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Edited Transcript of PDL.TO earnings conference call or presentation 2-Aug-19 1:00pm GMT

Q2 2019 North American Palladium Ltd Earnings Call

TORONTO Aug 7, 2019 (Thomson StreetEvents) -- Edited Transcript of North American Palladium Ltd earnings conference call or presentation Friday, August 2, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David C. Peck

North American Palladium Ltd. - VP of Exploration

* Erin Satterthwaite

North American Palladium Ltd. - VP of Corporate Affairs and Communications

* James E. Gallagher

North American Palladium Ltd. - President & CEO

* Timothy J. Hill

North American Palladium Ltd. - VP of Finance & CFO

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Conference Call Participants

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* David Stewart

GMP Securities L.P., Research Division - Research Analyst

* Derek Macpherson

Red Cloud Klondike Strike Inc., Research Division - VP of Research

* Steve Laciak;Echelon Wealth Partners;Analyst

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Presentation

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Operator [1]

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Welcome to the North American Palladium Second Quarter 2019 Earnings Conference Call. (Operator Instructions) As a reminder, the conference call is being recorded. I would now like to turn the conference over to Erin Satterthwaite, Vice President, Corporate Affairs and Communications for North American Palladium. Please go ahead, Erin.

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Erin Satterthwaite, North American Palladium Ltd. - VP of Corporate Affairs and Communications [2]

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Thank you, [Misden]. Good morning, everybody. I'm Erin Satterthwaite. Thank you for joining our call today. Today's webcast, we're going to discuss our second quarter financial and operational results.

With us today is Jim Gallagher, President and CEO; Tim Hill, Chief Financial Officer; and David Peck, Vice President, Exploration. As always, following today's presentation, our lines are going to be open for Q&A. And today's webcast and presentation will be made available later this afternoon on www.nap.com.

Please note that this conference call may include forward-looking information, which is based on a number of assumptions and actual results could differ materially. All mining involves a number of inherent risks, and as a result, we invite you to read and understand the disclaimer. All dollar amounts are shown in Canadian dollars unless otherwise noted.

And with that, I will hand the Q2 presentation over to Jim Gallagher, President and CEO. Jim?

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James E. Gallagher, North American Palladium Ltd. - President & CEO [3]

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Thank you, Erin, and good morning, everyone. I find myself this morning reflecting back a number of years. It's been almost 6 years since I started at North American Palladium and did some of my first conference call such as this and it was a very different vibe in those days. The -- then CEO in one memorable meeting used the term operational hiccup and one of the analysts -- a few analysts that were still covering company at that time took him to task because there were too many operational hiccups was his view. And we had huge challenges back in that time and even though I always believed in the asset, I do confess there were probably times where I wasn't certain that we could overcome all of the operational challenges that were in front of us.

But today is a very different call. Incredibly positive quarter and not only strong financials based on good operational performance and strong palladium prices, but I think what we want to talk about and illustrate is the demonstrated upside. This isn't about making promises; I think you'll see in some of the numbers that we're demonstrating the potential upside of the operation. So with the help from Tim and Dave, we're going to step through some of those.

So let me start with just some of the highlights -- very positive highlights from this quarter. As always, I want to start with the safety and the safety record, the culture that exist at the LDI site and I give credit to Bryan Wilson, our General Manager, and the team that he's assembled is infectious. When you walk on that site, whether you're a new employee or a contractor coming on, you understand from day 1 that safety is a serious objective at this site, and the results are showing.

Once again, we're almost approaching 1 year without a lost time injury. The last quarter and the previous quarter was injury free from a lost time perspective; our total reportable injury frequency is down at 1.4 -- 1.6 in the quarter, but 1.4 year-to-date in July -- at the end of July. And that's against the backdrop of the Ontario industry average at 2.8 and even the Ontario average has improved dramatically from where it was last year. So good numbers across the industry. Very good numbers at the site. And I want to remind everybody, we have almost 800 employees and contractors on-site and our numbers always include contractors; we take full ownership of that.

So on top of the excellent safety results, we also had record underground production for the quarter. Costs down of $41 a tonne, just over 7,000 tonnes per day for the quarter and even slightly higher in July and I will point that out in a minute. So the total quarter was 56,000 ounces, almost 500 ounces of payable palladium. We're going to talk about the mine expansion project, which is on target and on some metrics ahead of schedule. And we did spend some time talking about the mill last quarter and the challenges we were having. I didn't want to call them hiccups and we basically have recovered and again are showing some upside potential there. So I'll spend a minute talking about that.

