitely save us time. And for an end date Graham, I can't give you an end date. It wouldn't be right.

Okay. So if you could be a little more specific about the royalty situation. I mean, I guess there was an issue there that it' a transition, you called it. Now, when is that transition going to be finished and when will they turn the spigot on with the concentrate?

It already is finished. And they have already turned the spigot on, and they're already producing. And we believe selling the concentrate today. So they're still...

Okay. So they started when?

The beginning of this quarter.

Okay. So they started in July?

I'm assuming it was July, yes. But either way, they've told us it was in this quarter. But we do know that they've stopped producing the pellets. They publicly announced that. They've given us some explanation as to what has occurred. So we're quite comfortable with that move. And I haven't said anything nice about Cliffs for maybe a year because we've always had litigation with them. And we still do, but this makes a lot of sense. And we could see that they can sell the concentrates today without having to pay the cost to pelletize.

Okay. So what would be the price per pound or ton that -- off which MFC would get royalties? It would be a higher price or a lower price?

No, it's about the same.

Yes, there is really no difference. The reason why you shouldn't sell pellets is because the iron ore prices are -- well, concentrates are -- there's not a huge difference, if any.

We're getting about $9.34 average per ton, and that would be if it's pellets or concentrate.

Okay. Okay, so the reason we care whether it's concentrate or pellets is what?

We don't care.

We don't. But we only get paid, Graham, on sales. And when it's sold, we get our royalty. But we just want them to be a success.

So this was just -- this was basically a transitional shut-down period for them to change their way of delivering iron ore. And that just had -- they just took, what, a few months?

I don't even think it took a few months. I think that they also stockpiled pellets. And they don't -- don't forget, we don't get paid until they sell that pellet.

And also -- they're already making concentrate because you have to have concentrate to send to the pelletizer anyway. So it's not like they're switching something. They're just taking one step out of the chain.

And, I guess, to cut to the chase then, what could royalties be going toward, back to the sort of the normalized level per quarter? Or what kind of level do you think it should go to?

Well, are you speaking on price or volume?

Just dollars, U.S. dollars of royalty per quarter.

Well, they're staying about the same. I mean, if you look at the first and second quarter, they've only varied by about $0.02 a ton. So they're staying in the $9.30 to $9.35 range.

And, Graham, use a number of 3.1 million tons for this year, 3 million to 3.1 million tons. That's what they're saying to us.

Yes. I just -- I was trying to get a figure -- feeling for what the third and fourth quarter royalty could be or tons.

We think it could be quite handsome because they're shipping the pellets, which they hadn't sold prior, right, which were inventory on the pad, as we would say.

So the royalty -- I'm just looking here. I thought I had it in my quarterly sheet. The royalty in the first quarter was how much? You gave a first half number, so.

$9.35 a ton.

No, I mean the dollars that we receive?

On a gross? On a gross, it was about $3.7 million.

That was the second quarter, right?

No, first quarter. Second quarter was about $4.3 million.

Okay. So then the third and fourth quarter might be what relative to that; closer to the $4.3 million?

We would hope so.

All right. That's good. The other thing -- we haven't heard much, I think you referred to the importance of China. How large is that now overall? I know you've got the sort of medical operations. You've got a few things going on. Is that something we should focus on as a segment?

Well, no, not as a segment. But China is growing because of -- we're doing more and more of buying raw materials for the commodities in China. So now, our office, especially in Shanghai, is taking a much bigger role.

So you know Eugene, Graham? So Eugene's people and the Beijing people, which we acquired, are now making as a team to source their existing products and also new products in China. And also, then ship by -- of course, by sea in a more efficient way by integrating all the freight together...

Consolidating the freight into one shipment.

Which brings down the costs very, very considerably. So that's why China is important is because of that, consolidation as Rene called them.

So have you estimated what the cost savings could be per quarter or per year once you've integrated and once you've achieved these efficiencies and the trading out?

We have a plan and a budget and -- but I -- we have not made that public at this particular point, Graham.

I just -- okay. I guess what's hard for us is we're trying to make projections, okay? And it's kind of hard because so many things are in transition here. It comes along with the territory with several acquisitions at one time. But -- so is there a way that you can -- if you don't want to give us the savings, then maybe is there a way we can talk about sizing the trading operations in 1 or 2 years and revenues and what kind of a normalized margin might be, forgetting whatever the savings are? I mean, you're saying margins are going up. And so, where are they going up from and to what?

