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Executives

Camilla Bartosiewicz - Director of Investor Relations & Corporate Communications

André Jean Douchane - Chairman, Interim Chief Executive Officer and Member of Technical, Environmental, Health and Safety Committee

David C. Langille - Chief Financial Officer

Gregory R. Struble - Vice President and Chief Operating Officer

Analysts

Alex Terentiew - Raymond James Ltd., Research Division

Andrew Mikitchook - GMP Securities L.P., Research Division

Leon Esterhuizen - CIBC World Markets Inc., Research Division

Sam Crittenden - RBC Capital Markets, LLC, Research Division

Nathan Littlewood - Crédit Suisse AG, Research Division

Leily Omoumi - Scotiabank Global Banking and Markets, Research Division

Annie Zhang - Octagon Capital Corporation, Research Division

North American Palladium (PAL) Q4 2012 Earnings Call February 22, 2013 9:00 AM ET

Operator

Good morning, ladies and gentlemen. Welcome to North American Palladium's 2012 Results Conference Call and Webcast being held on Friday, February 22, 2013, at 9:00 a.m. Eastern time.

I would now like to turn the call over to Ms. Camilla Bartosiewicz, Director of Investor Relations and Corporate Communications. Please go ahead, Camilla.

Camilla Bartosiewicz

Thank you, Matt. Good morning, everyone, and welcome to North American Palladium's year ended December 31, 2012 results conference call and webcast. The company's financial results were issued yesterday and are available on our website at nap.com. Our presenters today are André Douchane, NAP's Chairman and Interim CEO; Dave Langille, Chief Financial Officer; and Greg Struble, Chief Operating Officer.

Please be advised that the information discussed today is current as of February 21, 2013, unless otherwise indicated, and that comments made on today's call may contain forward-looking information. This information, by its nature, is subject to risks and uncertainties and as such, actual results may differ materially from the views and expectations expressed today. For further information on these forward-looking statements, please consult the company's relevant filings on SEDAR and with the U.S. Securities and Exchange Commission.

Lastly, please be reminded that all currency amounts discussed today are in Canadian dollars, unless otherwise stated. All references to production in ounces refer to payable production and all tonnes are in metric tonnes. And now I'd like to turn the call over to André.

André Jean Douchane

Thank you, Camilla, and thanks to all of you for joining us this morning.

Through the substantial investment in the company's flagship palladium asset in 2012, North American Palladium accomplished a number of significant development milestones and that paved the way to the company's future growth. Lac des Iles is a world-class palladium asset with significant exploration and development upside. We are excited about the opportunities for organic growth, which is certainly complemented by our existing infrastructure.

As highlighted in our January 31, 2013 news release, our exploration program has been very successful in identifying a number of new potential sources of ore. And we intend to explore all opportunities available to us to capitalize on the rising palladium price.

Given the recent increase in palladium, we intend to conduct a detailed economic analysis to evaluate the potential of maximizing our mill capacity by potentially processing our 13 million tonne low-grade stockpile.

Looking ahead to 2013, the year will not be without its challenges. We will remain completely focused on our long-term strategy to establish our palladium operations for sustainable growth, to achieve our goal of becoming a low-cost, mid-tier palladium producer.

Operations in 2013 are expected to be similar to 2012 as we continue to prioritize the mine expansion. However, we are looking to accomplish a monumental milestone this year, marked by the completion of our first phase mining expansion, which will enable LDI to transition to shaft production by the end of third quarter. To summarize our 2012 performance, in 2012, LDI produced approximately 164,000 ounces of palladium at a cash cost of USD 401 per ounce. These are in U.S. dollars.

Our realized palladium selling price was USD 640 per ounce, which is, incidentally, the same as the spot average for the year, giving an operating margin of USD 239 per ounce, for a total operating margin of almost USD 39 million.

Our financial performance was, for the most part, within our expectations with over $160 million in revenue and an adjusted EBITDA of $28.5 million.

The LDI expansion continues to be the #1 priority at NAP. Through an investment of $127.5 million in 2012, we completed the majority of the surface construction and significantly advanced the underground development. The shaft is now down -- is now over 67% down to the 825 meter level, and we are well positioned to start hoisting from the shaft at the end of Q3 of this year.

We also invested $17 million in palladium exploration at LDI. As highlighted through our recent exploration update, LDI has excellent prospects for growth and future resource expansion.

In 2012, we identified a number of surface and underground targets near existing infrastructure that we will be investigating this year, as they represent potential near-term sources of additional production.

