Fortuna Mining Corp. Q2 FY2022 Earnings Call

Good afternoon, ladies and gentlemen. And welcome to Fortuna Silver Mines Quarter Two 2022 Financial and Operational Results Call. At this time, all participants have been placed on a listen-only mode and the floor will be open for questions-and-comments after the presentation. It is now my pleasure to turn the floor over to your host, Mr. Carlos Baca, Director of Investor Relations. Carlos, over to you.

Thank you, Jenny. 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 2022. Hosting the call today on behalf of Fortuna will be Jorge Alberto Ganoza, President and Chief Executive Officer; Luis Dario Ganoza, Chief Financial Officer; Cesar Velasco, Chief Operating Officer, Latin America; and Paul Criddle, Chief Operating Officer, West Africa. Today’s earnings call presentation is available on the Featured Presentation box on our homepage at fortunasilver.com. As a reminder, statements made during this call are subject to the reader advisories included in yesterday’s news release and in the earnings call presentation. Financial figures contained in the presentation and discussed in today’s call are presented in U.S. dollars, unless otherwise stated. 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.

Thank you, Carlos. Our business continued to perform well in the delivery of production and costs in the second quarter. We pre-released production figures on July 11, both silver and gold are tracking in line with management plans and expectations to meet annual guidance. For the first six months, we produced 129,000 gold ounces and 3.3 million ounces of silver, achieving the middle of our guidance range for the year. Gold accounted for roughly 70% of sales and silver for 20%, with byproduct zinc and lead making up the 10% balance. In spite of inflationary pressures on key consumables like diesel, steel, cyanide, and explosives, and the strain on the supply chain, costs at all our mines are tracking within the range we provided at the beginning of the year for annual guidance. Our Lindero, Yaramoko, and San Jose mines are in the upper range of guidance but within it. But more importantly is the fact that at the Séguélé construction, which is 66% complete as of the end of June, today approximately 70% complete. We are not experiencing any deviation with respect to our guided budget and timeline. We monitor active construction projects around the world and observe several experiencing challenges leading to significant deviations in CapEx and timeline. The strong delivery at Séguélé is the result of good planning, strong construction partners, and selected contractors, a consolidated owner’s team, and years of experience put to work. I am very satisfied with the outcome so far, and Paul Criddle, our Chief Operating Officer for West Africa, will provide you with details on the construction further down on the call. On sustainability, health and safety, I want to highlight a quarter free of lost time injuries with over 3.1 million hours worked across all our sites, zero environmental and social incidents of significance during the period as well. In the quarter, we realized a silver price of $22.62 per ounce and $1,870 per ounce of gold. Our headline financial numbers were a healthy free cash flow of $22 million, mine operating income of $32.5 million, adjusted EBITDA of $58 million, with an EBITDA margin of 34%, net income of $1.7 million or $0.01 per share, and adjusted net income of $2.1 million. We remain well-funded to meet our capital demands with a liquidity position of $136 million at the end of the period. I want to say that this has been a difficult quarter for several peer mining companies reporting losses in the period. Although, we met physical targets for gold and silver production, and cost targets, as I just described, and managed to log a small gain. We came below analyst expectations for earnings per share. Our revenue and earnings this quarter were impacted by the fact that 40% of our revenue comes from concentrate sales, where we were exposed to negative provisional pricing adjustments amounting to $6.6 million due to a steep decline in silver prices and zinc prices from April to June. And also impacting earnings was a $4 million inventory write-down of low-grade stockpiles at our Yaramoko mine. On the exploration front, we have 12 drill rigs turning across sites with an annual budget of approximately $30 million. We work from a base of consolidated reserves that add up to approximately 4 million gold equivalent ounces as disclosed in our annual result statement. Our exploration priorities are to continue to pursue several high-value opportunities at Séguélé, where we keep adding new resources. The December deposit with 350,000 inferred ounces being the latest success of that program. The other priority is reserve replacement at the San Jose and Yaramoko mines, and also definition of our investment case for the Boussoura Project in Burkina Faso this year. In the quarter, we began our share repurchase program with an initial return to shareholders of $3 million. For the execution of the program, we bring into consideration several aspects that include not only our valuation, but also risk to capital demands in a construction year and sensitivity of our liquidity position to the current volatility in gold and silver prices. So, with that, as an introduction, I’d like to turn it to our Chief Operating Officer, to give you a bit more color on the business. So, Cesar, you want to start?

