Pan American Silver - Earnings Call - Q2 2020

Transcript

Operator (participant)

Thank you for standing by. This is the conference operator. Welcome to the Pan American Silver Second Quarter Results 2020 conference call. As a reminder, all participants are in listen-only mode, and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. To join the question queue, you may press star then one on your telephone keypad. Should you need assistance during the conference call, you may signal an operator by pressing star and zero. I would now like to turn the conference over to Siren Fisekci, VP, Investor Relations. Please go ahead.

Siren Fisekci (VP of Investor Relations and Corporate Communications)

Thank you, Operator, and welcome everyone to Pan American Silver Second Quarter 2020 conference call. Media and other participants on the call are invited to participate in listen-only mode. We released our results after yesterday's market close, and a copy of the news release, MD&A, and presentation slides for today's call are available on our website. The material and today's call contain certain statements and information that constitute forward-looking statements and information. Please review the cautionary statements included in our news release and presentation, as well as the risk factors described in our most recent Form 40-F and Annual Information Form. I will now turn the call over to Pan American's President and CEO, Michael Steinmann, who will provide a brief review of our results. We will then open the call to questions and answers.

Michael Steinmann (President and CEO)

Thank you, everyone, for joining us today to discuss our second quarter results. The global COVID-19 pandemic had a significant impact on our operations over the second quarter. Despite strong government measures introduced in many of the countries where we operate to control the spread of the virus, infection rates are climbing, and healthcare systems are struggling to cope. Our operations in Mexico, Peru, Argentina, and Bolivia were also suspended for various durations during Q2 in order to comply with mandatory national quarantines imposed in response to the COVID-19 pandemic.

Silver and base metal production were most impacted, as limited gold production continued from the heap leach operations at Shahuindo, La Arena, and Dolores, and from the Timmins operation, which continued to produce gold at about 90% of capacity since the pandemic was declared. By June 1st, all our operations were back in production, except for Huaron and Morococha in Peru.

While those mines restarted in June, they were returned to care and maintenance on July 20th, following several workers testing positive for the COVID-19 virus. A reduced workforce is conducting care and maintenance activities at those mines until it is determined that normal operations can safely resume. Across all our operations, we have introduced comprehensive protocols to safeguard health and safety of our workforce and communities. The slides accompanying this call and posted on our website provide a general description of those protocols. We have limited the remobilization of the workforce in order to allow time to adopt and refine these protocols. Our mines are currently operating at lower capacities with reduced staffing levels to accommodate the COVID-19-related protocols, particularly physical distancing in the workplace, camps, cafeterias, and transport system.

Revenue in Q2 of $249 million reflects the impact on sales volumes from the mine suspensions, partially offset by higher realized precious metal prices. Mine operating earnings of $48.4 million were similar to last year's Q2, as lower costs of sales largely offset lower revenues, both on account of COVID-19 suspensions in Q2. As well, production costs in Q2 2020 benefited from devaluation of local currencies and lower energy costs. Net income in Q2 was $19.4 million, or $0.10 per share, which includes $52.2 million in care and maintenance costs and $47.5 million in investment income. Investment income largely reflects the realized gains on the partial sales of our interests in Maverix Metals and New Pacific Metals and the mark-to-market fair value adjustment on our remaining interest in New Pacific.

We continue using the equity method to account for our remaining interest in Maverix, and thus a mark-to-market adjustment for Maverix is not included in our net income. Adjusted earnings in Q2 were $58.4 million, or $0.28 per share. The investment income is included in adjusted earnings, while $46.5 million of COVID-related care and maintenance costs were removed. Cash flow from operations in Q2 totaled $62.8 million. Working capital changes in the quarter provided roughly $31 million source of cash, which is mostly due to the release of inventories from the continued leaching at our three heap leach operations. We are now replenishing these inventories, and as such, expect the drawdown in Q2 to be reflected in a larger use of cash working capital adjustment in Q3.

Excluding working capital changes, Q2 cash flow was more than sufficient to cover sustaining CapEx, taxes, and dividends, and the net $60 million repayment on our credit facility. At the end of the quarter, our cash and short-term investment balance increased by about $22 million-$262 million. We made a further repayment of $40 million on our credit facility in August, reducing the amount currently drawn to just $160 million. During Q2, we sold 10.35 million shares of Maverix and 10 million shares of New Pacific. We also exercised 8.25 million Maverix warrants, which added to our share position. We now hold an approximately 19.9% undiluted interest in Maverix and an approximately 9.96% undiluted interest in New Pacific. The other notable divestment we made in the quarter was the sale of the Juby and Knight exploration properties in Ontario that we had acquired as part of the Tahoe transaction.

