Earnings Call Transcript - CMCL Q2 2020

Operator, Operator

Hello, and welcome to Caledonia Mining's results for the quarter that ended on June 30, 2020. My name is Julie, and I will be your coordinator for today's event. I will now hand you over to your host, Chief Executive Steve Curtis, to start today's conference. Thank you.

Steve Curtis, CEO

Thank you very much, and welcome, everybody, who has joined this call. And it is our second quarter as our hosts mentioned, second quarter 2020 results. And we're very happy to release these and have an opportunity to discuss this with you. The presentation is on our website. So if you haven't had a chance to look at it, please go to that if you'd like to follow. And I'm joined on the call today by Mark Learmonth, who is our Chief Financial Officer; Dana Roets, Chief Operations Officer; and Maurice Mason, who is in charge of Business Development and Investor Relations. So I'd like to just proceed immediately and just draw your attention to the disclaimer, as usual, and take that as read and understood. The prime and probably prominent thing that's on everybody's mind is COVID. And if you have read the results this morning, you will notice that the production for the quarter was very good. And it really does demonstrate and illustrate that the mine has managed the COVID pandemic exceptionally well, and it really has had very little to no effect on our operations. I'm very pleased to say that we are free of any COVID infections at this point in time. And we continue to practice the best standards of protection and isolation and distancing that needs to be done. So yes, COVID has had very little effect on our operation. Mark will discuss costs a little bit later, and he will tell you that we have spent some money on COVID, but that's a positive, not a negative. So really, with no further review, what I'd like to do is ask Dana to take us into some of the aspects of operations, and let's take it on a couple of slides in the presentation. So let me hand over to Dana. Dana, are you there? Dana?

Dana Roets, COO

Sorry, I'm back, I was on mute. Review of Operations, Slide 7. We started the year very well in quarter 1. And end of quarter 1 going into quarter 2, we had the lockdown with the coronavirus. We're very lucky that we weren't severely affected by the coronavirus. And after a slow start during lockdown, we picked up, and we ended the quarter strong. The grade was slightly down, below target. But we saw a 6% increase quarter-on-quarter comparable with last year. And in half-year, we're actually up 12% if you compare 2019 to 2020. So overall, the outlook that we started putting in last year, the second half of 2019 continued into 2020 and the team is focused, and we saw that in the production. Production is still expected to increase to 80,000 ounces from 2022 onwards. And the tonnes milled also improved on quarter 2 due to, as I said, the Nyanzvi initiatives. What we also have done, we install the oxygen plant, and we saw great improvements as far as the recovery is concerned. We're closing now to 94%. Last year, we're hovering just above 93%. If we go to Slide 8 then, COVID-19. Back to you, Steve.

Steve Curtis, CEO

Thank you, Dana. So as you can see, as Dana has told us, operations are going well. We are sticking to the basics and the operation is moving towards being able to finish the Central Shaft with the equipping that's taking place during this year. There has been some interruption in terms of getting some highly qualified and specialist contractors up to the mine, but that's part of travel restrictions and that hopefully will be short-lived and then the program will go back to normal. The program is continuing all of this time and has continued the whole way through the lockdown. And we look forward to the finalization of the equipping of the Central Shaft. I've got nothing more to say on COVID. It is spoken about quite extensively on Page 8. So I think let's get into the guts of the conversation, and that's about the financials. And I'll hand over to Mark to do that.