Tim Hill is going to go through all of these numbers. I won't spend a whole lot of time other than to point out, we did have a record revenue quarter at $135.6 million and that's $263 million -- almost $264 million for the first half of the year. And the other number of which we're particularly proud of is the free cash flow, so almost $91 million for the first half in free cash flow and this is after spending significant money on our mine expansion, on the underground development program, on building infrastructure; we have a fairly high spend this year and will next year on tailings management facilities, building up for the future, and as Dave Peck will go through, we're spending a lot of money on exploration. And with all of those expenditures, we still have generated $91 million in free cash. So really exceptional and then that has led to the Board's decision to award not only the regular dividend at $0.10 but a special dividend of $0.35 on top of that for a total dividend of $0.45. So fantastic results and our commitment to return money to shareholders is continues.

And Dave is obviously going to talk about what I think is even more exciting than operational results is the exploration upside, extremely busy on the exploration front, a significant number of drills turning and just about every ore underground we turn, we're intersecting good mineralization and active on the surface and something like [projects] as well. So Dave will step through all of that as well.

So let me briefly move to Slide 5 and talk about the mine expansion. As most of you know, we are in essence and started really last year building a new 6,000 tonne a day mine on top of the existing 6,000 tonne a day mine, and then we are making very good progress. So we're on our way to 12,000 tonnes a day by later in 2021. And we did have and we talked about that in the first quarter, the mine contractor we brought on stumbled a bit getting out of the gate, slow ramp-up. We have essentially bought back all of those meters and in fact are slightly ahead on the lateral development. And total number of meters in the first quarter average almost 36 meters a day. So 36 meters a day, that's over 1 kilometer every month. That's about 2,200 tonnes per day just waste alone. And so it's really when you combine it with the production numbers that we talked about, there's a number of days that we have moved over 10,000 tonnes of rock underground. So really quite an effort, and again we've won back the shortfall from the first quarter and we are now slightly ahead on that front. So really quite an effort.

It isn't just the development, some of the pictures on the right hand of the screen. We have built and now commissioned and are using a new change house, a new mine dry to accommodate the increased workforce. We have expanded our camp to create our complex but we keep it clean and neat and tidy and we've expanded that to accommodate up to several hundred people. Freshwater water -- water treatment plant upgrades have been done and we're working of course on ventilation upgrades and things that support the expanded mine plan. So lots of activity on site.

The other key part of that, of course, if you're ramping up to 12,000 tonnes a day is the production numbers and you can see from the graph on Slide 6 that we're showing basically a month-on-month regular increase. We are ahead of our own internal budget here, and in July, we had almost 73,000 tonnes a day, almost 1,000 tonnes a day better than our internal budget. So the underground mine is performing extremely well and we expect those results to carry on. So really when you look at the development and the production profile, we are actually ahead of the curve on what we expect it to be in terms of this expansion projects. So again, really good results coming from the mine site.

The other thing we're quite pleased with is the turnaround in the mill performance. So we did talk at length in the first quarter presentation about the some of the challenges we were having at the mill. The graph on the right-hand side shows January, February, March at 12,000 tonne a day target and we were well, well below that. But you can see now the consistent increase and in fact, we've plugged in July because we hit 12,784 tonne per day. So when I talk about upside potential that is above our target, that is above our feasibility number and it shows the upside potential when we focus and the team gets a focus on the results.

So what did we really do, what changed? No question there has been an intense focus from myself all the way down to the shop floor. Everybody now has gotten on board with what the mill can do and should be doing. We had a number of -- we brought in partners in performance who we have worked with before; a management consulting firm, they did their diagnosis -- diagnostic upfront where they helped the team come to the realization of what some of the challenges are, the issues are, geared towards using KPIs better and setting expectations better. That's in conjunction with a number of senior consultants that we already had on board, some looking at the front end in the crushing grinding circuit; we're looking at the flotation, we're looking at the whole plant and we're looking at future upside capability of the plant all at the same time. So again this is isn't all just about fixing the problems we were having, we were already on a path to find a way to improve the overall results even above the 12,000 tonne a day, and I think you can see that there is some significant improvement in that direction.

