Largo Inc

TSX:LGO

Earnings Call Transcript 2018-Q2

[Operator]

Good morning. My name is Leoni, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Largo Resources Second Quarter financial results conference call and webcast. [Operator Instructions] Mr. Sims, you may begin your conference.

[Jim Sims]

Thank you, operator, and good day to everyone. Today's call is being recorded, and a replay will be available starting tomorrow in the Investor Center of our website located at largoresources.com. Our second quarter 2018 results press release, financial statements and our management discussion and analysis are all available on SEDAR and on the Largo website. Additionally, an updated Largo corporate presentation in PDF format is available for viewing and downloading on the website and on the event call webpage for those of you participating in today's call via the internet. Some of the information you will hear during today's presentation and discussion will consist of forward-looking statements, including, without limitation, those regarding future business outlook. In addition, non-IFRS financial measures, such as cash operating costs, will also be used during this conference call. Further information regarding Largo's use of non-IFRS measures is available in Largo's second quarter 2018 earnings press release and in the company's MD&A, which again are available on SEDAR and on our website at largoresources.com. Actual results or trends could differ materially from those discussed today. For more information, please refer to the risk factors discussed in Largo's most recent quarterly reports, which are on SEDAR and on the company's website. Largo assumes no obligation to update any forward-looking statements or information, which speak as of their respective dates, and all financial amounts presented today will be in Canadian dollars, except as noted otherwise. Speaking today on our call will be Largo President and CEO Mark Smith. Largo's Chief Financial Officer, Ernest Cleave, will then provide some additional detail on Largo's Q2 and year-to-date financial Performance. And finally, we'll open the call up to questions.So let's turn the call over to Mark Smith for opening remarks. Mark?

[Mark Allan Smith, CEO & Director]

