Lucara Diamond Corp

TSX:LUC

Earnings Call Transcript 2022-Q1

[Operator]

Good morning. My name is Aniz, and I will be your conference operator today. At this time, I would like to welcome everyone to the Lucara Diamond 2022 Q1 Results Conference Call. [Operator Instructions] Thank you. Ms. Eira Thomas, you may begin your conference.

[Eira Thomas, executive]

Thank you very much, operator, and welcome, everyone, to Lucara's First Quarter 2022 Results Call. We began the year on a very positive trajectory, delivering another strong quarter of operating and financial results in the first quarter, reflecting solid performance at the mine, combined with a healthy sales mix and continuing buoyancy and diamond prices. I am going to be making some forward-looking statements, and I do encourage you to review this cautionary statement, which is available on our website.

In Q1, preparation for main shaft sinking is now well underway and is anticipated to begin in Q2. Our multi-channel approach to sales through tenders, Clara and HB continues to mature, creating alignment along the value chain, delivering efficiencies and higher margins. Despite current geopolitical challenges, Lucara remains optimistic about diamond prices as natural rough diamond supply constraints continue to manifest globally.

Zara will now take us through the financial and operating highlights for the quarter.

[Zara Boldt, executive]

Thanks very much, Eira. Good morning and good afternoon, everyone, and thank you for joining our first quarter earnings call for 2022. Similar to Eira's remarks, I will be making some forward-looking statements. So please refer to slide 2 of today's presentation for our cautionary statements. Also, certain financial measures that I will refer to during today's call and which appear in the presentation are non-IFRS financial performance measures. These include adjusted EBITDA, adjusted operating earnings, operating cash flow per share, operating margin per carat sold and operating costs per tonne of ore processed.

Please refer to our interim MD&A for details on how these measures are calculated. And as a quick reminder, all references are to U.S. dollars, unless otherwise stated. So let's begin with the financial highlights from the first quarter. The company recognized total revenue of $68.2 million during the first quarter, a 28% increase from the $53.1 million earned in Q1 2021. This is a reflection of strong rough and polished diamond market fundamentals into the first quarter of this year. Sales of Karowe production represent most of the revenue earned in the quarter at $67.2 million.

This amount included top-up payments of $11.7 million received pursuant to our agreement with HB as well as $1 million from the sale of third-party goods on the Clara platform. The combination of a strong diamond market, combined with the sale of several higher-value rough diamonds in the first quarter generated an average price per carat sold excluding top-up payments of $690 per carat for Karowe diamonds. This compares to an average price per carat sold of $480 from Q1 2021. You can see that adjusted EBITDA of $36 million increased by 62% from $22.2 million for the same period in 2021.

This is attributed primarily to higher revenues. Net income from the quarter increased to $19 million or $0.04 basic earnings per share, up from $3.4 million or $0.01 basic earnings per share in Q1 2021. As a reminder, the net income achieved in each quarter is most impacted by the revenue earned during that quarter. Non-cash items such as depletion and amortization, foreign exchange gains and losses, gains and losses from derivative financial instruments as well as income tax expense do introduce volatility to net income. Our operating expenses decreased by about $1.7 million or 9% from $19.7 million in Q1 2021 to $18 million in Q1 2022. This reflects the combination of lower mining activity quarter-to-quarter, inventory buildup and the benefit of a stronger U.S. dollar, partially offset by inflationary pressures related to labor, fuel and power costs.

Cash flow from operations during the quarter was $0.08 per share, up from $0.06 per share in Q1 2021. The next slide sets out our operational highlights for the first quarter. Overall performance during the first quarter remained consistent with the strong operational results achieved over the past few years and was generally in line with our plan for 2022. We mined about 812,000 tonnes of ore and 482,000 tonnes of waste during the first quarter. Tonnage processed was on target at 7 million tonnes -- sorry, 0.7 million tonnes at an average grade of 12.6 carats per 100 tonnes with a total of almost 84,000 carats recovered from direct milling, ore processed was entirely from the South Lobe.

We recovered 186 Specials, including 10 diamonds greater than 100 carats in weight. Recovered Specials equated to 6.9% weight of total recovered carats from ore processed during the first quarter. In the comparative period, it was 6.8%. The recovery of large gem quality diamonds from the EM/PK(S) and M/PK(S) units from the South Lobe was in line with expectations and historical South Lobe recoveries. The consistent recovery in these large diamonds is a testament to the continued strong resource and plant performance at Karowe.

We sold 80,295 carats from Karowe during Q1 2022 at an average price of $690. This compares to the sale of almost 92,000 carats at an average price of $480 per carat sold in Q1 2021. Please note that the average price per carat sold excludes top-up payments of $11.7 million in the first quarter of '22 and top-ups of $9.1 million in the first quarter of 2021. Also in the first quarter of this year, operating expenses of $18 million equated to a $224 operating cost per carat sold or $29.30 per tonne of ore processed.

