Pan American Silver - Earnings Call - Q3 2019

Transcript

Operator (participant)

Operator, welcome to the Pan American Silver third quarter 2019 earnings 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, Vice President of Investor Relations. Please go ahead.

Siren Fisekci (VP of Investor Relations)

Thank you, Operator, and welcome everyone to Pan American Silver's third quarter 2019 conference call. We released our results after yesterday's market close, and a copy of the news release and presentation slides for today's call are available on our website. In a few moments, I will turn the call over to Pan American's President and CEO, Michael Steinmann, who will provide a brief review of our results.

I will then open the call to questions and answers. Joining us for the Q&A portion are Pan American's Chief Operating Officer, Steve Busby, Chief Financial Officer, Rob Doyle, Senior VP Project Development, George Greer, Senior VP Technical Services and Process Optimization, Martin Wafforn, and VP of Business Development and Geology, Chris Emerson. I'd like to remind everyone that our news release and certain statements and information in this call 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. Media and other participants on the call are invited to participate in listen-only mode. I will now turn the call over to Michael.

Michael Steinmann (CEO)

Thank you, Siren. Welcome everyone joining us today to discuss our results for the third quarter of 2019. Revenue in the quarter was $352 million, primarily reflecting increased gold production and higher gold and silver prices. Revenue estimated at $17.8 million was not realized in Q3 due to timing of shipments, resulting in an inventory build.

We expect the revenue associated with that metal inventory will be realized during Q4. Due to changes in market conditions and effective in Q3 2019, the Bell Creek and Timmins West mines are no longer classified as held for sale. As a result, the Timmins assets and liabilities are no longer presented separately on the company's September 30, 2019, balance sheet, and the net income generated by Timmins for the three and nine months are reflected on the company's income statements in the normal course.

Net income in Q3 was $37.7 million or $0.18 per share. Net income included investment income of $36.1 million, which was offset by $29.1 million of tax expense and a $15.6 million non-cash adjustment related to the reclassification of Timmins. Adjusted earnings were $74.2 million or $0.35 per share, which is higher than GAAP earnings due to the adjustments related to the reclassification of Timmins and NRV adjustment related to the Dolores heap-leach inventory and unrealized foreign exchange losses. Operating cash flow of $81.9 million was more than enough to fund all operating and growth needs, pay dividends of $7.3 million, and repay $20 million on the credit facility. Cash and short-term investments ended the quarter at $177 million. Total debt was $360.5 million, including lease liabilities of $45.5 million, and working capital was $459.3 million.

In Q3, we produced 6.7 million ounces of silver and 150,000 ounces of gold, which is on track to meet the guidance we revised on August 7 of 25.3-26.3 million ounces of silver and between 550,000 to 600,000 ounces of gold. Please keep in mind that the Tahoe transaction closed on February 22, which means that only 10 months of gold production from those mines is reflected in the guidance. Q3 consolidated silver bases cash costs were -$8.66, and all-in sustaining costs were -$0.11 per silver ounce sold. Costs for our silver segment operations and our gold segment operations are available in the Q3 results released yesterday.

Given that cost performance was better than expected and higher gold price assumptions, we have lowered our annual guidance for 2019 consolidated silver basis cash costs to between -$5.50 and -$3.80 per silver ounce, and all-in sustaining costs to between $6.00 and $7.50 per silver ounce. The related reductions in silver and gold segment cash costs and all-in sustaining costs are detailed in our Q3 results. In summary, our operating assets continue to perform very well, and we are on track to meet our revised production guidance from August 7, but at lower costs. Our financial position continues to strengthen, enabling us to advance growth projects in our portfolio and to focus on brownfield exploration, especially at La Colorada. During Q3, we completed another 14,300 meters of drilling on the La Colorada's skarn discovery.