Well, Graham, it's difficult. We believe our revenues are going up consistently and will. If we continue with this pleasant -- present operation, margins must follow. If they don't, that's when we must correct, and we're trying there. But it's very difficult for us to give out to you at this point what our margins, what we project them to be. I can say to you is that we have a platform. We have the people. We are looking for more people. And we have the credit. And we -- so, if you have the tools, you should be able to build a pretty nice house. And so that's what we're trying to do. I'm sorry I can't be more specific as the products and the products mix will change with demand and demand in different areas of the world.

I guess, Michael, and pardon me for being, if it appears, a little persistent on this. But it's just a pretty big window when the commodities and resources margins are -- were at 13.88% for the first half of this year and 9.05% for the first half of a year ago, that's a big window. And I just don't know. Maybe you can comment on whether that 9% is unusually high. The impression was back then, I don't think it was. But is that unusually high? And how much of this year's 3.8% or 3.9% is the result of these temporary things that you're doing, training costs, et cetera?

Well, Graham, you've also got to not look at this as a noncyclical business. Commodities get sold at different periods of the year. And I think that's one of the issues that you're not seeing when you're trying to just go quarter to quarter to quarter. We can see if we achieved that particular sale of that particular product at that time and what was the margin like. And I think it's so difficult. We've come a long way, but we've got a long way to go. Oh yes, for sure, and we're not there yet. I'm sorry, but I just can't. I can say to you is that if we continue with what we're doing, it's okay. Do we have the tools to do it? Yes, but I…

Maybe a different way. I know that it's hard for you to make estimates, but maybe a different way to get a feel for it so everybody can understand it, is you've acquired big operations in trading in different areas of the world with different commodities, which it just makes sense to diversify. And we have -- and we're trying to make estimates here of what you might be able to do in 1 or 2 years, okay? So will these new commodities and new operations tend to have lower or higher margins than the Vienna business?

Higher margins.

They should have higher margins. So we have -- so see, that tells me that there's very high probability that you should get your margins up closer to the 9%, which is what I believe is what the operation margins were before the acquisitions, is that correct? The 6 months last year, 2012, you had $21 million of net income, $21.5 million versus $238 million of revenues first half last year, or was that restated for last year to include both CL [ph] and ACC?

No, there was no restatement, Graham. I'm just not familiar with that particular period. All I can say to you, Graham, is that margin should increase. Long as you aggregate your freight, they will increase substantially. But margins will increase just because of the different products.

So you should increase your margins relative to the first half based on both a higher and richer mix of new products and efficiencies on transportation sharing, et cetera, is that...

And the real gift, if you want to call it, on your margin, is the transportation.

Okay. So the transportation -- I don't -- not having analyzed the business before, I'm not sure what -- so you're talking about its freighters coming half-haul or high-full or something and container ships, containers being more full and that kind of thing?

Yes, Graham, if I charter a ship from Shanghai making 3 stops down to Mexico, right, and I charter it for 80% of the freight on that ship, or I have for 10% of the freight, that my costs for the freight is hugely different when I control the vessel and I also control the stops, right?

Oh, I got it. Okay. All right.

The stops are huge, right. Because...

Yes, I didn't want to take too much of it. But I'm feeling a lot better about it than I -- there's a huge opportunity because what's happening, it sounds like, is the cost of the integration is obfuscating the margin potential. Plus you have not gotten over the efficiencies yet, which you anticipate receiving, what, in the next 12 months?

Yes, and that's why I'm happy the margins are up, but they're not up enough for us.

The next question comes from the line of William Horn of First Angel Capital.

I just wanted to clarify one of Graham's questions regarding Wabush. You state that Cliffs is guiding toward 3 million tons of production this year. They've done just shy of 900,000 so that leaves over 2 million tons remaining for the next 6 months. That would put it at about 1 million tons a quarter. So your royalty should be substantially higher in the coming quarters provided that Cliffs maintains their or meets their guidance productions, correct? I mean...

Yes.

I thought I heard Rene say that you should expect -- or the 4.2 is a reasonable expectation. But the expectation should be significantly higher than that, based on Cliffs meeting their production schedule.

