Ero Copper Corp. Q2 FY2020 Earnings Call

Thank you for standing by. This is the conference operator. Welcome to the Ero Copper Second Quarter 2020 Financial and Operating Results Conference Call. The conference is being recorded. I would now like to turn the conference over to Mr. Noel Dunn, Executive Chairman of Ero Copper. Please go ahead, sir.

Thank you, and good morning, everyone. The news release announcing Ero's second quarter results is available on our website and on SEDAR, as are our financial statements and MD&A for 3 and 6 months ended June 30, 2020. We will be making forward-looking statements on this call that involve risks and uncertainties concerning the businesses, operations, and financial performance of the company. We will refer you to our most recent AIF, also available on SEDAR, for a discussion of the risk factors of our business and their potential impact on future performance. Unless otherwise noted, all amounts are in U.S. dollars. Joining me on the call today are David Strang, Ero's Co-Founder, Chief Executive and President; Wayne Drier, Ero's Chief Financial Officer; and Makko DeFilippo, Vice President, Corporate Development. Before we dive into the results of the second quarter, I'd like to acknowledge that while the recent increase in infection rates of COVID-19 in Brazil have increased the risk of outbreaks in the communities near our operations, our in-country teams have continued to undertake extraordinary precautions to keep our employees, contractors, their families, and local communities safe. To date, early and detailed mitigation efforts undertaken throughout our organization have achieved this objective. During the second quarter alone, our operations contributed approximately $1 million towards community relief and on-site COVID-19 mitigation efforts. As a result of these ongoing efforts and our commitment to our in-country colleagues, we continue to experience no disruption to our operations, supply chains, or sales channels. During the first 6 months of this year, our core assets within the Curaçá Valley performed well. We're also seeing increased production from our NX Gold Mine as planned, which Dave will elaborate on further. From a financial and liquidity perspective, we remain in excellent shape and, frankly, as well prepared as we've ever been to continue to navigate in uncertain times. We ended the second quarter with approximately $52 million in cash. As a reminder, due to the amendment of our credit facilities during the first quarter, we had no material principal debt payments due until March of 2022. As evidenced by our record quarterly cash cost of $0.65 per pound of copper produced and $437 per ounce of gold produced at NX during the second quarter, our operating business has continued to significantly benefit from the currency tailwind associated with the weakening of the Brazilian real versus the U.S. dollar. The continued volatility in the underlying currencies impacted our GAAP earnings and working capital during the period due to the non-cash accounting treatment of U.S. dollar-denominated debt and forward-dated FX option contracts, which are designed to protect the business in the event of a rapidly strengthening Brazilian real against the U.S. dollar. It is worth noting that we achieved the strongest quarterly cash flow from operations in the history of the company, of $42.5 million, despite $4.4 million in cash settlements of derivative contracts during the second quarter. Looking into the future, if we continue to see a persistently weak Brazilian real against the U.S. dollar, our underlying business will benefit, and we will continue to make modest payments on the settlement of existing contracts as we've demonstrated during the second quarter. On the other hand, as we will inevitably see a global recovery from the COVID pandemic at some point, the export-driven Brazilian economy is likely to do well on a relative basis. We have protected our business against the strengthening of the currency and its impact on our profitability. With that, I will now pass the call over to David to provide a brief review and update of our operations, and Wayne will provide a review of the company's financial performance. Our team will be available for questions immediately following the call.