So what did we really do? Maintenance was a big factor here. We've gotten back to the basics on doing proper planned maintenance, really -- planning our shutdowns really well, we've got a shutdown coming up in August where we're going to do a major liner change-out of the SAG mill and that's been planned down to a T. We've got 4 general foremen now at the mill, 2 of them focused on maintenance -- the maintenance superintendent is moved over to the mill for the time being. So we're really getting back to the fundamentals including the right focus on there. Some of the winter freezing issues obviously have gone, but we're implementing through the course of this summer and this fall measures that we will make sure that those freezing issues don't come back. We're better insulating the building.

We're moving to a magnesium chloride to deal with the frozen underground muck issues that we had because of the much finer material. So there is a significant number of initiatives underway, not with a lot of capital cost, some higher operating costs, and Tim might reflect on those numbers, but I want to make the points that all of these changes in this improvement to 12,784 tonnes happen without spending a lot of significant capital at the mill. And again, you can see the KPIs, at the bottom, hourly throughput and that's instantaneous run rate in the mill has come up dramatically and the availability is almost at our 92% target, which is kind of industry class for availability in a mill. So it really has been a pretty good story of how quickly the team has been able to turn that around.

So with that, all of that has led to a really good quarter. And I'm going to let Tim step through the financial numbers on the quarter.

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Timothy J. Hill, North American Palladium Ltd. - VP of Finance & CFO [4]

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Thank you, Jim. Good morning, everyone. As mentioned in last quarter, one of our priorities as a management team has been to strengthen the company's balance sheet. As illustrated on this slide, the company's balance sheet has dramatically improved over the last year. During the last 12 months, cash generated from operations was greater than $196 million of which $80 million was used for financing expenses and to reduce debt, $66 million was invested in the capital and equipment, $44 million was held as cash and $7.7 million was returned to shareholders by means of dividends. Today, the company enjoys a robust balance sheet that is significantly healthier than that of 1 year (inaudible).

This slide illustrates the strong financial results [related to] last quarter. The company -- as Jim mentioned, the company generated its highest ever quarterly revenue again for the second consecutive time; the significantly increased revenue resulted from good palladium production and ongoing near-record palladium prices with year-to-date revenue on June 30th of $264 million. Cash flow from operations this quarter was $59 million, bringing the total to $134 million for the first half of 2019. Adjusted EBITDA for the quarter almost doubled over that in Q2 2018 with a year-to-date adjusted EBITDA of $134 million, greater than twice that over the same period last year. Net income for the quarter also dramatically increased compared to last year. The company realized net income of $134 million for first half of 2019.

The company's underground cost continues to be one of the sectors lowest at $41 per tonne milled -- mined. The slight increase in unit cost this quarter is due to additional operating development related to the underground expansion project. These higher underground costs combined with additional costs associated with mill optimization initiatives contributed to the year-over-year increase production cost per tonne milled. The other major factor in this increase in unit rate is lower tonnes milled, which were 11% fewer than that in Q2 2018. These increased operating costs have also contributed to higher all-in sustaining cost per ounce of produced palladium, and accounted for more than half of USD 176 [produced]. Other contributing factors to the year-over-year increase in all-in sustaining costs included lower byproduct revenue, additional royalties, which resulted from higher net smelter returns, fewer ounces of palladium produced during the quarter and a slight increase in sustaining capital over that in Q2 2018. Overall, in comparing revenue per ounce of palladium sold with the all-in sustaining cost per ounce of palladium produced, it is apparent that the company realized to start strong margins [in] last quarter.

Capital investments in the underground mine expansion. The tailings management facility, mobile equipment and infrastructure remain in line with the annual plan, and provide the groundwork necessary for the 12,000 tonne per day underground mine. As mentioned earlier by Jim, the expansion project and the related production rate are ahead of schedule. The company has also significantly increased investment in exploration as part of its comprehensive approach to expanding its existing reserves. Year-to-date, the company incurred $6.9 million of eligible exploration expenses towards a $10 million flow-through share offering completed last December.

On this slide, we provide an illustration of the company's share price performance as well as its relatively low valuation. As illustrated on the first graph, the company's 12-month trailing earnings per share have increased almost threefold this year to a healthy $2.25 per share. The low price earnings ratio of 6.4 and the enterprise value to EBITDA ratio of 3.6 signify that the company has relatively low share price valuation when compared to our peers. Additionally, the stock earnings yield of more than 15% demonstrates a strong return from the company's underlying business.

