SILVERMET INC. MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 Dated November 7, 2013
INTRODUCTION The following management s discussion and analysis ( MD&A ) of the financial condition and results of the operations of Silvermet Inc. ( Silvermet or the Company ) constitutes management s review of the factors that affected the Company s financial and operating performance for the three and nine months ended September 30, 2013. This MD&A was written to comply with the requirements of National Instrument 51-102 Continuous Disclosure Obligations. This discussion should be read in conjunction with the unaudited condensed interim consolidated financial statements of the Company for the three and nine months ended September 30, 2013, which were prepared in accordance with International Financial Reporting Standards ( IFRS ). All amounts referred to in this MD&A are in United States dollars unless otherwise specified. Information contained herein is presented as at November 7, 2013, unless otherwise indicated. Further information about the Company and its operations can be obtained from the offices of the Company, at www.silvermet.ca or from www.sedar.com. CAUTION REGARDING FORWARD-LOOKING STATEMENTS Except for statements of historical fact relating to the Company, certain information contained in this MD&A constitutes forward-looking information under Canadian securities legislation. Forward-looking information includes, but is not limited to, statements with respect to the potential of the Company s assets; the future prices of zinc; capital expenditure requirements; requirements for additional capital and other statements relating to the financial and business prospects of the Company. Generally, forwardlooking information can be identified by the use of forward-looking terminology such as plans, expects or does not expect, is expected, budget, scheduled, estimates, forecasts, intends, anticipates or does not anticipate, or believes, or variations of such words and phrases or statements that certain actions, events or results may, could, would, might or will be taken, occur or be achieved. Forward-looking information is based on the reasonable assumptions, estimates, analysis and opinions of management made in light of its experience and its perception of trends, current conditions and expected developments, as well as other factors that management believes to be relevant and reasonable in the circumstances at the date that such statements are made, and are inherently subject to known and unknown risks, uncertainties and other factors that may cause the actual results, level of activity, performance or achievements of the Company to be materially different from those expressed or implied by such forward-looking information, including but not limited to risks related to: unexpected events and delays during permitting; the possibility that future exploration results will not be consistent with the Company s expectations; timing and availability of external financing on acceptable terms and in light of the current decline in global liquidity and credit availability; future prices of zinc; currency exchange rates; government regulation; failure of equipment or processes to operate as anticipated; risks inherent in manufacturing and processing operations, including strike by unionized personnel, environmental hazards or industrial accidents; and uncertain political and economic environments. Although management of the Company has attempted to identify important factors that could cause actual results to differ materially from those contained in forward-looking information, there may be other factors that cause results not to be as anticipated, estimated or intended. There can be no assurance that such statements will prove to be accurate, as actual results and future events could differ materially from those anticipated in such statements. Accordingly, readers should not place undue reliance on forward-looking information. The Company does not undertake to update any forward-looking information, except in accordance with applicable securities laws. The Company is a reporting issuer under applicable securities legislation in the provinces of Alberta, British Columbia and Ontario and trades under the symbol SYI on the TSX Venture Exchange (the TSX-V ). Page 2