Moving onto our 2013 guidance. Payable palladium production is expected to remain between 150,000 and 160,000 ounces. And cash costs are expected to range between USD 375 and USD 425. We're planning to invest $105 million in capital expenditures of which $79 million will be invented in a mining expansion to complete Phase I. And an additional $26 million will be invested on sustaining and future-oriented capital investments in support of the expanding operations at LDI. We believe these investments will significantly enhance our world-class palladium operations and establish a solid foundation for sustainable growth into the future.

Exploration will remain a strategic focus of the company. However, we have temporarily scaled back our exploration expenditures to $12 million during this capital intensive year.

Before I turn the call over to David, I just want to reiterate that we are dedicated to building long-term shareholder value and realize our vision of becoming a low-cost, mid-tier precious metal producer through the completion of our mine expansion.

We believe that this real value creation will ultimately be reflected in our share price as we transition to shaft production, start to expand our operating margins and start to generate some meaningful free cash flow. We are very appreciative of our shareholders who continue to stand by us and we sincerely value your patience as we complete our transition. And now I'll turn the call over to Dave to discuss the financial results for 2012.

David C. Langille

Thank you, André, and good morning, everyone. Before I start, I'd like to highlight a change to our financial reporting method. Given the company's intention to sell the gold division, the company has treated it as a discontinued operation, essentially held for sale. Therefore, the financial statements have been adjusted accordingly, reflecting the continuing palladium operations.

As disclosed in the financial statements, the company has incurred a noncash impairment charge of $56 million on its gold division.

I'll start by recapping our financial performance in 2012. Revenue from continuing operations was $160.7 million compared to $143.7 million in the prior year.

Revenue from the palladium operations increased by $17 million, primarily due to higher palladium production and byproduct revenues, which were partially offset by a lower realized palladium price.

In 2012, the company realized a price of USD 640 per ounce of palladium sold, compared to USD 733 per ounce in the previous year.

The loss from continuing operations in 2012 was $11.4 million, or $0.07 per share, compared to income from continuing operations of $4.4 million, or $0.03 per share, in 2011.

The loss from discontinued gold operations for the year ended December 31, 2012, was $54.6 million, or $0.32 per share, which includes a $56 million noncash impairment charge, compared to a $69.5 million loss, or $0.43 per share, including a $49.2 million noncash impairment charge in 2011.

The net loss for the year ended December 31, 2012, was $66 million, or $0.39 per share, compared to $65.2 million or $0.40 per share in 2011.

Adjusted net income, which excludes exploration costs, loss from discontinued operations, including the asset impairment charges, mining restoration costs due to flooding and other onetime costs, were $7.7 million in 2012, compared with $14.3 million in 2011.

EBITDA was $9.4 million in 2012 compared to $16 million in 2011. Adjusted EBITDA, which excludes exploration expenses, mining restoration costs due to flooding and retirement payments, was $28.5 million in 2012 compared with $26 million in 2011. In 2012, the company's operating activities before changes in noncash working capital provided cash of $15.6 million or $0.09 per share, compared to $15.6 million or $0.10 per share in 2011.

Looking at our capital spend during the year, North American Palladium invested approximately $194 million in development and capital expenditures, which includes $166.3 million at LDI, of which $127.5 million was towards the mine's expansion and $28.1 million at the Vezza gold mine. Recall that until Vezza reaches commercial production, all costs will continue to be capitalized. The $127.5 million mine expansion cost reflects some cost overruns related to some project built [ph] changes and some extra contractor costs for shaft mucking and support. Part of the development costs for LDI also included $8 million of capitalized interest and $7.7 million related to some necessary upgrades to our tailings management facility. Due to the 2 severe rainstorms this year, extra water was directed to the TMF, which accelerated our timeline for the upgrades that were initially planned for 2013.

The impact of those rain events resulted in $3.8 million in additional onetime restoration costs related to pumping in surface and underground flood mitigation efforts. During the exploration, in 2012, the company invested $20 million in exploration. Approximately $17.2 million was invested in our palladium operation, of which $14.5 million was expensed. $2.8 million was spent at our gold operations. As we recently announced in the January 31 exploration news release, our 2012 palladium exploration program returned excellent results, highlighting the potential for future resource expansion at LDI.

Turning to the balance sheet, as of December 31, 2012, the company had $32.6 million in working capital, including $20.2 million of cash on hand and the availability under the company's USD 60 million credit facility was USD 27.5 million. We're in the process of exploring financing alternatives, and I'm confident that the company will be able to secure the financing required to execute on the 2013 plan.

