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Edited Transcript of SWY.TO earnings conference call or presentation 14-May-19 12:30pm GMT

Q1 2019 Stornoway Diamond Corp Earnings Call

VANCOUVER May 29, 2019 (Thomson StreetEvents) -- Edited Transcript of Stornoway Diamond Corp earnings conference call or presentation Tuesday, May 14, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alexandre Burelle

Stornoway Diamond Corporation - Manager of IR & Business Development

* Dino Rambidis

Stornoway Diamond Corporation - CFO

* Patrick Godin

Stornoway Diamond Corporation - President, CEO & Director

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Conference Call Participants

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* Edward Christopher Sterck

BMO Capital Markets Equity Research - Analyst

* Paul Zimnisky

* 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 day, ladies and gentlemen, and welcome to the Stornoway Diamond Corporation Q1 2019 Earnings Conference Call. (Operator Instructions)

I would now like to introduce to this conference call Mr. Alex Burelle, Manager of Investor Relations. You may begin.

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Alexandre Burelle, Stornoway Diamond Corporation - Manager of IR & Business Development [2]

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Thank you, Kevin. Good morning, everyone, and thank for joining us on the call. Yesterday evening, we released our first quarter 2019 results, which are available on our website or on SEDAR.

Here this morning to discuss our results, we have Patrick Godin, President and Chief Executive Officer; and Dino Rambidis, Chief Financial Officer. There's a presentation on our website that you are able to access at www.stornowaydiamonds.com that supplements our press release. Management will provide an overview of the first quarter 2019 results, followed by commentary on recent trends and an outlook for the business in 2019. Following our prepared remarks, we will then open the floor for questions from analysts. Please note, some numbers mentioned during this call may be rounded for ease of listening. However, the full and complete numbers will be listed in the presentation, in our financial statements and in our MD&A. Before we begin, please note that certain statements may be made on this call by management that may contain forward-looking information. I refer listeners to read the cautionary statements regarding forward-looking information in our press releases, on our website and in our presentation.

I will now turn the call over to Pat Godin, Stornoway's President and CEO. Pat?

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Patrick Godin, Stornoway Diamond Corporation - President, CEO & Director [3]

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Thank you, Alex, and thank you, everyone, for joining us this morning. I'm going to provide a quick summary of the quarter before turning it over to Dino. We will discuss the financial and operation results for Q1, and then I will wrap up with some of the indicators that we have for 2019 and our outlook before turning it over to your questions. We have a presentation that you can follow along with us. So after you have read the forward looking information on Slide 2 and 3, we can get started on Slide 4.

The first quarter of 2019 was a challenging quarter for the company in terms of weather. We saw strong performance in our underground mining rates and believe that the small [polish in] shortfall related to plan will be caught up over the balance of 2019. In the quarter, we had two lost time incidents. For lost time incident rates of 1.2 combined for Stornoway and contractors, and the reportable accident frequency rate of 12.7. The lost time incidents were not serious in nature, but these numbers are well above where we would like them to be, and I've initiated additional training and awareness program in an effort to reduce these metrics to more acceptable levels. On a positive note, again, in Q1 2019, we had 0 environmental infractions.

Operationally, the underground mine performed well, with extraction rates above designed capacity. We conduct our first blast underground for the Renard 3 pipe at the end of April, approximately 2 months ahead of schedule, and have begun mining and transporting R3 material to the process plant. Recall that R3 showed positive result in terms of grade quality and size distribution of the diamonds recovered in the open pit, and we are happy to be able to reintroduce this material to the plant ahead of schedule. We made a decision to temporarily suspend open pit mining operation in April as we have more than sufficient stockpile of materials that will allow us to process R65 material into the second quarter of 2020. The decision will have no impact on our revenues and will result in operating and capital cost savings. We end Q1 with $30 million in cash on our balance sheet and $328 million in debt.

On Slide 5, continued downward pressure on market price for rough diamonds as evident in the corporation's ability to generate positive free cash flow in 2019. To address this situation, the Corporation is taking a series of significant [and effective] actions to preserve its liquidity, including among other things cost reduction of $18 million to $20 million for fiscal year 2019, to be implemented over the course of this year, and the initiation of a strategic review to consider all options available to the Corporation. The Corporation's management is also in active discussion with its financial partners to secure its cooperation in long-term financial viability. The operation of Renard mine are performing in accordance with plan and management is continuing to make further improvement to support the long-term viability of the Renard mine.

