Fortuna Mining Corp. Q3 FY2020 Earnings Call

Ladies and gentlemen, hello and welcome. Thank you for joining us for this Fortuna Silver Mines Third Quarter 2020 Earnings Conference Call. As a reminder, all phone participants are presently in a listen-only mode, but after today's prepared remarks, you will have the opportunity to ask questions. To get us started today with opening remarks and introductions, I'm pleased to yield the floor to IR Manager, Mr. Carlos Baca. Good morning, sir.

Thank you, Jim. Good morning, ladies and gentlemen. I would like to welcome you to Fortuna Silver Mines and to our financial and operational results call for the third quarter of 2020.

Thank you, Carlos, and good morning to all, as we present an introduction to our third quarter results and discuss the status of our operations in Mexico, Peru, and Argentina, and then turn the call over to Luis who will take you through financial statements. On Slide 6 of the presentation, in the third quarter, we have reported the highest financial figures in the company's history for sales, free cash flow from operations, and adjusted EBITDA. Free cash from operations was a strong $30 million and our EBITDA margin stood at a robust 51% over sales. We have $85 million in cash as of the end of the quarter, and a comfortable liquidity position of $140 million with a moderate debt to EBITDA ratio of 0.7. At Lindero, we produced our first gold on October 20. We are pouring gold every week and made our first sales in November. We are immersed in the ramp-up activities with the aim to stabilize production of disabilities and parameters by year-end and into the first quarter. Despite continued COVID-19 related restrictions, our mines in Peru and Mexico met production objectives in the quarter. In Argentina, restrictions on the flow of personnel across national and provincial borders hinder our ability to provide quick responses to various issues that arise as part of any production ramp-up phase. Across all sites, we have strict sanitary protocols in place and have taken over 8,200 PCR tests on our personnel reporting approximately 391 positive cases for COVID so far.

Thank you, Jorge. So as was previously mentioned, we had a record quarter in terms of sales, EBITDA, and cash flow. We recorded sales of $83.4 million, which is 36% above Q3 2019. This increase was on the back of higher metal prices, along with higher metal production, partially offset by higher treatment charges compared to 2019. We reported quarterly net income of $13.1 million and $16.1 million on an adjusted basis, translating to earnings per share of $0.07. In the comparative period of Q3 2019, the loss was related to an $8.2 million foreign exchange loss associated with the Lindero VAT receivable in Argentina. In Q3 2020, we reported an FX loss of $3.5 million, of which $2.7 million is related to the Lindero VAT. Additionally, in the reporting quarter, we had higher effective tax rates than what we expect on a recurring basis, impacting earnings by approximately $0.01 per share. Consistent with the drivers I mentioned earlier, we saw a material increase in EBITDA and free cash flow as Jorge pointed out. Free cash flow from operations of $30.1 million represents 36% of sales. This number contains a positive impact of around $5.5 million from changes in working capital related to the timing of certain payroll items, but even excluding this effect, free cash flow was close to 30% of sales. On Slide 25, when breaking down our sales performance for the quarter, we can see the highest impact came from higher silver and gold metal prices. In particular, the silver price contributed $5.2 million out of the total $22 million increase in sales. It is also worth mentioning the negative impact we see from treatment and refining charges, which have been a consistent feature of 2020. We expect these to revert in 2021 as we are seeing much improved terms in the market for next year.

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

Gentlemen, thank you. We'll hear first from Trevor Turnbull at Scotiabank.

I had a question. You talked a little bit about what you're doing in the last few months of the year, November, December at Lindero. Can you talk a little bit about how October looked in terms of what you were able to get on the pad in terms of tons or ounces? And can you talk also a little bit maybe about how the mining costs are tracking at Lindero so far?

Yes. October was a difficult month in the ramp-up. We had two breakdowns, a conveyor head pulley, something quite unusual; we have never seen anyone on the team break pulleys like that, particularly new pulleys. So that was a problem with fabrication. That took us down for pretty much 12 to 13 days in the month. Those are very simple to manufacture; we manufactured them ourselves in Salta. We have made spare cat pulleys something that we have never carried in stock in light of what happened. Nevertheless, that took us down for around 12 days in October; our design rate of production in the crushing system is about 1,100 metric tons per hour. We are running right now on average at around 800 metric tons per hour for the year so far. In the ramp-up, we're doing well. But the loss of operating hours in October did take a toll. As I mentioned, I think we're tracking in the right direction with a team of inexperienced operators whom we have trained. However, there is always a learning curve as they gain more experience with the equipment, limited by the rotation of supervision and the speed at which we can address issues. But in November, we are faring better. Overall, the message is that we are heading in the right direction; it's just taking a bit longer because of these difficulties related to moving personnel and to our ability to resolve on-site issues.