We sold those properties for $10 million and retained a 1% NSR royalty. These transactions largely accounted for the $81.1 million in cash proceeds we realized from divestitures in the quarter. The partial sales of our interest in Maverix and New Pacific do not change our view of those companies. It was simply a timely opportunity for us to further strengthen our balance sheet. We retain exposure to further growth on Maverix while we remain committed to the future of New Pacific's exciting Silver Sand discovery. Juby is an early exploration stage property, which was not a fit with our portfolio. We will continue to look for opportunities to divest of other early-stage, smaller exploration assets within our portfolio, as our exploration efforts are focused mainly on reserve replacement at existing mines and large-scale projects.

While normal operations were significantly disrupted in Q2, we were able to progress some of our key sustaining capital projects. This includes work on the underground ventilation system at our La Colorada operation in Mexico. We expect to complete work on the ventilation raise from 345 to 528 level and install an underground booster fan in the third quarter of 2020. When completed, the mine will be able to increase production from the high-grade sulfide veins in the eastern part of the mine, in line with our previous rates before facing the ventilation restriction in Q1 2020. We are also advancing well on the long-term surface to 345-level ventilation raise, which we expect to complete by year-end. In Argentina, we resumed underground work at COSE and Joaquin in early May and expect to begin processing ores from those assets at our Manantial Espejo processing plant during Q3.

We also progressed one of our key catalysts for growing future shareholder value. Exploration drilling at our La Colorada's current discovery has enabled us to increase the estimate for the inferred mineral resource to 100.4 million tons, containing 141 million ounces of silver. Please see our news release issued on August 4th and our website for further details. We are continuing with drilling and environmental and metallurgical studies to advance the development of this exciting deposit. We are also investigating alternatives to access the ore body. Options are to decline from the bottom of the existing shaft, decline from surface, or develop a new shaft. I'm looking forward to discussing these alternatives in more detail in the coming quarters. Regarding another catalyst in our portfolio, the Escobal operation in Guatemala, we continue to await progress on the government's ILO 169 consultation process.

Obviously, the process has been disrupted given the current COVID restrictions and curfews. Guatemala has been severely impacted by COVID-19. Like many other countries in Latin America, Guatemala is working hard to balance the health risks and the economic impact. Our team continues to work closely with our employees and local communities to coordinate numerous requests for support. Escobal remains in care and maintenance, and we currently have no timeline for the consultation process or the reopening of the mine. Yesterday, we also provided the annual corporate reserve and resource update for the last 12 months of exploration and production. As you may remember, we moved our reserve update from year-end to mid-year in order to work with the latest reserve estimate in developing our annual budgets, a process that will begin in September.

Over the past year, we replaced 76% of the silver and 107% of the gold mined, adding 22.1 million ounces of silver and 719,000 ounces of gold to Proven and probable mineral reserves. The detail is provided in our August 5th news release. With the release of our Q2 results yesterday, we also provided revised guidance for 2020. We withdrew the guidance previously provided for 2020 because we were unable to determine the impact from the government-mandated suspensions at that time. While the situation regarding the COVID-19 pandemic is still very fluid and uncertain, we feel we are in a better position to provide guidance with most of our operations now having resumed. In 2020, we are expecting total silver production of 19 to 22 million ounces and gold production of 525 to 575,000 ounces.

All-in sustaining costs for the silver segment are expected to be between $10.50-$12.50 per ounce. For the gold segment, all-in sustaining costs are expected between $1,050-$1,125. Capital expenditures are estimated to total between $210-$215 million, including $25-$26 million for project capital. Again, there remains significant uncertainty in the second half of the year due to the potential impact of COVID-19 on production and cost. The past few months have been the most challenging in Pan American's 26-year history due to the global COVID-19 pandemic. I'm very proud of how our team has been managing this crisis, which gives me the confidence that our business is resilient and can navigate these extraordinary challenges. The unprecedented economic impact of the pandemic has forced governments to unleash monetary measures the scale of which we have never seen before.

Gold and silver have responded, with prices rising significantly over the course of the year. This should generate margin expansion and improved financial performance over the remainder of 2020. And with that, I would like to open for questions.

Operator (participant)

Thank you. We will now begin the question-and-answer session. To join the question queue, you may press star then one on your telephone keypad. You will hear a tone acknowledging your request. If you're using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press star then two. The first question comes from Chris Terry of Deutsche Bank. Please go ahead.

Christopher Terry (Director of Metals and Mining Equity Research)

Hi, Michael. Hope you're doing well. A few questions from me. Just wanted to start on the balance sheet. You're obviously in a really strong position after that quarter, particularly with the asset sales. So just wondered if you could talk through how you plan to allocate some of the capital, maybe in the context of dividends. Thank you.

Michael Steinmann (President and CEO)

Sure. Good morning, Chris. Look, really, nothing has changed in our capital allocation plan here. As I always said, number one is always our balance sheet. It's very dear and important to us, so we will keep aggressively paying back debt. I'm sure you've seen that we obviously paid back the $80 million that we took from our line of credit at the very beginning of the pandemic as a precautionary method. We did not need that money. We also paid back an additional $60 million during the quarter on the line of credit. And actually, we're able to pay already another $40 million on our line of credit after the quarter here just last week or early this week.

