Sierra Metals' (DBEXF) CEO Mark Brennan on Q2 2016 Results - Earnings Call Transcript

| About: Sierra Metals, (DBEXF)

Sierra Metals, Inc. (OTC:DBEXF) Q2 2016 Earnings Conference Call August 17, 2016 10:30 AM ET

Executives

Mike McAllister - VP Corporate Development

Mark Brennan - CEO

Ed Guimaraes - CFO

Gordon Babcock - COO

Analysts

Lee Cooperman - Omega Advisors

Heiko Ihle - Rodman and Renshaw

Alec Meikle - Cormark Securities

Operator

Good morning. My name is Chris and I will be your conference operator today. I’d like to welcome everyone to the Sierra Metals’ Second Quarter 2016 Results Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you.

Mike McAllister, Vice President Corporate Development. You may begin your conference.

Mike McAllister

Thank you, operator, and good morning, everyone. Welcome to Sierra’s Q2 2016 results conference call. On the call today we're joined by Mark Brennan, President and CEO; Ed Guimaraes, CFO and Gordon Babcock, COO.

Today’s call will be followed by a question-and-answer period. Today’s presentation is available for download both through this Web site and through the home page of the Company’s Web site at www.sierrametals.com. Monday's press release, the financial statements and the Management Discussion and Analysis are all posted on the Company’s Web site.

Before we start, I would like to remind everyone about our disclaimer that certain statements made today by the executive management team may contain forward-looking information. Anything not historical is considered forward-looking. For more information, please refer to our detailed cautionary notes in Monday's press release and to the disclaimer on Slide 2 of today’s presentation. Please note that all dollar amounts mentioned on this call are in U.S. dollars unless otherwise noted.

With that, I will now turn the call over to Mark Brennan, President and CEO.

Mark Brennan

Thank you, Mike, and good morning, ladies and gentlemen. I’d like to begin with an overview of Q2 2016 results for Sierra as well as discuss the operational and exploration highlights for the quarter. And I must say, we're feeling very positive about the significant progress being made on both the operational improvements front and with the exploration at Sierra companywide. Following my remarks, Ed Guimaraes will take us through our Q2 financial results. Following Ed's remarks, I would like to discuss today's press release which we likely use as a framework for future disclosure. The full management team will be available for questions at the end of the call.

During the second quarter, the company has continued to successfully work through the initial operational improvements process at Yauricocha while at the same time seeing record throughput at Bolivar and Cusi, and Mexico. The changes are highlighted by metal production in Yauricocha which has seen dramatic improvements from Q1 over Q4, 2015.

Sierra has improved its silver equivalent and copper equivalent production by 24% despite only a 4% increase in the throughput in Q2 compared to Q1 2016. This is the result of companywide focus on the production of higher net smelter tonnage which accompanied by the upturn in metal prices has contributed to a significant increase in revenues and adjusted EBITDA this quarter compared to the prior two quarters.

Looking at production this quarter, the company experienced lower silver equivalent and copper equivalent production compared to the record quarter of 2015 mainly due to lower head grades. However, the company has realized improved production of most metals this quarter compared to the previous two quarters and expect to see higher production with higher grade mining and continued operational improvements in the second half of the year.

On Slide 5, at Bolivar the company had another quarter of record plant throughput with a 13% increase in Q2 compared to Q2 2015. Although Bolivar encountered lower head grades and recoveries which resulted in a 5% decrease in copper equivalent production from the same quarter last year, head grades are expected to improve in the second half of this year. Cusi realized a 23% increase in silver equivalent production in this quarter over Q2 2015.

Additionally, the all-in sustaining costs for silver equivalent ounce decreased to 18.49 in Q2 ’16 from 27.92 in Q2 2015. Cusi also began production in the first half of 2016 of zinc which with production of 1.1 million pounds which helped contribute to the increase in silver equipment production when compared to same period in 2015.

Turning now to Slide 6, we are pleased to report that subsequent to the end of the second quarter, Sierra Metals has released an updated mineral reserve and resource estimate at the Yauricocha mine, including a maiden reserve and resource estimate for the recently discovered Esperanza zone. The maiden resource estimate for Esperanza has established 2.5 million tonnes of mineral resource in the measured and indicated category representing 32% of the total measured and indicated resource at Yauricocha. And 1.5 million tonnes in the inferred category representing 41% of total inferred resources at Yauricocha.

