Fortuna Silver Mines Inc

TSX:FVI

Earnings Call Transcript 2020-Q4

[Operator]

Good morning, ladies and gentlemen, and welcome to the Fortuna Silver Mines Fourth Quarter and Full Year 2020 Financial and Operational Results. [Operator Instructions]It is now my pleasure to turn the floor over to your host, Carlos Baca. Sir, the floor is yours.

[Carlos Baca, Investor Relations Manager]

Thank you, Matthew. Good morning, ladies and gentlemen. I would like to welcome you to Fortuna Silver Mines and to our financial and operations results call for the fourth quarter and full year 2020. Today, we will be using a webcast presentation, which will be controlled by us. To download the presentation, please go to our website at fortunasilver.com, click on the Investors tab, then on the Financials sub tab and under Q4 2020, click on the Earnings Call Presentation link. Jorge Alberto Ganoza, President, CEO and Director; and Luis Dario Ganoza, CFO, will be hosting the call. 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 Alberto Ganoza, Co-Founder of Fortuna.

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

Thank you, Carlos, and good morning to all. We will take you through our results for the quarter and year-end with the aid of the slide presentation Carlos mentioned before. So we can go on, Carlos, to Slide 5 of the presentation. Through our work over the last 3 years, we have come to place ourselves in the most exciting position today as we are delivering significant growth in gold production in a rising precious metals market. This year, our production guidance from our 3 mines is in the range of 260,000 to 300,000 gold equivalent ounces, an increase of 80% to 100% over 2020. Next slide, please. Under highlights for the quarter, we have reported record-breaking free cash flow of $34.5 million and our business operates with a robust adjusted EBITDA margin of 43%. We have strong liquidity of $132 million with net debt of $34 million and a debt-to-EBITDA ratio of 0.4. We expect to be net cash positive again this year. Lindero production first -- Lindero produced first gold in October 2020 and delivered 13,435 ounces in the fourth quarter as part of commissioning and ramp-up activities. During this ramp-up quarter, Lindero was cash positive, generating approximately $5 million in free cash with an all-in sustaining cost under $1,100. Ramp up to design capacity continues during Q1 of this year.During this unprecedented year, our operations suffered temporary suspensions of production. The San Jose Mine in Mexico was down for 54 days, the Caylloma Mine in Peru was down for 21 days and Lindero construction activities were suspended for almost 3 months considering remobilization. The company was quick to implement containment measures for COVID across all sites, mitigating risks to our people, neighbors, while complying with rapidly changing government regulations and guidelines and ensuring business continuity, where direct costs attributable to managing the COVID risks across all sites amounted to $4 million in the year. Moving on to Slide 7. We're listening to our shareholders and stakeholders in general. We're not only improving our reporting on ESG, but undergoing a cultural change of the way we incorporate sustainability in our strategy and business planning. Through rigorous materiality assessments, we are prioritizing our efforts. This is a journey of continuous improvement. We have strength in governance, as evidenced by the rating agencies and areas of improvement in taking longer-term views on environment and social. We're committed to show Fortuna as a strong ESG performer. Next slide, please. On Slide 8 of the presentation, we share our key safety performance indicators. We present KPIs as a 12-month rolling average to better represent trends. Our trend of improvement over the last years was truncated by the challenges imposed by COVID, particularly on the second half of 2020. In the last months of the year, we experienced a spike in total recordable incidents and lost time injuries. COVID restrictions, particularly at the San Jose Mine and start-up of operations at Lindero, explain the poor performance. High rotation of personnel due to the COVID contact tracing and incidents of suspect cases and inability to mobilize experienced operators and supervisors to Argentina due to the closing of the borders to foreigners weighted heavily on these results. I can share that for the start of 2021, we're seeing material improvements in performance at the Lindero Mine, while some challenges remain at San Jose. With respect to production for the quarter. Silver production was down