Dominion Diamond's (DDC) CEO Brendan Bell on Q4 2016 Results - Earnings Call Transcript

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Dominion Diamond Corporation (NYSE:DDC)

Q4 2016 Earnings Conference Call

April 14, 2016 08:30 ET

Executives

Richard Chetwode - Vice President, Corporate Development and Head, Investor Relations

Brendan Bell - Chief Executive Officer

Ron Cameron - Chief Financial Officer

Chantal Lavoie - Chief Operating Officer

Jim Pounds - Executive Vice President, Diamonds

Elliot Holland - Vice President, Projects

Analysts

Tanya Jakusconek - Scotia Bank

Des Kilalea - RBC

Richard Hatch - RBC

Edward Sterck - BMO

Ned Davis - William Smith

Operator

Good day, ladies and gentlemen and welcome to the Dominion Diamond Corporation Fiscal 2016 Fourth Quarter and Year End Earnings Results Conference Call. My name is Karen and I will be your operator for today’s call. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Richard Chetwode, Vice President, Corporate Development and Head of Investor Relations. Please go ahead.

Richard Chetwode

Thank you, operator. Good morning, everyone and welcome to our fiscal 2016 fourth quarter and year end earnings results conference call. On the call today is Brendan Bell, Chief Executive Officer; Ron Cameron, Chief Financial Officer; Chantal Lavoie, Chief Operating Officer; Jim Pounds, Executive Vice President, Diamonds; and Elliot Holland, Vice President, Projects, all of whom will be available to answer questions after the presentation.

Before we begin, I would like to point out that this conference call will include forward-looking information. Various material factors and assumptions we used in arriving at this information and actual results could differ materially. Additional information about these factors and assumptions and the risks that could cause actual results to differ materially from our current expectations are detailed in our most recently filed Annual Information Form and MD&A, which are publicly available. Our most recent results also include a reconciliation of certain non-IFRS financial measures to the most directly comparable IFRS measures.

With that, I will hand the call over to Brendan Bell.

Brendan Bell

Thank you, Richard. Good morning, ladies and gentlemen and welcome to our earnings call for the fourth quarter and for the 2016 financial year. We have reported positive cash flow for the third consecutive quarter in what has admittedly been a weak diamond market. As I commented in our last two analyst calls, we are in the transition to the very rich Misery Mine pipe coming on stream in fiscal 2017, the revenue from which we will start to see in the second half of this year.

I am going to begin by covering some of the main points and then I will turn it over to my colleagues to discuss different areas in more detail. I will then come back and conclude with some remarks about our overall business. Despite the weakness in diamond price, we continued to generate positive free cash flow and adjusted EBITDA in Q4, which Ron can talk to. From a balance sheet perspective, the company is well funded with $320 million of cash and virtually no debt and a further $210 million available under our revolving credit facility. The Board has also declared a final dividend of $0.20 per share to be paid at the beginning of June. From a growth perspective, we have adopted a twin-track approach to building our future. Alongside the construction of Sable and the advanced evaluation of Jay, we have started earlier stage work on the existing portfolio of kimberlites on the Ekati property and nearby, which Chantal and Elliot will speak to.

Let me now speak to the $19.8 million impairment of Ekati inventory. Q4 was always going to result in very low margins at Ekati as you would have seen from the implied low single-digit margin on goods available for sale at the end of Q3. In addition, diamond prices have continued to fall in January. Jim Pounds will give you some further insights on the diamond market in a minute. Approximately 60% of the carats we recovered in Q4 were low value material from Misery Satellites and Coarse Ore Rejects, both of which are non-reserved material. Chantel will give you a more detailed explanation shortly. But following the single source sampling of Misery’s Southwest material in October, we confirmed that Misery Southwest diamonds were of lower value than originally modeled. The weaker diamond price environment and the substantial number of low value carat produced meant we have to take an impairment on Ekati’s work in process inventory at the end of Q4.

On the project side, we published the Sable PFS in February and are progressing the permitting of Jay. We expect to present feasibility to the board in late May. And speaking of the board, I would also like to welcome Jim Gowans to his role as Chairman. I look forward to working with him. His extensive knowledge of the global diamond industry and mining coupled with operating experience working in Canada’s North, will certainly complement the management team. And I would also like to extend my deep appreciation to Bob Gannicott for his invaluable leadership, tireless contrition over the past 12 years as Chairman of this company. He has been instrumental in building this company from a junior explorer to the world’s third largest diamond producer, truly a Canadian success story. Let me now hand you over to Chantal to comment on the company’s Q4 production.

Chantal Lavoie

Thank you, Brendan and good morning everyone. Let me first focus on what is up at Ekati in the production aspects that led to the impairment. Then I will briefly update you on other operational aspects at Diavik and Ekati. In the fourth quarter of last year, we processed some Koala Underground material, a small amount of material from Pigeon and a substantial quantity of Misery Satellite material, almost all of which was from Misery Southwest satellite pipe and also some Coarse Ore Rejects. Overall for that period, the number of carats recovered from production was approximately 16% higher than what our models predicted. This continues to validate the revenue benefit of running the processing plant to maximize diamond liberation.

