Lucara Diamond Corp. (LUC) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. My name is Kelsey, and I will be your conference operator today. At this time, I would like to welcome everyone to the Lucara Diamond 2021 Year-end Results Conference Call. [Operator Instructions] Ms. Eira Thomas, you may now begin your conference.

Thank you very much, Kelsey, and welcome everyone to Lucara's 2021 Results Call. 2021 was an important arguably transformative year for Lucara, not only in terms of financing the underground and de-risking our primary opportunity for growth, but also in navigating the ongoing uncertainty imposed by COVID on our operations and taking bold decisions in respect of our sales strategy designed to protect and support prices for our large, high-value diamonds while increasing margin capture downstream. We begin 2022 in a much stronger place, well positioned to take advantage of what is widely being heralded as the best global diamond market we've experienced in more than 10 years. I will be making some forward-looking statements, so I do encourage you all to review our cautionary statement which is available on our website. Highlights from 2021 includes strong safe performance at the mine having met or exceeded on all of our physical operating metrics, including our best ever mill throughput of 2.8 million tonnes. Total recordable injury frequency came in at 0.1%, down from 0.3% in 2020 with 0 recordable injuries in 3 of 4 quarters for the year. We delivered revenues of $230.1 million and achieved an average price per carat of $603 and 84% an 80% increase respectively, over the previous year. 2021 was also another record year for the recovery of specials for diamonds in excess of 10.8 carats in size which underpinned our financial success, including our third diamond recovery over 1,000 carats in size. In terms of our sales, the negotiation and execution of a 24-month extension to the HB committed supply agreement for all diamonds greater than 10.8 carats was an important objective for the year. The agreement was revised to provide more cash upfront for Lucara, a deferral of fees payable until receipt of final polish proceeds and added in specific performance criteria. After almost 20 months of selling this way, we are realizing meaningful benefit, protecting and capturing more value for our most valuable production segment and creating true alignment between producer and manufacturer for the first time. Clara our secure web-based marketplace for the transaction of smaller diamonds between 1 and 15 carats in size also had a strong year and was successful in adding and growing third-party volumes, increasing total sales volumes by 168% year-over-year. The platform remains at an important inflection point and we are excited about the potential for adding meaningful third-party supply in 2022. Advancing the underground expansion project working to maintain critical path objectives, including procurement of long lead items and detailed engineering work in advance of project financing and full project sanction was also a top priority. In Q3, the company was successful in securing a senior secured project financing package for up to $220 million with a syndicate of 5 leading international financial institutions, including ING, Natixis, SocGen, Africa Finance Corp. and Afreximbank Bank. Thereafter, the project underwent full board sanction and the first drawdown of the facility took place in September. We ended the year with $27 million in cash and we begin 2022 on a solid financial and operating platform with underground tracking on schedule and budget and access to ample liquidity to deliver on our core objectives for 2022. As stated previously, 2021 was a record year for the recovery of large diamonds. A total of 841 specials or single diamonds in excess of 10.8 carats were recovered during the year, representing 7.8% by weight up from 6.7% in 2020 and that included a number of remarkable diamonds which are listed on the page, a total of 39 diamonds greater than 100 carats including 8 over 300, 8 between 200 and 300 along with a further 23 stones between 100 and 200 carats and of course our third diamond in excess of 1,000 carats. The graph in 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 EMPKS geological unit of the South lobe, the source of many of our historic diamond recoveries, including all 3 of our diamonds in excess of 1,000 carats in size. Greater access to the deeper portions of the South Lobe provides a compelling economic rationale for expanding our mine underground and using conservative diamond price assumptions. We're anticipating adding $4 billion of additional net revenues and expanding our mine life from 2023 out to 2040. As I already mentioned, we were successful in securing a supplemental financing package in 2021, which has allowed us to fully sanction the project and move forward. We spent a total of $86.3 million in 2021 and we have plans to spend a further $110 million in 2022. Some of the highlights from 2021 include over 1 million man-hours worked LTI-free and we also cleared for construction of almost half of our tower foundations for our 29-kilometer 132 kilovolt transmission line bulk power upgrade. And we also successfully mobilized all of our head frame materials and surface infrastructure, including the construction of a 200-person camp and a water treatment facility. Importantly, we basically completed the majority of our pre-sinking activities for the ventilation and production shops down to minus 36 and minus 41 meters respectively, to allow tow in construction to commence and we also commissioned the temporary generator. In 2022, we're really focused on commissioning the 4 main sinking winders and completing the steel head frames for both shops. We