Our draw on the line of credit is down right now, as of today, to $160 million, and we will continue to focus on that over the next month and quarters, for sure. Number two, always important to us, are high-quality accretive projects. We have a few in our portfolio. I'm sure you saw the incredible resource update on our discovery at La Colorada with over 100 million tons now in our skarn polymetallic discovery there. High-quality projects that will require capital. That's where we assign the second bucket from our free cash and capital available to us. Number three, as you mentioned, is dividend. If you look at it, we increased the dividend, actually, just at the beginning of the year. We actually did that probably the last three years at the beginning of the year. We'll definitely look at that again.

We're very happy to return money to shareholders. We're paying dividends since 2010. We have been returning to shareholders, I think, since then, about over $470 million, and we'll definitely continue to do so.

Christopher Terry (Director of Metals and Mining Equity Research)

Thanks, Michael. And then just in terms of the operations that are on care and maintenance, Huaron and Morococha, can you just give an update maybe on thoughts around what has to change to get those back online? Just wondering, I know it's uncertain, but anything you can provide on those?

Michael Steinmann (President and CEO)

Yeah, it's definitely uncertain right now. I mean, we see, like in many, many, many countries in the world, we've seen an increase of cases in Peru, especially in Central Peru, as well around the operations. There may be additional restrictions as well from the government in the future. We don't know, so it's really uncertain.

But we just defined it as when we deemed that it's safe for us to restart, we will for sure restart the operations then as quick as we can.

Christopher Terry (Director of Metals and Mining Equity Research)

Okay. Thank you. And then I see the strong results coming through on the Skarn deposit for La Colorada. Maybe if you could just give a timeline of the upcoming events or what you're doing now and drilling, when the next update will be, when you might get a reserve, just a timeline of events for that project. Thank you.

Michael Steinmann (President and CEO)

Sure. Yeah, very strong results there. Look, in my view, this is obviously a world-class deposit. It's very large. It can grow all around. It's open in most of the directions. I think we will focus on infill drilling from now on. I mean, we can, if not, we can spend a long time and make this much, much bigger.

But at the end of the day, I think we have to focus on increasing geological confidence here and pass tons into measured indicated and then do the technical studies that we need to do on that deposit to move it into our reserves, as you indicated. So timeline's still a bit early to say, Chris. For sure, I will have a bit more information on that the next quarter and the one after. We are discussing actually internally right now how to best access the top part of the skarn. We are looking at ramping down from existing underground levels or ramping down from surface with a large ramp to get access. The third alternative, and there's maybe a combination of those three as well, would be a large shaft from surface. So as you can imagine, there's a lot of technical studies needed for that.

But you should plan on that. You're going to see updates really on infill drilling from now on and increasing confidence on the geology so we can move forward with the technical work.

Christopher Terry (Director of Metals and Mining Equity Research)

Thank you. And then just a smaller one. On the second quarter, there was a difference between sales and production. Just thinking about the guidance you provided for the rest of the year, maybe you could just comment on expectations for sales versus production. Should we assume they're pretty close to each other in 3Q and 4Q?

Robert Doyle (CFO)

Hi, Chris. Good morning. Rob Doyle here. Yeah, you're right. We did have some benefit in Q2 of drawing down inventory and selling previously produced production. And in Q3, we expect to rebuild that inventory. But it should even out over the quarters. And we're expecting the second half sales to be virtually in line with production.

Perhaps a small lag just to build up the inventories as we ramp up, particularly at the heap leach operations.

Christopher Terry (Director of Metals and Mining Equity Research)

Thanks, Rob. Appreciate it. Hope you're well. And just one final question from me. I know, Michael, you normally have some good insights on the silver market. Just wondering whether you wanted to comment at all on what you're seeing. Obviously, there's been supply disruptions, investment demand improving, etc. I just wondered if you wanted to comment at all on some of the things you're seeing in the silver market.

Michael Steinmann (President and CEO)

For sure, large disruption on the production side in Mexico across the board, obviously not only from Pan Am, but just due to COVID. Same in Peru and other countries. So there will be disruption. I don't have an estimate yet. I haven't seen a number yet.

How much disruption on the mine production for the year, but I would expect that it's quite big, and as you recall, the last year or two years, it actually was already declining without COVID, the mine production. At the same time, kind of unlimited money supply as every country is really struggling here to kickstart their economy again, which is obviously one of the main reasons why we see the strong reaction in gold and silver prices. We have not seen really a big increase in an uptake of silver on the industrial side, so I'm a bit torn there to see what's going to happen. Normally, we see a bit slower increases there when metal prices are high for obvious reasons, and the high metal prices are pushed by the investment demand.

But I could also imagine here with the really strong desire to kickstart economies that it wouldn't have that big of an impact, the metal price to the industrial uptake this time. But time will tell. I don't have a crystal ball for that one either.