Now that November is settling in and is a little more typical of operating, can you say anything about how mining costs look on a unit cost basis compared to what you're targeting?

Unit costs of the mine are well within our expectations; we're not seeing any significant deviations. For Q4, we expect to report mining costs within our original plan, with no significant deviations. Of course, there are still distortions regarding plans and indirect costs, which are still being affected by the ramp-up. Overall, we see that our expected costs at a steady state are achievable and on track, which is in the range of $10.5 to $11 per ton of processed ore.

The main drivers for costs on the side of consumables are what we spend on fuel for energy, as we self-generate, cyanide, and lime. The pricing we have achieved on cyanide and fuel is well within what was in our budgets.

Yes, absolutely.

Okay. That sounds good. And I understand because the irrigation has been a little bit unsteady due to the stacking configurations. It hasn't gone exactly as you originally planned. Is it possible to give us a sense of recovery though from the heap? How if that's tracking also the way you wanted to?

Yes. As I mentioned, the leaching kinetics is something we're looking at carefully. We have the benefit that there is little interference with these initial cells as there is nothing stuck on top of them. The solution percolation irrigation cycle is quite rapid as these are the cells closest to the plastic right at the bottom. We also have our column tests to control what's happening, and what we are going to report is that the leaching curves are performing according to our expectations. Remember that we are currently placing coarser ore than was initially designed; we're placing ore at around 35 millimeters, while the design is 90 millimeters. We've carried out column tests and made projections based on this coarser ore crushed. We expect to achieve around 50% recovery within 90 days, and we're tracking towards that. In the initial cells, however, we had some issues that were more operational. We had a bit of bonding in one of the cells. We are stacking with trucks before we start the irrigation; we prepare the ground and rework the first 30 centimeters. We had to go a bit deeper due to traffic from trucks. Once we did that, the problem just went away. Additionally, we encountered some clogging of pipes due to the dosage of reactants we used to avoid the deposition of carbonates in the pipes. These issues were quickly addressed. These are just normal challenges that come during the ramp-up of a new operation. These problems are being managed, and the leaching kinetics are tracking along with our expectations. We are solving these issues. Regarding how swiftly we can incorporate new areas under irrigation, yes, we have made an adjustment in our forecast. We were unable to implement a retreat stacking, which would have allowed us to bring in irrigation at a much faster pace. We are stacking with trucks in an advance, not in retreat. Thus, we need to wait until the cell is completed before we can irrigate, which slows down our ability to bring new ounces under irrigation. This is a temporary issue related to the fact that we're stacking with trucks. This week, we began working with the conveyor stackers, which will alleviate this issue as it is designed for retreat stacking.

Yes, understood. Maybe just one very simple last question for Luis, and that is with respect to the VAT recovery. Any sense of how you expect that to play out?

Yes. We expect to start collecting VAT as soon as we commence sales. As Jorge mentioned, we had our first sale in November. Based on the existing regulation and the amounts we are able to collect as a percentage of sales every month, we expect that within 12 to 14 months, we should be able to collect the full amount in pesos. Just to clarify, the collection is in local currency. So that's the timeframe we are looking at.

Next, we'll hear from Chris Thompson at PI Financial.

Just looking at the pictures, it looks like a great place to build a mine. A couple of quick questions here. You do mention that you're allowing for additional time to fully take, I guess, the HPGR, agglomeration, and stacking systems to commercial. Now, is that built into the timeframe you anticipate for first commercial production in Q1?

We originally anticipated, Chris, to place about 0.5 million tons of crushed and agglomerated ore on the leach pad in December. We are reducing that tonnage down to about 320,000 tons. This adjustment accounts for what we are projecting would be more realistic based on the limitations we are facing in the current COVID environment, especially regarding the flow of personnel, supervision, and technical assistance. The commissioning process is dynamic; sometimes it goes very well and smoothly, and other times it presents challenges. So in this forecast, we're adopting a more conservative position regarding tonnage. However, we are monitoring closely and our current expectation is that early in Q1, we should be able to achieve around 0.5 million ounces of ore placed on the leach pad every month. Before incorporating the HPGR and conveyor, we were already approaching that rate of production.

Right. Can you, Jorge, remind me what you need to achieve to tick the box for commercial production?