OVERVIEW All amounts are stated in US dollars unless otherwise noted. Silvermet is a Canadian zinc production company headquartered in Toronto. It was incorporated under the laws of the Province of Ontario and its principal business activity is the development of the electric arc furnace dust ( EAFD ) recycling business in Turkey, recovering zinc from EAFD waste product of steel mills, and production of a zinc concentrate for sale to smelters. Silvermet began operations in 2009 through the acquisition of a shuttered plant that was restored to operating condition, in Iskenderun, Turkey. On October 27, 2010, Silvermet and an affiliate of Befesa Medio Ambiente, S.A. ( Befesa ), a Spanish company that operates a number of Waelz kilns throughout Europe, established a joint venture known as Befesa Silvermet Turkey, S.L. ( BST ) to operate the existing Iskenderun plant and develop the EAFD recycling business in Turkey, (the Turkish Operations ). BST is held 51% by Befesa and 49% by Silvermet, and owns 100% of Befesa Silvermet Iskenderun Celik Tozu Geri Donusumu A.S. ( BSI ), which holds and operates the Iskenderun facility. The condensed interim consolidated financial statements for the three and nine months ended September 30, 2013 and 2012 reflect the impact of using the equity method to account for Silvermet s interest in the joint venture with the Company s share of net earnings and net assets separately disclosed in the notes to the financial statements. HIGHLIGHTS Net income of $1,228,961 for the first nine months of 2013 increased from $228,590 for the same period in 2012 as a result of production efficiencies, higher sales volume and foreign exchange gains. Cash on hand at the corporate level at September 30, 2013 was $1,990,260. Silvermet received dividend disbursements of $896,975 to October 10, 2013. During the first nine months of 2013, Silvermet repurchased and cancelled 1,734,000 common shares under its normal course issuer bid at an average price of C$0.097 per share for a total cost of C$167,526. As of January 1, 2013 Silvermet adopted IFRS 11 and changed its accounting of BST joint venture from proportionate consolidation to using the equity method. OUTLOOK The working capital position of the Company continues to strengthen with no debt, established and improving operations, and stable zinc prices. The expansion plans in the Adana and Izmir regions of Turkey are progressing. Each new plant is planned to have annual EAFD processing capacity of 110,000 Dry Metric Tonnes ( DMT ) and is estimated to cost $70 million to construct, for a total investment of $140 million. The two new facilities will have significantly higher operating margins than the existing Iskenderun plant, with the use of improved technology. When all three facilities are in production, the total EAFD processing capacity will increase from the current 60,000 DMT per annum to 280,000 DMT and annual zinc concentrate production will increase to 100,000 DMT containing approximately 150 million pounds of zinc. Construction of Adana plant is expected to commence in 2014, with operations by 2015. Construction of Izmir facility is expected to commence later in 2014. BST is in various stages of formalizing arrangements with raw material suppliers for these facilities. Page 3
Key highlights of the expansion plans are as follows: In February 2013, the European Bank for Reconstruction and Development ( EBRD ), approved a project finance loan of US$49 million, which amount is equal to 70% of the estimated US$70 million cost for the new Adana zinc plant. The term of the project finance facility is 9.5 years, with no repayments during the first twenty-four (24) month period. Closing is subject to customary conditions precedent and completion of documentation. Environmental impact assessment ( EIA ) certificates for the two plants were received from the Turkish Ministry of Environment and City Planning in April 2013. Final documentation is pending. Final engineering is nearing completion; equipment and construction tenders have been received for the Adana plant. BST is currently negotiating final equipment and construction contracts. A turn-key, fixed price engineering, procurement and construction ( EPC ) contract for the construction of the Adana plant is nearing finalization. RESULTS OF OPERATIONS The following table summarizes comparative results of operations of the Company: Three months ended September 30, Nine months ended September 30, 2013 2012 2013 2012 Revenues $ 128,486 $ 102,054 $ 305,875 $ 310,154 General and administration 114,122 119,508 441,102 478,807 Share of net earnings from joint venture (902,479) (222,338) (1,387,974) (714,840) Depreciation - Canada - - 426 2,354 Stock option expense - 56,456 87,242 279,136 Finance income (1,073) (971) (3,371) (2,973) Other expense (income) 34,831 19,029 (60,511) 39,080 Net income $ 883,085 $ 130,370 $ 1,228,961 $ 228,590 Other comprehensive (loss) income $ (339,358) $ 21,920 $ (1,043,073) $ 69,346 Comprehensive income $ 543,727 $ 152,290 $ 185,888 $ 297,936 Revenues include management fees and sales commissions received from the joint venture. General and administration costs at the corporate level include general office and management expenses, the costs related to maintaining a public listing at TSX-V, professional fees, audit, legal, accounting, tax and consultants costs, insurance, travel and other miscellaneous office expenses. Share of net earnings from joint venture shows the Company s share of the joint venture s after tax net income as detailed in the Note 6 (Investment in Joint Venture) of the unaudited condensed interim consolidated financial statements of the Company for the three and nine months ended September 30, 2013. In Q3, 2013, share of net earnings from joint venture increased by 306% to $902,479 compared to $222,338 in Q3, 2012, mainly as a result of higher sales revenues and foreign exchange gains due to fluctuations of exchange rates between the joint venture s functional currency Turkish Lira (TL) and the US$, in which revenues and some costs are denominated. Page 4