Robert Doyle (CFO)

Okay. Thanks, Michael. Thanks, Rob. Appreciate all the answers.

Operator (participant)

Thank you. The next question is from Cosmos Chiu of CIBC. Please go ahead.

Cosmos Chiu (Executive Director of Institutional Equity Research)

Hi. Thanks, Michael and team. And first off, congratulations on a very solid Q2, all things considered. Maybe my first question is on your reserves update, very robust update, replacing silver, increasing gold. I see that you've used an assumption of $18 an ounce silver, $1,300 an ounce gold, clearly lower than where we are today in terms of spots. So I guess my question is in two parts, Michael.

Maybe first off, how did you arrive at these gold and silver price assumptions? What did you consider? And then number two, what's your sensitivity in terms of these reserve ounces to potentially higher gold and silver prices, especially for a lower-grade mine like Dolores?

Michael Steinmann (President and CEO)

Yes. How did you get to these prices? Well, don't forget that this is the reserves at end of June 2020. So we obviously have to define prices quite a bit in advance. Metal prices, don't forget, have been substantially lower at that time already. That was a big increase just over the last couple of months. So that's one reason why the big difference. But the main reason for it is really you have to be very careful when you see these big runs in metal prices, which can provide some really, really attractive returns to shareholders.

You have to be very careful not to run up the metal price and add in a lot of lower-grade reserves. So what we are focused on is to really add real reserves, not just marginal additional ounces to increase our reserve book, which provide a solid margin and even a bigger margin, obviously, today with the higher metal prices. Sorry, what was the other question?

Cosmos Chiu (Executive Director of Institutional Equity Research)

Yeah. In terms of potential sensitivity. Additional ounces, yeah.

Michael Steinmann (President and CEO)

Yeah. Well, the sensitivity, as you pointed out, of course, in a place like La Colorada, where we have very high grades, there is not a lot of sensitivity. I think if you run that at nearly any metal price, the reserves look probably pretty similar. Of course, there's a different story at Dolores when you look at material inside the pit that suddenly wouldn't be waste anymore.

Definitely, when we go through the budgets and mine plans, we will very carefully look at that material and make decisions then where to place that material. We're obviously not just blindly move everything to the waste dump if it makes money at $1,400 once we go through the mine plan in a mine like Dolores, especially as we're sitting on very high gold prices here and could create potentially a big margin from that material. You're absolutely right. Much bigger sensitivity on lower-grade assets. You will also see we provided an entire table of metal prices used in the back of our reserve update. I'm a firm believer that there's not just one number fits all. Each mine is a little bit different. They're not huge differences, but they're all a bit different. That just makes sense, right? We have mines with shorter mine life.

There you can be much more aggressive with the metal prices because you have less risk on there. We're probably all pretty bullish on gold and silver prices over the next few years. We have mines with very, very long metal prices where we have been probably a bit more conservative when we chose the metal price. So if you look at the table in the back of our reserves, you will see what prices we use. But if I'm not mistaken, I think it's all somewhere around $1,300-$1,350, maybe sometimes $1,400 that we use. For sure.

Cosmos Chiu (Executive Director of Institutional Equity Research)

And maybe a bit more. Good to see that at La Colorada, you were able to replace production in your latest reserve update. Clearly, La Colorada oxides in terms of reserves, that's likely finite. But is it too optimistic for me to believe that year after year you can actually replace production? And then on that, where are you finding more ounces to put into reserves?

Michael Steinmann (President and CEO)

Yeah. Look, I couldn't be more happy about the reserve replacement that the geology team provided on La Arena, Shahuindo, and Timmins. I think we really have to mention those three assets. Of course, we know that there's a very long life at Shahuindo, but adding over 400,000 ounces of reserves, and of course, we mined probably around 200 contained, but adding actually two years of production, it's amazing just in the short time that we own the asset. And there is definitely, and I think Cosmos we talked about that in the past, a lot of exploration upside around that asset, long life and a long time to explore and drill.

I'm not worried about that at all. But a lot of people have been quite worried about the reserves at La Colorada and Timmins a couple of years ago. And every year we replace basically reserves, pushing production out another year, another year, another year. At one point, that will come to an end for sure. But at the moment, we have very positive exploration results. And of course, there, when you look at the metal prices, and as I said, at shorter life mines, we will be more inclined to use a little bit higher prices to look at. I think there's still a lot to do there. So a lot of upside that I still see as well.

Cosmos Chiu (Executive Director of Institutional Equity Research)

And then maybe two quick questions on your guidance here. Good to see that you've reinstated guidance, at least in line with my expectations. I guess first off, Michael, as you talked about the Peruvian underground mines, it's a fluid situation. They're currently on care and maintenance. But in terms of your 19-22 million ounces in terms of silver production, what have you kind of factored in in terms of potential restart date at those Peruvian underground mines? And then on that, are these two mines and the potential startup the biggest sort of variable in you hitting your target for 2020?