Two things of note happened. Firstly, as part of the diamond liberation initiative, we began in July last year. We decided to run single source samples of kimberlite material through the process plant to better assess the impact of the changes we made. One of those single source samples was 72,000 ton of Misery Southwest, which we put through the plant in October. Misery Southwest is an inferred resource with a grade of 2.2 carats per ton, which we believe at a value of $70 a carat. Once this substantial batch of Misery Southwest material has been processed, the grade was demonstrated to be within the accuracy of an inferred resource estimate, 2 carats per ton versus our model that called for 2.2. But a valuation of the carats from this sample indicated that it was not $70 per carat as we have thought the same value as the Misery South and Misery’s Main diamonds, but between $40 to $55 a carat. Our guidance for this year takes into account what we have learned and we are therefore confident that we can achieve our production objective with a substantial amount of very high value Misery Main scheduled for H2.

Now, let me give you an update on the rest of Ekati. Pigeon moving commercial production in January, the top of the pipe was, as expected, heavily diluted with till, but we are now mining clean kimberlite. We processed the first production from Misery Main in March. We expect there to be approximately another 2 months of further waste stripping, which needs to take place before Misery Main can be put into continuous production from June onwards. As planned, we began waste pre-stripping at Lynx in December and this will continue until the end of the year. We expect very limited ore production from Lynx this year. The quarter also saw continued good production from Koala Underground. We then began drilling at Fox Deep in February. There is a significant resource of approximately 35 million tons below the bottom of the open pit. But to be of economic interest, the grade needs to increase at depth, something which has happened at Koala. The objective of this drilling campaign is to better understand the grade of that resource.

While the main focus of operation team is delivery of this year’s business objectives, we are expanding significant effort to continuously improve the operation at Ekati. Construction at the fine diamond DMS circuit is progressing as planned and scheduled for commissioning in Q4. Significant productivity improvements for both surface and underground mining activities have been made and the reduction in energy consumption has been realized. These gains have been built in our FY ‘17 objectives. Over the next few years, we plan to mine approximately 3 million tons of Misery Main from the existing open pits. We are also evaluating options to access additional tonnage of Misery possibly from two underground levels at the end of the current mine plan.

It is still early stage, but this could provide additional high value feed to our FY ‘21 production plan. At Diavik, there was good news with the latest reserve and resource statement with A-154 North probable reserves more than doubling to approximately 4.7 million ton or 11.1 million carats through the promotion of inferred resources and the addition of new kimberlite at depth. With this inferred material now converted to reserve status, this material will be included in the new life of mine plan for Diavik, which we expect will be delivered to us by the operator in the near future.

Finally, it is worth noting that despite a challenging winter road season with much warmer than usual winter temperature both Ekati and Diavik were successful in bringing to their respective sites the required fuel, supplies and equipment necessary to execute their business plans. This included all the critical dye construction equipment for the A-21 project at Diavik, which continues to proceed according to plan. I must commend the winter road joint venture operations team for a job well done under very difficult conditions. Thank you all and I will now hand you over to Elliot.

Elliot Holland

Thanks, Chantal and good morning everybody. Let me first turn to Sable, as you know we published the Sable PFS in February and reported a 10.1 million carat mineral reserve for the Sable pipe. Construction of the project has now started. We are comfortable the economics of the project support a positive investment decision irrespective of the results of the Jay feasibility study. To-date we have signed contracts with substantially all of this year’s construction program, completed engineering of the initial works and mobilized the construction fleet up the winter road.

On March 31, we started hauling granite from the Beartooth waste rock pile, begin building the all season access road to Sable which we aim to complete by September. After the road is completed we can establish a base of operations with the Sable site for the construction of project infrastructure. The main work at the site will be the construction of water management facility in Two Rock Lake. Two Rock Lake sits next to and downstream was Sable Lake, which is on top of the Sable kimberlite pipe. A frozen core dam will be built at the outlet of Two Rock Lake to control downstream discharge and a filter dike will be built across the middle of the lake to create two sedimentation cells. Once these structures have been completed next year, water will be pumped from Sable Lake into Two Rock Lake exposing the Sable Lake beds to the start of free stripping in fiscal 2019. The CapEx budget for fiscal 2017 remains at $55 million as stated in the PFS.

Turning to Jay, we continue to advance the permitting of the project. On February 1, the Mackenzie Valley Environmental Impact Review Board completed its report of environmental assessment for the Jay project and recommended to the GMWT Minister of Lands that the Jay project be approved subject to the 22 measures described in its report. We are comfortable that we can comply with all of these measures without a significant impact to the investment case. The minister is expected to make a decision in May 2016. If the minister confirms the review board’s decision, we will file our land use permit and water license application shortly thereafter. Dominion’s Board will review the Jay feasibility study in May. Without going into specifics ahead of this study, let me give a flavor of some of the positives and negatives since we published the PFS. As you are aware, market prices in US dollars have declined since the publication of the PFS, which was based on October 2014 pricing. However, in Canadian dollars, pricing is actually about the same as it was in the PFS.

