Unassociated Document
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-QSB
x
QUARTERLY REPORT UNDER
SECTION 13 OR 15(d)
OF
THE
SECURITIES EXCHANGE ACT OF 1934
For
the
quarterly period ended October 31, 2006
OR
o
TRANSITION REPORT UNDER
SECTION 13 OR 15(d)
OF
THE
SECURITIES EXCHANGE ACT OF 1934
For
the
transition period from __________ to
__________
Commission
File Number: 0-13078
CAPITAL
GOLD CORPORATION
(Exact
name of small business issuer as specified in its charter)
DELAWARE
|
13-3180530
|
(State
or other jurisdiction of
|
(I.R.S.
Employer
|
incorporation
or organization)
|
Identification
No.)
|
76
Beaver Street, 26TH
floor, New York, NY 10005
(Address
of principal executive offices)
Issuer's
telephone number: (212)
344-2785
(Former
name, former address and former fiscal year, if changed since last
report)
Check
whether the issuer (1) filed all reports required to be filed by Section 13
or
15(d) of the Exchange Act during the past 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days.
Yes x No o
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes o
No x
Indicate
the number of shares outstanding of each of the issuer's classes of common
equity as of the latest practicable date.
Class
|
Outstanding
at December 15, 2006
|
Common
Stock, par value $.0001 per share
|
133,482,854
|
Transitional
Small Business Format (check one);
Yes
o
No
x
PART
I. FINANCIAL INFORMATION
Item
1. Financial
Statements
The
accompanying financial statements are unaudited for the interim periods, but
include all adjustments (consisting only of normal recurring adjustments),
which
we consider necessary for the fair presentation of results for the three months
ended October 31, 2006.
Moreover,
these financial statements do not purport to contain complete disclosure in
conformity with U.S. generally accepted accounting principles and should be
read
in conjunction with our audited financial statements at, and for the fiscal
year
ended July 31, 2006.
The
results reflected for the three months ended October 31, 2006 are not
necessarily indicative of the results for the entire fiscal year.
CAPITAL
GOLD CORPORATION
|
(A
DEVELOPMENT STAGE ENTERPRISE)
|
CONDENSED
CONSOLIDATED BALANCE SHEET
|
(UNAUDITED)
|
|
|
October
31,
|
|
|
|
2006
|
|
ASSETS
|
|
|
|
Current
Assets:
|
|
|
|
Cash
and Cash Equivalents
|
|
$
|
1,936,828
|
|
Loans
Receivable - Affiliate (Note 8 and 11)
|
|
|
43,995
|
|
Prepaid
Assets
|
|
|
35,525
|
|
Marketable
Securities (Note 3)
|
|
|
140,000
|
|
Deposits
(Note 18)
|
|
|
1,679,110
|
|
Other
Current Assets
|
|
|
338,374
|
|
Total
Current Assets
|
|
|
4,173,832
|
|
|
|
|
|
|
Mining
Concessions (Note 6)
|
|
|
70,104
|
|
|
|
|
|
|
Property
& Equipment - net (Note 4)
|
|
|
4,499,160
|
|
|
|
|
|
|
Intangible
Assets - net (Note 5)
|
|
|
512,900
|
|
|
|
|
|
|
Other
Assets:
|
|
|
|
|
Other
Investments (Note 9)
|
|
|
28,052
|
|
Deferred
Financing Costs (Note 13)
|
|
|
683,849
|
|
Mining
Reclamation Bonds (Note 6)
|
|
|
35,550
|
|
Other
|
|
|
42,285
|
|
Security
Deposits
|
|
|
9,599
|
|
Total
Other Assets
|
|
|
799,335
|
|
|
|
|
|
|
Total
Assets
|
|
$
|
10,055,331
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
|
Current
Liabilities:
|
|
|
|
|
Accounts
Payable
|
|
$
|
289,934
|
|
Accrued
Expenses
|
|
|
584,116
|
|
Derivative
Contracts (Note 16)
|
|
|
115,424
|
|
Total
Current Liabilities
|
|
|
989,474
|
|
|
|
|
|
|
Note
Payable
|
|
|
1,250,000
|
|
Total
Long-term Liabilities (Note 13)
|
|
|
1,250,000
|
|
|
|
|
|
|
Commitments
and Contingencies
|
|
|
|
|
Stockholders’
Equity:
|
|
|
|
|
Common
Stock, Par Value $.0001 Per Share;
|
|
|
|
|
Authorized
200,000,000 shares; Issued and
|
|
|
|
|
Outstanding
132,785,129 Shares
|
|
|
13,278
|
|
Additional
Paid-In Capital
|
|
|
44,433,022
|
|
Deficit
Accumulated in the Development Stage
|
|
|
(32,549,272
|
)
|
Deferred
Financing Costs (Note 13)
|
|
|
(4,136,015
|
)
|
Deferred
Compensation
|
|
|
(52,500
|
)
|
Accumulated
Other Comprehensive Loss (Note 10)
|
|
|
107,344
|
|
Total
Stockholders’ Equity
|
|
|
7,815,857
|
|
Total
Liabilities and Stockholders’ Equity
|
|
$
|
10,055,331
|
|
The
accompanying notes are an integral part of the financial
statements.
CAPITAL
GOLD CORPORATION
|
(A
DEVELOPMENT STAGE ENTERPRISE)
|
CONDENSED
CONSOLIDATED STATEMENT OF OPERATIONS
|
(UNAUDITED)
|
|
|
|
|
|
|
For
the Period
|
|
|
|
For
The Three Months Ended
|
|
September
17, 1982
|
|
|
|
October
31,
|
|
(Inception)
To
|
|
|
|
2006
|
|
2005
|
|
October
31, 2006
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
-
|
|
$
|
-
|
|
$
|
-
|
|
Costs
and Expenses:
|
|
|
|
|
|
|
|
|
|
|
Mine
Expenses
|
|
|
212,227
|
|
|
540,551
|
|
|
9,816,940
|
|
Write-Down
of Mining, Milling and Other Property and Equipment
|
|
|
-
|
|
|
-
|
|
|
1,299,445
|
|
Selling,
General and Administrative Expenses
|
|
|
632,237
|
|
|
289,347
|
|
|
12,630,697
|
|
Stocks
and Warrants issued for Services
|
|
|
-
|
|
|
-
|
|
|
9,499,238
|
|
Depreciation
and Amortization
|
|
|
73,445
|
|
|
8,570
|
|
|
487,571
|
|
Total
Costs and Expenses
|
|
|
917,909
|
|
|
838,468
|
|
|
33,733,891
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from Operations
|
|
|
(917,909
|
)
|
|
(838,468
|
)
|
|
(33,733,891
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Other
Income (Expense):
|
|
|
|
|
|
|
|
|
|
|
Interest
Income
|
|
|
21,578
|
|
|
25,506
|
|
|
1,001,295
|
|
Interest
Expense
|
|
|
(22,581
|
)
|
|
-
|
|
|
(22,581
|
)
|
Miscellaneous
|
|
|
-
|
|
|
-
|
|
|
36,199
|
|
Loss
on Sale of Property and Equipment
|
|
|
-
|
|
|
-
|
|
|
(155,713
|
)
|
Gain
on Sale of Subsidiary
|
|
|
-
|
|
|
-
|
|
|
1,907,903
|
|
Option
Payment
|
|
|
-
|
|
|
-
|
|
|
70,688
|
|
Loss
on change in fair value of derivative
|
|
|
(241,857
|
)
|
|
|
|
|
(823,781
|
)
|
Loss
on Write-Off of Investment
|
|
|
-
|
|
|
-
|
|
|
(10,000
|
)
|
Loss
on Joint Venture
|
|
|
-
|
|
|
-
|
|
|
(901,700
|
)
|
Loss
on Option
|
|
|
-
|
|
|
-
|
|
|
(50,000
|
)
|
Gain
(Loss) on Other Investments
|
|
|
-
|
|
|
-
|
|
|
(3,697
|
)
|
Loss
on Write -Off of Minority Interest
|
|
|
-
|
|
|
-
|
|
|
(150,382
|
)
|
Total
Other Income (Expense)
|
|
|
(242,860
|
)
|
|
25,506
|
|
|
898,231
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
Before Minority Interest
|
|
|
(1,160,769
|
)
|
|
(812,962
|
)
|
|
(32,835,660
|
)
|
Minority
Interest
|
|
|
-
|
|
|
-
|
|
|
286,388
|
|
Net
Loss
|
|
$
|
(1,160,769
|
)
|
$
|
(812,962
|
)
|
$
|
(32,549,272
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss Per Common Share - Basic and Diluted
|
|
$
|
(0.01
|
)
|
$
|
(0.01
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
Average Common Shares Outstanding
|
|
|
132,597,627
|
|
|
95,969,218
|
|
|
|
|
The
accompanying notes are an integral part of the financial
statements.
CAPITAL
GOLD CORPORATION
|
(A
DEVELOPMENT STAGE ENTERPRISE)
|
CONDENSED
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
|
FOR
THE THREE MONTHS ENDED OCTOBER 31, 2006
(UNAUDITED)
|
|
|
|
|
|
|
|
|
Deficit
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
Other
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional
|
|
in
the
|
|
Comprehensive
|
|
Deferred
|
|
Deferred
|
|
Total
|
|
|
|
Common
Stock
|
|
paid-in-
|
|
Development
|
|
Income/
|
|
Financing
|
|
Compensation
|
|
Stockholder
|
|
|
|
Shares
|
|
Amount
|
|
capital
|
|
Stage
|
|
(Loss)
|
|
Costs
|
|
Costs
|
|
Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at July 31, 2006
|
|
|
131,635,129
|
|
|
13,163
|
|
|
40,733,825
|
|
|
(31,388,503
|
)
|
|
146,493
|
|
|
(522,541
|
)
|
|
(52,500
|
)
|
|
8,929,937
|
|
Deferred
Financing Costs
|
|
|
1,150,000
|
|
|
115
|
|
|
350,635
|
|
|
-
|
|
|
-
|
|
|
(350,750
|
)
|
|
-
|
|
|
-
|
|
Deferred
Financing Costs
|
|
|
-
|
|
|
-
|
|
|
3,314,449
|
|
|
-
|
|
|
-
|
|
|
(3,314,449
|
)
|
|
-
|
|
|
-
|
|
Amortization
of Deferred Finance Costs
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
51,725
|
|
|
-
|
|
|
51,725
|
|
Options
and warrants issued for services
|
|
|
-
|
|
|
-
|
|
|
34,113
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
34,113
|
|
Unrealized
loss on marketable securities
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
50,000
|
|
|
-
|
|
|
-
|
|
|
50,000
|
|
Change
in fair value on interest rate swaps
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(91,682
|
)
|
|
-
|
|
|
-
|
|
|
(91,682
|
)
|
Equity
adjustment from foreign currency translation
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
2,533
|
|
|
-
|
|
|
-
|
|
|
2,533
|
|
Net
loss for the three months ended October 31, 2006
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(1,160,769
|
)
|
|
-
|
|
|
|
|
|
-
|
|
|
(1,160,769
|
)
|
Balance
- October 31, 2006
|
|
|
132,785,129
|
|
$
|
13,278
|
|
$
|
44,433,022
|
|
$
|
(32,549,272
|
)
|
$
|
107,344
|
|
$
|
(4,136,015
|
)
|
$
|
(52,500
|
)
|
$
|
7,815,857
|
|
The
accompanying notes are an integral part of the financial statements.
CAPITAL
GOLD CORPORATION
|
(A
DEVELOPMENT STAGE ENTERPRISE)
|
CONDENSED
CONSOLIDATED STATEMENT OF CASH FLOWS
|
(UNAUDITED)
|
|
|
For
The
Three
Months Ended
|
|
For
The Period
September
17, 1982
|
|
|
|
October
31,
|
|
(Inception)
To
|
|
|
|
2006
|
|
2005
|
|
October
31, 2006
|
|
Cash
Flow From Operating Activities:
|
|
|
|
|
|
|
|
Net
Loss
|
|
$
|
(1,160,769
|
)
|
$
|
(812,962
|
)
|
$
|
(32,549,272
|
)
|
Adjustments
to Reconcile Net Loss to
|
|
|
|
|
|
|
|
|
|
|
Net
Cash Provided by (Used in) Operating Activities:
|
|
|
|
|
|
|
|
|
|
|
Depreciation
and Amortization
|
|
|
73,445
|
|
|
8,570
|
|
|
496,141
|
|
Gain
on Sale of Subsidiary
|
|
|
-
|
|
|
-
|
|
|
(1,907,903
|
)
|
Minority
Interest in Net Loss of Subsidiary
|
|
|
-
|
|
|
-
|
|
|
(286,388
|
)
|
Write-Down
of Impaired Mining, Milling and Other
|
|
|
-
|
|
|
|
|
|
|
|
Property
and Equipment
|
|
|
-
|
|
|
-
|
|
|
1,299,445
|
|
Loss
on Sale of Property and Equipment
|
|
|
-
|
|
|
-
|
|
|
155,713
|
|
Loss
on change in fair value of derivative
|
|
|
241,858
|
|
|
|
|
|
823,782
|
|
Loss
on Write-Off of Investment
|
|
|
-
|
|
|
-
|
|
|
10,000
|
|
Loss
on Joint Venture
|
|
|
-
|
|
|
-
|
|
|
901,700
|
|
Loss
on Write-Off of Minority Interest
|
|
|
-
|
|
|
-
|
|
|
150,382
|
|
Value
of Common Stock and Warrants Issued for Services
|
|
|
34,115
|
|
|
-
|
|
|
12,619,730
|
|
Changes
in Operating Assets and Liabilities:
|
|
|
|
|
|
|
|
|
|
|
(Increase)
Decrease in Prepaid Expenses
|
|
|
4,507
|
|
|
18,991
|
|
|
(16,575
|
)
|
(Increase)
Decrease in Other Current Assets
|
|
|
4,145,478
|
|
|
18,013
|
|
|
(1,120,361
|
)
|
(Increase)
in Other Deposits
|
|
|
(1,429,110
|
)
|
|
(18,000
|
)
|
|
(1,697,110
|
)
|
Increase
(Decrease) in Other Assets
|
|
|
768
|
|
|
-
|
|
|
(41,900
|
)
|
(Increase)
in Security Deposits
|
|
|
-
|
|
|
-
|
|
|
(9,605
|
)
|
Increase
(Decrease) in Accounts Payable
|
|
|
30,962
|
|
|
55,030
|
|
|
373,146
|
|
Increase
(Decrease) in Accrued Expenses
|
|
|
227,445
|
|
|
(46,819
|
)
|
|
364,374
|
|
Net
Cash Provided by (Used in) Operating Activities
|
|
|
2,168,699
|
|
|
(777,177
|
)
|
|
(20,434,701
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Cash
Flow From Investing Activities:
|
|
|
|
|
|
|
|
|
|
|
(Increase)
in Other Investments
|
|
|
(6,572
|
)
|
|
(260
|
)
|
|
(28,312
|
)
|
Purchase
of Mining, Milling and Other Property and
|
|
|
|
|
|
|
|
|
|
|
Equipment
|
|
|
(3,475,456
|
)
|
|
(17,524
|
)
|
|
(6,666,738
|
)
|
Purchase
of Concessions
|
|
|
-
|
|
|
-
|
|
|
(25,324
|
)
|
Investment
in Intangibles
|
|
|
(500,000
|
)
|
|
-
|
|
(518,620)
|
Proceeds
on Sale of Mining, Milling and Other Property
|
|
|
|
|
|
|
|
|
|
|
and
Equipment
|
|
|
-
|
|
|
-
|
|
|
275,638
|
|
Proceeds
From Sale of Subsidiary
|
|
|
-
|
|
|
-
|
|
|
2,131,616
|
|
Expenses
of Sale of Subsidiary
|
|
|
-
|
|
|
-
|
|
|
(101,159
|
)
|
Advance
Payments - Joint Venture
|
|
|
-
|
|
|
-
|
|
|
98,922
|
|
Investment
in Joint Venture
|
|
|
-
|
|
|
-
|
|
|
(101,700
|
)
|
Investment
in Privately Held Company
|
|
|
-
|
|
|
-
|
|
|
(10,000
|
)
|
Net
Assets of Business Acquired (Net of Cash)
|
|
|
-
|
|
|
-
|
|
|
(42,130
|
)
|
Investment
in Marketable Securities
|
|
|
-
|
|
|
-
|
|
|
(50,000
|
)
|
The
accompanying notes are an integral part of the financial
statements.
