Fortuna Mining Corp. Q4 FY2020 Earnings Call

Good morning, ladies and gentlemen, and welcome to the Fortuna Silver Mines Fourth Quarter and Full Year 2020 Financial and Operational Results. At this time, all participants have been placed on a listen-only mode. And we will open the floor for your questions and comments after the presentation. It is now my pleasure to turn the floor over to your host Carlos Baca. Sir, the floor is yours.

Thank you, Matthew. 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 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 www.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.

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 three years, we have come to place ourselves in a most exciting position today as we’re delivering significant growth in gold production in a rising precious metals market. This year, our production guidance from our three 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 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.

Yes. Thank you, Jorge. So, on slide 18. Yes, as has been discussed already 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 on 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, the 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.

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

Thanks so much for taking my call. Jorge, so you mentioned the stacking system. I read that it's at 23% in February, with performance increasing to 30% to 40% in March. What kind of level would you be comfortable with in order to meet the guidance in 2021?

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 any tonnage or extracted ounces we’re not placing with the stacking system, and we are making up for that by placing ore on the leach pad with trucks. So, what we are tracking is the amount of extractable ounces that we place on the leach pad every month. We are meeting the extractable ounces on the leach pad as per our guidance. The issue is that the ounces that we place with the stacking system, we expect gold extraction to be in the range of 75% to 78% over 90 days. With the ounces that we place with trucks, as they are a bypass that comes from the secondary crusher stockpile, and it's a 34-millimeter crush. 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, more ounces in the leach pad to comply with guidance. This is a temporary solution while we get the stacking system up to design. In these early days of March, we are seeing the stacking system performing at between 30% and 40%. We had a good day yesterday with 9,000 tons per day, which is more like 50% of capacity. We are dealing with some issues with the stocking; it's mainly the overland conveyor braking system malfunctions, generating massive spillages. It's basically the automation system of the stacking system that is not communicating properly at all times. We are testing what's happening, and we are trying to get it working. When the braking systems don’t work in sync, we get massive spillages from one of these large conveyor belts, which takes up to five hours to clean up and get running again. Nothing that we cannot address, but I believe this is a good example of how COVID is impacting us. This issue could be resolved in a matter of days or weeks, even hours. The problem is that we do not have the benefit of having the vendor technicians on-site working with our operators and maintenance team. We are making good use of technology, but it's not the same. A lot of these issues that I believe could take hours or days, end up taking days or weeks because we just don’t have the on-site vendor technicians. The Argentinean borders remain largely closed to foreigners, so we cannot get the technicians into the country.

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, maybe 0.83 grams per ton or something. You had previously been targeting above 1. But now, I see that the stack grades for the full year are 1 gram per ton which implies there's been an increase in the stack grade. Are you comfortable with the grades that you're stacking right now? And is it in line with your expectations and plans?

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

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 considering at this point or repaying the debt? What are your capital allocation priorities beyond investment in exploration?

Yes. And thanks for the question, because it allows me to point something here. We have three priorities. First, we believe at times like these, many companies need to strengthen their balance sheets. These are the opportunities we have in cycles like the one we are in now to fortify our balance sheet. We view having a strong balance sheet as a priority for us. Even though our debt to EBITDA is low, we will ensure that we come out of this cycle with a very strong balance sheet. Second is exploration investment. As I noted during my previous comments, we have been short-changing our investment in exploration for three years, as we prioritized capital allocation to Lindero construction. We drilled only 8,000 meters in 2020, not enough to manage depletion at our mines and expand research. So, we need to increase our drilling to north of 40,000 to 50,000 meters. We're drilling at all sites. We have new initiatives outside of brownfields that we will test this year in Mexico and Argentina. Lastly, returning to shareholders is something we will consider as the best way to return capital to shareholders, and we will evaluate those options against other growth opportunities that we might identify. Certainly, returning capital to shareholders through dividends, special dividends, or other means is something that the Board is considering.

Your next question is coming from James Huntington. Your line is live.

Just following up on previous questions about the stacking unit. What sort of timeline, just at your current rates, do you think you could have the stacking system ramped up? It's unfortunate that COVID is obviously restricting you a fair bit there. But do you think this would be like a two-month process or you’ll be like 90% of the way by the end of March? Just a bit more color there. Thanks.

