Ero Copper Corp. (NYSE:ERO) Q3 2022 Earnings Conference Call November 2, 2022 11:00 AM ET
Company Participants
Courtney Lynn – VP, Corporate Development and IR
Christopher Dunn – Executive Chairman
David Strang – Chief Executive Officer
Makko DeFilippo – President
Wayne Drier – Chief Financial Officer
Conference Call Participants
Stefan Ioannou – Cormark Securities
Craig Hutchison – TD Securities
Jackie Przybylowski – BMO Capital Markets
Bryce Adams – CIBC Capital Markets
Operator
Thank you for standing by. This is the conference operator. Welcome to the Ero Copper Third Quarter 2022 Financial and Operating Results Conference Call. [Operator Instructions] I would now like to turn the conference over to Noel Dunn, Executive Chairman of Ero Copper for opening remarks. Please go ahead.
Christopher Dunn
Thank you, and good morning, everyone. The news release announcing Ero’s third quarter ’22 operating and financial results is available on our website, as our financial statements, MD&A for the three months and 9 months ended September 30, 2022.
As per usual, we’re making forward-looking statements on this call that involve risks and uncertainties concerning the businesses, operations and financial performance of the company. We would refer you to our most recent AIF available on our website, also on SEDAR and EDGAR for a discussion of the risk factors of our business and their potential impact on future performance.
Again, as per usual, unless otherwise noted, all amounts are in U.S. dollars. Joining me on the call today are David Strang, Ero’s Co-Founder and Chief Executive Officer; Makko Defilippo, President; Wayne Drier, Chief Financial Officer; and Courtney Lynn, Vice President, Corporate Development and Investor Relations.
Before discussing our third quarter results, I’d like to touch on the recent presidential election in Brazil. While coverage of the election in the North American media, in our view, has largely centered on the differences between the two presidential candidates and the divided nature of the country is populous. It is clear from our perspective, our irrespective politics, Brazil has and continues to be on the path towards greater prosperity with more economic opportunity for citizens. It remains one of the leading global exporters of meat products, oil and gas, soya and iron ore. And therefore, its financial statistics are on a significantly improving path.
Turning to our third quarter results. period is best highlighted by: one, strong production at our Caraiba and Xavantina operations; two, strong progress across our strategic growth initiatives; and three, exciting development on the exploration front, including our recently announced discovery of a nickel sulfide system in the Curaca Valley.
While our team delivered strong production performance and project execution during the quarter, we are obviously experiencing challenging macroeconomic conditions, and these continue to impact operating costs and margins across the mining industry. Despite seeing moderation in many of our input costs during the quarter, some of our largest consumables, including diesel, cement and steel remain well above historic levels as compared to the copper price.
Lower metal prices during the period, combined with approximately $10.3 million of out-of-period revenue adjustments that Wayne will discuss in greater detail, did impact our financial results during the third quarter. So while we continue to navigate a fairly dynamic market, I am pleased to report we were able to make excellent progress on our strategic growth initiatives during the quarter.
At our Tucuma project, we completed critical road upgrades and drainage infrastructure that will allow us to maintain momentum throughout the upcoming rainy season.
Our mining contractor also mobilized site during the quarter and commenced pre-stripping activities. We are currently advancing ahead of schedule. Let me repeat that ‘ahead of schedule’. The various projects that comprise our Pilar 3.0 growth initiatives are also progressing well, which we plan on discussing in greater detail next week during our Annual Operational Project Exploration Update on November 8.
As we look ahead to 2023, we expect broader macroeconomic uncertainty and volatility to persist. Whilst the effects of this uncertainty are likely to be experienced differently across various markets and supply chains, we believe that our high-quality operations and favorable cost structure, embedded optionality across our assets and balance sheet leave us well positioned to deliver on our growth strategy. Our strategy aligns with a projected period of unprecedented copper demand growth.
I will now pass the call over to David to provide an overview of our operating performance and then over to Wayne who will cover Ero’s third quarter financial performance. As always, our team will be available for questions immediately following the call.
David Strang
Thank you, Noel. We achieved solid operating results across our assets this quarter that positions us well to achieve full year production at both of our operations. At the Caraiba operations, we processed over 720,000 tonnes of ore during the quarter at an average grade of 1.68% copper, resulting in copper production of nearly 11,200 tonnes after metallurgical recoveries of 92.2%.
Our copper grade continues to trend above our original copper grade guidance of 1.60%, supported by mining of the first project Honeypot stope. Process tonnage was lower compared to the second quarter due to planned maintenance on the Pilar Mine’s Material handling and transportation system. A portion of which is scheduled to be completed this month. As a result, fourth quarter copper production is expected to be similar to third quarter levels.