As mentioned earlier by Jim, the Board of Directors has approved a regular quarterly dividend of $0.10 per share, plus a special dividend of $0.35 per share to all shareholders of record on September 1, 2019. NAP's corporate philosophy includes the responsible allocation of capital and its Board of Directors remains committed to providing a return to shareholders. As of August 1, 2019, North American Palladium has declared cumulative dividends over a 7-month period of $0.58 per share, representing a significant dividend yield so far this year.

I'll now hand over the call to Dave Peck to provide a review of exploration activities that occurred during the quarter. Dave?

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David C. Peck, North American Palladium Ltd. - VP of Exploration [5]

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Thank you very much, Tim, and good morning, everyone. As Jim alluded to, we're really in an enviable position as a company with the wealth of exploration targets we have, both on our regional portfolio, but more importantly Lac des Iles. In order to tackle all these targets, the company announced recently that it is expanding its diamond drill budget at LDI by $6 million and that's going to allow us to get ahead of the mine planning, which is something we haven't been able to do until recently. We did provide comprehensive updates on our LDI underground exploration, surface exploration and our regional exploration programs especially focused on Sunday Lake earlier in the year.

The new exploration drift at Lac des Iles is on the 1065-mine level near the bottom of the underground mine, is now [on use] and will be completed later this year. The drift is being used to access the Camp Lake target, the C Zone, which was recently discovered and the B Zone satellite bodies to the Offset ore body. We continue to systematically explore for near-mine resources gains that will extend our mine life and increase feed grades. We have had a lot of successive of late both underground and at surface, and we expect to deliver additional positive news before the end of the year. Our regional programs are progressing steadily with new geophysical surveys being planned to look for additional LDI type and Sunday Lake type targets in our area of exploration interest within 100 kilometers from the mine.

Let's take a closer look at our underground exploration program. This slide is a level planned map at the 1065-level showing the new exploration drift and our many recently developed underground targets. A wealth of rich is in terms of high-potential resource gain areas in all and close proximity to existing or planned underground mine development. Adding new resources that can quickly be converted to reserves is a top priority for our team. We continue to work very closely with operations and technical services to ensure drilling stays ahead of critical decisions for future development. We retain a laser-like focus on the highest potential targets in terms of identifying those that have the largest tonnage potential but have higher grade near existing infrastructure.

The next slide shows a longitudinal section and our newly discovered C Zone. Right now at C Zone, we're at the point of just starting to test for continuity. We're focused on the lower part of the zone, below at the bottom of the current ramp and trying to see its continuity in terms of the higher grade part of this large zone. Potential tonnage here is quite big, but we're still establishing the continuity of the grade, and we'll be reporting on C Zone later in the year. You can see that it's quite a large target. It has over 1 kilometer of vertical extent, and may in fact outcrop at surface. We're also seeing a strike length of up to 300 meters, potentially more, it still open along strike. So the potential volume of this target is quite huge. We're now trying to assess, as I said, the continuity of the higher grade parts on the southwest or main branch of this intriguing new zone.

Previously reported results are shown here in this slide and discussed in more detail on our May 29th news release. It really is exciting to be able to report on the new discovery, really in the shadow of the head-frame and adjacent to active mining areas. We're really optimistic that this can deliver a large new [resource] in due course. Stay tuned for new results later in the year.

On the next slide, we show a surface bare photo of the East mine block target area. This is the focus for our surface drilling. We've had good success in the program so far this year, which is primarily focused up to date on the Creek Zone. The Creek Zone is located approximately 2 kilometers east of the Roby pit and is exposed at surface. Our East mine block drilling is being guided both by drill-hole results and recent geophysical surveys. I'll provide more detail on Creek Zone results on the next slide. We are also planning to start drilling again on the Baker Zone, which we had some really good results on last year, and had them [followed] up and we are waiting for new geophysical data to firm up the drill targets. That drilling should start within the next few weeks. Again, stay tuned for new results from this geophysical target testing later in the year.

The next slide shows our first cross-section of the Creek Zone. We've now proven that it extends at least 600 meters vertically from surface and has a minimum strike length of over 200 meters. We're still deciding if we want to go into a resource delineation stage of drilling on the Creek Zone. Until we do that, we're actually just still remodeling the data that we've received from the first half of the year and we'll make that decision later in the year. We hope to have more than 1 target to consider for resource delineation to add potentially significant new near-surface resources, which will really improve the long-term outlook for LDI.