Michael Steinmann (President and CEO)

Well, just in general, there's obviously a lot of uncertainty here with giving a guidance in time of COVID. And I'm sure everybody appreciates that. We did actually not just include certain restart dates, but more like looked at kind of factors or estimates corporate-wide, how the production could look like. And I'll have Steve giving you some more details.

Steve Busby (COO)

Yeah. Good morning, Cosmos. Or afternoon. Hi, Steve. Hi. Yeah.

I would say that when we look at restarting the operations that we're on a more cautious, the issue to us is more at what rates do we restart and at what rates do we ramp up over the rest of the year is probably going to drive that more so than the exact date of when we restart. So we've got some flexibility built into this guidance, this re-guidance that we've issued to allow for that. So we don't have a specific target date that we put into that. It's more just a sense of restart rates. We're going to start slowly. We know that. We're going to ramp in slowly because they are fairly large workforces. These are labor-intensive mines. So we have large workforces, and we just have to ease our way into it. We can't just jump right on it.

So to me, the big drivers to our silver production are obviously La Colorada. And getting that ventilation raise done this quarter is going to be opening up some good opportunities for us there. Also at Dolores, I would say, depending on the rains that are just starting now, how intense they are will allow us deep in the pit or not. That can drive more silver production or not. I think those are the big drivers as to what we have control and what we'll see for the full year silver production in the company.

Cosmos Chiu (Executive Director of Institutional Equity Research)

And then, Steve, on Dolores, as you mentioned, I believe in the MD&A underground restarted in July, the Pulp agglomeration plant restarted in mid-June. How is that going so far? Is that going to help you in terms of getting that production in the second half as well?

Steve Busby (COO)

Absolutely. The Pulp agglomeration plant came up really well. Actually, so did the underground. It is up and running now, and both are running well. It's just monitoring the workforce, monitoring the pandemic and the virus around where we operate, and making our shift changes as smoothly as we can each time we bring new crews in. Those are really the risky periods for us. So that's what we're managing. Right now, the operations are running pretty smoothly.

Cosmos Chiu (Executive Director of Institutional Equity Research)

Then the last part of my question here is in terms of guidance. I see that sustaining CapEx guidance is now $185-$189 million. Previously, it was $225-$240 million. How should we look at that difference? Is it going to be something that will likely be caught up later on? Does that mean that difference will likely potentially reappear in year 2021? So it's more a deferral? How should we look at it?

Steve Busby (COO)

Yeah. Absolutely, Cosmos. It's most definitely a deferral, particularly on leach pad constructions. So we'll have to do those in 2021.

Cosmos Chiu (Executive Director of Institutional Equity Research)

Okay. Perfect. Thanks a lot. Those are all the questions I have. Thanks once again.

Steve Busby (COO)

Thank you.

Michael Steinmann (President and CEO)

Thanks, Cosmos.

Operator (participant)

Thank you. The next question comes from Lawson Winder of Bank of America. Please go ahead.

Lawson Winder (Senior Equity Research Analyst)

Hey, Operator. Thank you. And thank you, everyone, for taking the call. I would like to follow up on some of the reserve questions as well. And I also make the comment that I'm very glad to hear you say that your goal is to add real reserves as opposed to chase the price higher. I think that's definitely what investors are looking for. Obviously, I was very impressed to see that you guys added a lot of reserves and did so with only very minor increases in the prices or no increases at all in the case of some of your gold assets.

So I just wanted to better understand where some of those increases were coming from. One on La Arena in the past, basically what's happened is material you thought was sulfide just turned out to be oxide. Is that what's happening here? And then what's the outlook for that to continue to happen? Thanks.

Christopher Emerson (SVP of Exploration and Geology)

Yes. Shahuindo, Chris Emerson here. The geology teams across the company did an exceptional job this year under very difficult circumstances with starting a whole reserve resource process through sort of February, March, April, and then obviously the pandemic coming in.

I mean, it took a huge effort from all our teams across the company and some really, really successful results without hiking up the prices or anything and keeping it very, very real. La Arena, as Mike alluded to just earlier on to the previous question, was infill drilling from that La Arena pit, which brought in the tilt structures, which were higher-grade structures. We focused on those, and there was some upside that we gained from the bottom of the pit into the west, so that was a nice increase there through La Arena at around 160,000 ounces coming in, easily replacing production. Shahuindo, we saw infill drilling at the back end of last year and into Q1 this year. That obviously got suspended through the pandemic, but that gave us some really nice results outside of what was that long-term life of mine pit.