The program is still in the early stages of delineation drilling and management believes our aggressive exploration program will continue to add high quality tonnage to our resources at Yauricocha in the coming months. We like to emphasize that we believe we are in the bottom of the first inning of a nine inning ball game at Esperanza. We are also pleased to report that initial ore from the Esperanza zone has been delivered to the 2B plant at Yauricocha for processing. From the initial discovery in late 2015, to the announcement of the discovery in January 2016 to first production recently delivered to the Chumpe mill all within less than a year speaks very highly to the expertise and quality of our technical professionals working at the Yauricocha mine. They are to be congratulated.

Turning now to the operation highlights on Slide 7, in Q2, Sierra processed a total of 503,000 tonnes representing a 4% increase over Q2’s 2015 record. The company produced 3 million silver equivalent ounces or 19.7 million copper equivalent pounds, representing a 9% decrease from Q2 2015’s record production level. This was mainly a result of reduced throughput, lower head grades and recoveries at Yauricocha due to the operational improvement programs taking place. Sierra did however see an increase of 15% of silver equivalent production for the Company during Q2 versus Q1 in 2016.

Management believes metal production and associated economics will continue to improve as we near the completion of certain aspects of the improvement program in the second half of this year and begin to access ore from the Esperanza zone. Looking now at Yauricocha silver equivalent production, was 1.9 million ounces, which was 14% lower than the record production level of Q2 2015. The company did see positive operational improvements at Yauricocha, however in Q2 over Q1 ’16 with a 24% increase in silver equivalent production as well as the increases in production of most metals.

At Bolivar, record plant throughput up 236,000 tonnes were processed which represents a 13% increase compared to Q2 2015. However lower head grades and recoveries resulted in a 5% decrease in copper equivalent production in the second quarter over 2015. Management continues to be optimistic that we will see higher metal production at Bolivar as we begin accessing higher grade ore by the end of the year.

At Cusi, silver equivalent production of 307,000 ounces represents an increase of over 23% over Q2 2015. Throughput increased by 7% this quarter compared to Q2 2015. In the first half of 2016 Cusi began the production of a zinc concentrate with production of 1.1 million pounds which helped contribute to the increase in silver equivalent production. The company began shipping zinc concentrate from the Malpaso plant in April 2015.

Turning to Slide 8, exploration has been an important part of our growth plan and during Q2 2016 the Company drilled 72 holes totaling 10,755 meters at Yauricocha at the following zones. At Esperanza, 32 holes totaling 5,455 meters. Mascota, 15 holes totaling 2,400 meters. Catas, 5 holes with a length of 880 meters of definition drilling to provide a greater level of assurance to the estimated resources within the orebody. Antacaca, 9 holes totaling 1,245 meters of definition drilling, Antacaca South, 2 holes totaling 197 meters of definition drilling and at Cachi Cachi, 9 holes totaling 577 meters at Karlita to provide a greater level of assurance with regards to the inferred resources within the orebody.

Exploration also continued to Bolivar during Q2 2016 with exploration starting along the Bolivar West fault area and at the La Sidra area and at the Bolivar Northwest. The company drilled a total of 6,000 meters of Bolivar. The company is really quantifying the extent of mineralization based on the existing drilled holes and hopes to be able to provide an update on this progress in the near-term.

In summary, 2016 will be a very significant year for Sierra Metals and we anticipate continued improvements to production grade and recoveries at Yauricocha throughout the year as the operational improvement programs continue and we begin to access and include production from the Esperanza Zone. Additionally, we anticipate further Brownfield exploration success at Yauricocha, Bolivar and Cusi. Sierra Metals is now on track to see strong production growth and exploration success. We believe the past year’s preparation should lead to the rubber hitting the road, which should increase shareholder value to the Company and its shareholders.

With that, I will now turn over the call to Ed Guimaraes our CFO, for the financial overview.

Ed Guimaraes

Thanks, Mark, and good morning, everyone.

Turning to Slide 10, the company continues to benefit from an increase in metal prices during the first half of 2016, compared to the lowest experienced during the second half of 2015. However, we are still in a lower metal price environment when compared to the second quarter of 2015. The company realized revenues of 36.9 million in Q2, which represents a 20% decline when compared to Q2 of 2015 or represents a 55% increase when compared to the first quarter of 2016.

Realized metal prices during Q2 2016 were 22% lower for copper, 13% lower for zinc, and 11% lower for lead when compared to Q2 2015. In addition to the lower metal prices realized, the decrease in revenue during the second quarter of 2016, compared to 2015 was due to a 4% decrease in throughput at Yauricocha, the decrease in silver, copper and gold head grades and recoveries of all metals except gold at Yauricocha. The decrease in head grades of all metals except gold at Bolivar, and the decrease in silver recoveries at Cusi.