And finally, on the last slide here on the exploration piece, we had a really good program at Sunday Lake. We finished the drilling in April and we've had a press release on those results, some of which I've highlighted here. We expect to continue with the project and they are currently making plans to complete testing on several remaining geophysical targets. We've also proven ability of [minerals] deposit model at Sunday Lake. And while we continue to drill our PGM Zone in order to establish its continuity, we'll also be searching more rigorously for massive sulfides, which we now believe will exist or could exist around the margins of the intrusion.

So that concludes the exploration update. I'll return the call to Jim Gallagher. Jim?

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James E. Gallagher, North American Palladium Ltd. - President & CEO [6]

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The palladium fundamentals obviously has taken a bit of a change given the dynamics yesterday, but really, I think the fundamental is same. In fact, The Financial Times yesterday had a very early morning article calling for new record highs for palladium. And then not much more than an hour later, they came out and said it's [crept] financial trigger at $1,490 and now there is a big sell-off and then it wasn't too long after that the Donald Trump tweeted about Chinese tariffs. And the market got really excited and commodities [across] the Board. We're seeing significantly in the red and has palladium has taken quite a deep dive, but it's done this before. Matter of fact, back in April, it dropped $200 in 1 day or over 1.5 days essentially. But over the period following that claimed its way back into the mid-$1,500s. And really if you look over the last quarter, palladium has actually been pretty consistently bounded by the $1,500 on the bottom and $1,600 on the top end. It tested the highs once or twice and came back to the mid-$1,500s and the tested the low at dipping into $1,400s just a few times in the quarter and always came back.

So again, the fundamentals, despite the current excitement in the market, remained strong. Demand is high despite weak global auto sales and that is due to the heightened emission standards in most jurisdictions of the world, particularly Europe and China. So much higher demand, as high as 30% higher loadings, which offsets a slight decrease in total auto sales. The electrification push continues to be net positive for palladium because the bulk of the electrification is in hybrids, and as we've mentioned before, hybrids tend to have slightly higher loadings of palladium than regular gasoline engines. I've seen a lot of press lately about a lot of it wrong about substitution with platinum. There is a number of articles that say it's a 1-on-1 replacement. It is not, that is technically not true, and there is a number of technical reasons, which we have talked to before, why the switch from a very efficient catalytic converter directly into platinum is not easy. Some substitution is likely to happen, but it's probably only going to be in the few percent range. And as we have reiterated before, platinum is in fact a much smaller market and it will not take much of a move to eliminate the surplus in platinum and drive its price up. So from a financial point of view, it really doesn't make sense. And there is lots of technical reasons why it's not an easy thing to do.

The other recent news over the last couple of months, which bodes well for the PGM basket, in general, is the push that a number of countries are making towards fuel cell vehicles. And in particular, Japan and China have made major announcements about building the infrastructure to support a fuel cell automobile market and very recently South Korea has done the same thing. And where this will go? I can't personally predict, but certainly fuel cells tend to be very platinum-rich and it's only going to help the PGM basket. So despite activity yesterday, the fundamentals are still in place. The outlook is very positive. And a potential outcome of the increased tariffs on China is further stimulation of the Chinese economy and the auto industry and support of the auto industry is something China has done many times before, not doing heavily now, so quite frankly, this could turn into a positive rather than -- as opposed to a negative. So we believe the fundamentals are going to stay strong.

So really based on that, looking forward, we're reiterating our guidance. We're quite comfortable the second half of the year with the increasing underground production will be better than the first from an ounces produced point of view. So we're comfortable that we're going to be well within our range on palladium. Our AISC is currently above our target, but again better production in the second half, more ounces we're starting to catch up on ounces. So we're quite comfortable that we're going to come down towards the upper end of our range on all-in sustaining costs.

So Tim mentioned our share valuation, certainly, whatever metric you use to measure our share price against the peer group, we certainly seem to be undervalued. We're listing again the coverage we currently have, ranging between 17 and 23.50 and I believe we've seen this morning that BMO is already bumped from [1,700] and added some value there. So we really do believe that there is significant upside on the share price and despite the current market dynamics, good place to invest, solid future with lots of upside.

So with that, I actually hope that there is some questions this morning, and we're going to turn it over to Erin to facilitate the questions and see who is online.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from David Stewart with GMP Securities.

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David Stewart, GMP Securities L.P., Research Division - Research Analyst [2]

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Congrats on the positive quarter.

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James E. Gallagher, North American Palladium Ltd. - President & CEO [3]

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Thanks, David.