Thank you, Jim, and good day to everyone. I especially want to extend a very warm welcome today to our many new investors in Largo as of the end of July. To begin and for the benefit of our new investors, let me summarize what I see as the key investment highlights for Largo Resources. First, Largo is one of only 3 large-scale primary vanadium mines in the world today. Second, our primary production facility in Brazil utilizes one of the world's highest grade vanadium deposits. Third, we have fine-tuned our production operations such that we enjoy a very low unit cost of production, in fact, one of the lowest among all vanadium producers today. Fourth, our relatively long-lived resource and highly experienced management and production teams have been able to position the company to capitalize on a strong upturn in global demand for vanadium, enhanced vanadium pricing. Fifth, as a result, Largo has emerged as one of the most profitable vanadium producers in the world today. And sixth, let's not forget, Bloomberg cited vanadium as the #1 battery material in 2017 in terms of price appreciation. Largo is extraordinarily well positioned to benefit from the market's increasing interest in and consumption of this strategic material. Okay. Let's review our second quarter 2018 results. You can see a summary of our year-to-date financial performance on Slide 15 of our corporate presentation available for download at largoresources.com. In the quarter, Largo continued to demonstrate strong operational and financial performance with record high revenue, higher net income and higher production and sales volumes, all as compared to the year-ago period. Revenue for the quarter was just over $103 million, that is the single highest recorded quarterly revenue by the company in its history and it represents a 189% increase over revenue of nearly $36 million in the year-ago period. It is also a 13% sequential increase over revenue of $91 million in the first quarter of 2018. Year-to-date revenue was $194 million. That's a 198% increase over revenues of $65 million in the first 6 months of 2017. Net income for the quarter after the recognition of a $46 million deferred income tax recovery was $90.7 million or $0.17 per share. Clearly, our after-tax net income for the quarter reflects a significant noncash gain, but it is a gain that was driven solely by our strong profitability. We continue to hold significant net operating losses, which will provide us with a very favorable tax situation in the years ahead. Year-to-date after-tax net income totaled $137 million, which compares to a loss of $24 million for the first 6 months of 2017. Net income before tax in the quarter was $50 million, which compares to a net loss before tax of approximately $14 million in the second quarter of 2017. Cash provided before noncash working capital items was just under $78 million in the second quarter of 2018. That represents a 25.5% increase over the first quarter of 2018 and it compares to $11 million in the second quarter of 2017. Year-to-date cash provided before noncash working capital items totaled $139.5 million, which compares to $16 million over the first 6 months of 2017. Ernest will provide a bit more detail on our financial performance for the quarter and year-to-date. Now let me highlight some key operational and other milestones that we have achieved in 2018 to date. I also want to touch upon Largo's strategic positioning in growing vanadium markets and on our business strategy going forward. As many of you know, production in May at our Maracás Menchen Mine was slightly impacted by the national truckers strike in Brazil. While production was temporarily offline for about 4 days, we took advantage of that downtime to complete maintenance that was originally scheduled for later. This included replacing the flaking wheel, working on the furnace refractory, changing the deammoniator's wires in the fusion section and completing minor repairs to the kiln and cooler refractory. The impact of shipments of our primary product, vanadium pentoxide, that were seen in May and in the beginning of June were fully resolved by the second half of June. In May 2018, production was 739 tonnes of vanadium pentoxide or V2O5 as we refer to it. That was lower than the 838 tonnes of V2O5 we produced in April, reflecting the impact of the truckers strike. However, production in June rose to 881 tonnes. That set a new average daily production record in any prior month, based on tonnes of V2O5 produced per day, and that record is approximately 10% above our nameplate capacity.Total production in the quarter was 2,458 tonnes, an increase of 13% from Q2 of 2017 and an 11% sequential increase from Q1 of this year. Year-to-date, Largo has produced 4,672 tonnes, which is a 10% increase over the 4,247 tonnes produced in the first 6 months of 2017. Largo's global recovery rate, something I'm personally very, very proud of, measured from mill head to the final flake product, averaged 79.2% in the quarter. That represents an increase of 6.6% against Q2 of 2017 and an increase of 4.3% against Q1 of 2018. This is primarily due to greater operational control in the kiln and cooler. This is one of the highest, if not the highest, vanadium recovery rates in our industry. The company forecasts an overall recovery rate of 79% for the remainder of 2018. The continuing efforts of the operations team at our Maracás Menchen Mine to improve maintenance, optimize production systems and maximize up-time is continuing to bear fruit. Our consistently low cash costs demonstrate that fact. As previously announced, we are now in the process of expanding our V2O5 production capacity by approximately 37.5%. That would bring our nameplate rate from about 800 tonnes per month of V2O5 to about 1,100 tonnes per month. Work on this expansion project began at the beginning of 2000 -- beginning of June of 2018, and we see an expected time table for completion of approximately 12 months. CapEx for this expansion is expected to total only USD 15.5 million. And I should note that at current vanadium prices, the estimated payback period on this investment is about 6 weeks once we hit 1,100 tonnes per month. We also want to note that, importantly, this expansion is not expected to impact current production operations in any way. We're also working to increase sales of high-purity V2O5 flake and powder. High-purity vanadium makes up about 9% to 10% of total vanadium sales worldwide today, and it commands a price premium above standard grade product. Market-based price premiums today are generally in the range of $3 to $4 per pound in U.S. dollars, and this product requires no additional cost for Largo to achieve. End markets that use high-purity V2O5 include high-performance alloys used in jet engines and other aerospace applications, chemical catalysts and vanadium redox flow batteries. Largo is very well positioned to take advantage of the higher margins afforded by high-purity vanadium because our ore grade is naturally high, our metallurgy is sound and our operations team is passionate about success. In the quarter, total sales of high-purity V2O5 flake were 420 tonnes, a 5% increase from Q1 of 2018. Year-to-date, we have produced 820 tonnes of high-purity product, that was a significant increase over the 205 tonnes we sold in all of 2017. We're focusing now on ramping up our ability to handle and pack increasing amounts of high-purity V2O5 powder. Largo's current target for 2018 production of high-purity V2O5 powder and flake is in the range of 2,000 to 3,000 tonnes for the year. As many of you know, Largo has previously issued both V2O5 production and annual average cost guidance for 2018. We are now forecasting full year production in the range of 9,150 to 10,150 tonnes of V2O5 or between 20.2 million and 22.4 million pounds at an average annual cost of USD 4 per pound of V2O5. We anticipate being able to meet or beat this guidance. As I note consistently to all of you, all of our internal incentive programs are built around pounds produced and unit costs of production, very simple and easy to understand by every single one of our employees. On the Capital Markets front, we've had a very busy and successful 2018. In May, we announced that we had successfully completed a private placement of USD 150 million aggregate principal amount of senior secured notes, due in 2021, with a coupon of 9.25%. On August 2, 2018, we used the proceeds from the note offering to fully repay our debt with the Brazilian National Economic and Social Development Bank, otherwise known as BNDES, and the remaining credit facilities held with a syndicate of commercial lenders in Brazil. This repayment represents a fundamental step forward in the company's development and it will allow us to realize the benefits of our recently completed note offering due to the improvement of our capital structure, reduction in interest costs and the simplification of reporting obligations. Also, on July 24, 2018, Largo successfully closed a 69 million common shares secondary offering at a public offering price of $1.40 per share. The 69 million shares included the exercise in full of the underwriters' overallotment option of 9 million shares. While Largo received no proceeds, this offering nonetheless represented a significant milestone for the company in gaining a broader institutional shareholder base. And I'm pleased to see that many of our new institutional investors are on today's call. The offering also helped to establish the float and liquidity necessary for proper valuation of the company, very important. When looking to the future of global vanadium markets, I remain very bullish on both demand growth prospects and on Largo's positioning in all of the vanadium markets. In 2017, there was about an 8,000 tonne shortage of vanadium supply in relation to demand. If we look at that supply shortage in conjunction with inventory data, you can see that the industry has essentially been using its inventories for the past 6 to 7 years to try to fill the supply-demand gap. In short, we are not producing enough vanadium to fully meet the world's needs. To add to the long-term demand trend for vanadium, a new standard for rebar used in China was announced in February of this year. That standard will go into effect in November of 2018. That standard requires stronger rebar material to be used, and that will require greater amounts of vanadium. As a result, we anticipate that the global vanadium supply deficit will almost certainly climb from the 8,000 tonne deficit in 2017 and go significantly higher starting in 2019. Not surprisingly, these market dynamics have continued to push up the price of vanadium. Until the market responds to stabilized pricing, we anticipate further price strengthening in the quarters ahead. Of course, all of this bodes very well for Largo as we work to increase our production. In summary, I was very pleased with the company's operational and financial performance in the second quarter and where we are year-to-date. Market fundamentals look very good, and Largo is very well positioned to take advantage of those fundamentals as we progress toward increasing output in order to meet rising global demand of vanadium. With that, let me turn the call over to Ernest for some additional detail on our Q2 financial performance. Ernest?

[Ernest M. Cleave, Chief Financial Officer]