I'm highly encouraged by the cash generation potential of LDI and look forward to optimizing the capital structure to support the company's growth initiatives. I will now turn the call over to Greg to discuss our operational and development activities during the year and our plans for 2013. Greg?

Gregory R. Struble

Yes, thanks, Dave. To start off with the past year, overall, LDI achieved solid operating results in 2012, surpassing the higher end of our production guidance. To briefly recap our production results, we produced nearly 164,000 ounces of payable palladium. Approximately 2 million tonnes of ore were mined with a majority, 1.2 million tonnes, contributed from the surface. Our average head grade at the mill was 3.4 grams per tonne and the recovery at the mill was 78%. Cash cost averaged USD 401 per ounce, which was essentially within our guidance range.

Turning now to our operation in 2013. As André mentioned, this year isn't expected to be materially different from 2012. Mining at LDI will continue to balance underground production with surface sources, mainly from the Roby Zone open pit and from the upper Offset Zone. Payable palladium production is expected to remain consistent at the 150,000 to 160,000 ounce mark. Of the 1.8 million to 2 million tonnes to be milled, the majority, approximately 1.1 million tonnes, will come from underground. We anticipate the slight improvement in our recoveries to 79% and our average head grade at the mill is expected to be 3.5 grams per tonne.

Cash costs are expected to average between USD 375 and USD 425 per ounce. And I would like to highlight that significant quarterly variability is to be expected during this critical transition year as we move to the full shaft.

This will have the mine sequencing that will have to balance production with our underground development that's ongoing.

In fact, cash costs are expected to be higher than our guidance range in the second and third quarters, potentially around USD 600 per ounce. However, this should decrease by fourth quarter and average between USD 375 and 425 USD for the year. Since the shaft is not expected to be fully operational until the end of the third quarter, the majority of our underground mining will continue to utilize their ramp system, which given where we are in the ore body right now, will also be a longer haul distance than we saw in 2012. We anticipate that improved rates, underground tonnage and costs will be skewed heavily towards the fourth quarter of 2013 once underground production fully transitions to the use of the shaft.

In 2013, we plan to make a substantial $105 million investment in capital expenditures at LDI to establish the operations for sustaining the future growth. Of the $105 million capital budget, $79 million will be invested to complete Phase I of the LDI mine expansion as detailed in the pre-feasibility study, which will transition operations to shaft production in the Offset Zone, allowing the company to significantly reduce its cash cost per ounce and tonne. This investment includes sinking the shaft to the 825 level meter -- meter level and advance the underground development in the Offset Zone, extending the ramp at depth and establishing new mine levels and stopes. $26 million will be invested primarily on sustaining the future-oriented capital investments in support of the expanding LDI operations. These include $14 million for the expansion of the tailings management facility; $5 million to upgrade the existing site infrastructure, including the replacement of equipment and mill maintenance and additional development; and $7 million of capitalized interest relating to the company's debt.

I would like to point out that LDI's sustaining capital expenditures, excluding underground development, are generally expected to be under $10 million per year once the underground infrastructure is fully set up and the TMF upgrades are completed.

With respect to the mine expansion, we accomplished a number of significant development milestones in 2012. We remain well positioned to transition our operations to shaft-supported production in Q3 of this year. The major surface construction components are essentially complete and fully operational. The production hoist has been installed and is currently undergoing mechanical and electrical testing, and the construction of the underground crusher and loading pocket has commenced. Likewise, underground development is progressing on schedule. Actually, as of this morning, the shaft continues to progress well. And as we said in our press release, we're at 550 meters, which is about 67% complete, with a total 825-meter planned level for this year. With that, I'll now turn the call back to André for some closing remarks. Andre?

André Jean Douchane

Thanks, Greg. Before we open the call up for questions, I just want to make a few brief comments about the palladium market. 2012 palladium spot prices averaged USD 640 per ounce as we said earlier. It ranged from USD 556 to as high as USD 719. Despite this volatility in prices, supply and demand fundamentals of palladium remained strong. A supporting factor behind the positive outlook for the metal's future performance is the resilient industrial demand, increasing investment demand and a constrained global supply.

For palladium, fundamentals are driven by few main things. Automotive demand, which uses about half of the mined palladium, continues to show steady growth, and it's clear that the automotive industry will consume more palladium this year than it did last year. We obviously see growth in China, we see growth in Brazil, and we see growth actually in North America as of late, as the cars continue to -- manufacture -- more carmakers continue to manufacture more and more cars on an annualized basis.

