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Fortuna Silver Mines Inc. (FSM) Q22019 Earnings Call Transcript

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Fortuna Silver Mines Inc. (NYSE: FSM)
Q2 2019 Earnings Call
Aug. 8, 2019, 12:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Please stand by. Good day, ladies and gentlemen. And welcome to your Fortuna Silver Mines second quarter 2019 financial and operational results conference call. All lines have been placed in a listen-only mode. And the floor will be open for you questions and comments following the presentation. If you should require assistance throughout the conference, please press *0 to reach a live operator. At this time, it is my pleasure to turn the floor over to Carlos Baca, Investor Relations. Sir, the floor is yours.

Carlos Baca -- Investor Relations Manager 

Thank you, Christy. 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 second quarter of 2019. Today, we will be using a webcast presentation, which will be controlled by us. To download the presentation, please go to our website at www.fortunasilver.com. Click on the investors tab. Then click on the financial subtab. And under Q2 2019, click on the earnings call webcast link. Jorge Alberto Ganoza, President, CEO, and Director, and Luis Dario Ganoza, CFO, will be hosting the call from Lima, Peru.

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 detected in the forward-looking information if contained in the company' annual information form and MD&A, which are publically available in 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, President, CEO, and Co-Founder of Fortuna.

Jorge Ganoza -- President and Chief Executive Officer

Thank you, Carlos. And good morning to all. I'll be presenting on production to our quarter results and progress on the Lindero gold mine construction in Argentina and then turn the call over to Luis, who will take you through the financial statements. After that, we will open the call for questions. On slide five of our presentation -- at a time of a surge in price of gold, we are months away from being in a position to increase our annual gold output from approximately 50,000 ounces to 180,000 ounces of gold, in addition, today, to 9 million ounces of silver we produce every year.

I expect to see a validation of our strategy of being countercyclical on growth and expansion of our footprint in Latin America. We're coming into the last mile of construction at the Lindero project in Argentina, which will complement our San Jose mine in Mexico and our Caylloma mine in Peru, as our third operating asset. Lindero has reserves for 15 years of gold production and is accretive to the strong consolidated EBITDA margins of our business.

Slide six, please. Under highlights for the period we present another quarter of robust margins and healthy free cash flow from our ongoing mines. Our available liquidity is adequate to meet capital needs. We maintain a reasonable debt level, with debt-to-EBITDA under 2 once the $150 million trade facility is fully drawn. Lindero, of course, is a large capital project. As of the end of June, we show a total project advance of 57%. Mission critical areas for production like power, water, mine pit preparation, operational permits, crushing area are either concluded, being commissioned, or well advanced. Critical path is on the crushing circuit. I'll give you further detail down on the -- down -- further down in the presentation on construction.

98% of direct capital costs have been committed here through equipment and supply purchases, structure fabrication, contracts, or contractor rewards. Remaining construction capital to completion is estimated at $82 million. Apart from the typical quarterly updates and construction news releases, we production a series of monthly videos that help us show our advance on a regular basis. The video can be found in our website. And I would like to encourage you to watch the videos and follow our progress. We're concluding the production of July episode. We're projecting to be placing ore on the leach pad in Q4 of this year, with first gold production of Q1 2020.

On slide seven under consolidated production for the period, here we clearly show we're on line to meet guidance for the year. And compared to the previous quarter -- to the comparable period, I'm sorry, we show no significant deviations. Next slide, please. Precious metals account for almost 80% of our contribution to sales. And our realized price for silver in the period was close to $15 and $1311 for gold. With the surge in prices we've seen, as you can imagine, we miners are expecting to see the benefit in our sales from that in our numbers. Next slide.

Under financial highlights, I will press here again that in spite of the price environment during the quarter, we still managed to show a robust EBITDA margin of 40%. And we reported a net income of $10 million with an adjusted net income of $7 million, still showing profitability in this price environment for the quarter. Next slide.

On our costs, our guidance for the year is $10 to $12 all in sustained costs on a consolidated basis. We came in at $11.30 consolidated, slightly higher than the comparable period but well within our guidance for the year. Our mines performed well. And we will discuss the impact on Caylloma further down in the presentation. Next slide, please.

On capex, the big capital project of course is Lindero. We can give you further detail on Lindero as we advance and get into the Lindero section of the presentation. So, next slide please. Well, we show our asset portfolio through this pyramid, where you can see our two producing mines, our development project, and exploration initiatives. Let's go into Lindero in the next slide.