We see it to be substantially higher, Bill, driven by 2 factors: One, inventory on the ground at June 30, and we only get paid upon sale, okay? So there, we will pick up in this particular quarter. But also, they're now producing concentrates. And we will, of those concentrates, those sales will go right out, and will not be pelletized. And we feel -- I feel pretty good that they're going to pick it up, that they've ordered...

Okay. But my clarification was more towards Rene's comment that the expectation should be consistent with what we saw in Q2. But in reality, it should be a higher number based on Cliffs' production.

I don't -- I don't think I said that. I was talking about the price. I wasn't talking any volume.

But, Bill, you're right. Q2, it's nothing to do -- it there's Q2 going forward, I will be very upset. You're right, you're right. It is completely right.

Thank you for clarifying that. I certainly don't want to beat a dead horse too much. But going back to the whole margin question, you state in your release that margins are improving, but they're not yet at acceptable levels. Cutting through everything, what are -- I know you can't -- you told Graham that you can't predict where margins are going or what they'll be. But what is an acceptable level for you? You say it's not at that acceptable level. So what is that acceptable level?

I should say that there'll never be an acceptable level, right, in reality. And what our competitors have is -- I don't think they have -- they're at acceptable levels either. We have room definitely to improve. And we know we have substantial room to improve with the freight. We are chartering, but we're not filling up the ships the way it should be done. And so this, it's amazing, Bill, the amount of savings on freight. It is substantial to us. And I can tell you that we can improve and that's a major focus for us.

So you're putting a lot of pressure on your logistics department, aren't you?

Yes, for sure. Yes, right, right, right. Why don't you buy a couple of ships, Bill, and we'll be your best client?

We can talk offline about that. In the release, you speak about the commodities trading and you give a nice overview of the German Pellets company and their association with MFC. What percentage of revenues does your wood commodity business make up?

I can't give you the percentage, but I can say to you it is substantially -- it has picked up substantially over the years, and Mr. Leibold has become a very good client. And we anticipate -- we would like to do his business in America, and he will become a bigger client and we congratulate him.

Is he the primary wood customer, or I mean, is your wood business broader than just German Pellets?

It's broader than just German Pellets.

Okay. Can you get into some specifics about other commodities? I mean, what are -- I mean, if you can't really -- can you give us an idea of what commodities are your biggest percentage of revenues, and give us an idea as to where the commodities business is focused right at the moment?

We do just-in-time deliveries for some of the major companies around the world. And when you -- so revenues are relevant, but margins is what counts. And that's profitable business. I think what's more relevant, maybe what we should be doing, Bill, is trying to give information out on margins by different products. I think that could be helpful. I think we could...

I think shareholders would certainly welcome the transparency on a commodities basis. So I would certainly be pleased with seeing more transparency on each of the commodity product levels.

No, I think that's a good idea. And I think we can do -- we'll work on that.

Okay. Getting back to Mazeppa for a second. In your release, you're talking about this midstream project requiring an investment of $220 million. And you listed the different components, the different initiatives of this expansion project. Last quarter -- or excuse me, Q1, you reported that this investment was going to be $360 million. Can you give us an idea as to what changed there? I mean, if I look at the initiatives, they're identical from each of the earnings releases, but you just dropped the investment by $140 million. I'm just trying to understand where the difference is.

Bill, it's kind of ironic. The turbines and some of the costs have come down so substantially. And I think it's come down because they don't have orders out there. People have found ways to reduce costs of gathering gas for other people, so that has saved us a substantial amount of money. But it's predominately in the equipment side and in the infrastructure side, and, really, nothing has changed outside of that. I guess you could say, "How come your numbers are so wildly different?" I'm happy for it. But I think that's a good number.

Okay. All right. All right. No, that helps. You've also talked about this joint partner -- or joint venture partner, with Mazeppa only taking a small part. I think you told Graham when you had talked about the timing that the Mazeppa had Phase 1 which may be mid next year, Phase 2 would be, say, 3 years out. What part of the project are you looking as the joint venture to participate in, the Phase 1 or the longer-term Phase 2?

Longer term.

Okay. And can you give an idea of what aspect that would be within the expansion project?

I don't want to do it until he's signed up.

Okay. Is this still moving forward on the letter of intent that was executed just before the end of -- or just before the previous conference call?