against the comparable quarter as a result of lower grades in the San Jose Mine, 17% lower grade. And gold was up 100% due to the contribution of first gold production from Lindero.Next slide, please. For the year, silver production was down 19%, mainly driven by the 54 days of suspension of production at San Jose and the impact of lower grades. Gold was up 10% off the back of Lindero contribution to production, as I mentioned, in the fourth quarter. Next slide, please. Sales. In the fourth quarter silver and Gold had an almost equal contribution to sales of 40% to 45%, and we captured in our sales and margins, the benefit of increased prices for both silver and gold. We sold silver in the quarter at a price of $24.40 per ounce and gold at a price of $1,864. Sales in the quarter jumped 50% to $103 million, or EBITDA jumped 48% to $45 million and our adjusted net income jumped 111% to $23 million or $0.12 per share. Next slide, please. For the year, we reported sales of $280 million and a very healthy EBITDA of $112 million with a margin of 40%. Our costs were impacted from the all-in sustaining perspective from the lower production of silver at the San Jose Mine, again, as a result of the shutdown and lower grades. And Caylloma, our costs were impacted also by the equivalency ratios with base metals. Next slide, please. We have concluded in 2020 a capital-intensive phase that we had embarked on for the last 3 years. The construction of Lindero is over, and we are in the commissioning and ramp-up phase. And our CapEx budgets are expect -- are trending now in -- are within the balance of -- or sustainability investment at all 3 sites. We are reenergizing also exploration looking forward, and we provided this -- we shared this in our guidance. We are reenergizing our budgets on exploration. We have traditionally been investing, up until 2017, approximately 4% of sales on exploration and having drilling meterage of always in excess of 30,000 meters. In 2020, our exploration budget was a low $8 million. We drilled 8,000 -- sorry, our drilling meters was a low 8,000 meters. And as a percentage of sales, our investment in exploration was under 2% of sales. For 2021, we are taking our exploration budgets back again to a level of around 4%, 4.5% of sales and drilling meterage is being expanded in excess -- to in excess of 40,000 meters a year. That is the kind of meterage and exploration investment we need to not only replenish reserves, resources, but also expand them. So in 2021, exploration is a topical issue for us, and you are going to see expanded investment on exploration now that the capital-intensive phase of Lindero construction is behind us. Next slide, please. With respect our activities in Lindero as -- by way of update, as at the end of February, our mining unit operations at Lindero are operating and delivering according to design capacity. Our ADR plant has been now, for several months, operating at design capacity, taking the full 400 cubic meters per hour of pregnant solution and achieving gold extractions in the range of 90%. Primary and secondary crushing circuits as of the end of February are operating at 67% of design capacity. And this month of March, we're already seeing a solid base at -- within 85% of design capacity. At the HPGR agglomeration and stacking, we are at 23% of design capacity. Here, the limiting factor has been the stacking system. We have been dealing with operating and heating issues at the stacking system. But I can advance that already in these early days of March, we're seeing performance improving and closer -- solid days closer to 30%, 40% of design capacity.So all in all, we're seeing a strong trend in the right direction. And we are expect -- continue to expect material advances on the ramp-up this month of March as we implement several measures and corrective measures on a lot of the components of the process, right? But most importantly, all of these things are issues we can address and correct. But our models, our reserve models are consolidating extremely well against production. And our leaching kinetics, gold leaching kinetics are performing according to our design parameters and expectations. So those are 2 things I want to highlight. And also the fact that, as I mentioned before, we're trending in the right direction with respect to our expectations on ramp up. We're still slightly behind -- somewhat behind on the stocking, but we're seeing solid improvement in March. Next slide, please. I think this is the end of my update on the presentation. Now I'll pass it on to Luis, who will give you the highlights of the financial results. Luis?