As part of our review of the 2015 bulk sample, the 1996 and 2006 samples are reinterpreted. This reinterpretation suggests, all things being equal, a marginally higher diamond price for Jay balanced by a lower grade than previously reported resulting in a net impact of a decrease in value per ton. It turned out that the sample plan slot screen configuration had been reported incorrectly resulting in an overestimation of the likely recovery of smaller Jay diamonds in the Ekati processing plant. While an unfortunate result, this demonstrates why it was important for Dominion to do our own bulk sample. However, the Fine DMS circuit now under construction is designed to improve small diamond recovery and will result in a smaller decrease in grade compared to the PFS.

As I mentioned in the September call, last year, we completed a geotechnical drilling program along the pit and dike alignment. The results are that we have identified a slightly shorter dike alignment and we expect that the feasibility study pit will have a substantially lower stripping ratio than the PFS due to our improved understanding of the geotechnical conditions in the pit walls. These are favorable for CapEx and OpEx, respectively, although there are offsetting cost increases likely in other infrastructure and support CapEx. We are reinvesting in early-stage exploration. The Board has approved a budget of $1.3 million to conduct the exploration work on the Lac de Gras Property, which we now hold 55% interest through joint venture with North Arrow Minerals. You may recall we conducted a systematic basal till sampling program on this property in 2013 using a track mounted RC drill, which along with historical data suggest that there are at least three strong regional kimberlite indicator mineral trains extending across the property as well as several local trains in two site specific anomalies.

The next stage of expiration will consist of data compilation work, airborne geophysical surveys and ground follow-up. We have also exercised our option to assume 100% ownership in 149 leases that were formerly part of the Diavik joint venture property. This area has been prospected in the past and with the subject of a desktop review by DDMI that resulted in their recommendation that most DDMI tenure on the eastern side of the Diavik joint venture property be released. This leased area to be designated the Glowworm Lake property will now undergo in depth review available sampling and geophysical data to prioritize future areas for follow-up in 2017. In addition, we have completed a desktop reevaluation of several undeveloped kimberlites in the Ekati property that we are considering for further drilling in 2017.

Thank you. And I will now pass you on to Ron.

Ron Cameron

Thank you, Elliot. Good morning, ladies and gentlemen. As always, just like to give a few highlights from our press release and give some further insights. As we have highlighted before, fiscal 2016 was the transitional year for Ekati and the fourth quarter was the weakest quarter with the high volume of lower value carats produced and a 5% fall in diamond prices. The fourth quarter was also impacted by a $19.8 million or $0.17 per share after tax impairment related to work-in-process inventory and a negative $16.9 million or $0.20 per share foreign exchange impact on income tax. During the quarter, we generated positive free cash flow of $27.5 million from operating cash flow of $83.6 million against capital expenditures of $56.1 million as we continue to invest significantly in the company’s main development projects as explained earlier in the call by Chantal and Elliot.

Fourth quarter adjusted EBITDA of $49 million remained steady despite the fall in diamond prices. Despite the transitional year at Ekati and the significant investment in development projects, we continue to have a very strong cash position with $320 million of unrestricted cash while also maintaining a $210 million credit facility, which was un-drawn at the end of the period. We continue to benefit operationally from the weak Canadian dollar versus the U.S. dollar. DDC reports and sales in U.S. dollars, but incurs the majority of its operating expenses in Canadian dollars. And to give you an idea of our foreign exchange sensitivity, we have broken production cost into three categories; current cash operating costs, periodic costs and non-cash depreciation. Current cash operating costs and this is a labor or contractors and it makes up about 50% of the total cash costs – of our total costs. These costs fluctuate in U.S. dollars terms as the Canadian strengths are weakened. Periodic costs and these are costs such as the diesel, ammonium nitrate and other storage inventory make up approximately 25% of total costs and they are purchased less frequently and are typically shipped up the winter road, which operates from February to the end of March. And as a result, the FX rate that applies to these costs will reset annually. The FX rate for diesel will relate to the applicable rate during the time of purchase of diesel in the prior year. And for items like ammonium nitrate, the FX rate is fixed during the winter road season when we move the ammonium nitrate.

Finally, non-cash depreciation is recorded at historic FX rate and currently makes up approximately 25% of total costs. When we purchased Ekati, the dollar was around par. However, there have been annual additions to fixed assets and we have been undertaking significant development activities, which are recorded at current FX rates. Although the majority of these costs are still at the acquisition date historic rate of approximately par our average depreciation and amortization rate for Ekati is now roughly $1.12. What does that mean, looking ahead to fiscal 2017, $0.01 movement in the average Canadian-U.S. dollar FX rate in a quarter is expected to result in approximately $500,000 change in cash production cost for that quarter.

