In this world nothing can be said to be certain, except taxes and death. --Benjamin Franklin

Transcription

1 Exploration Insights by Brent Cook Issue No. 280 April 13, 2014 In this world nothing can be said to be certain, except taxes and death. --Benjamin Franklin This week US tax returns are due, and Canadians get till the end of the month. For most of us reading or writing this letter, the only way out of paying taxes is to not make money. Ditto for mining projects-- the only way the owners don t pay is if they show no profit-- a not uncommon strategy. Although there are obviously some complex tax schemes, breaks, government incentives, etc., which enter into the equation, ultimately a profitable mine will pay taxes. A mine is not something one can pick up and move once the tax holiday expires or the government ups the tax rate mines are obvious, easy, and popular targets when a government is looking for revenue. Therefore, this tax week Tim Oliver, PE, P.Eng., takes up the issue of pre-tax versus post-tax economic mine evaluations. He points out, appropriately, I think, that to realistically assess a mine project, taxes have to be included. Many NI studies only provide pre-tax evaluations, presumably because the company paying for the study preferred it that way. I understand the rationale: It is already so damn hard to find an economically robust ore deposit, why throw in something like taxes? After reading Tim s commentary a few times, I have to fess up and plead guilty to accepting pre-tax numbers in these pages. We will be more cautious from here on out. It is also important to bear in mind that these economic evaluations are only at the project level. There are instances, probably many, where a company will view a project s tax liability and benefits quite differently than the engineering firm responsible for the study. As we noted in last week s discussion of the possible Yamana/Osisko deal, adding a Canadian mine to Yamana s portfolio would prove to be very beneficial by allowing Yamana to expense its Canadian corporate overhead to the Marlartic Mine profits. Similarly, although I missed this in our discussion of the Eleonore royalty, apparently Virginia has an ~$50 million tax loss carry-forward it can, presumably, write off against the royalty income. From an investor s perspective, we need to understand the value of a project on an after-tax basis. This is really no different to factoring in the metal recovery from the resource grade before multiplying by the payable metal price. Tim s commentary brings up some very good points and a few examples. Read on...

2 The Rant Pre-tax versus post-tax numbers by Tim Oliver In Part 2 of my Top 10 Signs of a Bogus NI Study (EI March 1 & 23), item #5 discussed, among other practices, the use of pre-tax financial results. Today s article will delve deeper into this matter. The topic is timely because Canadian security commissions have begun to insist that NI reports state financial results on an after-tax basis. Recently, the British Columbia Securities Commission (BCSC) required two companies (Corvus and Bravada) to issue revised NI reports and restate financial results on an after-tax basis, while the initial reports were pre-tax. Why? We all know taxes are a major element in a cash flow calculation. The graph below illustrates the relative contribution taxes make to the Life of Mine (LOM) balance sheet: Fully 16% of the revenue goes to taxes, including federal and State or Provincial income tax, plus (in Canada) Territorial or Provincial royalties. Ignoring taxes is equivalent to ignoring the metallurgical process operating costs. Why do some owners or engineering companies choose to ignore taxes and certain types of royalties in NI financial evaluations? Maybe it is just too much work? A debate raged on this very topic a couple of years ago in the Vancouver office of a major engineering firm. One party argued for including taxes, while the other insisted on using pre-tax numbers because implementing the change would require an extra stop on the NI study assembly line. After all, the firm was already enjoying a steady stream of business performing studies with pre-tax estimates. Why change? During a discussion with a securities regulator, a geologist representing an engineering firm attempted to make a case for using pre-tax numbers. He argued that the added accounting analysis required for determining after-tax numbers would add $30,000 to the cost of a PEA. That may be the first time in history that an engineering company argued against a practice that would add billable hours to a project.