[Luis Dario Ganoza Durant, Chief Financial Officer]

Yes. Thank you, Jorge. So on Slide 18. Yes, as has been discussed by Jorge, we had a strong fourth quarter, driven by a higher sales of 50% over Q4 2019. Our margins were significantly up, reflected in adjusted EBITDA and adjusted net income increases of 78% and 100%, respectively. Net income, however, was slightly below Q4 2019 due to certain items below the operating income line contributing to a higher net income in the comparative period of 2019. Specifically, in 2019, we recorded $11 million of investment gains in the large deferred tax credit-related to foreign currency fluctuations.Slide 19, please. So in the quarter, the highest impact in our sales came from both higher metal prices, silver, in particular, which was up 41%; and as Jorge mentioned, the contribution of Lindero with $20.3 million, for a total increase in sales of $34.5 million. The company elected to early adopt certain amendments to IAS 16, which deal with proceeds before intended use of assets. Under this mandate standard, company is required to recognize sales proceeds and related costs of items produced in the income statement while the company is preparing the asset for its intended use. Next slide, please, Slide 20. So reinforcing a bit of what Jorge discussed. When looking at our comparative segmented results, EBITDA is up significantly quarter over quarter at both the San Jose and Caylloma mines, reflecting the positive impact of higher metal prices, as previously discussed. Our production cash cost at both operations in Q4 remains at similar levels as at comparative quarter and is overall within the ranges we expect for 2021 based on our guidance. All-in sustaining cost at San Jose was $14.50 per equivalent ounce of silver for the quarter and $12 for the year. Again, based on guidance provided for 2021, we expect all-in sustaining cost to remain within a similar range of $12 and $14.50 per equivalent ounce of silver in 2021. Slide 21, please. Yes, on Slide 21, we provide some additional detail on the reported Lindero results. As disclosed, $20.3 million of sales contribution. Cash cost of sales shown in the table correspond to the full operating costs in the quarter. The only item of in-country costs and expenses that is not yet reflected in the income statement in Q4 is the off-site G&A of $1.1 million. Total Lindero contribution to our consolidated EBITDA was $11.3 million in the quarter. Also relevant to note, we have incurred export duties of 8% nominal rate over sales, which we expect to continue into 2021. Next slide, please, Slide 22. Yes, here, we show the breakdown of our general and administration line item out of the financial statements for the quarter and the year. For the full year, our corporate and in-country G&A expenses are below 2019. The increase in total G&A, both for the quarter and the year, is related to higher share-based payments related mainly to the performance of our share price. As shown on the slide as well, we recorded a foreign exchange loss for the quarter of $4.7 million and $12.2 million the year. A driver of these losses, as has been discussed in the past, is a construction VAT receivable in Argentina. In 2019, we incurred a loss of similar magnitude, which, cumulatively in the 2-year period, adds up to approximately $24 million. This, however, has been partially mitigated by investment gains of $3.3 million in 2020 and around $10 million in 2019. So cumulatively, the net loss is more in the range of $10 million. It is worth noting that we have already started recovering VAT with the first month, some amount of $10 million collected in January 2021. And the next slide, please, Slide 23. Yes, here, we provide a summary of our balance sheet and liquidity position. On the bar graph on the left, at the end of Q4 2020, our total liquidity came down slightly with respect to Q3 as our $150 million bank facility was scaled down to $120 million as well as contractually scheduled. Worth noting, our net debt position, shown at the bottom, improved from $56 million in Q3 to $34 million in Q4.With that, I will hand it back to you, Carlos. Thank you.

[Carlos Baca, Investor Relations Manager]

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

[Operator]

[Operator Instructions] Your first question is coming from Don DeMarco.

[Don DeMarco, Analyst]

Jorge, so you mentioned the stacking system. I read that is that 23% in February. Performance increasing to 30% to 40% in March. Well, what kind of level would you be comfortable with in order to meet the guidance in 2021?