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Timothy J. Hill, North American Palladium Ltd. - VP of Finance & CFO [4]

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Thanks, David.

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David Stewart, GMP Securities L.P., Research Division - Research Analyst [5]

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I'm just noticing the tax pools, which you've been enjoying for a while, there must be eroding pretty quickly at the current level of profit. At spot pricing, approximately when do you guys see the full tax is starting to be paid?

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Timothy J. Hill, North American Palladium Ltd. - VP of Finance & CFO [6]

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At spot pricing, so -- if you consider our feasibility study, we are beginning to pay full taxes in 2023 or thereabouts. We had a price assumption of USD 1,040 in the feasibility study. As you mentioned, David, we are depleting those pools quickly given the current price. An exact date I can't give you, but I can say it would be within the next couple of years for sure.

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David Stewart, GMP Securities L.P., Research Division - Research Analyst [7]

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And then on the exploration side, based on the results we've seen so far the C Zone is looking really interesting at this point for its resource expansion potential. Do you think that at the end of this year, you'll have drilled enough to come up with an initial resource estimate for the C Zone or maybe some of those B Zone targets as well?

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David C. Peck, North American Palladium Ltd. - VP of Exploration [8]

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Yes. It's on track for that, David. We are looking at trying to put out something first quarter of next year. And again, there is so much vertical extent and we don't have complete access to every part of the C Zone that we want to. We're really focused on determining, like I said, the continuity of the higher grade and then determining its limits. So we'll start to be able to put some sort of inferred resources together by early next year, but probably won't see a real big number until later on next year.

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David Stewart, GMP Securities L.P., Research Division - Research Analyst [9]

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And then just -- I'm just looking at Slide 18 here, based on the orientation of the C Zone and the geometry, it looks like it's kind of in the footwall and its intersecting a lot of the mining infrastructure. So again, I know it's early days, but would you have to mine that after you've mined out the SLS zone or can you be more agile there?

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David C. Peck, North American Palladium Ltd. - VP of Exploration [10]

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Again -- go ahead, Jim. I will let you answer that.

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James E. Gallagher, North American Palladium Ltd. - President & CEO [11]

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I think that was a mining question, Dave, so I'm going to try. So it's a fair and valid question because we have intersected the C Zone several times with the existing ramp. So one of the current challenges that the chief engineer has is where to move the ramp to for the future. We do want to get -- that's the C Zone envelope and finding sterilized ground is actually proven to be a bit difficult. So that's an exercise that we're going through at this point. Part of the reason to get ramp out and the focus on the depth is perhaps changing that. So mining some of the upper part presents some challenges, but if we can move the ramp and gets separated some of the lower material below the 1,000-meter level, we may be able to incorporate that into one consistent plan, but as Dave said, it's really early days. We haven't really figured out the total shape of this thing yet. And it is open both up and down. So we got a lot of ore in front of us right now. We have no trouble filling that, no. So it's a good problem to have towards the future. But exact mining plan is still hard to work on.

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David Stewart, GMP Securities L.P., Research Division - Research Analyst [12]

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Okay. That's helpful. And that's all the questions I had. Congrats again, guys.

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James E. Gallagher, North American Palladium Ltd. - President & CEO [13]

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Thank you.

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Timothy J. Hill, North American Palladium Ltd. - VP of Finance & CFO [14]

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Thanks, David.

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Operator [15]

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Next question comes from Derek MacPherson with Red Cloud.

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Derek Macpherson, Red Cloud Klondike Strike Inc., Research Division - VP of Research [16]

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I'll reiterate David's point. Congrats on a very good quarter. Couple of questions, first, on the cost guidance. You guys are saying you're coming at the upper end of the range. Is that more a function of sort of challenges of the first half or is it -- are we seeing a slightly higher cost profile going forward?

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Timothy J. Hill, North American Palladium Ltd. - VP of Finance & CFO [17]

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Derek, Tim here. It's the challenges from the first half. As I mentioned, the operating costs were up due to the ongoing mill optimization initiatives. That was a major driver of that. Our byproduct revenue analysis also accounted for a good portion of that, which we expect in the second half of the year to be much higher than in the first half. So as Jim mentioned earlier, we expect to see that all-in sustaining cost coming down to our higher end of guidance.

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Derek Macpherson, Red Cloud Klondike Strike Inc., Research Division - VP of Research [18]

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That's what I thought as well, but I just wanted to confirm it. And then just on costs, you guys mentioned that the underground project is ahead of schedule and the development is really picked up, which is good, but how are you guys doing on budget there?

