Gold Resource Corp Q2 FY2021 Earnings Call

Thank you for your patience. This is the conference operator. Welcome to the Gold Resource Corporation's Second Quarter 2021 Conference Call. The conference is being recorded. After the prepared remarks, there will be a chance to ask questions. I will now hand the call over to Ann Wilkinson, Vice President of Investor Relations and Corporate Affairs. Please proceed.

Thank you, Holly, and good morning, everyone. On behalf of the Gold Resource team, I would like to welcome everyone to our Second Quarter 2021 Results Conference Call. Before we begin the call, there are certain housekeeping matters I would like to cover. Please note that certain statements to be made today by the management team are forward-looking in nature, and as such are subject to numerous risks and uncertainties as described in our quarterly report on Form 10-Q and other SEC filings. On the call today we have Allen Palmiere, President and Chief Executive Officer; Kim Perry, Chief Financial Officer; and Alberto Reyes, Chief Operating Officer. Following Allen and Kim's prepared remarks, all three will be available to answer your questions. This conference call is being webcast. For those of you joining us on the webcast, you can download a PDF copy of the conference call slides from the materials tab under the ask-a-question tab. The event will also be available for replay on our website later today. Yesterday's news release issued following the close of the market and the accompanying financial statements and MD&A contained in our 10-Q have been filed with the SEC on EDGAR and are available on our website at www.goldresourcecorp.com. Also, please note that all amounts mentioned in this call are in U.S. dollars, unless otherwise stated. I will now turn the call over to Allen.

Thank you, Ann, and good morning, everyone. I would like to thank the participants for taking the time to join us and to welcome Alberto Reyes, our new Chief Operating Officer, to the call. Following my opening remarks, Kim Perry, our Chief Financial Officer, will describe our financial results. I will then provide you with a picture of our plans for the balance of 2021 and a few closing remarks, and then we will be able to take your questions. Before discussing the operating results, we want to note that our operations team continues to demonstrate their ability to be nimble and adaptive operators, all while focusing on excellent environmental, social and governance practices. Notwithstanding an excellent work culture, there were two lost time incidents at the Don David Gold Mine during the second quarter. While these incidents did not result in serious injury, measures are ongoing to reinforce adherence to safety protocols and to strengthen the safety culture. Accordingly, a series of programs are underway to improve the overall culture of safety. Turning to our infrastructure projects. We made significant construction progress on our filtration plant and dry stacks tailings project, which is targeted for completion in Q3. As we've noted, the dry stack tailings will accelerate reclamation of certain areas of the open pit mine, provide efficient storage of tailings, and, importantly, reduce water consumption, as approximately 80% of the processed water will be recycled and available for use. During the quarter we completed 156 meters of underground development on the northern and southern exploration drifts. From these exploration drifts, we completed over 3,400 meters of diamond drilling in 12 drill holes. Surface drilling on the Aguila project is ongoing, with 2069 meters of diamond drilling in two bowls. Exploration activities were focused on the Switchback vein system, which extends for over 1 kilometer of strike length and remains open both along strike and down dip, and as well as the parallel structures to this system. Most notably, the Sandy vein system, which is located between the Switchback and Arista systems. Exploration drilling mainly targeted expansion and delineation of the principal Soledad vein to define additional resources, as well as step-out drilling on the parallel Sandy system of veins for resource expansion. Drilling is also targeting strike extensions of the Arista system beyond the current mine plan. We have also renewed our focus on near-mine exploration with surface geological mapping and rock chip sampling in the Cerro Colorado area, notably in the vicinity of the Aguila open pit and the surrounding area with additional drilling planned for these areas in the second half of 2021. Turning to the second quarter operating results. I'm pleased to report that Gold Resource sold approximately 5,700 ounces of gold, 270,000 ounces of silver, 365 tonnes of copper, 1,200 tonnes of lead, and 3,200 tons of zinc. During the second quarter, we processed ore at an average rate of 1,500 tonnes per day compared to 1,950 per day in 2020. While it was lower quarter-over-quarter, it was consistent with our mine plan for the year. The base plant continues to provide substantial efficiencies by returning processing waste to underground workings as backfill. During the second quarter, we processed ore with average gold and silver grades that were 10% and 11% higher respectively than the same period last year. Overall base metal grades were lower during the three months ended June 30, 2021. As a result of a change in the mine plan necessitated by challenging ground conditions encountered in the first quarter. We are happy that these challenges have been overcome, and our mine plan is back on track. With that, I will turn the call over to Kim to discuss our financial results.

