Pan American Silver Corp (PAAS) 2004 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Pan American Silver Corporation second-quarter results conference call. At this time, all participants have been placed on a listen-only mode, and the floor will be open for your questions following the presentation.

It is now my pleasure to turn the floor over to our host, Mr. Geoff Burns, President and Chief Executive Officer. Sir, the floor is yours.

Thank you, operator, and good morning and good afternoon, ladies and gentlemen. Welcome to Pan American Silver's second-quarter earnings conference call. Our Chairman, Ross Beaty, is unavailable today, so I will do the honors. Joining me today are Andy Pooler, our Senior Vice President of Operations; Steve Busby, Senior Vice President of Projects; Rob Doyle, our Chief Financial Officer; and Brenda Radies, our Vice President of Corporate Relations. They are here to help answer any questions you might have at the end of my opening remarks.

As you have seen from our earnings release this morning, the second quarter was our best-ever performance on the numbers front. We were profitable. I'm going to repeat this, because for the first time in Pan American's history we have been able to say it. We were profitable. We generated excellent cash flow from our operations. We generated record silver production, with a particularly strong showing from our Peruvian mines, and we have made substantial progress on all our development projects.

Let me first make some comments with respect to our production and our financial results. Silver production was up 19 percent. Our average realized silver price was up 36 percent, and in April and May, we shipped almost all the concentrate inventory accumulated up to the end of March. Together, these factors increased our revenue by 67 percent over the same period in 2003. Our cash flow from operations increased tenfold, to 2.4 million before changes in working capital, reflecting the excellent operating performance in Peru. We also enjoyed one-time gain from the sale of a noncore property to Barrick Gold for $3.7 million. Offsetting these positive factors was a onetime debt retirement expense of 1.3 million from the conversion of our debentures, which we completed in May; 700,000 in stock compensation-based expense; and 1.1 million in increased exploration and development expenditures; and, to be frank, some disappointing results from our La Colorada mine in Mexico.

During the quarter, we repaid all of our bank debt. And, as I'm sure your recall, we converted to equity almost all of our debentures. With less than $1 million in our debentures outstanding, the Company is virtually debt-free, with $119 million in cash ready to fund our continuing growth. On that front, we expect to complete the purchase of the Morococha mine in Peru next month, and we have been and will continue to aggressively advance our development projects.

With the exception of La Colorada, it was a good-news quarter from the operations. Let's talk about Peru. At Huaron, our largest silver mine, with expected production of almost 4.5 million ounces in 2004, our operating performance improved substantially in the second quarter, as we expected. We have got the ground conditions stabilized, our equipment availability has improved as has our productivities, and we expect the mine's performance to continue on this improved level, as we have finished replacing the mining contractors with our own employees. We expect our cash cost to average under $3.50 an ounce for the rest of this year. This change in our operating strategy to our own employees from contractors is a prelude to the anticipated expansion at Huaron. Right now, we are continuing with our feasibility study, and with continued drilling to expand that project and that mine in 2005.

The drilling program which we started late last year has returned some excellent results, and we will continue to follow these results with additional drilling in the second half of this year. Our goal, to expand our mineable reserves. It's simple. We need to delineate and convert our resources to mineable reserves, which will allow us to plan our expansion and then maintain the productivity levels and production levels that we can achieve.

Quiruvilca has continued to perform exceptionally well. Cash costs for the quarter were $3.52 an ounce. We expect the changes that we have made there to continue to give us positive results for the foreseeable future. With some new veins discovered -- the Yunyan split-sewer (ph), for example -- we now have a definitive two-year mine plan, and expect the operation to continue well beyond that timeframe.

On our silver stockpiles, we continue to see excellent results. These are also improved. Our cost per ton sold declined to 42 cents per ton, net of our byproduct credits -- zinc, copper and lead -- which has increased our margins significantly. I want to remind everyone that our cost-per-ounce figures for the silver stockpiles are somewhat misleading, as the smelter charges are based on a sliding-scale royalty that increases with the price of silver. But so far, we remain well below $3, and we're hoping to produce over 1 million ounces from the silver stockpile this year at under that $3 figure.