Mark Learmonth, CFO

Thanks, Steve. Okay. Turning to Page 10. What you see here is just a little sort of summary information on the results. So gold production for the quarter was 13,500, up 6% better than the comparable quarter in quarter 2. The number that really sticks out here, the on-mine cost per ounce, which increased from $534 an ounce in quarter 2 of 2019 to $811 in quarter 2 of 2020. I want to come back and talk about that in quite some detail because the last thing I wanted people to leave the discussion thinking that costs are under control. But the headline is that the second quarter of 2019, that $534 was artificially known as various factors, and the quarter gets finished with artificially high for various factors. But I'll explain that in more detail and that really plays into the all of the pending costs per ounce. Average gold price, as you know, the gold price is high. So we benefited by that dollar amount in terms of realized gold price. Gross profit, that's a good number. That’s gone up from $7 million to $9 million. That really does reflect the strong performance of the business. Net profit attributable to shareholders, $23 million in quarter 2 of 2019 and $5 million this quarter ending, don’t forget. Please don’t forget that $23.3 million in the second quarter 2019 increased about $20 million of unrealized foreign exchange gain due to the rapid devaluation of the Zimbabwe dollar last year. So really, if you're looking at profitability, the meaningful number is the adjusted earnings per share, which increased from about $0.24, up to $0.36, so approximately 50% increase there. And that really does reflect the underlying performance of the business. The adjusted earnings per share, excluding some business relating to foreign exchange gains that excludes any profit realized on the disposable asset in South Africa and exclude deferred tax. So we strip out all the numbers and that, frankly, is the underlying performance of the business. And if you don't like accounting, if you go look at cash, maybe a realistic approach, net cash increased from $7.8 million at the end of the second quarter of 2019 to $11.6 million at the end of June this year. And that excludes another $1 million or so, the gold ETF, which we're holding in South Africa on a short-term basis to protect cash in South Africa against further devaluation of the South African rand. So actually, $11.6 million in sort of real terms is actually over $12.5 million. Looking at Page 11. We'll discuss revenue shortly. The royalties remain at 5%. I will address production costs in detail shortly. Production costs increased from 7.5 million to 11.4 million. Gross profit rose from 7 million to 9.2 million. Other income saw a significant increase this quarter, reflecting the Export Credit Incentive scheme initiated towards the end of the first quarter of 2020 and active for most of the second quarter. It was discontinued in May. We received a 25% increase, a 25% premium on the gold delivered to the government, mandated by the Zimbabwean authorities, paid in local currency. While it doesn't hold much value for us, we weren't particularly pleased with it nor upset by its removal, as we view it as a distorting factor in our dealings with Zimbabwe. We can delve into that further later, if there's interest. Other expenses totaled 1.3 million this quarter, primarily consisting of 1 million dedicated to COVID-19 initiatives outside the immediate mine area. Mining production costs included about 0.5 million in COVID-related expenses on the mine, along with another 1 million donated to the local community, and we also allocated about 200,000 for preliminary evaluations on the solar project. Admin expenses have decreased slightly due to reduced travel. The foreign exchange impact is just $1.4 million. The asset base in Zimbabwe has depreciated, resulting in less write-down as the local currency falls, which contributes to this reduction. The cash settled share-based payment is $700,000, reflecting the increased value of the long-term incentive plan linked to a higher share price. Operating profit for the quarter is just under $10 million, compared to $27 million in the previous comparable quarter. It's important to note that the previous $27 million included a $21 million gain from foreign exchange. Regarding taxes, the charge for the quarter was $3.5 million from an accounting profit before tax of nearly $10 million, leading to an effective tax rate of around 35%. Most of this tax is from Zimbabwe, where the income tax rate is approximately 25.75%. However, while our business in Zimbabwe operates using the U.S. dollar for accounting, tax calculations must be based on Zimbabwe dollar accounts, which means that losses and foreign exchange gains in U.S. dollars are viewed differently in Zimbabwe dollars. This led to getting a tax credit in the second quarter of 2019 due to significant unrealized foreign exchange movements, which is not a sustainable situation. So, the tax charge of $3.5 million for this quarter mainly consists of normal income tax in Zimbabwe, plus additional taxes for money transfers and a small income tax in South Africa related to procurement. Therefore, while the overall tax rate may appear high, it’s largely due to structural factors. That summarizes the profit and loss accounts. All you see on Page 12 is some background