I will now turn it over to Dino to discuss our financials and operating results. Dino?

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Dino Rambidis, Stornoway Diamond Corporation - CFO [4]

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Thank you, Patrick. Please turn to Slide 7. In the first quarter, we processed 583,000 tonnes of ore and recovered 445,000 carats. Although tonnes increased 4% year-over-year, it was below plan. With the transition to assisted block scaling, we started to seek larger particle sizes of the ore, which resulted in the requirement for additional rock breaking equipment at the front end of the plant. The cold weather also impacted the availability of the jaw pressure in Grizzly, and we saw rates below 6,000 tonnes per day in January and below 7,000 tonnes per day in February. The team has put an increased emphasis on maintenance in the plant, and we have seen the results of these efforts improve. In March, we saw an average daily rate of more than 7,200 tonnes per day, and in the most recent month, in April, we averaged over 7,700 tonnes per day, a record for Renard in terms of monthly processing rates. So we believe that we are well positioned to catch up on the tonnes that weren't processed in January and February. March and April production made up about half of the shortfall. Grade was largely in line with budget, and we have seen a significant year-over-year increase in the number of carats recovered. Production is tracking within guidance for the year.

We completed 2 sales in the first quarter, selling approximately 430,000 carats compared to 314,000 carats in 2 sales in Q1 2018. Recall that last year, we completed 9 sales where this year intention is to hold 8 tendered sales. The extra sale versus this year concluded at the end of March 2018, but revenues were not received until April. So that sale was recorded in Q2 2018 where we had 3 tender sales. Carat sales volume have increased significantly over the last half of 2018 and into 2019 on the increased carat production as we ramped up the underground mine to steady-state levels. We would expect sales volumes in Q2 to be higher than Q1 due to the strong production in Q1 and some of the Q4 production carrying over into Q2 sales due to the timing of the sales cutoff. Gross proceeds from sales increased 25% year-over-year and 55% sequentially to $47.3 million due to a higher number of carats sold and better sequential pricing. Year-over-year pricing was down, due to our lower quality mix of products and market factors. Recall that the market in the first half of 2018 was very strong. Prices have rebounded from Q4, but have not fully offset the correction that was experienced in the second half of 2018. For the quarter, we averaged USD 83 per carat, including supplemental carats, compared to USD 77 in Q4 2018 and USD 94 in Q1 2018.

If I can take you to Slide 8 now, cash operating costs were $57 per tonne and $75 per carat in the quarter, slight improvements sequentially. Included in cost of sales is approximately $9 million of NRV write-downs to bring our inventory values in line with market prices at the end of the quarter. This, along with the primary source of ore feeding being underground versus open pit, were the primary reasons for the increase in operating costs per tonne increase year-over-year. On a per carat basis, costs were lower due to the higher carat production. Operating costs were above the upper end of the guidance range due to the processing of a lower number of tonnes in the quarter, but we expect to be within the guidance range for the year as we catch up the tonnes processed over the balance of 2019.

Capital expenditures in the quarter were $17 million, a significant year-over-year decrease. Recall that in 2018, we were completing the construction of the ore sorting circuit and had a higher capital spend in terms of underground equipment in advance of the ramp-up of the underground mine. These 2 items as well as a decrease in the level of site services G&A were the drivers behind the lower year-over-year Capex. We do not expect any major equipment purchases in 2018 and as shown in the pie chart, the majority of our CapEx in the quarter was related to the development of the underground mine: the access ramp, the development of the 450 to 470 mining horizon in R2 and a development of the 290 mining horizon in R3. In total, more than 1,400 meters of lateral development were completed in Q1. The direct investment in the development of the next mining horizons and the associated G&A at the site related to the development work accounted for more than 80% of our capital spending in the quarter.

