Fortuna Silver Mines Inc

TSX:FVI

Earnings Call Transcript 2018-Q2

[Operator]

Greetings, and welcome to Fortuna Silver Mines Second Quarter 2018 Financial and Operational Results Conference Call. [Operator Instructions] And as a reminder, this conference is being recorded.I would now like to turn the conference over to Carlos Baca, Investor Relations Manager. Thank you. Please go ahead.

[Carlos Baca, Investor Relations Manager]

Thank you, Brenda. Good morning, ladies and gentlemen. I would like to welcome you all to Fortuna Silver Mines and to our Second Quarter 2018 Financial and Operational Results Call. Today, we'll be using a webcast presentation, which will be controlled by us. You can download the presentation at our website. Please click on the Investors tab, then click on the Financials tab and under Q2 2018, click on Earnings Call Webcast. Jorge Alberto Ganoza, President, CEO and Director; and Luis Dario Ganoza, CFO, will be hosting the call from the city of Salta in Argentina.Before I turn over the call to Jorge, I would like to indicate that this earnings call contains forward-looking information that is based on the company's current expectations, estimates and beliefs. This forward-looking information is subject to a number of risks, uncertainties and other factors. Actual results could differ materially from a conclusion, forecast or projection in the forward-looking information. Certain material factors or assumptions were applied in drawing a conclusion or making a forecast or projection as reflected in the forward-looking information. Additional information about the material factors that could cause actual results to differ materially from the conclusion, forecast or projection in the forward-looking information and the material factors or assumptions that were applied in drawing a conclusion or making a forecast or projection as reflected in the forward-looking information, is contained in the company's Annual Information Form and MD&A, which are publicly available on SEDAR. The company assumes no obligation to update such forward-looking information in the future, except as required by law. I would now like to turn the call over to Jorge Ganoza, President, CEO and Co-Founder of Fortuna.

[Jorge A. Ganoza Durant, President, CEO & Director]

