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Executives

Carlos Baca - IR

Jorge Ganoza - President & CEO

Luis Dario Ganoza - CFO

Analysts

Heiko Ihle - Euro Pacific Capital

Andy Schopick - Private Investor

Chris Thompson - Raymond James

Trevor Turnbull - Scotiabank

Ben Asuncion - Haywood Securities

Fortuna Silver Mines, Inc. (FSM) Q3 2012 Earnings Conference Call November 9, 2012 12:00 PM ET

Operator

Greetings and welcome to the Fortuna Silver Mines Third Quarter 2012 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Carlos Baca. Thank you. You may begin.

Carlos Baca

Good morning, ladies and gentlemen. I would like to welcome you all to for Fortuna Silver Mines third quarter financial and operation results call. Hosting the call are Jorge Ganoza and also President and CEO of the company and Luis Dario Ganoza, Chief Financial Officer. I would now like to turn the call over to Jorge Ganoza.

Jorge Ganoza

Thank you, Carlos. Good morning. I’m joined on the call today by Luis, our CFO. I will initiate the conference and with the assistance of Luis, we will be giving a summary and analysis of our operations and financial results for the third quarter of a year. Once concluded, we will address your questions.

During the third quarter our company reported record sales of $43.8 million, net income of $8 million or $0.06 per share and cash generated by operations before changes in working capital of $20 million or $0.16 per share. Historic records for both sales have cash from operations. Our earnings for the quarter are slightly below analysts' consensus of $0.07 per share. And our cash flow per share exceeded analysts' consensus of $0.12 per share for a quarter.

Production for a quarter was 1 million ounces of silver and 5,300 ounces of gold. Production for the first nine months of the year was 2.98 million ounces of silver and 16,300 ounces of gold. We are in a trajectory to exceed our 2013 annual guidance of 3.7 million ounces of silver and 70,000 ounces of gold.

Our precious metal production for a quarter accounted for 85% of revenue. Silver comprised 69% and gold accounted for 16% of revenue developed by probably enhancing sales. Silver price for the period was $29 $0.91 per ounce compared to $38.79 per ounce for Q3 2011.

Moving on to cost at our Caylloma and San Jose mines, cash cost for the quarter and nine months are in line with budget and of this month we are not anticipating material variations for the remainder of the year. At Caylloma, cost per ton of processed ore for the quarter was $85.84 for the nine months; this is consistent with our budget. At San Jose, cash costs per ton for the quarter was $80.59 and for the nine months $70.94. We do not see the increment in the quarter with respect to the nine months as a trend at this moment. We are seeing a cash cost at San Jose will remain in line with budget and in the lower 70s per ton for the year.

As we are clearly working on our 2013 budget, we continue to see cost pressures in Peru and Mexico but particularly in Peru. At this moment, we start to anticipate cost increments in the range of 5% to 7% for 2013 in certain areas of our operations, including mine, contractor parties, transport cost, diesel generated power to cover temporary constraints in power line at Caylloma knowledge.

Quarter consolidated cash cost per ounce and of payable silver, net of by-product gold and base metal was $4.81 and for nine months the cash cost fee here is $3.93, compared to a maximum industry average of approximately $8 per ounce who are primarily silver producers net of by-product.

With regard to our main capital project at San Jose we continue with execution of our expansion plan to take production from the current annual estimate of approximately 2 million ounces of silver and some 18,000 ounces of gold to the new rates of 3 million, 3.5 million ounces of silver and 25,000 ounces of gold by mid 2013. With this expansion our consolidated annual production will be ramped to 5 million to 5.5 million ounces of silver and some 27,000 to 30,000 ounces of gold.

Purchase orders for key equipment has been placed including involving our floatation sales and these are engineers, it has been awarded to a Mexican firm. Work is well advanced and within schedule. A site has been secured 300 kilometers from the mine for the construction of a concentrate leaching facility and the rate of using facility. We plan to present the environmental impact statement in early January. Approval time is expected to take approximately 12 months. Basic engineering is to culminate in early December, immediately followed by purchase orders for key equipment and (inaudible) engineering.