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James E. Gallagher, North American Palladium Ltd. - President & CEO [19]

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Well, you can see our operating cost at $41 a tonne underground and it's slightly higher; we were $39 I think, Tim, last quarter? And so it's up a little bit and because we picked up, for the half, we're really basically much on budget for an operating costs. I think one of the things to watch for as we move forward, of course, as we continue to ramp up to 12,000, we kind of pushed this bow wave of operating costs, drilling costs in front of us. This quarter, we're developing and drilling for the next couple of quarters, and of course, we are anticipating higher costs. So we're developing -- we're producing over 7,000 tonnes a day and we're developing and drilling for 7,500 tonnes and up to 8,000 tonnes a day by early next year. So I think you'll see this a little bit of bow wave, but overall, our costs and especially our unit costs are pretty much in line across the board.

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Timothy J. Hill, North American Palladium Ltd. - VP of Finance & CFO [20]

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Yes. If I may just expand on that; the unit cost per meter from our own development crews and from our contracting development crews are right on budget.

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Derek Macpherson, Red Cloud Klondike Strike Inc., Research Division - VP of Research [21]

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That's good to hear as well. Sometimes you can buy timing, if you will, right. And I guess the last question I have obviously the special dividend is very good and the markets reacted to it as it opens here, but just want to get some parameters or understand a little bit more about how you guys are -- that you and the Board are thinking about that the potential for future special dividends. Are you guys obviously, above [1,200] you've stated that the $0.10 quarter dividend is solid. What do you guys are using as a percentage of free cash flow generated or is it why a base level of cash that is sort of setting the floor as far as how much you guys are willing to potentially put at a future special dividends?

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Timothy J. Hill, North American Palladium Ltd. - VP of Finance & CFO [22]

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Great question. It is a percentage of cash flow generated in the prior quarter and that's where we're looking at.

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Erin Satterthwaite, North American Palladium Ltd. - VP of Corporate Affairs and Communications [23]

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[Misden] look at the next call.

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Unidentified Participant, [24]

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Hello?

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James E. Gallagher, North American Palladium Ltd. - President & CEO [25]

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Hello.

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Unidentified Participant, [26]

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(inaudible)

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James E. Gallagher, North American Palladium Ltd. - President & CEO [27]

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(inaudible) Is that Steve?

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Unidentified Participant, [28]

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No, it's (inaudible). Another congratulations on a great quarter and I applaud you and the Board for the special dividend. And it's -- not much we -- we don't see much of this in Canadian precious metal mining. Just on -- so Tim, just based on what you said, if prices stay high and generate a lot of free cash flow, special dividends [not a question] every quarter?

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James E. Gallagher, North American Palladium Ltd. - President & CEO [29]

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I'll jump in on that. I think we took some time to put lots of wording in the press release to try and describe the Board's direction here, and rather than increase at this time the regular dividend obviously given the potential volatility, which we saw yesterday, the Board has taken the decision to set a dividend that we're quite comfortable with that $0.10 and maintain that. And then each quarter-on-quarter, looking at where we're, looking at the cash flow, looking at upcoming capital spend and making a decision. So is it possible that we'll see a special every quarter? Yes, it is possible, but not guarantee.

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Unidentified Participant, [30]

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But it's a quarterly decision, basically, whatever you do it with that.

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James E. Gallagher, North American Palladium Ltd. - President & CEO [31]

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Correct.

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Unidentified Participant, [32]

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A question for Dave. Dave, with C Zone, if you look at the schematic you have in the presentation -- by the way, guys, one thing I would do is, I get the presentation on the webcast, I found it, but if you can get it there, right on the front webpage right away, you could have -- some people can get to earlier. That C Zone is right next to the Offset Zone, and it's been there a long time. It just kind of -- the question you must get a lot is, why now are you more realizing the potential in it versus yesteryear?

