Argonaut Gold Inc

TSX:AR

Earnings Call Transcript 2022-Q3

[Operator]

Good morning. My name is Michelle, and I will be your conference operator today. At this time, I would like to welcome everyone to the Argonaut's Q3 2022 Financial Results Conference Call and Webcast.

[Operator Instructions]

As a reminder, today's call is being recorded, November 4, 2022. Thank you. Mr. Radford, you may begin your conference.

[Lawrence Radford, executive]

Thank you, Michelle. Moving to Slide 1. Welcome to Argonaut Gold's Q3 2022 Financial and Operating Results Conference Call and Webcast. Thank you for taking the time to join the call today. From the Argonaut's team, I have Dave Ponczoch, CFO, who will review our financial performance for the quarter; and Lowe Billingsley, COO, who will review our operational results. As a reminder, we will be making forward-looking statements, so please read our cautionary note on Slide 2.

Slide 3, we continue to make progress as we transition our production and cost profile to a low-cost intermediate producer by putting our flagship project, Magino, into commercial production. On this front, we want to highlight some of the key advances, including Magino project construction is moving forward. I'll show you a few photos later on in this presentation. We are approaching first gold and have our teams preparing to operate the mill. As you can see, we've done a lot of work on the financing front. We're now on solid footing to move Magino forward. And we have bolstered our operational team in Canada with the addition of Chuck Hennessey. He brings a wealth of operations experience in Ontario and worldwide, and we're glad to have him on the team.

Moving to Slide 4. We announced on October 27 the completion of the debt financing for the Magino project. The company closed its previously announced USD 250 million loan facilities and drew down the first tranche of USD 80 million of the loan facilities, which was used to repay the balance outstanding of the former revolving credit facility. The loan facility consists of a term loan of USD 200 million in a revolving credit facility of USD 50 million for the ongoing development and construction of the Magino project.

Pursuant to the loan facilities, Argonaut had previously sold gold into gold forward contracts, amounting to 300,000 gold ounces at $1,860 an ounce and have now another 100,000 ounces of the gold price of USD 1,763 per ounce. Argonaut has hedged via forward contracts the Canadian dollar exposure at an average rate of CAD 1.334 per USD 1 for the next 24 months. In addition, Argonaut has closed the sale of a 2% net smelter return royalty on the Magino project and surrounding land package to Franco-Nevada Corporation for USD 52.5 million and a USD 10 million equity private placement.

The additional capital was raised in reflection of conservative inputs to the financial model built jointly between Argonaut and the banking syndicate. For example, nonhedge ounces were entered at USD 1,350 per ounce. With the royalty fund and the additional capital, essential loan covenants are projected to be covered. Future loan draws require banking syndicate review of projects and permitting progress, normal for this type of debt facility.

Slide 5, Magino update. We received all major process equipment for the mill. The mills and tanks are in place. Pumping, piping and electrical systems are being installed. Everything is enclosed and ready for winter. All 4 generators have been received and are in place. Our formal operations readiness initiative and commissioning initiative are progressing. We're at plus 72% action items completion. This is the most thorough operations readiness initiative that I've seen. I'll now run through the slides showing the construction progress.

Slide 6. We have made significant progress on the tailings management facility by the end of October. The concrete plants that you can see in the upper left photo at the toe of the plastics, that was a 77% completion at the end of October. The plastic itself is 61% complete at the end of October. In the upper right photo, the LNG power plant has shown all 4 generators are in place with blue covers. In the bottom left photo, the stockpile feed conveyor is shown. In the bottom middle photo, the secondary crusher is shown. In the bottom right photo, the Goudreau Lake Fish Habitat dewatering shelves are shown.

Slide 7. This slide demonstrates that the closed face ore-controlled drilling shows very close correlation with the resource model. About 1.5 years of full production has been drilled in this ongoing program.

I will now turn the presentation over to Dave, who will go through the key financial metrics for the quarter.

[DavidPonczoch, executive]

Thank you, Larry. Good morning, everyone. So if you'll turn with me to Slide 8, financial performance. Revenue for third quarter 2022 was $75.3 million, a decrease from $108.6 million in Q3 2021. During the quarter, gold ounces sold totaled 38,639 ounces at an average realized price per ounce of $1,895. And this is compared with 58,528 gold ounces sold at an average price of $1,789 for the same period in 2021.