Thank you, Carlos, and good morning to all. Along with Luis, our CFO, we will be presenting results of our business for the second quarter, encompassing our operating lines, development projects and exploration activities in Mexico, Peru, Argentina and Serbia.Moving on to the highlights slide. Highlights for the quarter include, in the first bullet, the strong performance of our mines, which is reflected in the robust 48% consolidated EBITDA margins and $28 million in free cash flow generation before Lindero CapEx. As of the end of the quarter, our liquidity stands at $278 million, with a debt-to-EBITDA ratio below 0.5. In the third bullet, at Lindero, we recently reported an update of our forecast for initial capital. With 71% of all direct capital costs assigned, we forecast an increment in the range of 10% to 17% in the initial capital from our $239 million budget. We view this variation within the limits of feasibility study levels, and we still carry a contingency fund of $24 million in the forecast figure. And last in the highlights, we have a very positive drill results from the exploration program we are funding as part of our 70% earning option agreement with Medgold Resources at the Barje gold, silver target in southeastern Serbia.Moving on to Slide 6. Our consolidated silver production grew by 10% in the quarter to a historic record of 2.3 million ounces. Gold production stayed flat at 14,600 ounces. The growth in silver production is a result of higher silver grades at our San Jose mine in Mexico. Zinc production grew 8% to 11.4 million pounds and lead production stayed essentially flat at 7.2 million pounds. Although we are not modifying our guidance, looking at mid-year production and reserves in the plan for the second half of the year, it is reasonable to expect we can meet or exceed guidance by a margin in the range of 10% for both silver and gold.Moving on to Slide 7 in the webcast presentation. Here, we show silver contributed 49% to provisional sales, gold 25%, for a combined precious metals contribution of 74%.In Slide 8. Here, we present 3 key financial metrics. Our sales grew by 15% to $73.7 million. We broke our historic record for EBITDA in the second quarter and the first half of the year. EBITDA in the quarter grew 33% to $35.2 million. Adjusted net income grew 9% to $10 million or $0.06 per share. Luis will be providing detail in the analysis of these figures further in the presentation.Moving on to Slide 9. We are moving to report all-in cost as a silver equivalent. The increased silver production and good cost performance translate in a drop of 17% in consolidated all-in sustaining cost to $10 per silver equivalent ounce. San Jose reports a drop of 16% to $9 and Caylloma, a drop of 19% to $10. At San Jose, the driver for lower all-in cost is higher silver production; and for Caylloma, 10% lower production cash cost, 20% and 10% higher zinc and lead prices, respectively, and lower execution of capital projects which should start to pickup in the second half of the year.In Slide 10. Our capital expenditures were $19 million in the quarter; $5.1 million in sustaining capital at our mines; $2.3 million in exploration; $1.3 million allocated to new exploration initiatives; and $10.3 million in Lindero.Moving on to Slide 11. At Lindero, we remain on schedule for commercial operations in the third quarter of 2019, although we have moved from early to late in the quarter. We had to abort the acquisition of modules for 350 beds from an operation [ under close renewal ] in Argentina. This resulted in a delay and slower than planned build up in temporary camp facilities, which in turn delayed the arrival of contractors to site. Mine equipment started to arrive in mid-July, with last arrivals scheduled for November. The plan is to have the mine delivering initial ore in March 2019, with a quick ramp up as there is no [ reversion ] to be removed with the highest gold grades portions of the deposit outcropping.As stated earlier, we have assigned $130 million or 71% of the project's direct capital costs. With all this information, we forecast a modest increase of 6% on direct costs against our budget. But where we are experiencing a significant increase is in the forecast of construction indirect costs and owners cost. The main driver for the forecasted rise on indirect cost is a 50% incremental on-site headcount to 950 people. These variations drive our total initial capital estimate of $239 million to an increment between 10% and 17% or $24 million to $40 million. Main components of indirect costs for these figures come from catering costs, which have grown by $5.5 million. 64% of that attributed to the higher headcount and 34% to the higher food rations cost, $3 million in additional camp facilities, $1.6 million associated with higher transport cost at Lindero is located remotely 8 hours away from the city of Salta. Half of the $1.6 million -- half of that is due to higher headcount and the other half is to a shorter rotation on the roster for personnel than we originally estimated. $1.8 million in higher energy costs and $6 million in owners costs G&A. These figures are under final review, as we see opportunity to optimize headcount for certain contractors program to come to site in the fourth quarter or starting to come to site in the fourth quarter. We plan to include the reviews -- we plan to conclude these reviews in the month of August. I want to mention that our forecasts still include a $24 million contingency fund. The project has a physical advance as of the end of Q2 of 15%, with $38 million spent on the project, of which $31 million came in, in the second quarter. We're seeing a significant pickup in spending as the physical execution is ramping up.The Arizaro Au project target presents a significant exploration opportunity as we view it as a potential satellite deposit to Lindero. We're currently drilling a 2,000-meter program to further enhance our knowledge of the mineralized systems and evaluate the ability of producing a resource estimation of our own. Arizaro is located within our mining concessions and approximately 3 kilometers from the crossing station at Lindero. Goldrock, the previous owner of Lindero, reported an NI 43-101 indicator resource of 340,000 ounces of gold and incurred resources of 230,000 ounces of gold at Lindero, and so just the deposit remains open. We aim to conclude the drilling at Arizaro in the month of August.On the exploration front -- next slide. On the exploration front, we have drilled approximately 13,000 meters at our mines during the quarter, with the bulk of that drilling at the San Jose operation. But the highlight from exploration activities in the quarter comes from Serbia, where we are currently in a 70% earning option agreement at the Tlamino project, which contains the Barje target. Medgold is the optioner [ incurring the work ] now. Very encouraging results from first phase of drilling have been published by Medgold on June 11, June 18 and July 5. Here, on the presentation, on this slide, we present some of the highlights of the program. This is a very exciting exploration opportunity on silver-gold epidermal system that's close to surface.With that now I'll ask Luis to advance on the presentation, giving you further detail on the financial results.