information that helps us understand how the revenue increased and what factors contributed to this growth, primarily driven by the gold price, and to a lesser extent, by the increase in tonnes milled as production grew. I’ll provide more context regarding the underlying factors behind the positive news on revenue. Page 13 details production costs, which is important because this highlights why the on-mine costs per ounce rose from $534 to $811. To break down production costs, wages and salaries increased from 2.9 million to about 4.9 million, reflecting a rise in headcount and hours worked. Additionally, around $300,000 was incurred due to changes in our working practices during the lockdown period to ensure social distancing in mine operations. This resulted in a reduction in the workforce present on-site, as we committed to paying all workers regardless of attendance. However, those who chose to work pointed out that it was unfair to receive the same pay as those who did not, which led us to offer a premium rate to employees who worked during the lockdown, adding approximately $300,000 to costs for the quarter. Consumable materials increased from 2.6 million to 3.7 million. This rise was primarily due to higher costs associated with maintaining our fleet of underground trackless equipment used in the decline. We acquired second-hand refurbished equipment, which incurs substantial maintenance costs. To tackle this challenge, we have engaged a contractor based in Johannesburg who will eventually come to the mine to help enhance equipment maintenance and lower costs. However, due to the current COVID-19 situation, they are unable to travel to the site, and employees also cannot get to the mine. While we had a plan to manage these rising costs, we cannot implement it at this moment. A significant factor driving up costs is electricity, which increased from less than $0.5 million in the second quarter of 2019 to just over $2 million this quarter. This increase is primarily because the $447,000 electricity costs in 2019 were paid in Zimbabwe dollars. As the value of the Zimbabwe dollar fell, the effective electricity unit cost dropped from $0.128 per kilowatt-hour to less than $0.02 per kilowatt-hour, a change reflected in the second quarter. This situation was not sustainable, and although it initially provided a profit boost, it has now stabilized to a little over $2 million, which includes around $300,000 from genset usage. This explains the main reason for the increase in on-mine costs. To understand why on-mine costs per ounce rose from $534 to $811, there are really four components involved. The artificially low electricity costs in the second quarter of 2019 accounted for about $150 per ounce. The increased use of gensets in the second quarter of 2020 added roughly $22 per ounce. Additionally, the higher maintenance costs on trackless equipment contributed around $64 per ounce, and COVID-19 related expenses, including consumables and labor, added about $38 per ounce. Altogether, these factors brought the cost from $534 to just over $800 per ounce, explaining the increase. However, we have these costs under control and they remain well within our guidance range for the year. Moving on to cash flow, I want to highlight five points. First, we need to account for significant unrealized foreign exchange gains of $22 million. Secondly, our cash flow from operating activities shows strength; in the second quarter of 2019, it was just over $2 million, while this recently concluded quarter saw nearly $4 million. For the half year, we've generated $14 million in cash, indicating that our business continues to perform well in terms of cash generation. You can see that the capital expenditure is still quite high, around $4 million or $3 million per quarter. In the second quarter of 2020, our capital expenditures were negatively impacted by the coronavirus, which limited our ability to procure and do as much as we hoped. We anticipate that will catch up towards the end of the year. However, starting in early 2021, we expect working capital expenditures to decline. The $1 million spent on the gold ETF is not really an investment but more like reallocating funds. I would say that increases the cash from $11.6 million to just over $12.5 million. Recently, dividends paid have also increased from $882,000 to just over $1 million, reflecting two dividend increases this year, one in January and the other on July 31. Additionally, the number of shares issued has increased as well, with about 700,000 new shares issued in January to Fremiro and the remaining 15% to Blanket mine. Page 15 just trying to show the main components of our quarterly cash flow, the cash from operations, and then how that might be affected by working capital and the cash from investing activities. Nothing really of note on the balance sheet. The balance sheet continues to grow as we invest in the project. And also the current assets typically tend to improve as we build up inventories to be defensive in the case of several interruptions to our supply chain. And also, we're finding increasingly even to make prepayments in Zimbabwe because there's no availability of supplier credit. So really, that's all I have on the finance. If anyone has any specific questions, we can come back to that in the Q&A session. Steve, I hand back to you.