On Slide 9, we show our quarterly accounting revenue, adjusted EBITDA and adjusted net income for the previous 5 quarters. Accounting revenues in Q1 decreased compared to the quarter -- sorry. Accounting revenues in Q1 decreased compared to the year-ago period due to the lower revenues recognized related to the amortization of the contract liability associate with the stream. In Q1 2018, there was a cumulative catch up of $10.5 million. Excluding this item, revenues from contract liabilities were actually similar year-over-year. Revenues from sales increased year-over-year as an increase in the number of carats sold and a more favorable exchange rate more than offset the lower U.S. dollar-denominated average selling prices.

Adjusted EBITDA in the quarter was $13.4 million compared to $24.7 million in Q1 2018, due to the lower reported revenues and higher operating cost on the NRV write-down mentioned previously. Adjusted net income in the quarter was a loss of $49.2 million or a loss of $0.05 per share due to the lower EBITDA reported, higher depreciation due to the development work from the underground mine and higher financing costs.

I will now turn it back over to Pat who will discuss our sales and operations in more details. Pat?

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Patrick Godin, Stornoway Diamond Corporation - President, CEO & Director [5]

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Thank you, Dino. On Slide 10, we highlight the sales statistics for our tender sales to the end of the first quarter. We all know that the market [rate was] in the second half of 2018 is represented in the overall reduction in the number of attendees and bidders at our tenders, but that the numbers look to have stabilized in the first quarter relative to the fourth quarter.

I invite you to go to Slide 11. In real terms, the Renard price index book, index looks to have stabilized in the first quarter. There has been volatility in the market, especially in the smaller size fraction and lower quality goods that can be seen in the second half of 2018 and given our production mix, we are exposed to the price swings in this segment of the market. Q1 results were largely in line with the Q4 quarter for Stornoway despite the decrease in the [www.rockpriceindex] over the same period.

I invite you to go to Slide 13. After a slow start, underground mining hit its stride in Q3 2018, and has continued to perform above expectations in 2019. We averaged more than 6,500 tonnes of ore hauled to surface in Q1, and April was also above 6,000 tonnes per day design capacity. We initiated the first blast of R3 underground ore and began transporting that material to surface more than 2 months ahead of schedule. R3 will allow us to have better feeding to the plant as the ore is softer than R2 and provides for more optimal blend in terms of processing characteristics. R3 is also an important contributor to the size and quality profile of the diamonds that we produce, so we are very proud of the accomplishment of the team to be able to achieve this ahead of schedule. We made the decision to temporarily shut down the mining of R65 in April, as we have more than sufficient stockpiles of ore to take us into Q2 2020 at the expected processing rate for R65 material. So the shutdown will have no impact on revenues and we -- and was the prudent decision to make in terms of working capital management. All of the affected surface workers were trained to transition to the underground mine and filled other open position.

We like to show the Slide 14, as it outlines how we are just scratching the surface in terms of what we outlined at Renard. The rim material represents open pit materials that have been mined and underground material that has been blasted and/or mined to date. Our forecast for the remainder of 2019 is to mine the underground material from the 290 level in R2 and R3 and to continue the developing of the next mining areas of R2 so that we can further diversify our source of feed. The rate at R2 improves [at depth] due to the increased prevalence of the higher grade kimberlite 2V unit, and we will hope to gain access to begin extraction from this level by the end of this year.

I invite you to go to Slide 15. It's been a year now since we integrated the ore sorting circuit at our process plant. The investment continues to pay off, where breakage level at industry average and with significant power consumption reduction at the plant. The reduction is in the order of 3 kilowatts per tonne, which represent over 15% of pre-OSP power consumption, and translates into cost saving of about $150,000 per month. In terms of overall plant [position], we have seen improvement throughout the first quarter and are confident that the gains made in this area can be sustained. We want to see the metrics at over 82% on a consistent basis. March and April saw our overall position at 40%, and at 80%, and 84%, respectively.

I invite you to go to Slide 16. We began an exploration program on the R7 pipe in March and expect to receive result from that work and complete the analysis over the course of 2019. We began a bulk sample plant of R4 in 2018 and have completed the extraction and processing of the sample. Analysis is ongoing and we expect to utilize the work on this ore body to work on a study to analyze the potential of an open pit at R4 subject to permitting.

On Slide 17 now. The Victor mine would close in 2019 and the Argyle mine would close in 2020. There are no major new mines opening in the immediate horizon. So expect to see a supply deficit, which will bode well to improve dropdown in prices, which have been challenged over the past few years.

