Second Quarter 2005 Earnings
July 28, 2005
Operator: Good morning and welcome to the Pan American Silver Corporation Second Quarter 2005 Earnings conference call. At this time all participants have been placed on a listen-only mode, and the floor will be open for questions following the presentation.
It is now my pleasure to turn the floor over to your host, Geoff Burns, President and CEO. Sir, you may begin.
Geoff Burns: Thank you operator and welcome ladies and gentlemen. Joining me today are Rob Doyle, our CFO, Andy Pooler, our Senior Vice-President of Operations, Steve Busby, our Senior Vice-President of Projects, and Brenda Radies, our Vice-President of Corporate Relations. They are here to help answer any questions you might have after I finish my opening remarks.
As always all the amounts I’m going to talk about are in US dollars. And with that let’s get started. You all have the numbers available to you so I’m going to focus on a few key points of the operations and then review the status of our projects.
We had a very good quarter, and most importantly we delivered on the commitments we made after the first quarter. We increased production at all of our operations relative to the first quarter. We reduced our unit costs and we improved on every single financial metric. Our silver production was 3.1 million ounces, up 24% from 2004, and plus almost 100,000 ounces as compared to our first quarter. Our zinc production was up. Our lead production was up, and our copper production was up. We had mine operating earnings of $3.1 million, up almost 38%, or $700,000 from the same period a year ago.
Our cash flow from operations was $3.4 million before adjustments for working capital, which is about $1.1 million per month after paying for our G&A and all our exploration activity. And we had net earnings, granted very small, but a huge improvement from the $2.8 million loss we experienced in Q1. In addition we had significant exploration success at Morococha. Alamo Dorado construction is moving ahead full stream, and finally we have just decided to proceed again with our sulphide production at La Colorada, and we should see that come back on stream over the balance of this year and into early 2006.
We still have a lot of work to do to generate sustainable profits, but I think this turn-around quarter demonstrates our focus and commitment. We are in a very different cost environment than we were a year ago. In June of 2004 crude oil was still under $25 a barrel, Peru had not yet introduced a 1% net smelter royalty on all mineral production, and Pan American was still using loss carry forwards to offset income taxes and worker participation. We have experienced the same cost creep as the rest of our industry, and as a result our profits today versus the same period last year are lower, but we have our costs under control and we expect to see the financial benefits of the improvements that we have implemented to get there through the remainder of 2005 and even more so in 2006.
Our star performer for the quarter was Morococha, which is rapidly becoming our best asset. We are extremely pleased with the mine’s performance and we think the news is just going to keep getting better. When we bought the mine last year we felt there was an enormous amount of untapped potential, and I’m very pleased to be able to say that we were right. We had some growing pains over the last couple of quarters as we integrated the mine into our Peruvian operations but these issues have been resolved and we expect this quarter’s performance to continue over the balance of this year and beyond. We produced almost 700,000 ounces of silver at Morococha in Q2, at $2.78 per ounce.
As many of you have seen from our news release last week, we have had tremendous success with our exploration program at Morococha, and there will be more to come. Adding almost 4 million tonnes and 21 million ounces of silver to the reserves and resources is no small feat, but more importantly the new ounces are contained in mantos which are larger and wider than the veins we have been mining. This makes them much lower cost and therefore higher value. To put things in perspective, at our current mining rate of about 600,000 tonnes per year, we’ve added 6-and-a-half years of new ore. We are continuing to drill through the reminder of the year, and we expect to continue to add reserves and resources with that drilling. Clearly, once we have defined the size of the new resources, we will put on our engineering hats and determine what is the best mining rates to use at Morococha. We’ve got a lot to think about, but please watch this space. In my view this is going to be our next most significant growth opportunity at Pan American.
Huaron is still an excellent long life asset for us, but it’s a tough mine. It requires constant management and attention to unlock its value. One area we’re looking very hard at right now is the metallurgy. From a mining perspective we’re doing very well. We’re moving up the production rates to almost 56,000 tonnes a month, but the ore we’re now in is metallurgically different than that which we’ve experienced before. We’re seeing slightly lower zinc grades and more significantly lower zinc recoveries. This has reduced our by-product metal production, and has had the effect of raising our cash production costs. We have an intensive metallurgical test program underway right now to try and get a handle on this problem. We also expect it to be alleviated somewhat in the second half of the year as we reach the Huayllay zone, which is higher grade and hopefully better recovery.
Quiruvilca had a good quarter. You might recall that only eighteen months ago we almost shut down this asset. We now expect it to be fully back on track, where it has been over the last several quarters, for the remainder of the year, producing good ounces at low cash costs, with positive cash flow. We’ve just completed installing a new conveyor system underground, which should help relieve some of the bottlenecks we experienced, particularly in the first part of the second quarter.
