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Edited Transcript of LUC.TO earnings conference call or presentation 9-Aug-19 2:00pm GMT

Q2 2019 Lucara Diamond Corp Earnings Call

VANCOUVER Aug 19, 2019 (Thomson StreetEvents) -- Edited Transcript of Lucara Diamond Corp earnings conference call or presentation Friday, August 9, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Eira Margaret Thomas

Lucara Diamond Corp. - Founder, President, CEO & Director

* John P. Armstrong

Lucara Diamond Corp. - VP of Technical Services

* Zara E. Boldt

Lucara Diamond Corp. - CFO & Corporate Secretary

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Conference Call Participants

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* Richard James Hatch

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Scott Macdonald

Scotiabank Global Banking and Markets, Research Division - Associate Analyst

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Presentation

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Operator [1]

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Good morning. My name is Sylvie, and I will be your conference operator today. At this time, I would like to welcome everyone to Lucara Diamond's Q2 2019 Results Conference Call. (Operator Instructions)

Thank you. Ms. Eira Thomas, please begin your conference.

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Eira Margaret Thomas, Lucara Diamond Corp. - Founder, President, CEO & Director [2]

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Thank you very much, Sylvie, and good morning, and thank you to everyone for joining Lucara's second quarter results conference call. Joining me today from management is Zara Boldt, CFO; John Armstrong, Vice President, Technical Services; and Ayesha Hira, Vice President, Corporate Development and Strategy.

I will be making some forward-looking commentary, and I encourage all of you to review our cautionary statements on Slide 2 at your leisure on our website.

Before I report on what was a very strong quarter for Lucara operationally, I wanted to take a few moments to provide some commentary about the diamond market itself as context for this discussion. As most of our peer group has already reported, it is likely no surprise to any of you on this call that the market for both rough and polished diamonds remains challenging due to an excess supply of polished diamonds and reduced credit available in the midstream of the supply chain. Liquidity issues and concerns over manufacturers' profitability have resulted in weaker demand, while global trade disputes and unrest, particularly between the U.S. and China, are also contributing factors. Weaker demand has been reported across all size classes, and larger producers are withholding goods or allowing their customers to defer rough diamond allocations.

As a reminder, however, Lucara's expected production of approximately 375,000 to 420,000 carats in 2019 accounts for a very small percentage of total global production, with the majority of value from Karowe diamonds resulting in the larger, higher quality diamond. It is important to note as we get into a discussion of our Q2 results that Lucara's rough diamond sales during the first 6 months of 2019 have been consistent with expectations and completely in line with 2019 revenue guidance of between USD 170 million and USD 200 million.

We also see Clara, our online sales platform for rough diamonds, continuing to gain real traction and momentum in the current pricing environment as it greatly reduces the need to borrow for the midstream and provides assurance on diamond provenance, something that has become increasingly important to the consumer. While the current market environment is expected to remain challenging in the shorter term, longer-term fundamentals for rough diamonds are robust.

Naturally, mine diamonds are rare, and they are getting rarer as a number of world-class diamond deposits are depleting and nearing their end-of-life within the next 3 to 4 years. As a high-margin producer with no debt, Lucara is well positioned not only to weather this difficult pricing environment, but to also be opportunistic in its pursuit of quality growth opportunities at the bottom of the cycle.

Moving on to our quarterly highlights. Q2 was another strong quarter for your company. We met or exceeded guidance with respect to ore and waste mined, ore processed and carats recovered. In addition, with our continued focus on operational excellence, we were able to drive our costs down.

Underpinning this success, not surprisingly, was our strong, continued, focused discipline on safety. I'm very proud to report that we have now passed a record 2 years without a lost time incident at our mine.

Another milestone from the quarter was the recovery of our record-breaking 1758-carat diamond, which was subsequently named Sewelô, which means rare find, by the people of Botswana. I'll see -- say just a bit more about that in a couple of slides.

