Pan American Silver Corporation Q3 2007 Earnings Call Transcript

Nov.12.07 | About: Pan American (PAAS)

Pan American Silver Corporation (NASDAQ:PAAS)

Q3 2007 Earnings Call

November 12, 2007 4:30 pm ET

Executives

Geoff Burns - President, CEO

Rob Doyle - CFO

Steve Busby – SVP, Project Development

Analysts

John Bridges – JP Morgan

Michael Dudas - Bear Stearns

Haytham Hodaly - Salman Partners

Howard Flinker - Flinker & Co

Alexander Emery - Bloomberg

Operator

I would like to welcome everyone to the Pan American SilverCorporation third quarter 2007 earnings conference call. (Operator Instructions) It is now my pleasure to turn the floor overto your host Mr. Geoff Burns, President and CEO. Sir, you may begin yourconference.

Geoff Burns

Thank you, operator.Good morning, ladies and gentlemen and welcome to Pan American's third quarter2007 earnings release conference call. Joining me today here in Vancouverare Steve Busby, Senior Vice President, Project Development; Andrew Pooler,Senior Vice President, Operations; Michael Steinmann, Senior Vice President,Exploration and Mine Geology; and Rob Doyle, our Chief Financial Officer.

The third quarter of 2007 was by all measures the best inthe company's history. We posted a new record for silver production at 4.45million ounces. We recorded our highest-ever quarterly cash flow from operatingactivities at $33.3 million before non-cash working capital adjustments; thatis $0.435 per share. Our revenues reached an all-time quarterly high at $87.9million, up 37% from the same period in 2006.

Our cash costs, although slightly higher than expected, werea very respectable $3.32 per ounce. Finally, we recorded net earnings of $23.9million, or $0.31 per share, a 46% increase as compared to the third quarter of2006. Record silver production, record cash flow, record revenue and oursecond-highest quarterly earnings ever; I think it is fair to say we had anexcellent third quarter.

Before taking a quick tour around our mining operations anddevelopment projects, I would like to make a few comments on the silver market.As I am sure you are all aware, even considering today's decline, the price ofsilver is up almost 13% from the start of the year. It is currently tradingjust under $15 per ounce.

Perhaps more significant is the 27% rise in the price sinceAugust 21, when the entire market shuddered in response to the credit andliquidity crisis in the United States and silver closed at $11.60 per ounce. Notwithstandingtoday, there is no doubt in my mind that during this last period silver hasbeen trading like the precious metal that it is and like gold, is responding toconcerns about the long-term value of the U.S. dollar.

But what about the fundamentals of supply and demand? I wasin New York last week to receiveGFMS Mid-Year Global Silver Survey update. Let me share with you a couple ofthe highlights of that update.

On the demand side, GFMS estimates that industrial demandhas risen sharply in 2007, more than offsetting the decline in photographic offtake,and now accounts for over 50% of world silver usage. The Indians, who left thesilver market last year in response to the price, have been active again in2007 and GFMS estimates that overall flatware and jewelry demand will be stableyear over year.

The ETF now stands over 140 million ounces, with investmentdemand remaining extremely strong. Net-net, silver demand is likely to growabout 2% in 2007 inspite of the increase in the price. World silver supply is likely to fallslightly in 2007, as an estimated 4% growth in new mine supply is offset bylower silver scrap and recycling and considerably lower government sales. TheChinese and the Indian governments have not been active sellers in 2007 andproducer hedging -- which brings silver back to the market -- has been minimal.

In conclusion, we are looking at about a 2% growth indemand, with supply basically flat in 2007; a balanced market with perhaps asmall deficit; a market where the fundamentals are clearly supportive of thecurrent price. While I remain bullish on the silver price, despite the factthat silver is off some today, I'm even more bullish on Pan American'sprospects going into the fourth quarter and on into 2008.

Let's take a look at how our mines performed in the thirdquarter, starting with our newest mine, Alamo Dorado in Mexico.You probably recall from earlier this year that Alamo Dorado was a little slowout of the gate, but during the second quarter we demonstrated clear signs thatproduction was steadily increasing and I was confident that we would reachdesigned capacity in the third quarter.

