Pan American Silver Management Discusses Q3 2012 Results - Earnings Call Transcript

| About: Pan American (PAAS)

Pan American Silver (NASDAQ:PAAS)

Q3 2012 Earnings Call

November 08, 2012 10:00 am ET


Kettina Cordero

Geoffrey A. Burns - Chief Executive Officer, President, Director, Member of Health, Safety & Environmental Committee and Member of Finance Committee

Steven L. Busby - Chief Operating Officer

Michael Steinmann - Executive Vice President of Geology and Exploration

A. Robert Doyle - Chief Financial Officer


Chris Lichtenheldt - UBS Investment Bank, Research Division

Adam P. Graf - Dahlman Rose & Company, LLC, Research Division

John D. Bridges - JP Morgan Chase & Co, Research Division

Robert Alford


Good morning. My name is Denise, and I will be your conference operator today. At this time, I would like to welcome everyone to the Pan American Silver Third Quarter Results Conference Call. [Operator Instructions] Kettina Cordero, you may now begin your conference.

Kettina Cordero

Thank you, operator, and good morning, ladies and gentlemen. Welcome to Pan American Silver's Third Quarter 2012 Earnings Conference Call. Joining me here today are our President and CEO, Geoff Burns; our Chief Financial Officer; Steve Busby; our Executive Vice President of Geology and Exploration, Michael Steinmann; and our Chief Financial Officer, Rob Doyle.

Before Geoff takes over, I would like to remind our listeners that this call cannot be reproduced or retransmitted without our consent and that -- and to indicate that certain statements and information in this call will constitute forward-looking statements and forward-looking information within the meaning of applicable securities laws.

All statements other than statements of historical fact are forward-looking statements. These statements reflect the company's current views with respect to future events and are necessarily based upon a number of assumptions and estimates that, while considered reasonable by the company, are inherently subject to significant business, economic, competitive, political and social uncertainties and contingencies.

Many known and unknown factors could cause actual results, performance or achievements to be materially different from those expressed or implied by such forward-looking statements, and the company has made assumptions and estimates based on or related to many of these factors.

We encourage investors to refer to the cautionary language included in our news release from November 7, 2012, as well as those factors identified under the caption Risks Related to Pan American's Business in the company's Form 40-F and Annual Information Form.

Investors are cautioned against attributing undue certainty or reliance on forward-looking statements, and the company does not intend or assume any obligation to update these forward-looking statements or information, other than as required by law.

With that, I will turn the call over to Geoff.

Geoffrey A. Burns

Thank you, Kettina, and thanks, everyone, for once again, taking the time to join us on the call this morning. I'm going to start with an overview of our third quarter results and as become our custom, will then pass the call over to Steve, Michael and Rob for a more thorough description of the highlights of our operations, our development projects, our exploration programs and our financial performance.

I'm happy to report that we had a solid quarter from our production perspective at all of our operations, with the exception of Manantial Espejo in Argentina. Our mines in Peru continue to show improvements, largely as a consequence of the investments we have been making in additional underground development over the last 12 months at both Huaron and Morococha.

In Mexico, our Alamo Dorado and La Colorada mines performed right in line with expectations, again showing the mature and reliable nature of these ore bodies and our ability to mine them productively. Our newly acquired Dolores mine was modestly behind where we thought it would be, as we continue to correct previous operating deficiencies and made solid strides in bringing the mine towards a sustainable and predictable operating base.

In Bolivia, our San Vicente mine produced a truly excellent quarter, solidly increasing its silver production and gaining a reputation within Pan American's portfolio as one of our most consistent and reliable operations. Our one blemish during the quarter was the performance of Manantial Espejo mine in Argentina, where production was below forecast. And as a result, costs were well above expectations.

As we discussed -- have discussed in the past, import restrictions have had a devastating impact on our ability to keep our mining equipment operational at anywhere near normal availabilities. As a consequence, we have fallen some 2 million tons behind our plan over the last 12 months in removing waste material to access and release new higher-grade ore. We made a conscious decision at the start of the quarter to focus on catching up this accumulated waste mining shortfall. While we focused on waste removal, our ore release from the open pit suffered, and we dipped into our lower-grade stockpiles to feed the mill. The result, lower silver and gold production and higher cost.