In terms of revenues, approximately 101,000 carats were sold during a single-tender held in May, achieving USD 41.2 million in gross proceeds and achieving an average price of USD 408 per carat. Carats sold were 28% above budget due to the higher recovery of fine or smaller diamonds, which resulted from strong plant availability and a higher mine call factor. As we've already discussed, the market was weaker in Q2. And we did experience price deterioration, particularly in the better color and quality plus 10.8 carat diamonds. We expect this trend to continue in Q3. Despite this downward pressure on prices, however, we are confident and comfortable with our guidance of between USD 170 million and USD 200 million for the full year.

On another positive note, we successfully completed our negotiations with the union during the quarter and have secured a 2-year agreement, the final terms of which were in keeping with our budget projections and estimates. Clara also continues to ramp up according to our plan, and we remain highly encouraged with feedback we are receiving from our growing customer base. As demand grows, Lucara is now preparing to add third-party production to the platform, and we continue on track to achieve this important milestone before the end of the year.

Finally, you will have seen our announcement declaring a third $0.025 quarterly dividend payable on September 19. Overall expenses are expected to remain within budget for the year, and our ending cash was $7.1 million, with $5 million outstanding on the credit facility.

So moving along, I've already touched on our strong continued safety performance at the mine, but I do want to take a moment to reiterate Lucara's strong commitment to best practices in relation to our environmental, social and governance goals. Highlighted on this slide is our Mokubilo Farm project, one of our most successful CSR initiatives, at under 1 year since implementation has already delivered tangible broad-based community benefits. I encourage everyone who has not already had the opportunity to do so to download our recently published sustainability report for 2018, which highlights how innovation, award-winning health and safety performance, operational excellence and our social license enabled us to achieve a number of important outcomes related to our sustainability goals. Lucara's sustainability report is prepared in accordance with the global reporting initiative standards, core option and selected G4 Mining and Metals Sector disclosures. And in 2018, we became a U.N. Global Compact participant and contribute to 10 of the 17 United Nations sustainable development goals highlighted on this slide. We are also certified by the RJC and compliant with Kimberley Process and a member of the DPA.

Moving on to Slide 7. I've already highlighted the gross proceeds from our May sale. Overall carats sold were up year-over-year by 42%, largely as a result of higher recoveries of fine diamonds from improved plant performance. Included in the sale were 7 diamonds which sold for greater than $1 million each, including 2 diamonds that sold for greater than $3 million each. Though fine diamond recoveries have increased and do impact overall average price per carat, it is important to note that the large diamond recoveries remain consistent and predictable and still account for 70% of diving revenues. In the quarter, 225 specials were recovered, representing 8.1% weight percentage of total recovered carats. As a final comment, we are now seeing that our strategy of moving into blended tenders is working well and results in a smoother revenue profile and decreased time to market for our higher-value diamonds.

The largest diamond to be unearthed in Botswana's 50-plus year history and the second plus-1000 carat diamond to be recovered at Karowe in just 4 years, Sewelô, is shown on this slide. It is a 1758-carat near-gem, and it was recovered undamaged in April and is a real testament to Karowe's remarkable geological endowment and the strong operating environment that prevails at the mine. This diamond is undergoing analysis in Antwerp, and we will be making a decision on how to proceed with unlocking more value from Sewelô in the coming months.

Turning now to our growth strategy. We are pleased to report that we are making good progress with our underground feasibility study, which aims to extend mine life at Karowe from 2026 to at least 2036. I think it is worth reminding our shareholders about the potential prize associated with extending the mine life at Karowe. From an initial investment of around $200 million and in just 7 years of open-pit mining, Karowe has generated $1.4 billion in revenue and produced 2 plus-1000 carat diamonds. Resource work in 2016 and 2017 not only demonstrated the potential for doubling the mine life at Karowe, it also confirmed that the ore body is actually getting richer with depth, which is an important economic driver in the current feasibility study. All technical components of the study have now been completed, and it is tracking on budget and on schedule for completion in Q4 of this year.