This is a summary of our -- on slide 13 of our current schedule. We are planning and aiming to replacing ore on the leach pad in the fourth quarter of the year. And being in a position to generate a sufficient, pregnant solution in the irrigation of a leach pad to resourcing a solution -- pregnant solution flow through the ADR in Q1. Commercial operations, declaration of commercial operations, will be a factor of when we can start feeding the ADR with a pregnant solution and a smooth commission. Again, our plans today, our best plans today, call for first [inaudible] and start of gold production with our entire circuit, without shortcuts to the circuit, in Q1 2020. Next slide, please.

Our overall project advance is 57% as of the end of June. 98% of the projects total direct capital costs had been committed. This is an important figure for us because it reduces potential risks to budget. And $260 million of construction paid -- spending taking place as of the end of June. That's 72% of our capex forecast. We have $82 million of construction capital remaining to completion. Our total construction capex forecast stands at $298 million, which includes a $10 million contingency figure. And our forecast of course does not include potentials gains from exchange rate in Argentina. Next slide, please.

Leach pad. We plan to have a leach pad ready to receive ore in September, late September, with bonds also coming in in late September, early October. Next slide. Crushing currently stands on the critical path of the project. We are concluded with mounting of crushers, screens. In the secondary area, we are now starting with installation of belt conveyors and ore bins. Primary crushing, this is not the most updated picture of the project changes by the date. We are start -- we have started with the construction of the primary crusher bin. The apron feeder is in play. The scalper is in play now. And the primary crusher's been mounted.

Here we show our HPGR, which is mounted. Electrical installation is taking place. All the electrical rooms for the tertiary, the HPGR, and secondary agglomeration have been placed. And we're also -- here we show the installation of the first agglomeration drum. We have two drums for the project. This one has been mounted already. And we are preparing to start mounting the second agglomeration drum in the coming days. On the upper left photo in the slide, we are placing concrete on the tunnel under the secondary crusher, ore being -- sorry, stock pile. And the tunnel is concluded by now. And the area is being -- is prepared. All the large concrete placement on the tunnel is concluded. Next slide, please.

On the left photo, we show the ADR building. The structures have been erected. We are finishing placing flooring on the area, concrete floors. And with that, we will be concluding structure -- internal structure installations. We already see some early placement of tanks in the area. And on the right, we show the SART plant. The SART plant is not on the critical path. It does not need to be operational on day one. So, it runs behind the ADR, which is also mission critical, and we need it early in Q1. Next slide.

Mine -- or mine has been developed outside Lindero. Access roads and -- we have prepared three production benches, which are ready to receive blasting any day. And we've been waiting for the last inspection of our [inaudible]. That inspection by the local authorities has taken place, and that final permit is expected any day for the operation of [inaudible].

Here on ancillary facilities, our truck shop, our camp -- we could have capacity to host roughly 1300 people on site. That's a peak of construction. We're starting to remobilize contractors by now. Once in operation, Lindero will have an onsite population of around 180 people only. On the right, our power station is an eight-mega watt fuel generation power line system. And also, important to mention is that our water system is on the final stages of construction. A 13-kilometer pipeline connecting the well field to the site is concluded. And we're currently on the --halfway with the installation of pumps and generators on the site of the well field.

With that, I'll let Luis take you through the financial statements now, and we can answer your questions later.

Luis Ganoza -- Chief Financial Officer

Thank you, Jorge. On slide 22, sales for the second quarter were $67.9 million, down 8% from 2018 due to lower metal prices, partially offset by higher silver sold compared to the prior year. We reported net income of $10.3 million compared to $11.2 million in Q2 of 2018. And adjusted net income of $7.2 million compared to $11.1 million in Q2 of 2018. The main items of the adjustment have to do with foreign exchange and deferred tax credits related to Lindero, which we strip out for adjusted net income purposes. The reduction of 35% in adjusted net income was driven by the lower sales and higher operating costs when compared to the prior year. Our costs for the period, however, are within a range of guidance for 2019.

Adjusted EBITDA was $27.2 million compared to $35.2 million recorded in 2018. And free cash flow from ongoing operations was $15.4 million compared to $9.1 million in the prior year. Free cash flow in the quarter was positively impacted by favorable changes in working capital and lower capital expenditure. Although not shown in the table, year-to-date free cash flow from ongoing operations was $17.2 million. This yields an average of $8.5 million per quarter for the first half of the year. On slide 23, when breaking down our sales performance for the quarter, we can see the highest impact came from lower silver and base metal prices, as well as higher treatment and refining charges. These effects were partially offset by higher silver sold and positive final sales adjustments.

