Earnings Call: Q4 2015

Mar 16, 2016

Greetings, and welcome to the Fortuna Silver Mines 2015 year-end earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Carlos Baca, Manager of Investor Relations. Thank you, Mr. Baca. You may begin. Thank you, Chris. Good morning, ladies and gentlemen. I would like to welcome you all to Fortuna Silver Mines, and to our 2015 year-end financial and operations results call. Jorge Alberto Ganoza, President and CEO, and Luis Dario Ganoza, CFO, will be hosting the call from Lima, Peru. 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, which is publicly available on SEDAR. 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. In 2015, we achieved key objectives to continue unlocking the potential of our assets, creating shareholder value. These achievements were underpinned by yet another year of delivering according to guidance and sound financial performance. When we look at our business, one of the measures we pay close attention to is mine operating and EBITDA margins over sales, which were 28% and 32% respectively for 2015. For San Jose Mine, we achieved margins of 39% and 49% respectively, which speaks of the quality of the asset and our capability to deliver. For Caylloma Mine, it was vulnerable in low metal price environments, but we still managed to achieve a cash balance year with margins of 7% and 19% respectively. Our cash costs continue to trend down in line with our budgets and guidelines. Analyzing our cash per ton at San Jose, we reported $58.08, 7% below 2014, and 6% below annual guidance. Caylloma for the year was $85.80, 5% below 2014, and 5% below annual guidance. We achieved a consolidated all-in sustaining cost net of byproducts of $14.50 for 2015, this being a capital-intensive year due to our expansion in Mexico and optimization at Caylloma. All-in was 11% below guidance and flat with respect to 2014. We have provided guidance of $11 for 2016 as major capital projects end mid-year. We expect all-in costs will continue to trend down in 2017 once we operate at sustaining capital levels with higher annual production as a result of expansion. The driver for the production growth and cost reduction is expansion, as I mentioned, of the San Jose Mine to a new rate of 3,000 tons per day. At this rate, San Jose will be in a capacity to produce 7-8 million ounces of silver per year and about 50,000 ounces of gold. The project is advancing according to our schedule and budget, aiming for commissioning in July of this year. At the new rate of production, San Jose will rank among the 13 largest primary silver producers in the world, operating with Tier 1 costs. I will now let Luis take you through the financial statements. Thank you, Jorge. For 2015, we recorded a net loss of $10.6 million, or $0.08 per share, compared to net income in 2014 of $15.6 million. The reason for the loss was an impairment charge at the Caylloma mine of $25 million before tax, or $17 million after tax. The impairment charge reflects a negative impact of lower metal price assumptions on Caylloma's mine plan and free cash flow generation. Adjusted net income for the year was $6.7 million, compared to $15.7 million in 2014, a 57% reduction attributable to a lower metal price environment. Adjusted earnings per share was $0.05 compared to $0.12 in 2014. Sales for the year were $154 million, 11% below the $174 million recorded in 2014. Realized prices on our provisional sales were $15.65 per ounce for silver and $1,150 per ounce for gold. That is 17% and 7% respectively below 2014. For zinc and lead, which comprise 17% of our total sales in the year, prices were down 12% and 15% respectively below 2014. These lower prices were partially offset by higher gold sold of 10% and higher zinc and lead sold of 31% and 44%. Mine operating earnings was $43.5 million, 28% below the previous year as a result of lower sales. Margins came down from 35% to 28%, reflecting the impact of lower metal prices. The negative impact was partially offset by lower unit costs at both San Jose and Caylloma of 5% and 7% respectively. Selling, general, and administrative expenses were $17.9 million. That is $7.2 million below 2014. A large part of the reduction is a result of a lower stock-based compensation charge in 2015 when compared to the previous year, which was in turn due to mark-to-market effects from the performance of our share price. We also had a $1.5 million reduction of corporate expenses contributing to the lower selling and G&A. Our effective tax rate for the year was 70%, and our effective tax rate at our Mexican operation, which is our main contributor to income today, was 39%. Focusing on the fourth quarter, we recorded a net loss of $17.2 million as a result, mostly of the Caylloma impairment. Adjusted net loss was $0.1 million, driven by a foreign exchange charge of $0.8 million and an adjusted operating loss at Caylloma, which nonetheless recorded an income tax expense, further contributing to the overall adjusted loss for the quarter. When looking at our segmented results for Q4, the San Jose Mine increased operating income by 27% over Q4 