During the nine months ended September 30, 2013, share of net earnings from the joint venture increased by 94% to $1,387,974 compared to $714,840 during the same period in 2012, as a result of increase in shipments, lower operating costs and foreign exchange gains. Depreciation Canada includes depreciation of computer equipment and telephone system. The remaining fixed assets (furniture and fixtures, leasehold improvements, office equipment) are fully depreciated. Stock Option Expense is allocated based on the vesting provisions of the options, where 100% of the expense is recognized for options that vest immediately, and a portion of the expense is recognized each period for options that vest over time or subject to certain performance criteria. Stock option expense is recorded based on fair value calculations determined using the Black-Scholes valuation method. Finance income is interest earned on cash invested in guaranteed income certificates. Other expense (income) includes foreign exchange gains and losses incurred due to fluctuations of exchange rates between the functional currency of Canadian $ (C$) for the head office and the US $, in which most of the cash on hand and some costs are denominated. Other comprehensive (loss) income includes share of currency translation adjustments of the joint venture and currency translation adjustments at the consolidated level. Currency translation adjustments arise from differences between the functional currency and reporting currency of the reporting entities. SELECTED QUARTERLY FINANCIAL INFORMATION Revenues Net income (loss) Net income (loss) per share 2013 Q3 (1,2) $ 128,486 $ 883,085 $0.006 Q2 (1) 105,421 223,584 0.001 Q1 (1) 71,968 122,292 0.001 2012 Q4 (1,3) $ 149,523 $ 706,264 $0.004 Q3 (1) 102,054 130,370 0.001 Q2 (1) 108,727 (187,496) (0.001) Q1 (1) 99,373 285,716 0.002 2011 Q4 (4) $ 2,320,991 $761,202 $0.005 (1) 2012 and 2013 figures reflect Silvermet s 49% interest in the joint venture with Befesa using the equity method, with the Company s share of net earnings of the joint venture. (2) Q3 2013 production availability was 98%. (3) Q4 2012, production availability was 97%, with production reaching its highest level since beginning of operations in 2009. (4) 2011 figures reflect Silvermet s 49% of interest in the joint venture with Befesa using the proportionate consolidation method, before adopting IFRS 11. Page 5
LIQUIDITY AND FINANCIAL POSITION Working Capital The working capital of the Company was in a surplus of $2.15 million at September 30, 2013 and $1.8 million at December 31, 2012. The various components of working capital are stated in the notes to the financial statements. Capital resources The Company has various capital expenditure projects planned and underway, which will eliminate bottlenecks, improve throughput and plant performance. Additionally, the Company is seeking to build two new plants, as the market demand exists for such additional capacity. The execution of all such plans will require financing in addition to cash flows generated from operations. CAPITAL MANAGEMENT In managing its capital, the Company s objective is to ensure the Company is able to continue its operations and that it has sufficient ability to satisfy its capital obligations and ongoing operational expenses. The Company considers the components of shareholders equity, as well as its cash and equivalents, notes receivable, credit facilities and long-term loan obligations as capital. Management adjusts the capital structure as necessary in order to support its business strategy. The Board of Directors does not establish quantitative return on capital criteria for management, but rather relies on the expertise of the Company s management team to sustain the future development of the business. The Company is not subject to externally imposed capital requirements. FINANCIAL RISK FACTORS The Company s activities expose it to a variety of financial risks: credit risk, liquidity risk and market risk (including interest rate, foreign exchange rate, and commodity and equity price risk) which are listed in Note 23 of its audited consolidated financial statements for the year ended December 31, 2012. RELATED PARTY TRANSACTIONS The Company lists its related party transactions in Note 13 of its audited consolidated financial statements for the year ended December 31, 2012 and in Note 8 of its unaudited condensed interim consolidated financial statements for the three and nine months ended September 30, 2013. OFF BALANCE SHEET TRANSACTIONS As of the date of this filing, the Company does not have any off balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on