Lucara's second growth project is Clara, our secured digital rough diamond sales platform that has been fully commercialized and is ramping up on plan. We began the call today discussing the challenging pricing environment that currently prevails, ore diamonds. In part, these challenges have arisen because there is a disconnect between the rough and polished markets, and the current supply chain is inflexible and inefficient. Clara changes this dynamic, tethering the 2 markets in a more tangible and transparent way and greatly reduces the need for inventory financing in the middle part of the pipeline. Clara is the new way forward, and our growing customer base is a testament to this need. Since December, we have held 7 sales with Clara and grown our customer base from 4 to 20. Feedback has been overwhelmingly positive, and we have slowly, systematically grown demand to the point where we are ready now to onboard additional third-party production. Discussions with third-party producers continue, and we remain on track to diversify our production profile before the end of this year.

And now I would like to turn the presentation over to Zara Boldt, our CFO, to go through some financial highlights from the quarter.

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Zara E. Boldt, Lucara Diamond Corp. - CFO & Corporate Secretary [3]

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Thanks very much, Eira. Good morning and good afternoon. I'll now review some of the financial highlights from the first 6 months of this year.

As a quick reminder, all of our financial results are reported in U.S. dollars. I will also be making some forward-looking statements over the next few minutes.

Starting with Slide 13. We have several financial highlights presented from the first half of 2019. Our financial results have been positively affected by the strong operating environment at the Karowe Mine during the first half of 2019. Revenue of $91.2 million is in line with our expectations and slightly ahead of the $89.9 million earned during the first 6 months of 2018. A blended tender quarterly sales process, which started in the third quarter of 2018, combined with sales through the Clara platform has resulted in more consistent revenue profile and less time to market for higher-value diamonds.

Despite this improvement, this year, we are utilizing our credit facility more frequently to manage fluctuations in working capital. But as sales on Clara ramp up, we expect that reliance will be reduced. As of June 30, we had drawn $5 million on the facility, and we had $45 million available.

We achieved a sales -- average sales price of $463 a carat during the 6-month period from the sale of about 197,000 carats. This compares to an average sales price of $648 per carat in the comparative period from the sale of about 139,000 carats. Better recoveries in the smaller, lower value sizes results from an improved mine call factor and 2 consecutive quarters of record production from the plant.

Adjusted EBITDA of $38.6 million is also slightly ahead of the comparative period's adjusted EBITDA of $37.5 million. Although operating expenses at $33.7 million were slightly higher than the comparative period of $31.2 million, a 27% decrease in administrative expenses was achieved in the first half of 2019 as compared to the same 6-month period in 2018. An operating cash cost of $31.16 per tonne process is significantly less than the operating cash cost of $36.64 per tonne process in 2018. The resulting -- pardon me, the decreased results from a combination of higher tonnes processed and significantly less waste mined in the first half of 2019, following a substantial completion of the cut 2 push back by the end of 2018.

Net income of $8.1 million and earnings per share of $0.02 during the 6 months ended June 30, compares to net income of $12.7 million and earnings per share of $0.03 in the comparative period. Net income this year has been significantly impacted by depletion and amortization expense of $23.7 million, which is more than double the $11.3 million for depletion and amortization expense recorded in the first half of 2018. The material change in this noncash expense results from a 42% increase in carats sold between the periods and a change in the reserve base last year, which increased the rate of depletion on assets amortized using the unit of production method. With forecast increases in the number of carats to be recovered and sold this year, we expect that depletion and amortization expense will continue to have a material impact on net income and earnings per share in 2019.

We will now move to Slide 14 for a short overview of quarterly highlights for the 3 months ended June 30, 2019. As you can see from the quarterly highlights table in the presentation, our production numbers were strong in the second quarter and continue a trend of significant operational improvement observed in the latter half of 2018, following the change in mining contractor. Improvements to maintenance scheduling and equipment availability are expected to help maintain a strong production trend for the remainder of the year.