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

Thank you for the question, Don. It is important to stress something that we try to describe well in the MD&A, which is we are bypassing whatever tonnage or extract ounces we are not placing with the stacking system, we are making up with placing ore on the leach pad with trucks, no? So what we are tracking is the amount of extractable ounces that we place on the leach pad every month, right? So we are meeting the extractable ounces on the leach pad as per our guidance, no? The issue is that the ounces that we place on the -- with the stacking system, we expect gold extraction to be in the range of 75%, 78% over 90 days. With the ounces that we place with trucks as they are a bypass that comes from the -- where we draw ore from the secondary crusher stockpile, and it's a 34-millimeter crush. And for that kind of crushed material, that P80 at 34 millimeters, gold extraction is more in the range of 50% over 90 days. Over time, we will achieve a higher extraction rate, not in the 75%, but certainly higher than 50% over time. So we're having to place more ounces to meet the guidance, no, more ounces in the leach pad to meet the guidance. So that's how we're managing it. This is a temporary solution while we get the stacking system up to design, right? What I said during the call is that in these early days of March, we are already seeing the stacking system performing at between 30% and 40%. We had, yesterday, a good day with 9,000 tonnes per day, which is more like 50% of capacity, no? We are dealing with some issues with the stocking. It's mainly the overland conveyor braking system malfunctions, no, that generate massive spillages. It's basically the automation system of the stacking system is not communicating properly at all times. And maybe more testing what's happening, and we get it working and then we have a miscommunication. And when the braking systems don't work in sync, sometimes we get massive spillages from one of these large conveyor belts, right? That takes up to 5 hours to clean up and get it up running again, no? So nothing that we -- and just to complement here, I believe that, for example, this is a good example of how COVID is impacting us. I believe this issue could be resolved in a matter of days or weeks, even hours. The issue is that we do not have the benefit of having the vendor technicians on-site working with our operators and maintenance team, right? We're making good use of technology, but it's not the same. So a lot of these issues, we are improving, getting the mechanical availability up, and up, and up. But again, things that I believe could take hours or days to resolve, end up taking days or weeks because we just don't have the -- something that you would see on a normal day, which is the -- or ramp-up the vendor technicians on-site with you, right? In this case, superior, the Argentinian borders are -- remain largely close to foreigners, so we cannot get the technicians in country, right?

[Don DeMarco, Analyst]

Okay. Okay. Also on stacking, but maybe shifting over to grade. I recall around mid-October, the initial grades that you had stacked were a little bit below like maybe 0.83 grams per tonne or something. You had previously maybe been targeting one -- above one. But now I see that the grade -- stack grades for the full year are 1 gram per tonne, which implies there's been an increase in the stack rate. Are you comfortable with the grades that you're stacking right now? And is it in line with your expectations and plans?

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

Yes, grade is in line with our plan. Absolutely.

[Don DeMarco, Analyst]

Okay. Okay. And then, finally, on capital allocation priorities, we have you generating a lot of free cash flow in 2021. You mentioned you have expanded investment on exploration. Is a dividend something that you're thinking about at this point or repaying the debt? What are your capital allocation priorities beyond investment in exploration?

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

Yes. And thanks for the question because it allows me to point something here. We have 3 priorities, no? One is, first, we believe at times like these companies -- many companies need to strengthen the balance sheet, right? These are the opportunities we have in cycles like these, legs of the cycles that we are now in to strengthen the balance sheet. So we view having -- putting together a fortress balance sheet as a priority for us, right? So that's number -- even though our debt to EBITDA is low and whatnot, we -- you will be seeing us ensuring that we come out of this leg of the cycle with a very strong balance sheet. Second is exploration investment. As I noted during the -- my intervention before, we've been shortchanging our investment in exploration for 3 years basically as we were prioritizing capital allocation to Lindero construction. We have been drilling 2020, only 8,000 meters, not enough to replenish -- deal with depletion at our mines and expand the research, obviously. So we got those drilling meter ages up north of 40,000, 50,000 meters. We're drilling at all sites. We have new initiatives outside of brownfields. We're going to be drill testing this year as well in Mexico and one in Argentina. And last is returning to shareholders, no? Yes, that's something that we will consider, the best way to return to shareholders, and we will evaluate those options against other opportunities for growth that we might identify. And -- but certainly, returning capital to shareholders is -- in the way of dividends or a special dividend or other means is something that the Board is considering already, no?