On slide 24, our comparative segmented results show a similar pattern at both operations, mainly lower margins driven by the lower prices and higher operating costs when compared to the second quarter of 2018. EBITDA at San Jose decreased 11% mainly as a result of higher production cash cost over 2018 as sales were flat year-over-year. Our cost performance shows significant variability in Q2 with production cash cost 14% higher than Q2 2018 for San Jose. When compared to the midpoint of our annual guidance, however, cash cost for quarter is pretty much in line with a minor deviation of 3%. We expect to close the year within our cash cost guidance range at Jose.

EBITDA at Caylloma had a larger fall when compared to 2018 as a result of lower sales related to a drop in base metal prices, higher treatment and refining charges, and higher production costs. In a similar as San Jose, Caylloma shows a high variability in cost performance due to an extent to timing issues. As cost execution in Q2 of 2018 was significantly below the annual average of the year. Production cost in Q2 of 2019 is 2% above the midpoint of our cash cost guidance for the full year.

On slide 25, G&A is 19% above Q2 2018 for our operating mines, with respect to the upper range of guidance of $2.4 million per quarter provided in our year end 2018 call. The deviation is below 5%. On a year-to-date basis, this line item is in line with our expectation and guidance. Corporate expenses are 14 percent above Q2 2018 and 10% above the upper range of our guidance. And this is mostly a temporary effect related to lower invoicing of management fees to the Lindero project in the quarter. Our effected tax rate per the quarter was positively affected by the combined effects of an appreciation of the Argentine peso in the quarter and persistently high inflation in Argentina. When stripping out these effects, the effective tax rate on an adjusted net income basis was 54%.

Finally, on slide 26, on the upper left-hand side of the slide, we show our projected minimum liquidity position throughout the construction period of $18 to $21 million. We will target a minimum level of $50 million of liquidity, which will involve expanding our debt availability by an additional $30 million. Considering a fully drawn amount of $150 million of fixed liquidity needs, this will represent less than 1.9 or 1.8 times EBITDA. And once Lindero is in production, the debt ratio will decrease significantly as shown in the bullets at the bottom of the slide.

With that, I will hand it back to you, Carlos.

Carlos Baca -- Investor Relations Manager 

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

Questions and Answers:

Operator

Thank you. The floor is now open for questions. If you do have a question, please press *1 on your telephone keypad to join the queue. If you're using a speakerphone, please pick up your handset to provide the best sound quality. We'll go to our first question from Chris Thompson, with PI Financial.

Chris Thompson -- PI Financial -- Analyst

Hey. Good morning -- good afternoon, guys. Thanks for hosting the call. Just a couple of quick questions, really exploration focused. I wonder if you could just update us on what's happening at your mine sites as well as Lindero as far as exploration.

Jorge Ganoza -- President and Chief Executive Officer

Okay. Lindero -- Chris, good morning. We are, as you can appreciate, focused on the construction right now. So, no exploration has been taking place at the Lindero site. We did important work on infield drilling last year, and we saw the benefits of that. But on some exploration drilling on Arizaro. But that was last year. This year the focus, camp availability, everything has been -- priority has been given to construction, right. We're active on exploration outside of the Brownfield's scope of Lindero. We're very active. We've been drilling targets in Salta, early stage -- post discovery, early stage prospects in the province. We like that province very much. We're very active there. But we have nothing to report in terms of results yet.

On Caylloma, we have paced down the exploration due to the fact that we have tremendous success two years ago with the extension and expansion of mineralization on the Animas vein. So, the focus on Caylloma today is capital spending to bring into -- develop infrastructure to bring into production in these areas which the traditional tons announces that came through this successful 2016, 2017 exploration programs at Caylloma. And at San Jose, we have 20,000-meter drill program this year where we've been focusing mainly on drilling the near boundaries of the mineralized system and resourced envelope on the deep end of mineralization, on the north end of mineralization, on the south end of mineralization. We have been enjoying success and -- with the drilling. And I think you will be able to appreciate that once we publish our updated research and see how we are dealing with depletion at that mine.

We have not had a stand alone discovery or something of that nature we can report. But I can say that our exploration drilling in the immediate vicinity of this vein system. And as you know, San Jose is not one vein. It's a system of stockworks and vein zones. Going back and working close with the model, we've been identifying zones even in the upper levels with additional mineralization that we're brining to the research this year.

Chris Thompson -- PI Financial -- Analyst

Right. Okay. Great, guys. Okay. Thanks for that. Yeah, thanks for hosting the call.

Jorge Ganoza -- President and Chief Executive Officer

Thank you, Chris.

Operator

And our next question comes from James Huntington with Scotiabank. Mr. Huntington, your line is open. Please go ahead.