Steve Curtis, CEO

Thank you, Mark. Thank you very much. And as we said right upfront, a great set of results. We're operating in a good sector. We've got a good gold price. And the message coming out is that the mine is still operating at a level that will generate sufficient cash flow to enable us to complete the Central Shaft project, which is what we've been doing for the last five years. So that message, I hope, is clear to everybody. Mark has spoken about dividends, but let me just elaborate a little bit on the solar project. We have got final Board approval to embark on the construction of a solar project that will give us the ability to provide the baseload during daylight hours to Blanket. And this is a strategic decision to protect Blanket from erratic and substandard quality power. We do get the majority of our power from the Zimbabwe grid. But as we have known in the past, the grid is old, and it has some problems. And the whole southern African region is short of power. South Africa is short in its own right, and Zimbabwe does purchase power from South Africa. So although COVID has depressed economic activities in the whole region, we know that will reverse and the demand for power will become higher and higher. Therefore, our decision to embark on a solar project. We'll start off with an initial 12 megawatts. And as I said, that will give us the baseload for the whole operation. Ultimately, we could add to that, but that will mean establishing other arrangements to sell excess power into the national grid, and we'll get there if that's appropriate. We're not going batteries for the nighttime and just from a cost perspective, so effectively, we will continue to run on a blend of grid power, diesel generator power where needed and the solar power. And the solar power would provide about 27% of our daily requirements. So that is exciting. We hope that so by this time next year that far will be up and operational. We have cleared ground. But again, the COVID travel restrictions will prevent the appropriate contractors from being able to get on site. But again, we're looking towards that as a temporary sort of blockage in the process. The next part of the discussion is really just the outlook and for people who are familiar with us know that we are in the shorter term embarking on increasing production from our current levels of 55,000, 56,000 ounces, up to 80,000 ounces, as Dana said, from 2022 onwards. And that comes from our ability to access deeper levels that the Central Shaft allows us to get to. So Dana and his mining teams are building the new mine underneath the existing mine and the Central Shaft with a much-increased capacity will enable us to extract higher tonnages and from multiple levels. So that is very exciting. We have got reserves and resources down there, and we will continue to do deep-level exploration as we get deeper. Because of the nature of the ore bodies, you have to be deeper in the mine to be able to do successful and full exploration. So yes, our objective is to get up to the 80,000 ounces. And we’ve indicated before, and we continue to look actively in the Zimbabwe arena for new opportunities into which we can deploy some of the cash that Blanket is going to generate. We are looking for brownfield operations, where we can do some exploration or we are looking for something that has already got a defined resource, and we believe that we can turn it to accounts with the expertise that we have in the country. This is a process that takes some time, and we've been at it for a long time. So we’ve covered an enormous amount of ground, but we are hoping that we will be able to announce something in the not-too-distant future. COVID is causing a bit of indigestion there as well. The shaft we've spoken about, and there's a slide on those in the deck. And that's really just for information purposes. But just to reiterate before I close, I'm on Slide 23. And really, the magic of this whole program is that when Blanket ramps up its production to 80,000 ounces, the cash generation and the free cash flow are going to be significant. The CapEx will decline. And you can pick the gold price, and we're anticipating that Blanket will be able to produce more in sustaining costs somewhere between $700 and $800 an ounce. And you can see at 80,000 ounces that does deliver a fair amount of free cash flow, which Blanket will dividend out to shareholders and us being the major shareholder, Caledonia will be a beneficiary of that. And we can decide on where to invest that for the best from a shareholder perspective. So I think that covers everything that we really wanted to talk about. And I think what we should do is now open up the floor to questions, and we invite people to keep please pose their questions to us and the team.

Operator, Operator

The first question is coming from the line of Nir Venda Halom, who is a private investor.

Unknown Shareholder, Shareholder

As a long-time shareholder, I am very pleased with how you performed under challenging conditions. Thank you to the whole team. I have four questions, if that's okay. The first one is for Mark. You mentioned that about $300,000 was spent this quarter on genset power, which is an increase of 2% based on my calculations. Do you expect that to rise? What is your outlook on that going forward, considering it will eventually decrease with the implementation of solar power? That's my first question.

Mark Learmonth, CFO

Okay. I'll answer this one and then you can handle the other three questions. We can't predict how much we'll use the gensets, as we need to respond to the situation as it develops. One of the main reasons we started this project wasn't just for the economic return, but to safeguard against a complete grid failure that could force us to rely on gensets constantly. Theoretically, we could operate the gensets all the time, but sourcing that much diesel quickly would be logistically challenging. Therefore, we can't estimate our diesel usage. The solar project we are implementing is expected to supply about 27% of Blanket’s daily electricity needs on a typical 24-hour basis, with the remainder coming from grid power and gensets, depending on grid availability. I'm afraid I can't provide a more detailed answer than that.