2014, and operating margin increased from 28% to 32%, in spite of the lower metal prices. However, in terms of our consolidated results, the weak performance at Caylloma, even after adjusting for the impairment, offset most of these gains. The effective tax rate for the quarter was 100%. The effective tax rate at our Mexican operation was 32%. Moving forward, in 2016, we expect Caylloma to be in a position to contribute to consolidated operating income and net income as the adjustments to the mine plan and cost restructurings yield results. In the first months of 2016, we are already achieving stronger base metal production compared to the last quarter of 2015. Moving on to the cash flow statement. Total cash provided by operating activities was $54.8 million. This included approximately $24 million contribution from changes in working capital and cash payments of income tax of $17.8 million. On the changes in working capital, the largest portion of it comes from an early collection of trade receivables in the month of December and from an increase in accounts payable related to the increased activity on our large CapEx projects at the San Jose mine. The $17 million of taxes paid includes $9 million of 2014 taxes paid in March of 2015. Total cash consumed on capital expenditures was $57.1 million of actual expenditures on mineral property, plant, and equipment, plus $6.7 million of deposits on long-term assets, for a total of $63.8 million. Out of this $57.1 million of expenditures on mineral properties, plant, and equipment, $26 million was spent in Q4 of last year. For 2016, we have a CapEx budget of $59 million, of which we expect $40 million to be spent in the first eight months of the year. Beyond that, we should start seeing positive free cash flow as we commission the expansion at San Jose in early Q3. Finally, our total cash balance, including short-term investments for year-end 2015, was $108 million, an increase of $30.9 million over year-end 2014, which includes the $40 million drawdown of our term loan in Q2 of 2015. Thank you. Back to you, Carlos. We would now like to turn the call over to any questions that you might have. Thank you. At this time, we will be conducting a question and answer session. Our first question comes from the line of Rahul Paul from Canaccord Genuity. Please proceed with your question. Hi, everyone. Congratulations on a very strong 2015. I had a question regarding the mill expansion, the San Jose expansion to 3,000 tons a day. You mentioned commissioning in July, but how long do you think it would take to ramp up to the 3,000 tons? Good morning, and thank you for that question. The mine will be in a position to source ore to the mill at a 3,000 ton per day rate in Q2. Already, we have the development ahead, and we don't see any issues with the mine being able to source 3,000 tons per day starting as early as this May. Now, the commissioning we expect to be short. This is really a bolt-on expansion. We are bringing in a new ball mill, which is being mounted as we speak, a new bench of flotation cells, and a new crusher, and a new screen in the crushing group. Really, we don't expect any complicated or long commissioning. We really expect the commissioning probably to begin in June. To drag on from June to July, two months of commissioning. This is the actually third expansion of this nature that we do at San Jose, and the two previous ones have been smooth. We expect so far a smooth commissioning period as well. Okay, thanks. I guess so you would expect it to be operating at 3,000 tons a day by the end of the year or earlier than that by- We budget to be operating in Q3, probably benefit of 3,000 tons per day, start seeing the full benefit of the 3,000 tons per day or a greater part of the benefit of the 3,000 tons per day in Q3 of this year. Perfect. Just moving on, bigger picture looking forward. Fortuna, the team has done a great job on the operational side of things. I guess your focus right now is just completing the San Jose expansion going on. Once that's done by mid-year, then you will be generating quite a bit of cash. I guess the question is, what would you look to do? What's next, going forward? Are you going to spend, devote more efforts to exploration or are you going to look at growth opportunities going forward? Well, to put this into context. Our focus for the last decade has been on organic growth. We saw early on a lot of potential in the assets to be unlocked, and that has been the cheapest way and the most efficient and effective way to create shareholder value. Last time we had to access the market to issue equity for capital was 2010. Right now, we see our assets achieving optimum rates of capacity based on the size of resources that we have. We will look to bulk our exploration efforts on the brownfields. Our exploration budget in 2014 was $4 million. In 2015, was around $4-$5 million as well. 2016, our budget is $8 million. Back in 2011, our budget was closer to $14 million. We've been favoring capital projects, infrastructure projects for the expansions, and in this low price environment, cutting