Why did we make this choice? I think the logic is pretty straightforward. At the current time, our ability to repatriate U.S. dollar profits out of Argentina is restricted. Consequently, accumulating and holding a large cash balance in Argentine pesos, which is essentially frozen, didn't seem like the best use of our depleting resource. So instead, we effectively reinvested in the mine to set it up for the future. In spite of the shortfall in Manantial, we still generated adjusted earnings of $38 million or $0.25 a share. Our cash flow from operations was $0.44 per share.

During the quarter, we returned $15.1 million to our shareholders through dividends and share repurchases, paid for all our sustaining capital, covered our exploration expense, paid our taxes and still banked close to $30 million. So far, this year, we have generated operating cash flow of $114 million after paying $133 million in taxes.

We reinvested in sustaining in project capital, distributed $48 million to our shareholders through share repurchases and dividends, paid for exploration programs and overheads and have still banked almost $60 million. Very respectable results in my opinion. Particularly given the fact that silver prices have averaged close to $30 per ounce this year, down almost 20% from last year.

We produced 6.3 million ounces of silver in the third quarter. This was the third highest silver production total in our company's history. We also produced 28,100 ounces of gold, our second highest quarterly gold production on record. Our cash cost increased to $13.87 per ounce, net of by-product credits, higher than our full year guidance. However, if you exclude the effect of Manantial,our cash costs were actually right in line with our forecast. We closed the quarter with working capital of close to $785 million, of which almost $550 million was cash in the bank and a balance sheet with virtually no debt, a very strong end to any quarter.

And in keeping with our stated intention of returning value directly to our shareholders, I am pleased to announce that yesterday, our Board of Directors approved the payment of our fourth quarterly dividend of the year of $0.05 per common share. And I look forward to 2013, when we will again look at materially increasing our dividend and sharing even more of our success directly with our shareholders.

I'd now like to turn the call over to Steve to review our operations and development projects, and I'll be back later to make some closing comments. Steve.

Steven L. Busby

Thank you, Geoff, and good morning, ladies and gentlemen. It is my pleasure to report additional details of our third quarter 2012 operating results and project development advances.

Our operating teams continue to address their unique challenges, delivering yet another solid quarter in line to achieve our full year consolidated production and cost guidance. During the quarter, we had started to realize performance improvements in Peru, where Huaron produced 735,000 ounces of silver, which was 10% greater than the third quarter of 2011. Huaron's cash cost increased as expected to $19.88 per ounce compared to $15.07 per ounce in Q3 of 2011, as we have successfully increased the underground development rates to nearly 4.6 kilometers during the quarter.

Morococha improved production to 544,000 ounces, nearly 42% greater than Q3 of 2011. Morococha's cash costs also increased as expected to $25.66 per ounce, as development rates were substantially stepped up to nearly 5.5 kilometers during the quarter. The increased development rates that Huaron, and in particularly, at Morococha are starting to release better quality ore than we've seen at these mines for the last couple of years. Couple that with our initiatives to mechanize more of our mining at these operations, and we are expecting to see productivities and eventually cash cost to improve during the next couple of years.

Our intense efforts on miner training over the last year has successfully converted 100% of all of our ore mining at Morococha to company employees, who focus more on ore quality than we had experienced with the contract miners we had been relying so heavily on in the previous years.

I'm pleased to report we have completed our ancillary relocation project at Morococha well within budget and relocation efforts have been initiated simultaneously with the Morococha town site relocation being conducted by Chinalco at the neighboring Toromocho project. We are confident these new modern facilities are going to bring us significant operational enhancements, not yet even contemplated in our planning. There's even additional excitement being generated in Peru, with some recent expiration successes that Michael will be touching on at both operations.

I must say it is a pleasure to describe the positive developments we are seeing at our Peruvian operations. And we will continue our quest to realize the true potential of Huaron and Morococha mines for a great many years to come.

As Geoff mentioned, after more than a year of struggling to adapt our business to the intense importation and currency controls put into place in Argentina, we literally found ourselves dug into a hole that was severely limiting our ability to mine quality ore productively. As such, we made a strategic decision during the quarter to redirect our open-pit mining fleet towards catching up on waste movements, deferring planned higher-grade ore production into 2013.