James Huntington -- Scotiabank -- Analyst

Hi, guys. Thanks for taking my call. Just a couple of questions regarding Lindero. Compared to the Q1 NDA, I see the ADR plan. And crushing circuits have been delayed about a quarter. Could you give some color just as to the cause of the delays?

Jorge Ganoza -- President and Chief Executive Officer

Yes. Yes. I have to say that we have no material source of delay on the ADR or SART. We have had in the past, particularly at the beginning of the launch of Lindero, large issues to deal with like camp availability, weather issues at the beginning of this year, issues with the amount of rock excavation for foundation work. Those were large issues that we identified and we've been vocal about at the start of the Lindero construction. But today, what we're seeing is a slight slippage due to research that's provided by contractors coming into the project, mainly on the electromechanical contract. I'm here to paint the picture. Earthworks work is the grunt of the -- the bulk of the earthworks is done, concluded, and behind us. In a month and a half, two, we are done with the leach pad, and that, which is a large contract, is over and done.

Then, is our concrete structures and placement of concrete. That's in the hands of a large contractor. All the mission critical areas on concrete are concluded -- or more than -- not concluded, 98% concluded, to be more precise. Mission critical areas of concrete are done. We still have flooring for the office area and other ancillary facilities but nothing that is mission critical. But we do take in our schedule some 20 to 40 days of delays from the slow ramp up of that contractor when he came into the project. Today, that contractor is working with all the resources we require on site. He's performing. And concrete is not in the mission critical part.

Right now the big contract, and the one that counts in the last mile of the project, is electromechanical and piping installation. The contractor is on site. We currently have about 120, 130 direct workers from the contractor on site. That is -- we have a small gap of about 10%, 12% with respect to what the plan calls in terms of man power. And it is those slow or small issues that have an impact in our projections. So, we are moving from early Q1 for placement of ore in the leach. But we're just saying -- sorry, early Q4 -- to saying Q4. And the availability of a pregnant solution from the irrigation then it's an issue. If we are early in Q4, then we should have plenty of time to generate enough solution to send to a navy yard that should be ready by early next year. But if we are placing ore in the leach, but instead of early in Q4, late in Q4, it'll take a bit more time to generate that pregnant solution to source steady flow to the ADR.

So, those are the things that are moving, or have potential to move, or are gearing our guidance today. We don't have issues with equipment. We have -- I think you can get a sense from that from the typical advance of a project or on where we are with the spending on the project. We have on site all the equipment, all the steel structures -- or not all, but 95% of the steel structures we need. But we are in our schedules. For the last year, we've been working on tight schedules. And we've been working -- we are working hard to -- for zero deviations here. But still, we're working within this quarter. So, if we're able -- as we are able to place ore in Q4 on the leach pad, as soon as we can generate enough solution, we'll have that ADR ready by -- in Q1 of next year, and we can start running at a steady flow.

We are not planning for shortcuts to produce first [inaudible] here. We want to launch our entire circuit. Of course, us commissioning demand on stages and what not. But we will be producing in a way that, when start producing gold, we can sustain it, and we can have a quick move to commercial operations within the assigned parameters. Of course, as you all know, there are risks associated to commissioning. And a swift commissioning under a mechanical availability and what not. But I can tell you that our plan calls for the entire circuit to come into line. And we're not shortcutting to show our first [inaudible], photo for the press. We want the entire circuit to come in.

James Huntington -- Scotiabank -- Analyst

Okay. Great. And just one more thing. Just for commercial production, what is your parameters you're looking for to declare that?

Jorge Ganoza -- President and Chief Executive Officer

One, mechanical. Basically a big component of this is the crushing circuit and stocking circuit. Let me go back. The mine -- on the mine, we have no issues with being able to source the mine feet at the rate -- the planned feet at the rate required from the mine. So, taken care of. On the plant -- on the crushing agglomeration side, as long as we are -- or we see ourselves well within 85% within design parameters, we're OK with ticking that box. And on the ADR side of things, we need to see gold extraction in also within 85% of design parameters on gold extraction from solution. As you know, a leach pad is a bit of a black box. And but we can get an early sense for -- because we have rapid extraction curves in our column tests. Within a reasonable time, I believe we can gauge the performance of gold extraction in the heap as well.

James Huntington -- Scotiabank -- Analyst

And sorry, I should have added to that. Do you have a sort of period for which you have to name those sort of parameters? Like is it 20 days, 60 days? Do you have any color on that?