CAPITAL
GOLD CORPORATION
|
(A
DEVELOPMENT STAGE ENTERPRISE)
|
CONDENSED
CONSOLIDATED STATEMENT OF CASH FLOWS
|
(UNAUDITED)
- (Continued)
|
|
|
For
The
Three
Months Ended
|
|
For
The Period
September
17, 1982
|
|
|
|
October
31,
|
|
(Inception)
To
|
|
|
|
2006
|
|
2005
|
|
October
31, 2006
|
|
|
|
|
|
|
|
|
|
Net
Cash Used in Investing Activities
|
|
|
(3,982,028
|
)
|
|
(17,784
|
)
|
|
(5,037,807
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Cash
Flow From Financing Activities:
|
|
|
|
|
|
|
|
|
|
|
Advances
to Affiliate
|
|
|
(2,250
|
)
|
|
(3,577
|
)
|
|
(47,572
|
)
|
Proceeds
from Borrowing on Credit Facility
|
|
|
1,250,000
|
|
|
|
|
|
1,250,000
|
|
Proceeds
of Borrowings - Officers
|
|
|
-
|
|
|
-
|
|
|
18,673
|
|
Repayment
of Loans Payable - Officers
|
|
|
-
|
|
|
-
|
|
|
(18,673
|
)
|
Proceeds
of Note Payable
|
|
|
-
|
|
|
-
|
|
|
11,218
|
|
Payments
of Note Payable
|
|
|
-
|
|
|
-
|
|
|
(11,218
|
)
|
Proceeds
From Issuance of Common Stock, net
|
|
|
-
|
|
|
-
|
|
|
26,850,844
|
|
Commissions
on Sale of Common Stock
|
|
|
-
|
|
|
-
|
|
|
(5,250
|
)
|
Deferred
Finance Costs
|
|
|
(241,624
|
)
|
|
-
|
|
|
(692,401
|
)
|
Expenses
of Initial Public Offering
|
|
|
-
|
|
|
-
|
|
|
(408,763
|
)
|
Capital
Contributions - Joint Venture Subsidiary
|
|
|
-
|
|
|
-
|
|
|
304,564
|
|
Purchase
of Certificate of Deposit - Restricted
|
|
|
-
|
|
|
-
|
|
|
(5,000
|
)
|
Purchase
of Mining Reclamation Bonds
|
|
|
-
|
|
|
-
|
|
|
(30,550
|
)
|
Net
Cash Provided By (Used In) Financing Activities
|
|
|
1,006,126
|
|
|
(3,577
|
)
|
|
27,215,872
|
|
Effect
of Exchange Rate Changes
|
|
|
2,533
|
|
|
(7,138
|
)
|
|
193,464
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase
(Decrease) In Cash and Cash Equivalents
|
|
|
(804,670
|
)
|
|
(805,676
|
)
|
|
1,936,828
|
|
Cash
and Cash Equivalents - Beginning
|
|
|
2,741,498
|
|
|
4,281,548
|
|
|
-
|
|
Cash
and Cash Equivalents - Ending
|
|
$
|
1,936,828
|
|
$
|
3,475,872
|
|
$
|
1,936,828
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental
Cash Flow Information:
|
|
|
|
|
|
|
|
|
|
|
Cash
Paid For Interest
|
|
$
|
-
|
|
$
|
-
|
|
$
|
-
|
|
Cash
Paid For Income Taxes
|
|
$
|
557
|
|
$
|
6,315
|
|
$
|
46,531
|
|
Non-Cash
Financing Activities:
|
|
|
|
|
|
|
|
|
|
|
Issuances
of Common Stock as Commissions
|
|
|
|
|
|
|
|
|
|
|
on
Sales of Common Stock
|
|
$
|
-
|
|
$
|
-
|
|
$
|
440,495
|
|
Issuance
of common stock and warrants as payment of financing costs
|
|
$
|
3,665,199
|
|
$
|
-
|
|
$
|
4,187,740
|
|
Change
in fair value of derivative instrument
|
|
$
|
91,682
|
|
|
|
|
$
|
91,682
|
|
Issuance
of common stock and warrants as payment for Expenses
|
|
$
|
-
|
|
$
|
-
|
|
$
|
192,647
|
|
Issuance
of Common Stock as Payment for Mining,
|
|
|
|
|
|
|
|
|
|
|
Milling
and Other Property and Equipment
|
|
$
|
-
|
|
$
|
-
|
|
$
|
4,500
|
|
Exercise
of Options as Payment of Accounts Payable
|
|
$
|
-
|
|
$
|
-
|
|
$
|
36,000
|
|
|
|
|
|
|
|
|
|
|
|
|
The
accompanying notes are an integral part of the financial
statements.
|
|
|
|
|
|
|
CAPITAL
GOLD CORPORATION
(A
DEVELOPMENT STAGE ENTERPRISE)
NOTES
TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
October
31, 2006
NOTE
1 -
Basis of Presentation
The
accompanying unaudited condensed consolidated financial statements include
the
accounts of Capital Gold Corporation and its subsidiaries, which are wholly
and
majority owned. All significant inter-company accounts and transactions have
been eliminated in consolidation.
Capital
Gold Corporation ("Capital Gold", "the Company", "we" or "us") was incorporated
in February 1982 in the State of Nevada. During March 2003 the Company's
stockholders approved an amendment to the Articles of Incorporation to change
its name from Leadville Mining and Milling Corp. to Capital Gold Corporation.
In
November 2005, the Company reincorporated in Delaware. The Company owns rights
to property located in the State of Sonora, Mexico and the California Mining
District, Lake County, Colorado and is in the process of constructing and
developing an open-pit gold mining operation to mine two of its Mexican
concessions All of the Company's mining activities are now being performed
in
Mexico. The Company is a development stage enterprise.
On
June
29, 2001, the Company exercised an option and purchased from AngloGold North
America Inc. and AngloGold (Jerritt Canyon) Corp. 100% of the issued and
outstanding stock of Minera Chanate, S.A. de C.V., a subsidiary of those two
companies (“Minera Chanate”). Minera Chanate's assets consisted of certain
exploitation and exploration concessions in the States of Sonora, Chihuahua
and
Guerrero, Mexico. We sometimes refer to these concessions as the El Chanate
Concessions.
Pursuant
to the terms of the agreement, on December 15, 2001, the Company made a $50,000
payment to AngloGold. AngloGold will be entitled to receive the remainder of
the
purchase price by way of an ongoing percentage of net smelter returns of between
2% and 4% plus 10% net profits interest (until the total net profits interest
payment received by AngloGold equals $1,000,000). AngloGold's right to a payment
of a percentage of net smelter returns and the net profits interest will
terminate at such point as they aggregate $18,018,355. In accordance with the
agreement, the foregoing payments are not to be construed as royalty payments.
Should the Mexican government or other jurisdiction determine that such payments
are royalties, we could be subject to and would be responsible for any
withholding taxes assessed on such payments.
Under
the
terms of the agreement, the Company has granted AngloGold the right to designate
one of its wholly-owned Mexican subsidiaries to receive a one time option to
purchase 51% of Minera Chanate (or such entity that owns the Minera Chanate
concessions at the time of option exercise). That Option is exercisable over
a
180 day period commencing at such time as the Company notifies AngloGold that
it
has made a good faith determination that it has gold-bearing ore deposits on
any
one of the identified group of El Chanate Concessions, when aggregated with
any
ore that the Company has mined, produced and sold from such concessions, of
in
excess of 2,000,000 troy ounces of contained gold. The exercise price would
equal twice the Company's project costs on the properties during the period
commencing on December 15, 2000 and ending on the date of such
notice.
The
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with U.S. generally accepted accounting principles for
interim financial information and with instructions to Form 10-QSB. Accordingly,
they do not include all of the information and footnotes required by U.S.
generally accepted accounting principles for complete financial statements.
In
the opinion of the Company's management, the accompanying condensed consolidated
financial statements reflect all adjustments (which include only normal
recurring adjustments) necessary to present fairly the condensed consolidated
financial position and results of operations and cash flows for the periods
presented.
Results
of operations for interim periods are not necessarily indicative of the results
of operations for a full year.
The
condensed consolidated financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and satisfaction
of
liabilities in the normal course of business. The Company is a development
stage
enterprise and has recurring losses from operations and operating cash
constraints that raise substantial doubt about the Company's ability to continue
as a going concern. These statements should be read in conjunction with the
Company’s consolidated financial statements included within our Form 10-KSB for
the fiscal year ended July 31, 2006, as filed with the SEC on November 1,
2006.
NOTE
2 -
Equity Based Compensation
In
connection with offers of employment to the Company’s executives as well as in
consideration for agreements with certain consultants, the Company issues
options and warrants to acquire its common stock. Employee and non-employee
awards are made in the discretion of the Board of Directors.
Such
options and warrants may be exercisable at varying exercise prices currently
ranging from $0.02 to $0.41 per share of common stock with certain of these
grants becoming exercisable immediately upon grant subject to shareholder
approval. Certain grants vest for a period of five months to two years
(generally concurrent with service periods for grants to employees/consultants
-
See Note 15 - Employee and Consulting Agreements). Certain grants contain a
provision whereby they become immediately exercisable upon a change of
control.
Effective
February 1, 2006, the Company adopted the provisions of SFAS No. 123R. Under
FAS
123R, share-based compensation cost is measured at the grant date, based on
the
estimated fair value of the award, and is recognized as expense over the
requisite service period. The Company adopted the provisions of FAS 123R using
a
modified prospective application. Under this method, compensation cost is
recognized for all share-based payments granted, modified or settled after
the
date of adoption, as well as for any unvested awards that were granted prior
to
the date of adoption. Prior periods are not revised for comparative purposes.
Because the Company previously adopted only the pro forma disclosure provisions
of SFAS 123, it will recognize compensation cost relating to the unvested
portion of awards granted prior to the date of adoption, using the same estimate
of the grant-date fair value and the same attribution method used to determine
the pro forma disclosures under SFAS 123, except that forfeitures rates will
be
estimated for all options, as required by FAS 123R.
The
cumulative effect of applying the forfeiture rates is not material. FAS 123R
requires that excess tax benefits related to stock options exercises be
reflected as financing cash inflows instead of operating cash
inflows.
The
fair
value of each option award is estimated on the date of grant using a
Black-Scholes option valuation model. Expected volatility is based on the
historical volatility of the price of the Company stock. The risk-free interest
rate is based on U.S. Treasury issues with a term equal to the expected life
of
the option. The Company uses historical data to estimate expected dividend
yield, expected life and forfeiture rates. The estimated per share weighted
average grant-date fair values of stock options and warrants granted during
the
three months ended October 31, 2006 and 2005, were $0.31 and $0, respectively.
The fair values of the options and warrants granted were estimated based on
the
following weighted average assumptions:
|
|
Three
Months ended October 31,
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
Expected
volatility
|
|
|
134
|
%
|
|
-
|
|
Risk-free
interest rate
|
|
|
6.25
|
%
|
|
-
|
|
Expected
dividend yield
|
|
|
-
|
|
|
-
|
|
Expected
life
|
|
|
4.5
years
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Stock
option and warrant activity for employees during the three months ended October
31, 2006 is as follows:
|
|
Number
of
Options
|
|
Weighted
Average
exercise
price
|
|
Weighted
average
remaining
contracted
term
(years)
|
|
Aggregate
intrinsic
value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at July 31, 2005
|
|
|
4,711,363
|
|
$
|
.30
|
|
|
0.30
|
|
$
|
1,277,977
|
|
Options
granted
|
|
|
4,611,363
|
|
|
.13
|
|
|
-
|
|
|
-
|
|
Options
exercised
|
|
|
(590,909
|
)
|
|
.05
|
|
|
-
|
|
|
-
|
|
Options
expired
|
|
|
(3,161,363
|
)
|
|
.05
|
|
|
-
|
|
|
-
|
|
Warrants
and options outstanding at July 31, 2006
|
|
|
5,570,454
|
|
$
|
.16
|
|
|
1.17
|
|
$
|
702,250
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options
granted
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Options
exercised
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Options
expired
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Warrants
and options outstanding at October 31, 2006
|
|
|
5,570,454
|
|
$
|
.16
|
|
|
0.92
|
|
$
|
702,250
|
|
Warrants
and options exercisable at October 31, 2006
|
|
|
4,120,454
|
|
$
|
.10
|
|
|
0.46
|
|
$
|
680,250
|
|
|
Unvested
stock option and warrant balances for employees at October 31, 2006
are as
follows:
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
Weighted
|
|
average
|
|
|
|
|
|
Number
|
|
Average
|
|
remaining
|
|
Aggregate
|
|
|
|
of
|
|
Exercise
|
|
contracted
|
|
Intrinsic
|
|
|
|
Options
|
|
price
|
|
term
(years)
|
|
value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at August 1, 2005
|
|
|
-
|
|
|
-
|
|
|
-
|
|
$
|
-
|
|
Options
granted
|
|
|
150,000
|
|
$
|
.32
|
|
|
1.58
|
|
|
16,500
|
|
Unvested
Options outstanding at October 31, 2006
|
|
|
150,000
|
|
$
|
.32
|
|
|
1.58
|
|
$
|
16,500
|
|
|
Stock
option and warrant activity for non-employees during the three months
ended October 31, 2006 is as
follows:
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
Weighted
|
|
average
|
|
|
|
|
|
Number
|
|
Average
|
|
remaining
|
|
Aggregate
|
|
|
|
of
|
|
Exercise
|
|
contracted
|
|
Intrinsic
|
|
|
|
Options
|
|
price
|
|
term
(years)
|
|
value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at July 31, 2005
|
|
|
31,902,004
|
|
$
|
.30
|
|
|
1.13
|
|
$
|
3,430,120
|
|
Options
granted
|
|
|
6,844,000
|
|
|
.28
|
|
|
-
|
|
|
-
|
|
Options
exercised
|
|
|
(12,835,004
|
)
|
|
.29
|
|
|
-
|
|
|
-
|
|
Options
expired
|
|
|
(350,000
|
)
|
|
.10
|
|
|
-
|
|
|
-
|
|
Warrants
and options outstanding at July 31, 2006
|
|
|
25,561,000
|
|
$
|
.29
|
|
|
1.33
|
|
$
|
1,939,530
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options
granted
|
|
|
12,600,000
|
|
$
|
.317
|
|
|
-
|
|
|
-
|
|
Options
exercised
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Options
expired
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Warrants
and options outstanding at October 31, 2006
|
|
|
38,161,000
|
|
$
|
.30
|
|
|
1.74
|
|
$
|
1,787,330
|
|
Warrants
and options exercisable at October 31, 2006
|
|
|
37,911,000
|
|
$
|
.29
|
|
|
1.44
|
|
$
|
1,786,430
|
|
Prior
to
the adoption of FAS 123R, the Company applied the intrinsic value-based method
of accounting prescribed by Accounting Principles Board (“APB”) Opinion
No. 25, Accounting
for Stock Issued to Employees,
and
related interpretations including FASB Interpretation No. 44, Accounting
for Certain Transactions involving Stock Compensation an interpretation of
APB
Opinion No. 25
issued
in March 2000 (“FIN 44”), to account for its fixed plan stock options.
Under this method, compensation expense was recorded on the date of grant only
if the current market price of the underlying stock exceeded the exercise price.
SFAS No. 123, Accounting
for Stock-Based Compensation,
established accounting and disclosure requirements using a fair value-based
method of accounting for stock-based employee compensation plans. In
December 2002, the FASB issued SFAS No. 148, Accounting
for Stock-Based Compensation Transition and Disclosure, an amendment of FASB
Statement No. 123.
This
Statement amended FASB Statement No. 123, Accounting
for Stock-Based Compensation,
to
provide alternative methods of transition for a voluntary change to the fair
value method of accounting for stock-based employee compensation.
The
following table illustrates the effect on the net loss and net loss per share
as
if the Company had applied the fair value recognition provisions of SFAS
No. 123 to stock based compensation prior to February 1, 2006:
|
|
Year
Ended
July
31, 2006
|
|
Net
loss
|
|
$
|
(4,804,692
|
)
|
Add
stock-based employee compensation expense (recovery) included in
reported
net income (loss)
|
|
|
-
|
|
Deduct
total stock-based employee compensation expense determined
under fair value based method for all awards, net
of tax
|
|
|
(773,263
|
)
|
Pro
forma net loss
|
|
$
|
(5,577,955
|
)
|
Pro
forma net loss per common share (Basic and diluted)
|
|
$
|
(.05
|
)
|
Weighted
average common shares outstanding:
Basic
and
diluted
|
|
|
112,204,471
|
|
|
|
|
|
|
Net
loss per common share basic and diluted
|
|
$
|
(.04
|
)
|
NOTE
3 -
Marketable Securities
Marketable
securities are classified as current assets and are summarized as
follows:
|
|
October
31,
|
|
|
|
2006
|
|
|
|
|
|
Marketable
equity securities, at cost
|
|
$
|
50,000
|
|
Marketable
equity securities, at fair value
|
|
$
|
140,000
|
|
(See
Notes 8 & 10)
|
|
|
|
|
NOTE
4 -
Property and Equipment
Property
and Equipment consist of the following at October 31, 2006:
|
|
|
|
Construction
in progress
|
|
|
4,101,478
|
|
Water
Well
|
|
|
141,242
|
|
Building
|
|
|
116,922
|
|
Equipment
|
|
|
75,756
|
|
Vehicle
|
|
|
80,200
|
|
Improvements
|
|
|
15,797
|
|
Office
Equipment
|
|
|
14,893
|
|
Furniture
|
|
|
1,843
|
|
|
|
|
|
|
Total
|
|
$
|
4,548,131
|
|
|
|
|
|
|
Less:
accumulated depreciation
|
|
|
(
48,971
|
)
|
|
|
|
|
|
Property
and equipment, net
|
|
$
|
4,499,160
|
|
The
Company issued purchase orders on material and equipment regarding its El
Chanate Project amounting to approximately $6,200,000 as of October 31, 2006,
and had paid approximately $3,200,000 on these commitments.
Depreciation
expense for the three months ended October 31, 2006 and 2005 was $12,267 and
$7,538, respectively.