No, because it's changed, right. There we were looking at an equal partnership, and we don't need it. A wonderful thing about Mazeppa, you have an infrastructure there, you have a quality plant there. And if we do the financing with some of the assistance we've got in the past, people have to pay for that right. I'm not going to give it away free. And I think that the way we've gone through the decision curve, initially, we felt maybe these people or other people could bring us some assistance in making the project.

But this partner, that would take a smaller piece, is it the same partner that you had the LOI with?

No, it's a different partner.

Okay. Just one quick question on Compton. I mean, looking at the metrics for your oil and gas production, in Q1, you had operating costs of $9.86. They rose to $12.81 for Q2, significant increase. Can you provide some color as to where or what was attributing that increase to?

Let's see. Bill, let us get back to you on that because I don't see those numbers. Let me get back to you on that.

Okay. All right, fair enough. Just one other question and I'll get back in the queue. You had indicated on the previous call that you had identified a COO internally and that this quarter, that you were -- you would announce the -- that hiring. Where does that stand? I mean, we saw an announcement of you adding a new director to the board, but there certainly wasn't any announcement done, the COO position.

We could have announced the COO, but we didn't. And we will in the next release. That's on board now.

The person's on board and sitting in the COO position?

Yes.

The next question comes from the line of George Berman of JP Turner.

Got a couple of quick questions. It looks like you've performed a major feat in the African nation now on the Kasese Cobalt Company and the hydroelectric plant, that according to your assay here, it's all back on track now, yes?

Yes. Yes, we're very pleased. I mean, we're very lucky, George, we've had some very good management there.

Good, and that will -- "We own that plant 100%" and that will add to revenues through the sale of electricity now?

Well, actually, George, we own 75% of the company that owns the plant. But that company owes us around $50 million. So from a business perspective, we own, well, commercially, 100%.

Got it. The total production from the Canadian assets, oil and gas, natural gas liquids, that's 1,871 equivalent barrels of oil per day, yes?

Yes.

Is any of that hedged?

We have a hedging program. And at June 30, we were not hedged. During June, we were hedged. And we have a specific policy where we use for hedging. As you know, natural gas today is down in value and we are not going to hedge at these prices.

Yes. And all oil, at the same time, is at all-time highs.

Right, right.

Close to all-time high. In your current assets, you also show assets held for sale of $106 million. Any update on when those sales may occur? You had alluded to that last quarter that you might sell some things off?

Yes. We're in discussion now, and I'm still fairly optimistic that we're going to achieve something before the end of the year. So it's in process, I guess you would say, George.

Okay. Then talking about your company and your stock, it seems to me that for some reason, you are, as a corporation, public company, awfully secretive about all the things that are going on. And where many, many public companies showcase all their achievements in sometimes major ways, even though there's not much behind it, you kind of almost purposely keep a very low profile. With a book value of $11.90, the stock, and basically trading at a little over $2 below that, $3 almost below it, have you considered maybe using some of your cash available, of which you have ample of, to initiate a stock buyback program to reduce the shares outstanding?

We've been through it many times. And I guess what we're saying, we want to finish this program which we're involved now. We firmly believe that we can finish building out this platform as we have the tools. And it will be foolish at this point to look to restructure our capital. At some point, we should, but not at this particular period of time. But I should say one thing also, George. If we did -- if today was the day to restructure the capital, I firmly believe you make the money out of restructuring for all the shareholders by doing it on a substantial way. Not a small buyback but by buying a substantial amount of stock and recapitalize it that way and I think that's where you get the value.

Agreed. Agreed. And then, no one in MFC Industrial's management team also is in ownership of the German Pellet company, huh?

Correct.

It's a completely third-party entity. Is there a chance to participate with these guys? I just returned from Germany. I know that the pellets are very, very big in Europe as a production for heat. That looks like a very strong business.

It is a strong business, and we're participating with them on a commercial basis, not on an ownership basis.

I mean, the way you describe it, you have a very good relationship. And for all I know, there might be a possibility to maybe even joint venture the fabrication or facilities they're looking to build here in the United States.

We've discussed all aspects of the business, George. And we're not ruling anything out as we go forward. These guys are growing very rapidly. And there's other parts of the world as well, which we're looking and talking to them about.

Yes, yes. Last but not least, a lot was talked about in this conference call about your shipping, your shipping costs, et cetera. I happen to know that prices for oceangoing vessels, OBOs et cetera, are at multiyear lows at the time. Would that possibly be a thought for you, guys, to own one of the other cargo ship?

