North American Palladium Management Discusses Q1 2013 Results - Earnings Call Transcript

May. 6.13 | About: North American (PAL)

North American Palladium (NYSEMKT:PAL)

Q1 2013 Earnings Call

May 06, 2013 8:30 am ET

Executives

Camilla Bartosiewicz - Director of Investor Relations and Corporate Communications

Philippus F. Du Toit - Chief Executive Officer and President

David C. Langille - Chief Financial Officer

Gregory R. Struble - Former Chief Operating Officer and Executive Vice President

Analysts

Alex Terentiew - Raymond James Ltd., Research Division

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

Leily Omoumi - Scotiabank Global Banking and Markets, Research Division

Sam Crittenden - RBC Capital Markets, LLC, Research Division

George J. Topping - Stifel, Nicolaus & Co., Inc., Research Division

Daniel McConvey

Nathan Littlewood - Crédit Suisse AG, Research Division

Matthew O'Keefe - Mackie Research Capital Corporation, Research Division

Annie Zhang - Octagon Capital Corporation, Research Division

Operator

Good morning, ladies and gentlemen. Welcome to North American Palladium's Quarter End March 31, 2013 Results Conference Call and Webcast being held on Monday, May 6, 2013, at 8:30 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, operator. Good morning, everyone, and welcome to North American Palladium's Q1 2013 Results Conference Call and Webcast.

The company's financial results were issued earlier this morning and are available on our website at www.nap.com. Our presenters this morning are Phil Du Toit, NAP's President and Chief Executive Officer; Dave Langille, Chief Financial Officer; and Greg Struble, Chief Operating Officer.

Please be advised that the information discussed today is current as of May 6, 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 on today's call are in Canadian dollars, unless otherwise indicated. 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 Phil.

Philippus F. Du Toit

Thank you, Camilla, and thank you, all, for joining us on this call this morning.

Having just recently joined the company at the end of March, a lot of my time has been spent appraising the business strategy, traveling to the mine site, reviewing our strategic mine plan, analyzing our development plans and, of course, getting to know our employees and some of our investors.

As part of that review, late in the first quarter, the management team embarked on an analysis of the 2013 operating and development plan, as well as the life-of-mine plan for the Offset Zone. The review is still in progress, however, it's proving to be a very valuable exercise, benefiting not only from the added skill set of the new management team, but also from the enhanced information about the ore body and a firmer grasp on costs.

We hope to formally complete our review by the end of the second quarter, and I commit keeping our shareholders and other stakeholders appraised of how our findings influence our strategic business plan on a go-forward basis. Being a technical person first and foremost, I plan to spend quite a bit of time at the LDI site. Having spent over 37 years in the industry, I've learned that mining, much like any other business, really comes down to the core fundamentals: health and safety, people in leadership, strategic mine planning, risk mitigation, costs and the financial fundamentals, efficiency and optimization of operations, and of course, sustainability. And that's where my focus will be.

There is significant value to be unlocked at the LDI and I'm encouraged by LDI's future cash generation potential.

I recognize, however, this value can only really be unlocked through the completion of Phase II of our expansion at depth and by optimizing our mining methods to leverage our existing surface infrastructure to move more volume.

This, I should clarify, is also all contingent on our ability to successfully complete financing.

Overall, my initial review has reaffirmed the potential that I saw when I accepted this position, but also identified some challenges and opportunities for improvement in areas such as strategic mine planning, cost optimization and project execution.

Our first quarter results are an example of some of the challenges that we are currently facing. They are concerning trends in our spending, our cash costs are higher than anticipated and the logistics of transition between the Roby Zone and the Offset Zone are proving to be a little bit more difficult, which has unfortunately resulted in the delay of our stope development.

This has adversely affected our stope sequencing plan and it's apparent to us now that we will get decreased volumes from the Offset Zone this year.

Although our review of the 2013 mine plan is still ongoing and subject to change, we think it's prudent, at this juncture, to recognize the potential downside as well.

Based on the preliminary findings, we believe that the low end of the 150,000 to 160,000-ounce production guidance will be difficult to achieve, and could potentially decrease by about 10% to 15%.

As a result of the decreased underground production levels and our lower head grade of mill feed, cash costs are expected to increase from our previous annual guidance of $370 to $425 per ounce target range.

Please bear in mind, this is still very indicative at this stage and remains subject to the ongoing review of the mine plan. Not to forget, this is also contingent on the successful completion of financing.

To compensate for our expected decreased production from the Offset Zone, we are actively pursuing production gains from other sources on the property during the transition. As those opportunities are properly evaluated later this year, we expect to have an improved outlook on the viability of those prospect. Amongst others, these opportunities include drilled off extensions of the Roby Zone, as well as from other surface sources, including stockpiles.

Recognizing that operating efficiency can only start to improve in a meaningful way once Phase II is completed, accelerating the shaft sinking beyond the Phase I 825-meter level will be a focus for 2013 development plan review currently underway.

As part of the ongoing reviews, the company is also considering alternative bulk mining methods for the Offset Zone to further optimize mining volumes and production costs.

For example, one method that will be considered is sub-level caving. Given LDI's rock competence, the ore body seems amenable to this mining method and if adopted, sub-level caving should allow for increased volumes at a reduced cost per tonne, all subject to our review.

The preliminary project review has indicated that the required capital expenditures to complete development of Phase I of the shaft project have been underestimated.

After a review of certain procurement items and development plans, including accelerating plans to commence Phase II of the shaft sinking in 2013, we expect that capital expenditures in '13 could be up by as much as 35% higher than prior guidance of $105 million.