So we added infill resources into reserves, increasing the tons there. And we've had a good positive reconciliation across Shahuindo. So all in all, really nice to add over 400,000 ounces of reserves in gold at Shahuindo. And Timmins, as Mike again said, they constantly, every year on year, are close to replacing the production, which really comes mainly from Bell Creek, where we've replaced over 100% of production. And that is the deepening of those structures. And as we get them into infill and convert infill into reserves, there's still room to increase. So from the gold assets, the gold segment, that is where the real drive came from. On the silver, certainly La Colorada, Huaron, and Manantial also gave us some good ounces back into reserves, which was really pleasing.

Michael Steinmann (President and CEO)

Just a word here, to be clear, La Colorada, not only on this skarn side, which is obviously in the resource, but I'm sure you've seen it in the press release, actually had 10 million ounces of silver just from the producing part of La Colorada from the veins. So a very strong result there as well.

Lawson Winder (Senior Equity Research Analyst)

Yeah. I'm actually glad you guys brought up La Colorada. Very impressive increase in the silver, though the base metals went down. Gold slightly, but it was more of the lead and zinc that declined. Is that just geology driving that, or is there economics getting involved here as well?

Michael Steinmann (President and CEO)

Well, Chris, you can take it.

Christopher Emerson (SVP of Exploration and Geology)

No, certainly. Lawson, I mean, La Colorada over the past couple of years, we've obviously been moving more to mechanized. That is increasing across the board.

A decision from that technical side was taken to slightly increase the width, the minimum mining width from 2.4-2.6. That did add in some tons, some slightly lower-grade material. Therefore, you did see a slight decrease in those grades,

Lawson Winder (Senior Equity Research Analyst)

And on the base metal, sorry. Am I understanding? So the base metal grade went down, so some fell out of reserves? I was asking more about just how the base metals weren't replaced as well. Obviously, the silver was more than that.

Christopher Emerson (SVP of Exploration and Geology)

It just depends how much we add in on the oxide side and on the sulfide side. Obviously, for the base metals, it depends in which area we are in the mine. As you can imagine, it's a really large mine now, and there's zonations of the base metals.

So in any given year, I would expect to add in more zinc and later on, probably more copper. That just makes sense what the geology shows to us.

Lawson Winder (Senior Equity Research Analyst)

Gotcha. Yeah. So geology. Okay. That's what I had suspected. Now, Michael, just I wanted to ask you on cost inflation. Obviously, every year there is some cost inflation, but I'm curious, are you seeing any early hints of cost inflation beyond what you've seen over the past several years, whether it be on labor or inputs?

Michael Steinmann (President and CEO)

Well, we definitely see some slightly higher cost because there's a COVID cost attached to it, and that will stay, obviously, as long as we deal with this pandemic. Just much more effort and work there and a bit less productivity. So you see an increase there. It's not dramatic. I think there are very strong tailwinds, obviously, that we deal with.

Of course, number one, metal prices that help us a lot on the byproduct. And even on the base metal side, slow but steady increases there as well that will help us in the future. We see also two other really important things I have seen in the past and still do is lower currencies. So we see advantages there on the exchange rates and definitely lower energy costs across the board. So maybe I'll pass it down to Steve for his comments, but I don't think that we see dramatic increases yet.

Steve Busby (COO)

No. The only thing I would add, Lawson, is that our normal collective bargaining with the unions, we'd be pretty far progressed on many of those this time of year normally. A lot of those have been disrupted because of the pandemic situation.

So we don't have a good sense yet of how those are going to fall out relative to our forecasts and that. Right now, we don't sense that they're going to be way out of line, but I don't really have any progress on actual negotiations to really make any statements in that respect.

Michael Steinmann (President and CEO)

Yeah. But definitely, control of cost will be one of our main focus always has been and will remain to be going into the future.

Lawson Winder (Senior Equity Research Analyst)

Yeah. If COVID costs are your only concern right now, I think that's a good situation. On the ventilation installation at La Colorada, will that have any impact on throughput over the coming quarters, or are the vents being installed out of the way from current production?

Steve Busby (COO)

Yeah. I'm going to let Martin Wafforn, he's on the line, our Senior VP of tech services, address that. Martin, do you want to take that?

Martin Wafforn (SVP of Technical Services and Process Optimization)

Yeah. Sure thing, Steve. Good morning, Lawson. No, the ventilation is more impacting our access to some of the higher-grade areas in the eastern part of the mine right now. So far, we've been able to get the production from other parts of the mine, but you see we are at slightly lower grades. I think one of the things that we're seeing perhaps with production is some of the COVID-19 protocols are. They're a constraint for sure on production. So they may impact things, but so far, we've been able to get around the ventilation by producing from other parts of the mine.

Lawson Winder (Senior Equity Research Analyst)

Okay. That's great. Now, I wouldn't mind asking about Guatemala. Thanks for addressing it in your comments, Michael. It sounds like your social license efforts have continued. You're helping the communities through COVID.

How would you describe the progress you guys have made to date on sort of improving the situation around social license, just putting aside entirely the ILO 169 progress?