We released our most recent drill results on October 30, which included some of the best drill intercepts to date, like 379 meters containing 54 grams per ton silver, 0.5% copper, 1.96% lead, and 3.73% zinc, or 253 meters with 67 grams per ton silver, 0.19% copper, 3.84% lead, and 6.56% zinc, just to mention two highlights. We have now completed over 52,400 meters of drilling on this skarn target, allowing us to substantially expand the mineralized footprint and to identify a high-grade core zone.

The drilling continues to define a large polymetallic mineralized skarn system and cross-cutting veins starting about 300 meters below and adjacent to the current lowest production level of the La Colorada mine. Preliminary metallurgical flotation test results are positive, with high metal recoveries and good concentrate qualities. We are aiming to provide a first resource estimate in December for this exciting discovery.

In Guatemala, a new federal government was elected in August. The transition to the new administration officially occurs in January 2020. As you know, the court-mandated ILO 169 consultation process is led by the Guatemalan Ministry of Mines, and we will support the process as required by the government. In the meantime, we are listening to and responding to inquiries from the communities near the Escobal property. As we've indicated previously, we are taking a patient approach and are not providing any timeline for a restart of the mine. As you can see from the quarterly results, integration of the Tahoe assets is moving along very well, and all assets are performing as planned. They're generating very strong cash flows and are focused on asset optimization, debt reduction, and brownfield exploration, all yielding very strong results.

That wraps up my formal comments, and I'd like to open the call for questions now.

Operator (participant)

Certainly, sir. 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. We will pause for a moment as callers join the queue. The first question comes from Cosmos Chiu of CIBC. Please go ahead.

Cosmos Chiu (Executive Director and Institutional Equity Research)

Hi, thanks, Michael and team, and congratulations on a very good financial quarter here. Maybe first off, on the former Tahoe assets, you've had almost nine months now with the former Tahoe assets. Could you maybe summarize for us what's been good, what continues to need improvement? Clearly, as I look at your results, it's been a net positive, as we see that throughput has increased and grade has also increased at many of these operations. But could you maybe give us a bit more color in terms of what you've been finding so far?

Michael Steinmann (CEO)

Sure. Good morning, Cosmos. I'll start just with some general comments, and then we'll pass it on to Steve to make a few more comments from really his view on the operations. In general, if you look at it, really positive how the integration advanced during the year. Don't forget that's only the second full quarter really we have the assets.

If you compare it to Q3 2018 results, that's just a few weeks before we announced actually transaction last year. You look at the three gold assets, La Arena, Shahuindo, and the Timmins mines, our all-in sustaining costs are down about 27%. So very positive advances there. And the biggest moves really in Timmins, where we saw big cost savings with the new shaft being in operation since like February, March, and very big improvement at Shahuindo, where we increased production substantially compared to a year ago.

So very good improvements on those mines. And as I said, I'm especially very happy with the integration over the last few months. But I'll pass it on to Steve for a few more comments here.

Cosmos Chiu (Executive Director and Institutional Equity Research)

Just to.

Michael Steinmann (CEO)

Yeah, and more specifically, I guess in the past, Shahuindo, crushing agglomerating was an issue. Is that still an issue here, Steve? And then, as Michael mentioned, the shaft at Bell Creek, there's potential for cost savings, as you talked about. Also potential, I believe, Bell Creek has higher grades. Is that what we should be expecting? And any other comments on La Arena as well? Thanks, Steve.

Steve Busby (COO)

Yeah, you bet, Cosmos. Relative to Shahuindo and the crushing and agglomeration circuit, as we reported last quarter and this quarter likewise, we're not running that circuit. We're not forecasting to run that circuit probably through next year as well. We do face some fine ores, some I'll call it a little bit of clay ores that do cause some permeability concerns.

But so far, we've been effective at blending that with the more competent ores, and we're able to process that and get pretty decent results out of the heap run of mine. So we're very pleased with that asset, very pleased with its performance. And to be honest, I think we see some more upside as we go into next year on that. So we're pretty excited about that one. At Timmins, as we mentioned last quarter, the shaft has performed better than we expected.