Absolutely. Thank you. Thank you, Jorge. In the second quarter, the three operating mines in Latin America delivered a strong production of 1.65 million ounces of silver and 37,600 ounces of gold. As Jorge highlighted, for Latin America, production for the first six months totaled 3.3 million ounces of silver and 36,000 ounces of gold, all mines are aligned to achieve the annual guidance range. Allow me to make some remarks at the assets. In Argentina, Lindero delivered a gold production of 29,000 ounces, which represents a 49% increase year-on-year and is on track to achieve the annual guidance range. Gold production for the first six months of the year totaled 59,000 ounces. During the second quarter, the operation delivered 99% of the 1.5 million tons of ore placed on the pad by means of the crushing and stacking circuit, demonstrating steady production performance. The operation continues to focus on capturing higher productivity opportunities in all processes and has been successful at achieving important reductions on key consumables during the second quarter, such as sulfuric acid, fresh makeup cyanide, and diesel. Moving on to Mexico, the San Jose mine delivered 1.38 million ounces of silver and 8,295 ounces of gold. Compared to the second quarter of 2021, production variations are a result of a combination of 7% lower mill throughput and lower head grades, which are in line with the Mineral Reserve estimates. With the aim to improve production capacity and reduce total mining costs per ton, the operation has successfully implemented long-haul stopping in selected areas of the mine. In addition, a new underground shotcrete plant was commissioned, which is expected to reduce overall mining cycle times and support costs. Silver and gold production for the first six months of the year totaled 2.7 million ounces and 16,534 ounces. The operation remains on track to achieve its annual production guidance range. The Caylloma Mine in Peru, a steady performer, delivered 267,500 ounces of silver, 10.8 million pounds of zinc, and 7.6 million pounds of lead. Production for the first six months totaled 539,000 ounces of silver, 21.6 million pounds of zinc, and 16.7 million ounces of lead. Production at Caylloma is on track to achieve the upper range of guidance. Back to you, Jorge.

Thank you, Cesar. Paul, please?

Thanks, Jorge. Operations in West Africa continued their solid performance in Q2 and are tracking well with respect to our plans and budgets. Ongoing worldwide inflationary and supply chain pressures did not impact operations in Yaramoko nor the construction progress at Séguélé. At the Yaramoko Mine, second quarter gold production of 24,553 ounces was in line with the plan, leaving the operation in a strong position with a year-to-date production of 52,788 ounces on target to meet the upper range of annual guidance. Moving to Côte d’Ivoire, on our construction progress at Séguélé continues to be steady and in line with plan. As of June 30, the project is 66% complete and approximately $96 million of the $173 million initial capital budget is accrued. Construction activities are progressing on time and on budget with first gold pour projected for mid-2023. The project continues to be derisked, having advanced through the critical bulk earthworks phase and now advancing key above ground scopes to notable milestones. The mining services contract was signed with Mota-Engil and long lead fleet ordered, currently consolidated in Europe and awaiting shipment to the plans of the third quarter. Mota has commenced establishing their facilities, as well as the mobilization of its management team to site. The project critical path processing plant EPC is on track at 70% completion. While HV grid connection scope is advancing just ahead of the plan at only 1% completion. The majority of equipment packages have been secured and first deliveries of Abidjan are arriving on site. All major construction contracts and mobilizations are underway with the critical S&P contractor now on site. The water storage embankment is complete, and we are now harvesting water ahead of commissioning activities with 75,000 cubic meters currently stored. The first structural steel shipments have begun to arrive at site. In parallel with the excellent progress on the ground, operational readiness scopes are advancing well with the operations team and system continuing to be established. A key member of the operational team, the General Manager of Operations, was hired during the quarter, with progress on the next level of management staffing advancing according to plan. Dialogue is open and ongoing with the mines and budget ministries in Côte d’Ivoire around the negotiation of Séguélé’s Mining Convention. Back to you, Jorge.