This new plant is planned to be operational in Q4 2013 now so the payback time on the project is three years for a $16 million capital budget estimate. Estimated impact of this project on our cost per ounce on a consolidated basis is a reduction of $2 per ounce.

We're also pleased to announce the completion of the pipeline installation which connects the Ocotlán sewage plant with our San Jose mine. This project is fully operational now. Since September 2010 we have been operating the sewage treatment plant located 13 kilometers away from our mine site. This is a project with the community and we're working jointly by upgrading and operating the plant we're contributing to improve the environment for community in exchange for residual water from the process that we'd use in the industrial process of our mine.

At Caylloma, the main project is a new phasing site, the Ministry of Energy and Mines started the site inspection, its final inspection on Monday the 5th of November, this past Monday. We expect the authorization within days. I believe we can be operational before the end of the month.

On the exploration front, we're working with eight drill rigs, five in Peru and our brownfields concessions are on the Caylloma mines and three in Mexico around our San Jose. This is part of a $15 million exploration budget for the year. We will releasing an exploration update before the end of the year and producing an update for resources and reserves with a cut date December 31st which will be made public by February of next year.

Moving forward, I'd like to say that I've never seen our company in a better position to continue delivering growth as a low cost silver producer. Our talented teams of professionals with a proven track record of performance and our solid financial position supports our growth strategy to become a leading silver mining company.

I will now let Luis take you through financial statements.

Luis Dario Ganoza

Thank you. As Jorge mentioned, this has been another solid quarter on the back of strong silver and gold production at both of our mines. We have reported record revenue of $43.8 million and record cash from operations of $20 million. Our reported net income was $8 million, down 22% over the prior period as our gross margins were impacted mainly by lower middle price and the combination of higher cost at Caylloma and lower base metals sold.

The increase in our sales for the quarter of 35% compared to the prior year was driven by the contribution from our San Jose mine which in Q3 2011 had only one month of commercial production. Revenue at Caylloma decreased 26% due to lower silver, lead and zinc prices of 23%, 20% and 15% respectively; and lower lead and zinc sold of 16%. Our total final price adjustment for the quarter were positive $1.7 million compared to positive $2 million in Q3 of last year.

Our mine operating income for the quarter decreased slightly compared to the prior year period by 3% and a contribution from San Jose was offset by lower margins at Caylloma, which were affected by the lower sales already mentioned and higher unit cash cost of 22%. Our consolidated gross margins came down from 61% to 44% driven again mainly by the lower price environment.

As Jorge has mentioned, cash cost performance at Caylloma for the quarter and year-to-date is inline with our budget.

Down below on the financial, the selling and G&A line item for the quarter shows an increase of 36% or $1.8 million over the prior year period. Out of this increment, $0.8 million is explained by the mark-to-market of share based payment instrument; $0.6 million in response to added G&A coming our operations in Mexico, and $0.4 million of higher corporate G&A.

Our operating income for the quarter was down 18% over the prior year period at $8 million.

Our effective tax rate for the quarter was 35%, slightly below the 38% to 39% we expect on average and significantly below the 64% recorded in Q2 of this year at the time we experienced significant fluctuation related to the exchange rate volatility.

Moving on the cash flow statement, cash generated by operating activities before changes in working capital and after taxes paid totaled $20 million for the quarter, an increase of 30% over the same period in 2011. The strong performance on a cash basis was driven by the strong cash margins from San Jose and the then overall lower cash tax rate.

Cash used in investing activities was $12.5 million for the quarter and $29 million year-to-date. Our investments over the course next few quarters are expected to increase as we advance with the expansion of San Jose and plan the infrastructure at Caylloma.

Our cash position including short term investments at the end of year was $62.7 million with an additional available revolving line of $20 million which we are in the process of expanding. And working capital worth $91 million, an increase of $27 million with respect to year end 2011, reflecting the increase in cash and accounts receivable related to higher sale. Thank you. Back to you, Carlos.