[Operator]

Your next question is coming from James Huntington.

[James Huntington, Associate]

Just following up from the previous questions on the stacking unit there, what sort of time line, like just at your current rates, you think you could be ramped up on the stacking system? It's, unfortunately, yes, COVID's obviously restricting you a fair bit there. But you think this would be like a 2-month process or sort of you'll be like 90% of the way by the end of March? Just a bit more color there.

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

Yes. And that's a tricky question to answer. We have -- our problems are -- with the stacking are isolated right now to the braking system -- to the communications on the braking system. It's an automation issue. We've been trying a lot of things and solving problems and improving, and now we're left with this one. And if you know how this works, you, all of a sudden, get it right and you get a bump on performance. And we're already starting to see better days, and all of a sudden, we can see significant jumping in performance. We're almost at mid-March. So it's still our expectation to get within 85% of performance in March. But if not, we'll see a spillage into April, right? But it's difficult for me to gauge. I believe the issues are issues that are solved in matters of days or weeks. What we have in front of us with the stacking is something that which should be solved in a matter of days or weeks, not months, right, because of the nature of the problem and where we are with the solution, no? So my best assessment would be days or weeks to get this problem. And it's just this one problem right now we're battling with, and we have been battling with for a few weeks now, right? So I believe we're on the last leg of a solution for this, right?

[James Huntington, Associate]

Okay. And then just if you could give us some color on the ramp-up and the status of the SART plant and sort of what -- how the ramp-up is going there as well.

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

Yes. The SART plant is not critical path for us. It's important. We need the SART plant, but we don't need it to produce gold, and we don't need it in Day 1, right? So the copper content in the pregnant solution up to now is manageable. We have -- the SART plant in February was at 37% of design capacity. But we have reallocated resources from the maintenance team and operations team to the areas that are key or on critical path for gold production, right? Basically, the stacking and the crushing system. So we have deprioritized efforts around the SART. We will come back to it once we get that stacking system running where we need it to be. The SART plant, we've been running it at around 37%, up to 40% of design capacity. It's been operating efficiently at those rates. We've been able to precipitate 80%, 90% of the coppering solutions. So the chemistry of the SART plant is performing, I will say, in exceeding our expectations. It's just a matter of increasing flow. Right now, we have an issue with the copper filter, no? We're waiting for some -- for a small repair on the copper filter, a minor issue. And -- but again, we have prioritized resources to critical path, which is basically the stacking and primary and secondary crusher.

[James Huntington, Associate]

Okay. And then just one last modeling question from me. For depreciation at Lindero, could you guide us what you're sort of expecting this year on like $1 per ounce for Lindero, and if possible, a more longer term value?

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

Luis, do you want to give a punt to this one?

[Luis Dario Ganoza Durant, Chief Financial Officer]

Yes. I heard you're asking for the depreciation dollars per ounce. I -- we're using the units of production method based on ounces produced. I don't have, unfortunately, a number in my head that I can share with you. But what we should expect as we are depreciating based on ounces on a per ounce basis, of course, is the depreciation tracking, of course, the production output throughout the life of mine, right? So that will be in sync with the evolution of income throughout the life of mine. Yes, I'm sorry, I can't give you a number right now because I don't have it in front of me.

[Operator]

Your next question is coming from Adrian Day.

[Adrian Vincent Day, Chairman, President & Treasurer]

My question has partly been answered already in one of your previous answers, but I wanted to ask you about the exploration a little bit more. In the foreseeable future, is it all exploration at or close to mine site? Or are there any new areas you're looking at?