Thank you, Noel. Just to briefly touch on what Noel mentioned, across our operations and throughout our organization, we continue to prudently manage our business so that we are as well positioned as possible to withstand any unforeseen challenges that may arise as a result of COVID-19. Our commitment as an organization to the health and well-being of our local communities and employees remains paramount to our leadership team, both in Brazil and North America. Our Brazilian colleagues have continued to demonstrate the resolve to keep our operations running safely while managing and mitigating the impact of COVID-19. The recent recognition we have received as a company regarding our ongoing ESG initiatives is a testament to their hard work and commitment to those principles. In terms of production during the quarter, our results continue to reflect solid underlying operational performance. We produced 11,178 tonnes of copper in concentrate at MCSA and 8,739 ounces of gold at NX Gold during the period. Focusing first on our MCSA operations in the Curaçá Valley, we milled 627,071 tonnes of ore, grading 1.98% copper and achieved average metallurgical recoveries of 90% during the quarter. Improvements were significantly driven by contributions from the Vermelhos Mine where 253,349 tonnes, grading 3.26% copper, were mined during the period. This marks a significant 56% increase in contained copper coming from Vermelhos compared to the first quarter. At the Pilar Mine, 371,794 tonnes, grading 1.4% copper, were mined during the period, essentially in line with the first quarter, albeit with a modest increase in tonnes mined. As Noel mentioned, we achieved a new quarterly record with respect to C1 cash costs of $0.65 per pound of copper produced, reflecting strong operational performance, continued currency tailwinds, and improved byproduct gold and silver prices during the second quarter. During the first half of 2020, C1 cash costs averaged $0.68 per pound of copper produced. We are maintaining our 2020 production guidance for our Curaçá Valley operations and previously revised C1 cash cost guidance of $0.70 to $0.85 per pound of copper produced. Similarly, we are maintaining our previously revised capital expenditure guidance range of $56 million to $68 million, with $20 million to $25 million in exploration expenditures through September of this year. Although all of our capital programs have and continue to run normally through the first half of the year, our full-year guidance is subject to an elevated degree of uncertainty as a result of the COVID pandemic. We continue to execute on and advance several key growth projects. Despite significant challenges associated with COVID-19, our project team was able to deliver and fully install our new high-intensity grinding mill in early July, only a week or two behind schedule. Instrumentation and control system integration are on track for completion this week, and commissioning is underway through a creative effort that involves both on-site teams who underwent strict quarantine measures, working alongside a virtual multinational commissioning support team. We expect full commissioning and handover to operations by the end of August. This is an incredible accomplishment with significant contributions from our entire project team globally, and I would like to congratulate them all on this call. Looking into the second half of the year, we expect to see a significant improvement in overall stabilization of metallurgical recoveries in the mill due to the commissioning. Our ore sorting testing campaign, which has been running at a commercial scale since January, is substantively complete, and we have now tested eight different discrete ore bodies throughout the Curaçá Valley across a variety of grades. The results are highly encouraging. We will continue to operate the test program through the third quarter on the last planned ore body, while data analysis, process integration, and operational optimization work continues to fully quantify the benefits of preconcentration. Based on work done to date, we believe that ore sorting will be an integral component in further optimizing the production portfolio for the various operations in the Curaçá Valley, as well as for new discoveries in the future. Additional detail on the work performed and the results of the test campaign are expected during the third quarter. In addition to ore sorting, I am very excited about the completion of a laboratory upgrade project that will allow us to do multi-element analysis in-house, specifically for platinum group metals. This project was completed at the end of the quarter, and we are ramping up daily sample volumes over the next several weeks as scheduled. Once fully integrated, we expect this addition to the laboratory to significantly reduce costs but more importantly, turnaround time for platinum group metal assay results, which will be a welcome addition to the ongoing work of our exploration department. On exploration in the Curaçá Valley, we currently have 28 drill rigs operating. Our in-and-near mine exploration programs remain focused on the deepening extension of the Pilar Mine, where we have continued to intercept very high-grade Superpod mineralization at depth, including the recently announced intercept of 96.4 meters, grading approximately 3.97% copper, the best hole we have ever drilled in the Curaçá Valley. Additionally, at Vermelhos, we are advancing drilling and borehole EM work, looking for down-plunge expansions of the Siriema massive sulfide conduit and continue to execute the fan drill program designed to test for the continuity of mineralization beneath the main Vermelhos ore bodies. With a substantive portion of our in and near-mine programs completed, we have been aggressively advancing our regional exploration efforts on four recently interpreted mineral systems. While preliminary results from these systems continue to be encouraging, additional detail on these ongoing exploration programs is planned for the second half of the year. Consistent with our scheduled quarterly updates, results from our ongoing exploration programs will be further detailed in the upcoming exploration update, which we typically release four to six weeks following our financial results. At the NX Gold Mine, production during the quarter totaled 8,739 ounces of gold and 5,327 ounces of silver from total mill feed of 39,108 tonnes, grading 7.75 grams per tonne gold, with average metallurgical recoveries of 89.6%. Gold production, mill throughput, and recoveries improved quarter-on-quarter, reflecting the anticipated ramp-up of mining at the Santo Antonio Vein. Operational performance contributed to record C1 cash costs of $437 per ounce of gold produced during the second quarter, an improvement of $157 per ounce compared to the first quarter. During the first half of 2020, C1 cash costs averaged $511 per ounce of gold produced. As previously noted, we continue to expect full-year production to be weighted towards the second half of the year. Our annual production guidance for the NX Gold Mine remains at 38,000 to 40,000 ounces of gold and previously revised C1 cash costs of $425 to $525 per ounce of gold produced. Annual capital expenditure guidance for the NX Gold Mine remains unchanged from previously revised guidance of $7 million to $9 million, with an additional $2 million to $3 million to fund its ongoing exploration programs. While not part of our current operating portfolio, an initial review of our buyer team to evaluate the Boa Esperanca copper project has resulted in some fairly compelling opportunities. Recall that we effectively inherited the existing design of the project following our acquisition of MCSA. For the first time, I've taken a very thorough look at the project with the engineering group. While we had initially planned a fairly routine desktop update, several aspects are pointing us to a rework of the entirety of the project from the ground up, and we continue to make progress on that front. With that, I will now pass it over to Wayne, who will provide an overview of our financial performance.