During the third quarter, Alamo Dorado produced 994,000 ounces of silver, up16% from the second quarter. In September alone, the mine produced 460,000 ounces of silver at acash cost of $3.88 per ounce, 8% above feasibility estimates. This trend hascontinued in October, where production topped 490,000 ounces.

Cash costs were higher than expected in the third quarter,primarily due to the failure of one of the two boilers that preheat metalbearing solutions prior to their entry into our refinery. That had a negativeimpact on our gold recoveries and reduced our byproduct credits. The boiler hasbeen fixed, gold recoveries have risen and as demonstrated in September, weexpect cash costs to decline over the balance of 2007.

We still believe Alamo Dorado will produce 3.6 millionounces of silver in 2007, with cash costs having crept up to the $4.25 perounce level. Alamo Dorado is now clearly living up to its pre-billing and isset to become our largest silver-producing asset going into the fourth quarterand beyond.

Moving on to our other Mexican operation, the La Coloradamine had another outstanding production quarter in the third quarter. Itproduced 995,000 ouncesof silver, up 8% from the same period in 2006. For the second consecutivequarter, La Colorada was our largest silver producer. Cash costs were $6.73 perounce, which are down from earlier this year as increased production has helpedoffset the effects of cost escalation.

Both the oxide and sulfide recovery circuits continue to runwell and underground operations have kept pace with the expanded processingcapacity of over 1,000 tons a day. We are right on target to produce 3.8million ounces of silver at La Colorada in 2007.

With the operation running smoothly, our attention hasshifted to exploration. There are currently three diamond drill rigs working atLa Colorada and I look forward to providing a formal update on the positiveresults that we have achieved from this program when we publish our new reserveand resource statement early in 2008. The exploration potential of La Coloradahas always been excellent, and we are starting to tap that potential.

Moving to Peru,at Morococha silver production for the third quarter was 750,000 ounces, up 8% from theyear earlier period, and cash costs were the lowest in the company at negative$2.92 per ounce. Cash costs continue to benefit from high byproduct zincproduction and excellent zinc prices. Morococha has delivered a fine quarterand is on track to produce 2.7 million ounces in 2007.

The Huaron mine maintained its solid performance throughoutthe third quarter and is one of our most consistent producing mines. Silverproduction at Huaron increased as compared to the third quarter of last year to951,000 ounces.Cash costs in the third quarter also increase somewhat to $2.93 per ounce ofsilver produced, as the mine continue to focus on throughput to offset aplanned decline in silver head grades. Huaron should meet our 2007 productionforecast of 3.8 million ounces.

We initiated the mine deepening program at Huaron earlierthis year, which is an investment in the long-term future of this operation. Asignificant portion of the highest grade reserves and resources are locatedbelow what is currently the lowest level in the mine, the 250 level. We havestarted to ramp below the 250 level and are also planning to deepen apre-existing shaft to open up a new mining area. This project will take atleast another full year to complete, but will provide access to higher gradeore for years to come.

At Quiruvilca, silver production for the quarter was 409,000 ounces at a cost of$1.33 per ounce. Production was down approximately 16% from a year ago, but wasalmost identical to the production and cost numbers that we recorded in thefirst and second quarters of this year.

We had expected to access higher grade ore from below the400 level as early as the third quarter of this year, with the completion ofthe 400 level ramp development project. However this project is running behindschedule as a result of low availability of contractor equipment. We are likelyto maintain similar production levels as we have seen all year into the fourthquarter, but are looking to increase silver grades and production levels as wemove into 2008.

To round out our operations, San Vicente in Boliviaproduced 236,400 ouncesof silver in the third quarter, as we continue to mine at extremely modest paces,processing about 250 tons per day. Cash costs for the third quarter were $5.21per ounce. In order to extract the real value of this high grade, long-life orebody, we have started our expansion project, which includes construction of anew 750 ton per day processing plant and expansion of underground mineworkings.

The expansion is scheduled for completion at the end of2008. The economic returns for this project are extremely attractive. For arelatively modest capital investment of $40.5 million, we will add almost 2million ounces of silver production per year at a cash cost just over $2.00 perounce. At current prices, the payback period is estimated to be just over oneyear. It is very early stages, but we are off to a very good start reasonablestart on our program at San Vicente. Mine development is moving ahead asplanned with the advance of our new production ramp approaching 400 meters. Civil work for the newplant site is 75% complete, the construction camp is being finished and shouldbe ready for occupancy shortly; detailed engineering is nearing completion andall major long-lead-time equipment has been ordered.