Thank you. Luis, you will provide a financial update.

Yes. So sales for the quarter were $167.9 million. This is a 9% increase over Q2 2021. The higher sales were driven by the contribution of Yaramoko with $45.9 million in the quarter and sales from San Jose of $57.2 million, which were 67% higher than Q2 2021 and representing an additional $23 million to our topline. This was partially offset by lower sales of San Jose of 34%, representing a decrease of close to $21 million in sales. This decrease at San Jose was driven by lower silver prices and concentrate sales adjustments in the context of declining prices throughout the quarter and lower production probably in line with our guidance for 2022. Our average provisional realized prices in the quarter were $18.70 per ounce for gold, compared to $18.12 in Q2 2021 and $22.6 per ounce for silver, compared to $26.9 in Q2 2021. Prices during the quarter, however, experienced, as Jorge mentioned, a steady decline, triggering $6.6 million of negative concentrate sales adjustments, a one-time effect typical experience at points of inflection in metal price trends. Around $3.5 million of this impact is provisional mark-to-market at the end of June. On a comparative basis, our accounting results are lower than Q2 2021 in spite of higher sales due to a reduction in operating income at our San Jose mine, which is not entirely offset by the contribution from Yaramoko in the quarter. A large contributor to this effect is the increased accounting depletion at Yaramoko that comes with purchase price accounting. With respect to operating costs, the quarter reflects the overall impact of inflationary pressures with higher costs in particular at Lindero and San Jose. In relation to our cost guidance on a consolidated basis, we estimate the impact to be around 5% of our cost savings. The G&A line item in our income statement of $14.8 million increased $5.6 million over the prior year. Page 12 of our MD&A provides a breakdown of our G&A, which includes added nine general and administrative expenses from Lindero and Yaramoko, as well as higher corporate G&A. Corporate G&A expense in the quarter is close to be $8.1 million. We expect our run rate to be in the range of $6 million to $7 million. Other items that impacted the quarter included an inventory write-off of low-grade stockpiles at Yaramoko. This was mentioned by Jorge and an FX loss of $3 million, mostly unrealized and related to the impact of a weaker euro on our VAT collectible balances at our operations in Burkina Faso as the local currency affects the euro. Our effective tax rate for the quarter was particularly high, mostly due to timing of withholding taxes. Our year-to-date effective tax rate at 42% was in line with our expectations for the year. An additional item worth noting on the income statement is a $5.9 million gain on the area of derivatives, which consisted of $6.4 million of unrealized gains and $0.6 million realized loss. The unrealized gain was driven by the drop in zinc prices in the quarter. EBITDA of $57 million was 5% above Q2 2021, but $23 million below our EBITDA in the prior quarter as a result of lower sales and higher costs. We reported strong free cash flow of $21.9 million in the quarter and $31 million year-to-date. This is free cash flow from ongoing operations before expenditures in new construction such as Séguélé. On the balance sheet, we closed the quarter with $136 million of liquidity, with $20 million undrawn under our $200 million revolving credit facility. Our total net debt including the outstanding convertible debenture is $110 million, which provides a very modest debt leverage. On the Séguélé construction, we funded $23 million in the quarter and $64 million year-to-date. On a project-to-date basis, we have funded close to $100 million of the $174 million of total initial capital declared. Back to you, Jorge.