[Luis Dario Ganoza Durant, Chief Financial Officer]

Thank you, Jorge. So turning on to Slide 14. We recorded net sales of $73.7 million, up 15% from the prior year driven by higher precious metal sales and zinc and lead prices. We reported net income of $11.2 million compared to $8.9 million in 2017 and earnings per share of $0.07 compared to $0.06. Our strong performance in the quarter didn't fully translate into higher adjusted net income due to a higher effective tax rate in the quarter, as I will discuss in the coming slides. Free cash flow excluding the Lindero construction for the quarter was $9.1 million, and although not shown in the slide, $28 million year-to-date.On to Slide 15. On breaking down our sales performance, we had higher total sales of $9.8 million with $5.5 million of contribution from higher metal volumes, mainly coming from silver; $2 million from improved metal prices, mainly zinc; and $2.7 million of improved treatment and refining charges. We recorded net sales adjustments of $2.7 million in the quarter, which was $0.5 million higher than the adjustment in our comparative quarter as shown in the bridge chart. Out of the total adjustment, $1.9 million was related to lower metal prices at the closing of June. In the first quarter of 2018, we reported a buildup of concentrate inventory at the San Jose mines corresponding to around 8 days of production, all of which has been sold as of the end of June.On to Slide 16. Our operating income and adjusted EBITDA reflect our stronger sales in the quarter and lower overall costs compared to 2017. Adjusted EBITDA at Caylloma was up 47%, reflecting mostly stronger zinc and lead prices, higher zinc production, lower production cash costs. Production cash costs at Caylloma was 10% below last year and 5% below our annual guidance. About half of these cost improvements with respect to annual guidance are related to productivity gains, which we expect will be maintained. EBITDA at San Jose was up 28%, as a result mostly of higher silver and gold production. In the case of production cash cost at San Jose, we have a slight decrease over 2017 and pretty much in line with our annual guidance. And as Jorge mentioned, both operation show improved performance from an all-in sustaining cost perspective, which we expect will be maintained as well in the second half of the year even as the level of sustaining capital expenditure picks up in Q3 and Q4.On to Slide 17. On expenses, total SG&A was $8 million, up 38% (sic) [ 36% ] compared to Q2 of 2017. Our operating mines SG&A and corporate SG&A are in line with guidance provided in March of this year during the Q4 2017 earnings call. Share-based payments of $2.4 million include approximately $1 million of mark-to-market effect from the stronger performance of our share price in the quarter. We have recorded a higher effective tax rate than usual of 55% (sic) [ 56% ] for Q2 of this year. This is mainly due to 2 factors. The strong devaluation of the Argentine peso, which has had a negative effect on the deferred tax component of our income tax expense, representing around $1.5 million; and a onetime charge of $1.3 million related to withhold impact we expect to pay in 2019 upon the repatriation of funds from our subsidiaries. Excluding these 2 items, effective tax rate would have been in the range of 44%.On to Slide 18. As we have highlighted at the beginning of the presentation, the company maintains a strong balance sheet position with a total cash and short-term investments as of the end of the quarter of $198 million, and total liquidity of $278 million considering our expanded credit facility of $120 million. Taking into account the updated initial capital forecast we have reported at the Lindero project, we continue to believe we're adequately funded, considering a range of slightly or potential downside metal price scenarios.Back to you, Carlos. Thank you.

[Carlos Baca, Investor Relations Manager]

We would now like to turn the call over to any questions that you may have.

[Operator]

[Operator Instructions] Our first question comes from the line of Chris Thompson with PI Financial.

[Chris Thompson]

Just a couple of quick questions. I'll start off with San Jose. Obviously, good grades in the Q2 here. I guess, on the back, maybe, correct me if I'm wrong, a slight revision of the mine plan. I guess, the question is, is whether these grades are sustainable at these levels? And whether there is going to be any adjustments later on in the foreseeable mine plan?

[Jorge A. Ganoza Durant, President, CEO & Director]

Chris. As I stated, yes, we do expect higher grades to continue in the second quarter -- sorry, in the second half of the year, that should lead to meeting or exceeding guidance by about 10%. That is, we are not moving to modify guidance, because we believe our 10% change does not warrant -- or variation of 10% does not warrant modifying guidance. But everything indicate suggest that we are heading in that way based on the plan -- mining plan for the second half of the year and what we have delivered this first half of the year. Moving forward, the reconciliation of reserves to production at this mine has always been very good. So long term, we continue to see the average grades of the reserves reflecting on production. But on a shorter term, like for the year, we provided guidance based on a plan that in the start of the year was later modified and the higher grades we're seeing with respect to the original plan and the original guidance are the result of that.

[Chris Thompson]

Okay. Just -- could you just comment on currently what's happening as far as exploration? I guess, you're now expanding towards the Trinidad North area. Give us a little bit of an update there.