NOTE
5 -
Intangible Assets
Intangible
assets consist of the following as of October 31, 2006:
Repurchase
of Net Profits Interest from FG
|
|
$
|
500,000
|
|
Investment
in Right of way
|
|
|
18,620
|
|
Less:
accumulated amortization
|
|
|
(
5,720
|
)
|
|
|
|
|
|
Intangible
assets, net
|
|
$
|
512,900
|
|
On
September 13, 2006, the Company repurchased the 5% net profits interest formerly
held by Grupo Minera FG (“FG”), and subsequently acquired by Daniel Gutierrez
Cibrian, with respect to the operations at the El Chanate mine. That net profits
interest had originally been granted to FG in connection with the April 2004
termination of the joint venture agreement between FG and MSR, Capital Gold’s
wholly owned Mexican subsidiary. MSR also received a right of first refusal
to
carry out the works and render construction services required to effectuate
the
El Chanate Project. This right of first refusal is not applicable where a
funding source for the project determines that others should render such works
or services. FG has assigned or otherwise transferred to MSR all permits,
licenses, consents and authorizations (collectively, “authorizations”) for which
FG had obtained in its name in connection with the development of the El Chanate
Project to the extent that the authorizations are assignable. To the extent
that
the authorizations are not assignable or otherwise transferable, FG has given
its consent for the authorizations to be cancelled so that they can be re-issued
or re-granted in MSR’s name. The foregoing has been completed. The purchase
price for the buyback of the net profits interest was $500,000, and was
structured as part of the project costs financed by the recently completed
loan
agreement with Standard Bank, Plc. (See Note 13). Mr. Gutierrez will retain
a 1%
net profits interest in MSR, payable only after a total $US 20 million in net
profits has been generated from operations at El Chanate. The Company recorded
this transaction on its balance sheet as an intangible asset under guidance
provided by FAS 142 - Goodwill
and Other Intangible Assets
to be
amortized over the period of which the asset is expected to contribute directly
or indirectly to the Company’s cash flow.
Amortization
expense for the three months ending October 31, 2006 and 2005 was $900 and
$1,032, respectively.
NOTE
6 -
Mining Reclamation Bonds
These
represent certificates of deposit that have been deposited as security for
Mining Reclamation Bonds in Colorado. They bear interest at rates varying from
4.35% to 5.01% annually and mature at various dates through 2010.
NOTE
7 -
Mining Concessions
Mining
concessions consists of the following:
|
|
|
|
El
Charro
|
|
$
|
25,324
|
|
El
Chanate
|
|
|
44,780
|
|
|
|
|
|
|
Total
|
|
$
|
70,104
|
|
The
El
Chanate exploitation and exploration concessions are carried at historical
cost
and were acquired in connection with the purchase of the stock of Minera Chanate
(see Note 1).
The
Company acquired an additional mining concession - El Charro. El Charro lies
within the current El Chanate property boundaries. The Company is required
to
pay 1 1/2% net smelter royalty in connection with the El Charro
concession.
NOTE
8 -
Loans Receivable - Affiliate
Loans
receivable - affiliate consist of expense reimbursements from a publicly-owned
corporation in which the Company has an investment. The Company's president
and
chairman of the board of directors is an officer and director of that
corporation. These loans are non-interest bearing and due on demand (see Note
3
& 11).
NOTE
9 -
Other Investments
Other
investments are carried at cost and consist of tax liens purchased on properties
located in Lake County, Colorado.
NOTE
10 -
Other Comprehensive Income(Loss)-Supplemental Non-Cash Investing
Activities
Other
comprehensive income (loss) consists of accumulated foreign translation gains
and losses and unrealized gains and losses on marketable securities and is
summarized as follows:
|
|
|
|
Balance
- July 31, 2005
|
|
$
|
157,714
|
|
|
|
|
|
|
Equity
Adjustments from Foreign Currency Translation
|
|
|
48,779
|
|
Unrealized
Gains (loss) on Marketable Securities
|
|
|
(60,000
|
)
|
|
|
|
|
|
Balance
- July 31, 2006
|
|
|
146,493
|
|
|
|
|
|
|
Change
in fair value of derivative instrument
|
|
|
(91,682
|
)
|
Equity
Adjustments from Foreign Currency Translation
|
|
|
2,533
|
|
Unrealized
Gains (loss) on Marketable Securities
|
|
|
50,000
|
|
|
|
|
|
|
Balance
- October 31, 2006
|
|
$
|
107,344
|
|
NOTE
11 -
Related Party Transactions
In
August
2002, the Company purchased marketable equity securities of a related company.
The Company recorded approximately $2,250 and $3,600 in expense reimbursements
including office rent from this entity for the three months ended October 31,
2006 and 2005, respectively (see Notes 3 and 8). The Company utilizes a Mexican
Corporation 100% owned by two officers/Directors and stockholders of the Company
for mining support services. These services include but are not limited to
the
payment of mining salaries and related costs. The Mexican Corporation bills
the
Company for these services at cost. Mining expenses charged by the Mexican
Corporation and reported on the statement of operations amounted to
approximately $113,000 and $25,000 for the three months ended October 31, 2006
and 2005, respectively.
During
the three months ended October 31, 2006 and 2005, the Company paid its V.P.
Development and Director $0 and $17,000, respectively, for professional
geologist and management services rendered to the Company. This individual
also
earned wages of $30,000 during the three months ended October 31, 2006. During
the three months ended October 31, 2006 and 2005, the Company paid its V.P.
Exploration and Director consulting fees of $0 and $17,000, respectively. In
addition, this individual earned wages of $30,000 during the three months ended
October 31, 2006. During the three months ended October 31, 2006 and 2005,
we
paid a director legal and consulting fees of $6,000 and $0,
respectively.
The
Company’s V.P. Development and Director has, since 1995, been a senior
consultant in the Minerals Advisory Group LLC, Tucson, Arizona, an entity that
provided $3,000 for services to the Company for the three months ended October
31, 2006.
In
January 2006, the Company extended the following stock options through January
3, 2007, all of which are exercisable at $0.05 per share: Chief Executive
Officer and Director - 1,250,000 shares; Director - 500,000 shares; V.P.
Investor Relations and Director - 327,727 shares; V.P. Development and Director
- 500,000 shares; and V.P. Mine Development - 25,000 shares.
There
was not a material increase in the intrinsic value of these options at the
date
of modification as compared to the intrinsic value of the original issuance
of
these stock options on the applicable measurement date.
NOTE
12 -
Stockholders' Equity
Common
Stock
At
various stages in the Company’s development, shares of the Company’s common
stock have been issued at fair market value in exchange for services or property
received with a corresponding charge to operations, property and equipment
or
additional paid-in capital depending on the nature of the services provided
or
property received.
During
the year ended July 31, 2006, the Company issued 4,825,913 shares of stock
upon
the exercising of common stock purchase warrants and options for net proceeds
of
$741,820, including 200,000 and 300,000 shares to its CEO and V.P. Mine
Development for net proceeds of $10,000 and $15,000, respectively. The Company
has also issued 1,000,000 shares of Common Stock (See Note 13) in connection
with receiving a commitment letter from Standard Bank informing the Company
of
its approval for providing a $12 million (now $12.5 million) senior financing
facility.
The
Company closed two private placements in 2006 pursuant to which the Company
issued an aggregate of 21,240,000 units, each unit consisting of one share
of
the Company’s common stock and a warrant to purchase ¼ of a share of the
Company’s common stock for net proceeds of $4,999,500, net of commissions of
$310,500. The Company also received net proceeds of $2,373,600, net of
commissions of $206,430, from the exercising of 8,600,000 warrants in February
2006. The Warrant issued to each purchaser is exercisable for one share of
the
Company’s common stock, at an exercise price equal to $0.30 per share. Each
Warrant has a term of eighteen months and is fully exercisable from the date
of
issuance. The Company issued to the placement agent in one of the placements
eighteen month warrants to purchase up to 934,000 shares of the Company’s common
stock at an exercise price of $0.25 per share. Such placement agent warrants
are
valued at approximately $189,000 using the Black-Scholes option pricing method.
The
Company issued 1,150,000 shares of common stock and 12,600,000 common stock
purchase warrants to Standard Bank as part of a commitment fee to entering
into
the credit facility on August 15, 2006, with its wholly-owned subsidiaries
MSR
and Oro. The Company recorded the issuance of the 1,150,000 shares of common
stock and 12,600,000 warrants as deferred financing costs of approximately
$351,000 and $3,314,000, respectively, as a reduction of stockholders' equity
on
the Company's balance sheet. The issuance of 1,150,000 shares was recorded
at
the fair market value of the Company's common stock at the closing date or
$0.305 per share. The warrants were valued at approximately $3,314,000 using
the
Black-Scholes option pricing model and were reflected as deferred financing
costs as a reduction of stockholders' equity on the Company’s balance sheet (See
Note 13). The balance of deferred financing costs net of amortization as of
October 31, 2006, as a reduction of stockholders' equity, was approximately
$4,136,000. Amortization expense for the three months ended October 31, 2006,
was $60,000.
Recapitalization
On
September 22, 2005, The Board of Directors recommended an amendment to the
Company's Certificate of Incorporation to increase the Company's authorized
shares of capital stock from 150,000,000 to 200,000,000 shares. In addition,
the
Board of Directors recommended that the Company reincorporate in the State
of
Delaware. These amendments were approved by the stockholders on November 18,
2005 and the Company effected the reincorporation in Delaware and the authorized
share increase on November 21, 2005. In addition, the par value was decreased
from $0.001 per share to $0.0001 per share.
Warrant
Re-pricing
In
December 2005, the Board of Directors ratified the temporary re-pricing of
certain warrants that were issued in connection with the February 2005 private
placement from $0.30 per share to $0.20 per share exercise price. In addition,
warrants issued to the placement agent were also re-priced from $0.25 per share
to $0.20 per share exercise price. These re-pricings were in effect for the
period November 28, 2005 through January 31, 2006.
Rights
Agreement
On
August
14, 2006, the Board of Directors (the "Board") of the Company declared a cash
dividend (the "Dividend") of one Series B common share purchase right (a
"Right") for each outstanding share of common stock, par value $.0001 per share.
Each Right represents the right to purchase one one-thousandth of Series B
Share. The Dividend is payable to holders of record on August 14, 2006. In
connection with the Dividend, the Company entered into a Rights Agreement with
American Stock Transfer & Trust Company as Rights Agent (the "Rights
Agreement"), specifying the terms of the Rights. The Rights will impose a
significant penalty upon any person or group that acquires beneficial ownership
of 20% or more of the Company's outstanding common stock without the prior
approval of the Board. The Rights Agreement provides an exemption for any person
who is, as of August 15, 2006, the beneficial owner of 20% or more of the
Company’s outstanding common stock, so long as such person does not, subject to
certain exceptions, acquire additional shares of the Company’s common stock
after that date. The Rights Agreement will not interfere with any merger or
other business combination approved by the Board. The Rights Agreement is
subject to approval by its stockholders.
NOTE
13 -
Project Finance Facility
On
August
15, 2006, the Company entered into a credit agreement (the “Credit Agreement”)
involving its wholly-owned subsidiaries MSR and Oro, as borrowers, us, as
guarantor, and Standard Bank plc (“Standard Bank”), as the lender and the
offshore account holder. Under the Credit Agreement, MSR and Oro have agreed
to
borrow money in an aggregate principal amount of up to US$12.5 million (the
“Loan”) for the purpose of constructing, developing and operating our El Chanate
Project (the “Mine”). The Company is guaranteeing the repayment of the loan and
the performance of the obligations under the Credit Agreement. The Loan is
scheduled to be repaid in fourteen quarterly payments with the first principal
payment due after certain Mine start-up production and performance criteria
are
satisfied, which the Company believes it will occur in the first calendar
quarter of 2008. The Loan bears interest at LIBOR plus 4.00%, with LIBOR
interest periods of 1, 2, 3 or 6 months and with interest payable at the end
of
the applicable interest period.
The
Credit Agreement contains covenants customary for a project financing loan,
including but not limited to restrictions (subject to certain exceptions) on
incurring additional debt, creating liens on its property, disposing of any
assets, merging with other companies and making any investments. The Company
is
required to meet and maintain certain financial covenants, including (i) a
debt
service coverage ratio of not less than 1.2 to 1.0, (ii) a projected debt
service coverage ratio of not less than 1.2 to 1.0, (iii) a loan life coverage
ratio of at least 1.6 to 1.0, (iv) a project life coverage ratio of at least
2.0
to 1.0 and (v) a minimum reserve tail. The Company is also required to maintain
a certain minimum level of unrestricted cash, and upon meeting certain Mine
start-up production and performance criteria, MSR and Oro will be required
to
maintain a specified amount of cash as a reserve for debt
repayment.
The
Loan
is secured by all of the tangible and intangible assets and property owned
by
MSR and Oro pursuant to the terms of a Mortgage Agreement, a Non-Possessory
Pledge Agreement, an Account Pledge Agreement and certain other agreements
entered into in Mexico (the “Mexican Collateral Documents”). As additional
collateral for the Loan, the Company, together with its subsidiary, Leadville
Mining & Milling Holding Corporation, have pledged all of its ownership
interest in MSR and Oro. In addition to these collateral arrangements, MSR
and
Oro are required to deposit all proceeds of the Loan and all cash proceeds
received from operations and other sources in an offshore, controlled account
with Standard Bank. Absent a default under the loan documents, MSR and Oro
may
use the funds from this account for specific purposes such as approved project
costs and operating costs.
As
part
of the fee for entering into and closing the Credit Agreement, the Company
issued to Standard Bank 1,150,000 shares of its restricted common stock and
a
warrant for the purchase of 12,600,000 shares of our common stock at an exercise
price of $0.317 per share, expiring on the earlier of (a) December 31, 2010
or
(b) the date one year after the repayment of the Credit Agreement. Previously,
pursuant to the mandate and commitment letter for the facility, the Company
issued to Standard Bank 1,000,000 shares of its restricted common stock and
a
warrant for the purchase of 1,000,000 shares of its common stock at an exercise
price of $0.32 per share, expiring on the earlier of (a) December 31, 2010
or
(b) the date one year after the repayment of the Credit Agreement. The Company
recorded the issuance of the 1,000,000 shares of common stock as deferred
financing costs of approximately $270,000 as a reduction of stockholders' equity
on its balance sheet. The issuance of these shares was recorded at the fair
market value of the Company’s common stock at the commitment letter date or
$0.27 per share. In addition, the warrants were valued at approximately $253,000
using the Black-Scholes option pricing model and were reflected as deferred
financing costs as a reduction of stockholders' equity on the Company’s balance
sheet in 2006. The Company registered for public resale the 2,150,000 shares
issued to Standard Bank and the 13,600,000 shares issuable upon exercise of
warrants issued to Standard Bank.
In
March
2006, The Company entered into a gold price protection arrangement with Standard
Bank to protect us against future fluctuations in the price of gold. The Company
agreed to a series of gold forward sales and call option purchases in
anticipation of entering into the Credit Agreement. Under the price protection
agreement, the Company has agreed to sell a total volume of 121,927 ounces
of
gold forward to Standard Bank at a price of $500 per ounce on a quarterly basis
during the period from March 2007 to September 2010. The Company will also
purchase call options from Standard Bank on a quarterly basis during this same
period covering a total volume of 121,927 ounces of gold at a price of $535
per
ounce. The Company paid a fee to Standard Bank in connection with the price
protection agreement. In addition, we provided aggregate cash collateral of
approximately $4.3 million to secure our obligations under this agreement.
The
cash collateral was returned to us after the Credit Agreement was executed
in
August 2006.
On
October 11, 2006, The Company completed the initial draw down on our credit
facility from Standard Bank receiving proceeds of $1,250,000. The Company used
these proceeds for the repurchase of the 5% net profits interest formerly held
by FG and to continue the mine development at the El Chanate Project (See Note
17 “Subsequent Events” for additional information on draw downs).
On
October 11, 2006, prior to the Company’s initial draw on the Credit Facility,
the Company entered into interest rate swap agreements in accordance with the
terms of the Credit Facility, which requires that the Company hedge at least
50
percent of our outstanding debt under this facility. The agreements entered
into
cover $9,375,000 or 75% of the outstanding debt. Both swaps covered this same
notional amount of $9,375,000, but over different time horizons. The first
covered the six months commencing October 11, 2006 and a termination date of
March 31, 2007 and the second covering the period from March 30, 2007 with
a
termination date of December 31, 2010. We intend to use discretion in
managing this risk as market conditions vary over time, allowing for the
possibility of adjusting the degree of hedge coverage as we deem appropriate.
However, any use of interest rate derivatives will be restricted to use for
risk
management purposes (See Note 16).
NOTE
14 -
Mining and Engineering Contracts
In
early
December 2005, the Company’s wholly-owned Mexican subsidiary, MSR, which holds
the rights to develop and mine El Chanate Project, entered into a Mining
Contract with a Mexican mining contractor, Sinergia Obras Civiles y Mineras,
S.A. de C.V,("Sinergia"). The Mining Contract becomes effective if and when
MSR
sends the Contractor a formal "Notice of Award".
On
August
2, 2006, the Company amended the November 24, 2005 Mining Contract between
its
subsidiary, MSR, and Sinergia. Pursuant to the amendment, MSR's right to deliver
the Notice to Proceed to Sinergia is extended to November 1, 2006. Provided
that
this Notice is delivered to Sinergia on or before that date, with a specified
date of commencement of the Work (as defined in the contract) not later than
February 1, 2007, the mining rates set forth in the Mining Contract will still
apply; subject to adjustment for the rate of inflation between
September 23, 2005 and the date of commencement of the work. As
consideration for these changes, the Company paid Sinergia $200,000 of the
requisite advance payment discussed below. On November 1, 2006, MSR delivered
the Notice of Award specifying January 25, 2007, as the date of commencement
of
Work.
Pursuant
to the Mining Contract, Sinergia, using its own equipment, will generally
perform all of the mining work (other than crushing) at the El Chanate Project
for the life of the mine. Subsequent to delivery of the Notice to Proceed and
prior to the commencement of any work by Sinergia, MSR must pay Sinergia a
mobilization payment of $70,000, and must also make an advance payment of
$520,000 to Sinergia (all of which has already been advanced). The advance
payments are recoverable by MSR out of 100% of subsequent payments due to
Sinergia under the Mining Contract. Pursuant to the Mining Contract, upon
termination, Sinergia would be obligated to repay any portion of the advance
payment that had not yet been recouped. Sinergia’s mining rates are subject to
escalation on an annual basis. This escalation is tied to the percentage
escalation in Sinergia’s costs for various parts for its equipment, interest
rates and labor. One of the principals of Sinergia is one of the former
principals of FG. FG was our former joint venture partner.