At our Xavantina operations, we saw a step-up in mine grades as planned to 8.55 grams per tonne gold compared to an average of 6.28 grams per tonne gold in the first half of the year. This increase in grade offset lower planned tonnes processed during the quarter of just under 43,000 tonnes, resulting in gold production of approximately 11,000 ounces after metallurgical recoveries of 93.3%. Similar production levels are expected in the fourth quarter with higher gold grades expected to continue.
As Noel mentioned, our operating costs during the quarter continues to be impacted by the influence of inflation on the cost of key variables. While we saw some moderation relative to peak pricing in the second quarter, our largest consumables, including diesel, remained well above historic and forecasted levels.
At our Caraiba operations, these cost impacts were further exacerbated priced by transitory items during the quarter that included increased trucking of ore and waste to surface at the Pilar mine due to maintenance of the material handling and transportation system.
Costs at Caraiba also continued to be impacted by a higher allocation of concentrate sales to the international market, which indicated some of the tax benefits we received when we sell to our domestic customer. Notwithstanding the immediate tax benefit on domestic sales, it is worth noting that we do recognize other tax benefits on international sales that are captured in the revenue line.
Our C1 cash costs for the quarter were at $1.46 per pound of copper produced — bringing year-to-date C1 cash cost to $1.34 per pound of copper produced. While we are reaffirming our revised full year copper C1 cash cost guidance of $1.20 to $1.35 per pound, we now expect to track towards the higher end of the range.
At our Xavantina operations, the impact of continued cost pressures related to key consumables were more than offset by higher mined processed gold grades during the quarter. As a result, C1 cash costs were down over $100 an ounce from $643 per ounce of gold produced in the second quarter to $537 per ounce of gold produced in the third quarter.
On a year-to-date basis, Xavantina’s C1 cash costs of $604 per ounce of gold produced are trending towards the low end of our revised full year guidance range of $600 to $700 per ounce. While like our peers, we continue to navigate challenging near-term market conditions that have resulted in compressed operating margins. We remain focused on advancing our growth strategy in anticipation of an unprecedented outlook for copper in the coming years.
At our Tucuma project, total project engineering construction are approximately 40% and 88% complete, respectively, on track with the feasibility study schedule. With respect to budget, we now have approximately 30% of planned capital expenditures under contract and other 50% of planned capital expenditures in various stages of tendering or negotiation, giving us visibility into roughly 80% of feasibility study capital expenditures.
Based upon prevailing foreign exchange rates, labor costs and diesel prices, these expenditures are currently forecast to be within 12% of pre contingency feasibility study estimates. While this estimate is still subject to final contract negotiations, I’m very pleased with where we are tracking and commend our teams here in Canada and in Brazil and our contractors around the world for their tireless efforts in driving this capital discipline.
I am equally pleased with the progress I’m seeing with our Pilar 3.0 initiative and in particular, the integration of Project Honeypot into Caraiba strategic life of mine plan, which was completed subsequent to quarter end.
Our investments in exploration as well as mining and milling infrastructure over the last 5 years have created tremendous operating flexibility that has been further enhanced with the success of Project Honeypot. By creating a two-mine system at the Pilar mine, supported by the addition of higher-grade material from Project Honeypot, we see significant increases in mine life of our Caraiba operations, where we expect to effectively increase the number of operating mines from three to four compared to just one operating mine in the Curaca Valley when we IPO-ed in 2017.
As a result, our team has been able to evaluate numerous production plans with various grade cost and capital profiles during this year’s strategic life of mine planning efforts. At a time when market conditions are uncertain, we believe this operational flexibility affords us a significant advantage in managing our business to maximize shareholder value. As Noel mentioned at the start of our call, we look forward to discussing progress related to our growth initiatives, including the updated Caraiba strategic life of mine plan during our Operational Project and on November 8.
During the event, we also plan to discuss the Curaca Valley nickel sulfide discovery that we announced at the end of September. This discovery is something that we’ve been working towards since we first observed nickel occurrences within the Vimeos mine in 2018. And we are excited about the potential we have seen to significantly expand the Umburana system in the months and years ahead.
With that, I will now turn the call over to Wayne to review our third quarter financial results.
Wayne Drier
Thank you, David, and good morning, everybody. As Noel and David noted, our third quarter financial results reflected solid operating and project execution, mixed with the impact of a challenging macroeconomic environment. Adjusted EBITDA and net income of $32.1 million and $4 million, respectively, were lower compared to the second quarter due to operating margin compression that was primarily top line driven.