Thank you, David, and good morning, everyone. During the quarter, the company sold 10,586 tonnes of copper in concentrate and 8,739 ounces of gold for consolidated revenues of $70.8 million. While copper sales volumes were in line with the prior period, gold sales volumes continued to improve and were 11% higher than the prior period due to the ramp-up in production from the Santo Antonio Vein. As David mentioned, we achieved record C1 cash costs at both MCSA and NX Gold during the quarter of $0.65 per pound and $437 per ounce, respectively. For the first 6 months of 2020, C1 cash costs averaged an impressive $0.68 per pound of copper and $511 per ounce of gold produced. These results are underpinned by strong operating performance from both of our operations, favorable exchange rates and, in the case of MCSA, higher byproduct gold and silver prices. These factors collectively contributed to $42.5 million in cash flow from operations, a record quarter for the company and a 13% improvement from the prior period. Adjusted EBITDA was $42.4 million, reflecting a 27% increase over the prior quarter. During the first 6 months of 2020, adjusted EBITDA totaled $75.9 million, which was in line with the first 6 months of 2019, despite a 17% decrease in the average prevailing copper price over the same period, which frankly speaks to the strength in profitability of our operations. While the weakening of the Brazilian real against the U.S. dollar has clearly benefited our operations and headline financial performance, we continue to see the impact of foreign exchange volatility flow through our second quarter results. Total foreign exchange losses during the period comprised of cash settlements on out-of-the-money callers totaling $4.4 million, unrealized foreign exchange derivative losses of $8.5 million based on the fair market value of these contracts at June 30 versus March 31, and an additional $3 million related to the translation of our U.S. dollar-denominated debt in Brazil, being the result of our functional currency being the real. While our headline net income for the quarter was $7.5 million or $0.08 per share after adjusting for the unrealized components of these foreign exchange losses, our adjusted net income was $20.3 million or $0.22 per share fully diluted, which far better reflects the performance of the underlying operations. Our total cash position at quarter end was $52.3 million, including restricted cash compared to $45.5 million at the end of the first quarter. The increase is primarily due to strong operational performance contributing to record cash flow from operations during the period. Our working capital position at the end of the period was adversely impacted by the current portion of the fair market value assessment of our outstanding foreign exchange contracts, the timing of some payments related to the HIG Mill, as David spoke about, associated consumables and critical spares, and the current liability associated with the short-term lines of credit that were drawn during the first quarter as a proactive measure against COVID-19. We are very comfortable with our ability to repay or roll these short-term lines given the robust nature of our balance sheet. As evidenced in our results during the first 6 months of 2020, our business continues to run extremely well and generate significant free cash flow, particularly at today's metal prices and foreign exchange rates. On that note, I will hand the call back over to Noel.