In addition, we've managed to substantially complete a ventilation raise and haulage ramp extension during the quarter, that had been holding back some of our underground, high-grade ore production. All of these factors led us to processing lower-grade ore in lieu of high-grade ore, driving our silver production down to 858,000 ounces, about 25% below plan, and gold production down to just under 9,000 ounces or about 35% below plan.

Direct production costs were impacted with logistical challenges preventing full operation of our new virtual gas pipeline for power supply, which coupled with the deferred high-grade ore production drove our cash costs to $21.61 per ounce, well above the $8.60 to $10.40 per ounce guidance we had provided.

We have started to see the critical spare parts that we need to rebuild our mobile equipment fleets beginning to arrive in country, and we have a new shovel delivery that's expected before year end.

We anticipate beginning to see steady and continual improvements in our critical equipment availabilities, which will drive production up and drive cost down over the next 4 to 6 months at Manantial Espejo, as we get back into mining the higher-grade ores.

Our San Vicente mine in Bolivia performed exceedingly well during Q3 of 2012, producing nearly 1 million ounces for the company at a cash cost of $18.59 per ounce, including the full effects of the increased COMIBOL share of the operating cash flows, now that the capital investment has been recovered.

Despite the notable conflicts with certain mining assets in the country and the recent empowerment of the cooperative mining sector, our employees, unions and communities remain solidly in support of our business, and our operation remains calm and productive. San Vicente has proven to be a solid asset with a strong committed operating team, and we are expecting the valuable contributions from this mine for all Pan American shareholders and certainly all of the local stakeholders for many years into the future.

The addition of the large Dolores mine to our La Colorada and Alamo Dorado mines has now firmly established the stable mining district of Mexico as our solid foundation for strong, reliable and profitable production. La Colorada continues to perform, producing 1.1 million ounces of silver at a cash cost of $9.93 per ounce during the quarter. We have successfully completed a new pump station underground as planned and have begun discussions on possible expansions, given the huge exploration successes that we have been seeing over the last couple of years. We have started conceptualizing a new shaft and possible haulage system improvements that would be necessary to fuel a possible production expansion over the next few years, once we lock into the optimal approach and complete the necessary feasibility and development works.

Alamo Dorado delivered 1.3 million ounces of silver during the quarter at a cost of $5.87 per ounce, as we have begun laying back the open pit towards the west that'll yield some additional ores to our remaining line. We are still conducting additional drilling around the perimeter of the open pit, and we'll be looking at a new open-pit design that'll include a relatively modestly increase to reserve to what was reported at the beginning of 2012.

Our newly acquired Dolores mine is settling in nicely and starting to make strides towards enhanced efficiencies as we schedule out our mobile equipment fleet rebuilds, focus on the leach pad construction and operations and advance exploration efforts around the perimeter of the open pit.

We did suffer a disruption production in August, when we had an unanticipated cone crusher failure, which was temporarily mitigated and brought back online until replacement parts can be acquired in 2013. Meanwhile, we completed some additional metallurgical studies aimed at simplifying and improving the potential mill development concept, which has yielded excellent results, which will be rolled up into the mill study and new mine plan now being scheduled for completion in early 2013.

I am starting to see our efforts at Dolores being divided into 2 distinct initiatives. The first initiative is focused on optimizing and securing production in the current crushed ore heap leach configuration. And is highlighted by intensive effort to extensively build out leach pads to allow us much better efficiency of recovery, flexibility of operation and overall reliability of production according to the existing ore reserves as defined by Minefinders. This effort is in full swing, as we took advantage of placing our Navidad project on current maintenance, pending the law reform in both Chubut, Argentina and simultaneously completing the Morococha relocation project, allowing us to reassign our strong projects group towards the Dolores leach pad expansion efforts. We anticipate getting ahead of our leach pad needs that'll help stabilize and improve the existing operation in the latter part of 2013.

Meanwhile, the second initiative is focused on defining and optimizing the incredible long-term potential of this deposit, including a careful evaluation of the mill opportunity, as well as optimizing the life of mine plan and defining additional exploration potential that may also lead to a future underground development at Dolores.