Thanks, Mark, and good day to everyone. Our record high Q2 revenues of $103.3 million were generated on higher production volumes and higher V2O5 pricing. This represents 189% increase over Q2 2017 revenue of $35.8 million. In the quarter, we produced 2,458 tonnes of V2O5, which was 13% higher than the 2,183 tonnes we produced in Q2 2017 and was 11% higher on a sequential basis. V2O5 pricing rose in the quarter to an average price per pound of USD 15.44 compared to an average price per pound of USD 5.76 for Q2 2017. Cash operating costs per pound in Q2 2018 decreased from the first quarter of 2018 by 4% to $4.97 per pound of V2O5. In US dollars that translated to a cash operating cost per pound of $3.85 and a 6.3% decline. The cost per pound for the second quarter of 2018 was lower when compared with the first quarter of 2018, primarily due to the higher production level and actions taken to control the issues encountered with the cooler refractory in the first quarter of 2018. The subsequent production stability resulted in lower specific consumption of sodium carbonate and fuel for kiln roasting during the quarter, and the company executed a new agreement for the supply of ammonium sulphate in April. This reversed the increase seen in the first quarter of 2018, which was, at that time, driven by underlying increase in the price of ammonia and sulfur. The overall benefit of increased revenues was tempered by increases in corresponding royalty expenses and certain largely noncash foreign exchange adjustments required as a result of the weakening of the Brazilian real against the U.S. dollar when accounting for the value of the company's U.S. dollar-denominated debt in Brazil. Going forward, the nature of these accounting adjustments will change as the FX movement would predominantly relate to revaluation adjustments pertaining to the USD 150 million in debt held in the Canadian parent company into its Canadian dollar equivalent. Finance costs in Q2 2018 were $8.4 million, a decrease from $11 million in Q2 2017. This was primarily attributable to a decrease in the interbank interest rate in Brazil from approximately 10.9% in Q2 2017 to approximately 6.4% in Q2 2018. In Q2 2018, the company recognized the income tax expense of $5.2 million versus a null expense in Q2 2017. For the 6 months ended June 30, 2018, our income tax expense was $8.8 million, a gain versus the null expense in the same prior year period. This was the result of recognizing taxable profits in the Mine Properties segment in the 3 and 6 months ended June 30, 2018. At June 30, 2018, we concluded that there is a sufficient history of taxable net income for Largo to recognize a net deferred tax asset of $43.343 million and a deferred tax recovery in Q2 2018 of $45.593 million. In the quarter, the company generated positive cash from operating activities, with net cash provided by operating activities of $69.5 million compared to $7.7 million in Q2 2017. On a year-to-date basis, cash provided by operating activities was $94.5 million versus $12 million in the same prior year period. The current portion of long-term debt increased by $165.37 million, primarily due to the classification of the senior secured notes of the current liability pending the satisfaction of the escrow release and security pledge conditions within the 180-day period ending November 18, 2018. Our strong balance sheet, obviously, presents opportunities for the company to consider in terms of how we continue to build shareholder return. As we consider the most efficient utilization of our cash assets going forward, management will likely present several strategies for the Largo's board's consideration. These include the following: continuing debt reduction; capital investments in production assets and strategies that can achieve a significant and relatively rapid return on investment; return of capital to shareholders, either through a buyback of shares or special dividends; and an institution of regular dividend payments to shareholders. In summary, our financial position remains strong. Largo's operational team continues to improve operational and production efficiencies and we are poised to take advantage of very strong growth trends in several downstream vanadium markets as we increase our production capacity over the coming several quarters.

[Mark Allan Smith, CEO & Director]

Thank you, Ernest. And just a final note that I wanted to add for the listeners today. I know we have discussed the fact that we have a fairly significant exploration program that we're undertaking this year to the tune of about $2 million and I wanted everyone to know that, that exploration program is going very well and that I will be in Brazil next week to get an update on that program, but we do expect to have it completed on time and at the end of this year, and then we will report our results. But we're very excited for that effort, and it's been a significant effort. Our Vice President of Exploration, Andy Campbell, has done a great job of monitoring and managing that program and we have some high hopes for that. So with that, Jim.

[Jim Sims]

Operator, let's open the call up to questions.

[Operator]

[Operator Instructions] Your first question is from Piyush Sood from Morgan Stanley.

[Piyush Sood, Research Associate]

Congratulations on the offering, the stock's recent performance and strong 2Q results. A couple of questions from me. Could you talk a bit more about your -- any further expansion possibilities beyond 1,100 tonnes per month? Kind of -- what kind of sustainable vanadium price could bring that expansion and if you have a hurdle rate in mind? And the connected one that, where would this rank versus your targets of debt reduction and return of cash to shareholders?

[Mark Allan Smith, CEO & Director]

Let me start by answering the first part of that question, Piyush, and I'll let Ernest discuss the second part. As you know, we are undertaking a USD 15.5 million expansion right now that will take our production up by 37.5%. We also anticipate something greater than $0.50 per pound reduction in our unit operating costs as a result of that expansion. I wanted to mention that because the next level of expansion will be quite significant. The expansion that we're undertaking between now and mid-2019 is really more of a debottlenecking process of the current plant. As we get into an expansion program after this initial one that we're undertaking, it will be more akin to the construction of a new processing facility that is going to be largely driven by the results of this exploration program that I had mentioned a moment ago. But we feel, at present, that we have an ore body that can support even further expansions. But the further expansions will be akin to building a whole new processing facility that would sit right next to the existing processing facility. Now you're talking about probably something in the 5,000 tonne per year or more type expansion capacity. So that's the type of expansion that we would look to do. SWAG estimates on those types of expansion projects are probably somewhere in the neighborhood of about USD 75 million, so it does go up, but again the payback would be very quick at today's prices. So we are and have been in the process of evaluating those types of expansions and look forward to announcing those as the studies come to a conclusion. In terms of prices that would support that, that's why I'd mentioned the reduction in unit operating costs. If we take our current projection between now and the end of the year being at $4 per pound, we can reduce that by another $0.50 a pound with this current expansion. You can see that it doesn't take very much in terms of a price for vanadium to easily support a further expansion at this mine. So that's how we're looking at it. We would hope to have some studies done by that later this year, early next year and then we can announce things accordingly. Ernest, do you want to handle the distribution of cash question?