Thank you, Allen, and good morning, everyone. We closed the quarter with a strong balance sheet, consisting of just over $30.5 million in cash and no debt. Cash from operating activities was $9.3 million for the quarter, and working capital from continuing operations was nearly $32.6 million at June 30, 2021. For the second quarter, we reported net income of $1.3 million. Net income is a result of just over $30.8 million in revenue. Net revenues reflect a 12% decrease in concentrate treatment charges, which are netted against concentrate sales. These treatment charges for the three months ended June 30 were $2.9 million or $609 per base metal ton sold compared to $3.3 million or $864 per base metal ton sold for the same period in 2020. This decrease is largely dependent on the spot treatment charge market for zinc, which can be volatile. Total production costs of $19.5 million for the three months ended June 30, 2021, were 84% higher than the production cost of $10.6 million for the same period in 2020. This increase is primarily related to the increase in production volumes. Additionally, there was a $1.2 million impact related to the Mexican labor law reform. Finally, during the three months ended June 30, 2021, we were impacted by a 13% price increase in consumables used in operations and a 5% increase in the volume of diesel consumed. The increased diesel consumed relates to increased power consumption, primarily from the diesel generators for the filtration plants and underground ventilation. The Don David Gold Mine's total cash cost was $713 per ounce and total all-in sustaining cash costs were $1,250, excuse me, $1,280. This is after co-product credits. We expect these costs to significantly lower in the second half of 2021 and maintain our full year guidance of total cash costs of between $210 and $225 per gold equivalent ounce and total all-in sustaining cost between $800 and $900 per gold equivalent ounce.

Thank you, Kim. Management continues its focus on unlocking the value of the mine, existing infrastructure and our large property position and providing growth to our shareholders. Accordingly, we invested $11.2 million in infrastructure and exploration in the Don David Gold Mine. In our process plant, we completed metallurgical testing and initiated design and engineering of a tailings regrind circuit, including procuring certain parts and equipment. The project, unfortunately, has been delayed due to longer lead times than expected. And this project is now expected to be completed in early 2022. The new circuit is expected to increase gold recovery by between 6% and 10%. Please note, it is unlikely that the full amount of $9.8 million for underground development will be expensed in 2021 as a result of the mine sequence changes made during the first half of the year. In closing, we remain on track for full year guidance, with the exception of development capitals previously discussed. As we expect to see improvements in grades in the second half of the year, we have already seen encouraging and affirming results in July as we are back in the Soledad vein. With the expected second half results, we are well positioned to have more than $50 million in cash by the end of the year and a free cash flow yield greater than 15%. This, along with our dividend yield, substantially outperforms our peers. I also want to repeat Kim's comment that the company has a strong balance sheet which provides us with flexibility for growth and exceptional returns for shareholders. Thank you all for taking your time to listen in. This concludes our prepared remarks. I'll now turn the call back over to the operator for any questions that may arise.

Your first question for today is coming from Heiko Ihle.

And I just want to point out that the company has a bigger yield than the S&P 500. So clearly some optionality here. You stated in the release that you have started some profit sharing with your employees. Though there aren't really any details in the release. Just a couple of things. I'm just trying to clarify. What factors are people ranked on? Is it safety? Is it production? Is there anything else?

That's actually an excellent question. And there's actually very little guidance out regarding what factors will ultimately be incorporated. And there's a lot of legislation going on right now and discussions with the legislation regarding what that will look like. Right now we are taking the basis that is 10% of net income. So with maybe taking a bit more of a conservative approach, we know it won't exceed that. Obviously, we'll reward employees if it's appropriate to go higher than that. But at this point, that's the approach we're taking, the assumption we're taking and the path we're following to determine those factors.

You already answered one of my next questions, which was how much is it going to be? And then when does the whole thing start? And also, can we trendline the same 10% figure or whatever wherever it might come in this year into next year as well, please?