Investor behavior, which recently saw demand from the ETF investors, increasing global ETF holdings to 2 million ounces. That's significant in several ways, but it does show that there is a strong belief in the fact that palladium will remain at high levels and probably continue to go up, which would be based on a -- sort of a 0 growth and the price that it would probably take to begin to bring scrap from catalytic converters back into the market. I think the scrap price that most experts feel that you'll start to see a lot of scrap come back in the market is probably around USD 900 an ounce. But between here and USD 900 an ounce, if the demand stays where it is and production stays where it is or goes lower, the price should stay in this range over the next several years.

Both Russia and South Africa continue to show no growth and there's not been a lot of growth actually shown in North America with respect to the metal either. The next, I think, significant or bump in growth will come from LDI between now and 2015. With palladium having reached a 12-month high at USD 765, we remain very optimistic about its prospects and believe that our investments to expand our palladium operations as well, tying them to the commodity cycle. Thanks for listening, and now we look forward to answering your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Okay, first up, we have Alex Terentiew with Raymond James.

Alex Terentiew - Raymond James Ltd., Research Division

It's Alex Terentiew with Raymond James. Just a couple of questions for you. I just want to clarify, Greg, I think I heard you say on the call that -- I understand that it was on your press release as well. Variability, quarterly, we can expect that at LDI over 2013. With -- on cash costs, can you confirm that you're noting cash costs in Q2 and Q3 could be around USD 600 an ounce? And I guess that would imply Q1 and Q4 could be a little better? Was that correct?

Gregory R. Struble

Yes. Alex, I think the best way to look at this is we know we've got a long haul from the current [indiscernible] Offset stope up to the surface. Until the pocket goes in and is fully operational, we expect those costs to grow to a certain degree. I think we're probably being conservative in our estimates. But it shouldn't vary on the year. I think the important thing to watch is going to be the overall year.

Alex Terentiew - Raymond James Ltd., Research Division

And do grades have a role in that -- in the change in the cash cost? Or is it really just the haul distance, the operating cost?

Gregory R. Struble

You see our grades being fairly flat so it's going to be more operationally.

Alex Terentiew - Raymond James Ltd., Research Division

I missed the first few minutes of the call so I apologize if you had said this already. But the $56 million write-down of the gold division this year, you spent I believe about $26 million at Vezza in 2012. What's the remaining book value of your gold unit?

David C. Langille

It's approximately $18 million.

Alex Terentiew - Raymond James Ltd., Research Division

Okay. And for 2013, what are you guys planning to do operationally there? And I guess in more with respect to what sort of cash outlay can we expect?

André Jean Douchane

This is André. It's for sale, and we're treating it that way. We think it's fairly well cash neutral at the moment.

Alex Terentiew - Raymond James Ltd., Research Division

So but you are -- I mean, you do have people there operating? I mean, you are pulling more out? So there are operations ongoing, I guess?

André Jean Douchane

Don't feel bad. I had a discussion with the auditors myself. It's not -- yes, that's an audit term, an accounting term, discontinued operations, held for sale. That's -- that doesn't mean what it says. There's people there and we're still mining gold.

Alex Terentiew - Raymond James Ltd., Research Division

Okay. But is it fair to assume though that the capitalized -- well, I mean, the expenditures in 2013 will be a lot less than they were last year?

André Jean Douchane

As I said before, we expect them to be fairly neutral.

Operator

Next up, we have Andrew Mikitchook with GMP Securities.

Andrew Mikitchook - GMP Securities L.P., Research Division

Especially with the kind of guidance now with the increasing costs throughout the year until the loading pocket and the shaft is in place, what kind of guidance or -- can you provide for us with respect to when it would be prudent to have full financing package in place for the year?

André Jean Douchane

This is André. We've committed to do a lot of things this year, Dave and I and the team here. One of them is obviously to make sure that this project gets done in a timely fashion and we get the shaft moving and utilized as quickly as possible. The other commitment we're making here is to fix the balance sheet. And the timing on that? Who can say. We continue to work on that and we continue to work on looking at many methods of doing that. So -- but we're fully committed to having that balance sheet fixed. And we see, at this junction, no reason why we shouldn't be able to accomplish that some time in the first half of the year.

Andrew Mikitchook - GMP Securities L.P., Research Division

Okay. And I guess that there's already been a discussion on the grade. In terms of the surface contribution, is that also skewed for the front of the year and kind of ending before the end of the year, without having added anything else from some of these new surface targets?

André Jean Douchane

Yes, I think that's a fair assumption. But it goes through a significant part of the year, Andrew. So we're not too concerned about that and we do have extra resources that we can bring to bear.