On Slide 18, we are maintaining our guidance as we disclosed to the market in January. While we were above our operating cost due to the lower tonne processed, we expect to be within the guidance range for the full year as we catch up the tonnes. We are cautiously optimistic that we will come in below the low end of the CapEx range, but are not making any changes to guidance at this point.

Finally, on Slide 19. Before wrapping this up and taking your questions, I would like to highlight that Stornoway's mine rescue team participate in the 57 provincial mine rescue competition from May 2nd to May 4 in La Sarre, Quebec. For the second year that Stornoway participate at the year-end and was the second year in a row that we were awarded the overall title for the team's extraordinary performance. The team, led by Yannick Savard and including Danny Berube, Mathieu Dresdell, Raphael Duchesne, Simon Gelinas, Francois Gilbert, Guillaume Lemay, Rachel Major, Adam Paquet, and Patrick Tremblay, won all of the awards this year. These individuals are mechanics, engineers, nurses, and perform other jobs at site in addition to their volunteer roles within the mine rescue team. I would like to take the opportunity again to say how proud I am and how proud the team of Stornoway is for your accomplishments. Your performance speaks to the health and safety culture that we live every day at Renard.

So to summarize the call the quarter, on Slide 20, we had a small shortfall in the plan due to some weather and mechanical issues, but that has been resolved, and we are well on our way to making that up over the rest of the year. The underground mine continues to perform well, and we are able to begin extracting ore from R3 more than 2 month ahead of schedule, which will help our sales in the second half of the year in terms of [sales] distribution impact that R3 brings as well as the benefit the process plant and the sorter ore added into the mix. And we continue to have productive discussion with our stakeholders with regard to our capital structures.

And with that, I will turn it over to the operator for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Edward Sterck of BMO.

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Edward Christopher Sterck, BMO Capital Markets Equity Research - Analyst [2]

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So I've a couple of questions for me this morning. Just on the cost savings, I know you talked about them, but can you break them down a little bit more? So how much should we expect be saved on a net basis from halting mining R65? And where are the other main savings to come from? That's my first question.

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Patrick Godin, Stornoway Diamond Corporation - President, CEO & Director [3]

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Yes, good question. So thank you. I think the savings are more or less spread on all across the expense our OpEx and in CapEx. So if you look all in, in mining, it's R65. But also it's we will extract more tonnes from underground, so it's a saving really important. We will -- we have also savings in terms of [sensors] and power generation. So we reduced there significantly our expense. We reduced our capital expenditures by more -- close to $6 million. We will also have a manpower reduction, we are turning around the $2 million -- sorry, about $7 million. We will dispose the equipment that we are not using now. So more or less all in, it's turning about $18 million to $20 million from now to the end of the year. And it's going to help also to -- it's going to contribute to reinforce our balance sheet.

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Edward Christopher Sterck, BMO Capital Markets Equity Research - Analyst [4]

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Okay. And just on the CapEx savings, $6 million. What's being postponed for that, I guess? Or how are the savings being generated?

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Patrick Godin, Stornoway Diamond Corporation - President, CEO & Director [5]

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Here we are talking about -- so we chose not to schedule. So it's infrastructures underground that we will delay it in terms of getting some better capital management. We -- the development will be limited to what we need to do for the next mining horizon. And it's mainly, we will postpone some investment in the plan that will be -- that we resolve the issue so basically we will not have to do this. And we plan to replan some equipment that we delayed to -- and we will -- we canceled also a major overhaul in equipment due to the fact that we suspend the activity in R65.

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Edward Christopher Sterck, BMO Capital Markets Equity Research - Analyst [6]

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Okay. And then my second question is -- I'm sorry, you may have answered this already, but I've been jumping on and off the call. Just on the write-down of inventories, can you give us some color on the reasoning behind that? Last year, with the write-down then it's largely attributable to the slow ramp-up of underground, where stockpiles were run down. But mining operations stabilized. Is this simply for a certain portion of the production is just uneconomic at current production costs? So what's the -- or was there a change in the grade recovery profile? What's the rationale for the write-down of the inventories?

