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Pan American Silver Corp. (NASDAQ:PAAS)

Q4 2008 Earnings Call

February 19, 2009 11:00 am ET

Executives

Geoffrey Burns - President & CEO

Steve Busby - COO

Michael Steinmann - EVP, Exploration & Mine Geology

Rob Doyle - CFO

Kettina Cordero - Coordinator, IR

Operator

Welcome to the Pan American Silver Fourth Quarter and Year End 2008 Earnings Call. During today's presentation all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions) This conference is being recorded today, Thursday, February 19, 2009.

I would now like to turn the conference over to Mr. Geoff Burns, President and CEO. Please go ahead sir.

Geoff Burns

Thanks, operator. Good morning ladies and gentlemen and welcome to Pan American Silver's fourth quarter and year end 2008 earnings release conference call. Joining me today here in Vancouver are Steve Busby, our Chief Operating Officer; Michael Steinmann, our Executive Vice President of Exploration and Mine Geology; Rob Doyle, our Chief Financial Officer; and Kettina Cordero, our Coordinator of Investor Relations.

Before I ask Steve, Michael, and Rob, to update you on our mining operations, our development projects, our exploration programs and our financial conditions, I would like to start by making some brief comments about our performance during the fourth quarter and some observations about the current environment.

When we last spoke at our third quarter earnings release call, on November 13th last year, I talked about how the precipitated fall in base metal and silver prices would impact Pan American's fourth quarter. I also outlined for you a number of steps we had implemented to combat the declining prices we were seeing.

As a reminder, here is what we did last November. To insure we were well positioned to weather these volatile times, we immediately reduced our workforce company-wide by over 500 employees in contract. All of our senior executives took a 10% wage roll back. We deferred almost all of our Greenfield exploration programs and significantly reduced our Brownfield explorations.

We revised our mining plants to increase mined ore grades across all operations. We canceled discretionary capital expenditures. We reduced or eliminated these external consultants and contractors and where elimination was not an option, we requested that charge out rates be reduced. We reviewed all our major supply and service contracts and requested price adjustments.

In addition, we updated yield in early January with a release describing what we were seeing. So I trust this comes as no surprise that our fourth quarter results were less than scintillating. Here are our headline metrics. In the fourth quarter, we produced 4.6 million ounces of silver at a cash cost of $8.24 per ounce. We recorded a net loss of $33.3 million or $0.41 per share, which included atypical charges of $35.5 million, which I am sure Rob will describe for you in a few moments. And we generated a very modest positive adjusted cash flow from operation of $4.3 million.

Even with the most difficult fourth quarter I would have to say that our full year results were very respectable and we accomplished a number of things which has positioned us extremely well going forward. We produced almost as forecast, our company record 18.7 million ounces of silver, at a cash cost of $5.96 per ounce, registering our 13th consecutive year of growth. We recorded net income for the year of $24.6 million or $0.31 per share.

We generated a record adjusted cash flow from operating activities of $95.6 million or $1.19 per share. We basically replaced all the proven and probable reserves that we mine, or were lost due to lower price assumptions and we start 2009 with a healthy 224 million ounces of silver in proven and probable reserves.

We completed construction of our Manantial Espejo [silver dore] and gold mine in December and are ahead of our planned commissioning timetable. And our expansion of San Vicente was 92% complete at the end of December.

We accomplished almost everything we set out to do, in spite of having to rise through an exceedingly difficult period. Yes, we got on the wrong side on the strengthening US dollar which hurts. Yes, base metal prices fell further and faster than probably anyone could have guessed and yes, costs climbed higher and faster than we could come back, propelled by energy prices and material costs.

That is history and what counts is how we responded, where we are right now and what we see going forward. I am going to save my comments on Pan American's future outlook until after Steve, Michael and Rob have provided you with some additional detail on commentary for the recently completed quarter. Steve?

Steve Busby

Thank you, Geoff and good morning ladies and gentlemen. As we discussed in our third quarter conference call last November the fourth quarter started with the realization that the collapse of the metal prices had undermined our operating plans and immediate reaction was needed. We immediately gathered our top managers via teleconferences, site visits and meetings conducting a detailed examination of our mine plans under the new price environment for metals, and debated each of our primary costs and productivity drivers.

