Mountain Province Diamonds Inc

TSX:MPVD

Earnings Call Transcript 2017-Q4

[Operator]

Good day, ladies and gentlemen, and welcome to the 2017 Fourth Quarter and Year-end Results Conference Call for Mountain Province Diamonds. [Operator Instructions] As a reminder, this conference is being recorded.I would now like to introduce your host for today's conference, Mr. David Whittle, Interim President and CEO. Sir, you may begin.

[David E. Whittle, Interim President, CEO & Director]

Thank you, everyone, for ringing in this morning to Mountain Province's 2017 Year-end Financial Reporting Conference Call. My name is David Whittle, Interim President and CEO. And joining me is Perry Ing, our Chief Financial Officer; and Reid Mackie, our Vice President, Diamond Marketing.The call is scheduled for about 0.5 hour. But to start, I'll remind everyone that we will be discussing forward-looking information and making forward-looking statements during the call. Actual results can vary materially from those anticipated in such statements. Please refer to the cautionary note regarding forward-looking statements in both our press release and our MD&A.2017 was a year of contrast for Mountain Province. We faced notable successes. The Gahcho Kué diamond mine declared commercial production. The processing plant performed admirably, well exceeding its nameplate capacity right from the start. The great recovery from the 5034 pipe has notably outperformed expectations. We have a health and safety record at site that's truly a point of pride for the team that works there. And our team created a diamond marketing platform from scratch that, by all assessments, has performed exceptionally well right from the first sale and continually since.But we faced notable challenges as well. We entered production during a difficult period in the rough diamond market, exacerbated by the Indian demonetization. We faced quality distribution issues in the profile of our diamond production compared to what we'd anticipated from our original bulk sample. And the resulting impacts on our price realization meant we were unable to meet the schedule for funding the reserve accounts under our project lending facility.It was a long, difficult and frustrating year. The close of 2017, however, saw us turn to the positive. We successfully launched a USD 330 million secured bond offering, enabling us to fully retire the project lending facility, cleaning up our balance sheet and lifting the pressures on our treasury. And the rough diamond market has taken a meaningful turn to the positive. We've seen an average of over 12% improvement in prices across all product categories since October, and with over half of that coming here in the new year. The retail jewelry segment reported a very robust holiday season that's just ended, both in North America and in Asia, creating pull-through and generating restocking demand within the cutting and polishing markets. And sentiment within the diamond mid-market is positive, creating a good competitive environment for our tender selling platform.Seasonally, the first few sales of the year are traditionally strong, but the results of our first couple of sales in 2018 have well exceeded the expectations that we had going in. And in light of the headway that we faced with sales and rough diamond market conditions, I think our operations show the remarkable resiliency through the financial results that we've generated for 2017. The earnings and cash flow we've generated under challenging conditions would be enviable in the mining industry in any market and, I think, give a hint of what Mountain Province can do as the fundamentals in the diamond industry begin to firm.With that, I'll turn it over to our Chief Financial Officer, Perry Ing, for commentary on the financial results.

[Perry Y. Ing, VP of Finance & CFO]

