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Silver Wheaton Corp. (SLW)

Q2 2007 Earnings Call

August 3, 2007 11:00 am ET

Executives

Peter D. Barnes - President, Chief Executive Officer, Director

Nolan Watson - Chief Financial Officer

Randy Smallwood - Executive Vice President of Corporate Development

Analysts

John Bridges - JP Morgan

Tony Lesiak - UBS

Presentation

Operator

Good morning, ladies and gentlemen. Welcome to the Silver Wheaton second quarter results conference call. Please be advised that this call is being recorded. I would now like to turn the meeting over to Mr. Peter Barnes, President and CEO. Please go ahead, Mr. Barnes.

Peter D. Barnes

Thank you. Good morning, ladies and gentlemen and welcome to our second quarter earnings call. Some of my commentary may contain forward-looking information, therefore you are cautioned that our actual results could differ materially from my conclusions, forecasts, or projections. I refer you to the section entitled Description of our Business Risk Factors in our most recent annual information form available on [CEDAR], which sets out certain material factors that could cause actual results to differ.

Net earnings for the quarter were $23 million, or $0.10 a share from the sale of 3.1 million ounces of silver, compared with $25 million, or $0.12 a share from the sale of 3.8 million ounces of silver in 2006.

Operating cash flows were $28 million, or $0.13 a share, compared with $33 million or $0.15 a share last year. These results were impacted by temporary production shortfalls at Luisman’s San Dimas mines in Mexico, where silver production was close to 800,000 ounces below budget for the quarter. All of our other operations were at or above expectations.

San Dimas sees their production shortfalls continuing for the remainder of this year and as a result, we are reducing our guidance for the second half of the year to 6.5 million ounces from 8 million. We are confident though that the San Dimas production shortfall is only temporary and that it will be resolved by the end of the year.

Randy Smallwood, our EVP of Business Development, will discuss our operations in a bit more detail in a few minutes.

Really though, the major story of our second quarter is our two acquisitions, which will transform the company. These two acquisitions help us more than double our annual ounces sold over the next five years to close to 30 million ounces a year. In addition, they will boost our long-term cash flow per share by about 30%, with no shareholder dilution.

Goldcorp’s Penasquito Project in Mexico also provides us with a very strong organic growth profile through further exploration success. Just in the last 12 months, Penasquito’s silver reserves increased by 50% as a result of strong exploration results, and this is expected to continue going forward.

There also appears to be strong potential for the open pit production from Penasquito to be increased by up to 30% a year above the feasibility study levels at no further cost to Silver Wheaton. Also, there is good potential that Penasquito will ultimately develop into an underground mine, again at no extra cost to us, and that would further boost annual production levels.

The future growth prospects for Silver Wheaton have never been better. Our expectation is that we have positioned ourselves to do a minimum of two to four accretive transactions a year over the next several years.

I shall now turn it over to Nolan Watson, our CFO, to review our quarterly results, following which Randy will make a few comments on the operations.

Nolan Watson

Thank you, Peter and good morning, ladies and gentlemen. As Peter mentioned, net earnings and operating cash flow for the second quarter of 2007 were $22.9 million, or $0.10 per share, and $27.8 million, or $0.13 per share respectively, from the sale of 3.1 million ounces of silver with an average realized price of $13.58 per ounce. This compares to net earnings and operating cash flow of $25.2 million, or $0.12 per share, and $32.7 million, or $0.15 per share respectively from the sale of $3.8 million ounces at $12.46 per ounce in the same quarter of 2006.

The difference between the two quarters is partly driven by the fact that Luisman had a record quarter in the second quarter of 2006.

Our cash margin for the second quarter of 2007 was over 70%, again due to a strong silver price and a fixed cash cost of only $3.90 per ounce and the fact that we structure our contracts to pay zero income taxes.

With respect to operating results, during the quarter we acquired and sold 1.4 million ounces of silver from Luisman, generating net earnings and cash flow of $12.4 million and $12.7 million respectively. The average silver grade for the period of Luisman’s San Dimas mine, which is where we get most of our silver, was 286 grams per ton, which is below the average reserve grade of 388 grams per ton by 26%, and as Peter mentioned, Randy will be talking more about the operations of our various mines in a few minutes.