As Geoff mentioned again, despite the shortfall in Argentina due to factors largely outside of our control, I remain confident that we will achieve our full year consolidated silver production guidance of 24.25 million to 25.5 million ounces and our annual cash and cost guidance of $11.50 to $12.50 per ounce, net of by-product credits, while aggressively refocusing our talented project development group towards significant opportunities that exist at our newly acquired Dolores mine in Mexico.

With that, I'll now turn the call over to Michael Steinmann for the exploration update.

Michael Steinmann

Thank you, Steve. Good morning, everybody. Like every quarter, I would like to start with the drill statistics. Between brownfield and greenfield expiration, we achieved over 57,000 meters of diamond drilling in Q3. Our annual program calls for 220,000 meters drilling, and we completed in the first 9 months of the year about 141,000 meters or 64% of it. The largest drill contribution on the brownfield side came from La Colorada, Morococha, Dolores and Huaron, and on the greenfield side from the La Virginia project.

But let's go directly to La Colorada and discuss the outstanding results there. Since Q2, we increased the annual exploration program by over $3.2 million for additional 21,000 meters of diamond drilling. The total 2012 program for La Colorada stands now at a record of 42,500 meters, and we plan to spend about $5.9 million.

Most of the increased exploration drilling is taking place at the Amolillo vein, where we added 2 additional surface rigs, drilling now with 3 machines. As discussed in Q2 conference call and in the August press release, the results have been, and still are, outstanding. For example, we intersected 2.3 meters true width containing 1,470 grams silver, 0.6 grams gold, 4.34% lead and 10% zinc and sulfides, or 3.4 meters true width containing 465 grams silver and 0.38 gram gold in oxides. In addition, we discovered the split structure of the main Amolillo vein, which is nearly 2 meters wide and returned 1,295 grams of silver.

The dry strength of Amolillo vein containing positive true results increased now from 300 to over 900 meters. This is a very important discovery for 2 main reasons. First, it confirms a strongly mineralized vein in higher levels than most of the current mine reserves. Although drilling confirmed the continuation of the high-grade Amolillo vein down to 600 level, the current Amolillo reserves reached only down to 275 level, 325 vertical meters higher than in the rest of the mine. And second, it is adding to the mineralized footprint of La Colorada, opening the door for a potential production increase in the coming years.

The main NC2 and HW structures, which are currently producing 88% of the ore returned exceptional results as well. Extending the vein alongside to the east and at the mid 2 to 5 meters wide intersections suction, returning 300 to 650 grams silver and 3% to 10% lead zinc combined. Our current reserves on these 2 main veins reach currently down to 600 level, but the structures are open-ended with positive results in the deepest hole drilled so far at level 1,008, over 1 kilometer below surface.

I simply can't say enough about the exceptional exploration results enjoyed at La Colorada during the last couple of years. And I'm convinced that we will see once again in December substantial reserve and resource addition from La Colorada.

Steve mentioned Huaron already. For the first time in several years, we discovered again some wide ore bodies at Huaron in addition to the normal vein mineralization. We stepped up drilling in these zones and working on underground access. Mineralization is wide and returned some high-grade results. For example, 22 meters containing 254 grams silver, 5.99% lead and over 10.5% zinc. Increased drilling and results will be reflected in the new reserve and resource statement at the end of the year.

Our Dolores mine in Mexico saw an important drill program in Q3 as well, completing over 9,000 meters of drilling. Like in Q2, we focused on the East Dike zone, as we need to define the possible fit expansion to the east in order to plan the final leach pad outline. The main exploration focus from Q4 onward will be on a potential north and south pit expansion, as well as an underground mining targets. Drilling on the East Dike has been mostly finalized. And new resource estimation is in progress. Results will be incorporated in the year-end reserve estimation, which will be published in February.

The Waterloo project in California did not see any drilling in Q3, as we are preparing for the large Phase 2 program during the much cooler fall and winter month. Drilling resumed last week with one rig, and we plan to add a second one before the end of November. Meanwhile, we have work on metallurgical test, geological and structural interpretation. We plan to spend about $1.1 million at Waterloo for the rest of the year and remain on track for a new resource and reserve estimation towards the end of 2013.

The exploration program at all of our operations now are shaping up nicely. Drilling has added substantial new resources in most of our mines and will hopefully more than replace the mine reserves at the end of the year, once results are incorporated into our mine plans.