Ore and waste tonnes mined have met or exceeded planned volumes for the first 6 months of 2019, with ore mined at about 774,000 tonnes. This is trending higher than guidance due to resource gains in the north and central pipes previously categorized as waste. Waste mined at about 1.8 million tonnes for the quarter is as expected but is significantly lower than the second quarter of 2018, when we were engaged in a large waste stripping campaign. As a result of higher-than-expected ore tonnes mined, no waste was capitalized during the quarter and no waste capitalization is expected for the remainder of the year.

We processed about 713,000 tonnes of ore during the quarter, not quite at the record level achieved in the first quarter, but close. Excellent performance from the plant resulted in a recovery of just over 109,000 carats.

Revenue of $42.5 million from the sale of about 102,000 carats resulted in an average price per carat sold of $417 and an operating margin of $243 a carat or 58%. These results are consistent with our expectations for the quarter.

Moving now to our half year operating and financial highlights on Slide 15. Again, looking at the table on Slide 15, we see strong production numbers for the first half of the year, with ore tonnes mined and processed and carats recovered significantly higher than the same period in 2018. Waste tonnes mined of 4.3 million is about half the tonnage mined last year for the reason previously noted.

Revenue for the 6 months ended June 30, 2019, was $91.2 million or $463 a carat from the sale of approximately 197,000 carats. Operating margin per carat was $292 or 63%. For the same period last year, we achieved an operating margin of 65%.

Moving now to Slide 16. I'd like to speak briefly about some changes to guidance. We have not made any adjustments to our revenue guidance for 2019 despite widely reported market weakness in overall demand and pricing. To date, our results have been in line with management expectations and are tracking to be within our revenue guidance of $170 million to $200 million for this year. As a result of record plant processing performance over consecutive quarters, annual carats recovered and carats sold are expected to increase to between 375,000 and 420,000 carats. Greater asset availability and utilization, together with an improved mine call factor, are driving this increase in recoveries, which do consist mostly of small diamonds.

Ore tonnes mined are forecast between -- to be between 3 million and 3.4 million this year due to resource gains that offset planned waste mining in the first quarter. Waste tonnes mined is unchanged at between 6 million and 9 million, although we expect our full year results to be at the lower end of this guidance.

Ore tonnes processed is unchanged at 2.5 million to 2.8 million tonnes for the year. Given the excellent plant availability achieved to date, it is likely that we will achieve the upper end of our full year guidance.

Presently, our cost per tonne process of $31.16 is slightly below guidance of $32 to $37 per tonne processed for the year. Based on results to date and planned production in the second half of the year, we should be at the lower end of our cost guidance for 2019.

To wrap up, the Karowe Mine is a high-margin mine in an excellent jurisdiction with open-pit mineable reserves to 2026 and the potential for an underground development that would extend the mine life to 2036. We have demonstrated strong safety and operational performance for several consecutive quarters, reaching an important milestone of 2 years without a lost time injury in May this year. Karowe's known for a diamond population characterized by specials, which are diamonds in excess of 10.8 carats. And in April, we recovered the 1758-carat Sewelô. The Karowe Mine is the only mine in the world were 2 diamonds in excess of 1,000 carats have been recovered.

In the fourth quarter, we expect to announce the results of the underground feasibility study, and we expect Clara to continue to ramp up. Clara's business model is working well, particularly during this period of market weakness as manufacturers are able to purchase only the diamonds they require for their business quickly and efficiently. Both the potential underground development and continued success with Clara are important catalysts for Lucara.

With that, thank you for your attention today, and we're happy to answer any questions you may have. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And your first question will be from Richard Hatch at Berenberg.

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Richard James Hatch, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [2]

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First one, just on inventory. So I note an inventory build in the second quarter. And are you able just to give a little bit more color around that? Is that just purely a timing function from when the diamonds were mined to when they'll be sold? And are you able to give us any flavor in terms of mix? I suppose the crux of my question is, is there -- are you holding back goods because of a weaker market for small diamonds? Or are you still selling what you produce, but this is just a timing issue?