Carlos Baca

Thank you very much to all for joining today's conference call. Jorge and Luis will now like to address any questions that you might have.

Question-and-Answer Session

Operator

We will now be conducting a question-and-answer-session. (Operator Instructions).

Our first question comes from line of Heiko Ihle with Euro Pacific Capital. Please proceed with your question.

Heiko Ihle - Euro Pacific Capital

I was trying to get a grasp on the cost pressures don't improve for next year in 2014. Can you just maybe elaborate a little more pass which is given in the press release, would you expect to see next year? And also in '14 given the current political climate with Humula and the overall strong demand that everybody there is seeing for fewer months' labor?

Jorge Ganoza

Yes. Thank you for the question. We expect to cost pressures for both our operations. In Mexico, we do not see any major pressures apart from the expected rate of our inflation and for general inflation. In Peru, we are in the budgeting process right now and doing forward looking at our costs in 2013. And we are -- I do see pressures mainly on labor. The labor really accounts roughly for 40% of total consolidated cost, including the impact of labor on our contractors, and it is significant.

And there is certainly a pressure driven by higher demand on production expansions in Peru. In Peru, remember that there is a portfolio of $50 billion in mining projects over the next 10 years and some of those projects are advancing. And they become as they advance, they do require people and services. And even though we do not compete for the same talent as most of these projects are large scale mining and infrastructure projects. We do not compete necessarily for the same pool of talent, there is definitely a domino effect and a overlap in some area, which generates the press of the labor market. So, we do expect and we are seeing already pressures coming mainly on the part of contractors, mining contractors and certain services driven by labor and technical stuff.

At Caylloma, we also have a temporary constraint on power availability. That means due to a power line we are working with our neighbors to achieve a new inter-connection to a secondary lines which has capacity. By doing this we will free power availability in the line we are connected to. But until that happen, we are having to burn diesel to cover power deficiency that we have in the system. So, we expect that will be the case at least into the first half of next year as well. So that will bring that cost pressures at the Caylloma mine. But we believe that all of these -- at the same time we have cost reduction initiatives that are taking place. They are discussing the MD&A. We are changing mining network in the narrow range. We are consolidating our pool of contractors on site and initiatives of that sort. So, we believe the net effect of inflation into the next year as we see that this moment could be the range of 5% to 7% with respect to our cost structure for 2012.

Heiko Ihle - Euro Pacific Capital

Have you made any progress in doing any sort of meaningful M&A activity? I mean, not only you have a lot of producing asset you have the balance sheet to do it, but it would also sort of help you smooth out temporary production shortfall or temporary cost pressures?

Jorge Ganoza

Well, first, we are currently engaged in an expansion project that at the Mexican operation that cures our growth, continued growth over the next 12 to 18. As we take San Jose from the current 1000 ton per day throughput to 1,500 tons per day. Apart from that we are targeting the avenue of organic growth in our properties. We have higher expectations adding new resources in surrounding ground on both of our mines and we're deploying the resources to that end. Again, we have eight drill rigs turning its in development as we speak, $15 million budget for this and I can anticipate a similar budget going into next year.

For M&A, we are aggressively pursuing initiatives on that end. The first step we took was to strengthen our internal capability to identify these initiatives. We created a new position in the company that of Vice President of Corporate Development. Mr. Robert Brown joined the company a couple of months ago. And he is working closer with me and board in identifying and pursuing some of these initiatives. So, as you can imagine, I can't discuss at this moment any particular one, but I can tell you that we're actively in Mexico, in Peru, and mainly focusing on full discovery predevelopment opportunity but also looking at some opportunities with other producers.

Heiko Ihle - Euro Pacific Capital

Should I be shocked to see something done this year or are we looking at Q1 or Q2?