This estimate is still preliminary and will be refined when we complete our review.

Looking ahead, it's very clear to me that the value creation, from this point onwards, will depend on our execution. It's also important to recognize that our plan to unlock the high potential value of LDI is dependent on a successful completion of financing.

As Dave will tell you next, we are currently in the process of evaluating our financing opportunities, and this remains a very high priority for the company.

In the near-term, our priority remains to finish the phase of the shaft as soon as practical, that is Phase I, which we still expect will be by the end of the third quarter, and to ensure that our operations are prepared for the changeover.

However, from this point on, our growth efforts are supported by existing infrastructure, an improved understanding of the geology at LDI and an enhanced plan for mitigating risks and improving operating performance.

Moreover, our expansion does not rely on any technology, so -- any new technology, so essentially, it only comes down to refining our life-of-mine plan.

So from a technology perspective, there is limited risk in going forward.

Further to help prevent project cost overruns and delays, we plan to engage a professional project management firm to support our project team with Phase II capital estimates and the implementation plan.

So before I turn the call over to Dave for a recap of our financial performance, I wanted to take a minute to express the company's appreciation for Greg Struble's contribution to the company during his 2.5-year tenure as Chief Operating Officer.

Greg's leadership was instrumental in rebuilding our team at the mine site and pursuing new sources of production to support our operations during our development transition. His collaborative management style aligned our efforts from operations, development and exploration towards a single shared vision.

While sad to see him go, we all wish him very well with his new endeavor.

And now I will turn the call over to Dave for the financial results of the first quarter. Dave?

David C. Langille

Thank you, Phil, and good morning, everyone. I'll start off by recapping our financial performance in the first quarter in comparison to the same quarter in 2012.

Revenue was $47.1 million compared to $41.6 million. The increase in revenue was primarily due to greater quantities of payable metals sold, more favorable exchange rates and higher realized prices for palladium.

In Q1, the company realized the price of USD 730 per ounce palladium sold. Net loss was $2.8 million or $0.02 per share compared to a net loss of $0.9 million or $0.01 per share.

Adjusted net loss, which excludes exploration costs, gains and losses from discontinued operations and insurance recoveries, net of mine restoration costs, was $0.8 million compared to adjusted net income of $3.3 million.

EBITDA was $2.9 million compared to $5 million. Adjusted EBITDA, which excludes interest and other financing cost, depreciation and amortization, exploration and insurance recoveries, net of mine restoration costs, was $7.5 million compared to $8.2 million.

Looking at our capital spend during the first quarter, North American Palladium invested $38.1 million in development and capital expenditures at LDI, which included $31.7 million investment in the LDI mine expansion, including $2.3 million of capitalized interest, and an additional $6.4 million of other development, of which, $5.5 million was invested in the tailings management facility.

Turning to exploration, in the first quarter, the company invested $6.1 million in exploration, of which, $1.3 million was capitalized as part of the mine expansion expenditures, and $4.8 million was expensed.

We expect to have an update on our drilling results from the first quarter by July.

Turning to the balance sheet. As at March 31, 2013, the company had cash and cash equivalents of $23.5 million. This includes the proceeds received from the sale of the gold division.

Recognizing that anticipated cash flows are not expected to provide sufficient cash to fund our planned capital expenditures this year, we plan to access the capital markets to fill that gap and plan to execute a financing later this quarter.

We are currently in the process of exploring financing alternatives, and based on the level of interest expressed through this process, we believe the debt and equity markets are available to us, although certainty of completing a financing cannot be assumed at this time. If sufficient financing is not obtained, it could have a material or negative impact on the company.

I will now turn the call over to Greg to discuss our operational and development activities during the first quarter. Greg?

Gregory R. Struble

Thanks, Dave. To briefly recap our production results in the first quarter, we produced 38,654 ounces of payable palladium, approximately 540,000 tonnes of ore was mined, with approximately 295,000 tonnes procured from surface and 246,000 tonnes from the underground.

Approximately 503,000 ore tonnes were milled at an average head grade of 3.3 grams per tonne, with an overall recovery improved to 80%.

Our total cash cost per tonne milled was $57 per tonne and cash cost per ounce averaged $490.

With respect to the mine expansion, we made good progress in the first quarter and we will remain well positioned to transition our operations to shaft support and production by the end of Q3 this year.

Recent highlights include: The shaft sinking is on schedule, recently reaching a depth of 695 meters below the surface, representing 84% completion of the total 825 meters planned for the first phase of the shaft.

The production hoist is now operational, and the installation of the main skip dumps is in progress.

The first Offset Zone mining stope, where mining commenced in the fourth quarter of 2012, has been successfully mined out, and production commenced in the second Offset stope on the 735 level.

The development of additional mining stopes experienced some delays, but is in progress and should be recovered by the fourth quarter.

The ramp extension reaching 825-meter level depth, and the shaft station have been excavated and are being prepared for the shaft to land at that location.

Now before I turn the call back to Phil, I wanted to take the opportunity to say that it's been a privilege to work alongside the many talented people that I have met and worked with in this company. And despite some of the challenges that we've been through, I'm proud of the work that we have accomplished together. North American Palladium has a bright future ahead and I have full confidence in the new leadership. As a fellow shareholder, I look forward to tracking the progress in the years ahead.

Now I'll turn it back to Phil. Phil?

Philippus F. Du Toit

Thank you, Greg. Before we open the call up for questions, I'll make a few brief comments about the palladium market.

Palladium spot prices averaged $738 per ounce in quarter 1, ranging from a low of $686 -- $668 to a high of $780 per ounce.