Michael Steinmann (President and CEO)

Well, look, obviously, a lot of work that went in there. Big change of our team, having a big, local, very strong local team there. Of course, the pandemic changed everything at short term, not only in Guatemala but anywhere on the planet. And Guatemala has been really severely impacted by that, and the government is working on to minimize this for sure. But like any other countries, they're really working hard on balancing the health risk and the economic impact of the pandemic. We do a lot of work there. Our team really works closely together with our employees and the communities to coordinate actually a huge amount of requests for support and help.

That's, by the way, not only in Guatemala but really across many jurisdictions we are. So we are very, very active there. A lot of work has been done. But sorry, I still don't have a timing for the ILO 169 process, especially as we have to wait to advance a bit further through this pandemic.

Lawson Winder (Senior Equity Research Analyst)

Okay. Thanks. And then maybe, Michael, just an additional question on the capital allocation framework that you provided and have consistently provided for some time. So in the past, I mean, yes, dividends have been number three on the rung, but in the past, you've also used buyback as a way to supplement dividends. And of course, debt is your main goal right now, but at current prices, it won't be long before your debt is gone. And how do you think about a buyback vis-à-vis your current dividend going forward?

Michael Steinmann (President and CEO)

Sure. We have, of course, and I have made a lot of investors' discussions on buyback versus dividends all the time. It's a pretty good discussion actually to have, not only in high metal price but in low metal prices when we actually discuss how we return money to shareholders. There's obviously different views depending much on tax regimes in different countries as well on preference of shareholders. For me personally, I absolutely believe that the best return are high-quality projects and being able to finance them from cash flow on hand and free cash flow like an expansion or a skarn development at La Colorada is an amazing opportunity. Definitely focus on that. I think that will provide a much better return to shareholders than buying back a lot of the shares.

Just as a general statement, that's my personal view that a lot of companies start share buybacks, obviously, when they have the biggest cash flow. That means normally when there is the highest metal price, that means when they're looking at the highest share price as well. So if you do share buybacks normally, I think it's better to shore up your balance sheet and maybe do that a bit later on.

Lawson Winder (Senior Equity Research Analyst)

That makes a lot of sense, and just one final question for me on the capital allocation. The La Colorada seems like the obvious next sort of larger project with which to use that or on which to use that capital. I'm curious, are there any other potential projects that might be in the pipeline that we're not seeing right now, like any potential expansions at the existing assets or something along those lines? Thanks.

Michael Steinmann (President and CEO)

Obviously, nothing in the size of La Colorada. This is just obviously overwhelming everything as it's such a large deposit and will be the largest amount required for that development in capital. I'm sure Steve and Martin, they always come up with some really clever ideas how to squeeze a little bit more left and right, but that won't be material numbers really on the capital allocation for those assets just to keep optimizing them. But of course, there's still Navidad there in Argentina, which is probably about a similar statement there than in Guatemala that with COVID, there's kind of a holding pattern right now on that. That's obviously a bit further out there, but that could be another large project that would require capital. Of course, Guatemala is already built, so capital requirements there will be quite modest.

Lawson Winder (Senior Equity Research Analyst)

Thanks very much, guys. Enjoy the rest of your summers.

Michael Steinmann (President and CEO)

Thanks, Lawson.

Operator (participant)

Thank you. The next question comes from Chris Thompson of PI Financial. Please go ahead.

Chris Thompson (Mining Analyst and Head of Research)

Hey, good morning, guys. Thanks for answering my questions. Hey, Michael. It must be a little frustrating not to have a fully ramped-up silver side of the business looking at silver this morning at $28. Just a lot of my questions have been answered, but just a little bit more detail, I guess, on how you're doing at Dolores by way of the underground and the pulp agglomeration. Just remind us, what are the goals by way of ramp-up and maybe sort of the timing for that on both components?

Steve Busby (COO)

Yeah. Good morning, Chris. Steve here. Regarding the pulp agglomeration plant, I mean, we kind of targeted about 5,500 tons a day throughput this year before the COVID pandemic.

In the restart, I've got to say we kept everything in really good shape during care and maintenance, and we're basically restarted above 5,000 tons a day. I only caution the uncertainties of these shift changes. That's what we monitor, and we've extended shifts. We're very careful of how we do the shift changes, but that's where we're seeing our biggest risk, so the uncertainty is whether or not each shift change will have enough personnel to run at full capacity rates during each shift change. Right now, today, we are, and underground mining, we just got the first shifts in there during this month, this last month, July. It's ramping up well. We're probably just near the 1,000 ton a day mark. We were hoping to ramp up by the end of the year to 1,500 tons a day.

We did kind of knock that back with COVID, and we're kind of in that 1,000 ton a day range for the rest of the year.

Great. Thanks for that, Steve. And then just finally, I guess switching gears to the Timmins asset, the Bell Creek expansion, maybe a little bit of color on. I know that you were planning on expanding, I think, the facility with 20%. Is that right? I mean, where do we sit with that right now?