Let me now turn to the subject of the inventory impairment. We have 10 production and sales cycles a year and it takes on average approximately three months from when we recovered diamonds in the process plant until they are sorted, valued and sold. The sorting and valuation process takes the majority of the three months period. And when it is complete, we classify these diamonds as available for sale inventory. It is not until this stage in the inventory cycle that there is detailed pricing information available for these goods. Until we are able to give them a value, they are classified as work-in-process. Once again, detailed pricing information is not available until this stage is complete and the inventory is classified as available for sale.

As we completed the January 31, 2016 financial statements, we conducted our quarterly inventory valuation test against sales information from February and March as well as our valuation of the year end width, which takes place after the end of the year as the diamonds are valued. Against the estimated net realizable value and as a result, recorded an impairment of our work in process course inventory of $19.8 million, which is included in our fourth quarter cost of sales. The inventory impairment represents the excess of inventory, cash and non-cash cost over net realizable value or the amount the company realized or expects to realize upon the final sorting valuation and subsequent sale of this inventory. The value of production and therefore the margin and ending inventory in the fourth quarter was negatively impacted by a relatively high proportion of Misery Southwest and Coarse Ore Rejects material – core material, which is all being high grade of a much lower price per carat. Upon completing the detailed valuation of this production, it was determined that the actual value was even lower than models and the inventory impairment was required.

Amortization of the capitalized stripping cost from Misery Satellite and Pigeon is on a unit of production basis. Accordingly, as production from these areas increased, there was a proportional increase in the depreciation and amortization recognized in the fourth quarter. While the non-cash cost to production has driven from $28 per ton in Q4 2015 to $38 per ton in Q4 of 2016, I would like to draw your attention to the fact the same comparative periods the cash cost production has fallen from approximately $96 million to $82 million a result of both the exchange rates and good cost management. Also, I would like to draw your attention to a change in the accounting policy related to the asset retirement obligation, which moved it from non-monetary liabilities to a monetary liability. In other words, the cost of the environmental closures are reported at today’s exchange rate, not historic rates, which in the case of Ekati was the exchange rate at the time of acquisition, which was almost at par. This has reduced Dominion’s AR reliability on the balance sheet per share of Diavik and Ekati from $458 million to $344 million.

In conclusion, I would like to reiterate that we are comfortable that despite the large development projects ahead of us, we have a strong balance sheet which puts us in the position of being able to maintain a sustainable dividend. Thank you. And let me hand you over to Jim.

Jim Pounds

Thanks, Ron and good morning. As you all know, the U.S. market is the largest market for diamond jewelry consumption and somewhere around 40% of that consumption takes place in the fourth quarter. Pleasingly, there was a good end of the year season and positively restocking has started in January. China, the second largest consumer of diamond jewelry, is increasingly becoming two different markets. Hong Kong and Macau continued to be much weaker as a result of the slowing mainland tourist shape, while it’s Mainland China, where sales have flattened, the market has moved from being a diamond market primarily focused on pure luxury and more and more into a diamond market that’s being driven by the expanding middle class. Late last year, the unusual seasonal weakness in polished demand was exacerbated by Chinese retailers not leading to buy any polished, because they had overstocked in their continued expectation of the dash for growth. However, this year, one of the most encouraging factors at the recent Hong Kong Show in March, with the reemergence of these Mainland Chinese retailers into the polished market.

In India, there was definitely more interest in the diamond jewelry during the wedding season this time with interest returning after some years of flat growth. And encouragingly, the trend of purchases is moving more and more into regional chains and away from the traditional single-family jewelers. This indicates the trend of a wider interest in more varied jewelry designs. Also that leads us to an indication the gifts of diamond jewelry extend beyond the more traditional gift-giving occasions. A lot of the markets outside the U.S. is still under pressure from the strong U.S. dollar, which means that diamond prices haven’t fallen in local currency terms, but overall there is a better picture now than last year.

While the story of last year was that of running down excess stocks of polished, what no one had realized was how short the market was at rough diamonds. And the first sale for this year has seen a very good demand for rough. Consequently, the price fall in January was quickly reversed in February and there are definitely shortages in some categories of polished and therefore, rough with demand centered on what we call commercial goods, primarily SI1 type diamond, which is classic in American Chinese bridal. On the other side, however, there is a continued weakness in the very cheap ground goods. The prices are now slightly higher than before the January price cuts and we see and hope that prices will remain stable for the rest of this year. Our last 18 months sales contracts ended on December 31 last year. And the new contracts will be aligned to realize the change in production in Ekati, where the blend of diamonds this year is more based on the commercial goods that I referred to earlier. So, we are now in the process of finalizing the slightly longer contracts this time. I remind everyone that this quarter, which is the first quarter of fiscal 2017, we have two sales as opposed to three in the last quarter.