Despite some of the volatility that we've recently seen in price, the supply and demand fundamentals of palladium remains strong. The supporting factor behind the positive outlook for the metal's future performance is the resilient industrial demand, increasing investment demand and constrained global supply.

We remain very optimistic about this prospect and believe that our investment to expand our palladium operations are well timed in the commodity cycle.

In closing, I want to reiterate that we are dedicated to build -- in building a long-term shareholder value by realizing our vision of becoming a low-cost precious metal producer through the completion of our mine expansion.

We believe that this value creation will ultimately be reflected in our share price as we transition the shaft production and increase our mining volumes, start to expand our operating margins and start to generate some meaningful free cash flow.

We are appreciative of the shareholders who continue to stand by us, sincerely value your patience as we complete our transition.

Our annual meeting of shareholders is scheduled for this Thursday morning, and for those of you who are based in Toronto, we hope that you can attend.

Thank you for listening and now we look forward to answering your questions.

Question-and-Answer Session

Operator

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

Alex Terentiew - Raymond James Ltd., Research Division

I just got a couple of questions for you here. I just want to start with the financing comments. You mentioned, several times here, that development is contingent on a successful quick completion of financing. Is there anything you can tell us about the amount and sources of financing that you're looking at?

Philippus F. Du Toit

I will turn that question over to Dave.

David C. Langille

Yes, Alex, I mean, right now we're not giving specific guidance on the amounts. Obviously, we have ongoing reviews. We're looking at the project. First of all, a review of the project and we're also looking at the mine plan in general. And just -- so at this point, we're not giving specifics about the amount we're looking at. We have been talking with markets participants, and we have had active ongoing discussions with them.

Alex Terentiew - Raymond James Ltd., Research Division

Okay. I mean, assuming -- if you guys don't get the full amount that you're looking for, is it possible to keep using the decline for the next 1 to 2 years? I know you said your going through -- a mine plan review at the moment, but -- because obviously, I mean, the way I understand it is you've got $100-plus million still left to spend this year on -- to complete the Phase I of the shaft. Is it still -- and if you -- obviously, if you don't raise enough money, then you can't complete everything but so is it possible to keep using the decline for the next while, I mean, is that a feasible option that you see at the moment?

Philippus F. Du Toit

That is certainly possible to use it because as you well know, we're right in the upper zone of the Offset, so we can, certainly, still use the decline for about 2 years without any problems. It is just the cycle time and the costs that is not that advantageous to us. But, of course, it can be used.

Alex Terentiew - Raymond James Ltd., Research Division

Okay. Next question, moving on then. Could you elaborate a bit more on what the challenges are -- you're seeing from transitioning from the mining the Roby Zone to the Offset Zone?

Philippus F. Du Toit

Greg, maybe you can give us a clear picture on those challenges?

Gregory R. Struble

Sure. I think as we're getting into the Offset Zone in proper now, our mine plans included some assumptions on pillar thicknesses and size of stopes and things like that. Obviously, once we made the plan, we wanted to go back and validate those assumptions. So in late February, we received a results of an independent review, which suggested that we thicken those pillars. In general, that is going to take some tonnes away from this year's plan. We don't lose them, they go into inventory, but it does provide a bit of a challenge in the short-term that we're looking at right now.

Alex Terentiew - Raymond James Ltd., Research Division

Okay. All right. Last question, Phil, a couple of times, you mentioned full potential to be unlocked with completion of Phase II. I just wanted to clarify, I mean, the operating costs, are we expected to read into this, that operating costs may not see much savings or much improvement until 2014 or 2015, or should we still expect to see a noticeable improvement with the start-up of the shaft at the end of Q3?

Philippus F. Du Toit

We should certainly see, Al, initial improvement with the start above the shaft in Q4. End of Q3, we should finish. Start-up in Q4, so we will start seeing improved costs for Q4 this year already, but the disadvantage, of course, as we proceed with the sink rate of the mine, we would like to see Phase II complete soon thereafter.

Operator

Our next question comes from Andrew Mikitchook with GMP Securities.

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

Maybe somebody could just give us an idea of what are the major components that are seeing expenditures in terms of CapEx where you're saying up to 35% increase is possible? Is this all kind of shaft sinking related or where are you getting concerns in having to put out these kinds of guidance adjustments?

Philippus F. Du Toit

Greg, would you like to comment on that?

Gregory R. Struble

Sure. I think on the existing mine side, we've seen a lot of cost come into our TMF expansion area that were unanticipated but necessary to ensure that the facility is structurally competent and ready to accept further phase developments, Phase II and Phase III, ultimately. That's one piece of it. The other piece of it is, we didn't estimate correctly the cost of our station developments as we came into the shaft areas. For example, 685 is the first station area and we encountered more difficulties in getting that station established and progressing onto the next part of the shaft. We anticipate now that those same types of issues -- well, we're -- we're factoring those in, I should say, are going to affect us as well in the 740 and the 825 station. We could be a surprise pleasantly, but I feel better to say that they'll be there. Likewise, we had some additional machinery we had to pick up that wasn't included in the budget for a couple extra trucks to replace some of our aging fleet that was not identified in the earlier budget run. And I think the rest of it is, really, more incremental scope creep that we see, some of our cost per meter with development and shaft. Other than that, that's what we're trying to place into our estimate going forward.

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

Okay. And then, maybe Greg, you can further comment to this follow-up. You've indicated that you're having delays developing more levels. From my memory, the last conference calls that you held, you indicated the ramps and level development was actually advancing better than you expected and it was the shaft that was giving you more concerns. Has that essentially, reversed itself at this point in time or am I not comparing the right comments?