At our Pyrite Stockpile operations the Doe Run smelting company has been buying less than they did a year ago. As you recall this is effectively a surface trucking operation, and the ounces sold from there are solely at the discretion of Doe Run. Right now we don’t see their off-take increasing, so we’ll probably sell less than the 960,000 ounces we forecasted at the beginning of the year, likely in the 750,000 ounce range, but still at very low cash costs and very, very profitable.
Moving to Mexico, we were very pleased with the performance of La Colorada. They had record production this quarter for silver, a 57% increase over the same period last year, yet only mining 9% more tonnes. The more selective mining methods that we introduced are working and the oxide mill is now running above design capacity. We have also just approved the commencement of stockpiling of sulphide ore that is going to be processed through the sulphide plant that we are commencing to bring back on line. We should be able to produce an additional 900,000 ounces of silver a year from the sulphide material, and we’re expecting the plant to start up in early February of 2006. The silver from the sulphide should be produced at about $2.20 an ounce, which will immediately have a positive impact on our bottom line. La Colorado had a tough startup, but this complete turnaround is a testament to the quality of the mining operations group you have at Pan American.
It was also a very productive quarter on our project front. First and foremost, is Alamo Dorado. We are off to a great start and we are continuing to make excellent progress, on time and on budget. The key for us has been securing the major pieces of equipment. As some of you may know, with the mining boom of the past few years, lead-times for major equipment can be up to 18 months, and prices are escalating weekly; however, all of our critical items have been secured, and all the key members of the operating team are now in place.
I was just down at the site a couple of weeks ago. We’re digging ground for the process plant, the lab, the admin buildings. We’re erecting the truck shop and warehouse. Our mining fleet is being delivered. We’re pioneering the main haul road to our open pit, and we’re just getting going on our main power line. It’s damn exciting! We’re in full construction mode. We’ve got a long way to go, but I can’t wait to see us pouring silver there in about fifteen month’s time.
We’re continuing on target to deliver a completed feasibility study at Manantial Espejo, in likely the early part of the fourth quarter. Right now our focus is on finding ways to optimize the economics. We think there’s some opportunities on power and infrastructure, but as I’m sure you can appreciate we can’t say too much at this time. I will say that we think there is more resource potential on this property and the team is reviewing all of the geological modeling and data to look for opportunities to add to the current measured and indicated resources.
Turning now to Bolivia, we are fortunate that the recent instability there has not had any effect on our San Vicente project, and in fact during the quarter we finally signed an agreement with Comibol, the state mining company, to recommence production at San Vicente. We have also devised a better operating plan, one that should increase San Vicente’s production and profitability. Our strategy there has been simple. We’ve attempted to minimize our at-risk investment there, and utilize the cash flow from the mine to ramp up production. San Vicente is a great silver ore body. It had grades in excess of 450 grams per tonne silver and plus 2.5% zinc.
Right now, as I just mentioned, we have resumed mining and are stockpiling ore, while we look at refurbishing the Vetillas mill, which is an old mill that is already on the site. Our review shows that this is a much better option than toll milling that same ore elsewhere. We expect that we will be able to increase our production from San Vicente to almost 2.6 million ounces a year at a much lower cost. As a result of this new plan we’re deferring until 2006 the production we thought we were going to get this year, which was about 735,000 ounces of silver. But as I said, we should see these ounces and more at a much lower cost. This, in conjunction with the change in the delivery schedule at our Pyrites, is going to effect our consolidated production for this year. We’re now forecasting approximately 12.5 million ounces of production, down from the 13.5 we previously had talked about.
Finally, just a few words on the silver market; while prices have settled a bit in July the second quarter overall was a continuation of the volatility that we have seen over the past 2 years. Today, silver is $7.11; this is a great price for Pan American. During the quarter Gold Fields Mineral Services released the annual Silver Survey and reaffirmed the bullish case for future silver prices. Despite the rise in silver prices, fabrication demand held up very well in 2004 and investment demand saw a major jump. The silver ETF is expected to fuel that demand and in June Barclays filed a registration statement with the SEC to launch that product. The timing of when it will get going is now in the hands of the regulators but I think the view is that it should be a smoother process than the gold ETF went through about a year ago.
On the supply side scrap supply is declining and we have significantly lower government sales, particularly out of China. We did see a rise in mine supply, but as Gold Fields said they don’t believe it will have much impact.
And with that, operator, I’d like to open the floor to questions.
Operator: Thank you. The floor is now open for questions. If you have a question you may press star, one, on your touchtone phone. If at any point your question is answered you may remove yourself from the queue by pressing the pound key. We do ask that while you pose your question that you pick up your handset to provide optimum sound quality. Once again, that is star, one, on your touchtone phone at this time. Please hold while we poll for questions.