Jorge Ganoza -- President and Chief Executive Officer

We don't have a set period and -- for example, the crushing, yes, you like to see the crushing operations steady for a period of time, 20 days, a month. Now, the crushing is starting in October, November. So, by December, we should be ticking the box of the crushing circuit, right. And while we're doing that, you commission the crushing by crushing. So, that's part of the ramp up of the stockpiling, right.

James Huntington -- Scotiabank -- Analyst

Okay. Great. No further questions from me. Thank you.

Operator

Again, ladies and gentlemen, if you do have a question or comment, please press *1 on you telephone keypad to join the queue. And we'll take out next question from Ryan Thompson with BMO. Please go ahead.

Ryan Thompson -- BMO -- Analyst

Hey, guys. Thanks for the sort detailed update on the construction progress there. Can you just kinda help me out with my modeling and just timing of cash flows? You mentioned that there's still some more VAT that has to go out the door. Could you just remind us how we should be modeling that in terms of recovering it? And then, how should we be modeling the $25 million of preproduction expense that you also mentioned in the press release?

Luis Ganoza -- Chief Financial Officer

Yeah. So, in terms of VAT -- so at the end of June, we had around $29 million. As we disclosed in the news release, we expect to incur an additional $18 million. So, overall, we expect to close the construction phase with around $27 million of VAT to collect. Our best estimate today is that we can do it in a period of two years. We don't see any material reason why we -- after commercial production begins in a two-year period, we don't see any material reason why that shouldn't be achievable at this stage. And with a tick to preproduction -- that's comprised of -- there's around $5 million of inventory supplies and $20 million of strictly preproduction that will allow us to accumulate a stockpile of ore by the end of preproduction phase of around 1.9 million tons. And we will have processed at that time an additional 1.4 or 1.5 million tons. So, the preproduction really is related to advanced opex, right. And it is within the range of our unit costs. Those numbers come around -- if you do the math -- $11 per ton of ore, mine and processed. So, that's the nature of those expenses.

Ryan Thompson -- BMO -- Analyst

Okay. So, it sounds like it's probably mostly gonna be incurred in the fourth quarter and maybe a bit in the first quarter of 2020 as well?

Jorge Ganoza -- President and Chief Executive Officer

Yes. Yes. That's fair enough. Yes.

Ryan Thompson -- BMO -- Analyst

Okay. All right. Thanks. That's helpful. That's all I had. Thanks guys.

Operator

And our next question comes from George Foley with Pacific Income Advisors. Please go ahead. Mr. Foley, your line is open. Please ask your question now. And as a reminder, ladies and gentlemen, if you do have a question or a comment, you may press *1 on your telephone keypad to join the queue.

George Foley -- Pacific Advisors -- Analyst

Hello? Hello? Hello?

Jorge Ganoza -- President and Chief Executive Officer

We hear you. We hear you.

George Foley -- Pacific Advisors -- Analyst

Oh, I'm sorry. Yeah, this is George Foley, Pacific Income Advisors in Santa Monica. Have you considered instead of going and spending the bank line to do a convertible security for this next piece of money you need to complete the mine?

Jorge Ganoza -- President and Chief Executive Officer

We have suite of options in front of us. Here, the -- first, the nature for need is to give flexibility to the start of operations in Argentina, right. So, we have ample net capacity to give ourselves an additional -- something in the range of $30 million to provide Lindero with that start-up, working capital flexibility. And a convertible is something that we would consider within that suite of possibilities, yes. On some end, yes.

George Foley -- Pacific Advisors -- Analyst

Okay. Great. Once production is up and stabilized like in the second quarter of last year, what would be the daily tons through the plant?

Jorge Ganoza -- President and Chief Executive Officer

We are expected to be running from early in the -- after commissioning of the crushing circuit in the fourth quarter of this year at a rate of 18,750 metric tons per day.

George Foley -- Pacific Advisors -- Analyst

Wow. Okay. Well, thank you very much. And congratulations on a successful bill. That's a big project. Incredible.

Jorge Ganoza -- President and Chief Executive Officer

Thank you.

Operator

And with that, there appear to be no further questions, so I will turn this back over to Carlos for any closing remarks.

Carlos Baca -- Investor Relations Manager 

Thank you, Christy. 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

And that does conclude today's teleconference. We thank you for you participation. You may disconnect your lines at this time. And have a great day.

Duration: 48 minutes

Call participants:

Carlos Baca -- Investor Relations Manager 

Jorge Ganoza -- President and Chief Executive Officer

Luis Ganoza -- Chief Financial Officer

Chris Thompson -- PI Financial -- Analyst

James Huntington -- Scotiabank -- Analyst

Ryan Thompson -- BMO -- Analyst

George Foley -- Pacific Income Advisors -- Analyst

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