So, just quickly touching on our Canada Mark initiative, interest in the Canada market continues to grow at the retailer level and I am now talking to specific retailers about how to take this initiative forward. Thank you. And I will now hand you back to Brendan.

Brendan Bell

Thanks, Jim. The story of Ekati was always the story of accessing Misery Main’s cash generating ability, which we will realize later this year. We started construction of the Sable access road and we are progressing the feasibility study at Jay. We also begun drilling at Fox Deep to ascertain if there is a development potential below the currently identified resource. And in addition, we are evaluating other opportunities on the Ekati property as well. We have a strong balance sheet and we are encouraged by the recent rebound of prices in the diamond market.

Thank you very much for tuning in and we now welcome your questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And we have a question from the line of Tanya Jakusconek from Scotia Bank.

Tanya Jakusconek

Yes, good morning everybody.

Brendan Bell

Hi, Tanya.

Tanya Jakusconek

Yes, good morning. I have a couple of questions and so maybe I will start with Elliot and thank you very much, Elliot for some color on Jay. Just wanted to know, first off, when you come out with your feasibility study on Jay, is it going to be just Jay standalone as it appears now that you have gone ahead with Sable on its own?

Elliot Holland

Thanks, Tanya. The Jay feasibility study will be incremental to all the other reserves on the Sable property, including all the other reserves in the Ekati property, including Sable.

Tanya Jakusconek

Okay, so it will incorporate Sable?

Elliot Holland

Yes, the investment case will incorporate Sable.

Tanya Jakusconek

Okay. And thank you for giving us some color on the market prices. I am having declined in U.S. dollars for Jay and are actually the same in Canadian. When you mentioned that you took the bulk sample and that value has decreased in dollar per ton, was that in U.S. dollars or Canadian dollars?

Elliot Holland

So, the value of the Jay goods has decreased in U.S. dollar terms since the PFS.

Tanya Jakusconek

Okay. So, the exchange rate obviously used at the time versus today will offset some of that decrease in dollars – in value per ton?

Elliot Holland

Exactly. What we are seeing is on a Canadian dollar basis. The prices we are using in the feasibility study are very similar to the prices used in the pre-feasibility study.

Tanya Jakusconek

Okay. So both on, okay, so that’s helpful. Thank you. And then at you mentioned that obviously taking this bulk sample, then reviewing your cap, the dike and so forth, you are seeing lower CapEx and operating cost because of the stripping. Obviously, the CapEx would be the pre-strip operating cost because of the lower strip ratio, but you haven’t given us an idea on the impact of the Canadian dollar or the oil price on these numbers?

Elliot Holland

I think we will get into that detail when the study itself comes out in a few weeks.

Tanya Jakusconek

Okay. And does the bulk sample and what you took have an impact on the reserve, the mine life of 11 years that you previously published?

Elliot Holland

Well, when we incorporated Sable into the mine plan, we will be co-processing Jay and Sable at the beginning of the project. So that has the effect of extending the mine life of Jay from the first pre-stripping to the last processing.

Tanya Jakusconek

Can you remind me what the mine life with the two combined would be?

Brendan Bell

We are looking at around 13 years.

Tanya Jakusconek

Okay. Thank you. And then – sorry, that was for both inclusion?

Brendan Bell

That’s from the beginning of Jay mining to the end of Jay mining.

Tanya Jakusconek

Okay. And then maybe just how and maybe Brendan, this is for yourself to take this question on how you are going to be looking at the case to go ahead with Jay, like what sort of parameters or is it an internal rate of return that you are looking for, how are you going to approach whether it’s a go ahead or not?

Brendan Bell

Yes. Look it’s, we are measuring it and evaluating the course on MPV and IRR. We do have an internal hurdle rate. It’s not something that we have published in the past, but look I can tell I wouldn’t feel comfortable in putting something in front of the Board that didn’t at least get 15% IRR. We are going to run a number of sensitivities, including how Jay would fare on flat diamond price. So you will see all of those scenarios and that evaluation as we come out with this post Board discussion end of May.

Tanya Jakusconek

Okay. Is there anything that as you are looking at it that differs substantially from the pre-feas?

Brendan Bell

Now, look I think you will see those details. But I think Elliot has given you the color that what we are seeing is very similar to the pre-feas. Diamond price down, yes, the tailwind from the CAD weakness have helped and there have been a number of offsets, which we will get into, which then takes of course as always the case when we are doing feasibility work. But look it’s going through – it’s been a rigorous and very disciplined approach we have taken to evaluating this project including subjecting it now to third party independent reviews before put it in front of the Board. This is something that we are doing very carefully, taking obviously very seriously, so the critical project for this company. So what you will see is that there has been a lot of work and evaluation going into this decision.

Tanya Jakusconek

And also I guess from redoing your reclamation obligation, I mean that clearly has gone down so that would be helped obviously the MPV of the project too?