The results plainly demonstrated to each of us that we needed to drastically change the way we approach our business and as such we launched the 15 point action plan that Geoff has summarized including: reductions in workforce, reductions in salaries, aggressive pursuit of supplier and contractor cost reductions, implementing a hiring wage freeze, showing up our mine cut off grades against the new metal prices and operating costs, reducing our mine developments to only those areas for no more than 2 years in advance of mining and reducing discretionary spending to absolute minimum levels.

Our fourth quarter was a time to challenge our management skills to successfully implement the 15 point cost saving initiative we had to develop. I am pleased to be able to tell you that we are indeed succeeding in these efforts. However, before I tell you about the successes we are seeing I must report our operating performance results during the difficult transition period of the fourth quarter.

During the fourth quarter our operations produced 4.64 million ounces of silver at a cash cost of $8.24 per ounce, which was heavily impacted by the declines in the price of our base metal by-product credits; lingering severe cost escalation in labor, energy and materials, as well as production disruptions from a few unexpected mechanical failures and impact from extreme climatic events, which have all now been rectified.

Our fourth quarter production was again led by Alamo Dorado's 1.4 million ounces of silver in Mexico, at a cash cost of $6.18 per ounce. Alamo Dorado's production was slowed in mid October after hurricane Norbert hit the mine in the surrounding areas. The surrounding communities and access roads incurred heavy damage, but fortunately the Alamo Dorado mine had minimal impact and our environmental protection systems held up well.

Alamo Dorado has produced over 518,000 ounces of silver at a cash cost of less than $5.50 per ounce in January of 2009. We anticipate this style of result to continue and deliver us the solid first quarter 2009 performance.

The La Colorada Mine in Mexico produced 962,000 ounces of silver at a cash cost of $8.50 per ounce in the fourth quarter of 2008. We have significantly reconfigured the La Colorada operation during the fourth quarter and into January of 2009, reducing the overall mining rate 27%, from 31,250 tonnes of ore per month in the fourth quarter, to 22,800 tonnes per month planned for 2009, while increasing the grade of ore mined. We will be targeting grades of 436 grams of silver per tonne and 1.57 grams of gold per tonne during 2009. This compares to 362 grams per tonne of silver and 0.43 grams per tonne of gold achieved in the fourth quarter of 2008.

This reconfiguration allows us to knock out marginal ores reducing the operating costs from $8.50 per ounce achieved in the fourth quarter to an estimated cost of $8 per ounce in 2009. The mine has been successfully reconfigured and we have just completed three critical ventilation raises setting us up well for achieving our 2009 forecast.

Our Peruvian operations required the most retooling efforts with their heavy reliance on base metal by-product credit. During the fourth quarter of 2008, our Peruvian operations produced 1.8 million ounces of silver at a cash cost of $10.33 per ounce; heavily burdened by falling base metal prices and the lingering cost escalation, as well as production disruption caused by a pinion and gear failure on the primary ball mill at Huaron and a loss of a drive motor on the main underground access shaft at Morococha, which has both been rectified going into 2009.

During the fourth quarter and into 2009, our Peruvian operations reduced their overall workforce by 724 individuals. They have minimized all discretionary spending. They have limited mine developments to no more than two years now and reconfigured their mine plans targeting higher grade ores.

Pan American Silver also announced in early January 2009, that it was beginning preparations to suspend operations at Quiruvilca as a consequence of the lower prices. These changes are all starting to show benefits, as our operating results improved during January 2009 show 686,000 ounces of silver produced at a cash cost of $6.53 per ounce or a 37% improvement over the fourth quarter of 2008 including achieving the positive cash flow from our Quiruvilca mine as it prepares for suspension.

We anticipate sustaining or improving these programs through all of 2009 with the suspension of the Quiruvilca mine depending on when we exhaust the profitable ores given the actual metal prices of the day.

Our San Vicente project in Bolivia actually had an excellent fourth quarter, [firstly and] producing 361,000 ounces of silver at a cash cost of $6.10 per ounce, while advancing the plant construction project to 92% complete at year-end.

We had opened our first mining level under new high grade litoral vein, which has led up to everything we had anticipated it to be and was largely responsible for lifting the ore feed grade in the fourth quarter to 472 grams per ton of silver, compared to the previous quarter of 324 grams per ton of silver, along with 2.6% zinc and 0.4% copper.

Actually, we are able to process some limited litoral ores in January of 2009, although we had not planned for it, but the total treatment program is now complete and we are getting ready to start production in our new plant.

We have essentially completed construction of the new plant and associated infrastructure and have begun commissioning. We are expecting our first ore to the plant in early March ramping to full production through August of 2009.