I'm looking forward to update you in details on the new corporate-wide reserves and resources and final 2012 exploration results in February next year, first, with the press release and then followed up during the Q4 conference call.

Now to Rob for the financial review.

A. Robert Doyle

Good morning, ladies and gentlemen. As Geoff mentioned, Q3 was another quarter of steady financial performance for Pan American and a significant improvement over our Q2 results.

Our adjusted earnings, after adjusting for unrealized losses on derivatives and commodity contracts and adjustment on the sale of [indiscernible] and unrealized FX gains were $37.6 million or $0.25 per share, considerably better than the adjusted earnings of $17.1 million or $0.11 per share in Q2 2012. This increase in adjusted earnings was largely driven by a 21% increase in mine operating earnings from Q2 2012, up to $68.2 million, the result of higher quantities of silver and gold sold, as there was very little change in our realized metal prices from Q2 to Q3.

Our mine operating earnings of the sales margin or gross margin remained in the 28% range, similar to Q2. Adjusted earnings in Q3 also benefited from a return to more normal levels of G&A and exploration costs and the lower tax expense relative to Q2. The higher quantities of precious metal sold in Q3 ensured that we achieved record quarterly revenue of $251.8 million, 26% higher than Q2 revenues. Cash flows from operation before working capital changes was a healthy $65.7 million, an 88% increase from the $35 million in the previous quarter.

As you would expect with such strong operating cash flow, we were able to bank $28.2 million during the quarter, which was after investing $45.8 million in our capital projects and operations and returning $15.1 million to shareholders in the form of dividends and share buybacks. All told, a satisfying performance relative to the previous quarter. Although some way off the profitability levels we enjoyed a year ago, when our gross margin was 48%, a consequence of a significantly higher price environment in 2011 and also the impact of additional depreciation from Dolores and higher royalties in Bolivia.

Overall, Q3 was a relatively clean quarter, with very few unusual items having an impact on our results. We were able to sell down some of the metal inventories that we built up during Q2. In total, we sold some 6.3 million ounces of silver and 32,800 ounces of gold, thereby reducing inventories by some 0.4 million ounces of silver and 4,500 ounces of gold. These inventories were drawn down mostly from Manantial Espejo and Dolores, where after tax margins are relatively thin. We calculate an after-tax contribution to earnings of approximately $3.6 million from the sale of inventory during Q3 2012.

Steve has touched on some of the impacts that cost escalation is having on our business. Overall, we've seen about an 11% increase in our average cost per ton in Q3 over costs from a year ago compared to our budget expectation of a 9% increase.

Ironically, it is our most profitable mine, Alamo Dorado, where throughput rates have been challenged by harder than expected ore that have taken our consolidated cost per ton above our expectations. Alamo's cost per ton are up about 20% compared to an average increase at our other operations of 7% year-over-year. The high production cost that you see on our income statement compared to Q3 of 2011 were the combined effect of more sales volume by an incredible 41% on an equivalent silver ounce basis and the cost escalation just described.

Price adjustments relating to previously reported sales were not a material item for us in Q3, as they were in the prior quarter. The combination of price and quantity adjustments from our concentrate contracts resulted in a $1 million negative adjustment revenues in Q3.

We recognized a downward adjustment of $3.4 million to the gain that we had previously recognized on the sale of Quiruvilca. The adjustments related to final settlements on wage and capital balances at the time that the mine was sold and capital projects that we had undertaken to complete. No further adjustments are expected from the disposal of Quiruvilca, other than the potential for income from the ongoing Silver Stream and royalty interest that we retained.

Our effective tax rate for the third quarter was 45%, which was higher than the 30% to 35% we would expect in a long term, principally due to the effect of the loss on derivatives, which added 8.4% to our effective tax rate.

Moving to the balance sheet. We saw a $15.8 million increase in working capital, reflected primarily in higher cash and short-term investment balances, partially offset by normal cost increases in accounts payable. Cash and short-term investment balances ended the quarter at $548 million, with working capital at a solid $784.6 million.