While we are seeing inflationary pressures on labor costs, fuel, power and insurance, we did benefit from a stronger U.S. dollar in the first quarter. As a result, we have not changed our full year cost guidance, which sits between $29.50 and $33.50 per tonne of ore processed. Slide 6 sets out how we sold our diamonds in the first quarter of 2022. We sold almost 3,000 carats under the HB agreement and recognized revenue of $33.5 million, excluding top-up payments of $11.7 million. In the first quarter of last year, all plus 10.8 carat stones were sold through HB. Beginning in April of 2021 when the HB agreement was extended any plus 10.8 carat stones not earmarked for manufacturing by HB were sold through our quarterly tender process.

The increase in revenue in Q1 2022 is attributed to higher prices achieved despite lower sales volume. This reflects a significant improvement in diamond market fundamentals between the 2 comparative quarters. Due to natural variability and the quality profile of the plus 10.8 carat production and any production period or fiscal quarter, the recorded revenue and associated top-up will fluctuate. This is expected and reflects the combination of current diamond market prices as well as variability in the quality of our production profile in any given period.

We sold almost 3,000 carats of Karowe production through Clara in the first quarter and generated revenues of $6 million. Importantly, we transacted a further $1 million of non-Karowe goods through the Clara platform, and we expect to commence a series of trial sales on the Clara platform with a third-party producer in Q2. It is our intention to continue to source additional supply in 2022, both from third-party producers and the secondary markets. The first quarter tender of this year reflects strong performance in rough diamond pricing across all tendered size classes. Almost 75,000 carats were sold in the March 2022 tender, generating revenues of $16 million.

This compares to revenues of $9.1 million from the sale of almost 77,000 carats in Q1 2021. As mentioned previously, these tender results are not directly comparable because our 2022 tender includes plus 10.8 carat production not sold to HB. Let's move quickly now to look at our 2022 guidance, which is set out here on slide 7. In February this year, based on updated expectations for revenue in 2022 attributed to the expected strength in the rough and polished diamond market, we adjusted our diamond revenue guidance to between 195 and $225 million for the current year.

Our revenue guidance does not include revenue related to the sale of exceptional stones, such as the 549 carat Sethunya. We have made no other changes to guidance following the first quarter. Moving on to look at the underground projects; following projects sanctioned in September 2021, progress on the underground expansion has been very good. We've drawn $45 million from the $170 million project loan facility. And in the first quarter, we spent just over $31 million on the bills, and I'll go through some of those highlights in just a moment.

We expect to spend about $110 million on the expansion project this year with the starting of the ventilation shaft sinking in the next few weeks, followed by the start of the production shaft sink shortly thereafter. If we move to the next slide, we have some of the highlights of this spend on the underground during the first quarter. So in the first quarter most of the work focused on engineering, procurement of long lead items and ongoing construction activities.

These included pre-sink activities for both the production and ventilation shafts, placement of the ventilation shaft main sinking stage into the shaft column, along with placement of the ventilation shaft headgear over the shaft column, assembly of the production shaft main sink stage with outfitting planned for Q2 in preparation for its installation in the shaft column, while preassembly of the production shaft headgear steel continued. Cold commissioning of the ventilation shaft kibble winder was completed, with progress on the ventilation shaft stage winder in preparation for winder rope-ups in April, while installation of the production shaft stage winder commenced.

We completed construction of all 88 tower foundations for the 29-kilometer 132 kilovolt transmission line bulk-power upgrade and recommenced construction at both the Letlhakane and Karowe substations. We have had some questions about the impact of escalation on our construction costs for the Karowe underground project. As mentioned previously, when speaking about our operating costs, we are seeing escalation with respect to labor, fuel and power.

Our budget assumptions for 2022 included a fairly healthy provision for increases. And so we are not seeing a significant difference from budget at this point, although it is just the first quarter. With respect to the underground expansion program, the majority of the procurement for the program was conducted in 2020 and 2021. As a result, we are not seeing significant escalation for materials used for the pre-sink or for the main sink at this point.

I think we will turn the floor back to Eira for the next part of the presentation. Thank you.

[Eira Thomas, executive]

Thank you very much, Zara. I'm going to talk a little bit more about the diamond market itself. Prices continued strong throughout most of the first quarter. However, we did experience some softening in March in response to geopolitical stresses, including the Russian invasion of Ukraine and the ongoing COVID response in China. Concerns over global inflation are also a factor in weaker demand. However, medium to longer term outlook remains strong as global natural rough diamond supply constraints really continue to play out in the market.