This was partly offset by record throughput at Bolivar and Cusi, as well as the 5% increase in silver prices realized in Q2 2016 compared to Q2 2015. Adjusted EBITDA in Q2 2016 was 5.3 million, compared to 18.2 million in Q2 2015. The decrease in adjusted EBITDA was primarily due to a 5 million decrease and revenue at Yauricocha, a 5.2 million decrease in revenue at Bolivar, partially offset by 1.1 million increase in revenue at Cusi. The decrease in revenue at Yauricocha and Bolivar was mainly due to declines in metal prices, head grades and recoveries.

Yauricocha’s cash costs per silver equivalent payable amounts in Q2 2016 was $9.30 versus $5.76 in Q2 2015 and the all-in sustaining cost was $14.27 compared to $11.72 in Q2 2015. The increase in cash cost and all-in sustaining cost at Yauricocha during Q2 2016 were due to the decrease in plant throughput and ore feed head grades caused by the decrease in available productions from higher grade zones in the mine and additional costs related to the mechanization and water management controls continuing to be implemented at the mine.

Bolivar’s Q2 cash cost per copper equivalent payable pound was a $1.25 compared to $0.99 in Q2 2015 and the all-in sustaining cost was $2.41 versus $1.78 in Q2 2015. The increase in cash costs and all-in sustaining cost at Bolivar was mainly due to a decrease in head grades and recoveries for all metals with the exception of gold as well as an increase in mining costs and equipment maintenance costs.

Cusi’s Q2 2016 cash cost for silver equivalent payable ounce was $10.63 compared to $6.27 in Q2 2015 and the all-in sustaining cost was $18.49 compared to $27.92 in Q2 2015. The decrease in all-in sustaining costs at Cusi during Q2 2016 was due to increased planned throughput and the addition of a zinc concentrate which increased the silver equivalent ounces sold as well as the increase in head grades and recoveries of all metals except silver recoveries which resulted in a higher percentage of payable metal per ton of ore process. The results for a decrease in sustaining capital expenditures related to stope and drift development within the mine as the company incurred a significant amount of those costs during 2015.

Cash flow generated from operations before movements in working capital was $6.2 million compared to $18.8 million in Q2 2015, which was mainly due to lower revenues and lower gross margins generated.

I would now like to review our cash flows which provide the clearest perspective on our financial performance. I have summarized the changes in cash during Q2 2016 on Slide 11. During Q2, our operating cash flow before working capital adjustments was $6.2 million. We incurred $7.6 million in capital expenditures in Mexico and Peru, paid approximately $1 million of income tax in Peru and had positive working capital adjustments of $7 million.

We paid $3.3 million of interest and principal repayments on our credit facilities and received proceeds of $5 million from the drawdown of a credit facility in Peru. We also transferred $4.7 million into an escrow account which has been classified as restricted cash on our statement of financial position. These items increased our cash balance from $19.1 million as at March 31, 2016 to $20.6 million as at June 30, 2016.

Turning to the balance sheet and liquidity on Slide 12, we have ended Q2 2016 in a strong financial position with $21 million in cash and $5 million in restricted cash with $15 million of undrawn credit facilities, which when combined, gives the company total liquidity of $41 million.

The company’s net debt was $59.8 million at June 30, 2016. The company has principal payment obligations on its loans and credit facilities of approximately 5.6 million remaining to be paid in 2016, 15.5 million to be paid in 2017, 13.9 million to be paid in 2018, 8.3 million to be paid in 2019 and 28.5 million to be paid in 2020. I would also like to highlight the sensitivity of our profit to changes in the exchange rate.

Approximately 70% of our cost at Yauricocha is denominated in Peruvian Soles and approximately 60% of our cost in Mexico are denominated in Mexican Pesos. At June 30th, 2016 the Sol to U.S. dollar exchange rate was 3.3 and the Mexican Peso to U.S. dollar exchange rate was 18.49. Thus far in 2016 the Sol and Peso have remained relatively unchanged against the U.S. dollar. A 10% decrease in the value of the Sol and Peso against the U.S. dollar would result in an increase of 3.8 million and 1.6 million in the company’s net income respectively, assuming that our operational performance during 2016 is consistent with 2015.

We are confident that our financial position together with a potential future cash flow generation from our three producing mines including the recently discovered Esperanza zone and available credit facilities will be sufficient to support the company’s financial commitments for the remainder of the year and beyond.

I’ll now turn it back to Mark.

Mark Brennan

Thanks Ed. At this stage I’d like to discuss the press release we issued this morning. The purpose for the release was to highlight the numerous opportunities that Sierra has at all its properties to increase tonnage and grade dramatically. We hope today’s press release will provide a framework from which interested parties can monitor our progress in these areas going forward. The last year has seen significant transition and we believe we are now ready to provide consistent progress and news flow to show that we are taking advantage of the tremendous opportunities at all our mines to show strong growth.