the results of operations or financial condition of the Company, including, and without limitation, such considerations as liquidity and capital resources. SIGNIFICANT ACCOUNTING POLICIES AND CRITICAL ACCOUNTING ESTIMATES AND JUDGMENTS The Company prepares its consolidated financial statements in conformity with generally accepted accounting principles in Canada. The preparation of the Company s consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. The Company lists its significant accounting policies in Note 3 and its critical accounting estimates and judgments in Note 4 of its audited consolidated financial statements for the year ended December 31, 2012. The accounting policies adopted are consistent with those of the previous financial year, except for the adoption of new standards and interpretations issued by the International Accounting Standards Board ( IASB ) or International Financial Reporting Interpretation Page 6
Committee ( IFRIC ) that were effective as of January 1, 2013, as stated in Note 3 of the condensed interim consolidated financial statements as at and for the period ended September 30, 2013. RISKS AND UNCERTAINTIES Equipment failures: The Company s equipment is complex and has many components. Equipment failures can occur due to the failure of individual components such as electric motors, causing a temporary halt in operations while repairs are made. Equipment downtime may also be experienced due to over-heating of the kiln, requiring a period of cooling before re-start. Potential catastrophic failures would include failures of the kiln shell, the failure of the kiln s brick lining or the failure in the primary drive gears. Catastrophic failures would result in an extended period of shut down while repairs are made, including the lead time required to order and receive replacement equipment. Energy costs: The major cost components to the Company s process relate to energy coke, anthracite, natural gas, diesel fuel and electricity. The costs of natural gas and electricity are regulated in Turkey. In the case of coke and anthracite, costs are driven by global events that impact these commodities and transportation costs. Significant adverse changes to such costs could impact the ability of the Company to operate profitably. Any interruption in the supply of these energy inputs would result in cessation of operations until such supplies resumed. Uncertainty due to foreign legal and political factors: Risks may include political unrest, corruption, civil disturbances and terrorist actions, arbitrary changes in law or policies, changes to government regulation, foreign taxation, price and currency controls, delays in obtaining, or the inability to obtain necessary governmental permits, limitations on foreign ownership, limitations on the repatriation of earnings and increased financing costs. Environmental regulations: The Company s business is subject to a variety of environmental regulations. Failure to properly process and handle EAFD in accordance with such regulations could expose the Company to liabilities and/or result in a withdrawal of operating permits. The Company has procedures in place to ensure compliance with environmental regulations. However, new laws and regulations could be passed at any time that could materially affect the Company s operations. Raw material supply: The Company requires a steady supply of EAFD in order to continue operating at an optimum level and to maintain profitable output levels. The Company relies on the continuing operations of the local steel mills at reasonable levels in order to meet its EAFD supply requirements. The closing of one or more local steel mills would have an adverse impact on the available supply. Additional funding: The Company anticipates the need for additional funding to support capital expenditures to improve the current Waelz kiln facility and to support planned expansions at other sites in Turkey. Failure to obtain such additional funding at critical times could lead to delay or indefinite postponement of such projects. There is no assurance that such funding will be available or that it will be obtained on favourable terms. Dependence on Key Personnel: The development of the Company s business is and will continue to be dependent on its ability to attract and retain highly qualified management personnel. The Company faces competition for personnel from other employers. Price volatility: Prices of commodities can fluctuate widely and are affected by numerous factors including demand, inflation, strength of various currencies, interest rates, forward sales by producers, global or regional political or financial events, and production and cost levels in major producing regions. In addition, commodities prices are sometimes subject to rapid short-term changes because of speculative Page 7
