Fortuna Silver Mines Inc (NYSE:FSM) Q2 2018 Earnings Conference Call August 9, 2018 12:00 PM ET
Carlos Baca - Manager of Investor Relations
Jorge Ganoza - President and Chief Executive Officer
Luis Ganoza - Chief Financial Officer
Chris Thompson - PI Financial Corp.
Mark Magarian - UBS Financial Services, Inc.
Greetings and welcome to Fortuna Silver Mines Second Quarter 2018 Financial and Operational Results Conference Call. At this time, all participants are in a listen-only mode and a brief question-and-answer session will follow the formal presentation. [Operator Instructions] And as a reminder, this conference is being recorded.
I would now like to turn the conference over to Carlos Baca, Investor Relations Manager. Thank you. Please go ahead.
Thank you, Brenda. Good morning, ladies and gentlemen. I would like to welcome you all to Fortuna Silver Mines and to our second quarter 2018 financial and operational results call. Today, we will be using a webcast presentation, which will be controlled by us. You can download the presentation at our website. Please click on the Investors tab then click on Financials tab and under Q2 2018, click on Earnings Call webcast.
Jorge Alberto Ganoza, President, CEO and Director; and Luis Dario Ganoza, CFO, will be hosting the call from the City of Salta in Argentina.
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 our 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. That 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 Ganoza, President, CEO and Co-Founder of Fortuna.
Thank you, Carlos, and good morning to all. Along with Luisa, our CFO, we will be presenting results of our business for the second quarter, encompassing our operating line, development project and exploration activities in Mexico, Peru, Argentina and Serbia.
Moving on to the highlights slide. Highlights for the quarter includes in the first bullet, the strong performance of our mines, which is reflected in the robust 48% consolidated EBITDA margins and $28 million in free cash flow generation before the Lindero CapEx. As of the end of the quarter, our liquidity stands at $278 million with a debt-to-EBITDA ratio below 0.5.
In the third bullet, at Lindero, we recently reported an update of our forecast for initial capital. With 71% of our direct capital costs for sign, we forecast and increment in the range of 10% to 17% in the initial capital from our $239 million budget. We view this variation within the limits of feasibility study level, and we feel contingency of $24 million in the forecast figure. And last in the highlights, we have a very positive results from the expiration program we are funding as part of our 70% earning option agreement with Medgold Resources at the Prospero Silver target in Southeast Serbia.
Moving on to Slide 6. Our consolidated silver production grew by 10% in the quarter to a historic record of 2.3 million ounces. Gold production stayed flat at 14,600 ounces. The growth in silver production is a result of higher silver grades at our San Jose mine in Mexico.
Zinc production grew 8% to £11.4 million and net production stayed essentially flat at £7.2 million. Although we are not modifying our guidance, looking at mid-year production and reserves in the plan for the second half of the year, it is reasonable to expect we can meet or exceed guidance by a margin in the range of 10% for both silver and gold.
Moving on to Slide 7 in the webcast presentation. Here we show silver contributed 49% to provisional sales, gold 25%, for a combined precious metals contribution of 74%.
In Slide 8. Here we present three key financial metrics. Our sales grew by 15% to $73.7 million. We broke our historic record for EBITDA in the second quarter and the first half of the year. EBITDA in the quarter grew 33% to $35.2 million. Adjusted net income grew 9% to $10 million or $0.06 per share. Luis will be providing detail in the analysis of these figures further in the presentation.
Moving on to Slide 9. We are moving to report all-in cost as a silver equivalent. The increased silver production and good cost performance translate in a drop of 17% in consolidated all-in sustaining cost to $10 per silver equivalent ounce. San Jose reports a drop of 16% to $9, and Caylloma, a drop of 19% to $10. At San Jose, the driver for lower all-in cost is higher silver production, and for Caylloma, 10% lower production cash cost, 20% and 10% higher zinc and lead prices, respectively, and lower execution of capital, which we start to pickup in the second half of the year.