Andrew Mikitchook - GMP Securities L.P., Research Division

Okay. And then just lastly, I'm not sure who put this out at the beginning of the call. I think André, it might have been yourself, the concept [ph] of the 13 million tonne stockpile, that was about a gram wasn't it, historically?

André Jean Douchane

Yes, historically, it's somewhere close to that. Hence, historically, its' recovery is in the middle 60s and it sort of has the same amount of copper, nickel, gold and platinum bouncing around it. So palladium would be about 70% of the value of it. It's not as simple as it sounds. It's something that we are looking at a business case of putting some of that in there, because price is high and it starts to make that rock worth a little more than the milling cost. And cash is cash.

Andrew Mikitchook - GMP Securities L.P., Research Division

Right, right. And I guess you guys are thinking about variations on blending, essentially, with some of the more substantial grades that'll start hitting the -- coming up from the mine, right?

André Jean Douchane

Yes, it's always best if the mill sees a relatively uniform feed, and we always optimize to do that. The reason is, so your concentrate grade doesn't slide all over the place and you don't give your smelter fits. But the whole idea is to try and put out a uniform -- as uniform a concentrate as you can so that you can really predict your payment schedules, because that slides around -- you've probably never -- I don't know if you've ever gotten into smelter contracts, but there's -- they're complex for a lot of reasons.

Andrew Mikitchook - GMP Securities L.P., Research Division

Okay. And this stockpile is obviously on surface. Most of it would have come from the open pit, I assume. Does that have an impact on how this shows up in the mill in terms of the sizing of what's sitting around on surface and/or oxidations after sitting there for a few years?

André Jean Douchane

No, it's been -- a lot has been sitting there a long time. A lot of it came from back when I first showed up on the scene in 2003. And a lot of it came from 2002 when they had the problem with crusher and they couldn't crush as much ore. So they stockpiled a lot of what they call, lower-grade ores, so they could keep the higher grade going through the mill. It was probably a bad move, but they did. They put a lot of 1-gram stuff on the ground. And throughout periods, it has done that. This ore doesn't oxidize very well, so it really doesn't change chemically. They have a lot of trouble in someplace called the Twilight Zone, where they stockpiled some stuff from there too. It just was mostly put in place probably between 2000 and -- late 2001 and 2005, but there is a smaller pile that's boulders that we've mostly work through. I think there's still -- last time I was up there, there's still a little bit of it left. But whether it's high grade or boulders, I'm not sure. So...

Andrew Mikitchook - GMP Securities L.P., Research Division

So at least in terms of treating it, it wouldn't be significantly different from the historical stuff that was mined and could be used?

André Jean Douchane

They have to pick it up with a loader and put it in a big truck, which we have all of that stuff, and put it in a crusher in some sort of blending arrangement with the underground ore, if it makes sense. It may not make sense, but it's something we looked into. So I wouldn't put it in the plan yet.

Operator

Okay. Next up, we have Mr. Leon Esterhuizen with CIBC.

Leon Esterhuizen - CIBC World Markets Inc., Research Division

I just want to sort of focus on the back-end of your forecast for 2013. Given the fact that you're talking sort of USD 600 costs in Q2 and Q3, just back of the envelope calc sort of implies that you're going to be doing something in the order of USD 200 an ounce in the final quarter to get to your full year guidance of, say, USD 400. Is that a good assumption or estimate?

Gregory R. Struble

André -- excuse me, Leon, I think that's probably aggressive. However, I think our second and third quarters are conservative.

Leon Esterhuizen - CIBC World Markets Inc., Research Division

Okay. Because I'm trying to sort of look through this being your transition year and trying to look for what happens after this. And even if I'm aggressive and let's call it USD 300, then obviously, 2014 looks like a significantly better year in terms of costs. At what point then do we get to Phase II?

Gregory R. Struble

Right now, we're showing -- our internal targets are continuing to push towards the 250 nominal ounce production by 2015. So we're still feeling pretty good about that type of a timeline. This is going to -- a lot of it is going to depend, Leon, on how we do this year and the targets we meet, as well as I think the growth we're going to see in the resource. So we're very pleased with a lot of things that are happening on the exploration site around the surface and underground. And that's going to have an impact that we need to understand before we really go forward on how we get to that full target.

Leon Esterhuizen - CIBC World Markets Inc., Research Division

Okay. Because that leads into the next question. After the resource -- or the reserve announcement the other day, you've now dropped the cutoff grade, which brings in a significant amount of extra metal. Is this a play on reducing your capital expenditure, going deeper and trying rather to just get more tonnes off the same horizontal level? Is this what we should be expecting?

