Lucara Diamond Corp. (OTCPK:LUCRF) Q2 2022 Earning Conference Calls August 11, 2022 10:00 AM ET
Company Participants
Eira Thomas – President and Chief Executive Officer
Zara Boldt – Chief Financial Officer and Corporate Secretary
Conference Call Participants
Paul Zimnisky – PZDA
Operator
Good morning. My name is Justin, and I will be your conference operator today. At this time, I would like to welcome everyone to the Lucara Diamond 2022 Q2 Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]
Ms. Eira Thomas, you may begin your conference.
Eira Thomas
Okay. Thank you very much, Justin, and welcome, everyone, to Lucara’s Q2 conference call, and thank you for joining us today. On the call from management we have Zara Boldt, our CFO, and [Chris Schaufele] our Project Manager for the underground expansion project, and we’re really pleased to be welcoming Chris to his first results call of the company.
I will be making forward-looking statements, so I do draw your attention to our cautionary statement, which is Slide 2, and it is available for your perusal on our website. In Q2, Lucara celebrated 10 years of continuous operations at its 100% owned Karowe Diamond Mine and delivered another solid quarter in respect of operating performance of the mine, including 590 days LTI-free.
Our multichannel approach to sales continues to mature, driving stronger revenues from a more efficient, transparent supply chain and contributed $52.3 million in revenues, a 13% increase over Q2 2021, which despite growing global economic uncertainties, evidences the continuation of strong prevailing rough and polished diamond market fundamentals.
Diamond sold during the quarter generated an average price per carat, excluding top-up payments of $557, consistent with the comparative period and reflects a stronger diamond market, offset by natural variability in size, color and quality of rough diamonds recovered and sold in each period.
All three of Lucara’s sales channels performed well in Q2 and better than in the comparative period, with HB, Clara and tenders achieving $32.4 million, $9.4 million and $10.5 million, respectively.
In terms of diamond recoveries from the mine during the period, we recovered 194 Specials or single diamonds greater than 10.8 carats, including five greater than 100 carats in size, representing approximately 6.1% by weight Specials of total carats recovered, which is consistent with historical recovery and quarterly variability expected within the South Lobe.
Karowe underground expansion programs continued to make solid progress in Q2. We invested approximately $29.1 million and completed all pre shaft sinking activities for both the ventilation and production shafts, commenced main shaft sinking at the ventilation shaft and advanced power line and associated substation construction on the plan. Importantly, we concluded negotiations and executed the main shaft sinking contracts with UMS which resulted in a modest 2.5% CapEx increase from $534 million to $547 million, reflecting the inclusion of updated detailed pricing.
The transition to main sinking over the last few weeks has been slower than anticipated. However, we are in a ramp-up period and cycle rates are continuously improving and opportunities have been identified to decrease main sink cycle times and reduce any potential impacts on schedule.
Finally, in respect of liquidity, the company reduced the balance on the working capital facility to zero during the period. And as of June 30, had cash and cash equivalents of $40.8 million and has drawn an additional $20 million from the $170 million project loan facility for a total drawdown to date amount of $65 million. The company retains access to ample liquidity to execute on its growth plans. The full $50 million working capital facility was unutilized as of June 30.
I would now like to invite Zara to take you through a more detailed overview of our financial and operating performance for the period.
Zara Boldt
Thanks very much, Eira. Good morning and good afternoon, everyone. Thank you for joining us for our second quarter earnings call. Just a quick reminder that I’ll be making some forward-looking statements. So please refer to Slide 2 of today’s presentation for our cautionary statement.
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. This 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. As a reminder, all references in the presentation will be to U.S. dollars unless otherwise stated.
So let’s begin with the financial highlights from the second quarter. The company recognized total revenue of $52.3 million during the first quarter — sorry, during the second quarter, a 13% increase from the $46.3 million earned in Q2 2021. This is representative of a continuation of strong prevailing rough and polished diamond market fundamentals. Revenues from the sale of Karowe diamonds were $50 million. The sales agreement with HB accounted for 65% of total Karowe revenue recognized in the quarter.