our exploration budgets to minimum levels. One thing, once we come out of this capital-intensive phase, we will start giving more funding to our brownfields explorations. For one, we believe there is tremendous exploration potential in our properties. Something that we like to stress is that we own the camps where we operate. Around our San Jose mine, we hold over 60,000 hectares of continuous ground, and there is lots of work to be done there for years to come. It's a similar situation in Caylloma with a smaller land package, but still, we control a commanding land position in and around our operation. That presents strong opportunities for growth. Second, we are looking at new opportunities outside the firm. For the past 2 years, we've been more active. Gradually more active, I'll say, than before. We sense a change out there with respect to the willingness of groups to transact. As we all know, and I think that's been broadly discussed, we have seen some entrenched groups, from our angle, to some degree, an absence of the kind of quality assets visible to us and transactable to us. As I said early in the presentation, something we look at very closely is, what is it that we're bringing, the new projects or targets that we intend to bring on, what is it doing to our portfolio? We look at margins very closely. Is it enhancing our margins? Is this a margin-neutral transaction? Is it deterring from our margins? To be honest, we have a very high bar with San José. I can say that we're more active than before. I can say that we are starting to see groups more open to discussions and potential transactions. I can say that we are actively looking in Latin America and abroad, and our search is driven by quality of assets. A key question we ask ourselves, even if it's an early-stage project, is what will this do to our margins? It's not just about size, as we all know, and that's been a driving principle for us since the very early days. The question is, what does this do to our margins and the health of our business? We want a business that's strong throughout the cycle. Perfect. Just to follow up on that, I guess what we've seen in the last year or so has been your peers, other silver producers, diversifying to increase their weighting towards gold assets. Is that something that you're open to doing, or would you rather stay sort of a pure silver company, or at least primary silver? No, we will look at gold. Okay. We will certainly look at gold. We'll certainly look at gold-silver, gold only opportunities. Depending on, again, the quality of those assets, will be a key factor. Okay. We'll be patient until we find something that meets our criteria. Okay, that's all that I have. Thanks a lot, Jorge. Thanks very much. Sure. Our next question comes from the line of Jessica Fung from BMO Capital Markets. Please proceed with your questions. Hi, thanks. Good afternoon, everyone. Just wanted to touch quickly on Caylloma, and what you guys are planning to do there. Do you view a lot of potential there? How do you expect to get costs down there as well? Thank you. With respect to Caylloma, first to talk about exploration. We've been short-cutting Caylloma severely on the exploration front for two, three years now. Now, we were able to do that because in the good days, we were very diligent with our exploration spending. That exploration spending was quite successful in building a good base of resources and reserves for this mine. We have had a change in strategy at Caylloma. We have refocused the mine and concentrated the mining operations in one zone of the main vein, Animas. Caylloma has traditionally, up until early last year, 2015, operated on multiple veins, mainly the Animas vein as an anchor vein, and then sourcing high-grade silver from narrow labor-intensive veins in the north part of the mine. That narrow vein mining made sense with silver at around $19. It doesn't make sense with silver at $15, $14. We closed down those areas. That helped bring costs down. In the Animas vein, we were mining on multiple levels. We decided to concentrate mining on levels 13 and 12 for the bulk of production. Those two levels are integrated. We can achieve better efficiency with the contractor equipment and supervision. Those are the kind of measures that we are taking. This shift towards the deeper levels of the Animas Vein is the reason why silver production in 2015 and in our 2016 budget is down with respect to what historically we have produced at this mine, which historically is 2 million ounces. Now it's more in the 1.5, 1.2 million ounce level. As you see, our lead and zinc output at this mine has increased significantly. We're producing about 20,000 tons of lead and 20,000 tons of zinc annually. That's our guidance for 2016. That's 25%-30% above what we have traditionally produced. Even though the silver output production is down, the net smelter return value, return of ore, is higher. Our margins are improving because the Animas Vein is highly mechanized, well integrated, we're more effective, more efficient. We're being able to bring costs down per ton and getting