Gregory R. Struble

I think my biggest goal is to move as much laterally as we can. That really gives us time to really fully understand the full depth of this thing. We know it's got a good, good -- to extend the depth but we need this year to really figure that out. So, yes, to your question. We want to be able to grow laterally as much as we can.

Leon Esterhuizen - CIBC World Markets Inc., Research Division

Okay. So the final thing then is are you guys expecting to mine anything from Sheriff or any of the other zones then in the next 12 months?

Gregory R. Struble

Really, what we're looking to have focus on is purely Offset. We think most of our opportunities are there. A little bit left in Roby. But Sheriff and Cowboy needs a little bit more work and they'll probably come into a bigger piece as we get deeper into Phase I, but look more for those type of contributions down the road.

Operator

Next up, we have Mr. Sam Crittenden with RBC Capital Markets.

Sam Crittenden - RBC Capital Markets, LLC, Research Division

Just a follow-up on the Offset Zone cutoff grade. Greg, is there some flexibility to increase that cutoff and sort of mine of at higher grades if you needed to, say, if palladium were to correct significantly over the next 12 months or so?

André Jean Douchane

Greg, you can answer. But I mean -- this is André. Absolutely. I mean you can always high grade the thing. It's not the right thing to do and we certainly don't believe it's going to happen. Obviously, when you go to 2.5-gram, 2-gram cutoff, 2 grams makes pretty good money. So we're mining for cash here. So it's important that we keep this operation as efficient and as flexible as possible, to be able to exploit as much of the ore that we have developed and -- as we can.

Sam Crittenden - RBC Capital Markets, LLC, Research Division

And then just if you could talk about the mining you've done so far in the Offset Zone? Have the grades have been sort of reconciling close to plan and the sort of productivity you expect there or are seeing there, has it been sort of in line with what you were expecting?

André Jean Douchane

Yes.

Sam Crittenden - RBC Capital Markets, LLC, Research Division

And then question on the exploration spend for 2013. Is most -- is the $5 million that's going to be capitalized, is that sort of required for mining operations? And the other is somewhat discretionary? And also could you sort of defer that to the back half of the year? Is that sort of the plan?

Gregory R. Struble

We have that opportunity, but it's really to help us grow Offset laterally and get a good preview of what we have at depth. So that capital is dedicated towards that.

André Jean Douchane

Well, this is André. The $5 million is infill drilling and it has to be treated financially the way we're treating it. And infill drilling is necessary for us to help our short-term planning for our mining operations. The rest of it, I think, is extremely important. It's -- you saw the actual reserves that were put out, about 7 million, almost 8 million tonnes. It doesn't take us very far down the road. As with any underground mine, you have to continually drill, and we're very fortunate to have 3 or 4 years ahead of us. Most mines have less than 1. Even though we know that the veins are there and the mineralization is quite continuous and continues in a lot of areas. So I think it's critical for us to have long-term planning to get this drilling done this year. So it's -- in my mind, it's not all that discretionary.

Operator

Okay, next up, we have Mr. Nathan Littlewood with Crédit Suisse.

Nathan Littlewood - Crédit Suisse AG, Research Division

I had a question about your exploration spend on some of the more regional targets. You mentioned earlier that it's not quite as big this year as you would like given the balance sheet constraints. But in an ideal world, if the balance sheet was fixed, sort of maybe looking to the back half of this year, what would you like to be spending on some of these regional targets?

Gregory R. Struble

Yes, Nathan, listen. I think our real focus now has to be at the site, close in and hold our position on regional. We think there's a lot of growth potential regionally. But this year, we really got to focus on our knitting and to stay close to home. I think we've done a good job of expanding our footprint and getting where we need to be within the region. So that's really our focus this year, that's to stay closer to the site and see what we can do to help improve our local picture.

Nathan Littlewood - Crédit Suisse AG, Research Division

Got it. Okay. The next one I had is just on understanding the underground tonnages that you've quoted for this year. You got me a little bit confused here. So 2012 was around about 2,500 tonnes per day. And that's probably, I would guess, a pretty good outcome for the first 3 quarters of this year, given that you're going to be getting a little bit deeper. Then if we assume that, very simplistically, let's keep the math neat, if we assume that on the 1st of October this year, being fourth quarter, you commission this shaft and you have an instantaneous step-up to 3,500 tonnes per day, which is probably optimistic. But let's say that did happen, then the total tonnage from underground for the year would be about 1 million tonnes. So I was just wondering if you could help me understand the gap between that simple math [ph] and the 1.1 million tonnes that you've guided for?