It's tracking along kind of what we saw at La Colorada. Over the two years after commissioning in La Colorada, we saw better than expected productivities and lower costs coming from that shaft than we had expected. I think we're seeing the same kind of trend at Bell Creek. As Michael mentioned, we are very happy with the cost structure, the cost that's coming out of that whole operation between Timmins West and Bell Creek. And that's highlighted by our AISC that came in at the quarter of $1,000.26 an ounce. If you compare that back to Q3 under Tahoe last year, we're 20% below that, albeit with a little higher grade. We're still like 12%-15% lower on a cost per ton basis.

The interesting thing about that is, with that lower cost, it helps us to look at the life of mine economics and push for the highest profitability we can on that mine site by dialing in the cutoff grade to the most optimum levels. So while we did see higher grades in Q3, I think as we go forward, we're going to see that grade kind of come back to what you probably typically saw in the past, but still have some very healthy margins given today's metal prices and its current cost structure. So we're really happy about that. We think there's some upside in terms of life of mine economics. As we look at that, we think we can extend the life out a little bit more on those assets. We're really happy with that.

La Arena, we were through a pretty substantial stripping cycle during the first three quarters of 2019. We're moving into the ore now. We expect a pretty strong Q4. And we're looking at next year as to whether to do and how big of a layback we may do again going into next year. And actually, we've opened up some areas for some additional drilling there that may enhance that resource a little bit.

So we're pretty excited about that one as well. Overall, I got to say, it's a great story. Those assets have been performing well. They helped us step up our game at our assets at Pan American Silver. And we kind of got an internal run every quarter to quarter, really every month to month between the operations. It's kind of a race between Shahuindo, Timmins, La Colorada, even Dolores is in that race now.

And I think La Arena is coming right in there. So it's kind of fun. It's keeping us all on our toes, and we see a lot of upside across the board.

Cosmos Chiu (Executive Director and Institutional Equity Research)

For sure. And then, I guess going back to Timmins here, clearly the operational improvements were a factor in Timmins no longer being classified as available for sale. But I think, Michael, you also mentioned the other factor being market conditions. Which of the two was a bigger factor in your decision to make it no longer available for sale? And then, Michael, if you can make any kind of general market comments in terms of what is the market like right now for asset sales?

Michael Steinmann (CEO)

Sure. Sure. Look, in general, to say, we obviously are always looking at our assets. We have a big suite of assets in different places. We are always looking at the best long-term fit and best strategy and return on investment on these assets. So that does not change. We do that month by month or quarter by quarter looking at them. And I think we're very comfortable with the asset suite we are holding right now.

In general, if you look, there was very little M&A activity actually over the last few quarters. Probably a bit surprising, little actually. And I've seen the market being very cautious on M&A. And then you couple that with the strong improvements, as I said, the Timmins assets lowering cost by 20% compared to a year ago. And the entire gold asset suite from Tahoe being down 27% on the cost side.

And put on top of that, substantially higher gold price. For us, that obviously kind of tipped it over and made us think again what to do with these assets. And as you've seen there, Timmins was a major contributor to the consolidated free cash flow in Q3. So our view right now is that the performance provides a much better long-term return for our shareholders than it would be accepting an insufficient offer, kind of looking at an insufficient asset value that will come from somewhere. So that's where we stand right now. And I'm very happy with it.

Cosmos Chiu (Executive Director and Institutional Equity Research)

For sure. Maybe switching gears a little bit, talking about one of your longer-standing assets here, Dolores. I noticed that Dolores grades were higher in Q3, 51 grams per ton for silver, 0.78 grams per ton for gold. Could you remind us, is that higher grade due to any kind of, are you back doing underground mining at this point in time? If not, when is that going to come back? And from that perspective, what's the sustainability of some of these higher grades that we were able to see in Q3?