Karowe Diamond sold during the quarter generated an average price per carat, excluding top-up payments of $557, the similar price per carat to the comparative period reflects a stronger diamond market, offset by variability in the size, color and quality of rough diamonds sold in each period. Total revenue recognized includes top-up payments of $13.1 million from the HB agreement as well as $2.3 million from the sale of third-party goods on the Clara platform. Karowe goods made up less than 60% of the total volume transacted through Clara in the second quarter as a third-party producer commenced a series of trial sales, which are continuing into the third quarter of this year. You can see that adjusted EBITDA of $24.4 million increased by 10% from $22.2 million for the same period last year, attributed primarily to higher revenues.
Net income for the quarter increased to $12.5 million from $6 million in Q2 2021. That equates to $0.03 basic earnings per share in the current quarter. As a reminder, the net income achieved in each quarter is most impacted by the revenue earned during that quarter, noncash items such as depletion and amortization, foreign exchange gains and losses, gains and losses from derivative financial instruments and income tax expense to introduce volatility to net income.
Operating expenses increased $1.9 million or approximately 13% to — from $15.1 million in the comparative quarter to $17 million in the second quarter of 2022, reflecting a combination of increased ore tonnes mined, inventory buildup due to timing of scheduled quarterly tenders and the benefit of a stronger U.S. dollar, offset by input cost increases, particularly as those related to labor, fuel, insurance and power costs. Cash flow from operations for both the current and comparative quarter was $0.05 per share.
The next slide sets out our operational highlights for the second quarter. At the end of the second quarter, our production metrics remained in line with our 2022 guidance with 1.1 million tonnes of ore and 0.4 million tonnes of waste mined and 0.7 million tonnes of ore processed during the three months ended June 30, 2022. We recovered just over 86,000 carats during the second quarter this year, achieving a recovery grade of 12 carats per 100 tonnes. This is about 15% less than recovered carats in the comparative quarter where the average grade was 13.9 cpht, all ore process came from South Lobe material.
Eira spoke to the number of Specials that we recovered during the quarter, including five diamonds greater than 100 carats and we sold just over 66,000 carats from the Karowe mine for gross proceeds of $50 million. Operating expenses were $17 million or $221 per carat sold, the 5% increase in operating expenses per carat sold is attributed to a 4% decrease in the volume of carats sold and lower operating expenses attributed to the net impact of the depreciation of the Botswana pula against the U.S. dollar, offset by higher labor, fuel and energy costs. Despite inflationary pressures, we do expect to remain within our full year guidance of $29.50 to $33.50 per tonne of ore processed. Our overall performance during the second quarter, like the first quarter this year remains consistent with the strong operational results achieved over the past few years and is generally in line with our plan for 2022.
Moving now to some financial highlights from the six months ended June 30, 2022. Our results for the six-month period were strong from both a financial and operational perspective. We recognized revenue of $120.5 million during the six months ended June 30, 2022, as the number of high-value stones delivered to HB in 2021 have now been manufactured and sold resulting in top-up payments of $24.8 million year-to-date. The average price per Karowe diamonds sold, excluding top-ups, was $619 a carat for this period. This price reflects the combination of strong diamond market fundamentals and the mix of diamonds recovered and sold during the first half of this year.
Strong revenues are the main driver for both the adjusted EBITDA of $60.4 million and net income for the six months ended June 30, 2022, of $31.5 million. Depletion and amortization expense of $10.7 million, deferred income tax expenses of $22.8 million and a $7.2 million gain on interest rate swaps had the most impact on net income for the first half of this year. Strong cash flow from operations equivalent to $0.13 per share allowed us to reduce the working capital facility balance to zero as of June 30 and to support an investment of $60.2 million in the Karowe Underground Expansion project so far this year.
Operational cash flows directed to the underground spend were supplemented by two $20 million draws from the project finance facility, which were completed since January 1 of this year, increasing the amount drawn from the facility to $65 million. The cost per tonne of ore processed was $28.22 for the six months ended June 30, 2022, and reflects cost inflation, again, primarily related to labor, fuel, power and insurance, offset by fluctuations in currency exchange rates. Our full year cost guidance remains between $29.5 and $33.5 per tonne of ore processed.
Let’s now look briefly at some operational highlights for the six months ended June 30. During the first half of 2022, we mined 1.9 million tonnes of ore, and we processed almost 1.4 million tonnes of ore, recovering just over 170,000 carats. We made no changes to our full year guidance with ore tonnes mined expected to be between 3.1 million and 3.5 million tonnes and ore tonnes processed expected to be between 2.6 million and 2.8 million. Carats recovery to date are tracking well to our full year guidance of between 300,000 and 340,000 carats.