With that, I’ll pass it over to Mike.

Mike McAllister

Thanks Mark. Thank you operator. That concludes the speaking portion of today’s call. We would now like to open up the call to questions from participants. Operator, please open the lines.

Question-and-Answer Session

Operator

Certainly. [Operator Instructions] The first question is from Lee Cooperman with Omega Advisors. Your line is open.

Lee Cooperman

Thank you. I have to admit a certain degree of lack of knowledge, sophistication of the technical knowledge of your business and having trouble interpreting some of these press releases and you seem to be very desirous of keeping the public informed, which I complement you on because you have a large number of releases.

What’s the possibility of you trying to get some independent appraiser to appraise our reserve base and provide the shareholders with a net asset value or perhaps a present value of that resource base at current prices? Because we have partial interest in different mines and it’s very hard to figure out what the values really are. Even if the second possibility is, if you take your pro rata share of the different mines, what is the reserve base in terms of ounces of silver or ounces of gold that we think we have in the company for the shareholders. So that will be one question. What can you do to help us value the company more intelligently?

Second, the control of the company lies with a private equity fund and it was my understanding that this private equity fund has a finite life, which is not that much longer than another year or two. What do you think is the likely outcome as to the private equity funds disposition of their interest in the company? Thank you for any help you could be.

Mark Brennan

Thank you Lee and yes first of all let me just take a step back. Last year, the last 12 months have really been a year of transition for us, and hopefully investors and the investment community at large has seen a dramatic shift in the operations improvements, likewise the move towards more aggressive tonnage built with exploration successes as at Esperanza. We will try to be more forthwith and more engaged with the investment community going forward without hopefully being overly so.

With regard to the independent analysis and valuation of the projects, as per our press release that we issued on Thursday of last week, that essentially was a resource and reserve statement for the Yauricocha mine. This was conducted by two independent engineering firms, SRK and Gustavson out of Denver. They essentially will be providing, within the next 40 days or so, we will be publishing a 43-101, which will provide many of the characteristics and many of the variables, which people can go in and provide their independent value.

As for the company itself providing metrics of value, Lee you can imagine our concern there as it applies to securities laws and regulations, not wanting to be put in a position where we can be held accountable for perhaps some numbers that the market or people may not see as valid. Thusly, we will use third-party independent valuers such as SRK and Gustavson to provide reports where investors should be able to come to their own conclusions.

That said, we expect that, with the transition from a basic renovation of operations or remediation of operations and strong tonnage growth, we do expect to see a number of third-party analyst covering the company. We are actually doing a site visit to Yauricocha in September with a number of analysts. We had a number of groups at the site recently. Basically, we are trying to engage the investment community to provide their own independent valuations, which I hope should be able to provide guidance to the investment community at large.

On the second question, with regard to the PE fund, I guess with respect to -- we have a group called Arias Resource Capital, or the ARC funds, that essentially have a 52% interest through two funds in Sierra Metals. Basically, they have a number of years from now to sell their position or to reduce their position in Sierra. The company itself is endeavoring to put the operations in the best possible shape that it can, and then likewise to see very strong growth in the next couple of years in order to enhance the value to all shareholders.

What we’re anticipating here is, we’ve seen some very strong movements in ore operational activity and exploration that we think will substantial increase value. The number of ways that the fund can realize on its position. It can either sell its fund position into the market, it can try to enact a sale of the Company, it can distribute the shares to its limited partners. So from that perspective, there is a wide variety that they can attain. But I would say that, at this point, the private equity fund, ARC, and the management and the company as a whole are aligned in the sense that we're trying to create the maximum value that we can in hopefully the shortest period of time considering long term growth into the equation.

Lee I don't know if you have any -- if I answered your question fully.

Operator

We’ve unfortunately lost Lee, but the next question is from Heiko Ihle with Rodman and Renshaw, your line is open.

Heiko Ihle

Hey guys congrats on the quarter, on the release, pretty much everything. I was pretty positively surprised by a variety of things I saw in the release and I am not really sure why the stock is down right now, but anyways. So you mentioned there is possibly a copper moly porphyry that was identified at Cusi ground on the 720 level. It seems to me that there is only 400 meters, 500 meters from Mascota and Esperanza, so it's fairly compact, fairly local, you need to access underground. I mean that's a pretty good example of the Brownfield exploration I think you guys should be doing. And in the past it sure seems like a lot of such exploration really wasn't done or at least not done enough.

So given that you're doing everything a lot more commercialized rather than just chasing veins or just chasing stuff, walk us through the expenditures, proposed expenditures to areas such as these and just in general your Brownfield exploration expenditures that you're anticipating please?