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Dino Rambidis, Stornoway Diamond Corporation - CFO [7]

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So the write-down of the inventory is really reflective of the market price -- the market price of diamonds. So -- and it's as simple as that, I mean, as you know, inventory is built up with different costs, including a lot -- including depreciation and other costs. However, it's just reflective of the market price -- the short term market price based on what we've -- on sales that we've done.

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Edward Christopher Sterck, BMO Capital Markets Equity Research - Analyst [8]

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Okay. So is this a one -- is it, just to be clear on this. Is this related to a recent production or is this broader? Should we expect some -- if you see no improvements in market prices, should we see a write-down every quarter?

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Dino Rambidis, Stornoway Diamond Corporation - CFO [9]

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I mean at the end of the day, what we do is we look at our inventory, and we compare it to the market prices, and we can't realize what's on the balance sheet we write it down, and that's what going on.

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Operator [10]

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Our next question comes from Scott Macdonald with Scotiabank.

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Scott Macdonald, Scotiabank Global Banking and Markets, Research Division - Associate Analyst [11]

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Just going to -- I have a few about the restructuring plan and maybe I'll just start with a few that are sort of more factual. Just on the stream. Can you confirm what the secured balance is as of March 31? The balance of the obligation?

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Unidentified Company Representative, [12]

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Sorry -- so you are asking what is the balance of the...

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Scott Macdonald, Scotiabank Global Banking and Markets, Research Division - Associate Analyst [13]

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In the event that it became accelerated and you had to pay it back to the streamers, what would the balance be as of March 31 for the stream agreement?

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Unidentified Company Representative, [14]

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There is an approximately, I believe, CAD 340 million of non-offset balance of the deposits under the stream agreement.

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Dino Rambidis, Stornoway Diamond Corporation - CFO [15]

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And if you look at the balance sheet -- sorry, it is indicated under contract liabilities.

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Scott Macdonald, Scotiabank Global Banking and Markets, Research Division - Associate Analyst [16]

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Okay. I thought that might have differed from -- the balance sheet might have -- amount might have differed from the contractual amount, but okay. And do you think you could just briefly remind us what the, if you could run through the security rankings of the various debt tranches and where the stream fits in there?

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Unidentified Company Representative, [17]

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The stream is first ranking, but it's pari passu with the senior loan.

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Scott Macdonald, Scotiabank Global Banking and Markets, Research Division - Associate Analyst [18]

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Okay. And the road loan and the finance leases and the other secured debt, is that pari passu as well?

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Unidentified Company Representative, [19]

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The road loan is unsecured. The debt convertible are unsecured and cap has security over the equipment.

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Scott Macdonald, Scotiabank Global Banking and Markets, Research Division - Associate Analyst [20]

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Okay. Just limited to the equipment itself.

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Patrick Godin, Stornoway Diamond Corporation - President, CEO & Director [21]

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Yes.

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Scott Macdonald, Scotiabank Global Banking and Markets, Research Division - Associate Analyst [22]

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Okay. And on the convertible bonds, have you decided or did you have the intention to pay the upcoming coupons with issuing shares? Or is that still going to be cash for the time being?

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Unidentified Company Representative, [23]

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I think we'd refer you to the actual text of the debenture indenture, which actually does not in and of itself allow coupons to be paid in shares.

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Scott Macdonald, Scotiabank Global Banking and Markets, Research Division - Associate Analyst [24]

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Okay. Okay. And then so given the sort of cost-saving initiatives you've laid out and your current liquidity situation, in the absence of an additional financing or restructuring, what's your view on your liquidity runway? Or when would you exhaust your existing liquidity, do you forecast?

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Dino Rambidis, Stornoway Diamond Corporation - CFO [25]

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To that I would answer is, we're managing our cash flow very closely on a short and midterm basis. And in a sufficient manner to manage also and in parallel with the [during half] in terms of the restructuring.

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Scott Macdonald, Scotiabank Global Banking and Markets, Research Division - Associate Analyst [26]

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Okay. Okay. So maybe just -- maybe a more of high-level question. I mean it seems to me and you'd probably agree that the mine hasn't quite yet put out, sort of, hit its stride yet in terms of putting out its financial results as to where they could be. But at the same time, you're kind of in the middle of restructuring and you may be sort of working against the clock in that regard. Can you talk a bit about how you can manage that tradeoff, I mean in terms of deciding how much indebtedness this mine can handle, when you're not quite sure yet what the steady state looks like?