Total capital expenditure through yearend was $64.7 million with a total estimate on completion now at $71.3 million, within about 10% of our previous estimate.

We have the commissioning and training teams on site and have hired essentially all of the plant and maintenance personnel needed for the long-term operation. We are very excited to get this plant running particularly with the excellent results we have tasted from the new Litoral high grade ore development.

I am very pleased to report that our startup at Manantial Espejo in Argentina is advancing extremely well following the first dore poured on December 29, 2008. We have overcome tremendous obstacles at Manantial Espejo relative to unprecedented demand for mine development equipment, materials and personnel in a country that is just beginning to accept the benefits of mining and we have endured some incredibly hostile climatic conditions in this remote location.

It has not been without challenges that the outcome is very gratifying, as we watch shipments of dore leaving the mine. I am very pleased to report that we have produced 207,000 ounces of silver and doré bars at Manantial Espejo in January 2009 at a cash cost of $2.22 per ounce, and that is a gold byproduct credit.

In addition to the dore, we had another 114,000 ounces of silver contained in precipitant waiting for melting at the end of January. Incredibly, we have had to put double shifts on in our refinery, which is a kind of startup problem everybody only dreams about.

The plant processed nearly 38,000 tones of high grade ore in January, which is about 61% design capacity and ahead of our ramp up projections. The silver and gold recoveries in January were 84% and 93.5% respectively which is within 9% of the silver design and 1% of the gold design also well ahead of our ramp up expectations.

February is progressing very well and barring any unforeseen disruptions, we expect to reach design capacities and recoveries by the end of March of 2009, and hope to declare commercial production in the first quarter.

We have appeared to achieve positive cash flows in February and have established the final mine development capital cost at $224.6 million inclusive of $29.7 million of recoverable VAT tax.

The underground surface mines are well advanced and we have over 200,000 tons of ore stockpiled ahead of the mill. We are confident Manantial Espejo will achieve its annual average 4 million ounces of silver and 60,000 ounces of gold production for many years to come.

Overall, Pan American Silver has produced 1.7 million ounces of silver in January of 2009 at a cash cost of $5.97 per ounce reflecting the successes of our cost saving initiatives that were launched in the fourth quarter of 2008, where we had produced 4.6 million ounces of silver at a cash cost of $8.24 per ounce.

I am very pleased with the quick and decisive actions from our quality management team during the fourth quarter and proud that these actions have started to show such excellent results.

I will now turn it over to Michael Steinmann for an exploration update.

Michael Steinmann

Thank you, Steve and good morning everybody. During each quarterly conference call in 2008, I updated you on the results and the advances of the exploration programs in our greenfield and brownfield projects. These efforts and results are reflected in the 2008 reserve and resource statement, which we finalized as of December 31, 2008.

Details for each operation have been published in our press release on February 17th and are available on our corporate web site. Although we made some important changes, especially to our greenfield programs during the last quarter, we essentially completed our 2008 planned, 100,000 meter Diamond Drill program.

As with previous years we have been very successful with the exploration of our operations. It is covered and defined during 2008 a total of 26.9 million ounces of silver, more than replacing the 22.2 million ounces mined. However, lower base metal price assumptions, coupled with higher cut-off grades, downgrades of 8.8 million ounces from reserves to resources, resulting in a corporate proven and probable reserve of 223.7 million ounces as of December 31, 2008, only 1.8% lower than the year before while ore reserves increased by 1% to 701,000 ounces.

I am extremely pleased with this result. It confirms again the tremendous exploration potential we have in some of our assets. As mentioned before, detailed results from each of our operations and for all reserve and resource categories are available on our web site,

and I would like to discuss here some of the highlights in further detail.

At Huaron, proven and copper reserves increased 5% or 3.2 million ounces; after subtracting ore mines during 2008 were a total of over 62 million ounces, larger than indicated resources spent at 11 million ounces and incurred resources contained over 30 million ounces making Huaron one of our largest silver resource.

The most significant increase came from the [course of the year] where we added 5.7 million ounces. Morococha's proven and probable reserves increased by 10% or 3.1 million ounces net of 2008 for a total of over 35 million ounces, also with an indicated resource of another 15.7 million ounces, while inferred resources account for additional 40.8 million ounces. No doubt that the best exploration results have been achieved in the Morro Solar vein where we added over 10 million ounces of resources of which 4.5 million ounces have been upgraded into proven and probable reserves. Exploration will continue at Morro Solar and parallel veins in 2009, and only a small portion of the 2.5 kilometer long vein has been drilled up to now.