[Ernest M. Cleave, Chief Financial Officer]

Yes. So Piyush, as it relates to the expansion, we don't actually need the revenues and the cash earning capability of the expansion to actually facilitate the payback of our debt. At the current run rate, we're doing -- and we're using very rough numbers, we're doing about USD 20 million in EBITDA level type of cash. So our near-term focus is -- one of them includes paying down debt. And I don't believe that the expansion beyond the 1,100 tonnes per month actually fundamentally alters that strategy. As a matter of fact, we will be well done with paying out debt before we even get to the second expansion. And just to be very clear, those numbers that we're providing are, and as Mark said, those are very rough SWAG numbers. We haven't done the necessary technical work to give you a great amount of detail around it. But suffice to say that it is an alternative and it's something that we're definitely going to look at, given the company's low-cost strength and the state of the vanadium market.

[Piyush Sood, Research Associate]

That's really useful. And one more question from me. Are you looking at any kind of downstream opportunities, either organic, inorganic, where you could use your high-purity vanadium, let's say, in batteries or something else? Also, any plans to use some of your tailings to extract more value?

[Mark Allan Smith, CEO & Director]

Yes, Piyush, again, excellent questions, and we love to answer these. On the downstream side, it's all about optimizing the value of that V2O5. And so we will look at every opportunity to take that high-purity vanadium, convert it to whatever we need to, to gain extra cents or pounds per -- or cents or dollars per pound on that product because we're in that really great position where it doesn't cost us any more money to produce that high purity. There's very few high-purity producers in the world. So we plan to take full advantage of that. We obviously will be very cognizant about vertical integration and making sure that we keep that well tempered. We are a primary vanadium producer, and we want to make sure we stay within our areas of competency and within our core capabilities. But we are interested in many alternatives and are looking at many alternatives to enhance our capability to move into those high-purity, high-premium downstream applications. Sorry, Piyush, the second part of that question, can you repeat?

[Piyush Sood, Research Associate]

Any plans of, say, monetizing your tailings or extracting some more value from them?

[Mark Allan Smith, CEO & Director]

Thank you, again. We have 3 different technical projects that we're working on, on various portions of tailings at the site. And the answer is absolutely yes. We have very significant quantities of titanium. We have very significant quantities of iron. And we have some reasonably significant quantities of PGMs in one part of our tailings. And we're looking at possible ways to extract value from those minerals and return that to the shareholders as well. We have 1 project in particular that's focused on the titanium side of things. And the initial results from the tests that we've done have actually been very favorable, and we could undertake a very -- it's a very insignificant cost to the project, but we could start selling some ilmenite by the end of this year, early part of next year. So we are looking at every possible way of taking value from the minerals that are in our ore body and returning that to the shareholders as soon as possible.

[Piyush Sood, Research Associate]

So should we think of these small projects as really the tens of millions of dollars or are they collectively like less than $100 million? Or are they fairly insignificant like, in total, less than $10 million? Any sense would be really helpful.

[Mark Allan Smith, CEO & Director]

Let say's the one that I just mentioned concerning ilmenite is less than $10 million. And then collectively, we don't know exactly what that total could be on some of the others, for instance, the iron ore side of the equation. Because now you get into much bigger volumes and, of course, the price associated with equipment with larger volumes can take the project up higher. So one thing for sure that we will be looking at, and Ernest laid this out in his comments, our first priority is the reduction of debt. The second priority will be how can we absolutely maximize returns to shareholders, and when we find projects like our current expansion project that have paybacks of 6 weeks, we will undertake those types of efforts immediately and very efficiently. So we're not looking at spending money foolishly. We want to make sure that we either spend that money on behalf of the shareholders and make sure there's a great return for them or that we return the money or buy shares back, whatever one makes most sense.

[Operator]

Your next question is from Heiko Ihle from H.C. Wainwright

[Matthew James Barry, Associate]

This is Matt Barry here for Heiko. I'll start with more of a comment. Your share price has performed better than the vast majority of the firms in our coverage universe. I pulled up a one-year chart and you could almost put a ruler on it, so congratulations.

[Mark Allan Smith, CEO & Director]

Thank you, Matt. A lot of good hard work by good people.

[Matthew James Barry, Associate]

Absolutely. So regardless of where one stands on the political aisle, one of the growth drivers for vanadium has been the shuttering of Chinese supply. Can you just walk us through what, if any, impact you see on their longer term production profile and their willingness to do things that maybe they wouldn't have done in the past, given the current negative tone between the 2 countries?

[Mark Allan Smith, CEO & Director]

Yes, Matt, this is an issue that we're certainly watching and monitoring very carefully because it is an unknown. I think the basic conclusion that we have reached so far, and things are changing daily so this is our conclusion as of this morning before anything happens, but our conclusion so far is that there is such a significant shortfall in supply that if 1 section of the world creates an import duty situation where vanadium cannot flow into or out of a country, it really is just going to cause that vanadium to move somewhere else in the world. And so we're not seeing any impact whatsoever from this right now. The other point that I would make is, as I know I have explained to a lot of our investors, about 90% of the vanadium in the world today is used in the steel industry to make high-strength low-alloy steel, and about half of that is used to produce rebar. Interestingly enough, China produces about 75% of the rebar in the world. And of course, China is also the largest producer of vanadium. So those 2 things are going to stay coupled together very well. And unless the rest of the world can start to produce more rebar, I think that there is not going to be much of a choice but for the rest of the world to continue to purchase Chinese rebar regardless of the import duty situation or trade sanctions that may be imposed. So we're kind of in a very interesting situation here where I think the market is going to control these things to a large extent and there is so much supply deficit that the product will be able to move somewhere. It's just a matter of who allows it to come in. So we're -- right now, I would say that we're just kind of neutral. We're not seeing any impact, but we are monitoring this very carefully.

[Matthew James Barry, Associate]

Great. And then just regarding the high-purity V2O5 flakes, can you quantify what we've seen so far in Q3, I know you guys sold 820 tonnes in the first half and touched on your plans for the rest of the year, but can you just help us understand the growth trajectory and the incremental margins going forward for this?