During the quarter, Silver Wheaton acquired and sold 844,000 ounces of silver from Yauliyacu, generating net earnings and cash flow of $5.2 million and $8.3 million respectively, and then there is Zinkgruvan contract. The company sold 539,000 ounces for the quarter, generating net earnings of $4.8 million and operating cash flow of $5.7 million.

This actually represents record earnings and cash flow from the Zinkgruvan contract compared to all previous quarters and it just goes to show the power of our model, and as we continue to expand, even when some contracts have temporary reductions in sales, other contracts are setting records.

In April, the company purchased the new Stratoni contract for $57.5 million, which was financed with cash on hand. From this contract, the company purchased and sold 276,000 ounces during the quarter, generating net earnings of $1.5 million and operating cash flows of $2.4 million. This represents production of over 90,000 ounces per month and is typical of what we are expecting for the remainder of 2007.

Depreciation for this contract was $3.98 per ounce during the quarter, and we do expect that to fall in future years, as they continue to have exploration success.

During the quarter, we entered into an agreement with Goldcorp to purchase 25% of the license mine silver produced at the Penasquito mine. That deal was completed on July 24th. Production and therefore earnings and cash flow is expected to begin at the end of 2008 from that contract.

In order to fund the $485 million purchase price, the company entered into a $200 million, seven-year amortizing term loan and a $300 million seven-year revolving facility, of which the term loan is now fully drawn and we have drawn $246 million of the revolver, while the balance of the purchase price was paid with cash on hand.

Upon entering into this debt facility, we cancelled our existing $25 million revolving facility.

General and administrative expenses for the quarter were approximately $2.3 million. This includes $0.6 million of amortization of stock-based compensation, which is a non-cash item. Silver Wheaton’s strategic investments continue to perform well and at June 30th, had a market value of $123 million, representing significant value accretion to Silver Wheaton compared to the cost of those investments.

And that’s the financial summary, and now I will turn it over to Randy.

Randy Smallwood

Thanks, Nolan and good morning, everyone. I’m just going to provide a bit of an update on the operations. I’ll start with the San Dimas operations down in Mexico with their slight production shortfall.

San Dimas is a broad epithermal vein camp that produces from many veins, sometimes up to five or ten different veins producing at the same time. One of the most prolific veins down there has sort of reached a narrow -- it was a good wide zone, or a good wide system, consistently averaging about six meters in thickness and they are just going through a transition over the next few months as it has come down to about a two-and-a-half meter thickness and working their way forward.

It has had a bit of an effect on silver production. It’s typical of these camps but there are a couple of other ore chutes that are coming on stream on the other vein systems, [Repetita] and Roberta, that will be phased in over the next couple of months and we do expect this prolific camp to continue moving its way forward and meeting the goals that we have set out.

As mentioned earlier on, the new production schedule out of San Dimas will be 6.5 for the year, which means another 3.3 million over the next two quarters. No reason to expect that -- I mean, everything looks pretty positive towards that and should be back on stream by the end of the year for 2008.

Down at Yauliyacu, there’s continued success drilling at depths below the 39 level. There’s a pretty active drill program. I think right now there’s three drills on the cross cuts, drilling out additional reserves at depth, so we continue to see great growth in the Yauliyacu camp.

The Zinkgruvan operations, we’ve got directional drilling undergoing on a depth extent of the Zinkgruvan asset with pretty positive results. It’s follow-up to the two drill holes that were completed in 2006 and so we do expect some pretty significant resource growth in that area over the next few months as they continue defining that growth there and, of course, it all comes as part of the contract moving forward, so quite happy with that one.

On the Stratoni contract in Greece, the development decline that’s going underneath the ore bodies, we’ve got a couple of drills active on that decline with positive results and so we are quite happy with the depth extent potential on this. It has performed very well for us in the short time that we’ve had it and we are quite excited about that exploration potential and look forward to that one growing up into one of the major contributors to Silver Wheaton.