Brendan Bell

Yes. Obviously, the benefit from Jay reclamation is that as we process material in the plant, we will be able to refill some of our pits the underground complex at Koala. That certainly is an assist to the overall cost of reclamation. That will be included of course in Jay feasibility when we come out with it.

Tanya Jakusconek

Okay. Well, we look forward to seeing that. Thank you. I will let someone else ask some additional questions.

Brendan Bell

Thanks for the questions Tanya.

Operator

Thank you. [Operator Instructions] Our next question comes from the line of Des Kilalea from RBC.

Brendan Bell

Good morning Des.

Operator

Des, your line is open, could you check your mute button please.

Des Kilalea

Sorry, can you hear me now.

Brendan Bell

Yes, we can. Hi Des.

Des Kilalea

Sorry. I think I was a bit late on the call, so I may have missed it. Perhaps, it was addressed. When last we talked, I think we talked about the potential for some large expansion in the underground pit potentially at Fox, just maybe some update on that. And then for Jim, the question on – maybe you could comment on the liquidity position in cutting centers given the cutbacks in banks where we seize it now given that the market has improved a bit? Thanks.

Brendan Bell

Why don’t we start with Jim on the market?

Jim Pounds

Yes absolutely. One of the concerns that we had last year was the reduction in the availability of credits to the business. One of the things that the market focused on towards the end of last year was actually reducing the stockpiles, which we have now seen that they did very successfully indeed and focusing more on growing their business and reacting to the market. They are very much aware there is the possibility of reducing credit. So cash was coming in, they were selling their goods and therefore they were in a much better liquidity position as we went into earlier this year than before. Although we have seen some of the banks showing, should we say, a small amount of reduced enthusiasm for the business. When I go around the cutting centers now and talk to the banks, they are very comfortable with the position that they have currently reached. Yes, I am sure they reduced some of their lines and – but in other words and in other terms, some of the more successful players in our business, they have actually increased their lines. So conversely 6 months to 8 months ago, I think the industry is in a comfortable position at all levels of liquidity and the banks will obviously be looking to make sure that the current acceleration in business is maintained and there is every indication that, that will happen.

Brendan Bell

And the drill program in the pit at Fox deep to better understand that resource, Chantal?

Chantal Lavoie

Yes. So as I mentioned, we have got a resource of about 35 million tons, what we call Fox deep, which is below the existing open pit. We started the drilling in February, which is RC, so large diameter drilling similar to what we have done at Sable last year. So we started the drilling in February and expect to complete that drilling by the end of April. From then, we will have – we will treat the samples and we expect to get results from grade to valuation coming from Jim’s team and put all these things together to complete our assessment sometime this summer to assess really the economic opportunities around Fox deep. As we all know, Fox have very nice very high value stones and really for us is to understand is there a change of grade as we go at depth and the kind of change that we have seen as an example in Koala. So that’s the plan right now for the work at Fox deep.

Des Kilalea

Thank you very much.

Operator

Thank you. And our next question comes from the line of Richard Hatch from RBC.

Richard Hatch

Thanks and good morning guys. Just a quick one on the Misery Southwest extension prices being lowered, I mean is that something you expect to remain sort of as you have guided, is it $45 to $65 a carat. And also do you see any risk of impairment on Misery as a result of the reduction in the prices? Thanks.

Brendan Bell

Yes. Richard, we obviously have processed the significant volume of Southwest in the past year and it really wasn’t until the bulk of material going through the plant was Southwest that we recognize that it was lower value. Of course we have to mine this material in accessing the Misery Main ore body, but now our current approach for what’s left and can’t give you an exact number but most of it we have been through, but what’s left is now being stockpiled. We will run that again through the sample plant before putting any more through the process plant to make sure that we to understand the value of those carats. So I think we are in a place now where we are able to reassess and don’t intend to process more of that material. Now that we have the luxury of having Pigeon and are into that production, we have got these options. So, last year we didn’t have much choice to do that. The process this year we have more flexibility, more ability to not put it through the mill if it doesn’t release the value that we need.

Richard Hatch

Okay. So no impairment expected, any more impairments expected?

Brendan Bell

It’s not our expectation. Of course, we were through some of this Misery Southwest than it was in with. That’s been sold through now. We are not expecting an impairment but look we really have to see until this is finally – the sales values are tallied up.

Richard Hatch

Okay, I appreciate that. Thank you.

Operator

Thank you. And we also have a question from the line of Edward Sterck from BMO.

Edward Sterck

Good morning and thank you.

Brendan Bell

Good afternoon Ed.

Edward Sterck

Hello. This is a question for Jim really. I guess just on the Chinese retailers, with their return to the market, does this indicate that the destocking prices is completely finished and our buying levels from Mainland China back up to where one would expect given the reduction in working inventories?