Okay. That’s all for management. Carlos?

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

Thank you. The first question is coming from Trevor Turnbull of Scotiabank. Trevor, please ask your question.

Thank you. Jorge, you mentioned, I think, in your write-up that there were some optimization projects at Lindero that would help potentially reduce some of the input costs that you have at the SART plant, and I just wondered if you could talk a little bit about the timing of those projects and maybe how much of a benefit you would expect to get out of that in terms of cash cost savings?

Yes. I can let Cesar provide more details on the optimization cost initiatives. Currently, the main focus is the optimization of the SART plant, which helps us significantly decrease makeup cyanide in the system. In our feasibility study, we estimated cyanide usage at about 0.5 kilograms per ton, but we expect to achieve only a quarter of a kilogram per ton. This also involves a more efficient use of sulfuric acid, which we estimated at 1.2 kilos per cubic meter in our budget, but we are currently operating under a kilo per cubic meter. Cesar, would you like to elaborate on some of the other initiatives?

Certainly, Jorge. As you mentioned, cyanide is one of the key aspects here. We also have some significant improvements in the sulfuric acid consumption when compared to the feasibility study, we are in the range of 40% to 46% below in consumption versus feasibility. So, we expect a full impact on cost reduction for the year by the end of the year as well and we have increased significantly our haulage productivity, as well as lowering the diesel consumption for our mining fleet, which in today’s prices obviously has a significant impact on the total cost.

The Lindero Mine's all-in sustaining costs are competitive at around $1,100 per ounce. These costs are still somewhat affected by ongoing corrective maintenance initiatives aimed at improving productivity. However, as we progress, I believe that costs will begin to trend more towards the lower end of the range, between $1,100 and $1,000. We still have considerable corrective maintenance work to do, which weighs on our all-in sustaining costs and is a result of the challenges faced during the difficult commissioning phase impacted by the COVID pandemic. Despite this, the mine continues to perform well within our guidance and maintains competitive costs of $1,100 all-in sustaining, despite the ongoing maintenance efforts.

No. That sounds good. I appreciate the details. I had one other question about West Africa, and again, you mentioned the Sunbird resource that came in as a satellite deposit, where you put out the first inferred resources. I was just wondering, if we should look for another satellite deposit that you might be targeting that we might see a first resource maybe next year on one of the other deposits?

One of the key factors for acquiring the business combination with Roxgold was our strong belief in the potential of Séguélé to continue providing similar opportunities, like the one we are developing with Sunbird. Currently, Sunbird is estimated to have a resource of 350,000 ounces of gold with grades around 3.6. However, these grades are hiding a higher-grade ore, and we are already considering moving forward with an underground mining plan for this higher-grade ore. Sunbird remains open for further exploration. In the last quarter, we reported exceptional drill results outside the existing shell of inferred resources that include the 350,000 ounces, which suggests that Sunbird will continue to expand. Regarding your question, we currently have about 40 targets in our inventory, and we are drilling some of them. We look forward to sharing results soon. Our ongoing drilling program is focused on testing targets beyond our current deposits, which are Antenna, Ancien, Koula, Agouti, and Sunbird. Besides these, we are actively drilling and pursuing more satellite deposits. We believe we have a 30-kilometer stretch along the corridor that hosts Séguélé, and within this area, we have 40 targets to explore. While some companies may slow down exploration during construction, we view these as high-value opportunities and, as we are building, we continue to drill aggressively.

Okay. Yeah. Look forward to seeing drill results from some of these other targets. That’s all I had, though. Thank you, Jorge.

Thank you, Trevor.

Your next question is coming from Don DeMarco of National Bank Financial. Don, please ask your question.

Thank you, Operator, and good morning, Jorge and team. Just continuing on with West Africa, could you tell us a little bit more about the QV Prime zone at Bagassi South? I see that you are planning to do earlier development there? And maybe if you could just talk about how much incremental CapEx you might be spending there in 2022 and what it means for production in 2023 and 2024?

