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Fortuna Silver Mines Inc. (NYSE:FSM)
Q1 2019 Earnings Call
May 15, 2019, 12:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to the Fortuna Silver Mines' First 2019 Financial and Operational Results Call. All lines have been placed on a listen-only mode and the floor will be open for your questions and comments following the presentation. If you should require assistance throughout the conference, please press *0.

At this time, it is my pleasure to turn the floor over to Mr. Carlos Baca, Investor Relations Manager. Sir, the floor is yours.

Carlos Baca -- Investor Relations Manager 

Thank you, Tom. 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 first quarter of 2019.

Today, we'll be using a webcast presentation which will be controlled by us. To download the presentation, please go to our website at www.fortunasilver.com. Please click on the Investors tab then click on the Financials subtab and under Q1 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.

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, President, CEO, and Co-Founder of Fortuna.

Jorge Ganoza -- President and Chief Executive Officer

Thank you, Carlos and good morning to all. I will be presenting an introduction to our quarterly 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'll open the call for questions.

On slide 4, today we show a solid track record of organic growth and profitability from our mines in Mexico and Peru which underpins our business. For the investor's attention, let's focus now on our execution of Lindero. Lindero will be our third operating mine and is a strategic asset to the company. This mine has reserved for 15 years of gold production and is critical to the strong consolidated margins of our business.

Slide 5, please. Under Q1 2019 highlights, our adjusted EBITDA for the first quarter was $23.8 million representing our robust 40% margin over sales. Liquidity available stands at $193 million which includes our available trade lines while keeping a modest debt to EBITDA ratio of 0.7 at the end of the quarter. The next thing for us now until Q1 of next year is the successful completion of Lindero. As of the end of April, we have a 47% advance toward completion, 97% of the direct capital costs have been committed and remaining construction capital to completion is estimated at $115 million. Apart from the typical quarterly updates on construction and news releases, we're producing a series of monthly videos that help us show our advance on a regular basis. The construction videos can be found on our website and I would like to encourage you to access the videos and follow our progress.

On May 9th, we were pleased to announce the publication of our 2018 Sustainability Report. This is our first Sustainability Report and was produced under the GRI standard. This document presents a comprehensive view of the commitments and actions we're taking to conduct our business in an ethical manner, measuring our economic, social, and environmental impacts. This document one more step we take toward improving transparency and communication with stakeholders.

Slide 6. Our mines teams delivered another consistent quarter with silver and gold production tracking in line with our 2019 guidance of 8.2 to 9 million ounces of silver and 49,000 to 54,000 ounces of gold. Measured against the previous quarter, silver and gold production was down 7% and 11% respectively. This is explained largely by silver and gold rates being down 6% and 12% respectively against the comparative quarter. It is worth noting that the first quarter of 2018, we had positive reconciliation in high-grade stocks and mining concentrated in some of these high-grade areas within the quarter for operational reasons.

Slide 7. Precious metals accounted for 75% of the $59 million in sales for the quarter. Average realized silver price for the period was $15.60 per ounce and $1,316 per ounce for gold. This is 7% lower for silver and only about 1% lower gold against the comparable period. By-product lead and zinc prices were down 19% and 21% respectively.

Slide 8. Our sales were down 16%. Adjusted EBITDA down 25% and adjusted net income down 36%. In spite of the significant drops, we managed to sustain an EBITDA margin of 40% down from 45% in the comparable quarter and adjusted net income of $8.5 million. The lower sales figures against the comparable quarter are largely explained by lower metal prices, less metal produced, and concentrate inventory buildup of Jan Jose.

Slide 9. All-in sustaining costs of $10.70 is within our range or guidance for the year, but 11% above the comparable quarter. Jan Jose all-in cost has no variation with last year and Caylloma all-in cost is impacted by the drop in base metal prices and better-sustaining capital execution. Cast costs per ton at both operations are marginally higher when compared against Q1 2018 and below budget.

