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HudBay Minerals Inc. (NYSE:HBM)

Q2 2014 Earnings Conference Call

July 31, 2014 10:00 AM ET

Executives

Candace Brule - Director, IR

David Garofalo - President and CEO

David Bryson - SVP and CFO

Alan Hair - SVP and COO

Analysts

David Charles - Dundee Capital Markets

Matt Murphy - UBS

Stefani Anu - Hybrid Securities

Greg Barnes - TD Securities

Gary Lampard - Canaccord Genuity

Orest Wowkodaw - Scotiabank

Operator

Good day and welcome to the HudBay’s Q2 2014 Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Ms. Candace Brule, Director, Investor Relations. Please go ahead, Ms. Brule.

Candace Brule

Thank you operator. Good morning and welcome to Hudbay’s 2014 second quarter results conference call. Hudbay’s financial results were issued yesterday and are available on our website at www.hudbayminerals.com. A corresponding PowerPoint presentation is also available and we encourage you to refer to it during this call.

Our presenter today is David Garofalo, Hudbay’s President and Chief Executive Officer. Accompanying David for the Q&A portion of the call will be David Bryson, our Senior Vice President and Chief Financial Officer; Alan Hair, our Senior Vice President and Chief Operating Officer; Brad Lantz, our Vice President Business Development and Technical Services and Rob Winton, our Vice President Manitoba Business Unit.

Please note the comments made on today’s call may contain forward-looking information, and this information by its nature is subject to risks and uncertainties and as such actual results may differ materially from the views expressed today. For further information on these risks and uncertainties, please consult the Company’s relevant filings on SEDAR and EDGAR. These documents are also available on our Web site.

For the purposes of this presentation we have assumed a U.S. to Canadian dollar conversion ratio of 1:1. And now, I’ll pass the call over to David Garofalo. Dave?

David Garofalo

Thanks Candace. Good morning everyone. During the second quarter we saw notable increases in our production earnings and cash flow over the same period last year. These increases are especially significant since it represents the beginning of our expected production earnings and cash flow increases as we are on the verge of completing the mine building plan we laid out four years ago. We also continue to solidify reputation as being a low cost operator. Our operating costs at our Manitoba business unit improved in the second quarter relative to comparable periods, primarily reflecting economies from the increase in scale of our business in Manitoba.

Ore production at our Manitoba business unit was 23% higher than the prior year’s second quarter as a result of higher production volumes at Lalor and a full quarter of production at Reed. This, factored together with the continued reduction of contract labor at 777 at Lalor resulted in an improved unit cost performance across the Manitoba business unit.

Despite the increases in production, earnings and cash flow, our financial results were negatively affected by continued accumulation of unsold copper in concentrate and refined zinc amounting to approximately 14% and 8% respectively of the quantity produced in the quarter. This was due to poor rail service availability following extreme weather conditions in early 2014 and recent flooding in Manitoba. Steps have been taken to improve rail car availability and the excess copper concentrate and zinc metal inventories are expected to be drawn down over the balance of 2014 with a majority of the draw down in the fourth quarter.

Our production and operating cost results to date, the successful completion of Lalor shaft, the Snow Lake concentrator expansion commissioning and full a production at Reed have enabled us to remain confident in our 2014 guidance, which remains unchanged. During the quarter, we executed the previously announced $150 million four year Constancia standby credit facility. We also entered into a long term agreement for the sale of approximately 20% of the life-of-mine copper concentrate production from Constancia on standard market terms.

We continue to achieve significant milestones in our growth projects. At Constancia we’ve achieved 15 million man-hours without a loss-time accident. The project is on track towards initial production late this year with construction approximately 85% complete at June 30, 2014.

Construction of the power transmission line for Tintaya to Constancia is complete and is expected to be commissioned shortly. Pre-stripping continues to advance well and first ore was placed on the run of mine pad in July. Mine construction activities continue to progress well. At the Lalor project we are approaching 1000 days without a loss-time accident. The underground mine project development was completed on time and on budget. We’ve also completed a new 6000 tonne per day production shaft and the [indiscernible] commissioned it for ore and waste hoisting as well as personnel transport.

Handover activities continue with ore and waste being skipped in July and with the substantial completion of the Snow Lake concentrator refurbishment our processing capacity will more than double to 2,700 tonnes per day. In July 2014 we successfully acquired the Rosemont project through the acquisition of the Augusta Resource Corporation. Rosemont provides us with another meaningful source and medium term copper production growth complementing our already sector leading production increases expected over the next year.