Steve Busby (COO)

Yeah, Cosmos, Steve again. The underground mining is continuing. We continue to run at about a 1,000-ton per day pace. It is generating some decent grade ores that we feed to the pulp agglomeration plant. We'll be ramping that up continuously over the next six months or so to the 1,500-ton a day design. That'll help as well. But really, the high grades that you saw during Q3 were really a function of sequencing in the open pit. And I think if you go back to the 43-101 grade distribution, you'll see as we phase through these pits, we get into that high grade a little bit more each time we get down there. So we got down there during Q3. We'll see that carry into Q4. We got a little bit of stripping to do again next year.

And then we're getting into it pretty heavily towards the end of next year and certainly into 2021. It's just the nature of the ore body and nature of the mineral distribution.

Cosmos Chiu (Executive Director and Institutional Equity Research)

For sure. And then one last question from me here, if I may. Looking at your four-year gold guidance, I think you've kind of answered this question, but you'll need a quarter-over-quarter increase in Q4 production to get to four-year guidance. Could you maybe just summarize for us in terms of what you're expecting, which asset's going to generate that quarter-over-quarter increase for you in gold going to Q4?

Steve Busby (COO)

Yeah. I mean, I'll be honest. It's a challenge. We are expecting increased production, particularly at La Arena, as I mentioned, also at Dolores with that high grade that came during Q3, and the end of Q3 is kind of our rainy period there, so we do get a little bit of inventory buildup and hopefully start to see it come out as the rains subside in November, so we are challenged, but according to our mine plan and what we see, we do expect to see those higher productions at those two facilities, particularly, to drive us back into what we have on our guidance.

Cosmos Chiu (Executive Director and Institutional Equity Research)

For sure. Thanks again, Michael and Steve and team. And congrats again on a very good financial quarter.

Steve Busby (COO)

Thanks, Cosmos. Thanks.

Operator (participant)

The next question comes from Chris Thompson with PI Financial. Please go ahead.

Chris Thompson (Head Of Research)

Hey, good morning, guys. Congratulations on a really solid quarter. A number of my questions have been answered, but I got a couple here. Just the, I guess, reversal of the status of the Timmins assets, Mike. Are you concerned this is sort of maybe a departure from a move back towards being a primary silver producer? Or just is the reality that, I guess, margin and cash flow outweighs that strategy?

Michael Steinmann (CEO)

No, I'm not concerned at all. Chris, you look at our reserve, and we update now our reserve statement mid-year, and if you look at the reserve, that obviously gives you an idea where Pan American's going at longer term. It's a solid, large, very large, strong silver producer. Right now, where we stand, of course, we're producing more gold than silver. That's just a matter of the distribution of the assets. But nevertheless, it doesn't matter what we produce. If it's some base metal, some gold or silver, we obviously always focus on optimizing our assets and return on our investment. If it's on short term now on these gold assets, then we will do it on that, and longer term, obviously, it will return to our normal silver-gold distribution. So no, I'm not concerned at all.

Chris Thompson (Head Of Research)

Yep. Okay. Good answer. Just quickly, quick question on, I guess, the skarn discovery there. You mentioned that we're anticipating a resource update estimate, rather, in, I guess, before the end of the year. Could you just sort of lay out sort of milestones moving forward from that on how this asset's going to hopefully mature to be an operation by way of economic study?

Michael Steinmann (CEO)

Sure. And quite a few answers here are very preliminary. I don't have the detailed plan yet as this is growing by the day. I'm sure many of you have seen our latest press release with some of the best intercepts we had to date. And actually, to be honest, probably some of the best drill intercepts I have seen in my career. I mentioned there too in my call, 200-300 meters wide intercept. One is nearly 400-meter high grade, base metals with some really good silver grade as well. And I would encourage everybody to have a look on our website where you see plans and sections. And there is a whole bunch of core photos as well.

And you will see that there's many pretty long intercepts as well that run as high as over 40%, let's think, combined with, in some places, very high silver grade as well. So in general, a very, very exciting discovery that unfolds here in front of our eyes. We will come out with a maiden resource before the end of the year. So there's only a few weeks left. I'm looking forward to that. We will continue to drill. I think, Chris, we are how many drills do we have going right now?