And lastly, a bit of a Penasquito update; progress is going well. They’ve got about 35% of the BCM contracts have been issued out for the sag line. Concrete is being poured, the primary crusher foundation is done, the camp is up and running. They’ve got 300 people in the camp. Power line is nearly complete, probably about 85%, 90% complete in terms of the tower construction and highway by-passes are very near completion, so progress is going very well at Penasquito.

It’s a very busy site, as you can imagine. There is a pilot plant test, a decline that is being driven down and a pilot plant that is going to be up and running in September and October and looking forward to this, as this deposit matures, turning into a big contributor.

There is a lot of studies going on with the deep potential of Penasquito. Some of the high-grade results that have been released to date by Goldcorp show great promise for traditional mining but the concept of block caving on a large bulk underground mining concept is getting serious study by all parties and by all means, everything that we’ve seen so far indicates that the mineralization will support such a focus as this deposit matures.

With that, I will turn it back to Peter Barnes, the CEO. Thank you, everyone.

Peter D. Barnes

Great, thanks, Randy. We’ll open it up for questions now.

Question-and-Answer Session

Operator

(Operator Instructions) The first question is from John Bridges. Please go ahead.

John Bridges - JP Morgan

Hi, everybody. I just wanted to dig a little bit deeper into this Luisman situation, to begin with. The company is aggressively developing up for this big expansion which has been promised to us, and I am just surprised that this narrowing would surprise them. How much proven reserve do they have? How many years of proven reserve do they have?

Randy Smallwood

Right now, they’ve got about 1.6 million gold equivalent ounces, slightly over -- I think it is about 90 million silver equivalent, so we are talking about probably 50 million silver ounces in the reserves going forward, 55 million.

The issue, the [Santo Macea] vein system was one of the most prolific producers over the last five years. It has consistently averaged over six meters in thickness and we’ve now reached the top third of this vein system, where it does significantly narrow up. Some supporting development that was supposed to make up the production shortfall from that is on schedule now to be completed here shortly but it just didn’t step in at the same time that the [Santo Macea] narrowed up, and hence the production shortfall.

John Bridges - JP Morgan

So what went wrong?

Randy Smallwood

Obviously a bit of a mistake in short-term planning.

John Bridges - JP Morgan

There were some labor problems in Mexico recently. Was it related to that?

Randy Smallwood

No, at the San Dimas operations, the disturbance was very short. I think it was measured in the amount of days, not even a week, so I don’t think that had any issues there at all.

These epithermal veining systems are always -- there is always a bit of a challenge in terms of keeping the right amount of working faces in front of you and they are so development intensive that I think this one here, just transitioning from a vein system that is typically six meters wide to something that is a little bit over two meters wide, that essentially means you have to have two other working faces coming on stream to replace it, you know, if the average thickness is typically about two meters, and it was just a little bit of a mix-up in short-term, or a little bit of a miss in short-term planning.

John Bridges - JP Morgan

Okay. I think to some extent you answered my second question in your talk but the contract levels of sales from Yauliyacu are significantly different to the ones you are reporting at the moment. How are we going to get from that to the contract levels, or are we going to get to the contract levels?

Randy Smallwood

Yauliyacu is essentially made up of a -- I’m going to use their terminology -- corpos ore bodies, which are wide, sort of almost vein intersections, and then vesas, or veins, which is the narrower portions. The corpos are the more zinc-rich zones and they have lower silver grades but because they are thicker, they are more profitable for mining. The vesas, the veins, are more lead-rich and therefore have higher silver grades but a higher cost of mining.

Essentially the challenge that we’ve had at Yauliyacu is that the exploration success that they’ve had there has meant that there is more corporal production, you know, ore body production, more zinc-rich production and less silver-rich production. The veins are still there, the reserves are there but it is just a matter of the operational flexibility that Yauliyacu has in terms of taking the most profitable materials in front of them as they are going forward.