Also improved is the Morococha mine, which we are finally in the finishing process of making the acquisition. As often happens with deals that require various levels of approvals, this process has not gone as quickly as we would like. But just last week, we launched a public offer for the shares of Argentum. Argentum is the company that holds the Morococha assets. The offer is open for 20 business days, and we have a lock-up on 92 percent of the common shares. So now we are expecting to close this transaction on August 23.

It is very pleasing to report that Morococha also has been performing very well this year, and that the financial benefit from this performance will pass to us on completion of the acquisition. We expect to see 1.5 million ounces of silver production to our account this year from Morococha, and on an annualized basis, we expect to see about 3.5 million ounces of silver, at a cash cost of about $3 an ounce. So far this year, through the end of June, Morococha has produced almost 1.7 million ounces of silver, at a cost of under $3 an ounce, and that performance is expected to continue.

After the acquisition of Morococha, our total silver production from Peru alone will rise to almost 10 million ounces annually. Morococha is a great asset. The exploration potential and the land package is excellent. It's going to be low cash cost, and it provides significant synergies with our other operations in Peru, Huaron and Quiruvilca.

Turning now to Mexico, La Colorada has clearly posed our most significant challenge in the quarter. A number of different circumstances has kept La Colorada from performing to its potential, and we have been working very, very hard to overcome these difficulties. The bottom line -- we will not reach our anticipated production this year. Our expectation is to produce approximately 1.8 million ounces of silver at La Colorada, at a cash cost of about $5.50.

There is good news. The good news is that we have a plan in place to bring up production and lower the unit costs, and we are now starting to see the operational improvements that we have been planning for. We have seen a dramatic improvement in safety at the mine. So far this quarter, we have had no incidents, and that has been translating into improved morale, better productivity and better production results overall.

We have completed a new, long-range mine plan, and we expect that a change in our mining methods to a more selective, narrow-vein mining method is going to increase our grade and improve the profitability at La Colorada. We won't see it this year, but our expectation is in January of 2005 to start to see the feasibility results that we have been anticipating.

Dewatering will be a crucial issue for La Colorada, and we've brought in expertise and have a plan in place to bring water levels down to allow the sulfide production to continue. Probably most importantly, we have a new mine management team in place at the mine, and they have to be congratulated on the way they have been able to come to grips with the issues and the challenges, and are starting to put the mine back on a solid footing.

In addition to our operations, we have also made excellent progress on our development projects -- the Huaron expansion, as I mentioned earlier; Manantial Espejo, our joint venture with Silver Standard in Argentina; Alamo Dorado, our development project also in Mexico; and San Vicente in Bolivia.

We are very excited about the results from this year's drill program at Manantial Espejo. As we said in our last conference call, we have encountered some spectacular holes, such as 50 meters grading almost 800 grams per ton silver and seven grams per ton gold. This is equal to 165 feet of 24 ounces per ton of silver and 0.21 ounces per ton of gold. The resource base continues to grow, and with completion of the resource estimate, we are now moving straight into an operating and capital cost study. We expect the first study to be completed at the end of August, which will give us the fundamental economics to move directly and completely into full feasibility studies. We still expect the feasibility to be completed in early 2005.

At Alamo Dorado, we have also continued to advance that project. We have completed our capacity optimization study, which looks at us building a 3,000 ton per day milling operation. Permitting is well under way, cyanide recovery options are being tested, and the processing flowsheet alternatives are also being optimized. A production decision on Alamo Dorado is still anticipated at the end of December of this year.

At San Vicente, the project is undergoing small-scale mining as we speak. We will expect almost 500,000 ounces of silver to come to our account from San Vicente this year, as we continue with the feasibility study. Right now, we are preparing an economic evaluation, and we are evaluating several different alternative development strategies, which would actually minimize our capital invested in Bolivia and see mining activity there much faster.

That comes to the conclusion of my remarks on our operations and our development projects, and I would like to spend a couple of minutes just to talk about the silver market. Very recently we have seen a lot of volatility in the silver price. We have seen some significant gyrations in price, sometimes as much as 30 cents in a single day. Right now, we're seeing both gold and silver respond to the US dollar. Both the movement in the dollar and the sentiment about future movement in the dollar are being reflected in both the gold and silver price. Hedge funds, again, are significant players in the metal markets, and they are contributing to this volatility.