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Patrick Godin, Stornoway Diamond Corporation - President, CEO & Director [27]

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Yes. First on the operations side. I think we know we will catch up what we miss in the first 2 months of the year. I think [essentially] if you look at a big gap to fill. The underground mine is performing well above the minimum grade capacity. We are mining -- it's a block cave so we have some variability in the grade but more or less this mine as concerning the grade and the tonnes and historically, and what we expect in terms of resources there, we are succeeding in the development of the lower mining horizon. We are very pleased by what we -- by the information that we gathered from the development compared to the model. So I think in terms of stability of the operation at the mine of this tonnage, we are in excellent -- we are in a good position. And the fact that R3 is -- we anticipate R3 in the feed will give us more opportunities. And the fact that the development is on time to access the lower mining horizon, we're going to have more or less 4 source of feed for the plant. And I think we believe -- and historically were successful, also we have better results, when we're about to blend the materials. So on this matter, Scott, I believe that we are -- strongly believe that we are in a good position with the operation. We have a good workforce, well-trained for now. We have stability with the manpower that we have. And our guys have the skills that were demonstrated in the past. So I think based on that, I think I'm pretty comfortable that going forward, our main challenge is to resolve our liquidity issue and it's on what we are focusing mainly, actually.

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Operator [28]

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(Operator Instructions) Our next question comes from Paul Zimnisky with PZDA.

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Paul Zimnisky, [29]

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I guess just following up on what Scott was getting at. I guess could you try to maybe paint a clearer picture as to when you think the steady-state production and maybe a more normalized product mix will be reached? And do you expect that by the end of, by the end of 2019? I know the goods that you were selling in Q1 were kind of from the goods that you were producing during the underground transition period in Q4 2018. So I'm still trying, I guess get a better picture of the timeline, when we are going to expect maybe more a normalized product mix at sales?

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Patrick Godin, Stornoway Diamond Corporation - President, CEO & Director [30]

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Actually, we are -- up to the end of April we are processing, 6,500 tonnes more or less of R2 were coming from underground and 5,500 tonnes of R65, that was our blend. From now to the, for the next 3 months, we reduce contribution of R2 by 1,000 tonnes that will be replaced by R3. And in 3 months, we plan to have -- that will represent 14% of the feed will be R3, 7% will be R65 and the balance will be R2 from 2019. In 3 months from now, it's going to be 28% that will be extracted from R3. So the blend will be 7% for R65, 28% from R3 and the balance from R2 underground. And we will initiate production blasting to initiate the cave at the -- in December in the [417] mining horizon. So at that time, it's going to be our resource of ore that will be in the blend. And in the middle of -- and it will compared to the R90 level, 290 level when we initiate the mining, so just remind to you that initially we plan to do block hole shrinkage topping, and we're mining from the North to the South. Now we're going to start from the middle of the ore body when we have more R2 [be the dodge]. So again, grade will be better. I think and so at the end of the year, we will have a mix where R219 mining horizon will be turning around 55% to 60% of the feed, and we will mix with other. So it's going to be at our benefit, I strongly believe in that.

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Paul Zimnisky, [31]

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Okay. That's helpful. And I guess regarding just what you've seen the last month or 2. Have you seen any exceptional stones? Or any really nice diamonds that kind of provides optimism?

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Patrick Godin, Stornoway Diamond Corporation - President, CEO & Director [32]

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So I think what I can say to you, nothing more than normal. So the production feed is pretty steady.

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Operator [33]

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And I'm not showing any further questions at this time. I would like to turn the call back over to our host.

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Dino Rambidis, Stornoway Diamond Corporation - CFO [34]

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Thank you, Kevin. As there is no further questions, we will conclude the call for today.

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Operator [35]

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Ladies and gentlemen, this does conclude today's presentation. You may now disconnect. And have a wonderful day.

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Patrick Godin, Stornoway Diamond Corporation - President, CEO & Director [36]

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Thank you.

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Dino Rambidis, Stornoway Diamond Corporation - CFO [37]

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Thank you.

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Unidentified Company Representative, [38]

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Thank you.