[Jorge A. Ganoza Durant, President, CEO & Director]

Yes, in a second here. We have 5 drill rigs turning at San Jose, between 4 and 5, depending what time of the year, drilling that north extension in different parts. We have all the underground infrastructure available. We are hitting structure, we're hitting grade. I cannot report to you at this stage that we -- the outlining for a coherent or significant area. We are hitting some grade in some areas. We are going to -- we are working on a resource estimation for the second half of the year, the one we use to update our resources, reserves and mine plans and budget. So on the Victoria vein, we are aiming to do a resource, this is the first time we're going to attempt a resource at the Victoria vein. And in the North, we are drilling aggressively, and we will be reporting results of -- when they come and are of significance. But -- and we have not reported the results yet, even though we are drilling aggressively because we're not seeing results that support areas that we believe are mineable yet. These are big area, we're drilling aggressively, we're hitting structure, we're seeing mixed results on the drilling, but we need to continue pushing there.

[Chris Thompson]

Okay, great. I guess, just a final question, as far as Lindero, the CapEx escalation there. I mean on the costs, et cetera, are you getting any benefit from peso devaluation?

[Jorge A. Ganoza Durant, President, CEO & Director]

We're currently updating our numbers on that. I'll let Luis give you more color.

[Luis Dario Ganoza Durant, Chief Financial Officer]

So I mean, in short -- the short answer is, yes. Based on our budget figures and the time of feasibility study, the time it was put together, the real depreciation considering inflation is in the range of 25% to 27%. But that so far mostly provided a benefit in terms of overheads, as the construction really started ramping up in the second half of the second quarter. So in -- the [ value ] component of our forecast, of our CapEx, is still ahead of us. Now we don't anticipate that 27%, 25% real depreciation of a peso throughout the construction period, which extends up to September of 2019 is likely. So for more reasonable scenarios of, let's say, 10% real depreciation of the peso, that is, again, discounting for inflation factors, we should see a benefit in the range of $8 million to $9 million, which is currently not in our forecast figures. So we're not factoring in any benefits from devaluation.

[Chris Thompson]

Okay. All right. So if I can read you correctly on that, you're taking a very conservative stance on peso devaluation?

[Luis Dario Ganoza Durant, Chief Financial Officer]

Yes. As we've said before, our stance is that of a neutral effect. And as we advance the construction and the spending, we think -- continue along the trend we've seen, we are likely to see -- benefit materially.

[Operator]

Our next question comes from the line of Mark Magarian with UBS.

[Mark Magarian]

I just had -- just wanted to clarify one point you made a couple of times away regarding the -- was it $24 million contingency in your original Lindero cost plan? You're basically saying that this increasing cost, which you've just reported, could well come under that contingency which was on the original numbers. Is that what I'm hearing?

[Jorge A. Ganoza Durant, President, CEO & Director]

Yes. But I believe that I should give a bit more clarity on how we manage the contingency. It is $239 million initial capital estimate we produced initially, carry about $23 million in the contingency fund. And the actual physical execution of the project is only starting. The physical advance of the project as of the end of the second quarter is only about 15%. So -- our updated forecast comes from having detailed engineering concluded and contracts awarded or very close to being awarded as is the case of electromechanical and piping contract. So we have a lot more better information, detailed information coming from the engineering and from actual costs that have been already assigned and awarded, equipment purchase. Now before we had quotes for equipment, now the equipment are in, the purchase orders are out. That detail is coming in our forecast now. And our contingency fund remains at $24 million. So we will start discounting that $24 million as the execution -- the physical execution of the project advances. It is -- if the project advances. So as the project advances, if there are variations in the execution, we will start applying the contingency fund to those variations. That is how we manage the -- so any variation in the execution will not translate automatically or directly over the 17%, 10% variation we're currently forecasting. The contingency fund on the future execution should eat those differences, start eating those differences and help to mitigate variations in the actual physical execution. That is how we manage the contingency fund.

[Operator]

[Operator Instructions] And it seems we have no further questions. I'd like to turn the floor back over to management.

[Carlos Baca, Investor Relations Manager]

Thank you, Brenda. If there are no further questions, I would like to thank everyone for listening to today's earnings call, and we look forward to you joining us next quarter. Have a good day.

[Operator]

This concludes today's teleconference. You may disconnect your lines at this time, and enjoy the rest of your day.