Thank you, David. A number of critical milestones were achieved by the company in 2017. From a financial reporting perspective, I'll focus primarily on the second half of 2017 as we only declared commercial production at the GK mine in March -- on March 1, 2017. And accordingly, only diamond production from that point forward is reflected in our statement of comprehensive income.Based on our diamond sales cycle of 10 sales per year, that meant that sale 5 in June was the first sale recorded through our P&L, while sales 6 through 10 in the second half of the year were fully reflected in our statement of operations.Preproduction diamond sales from sales 1 through 4 were credited against the cost of building the mine. Readers of our financial statement should also be aware that in addition to our tender sales in Antwerp, we also "sell diamonds" directly to De Beers Canada on our fancies and specials, which represents about 4% of our sales recorded for the year.For full year 2017, we reported sales of 2.7 million carats for -- revenue of CAD 238 million, of which 2 million carats from sales 5 through 10 yielded CAD 170 million. We achieved an average price realization of USD 70 a carat or approximately $89 per carat on all carats sold during the year.From a cost standpoint, we are very pleased with the operations at the GK mine as constant production came in at $73 per tonne or $33 per carat, which is broadly in line with our expectations despite initial ramp-up problems in early 2017.Initial measures to address these issues resulted in a production pickup by February, which allowed us to declare commercial production on March 1.A complete remedy to the problems encountered on the conveyance system should be completed over the coming weeks as the partial enclosures for the conveyors are due to be installed.From a production standpoint, 2.775 million tonnes of ore were treated yielding 5.9 million carats recovered at an average rate of 2.14 carats per tonne or approximately 32% above our grade expectation for 2017.The production rate increased throughout 2017, with the plant frequently operating at over 10,000 tonnes per day. Going forward, this is reflected in our updated mine plan, which calls for an annual production rate of 3.15 million tonnes per year versus the original 3 million tonne per year design.The improvement in performance is reflected on our fourth quarter 2017 stats, which show $62 per tonne process cost, inclusive of capitalized stripping, or $26 per carat recovered.Overall, we reported earnings from mine operations of $52 million and net income of $17.2 million or $0.11 a share for the year. EBITDA for the second half of the year was $56.6 million, which, again, shows the strong cash flow-generating capability of the company.Looking at the fourth quarter alone, we recorded a loss of $16 million or $0.10 a share. However, that loss was primarily due to onetime costs associated with the expensing of deferred financing charges of approximately $16 million related to our old project loan facility. In addition, we recorded foreign exchange losses for the fourth quarter of approximately $3 million.Impacting our performance slightly in the fourth quarter was a softer diamond market in the fourth quarter with cautions heading into the holiday season, along with some bankruptcies of manufacturers in India, which affected sentiment in the market. We should also note that we had a finer size of distribution in our product mix, which is a consequence of the over performance in grade factor, reflecting in smaller-sized goods. Overall, from a cash flow standpoint, this is still a net positive to us, and still, diamonds sold are accretive.As David mentioned, we should also point out the strong performance of our diamond marketing channel as marketing costs came in well below 2.5% of gross sales for the year.Turning to our balance sheet and liquidity position. We ended the year at a much stronger and cleaner -- with a much stronger balance sheet and a cleaner position compared to the prior year. We ended the year with cash of $43 million compared to $7 million at the beginning of the year as most of the cash previously was restricted under our prior loan facility.In the fourth quarter of 2017, we successfully completed the $330 million bond offering of second lien secured notes, as David mentioned, for which we used the proceeds to repay the $357 million loan facility. Key features of the bond are that it is a 5-year bond with an 8% coupon, which is noncallable for the first 2 years but allows a special call feature that allows us to redeem up to 10% of the principal for each of the first 2 years at a price of 103.Concurrent with the offering and retirement of the loan facility, we also repaid CAD 49 million of some cost to De Beers, which is otherwise due in the second half of 2018. From a cash flow standpoint, this is reflected in our cash flows used in investing activities in the PP&E line and is obviously a onetime event.For liquidity purposes, concurrent with the bond offering, we also entered into USD 50 million senior secured revolving loan facility, which remains undrawn. Our working capital position at December 31 has greatly improved at $97 million compared to negative $49 million at the end of the third quarter and negative $30 million at the beginning of the year.Looking ahead, as David mentioned, we started the year strong with a very good result in tender sales 1 and 2, and viewings for tender 3 just started yesterday, although sale 3 won't close until April so that will be recorded in the second quarter -- in our second quarter 2018 results.On 100% basis, the GK mine is expected to produce between 6.3 million to 6.6 million carats, so our share should be between 3.1 million and 3.3 million carats.Based on the table of production costs that we put out in our press release and MD&A, we expect cash cost of $96 a tonne or $46 per carat. This is an -- reflects an increase from 2017, but we do believe that we have significant opportunities to try to come in below those costs.So with that, I'll turn it back over to David Whittle.

[David E. Whittle, Interim President, CEO & Director]