Yes, Heiko, I believe that's a reasonable assumption. We based our calculations on a full year impact, so the $1.2 million for profit sharing was determined from January through June. Unless there are any changes in legislation, this should continue in the future.

Got it. Okay. Very good. And just one little clarification at the end here. You came in at $1,280 for all-sustaining cost for GEO. Walk us through, as detailed as you can in this setting, what you expect to see for the remainder of the year and factors that may influence this figure in either direction, especially considering all the capital improvements that are being undertaken at the site, please?

Heiko, the reason that our all-in sustaining was higher than originally projected was the fact that during Q2 we were mining in alternative mining zones. You'll recall in late Q1 we had some ground control issues, and that necessitated a change in plan. The result of that, we were in lower grade areas and our by-product credit suffered. We are now back on track with our original mine plan in the original areas that we had anticipated. The result of that is our base metal credits, our by-product credits are going to increase significantly in the second half and bring our all-in sustaining and our cash costs back in line with our guidance. It was a timing issue and was stated by the ground control issues we had earlier in the year.

Holly, I think the next person in line is Ron Aubrey. Can you add him in?

Yes, this is Ron here. Allen, it's good to talk to you again. The company reached peak production last fall, so this marks the third consecutive quarter of sequential decline. It's clear that you have faced challenges while completely rebuilding your management team. I'm relieved to hear that the ground conditions for Q1 have been resolved. I'm interested in understanding when you expect to return to production growth, including improvements in grade. Could you please take a moment to summarize some of the mining challenges and your plans for addressing them going forward?

Sure. The plan for this year has always been to reduce our production rate to 1,500 tonnes a day. Last year, we were operating at around 1,980 tonnes. The company managed to maintain that production level by concentrating solely on the Soledad structure in Switchback, which is quite wide and long, making it easier to sustain volume. However, this exclusive focus meant missing opportunities to capitalize on some of the narrow, high-grade veins in the Arista system. We made a deliberate choice to decrease our volume and shift our focus to some of the high-grade veins in Arista. In the second half of this year, you can expect to see increased grades from two areas: Soledad in Switchback and the Candelaria and other veins in Arista. This decision was intentional, as mining narrow veins naturally results in lower productivity since materials cannot be moved as quickly. Nevertheless, the grades are promising. The geology of the mine determines production levels, so I can't guarantee a continuous increase in production rates. Our aim is to maximize what is available based on geological constraints and to operate as efficiently as possible. Alongside this, we've started programs in the past several weeks to thoroughly assess and improve all our systems within the mine, including geology, operations, maintenance, and processing, with a focus on efficiency and governance. Although this work is just beginning, I believe that by Q4, we may start seeing improved profitability for the tonnes we are able to mine underground. Does that address your question?

Yes, it does. I appreciate that information. I wanted to follow up on your guidance for cash costs and all-in sustaining costs after by-product credits. Could you provide an updated outlook on production, specifically for silver and zinc, which have not met expectations so far? It seems like you are working to catch up in that area. How confident are you about reaching your targets of 1.7 million to 1.8 million ounces of silver and 21,000 tons of zinc?

We ended up mining in lower grade areas of the mine, particularly in the second quarter, but also a significant part of the first quarter. While we will not be able to completely catch up on zinc and silver tonnage, the production rate for the second half of the year will exceed our original plans. So we are making up some ground, but the truth is we will not be able to fully recover this year. Our ability to meet targets is largely due to strong commodity prices. Although I hesitate to take credit for factors beyond my control, it's true that a rising tide helps everyone. We are currently on track with our production profile, but full recovery this year is not feasible.

No, that's fine. But at least directionally it appears that the worst is behind us and now we're back on a path to get to where you certainly would like to be, and that's good enough for me.

Okay. Thanks, Rob. We are back on track.

So Holly, James Tad is up next. Can you please make his line live?

Congratulations to the team on the quarterly cash flow yield results. I believe most of my questions about the prudent matters have been addressed. I have a few clarification points I'd like to ask. The first is probably for Kim. Regarding the $1.9 million spent on onboarding third-party employees in Q2, will any of that expense carry over into Q3 or beyond, or was that a one-time charge for the last quarter?