[Mark Allan Smith, CEO & Director]

Yes, and again, this is -- I would take this as very forward-looking, so treat it accordingly. But we're producing roughly about 150 tonnes a month of the high-purity flake that is being sold into the aerospace alloy sector right now. And we're in very close to final discussions to start moving high-purity powder into the chemical catalyst side of vanadium applications right now. That will take us up another 50 to 100 tonnes per month for the high-purity powder. So in total, as I mentioned earlier, we anticipate something in the 2,000 to 3,000 tonnes per year range for 2018. Our goal in 2019 is to double that again because there is plenty of applications for this material, there is very little of it produced, and our material is being very quickly and readily accepted into these applications. There is a qualification process that you have to go through for all of these. So it does take a little longer than what you would like. But with the shortage of vanadium and particularly the shortage of high-purity vanadium right now, these qualification periods are being done very quickly. So we're excited about this. We do anticipate seeing, as a company, much higher premiums coming back to the company on these products in 2019 versus 2018 because of some contractual situations that really are out of our control. But in 2019, everything starts to head into a market-based premium approach, and we'll see our premiums on these products go up to what they should be.

[Matthew James Barry, Associate]

Perfect. And I think the premiums this year were $3 to $4 above spot prices. So what -- potentially, how much could it increase next year?

[Mark Allan Smith, CEO & Director]

Well, that would be about what it would go to, Matt. We're not realizing that price premium yet because of some contractual issues involving our offtake partner. But we do expect all of those to go by the wayside at the end of 2018. Those contracts expire and then we get into real life again where the market-based pricing comes into play and Largo will be the beneficiary of that.

[Operator]

Your next question is from Lee Cooperman from Omega Advisors.

[Leon G. Cooperman, President, CEO & Chairman]

I have a bunch of questions. So if you don't mind, I may -- I'd get them all out, and you can answer them in any order you want to answer them. First, simply, you produced 2,458 tonnes of vanadium pentoxide in the second quarter. Do you expect to produce more in Q3 and 4 or less? Was that representative of a peak for now? Second, importantly, and you went through your numbers. You're going to go from 800 tonnes of capacity to 1,100 tonnes of capacity over the next 12 months for $50.5 million cost, and you're going to get paid back in 6 weeks. Everybody is making the same calculation. So what gives you confidence that the price level of the commodity is going to hold? That in the history of the world, excess profitability brings in capacity and inadequate profitability drives out of capacity, what's the chance that more capacity comes in than you're relying on? Third, could you talk about this deferred income tax recovery, what it resulted from and whether there's more of this that we could be positively surprised about? And then, I think, for the priorities of use of the free cash flow, I mean, we're -- you're talking small numbers, but I calculate that the company is generating huge numbers. Whereas, if the price of the commodity holds here, which seems to be what your belief is, if not, in fact, it moves higher, in the next 3 years, you're going to generate $1 billion of cash flow -- of free cash flow. And so you're going to be debt free at the end of next year, and you have a lot of cash. What is the second and third priorities for the return of that money to the shareholders? And finally, if you -- 2 other questions. The Glencore deal expires in May of 2020. If the Glencore deal didn't exist today, basically, how much more money would we be earning than we are reporting because the Glencore deal is costing us money? And finally, do you have any insight into Alberto Arias' plans for his remaining holdings? But any help you could be in all these questions, I would be very appreciative.

[Mark Allan Smith, CEO & Director]

Thank you, Lee, and thank you for joining us today. Let me start out. I'll answer the first 2, and then I'll ask for some help from Ernest on your deferred tax benefit question. And then we'll handle the rest as well. But the 2,458 tonnes that we produced in the second quarter, how does that compare to what we foresee for Q3 and Q4? And I think it's safe to say, at this point, Q3 looks like it will be a better quarter than Q2. And I have no reason to believe that Q4 won't be just as good, if not better, than Q3. Production is really running well right now at the site, and we are continuing to improve our average daily production every day. So we do anticipate a better Q3 and Q4. In terms of the second question, kind of a point, when we go to 1,100 tonnes per month based on a USD 15.5 million investment and we have a 6-week payback period, what gives us confidence that we'll have a 6-week payback period and that prices will stay where they are, and that largely goes to what we are aware of out in the world today in terms of new production or expanding production from existing facilities that could occur and the timing for when any of that could occur. We strongly believe that ourselves, Largo and one other primary producer in South Africa have the fastest projects that can be brought on. Neither one of these projects, individually or collectively, will take care of the deficit, and clearly, it doesn't take care of the current deficit, much less what the deficit is going to be when the Chinese rebar standard comes to play later this year. And so we're going to continue to have a supply and demand situation where supply is just significantly lower than what the demand is. And you take a look at any other greenfield or brownfield operations that can be brought on, we're looking at, in our opinion, based on my 37 years of experience and Paulo Misk has 30-plus of experience, we take a look at these things and read the news releases and the websites for all of them. We anticipate, a minimum, 3 years for any of these other projects to come on, and we think we're being pretty gratuitous by saying 3 years. Realistically, it's probably more like 4 or 5. So everything that we look at in the world in terms of new or expanded production coming on, really isn't going to take care of what the demand situation is right now and doesn't take care of that supply deficit. And then we have the timing issue that couples with it. So we anticipate being in a very favorable price environment for some time to come as a result of that evaluation. Ernest, do you want to discuss the deferred tax benefit in some more detail?

[Ernest M. Cleave, Chief Financial Officer]

Absolutely. Lee, just before I jump into tax, just to refine the whole question of production. As you know, we've done 10.3 million pounds to date of V2O5, and we provided the public with our projection of production for the year. So the mid-range of the projection is 9,650 tonnes, which is 21,275,000 pounds, which means that presupposes, then, that for the second half of the year, we're going to do just under 11 million pounds, 10,975,000. So that's about a 7% increase. So semester 1 versus semester 2, you're looking about a 7% increase. So turning to your taxes, the $45 million-odd that we recognized, they are existing NOLs, and they're all the Brazilian NOLs that exist in the company. And we've recognized all of it and actually brought it into the books because we have great visibility on our profitability. Whereas, in previous quarters, we didn't necessarily have that or, in making losses, you had no runway to know that you would actually make good on those NOLs. So from an NOL perspective, there's nothing new that's going to be added. Because we can only use 30% of those NOLs there, you're going to be seeing the impacts for a very long period of time because the tax rate is very low in Brazil, 15.25%. So combine that with only using 30% of the NOLs at any particular time, it's going to have an impact on probably the next 4.5 years using Q2's run rate. But we just recognized and brought it on to the books, again, because the clarity we now have on our profitability. That's all it does.