Continuing with our growth plans, construction anddevelopment of our biggest project to date, Manantial Espejo in Argentina,is progressing extremely well. I was fortunate enough to be in Argentinaa couple of weeks back and saw firsthand the results of our mine-buildingefforts. I am very happy to tell you that I was extremely pleased with what Isaw.

Our construction and mine development activities are nearingpeak levels, with nearly 500 Pan American employees and constructioncontractors now on site. The tailings dam has been completed. Concreteplacement is close to 60% done. The admin building and laboratory building havebeen completed and should be occupied shortly and steel erection for the mainleaching and thickening tank is underway. The site is literally alive withactivity.

On the mining side, the Melissa and Maria underground rampshave advanced a total of 1,129 meters and we have intersected both ore bodies undergroundas we have modeled. In addition, we have moved more than 1.6 million tons ofwaste material from the Karina Union and Maria open pits and have begun tostockpile ore.

To the end of September, we have committed almost $94million of this $170 million project, which when completed, will produce 4.1million ounces of silver and 60,000 ounces of gold annually.

I am a bit concerned with Manantial Espejo's schedule. We hadplanned to mechanically complete the construction by the end of April of nextyear. However, possible delays in equipment deliveries and some issues withcontractor performance are clearly putting this schedule under pressure. It isa very remote location and we are fighting to keep our original schedule, butit is not going to be easy.

I hope I have given you the impression that we are extremelyactive executing our growth plans, because we are. With Manantial Espejoscheduled to come on stream in the middle of next year and San Vicente by theend of December, we are clearly poised to see continued production growth atPan American. I am projecting productionin excess of 25 million ounces annually by 2009.

Let me take a moment to summarize the third quarter beforewe open up the call to questions. We have produced 4.45 million ounces ofsilver in the third quarter at a cost of $3.32 per ounce. Alamo Dorado hasachieved and actually exceeded our feasibly estimates and our La Colorada,Huaron and Morococha mines are running extremely well. We posted record cashflow, record revenues and the second-highest earnings in the company's history.

We finished September with over $207 million in workingcapital and no debt, clearly capable of meeting the capital requirements of ourexpansion projects. There is no question that we had the best quarter in the company'shistory. We are set to produce nearly 17 million ounces of silver in 2007 andwith silver prices remaining strong, although volatile, and plans for anotherincrease in production, I fully expect to be posting even more records by theend of this year.

Thank you, and I would ask the operator to open the linesfor questions.

Question-and-AnswerSession

Operator

Your first question comes from John Bridges – JP Morgan.

John Bridges - JP Morgan

You have this stockpile that is hanging on from the previousperiod; roughly what should we look at as a normal inventory for you, to get asense as to how much additional sales we can put in for this final quarter?

Geoff Burns

Thanks, John. Weended the quarter with, if I recall, about 13,000 tons of concentrateinventory, which I assume is what you are referring to. At the end of December,we had just a little over 3,000 tons. On an ongoing basis, a normal level wouldbe around 5,000 tons. That is probably our normal inventory level, although aswe have seen, they do fluctuate up and down.

My expectation is we should achieve this level again by theend of December. I thought we would see a little bit of decline or pull down inthat inventory during the third quarter, but, again, simply as a function ofhow our shipping process works, we didn't see that decline, but I am lookingfor it in the fourth quarter.

John Bridges - JP Morgan

How much confidencecan you have of that, because as I understand it the shipping market is somewhatdifficult to manage?

Geoff Burns

Well, I am not surewe actually manage the final shipping market. John, I guess it really comesdown to experience. I mean over the course of the last three years, we havetended to ship all the concentrates and that we have produced in any given yearand while we don't control when the boats leave the Port of Callao in Peru,that has been our experience. As I said, I do expect us to see that happenagain.

John Bridges - JP Morgan

I would imagine thereis going to be on awful lot of people in the same position as yourselveslooking for space on boats at the end of this year.

Geoff Burns

No question.

John Bridges - JP Morgan

Secondly, what sort of tax rate should we put into ournumbers for the year?

Geoff Burns

I am going to throwthat over to Rob Doyle, our Chief Financial Officer.