Thank you, Wayne. Our performance during the second quarter can be summarized as follows: one, proactive and ongoing efforts to mitigate the impact of COVID-19 in our operations to keep them running safely, paired with extraordinary support of our local community response efforts; two, continued advancement of key growth projects despite challenging conditions; three, exceptional operating and financial performance across our core business, bolstered by ongoing currency tailwinds. Thank you very much for joining the call. We will turn it back to the operator to open the line for questions.

First question comes from Orest Wowkodaw from Scotiabank.

I'm curious why your operating guidance remains unchanged. In the first half of the year, the throughput has exceeded expectations, while the grade has fallen short of what you guided. I'm wondering how we should approach this for the second half of the year. Do you anticipate that throughput will decrease significantly with an increase in grade, or should we focus solely on the copper production guidance without considering those details?

Yes. Orest, thanks for your great question. With respect to the second half of the year, we're very focused on copper production. As you can well imagine, with an ore operation like ours, with the high-grade nature of the various ore bodies and the heterogeneous nature of mineralization, we do see variety in terms of grade as it relates to stope sequences. So we're maintaining guidance, as we've highlighted, with regards to copper production. I think you want to adjust around that with respect to your grades and/or your production in terms of ore being mined. It's related to sequencing off stopes. You would anticipate in the second half of the year in order to maintain that kind of production level of copper that you will see a decrease in ore throughput and a subsequent increase in grade, along with an anticipated increase in recovery related to the commissioning of the HIG Mill.

Can you provide some insight into why you expect throughput to decrease? Is it due to mining constraints or other factors driving this change?

We're constrained with respect to stope availability. That's the constraint that we have in terms of the design of what we're trying to do on a month-by-month basis. For instance, you would see, in terms of perhaps what we'll see at Vermelhos is some rock fill we have to do with regard to replacement. As we know, we don't have a plant up there. So we use rock fill. Timing with regards to being able to fill stopes with rock fill, et cetera, affects that throughput. We're always going to try to produce more when we can concerning our throughput through the mill, but it's not a perfect science on a month-by-month basis. That's why we are maintaining our guidance in terms of copper production.

Okay. Perfect. And then just finally for me. Can you just remind us how much of an improvement in copper recoveries you're expecting from the HIG Mill?

We have guided the marketplace to expect somewhere in the order of 2% to 4%.

Okay. And that would take how long to realize, is that sort of exiting the year?

I hope we will start seeing those improvements, considering that we are slightly delayed due to the COVID situation and commissioning. If you plan to update your models, I recommend waiting until October to take any action.

The next question comes from Jackie Przybylowski from BMO Capital Markets.

Just a follow-up on the line of questioning that ore has been on. I know you guys had talked before about a second mill. And I know it's still very early. You haven't fully commissioned the first HIG Mill yet. Can you give us maybe a little bit more color or an update in terms of what you're thinking now about installation of a vertical mill or a second HIG Mill? And maybe what the timing would be on that, if it's still kind of consistent in a couple of years or if that's changed at all?

Yes, Jackie. Thanks. With respect to the ongoing installation and you're talking about continuing to increase the capacity of the mill, I think what we want to do now is get the HIG Mill settled in. We want to operate it such that we can test its capabilities above and beyond the metallurgical improvements and the potential to allow it to help us increase our capacity from our current capacity of about 3.2 million tonnes, and we've guided that we think that could go to 3.7 million. I would like to see that mill operating, and I believe everyone feels the same. The good news about that mill is its variable gearing, which provides us with significant flexibility in its management and operation, enabling us to explore its performance potential. Once we feel confident in its operation, we can consider future expansion plans. However, any further expansion is tied to our success in exploration. Currently, the installation of the HIG Mill and our work on ore sorting is providing us with great flexibility to potentially upgrade ore, allowing us to produce more copper than we initially expected from the mill's capacity. There are many factors at play right now, and we intend to navigate through the next couple of years before making any definitive decisions.

Got it. Can you provide an update on ore sorting? I understand it's probably an unfair question since the studies aren’t complete, but you’ve already analyzed various ore types. Are you noticing a consistent benefit from ore sorting, or do some ore types seem to perform better than others? Based on your early impressions, how do you foresee incorporating this into your future plans?