Third quarter revenues of $85.9 million were down approximately $29 million due to the combination of lower average copper and gold prices, lower quarter-on-quarter production and a higher allocation of copper concentrate sales to international customers as well as a $10.3 million in out-of-period adjustments related to the final settlements of provisionally priced copper concentrate shipments from the first half of 2022.
While a high allocation of copper concentrate sales to international customers is expected to continue through the end of the year, adjustments related to copper price volatility in the first half of the year have now been effectively settled. With respect to foreign exchange derivative contracts, we reported realized losses during the third quarter of $5 million relating to legacy hedges that have now been closed out.
We also recorded an unrealized gain of $6.8 million on a refreshed hedge book, which has an average floor of BRL 5.06 per U.S. dollar and a ceiling of BRL6.26 per U.S. dollar at the end of the quarter. With a significant portion of our BRL exposure hedged over the next 15 months, we have mitigated much of the FX risk related to our future operating margins.
In line with our growth initiatives, our capital expenditures increased to over $90 million in the third quarter and were partially offset by strong cash flows from operations of $43 million. As we approach the end of the year, our balance sheet remains in great shape as our growth initiatives continue to accelerate. With that, we ended the period with $435 million in total liquidity.
With that, I’ll hand the call back to Noel to share some final comments.
All right. It appears that Noel, may have –
Christopher Dunn
Sorry, I was on mute. Thank you, Wayne, and everyone who joined the call today. Before we open the call to questions and answers, I’d like to thank our team in Brazil for the strong operating performance and project execution we achieved during the third quarter. I will now turn the call back to the operator to open the line-up for questions.
Question-and-Answer Session
Operator
We will now begin the question-and-answer session. [Operator instructions] Our first question comes from Stefan Ioannou of Cormark Securities.
Stefan Ioannou
I’m just curious, and maybe this question is a bit premature given the update we’re going to see early next week. But just thinking about the growth, it’s obviously very compelling. Just given sort of maybe the finished cash flow we saw this quarter, can we anticipate maybe a change to the schedule to get some of these big growth projects done in terms of just modest deferrals over time just to make sure the balance sheet remains strong through that process?
David Strang
Thanks for that question, Stephan. And a good one. Like many companies dealing with margin restriction, we obviously look to everything that we’re doing to be able to see where and when and what we can do with regards to cash maintenance, I guess, is the right word to use with respect to that.
As I mentioned in my talk, my portion of the presentation, and please excuse us as a fire engine going by the building. Honeypot provides us with a lot of flexibility as we continue to develop our assets in the Curaca Valley. We’ll be able to share some of that with you when we talk to you.
But certainly, I think like every company, we review everything. We feel that we’re in a good position to maintain our guidance as we’ve seen it over — and whereas we put it out last year and potentially to improve upon that with the addition of Honeypot with the reworking as we’re moving forward of the production plan at Boa. So we feel we’re in a fairly comfortable position right now with regards to how we’re managing our cash and how we’re managing our capital programs and projects.
Operator
Our next question comes from Craig Hutchison of TD Securities.
Craig Hutchison
Maybe a bit of a follow-on question from Stefan. Just with respect to, I guess, the capital spend to date, you guys are tracking quite a bit below guidance. Can we assume that most of that will get caught up in Q4? Or I guess, again, as a follow-on to Stefan’s question. Maybe there’s a possibility of some of that actually does get deferred into next year.
Wayne Drier
Yes, Craig, some of it will be deferred into next year. It’s as a matter of the closing of contracts and timing of payments more than anything else. And so when we look at it, yes, at the beginning of the year, we have a crystal ball. We’re trying to project as best we can with regards to when capital is going to go out the door. And obviously, you don’t — reality never follows the crystal ball in terms of projections, particularly as we’re moving forward with our projects.
What I can tell you is our projects are on time and on schedule. And what we’ve said in the presentation today reflects that. It’s merely where we’re seeing things right now on Boa is related to the fact of timing of payments on certain capital items with regards to — as we continue to develop Pilar 3.0, there’s opportunities that we’re seeing with respect to development of the project in light of Honeypot that allows us to potentially reallocate capital in a more advantageous way. And we’ll just leave it at that.
Craig Hutchison
Great. And so with the life of mine plan that comes out next week, will that, I guess, will make some things more clear in terms of capital. Will that include some updated capital and costs? Or is it more just around grades and tonnes from the different projects you have.
David Strang
Yes, it’s going to be more grades and tonnes with regards to that. We will be coming out with updated guidance in the new year as everybody else does, but it will be a production profile. And yes, we’ll come out with new guidance in the new year.