Slide 10. We recorded capital expenditures of $37.6 million for the quarter of which approximately $31 million are attributed to Lindero. It is worth mentioning that during the quarter, we have spent $42 million comprised of recorded capital expenditures plus advances at Lindero. Our spending on the project is planned to continue at this pace which is what the project requires for completion at year-end.

Next slide, please. On slide 11, we show our portfolio pyramid. I would like to highlight here that with Lindero in production, we will be in a position to take our annual gold production from the current 50,000 ounces of gold to north of 200,000 ounces of gold while maintaining silver production at 8 million to 9 million ounces of silver.

Next slide, please. Slide 12 shows a simplified schedule with some selected milestones. I would like to move on to the next slide, please. Just to recap, we continue to plan for commercial operations in Q1 2020. The project shows a 47% advance as of April. 97% of the projects total direct capital costs have been committed. $150 million construction capital remains until completion and we continue to forecast $295 million for the total capital capex. We continue to report approximately $17 million in contingencies within the $295 million fee.

Next slide, please. Here I would like to present you with some of the latest photos showing the advance at Lindero. This is a view of our start-up leach pad on slide 14. As you can see, the complete 35 hector site of the start-up leach pad is ready and receiving liner and over liner. We expect to conclude the leach pad by the month of August so it will be ready to start receiving first ore in October, early in Q4.

Next slide, please. In slide 15, we present pictures of the crushing circuit. This is the critical path of construction. We started the electromechanical installation of the tertiary crusher, which is an HPGR, higher pressure grinder roll. The equipment is mounted on the final stages of installation as we speak. We are starting this week with the mounting of secondary crushers. The primary crusher is the last piece of equipment that is going to be installed and here all of the ground preparation and foundation work for the crushers is concluded and retention walls are virtually concluded by now as well.

Next slide. Here we show in the upper pictures this is the tunnel under the stockpile that will feed the HPGR coming from the secondary crusher. This is a tunnel that takes a lot of concrete but it is well advanced by now. We started placing concrete in the tunnel this week as well.

Next slide. ADR and SART plants are not on the critical path of the project. Foundations are concluded and this project needs to be commissioned in late November or early December. We are on schedule with that timeline.

Next slide. Mine development, we have on site all the mine fleet. The mining fleet is operational and complete. Six 100-ton trucks, two-wheel loader, a shovel, two driller rigs for production, graters, dozers. The mine work has advanced, and the mine is prepared for production. We expect to initiate the production blasting in the month of July. I would like to remind everybody that at Lindero, Lindero benefits from very low strip ratio as high-grade mineralization outcrops over extensive areas on the surface. So, we benefit from accessing ore from the start at the mine. This is no over stripping or extensive mine preparation that needs to take place. So, the mine is ready for production as we speak.

Next. Slide 19, we are advancing with ancillary facilities. Here you see on the left the structure being installed and mounted and on the right pictures of our plant. The plant is ready for commissioning by mid-year. So, we'll be fully operational with power from this 8-megawatt plant where we're going to be self-generating power for our operations.

Next slide. So, with this, I will pass on the call to Luis.

Luis Ganoza -- Chief Financial Officer

Thank you, Jorge. Slide 21. So, sales for the first quarter were $59 million down 16% from 2018 due to lower metal prices and lower metal production when compared to the prior year. We reported net income of $2.2 million compared to $13.8 million in Q1 2018 and adjusted net income of $8.4 million compared to $13.2 million in Q1 of 2018. The reduction was driven mainly by lower sales. Our adjusted EBITDA was $23.8 million compared to $31.8 million recorded in 2018 and free cash flow from ongoing operations was $2.2 million compared to $16.8 million in 2018. Free cash flow in the quarter was affected by short-term movements in inventory and accounts receivable of around $7.1 million. At current metal prices, we expect free cash flow to be on average in the range of $8 million to $10 million for the quarter.

Next slide, please. On slide 22, when breaking down our sales performance for the quarter, we can see the highest impact came from lower silver and base metal prices. Lower silver and gold sold. Less favorable treatment and refining charges in 2019 also had an impact on sales when compared to 2018.

