Turquoise Hill Resources Ltd. (NYSE:TRQ) Q2 2016 Earnings Conference Call August 3, 2016 11:00 AM ET
Tony Shaffer - IR
Jeff Tygesen - CEO
Steeve Thibeault - CFO
Brendan Lane - VP Operations & Development
Sasha Bukacheva - BMO Capital Markets
Craig Hutchison - TD Securities
Good day, ladies and gentlemen. Thank you for joining us today. Welcome to the Q2 Results Call. I would now like to turn the call over to Mr. Tony Shaffer. This call is being recorded and will be available later today for replay. Please go ahead,
Thank you, operator. I want to welcome you to our financial results conference call. Yesterday, we released our second quarter results press release, MD&A, financial statements. These items are available on our website and on SEDAR.
With me today is our CEO, Jeff Tygesen; Steeve Thibeault, our Chief Financial Officer; and Brendan Lane, Vice President of Operations and Development. We will take your questions after our prepared remarks. This call will include forward-looking statements. Please refer to the forward-looking language included in our press release and MD&A.
I'd now like to turn the call over to Jeff.
Thanks Tony. Everybody knows we received approval in May. Underground activities continue to progress. In early June, Oyu Tolgoi appointed Jacobs Engineering EPCM contractor. In July, Thiess, Khishig Arvin were appointed the contractors for the development of the decline. I am pleased with how things are moving forward. There has been an increase in mobilization by several contractors and key first step Site specific Site Training of new and returning personnel.
The Turquoise Hill management team is with the board in Mongolia and yesterday we visited [ph] was taking place. The team at Oyu Tolgoi are very focused at advancing construction of the underground with each day moving closer to underground production. During the Oyu Tolgoi threw down approximately $4.3 billion for the project finance facility. As stated previously net funding was reduced to pay down shareholder loans to Turquoise Hill.
Steve will talk more about this shortly. We are working on our new technical report which we expect to publish later this year. There are no material stroke changes from the 2014 report. The primary purpose of the update is to align the production schedule, to reflect our recent notice to proceed approval. We also plan to include several high end level case including production schedules and economics.
We think this will provide a more robust view of Oyu Tolgoi's optionality and allow for greater option visibility. With the development of Hugo North underway we are beginning to anticipate the next logical steps in the long term development of Oyu Tolgoi.
Once Hugo North begins production, we expect to undertake additional to achieve our North West too. And plan on converting it from resource to reserve. Because lift 2 is below lift 1 we cannot begin large scale production from lift 2 until lift 1 is nearly complete which is anticipated around 2038 to 2039.
One of the benefits of the decline used to convey ore from Hugo North lift 1 is that it passes by design, near Hugo South. Once the decline is complete, additional drilling at Hugo South is possible. And we hope to able to also convert it from resource to reserve.
One of the productions carrier options being reviewed is Hugo South will allow us to consider increase in concentrated capacity. Thereby, increasing production. Clearly our immediate focus is on the development of Hugo North West One but we are already started to think longer term.
One of the key aspects of Oyu Tolgoi is development, production optionality. A parameter of world class asset. Moving to current operations, Oyu Tolgoi has another outstanding safety performance during the second quarter with the year-to-date injury frequency rate of 0.13 for 200,000 hours work.
The Oyu Tolgoi work force continues to truly impress with their industry leading safety performance. During the second quarter we began to see an impact to reduce lining to phase 2 of the open pit. We have been flagging this for some time mainly because of the drop in gold production expected in the second half of this year.
Mining will occur in phases 3 and 6 in the second half of this year. These phases have copper production consisting of previously mined sections of the open pit but they contain much lower gold today. We don't expect to see gold rates increase until we begin mining phase 4 or in mid to late 2018.
For people who may be new to Turquoise Hill, this cold grade decline was anticipated in our 2014 technical report. Second quarter revenue decreased 23% over the first quarter mainly due to lower gold volumes. We reported operating cash flow of more than a $160 million over the second quarter, a decrease of approximately 17% over the first quarter also reflecting lower gold production settled. Both copper and gold production were lower in the second quarter compared to the first quarter as mining in phase 2 was reduced. Copper production in the quarter was primarily impacted by lower headwinds.
In summary, I am pleased with our progress on underground development. Gold production is pretty much as we expect it due to reduced mining in Phase 2. We remain focused on developing efficient cost structure in the next years as gold rates are low.
At this point I am going to turn the call over to Steve to discuss the financial aspects of the quarter in more detail.
Thank you, Jeff. I wanted to start off with the Nova DRP project finance drawdown that took place during the quarter. As Jeff mentioned Oyu Tolgoi threw down $4.3 billion during the quarter. We are working with Oyu Tolgoi to finalize the drawdown of the remaining amount.
Oyu Tolgoi deducted $33 million for banking fees and used approximately $100 million of its own cash to pay additional bank fees. The net process proceeds was $4.3 billion which was used to pay their shareholder loans. We paid an additional $118 million in withholding taxes and placed $4.2 billion on the audit with Rio Tinto. This was in accordance with the previously agreed cash management services agreement. We will redraw these funds as required for Oyu Tolgoi or underground development. While these balances are in deposit with Rio Tinto we benefit from the reduction in the guarantee fee payable on the projects line instead. Projects line is borrowing and has been recorded as non-current debt.