Rob Doyle

It should stabilize around about 30%. The tax rate,effective tax rate in Peru,taking into account the workers' participation is a steady 5.6% and in Mexicowhere we are starting to become tax paying in our various entities, it is 28%.So somewhere in the low 30% is really where we should be stabilizing.

John Bridges - JP Morgan

So was there anyparticular driver of this low tax rate this quarter?

Rob Doyle

You know, the otherthing, of course, that goes into our provision is our future income taxcalculation which is a fairly complicated calculation. There was a tax assetthat we recognized in Boliviaactually that has brought us down by about $1.4 million in the quarter. So thatwas the main reason why that the effective tax rate moved a little lower thisquarter. But over the longer term, I would say that 30% is as good a number asany.

John Bridges - JP Morgan

So would 30% be goodfor this year or would it be a bit below that because of the tax asset?

Rob Doyle

Perhaps this year itwould be a little lower, but on an ongoing basis, say 30%.

Operator

Your next question comes from Michael Dudas - Bear Stearns.

Michael Dudas - Bear Stearns

Regarding Argentina,maybe a little bit more color on the difficulty and the slippage from April. Isit more a function of getting contractors to where they need to be, given thereare a lot of things going on in the marketplace or is there a lot of slippagein equipment? If I could get a little bit more detail on that. Should we beconcerned about a slip from April to May or April to September?

Geoff Burns

Well to start, Ihaven't given up on the end of April in terms of meeting our schedule, butthere are a couple of things that really have to line up for us on theequipment delivery side to make that schedule, not the least of which is thedelivery of our SAG mill, which at the moment looks to be sort of six to eightweeks behind where we would like it. I don't have a concern that we are goingto see end of April to the end of September. That is not in my horizon, but Iwouldn't be surprised at the end of the day if we were six to eight weeksbehind where we would like to be. I haven't given it up yet, but that would notsurprise me.

In terms of the contractor side of things, it is more, I amgoing to say not so much in terms of an industry situation, it is morespecifically an Argentine situation. Argentinais not a renowned mining country and so we are using some contractors that arevery experienced; an example is steel erection, but it is not perhaps one oftheir mainstay activities, so there is a little bit of learning curve that weare dealing with in getting those contractors mobilized and identified. Thatalways plays into the schedule a little bit.

I think the very last thing which I didn't really mention inmy comments, Manantial Espejo is by far the windiest site that I have ever beenon. As you know, it is in the Patagonian and as a consequence of the jet streamflows at different points in time can have a long periods of winds in excess of70 to 80 kilometersan hour and that is not the easiest conditions to be pouring concrete framesand erecting steel. So it is not unlike just about every mine that I have everbeen involved in building, it has a couple of its own unique challenges.

Michael Dudas - Bear Stearns

Sounds like a littlebit too strong for a wind farm?

Geoff Burns

It actually is. Wedid look at that in the past and most of those units kind of max out at about30 to 40 kilometersan hour, and there is a lot of energy down there if someone could figure outhow to tap it in wind.

Michael Dudas - Bear Stearns

Secondly Geoff, looking out to '08 level of cost inflationex volume-related issues relative to what you have seen in '07? In general,nothing too specific.

Geoff Burns

In general. Thanks, Michael, for letting me off. I think ourcosts in the third quarter at $3.32 are higher than where we are going to endup being largely because of the Alamo Dorado, which is now starting to have amuch higher multiplier or weighted average effect into our structure and as Isaid, because of the lack of some gold production, was about $1 higher, maybeeven a little bit more than $1 higher than what I would expect long term. Myexpectation is to see costs for us under the $3.00 number going forward andalso into 2008, given two other events and that is given zinc prices, goldprice, lead price relative stability.

Michael Dudas - Bear Stearns

On that topic, you did mention about you have zinc forward inthe little quarter. A little bit more on what your thoughts on pricing andstrategy there, and what is the board thinking about relative to $800-plusgold?

Geoff Burns

Starting with the zinc, I think on the zinc side, I mean,there is a lot of discussion in the market about production surplus orproduction excess going into 2008. We decided to move back into the forwardmarket, hedging close to 50% of our 2008 production. If I recall, the minimumaverage price is just a little over $3,000 so I'm pretty comfortable with that.