Craig Hutchison
Okay. Great. And maybe just one last question. Just with respect to labor costs. I mean have you guys settled all your union contracts already at this point? And kind of what are you seeing in terms of cost inflation on the labor side?
David Strang
Yes. We haven’t completed everything. It’s just normal cost of business with us with our union. Difficult to say where negotiations come out, but we anticipate them to be lower than what we’ve seen in the past.
Operator
Our next question comes from Jackie Przybylowski of BMO Capital Markets.
Jackie Przybylowski
I think the first one I’ll ask is on Boa. You mentioned in the release the critical path earthworks and site drainage are complete going into the rainy season. Can you talk a little bit about what the construction plan is during the rainy season and where you might see any risks to construction time lines, if there is excessive rain?
David Strang
Thanks, Jackie. The critical path items for everybody who doesn’t know the Tucuma project is up in [indiscernible], which is a very intense rainy season. As such, it was critical for us to have certain parts of the project that probably would be done later in a lot of other projects done earlier. And we’re happy to say that those came in on time and on budget.
We’ve also had a significant rain event. We got 2.5 — I think it was 2.5 inches or something of rain in a 15-minute period that put a good stress test on the project, and we’re happy to say, it came through in flying colors. As we continue to move forward right now, the path that we’re working on right now, Jackie, are related to completion of the waste dump liners and construction there, and we anticipate starting to put down some of the first material on the waste dump over the course of the next month or so.
The pre-stripping of the deposit has begun. Obviously, they’re putting some of that waste on the waste dump. And then we are in the process of doing site clearance and earthworks related to the plant infrastructure. All of that is ongoing right now and is progressing on time, and we’re very, very comfortable with that.
With respect to long lead time items, i.e., as we mentioned in our last quarter, the big critical path items on long lead time are related to the mills. Happy to say that our bore mill is on the ship already on its way to Brazil. Happy to say that we’ve concluded our contracts with regards to our hec mills and so where we stand right now, Anthea and the team and Tiago, our great leader down in Brazil.
And this project have done an outstanding job considering what we’ve seen in other companies around the world with regard to critical path items, et cetera, to get us into a situation where we are today. And so we are incredibly comfortable. I think the biggest single risk factor to the project that hurdle has been cleared, and we’re looking good right now.
Jackie Przybylowski
Absolutely. Congratulations to Anthea and the whole team. I think the spending that you guys reported is a very positive surprise given the inflationary pressures we’re seeing. Can you give an update on speaking of cost inflation maybe, but can I ask for an update on the domestic smelter that you would normally be shipping to?
I know I probably asked this in the last quarter, and I think you said it’s basically out for this year. Is that still the case? Do you expect you’ll be able to ship domestic concentrate and bigger volumes again early next year? Or do you have any thoughts on that?
David Strang
Yes, Jackie. They’ve bought through their issues, and they’re coming back on schedule and on steam. From our perspective, we’d like to just see them get a little bit further down the road with regards to the working capital, et cetera, in order to start being more comfortable shipping back to them. We are doing a little bit of shipments to them right now.
Wayne and Eduardo have been working really hard with them and another company to come up with some ideas with regards to how we can start to move back to them and do things that don’t put our cash flows or revenues from them at risk. And I think it’s watch this space over the course of the next quarter to see how that starts to play out.
But we obviously — PMA is an important customer of ours. We’re super excited with respect to how they’ve come through a very challenging period. for themselves. And we really want to look forward and support them going into the next year with regards to greater sales to them if we can.
Jackie Przybylowski
That sounds very encouraging. Thanks, David and congrats.
Operator
Our next question comes from Bryce Adams of CIBC Capital Markets.
Bryce Adams
Yes. I want to ask on potential copper hedges. Given the multiyear build, do you internally discuss copper hedges? I understand that the financing was stressed to 3.25% copper. So given where spot is today, how much consideration do you give to copper hedges over the next 12 to 18 months?
David Strang
It’s a good question, Bryce. Like everything else, we are constantly working with the finance team to evaluate where our cash is, where our cash outlays are going, where our profitability is. And frankly, I think it would be naive in the current world market and where the copper price is and where cost inflation is to not consider all alternatives to yourselves with regards to that. So yes, we have discussions with Gust Copper Hedging. Have we considered it either way? No, at this stage. Could that change? Yes. But we’re not going to be naive say, no, we don’t consider it, we have.
Operator
This concludes the question-and-answer session. I would like to turn the conference back over to management for any closing remarks.
Christopher Dunn
Well, thank you all for joining the call. And we want to remind you that the team is available for any follow-up questions as we always are. And we’re happy to discuss any aspects of our business. Thank you all, and have a good day.
Operator
This concludes today’s conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.
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