3 Clearly the pre-tax method yields a more attractive financial result since the money that should be attributed to taxes ends up as positive cash flow-- and an anemic project becomes robust. Here s a headline from a June 2013 news release regarding one of those studies that later had to be restated. Corvus Gold Optimizes North Bullfrog Mine Development Plan, Significantly Enhancing Economics in PEA Update $1,300 base case NPV5% increases 127% to $146.8M with IRR of 23% Recoverable ounces increase 12% to 852,700 gold & 333,200 silver Total cash costs drop 5% to $778 per ounce of gold A second news release came out October 21, 2013, after the BCSC acted: Corvus Gold Announces Technical Disclosure Clarification A third news release, dated October 28, 2013, announced the not-so-robust after-tax results: NPV5% of $94.6 million, NPV10% of $44 million, and an IRR of 17%. Bravada Gold Corporation also had to restate an earlier news release in this January 15, 2014 announcement: The disclosure of its preliminary economic evaluation in news releases of May 1 and 15, 2012; the President s Letter of June 19, 2013; a corporate video; the Company website; and the corporate presentation for the Wind Mountain Project reported Pre-tax costs and economic parameters, which included Nevada Net Proceeds Tax but which did not include an estimate of Corporate Income Tax, which may substantially overstate the value of the project [emphasis added]. An estimate of the effect of Corporate Tax on economic parameters has been calculated and will be included in the modified Technical Report. After-tax parameters will be included in updates to the Company website and corporate presentations. To prepare for this article, I reviewed about ten recent studies presenting both pre and after-tax results. As a general rule it seems that an after-tax IRR is about five percentage points lower than a pre-tax IRR. The after-tax NPV at a 5% discount rate is about half the pre-tax NPV for a 10-year mine life. Could it be these companies and their engineering accomplices choose to deliberately deceive the public in their disclosures? Isn t that a bit ham-handed and obvious? The answer to the question, Why? eludes me. Maybe it is a combination of three reasons: error, laziness, and deceit.

4 Is it legal? What does NI say? It is ambiguous. Here is the pertinent section s exact wording: Item 22: Economic Analysis Provide an economic analysis for the project that includes (a) a clear statement of and justification for the principal assumptions; (b) cash flow forecasts on an annual basis using mineral reserves or mineral resources and an annual production schedule for the life of project; (c) a discussion of net present value (NPV), internal rate of return (IRR), and payback period of capital with imputed or actual interest; (d) a summary of the taxes, royalties, and other government levies or interests applicable to the mineral project or to production, and to revenue or income from the mineral project; and (e) sensitivity or other analysis using variants in commodity price, grade, capital and operating costs, or other significant parameters, as appropriate, and discuss the impact of the results. Clearly the spirit of the rule is to require an evaluation of the effects of taxes and royalties on financial estimates. However, the rule does not explicitly state that the NPV and IRR discussions must themselves account for effects of taxes and royalties on the NPV and IRR values. This ambiguity opens the door for a (too) clever owner or study manager to ignore the effects of taxes on the NPV and IRR so long as the study report includes a summary of taxes, royalties, and other government levies. The result is a strictly compliant report with a brief tax summary, independent of the financial performance figures, tucked away someplace where it can t do any harm. In a practical sense, legality is a matter of interpretation and enforcement. The pretax practice is probably legal under a literal interpretation of the rule, but seems to violate the spirit of the rule. The Provincial securities regulators in British Columbia, Ontario, and Quebec agree and are getting tougher. While they haven t launched a formal enforcement campaign or initiative, they are pressuring companies whose activities come to their attention for other reasons, such as a Continuous Disclosure Review. The word is getting out that disclosure of only pre-tax financial results is no longer considered compliant with NI None of this should imply that tax issues are simple. This review only examines the specific case of mine project cash flow calculations for NI disclosures. It may be that tax factors can benefit a project s economics; and it is safe to conclude that no company will overlook tax issues that positively affect project economics. Last June, the Ontario Securities Commission released a report 1 detailing staff findings from a review of selected mining NI reports: We also found that 40% of the Technical Reports on mineral projects at a PEA-stage did not adequately address the issue of taxes applicable to the mineral project. 1 OSC STAFF NOTICE , REPORT ON STAFF S REVIEW OF TECHNICAL REPORTS BY ONTARIO MINING ISSUERS