Gregory R. Struble

Yes. We're actually seeing or we're projecting some larger stopes that will be our initial production in Offset. So they're bigger than some of the material we've been mining in Roby during this past year. So that's going to have a little bit of an effect in terms of our tonnes per day, being able to bump that up a bit, Nathan. And then likewise, we're not done with the upper Roby. We think there's some more room to grow there. So we're not ready to say that, that will no longer be a part of our longer-term plans yet.

Nathan Littlewood - Crédit Suisse AG, Research Division

Okay. So for the first 3 quarters of this year, you should be doing something more like 2,700, maybe 2,800 tonnes per day from the underground then? Is that fair?

Gregory R. Struble

That's probably pretty fair.

Nathan Littlewood - Crédit Suisse AG, Research Division

Okay, okay. The other question I had on a similar subject was just in relation to the 43-101 from the other day. You show on Page 1627 [ph] at Table 16.13, which is annual production numbers, and you've got on Offset Zone tonnage there for 2014 of 4,000 tonnes per day, so significantly higher than the 3,500 that you've talked about. Could you, again, offer a little more color on that? What's driving that?

Gregory R. Struble

Yes, that's basically stope prep, Nathan. We know we have capacity with the shaft, but the real target or the real thing to focus on, for us, is stope prep. We need to have the ability to feed the shaft. So what we're seeing is because we have -- the next level that we're planning to has a lot more [indiscernible] than what we're currently adding in the Offset. We know it gets wider. We know it gets longer as you go deeper. We're going to have more panels available. So we're assuming that we're going to be able to increase our production to that level.

Nathan Littlewood - Crédit Suisse AG, Research Division

Okay, great. Final question was for Dave. Just on the financial modeling and balance sheet. You guys have obviously got your own detailed model on this thing, and it's probably a whole lot better than ours. You've got your price forecasts and you've got your cash costs forecasts. On your modeling, I know you can't talk about timing and exactly what the solution will be yet, but on your modeling, how much extra cash do you think you need over the next 2 years?

David C. Langille

I can't talk about that either, basically and in terms of the numbers. But, I mean, there is a funding requirement that we're interested in. There's certainly been a lot of activity. I mean, I'm in week 5 here. So there are a lot of interests from a lot of different markets in terms of the company and the metal. So we think that the markets are completely open to us. But in terms of providing precise number, I guess I'm not willing to go there at this point in time.

Nathan Littlewood - Crédit Suisse AG, Research Division

You can be vague, if you want. Have you got a range in mind? And are you willing to talk about the types of solutions that you might be looking at?

David C. Langille

Well we've had a variety of people approach the company with different alternatives. Having said that, obviously, very cautious of shareholder value and dilutive effects, but we are looking at a variety of alternatives and the board will have to consider those.

Operator

Next up, we have Leily Omoumi with Scotiabank.

Leily Omoumi - Scotiabank Global Banking and Markets, Research Division

Just a few questions and just want to start with your best estimate for CapEx spending in 2014? I know there were some numbers released with your feasibility study, but just to have a general sense of what we're looking at next year, can you maybe comment on that?

David C. Langille

No.

Leily Omoumi - Scotiabank Global Banking and Markets, Research Division

Okay. Also on the secured -- the senior secured notes that is due, I believe, October 2014 in the amount $67 million or so, I believe there's an option to delay the maturity on that by 1 year. Is that something that you are considering? And what are some of the potential penalties that could come with that?

David C. Langille

I mean, that option is always open to the company. And I guess when we get to 2014, it's something we'll have to consider and look at. I believe -- I'll have to get back to you. I believe there is a fee for that.

Leily Omoumi - Scotiabank Global Banking and Markets, Research Division

Okay. Would you be able to get back to me on that then?

David C. Langille

Sure, I can do that.

Leily Omoumi - Scotiabank Global Banking and Markets, Research Division

And would it be fair to say that if your plans to secure funding, say, sometime in Q2, don't go as you hope, that some of the spending would be obviously delayed? I mean, I'm just looking at my numbers and I think you would need at least $40 million to $50 million this year in order to meet your capital requirement expenditures of $105 million. Could you maybe comment on that?

André Jean Douchane

Yes. Go ahead, Dave. But I mean, basically we don't see that as anything that's going to occur.