Well, I think we've got to be careful about selective disclosure with certain people versus the market in general. The best thing for me to say is look out as we pull this all together for a news release. We're very happy with what's happened with it. Our consultants that we have now brought in to help us understand how we move from a testing situation to full integration have been very impressed with the results we've got. But to be honest, Jackie, I don't want to get too far ahead. We will ensure that we give the market a full understanding of the results as we can in a timely manner.

The next question comes from Dalton Baretto from Canaccord Genuity.

Jackie beat me to the ore sorting questions, so I've got a pivot now, but I've got a couple more here. So just putting this all together, Dave, and looking forward to the tack report in November, can you give us a sense of what you're targeting to get in there in terms of the drilling, in terms of kind of a mine plan, from a mine life perspective and a capacity perspective? Whether some of this ore sorting stuff will get captured in there?

Great. Good to hear from you, Dalton. Yes, good question with regards to that. Obviously, the most important thing we want to include in the 43-101 is the deepening project. This project is now coming together really well, and we anticipate that it will form the cornerstone of anything we do in the technical report. With regards to ore sorting, we would like to integrate that into our 43-101 with respect to where we see the opportunity to use it. But it's too early to confirm that it's going to be included. We are working with SENCO right now regarding how we go about integrating the various projects with the use of ore sorting into the mine plan. If they meet our return metrics, we will include them, but I don't want to be drawn into saying that it's absolutely going to be included or not yet. We are encouraged, very encouraged.

That's fair. That's fair. And then you've got the lab on-site now, Keel Zone Siriema PGMs. Is the benefit there just a faster turnaround? Or are you expecting a pivot in the exploration strategy around Siriema?

Look, the first and foremost reason why we put a full ICT suite analyzer in the lab was to provide the exploration team with the ability to look at all minerals. Regarding magmatic sulfide exploration efforts, one of the things that all the consultants we've used have detailed is that your ability to look at your samples is crucial in identifying and helping you target certain types of ore bodies. With regards to the PGMs, we've historically faced challenges with getting all holes tested because we have had to be selective with regards to the sampling that we sent out. What we see with respect to PGMs has suggested that this part of our exploration program has been underlooked. We now want to spend more time examining the concentration levels of PGMs within our ore bodies. This is early days, but having the lab should help accelerate that understanding.

And then I was surprised to hear Boa get some airtime today. What's prompting the overall rework? What are you guys thinking? What's the overall thinking on that project not from a strategic perspective?

The addition to our team of Ricardo Re, who is a resource king, has prompted us to take a fresh look at Boa. He initially reviewed Boa and suggested that we engage the engineering firm that conducted the feasibility study for Glencore. Conversations that followed made us realize we've got to reevaluate the project from the ground up. There were areas that suggested a more optimal way of approaching the project, and we also see significant opportunities to potentially expand the resource. A substantial amount of drilling ended in some high-grade mineralization, which we hadn't previously explored. We believe there's potentially more to Boa than we ever thought before, which is exciting for the team, but it’s early days. A lot more work has to be done.

Got it. Okay. And then just maybe one last one for me. Dave, last year, on the Q2 call, you were kind enough to give us the internal plan in terms of an aggressive ramp-up. I'm wondering if you want to do that again for this year.

Thanks, Dalton. No, I think I'm going to wait until we get the 43-101 out to all of you later this year.

The next question comes from Stefan Ioannou from Cormark Securities.

Great to see the quarter. Maybe just to sort of follow up on Jackie's ore sorting question. I know you've already provided a lot of info. Just curious, you mentioned that there were eight sort of batches or big sort of test runs through the ore sorting plants so far. Could you maybe, without saying too much, give us an idea? Was it all sort of lower-grade open-type ore? Or did you actually look at some sort of moderate-grade stuff that may be coming from underground that could travel with ore sorting?

Thanks, Stefan. Great question. Yes. When we looked at the eight different ore types, that includes both underground and open pit. They included high-grade and low-grade. We've aimed for a comprehensive approach regarding the work done with regards to ore sorting, and we’ve run just over 100,000 tonnes through the plant to date. We're very happy with everything that's been done.

Okay. Great. Great. And then just switching gears over to NX Gold. I know in the past, you sort of mentioned that there was going to be some complementary regional exploration for the first time in a long time. Is that still happening? Or is that sort of just the focus back on the Vein itself?