The fundamentals for silver remain strong. Overall, demand was up 1.6 percent in 2003, according to Goldfields Mineral Services, who conducts their annual survey. They expect this trend to continue in 2004 and beyond. We believe the silver supply deficit, which was some 92 million ounces last year, was again filled up with government sales, primarily. We also believe that the stockpile supplies are nearing depletion, making a continued bullish case for silver, based on the basic supply and demand fundamentals.

So, to sum up, we had an excellent quarter. We are in the strongest financial position we have ever been in, and the market fundamentals for silver continue to be strong. We are profitable, debt-free, fully funded for our primary growth projects, and are performing at peak efficiency. With a continuing focus on improvements at La Colorada, we believe we can build on this quarter's achievements and continue to be profitable into the future. Our leverage to silver prices is profound, and will increase even more with the closure of the Morococha asset, and as we continue to deliver on our growth projects.

Thank you, and now I would like to take some time to answer any questions you might have. Operator?

(OPERATOR INSTRUCTIONS). Haytham Hodaly, Salman Partners.

Just a question. You indicated that this was your first profitable quarter. But looking excluding unusual items and including the loss associated with the debenture conversion, we actually look and estimate a net loss of about 1.1 million or a loss of 2 cents per share. Now, isn't that probably more accurate?

A couple of comments there. I think there's a couple of other things to take into account as we move forward. The first one is at Manantial Espejo, we have been expensing all our preproduction development costs at this point in time. Our expectation is with the completion -- and that's almost $700,000 during the quarter for that. Our expectation is that this quarter, with a positive result on our scoping study, that we will look very hard at that policy and probably will start capitalizing that going forward. And those expenditures will continue to increase during the balance of the year, so that's about 700,000 there.

The second thing is, within our exploration and development expenditures, we also had a very hard look at a property, and we spent almost $500,000. That was not a successful business development opportunity, but that's not likely a repeatable event. So you put those two together, that's almost 1.1 million, 1.2 million during the quarter.

I think the very last thing is, during the quarter -- and it's buried in revenue -- we had a hedging loss on our base metal production -- not on silver, we don't hedge our silver, but on our based metal production -- of over $1 million. And those were related to contracts that we placed primarily for zinc, to a lesser extent lead, in 2003 that matured in 2004. A lot of those contracts (technical difficulty) 37.5 cents zinc. So you take out those factors, which are not readily apparent to you -- I appreciate that -- when you look at our financials, and even taking out the exceptional items, we would have been profitable this quarter. So our expectation is, excluding exceptional items or extraordinary items -- they are not really extraordinary, but exceptional -- we think we're going to be profitable in the third and fourth quarter, given these metal prices and our production profile.

Now, you mentioned the base metal hedging. Is there anything that's going to show up in the third and fourth quarters?

Our hedging levels now are much closer to what the current market is. We are a little negative on the lead, because lead is, as you are probably very aware, the last time -- I didn't look today, but we traded almost $1,000 a ton for lead, which are I-don't-know-how-many-year highs. But our program is probably around 825, 800 on the lead side. On the zinc, we are around $900 per ton on the zinc side. So we're not expecting that same level. Most of those contracts that are entered in 2003 are finished, and we are now seeing much more market-close prices on our program going forward. So we're not expecting that sort of loss.

And just at Quiruvilca, there there has been discussions in the past about looking at finally shutting down Quiruvilca. Obviously, with silver prices over $6, it doesn't justify it at this point. But what are you using, looking at your long-term -- sorry, I guess, what is your long-term silver price, and what do you use in assessing whether Quiruvilca should keep going or not?

Well, Haytham, I think the biggest thing right now is we have come into a couple of new veins -- the Yunyan split-sewer, Yunyan sewer, which we had not known before, and are within the framework of our current infrastructure/development. Right now we (technical difficulty) mine plan just on those veins, and our expectation is that we will see continued production there, at least for another three years and hopefully beyond. I think we're now going back in doing some additional drilling to see if we can expand the reserve there. Haytham, we're still looking at a long-term silver price, when we're looking at our operations of $5, and that's the basis for our continuing to mine or not mine.

And one final question, Geoff. With regards to La Colorada, you've given as an idea of what 2004 forecast cash costs will be like. Can you give us an idea of 2005, just so we can assess whether these problems will flow into 2005 or not?