We sold about 146,000 carats during the six months ended June 30, 2022, which is also tracking well to our full year guidance of between 300,000 and 340,000 carats. The operating cost per carat sold of $215 is reflective of higher input costs, generally offset by the benefit of a stronger U.S. dollar against the Botswana pula. Our strong operational results were achieved with an excellent safety record as the mine has operated for 590 consecutive days without a lost time injury.
Moving now for a quick review of our three different sales channels. We continue to sell the largest volume of our production through a quarterly tender, but the largest value of our production comes through sales with HB. The average price per carat sold for the HB sales was just over $6,500 per carat, top-up payments and third-party transactions to Clara totaled $15.4 million for total revenue in the second quarter of $52.3 million, so a very strong result.
Let’s move on to our full year guidance, please. I’ve already spoken to some of our assumptions with respect to the production KPIs and our cost KPIs, we made no changes to our guidance in the second quarter. We are tracking well.
So moving on, let’s look at our accomplishments for the Karowe underground expansion. So the mine life is expected to be extended until at least 2040. The project was fully financed in September of last year, and construction is advancing well. The underground expansion CapEx has gone up a little bit to $547 million. As Eira mentioned, this is the result of detailed engineering and schedules from the main sink contract.
We do not expect any issues with funding that very modest increase, which is, again, will come from operating cash flow and draws on the project finance facility. I mentioned earlier that we spent $29.1 million in the second quarter, completing pre-sink activities and construction of the power substation continues. We are transitioning to the main shaft sinking, the ventilation shaft sinking started in June and the production shaft sinking, it will start this month, it was expected to start this month. Some other highlights from the second quarter year — pardon me, project to date, we’ve invested $165 million in the underground expansion program and we’ve committed about $310 million. So we are well on our way towards that total CapEx of $547 million.
As Eira mentioned, we executed both of the — sorry, we executed the main sink contract for both the production and ventilation shaft with a very modest increase in the overall CapEx. During the second quarter, activities focused on ongoing construction and procurement, including completion of pre-sink activities for both shafts, commencement of main sinking for the ventilation shaft, on the production shaft, the headgear was erected. The stage winder was installed and roped up. I will also mention that the transition to the main sinking phase has been slower than anticipated. However, we have identified opportunities to decrease the main sink cycle time and any potential impacts to the schedule.
Procurement of shaft station underground mobile equipment and the mine bulk air cooler was initiated and the Letlhakane and Karowe power substation construction continued, transmission line towers have been erected in preparation for the stringing of transmission lines.
I will now hand back to Eira for the remainder of the call. Thank you very much.
Eira Thomas
Thank you very much, Zara. And I’m going to switch gears now and talk a little bit about the diamond market and our approach to sales. Healthy rough and polished diamond prices prevailed during the second quarter despite worsening global economic and geopolitical developments during the period, reaffirming that the global rough diamond supply constraints that continue to play out in the market. We did experience some price softening, particularly for certain categories of smaller diamonds; however, approximately 70% of our revenues continue to be generated from our large, high-value diamonds, prices for which continued to be stable. Our longer-term outlook for the diamond market remains positive.
Resource performance and the recovery of Specials in Q2 remain in line with expectations and consistent with historical recoveries and quarterly variability expected within the South Lobe. During the period, as I’ve already mentioned, we had a healthy recovery of Specials, 194 in total. And these are diamonds single diamonds greater than 10.8 carats in size. That included five diamonds and 100 carats in size, representing approximately 6.1% by weight Specials of total carats recovered. As messaged in recent preceding quarters, the carats approach to sales has evolved from a single tender or auction style platform to an optimized multichannel 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 then our higher quality plus 10.8-carat diamonds are being sold as polished diamonds exclusively through our novel committed supply agreement with HB in Antwerp. In addition, we have forged direct collaboration agreements with HB and certain brands, including Louis Vuitton, in respect of some of our truly exceptional high-value diamond recoveries such as Sethunya, and the Sewelô.