The $4.3 billion drawdown was offset on initial recondition by transaction cost of $218 million. The transaction costs are amortized of the life of the borrowing as a constituent of the interest charges. Amortization of transaction costs in the quarter since drawdown is approximately $2.1 million resulting in balance sheet borrowings of approximately $4.1 billion.
The amount of $4.2 billion deposits with Rio Tinto has been recorded as a loan to relay the funding in the balance sheet. As summary of the deployed return together with the impact on the guarantee fee can be found on those 20 [ph] the current quarter courtesy of the financial statements.
Revenue for the quarter was $333 million a decrease of 22% when compared with the first quarter of 2016. The decrease was mainly due to the reduced in concentrates sold as a result of lower rates. Average copper prices in the quarter was $2.14 per pound compared with first quarter $2.11. Copper prices at the end of June were $2.19 per pound with $2.20 at the end of March.
The average gold prices for the quarter increased by 6.5% on $1,183 per ounce to $1,260 per pound compared with the first quarter. Gross margin was lower than previous quarter at 28.1% compared to 50.8% in the first quarter. The decrease was a result of lower gold revenue and higher unit costs on production and lower grade and low recovery.
Income attributable to Turquoise Hill shareholder in the current quarter was $30 million. Due to continued forecast middle prices medium grade copper gold stockpiles expected to be processed in more than one year are fully provided again. A charge of $3.9 million was recognized in the quarter. The opening cash at Oyu Tolgoi was $216 million compared with $197 million in Q1.
The increase was mainly driven by Oyu Tolgoi administrative costs including additional management services fee or MS Fee entered in the execution of the project finance during the quarter. At June 30, 2016 our cash balance was approximately $1.5 billion. Operating cash flow for the quarter was $162 million, 17% below Q1 reflecting the lower wholesales.
Cash flow expenditure on the cash basis was $53 million for the quarter including $37 million for underground development and pre start activities. To see what costs in the first quarter were $1.12 per pound compared with $0.06 per pound in the first quarter? The increase was mainly due to the lower gold credit combined with the higher unit cost of production reflecting the lower copper grades.
First quarter in sustaining costs were $1.55 per pound compared with $0.66 in Q1. The increase in all in sustaining costs was due to the same drivers as though having an impact on Q1 cost. We have updated some aspects of our guidance for 2016. Copper and gold production guidance remains unchanged at 135,000 tons to 195,000 of copper and 225,000 to 285,000 ounces of gold.
Sustaining cash flow expenditure or the open pit has been revised to approximately $200 million from $300 million previously. This is mainly due to reduced effort sweeping due to open pit optimization to reduce weight bringing forward metal from phase 4 and changes in strip ratio updated for the most recent reserved estimate.
Operating cost guidance is now increased to approximately $840 million from $800 million. The revision is a result from the net impact in the changes in the first stripping and additional management service fee incurred in relation to project finance partially offset by cost reduction.
So that concludes my comments and I am going to turn the call back to Jeff.
In summary progress continues on underground development. Due to reduced mining in phase 2 the open pit is pretty much as we expected with lower expected gold productions. OT remains focused on developing efficient cost structure over the next few years as gold grades are low.
That concludes our remarks. John we are ready to take questions.
Thank you Sir. [Operator Instructions] Our first question is from Aurous [ph] from Scotia Bank. Please go ahead.
Hi good morning. I was wondering if you could give us some idea on how the changes you just talked about in terms of stripping and so forth impact the mine plan for 2017 specifically in terms of what that might mean in terms of Copper and Gold production.
Yes. Thanks for the question. What the team is then working on is a way to pull some copper forward, I guess in reference or comparison to the 2014 tech report. And how they have been able to do that although we haven’t given guidance for 2017 is by splitting phase 4 in to two halves and focusing on what the one half that has a shallower or lower strip ratio and that’s how we will be able to pull that forward in combination with having the experience or phases 1 and phase 2 and seeing how the rock is performing. There is some upside in the slope angles and being able to defer some of that waste.
The tech report that’s going to come out I assume, over the next two months or so, will it give us that kind of detail for what’s left of the open pit or will it only look at the underground?
Oh, no. It will be a refresh of where we are at today. What I wanted to avoid by having the updated tech report is have people try to match up what we said, the production schedule open pit with the delay so we will show a new schedule going forward in 2017 combined open pit underground.
Okay. And what’s the expected filing date for the tech report right now?
I am officially saying second half of this year. We are going through the review process. I don’t want to commit to a date but it will be definitely be in the second half of this year.
Okay. And is this not subject to the 40 day 403101 requirements from a filing perspective?
It’s not. Okay. Thank you.
Operator before we move to the next question, Jeff what I would like to do, I just realized that in my text I gave you a different guidance on the gold. I said 225,000 to 285,000. The guidance we have and we maintain is 255,000 to 285,000. So just wanted to make sure that I have the record straight here. Okay? Sorry about that.
Thank you. The next question is from Sasha Bukacheva from BMO Capital Markets. Please go ahead.