Unknown Shareholder, Shareholder

Okay. No, that's fine. I mean in terms of, I guess, the CapEx, what percentage of the CapEx roughly is in development, in a ramping-down, declining? And do you have a ballpark figure for cost per meter of development, final development?

Mark Learmonth, CFO

Probably, Dana is best placed to answer that. Dana, if you could?

Dana Roets, COO

Our capital and development are very robust. For development, which is approximately $600 per meter, trading development is close to $1,000. Our decline developments, which utilize trackless equipment, are around $1,500 per meter. We anticipate completing roughly 400 meters of development each month. This equates to about five pillars and approximately 5,000 tonnes, which translates to around 5 million in development. Looking ahead, this does not represent the entirety of our capital.

Unknown Shareholder, Shareholder

Okay. That's really helpful. This leads into my next question. My understanding from the 43-101 and historical production is that you had a significant bonanza in AR, particularly with the AR Main orebody, which I believe is quite wide. However, I'm curious about your plans as you ramp up to 80,000 ounces. What mining methods will you be utilizing? I know you're using trackless machines, but some of the other orebodies in the region and historical orebodies tend to be narrower. Do you have an estimate of the proportion that will be mined using trackless methods versus conventional shrinkage techniques? Can you provide some insight on that?

Dana Roets, COO

We have our wide orebodies at AR Main and AR South, with AR South being the primary high-grade producer. Looking ahead, within the next five years, the majority of our production will come from the Blanket orebody, which is narrower. Thus, we will continue using trackless mining at AR Main and AR South. For Blanket, we will revert to conventional methods. There may be some long-haul stoping in certain areas, but it will primarily involve handheld conventional long-haul machines. Moving forward, our approach will be a hybrid that leans more towards conventional mining. There may also be opportunities for some trackless mining at Eroica, but overall, it's about the mining process itself.

Unknown Shareholder, Shareholder

Okay. And then my last question is, obviously, you're not sure when you're going to have contractors back up there in that site, assuming you could get the contractors back up there in say the next month or so, I would imagine, what was your projected target base for commissioning the shaft?

Dana Roets, COO

We believe we can still complete the shaft quite late in the fourth quarter, even with the current delay. If we can bring the contractors back now, we are confident we can finish within the throughput or commissioning of the shaft.

Unknown Shareholder, Shareholder

Okay. And once again, congratulations to the team. Very, very happy with how you got it done. Well done.

Operator, Operator

And the next question is coming from the line of Howard Flinker from Flinker & Co.

Howard Flinker, Analyst

I have a few questions. One, are those expenses of 500,000 and 870,000 pretax or post-tax?

Mark Learmonth, CFO

Pretax.

Howard Flinker, Analyst

Mark, when you were discussing the 11.5 million in expenses compared to about 7.5 million, did I hear you correctly that you believe around 1.25 million to 1.5 million of that can be reduced?

Mark Learmonth, CFO

The production cost was 7.5 million in the second quarter last year, and this year it increased to 11.4 million. Approximately 1.6 million of that increase is due to electricity costs, which are expected to remain. Additionally, the costs associated with maintaining the trackless equipment amount to around 870,000, and these include COVID-related expenses. If COVID eventually disappears, we hope those costs would not recur. We will still require gensets in the future, so they won’t completely go away. I would estimate that 900,000 to about 1.4 million of the costs should not be recurring.

Howard Flinker, Analyst

Okay. When the current medical crisis ends, of course, not necessarily this afternoon.

Mark Learmonth, CFO

Yes. Not this quarter.

Howard Flinker, Analyst

Additionally, have you completed your sale at the market? Or is there still some to go?

Mark Learmonth, CFO

No, it's still ongoing?

Howard Flinker, Analyst

It is. All right. I have a final question regarding taxes. Did I understand correctly that your taxes will remain at the current rate? Or will the balance between tax credits and tax payments result in a rate somewhat lower than the current 35%?