In
June
2006, the Company's Mexican operating subsidiary retained the contracting
services of Mexican subsidiary of M3 Engineering & Technology Corporation
("M3M") to provide EPCM (engineering procurement construction management)
services. M3M will supervise the construction and integration of the various
components necessary to commence production at the El Chanate Project. The
contracted services shall not exceed $1,200,000 and the contract is based on
the
EPCM services to be provided by M3M. As of October 31, 2006, the Company has
incurred approximately $346,000 pursuant to this contract.
NOTE
15 -
Employee and Consulting Agreements
On
March
1, 2006, the Company entered into a consulting agreement with Christopher
Chipman pursuant to which the Company has retained Mr. Chipman as its Chief
Financial Officer. Pursuant to the Agreement with Mr. Chipman, Mr. Chipman
devotes approximately 50% of his time to the Company's business. He receives
a
monthly fee of $7,500 and he was issued two year options to purchase an
aggregate of 50,000 shares of the Company's common stock at an exercise price
of
$.34 per share. The options will vest at the rate of 10,000 shares per month
during the initial period of his engagement. Notwithstanding the foregoing,
the
options are not exercisable unless and until the issuance of the options is
approved by the Company's stockholders. The agreement runs for an initial one
year period, and is renewable thereafter for an additional year. The Company
can
terminate the agreement at any time; however, if the Company terminates the
agreement other than for cause (as defined in the agreement), the Company is
required to pay Mr. Chipman the fees otherwise due and payable to him through
the last day of the then current term of the Agreement or six months from such
termination, which ever is shorter. Mr. Chipman can terminate the Agreement
on
30 days notice. On September 1, 2006, the Company amended its consulting
agreement with its Chief Financial Officer. Pursuant to the agreement, the
Company’s Chief Financial Officer devotes approximately 50% of his time to our
business. He receives a monthly fee of $10,000. The agreement runs for an
initial one year period, and is renewable thereafter for an additional year.
He
can terminate the Agreement on 60 days notice. In conjunction with the amended
consulting agreement, the Company entered into a change of control agreement
similar to the agreements entered into with other executive officers; except
that the Company’s CFO agreement renews annually and his benefits are based upon
one times his base annual fee.
On
May
12, 2006, the Company entered into an employment agreement with John Brownlie,
pursuant to which Mr. Brownlie serves as Vice President Operations. Mr. Brownlie
receives a base annual salary of $150,000 and is entitled to annual bonuses.
Upon his employment, he received options to purchase an aggregate of 200,000
shares of the Company’s common stock at an exercise price of $.32 per share.
50,000 options vested immediately and the balance vest upon the Company
achieving "Economic Completion" as that term is defined in the loan agreement
with Standard Bank plc (when the Company has commenced mining operations and
has
been operating at anticipated capacity for 60 to 90 days). The term of the
options is two years from the date of vesting. The agreement runs for an initial
two year period, and automatically renews thereafter for additional one year
periods unless terminated by either party within 30 days of a renewal date.
The
Company can terminate the agreement for cause or upon 30 days notice without
cause. Mr. Brownlie can terminate the agreement upon 60 days notice without
cause or, if there is a breach of the agreement by the Company that is not
timely cured, upon 30 days notice. In the event that the Company terminates
him
without cause or he terminates due to the Company’s breach, he will be entitled
to certain severance payments. The Company utilized the Black-Scholes method
to
fair value the 200,000 options received by Mr. Brownlie. The Company recorded
approximately $70,000 as deferred compensation expense as of the date of the
agreement and recorded the vested portion or $17,500 as stock compensation
expense for the year ended July 31, 2006.
Effective
July 31, 2006, the last day of the Company’s fiscal year, the Company entered
into employment agreements with the following executive officers: Gifford A.
Dieterle, the Company’s President and Treasurer, Roger A. Newell, the Company’s
Vice President of Development, Jack V. Everett, the Company’s Vice President of
Exploration, and Jeffrey W. Pritchard, the Company’s Vice President of Investor
Relations.
The
agreements run for a period of three years and automatically renew for
successive one-year periods unless the Company or the executive provides the
other party with written notice of the Company’s or his intent not to renew at
least 30 days prior to the expiration of the then current employment
period.
Mr.
Dieterle is entitled to a base annual salary of at least $180,000 and each
of
the other executives is entitled to a base annual salary of at least $120,000.
Each executive is entitled to a bonus or salary increase in the sole discretion
of the Company’s board of directors. In addition, each of the executives
received two year options to purchase an aggregate of 250,000 shares of the
Company’s common stock at an exercise price of $0.32 per share (the closing
price on July 31, 2006). The Company utilized the Black-Scholes method to fair
value the 1,000,000 options received by the executives as part of these
employment agreements. The Company recorded approximately $204,000 as stock
compensation expense as of July 31, 2006.
The
Company has the right to terminate any executive's employment for cause or
on 30
days' prior written notice without cause or in the event of the executive's
disability (as defined in the agreements). The agreements automatically
terminate upon an executive's death. "Cause" is defined in the agreements as
(1)
a failure or refusal to perform the services required under the agreement;
(2) a
material breach by executive of any of the terms of the agreement; or (3)
executive's conviction of a crime that either results in imprisonment or
involves embezzlement, dishonesty, or activities injurious to the Company or
the
Company’s reputation. In the event that the Company terminates an executive's
employment without cause or due to the disability of the executive, the
executive will be entitled to a lump sum severance payment equal to one month's
salary, in the case of termination for disability, and up to 12 month's salary
(depending upon years of service), in the case of termination without
cause.
Each
executive has the right to terminate his employment agreement on 60 days' prior
written notice or, in the event of a material breach by us of any of the terms
of the agreement, upon 30 days' prior written notice. In the event of a claim
of
material breach by us of the agreement, the executive must specify the breach
and the Company’s failure to either (i) cure or diligently commence to cure the
breach within the 30 day notice period, or (ii) dispute in good faith the
existence of the material breach. In the event that an agreement terminates
due
to the Company’s breach, the executive is entitled to severance payments in
equal monthly installments beginning in the month following the executive's
termination equal to three month' salary plus one additional month's salary
for
each year of service to us. Severance payments cannot exceed 12 month's
salary.
In
conjunction with the employment agreements, the Company’s board of directors
deeming it essential to the best interests of the Company’s stockholders to
foster the continuous engagement of key management personnel and recognizing
that, as is the case with many publicly held corporations, a change of control
might occur and that such possibility, and the uncertainty and questions which
it might raise among management, might result in the departure or distraction
of
management personnel to the detriment of the company and the Company’s
stockholders, determined to reinforce and encourage the continued attention
and
dedication of members of the Company’s management to their engagement without
distraction in the face of potentially disturbing circumstances arising from
the
possibility of a change in control of the company, the Company entered into
identical agreements regarding change in control with the executives. Each
of
the agreements regarding change in control continues through December 31, 2009
and extends automatically to the third anniversary thereof unless the Company
gives notice to the executive prior to the date of such extension that the
agreement term will not be extended. Notwithstanding the foregoing, if a change
in control occurs during the term of the agreements, the term of the agreements
will continue through the second anniversary of the date on which the change
in
control occurred. Each of the agreements entitles the executive to change of
control benefits, as defined in the agreements and summarized below, upon his
termination of employment with us during a potential change in control, as
defined in the agreements, or after a change in control, as defined in the
agreements, when his termination is caused (1) by us for any reason other than
permanent disability or cause, as defined in the agreement (2) by the executive
for good reason as defined in the agreements or, (3) by the executive for any
reason during the 30 day period commencing on the first date which is six months
after the date of the change in control. Each executive would receive a lump
sum
cash payment of three times his base salary and outplacement benefits. Each
agreement also provides that the executive is entitled to a payment to make
him
whole for any federal excise tax imposed on change of control or severance
payments received by him.
NOTE
16 -
Sales Contracts, Commodity and Financial Instruments
In
March
2006, the Company entered into two identically structured derivative contracts
with Standard Bank (See Note 13). Each derivative consisted of a series of
forward sales of gold and a purchase gold cap. The Company agreed to sell a
total volume of 121,927 ounces of gold forward to Standard Bank at a price
of
$500 per ounce on a quarterly basis during the period from March 2007 to
September 2010. The Company also agreed to a purchase gold cap on a quarterly
basis during this same period and at identical volumes covering a total volume
of 121,927 ounces of gold at a price of $535 per ounce. Under FASB Statement
No.
133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133"),
these contracts must be carried on the balance sheet at their fair value, with
changes to the fair value of these contracts reflected as Other Income or
Expense. These contracts were not designated as hedging derivatives; and
therefore, special hedge accounting does not apply.
The
first
derivative was entered into on March 1, 2006 for a premium of $550,000; and
the
second was entered into on March 30, 2006 for a premium of $250,000. The gold
price rose sharply during the period March 1, 2006 through July 31, 2006 and
was
the primary reason for the decrease in premium on the derivative contracts.
As
of October 31, 2006, the carrying value of this derivative liability was
approximately $24,000. The change in fair value on these derivative contracts
was approximately $242,000 for the three months ended October 31, 2006, and
was
recorded as an other expense.
On
October 11, 2006, prior to the Company’s initial draw on the Credit Facility,
the Company entered into interest rate swap agreements in accordance with the
terms of the Credit Facility, which requires that the Company hedge at least
50
percent of the Company’s outstanding debt under this facility. The agreements
entered into cover $9,375,000 or 75% of the outstanding debt. Both swaps covered
this same notional amount of $9,375,000, but over different time horizons.
The
first covered the six months commencing October 11, 2006 and a termination
date
of March 31, 2007 and the second covering the period from March 30, 2007 and
a
termination date of December 31, 2010. The Company intends to use
discretion in managing this risk as market conditions vary over time, allowing
for the possibility of adjusting the degree of hedge coverage as the Company
deems appropriate. However, any use of interest rate derivatives will be
restricted to use for risk management purposes.
The
Company uses variable-rate debt to finance a portion of the El Chanate Project.
Variable-rate debt obligations expose the Company to variability in interest
payments due to changes in interest rates. As a result of these arrangements,
the Company will continuously monitor changes in interest rate exposures and
evaluate hedging opportunities. The Company’s risk management policy permits it
to use any combination of interest rate swaps, futures, options, caps and
similar instruments, for the purpose of fixing interest rates on all or a
portion of variable rate debt, establishing caps or maximum effective interest
rates, or otherwise constraining interest expenses to minimize the variability
of these effects.
The
interest rate swap agreements are accounted for as cash flow hedges, whereby
“effective” hedge gains or losses are initially recorded in other comprehensive
income and later reclassified to the interest expense component of earnings
coincidently with the earnings impact of the interest expenses being hedged.
“Ineffective” hedge results are immediately recorded in earnings also under
interest expense. No component of hedge results will be excluded from the
assessment of hedge effectiveness. The amount expected to be reclassified from
OCI to earnings during the 12 months ending July 31 2007 from these two swaps
was determined to be immaterial. As of October 31, 2006, the Company recorded
$91,643 as a derivative liability with the offset going to other comprehensive
income.
The
Company is exposed to credit losses in the event of non-performance by
counterparties to these interest rate swap agreements, but the Company does
not
expect any of the counterparties to fail to meet their obligations. To manage
credit risks, the Company selects counterparties based on credit ratings, limits
its exposure to a single counterparty under defined guidelines, and monitor
the
market position with each counterparty as required by
SFAS 133.
NOTE
17 -
Subsequent Events
On
November 1, 2006, and December 1, 2006, the Company completed the second and
third draw down on its credit facility from Standard Bank receiving proceeds
of
$3,500,000 and $2,250,000, respectively. The Company is using and anticipates
using these proceeds mainly for the remaining balances on the Crushing and
conveyor system purchase orders and site work for the leach pad and ponds at
its
El Chanate Project.
On
November 30, 2006, the Company’s board of directors granted 100,000 common stock
options to each of John Postle, Ian A. Shaw and Mark T. Nesbitt, the Company’s
independent directors. The options are to purchase shares of the Company’s
common stock at an exercise price of $0.33 per share (the closing price of
our
common stock on that date) for a period of two years. The options cannot be
exercised unless and until they have been approved by our stockholders. The
Company utilized the Black-Scholes method to fair value the 300,000 options
received by the directors. The Company will record approximately $52,800 as
stock compensation expense in the following fiscal quarter ended January 31,
2007.
On
December 5, 2006, effective January 1, 2007, the Company entered into an
employment agreement with J. Scott Hazlitt, its Vice President of Mine
Development. The agreement runs for a period of three years and automatically
renews for successive one-year periods unless the Company or Mr. Hazlitt
provides the other party with written notice of the Company’s or his intent not
to renew at least 30 days prior to the expiration of the then current employment
period. Mr. Hazlitt is entitled to a base annual salary of at least $105,000.
He
is entitled to a bonus or salary increase in the sole discretion of our board
of
directors. The Company has the right to terminate Mr. Hazlitt’s employment for
cause or on 30 days’ prior written notice without cause or in the event of his
disability (as defined in the agreement). The agreement automatically terminates
upon his death. “Cause” is defined in the agreement as (1) a failure or refusal
to perform the services required under the agreement; (2) a material breach
by
executive of any of the terms of the agreement; or (3) executive’s conviction of
a crime that either results in imprisonment or involves embezzlement,
dishonesty, or activities injurious to us or our reputation. In the event that
we terminate his employment without cause or due to the disability of the
executive, the executive will be entitled to a lump sum severance payment equal
to one month’s salary, in the case of termination for disability, and up to 12
month’s salary (depending upon years of service), in the case of termination
without cause.
Mr.
Hazlitt has the right to terminate his employment agreement on 60 days’ prior
written notice or, in the event of a material breach by the Company of any
of
the terms of the agreement, upon 30 days’ prior written notice. In the event of
a claim of material breach by the Company of the agreement, he must specify
the
breach and the Company’s failure to either (i) cure or diligently commence to
cure the breach within the 30 day notice period, or (ii) dispute in good faith
the existence of the material breach. In the event that an agreement terminates
due to the Company’s breach, Mr. Hazlitt is entitled to severance payments in
equal monthly installments beginning in the month following his termination
equal to three month’ salary plus one additional month’s salary for each year of
service to us. Severance payments cannot exceed 12 month’s salary.
In
conjunction with the employment agreement, the Company’s board of directors
deemed it essential to the best interests of the Company’s stockholders to
foster the continuous engagement of key management personnel and recognizing
that, as is the case with many publicly held corporations, a change of control
might occur and that such possibility, and the uncertainty and questions which
it might raise among management, might result in the departure or distraction
of
management personnel to the detriment of the company and its stockholders,
determined to reinforce and encourage the continued attention and dedication
of
members of the Company’s management to their engagement without distraction in
the face of potentially disturbing circumstances arising from the possibility
of
a change in control of our company, the Company entered into an agreement
regarding change in control with Mr. Hazlitt identical to the agreements entered
into with its other executives. The agreement regarding change in control
continues through December 31, 2010 and extends automatically to the third
anniversary thereof unless the Company gives notice to Mr. Hazlitt prior to
the
date of such extension that the agreement term will not be extended.
Notwithstanding the foregoing, if a change in control occurs during the term
of
the agreement, the term of the agreement will continue through the second
anniversary of the date on which the change in control occurred. The agreement
entitles Mr. Hazlitt to change of control benefits, as defined in the agreement
and summarized below, upon his termination of employment with us during a
potential change in control, as defined in the agreement, or after a change
in
control, as defined in the agreement, when his termination is caused (1) by
the
Company for any reason other than permanent disability or cause, as defined
in
the agreement (2) by Mr. Hazlitt for good reason as defined in the agreement
or,
(3) by Mr. Hazlitt for any reason during the 30 day period commencing on the
first date which is six months after the date of the change in control. Mr.
Hazlitt would receive a lump sum cash payment of three times his base salary
and
outplacement benefits. The agreement also provides that Mr. Hazlitt is entitled
to a payment to make him whole for any federal excise tax imposed on change
of
control or severance payments received by him.
On
December 13, 2006, subsequent to the end of the quarter, the Company issued
two
year options to purchase our common stock at an exercise price of $0.36 per
share to its V.P. of Operations and CFO and the Company’s Canadian counsel.
These options are for the purchase of 250,000 shares, 100,000 shares and 100,000
shares, respectively. These
options cannot be exercised unless and until they are approved by the Toronto
Stock Exchange and Stockholders.
On
December 13, 2006, the Company’s Board of Directors adopted the 2006 Equity
Incentive Plan. Stockholder approval of the plan will be sought at the Annual
Meeting. The Equity Incentive Plan authorizes the grant of non-qualified and
incentive stock options, stock appreciation rights and restricted stock awards
(each, an “Awards”). A maximum of 10,000,000 shares of common stock will be
reserved for potential issuance pursuant to Awards under the Equity Incentive
Plan. Unless sooner terminated, the Equity Incentive Plan will continue in
effect for a period of 10 years from its effective date. The Equity Incentive
Plan is administered by the Board of Directors or a committee thereof. The
Equity Incentive Plan provides for awards to be made to such employees,
directors and consultants of the Company and its affiliates as the Board may
select. As of the date hereof, 450,000 options have been granted under the
Equity Incentive Plan to two of the Company’s officers and its Canadian counsel.
These options cannot be exercised unless and until they are approved by the
Toronto Stock Exchange and Stockholders.