And with respect of our HB agreement, all of Lucara’s plus 10.8-carat production from Karowe has been channeled into this unique manufacturing partnership rather than being sold as rough. 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 largest, most valuable polished gems and delivering Lucara a polished price less a set fee and the cost of manufacturing. The benefits of the committed sales agreement with HB continued to be realized during the second quarter of 2022 as the company participated in the upside to manufacturing polished diamonds for goods delivered in previous quarters. And what we’re just showing on the screen is an example of some of the high-value rough polished that has been manufactured and resulting beautiful, polished outcome. And what you’re looking at there, the 62-carat Boitumelo pink rough diamond with the principal diamond yielded from that stone being over 20 carats and graded as a fancy purplish pink by the GIA and delivering significant upside for Lucara.
In Q2 Clara, Lucara’s 100% owned proprietary secure web-based digital sales platform continue to grow in scale and interest and importantly, continue to add third-party supply volumes. In Q2, we completed 5 sales on Clara reporting total sales volume transacted up $9.4 million, which, as Zara mentioned, is a 13% increase from Q2 2021. The strong price trends observed in Q1 for Clara continued into Q2, and the number of buyers on the platform remains stable, though an active wait list continues to be maintained. While most of the stones transacted through the platform are supplied from the Karowe mine, secondary market stones continue to be offered for sale through the platform with good results and a series of trial sales with another producer also began during the period, which has also generated encouraging early results and will continue into Q3. Third-party volumes sold on Clara in Q2 accounted for close to 40% of total transactions, and the company continues to engage with other potential third-party suppliers, including other producers and the secondary market.
Next, I’d really like to just highlight our focus on sustainability. It really underpins everything we do at Lucara. We have been producing a sustainability report now for a decade, and we are very close to issuing our latest sustainability report from 2021. So please do look for that on our website soon. And just as a reminder, we are certified by the Responsible Jewellery Council.
We are compliant the Kimberley Process and a member of the Natural Docker Council. In 2018, we also became a participant in the United Nations Global Compact, and we currently contribute to 10 of their 17 U.S. sustainable development goals. So I think just to conclude our call today, we end the quarter in a very strong position. We can continue to reiterate the strong investment rationale for Lucara.
We have a very strong high-margin assets in Karowe, which is now just into its 10th year of production and we are extremely excited about the potential for expanding this extraordinary resource underground and extending our mine life out to at least 2040. In addition, we continue to maintain exciting asset diversification optionality through Clara, the first-ever digital diamond sales platform in the world and we are continuing to see good traction there.
So thank you very much, everyone. And now I will turn it back to the operator to open up the stage for questions.
Question-and-Answer Session
Operator
[Operator Instructions] Our first question comes from Paul Zimnisky with PZDA.
Paul Zimnisky
You left operating cost guidance unchanged. How much of this is just a result of you having conservatively forecast fuel, labor, consumable costs in the midst of inflation. And then on the CapEx increase, just to be clear, how much of that is a result of cost inflation versus modification to the engineering or the design of the build?
Eira Thomas
Thanks very much, Paul. I think I’ll direct the first part of that question to Zara, and then I’ll invite Chris to speak to the underground portion, please.
Zara Boldt
With respect to our operating costs, we are seeing a natural hedge to inflation from the strength of the U.S. dollar. We did have reasonably — what we — at the time, what we had hoped would be reasonably conservative assumptions for increases to fuel, power and labor going into 2022. We did see the benefit of those really just in the first quarter. Fuel has increased significantly in Botswana and is expected to continue to go up for the remainder of the year. Power has not yet increased, but we are expecting an increase before the end of the year. So it’s a little bit of a combination of things, conservative assumptions but also the natural hedge from the U.S. dollar.
Unidentified Company Representative
Paul, Chris here. The majority of the cost increase was associated with, I’d say, labor as that forms the largest part of the contract with UMS. Engineering changes were minimal as most of the equipment had to be procured ahead of time and was at site for the installation during the pre-sinking phase. So the majority of the increase is associated with consumables and labor.
Operator
[Operator Instructions] That does conclude the question-and-answer session. I’ll turn the conference back over to you for any additional remarks.
Eira Thomas
Okay. Well, thank you very much, everybody. We appreciate you taking time out of your summer to join the call today. We continue to be very excited about the trajectory for Lucara going forward here, the remainder of the year and as we work to execute on the underground on Clara and we look forward to speaking with you again with a further update in Q3. Thanks very much, and enjoy the rest of your day.
Operator
Thank you. That does conclude today’s conference. We do thank you for your participation. Have an excellent day.
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