will also continue with detailed design and engineering and we are looking forward to commissioning our new power supply coming in from the new transmission line by the end of the year. Moving on now, I'm going to talk a little bit about our approach to sales. I think Lucara has become well known for its approach to innovation and its incorporation of new technologies into its mine design. We have expanded the same approach to our sales strategy. For generations, we have relied on the same processes to distribute rough diamonds between producers and the midstream who then manufacture and deliver polished diamonds downstream to the retailers. Traditionally, each participant in the value chain is earning its margin on the back of another. Lucara believes this model is broken, inefficient, inflexible and lacks transparency. Clara was the first step in our journey towards a more efficient supply chain using a web-based digital marketplace to sell individual rough diamonds between 1 and 15 carats in size, stone by stone based on existing demand, creating true alignment between the producer and manufacturer for the first time. The deep discounts experienced for rough diamonds during the pandemic compounded the rationale to apply the same approach to sales of our large high-value diamonds and we moved into a novel partnership with HP, Antwerp to participate in the manufacturing of all of our diamonds greater than 10.8 carats under a committed supply agreement. Through HP, we have also gained direct access to large luxury retail brands such as Louis Vuitton, which has led to further collaboration downstream and we now have agreements in place in respect of our 1,758 carat Sewelo, the largest diamond mine from Botswana to-date and the 549 carat Sethunya, 2 of our truly exceptional large diamonds recovered from Karowe. The results of this approach has been price stabilization for the largest, most valuable diamond segment of our production and an opportunity to increase margin share downstream for our entire production range. We now sell our diamonds through 3 principal channels, tenders, Clara and HP, with 65% to 70% of our revenue is now being generated from the sale of polished. In 2021, the Clara platform continued to mature and though planned producer trials were largely deferred as companies work to repair balance sheets and recover from the pandemic, we were successful in adding third-party supply from primarily secondary sources and increased volumes transacted on Clara by 168%. Now that most producers are back on their feet. We have reengaged once again and we remain optimistic that planned producer trials will move forward in 2022 in tandem with growing third-party supply from the secondary market where our buyers have now also become our sellers to Clara providing an ideal avenue to transact unwanted inventory. And on this slide, we're summarizing the sales completed to date, almost $50 million worth of diamonds sold by value true platform. And we are sitting with a customer base of 88 companies by the end of 2021. Our ambition with Clara is to get to a modest 10% of global market share. We actually think that, that is conservative and that we could do much better. But in doing so, over 5 years, Clara has the potential to generate as much cash for us as our existing mining operations at Karowe. In respect of our HB agreement for the first time in 10 years, Lucara has a line of sight 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 gemstones 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 reflect this. I've already mentioned our unique 3-way collaboration with HB and LV. By way of an update after a year's delay on the COVID, the Sewelo has now finished its world tour with Louis Vuitton and is heading into manufacturing with all 3 partners now engaged at the planning stage for the creation of a bespoke collection of polished diamonds celebrating Botswana's largest diamond. Though the market has been remarkably blamed in 2021 prices for our very largest, most valuable diamonds have been slower to recover. Recent trends have been positive, however, and Lucara made a strategic decision to defer the sale of the Sethunya in 2021 to ensure that we are achieving the best possible outcome for this truly special diamond one of the finest gem quality, exceptional diamonds produced from the Karowe mine to-date. As I stated in my opening comments, we are experiencing a very strong diamond market. The diamond market has rebounded quickly from the deep discounts we observed during the pandemic and decreasing global supplies of rough diamonds combined with record diamond jewelry demand has pushed prices higher. Paul Zimnisky rough diamond price index suggests that overall rough diamond prices are in fact sitting at an all-time high, though we absolutely agree with this analysis for Lucara's unique production profile, our view is slightly more tempered. As mentioned before, prices for our largest, most valuable diamonds have certainly stabilized over the last year. However, we are still in the earliest stages of price recovery for this segment, and we're excited about the potential for further price appreciation as we continue on our journey with HB in 2022. What is most encouraging about the current market environment is the fact that price strength is being observed and is tracking in tandem for both rough and polished diamonds across a broad range of sizes, colors and qualities, reflecting much stronger overall global demand for diamond jewelry particularly out of the U.S. This market balance is encouraging and underpins our confidence in a stronger price outlook for the foreseeable future. I would now like to turn it over to Zara Boldt, our CFO, who will take us through some financial highlights for the year.