Jorge Ganoza

No, we are -- this is a process. We need to -- we understand the subject and we have been very disciplined and I like to stress this and selective in our approach to growing this company. And we believe we have two assets that give us a great foundation to take Fortuna to the next level. We not only have production and sustained growing production over the last six, seven years that is low cost silver production. So, we will continue focusing on high margin low cost silver and gold producing opportunities in the Americas mainly from our bases of operations in Peru and Mexico. But it is a process. Even if we get involved -- even if its an early project we ask ourselves is it in the right place, we socialize (inaudible) correctly and we believe we can gain the kind of socializing. What is the cost structure? Even though if its only (inaudible) because what we want to see is the translation of work houses in the ground to the balance sheet in a profitable way.

So, we are not rushing out there to just do a transaction, to show the market we can do a transaction, but we're being thoughtful, methodical and we really want to be able move faster than our competitors, being smarter look deeper and find value just like we had done in the past.

Operator

Our next question comes from the Andy Schopick, a private investor. Please proceed with your question.

Andy Schopick - Private Investor

Several questions for you. First, can you give us additional color on the expectation for improvement in silver recoveries at Caylloma in the year ahead?

Jorge Ganoza

Yes, I'll address that question. The historic recovery at Caylloma is in the range of 85% to 88%. That is what we've been mining on the solidified portion of the deposit. The mine is today (inaudible) through a portion of the reverses that is close to surface on level 6. We've been mining there for two years now, and that area is sourcing today roughly 30% of mill feed. The ore in that upper portion of the reserves close to surface is not completely oxidized but there is mixed sulfide oxide ore. And the mineral species that we find in that portion of the reserves interfere with floatation. So that is the reason for the lower recoveries we have been experiencing.

We've been driving initiatives to try to improve or process to accommodate this challenging ore. It is a fact that oxide zones floatate -- they do not floatate or floatate fully. And so, we do two things. One, we try to balance the mixture of level six ore that we send to mill, not having exceed 30% of total contribution. And second, again, we are driving several initiatives. We are seeing improvements in the recoveries over the last couple of months among closer to the range of 77. And we have had days of up to 80% recoveries for silver at Caylloma. But this is a process, it's slow, it is painful.

Eventually, the mine will transition outside of a level 6. We expect that would take place towards the end of 2013 into early 2014. We do not have more oxide ore in our reserves apart from what is found on level 6 today. So, it is a temporary issue but we expect we will be out of there in late next year.

I would like to add that what we expect out of Caylloma is a contribution of 2 million ounces of silver a year. And even though at -- we've been experiencing lower methodological recoveries at the Caylloma mine from the historic 88% down to like lower 74% or 75%, the ore from level 6 is higher grade than the average of the reserve. So, we balance the contribution of level 6 in a way that even though we achieved lower recoveries we can meet the contribution of 2 million ounces or so of silver out of the mine.

Andy Schopick - Private Investor

Thank you for explaining that. Furthermore, could you give any additional color on the expectation for completing the construction of the Dore plant at San Jose?

Jorge Ganoza

Yes. I will have to start. I will give you a little background. One of our commitments with the community of San Jose was that we would not use cyanide in our process. So, our plant at San Jose is a conventional flotation plant and we will not use cyanide. So, for commercial purpose this mine is a high grade silver gold concentrate, which we sell through metal traders. Our concentrates are going to Korea to be smelted.

Of course, there is an added and significant cost in treatment and refining charges, smelting charges related to handling and selling of concentrate. And we believe, we can save as much as $2 per ounce in cost by producing at the river. So, that requires that we do a cyanide bleaching plant for the concentrate. We know for concentrate an ore is very amenable to cyanide bleaching. We achieve recoveries in concentrate as high as 98% for both metal, silver and gold, by cyanide bleaching the concentrate.

So, we began searching for an off site location away from our mine where we could locate this plant. That process has longer than we expected and has been the main source of delay up to now for us to get really going with this project. We have scouted various places in the state of Oaxaca, in the neighboring states of (inaudible) in central Mexico and in northern Mexico. And we have now secured a site in an industrial park in the state of (inaudible) where we got a good reception by the local authorities and other members of the industrial park.