Steve Busby (COO)

We have eight drills going at the moment.

Michael Steinmann (CEO)

Okay. Eight drill rigs going just on the skarn, just on the skarn target between underground and surface drilling. That will continue for sure as it is so large. I would see at least another year, maybe two years. I didn't go through the details yet in a budget, but I could imagine that that's how it looks like. We will continue with metallurgical work next year. Maybe start later next year some early stage kind of engineering or ideas how we're going to tackle that asset. As I always pointed out here, this will not affect for a long time the La Colorada silver mine. The silver mine that we have right now with the new plant that's performing really well, producing over eight million ounces of silver on the high-grade silver vein. That will obviously continue.

This skarn is a bit deeper down and a bit offset to a large part of the silver veins, so that would obviously require a whole different set of plant and levels of extraction as it is much, much larger than the veins, so keep tuned. We will update everybody. I could see probably drill results quarterly and then the update during the conference call and in the press release, but I see that's only a year now, just about a year since we announced the discovery hole, so having drilled over 50,000 meters already by now, it's very good advances, and I'm really looking forward here to come out with the resource estimate and then advance the project for the next year.

Chris Thompson (Head Of Research)

Fantastic, Mike. Really exciting. Final quick question. This is probably one for Rob. The taxes in the Q3 here, a little bit of a jump. Any color on that?

Rob Doyle (CFO)

Good morning, Chris. Quarter by quarter, the effective tax rate is going to move around. You're right. The 43%-44% effective tax rate that we had in Q3 was elevated above what we normally see. The year-to-date is probably a more reflective number coming in around 34%. So anywhere in that sort of mid-30s%, maybe a little bit higher would be our long-term expectation. But there's just so many moving parts between the deferred tax and current tax piece that it's really hard to guide it on a three-month basis.

Chris Thompson (Head Of Research)

Okay. No worries. Okay. Thanks, guys. Congrats.

Rob Doyle (CFO)

Thank you.

Operator (participant)

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

John Tumazos (Analyst)

Thank you for taking my question. Could you give us an update on the Escobal contingent value right? Is it indefinite or when does it expire? And might you register for the security to trade? Second, could you give us a little update on Argentina? I want to know when we're all going to sing Feliz Navidad for Navidad. And third, what is a reasonable timetable for all your drilling to get done and a definitive feasibility for the La Colorada expansion? I know that the bigger it is, the longer it takes, and the better it is, the longer it takes, and it's looking bigger and better. Thank you.

Rob Doyle (CFO)

Sure. Good morning, John. Rob Doyle here. I'll take the CVR question and then hand it over to Steve on the assets and Mike. The contingent value right that we issued as part of the consideration for the Tahoe transaction is a 10-year instrument. So it was issued in February of this year. So it still has about nine and a half years until final maturity. As you know, the right to additional Pan American shares, about 15 million additional Pan American shares, would be triggered upon the first concentrate shipment from the Escobal mine. That security is not listed. It is transferable, but it is not a listed instrument. We understand that there is an OTC market that some of the banks are making, but it's not a listed instrument.

Michael Steinmann (CEO)

Okay. I'll give you an answer to Argentina. As we all know, October 27, we saw the federal election in Argentina happen. There will be a change of the president here coming. I believe it's in the first or second week of December. Actually, I think it's December 10th. We also saw elections in all the provinces that happened actually a bit earlier in the province of Chubut that happened in June. So both federally and provincially, we'll see a new administration, obviously looking forward to start working with the new administration.

Just to remind everybody that the Navidad project, in order to go ahead, requires a change of the mining law in the province of Chubut to allow open-pit mining for that exciting project. In general, quite a few changes in Argentina over the last few months. We obviously saw some currency restrictions in Argentina.

And we'll look at that. We also saw the reinstatement of the export tax earlier this year. We all know about that. That's impacting, obviously, projects. It's impacting, obviously, right now, our Manantial Espejo COSE Joaquin complex as well. But look, any decisions and investments we do in Argentina, we do our appropriate analysis and look at risk versus returns to make the best decision for our shareholders. Sorry, what was the third question?