Mark Brennan

I am going to start with the response and I am going to pass on the response to Gord. I will just say this. From a corporate perspective, we saw tremendous success at Esperanza with very limited use of capital. And we see as highlighted in today's press release, we see a number of areas at Yauricocha, at Bolivar, at Sierra that we highlighted in the release today that we think can have a substantial impact and difference on the value and the tonnages of the assets. And so the management perspective, the corporate perspective is, we will make funds available on these different projects as long as we can see or we believe that they will have a positive impact on an NPV basis. With that Gord I'll let you response to the balance.

Gordon Babcock

Okay, thanks. Basically speaking it's as Mark is speaking to, the question, the main issue that we had for 2016 was we have a definition program of work that goes on at the Yauricocha asset and that’s concentrated on Cuerpos Chicos to small zones that are high grade, as a regulator for the mill. The area, the central mine zone, area like Mascota, but we have known areas and then we put together a program at the beginning of the year just finding the Esperanza zone and the Esperanza program, so basically what we were trying to do is to put together a tonnage package that would put us in good shape for the next year, the year and a half.

And that being said, that program was set up to decline the area from 870 level down to the 970 level. And as we move along when we drill these different programs specifically in areas such as Mascota and any area we drilled to the intrusive contact and when we do that this area is quite a prolific mineralization producer, there is a lot of zones that are in parallel to the main zones. There is a lot of opportunity, so as we do these drilling programs we delineate new zones, than they become potential targets in the future and that’s basically how the Esperanza discovery was made. It was made by working on the Mascota zones working forward.

Now in the process right now, we got other Brownfield targets and one of them being the copper moly [indiscernible] zone or that core free. That has been known for better than 10 plus 15 years, it a surfaces expression, its very low grade on surface, it has a little bit better grade in the 720 levels. So that warrants some holes and that’s going to be coming up in the next budget preparation for mostly likely 2017 and it may very well come up a little bit sooner next board meeting that we have.

So as you can probably imagine this kind of -- this area here of Yauricocha is one of things that interested me because it’s so prolific and so many different mineralization opportunities and its really target rich. So you have to be [technical difficulty] of not blowing money where you don’t need to bow it and right now our concentration is trying to get a consistent no key to get our NSRs up to numbers that really help the company move forward. Does that answer the question?

Heiko Ihle

Yes. It does. The answer is a very detailed, I appreciate that. So going over to Cusi, I mean the turnaround at Cusi is clearly in progress. You guys had a very nice decrease in outstanding costs on an ounce basis, I mean it was at $19 or $18 form $30. Walk be through other things that you guys are going to do there in Q2 and Q3 and if you could outline it by quarter as well that would be great. I mean obviously the zinc was a big factor in the all-in sustaining cost. Again what else are we expecting and maybe timeline and cost would be quite helpful.

Mark Brennan

Gordon do you want to respond to that?

Gordon Babcock

Yeah, basically the concept is that the plan in fact in Cusi is to improve our [technical difficulty] going into the Malpaso plant. We’ve made some operational improvements to the plant and it should see some benefits in the near-term with regards to our zinc production. We’ve delineated new areas in the mine such as our Yauricocha depth and those areas are more base metal rich opportunities and we are going to see some improvements in our zinc production, I’m anticipating that. And the other thing we’re doing is moving in some different equipment and we’re getting some smaller equipment so we can impact some of these areas of the -- several rich high grade zones, so we can add to the mill feed going into -- I’m looking for an improvement in the mill feed grade. So that’s consistently moving along, is what we’re looking for, those kinds of things.

In the next quarter we should be in a good position at both Bolivar and Cusi in that we’re receiving some new equipment. So some of the older equipment that’s suffered over time with maintenance costs being high, we’re replacing some of these pieces of gear. We’ve got two small half yard machines coming into the Cusi operation, which should benefit immensely in the rip development on ore and that’s the focus here. And we’re trying to maximize what we can do with what we have. So the mining group that we have in Mexico are quite good, it’s just that when we get down to low levels, we have other things to look forward to with these base metals credits coming in, so that’s what I’m looking for, things like that.

Mark Brennan

Maybe also I can add. With regard to Cusi, it is, we’ve seen it move away from development to production, and that’s helped out a lot. I think what’s interesting is there is a project very nearby, 30 kilometers or 40 kilometers away, called Los Gatos which is owned by Sunshine and basically they are probably deeper in the system and basically have more have more zinc and lead content as they are moving deeper and I think what we are hoping for is to see perhaps some, as Gordon alluded to, some more these zinc and lead and potentially hopefully seeing wider widths in the near-term, Heiko.