Yes. James, thank you for that question. First of all, I want to clarify that the total $1.9 million was not a cash impact during the quarter. It is $1.2 million related to the profit sharing. That will continue, and that's been reflected in short-term liabilities and will be paid in 2022. The other $700,000 that you've seen is actually sitting in our long-term liabilities and relates to severance payments that if an employee is terminated, you're obligated to pay under Mexican law. We did honor tenure by substituting our employees from the third-party into our company. So we felt it was appropriate to report that liability so that those seniority payments would be paid upon termination should there be attrition. So that $700,000 really, James, is probably more of a one-time blip. There will be occasional adjustments to that for price increases if there's changes in employee headcount, inflation, et cetera, but it will be rather minimal.

Great. And the next question, I guess, is for Allen. In terms of the reduction in the budget for the underground mine development, what led to that reduction? And what impact will that have on operations going forward, if any?

It wasn't a reduction in budget. What it was is we had underperformed our plan. And the reason for that, James, as you'll recall, we did suffer some ground control issues in late Q1. That necessitated new development that was not in the plan to get back into the Soledad vein. We have done that. But by doing that, we were unable to maintain our development rate as originally planned. Effectively, we diverted scarce resources to maintaining our production profile at the expense of the longer term development. Will it have an impact? Yes. Do I expect it to be something that you will see in the financial statements? No. We do have scarce resources in terms of development. We've got limited development teams. We've got limited development equipment. We are placing a great deal of emphasis on our exploration development. And at the same time, we need to recoup the lost meterage that we suffered because of the ground control issues. Now in a mine like this, typically you want about a year of developed workings ahead of you. Today we don't have that. So we are going to be making a huge push over the remainder of this year and most of next year to get back on track. I do not expect it to impact our operating results. It is certainly going to impact the schedule of the guys at the mine, but I don't think it will surface to the point of the financial statements.

Okay. That's good news. And then in terms of the renewed emphasis on the satellite areas such as Cerro Colorado and the area surrounding the Aguila project, should we expect any increase in the original exploration budget above the $7.2 million that was allocated? And also, can you give us any preview of the results to date on the drilling programs, either for delineation and expansion and its potential impact on the resource estimates?

It's premature for me to be able to address the latter at this point. However, what we are doing is placing a great deal of emphasis on in-mine and near-mine exploration. Those areas that you've just mentioned are all near-mine exploration. What we're trying to do is build up our resource and then subsequently our reserves to take away the perception in the marketplace that we're a short-lived asset. And that's really the thrust. We can go and focus on greenfields exploration miles away, but that doesn't move the dial in terms of resource growth. And we really do, I believe, need to be able to demonstrate increased resources just to put some investors at ease. Some investors do not understand that a mine of this type typically only has anywhere from 3 to 5 years ahead of it at any point in time. Exploration is difficult, mostly because it's primarily done underground. Driving exploration drifts is slow and time-consuming. So it's difficult to get a big resource ahead of us. That being said, that is our focus right now, both in terms of exploration drilling and infill drilling to upgrade mineralized material into the proven and probable categories. Does that answer your question?

It does, Allen. And that's fine. There's two last questions I have if time permits. One was for Kim. You had mentioned, Kim, that there was an increase on the consumable prices as well as the volume of diesel. Is that something we should be considering an ongoing increase for future quarters? Or is that a temporary one-time charge?

I'm going to take part of that question, James. Right now you're seeing increased cost per diesel for one primary reason. And that is we have been for this past quarter running two of our gen sets to supplement the grid power from Mexican authorities. We are anticipating that we will be getting an additional allocation of power from the grid beginning in September, which will hopefully eliminate that bump in diesel consumption, and you'll see that decrease. There are in fact, and everybody knows it, whether the feds or anybody else is willing to admit it, there is, in fact, inflation. And we are seeing the impact of it. Is it significant? It doesn't move the dial dramatically. Is it going to continue? Your guess is as good as mine. I personally, I think it will. But typically what happens in that environment is your inputs increase because of rising commodity prices, so does your revenue. So that may be overly optimistic, I accept, but that's really what I think will happen.