the margins we need. We have also achieved the power interconnection to the grid. Caylloma was sourcing 70% of its power from the grid, and the balance was being sourced from self-generation with diesel. Now, starting February, 100% of the power comes from the grid. That will help costs in 2016. We are also commissioning, as we speak, the optimization of the plant. We are expecting to, through the optimization, achieve 1,500 tons per day throughput capacity from the current 1,300. We are also expecting that this optimization will allow us to improve metallurgical recovery slightly for silver as well. All in all these changes are reflected in our guidance. All of these changes that I just described are reflected in our cost guidance, are incorporated in the guidance. For this year, we are expecting Caylloma to contribute cash. We are at the prices in our budget. We are today at our budget prices. With these prices for lead, zinc, silver, and the actions we've taken, we believe we are in line with budget, and we should have a cash positive year. Okay, perfect. Thank you very much. Our next question comes from the line of Chris Thompson from Raymond James. Please proceed with your questions. Good morning, guys. Thanks for taking my questions, and congratulations on a good year. Got a couple of quick questions here, but let's start off, when do you hope to announce revised reserves resources for your projects? That should be out by now, Chris, but we have had competing tasks with the technical service group. We have given priority to the other tasks. We have a small delay with what usually is our publication time, which is February. I expect end of March, mid-April. Great. Okay. Thanks for that. Just moving on quickly to San Jose. I might have missed this, I apologize. Can you just remind me again on the CapEx remaining for this year, by way of what's required, I guess, on the ramp-up, both the dry stack and the plant? Yes, Chris. CapEx for San Jose in 2016 is $46 million. That's the budget. Out of that, the balance for the expansion to 3,000 ton per day is $23 million. Mm-hmm. Sustaining CapEx, in general, is a bit below $14 million. Okay, great. The $23 million would include the money to be spent on the dry stack, considering an expansion there, obviously, is an ongoing thing as well as the plant? We do have, I believe it's $2 or $3 million of additional CapEx to spend on the dry stack, and it would be within the $23 million, yes. Perfect. Okay. Thanks, guys. Thanks. Just moving on very quickly. Could you just comment a little bit on what are you seeing right now as far as grade reconciliation at San Jose? This is in the context, I guess, of good grade you guys delivered for much of last year and whether you see an opportunity for that to extend into this year. We are seeing globally a good, great reconciliation. A consistent great reconciliation globally. At the mine operating control level, on the monthly basis, it's a gold deposit, so we are exposed to some minor variations. Globally, the deposit is reconciling well. You know, Chris, that this is a deposit that's very concentrated. We keep development ahead of production. We always have good flexibility as well to respond. For example, this year, we were able to respond to the shortfall in silver production coming from Caylloma due to the change in mine plan. We were quick to just increase grades at San Jose, not necessarily because of a deviation in reconciliation, but us being able to access higher grade zones that we had already developed and increase production in those zones. Okay, great. Just a quick comment on recoveries, if you would. Obviously, good recoveries on the gold and the silver in the Q4. Would that be a good proxy to use as an estimate for this year? That's a good question because we're seeing recoveries as high as 93%. We have budgeted 92%. Mm. That has been a bit of a discussion there with our operating group. We have budgeted 92%, but we are seeing recoveries as high as 93 already. All right. Well, that's great. Just finally, just before we move on to Caylloma very quickly, just a comment on exploration. What's happening right now in the context of permitting and drilling, Jorge? With respect to permits and for surface access, I have nothing new to report. With respect to exploration, we have at San Jose three ongoing programs currently. One rig is drill testing the Trinidad central deposit. The central part, the main portion of part of the deposit, is testing the deep extent. We call it Trinidad Deep. We have a mineralization open at the very end, and we're drill testing, trying to pursue that. On Trinidad North, we are drifting. We have around 250-300 meters advance on the drift. This will be the main exploration drift that will give us access to continue testing the north extent of Trinidad North. Mm. We expect to be concluded with the 1,500 m by year-end, and we expect to be drill testing the north end of Trinidad North, which has not been tested to date from the drift by year-end. Third, we're drill testing La Noria vein system, which is a parallel vein system to the Trinidad