At our 100% owned Constancia project in Peru, we have invested and committed approximately $1.6 billion through June 30, 2014 of the construction budge $1.7 billion. The project was approximately 85% complete on a proportion spent basis at the end of June of 2014.

Construction of the power transmission line from Tintaya to Constancia is complete and we expect it to be commissioned shortly. The main substation at Constancia has already been energized using diesel power generation and plank commissioning activities have begun. Pre-stripping continues to advance well and first ore was placed on the run of mine pad in July. The contract for concentrate transport is expected to be awarded in the third quarter of 2014. Mine support facilities are well advanced with the explosives magazine substantially completed and construction of the truck shop well advanced.

Construction activities continue to progress well. Commissioning activities have begun on the primary pressure in course or stockpile conveyance systems. Major mechanical installation is now complete in the grinding area with work focused on piping and electrical installation. Tank and floatation cell leak testing has now commenced in the flotation and thickening area. Heavy civil works also continue to progress well in all areas and targeted water empowerment [ph] volumes for start-up have now been achieved.

The project remains on track for first production late 2014 and commercial production in the second quarter of 2015. At a 100% owned Lalor project in Manitoba, we have invested approximately $404 million of the total mine construction budget of $441 million and have entered into an additional $32 million of commitments to June 30, 2014. We’ve completed the underground mine development as well as the new 600,000 ton per day capacity production shops and mechanically commissioned it for hoisting as well as personnel transport.

Construction is complete on the 910 and 955 meter levels on the mine dewatering systems, rock breakers and the load dock systems. There is minor electrical work remaining that is expected to be completed next month. Commissioning of the rock breakers the load dock system is complete and we will commission the main dewatering system after the remaining electrical work has been completed. The remaining committed funding is largely for the office and change house and surface exhaust fan installation. We expect the completion of the remaining surface construction to be completed in late 2014. We’ve also substantially completed the refurbishment of a Snow Lake concentrator which is now being commissioned to treat 2,700 tonnes per day, doubling its previous capacity.

An underground exploration ramp at Lalor from the 955 meter level will be started in the third quarter of 2014. Once established, we expect to conduct approximately 1,300 meters drilling on lens 27, the copper/gold zone in the fourth quarter of this year. The exploration drilling is intended to assist in the upgrading of improved resource to a higher resource category and allow for an expanded program in 2015 to further test the down dip extension of the copper/gold zone.

We have total pro forma available and committed liquidity of approximately $1.0 billion, including $547 million in cash and cash equivalents at June 30, 2014, $135 million due from Silver Wheaton and a $150 million in availability under the Constancia credit facility. We also intend to refinance the $117 million of loans made to Augusta with the proceeds from the proposed $150 million bond financing announced this morning. During the last six months of 2014, we anticipate making approximately $291 million in capital expenditure on the Constancia Lalor projects in addition to $209 million in accrued but unpaid expenditures on these projects as of June 30, 2014.

2014 represents a year of significant growth milestones for HudBay. In the first half of this year, we achieved commercial production on time and under budget for Reed and now we are enjoying the benefits of full production at that project. We’ve also completed the construction at the Lalor mine on time and on budget. Handover activities continue with ore and waste being skipped in July and we substantially completed the upgrade to the Snow Lake concentrator which has a production capacity of 2,700 tonnes per day, double as previous rate.

Our next major milestone with Lalor is completing the exploration ramp, which we expect to start in the third quarter. We also recently acquired the Rosemont project adding another growth opportunity to our portfolio of long life low cost projects. And finally, at Constancia we remain on track towards achieving first production which is expected during the fourth quarter of this year.

With that operator, we’d be pleased to take questions.

Question-and-Answer Session

Operator

The first question comes from David Charles from Dundee Capital Markets. Please go ahead.

David Charles - Dundee Capital Markets

Maybe just a quick question, a little bit of a detail. I think early this year you guided that as you move from the last phase to the current phase at Lalor, there might be a period of a month or two where you would have to decide at what point you would declare commercial production. When I read your MD&A, it sounds like that's gone down to a month. I just wanted to be sure that it looks like Lalor is going a little bit maybe faster than expected and that would suggest that third quarter will be a little bit better than you had previously hoped?