We have had a number of questions about Russian diamonds as they have become increasingly difficult to transact as sanctions were broadened more globally and large luxury retail brands have also become much more proactive in their demand for full transparency in respect of diamond provenance. This bodes well for the continued adoption of our digital sales platform Clara, and will likely exacerbate the natural rough diamond supply constraints that were already beginning to manifest in 2021. As Zara has already talked to, the next slide demonstrates that we're off to a great start in 2021 with respect to resource performance and recovery of Specials or diamonds greater than 10.8 carats in size.

We recovered 10 diamonds in excess of 100 carats during the period, including 2 greater than 200 and 1 greater than 300 carats in size. The graph on the lower right also clearly demonstrates that the contribution of large diamonds is increasing as we mine deeper in the open pit and are able to gain greater access to the highest value EM/PK(S) geological unit of the South Lobe, which, as a reminder, has been the source of many of our historic diamond recoveries, including all 3 diamonds recovered in excess of 1,000 carats in size. And Karowe is the only diamond mine reported in history to have ever achieved that.

On the next slide, we're highlighting Lucara's approach to sales, which has evolved from a single tender auction style platform to a multi-channel approach with the aim of creating better alignment along the value chain and increasing margin capture downstream. As a result, we continue to tender our smaller and lower quality goods and have migrated our better quality 1 to 10.8 carat diamonds into sales through Clara, our secure web-based digital marketplace, and our higher quality plus 10.8 carat diamonds are being sold as polished exclusively through our novel committed supply agreement with HB.

In addition, we have forged 2 collaboration agreements with HB and Louis Vuitton in respect to 2 of our exceptional diamond recoveries, the largest diamond to come out of Botswana, the 1,879 carat Sewelo, and the 549 Sethunya. Those partnerships are aimed at creating made-to-order jewelry collections targeting LV's global customer base. In respect of our HB agreement, for the first time in our 10-year production history, Lucara has a line of sight as to what becomes of our large, high-value diamonds beyond the mine gate.

HB is using state-of-the-art scanning, planning and manufacturing technologies to maximize the value of each and every rough diamond selling into existing demand, protecting prices for our most valuable polished gems and delivering Lucara a polish price, less a set fee and the cost of manufacturing. In 2021, we began realizing significant benefits from selling this way, and our revenues in the first quarter of 2022 continue to reflect this. And as Zara highlighted in the first quarter, we generated $33.5 million in revenues from the sale of 2,870 carats, excluding top-up payments.

In Q1, Clara, which is Lucara's 100% owned proprietary secure web-based digital sales platform continued to gain scale and interest. In the first quarter, 3 sales took place with total sales volume transacting of $7 million, a 17% increase from the $6 million transacted in the first quarter of 2021, reflecting a strong upward price trend observed on the platform during the quarter. The number of buyers on the platform has also increased to 92, and the company continues to maintain a waiting list to manage supply and demand. While most of the stones transacted through the platform have been supplied from the Karowe mine itself, the secondary market stones continue to be offered for sale with good results.

And we're excited to be announcing the commencement of a series of trial sales on the Clara platform in Q2 with a third-party producer. I've included a slide on Lucara's approach to sustainability because it is foundational to everything that we do. We are shortly intending to publish our 10th consecutive sustainability report. And as a reminder, we are a member of the United Nations Global Compact and we contribute to 10 of the 17 United Nations Sustainable Development goals. We're also certified by the Responsible Jewelry Council, compliant with the Kimberly Process and a member of the Natural Diamond Council.

I do encourage all of you to look for the latest copy of our Sustainability Report on our website within the next few weeks. So I think I wanted to sum up today and conclude by really highlighting what we believe is a very compelling investment rationale for Lucara. We've come through a major period of de-risking in 2021. We've got an exciting underground expansion project that is tracking on plan, and we'll extend our mine life out to at least 2040. We have a strong economic engine with the Karowe Diamond mine itself, which continues to deliver very strong operating results and really fueled by consistent recovery of large, high-value gem diamonds.

And in addition, we have exposure to a completely independent business, which is a technology business called Clara, which is the first of its kind digital marketplace for the transaction of rough diamonds, and we are at a very important inflection point with Clara adding additional third-party goods in 2022, and we really do believe that Clara will start to generate and make important contributions of cash, which further highlights the compelling investment opportunity for Lucara shares at the current share price.

So with that, I'd just like to say thank you very much for joining us today, and we would now like to open up the call to questions. Thank you, operator.

[Operator]

[Operator Instructions] Your first question comes from Paul Brockington with the Brockington Association (sic) [ Brockington and Associates ].

[Unknown]

I have one question for you specifically with regards to your projections for Clara. You show really dynamic revenue growth in 2023. Perhaps you could expand a little more upon where you see that emanating from?