We would like to see the mechanical aspects of the operation operating at 85% of design. First, the mine needs to be running at the design rate. Primary and secondary crushing have been operating within that efficiency range. We need to be able to sustain that, and we need to incorporate this last part of the train. With respect to the metallurgical performance, we'll know that through leaching kinetics; so far, and the AVR plant we also had some early issues with getting the temperature in the cauldrons up to the design level, but those issues have been resolved. The AVR is currently at or close to the design parameters. I believe the most crucial factors now are ensuring that the last portion of the crushing system is up and running efficiently and that the entire process train from primary crushing to stacking, can consistently deliver at or around 900 pounds per hour.

Okay. Just moving on and chatting about grade. When do you anticipate being in a position to increase the grade to expectations on the pad?

We are delivering the expected grade currently. If you look at the aggregate, we are falling behind. The only reason for this is that in the early stages of crushing, we didn’t have enough room in the camp to accommodate the operations workforce due to social distancing guidelines. Therefore, we were feeding the mill with a medium low-grade stockpile, which is what's causing our aggregate to fall behind. The reconciliation is going well, and this was an issue related to the first month or two of initial production. Our operations are currently delivering on grade; I don't foresee any issues in this regard.

All right. Okay. So we can expect you are stacking 0.9 grams per ton right now on the pad?

If I go by today's report, we are at 1.2 grams per ton. We are trucking with expectations here.

All right. Thank you for that, Jorge. And just flipping gears a little bit, I wonder if you could update us on the royalty disagreement with the government. Any developments on that front?

Nothing new. Just as a recap, the case is in court. We have been granted a stay of execution by the court, protecting us from any intention to collect the royalty by the Secretary of Mines. The case is still active in court. The development could be that we have indications that might lead to a ruling on first instance faster than we originally anticipated. We were expecting this would take several months to resolve, but the latest suggests there could be a ruling before the end of this year. A ruling would be a first-instance decision that any of the parties can appeal. If that were the case, the stay of execution protects the company throughout the appeal process. I think the only change could be that there are indications we might see a ruling on the first instance faster than initially anticipated.

Next, we'll hear from an individual investor.

You boys are doing a good job, and VectorVest Canada, they have the company valued at $16.62 Canadian per share. The last question is just wondering if Warren Buffett is interested in taking a large position. Thank you very much.

We have no relation with that banking. So we don't know about that coverage. The last I heard, Warren is not interested in taking a position.

Next, we'll hear from Garrett Goggin with Silver Stock Analysts.

I had questions about Lindero, how we're looking in 2021 and through the end of this year, but I guess we went over them pretty clearly. I guess my second question would be regarding Argentina and the capital controls. What was it, there was about $106 million you could get out before capital controls kicked in; has that changed at all? Could you discuss that please, Luis?

Yes. I can give a quick introduction to that. Yes, we all know there are capital controls or restrictions on access to the dollar exchange rate in Argentina. We have a repatriation plan in place considering all the current restrictions. Our repatriation plan is not impacted for the better part of 2021 by any of these measures, because of the structures we used to contribute the funding to Lindero. Luis, do you want to elaborate?

Garrett, to be more precise, we should be fine for the first $120 million to $130 million. We should be able to repatriate directly out of sales proceeds without having to bring those funds back into the country again, under the intercompany debt structure that we have in place. This particular component of the company is out of the scope of existing restrictions currently. As Jorge mentioned, that should cover us for at least eight to nine months of 2021.

Yes.

We'll hear next from Ryan Thompson at BMO.

Yes, I was actually going to ask the same question as the last caller, but maybe I'll just ask another one. In Argentina, there was an export tax that was reintroduced; I think it was last year at some point, and there was talk of that export tax potentially going away at some point. Can you maybe just comment on where things currently stand with that tax?

The export tax is currently at 8% for gold products, Ryan, and in our particular case, we have a tax stability agreement that fixes it at about 5%. However, this is something that in Argentina, you must claim after closing the exercise for the year. In March, we are not planning to claim back anything for 2020. Our plan right now for 2021, which would include the entire 2020, is to initiate the process of claiming back the difference. The process in Argentina is different from that in other countries like Peru, which also have tax stability agreements. In Argentina, the total tax burden is fixed and considers all taxable components. You can then claim the difference based on gains or losses. Unlike Peru, where you can fix the income tax or the royalty itself. We plan to evaluate any difference in 2021 and subsequently claim that through 2022.

Ladies and gentlemen, that does conclude our Q&A session for today's call. I'm pleased to turn the floor back to the leadership team for Fortuna and Mr. Carlos Baca.

Thank you, Jim. We would like to thank everyone for listening to today's earnings call and look forward to you joining us next quarter. Have a good end of the year. Bye.