Gregory R. Struble

I think it hasn't reversed. In other words, we're actually in pretty good shape on the 825-level. Where we get into some difficulty is, as I mentioned earlier, with a bit of a revision on our 2013 plan, we think it's prudent to increase the size of our rib pillars and our sill pillars. So obviously, that's going to take production material away from the short-term plan. We'll lose it, but it stays in solid form. So that puts a little pressure now on us to be able to further accelerate some of that work on our level development at depth on the 825 to help compensate for that or other areas in the mine where we have resource opportunities, which we're actively looking into right now. So I think your question was, have we reversed our stance? No. We did have some delays in the shaft earlier on, but those seem to have recovered, other than what I mentioned on the shaft stations. Our development is fairly good considering where we're at with the modifications to our stope designs.

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

Okay. And maybe my last question is for Dave. Can you just -- I'm just flying through your Power -- through your review filings here. But maybe you can just give everybody an update. Where do you stand on drawdown of your lines of credit and equipment financing facilities at this point in time, and how much is available on each?

David C. Langille

We are pretty tight on both of them. Basically, the credit facility, the revolver is fully drawn and not a lot of room there. And the lease lines are also pretty much drawn at this point in time. So right now there's the $23 million on the balance sheet, which at March 31, was the primary resource we have available to us.

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

Okay. And then, the working capital, the current liabilities, how much of that is 1 quarter away and how much is more than 1 quarter way? Just -- or generally, what -- can you give us a characterization?

David C. Langille

Well, I guess, you have to, I mean, the working capital, you've got the receivables and the payables, obviously, are similar numbers and when you've got an inventory level as well, so there is some cash flow there. Keep in mind that the credit facility is also based on a borrowing base, So to a large extent, the receivables inventory are pledged against that. But those -- they match reasonably well in the first quarter if you look at the rate of expenditure. We roughly went through $40 million in the first 3 months of the year. So that gives you an idea of what the burn rate currently is. I think the operations themselves seem to be relatively cash flow-neutral. It's the major project and the development of the Offset Zone, which is incrementally utilizing that extra cash.

Operator

Our next question comes from Leily Omoumi with Scotiabank.

Leily Omoumi - Scotiabank Global Banking and Markets, Research Division

Just on the production side. You're saying that production is going to be 150 -- sorry, 10% to 15% lower than the previous guidance. Can you just give us a bit more color in terms of where that reduction's coming from? Obviously, it's a combination of throughput grade, but maybe you could just give us a bit more color. Obviously, if you were to project your Q1 numbers, then, we wouldn't be at 10% to 15% lower. So maybe, can you just expand on that?

Gregory R. Struble

Yes, Leily, this is Greg again. Recall that I mentioned we have engaged third party geotechnical review of our 2013 mining plan for the very upper part of the Offset. And we had some stope designs there that were -- that had a pillar configuration that was narrower than what we need to go to, to maintain stability at this point, okay? So what happens is, by increasing the size of those pillars, the width and thickness, we effectively draw production tonnes away from our 2013 operating plan. We don't lose those tonnes, they just go into pillar status. So that reduces some of the material that we have available in front of us, right now, from those 2 stopes. Now as we got this report at the end of February, we started looking at what our options are. We're currently in the process of trying to review what can we do to recover some of those tonnes back, whether it's from Roby extensions or faster development on the 825 level in Offset. So that, at the end of it is, by increasing the size of our pillars, in a prudent manner, we've taken some material away from our production plan that we're trying to represent in our guidance going forward.

Leily Omoumi - Scotiabank Global Banking and Markets, Research Division

Okay. And then, on the last conference call, you had mentioned that Q2, Q3 cash cost could be in the $600 per ounce range. What could we be looking at now given this change?

Philippus F. Du Toit

Greg, you want to ...

Gregory R. Struble

Yes, I think they could still be challenged for sure. A lot of it will depend on how well we're able to find additional material to offset what comes out of our current plan, subject to the review that we're currently undergoing at the mine plan right now.

Leily Omoumi - Scotiabank Global Banking and Markets, Research Division

Okay. And then, lastly, the new CapEx -- 100, I guess, we're looking at, potentially, $140 million for the year or thereabouts. Can we assume that's going to be evenly split for the remainder of the year? And at what point, I guess, my question is at what point -- I mean, obviously, you don't have the resources right now to go ahead with these expenditures. At what point do we need to -- or will you be making changes to the plans or will have to have the financing in place?

Philippus F. Du Toit

Dave, would you care to?

David C. Langille

Yes. Leily, I'll address the first part. In terms of the CapEx timing of the expenditures we certainly expect the fourth quarter to be lower than the second and third quarters, keeping in mind that we are going to continue Phase II of the shaft and that would continue into the fourth quarter, but we basically have the top end of the shaft down to the 825-meter level completed at that point in time, we'd have 3 major pockets put in place. So that will be behind us, and we'd have the production going up the shaft. The other thing we have planned for this summer, over the next 4 months, is a further lift to the tailings management facility. So that's something which will be done by the end of August based on current planning and timing. So that would also drop our CapEx expenditures to some extent. So that's the first part of the question.

Philippus F. Du Toit

The second part was just about the timing of the financing.

David C. Langille

Yes. The timing of the financing, I think, I sort of tried to paint a picture to exactly the cash position right now in terms of the burn rate we have. But yes, so it's something that we are actively discussing with parties, both in the credit and the debt markets. So it's something we are actively pursuing. And to the extent that, that financing's not available, obviously, we are looking at alternative plans in terms of operational perspective as to how to preserve cash on a go-forward basis.