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David C. Peck, North American Palladium Ltd. - VP of Exploration [33]

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That's a very good question. So we usually with our underground exploration always have challenges getting the drill and an efficient place to drill shorter holes at better angles. Most of the drilling we did on the main Offset ore body was from the East side or [Hanging Wall] side into the footwall, and there is a low-grade area past the main Offset Zone in the footwall, which is really our stock point. So once we hit that lower grade area that was the end of the hole. We had a few historical holes that hit C Zone at different levels, but it was just more of a curiosity to make sense of the time until we started to get our head around the structures that might be controlling C Zone but also all these satellite ore bodies. That's been a big step change in the last couple of years. And now we know that C Zone is likely following a major [fall] and it is peeling away from infrastructure going to the West-Southwest, that is basically parallel to all of those historical holes for defining the reserves and resources in offset. So glancing blows here and there, but never really fully appreciating the structure and that's a new trend. It's a different strike and that's the explanation, I guess.

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Unidentified Participant, [34]

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Does it have the potential to carry similar grades as the Offset?

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David C. Peck, North American Palladium Ltd. - VP of Exploration [35]

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What we've seen so far, especially close in, I mean where we have more information, we've got chip samples that are noncompliant. So we don't talk about them but chip samples, we've got definition holes and increasing number of exploration holes. There is a high-grade component to C zone. There is a big (inaudible) envelope of – above our 1 gram sort of shell we used to define the mineralization in Offset and the B series satellites. There is a high-grade core and that's what our real focus is on. There is a minimum grade required to mine anything from underground and we don't know what the mine that it's going to be. We don't know the ultimate size and tonnage and grade, but that is there. It is present; plus 4-gram material is quite common in C Zone. So that's really the focus. The question is, as you're asking what's that continuity and that higher grade, we don't know yet. This is our first systematic program of drilling relatively closely spaced holes.

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Operator [36]

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Next question comes from Steve Laciak from Echelon Partners.

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Steve Laciak;Echelon Wealth Partners;Analyst, [37]

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The mining and production was well covered. Tim, could I ask you, how does this catch up on prior quarter pricing work? I mean the pricing was extremely strong, February, March and then a weak in April, May, June, but you still had a positive adjustment on accounts receivable would surprise me. I thought it might have been negative on the catch-up

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Timothy J. Hill, North American Palladium Ltd. - VP of Finance & CFO [38]

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So Steve, we have the -- what we quotational period between the time of delivery of our concentrate until the final pricing of the metals in that concentrate. So for example, at the end of Q1, our accounts receivable were all priced at forward prices at that time that we obtained from concessions from the banks.

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Steve Laciak;Echelon Wealth Partners;Analyst, [39]

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And then it had plunged, I guess, so that's why...

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Timothy J. Hill, North American Palladium Ltd. - VP of Finance & CFO [40]

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That's correct. So they had a bit at the end there. So during the...

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Steve Laciak;Echelon Wealth Partners;Analyst, [41]

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You were not pricing each shipment and then adjusting that you're doing it at quarter end, is that?

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Timothy J. Hill, North American Palladium Ltd. - VP of Finance & CFO [42]

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We do it at each month end we mark-to-market.

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Steve Laciak;Echelon Wealth Partners;Analyst, [43]

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At each month end?

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Timothy J. Hill, North American Palladium Ltd. - VP of Finance & CFO [44]

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Yes. Yes. So in the quarter, we do a reconciliation what we've been paid, but we have an accounts receivable and then we price that based on forward prices at that time.

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Steve Laciak;Echelon Wealth Partners;Analyst, [45]

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So at the end of March relative to actual March that plunge and that's what set up the accounts receivable being positive as opposed to negative, right?

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Timothy J. Hill, North American Palladium Ltd. - VP of Finance & CFO [46]

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Yes. So the prices we were using at the end of March were lower than the prices we realized throughout the quarter.

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Steve Laciak;Echelon Wealth Partners;Analyst, [47]

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But it's a 3-month blend, it's not right at the end of March?

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Timothy J. Hill, North American Palladium Ltd. - VP of Finance & CFO [48]

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That's correct. What the pricing is (inaudible) at the same time, it's mark-to-market at the same time, Steve, at one – at any given period.

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Steve Laciak;Echelon Wealth Partners;Analyst, [49]

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I think I'll give you a separate call to understand that. Okay, that's all I have.

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Timothy J. Hill, North American Palladium Ltd. - VP of Finance & CFO [50]

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It did cause some confusion last quarter as well when we published a realized price per ounce sold. We did change the calculation a little bit in our MD&A to try to clarify that, but yes, it is a bit of a complicated calculation.

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Steve Laciak;Echelon Wealth Partners;Analyst, [51]

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And Dave, I hope you have more exploration success. Thank you very much.

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Operator [52]

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This concludes both the question-and-answer session and today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.