Scully Royalty Ltd. annual report, Q4 FY2018

Business context and reporting period

This is an annual Form 20-F for the fiscal year ended December 31, 2018, not a standalone fourth-quarter report. The filing identifies the registrant as MFC Bancorp Ltd.; this differs from the requested company name, Scully Royalty Ltd. Financial statements are prepared under IFRS in Canadian dollars (CAD), unless otherwise stated.

MFC described itself as an international merchant bank and structured-trade provider, with its core asset an interest in the Scully iron ore mine in Newfoundland and Labrador. Its segments were Merchant Banking and All Other.

Key financial results and position

Revenue fell approximately 49%, primarily because the company exited product lines and geographies. Merchant banking revenue was CAD 134.5 million, down from CAD 256.4 million; All Other revenue was CAD 5.3 million, down from CAD 17.6 million. Costs of sales and services were CAD 129.5 million and selling, general and administrative expenses were CAD 26.4 million. The reported profit and any implied margin should be viewed in light of the unusually large, non-cash asset impairment reversal described below.

Operating, investing and financing activities used CAD 7.2 million, CAD 1.3 million and CAD 0.9 million, respectively. Cash declined CAD 7.1 million during the year. The company reported CAD 22.3 million of bank credit facilities, principally non-recourse receivables factoring and commodity hedging facilities. It also had a CAD 4.0 million non-interest-bearing loan payable with no fixed repayment date; its disclosed undiscounted contractual amount was CAD 57.4 million, payable from the relevant subsidiary’s surplus cash.

Material changes versus the prior year

• The company returned to profitability after losses in 2017 and 2016, largely because of a CAD 188.2 million pre-tax, non-cash reversal of prior impairment on its Scully iron ore interest. The company reported an after-tax non-cash gain of CAD 137.4 million. A CAD 50.8 million deferred tax liability was recognized in connection with the reversal.
• Revenue declined substantially as the company exited plastics, steel products, and minerals, chemicals and alloys, among other product lines. Hydrocarbon revenue increased with higher pricing and production.
• SG&A fell about 42% to CAD 26.4 million, reflecting exits, subsidiary deconsolidations, office closures and cost reductions. Headcount declined to 216 from 230.
• Credit losses on loans, receivables and guarantees rose to CAD 35.0 million from CAD 23.9 million. The company recognized CAD 21.8 million of credit loss and wrote off the remaining receivable from a former insolvent customer group.
• Long-term debt and short-term bank borrowings were eliminated from the year-end balance sheet, primarily through subsidiary deconsolidations. Finance costs fell to CAD 2.1 million from CAD 8.4 million.

Outlook, risks and unusual items

• Scully mine restart: The operator, Tacora Resources, announced completed financing and planned to restart the mine in summer 2019, with production ramp-up continuing through 2021. This was a third-party plan, not a production guarantee. MFC has limited operational control and limited access to technical and reserve data. Its lease provides for a minimum annual payment of CAD 3.25 million, subject to the agreement’s terms.
• Earnings variability: Management warned that revenue and earnings can fluctuate significantly because merchant-banking fees depend on transaction completion and asset realizations are difficult to time. Commodity prices, customer demand and transaction activity also affect results.
• Other unusual items: The company recognized a CAD 25.8 million gain from deconsolidating subsidiaries, a CAD 5.6 million non-cash settlement charge related to former hydrocarbon subsidiaries, and a CAD 2.4 million reversal of previously recognized royalty revenue. It also wrote off CAD 3.9 million of disputed royalty receivables after an adverse court outcome and denial of leave to appeal.
• Taxes and contingencies: Income tax expense was CAD 55.6 million, mainly reflecting deferred taxes from the mine impairment reversal and subsidiary deconsolidations; cash income taxes paid were CAD 2.6 million. Tax audits and disputes remain, including assessments concerning VAT and expatriate payroll tax. Management did not expect outstanding legal and tax matters to materially affect results, but outcomes are uncertain.
• Capital and corporate plans: Management said it was developing a strategy intended to reduce the discount between the market price and stated net book value per share, but provided no specific implementation details. Shareholders were scheduled to consider a name change to “Scully Limited” and a 25-for-1 consolidation followed by a 1-for-25 split in May 2019, then expected around June 3, subject to approval.
• The company reported no cash dividends to shareholders in 2018. It identified risks from customer and counterparty defaults, market and currency volatility, regulation, liquidity and access to capital, environmental obligations, and potential impairment of long-lived assets. Hydrocarbon decommissioning obligations were CAD 13.6 million.

Important facts for investors to verify

• Confirm the issuer identity: the provided filing is for MFC Bancorp Ltd., although the request names Scully Royalty Ltd.
• Review the assumptions supporting the CAD 188.2 million mine impairment reversal, particularly operator financing, restart timing, ramp-up, reserves, royalty terms and the 8.3% discount rate.
• Assess how much of reported earnings and equity growth is non-cash and dependent on valuation estimates; compare the CAD 112.3 million shareholder profit with negative operating cash flow.
• Investigate the recoverability and legal status of receivables, including the former customer group write-off and disputed royalty receivables.
• Understand the CAD 4.0 million loan payable’s fair-value estimate versus its CAD 57.4 million undiscounted contractual amount, and review liquidity needs and available credit facilities.
• Track whether the mine restart and proposed name/share changes occurred as planned, and whether management subsequently disclosed its strategy for addressing the market-value discount.