John Tumazos (Analyst)

What might be a timetable for definitive feasibility on La Colorada expansion?

Michael Steinmann (CEO)

I kind of gave a little idea there, John, in the question before. I think at the moment, we are really focused on drilling. We haven't found an end yet to that mineralization. It's actually open on all sides so far. So it's a bit difficult to put the timing here on a definitive study as we really focus on drilling. That's a very exciting development, obviously. The bigger it gets, especially with this kind of grade, the better. I would really think it's a safe thing to say that we need at least another year of drilling like we do now. Maybe it's going pushing it for two.

But I'm sure we will do parallel to that, starting with our technical studies on the metallurgy, on the ground conditions, on the mining method, on get ideas on how big the mill should be, etc., etc.

So that will all take its time. So sorry, I don't have a timeframe yet. But stay tuned. As I said, we will keep drilling full speed during the end of the year and next year. And you could imagine that we have more technical information come mid of next year.

John Tumazos (Analyst)

So Mike, if an analyst like me put a 10,000-ton-a-day mill into our model five years from now, do you think that would be premature or full of prunes?

Michael Steinmann (CEO)

Let's see what we come out with the resource estimate. As I said, we did not define any size, neither of the resource, which will happen in a few weeks here. And we did not define any size of any installation or mill. So that will come in due time. But so far, as I said, very exciting development at La Colorada. There's obviously no way to generate more value for our shareholders than finding a large, exciting project like that in one of our assets that we own 100% of.

John Tumazos (Analyst)

Thank you very much. And thank you for not selling any assets on lousy terms. You bought very well. Thank you.

Michael Steinmann (CEO)

Thank you, John.

Operator (participant)

Once again, if you have a question, please press star, then one. The next question comes from Don DeMarco of National Bank Financial. Please go ahead.

Don DeMarco (Precious Metals Equity Research Analyst)

Oh, hi, gentlemen. Thanks for taking my call. My question is on Shahuindo. And I see that the AISC has been trending up over the past few quarters. Although I'm encouraged to hear that you're not running crushing agglomeration, that's positive. But yet, I see these costs increasing. And I also noticed that you guided toward sustaining CapEx on the order of about $45-$50 million in 2019, yet you've only spent about $16 million year to date. So maybe if you could just provide a little color on what we should expect in Q4 and going forward. In other words, are you planning to accelerate this CapEx spend, or will some of this be moved into 2020?

Steve Busby (COO)

Yeah. Very good question, Don and Steve Busby. Yeah, they're kind of interrelated. The reason you're seeing the increase in Escobal at Shahuindo is because of the capital spending, because higher sustaining capital spending through the quarters, and that's related to weather-related events. We can only do the heavy civil works for leach pads and waste dump preparations during the dry seasons. So we are just approaching the wet season coming up. So there are some heavy civil works going on right now. We are expecting a pretty heavy sustaining capital spend during Q4, which will be reflected in the Escobal as well. So that's why you're seeing those kind of when you look at the guidance, we think we'll come in on guidance. So that you can kind of figure that through.

Don DeMarco (Precious Metals Equity Research Analyst)

Oh, okay. So we should probably expect maybe higher AISC in Q4, but then just given the weather, seasonal patterns, and so on, and pace of spend, probably lower values in Q1, Q2, and then increasing again. Is that the seasonal?

Steve Busby (COO)

I'd say that's a good way to think about it. Yes.

Don DeMarco (Precious Metals Equity Research Analyst)

Okay. Thanks a lot. That's all for me.

Operator (participant)

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

Michael Steinmann (CEO)

Thank you, Operator. And thank you, everyone, for calling in today and discussing our Q3 results. And looking forward to talking to everybody again in, I think, February already will be to look at our year-end results and forecast guidance for 2020. Have a good rest of the year. Thank you, everybody.

Operator (participant)

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