La Colorada, we added 4.6 million ounces of silver and this time we spent 1.4 million ounces basically replacing all the resource mined during 2008. We experienced a reserve loss of 5.9 million ounces of Alamo Dorado due to mine production during the year and 4.1 million ounces at Quiruvilca due to mine production and the company's intention to prepare the mine for a period of care maintenance.

We heard from Steve the exciting news on the Manantial Espejo; we are holding over 25,000 hectares of land around Manantial, which contains a very large number of large [outcropping core veins]. Some of them have been partially drilled, but most are completely unexplored. I am very excited that now with the construction of the mining processing plant complete, we can resume our exploration of Manantial Espejo and explore its enormous potential.

The corporate 2009 exploration program contains a total of 53,000 meters of Diamond Drilling at a cost of approximately $4.8 million. Our exploration efforts will remain largely focused to how we operate and on a limited number of select high-potential projects in Mexico and Peru, while maintaining our important land positions in both the countries.

Now to Rob for a financial review.

Rob Doyle

Thank you Michael and good morning everyone. Our financial results in Q4 2008, is really impacted by the turmoil in the metros and FX market. Soft decline in base metals was the primary factor behind the decision to prepare Quiruvilca for care and maintenance in 2009 and as consequence of that decision, to write down the carrying value of the mine to zero and to fully accrue all cost related to the impending decision of mining activities.

As a result an impairment charge of $15.1 million was recognized along with an increase of $3.3 million for the provision of severance payments, which was charged to other expenses. Also included in other expenses for the quarter, were expenses related to reducing our workforce across the entire company of $1.1 million.

Declining metals prices in Q4 also led to negative price adjustment of $8.8 million; as provision of concentrate sales recorded in Q3 were adjusted downward to reflect the lower prices. This negative adjustment to the sales line in our statement of operations was one of the factors behind the mine operating loss generated in the quarter of $9.9 million; the first such loss since the first quarter of 2003.

Soaring US dollar caused us to recognize significant losses against our forward purchased of Mexican pesos and American dollars. In total, we recorded losses on these currency books of $12.3 million in the quarter of which $2.8 million was recognized.

These losses were partially offset by gains of 6.4 million, which came from our zinc and lead forward sales position, leaving us with a net loss on commodity and currency contracts for the quarter of $5.8 million.

In addition, the strengthening US dollar caused us to revaluate our non-US dollar cash and other working capital balances lower, creating a loss of $8.3 million in the quarter offset by gains on non-US dollar liabilities of $7.2 million; leaving us with a net FX loss of $1 million.

Items I have mentioned unadjusted for tax effects totaled $35.5 million. These actions were distinct from our normal operating results and go a long way on explaining the net loss we incurred in the period of $33.3 million.

Another negative impact of lower base metal prices that Steve highlighted was seen in our reported cash cost per ounce as we utilized revenues from our base metal production as the byproduct credit against the cost of producing silver.

These credits declined by $4.61 per payable ounce in Q4 relative to the comparable period of 2007, and as a consequence, our cash cost declined to $8.24 per ounce in the fourth quarter.

Our income tax recovery for the quarter was $8.5 million, which was an effective tax recovery rate of only 20%, and effective rates were well below our expectation, given the tax rate prevailing in the jurisdictions in which we operate. However, we had several expenses which were not tax effective in the period and also paid approximately $2 million under the new IETU Flat Tax regime in Mexico, that was instituted in 2008; both of which had the effect of reducing our tax recovery rate for the quarter.

Cash flows for the quarter were dominated by our investments to complete the construction of Manantial Espejo and to advance the expansion of San Vicente to an estimated 92% completion.

In the Manantial Espejo, we spent $28.5 million, bringing our total capital cost at mechanical completion, which reached in late December to $224.6 million. That is inclusive of $29.7 million of refundable debt as reported earlier by Steve.

While at San Vicente we spent an additional $22.1 million during the quarter. In total, we invested $60.2 million in mineral property advance and equipment during the quarter, which was funded out of our cash and short-term investment balances.

As Geoff mentioned earlier, despite a very challenging fourth quarter, overall 2008 was a successful year for Pan American. We reported record sales of $338.6 million on the background of outstanding year of [dore mined order], generated record cash flow from operating activities of $93 million with each of our operations contributing meaningfully.