David C. Langille

Yes, I mean, cash is king. And obviously, our job as management is to make sure the funding is available and optimize the value of this asset. And we think the markets are available to us. But if something was to happen, obviously, management would take action to adjust the plan accordingly.

Leily Omoumi - Scotiabank Global Banking and Markets, Research Division

Okay. And what portion of the capital expenditures do you -- this year do you think would be -- you would be able to fund if you were to raise money through flow-through shares? What portion would be eligible?

André Jean Douchane

I don't know. I think we've got probably up to $25 million that could be eligible. It all depends on when the shaft comes -- the shaft starts commercially rolling. We think it's going to at the end of September then it's closer to $30 million. If we get it up and going earlier, then it's closer to $25 million. So something in that range. It could be used as flow-through. It could be flow-through eligible.

Leily Omoumi - Scotiabank Global Banking and Markets, Research Division

Okay. And then also could you just comment maybe on the new -- your CEO search, where you're seeing spend on that front.

André Jean Douchane

Sure, I'll do that. We're still looking. We had a CEO candidate that we had chosen. Just an unfortunate set of circumstances came up to where this individual couldn't leave the company that they were with in the time frame that they intended. They still would like to come and do the job, but they've been delayed considerably, so we continue to look. But in the interim, I don't know if anybody has seen it, but I did step down from the company that I was CEO of and so there is a permanent CEO here, a full-time CEO, although he is interim. And we continue to look for someone but this ship is not without a rudder.

Leily Omoumi - Scotiabank Global Banking and Markets, Research Division

Fair enough. And then just a housekeeping question. What U.S.-Canadian exchange rate do you assume for this year?

David C. Langille

We just use parity.

Operator

[Operator Instructions] And next up we have Annie Zhang with Octagon Capital.

Annie Zhang - Octagon Capital Corporation, Research Division

Probably I have more questions for Dave. Since you started mining the Offset stopes early this year, should we assume that your depreciation for the Phase I CapEx should start kicking in maybe earlier than Q3?

David C. Langille

The Phase I CapEx, a portion of it will, because we're ramping that to surface in the interim. So it will kick in. Keep in mind that we obviously have to adjust and we'll have a midyear reserve and resource estimate coming out as well with new [ph] numbers. So it will change going forward. But yes, the Offset Zone, there will be a portion included in there from the depreciation calculation.

Annie Zhang - Octagon Capital Corporation, Research Division

As soon as you start the mining on from the Offset stope, so probably in the second quarter?

André Jean Douchane

We're mining now.

David C. Langille

We're currently mining there.

Annie Zhang - Octagon Capital Corporation, Research Division

Okay. Secondly, I just want to verify, you only mentioned about the 55,000 ounces of palladium on the financial contract as of the year end. You don't have any ounces of gold left?

David C. Langille

I'm sorry, could you repeat the question. I'm not sure I understand it, Annie.

Annie Zhang - Octagon Capital Corporation, Research Division

Yes, so you have -- normally, you have a financial contract for metals in order to hedge. In the reporting, you only mentioned about the 55,000 of palladium last -- as of the year end. Do you have any contract on gold?

David C. Langille

No, we did not at year end.

Annie Zhang - Octagon Capital Corporation, Research Division

And then lastly, since you are assessing the possibility even to process the stockpile ore at less than 1 gram per tonne, is it fair to assume that you will continue to process the open pit material through maybe the end of 2014 until, I guess, as much as you could?

André Jean Douchane

This is André. I'll answer that. It goes back to what Greg said earlier. I mean, the answer is no, if it runs out before the end of the year, but it goes quite a ways into the year. So it's what it is, unless we find something to replace it.

Annie Zhang - Octagon Capital Corporation, Research Division

Okay. So you will run out the stockpile -- okay, that's all the questions that I have.

Gregory R. Struble

Not stockpile.

André Jean Douchane

Not stockpile. We'll run out of the open pit ore.

Gregory R. Struble

And reserves.

Annie Zhang - Octagon Capital Corporation, Research Division

Yes. But you still have about 2.5 million tonnes in indicated as of 2011 year end?

Gregory R. Struble

Yes, that's in indicated, Annie. And right now, we haven't moved any of that into our plans beyond what we currently have for this year. Not that it couldn't come in at some point, but that needs more time and more review.

Operator

So that's all the time we have for questions today, ladies and gentlemen. I'll turn it back to our speakers for closing remarks.

André Jean Douchane

Thank you, operator, and thank you, all of you, for participating and have a great day.

Operator

Thank you, ladies and gentlemen. This webcast is now concluded.

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