[Eira Thomas, executive]

Paul, it's been a while since we've caught up, thanks for calling in. The business model with Clara is really premised on the idea of adding third-party volumes. So we think we've actually got quite a conservative 5-year plan, Paul, where we are working to basically transact up to 10% of global production, which, again, we think is conservative. We do think digital sales platforms like Clara makes a lot of sense going forward. So again, we're assuming about a 10% adoption over 5 years and really 2022 is all about driving those third-party sales upwards. And if you just think about global supply accounting is about $17 billion, $18 billion of natural rough diamond supply. We're targeting $1.5 billion of that within 5 years.

[Operator]

Your next question comes from Scott Macdonald with Scotiabank.

[Scott MacDonald, analyst]

I just wanted to ask just about the diamond market and how you are -- you see yourselves being affected by some of those factors you laid out, namely that the sanctions on Russian diamonds, lockdowns in China and inflation concerns for consumers. Just kind of wondering how much these factors are going to impact you relative to maybe your peers. So I'm just kind of wondering like how much of just firstly on sanctions of Russian diamonds. Alrosa is obviously a major global producer overall, but I'm wondering if they compete with you a lot in the larger Diamond segment or are they less of a contributor to that market segment?

[Eira Thomas, executive]

Yes. Listen, it's a good question, Scott. I mean, there's a lot of uncertainty around what's going to happen with Russia, but I think the consensus really is that it's going to put more upward price pressure on diamonds. With respect to our own production, as we discussed in our year-end call, while we've seen very strong diamond price recovery across all sizes and qualities, it was less pronounced in our largest, highest value diamonds. What we saw was that segment is good stabilization over the last 5 quarters and price is really just beginning to recover as we got into the fourth quarter of 2021. So we still feel there's a fair bit of room to go with this 1 stone.

But similarly, as we've seen prices kind of pull back a bit in March and April, which, by the way, we see is actually a healthy thing because we've had quite a hot market here over the last several 2 quarters, in particular. We did not see the same impact on our own production, again, because of the heavy weighting towards large, high-value stones. They haven't recovered as quickly and we didn't see a big adjustment downward either. So I think the theme for us has been more one in stabilization, but our medium- and longer-term view is that the broader market will continue to be supported with good healthy diamond prices because the global supply constraints are continuing to prevail. And Russia is just pointing at that situation more challenging in my view.

[Scott MacDonald, analyst]

So that's kind of -- you touched on the supply side there. I was just kind of wondering also on the demand side, particularly, as you mentioned, you have much better visibility on the end consumer demand for your products now via the HB agreement. Compared to diamond, global diamond demand, do you think your -- the demand for your products might be less sensitive to inflation -- consumer inflation concerns and the China lockdowns compared to perhaps your peers?

[Eira Thomas, executive]

Yes. Listen, I think there is a real rationale for investing in diamonds at this kind of a global situation. So I think there definitely is interest in our diamonds for investment purposes in addition to using our diamonds for diamond jewelry consumption more broadly. But I don't know that it's going to really be a huge differentiator for us.

[Scott MacDonald, analyst]

Okay. And then just one last one. Have you given any thoughts or are you starting to think about whether to extend the HB agreement beyond the current term?

[Eira Thomas, executive]

Yes. Listen, we're very pleased with the way the agreement is performing for us. So -- and we are really convinced that creating alignment in the value chain is something that can unlock value for all the participants in the value chain. So we obviously have some time before we have to officially extend that agreement. But the way things are going now, I would say we would certainly be inclined to do so.

[Operator]

Your next question comes from Paul Zimnisky with PZDA.

[Paul Zimnisky;PZDA;Analyst, analyst]

I guess with Lucara's involvement with the Natural Diamond Council, I'm just kind of curious if anybody could maybe offer some comments on the potential impacts of Alrosa leaving that organization?

[Eira Thomas, executive]

Yes, Paul, thanks for the question. I mean I think it's really kind of too early to say. Obviously, they were a major funding contributor to NDC, but the organization is still in very good shape with the existing members in terms of the budgets and programs that we've laid out for 2022. So I think we're feeling quite comfortable. As you know, the NDC has gone through a fairly major refresh in the last couple of years and made a lot of good progress. And part of that is sort of broadening kind of the way the programs that basically are run and the audience they're reaching. So we still feel very strongly that there is a strong need for the NDC and a strong rationale for it and the members are very committed.

[Operator]

There are no further questions at this time. Ms. Thomas, you may proceed.

[Eira Thomas, executive]

Okay. Well, thank you very much, everybody, for joining us today, and please enjoy the rest of your day wherever you are. Thanks so much.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a great day.