Thanks very much, Eira. Good morning and good afternoon, everyone. Thank you for joining us for our fiscal 2021 earnings call. Just a quick reminder that I will be making some forward-looking statements. So please refer to Slide 2 of today's presentation for a cautionary statement. Also, certain financial measures that I will refer to during today's call and which appear in the presentation are non-GAAP for 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 MD&A for details on how these measures are calculated. As a reminder all references are to U.S. dollars, unless otherwise stated. So let's begin with the financial highlights from the fourth quarter. The company recognized revenue of $57.9 million or $560 per carat in the fourth quarter of 2021, resulting in a margin of 62%. This compares to revenues of $42.4 million or $402 per carat for sales in the fourth quarter of 2020. Margin there was about 49%. The average sales price in the fourth quarter of 2021 reflects an overall higher market price for diamonds. You can see that adjusted EBITDA of $21.1 million in the fourth quarter more than doubled from the same quarter in 2020 again, really driven by higher achieved diamond prices. We recorded net income of $1.7 million for the current quarter, up from a net loss of $3.9 million in Q4 2020. 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 expenses introduced volatility to net income. In Q4, our operating expenses increased approximately 3% quarter-over-quarter due to a combination of higher power, labor and insurance costs. Operating cash flow during the quarter was $0.05 per share, up from $0.02 in the same quarter in 2020. Moving now to review the full year financial results. On this slide, the strong financial results we achieved in 2021 are very evident. Revenue of $230.1 million resulted in an average price per carat sold of $603. This represents an 84% and an 80% increase respectively over the previous years and is reflective of the impact of strong demand for both rough and polished diamonds, combined with supply constraints in certain size classes. I would point out that 2021's revenue does not include any provision for the sale of the 549 carat at Sethunya. As Eira explained just a moment ago in late 2021 we made the strategic decision to defer the sale of that exceptional diamond given the strength of both the diamond market and our financial position at the end of the year. The amended and extended sales agreement with HB accounts for 65% of total revenues recognized in 2021 and we'll look at that in more detail in just a moment. Year-over-year operating cash costs increased 8% to $30.02 per tonne processed from $27.80 per tonne processed last year. This expense is higher than in 2020 due to a combination of increased mining and processing activity and higher power, labor and insurance costs. Adjusted EBITDA of $102.5 million was 5x higher than the same period in 2020, again attributed primarily to higher revenues. Net income for the year increased to $23.8 million or $0.06 per share. We also saw a significant increase in cash flow from operations, which increased from $0.04 per share in 2020 to $0.24 per share for the year ended December 31, 2021. The next slide sets out our operational highlights for the fourth quarter. Overall performance during the fourth quarter remains consistent with the strong operational results achieved over the past 2 to 3 years. Mining and processing results were generally on plan during the fourth quarter, except for waste tonnes mined at 0.3 million tonnes. Ore mining which was about 610,000 tonnes continue to be prioritized over waste to enable de-stacking of benches in the northern part of the pit, which enhances flexibility to improve access to South Lobe ore as the pit deepens, it was also done to support dewatering activities ore gains were realized on the western contact of the South Lobe and those ore tonnes have been stockpiled. During Q4 2021, approximately 706,000 tonnes were processed at an average grade of 12.8 carats per 100 tonnes, which was on target. Almost 91,000 carats were recovered. During this period the ore processed was entirely from the South Lobe. A total of 180 specials were recovered in the fourth quarter, including 9 diamonds greater than 100 carats in weight. Recovered specials equated to 5.7% of total recovered carats from ore processed during Q4 2021. We sold just under 103,000 carats during the fourth quarter at an average price of $550 per carat. In the fourth quarter, operating expenses of $22.3 million equated to a $217 operating cost per carat sold. Operational highlights for 2021 from the Karowe mine are set out on the next slide. We mined 3.7 million tonnes of ore and 2.6 million tonnes of waste with total tonnes mined of $6.3 million in the midrange of our 2021 guidance. We processed over 2.8 million tonnes of ore, which represents a new annual record since the start of production at the Karowe mine. Just over 369,000 carats were recovered at a recovered grade of 12.93 carats per 100 tonnes of direct milled ore. This is 3% lower than 2020 as the higher throughput was offset by the lower grade of milled material. Just over 380,000 carats were sold during the year at an average price of $603 per carat. This represents an increase of 2% by volume and 80% by value when compared to our results from 2020. Both carats recovered and carats sold came in at the higher end of our 2021 guidance. During 2021, the specials recovered equated to 7.8% of total recovered carats, again achieving a record volume of specials recovered for the second consecutive year. Also of note, as Eira mentioned previously would be 39 diamonds recovered greater than 100 carats during the year, including the third 1,000-carat diamond recovered since 2015. Operating cash costs were $30.02 per tonne processed or $210 per carat sold. Operating cash costs were in line with our forecast of $28 to $32 per tonne processed but approximately 8% higher than 2020. The current year increase is reflective of cost reductions implemented in 2020, owing to the uncertainty of the impact of the global pandemic that were gradually lifted in 2021, offset by a 6% increase in tonnes processed as compared to 2020. Moving to Slide 19. This slide sets out how we sold our diamonds in the fourth quarter and for the year ended December 31, 2021. The exceptionally strong performance throughout 2021 was driven by higher diamond prices, which were reflective of the impact of strong demand for both rough and polished diamonds, combined with supply constraints in certain size classes. In 2021, diamond sales continue to be held through a combination of regular tenders and the Clara platform and through the HB agreement for gem and near gem diamonds greater than 10.8 carats, which are to be manufactured and sold as polished. Like previous periods, most of our sales by volume were realized through the quarterly tender process and by value through our agreement with HB. In 2021, we amended and extended our agreement with HB to at least 2023 and we made certain changes to the payment terms to better reflect the timing of mine production and HB's manufacturing process. The unique pricing mechanism of the HB agreement delivers regular cash flow for the highest value segment of our production profile. Because of the amendments that we made in 2021, we expect that the influence of top-up payments will lessen over time. For the year ended December 31, 2021, we recorded revenue of $150.4 million from the HB agreement from the sale of 23,000 carats. The increase is generally attributable to the contract covering in 12 months in 2021 versus 6 months in 2020. In addition, prices achieved continued to increase through 2021 and certain high-value stones delivered in 2020 were sold in 2021. Last year 21 sales took place on Clara with a total sales volume transacted of $28.7 million, which represents 168% increase from the $10.7 million transacted in 2020. During Q4 2021, the sales volume transacted was $7.7 million a 93% increase when compared to the same quarter in 2020. Clara also observed a steady upward price trend at each subsequent sales throughout fiscal 2021. 4 quarters were held in Antwerp in 2021 due to the ongoing uncertainty around travel restrictions through much of the year. Normally, these sales would be held in Gaborone, Botswana. Now let's review our 2022 guidance, which is set out on Slide 20. Based on updated expectations for revenue in 2022 attributed to the recent and expected strength in the rough and polished diamond markets diamond revenue guidance has been increased to between $195 million and $225 million, which is up from a range of $185 million to $215 million. All other metrics remain the same. I would note that the diamond revenue guidance does not include revenue related to the sale of exceptional stones or the Sethunya. At this point, I'd like to turn the floor back to Eira for an overview of our approach to sustainability and some closing remarks. Thank you very much.