Operator

Our next question comes from Sam Crittenden with RBC.

Sam Crittenden - RBC Capital Markets, LLC, Research Division

Just to clarify, does the increased CapEx for 2013 include anything for Phase II or could you potentially have to add that in, sort of, once the review's done?

Philippus F. Du Toit

Yes, it does. The plan is, really, is -- once we've got the shaft to the 825 level at the end of Q3, the idea would be to carry on in Q4 to get the shaft deeper, probably, to the 950-plus level in 2013. So the CapEx that you've seen there includes an amount of roughly about $8 million for the Phase II that we want to execute in 2013.

Sam Crittenden - RBC Capital Markets, LLC, Research Division

And you touched on it earlier, but could you just elaborate on why it's so important to get the Phase II going? I mean, on the last conference call, it seemed like you could defer it and sort of mine around the 825 level. Is it having 2 sort of working areas going at the same time? Is that where you get cost efficiencies or could you just elaborate on that a bit?

Philippus F. Du Toit

Yes, if you look at the timing that it will take us to get Phase II finished, we plan to be there end of '14, early '15. Or if we can do it quicker, even the better for us. You can just imagine the sink rate of mine over that -- over the next 1.5 years. So looking at it from a prospective way, we will be at the mining phase versus the lifting position, we will still have to employ quite a lot of trucking to take it to the Stage I of the shaft. In actual fact, that will have a detrimental effect on our cost, timing and volume. So the sooner we can get Phase II operating, the better for us.

Sam Crittenden - RBC Capital Markets, LLC, Research Division

And then, what about the grades. You -- it looked like you mined at 3.8 grams per tonne in the Offset Zone this quarter, the reserve grades at 4.3. Is that -- were you expecting a little bit lower grades than this -- the first stope or is it something like you're seeing more dilution in the Offset Zone or could you explain what happened there?

Philippus F. Du Toit

Greg?

Gregory R. Struble

Yes, actually, our first stope is Block 5, cut very nicely to the model. It was above 5 grams. But in -- as we had started in quarter 1, we had a lot of sealing muck that was coming in, still, from the development of the subsequent panels, which tends to bring that down. That's not going to be as high a grade as you're coming in and out of the ore, some in the bottom, and the tops.

Sam Crittenden - RBC Capital Markets, LLC, Research Division

And then, just last question on this -- the extra pillars and support. What precipitated that independent review, is that something you brought in as part of the mine plan or why did that independent review sort of happen? What precipitated that?

Gregory R. Struble

Yes, Sam. Back when I came in 2011, of course we had some geotechnical issues in the Roby Zone itself, I don't know if you recall back then. So at the time, I thought it was prudent to bring in extra geotechnical consultancy to be able to review what was going on in light of our original assumptions. So we've kept that philosophy in place. And as we go forward, we continue to seek extra help in terms of reviewing our plans to make sure they're solid. So it's just part of an ongoing process that we intend to keep doing. We're going into the new area of the mine, we want to make sure that we're doing it right.

Sam Crittenden - RBC Capital Markets, LLC, Research Division

And ground support on the Offset Zone and the way the stope reacted was that sort of -- as you were expecting?

Gregory R. Struble

It was, we call it -- this is just a model. So we hadn't opened anything up yet, but the geotechnical model indicated that we could have problems. So the first line of defense is adjust your plans so that you wouldn't. However, as we get into it, we could look at what we can do to test the model for future changes to how we look at it. So that's really where it's at. We didn't have issues or problems geotechnically, it's just a prudent reaction to the data that was revealed from the geotechnical model.

Sam Crittenden - RBC Capital Markets, LLC, Research Division

That is helpful. Do you think sub-level caving is prudent, given that you're needing extra support and things like that? Do you think the deposit would support that mining method?

Gregory R. Struble

That's a very good question, Sam. And if you look at what we have for ground conditions or the rock type here in LDI, it's virtually the same as what's in Sudbury. It's not much different at all. In fact, with the sub-level block cave, you actually have the benefit of being able to get your high volumes, but you have to create a bit of a fill. I don't want to go into a long discussion here, but it was somewhat in the back of our head as we went forward into 2013 anyway. And our development that we've been doing into the Offset has been somewhat conducive to making a transition in the future if we determine that's a viable option to employ. So yes, there's some risks at the top, but I would look to the way Sudbury has minimized those risks with waste covers and things like that, that we can do to manage the sub-level cave. So there's more opportunity to manage that successfully than there ever would have been in the super shrinkage stoping plan that was initially called out for the Offset Zone.

Operator

Our next question comes from George Topping with Stifel Nicolaus.

George J. Topping - Stifel, Nicolaus & Co., Inc., Research Division

Greg or Phil, could you give us an update on the open pit life for this year?

Philippus F. Du Toit

Yes. We can, certainly, give you a very quick overview. Greg, he's been living very close to it in the last couple of months.

Gregory R. Struble

Yes. We -- we plan for it to go for most of the year, but we're looking at what we can do to accelerate that into the second quarter. So we really see it being done by midyear.

George J. Topping - Stifel, Nicolaus & Co., Inc., Research Division

So depleted by midyear. Is it a similar -- or similar rate to -- you did in Q1 or?

Gregory R. Struble

It's going to be similar, George, but recall that it's going to be a little more difficult to move at the bottom of the pit. From your trip up there, I'm sure you can appreciate the narrowness as we go deeper, but yes, that's our plan is to try to move it ahead to the rest of the year.