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

Yes. It have a bit of everything, Adrian. So at the San Jose Mine in Mexico, we have an aggressive program -- drilling program in the immediate vicinity of the mine, both on the north boundary of existing resources on the deep extensions and to the south. We have identified also 4 kilometers -- sorry, 400 meters due east from the main ore shoot, 2 parallel structures, one that today hosts resources is the Victoria vein, where we have done no mining up to now. And then a bit further east from Victoria, we have also a couple of interesting drill intercepts of another blind structure with grades in the range of 135 grams over a couple of meters. So we have a lot of drilling allocated to that. In addition, at the San Jose Mine, we are exploring other areas and other veins within the system. But I would consider all of this in the -- within the reach of brownfields, no? So opportunity that -- where we are successful, we could have the opportunity to truck ore to our San Jose Mill. We signed this year -- 2020, an agreement with Minaurum. We have optioned the Higo Blanco property. It's some 15, 20 kilometers due east from San Jose. It's an exciting exploration project with some exciting drill results that need follow-up. And that information is public, and you can look at it. So all of this is within our plans for 2021. In the case of the Caylloma Mine, we have also a similar scenario, drilling within the extensions of non-mineralization and also stepping out into new areas, testing new ideas in a vein system that has been so productive for over 500 years literally. So in the case of Lindero, we are not doing near mine -- near resource drilling. We are stepping out to the Arizaro gold porphyry. We're going to be drilling there this first half of the year. Arizaro is a gold porphyry -- is a second gold porphyry center in our property. Lindero is the one that we're bringing -- we have brought into production. And Arizaro is located 3.5 kilometers from Lindero, so well within tracking distance. There is a well-identified gold porphyry system there that has received drilling throughout the years. We believe there is potential, as evidenced by past drilling, for near-surface, high-grade satellite, perhaps not too big. But as we have infrastructured so close, we don't need a stand-alone. So this satellite is going to contribute, what, 5 million, 10 million, 20 million tonnes at grades in excess of 0.4, 0.5 grams gold, we believe, as high as 0.7, as some drilling would suggest. So we are going to be testing those potential satellites at Arizaro, no? So apart from that, we have drilling in new projects in Mexico and Argentina. Exploration, we have option properties, and we're advancing work and work advances. And we firm our commitments on those projects, we'll be discussing them publicly, right?

[Operator]

Your next question is coming from Justin Stevens.

[Justin Stevens, Precious Metals Analyst]

Most of what I wanted to get has really been covered off. But I was just mostly wondering, how much copper are you guys seeing so far at Lindero? And the flip side of that would be, how is the cyanide consumption relative to what you're looking for?

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

Sorry, I didn't hear you all that well. You're asking about the copper content in Lindero?

[Justin Stevens, Precious Metals Analyst]

Yes, in the ore placed so far at Lindero and the cyanide consumption as well.

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

Yes. Copper is -- copper grades are trending along with what we see in our resource reserve model, around 0.1% copper is what we're seeing. And in the case of Lindero, what makes Lindero viable, technically viable, is the fact that 95% of that copper, that 0.1% copper that we see in the Lindero porphyry is in the form of chalcopyrite. So only 5% of copper in chalcopyrite leaches under a cyanide solution. So it doesn't eat cyanide like other copper mineral forms, like chalcocine, where 70% of copper will leach in the mineral form of chalcocine -- chalcocite, chalcocine, covellite or bornite. Those are the cyanide eaters. In the case of Lindero, we have chalcopyrite, and the grade of copper is within our expectations at 0.1. Our cyanide consumption right now is slightly below half -- 0.5 kilos per tonne. So it's tracking well within what we expect. And the copper that we're seeing in the pregnant solution, it's also within what we would expect with this leaching kinetics. So we're seeing copper in the range of 400 to 500 ppm in the pregnant solution. So we're managing that with cyanide. And the SART plan that -- although it's running at 30%, 40% of design capacity, it's doing the work, all right?

[Justin Stevens, Precious Metals Analyst]

Yes. No, that's great. And then the only other question I had was, do you guys have timing for your planned annual reserve and resource update?

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

Yes. We'll be releasing reserves resources in the coming weeks.

[Operator]

There are no further questions in the queue at this time.

[Carlos Baca, Investor Relations Manager]

Thank you, Matthew. 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]

Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.