NOTE
18 -
Deposits
Deposits
are classified as current assets and represent payments made on mining equipment
for the Company’s El Chanate Project in Sonora, Mexico. Deposits are summarized
as follows:
|
|
October
31,
|
|
|
|
2006
|
|
Advance
payment on Mining Contract to Sinergia
|
|
$
|
520,000
|
|
Crushing
system
|
|
|
923,370
|
|
Laboratory
Building & Equipment
|
|
|
150,000
|
|
Other
|
|
|
85,740
|
|
Total
Deposits
|
|
$
|
1,679,110
|
|
NOTE
19 -
New Accounting Pronouncements
In
February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid
Financial Instruments” (“FAS 155”) - an amendment of FASB Statements
No. 133 and 140. FAS 155 amends SFAS No. 133, “Accounting for Derivative
Instruments and Hedging Activities” (“FAS 133”), and SFAS No. 140 (“FAS 140”),
“Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities”, to permit fair value re-measurement of any hybrid financial
instrument that contains an embedded derivative that would otherwise require
bifurcation. Additionally, FAS 155 seeks to clarify which interest-only strips
and principal-only strips are not subject to the requirements of FAS 133 and
to
clarify that concentrations of credit risk in the form of subordination are
not
embedded derivatives. This Statement is effective for all financial instruments
acquired or issued after the beginning of an entity’s first fiscal year that
begins after September 15, 2006. Management does not believe the adoption
of this standard will have a material impact on the financial condition or
the
results of operations of the Company.
On
July
13, 2006, the Financial Accounting Standards Board issued Interpretation No.
48,
"Accounting for Uncertainty in Income Taxes" (“FIN 48”). The requirements are
effective for fiscal years beginning after December 15, 2006. The purpose
of FIN 48 is to clarify and set forth consistent rules for accounting for
uncertain tax positions in accordance with Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes". The cumulative effect of
applying the provisions of this interpretation are required to be reported
separately as an adjustment to the opening balance of retained earnings in
the
year of adoption. Management does not believe the adoption of this standard
will
have a material impact on the financial condition or the results of operations
of the Company.
Cautionary
Statement on Forward-Looking Statements
Certain
statements in this report constitute “forwarding-looking statements” within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities and Exchange Act of 1934. Certain, but not necessarily all, of such
forward-looking statements can be identified by the use of forward-looking
terminology such as “believes,” “expects,” “may,” “will,” “should,” or
“anticipates” or the negative thereof or other variations thereon or comparable
terminology, or by discussions of strategy that involve risks and uncertainties.
All statements other than statements of historical fact, included in this report
regarding our financial position, business and plans or objectives for future
operations are forward-looking statements. Without limiting the broader
description of forward-looking statements above, we specifically note that
statements regarding exploration and mine development and construction plans,
costs, grade, production and recovery rates, permitting, financing needs, the
availability of financing on acceptable terms or other sources of funding,
and
the timing of additional tests, feasibility studies and environmental permitting
are all forward-looking in nature.
Such
forward-looking statements involve known and unknown risks, uncertainties and
other factors, including but not limited to, the factors discussed below in
“Risk Factors,” which may cause our actual results, performance or achievements
to be materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements and other factors
referenced in this report. We do not undertake and specifically decline any
obligation to publicly release the results of any revisions which may be made
to
any forward-looking statement to reflect events or circumstances after the
date
of such statements or to reflect the occurrence of anticipated or unanticipated
events.
Results
of Operations
General
Sonora,
Mexico
During
and subsequent to the quarter ended October 31, 2006, we continued to make
progress towards commencement of mining operations at the El Chanate concessions
in Mexico. In this regard, as discussed in greater detail below and in Part
II,
Item 5, during and subsequent to the end of the quarter:
Through
a
wholly-owned subsidiary and an affiliate, Capital Gold Corporation owns 100%
of
16 mining concessions located in the Municipality of Altar, State of Sonora,
Republic of Mexico totaling approximately 3,544 hectares (8,756 acres or 13.7
square miles). We are in the process of constructing and developing an open-pit
gold mining operation to mine two of these concessions. We sometimes refer
to
the planned operations on these two concessions as the El Chanate
Project.
We
plan
to construct a surface gold mine and facility at El Chanate capable of producing
about 2.6 million metric tons per year of ore from which we anticipate
recovering about 44,000 to 48,000 ounces of gold per year, over a seven year
mine life. We are following the updated feasibility study (the “2005 Study”) for
the El Chanate Project prepared by M3 Engineering of Tucson, Arizona which
was
completed in October 2005, as further updated by an August 2006 technical report
from SRK Consulting, Denver, Colorado (the “2006 Update”). The original
feasibility study (the “2003 Study”) was completed by M3 Engineering in August
2003. Since completion of the 2003 Study, both the price of gold and production
costs have increased and equipment choices have broadened from those identified
in the 2003 Study.
The
2005
Study includes the following changes from the 2003 Study:
·
|
an
increase in the mine life from five to six
years,
|
·
|
an
increase in the base gold price from $325/oz to
$375/oz,
|
·
|
use
of a mining contractor,
|
·
|
revised
mining, processing and support
costs,
|
·
|
stockpiling
of low grade material for possible processing in year six, if justified
by
gold prices at that time,
|
·
|
a
reduced size for the waste rock dump and revised design of reclamation
waste dump slopes,
|
·
|
a
revised process of equipment selection
and
|
·
|
evaluation
of the newly acquired water well for processing the
ore.
|
In
view
of a significant rise in the gold price, in June 2006, we commissioned SRK
Consulting, Denver, Colorado, to prepare an updated Canadian Securities
Administration National Instrument 43-101 compliant technical report on our
El
Chanate Project. SRK completed this technical report in August 2006 (the “2006
Update”). The 2006 Update provided the following updated information from the
2005 Study:
·
|
a
33% increase in proven and probable gold
reserves,
|
·
|
an
increase in mine life from six to seven
years,
|
·
|
an
increase in the base gold price from $375/oz to $450/oz
and
|
·
|
Stockpiling
of low grade material for possible processing in year seven, if justified
by gold prices at that time.
|
Pursuant
to the 2005 Study, as updated by the 2006 Update using a $450 per ounce gold
price, our estimated mine life is now seven years as opposed to five years
and
the ore reserve is 490,000 ounces of gold present in the ground (up 122,000
ounces or 33%). Of this, we anticipate recovering approximately 332,000 ounces
of gold (up 74,000 ounces or 29%) over a seven year life of the mine. The
targeted cash cost (which include mining, processing and on-property general
and
administrative expenses) per the 2005 Study is $259 per ounce (up $29 per
ounce). The 2005 Study contains the same mining rate as the 2003 Study of 7,500
metric tonnes per day of ore. It should be noted that, during the preliminary
engineering phase of the project it was decided to design the crushing screening
and ore stacking system with the capability of processing 10,000 tonnes per
day
of ore. This will make allowances for any possible increase in production and
for operational flexibility. It was found that the major components in the
feasibility study would be capable of handling the increase in tonnage. Design
changes were made where necessary to accommodate the increased tonnage. The
2005
Study takes into consideration a more modern crushing system than the one
contemplated in the 2003 Study. The crushing system referred to in the 2005
Study is a new system, that, we believe will be faster to install and provide
more efficient processing capabilities than the used equipment referred to
in
the 2003 Study. In March 2006, we made a $250,000 down payment to a US Supplier
to acquire a portion of a new crushing system. In October 2006, we paid an
additional $230,000 towards this equipment and we now have purchase orders
for
all of the new crushing system.
The
2005
Study assumes a mining production rate of 2.6 million tonnes of ore per year
or
7,500 tonnes per day. The processing plant will operate 365 days per year.
The
processing plan for this open pit heap leach gold project calls for crushing
the
ore to 100% minus 3/8 inch. Carbon columns will be used to recover the
gold.
The
following Summary is extracted from the 2005 Study, as updated by the 2006
Update. Please note that the reserves as stated are an estimate of what can
be
economically and legally recovered from the mine and, as such, incorporate
losses for dilution and mining recovery. The 489,952 ounces of contained gold
represents ounces of gold contained in ore in the ground, and therefore does
not
reflect losses in the recovery process. Total gold produced is estimated to
be
approximately 339,047 ounces, or approximately 69% of the contained gold. The
gold recovery rate is expected to average approximately 69% for the entire
ore
body. Individual portions of the ore body may experience varying recovery rates
ranging from about 73% to 48%. Oxidized and sandstone ore types may have
recoveries of about 73%; fault zone ore type recoveries may be about 64%; and
siltstone ore types recoveries may be about 48%.
El
Chanate Project
Production
Summary
|
Metric
|
U.S.
|
Materials
Reserves
Other
Mineralized Materials
Waste
Total
Contained
Gold
Production
Ore
Crushed
Operating
Days/Year
Gold
Plant Average Recovery
Average
Annual Production
Total
Gold Produced
|
19.9
Tonnes @ 0.767 g/t*
0
Million Tonnes
19.9
Million Tonnes
39.8
Million Tonnes
15.24
Million grams
2.6
Million Tonnes /Year
7,500
Mt/d*
365
Days per year
69.2
%
1.38
Million grams
10.55 Million grams
|
21.9
Million Tons @ 0.022 opt*
0
Million Tons
21.9
Million Tons
43.8
Million tons
489,952
Oz
2.86
Million Tons/Year
8,250
t/d
365
Days per year
69.2
%
44,395
Oz
339,047 Oz
|
*
“g/t”
means grams per metric tonne , “Mt/d means metric tonnes per day and “opt” means
ounces per ton.
Pursuant
to the 2005 Study, as updated by the 2006 Update, based on the current reserve
calculations, the mine life is estimated to be approximately seven years, and
at
least another year will likely be required to perform required reclamation.
The
2005 Study forecasts initial capital costs of $17.9 million, which includes
$1.7
million of working capital. Annual production is planned at approximately 44,000
to 48,000 ounces per year at an average operating cash cost of $259 per ounce.
We believe that cash costs may decrease as the production rate increases. Total
costs (which include cash costs as well as off-property costs such as property
taxes, royalties, refining, transportation and insurance costs and exclude
financing costs) will vary depending upon the price of gold (due to the nature
of underlying payment obligations to the original owner of the property). Total
costs are estimated in the 2005 Study to be $339 per ounce at a gold price
of
$417 per ounce (the three year average gold price as of the date of the study).
We will be working on measures to attempt to reduce costs going forward. Ore
reserves and production rates are based on a gold price of $375 per ounce,
which
is the Base Case in the 2005 Study. During 2005, the spot price for gold on
the
London Exchange has fluctuated between $411.10 and $537.50 per ounce. Between
January 1, 2006 and December 1, 2006, the spot price for gold on the London
Exchange has fluctuated between $524.75 and $725.00 per ounce.
Management
believes that the capital costs to establish a surface, heap leach mining
operation at El Chanate will be between $17.5 and $18.5 million. For more
information on the capital costs and our funding activities, please see
“Liquidity
and Capital Resources; Plan of Operation” below.
Leadville,
Colorado
We
own or
lease a number of claims and properties, all of which are located in California
Mining District, Lake County, Colorado, Township 9 South, Range 79. During
the
quarter ended October 31, 2006, activity at our Leadville, Colorado properties
consisted primarily of mine maintenance. Primarily as a result of our focus
on
El Chanate, we ceased activities in Leadville, Colorado. During the year ended
July 31, 2002, we performed a review of our Leadville mine and mill improvements
and determined that an impairment loss should be realized. Therefore, we
significantly reduced the carrying value of certain assets relating to our
Leadville, Colorado assets by $999,445. During the year ending July 31, 2004,
we
again performed a review of our Colorado mine and mill improvements and
determined that an additional impairment loss should be recognized. Accordingly,
we further reduced the net carrying value to $0, recognizing an additional
loss
of $300,000.
Three
Months Ended October 31, 2006 compared to Three Months Ended October 31,
2005
Net
Loss
Our
net
loss for the three months ended October 31, 2006 and 2005 was approximately
$1,161,000 and $813,000, respectively, an increase of approximately $348,000
or
43% from the three months ended October 31, 2005. The primary reason for the
increase in loss during the three months ended October 31, 2006 was due to
1) an
increase in selling, general and administrative expenses of approximately
$343,000 as compared to the same period a year ago and 2) losses of
approximately $242,000in the current period due to the change in fair value
of
our derivative instruments. These increases in loss were offset by a decrease
in
mine expenses due to higher planning and engineering costs being expensed in
the
prior period. Net loss per share was $0.01 and $0.01 for the three months ended
October 31, 2006 and 2005, respectively.
Revenues
We
generated no revenues from mining operations during the three months ended
October 31, 2006 and 2005. There were de minimis non-operating revenues during
the three months ended October 31, 2006 and 2005 of approximately $22,000 and
$25,000, respectively. These non-operating revenues primarily represent interest
income.
Mine
Expenses
Mine
expenses during the three months ended October 31, 2006 were $212,000, a
decrease of $328,000 or 61% from the three months ended October 31, 2005. Mine
expenses were lower in the current period versus the same period a year earlier
primarily due to higher engineering and planning costs related to our El Chanate
Project being expensed in the prior period.
Selling,
General and Administration Expense
Selling,
general and administrative expenses during the three months ended October 31,
2006 were $632,000, an increase of approximately $343,000 or 119% from the
three
months ended October 31, 2005. The increase in selling, general and
administrative expenses resulted primarily from higher salaries and wages,
higher professional and consulting fees related to investor relations, general
legal and accounting as well as an increase in stock compensation expense
incurred during the three months ended October 31, 2006 versus the same period
a
year earlier.
Depreciation
and Amortization
Depreciation
and amortization expense during the three months ended October 31, 2006 and
2005
was approximately $73,000 and $9,000, respectively. The primary reason for
the
increase was due to the initiation of amortization charges on deferred financing
costs resulting from the credit agreement entered into in August 2006 with
Standard Bank Plc. This accounted for approximately $60,000 of the increase
in
the current quarter versus the same period a year ago.
Other
Income and Expense
Our
loss
on the change in fair value of derivative instruments during the three months
ended October 31, 2006 and 2005, was approximately $242,000 and $0,
respectively. This
was
primarily due to us entering into two identically structured derivative
contracts with Standard Bank in March 2006. Each derivative consisted of a
series of forward sales of gold and a purchase gold cap. We agreed to sell
a
total volume of 121,927 ounces of gold forward to Standard Bank at a price
of
$500 per ounce on a quarterly basis during the period from March 2007 to
September 2010. We also agreed to a purchase gold cap on a quarterly basis
during this same period and at identical volumes covering a total volume of
121,927 ounces of gold at a price of $535 per ounce. Under FASB Statement No.
133, “Accounting for Derivative Instruments and Hedging Activities” (“FAS 133”),
these contracts must be carried on the balance sheet at their fair value, with
changes to the fair value of these contracts reflected as Other
Income or Expense.
These
contracts were not designated as hedging derivatives; and therefore, special
hedge accounting does not
apply.
The
first
derivative was entered into on March 1, 2006 for a premium of $550,000; and
the
second was entered into on March 30, 2006 for a premium of $250,000. The gold
price rose sharply in second quarter 2006, and was the primary reason for the
decrease in premium on the derivative contracts. The change in fair value during
the three months ended October 31, 2006 reduced the carrying value on these
derivative contracts by approximately $242,000, and was reflected as an other
expense during the current period. There was no such transactions entered into
during the same period in 2005.
Interest
expense was approximately $23,000 for the three months ended October 31, 2006
versus no such expense for the same period in 2005. This increase was mainly
due
to interest expense associated with the initial draw down from the credit
agreement entered into in August 2006 with Standard Bank Plc of $1,250,000
on
October 11, 2006.
Loss
from Changes in Foreign Exchange Rates
During
the three months ended October 31, 2006, we recorded equity adjustments from
foreign currency translations of approximately $ 3,000.
These translation adjustments are related to changes in the rates of exchange
between the Mexican Peso and the US dollar.
Liquidity
and Capital Resources; Plan of Operations
As
of
October 31, 2006, we had working capital of approximately $3,184,000 a decrease
of $3,847,000 from July 31, 2006. This decrease was primarily due to capital
expenditures associated with our El Chanate Project. Our plans over the next
12
months primarily include the construction of the El Chanate open-pit gold mine
in Mexico, commencement of gold production at this site and continued
exploration in northern Mexico. Please see the disclosure in our annual report
on Form 10-KSB for the year ended July 31, 2006 for more detailed information.
Management believes that the capital costs to establish the mining operation
will be between $17.5 and $18.5 million, of which we have expended approximately
$ 9,400,000
as of December 15, 2006. We also anticipate non-mine related operating expenses
of approximately $1.4 million. The actual activities and the costs may vary
materially, especially if there are significant increase in costs related to
such items as fuel, construction materials and labor.
Historically,
we have not generated any material revenues from operations and have been in
a
precarious financial condition. Our consolidated financial statements have
been
prepared on a going concern basis, which contemplates the realization of assets
and satisfaction of liabilities in the normal course of business. We have
recurring losses from operations. Our primary source of funds used during the
quarter ended October 31, 2006 was from the sale and issuance of equity
securities during fiscal 2005 and 2006. We anticipate that our operations
through fiscal 2007 will be funded from the balance of the proceeds from these
placements, sale of our securities (possibly through the exercising of certain
options and warrants) and the loan proceeds from the credit agreement entered
into in August 2006 with Standard Bank Plc. We do not anticipate achieving
positive cash flow from our operating activities for some time. Until such
point, we may need to raise additional capital to fund on-going general and
administrative expenses and exploration. The private placements of our
securities and the Standard Bank credit agreement are discussed below.
2006
Private Placements & Warrant Exercises
We
closed
two private placements in 2006 pursuant to which we issued an aggregate of
21,240,000 units, each unit consisting of one share of our common stock and
a
warrant to purchase ¼ of a share of our common stock for net proceeds of
$4,999,500, net of commissions of $310,500. We also received net proceeds of
$2,373,570, net of commissions of $206,430, from the exercising of 8,600,000
warrants in February 2006. The Warrant issued to each purchaser is exercisable
for one share of our common stock, at an exercise price equal to $0.30 per
share. Each Warrant has a term of eighteen months and is fully exercisable
from
the date of issuance. We issued to the placement agent in one of the placements
eighteen month warrants to purchase up to 934,000 shares of our common stock
at
an exercise price of $0.25 per share. Such placement agent warrants are valued
at approximately $189,000 using the Black-Scholes option pricing method.