Bonanza, where our mine is located approximately 1.8 km due west, and we have there one rig working currently. Perfect. Excellent. Okay. A quick question or two on Caylloma. Obviously, I was listening to the discussion relating to the change in mine plan, obviously a focus more on the base metals rather than the silver. Jorge, at what sort of silver price would you consider maybe looking again at mining from some of the high-grade silver zones there? And how quickly could that be achieved? Can be achieved really quickly. No? Mm-hmm. The underground workings are accessible. We don't have water problems or anything like that there. Mm-hmm Just ready to bring into operation anytime we decide. I believe that price is closer to $19. In 2014, the average price for the year was $19, and we were happily mining there. The issue is 2015, where we started seeing prices drop to $16, $15. The high grades that we see in those narrow veins do come with high variability. We can be making cuts of a kilo of silver, and the next cut can be 200-300 grams silver. When you're mining at $19, you are either making a lot of money or you are just making good money. With $14, you're either making some money or losing money. We have no tolerance for losing money, so we decided to shut it down. Fair enough. Great. Thanks, guys. Congratulations. Thanks. Our next question comes from the line of Ragu Garam, Private Investor. Please proceed with your questions. Yeah. Thank you. The analysts have asked excellent questions, so I have some comments and then a few questions. First and foremost, I want to congratulate senior management for doing an excellent job, actually exceptional job actually on all fronts, especially maintaining balance sheet strength during an industry downturn, overall cost control, initiating expansion projects for growth, as well as brownfield exploration successes in the last few months, last couple of years at Trinidad North and elsewhere. It's really remarkable. Also, thanks for your efforts over many years. Fortuna is the lowest cost producer in silver space. Fortuna production cash cost, as I see, is the lowest in industry. Going forward also, our production cost is actually stunningly low in my opinion. That's actually unbelievable for me, is that at $1.50, something in that range going forward is really great. With that, I want to ask a couple of minor questions. First one is, how soon you may be able to announce some initial exploration results of La Noria to the market? Yes, we are currently drilling with one rig. We will likely be releasing results sometime in April. We're drilling only with one rig, so the advance is low. We'll have likely a batch of results for, if not the end of March, April. Okay. That's what I would expect. Yeah. Thank you. Next question is, were you able to acquire additional land packages near current operations? In the immediate area of operations, our land packages have not changed materially over the last years. At San Jose, we did add one concession last year, which is on a far north projection of the system where we're currently mining, the Trinidad system. That was a concession we placed for comfort. We have applied for more ground in other areas, both in Mexico and Peru. We have a new concession in South Oaxaca, Southeast Oaxaca. It's an exploration target for carbonate replacement deposit. In northern Mexico, north central Mexico, we have also applied for some large concessions in some historic camp areas. Now, all of that is early stage work with some surficial showings, so I would not be inclined to make comments or predictions regarding the potential of that ground until we can do a bit more work. Yeah. Actually, I think we should also not divulge to the market until the work is done. Acquiring it should be confidential without telling where we're trying to acquire. Lastly, this may sound a little bit ambitious on my part, but how about initiating a small dividend, because we are the lowest cost producer, and we have major capital expenses done. Maybe a small, couple of percentage dividend initiation to differentiate Fortuna from the rest of the companies in the space. I think that would go a long way to state the quality of the company. I appreciate if your management consider that going forward, and I really appreciate your efforts. Thank you. No, thank you. To elaborate more on that last point that you brought. For us, I think the discussion is not if we pay a dividend, but when we start paying the dividend. I think management and the board view favorably returning to shareholders. We believe what would be prudent is to end this capital-intensive phase and then consider a way to start returning to shareholders. This is a discussion that's already taking place at some level at the board, and I believe the appropriate time would be the end of this year, start of next. Excellent. Thank you again, and congratulations. Thank you. Ladies and gentlemen, there are no further questions at this time. I'll now turn the conference back over to Carlos for any closing remarks. 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.