Thanks for that, Perry. Looking forward, 2018 is our year for delivery. As Perry noted, we intend to process over 3.1 million tonnes of ore and recover over 6.5 million carats on a 100% basis.Prestripping is underway at the Hearne pipe and through 2018 production from -- sorry, through 2018, production from Hearne will start to be blended in the 5034 ore feed, giving us ore feed from 2 operating pits. Strategically, for any mine, reserve replacement is an important objective. As you know, in recent months, we've been engaging in in-mine and near-mine exploration. A drill program has been carried out in the Southwest Corridor area, around the south pipe between the 5034 and Hearne. That program has just wrapped up. And in the coming days, we expect to press release the logged results from the balance of the holes that have been completed. I think I can fairly categorize the program as successful, and we expect it will enable us to define a resource estimate around the Southwest Corridor later in 2018, so we can formally incorporate it into the mine plan going forward.Also, at the end of January, we announced a proposal to acquire 100% of Kennady Diamonds, an advanced exploration project immediately adjacent to the Gahcho Kué mine. Kennady has 18.5 million carats of defined resources existing now in its Kelvin and Faraday deposits. With clear expectations, those resources will increase based not only on drilling completed after the cutoff date for those resourced estimates but on drilling being carried out right now in the winter exploration program Kennady is currently running and which will continue to run right through April. Kennady's land holdings essentially surround the Gahcho Kué mine site, and Kennady has an excellent portfolio of new greenfield targets, particularly in the corridor that extends directly down from Kelvin-Faraday through the Gahcho Kué kimberlites and on southward through Kennady's [indiscernible] Lake's area holdings.In the big-picture sense, Kennady's landholdings are a clear opportunity for substantial mine life extension at Gahcho Kué. However, even more importantly, they provide a near-term opportunity to augment what's always been projected as a lower-grade production anticipated from the Tuzo pipe in about the 2024 time frame. Granitic dilution in the middle zone of the Tuzo pipe is expected to result in notably reduced head grades while we mine through that zone. And it's been an objective of both ourselves and De Beers to mitigate that impact.We see Kennady as a strong opportunity to achieve that mitigation with augmenting ore feed coming from mining Faraday and Kelvin.To integrate those deposits into the mine plan within the necessary time frame, particularly given the permitting and engineering time lines involved, we need to start moving this year, basically now. The acquisition of Kennady entails near-term share dilution, and we are fully cognizant of that. Our partner recognizes the same issues with Tuzo, of course, and they have publicly indicated their support for initiatives that will benefit the Gahcho Kué project as a whole. The decision to acquire Kennady was not taken lightly. A special committee of the board worked closely with our financial and engineering advisers to ensure that it was supported by a strong business case. We are confident that our integration of the Kennady assets into the Gahcho Kué mine plan, the value of this transaction, will be fully realized. The transaction remains subject to shareholder approval, and the meeting is being held on April 9. The board strongly recommends in favor of the transaction, and we ask that you please participate and cast your supporting vote.Lastly, I want to reiterate and confirm our commitment to our fundamental strategy of returning value to shareholders. We have demonstrated strong margins and cash flow-generating capability with modest overheads and modest capital expenditure requirements. We have set a goal for ourselves of initiating a dividend policy in 2018. Specifics will be determined in the next few months as rough diamond price trends are confirmed, and they'll be established in a prudent manner as we set an appropriate allocation of capital between retirement of some of our senior notes and distributions to our equity holders.Many of our shareholders have been with Mountain Province for a great many years, looking forward to this day when we're a producing diamond miner on the world stage. We know that this 2017 year has tested that loyalty. We are deeply appreciative of the support we've received through the years we fought to overcome the challenges we face. But those challenges are now behind us. And for 2018, our focus will be to ensure that, that loyalty is properly rewarded.With that, I'll turn the call back to the operator and open up for questions.

[Operator]

[Operator Instructions] And our first question comes from the line of Sam McGovern.

[Emma Alcock]

This is Emma, on for Sam. First off, can you give us a sense on the timing of the proposed quarterly dividend? And I know you said it's going to be a little bit dependent on rough diamond prices. But do you have any kind of sense of what the amount will be?

[David E. Whittle, Interim President, CEO & Director]

No. At this point, I won't give an indication on the amount other than say, at this point, we'll repeat a prudent distribution. We do want to see what develops in the way of rough diamond pricing trends. Timing is, again, we're probably Q2, Q3, Q3, I'll center on that, but it is a matter for discussion and again, tied into the same concept. We'll assess that over the next couple of months as to the appropriate prudence.

[Emma Alcock]

Got it. And my next question, how are your discussions with De Beers going with regard to Kennady? And how quickly, after that acquisition is closed, can we expect the agreement to contribute that asset into the JV? Would that be kind of a matter of months or further out?

[David E. Whittle, Interim President, CEO & Director]

The discussions are ongoing, of course. Obviously, we need to complete the Kennady transaction before we make the moving -- a meaningful move on the next step with De Beers. As far as integration into the mine plan, at the outside, you're looking at around 2023 is when we would expect to see the beginning of mining, so it'd be prior to that. I would anticipate sometime in the year, year or so following the Kennady acquisition.

[Emma Alcock]

Got it. That's helpful. And my last question. I think you touched on this earlier in the prepared remarks, but just to confirm, regarding potentially redeeming some bonds, you said that, that's -- we're talking about the 10% call at 103, correct?

[David E. Whittle, Interim President, CEO & Director]

Correct. Yes, that's one of the features of the bond. It enables us a 10% call in the first year.

[Operator]

And our next question comes from the line of Edward Sterck.

[Edward Christopher Sterck, Analyst]

A few questions for me. Firstly, just on the topic of the dividend. The debt, I believe, has incurrence covenants attached to it. Are there any limitations in terms of the scale of the payout that those incurrence covenants would allow?

[David E. Whittle, Interim President, CEO & Director]

Yes. There's a test in order to make a payment to the dividend, which we don't expect to be an issue for us to achieve. The quantum of the dividend is, broadly speaking, an approval that builds up based on approximately 1/2 of our net income. There are some adjustments to that net income for large, I'll say, noncash items, for example, stock-based compensation is not counted. But roughly speaking, 1/2 of net income is available for distribution.