Your first question is coming from Haytham Hodalay with Salomon Partners.
Hatham Hodalay: It’s Hatham Geoff, how are you?
Geoff Burns: Good Hatham, yourself?
Hatham Hodalay: Good, a couple of questions. Just on the income statement. What was the investment and other income of 990,000?
Geoff Burns: Rob, perhaps you could take that question?
Rob Doyle: Sure. The bulk of that, Haytham, is – is just the returns that we get on our treasury assets, on our cash position. There was some small other incidental income from the sale of some assets in Peru but, you know, very small. The bulk of it is really just interest income.
Hatham Hodalay: How much – what’s the interest rate you get on those assets, because I calculated that if it’s somewhere around 3% only about $150,000 to less than $200,000 of that would be interest income for the quarter?
Rob Doyle: Our effective interest rate is roundabout – averaging on about 3.5%, and that’s interesting. Perhaps I can just get on the line with you after, and go over the calculation.
Hatham Hodalay: Sure that will be great. One more question, I guess, just to Geoff. Alamo Dorado you spent – how much have you spent to date so far out of the full CapEx?
Geoff Burns: I think we’re, at this stage, in around $10 million, Haytham.
Hatham Hodalay: And then in the second half you said $33.5 in the news release and so what does that leave for next year?
Geoff Burns: Well we’re still tracking to a full cost of about $76.5 million including the start up working capital as well as our inventory purchases for mine supplies, et cetera, so do the math there and that’s what should be left for next year.
Hatham Hodalay: And just refresh my memory Geoff, on the method of financing this?
Geoff Burns: The financing is coming out of our cash reserves. We’re not doing anything new on financing so we have the cash available to do it.
Hatham Hoday: OK, fair enough. Thank you.
Operator: Thank you. Your next question is coming from Ian Howat with National Bank Financial.
Ian Howat: Good morning Geoff.
Geoff Burns: Good morning Ian, how are you doing?
Ian Howat: Not bad. Do you so see any risks that when the silver ETF comes out that even though it may, you know, increase silver demand, providing another silver investment alternative for investors, that it may take some interest out of your shares themselves?
Geoff Burns: Good question Ian. I think by opening the ETF that what you’re doing – I’m hoping that what it’s going to do is provide an investment that a broader range of people can purchase than just what we found has been in the silver equities, per se. There’s no question that there is going to be a choice between buying Pan American stock and buying the silver ETF, and I’m guessing that we’ll lose some investors to the ETF, but I’m hoping that it actually – what it does is going to expand the market for silver investors versus just taking the market that currently exists and dividing it into smaller pots.
Ian Howat: OK. And just if you can give sort of what you see as your silver production gross profile over, you know, from this year, ’06, and ’07?
Geoff Burns: I don’t have the absolute detail but let me just give you the – and you can confirm with Brenda, maybe later. I mean Alamo Dorado is going to come on stream in the fourth quarter of next year, that’s going to add, you know, 5 million ounces a year over at least an 8 year life, or longer. And Manantial Espejo, at this stage, if we hit everything we’ll have the feasibility study in the fourth quarter, it would be sort of an eighteen-month construction starting in January. So eighteen months in sort of 2007 we’d see Manantial coming on, our 50% would add about another 2 million ounces of silver and about 40,000 ounces of gold, so add that to our current production profile. And I guess the one big unknown is what we’re really going to end up with at Morococha. I don’t even want to speculate numbers at this point in time, but there’s no question, given the discoveries that we’ve made, that we need to look at what the correct production rates are, and it’s not going to be 50,000 tonnes per month of throughput, which is where we’re getting to right now, it’s going to be something significantly above that. But I just don’t know, you know I don’t want to speculate on where – what those numbers might be.
Ian Howat: And if you find significantly more ore, are there any limitations on the ability to process it, or on the storage of tailings?
Geoff Burns: There’s certainly nothing on the storage of tailings. The tailings go into Wascacocha Lake, which has been the tailings repository long before we arrived on the scene, and that probably has a 20-year capacity, at least, with some very modest dam raises, so there’s no – no issue there.
The real issue is if we are going to change the capacity we have another plant already on site that we’re not using called Sacracancha. The question is whether we would look at, you know, reestablishing processing at that plant or look at putting in something brand new with the latest technology. So that – there is – I don’t see a limitation on that, there may be a capital investment required but it’s certainly not a limitation.
Ian Howat: OK. And one last question. OK, so you have enough cash available for Alamo Dorado. On the preliminary numbers for Manantial Espejo, do you have enough money for that as well, or would you have to raise some debt?