So, now that we have secured the site we are working on advancing basic engineering to go into detailed engineering and adjusting our budget to the new physical requirements for the new site. And it's a $16 million budget and it has got a pay back time of three years. So, it's a very profitable project. It makes all the sense in the world and we expect we can have it up and running in the fourth quarter of next year.

So, the project as it stands today it has been delayed by almost three months or a quarter with respect to our original estimation at the beginning of the year and as I explained maybe due to the difficulties in finding an adequate site to locate the facility.

Andy Schopick - Private Investor

So your expectation is that you will have construction completed by the end of 2013?

Jorge Ganoza

Yes.

Andy Schopick - Private Investor

And my last question for you is on the current estimate life of mine at Caylloma, what is that and do you anticipate that that will be improved when you give us a update on resources early next year?

Jorge Ganoza

Okay. If you look at our published reserves at Caylloma, we report about 4.5 million tones of reserves. Now, we have experienced from 2011 into 2012 significant cost escalation that was accounted for in the second half of last year. So, the impact on -- that cost escalation will have an impact on our reserves. We can anticipate some of our reserves will be migrating back to resources due to the cost escalation using the cooling price environment, no. Remember, prices last year hovered around $35, $38 they were looking about $30, $32.

So, with that combined effect we are estimating a reduction of reserves. We do not believe it will be at this point a reduction of reserve that had compromised or mine in any way in the long-term because we do have -- this mine has a traditional five to seven years of reserves as much of eight years depending on what prices and costs are doing. And then, we have a significant base of resources from which we convert annually. This mine has been operating a -- it is a vein deposit and as such it is replacing reserves and resources year on year keeping a cushion of five to eight years.

We have been very successfully in replacing what we consume and increasing reserves beyond what we consume annually. But in the short-term, I think our guidance would be to expect a reduction in reserves and maybe resources to stay at the same level or increase.

Operator

Our next question comes from line of Chris Thompson with Raymond James. Please proceed with your question.

Chris Thompson - Raymond James

I just got one question relating to the production expansion that is Caylloma. Is that still on the cards or is that pretty much dependent on the power? And what sort of scale of expansion are we looking at?

Jorge Ganoza

Thanks for you question, Chris. The power constraint, we believe at this moment is only temporary. There is a long-term solution for the power requirement which is mainly related to the saturation of a core and transmission line. But we believe that problem should be resolved early next year at the latest because it is not only ours but other offshore mines mainly in the district are going through same issues. So, we are all working for our solutions here.

With regard to the -- going past now the energy limitations which are temporary, our current name plate capacity is for 1,300 tons per day. And we have been working on our projects to optimize and increase this with a view that we could achieve 1,600 tons per day.

Have to say that in light of challenges we have been battling with this year to increase metallurgical recoveries and improve of flotation of oxide at this mine, we have a deep prioritize expansion project trying to focus more on a ground work, metallurgical work and process optimization. That has been and continues to be the big focus of our work at Caylloma.

And so, into next year we are locating budgets to achieve more than -- grow beyond 1,300. We are locating budget to optimize the process at this plant and make it more efficient. There are a lot of opportunities for optimization that should result in improvements in recovery and on cost efficiencies as well. So, parts of our cost cutting initiatives go through a process optimization at the plant. So, we are -- I have to say that there has been a shift in focus from expansion to optimization of this plant at this moment.

Operator

Our next question comes from the line of Trevor Turnbull with Scotiabank. Please proceed with your question.

Trevor Turnbull - Scotiabank

Yeah, just maybe continuing on quickly with Caylloma, I was wondering if you could give us a sense of how much getting to the grid power and off of having to use diesel at Caylloma, would save you on a say per ton or per ounce basis?

Jorge Ganoza

We believe the cost increments, Trevor, related to energy in the range of $4 per ton of ore. That is what we are seeing right now. For example, the new tailing facility requires pumping, so we need power for those pumps and that power will not come from the grid right now, will be generated by diesel. So, thermal generators so. And we are also taking some initiatives, for example, regarding compressed air in remote locations and for example, production in the narrow range on the backend of the property of the (inaudible) vein has been stopped. So, that brings also reduce the energy needs and compressed air needs that were meet with diesel generation. So, we are taking a series of initiatives running to next year what we are seeing is as much as $4 for ton.