[Mark Allan Smith, CEO & Director]

And then Ernest, do you want to address the use of cash? We'd had that in your section of the presentation. I'll be happy to supplement it. But I think, Lee is looking for just a little more light on that.

[Leon G. Cooperman, President, CEO & Chairman]

A lot more.

[Mark Allan Smith, CEO & Director]

Okay, Lee.

[Ernest M. Cleave, Chief Financial Officer]

Fair enough, Lee. So -- and not to belabor this, Lee, but from management's perspective, our first objective is debt reduction. Given how bucolic metals and mining can be at times, we think it's very prudent to stay very focused on debt reduction. Outside of that, you're looking at very small, on a dollar value basis, capital investment on production assets that could give us a very good return on investment. But again, just to reiterate, these are not $100 million projects. They're very small. But then finally, we're looking at returning capital to shareholders. To the extent that we can't generate a very substantial return in other ways, we're looking at things such as buyback of shares or dividends and, obviously, the institution of a regular dividend payment to shareholders. So those are all undercurrents. Candidly, we're going to have to get through most of this year and see what the note holders do in terms of some of their elections, in terms of how much cash that makes available. But as a concept, we're very much aligned with actually rewarding our shareholders. We don't have any issue with it, and we actually think it's a fantastic thing, and we are happy, very happy to do so. So we don't have a great amount of detail exactly in terms of, at this stage, what it's going to look like, but conceptually it is 100% on the cards.

[Leon G. Cooperman, President, CEO & Chairman]

What about the Glencore? What does that deal costing the company? Without going overly specific about the arrangement, I assume when the Glencore deal expires, if the price level of the commodity stays here, you'd earn substantially more money because Glencore is making money off of us.

[Mark Allan Smith, CEO & Director]

Yes, that's correct, Lee. And depending on the price that we use for that evaluation, we believe that the company can put right to top and bottom line a range of somewhere between 5% to 15% increase. So this is very significant. We're very focused on it. And we look forward to resolving that one way or another with Glencore in the near future. But that is something that we're very focused on.

[Leon G. Cooperman, President, CEO & Chairman]

If I could make a -- can I make a recommendation to you because I've done a lot of work in the area of stock repurchase. The -- I totally agree with the comments that we should get to be debt-free because we are risky company, because it's 1 commodity, and the commodity's gone from $3 or $4 a pound to $19 a pound, maybe heading to $25, which we're going to coin money. But -- so I agree with paying off the debt. But I think you guys have to do a calculation of what you think the value of our business is? And if the stock is materially below the value you think the business is, you would be enhancing the value to all the shareholders if we took some of this cash flow and bought back stock, and you may have a natural supplier in missed areas in terms of -- personally at $1.40, I would've bought a s***load of stock, but I realize you wanted to improve the liquidity in the market. But I would focus on determining the value of your business and then make a determination. The stock, as you know, 30%, 40%, 50% below the value what you think it's worth. Channeling some of that money into stock repurchase would be very prudent.

[Mark Allan Smith, CEO & Director]

Yes. We completely agree, Lee. No arguments whatsoever, and that's exactly how we're looking at it. Your last question did concern Arias Resource Capital. And obviously, I have no insight as to what ARC is planning to do, and I would encourage you to contact Arias Resource Capital and talk to them. But that is something we don't have any knowledge of.

[Operator]

Your next question is from Brian Nunes from Gramercy.

[Brian Nunes]

A few things. The remaining debt outstanding, now that you've got the BNDES loan paid off and the '16 and '17 and the ECAs, I see the swap facility was still outstanding per the subsequent notice. Is that correct?

[Mark Allan Smith, CEO & Director]

That is correct.

[Ernest M. Cleave, Chief Financial Officer]

That is correct.

[Brian Nunes]

But there's no prohibition on paying that early because there's no penalty, right?

[Mark Allan Smith, CEO & Director]

That's correct.

[Ernest M. Cleave, Chief Financial Officer]

No penalty involved in paying that back. That is correct.

[Brian Nunes]

And is that debt secured over any of the assets?

[Ernest M. Cleave, Chief Financial Officer]

No, it's unsecured.

[Brian Nunes]

Okay. So as you continue to look to pay down the debt, that would be something you could focus on in addition to fulfilling any put by the note holders, right?

[Ernest M. Cleave, Chief Financial Officer]

100%.

[Mark Allan Smith, CEO & Director]

Correct.

[Ernest M. Cleave, Chief Financial Officer]

As long as the -- as long as it fits within the parameters of dispensation rules within the notes, 100% is something we can do, and it is, in fact, something that we are looking at.

[Brian Nunes]

Okay. And then just switching over to production. I see a couple of operators have been able to do this, where you have nameplate capacity and you're consistently producing over that. When you say -- and you guys have achieved that when you have a strong month like you did in June. But when you say we're going to move capacity from 800 to 1,100 tonnes, is that moving your nameplate? But would you still be expect to be able to produce over that nameplate capacity? Or if you think that is truly what you could achieve with this plant once all the expansion is done.

[Mark Allan Smith, CEO & Director]

Brian, it's a great question. And I still remember one of the very first days when I started engineering school as a young man and a professor advised us that any good engineer needs to be trained well enough so that they can achieve 10% or higher above nameplate capacity. So I can assure you that we have very laser-focused efforts. And we will incentivize accordingly to make sure that 1,100 will go down as the nameplate, and we will do everything in our power to go above 1,100 tonnes per month.