Yes. And that’s a tricky question to answer. Our problems with the stacking are isolated right now to the braking system and communications issues on that system. We've been trying a lot of things and solving problems, and now we're left with this one. If you know how this works, you can suddenly get it right and see a bump in performance. We're already starting to see better days and can foresee significant improvement in performance. We're almost at mid-March, and our expectation is to get within 85% of performance in March. If not, we might see some spillover into April. But it’s difficult for me to gauge. The issues should be resolved in a matter of days or weeks, not months, because of the nature of the problem and where we are with the solution. So, my best assessment would be days or weeks to get this problem sorted out since this is the only issue we are currently battling.

And then, could you provide some color on the ramp-up and the status of the SART plant and its ramp-up as well?

Yes. The SART plant is not critical for us, but it's important. We need the SART plant, but we don’t need it to produce gold, and we don’t need it right away. The copper content in the pregnant solution thus far is manageable. In February, the SART plant was operating at 37% of design capacity. We have diverted resources from the maintenance and operations teams to critical areas needed for gold production, specifically the stacking and the crushing system. We have deprioritized efforts around the SART. Once we get that stacking system running at the required efficiency, we will come back to the SART plant. We've been able to precipitate 80% to 90% of copper in solutions, so the chemistry is exceeding our expectations; we just need to increase flow. Currently, we have an issue with the copper filter, waiting for a minor repair. However, we are prioritizing resources to critical areas.

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

Yes. I understand you’re asking for the depreciation dollars per ounce. We're using the units of production method based on ounces produced. Unfortunately, I don’t have a specific number in my head that I can share at this moment. However, we should expect depreciation to track along with the production output throughout the life of mine. So, that will be in sync with the evolution of income throughout the life of mine. I apologize; I can't provide a specific number right now because I don't have it readily available.

Your next question is coming from Adrian Day. Your line is live.

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

Yes. It’s a bit of everything, Adrian. At the San Jose Mine in Mexico, we have an aggressive drilling program in the immediate vicinity of the mine, both on the north boundary of existing resources and on the deep extensions to the south. We have also identified 400 meters due east from the main ore shoot, with two parallel structures; one that today hosts resources, the Victoria vein, where we have done no mining thus far. Also further east from Victoria, we have a couple of interesting drill intercepts of another blind structure with grades in the range of 135 grams over a couple of meters. We have a significant amount of drilling planned. In addition, at the San Jose Mine, we are exploring other areas and veins within the system. I would consider all of this within reach of brownfields, where successes could allow us to truck ore to our San Jose Mill. We signed an agreement this year, 2020, with Mina room and optioned the Higo Blanco property, some 15 to 20 kilometers due east from San Jose. It's an exciting exploration project. All of this is within our plans for 2021. At the Caylloma Mine, we have a similar scenario, with drilling in the extensions of non-mineralization and testing new areas and ideas in this productive vein system, which has been operational for over 500 years. For Lindero, we are stepping out to the Arizaro gold porphyry. We will be drilling that in the first half of the year. Arizaro is located 3.5 kilometers from Lindero, which is well within trucking distance. There has been drilling in the area over the years, and we believe there's potential for near-surface, high-grade satellite deposits. These satellites could contribute anywhere from 5 million to 20 million tons at grades in excess of 0.4, 0.5 grams gold, potentially as high as 0.7 based on previous drilling. So, we are testing those potential satellites at Arizaro as well as drilling new projects in Mexico and Argentina.

Your next question is coming from Justin Stevens. Your line is live.

Thanks, guys. Yes, most of what I wanted to get has really been covered already. I was mostly wondering how much copper are you guys seeing so far at Lindero? And conversely, how is the cyanide consumption relative to what you're looking for?

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

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

Yes. Copper grades are trending along with what we see in our resource reserve model, around 0.1% copper is what we're seeing. In the case of Lindero, what makes it viable is that 95% of that 0.1% copper that we see is in the form of chalcopyrite. So only 5% of that leaches under a cyanide solution. It does not consume cyanide like other copper mineral forms. Currently, our cyanide consumption is slightly below half, around 0.5 kilos per ton. So, it's tracking well within expectations. The copper in the pregnant solution is also in line with what we would expect in terms of leaching kinetics. We are seeing copper in the range of 400 to 500 ppm in the pregnant solution, so we’re managing that well with cyanide. The SART plant, although running at 30% to 40% of design capacity, is still doing the work required.

Yes, 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?

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

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

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

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.