Slide 23. Our comparative segmented results show a similar pattern in both operations, mainly lower margins driven by lower prices and slightly higher costs in the case of Jan Jose. Cash costs at Jan Jose were $68.7 per ton, which was about the mid-point of our guidance for the year but aligned with our budget for the first quarter. Cash costs at Caylloma were slightly below the range of our cost guidance for the year and are expected to increase closer to the mid-point of our guidance.

Slide 24. G&A is slightly below Q1 2018 and inline with guidance provided in our year-end call. Our effective tax rate for the quarter was affected by the devaluation of the Argentine Peso of 24 percentage points of out of the 76% effective tax rate are explained by this factor alone.

Next slide, slide 25. Finally, on slide 25 the evolution of our cash balance reflects the increased pace of spending at Lindero. We closed the quarter with $113 million in the treasury and total liquidity of $193 million. Construction spending on Lindero in the quarter was $42.2 million while total spending on the construction at the end of March was $165 million. This leaves a total amount remaining to spend on the construction budget of $130 million as of the end of March. And as Jorge disclosed, at the end of April, this amount was $115 million. This amount excludes any VAT.

So, thank you and 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 might have.

Questions and Answers:

Operator

Thank you. The floor is now open for your questions. If you do have a question, please press * 1 on your telephone keypad at this time. If you are using the speakerphone, we ask that while posing your question you pick up your handset to provide favorable sound quality. Again, ladies and gentlemen, if you do you have a question or comment, please press * 1 on your telephone keypad at this time. Please hold while hold for your questions.

We'll take our first question from Ife McGowan with CAPIA.

Eithel Mc Gowen -- CAPIA -- Analyst

Hi, Jorge. Hi, Luis. My question is about the Lindero depreciation and depletion for the first few years. So, given that the 20% increase in capex required for the project and accelerate depreciation schedule, how much are you expecting of depreciation and depletion for the first three years of the operation?

Jorge Ganoza -- President and Chief Executive Officer

Depletion will take place -- I take it we are talking about financial depreciation and depletion. Depletion will take place over the life of the mine. That is 12 to 13 years. So, I'm doing the quick math here as we speak. That is $295 million capex over 13 years. That's around $22 million a year of depreciation and depletion combined, I'd say on average per year. You mentioned accelerated depreciation. That would be a feature of tax depreciation. There is some of that we expect to benefit from, but I'm not sure that was what you were referring to.

Eithel Mc Gowen -- CAPIA -- Analyst

Yes, related to the tax depreciation.

Jorge Ganoza -- President and Chief Executive Officer

Yes. On the tax side of things, there are incentives that would allow us to benefit from accelerated depreciation on fixed assets over, if I'm not mistaken, a three year period for a significant portion of the construction spend.

I'm not able to give you precise figures at this very moment. I'm happy to share them outside of the call.

Eithel Mc Gowen -- CAPIA -- Analyst

Okay. Thanks.

Operator

And we'll take our next question from Chris Thompson with PI Financial.

Chris Thompson -- PI Financial -- Analyst

Hey. Good morning, guys. Just a couple of quick questions. We'll start out with Jan Jose and then I just wanted to ask a question on Lindero. So, Jan Jose, first of all, I did notice an uptick in unit costs in the quarter. It currently looks like on the high side of guidance. Do you expect these to remain there or can we see them retreating more to 2018 levels?

Luis Ganoza -- Chief Financial Officer

Chris, thanks for the question. We expect to be within the range of guidance. We see nothing that suggests a trend away from our guidance, Chris.

Chris Thompson -- PI Financial -- Analyst

Okay. All right. Just on the grades, I know that you did mention that they were a little lower than anticipated. They beat our expectations and it looks like they are tracking above guidance as well. Again, a similar sort of question. How should we be modeling the grades both gold and silver for the remainder of the year?