In Slide 10. Our capital expenditures were $19 million in the quarter. $5.1 million in sustaining capital that remains $2.3 million in exploration, $1.3 million allocation to newer exploration initiatives and $10.3 million in Lindero.
Moving on to Slide 11. At Lindero, we remain on schedule for commercial operations in the third quarter of 2019, although we have moved from early to late in the quarter. We have to aboard the acquisition of modules for 350 basis points from an operation under close renewal in Argentina, which resulted in a delay and slower and brand build up in temporary camp facilities, which in turn delays the arrival of contractors to site.
Mine equipment started to rise in mid-July, with arrival scheduled for November. The plan is to have the mine delivering initial core in March 2019, with a quick ramp up as there is no river we move with the highest gold rate portions of the outcropping. As stated earlier, we have signed $130 million or 71% of the projects direct capital cost.
With all this information, we forecast a modest increase of 6% on direct costs against our budget. But we are experiencing a significant increase is in the forecast of construction indirect cost and owners cost. The main driver for the forecasted rise in indirect cost is a 50% incremental on-site headcount of 950 people. These variations drive our total initial capital estimate of $239 million to an increment between 10% and 17% or $24 million to $40 million.
Main components of indirect costs were these figures comes from catering costs, which have grown by $5.5 million, 64% of that attributed to the higher headcount and 34% to the higher food ratios cost. $3 million in additional camp facilities, $1.6 million associated with higher transport cost at Lindero is located remotely eight hours away from the.
Half of the $1.6 million – half of that is due to higher headcount and the other is to sort through for personal and estimates. $1.8 million in higher energy costs and $6 million in owners cost G&A. These figures are under final review, as we see opportunity to optimize headcount for certain contractors program to come to site in the fourth quarter – are starting to come to site in the fourth quarter.
We plan to include the reviews – we plan to conclude these reviews in the month of August. I want to mention that our forecast still include a $24 million contingency front. The project has a typical advance as of the end of Q2 of 15%, with $38 million spent on the project, of which $31 million came in the second quarter. We are seeing a significant pickup in spending data as critical execution is ramping up.
The Arizaro project target presents a significant exploration opportunity as we view it as a potential federal deposit to Lindero. We are currently drilling a 2,000-meter program to further enhance our knowledge of the assistant and evaluate the ability of producing a resource estimation of our own. Arizaro is located within our mining concessions and approximately three kilometers from the crossing station at Lindero.
Goldrock, the previous owner of Lindero, reported an NI 43-101 indicated resource of 340,000 ounces of gold and incurred resources of 230,000 ounces of gold at Lindero. And so just the remain soften. We aim to conclude the drilling at Arizaro in the month of August.
Next Slide, on the exploration front, we have drilled approximately 13,000 meters at our mines during the quarter, with the bulk of that drilling at the San Jose operation, but the highlight from exploration activities in the quarter comes from Serbia, where we are currently in 70% earning option agreement under the Tlamino project, which contains the Barje target.
Medgold is a option incurring the work now. Very encouraging results from first phase of drilling have been published by Medgold on June 11, June 18 and July 5. Here on the presentation, on this slide, we present some of the highlights of the program. This is a very exciting exploration opportunity on silver, gold, thermal system that's close to surface.
With that now, I'll ask Luis to advance on the presentation, further details on the financial results.
Thank you, Jorge. So turning on to Slide 14, net sales of $73.7 million, up 15% from the prior year driven by higher precious metal sales and zinc, and lead prices, we reported net income of $11.2 million compared to $8.9 million in 2017 and earnings per share of $0.07 compared to $0.06.
Our strong performance in the quarter didn't fully translate into higher adjusted net income due to a higher effective tax rate in the quarter as I will discuss in the coming slides. Free cash flow, excluding the Lindero construction for the quarter was $9.1 million and although not shown in the slide, $28 million year-to-date.