[Brian Nunes]

Okay, that's great. And then just on that 1,100. Originally, it was going to go from 800 to 1,000 with the option to go up to 100. But I see the CapEx amount have stayed static, but we -- upgrading by 100 tonnes by month. What was that delta from 1,000 to 1,100? What did you change there?

[Mark Allan Smith, CEO & Director]

Yes, Brian. And this is something that, I'll readily admit, I don't think we communicated very well. But the total of USD 15.5 million covers not only the equipment changes or increases to achieve 200 tonnes per month more, but it also included modifications to the kiln, modifications that we are now very confident will be effective to achieve the additional 100 tonnes per month for a total of 300 tonnes per month increase in production. And the total cost of that is USD 15.5 million. So I think we didn't communicate it as well as we should have. But the plan all along has been to take it from 800 to 1,100.

[Brian Nunes]

Okay. Got it, understood. And then when you talk about the byproducts, potentially, the titanium from the [indiscernible], what would that do to your unit cost?

[Mark Allan Smith, CEO & Director]

We haven't even taken a look at the ilmenite project on a byproduct basis yet, so I don't have a number for that. Maybe Ernest has looked at that, but I have not. But we do know that just the expansion case alone, going from 800 to 1,100 design rate capacity, will lower our unit production costs by about USD 0.50 per pound. Ernest, any other detail on that?

[Ernest M. Cleave, Chief Financial Officer]

No. I -- we obviously -- we haven't actually run the economics of looking what that ilmenite does through our existing flow. So we don't have a good answer that we'd feel comfortable with right now. As Mark said, on the expansion, yes, we have a very good sense, you're definitely guaranteed about a $0.25 spend reduction. And then the costs that are sort of semi-variable, you could potentially get another $0.25, as Mark said, up to $0.50, so $0.25 to $0.50 overall reduction. But we will -- we'll be working on the ilmenite case over the next 6 months. And when we have something much more concrete, then we'll try and quantify that for folks. But right now, we just, candidly, don't have that.

[Brian Nunes]

Okay. And then just moving on, I understand you're going to the site next week to review the drilling programs and that. But would you, at a high level, say that, at the end of the year, you will be in a net increase position, whereby your new reserves have exceeded depletion -- production depletion?

[Mark Allan Smith, CEO & Director]

Yes. That's clearly our goal or more, I might add, Brian. And then after -- because of the cash situation of the company, we really didn't engage in a lot of exploration activity out there to address the reserve situation. We are now in a position to do that. So we're trying to catch up, so to speak. So I do anticipate some very favorable results towards the latter part of this year. Going forward, we will then get into a program which would be more normal for a mining company, where we spend maybe $750,000 a year. And that -- the purpose behind that will be primarily to simply replace what we have mined every year so that we just keep over mine life at a very constant level going forward. So we had to do what we had to do when the prices were low and we survived. Now we're in a position where we can manage our assets very differently and very professionally.

[Brian Nunes]

Okay. And last question, if I may. The high-purity product, the -- you've taken it from roughly 16% of production now to a weighted average over the year of 20% to 30%. What is the production limitation once you have the ability to bag powder on your monthly production? Is it 30%, 40%? How much could you feasibly do?

[Mark Allan Smith, CEO & Director]

100% of the product that we produce at Maracás meets the high-purity specifications. So that's the first answer. And then in terms of breaking that down, we can easily do 100% of that in flake. And the only limitation we have on the powder is the size of the -- it's a sizing unit that filters the product so that we get the right sizing specs for the customer. And that equipment currently is limited to about 150 tonnes per month, but we can very easily expand that for absolute nominal amounts of capital. So we do have a physical limitation on the powder right now, but it's very easy to remove that limitation or increase that amount easily.

[Brian Nunes]

That was my understanding about the flake, that it -- that your entire ore body is -- meets the high spec. Is there a beneficiation cost to -- which I don't think there is when I was there. Why wouldn't you be producing 100% today on the flake?

[Mark Allan Smith, CEO & Director]

Well, we are producing -- everything we produce, whether we call it standard grade or high purity, everything we produce meets the high-purity spec. So it's really a matter of customer orders coming in, requesting one grade or the other, and we put it in the appropriate bag is what it boils down to. So there really are no limitations. It just takes a while to qualify your material. We are qualified at every single one of the 4 aerospace alloy companies. And we're securing more and more qualifications at the chemical catalyst companies now as well, which are the primary users of the powder. So you're going to see that powder go up pretty quickly now.

[Operator]

Your next question is from Wayne Cooperman from Cobalt Capital.

[Wayne Manning Cooperman, President]

Just on the expansion that you're undergoing now, could you just -- does that come on ratably? Does that come on all at once? Can you potentially just walk us through the cadence of the capacity and kind of build-out at '19 or '20 model as far as nameplate capacity?

[Mark Allan Smith, CEO & Director]

Yes. What we've done -- I mean, Wayne, just to get real particular about it. There's 3 pieces of equipment that we're increasing the capacity of by simply putting a new unit in or, alternatively, putting another unit side-by-side to increase the capacity. So there is very, very little changeover or tie-in associated with this project. And once the construction is complete, we -- the pieces of equipment are built off-site. They will be shipped into the mine site, we'll install them and then we'll do the tie-ins. And we expect little or no impact to production as a result of this. Technically speaking, this should be a very, very quick ramp-up to the 1,100. But we have given ourselves a 3-month period in the project's schedule for that ramp-up, just in case something goes wrong. But the way that we run the facility right now with these intermediate stockpiles, we anticipate 0 impact to current production and a very quick ramp-up to the new production. So about...