Thank you very much, Zara. And I just wanted to take a moment to talk about sustainability, which for Lucara is foundational to everything we do. This is top of mind for investors today. And as a reminder, Lucara has been producing a sustainability report for the better part of a decade now. We are a participant in the United Nations Global Compact and we do contribute to 10 of the 17 sustainable development goals. In addition, we're certified by the Responsible Jewelry Council compliant with the Kimberly process and a member of the Natural Diamond Council. I do encourage you all to have a look at our annual sustainability report, which is available on our website, and we do anticipate updating with this year's report in the second quarter of 2022. I also do want to make mention what is currently happening in country in Botswana in respect of our response to COVID. We are really pleased to be able to report that our workforce is currently sitting at about 97% vaccinated which is a major change over where we were sitting this time last year. That is another major de-risking event for our company and our operations. And the country is now really beginning to open up. So certainly pleased to be able to report on that this year. So just to conclude, I think it's really interesting time for the diamond industry I think that Lucara represents a premium diamond equity, which has gone through a major de-risking event in 2021, and we're now really positioned for long-term growth and highly levered to improving diamond prices. We don't believe diamonds have had her day in the sun as of yet and a lot of the equities represent very good value. But for our company, we have maintained strong high margins since mining began back in 2012 on Karowe. And we're very excited to be looking forward now to another minimum 15 years of mine life extending our operations to at least 2040. And then in addition, we have Clara, which is an exciting new business for our company which provides asset diversification and optionality and the potential to generate significant cash flow going forward. So with that, I'd like to thank everybody for participating today, and we're welcome to open it up to questions.

[Operator Instructions] And your first question does come from Oliver Grewcock from Berenberg.

Just a quick one. And what kind of percentage increase do you think you've seen in the diamond market so far in 2022, please?