Onto Slide 15 and breaking down our sales performance. We have higher total sales of $9.8 million with $5.5 million of contribution from higher metal volumes mainly come from silver. $2 million from import metal prices, mainly zinc, and $2.7 million of improved treatment and refining charges.
We recorded net of sales adjustments of $2.7 million in the quarter, which was $0.5 million higher than the adjustment in our comparative quarter as shown in the bridge chart. Out of the total adjustment, $1.9 million was related to lower metal prices at the closing of June. In the first quarter of 2018, we reported a buildup of concentrate inventory at the San Jose mines corresponding to around eight days of production, one of which has been sold as of the end of June.
Onto Slide 16, our operating income and adjusted EBITDA reflect our stronger sales in the quarter and lower overall costs compared to 2017. Adjusted EBITDA Caylloma was up 47%, reflecting mostly stronger zinc and lead prices, higher zinc production, lower production cash cost. Production cash cost at Caylloma was 10% below last year and 5% below our annual guidance. About half of these cost improvements with respect to annual guidance are related to productivity gains, which we expect will be maintained.
EBITDA at San Jose was up 28%, as a result mostly of higher silver and gold production. In the case of production cash cost, at San Jose, we have a slight decrease of our 2017 and are pretty much in line with our annual guidance. And as Jorge mentioned, operation showed improved performance from an all-in sustaining cost perspective, which we expect will be maintained as well in the second half of the year in – at the level of sustaining capital expenditures picks up in Q3 and Q4.
Onto Slide 17. On expenses, total SG&A was $8 million, up 38% compared to Q2 of 2017. Our operating mines SG&A and corporate SG&A are in line with guidance provided in March of this during the Q4 2017 earnings call. Share-based payments at $2.4 million include approximately $1 million of market-to-market effect from stronger performance of our share price in the quarter.
We have recorded a higher effective tax rate unusual of 55% for Q2 of this year. This is mainly due to two factors. The strong evaluation of the Argentine peso, which has had a negative effect on the deferred tax component of the income tax expense, representing around $1.5 million and one-time charge of $1.3 million related to with whole impact us we expect to pay in 2019 upon the repatriation of funds from our subsidiaries. Excluding these two items effective tax rate would have been in the range of 44%.
Onto Slide 18. As we have highlighted the beginning on the presentation the company maintains a strong balance sheet position with a total cash and short-term investments at the end of the quarter of $198 million and total liquidity of $278 million considering our expanded credit facility of $120 million.
Taking into account, the updated initial capital forecast we have reported at Lindero project, we continue to believe we are adequately funded, considering a range of slightly potential downside metal price scenarios.
Back to you, Carlos. Thank you.
We would now like to turn the call over to any questions that you may have.
Thank you. [Operator Instructions] Our first question comes from the line of Chris Thompson with PI financial.
Hi. Good morning, guys. Just a couple of quick questions. I'll start up with San Jose. Obviously good growth in the Q2 here. I guess, on the back, maybe, correct me if I'm wrong, slight revision of the mine plant. I guess, the question is, is whether these grades are sustainable at these levels? And then whether that there is going to be any adjustments right around in the foreseeable mine plan?
Hello Chris. As I stated, yes, we do expect higher grades to continue in the second half of the year that should lead to a meeting or exceeding guidance by about 10%, that is we are not moving to modified guidance, because we believe our 10% change [indiscernible] valuation of 10% is not modifying guidance. But everything indicates suggest that we are heading in the way based on the plan – mining plan for the second half of the year and what we have delivered this first half of the year.
Moving forward, the reconciliation of reserves to production at this mine has always been very good. So long-term, we continue to see the average grades of the reserves reflecting on production. But on a shorter term, like for the year, we provided guidance based on the plan that is in the start of the year was later modified and the higher grades we're seeing with respect to the regional plan and the regional guidance are the result of that.
Okay. Thanks for that. Could you just comment on currently what's happening as far as exploration? I guess, you're not expanding towards the Trinidad North area. Give us a little bit of an update there?