February
2005 Private Placement
In
the
private placement that closed in February 2005, we issued 27,200,004 units,
each
unit consisting of one shares of our Common Stock and one Common Stock Purchase
Warrant for an aggregate gross purchase price of approximately $6.8 million
and
we received approximately $6.2 million in net proceeds. The Warrant issued
to
each purchaser was originally exercisable for one share of our Common Stock,
at
an exercise price equal to $0.30 per share. We temporarily lowered the exercise
price of the Warrants to $0.20 per shares for the period commencing on November
28, 2005 and ending on January 31, 2006, after which time the exercise price
increased back to $0.30 per share Each Warrant has a term of two years
and is fully exercisable from the date of issuance. We issued to the placement
agent two year warrants to purchase up to 2,702,000 shares of our Common Stock
at an exercise price of $0.25 per share. Such placement agent warrants are
valued at approximately $414,000 using the Black-Scholes option pricing
method.
Pursuant
to our agreement with the purchasers we registered the foregoing shares and
shares issuable upon the exercise of the foregoing Warrants for public resale.
We also agreed to prepare and file all amendments and supplements necessary
to
keep the registration statement effective until the earlier of the date on
which
the selling stockholders may resell all the registrable shares covered by the
registration statement without volume restrictions pursuant to Rule 144(k)
under the Securities Act or any successor rule of similar effect and the date
on
which the selling stockholders have sold all the shares covered by the
registration statement. If, subject to certain exceptions, sales of all shares
registered cannot be made pursuant to the registration statement, we will be
required to pay to these selling stockholders in cash or, at our option, in
shares, their pro rata share of 0.0833% of the aggregate market value of the
registrable shares held by these selling stockholders for each month thereafter
until sales of the registrable shares can again be made pursuant to the
registration statement. In this regard, we paid $7,100 to the purchasers
representing liquidated damages.
In
addition, we agreed to have our Common Stock listed for trading on the Toronto
Stock Exchange. If our Common Stock was not listed for trading on the Toronto
Stock Exchange within 180 days after February 8, 2005, we were required to
issue
to these selling stockholders an additional number of shares of our Common
Stock
that is equal to 20% of the number of shares acquired by them in the private
placement. We did not timely list our shares on the Toronto Stock Exchange
and,
in August 2005, we issued 5,440,000 shares to the selling stockholders. We
subsequently registered these 5,440,000 shares for public resale.
Project
Finance Credit Facility
On
August
15, 2006, we entered into a credit agreement (the “Credit Agreement”) involving
our wholly-owned subsidiaries MSR and Oro, as borrowers, us, as guarantor,
and
Standard Bank plc (“Standard Bank”), as the lender and the offshore account
holder. Under the Credit Agreement, MSR and Oro have agreed to borrow money
in
an aggregate principal amount of up to US$12.5 million (the “Loan”) for the
purpose of constructing, developing and operating our El Chanate Project (the
“Mine”). We are guaranteeing the repayment of the loan and the performance of
the obligations under the Credit Agreement. The Loan is scheduled to be repaid
in fourteen quarterly payments with the first principal payment due after
certain Mine start-up production and performance criteria are satisfied, which
we believe will occur in the first calendar quarter of 2008. The Loan bears
interest at LIBOR plus 4.00%, with LIBOR interest periods of 1, 2, 3 or 6 months
and with interest payable at the end of the applicable interest
period.
The
Credit Agreement contains covenants customary for a project financing loan,
including but not limited to restrictions (subject to certain exceptions) on
incurring additional debt, creating liens on our property, disposing of any
assets, merging with other companies and making any investments. We are required
to meet and maintain certain financial covenants, including (i) a debt service
coverage ratio of not less than 1.2 to 1.0, (ii) a projected debt service
coverage ratio of not less than 1.2 to 1.0, (iii) a loan life coverage ratio
of
at least 1.6 to 1.0, (iv) a project life coverage ratio of at least 2.0 to
1.0
and (v) a minimum reserve tail. We are also required to maintain a certain
minimum level of unrestricted cash, and upon meeting certain Mine start-up
production and performance criteria, MSR and Oro will be required to maintain
a
specified amount of cash as a reserve for debt repayment.
The
Loan
is secured by all of the tangible and intangible assets and property owned
by
MSR and Oro pursuant to the terms of a Mortgage Agreement, a Non-Possessory
Pledge Agreement, an Account Pledge Agreement and certain other agreements
entered into in Mexico (the “Mexican Collateral Documents”). As additional
collateral for the Loan, we, together with our subsidiary, Leadville Mining
& Milling Holding Corporation, have pledged all of our ownership interest in
MSR and Oro. In addition to these collateral arrangements, MSR and Oro are
required to deposit all proceeds of the Loan and all cash proceeds received
from
operations and other sources in an offshore, controlled account with Standard
Bank. Absent a default under the loan documents, MSR and Oro may use the funds
from this account for specific purposes such as approved project costs and
operating costs.
As
part
of the fee for entering into and closing the Credit Agreement, we issued to
Standard Bank 1,150,000 shares of our restricted common stock and a warrant
for
the purchase of 12,600,000 shares of our common stock at an exercise price
of
$0.317 per share, expiring on the earlier of (a) December 31, 2010 or (b) the
date one year after the repayment of the Credit Agreement. We recorded the
issuance of the 1,150,000 shares of common stock and 12,600,000 warrants as
deferred financing costs of approximately $351,000 and $3,314,000, respectively,
as a reduction of stockholders' equity on our balance sheet. The issuance of
1,150,000 shares was recorded at the fair market value of our common stock
at
the closing date or $0.305 per share. The warrants were valued at approximately
$3,314,000 using the Black-Scholes option pricing model and were reflected
as
deferred financing costs as a reduction of stockholders' equity on our balance
sheet.
Previously,
pursuant to the mandate and commitment letter for the facility, we issued to
Standard Bank 1,000,000 shares of our restricted common stock and a warrant
for
the purchase of 1,000,000 shares of our common stock at an exercise price of
$0.32 per share, expiring on the earlier of (a) December 31, 2010 or (b) the
date one year after the repayment of the Credit Agreement. We recorded the
issuance of the 1,000,000 shares of common stock as deferred financing costs
of
approximately $270,000 as a reduction of stockholders' equity on our balance
sheet as of July 31, 2006. The issuance of these shares was recorded at the
fair
market value of our common stock at the commitment letter date or $0.27 per
share. In addition, the warrants were valued at approximately $253,000 using
again the Black-Scholes option pricing model and were reflected as deferred
financing costs as a reduction of stockholders' equity on our balance sheet
as
of July 31, 2006. We have registered for public resale the 2,150,000 shares
issued to Standard Bank and the 13,600,000 shares issuable upon exercise of
warrants issued to Standard Bank.
In
March
2006, we entered into a gold price protection arrangement with Standard Bank
to
protect us against future fluctuations in the price of gold. We agreed to a
series of gold forward sales and call option purchases in anticipation of
entering into the Credit Agreement. Under the price protection agreement, we
have agreed to sell a total volume of 121,927 ounces of gold forward to Standard
Bank at a price of $500 per ounce on a quarterly basis during the period from
March 2007 to September 2010. We will also purchase call options from Standard
Bank on a quarterly basis during this same period covering a total volume of
121,927 ounces of gold at a price of $535 per ounce. We paid a fee to Standard
Bank in connection with the price protection agreement. In addition, we provided
aggregate cash collateral of approximately $4.3 million to secure our
obligations under this agreement. The cash collateral was returned to us after
the Credit Agreement was executed in August 2006.
On
October 11, 2006, we completed the initial draw down on our credit facility
from
Standard Bank receiving proceeds of $1,250,000. We are using these proceeds
for
the repurchase of the 5% net profits interest formerly held by FG and to
continue the mine development at the El Chanate Project. On November 1, 2006,
and December 1, 2006, we completed the second and third draw down on our credit
facility from Standard Bank receiving proceeds of $3,500,000 and $2,250,000,
respectively. We are using and anticipate using these proceeds mainly for the
remaining balances on the Crushing and conveyor system purchase orders and
site
work for the leach pad and ponds at our El Chanate Project.
On
October 11, 2006, prior to our initial draw on the Credit Facility, we entered
into interest rate swap agreements in accordance with the terms of the Credit
Facility, which requires that we hedge at least 50 percent of our outstanding
debt under this facility. The agreements entered into cover $9,375,000 or 75%
of
the outstanding debt. Both swaps covered this same notional amount of
$9,375,000, but over different time horizons. The first covered the six months
commencing October 11, 2006 and a termination date of March 31, 2007 and the
second covering the period from March 30, 2007 and a termination date of
December 31, 2010. We intend to use discretion in managing this risk as
market conditions vary over time, allowing for the possibility of adjusting
the
degree of hedge coverage as we deem appropriate. However, any use of interest
rate derivatives will be restricted to use for risk management
purposes.
To
the
extent that the balance of funds from the private placements and the proceeds
from the credit facility are not adequate for our needs and we need to obtain
additional capital to complete the mine, commence operations, cover any material
cost overruns, cover ongoing general and administrative expenses and/or fund
exploration, management intends to raise such funds through the sale of our
securities (including, possibly, from the exercise of outstanding warrants),
the
sale of a royalty interest in the future production from the Chanate properties
and/or joint venturing with one or more strategic partners. We cannot assure
that, if we need additional funding, such funding will be available. If we
need
additional funding but are unable to obtain it from outside sources, we will
be
forced to reduce or curtail our operations. Please see “We
lack operating cash flow and rely on external funding sources. If we are unable
to continue to obtain needed capital from outside sources until we are able
to
generate positive cash flow from operations, we will be forced to reduce or
curtail our operations”
in
“Risk
Factors.”
Environmental
and Permitting Issues
Management
does not expect that environmental issues will have an adverse material effect
on our liquidity or earnings. In Mexico, although we must continue to comply
with laws, rules and regulations concerning mining, environmental, health,
zoning and historical preservation issues, we are not aware of any significant
environmental concerns or existing reclamation requirements at the El Chanate
concessions. We received the required Mexican government permits for
construction, mining and processing the El Chanate ores in January 2004. The
permits were extended in June 2005. Pursuant to the extensions, once we file
a
notice that work has commenced, we have one year to prepare the site and
construct the mine and seven years to mine and process ores from the site.
We
filed the notice on June 1, 2006. We received the explosive permit from the
government in August 2006. This permit expires on December 31, 2006, and we
are
in the renewal process for 2007.
We
own
properties in Leadville, Colorado for which we have recorded an impairment
loss.
Part of the Leadville Mining District has been declared a federal Superfund
site
under the Comprehensive Environmental Response, Compensation and Liability
Act
of 1980, and the Superfund Amendments and Reauthorization Act of 1986. Several
mining companies and one individual were declared defendants in a possible
lawsuit. We were not named a defendant or Principal Responsible Party. We did
respond in full detail to a lengthy questionnaire prepared by the Environmental
Protection Agency ("EPA") regarding our proposed procedures and past activities
in November 1990. To our knowledge, the EPA has initiated no further comments
or
questions.
We
do
include in all our internal revenue and cost projections a certain amount for
environmental and reclamation costs on an ongoing basis. This amount is
determined at a fixed amount of $0.13 per metric tonne of material to be milled
on a continual, ongoing basis to provide primarily for reclaiming tailing
disposal sites and other reclamation requirements. At this time, there do not
appear to be any environmental costs to be incurred by us beyond those already
addressed above. No assurance can be given that environmental regulations will
not be changed in a manner that would adversely affect our planned operations.
Although, we have not yet initiated production, we have estimated the
reclamation costs for the El Chanate site to be approximately $2.1 million.
These costs would be accrued proportionately over the estimated mine life of
7
years.
New
Accounting Pronouncements
In
February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid
Financial Instruments” (“FAS 155”) - an amendment of FASB Statements
No. 133 and 140. FAS 155 amends SFAS No. 133, “Accounting for Derivative
Instruments and Hedging Activities” (“FAS 133”), and SFAS No. 140 (“FAS 140”),
“Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities”, to permit fair value re-measurement of any hybrid financial
instrument that contains an embedded derivative that would otherwise require
bifurcation. Additionally, FAS 155 seeks to clarify which interest-only strips
and principal-only strips are not subject to the requirements of FAS 133 and
to
clarify that concentrations of credit risk in the form of subordination are
not
embedded derivatives. This Statement is effective for all financial instruments
acquired or issued after the beginning of an entity’s first fiscal year that
begins after September 15, 2006. Management does not believe the adoption
of this standard will have a material impact on the financial condition or
the
results of operations of the Company.
On
July
13, 2006, the Financial Accounting Standards Board issued Interpretation No.
48,
"Accounting for Uncertainty in Income Taxes" (“FIN 48”). The requirements are
effective for fiscal years beginning after December 15, 2006. The purpose
of FIN 48 is to clarify and set forth consistent rules for accounting for
uncertain tax positions in accordance with Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes". The cumulative effect of
applying the provisions of this interpretation are required to be reported
separately as an adjustment to the opening balance of retained earnings in
the
year of adoption. Management does not believe the adoption of this standard
will
have a material impact on the financial condition or the results of operations
of the Company.
Disclosure
About Off-Balance
Sheet Arrangements
On
October 11, 2006, prior to the initial draw on our Credit Facility, we
entered into interest rate swap agreements with total notional amounts of
$18,750,000 in accordance with the terms of the Credit Facility. There was
one
six month swap contract totaling $9,375,000 (75% of the outstanding debt) with
an effective date of October 11, 2006 and a termination date of March 31, 2007
and one three-year nine month swap contract totaling $9,375,000 (75% of the
outstanding debt) with an effective date of March 30, 2007 and a termination
date of December 31, 2010. These swaps were entered into for the purpose of
hedging a portion of our variable interest expenses. Although we are required
by
our lenders to hedge at least 50% of the outstanding debt, we retain the
authority to hedge a larger share of this exposure, and we will use discretion
in managing this risk as market conditions vary over time. We only issue and/or
hold derivative contracts for risk management purposes.
We
do not
have any other transactions, agreements or other contractual arrangements that
constitute off-balance sheet arrangements.
Critical
Accounting Policies
Our
financial statements and accompanying notes are prepared in accordance with
accounting principles generally accepted in the United States of America.
Preparing financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenue,
and expenses. These estimates and assumptions are affected by management’s
application of accounting policies. Critical accounting policies for us include
impairment of long-lived assets, accounting for stock-based compensation and
environmental remediation costs.
Impairment
of Long-Lived Assets
In
accordance with SFAS 144, “Accounting for the Impairment and Disposal of
Long-Lived Assets,” we review our long-lived assets for impairments. Impairment
losses on long-lived assets are recognized when events or changes in
circumstances indicate that the undiscounted cash flows estimated to be
generated by such assets are less than their carrying value and, accordingly,
all or a portion of such carrying value may not be recoverable. Impairment
losses then are measured by comparing the fair value of assets to their carrying
amounts.
Environmental
Remediation Costs
Environmental
remediation costs are accrued based on estimates of known environmental
remediation exposure. Such accruals are recorded even if significant
uncertainties exist over the ultimate cost of the remediation. It is reasonably
possible that our estimates of reclamation liabilities, if any, could change
as
a result of changes in regulations, extent of environmental remediation
required, means of reclamation or cost estimates. Ongoing environmental
compliance costs, including maintenance and monitoring costs, are expensed
as
incurred. There were no environmental remediation costs incurred or accrued
at
October 31, 2006.
Stock
Based Compensation
In
connection with offers of employment to our executives as well as in
consideration for agreements with certain consultants, we issue options and
warrants to acquire our common stock. Employee and non-employee awards are
made
in the discretion of the Board of Directors.
Effective
February 1, 2006, we adopted the provisions of SFAS No. 123R. Under FAS 123R,
share-based compensation cost is measured at the grant date, based on the
estimated fair value of the award, and is recognized as expense over the
requisite service period. We adopted the provisions of FAS 123R using a modified
prospective application. Under this method, compensation cost is recognized
for
all share-based payments granted, modified or settled after the date of
adoption, as well as for any unvested awards that were granted prior to the
date
of adoption. Prior periods are not revised for comparative purposes. Because
we
previously adopted only the pro forma disclosure provisions of SFAS 123, we
will
recognize compensation cost relating to the unvested portion of awards granted
prior to the date of adoption, using the same estimate of the grant-date fair
value and the same attribution method used to determine the pro forma
disclosures under SFAS 123, except that forfeitures rates will be estimated
for
all options, as required by FAS 123R.
Accounting
for Derivatives and Hedging Activities
We
entered into two identically structured derivative contracts with Standard
Bank
in March 2006. Each derivative consisted of a series of forward sales of gold
and a purchase gold cap. We agreed to sell a total volume of 121,927 ounces
of
gold forward to Standard Bank at a price of $500 per ounce on a quarterly basis
during the period from March 2007 to September 2010. We also agreed to a
purchase gold cap on a quarterly basis during this same period and at identical
volumes covering a total volume of 121,927 ounces of gold at a price of $535
per
ounce. Although these contracts are not designated as hedging derivatives,
they
serve an economic purpose of protecting us from the effects of a decline in
gold
prices. Because they are not designated as hedges, however, special hedge
accounting does not apply. Derivative results are simply marked to market
through earnings, with these effects recorded in other
income
or
other
expense,
as
appropriate under FASB Statement No. 133, “Accounting for Derivative Instruments
and Hedging Activities” (“FAS 133”).