Now the higher average realized gold price per ounce during Q3 2022 is primarily due to delivering into gold forwards that we locked in earlier this year. For the quarter, we sold less than produced due to the timing of sales and this was then sold in early October. So the third quarter net income was slightly lower than the third quarter last year due to a combination of lower revenue and higher cash costs. The higher cash costs are primarily related to higher consumable costs than we saw a year ago. For the quarter, we delivered $14 million in cash flow and ended with $89 million in cash. Now Larry has already walked through the additional financing for the quarter, so I will not go through those.

If you'll turn to the next slide, Slide 9, third quarter capital spending and cash flow. Looking at the third quarter cash flow reconciliation. We began the quarter with $76 million in cash. We generated approximately $14 million in cash flow and invested $99 million in capital programs with the bulk of that being in the Magino construction project. We also added the $141 million in equity, and this is net of fees, as we've previously announced. Approximately 86% of the capital during the quarter went towards the Magino construction project. For the third quarter, we incurred -- of that, approximately $85 million in costs related to Magino.

I'll now turn the call over to Lowe Billingsley, our Chief Operating Officer, to walk through the operational highlights for the quarter. Lowe?

[Lowe Billingsley, executive]

Great. Thanks, Dave. Slide 10, operations overview. Year-to-date, our production results are in line with our expectations of 161,000 gold equivalent ounces. Year-to-date production was planned to be lower versus 2021, primarily driven by less ore production from the higher grade El Creston phase at La Colorada, which is nearing completion and ore mining now shifts to the lower-grade Veta Madre pit. Operationally, the third quarter was challenging, but we continue to have consistent performance from the El Castillo complex, which mostly offset performance at La Colorada and Florida Canyon during the quarter. Both of these mines experienced challenges with block model performance.

At La Colorada, where we were mining the last benches of El Creston Phase 3, we encountered lower ore tons than planned. In addition, we experienced heavier-than-expected seasonal rains that resulted in delayed mining in El Creston Phase 3, which will now be completed in the fourth quarter. The Florida Canyon, the block model yielded lower grades and recovery is more run of mine material was placed during 2022, which was partially offset by higher ore tons placed. We continue to execute infill drilling programs to improve block models, and we expect to improve reconciliation as a result of those programs.

For the quarter, higher cash costs are primarily driven by unit cost inflation in key consumables like diesel, cyanide and lime. 70% of higher costs were driven by price escalation and 30% is driven by higher mine volumes. Just as an example, the increase in diesel price constitutes 23% of higher cash costs. Secondly, the normal Mexico rainy season impacts Q3 so the pure ounces are placed, thus increasing the cost per ounce. And finally, as we mentioned, there were some block model performance issues at La Colorada and Florida Canyon. Fortunately, the rainy season has completed for the year. We're addressing the block model with additional infill drilling. However, the consumable costs will continue to be market-driven.

Slide 11. 2022 guidance. Year-to-date, we've generally met expectations. We are maintaining our full year production guidance of 200,000 to 230,000 ounces. Given the heavier-than-normal rainy season in Mexico, full year production might trend towards the lower third of the rains due to delayed PLS grade improvement resulting from the rains diluting the solution grades arriving at the plants. As I said on the prior slide, the impact of escalating input costs on cash costs and all-in sustaining cost per ounce is notable. In light of the inflationary environment, we have experienced this year and considering current projections, we have adjusted our guidance for cash costs and all-in sustaining costs compared to guidance provided in August.

Slide 12, sustainability. Our operations in Mexico and on our Magino project, have achieved some significant safety milestones that I would like to recognize. At La Colorada, we have no lost time incidents year-to-date, and we have exceeded 1.2 million man hours incident free. At San Agustin, we have exceeded 1.2 million hours in 14 months without a lost time incident. And at El Castillo, at the end of September, we completed 18 months or 1.2 million man hours also without a lost time incident. At Magino, we've achieved 2 million man hours without a lost time incident, which is notable for a project in construction. And congratulations to these teams on a job well done that never ends.

In October, we commissioned the power line of San Agustin. Going forward, the switch to grid power will eliminate about 300,000 liters of diesel consumption each month. At Magino, our team continues to engage with community members and all indigenous communities to ensure our neighbors are well informed of all activities with the project.

With that, I'll turn the call back to Larry.

[Lawrence Radford, executive]

Thanks, Lowe. We have made significant progress positioning Argonaut for future success with the pending completion of Magino...

[Technical Difficulty]

[Operator]

Ladies and gentlemen, please stand by. Please continue, Mr. Ponczoch.