Well, we've been continually working on the Vein itself. We also started working on some other areas and initiated our regional program probably a couple of months ago. So yes, we're beginning to expand the program. As I said, we have four to five rigs there right now. We would like to see the program expand more as we progress, but that's dependent on rig and crew availability. COVID-19 has required us to be cautious when bringing teams into the environment. Long answer to a short question, but yes, we are stepping out into the region.

The next question comes from Raphael De Souza from CIBC.

Most of my questions have already been answered. But just one last one, guys. So with gold and silver prices being so high right now, any changes to the way you're thinking about NX Gold and the potential divestment?

No. Right now, we're very, very happy with NX, where it stands. We still have a lot more work to do, and we're excited regarding the exploration program. We certainly hope that when you come out with a new 43-101 at the end of the year, we will be able to show more extension of mine life. We are constantly evaluating opportunities to get the highest value from our assets. We're evaluating various opportunities regarding how to extract more value from NX right now, but there’s nothing concrete that I’d like to share at this stage.

And just one more quick question on NX Gold. So, in order to get to your - I think it's 9 grams per ton guidance, grades have to pick up quite significantly in the second half of the year. So what sort of grades should we expect for the upcoming quarters?

I’d rather not go into that right now, Raphael. I'll turn it over to Makko, who spends a lot of time working with the NX Gold team. Makko, do you have anything to add regarding that?

Yes, Raphael. Look, I'd say we've obviously maintained our guidance for the entire year. We have always indicated that production was going to be weighted towards the second half of the year. Looking at our guidance for the full year helps you back-calculate what the grade ought to be for the second half. We're working hard with the team to achieve that.

The next question comes from Jackie Przybylowski from BMO Capital Markets.

I apologize for asking more questions that may be difficult to answer. However, I would like to revisit your regional drill program. You mentioned that you hope to deploy more rigs there depending on their availability. My first question is whether this availability comes from your existing near-mine programs or if you are considering additional rigs beyond the 28 you currently have. Additionally, could you clarify whether you are using RC or diamond drills, or both? Finally, it would be helpful if you could discuss your drilling approach in more detail. Is it focused on specific targets, or are you exploring various core systems that you have identified? Any information you can provide would be appreciated.

Jackie, when we talk about rig availability, it's primarily from our internal supply of rigs. We did add one rig, as you can see from the beginning of the year; we're at 28. It's possible we may add another one for a specific purpose that we're looking to do. But right now, around 27 to 29 rigs is probably where we will be. All but one is core. We have the one big rig that we use. That's our scouting rig throughout the Valley, and it goes and looks at certain areas. As we've been pivoting to the regional, I think some of the continued exploration success we’ve seen, particularly around the deepening project, is probably why we haven't put as many rigs on the region as we anticipated at this time, but we will as we go forward in the second half of the year. We are targeting certain specific areas right now, primarily in and around the Sirabian district in terms of our first pass and some of the things we’ve seen there in terms of the complete greenfields work. We'll see how we go.

So I guess the gist of my question is, like, will you have enough information from the regional program that you can start adding some of that into inferred or M&A or some kind of resource category?

This year. Yes. Jackie, that's a good question. But it's hard to provide a reasonable answer. With regards to anything we do, certainly, once we are into a new discovery and if you look at Siriema last year as an example, there is the possibility that could occur. But generally, we want to ensure that the resource has the potential to come into the 43-101 before we announce a new discovery.

There are no more questions at this time, sir. I would like to turn the conference back over to management for any closing remarks.

Noel, do you want to give some closing remarks?

Yes. Look, thank you, everybody. As David said, we have a lot of moving parts in our business, both at NX and the MCSA. We're having to deal with the COVID crisis at the same time. I think the company is doing exceptionally well regarding its operations. We continue to receive total praise from our management team and employees in Brazil; they're doing an incredible job in very trying circumstances. We have a tremendous opportunity in front of us. We have a lot of things to do. It's a difficult time, but I think the team and the company is performing as best as it can in generating such tremendous returns and profitability. Our cash costs being so low on a global basis mean your company is in great shape, and we look forward to speaking to you again in the future. Thank you.

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