No, I just sort of charter them, let somebody else take the pleasure of that depreciation or the demurrage costs. Because it takes an entirely different talent level, doesn't it? And I know you've been around shipping a long time, George.

The next question is from the line of Joe Pratt of Wells Fargo Advisors.

Well, my question was answered.

And the next question is from the line of Graham Tanaka of Tanaka Capital.

Just yes, I really reiterate what was just said about disclosure, Michael. We've discussed this in the past. You've diversified quite a bit. I think it'd be helpful just to get a breakdown of the commodities, the percent of which commodities, that'd be helpful. I know margins will take more time to do. But just getting back to Compton, what kind of -- what are the revenues and profits of Compton in the first and second quarter? And what could that become once you do Phase 1 and Phase 2 of Mazeppa, et cetera?

Graham, we don't break out those revenues. But I can tell you the depletion number, so you can get a feeling there. And I think if you take the tables, you can get a feeling of the gross revenues and expenses. So I think you can put it together, but we don't put it together ourselves. Going forward, it's difficult, Graham, to give you the numbers at this time because we can't -- it all has got to do with the price of the commodity, right? And so what happens with natural gas? Right now, we're at the low period of natural gas and we're -- it depends on what you're -- how you see it. I can say to you is that on the midstream operation, that's an entirely different business. It relates to natural gas, but it's really a processing business, and the returns there are quite handsome. And your goal on that business for a return is 20%. And that all depends upon volume, of course, but it's -- that's a goal. So that's quite a nice business.

Okay. So just to size the midstream business, you're talking -- that $220 million number, is that all for the midstream that you're talking about? So that we can say, "Okay. If you invest $220 million, you should get $40-something-million return on that."?

So Graham, I think, if you said -- you should also know that the $220 million is of new facilities, not including our existing facilities. So let's just round some numbers for a moment. You should put on there another $50 million or $60 million of existing facilities.

Okay. So the existing facilities might be worth $50 million to $60 million of assets?

Correct. And they're in operation today, processing sweet and sour gas. And now the attitude is let's increase that to produce electricity and start to upgrade those facilities, to produce other products to generate continuous revenues from processing.

So to scale this, this shows proportionally that this is a considerably larger -- it's literally 4x the size of the existing asset. Or were you talking about historic assets are now worth more? Is that $50 million to $60 million a replacement cost, or is that a historical cost?

Historical cost.

So today, that might be worth what?

It's hard to say, Graham, but it's -- really, what it's worth is what revenues we can get off of it, right? And right now, it's -- the industry is -- these products work generally in this industry at this time. And so we want to take advantage of it.

Okay. So I'm just trying to get -- maybe, I'm trying to get, in a backwards way, the revenue contribution from this new investment of $220 million. And if you invest $220 million, what kind of revenues might you get? Since it's a processing business, it's less subject to the volatility of prices. Are we talking about revenues equal to the assets invested, or 2x or 1.5x? What kind of range?

Graham, I -- we want to make that all at one time to the people, and we haven't made that public disclosure at this particular point. What I can say to you is the goal, which we have said publicly, is 20% return on capital. And that is what we would it like to be.

And that's on income or pretax?

That will be pretax.

The last question for today's call comes from the line of William Horn of First Angel Capital.

I just had one quick follow-up question. You indicated in the release that earnings were impacted for 3 main reasons. One of them we haven't talked about was the FX loss; looks like there was probably about a $3.2 million FX loss for Q2. Can you give us a little more insight as to what occurred there, and what currencies were involved?

Well, the U.S. had to be involved, but I don't know what that FX -- which one was it?

Euros and [indiscernible].

Okay. The U.S. dollar was up, Bill, and so -- but, obviously, some asset got sold that was euro denominated?

Financial instruments.

Financial instruments. It was strictly financial instruments, not products, but predominately euro? Predominately euro? Predominately euro.

Euro and U.S.

Yes. Euro-U.S. is the guilty one.

And as we did the royalty, I think it was the exchange rate was...

Right. And Canadian dollars to a lesser degree, Bill.

I would now like to turn the call over to Mr. Michael Smith for closing remarks.

We sincerely thank you very much for attending the call today, and please do not hesitate to give Rene or myself a question, any questions you have. And please do it by phone or by email. We would like that. Thank you very much.

Thank you for joining today's conference. This concludes the presentation. You may now disconnect, and good day.