Yes. QV Prime today is about 30,000 ounces of gold in our inventory and we are advancing this year with the development of QV Prime to provide further flexibility to the mine in 2024, sorry, in 2023. So we are also contemplating a change in mining method that will allow us to reduce costs as we mine this resource. We have brought into the budget for development this year $7 million that was not included in our budget and capital guidance at the beginning of the year. But we have assessed with Paul and team that this will be very welcome flexibility into 2023.

Okay. Thank you. So maybe an incremental $7 million. I appreciate that. So speaking of mine that is and shifting over to San Jose, you have implemented long-haul stope at San Jose. Looking forward, would we expect to see an increase in tonnage or maybe decreasing grades if tonnage were to increase in the coming quarters?

No, that is not in our plan. At San Jose, as we have been mining through the reserves over the years, we are experiencing a narrower production zone. Five years ago at San Jose, our stopes were 20 meters wide. Today, they are more like 3 meters wide or 5 meters wide. The change in mining method helps us ensure that we can meet the nameplate capacity of the plant. In the quarter, we experienced 7% less throughput compared to a year ago. The reason for that was that during the quarter, we had three days of non-continuous blockades that impacted production for about five days due to blockading international sports in Oaxaca. All of those issues have been resolved, so everything is good. That’s why we saw the shortfall of 7% in throughput compared to what we planned and against the previous year. However, the change in mining method is providing greater flexibility to the operation to meet throughput, lower costs, and improve efficiency.

Okay. Okay. That’s good. And if I ask a final question then, you mentioned Lindero, cost actually fairly attractive $1,150 AFC in Q2. But it was noted in the report that the inflationary pressures are most pronounced at Lindero. Why is that? What is specific to Lindero versus the other mines? Is it because of the higher cyanide costs specifically?

Yeah. It really has to do with the higher dependence in the cost structure related to certain key consumables, mainly cyanide, P cells, sulfuric acid. That’s the key reason.

Okay. Okay. Well, thank you very much. That’s all for me.

Thank you. Your next question is coming from David Kranzler of Investment Research Dynamics. David, please ask your question.

Hi, guys. Thanks for taking my call. I just have a couple of quick questions. Do you know offhand how much of the variance in operating income between the second quarter of 2021 and second quarter of 2022 is attributable to the lower average cost of silver in 2022?

How much is due to the lower price of silver? I will say, if you give us a moment, we can provide a more accurate figure. However, I believe that around 40% of the decrease in operating income can be attributed to the price of silver, which has decreased by 16%.

Yes. From $27 to $20 right around $21 I think. You also have to consider the effect that, I mean, we disclosed those average provisional prices for the metal. But as we emphasize with the adjustments on concentrate sales, which come particularly from the San Jose contract, let’s say, where the silver production comes from, they have that compounding effect. So, yes, on the top of my head, I would say around 40%.

Okay. Great. So, I mean, I guess, assuming that the price of silver goes back up, which is why everyone would invest in Fortuna, not everyone, but one of the reasons. This potentially is just a one-time thing, again, assuming the price of silver goes higher?

Certainly. Fairly depending on, right, your expectations on the silver price.

Yes. I mean, we delivered the ounces and the costs and this is a business driven by physical metrics, right?

That’s right. And then the second question has to do with that $4 million write-down of the low-grade stockpile at Yaramoko. Is that kind of a one-time thing, did you write it down enough so that if the price of gold maybe is a little bit lower, stays the same, that won’t happen again?

David, the short answer is yes, regarding raw materials. We anticipate this will be a one-time occurrence linked to how we've managed our historic inventories, which are substantial, exceeding 100,000 tons. The accounting has been based on average cost, not necessarily reflecting the economics of accumulating these stockpiles. It's more about incremental costs where the mining cost remains relatively stable. To clarify, we don't foresee accumulating much more low-grade ore at Yaramoko, and we will be revising how we account for these inventories. Therefore, we do not expect anything of that magnitude in the future; if anything, future amounts should be significantly lower.