Jim Pounds

Yes. And I think this is a good question, thanks Ed. Because I think there is a definite distinction between some of the larger retailers that are Hong Kong-based Chow Tai Fook, Chow Sang Sang and Luk Fook where they are probably – in their case, they probably do have some inventory to work through. And I think it is that group of Mainland Chinese who have really been able to get back in probably stock a bit better than some of the big three with the benefit of hindsight. And therefore, they come and so after reasonably good New Year season at the beginning of February looking to restock and they feel in certain discussions I have had with them, they feel quite positive about the markets going forward. So, we will see that they restocked at the March show and then of course we got the June show and the Las Vegas show coming up in Hong Kong and Las Vegas respectively. So yes, I think probably with the benefit of hindsight, their stock handling and stock control versus was probably a little better.

Edward Sterck

Okay, thank you. And then just an extension to that question is, what was the rough estimate for the split in terms of Chinese demand between the Mainland Chinese and the Hong Kong and Macau jewelers?

Jim Pounds

Well, in terms of total value…

Edward Sterck

Not total value percentages.

Jim Pounds

Yes. I would say that it’s about – probably still dominated by the Hong Kong Macau still by about 60:40, but I will have to check on that, Ed and get back to you, because with Macau and Hong Kong really have been suffering a bit, so let me just review that and get back to you on them.

Edward Sterck

Okay. Thanks, Jim.

Operator

Thank you. And we have a question in queue from the line of Ned Davis from William Smith.

Ned Davis

Yes, thank you. Two questions. First of all, last year, you engaged in kind of a strategic evaluation and you hired investment bankers, have you basically dropped that entirely – that initiative or is it still underway?

Brendan Bell

No, thank you, Ned. Good question. No, we haven’t dropped it. It is still currently underway. I can’t give you a definitive date, but I can tell you we are much nearer the end and the beginning of that process, but look I think we will see at the end of May, we will come out with the Jay feasibility study. And I expect at that point we will also be able to provide some more color on the strategic process.

Ned Davis

Okay. Another question, you mentioned your free cash resources and this would be adequate going forward with your projected CapEx. Does that include the projected full development assuming you go ahead of the Jay project? In other words, is that cash adequate for the company assuming a reasonable amount of operating cash flow during the end of the period to go ahead and do the Jay investment without any additional new equity or debt capital?

Brendan Bell

Yes, Ned, that is the case and this really is because of the cash generating ability of Misery Main, which comes online, I mean, the value of that rock very high, grade 4.7 carat per ton. Even at $75 diamonds in today’s lower diamond market, this still is throwing off an awful lot of cash. And I think as you are aware, we also have joint venture partners who we expect to participate in Jay. So, it is enough. Our cash producing ability is enough for us to fund our 65% of Jay.

Ned Davis

So, the joint venture partner is the ongoing partnership that you have. There is nothing – there is no new partners that I haven’t heard about rather? It’s the existing Ekati partners, okay.

Brendan Bell

Correct.

Ned Davis

And then on the – it’s always helpful to get this sort of rundown on the marketplace, India, China etcetera, but I have kind of lost perspective on how significant each of the major markets in the world probably are for you. I know it’s theoretically a commodity, but as a practical matter, I would think there are different weightings of influence. So, could you just give us a thumbnail sketch of how significant you think China Mainland, China, Hong Kong, India, Europe, U.S., and other markets are for you? Can you give us an update of that? Looking forward, not really looking back, looking forward at Misery production and other production in the next couple of years?

Brendan Bell

So, why don’t….

Jim Pounds

Yes. Thanks, Ned. That’s a good question. As we move forward just basically, we always judge that the U.S. market is around 40% China, Mainland, Hong Kong or we lump them together at 15% to 20% India and 8% to 10% and then the rest of the world divided between those. With Japan – and remember Japan was once 30% of the market and it is now around 5%, yes. So, as we move forward and if we look at our production particularly this year and we are going into more commercial ranges of goods, certainly, it is encouraging to see that when we see that in America really is a good market for these goods is the main market for these goods. And the encouragement that we see from the development of the middle class is both in India and China, who are now becoming where the – what we say the desire for the diamonds is growing and they are becoming active purchasers of these commercial goods. So, what we see going forward is not only is our ability to supply these markets because of our marketing mix changing slightly into these is also there will be some dynamic in the competition between these markets. So, we feel very comfortably placed to be heading into the next years of the large Misery production.

Ned Davis

About 2 years ago, there were I think two very detailed studies of the long-term potential for the diamond market, which basically indicated – both of them indicated a growing dis-balance in favor of demand over supply for the world marketplace. Is that analysis, in your view, still valid going forward as you look at all the different factors? I realize it’s a complex marketplace, but that was a pretty strong inclusion. I think it was Mackenzie and I forget the other big consulting firm that looked at this came to the same conclusion?

Jim Pounds

That’s very great, Ned. It was Bain’s who is the other one.

Ned Davis

Bain’s.