We completed our share buyback program during the quarter, spending $7.5 million to buy back and cancel an additional 0.5 million shares. In total, we have bought back and canceled 5.4 million shares at a cost of $124.9 million. We also obtained approval to buy back an additional 7.6 million shares, up until the end of August 2013 as a potential way to continue returning value to our shareholders.

With that, I'll hand it back to Geoff for some closing comments.

Geoffrey A. Burns

Thanks, Rob. There's not much new to report with respect to our Navidad project. As we discussed last quarter, we have throttled back our spending and are waiting to see what will happen with the provincial legislation.

Navidad is an amazing deposit, and I know that we will have a chance to unlock its value one day, but for the moment, it's stalled. The provincial government has continued to study the situation carefully, and I am still of the opinion that it was not the provincial government's intent to render Navidad uneconomic and dissuade further potential investment in mining in the province.

I still don't think the draft legislation as it was presented in June is going to pass. There will be some modifications. We'll just have to be patient and let the political process work and evaluate our next steps when the final legislation is passed, which I believe might well happen before the end of this year.

We're -- as Steve mentioned, we are not sitting idle though. We have redeployed our project team and are working on some other pretty interesting organic opportunities to grow our production.

As Michael described, drilling at La Colorada continues to return wonderful results. And we have clearly reached a point where the size of the resource dictates that we reevaluate the optimal mining scenario at La Colorada. And we have started, as Steve mentioned, the process of evaluating the mine expansion.

In addition, we are cranking up our work program at Waterloo, having been equally encouraged by the positive drilling results we have seen and the warm reception we have received from the San Bernardino County. It is still early days, but I'm hopeful we will be able to create some real long-term value from this plus 100 million-ounce resource.

Lastly, we have been progressing our evaluation of the milling option at Dolores. Without going into any further details, the project is really starting to take shape. We are hoping to have the scoping levels study done to share with you before the end of this year, but it now looks like it might slip into the first quarter of 2013. Suffice to say, at this point, I really like what I am seeing.

I'd like to close by making a short observation. In spite of a plus 20% decline in the price of our primary commodity silver and some difficult obstacles to manage around in Argentina, Pan American continued to generate solid earnings and cash flow, continues to return cash directly to our shareholders, continues to be responsive and innovative and move forward with growth projects. And while I remain optimistic that we will see the prices for both silver and gold move materially upward, given the ever worsening government debt levels, I am comforted to know that Pan American remain in excellent condition, even as prices have drifted lower.

With that, I'd now like to open the call to questions.

Question-and-Answer Session


[Operator Instructions] Your first question comes from Chris Lichtenheldt with UBS.

Chris Lichtenheldt - UBS Investment Bank, Research Division

Situation at Manantial. First, you said -- I think you said the equipment availability has improved a little bit, and your ability to bring pricing is a bit better. Can you describe a little bit what's happened there to make that better or -- and will that last?

Steven L. Busby

Chris, yes, this is Steve. It's really -- the situation is, finally, starting to resolve itself, relative to the government recognizing what they can actually produce in country, and what they can't. So there's a lot more clarity there. There's a lot more systems in place now that we've worked through the systems of importation of parts. We kind of know the ropes, if you will, of how to get parts into the country better now under this new scenario, and things are starting to flow. Our availabilities on some of our critical pieces of open-pit gear fell even below 50% here over the last 3 months or 4 months. During October, we've seen that turnaround In October, lots of that gear was up into the 60% and even 70% availabilities. And we know we still have some major rebuilds to do. We still have those parts coming in. We're seeing them at the port and coming through the ports. So we're optimistic. We've reached bottom, and we're pulling our self out on those availabilities right now.

Chris Lichtenheldt - UBS Investment Bank, Research Division

Okay, sounds good. And secondly, you said you'll be going back in. You've achieved some of the waste removal that you needed to. Will there be potentially an improvement in your ability to repatriate funds in conjunction with higher cash flow, or is that still a challenge?

Geoffrey A. Burns

That remains a challenge right now. We have been able to repatriate funds through the repayment of interest and scheduled loan repayments on our investment going into the country. But in terms of our ability to repatriate dividends, while we have applied and have not been rejected, essentially nothing is moving. And it isn't a rejection. It's just there's no response. So as it stands today, no, we have not seen any light, I guess, at the end of the tunnel, in terms of moving cash back out of the country. And offhand, I don't expect that to change in the near term. I think it's going to be a little while before the Central Bank in Argentina has decided that it has sufficient reserves to allow for a freer flowing of U.S. dollars out of the country.