Okay. Great. And then just a quick follow-up on that, is that low-grade stockpile, is that something that could be processed profitably if we get lucky in the price of gold moves, say, over $2,000 an ounce?

The metal content in those stockpiles is above the processing tariff. Our current prices are profitable for processing stockpiles, especially towards the end of the mine's life.

Great. Thank you very much, and Jorge, I am sure I will have more questions for you tomorrow on the Arcadia Economics podcast. Thank you.

Look forward to that. Thank you.

Thank you very much. Your next question is coming from Ronald Brandsteka, a private investor. Ronald, please ask your question.

Okay. Hey. Thanks, guys, for taking my call, Jorge and team. Most of my questions have been answered, but I wanted to ask about Yaramoko. When I look at the last four quarters, the all-in sustaining costs have experienced some rather significant variations. I guess, two questions, what’s driving that and should we expect that variance to continue to be the case in the coming quarters and years?

I can start to address that and then let Paul provide more details. What we’ve observed with Yaramoko is that the mine's profile has been consistently declining along with the reserves. As a result, the mine is producing fewer ounces. We are currently mining between 5 to 7 grams per ton, which has led to a decrease in production. In terms of costs, on a per ton basis, we are managing operations at around $160 per metric ton, which has remained stable over the last year despite some capital expenses. Overall, from an all-in sustaining cost perspective, lower ounce production and capital requirements are affecting costs. Paul, would you like to add anything?

Yeah. I think very much in line with what Jorge is saying, Ron. The mine’s capital density relative to the gold production changes at depth. The strike length has come in, so it’s shorter. But we are still having to develop the decline at the same rate to access at the bottom of the mine. So, yeah, that relative to gold production we are looking, I think, where it is. I think it will be fairly consistent with where it is now for the next little while before the mine turned into a harvesting mode, i.e., we get to the bottom of the mine. We stopped developing the decline, and then those costs come way down for the last 12 months, 18 months of the mine’s life, while we are just in stoping harvesting mode. So I don’t anticipate any increases until we get to the bottom of the decline.

So you are incurring some expenses. Did the $4 million write-down during the quarter impact the all-in sustaining cost?

The answer is yes to the question.

Okay. Okay. Look forward to that…

So both the stockpile write-down and as per the question of Don earlier, the additional capital to develop across QV Prime is included in the quarter and the forecast for the year, which still tracks within our guidance.

If I may address a prior question on the impact of the silver price on the operating income drop of around $10 million. I just want to confirm that, yes, silver price, let’s say, would have been within 40% to 50% of the overall drop in operating income and that will be coming, as I mentioned, mainly from San Jose, yes.

Thank you very much. Your next question is coming from Adrian Day of Adrian Day Asset Management.

Oh! Yes. Good afternoon. Listen, I may have missed it at some point, but I just wondered if there was any kind of update on San Jose with regard to the lawsuit and the discussions that you were having with SEMARNAT and others?

Good morning, Adrian. The short answer is no. We are still in the court proceedings, where we are appealing to overturn that resolution. We firmly believe—it’s a viewpoint that strengthens as the process continues—that the way it was handled renders the resolution invalid. Just based on the procedure, that resolution shortening the term of our EIA is not valid. Therefore, we have a strong expectation that there is a critical flaw in how the Secretary of Environment Office issued that resolution affecting our EIA's term. Although I remain cautious until we hear from the judge, the fact that the judge promptly granted the company a stay of execution and protection is a positive sign. However, there have been no updates; we have not heard back from the court. We anticipate hearing from the court this year.

Okay. Okay. Thank you.

Okay. We appear to have no further questions in the queue. I will now turn it back over to management for any closing remarks.

Thank you, Jenny. 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 great 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.