[Edward Christopher Sterck, Analyst]

Okay. And then my next question is just on the Southwest Corridor. Just looking at the mine plan and the technical reports, there is a bit of infrastructure crossing that sort of area in -- within the license area. Is that a major issue? Can you expand the license area to allow for roads? And are there sort of supporting infrastructure to bypass that reach between Hearne and 5034?

[David E. Whittle, Interim President, CEO & Director]

It's a potential partial issue, I'll say. It is conceivable that the waste dump will encroach or overset what might turn out to be some of the resource that could be established under the Southwest Corridor. I don't think it will be a substantial portion, but if it did, it would sterilize it. We're not -- I don't anticipate we'd be moving the waste dump for accessing. But it would not, as I said -- it doesn't sterilize the entire Southwest Corridor. It would only be a portion of it.

[Edward Christopher Sterck, Analyst]

Okay. And then the -- my next question is just on specials. Can you give us an indication of -- obviously, the agreement with the bids is that diamonds above a certain size or that meet a certain criteria, a bid for between the 2 joint venture partners. What's been the sort of focus over the course of, well, since production began? Has it mainly been to the bids, yourselves? Any other color that you can provide there?

[David E. Whittle, Interim President, CEO & Director]

Yes, just for those on the line, just by way of background is what Ed is talking about are stones 10.8 carats and above. They're too granular for us to evenly split between the partners, so the process is that each production is split. We essentially value those stones for ourselves. Each of us makes a bid, the high bid wins those stones to be sold through their marketing channel. They pay out their partner immediately for their partner's proportional share of those stones. So in that process, we -- I'd say the bidding has been won by both partners roughly equally. We probably won slightly more than half to our accounts. And for commercial reasons, I'm unable to go into the specifics of it other than to say that it's been a favorable experience for us, I would say.

[Edward Christopher Sterck, Analyst]

And then just my final question, just a question about -- just a bit of clarification here. You were talking about the Kennady and De Beers. You said that De Beers also centers around the situation over Tuzo. I'm not quite sure I understood what that was referring to and...

[David E. Whittle, Interim President, CEO & Director]

Oh, that means -- meaning, they share our -- they share in the view that we need to mitigate. We want to mitigate the impacts of the Tuzo. So Tuzo has got this granitic dilution in the upper portion. It's the middle portion of the pipe, actually. And so there'll be a diluted head grade going through the plant. That means a fairly significantly reduced cash flow for about 1.5 years under the existing mine plan. So both De Beers and us, obviously, are working quite strongly at what opportunities exist to mitigate that cash flow dip, and that's what I was referring to.

[Operator]

[Operator Instructions] Our next question comes from the line of [ Paul Zimansky ].

[Unknown Analyst]

Can you talk a little bit about where you are in the ore body at the moment? You said that the quality of distribution of 5034's upper layer was lower than what was sampled. I mean, are you seeing improvement as you move lower?

[David E. Whittle, Interim President, CEO & Director]

I'll say we're still broadly in the upper portion. We're getting down into the course, but we're all still broadly in the upper portion. There is a -- what we've seen in terms of quality distribution and in a simplistic sense, I'll be talking about the proportion of stones between light gem and brown gem, for example, in that spectrum has been a little more to the browner side of the scale than what was indicated by the original bulk sample, a large diameter of drilled core data. So there's an anticipation that as we get down more into the heart of the ore body, get down deeper into the 5034 pipe, that we'll start to see and experience what's more indicative of what that distribution was indicated in the giant large diameter drilled core data. We're not there yet, and there's been no bright line test. There's no hard line within the ore body that we need to cross to get over. This is going to be a gradual thing. I would expect, as we get towards late 2018, we're hopeful that we'll start to see that trend materialize. At this point, it's been some small indications, I would suggest, of an improvement in quality distribution, but it's still very early and too early, in fact, to be conclusive about saying that.

[Unknown Analyst]

Okay. And then -- I mean, is it realistic that you can keep or approach 30% white stones? I think you said you're 14%, 15% right now. I mean, is that a possibility? Or I guess, has the expectation been significantly reduced longer term as well?

[David E. Whittle, Interim President, CEO & Director]

Again, as I say, I think until we get into -- see how the year transpires, obviously, we're short of what that 30% type of split originally anticipated. I mean, it remains to be seen as we go through the year if we'll graduate towards that figure as we get deeper into the ore body.

[Operator]

And I'm not showing any further questions. Would you like to proceed with any further remarks?

[David E. Whittle, Interim President, CEO & Director]

I think that's fine. Appreciate that. Again, thank you, everyone, not only for your support through this past year but for your attendance on the call today.

[Operator]

Ladies and gentlemen thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.