On
October 11, 2006, prior to our initial draw on the Credit Facility, we entered
into interest rate swap agreements in accordance with the terms of the Credit
Facility, which requires that we hedge at least 50 percent of our outstanding
debt under this facility. The agreements entered into cover $9,375,000 or 75%
of
the outstanding debt. Both swaps covered this same notional amount of
$9,375,000, but over different time horizons. The first covered the six months
commencing October 11, 2006 and a termination date of March 31, 2007 and the
second covering the period from March 30, 2007 and a termination date of
December 31, 2010. We intend to use discretion in managing this risk as
market conditions vary over time, allowing for the possibility of adjusting
the
degree of hedge coverage as we deem appropriate. However, any use of interest
rate derivatives will be restricted to use for risk management
purposes.
We
use
variable-rate debt to finance a portion of the El Chanate Project. Variable-rate
debt obligations expose us to variability in interest payments due to changes
in
interest rates. As a result of these arrangements, we will continuously monitor
changes in interest rate exposures and evaluate hedging opportunities. Our
risk
management policy permits us to use any combination of interest rate swaps,
futures, options, caps and similar instruments, for the purpose of fixing
interest rates on all or a portion of variable rate debt, establishing caps
or
maximum effective interest rates, or otherwise constraining interest expenses
to
minimize the variability of these effects.
The
interest rate swap agreements will be accounted for as cash flow hedges, whereby
“effective” hedge gains or losses are initially recorded in other comprehensive
income and later reclassified to the interest expense component of earnings
coincidently with the earnings impact of the interest expenses being hedged.
“Ineffective” hedge results are immediately recorded in earnings also under
interest expense. No component of hedge results will be excluded from the
assessment of hedge effectiveness.
We
are
exposed to credit losses in the event of non-performance by counterparties
to
these interest rate swap agreements, but we do not expect any of the
counterparties to fail to meet their obligations. To manage credit risks, we
select counterparties based on credit ratings, limits our exposure to a single
counterparty under defined guidelines, and monitor the market position with
each
counterparty as required by SFAS 133.
Risk
Factors
We
are
subject to various risks that may materially harm our business, financial
condition and results of operations. If any of these risks or uncertainties
actually occur, our business, financial condition or operating results could
be
materially harmed. In that case, the trading price of our common stock could
decline and you could lose all or part of your investment.
Risks
related to our business and operations
We
have not generated any operating revenues. If we are unable to commercially
develop our mineral properties, we will not be able to generate profits and
our
business may fail.
To
date,
we have no producing properties. As a result, we have no current source of
operating revenue and we have historically operated and continue to operate
at a
loss. Our ultimate success will depend on our ability to generate profits from
our properties. Our viability is largely dependent on the successful commercial
development of our El Chanate gold mining project in Sonora,
Mexico.
We
lack operating cash flow and rely on external funding sources. If we are unable
to continue to obtain needed capital from outside sources until we are able
to
generate positive cash flow from operations, we will be forced to reduce or
curtail our operations.
We
do not
generate any positive cash flow from operations and we do not anticipate that
any positive cash flow will be generated for some time. Until such point, we
may
need to raise additional capital to fund on-going general and administrative
expenses and exploration. Our primary focus is the development of our El Chanate
Project which, we anticipate, will cost between $17.5 and $18.5 million. We
also
anticipate non-mine related operating expenses of approximately $1.4 million.
During the fiscal year ended July 31, 2006, we raised approximately $8,115,000
through private placements of our shares and warrants and from the exercise
of
warrants and options. Also, in August 2006, we and two of our Mexican
subsidiaries entered into a credit agreement (the “Credit Agreement”) with
Standard Bank PLC (“Standard Bank”) to borrow up to US$12.5 million for the
purpose of constructing, developing and operating the El Chanate Project. To
the
extent that we need to obtain additional capital to commence operations, cover
any material cost overruns, cover ongoing general and administrative expenses
and/or fund exploration, management intends to raise such funds through the
sale
of our securities, the sale of a royalty interest in the future production
from
the Chanate properties and/or joint venturing with one or more strategic
partners. We cannot assure that adequate additional funding will be
available.
If
we are
unable to obtain needed capital from outside sources, we will be forced to
reduce or curtail our operations.
Our
year end audited financial statements contain a “going concern” explanatory
paragraph. Our
inability to continue as a going concern would require a restatement of assets
and liabilities on a liquidation basis, which would differ materially and
adversely from the going concern basis on which our financial statements
included in this report have been prepared.
Our
consolidated financial statements for the year ended July 31, 2006 included
in
our annual report on form 10-KSB for the year then ended have been prepared
on
the basis of accounting principles applicable to a going concern. Our auditors’
report on the consolidated financial statements contained therein includes
an
additional explanatory paragraph following the opinion paragraph on our ability
to continue as a going concern. A note to these consolidated financial
statements describes the reasons why there is substantial doubt about our
ability to continue as a going concern and our plans to address this issue.
Our
July 31, 2006 and October 31, 2006 consolidated financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
Our inability to continue as a going concern would require a restatement of
assets and liabilities on a liquidation basis, which would differ materially
and
adversely from the going concern basis on which our consolidated financial
statements have been prepared. See, “Management's
Discussion and Analysis of Financial Condition and Results of Operations;
Liquidity and Capital Resources; Plan of Operations.”
If
our stockholders do not approve an amendment to our Certificate of Incorporation
to increase the number of shares we are authorized to issue, we may not be
unable to raise additional funds, if needed, through the sale of equity
securities and it may make it more difficult to attract key
employees.
As
of
December 15, 2006, we had 133,482,854 shares of Common Stock outstanding and
approximately 44,208,727 shares reserved for future issuance under outstanding
options, warrants and the 2006 Equity Incentive Plan, leaving only approximately
22,308,419 shares of Common Stock available for future issuances. We have
scheduled an annual meeting of our stockholders to be held on February 21,
2007
to approve an amendment to our Certificate of Incorporation to increase the
number of our authorized shares. As discussed in the risk factors above, we
may
need to raise additional funds. In addition, we will need additional shares
for
other corporate purposes including, possibly, attraction of key employees.
If our stockholders do not approve this amendment, we most likely will not
be
able to raise additional funds, if needed, through the sale of equity
securities.
Our
Credit Facility with Standard Bank imposes restrictive covenants on us.
Our
Credit Facility with Standard requires us, among other obligations, to meet
certain financial covenants including (i) a debt service coverage ratio of
not
less than 1.2 to 1.0, (ii) a projected debt service coverage ratio of not less
than 1.2 to 1.0, (iii) a loan life coverage ratio of at least 1.6 to 1.0, (iv)
a
project life coverage ratio of at least 2.0 to 1.0 and (v) a minimum reserve
tail. We are also required to maintain a certain minimum level of unrestricted
cash. In addition, the Credit Facility restricts, among other things, our
ability to incur additional debt, create liens on our property, dispose of
any
assets, merge with other companies or make any investments. A failure to comply
with the restrictions contained in the Credit Facility could lead to an event
of
default thereunder which could result in an acceleration of such indebtedness.
We
will be using reconditioned and used equipment which could adversely affect
our
cost assumptions and our ability to economically and successfully mine the
project.
We
plan
to use reconditioned and used carbon column collection equipment to recover
gold. Such equipment is subject to the risk of more frequent breakdowns and
need
for repair than new equipment. If the equipment that we use breaks down and
needs to be repaired or replaced, we will incur additional costs and operations
may be delayed resulting in lower amounts of gold recovered. In such event,
our
capital and operating cost assumptions may be inaccurate and our ability to
economically and successfully mine the project may be hampered, resulting in
decreased revenues and, possibly, a loss from operations.
As
a result of the projected short mine life of seven years, if major problems
develop, we will have limited time to correct these problems and we may have
to
cease operations earlier than planned.
Pursuant
to the 2005 Study, as updated by the 2006 Update the mine life will be only
approximately seven years. If major problems develop in the project, or we
fail
to achieve the operating efficiencies or costs projected in the feasibility
study, we will have limited time to find ways to correct these problems and
we
may have to cease operations earlier than planned.
The
gold deposit we have identified at El Chanate is relatively small and low-grade.
If our estimates and assumptions are inaccurate, our results of operation and
financial condition could be materially adversely affected.
The
gold
deposit we have identified at our El Chanate Project is relatively small and
low-grade. If the estimates of ore grade or recovery rates contained in the
feasibility study turn out to be higher than the actual ore grade and recovery
rates, if costs are higher than expected, or if we experience problems related
to the mining, processing of, or recovery of gold from, ore at the El Chanate
Project, our results of operation and financial condition could be materially
adversely affected. Moreover, it is possible that actual costs and economic
returns may differ materially from our best estimates. It is not unusual in
the
mining industry for new mining operations to experience unexpected problems
during the start-up phase and to require more capital than anticipated. There
can be no assurance that our operations at El Chanate will be
profitable.
Our
currently permitted water rights may not be adequate for all of our total
project needs over the entire course of our anticipated mining operations.
If we
need to obtain additional rights, but are unable to procure them our planned
operations may be adversely affected.
The
2005
feasibility study indicates our average life of mine water requirements, for
ore
processing only, will be about 94.6 million gallons per year (11.4 liters per
second). The amount of water we are currently permitted to pump for our
operations is approximately 71.3 million gallons per year (8.6 liters per
second). Our currently permitted water rights may not be adequate for all of
our
total project needs over the entire course of our anticipated mining operations.
We are looking into ways to rectify this issue. If we need to obtain additional
rights, but are unable to procure them our planned operations may be adversely
affected.
We
have a limited number of prospects. As a result, our chances of commencing
viable mining operations are dependent upon the success of one
project.
Our
only
current properties are the El Chanate concessions and our Leadville properties.
At present, we are not doing any substantive work at our Leadville properties
and, in fact, have written these properties off. Our El Chanate concessions
are
owned by one of our wholly-owned subsidiaries, Oro de Altar. Minera Santa Rita
S. de R.L. de C.V., another of our Mexican subsidiaries leases the land and
claims at El Chanate from Oro de Altar. FG, our former joint venture partner,
has the right to receive five percent of Minera Santa Rita's annual dividends,
when declared. We currently do not have operations on either of our properties,
and we must commence such operations to receive revenues. Accordingly, we are
dependent upon the success of the El Chanate concessions.
Gold
prices can fluctuate on a material and frequent basis due to numerous factors
beyond our control. If and when we commence production, our ability to generate
profits from operations could be materially and adversely affected by such
fluctuating prices.
The
profitability of any gold mining operations in which we have an interest will
be
significantly affected by changes in the market price of gold. Gold prices
fluctuate on a daily basis. During 2005, the spot price for gold on the London
Exchange fluctuated between $411.10 and $537.50 per ounce. Between January
1,
2006 and December 15, 2006, the spot price for gold on the London Exchange
has
fluctuated between $524.75 and $725.00 per ounce. Gold prices are affected
by
numerous factors beyond our control, including:
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the
level of interest rates,
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world
supply of gold and
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·
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stability
of exchange rates.
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Each
of
these factors can cause significant fluctuations in gold prices. Such external
factors are in turn influenced by changes in international investment patterns
and monetary systems and political developments. The price of gold has
historically fluctuated widely and, depending on the price of gold, revenues
from mining operations may not be sufficient to offset the costs of such
operations.
We
may not be successful in hedging against gold price and interest rate
fluctuations and may incur mark to market losses and lose money through our
hedging programs.
We
have
entered into metals trading transactions to hedge against fluctuations in gold
prices, using call option purchases and forward sales, and have entered into
various interest rate swap agreements. The terms of our debt financing with
Standard Bank require that we utilize various price hedging techniques to hedge
a portion of the gold we plan to produce at the El Chanate Project and hedge
at
least 50% of our outstanding loan balance. There can be no assurance that we
will be able to successfully hedge against gold price and interest rate
fluctuations and if we fail to maintain the minimum level of hedge transactions
required by the terms of our debt financing, our ability to draw amounts from
Standard Bank may be adversely affected.
Further,
there can be no assurance that the use of hedging techniques will always be
to
our benefit. Hedging instruments that protect against metals market price
volatility may prevent us from realizing the full benefit from subsequent
increases in market prices with respect to covered production, which would
cause
us to record a mark-to-market loss, decreasing our revenues and profits. Hedging
contracts also are subject to the risk that the other party may be unable or
unwilling to perform its obligations under these contracts. Any significant
nonperformance could have a material adverse effect on our financial condition,
results of operations and cash flows.
In
addition, we expect to settle our forward sales at a time when the El Chanate
Project is in production. If the completion of the project is delayed or if
we
are unable for any reason to deliver the quantity of gold required by our
forward sales, we may need to settle the forward sales by purchasing gold at
spot prices. Depending on the price of gold at that time, the financial
settlement of the forward sales could have a material adverse effect on our
financial condition, results of operations and cash flows.
Our
material property interests are in Mexico. Risks of doing business in a foreign
country could adversely affect our results of operations and financial
condition.
We
face
risks normally associated with any conduct of business in foreign countries
with
respect to our El Chanate Project in Sonora, Mexico, including various levels
of
political and economic risk. The occurrence of one or more of these events
could
have a material adverse impact on our efforts or future operations which, in
turn, could have a material adverse impact on our future cash flows, earnings,
results of operations and financial condition. These risks include the
following:
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invalidity
of governmental orders,
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·
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uncertain
or unpredictable political, legal and economic
environments,
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war
and civil disturbances,
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changes
in laws or policies,
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delays
in obtaining or the inability to obtain necessary governmental
permits,
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governmental
seizure of land or mining claims,
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limitations
on ownership,
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limitations
on the repatriation of earnings,
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increased
financial costs,
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·
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import
and export regulations, including restrictions on the export of gold,
and
|
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foreign
exchange controls.
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These
risks may limit or disrupt the project, restrict the movement of funds or impair
contract rights or result in the taking of property by nationalization or
expropriation without fair compensation.
We
anticipate selling gold in U.S. dollars; however, we incur a significant amount
of our expenses in Mexican pesos. If and when we sell gold, if applicable
currency exchange rates fluctuate our revenues and results of operations may
be
materially and adversely affected.
If
and
when we commence sales of gold, such sales will be made in U.S. dollars. We
incur a significant amount of our expenses in Mexican pesos. As a result, our
financial performance would be affected by fluctuations in the value of the
Mexican peso to the U.S. dollar.
Changes
in regulatory policy could adversely affect our exploration and future
production activities.
Any
changes in government policy may result in changes to laws
affecting:
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environmental
regulations,
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·
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repatriation
of income and
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Any
such
changes may affect our ability to undertake exploration and development
activities in respect of present and future properties in the manner currently
contemplated, as well as our ability to continue to explore, develop and operate
those properties in which we have an interest or in respect of which we have
obtained exploration and development rights to date. The possibility,
particularly in Mexico, that future governments may adopt substantially
different policies, which might extend to expropriation of assets, cannot be
ruled out.
Compliance
with environmental regulations could adversely affect our exploration and future
production activities.
With
respect to environmental regulation, environmental legislation generally is
evolving in a manner which will require:
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stricter
standards and enforcement,
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·
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increased
fines and penalties for non-compliance,
|
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·
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more
stringent environmental assessments of proposed projects and
|
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·
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a
heightened degree of responsibility for companies and their officers,
directors and employees.
|
There
can
be no assurance that future changes to environmental legislation and related
regulations, if any, will not adversely affect our operations. We could be
held
liable for environmental hazards that exist on the properties in which we hold
interests, whether caused by previous or existing owners or operators of the
properties. Any such liability could adversely affect our business and financial
condition.
We
have limited insurance against any losses or liabilities that could arise from
our operations because we have not commenced operations at El Chanate. Although
we plan on obtaining additional insurance once
construction begins,
such insurance may not be adequate. If
we incur material losses or liabilities because our insurance coverage is not
adequate, our financial position could be materially and adversely
affected.
We
are in
the process of developing our Mexican concessions and hope to commence mining
operations during the first calendar quarter of 2007. If and when we commence
mining operations, such operations will involve a number of risks and hazards,
including:
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metallurgical
and other processing,
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·
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mechanical
equipment and facility performance problems.
|
Such
risks could result in:
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damage
to, or destruction of, mineral properties or production
facilities,
|
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personal
injury or death,
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monetary
losses and /or
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possible
legal liability.
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Industrial
accidents could have a material adverse effect on our future business and
operations. Although as we move forward in the development of the El Chanate
Project we plan to obtain and maintain insurance within ranges of coverage
consistent with industry practice. In this regard, prior to execution of the
credit agreement with Standard Bank, we obtained general liability coverage
of
$2,000,000, basic insurance coverage of $2,000,000 for property and equipment
in
transit to the El Chanate Project and $4,000,000 for the property and equipment
upon delivery to the site. We plan to increase coverage as warranted thereafter
as the property and equipment are erected and placed into service. We cannot
be
certain that this insurance will cover the risks associated with mining or
that
we will be able to maintain insurance to cover these risks at economically
feasible premiums. We also might become subject to liability for pollution
or
other hazards which we cannot insure against or which we may elect not to insure
against because of premium costs or other reasons. Losses from such events
may
have a material adverse effect on our financial position.
Calculation
of reserves and metal recovery dedicated to future production is not exact,
might not be accurate and might not accurately reflect the economic viability
of
our properties.
Reserve
estimates may not be accurate. There is a degree of uncertainty attributable
to
the calculation of reserves, resources and corresponding grades being dedicated
to future production. Until reserves or resources are actually mined and
processed, the quantity of reserves or resources and grades must be considered
as estimates only. In addition, the quantity of reserves or resources may vary
depending on metal prices. Any material change in the quantity of reserves,
resource grade or stripping ratio may affect the economic viability of our
properties. In addition, there can be no assurance that mineral recoveries
in
small scale laboratory tests will be duplicated in large tests under on-site
conditions or during production.