[Wayne Manning Cooperman, President]

So -- but when you -- you don't get a little bit every month as you're doing this. Because once the equipment's in, you get a very -- a quick pop up to the 1,100. And so we should think of 0 growth and then a big ramp as soon as the equipment's in.

[Mark Allan Smith, CEO & Director]

Correct. 300 tonnes a month more. And again, we've given ourselves 3 months for that ramp-up.

[Wayne Manning Cooperman, President]

And you're saying 12 months from today it should be complete.

[Mark Allan Smith, CEO & Director]

We should be complete with the construction, and then we'll start the units up.

[Operator]

Your next question is from Jim Young from West Family Investments.

[James Young, Investment Analyst]

A couple questions. Just to clarify the -- your normalized tax rate going forward. If I heard correctly, the Brazilian corporate tax rate is 15.25%. But if you can only -- if you use 30% that would suggest that the effective tax rate would be 10.675%. Am I doing the math correctly there? And that would last for the next 4.5 years. Can you please clarify?

[Ernest M. Cleave, Chief Financial Officer]

That's right, Jim. So on a cash basis, that's what we're going to be looking at for the next sort of 4.5 years. That's presupposing, obviously, prices are exactly where they were in Q2. That time frame would reduce even at today's price, but that 4.5 years is roughly what you could look at where we'd be paying, on a cash basis, that 10.675%.

[James Young, Investment Analyst]

.Okay, great. And then secondly, you had mentioned in your release that the average price in the second quarter for V2O5 was $15.44. Can you give us an update or a sense of, quarter-to-date, where our price is currently?

[Ernest M. Cleave, Chief Financial Officer]

Yes. So if you look at our revenue, Jim, and thanks for the question, in Q2, the price was $14.76 just on an implied basis. And so that price would be net, obviously, of the commissions that we paid at Glencore and the actual functioning of the contract that we have with Glencore. So it's about a -- there's about a 4.41% variance there. Hopefully, that helps you.

[James Young, Investment Analyst]

No. What I'm actually looking for is that the reported average price for V2O5 in the second quarter, from your release, is $15.44 a pound. But where have prices gone since the end of the June quarter? Can you give us a sense as to where prices are, on average, quarter-to-date in the third quarter?

[Ernest M. Cleave, Chief Financial Officer]

Yes. So we're currently at $18.875 on an average London Metal Bulletin basis. We have made that number public as well. So that's where we are, a pretty substantial increase.

[Mark Allan Smith, CEO & Director]

It has been quite steady, Jim, for about the last 4 weeks.

[Operator]

Your next question is from Lee Cooperman from Omega Advisors.

[Leon G. Cooperman, President, CEO & Chairman]

Not really a question, but a suggestion and to create an analogy. In 2008, the banks sold a s***load of stock at very, very depressed prices to deal with the financial issues they had during the financial crisis. And really, beginning a couple or 3 years ago, they all started to try to buy back, Citibank, JPMorgan Bank of America, all the shares they were forced to issue. In a sense, you guys issued a s***load of warrants when you were in a problematic situation. I think, if my memory is right, it's about 153 million warrants outstanding with an average strike price of CAD 0.51. Why don't we find a way of forcing those warrants to be exercised, which will increase the marketability of the stock without having Alberto sell any more stock and eliminate the free ride the warrant holders are getting. And it'll help you achieve your goal of reducing or eliminating your debt. So for example, what I've seen done in the past is, maybe for a 30-day window, you reduce modestly the strike price or the exercise price of the warrants, encouraging people to convert. I don't know whether that's okay under Canadian law. Encourage people to convert and so you get cash into the company. You eliminate the warrants and you create more liquidity in the stock, which would be helpful for valuation. Just a suggestion, not really a question.

[Mark Allan Smith, CEO & Director]

Got it, and very good suggestion, Lee, and all items that we have been looking at. There are some limitations on that under TSX rules. So those have been the issues that we're trying to figure out and work through. But good suggestion, and we are looking at it.

[Operator]

Our last question comes from John Hardy from Vm100 Group Ltd.

[John Joseph Hardy, Director]

And congratulations also on nursing this business through some tough times so that we can all benefit in the current times. Couple of questions, please. One is on the premium products. Would the premium price that you indicated, $3-plus, apply to the powder as well as the flake?

[Mark Allan Smith, CEO & Director]

Yes, it does. It pretty much applies across the board on both powder and flake.

[John Joseph Hardy, Director]

And I think you said that the premium currently, because of the offtake agreement, you're not seeing that, but you would expect to or actually will be seeing it come 2019. Is that correct?

[Mark Allan Smith, CEO & Director]

Yes. There's 2 components to that, though, John. One is we do expect the total premium for our product to increase significantly in 2019. But remember, and this is all in our press releases announcing the amendments to the contract with Glencore, but until May of 2020, we get half of that -- of whatever premium Glencore secures in the market with our material.

[John Joseph Hardy, Director]

Okay. That's clear. And my final question is to do with the possibility of an expansion post the, what you called, debottlenecking and time lines for such a project, if it were to be developed, as you have touched upon. Are you talking, from a go-ahead, a 3-plus year or 4 year or 2 year? What sort of time scale?

[Mark Allan Smith, CEO & Director]

Again, great question. It really helps everyone to understand. So thanks for asking, John. Again, about as accurate as the swag estimate we provided for the cost, but we would anticipate about a 3-year process, including permitting, to have that built and ready to commission.

[Jim Sims]

Well, thank you, operator, and thanks to everyone for joining us today. We're running a little long, but that was just fine. And if anyone has any questions that you did not get a chance to ask, please get in touch with us with your questions. You can e-mail us at [e-mail]. As we noted Largo's Q2 news release, our financial statements, our MD&A and our updated PowerPoint presentation can be found in the Investor Relations section of Largo's website at www.largoresources.com. This concludes today's call. Have a great day, everyone.

[Operator]

Ladies and gentlemen, we thank you for participating and ask that you please disconnect your lines.