Heiko Ihle

Got you, okay. Fair enough. Thank you guys so much. I’ll stop hogging the queue.

Operator

The next question is from Alec Meikle with Cormark Securities. Your line is open.

Alec Meikle

Hi guys. It was nice to see the quarter and it was extra nice to see the Esperanza resource come out last week. My question is focused mostly on the Esperanza zone, and I was wondering if you could maybe provide some color on when this Esperanza zone can be added to the mine plan, and how quickly can you add it and then just the capital costs associated with adding this into the processing plant.

Mark Brennan

Gord, do you want to --.

Gordon Babcock

Right now, what we have done, as we have been working through this exploration program, we have been -- we’re doing drift development on the ore zones and we’ve gotten test stopes that have begun. So right now we are actually doing a draw on the upper part of the 870 level Esperanza zone. I don’t really want to get into the capital costs because we’ve -- this is, since it’s so close to the major arteries in the mine, the capital that we are extending is internal. It’s really burned right into the OpEx.

So all of our development and so on, like everything at this mine so close, like on the 870 level for instance, we are only 150 meters away from the zone. And in the course of development, we crossed over some other zones that we were headed to mine anyway. So all of this is internal in our OpEx. We haven’t put together a full-blown CapEx program which is going after everything at that depth. We are doing this as we are moving along. We have access on the 870 level, we have access on the 920 level and we have a major program ongoing now at the 1070 level.

The 1070 level is the lowest portion of the mine and that level in return is going to have access to the central mine zones in Mascota and to the Cuerpos Chicos as well as Esperanza. In fact, that’s where the drill platform is, base drill platform is on the 1070 level now. So all of this in-house is happening. When we get into a major ramp development that will be CapEx though. Does that answer the question?

Alec Meikle

Yes, that's great. I was just trying to get at the idea that this wasn't a huge capital expenditure to undertake. And then just a follow-up question. On the grade, how easy is it to selectively mine this new zone? And I notice it's high-grade overall, but how easy is it to focus on the higher grade areas of this new resource?

Gordon Babcock

I think the average grade that we are anticipating to see coming out something like Esperanza is going to be better than the central mine zones. So we are talking anywhere from 2 to 3 ounces of silver. If you look at the reserve days and you look at the numbers in the reserve, I think those are very, very realistic expectations for that zone. Remember one thing the Yauricocha mine is always been a mine where there has been custom blending going on with areas like Cuerpos Chicos and areas like Cachi Cachi in those areas you have smaller tonnages but you have extremely high grades anywhere from, zincs can go up to 50%, led goes 8% to 10%, silver can be 200 grams to 300 grams. So those are the regulators and this particular asset is experiencing the same it's just that Esperanza has some wider widths and it has some more opportunity in comparison with the central mine zone.

I think that’s probably a fair way to make the assumption. The reserve base, the reserve and resource pretty much delineates what we're looking at here.

Alec Meikle

Okay, great. That was very helpful. Congratulations on the [technical difficulty].

Operator

[Operator Instructions] And the next question is from Jim Young with West Family. Your line is open.

Jim Young

As a follow-up to Lee's question with respect to independent reserves studies being conducted, it was good to see the Yauricocha announcement that came out, but my question is with respect to upcoming 43-101 for either Bolivar and for Cusi. Is there anything that we can be expecting in the near term horizons since Bolivar platform I recall was from 12.31 of 2012?

Mark Brennan

I guess I'll answer that Jim. The, we're working very, very hard to come up with a new 43-101 at Bolivar and Cusi. I guess what I would -- to be conservative I'd say that we're targeting for the end of the first quarter next year. We fully expect to add new areas, new tonnage in the next coming months and so I think that would probably be the opportune time for us to release Bolivar and Cusi. But yes, we're working with SRK and Gustavson already in terms of to putting together these reports and those will come before the end of the first quarter.

Jim Young

Okay. Thank you. And then secondly, the second question pertains to the outlook in the third quarter and the fourth quarter, because, as I recall, your restructuring really started in the third quarter of 2015. So, we've seen some nice sequential improvements starting from the fourth quarter to the first quarter, and now the most recently reported second quarter. But moving forward, you've got a better pricing environment, and volumes are improving. So when you mentioned in the MD&A about the outlook for improved operating margins and cash flow, can you give us a sense as to which -- what levels can we expect to see in the third quarter and fourth quarter with respect to operating margins or other financial targets that you are focused on at this time?