Thank you. Jeff you mentioned that once you had the chance to upgrade, restore some Hugo South you might be looking at an increase in concentrator capacity. So do you have an idea of what might be an optimal concentrator increase to support that? Would you have to an assessment? How should we think about that optionality?
Sasha, I'll take your question. There is the option I have referenced at before. We will have to a feasibility study as we have to review the cost of that development. In the time frame for that given the drilling, feasibility study we will be looking at the earliest around 2027 timeframe. But it could have the range of the 30,000 ton to 50,000 ton range depending on what the feasibility shows for Hugo South.
30,000 ton to 50,000 per day?
And would it make sense, is that something you might make sense to implement sooner and supplement it with the seat from the open pit before you transition into Hugo South?
Did you mean Hugo North lift 1 transition?
So, what I mean is make the concentrator bigger rotor before 2027 before the feed from Hugo South becomes relevant and put the open pit material through the concentrator to supplement the feed you are getting from the Hugo North.
I think we will provide some clarity in the upcoming tech report. So, there’s several combinations if you look at the, I know you have the 2014 and we are reviewing those right now so those will be in the upside cases.
Okay. Sounds good. Thank you.
The next question is from Craig Hutchison from TD Securities. Please go ahead.
Hi, good morning. Just follow up on the development options that you are going to align in the tactical report. Can you give us a sense of which options you are looking at, obviously the options are Hugo South and Extension there, Lift 2, would Heruga factor in at all this point or you just sort of looking at different options in terms of Lift 2 and Hugo South?
Craig, thanks for that question. Looking at the lift 2 and Hugo South in priority over Heruga at this point primarily just because of location with respect to facilities and more importantly grade. So the lift 2 has the higher grade behind lift 1 followed by Hugo South and they are still staying in the order with Heruga that we outlined in the 2014 report. So location is one and use of combined infrastructure and these are the reasons for going in that particular order.
Can Hugo South be developed before Hugo North too correct?
From a timing standpoint I can’t start drawing from lift 2 until lift 1 is mostly completed because it sits vertically below versus Hugo South sits of to the side. So, if the scenario looks favorable for Hugo South that could come online before lift 2.
Okay. And in terms of guidance for next year, can we assume we will get some kind of guidance from the technical report that comes out and just in terms of the underground development spending, when can we get a sense of what those numbers and budgets will be?
So yes you will see guidance on 2017 going forward production and the second part was guidance for capital spend. I am guessing that’s towards the underground?
That’s correct, yes.
Currently the roof on size is about a 1000 people and as I mentioned a lot of what’s going on is refresher training as that’s the key component of Oyu Tolgoi’s operating philosophy. And the plan is to end the year somewhere between 2000 to 2500 and also start at next year so it is a timing of when people are actually on site and we will have better clarity as that progresses. But the 1000 people on site and the work we see occurring now is pretty impressive from my standpoint given the short timeframe of notice to proceed and activating the contracts.
So we have contracts for EPCM, the decline, underground development and two shafts and it is getting all those people mobilized in on-site to that and the spending kind of lags a little bit behind that, so I think in the next quarter we'll be able to have better clarity on what that profile looks like.
Great. The team is working very hard at this moment to put these numbers together. I wish to give you a number today but nothing -- was comfortable with. When we started to poke different things, I mean we're willing to go in the cash basis as we do usually because I think it's more useful for you guys and I was not comfortable with the numbers because they were different. So actually I had something one -- I feel more comfortable to think give that information.
Key point, and Craig to follow-up on Steve's response.
If it wasn't the year end, it would be an easier number but because some might fall a little bit in December or January, that's where as opposed to earlier in the year an easier number to hit. And also at the start of these projects, the ramp up is pretty steep and picking which one day fall is different towards the end of the year.
And just one last question for me. In terms of recoveries in the quarter, it came down a fair bit for copper and gold; I know some of that is great related to it but is there something specific about phase 6 or is it higher oxidized material that's impacting those recoveries and do you expect them to improve towards the back end of this year?
Craig, as we've stated before, phase 6 does have different metallurgical characteristics than 1 and 2; 1 and 2 are really good. So they are relatively lower phase 3 and phase 6 compared to 1 and 2. But I wouldn't say compared to our plan they are materially different but they are lower. But I think the biggest contributor from a copper standpoint is just lower head raise and pretty much by definition and all of deposits I worked in, lower the head, we end up with slightly lower recoveries.
Okay, thanks guys.
I should maybe as Steve mentioned, we're staying on target for the copper guidance and we -- last quarter we updated the gold guidance. So I'm still feeling comfortable with those.
Thank you. There are no further questions registered for the moment. I'd like to turn it back over to Mr. Jeff Tygesen. Please go ahead sir.
Thanks for joining us on today's for the call. As I mentioned earlier, it's an excited day and going through both, the current operations and seeing the underground. 80% of OyuTolgoi's value resides in our underground reserves. And I stated recently, that throughout this year, in my opinion it's the best copper opportunity for development today. Thank you.
Thank you. The conference has now ended. Please disconnect your lines at this time. And we thank you for your participation.
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