Trevor Turnbull - Scotiabank

Okay. And I guess, you mentioned the tailings, you also said that the ministry came in and did an onsite inspection earlier this week. Do you know what the kind of next steps are? Is it just kind of these guys making a decision back in their office or is there anything else that has to happen before the could issue an operating permit?

Jorge Ganoza

No, just to describe the process. We were granted over a year ago the environmental impact statement, that was approved. After that you have to get a construction permit. That construction permit is what is delayed. It was that we were caught in the middle of a change of government last year. So, we got that we advancing the construction of the facility. The construction of the facility was virtually nil and then we were granted the permit, the construction permit we made that part of our disclosures in the MD&A.

The site visit that took place now is just an inspection the Ministry of Mines where they go to the field and compared what you applied for with what has actually been built. And once they do that review they just give you authorization to discharge. That inspection took place this last Monday and the timing for them to grant the authorization to discharge into a facility is expected within days.

There is a small process in the Ministry of Mines where the technical review team produces a document that goes to a legal area in the Ministry of Mines, so we have to work closely with them to ensure that we are talking them to move at the pace that we need. And the expectation is that we are operational and discharging into a new facility by the end of this month.

Having said that, I would like to stress what we already mentioned repeatedly before that we de-risk this project by expanding the existing facility. And the existing facility where we are discharging today has enough holding capacity until June of next year.

Trevor Turnbull - Scotiabank

Okay. And then, I have just one other question with respect to Caylloma. You talked about the Animas vein having to be the near surface to get more oxide and you thought that would probably contribute to the ore feed probably to the end of next year. And then, you would be getting away from some of that oxide material. Can you give us a sense that when that change over happens, will there be a change in base metal grades as well? Should we be looking for a trend towards higher or lower lead and zinc content?

Jorge Ganoza

That is a good question. What we should see is base metal is moving higher.

Trevor Turnbull - Scotiabank

And then, -- right. That would make sense and that is something probably to look for towards the end of 2013 or 2014?

Jorge Ganoza

Yes. So, we are already working on a five year models and think that is what we are seeing. Once the contribution of level 6 starts reducing we see an up tick in base metal grade.

Trevor Turnbull - Scotiabank

Yes.

Jorge Ganoza

And there will be a slight reduction, potential reduction in silver grid. And that is offset in terms of net silver production by increase recoveries as well.

Trevor Turnbull - Scotiabank

Right. Okay. And a final question, I guess with respect to San Jose, I know that as the mine gets developed a bit deeper as you get into the mine life you are expecting higher grades. Should we started to look for those in 2013 or does that take a bit longer for the grades to move up?

Jorge Ganoza

Well, we are already benefiting from some of the higher grids in the deeper parts. We have been outperforming our guidance on the back of higher grades at San Jose up until the third quarter. And that is because the main decline at San Jose has the mine has been able to accelerate beyond our initial plan, the deepening of the deep line which has given access to deeper levels with better grades. And as we start developing and advancing on those levels, we've been having enjoying more flexibility. We will now work in phases with better grades. So, that has translated into our quarterly production. That's why we are giving our guidance for the year.

What we have -- a big portion of the better grade in the deeper is still in third resource category, the reserve that we have reported has an increasing grade profile, but the big upside is we get conversion of inferred resources. And we are going to be drilling starting early next year for resource conversion from the underground. And it's a big program that we have to start early next, and with expectation that by mid next year we can have an updated resource reserve estimation by mid 2013 we can have an updated reserve which is incorporating the migration of these inferred resources and to measure indicated on reserves.

Operator

(Operator Instructions). Our next question comes from the line of Ben Asuncion with Haywood Securities. Please proceed with your question.