Mark Brennan

I am going to dance around this a little Jim, just because I think with regard to Yauricocha we're just starting to bring in Esperanza and Esperanza we're seeing higher grade material for the most part of it as Gord just mentioned. We are still trying to get into a standard operation role and we're not quite there yet. As we’ve mentioned we really started production here in July and so we're a month in and what I'd like to say is that we’re very confident that we’re going to see improved operating metrics at Yauricocha as a consequence of two things, one I think Gordon and his team have done a fantastic job with the operational improvements. You know for the most part that the heavy lifting is done, but Gord will be the first guy to say it’s not over and we still have a lot of work to continue on that path. But the second thing is bringing in new zones which we’re trying to find higher quality NSR tonnage. And basically -- so I don’t want to be pinned down, but I would hope to continue to see sequential growth as we move forward.

You mentioned pricing, the pricing environment is still lower than we were a year ago at quarter two on quarter two ‘15 over to ’16. So from that perspective we’ve seen a little bit of resurgence in the base metals and pricing. But we’re still behind where we were in 2015. But irrespective of that, I’m expecting to see a better sequential growth. With regards to Cusi and Bolivar, Bolivar we’re making very strong strides in terms of trying to find again higher quality NSR tonnage, that is a work in progress and we’re very optimistic about that moving forward.

Cusi, Gord just mentioned to you earlier, so I won’t elaborate that, but we’ve very confident that we’ll see continued growth but at this point we haven’t got your point where we’re confident yet to provide absolute numbers.

Jim Young

So, I guess, Mark, could you then share with us though which financial metrics are you most focused on as you look at Yauricocha, Bolivar and Cusi?

Mark Brennan

Cash flow and it’s always cash flow. There is no metric beyond cash flows that we’re trying to generate here. And basically how we’re going to accomplish that is by having our cost at the most efficient level and then again increasing the higher quality NSR tonnage. Those are the two raison d'etres that we have. And basically how we’re accomplishing that is to the operational improvements and also through trying to optimize current areas of mining in terms of higher value material and likewise also new areas that we can find higher quality NSR tonnage. It’s a pretty straight forward equation Jim.

Jim Young

Right. That's why I'm just trying to get a sense as to what you're focused on. And we can talk about it in qualitative terms, but I'm looking for a little bit more quantification and [multiple speakers]. So if you look at Yauricocha for example, you've had some additional costs, as you mentioned, related to the mechanization, and also water management controls. Can you give us a sense as to is that 90% done at this stage? Is that -- and when can we -- because if we can get a sense as to when those costs have been fully spent, we should be starting to see some declines in the costs coming out of Yauricocha, and likewise at Bolivar and Cusi. So, that's why I'm just asking for some quantification at this time.

Mark Brennan

Sure. No that’s very fair. The topline is that we’re still very comfortable within our guidance at production and we’re looking at copper closing at 69 to 85 million tonnes. On the silver basis we’re looking at 10 million to 12.8 million ounce of silver, so that’s the topline. With regard to operational cost as Yauricocha, I expect that they’re going to probably remain pretty much the same for the balance of the year. Now that could change if we can beat our estimates in terms of tonnage throughput, but at the same point, that’s an if.

With regard to Bolivar, I would hope that we’re going to see our costs remain the same, and again, seeing higher quality throughput NSR tonnage, which should see a higher value and therefore the top-line growing. Cusi, again, we are seeing less, the costs should continue to come down based on the fact that we are hoping that we’re going to continue to see lower development work associated with higher volume and higher grade material.

Jim Young

Okay. And then speaking of Bolivar, as the ore grades have declined over the last several quarters, can you give us some sense of confidence? Are you already seeing in the third quarter an improvement in the ore grade and also in recovery rates out of Bolivar, or is that not going to be expected in Cusi until the fourth quarter?

Mark Brennan

I think we are hopeful that we will see that in the third quarter. One of the interesting charts or cross-sections in today’s presentation. Figure 5 shows you the El Gallo zone and it shows you the chimneys. Now, we’ve continued to mine along the Gallo inferior mentos and basically what we found last year, is we found that there are chimneys which are coming from some potential heat source, possibly a porphyry, we don’t know at this point. But this actually -- if you look at Figure 5 Jim, you’ll see that we’ve actually ramped down into these chimneys. And it takes -- we can talk about, we’re going to go and do this, but it takes months and quarters to actually do ramping.

So we’ve done a lot of ramping at that, we’ve done a lot of preparatory work with these chimneys in terms of ramping down and accessing the ore. And so what we anticipate is starting in the third quarter, we’ll start to see higher grade tonnage. Now, historically, if you look at Bolivar, five years ago, it was producing 1.8% copper with zinc and lead credits, very strongly zinc and lead credits. Recently, in the recent past, it’s been about 1.3%-1.4%. And now we are down about 1%. Basically that’s been because we’ve mined out a lot of the Gallo superior. But what we are finding now is that these chimneys are starting to augment the value at -- the value inferior.