[DavidPonczoch, executive]

Good morning, everyone. This is Dave Ponczoch. It looks like Larry and Lowe's line is having some technical difficulties. So I'll just -- this is the final slide we have. So as Larry was saying, we've made a lot of progress positioning Argonaut for future success, and we do this by improving our operational portfolio and the completion of Magino. With a much lower cost, longer life of mine, Magino represents a significant value driver for the company in which we see the majority of our production and cash flow, which will come out of this Tier 1 jurisdiction. As we're approaching the commissioning of this project in the upcoming months. We believe there is a potential opportunity for patient investors willing to see Magino through completion to see a re-rating in the stock price.

So with that, I'll turn it back over to Michelle for any question and answers. And we'll look forward to Larry and Lowe joining us back soon.

[Operator]

[Operator Instructions]

First question comes from Michael Fairbairn of Canaccord Genuity.

[Michael Fairbairn, analyst]

I've got a couple here. And I wanted to start with just the cost pressures that you're seeing this quarter. Just with inflationary pressures pushing up costs this year, just wondering if you see these pressures abating at all heading into 2023. And kind of leading into that, do you think the longer-term cost profiles that were published with the various tech reports that came out earlier this year are still representative of the current environment?

[Lawrence Radford, executive]

Yes. Thanks, Michael. Good question. I'm sorry, we dropped off. I don't really know what happened there. It's a good question. And we have seen a little bit of relief in diesel, certainly, with commodities that are, by and large, natural gas base, say, explosives. We haven't seen much. I don't think that we're terribly different from the other companies that have reported. I listened to, say, Barrick and Newmont's reports, and I think we're all kind of feeling the same pressures, but I'll ask Lowe to comment further.

[Lowe Billingsley, executive]

Yes. Thanks, Larry. Yes, that's right. I mean we're.

[Lawrence Radford, executive]

Are we still on?

[Lowe Billingsley, executive]

Are we still there?

[DavidPonczoch, executive]

Yes. No, I can still hear you. Yes.

[Lowe Billingsley, executive]

Okay. Great. Thank you. It sounds like we got disconnected. We're seeing -- just like Larry mentioned and what we're seeing across the industry, we've seen about 12.5% inflation year-to-date versus what our plan had been. We're very focused on continued optimization and efficiencies across all of our operations, I mean, cost control is an equal importance or significance in terms of focus as our gold production is. It's -- we're doing everything there that we can relative to it. I think the biggest question around looking at 2023 is, they're just -- there continues to be a lot of instability and unpredictability in terms of the markets. There's geopolitical instability, we have economic instability, and I think just as we go forward or something that the -- certainly, we and the entire rest of the industry will continue to be focused on and trying to optimize everything that we can.

[DavidPonczoch, executive]

And Michael, you had a second question?

[Michael Fairbairn, analyst]

Yes. I wanted to ask about the Magino tailings pond as well. I know you've talked about that in the past. It's been a key area of focus for the team. Just wondering if it's still an area of risk for the project schedule?

[Lawrence Radford, executive]

Yes. As far as the owner scope, I think the 2 areas that we're most focused on are the tailings dam completion of the first phase anyway and the completion of the LNG power plant. As I mentioned in the presentation, we've had good progress in the last same month. And really, the biggest risk in completion of the tailings dam is the weather and being able to pour concrete, once it gets below freezing and gets complicated. We actually are prepared to pour concrete subfreezing. Unfortunately, we haven't had to yet. So the progress has been pretty good. It still remains a risk, but that risk is starting to diminish.

[Michael Fairbairn, analyst]

Okay. Perfect. And just 2 more for me, if I can. I wanted to revisit the block model performance at Florida Canyon and La Colorada. Just wondering if these are new issues with the block model reconciliation. And if you know how pervasive the issues might be at this point?

[Lawrence Radford, executive]

Yes, I'll ask Lowe to comment. At La Colorada, there's 2 pits, Veta Madre and El Creston. El Creston on is kind of a dixie cup last few benches in Phase 3, which the deeper ore was not drilled historically very well and that's resulted certainly in some variation, and we are drilling there now. I was just down there a few weeks ago and saw the drill in the bottom of the pit to sort of improve our reconciliation. But I'll turn this over to Lowe and ask him to comment.

[Lowe Billingsley, executive]

Sure. Thanks, Larry. Just to continue with La Colorada, Larry kind of described the El Creston reconciliation. That's really been the challenge that we saw in the third quarter, combined with the rain season as we mentioned that made mining difficult and pushed some production from La Colorada into quarter 4. On the good side, the good -- really good news that La Colorada has been at the Veta Madre pit. We started mining that pit just over a year ago. And the block model performance there has actually -- it has been aligned with expectations. And so we have reasonable confidence going forward the Veta Madre will continue to perform that way.