George J. Topping - Stifel, Nicolaus & Co., Inc., Research Division

I see. Then, going back to the shaft because that makes the shaft timing critical not regard to the -- so if the -- the shaft has finished sinking at the end of Q3, how long will the equipping and other auxiliary work take until you're ready to actually start hoisting and transferring ore up the shaft?

Philippus F. Du Toit

George, it's Philip speaking. The plan is to finish the equipping, as well as the changeover for the end of Q3, so that we can actually start hoisting ore in Q4. So as we speak, we have started with the equipping of the stations. The shaft equipment is going on as we go down. And so as I've said, by end of Q3, early Q4, we will be in a position to start to hoist ore.

George J. Topping - Stifel, Nicolaus & Co., Inc., Research Division

Very good. So that's October -- we'll look for that. That's good. And then for David, are there any debt covenants at risk from your previous fundings?

David C. Langille

No, we're on track[ph] with all of our debt covenants.

George J. Topping - Stifel, Nicolaus & Co., Inc., Research Division

I see. And the debt that -- or the credit markets you're looking at, would that be more of -- is it conventional debt or are you looking at alternatives such as streaming and other alternative financers like Sprott?

David C. Langille

Yes, we're looking at, basically, what you would consider traditional debt. Streaming is especially something that we view LDIs having significant upside in terms of exploration potential. So one of the downsides about streaming is that you give up a lot of that upside on whatever metal you choose to stream and you -- depending on whether you're inside[ph] the property or not, you certainly give up a lot of the exploration upside as well. So it's not something we're willing to do at this point in time. Yes, the financing is critical for this year and for next, but the longer term robustness out of the ore body I think, we all believe, is still there. Still, it's a very good ore body. So we don't want to give the perpetuity on the upside just to finance what's basically a mid- to short-term issue.

George J. Topping - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And so other alternative funders such as the Sprott resources of this world, is that under consideration or is that a source that you're looking at more than normal, just, bank debt?

David C. Langille

Yes, we're looking at a variety of specialists. People highly knowledgeable in the mining secular, certain people we're having conversations with and Sprott would be -- Sprott -- or their like would, certainly, included in that group of highly knowledgable mining people.

Operator

Our next question comes from Daniel McConvey with Rossport Investments.

Daniel McConvey

A couple of questions. Greg, just on the pillars. The pillars will be mined later in the mine life, so it would be 2014, 2015, but it'd be probably later when you go back in that area, the same thing as you are considering doing in the Roby Zone, is that correct?

Gregory R. Struble

Yes, that's a fair statement.

Daniel McConvey

Okay. Just, Phil, on the schematic that was with your feasibility or the most -- latest technical update, just -- I think kind of, I'm curious -- Greg, the south zone has some potential that would, I guess, would feed the extra feed for Phase I. I just wonder if you could comment on that. And then, as you get deeper, to me it looks like the continuity deep in the Offset Zone has not fully been established yet. You want to get, I guess, you want to get down or you want to drill it out. But right now, the deeper part, maybe because the drilling is lighter than the upper part, and it just seems to me like you want to get Phase II to get that ore, number one; but number two, to drill out and find out what's there, which brings some risks and opportunities.

Philippus F. Du Toit

Yes, I think it's important to recognize here that there's really a lot of potential that we're discovering virtually daily at the LDI and the immediate vicinity areas. And certainly, we are -- the big focus now, because of the dilemma we face in '13 and '14, while we want to get ready for the Offset Zone is we would like to try and look at resources closer to surface, and our exploration team is very much focused on that now within the Roby Zone, within the close vicinity of the Roby Zone, where we've got good infrastructure that we can identify something that we can get going in the short-term. And you're absolutely right about deeper drilling. We would certainly, once we've got the access ramps down there, we would certainly do deeper drilling, as all indications are that it is absolutely world-class deposit and there's a lot to be discovered further down. Greg, I don't know if you want to add anything else to that?

Gregory R. Struble

Yes. I think, to strengthen what Phil said, I think, since day one, we've been focused very hard on growing laterally and up as much as we can to preserve the ability to -- when we get Phase II down, really understand what the full scope of this is. So the area of ore you're -- or you mentioned, the south of the shaft extension on the Offset, that could be a real game changer for the company. And we don't know much about it other than what we drilled in the first quarter of this year. So we want to make sure that we're doing what we can to maybe not go after that piece of ore as a reaction, but rather, look towards finding something higher up in Roby or whatever we can use to stay lateral and above. The primary is at the Offset.

Daniel McConvey

Okay. As you -- maybe, over the next couple of years, what would you hope to be able -- to be able to drill out? Would you drill out the south zone more, how much more -- and in terms of having good access to drill out the deeper Offset Zone when we have the ability to do that?

Philippus F. Du Toit

The plan, certainly, is to go at the deeper areas in the south Offset, as soon as we've got good access in the bottom there to really define what is there. It looks very promising at the moment, but I think as Greg has mentioned, and I've mentioned earlier, right now our short-term focus is to look a little bit higher up and laterally in the Roby Zone so that we can finish Phase II and then, have an absolute -- absolutely maximizing the value of the Offset Zone.

Daniel McConvey

Okay. So fair to say, we're probably a couple of years away from having good access in drilling out the deeper part of the Offset Zone?

Philippus F. Du Toit

I would say, yes, probably 18 months plus.

Daniel McConvey

Okay, great. And last question. Do you -- any plans -- is there a search on to replace Greg?

Philippus F. Du Toit

The idea would be to replace Greg in future and we have started to initiate some actions in that regard.

Operator

Our next question comes from Nathan Littlewood with Crédit Suisse.