We
are dependent on the efforts of certain key personnel and we need to retain
additional personnel and/or contractors to develop our El Chanate Project.
If we
lose the services of these personnel or we are unable to retain additional
personnel and/or contractors, our ability to complete development and operate
our El Chanate Project may be delayed and our planned operations may be
materially adverse affected.
We
are
dependent on a relatively small number of key personnel, including but not
limited to John Brownlie, Vice President of Operations, who oversees the El
Chanate Project, and Dave Loder, the General Manager of the El Chanate Project,
the loss of any one of whom could have an adverse effect on us. In addition,
while certain of our officers and directors have experience in the exploration
and operation of gold producing properties, we may need to retain additional
personnel and/or contractors to develop and operate our El Chanate Project.
Certain of these personnel and consultants, including Messrs. Brownlie and
Loder, have already been engaged. There can be no guarantee that any needed
personnel or contractors will be available to carry out necessary activities
on
our behalf or be available upon commercially acceptable terms. If we lose the
services of our key personnel or we are unable to retain additional personnel
and/or contractors, our ability to complete development and operate our El
Chanate Project may be delayed and our planned operations may be materially
adversely affected.
There
are uncertainties as to title matters in the mining industry. We believe that
we
have good title to our properties; however, any defects in such title that
cause
us to lose our rights in mineral properties could jeopardize our planned
business operations.
We
have
investigated our rights to explore, exploit and develop our concessions in
manners consistent with industry practice and, to the best of our knowledge,
those rights are in good standing. However, we cannot assure that the title
to
or our rights of ownership of the El Chanate concessions will not be challenged
or impugned by third parties or governmental agencies. In addition, there can
be
no assurance that the concessions in which we have an interest are not subject
to prior unregistered agreements, transfers or claims and title may be affected
by undetected defects. Any such defects could have a material adverse effect
on
us.
Should
we successfully commence mining operations in Mexico, our ability to remain
profitable long term, should we become profitable, eventually will depend on
our
ability to find, explore and develop additional properties. Our ability to
acquire such additional properties will be hindered by competition. If we are
unable to acquire, develop and economically mine additional properties, we
most
likely will not be able to be profitable on a long-term
basis.
Gold
properties are wasting assets. They eventually become depleted or uneconomical
to continue mining. The acquisition of gold properties and their exploration
and
development are subject to intense competition. Companies with greater financial
resources, larger staffs, more experience and more equipment for exploration
and
development may be in a better position than us to compete for such mineral
properties. If we are unable to find, develop and economically mine new
properties, we most likely will not be able to be profitable on a long-term
basis.
Our
ability on a going forward basis to discover additional viable and economic
mineral reserves is subject to numerous factors, most of which are beyond our
control and are not predictable. If we are unable to discover such reserves,
we
most likely will not be able to be profitable on a long-term
basis.
Exploration
for gold is speculative in nature, involves many risks and is frequently
unsuccessful. Few properties that are explored are ultimately developed into
commercially producing mines. As noted above, our long-term profitability will
be, in part, directly related to the cost and success of exploration programs.
Any gold exploration program entails risks relating to
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the
location of economic ore bodies,
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development
of appropriate metallurgical processes,
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receipt
of necessary governmental approvals and
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construction
of mining and processing facilities at any site chosen for mining.
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The
commercial viability of a mineral deposit is dependent on a number of factors
including:
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the
particular attributes of the deposit, such as its
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proximity
to infrastructure,
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importing
and exporting gold and
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environmental
protection.
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The
effect of these factors cannot be accurately predicted.
Risks
related to ownership of our stock
There
is a limited market for our common stock. If a substantial and sustained market
for our common stock does not develop, our stockholders may have difficulty
selling, or be unable to sell, their shares.
Our
common stock is tradable in the United States in the over-the-counter market
and
is quoted on the Over-The-Counter Bulletin Board and our shares of common stock
trade on the Toronto Stock Exchange. There is only a limited market for our
common stock and there can be no assurance that this market will be maintained
or broadened. If a substantial and sustained market for our common stock does
not develop, our stockholders may have difficulty selling, or be unable to
sell,
their shares.
Our
stock price may be adversely affected if a significant amount of shares are
sold
in the public market.
As
of
December 15, 2006, approximately 76,326,058 shares of our Common Stock,
constituted "restricted securities" as defined in Rule 144 under the Securities
Act of 1933. We have registered more than half of these shares for public
resale. In addition, we have registered 37,361,000
shares of Common Stock issuable upon the exercise of outstanding warrants and
872,727 shares of Common Stock issuable upon the exercise of outstanding
options. All of the foregoing shares, assuming exercise of all of the above
options and warrants, would represent in excess of 50% of the then outstanding
shares of our Common Stock. Registration
of the shares permits the sale of the shares in the open market or in privately
negotiated transactions without compliance with the requirements of Rule 144.
To
the extent the exercise price of the warrants or options is less than the market
price of the Common Stock, the holders of the warrants are likely to exercise
them and sell the underlying shares of Common Stock and to the extent that
the
exercise prices of these securities are adjusted pursuant to anti-dilution
protection, the securities could be exercisable or convertible for even more
shares of Common Stock. We
also
may
issue
shares
to be used to meet our capital requirements or use shares to compensate
employees, consultants and/or directors. We are unable to estimate the amount,
timing or nature of future sales of outstanding Common Stock. Sales of
substantial amounts of our Common Stock in the public market could cause the
market price for our Common Stock to decrease. Furthermore, a decline in the
price of our Common Stock would likely impede our ability to raise capital
through the issuance of additional shares of Common Stock or other equity
securities.
We
do not intend to pay cash dividends in the near future.
Our
board
of directors determines whether to pay cash dividends on our issued and
outstanding shares. The declaration of dividends will depend upon our future
earnings, our capital requirements, our financial condition and other relevant
factors. Our board does not intend to declare any dividends on our shares for
the foreseeable future. We anticipate that we will retain any earnings to
finance the growth of our business and for general corporate purposes.
Provisions
of our Certificate of Incorporation, By-laws and Delaware law could defer a
change of our management which could discourage or delay offers to acquire
us.
Provisions
of our Certificate of Incorporation, By-laws and Delaware law may make it more
difficult for someone to acquire control of us or for our stockholders to remove
existing management, and might discourage a third party from offering to acquire
us, even if a change in control or in management would be beneficial to our
stockholders. For example, our Certificate of Incorporation allows us to issue
different series of shares of common stock without any vote or further action
by
our stockholders and our Board of Directors has the authority to fix and
determine the relative rights and preferences of such series of common stock.
As
a result, our Board of Directors could authorize the issuance of a series of
common stock that would grant to holders the preferred right to our assets
upon
liquidation, the right to receive dividend payments before dividends are
distributed to the holders of other common stock and the right to the redemption
of the shares, together with a premium, prior to the redemption of other series
of our common stock. In this regard, in August 2006, we adopted a stockholder
rights plan and, under the Plan, our Board of Directors declared a dividend
distribution of one Right for each outstanding share of Common Stock to
stockholders of record at the close of business on August 14, 2006. Each Right
initially entitles holders to buy one one-thousandth of a share of Series B
Common Stock for $3.00 once the Rights become exercisable. The Rights generally
are not transferable apart from the common stock and will not be exercisable
unless and until a person or group acquires or commences a tender or exchange
offer to acquire, beneficial ownership of 20% or more of our common stock.
However,
the
Rights
Agreement provides an exemption for any person who is, as of August 15, 2006,
the beneficial owner of 20% or more of our outstanding common stock, so long
as
such person does not, subject to certain exceptions, acquire additional shares
of our common stock after that date. The Rights will expire on August 15, 2016,
and may be redeemed prior thereto at $0.001 per Right under certain
circumstances.
If
our Common Stock is deemed to be a "penny stock," trading of our shares would
be
subject to special requirements that could impede our stockholders' ability
to
resell their shares.
"Penny
stocks" as that term is defined in Rule 3a51-1 of the Securities and Exchange
Commission are stocks:
|
i.
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with
a price of less than five dollars per share;
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ii.
|
that
are not traded on a recognized national
exchange;
|
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whose
prices are not quoted on the NASDAQ automated quotation system;
or
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iii.
|
of
issuers with net tangible assets equal to or less than
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-$2,000,000
if the issuer has been in continuous operation for at least three
years;
or
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-$5,000,000
if in continuous operation for less than three years,
or
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of
issuers with average revenues of less than $6,000,000 for the last
three
years.
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Our
Common Stock is not currently a penny stock because we have net tangible assets
of more than $2,000,000. Should our net tangible assets drop below $2,000,000
and we do not meet any of the other criteria for exclusion of our Common Stock
from the definition of penny stock, our Common Stock will be a penny
stock.
Section
15(g) of the Exchange Act, and Rule 15g-2 of the Securities and Exchange
Commission, require broker-dealers dealing in penny stocks to provide potential
investors with a document disclosing the risks of penny stocks and to obtain
a
manually signed and dated written receipt of the document before effecting
any
transaction in a penny stock for the investor's account. Moreover, Rule 15g-9
of
the Securities and Exchange Commission requires broker-dealers in penny stocks
to approve the account of any investor for transactions in such stocks before
selling any penny stock to that investor. This procedure requires the
broker-dealer:
i. |
to
obtain from the investor information concerning his or her financial
situation, investment experience and investment objectives;
|
ii. |
to
determine reasonably, based on that information, that transactions
in
penny stocks are suitable for the investor and that the investor
has
sufficient knowledge and experience as to be reasonably capable
of
evaluating the risks of penny stock transactions;
|
iii. |
to
provide the investor with a written statement setting forth the
basis on
which the broker-dealer made the determination in (ii) above;
and
|
iv. |
to
receive a signed and dated copy of such statement from the investor,
confirming that it accurately reflects the investor's financial
situation,
investment experience and investment objectives.
|
Should
our Common Stock be deemed to be a penny stock, compliance with the above
requirements may make it more difficult for holders of our Common Stock to
resell their shares to third parties or to otherwise dispose of them.
Item
3. Controls
and Procedures.
The
term
"disclosure controls and procedures" is defined in Rules 13a-15(e) and 15d-15(e)
of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). This
term refers to the controls and procedures of a company that are designed to
ensure that information required to be disclosed by a company in the reports
that it files under the Exchange Act is recorded, processed, summarized, and
reported within the required time periods. Our Chief Executive Officer and
our
Chief Financial Officer have evaluated the effectiveness of our disclosure
controls and procedures as of the end of the period covered by this quarterly
report. They have concluded that, as of that date, our disclosure controls
and
procedures were effective at ensuring that required information will be
disclosed on a timely basis in our reports filed under the Exchange
Act.
No
change
in our internal control over financial reporting occurred during the period
covered by this report that has materially affected, or is reasonably likely
to
materially affect, our internal control over financial reporting.
PART
II - OTHER INFORMATION
Item
1. Legal
Proceedings.
None.
Item
2. Unregistered
Sales of Equity Securities and Use of Proceeds.
During
the current quarter, as part of the fee for entering into and closing the Credit
Agreement, we issued to Standard Bank 1,150,000 shares of our restricted common
stock and a warrant for the purchase of 12,600,000 shares of our common stock
at
an exercise price of $0.317 per share, expiring on the earlier of (a) December
31, 2010 or (b) the date one year after the repayment of the Credit Agreement.
Subsequent
to the fiscal quarter ended October 31, 2006, we issued 275,000 shares of our
common stock upon the exercise of outstanding options at an exercise price
of
$.05 per share for proceeds of $13,750, including 25,000 options exercised
by J.
Scott Hazlitt, our V.P. Mine Development.
In
addition, on December 13, 2006, subsequent to the end of the quarter, we issued
two year options to purchase our common stock at an exercise price of $0.36
per
share to John Brownlie and Christopher Chipman and our Canadian counsel. These
options are for the purchase of 250,000 shares, 100,000 shares and 100,000
shares, respectively. These
options cannot be exercised unless and until they are approved by the Toronto
Stock Exchange and Stockholders.
All
of
the foregoing issuances were exempt from registration pursuant to the provisions
of Section 4(2) of the Securities Act of 1933.
Item
3. Defaults
Upon Senior Securities.
None.
Item
4 Submission
of Matters to a Vote of Security Holders.
None.
Item
5. Other
Information.
We
have
scheduled our next Annual Meeting of Stockholders to be held on February 21,
2007.
On
December 13, 2006, our Board of Directors adopted the 2006 Equity Incentive
Plan. Stockholder approval of the plan will be sought at the Annual Meeting.
The
following general description of certain features of the Equity Incentive Plan
is qualified in its entirety by reference to the Equity Incentive Plan, which
is
filed as an exhibit hereto. Capitalized terms not otherwise defined herein
have
the meanings ascribed to them in the Equity Incentive Plan.
The
Equity Incentive Plan authorizes the grant of non-qualified and incentive stock
options, stock appreciation rights and restricted stock awards (each, an
“Awards”). A maximum of 10,000,000 shares1
of
common stock will be reserved for potential issuance pursuant to Awards under
the Equity Incentive Plan. Unless sooner terminated, the Equity Incentive Plan
will continue in effect for a period of 10 years from its effective
date.
1 |
The
Company has only reserved 1,000,000 shares for issuance under the
Plan at
this time. It will increase the number of shares reserved for issuance
under the Plan as more shares become available from, among other
things,
expired warrants or approval of an increase in our authorized shares
of
common stock at the upcoming Annual
Meeting.
|
The
Equity Incentive Plan is administered by the Board of Directors or a committee
thereof. The Equity Incentive Plan provides for awards to be made to such
employees, directors and consultants of the Company and its affiliates as the
Board may select. As of the date hereof, 450,000 options have been granted
under
the Equity Incentive Plan to two of our officers and our Canadian counsel.
These
options cannot be exercised unless and until they are approved by the Toronto
Stock Exchange and Stockholders.
Stock
options awarded under the Equity Incentive Plan may vest and be exercisable
at
such times (not later than 10 years after the date of grant) and at such
exercise prices (not less than fair market value at the date of grant) as the
Board may determine. The Board may provide for options to become immediately
exercisable upon a "change in control," which is defined in the Equity Incentive
Plan to occur in the event one or more persons acting individually or as a
group: (i)
acquires sufficient additional stock to constitute more than 50% of (A) the
total Fair Market Value of all Common Stock issued and outstanding or (B) the
total voting power of all shares of capital stock authorized to vote for the
election of directors; (ii) acquires, in a 12-month period, 35% or more of
the
voting power of all shares of capital stock authorized to vote for the election
of directors, or alternatively a majority of the members of the board is
replaced during any 12-month period by directors whose appointment was not
endorsed by a majority of the members of the board; or (iii) acquires, during
a
12-month period, more than 40% of the total gross fair market value of all
of
the Company’s assets.
The
exercise price of an option must be paid in cash. No options may be granted
under the Equity Incentive Plan after the tenth anniversary of its effective
date. Unless the Board determines otherwise: (i) the options shall provide
that,
in the event a participant’s continuous service to the Company terminates, the
options will terminate either immediately or within a specified period after
continuous service terminates, depending upon the cause of such termination;
and
(ii) the options will be transferable only by will or the laws of descent and
distribution.
Stock
appreciation rights awarded under the Equity Incentive Plan may be granted
(i) in
connection and simultaneously with the grant of another Award, (ii) with
respect to a previously granted Award, or (iii) independent of another
Award. Stock appreciation rights to receive in shares of Common Stock the excess
of the Fair Market Value of Common Stock on the date the rights are surrendered
over the Fair Market Value of Common Stock on the date of grant may be granted
to any Employee, Director or Consultant selected by the Board. The Board may,
in
its discretion and on such terms as it deems appropriate, require as a condition
of the grant of a stock appreciation right that the participant surrender for
cancellation some or all of the Awards previously granted to such person under
the Plan or otherwise. A stock appreciation right, the grant of which is
conditioned upon such surrender, may have an exercise price lower (or higher)
than the exercise price of the surrendered Award, may contain such other terms
as the Board deems appropriate, and shall be exercisable in accordance with
its
terms, without regard to the number of shares, price, exercise period or any
other term or condition of such surrendered Award.
Restricted
stock awarded under the Equity Incentive Plan may be granted on such terms
and
conditions as the Board may determine. The terms and conditions of restricted
stock Award Agreements may change from time to time, and the terms and
conditions of separate restricted stock Award Agreements need not be identical.
Each restricted stock Award Agreement: (i) may be awarded in consideration
for
past services actually rendered, or for future services to be rendered, to
the
Company or an Affiliate for its benefit; (ii) may be subject to a vesting
schedule to be determined by the Board, or be fully vested at the time of grant;
(iii) shall provide that, unless otherwise provided in the restricted stock
Award Agreement, in the event a participant’s continuous service to the Company
terminates for cause prior to a vesting date set forth in the restricted stock
Award Agreement, any unvested restricted stock Award shall be forfeited; and
(iv) unless otherwise provided for therein, shall not be
transferable.
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10.2
|
2006
Equity Incentive Plan
|
|
31.1
|
Certification
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 from the
Company's Chief Executive Officer.
|
|
31.2
|
Certification
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 from the
Company's Chief Financial Officer.
|
|
32.1
|
Certification
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 from the
Company's Chief Executive Officer.
|
|
32.2
|
Certification
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 from the
Company's Chief Financial Officer.
|
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant
has
duly caused this report to be signed on its behalf by the undersigned thereto
duly authorized.
|
|
|
|
CAPITAL
GOLD CORPORATION
Registrant
|
|
|
|
|
By: |
/s/ Gifford A. Dieterle |
|
Gifford
A. Dieterle
President/Treasurer
|
Date:
December 19, 2006