David Bryson

Hey, David. It’s David Bryson. With the accounting definition of commercial production, it varies based on the circumstances and for the commissioning of the Lalor production shaft, given that there is already an operating mine underground, we determined that it was appropriate to just have a 30 day test for the main production shaft there. That was really independent with any assessment time how the project is going, although it’s going well. So what we expect during the third quarter is certainly that month we would be back in pre-commercial production. The revenues and cost associated with that would go to the balance sheet rather than to the P&L, although that’s going to be smoothed out a little bit because that flows through into inventory and so we’ll have inventory that was produced prior to the start of that period, that we’ll still recognize into earnings and then some of the inventory produced during the pre-commercial production period will be sold and recognized after the end of the period. So you should see some impact on that in Q3, but probably not a dramatic impact.

David Charles - Dundee Capital Markets

Excellent and is it safe to say that if I’m not mistaken, the hoisting is going very, very well and that you’ve lots of underground development already completed and so your expectation would be that as you said, that basically production from Lalor would start to ramp up pretty fast?

Alan Hair

Hi David its Alan Hair. Yes, that’s correct, the shafts [indiscernible] have been commissioned and both ore and waste has been hoisted up the shaft. So we’re just doing handover to operations currently and we should slowing into production and early August.

Operator

Thank you. The next question comes from Matt Murphy from UBS. Please go ahead.

Matt Murphy - UBS

Just wondering if you have had any change in -- progress and thoughts on a Lalor concentrator given your acquisition of Augusta?

David Garofalo

We’re still -- we’re looking at basically we did the optimizing the Lalor mine plant in the concentrator path going forward. So that work is still underway and we should have reached a conclusion by later this year

Matt Murphy UBS

By late this year?

David Garofalo

Yes.

Matt Murphy – UBS

Okay. And on Augusta just any updates on you’re thinking on timelines for permitting of Rosemont?

David Garofalo

Its early days. That's as far we’re concerned. Obviously we’ve just taken over the project. We'd like the permitting process to go forward as quickly as possible but we want to respect the process and make sure that the process is forward we end up with the permits in a timely fashion. So really I don’t think we’re really in a position to give any specific guidance on timeline at this stage. Obviously our expectations previously were it take longer to get penalties than Augusta had been indicating and that's still our view.

Operator

Thank you. Your next question comes from Brett Levy from Jeffries. Please go ahead.

Brett Levy - Jeffries

Yes, the time that the Augusta Rosemont transaction was announced, you’d probably only need to spend about $30 million on the ramp up before Constancia was at full production. As you sort of get in there, give a little sense as to what you think the timeline might be and the expenditures on Rosemont as Constancia ramps up.

David Bryson

I'd suggest it is very early days. Yet we've really only started to look under the hood as it were and currently still developing budgets and plans around that. So I don’t think it’s appropriate to give guidance at this time.

David Garofalo

But I think Brett, it's is fair to say that the spending that we anticipate on Rosemont prior to commercial production at Constancia is not particularly material.

Brett Levy - Jeffries

All right. And with this new refinancing and some of the other sort of I think you said 219 and 209 of other expenditures, can you give a revised CapEx budget for this year and then also can you sort of say the point at which liquidity as you guys see it, would be at its lowest and give a rough sense as to what trough liquidity would be somewhat near?

David Garofalo

Okay. The CapEx for each of our projects are laid out in our MD&A and our CapEx for Constancia and Lalor, all of that is going to be spent this year. Our sustaining CapEx guidance is on track for the full year. As we look ahead from a liquidity perspective, we expect to reach minimum cash position in either very late this year or during the first quarter of 2015. And I think including available credit facilities and minimum cash, we’d expect minimum liquidity, obviously recognizing that there is a financing transaction pending that we’re not in a position to speak to in any detail, but I think we'd anticipate minimum liquidity of comfortably above $300 million if not significantly higher than that.

Operator

Thank you. The next question comes from Stefani Anu from Hybrid Securities. Please go ahead.

Stefani Anu - Hybrid Securities

Just wondering the $135 million from Silver Wheaton, is that something that's come in this quarter or is it about to come in or can you give us some maybe guidance on timing for that?

David Garofalo

We expect to receive that during this third quarter, Stefani.

Stefani Anu - Hybrid Securities

And just I know its early days are Rosemont, but just now that [indiscernible] in your hand, you reviewed the project obviously to a certain extent to make the acquisition. Would there be any sort of notable scope changes that something that you may do differently in the development plan that would also alter the permitting schedule on that project or is it the way it’s laid out in the feasibility from Augusta’s work, is that pretty much the status quo going forward?