Yes. We're looking -- Haytham, that's easy. We're looking in excess of 3 million ounces. The number that's in my mind is about 3.2 million ounces of production in 2005, and we're looking at cash costs of $3.50 an ounce.

Adrian Day, Global Strategic Management.

I had three quick questions, if I may. First of all, is there any -- shall I just ask them all in one go? First of all, is there any development on Dukat at all, or any expectations? The second thing is, on the silver market you talked about government supplies. Are we talking about China there? And if not, can you talk about China for a second? And then, thirdly, are you seeing any new acquisition opportunities, or do you see them as really dried up?

Thanks, Adrian, I'll -- I think I scribbled down those questions in order. Dukat -- we know that Dukat is in production; last year, it produced about 9 million ounces. From the information that was provided to us, this year I think it's scheduled to produce somewhere around 12 to 13 million ounces. We're not seeing the profitability that we would have liked to see out of Dukat, had we been the operators there. And I think I wouldn't be surprised to see if there is some strategy that would allow us to either exit Dukat or totally, conversely, take a higher degree of control. Right now, we maintain it at zero value. As you are aware, we are not showing it in our production. It is a gem of a silver asset. It is in production. I think we have one of two options there. As I said, one is to find a way to exit with some value or take a higher interest, and I'm going to leave my comments at that.

In terms of the silver market, we are certainly seeing continued sales from government sectors to offset the deficit. At this stage, we are not sure -- at least, the information that we're seeing -- whether that's China or whether that's coming from other sources, potentially even India. Our expectation is that China, over the last four years, has been liquidating somewhere between 60 to 80 million ounces of silver per year, and we don't see that as sustainable.

Now, there's not a lot of transparency in China; there's not a lot of transparency with respect to their holdings. But we just don't believe that we're going to see the same levels of government liquidation as we have seen in the past. There is going to be a point -- it's kind of the story of -- and I know anyone who has followed the silver market has watched us for quite some years -- is the above-ground stockpiles are kind of like the water in a barrel. We know it's coming down. We don't exactly know how much is left in that barrel, but we know at some point it is going to run out. Whether it runs out in China, whether it runs out in some other above-ground stockpiles, whether it runs out of India, none of us can be sure. What we can be sure of is the fundamentals continue to be strong.

In terms of acquisitions, certainly Morococha has come on board this year; we're just finishing that up. As I mentioned to Haytham in response to one of his questions, we did look very hard at another silver acquisition earlier this year, and spend a considerable amount of money on it. Unfortunately, pricing on that particular asset was beyond what we thought was fair value, so we bowed out of that process. There are still acquisitions out there. We are still very aggressive, in terms of looking at that. It is our fundamental goal, above and beyond our internally-generated growth, to look at providing additional silver opportunities for our shareholders. They are out there, and we are going to be on top of them. I can assure everyone listening of that fact.

Ronald Silberg (ph), Viking Asset Management.

My question is, when your company gets to the point in the future where you're going to have more free cash flow, is it likely that you would use it at that point for further acquisitions, for share buybacks, or would you start a dividend? And if you did begin to pay a dividend, is it possible that you would consider paying it out in physical silver?

Thanks, Ron. That's a good question. At this point in time, I think you characterized us right on. We have a number of growth projects in front of us. We are going to use the funds that we have accumulated, as well as continuing cash flow, to make sure we can deliver on those growth projects and provide the production profile. When we get to a point where we have excess free cash flow above and beyond the growth projects we have in front of us, I think we will make a decision on, A, as you point out, dividends and dividending backout value to the our shareholders or, B -- and we have heard this a number of different times -- on holding onto physical silver. I think those are both genuine opportunities and genuine things we will consider for the shareholders, and I wouldn't rule either one of them out, in terms of holding onto physical silver and not selling and/or returning cash to our shareholders to let them decide where they would like to invest that cash. In reality, we are probably 18 months to 24 months away from having to make that decision. And rest assured, we will inform you of what our thoughts are when we get to that point in time.

I've got one last question, if I may. You said you are still in fairly aggressive acquisition mode. At the same point, you have just recently paid down all your debt on the balance sheet. Is it possible that you'd consider leveraging the balance sheet again in the context of a bigger acquisition?