With the exploration success on these corpos, it’s been more of a focus toward that style of production over this period. Those vesas, those silver-rich reserves are still there and they will feed into the play as we move forward on this one but that’s really what it comes down to. There’s some zinc-rich zones and there’s some silver-rich zones.

John Bridges - JP Morgan

That’s helpful color. With respect to the big jump we’ve seen in the lead price, is that likely to have enough of an influence to get them back into the vesas?

Randy Smallwood

I sure hope so. No, there is no doubt that the lead has become much more attractive with the current upswing in lead prices.

Peter D. Barnes

They are also looking to ramp up production there too, which will -- even if they are producing more from the zinc-rich zones, they will also produce more from the silver-rich zones too, so we are not concerned that we are not going to get our silver. Remember, if there is any shortfall in any year, they’ve got to make it up in future years.

John Bridges - JP Morgan

It’s fascinating to see the limited influence of the miss in Luisman. It sort of supports your profile. The impact on the bottom line of the miss at Luisman at the mine level is significantly more impressive, I would think. Anyway, thanks a lot.

Operator

(Operator Instructions) The next question is from Tony Lesiak. Please go ahead.

Tony Lesiak - UBS

Good morning. Peter, could you just run through what your forecasts look like for Luisman in 2008, 2009?

Peter D. Barnes

Well, 2009, they still believe they will get up to 13 million ounces a year. 2008, I would prefer to wait for now. I mean, they think that over the next five, six months they are going to get back to normal levels. If they do, we are comfortable that overall, we’ll be between 15 million and 16 million ounces company wide next year, just from existing contracts.

But I don’t want to start getting into Luisman numbers for next year until we see how this thing goes. I mean, we are hopeful that it is not going to take six months but I don’t want to get burned again.

Tony Lesiak - UBS

How about I ask you what the breakdown is for the other contracts, so I can back-calculate what the number for Luisman would be?

Peter D. Barnes

No, I mean I think we are comfortable. Even on a conservative basis for Luisman for next year, we think we are going to be in the $15 million to $16 million range overall for the company next year.

Tony Lesiak - UBS

Just on the new debt, I am assuming you are going to be capitalizing the bulk of that?

Peter D. Barnes

When you say capitalizing --

Tony Lesiak - UBS

Or are you going to be expensing it on your income statement?

Peter D. Barnes

Well, we expense the interest.

Tony Lesiak - UBS

So all of it is going to be expensed?

Peter D. Barnes

Yes, it is.

Tony Lesiak - UBS

Okay, going forward, all right. And just on Yauliyacu again, obviously there is a time value of money associated with them chasing the zinc in favor of the NSRs there. Is there any sort of contingency for them delaying paying you out the residual on the contract?

Peter D. Barnes

No, I mean -- again, if there is a shortfall in a year, and there is this year, then they make it up in future years. As I said before, they are looking at ramping up production over the next couple of years, so we are very comfortable we are going to get it back in not too long a point of time. And then, of course, over the life of the contract there is also a minimum but we don’t expect that to be an issue at all.

Tony Lesiak - UBS

Okay, and just on the ramp-up, can you talk to what kind of [percentages] they are planning to get to?

Randy Smallwood

They are looking at a potential expansion of about 30% on top of current production rates, so they will be -- the content right now would have that coming into play in 2009, during 2009.

Tony Lesiak - UBS

Okay, so they’d be over a million tons a year on a throughput basis?

Randy Smallwood

Yes.

Tony Lesiak - UBS

Okay, great. Thanks very much.

Operator

Thank you. There are no further questions registered at this time. I would now like to turn the meeting back over to Mr. Barnes.

Peter D. Barnes

Okay, well thank you very much, ladies and gentlemen. Obviously the quarterly results were a bit disappointing in terms of number of ounces produced but as we said before, we are very happy if that is a short-term phenomenon and I think the growth that we generated during the quarter has added a huge amount of value to the company over and above these short-term issues. We look forward to continuing to grow the company. Thank you very much. Bye.

Operator

Thank you. The conference has now ended. Please disconnect your lines at this time. Thank you for your participation and have a great day.

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