We have five drill rigs turning at San Jose, between four and five, depending what time of the year, drilling that north extension in different parts. We have all the underground infrastructure available. We are hitting structure. We are hitting rate. I cannot report to you at this stage that the outlining of coherent are significant area. We are hitting some grades in some area. We are going to – we are working on resource estimation for the second half of the year when we use to update our resources, reserves, and mine plans and budget.
So on the Victoria vein, we are aiming to do a resource. Is the first time we are going to attempt a resource at Victoria vein. And in the north, we are drilling aggressively, and we will be reporting results of – come on a significant. But we have not reported the results yet, even though we are drilling already, because we are not seeing results to support areas that are mine yet. These are big area. We are dealing aggressively, we are hitting structure, seeing mixed results on the drilling, but we need to continue position there.
Okay. Great. I guess just a final question as far as Lindero, the CapEx escalation there. I mean – on the cost, et cetera. Are you getting any benefit from peso devaluation?
We are just currently updating our numbers on that. I'll let Luis give you more for that.
So I mean currently, yes. Based on our budget figures and the time of feasibility study, the time was put together, the depreciation considering inflation is in the range of 25% to 27%. But that's so far mostly provided at a benefit in terms of overheads, as the construction really started ramping up in the second half of the second quarter. So the value component of our forecast, of our CapEx, is still ahead of us.
Now we don't anticipate that a 27%, 25%, real depreciation of peso throughout the construction period, which extends up to September of 2019 is slightly. So for more reasonable scenarios of, let's say, 10% recapitalization of peso, that is, again, discounting for inflation factors, we should see a benefit in the range of 8% to 9%, which is currently not in our forecast figures. So we are not up to remain any benefits from the evaluation.
Okay, all right. So if I can read you correctly on that, you are taking a very conservative step on peso devaluation?
Yes, as we’ve said before, our spend is [indiscernible] mutual affect. And as we have the construction and the spending, we think continue along the trend we've seen. We are likely to see material.
Perfect, all right, guys. All right. Thank you. Thank you very much.
Our next question is come from the line of Mark Magarian with UBS.
Hi guys. Good job on a seamless quarter. I just had – just wanted to clarify one point, you made a couple of times away regarding the – was it $24 million contingency in your original Lindero cost plan? And as you basically saying that this increases in cost, which you've just reported could well come on that contingency, which was on the original numbers. Is that what I'm hearing?
I should be more clarity on how we manage the contingency. It is $239 million initial capital estimate we produced initially and carry about $23 million in the contingency filed and the actual physical execution of it is only starting. The physical advance of the project as of the end of the second quarter is only about 15%.
So our updated forecast comes from having detailed engineering concluded and contracts awarded or very close to being awarded as in the case of electromechanical on pricing contract. So we have a lot more better information, detailed information coming from the engineering and from actual costs that have been already assigned and awarded, equipment purchase, not before we have gold’s for equipment, and the purchase orders are out.
Now that detail, it's coming in our forecast now. And our contingency remains at $24 million. So we will start discounting that $24 million as the execution with physical execution of the project advances. It's the project advances. So as a great advantage in your evaluation in the execution, we will start applying the contingency front to those variations.
That is how we manage the – so any variation in the execution will not translate automatically or directly over the 17.10% variation we clearly forecasted. The contingency fund on the future execution should hit those differences, start hitting those differences and help to mitigate variations in the actual physical execution. That is how we manage the contingency front.
Thanks for the clarity. That’s fine. Thank you.
End of Q&A
Thank you. [Operator Instructions] And it seems we have no further have no further questions. I'd like to turn the floor back over to management.
Thank you, Brenda. If there are no further questions, I would like to thank everyone for listening to today's earnings call. And we look forward to rejoining us next quarter. Have a good day.
This concludes today’s teleconference. You may disconnect your lines at this time, and enjoy the rest of your day.