Ron, I think the answer is, absolutely. Under the right circumstances, I think some leverage on our balance sheet is fine. I think it provides additional leverage to shareholders, and I think on a project basis, if it's the right acquisition, some leverage is a good thing, and I would not at all -- and Pan-American would not at all -- be opposed to putting a project financing in place. Again, given that the terms are fair and reasonable for the project.

Terence Ortslan, TSO & Associates.

Actually, just following up the previous question here, how much capacity do you think you have on the balance sheet, the cash and the debt, excluding any new issues or issuing the paper (ph) you can do major acquisition figure (ph)? I don't know what your credit lines are like.

That's an interesting question. I don't think we've really tested that capacity. Certainly, debt-free with our market cap, one would assume that under the right circumstances, something in the neighborhood of $100 to $150 million of leverage was probably a very doable scenario, and given the right project and the right mix. To be frank, we haven't actually gone out and tested that market to see what that capacity is.

I don't have anything in mind (ph) for you; don't worry about it. Just for the second half, could we just go over the budget and say what's your expected cash cost going to me, second half? Sorry, I came a bit late. Maybe you discussed that. And also, your total costs and also your ounces for second half?

Yes, second half I think we're going to see our cash costs come much lower, down to -- on a consolidated basis -- around $3.50 per ounce. And in terms of production, assuming we get Morococha closed as we are anticipating, we are probably looking at about 6.5 million ounces of silver in the second half of the year.

And your total costs should be approximately what, 4.40 or so for the year?

Yes. Total (multiple speakers). Rob, could you maybe help me out with what you think the total costs are going to be, including our depreciation charges?

Sure, Geoff. Roughly, on a consolidated basis, I think you've got to add about $1 back to (ph) the cash cost. If we can't get our cash cost for the remainder of the year down to under about 3.50, if you add $1, that would be (indiscernible).

(inaudible). That's good. You're looking for 4.50 (ph)? That's good, for the second half.

Yes.

(multiple speakers). That would be for the second six months, Terry.

(OPERATOR INSTRUCTIONS). Haytham Hodaly.

Geoff, a couple of quick questions -- actually, a question and a comment. Morococha -- you indicated closing August 23rd, I think you said; is that correct?

That's correct, Haytham.

And how will you account for it, in terms of would you account roughly for like a half-year? Previously, you've been talking that it would be retroactive to a certain point in time.

In terms of production, Haytham, because we've launched the offer for -- a public offer in essentially early/mid-July, we are probably going to look at accounting production from July 1 forward. So it will make a nice, clean cut-off. So six months on the production side. On the profit side, we're expecting Argentum, when we pick it up, to have a significant cash balance, reflective of the earnings that it's made, certainly, for the first six months of this year. And the likely impact of that, on an accounting basis, will be just a reduction in the purchase price. So our effective purchase price for the 92 percent is going to be about $35 million. Net net, when we are all done, we expect that number to decrease significantly, so we'll have a much lower carrying, and then consolidated results July 1 forward.

And one last question or a comment. You talked a little bit earlier about potentially capitalizing versus expensing it. I think one was Manantial Espejo, and maybe other projects. Just to give my two cents, I think more companies should be going towards expensing everything like that at this point, just so it really, truly shows the profitability of the Company. And I would probably say I wouldn't capitalize anything you don't have to capitalize, at this point.

Haytham, your comment is duly noted. Let me just give you a bit of -- to make you feel comfortable. Right now, we are carrying a Manantial at about 2.5 million, which has strictly been our property acquisition costs. And we have expensed everything since basically early 2003, when we got involved at Manantial, and that includes all the drilling and all the prefeasibility work we have done so far.

Where we are going to get at the end of August is, with our scoping study we are going to have in our hands what is very clearly a highly economic project, at which point I think it's prudent and correct to start to capitalize, or we're going to defer that decision until we have a final, completed feasibility in our hands. And your comment is very, very much in tune with our thinking. We're going to err on the conservative side here; we don't want to end up with a large carrying value, which really doesn't reflect what the potential of the property is. But at the moment in time where we do know we have an economics, viable project in our hands, I think accounting actually dictates that you start to capitalize.