I do think there could be some continued downward pressureon zinc in the short term and that seems to be a consensus among a lot ofpeople who are following the industry. So going forward, I can see us movingback into the market again on some price spikes and I do expect to see pricespikes in the zinc market, that is normal, and to try and maintain a 50% hedgelevel is probably a pretty good watermark for us.

On the gold side, I have to say, plus $800 gold, knowingthat we have a considerable amount of gold production, particularly coming fromManantial Espejo, is pretty tempting also considering that for us gold isreally a byproduct. I don't think many people buy Pan American for our goldexposure.

Having said that, I think there are still legs in the goldmarket, Michael, I mean today may not be the best day to be prognosticating onstrength, but I really don't see anything that is going to strengthen the U.S.dollar in the short to medium term. I just don't. I think you have one ortwo-day trading changes, but overall, I don't see anything breaking that trend,personally.

I think gold will continue to trade conversely to thatweakness. I have heard people talk about$1,000 gold. I don't know that is in my mind, but I do see some more legs and Iwould be reluctant at this stage to jump into that market until I was a littlemore comfortable that we might have actually come to a top.

Operator

Your next question comes from Haytham Hodaly - SalmanPartners.

Haytham Hodaly - Salman Partners

I missed the very beginning of the call, so you may haveaddressed this. Do you have anything in asset-backed commercial paper rightnow?

Geoff Burns

We do not.

Haytham Hodaly - Salman Partners

A couple of housekeeping questions and then I will ask you ahard one. Your full year G&A for this year, last quarter was a littlelower. What do you expect your full year to be?

Geoff Burns

I don't have it right in front of me, Haytham, but if Irecall, we ran just under $2 million in G&A for the quarter.

Haytham Hodaly - Salman Partners

Great. $1.8 million Ithink it was, yes.

Geoff Burns

You know what, Iwould expect us to be $2.5 million, give or take, in the fourth quarter, sofull year right around $9 million.

Haytham Hodaly - Salman Partners

Is that a reasonable number to use going forward?

Geoff Burns

I think it is, yes.

Haytham Hodaly - Salman Partners

Exploration and project development was a little low. Canyou give us an idea of what you are looking at in terms of full-year expensenumbers? Let me tell you what it was at. It was at 100,000.

Geoff Burns

Yes, exploration and development, we had some reallocationof some previous costs which in reality kept this month's expendituresrelatively low. I would expect us to see at least a couple million dollars overor during the fourth quarter on exploration. We are drilling on a couple of greenfieldprospects that we weren't doing earlier this year and we are still very activeat all our sites. Some of that gets captured in our capital, but there will besome of that expense, so full year, I would see us somewhere around $3.5million, $3.6 million.

Haytham Hodaly - Salman Partners

Your plans for nextyear in terms of exploration, is there anything in the works, anything you havebudgeted or you can see yourself drilling that you would be expensing ratherthan capitalizing?

Geoff Burns

It is a little early to make some of the comments on nextyear's plans. We are actually just going into our budget cycle right now.Having said that, we are going to be significantly more active on thegreenfield side of things both in Mexico and in Peru, so I would expect ourexploration budget to increase fairly significantly going into 2008. I don't have a number that I can give youtoday.

Haytham Hodaly - Salman Partners

Your forecast for 17 million ounces in 2007, that iscontained metal, is that correct?

Geoff Burns

That is correct. Notpayable, that's contained.

Haytham Hodaly - Salman Partners

Can you just break down roughly where you are seeing thatjust to confirm, to see what's changed?

Geoff Burns

We certainly have forecasts for each one of our operations,we can go through them individually on the phone with you. Can I get Rob togive you a call?

Haytham Hodaly - Salman Partners

That would be great,or better yet, have they changed from the last time we talked?

Geoff Burns

They have not.

Haytham Hodaly - Salman Partners

Well that is fine, then. Perfect. Thank you, Geoff.

Operator

Your next question comes from Howard Flinker - Flinker &Co.

Howard Flinker - Flinker & Co.

Did you guys issue a completeincome statement, balance sheet and cash flow statement with your earningsrelease? I didn't notice that on your release or EDGAR?

Geoff Burns

It is posted in itsfull glory on our website and referred to in our earnings release at thatlocation.

Howard Flinker - Flinker & Co.