David Garofalo

Certainly our view currently that it will be far simple. So continue with the financing process that’s already in place. So we don’t want to be changing anything mid-cost.

Operator

(Operator Instructions). The next question comes from Greg Barnes from TD Securities. Please go ahead.

Greg Barnes - TD Securities

Alan, can you step us through the next six to nine months at Constancia and how you see the ramp up of the concentrator going and what the critical steps in your view are?

Alan Hair

We're obviously well advanced now on the construction side. So there is a critical path there that's really defined by electrical installation and commissioning of the backend of the plant currently. The crusher at the front end of the plant is well advanced. So obviously the pre-stripping has been going very well and the mining side of things is really well. We're very pleased with it. So we're still basically in line with our previous guidance drag that we anticipate commissioning the primary crusher before the end of Q3. And then we'll get some grinding lines which will commission sequentially in either late October, early November 1st and the second and by the end of November the current plan.

And then we’ve got reasonably conservative ramp up schedule we believe that takes us through to achieving our definition of commercial production sometime before the middle of the year, sometime in Q2 and that’s three months at 60% of it is only throughput.

All the key issues are addressed. We’ve got actually more than adequate water for startup captured now. The heavy civil site, the whole [indiscernible] construction has gone very well. In fact we're now and just commencing the actual construction of the West [indiscernible] facility. So all the things that need to be in place to allow us to achieve the targeted ramp up are all happening as well. On an operational readiness point of view, we've basically got the -- the owners operating team assembled and will very shortly be resting [ph] on site permanently so. So the really the things are coming together pretty much as we’ve indicated previously.

Greg Barnes - TD Securities

What about finding Peruvians to run the plant and run the mine? Are you having any issues there or is that well in hand as well?

Alan Hair

No, that’s actually not been a problem. Operations at Yanacocha have been ramping down. There's actually quite good availability of test now right now in Peru and I think that we’ve got a very, very good mainly local Peruvian operating team that the project team was very much a U.S. expat team. The operating team is almost exclusively local Peruvians of what tells where in Peru.

Greg Barnes - TD Securities

And the initial ore in to the concentrator is just straight typical [indiscernible] recover, no anticipated issues on that front from the mine plant?

Alan Hair

No we don’t anticipate. Certainly in the early phases of the mine plant, there should be no issues. A bit of concern as we've again indicated there are some [indiscernible] zones but they're not part of the initial production phase.

Operator

Thank you. The next question comes from Oscar Cabrera from Bank of America. Please go ahead.

Oscar Cabrera - Bank of America

Just wanted to focus on the cost of sales during the quarter and just questions about the purchase of concentrate and the changes in domestic inventory. Those two figures -- the purchase of concentrator has been steady over the last five quarters but the changes in domestic inventory, those two figures -- the purchase of concentrator has been steady over the last five quarters but the changes in domestic inventory have swing around quite a bit. So in the quarter, was that just the railroad disruption? How should we think about your purchase of concentrate going forward as well as these changes in domestic inventory?

David Garofalo

Hi, Oscar. What's been happening is sort of not to belabor the rail situation, but in addition to having challenges, getting copper concentrate and zinc metal out, we also had some issues with getting some -- purchasing concentrate that we had committed to into Flin Flon given the winter weather issue. And so over the course of Q1 and Q2 we’ve been receiving purchase concentrate, putting that into the zinc plant which does tend to affect our financial results on an earnings basis if not on a cash basis because we’re putting in higher cost concentrate by running the purchase through it then the domestic con, that still economic for us to run that purchase con through the zinc plant. But we don’t anticipate any further purchases of zinc con going forward assuming that the Lalor operations produce according to plan for the balance of this year and into 2015. We should be in a good situation for concentrate. So we do anticipate this issue going away. By the end of the year we’ll be back to normal zinc concentrate inventory levels and won’t have this higher cost of purchased zinc inventory washing through our cost of sales.

Oscar Cabrera - Bank of America

Okay, great. That’s very helpful. We’re looking forward to see Constancia in September but thinking about the next phase of expansion, what do you think is the biggest bottleneck? Is it financing for Rosemont? Would you try free cash flow Constancia as much as possible before you get that project started or are you looking at different capital structures to be able to crystallize that growth profile?