Chris Lichtenheldt - UBS Investment Bank, Research Division

Okay. It's good to know. And so we should expect production to return somewhat normal, sales to improve, but then an accumulation of pesos?

Geoffrey A. Burns

Yes. Chris, I just -- we're not going to push hard. It just -- there's no other way to say this nicely. But it does not make sense to me to try and crank production back up and take advantage of our highest-grade material, when we're ending up leaving pesos in the country of Argentina, which I think are at the moment -- are very susceptible to further exchange rate deterioration relative to U.S. dollar. So we're going to improve our production. I mean, we could do better than we did last quarter as we fight through, as Steve mentioned, some of our availability issues. But I'm not going to push that asset at the moment. It just doesn't make sense to do that.

Chris Lichtenheldt - UBS Investment Bank, Research Division

Yes, makes sense. And then finally, just actually is there any practical way to hedge against some of the potential devaluation of the currency if you are sitting on pesos or do you...

Geoffrey A. Burns

We're investigating alternatives, but as it stands today, the forward market that is available gets you out to about 7:1 relative to today's current exchange rate, which is 4.75 to 1. So there really isn't -- the most effective way is frankly what we did, which is reinvest into the -- to setting the mine up for better performance in the future. As Steve mentioned, we did acquire a new shovel. And again, that's reinvestment, but we're investing in essentially hard assets versus just leaving the money in the bank.


Your next question comes from line of Adam Graf with Dahlman Rose.

Adam P. Graf - Dahlman Rose & Company, LLC, Research Division

Question, maybe for Geoff. On a global basis outside of the issues in Argentina, what are you guys seeing as far as labor and capital cost inflation here?

Geoffrey A. Burns

In Mexico, I would say, and it's a bit -- a little bit country specific, so I'm going to go through them in order. In Mexico, we're seeing relatively low levels of inflation in the sort of under 5% range, both for labor and commodity inputs into our operation. In Peru, it's a little bit higher than that, largely driven by labor. Some of the labor increases are higher than the 5% range, in the 7% range. And we have seen some increases in energy and the cost of energy. But in general, it's not -- and I'm talking operations specifically now, pardon me. It hasn't been out of line. And in Bolivia, again, it's been relatively stable and under certainly the under 10% range on an operating cost basis. Outside of Argentina as you mentioned, where things are 25% and 30% and have remained at that level. On a capital cost basis, we're not, at the moment, engaged in any major projects, partly by circumstance and also partly by choice to be honest, because we're still seeing some pretty hefty cost inflation on capital projects. I think you're seeing the same thing announced by other very large companies that are facing those issues. But we are starting to see it turn a little bit with some of the announcements of the very large mining companies, Tek and Newmont and others of that size are deferring projects. It is going to take some of the pressure off the capital cost. And where that ends up? It's probably too early to make a call on how much that pressure will ease off in the coming months.


Your next question comes from the line of John Bridges, JPMorgan.

John D. Bridges - JP Morgan Chase & Co, Research Division

Just wondered, we were thinking that there might have been concentrate -- a positive concentrate adjustment, which would have given you better than market ledging prices. Was there any -- what was the concentrate adjustment this quarter?

A. Robert Doyle

John, Rob here. Actually, in total, it ended being a small negative. I was a little bit surprised by that too. And then we dug into the detail, what ended up happening actually was a lot of QPs were declared in the early part of the quarter and prices were -- when you look at most of the metal price graphs, really September was a good month, where we saw a lot of a good runup in metal prices. But the first couple of months of the quarter were relatively soft. And that's when we had an overweighting of pricing. There were also -- specific to our Mexican operation, there were some quantity adjustments that flowed through in the quarter, which were negative and pulled that over to a negative overall adjustment in the quarter.

John D. Bridges - JP Morgan Chase & Co, Research Division

Okay, it was primarily timing.

Geoffrey A. Burns


A. Robert Doyle

Okay. And just wondered, how much money are you going to put at risk in California prior to getting permits and being able to have the right to mine there?