Jorge Ganoza -- President and Chief Executive Officer

Grades were basically in line with our budget for the quarter. We show lower grades at San Jose compared to the comparable quarter, Q1 2018. That leads to the drop in metal in production against the comparable quarter as well. But 2018, in the start of 2018, it benefited from positive reconciliation and concentration of mining on high-grade areas due to operational reasons which lead us to mine above budget and plan in the start of the year. So, that's why you see a drop quarter versus quarter in metal and that's lead by grade. Our grades at this mine are tracking along plan and I think something I can say about this mine is that our ability to project grade and tonnage has always been very good due to the nature of the deposit and we expect no deviations with respect to guidance and grade. We're what we planned.

Chris Thompson -- PI Financial -- Analyst

Okay. That's good enough. Just on expiration, maybe a little bit of an update of what's happening at San Jose?

Jorge Ganoza -- President and Chief Executive Officer

At San Jose we are preparing to -- We do our costs for resources around mid-year. So, we are guiding up our drilling. Our focus, we have three or four rigs working on peripheral areas on the deep extension and to the south and some areas in the north around the shell of existing resources. We have provided some results previously. We need to provide a market update on additional results but we expect based on what we're seeing that we will be able to have new resources come in that will help us deal with depletion. That's our expectation based on the drilling to date. I cannot report any game-changing discovery or anything like this. I think San Jose is at a stage where our exploration is yielding resources that help us deal with depletion. So, we are preparing to close our drilling for the first half of the year to consolidate the data that will go into the resource estimations in the second half of the year which supports our budgeting and reserve exercises.

Chris Thompson -- PI Financial -- Analyst

Okay. Great. A final question about Lindero, here. You were talking about the crusher being a critical path item. Maybe just can you outline the remaining critical path items for the project and sort of put it in context by way of timing?

Jorge Ganoza -- President and Chief Executive Officer

Yes. All of the eyes and efforts of the construction team are on the crushing and leach pad. We are pushing and working on our schedule to keep on track. We plan to start placing ore in October in the leach pad. So, that will require the entire crushing system to be operational. That will require power. That will require a leach pad to receive the ore. That will require the stacking system. And when I talk about crushing, it's crushing and agglomeration system. So, crushing and agglomeration, power, water, stockers, leach pad. Out of all of those, the one that is on the critical path is the commissioning of the crushing and agglomeration. We have the stackers arriving on site as we speak. We already received about half of the stackers. Those are starting to being assembled. So, no issues there.

The leach pad, as you have seen on the picture, all of the area works related to the leach pad and site preparations are concluded. We need to roll out the geomembrane and then place over liner on top of that. So, that work is ongoing and our plan calls for the completion of the leach pad and have it ready to receive ore in August. So, that is running with time in our schedule. Power, we will have power available from the 8-megawatt plant in June or July. So, no issues there. As you have seen in the pictures, all of the power stations are there, are installed with the secondary tension line, the secondary transmission power line is advancing well according to plan. So, no issues there.

Water, our well field is 13 kilometers away from the site. The wells, of course, we concluded early in the project and we're laying down the water pipeline. This is also a work that we plan to have concluded by mid-year and it's advancing well. So, the last thing to be delivered within all of this is the actual crushing and agglomeration. We need to mount the equipment, install it, put up the belt conveyors, and commission the crushing. And it is a big work. The bulk of that excavations and the riskier part of that in terms of uncertainties are related usually to excavations and all of that is done. All of the excavations are done. As you see, we have built the retention walls. We are basically concluded with all the major placement of concrete for large foundations with the exception of the tunnel for the stockpile between the secondary and HPGR. But as you've seen in the pictures as well, that work is advancing and advancing according to plan.