5 Reporting of only pre-tax cash flows in a Technical Report for an advanced property which includes results of a PEA, pre-feasibility or feasibility study does not meet the disclosure requirement Item 22(d) of Form F1 or provide sufficient information for investors to properly assess the mineral project. Who? Surely this misleading practice is limited to a few unsavory or lazy companies and their fly-by-night engineering cronies hoping to make a fast buck off a quick stock bump? Unfortunately, no; the practice is widespread. Pre-tax results show up in studies prepared by some of North America s premier engineering firms for projects currently at the top of many investment lists. For the most part, we suspect the firms are complying with the original work contract as laid out by the company. Effects Doubtless some investors have been duped by headlines such as the one presented above. Those investments may or may not turn sour. I certainly would be wary of investing in a project when knowing only the pre-tax financial prognosis. I would also be wary of investing in a company that elects to limit disclosure to pre-tax results. The pre-tax reporting practice undermines the soundness of the NI program, erodes junior mining companies already tenuous credibility, and negatively affects investors confidence. Another issue at hand is the more insidious risk arising from the overall lack of confidence in the mining industry as a whole. Each time a miner endeavors to develop a mineral resource, some resistance from the public at large and government regulators is encountered. One argument in favor of mine development is the growth of a local tax base and the contribution mines make to the economy. The most obvious and visible tax revenues are income taxes and royalties. How are we to approach a community or a permitting agency to begin discussions about the advantages of mine development if our own studies show little, if any, tax contributions? It s another way the mining community works against its own best interest when trying to establish a social contract to operate. Rather than ignoring or hiding taxes, we should highlight them. What to do? Fortunately, the Provincial securities commissions are taking a stand. Investors also have leverage with mining companies by way of their investment decisions: when encountering studies or news release headlines announcing robust pre-tax economic results, call the company s CFO and request the after-tax results. If the company says they don t have the after-tax figures, it isn t true. No officer or director should be naïve enough to accept pre-tax numbers in their internal evaluations. With a bit of pressure from potential investors and securities regulators, the pre-tax issue should quietly die away. -T.O.

6 That s the way I see it. Brent Cook Travel and Appearances (We will be in Mexico visiting a few mine sites early in the week.) On May 31, I will be appearing with T. Boone Pickens and others at the Stansberry Society Event in Dallas. Details are here; discounted tickets are available through April 30. June 1 and 2 is the Cambridge House Canadian Investor Conference where I will be presenting, details here, and researching investment opportunities. Disclaimer This letter/article is not intended to meet your specific individual investment needs and it is not tailored to your personal financial situation. Nothing contained herein constitutes, is intended, or deemed to be -- either implied or otherwise -- investment advice. This letter/article reflects the personal views and opinions of Brent Cook and that is all it purports to be. While the information herein is believed to be accurate and reliable it is not guaranteed or implied to be so. The information herein may not be complete or correct; it is provided in good faith but without any legal responsibility or obligation to provide future updates. Research that was commissioned and paid for by private, institutional clients are deemed to be outside the scope of the newsletter and certain companies that may be discussed in the newsletter could have been the subject of such private research projects done on behalf of private institutional clients. Neither Brent Cook, nor anyone else, accepts any responsibility, or assumes any liability, whatsoever, for any direct, indirect or consequential loss arising from the use of the information in this letter/article. The information contained herein is subject to change without notice, may become outdated and my not be

7 updated. The opinions are both time and market sensitive. Brent Cook, entities that he controls, family, friends, employees, associates, and others may have positions in securities mentioned, or discussed, in this letter/article. While every attempt is made to avoid conflicts of interest, such conflicts do arise from time to time. Whenever a conflict of interest arises, every attempt is made to resolve such conflict in the best possible interest of all parties, but you should not assume that your interest would be placed ahead of anyone else's interest in the event of a conflict of interest. No part of this letter/article may be reproduced, copied, ed, faxed, or distributed (in any form) without the express written permission of Brent Cook. Everything contained herein is subject to international copyright protection.