And then so what we see here is the preparatory work that is being conducted over basically the last two quarters, well it should start to come into the production schedule. And also what I anticipate later in the year is we’re going to see other areas coming into the Piedra Verdes plant, which essentially will augment the ore as well. And then so, I guess, I would like to give you a quantification. I’m not sure I am eligible to give you quantification, but I do believe that we’re going to see grades coming back to -- we are hopeful that we will see grades coming back to previous recent history levels.

Jim Young

Okay, great. And my last question is for Gordon with respect to Yauricocha and Esperanza, the 1070 level, as you've gotten the drill stations positioned. Gordon, can you give us a sense as to what kind of preliminary results you are seeing from the drilling program at the -- out of the 1070 level?

Gordon Babcock

The drilling, the work that’s been going on at the 1070 level of delineated mineralization is very [technical difficulty] and seen mineralization up above. We are still leading on grades and assay results to come back, and our quality controls program. So what we are seeing is something very similar to what we see up above. The widths tend to be similar or in some cases some sections are wider. This is a whole series of this is the whole series of dispersed [indiscernible] system, with copper bearing areas and then you've got base metal areas with lead, zinc and silver credit. So it's very, very similar to what we're seeing up above. So, it's very positive and so it's looking quite good.

And the other program that we are working on now as we just defined in the last release is a drill program that's going to be conducted from the 720 level in Yauricocha tunnel and that drill program is delineating any target that move up from the Esperanza zone going north and that's another open ended area. So basically, we still have the Esperanza zone open at depth, open to the south, open to the north.

So what I am seeing so far is very positive and it gives us a great horizon to get towards on that 1070 level. So our plans are to get our drift programs, our development programs, fast track them towards these areas, 920 similarly in 1070 and we're driving a wrap right now from the 870 level down towards the 920 level, so we will be able to -- we are mining there in the same sublevel cave fashion as we've been doing for the rest of the mine and in some areas in the future we have [indiscernible] program. So those areas are still under the same consideration.

Jim Young

Okay, great. And lastly, Gordon, what percentage of the ore that's being processed at the Chumpe mill currently is coming from the Esperanza zone?

Gordon Babcock

The contribution from Esperanza can vary anywhere from 5,000 to 15,000 tons in the course of the month. Once we get into the wider zones the contribution will bse heavier. So in a typical month we're looking at mill feed of 70,000 tons to 75,000 tons and that's going to stabilize our cost and we have a blend coming in with our Cuerpos Chicos as well as polymetallics coming from other areas of the mine. So on a percentage basis you can figure it out, anywhere from a 5,000 tons to 15,000 tons out of the 75,000 tons max mill feed, so that's the contribution.

Now, as we get deeper and as we get into the higher the wider zones with more width and more volume, that's going to change. But right now the initial push is to try and feed close to the 10,000 tonne per month mark and we are expecting because these zones are [indiscernible] we are expecting we'll have a good run for a month or two and then after that we have to do more development then we got to get back into the zone down below. So it’s going to be up and down for a while until we get all of our development established in a fashion way. We're efficiently ready to go in and attack all these zones. Remember we've gone from exploration to experts in development and fast tracking the whole progress, as well as studying the ore zone. Does that answer your question.

Jim Young

Yes, it does. And I recognize how quickly things have developed at Esperanza, and appreciate the hard work from you and the team down at Yauricocha.

Gordon Babcock

Okay. Thanks.

Operator

We have no further questions at this time. We will turn the call back to the presenters.

Mark Brennan

Thank you, Chris. Just one quick point again. I wanted to just highlight the fact of this press release earlier today. What we're trying to do here is we're trying to show the various different opportunities that we have, they’re multitude as you can see, we believe that most of these have an impact which can have a substantial impact on our operations at each of these various mines. What we try to do is provide you with a framework for as we go forward you can see where and how we’re developing the different mines and you can hold us accountable for that. We’re very confident that we’ll be able to push these operations and each of these opportunities aggressively forward and thus the reason for the press release today.

With that, I’ll pass the call over to Mike and I’d like to thank everyone for their support and interest in the Sierra story. Thank you.

Mike McAllister

Thank you everybody. That concludes today’s call. On behalf of the management team, I would like to thank all participants for joining us today and for the excellent questions. A replay of the webcast and of all materials can be found on our website again at www.sierrametals.com. If there are any further or follow-up questions or concerns, you can reach out to the management team. Out contact information can be found on Slide 13 in today’s presentation or on the Company’s website.

Thank you operator, please conclude the call.

Operator

Ladies and gentlemen this concludes today’s conference call. You may now disconnect. Thank you.

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