(OPERATOR INSTRUCTIONS). Peter Strubby (ph), Strubby Associates (ph).

Good work. You guys are doing a good job these days, Geoff. I'm particularly interested, having spent a lot of time in Peru, on what you see as the future for different forms of increased taxation in Peru. There's been an awful lot of talk about it in both Chile and Peru, and in Chile, some things have been done and there have been, I think, a couple of bills introduced into the Peruvian Congress relating to this. And I never know what the latest is on their treatment, but it could have a serious effect, I would think, on the profitability, whatever form the taxation might take on Peruvian operations for miners, which, obviously, are very important to you. And so I was wondering, as the first question, what the latest was on that, and how the recent developments have, in your view, affected the outlook down there.

The second question relates to the base metals production by Pan American, whether -- my recollection is, certainly back in the old days, Morococha used to produce a lot of base metals and a certain amount of copper. I think that was taken off with -- some of that was taken off, at least, with separation of Toromocho. But base metals still must represent a fairly important factor in your overall production and your overall byproduct cost and credits. So I just wondered if you could touch on that a little bit.

Absolutely. Let's go to your first question on Peru. I think it's been a fairly well-publicized development in Peru that they have been looking at a net smelter royalty similar to what has also been very recently introduced in Chile. I can't say that we are very excited about that development, but the reality is that in Peru, mining is just about 50 to 60 percent of the gross national product -- very, very important to the national economy. And in any economic situation like you find in Peru, where they are struggling to raise revenues for their social requirements, you're going to face issues of taxation or increased taxation. And occasionally, kind of out of left field, you'll see these royalty introductions. With the royalty program that's in place, which has now been made law in Peru, we are looking in our particular circumstance at a royalty that will probably be roughly 1 percent of our net smelter returns. And that is subject to some tweaking which is going to go on within the actual development of the rules (ph). In our estimate right now, it's about a $700,000 a year cost to us. We are not happy about it. We understand it. We think that, in the long term, that we're going to see some continuing pressure on properties, particularly mining properties in Peru, to provide additional revenues for the government.

Our strategy going forward is to look very strongly at entering into tax stability agreements, similar agreements that Barrick, Barricks of the world, Antevina (ph), which is one of the larger properties Newmont has at Yanacocha, and at least have some certainty in where we're going on a future basis. And I think we're very comparable with the political environment there. What we need to do is just defend ourselves on the increasing tax environment. I don't think that's going to change any more than it changes, unfortunately, in North America in our own personal taxes. There seems to be a preponderance to try and grab a few more dollars from all of us. But I think our process there is to continue to monitor it very closely. We're very active in the Chamber of Mines down there, which monitors these things very closely, very proactive, and put ourselves in a position where we will not potentially face, in the future, some of these tax increases. We're working very hard on that front right now.

Base metal production (ph), yes, very important to us. Morococha is a base metal producer of zinc, lead and copper, all three. The primary base metal byproduct is zinc. Approximately 50 percent and plus of the revenue coming from Morococha is silver. It's a higher-grade silver deposit, actually, then Huaron, so it's more dependent on the silver price. So, yes, it is still very important to us, the base metal prices, and as we indicated before, we do have a base metal price protection program in place. We're trying to take advantage right now of some of the very lead prices, in particular, and zinc prices we're seeing over the next 18 to 24 months, to ensure that we get very good revenues from that part of the production.

Morococha is going to continue to produce almost 40 to 50 percent of its revenues from those three products; that's the future of that mine. It's polymetallic, high-grade silver, but it has a significant base metal component, and we're going to continue to monitor those prices and protect ourselves on that price side.

Thanks very much, Geoff -- good answers.

At this time, there appear to be no further questions.

Operator, thank you very much. I'd just like to take one moment to thank everyone for listening to our second-quarter conference call. I'm going to say this one more time -- this is the first quarter in the Company's history that we have been profitable, excluding those extraordinary items. Haytham, if you're still on the phone, we expect this profitability to continue into the third quarter and into the fourth quarter, if we can continue to see the prices at the levels they are right now. I look forward to talking to you again sometime in late October or early November, when you see our next quarter results come out. Good day.

Thank you and thank you, callers. This does conclude today's conference. You may disconnect your lines at this time, and have a wonderful day.