So, I just tried to give you a bit more color of where we are with all of this. So, we need to start placing ore in early Q4 on the leach pad and then the delivery of SART and AVR comes in late November or early December. We have no elements on critical path on the side of procurement and expediting. All of that, we have no red flags there. Everything we need is arriving on time. We have the contractors on site. I have to say that getting the project to this stage has been a monumental effort. As we have shared with you, the challenges that we faced with the start of this project with delays on camp availability, challenges with the excavations in the leach pad and foundations, all of those issues are resolved. We currently have roughly 1200 people on site, close to a thousand people to date climbing up to 1200 on site. All the major contractors are running on all cylinders on the project and the project is really advancing at the pace that we need. That's also reflected in the rate of spending of the project. In Q1 we spent $42 million and that is the rate of spend that we need on the project for conclusion at year end.

Based on the activities that we're seeing, which are the planned activities, we can sustain the rate of spend and bring this project to a successful conclusion by year end.

Chris Thompson -- PI Financial -- Analyst

Great. Thank you, Jorge. Thanks for that.

Operator

Again, ladies and gentlemen, that's * 1 on your touchtone telephone if you do have a question, * 1 at this time, please.

We'll go next to Adrian Day, Asset Management.

Adrian Day -- Asset Management -- Analyst

Yes. Good afternoon. My question is specifically on Caylloma. You gave us a breakdown of metals by production. Can you tell us how that compares with the comparable period, the comparable quarter? Also, perhaps, just discuss a little bit about the variability of metal production specifically going forward, how you see it.

Carlos Baca -- Investor Relations Manager 

Good morning, Adrian.

Jorge Ganoza -- President and Chief Executive Officer

All of your questions just refers to Caylloma, no?

Adrian Day -- Asset Management -- Analyst

Correct.

Jorge Ganoza -- President and Chief Executive Officer

For Caylloma today, zinc and lead are major components of value. So, with respect to zinc and lead against the comparable quarter, as we showed in the presentation, there is no significant variance in terms of metal output for zinc and lead. Our zinc production is up 2% compared against Q1 2018 and our lead production is up 2% against Q1 2018. So, and silver production is basically on line as well with Q1 2018. What has hit Caylloma comparing against the comparable quarter is the large drop in zinc and lead prices we've seen compared to a year ago. Lead prices are down 19% and zinc prices are down 21%. No?

Adrian Day -- Asset Management -- Analyst

Okay.

Jorge Ganoza -- President and Chief Executive Officer

But in terms of metal output, the mine is running well according to plan. Even though we are seeing also higher all-in sustaining costs. That's also explained by higher sustaining capital. But it is basically a good execution of our budget in the quarter compared against last year. Last year we had a larger sustaining capital budget at Caylloma. It was about $16 million. This year our capex budget for Caylloma is about $13 million. So, it's a lower sustaining capital or investment budget for that mine. But we had a much better execution of that budget at the start of this year compared to last year. So, that's also impacting our all-in sustaining costs.

The way to view the cost performance of the mine, to better view the cost performance is on a cost per ton basis. On a cost per ton, we are on line with budget.

Adrian Day -- Asset Management -- Analyst

Okay. So, the relative of production of zinc, lead, and then silver doesn't really change much?

Jorge Ganoza -- President and Chief Executive Officer

No. The mine is operating at a steady state and we have provided guidance.

Adrian Day -- Asset Management -- Analyst

Okay. Thank you.

Operator

Once again, ladies and gentlemen, that's * 1 on your touchtone telephone if you do have a question, * 1 at this time, please.

Mr. Baca, there appears to be no further questions at this time. I'll turn the call back over to you for any additional or closing remarks.

Carlos Baca -- Investor Relations Manager 

Thank you, Tom. 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

Ladies and gentlemen, thank you. This does conclude today's teleconference. We thank you for your participation. You may disconnect your lines at this time. Have a great day.

Duration: 40 minutes

Call participants:

Carlos Baca -- Investor Relations Manager 

Jorge Ganoza -- President and Chief Executive Officer

Luis Ganoza -- Chief Financial Officer

Eithel Mc Gowen -- CAPIA -- Analyst

Chris Thompson -- PI Financial -- Analyst

Adrian Day -- Asset Management -- Analyst

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