Yeah. The expansion project we defined was more like about 10%-12%, and it was a modest $5 million investment, $5.5 million investment that we scheduled for the year to do that. COVID has disrupted that to a degree. We were hoping to have that done by the end of Q2. We did advance.

We're about 90% complete, and a lot of it's just upgrading pumps and pipelines and things like that through the plant and a couple pieces of equipment bought for the mine. So that's 90% complete at quarter end. It looks really good. With that said, we are restricted on personnel at Timmins in terms of how many people we can bring on and maintain the physical distancing restraints that we have. So unfortunately, we don't see that ramped up, that 12% target. We don't see that happening for a while yet. So technically and mechanically, we'll be there probably during this quarter, but from a personnel staffing standpoint, we'll probably be later to get to that point.

Chris Thompson (Mining Analyst and Head of Research)

Great. Thanks again, Steve, and congratulations, guys, on a tough quarter.

Steve Busby (COO)

Thanks, Chris.

Michael Steinmann (President and CEO)

Thanks, Chris.

Operator (participant)

Thank you. The next question comes from John Tumazos from John Tumazos Very Independent Research. Please go ahead.

John Tumazos (Owner and CEO)

Thank you very much for your service to the company on the tough times.

Steve Busby (COO)

Thank you.

John Tumazos (Owner and CEO)

In terms of your business planning, we would expect your future reserves to reflect three-year average metals prices per SEC guidelines. But will you plan any of your mines perhaps more conservatively at even lower metals prices, or how might you be changing mine plans as the metals prices rise? We have all the same tough trouble figuring out metal prices as you do.

Steve Busby (COO)

Yeah. John, that's a very good question. This is Steve here. As we look at our mine plans, I mean, we do try to discipline ourselves strictly to our long-term reserve price outlooks, and we try to run the operation at that. There's times when metal prices fall below reserves where we shore up and increase our cutoff grades a bit.

There's times like now where metal prices have run way out ahead of us, and it requires a lot of discipline to maintain kind of where we're at. With that said, it also provides us opportunities if there's some kind of squeeze point in the mine plan, some kind of constraint that we're facing. It gives us some flexibility to kind of get over some of the humps. So we do take advantage of that where we can, but it does require, as any miner would tell you, with these high metal prices, it does require some discipline to maintain your outlook because the overall objective is what is the average metal price over the life of the asset. That's really what we're focused on, and you've got to kind of look beyond these short-term swings, and that's the way we look at it when we build our mine plans.

John Tumazos (Owner and CEO)

So would you change your gold or silver price long-term assumptions at all for the gains in 2019 and 2020?

Steve Busby (COO)

I mean, we just came out with the reserves at the end of June. We did not, I mean, we upped it a little bit, but it was very modest, and obviously, it's taken off after that. I would say it's hard to say, John, until next year and where we're at. We don't need to set that price until next June, so.

Michael Steinmann (President and CEO)

I think the important part is also when you look at your mine plan that you don't sterilize. If you don't sterilize material, that you can access later on. And if this runs your metal price substantially in the future here, then you always have access to that material later on.

But as Steve said, this metal price run here has been pretty recent over the last two months, actually post what we actually decided on prices.

John Tumazos (Owner and CEO)

If I can ask another, is it fair to view the one-year extension to La Arena oxides and two-year extension in the life of Shahuindo oxides as giving you another year and another two years more time strategically to evaluate the divestiture, JV, or optimization of the sulfides at each location?

Michael Steinmann (President and CEO)

Well, we're not talking about the sulfides yet at Shahuindo. I think this is coming down in the future, but it's absolutely fair, your view there, to say that that gives us even another year to think what we're going to do at what you refer to as called La Arena II, the sulfide, the big copper-gold deposit sitting below and on the side of the current La Arena mine.

Absolutely, that gives us even another year there and gives us a lot of time to think and work on what we want to do in the future with that asset. If I can ask one more, finally, is Juby's four million ounce divestiture the only gold resource divestiture you're contemplating, or might there be more sorted out from the exploration assets in the next year or two?

Steve Busby (COO)

No, look, there's a large amount of projects, early-stage projects, smaller projects that we have in our portfolio, some for a long time. As you can imagine, there is much more interest in exploration assets than there has been for a long time. So absolutely, we will try to optimize our portfolio here in the future, and you should expect that there will be more to come.

John Tumazos (Owner and CEO)

Thank you, and congratulations on everything.

Michael Steinmann (President and CEO)

Thank you, John.

Operator (participant)

Thank you. This concludes the question-and-answer session. I would like to turn the conference back over to Mr. Michael Steinmann for any closing remarks.

Michael Steinmann (President and CEO)

Thank you, everyone, for calling in today. Looking forward to give you an update on Q3. That's, wow, November already. So enjoy the rest of the summer, and most importantly, stay healthy and safe. Thank you.

Operator (participant)

This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.