Oliver, I'll start and I'll let the team jump in. And I was remiss in introducing the rest of the Lucara executive that's participating on the call today. Besides Zara and myself, we do have Dr. John Armstrong, our VP of Technical Services. And we're also really pleased to be welcoming Naseem Lahri our Managing Director of our operations in Botswana. So Oliver, just to start on that question as you know, diamonds are a very heterogeneous commodity and there's many individual price points and they don't necessarily move in tandem. I think what we're certainly encouraged to see is overall price improvement across a broad range of diamond qualities and sizes and colors, and that has obviously had a very positive impact on the overall market and Lucara has no exception. I think it's fair to say that we've seen double-digit improvements. But again, as I mentioned in my remarks earlier prices for our largest, highest value diamonds have lagged. They are certainly stable and we're pleased to see that. And very recently, we've seen prices moving up for those as well. So we do believe that there is further price improvement ahead of us at Lucara. John, did you want to jump in on anything else there?

Sure we will be holding our first tender of 2022 at the end of next week. So we'll see how we stack up against our sale in December in terms of the price improvement from December until now. But we can see that in terms of polished prices in terms of goods being sold by HB that in certain sizes, the polished market has also improved since December, up a few percentage points for some of the larger goods which is positive as well.

Sorry, Eira, to clarify, did you say you seeing double-digit improvements already this year?

Year-over-year, the recovery started in late 2020 continued right through 2021 and continues into '22. But again, that is a pretty big generalization we've seen there is variability between small diamonds and big diamonds and different colors and qualities. But what is most encouraging is that the overall uplift is broad-based and widespread.

Your next question comes from Scott MacDonald from Scotiabank.

I just had a couple of related questions about your 2022 revenue guidance just with respect to some specific stones. Just on the Sewelo you mentioned and you also had some kicks in 393-carat top white they were all recovered in July. I'm just wondering whether you expect to see or if you could give any color on when you expect to see revenue from those diamonds and whether or not that's included in your guidance? I know you say no exceptional are included in your guidance. So I'm just not sure if those are considered in that bucket or not?

Those diamonds are included in that bucket. And then we say exceptionally right now what we've excluded from our guidance is the Sethunya.

It's John here. I'll just jump in. We have received the bulk of the revenue from...

Sorry John, we're getting a bunch of background.

I don't think it's not sure where it's coming from. For instance, for the $3.93 we've seen the bulk of the payments that we would expect from…

And when you say you received the bulk was that in 2021 or in 2022.

2021.

One of the things, I think Scott that Zara mentioned is that as our relationship with HP has matured and the processes have become more streamlined, we are seeing the timeline shortened between delivery of rough diamonds to final polished sales. So that's also helping.

Got you. And any sense of when you'll get proceeds from Sewelo?

No. We're taking our time with that one. I mean we got to go through quite a process here to open it up and sort of identify all the different opportunities and decide what makes the most sense for 3 partners. But it's a really important storytelling piece for us. As you may recall, if the diamond as coated in black diamond we know there's some white diamonds in there, but the real value has yet to be determined. And then only when we open it up, are we really going to have a real sense of where we want to go with it. So we're just starting, we basically planning out the first office to get a better look inside.

And your next question comes from Paul Zimnisky from PZDA.

Congrats to everybody on a really strong year. Maybe just following up on Scott's question on the revenue guidance. It is specified that it does not include the sale of exceptional stones. I'm still not really clear on that. So how do you define exceptional stones in that context?

That would be…

There's 2.

Sorry, go ahead, Zara.

No, go ahead.

I was just going to say for the short answer is a single stone that achieves more than $10 million.

Okay. Very clear on that. And then just maybe one for John. Maybe you can provide some color on the parts of the ore body that you'll be accessing this year and maybe what that could mean for the recovery of specials?

Sure. Thanks for the question, Paul. So the plan for 2022 is similarly aligned to that of 2021 in terms of -- it will be -- the bulk of the feed will be from the South Lobe and the split between NPKS and the EMPKS will be similar to previous years. So it works out to about 35% E and about 65% M in terms of the split of material going to the plant.

[Operator Instructions] There are no further questions at this time. You may please proceed, Ms. Thomas.

Okay. Well, thank you very much everybody for participating today. We are very excited about how your company is positioned going forward in 2022 and looking forward to another busy and productive year, advancing the underground, advancing our ambitions around Clara and of course continuing to deliver on our large diamond profile and our sales through HP. So thank you very much, and enjoy the rest of your day.

Ladies and gentlemen, this concludes your conference call for today. We thank you very much for participating and ask that you please disconnect your lines.