activities. The success of the Company s Waelz kiln operations is dependent on market prices for zinc and the related treatment charges from smelters. Currency risk: The Company s activities are primarily carried on in Turkey. All revenues and some items of cost are U.S. dollars based. Most operating expenses are incurred in Turkish Lira and head office related costs are incurred in Canadian dollars. Such activities are subject to risks associated with fluctuations in the rate of exchange of these foreign currencies. Critical Accounting Estimates: Critical accounting estimates used in the preparation of the financial statements include the Company s estimate of the value of stock-based compensation. These estimates involve considerable judgment and are, or could be, affected by significant factors outside Company s control. Factors affecting stock-based compensation include estimates of when stock options might be exercised and the stock price volatility. The timing for exercise of options will depend, among other things, upon a variety of factors including the market value of Company s shares and financial objectives of the holders of the options. The Company uses historical data to determine volatility in accordance with Black-Scholes modeling, however future volatility is inherently uncertain and the model has its limitations. These estimates may have a material impact on the stock-based compensation and hence results of operations, there is no impact on the Company s financial condition. OUTSTANDING SHARE DATA As at November 7, 2013 the outstanding common shares, share purchase warrants and stock options are: Common shares outstanding 154,667,216 Options 13,550,000 Fully diluted shares outstanding 168,217,216 MANAGEMENT S RESPONSIBILITY FOR FINANCIAL INFORMATION The Company s financial statements are the responsibility of the Company s management, and have been approved by the board of directors. The consolidated financial statements were prepared by the Company s management in accordance with Canadian generally accepted accounting principles. The consolidated financial statements include certain amounts based on the use of estimates and assumptions. Management has established these amounts in a reasonable manner, in order to ensure the financial statements are presented fairly in all material respects. DISCLOSURE OF INTERNAL CONTROLS Management has established processes to provide sufficient knowledge to support representations that it has exercised reasonable diligence that (i) the unaudited interim consolidated financial statements do not contain any untrue statement of material fact or omit to state a material fact required to be stated or that is necessary to make a statement not misleading in light of the circumstances under which it is made, as of the date of and for the periods presented by the unaudited interim consolidated financial statements, and (ii) the unaudited interim consolidated financial statements fairly present in all material respects the financial condition, results of operations and cash flows of the Company, as of the date of and for the periods presented. In contrast to the certificate required under Multilateral Instrument 52-109 Certification of Disclosure in Issuers' Annual and Interim Filings (MI 52-109), the Company utilizes the Venture Issuer Basic Certificate, which does not include representations relating to the establishment and maintenance of disclosure controls and procedures (DC&P) and internal control over financial reporting (ICFR), as defined in MI 52- Page 8
109. In particular, the certifying officers filing the certificate are not making any representations relating to the establishment and maintenance of: (i) controls and other procedures designed to provide reasonable assurance that information required to be disclosed by the issuer in its annual filings, interim filings or other reports filed or submitted under securities legislation is recorded, processed, summarized and reported within the time periods specified in securities legislation; and (ii) a process to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with the issuer's GAAP. The Company s certifying officers are responsible for ensuring that processes are in place to provide them with sufficient knowledge to support the representations they are making in this certificate. Investors should be aware that inherent limitations on the ability of certifying officers of a venture issuer to design and implement on a cost effective basis DC&P and ICFR as defined in MI 52-109 may result in additional risks to the quality, reliability, transparency and timeliness of interim and annual filings and other reports provided under securities legislation. ADDITIONAL INFORMATION Additional information can be accessed at the Company s website www.silvermet.ca or through the Company s public filings at www.sedar.com. Silvermet Inc. Tel: 1 (416) 203-8336 8 King St. East, Suite 1700, Toronto, ON, M5C 1B5, Canada Stephen G. Roman Stephen G. Roman Chairman, President & Chief Executive Officer info@silvermet.ca Ian D. Atacan Ian D. Atacan Chief Financial Officer iatacan@silvermet.ca November 7, 2013 Page 9