Geoffrey A. Burns

Yes, we're -- Michael said we're looking at about a $1.7 million program right now. We'll probably look at something around $2.5 million to $3 million next year, which should put us in a pretty good position to have -- to find a 43-101 level resource, as well as probably get, at least on paper, an early stage scoping study done. We probably aren't going to go much further than that, so in total, that's about $4.5 million to $5 million. We probably wouldn't go much further than that without getting some real clarity on our ability to permit and move that project forward.

John D. Bridges - JP Morgan Chase & Co, Research Division

Okay, good. And then just a silly question. I just wondered, if you knew how good La Colorada was turning out to be, would you have bought Dolores?

Geoffrey A. Burns

John, absolutely. I mean, we had indications of how positive the results were at La Colorada. And even a year ago, at this time, had started talking about maybe it's -- maybe we better start looking at what the optimal mining rates are there and what our potential is to expand. I mean, I really like what we're seeing at Dolores. We're a little slow in getting where we thought we're going to be. There was -- to be blunt, there was a few more issues to overcome than we had assessed during our due diligence, but the issues I'm seeing, they're all solvable. They're just -- they're -- we're not -- we were talking a few months of delay relative where we thought we'd be. And the ore body, it's a 16-, 17-year ore body, and as the guys described, I think there is a significant potential to go underground somewhere during that 16- or 17-year mine life. We still need to determine that. And the mill option that we're looking at right now, again, I don't want to, I can't go too far, because we don't have enough preparation, but we've seen some very positive results in our metallurgical testing and how we relate that to our remodeling of the ore reserve. So no, I'm pleased that we have Dolores, and I'm pleased that we're now, as it turned out, much more overweight Mexico than we were at the start of the year, frankly.


[Operator Instructions] Your next question comes from Robert Alford with Atlas.

Robert Alford

Joined your call a little late, so I apologize. Can you review your capital allocation, stock buybacks, what you're doing with cash flow? Where you expect that to be?

Geoffrey A. Burns

Actually, pardon me. could you -- we only caught about half of your question there, Robert. If you wouldn't mind, could you repeat that?

Robert Alford

Sure. I apologize, again, if it's another -- if it's repetition for you. But could you review your cap allocation going forward, in terms of stock buyback? Were you -- how much CapEx? Where do you expect free cash flow to be? And where you're going to allocate your capital expenses?

Geoffrey A. Burns

In terms of our current planning, we don't have any major projects that we have completely defined at this moment in time. So our capital expenditures relative to our operating cash flow will be limited to sustaining capital. I see that as probably the case, at least for the next 12 months until we get more definition on our organic growth opportunities. We're spending in the neighborhood of about $4.5 to $5 per ounce on average, per ounce of production on capital's -- there's sustaining capital. So give or take, that's about $100 million a year. In terms of our ability to generate cash flow at these pricing -- price levels, I'd see us anywhere from $150 million to $200 million of bankable cash over an annual basis. And we will be looking predominantly towards the dividends and the potential increase in dividend as a way of distributing that cash back to -- back directly to our shareholders. We looked at it very briefly. We did increase our dividend literally last quarter. We looked at it very briefly this quarter, but we're right in the middle of our annual budgeting process. And I think I certainly would be more comfortable once I've gone through that entire process and know with certainty what next year is going to look like, subject to variances in silver and gold prices, before I bring that topic back up with our Board of Directors. But I am confident that we'll be in a very good position, come February to look at increasing our dividend substantially from where we are today.

Robert Alford

And stock buybacks?

Geoffrey A. Burns

We have a program in place right now, as we mentioned. I can tell you right at the moment, we're not active with that program. It's available to us. We did complete our full program last year. And I would say at these price levels, I don't see us entering the market to repurchase. We continually reevaluate our share price and what we believe our net asset value is and cash flow generating capacity is. And should we see more softness in the price, we'll probably go back in and enter the market again. But as I said, our preference, predominantly, is to try and increase our dividends.


Ladies and gentlemen, this concludes today's question-and-answer session. I will now turn the call back over to Mr. Burns.

Geoffrey A. Burns

Thank you, operator, and thank you participants. It's always a pleasure to be able to update you on our progress and status. And I look forward to doing it once again in mid-February. Thank you.


This concludes today's conference call. You may now disconnect.

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