Ben Asuncion - Haywood Securities

I guess most of my stuff was answered. I just wanted to touch base with respect to San Jose. I guess on the last press release you acquired 1,800 ton per day ball mill. Can you give any color on what your thoughts are in terms of how soon you could potentially see an additional increased I guess from 1,500 to 1,800?

Jorge Ganoza

That is a good question. The reading of the sign of the mine, the mine has an integral design when we first conceived it back in 2009. And we did the basic engineering for a 1,500 ton per day mine. And at the time, the bottleneck, if you will, to think beyond that was in the weather (inaudible). The valley of Ocotlán where our operation is located is a dry basin. So, our team has devised a very imaginative sources of water for the project. One, we capture in a dam that it is a dew obtaining stretch of water reservoir, it capture rainfall water that we store. We recycle all the water in the mine. We have sealed discharge of water or industrial affluent from the plant. We recycle everything.

And with enabling community we developed a very smart project, we are proud of, where we upgraded the sewage facility of a neighboring town at our own cost. We revamped it at our own cost and we are operating it. We have an agreement with the municipality of the town where we have to operate the plant at our own cost and we invested our $1 million in upgrading the facility. And we do that in exchange for the residual water from the treatment of sewage. So, that water we pump it to in mine site, which is located 13 kilometers away and that adds to our water balance. So, we are growing to 1,500 tons per day. And we will be revisiting our water balance after a year of operations at San Jose.

With that hard data, not just estimate, we will be fine tuning our water balance to see if we have enough water availability in the balance to think beyond 1,500 at this moment. We do not see bottlenecks at the mine today. And at the plants, we do not see bottlenecks either to think beyond 1,500. In fact, as you already noted we bought -- we purchased a ball mill or second ball mill for expansion, it is an upside precisely for 500 tons per day but rather 500 tons, 800 tons per day. With that we can be producing in the range of 1,800 tons per day. We have enough milling capacity for our 1,800 tons per day and if we push like 15 mill each harder perhaps, we can go to 1,200, so we can be between 1,500 and 2,000 tons per day with the milling capacity that we would have in place.

Of course, there will minor changes required to go beyond 1,500, but in the main core the plant is in the milling and we would have enough milling capacity to think beyond 1,500. But the bottleneck is in the weather balance and that is something we are going to be answering in the coming months. Now, that we have the inputs of the water from the sewage plant and we have a year of hard date collected from the operation.

Ben Asuncion - Haywood Securities

And then, I guess just touch on that water plant. Can you give us an update on where you stand with that final, sort of missing key to the pipeline? And if you have any better estimate in terms of when you think we can see a solution for that?

Jorge Ganoza

I just -- during the call I mentioned it, I will repeat it. We this past month of October, we connected the last two kilometers of the pipeline, so the wires, the sewage plant is operational. The plant -- the pipeline is connected and we are currently receiving about 700 cubic meters of water per day from the plant on site.

Ben Asuncion - Haywood Securities

Perfect. Thanks. Sorry, I must have missed that out. And then, the last question here is just with respect to the grades you have been delivering at San Jose have been above plan. I guess this is result of the development that was sort of a ahead of schedule in accessing those higher grade blocks. Will we see this, I guess, continue here if we will look at the last study, would we still anticipate sort of grades higher than what we originally forecasted?

Jorge Ganoza

Well, what I can tell you is we are going to continue to push the ramp to deepen and deepen fast because we like flexibility in our mines. And we are going to give guidance for 2013 in January.

Ben Asuncion - Haywood Securities

Okay.

Jorge Ganoza

So, right now, we are working on our planning, revisiting our -- as we do every year at this time, we are revisiting our annual planning, our five year planning. And we will be giving guidance in January and there you will be able to see how as we are going to manage it.

Operator

There are no further questions at this time. I would like to hand the call back over to management for closing comments.

Carlos Baca

We want to thank you for your interest in the company and continued support. Have a good day.

Operator

Ladies and gentlemen, this concludes today’s teleconference. You may disconnect your lines at this time and thank you for your participation.

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