Jim Pounds

That’s right. And we saw this gap between which we still believe in because of the reasons I just gave of the demand and growing demand that we get from the middle classes, the strong support of the American market. And we also say that the older diamond mines are probably falling away in terms of production. We will see some of the larger ones even sort of close down in the foreseeable future. We will probably – as far as I understand, the Aargau mine closing in 2020 or 2021, which is a vast amount of carats coming on to the market that won’t be there anymore. So, we will see this fall in the overall level of supply and the growth in the demand. Of course, there are other properties like the Russia and Angola and our own developments going forward, which will keep a decent level of supply going. But that gap that Bain and Mackenzie have both predicted, we feel confident that we will be seeing that will help us increase diamond prices in the future.

Ned Davis

Okay, thank you very much. Appreciate it.

Operator

Thank you. And we have a follow-up from the line of Edward Sterck from BMO.

Edward Sterck

Thank you very much. Brendan, just a question on Jay and financing first, I mean, you commented just now that it is fundable or it looks like it will be fundable from projected cash flows from the existing operations. Can you just give us some sorts on how – what the optimal shape of the balance sheet would be, whether yes, it might be fundable from cash flows, but would project finance be a more feasible method of financing etcetera?

Brendan Bell

Project finance is possible, but it may not be where we want to go. We are having that discussion internally, Ed, you are right. I mean, the optimal structure will be something that we continue to discuss and to debate internally here. As we mentioned theoretically, we could fund this all from our balance sheet and future production cash generation from Misery Main, but of course we may determine that, that’s not optimal for us, but more to come on that, I think, at this point that is about all I can say.

Edward Sterck

Okay, thank you very much.

Operator

Thank you. And we have another follow-up from the line of the Tanya Jakusconek from Scotia Bank.

Tanya Jakusconek

Yes, thank you. Just wanted to ask about Note 26 on subsequent events, that was stated on the Buffer Zone and your joint venture Archon Minerals that I guess have provided notice that they do not want to participate in some of the CapEx elements of your 2017 program. Can you just remind us what the dilution mechanism is? B) What exactly your dollar amount that they don’t want to participate in? And C), is this an indicative of their participation in Jay, which is also in the Buffer Zone?

Brendan Bell

Yes, I think what I will say is that we understand that Archon is very excited about the Jay prospect, intends to define as their share of Jay. We are having an internal discussion about Lynx and about some of the Jay expenditures. But I think at this point it’s premature. We are waiting for some detailed feedback from Archon to understand exactly where their objections sit. I don’t have the exact details of the dilution mechanism in the joint venture sitting here in front of me. But hopefully, we will land at that when we have to. We are still quite optimistic that Archon will choose to participate. But of course we have to plan for this possibility that they don’t. Elliot, are you aware of any of the dilution mechanisms at your fingertips, I don’t think you probably do, do you?

Elliot Holland

It’s a straight line dilution mechanism for – when we have been notified in advance of non-contribution.

Tanya Jakusconek

Okay. So is this what we have heard from them on the not wanting to participate and is it just specific to 2017?

Brendan Bell

We are having an ongoing discussion, I think Tanya it’s the best thing that I can say at this point.

Tanya Jakusconek

Okay, alright. Maybe I will just circle back on this dilution mechanism a little later on offline. Thank you.

Operator

Thank you. And Edward Sterck from BMO has another follow-up question. Your line is open sir.

Edward Sterck

Thank you. So I am late to the call and I came in, in the middle of the discussion on the exploration opportunities outside of the existing operations and I just wanted to just ask you, is it possible to recap on what the expected news flow from that exploration is in terms of the timing over the course of the next, let’s say 12 months to 24 months?

Brendan Bell

Let’s first talk about Fox and when we expect results from the Fox deep drilling, Chantal?

Chantal Lavoie

As I mentioned Fox, we expect to complete drilling at south by the end of this month. It will take us probably another three months to four months to process the sample, do the valuation, so we would expect to release some information and have an assessment done by mid-summer.

Brendan Bell

Yes. And in terms of identifying other targets, other prospects, that’s ongoing work, Ed. Of course, we got the HW properties south of Ekati and Diavik. We picked up the – what we refer to as the Glowworm property that was vacated by Diavik. So we are assessing and evaluating possible target there as well in addition to other kimberlites on our own Ekati property. But this will be worked that we would drill work now as we switch seasons that wouldn’t take place until winter of next year and the results flow from that following the summer likely.

Elliot Holland

And we are typically filing our exploration permits in the fall for the succeeding winter program.

Edward Sterck

Great. Thank you very much.

Operator

Thank you. And that concludes our question-and-answer session for today. I would like to turn the conference back over to Brendan Bell for any additional comments.

Brendan Bell

Thank you, operator and thank you all for joining the call. If you have any follow-up questions, those can be addressed either through Richard or Kelley Stamm in Toronto. And we look forward to talking to you again when we report fiscal 2017 first quarter results. Thank you all.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may now disconnect. Everyone, have a good day.

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