It is? I checked thelink and I didn't see it, that's why I am asking.

Geoff Burns

It is also posted on SEDAR, which is the Canadian filingequivalent to EDGAR.

Howard Flinker - Flinker & Co.

Is that under a 10-Q or a 6-K under SEDAR?

Geoff Burns

Pardon me, Howard, that is the U.S.filing equivalent numbers. I couldn't give you the offhand what the Canadianequivalent to that is.

Howard Flinker - Flinker & Co.

But you're sure it ison SEDAR?

Geoff Burns

I am absolutelypositive.

Rob Doyle

On EDGAR on Tuesday.

Howard Flinker - Flinker & Co.

EDGAR tomorrow? Nowonder. Maybe it would be easier if you issued it at the same time as yourshortened earning release.

Operator

Your next question comes from John Bridges - JP Morgan.

John Bridges - JP Morgan

I was just interested by your high-quality problem of thenon-stop gale in Argentina.I would think that would be beneficial. Where is your power coming from? Whatare you paying for that?

Geoff Burns

Steve, do you want tohandle that?

Steve Busby

Sure. John, we arelooking at bringing in the power line with a government-sponsored program wherewe are contributing about a third of the capital price to bring that in fromthe town site of San Julian. The idea is that we would be generating power withthe government in San Julian using gas turbines. We anticipate that to beslightly off the schedule of when we need it, so we are considering bringing insome temporary diesel-generated power to get started and then once that powerline is completed between six months to one year, we would convert over to the powerline.

John Bridges - JP Morgan

Interesting. What is the elevation like? Could you have awind turbine and pump storage to give you stability of power supply?

Steve Busby

It is windy during the summer, actually very windy right nowwhich is moving into the middle of the summer season. The winters, actually, wehave less wind typically in the wintertime, colder temperatures occasionally weget a little bit of snow, not a lot. The site is very, very dry. We only havean average of a little over 100 millimeters of rainfall every year.

Operator

Your next question comes from Alexander Emery - Bloomberg.

Alexander Emery - Bloomberg

I had a question about your Bolivian operation seeing thesituation there, just to see what your take is on there and whether the projectis possibly being delayed there because of the problems we see with Glencoreand the Jindal project and still continued grumbling about the higher taxes onmining in Bolivia.

But also, you seem to be pressing ahead more aggressively inArgentina and Mexicoand even a largely depleted project like Morococha. I was just interested to see, are thingsmoving ahead more slowly in Boliviabecause of the situation there?

Geoff Burns

Thanks for thequestion, Alexander. First, Morococha is not largely depleted. My belief is wehave ten years of proven reserves and probably another ten years of resourcesat Morococha, so far from being depleted.

In terms of Bolivia, I think we are off to a pretty goodstart and we are not seeing our project delayed at this stage by, as I say, anyof the political issues that possibly Glencore has faced over the last littlewhile. I won't kid you, Boliviais a difficult place to do business, but it does have a considerable mininghistory whereas in Argentina,at different points in time, it is hard to locate skilled miners and equipment,Bolivia isquite the opposite. It is actually very easy to locate skilled people in themining industry.

So far, I'm going to say some of the overall countrypolitics that have affected others have not affected us. We have a very strongsupport of our local union, who are very vocal with keeping our project ontrack and frankly, keeping them employed. So I don't think we are seeing anyparticular slowdown at this stage.

As for the long term taxes, it has been over a year since the governmentintroduced draft proposals to increase the tax rate, so I can tell you when wemade our decision to go ahead, we fully incorporated those higher tax rates inour economic evaluations. To date, that legislation has not passed through intolaw and as it stands right now, we are still under the same tax regime we wereover a year ago.

That is probably in and of itself an example of I'm going tosay some of the difficulty in working in a country like Bolivia, where it takesmore than a year to pass a simple tax legislation.

Operator

There appear to be no further questions at this time. I willnow turn the floor back over to management for any closing remarks.

Geoff Burns

Thank you, operator. Howard, if you are still on the line Ijust want to assure you once again that the complete financials and MD&Afor our current quarter are available on SEDAR and are also on our website.

Thanks, everyone for joining us here today for our thirdquarter conference call and as I said, I look forward to setting even morerecords as we move into the fourth quarter of this year. Good day.

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