Mark Learmonth, CFO

No, I still think it will continue at approximately 35% because the tax in Zimbabwe is a combination of income tax and deferred tax, which should balance out at around 25%. When we stop investing heavily, we’ll pay more income tax and deferred tax, but we will still face tax leakage on the movement of funds out of Zimbabwe, specifically withholding tax on dividend payments. This would likely increase as we start to generate more revenue and distribute more money out of Zimbabwe, resulting in higher withholding tax on dividend distribution to the U.K. Additionally, we will continue to incur income tax in South Africa on intercompany profits from group procurement activities, as we will keep procuring in South Africa.

Howard Flinker, Analyst

I thought those profits would be sent to Jersey or Guernsey instead of...

Mark Learmonth, CFO

No. No. Because the people actually do the procurement, live and work in Johannesburg they need to. They need to be able to pop down the road the box burden and look at a bit of kit. So we can't really do that with some area. So structurally, we are going to continue to incur an overall tax rate that is higher than the basic rate of tax because of the cost of using money around and also because of the tax leakage arising in South Africa. There's nothing we can do about that.

Howard Flinker, Analyst

There is one more question. Related to those $870,000 of maintenance expense, I wasn't clear why that arose. Is that continuous? Or is that extra expenses just to keep the equipment operational when you're not actually using it?

Mark Learmonth, CFO

No. It's because we purchased second-hand equipment. Dana is probably the best person to discuss that. Dana, could you explain the maintenance costs, please?

Dana Roets, COO

Yes. Initially, we purchased refurbished equipment because that was what we could afford at the time. We have been using our equipment quite intensively since we started with the tracking equipment in 2015, which means it has been operational for five years. By 2018, we faced significant challenges in sourcing parts. At the end of 2018, with the introduction of the Zim dollar, we received only 35% of our currency in dollars. This made obtaining parts difficult. However, the situation improved in 2019, and has continued to improve since then, allowing us to acquire enough critical spare parts and new equipment. Unfortunately, our older fleet deteriorated significantly, particularly during the lockdown, which hindered our ability to get technicians and parts into the country. At the end of 2019, we had a South African maintenance contractor come to assist us, especially as we lost some of our maintenance staff to Vietnam during that challenging period, and it became impossible to pay people in U.S. dollars. When lockdown occurred, we were unable to access the mine, which severely affected our trackless equipment. We are now working to catch up, and while we have seen an increase in those costs, we expect them to decline as we become more efficient.

Howard Flinker, Analyst

So they're not continuous. It's not 870,000 every quarter.

Mark Learmonth, CFO

No. I would like to point out that we have initiated a program to replace the worn-out old equipment with brand new equipment. This should also lead to a reduction in maintenance costs.

Howard Flinker, Analyst

Has the lockdown in South Africa continued, or has it ended?

Steve Curtis, CEO

Currently, it is still ongoing, but we are expecting an announcement from the President any day regarding a potential relaxation. We seem to have made progress in some provinces, and we are waiting to see if there will be any easing of restrictions. However, aside from highly skilled technical personnel, the supply chains are functioning well. Despite the travel limitations, it is still possible to bring people to the bank. Recently, we were able to bring in additional staff for the Central Shaft. We collaborate with the authorities through the Ministry of Mines and the Ministry of Health to secure specific permissions to bring in personnel, although it takes longer than simply purchasing a plane ticket and boarding a flight. Nonetheless, it is achievable, and we are receiving a lot of support from the authorities to ensure we have the right people in the right locations.

Operator, Operator

As of now, there are no further questions in the queue.

Steve Curtis, CEO

Well, then, Judy, let me wrap up and just thank everybody for joining the call today. And I hope you've been able to get the information that you needed. It's very encouraging to see that this is the largest number of participants that we've had on one of these calls. And thank you from us and the team for you participating. And let's hopefully keep on watching the success of Caledonia. And we will continue to deliver. And as Dana says, the target is still to get the Central Shaft complete, and then we'll do the ramp-up. And the story will continue. So thank you once again. Thank you to the team for joining the call, and thank you to everybody who dialed in, and I just wish you good health and stay safe, everybody. Bye-bye now.

Operator, Operator

Thank you, everyone, for joining us on today's call. You may now disconnect your handsets. Host, please be connected.