Sure. That is something I'm hoping for in some ways. I guess the last question was something I've heard with some of my readership, which is concerns or questions about the large increase in the potential issuance of new shares outstanding and the growth in the balance sheet. On a prior call, Allen, you had mentioned that the company is looking and targeting potential acquisition opportunities. Do you have any further color on how that's progressing with any prospects? Or are you still anticipating that's going to be a 2022 timeframe?

I don't have a timeline. Let me first address the initial part of your question regarding the increase in authorized capital. It was a significant increase, but it's important to note that we have a shelf prospectus for the ATM on file with the SEC. If we were to issue the shares mentioned in that prospectus, we would exceed our authorized capital, which would complicate the management of our capital structure. Therefore, we decided to increase flexibility. If we identify a suitable target, we would consider using our stock for the acquisition, but only if the transaction adds value on almost every metric. We will not issue a large amount of stock just to dilute the per-share net asset value or cash flow for our shareholders. By maintaining strict discipline and ensuring that any potential transaction is accretive, we are narrowing the field of possible acquisitions. Historically, the mining industry has struggled with discipline in mergers and acquisitions, often resulting in poor deals due to overpayment and neglect of M&A fundamentals. Transactions should only be pursued if they make sense and create value; larger size should not be the sole motivation, which seems to drive many M&A activities. This focus makes it challenging for me to provide a timeline for the company's potential activities. I am constantly looking for opportunities as they arise, particularly in the pure gold sector, where finding a sensible transaction is extremely difficult. You will see late development stage projects selling for a significantly low percentage of NAV, leaving little for buyers. The only way such deals could work is if gold prices are expected to rise significantly. If the gold price drops, it leads to failed transactions, which is not a risk I am willing to take. I want to grow the company, but I refuse to do so through undisciplined or inappropriate transactions. I can't provide timing on this, and while I wish I could, this initiative is inherently opportunistic, and it will happen when it happens.

That's fair, Allen. I appreciate the color, especially on the ATM as well as the metrics you might be looking at.

Your next question is coming from John Bair.

With Ascend Wealth Advisors. A number of them have been addressed here. I do want to go back to the onboarding aspect. And I guess, would it be fair to say that the requirements that you've had to address are across the board for other mineral companies, other exploration? My brain is in it. No other mineral companies, other exploration…

Yes. Let me answer it. I think I know where you're going. This onboarding process was necessitated by the change in labor legislation in Mexico. Historically, most companies, mining and other companies, hired their employees indirectly through, I will call it a service provider who actually hired the employees and then the operating company would enter into a service contract with the third party. Under the terms of this legislation, the government has determined that they want to eliminate that and have companies employ their workers directly. This is across the board. This is not mining-specific, it's Mexico-specific. The 10% that we've talked about in terms of bonus is mandated by legislation. However, there is no guidance within the legislation as to what that really means. When you talk to legal counsel, they would suggest that that is the top end of the bonus range. And there may, in fact, if you apply appropriate operating metrics and thresholds to it, it may be totally appropriate to pay a lesser amount, but we don't know yet. So we have taken a very conservative stance, taken the legislative amounts. So said that's what we're paying. The one-time cost that Kim alluded to of $700,000 is something that we would have incurred anyway. Our third-party service provider had to make severance payments when employees left. When we moved them across to our payroll, we carried with them their seniority and their history straight across. And that $700,000 effectively represents accrued severance and retirement obligations arising from past service. Does that put it in perspective for you a little bit?

Yes. That's very helpful. And so essentially they're eliminating staffing companies, that's basically what the legislation effectively does, assuming that happens for mining or oil and gas or agriculture or anything, it's pretty much across the board, is that fair?

That is correct.

Okay. Along the same lines, does that mean you may have to cover health care costs? I'm not sure about the structure down there or the legislative requirements. In other words, is it very different from the U.S. system if you're an employee of a company? Are there specific arrangements, or is everything like health care benefits handled by the government?

We provide our employees with health care benefits similar to those offered by U.S. employers. However, the cost of health care in Mexico is much lower than in the United States, making that portion of the expense significantly less. We were already covering these costs indirectly through our service provider, so we haven't noticed any changes in labor rates or benefits; those were just a pass-through. The only impact we experienced was due to the legislative change regarding the 10%. It's important to note that we have paid bonuses in the past, so while this may seem drastic, it is not a substantial operational shift for us. In some respects, it is more about appearances than about actual changes from a financial reporting standpoint.