Nathan Littlewood - Crédit Suisse AG, Research Division

Listen, I just was hoping to get some assistance with defining, I guess, a scenario A and scenario B for this year's production. And if we say that the difference between scenario A and scenario B is that one, you get 100% of your financing done; in the other, you don't get any of your financing done. So scenario A, it looks to me like these larger pillars, amending that they'll be circa 20% less tonnage coming out of the underground and that you essentially kind of kick along that 2,500, maybe 2,700 tonnes per day via the decline. Scenario B would be that you've still got these volume constraints, near-term, due to the lower pillars, but with the shaft commissioning later in the year, you can kick up the volume to about 3,500 tonnes per day. So I guess, my question is am I thinking about that correctly in terms of the tonnage and the physicals and if so, what's the difference between the two in terms of dollar million costs spend?

Gregory R. Struble

I think in terms of the physicals, Nathan, yes, there is a short term limitation on the upper Offset stopes above the 735. But as soon as that was discussed and looked at, started a pretty active aggressive look at where we can get it back. So the development on the 825, the blocks below will be accelerated. To some degree, we're still going through that work now. So it's too soon to comment on. And likewise, as Phil mentioned, what we can do up in upper Roby, South and North to help go back to some of those areas under a revised cut-off as we're using in Offset, shows a lot of promise as well. So to your scenario A, what it means is that we -- or scenario B, I kind of forget, but if what we have in front of us is a 20% loss in this year, then yes, what you described is the case. But we don't see that as being a static event. We want to make sure that we we're doing whatever we can to recover anything that's tied up in pillars back into the inventory from other sources.

Nathan Littlewood - Crédit Suisse AG, Research Division

Okay, got it. And am I correct in saying that looking at the current balance sheet and the current rate of cash spend that some stage in the June quarter, you have to have a funding solution in place, otherwise you're going to run out of cash with this Phase I project?

David C. Langille

Yes, I think that your calculations are reasonably accurate, yes.

Operator

Our next question comes from Matthew O'Keefe.

Matthew O'Keefe - Mackie Research Capital Corporation, Research Division

Just a quick question on -- going back to the Phase II. Can you remind us, again, the scope of that and the anticipated costs?

Gregory R. Struble

Matthew, this is Greg. Phase II is somewhat a work in progress right now. What we did with -- the original assumptions around the scoping study was take that and turn it into Phase I, which is what you currently see in the tech report; and Phase II, which, ideally, would be everything below Phase I. However, because we have more to find out and more to do, it's going to be a component of that which is the shaft and the infrastructure at the bottom to allow us to be able to not only go after the material below Phase I, but any other lateral growth and things that we can find adjacent and above Phase I and Phase II. So Phase II is really a bit of a work in progress, but the fundamental critical path item for it is getting the shaft down the depth and the infrastructure to be able to move ore directly to that lower pocket.

Matthew O'Keefe - Mackie Research Capital Corporation, Research Division

Okay. So this overrun, sort of the 35% cost overrun, assuming you get this financed, would you be financed to get through Phase II or could you -- I guess, which means getting the shaft down to that depth or would you be able to fund that out of cash flow or do we have to expect that there would be an additional funding requirement to complete Phase II?

David C. Langille

It's Dave here, Matt. For Phase II, it's something that is ongoing. We are bringing in people to assist us with that, but at this point in time, unless we have an extremely high palladium price, we'll be looking at an additional funding at some point to complete it. The initial -- and it depends on the depth in the structure, but the initial thought, I believe is right now and Greg can correct me if I'm off on the technical numbers, the shaft depth is going down about the 1,275 level, putting a drift across, basically, the bottom of the Offset Zone and that drift would be -- there'd be a production drift, but it would also be a conveyor drift, having a crushing station and a loading pocket at the bottom. So that's sort of the overall pits of Phase II. It's the development, I guess, is what [indiscernible] baked in and decide. So as Greg mentioned, it is a work in progress. That's one of the things we want to get more clarity on in the next few months.

Matthew O'Keefe - Mackie Research Capital Corporation, Research Division

Okay. And will you be releasing some sort of update to the market as to what that looks like at that time?

David C. Langille

Yes, our current plan would be to, yes, we'll give a more fulsome update as to what that would look like.

Matthew O'Keefe - Mackie Research Capital Corporation, Research Division

Okay. And then, just one other question. With the cost overrun that you've guided here, you had an exploration budget, I think, the last time we talked. Is that still intact? Do you still -- if it's still intact, are you still planning on doing a fairly extensive exploration program in these surrounding areas or is that going to get scaled back?

Philippus F. Du Toit

For '13, it's pretty much intact. '14, '15 and '16 is under review at the moment.

Operator

Next up we have Annie Zhang with Octagon Capital.

Annie Zhang - Octagon Capital Corporation, Research Division

First of all, with regard to the Phase II development, could you comment on which contract have you retained to work on [indiscernible] and the timing on the study outcome?

Philippus F. Du Toit

We have not retained a contractor yet. We've had proposals from contractors, which we are busy evaluating.

Annie Zhang - Octagon Capital Corporation, Research Division

Okay. And secondarily, Greg, you mentioned that all reconciliation within the Offset. First mining stope within the Offset Zone was actually excellent, but if included, the marking material -- the dilution, the entire dilution is about 12%. How long do you think that this sort of dilution would take impact?

Gregory R. Struble

I'm sorry, Annie, I didn't quite understand that last part.

Annie Zhang - Octagon Capital Corporation, Research Division

Okay. How long do you think that this marking material will continue to dilute the ore grade from the Offset Zone?