Michael, you had asked about Florida Canyon there. It's the same type of situation just from a standpoint of where we were mining during the quarter, mining in some areas that have some wide space drilling along with some historic drilling that has proven to not be very reliable, but we do have infill drill programs that we've been executing at Florida Canyon through the year and that are ongoing right now to improve that reconciliation.

[Michael Fairbairn, analyst]

Okay. Perfect. And last one for me on La Colorada again. You had a quarter of pretty heavy stripping at La Colorada this quarter. Just wondering if it's going to continue over the next few quarters. And by front-loading some of the stripping if we should expect a smoother production profile over the next few years than what we saw in the tech report that was published earlier this year?

[Lawrence Radford, executive]

Yes, we have -- so what we started in Q3 was the stripping of Phase 4 in El Creston, which it's going to be ongoing actually for a couple of years. And we started it because the rains were intense enough that the ore at the bottom of Phase 3 wasn't accessible, so we started up in Phase 4 stripping. But that's going to be ongoing as we're mining Veta Madre simultaneously. Lowe?

[Lowe Billingsley, executive]

Yes. Thanks, Larry. That's correct. The stripping phases, we did get a jump on stripping El Creston Phase 4, in order to utilize our equipment during the rainy seasons, as Larry said, and that stripping will be continuing going forward, certainly through 2023. We've -- that's been kind of the production plan that we've had for that. So I think just from the standpoint of expectations, continue to see those elevated stripping levels is what I would expect.

[Operator]

The next question comes from Gabriel Gonzalez of Echelon Capital Markets.

[Gabriel Gonzalez, analyst]

Good work on a job well done tying the financing package together and the royalty as well with Franco-Nevada. My question just is, with regards to the ore-controlled drilling at Magino, do you already have enough modeled information to say whether the positive reconciliation that you're seeing is within the predicted bounds of what you'd expect?

Or are you seeing a little bit more variation than your predictive models would expect? Or is it still a little bit too early to say? In other words, did you still have to do a little bit more of that or controlled drilling to really tie down predictability and variance models on the ore control?

[Lawrence Radford, executive]

That's a great question. It's a key issue for Magino and one that we are very focused on. For instance, operationally, we've put together a draft ore-controlled procedure because it's an absolutely a key element making Magino a success. As far as the ore-controlled drilling, as I pointed out, we have about 1.5 years' worth of production, not necessarily sequentially but in aggregate, drilled out on very close facing. And as you can see in the slide deck that it's confirming the resource model. So it's neither up nor down. It's actually spot on, which is reassuring. And for all the due diligence that's been done on this property, it's what everybody wants to look at. So I thought I'd throw a slide in this time to show how we're doing.

[Gabriel Gonzalez, analyst]

Okay. Perfect. And just in regards to the power line replacing the diesel at San Agustin, is there a quantifiable amount of potential cost savings that you'd expect from this? Or is it mainly -- is it the main benefit simply from having a more stable cost from the CFE in Mexico versus variability associated with diesel?

[Lawrence Radford, executive]

Well, there's absolutely a cost savings. It's one of the reasons the line was put in, but Lowe will probably has the numbers at hand.

[Lowe Billingsley, executive]

Yes, sure. As we look at that, our biggest change by moving to line power, we get a -- it's not so much about the stability of the power supply. And we were, of course, self-maintaining power generation in San Agustin, but it was more on the cost savings side. We're going to -- we're able to save about $350,000 a month in diesel consumption -- diesel spend at San Agustin by switching over to line power. Certainly, line power isn't for free, but there's a significant cost reduction there that we should be now beginning to experience the San Agustin going forward.

[Gabriel Gonzalez, analyst]

Perfect. And just one last question. In regards to the additional capital costs within guidance for the operating assets, I believe you mentioned that about 70% of higher costs operationally are being driven by cost escalation. And so I just wanted to ask if the increase in the capital costs can largely also be attributed to that in terms of proportion to increase capital costs, inflation, consumables and that sort of thing?

Or is there, I guess, a quantifiable amount that is being driven also for instance, by the additional ore-controlled drilling that you're having to do at Florida Canyon. I just wanted to get a little bit more color on that increase in the...

[Lawrence Radford, executive]

Okay. Yes. Thanks. Lowe is ready to answer that question.