David Garofalo

I think critical path for the project for Rosemont is permitting engineering. That will drive our timing on that project more than financial capacity. I think we’re going to have more than sufficient financial capacity to fund it internally from other debt sources as we ramp up our existing business, but our focus right now is just integrating the project, filling up our business unit Arizona and staring the engineering process, because even if Augusta had received the permits in timeline they'd advertised, the project was not in a position to start construction. It hadn’t been sufficiently engineered. So we want to get that going contemporaneously with the permitting process.

Operator

Thank you. The next question comes from Gary Lampard from Canaccord Genuity. Please go ahead.

Gary Lampard - Canaccord Genuity

Good morning, everyone. My question concerns some of the working capital issues at Constancia. I’m assuming that $209 million of accrued but not yet paid CapEx is sitting in the accounts payable line, which is about $300 million. So, is it a fair assumption to assume that that will probably stay about $300 million until the end of this year and then through the early part of next year, that should drop down to about $100 million? So there is $200 million of cash needed for those accruals. And if that’s correct, on top of that, what do you think at this stage as the right working capital allowance to actually start the operations?

David Bryson

Gary, the accrued expenditures that we talk about in our liquidity discussion, yes, those are essentially accounts payable with respect to mainly the Constancia project and so we would expect that to be drawn down over the course of Q4 and Q1 of next year.

I don’t think that accounts -- I think that accounts payable, just given the growth in our operations that the run rate will be higher, obviously, with all of the mines up and running than it has been with just the Manitoba operations historically, but we will need to fund and have liquidity in place to fund the construction accounts payable and then I would anticipate another 50 to perhaps ultimately $100 million in additional funding required for the Constancia working capital build.

We’ve got levers available to us on how we dispose of the initial concentrate production and that allow us to manage that working capital build. For example, selling some of the early production to traders rather than smelters will get us paid faster as we feather some of the smelter contracts into the sales program later in 2015 and that will start to stretch things out. But that’s sort of an overall view where I see working capital going.

Gary Lampard - Canaccord Genuity

Okay. That’s helpful. So the bottom line there even though accounts payable will go up to a higher level in the future, so will accounts receivable, but from where we’re sitting at the moment, we need to allow for $200 million of accruals plus $50 million to $100 million on top of that?

David Bryson

Yes, although I wouldn’t see it’s getting to 100 million until we're free cash generating from Constancia. So it will be self-funding.

Gary Lampard - Canaccord Genuity

Okay, right and just a follow up question. Somebody earlier asked you for a best guess of maximum liquidity and I think you said $300 million. Did that include or not include the impact of the debt that you’ve announced this morning?

David Bryson

That would -- I would describe that Gary as a minimum liquidity position. I’ve talked in the past about how we would want our cash balances to be never less than $100 million. We’ve arranged the Constancia credit facility. We have our corporate revolver available to us and so on, aggregating all of those together, but I would see that as more of a stress case liquidity situation and I'm not sure that I want to give a point estimate for where we expect to be on a minimum cash basis assuming that those credit facilities remain undrawn, but I certainly expect it to be higher than 300 million total liquidity or higher than $100 million minimum cash.

Operator

Thank you. The next question comes from Orest Wowkodaw from Scotiabank. Please go ahead.

Orest Wowkodaw - Scotiabank

I realize it's early but we can finally sort of see the light at the end of the tunnel here with the production growth coming with Constancia and Lalor. Just a curious question for David. Could you sort of set out the criteria on what it would take to reinstate your dividend? I realize we're probably 12 to 18 months early on this, but I'm just curious where your head might be at with that?

David Bryson

Well, we're certainly revisiting that in the context of just revisiting our strategy as we do every couple of years with our Board and on the strategy side, we don't expect to change significantly at all any of our geological or geographical criteria. I think we're going to stay in the same narrow geographies and geologies and we're also looking at optimum capital structure and I think the offering that we're doing today as part of that exercise and it'll include at some point introducing a dividend formula based on operating cash flow, less sustaining capital. It's something we're discussing with our Board. We know conceptually they're very supportive and as we redo our budgets and five-year plans over the course of this year into early next year, we do expect to talk about a longer term dividend policy with our shareholders.

Operator

Thank you. Ladies and gentlemen, this concludes conference call for today. We thank you for your participation. You may now disconnect your lines and have a great day.

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Source: HudBay Minerals' (HBM) CEO David Garofalo on Q2 2014 Results - Earnings Call Transcript

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