Gregory R. Struble

Okay. I think the way to look at that is, you have to look at each stope independently and what happens is is the dilution is calculated into the initial volume of muck that's been drilled and blasted and ultimately, pulled out of the stope. So once you've cleaned out the stope, you clean it out rapidly the dilution -- any further dilution really doesn't matter because you wouldn't mine it out, you wouldn't pull it from the stope. So what we're seeing is the -- and we have more work to do as far as final reconciliations, but what we're seeing initially is that the fully designed, fully diluted stope grades that we've projected are reconciling quite well with the muck samples that are coming out of the mine -- out of the stope. So the dilution, just, I would keep the same dilution assumptions that we currently show in our tech report.

Operator

Our next question comes from George Topping with Stifel Nicolaus.

George J. Topping - Stifel, Nicolaus & Co., Inc., Research Division

Just as a follow up on cash costs, dollar per tonne mined was $57. Could you break that out into open pit and underground for me?

Gregory R. Struble

Hang on a second, George. Or we could get back to you. We've got the information, we could probably get back to you. I just don't have it right here at my fingertips.

George J. Topping - Stifel, Nicolaus & Co., Inc., Research Division

Okay. That will be fine.

Operator

And next up we have Sam [ph] with Interlink Research.

Unknown Analyst

I'd like to know, on the financing, will there be issuing more shares?

David C. Langille

The financing, we're looking at the capital markets in general so it would be -- we're looking at both debt and equity at this point in time. So I can't really be specific until we have something pulled together and in place.

Unknown Analyst

Wouldn't that be more dilution for shareholders? Wouldn't it be more prudent to do like a merger or buyout because we're going to be diluted again?

David C. Langille

Certainly, that would be an alternative for the board to consider.

Unknown Analyst

Right. The main thing are shareholders and not the company. I mean, if we're going to dilute them -- we're now -- and another thing, we're going to have a debt spiral since everyone knows that we're looking for financing, the stock price will go down and there will be more dilution.

David C. Langille

Yes, well, when you issue shares, certainly it does have a dilutive impact, obviously.

Unknown Analyst

Right. But since people know that we're looking for financing, we're going to see the stock price drop. And as soon as we drop, it's going to be a debt spiral, it's going to drop under $1. So there will be even more dilution?

Camilla Bartosiewicz

Again, it depends on which number we go after. We are cognizant of shareholder dilution, and as Dave pointed out, we're looking at both debt and equity solutions. And when we're in a position to provide, affirm or update on what that quantum will be like, we'll certainly communicate with our shareholders.

Operator

Next up, we have Leily Omoumi with Scotiabank.

Leily Omoumi - Scotiabank Global Banking and Markets, Research Division

Just a quick follow-up question. Could you just remind me what your exploration budget for the year is, capitalized and interest -- sorry, and expensed?

Philippus F. Du Toit

Dave?

David C. Langille

Yes, Leily, it was $10.6 million was the -- sorry, you're talking about exploration?

Leily Omoumi - Scotiabank Global Banking and Markets, Research Division

Yes.

David C. Langille

Yes, $10.6 million was what we were planning. $10 million, $11 million.

Leily Omoumi - Scotiabank Global Banking and Markets, Research Division

That's combined for expensed and capitalized?

David C. Langille

Correct. $5 million would be capitalized for the Offset Zone.

Operator

Next up, we have Annie Zhang with Octagon Capital.

Annie Zhang - Octagon Capital Corporation, Research Division

Just a follow-up question. Dave, did you just mention that your 2013 exploration budget now is between $10 million and $11 million?

David C. Langille

Correct, yes. But $5 million is capital and roughly $6 million will be expense.

Annie Zhang - Octagon Capital Corporation, Research Division

But that's also increase from previously $6 million or $7 million, right?

David C. Langille

No, it's unchanged from what we previously had.

Operator

And next up, we have Nathan Littlewood with Crédit Suisse.

Nathan Littlewood - Crédit Suisse AG, Research Division

Sorry if I missed this earlier, but could you give us an update, Greg, on some of the new mine exploration opportunities, which you were talking about earlier in the year?

Gregory R. Struble

Sure. Certainly, Nathan. We talked a bit about Sheriff, we still have more work to do on that. It looks like, initially, it's going to be a little challenging from a surface mine perspective, but we're still pretty excited about what that can develop to at depth. We're understanding a lot more of the structure and how Sheriff may actually interact with upper Offset. So from our knowledge on that, and from our knowledge on our first quarter drilling that we did, it's really leading us into more opportunity, we think, on the upper Offset, potentially, trending over towards Sheriff, we've got more to do there. So that's external to the upper Offset as we know it, and we're looking at some ways of testing that this summer when we restart our drill program, and we're pretty excited about it. Likewise, on the north Roby, that area has always been somewhat challenging with width, ore width and grade. It's been high-grade, but very narrow. And then, some of the work we're doing now is to remodel that section of Roby with a 2.5 gram cutoff and that's leading us to some pretty interesting opportunities. The other thing we're starting to see is there may actually be bit of a connection around what we're seeing on the surface with North VT Rim and maybe what's happening on the north Roby extension. So there's lots to do, but we think as we step out, our goal's going to be to step out a bit gradually from the known to the unknown and then, test these concepts that Dave Peck and his team have been working up. It's really, I should make this one comment, that the difference in the interaction between exploration and operations in the last 6 months or so since Dave has come, really, into the fold, has been just phenomenal. We've really been enjoying the ability to look closely at what these things can grow to, so. I apologize for rambling there.

Operator

Okay. And that appears that, that was our last question. I'll turn it back to our speakers for closing remarks.

Camilla Bartosiewicz

Okay. Thank you, operator. Thank you, all, for participating. Have a good day.

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