[Lowe Billingsley, executive]

Gabriel, can you still hear us?

[Gabriel Gonzalez, analyst]

Yes, I can.

[Lowe Billingsley, executive]

Okay. Thank you. I thought the line dropped again. No, I think when we look at it just from a standpoint of the operating costs, if you look at the price pressures that we're seeing, certainly, those are flowing through the key consumables. We do see them, the industry-wide our peers and colleagues in Nevada specifically talking about Florida Canyon. We are certainly seeing those types of costs roll through our suppliers as well. So from the standpoint of contractors, any type of maintenance contractors, other provided services, we are certainly seeing those pressures. We're not alone in that, and that's the market and the environment that we're in.

You had asked about capital. I think this is from the standpoint of most of the capital is being driven by its energy costs, certainly, we get into steel cost inflation, anything that is related to anything in the energy sector, we certainly would be seeing and are experiencing some of that flowing through as well. Fortunately, at Florida Canyon, we're not very capital intensive there. So we don't have much of a concern in that regard.

[Operator]

[Operator Instructions]

The next question comes from Wayne Lam, RBC.

[Wayne Lam, analyst]

Just wondering maybe at Florida Canyon, the prior management team had indicated some potential for cost optimization related to improvement in efficiencies. Just wondering if you guys have taken over the assets, do you expect to realize some of these optimizations to help offset these inflation pressures you're seeing?

[Operator]

David, if you could answer that question, please. The line has dropped again.

[DavidPonczoch, executive]

Wayne, this is Dave. I'm sure Lowe could share some additional things. What we're looking at now is certainly a whole host of activities to improve operational performance at Florida Canyon. Looking at operational efficiencies, especially the ones looking at the conveying are one of those. And so we have, right now, currently a very keen focus on improving Florida Canyon because the results and the costs are not where we want them to be. And so looking at the crush and convey optimization is one of those we're looking at the mine sequencing and bringing in additional higher-grade areas is another. And so yes, we're very focused on Florida Canyon.

[Wayne Lam, analyst]

Okay. Great. And then maybe just at Magino. Just wondering if you could walk us through what the remaining large spend items are as you get to completion and the level of confidence in those components relative to the $920 million budget. And just wondering on the previous breakdown in the budget, there had been about $60 million in contingency. Just wondering what the inflation you've been seeing, if you happen to have an estimate of how much of that is remaining?

[DavidPonczoch, executive]

Yes. So...

[Lawrence Radford, executive]

Okay. Dave, I can jump in.

[DavidPonczoch, executive]

Awesome. Okay. Thanks.

[Lawrence Radford, executive]

Yes. Of the contingency in the original estimate, the contingency plus management reserve amounted to about $50 million, at $48 million to be precise, and of that, we've committed $16 million at the end of September. And I believe there will be more accounting, but so far, that's all we've committed to contingency.

[Wayne Lam, analyst]

Okay. And just in terms of the other part of the question, on the remaining spend at Magino. Maybe if you could provide a bit more detail on where the large capital items are in getting to completion?

[Lawrence Radford, executive]

Sure. Obviously, the mill itself is a large piece of the remaining spend. Going together fast, as you probably remember, the mill is on a fixed-price EPC contract and the payments are made off of milestones. So as Ausenco checks off those milestones, we'll be making payments. Mining goes on, it's actually drift -- it's a little bit lower than -- because Phase 1a of the tailings dam is essentially complete from mine delivery perspective. We've actually dropped some of our mining bed, but we're still delivering material to the next phase of the tailings down. And then beyond that, the LNG power plant, the tailings completion, those sorts of things are kind of in descending order of what's left to be spent. Dave, do you have anything to add?

[DavidPonczoch, executive]

No, I think you're right. We've got -- looking at the estimates, we've got about half of it -- well, not CAD 60 million of EPC payments. And that's, as Larry mentioned, that's for the mill. And then as far as site development, which the majority of that is tailings, is also about $60 million. And then we've got a variety of other with the power plant and indirects and owner's cost is the remaining.

[Operator]

Thank you. There are no further questions at this time. Please continue with closing remarks.

[Lawrence Radford, executive]

Thanks, everybody, for joining our Q3 conference call. It's exciting times at Argonaut as we can see the finish line at Magino. It's coming fast, and we're all looking forward to commissioning and ramp up and getting the project into production. Thanks, everybody.

[Operator]

This concludes the conference call. Thank you, everyone. You may now disconnect.