Okay, very good. Shifting to the dry stack facilities and what you're doing there, is this going to allow for increased processing of material? Or are you just simply improving your disposal tailings and so forth that could be perhaps reprocessed at a later date should commodity prices rise? And what minerals are within that? Is it your byproducts as well as gold and silver?

Okay. I'll begin with the first question and address them. The use of dry stack is important because conventional tailings facilities can become filled over time. Eventually, you either need to expand or build new facilities, or you can adopt new technology. In our situation, we've determined that dry stack is more beneficial than conventional tailings for two main reasons. Firstly, it enables us to reclaim the original open pit by using it for dry stack deposition, allowing us to progress significantly in site remediation. In fact, we will exceed the required standards for site remediation by implementing dry stack technology. This choice is not driven by cost; when you analyze the profit and loss between the two methods, the filtration and dry stack option is slightly more expensive than conventional tailings deposition. However, the construction costs of the tailings management facility are extremely high. Thus, there's a trade-off between capital and operating costs. Environmentally, dry stack is much better. It's also superior from a reclamation standpoint and significantly reduces water usage as we recycle 80% of our processed water now. Previously, that water would exit through the tailings facility and be lost to evaporation, which greatly cut down our water consumption. Regarding our tailings, they will include everything we produce. However, if we manage our operations correctly, the amount of metals in our tailings will be minimal, resulting in no appreciable residual value now or in the future. You might have heard of companies reprocessing historic tailings where older gold mines might have around 4 to 5 grams in their tailings while they were mining 30 grams, meaning they weren't focused on extracting every bit of payable metal. In contrast, advancements in practices over the last 20 years have led to a significant increase in metal recovery through leaching or flotation technologies, resulting in very little payable metal in our tailings. Does that answer your question?

Absolutely. That's very good. I appreciate that.

Your next question is from Lawrence Danny.

I'm a private investor and shareholder. And first of all, I'd like to congratulate you all on a good second quarter. Here's my question. So given your strong cash flow and increased capital in the bank, is it feasible? I know you've got infrastructure that you're investing in, but is it feasible that in the next 6 to 18 months, a dividend increase is possible?

Your question seems straightforward at first, but it becomes quite complex upon closer examination. It really gets to the core of capital allocation and management. I have consistently expressed my commitment to growing the company. If I'm successful in achieving that, there could be alternative ways to use our capital that might provide a greater return for investors than simply a slight increase in the dividend. If we find ourselves in 18 months with around $80 million in the bank and no immediate strong capital use, I would certainly consider returning some of that capital to shareholders. However, my primary focus right now is on maintaining our dividend, which is currently around a 2% yield, and I do not intend to discontinue that. I aim to build a substantial cash reserve that allows us to seize opportunities as they arise. So while I am not ignoring your question, I want to emphasize that my priority is to establish cash reserves for flexibility in growing the company. If opportunities do not emerge, I would definitely think about distributing some of that capital back to shareholders.

There was a question that came online from George regarding the number of employees that were impacted by the labor reforms. And George, thank you for that question. It was approximately 500 employees at some round numbers. And we do have other individuals on site, but they're working on construction and other projects.

I received an online question about whether we are considering buying back shares in the open market. This relates to the earlier question and involves capital allocation. I want to share my perspective. Throughout my experience as a director and manager of various companies, I have seen that share buybacks, whether through a normal course issuer bid or a substantial issuer bid, often don't achieve their intended goals. Typically, the bank balance declines, the stock price remains stagnant, and the float is reduced. While it could work if you were to conduct substantial issuer bids and buy back a significant portion of your company, small-scale buybacks tend to be ineffective. Personally, I prefer shareholder distributions via dividends over share buybacks. This is my personal opinion and doesn't represent the views of the entire Board of Directors. It may not be a widely accepted stance, but I believe dividends are a more effective method for returning capital to shareholders than stock buybacks.

So Allen, at this time, there are no further questions. We would like to thank you again for attending the call, and we will talk to you again next quarter.

Thanks, everyone.

Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.