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Zara E. Boldt, Lucara Diamond Corp. - CFO & Corporate Secretary [3]

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So I think I'll take the first part of that question, Richard, and John will likely answer the second part. So as you're aware, inventories consist of rough diamonds or ore stockpiles and parts and supplies. The biggest increase has been in our rough diamond inventory, which is sold on a regular basis. The increase in that value is driven by a higher number of carats recovered. Our ore stockpile has also increased as a result of the gains that were achieved in ore, which haven't been in plan in the earlier part of the year. Parts and supplies inventory is up about 16%. And the reason for that is making sure that we've got the right parts and supplies in the event that they're needed in the plant. With the excellent performance that we have seen over the first 6 months of the year, we are being proactive in terms of our maintenance programs there.

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John P. Armstrong, Lucara Diamond Corp. - VP of Technical Services [4]

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Yes. And then I'll answer the second part of the question. We continue to sell our run-of-mine material. We're not holding in inventory any particular part of the mix.

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Richard James Hatch, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [5]

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Okay. So the stock build in the second quarter, it's kind of a broadly kind of standard size frequency distribution that kind of skews one way or another?

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Eira Margaret Thomas, Lucara Diamond Corp. - Founder, President, CEO & Director [6]

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Correct.

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John P. Armstrong, Lucara Diamond Corp. - VP of Technical Services [7]

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Yes. Yes.

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Richard James Hatch, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [8]

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Okay. Right, helpful. Second one, just on the production that you made right into the second half. So I kind of -- from what -- you had a very strong first half in terms of carats produced. Kind of backing out your guidance since the second half, it's a little bit lighter. So what is the driver of that? Is that -- you're a little bit lower on grade because you don't process as much kind of stockpile material? Or is it the plant just takes a little bit of a step back, just to kind of normalize? Or what's the driver on the slightly lower production quarter-on-quarter?

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John P. Armstrong, Lucara Diamond Corp. - VP of Technical Services [9]

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It was a mix of grade, Richard. Like in quarter 1, we did put more material from the center and the north load through, which is higher grade, and we saw a better mine call factor there. So in part, that's some of the carats that came through. But that would be -- mainly that's the main driver. We're not throttling back the plant or anything like that. We're -- as you can see from the tonnes milled, we're trying to achieve as best we can to get material through the plant. So it's more just a grade and we're trying not to process stockpiles. We're trying as best we can to decrease costs and rehandling costs is to take material out of the pit directly to the plant.

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Richard James Hatch, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [10]

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Makes sense. John, while I've got you and just a question. So on the South lobe, I mean I think, how do you think around or how should we think around the South lobe grade versus realized prices? Because I kind of -- I think, every kind of quarter at the moment you're kind of beating me on grade, but like the average price is a bit lower because you're over-recovering the smalls just on $1 per carat basis. So is this something that perhaps you're going to kind of reflect in the reserve resource update, where perhaps for the South lobe your grade increases, but then your average price comes down but on $1 per tonne basis, perhaps you were flat. But perhaps, can you help me around that?

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John P. Armstrong, Lucara Diamond Corp. - VP of Technical Services [11]

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So we -- as part of the feasibility study, we will be updating the resource. And there will be -- at that time, we will also provide an update on the average price per carat that we use for each of the lobes. And we'll also produce one for the EM/PK(S) and the M/PK(S), the 2 dominant rock types in the South lobe. And if you refer to the material. I mean the average price per carat is sensitive to single-stones, where that's the bulk of the value sits in a very small percentage of production. We did see some weakness in that through the first part of the year, which is sort of revenue neutral, but it has a big impact on the average price. But I think that once the feasibility study is completed and published, you'll see a revision to our average price per carat models going forward that we use.

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Richard James Hatch, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [12]

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Okay. Sorry, I appreciate I'm hogging the call. I've just got 2 more. First one is just on 2020, is the mine plan still that you will increase your production in the Central lobe and then reduce from the South lobe? Or is there kind of some kind of perhaps an adjustment or consideration of trying to adjust the mine plans, just to kind of smooth out that revenue kind of volatility?