Geoff Burns: We’d have some financing there, Ian. It’s – at this stage it’s way too early to know whether we’d look at that or whether we’d look at equity. We are going to continue to generate some positive cash flow from our operations during this period of time. The answer is we won’t have enough from that to cover the full construction cost. We will have to do something.
Ian Howat: OK, thanks very much Geoff.
Geoff Burns: Ian, just the last thing, the other part to add to the production profile is going to be the sulphide production that’s coming on at La Colorada starting February next year, and as we said I think in the release, it’s about 900,000 ounces a year in addition to what’s coming out of there right now.
Ian Howat: OK, thank you.
Operator: Thank you. Your next question is coming from Stuart Lobenberg who is a shareholder,
Stuart Lobenberg: Yes, hi. I would like to know, this is a very general question, how your – you started selling silver at retail level I guess you’d say, and I haven’t heard much about that since that began, and I’m wondering what effect that has, if any?
Geoff Burns: OK, Stuart. I guess real quickly, the last discussion I had with the Northwest Territorial Mint, who is actually minting the coins and selling them on, we’d sold about 200,000 ounces since we really kicked that program off, I guess it was about April of this year. Just so you know, we’re not – we’re supplying the silver and selling it to the Mint, who are then selling it on for retail, so we’re not – we’re not in the actual collection on the retail side, the Northwest Territorial Mint is looking after that. But so far and demand has been very good. I don’t know what to expect over the balance of the year but we’re getting good solid demand right now.
Stuart Lobenberg: OK, well I bought some of the product and I was very happy with it, so keep up the good work.
Geoff Burns: Oh excellent.
Stuart Lobenberg: OK, well thank you.
Operator: Our next question is coming from Haytham Hodalay, with Salomon Partners.
Hatham: Sorry Geoff, just a follow up. Just the cost, looking at Huaron here, going forward, what realistically do you think you’ll be able to get them down to eventually once all the problems are sorted out
Geoff Burns: Yeah, I’m – right now I’m looking at about $4.25, is what I think we’re going to see at Huaron. In terms of actual dollar expenditures, Haytham, we haven’t seen cash out the door in terms of operating, has not gone up very much at all. In fact it’s been very minimal. What you’re seeing, the biggest impact, or two impacts are, one, is the zinc by-product credit. Our recoveries have fallen there from, you know, almost the 80% level down to the low 60s, so that has had a real impact, almost 70 cents an ounce at Huaron, is a loss of that by-product credit, so we’re hoping that the met testing we’ve got going on right now, and a little bit of reconfig on the mill is going to get that 70 cents back for us.
The second impact is we’re seeing lower production and we are going to see production up to, as I said, averaging about 56,000 tonnes plus over the next quarter we should our production go up about 10% above where it is right now, in that neighborhood. Put those two things together, I think $4.25 is the number you’re looking at.
Haytham: Geoff, what was your realized price for silver overall this quarter?
Geoff Burns: Rob, can you take that one for me? I don’t have that number right in my head.
Rob Doyle: Sure. I’ve got a year to date number of $7.05 as our realized price. For the quarter it was actually right around the average which I think was somewhere around $7.15 I believe.
Haytham: Yeah it’s about right. OK, and just one more thing, Rob, your calculation does work out. I actually was just excluding the short term investment, so that does make up most of the difference on an earnings perspective.
Rob Doyle: OK, so if there’s any follow up on that I’ll be available to go through the calculations.
Haytham: No, that’s perfect. One more question, one last question for Geoff. Geoff, how do you think your stocks should be valued, based on what metrics?
Geoff Burns: Haytham, you’re the analyst; you’re supposed to tell me what metrics are key.
Haytham: Oh, no, I have my own. I’m just curious what you think, I mean is it more of an option process valuation methodology you think people should be looking at, or is it truly based on fundamentals?
Geoff Burns: There’s no question that we’re not valued like a base metal company, where you take our net asset value at discount. I mean that’s just not part of the way the silver assets are being valued. I think there is an option value in the share price. I think it’s a combination of that option value and production - and growing your production. So when I look at our valuation what I focus on, on the operating side, is what is our cash flow, what are our cash costs, what is our production, and to that I think you add the option value of where silver could be going.
Hatham Hoday: Thank you Geoff, I appreciate it.
Operator: There appears to be no further questions. I would now like to turn the floor back over to management for any closing remarks.
Geoff Burns: Thanks operator. Well, everybody thank you very much for joining us today. I very much look forward to talking to you again in probably late October at the end of the third quarter, to give you a further update of where we’re going with Alamo Dorado, how we’re making out at Manatial, and some additional progress at our operations. Thanks again.
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