Our non-operating earnings were a healthy $93.2 million and net income for the full year 2008 was $24.6 million or $0.31 per share. Cash flow generated from operations during 2008 of $93 million; together with proceeds from the warrants exercised in the first quarter of $50.8 million; proceeds from the sale of our interest in Dukat of $12.2 million, and $87.9 million of our treasury assets were all used to fund our investment in our project development activities and operations of $243.8 million for the year.

Getting to the balance sheet, we finished the year with the working capital position of $93.5 million, with the current ratio of 2.2 to 1. Our current liquidity position after the receipts of proceeds of our recent common share offering of $98.6 million is a healthy $125 million in cash and short-term investments.

We have no debt and our forecast for 2009 indicates that we will generate positive cash flow from operations and our budgeted prices from each of our hedged mines sufficient to cover our consolidated capital budget of $29.4 million, including 5.4 of capital remaining to be spent in San Vicente.

Our budget assumptions for metal prices were $10 for silver, $725 for gold, $1150 for zinc, $1800 for lead, and $3500 for copper. The current precious metal price is significantly above those levels. We expect that our liquidity and working capital position will continue to strengthen over the course of 2009.

In addition to our liquidity and capital resources, we have an un-drawn $70 million revolving credit facility that can be used for general covert purposes, including acquisitions.

With those comments, I will hand it back to you, Geoff.

Geoffrey Burns

Thanks, Rob. Okay, you have now heard in detail where we were. Let's look at where Pan American is headed, and why I am exceedingly optimistic about our prospects for 2009 and beyond.

We are forecasting our 14th consecutive year growth in 2009 and are planning to produce 21.5 million ounce of silver at an average cash cost of $6.28 per ounce. We plan to more than double, actually almost triple our gold production and are planning on producing 85,000 ounces of gold in 2009.

With the start up of Manantial Espejo and the expansion of San Vicente fuelling our growth, we will also see a significant reduction in our overall exposure to base metals.

We estimate that in 2009, silver will account for 58% of our revenues, while gold sales should account for another 16%. 74% of our revenues are now exposed to precious metals. We have swallowed the bitter pill and taken a tough step to reposition our mining operation and the results are now showing. I think it is worth repeating what Steve mentioned in his review. In January, we produced 1.7 million ounces of silver at a cash cost of $5.97 per ounce; that is a 28% reduction in our cash cost, as compared to the fourth quarter of last year.

We are preparing the highest cost of operation at Quiruvilca for a period of care and maintenance. Probably the toughest decision given the care growth was Pan American's founding operations when it was first acquired back in 1995, but its cost of production was rising and silver production was declining as it became more and more dependent on zinc. And Pan America can better expend its people resources on creating more value at our other assets. This has been wonderful mine for us this time.

With the recent financing, no debt and untapped line of credit, and expected positive operating cash-flows this year, we are exceedingly well positioned to aggressively look for new growth opportunities, where we can make a positive contribution. Last week, our move toward increase sale and exposure to both gold and silver could not be more timely, in my opinion. The prices of both precious metals have significantly increased since the end of last year in response to an economic crisis of global proportion.

Silver is trading at $14 per ounce, although off a little bit this morning. And gold is closing in on a $1000 per ounce. And I think these are ample reasons to believe they will push higher in 2009. Pan America is again well positioned to reap the benefits of what I believe, will be a stronger price drift over this year.

In closing, I would like to thank all our long-term shareholders who have ridden with us through a difficult second half of 2008 and I would like to welcome our new shareholders, who have recently come on board with our equity financing. I am hopeful; you and all of our stakeholders will be rewarded in 2009 and beyond.

Thank you and I would ask the operator to open the line for questions.

Question-and-Answer Session

Operator

Thank you Sir. We will now begin the question and answer session. (Operator Instructions). One moment please for our first question. And Mr. Burns, it appears there are no questions at this time.

Geoff Burns

Right. Thank you operator. Again I would like to thank everyone for joining us here this morning and I am very much looking forward to reporting back to you with our results through the first quarter, probably in mid-May and to update you on our startups at San Vicente and how we are progressing and Manantial Espejo. Until then thanks very much.

Operator

Thank you, ladies and gentlemen. This concludes the Pan American Silver fourth quarter and year-end earnings conference call. This conference will be available for replay after 10 am, Pacific Standard Time, today through, through February 26, 2009 at midnight Pacific. You may access the replay system at any time by dialing 1800-406-7325 and entering the access code of 3984271. Thank you for your participation. You may now disconnect.

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