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John P. Armstrong, Lucara Diamond Corp. - VP of Technical Services [13]

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There will be another -- like I think, Richard, if you -- again, when we publish the feasibility study, there'll be a revised life-of-mine plan for the open pit that will match with any potential underground working. So that -- I would sort of just say, be patient. And then when we make that update, there will be some changes obviously to the life-of-mine plan for the open pit. But -- and we'll make adjustments as we go in terms of maximizing the value that's going to the plant. So again, if we end up setting any more South versus Center, then that's what we would do in the short term.

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Operator [14]

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(Operator Instructions) Your next question will be from Scott Macdonald at Scotiabank.

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Scott Macdonald, Scotiabank Global Banking and Markets, Research Division - Associate Analyst [15]

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Congrats on another good operating quarter. You've covered off a few of my questions already, but maybe just one for John. The diamonds you're recovering from the reprocessing tailings, could you give a little color on how the quality and size frequency of those recoveries compares to your sort of direct milling diamonds? Are they sort of, on average, lower quality? Or how would you describe them?

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John P. Armstrong, Lucara Diamond Corp. - VP of Technical Services [16]

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The best way to answer that question, I mean the size distribution is finer. It's significantly finer than our regular direct-milling carats. And in terms of the quality profile, the quality profile is consistent with -- in value-wise, consistent with what our direct-milling carats. It's just a much finer size distribution.

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Scott Macdonald, Scotiabank Global Banking and Markets, Research Division - Associate Analyst [17]

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Okay. So the prices you'll realize from that production stream will probably be quite a bit less than your average. Is that fair to assume?

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John P. Armstrong, Lucara Diamond Corp. - VP of Technical Services [18]

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Yes. In terms of an average price for it, it would be lower, and that's driven by finer size distribution out of the recovery tails carats.

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Operator [19]

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Next is a follow-up from Richard Hatch.

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Richard James Hatch, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [20]

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I suppose -- can I just ask a question on dividends? I suppose my kind of concern is that if the cash flow is kind of a bit softer depending on the variability of the revenue and then obviously, you've got the CapEx for Karowe underground in mind over the next few years, how are you thinking about the dividend in terms of its sustainability? Do you feel comfortable with it? Or is it just kind of a still watch and brief and you think about what's in the best interest to shareholders in terms of creating value?

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Eira Margaret Thomas, Lucara Diamond Corp. - Founder, President, CEO & Director [21]

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Sure, Richard. I'll tackle that. Good afternoon. Listen, as we've always said, we have been returning cash to our shareholders if we do not have a better use of proceeds. We will be completing the feasibility study in the fourth quarter. We're feeling very optimistic about the outcome of that study. We think it will make sense to consider an investment in building an underground mine and extending mine life out to at least 2036. And we will need to see the results of that study and the capital requirements and make an assessment on whether continuing to pay the dividend at the current level makes sense. But at this stage, we're very comfortable in being able to cover this dividend out of cash flows. And our Board reserves the right to review this, quarter-by-quarter basis.

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Richard James Hatch, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [22]

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Okay. I appreciate that. All right. And my last one is just in terms of kind of the softer market in the smalls, which hopefully will improve at some point in the near future. Is there any consideration for adjustments to your bottom cutoff size at Karowe? Or is it just simply the fact that you kind of -- you feel that the revenue per tonne you're generating from the mine at the moment is as optimal as you can get it and you need to try and sell what you produce?

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Eira Margaret Thomas, Lucara Diamond Corp. - Founder, President, CEO & Director [23]

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We have no plans, Richard, to change our bottom cutoff size. The diamonds that we're recovering are contributing to our bottom line revenue, so we're very comfortable.

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Operator [24]

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(Operator Instructions) And at this time, Ms. Thomas, we have no other questions registered. So I would like to turn the call back over to you for any additional comments.

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Eira Margaret Thomas, Lucara Diamond Corp. - Founder, President, CEO & Director [25]

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Okay. Well, we'd like to thank you for joining Lucara's second quarter conference call, and we look forward to speaking with you all next quarter. Thank you very much.

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Operator [26]

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Thank you. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines. Enjoy the rest of your day.